{"filename":"783414_1995.txt","cik":"783414","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund XXIII, L.P., (the \"Partnership\"), formerly known as Southmark Realty Partners III, Ltd. was organized on March 4, 1985 as a limited partnership under the provisions of the California Uniform Limited Partnership Act to acquire and operate residential properties. 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 Southmark Investment Group 85, Inc. (the \"Original General Partner\"), a Nevada corporation and a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"). The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas 75240.\nOn February 25, 1986, the Partnership registered with the Securities and Exchange Commission (\"SEC\") under the Securities Act of 1933 (File No. 33-1620) and commenced a public offering for sale of $45,000,000 of limited partnership units. Two classes of limited partnership units were offered, designated as Current Income Units and Growth\/Shelter Units (referred to collectively as \"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 24, 1987, with 16,204,041 Units (9,461,580 Current Income Units and 6,742,461 Growth\/Shelter Units) sold at $1 each, or gross proceeds of $16,204,041. 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. 0-15459). In 1991, 76,000 Units were rescinded and in 1994, 20,000 Units were relinquished leaving 16,108,041 Units (9,419,080 Current Income Units and 6,688,961 Growth\/Shelter Units) outstanding at December 31, 1995. On January 1, 1996, pursuant to the Partnership's bankruptcy reorganization plan, the Partnership redeemed 4,450,311 Units for cash consideration equal to 1\/1,000th of a cent per Unit redeemed.\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 of 34 limited partnerships (including the Partnership) in the Southmark portfolio to McNeil or his affiliates.\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 and 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 limited partners approved a restructuring proposal that provided for (i) the replacement of the Original General Partner with a new general partner, McNeil Partners, L.P.; (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; (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 XXIII, L.P. Under the Amended Partnership Agreement, the Partnership began accruing an asset management fee, retroactive to February 14, 1991, which is payable to the new General Partner. For a discussion of the methodology for calculating the asset management fee, see Item 13 Certain Relationship and Related Transactions. The proposals approved at the March 30, 1992, meeting were implemented as of that date.\nConcurrent with the approval of the restructuring, the General Partner acquired from Southmark and its affiliates, for aggregate consideration of $350,466 (i) the right to receive payment on the advances owing from the Partnership to Southmark and its affiliates in the amount of $4,375,661, and (ii) the general partner interest of the Original General Partner. The General Partner owns in the aggregate less than 1% of the Units.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership is engaged in diversified real estate activities, including the ownership, operation and management of residential real estate. 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 investment portfolio of the Partnership at December 31, 1995. The buildings and the land on which the property is located are owned by the Partnership in fee, subject to a first lien deed of trust as described more fully in Item 8 - Note 6 - \"Mortgage Notes Payable.\" See also Item 8 - Note 5 - \"Real Estate Investment\" and Schedule III - \"Real Estate Investment and Accumulated Depreciation.\" In the opinion of management, the property is adequately covered by insurance.\n(1) Harbour Club II Apartments is owned by Beckley Associates which is 99.99% owned by the Partnership.\nThe following table sets forth the property's 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 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. No residential tenant leases 10% or more of the available rental space.\nCompetitive conditions - ----------------------\nHarbour Club II, located in Belleville, Michigan, was built in 1971 as a part of a four-phase apartment complex. The property offers a complete package of amenities including a golf course, clubhouse, exercise room, tanning beds, tennis courts, saunas, boat docks and launch, and playgrounds. The Belleville market has significantly rebounded to an average area occupancy rate of 95% and the property's closest competitor has rental rates approximately $100 per month above Harbour Club II's rates. Harbour Club II has had difficulty increasing rents for four years due to lack of capital improvements. Security concerns are prompting demands from tenants for improved lighting, limited access gates and fencing, as offered by competitors. The property has a large amount of deferred maintenance due to high debt service and is unable to generate cash to meet its capital improvement needs. Management is currently seeking alternatives to fund the needed capital improvements. The ability of the property to compete in the market will be directly determined by the amount of capital dollars spent to upgrade the property to community standards.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nExcept for the Partnership's Chapter 11 bankruptcy proceeding, the 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) Robert and Jeanette Kotowski, et al. v. Southmark Realty Partners III, Ltd. (presently known as McNeil Real Estate Fund XXIII, L.P.) and Southmark Investment Group 85, Inc. The plaintiffs sought rescission, pursuant to the Illinois Securities Act, of principal invested in McNeil Real Estate Fund XXIII, L.P. and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The defendants filed an answer denying all of the allegations set forth in the plaintiff's complaint. The defendants filed a motion to dismiss the case, and two out of the three counts were dismissed. The remaining count was limited to the plaintiffs who purchased the securities within three years of the date the suit was filed. In this regard, the Partnership agreed to rescind 76,000 Units and settled claims totaling $116,374. The claims consisted of the $76,000 original purchase price of the units plus $51,395 interest less distributions of $11,021 previously paid. The $64,979 original purchase price net of distributions paid was charged to limited partners' deficit in 1991 and accrued interest was charged to interest expense in 1993, 1992 and 1991. On September 15, 1992, the Partnership entered into an agreement with the plaintiffs whereby the Partnership agreed to pay the settled claims over 60 months at an interest rate of 8%, and pursuant to terms and conditions as outlined in the agreement. The Partnership made the first two payments due under the agreement; however, the October 1993 installment and both installments due during 1994 were not made due to the lack of funds available to the Partnership. An appeal had been filed by the plaintiffs who lost on the two dismissed counts. On November 30, 1992, the Court dismissed all but $116,374 of claims that had previously been agreed to by the Partnership. The plaintiffs presented, on February 3, 1995, their motion to file an amended consolidated class action complaint and, on February 15, 1995, their motion to certify a class. The Partnership's Reorganization Plan and Disclosure Statement were submitted February 20, 1995 to a vote of the impaired creditors, as defined. The plaintiffs filed objections to confirmation of the Partnership's First Amended Plan of Reorganization. On April 12, 1995, the Bankruptcy Court did grant the order to sell Woodbridge Apartments but denied confirmation of the Reorganization Plan. The Partnership filed an appeal of the Bankruptcy Court's ruling and, in the meantime, attempted to settle the matter with the plaintiffs, which would allow for confirmation of the Reorganization Plan. On May 10, 1995, the Reorganization Plan was amended to provide for full payment to the plaintiffs, including legal costs. The Reorganization Plan, as amended, was subsequently confirmed by the Bankruptcy Court on May 17, 1995, and on June 2, 1995, the Partnership paid $156,566 to the plaintiffs.\n2) Martha Hess, et al. v. Southmark Equity Partners II, Ltd., Southmark Income Investors, Ltd., Southmark Equity Partners, Ltd., Southmark Realty Partners III, Ltd. (presently known as McNeil Real Estate Fund XXIII, L.P.), and Southmark Realty Partners II, Ltd., et al. (\"Hess\"); Kotowski v. Southmark Equity Partners, Ltd. and Donald Arceri v. Southmark Income Investors, Ltd. These cases were previously pending in the Illinois Appellate Court for the First District (\"Appellate Court\"), as consolidated Case No. 90-107. Consolidated with these cases are an additional 14 matters against unrelated partnership entities. The Hess case was filed on May 20, 1988, by Martha Hess, individually and on behalf of a putative class of those similarly situated. The original, first, second and third amended complaints in Hess sought rescission, pursuant to the Illinois Securities Act, of over $2.7 million of principal invested in five Southmark (now McNeil) partnerships, and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The original, first, second and third amended complaints in Hess were dismissed against the defendant-group because the Appellate Court held that they were not the proper subject of a class action complaint. Hess was, thereafter, amended a fourth time to state causes of action against unrelated partnership entities. Hess went to judgment against that unrelated entity and the judgment, along with the prior dismissal of the class action, was appealed. The Hess appeal was decided by the Appellate Court during 1992. The Appellate Court affirmed the dismissal of the breach of fiduciary duty and consumer fraud claims. The Appellate Court did, however, reverse in part, holding that certain putative class members could file class action complaints against the defendant-group. Although leave to appeal to the Illinois Supreme Court was sought, the Illinois Supreme Court refused to hear the appeal.\nProceedings against the Partnership were stayed pursuant to the voluntary petition for reorganization filed by the Partnership on June 30, 1994. Plaintiffs have agreed that all claims against the Partnership have been fully satisfied in the bankruptcy. The Court has dismissed the Partnership as a party-defendant to the action.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNERSHIP AND - ------- ------------------------------------------------------------\nRELATED 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 948 as of February 16, 1996\n(C) No distributions were made to the partners during 1995 or 1994 and none are anticipated in 1996. 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 - Financial Statements and Supplemental Data.\nSee Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------- ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe accompanying financial statements have been prepared assuming the Partnership will continue as a going concern. The Partnership has suffered recurring losses from operations and has relied on advances from affiliates to meet its debt obligations and to fund capital improvements.\nThe Partnership's operating activities used $26,451 in 1995, as compared with $149,667 provided by and $14,579 used by operating activities in 1994 and 1993, respectively. The decrease in cash flow from operating activities is primarily due to $248,057 of reorganization costs paid by the Partnership in connection with its Chapter 11 bankruptcy filing. No such costs were paid in 1994. Also, due to the Partnership's Reorganization Plan, the Partnership was allowed to pay pre-petition claims in October 1995. Other changes in cash flows were primarily the result of the sale of Woodbridge Apartments on May 25, 1995 including decreases in cash received from tenants, cash paid to suppliers and property taxes paid.\nCash used for capital expenditures totaled $124,698 during 1995 as compared to $105,422 during 1994. Cash provided from the sale of Woodbridge Apartments totaled $3,078,096. $2,641,421 of the proceeds from the sale of Woodbridge Apartments were used to retire the mortgage notes secured by the property.\nIn the past, cash deficits from operating activities were partially funded through advances from affiliates of the General Partner. The Reorganization Plan, confirmed by the Bankruptcy Court on May 17, 1995, allowed for the discharge of $459,364 of advances from the General Partner and from various affiliates of the General Partner, as well as $88,429 of accrued interest related to such advances. The Reorganization Plan also provided for the discharge of $887,231 of reimbursable costs and asset management fees due to the General Partner. The discharge of debts due to the General Partner and its affiliates resulted in an extraordinary gain of $1,435,024.\nPrior to the restructuring of the Partnership, affiliates of the Original General Partner advanced funds to enable the Partnership to meet its working capital requirements. These advances (the \"Purchased Advances\") were purchased by, and were payable to, the General Partner. The Purchased Advances totaled $4,375,661 plus accrued interest of $704,482. Concurrent with the Partnership's Chapter 11 filing, the General Partner contributed the Purchased Advances to the Partnership.\nAt December 31, 1995, the Partnership held cash and cash equivalents of $233,222.\nShort-term liquidity:\nThe General Partner has established a revolving credit facility not to exceed $5,000,000 in the aggregate which is 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. As discussed above, the Partnership had received advances under the revolving credit facility to fund additions to the Partnership's real estate investments and costs incurred in connection with the refinancing of the Partnership's mortgage note payable. Such advances were discharged as a result of the Chapter 11 proceedings. There is no assurance that the Partnership will receive any additional funds under the facility because no amounts will be reserved 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 expires on March 30, 1997.\nAdditionally, the General Partner has, at its discretion, advanced funds to the Partnership in addition to the revolving credit facility. As discussed above, the Partnership received other advances that were used to fund working capital requirements. Such advances were discharged as a result of the Chapter 11 proceedings. The General Partner is not obligated to advance funds to the Partnership and there is no assurance that the Partnership will receive additional funds.\nAlthough the sale of Woodbridge Apartments provided some additional cash reserves for the Partnership, the Partnership still faces liquidity problems because of urgently needed capital improvements at Harbour Club II Apartments for which no financing has been secured. Operating activities at Harbour Club II Apartments for 1996 are expected to provide sufficient positive cash flow for normal operating expenses and debt service payments. However, the needed capital improvements will require the use of other sources of cash. No such sources have been identified. The Partnership has no established lines of credit from outside sources. Other possible actions to provide financing for the capital improvements may include refinancing or modifying the property's mortgage debt. Should such refinancing or modification of Harbour Club II's mortgage debt prove unfeasible, the Partnership could be forced to either sell the property or to relinquish control of the property to the mortgage note holder.\nLong-term liquidity:\nThe Partnership has been in a distressed cash situation for several years. Although Harbour Club II is able to operate in such a manner to provide for operating expenses and debt service payments, the property has not proven the capability to produce the cash flow necessary for capital improvements nor to support Partnership operations. The inability to make necessary capital improvements has led to deteriorating conditions at the property. In the opinion of management, if capital improvements are not made to make the property more marketable, the net realizable value of the property may be further impaired.\nHarbor Club II Apartments is part of a four-phase apartment complex located in Belleville, Michigan. Phases I and III of the complex are owned by partnerships in which the General Partner is the general partner; while Phase IV is owned by University Real Estate Fund 12, Ltd., (\"UREF 12\") whose general partner is an affiliate of Southmark. McREMI managed all four phases of the complex until December 1992, when the property management agreement between McREMI and UREF 12 was canceled. Additionally, in January 1993, Phase I defaulted on its United States Department of Housing and Urban Development (\"HUD\") mortgage note. Unless a refinancing agreement can be reached with the lender, the property is subject to foreclosure. If Phase I is lost to foreclosure, it would be extremely difficult to operate Phases II and III because the pool and clubhouse used by all three phases are located on Phase I. As of year end, no steps have been taken to foreclose on Phase I.\nThese conditions raise substantial doubt about the Partnership's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nDistributions - -------------\nTo maintain adequate cash balances of the Partnership, distributions to Current Income Unit holders were suspended in 1988. There have been no distributions to Growth\/Shelter Unit holders. Distributions to Unit holders will remain suspended for the foreseeable future. The General Partner will continue to monitor the cash reserves and working capital needs of the Partnership to determine when cash flows will support distributions to the Unit holders.\nFINANCIAL CONDITION - -------------------\nHarbour Club II Apartments was 92% occupied at the end of December 1995 as compared to 86% and 85% at the end of December 1994 and 1993, respectively. Harbour Club II was able to provide enough cash flow from operations to meet ordinary operating expenses as well as the debt service for its related mortgage during 1995; however, the property is in need of major capital repairs and improvements in order to compete in its local market. The Partnership is seeking alternatives to fund the necessary improvements, but at this time no sources have been found.\nUntil the Partnership is able to generate cash from operations or sales, the Partnership will be dependent on its present cash reserves, operation of its property, or financial support from affiliates. Distributions will remain suspended until cash reserves are judged adequate.\nRESULTS OF OPERATIONS - ---------------------\n1995 compared to 1994\nRevenue:\nRental revenue decreased $303,325 in 1995 compared to 1994 due to the sale of Woodbridge Apartments on May 25, 1995. However, rental revenue increased $118,455 or 9.9% at Harbour Club II Apartments as the Partnership was able to implement modest increases in base rental rates accompanied by increased occupancy. Total revenue increased $312,283 to $2,212,756 in 1995. The increased revenue was the result of a $554,047 gain related to the sale of Woodbridge Apartments and receipt of a $53,233 refund of property taxes due to a successful appeal of the property tax assessments on Harbour Club II Apartments.\nExpenses:\nTotal expenses decreased $1,167,721 during 1995 compared to 1994. Three one-time transactions affect the comparison. First, the 1994 expenses include a $661,921 write-down for permanent impairment of real estate related to Woodbridge Apartments. No such write-down was recorded in 1995. Second, the sale of Woodbridge Apartments on May 25, 1995 eliminated operating expenses for that property for seven months in 1995, whereas twelve months of operating expenses at Woodbridge Apartments are reported in the Partnership's 1994 Statement of Operations. Finally, the 1995 income statement includes a one-time charge of $257,303 for reorganization expenses related to the Partnership's Chapter 11 Bankruptcy filing. No such expenses were recorded in 1994. Expenses related to Harbour Club II Apartments decreased $67,911 or 5.0% in 1995 compared to 1994.\nFor comparability, the discussion of expenses to follow will generally exclude the consideration of expenses incurred at Woodbridge Apartments.\nProperty taxes assessed against Harbour Club II Apartments decreased $15,123 or 12.2% in 1995 compared to 1994. The Partnership succeeded in having the assessed value of Harbour Club II Apartments reduced for property tax purposes. Not only were current year property taxes reduced, the Partnership also received a $53,233 refund of prior year property taxes. The refund was recorded as an income item on the 1995 Statement of Operations.\nRepairs and maintenance expenses at Harbour Club II Apartments decreased $19,258 or 10.8% in 1995 compared to 1994. Expenses incurred for interior painting and replacement of appliances were the significant items that led to the decrease. These decreases were partially offset by increased expenses for grounds maintenance and security on the property.\nOther property operating expense incurred at Harbour Club II Apartments decreased $14,943 or 11.9% in 1995. Due to significant efforts by management, as well as an improving local economy, bad debt expenses, expenses for evictions and other legal and credit-related expenses were significantly reduced.\nGeneral and administrative - affiliates expense decreased $33,184 or 15.0% in 1995 compared to 1994. These expenses represent reimbursable expenses incurred by affiliates of the General Partner for administering the affairs of the Partnership. Such expenses are generally incurred based upon the proportion of properties owned by the Partnership to the total number of properties managed by the General Partner and its affiliates for the Partnership and other affiliated partnerships. The sale of Woodbridge Apartments reduced the costs allocated to the Partnership in 1995.\nInterest - affiliates decreased $186,321 during 1995 as compared to 1994. The discharge of affiliated advances resulting from the Partnership's Reorganization Plan also effectively reduced the interest charges on such debt.\nAll other expense line items (after eliminating expenses pertaining to Woodbridge Apartments), both individually and as a group, changed less than 8% in 1995 compared to 1994.\n1994 compared to 1993\nRevenue:\nTotal Partnership revenues decreased by $145,728 in 1994 as compared to 1993 primarily due to recording $133,369 of property tax refunds for Harbour Club II as income during 1993. No such refunds were recorded during 1994.\nExpenses:\nTotal expenses increased by $513,799 in 1994 as compared to 1993. The 1994 expenses include a $661,921 write-down for permanent impairment of Woodbridge Apartments.\nInterest expense - affiliates decreased $129,349 in 1994 as compared to 1993 due to the contribution of the Purchased Advances by the General Partner on June 30, 1994, as discussed in Liquidity and Capital Resources above.\nProperty tax expense decreased by $43,784 in 1994 as compared to 1993 due to the lower appraisal value at Harbour Club II Apartments following a successful tax appeal.\nRepairs and maintenance expense decreased by $34,932 in 1994 as compared to 1993. Both of the Partnership's properties had been operating in distressed financial conditions. As such, both properties had made cutbacks in service, cleaning and decorating expenses.\nProperty management fees decreased by $13,419 in 1994 as compared to 1993. During 1993, the Partnership received approval of HUD, the co-insurer of the mortgage on the property, to change property management fees of Harbour Club II Apartments from 4.25% to 5% retroactive to May 30, 1991. An additional $18,562 in property management fees were accrued in 1993 due to this change.\nOther property operating expenses increased $61,187 in 1994 as compared to 1993. Due to the lack of funds available to maintain marketability, the Partnership's properties have had difficulty attracting higher profile tenants. As a result, bad debt expense and professional fees related to eviction of tenants have increased.\nGeneral and administrative expense decreased $20,798 in 1994 as compared to 1993 primarily due to a decrease in tax preparation fees.\nAll other expenses in 1994 were comparable to 1993.\nITEM 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 XXIII, L.P.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund XXIII, L.P. (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 XXIII, 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.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 8 to the financial statements, the Partnership has suffered recurring losses from operations and the Partnership's only property is in need of major capital improvements in order to maintain occupancy and rental rates at a level to continue to support operations and debt service. Additionally, the property is part of a four phase complex. Phase I of the complex defaulted on the mortgage loan to the United States Department of Housing and Urban Development in January 1993. Phase I is subject to foreclosure unless a refinancing agreement can be reached with the lender. If Phase I is lost to foreclosure, it would have a significant impact on the operations of Phase II, owned by the Partnership, as the pool and clubhouse are located in Phase I. As of year end, no steps have been taken towards the foreclosure of Phase I. Management's plans in regard to these matters are also described in Note 8. These conditions raise substantial doubt about the Partnership's ability to continue as a going concern. 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 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 Anderson LLP\nDallas, Texas March 13, 1996\nMcNEIL REAL ESTATE FUND XXIII, L.P.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIII, L.P.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIII, 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 XXIII, L.P.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee discussion of noncash investing and financing activities in Note 3 - Transactions with Affiliates.\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIII, L.P.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Income (Loss) to Net Cash Provided by (Used in) Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIII, L.P.\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------\nOrganization - ------------\nMcNeil Real Estate Fund XXIII, L.P. (the \"Partnership\"), formerly known as Southmark Realty Partners III, Ltd., was organized on March 4, 1985 as a limited partnership under the provisions of the California Revised Limited Partnership Act to acquire and operate residential properties. 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 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 Southmark Investment Group 85, Inc. (the \"Original General Partner\"), a Nevada corporation and a wholly-owned subsidiary of Southmark Corporation. 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 5 - Real Estate Investment.\nChapter 11 Reorganization - -------------------------\nOn June 30, 1994, the Partnership filed a voluntary petition for protection under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"). The Partnership filed its First Amended Plan of Reorganization (the \"Reorganization Plan\") with the United States Bankruptcy Court - Northern District of Texas, Dallas Division (the \"Bankruptcy Court\"), on February 13, 1995. The Partnership conducted its affairs as a debtor-in-possession until the Reorganization Plan was confirmed by the Bankruptcy Court on May 17, 1995. Pursuant to the Reorganization Plan, the Partnership sold its interest in Woodbridge Apartments to an unaffiliated buyer on May 25, 1995. The Partnership used the proceeds from the sale of Woodbridge Apartments to satisfy all pre-petition liabilities of the Partnership that were not otherwise discharged by the Bankruptcy Court. See Note 2 - \"Chapter 11 Reorganization.\"\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 Beckley Associates (\"Beckley\"), a single asset limited partnership formed to accommodate the refinancing of Harbour Club II Apartments. The Partnership is the general partner of Beckley, and holds a 99.99% interest in Beckley. The Partnership exercises effective control of Beckley. The minority interest is not presented as it is both negative and immaterial.\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 5 to 25 years.\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. Cash and cash equivalents at December 31, 1994, also included cash balances of $79,303 which were restricted by the Bankruptcy Court. 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.\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 mortgage notes payable is included in interest expense on the Statements of Operations.\nRental Revenue - --------------\nThe Partnership leases its residential property 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 generally provides that net income (other than net income arising from sales or refinancing) shall be allocated one percent (1%) to the General Partner and ninety-nine percent (99%) to the limited partners equally as a group, and net loss shall be allocated one percent (1%) to the General Partner, nine percent (9%) to the limited partners owning Current Income Units and ninety percent (90%) to the limited partners owning Growth\/Shelter Units.\nFor financial statement purposes, net income arising from sales or refinancing shall be allocated one percent (1%) to the General Partner and ninety-nine percent (99%) to the limited partners equally as a group.\nFor tax reporting purposes, net income arising from sales or refinancing shall be allocated as follows: (a) first, amounts of such net income shall be allocated among the General Partner and limited partners in proportion to, and to the extent of, the portion of such partner's share of the net decrease in Partnership Minimum Gain determined under Treasury Regulations, (b) second, to the General Partner and limited partners in proportion to, and to the extent of, the amount by which their respective capital account balances are negative by more than their respective remaining shares of the Partnership's Minimum Gain attributable to property still owned by the Partnership and (c) third, 1% of such net income shall be allocated to the General Partner and 99% of such net income shall be allocated 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 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, distributable cash (other than cash from sales or refinancing) shall be distributed 100% to the limited partners, with such distributions first paying the Current Income Priority Return and then the Growth\/Shelter Priority Return. Also at the discretion of the General Partner, the limited partners will receive 100% of distributable cash from sales or refinancing with such distributions first paying the Current Income Priority Return, then the Growth\/Shelter Priority Return, then repayment of Original Invested Capital, and of the remainder, 5.88% to limited partners owning Current Income Units and 94.12% to limited partners owning Growth\/Shelter Units. The limited partners' Current Income and Growth\/Shelter Priority Returns represent a 10% and 8%, respectively, cumulative return on their Adjusted Invested Capital balance, as defined. No distributions of Current Income Priority Return have been made since 1988, and no distributions of Growth\/Shelter Priority Return have been made since the Partnership began.\nIn connection with a Terminating Disposition, as defined, cash from sales or refinancing and any remaining reserves shall be allocated among, and distributed to, the General Partner and limited partners in proportion to, and to the extent of, their positive capital account balances after the net income has been allocated pursuant to the above.\nNet Income (Loss) Per Thousand Limited Partnership Units - --------------------------------------------------------\nNet income (loss) per thousand limited partner Current Income and Growth\/Shelter units (\"Units\") is computed by dividing net income (losses) allocated to the limited partners by the weighted average number of Units outstanding expressed in thousands. Per thousand Unit information has been computed based on 9,419 weighted average Current Income Units (in thousands) outstanding in 1995, 1994, and 1993, and 6,689, 6,689 and 6,709 weighted average Growth\/Shelter Units outstanding in 1995, 1994, and 1993, respectively.\nNOTE 2 - CHAPTER 11 REORGANIZATION - ----------------------------------\nOn June 30, 1994, the Partnership, excluding Beckley, filed a voluntary petition for Chapter 11 reorganization. The Partnership continued to conduct its affairs as a debtor-in-possession, subject to the jurisdiction and supervision of the Bankruptcy Court. Concurrent with the Chapter 11 filing, the General Partner contributed to the Partnership $4,375,661 of advances and $704,482 of accrued interest on advances that were payable by the Partnership to the General Partner. See Note 3 - Transactions with Affiliates.\nWoodbridge Apartments, one of the Partnership's properties, was encumbered by two mortgage notes payable. The first lien mortgage note payable was co-insured by the Federal Housing Administration and was, therefore, regulated by the United States Department of Housing and Urban Development (\"HUD\"). The second lien mortgage note payable was payable in monthly installments of interest only. Such payments were limited to \"surplus cash,\" as defined by HUD and as calculated at June 30 and December 31 of each year. No \"surplus cash\" was available to make the interest payments on the second lien, and therefore, the Partnership ceased making such payments in April 1994. The Partnership was unsuccessful in attempting to negotiate a restructuring of the mortgage, and the second lienholder was expected to initiate foreclosure proceedings. The Chapter 11 proceeding was filed to prevent the foreclosure actions.\nThe Partnership's First Amended Plan of Reorganization (the \"Reorganization Plan\"), which contemplated a sale of Woodbridge Apartments, was submitted to the Bankruptcy Court on February 13, 1995. The Partnership's Disclosure Statement of Debtor-in-Possession (the \"Disclosure Statement\") was approved by the Bankruptcy Court on February 14, 1995.\nThe Partnership's Reorganization Plan and Disclosure Statement were submitted February 20, 1995, to a vote of the impaired creditors, as defined. The impaired creditors included a class of creditors who had filed a judgment lien against Woodbridge Apartments in connection with the Illinois rescission suit (See Note 9 - Legal Proceedings). The judgment lien creditors filed objections to confirmation of the Reorganization Plan. On April 18, 1995, the Bankruptcy Court did grant an order to sell Woodbridge Apartments but denied confirmation of the Reorganization Plan. The Partnership filed an appeal of the Bankruptcy Court's ruling and, in the meantime, attempted to settle the matter with the judgment lien creditors, which would allow for confirmation of the Reorganization Plan. On May 10, 1995, the Reorganization Plan was amended to provide for full payment to the judgment lien creditors. The Reorganization Plan, as amended, was subsequently confirmed by the Bankruptcy Court on May 17, 1995.\nWoodbridge Apartments was sold on May 25, 1995, and, in accordance with the Reorganization Plan, the first and second mortgage notes payable and the related outstanding accrued interest were paid. The Partnership also utilized $156,566 of the proceeds from the sale to pay the settlement and legal fees to the judgment lien creditors, as discussed above.\nOn September 11, 1995, the Bankruptcy Court entered an Order Regarding Objections to Claims that allowed the Partnership to pay outstanding pre-petition claims totaling approximately $12,000 in October 1995.\nAs outlined in the Reorganization Plan, any payments of advances and fees owed to affiliates of the General Partner were limited to remaining cash, after the pre-petition and reorganization related costs were paid. The Partnership had $37,228 of such cash available to distribute to affiliate creditors. The remaining amounts owed to affiliates of the General Partner as of May 17, 1995 were discharged resulting in an extraordinary gain of $1,435,024.\nOn August 15, 1995, the Partnership sent an election form to each limited partner which allowed them to choose whether to redeem their interest in the Partnership. The redemption price was 1\/1000th of a cent per Unit. The limited partners were required to respond within 30 days, and at the close of the 30 day period, 310 limited partners had elected to redeem 4,450,311 Units. In connection with the redemption, the partnership obtained a \"no-action\" letter from the Securities and Exchange Commission (\"SEC\") that provided that (1) the redemption could be accomplished without compliance with Rule 13e-3 of the Securities Exchange Act of 1934, and (2) the SEC did not intend to pursue an enforcement action if the Reorganization Plan was consummated. Redemption of the affected Units was completed on January 1, 1996.\nOn November 18, 1995, the Partnership submitted to the Bankruptcy Court a request for an Application to Close Case, which was entered on December 11, 1995. The Partnership was awaiting confirmation of the Order Approving the Application to Close Case as of March 13, 1996.\nExpenses incurred by the Partnership in connection with its Chapter 11 filing have been expensed as \"reorganization expenses\" in the accompanying Statements of Operations. Interest earned on funds restricted by the Bankruptcy Court are presented as \"interest on reorganization funds\" in the Statements of Operations.\nThe Partnership's financial statements include the accounts of Beckley, which owns Harbour Club II Apartments. Beckley was not included in the bankruptcy filing. Summarized below is a statement of assets, liabilities and partners' deficit of the portion of the Partnership included in the Chapter 11 filing as of December 31, 1994. No such statement is presented as of December 31, 1995, as the Partnership is effectively no longer subject to the Chapter 11 proceedings. The assets, liabilities and partners' equity pertaining to Beckley, which were not included in the Chapter 11 filing, are excluded.\nSummarized on the next page are statements of operations for that portion of the Partnership included in the Chapter 11 filing for the period from the June 30, 1994 filing date through December 31, 1994 and for the period from January 1, 1995 through December 11, 1995, the date that the Partnership requested the Bankruptcy Court dismiss the bankruptcy filing. The revenues and expenses pertaining to Beckley, which were excluded from the bankruptcy filing, are excluded.\nNOTE 3 - TRANSACTIONS WITH AFFILIATES - -------------------------------------\nThe Partnership pays property management fees equal to 5% of the Partnership's gross rental receipts to McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of the General Partner, for providing property management and leasing services for the Partnership's residential properties. The Partnership received approval from HUD to increase the property management fees of Harbour Club II Apartments from 4.25% to 5% of the property's gross rental receipts retroactive to May 30, 1991. An additional $18,562 of property management fees were accrued in 1993 due to this change. The Bankruptcy Court required that the property management fees for Woodbridge Apartments be reduced to 3% of the property's gross rental receipts for the period from December 1, 1994 until May 25, 1995, the date the Partnership sold Woodbridge Apartments.\nThe Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs. Reimbursable costs that were incurred prior to the Partnership's bankruptcy filing, in the amount of $520,902, were discharged under terms of the Partnership's Reorganization Plan.\nUnder the terms of the Amended Partnership Agreement, the Partnership incurs an asset management fee payable 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% to the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit for each 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. The fee percentage decreases subsequent to 1999. Asset management fees that were incurred but unpaid prior to the Partnership's bankruptcy filing, in the amount of $366,329, were discharged under terms of the Partnership's Reorganization Plan.\nCompensation and reimbursements paid to or accrued for the benefit of the General Partner or its affiliates are as follows:\nPrior to 1992, affiliates of the Original General Partner advanced funds (the \"Purchased Advances\") to enable the Partnership to meet its working capital requirements. The Purchased Advances were purchased by, and were payable to, the General Partner. Concurrent with the Partnership's bankruptcy filing, the General Partner contributed the Purchased Advances to the Partnership. The Purchased Advances contributed to the Partnership totaled $4,375,661 plus accrued interest of $704,482.\nThe General Partner has established a revolving credit facility not to exceed $5,000,000 in the aggregate which is 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. The Partnership had received advances under the revolving credit facility to fund additions to the Partnership's real estate investments and costs incurred in connection with the refinancing of the Partnership's mortgage notes payable. There is no assurance that the Partnership will receive any additional funds under the facility because no amounts will be reserved 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. The balance of the Partnership's outstanding loans under terms of the revolving credit facility, in the amount of $65,670 together with $6,696 of accrued interest thereon, were discharged under terms of the Partnership's Reorganization Plan.\nAdditionally, the General Partner has, at its discretion, advanced funds to the Partnership in addition to the revolving credit facility to fund working capital requirements of the Partnership. The General Partner is not obligated to advance funds to the Partnership and there is no assurance that the Partnership will receive additional funds. The Partnership's other advances from the General Partner, in the amount of $280,694 together with $49,090 of accrued interest thereon, were discharged under terms of the Partnership's Reorganization Plan.\nDuring 1992, the Partnership received an unsecured loan of $113,000 for working capital requirements from McNeil Real Estate Fund XXV, L.P. (\"Fund XXV\"). Fund XXV owns Phase I of the Harbour Club Apartments (the Partnership owns Phase II of Harbour Club Apartments), and is affiliated with the General Partner. The $113,000 unsecured loan due to Fund XXV, together with $32,643 of accrued interest thereon, was discharged under terms of the Partnership's Reorganization Plan.\nAdvances from affiliates at December 31, 1995 and 1994, consist of the following:\nThe advances were unsecured, due on demand and accrued interest at the prime lending rate of Bank of America plus 1%. The prime lending rate of Bank of America was 8.5% at December 31, 1994.\nPayable to affiliates - General Partner at December 31, 1995 and 1994, consists of property management fees, reimbursable costs and asset management fees that are due and payable from current operations.\nNOTE 4 - TAXABLE INCOME (LOSS) - ------------------------------\nMcNeil Real Estate Fund XXIII, 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 tax reporting purposes exceeded the net assets and liabilities for financial purposes by $2,256,527, $2,787,669 and $3,539,334 at December 31, 1995, 1994 and 1993, respectively.\nNOTE 5 - REAL ESTATE INVESTMENT - -------------------------------\nThe basis and accumulated depreciation of the Partnership's real estate investment at December 31, 1995 and 1994, are set forth in the following tables:\nThe Partnership's real estate investment is encumbered by a mortgage note as discussed in Note 6 - \"Mortgage Notes Payable.\"\nDuring 1994, the General Partner placed Woodbridge Apartments on the market for sale. Woodbridge Apartments was sold on May 25, 1995. See Note 7 - \"Disposition of Real Estate.\" Woodbridge Apartments is classified as an asset held for sale at December 31, 1994.\nNOTE 6 - 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 discount for Harbour Club II mortgage note is based on an effective interest rate of 9.13%.\n(c) As discussed in Note 2 - \"Chapter 11 Reorganization,\" the mortgage note payable was fully secured by Woodbridge Apartments. The cash collateral order permitted payments on the mortgage note to the extent of excess cash.\n(d) Discounts for the Woodbridge mortgage notes were based on effective interest rates of 9%.\n(e) The mortgage note payable was fully secured by Woodbridge Apartments. Payments on the second mortgage note were limited to surplus cash as defined by HUD. See Note 2 - \"Chapter 11 Reorganization.\" There was no surplus cash available to make these interest payments. In 1994, the Partnership ceased making debt service payments, which constituted a default under the mortgage note agreement. In May 1994, the holder of the second mortgage note accelerated the interest rate on the second mortgage note to 12% in accordance with the mortgage note agreement.\nScheduled principal maturities of the mortgage note under the existing agreement, excluding the $603,508 discount, are as follows:\n1996 .............................................. $ 46,259 1997 .............................................. 49,851 1998 .............................................. 53,721 1999 .............................................. 57,891 2000 .............................................. 62,385 Thereafter ........................................ 4,121,203 ---------\nTotal $4,391,310 =========\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 $4,112,000 at December 31, 1995.\nNOTE 7 - DISPOSITION OF REAL ESTATE - -----------------------------------\nOn May 25, 1995, the Partnership sold Woodbridge Apartments to an unrelated third party for a cash purchase price of $3,200,000. Cash proceeds from the sale, as well as the gain on disposition of Woodbridge Apartments, are shown below:\nNOTE 8 - FINANCIAL CONDITION AND GOING CONCERN CONSIDERATIONS - -------------------------------------------------------------\nThe accompanying financial statements have been prepared assuming the Partnership will continue as a going concern. The Partnership had suffered recurring losses from operations and has relied on advances from affiliates to meet its debt obligations and to fund capital improvements.\nOperations at Harbour Club II, the Partnership's sole remaining property, are expected to be sufficient to provide cash for operating expenses and debt service for 1996. However, the property is in need of major capital improvements in order to maintain occupancy and rental rates at a level sufficient to fund operating expenses and debt service in future years. The Partnership's cash reserves are inadequate to fund the needed capital improvements, and it is unlikely that cash flow from operating activities will be sufficient to provide for the needed capital improvements. No outside sources of financing have been identified. Although affiliates of the Partnership have previously provided working capital for the Partnership, there can be no assurance that the Partnership will receive additional funds from the General Partner or other affiliates. Management is currently seeking additional financing to fund the needed capital improvements; however, such financing is not assured. If the property is unable to obtain additional funds and cannot maintain operations at a level to pay operating expenses and debt service, the property may ultimately be foreclosed on by the lender.\nHarbour Club II is part of a four-phase apartment complex located in Belleville, Michigan. Phases I and III of the complex are owned by partnerships in which McNeil Partners, L.P. is the general partner; while Phase IV is owned by University Real Estate Fund 12, Ltd., (\"UREF 12\") whose general partner is an affiliate of Southmark. McREMI had been managing all four phases of the complex until December 1992, when the property management agreement between McREMI and UREF 12 was canceled. Additionally, in January 1993, Phase I defaulted on its mortgage loan to the United States Department of Housing and Urban Development (\"HUD\") and, unless a refinancing agreement can be reached with the lender, the property is subject to foreclosure. If Phase I is lost to foreclosure, it would be extremely difficult to operate Phases II and III because the pool and clubhouse are located in Phase I. As of year end, no steps have been taken towards the foreclosure of Phase I.\nThese conditions raise substantial doubt about the Partnership's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nNOTE 9 - LEGAL PROCEEDINGS - --------------------------\nExcept for the Partnership's Chapter 11 bankruptcy proceeding, the 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) Robert and Jeanette Kotowski, et al. v. Southmark Realty Partners III, Ltd. (presently known as McNeil Real Estate Fund XXIII, L.P.) and Southmark Investment Group 85, Inc. The plaintiffs sought rescission, pursuant to the Illinois Securities Act, of principal invested in McNeil Real Estate Fund XXIII, L.P. and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The defendants filed an answer denying all of the allegations set forth in the plaintiff's complaint. The defendants filed a motion to dismiss the case, and two out of the three counts were dismissed. The remaining count was limited to the plaintiffs who purchased the securities within three years of the date the suit was filed. In this regard, the Partnership agreed to rescind 76,000 Units and settled claims totaling $116,374. The claims consisted of the $76,000 original purchase price of the units plus $51,395 interest less distributions of $11,021 previously paid. The $64,979 original purchase price net of distributions paid was charged to limited partners' deficit in 1991 and accrued interest was charged to interest expense in 1993, 1992 and 1991. On September 15, 1992, the Partnership entered into an agreement with the plaintiffs whereby the Partnership agreed to pay the settled claims over 60 months at an interest rate of 8%, and pursuant to terms and conditions as outlined in the agreement. The Partnership made the first two payments due under the agreement; however, the October 1993 installment and both installments due during 1994 were not made due to the lack of funds available to the Partnership. An appeal had been filed by the plaintiffs who lost on the two dismissed counts. On November 30, 1992, the Court dismissed all but $116,374 of claims that had previously been agreed to by the Partnership. The plaintiffs presented, on February 3, 1995, their motion to file an amended consolidated class action complaint and, on February 15, 1995, their motion to certify a class. The Partnership's Reorganization Plan and Disclosure Statement were submitted February 20, 1995, to a vote of the impaired creditors, as defined. The plaintiffs filed objections to confirmation of the Partnership's First Amended Plan of Reorganization. On April 12, 1995, the Bankruptcy Court did grant the order to sell Woodbridge Apartments but denied confirmation of the Reorganization Plan. The Partnership filed an appeal of the Court's ruling and, in the meantime, attempted to settle the matter with the plaintiffs which would allow for confirmation of the Reorganization Plan. On May 10, 1995, the Reorganization Plan was amended to provide for full payment to the plaintiffs, including legal costs. The Reorganization Plan, as amended, was subsequently confirmed by the Bankruptcy Court on May 17, 1995, and on June 2, 1995, the Partnership paid $156,566 to the plaintiffs.\n2) Martha Hess, et al. v. Southmark Equity Partners II, Ltd., Southmark Income Investors, Ltd., Southmark Equity Partners, Ltd., Southmark Realty Partners III, Ltd. (presently known as McNeil Real Estate Fund XXIII, L.P.), and Southmark Realty Partners II, Ltd., et al. (\"Hess\"); Kotowski v. Southmark Equity Partners, Ltd. and Donald Arceri v. Southmark Income Investors, Ltd. These cases were previously pending in the Illinois Appellate Court for the First District (\"Appellate Court\"), as consolidated Case No. 90-107. Consolidated with these cases are an additional 14 matters against unrelated partnership entities. The Hess case was filed on May 20, 1988, by Martha Hess, individually and on behalf of a putative class of those similarly situated. The original, first, second and third amended complaints in Hess sought rescission, pursuant to the Illinois Securities Act, of over $2.7 million of principal invested in five Southmark (now McNeil) partnerships, and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The original, first, second and third amended complaints in Hess were dismissed against the defendant-group because the Appellate Court held that they were not the proper subject of a class action complaint. Hess was, thereafter, amended a fourth time to state causes of action against unrelated partnership entities. Hess went to judgment against that unrelated entity and the judgment, along with the prior dismissal of the class action, was appealed. The Hess appeal was decided by the Appellate Court during 1992. The Appellate Court affirmed the dismissal of the breach of fiduciary duty and consumer fraud claims. The Appellate Court did, however, reverse in part, holding that certain putative class members could file class action complaints against the defendant-group. Although leave to appeal to the Illinois Supreme Court was sought, the Illinois Supreme Court refused to hear the appeal.\nProceedings against the Partnership were stayed pursuant to the voluntary petition for reorganization filed by the Partnership on June 30, 1994. Plaintiffs have agreed that all claims against the Partnership have been fully satisfied in the bankruptcy. The Court has dismissed the Partnership as a party-defendant to the action.\nNOTE 10 - PRO FORMA DISCLOSURE - ------------------------------\nThe following pro forma information for the years ended December 31, 1995 and 1994, reflects the results of operations of the Partnership as if the sale of Woodbridge Apartments had occurred as of January 1, 1994. The pro forma information is not necessarily indicative of the results of operations that actually would have occurred or those which might be expected to occur in the future.\nMcNEIL REAL ESTATE FUND XXIII, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXIII, 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 approximately $8,786,061 and accumulated depreciation was $5,016,189 at 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.\n(c) The carrying value of Harbour Club II apartments was reduced by $1,783,702 in 1992 and $320,588 in 1989.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXIII, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nMCNEIL REAL ESTATE FUND XXIII, L.P.\nNotes to Schedule III\nReal Estate Investments and Accumulated Depreciation\nA summary of activity for the Partnership's 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 - -------- -------------------------------------------------- Neither 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 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 registrant is the beneficial owner of more than 5 percent of the Partnership's Units.\n(B) Security ownership of management.\nThe General Partner owns 5,000 limited partnership units, which represents 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 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% to the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit 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 $83,631 of such asset management fees. Total accrued but unpaid asset management fees of $52,316 were outstanding at December 31, 1995. Asset management fees that were incurred but unpaid prior to the Partnership's Chapter 11 filing, in the amount of $366,329, were discharged under terms of the Partnership's Reorganization Plan.\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of its residential properties to McREMI, an affiliate of the General Partner, for providing property management services. Due to the bankruptcy proceedings, the property management fees paid by Woodbridge Apartments were reduced to 3% beginning December 1, 1994. 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 $177,929 of such property management fees and reimbursements. Reimbursable costs that were incurred prior to the Partnership's Chapter 11 filing, in the amount of $520,902, were discharged under terms of the Partnership's Reorganization Plan.\nThe General Partner has established a revolving credit facility not to exceed $5,000,000 in the aggregate which is 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. As of December 31, 1994, the Partnership borrowed $65,670 under this revolving credit facility. In addition to the revolving credit facility, the General Partner had advanced funds to the Partnership in the amount of $280,694. In 1992, the Partnership also received an unsecured loan of $113,000 from McNeil Real Estate Funds XXV, L.P., an affiliate of the General Partner that owns a Phase I of Harbour Club Apartments. The advances from the General Partner and the Fund XXV loan (the \"affiliate advances\") were unsecured and due on demand, and accrued interest at a rate equal to the prime lending rate of Bank of America plus 1%. The affiliate advances, together with $88,438 of accrued interest thereon, were discharged under terms of the Partnership's Reorganization Plan. See Item 1 - Business, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 - Note 3 - \"Transactions with Affiliates.\"\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS ON FORM 8-K\nSee accompanying Index to Financial Statements at Item 8.\n(A) Exhibits --------\nExhibit Number Description ------ -----------\n4. Amended and Restated Limited Partnership Agreement dated March 30, 1992. (Incorporated by reference to the Current Report of the Registrant on Form 8-K dated March 30, 1992, as filed on April 10, 1992).\n10.2 Portfolio Services Agreement dated February 14, 1991, between Southmark Realty Partners III, Ltd. and McNeil Real Estate Management, Inc. (1)\n10.3 Modification of Note and Mortgage dated May 1, 1984, between Knoblinks Associates II and Samuel R. Pierce, Jr., as Secretary of Housing and Urban Development relating to Harbour Club II. (1)\n10.4 Property Management Agreement dated March 30, 1992, between McNeil Real Estate Fund XXIII, L.P. and McNeil Real Estate Management, Inc. (2)\n10.5 Amendment of Property Management Agreement dated March 5, 1993. (2)\n10.6 Revolving Credit Agreement dated August 6, 1991, between McNeil Partners, L.P. and various selected partnerships, including the Registrant. (3)\n10.7 Property Management Agreement dated March 30, 1992 between Beckley Associates and McNeil Real Estate Management, Inc. (3)\n10.8 Disclosure Statement of Debtor-in-Possession pursuant to Section 1125 of the Bankruptcy Code.(4)\n10.9 Debtor's First Amended Plan of Reorganization (as Modified), dated February 13, 1995.\n10.10 Order Confirming Plan, dated May 17, 1995.\n11. Statement regarding computation of Net Loss per Limited Partnership Unit (see Note 1 to Financial Statements appearing in Item 8).\n22. Following is a list of subsidiaries of the Partnership:\nThe Partnership has omitted certain documents pertaining to the Partnership's Chapter 11 filing and other 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(1) Incorporated by reference to the Quarterly Report of the registrant, on Form 10-Q for the period ended March 31, 1991, as filed on May 14, 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(3) 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.\n(4) Incorporated by reference to the Annual Report of the registrant, on Form 10-K for the period ended December 31, 1994, as filed on March 30, 1995.\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 XXIII, L.P.\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":"714530_1995.txt","cik":"714530","year":"1995","section_1":"Item 1. Business\nREGISTRANT\nLSB Bancshares, Inc. (\"Bancshares'\") is a bank holding company headquartered in Lexington, North Carolina and registered under the Bank Holding Company Act of 1956, as amended. Bancshares' principal business is providing banking and other financial services through its banking subsidiary. It was incorporated on July 1, 1983. Bancshares is the parent holding company of Lexington State Bank (\"LSB\"), a North Carolina-chartered commercial bank. The principal assets of Bancshares are all of the outstanding shares of common stock of LSB. At December 31, 1995, Bancshares and its subsidiary had consolidated assets of $375 million and 250 employees.\nSUBSIDIARY BANK\nLSB is chartered under the laws of the state of North Carolina to engage in general banking business. Founded in 1949, LSB offers a complete array of services in the commercial banking, savings and trust fields through 14 offices in six communities located in Davidson County, North Carolina. LSB provides a full range of financial services including the acceptance of deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions. LSB operates the only independent trust department in Davidson County, providing estate planning, estate and trust administration, IRA trusts, personal investment accounts and pension and profit-sharing trusts.\nNON-BANK SUBSIDIARIES\nLSB has two wholly-owned non-bank subsidiaries: Peoples Finance Company of Lexington, Inc. (\"Peoples Finance\") and LSB Financial Services, Inc. (\"LSB Financial Services\"). Peoples Finance was acquired by LSB on January 1, 1984 and operates as a finance company licensed under the laws of the State of North Carolina. Peoples Finance operates from one office located in Lexington, North Carolina with four employees. As a finance company, Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000, as well as dealer originated loans.\nLSB Financial Services is incorporated under the laws of the State of North Carolina and offers a full range of uninsured, nondeposit investment products, including mutual funds, annuities, stocks and bonds. LSB Financial Services operates from offices located within LSB's main office with two employees. LSB Financial Services offers products through Liberty Securities Corporation, an independent broker-dealer, which is a member of the National Association of Securities Dealers and the Securities Investor Protection Corporation. Investments are neither deposits nor obligations of Lexington State Bank, nor are they guaranteed or insured by any depository institution, the FDIC, or any other government agency. LSB Financial Services began operation on December 1, 1994 and during 1995 lost approximately $78,000.\nCOMPETITION\nCommercial banking in LSB's service area of Davidson County, North Carolina is highly competitive. LSB competes not only with major commercial banks but also with thrift institutions, credit unions, investment brokers, mortgage and finance companies. North Carolina permits state-\nwide branching, which is widely practiced. In recent years, competition between large major banks and smaller independent banks has intensified significantly as a result of deregulation of the financial industry. In addition to in-state competition, banks such as LSB have a high degree of competition from out-of-state financial service companies offering mutual funds.\nAfter several years of exceptional employment growth in North Carolina, the North Carolina Employment Security Commission projects the State's economy to remain sound in 1996, with low unemployment and low inflation. North Carolina's unemployment rate has remained at or near the lowest of the 11 large states surveyed by the Federal Government. Davidson County, with a labor force of approximately 75,000, had an unemployment rate in the 3.5% range for 1995.\nREGULATION\nAs a bank holding company, Bancshares is subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System. LSB is chartered by the Sate of North Carolina and as such is subject to supervision, examination and regulation by the North Carolina State Banking Commission. LSB is also a member of the Federal Deposit Insurance Corporation and is therefore subject to supervision and examination by that agency.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nPROPERTIES\nBancshares' principal executive offices are located at One LSB Plaza, Lexington, North Carolina. This five-story office building totals 74,800 square feet and also serves as the home office of LSB. A majority of the major staff functions are located within this office complex.\nIn addition, LSB operates thirteen branch offices and four off-premise automated teller locations. Six of LSB's branch offices are located within Lexington. The remaining branch offices are located in the communities of Thomasville, Welcome, Midway, Arcadia and Wallburg, all of which are located within Davidson County, North Carolina.\nBancshares' principal office and seven branches are owned by LSB, while six branches and the off-premise ATM locations are leased. LSB's leased properties are subject to leases which expire on various dates from January 31, 1996 to June 30, 2004. Peoples Finance operates from an 1,800 square foot, one-story building located at 203 Center Street in Lexington, which it owns. LSB Financial Services leases 800 square feet within the principal office building of LSB. Except as described herein, Bancshares, LSB, Peoples Finance and LSB Financial Services own all properties free and clear of encumbrances.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information required under this item is contained in Note 9 to the Notes to Consolidated Financial Statements on page 30 of the 1995 Annual Report and is 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 during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nRobert F. Lowe (53) Chairman, President and Chief Executive Officer and a Director of Bancshares and the Bank. Prior to becoming President on January 1, 1984, Mr. Lowe had served as Executive Vice President of Bancshares and of the Bank. Mr. Lowe joined the Bank in 1970 and was elected Vice President in 1973. He was elected Senior Vice President in 1980 and Executive Vice President in 1982. In 1983, he was elected a Director. Mr. Lowe is also President of Peoples Finance Company of Lexington, Inc., which is a subsidiary of the Bank and President and a director of LSB Financial Services, Inc., a subsidiary of the Bank.\nH. Franklin Sherron, Jr. (40) Vice President and Assistant Secretary of Bancshares joined the Bank in 1990 as Senior Vice President. Prior to this, he served as President of J. J. Barnes, Inc., a mechanical contracting firm, from 1981 to 1990. From 1997 to 1981, he served as Assistant Cashier with Peoples Bank & Trust Company.\nRonald J. Meadley (62) Vice President and Assistant Secretary of Bancshares joined the Bank as Vice President in 1979, with 24 years of banking experience. He was elected Senior Vice President in 1986.\nMonty J. Oliver (54) Secretary and Treasurer of Bancshares joined the Bank as Vice President in 1978, with 13 years of banking experience. He was elected Cashier of the Bank in 1980 and Vice President and Treasurer of Bancshares in 1983. In 1986, he was elected Senior Vice President of the Bank.\nPART II.\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe information regarding the market price of the Company's Common Stock and related stockholder matters is set forth in the 1995 Annual Report under the heading \"Stock and Dividend Information\" on page 35 and is incorporated by reference herein.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required under this item is contained in the 1995 Annual Report under the heading \"Summary of Selected Financial Data\" on page 11 and is incorporated by reference herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nThe information required under this item is contained in the 1995 Annual Report under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 13 through 21 and is incorporated by reference herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements and notes as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995, together with the independent auditors' report of Turlington and Company, L.L.P. dated January 31, 1996, appearing on pages 22 through 32 of the 1995 Annual Report are incorporated by reference herein.\nItem 9.","section_9":"Item 9. Changes in the Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no changes in or disagreements with accountants on accounting and financial disclosures during the two-year period ended December 31, 1995.\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 contained in Part I of this Form 10-K and in the 1996 Proxy Statement under the heading \"Election of Directors\" and is incorporated by reference herein.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required under this item is contained in the 1996 Proxy Statement under the heading \"Executive Compensation\" and is incorporated by reference herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required under this item is contained in the 1996 Proxy Statement under the heading \"Management's Ownership of Common Stock\" and is incorporated by reference herein.\nItem 13.","section_13":"Item 13. Certain Relationship and Related Transactions\nNone\nPART IV.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n* Incorporated by reference from the indicated pages of the 1995 Annual Report.\n2. Financial Statement Schedules:\nAll schedules are omitted because the related information is included in the Consolidated Financial Statements or notes thereto or because they are not applicable.\n3. Exhibits\n3.1 Articles of Incorporation of LSB Bancshares, Inc., as amended, which are incorporated by reference to Exhibit 4.2 of the Registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on November 17, 1992 (file No. 33-54610).\n3.2 Bylaws of LSB Bancshares, Inc. as amended.\n4 Specimen certificate of common stock, $5.00 par value, which is incorporated by reference to Exhibit 4 of the registrant's Registration Statement on Form S-1 (File No. 2-99312).\n10.1 1986 Employee Incentive Stock Option Plan of LSB Bancshares, Inc., as amended, which is incorporated by reference to the registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on November 17, 1992 (File No. 33-54610).\n10.2 1996 Omnibus Stock Incentive Plan.\n10.3 1996 Management Plan.\nExhibits 10.1, 10.2 and 10.3 set forth above are management contracts or compensatory plans and arrangements and are required to be filed as an exhibit to this form pursuant to Item 601 of regulation S-K.\n13 Annual Report to Shareholders for the Year Ended December 31, 1995.\n21 List of Subsidiaries at December 31, 1995.\n23 Consent of Turlington and Company, L.L.P.\n27 Financial Data Schedule (for SEC use only)\n(b) Reports on Form 8-K\nThere were no reports filed on Form 8-K during the fourth quarter of 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, thereto duly authorized.\nLSB BANCSHARES, INC.\nDate: February 13, 1996 By \/s\/ Robert F. Lowe --------------------------- Robert F. Lowe, 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.\nEXHIBIT INDEX\n3.2 Bylaws of the Registrant, as amended\n10.2 1996 Omnibus Stock Incentive Plan\n10.3 Management Incentive Plan\n13 Annual Report to Shareholders for the Year Ended December 31, 1995\n21 List of Subsidiaries of Registrant at December 31, 1995\n23 Consent of Turlington and Company, L.L.P.\n27 Financial Data Schedule (for SEC use only)","section_15":""}
{"filename":"779742_1995.txt","cik":"779742","year":"1995","section_1":"Item 1. Business. --------\nNew England Life Pension Properties IV; A Real Estate Limited Partnership (the \"Partnership\") was organized under the Uniform Limited Partnership Act of the Commonwealth of Massachusetts on October 16, 1985, to invest primarily in newly constructed and existing income-producing real properties.\nThe Partnership was initially capitalized with contributions of $2,000 in the aggregate from Fourth Copley Corp. (the \"Managing General Partner\") and CCOP 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, 1985, 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 3, 1986.\nThe first sale of Units occurred on May 29, 1986, 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, 1986. As of January 31, 1987, a total of 94,997 Units had been sold, a total of 17,207 investors had been admitted as limited partners (the \"Limited Partners\") and a total of $94,348,550 had been contributed to the capital of the Partnership. The remaining 25,003 Units were de-registered on February 23, 1987.\nAs of December 31, 1995, the Partnership had investments in the six real property investments described below. In December 1988, the Partnership sold one of its investments and received sale proceeds of $10,577,476 which were substantially reinvested. A second investment located in Atlanta, Georgia was sold on August 6, 1993 that resulted in sale proceeds, after closing costs, totaling $7,917,000. The sale proceeds were distributed to the Limited Partners in October 1993, in the amount of $82.00 per Unit. A third investment located in Rancho Cucamonga, California was sold on December 30, 1994, resulting in sale proceeds, after closing costs, totaling $5,261,275. On January 26, 1995, $5,224,835 ($55 per Unit) of the sale proceeds was distributed to the Limited Partners.\nThe Partnership has no current plan to renovate, improve or further develop any of its real property. In the opinion of the Managing General Partner of the Partnership, the properties are adequately covered by insurance. The Partnership has no employees. Services are performed for the Partnership by the Managing General Partner and affiliates of the Managing General Partner.\nA. Apartment Complex in Fort Myers, Florida (\"Reflections\"). ---------------------------------------------------------\nOn August 1, 1986, the Partnership acquired a 60% interest in Lee Partners (the \"Joint Venture\"), a joint venture formed with Lee-Oxford Limited Partnership, a Maryland limited partnership (\"Lee-Oxford\"). As of December 31, 1995, the Partnership had contributed $8,190,145 to the capital of the Joint Venture out of a maximum obligation of $8,685,000. The joint venture agreement entitles the Partnership to receive 60% of all cash flow from operations, refinancing proceeds and net sale proceeds.\nThe Partnership also committed to make a loan for investment in the joint venture of up to $5,790,000 to Lee-Oxford, of which $5,460,097 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 entire outstanding principal balance of the loan matures in December, 1999 or will be due on the sale of all or substantially all of the assets of the Joint Venture or the sale of Lee-Oxford's interest in the Joint Venture. Lee-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 payment of the interest on and principal of the loan. The Partnership agreed, effective January 1, 1988, that to the extent that Lee-Oxford's 40% share of the cash flow is not sufficient to pay interest currently due, interest due on the loan shall accrue and compound at a rate of 10.5%. The Partnership agreed, effective May 1, 1992, to extend the maturity date of the loan from August, 1996 to December, 1999, and the borrower agreed to pay interest, currently, at a minimum of 7% with the remainder accruing at 10.5% per annum compounded monthly. The loan is secured by Lee-Oxford's interest in the Joint Venture and by a guarantee of Oxford Development Corporation, an affiliate of Lee-Oxford.\nThe joint venture owns approximately 12.63 acres of land located in Fort Myers, Florida and has completed construction of a 282-unit apartment complex consisting of 12 2- and 3-story buildings thereon. The complex was approximately 96% occupied as of December 31, 1995.\nB. Office\/Industrial Buildings in Phoenix, Arizona (\"Metro Business ---------------------------------------------------------------- Center\"). ------\nOn September 15, 1986, the Partnership acquired a 60% interest in Copley\/Hewson Northwest Associates, a joint venture formed with an affiliate of The Hewson Company. Effective January 1, 1990, as a result of operating deficits, the joint venture agreement was amended to reflect an increase of the Partnership's interest in the joint venture to 80% and a decrease in The Hewson Company's interest to 20%. As of December 31, 1995, the Partnership had contributed $5,302,193 to the capital of the joint venture out of a maximum obligation of $5,580,000.\nThe Partnership also committed to make a loan for investment in the joint venture of up to $3,988,000 to an affiliate of The Hewson Company, of which $3,534,796 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 has a ten-year term and is not prepayable. The Hewson Company must apply any cash flow received from operations of the joint venture to interest payments on the loan and must apply proceeds of refinancings or sales received from the joint venture to payments of interest on and principal of the loan. The loan is secured by the borrower's interest in the joint venture.\nOn January 1, 1996 a letter agreement was executed which modified certain terms of the Joint Venture Agreement. The letter agreement, which constitutes an amendment to the Joint Venture Agreement, granted the Partnership full control over management decisions, except that the Partnership does not have the authority to offer the property for sale prior to July 1, 1996, unless The Hewson Company approves. The joint venture agreement entitles the Partnership to receive 80% of net cash flow, refinancing proceeds and sale proceeds once the loan and accrued interest are repaid in full.\nThe joint venture owns approximately seven acres of land located in Phoenix, Arizona, improved with four one-story warehouse buildings containing approximately 109,930 square feet of space. The buildings were 91% leased as of December 31, 1995.\nC. Office, Industrial and Retail Buildings in Las Vegas, Nevada ------------------------------------------------------------ (\"Palms Business Centers\"). --------------------------\nOn December 29, 1986, the Partnership acquired a 60% interest in Rancho Road Associates, a joint venture formed with an affiliate of Commerce Centre Partners. In the first quarter of 1990, the Partnership committed to increase its maximum obligation from $13,400,000 to $15,300,000. On October 2, 1991, the Partnership committed to increase its maximum obligation from $15,300,000 to $15,840,000. As of December 31, 1995, the Partnership had contributed $15,840,000 of capital to the joint venture. The additional funds were used to pay for higher than anticipated tenant finish costs and the costs of re-leasing the space vacated by tenants when leases expired. The joint venture agreement entitles the Partnership to receive a preferred cumulative compounded return of 11% per annum on its capital contribution, of which 9.5% per annum is due currently and up to 1.5% per annum may be accrued if sufficient cash is not available therefor. The entire unpaid accrued preferred return is due and payable at the end of the tenth year of the joint venture's operations. The joint venture agreement also entitles 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. As of January 1, 1995, the joint venture agreement was amended and restated granting the Partnership control over management and operating decisions. Additionally, the venture partner will receive 40% of the excess cash flow above a specified level until its cash investment of $360,000 is repaid in full.\nThe joint venture owns approximately 14.1 acres of land in Las Vegas, Nevada improved with 15 one-story buildings suitable for office, industrial and retail use and containing approximately 224,474 square feet of space. The first phase, which was completed in the second quarter of 1988, and the second phase, which was completed in the fourth quarter of 1988, were 93% and 99% leased, respectively, as of December 31, 1995.\nOn November 16, 1990, the joint venture filed a complaint against a tenant for failure to pay rent and fraud, totaling approximately $500,000. A judgment in the amount of $911,200 was recorded in 1995. The Partnership has not collected on or recognized the judgment as of December 31, 1995.\nOn October 26, 1994, the joint venture filed a complaint against Han Lee, Inc. for failure to pay rent totaling $69,171, including late charges. In August, 1995, a Judgment by Default in the amount of $83,856 was recorded. The Partnership has not collected on or recognized the judgment as of December 31, 1995.\nD. Office\/Research and Development Buildings in Columbia, Maryland --------------------------------------------------------------- (\"Columbia Gateway Corporate Park\"). -----------------------------------\nOn December 21, 1987, the Partnership acquired a 17% interest in a joint venture formed with an affiliate of the Partnership (the \"Affiliate\"), which had a 33% interest, and M.O.R. Gateway 51 Associates Limited Partnership.\nAs of April 20, 1989, the joint venture agreement was amended and restated reflecting an increase in the Partnership's interest in the joint venture to 34.75% and a decrease in the Affiliate's interest in the joint venture to 15.25%. In addition, the amended and restated joint venture agreement increased the Partnership's maximum obligation to contribute capital to the joint venture and reallocated the capital contributed to the joint venture between the Partnership and the Affiliate. As of December 31, 1995, the Partnership had contributed $14,086,147 to the capital of the joint venture out of a maximum obligation of $14,598,000.\nThe joint venture agreement entitles the Partnership and the Affiliate to receive a preferred return on the 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 therefore, 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 34.75% of cash flow following payment of the preferred return and 34.75% 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 by 1992 and included the construction of four, one-story 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 term of ten years. As of December 31, 1995, the project was 92% leased.\nE. Office\/Research and Development Buildings in Frederick, Maryland ---------------------------------------------------------------- (\"270 Technology Center\"). -------------------------\nOn December 22, 1987, the Partnership acquired a 50% interest in a joint venture formed with MORF Associates VI Limited Partnership. As of December 31, 1995, the Partnership had contributed $4,857,000 to the capital of the joint venture out of a maximum obligation of $5,150,000. The joint venture agreement entitles the Partnership to receive a preferred return on its invested capital at the rate of 10% per annum. Such preferred return was payable currently through September 30, 1988; presently, and until the termination of the joint venture's operations, to the extent that sufficient cash flow is not available therefor, the preferred return will accrue and bear interest at the rate of 10% per annum, compounded monthly. The joint venture agreement entitles the Partnership to receive 50% of the net proceeds of sales and financings after return of its equity and preferred return.\nAs of July 3, 1990, the joint venture sold approximately 3.9 acres of land to an unrelated third party. In return, the joint venture received approximately $500,000 and a parcel of land consisting of approximately .4 acres. The joint venture currently owns approximately 8 acres of land in the 270 Technology Center in Frederick, Maryland, together with two one-story research and development\/office buildings, containing approximately 73,360 square feet of space, located thereon. As of December 31, 1995, the buildings were approximately 98% leased.\nF. Office Building in Decatur, Georgia (\"Decatur TownCenter II\"). -------------------------------------------------------------\nOn December 31, 1987, the Partnership acquired a 60% interest in a joint venture formed with an affiliate of Pope and Land Enterprises. As of May 11, 1989, the Partnership increased its maximum obligation to the joint venture from $11,180,000 to $11,600,000. As of December 31, 1995, the Partnership had contributed $10,985,575 to the capital of the joint venture. The joint venture agreement entitles the Partnership to receive a preferred return on its invested capital at the rate of 10.5% per annum.\nThe preferred return on $7,826,000 of the Partnership's capital is payable currently; until December 31, 1994, if sufficient cash flow was not available to pay the preferred return on the balance of the Partnership's capital, payment of the preferred return on $3,774,000 would accrue and bear interest at the rate of 10.5% per annum, compounded monthly, and thereafter would be payable currently. On January 1, 1995 the joint venture agreement was amended to allow the $3,774,000 to accrue until December 31, 1996. The joint venture was further amended to give the Partnership\nthe sole right to cause a sale on or after January 1, 1996. The joint venture agreement also entitles the Partnership to receive 60% of the net proceeds of sales and refinancings after return of its equity and 60% of cash flow remaining after payment of the preferred return.\nThe joint venture owns approximately 2.5 acres of land in Decatur, Georgia improved with a five-story steel frame office building containing approximately 98,840 square feet of space. As of December 31, 1995, the building was 98% leased.\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 year.\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.\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.\nApartment Complex in Fort Myers, Florida - ----------------------------------------\nReflections is located in the City of Fort Myers in Lee County. Reflections competes directly with seven other apartment complexes comprising 2,547 units. This sub market had occupancy of approximately 93%, a slight decrease from last year.\nOffice\/Industrial Buildings in Phoenix, Arizona - -----------------------------------------------\nThis property is located in the metropolitan Phoenix market which includes 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.\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.\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, Research and Development Buildings in Frederick, Maryland - -----------------------------------------------------------------\nThe Frederick R&D market contains approximately 5.5 million square feet of R&D\/Industrial space with a vacancy rate of approximately 9%. This is a strong improvement from 1994 when the vacancy rate stood at 16%. The improvement is attributed to a lack of new construction and positive job growth.\nOffice building in Decatur, Georgia. - -----------------------------------\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% rate 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.\nItem 3.","section_3":"Item 3.\nLegal Proceedings - -----------------\nThe Partnership is not a party to, nor are any of its properties subject to, any material pending legal proceedings. A joint venture in which the Partnership holds an interest has received judgments against two former tenants for defaults under leases. See Item 1.C.\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 17,443 holders of Units.\nThe Partnership's Amended and Restated Agreement of Limited Partnership dated May 29, 1986, 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. 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 $5,711,220. 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 $ 10,021,234, including $5,224,835 ($55 per Limited Partnership Unit) from the proceeds of a property sale.\nCash distributions exceeded net income in 1995 and, therefore, resulted in a reduction of partners' capital. Reference is made to the Partnership's Statement of Changes in Partner's Capital (Deficit) and Statement of Cash Flows in Item 8 hereof.\nItem 6.","section_6":"Item 6. Selected Financial Data. -----------------------\n(1) Cash distributions include $8.09 per Limited Partnership Unit that is attributable to a discretionary reduction of cash reserves, which had been previously accumulated through operating activities.\n(2) Net income includes a gain on the sale of a joint venture investment of $399,865. Cash distributions include a return of capital of $55.00 per Limited Partnership Unit.\n(3) The Partnership recorded investment valuation allowances totaling $2,760,784 ($28.77 per Limited Partnership Unit) during 1993. Cash distributions include a return capital of $82.00 per Limited Partnership Unit.\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 1986. A total of 94,997 units were sold. The Partnership received proceeds of $85,677,259, net of selling commissions and other offering costs, which have been invested in real estate, used to pay related acquisition costs or retained as working capital reserves. The Partnership made nine real estate investments; those currently owned are described in Item 1 hereof. Three investments have been sold; one in 1988 and one each in 1993 and 1994. As a result of the sales, capital of $13,014,589 has been returned to the Limited Partners through December 31, 1995.\nOn December 30, 1994, the Rancho Cucamonga joint venture sold its property and the Partnership received net sale proceeds of $5,261,275. On January 26, 1995, the Partnership made a capital distribution of $55 per limited partnership unit ($5,224,835) from the proceeds of the sale. The adjusted capital contribution after this distribution is $863 per unit.\nAt December 31, 1995, the Partnership had $7,416,538 in cash, cash equivalents and short-term investments, which was partially used for cash distributions of $1,242,638 to partners on January 25, 1996. The remainder will primarily be used for working capital reserves. The source of future liquidity and cash distributions to partners will be cash generated by the Partnership's real estate and short-term investments and proceeds from the sale of such investments. Distributions of cash from operations relating to the first quarter of 1995 were made at the annualized rate of 6% on the weighted average adjusted capital contribution. In addition, at this time, a special distribution totaling $776,289 ($8.09 per limited partnership unit) was made which was attributable to a discretionary reduction of cash reserves which had previously accumulated from operating activities. Since the total quarterly distribution exceeded the rate of 2%, previously deferred management fees to the advisor were paid in the amount of $175,374 or 50% of the excess distribution. The Managing General Partner will continue to evaluate reserve levels in the context of the Partnership's investment objectives. Distributions of cash from operations relating to the second, third and fourth quarters of 1995 were made at the annualized rate of 6% on the adjusted capital contribution. Distributions of cash from operations relating to the first, second, third and fourth quarters of 1994 were made at the annualized rates of 5%, 5.5%, 5.5%, and 6%, respectively, on an adjusted capital contribution of $918 per unit. The increase in the distribution rate results from the attainment of appropriate cash reserve levels and the stabilization of property operations.\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 values of certain investments exceeded the related carrying values by an aggregate of $9,400,000 and the appraised values of the remaining investments were less than the related carrying values by an aggregate of $1,400,000. 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 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 investments currently in the portfolio are structured as joint ventures with real estate development\/management firms. However, effective January 1, 1995, the Palms Business Center joint venture was restructured to grant the Partnership control over management decisions and the investment has been accounted for as a wholly-owned property since that date. The Summit Vinings\napartment complex, which was sold in August 1993, was a wholly-owned property. The Rancho Cucamonga property, which was sold in December 1994, was owned by a joint venture.\nOPERATING FACTORS\nOverall occupancy at the Columbia Gateway Corporate Park remained at 92% at December 31, 1995, where it was at 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 at 73% at December 31, 1993.\nOccupancy at Reflections Apartments ended 1995 at 96%; it ranged from 92% to 96% during 1995. Occupancy during 1994 and 1993 was in this same range. Although the Fort Myers apartment market remains competitive, rental rates have improved during 1995.\nOccupancy at Metro Business Center at December 31, 1995 was 91%, down from 100% a year ago, although it had been at 98% for the first three quarters of 1995. Occupancy was 98% at December 31, 1993. Rental rates are increasing as the Phoenix market appears to have stabilized. However, this property faces significant leasing exposure during 1996 as leases for approximately 46% of the space expire.\nLeasing at Decatur TownCenter II decreased to 98% during 1995, down from 100% a year ago, but up from 93% at December 31, 1993.\nOccupancy at Palms Business Centers was 96% at December 31, 1995, consistent with one year ago and up from 91% two years prior. The overall health of the Las Vegas market has improved and there has been some upward movement in rental rates.\nLeasing at 270 Technology Center was 65% at December 31, 1993 and increased to 100% during the third quarter of 1994, where it remained until the second quarter of 1995. Leasing declined to 92% during the third quarter of 1995 and ended the year at 98%. However, leases for one-third of the space expire in 1996 and for 60% of the space in 1997.\nINVESTMENT RESULTS\nOn December 30, 1994, the Rancho Cucamonga joint venture sold its property and the Partnership recognized a gain of $399,865. In August 1993, the Partnership sold the Summit Vinings Apartments in Atlanta, Georgia at no gain or loss. During the first and second quarters of 1993, however, its carrying value had been reduced to the approximate selling price. The Managing General Partner determined in 1993 that the carrying value of Columbia Gateway Corporate Park should be reduced to its estimated net realizable value, which resulted in an investment valuation allowance of $1,050,000.\n1995 Compared to 1994\nInterest on cash equivalents and short-term investments increased as a result of larger invested balances, as well as an increase in interest rates.\nExclusive of the gain from the Rancho Cucamonga sale in 1994 and its 1994 operating results ($309,969), real estate operating activity was $4,402,974 for 1995 and $3,490,615 for 1994. This 26% increase was due to improved operating results at all of the Partnership's investments. Improvement was most notable at Columbia Gateway Corporate Park, from which results increased by approximately $289,000 due to improvements in rental income. Improved occupancy and rental rates also resulted in an increase of approximately $272,000 in net operating income generated from Palms Business Center. Net operating income at Decatur TownCenter II increased by approximately $203,000 as a result of a lease termination fee.\nNotwithstanding the improved operating results and excluding $488,772 in cash flow from Rancho Cucamonga in 1994, cash flow from operations decreased $24,657. The change primarily stems from discretionary adjustments to cash reserve levels made by joint ventures. Both 270 Technology Park and Columbia Gateway Corporate Park reduced cash reserves held at the property level in 1994 and, therefore, increased the Partnership's cash flow in 1994. Metro Business Center\nreduced cash reserves at the property level and increased Partnership cash flow in 1995. Operating cash flow from the remainder of the Partnership's investments was consistent with the change in operating results. The decrease in operating cash flow was also due to the payment of previously accrued, but deferred management fees to the advisor of $175,374.\n1994 Compared to 1993\nInterest on cash equivalents and short-term investments increased as a result of larger invested balances, as well as an increase in interest rates.\nExclusive of the gain from the Rancho Cucamonga sale in 1994, investment valuation allowances in 1993, and the operating results of Summit Vinings, real estate investment results were $3,800,584 for 1994 and $2,720,859 for 1993. This 40% increase was primarily due to improved operating results at all of the Partnership's investments, with the exception of Rancho Cucamonga, as described below. Improvement was most notable at Palms Business Center and Columbia Gateway Corporate Park, at which results increased by approximately $300,000 in both cases; at Metro Business Center, at which results increased by approximately $250,000; and at 270 Technology Center and Reflections Apartments at which results increased by approximately $100,000 in both cases. Operating income at Rancho Cucamonga declined during 1994 as a result of lower rental revenue from the new tenant lease effective May 1, 1993.\nOperating cash flow, exclusive of the results from Summit Vinings of $336,532 in 1993, increased by $1,660,323 or 40% between 1993 and 1994. In addition to the effect of improved operating results as previously described, cash flow also increased during 1994 as a result of the timing of cash distributions to the Partnership from certain joint ventures which previously had been retaining additional working capital reserves. This reduction in working capital reserves was most notable at 270 Technology Center ($575,000), Rancho Cucamonga ($400,000) and Columbia Gateway Corporate Park ($325,000). Cash distributions decreased from Decatur TownCenter II by approximately $350,000 due to costs associated with re-leasing and from Metro Business Center by approximately $210,000 due to timing.\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 primarily consist 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 approximately 10% or $32,000 primarily due to legal fees associated with the various investment restructurings.\n1994 Compared to 1993\nThe Partnership management fee increased due to an increase in distributable cash flow from operations. General and administrative expenses increased approximately 13% or $37,000 primarily due to increased professional fees.\nINFLATION - ---------\nBy their nature, real estate investments tend not to be adversely affected by inflation. Inflation may tend to 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 the Partnership operations, due to market and economic conditions, have overshadowed the overall 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 16, 1985. 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 16, 1985. 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 Notes 1, 2 and 6 to Notes to Financial Statements.\nThe following table sets forth the amounts of the fees and cash distributions and reimbursements of 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.\nFor the year ended December 31, 1995 the Partnership allocated $50,454 of 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. --------------------------------\nAn affiliate of the Managing General Partner of the Partnership owned 1,558 Units as of 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 and Financial Statement Index No. 2 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 is 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 ended December 31, 1995, the Partnership filed no Current Reports on Form 8-K.\nNew England Life\nPension Properties IV;\nA Real Estate Limited Partnership\nFinancial Statements\n*******\nDecember 31, 1995\nNEW ENGLAND LIFE PENSION PROPERTIES IV; -------------------------------------- A REAL ESTATE LIMITED PARTNERSHIP ---------------------------------\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE ------------------------------------------\nReport of Independent Accountants ---------------------------------\nTo the Partners\nNEW ENGLAND LIFE PENSION PROPERTIES IV; 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 Life Pension Properties IV; 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 Fourth 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 Decatur TownCenter II 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 $680,012 for the year ended December 31, 1995. We also did not audit the financial statements of the Partnership's Columbia Gateway Corporate Park, 270 Technology Center and Reflections joint venture investees for the years ended December 31, 1995, 1994 and 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 these ventures aggregated $2,022,381, $1,631,665 and $1,118,613 for the years ended December 31, 1995, 1994 and 1993, respectively. We also did not audit the financial statements of the Partnership's Metro Business Center joint venture investee for the years ended December 31, 1995 and 1994, 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 $394,403 and $354,788 for the years ended December 31, 1995 and 1994. We also did not audit the financial statements of the Partnership's investment in Palms Business Centers for the years ended December 31, 1995, 1994 and 1993. Operating income for this investment was $1,770,345 for the year ended December 31, 1995, and equity in joint venture income was $1,053,707 and $739,894 for the years ended December 31, 1994 and 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 amount included for the equity in joint venture income for Decatur TownCenter II for the year ended December 31, 1995, and for Columbia Gateway Corporate Park, 270 Technology Center and Reflections for the years ended December 31, 1995, 1994 and 1993, respectively, and for Metro Business Center for the years ended December 31, 1995 and 1994, respectively, and for the operating income and equity in joint venture income for Palms Business Centers for the years ended December 31, 1995, 1994 and 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 LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nBALANCE SHEET\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF OPERATIONS\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CASH FLOWS\nNON-CASH TRANSACTION:\nEffective January 1, 1995, the Partnership's joint venture investment in Palms Business Center was converted to a wholly-owned property. The carrying value of this investment at conversion was $12,519,964.\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nNote 1 - Organization and Business - ----------------------------------\nGeneral\nNew England Life Pension Properties IV; 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 organizations intended to be exempt from federal income tax. The Partnership commenced operations in May, 1986 and acquired the six real estate investments it currently owns prior to the end of 1987. It intends to dispose of its investments within twelve years of their acquisition, and then liquidate; however, the Managing General Partner could extend the investment period if it is considered to be in the best interest of the limited partners.\nThe Managing General Partner of the Partnership is Fourth Copley Corp., 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 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.\nAt December 31, 1995 an affiliate of the Managing General Partner owned 1,558 units and at December 31, 1994 the Managing General Partner owned 1,300 units of limited partnership interest, which were repurchased from certain qualified plans, within specified annual limitations as 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. Payment of 50% of management fees incurred is deferred until cash distributions to limited partners exceed a specified rate. Cash distributions for the first quarter of 1995 exceeded the stipulated minimum, which resulted in a payment to Copley of previously deferred management fees totaling $175,374. Deferred management fees were $2,094,251 and $2,085,277 at December 31, 1995 and 1994, respectively. Copley is also reimbursed for expenses incurred in connection with administering the Partnership ($13,874 in 1995, $21,155 in 1994 and $15,490 in 1993). Acquisition fees paid were based on 2% of the gross proceeds from the offering. 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. Deferred disposition fees were $712,653 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 $21,543, $30,526, and $25,358 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, plus other operating net assets (liabilities). The Partnership's 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.\nCertain tenant leases at the property 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 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 disposal 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\nLong-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. 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. During 1993, the Managing General Partner determined that the carrying value of the Columbia Gateway Corporate Park and Summit Vinings investments should be reduced to net realizable value. (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 the related carrying values by an aggregate of $9,400,000 and $6,700,000, respectively; and the appraised values of the remaining investments were less than the related carrying values by an aggregate of $1,400,000 and $2,000,000, 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 one month, 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 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 - Real Estate Joint Ventures -----------------------------------\nThe Partnership has investments in six real estate joint ventures which are organized as general partnerships with real estate management\/development firms. (A seventh investment was sold in December 1994). It made capital contributions to the ventures, which are generally subject to preferential cash distributions at a specified rate and to priority distributions with respect to sale or refinancing proceeds. The Partnership also made loans to certain of its venture partners who, in turn, contributed the proceeds to the capital of the venture. The loans bear interest at a specified rate. The loans are in substance real estate investments and are accounted for accordingly. The joint venture agreements provide for the funding of cash flow deficits by the venture partners in proportion to their ownership interests.\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:\nReflections\nOn August 1, 1986, the Partnership entered into a joint venture with an affiliate of Oxford Development Corporation to construct and operate a multi- family apartment complex. The Partnership's commitment is for a total cash investment of $14,475,000, $5,790,000 of which is a loan to the venture partner. In May 1992, the Partnership agreed to extend the maturity of the loan from August, 1996 to December, 1999 and the venture partner agreed to pay interest at a minimum of 7% per annum with the unpaid amount subject to compounding at 10.5%. The loan is secured by the venture partner's interest in the joint venture, as well as a guarantee from an affiliate of the venture partner.\nMetro Business Center\nOn September 15, 1986, the Partnership entered into a joint venture with an affiliate of Hewson Properties, Inc., to construct and operate four multi-tenant office\/warehouse buildings. The Partnership committed to make a maximum cash investment of $9,568,000, $3,988,000 of which is a loan to the venture partner. The loan matures in October 1996 and is secured by the venture partner's interest in the joint venture. Subsequent to December 31, 1995, and effective January 1, 1996, the joint venture agreement was amended to grant the Partnership full control over management decisions, except that it does not have the authority to unilaterally offer the property for sale prior to July 1, 1996. The minimum future rentals due to the venture under non-cancelable operating leases are: $506,391 in 1996, $288,080 in 1997, $98,065 in 1998 and $3,500 in 1999.\nPalms Business Centers\nOn December 29, 1986, the Partnership entered into a joint venture with an affiliate of Commerce Centre Partners to construct and operate fifteen one-story office\/industrial buildings. The Partnership committed to make a capital contribution of $15,840,000.\nEffective January 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).\nColumbia Gateway Corporate Park\nOn December 21, 1987, the Partnership entered into a joint venture with an affiliate of the Partnership and with an affiliate of the 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 $14,598,000 capital contribution. The Partnership and its affiliate collectively have a 50% interest in the joint venture. The minimum future rentals due 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.\nIn 1993, the Managing General Partner determined that the carrying value of this investment should be reduced to its estimated net realizable value, which resulted in an investment valuation allowance of $1,050,000.\n270 Technology Center\nOn December 22, 1987, the Partnership entered into a joint venture with an affiliate of the Manekin Corporation to construct and operate two research and development\/office buildings. The Partnership committed to make a $5,150,000 capital contribution. The minimum future rentals due to the venture under non- cancelable operating leases are: $387,579 in 1996 and $147,418 in 1997.\nDecatur TownCenter II\nOn December 31, 1987, the Partnership entered into a joint venture with an affiliate of Pope & Land Enterprises to construct and operate an office building. The Partnership committed to make an $11,600,000 capital contribution. To the extent that up to $7,826,000 of the Partnership's contribution is returned within ten years, the joint venture agreement provides for a prepayment premium to the Partnership. The minimum future rentals due to the venture under non-cancelable operating leases are: $1,431,662 in 1996, $1,212,866 in 1997, $1,186,138 in 1998, $941,181 in 1999, $861,897 in 2000 and $3,725,478 thereafter. A portion of the land on which the building was constructed consists of a leasehold interest assigned to the venture. The lease terminates in 2073 and requires annual ground rental payments of $32,349. These payments are adjusted for inflation every five years.\nDuring 1995, the joint venture agreement was amended to allow the Partnership the sole right to cause a sale on or after January 1, 1996.\nSale of Rancho Cucamonga\nOn September 4, 1986, the Partnership entered into a joint venture with an affiliate of Vance Charles Mape III to construct and operate a warehouse facility. The Partnership made a contribution of $5,273,545. On December 30, 1994, the joint venture sold the property for a total sales price of $5,472,000. After closing costs, the Partnership received its share of the proceeds of $5,261,275 and recognized a gain on the sale of $399,865 ($4.17 per limited partnership unit). A disposition fee of $164,160 was accrued but not paid to Copley. A capital distribution to the limited partners was made on January 26, 1995 in the aggregate amount of $5,224,835 ($55.00 per limited partnership unit).\nSummarized Financial Information --------------------------------\nThe following summarized financial information is presented in the aggregate for the joint ventures:\nAssets and Liabilities ----------------------\nResults of Operations ---------------------\nLiabilities and expenses exclude amounts owed and attributable to the Partnership and (with respect to one joint venture) its affiliate on behalf of their various financing arrangements with the joint ventures.\nThe Rancho Cucamonga investment was sold on December 30, 1994. The above amounts include the results of operations through that date. The Palms Business Center investment was converted to a wholly-owned property on January 1, 1995. The above amounts exclude its results of operations for 1995.\nNote 4 - Property - -----------------\nPalms Business Center\nEffective January 1, 1995, the Palms Business Center joint venture was restructured, giving the Partnership control over management decisions. Since that date, the investment is being accounted for as a wholly-owned property. The carrying value of the joint venture investment at conversion was allocated to land, building and improvements, amount payable to venture partner and other net operating liabilities. The venture partner will receive 40% of the excess cash flow above a specified level until the initial obligation of $360,000 is repaid in full.\nThe following is a summary of the Partnership's investment at December 31, 1995:\nThe buildings and improvements are being depreciated over 25 years, beginning January 1, 1995.\nThe minimum future rentals under non-cancelable operating leases are: $1,579,802 in 1996, $1,066,615 in 1997, $344,574 in 1998, $87,837 in 1999 and $35,844 in 2000.\nSummit Vinings\nOn August 6, 1993, the Partnership sold the Summit Vinings apartment complex located in Atlanta, Georgia. The total sales price was $8,100,000. After closing costs, the Partnership received proceeds of $7,916,614. In anticipation of the sale, the carrying value of the investment had been reduced in the first and second quarters of 1993 to approximate the selling price through the recognition of an investment valuation allowance of $1,710,784. A disposition fee of $243,000 was accrued but not paid to Copley. On October 28, 1993, the Partnership made a capital distribution to the limited partners in the aggregate amount of $7,789,754 ($82 per limited partnership unit.)\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 (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 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 $918 in 1993 and to $863 in 1995 as a result of the capital distribution from the Summit Vinings and Rancho Cucamonga sales, respectively. 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 $1,242,638 ($12.95 per limited partnership unit).\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSchedule III REAL ESTATE AND ACCUMULATED DEPRECIATION AT DECEMBER 31, 1995\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSchedule III REAL ESTATE AND ACCUMULATED DEPRECIATION AT DECEMBER 31, 1995 (Continued)\nNEW ENGLAND LIFE PENSION PROPERTIES IV; A REAL ESTATE LIMITED PARTNERSHIP\nSchedule III NOTE A JOINT VENTURES SUMMARY AT DECEMBER 31, 1995\nGATEWAY 51 PARTNERSHIP (A MARYLAND GENERAL PARTNERSHIP)\nFINANCIAL REPORT\nDECEMBER 31, 1995\nFINANCIAL STATEMENTS INDEX NO. 2\nAUDITOR'S REPORT AND FINANCIAL STATEMENTS\nOF GATEWAY 51 PARTNERSHIP\n[LETTERHEAD OF WOLPOFF & COMPANY, LLP]\nTo the Partners Gateway 51 Partnership (A Maryland General Partnership) Columbia, Maryland\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENTS ----------------------------------------------------\nWe have audited the balance sheet of Gateway 51 Partnership (A Maryland General 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, 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 Gateway 51 Partnership (A Maryland General 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, 1994 and 1993, in conformity with generally accepted accounting principles.\n\/S\/ WOLPOFF & COMPANY, LLP\nWOLPOFF & COMPANY, LLP\nBaltimore, Maryland January 22, 1996\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nBALANCE SHEET -------------\nASSETS ------\n_______________\nThe notes to financial statements are an integral part of this statement.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nBALANCE SHEET -------------\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\n____________\nThe notes to financial statements are an integral part of this statement.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nSTATEMENT OF INCOME -------------------\n_______________\nThe notes to financial statements are an integral part of this statement.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nSTATEMENT OF PARTNERS' CAPITAL ------------------------------\n_______________\nThe notes to financial statements are an integral part of this statement.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nSTATEMENT OF CASH FLOWS -----------------------\n_______________\nThe notes to financial statements are an integral part of this statement.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nDECEMBER 31, 1995 -----------------\nNote 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization ------------ Gateway 51 Partnership (A Maryland General Partnership) was formed on December 21, 1987, under the Maryland Uniform Partnership Act. The agreement was amended and restated in 1989 to reflect changes in partner ownership percentages.\nProperty -------- The Partnership owns 21 acres of land in Howard County, Maryland. The property has been developed with six office\/research type buildings, with two placed into service in August 1994. Plans call for a seventh building with approximately 15,000 square feet of space.\nAll property is recorded at cost. Information regarding the buildings is as follows:\nCarrying costs, operating expenses and depreciation begin as a charge against operations on the date the buildings are placed into service.\nInitial Rental Operations ------------------------- As buildings became substantially complete, the Partnership recognized related revenues and expenses (including depreciation and interest) pertaining to that space. Buildings were considered substantially complete upon the earlier of the completion of substantial tenant improvements or 1 year from the completion of the building shell. Incidental rental revenue and expenses incurred prior to substantial completion were included in building costs.\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 1 - Cash and Cash Equivalents ------------------------- (Cont.) The Partnership considers all highly liquid debt instruments purchased with a maturity of 3 months or less to be cash equivalents.\nThe majority of the Partnership's cash is held in financial institutions with insurance provided by the Federal Deposit Insurance Corporation (FDIC) up to $100,000. Periodically during the year, the balance may have exceeded the FDIC limitation.\nDepreciation ------------ Building costs and tenant improvements are being depreciated using the straight-line method over the estimated useful lives of 50 years.\nRental Income ------------- Rental income for major leases is being recognized on a straight-line basis over the terms of the leases. The excess of the rental income recognized over the amount stipulated in the lease is shown as deferred rent receivable.\nAmortization ------------ Deferred costs are amortized as follows:\nIncome Taxes ------------ Partnerships, as such, are not subject to income taxes. The individual partners are required to report their respective shares of partnership income or loss and other tax items on their individual income tax returns (see Note 5).\nCapital Placement Fee --------------------- Costs incurred for arranging the Partnership's equity have been treated as a reduction of partners' capital (see Note 2).\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 2 - PARTNERS' CAPITAL\nCapital Investment ------------------ New England Life Pension Properties IV (NELPP IV) and New England Pension Properties V (NEPP V) have agreed to provide equity of $14,598,000 and $6,402,000, respectively, totaling $21,000,000. During 1994, NELPP IV and NEPP V made capital contributions of $1,753,550 and $769,543, respectively, to fund the construction and completion of Buildings D and E. As of December 31, 1995, 1994 and 1993, total capital contributions amounted to $20,267,826, $20,267,826 and $17,744,733, respectively.\nCumulative Priority Return -------------------------- NELPP IV and NEPP V are entitled to cumulative priority returns of 10.5%, compounded monthly on capital invested. The Partnership paid priority returns totaling $1,200,000, $1,205,000 and $310,000 during 1995, 1994 and 1993, respectively. As of December 31, 1995, 1994 and 1993, unpaid priority returns amounted to $5,427,949, $3,832,711 and $2,993,149, respectively.\nCapital Placement Fee --------------------- The Partnership incurred fees of $202,678 with Paine Webber Mortgage Finance, Inc. with respect to capital raised by the Partnership. This amount has been charged against partners' capital.\nNote 3 - TENANT IMPROVEMENT LOANS RECEIVABLE\nThe Partnership has made several tenant improvement loans to tenants. These loans require monthly principal and interest payments. Pertinent terms are as follows:\nGATEWAY 51 PARTNERSHIP ---------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 4 - RELATED PARTY TRANSACTIONS\nManagement Fees --------------- The Partnership has entered into an agreement with Manekin Corporation to act as management agent for the property. The management agreement provided for a management fee equal to 3.5% of rent and tenant expense billings during 1994 and 1993. The agreement was modified to adjust the fee to 3%, effective January 1, 1995.\nDevelopment Fees ---------------- The Partnership has entered into a development agreement with Manekin Corporation. A fee of $138,611 was incurred in 1992 and is included in building costs.\nNote 5 - TAX ACCOUNTING\nTax accounting differs from financial accounting as follows:\nNote 6 - LEASES\nThe following is a schedule of future minimum lease payments to be received under noncancelable operating leases at December 31, 1995:\nTo the Partners Gateway 51 Partnership (A Maryland General Partnership) Columbia, Maryland\nINDEPENDENT AUDITOR'S REPORT ON SUPPLEMENTARY INFORMATION ---------------------------------------------------------\nOur audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information contained on pages 12 and 13 is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information has not been subjected to the auditing procedures applied in the audits of the basic financial statements, and accordingly, we express no opinion on it.\n\/s\/ WOLPOFF & COMPANY, LLP\nWOLPOFF & COMPANY, LLP\nBaltimore, Maryland January 22, 1996\nGATE 51 PARTNERSHIP ------------------- (A MARYLAND GENERAL PARTNERSHIP) --------------------------------\nSCHEDULE OF PARTNERS' CAPITAL -----------------------------\nDECEMBER 31, 1995 -----------------\n_______________\nSee Independent Auditor's Report on Supplementary Information.\n______________\nSee Independent Auditor'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 IV; 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. Mackowiak\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 INDEX -------------\nEXHIBIT INDEX -------------\nEXHIBIT INDEX ----------------\n____________________________________________________________________ * Previously filed and incorporated herein by reference","section_15":""}
{"filename":"824430_1995.txt","cik":"824430","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS.\n(1) The Company. Xanthic Enterprises, Inc. was incorporated in Colorado on October 27, 1986 and has not yet commenced operations. The primary activity of the Company will involve seeking merger or acquisition candidates.\n(2) Plan of Operations. The Company plans to seek merger or acquisition candidates.\n(3) Employees. At the present time the Company has no employees other than its officers. The officers devote as much time as they deem appropriate to the Company's business. The officers are not paid salary or expenses.\n(4) Administrative Offices. The Company maintains its executive offices at 8833 Sunset Blvd., Suite 200, West Hollywood, CA 90069 pursuant to an oral lease agreement with David Lilly, a shareholder of the Company on a month to month basis. No rent is paid for this office at this time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns no properties, plans or other real estate, and has no Letters of Intent to purchase or acquire any property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn November 2, 1991 the State of Oregon issued a cease and desist order ordering the Company to cease and desist issuing unregistered securities in the State of Oregon. The proceeding was based on the distribution of shares and warrants to Oregon shareholders (registered by way of a S-18 registration statement) pursuant to the agreement for such distribution between the Company and Automated Services, Inc.\nOn April 2, 1992 the State of Oregon issued a final order to cease and desist violating any provision of Oregon Securities Law. Xanthic was denied the use of any statutory exemption provided in ORS 59.022 and ORS 59.035. Xanthic, Mark Lilly and Glenn DeCicco were assessed civil penalties of $ 750.00 each for violating ORS 59.055 and ORS 59.132(2). Directors Mark Lilly and Glenn DeCicco were ordered to cease and desist violating any provision of ORS Chapter 59. Neither the Company nor the Directors appealed.\nThe Company has been advised that the effect of the Oregon ruling was to\ninvalidate the issuance and distribution of the registered shares and warrants to residents of Oregon until such time as said securities are registered pursuant to the provisions of the Oregon Securities Law.\nThe number of shares affected by the ruling is estimated to be 188,000 shares owned by approximately 650 residents of Oregon. The 188,000 shares represent approximately 3.4% of the issued and outstanding shares of Xanthic.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to the shareholders during the year 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThere is no established public trading market for the common shares of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThis information is omitted as allowed by General Instruction 1 of Form 10-K as the information is adequately reflected in the certified financial statements as set forth in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n(1) LIQUIDITY. The Company has no cash assets and no liquidity.\n(2) CAPITAL RESOURCES. The Company has no capital resources.\n(3) RESULTS OF OPERATIONS. The Company has not operated during the past fiscal year and there are no results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAttached one audited financial statements for the Company as of December 31, 1995.\nXANTHIC ENTERPRISES, INC.\n(A DEVELOPMENT STAGE COMPANY)\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995 AND 1994\nCONTENTS\nPAGE\nAUDITOR'S REVIEW REPORT.................................................... 6\nFINANCIAL STATEMENTS:\nBALANCE SHEET............................................................ 7\nSTATEMENTS OF OPERATION.................................................. 8\nSTATEMENT OF STOCKHOLDERS' EQUITY........................................ 9\nSTATEMENTS OF CASH FLOWS................................................. 10\nNOTES TO FINANCIAL STATEMENTS............................................11-12\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF XANTHIC ENTERPRISES, INC.:\nWe have audited the accompanying balance sheets of Xanthic Enterprises, Inc. (a development stage company) as of December 31, 1995 and 1994, and the related statements of operations, stockholders' equity (deficit), and cash flows for the years then ended and for the period from October 27, 1986 (inception), to December 31, 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 Xanthic Enterprises, Inc. as of December 31, 1995, and 1994, and the results of its operations and cash flows for the years then ended and from October 27, 1986 (inception), to December 31, 1995 in conformity with generally accepted accounting principles.\nHarlan & Boettger, CPA's San Diego, California February 24, 1997\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nORGANIZATION\nXanthic Enterprises, Inc., a Colorado corporation, was incorporated October 27, 1986, and since its inception, the Company has been in the development stage. The Company's primary intended activity is to engage in all aspects of review and evaluation of private companies, partnerships, or sole proprietorships for the purpose of completing mergers or acquisitions with the Company, and to engage in mergers acquisitions with any or all varieties of private entities.\nThe Company has had no operations since its inception except for expenses related to maintaining the corporate status.\nBASIS OF ACCOUNTING\nThe Company's policy is to use the accrual method of accounting and to prepare and present financial statements which conform to generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nB. ACCOUNTS PAYABLE:\nAccounts payable at December 31, 1995 represents amounts due the Company's stock transfer agency, AST.\nC. CAPITAL STOCK\nThe Company is authorized to issue 50,000,000 shares of common stock, with a par value of $.0001 per share.\nIn May, 1989 the Company became obligated to distribute shares and warrants to the shareholders of ASI pursuant to the S-18 registration statement. The Company distributed 313,826 shares of stock and 627,652 warrants pursuant to the agreement with ASI. The shares and warrants were delivered at various dates between May of 1989 and February of 1990. This distribution included 313,826 shares of common stock and one (1) Class A Warrant and one (1) Class B Warrant with each share of stock distributed. Each warrant allowed the holder to acquire an additional share of common stock as follows: The Class A Warrant had an exercise price of $0.75 per share and an expiration date of April 30, 1990. The Class B Warrant had an exercise price of $1.50 per share and an expiration date of April 30, 1992. No warrants were exercised.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 (CONTINUED)\nD. LITIGATION:\nOn November 2, 1991 the State of Oregon issued a cease and desist order ordering the Company to cease and desist issuing unregistered securities in the State of Oregon. The proceedings was based on the distribution of shares and warrants to Oregon shareholders (registered by way of a S-18 registration statement) pursuant to the agreements for such distribution between the Company and Automated Services, Inc.\nOn April 2, 1992 the State or Oregon issued a final order to cease and desist violating any provision of Oregon Securities Law. Xanthic was denied the use of any statutory exemption provided in ORS 59.022 and ORS 59.035. Xanthic, Mark Lilly and Glenn DeCicco were assessed civil penalties of $750.00 each for violating ORS 59.055 and ORS 59.132(2). Directors Mark Lilly and Glenn DeCicco were ordered to cease and desist violating any provision of ORS Chapter 59. Neither the Company nor the Directors appealed.\nThe Company has been advised that the effect of the Oregon ruling was to invalidate the issuance and distribution of the registered shares and warrants to residents of Oregon until such time as said securities are registered pursuant to the provisions of the Oregon Securities Law. The number of shares affected by the ruling is estimated to be 188,000 shares owned by approximately 650 residents at Oregon. The 188,000 shares represent approximately 3.4% of the issued and outstanding shares of the Company.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThere is no disagreement with any prior accountant.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nMark A. Lilly, President and a Director. Mr. Lilly, age 32, has been President of Xanthic since inception. During 1988 he was President of NinHao Enterprises, Inc., a Colorado corporation. NinHo Enterprises is no longer active. Mr. Lilly was an Assistant Health Planner for the Alameda Health Consortium from February 1987 to May, 1988. Since May, 1988 Mr. Lilly was self employed as a free lance computer programer.\nGlenn DeCicco, Vice-President, Secretary and a Director. Mr. DeCicco, age 35, was a Senior Vice President of Nin Hao Enterprises during 1988 and was President of Land and Water Real Estate Company, an inactive development stage real estate consultation company formed in 1987. Land and Water Real Estate Company has no assets, income or employees.\nJohn D. Lilly, Vice-President. Mr. Lilly, age 29, has been a free lance computer consultant since 1994.\nJohn Lilly and Mark Lilly are brothers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nDuring the past year the Company did not compensate any officer or director. The Company has no plans to compensate any officer or director at the present time.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n*The total number of shares owned by officers and directors is 2,534,500.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot Applicable.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements and Schedules.\nThe Company incorporates by reference the exhibits filed with its registration statement and the amendments thereto. There have been no 8-K filings during the past year. Attached under Item 8 are audited financial statements for the Company as of December 31, 1995.\nSIGNATURE\nIn accordance with Section 12 of the Securities Exchange Act of 1934, this registrant caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.\nXANTHIC ENTERPRISES, INC.\nDated: 4\/2\/97 -------------------------------\nBy: \/s\/ Mark A. Lilly ---------------------------------- Mark A. Lilly, President, Director and Chief Financial Officer\nDated: 4\/2\/97 -------------------------------\nBy: \/s\/ Glenn DeCicco ---------------------------------- Glenn DeCicco, Vice President and Director","section_15":""}
{"filename":"722648_1995.txt","cik":"722648","year":"1995","section_1":"ITEM 1. BUSINESS\nReal Estate Associates Limited VII (\"REAL VII\" or the \"Partnership\") is a limited partnership which was formed under the laws of the State of California on May 24, 1983. On February 1, 1984, the Partnership offered 2,600 units consisting of 10,400 limited partnership interests and warrants to purchase a maximum of 5,200 additional limited partnership interests through a public offering managed by Lehman Brothers Inc.\nThe general partners of the Partnership are National Partnership Investments Corp. (\"NAPICO\"), a California Corporation (the \"Corporate General Partner\"), and National Partnership Investments Associates II (\"NAPIA II\"). NAPIA II is a limited partnership formed under the California Limited Partnership Act and consists of Mr. Charles H. Boxenbaum and an unrelated individual as limited partners and NAPICO as general partner. The business of the Partnership is conducted primarily by its general partners as the Partnership 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.\nThe Partnership holds limited partnership interests in thirty-two local limited partnerships as of December 31, 1995. The Partnership also holds a general partner interest in Real Estate Associates IV (\"REA IV\") which, in turn, holds limited partnership interests in sixteen additional local limited partnerships; therefore, the Partnership holds interests, either directly or indirectly through REA IV, in forty-eight local limited partnerships. The other general partner of REA IV is NAPICO. Each of the local partnerships owns a low income housing project which is subsidized and\/or has a mortgage note payable to or is 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 the Partnership 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 partnerships in which the Partnership has invested are principally existing local limited partnerships. The Partnership became the limited partner in these local limited partnerships pursuant to arm's-length negotiations with the local partnership's general partners who are often the original project developers. In certain other cases, the Partnership invested in newly formed local partnerships which, in turn, acquired the projects. As a limited partner, the Partnership's liability for obligations of the local limited partnership is limited to its investment. The local general partner of the local limited partnership retains the responsibility of maintaining, operating and managing the project. Under certain circumstances, the Partnership has the right to replace the general partner of the local limited partnerships.\nAlthough each of the partnerships in which the Partnership 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.\nDuring 1995, all of the projects in which the Partnership 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 the Partnership, either directly or indirectly through REA IV, has invested.\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS AN INVESTMENT DECEMBER 31, 1995\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS AN INVESTMENT DECEMBER 31, 1995 (CONTINUED)\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS AN INVESTMENT DECEMBER 31, 1995 (CONTINUED)\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS AN INVESTMENT DECEMBER 31, 1995 (CONTINUED)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThrough its participation in local limited and general partnerships, the Partnership 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 Corporate General Partner was a plaintiff or defendant in several lawsuits, In addition, the Partnership is involved in the following lawsuits. In the opinion of management and the Corporate General Partner, the claims will not result in any material liability to the Partnership.\nJohn Mitchell v. Oakwood Apartments, NAPICO et al., Case No. 94CV112108, Court of Common Pleas, Lorain County, Ohio. On March 31, 1994, the Plaintiff filed a lawsuit alleging that on May 5, 1992, while returning to his apartment (Oakwood Apartments, Lorain, Ohio) he tripped and sustained mental and physical injuries. The Plaintiff voluntarily dismissed his action and a Notice of Voluntary Dismissal without prejudice was filed. The Plaintiff, however, refiled the action which remains pending.\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 interest. Limited Partnership Interests may be transferred only if certain requirements are satisfied. At December 31, 1995, there were 3,666 registered holders of units in the Partnership. No distributions have 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.\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\nThe Partnership's primary sources of funds include interest income on money market funds and certificates of deposit and distributions from local partnerships 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.\nCAPITAL RESOURCES\nThe Partnership received $39,000,000 in subscriptions for units of limited partnership interests (at $5,000 per unit) during the period March 7, 1984 to June 11, 1985, pursuant to a registration statement on Form S-11.\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 the Partnership has invested could produce tax losses for as long as 20 years. The Partnership will seek to defer income taxes from sale 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 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.\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. Available cash is invested in money market funds and certificates of deposit which provide interest income as reflected in the statement of operations. These temporary investments can be easily 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 management fee. The fee is payable monthly to the corporate general partner of the Partnership and is calculated as a percentage of the Partnership's invested assets. The fee is payable beginning with the month following the Partnership's initial investment in a local partnership.\nGeneral and administrative expenses of the Partnership consist substantially of professional fees or services rendered to the Partnership.\nInterest expense did not vary significantly in the years presented.\nThe Partnership, as a limited 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\nNot applicable.\nREAL ESTATE ASSOCIATES LIMITED VII (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 VII (A California limited partnership)\nWe have audited the accompanying balance sheets of Real Estate Associates Limited VII (a California limited partnership) as of December 31, 1995 and 1994, and the related 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 at 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 31 percent and 36 percent of total assets as of December 31, 1995 and 1994, respectively, and the equity in loss of these limited partnerships represents 21 percent, 14 percent and 28 percent of the total net 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit 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 VII 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\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nSTATEMENTS OF PARTNERS' DEFICIENCY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED VII (a California 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 financial statements.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION\nReal Estate Associates Limited VII (the \"Partnership\") was formed under the California Limited Partnership Act on May 24, 1983. 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. The general partners are Coast Housing Investments Associates, a limited partnership and National Partnership Investments Corp. (NAPICO), the corporate general partner, and National Partnership Investments Associates II (NAPIA II), a limited partnership. Casden Investment Corporation owns 100 percent of NAPICO's stock. The general partner of NAPIA II is NAPICO.\nThe Partnership issued 5,200 units of limited partnership interests through a public offering. Each unit was comprised of two limited partnership interests and two warrants granting the investor the right to purchase two additional limited partnership interests. An additional 10,400 interests associated with warrants were exercised. The general partners have a 1 percent interest in 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, 2033) 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 partners' fee may accrue but shall not be paid until the limited partners have received distributions equal to 100 percent of their capital contributions.\nUSES 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\nThese financial statements include the accounts of Real Estate Associates Limited VII and Real Estate Associates IV (\"REA IV\"), a California general partnership in which the Partnership holds a 99 percent general partner interest. Losses in excess of the minority interest is equity that would otherwise be attributed to the minority interest are being allocated to the Partnership.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\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.\nNET LOSS PER LIMITED PARTNERSHIP INTEREST\nNet loss per limited partnership interest was computed by dividing the limited partners' share of net loss by the number of limited partnership interests outstanding during the year. The number of limited partnership interests was 20,802 for all years presented.\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 32 limited partnerships. In addition, the Partnership holds a general partner interest in REA IV, NAPICO is also the general partner in REA IV. REA IV, in turn, holds limited partner interests in 16 additional limited partnerships. In total, therefore, the Partnership holds interests, either directly or indirectly through REA IV, in 48 partnerships all of which own residential low income rental projects consisting of 4,731 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 93 percent and 99 percent of the profits and losses in the limited partnerships it has invested in directly. The Partnership is also entitled to 99 percent of the profits and losses of REA IV. REA IV holds a 99 percent interest in each of the limited partnerships in which it has invested.\nEquity in losses of limited partnerships is recognized in the financial statements until the limited partnership investment account is reduced to a zero balance. 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 certain unconsolidated limited partnerships was approximately $6,359,000 and $5,063,000 as of December 31, 1995 and 1994, respectively.\nDistributions from the 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.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENT IN LIMITED PARTNERSHIPS (CONTINUED)\nThe following is a summary of the investments in limited partnerships and reconciliation to the limited partnership accounts:\nThe difference between the investment per the accompanying balance sheets at December 31, 1995 and 1994, and the equity per the limited partnerships' combined financial statements is due primarily to cumulative unrecognized equity in losses of certain 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:\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENT IN LIMITED PARTNERSHIPS (CONTINUED)\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 investee 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 26 of the limited partnerships included above, and another affiliate receives property management fees of approximately 5 to 6 percent of the revenue from three of these partnerships. The affiliate received property management fees of $116,175, $107,237 and $107,173 in 1995, 1994 and 1993 respectively. The following sets forth the significant data for these partnerships in which an affiliate of NAPICO was the general partner, reflected in the accompanying financial statements using the equity method of accounting:\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n3. NOTES PAYABLE\nCertain of the Partnership's investments involved purchases of partnership interests from partners who subsequently withdrew from the operating partnership. The Partnership is obligated on non-recourse notes payable of $24,869,501, bearing interest at 9 1\/2 percent, to the sellers of the partnership interests. The notes have principal maturity dates ranging from August 1999 to December 2002 or upon sale or refinancing of the underlying partnership properties. These obligations and related interest are collateralized by the Partnership's investments in the investee limited partnerships and are payable only out of cash distributions from the investee partnerships, as defined in the notes. Unpaid interest is due at maturity of the notes.\nMaturity dates on the notes payable are as follows:\n4. FEES AND EXPENSES DUE GENERAL PARTNER\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 .5 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 interest in the capital accounts of the respective partnerships.\nAs of December 31, 1995, the fees and expenses due the general partner exceeded the Partnership's cash. The general partners, during the forthcoming year, will not demand payment of amounts due in excess of such cash or such that the Partnership would not have sufficient operating cash.\nThe Partnership reimburses NAPICO for certain expenses. The reimbursement to NAPICO was $39,900, $38,450 and $39,725 in 1995, 1994 and 1993, respectively, and is included in operating expenses.\nREAL ESTATE ASSOCIATES LIMITED VII (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n5. CONTINGENCIES\nThe corporate general partner of the Partnership and the Partnership are involved in various lawsuits arising from transactions in the ordinary course of business. In the opinion of management and the corporate general partner, the claims will not result in any material liability to the Partnership.\n6. 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. 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.\n7. 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 notes payable are collateralized by the Partnership's investments in investee limited partnerships and are payable only out of cash distributions from the investee partnerships. The operations generated by the investee limited partnerships, which account for the Partnership's primary source of revenues, are subject to various government rules, regulations and restrictions which make it impracticable to estimate the fair value of the notes payable and related accrued interest and amounts due general partner. 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.\n8. 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 loss of limited partnerships reflected in the accompanying annual financial statements is based primarily upon audited financial statements of the investee limited partnerships. The decrease of approximately $164,000 between the estimated nine-month equity in loss and the actual 1995 year end equity in loss has been recorded in the fourth quarter.\nSCHEDULE\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (Continued)\nREAL ESTATE ASSOCIATES LIMITED VII INVESTMENTS IN, EQUITY IN EARNINGS OF AND DIVIDENDS RECEIVED FROM AFFILIATES AND OTHER PERSONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTES: 1. Equity in income (losses) of the limited partnerships represents the Partnership's allocable share of the net results of operations 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.\nSCHEDULE III\nREAL ESTATE ASSOCIATES LIMITED VII REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS INVESTMENTS DECEMBER 31, 1995\nREAL ESTATE ASSOCIATES LIMITED VII SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (CONTINUED) OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS INVESTMENTS DECEMBER 31, 1995\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED VII REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS INVESTMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTES: 1. Each local limited partnership has developed, owns and operates the housing project. Substantially all project costs, including construction period interest expense, were capitalized by the limited 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 from 25 to 40 years.\n3. Investments in property and equipment:\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED VII REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VII HAS INVESTMENTS DECEMBER 31, 1995, 1994 AND 1993\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nREAL ESTATE ASSOCIATES LIMITED VII (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 Company, 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.\nMr. 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 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 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.\nPATRICIA 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.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS\nReal Estate Associates Limited VII has no officers, directors or employees. 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 the 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.\nAn affiliate of the General Partner is responsible for the on-site property management 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 VII; no person is known to own beneficially in excess of 5 percent 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 VII.\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 accompanying notes to the financial statements.\nITEM 14.","section_14":"ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORT ON FORM 8-K\nFINANCIAL STATEMENTS\nReport of Independent 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' Deficiency 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 APPLICABLE TO REAL ESTATE ASSOCIATES LIMITED VII, REAL ESTATE ASSOCIATES IV AND THE LIMITED PARTNERSHIPS IN WHICH REAL ESTATE ASSOCIATES LIMITED VII AND REAL ESTATE ASSOCIATES IV HAVE INVESTMENTS.\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 the required information is included in the financial statements and notes thereto or they are not applicable or not required.\nEXHIBITS\n(3) Articles of incorporation and bylaws: The registrant is not incorporated. The Partnership Agreement was filed with Form S-11 #2-84816 which is incorporated herein by reference.\n(10) Material contracts: The registrant is not party to any material contracts, other than the Restated Certificate and Agreement of Limited Partnership dated May 24, 1983 and the forty-eight contracts representing the partnership investment in local limited partnership's as previously filed at the Securities Exchange Commission, File #2-84816 which is hereby incorporated by reference.\n(13) Annual report to security holders: Pages ____ to ____.\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the year ended December 31, 1995.","section_15":""}
{"filename":"35527_1995.txt","cik":"35527","year":"1995","section_1":"ITEM 1. BUSINESS\nORGANIZATION\nRegistrant was organized in 1974 under the laws of the State of Ohio. It began operations in 1975 upon reorganization of its principal subsidiary, The Fifth Third Bank. The executive offices of the Registrant are located in Cincinnati, Ohio. The Registrant is a multi-bank holding company as defined in the Bank Holding Company Act of 1956, as amended, and is registered as such with the Board of Governors of the Federal Reserve System. The Registrant is also a multi-savings-and-loan holding company and is registered with the Office of Thrift Supervision. Registrant has sixteen wholly-owned subsidiaries: Fifth Third Kentucky Bank Holding Company; The Fifth Third Bank; The Fifth Third Bank of Columbus Ohio; The Fifth Third Bank of Northwestern Ohio, N.A.; The Fifth Third Bank of Southern Ohio; The Fifth Third Bank of Western Ohio; Fifth Third Bank of Northeastern Ohio; Fifth Third Savings Bank of Northern Ohio, FSB; Fifth Third Bank of Florida; Fifth Third Bank of Northern Kentucky, Inc.; Fifth Third Bank of Kentucky, Inc.; The Fifth Third Savings Bank of Western Kentucky, FSB; Fifth Third Community Development Company; Fifth Third Investment Company; and Fountain Square Insurance Company. Unless the context otherwise indicates the term \"Company\" as used herein means the Registrant and the term \"Bank\" means its wholly-owned subsidiary, The Fifth Third Bank.\nAs of December 31, 1995, the Company's consolidated total assets were $17,052,883,000 and stockholders' equity totalled $1,724,575,000.\nThe Bank has four wholly-owned subsidiaries: Midwest Payment Systems, Inc.; Fifth Third Securities, Inc.; The Fifth Third Company; and The Fifth Third Leasing Company.\nACQUISITIONS\nThe Company is the result of mergers and acquisitions over the years involving financial institutions throughout Ohio, Indiana, Kentucky, and Florida. The Company made the following acquisitions during 1995:\nOn January 20, 1995, the Company acquired Mutual Federal Savings Bank of Miamisburg (Ohio), A Federal Savings Bank, with total assets of approximately $78 million, in a transaction accounted for as a pooling of interests.\nOn June 23, 1995, the Company purchased approximately $16 million in deposits and the fixed assets of the Lebanon, Ohio branch of Bank One.\nOn July 21, 1995, the Company acquired Falls Financial, Inc., with consolidated assets of approximately $573 million, and its wholly-owned subsidiary, Falls Savings Bank, FSB (\"Falls FSB\") in a transaction accounted for as a pooling of interests.\nPage 3\nOn September 8, 1995, the Company acquired Bank of Naples (Florida), with total assets of approximately $49 million, in a transaction accounted for as a pooling of interests. Concurrent with this transaction, Fifth Third Trust Co. & Savings Bank, FSB retained the bank charter of Bank of Naples and was renamed Fifth Third Bank of Florida.\nOn September 22, 1995, the Company purchased the Dayton Division of PNC Bank (Ohio). The offices, with approximately $256 million in deposits and $215 million in assets, were merged into the Bank's branch network.\nOn November 17, 1995, the Company purchased approximately $118 million in deposits and the fixed assets of several offices of Bank One, Cincinnati.\nIn August of 1995, the Company entered into a merger agreement with Kentucky Enterprise Bancorp, Inc., with $280 million in assets. In October of 1995 the Company entered into an agreement with NBD Bank (Ohio), a subsidiary of NBD Bancorp, Inc. to acquire 25 offices with deposits of $542 million in Columbus and Dayton. These transactions are expected to be completed in the first quarter of 1996.\nOn January 19, 1996, the Company purchased approximately $1.4 billion in deposits and the fixed assets of 28 Cleveland-area offices from 1st Nationwide Bank. The acquisition price of the deposits, offices and other fixed assets was approximately $136 million.\nCOMPETITION\nThere are hundreds of commercial banks, savings and loans and other financial services providers in Ohio, Kentucky, Indiana, Florida and nationally, which provide strong competition to the Company's banking subsidiaries. As providers of a full range of financial services, these subsidiaries compete with national and state banks, savings and loan associations, securities dealers, brokers, mortgage bankers, finance and insurance companies, and other financial service companies. With respect to data processing services, the Bank's data processing subsidiary, Midwest Payment Systems, Inc., competes with other electronic fund transfer (EFT) service providers such as Deluxe Data Services, EDS and Electronic Payment Systems and other merchant processing providers such as FDR, NPC and FIRST USA.\nThe earnings of the Company are affected by general economic conditions as well as by the monetary policies of the Federal Reserve Board. Such policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits.\nREGULATION AND SUPERVISION\nThe Company, as a bank holding company, is subject to the restrictions of the Bank Holding Company act of 1956, as amended. This Act provides that the acquisition of control of a bank is subject to the prior approval of the Board of Governors of the Federal Reserve System. The Company is required to obtain the prior approval of the Federal Reserve Board before it can acquire control of more than 5% of the voting shares of another bank. The Act does not permit the Federal Reserve Board to approve an acquisition by the Company, or any of its subsidiaries, of any bank located in a state other than Ohio, unless the acquisition is specifically authorized by the law of the state in which such bank is located. Page 4\nOn September 29, 1994, the Act was amended by The Interstate Banking and Branch Efficiency Act of 1994 which authorizes interstate bank acquisitions anywhere in the country effective one year after the date of enactment, and interstate branching by acquisition and consolidation effective June 1, 1997, in those states that have not opted out by that date. The impact of this amendment on the Company cannot be measured at this time.\nThe Company's subsidiary state banks are primarily subject to the laws of the state in which each is located, the Board of Governors of the Federal Reserve System and\/or the Federal Deposit Insurance Corporation. The subsidiary bank which is organized under the laws of the United States is primarily subject to regulation by the Comptroller of the Currency and the Federal Deposit Insurance Corporation. The Company, as a savings and loan holding company, and its savings and loan subsidiaries are subject to regulation by the Office of Thrift Supervision.\nThe Company and its subsidiaries are subject to certain restrictions on intercompany loans and investments. The Company and its subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting and public sale and distribution of securities. In addition, the Company and its subsidiaries are subject to examination at the discretion of supervisory authorities.\nThe Bank Holding Company Act limits the activities which may be engaged in by the Company and its subsidiaries to ownership of banks and those activities which the Federal Reserve Board has deemed or may in the future find to be so closely related to banking as to be a proper incident thereto.\nThe Financial Reform, Recovery and Enforcement Act of 1989 (FIRREA) provides that a holding company's controlled insured depository institutions are liable for any loss incurred by the Federal Deposit Insurance Corporation in connection with the default of, or any FDIC-assisted transaction involving, an affiliated insured bank or savings association.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"FDIC Improvement Act\") covers a wide expanse of banking regulatory issues. The FDIC Improvement Act deals with the recapitalization of the Bank Insurance Fund, with deposit insurance reform, including requiring the FDIC to establish a risk-based premium assessment system, and with a number of other regulatory and supervisory matters.\nEMPLOYEES\nAs of December 31, 1995, there were no employees of the Company. Subsidiaries of the Company employed 6,432 employees--1,042 were officers and 1,270 were part-time employees.\nSTATISTICAL INFORMATION\nPages 6 to 12 contain statistical information on the Company and its subsidiaries.\nPage 5\nSECURITIES PORTFOLIO\nThe securities portfolio as of December 31 for each of the last five years, and the maturity distribution and weighted average yield of securities as of December 31, 1995, are incorporated herein by reference to the securities tables on page 32 of the Company's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nThe weighted average yields for the securities portfolio are yields to maturity weighted by the par values of the securities. The weighted average yields on securities exempt from income taxes are computed on a taxable equivalent basis. The taxable equivalent yields are net after-tax yields to maturity divided by the complement of the full corporate tax rate (35%). In order to express yields on a taxable equivalent basis, yields on obligations of states and political subdivisions (municipal securities) have been increased as follows:\nUnder 1 year 2.48% 1 - 5 years 2.56% 6 - 10 years 2.63% Over 10 years 2.95% Total municipal securities 2.56%\nAVERAGE BALANCE SHEETS\nThe average balance sheets are incorporated herein by reference to Table 1 on pages 28 and 29 of the Company's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nANALYSIS OF NET INTEREST INCOME AND NET INTEREST INCOME CHANGES\nThe analysis of net interest income and the analysis of net interest income changes are incorporated herein by reference to Table 1 and Table 2 and the related discussion on pages 28 through 30 of the Company's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nPage 7\nPage 8\nPage 9\nPage 10\nReserve for Credit Losses - -------------------------\nThe reserve for credit losses is established through charges to operations by a provision for credit losses. Loans and leases which are determined to be uncollectible are charged against the reserve and any subsequent recoveries are credited to the reserve. The amount charged to operations is based on several factors. These include the following:\n1. Analytical reviews of the credit loss experience in relationship to outstanding loans and leases to determine an adequate reserve for credit losses required for loans and leases at risk. 2. A continuing review of problem or at risk loans and leases and the overall portfolio quality. 3. Regular examinations and appraisals of the loan and lease portfolio conducted by the Bank's examination staff and the banking supervisory authorities. 4. Management's judgement with respect to the current and expected economic conditions and their impact on the existing loan and lease portfolio.\nThe amount provided for credit losses exceeded actual net charge-offs by $13,101,000 in 1995, $18,306,000 in 1994 and $20,963,000 in 1993.\nManagement reviews the reserve on a quarterly basis to determine whether additional provisions should be made after considering the factors noted above. Based on these procedures, management is of the opinion that the reserve at December 31, 1995 of $177,388,000 is adequate.\nMaturity Distribution of Domestic Certificates of Deposit of $100,000 - --------------------------------------------------------------------- and Over at December 31, 1995 ($000's) --------------------------------------\nThree months or less $456,803 Over three months through six months 149,296 Over six months through twelve months 69,059 Over twelve months 29,810 -------- Total certificates - $100,000 and over $704,968 ========\nNote: Foreign office deposits are denominated in amounts greater then $100,000.\nPage 11\nReturn on Equity and Assets - ---------------------------\nThe following table presents certain operating ratios:\n1995 1994 1993 ------ ------ ------ Return on assets (A) 1.78% 1.77 1.71\nReturn on equity (B) 18.1% 18.6 17.8\nDividend payout ratio (C) 33.9% 32.3 31.7\nEquity to assets ratio (D) 9.82% 9.50 9.61 - ------------------------------------ (A) net income divided by average assets (B) net income divided by average equity (C) dividends declared per share divided by fully diluted net income per share (D) average equity divided by average assets\nPage 12\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices and the main office of the Bank are located on Fountain Square Plaza in downtown Cincinnati, Ohio, located in a 32-story office tower and a 5-story office building and parking garage known as the Fifth Third Center and the William S. Rowe Building, respectively. One of the Bank's subsidiaries owns 100% of these buildings.\nThe Company, through its subsidiary banks and savings banks, seven located in Ohio, three in Kentucky, one in Indiana and one in Florida, operate 384 banking centers, of which 191 are owned and 193 are leased. The properties owned are free from mortgages and encumbrances.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are not parties to any material legal proceedings other than routine litigation incidental to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this item is incorporated herein by reference to Page 1 of Registrant's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated herein by reference to page 37 of Registrant's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is incorporated herein by reference to pages 28 through 36 of Registrant's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is incorporated herein by reference to pages 15 through 27 and page 37 of Registrant's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item concerning Directors is incorporated herein by reference under the caption \"ELECTION OF DIRECTORS\" of the Registrant's 1996 Proxy Statement. The names, ages and positions of the Executive Officers of the Company as of January 31, 1996 are listed below along with their business experience during the past 5 years. Officers are appointed annually by the Board of Directors at the meeting of Directors immediately following the Annual Meeting of Stockholders.\nCURRENT POSITION and Name and Age Business Experience During Past 5 Years\nGeorge A. Schaefer, Jr., 50 PRESIDENT AND CEO. President and Chief Executive Officer of the Company and the Bank since January, 1991. Previously, Mr. Schaefer was President and COO of the Company and the Bank.\nGeorge W. Landry, 55 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank.\nStephen J. Schrantz, 47 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank.\nMichael D. Baker, 45 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank since August, 1995. Previously, Mr. Baker was Senior Vice President of the Company since March, 1993, and of the Bank.\nP. Michael Brumm, 48 EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. Executive Vice President of the Company and the Bank since August, 1995. Previously, Mr. Brumm was CFO of the Company and the Bank and Senior Vice President of the Bank.\nRobert P. Niehaus, 49 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank since August, 1995. Previously, Mr. Niehaus was Senior Vice President of the Company since March, 1993, and Senior Vice President of the Bank.\nMichael K. Keating, 40 EXECUTIVE VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY. Executive Vice President of the Company and the Bank since August, 1995 and Secretary of the Company and the Bank since January, 1994. Previously, Mr. Keating was Senior Vice President and General Counsel of the Company since March, 1993, and Senior Vice President and Counsel of the Bank. Mr. Keating is a son of Mr. William J. Keating, Director.\nCURRENT POSITION and Name and Age Business Experience During Past 5 Years\nRobert J. King, Jr., 40 SENIOR VICE PRESIDENT. Senior Vice President of the Company since March, 1995, and President and CEO of Fifth Third Bank of Northwestern Ohio, N.A.\nJames R. Gaunt, 50 SENIOR VICE PRESIDENT. Senior Vice President of the Company since March, 1994, and President and CEO of Fifth Third Bank of Kentucky, Inc. since August, 1994. Previously, Mr. Gaunt was Senior Vice President of the Bank.\nNeal E. Arnold, 35 TREASURER. Treasurer of the Company and the Bank, and Senior Vice President of the Bank since April, 1993. Previously, Mr. Arnold was Vice President of the Bank.\nGerald L. Wissel, 39 AUDITOR. Auditor of the Company and the Bank, and Senior Vice President of the Bank since November 1991. Previously, Mr. Wissel was Vice President of the Bank.\nRoger W. Dean, 33 CONTROLLER. Controller of the Company and Vice President of the Bank since June, 1993. Previously, Mr. Dean was with Deloitte & Touche LLP, independent public accountants.\nPaul L. Reynolds, 34 ASSISTANT SECRETARY. Assistant Secretary of the Company since March, 1995, and Vice President, General Counsel and Assistant Secretary of the Bank since January, 1995. Previously, Mr. Reynolds was Vice President, Counsel and Assistant Secretary of the Bank.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference under the caption \"EXECUTIVE COMPENSATION\" of the Registrant's 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated herein by reference under the captions \"CERTAIN BENEFICIAL OWNERS, ELECTION OF DIRECTORS, AND EXECUTIVE COMPENSATION\" of the Registrant's 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference under the caption \"CERTAIN TRANSACTIONS\" of the Registrant's 1996 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\na) Documents Filed as Part of the Report PAGE\n1. Index to Financial Statements\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 *\nConsolidated Balance Sheets, December 31, 1995 and 1994 *\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 *\n* Incorporated by reference to pages 15 through 27 of Registrant's 1995 Annual Report to Stockholders attached to this filing as Exhibit 13.\n2. Financial Statement Schedules\nThe schedules for Registrant and its subsidiaries are omitted because of the absence of conditions under which they are required, or because the information is set forth in the consolidated financial statements or the notes thereto.\n3. Exhibits\nEXHIBIT NO.\n3- Amended Articles of Incorporation and Code of Regulations (a)\n10(a)- Fifth Third Bancorp Unfunded Deferred Compensation Plan for Non-Employee Directors (b)\n10(b)- Fifth Third Bancorp 1990 Stock Option Plan (c)\n10(c)- Fifth Third Bancorp 1987 Stock Option Plan (d)\n10(d)- Fifth Third Bancorp 1982 Stock Option Plan (e)\n10(e)- Fifth Third Bancorp Stock Option Plan for Employees of The Fifth Third Bank of Miami Valley, National Association (f)\n10(f)- Fifth Third Bancorp Stock Option Plan for Employees of The Fifth Third Bank of Eastern Indiana (g)\n10(g)- Indenture effective November 19, 1992 between Fifth Third Bancorp, Issuer and NBD Bank, N.A., Trustee (h)\n10(h)- Fifth Third Bancorp Amended and Restated Stock Option Plan for Employees and Directors of The TriState Bancorp (i)\n10(i)- Fifth Third Bancorp 1993 Discount Stock Purchase Plan (j)\n10(j)- Fifth Third Bancorp Amended and Restated Stock Incentive Plan for selected Executive Officers, Employees and Directors of The Cumberland Federal Bancorporation, Inc. (k)\n10(k)- Fifth Third Bancorp Master Profit Sharing Plan (l)\n10(l)- Fifth Third Bancorp Amended and Restated Stock Option and Incentive Plan for Selected Executive Officers, Employees and Directors of Falls Financial, Inc. (m)\n11- Computation of Consolidated Net Income Per Share for the Years Ended December 31, 1995, 1994, 1993, 1992 and 1991\n13- Fifth Third Bancorp 1995 Annual Report to Stockholders\n21- Fifth Third Bancorp Subsidiaries\n23- Independent Auditors' Consent\nb) Reports on Form 8-K\nNONE. ____________________ (a) Incorporated by reference to Registrant's Registration Statement, Exhibits 3.1 and 3.2, on Form S-4, Registration No. 33-19965 which is effective.\n(b) Incorporated in this Form 10-K Annual Report by reference to Form 10-K filed for fiscal year ended December 31, 1985.\n(c) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 34075, which is effective.\n(d) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 13252, which is effective.\n(e) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 2-98550, which is effective.\n(f) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 20888, which is effective.\n(g) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission on November 18, 1992 a Form 8-K Current Report as an exhibit to a Registration Statement on Form S-8, Registration No. 33-30690, which is effective.\n(h) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission on November 18, 1992 a Form 8-K Current Report dated November 16, 1992 and as Exhibit 4.1 to a Registration Statement on Form S-3, Registration No. 33-54134, which is effective.\n(i) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 51679, which is effective.\n(j) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 60474, which is effective.\n(k) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 55223, which is effective.\n(l) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 55553, which is effective.\n(m) Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 61149, which is effective.\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.\nFIFTH THIRD BANCORP (Registrant)\n\/s\/George A. Schaefer, Jr. February 20, 1996 George A. Schaefer, Jr. President and CEO (Principal Executive Officer)\nPursuant to requirements of the Securities Exchange Act of 1934, this report has been signed on February 20, 1996 by the following persons on behalf of the Registrant and in the capacities indicated.\n\/s\/P. Michael Brumm \/s\/Roger W. Dean P. Michael Brumm Roger W. Dean Executive Vice President and CFO Controller (Chief Financial Officer) (Principal Accounting Officer)\n\/s\/John F. Barrett \/s\/Michael H. Norris John F. Barrett Ivan W. Gorr Michael H. Norris Director Director Director\n\/s\/Joseph H. Head, Jr. \/s\/James E. Rogers Milton C. Boesel, Jr.Joseph H. Head, Jr. James E. Rogers Director Director Director\n\/s\/Clement L. Buenger\/s\/Joan R. Herschede \/s\/Brian H. Rowe Clement L. Buenger Joan R. Herschede Brian H. Rowe Director Director Director\n\/s\/Gerald V. Dirvin \/s\/George A. Schaefer, Jr. Gerald V. Dirvin William G. Kagler George A. Schaefer, Jr. Director Director Director\n\/s\/William J. Keating \/s\/John J. Schiff, Jr. Thomas B. Donnell William J. Keating John J. Schiff, Jr. Director Director Director\n\/s\/James D. Kiggen \/s\/Dennis J. Sullivan, Jr. Richard T. Farmer James D. Kiggen Dennis J. Sullivan, Jr. Director Director Director\n\/s\/John D. Geary \/s\/Robert B. Morgan \/s\/Dudley S. Taft John D. Geary Robert B. Morgan Dudley S. Taft Director Director Director","section_15":""}
{"filename":"934612_1995.txt","cik":"934612","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSet forth below is a description of certain legal proceedings involving BNSF and its subsidiaries.\nWHEAT AND BARLEY TRANSPORTATION RATES\nIn September 1980, a class action lawsuit was filed against BNRR in United States District Court for the District of Montana (\"Montana District Court\") challenging the reasonableness of BNRR export wheat and barley rates. The class consists of Montana grain producers and elevators. The plaintiffs sought a finding that BNRR single car export wheat and barley rates for shipments moving from Montana to the Pacific Northwest were unreasonably high and requested damages in the amount of $64 million. In March 1981, the Montana District Court referred the rate reasonableness issue to the ICC. Subsequently, the state of Montana filed a complaint at the ICC challenging BNRR's multiple car rates for Montana wheat and barley movements occurring after October 1, 1980.\nThe ICC issued a series of decisions in this case from 1988 to 1991. Under these decisions, the ICC applied a revenue to variable cost test to the rates and determined that BNRR owed $9,685,918 in reparations plus interest. In its last decision, dated November 26, 1991, the ICC found BNRR's total reparations exposure to be $16,559,012 through July 1, 1991. The ICC also found that BNRR's current rates were below a reasonable maximum and vacated its earlier rate prescription order.\nBNRR appealed to the United States Court of Appeals for the District of Columbia Circuit (\"D.C. Circuit\") those portions of the ICC's decisions concerning the post-October 1, 1980 rate levels. BNRR's primary contention on appeal was that the ICC erred in using the revenue to variable cost rate standard to judge the rates instead of Constrained Market Pricing\/Stand Alone Cost principles. The limited portions of decisions that cover pre-October 1, 1980 rates were appealed to the Montana District Court.\nOn March 24, 1992, the Montana District Court dismissed plaintiffs' case as to all aspects other than those relating to pre-October 1, 1980 rates. On February 9, 1993, the D.C. Circuit served its decision regarding the appeal of the several ICC decisions in this case. The court held that the ICC did not adequately justify its use of the revenue to variable cost standard as BNRR had argued and remanded the case to the ICC for further administrative proceedings.\nOn July 22, 1993, the ICC served an order in response to the D.C. Circuit's February 9, 1993 decision. In its order, the ICC stated it would use the Constrained Market Pricing\/Stand Alone Cost principles in assessing the reasonableness of BNRR wheat and barley rates moving from Montana to Pacific Coast ports from 1978 forward. The ICC assigned the case to the Office of Hearings to develop a procedural schedule.\nOn October 28, 1994, plaintiffs filed their opening evidence arguing that the revenue received by BNRR exceeded the stand alone costs of transporting that traffic and that BNRR rates were unreasonably high. BNRR filed its evidence March 29, 1995, showing that the stand alone costs of transporting the traffic exceeded the revenue derived by BNRR on that traffic and that consequently, its rates were not unreasonably high. The parties filed briefs simultaneously on August 16, 1995, and the proceeding awaits decision by the Surface Transportation Board, successor to the ICC.\nCOAL TRANSPORTATION CONTRACT LITIGATION\nOn April 26, 1991, an action was filed against BNRR in the 102nd Judicial District Court for Bowie County, Texas, seeking a reduction of the transportation rates required to be paid under two contracts (Southwestern Electric Power Company v. Burlington Northern Railroad Company, No. D-102-CV- 91-0720). The plaintiff, Southwestern Electric Power Company (\"SWEPCO\"), was challenging the contract rates for transportation of coal to its electric generating facilities at Cason, Texas, and Flint Creek, Arkansas. SWEPCO contended that productivity gains achieved by BNRR constituted unusual economic conditions giving rise to a \"gross inequity\" because BNRR's costs of providing service have been reduced over the contracts' terms. On August 2, 1994, plaintiff amended its complaint to further allege that BNRR had been unjustly enriched by retaining differences between the rates actually charged and those that SWEPCO alleged should have been charged. SWEPCO sought both prospective rate relief and recovery of alleged past overcharges.\nBNRR's primary contention was that both parties anticipated productivity gains in the rail industry when negotiating the contracts and agreed that BNRR would retain most of its productivity gains. BNRR further contended that there was no agreement that transportation rates paid by SWEPCO would be based on BNRR's cost of providing service.\nOn November 18, 1994, the jury rendered a verdict denying plaintiff's request for prospective rate relief and that plaintiff take nothing on its principal claims of \"gross inequity.\" However, BNRR was assessed damages approximating $56 million relating to plaintiff's alternative claim of unjust enrichment. On January 20, 1995, the trial court rendered a judgment on the verdict in an amount approximating $74 million, which included attorneys' fees and interest. The judgment further awarded post-judgment interest at 10 percent per annum and issued declaratory orders pertaining to the two contracts. BNRR filed its notice of appeal in the case on February 17, 1995 and posted a bond staying enforcement of the judgment in the Court of Appeals for the Sixth Court of Appeals District of Texas, Texarkana, Texas (Burlington Northern Railroad Company v. Southwestern Electric Power Company, No. 06-95- 00024-CV). SWEPCO has filed a notice of cross appeal and the case is awaiting review. In the opinion of outside counsel, BNRR has a substantial likelihood of prevailing on appeal, although no assurances can be given due to the uncertainties inherent in litigation.\nENVIRONMENTAL PROCEEDINGS\nBy letter dated August 31, 1995, the Wisconsin Department of Justice, on behalf of the State of Wisconsin, notified BNRR of its intent to file a complaint by the end of September 1995 seeking penalties of $200 per day, a penalty assessment, and an environmental assessment for BNRR's alleged failure, for 964 days, to submit a remedial action plan for the Ashland Railyard, Ashland, Wisconsin, by May 7, 1993, as established by the Wisconsin Department of Natural Resources. BNRR undertook groundwater monitoring and removed and disposed of all former railroad structures on the property, but because of the existence of contamination from offsite and upgradient sources, did not believe that it would be prudent or technically reasonable to accomplish site remediation until all upgradient and contributing sources were properly considered. The property had been leased for many years to another railroad which operated the railyard facility. In State of Wisconsin v. Burlington Northern Railroad Company and Soo Line Railroad Company (Case No. 96 CV 007), BNRR settled this matter for $106,580 pursuant to a stipulation and order for judgment entered on January 22, 1996, by the Circuit Court for Ashland County, Wisconsin. This matter is now considered terminated.\nOn December 18, 1995, the State of Illinois filed a Complaint captioned People of the State of Illinois v. Burlington Northern Railroad Company, Beazer East, Inc. and Koppers Industries, Inc. (PCB No. 96-132) before the Illinois Pollution Control Board against BNRR, Beazer East, Inc. and Koppers Industries, Inc. alleging violations of the Illinois Environmental Protection Act with respect to a facility in Galesburg, Illinois. This facility is not operated by BNRR. The proceeding may result in monetary sanctions in excess of $100,000. BNRR and Beazer East, Inc. have made an offer to the State of Illinois to settle this matter.\nMERGER-RELATED LITIGATION\nNumerous complaints were filed arising out of the Agreement and Plan of Merger dated June 29, 1994, as amended, between BNI and SFP. On June 30, 1994, shortly after announcement of the proposed BNI-SFP merger (\"Merger\"), two purported stockholder class action suits were filed in the Court of Chancery of the State of Delaware (Miller v. Santa Fe Pacific Corporation, C.A. No. 13587; Cosentino v. Santa Fe Pacific Corporation, C.A. No. 13588). On July 1, 1994, two additional purported stockholder class action suits were filed in the Court of Chancery of the State of Delaware (Fielding v. Santa Fe Pacific Corporation, C.A. No. 13591; Wadsworth v. Santa Fe Pacific Corporation, C.A. No. 13597).\nThe actions named as defendants SFP, the individual members of the SFP Board of Directors, and BNI. In general, the actions variously alleged that SFP's directors breached their fiduciary duties to the stockholders by agreeing to the proposed merger for allegedly \"grossly inadequate\" consideration in light of recent operating results of SFP, recent trading prices of SFP's common stock and other alleged factors, by allegedly failing to take all necessary steps to ensure that stockholders will receive the maximum value realizable for their shares (including allegedly failing to actively pursue the acquisition of SFP by other companies or conducting an adequate \"market check\"), and by allegedly failing to disclose to stockholders the full extent of the future earnings potential of SFP, as well as the current value of its assets. The Miller and Fielding cases further alleged that the proposed Merger was unfairly timed and structured and, if consummated, would allegedly unfairly deprive the stockholders of standing to pursue certain pending stockholder derivative litigation. Plaintiffs also alleged that BNI was responsible for aiding and abetting the alleged breach of fiduciary duty committed by the SFP Board. The actions sought certification of a class action on behalf of SFP's stockholders. In addition, the actions sought injunctive relief against consummation of the Merger and, in the event that the Merger was consummated, the rescission of the Merger, an award of compensatory or rescissory damages and other damages, including court costs and attorneys' fees, an accounting by defendants of all profits realized by them as a result of the Merger, and various other forms of relief.\nOn October 6, 1994, shortly after Union Pacific Corporation (\"UPC\") issued a press release in which it announced a proposal for UPC to acquire SFP (the \"UPC Proposal\"), plaintiffs in the four lawsuits described above filed in the Court of Chancery of the State of Delaware a Consolidated Amended Complaint (Miller v. Santa Fe Pacific Corporation, C.A. No. 13587). In their Consolidated Amended Complaint, plaintiffs repeated the allegations contained in their earlier lawsuits and further alleged that, in light of the UPC Proposal, SFP's directors had breached their fiduciary duties by failing to fully inform themselves about and to adequately explore available alternatives to the merger with BNI, including the alternative of a merger transaction with UPC, and by failing to fully inform themselves about the value of SFP. The Consolidated Amended Complaint sought the same relief sought in plaintiffs' earlier lawsuits and, in addition, requested that SFP's directors be ordered to explore alternative transactions and to negotiate in good faith with all interested persons, including UPC.\nAlso, on October 6, 1994, five additional purported stockholder class action suits relating to SFP's proposed participation in the Merger with BNI were filed in the Court of Chancery of the State of Delaware (Weiss v. Santa Fe Pacific Corporation, C.A. No. 13779; Lifshitz v. Krebs, C.A. No. 13780; Stein v. Santa Fe Pacific Corporation, C.A. No. 13782; Lewis v. Santa Fe Pacific Corporation, C.A. No. 13783; Abramson v. Lindig, C.A. No. 13784). On October 7, 1994, three more purported stockholder class action suits relating to SFP's proposed participation in the Merger with BNI were filed in the Court of Chancery of the State of Delaware (Graulich v. Santa Fe Pacific Corporation, C.A. No. 13786; Anderson v. Santa Fe Pacific\nCorporation, C.A. No. 13787; Green v. Santa Fe Pacific Corporation, C.A. No. 13788). All of these lawsuits named as defendants SFP and the individual members of the SFP Board of Directors; the Lifshitz case further named BNI as a defendant. In general, these actions variously alleged that, in light of SFP's recent operating results and the UPC Proposal, SFP's directors breached their fiduciary duties to stockholders by purportedly not taking the necessary steps to ensure that SFP's stockholders would receive \"maximum value\" for their shares of SFP stock, including purportedly refusing to negotiate with UPC or to \"seriously consider\" the UPC Proposal and failing to announce any active auction or open bidding procedures. The actions generally sought relief that is materially identical to the relief sought in the Miller case, and in addition sought entry of an order requiring SFP's directors to immediately undertake an evaluation of SFP's worth as a merger\/acquisition candidate and to establish a process designed to obtain the highest possible price for SFP, including taking steps to \"effectively expose\" SFP to the marketplace in an effort to create an \"active auction\" in SFP. The Weiss case further sought entry of an order enjoining SFP's directors from implementing any poison pill or other device designed to thwart the UPC Proposal or any other person's proposal to acquire SFP.\nThe Anderson lawsuit was subsequently withdrawn. On October 14, 1994, the Chancery Court entered an order consolidating the remaining 11 purported stockholder class action suits under the heading In Re Santa Fe Pacific Corporation Shareholder Litigation, C.A. No. 13587 (the \"Shareholder Litigation\").\nOn October 26, 1994, BNI filed a Motion to Dismiss the Consolidated and Amended Complaint.\nOn March 6, 1995, plaintiffs in the Shareholder Litigation filed a Revised Second Consolidated and Amended Complaint, which superseded their previously filed complaints. The Revised Second Consolidated and Amended Complaint generally repeated many of the same allegations, and requested relief similar to that requested in plaintiffs' earlier complaints. In addition, the Revised Second Consolidated and Amended Complaint alleged that SFP's directors breached their fiduciary duties: by proceeding with and completing the joint SFP-BNI Tender Offer; by approving and implementing the Shareholder Rights Plan, which purportedly resulted in a \"premature ending\" of the \"bidding process\" by allegedly deterring and defeating UPC's acquisition overtures, exempting BNI from its provisions, and \"coercing\" SFP stockholders to vote in favor of the Merger; by approving the termination fee and expense reimbursement provisions of the Merger Agreement by authorizing the stock repurchase provisions of the Merger Agreement, which allegedly were designed to \"lock-up\" the Merger by providing stockholders with an \"illusory promise\" that the Merger Agreement exchange ratio would increase, while reserving SFP's right not to repurchase such stock; and by purportedly failing to disclose all material facts necessary for SFP's stockholders to evaluate in an informed manner and vote on the Merger, including purportedly failing to fully disclose the risks that the ICC would not approve the Merger and purportedly failing to fully disclose SFP's intentions with respect to the repurchase of SFP stock, as permitted by the Merger Agreement, as well as whether there will be a fair opportunity for all SFP stockholders to \"participate\" in any SFP stock repurchases, and on what basis. As additional relief to that requested in the earlier complaints, plaintiffs requested injunctive and other relief: enjoining consummation of the Merger; ordering SFP, SFP's directors, and BNI to make unspecified supplemental disclosures to stockholders; requiring SFP to conduct a new vote on the Merger subsequent to such disclosures; enjoining SFP from improperly or discriminatorily implementing the Shareholder Rights Plan or any other \"defensive\" tactic; ordering SFP's directors to take all appropriate steps to enhance SFP's value and attractiveness as a merger or acquisition candidate, including \"effectively exposing\" SFP to the marketplace by means of an active auction on a \"level playing field\"; and declaring the termination fee and expense reimbursement provisions of the Merger Agreement invalid and unenforceable.\nOn March 13, 1995, SFP and SFP's directors filed a motion to dismiss the Shareholder Litigation on the grounds that the Plaintiffs failed to state a cause of action upon which relief may be granted. BNI also filed a motion to dismiss the Revised Second Consolidated and Amended Complaint. On May 31, 1995, the Delaware Chancery Court rendered its decision granting the motion to dismiss that was filed by SFP and SFP's directors on March 13, 1995 and the motion to dismiss filed by BNI. The plaintiffs appealed the dismissal to the Delaware Supreme Court.\nOn November 22, 1995, the Delaware Supreme Court issued an opinion that affirmed in part and reversed in part the May 31, 1995 decision of the Delaware Chancery Court. The Delaware Supreme Court reversed the Chancery Court's dismissal of plaintiffs' claims that, in taking the alleged \"defensive\" actions identified in the Revised Second Consolidated and Amended Complaint, including approval and implementation of the Shareholder Rights Plan, SFP's directors violated their fiduciary duties to stockholders. The Delaware Supreme Court affirmed the Chancery Court's dismissal of all other claims asserted by plaintiffs in the litigation, including all claims against BNI.\nOn December 11, 1995, the SFP defendants filed with the Delaware Chancery Court a motion for summary judgment against plaintiffs' remaining claims in the Shareholder Litigation, which motion is pending. On December 29, 1995, the SFP defendants filed their Answer to plaintiffs' Revised Second Consolidated and Amended Complaint.\nBNSF believes this lawsuit is meritless and continues to oppose it vigorously.\nICC MERGER CASE\nOn October 13, 1994, BNI, BNRR, SFP, and ATSF (\"Applicants\") filed a railroad merger and control application with the ICC, Finance Docket No. 32549, Burlington Northern Inc. and Burlington Northern Railroad Company-- Control and Merger--Santa Fe Pacific Corporation and The Atchison, Topeka and Santa Fe Railway Company. Applicants sought an order, pursuant to 49 U.S.C. (S)(S) 11343-11347 (1988), approving and authorizing BNI's acquisition of control of and merger with SFP, the resulting common control of BNRR and ATSF by BNSF, the consolidation of BNRR and ATSF by BNSF, the consolidation of BNRR and ATSF operations, and the merger of BNRR and ATSF. The ICC approved the application in its written decision served August 23, 1995, which decision was effective as of September 22, 1995. Several petitions for reconsideration or to reopen the ICC's decision were filed by parties to the proceeding and all of these have been denied. Additionally, eight parties to the proceeding filed petitions for review of the ICC's approval decision with the United States Court of Appeals for the District of Columbia, which petitions are now pending before that court. Each of the petitions for reconsideration or to reopen and for review challenge various aspects of the ICC's decision, including the extent of conditions imposed on its approval. None of these petitions is expected to affect materially the benefits to be realized by the acquisition of common control of BNRR and ATSF by BNSF.\nCROW RESERVATION CROSSING ACCIDENT CASE\nAt approximately 10:15 a.m. on November 22, 1993, there was an accident at a BNRR railroad crossing located within the boundaries of the Crow reservation in which three members of the Crow tribe were killed. The crossing, which is located on a rural gravel road just south of Lodge Grass, Montana, was protected by crossbucks and advance warning signs.\nA lawsuit was filed in the Crow Tribal Court (Estates of Red Wolf, Red Horse and Bull Tail v. Burlington Northern Railroad Company, Case No. 94-31) on behalf of the estates of the driver and the two passengers. One of the passenger cases was severed and has yet to go to trial. The other two cases proceeded to trial in January 1996 and, on February 6, 1996, a Crow Tribal Court jury rendered a verdict against BNRR for compensatory damages in the total amount of $250 million.\nBNRR has filed an appeal to the Crow Court of Appeals in and for the Crow Indian Reservation, where it will seek, among other things, to have the case dismissed on the basis that the Crow Tribal Court lacks subject matter jurisdiction over these claims. If the appellate court fails to grant relief to BNRR, BNRR will pursue its defenses in federal court. On February 26, 1996, the Federal District Court for the District of Montana entered an order enjoining any action by plaintiffs to enforce the judgment pending appeal through the tribal court and federal court systems. BNRR was required to post a $5 million bond with the federal court.\nOTHER CLAIMS\nBNSF and its subsidiaries also are parties to a number of other legal actions and claims, various governmental proceedings and private civil suits arising in the ordinary course of business, including those related to environmental matters and personal injury claims. For a description of certain claims against SFP Pipelines and the Partnership, see the sections entitled \"East Line Civil Litigation and FERC Proceeding,\" \"East Line Civil Litigation,\" and \"FERC Proceeding\" under Item 3, Legal Proceedings, of the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995, which sections are hereby incorporated by reference. While the final outcome of these and other legal actions cannot be predicted with certainty, considering among other things the meritorious legal defenses available, it is the opinion of BNSF management that none of these items, when finally resolved, will have a material adverse effect on the annual results of operations, financial position or liquidity of BNSF, although an adverse resolution of a number of these items could have a material adverse effect on the results of operations in a particular quarter or fiscal year.\nReference is made to Note 6 to the consolidated financial statements on pages 29 and 30 of BNSF's 1995 Annual Report to Shareholders for information concerning certain pending administrative appeals between BNI and SFP and the Internal Revenue Service, which information is hereby incorporated by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted by BNSF to a vote of its securities holders during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nListed below are the names, ages, and positions of all executive officers of BNSF (excluding one executive officer who is also a director of BNSF) and their business experience during the past five years. Executive officers hold office until their successors are elected or appointed, or until their earlier death, resignation, or removal.\nJOHN Q. ANDERSON, 44\nSenior Vice President-Coal, Metals and Minerals Business Group since February 1996. Prior to that, Senior Vice President-Coal Business Group since September 1995, Executive Vice President, Coal Business Group of BNRR since June 1994, and Executive Vice President, Marketing and Sales of BNRR since February 1990.\nDOUGLAS J. BABB, 43\nSenior Vice President and Chief of Staff since September 1995. Prior to that, Vice President and General Counsel of BNRR from December 1986.\nJAMES B. DAGNON, 56\nSenior Vice President-Employee Relations since September 1995. Prior to that, Executive Vice President, Employee Relations of BNI since January 1992, and Senior Vice President, Employee Relations of BNI since August 1991.\nTHOMAS N. HUND, 42\nVice President and Controller since September 1995. Prior to that, Vice President and Controller of SFP since July 1990.\nDONALD G. MCINNES, 55\nSenior Vice President and Chief Operations Officer since September 1995. Prior to that, Senior Vice President and Chief Operating Officer of ATSF since January 1994, Senior Vice President-Intermodal Business Unit of ATSF since January 1992, and Vice President-Intermodal of ATSF since July 1989.\nJEFFREY R. MORELAND, 51\nSenior Vice President-Law and General Counsel since September 1995. Prior to that, Vice President-Law and General Counsel of SFP from October 1994, and Vice President-Law and General Counsel of ATSF from June 1989.\nCHARLES L. SCHULTZ, 48\nSenior Vice President-Intermodal and Automotive Business Unit since February 1996. Prior to that, Vice President-Intermodal from September 1995, Vice President-Intermodal of ATSF from January 1994, Vice President-Management Services of ATSF from June 1991, and Vice President-Information Services of ATSF from July 1989.\nDENIS E. SPRINGER, 50\nSenior Vice President and Chief Financial Officer since September 1995. Prior to that, Senior Vice President and Chief Financial Officer of SFP from October 1993, Senior Vice President, Treasurer and Chief Financial Officer of SFP from January 1992, and Vice President, Treasurer and Chief Financial Officer of SFP from January 1991.\nGREGORY T. SWIENTON, 46\nSenior Vice President-Consumer and Industrial Business Unit since February 1996. Prior to that, Senior Vice President-Industrial Business Unit from September 1995, Executive Vice President, Intermodal Business of BNRR from June 1994, and Executive Director-Europe and Africa (Brussels) of DHL Worldwide Express (international freight company) from January 1991.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation as to the principal markets on which the common stock of BNSF is traded, the high and low sales prices of such stock for the two years ending December 31, 1995 (or the common stock of BNI prior to September 22, 1995) and the frequency and amount of dividends declared on such stock during such period, is set forth below the heading \"Quarterly Financial Data-Unaudited\" on page 39 of BNSF's 1995 Annual Report to Shareholders and is hereby incorporated by reference. The approximate number of record holders of the common stock at January 31, 1996 was 85,000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThere is disclosed on page 1 of BNSF's 1995 Annual Report to Shareholders selected financial data of BNSF for each of the last five fiscal years. Such data with respect to the following topics are incorporated by reference: Revenues; Operating income (loss); Income (loss) before extraordinary item and cumulative effect of change in accounting method; Accounting change\/Extraordinary item; Net income (loss); Primary earnings (loss) per share; Fully diluted earnings (loss) per share; Dividends declared per common share; Total assets; Long-term debt, including current portion and commercial paper; and Redeemable preferred stock.\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 13 through 20 of BNSF's 1995 Annual Report to Shareholders is hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of BNSF and subsidiary companies, together with the report thereon of Coopers & Lybrand L.L.P. dated February 15, 1996, appearing on pages 21 through 39 of BNSF's 1995 Annual Report to Shareholders, are hereby incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the directors of BNSF is provided on pages 2 through 5 of BNSF's proxy statement dated March 5, 1996, under the heading \"Name, Age and Business Experience of Nominees for Director\" and the information under that heading is hereby incorporated by reference.\nInformation concerning the executive officers of BNSF (excluding one executive officer who is also a director of BNSF) is included in Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning the compensation of directors and executive officers of BNSF is provided on pages 6 through 7 under the heading \"Directors' Compensation\" and pages 26 through 33 under the heading \"EXECUTIVE COMPENSATION AND OTHER INFORMATION\" in BNSF's proxy statement dated March 5, 1996, and the information under those headings is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning the ownership of BNSF equity securities by certain beneficial owners and management is provided on pages 8 through 10 under the headings \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\" and \"SECURITY OWNERSHIP OF MANAGEMENT\" of BNSF's proxy statement dated March 5, 1996, and is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning certain relationships and related transactions is provided on page 7 under the heading \"Certain Relationships and Related Transactions\" of BNSF's proxy statement dated March 5, 1996, and the information under that heading is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this report:\n- -------- (*Incorporated by reference from the indicated pages of BNSF's 1995 Annual Report to Shareholders.)\n2. Consolidated Financial Statement Schedules for the three years ended December 31, 1995:\nSchedules other than that listed above are omitted because they are not required or applicable, or the required information is included in the consolidated financial statements or related notes.\n3. Exhibits:\nSee Index to Exhibits on pages E-1-E-4 for a description of the exhibits filed as a part of this Report.\n(b) Reports on Form 8-K\nBNSF filed the following Reports on Form 8-K during the quarter ended December 31, 1995:\nRegistrant filed Amendment No. 1 on Form 8-K\/A dated November 13, 1995 to Current Report on Form 8-K (Date of earliest event reported: September 22, 1995) which included under Item 7.B., Financial Statements, Pro Forma Financial Information and Exhibits, unaudited pro forma financial information reflecting the business combination of BNI and SFP effective September 22, 1995.\nRegistrant filed a Current Report on Form 8-K (Date of earliest event reported: November 21, 1995) which referenced under Item 5, Other Events, the establishment by the registrant on November 21, 1995 of two new credit facilities allowing borrowings of $2.5 billion and a commercial paper program.\nRegistrant filed a Current Report on Form 8-K (Date of earliest event reported: November 30, 1995) which referenced under Item 5, Other Events, and incorporated by reference a pro forma computation of ratio of earnings to fixed charges for the nine months ended September 30, 1995 and the year ended December 31, 1994, to reflect the business combination of BNI and SFP effective September 22, 1995.\nSIGNATURES\nBURLINGTON NORTHERN SANTA FE CORPORATION, PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nBURLINGTON NORTHERN SANTA FE CORPORATION\n\/s\/ Denis E. Springer By: _________________________________ Denis E. Springer Senior Vice President and Chief Financial 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 BURLINGTON NORTHERN SANTA FE CORPORATION AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nS-1\n\/s\/ Jeffrey R. Moreland *By _________________________________ Jeffrey R. Moreland Senior Vice President-Law and General Counsel Attorney in Fact\nDated: March 29, 1996\nS-2\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Burlington Northern Santa Fe Corporation and Subsidiaries\nOur report on the consolidated financial statements of Burlington Northern Santa Fe Corporation and Subsidiaries has been incorporated by reference in this Form 10-K from page 21 of the 1995 Annual Report to Shareholders of Burlington Northern Santa Fe Corporation. In connection with our audits of such consolidated financial statements, we have also audited the related financial statement schedule listed in the index of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic 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.\nFort Worth, Texas February 15, 1996\nSCHEDULE II\nBURLINGTON NORTHERN SANTA FE CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN MILLIONS)\n- -------- (1) Represents SFP's recorded liability at date of Merger (2) Principally represents cash payments (3) Classified in the consolidated balance sheet as follows:\nBURLINGTON NORTHERN SANTA FE CORPORATION\nINDEX OF EXHIBITS\n- -------- *Management contract or compensatory plan or arrangement.\nE-1\n- -------- *Management contract or compensatory plan or arrangement.\nE-2\n- -------- *Management contract or compensatory plan or arrangement.\nE-3\nE-4","section_15":""}
{"filename":"351012_1995.txt","cik":"351012","year":"1995","section_1":"ITEM 1. BUSINESS DESCRIPTION\nIntermagnetics General Corporation (\"the Company\") designs, develops and manufactures its products through two significant segments: Magnetic Products and Cryogenic Products. Magnetic Products consist primarily of low temperature superconducting (\"LTS\") magnets, wires and cable. These are developed and sold through the Company's Magnet Business Unit, and IGC Advanced Superconductors Division. As a part of its Magnetic Products segment, the Company also sells permanent magnet products through its Field Effects Division, and high temperature superconducting (\"HTS\") products through its Technology Development Operations. The Company's Cryogenic Products segment consists of low and extremely low temperature refrigeration equipment, which is designed, developed, manufactured and sold through the Company's wholly-owned subsidiary, APD Cryogenics Inc.\nMAGNETIC PRODUCTS\nGeneral Background\nSuperconductivity is the phenomenon in which certain materials lose all resistance to the flow of electrical current when cooled below a critical temperature. Consequently, devices made with superconductive materials require special refrigeration equipment, known as cryogenic systems, to maintain the materials at the very cold temperatures at which superconductivity occurs. Superconductors offer advantages over conventional conductors by carrying electricity with virtually no energy loss, and generating comparatively more powerful magnetic fields.\nThere are two broad classes of superconductive materials. LTS materials are metals and alloys that become superconductive when cooled to temperatures near absolute zero (4.2 Kelvin or minus 452 degrees Fahrenheit). Because of their superior ductile characteristics, LTS materials are generally used in the form of flexible wire or tape (\"Wire\/Tape\"). HTS materials are composed of specific compounds that become superconductive when cooled to temperatures close to that of liquid nitrogen (77 Kelvin or minus 320 degrees Fahrenheit). Although large scale commercial applications have not yet emerged for HTS materials, the Company is currently doing development work on various applications of HTS technology in the form of less flexible Wire\/Tape. See \"Research and Development - New Products\" below.\nApplications of Superconductivity Technology\nThe single largest existing commercial application for superconductivity is the magnetic resonance imaging (\"MRI\") medical diagnostic system (\"MRI System\"). MRI Systems are used in hospitals and clinics for non-invasive, diagnostic imaging of a patient's body. At the core of an MRI System is a large, highly engineered magnet system. The magnet system can be based upon a conventional resistive electro-magnet, a permanent magnet or a superconductive magnet. Although more expensive to manufacture, superconductive magnets offer far more powerful, high quality magnetic fields with virtually no power loss. Higher magnetic field strengths correlate with improved \"signal-to-noise\" ratios which can in turn lead to higher quality images. The commercial market for MRI Systems is estimated at approximately $1.5 billion worldwide. The worldwide market for MRI Systems has been essentially flat in recent years as declines in the U.S. market are offset by gains in overseas markets. The decline in sales in the U.S. market has generally been attributed to the impact of the national debate on health care reform within the U.S., and general economic conditions. The MRI industry is increasingly dominated by a small number of systems integrators worldwide who sell MRI Systems to end-users. The General Electric Company (\"GE\"), Siemens Corporation, Philips Medical Systems Nederlands B.V. (\"Philips\"), Hitachi Medical Corporation, Toshiba Corp., and Picker International Ltd. are the major MRI System integrators. The Company is a supplier of key components to MRI Systems integrators.\nA less significant but well-developed application for superconductivity is nuclear magnetic resonance (\"NMR\") spectroscopy. NMR spectroscopy is used in the research and testing of the composition and structure of non-ferrous materials. The Company does not currently compete in this market, although it is considering doing so in the future. See \"Principal Products - Other Superconductive Magnet Systems\" below.\nSuperconductivity is also applicable to other scientific, defense and research applications including particle accelerators and light sources. As with MRI and NMR, superconductive magnets generally compete in these areas on price and field strength with resistive or permanent magnets.\nThe Company believes that superconductive Wire\/Tape may have significant application in several other emerging areas. For example, the electric power industry, the Department of Defense and certain other users of electric power are currently exploring superconductive magnetic energy storage (\"SMES\") systems as a means of solving electricity transmission problems such as power sags and surges. See \"Research and Development - New Product Development: SMES\" below. HTS and novel permanent magnet materials may soon permit the commercially viable manufacture of motors, generators and other power devices that are more compact yet just as powerful as their conventional counterparts. See \"Research and Development - New Product Development: HTS\" below. In addition, superconductive magnets have transportation uses, which include the magnetic levitation of vehicles (\"MAGLEV\") including high-speed trains.\nAlthough the potential applications of superconductivity outlined above would incorporate technology currently in use or in development by the Company, there can be no assurances that commercially usable applications will emerge in the future or that the Company will be able to participate successfully in them.\nPrincipal Products\nWithin its Magnetic Products segment, the Company produces four distinct, significant types of products: Superconductive MRI Magnet Systems, Other Superconductive Magnet Systems, Superconductive Wire and Permanent Magnet Products.\n* Superconductive MRI Magnet Systems. Through its Magnet Business Unit, the Company sells superconductive MRI magnet systems to MRI Systems integrators for use in mobile and stationary MRI Systems. During fiscal years 1995, 1994 and 1993, MRI magnet systems (excluding the cryogenic shield cooler component) accounted for 46%, 31% and 34%, respectively, of the Company's net sales.\nThe Company's superconductive MRI magnet systems are solenoid magnets. These systems include a superconductive magnet, a cryostat (insulation device) to maintain the very cold environment necessary to support superconductivity, and an electronic system that energizes, monitors, controls and protects the magnet and the cryostat. The Company's magnets for MRI Systems are fitted with cryogenic refrigerators supplied by its subsidiary, APD Cryogenics Inc. (\"APD\"). In fact, the Company is the only vertically integrated manufacturer of superconductive MRI magnet systems, which the Company believes is an important source of competitive strength.\nIn November, 1993, the Company began introduction of its latest generation of superconductive MRI magnet systems, which by November, 1994 included three new MRI magnet systems with field strengths of 0.5, 1.0 and 1.5 Tesla (the \"New Magnets\"). Because the Company's previous superconductive MRI magnet system, the TM-5, was available only at a field strength of 0.5 Tesla (\"T\"), the New Magnets substantially broadened the Company's product line. Additionally, the Company believes that the New Magnets offer customers a substantial technological improvement over other MRI magnet systems currently available in commercial quantities from its competitors. Specifically, the Company believes that the New Magnets are lighter, more compact, easier to site in a hospital or clinic and may have lower maintenance costs than other available superconductive MRI magnet systems - all factors that the Company believes are important in an end-user's selection of an MRI System. To date, these New Magnets have been favorably received in the marketplace, with the Company's customers reporting substantial success in selling products incorporating the New Magnets to the end-user market.\n* Superconductive Wire. Through its IGC Advanced Superconductors (\"IGC-AS\") Division, the Company manufactures the two principal LTS materials that are commercially available for the construction of superconductive magnets: niobium-titanium (\"Nb-Ti\") wire, and niobium-tin (\"Nb3Sn\") wire. In contrast to the relatively large market for Nb-Ti wire, Nb3Sn multi-filamentary wire, which has been under development for many years, is sold only in limited quantities. During fiscal years 1995, 1994 and 1993, sales of superconductive wire accounted for 24%, 26% and 23%, respectively, of the Company's net sales.\nNb-Ti superconductive wire is composed of hundreds to thousands of continuous Nb-Ti filaments embedded in a matrix of copper or other nonferrous material. The process of manufacturing Nb-Ti wire is exacting, and some fabrication losses may be incurred.\n* Other Superconductive MRI Magnet Systems. Through its Magnet Business Unit, the Company also designs and builds superconductive magnet systems for various scientific and defense applications. These special purpose superconductive magnet systems are typically one of a kind, custom built systems. In the past several years, these have included a Large Gap Magnetic Suspension System for NASA, and a prototype ship propulsion system (similar to that found in the popular novel Hunt for Red October by Tom Clancy) for the Naval Undersea Warfare Center. The Company is currently manufacturing a portion of a 45 Tesla Hybrid Magnet for the National High Magnetic Field Laboratory at Florida State University (\"NHMFL\"). The Company is also designing and building a SMES System which it hopes will ultimately lead to a much larger market for multiple systems. See \"Research and Development - New Product Development: SMES\" below. The Company is also in advanced negotiations with NHMFL regarding the design and manufacture of a technology-leading 900 MHz superconductive magnet for NMR. Although the Company is not currently a significant player in the NMR market, it believes that the successful manufacture of such a cutting edge, 900 MHz superconductive magnet could position it to enter the high end of the NMR market if it so chooses.\n* Permanent Magnet Products. The Company's Field Effects Division (\"Field Effects\") develops and manufactures permanent magnet devices for various scientific and government defense applications. Field Effects recently delivered what the Company believes is the world's highest field permanent magnet \"wiggler\" for use at Stanford University's Synchrotron Radiation Laboratory.\nField Effects also sells permanent magnet systems for use in low field-strength MRI Systems. A maintenance-free magnet and a self-contained magnetic field with small fringe fields are among the advantages of these magnet systems. The potentially lower costs of certain permanent magnet MRI Systems may enable many smaller community hospitals and hospitals located in developing countries to provide MRI diagnostic services to their patients. The imaging quality of such systems is adequate for many diagnostic purposes, but it may not, under current technology, be comparable to images obtained with higher field-strength superconductive systems. Sales of such magnet systems to date have not been significant.\nMarketing\nThe Company markets its magnetic products and technology through its own personnel, and licenses the manufacture and marketing of superconductive MRI magnet systems for certain customers to its European joint venture. The Company also has a wholly-owned European marketing and service subsidiary located in England, as well as a foreign sales corporation located in Barbados. See Note J of Notes to Consolidated Financial Statements, included in response to Item 8 hereto.\nExport Sales. MRI magnets sold to Philips, a Dutch company, and Hitachi Medical Systems, a Japanese company, were accounted for as export sales even if installed in the U.S. On that basis, the Company's net export sales (including the Cryogenics segment) for fiscal years 1995, 1994 and 1993 totaled $51.6 million, $22.0 million and $31.8 million, respectively, most of which were to European customers.\nEuropean Joint Venture. The Company and GEC Alsthom S.A. (\"GEC-Alsthom\"), a leading French industrial group in the areas of electrical and electromechanical equipment, have participated since 1987 in a joint venture named GEC Alsthom Intermagnetics S.A. (\"AISA\"). AISA manufactures and markets in France, under license from the Company, superconductive MRI magnet systems. AISA also manufactures and markets, under license from the Company and GEC-Alsthom, superconductive wire. The licenses pursuant to which AISA manufactures superconductive MRI magnet systems and superconductive wire are set to expire in May, 1997. The Company currently owns twenty five percent (25%) of AISA. The Company's investment in AISA has been accounted for using the equity method of accounting. Accordingly, the Company's share of AISA's losses have been charged to operations to the extent of the Company's investment in AISA.\nThe Company and GEC Alsthom are currently re-negotiating the agreement pursuant to which the parties created AISA, and the various licenses under which AISA conducts its business. The Company does not currently believe that a failure to reach agreement with GEC Alsthom prior to expiration of the licenses would have a material adverse impact on the Company's business.\nPrincipal Customers. Most of the Company's sales are through its Magnetic Products segment, and most of those sales consist of MRI related products - superconductive MRI magnet systems or superconductive wire for use in such systems. During the past three fiscal years, sales to customers accounting for more than 10% of the Company's net sales in such years aggregated approximately 73% of net sales in fiscal 1995, 74% of net sales in fiscal 1994 and 79% of net sales in fiscal 1993. See Notes I and J of Notes to Consolidated Financial Statements, included in response to Item 8 hereto.\nSubstantially all of the Company's sales to the MRI industry are to four customers, two of which are significant. Philips is the current principal customer for the Company's MRI products. Pursuant to a five-year agreement (which expires in June, 1997, subject to automatic extension for successive one-year periods unless previously terminated in accordance with the agreement), the Company sells to Philips superconductive MRI magnet systems of various field strengths for incorporation in Philips' proprietary MRI Systems. The agreement requires Philips to purchase a certain level of its requirements for such superconductive MRI magnet systems from the Company at annually determined prices, with the balance to be acquired from AISA, all in accordance with an agreement between AISA and the Company. See \"Marketing - European Joint Venture\" above. Sales to Philips (including sales by the Cryogenic Products segment) amounted to approximately 52%, 32% and 46% of the Company's net sales for fiscal 1995, 1994 and 1993, respectively.\nThe Company's second principal customer for MRI products is GE. The Company has an agreement (which expires in December 1996) with GE providing for the sale of superconductive wire for use in MRI magnets manufactured by GE. Under the agreement, GE retains the right to decrease or cancel orders upon notice to the Company and payment for work performed prior to such decrease or cancellation. GE accounted for approximately 21%, 26% and 16% of the Company's net sales in fiscal 1995, 1994 and 1993, respectively.\nWithin the Magnetic Products segment as a whole, the Company's third most significant customer is the U.S. government or its agencies. Approximately 9%, 16% and 17% of the Company's net sales in fiscal 1995, 1994 and 1993, respectively, involved direct sales to the U.S. government or its agencies. The Company also has contracts with private parties that are funded under U.S. government programs and which are not included in the percentages above. Direct and indirect U.S. government programs are a principal portion of the Company's externally funded research and development activities. See \"Research and Development\" below. In general, direct and indirect U.S. government contracts are subject to renegotiation or termination under various circumstances. See \"Backlog\" below.\nCompetition\/Market\nAcross its four principal types of products (see \"Principal Products\" above), the Company derives more than 79% of its revenue from manufacturing and selling superconducting MRI magnet systems, superconductive wire and permanent MRI magnet systems for use in MRI Systems. Although US demand for MRI Systems\nappears to be declining and non-US demand growing, the Company believes that worldwide sales of MRI Systems in 1996 will not be significantly different from 1995.\nA significant factor affecting the Company is the fact that MRI Systems compete with other diagnostic imaging methods such as conventional and digital X-ray systems, nuclear medical systems, ultrasound, and X-ray CT scanners. Additionally, most large MRI Systems suppliers perceive that there are technical advantages to higher field-strength (0.5T or greater) imaging systems based upon superconductive magnets. However, there are MRI Systems that use resistive electromagnets and permanent magnets, which are limited by high power consumption or by basic material properties. As a result, these systems produce lower magnetic field-strengths than do superconductive magnets. Lower field strengths generally translate into lower signal-to-noise ratios and lower quality images. The cost of certain cryogenic liquids, such as helium, may cause markets in developing countries to prefer the lower operating costs that result from use of resistive or permanent magnets, despite image quality. Moreover, improved MRI Systems components have improved signal-to-noise ratios and so reduced the impact of field strength on image quality. Indeed, several significant MRI Systems integrators have recently introduced MRI Systems based upon such low field resistive or permanent magnets.\nThe Company's Magnetic Products are subject to substantial competition within each of the markets for its principal products. Moreover, practical and cost-effective conductors developed as a result of new discoveries in the field of HTS materials could eventually reduce the market for the Company's current LTS technology, although the Company (based upon the information currently available to it) does not believe this is likely to happen in the near future. See \"Research and Development - New Product Development: HTS\" below.\n* Superconductive MRI Magnet Systems. Within the market for MRI magnet systems, the Company's competitors fall into two categories: (1) magnet manufacturers that make MRI magnet systems for sale to MRI Systems integrators, and (2) MRI Systems integrators that manufacture superconductive magnet systems for their own use.\nThe Company considers its principal competitor in the manufacture of superconductive MRI magnet systems to be Oxford Magnet Technology Limited (\"OMT\"), a joint-venture between Siemens AG (51%) and Oxford Instruments Group, plc (49%) (\"Oxford\"), a United Kingdom company that formerly owned 100% of OMT. While OMT has sold substantially more superconductive MRI magnet systems, has greater production capacity, and greater financial resources than the Company, the Company believes it can compete effectively against OMT on both technological and cost bases.\nGE and Toshiba are examples of MRI Systems integrators that manufacture MRI magnet systems for use in their own MRI Systems. Historically, these integrators have been unavailable to the Company as customers for its superconductive MRI magnet systems, notwithstanding the fact that they represent a substantial portion of the potential market for superconductive MRI magnet systems. The Company has instead treated these companies as customers or potential customers for the Company's component products, such as superconductive wire or cryogenic coolers. The Company believes that as the market for MRI Systems continues to mature, its specialization in MRI magnet systems will permit it to offer superior products at highly competitive prices (made possible in part through the economies of volume production). The Company hopes that under these circumstances it could persuade one or more of these competitors to switch to the Company's superconductive MRI magnet systems. There is no assurance however that the Company's strategy will succeed in light of the fact that these competitors are well-capitalized, engaged in substantial research and development, and appear committed to the manufacture of what they view as an important and proprietary component of their MRI Systems.\n* Superconductive Wires. The single largest market for superconductive wire is MRI. In fact, most of the superconductive wire manufactured by the Company is used to manufacture superconductive MRI magnets (either internally by its own Magnet Business Unit, or externally by other customers). Regarding its superconductive wire products, the Company believes that it, Oxford Superconducting Technology, and Supercon, Inc. are the major suppliers of Nb-Ti in LTS wire form for the domestic (U.S.) markets. The Company also believes that the three of them along\nwith Teledyne S.C. (a subsidiary of Teledyne Wah Chang) are the major suppliers of Nb3Sn bulk processed superconductive materials for the domestic markets. There are several foreign manufacturers of Nb-Ti superconductive materials in wire form; none of them have been a significant factor in the domestic market.\nThe Company's prices for superconductive materials are generally competitive, and the Company believes that product quality and the ability to meet delivery schedules are factors important to its market position.\n* Other Superconductive Magnet Systems. With respect to Other Superconductive Magnet Systems, the Company has no single identifiable competitor. Historically, the Company has competed against many different companies, domestically and internationally, for the opportunity to design and build non-MRI superconductive magnet systems. The Company expects that competition for such opportunities will vary on a case to case basis, but that such competition will generally focus on price and technology. While the Company believes that it can remain competitive within this area, there can be no assurances that the Company will continue to be successful.\n* Permanent Magnet Products. In the development and manufacture of permanent magnets for MRI Systems, the principal competitor of the Company's Field Effects Division is Sumitomo Special Metals Co., Ltd. (\"Sumitomo\"), a Japanese company which was the first company to market such magnets utilizing neodymium boron iron (NdBFe) material. The Company believes that Sumitomo's primary customer for its permanent magnet products is Hitachi.\nThe Company believes that patents are not a significant competitive factor in the conduct of its business in this segment. While the Company does not have any substantial patent protection in this segment, it owns, or is a licensee under, a number of patents relating to superconductive materials, the manufacture of superconductive materials, and the permanent magnet systems manufactured by the Field Effects Division.\nBacklog\nThe Magnetic Products backlog at July 30, 1995 was approximately $33.7 million, compared to approximately $28.1 million on July 30, 1994. Approximately 24%, 29% and 36% of this segment's backlog at July 30, 1995 were represented by orders from GE, the U.S. government or its agencies and Philips, respectively. Most of the July 30, 1995 backlog is expected to be completed in fiscal 1996. However, the amount of backlog is not necessarily indicative of future revenues because the Company's backlog in this segment is subject to variations from time to time as products are manufactured and new orders are received.\nBacklog represents orders believed by the Company to be firm on the date indicated, subject, in certain cases, to future agreement on delivery dates and technical specifications. The Company's contract with GE for superconductive wire, which expires December 31, 1996, contains provisions allowing GE to increase, reduce or cancel orders, or delay delivery dates, subject to certain restrictions and payments. Direct contracts with the U.S. government (including cost-plus contracts) are included in the backlog figures at the contract amount less amounts previously recognized as revenue. Approximately $4,071,000 of such backlog has not yet been funded by the government. Certain direct and indirect (as a subcontractor) contracts with the U.S. government have provisions permitting the government to perform a final audit of such contracts and possibly seek a downward adjustment of the contract price on the basis of such audit and also contain provisions permitting termination for the convenience of the government. Upon such termination, the Company would be entitled to be compensated for costs incurred, including reasonable termination costs. Certain of such contracts may also be subject to termination in the event that more than 5% of the Company's outstanding shares become subject to foreign ownership.\nRaw Materials and Inventory\nThe Company's manufacturing process for superconducting and permanent magnet systems requires production periods of up to six months. Additionally, certain materials and parts used in production must be ordered well in advance\nof required delivery dates. The Company's investment in inventories for production of MRI magnet systems is based primarily on production schedules required to fill existing and anticipated customer orders. In addition, the Company maintains sufficient inventories of raw materials in order to produce small orders of superconductive wire.\nNb-Ti raw material required for production of Nb-Ti superconductive wire is purchased from several different sources. The Company has not experienced substantial difficulty in obtaining such materials.\nThe Company's Field Effects Division obtains its permanent magnet (ferrite) materials from Arnold Engineering Company located in Sevierville, Tennessee. There are alternative qualified domestic and international sources for these ferrite materials, but the industry is currently running at capacity in response to strong demand from the automotive industry. The principal effect of this strong demand has been to increase the price for ferrite materials and lengthen the Company's lead time for ordering the substantial quantities of this material required for its products. In light of the current low level of demand for its permanent magnet products and efficient management of its needs, the Company does not at this time believe that the supply of permanent magnet materials would have a substantial impact on its business.\nWarranty\nThe expense to the Company to date for performance of its warranty obligations has not been significant.\nCRYOGENIC PRODUCTS\nPrincipal Products\nThe Company's subsidiary, APD, produces specialty cryogenic refrigeration equipment for use in medical diagnostic equipment, laboratory research and semiconductor manufacturing. These products include:\n* MRI Products. APD produces specialized shield coolers and recondensers (refrigerators) that reduce or eliminate liquid helium and liquid nitrogen boil-off during normal operation of conventional superconductive MRI magnet systems. Recondensers are particularly important where helium prices are high because they greatly reduce periodic charges to replace liquid helium lost through boiling (known as \"boil-off\"). The Company's Magnet Business Unit uses APD refrigerators for its superconductive MRI magnet systems. In addition, APD sells these refrigerators to other manufacturers of superconducting MRI magnet systems. APD licensee Daikin Industries, Ltd. (\"Daikin\"), is a Japanese company that produces shield coolers and other cryogenic products for the Japanese market. It has captured a significant portion of that market for shield coolers.\n* Laboratory Cryogenic Systems. Laboratory cryogenic systems are sold to government, university and industrial research laboratories for use in applications such as spectroscopy, X-ray diffraction and narrow gap magnet studies, where they are used to reduce the temperatures of materials under study. These products generate cryogenic interface temperatures ranging from 2 Kelvin to 77 Kelvin using liquid nitrogen or helium open-cycle transfer systems or closed-cycle refrigeration systems.\n* Cryogenic Vacuum Pumps (Cryopumps). Cryopumps are used principally in the semiconductor industry, but have other industrial and research applications. APD sells cryopumps principally to manufacturers of semiconductor production equipment. Through a joint effort with Daikin, APD recently introduced the Marathon(R) line of cryopumps. The product line is tailored for semiconductor processing equipment and is supported by a comprehensive world-wide sales and service network.\n* CRYOTIGER(R) Refrigeration Systems. APD also sells a line of specialized cryogenic refrigeration systems under the registered tradename \"CRYOTIGER\". These refrigeration systems are intended to provide refrigeration optimization in the range of 70 Kelvin to 120 Kelvin for a broad range of applications. The first application of CRYOTIGER systems has been in electronic detector systems. Because the CRYOTIGER line is a closed-cycle refrigeration system, it competes\nprincipally against liquid nitrogen coolers, which in contrast to the CRYOTIGER line, requires the continued purchase of liquid nitrogen.\nMarketing\nThe Company markets its MRI products in this segment through a direct sales force based in APD's Allentown, Pennsylvania headquarters, APD's West Coast office in Sunnyvale, California and a European office near Oxford, England. APD also markets its laboratory systems and cryopump products through scientific and medical equipment sales representatives and distributors. APD also has a world-wide partnership with Daikin pursuant to which the parties sell common cryopumps under the \"Marathon\" trademark in well-defined territories. CRYOTIGER refrigeration systems are sold through APD's direct sales force, as noted above, and through scientific equipment sales representatives.\nCompetition\/Market\nThe Company's Cryogenic Products are subject to substantial competition within each of the markets for its principal products.\n* MRI Products. The Company considers its principal competitor in the manufacture of recondensers and shield coolers to be Leybold AG (\"Leybold\"). Leybold is headquartered in Germany, and has sold substantially more recondensers and shield coolers than the Company. Moreover, Leybold has greater production capacity, greater financial resources than the Company, and successfully locked up many of APD's potential customers in multi-year supply agreements. The Company nonetheless believes that it can compete with Leybold on both technological and cost bases.\n* Laboratory Cryogenic Systems. With respect to Laboratory Cryogenic Systems, the Company has no single identifiable competitor. Historically, the Company has competed against many different companies, domestically and internationally. The Company generally competes in this area on the basis of price and product quality.\n* Cryogenic Vacuum Pumps (Cryopumps). The Company believes Helix Technology Corporation (\"Helix\") (which markets its products under the names \"CTI Cryogenics\" and \"CTI\") to be the world leader in marketing cryopumps. The Company believes that Helix controls 50% or more of the world market for cryopumps. Notwithstanding Helix's market predominance, the Company believes that it can compete with Helix on technological and equipment performance bases.\n* CRYOTIGER Refrigeration Systems. Because the CRYOTIGER line is based upon proprietary technology recently developed and patented by APD, the Company feels that there is a significant opportunity for this product in the marketplace. CRYOTIGER refrigeration systems presently compete against certain closed-cycle machines, known as Sterling refrigerators, which the Company believes are more costly and less reliable than its CRYOTIGER product. Additionally, CRYOTIGER refrigerators, which are closed-cycle refrigeration systems, compete principally against open-cycle coolers that rely on reservoirs of liquid nitrogen which must be replenished periodically. Consequently, although the initial purchase price for a CRYOTIGER refrigerator may exceed the price of a comparable liquid nitrogen cooler, this higher initial cost will be offset by lower operating and maintenance costs and greater ease of use.\nBacklog\nDue to APD's relatively short production cycle, the Company does not consider backlog to be material to an understanding of APD's business.\nRaw Materials and Inventory\nAPD purchases certain major components for its products from single sources, but the Company believes alternate sources are available. APD generally maintains a sufficient inventory of raw materials, assembled parts, and partially and fully assembled major components to meet production requirements.\nWarranty\nThe expense to the Company to date for the performance of its warranty obligations has not been significant.\nRESEARCH AND DEVELOPMENT\nGeneral Research and Development\nThe Company believes its research and development activities are important to its continued success in new and existing markets. Externally-funded development programs have directly increased sales of design services and products and, at the same time, assisted in expanding the Company's technical capabilities without burdening operating expenses. Under many of the Company's government contracts, the Company must share any new technology resulting from such contracts with the government, which would include the rights to transfer such technology to other government contractors; however, the Company does not currently expect such rights to have a material adverse effect on it.\nPreviously, a substantial portion of research and development expenditures have been covered by external funding, principally from the U.S. government. In fiscal 1995, approximately 53% of total research and development activities were paid by such external programs compared to approximately 78% and 86% in fiscal years 1994 and 1993, respectively. During fiscal years 1995, 1994 and 1993, product research and development expenses, including those of the Cryogenic Products segment, were as follows:\nThe Company believes that, apart from continued reductions in federal spending on research and development, two other trends may limit external funding from U.S. government sources. First, and especially in the context of HTS technology, government contracts are emphasizing cost-sharing, which requires the awardee to contribute 20% to 50% of the total cost of the development effort. This cost-sharing requirement may limit the Company's reliance on the government as a significant source of research and development funds.\nSecond, the Company's continued growth will soon place it outside the definition of a \"small business\" for U.S. government funding purposes. \"Small businesses\" are defined as concerns which employ fewer than 500 employees. While a sign of the Company's overall success, the growing employee count will make the Company ineligible for certain government-sponsored research and development programs for small businesses, such as Small Business Innovation Research (\"SBIR\") grants. The Company completed fiscal year 1995 as a small business with an employee count of 494. During its fiscal year 1995, the Company won SBIR grants totaling approximately $5,004,000, all of which will be completed even if the Company loses its small business status prior to such completion.\nAlthough external funding for research and development has declined in recent years, the Company can experience, in any given year, significant increases or decreases in external funding depending on its success in obtaining large dollar funded contracts.\nNew Product Development: HTS Materials.\nThe Company believes that HTS materials in the form of Wire\/Tape may, in the future, have a substantial impact on commercial markets and applications for superconductors. In particular, the Company believes HTS materials could be suitable for larger scale specialized electric power applications and high field magnets in five to ten years, depending upon further advances. Accordingly, the Company's research and development activities are focused on: (1) converting HTS materials into usable Wire\/Tape with acceptable current densities, and (2) creating devices and equipment based upon such Wire\/Tape.\nBecause the Company believes that its expertise in processing LTS materials into wire and tape is applicable to the processing of HTS materials, the Company has focused its efforts on the development of HTS Wire\/Tape. The Company does not currently conduct substantial research and development on the use of HTS materials in the form of thin films. Additionally, although the Company has done some basic research on identifying new HTS materials, the Company does not believe it currently has the resources to make a meaningful contribution in the highly competitive and costly endeavor of identifying new HTS materials.\nThe Company's activities in this area have been funded primarily through government-supported research and development programs, including joint research agreements. Near the end of the 1995 fiscal year, the Company's joint development agreement with the U.S. Department of Energy's Argonne National Laboratory to develop commercial HTS wire products from Bismuth-based materials was extended. As part of the two-year project, the Department of Energy will provide the Company with $500,000 in research and development funds, which the Company will match. The project's goal is to implement a prototype manufacturing process that would improve the properties and reproducibility, and reduce the costs of manufacturing longer HTS wire lengths. An earlier collaboration between the Company and Argonne resulted in the successful manufacture of up to 800-meter lengths of multifilament conductor and high-performance monofilament tape conductors in lengths exceeding 100 meters. The long lengths of conductor were used to fabricate an engineering model magnet that generated a then-world record of 2.6T.\nWhile the Company expects to continue its focus on Bismuth-based HTS materials, it is seeking to broaden its technology base by developing wires using Thallium-based materials, which show promise of even higher superconducting performance than their Bismuth-based counterparts.\nThe Company does not believe its current operations depend upon successful market acceptance of HTS-based products, nor are the Company's continued operations necessarily dependent on its success in the HTS marketplace even if HTS-based products do become commercially viable. However, if technical problems are solved and HTS materials become feasible for commercial applications in fields in which the Company competes, then the Company could be adversely affected unless it is able to develop products using HTS materials. Accordingly, while representing a relatively high-risk, long-term investment of its resources, the Company perceives HTS technology as an important future commercial opportunity of major strategic significance. Consequently, the Company expects to continue to work in this area.\nBecause of the perceived high commercial potential of HTS materials, HTS research is a highly competitive field, and currently involves many commercial and academic institutions that may have more substantial economic and human resources to devote to HTS research and development than the Company. In addition, due to the proliferation of patents and patent applications, there can be no assurance that the Company will be able to compete effectively in this area due to the potential patent position of competitors.\nNew Product Development: SMES\nAs referenced above, the Company recently was awarded a contract to build a micro superconductive magnetic energy storage (\"SMES\") system for the U.S. Air Force. The Company believes the contract award represents an opportunity to enter a new market with promising commercial applications for superconductive magnets. A SMES acts as an electro-magnetic storage system that protects critical power loads from interruptions, spikes and sags. Utilities currently minimize power interruptions through use of Uninterruptible Power Supplies (UPS), which may use tens of hundreds of conventional lead acid batteries per system, require costly maintenance, and present an environmental hazard upon disposal. By contrast, a micro SMES is more energy efficient, easier to maintain, has a life of more than 20 years, and is environmentally friendly.\nWhile the potential SMES market appears substantial, there can be no assurances that the market will develop or that the Company will be able to successfully build on its entrance into that market through the award of the micro SMES system contract. Additionally, the Company faces other competitors interested in the SMES market, some of which may have superior resources and patent positions.\nNew Product Development: Refrigerants\nThe Company believes that its FRIGC(R) family of environmentally acceptable refrigerants has broad-based commercial potential as replacements for ozone-depleting chlorofluorocarbons (\"CFC's\") currently being used as refrigerants. FRIGC refrigerants consist of various blends of refrigerant chemicals, each custom designed for a specific application. The Company has demonstrated various custom tailored blends of its FRIGC refrigerant under different operating conditions in automobiles, household refrigerators, home and commercial air conditioners and commercial freezers.\nThe Company's FR-12(R) refrigerant is the first commercial product from its FRIGC family of refrigerants. The Company developed FR-12 refrigerant for use as a replacement for Freon R-12 in the after-market for automobile air conditioning refrigerants. (Most post-1994 automobile air conditioning systems have been designed for use with HFC-134a refrigerant. HFC-134a, however, cannot be used in most pre-1994 R-12 automotive air conditioning systems without substantial and costly changes - changes not required for use of FR-12 refrigerant.) Although this market for pre-1994 automobile air conditioning systems is finite in nature, the Company believes that by entering a niche but substantial market with limited interest to its competitors now, it will gain valuable experience and name recognition that will greatly facilitate future commercialization of other FRIGC refrigerants for other applications. The Company also believes that this market niche could prove significant as production of R-12 in the United States ceases after December 31, 1995, and existing stockpiles of R-12 are steadily depleted over the next several years.\nThe Company has identified at least four important factors upon which successful commercialization of FRIGC FR-12 refrigerant will depend. There can be no assurances, however, that even if the Company succeeds with respect to these four factors that FRIGC FR-12 refrigerant will be accepted by the market or otherwise prove a commercial success. The Company believes that to successfully commercialize FR-12 refrigerant it must secure:\n* EPA listing of FR-12 refrigerant as an acceptable substitute for R-12. Effective as of July 13, 1995, the Company successfully obtained final EPA listing of FRIGC FR-12 refrigerant as an acceptable substitute for R-12 in mobile air conditioning applications. In this regard, FR-12 refrigerant met or exceeded the EPA's listing requirements, including proof that FR-12 refrigerant meets ozone depletion and global warming targets, and that FR-12 refrigerant is neither toxic nor flammable under use conditions. Use of FR-12 refrigerant is nonetheless subject to certain standard conditions (primarily the use of special fittings which are required for all refrigerants) to prevent unintended mixing of different refrigerants and facilitate recovery of refrigerants for recycling.\n* Patent protection for FR-12 refrigerant. In June, 1995, the U.S. Patent Office issued to the Company U.S. Patent # 5,425,890 entitled Substitute Refrigerant For Dichlorodifluoromethane Refrigeration Systems. This patent, which broadly protects FRIGC FR-12 refrigerant, covers the specific formula approved for listing by the EPA. The Company is currently pursuing foreign protection in targeted markets.\n* A reliable, high quality source of FR-12 refrigerant. On May 11, 1995, the Company signed an agreement with Schenectady International, Inc. (\"SII\") for the manufacture of FR-12 refrigerant. The Company believes that the agreement with SII, a privately held, multinational chemical company with thirteen (13) manufacturing facilities in ten (10) countries, will assure a quality supply of FR-12 refrigerant. SII's ability to produce commercial quantities of FR-12 refrigerant will depend on the availability of raw materials, which are manufactured by a small number of companies, including E.I. du Pont de Nemours & Co. (\"duPont\"), Allied Signal Corporation and Ausimont (Italy). Due to the small number of suppliers, there are no assurances the Company will be able to produce FR-12 refrigerant at a competitive cost.\n* A marketing and distribution network targeted on identified niche opportunities. With respect to marketing and distribution, the Company has initially targeted automobile and truck fleet operators for the first commercial introduction of FRIGC FR-12 refrigerant. In fact, the Company delivered FR-12 refrigerant against its first significant order on May 6, 1995 to Tinker Air Force Base (\"Tinker\"). Tinker is using the refrigerant in its vehicle fleet, and is exploring its use in other applications, including aircraft, ground support equipment and temperature carts. The Company believes that sales of FR-12 refrigerant to fleet operators will accelerate its market penetration by concentrating its sales efforts on customers that will realize the most significant cost savings.\nNotwithstanding its success to date with FR-12 refrigerant, the Company does not have extensive experience marketing, selling and distributing refrigerants. Consequently, the Company continues to examine its need for a strategic partner to assist it with commercialization of FRIGC FR-12 refrigerant. There can be no assurances that the Company will be successful in marketing and distributing FR-12 refrigerant, either on its own or with the assistance of a strategic partner, or that the market will accept FR-12 refrigerant as a viable alternative to R-12.\nUnder a letter of intent with the Chrysler Corporation (\"Chrysler\") entered early in fiscal year 1994, Chrysler indicated its interest in purchasing quantities of FRIGC refrigerant, although such purchases were contingent upon the Company meeting regulatory approvals as well as performance and price targets. While the Company has recently made substantial progress in initiating commercialization of its FRIGC refrigerant, as noted above, there can be no assurances that the Company will meet the various remaining contingencies set forth in the letter of intent, or that Chrysler's requirements for FRIGC refrigerant will materialize as envisioned in light of duPont's extension of the production of R-12 refrigerant through December, 1995. The Company does not currently believe that Chrysler will purchase material quantities of FRIGC refrigerant during the Company's fiscal year 1996.\nThe Company currently expects that, over the long run, it will introduce other refrigerants from its FRIGC family of refrigerants for other carefully targeted market opportunities. The Company believes that its refrigerant technology - which is an outgrowth of its expertise in cryogenic technology - may give it a superior insight into refrigerant design and more flexibility in designing refrigerating hardware. Nonetheless, many other companies and research facilities currently are working to identify environmentally acceptable alternatives to the existing CFC- and HFC-based refrigerants. Many of these companies are larger, better financed, better staffed and more experienced in the refrigerant business than the Company. There can be no assurances that the Company's future refrigerants will meet all relevant regulatory and commercial requirements or that they will be accepted in the market.\nMoreover, the Company's success in developing and commercializing FRIGC refrigerant and associated technology will depend on its continued ability to obtain patents, maintain trade secret protection and operate without infringing on the proprietary rights of third parties. The Company expects to continue filing additional patent applications relating to its new refrigerant technology in the near future. No assurance can be given that any additional patents will issue with respect to patent applications filed or to be filed by the Company. Furthermore, even if such patents issue, there can be no assurance that any issued patents will protect against competitive products or otherwise be commercially valuable.\nINVESTMENTS\nULTRALIFE BATTERIES, INC.\nThe Company owns 1,060,753 shares of the common stock (approximately 14% of the outstanding common stock) of Ultralife Batteries, Inc. (\"Ultralife\"). Headquartered in Newark, N.Y., Ultralife produces lithium batteries that are the same size and voltage as standard batteries, but have double the operating life and a longer shelf life (up to 10 years) than alkaline or zinc carbon batteries. These batteries currently command a premium price in the market for long-life batteries.\nUltralife focuses on markets which require increased energy density and extended shelf life. The Company is represented on Ultralife's Board of Directors, and the companies have entered an agreement under which the Company is paid for providing certain technical advice and consulting services to Ultralife. To date, the amount of money received by the Company under this agreement has not been material.\nUltralife completed an initial public offering of its common stock on December 31, 1992, and a second public offering on December 9, 1994. Although the Company elected to offer a portion of its Ultralife shares in connection with the underwriter's overallotment right in Ultralife's second public offering, this overallotment right was never exercised, and the Company ultimately sold none of these shares. The Company may in the future seek to sell all or a portion of these Ultralife shares.\nUltralife's common stock is traded on the NASDAQ National Market System under the symbol ULBI. On July 31, 1995, Ultralife's common stock closed at a price of $16.50 per share.\nSURREY MEDICAL IMAGING SYSTEMS LIMITED\nAs of July 31, 1995, the Company owns 354,223 shares of the outstanding ordinary shares (approximately 23%) of Surrey Medical Imaging Systems Limited (\"SMIS\"). Located in Guildford, England, SMIS focuses on developing and marketing electronics and software for MRI and nuclear magnetic resonance spectroscopy applications. It also supplies equipment using X-ray and gamma ray Computerized Tomography (\"CT\") and Ultrasonics for use in non-destructive testing of a variety of materials.\nThe Company believes that complete magnetic resonance system products can be built by combining SMIS' systems electronics and software with Intermagnetics' magnet systems. In this way, Intermagnetics and SMIS are able to address certain niche markets in both the clinical and industrial sectors which would be largely unavailable to the parties separately. Further, access of each party to a broader customer base, and augmented market intelligence, are expected to provide a greater sales potential for each of the parties' products individually. To date, the parties have collaborated on a variety of different opportunities including most recently a successful joint bid to develop a non-destructive NMR System for food analysis.\nAs SMIS is privately held, the market value of this investment is not readily determinable.\nPERSONNEL\nAt May 28, 1995, the Company employed 494 people.\nWithin the Magnetic Products segment, the production and maintenance employees of the Company's IGC-AS Division, which is located in Waterbury, Connecticut, are represented by the United Steelworkers of America (\"United Steelworkers\"). The Company and the United Steelworkers negotiated a five year collective bargaining agreement, effective May 31, 1993. Within the Cryogenic Product segment, the production employees of the Company's subsidiary, APD, which is located in Allentown, Pennsylvania, are also represented by a labor union, the International Association of Machinists and Aerospace Workers (\"IAMAW\"). The Company and IAMAW negotiated a three-year collective bargaining agreement, effective August 8, 1994.\nThere is great demand for trained scientific and technical personnel, and the Company's growth and success will require it to attract and retain such personnel. Many of the prospective employers of such personnel are larger and have greater financial resources than the Company and may be in a better position to compete with the Company for prospective employees.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are:\nMr. Rosner has been Chairman of the Board of Directors of the Company since the Company's formation in 1971 and before that headed the Superconductive Products Operation of GE. A principal founder of the Company, he also served as the Company's President and Chief Executive Officer until December 1978 and October 1981, respectively. He was renamed President and Chief Executive Officer in 1984, and has held such position since then.\nMr. Dannemann was named Senior Vice President-Operations on May 1, 1995. Before joining the Company he was a corporate Vice President at Spar Aerospace, Ltd., in Toronto, Canada from May, 1984, and before that spent seventeen years at General Electric in aerospace marketing and business development.\nMr. Zeigler was appointed Senior Vice President-Finance and Chief Financial Officer of the Company in September 1993. He previously served as Vice President-Finance and Chief Financial Officer of the Company from June 1987 until his appointment as a Senior Vice President, and served as the Company's Controller from June 1985 through June 1987.\nMr. Zeitlin has been employed by the Company in various capacities since 1974. He has been responsible for marketing superconductive materials since 1982, and became Vice President-Materials Technology of the Company in 1985. Mr. Zeitlin has also headed the Company's superconductive materials operations (now IGC-AS) since 1987.\nMr. Hordeski was appointed APD Cryogenics Inc. - Vice President and General Manager in 1990. Before joining the Company, he was employed by Leybold Vacuum Products, Inc. from 1982 to 1990, most recently as Vice President of Marketing.\nDr. Pykett was appointed Technology Development Operations - Vice President in 1991. Prior to joining the Company, he had been President and Chief Executive Officer of Advanced NMR Systems, Inc., a diagnostic imaging company he co-founded in 1983.\nMr. Rhodenizer was appointed Magnet Business Unit - Vice President in 1991. He originally joined the Company in 1971 as a project engineer and then served as Manager of Cryomagnetics and Manager of Projects until 1977. Between 1977 and 1990, Mr. Rhodenizer was employed by General Electric in a succession of management positions, culminating with the position of Manager, Superconducting Applications Program.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nSince March, 1994, the Company's corporate offices, MBU and HTS Laboratory have been located in 145,810 square feet of newly constructed or newly renovated space located in Latham, New York (the \"Latham Facility\"). The Company financed the construction of the Latham Facility using existing cash reserves. In April, 1994, the Company executed a promissory note in the principal amount of $6,500,000 payable to a bank, which note was secured by a collateral assignment of a deposit account containing proceeds from a $6,500,000 loan from the bank. In August, 1994, the Company executed a mortgage in favor of the bank on the Latham Facility (including the land on which it is sited, and certain fixtures associated with the Latham Facility) in the amount of the unpaid principal due on the promissory note and the collateral assignment on the deposit account was released. The loan which is secured by the mortgage bears interest at the rate of 7.5%, and matures in May, 2001.\nThe Company's production facilities for superconductive materials are located in Waterbury, Connecticut in premises of approximately 212,700 square feet (of which 57,900 square feet are presently being used) pursuant to a thirty year prepaid lease which expires in December 2021. The facility's equipment includes a drawbench with a pulling force of up to 150,000 pounds and a length of approximately 400 feet. The Company believes that this drawbench is one of the largest in the world.\nThe Field Effects Division operates out of leased premises totaling 12,600 square feet in Acton, Massachusetts. Field Effects' facilities are subject to a one year lease expiring July 1, 1996. The Company does not believe that Field Effects' facility is significant to the Company's operations, and the Company does not believe that the failure to renew, or the loss of, this lease would have a material adverse effect on the Company's operations.\nAPD operates out of a building, which it owns, in Allentown, Pennsylvania totaling 56,550 square feet.\nThe Company believes its facilities are adequate and suitable for its current and near-term needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Company nor any of its subsidiaries is a party to any material legal proceeding. To the Company's knowledge, no director, officer, affiliate of the Company, holder of 5% or more of the Company's Common Stock, or associate of any of the foregoing, is a party adverse to, or has a material interest adverse to, the Company or any of its subsidiaries in any proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock is traded on the American Stock Exchange under the symbol IMG. The high and low sales prices of the Common Stock for each quarterly period for the last two fiscal years, as reported on the American Stock Exchange, are shown below.\n------------- (1) The closing prices have been adjusted to reflect a five-for-four stock split that was distributed on September 8, 1994 to stockholders of record as of August 25, 1994 rounded to the nearest $1\/8, and a three percent stock dividend distributed on June 15, 1995 to stockholders of record on May 31, 1995, rounded to the nearest $1\/8.\nThere were 2006 holders of record of Common Stock as of August 11, 1995. The Company has not paid cash dividends in the past ten years, and it does not anticipate that it will pay cash dividends or adopt such a cash dividend policy in the near future. The Board of Directors of the Company has declared a policy of granting annual stock dividends where, and to the extent that, the performance of the Company warrants such a declaration. Under the Company's bank agreements, prior bank approval is required for cash dividends in excess of the Company's net income for the year to which the dividend pertains.\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 selected statement of operations data and the selected balance sheet 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 and the Consolidated Financial Statements and related Notes included in response to Items 7 and 8 hereto.\n--------------- (a) Income per primary share has been computed during each period based on the weighted average number of shares of Common Stock outstanding plus dilutive common stock equivalents (where applicable).\n(b) The Company did not pay a cash dividend on its Common Stock during any of the periods indicated.\n(c) Net income per primary share has been restated to give effect to the five-for-four stock split effected September 8, 1994, and the 3% stock dividends distributed in September, 1991, September, 1992, September, 1993, and June, 1995.\n(d) Net income for the fiscal year ended May 29, 1994 reflects a cumulative effect of accounting change in the amount of $888,000 or $.08 per primary share.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSUMMARY\nThe following tables set forth, for the periods indicated, the percentages which certain items reflected in the financial data bear to total revenues of the Company and the percentage change of such items from period to period. See the Consolidated Financial Statements included in response to Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nAttached hereto and filed as part of this report are the financial statements and supplementary data listed in the list of Financial Statements and Schedules included in response to Item 14 of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nEffective September 1, 1994, the Company's certifying accountant, the firm of Ernst & Young, LLP (\"Ernst & Young\"), closed their Albany, New York practice. As of September 12, 1994, the client-auditor relationship between the Company and Ernst & Young ceased.\nErnst & Young had been the Company's auditors since the Company's initial public offering. The reports of Ernst & Young on the Company's financial statements for fiscal 1994 and 1993 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 Company's financial statements for each of the two fiscal years ended May 29, 1994 and May 30, 1993, and in the subsequent interim period, there were no disagreements 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, would have caused Ernst & Young to make reference to the matter in their report. In connection with the filing by the Company of a Report on Form 8-K, dated September 12, 1994, Ernst & Young submitted a letter addressed to the Securities and Exchange Commission in which it agreed with the Company's foregoing statements.\nAt a meeting held on November 9, 1994, the Audit Committee of the Board of Directors of the Company approved the engagement as of that date of KPMG Peat Marwick LLP (\"KPMG\") as the Company's independent auditors for the fiscal year ending May 28, 1995.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information concerning directors called for by Item 10 of Form 10-K will be set forth under the heading \"Election of Directors\" in the Company's definitive proxy statement relating to the 1995 Annual Meeting of Shareholders (the \"Proxy Statement\"), and is hereby incorporated herein by reference.\nThe information concerning executive officers called for by Item 10 of Form 10-K is set forth in \"Item 1. Business\" of this annual report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information with respect to compensation of certain executive officers and all executive officers of the Company as a group to be contained under the headings \"Executive Compensation\" and \"Certain Transactions\" 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 information with respect to ownership of the Company's Common Stock by management and by certain other beneficial owners to be contained under the heading \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement is hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information with respect to certain relationships and related transactions to be contained under the heading \"Certain Transactions\" 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) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS.\nAttached hereto and filed as part of this report are the financial statements, schedules and the exhibits listed below.\n1. Financial Statements\nReport of Independent Auditors\nConsolidated Balance Sheets as of May 28, 1995 and May 29, 1994\nConsolidated Statements of Income for the fiscal years ended May 28, 1995, May 29, 1994 and May 30, 1993\nConsolidated Statements of Shareholders' Equity for the fiscal years ended May 28, 1995, May 29, 1994 and May 30, 1993\nConsolidated Statements of Cash Flows for the fiscal years ended May 28, 1995, May 29, 1994 and May 30, 1993\nNotes to Consolidated Financial Statements\n2. Schedules\nII Valuation and Qualifying Accounts\nAll other schedules are not required or are inapplicable and, therefore, have been omitted.\n3. Exhibits\nArticles of Incorporation and By-laws\n3(i) Restated Certificate of Incorporation (4) (Exhibit 3.1)\n3(ii) By-laws, as amended (5) (Exhibit 3.2)\nInstruments defining the rights of security holders, including indentures\n4.1 Form of Common Stock certificate (8) (Exhibit 4.1)\n4.2 Amended and Restated Loan Agreement dated as of December 23, 1991 among Meridian Bank, Intermagnetics General Corporation, APD Cryogenics Inc., Magstream Corporation and IGC Advanced Superconductors Inc.(8) (Exhibit 4.3)\n4.3 First Amendment dated as of February 26, 1992 to the Amended and Restated Loan Agreement dated as of December 23, 1991 among Meridian Bank, Intermagnetics General Corporation, APD Cryogenics Inc., Magstream Corporation and IGC Advanced Superconductors Inc. (8) (Exhibit 4.4)\n4.4 Second Amendment dated as of June 14, 1994 to the Amended and Restated Loan Agreement dated as of December 23, 1991 among Meridian Bank, Intermagnetics General Corporation, APD Cryogenics Inc. and Magstream Corporation. (11)\n4.5 Third Amendment dated as of August 1, 1994 to the Amended and Restated Loan Agreement dated as of December 23, 1991 among Meridian Bank, Intermagnetics General Corporation, APD Cryogenics Inc. and Magstream Corporation (11)\nMaterial Contracts\n10.1 Agreement Restating and Superseding Lease and Granting Rights to Use Common Areas and Other Rights dated as of December 23, 1991 between Waterbury Industrial Commons Associates, IGC Advanced Superconductors Inc. and Intermagnetics General Corporation (8) (Exhibit 10.1)\n+ 10.2 1990 Stock Option Plan (7) (Appendix A)\n+ 10.3 1981 Stock Option Plan, as amended (2) (Exhibit 10.7)\n+ 10.4 Supplemental Executive Benefit Agreement (1) (Exhibit 10.37)\n+ 10.5 Stock Option Plan for Non-Employee Directors, as amended (2) (Exhibit 10.21)\n10.6 Agreement dated June 9, 1992 between Philips Medical Systems Nederlands B.V. and Intermagnetics General Corporation for sales of magnet systems (12) (Exhibit 10.6)\n10.7 Purchase Agreement dated as of January 1, 1994 between Intermagnetics General Corporation and General Electric Company (12) (Exhibit 10.7)\n+ 10.8 Employment Agreement between Intermagnetics General Corporation and Carl H. Rosner (8) (Exhibit 10.8)\n10.9 Share Purchase Agreement, dated January 23, 1992, by and between Ultralife Batteries, Inc. and Intermagnetics General Corporation (9) (Exhibit 10.1)\n10.10 Letter of Intent, dated as of May 23, 1993, by and between Chrysler Corporation and APD Cryogenics Inc., a wholly-owned subsidiary of Intermagnetics General Corporation (1\") (Exhibit 10.11)\nLetter regarding change in certifying accountant\n16.1 Letter, dated September 12, 1994, to the Securities and Exchange Commission from Ernst & Young LLP, the registrant's former certifying accountant (13) (Exhibit 16.1)\n16.2 Letter, dated November 10, 1994, to the Securities and Exchange Commission from Ernst & Young LLP, the registrant's former certifying accountant (14) (Exhibit 16.1)\nSubsidiaries of the registrant\n* 21 Subsidiaries of the Company\nConsents of experts and counsel\n* 23 Consent of KPMG Peat Marwick, LLP with respect to the Registration Statements Numbers 2-80041, 2-94701, 33-2517, 33-12762, 33-12763, 33-38145, 33-44693, 33-50598, 33-55092 and 33-72160 on Form S-8.\n------------------ (1) Exhibit incorporated herein by reference to the Registration Statement on Form S-2 (Registration No. 2-99408) filed by the Company on August 2, 1985.\n(2) Exhibit incorporated herein by reference to the Annual Report on Form 10-K filed by the Company for the fiscal year ended May 31, 1987.\n(3) Exhibit incorporated herein by reference to the Quarterly Report on Form 10-Q filed by the Company for the six months ended November 29, 1987.\n(4) Exhibit incorporated herein by reference to the Annual Report on Form 10-K filed by the Company for the fiscal year ended May 28, 1989.\n(5) Exhibit incorporated by reference to the Annual Report on Form 10-K filed by the Company for the fiscal year ended May 27, 1990.\n(6) Exhibit incorporated by reference to the Annual Report on Form 10-K filed by the Company for the fiscal year ended May 26, 1991, as amended by Amendment No. 2 on Form 8 dated October 22, 1991.\n(7) Exhibit incorporated by reference to the Proxy Statement dated October 4, 1991 for the 1991 Annual Meeting of Shareholders.\n(8) Exhibit incorporated herein by reference to the Annual Report on Form 10-K filed by the Company for the fiscal year ended May 31, 1992, as amended by Amendment No. 1 on Form 8 dated November 17, 1992.\n(9) Exhibit incorporated herein by reference to the Quarterly Report on Form 10-Q filed by the Company for the six months ended November 29, 1992.\n(10) Exhibit incorporated herein by reference to the Annual Report on Form 10-K\/A1 for the fiscal year ended May 30, 1993. Portions of this Exhibit were omitted and filed separately with the Secretary of the Securities and Exchange Commission pursuant to an Application for Confidential Treatment under Rule 24b-2 of the Securities Exchange Act of 1934, as amended.\n(11) Exhibit incorporated herein by reference to the Annual Report on Form 10-K for the fiscal year ended May 29, 1994.\n(12) Exhibit incorporated herein by reference to the Annual Report on Form 10-K\/A2 for the fiscal year ended May 29, 1994. Portions of this Exhibit were omitted and filed separately with the Secretary of the Securities and Exchange Commission pursuant to an Application for Confidential Treatment under Rule 24b-2 of the Securities Exchange Act of 1934, as amended.\n(13) Exhibit incorporated herein by reference to the Report on Form 8-K filed by the Company on September 12, 1994.\n(14) Exhibit incorporated herein by reference to the Report on Form 8-K filed by the Company on November 11, 1994.\n* Filed with the Annual Report on Form 10-K for the fiscal year ended May 28, 1995.\n+ Management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report on Form 10-K.\nThe Company agrees to provide the SEC upon request with copies of certain long-term debt obligations which have been omitted pursuant to the applicable rules.\nThe Company agrees to furnish supplementally a copy of omitted Schedules and Exhibits, if any, with respect to Exhibits listed above 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, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTERMAGNETICS GENERAL CORPORATION\nDate: August 24, 1995 By: \/s\/ Carl H. Rosner ----------------------- Carl H. Rosner 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.\nEach person in so signing also makes, constitutes and appoints Carl H. Rosner, Chairman, President and Chief Executive Officer, Michael C. Zeigler, Senior Vice President - Finance and Chief Financial Officer, and each of them, his true and lawful attorneys-in-fact, in his name, place and stead to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this report.\n1. Financial Statements\nKPMG PEAT MARWICK LLP\n74 North Pearl Street Albany, NY 12207\nIndependent Auditors' Report\nBoard of Directors and Shareholders Intermagnetics General Corporation\nWe have audited the accompanying consolidated balance sheet of Intermagnetics General Corporation as of May 28, 1995, and the related consolidated statements of income, 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. The accompanying consolidated financial statements of Intermagnetics General Corporation as of May 29, 1994, were audited by other auditors whose report thereon dated July 18, 1994, except for Note C, as to which the date is August 1, 1994, expressed an unqualified opinion on those statements.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intermagnetics General Corporation as of May 28, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nJuly 14, 1995\n\/s\/KPMG Peat Marwick LLP\nMember Firm of Klymveld Peat Marwick Goerdeler\nErnst & Young, LLP 1800 One MONY Plaza Phone: 315 425 8011 Syracuse, New York 13202 Fax: 315 422 5226\nReport of Independent Auditors\nBoard of Directors and Shareholders Intermagnetics General Corporation\nWe have audited the accompanying consolidated balance sheet of Intermagnetics General Corporation as of May 29, 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the two fiscal years in the period ended May 29, 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 Intermagnetics General Corporation at May 29, 1994, and the consolidated results of its operations and its cash flows for each of the two fiscal years in the period ended May 29, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note A to the consolidated financial statements, in 1994 the Company changed its method of accounting for income taxes.\n\/s\/ Ernst & Young LLP\nAlbany, New York July 18, 1994, except for Note C, as to which the date is August 1, 1994\nCONSOLIDATED BALANCE SHEETS INTERMAGNETICS GENERAL CORPORATION (Dollars in Thousands)\nASSETS May 28, 1995 May 29, 1994 ------------ ------------ CURRENT ASSETS Cash and cash equivalents $13,009 $13,196 Trade accounts receivable, less allowance (1995 - $145; 1994 - $100) 20,267 12,957 Costs and estimated earnings in excess of billings on uncompleted contracts 1,144 2,704 Inventories: Finished products 605 733 Work in process 16,960 16,067 Materials and supplies 8,828 9,313 -------- --------- 26,393 26,113 Prepaid expenses and other 1,244 1,362 -------- --------- TOTAL CURRENT ASSETS 62,057 56,332\nPROPERTY, PLANT AND EQUIPMENT Land and improvements 1,502 1,502 Buildings and improvements 16,214 15,540 Machinery and equipment 27,364 24,171 Leasehold improvements 233 233 -------- --------- 45,313 41,446 Less allowances for depreciation and amortization 22,766 19,832 -------- --------- 22,547 21,614 Equipment in process of construction 2,632 2,564 -------- --------- 25,179 24,178\nINTANGIBLE AND OTHER ASSETS Available for sale securities 5,100 Other investments 8,502 10,052 Purchased technology, less accumulated amortization (1995 - $1,108; 1994 - $1,011) 483 580\nRoyalties receivable 68 Other assets 2,385 2,577 -------- --------- TOTAL ASSETS $103,706 $93,787 -------- ---------\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS INTERMAGNETICS GENERAL CORPORATION (Dollars in Thousands)\nLIABILITIES AND SHAREHOLDERS' EQUITY May 28, 1995 May 29, 1994 ------------ ------------ CURRENT LIABILITIES Note payable $94 Current portion of long-term debt $238 279 Accounts payable 4,032 2,552 Salaries, wages and related items 2,402 1,919 Customer advances and deposits 496 764 Product warranty reserve 822 562 Accrued interest expense 323 367 Other liabilities and accrued expenses 1,089 456 -------- --------- TOTAL CURRENT LIABILITIES 9,402 6,993\nLONG-TERM DEBT, less current portion 39,807 39,859 DEFERRED INCOME TAXES, on unrealized gain on available for sale securities 1,192\nSHAREHOLDERS' EQUITY Preferred Stock, par value $.10 per share: Authorized - 2,000,000 shares Issued and outstanding - None Common Stock, par value $.10 per share: Authorized - 20,000,000 shares Issued and outstanding (including shares in treasury): 1995 - 11,081,303 shares 1994 - 10,865,483 shares 1,108 1,055 Additional paid-in capital 55,166 49,133 Retained earnings (deficit) (2,495) (2,595) Unrealized gain on available for sale securities 1,787 Foreign currency translation adjustments (46) 194 -------- --------- 55,520 47,787\nLess cost of Common Stock in treasury (1995 - 242,768 shares; 1994 - 126,812 shares) (2,215) (852) -------- --------- 53,305 46,935 -------- ---------\nTOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $103,706 $93,787 ======== =========\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME INTERMAGNETICS GENERAL CORPORATION (Dollars in Thousands, Except Per Share Amounts)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY INTERMAGNETICS GENERAL CORPORATION Fiscal Years Ended May 28, 1995, May 29, 1994 and May 30, 1993 (Dollars in Thousands, Except Per Share Amounts)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS INTERMAGNETICS GENERAL CORPORATION (Dollars in Thousands)\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS INTERMAGNETICS GENERAL CORPORATION\nNOTE A - ACCOUNTING POLICIES\nPrinciples of Consolidation:\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The Company's 25% investment in a joint venture (GEC Alsthom Intermagnetics, a European manufacturer of magnetic products) is accounted for using the equity method of accounting.\nCash Flows:\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nSales:\nSales are generally recognized as of the date of shipment or in accordance with customer agreements.\nSales to the United States Government or its contractors under cost reimbursement contracts are recorded as costs are incurred and include estimated earned fees.\nSales of products involving long-term production periods and manufactured to customer specifications are generally recognized by the percentage-of-completion method, by multiplying the total contract price by the percentage that incurred costs to date bear to estimated total job costs, except when material costs are substantially incurred at the beginning of a contract, in which case material costs are charged to the contract as they are placed into production. At the time a loss on a contract is indicated, the Company accrues the entire amount of the estimated ultimate loss.\nThe Company accrues for possible future claims arising under terms of various warranties made in connection with the sale of products.\nInventories:\nInventories are priced at the lower of cost (first-in, first-out) or market value.\nProperty, Plant and Equipment:\nLand and improvements, buildings and improvements, machinery and equipment and leasehold improvements are recorded at cost. Provisions for depreciation are computed using the straight-line method in a manner that is intended to amortize the cost of such assets over their estimated useful lives. Leasehold improvements are amortized on a straight-line basis over the remaining initial term of the lease.\nIncome Taxes:\nEffective May 31, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) 109, \"Accounting for Income Taxes.\" Under 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 the financial reporting and income 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 under this new standard, prior years' financial statements have not been restated. The cumulative effect of adopting SFAS 109 on the Company's financial statements was to increase net income by $888,000 for the year ended May 29, 1994.\nPension Plan:\nThe Company has a pension plan covering all eligible employees. Prior service costs are amortized over a period of 30 years. It is the policy of the Company to fund pension costs accrued.\nPurchased Technology:\nThe Company has acquired technology in connection with business acquisitions. The cost of such purchased technology is amortized over the estimated useful life (ten to fifteen years) using the straight-line method.\nCapitalized Interest:\nThe Company capitalizes interest costs on certain assets constructed for its own use. No interest was capitalized during fiscal 1993 or fiscal 1995. In fiscal 1994 $186,000 ($.02 per share) of the $1,999,000 interest incurred was capitalized as part of buildings.\nNOTE B - INVESTMENTS\nAs of May 28, 1995, the Company owned 1,060,753 shares (approximately 14%) of the common stock of Ultralife Batteries, Inc., a manufacturer of lithium batteries, acquired at a total cost of $7,527,000 including 429,417 shares of the Company's Common Stock valued at $2,952,000 (based on a Stock Purchase Agreement). The market value of these securities at May 28, 1995 was $18,033,000, the sale of which is restricted under US Securities laws. As of May 28, 1995, the cost and market value of \"Available for Sale\" securities, representing those salable under Securities laws were $2,121,000 and $5,100,000, respectively. During fiscal 1995, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) 115, \"Accounting for Certain Investments in Debt and Equity Securities\". Application of SFAS 115 resulted in an increase in the carrying value of the Ultralife investment of $2,979,000 and corresponding increases in the deferred tax liability and shareholders' equity of $1,192,000 and $1,787,000, respectively.\nAs of May 28, 1995, the Company owned 292,612 shares (approximately 19%) of Surrey Medical Imaging Systems Limited (SMIS), a UK company engaged in the manufacture and sale of electronics and software for magnetic resonance imaging and nuclear magnetic resonance spectroscopy applications. During fiscal 1994, 249,902 shares were acquired for cash of $2,525,000. The remaining 42,710 shares were acquired in fiscal 1995 for cash of $445,000. The investment is carried at cost ($3,526,000). As SMIS is privately held, the market value of this investment is not readily determinable. In June of 1995, the Company acquired an additional 61,611 shares for cash of $558,000. Beginning in fiscal 1996, the Company will be required to adopt the equity method of accounting for this investment.\nNOTE C - NOTE PAYABLE AND LONG-TERM DEBT\nThe Company has a three year, unsecured $10,000,000 bank line of credit which is scheduled to expire in November, 1997. Borrowings under the line (none at May 28, 1995) bear interest at either the London Interbank Offered Rate (LIBOR) (6.06% at May 28, 1995) plus 1.25% or prime (9% at May 28, 1995), at the Company's option. Borrowings under the line at May 29, 1994 bore interest at prime (7.25%) plus .25%.\nLong-term debt consists of the following:\n(In Thousands) May 28, May 29, 1995 1994 ------- ------- Revenue bonds $ 1,875 $ 1,950 Mortgage payable 6,343 6,492 Installment notes 6 63 Unsecured notes 1,821 1,633 Convertible debentures 30,000 30,000 ------- ------- 40,045 40,138 Less current portion 238 279 ------- ------- Long-term debt $39,807 $39,859 ======= =======\nRevenue bonds consist of a subsidiary's (APD Cryogenics Inc.) obligation under an agreement with an Economic Development Authority with respect to revenue bonds issued in connection with the acquisition of certain land, building and equipment acquired at a total cost of approximately $2,408,000. The bonds bear interest at a weekly adjustable rate (convertible to fixed rate at the option of the Company) which averaged 3.74% for the year ended May 28, 1995 (2.69% for the year ended May 29, 1994). The bonds mature serially in amounts ranging from $75,000 in December 1995 to $200,000 in December 2009. In the event of default or upon the occurrence of certain conditions, the bonds are subject to mandatory redemption at prices ranging from 100% to 103% of face value. As long as the interest rate on the bonds is adjustable weekly, the bonds are redeemable at the option of the Company at face value. The Company makes monthly advance payments to restricted cash accounts in amounts sufficient to meet the interest and principal payments on the bonds when due. The balances of these accounts, included in \"Cash and Cash Equivalents\" on the accompanying consolidated balance sheets, were $32,000 at May 28, 1995, and May 29, 1994.\nThe mortgage payable bears interest at the rate of 7.5%, is payable in monthly installments of $52,000, including principal and interest through April, 2001 with a final payment of $5,155,000 due in May 2001. The loan is secured by land and buildings and certain equipment acquired at a cost of approximately $10,800,000.\nThe installment note bears an interest rate of 12.5% and is payable in monthly installments, including principal and interest, totaling $500 through August 1995 with a final payment of $5,000 in September 1995. This note is secured by equipment acquired at a cost of approximately $24,000.\nUnsecured notes consist of ten-year notes payable in one installment on December 30, 1996, in the principal amount of $1,700,000 issued in connection with an acquisition. Such notes were non-interest bearing through May 31, 1992, and thereafter bear interest at 6% per annum payable on December 30, 1996. The notes have been discounted to reflect a market rate of interest.\nConvertible debentures at May 28, 1995 consist of $30,000,000 of 5.75% convertible subordinated debentures due September 2003, issued in a private placement, which are convertible into Common Stock at approximately $15.15 per share. Interest on the debentures is payable semi-annually. The debentures are redeemable, in whole or in part, at the option of the Company at any time on or after September, 1996 at prices ranging from 104.025% to 100.575% and mature in September 2003. The debentures also provide for redemption at the option of the holder upon a change in control of the Company, as defined, and are subordinated to senior indebtedness, as defined.\nAggregate maturities of long-term debt for the next five fiscal years are: 1996 - $238,000; 1997 - $2,277,000; 1998 - $283,000; 1999 - $298,000 and 2000 - $212,000.\nInterest paid for the years ended May 28, 1995, May 29, 1994, and May 30, 1993 amounted to $2,461,000, $1,434,000 and $931,000, respectively.\nNOTE D - SHAREHOLDERS' EQUITY\nIn March 1995, the Company declared a 3% stock dividend which was distributed on all outstanding shares, except Treasury Stock, on June 15, 1995. The financial statements have been adjusted retroactively to reflect this stock dividend in all numbers of shares, price per share and earnings per share.\nThe Company has established three Stock Option Plans: the 1981 Stock Option Plan, the Stock Option Plan for Non-Employee Directors and the 1990 Stock Option Plan. Shares and prices per share have been adjusted to reflect the 3% stock dividend distributed in June 1995. During fiscal 1995, the Board of Directors authorized an increase of 500,000 shares available for grant under the 1990 Stock Option Plan and granted options therefrom, all of which is subject to shareholders' approval at the 1995 Annual Meeting. The total shares authorized for grant under such plans are 1,406,885, 492,409 and 1,879,035, respectively.\nOption activity under these plans was as follows:\nAs of May 28, 1995, options under the Plans were exercisable as follows:\n1981 Stock Option Plan 127,809 1990 Stock Option Plan 460,150 ------- Exercisable options 587,959 =======\nFollowing are the shares of Common Stock reserved for issuance and the related exercise prices for the outstanding stock options at May 28, 1995:\nNumber Exercise Price of Shares Per Share --------- --------------- 1981 Stock Option Plan 129,216 $2.666 to 4.887 1990 Stock Option Plan 1,334,360 $4.354 to 14.927 --------- Shares reserved for issuance 1,463,576 =========\nNOTE E - RETIREMENT PLANS\nThe Company has a non-contributory, defined benefit plan covering all eligible employees. Benefits under the plan are based on years of service and employees' career average compensation. The Company's funding policy is to contribute annually an amount sufficient to meet or exceed the minimum funding standard contained in the Internal Revenue Code.\nContributions are intended to provide not only for benefits attributable to service to date, but also for those expected to be earned in the future.\nThe following table sets forth the plan's funded status and amounts recognized in the Company's consolidated balance sheets at May 28, 1995 and May 29, 1994:\nNet pension cost includes the following components:\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8% in each of the three years ended May 28, 1995, May 29, 1994, and May 30, 1993. The rate of increase in future compensation levels used in determining the aforementioned obligation was 6% in each of the three years ended May 28, 1995, May 29, 1994, and May 30, 1993. The expected long-term rate of return on plan assets in each of the years ended May 28, 1995, May 29, 1994 and May 30, 1993 was 8%.\nThe Company also maintains an employee savings plan, covering substantially all employees, under Section 401(k) of the Internal Revenue Code. Under this plan, the Company matches a portion of employees' contributions. Expenses under the plan during the years ended May 28, 1995, May 29, 1994 and May 30, 1993 aggregated $232,000, $216,000 and $198,000, respectively.\nThe Company maintains supplemental retirement and disability plans for certain of its executive officers. These plans utilize life insurance contracts for funding purposes. Expenses under these plans were $35,000, $39,000 and $40,000 for the years ended May 28, 1995, May 29, 1994 and May 30, 1993, respectively.\nNOTE F - INCOME TAXES\nThe components of the provision for income taxes are as follows:\n(In Thousands) Fiscal Year Ended -------------------------------------------------- May 28, 1995 May 29, 1994 May 30, 1993 ------------ ------------ ------------ Current Federal $ 2,006 $ 901 $ 585 State 481 424 525 ------- ------- ------- 2,487 1,325 1,110\nDeferred Federal 16 (437) (48) State 2 (49) (10) ------- ------- ------- 18 (486) (58)\nBenefits from use of operating loss and tax credit carryforwards (291) ------- ------- ------- Provision for income taxes $ 2,505 $ 839 $ 761 ======= ======= =======\nIn the first quarter of fiscal 1994, the Company adopted the Statement of Financial Accounting Standards (SFAS) 109. Under provisions of the SFAS the Company recorded a net deferred tax asset of $888,000 and a corresponding increase in net income.\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 net current and non-current deferred tax assets, which are included in \"Prepaid Expenses and Other\" and \"Other Assets\", respectively, are as follows:\n(In Thousands) May 28, 1995 May 29, 1994 ------------ ------------\nCurrent Inventory reserves $972 $728 Non-deductible accruals 418 442 Product warranty reserve 241 208 Other (26) (26) Less: Valuation allowance (517) (517) ------ ------ Total current 1,088 835 ------ ------ Non-Current Depreciation 112 32 Foreign subsidiaries 317 317 Other 158 111 Tax credits 398 Less: Valuation allowance (319) (319) ------ ------ Total non-current 268 539 ------ ------ TOTAL $1,356 $1,374 ====== ======\nThe reasons for the differences between the provision for income taxes and the amount of income tax determined by applying the applicable statutory federal tax rate to income before income taxes are as follows:\nThe Company paid income taxes of $1,118,000, $411,000 and $1,365,000 during the years ended May 28, 1995, May 29, 1994 and May 30, 1993, respectively.\nNOTE G - PER SHARE INFORMATION\nIncome per share amounts are based on the weighted average number of common shares outstanding during the year plus common stock equivalents as shown below:\nBoth primary and fully diluted shares include the dilutive effect (common stock equivalents) of outstanding stock options based on the treasury stock method using average market price for primary and closing market price (unless the average market price is higher) for fully diluted. Shares issuable upon conversion of the $30,000,000 convertible subordinated debentures are considered in calculating fully diluted earnings per share, but have been excluded as the effect would be antidilutive.\nThe Company distributed 3% stock dividends to shareholders on June 15, 1995, September 1, 1993 and September 2, 1992. In September 1994, the Company distributed a five-for-four stock split. The distributions have been made from the Company's authorized but unissued shares. All data with respect to earnings per share, weighted average shares outstanding and common stock equivalents have been adjusted to reflect these stock dividends and stock split.\nNOTE H - LEASE COMMITMENTS\nThe Company leases certain equipment under operating lease agreements expiring at various dates through December, 1999. Through March, 1994, the Company also leased certain office and manufacturing facilities. Certain of the leases provide for renewal options. Total rent expense was $208,000 for the year ended May 28, 1995, $526,000 for the year ended May 29, 1994 and $542,000 for the year ended May 30, 1993.\nFuture minimum rental commitments, excluding renewal options, under the noncancellable leases covering certain equipment through the term of the lease are as follows:\nFiscal Year ----------- 1996 $ 55,000 1997 45,000 1998 34,000 1999 31,000 2000 18,000 -------- Total $183,000 ========\nNOTE I - INFORMATION BY INDUSTRY SEGMENT\nThe Company operates in two business segments: superconductive magnets and materials, permanent magnets and other magnetic products (Magnetic Products) and cryogenic refrigeration equipment and refrigerants (Cryogenic Products).\nNet sales by business segment represent sales to unaffiliated customers. No significant transfers between segments have occurred. Income (loss) from operations represents net sales less operating expenses.\nIdentifiable assets are those used specifically in each segment's operations.\nIncome of foreign subsidiaries, primarily in the Cryogenic Products segment, amounted to $66,000, $190,000 and $63,000 in fiscal 1995, 1994 and 1993, respectively.\nThe Company's segment information is as follows:\nNOTE J - PRINCIPAL CUSTOMERS AND EXPORT SALES\nSales to significant customers, substantially all of which were sales by the Magnetic Products segment, during the last three fiscal years are as follows:\nThe Company's net export sales for the fiscal years ended May 28, 1995, May 29, 1994, and May 30, 1993 totaled $51,600,000, $22,022,000 and $31,816,000, respectively, substantially all of which were to European customers.\nNOTE K - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly financial data for fiscal 1995 and 1994 are as follows:\nIn the quarter ended August 29, 1993, net income and earnings per primary share included $888,000 and $.08, respectively, of cumulative effect of change in method of accounting for income taxes, see Note F.\nExhibit Index\nExhibit Page ------- ---- 21 Subsidiaries of the Company 53\n23 Consent of KPMG Peat Marwick, LLP with 54 respect to the Registration Statements Numbers 2-80041, 2-94701, 33-2517, 33-12762, 33-12763, 33-38145, 33-44693, 33-50598 and 33-72160 on Form S-8","section_15":""}
{"filename":"710752_1995.txt","cik":"710752","year":"1995","section_1":"ITEM 1. BUSINESS.\nDESCRIPTION OF THE TRUST\nSabine Royalty Trust (the \"Trust\") is an express trust formed under the laws of the State of Texas by the Sabine Corporation Royalty Trust Agreement (the \"Trust Agreement\") made and entered into effective as of December 31, 1982, between Sabine Corporation, as trustor, and InterFirst Bank Dallas, N.A. (\"InterFirst\"), as trustee. The current trustee of the Trust is NationsBank of Texas, N.A. (\"NationsBank\"). In accordance with the successor trustee provisions of the Trust Agreement, NationsBank, as trustee of the Trust (the \"Trustee\"), is subject to all the terms and conditions of the Trust Agreement. The principal office of the Trust (sometimes referred to herein as the \"Registrant\") is located at NationsBank Plaza, 12th Floor, 901 Main Street, Dallas, Texas 75202. The telephone number of the Trust is (214) 508-2400.\nOn November 12, 1982, the shareholders of Sabine Corporation approved and authorized Sabine Corporation's transfer of royalty and mineral interests, including landowner's royalties, overriding royalty interests, minerals (other than executive rights, bonuses and delay rentals), production payments and any other similar, nonparticipatory interest, in certain producing and proved undeveloped oil and gas properties located in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas (the \"Royalty Properties\") to the Trust. The conveyances of the Royalty Properties to the Trust were effective with respect to production as of 7:00 a.m. (local time) on January 1, 1983.\nIn order to avoid uncertainty under Louisiana law as to the legality of the Trustee's holding record title to the Royalty Properties located in that state, title to such properties is held by a separate trust formed under the laws of Louisiana, the sole beneficiary of which is the trust. Sabine Louisiana Royalty Trust is a passive entity, with the trustee thereof, Hibernia National Bank in New Orleans, having only such powers as are necessary for the collection of and distribution of revenues from and the protection of the Royalty Properties located in Louisiana and the payment of liabilities of Sabine Louisiana Royalty Trust. A separate trust also was established to hold record title to the Royalty Properties located in Florida. Legislation was adopted in Florida in 1992 that eliminated the provision of Florida law that prohibited the Trustee from holding record title to the Royalty Properties located in that state. In November 1993, record title to the Royalty Properties held by the trustee of Sabine Florida Land Trust was transferred to the Trustee. As used herein, the term \"Royalty Properties\" includes the Royalty Properties held directly by the Trust and the Royalty Properties located in Louisiana and Florida that are or were held indirectly through the Trust's ownership of 100 percent beneficial interest of Sabine Louisiana Royalty Trust and Sabine Florida Land Trust. In discussing the Trust, this report disregards the technical ownership formalities described in this paragraph, which have no effect on the tax or accounting treatment of the Royalty Properties, since the observance thereof would significantly complicate the information presented herein without any corresponding benefit to Unit holders.\nCertificates evidencing units of beneficial interest (the \"Units\") in the Trust were mailed on December 31, 1982 to the shareholders of Sabine Corporation of record on December 23, 1982, on the basis of one Unit for each outstanding share of common stock of Sabine Corporation. The Units are listed and traded on the New York Stock Exchange under the symbol \"SBR\".\nIn May 1988, Sabine Corporation was acquired by Pacific Enterprises, a California corporation. Through a series of mergers, Sabine Corporation was merged into Pacific Enterprises Oil Company (USA) (\"Pacific (USA)\"), a California corporation and a wholly owned subsidiary of Pacific Enterprises, effective January 1, 1990. This acquisition and the subsequent mergers had no effect on the Units. Pacific (USA), as successor to Sabine Corporation, assumed by operation of law all of Sabine\nCorporation's rights and obligations with respect to the Trust. References herein to Pacific (USA) shall be deemed to include Sabine Corporation where appropriate.\nIn connection with the transfer of the Royalty Properties to the Trust upon its formation, Sabine Corporation had reserved to itself all executive rights, including rights to execute leases and to receive bonuses and delay rentals. In January 1993, Pacific (USA) completed the sale of substantially all of Pacific USA's producing oil an gas assets to Hunt Oil Company. The sale did not include the executive rights relating to the Royalty Properties, and Pacific (USA)'s ownership of such rights was not affected by the sale.\nThe following summaries of certain provisions of the Trust Agreement are qualified in their entirety by reference to the Trust Agreement itself, which is an exhibit to the Form 10-K and available upon request from the Trustee. The definitions, formulas, accounting procedures and other terms governing the Trust are complex and extensive and no attempt has been made below to describe all such provisions. Capitalized terms not otherwise defined herein are used with the meanings ascribed to them in the Trust Agreement.\nASSETS OF THE TRUST\nThe Royalty Properties are the only assets of the Trust, other than cash being held for the payment of expenses and liabilities and for distribution to the Unit holders. Pending such payment of expenses and distribution to Unit holders, cash may be invested by the Trustee only in certificates of deposit, United States government securities or repurchase agreements secured by United States government securities. See \"Duties and Limited Powers of Trustee\" below.\nLIABILITIES OF THE TRUST\nBecause of the passive nature of the Trust's assets and the restrictions on the power of the Trustee to incur obligations, it is anticipated that the only liabilities the Trust will incur are those for routine administrative expenses, such as insurance and trustee's fees, and accounting, engineering, legal and other professional fees. The total general and administrative expenses of the Trust for 1995 were $1,367,310, of which, pursuant to the terms of the Trust Agreement, $187,966 was paid to NationsBank, as Trustee, and $563,908 was paid to NationsBank, as escrow agent.\nDUTIES AND LIMITED POWERS OF TRUSTEE\nThe duties of the Trustee are specified in the Trust Agreement and by the laws of the State of Texas. The basic function of the Trustee is to collect income from the Trust properties, to pay out of the Trust's income and assets all expenses, charges and obligations, and to pay available income to Unit holders. Since Pacific (USA) has retained the executive rights with respect to the minerals included in the Royalty Properties and the right to receive any future bonus payments or delay rentals resulting from leases with respect to such minerals, the Trustee is not required to make any investment or operating decision with respect to the Royalty Properties.\nThe Trust has no employees. Administrative functions of the Trust are performed by the Trustee.\nThe Trustee has the discretion to establish a cash reserve for the payment of any liability that is contingent or uncertain in amount or that otherwise is not currently due and payable. The Trustee has the power to borrow funds required to pay liabilities of the Trust as they become due and pledge or otherwise encumber the Trust's properties if it determines that the cash on hand is insufficient to pay such liabilities. Borrowings must be repaid in full before any further distributions are made to Unit holders. All distributable income of the Trust is distributed on a monthly basis. The Trustee is required to invest any cash being held by it for distribution on the next Distribution Date or as a reserve for liabilities in certificates of deposit, United States government securities or repurchase agreements\nsecured by United States government securities. The Trustee furnishes Unit holders with periodic reports. See \"Item 1 - -Description of Units--Reports to Unit Holders\".\nThe Trust Agreement grants the Trustee only such rights and powers as are necessary to achieve the purposes of the Trust. The Trust Agreement prohibits the Trustee from engaging in any business, commercial or, with certain exception, investment activity of any kind and from using any portion of the assets of the Trust to acquire any oil and gas lease, royalty or other mineral interest other than the Royalty Properties. The Trustee may sell Trust properties only as authorized by a vote of the Unit holders, or when necessary to provide for the payment of specific liabilities of the Trust then due or upon termination of the Trust. Pledges or other encumbrances to secure borrowings are permitted without the authorization of unit holders if the Trustee determines such action is advisable. Any sale of Trust properties must be for cash unless otherwise authorized by the Unit holders or unless the properties are being sold to provide for the payment of specific liabilities of the Trust then due, and the Trustee is obligated to distribute the available net proceeds of any such sale to the Unit holders.\nLIABILITIES OF TRUSTEE\nThe Trustee is to be indemnified out of the assets of the Trust for any liability, expense, claim, damage or other loss incurred by it in the performance of its duties unless such loss results from its negligence, bad faith or fraud or from its expenses in carrying out such duties exceeding the compensation and reimbursement it is entitled to under the Trust Agreement. The Trustee can be reimbursed out of the Trust assets for any liability imposed upon the Trustee for is failure to ensure that the Trust's liabilities are satisfiable only out of Trust assets. In no event will the Trustee be deemed to have acted negligently, fraudulently or in bad faith if it takes or suffers action in good faith in reliance upon and in accordance with the advice of parties considered to be qualified as experts on the matters submitted to them. The Trustee is not entitled to indemnification from Unit holders except in certain limited circumstances related to the replacement of mutilated, destroyed, lost or stolen certificates. See \"Item 1 - -Description of Units--Liability of Unit Holders\".\nDURATION OF TRUST\nThe Trust is irrevocable and Pacific (USA) has no power to terminate the Trust or, except with respect to certain corrective amendments, to alter or amend the terms of the Trust Agreement. The Trust will exist until it is terminated by (i) two successive fiscal years in which the Trust's gross revenues from the Royalty Properties are less than $2,000,000 per year, (ii) a vote of Unit holders as described below under \"Voting Rights of Unit Holders\" or (iii) operation of provisions of the Trust Agreement intended to permit compliance by the Trust with the \"rule against perpetuities\". Upon the termination of the Trust, the Trustee will continue to act in such capacity until all the assets of the Trust are distributed. The Trustee will sell all Trust properties for cash (unless the Unit holders authorize the sale for a specified non-cash consideration, in which event the Trustee may, but is not obligated to, consummate such non-cash sale) in one or more sales and, after satisfying all existing liabilities and establishing adequate reserves for the payment of contingent liabilities, will distribute all available proceeds to the Unit holders.\nVOTING RIGHTS OF UNIT HOLDERS\nAlthough Unit holders possess certain voting rights, their voting rights are not comparable to those of shareholders of a corporation. For example, there is no requirement for annual meetings of Unit holders or for annual or other periodic re-election of the Trustee.\nThe Trust Agreement may be amended by the affirmative vote of a majority of the outstanding Units at any duly called meeting of Unit holders. However, no such amendment may alter the relative rights of Unit holders unless approved by the affirmative vote of 100 percent of the Unit holders and by the Trustee. In addition, certain special voting requirements can be amended only if such\namendment is approved by the holders of at least 80 percent of the outstanding Units and by the Trustee.\nRemoval of the Trustee requires the affirmative vote of the holders of a majority of the Units represented at a duly called meeting of Unit holders. In the event of a vacancy in the position of Trustee or if the Trustee has given notice of its intention to resign, a successor trustee of the Trust may be appointed by similar voting approval of the Unit holders.\nThe sale of all or any part of the assets of the Trust must be authorized by the affirmative vote of the holders of a majority of the outstanding Units. However, the Trustee may, without a vote of the Unit holders, sell all or any part of the Trust assets upon termination of the Trust or otherwise if necessary to provide for the payment of specific liabilities of the Trust then due. The Trust can be terminated by the Unit holders only if the termination is approved by the holders of a majority of the outstanding Units.\nMeetings of Unit holders may be called by the Trustee at any time at its discretion and must be called by the Trustee at the written request of holders of not less than 10 percent of the then outstanding Units. The presence of a majority of the outstanding Units is necessary to constitute a quorum and Unit holders may vote in person or by proxy.\nNotice of any meeting of Unit holders must be given not more than 60 nor less than 20 days prior to the date of such meeting. The notice must state the purposes of the meeting and no other matter may be presented or acted upon at the meeting.\nDESCRIPTION OF UNITS\nEach Unit represents an equal undivided share of beneficial interest in the Trust and is evidenced by a transferable certificate issued by the Trustee. Each Unit entitles its holder to the same rights as the holder of any other Unit, and the Trust has no authorized or outstanding class of equity security. At March 15, 1996, there were 14,579,345 Units outstanding.\nThe Trust may not issue additional Units unless such issuance is approved by the holders of at least 80 percent of the outstanding Units and by the Trustee. Under limited circumstances, Units may be redeemed by the Trust and cancelled. See \"Possible Divestiture of Units\" below.\nDISTRIBUTIONS OF NET INCOME\nThe identity of Unit holders entitled to receive distributions of Trust income and the amounts thereof are determined as of each Monthly Record Date. Unit holders of record as of the Monthly Record Date (the 15th day of each calendar month except in limited circumstances) are entitled to have distributed to them the calculated Monthly Income Amount for the related Monthly Period no later than 10 business days after the Monthly Record Date. The Monthly Income Amount is the excess of (i) revenues from the Trust properties plus any decrease in cash reserves previously established for contingent liabilities and any other cash receipts of the Trust over (ii) the expenses and payments of liabilities of the Trust plus any increase in cash reserves for contingent liabilities.\nTRANSFER\nUnits are transferable on the records of the Trustee upon surrender of any certificate in proper form for transfer and compliance with such reasonable regulations as the Trustee may prescribe. No service charge is made to the transferor or transferee for any transfer of a Unit, but the Trustee may require payment of a sum sufficient to cover any tax or governmental charge that may be imposed in relation to such transfer. Until any such transfer, the Trustee may conclusively treat the holder of a\nUnit shown by its records as the owner of that Unit for all purposes. Any such transfer of a Unit will, as to the Trustee, vest in the transferee all rights of the transferor at the date of transfer, except that the transfer of a Unit after the Monthly Record Date for a distribution will not transfer the right of the transferor to such distribution.\nThe transfer of Units by gift and the transfer of Units held by a decedent's estate, and distributions from the Trust in respect thereof, may be restricted under applicable state law. See \"Item 1 - -State Law and Tax Considerations\".\nChemical Shareholder Services Group, Inc. serves as transfer agent and registrar for the Units.\nREPORTS TO UNIT HOLDERS\nAs promptly as practicable following the end of each fiscal year, the Trustee mails to each person who was a Unit holder on any Monthly Record Date during such fiscal year, a report showing in reasonable detail on a cash basis the receipts and disbursements and income and expenses of the Trust for federal and state tax purposes for each Monthly Period during such fiscal year and containing sufficient information to enable Unit holders to make all calculations necessary for federal and state tax purposes. As promptly as practicable following the end of each of the first three fiscal quarters of each year, the Trustee mails a report for such fiscal quarter showing in reasonable detail on a cash basis the assets and liabilities, receipts and disbursements, and income and expenses of the Trust for such fiscal quarter to Unit holders of record on the last Monthly Record Date immediately preceding the mailing thereof. Within 120 days following the end of each fiscal year, or such shorter period as may be required by the New York Stock Exchange, the Trustee mails to Unit holders of record on the last Monthly Record Date immediately preceding the mailing thereof, an annual report containing audited financial statements of the Trust and an audited statement of fees and expenses paid by the Trust to NationsBank, as Trustee and escrow agent. See \"Federal Taxation\" below.\nEach Unit holder and his duly authorized agent has the right, during reasonable business hours at his own expense, to examine and make audits of the Trust and the records of the Trustee, including lists of Unit holders, for any proper purpose in reference thereto.\nLIABILITY OF UNIT HOLDERS\nAs regards the Unit holders, the Trustee, in engaging in any activity or transaction that results or could result in any kind of liability, will be fully liable if the Trustee fails to take reasonable steps necessary to ensure that such liability is satisfiable only out of the Trust assets (even if the assets are inadequate to satisfy the liability) and in no event out of amounts distributed to, or other assets owned by, Unit holders. However, the Trust might be held to constitute a \"joint stock company\" under Texas law, which is unsettled on this point, and therefore a Unit holder may be jointly and severally liable for any liability of the Trust if the satisfaction of such liability was not contractually limited to the assets of the Trust and the assets of both the Trust and the Trustee are not adequate to satisfy such liability. In view of the substantial value and passive nature of the Trust assets, the restrictions on the power of the Trustee to incur liabilities and the required financial net worth of any trustee of the Trust, the imposition of any liability on a Unit holder is believed to be extremely unlikely.\nPOSSIBLE DIVESTITURE OF UNITS\nThe Trust Agreement imposes no restrictions based on nationality or other status of the persons or entities which are eligible to hold Units. However, the Trust Agreement provides that if at any time the Trust or the Trustee is named a party in any judicial or administrative proceeding seeking the cancellation or forfeiture of any property in which the Trust has an interest because of the nationality, or any other status, of any one or more Unit holders, the following procedure will be applicable:\n1. The Trustee will give written notice to each holder whose nationality or other status is an issue in the proceeding of the existence of such controversy. The notice will contain a reasonable\nsummary of such controversy and will constitute a demand to each such holder that he dispose of his Units within 30 days to a party not of the nationality or other status at issue in the proceeding described in the notice.\n2. If any holder fails to dispose of his Units in accordance with such notice, the Trustee shall have the preemptive right to redeem and shall redeem, at any time during the 90-day period following the termination of the 30-day period specified in the notice, any Unit not so transferred for a cash price equal to the closing price of the Units on the stock exchange on which the Units are then listed or, in the absence of any such listing, the mean between the closing bid and asked prices for the Units in the over-the-counter market, as of the last business day prior to the expiration of the 30-day period stated in the notice.\n3. The Trustee shall cancel any Unit acquired in accordance with the foregoing procedures.\n4. The Trustee may, in its sole discretion, cause the Trust to borrow any amount required to redeem Units.\nFEDERAL TAXATION\nIn May 1983, the Internal Revenue Service (the \"Service\") ruled that the Trust would be classified as a grantor trust for federal income tax purposes and not as an association taxable as a corporation. Accordingly, the income and deductions of the Trust are reportable directly by Unit holders for federal income tax purposes. The Service also ruled that Unit holders would be entitled to deduct cost depletion with respect to their investment in the Trust and that the transfer of a Unit in the Trust would be considered to be a transfer of a proportionate part of the properties held by the Trust.\nTransferees of Units transferred after October 11, 1990 may be eligible to use the percentage depletion deduction on oil and gas income thereafter attributable to such Units, if the percentage depletion deduction would exceed cost depletion. However, no Unit holders were eligible to claim percentage depletion deductions for 1990 or any subsequent year because cost depletion has exceeded percentage depletion.\nIf a taxpayer disposes of any \"section 1254 property\" (certain oil, gas, geothermal or other mineral property), and if the adjusted basis of such property includes adjustments for deductions for depletion under section 611 of the Internal Revenue Code (the \"Code\"), the taxpayer generally must recapture the amount deducted for depletion in ordinary income (to the extent of gain realized on the disposition of the property). This depletion recapture rule applies to any dispositon of property that was placed in service by the taxpayer after December 31, 1986. Detailed rules set forth in Sections 1.1254- 1 through 1.1254-6 of the United States Treasury regulations govern dispositions of property after March 13, 1995. The Service will likely take the position that a Unit holder who purchases a Unit subsequent to December 31, 1986 must recapture depletion upon the disposition of that Unit.\nIn order to facilitate creation of the Trust and to avoid the administrative expense and inconvenience of daily reporting to Unit holders by the Trustee, the conveyances by Sabine Corporation of the Royalty Properties located in five of the six states provided for the execution of an escrow agreement by Sabine Corporation and InterFirst (the initial trustee of the Trust), in its capacities as trustee of the Trust and as escrow agent. The conveyances by Sabine Corporation of the Royalty Properties located in Louisiana provided for the execution of a substantially identical escrow agreement by Sabine Corporation and Hibernia National Bank in New Orleans, in the capacities of escrow agent and of trustee of Sabine Louisiana Royalty Trust.\nPursuant to the terms of the escrow agreements and the conveyances of the Royalty Properties, the proceeds of production from the Royalty Properties for each calendar month, and interest thereon,\nare collected by the escrow agents and are paid to and received by the Trust only on the next Monthly Record Date. The escrow agents have agreed to endeavor to assure that they incur and pay expenses and fees for each calendar month only on the next Monthly Record Date. The Trust Agreement also provides that the Trustee is to endeavor to assure that income of the Trust will be accrued and received and expenses of the Trust will be incurred and paid only on each Monthly Record Date.\nAssuming that the escrow arrangement is recognized for federal income tax purposes and that the Trustee and the escrow agents are able to control the timing of income and expenses, as stated above, cash and accrual basis Unit holders should be treated as realizing income only on each Monthly Record Date. The Trustee and the escrow agents may not be able to cause third party expenses to be incurred on each Monthly Record Date in all instances. Cash basis Unit holders, however, should be treated as having paid all expenses and fees only when such expenses and fees are actually paid. Even if the escrow arrangement is recognized for federal income tax purposes, however, accrual basis Unit holders might be considered to have accrued expenses when such expenses are incurred rather than on each Monthly Record Date when paid.\nNo ruling was requested from the Service with respect to the effect of the escrow arrangement. Due to the absence of direct authority and the factual nature of the characterization of the relationship among the escrow agent, Pacific (USA) and the Trust, no opinion has been expressed by legal counsel with respect to the tax consequences of the escrow arrangement. In the absence of the escrow arrangement, the Unit holders would be deemed to receive or accrue income from production from the Royalty Properties (and interest income) on a daily basis, in accordance with their method of accounting, as the proceeds from production and interest thereon were received or accrued by the Trust. If the escrow arrangement is recognized, the income from the Royalty Properties for a calendar month and interest income thereon will be taxed to the holder of the Unit on the next Monthly Record Date without regard to the ownership of the Unit prior to that date. The Trustee is treating the escrow arrangement as effective for tax purposes and has furnished tax information to Unit holders on that basis.\nThe Service might take the position that the escrow arrangement should be ignored for tax purposes. In such case, the Trustee could be required to report the proceeds from production and interest income thereon to the Unit holders on a daily basis resulting in a substantial increase in the administrative expense of the Trust. In the event of a transfer of a Unit, the income and the depletion deduction attributable to the Royalty Properties for the period up to the date of transfer would be allocated to the transferor, and the income and depletion deduction attributable to the Royalty Properties on and after the date of transfer would be allocated to the transferee, even though the transferee was the holder of the Unit on the next Monthly Record Date and, therefore, would be entitled to the monthly income distribution. Thus, if the escrow arrangement is not recognized, a mismatching of such income and deduction could occur between a transferor and a transferee upon the transfer of a Unit.\nUnit holders of record on each Monthly Record Date are entitled to receive monthly distribution. See \"Distribution of Net Income\" above. The terms of the escrow agreements and the Trust Agreement, as described above, seek to assure that taxable income attributable to such distributions will be reported by the Unit holder who receives such distributions, assuming that such holder is the holder of record on the Monthly Record Date. In certain circumstances, however, a Unit holder may be required to report taxable income attributable to his Units but the Unit holder will not receive the distribution attributable to such income. For example, if the Trustee establishes a reserve or borrows money to satisfy debts and liabilities of the Trust, income used to establish such reserve or to repay such loan will be reported by the Unit holder, even though such income is not distributed to the Unit holder.\nInterest and royalty income attributable to ownership of Units and any gain on the sale thereof are considered portfolio income, and not income from a \"passive activity\", and therefore generally may not be offset by losses from any passive activities.\nIndividuals may deduct \"miscellaneous itemized deductions\" (including, in general, investment expenses) only to the extent that such expenses exceed two percent of the individual's adjusted gross income. Although the Trustee believes that no portion of a Unit holder's share of administrative expenses of the Trust is subject to the floor, it is possible that the Service could take such a position.\nThe foregoing summary is not exhaustive, and many other provisions of the federal tax laws may affect individual Unit holders. Each Unit holder should consult his personal tax adviser with respect to the effects of his ownership of Units on his personal tax situation.\nSTATE LAW AND TAX CONSIDERATIONS\nThe following is intended as a brief summary of certain information regarding state income taxes and other state law matters affecting the Trust and the Unit holders. Unit holders are urged to consult their own legal and tax advisers with respect to these matters.\nTexas. Texas does not impose an income tax. Therefore, no part of the income produced by the Trust is subject to an income tax in Texas. However, corporations doing business in Texas are subject to the Texas franchise tax, which includes a calculation based upon the corporation's taxable income for federal income tax purposes. It is currently unclear whether the ownership of Units would be sufficient to subject a corporate Unit holder who is not otherwise doing business in Texas to the franchise tax. Under certain circumstances, Texas inheritance tax may be applicable to property in Texas (including intangible personal property such as the Units) of both resident and nonresident decedents.\nLouisiana. Units held by residents of Louisiana, to the extent that they represent a proportionate share of mineral royalties from mineral interests located in Louisiana, are subject to Louisiana inheritance and other taxes and probate, community property, forced heirship and other rules. Units held of record by a person who was not domiciled in Louisiana at the date of death generally are not subject to Louisiana inheritance taxes or probate, community property or forced heirship rules, and Units transferred inter vivos by non- domiciliaries of Louisiana generally are not subject to Louisiana gift tax. Income of the Units attributable to interests located in Louisiana will, subject to applicable minimum filing requirements, be subject to Louisiana income tax, and the Trustee is required to file with Louisiana a return reflecting the income of the Trust attributable to mineral interests located in Louisiana.\nFlorida, Mississippi, New Mexico and Oklahoma. Florida imposes an income tax on resident and nonresident corporations but not individuals. Mississippi, New Mexico and Oklahoma each impose an income tax applicable to both resident and nonresident individuals and corporations which will be applicable to royalty income allocable to a Unit holder from properties located within that state. Although the Trust may be required to file information returns with taxing authorities in those states and provide copies of such returns to the Unit holders, the Trust should be considered a grantor trust for state income tax purposes and the Royalty Properties that are located in such states should be considered economic interests in minerals for state income tax purposes.\nGenerally, the state income tax in these states is computed as a percentage of taxable income attributable to the particular state. Furthermore, even though there are variances from state to state, taxable income for state purposes is often computed in a manner similar to the computation of taxable income for federal income tax purposes. Some of these states given credit for taxes paid by their\nresidents on income from sources in other states. In certain of these states, a Unit holder is required to file a state income tax return if income is attributable to the Unit holder even though no tax is owed.\nREGULATION AND PRICES\nREGULATION\nGeneral\nExploration for and production and sale of oil and gas are extensively regulated at the national, state and local levels. Oil and gas development and production activities are subject to various state laws and regulations (and orders or regulatory bodies pursuant thereto) governing a wide variety of matters, including allowable rates of production, marketing, pricing, prevention of waste, and pollution and protection of the environment. These laws, regulations and orders may restrict the rate of oil and gas production below the rate that would otherwise exist in the absence of such laws, regulations and orders.\nLaws affecting the oil and gas industry are under constant review for amendment or expansion, frequently increasing the regulatory burden. Numerous governmental departments and agencies are authorized by statute to issue and have issued rules and regulations binding on the oil and gas industry which often are difficult and costly to comply with and which carry substantial penalties for the failure to comply.\nNatural Gas\nOn January 1, 1993, pursuant to the Natural Gas Wellhead Decontrol Act of 1989, the maximum lawful prices prescribed for the sale of natural gas under the Natural Gas Policy Act of 1978 (the \"NGPA\") were eliminated. Consequently, prices for the sale of natural gas, like the sale of other commodities, are governed by the marketplace and the provisions of applicable gas sales contracts.\nThe Federal Energy Regulatory Commission (\"FERC\") has taken significant steps in the implementation of a policy to restructure the natural gas pipeline industry to promote full competition in the sales of natural gas, so that all natural gas suppliers, including pipelines, can compete equally for sales customers. This policy, set forth principally in Order 636, issued on April 8, 1992, and its progeny, is being implemented largely through restructuring proceedings for each pipeline. These factors make the future effect of that order upon the natural gas markets uncertain.\nThere are many other statutes, rules, regulations and orders that affect the pricing or transportation of natural gas. Some of the provisions are and will be subject to court or administrative review. Consequently, uncertainty as to the ultimate impact of these regulatory provisions on the prices and production of natural gas from the Royalty Properties is expected to continue for the foreseeable future.\nEnvironmental Regulation\nGeneral. Activities on the Royalty Properties are subject to existing federal, state and local laws (including case law), rules and regulations governing health, safety, environmental quality and pollution control. It is anticipated that, absent the occurrence of an extraordinary event, compliance with existing federal, state and local laws, rules and regulations regulating health, safety, the release of materials into the environment or otherwise relating to the protection of the environment will not have a material adverse effect upon the Trust or Unit holders. The Trustee cannot predict what effect additional regulation or legislation, enforcement policies thereunder, and claims for damages to property, employees, other persons and the environment resulting from operations on the Royalty\nProperties could have on the Trust or Unit holders. Even if the Trust were not directly liable for costs or expenses related to these matters, increased costs of compliance could result in wells being plugged and abandoned earlier in their productive lives, with a resulting loss of reserves and revenues to the Trust.\nSuperfund. The Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), also known as the \"superfund\" law, imposes liability, regardless of 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. These persons include the current or previous owner and operator of a site and companies that disposed, or arranged for the disposal, of the hazardous substance found at a site. CERCLA also authorizes the Environmental Protection Agency and, in some cases, private parties to take actions in response to threats to the public health or the environment and to seek recovery from such responsible classes of persons of the costs of such action. In the course of operations, the working interest owner and\/or the operator of Royalty Properties may have generated and may generate wastes that may fall within CERCLA's definition of \"hazardous substances.\" The operator of the Royalty Properties or the working interest owners may be responsible under CERCLA for all or part of the costs to clean up sites at which such substances have been disposed. Although the Trust is not the operator of any Royalty Properties, or the owner of any working interest, its ownership of royalty interests could cause it to be responsible for all or part of such costs to the extent CERCLA imposes responsibility on parties as \"owners\".\nSolid and Hazardous Waste. The Royalty Properties have produced oil and\/or gas for many years, and, although the Trust has no knowledge of the procedures followed by the operators of the Royalty Properties in this regard, hydrocarbons or other solid or hazardous wastes may have been disposed or released on or under the Royalty Properties by the current or previous operators. Federal, state and local laws applicable to oil- and gas-related wastes and properties have become increasingly more stringent. Under these laws, removal or remediation of previously disposed wastes or property contamination could be required.\nPRICES\nOil\nCrude oil prices are affected by a variety of factors. Since domestic crude oil price controls were lifted in 1981, the principal factors influencing the prices received by producers of domestic crude oil have been the pricing and production of the members of the Organization of Petroleum Exporting Countries (\"OPEC\").\nThe Trust's average per barrel oil price increased from $14.28 in 1994 to $15.65 in 1995. The Trustee believes that the higher average price per barrel of crude oil realized by the Trust in 1995 can be attributed to normal market fluctuations.\nNatural Gas\nSubstantial competition in the natural gas marketplace continued in 1995. Competition with alternative fuels and excess gas supplies persist. Natural gas prices, which once were determined largely by governmental regulations, are now being generally governed by the marketplace. The average price received by the Trust in 1995 on natural gas volumes sold of $1.45 per Mcf represented a decrease from the $1.89 per Mcf received in 1994, due in part to a continued oversupply of gas which began during a mild winter at the end of 1994.\nFERC is the federal agency responsible for implementing regulations governing the natural gas industry. The current policy of FERC is designed to promote increased competition among gas\nindustry participants. Accordingly, Order 636 and various other orders have been proposed and implemented to encourage nondiscriminatory open-access transportation by interstate pipelines, to provide for the release of natural gas dedicated to long-term contracts but not required by pipelines to meet near-term system supply needs, and to provide for the unbundling of pipeline services so that such services may also be furnished by nonpipeline suppliers on a competitive basis. Certain of these orders have been or will be challenged in the courts, and no prediction can be made regarding the future impact on the industry of FERC's current or proposed regulations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe assets of the Registrant consist principally of the Royalty Properties, which constitute interests in gross production of oil, gas and other minerals free of the costs of production. The Royalty Properties consist of royalty and mineral interests, including landowner's royalties, overriding royalty interests, minerals (other than executive rights, bonuses and delay rentals), production payments and any other similar, nonparticipatory interest, in certain producing and proved undeveloped oil and gas properties located in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas.\nThe following table summarizes total developed and proved undeveloped acreage represented by the Royalty Properties at February 15, 1996.\nDetailed information concerning the number of wells on royalty properties is not generally available to the owner of royalty interest. Consequently, the Registrant does not have an accurate count of the number of wells located on the Royalty Properties and cannot readily obtain such information.\nTITLE\nThe conveyances of the Royalty Properties to the Trust covered the royalty and mineral properties located in the six states that were vested in Sabine Corporation on the effective date of the conveyances and that were subject to existing oil, gas and other mineral leases other than properties specifically excluded in the conveyances. Since Sabine Corporation may not have had available to it as a royalty owner information as to whether specific lands in which it owned a royalty interest were subject to an existing lease, minimal amounts of nonproducing royalty properties may also have been conveyed to the Trust. Sabine Corporation did not warrant title to the Royalty Properties either expressly or by implication.\nRESERVES\nThe Registrant has obtained from DeGolyer and MacNaughton, independent petroleum engineering consultants, a study of the proved oil and gas reserves attributable as of January 1, 1996 to the Royalty Properties. The following letter report summarizes such reserve study and sets forth information as to the assumptions, qualifications, procedures and other matters relating to such reserve study. See Note 8 of the Notes to Financial Statements incorporated by reference in Item 8 hereof for additional information regarding the proved oil and gas reserves of the Trust.\nDeGolyer and MacNaughton One Energy Square Dallas, Texas 75206\nMarch 14, 1996\nTELEPHONE (214) 366-6391 TELEX 73-0485 CABLE: DEMAC\nNationsBank of Texas, N.A. P.O. Box 830650 Dallas, Texas 75283-0650\nGentlemen:\nPursuant to your request, we have prepared estimates, as of January 1, 1996, of the extent and value of the proved crude oil, condensate, natural gas liquids (NGL), and natural gas reserves of certain royalty interests owned by Sabine Royalty Trust, hereinafter referred to as the \"Trust.\" The properties appraised consist of royalties located in the states of Florida, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas. NationsBank of Texas, N.A. (NationsBank) acts as trustee of the Trust.\nThis report presents values for proved reserves that were estimated using current prices provided by NationsBank. These prices are held constant for the lives of the properties. A detailed explanation of future price assumptions is included below.\nReserves estimated in this report are expressed as net reserves. Gross reserves are defined as the total estimated petroleum to be produced from these properties after December 31, 1995. Net reserves are defined as that portion of the gross reserves attributable to the interests owned by the Trust after deducting royalties and other interests owned by others.\nValues of the net proved reserves are expressed in terms of estimated future net revenue and present worth of future net revenue. These values are based on the continuation of prices in effect on December 31, 1995. Future gross revenue is defined as that revenue to be realized from the production and sale of the estimated net reserves. Future net revenue is calculated by deducting estimated severance and ad valorem taxes from the future gross revenue. Present worth of future net revenue is calculated by discounting the future net revenue at the arbitrary rate of 10 percent per year compounded monthly over the expected period of realization.\nEstimates of oil, condensate, NGL and gas reserves and future net revenue should be regarded only as estimates that may change as further production history and additional information become available. Not only are such reserves and revenue estimates based on that information which is currently available, but such estimates are also subject to the uncertainties inherent in the application of judgmental factors in interpreting such information.\nInformation used in the preparation of this report was obtained from NationsBank, from records on file with the appropriate regulatory agencies, and from public sources. During this investigation, we consulted freely with officers and employees of NationsBank and were given access to such accounts, records, geological and engineering reports, and other data as were desired for examination. In our preparation of this report we have relied, without independent verification, upon information furnished by NationsBank with respect to property interests owned by the Trust, production from such properties, current prices for production, agreements relating to current and future operations and sale of production, and various other information and data that were accepted as represented. It\nwas not considered necessary to make a field examination of the physical condition and operation of the properties in which the Trust owns interests.\nThe development status shown herein represents the status applicable on January 1, 1996. In our preparation of the study, data available from wells drilled on the appraised properties through December 31, 1995, were used in estimating gross ultimate recovery. Where applicable, gross production estimated to January 1, 1996, was deducted from gross ultimate recovery to arrive at the estimates of gross reserves as of January 1, 1996. In most fields, this required that the production rates be estimated for up to 2 months since production data were available only through October 1995.\nOur reserves estimates were prepared by the use of standard geological and engineering methods generally accepted by the petroleum industry. The method or combination of methods used in the analysis of each reservoir was tempered by experience with similar reservoirs, consideration of the state of development, and the quality and completeness of basic data. The Trust owns several thousand royalty interests. In view of the limited information available to a royalty owner and the small reserves attributable to many of these interests, certain of them representing approximately 41.2 percent of the total reserves of the properties included herein were summarized by state or field and worked in total rather than being appraised individually. Historical records of net production and revenue and experience with similar properties were used in analyzing these properties.\nPetroleum reserves included in this report are classified as proved and are judged to be economically producible in future years from known reservoirs under existing economic and operating conditions and assuming continuation of current regulatory practices using conventional production methods and equipment. In the analyses of production-decline curves, reserves were estimated only to the limit of economic rates of production under existing economic and operating conditions using prices and costs as of the date the estimate is made, including consideration of changes in existing prices provided only by contractual arrangements but not including escalations based upon future conditions. The petroleum reserves are classified as follows:\nProved--Reserves that have been proved to a high degree of certainty by analysis of the producing history of a reservoir and\/or by volumetric analysis of adequate geological and engineering data. Commercial productivity has been established by actual production, successful testing, or in certain cases by favorable core analyses and electrical-log interpretation when the producing characteristics of the formation are known from nearby fields. Volumetrically, the structure, areal extent, volume, and characteristics of the reservoir are well defined by a reasonable interpretation of adequate subsurface well control and by known continuity of hydrocarbon-saturated material above known fluid contacts, if any, or above the lowest known structural occurrence of hydrocarbons.\nDeveloped--Reserves that are recoverable from existing wells with current operating methods and expenses.\nDeveloped reserves include both producing and nonproducing reserves. Estimates of producing reserves assume recovery by existing wells producing from present completion intervals with normal operating methods and expenses. Developed nonproducing reserves are in reservoirs behind the casing or at minor depths below the producing zone and are considered proved by production from other wells in the field, by successful drill-stem tests, or by core analyses from the particular zones. Nonproducing reserves require only moderate expense to be brought into production.\nUndeveloped--Reserves that are recoverable from additional wells yet to be drilled.\nUndeveloped reserves are those considered proved for production by reasonable geological interpretation of adequate subsurface control in reservoirs that are producing or proved by other wells but are not recoverable from existing wells. This classification of reserves requires drilling of additional wells, major deepening of existing wells, or installation of enhanced recovery or other facilities.\nReserves recoverable by enhanced recovery methods, such as injection of external fluids to provide energy not inherent in the reservoirs, may be classified as proved developed or proved undeveloped reserves depending upon the extent to which such enhanced recovery methods are in operation. These reserves are considered to be proved only in cases where a successful fluid- injection program is in operation, a pilot program indicates successful fluid injection, or information is available concerning the successful application of such methods in the same reservoir and it is reasonably certain that the program will be implemented.\nNet proved reserves, as of January 1, 1996, of the Trust from the properties appraised are estimated in barrels and thousands of cubic feet as follows:\nGas volumes shown herein are salable gas volumes and are expressed at a temperature base of 60 degrees Fahrenheit and at the legal pressure bases of the states in which the interests are located. Condensate reserves estimated herein are those to be obtained from normal separator recovery. NGL reserves are those attributed to the leasehold interests according to processing agreements.\nRevenue values in this report were estimated using the initial prices and costs provided by NationsBank. Future prices were estimated using guidelines established by the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB). The initial and future prices and producing rates used in this report have been reviewed by NationsBank and it has represented that the prices and rates used herein are those that the Trust could reasonably expect to receive. The assumptions used for estimating future prices and costs are as follows.\nOil, Condensate, Natural Gas Liquids, and Natural Gas Prices\nYear-end oil, condensate, natural gas liquids, and natural gas prices were furnished by NationsBank. These prices were used as initial prices and were held constant for the lives of the properties.\nA projection of the estimated future net revenue from the properties appraised, as of January 1, 1996, based on the aforementioned assumptions concerning prices and costs is summarized as follows:\nThe present worth of future net revenue, as of January 1, 1996, is estimated as follows:\nIn our opinion, the information relating to estimated proved reserves, estimated future net revenue from proved reserves, and present worth of estimated future net revenue from proved reserves of oil, condensate, natural gas liquids, and gas contained in this report has been prepared in accordance with Paragraphs 10-13, 15 and 30(a)-(b) of Statement of Financial Accounting Standards No. 69 (November 1982) of the FASB and Rules 4-10(a)(1)-(13) of Regulation S-X and Rule 302(b) of Regulation S-K of the SEC; provided, however, (i) certain estimated data have not been provided with respect to changes in reserve information, (ii) future income tax expenses have not been taken into account in estimating the future net revenue and present worth values set forth herein, (iii) at the request of NationsBank and due to the limited availability of data, proved reserves, future net revenue therefrom, and the present worth thereof for certain royalty interests accounting for approximately 41.2 percent of the Trust's total proved reserves have been estimated in the aggregate by state or field rather than on a property-by- property basis using net production and revenue data and our general knowledge of producing characteristics in the geographic areas in which such interests are located, and (iv) at the request of NationsBank, we have estimated future net revenue and the present worth thereof by holding constant current gas prices for the remaining lives of the applicable reserves in accordance with NationsBank's advice that these are the prices that the Trust can reasonably expect to receive.\nTo the extent the above-enumerated rules, regulations, and statements require determinations of an accounting or legal nature or information beyond the scope of our report, we are necessarily unable to express an opinion as to whether the above-described information is in accordance therewith or sufficient therefor.\nSubmitted,\nDeGOLYER and MacNAUGHTON\n----------------\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production and timing of development. The preceding reserve data in the letter regarding the study represent estimates only and should not be construed to be exact. The estimated present worth of future net revenue amounts shown by the study should not be construed as the current fair market value of the estimated oil and gas reserves since a market value determination would include many additional factors.\nReserve estimates may be adjusted from time to time as more accurate information on the volume or recoverability of existing reserves becomes available. Actual reserve quantities do not change, however, except through production. The Trust continues to own only the royalty properties that were initially transferred to the Trust at the time of its creation and is prohibited by the Trust Agreement from acquiring additional oil and gas interests.\nThe future net revenue shown by the study has not been reduced for administrative costs and expenses of the Trust in future years. The costs and expenses of the Trust may increase in future years,\ndepending on the amount of income from the Royalty Properties, increases in the Trustee's and escrow agents' fees and expenses, accounting, engineering, legal and other professional fees, and other factors. It is expected that the costs and expenses of the Trust in 1996 will be approximately $1,350,000.\nThe volatile nature of the world energy markets makes it difficult to estimate future prices of oil and gas. The prices obtained for oil and gas depend upon numerous factors, including the domestic and foreign supply of oil and gas and the price of foreign imports, market demand, the price and availability of alternative fuels, the availability of pipeline capacity and the effect of governmental regulations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings to which the Registrant 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.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe section entitled \"Units of Beneficial Interest\" appearing on the inside front cover of the Trust's Annual Report to Unit holders for the year ended December 31, 1995 sets forth certain information with respect to the Units of the Trust and the market therefor, and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information under \"Selected Financial Data\" appearing on the inside front cover of the Trust's Annual Report to Unit holders 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.\nThe \"Trustee's Discussion and Analysis\" of financial condition and results of operations appearing on page 2 of the Trust's Annual Report to Unit holders 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 financial statements of the Trust and the notes thereto, together with the report thereon of Deloitte & Touche LLP dated March 19, 1996 appearing on pages 3 though 8 of the Trust's Annual Report to Unit holders for the year ended December 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.\nThe Registrant has no directors or executive officers. The Trustee is a corporate trustee which may be removed, with or without cause, by the affirmative vote at a meeting duly called and held of the holders of a majority of the Units represented at the meeting.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNot applicable.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Security Ownership of Certain Beneficial Owners. As of March 15, 1996 there were no Unit holders known to the Trustee to be beneficial owners of more that 5% of the outstanding Units.\n(b) Security Ownership of Management. The Trust has no directors or executive officers. NationsBank of Texas, N.A., the Trustee, held as of March 15, 1996 an aggregate of 153,367 Units in various fiduciary capacities, with respect to which it had sole voting and investment power over all 153,367 of such Units.\n(c) Changes in Control. The Trustee knows of no arrangements 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.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as a part of this report:\n1. Financial Statements (incorporated by reference in Item 8 of this report)\nIndependent Auditors' report Statements of Assets, Liabilities and Trust Corpus at December 31, 1995 and 1994 Statements of Distributable Income for Each of the Three Years in the Period Ended December 31, 1995 Statements of Changes in Trust Corpus for Each of the Three Years in the Period Ended December 31, 1995 Notes to Financial Statements\n2. Financial Statement Schedules\nFinancial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements and notes thereto.\n3. Exhibits\n- -------- * Exhibits 4(a) and 4(b) are incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nSABINE ROYALTY TRUST\nBy NATIONSBANK OF TEXAS, N.A. (as successor), Trustee\nBy: \/s\/ Ron E. Hooper ----------------------------------- Ron E. Hooper Vice-President\nDate: March 28, 1996\n(THE REGISTRANT HAS NO DIRECTORS OR EXECUTIVE OFFICERS.)","section_15":""}
{"filename":"783464_1995.txt","cik":"783464","year":"1995","section_1":"Item 1.\t Business.\n(a) General Development of Business Certificates of Participation (\"COPs\") represent an assignment from the issuing general partners of some, but not all, of their rights to participate in the profits, losses and gains of, and to receive distributions from Burger King Limited Partnership I, Burger King Limited Partnership II, and Burger King Limited Partnership III. The issuing general partners and their respective partnerships are BK I Realty Inc. (formerly Shearson\/BK Realty, Inc.) (\"GP-I\"), a New York corporation and the general partner of Burger King Limited Partnership I (\"BK-I\"), a New York limited partnership; BK II Properties Inc. (formerly Shearson\/BK Properties, Inc.) (\"GP-II\"), a New York corporation and the general partner of Burger King Limited Partnership II (\"BK-II\"), a New York limited partnership; and BK III Restaurants Inc. (formerly Shearson\/BK Restaurants, Inc.) (\"GP-III\"), a New York corporation and general partner of Burger King Limited Partnership III (\"BK-III\"), a New York limited partnership. (G P-I, GP-II, and GP-III are collectively referred to herein as the \"General Partners\". BK-I, BK-II, and BK-III are collectively referred to herein as the \"Partnerships\".) All the General Partners are affiliates of Lehman Brothers Inc. (\"Lehman\") (formerly Shearson Lehman Brothers, Inc. (\"Shearson\"), (see Item 10).\nCOPs includes an assignment from GP-I of some, but not all, of GP-I's rights to participate in the profits, losses and gains of, and to receive distributions from BK-I (the \"BK-I COPs\"). More specifically, BK-I COPs represent, in the aggregate, an assignment to the holders of the BK-I COPs (\"BK-I COPs Holders\") as defined under the terms of the partnership agreement of BK-I (the \"BK-I Partnership Agreement\"), the rights of GP-I to receive (i) as distributions from BK-I, up to an additional 4% of BK-I net cash flow from operations for each year that the BK-I limited partners have received cash distributions equal to 12 1\/2% per annum of their BK-I remaining invested capital, and, after BK-I Payout, as defined in the BK-I Partnership Agreement, (BK-I \"Payout\"), 8.89% of BK-I net property disposition proceeds; and (ii) as allocations by BK-I, 4% of any excess of net taxable income over BK-I net cash flow from operations; after BK-I Payout, 10.11% of losses; and after BK-I Payout, 10.11% of gain on disposition of BK-I's properties (collectively, the \"BK-I Assigned Interest\"). The BK-I Assigned Interest has been assigned in equal parts to the BK-I COPs Holders. The unassigned portion of the rights of GP-I to receive distributions and allocations from BK-I represents GP-I's retained interest.\nCOPs also includes an assignment from GP-II of some, but not all, of GP-II's rights to participate in the profits, losses and gains of, and to receive distributions from BK-II (the \"BK-II COPs\"). More specifically, BK-II COPs represent, in the aggregate, an assignment to the holders of the BK-II COPs (\"BK-II COPs Holders\") as defined under the terms of the partnership agreement of BK-II (the \"BK-II Partnership Agreement\"), the rights of GP-II to receive distributions from, and allocations by, BK-II in amounts identical to those for the BK-I Assigned Interest (collectively, the \"BK-II Assigned Interest\"). The BK-II Assigned Interest has been assigned in equal parts to the BK-II COPs Holders. The unassigned portion of the rights of GP-II to receive distributions and allocations from BK-II represents GP-II's retained interest.\nFinally, COPs includes an assignment from GP-III of some, but not all, of GP-III's rights to participate in the profits, losses and gains of, and to receive distributions from BK-III (the \"BK-III COPs\"). More specifically, BK-III COPs represent, in the aggregate, an assignment to the holders of the BK-III COPs (\"BK-III COPs Holders\") as defined under the terms of the partnership agreement of BK-III (the \"BK-III Partnership Agreement\")(collectively, the BK-I Partnership Agreement, the BK-II Partnership Agreement and the BK-III Partnership Agreement are defined as the \"Partnership Agreements\"), the rights of GP-III to receive (i) as distributions from BK-III, 4% of BK-III net cash flow from operations for each year and, after BK-III Payout, as defined in the BK-III Partnership Agreement, (BK-III \"Payout\"), 4.7% of BK-III net property disposition proceeds; and (ii) as allocations by BK-III, 4% of net taxable income; after BK-III Payout, 4.88% of losses; and, after BK-III Payout, 4.88% of gain on disposition of the BK-III's properties (collectively, the \"BK-III Assigned Interest\"). The BK-III Assigned Interest has been assigned in equal parts to the BK-III COPs Holders. The unassigned portion of the rights of BK-III represents GP-III's retained interest.\nBK-I COPs Holders, BK-II COPs Holders and BK-III COPs Holders are collectively referred to as \"COPs Holders.\"\nThe Partnerships originally acquired or ground leased, the sites for, and constructed, 32, 33, and 27, respectively, free-standing Burger King fast food restaurants (each referred to as the \"Property\", collectively, the \"Properties\") which are leased on a long-term net basis to franchisees of Burger King Corporation (\"Burger King\"). Prior to the Partnerships' acquisition of each Property, Burger King proposed the site for approval by each respective General Partner. The sites are geographically diversified throughout the United States. No further site acquisitions are anticipated. The General Partners do not manage or operate any Property nor do they acquire or finance the acquisition of the equipment necessary to operate the Properties. Reference is made to Item 2","section_1A":"","section_1B":"","section_2":"Item 2.\tProperties.\nThe following tables set forth the location of sites which the Partnerships have acquired or ground leased as of December 31, 1995. The Partnerships own the completed improvements in fee ownership and either have a fee ownership in the land or a ground leasehold interest in the land as indicated. Also included is the location of sites which the Partnerships have sold as of December 31, 1995, the acquisition date, and the date of sale. Financial information regarding sales includes book value, selling price and gain on the sale.\nIn the event one of the Properties defaults on its rent obligations, Burger King is required to pay to the respective Partnership the minimum rent due under the Property's lease. If a Property remains in default for 12 months, Burger King can either declare economic abandonment of the Property and supervise its sale to a third party or purchase the Property from the Partnership at a purchase price which is equal to the greater of the fair market value of the Property or the minimum guaranteed price as set forth in the management agreements between Burger King and the Partnerships.\nBK-I Properties owned as of December 31, 1995\n\tAtlanta, Georgia*\t\tKlamath Falls, Oregon*\t \tDecatur, Alabama\t\tSpringdale, Arkansas Fairfield, Ohio Springfield, Massachusetts* \tGreenfield, Wisconsin\t\tStatesville, North Carolina Greenville, South Carolina Wichita, Kansas\n\t*\tSubject to a ground lease. \t\t\t\t BK-I Properties Sold as of December 31, 1995\nSite Acquisition Sale Net Adjusted Gain Location Date Date Book Value Selling Price on Sale 1. Altus, Oklahoma 11\/10\/82 12\/30\/91 $ 259,954 $ 290,164 $ 30,210 2. Grand Island, Nebraska 05\/07\/82 10\/01\/92 218,064 686,000 467,936 3. Marion, Virginia 11\/24\/82 10\/01\/92 119,207 229,900 110,693 4. Sunnyvale, California 02\/03\/83 10\/01\/92 151,063 348,000 196,937 5. Greenbelt, Maryland 10\/12\/82 11\/23\/92 127,217 478,500 351,283 6. Guilderland, New York 05\/20\/82 12\/23\/92 440,742 853,000 412,258 7. Atlantic Highlands, New Jersey 04\/08\/83 03\/04\/93 129,381 158,002 28,621 8. Rohnert Park, California 10\/11\/82 03\/23\/93 111,445 206,500 95,055 9. Dothan, Alabama 11\/11\/82 03\/26\/93 298,067 725,000 426,933 10.Madison Heights, Virginia 02\/23\/83 07\/01\/94 274,271 369,218 94,947 11.Pearl, Mississippi 06\/29\/82 08\/01\/94 257,672 427,108 169,436 12.Falmouth, Massachusetts 09\/24\/82 08\/01\/9 289,187 568,353 279,166 13.Tucson, Arizona 10\/07\/82 08\/01\/94 74,146 161,163 87,017 14.W. Springfield, Massachusetts 10\/18\/82 08\/01\/94 104,977 151,391 46,414 15.Jackson, Mississippi 02\/06\/85 08\/01\/94 332,299 503,149 170,850 16.Kansas City, Missouri 01\/10\/83 12\/02\/94 290,626 536,691 246,065 17.Salem, Massachusetts 09\/23\/82 12\/09\/94 335,664 590,264 254,600 18.Pasco, Washington 06\/01\/82 12\/15\/94 271,444 618,487 347,043 19.West Allis, Wisconsin 10\/07\/82 12\/15\/94 366,838 711,987 345,149 20.Washington, North Carolina 08\/20\/82 03\/08\/95 180,837 619,944 439,107 21.Big Spring, Texas 07\/01\/84 03\/31\/95 130,499 455,898 325,399 22.Carlsbad, New Mexico 05\/12\/84 03\/31\/95 240,175 728,684 488,509\nBK-II Properties owned as of December 31, 1995\n\tCeres, California \t\tOrange, California* \tColumbus, Mississippi \t\tPelham, Alabama \tCorpus Christi, Texas \t\tPhoenix, Arizona \tErlanger, Kentucky*\t\tPlano, Texas* Garland, Texas Redlands, California \tGlendale, Arizona*\t\tRiverdale, Georgia \tGreenville, Mississippi\t\tRocky Mt., North Carolina Greenville, North Carolina South Bend, Indiana \tHot Springs, Arkansas \t\tSpringfield, Massachusetts* \tKansas City, Kansas* \t\tSt. Peters, Missouri \tMarietta, Georgia\t\tStatesboro, Georgia* Marietta\/Johnson, Georgia Tucson, Arizona* \tMilan, Tennessee\t\tVernon, Connecticut* \tMt. Clemens, Michigan* \t\tWilmington, North Carolina* \tNederland, Texas\n\t*\tSubject to a ground lease.\nBK-II Properties Sold as of December 31, 1995\nSite Acquisition Sale Net Adjusted Gain Location Date Date Book Value Selling Price on Sale 1. Westminster, Colorado 7\/06\/83 08\/21\/89 $401,261 $446,034 $ 44,773 2. Mt. Pleasant, Wisconsin 3\/11\/83 10\/31\/90 293,113 754,394 461,281 3. Downey, California 4\/15\/83 02\/25\/93 87,952 132,059 44,107 4. Ferguson, Missouri 7\/02\/84 06\/30\/95 101,873 151,691 49,818\nBK-III Properties owned as of December 31, 1995\nAlbuquerque, New Mexico* Gary, Indiana \tAtlanta, Georgia \t\tGallatin, Tennessee Brooklyn Park, Maryland* Largo, Florida \tChattanooga, Tennessee\t\tMemphis, Tennessee \tCleburne, Texas \t\tMontgomery, Alabama* \tColumbus, Indiana\t\tMounds View, Minnesota \tCovina, California\t\tNashville, Tennessee \tDelhi Township, Ohio*\t\tNorth Augusta, South Carolina \tEdison, New Jersey\t\tSan Bernardino, California* Fayetteville, North Carolina* Shelbyville, Tennessee Federal Heights, Colorado* Sulphur Springs, Texas \tFrankfort, Kentucky\t\tWilson, North Carolina\n\t*\tSubject to a ground lease.\nBK-III Properties Sold as of December 31, 1995\nSite Acquisition Sale Net Adjusted Gain Location Date Date Book Value Selling Price on Sale 1. Woodstock, Georgia 7\/19\/84 4\/12\/91 $304,047 $380,059 $ 76,012 2. Kansas City, Missouri 5\/05\/86 2\/10\/93 336,807 398,189 61,382 3. Waterford Township, Michigan 3\/21\/86 3\/08\/93 430,678 531,809 101,131\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no pending legal proceedings to which the Partnerships' are a party or to which any of their assets are subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Units and Related Security Holder Matters.\n\t(a)\tMarket Information No public market for the COPs units (the \"Units\") presently exists. Each Unit consists of one BK-I COPs, one BK-II COPs and one BK-III COPs.\n\t(b)\tHolders \t\tThe number of COPs Holders as of December 31, 1995 was 608.\n\t(c)\tDistributions The following table illustrates the per Unit quarterly cash distributions paid to COPs Holders during the past two years.\nQuarter Declared 1995 1994\nFirst Quarter $ 11.70 (1) $ 6.72 Second Quarter 5.31 (2) 4.83 Third Quarter 5.46 10.41 (3) Fourth Quarter 37.92 51.88 (4)\nTotal Cash Distributions $ 60.39 $ 73.84\n(1) Includes a $5.05 distribution of proceeds received from Property sales paid on April 28, 1995.\n(2) Includes a $0.39 distribution of proceeds received from a Property sale paid on August 1, 1995.\n(3) Includes a $5.49 distribution of proceeds received from Property sales paid on October 28, 1994.\n(4) Includes a $5.53 distribution of proceeds received from Property sales paid on January 30, 1995.\nReference is also made to the \"Message to Investors\" of COPs 1995 Annual Report to COPs Holders, which is filed as an exhibit under Item 14, for additional information concerning cash distributions paid by the Partnership.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth below should be read in conjunction with the Partnership's Financial Statements and notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" also included elsewhere herein.\n\tGP-I\n1995 1994 1993 1992 1991 \tEquity in earnings of BK-I $ 49,322 $ 89,234 $ 78,707 $105,527 $ 98,191 Net income 34,190 59,579 53,140 68,549 64,601 \tNet income attributable to COPs Unitholders 27,352 47,663 42,512 54,839 51,681 Net income per Unit(1)(2) 8.87 15.45 13.78 17.78 16.76 \tTotal Assets at year end (62,210) (15,052) (11,408) 37,777 38,126 \t\n\tGP-II\n1995 1994 1993 1992 1991 \tEquity in earnings of BK-II $ 94,130 $ 97,210 $ 94,704 $ 89,576 $ 93,863 Net income 62,415 64,073 62,724 59,788 62,271 \tNet income attributable to COPs Unitholders 49,932 51,258 50,179 47,830 49,817 Net income per Unit(1)(2) 16.19 16.62 16.27 15.51 16.15 \tTotal Assets at year end 23,371 28,304 21,033 25,596 23,507\n\tGP-III\n1995 1994 1993 1992 1991 \tEquity in earnings of BK-III $ 80,307 $ 84,786 $ 83,386 $ 88,879 $ 91,823 Net income 54,119 56,858 56,002 59,362 61,163 \tNet income attributable to COPs Unitholders 43,295 45,486 44,802 47,490 48,930 Net income per Unit(1)(2) 14.04 14.75 14.53 15.40 15.87 \tTotal Assets at year end (2,424) 2,945 211 14,915 10,595\n(1) Net income per COPs Unit represents 80% of the net income of GP-I, GP-II and GP-III, respectively, divided by the total number of COPs' units outstanding.\n(2) 3,084 COP Units outstanding.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources The General Partners do not engage in the sale of goods or services. Their only assets are the investments in the Partnerships.\nThe Partnerships' prospectuses specify that Burger King had the option to purchase any or all of the restaurants at fair market value, determined by an independent appraisal, at any time during the eighth through tenth years following the date of completion of the offering of limited partnership interests in each Partnership. The offering of interests in BK-I, BK-II and BK-III occurred in 1982, 1983 and 1984, respectively. As of December 31, 1994, Burger King's options to purchase the Properties had expired.\nOn September 23, 1994, BK-I notified the Wisconsin Department of Natural Resources (the \"WDNR\") that petroleum and chlorinated compounds were discovered at its Greenfield, Wisconsin Property (the \"Greenfield Property\"). The WDNR has indicated that under Wisconsin state law, BK-I is responsible for remediating the site. On May 26, 1995, BK-I proposed site-specific soil clean-up standards (\"Clean-up Standards\") on the Greenfield Property for the WDNR's approval. To date, BK-I has not received a response from the WDNR to the proposal. Until the WDNR approves the Clean-up Standards and the costs of the remediation can be assessed, it is extremely difficult to move forward with the sale of BK-I's remaining 10 restaurant Properties. In accordance with BK-I's Partnership Agreement, BK-I has set aside $300,000 from net cash flow from operations to fund potential environmental remediation costs in connection with the Greenfield Property. GP-I currently anticipates that the cost of the environmental remediation should be recovered from the proceeds to be received from the eventual sale of the Greenfield Property. Until all of BK-I's Properties are sold, BK-I will continue to operate its Properties, and it is intended that cash flow from operations will be distributed to the partners in accordance with the terms of the BK-I Partnership Agreement.\nBK-II has agreed to sell 17 of the Partnership's Properties owned in fee simple and to assign all of its rights in 11 of the Partnership's Properties subject to ground leases to the Buyer, pursuant to the Purchase Agreement. Pursuant to the terms of the Purchase Agreement, the Buyer agreed to acquire the Properties for the Purchase Price, subject to adjustments and prorations for base and percentage rents as well as certain other charges payable in respect of the Leased Properties and adjustments in respect of certain closing costs. The Purchase Price is also subject to an increase of $200,000 to an aggregate of $17,225,000 if the Partnership elects to include the Marietta Property in the Proposed Sale. GP-II is pursuing parties that may have an interest in purchasing the Marietta Property for a price in excess of $200,000. If GP-II is unable to locate a potential purchaser at an appropriate price, BK-II would, in all likelihood, include the Marietta Property in the Proposed Sale.\nPursuant to the BK-II Partnership Agreement, the unitholders of BK-II (\"BK-II Unitholders\") have the right to vote (assuming certain conditions described in the BK-II Partnership Agreement are met) only upon certain matters, and BK-II Unitholders voting a majority in interest may, without the concurrence of GP-II, cause, among other things, the disapproval of any sale of all or substantially all of the assets of BK-II in a single sale. The Proposed Sale would constitute a sale of all or substantially all of the BK-II's assets. Accordingly, BK-II Unitholders have the right to disapprove the Proposed Sale.\nA proxy statement was mailed to the BK-II Unitholders on March 25, 1996 (the \"Proxy\") describing the terms of the Proposed Sale and presenting the BK-II Unitholders with the opportunity to call a meeting to consider whether to disapprove of the Proposed Sale. In order to effect a vote to disapprove the Proposed Sale, BK-II Unitholders holding 10% or more in interest of the outstanding limited partnership units of BK-II (the \"BK-II Units\") must submit written requests for a meeting of BK-II Unitholders pursuant to the BK-II Partnership Agreement. While GP-II may call a meeting of the BK-II Unitholders for any purpose, GP-II believes that the Proposed Sale is in the best interest of the BK-II Unitholders and has, therefore, determined not to call a meeting for the purpose of considering the disapproval of the Proposed Sale. However, if BK-II receives written requests from BK-II Unitholders holding 10% or more in interest of the BK-II Units on or before April 30, 1996, GP-II will be required to call a meeting of the BK-II Unitholders to consider the disapproval of the Proposed Sale. If a meeting of the BK-II Unitholders is called, and the Proposed Sale is disapproved by a majority in interest of the BK-II Unitholders, the Purchase Agreement will be terminated pursuant to its terms, and BK-II will continue to operate the Properties and distribute the cash flow from operations to the partners of BK-II in accordance with the BK-II Partnership Agreement. If, however, a meeting of BK-II Unitholders is called, and BK-II Unitholders holding less than a majority in interest vote to disapprove the Proposed Sale, the Proposed Sale will be consummated pursuant to the terms and subject to the conditions set forth in the Purchase Agreement.\nBK-III is currently analyzing market conditions to determine when BK-III's remaining Properties should be marketed for sale. Until BK-III's remaining Properties are sold, BK-III intends to continue operating the Properties and distributing cash flow from operations to the partners of BK-III in accordance with the terms of the BK-III Partnership Agreement.\nAt December 31, 1995, GP-I's investment in BK-I was $(62,210) and GP-III's investment in BK-III was $(2,424), reflecting distributions in excess of equity in earnings plus the initial investments. GP-II's investment in BK-II was $23,371 at December 31, 1995, compared to $28,304 at December 31, 1994. The decrease in GP-II's investment in BK-II was a result of cash distributions in excess of the allocation of equity in earnings during 1995.\nResults of Operations The results of operations for the 1995, 1994, and 1993 fiscal years are primarily attributable to the investments in BK-I, BK-II and BK-III.\nFor the years ended December 31, 1995, 1994 and 1993, GP-I's net income was $34,190, $59,579 and $53,140, respectively. For the years ended December 31, 1995, 1994 and 1993, GP-II's net income was $62,415, $64,073 and $62,724, respectively. For the years ended December 31, 1995, 1994 and 1993, GP-III's net income was $54,119, $56,858 and $56,002, respectively. The net income fluctuated each year primarily as a result of the sales of Properties, reduced levels of depreciation expense, reduced rental income as a result of the sale of Properties, and increases and decreases in percentage rents received from the franchisees operating each of the Properties. During 1995, BK-I sold three Properties, realizing a total gain of $1,253,015. During 1995, BK-II sold one Property, realizing a total gain of $49,818. BK-III did not sell any Properties during 1995. During 1994, BK-I sold 10 Properties, realizing a total gain of $2,040,687. BK-II and BK-III did not sell any properties during 19 94. During 1993, BK-I sold three Properties realizing a total gain of $550,609; BK-II sold one Property realizing a total gain of $44,107; and BK-III sold two Properties realizing a total gain of $162,513.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated by reference to COPs 1995 Annual Report to COPs Holders, included as an exhibit under Item 14.\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.\nOn July 31, 1993, 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 Partnerships or the General Partners. However, the assets acquired by Smith Barney included the name \"Shearson.\" Consequently, effective January 24, 1994, Shearson\/BK Realty, Inc., Shearson\/BK Properties, Inc. and Shearson\/BK Restaurants, Inc. changed their names to delete any reference to \"Shearson.\"\nCOPs has no officers or directors. The General Partners of the Partnerships manage and control the affairs of the Partnerships and have general responsibility and authority in all matters affecting its business. Certain officers and the director of the General Partners are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the market in which that real estate is located and, consequently, the partnerships sought the protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nThe director and executive officers of the General Partners as of December 31, 1995, are set forth below. There are no family relationships between or among any officer and any other officer or director.\nName Age Office Rocco F. Andriola 37 Director, President and Chief Financial Officer Kenneth Boyle 32 Vice President \tMark J. Marcucci\t33\tVice President \tTimothy E. Needham\t27\tVice President\nThe foregoing director has been elected to serve as director until the next annual meeting of the General Partners.\nRocco F. Andriola is a Senior Vice President of Lehman in its Diversified Asset Group. Since joining Lehman in 1986, Mr. Andriola has been involved in a wide range of restructuring and asset management activities involving real estate and other direct investment transactions. From 1986-89, Mr. Andriola served as a Vice President in the Corporate Transactions Group of Shearson Lehman Brothers' office of the general counsel. Prior to joining Lehman, Mr. Andriola practiced corporate and securities law at Donovan Leisure Newton & Irvine in New York. Mr. Andriola received a B.A. degree from Fordham University, a J.D. degree from New York University School of Law, and an LL.M degree in Corporate Law from New York University's Graduate School of Law.\nKenneth Boyle is a Vice President of Lehman in its Diversified Asset Group. Mr. Boyle joined Lehman in January 1991. Mr. Boyle is a Certified Public Accountant and was employed by the accounting firm of KPMG Peat Marwick LLP from 1985 to 1990. Mr. Boyle graduated from the State University of New York at Binghamton with a B.S. degree in Accounting.\nMark J. Marcucci is a Vice President of Lehman Brothers in its Diversified Asset Group. Since joining Lehman Brothers in 1988, Mr. Marcucci's responsibilities have been concentrated in the restructuring, asset management, leasing, financing, refinancing and disposition of commercial office and residential real estate. Prior to joining Lehman Brothers, Mr. Marcucci was employed in a corporate lending capacity at Republic National Bank of New York. Mr. Marcucci received a B.B.A. degree in Finance from Hofstra University and a Master of Science in Real Estate degree from New York University. In addition, Mr. Marcucci holds both Series 7 and Series 63 securities licenses.\nTimothy E. Needham is an Associate of Lehman Brothers and assists in the management of commercial real estate in the Diversified Asset Group. Mr. Needham joined Lehman Brothers in September 1995. Prior to joining Lehman Brothers, Mr. Needham was a consultant with KPMG Peat Marwick LLP in the Banking and Investment Services Group from 1994-1995. Mr. Needham received his M.B.A. from the American Graduate School of International Management in December 1993. Previous to entering graduate school, Mr. Needham worked in Tokyo for approximately one year doing market research for a Japanese firm. In addition, Mr. Needham is a candidate for the designation of Chartered Financial Analyst.\nItem 11.","section_11":"Item 11. Executive Compensation.\nOfficers and the director of the General Partners are employees of Lehman Brothers and are not compensated by the Partnerships or the General Partners for services rendered in connection with the Partnerships.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n\t(a)\tSecurity ownership of certain beneficial owners The Registrant knows of no person who beneficially owns more than 5% of the Units.\n\t(b)\tSecurity ownership of management GP-I, GP-II, and GP-III, under the terms of the Partnership Agreements of BK-I, BK-II and BK-III, respectively, manage the affairs of BK-I, BK-II, and BK-III, respectively. The General Partners retained 20% of their allocations of distribution and disposition proceeds (profit, loss) from BK-I, BK-II, and BK-III. Neither the director nor the officers of the General Partners own any Units.\n\t(c)\tChanges in control \t\tNone.\nItem 13.","section_13":"Item 13.\tCertain Relationships and Related Transactions.\n\t(a)\tTransactions with Management and Others Reference is made to Note 6 of the Notes to Financial Statements for each General Partner as part of COPs 1995 Annual Report to COPs Holders, filed as an exhibit under Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n\t(a)\t(1)\t Financial Statements and Supplementary Data:\nGP-I:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Changes in Stockholder's Deficit 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\nGP-II:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Changes in Stockholder's Deficit 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\nGP-III:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Changes in Stockholder's Deficit 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\nThe financial statements for GP-I, GP-II and GP-III are incorporated by reference to COPs' Annual Report to COPs Holders for the year ended December 31, 1995.\n\t\t(2)\t Financial Statement Schedules:\nNo other schedules are presented because the information is not applicable or is included in the financial statements or notes thereto.\n\t\t(3)\t Exhibits:\n3.1 BK-I:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Partners' Capital (Deficit) 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\n3.2 BK-II:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Partners' Capital (Deficit) 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\n3.3 BK-III:\nIndependent Auditors' Report Financial Statements: Balance Sheets at December 31, 1995 and 1994 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Statements of Partners' Capital (Deficit) 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\n13.1 Annual Report to COPs Holders for the year ended December 31, 1995.\n\t\t27.1\tFinancial Data Schedule for BK I Realty Inc.\n\t\t27.2\tFinancial Data Schedule for BK II Properties Inc.\n\t\t27.3\tFinancial Data Schedule for BK III Restaurants Inc.\n\t(b)\tReports on Form 8-K:\n(1) There have been no reports filed 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.\nDated: March 29, 1996\nCERTIFICATES OF PARTICIPATION BK I REALTY, INC. BK II PROPERTIES, INC. BK III RESTAURANTS, INC.\nBY: BK I Realty, Inc. BK II Properties, Inc. BK III Restaurants, Inc. Registrant\nBY: \/s\/Rocco F. Andriola Name: Rocco F. Andriola Title: Director, 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.\nBK I REALTY, INC. BK II PROPERTIES, INC. BK III RESTAURANTS, INC. Registrant\nDate: March 29, 1996\nBY: \/s\/Rocco F. Andriola Rocco F. Andriola Director, President and Chief Financial Officer\nDate: March 29, 1996\nBY: \/s\/Kenneth Boyle Kenneth Boyle Vice President\nDate: March 29, 1996\nBY: \/s\/Mark J. Marcucci Mark J. Marcucci Vice President\nDate: March 29, 1996\nBY: \/s\/Timothy Needham Timothy Needham Vice President","section_15":""}
{"filename":"837290_1995.txt","cik":"837290","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nKey Production Company, Inc. (Key or the Company) is an independent oil and gas company engaged in oil and gas exploration, development and production in the continental United States. The Company's exploration interests are spread over 14 states with primary focus areas in the Anadarko Basin of Oklahoma, California, the Rocky Mountain region and the Gulf Coast. The Company was incorporated in Delaware on June 22, 1988, and maintains its corporate offices in Denver, Colorado. Key opened regional exploration offices in Tulsa, Oklahoma and Houston, Texas in October 1994 and March 1995, respectively. The Company's common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol KPCI.\nBUSINESS DURING 1995\nProduction during 1995 totaled 633 Mbbls of oil and 5,262 MMcf of gas. Oil and gas production increased 26 percent and 16 percent, respectively, primarily as a result of production from new drilling. Product prices averaged $15.70 per barrel of oil and $1.71 per Mcf of gas.\nIn 1995, the Company spent $13 million on exploration and development activities. Key participated in drilling 56 gross (8.35 net) wells in 1995. During 1995, 48 gross (6.36 net) wells were completed as producers and 8 gross (1.99 net) wells were dry. Sales of producing properties were not significant in 1995.\nKey has working interests in approximately 1,286 gross (94 net) wells located primarily in the Anadarko Basin of Oklahoma, Wyoming, southern Texas, Louisiana and offshore Gulf of Mexico. In addition, Key has royalty or overriding royalty interests in approximately 60 properties in the Midcontinent region, 60 properties in the Gulf Coast region and 1,775 properties in the Rocky Mountain region. At year end, Key held approximately 92,900 net acres of developed leasehold located primarily in Oklahoma, Wyoming, Texas and Louisiana. Key also held approximately 353,000 net acres of undeveloped leasehold located primarily in the Rocky Mountain region.\nDuring 1995, the majority of Key's spot market gas production was marketed by Apache Corporation (Apache) and sold to Natural Gas Clearinghouse (NGC). Sales to NGC accounted for 37 percent of Key's 1995 oil and gas revenues. Eighty-Eight Oil Company (Eighty-Eight Oil) was the largest purchaser of Key's crude oil production. Approximately 29 percent of 1995 revenues resulted from crude oil sales to Eighty-Eight Oil. No other single purchaser accounted for more than 10 percent of revenues in 1995.\nOn December 21, 1995, the Company announced that Key and Brock Exploration Corporation (Brock) had entered into a definitive merger agreement that would combine the two companies. The merger will be structured as a tax-\nfree exchange with each Brock shareholder receving one share of Key stock for each 1.45 Brock share held. The proposed transaction is subject to approval by the stockholders of both Key and Brock and certain other conditions. Both Key and Brock will submit the merger to their respective stockholders for approval at special meetings on March 28, 1996. Subject to stockholder approval and other conditions, the transaction will be consummated as soon as practicable in the Spring of 1996.\nCOMPETITION\nThe oil and gas industry is highly competitive. As an independent oil and gas company, Key must compete against companies with substantially larger financial and other resources for a variety of opportunities including reserve and lease acquisitions and marketing agreements.\nNATURAL GAS AND OIL PRICES\nKey's gas price averaged $1.71 per Mcf in 1995, $.27 lower than the prior year average of $1.98 per Mcf. Key's average realized oil price rose to $15.70 per barrel in 1995, up from $14.27 in the prior year. Key's business will continue to be affected by future changes in domestic and international oil and gas prices. No assurances can be given as to the trend in, or level of, future oil and gas prices.\nRESERVE VALUE CEILING TEST\nKey reviews the carrying value of its oil and gas properties on a quarterly basis under the full cost accounting rules of the Securities and Exchange Commission (SEC or the Commission). Under the full cost accounting rules, capitalized costs of oil and gas properties may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10 percent, plus the lower of cost or fair market value of unproved properties, as adjusted for related tax effects and deferred tax reserves. Application of this rule generally requires pricing future revenues at the unescalated prices in effect at the end of each fiscal quarter and requires a write-down if the \"ceiling\" is exceeded, even if prices declined for only a short period of time. If a write- down were required, the charge to earnings would not impact cash flow from operating activities. Key did not record any write-downs in the three years ended December 31, 1995.\nREGULATION OF OIL AND GAS\nKey's exploration, production and marketing are regulated extensively at the federal, state and local levels. Oil and gas exploration, development and production activities are subject to various laws and regulations governing a wide variety of matters. For example, the states in which Key produces oil and gas have statutes or regulations addressing production practices that may affect Key's operations and limit the quantity of hydrocarbons Key may produce and sell. Other regulated matters include the marketing and transportation of oil and gas and the valuation of royalty payments.\nAmong other regulated matters on the federal level, the Federal Energy Regulatory Commission (FERC) regulates interstate transportation of natural gas under the Natural Gas Act. Key's gas sales are affected by regulation of intrastate and interstate gas transportation. In an attempt to promote competition, FERC has issued a series of orders which have significantly altered the marketing and transportation of natural gas. To date, Key has not experienced any material adverse effect on gas marketing as a result of these FERC orders. However, the Company cannot predict what effect subsequent regulations may have on its future gas marketing.\nENVIRONMENTAL\nKey, as an owner of interests in oil and gas properties, is subject to various federal, state, and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations, subject the lessee to liability for pollution damages, require suspension or cessation of operations in affected areas and impose restrictions on the injection of liquids into subsurface aquifers that may contaminate groundwater.\nKey has made and will continue to make expenditures in its efforts to comply with these requirements, which it believes are necessary business costs in the oil and gas industry. These costs are inextricably connected to normal operating expenses such that the Company is unable to separate the expenses related to environmental matters. However, the Company does not believe any such additional expenses will materially affect its business. Although environmental requirements do have a substantial impact upon the energy industry, generally these requirements do not appear to affect Key any differently or to any greater or lesser extent than other companies in the industry.\nThe Company is not aware of any environmental claims existing as of December 31, 1995, which would have a material impact upon the Company's financial condition or results of operations. Key does not believe that compliance with federal, state or local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have such an impact.\nEMPLOYEES\nOn December 31, 1995, Key had 28 full-time employees.\nOFFICES\nKey's principal executive offices are located at One Norwest Center, 20th Floor, 1700 Lincoln Street, Denver, Colorado 80203-4520.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPRODUCTIVE WELLS AND ACREAGE\nThe number of productive gas and oil wells in which Key has working interests as of December 31, 1995, is set forth below. Substantially all of these properties are operated by other owners.\nIn addition, Key has royalty or overriding royalty interests in approximately 60 properties in the Midcontinent region, 60 properties in the Gulf Coast region and 1,775 properties in the Rocky Mountain region. As of December 31, 1995, Key held approximately 92,900 net developed acres. Approximately 70,700 net acres are located in the Rocky Mountains with the remainder located in the Midcontinent and Gulf Coast regions.\nGROSS WELLS DRILLED\nThe following table sets forth the number of wells drilled during 1995, 1994 and 1993 in which the Company participated.\nAt December 31, 1995, 7 gross (1.36 net) wells were in the process of being drilled.\nUNDEVELOPED ACREAGE\nAs of December 31, 1995, Key held an interest in approximately 353,000 net undeveloped acres located in the Rocky Mountain region.\nPRODUCTION AND PRICING INFORMATION\nThe following table describes, for each of the last three fiscal years, oil and gas production and pricing data for the Company.\nRESERVE VALUE INFORMATION\nThe estimated proved oil and gas reserves of Key, as of December 31, 1995, 1994 and 1993, and the standardized measure of discounted future net cash flows attributable thereto at December 31, 1995, 1994 and 1993, are included in Supplemental Oil and Gas Disclosures to Financial Statements appearing on pages 31 through 33 of this Form 10-K. Supplemental Oil and Gas Disclosures also include Key's net revenues from production (including royalty and working interest production) of oil and natural gas for the three years ended December 31, 1995.\nFuture reserve values are based on year-end prices except in those instances where the sale of gas is covered by contract terms providing for determinable escalations. Operating costs, production and ad valorem taxes and future development costs are based on current costs with no escalations.\nThe present value of estimated future net cash flows from proved reserves after income taxes are $50,758,000, $42,722,000 and $32,110,000 for 1995, 1994 and 1993, respectively.\nEstimated future net cash flows at December 31, 1995, are expected to be received as shown in the following years:\nOther than the proposed merger described in Item 7 on page 13, no major discovery or other favorable or adverse event is believed to have occurred since December 31, 1995, which would cause significant change in the estimated proved reserves reported herein. The above estimates are based on year-end pricing in accordance with Commission guidelines and do not reflect current prices. Since January 1, 1995, no oil or gas reserve information has been filed with, or included in any report to, any federal authority or agency other than the SEC and\/or the Energy Information Administration.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not subject to any pending litigation that, in the opinion of the Company's management, will materially affect the financial position or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted for a vote of security holders during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nFRANCIS H. MERELLI, 60, has been chairman of the board of directors, president and chief executive officer of the Company since September 9, 1992. From July 1991 to September 1992, Mr. Merelli was engaged as a private consultant in the oil and gas industry. Mr. Merelli was president and chief operating officer of Apache Corporation, and president, chief operating officer and a director of Key from June 1988 to July 1991, at which time he resigned from those positions in both companies. He was president of Terra Resources, Inc. from 1979 to 1988.\nMONROE W. ROBERTSON, 46, has been with the Company since September 10, 1992. Since February 1994, he has served as senior vice president and corporate secretary and prior to that time as vice president and corporate secretary. From August 1988 to July 1992, he was employed by Apache Corporation in various capacities, the most recent of which was director of operational planning. From 1986 to 1988, Mr. Robertson was director of\ncorporate planning for Terra Resources, Inc. From 1973 to 1986, Mr. Robertson was employed by Gulf Oil Corporation.\nCATHY L. ANDERSON, 40, has been controller of the Company since January 15, 1993. From July 1985 to January 1993, Ms. Anderson was employed by Arthur Andersen LLP, a public accounting firm, in various capacities, the most recent of which was audit manager.\nSTEPHEN P. BELL, 41, has been vice president - land of the Company since February 2, 1994. From March 1991 to February 1994, he was president of Concord Reserve, Inc., a privately-held independent oil and gas company. He was employed by Pacific Enterprises Oil Company (formerly Terra Resources, Inc.) as midcontinent regional manager from February 1990 to February 1991 and as land manager from August 1985 to January 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nKey's common stock, par value $.25 per share, trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol KPCI. No dividends were paid in 1995 or in 1994. The table below shows the market price of the common stock for 1995 and 1994:\nThe closing price of Key's common stock as reported on The Nasdaq Stock Market for March 22, 1996, was $5.50. At March 22, 1996, the Company's 8,849,468 shares of common stock outstanding were held by 5,323 stockholders of record and approximately 5,400 beneficial owners.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data of the Company for each of the years in the five-year period ended December 31, 1995, which information has been derived from the Company's audited financial statements. This information should be read in connection with and is qualified in its entirety by the more detailed information and financial statements under Item 8 below.\n\/(a)\/ Net income for 1993 includes a non-recurring gain of $1,603,000 ($.16 per share) due to a change in the method of accounting for income taxes and an extraordinary loss on early extinguishment of debt of $122,000 ($.01 per share).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL RESULTS\nKey is reporting 1995 net income of $3.1 million, or $.32 per share. On a per share basis, net income rose 7 percent over the $.30 per share reported in 1994, and 68 percent over the $.19 per share from continuing operations reported in 1993. Earnings for 1995, 1994 and 1993 are based on oil and gas revenues of $19.3, $16.3, and $11.7 million, respectively.\nNet income for 1993 was $3.5 million ($.34 per share) and includes a $1.6 million non-recurring benefit resulting from the adoption of Statement of Financial Accounting Standards No. 109 in January 1993 and $122,000 loss on early extinguishment of debt.\nREVENUES\nIn 1995, oil and gas revenues climbed 18 percent to $19.3 million. The surge in revenues is primarily the result of production increases. Sales for 1995 reflect a full year of production from the Company's 1994 acquisition and additional volumes from successful drilling projects.\nBetween 1994 and 1993, oil and gas revenues rose by $4.6 million, or 40 percent to reach $16.3 million. The significant increase to 1994 sales encompasses eight months of production from the Company's second quarter 1994 acquisition of producing properties and the positive impact that wells drilled or recompleted since 1993 had on oil and gas production.\nGas sales between 1995 and 1994 remained relatively flat at $9.0 million. Daily gas volumes climbed 16 percent from 12,389 Mcf per day in 1994 to 14,416 Mcf per day in 1995, adding approximately $1.5 million in value. Increased gas production from new drilling and the 1994 acquisition were just enough to offset a drop in Key's average gas price. Average gas prices fell from $1.98 per Mcf in 1994 to $1.71 per Mcf in 1995.\nGas sales increased 7 percent between 1994 and 1993. The increase in gas sales is the result of gas volumes climbing 18 percent between 1994 and 1993. Daily production volumes went from 10,470 Mcf per day in 1993 to 12,389 Mcf per day in 1994 and had a positive impact of $1.5 million. This production increase was more than enough to counteract the effect of falling prices in the latter part of 1994. Key's average gas price dropped from $2.19 per Mcf in 1993 to $1.98 per Mcf in 1994.\nOil sales of $9.9 million in 1995 increased $2.7 million, or 38 percent, over the comparable 1994 sales. Increases to both price and production volumes account for the substantial gain. Daily production volumes increased 26 percent from 1,382 barrels per day in 1994 to 1,736 barrels per day in 1995. Additional volume in 1995 added approximately $1.8 million to oil sales. Key's average oil price increased 10 percent from $14.27 per barrel in 1994 to $15.70 per barrel in 1995. The favorable price variance had a positive impact of $.9 million.\nSpurred on by the acquisition, 1994 oil sales increased by $4 million over 1993 oil sales. Daily oil production more than doubled, going from 569 barrels per day in 1993 to 1,382 barrels per day in 1994. Production increases added $4.6 million to sales, while a 7 percent dip in prices reduced sales by $.6 million. The average price for oil was $14.27 per barrel in 1994 compared to $15.36 per barrel in 1993.\nProduct sales from gas processing plants contributed $301,000, $140,000 and $106,000 to oil and gas production revenues in 1995, 1994 and 1993, respectively. In 1995, Key's oil and gas revenues are derived from the following product mix: 52 percent oil, 47 percent gas and the balance from plant product sales. This compares to the following components for 1994: 44 percent oil, 55 percent gas and 1 percent plant products.\nOther revenues for 1994 include proceeds from a gas contract settlement in the amount of $300,000.\nCOSTS AND EXPENSES\nDepreciation, depletion and amortization (DD&A) expense increased 40 percent to $7.5 million for 1995. The increase to DD&A expense was triggered by higher oil and gas revenues as discussed above, and an increase to the amortization rate. Key's annualized amortization rate as a percentage of revenue increased from 32.1 percent in 1994 to 38.0 percent in 1995. The rate increase was a consequence of significantly lower gas prices and their effect on the future gross revenue component of the DD&A calculation. DD&A expense increased between 1994 and 1993. The 1994 increase was due to relatively higher oil and gas sales and net properties in 1994. Reserve additions from the acquisition and drilling helped reduce the amortization rate to 32.1 percent of revenue from 33.1 percent in the prior year.\nAs anticipated, operating expenses for 1995 rose 25 percent to $6.4 million. The increase can be attributed to the Company's 1994 acquisition and the numerous workovers performed in 1995 to maintain production on older, declining wells. On a unit of production basis, 1995 operating expenses are $.70 per EMcf, compared to $.68 per EMcf in 1994. Key's expenses on a unit of production basis increased in 1995 because the newly acquired properties have a greater oil percentage than Key's pre-acquisition properties and oil properties generally have higher lifting costs than gas properties. Key's operating expenses increased 1.9 million, or 59 percent, between 1994 and 1993. This increase was largely due to the second quarter acquisition and is in line with the boost to oil and gas revenues. On a unit of production basis, operating expenses for 1994 are $.68 per EMcf, up from the $.63 per EMcf in 1993.\nAdministrative, selling and other costs held steady with just a 2 percent increase to reach $1.5 million for 1995. Between 1995 and 1994, administrative expense dropped from $.19 per EMcf to $.16 per EMcf. Due to certain economies of scale and full cost accounting rules which provide for the capitalization of direct overhead related to exploration and development activities, the Company was able to maintain levels of administrative expense while managing a larger asset base. Administrative expenses declined seven\npercent between 1994 and 1993. On a units of production basis, administrative expense decreased to $.19 per Emcf in 1994, compared to $.30 per EMcf in 1993. Apache Corporation provided accounting and administrative services to Key for the first four months of 1993. Key paid Apache $300,000 for the services provided and this amount is included in the 1993 total.\nKey has a $50 million credit facility with NationsBank of Texas, N.A. In 1995, the Company elected to increase its borrowing base from $18 million to $22 million. During the year, an additional $4.6 million was borrowed to fund various exploration and development projects. Annual interest for 1995 increased from $446,000 to $828,000. Interest expense for 1995 includes interest on the additional $4.6 million borrowing and twelve months of interest versus eight months in 1994. Interest expense was only $125,000 in 1993 and reflects the Company's pre-acquisition debt levels.\nInterest of $574,000 was capitalized in 1995 for borrowings associated with the undeveloped leasehold acquired in 1994. Capitalized interest of $309,000 was recorded for the same period of 1994. No interest was capitalized for 1993.\nInterest income of $16,000, $110,000 and $282,000 was recorded for the years 1995, 1994 and 1993, respectively. The higher interest income in 1994 and 1993 reflects the investment of property sales proceeds received in the first quarter of 1993 and held until the second quarter of 1994. Available cash was used to partially fund the acquisition.\nAs discussed in more detail in Footnote 3, \"Income Taxes\", the Company has determined that it is no longer necessary to maintain a valuation allowance against its deferred tax asset. This adjustment decreased the combined federal and state effective tax rate from 38 percent to approximately 19 percent for 1995.\nCASH FLOW AND LIQUIDITY\nLiquidity refers to the ability of an enterprise to generate adequate amounts of cash to satisfy its financial commitments. Key's primary needs for cash are to fund oil and gas exploration, development and acquisition activities and for payment of existing obligations and trade commitments related to oil and gas operations. The Company's primary sources of liquidity are cash flows from operating activities and proceeds from financing activities. Management believes that the overall sources of funds available to Key will continue to be more than sufficient to satisfy the Company's financial obligations.\nCash from operating activities declined slightly from $11.6 million in 1994 to $11.3 million in 1995. An increase to net income between the two years added $.1 million to cash from operating activities, and the increase in DD&A added another $2.1 million. These 1995 increases were offset by a $1 million decrease in deferred taxes and normal fluctuations in the other balance sheet components. Cash from operating activities soared from $6.7 million in 1993 to $11.6 million in 1994. Most of this increase can be traced to Key's 1994 acquisition and active drilling program. The resulting higher\noil and gas production translates into elevated oil and gas revenues and a boost to cash from operating activities.\nCash expenditures for exploration and development for 1995 totaled $13.5 million, or 119 percent of cash from operating activities. This compares to $6.1 million and 53 percent of cash from operating activities in 1994, and $1.9 million and 29 percent of cash from operating activities in 1993. The Company implemented a strategy to increase production and reserves through selective drilling in the second quarter of 1993. Since that time, the Company has steadily expanded its exploration and development activities. Key drilled 56 gross wells (8.35 net) in 1995, 45 gross wells (6.25 net) in 1994 and 27 gross wells (.6 net) in 1993.\nIn the second quarter of 1994, Key completed a transaction to acquire assets in the Rocky Mountain region for $22.75 million. As of the October 1, 1993 effective date, the acquisition included 2.6 million barrels of oil, 8 billion cubic feet of natural gas and approximately 980,000 net undeveloped acres. Only minor acquisitions of oil and gas properties were made in 1995 and no acquisitions were made in 1993.\nIn 1993, the Company received $3.9 million in proceeds from the sale of approximately 1,100 low value oil and gas properties, the sale of a net profit reversionary interest and the sale of a negative reversionary interest. The properties and net profit interests were sold to Apache to reduce the administrative expense Key would incur accounting for numerous low-value properties. Key received proceeds for small property sales in 1995 and 1994.\nIn the second quarter of 1994, Key borrowed $12.5 million against its credit facility with NationsBank to partially fund the acquisition. In the second half of 1994, the Company repaid $2.5 million of the loan using cash from operations. In 1995, the Company borrowed a net of $4.6 million against its NationsBank credit facility to finance exploration and drilling activities and stock repurchases in excess of cash generated by operating activities.\nIn the fourth quarter of 1995, Key purchased 331,000 shares of its own stock from Apache Corporation for $1.7 million, or $5.00 per share. In 1994, Key purchased 292,171 shares of its own stock for $1.3 million, or an average of $4.58 per share. In a non-cash transaction in 1994, the Company exchanged approximately 200,000 net undeveloped acres in the Green River Basin in Wyoming for 800,000 shares of Key common stock held by Apache. Transactions for the purchase of shares in 1993 were immaterial.\nThe Company's ratio of current assets to current liabilities was 1.1 to 1 at December 31, 1995, an increase from the 1 to 1 ratio calculated at December 31, 1994.\nManagement believes that cash on hand at year-end, net cash generated from operations and remaining amounts available under the existing line of credit will be adequate to meet future liquidity needs, including satisfying the Company's financial obligations and funding operations, exploration and development activities.\nFUTURE TRENDS\nConsistent with its stated objective over the last several years, the Company will continue to pursue expansion of its exploration and development activities in 1996. As discussed above, cash expenditures for exploration and development activities totaled $1.9 million, $6.1 million and $13.5 million in fiscal 1993, 1994 and 1995, respectively.\nTotal reserve additions in 1995 replaced 154% of that year's production and, on a year-end comparative basis, reserve quantities increased approximately 9% to 60.2 EBcf. Production for the year increased approximately 20% on an EMcf basis. These production and reserve quantity increases are primarily attributable to the results of successful drilling projects. The Company intends to continue to increase exploration and development expenditures. However, as in the past, Key will invest only in those projects that meet its economic investment criteria. Depending on the number and quality of drilling opportunities identified, total cash available under the credit facility combined with cash from operating activities may exceed the dollar amount of the investment opportunities identified. This has been the case in each of the last three fiscal years.\nIn December 1995, Key and Brock Exploration Corporation (Brock) entered into a definitive merger agreement that would combine the two companies. The agreement provides that each Brock stockholder will receive one share of Key common stock for each 1.45 Brock shares held. The transaction is subject to approval by stockholders of both companies and will be voted upon at special meetings of the respective stockholders on March 28, 1996. If the requisite approval is received, the merger will be close as soon as reasonably practicable thereafter. Based on information currently available, Key expects the transaction to be consummated.\nDetails of the merger and pro forma information about the combined companies is contained in a Joint Proxy Statement\/Prospectus that was mailed to stockholders of both companies on or about February 16, 1996. As described therein, subsequent to the merger, Brock would be a wholly-owned subsidiary of Key. Administrative and accounting functions previously performed by Brock employees in Brock's offices in New Orleans, LA would be consolidated in Key's Denver office. Key expects to maintain a small staff of former Brock employees in Brock's exisiting New Orleans office. Personnel in that office will focus on exploration and acquisition activities. Key expects to realize significant administrative savings compared to the combined pre-merger expenses of the two companies.\nIn connection with the merger, Key will assume all of the assets and liabilities of Brock, including Brock's exisiting bank debt. The borrowing base under Key's line of credit with NationsBank is based on the value of its oil and gas properties. Key is currently negotiating with NationsBank to obtain an increase in its borrowing base using the reserve value of the combined companies. The Company expects to obtain this increase and will use the additional funds available under the facility to repay Brock's exisiting bank debt thereby taking advantage of Key's more favable interest rate terms.\nKey will continue to pursue its strategy of centralized administration and regionally-decentralized exploration in 1996. Regional offices were opened in Tulsa, OK and Houston, TX in October, 1994 and March 1995, respectively, and as discussed above, consummation of the merger with Brock will add a regional office in New Orleans. Personnel in the regional offices will seek to identify attractive exploration and acquisition opportunities in their respective geographical areas with the overall corporate goal of increased production, reserves and profitability.\nKey's regional efforts have historically been focused in the Rocky Mountain, Gulf Coast and Mid Continent areas. During 1995, Key launched exploration activities in a fourth regional area - California. Under the terms of a joint venture agreement with Mobil Exploration & Producing U.S. Inc. (Mobil), Key obtained exploration rights on approximately 15,000 gross acres of producing leasehold in the gas-prone Sacramento basin. To date, results have been encouraging with three of the four wells drilled completed as producers. These three wells were placed on production in January, February and March, 1996. These wells are currently producing and selling gas. Key has access to the 3-D seismic information previously obtained by Mobil and is in the process of conducting additional 3-D seismic surveys in the area. Additional drilling is planned in this area during 1996, although the exact number of wells to be drilled has not been determined at this time.\nThe Company expects that cash on hand, net cash generated by operating activities and amounts available under the credit facility will be adequate to meet future liquidity needs under corporate policies. Management believes that the overall sources of funds available to Key will continue to be sufficient to satisfy the Company's financial obligations and to provide resources for exploration, development and acquisition activities.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee following Index\nKEY PRODUCTION COMPANY, INC.\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES\nAll other supplemental information and schedules have been omitted because they are not applicable or the information required is shown in the financial statements or related notes thereto.\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF INCOME\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF CASH FLOWS\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nBALANCE SHEET\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF STOCKHOLDERS' EQUITY\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFORMATION OF KEY PRODUCTION COMPANY, INC.\nKey Production Company, Inc. (Key or the Company) was formed in 1988 to succeed to a portion of the assets and liabilities of Apache Petroleum Company L.P. (APC). From 1988 through the third quarter of 1992, the Company used operating cash flow and property sales proceeds to reduce debt, repurchase shares of its common stock and pay dividends. In light of its depleting reserves and increasingly disproportionate general and administrative costs, the Company began evaluating strategic alternatives for its future.\nSince inception, all of Key's operating and managerial functions had been performed by Apache Corporation (Apache) under the terms of a management agreement between Key and Apache. On September 9, 1992, Key's board of directors announced its intention to establish a management team independent of Apache and to engage the Company in active operations. They appointed a board of directors unrelated to Apache. The newly-elected board announced its intention to discontinue semiannual dividend payments and use the Company's cash flows to actively pursue alternatives for increasing its reserve base.\nApache subsequently gave Key notice of its intent to dissolve APC Operating Partnership L.P. (APCOP) and, effective January 1, 1993, the parties entered into an agreement covering the distribution of APCOP's assets. Under the terms of the agreement, Apache assumed the majority of APCOP's trade payables and accrued liabilities plus a portion of its long-term debt in exchange for a portion of APCOP's current assets. APCOP's remaining assets were distributed to Apache and Key in accordance with their respective partnership interests. Immediately following the dissolution of APCOP, Key sold its interest in approximately 1,100 properties to Apache. The properties sold were primarily those with low individual values. These properties were sold to reduce the overhead Key would subsequently incur by accounting for numerous low-value properties.\nKey is an independent oil and gas company engaged in oil and gas exploration, development and production in the continental United States. The Company's exploration interests are spread over 14 states with primary focus areas in the the Anadarko Basin of Oklahoma, California, the Rocky Mountain region, and the Gulf Coast.\nBASIS OF PRESENTATION\nThe accompanying financial statements include the accounts of Key for 1995, 1994 and 1993.\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\nstatements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nOIL AND GAS PROPERTIES\nThe Company follows the full cost method of accounting for its investment in oil and gas properties and, accordingly, capitalizes all exploration and development costs incurred for the purposes of finding oil and gas reserves, including dry hole costs, geological and geophysical costs and direct overhead related to exploration and development activities. Payroll and other internal costs capitalized include salaries and related benefits paid to employees directly engaged in the acquisition, exploration and development of oil and gas properties, as well as other specifically identifiable internal costs. Future development, site restoration, dismantlement and abandonment costs, net of salvage values, are estimated on a property-by-property basis using prevailing prices. No gains or losses are normally recognized on the sale or disposition of oil and gas properties under full cost accounting.\nKey computes the provision for depreciation, depletion and amortization (DD&A) of oil and gas properties on a quarterly basis using the future gross revenue method. The quarterly provision is calculated by multiplying the quarter's oil and gas revenues by an overall rate determined by dividing the total unamortized cost of oil and gas properties including estimated future development costs (excluding the cost of investments in unproved and unevaluated properties) by the total estimated future oil and gas revenues.\nKey limits the capitalized costs of oil and gas properties, net of accumulated DD&A, to the estimated future net cash flows from proved oil and gas reserves discounted at ten percent, plus the lower of cost or fair market value of unproved properties as adjusted for related tax effects. This limit may be particularly sensitive to changes in the near term in pricing and production rates. If capitalized costs exceed this limit, the excess is charged to DD&A expense. The Company has not recorded any such write-downs of capitalized costs for the three years ended December 31, 1995.\nThe costs of certain unevaluated leasehold acreage and wells in the process of being drilled are not amortized. Amortization commences when such costs are evaluated or upon completion of wells in progress. Costs not being amortized are periodically assessed for possible impairments or reductions in value. If a reduction in value has occurred, the portion of the carrying cost in excess of the current value is included in the costs subject to amortization. Interest costs related to undeveloped properties are also capitalized. Financing costs were reduced by capitalized interest totaling $574,000 and $309,000 in 1995 and 1994, respectively. No interest was capitalized during 1993.\nOffice furniture and equipment are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets which range from five to ten years.\nREVENUE RECOGNITION\nKey uses the sales method of accounting for natural gas revenues. Under this method, revenues are recognized based on actual volumes of gas sold to purchasers. The volumes of gas sold may differ from the volumes to which Key is entitled based on its interests in the properties. Differences between volumes sold and volumes based on entitlements create gas imbalances which are reflected as adjustments to reported gas reserves and future cash flows. Adjustments for gas imbalances reduced Key's proved gas reserves by approximately eight percent at December 31, 1995.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires an asset and liability approach to accounting for income taxes. A deferred tax liability or asset is determined based on the temporary differences between the financial reporting and tax basis of assets and liabilities as measured by the enacted tax rates. A valuation allowance must be established for any portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized. In 1993, the Company recognized a one- time cumulative benefit of the accounting change on prior years of $1,603,000.\nNET INCOME PER SHARE\nNet income per share amounts are based on the weighted average number of common shares outstanding for each year. When dilutive, outstanding options to purchase common stock are included as share equivalents using the treasury stock method. In 1995, only one per share figure is presented because the fully diluted and primary earnings per share amounts are not materially different. For 1994 and 1993, the common stock equivalents were either antidiulutive or their inclusion did not materially affect the net income per share amounts.\nSTATEMENT OF CASH FLOWS\nThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. These investments earned 5.3 percent rates of interest at December 31, 1995 and 1994, with cost approximating market.\nRECLASSIFICATION\nCertain prior year amounts have been reclassified to conform with the 1995 presentation.\nTREASURY STOCK\nTreasury shares were acquired in 1995, 1994 and 1993 under the Company's policy of repurchasing shares when market conditions appear favorable. Treasury stock is recorded at cost.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS\n1. ACQUISITIONS AND DIVESTITURES\nOn April 29, 1994, Key completed a transaction to purchase all the assets of a privately-held independent oil and gas company for $22.75 million. As of the effective date, October 1, 1993, the assets included 2.6 million barrels of oil, 8 billion cubic feet of natural gas and approximately 980,000 net undeveloped acres. Key used cash on hand and a $12.5 million draw on its credit facility to fund the acquisition.\nThe following unaudited pro forma information was prepared as if the acquisition occurred on January 1, 1993. The pro forma data presented is based on numerous assumptions.\n2. DEBT\nBANK FINANCING-The bank financing is a $50 million revolving credit facility with NationsBank of Texas, N.A. The Company entered into the agreement on April 25, 1994, to fund the above-mentioned acquisition and any future acquisition and drilling opportunities. In 1995, the Company elected to increase the borrowing base from $18 million to $22 million. The current borrowing base is still significantly less than the total borrowing base that could have been requested under the terms of the agreement.\nInterest on amounts borrowed is charged at NationsBank's prime rate or at London Interbank Offered Rates (LIBOR) plus .5 to 1.125 percent, at the Company's option. The factor added to LIBOR is determined by the Company's debt to capitalization ratio at the time of borrowing. The average interest rate on the various maturities of debt outstanding at December 31, 1995, was 6.63 percent. Key pays a .25 percent fee on the unused portion of the borrowing base, as well as other fees of approximately $10,000 per year in return for the bank's commitment to maintain the availability of those funds. On April 1, 1997, the borrowing converts from a revolving loan to a term note. At that point, if not renegotiated before then, the Company must commence quarterly principal payments in addition to paying interest. The entire facility matures on January 1, 2000.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nIn accordance with full cost accounting rules, the Company capitalizes interest expense on borrowings associated with undeveloped leasehold. For 1995 and 1994, the Company capitalized $574,000 and $309,000, respectively. No interest was capitalized for 1993.\nThe credit facility with NationsBank requires the Company to comply with certain covenants contained within the Credit Agreement (Agreement) until full and final payment of the obligaton and termination of the Agreement. The Company has been in compliance with the covenants since April 1994 when the Agreement was signed.\nAggregate maturities of long-term debt outstanding at December 31, 1995, are as follows:\nThe fair value for long-term debt is estimated based on current rates available for similar debt with similar maturities and securities, and at December 31, 1995, approximates the carrying value.\n3. INCOME TAXES\nThe cumulative effect of the change in the method of accounting for income taxes attributable to fiscal years prior to 1993 was an increase in net earnings of $1,603,000 or $.16 per share, which has been reflected as a change in accounting method in the accompanying financial statements.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nDeferred tax liabilities and assets are comprised of the following components at December 31, 1995 and 1994:\nThe Company had net tax operating loss carryforwards of approximately $4.8 million at December 31, 1995, which expire in the years 2003 through 2009.\nIn connection with adoption of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993, the Company established a valuation allowance for a portion of its deferred tax asset. At that time, it was unknown whether the Company would be able to fully utilize the net operating loss (NOL) carryforwards underlying the deferred tax asset.\nIn 1994, a significant portion of the NOL carryforwards were utilized in connection with a sale of non-producing leasehold and, based on current projections, it appears more likely than not that the Company will be able to utilize the remaining NOL carryforwards before they expire. As a result, the Company has determined that it is no longer necessary to provide a valuation allowance. This adjustment decreased the combined federal and state effective tax rate from 38 percent to approximately 19 percent for 1995.\nIncome tax expense consisted of the following:\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n4. NON-CASH INVESTING AND FINANCING ACTIVITIES\nSupplemental Disclosure of Cash Flow Information\nSupplemental Disclosure of Non-Cash Investing and Financing Activities\nOn July 19, 1994, the Company exchanged approximately 200,000 net undeveloped acres in the Green River Basin in Wyoming for 800,000 shares of Key common stock held by Apache and the formation of an exploration joint venture which gives Key the right to explore on all of Apache's non-Green River Basin acreage in Wyoming and access to all of Apache's seismic and other data in Wyoming. The trade involved approximately 25 percent of Key's Rocky Mountain acreage. The transaction value was based on the price for the Company's common stock at that date and, accordingly, Key reduced the carrying value of its undeveloped properties by $3.3 million.\n5. STOCK OPTIONS\nThe Key Production Company, Inc. 1992 Stock Option Plan reserves 1,000,000 shares of common stock for issuance to the Company's officers and employees. A total of 500,000 options were outstanding at year end. The options expire at various dates through 2005 and are at prices ranging from $2.50 to $4.875 per share with an aggregate exercise price of $1,598,750.\nThe Key Production Company, Inc. Stock Option Plan for Non-Employee Directors reserves 180,000 shares of common stock for issuance to the Company's non-employee directors. There were 90,000 options outstanding at year end at an aggregate exercise price of $258,750. These options expire in 2002. No options have been granted since 1992.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company's president was granted options for 500,000 shares of the Company's common stock in 1992 in accordance with the terms of his employment agreement. These outstanding options were granted at an exercise price of $3.00 and expire in 2002.\nAll options granted had an exercise price equal to or above fair market value on the date of grant. Subject to accelerated vesting under certain circumstances such as death of the employee or change in control of the Company, one-third of the options vest in each of the three years following the date of grant. At December 31, 1995, a total of 840,000 outstanding options were vested.\nThe following table summarizes the changes in stock options for the year and the number of common shares available for grant at year end.\n6. EMPLOYEE BENEFIT PLANS\nRETIREMENT PLAN-The Company provides a 401(k) retirement\/savings plan for all employees. This plan allows participants to contribute up to 10 percent of their compensation, with Key matching contributions up to a maximum of 4 percent of their compensation. The Company's contribution is made in the form of Key common stock. Employees vest in the Company's contribution at the rate of 25 percent per year. Total expenses for the Company's matching contribution were $55,362, $33,029 and $18,505 in 1995, 1994 and 1993, respectively. In connection with the annual testing required on all 401(k) plans, Key made qualified non-elective contributions for the benefit of all non-highly compensated employees. Qualified non-elective contribution expense was $23,056 and $11,980 in 1995 and 1994, respectively. The contribution was required to keep the plan qualified due to the top heavy status of the plan. No comparable contribution was required for 1993.\nDEFERRED COMPENSATION PLAN-Effective December 1, 1993, the Company established the Key Production Company, Inc. Deferred Compensation Plan. This plan is intended to provide a mechanism whereby certain management employees of the Company may defer compensation. The Company intends this plan to provide the eligible employees with the opportunity to defer compensation in cases where deferrals under the 401(k) plan may be limited by applicable provisions of the Internal Revenue Code of 1986.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nINCOME CONTINUANCE PLAN-Effective June 1, 1994, the Company established the Key Production Company, Inc. Income Continuance Plan. This plan provides for the continuation of salary and benefits for certain employees in the event of a change in control of the Company.\nThe administrative, compliance, and legal costs associated with administering these plans are paid by Key. Such expenses were not significant in 1995, 1994 or 1993.\n7. COMMITMENTS AND CONTINGENCIES\nLEASE COMMITMENTS-The Company has leases for office space with varying expiration dates through 1998. Rental expense was $96,997, $52,683 and $13,746 for 1995, 1994 and 1993, respectively.\nAs of December 31, 1995, minimum rental commitments under these leases are payable in the following years:\nLITIGATION-The Company is involved in litigation claims and is subject to governmental and regulatory controls arising in the ordinary course of business. It is the opinion of the Company's management that all claims and litigation involving the Company are not likely to have a material adverse effect on its financial position or results of operations.\nENVIRONMENTAL-The Company is not aware of any environmental claims existing as of December 31, 1995, which would have a material impact upon the Company's financial condition or the results of operations. Key does not believe that compliance with federal, state or local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have such an impact.\n8. TRANSACTIONS WITH RELATED PARTIES\nIn connection with the APCOP dissolution, Key entered into an agreement with Apache whereby Apache provided accounting and administrative services to Key for the first four months of 1993. Key paid Apache $300,000 for services provided under this agreement.\nDuring 1994, Key entered into three other transactions with Apache. As discussed in Note 4, in July 1994, Key exchanged approximately 200,000 net undeveloped acres in the Green River Basin of Wyoming for 800,000 shares of Key's common stock held by Apache. Later in July, 1994, Key purchased 200,000\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nshares of its common stock from Apache at a price of $4.50 per share and in December, 1994, Key purchased an additional 91,000 shares from Apache at $4.75 per share.\nIn October, 1995, Key purchased 331,000 shares of its own stock from Apache at $5.00 per share.\n9. CONCENTRATION OF CREDIT RISK\nSubstantially all of the Company's accounts receivable at December 31, 1995 and 1994, result from oil and gas sales to other companies in the oil and gas industry. This concentration of customers may impact the Company's overall credit risk, either positively or negatively, in that these entities may be similarly affected by industry-wide changes in economic or other conditions. Such receivables are generally not collateralized.\nThe following parties purchased 10 percent or more of Key's oil and gas production:\nEffective January 1, 1993, Key entered into an agreement with Apache under which Key pays Apache a fee to market the majority of its gas production that is not subject to traditional gas contract arrangements. From 1993 to 1995, the majority of Key's gas production marketed by Apache was sold to Natural Gas Clearinghouse (NGC).\n10. SUBSEQUENT EVENT\nOn December 21, 1995, Key announced the signing of a definitive agreement to merge with Brock Exploration Corporation (Brock). The merger will be structured as a tax-free exchange with each Brock stockholder receiving one share of Key stock for each 1.45 Brock share held. The merger is subject to approval by the stockholders of both Key and Brock and certain other conditions. Both Key and Brock will submit the merger to their respective stockholders for approval at special meetings on March 28, 1996. Subject to stockholder approval and other conditions, the transaction will be consummated as soon as practicable in the Spring of 1996.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Key Production Company, Inc.:\nWe have audited the accompanying balance sheets of Key Production Company, Inc. (a Delaware corporation) 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 Key Production Company, 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.\nAs explained in Note 3 to the financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes.\nARTHUR ANDERSEN LLP\nDenver, Colorado, February 28, 1996.\nKEY PRODUCTION COMPANY, INC.\nSUPPLEMENTAL OIL AND GAS DISCLOSURES\nOIL AND GAS OPERATIONS-The following tables contain revenues and direct cost information relating to the Company's oil and gas exploration and production activities for the periods indicated. Key has no long-term supply or purchase agreements with governments or authorities in which it acts as producer.\nCAPITALIZED COSTS-The following table sets forth the capitalized costs and related accumulated depreciation, depletion and amortization relating to the Company's oil and gas production, exploration and development activities.\nCOSTS NOT BEING AMORTIZED-Oil and gas property costs not being amortized at December 31, 1995, consist of $9,104,000 of leasehold cost. Of the total, $2,270,000, $6,814,000 and $20,000 was incurred in 1995, 1994, and 1993, respectively.\nOIL AND GAS RESERVE INFORMATION (UNAUDITED)-Proved oil and gas reserve quantities are based on estimates prepared by the Company's engineers, and were audited by Ryder Scott Company Petroleum Engineers, independent petroleum engineers, in accordance with guidelines established by the Securities and Exchange Commission (SEC). Reserve estimates are based on economic and operating conditions existing at December 31 of each year presented.\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production and timing of development expenditures. The following reserve data represents estimates only and should not be construed as being exact. All of the Company's reserves are located in the continental or offshore United States.\nFUTURE NET CASH FLOWS (UNAUDITED)-Future revenues are based on year end prices except in those instances where the sale of gas is covered by contract terms providing for determinable escalations. Operating costs, production and ad valorem taxes and future development costs are based on current costs with no escalation.\nThe following table presents information concerning future net cash flows from the production of oil and gas reserves, net of income tax expense. Income tax expense has been computed using expected future tax rates and giving effect to permanent differences and credits which, under current laws,\nrelate to oil and gas producing activities. This information does not purport to present the fair market value of Key's oil and gas assets, but does present a standardized disclosure concerning possible future net cash flows that will result under the assumptions used.\nDISCOUNTED FUTURE NET CASH FLOWS AND CHANGES RELATING TO PROVED RESERVES AT DECEMBER 31,\nIMPACT OF PRICING (UNAUDITED)-The estimates of cash flows and reserve quantities shown above are based on year end oil and gas prices, except in those cases where future gas sales are covered by contracts at specified prices. Fluctuations are largely due to the seasonal pricing nature of natural gas, supply perceptions for natural gas and significant worldwide volatility in oil prices.\nUnder SEC rules, companies that follow full cost accounting methods are required to make quarterly \"ceiling test\" calculations. Under this test, capitalized costs of oil and gas properties may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10 percent, plus the lower of cost or fair market value of unproved properties, as adjusted for related tax effects and deferred tax reserves. Application of these rules during periods of relatively low oil and gas prices, even if of short-term duration, may result in write-downs.\nKEY PRODUCTION COMPANY, INC.\nSUPPLEMENTAL QUARTERLY FINANCIAL DATA\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information set forth under the caption \"Information About Nominees for Election as Directors\" in the Company's proxy statement relating to the Company's 1995 annual meeting of stockholders (Proxy Statement) is incorporated herein by reference. Certain information with regard to the executive officers of the Company is set forth under the caption \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Summary Compensation Table,\" \"Aggregated Option Exercises In The Last Fiscal Year and Fiscal Year End Option Values,\" \"Director Compensation,\" \"Employment Agreements\" and \"Board Compensation Committee Report on Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the caption \"Transactions with Affiliates\" in the Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. The following financial statements are included in Item 8 to this 10-K.\nStatement of income for each of the three years in the period ended December 31, 1995.\nStatement of cash flows for each of the three years in the period ended December 31, 1995.\nBalance sheet as of December 31, 1995 and 1994.\nStatement of changes in stockholders' equity for each of the three years in the period ended December 31, 1995.\nSummary of significant accounting policies.\nNotes to financial statements.\nReport of independent public accountants.\nSupplemental oil and gas disclosures.\nSupplemental quarterly financial data.\n2. Schedules: None.\n3. Exhibits:\nExhibits not incorporated by reference to a prior filing are designated by an asterisk (*) and are filed herewith; all exhibits not so designated are incorporated by reference to a prior SEC filing as indicated.\nExhibits designated by a plus sign (+) are management contracts or compensatory plans or arrangements required to be filed herewith pursuant to Item 14.\nExhibit No. Description ----------- -----------\n2.1 -- Dissolution Agreement and Quitclaim Assignment between APC Operating Partnership L.P., Apache Corporation and\nthe Registrant, dated as of January 1, 1993 (incorporated by reference to Exhibit 2.1 to the Registrant's Form 10-Q for the period ended March 31, 1993, file no. 0-17162).\n2.2 -- Agreement and Plan of Merger dated as of December 21, 1995 among Key Production Company, Inc., Key Acquisition One, Inc. and Brock Exploration Corporation (incorporated by reference to Exhibit 2.2 to the Registrant's Statement on Form S-4, registration no. 333-00889 filed with the SEC on February 15, 1996).\n3.1 -- Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-4, registration no. 33-23533 filed with the SEC on August 5, 1988).\n3.2 -- Amendment to Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-4, registration no. 33-23533 filed with the SEC on August 5, 1988).\n3.3 -- Bylaws of the Registrant, as amended and restated on June 8, 1995 (incorporated by reference to Exhibit 3.3 to the Registrant's Form 10Q for the quarter ended June 30, 1995, file no. 0-17162.\n4.1 -- Form of Common Stock Certificate (incorporated by reference to Exhibit 4.12 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4, registration no. 33- 23533 filed with the SEC on August 15, 1988).\n10.6 -- Standstill Agreement between Registrant and Apache Corporation dated March 1, 1990, effective February 1, 1990 (incorporated by reference to Exhibit 10.6 to the Registrant's Form 10-K for the fiscal year ended December 31, 1991, SEC file no. 0-17162).\n+10.7 - Key Production Company, Inc. 1992 Stock Option Plan (incorporated by reference to Exhibit 10.7 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n+10.8 - Key Production Company, Inc. Stock Option Plan for Non- Employee Directors, (incorporated by reference to Exhibit 10.8 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n+10.9 --Stock Option Agreement between the Registrant and Francis H. Merelli, dated September 1, 1992 (incorporated by reference to Exhibit 10.9 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n+10.10 --Key Production Company, Inc. 401(k) Plan (incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n+10.11 --Employment Agreement between the Registrant and Francis H. Merelli, dated as of September 1, 1992 (incorporated by reference to Exhibit 10.11 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n+10.12 --Employment Agreement between the Registrant and Monroe W. Robertson, dated as of September 1, 1992 (incorporated by reference to Exhibit 10.12 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n10.13 --Stock Appreciation Rights Agreement between Apache Corporation and Francis H. Merelli, dated September 1, 1992 (incorporated by reference to Exhibit 10.13 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n10.14 --Stock Purchase Agreements between Apache Corporation and Francis H. Merelli, dated September 1, 1992 (incorporated by reference to Exhibit 10.14 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992, file no. 0-17162).\n10.15 --Purchase and Sale Agreement between Chorney Oil Company, The Estate of Raymond Chorney, Joan Chorney, Lancaster Corporation and Seabrook Corporation, collectively as seller, and Key Production Company, Inc., as buyer, dated April 29, 1994, effective October 1, 1993 (incorporated by reference to Exhibit 10.15 to the Registrant's Form 8-K dated April 29, 1994, file no. 0-17162).\n10.16 --Credit Agreement between Key Production Company, Inc. and NationsBank of Texas, N.A., dated April 25, 1994 (incorporated by reference to Exhibit 10.16 to the Registrant's Form 8-K dated April 29, 1994, file no. 0- 17162).\n10.17 --Purchase and Sale Agreement between Key Production Company, Inc., as seller; and Apache Corporation, as buyer, dated effective June 30, 1994 (incorporated by reference to Exhibit 10.17 to the Registrant's Form 10-Q for the quarter ended September 30, 1994, file no. 0-17162).\n+10.18 --Key Production Company, Inc. Income Continuance Plan, dated effective June 1, 1994.\n*24.1 --Consent of Arthur Andersen LLP dated February 28, 1996.\n*27.1 --Financial Data Schedule for Commercial and Industrial Companies per Article 5 of Regulation S-X for the year ended December 31, 1995.\n(b) Reports on Form 8-K:\nOn January 3, 1996, the Company filed a report dated December 21, 1995, on Form 8-K. The Form 8-K announced that Key Production Company, Inc. and Brock Exploration Corporation had entered into a definitive merger agreement that would combine the two companies.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKEY PRODUCTION COMPANY, INC.\nBy: \/s\/ F. H. Merelli _______________________________________ F. H. Merelli Date: March 28, 1996 Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ F. H. Merelli Director, Chairman, - --------------------------- President and Chief F. H. Merelli Executive Officer (Principal Executive Officer) March 28, 1996\n\/s\/ Monroe W. Robertson Senior Vice President ____________________________ and Secretary Monroe W. Robertson (Principal Financial Officer) March 28, 1996\n\/s\/ Cathy L. Anderson Controller ____________________________ (Principal Accounting Cathy L. Anderson Officer) March 28, 1996\n\/s\/ Cortlandt S. Dietler Director March 28, 1996 ____________________________ Cortlandt S. Dietler\n\/s\/ Timothy J. Moylan Director March 28, 1996 ____________________________ Timothy J. Moylan","section_15":""}
{"filename":"812703_1995.txt","cik":"812703","year":"1995","section_1":"ITEM 1. BUSINESS\nDigital Microwave Corporation (the \"Company\" or \"DMC\") designs, manufactures and markets advanced and high-performance digital microwave equipment for a wide variety of short- and medium-haul communication applications worldwide. The Company's comprehensive portfolio of technologically advanced products is designed for use by telecommunication operators providing Personal Communication Services (\"PCS\")\/Personal Communication Networks (\"PCN\"), mobile telephone services, and local access, as well as for use in private networks worldwide. The Company offers its products to wireless service providers such as Panafon in Greece, Piltel in the Philippines, Airtouch Cellular, E-Plus in Germany and U.S. West New Vector; telephone companies and common carriers such as British Telecom and Mercury Communications Ltd.; and private networks such as the State of California and the United States Forestry Service. In addition, the Company forms alliances with major international telecommunications equipment providers such as AT&T, Bell South, Motorola, Northern Telecom, Ericsson, and Siemens AG as a means of accessing market opportunities. With approximately 87% of the Company's fiscal 1995 net sales generated from international sales, the Company has a worldwide sales and service organization operating through 13 sales and service offices in nine countries to address DMC customers' individualized geographic, regulatory and infrastructure requirements.\nINDUSTRY BACKGROUND\nOver the past decade, there has been a significant increase in worldwide demand for rapid, reliable, high-quality telecommunications equipment for voice, data, facsimile, and video image information. This trend is expected to continue. This demand has been fueled by changes in the regulatory environment in many developed countries; technological advances, particularly in the wireless communications arena; the rapid establishment of telecommunications infrastructures in many developing countries; and the growth in private communications networks. These developments have resulted in significant worldwide construction of new telecommunications infrastructures.\nMICROWAVE PRODUCTS\nThe Company's digital microwave radios consist of three basic components: a digital modem for interfacing with digital terminal equipment, a radio frequency (\"RF\") unit for converting a low frequency carrier signal from the modem to a high frequency microwave signal, and an antenna to radiate transmitting signals and capture receiving signals.\nThe Company manufactures digital microwave products that operate within the 2, 6, 7, 8, 10, 11, 13, 15, 18, 23, and 38 GHz frequency bands. These radios are used in point-to-point applications by cellular phone companies, telephone operating companies, Fortune 1000 companies, utilities, and government and military agencies.\nCURRENT PRODUCTS\nThe Company currently offers several product families each of which is designed to suit the requirements of specific telecommunications applications. The principal product families are the Quantum Series, the M Series, the SPECTRUM(TM) Series and the DMC Net(TM). The Quantum Series is designed primarily to serve as the backbone of a customer's transmission network by meeting all of that customer's medium-haul (20-60 miles) needs. The M-Series is designed to meet a variety of short- to medium-haul (5-20 miles) customer needs, while the SPECTRUM(TM) II Series is designed primarily as a microcell (under 5 miles) solution. In addition, the Company offers its NSL-15, In-Flight Phone and LC radio products on a selective basis. Each of these product lines and the Company's principal other products are described below.\nTHE QUANTUM SERIES. This family of radios provides the Company with access to markets requiring high performance transmission of medium to high capacity signals over long distances and more difficult terrain. The radio is designed to operate in the North American bands at 2, 6, 10, and 11 GHz, the International bands at 2, 7, 8, 13, 15 GHz and has many features that ensure a high grade of transmission on long paths or over water paths where microwave transmission can be impaired. The typical deployment of the radio is in back haul transmission for cellular networks in developing countries and for the private networks supporting control of gas or electric utility operations. Development of the Quantum Series products will continue in fiscal 1996 with the planned addition of a higher capacity version (aggregate of 80 Mbit\/s) for international markets.\nTHE M SERIES AND M-SE SERIES. The M-Series has grown to be the Company's biggest selling product todate. First introduced in 1989 at 18 GHz for the Northern American market, the platform has been significantly expanded and enhanced to become the choice of new cellular operators worldwide for cell site interconnections. Available in 7, 8, 13, 15, 18, and 23 GHz band, this radio allows a common product family to be used throughout an entire network even where different frequency bands are necessary to meet licensing or path distance requirements. The DMC-M Series is a low-to-medium capacity digital microwave radio family of products that is used for applications such as linking cell sites and connecting them back to central switching locations. The DMC-M Series products are designed to include user-convenient test features and built-in multiplexer options to simplify the work of both the network designer and the network operator. The high system gain of the DMC-M Series ensures reliable operation on longer paths and in adverse weather conditions. The Company expanded this product line to include the DMC M-SE Series of products which provide more efficient use of spectrum space by utilizing a more sophisticated digital modulation technique. As is the case for many of the Company's products, a synthesized frequency source is available, enabling an operator to easily change radio frequency in the event of a system relocation or when installing spare parts, resulting in reduced sparing costs and ease of system planning. Recent focus has been on performance enhancements and cost improvements to keep the product competitive. The M-Series has an excellent in service reliability record in some of the worlds largest GSM networks.\nTHE SPECTRUM(TM) SERIES. The SPECTRUM(TM) product was conceived to provide lower cost, short haul interconnections for cellular and PCS\/PCN applications. The Company initially launched the first SPECTRUM(TM) product in 1991 with a version operating in the millimeter waveband at 38GHz and targeted at the European PCN market. The rapid growth in this market segment worldwide and the demand of the operators and infrastructure suppliers has led to the second generation of the SPECTRUM(TM) product which is broadened to cover all the frequency bands typically utilized for low to medium capacity transmission application. The SPECTRUM(TM) II contains design enhancements over the Company's earlier products that make it a more natural choice for the wireless network market (Cellular, PCS\/PCN) as well as the local access markets of new public telecommunications operators (PTO). SPECTRUM II is designed for more rapid manufacture and deployment allowing shorter lead times and lower installation costs.\nThe completion dates for the release of SPECTRUM(TM) II products have been delayed from the originally scheduled dates for various reasons related to difficulties in design, development and manufacture of these products. The delays resulted in the imposition on the Company of substantial product discounts on Interim Equipment and related costs in the fourth quarter of fiscal 1995 as provided for under the E-Plus Supply Agreement as amended. The substantial discounts on Interim Equipment resulted in negative margins for these sales, and accordingly the Company has accrued these losses and other related costs as of March 31, 1995. Currently the Company is awaiting E-Plus's acceptance of the product in field tests being conducted. There is no assurance that the customer will accept the results of the field tests. If the field tests are not successfully completed, E-Plus may assess additional substantial penalties and or cancel some or all of the orders. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Financial Results\" incorporated herein by reference, \"E-Plus Contract\" and \"Manufacturing and Suppliers.\"\nOTHER PRODUCTS\nThe Company manufactures a number of other products some of which are still supported because of their low cost, reliability and popularity and others which are supplied uniquely to certain customers.\nThe 23 Classic is the current implementation of the Company's first product which was originally designed and introduced in 1985. Its simplicity, low cost and dependability generates modest on-going business primarily with existing users. The 23 Classic finds applications in private networks and is suited to emergency restoration systems where its small size and low power consumption allow easy transportation and compatibility with solar power systems.\nThe LC Series operates in the 23 GHz and 18 GHz bands, with up to 8T1 or 8E1 capacity. The 23 LC with 8E1 capacity provides a very economical medium capacity transmission facility ideally suited for applications not requiring high bandwidth efficiency.\nThe NSL-15 is a specialized radio operating in the 15 GHz frequency band that is sold to military or other government users. With a capacity of 2 megabits per second, the NSL-15 is built to very stringent military specifications and is supplied to end-users both directly by the Company and in partnership with NERA in Norway.\nIFPC radios are specialized air-to-ground digital microwave radios developed for the In-Flight Phone Corporation (\"IFPC\") for use on commercial and general aviation aircraft. The IFPC radios are designed to permit digital voice and data communications between airline passengers and the ground- based public switched telephone network.\nDMC Net(TM) is a network monitoring and control system designed to manage a network of Company products from a single location. Network management has become an essential part of the very large networks being installed by cellular based telephone companies. DMC Net(TM) allows customers to monitor equipment and path performance to detect problems before they disrupt the network, and to dispatch repair crews equipped with the correct spare parts and test equipment to make repairs. Second and third trips can often be avoided, reducing costs and maximizing network availability. DMC Net(TM) has in many cases been integrated into an overall network management system, allowing the monitoring of the status of a complete cellular system, including microwave, UHF, power system and switching equipment. DMC Net(TM) can be used with almost any mix of DMC products. In recognition of its importance, the Company continues to invest development resources in the expansion and improvement of DMC Net(TM).\nPRODUCTS UNDER DEVELOPMENT\nThe Company's current product development efforts are principally focused on the development of the following products:\nQUANTUM(TM) . The Company is continuing product development efforts in fiscal 1996 to enhance the QUANTUM(TM) product line. These efforts are intended to provide higher capacity options and operation in additional frequency bands. It is expected that the portion of the Company's sales attributable to QUANTUM(TM) products will continue to increase as a result of these product development efforts.\nSPECTRUM(TM) II. The Company is continuing substantial product development efforts in fiscal 1996 to enhance and expand the SPECTRUM(TM) II product line. These efforts are intended to provide higher capacity options and operations in additional frequency bands.\nDMC Net(TM). An improved version of DMC Net(TM) is under development. The objective of this development is to allow the use of DMC Net(TM) on networks comprised of several thousand radio terminals and to provide a graphical user interface making DMC Net(TM) easier to operate.\nThere can be no assurance that the Company will be successful in developing and marketing these products, that the Company will not experience difficulties that could further delay or prevent the successful development, introduction and sale of future products, or that these products will adequately meet the requirements of the marketplace and achieve market acceptance. See \"Management's Discussions and Analysis of Financial Condition and Results Operations - Factors That May Affect Future Financial Results\" incorporated herein by reference.\nMARKETING, CUSTOMERS AND APPLICATIONS\nThe Company markets its products across most sectors of the telecommunications industry. A number of the Company's major customers are joint ventures or consortiums whose members include Bell South, AT&T, Siemens AG, Nokia Cellular Systems OY, and Ericsson. The principal market segment addressed by the Company, and examples of applications within those markets, are set forth below:\nWIRELESS SERVICE PROVIDERS\nCustomers include cellular telephone companies and PCN\/PCS companies in the United States and abroad which use the Company's microwave radios to connect cell sites and link them back to switching centers for connection to the public switched telephone network. Cellular technology has become the medium of choice in many developing countries where upgrading the telecommunication infrastructure is an urgent priority. The Company believes that a substantial majority of its products sold are used in cellular, PCN, PCS or similar applications.\nTypical of customers in this segment, Panafon, one of the Company's Global Systems Mobile Communications (\"GSM\") cellular telephone customers, is using the Company's products to interconnect cells and switching equipment for a cellular telephone network being constructed to cover the major metropolitan areas in Greece. E-Plus, a GSM cellular and PCN provider in Germany, has ordered the Company's digital microwave equipment for a mobile telecommunications network being created throughout certain regions of Germany.\nTELEPHONE COMPANIES AND COMMON CARRIERS\nCustomers include domestic and foreign telephone companies and long distance and inter-exchange carriers desiring to provide their customers with a greater variety of services, including direct access to long distance networks. Typical customer applications include trunking and local distribution.\nPRIVATE NETWORKS\nCustomers include corporations, institutions, various agencies of the United States and foreign governments and other organizations seeking greater control over the cost and availability of their communications services. Typical applications in this segment range from a single transmission link connecting two buildings to complex major networks comprised of dozens of microwave terminals.\nBANAMEX, a private banking institution, has established a private network using the Company's products to connect several of the banks throughout Mexico to facilitate the rapid communication of information.\nThe State of California uses the Company's products to interconnect several data centers throughout California.\nThe following is a list of representative customers, for the past three fiscal years, within each of the Company's principal segments:\n- -------------------------- WIRELESS SERVICE PROVIDERS - -------------------------- Panafon (Greece) Comviq (Sweeden) Advance Information System (Thailand) Grupo Iusacell (Mexico) Celumobil (Colombia) Bell Cellular (Canada) Cantel (Canada) U.S. West New Vector Airtouch AT & T Siemens AG\n- ------------------------------------------- TELEPHONE COMPANIES AND COMMON CARRIERS - ------------------------------------------- TELMEX (Mexico) Impsat (Colombia\/Argentina) Regional Bell Operating Companies (USA) British Telecom plc (United Kingdom) Mercury Communications Ltd. (United Kingdom) MCI Bell of Canada Piltel (Philippines)\n- ------------------------- PRIVATE NETWORKS - ------------------------- BANAMEX (Mexico) Americatel (Colombia) Bancomer (Mexico) State of California Seattle Post-Intelligence\nCUSTOMER CONCENTRATION\nThe Company has historically relied upon major orders from a small number of customers for a large portion of its net sales and these key customers have changed from period to period. As of March 31, 1995, the Company's three largest customers accounted for approximately 42% of the approximate $93.2 million backlog. For fiscal 1995, there were however, no customers that accounted for 10% or more of the Company's net sales of $153.6 million. While management considers the Company's relationships with each of its major customers to be good, there can be no assurance that the Company's principal customers will continue to purchase products from the Company at current levels, if at all, and the loss of any one key customer could have a material adverse effect on the Company's results of operations.\nBACKLOG\nThe Company's backlog at March 31, 1995 was approximately $93.2 million, as compared with approximately $71.8 million at March 31, 1994. The Company includes in backlog only orders scheduled for delivery within 12 months. Because of the timing of orders, delivery intervals, customer and product mix and the possibility of changes in delivery schedules and additions to or cancellation of orders, the Company's backlog at any particular date may not be representative of actual sales for any succeeding period. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" incorporated herein by reference.\nThe Company's major contractual awards are often subject to the receipt of firm orders, which in turn may be subject to many conditions including that the equipment purchased be competitive in the telecommunications marketplace with respect to technology, price, quantity, and other commercial concerns. In addition, because the Company's major orders often require deliveries for periods over 12 months, such products are subject to risks associated with obsolescence due to rapidly changing technological advances. There can be no assurance that the Company will be able to continue to provide competitive products. See \"E-Plus Contract\".\nE-PLUS CONTRACT\nIn November 1993, the Company entered into a Teaming Agreement (the \"E-Plus Teaming Agreement\") with Siemens AG (\"Siemens\") to supply digital microwave radios and network management software to E-Plus, a GSM cellular and PCN operator in Germany whose partners include Bell South, a United States company, Vodaphone plc, a United Kingdom company, and Thyssen and Veba, both German companies. Concurrent with executing the E-Plus Teaming Agreement, Siemens entered into a supply agreement with E-Plus (the \"E-Plus Supply Agreement\") wherein Siemens agreed to act as the prime contractor for the supply, installation and commissioning of certain digital microwave equipment and related services to E-Plus. The Company and Siemens have agreed, under the terms of the E-Plus Teaming Agreement, to divide responsibilities for satisfaction of the E-Plus Supply Agreement. The Company's responsibilities to Siemens under the E-Plus Teaming Agreement for the Company's portion of the equipment and services generally correspond to Siemens' obligations under the E-Plus Supply Agreement.\nThe Company is responsible for delivering approximately 80% of the value of the equipment and associated services called for under the E-Plus Supply Agreement. Siemens is responsible for providing all other services. Of the Company's approximately $92.3 million in backlog at March 31, 1995, approximately $15.6 million was attributable to the E-Plus Teaming Agreement. The products forecasted to be delivered periodically are subject to the release of confirmation orders from E-Plus. E-Plus is allowed to terminate any confirmation order in whole or in part for justified reasons and, subject to cure, E-Plus may terminate any confirmation order at its discretion without liability if the Company\/Siemens team commits a material breach of the confirmation order.\nE-Plus has agreed to purchase 100% of the microwave equipment it requires for the regions of Frankfurt, Nurnberg, Karlsruhe and Munchen until the end of 1997 from the Company\/Siemens team. E-Plus's commitment to buy equipment under the E-Plus Teaming Agreement is conditional upon the equipment purchased being competitive in the telecommunications marketplace with respect to the technology, software, hardware, support, price and other commercial concerns.\nThe E-Plus Teaming Agreement contains significant penalty provisions for delays in the delivery of specified products. If a delay, attributable to the Company\/Siemens team, occurs in (i) the successful and satisfactory completion of the system testing and integration of the Company's product into the E-Plus network; (ii) the satisfactory completion of link testing of the Company's products; or (iii) the delivery of any other items subject to the contract, the Company\/Siemens team could be subject to liquidated damages assessed at up to 15% of the value of the undelivered portion of a confirmation order. The E-Plus Teaming Agreement stipulates that the Company is responsible for that portion of a penalty attributable to its contract share.\nThe E-Plus Teaming Agreement provides for delivery of the Company's 23 GHz M-Series and SPECTRUM(TM) I-38 series products as an interim solution (the \"Interim Equipment\") until the Company's SPECTRUM(TM) II series equipment (\"SPECTRUM(TM) II Equipment\") is available. The Company commenced initial shipments of the Interim Equipment in December 1993. The E-Plus Teaming Agreement states that after the SPECTRUM(TM) II series equipment becomes available, E-Plus may choose to either leave the Interim Equipment installed or replace it with the SPECTRUM(TM) II equipment. In October 1994, the Company, Siemens and E-Plus entered into an amendment to the E-Plus Teaming Agreement under which the maximum percentage of Interim Equipment installed by February 28, 1995 that can be replaced with SPECTRUM(TM) II product free of charge will not exceed 20% of the installed base. In addition, the amendment extended the cutover date for the installation of the SPECTRUM(TM) II product to\nMarch 1, 1995. Delivery of Interim Equipment after this date will result in substantial sales price discounts on the product and cause negative margins on the sales. The Company also agreed to provide E-Plus certain products and other equipment free of charge, and E-Plus agreed to waive contractual liquidated damages related to the delayed delivery of the SPECTRUM(TM) II product. As a result of this amendment, in the third quarter of fiscal 1995 the Company recorded $11.4 million of revenue with nominal margins, representing 80% of the Interim Equipment shipped through December 31, 1994. The remaining 20% of Interim Equipment has not been recognized as revenue but is carried as inventory and deferred revenue on the Company's balance sheet. The Company makes an ongoing assessment of the obsolescence exposure related to the Interim Equipment.\nAcceptance tests of the SPECTRUM(TM) II product under the E-Plus Teaming Agreement have not yet been completed. As a result of these delays, in the fourth quarter of fiscal 1995 the Company recorded significant reserves for losses on product discounts and other costs related to additional Interim Equipment that the Company estimates will be ordered by E-Plus through the anticipated date of final acceptance of the Spectrum II product. These reserves contributed to the Company's lower margins and net loss of $5.0 million in the fourth quarter.\nContinued delays in the acceptance of the SPECTRUM(TM) II product by E-Plus could result in the imposition on the Company of additional product discounts, penalties, and other related costs and\/or the cancellation of orders. To the extent that the SPECTRUM(TM) II product is delivered later than currently scheduled, the Company's obligation to deliver substantially discounted Interim Equipment could be increased. The Company's profitability in fiscal 1996 will be affected by its ability to deliver in large quantities the SPECTRUM(TM) II products which carry higher margins than the current product line. See \"Management's Discussion and Analysis of Financial Conditions and Results of Operations - Factors that May Affect Future Financial Results:\" and Notes 2 and 9 of Notes to the Consolidated Financial Statements in the Company's fiscal 1995 Annual Report, incorporated herein by reference.\nThe Company is working closely with Siemens AG and E-Plus to resolve the remaining issues precluding acceptance. However, there can be no assurance that the Company will be successful in securing E-Plus acceptance.\nSALES AND SERVICE\nThe Company believes that a direct and continuing relationship with its customers is a competitive advantage in attracting new customers and satisfying existing ones. The Company offers its products and services principally through its own sales and service organization. To closely monitor the needs of its customers, the Company has designed a sales and service organization that maintains 13 sales or service offices in nine countries. The Company has five regional sales offices and service centers in North America located near Seattle, Washington; Chicago, Illinois; Toronto, Canada; Atlanta, Georgia; and San Jose, California, where the Company's North America sales organization is headquartered. The Company also has sales and\/or service centers in the United Kingdom, Germany, Sweden, Mexico, Colombia, Singapore and the Philippines. In addition, the Company uses independent agents, distributors and international resellers worldwide in concert with its direct sales operation.\nThe Company considers its ability to create and maintain long-term customer relationships an important component of its overall strategy in each of its markets. The Company employs over 106 people in its sales and service organization, approximately 70% of whom primarily support sales outside North America. Sales personnel are highly trained to provide the customer with assistance in selecting and configuring a digital microwave system suitable for the customer's particular needs. The Company's service and customer support personnel provide customers with training, installation, customer service and maintenance of the Company's systems under contract. The Company generally offers a standard two-year warranty for all customers. The Company provides warranty and post-warranty services from its San Jose manufacturing location and service centers in the United Kingdom and Canada.\nFOREIGN EXCHANGE\/INTERNATIONAL SALES\nTotal international sales for fiscal 1995 and 1994 were 87.0% and 90.5% of total net sales, respectively. The Company expects that international sales will continue to account for the majority of its net sales in the foreseeable future. The Company is subject to the risks of foreign currency fluctuations, and the changing value of the dollar in relationship to foreign currencies could negatively impact its operating results. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 2 of Notes to Consolidated Financial Statements incorporated herein by reference. International operations and sales may also be adversely affected by the imposition of government controls, export licensing requirements, restrictions on the export of critical technology, political and economic instability, trade restrictions, changes in tariffs and taxes, and general economic conditions, including inflation.\nRESEARCH AND DEVELOPMENT\nThe Company has a continuing program of research and development directed toward the enhancement of existing products in response to customer needs and the introduction of new products to broaden its product line. Approximately 7.4%, or $11.4 million of the Company's net sales were invested in research and development in fiscal 1995, compared to 8.0% of net sales, or $9.3 million, in fiscal 1994. The increase in research and development expenses in fiscal 1995 from fiscal 1994 was due to increased development efforts on the second generation SPECTRUM(TM) II products. The Company expects research and development spending to increase because the Company believes that its future performance will depend on its ability to continue to enhance its existing products and to develop new products that meet market needs. There can be no assurance, however, that the Company's product development efforts will result in commercially successful products. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" incorporated herein by reference.\nMANUFACTURING AND SUPPLIERS\nThe Company's manufacturing operations consist primarily of final assembly, test and quality control of materials and components. The manufacturing process, performed at the Company's San Jose, California facility consists primarily of materials management, extensive unit and environmental testing of components and subassemblies at each stage of the manufacturing process, final assembly of the terminals and, prior to shipment, quality assurance testing and inspection of all products.\nThe Company's manufacturing operations are highly dependent upon the delivery of materials by outside suppliers in a timely manner. The Company uses local and offshore subcontractors to assemble major components and subassemblies used in its microwave products. In the future, the Company expects to continue to increase the extent to which outside suppliers and subcontractors provide completed product components. The Company is reliant on the timely delivery of certain key components to meets its manufacturing plan. In particular, the development and manufacture of the Company's generation SPECTRUM(TM) II products have been delayed due to among other things, component development and associated delivery delays. The inability of the Company to develop alternative sources of supply quickly and on a cost-effective basis could materially impair the Company's ability to manufacture and deliver its products. There can be no assurance that the Company will not experience component delays or other supply problems.\nCertain microwave integrated circuit subassemblies which are used in all of the Company's microwave radio products, are supplied primarily by Microelectronics Technology, Inc. (\"MTI\") of Taiwan. These subassemblies, which are manufactured by MTI in Taiwan, form the nucleus of the RF Unit. The Company's relationship with MTI commenced in March 1984, at which time the Company and MTI entered into an agreement (the \"Development Agreement\") pursuant to which MTI performed development engineering work for the Company. The Development Agreement provides MTI with the right to manufacture up to 75% of the Company's production requirements for microwave integrated circuit subassemblies designed by MTI for the Company as long as MTI is able to meet cost, quality and delivery standards available to the Company from other sources. The Development Agreement also provides MTI with a right of first refusal to manufacture certain of the Company's microwave products\nif the Company determines to subcontract the manufacturing of these products. During the term of the Development Agreement and for a period of one year after termination thereof, MTI may not design, develop, manufacture or cause to be manufactured or sold, for other persons or companies who are, or may become, competitors to the Company, any proprietary designs or components that are similar to certain of the Company's products. The Development Agreement may only be terminated by either party in the event of a breach by the other.\nFrom time to time, the Company has experienced delays and other supply problems with MTI, but such delays and other problems have not had a significant impact on the Company's results of operations. To avoid any future problems associated with delays, the Company has contracted for component and subassembly parts from additional sources. The Company and MTI maintain a high level of communication at all levels of their respective management to ensure that production requirements and constraints are taken into account in each company's respective production plans. The Company does not currently anticipate any future delays or other supply problems with MTI, although there can be no assurance in this regard.\nCOMPETITION\nThe short-haul and medium-haul transmission business is a specialized segment of the telecommunications equipment market and is intensely competitive. A substantial number of established and emerging companies offer a variety of microwave, fiber optic and other transmission products for applications similar to those of the Company's products. Many of the Company's competitors have more extensive engineering, manufacturing and marketing capabilities and substantially greater financial, technical and personnel resources than the Company. The Company considers its primary competitors to be Alcatel, NEC, California Microwave, Inc., P-Com, Inc. and the Farinon Division of Harris Corporation. In addition, other existing competitors include L.M. Ericsson, Siemens AG, Nokia, SIAE, and NERA. Some of the Company's largest customers could develop the capability to manufacture products similar to those manufactured by the Company. Existing and potential competition in the industry has resulted in and will continue to result in significant price competition and pressure on gross margins. The Company believes that competition in its markets is based primarily on technological capability, performance, on-time delivery, price, reliability and customer support. The Company's future success will depend upon its ability to address the increasingly sophisticated needs of its customers by enhancing its current products, by the development and timely introduction of new products that keep pace with technological developments and emerging industry standards, and by providing such products at competitive prices.\nThe Company often forms alliances, or teaming arrangements, with major international telecommunications equipment providers as a means of increasing the Company's ability to pursue these limited number of major awards each year. These alliances are necessary for the Company where the customer requires a single system provider with a variety of equipment and service capabilities, as well as for financial strength. There can be no assurance that the Company will be able to continue to develop such alliances, or that if such alliances are developed, that such alliances will be successful.\nPATENTS\nThe Company does not presently have any patents covering its products. The Company believes that its success is not dependent on the ownership of patents but rather on its innovative skills, technical expertise and timely introduction of new products.\nGOVERNMENT REGULATIONS\nRadio transmission in the United States is controlled by federal regulation and all microwave radio links installed in the United States, except for those utilizing certain frequencies operating under FCC part 15 rules, must be licensed by the FCC. Since microwave radios all share the same transmission medium, the FCC requires that every prospective microwave radio licensee assure that it will not interfere with the operation of any existing system. This requirement, known as frequency coordination, must be satisfied before permission for operation will be granted by the FCC.\nThe FCC and similar foreign regulatory bodies require that the Company's products comply with certain rules and regulations governing their performance when operating within their jurisdiction. The Company has complied with such rules and regulations with respect to its existing products. Any delays in compliance with respect to future products could delay their introductions.\nIn the United States, Federal deregulation, which allows common carriers greater flexibility in establishing rates which may be charged for common carrier services, is likely to continue to affect the relative cost effectiveness of private telecommunications networks versus common carrier telecommunication networks. Each state has jurisdiction over the common carrier aspects of intrastate radio and wireline communications, and the nature of this regulation varies widely among the states. Internationally, similar control over rates charged to customers of common carriers is exerted by central governments. User uncertainty as to future government regulatory policies may affect the demand for private network telecommunications products, including the Company's products.\nIn addition, radio transmission is subject to regulation by foreign laws and international treaties. The Company's equipment must conform to international requirements established to avoid interference among users of microwave frequencies and to permit interconnection of equipment. In many developed countries, the unavailability of frequency spectrum has historically inhibited the growth of microwave systems. However, current regulatory efforts by international regulatory authorities are directed at providing microwave frequencies for new PCS. Equipment to support these services can be marketed only if permitted by suitable frequency allocations and regulations.\nLITIGATION\nIn connection with the six class action lawsuits alleging securities law violations in fiscal 1994, the Company reached an agreement under which the Company and its Directors would be released from any further liabilities. In fiscal 1994, the Company recorded a charge to earnings for the settlement of the litigation of $20.0 million, which included the settlement amount, certain attorneys' fees, estimated interest and other costs related to the litigation. The Company paid the settlement amount of the litigation and obtained the final judgment and order of dismissal of the litigation in fiscal 1995 from the United States District Court of Northern California.\nDMC TELECOM (MALAYSIA) SDN BHD\nIn fiscal 1991, the Company expanded its presence in the Asia Pacific market with the formation of DMC TeleCom (Malaysia) Sdn Bhd (\"DMCT(M)\"). The Company's partners in this joint venture were two Malaysian companies. However, in the third quarter of fiscal 1994, the Company wrote down its investment in DMC Malaysia resulting in a charge to earnings of $7.0 million. The Company's net investment in DMC Malaysia was $4.0 million which consisted of receivables outstanding from DMC Malaysia of approximately $6.0 million at March 31, 1994, reduced by a reserve of $2.0 million for deferred margin on sales to the joint venture. The Company was also the guarantor of approximately $2.0 million of DMC Malaysia indebtedness to a bank, which was due in July, 1994. This charge to earnings took into account the full amount of the receivables, the guarantee of indebtedness to the bank, anticipated legal fees, and other charges associated with the anticipated liquidation of the joint venture less applicable reserves. On December 23, 1994, the Company reached an agreement with the shareholders of DMCT(M) related to the liquidation of the joint venture. The Company paid approximately $2.1 million for its 45% share of the cost of liquidating the joint venture, and received inventory and fixed assets valued at approximately $600,000 and $300,000 respectively. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 7 of the Notes to Consolidated Financial Statement of the Company's fiscal 1995 annual report incorporated herein by reference.\nEMPLOYEES\nAs of March 31, 1995, the Company employed 606 full-time and temporary employees, including approximately 50 employees in the United Kingdom. None of the Company's employees are represented by a collective bargaining agreement. The Company's future performance will depend in large measure on its ability to attract and retain highly skilled employees. The Company believes that it has good relations with its employees and has never experienced a work stoppage.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate offices, and principal research, development and manufacturing facilities are located in San Jose, California, in three leased buildings aggregating approximately 160,000 square feet. The Company owns 20,000 square feet of office and manufacturing space in East Kilbride, Scotland, 1,500 square feet of which has been sublet for eight years. The Company also leases four sales offices located throughout the North America and a 17,000 square foot customer service and marketing office in Coventry, England. The Company believes these facilities are adequate to meet its anticipated need for the foreseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee \"Business - Litigation\" and Note 7 and 8 of Notes to Consolidated Financial Statements incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information regarding price range per share in the Company's 1995 Annual Report to Stockholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information regarding selected financial data from fiscal 1991 through fiscal 1995 in 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 appearing 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 incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data in 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\nInformation concerning directors and executive officers under the caption \"Election of Directors,\" \"Board Meetings and Committees,\" \"Security Ownership of Certain Beneficial Owners and Management\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on July 26, 1995 (the \"Proxy Statement\"), is incorporated herein by reference. In addition to executive officers who are also directors of the Company, the following executive officers are not directors:\nMr. Byington has served as Vice President of Engineering from April 1989 to November 1990 and from January 1993 to present. During the interim period of November 1990 to January 1993, Mr. Byington participated in the design of the Company's SPECTRUM(TM) and QUANTUM(TM) radio products. From February 1984 to April 1989, Mr. Byington served as Senior Development Engineer and Director of Digital Signal Processing in Engineering. From 1976 to 1984, Mr. Byington held various positions at the Farinon Division of Harris Corporation. Mr. Byington holds a BSEE degree from Stanford University.\nMr. Hal E. Edmondson joined the Company as Vice President of Manufacturing in January, 1995. He was most recently the Corporate Vice President of Worldwide Manufacturing for Hewlett Packard (\"HP\"). His tenure with Hewlett Packard spans over 30 years of increasing responsibility in Manufacturing at several HP divisions including the General Manager of the Microwave Product Division. Mr. Edmondson holds a B.S. degree in Mechanical Engineering from the University of Kansas and an MBA from Harvard.\nMr. Timothy R. Hansen was promoted to Vice President SPECTRUM(TM) Business Unit in February, 1995. Prior to this promotion, he was Vice President and Program Manager of the Spectrum Product line. He joined Digital Microwave Corporation in August, 1984 as product line manager, and has held management positions in marketing, planning, sales and order management. Mr. Hansen holds a B.S. degree in Electrical Engineering from the University of Illinois, and a MBA from UCLA.\nMr. Shaun McFall was promoted to Vice President, Corporation Marketing in February, 1995. Prior to his promotion, he was the Director of Marketing. He joined Digital Microwave UK operations in January, 1989 and has held several management positions in Marketing. Prior to joining Digital Microwave, he worked for GEC Telecommunication Ltd. in Germany, and Ferranti Ltd in Edinburgh, Scotland. Mr. McFall holds a B.S. degree in Electrical Engineering from the University of Strathclyde in Scotland.\nMr. John O'Neil joined the Company as Vice President of Human Resources of the Company in May, 1993. Mr. O'Neil was Vice President of Personnel and Administration of BEI Electronics, Inc., a defense electronics firm, from January 1989 to April 1993. From 1987 to 1988 Mr. O'Neil was Human Resources Vice President at C.P. National Corporation, a communication and energy company. Mr. O'Neil holds a B.S. degree in Business Administration from the University of San Francisco and a M.B.A. degree from Pepperdine University.\nMr. Graham J. Powell was promoted to Vice President, of Worldwide Sales in February, 1995. Prior to this promotion, he was Vice President for Sales in Europe, Africa and the Middle East. Mr. Powell joined Digital Microwave in Coventry, England in July 1990 as Vice President of Sales in the United Kingdom. Previously he worked for GEC Telecommunications Ltd and was Group Marketing Director for Vanderhoff plc. He holds a degree in Electrical Engineering from Lanchester College.\nMr. Carl A. Thomsen joined the Company as Vice President, Chief Financial Officer and Secretary in February, 1995. Prior to joining Digital Microwave, he was Senior Vice President and Chief Financial Officer of Measurex Corporation. Mr. Thomsen joined Measurex Corporation in 1983 as Corporate Controller, was promoted to Vice President in 1986, to Vice President Finance in 1991, to Chief Financial Officer in 1992, and to Senior Vice President in 1993. Mr. Thomsen holds a B.S. degree in Business Administration from Valparaiso University and an MBA from the University of Michigan.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information included in the Company's Proxy Statement under the captions \"Compensation of Directors,\" \"Executive Compensation and Other Information,\" \"Stock Options,\" \"Option Exercises and Holdings\" \"Compensation Committee Interlocks and Insider Participation\" and \"Employment and Termination Arrangements\" is incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information is included in the Company's Proxy Statement under the captions \"Security Ownership of Certain Beneficial Owners and Management\" and \"Employment and Termination Arrangements\" is incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Manufacturing and Suppliers.\" and Note 7 of Notes to Consolidated Financial Statements of the Company's 1995 Annual Report 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 consolidated financial statements are contained in the Company's fiscal 1995 Annual Report to Stockholders:\n1. Consolidated Balance Sheets as of March 31, 1995 and 1994\n2. Consolidated Statements of Operations for each of the three years in the period ended March 31, 1995\n3. Consolidated Statements of Stockholders' Equity for each of the three years in the period ended March 31, 1995\n4. Consolidated Statements of Cash Flows for each of the three years in the period ended March 31, 1995\n5. Notes to Consolidated Financial Statements\n6. Report of Independent Public Accountants\n2. FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedules for each of the three years in the period ended March 31, 1994 are submitted herewith:\nII Valuation and Qualifying Accounts and Reserves\nSchedules not listed above have been omitted because they are not applicable or required, or information required to be set forth therein is included in the Consolidated Financial Statements, including the Notes thereto, incorporated herein by reference.\n3. EXHIBITS\nThe Exhibit Index begins on Page 22 hereof.\n(b) No reports on Form 8-K were filed by the Registrant during the quarter ended March 31, 1995.\n(c) See Item 14 (a) 3 above.\n(d) 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.\nDate: June 28, 1995.\nDIGITAL MICROWAVE CORPORATION\nBy: \/s\/ Richard C. Alberding By: \/s\/Clifford H. Higgerson - --------------------------------- -------------------------------- Richard C. Alberding Clifford H. Higgerson Co-Chief Executive Officer Co-Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS:\nThat the undersigned officers and directors of Digital Microwave Corporation do hereby constitute and appoint Richard C. Alberding, Clifford H. Higgerson and Carl A. Thomsen, and each of them, the lawful attorney and agent or attorneys and agents with power and authority to do any and all acts and things and to execute any and all instruments which said attorneys and agents, or either of them, determine may be necessary or advisable or required to enable Digital Microwave Corporation to comply with the Securities and Exchange Act of 1934, as amended, and any rules or regulations or requirements of the Securities and Exchange Commission in connection with this Form 10-K Report. Without limiting the generality of the foregoing power and authority, the powers include the power and authority to sign the names of the undersigned officers and directors in the capacities indicated below to this Form 10-K report or amendment or supplements thereto, and each of the undersigned hereby ratifies and confirms all that said attorneys and agents or either of them, shall do or cause to be done by virtue hereof. This Power of Attorney may be signed in several counterparts.\nIN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of the date indicated opposite his name.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates as indicated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE\nTo: Digital Microwave Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Digital Microwave Corporation's Annual Report incorporated by reference in this Form 10-K, and have issued our report thereon dated May 8, 1995. 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 item 14a(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 audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the consolidated financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nSan Jose, California May 8, 1995\nSCHEDULE II\nDIGITAL MICROWAVE CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nEXHIBIT INDEX\nEXHIBIT NUMBER DESCRIPTION\n3.1 Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 33-13431) (reference is also made to Exhibit 4.2).\n3.2 Amended and Restated Bylaws. (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended March 31, 1993.)\n4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the year ended March 31, 1988).\n4.2 Rights Agreement dated as of October 24, 1991 between the Company and Manufacturers Hanover Trust Company of California, including the Certificate of Designations for the Series A Junior Participating Preferred Stock (incorporated by reference to Exhibit 1 to the Company's Current Report on 8-K filed on November 5, 1991).\n10.1+ Digital Microwave Corporation 1984 Stock Option Plan, as amended and restated on June 11, 1991. (incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.2+ Form of Installment Incentive Stock Option Agreement (incorporated by reference to Exhibit 28.2 to the Company's Registration Statement on Form S-8 (File No. 33-43155).\n10.3+ Form of installment Non-qualified Stock Option Agreement (incorporated by reference to Exhibit 28.3 to the Company's Registration Statement on Form S-8 (File No. 33-43155)).\n10.4* Private Label Agreement dated January 16, 1990 between the Company and the Network Systems Division of American Telephone & Telegraph Company. (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended March 31, 1990).\n10.5 Lease of premises located at 170 Rose Orchard Way, San Jose, California (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year-ended March 31, 1991).\n10.6 Lease of premises located at 130 Rose Orchard Way, San Jose, California. (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.7 Lease of premises located at 110 Rose Orchard Way, San Jose, California. (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.8 Microelectronics Technology, Inc. Stock Purchase Agreement dated as of March 9, 1984 (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 33-13431).\n10.9 Microelectronics Technology, Inc. Development Agreement dated as of March 9, 1984 (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 33-13431).\n10.10* Agreement dated July 17, 1990 between the Company and In-Flight Phone Corporation. (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.11 Form of Indemnification Agreement between the Company and its directors and certain officers (incorporated by reference to Exhibit 10.16 to the Company's Registration Statement on Form S-1 (File No. 33-13431).\n10.12* Technology Transfer & Marketing Agreement dated October 2, 1987 between Microelectronics Technology Inc. and the Company (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended March 31, 1988).\n10.13* Business Agreement dated August 28, 1987 between Sungmi Telecom Electronics Co., Ltd. and the Company (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended March 31, 1988).\n10.14* Technical License Agreement dated August 28, 1987 between Sungmi TeleCom Electronics Co., Ltd. and the Company (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended March 31, 1988).\n10.15 Agreement of Purchase and Sale of Stock dates as of March 29, 1989 between Optical Microwave Networks Inc. and the Company (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended March 31, 1989).\n10.16 Agreement of Purchase and Sale of Stock dated as of March 30, 1989 between the Company and Microelectronics Technology, Inc. (Taiwan) and Microelectronics Technology, Inc. (USA) (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended March 31, 1989).\n10.17 Shareholders' Agreement of Optical Microwave Networks Inc. dated as of March 30, 1989 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended March 31, 1989).\n10.18 License Agreement dated as of March 30, 1989 among the Company, Optical Microwave Networks, Inc., Microelectronics Technology, Inc. (Taiwan) and Microelectronics Technology, Inc. (USA) (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended March 31, 1989).\n10.19 Shareholders' Agreement of DMC TeleCom (Malaysia) Sdn.Bhd .dated as of February 9, 1991. (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.20 Technology Transfer Agreement dates as of February 9, 1991 between the Company and DMC TeleCom (Malaysia) Sdn. Bhd. (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended March 31, 1991).\n10.21* Teaming Agreement dated November 20, 1991 between DMC TeleCom U.K. Ltd. and AT&T Network Systems Deutschland GmbH. (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended March 31, 1992).\n10.22 Loan and Security Agreement dated June 25, 1992 between the Company and CoastFed Business Credit Corporation. (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended March 31, 1992).\n10.23 Accounts Collateral Security Agreement dated June 25, 1992 between the Company and CoastFed Business Credit Corporation. (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended March 31, 1992).\n10.24 Letter of Credit Collateral Agreement dated June 25, 1992 between the Company and CoastFed Business Credit Corporation. (incorporated by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended March 31, 1992).\n10.25 Letter Agreement dated June 23, 1993 between the Company and CoastFed Business Credit Corporation (incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended March 31, 1993).\n10.26* Product Acquisition Agreement dated as of September 23, 1992 between the Company and Microelectronics Technology, Inc. (incorporated by reference to Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended March 31, 1993).\n10.27* Product Acquisition Agreement dated as of December 28, 1992 between the Company and Microelectronics Technology, Inc. (incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended March 31, 1993).\n10.28* Teaming Agreement dated as of November 16, 1993 between the Company and Siemens AG (including the Supply Agreement dated November 16, 1993 between Siemens AG and E-Plus Mobilfunk GmbH). (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended March 31, 1994).\n10.29 Amendment to Loan Documents between the Company and CoastFed Business Credit Corporation dated as of July 28, 1994 (incorporated by reference to Exhibit (1) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994).\n10.30 Amended and Restated Accounts and Inventory Collateral Security Agreement between the Company and CoastFed Business Credit Corporation dated as of July 28, 1994 (incorporated by reference to Exhibit (2) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.).\n10.31 Loan Agreement dated October 28, 1994 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994).\n10.32 Agreement on Exchange of Interim Equipment dated October 27, 1994 (incorporated by reference the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994).\n10.33+ Digital Microwave Corporation 1994 Stock Incentive Plan. (incorporated by reference to the Registration Statement on Form S-8 filed with the Commission on October 17, 1994).\n10.34 Loan and Security Agreement dated March 21, 1995 between the Company and Bank of the West.\n10.35 Amendment to Security Agreement dated March 31, 1995 between the Company and Heller Financial, Inc.\n13.1 Annual Report to Stockholders.\n21.1 List of subsidiaries. (incorporated by reference to the Company's 1994 Annual Report on Form 10K for the year ended March 31, 1994).\n23.1 Consent of Independent Public Accountants.\n24.1 Power of Attorney (included on page 19 of this Annual Report on Form 10-K).\n27.1 Financial data schedule\n+ Management Contract or Compensatory Plan or Arrangement.\n* Confidential treatment of certain portions of this exhibit has been requested.","section_15":""}
{"filename":"711418_1995.txt","cik":"711418","year":"1995","section_1":"Item 1. Business.\nDevelopment\nWinthrop Residential Associates III (\"WRA III\"), a limited partnership, was originally organized under the Uniform Limited Partnership Act of the State of Maryland on June 28, 1982, for the purpose of investing, as a limited partner, in other limited partnerships which would develop, manage, own, operate and otherwise deal with apartment complexes which would be assisted by federal, state and local government agencies (\"Local Limited Partnerships\") pursuant to programs which would not significantly restrict distributions to owners or the rates of return on investments in such complexes. On December 15, 1982, WRA III elected to comply with and be governed by the Maryland Revised Uniform Limited Partnership Act (the \"Act\") and filed its Agreement and Certificate of Limited Partnership (the \"Partner ship Agreement\") with the Maryland State Department of Assess ments and Taxation. In accordance with, and upon filing its certificate of Limited Partnership pursuant to, the Act, WRA III changed its name to Winthrop Residential Associates III, A Limited Partnership (the \"Partnership\").\nThe General Partners of the Partnership are Two Winthrop Properties, Inc. (\"Two Winthrop\") and Linnaeus-Oxford Associates Limited Partnership (\"Linnaeus-Oxford\"). The Initial Limited Partner is WFC Realty Co., Inc. (\"WFC\"). Two Winthrop and WFC are Massachusetts corporations which are wholly owned subsidiaries of First Winthrop Corporation (\"First Winthrop\"), a Delaware corporation, which in turn is wholly-owned by Winthrop Financial Associates, A Limited Partnership (\"WFA\"), a Maryland public limited partnership. Linnaeus-Oxford is a Massachusetts limited partnership. Two Winthrop is the Partnership's Managing General Partner. See \"Change in Control\".\nThe Partnership was initially capitalized with contributions totaling $2,000 from its General Partners and $5,000 from WFC.\nIn late 1982, the Partnership filed a Registration Statement on Form S-11 with the Securities and Exchange Commission with re spect to a public offering of 25,000 Units of limited partnership interest (\"Units\") at a purchase price of $1,000 per Unit (an aggregate of $25,000,000). The Registration Statement was\ndeclared effective on March 8, 1983. The offering terminated in July 1983, at which time subscriptions for 25,000 Units, repre senting capital contributions from Investor Limited Partners of $25,000,000, had been accepted. Capital contributions net of selling commissions, sales and registration costs, were utilized to purchase investments in Local Limited Partnerships and temporary short-term investments.\nDescription of Business\nThe only business of the Partnership is investing as a limited partner in other limited partnerships that own, operate and otherwise deal with apartment properties with financing in sured by the U.S. Department of Housing and Urban Development (\"HUD\"). The Partnership's investment objectives and policies are described at pages 21-26 of its Prospectus dated March 11, 1983 (the \"Prospectus\") under the caption \"Investment Objectives and Policies,\" which description is attached hereto as an exhibit and incorporated herein by this reference. The Prospectus was previously filed with the Commission pursuant to Rule 424(b).\nChange in Control\nOn December 22, 1994, Arthur J. Halleran, Jr., the sole general partner of Linnaeus Associates Limited Partnership (\"Linnaeus\"), the sole general partner of WFA, pursuant to an Investment Agreement entered into among Nomura Asset Capital Corporation (\"NACC\"), Mr. Halleran and certain other individuals who comprised the senior management of WFA, transferred the general partnership interest in Linnaeus to W.L. Realty, L.P. (\"W.L. Realty\"). W.L. Realty is a Delaware limited partnership, the general partner of which was, until July 18, 1995, A.I. Realty Company, LLC (\"Realtyco\"), an entity owned by certain employees of NACC. On July 18, 1995 Londonderry Acquisition II Limited Partnership (Londonderry II\"), a Delaware limited partnership, and affiliate of Apollo Real Estate Advisors, L.P. (\"Apollo\"), acquired, among other things, Realtyco's general partner interest in W.L. Realty and a sixty four percent (64%) limited partnership interest in W.L. Realty, and WFA acquired the sole general partnership interest in Linneaus-Oxford.\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, effective July 18, 1995,\nLondonderry II, an affiliate of Apollo, became the controlling entity of the General Partners. In connection with the transfer of control, the officers and directors of Two Winthrop resigned and Londonderry II appointed new officers and directors. See Item 10, \"Directors and Executive Officers of Registrant.\nLocal Limited Partnerships\nThe Partnership initially acquired equity interests in the form of limited partnership interests in 12 Local Limited Partnerships owning and operating apartment properties. The Partnership sold its interests in four Local Limited Partnerships owning the following properties: Fairfax Towers (October 1988); Harborside Apartments Phase II (February 1989); and Hunter's Ridge Apartments Phase I and Hunter's Ridge Apartments Phase II (October 1991). The Partnership lost its ownership interest in a fifth property, Liberty Square Townhomes, when HUD foreclosed on the Local Limited Partnership owning that property in February 1992. In addition, the Partnership reduced its interest in two Local Limited Partnerships, those owning Maple Manor and The Groves, during 1988 to 50%.\nThe following table sets forth certain information regarding the properties owned by the seven Local Limited Partnerships in which the Partnership has retained an interest and which continue to own apartment properties as of March 15, 1996:\n(1) Represents the mortgage amount or mortgage commitment as of the time the Partnership acquired its interest in the Local Limited Partnership. (2) Represents the full term or the remaining term of the mortgage, as the case may be, at the time the Partnership acquired its interest in the Local Limited Partnership. (3) This Local Limited Partnership's mortgage is held by HUD. (4) This Local Limited Partnership is operating under a Provisional Workout Arrangement with HUD which expires May 31, 1998. (5) This property is managed by Winthrop Management, an affiliate of WFA. (6) This Local Limited Partnership is currently in default on its mortgage obligation.\nDescriptions of the properties and the terms upon which the Partnership acquired them are set forth at pages 32-45 of the Prospectus under the caption \"Initial Investment\"; pages 1-10 of the Supplement to the Prospectus dated July 20, 1983 (the \"July 20, 1983 Supplement\"), under the caption \"Investments in Local Limited Partnerships\"; pages 17-20 of the Property Report of the Partnership dated September 30, 1983, and pages 7-27 of the Partnership's Annual Report on Form 10-K filed March 31, 1984 under the caption \"Item 1. Business,\" all of which descriptions are attached hereto as an Exhibit and incorporated herein by this reference. The July 20, 1983 Supplement was filed with the Commission as Post Effective Amendment No. 2 to the Partnership's Registration Statement on Form S-11 (Registration No. 2-81033). See also Note 4 of Notes to Financial Statements included as a part of this Annual Report for additional information concerning the properties.\nDefaults\nThe Partnership holds limited partnership interests in Local Limited Partnerships which own apartment properties, all of which were originally financed with HUD-insured first mortgages. If a Local Limited Partnership defaults on a HUD-insured mortgage, the mortgagee can assign the defaulted mortgage to HUD and recover the principal owed on its first mortgage from HUD. HUD, in its discretion, may then either (i) negotiate a workout agreement with the Local Limited Partnership, (ii) sell the mortgage to another lender, or (iii) pursue its right to transfer the own ership of the property from the Local Limited Partnership to HUD or a new lender if HUD sells its mortgage (collectively, the \"Lender\") through a foreclosure action. The objective of a workout agreement between an owner and the Lender is to secure the Lender's sanction of a plan which, over time, will cure any mortgage delinquencies. While a workout agreement is effective and its terms are being met, the Lender agrees not to pursue any remedies available to it as a result of the default. If the owner does default under the terms of the workout agreement or if the Lender concludes that a property in default lacks the ability to generate sufficient revenue to cure its default, it may pursue its right to assume ownership of the property through foreclosure.\nTwo Local Limited Partnerships (owning Autumn Chase and Clear Creek), which were previously in default, currently have Provisional Workout Arrangements in effect with HUD, which expires in April 2000 and May 1988, respectively. The Partnership also holds an ownership interest in a Local Limited Partnership (owning Dunhaven Apartments, Section 2, Phase 2) which is currently in default on its mortgage obligation. This mortgage was assigned to HUD on March 23, 1995. The Partnership is working with the Local Limited Partnership to bring this debt current. See Item 7 \"Management's Discussion and Analysis of Financial Condition - Results of Operation\".\nEmployees\nThe Partnership does not have any employees. Services are performed for the Partnership by the Managing General Partner, and agents retained by it.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nOther than the limited partnership interests set forth in Item 1 above, the Partnership does not own any property.\nItem 3.","section_3":"Item 3. Legal Proceedings. None.\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 Common Stock and Related Stockholders Matters.\nThe Registrant is a partnership and thus has no common stock. There 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 2,220 holders of the Units.\nThe Partnership Agreement requires that if the Partnership has Cash Available for Distribution it be distributed quarterly to the Partners in specified proportions. The Partnership Agreement defines Cash Available for Distribution as Cash Flow less cash designated by the Managing General Partner to be held for restoration or creation of reserves. Cash Flow, in turn, is defined as cash derived from the Local Limited Partnerships (but excluding sale or refinancing proceeds) and all cash derived from Partnership operations, less cash used to pay operating expenses of the Partnership. During the years ended December 31, 1995 and 1994, Registrant has made the following cash distributions with respect to the Units to holders thereof as of the dates set forth below in the amounts set forth opposite such dates:\nDistribution with Amount of Distribution Respect to Quarter Ended Per Unit\n1995 1994 ---- ----\nMarch 31 10.00 10.00 June 30 10.00 10.00 September 30 7.00 10.00 December 31 7.00 10.00\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following represents selected financial data for 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.\n(1) Includes $20.00 per Unit from reserves. (2) Includes $160 per Unit from the sale proceeds from Hunter's Ridge Phases I and II and reserves. (3) Includes $26 per Unit from reserves.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Reserves\nAs of March 15, 1996, the Partnership retained an equity interest in seven Local Limited Partnerships. The Partnership follows the equity method of accounting for these interests and recognizes its proportionate share of income and losses incurred by the Local Limited Partnerships. Generally, the Partnership's equity in losses in the Local Limited Partnerships decrease over time. Losses attributable to a Local Limited Partnership are not recognized if those losses would cause the Partnership's investment account for that Local Limited Partnership to become negative since the Partnership has no obligation to fund them. In 1993, the equity in losses decreased because The Groves' remaining investment account was not sufficient to recognize all 1993 losses from the Local Limited Partnership. In 1994, the equity in losses decreased since the only losses recognized by the Partnership were from Maple Manor. For fiscal 1995, $192,352 of the Partnership's share of losses from the Local Limited Partnerships were not recognized since the related investments had been fully written off. Cumulatively through 1995, a total of $4,672,335 of the Partnership's equity in losses from the Local Limited Partnerships has been deferred.\nThe equity method of accounting is used solely for financial reporting purposes; all losses continue to be recognized for tax purposes. The tax losses of the Partnership will decrease over time because the advantages of accelerated depreciation taken by the Local Limited Partnerships are greatest in the earlier years. Also, the deductions for mortgage interest expense will steadily decrease as the mortgage principals are amortized.\nThe Partnership requires cash to pay its general and administrative expenses or to make advances to any of the Local Limited Partnerships the Managing General Partner deems to be in the Partnership's best interest to preserve its ownership interest. To date, all cash requirements have been satisfied by interest income earned on short-term investments and cash distributed to the Partnership by the Local Limited Partnerships. If the Partnership funds any operating deficits, it will use monies from its operating reserves. As of December 31, 1995, the Partnership held operating reserves (after satisfaction of liabilities) of approximately $1,419,000 which is expected to be\nsufficient to fund any anticipated deficits. Reserves of $652,285 were used in 1995 to fund distributions to Investor Limited Partners. The Managing General Partner's current policy is to maintain a reserve balance sufficient to provide, at a minimum, interest income in an amount equal to the Partnership's annual general and administrative expenses. Therefore, a lack of cash distributed by the Local Limited Partnerships to the Partnership in the future will not deplete the reserves, though it may restrict the Partnership from making distributions to the Investor Limited Partners.\nThe Partnership has reserves which, in principal, could be used to make advances to the Local Limited Partnerships. However, the Partnership does not intend to make advances to fund any future operating deficits incurred by the Local Limited Partnerships, but retains its prerogative to exercise a business judgment to reverse this position if circumstances warrant a change in this policy. Moreover, the Partnership is not obligated to provide any additional funds to the Local Limited Partnerships to fund operating deficits. If a Local Limited Partnership sustains continuing operating deficits and had no other source of funding, it is likely that the Local Limited Partnership will eventually default on its mortgage obligation and risk a foreclosure on its property by the lender. If a foreclosure were to occur, the Local Limited Partnership would lose its investment in the property and would incur a tax liability due to the recapture of tax benefits taken in prior years. The Partnership as an owner of the Local Limited Partnership, would share these consequences in proportion to its ownership interest in the Local Limited Partnership.\nResults of Operations\nA number of the properties owned by the Local Limited Partnerships in which the Partnership has invested have operated at a deficit for many years due to their location in areas with weak economies or overbuilt rental markets. Economic and competitive forces also impede properties operating at break even or better to improve their financial operating results, that is, to generate increasing net cash flow in each subsequent year after operating expenses and financial obligations. As markets deteriorated during the mid-1980's, the Local Limited Partnerships experiencing financial difficulties sought alternative sources of funding to cover operating deficits. In some cases, these Local Limited Partnerships secured additional\nfunding from their general partners. From 1985 through 1988, the Partnership did provide some funding to five Local Limited Partnerships to preserve its ownership interest in those properties. However, as it became apparent that the recovery of these markets would be prolonged and that the Partnership's resources were limited, funding was discontinued. Consequently, some Local Limited Partnerships incurring continuing deficits ceased making full debt service payments, putting the mortgages into default, and instead began negotiating with lenders for mortgage modifications to reduce debt service payments to a level property operations could support.\nThree Local Limited Partnerships, owning Autumn Chase, Clear Creek and Dunhaven Apartments, Section 2, Phase 2, were in default during 1995 on their mortgage obligations.\nOn October 1, 1995, the mortgage encumbering Autumn Chase was modified such that the Local Limited Partnership is no longer in default. Prior to October 1, 1995, the mortgage was in default and the property operated under a Provisional Workout Agreement which required minimum payments of $24,428 per month. Pursuant to a mortgage modification agreement effective October 1, 1995, the outstanding principal balance on the note was increased to $3,181,513 by adding to the existing note an amount equal to the existing accrued and unpaid interest of $108,057. Beginning on November 1, 1995, monthly installments of $22,435 including interest at 7.5% are required under this note. The modified loan matures on November 1, 2024.\nClear Creek is currently operating under a Provisional Workout Arrangement which is effective from December 1, 1995 through May 31, 1998. The terms of the agreement require minimum monthly payments equal to approximately 130% of accruing interest as well as payments for a service charge and real estate taxes. The two previous workout agreements which expired in July 1995 and July 1994 required minimum monthly debt service payments equal to 130% and 110%, respectively, of the accruing interest as well as a service charge and real estate tax payments. Clear Creek has met the minimum debt service requirements in 1993 and 1994 and 1995. Due to the financial condition of Clear Creek, however, no cash distributions have been made to the Partnership in 1993, 1994 or 1995 and no cash distribution is expected to be made to the Partnership in 1996.\nThe Local Limited Partnership owning Dunhaven Apartments, Section 2, Phase 2 defaulted on its mortgage obligation in June 1994. The mortgage was assigned to HUD on March 23, 1995. Due to Dunhaven's financial situation, no cash distribution will be made to the Partnership in 1996 from 1995 operations. While Dunhaven Apartments, Section 2, Phase 2 was able to meet its debt service payments in 1993 through funding by the local general partner and Dunhaven Apartments, Section 2, Phase 1, no cash was distributed to the Partnership from 1993 operations.\nDunhaven Apartments, Section 2, Phase 1 operated at breakeven in 1995 and incurred a slight deficit in 1994 which was funded by cash reserves. Accordingly, no cash distribution was made to the Partnership in 1995 and none is expected in 1996. While Dunhaven Apartments, Section 2, Phase 1 was able to generate a small amount of cash flow in 1993, no cash distributions was made to the Partnership.\nVillage Square generated substantial operating cash flow in 1995 and it is anticipated that a cash distribution will be made to the Partnership in 1996 from the 1995 cash flow. The Partnership received cash distributions from Village Square of $186,573 in 1995, $263,298 in 1994 and $246,843 in 1993 from cash flow generated by Village Square in 1994, 1993 and 1992, respectively.\nMaple Manor generated positive cash flow in 1995. However, the cash flow is being retained by the Local Limited Partnership for working capital and, therefore, it is not expected that a cash distribution will be made to the Partnership in 1996. In 1994, Maple Manor operated at breakeven. In 1993, Maple Manor generated positive cash flow, a portion of which was used to make a capital contribution to The Groves.\nThe Groves operated at breakeven in 1995 and will not be making a cash distribution to the Partnership. The Groves generated positive cash flow in 1994, however, the cash flow was retained as working capital by the Local Limited Partnership. In 1993, The Groves operated at a deficit. The improved operations are due, in part, to a reduction in repair and maintenance expenditures. An aggressive repair and maintenance program which began in 1992 and was completed in 1993. As a result, lower repair and maintenance expenditures were incurred in 1994 as compared to 1993.\nThe Local Limited Partnerships' objectives are to improve operating results for all properties and to continue to operate under Lender-sanctioned workout agreements for those properties that are in default on their mortgage obligations until any delinquencies are cured. The Partnership believes that as long as the Local Limited Partnerships which own properties in default continue to negotiate with the Lender to work out their financial difficulties, the threat of foreclosure is mitigated. Moreover, any workout agreement entered into between the Lender and the Local Limited Partnerships will have no affect on the Partnership's ability to deduct mortgage interest expense unless the Lender agrees to forgive such interest indebtedness. As of March 15, 1996, none of the Local Limited Partnerships had agreements with their respective Lender which would forgive accrued interest.\nThe results of operations for future years may differ from those in 1995 as a result of many factors. One will be the ability of the Local Limited Partnership which currently has a provisional workout agreements with HUD to extend the agreement until all mortgage delinquencies have been cured. Another factor will be the ability of the Local Limited Partnership owning Dunhaven Apartments, Section 2 Phase 1 to operate at break even or better. Another factor will be the ability of each Local Limited Partnership to deal with the consequences of changing economic conditions that affect property operations. The Partnership's investment in Local Limited Partnerships owning rental real estate is subject to the risk involved with the management and ownership of rental real estate. Vacancy levels, rental payment defaults and operating expenses are all dependent on general and local economic conditions. Shifts in the economy could result in differing operating results for each individual Local Limited Partnership. In these markets, operating results in future years may depend on the properties' ability to maintain competitive rental rates while using its available resources to fund necessary repairs and replacements.\nThe Partnership's plan is to work with the Local Limited Partnerships to maintain ownership of and seek workout agreements with the Lenders for those properties in default on their mortgages. Although the Partnership has no ability to force a sale of properties owned by the Local Limited Partnerships, the Partnership will also work with the Local Limited Partnerships to investigate sale opportunities and will continue to work with the\nLocal Limited Partnerships to improve the financial performance of all the properties.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nWINTHROP RESIDENTIAL ASSOCIATES III, A LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS AND SCHEDULE\nINDEX\nFINANCIAL STATEMENTS\nReports of Independent Public Accountants\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993\nBalance Sheets as of December 31, 1995 and 1994\nStatements of Changes in Partners' Capital for the Years Ended December 31, 1995, and 1994 and 1993\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nSCHEDULE\nIII - Real Estate and Accumulated Depreciation of Property Held by Local Limited Partnerships as of December 31, 1995\nAll schedules prescribed by Regulations S-X other than the one indicated above have been omitted as the required information is inapplicable or the information is presented elsewhere in the financial statements or related notes.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo WINTHROP RESIDENTIAL ASSOCIATES III, A LIMITED PARTNERSHIP:\nWe have audited the accompanying balance sheets of WINTHROP RESIDENTIAL ASSOCIATES III, A LIMITED PARTNERSHIP (a Maryland limited 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. We did not audit the financial statements of certain Local Limited Partnerships, the investments in which are reflected in the accompanying financial statements using the equity method of accounting and have been written down to zero (see Note 2). 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 those Local 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing 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 financial statements referred to above present fairly, in all material respects, the financial position of WINTHROP RESIDENTIAL ASSOCIATES III, A 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\nBoston, Massachusetts March 20, 1996\nThe accompanying notes are an integral part of these financial statements.\nBALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nSupplemental disclosure of noncash activities: The Managing General Partner declared a fourth quarter distribution of $189,227, which was distributed on February 14, 1996.\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995\n1. ORGANIZATION\nWinthrop Residential Associates III, a Limited Partnership (the \"Partnership\") was organized on June 28, 1982 under the Uniform Limited Partnership Act of the State of Maryland to invest in limited partnerships (the \"Local Limited Partnerships\") which develop, manage, operate and otherwise deal in government-assisted apartment complexes that do not significantly restrict distributions to owners or the rate of return on investments in such properties. On December 15, l982, the Partnership elected to comply with and be governed by the Maryland Revised Uniform Limited Partnership Act. The Partnership will terminate on December 31, 2003, or sooner, in accordance with the terms of the Partnership Agreement.\n2. SIGNIFICANT ACCOUNTING POLICIES\nFinancial Statements - The financial statements of the Partnership are prepared on the accrual basis of accounting.\nCash and Cash Equivalents - Cash and cash equivalents consist of money market mutual funds that invest in treasury bills and repurchase agreements with original maturities of three months or less. Cash equivalents are valued at cost, which approximates market value.\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 - No provision has been made for federal, state or local income taxes in the financial statements of the Partnership. The Partners are required to report on their individual tax returns their allocable share of income, gains, losses, deductions and credits of the Partnership. The Partnership files its tax returns on the accrual basis. On May 6, l983, the Internal Revenue Service issued a ruling that the Partnership should be classified as a partnership for federal income tax purposes.\nInvestments in Local Limited Partnerships - The Partnership accounts for its investment in each Local Limited Partnership using the equity method. Under the equity method of accounting, the investment cost (including amounts paid or accrued) is subsequently adjusted by the Partnership's share of the Local Limited Partnership's results of operations and by distributions received or accrued. Equity in the loss of Local Limited Partnerships is not recognized to the extent that the investment balance would become negative because the Partnership has no obligation to fund these losses.\n2. SIGNIFICANT ACCOUNTING POLICIES (Continued)\nDistributions to Partners - Cash distributions from the Local Limited Partnerships (Cash Flow) are included in the computation of the Partnership's Cash Available for Distribution in the quarter received. As provided for in the Partnership Agreement, quarterly distributions are payable to the Partners within 60 days after the end of the quarter, exclusive of sales proceeds. The total amount distributed or accrued was approximately $919,100 in 1995 and $1,081,300 in 1994 and 1993.\n3. TRANSACTIONS WITH RELATED PARTIES\nTwo Winthrop Properties, Inc. (\"Two Winthrop\"), the Managing General Partner, is a wholly owned subsidiary of First Winthrop Corporation (\"First Winthrop\"), which, in turn, is wholly owned by Winthrop Financial Associates, A Limited Partnership (\"WFA\").\nAt December 31, 1995, a subsidiary of First Winthrop remains a comanaging general partner in a Local Limited Partnership.\nThe General Partners are entitled to 7.5% of Cash Available for Distribution. The General Partners had been accrued or received cash distributions of approximately $68,900 in 1995 and $81,100 in 1994 and in 1993.\nDuring the liquidation stage of the Partnership, the General Partners and their affiliates are entitled to receive certain distributions, subordinated to specified minimum returns to the Limited Partners as described in the Partnership Agreement.\n4. INVESTMENTS IN LOCAL LIMITED PARTNERSHIPS\nAs of December 31, 1995, the Partnership has limited partnership equity interests in seven Local Limited Partnerships that own fully operating apartment complexes. These Local Limited Partnerships have outstanding mortgages totaling $21,261,070, which are secured by the Local Limited Partnerships' real property, security interests, liens and endorsements common to first mortgage loans.\nSince inception, the Partnership has made additional investments of $291,489 in several Local Limited Partnerships, $154,382 of which was accounted for as operating deficit advances and $137,107 as capital contributions by the Local Limited Partnerships. Additional investments in 1993 were $16,500. There were no additional investments in 1994 or 1995.\n4. INVESTMENTS IN LOCAL LIMITED PARTNERSHIPS (Continued)\nDuring 1988, the Partnership entered into agreements with the local General Partner of the Savannah River Associates Limited Partnership and Fayetteville Apartments. The agreement stipulates that the local General Partner will contribute additional capital in the aggregate of $250,000 to avoid an assignment of the mortgages by the mortgage lender to HUD. There is no obligation on the part of the General Partner to make any contribution when, in the exercise of reasonable business judgment, it is determined that it is not reasonably likely that the partners will realize a return on their investment sufficient to justify making such contribution. In exchange for this agreement to fund additional capital, the Partnership's interest in the sharing arrangements of profit, losses, cash flow and residuals has been reduced.\nThe investments in Local Limited Partnerships as of December 31, 1995 and 1994 are as follows: - ------------------------------------------------------------\n4. INVESTMENTS IN LOCAL LIMITED PARTNERSHIPS (Continued)\nThe combined balance sheets of the Local Limited Partnerships at December 31, 1995 and 1994 are as follows:\nThe combined statements of operations of the Local Limited Partnerships for the years ended December 31, 1995, 1994 and 1993 are as follows:\n5. TAX LOSS\nThe Partnership's tax loss for 1995 differs from net income for financial reporting purposes primarily due to accounting differences in the recognition of construction period costs, calculation of depreciation incurred by the Local Limited Partnerships, and losses not recognizable under the equity method. The tax loss for 1995 is as follows:\n6. LOCAL LIMITED PARTNERSHIPS\nThe Local Limited Partnership owning Autumn Chase, which had been in default since 1989, secured a Provisional Workout Arrangement with the Department of Housing and Urban Development (HUD) during 1994. Effective October 1, 1995, the Local Limited Partnership entered into a mortgage modification agreement which has satisfied the requirements of HUD.\nDuring 1994, the Local Limited Partnership owning Clear Creek secured a Provisional Workout Arrangement with HUD which expired in July of 1995. The Local Limited Partnership secured an amended agreement which covers the period beginning December 1, 1995 and expires May 31, 1998.\nThe Local Limited Partnership owning Dunhaven Apartments, Section 2, Phase 2, defaulted on its mortgage obligation in June 1994. The mortgage was assigned to HUD on March 23, 1995. Management makes payments as funds become available, and they were delinquent as of December 31, 1995.\nThe Partnership is unable to determine at this time if these Local Limited Partnerships will be able to meet their financing requirements during the coming year. The Partnership is not obligated to fund operating deficits or mortgage loans of these Local Limited Partnerships. The Partnership's investment balance in these Local Limited Partnerships is zero at December 31, 1995.\nSUPPLEMENTARY INFORMATION REQUIRED PURSUANT TO SECTION 9.4 OF THE PARTNERSHIP AGREEMENT\n2. Fees or other compensation were paid or accrued to the General Partners or their affiliates during the three months ended December 31, 1995:\nEntity Receiving Form of Compensation Compensation Amount\nGeneral Partners Interest in Cash Available for Distribution $14,192\nWFC Realty Co. Interest in Cash $ 35 Available for Distribution\nAll other information required pursuant to Section 9.4 of the Partnership Agreement is set forth in the attached financial statements and related notes or Annual Partnership Report.\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. Registrant has no officers or directors. The Managing General Partner manages and controls substantially all of Registrant's affairs and has general responsibility and ultimate authority in all matters effective its business. As of March 1, 1996, the names of the directors and executive officers of the Managing General Partner and the position held by each of them, are as follows:\nHas Served as Position Held with the a Director or Name and Age Managing General Partner Officer Since\nMichael L. Ashner Chief Executive Officer 1-96 and Director\nRonald J. Kravit Director 7-95\nW. Edward Scheetz Director 7-95\nRichard J. McCready President and Chief Operating Officer 7-95\nJeffrey D. 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\n(c) Identification of Certain Significant Employees. None.\n(d) Family Relationships. None.\n(e) Business Experience. The Managing General Partner was incorporated in Massachusetts in October 1978. The background and experience of the executive officers and directors of the\nManaging General Partner, described above in Items 10(a) and (b), are as follows:\nMichael L. Ashner, age 44, has been the Chief Executive Officer of Winthrop Financial Associates, A Limited Partnership (\"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.\nW. Edward Scheetz, age 31, has been a Director of WFA since July 1995. Mr. Scheetz was a director of NPI from October 1994 until January 1996. Since May 1993, Mr. Scheetz has been a limited partner of Apollo Real Estate Advisors, L.P. (\"Apollo\"), the managing general partner of Apollo Real Estate Investment Fund, L.P., a private investment fund. Mr. Scheetz has also served as a Director of Roland International, Inc., a real estate investment company since January 1994, and as a Director of Capital Apartment Properties, Inc., a multi-family residential real estate investment trust, since January 1994. From 1989 to May 1993, Mr. Scheetz was a principal of Trammel Crow Ventures, a national real estate investment firm.\nRonald Kravit, age 39, has been a Director of WFA since July 1995. Mr. Kravit has been associated with Apollo since August 1995. From October 1993 to August 1995, Mr. Kravit was a Senior Vice President with G. Soros Realty Advisors\/Reichman International. Mr. Kravit was a Vice President and Chief Financial Officer of MAXXAM Property Company from July 1991 to October 1993.\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.\nOne or more of the above persons are also directors or 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; 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 Growth Investors I Limited Partnership; Winthrop Interim Partners I, A Limited Partnership; Winthrop Financial Associates, A Limited Partnership; Southeastern Income Properties Limited Partnership; Southeastern Income Properties II Limited\nPartnership; Winthrop Miami Associates Limited Partnership; and Winthrop Apartment Investors Limited Partnership.\n(f) Involvement in certain legal proceedings. None.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe Partnership 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.\n(a) Security ownership of certain beneficial owners.\nThe General Partners own all the outstanding general partnership interests. No person or group is known by the Partnership to be the beneficial owner of more than 5% of the outstanding Units at March 15, 1996. Under the Partnership Agreement, the voting rights of the Limited Partners are limited.\nUnder the Partnership Agreement, the right to manage the business of the Partnership is vested in the General Partners and is generally to be exercised only by the Managing General Partners, although approval of Linnaeus-Oxford is required as to all investments in Local Limited Partnerships and in connection with any votes or consents arising out of the ownership of a Local Limited Partnership interest.\n(b) Security ownership of management.\nAs of March 15, 1996, one Partner of WFA owns five Units in the Partnership and WFC Realty Co., Inc. owns 100 Units, which together is less than 1%. None of the officers, directors or the general partner of the General Partners own any Units.\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 General Partners and their affiliates are entitled to receive various fees, commissions, cash distributions, alloca tions of taxable income, or loss and expense reimbursements from the Partnership. The amounts of these items and the times at which they are payable to the General Partners and their affiliates are described at pages 16-18 and 30-32 of the Prospectus under the captions \"Management Compensation\" and \"Profits or Losses for Tax Purposes and Cash Distributions,\" which descriptions are incorporated herein by this reference.\nFor the years ended December 31, 1995, 1994 and 1993, the Partnership allocated taxable in the General Partners of $20,434, $22,818 and $13,179, respectively. For the years ended December 31, 1995, 1994 and 1993, the Partnership paid or accrued cash distributions to the General Partners of $68,933, $81,097, and $81,096, respectively. For the year ended December 31, 1995, Village Square paid $103,484 of property management fees to Winthrop Management, an affiliate of WFA.\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 - The Financial Statements listed on the accompanying Index to Financial Statements and Schedule are filed as a part of this Annual Report.\n2. Financial Statement - Schedule. The Financial Statement Schedule listed on the accompanying Index to Financial Statements and Schedule is filed as a part of this Annual Report.\n3. Exhibits - The exhibits listed in the accompanying Index to Exhibits are filed as part of this Annual Report.\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, there unto duly authorized as of this 29th day of March 1996.\nWINTHROP RESIDENTIAL ASSOCIATES III, A LIMITED PARTNERSHIP\nBy: ONE WINTHROP PROPERTIES, INC.\nBy: \/s\/ Michael L. Ashner Michael L. Ashner 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\/Name Title Date\n\/s\/ Michael L. Ashner Chief Executive March 29, 1996 Michael L. Ashner Officer and Director\n\/s\/ Ronald J. Kravit Director March 29, 1996 Ronald J. Kravit\n\/s\/ Anthony R. Page Chief Financial Officer March 29, 1996 Anthony R. Page\nINDEX TO EXHIBITS\nExhibit Number Title of Document\n3.A. Agreement and Certificate of Limited Partnership of Winthrop Residential Associates III, A Limited Partnership, dated as of June 28, 1982 (incorporated herein by reference to the Fund's Registration Statement on Form S-11, File No. 2-81033).\n3.B. Twelfth Amendment dated as of January 24, 1984 to the Agreement and Certificate of Limited Partnership (incorporated herein by reference to the Partnership's Annual Report on Form 10-K filed March 30, 1984, File No. 2-81033).\n4. Agreement and Certificate of Limited Partnership of Winthrop Residential Associates III, A Limited Partnership, dated as of June 28, 1982 (incorporated herein by reference to Exhibit 3A hereto).\n10.A. Sales Agency Agreement between Winthrop Residential Associates III, A Limited Partnership and Winthrop Securities Co., Inc. (incorporated herein by reference to the Registrant's Registration Statement on Form S-11, File No. 2-81033).\n10.B. Escrow Deposit Agreement among Winthrop Residential Associates III, A Limited Partnership, Winthrop Securities Co., Inc. and United States Trust Company (incorporated herein by reference to the Registrant's Registration Statement on Form S-11, File No. 2-81033).","section_15":""}
{"filename":"75042_1995.txt","cik":"75042","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nOshKosh B'Gosh, Inc. (together with its subsidiaries, the \"Company\") was founded in 1895 and was incorporated in the state of Delaware in 1929. The Company designs, manufactures, sources and sells apparel for the children's wear, youth wear, and men's wear markets. While its heritage is in the men's workwear market, the Company is currently best known for its line of high quality children's wear. The children's wear and youth wear business represented approximately 92% of consolidated Company revenues for 1995. The success of the children's wear business can be attributed to the Company's core themes: quality, durability, style, trust and Americana.\nThese themes have propelled the Company to the position of market leader in the branded children's wear industry. The Company also leverages the economic value of the OshKosh B'Gosh name via both domestic and international licensing agreements.\nThe Company's long-term strategy is to provide high quality, high value clothing for the entire family. Toward this end the Company continues to expand its business lines and avenues for marketing its products. In 1990, the Company acquired Essex Outfitters, Inc. (\"Essex\"), a vertically integrated children's and youth wear retailer marketed under the Boston Trader label through a licensing agreement with Boston Trader Ltd. In 1994, the Company merged the operations of Essex into OshKosh B'Gosh, Inc. and created a new brand name, Genuine Kids , for the line of children's and youth wear formerly marketed under the Boston Trader label. The Genuine Kids line of apparel is sourced from third party manufacturers, primarily offshore, and sold primarily through a chain of 92 domestic retail stores.\nOshKosh B'Gosh International Sales, Inc. was created in 1985 for the sale of OshKosh B'Gosh products to foreign distributors. In 1990, the Company formed OshKosh B'Gosh Europe, S.A. in conjunction with a joint venture with Poron Diffusion, S.A. to provide further access to European markets.\nIn 1992 the Company acquired Poron's 49% interest in OshKosh B'Gosh Europe, S.A. During 1993 OshKosh B'Gosh made moves to strategically position itself for international expansion. OshKosh B'Gosh\/Asia Pacific Ltd. was created in Hong Kong to oversee licensees and distributors in the Pacific Rim, to assist international licensees with the sourcing of product, and to expand the Company's presence in that region. OshKosh B'Gosh U.K. Ltd. and OshKosh B'Gosh Deutschland GmbH, incorporated in the United Kingdom and Germany respectively, were established to increase sales emphasis in those countries.\nThe Company's chain of 80 domestic OshKosh B'Gosh factory outlet stores sells irregular and first quality OshKosh B'Gosh merchandise throughout the United States. In 1994, the\nCompany opened an OshKosh B'Gosh showcase store in New York City bringing total domestic stores to 81. In addition, Oshkosh B'Gosh Europe opened showcase stores in London and Paris during 1994. The showcase stores are designed to reinforce awareness and demand for OshKosh B'Gosh as a global brand. In 1993, the Company distributed its first children's wear mail order catalog. Due to low sales volume the decision was made to discontinue the catalog sales as of December 31, 1995.\nThe Company has been expanding its utilization of off- shore sourcing as a cost-effective means to produce its products and to this end leased a production facility in Honduras in 1990 through its wholly owned subsidiary Manufacturera International Apparel S.A. As a part of the Company's ongoing review of its internal manufacturing capacity, operational effectiveness, and alternative sourcing opportunities, during 1995 the Company decided to close two of its operating facilities and downsize an operating facility.\nFor the last nine years the Company has licensed its name for use on footwear. In 1995, the Company began sourcing footwear itself and distributed its first footwear line in the fall of 1995.\n(b) Financial Information About Industry Segments\nThe Company is engaged in only one line of business, namely, the apparel industry.\n(c) Narrative Description of Business\nProducts\nThe Company designs, manufactures, sources and markets a broad range of children's clothing as well as lines of youth wear and men's casual and work wear clothing under the OshKosh, OshKosh B'Gosh, Baby B'Gosh , Genuine Kids or OshKosh Men's Wear labels. The products are distributed primarily through better quality department and specialty stores, 173 Company owned domestic stores, direct mail catalogs and foreign retailers. The children's wear and youth wear business, which is the largest segment of the business, accounted for approximately 92% of 1995 sales compared to approximately 94% of such sales in both 1994 and 1993.\nThe children's wear and youth wear business is targeted to reach the middle to upper middle segment of the sportswear market. Children's wear is in size ranges from newborn\/infant to girls 6X and boys 7. Youth wear is in size ranges girls 7 to 16 and boys 8 to 16.\nThe Company's children's wear and youth wear business includes a broad range of product categories organized primarily in a collection format whereby the products in that collection share a primary design theme which is carried out through fabric design, screenprint, embroidery, and trim applications. The Company also offers basic denim products\nwith multiple wash treatments. The product offerings for each season will typically consist of a variety of clothing items including bib overalls, pants, jeans, shorts, and shortalls (overalls with short pant legs), shirts, blouses and knit tops, skirts, jumpers, sweaters, dresses, playwear and fleece.\nThe men's wear line is the original business that started the Company in 1895. The current line comprises the traditional bib overalls, several styles of waistband-work, carpenter, and painters-pants, five pocket jeans, work shirts and flannel shirts as well as coats and jackets. The line is designed with a full array of sizes up to and including size 60 inch waists and 5x size shirts.\nMost products are designed by an in-house staff. Product design requires long lead times, with products generally being designed a year in advance of the time they actually reach the retail market. In general, the Company's products are traditional in nature and not intended to be \"designer\" items.\nIn designing new products and styles, the Company attempts to incorporate current trends and consumer preferences in its traditional product offerings.\nIn selecting fabrics and prints for its products, the Company seeks, where possible, to obtain exclusive rights to the fabric design from its suppliers in order to provide the Company with some protection from imitation by competitors for a limited period of time.\nRaw Materials, Manufacturing, and Sourcing\nAll raw materials used in the manufacture of Company products are purchased from unaffiliated suppliers. The Company procures and purchases its raw materials directly for its owned manufacturing facilities and may also procure and retain ownership of fabric relating to garments cut and assembled by contract manufacturers. In other circumstances, fabric is procured by the contract manufacturer directly but in accordance with the Company's specifications. In 1995, approximately 74% of the Company's direct expenditures for raw materials (fabric) were from its five largest suppliers, with the largest such supplier accounting for approximately 24% of total raw material expenditures. Fabric and various non- fabric items, such as thread, zippers, rivets, buckles and snaps are purchased from a variety of independent suppliers. The fabric and accessory market in which OshKosh B'Gosh purchases its raw materials is composed of a substantial number of suppliers with similar products and capabilities, and is characterized by a high degree of competition. As is customary in its industry, the Company has no long-term contracts with its suppliers. To date, the Company has experienced little difficulty in satisfying its requirements for raw materials, considers its sources of supply to be adequate, and believes that it would be able to obtain sufficient raw materials should any one of its product suppliers become unavailable.\nProduction administration is primarily coordinated from the Company's headquarters facility in Oshkosh with most production taking place in its one Wisconsin, six Tennessee, and four Kentucky plants. Overseas labor is also accessed through a leased sewing plant in Honduras, where cut apparel pieces are received from the United States and are reimported by OshKosh B'Gosh as finished goods. In addition, product is produced by contractors in 16 countries and imported into the United States.\nThe majority of the product engineering and sample making, allocation of production among plants and independent suppliers, material purchases and invoice payments is done through the Company's Oshkosh headquarters. All designs and specifications utilized by independent manufacturers are provided by the Company. While no long-term, formal arrangements exist with these manufacturers, the Company considers these relationships to be satisfactory. The Company believes it could obtain adequate alternative production capacity if any of its independent manufacturers become unavailable.\nBecause higher quality apparel manufacturing is generally labor intensive (sewing, pressing, finishing and quality control), the Company has continually sought to upgrade its manufacturing and distribution facilities. Economies are therefore realized by technical advances in areas like computer-assisted design, computer-controlled fabric cutting, computer evaluation and matching of fabric colors, automated sewing processes, and computer-assisted inventory control and shipping. In order to realize economies of operation within the domestic production facilities, cutting operations are located in two of the Company's eleven plants, with all product washing, pressing and finishing done in one facility in Tennessee and all screenprint and embroidery done in one facility in Kentucky. Quality control inspections of both semi-finished and finished products are required at each plant, including those of independent manufacturers, to assure compliance.\nCustomer orders for fashion products are booked from three to six months in advance of shipping. Because most Company production of styled products is scheduled to fill orders already booked, the Company believes that it is better able to plan its production and delivery schedules than would be the case if production were in advance of actual orders. In order to secure necessary fabrics on a timely basis and to obtain manufacturing capacity from independent suppliers, the Company must make substantial advance commitments, sometimes as much as five to seven months prior to receipt of customer orders. Inventory levels therefore depend on Company judgment of market demand.\nTrademarks\nThe Company utilizes the OshKosh , OshKosh B'Gosh , Baby B'Gosh or Genuine Kids trademarks on most of its products, either alone or in conjunction with a white triangular\nbackground. In addition, \"The Genuine Article \" is embroidered on the small OshKosh B'Gosh patch to signify apparel that is classic in design and all-but-indestructible in quality construction. The Company currently uses approximately 24 registered and 22 unregistered trademarks in the United States and has registered trademarks in 84 other countries. These trademarks and universal awareness of the OshKosh B'Gosh name are significant in marketing the products.\nSeasonality\nProducts are designed and marketed primarily for three principal selling seasons:\nRETAIL SALES SEASON PRIMARY BOOKING PERIOD SHIPPING PERIOD Spring\/Summer August-September January-April Fall\/Back-to-School January-February May-August Winter\/Holiday April-May September-December\nThe Company's business is increasingly seasonal, with highest sales and income in the third quarter which is the Company's peak wholesale shipping period and a major retail selling season at its retail outlet stores. The Company's second quarter sales and income are the lowest because of both relatively low domestic wholesale unit shipments and relatively modest retail outlet store sales during this period. The Company anticipates this seasonality trend to continue to impact 1996 quarterly sales and income.\nWorking Capital\nWorking capital needs are affected primarily by inventory levels, outstanding accounts receivable and trades payable. The Company maintains a credit agreement with a number of banks which provides a $60 million revolving credit facility and a $40 million revocable demand line of credit for cash borrowings, issuance of commercial paper and letters of credit. The agreement expires in June 1997. There were no outstanding borrowings against these credit arrangements at December 31, 1995. Letters of credit of approximately $19 million were outstanding at December 31, 1995.\nInventory levels are affected by order backlog and anticipated sales. Accounts receivable are affected by payment terms offered. It is general practice in the apparel industry to offer payment terms of ten to sixty days from date of shipment. The Company offers net 30 days terms only.\nThe Company believes that its working capital requirements and financing resources are comparable with those of other major, financially sound apparel manufacturers.\nSales and Marketing\nCompany products are sold primarily through better quality department and specialty stores, although sales are also made through direct mail catalog companies, foreign\nretailers and other outlets, including 172 Company operated domestic retail and factory outlet stores and one retail showcase store. No one customer accounted for more than 10% of the Company's 1995 sales. The Company's largest ten and largest 100 customers accounted for approximately 42% and 62% of 1995 sales, respectively. In 1995, the Company's products were sold to approximately 3,200 wholesale customers (approximately 9,600 stores) throughout the United States, and a sizeable number of international accounts.\nProduct sales to better quality department and specialty stores are primarily by an employee sales force with the balance of sales made through manufacturer's representatives or to in-house accounts. In addition to the central sales office in Oshkosh, the Company maintains regional sales offices and product showrooms in Dallas and New York. Most members of the Company's sales force are assigned to defined geographic territories, with some assigned to specific large national accounts. In sparsely populated areas and new markets, manufacturer's representatives represent the Company on a non-exclusive basis.\nDirect advertising in consumer and trade publications is the primary method of advertising used. The Company also offers a cooperative advertising program, paying half of its customers' advertising expenditures for their products, generally up to two percent of the higher of the customer's prior or current year's gross purchases from the Company.\nBacklog\nThe dollar amount of backlog of orders believed to be firm as of the end of the Company's fiscal year and as of the preceding fiscal year end is not material for an understanding of the business of the Company taken as a whole.\nCompetitive Conditions\nThe apparel industry is highly competitive and consists of a number of domestic and foreign companies. Some competitors have assets and sales greater than those of the Company. In addition, the Company competes with a number of firms that produce and distribute only a limited number of products similar to those sold by the Company or sell only in certain geographic areas being supplied by the Company.\nA characteristic of the apparel industry is the requirement that a marketer recognize fashion trends and adequately provide products to meet such trends. Competition within the apparel industry is generally in terms of quality, price, service, style and, with respect to branded product lines, consumer recognition and preference. The Company believes that it competes primarily on the basis of quality, style, and consumer recognition and to a lesser extent on the basis of service and price. The Company is focusing attention on the issue of price and service and has taken and will continue to take steps to reduce costs, become more\ncompetitive in the eyes of value conscious consumers and deliver the service expected by its customers.\nThe Company's share of the overall children's wear market is quite small. This is due to the diverse structure of the market where there is no truly dominant producer of children's garments across all size ranges and garment types. In the Company's primary channel of distribution, department and specialty stores, it holds the largest share of the branded children's wear market.\nEnvironmental Matters\nThe Company's compliance with Federal, State, and local environmental laws and regulations had no material effect upon its capital expenditures, earnings, or competitive position. The Company does not anticipate any material capital expenditures for environmental control in either the current or succeeding fiscal years.\nEmployees\nAt December 31, 1995, the Company employed approximately 6,500 persons. Approximately 41% of the Company's personnel are covered by collective bargaining agreements with the United Garment Workers of America.\nThe Company considers its relations with its personnel to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive and administrative offices are located in Oshkosh, Wisconsin. Its principal office, manufacturing and distribution operations are conducted at the following locations:\nApproximate Floor Area in Principal Location Square Feet Use\nAlbany, KY 20,000 Manufacturing Byrdstown, TN 32,000 Manufacturing Celina, TN 100,000 Manufacturing Celina, TN 90,000 Laundering\/Pressing Columbia, KY 78,000 Manufacturing Columbia, KY 23,000 Manufacturing Dallas, TX (1) 1,995 Sales Offices\/Showroom Gainesboro, TN 61,000 Manufacturing Gainesboro, TN 29,000 Warehousing Jamestown, TN 43,000 Manufacturing Liberty, KY 218,000 Manufacturing\/ Warehousing Liberty, KY (2) 32,000 Warehousing\nNew York City, NY (3) 18,255 Sales Offices\/Showrooms Oshkosh, WI 99,000 Exec. & Operating Co. Offices Oshkosh, WI 88,000 Manufacturing Oshkosh, WI 128,000 Distribution\/ Warehousing Red Boiling Springs,TN 41,000 Manufacturing White House, TN 284,000 Distribution\/ Warehousing\nAll properties are owned by the Registrant with the exception of: (1) Lease expiration date - 1998 , (2) Lease expiration date - 1999, (3) Lease expiration date - 2007.\nThe Company believes that its properties are well maintained and its manufacturing equipment is in good operating condition and sufficient for current production.\nSubstantially all of the Company's retail stores occupy leased premises. For information regarding the terms of the leases and rental payments thereunder, refer to the \"Leases\" note to the consolidated financial statements on page 26 of this Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are not parties to any material pending legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED\nSTOCKHOLDER MATTERS.\nQuarterly Common Stock Data\n1995 1994 Stock Price Dividends Stock Price Dividends High Low Per Share High Low Per Share\nClass A Common Stock 1st $15 $13-1\/2 $ 0.07 $21-3\/4 $14-1\/2 $ 0.1025 2nd 16-3\/4 14 0.07 15 12-1\/4 0.1025 3rd 18 15-1\/2 0.07 15-1\/2 13-1\/2 0.1025 4th 17-1\/2 11-1\/2 0.07 15-1\/4 13 0.07\nClass B Common Stock 1st $15 $13-1\/2 $ 0.06 $22 $16-3\/4 $ 0.09 2nd 16-1\/2 14-1\/4 0.06 17 13-3\/4 0.09 3rd 18 16-1\/4 0.06 15-1\/2 14 0.09 4th 18-3\/4 17-1\/4 0.06 15-1\/4 13-1\/2 0.06\nThe Company's Class A common stock and Class B common stock trade on the Over-The-Counter market and are quoted on NASDAQ under the symbols GOSHA and GOSHB, respectively. The table reflects the \"last\" price quotation on the NASDAQ National Market System and does not reflect mark-ups, mark- downs, or commissions and may not represent actual transactions.\nThe Company has paid cash dividends on its common stock each year since 1936. The Company's Certificate of Incorporation requires that when any dividend (other than a dividend payable solely in shares of the Company's stock) is paid on the Company's Class B Common Stock, a dividend equal to 115% of such amount per share must concurrently be paid on each outstanding share of Class A Common Stock. Company management currently expects that quarterly dividends comparable to dividends paid in 1995 will continue.\nAs of February 16, 1996, there were 1,721 Class A common stock shareholders of record and 176 Class B common stock shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFinancial Highlights (Dollars in thousands, except per share amounts)\nYear Ended December 31, 1995 1994 1993 1992 1991 Financial Results\nNet Sales $ 432,266 $ 363,363 $ 340,186 $346,206 $ 365,173 Net Income 10,947 7,039 4,523 15,135* 23,576 Return on Sales 2.5% 1.9% 1.3% 4.4% 6.5%\nFinancial Condition\nWorking Capital $ 95,414 $ 101,946 $ 111,794 $111,075 $ 106,803 Total Assets 208,579 217,211 229,131 226,195 214,963 Shareholders' Equity 150,078 158,814 171,998 175,153 167,380\nData per Common Share\nNet Income $ .85 $ .50 $ .31 $ 1.04* $ 1.62 Cash Dividends Declared Class A .28 .3775 .5125 .5125 .5125 Class B .24 .33 .45 .45 .45 Shareholders' Equity 12.05 11.76 11.79 12.01 11.48\n* After a charge of $601 or $.04 per share to reflect cummulative effect of change in accounting for nonpension postretirement benefits.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF\nOPERATIONS AND FINANCIAL CONDITION\nResults of Operations\nThe following table sets forth, for the periods indicated, selected Company income statement data expressed as a percentage of net sales and the percentage change in dollar amounts compared to the previous years.\nAs a Percentage of Net Sales Percentage Change in For the Years Ended Dollar Amounts December 31, from Fiscal Year 1995 1994 1993 1995 to 1994 1994 to 1993 Net sales 100.0% 100.0% 100.0% 19.0% 6.8% Cost of products sold 68.2% 71.4% 72.0% 13.6% 5.9% Gross profit 31.8% 28.6% 28.0% 32.3% 9.1% Selling, general, and administrative expenses 27.6% 26.1% 23.1% 25.6% 21.0% Restructuring & plant closings 0.6% --- 3.2% --- -100.0% Operating income 3.6% 2.5% 1.7% 73.0% 51.0% Other income - net 1.1% 1.1% 1.0% 17.2% 19.0% Income before income taxes 4.7% 3.6% 2.7% 55.8% 39.5% Income taxes 2.2% 1.7% 1.4% 56.1% 24.1% Net income 2.5% 1.9% 1.3% 55.5% 55.6%\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994\nNet sales in 1995 were $432.3 million, an increase of $68.9 million (19%) over 1994 sales of $363.4 million. The Company's 1995 domestic wholesale business of approximately $255 million was 9% more than 1994 sales of approximately $234 million, with a corresponding increase in unit shipments of approximately 11.7%. The average unit selling price during 1995 was down slightly due primarily to product mix (i.e., consumer preference towards garments with lighter weight fabrics). The increase in domestic wholesale unit shipments was the result of a number of factors. Improved product design during 1994 contributed to better \"sell-thrus\" and margins for a majority of our wholesale customers, and resulted in significantly higher spring 1995 (shipped primarily during the Company's first quarter) and fall back- to-school (shipped primarily during the Company's third quarter) children's fashion shipments. In addition, Company initiatives undertaken during 1994, and continuing during 1995, resulted in significantly improved shipping performance to customers on spring and fall back-to-school orders. Difficulties experienced by the Company in coordinating the transition of its sourcing strategy (which calls for increasing sourcing of its product from offshore contractors) resulted in the inability of the Company to make timely deliveries on certain holiday orders to customers. This resulted in a slowdown in the rate of unit shipment growth during the fourth quarter of 1995. Company management is implementing adjustments to its sourcing plan and anticipates improved shipping performance in 1996.\nWith a relatively weak apparel market in general, the Company does not anticipate the unit shipment growth experienced during 1995 to continue in 1996. The Company's preliminary outlook for 1996 indicates that unit shipments of domestic wholesale products will be generally flat as compared with 1995.\nCompany retail sales at its OshKosh B'Gosh branded outlet stores and Genuine Kids stores were approximately $138.4 million for 1995, a 39.2% increase over 1994 retail sales of approximately $99.4 million. This retail sales increase was primarily driven by the opening of an additional 35 retail stores during 1995. In addition, the Company's comparable store sales for 1995 were up approximately 3.6%. At year end, the Company operated 81 OshKosh B'Gosh branded stores and 92 Genuine Kids stores. Current Company plans for 1996 call for the opening of approximately 14 new retail stores and the closing of 8 to 10 unprofitable stores. Accordingly, the Company anticipates a slowdown in its retail sales growth for 1996 as compared to 1995 and 1994.\nThe Company's gross profit margin as a percent of sales increased to 31.8% in 1995 compared with 28.6% in 1994. This gross profit margin improvement was due to the impact of the Company's increased retail sales at higher gross margins relative to its domestic wholesale business, as well as\nimprovement in the wholesale business gross profit margin. The Company's restructuring and plant closing initiatives over the past two years, including redirection to a higher volume of product sourced offshore, improved internal manufacturing efficiencies, as well as more focused attention to product design, have also contributed to the Company's increased gross profit margin experienced during 1995. With the anticipated growth of the Company's retail business during 1996, along with the continuing effects of its internal manufacturing capacity reduction initiatives, the Company anticipates further improvement in its gross profit margins during 1996.\nSelling, general, and administrative expenses for 1995 (excluding the $2.7 million charge for plant closures recorded during the third quarter) increased $24.3 million over 1994. As a percent of net sales, these costs increased to 27.6% as compared to 26.1% in 1994. The primary reason for the increase in the Company's selling, general, and administrative expenses is the Company's expansion of its retail business. In addition, the Company's expansion of its international operations have added to these costs.\nDuring the third quarter of 1995, the Company recorded a pretax charge for plant closings of $2.7 million. This plant closing charge (net of income tax benefit) reduced net income by $1.6 million ($.13 per share) in 1995. As a part of the Company's ongoing review of its manufacturing capacity, operational effectiveness, and alternative sourcing opportunities, the Company decided to close its Hermitage Springs and McEwen, Tennessee facilities and downsize its Oshkosh, Wisconsin sewing facility.\nDuring the fourth quarter of 1995, the Company substantially completed its downsizing of the Oshkosh sewing facility. The Hermitage Springs and McEwen facilities were closed in January, 1996. The Hermitage Springs facility was also sold in early 1996.\nThe $2.7 million pretax charge for plant closings included approximately $1.9 million of severance and related costs pertaining to workforce reductions, as well as $750,000 for facility closings and the write-down of the related assets. The Company anticipates that the plant closings (net of income tax benefit) will require cash expenditures of approximately $1.1 million. Of this amount, $375,000 was expended in the fourth quarter of 1995. The Company believes that these plant closings, along with its other restructuring initiatives carried out over the past two years, will result in reduced cost of products and improved gross profit margins. During 1993, the Company recorded a pretax restructuring charge of $10.8 million. The restructuring charge including approximately $3.3 million for facility closings, write-down of the related assets, and severance costs pertaining to workforce reductions. The restructuring charge also reflected the Company's decision to market its Trader Kids line of children's apparel under the new name of Genuine Kids and the resulting costs of the Company's decision not to renew its Boston Trader license arrangement beyond 1994, as well as\nexpenses to consolidate its retail operations. Accordingly, the restructuring charge included approximately $7.5 million for write-off of unamortized trademark rights and expenses related to consolidating the Company s retail operations.\nDuring 1994, the Company implemented its restructuring plan. The Company closed its McKenzie, Tennessee facility and reached satisfactory agreements with all affected workforce concerning severance arrangements. The Company began to market a portion of its children's wear line under the Genuine Kids label, discontinuing the Trader Kids line of children's apparel. The Company also successfully consolidated the operations of its retail business into its Oshkosh office.\nDuring 1995, the Company finalized its 1993 restructuring plan by closing its Marrowbone, Kentucky and Dover, Tennessee facilities. The Dover facility has been sold, and the Company reached satisfactory agreements with the workforce concerning severance arrangements.\nThere were no material changes in cost to fully implement the Company's 1993 restructuring plan. The Company's cash expenditures (net of income tax benefit) to carry out this restructuring plan were approximately $4.4 million.\nInterest expense for 1995 was $1.8 million compared to $1.0 million in 1994. This increase is the result of additional Company borrowings to finance the Company's stock repurchase program.\nThe Company licenses the use of its trade names to selected licensees in the U.S. and in foreign countries. The Company's net royalty income was $4.4 million in 1995, a $1.0 million increase over 1994 net royalty income of $3.4 million. Net royalty income from domestic licensees was approximately $2.3 million in 1995 as compared to $2.4 million in 1994. Net royalty income from foreign licensees was approximately $2.1 million in 1995 as compared to $1.0 million in 1994. The increase in royalty income from foreign licensees is the result of both the addition of new licensees during 1994 and 1995 as well as the increased royalties from existing licensees.\nThe Company's effective tax rate for 1995 was 45.8% compared to 45.7% in 1994. The relatively high effective tax rates for both years result primarily from the Company's foreign operating losses (principally in Europe), which provide no tax benefit. Company management believes that the $11.4 million deferred tax asset at December 31, 1995 can be fully realized through reversals of existing taxable, temporary differences, and the Company's history of substantial taxable income which allows the opportunity for carrybacks of current or future losses.\nNet income per share of $.85 in 1995 was a 70% increase over 1994 net income per share of $.50. While the Company's domestic wholesale and retail operations demonstrated progress during 1995, its European subsidiaries continued to struggle. The Company incurred a loss from its European subsidiaries of\napproximately $4.6 million in 1995 as compared to an approximate $1.7 million loss in 1994. Management is currently instituting a number of changes including elimination of independent European design and sourcing functions. Beginning with the fall 1996 product line, the European subsidiaries will function primarily as distributors of U.S. designed and sourced products. Management believes that these changes will serve to improve European operating results primarily during the second half of 1996. Management is also evaluating alternative product sales and marketing options for Europe.\nIn March, 1995, the Financial Accounting Standards Board issued its Statement No. 121 entitled \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". This standard 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 during 1996. The effect of applying this new standard has not yet been fully determined.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nNet sales in 1994 were $363.4 million, an increase of $23.2 million (6.8%) over 1993 sales of $340.2 million. The Company's 1994 domestic wholesale business of approximately $234 million was 9% less than 1993 sales of approximately $257 million, with a corresponding decline in unit shipments of approximately 6.7%. The decrease in domestic wholesale unit shipments related primarily to the effects of the competitive environment in the children's wear business combined with the effects of prior years' poor shipping performance and perceived weakness in product design.\nCompany retail sales at its OshKosh B'Gosh branded outlet stores and Genuine Kids stores were approximately $99.4 million for 1994, a 52.5% increase over 1993 retail sales of approximately $65.2 million. This retail sales increase was primarily driven by the opening of an additional 46 retail stores during 1994. In addition, the Company's comparable store sales for 1994 were up approximately 3.6%. At December 31, 1994, the Company operated 61 OshKosh B'Gosh branded stores and 77 Genuine Kids stores.\nThe Company's gross profit margin as a percent of sales improved to 28.6% in 1994 compared with 28.0% in 1993. This gross profit margin improvement was due primarily to the impact of the Company's increased retail sales at higher gross margins relative to its domestic wholesale business. The favorable impact of the Company's retail gross margins was offset in part by the domestic wholesale gross margin, which was down in 1994 primarily as a result of the adverse impact\nof reduced unit volume on our manufacturing operations and slightly lower pricing to wholesale customers.\nSelling, general, and administrative expenses for 1994 increased $16.5 million over 1993. As a percent of net sales, selling, general, and administrative expenses were 26.1% in 1994, up from 23.1% in 1993. The primary reason for the increased selling, general, and administrative expenses is the Company's aggressive expansion of its retail business. In addition, the Company's increasing focus on its international operations resulted in an increase in 1994's selling, general, and administrative expenses of approximately $2.7 million. Also, the Company's catalog division, initiated in the second half of 1993, added approximately $1.6 million to selling, general, and administrative expenses in 1994.\nDuring the fourth quarter of 1993, the Company recorded a pretax restructuring charge of $10.8 million. Restructuring costs (net of income tax benefit) reduced net income by $7.1 million ($.49 per share) in 1993.\nThe Company's effective tax rate for 1994 was 45.7% compared to 51.3% in 1993. The relatively high effective tax rates for both years result primarily from the Company's foreign operating losses, which provide no tax benefit. In addition, the high 1993 effective tax rate was the result of substantially lower U.S. income before income taxes in 1993 (which resulted in part from the restructuring charge).\nSeasonality\nThe Company's business is increasingly seasonal, with highest sales and income in the third quarter, which is the Company's peak wholsesale shipping period and a major retail selling season at its retail outlet stores. The Company's second quarter sales and income are the lowest both because of relatively low domestic wholesale unit shipments and relatively modest retail outlet store sales during this period. The Company anticipates this seasonality trend to continue to impact 1996 quarterly sales and income.\nFinancial Position, Capital Resources, and Liquidity\nThe Company's financial strength is demonstrated by its balance sheet. At December 31, 1995 and 1994, the Company did not have any outstanding long-term debt.\nAt December 31, 1995, the Company's cash and cash equivalents were $2.4 million compared to $10.5 million at the end of 1994 and $17.9 million at the end of 1993. The decrease in cash and cash equivalents is primarily due to the Company s stock repurchase program which was completed in 1995. Net working capital at the end of 1995 was $95.4 million, compared to $101.9 million at 1994 year end and $111.8 million at 1993 year end. Cash provided by operations was approximately $19.5 million in 1995, compared to $22.1 million in 1994, and $21.6 million in 1993.\nAccounts receivable at December 31, 1995 were $24.7 million compared to $23.9 million at December 31, 1994. Inventories at the end of 1995 were $95.7 million, up $1.8 million from 1994. Management believes that year end 1995 inventory levels are generally appropriate for anticipated 1996 business activity.\nCapital expenditures were approximately $9.7 million in 1995 and $9.9 million in 1994. Capital expenditures for 1996 are currently budgeted at approximately $10 million.\nThe Company's stock repurchase program announced in 1994 was completed in 1995. A total of 2,150,000 shares of Class A common stock were acquired under the repurchase program, requiring a cash outlay of approximately $16.8 million in 1995 and $15.0 million in 1994.\nThe Company has a credit agreement with participating banks. This arrangement provides a $60 million revolving credit facility and a $40 million revocable demand line of credit for cash borrowings, issuance of commercial paper, and letters of credit. The agreement expires in June, 1997. The Company believes that these credit facilities, along with cash generated from operations, will be sufficient to finance the Company's seasonal working capital needs as well as its capital expenditures, remaining plant closing costs, and business development needs.\nDividends on the Company's Class A and Class B common stock totaled $.28 per share and $.24 per share, respectively, in 1995 compared to $.3775 per share and $.33 per share on the Company's Class A and Class B common stock, respectively, in 1994. The dividend payout rate was 33% of net income in 1995 and 75% in 1994.\nInflation\nThe effects of inflation on the Company's operating results and financial condition were not significant.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Financial Statements: Reports of Independent Auditors 17 Consolidated Balance Sheets - December 31, 1995 and 1994 18 Consolidated Statements of Income - years ended December 31, 1995, 1994, and 1993 19 Consolidated Statements of Changes in Shareholders' Equity - years ended December 31, 1995, 1994, and 1993 20 Consolidated Statements of Cash Flows - years ended December 31, 1995, 1994, and 1993 21 Notes to Consolidated Financial Statements 22\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors OshKosh B'Gosh, Inc. and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of OshKosh B'Gosh, Inc. and subsidiaries (the Company) as of December 31, 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. Our audits also included the financial statement schedule listed in the Index at Item 14. 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 beleive that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 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\nMilwaukee, Wisconsin ERNST & YOUNG LLP February 2, 1996\nOSHKOSH B'GOSH, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets (Dollars in thousands, except share and per share amounts)\nDecember 31, 1995 1994 ASSETS Current assets Cash and cash equivalents $ 2,418$ 10,514 Accounts receivable, less allowances of $3,970 in 1995 and $3,700 in 1994 24,691 23,857 Inventories 95,743 93,916 Prepaid expenses and other current assets 3,127 2,510 Deferred income taxes 11,400 11,510 Total current assets 137,379 142,307 Property, plant, and equipment, net 65,011 69,829 Other assets 6,189 5,075\nTotal assets $208,579 $217,211\nLIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent liabilities Accounts payable $ 13,910$ 9,436 Accrued liabilities 28,055 30,925 Total current liabilities 41,965 40,361 Deferred income taxes 2,700 2,869 Employee benefit plan liabilities 13,836 15,167 Commitments - - Shareholders' equity Preferred stock, par value $.01 per share: Authorized - 1,000,000 shares; Issued and outstanding - None - - Common stock, par value $.01 per share: Class A, authorized - 30,000,000 shares; Issued and outstanding - 11,189,387 shares in 1995, 12,233,787 shares in 1994 112 122 Class B, authorized - 3,750,000 shares; Issued and outstanding - 1,266,413 shares in 1995, 1,267,713 shares in 1994 13 13 Retained earnings 149,720 158,933 Cumulative foreign currency translation adjustments 233 (254) Total shareholders' equity 150,078 158,814\nTotal liabilities and shareholders' equity $208,579 $217,211\nSee notes to consolidated financial statements.\nOSHKOSH B'GOSH, INC. AND SUBSIDIARIES\nConsolidated Statements of Income (Dollars and shares in thousands, except per share amounts)\nYear Ended December 31, 1995 1994 1993\nNet sales $432,266 $363,363 $340,186 Cost of products sold 294,770 259,416 244,926\nGross profit 137,496 103,947 95,260\nSelling, general, and administrative expenses 119,295 94,988 78,492 Restructuring and plant closings 2,700 - 10,836\nOperating income 15,501 8,959 5,932\nOther income (expense): Interest expense (1,772) (1,034) (626) Interest income 1,383 1,048 1,114 Royalty income, net of expenses4,443 3,442 3,417 Miscellaneous 633 543 (545)\nOther income - net 4,687 3,999 3,360\nIncome before income taxes 20,188 12,958 9,292\nIncome taxes 9,241 5,919 4,769\nNet income $ 10,947 $ 7,039 $ 4,523\nWeighted average common shares outstanding 12,865 14,144 14,586\nNet income per common share $.85 $.50 $.31\nSee notes to consolidated financial statements.","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"103466_1995.txt","cik":"103466","year":"1995","section_1":"ITEM 1 BUSINESS\nGENERAL\nVictoria Bankshares, Inc. (the \"Company\") is a bank holding company organized under the laws of the State of Texas in 1973 and registered under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). The Company's primary subsidiary is Victoria Bank & Trust Company (the \"Bank\"), a commercial bank which commenced operations in 1875. The Company also conducts operations through four other nonbank subsidiaries (collectively referred to as the \"Nonbank Subsidiaries\"). At December 31, 1995, the Company and its subsidiaries had consolidated total assets of $1.96 billion, net loans outstanding of $703 million, total deposits of $1.66 billion, and stockholders' equity of $190.3 million.\nA special meeting of the shareholders of the Company will be held on April 2, 1996, to consider and vote upon a proposal to approve the Agreement and Plan of Merger dated November 12, 1995, between the Company and Norwest Corporation (\"Norwest\"). The Plan of Merger has been approved by the boards of both companies and is pending regulatory approval. Norwest will issue 1.05 shares of Norwest common stock in exchange for each share of the Company's common stock. The exchange will be tax-free for the Company's shareholders and will be accounted for by Norwest as a pooling- of-interests.\nNorwest is a $72.1 billion company providing banking, mortgage, investments, insurance, and other financial services through 3,042 stores in all 50 states, Canada, the Caribbean, Central America, and elsewhere internationally.\nDuring 1995, the Company made two acquisitions which increased the Company's assets by approximately $165 million. See \"ACQUISITIONS.\"\nThe Bank offers a full range of banking services including checking and savings accounts, business loans, personal loans, residential mortgage loans, loans for education, health and similar expenditures, other consumer oriented financial services, safe deposit, and night depository facilities. In addition, a full-time depository service is available for checking and savings accounts whereby customers may make deposits and withdrawals from a network of automatic teller machines. As of March 1996, the Bank has 42 branch offices in 33 communities and 22 counties of South Central Texas (see \"BUSINESS ACTIVITIES\"). A total of 103 automated teller machines in 53 cities provide 24-hour \"Transact\" banking services to customers. Through the Bank's membership in the Pulse and Cirrus networks, customers have 24-hour access to their accounts throughout the United States. The Bank also offers correspondent\nbanking, trust, investment and custodial services. The Company's goal is to provide quality financial services to the communities within which the branch offices are located.\nAs a bank holding company, the Company owns the Bank and furnishes services for the Bank. The Company assists in the management of and coordinates the financial resources of the Bank. The Bank derives its sources of funds predominantly from deposits within its market area. The customer base for deposits is diversified between correspondent banks, individuals, partnerships, corporations and public entities, which assists the Company in avoiding dependence on large concentrations of funds. The principal office of the Bank located in Victoria provides assistance with respect to various aspects of the branch offices' operations, including business development, advertising, loan policies and procedures, loan review, data and item processing, auditing, budgetary planning, and legal and regulatory compliance.\nAs a holding company, the Company's principal sources of cash flow are the dividends it receives from its subsidiaries and the proceeds from the sales and maturities of investment securities. Other sources may include the Company's access to capital markets through equity offerings, borrowings, and similar traditional funding sources. It is the Company's current policy to provide additional capital funds, if necessary, to the Bank by direct financings at the Company level rather than at the Bank level. The Company was paid $6.9 million in dividends during 1995 from a subsidiary. At December 31, 1995, the Company held $179 thousand in the AIM Short-term Investment Company (U. S. Treasury) Fund and $8.7 million in securities available for sale, both of which are used for corporate purposes, including short-term liquidity requirements. For information as to legal restrictions on the ability of the subsidiaries to pay dividends to the Company, see \"SUPERVISION AND REGULATION.\"\nThe Company continues to be well-capitalized. At December 31, 1995, the Company's leverage ratio of 8.8% substantially exceeded the 4.0% regulatory requirement. Additionally, the Company's risk-based capital ratio of 16.3% substantially exceeded the 8.0% regulatory requirement. See \"SUPERVISION AND REGULATION.\"\nPresented below are selected consolidated average balances of the Company and its subsidiaries (in thousands):\nFor certain financial information relating to the Company and its subsidiaries, please refer to Part II Item 7 \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY\" on pages 17 through 48 herein and the financial statements of the Company included on pages 50 through 73 herein.\nBUSINESS ACTIVITIES\nGEOGRAPHIC SERVICE AREA The Company's principal office is located in the City of Victoria, Texas, which is situated between Houston and Corpus Christi, Texas, and has a population of approximately 61,000. The largest communities served by the Company are Corpus Christi with a population of approximately 272,000 and Bryan\/College Station with a population of approximately 120,000. Other branch offices are generally located in smaller and mid-sized communities in Texas, within a region outlined by the cities of Houston, Bryan\/College Station, Austin, San Antonio, and Corpus Christi.\nCOMMERCIAL BANKING The Bank provides commercial banking services and facilities to small and medium size commercial businesses, including loans, deposit facilities, certificates of deposit, lines of credit, letters of credit, and cash management services.\nREAL ESTATE LENDING The Bank provides permanent financing for residential properties, including multifamily dwellings, commercial projects, and agricultural properties as well as the origination of mortgage loans for sale in the secondary market. The Bank also provides a source of financing for real estate developers and others engaged in construction and land development in central and southern Texas.\nCONSUMER BANKING The Bank provides consumer banking services to individuals, including savings programs, installment lending services, financing of new cars through a network of auto dealers, investment services, checking accounts, money market deposit accounts, and safe deposit facilities. Most of the branch offices also participate in the Company's automated banking network. The branch offices also provide the \"Money-In-The-Bank Loan Line\" which provides customer access to preapproved credit lines through automated teller machines. The Bank's customers are provided with convenient, around-the-clock service through the use of Transact Infoline, a telephone service that allows customers to perform many banking transactions from the convenience of their own homes.\nAGRICULTURAL LENDING\nThe Bank provides financing to a diversified group of agricultural businesses for working capital requirements, equipment purchases, and similar requirements.\nCORRESPONDENT BANKING The Bank acts as a correspondent for banks in Texas which maintain deposits and receive from the Bank a full range of correspondent banking services, including check clearing, transfer of funds, loan participations, data processing, investment advice, safekeeping, and securities custody and clearance. The Bank also offers seminars on new developments in the banking industry.\nTRUST AND ASSET MANAGEMENT\nThe Bank provides trust and fiduciary management and advisory services to businesses, individuals, and charitable trusts. These services include investment account management for employee benefit plans and individuals and the administration of personal estates and trusts. Estate administration services include helping individuals establish estate plans including wills, powers of attorney, and investment strategies, and serving as executor under their wills.\nNONBANK SUBSIDIARIES\nThe Company has five wholly owned Nonbank Subsidiaries: Transact Financial Corporation (mortgage loans); Central Computers, Inc. (data processing for commercial banks); Victoria Capital Corporation (investments in small businesses); Victoria Securities Corporation (discount brokerage services); and Victoria Financial Services, Inc. (second tier holding company). Victoria Financial Services, Inc., owns 100% of the banking subsidiary, Victoria Bank & Trust Company. The Bank owns 100% of Central Computers, Inc., and Victoria Capital Corporation.\nThe Company has liquidated two of its inactive subsidiaries V.B.I., Inc. and Transact Financial Corporation as of October 31, 1995 and February 29, 1996, respectively.\nACQUISITIONS\nOn June 30, 1995, United Bancshares, Inc. (\"United\"), parent company of Rosenberg Bank & Trust (\"Rosenberg\"), merged with and into the Company. The merger was consummated through the exchange of 306,383 shares of the Company's common stock for all of the outstanding shares of common stock of United. This transaction increased consolidated assets by approximately $65 million and increased consolidated deposits by approximately $61 million. The acquisition was accounted for as a pooling-of-interests. The Company's prior period consolidated financial statements have been restated to include the accounts of United. All intercompany accounts have been eliminated.\nOn August 25, 1995, the Company acquired Cattlemen's Financial Services, Inc. The transaction was accounted for as a purchase. The Company acquired approximately $100 million in assets and assumed $93 million in liabilities, paying a premium of $6.7 million over the book value of the net assets. The principal subsidiary of Cattlemen's Financial Services, Inc., is Cattlemen's State Bank. Cattlemen's State Bank has two branches and a mortgage production office, all of which are located in Austin, Texas.\nEMPLOYEES\nAs of December 31, 1995, the Company and its subsidiaries had approximately 915 full-time employees and approximately 216 part-time employees. The Company considers its employee relations to be good and is not subject to any collective bargaining agreement.\nCOMPETITION\nThe banking business in Texas is highly competitive. The Bank is the ninth largest bank chartered to do business in the State of Texas and the Company is the second largest publicly traded bank holding company headquartered in Texas. Each activity engaged in and geographic market served involves competition with other banks, as well as with nonbanking financial institutions and nonfinancial enterprises. The Bank competes with other banks in its efforts to obtain deposits and make loans, in scope and type of services offered, in rates paid on deposits and charged on loans, and in other aspects of banking.\nThe Bank also competes with savings and loan associations, credit unions, insurance companies, small loan companies, consumer finance companies, mortgage companies, department stores, and credit card organizations. There is active competition for the provision of various types of fiduciary and investment advisory services from bank and trust companies, insurance companies, investment counseling firms, mutual funds, and other similar entities.\nThe Bank competes with other financial institutions for new depositors and loan customers through radio, newspaper, and television advertising and through individual contacts by bank employees. The participation of the Bank in community activities also aids in the promotion of the Bank. Customers of all of the branch offices are made aware of products and services in order to maintain customer relationships and service customer needs.\nIn addition to competition from other banks and financial institutions headquartered in central and southern Texas, the Bank competes, in the marketing of certain financial services to large customers, with banks located in the major urban areas of Texas and elsewhere. These competing urban banks are generally larger than the Company in terms of capital, services, and personnel.\nREGIONAL ECONOMY\nThe economy of the market area served by the Company is characterized by petroleum and natural gas production and sales of related supplies and services, petrochemical operations, light and medium manufacturing operations, agribusinesses, and tourism. The agricultural businesses are highly diversified, including beef and dairy cattle, poultry, cotton, and a variety of grain crops. Also, through the acquisition of a bank in Bryan in 1993 and a bank in\nAustin in 1995, the Company expanded into areas positively affected by major educational centers.\nIn general, real estate values, as well as real estate development and sales activities, tend to reflect a region's economic environment. The Texas real estate environment continues to show signs of improvement. Management believes that the loans in the real estate portfolio are adequately supported by market prices or other credit factors.\nAt December 31, 1995, the Company's loans secured primarily by real estate consisted of (i) loans for commercial and residential construction and land development (none of which are located in major Texas metropolitan areas) which constituted 2.8% of the total loan portfolio and (ii) other real estate loans (including loans for 1-4 family, multi-family, and nonfarm\/nonresidential properties) which constituted 41.1% of the total loan portfolio. The remaining loan portfolio categories and the percentage of each to the total loan portfolio at December 31, 1995, consisted of the following: loans to oil and gas producers and related service businesses, 0.2%; agricultural loans (other than loans secured by agricultural real property), 5.7%; other commercial and industrial loans, 20.4%; consumer loans, 29.6%; and all other loans (including loans to financial institutions), 0.5%.\nECONOMIC ENVIRONMENT\nGeneral economic conditions impact the banking industry. The credit quality of the Company's loan portfolio necessarily reflects, among other things, the general economic conditions in the areas in which it conducts its business. The continued financial success of the Company depends to some extent on factors that are beyond the Company's control, including national and local economic conditions, the supply and demand for investment funds, interest rates, regulatory policies and federal, state and local laws affecting these matters. Improvement in general economic conditions that affects the region in which the Company operates could have a favorable effect on the Company's financial condition and results of operations. Conversely, a deterioration in general economic conditions could have an adverse effect.\nThe policies of regulatory authorities, including the monetary policy of the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"), have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. 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 and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits.\nFederal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company cannot be predicted.\nSUPERVISION AND REGULATION\nBANK HOLDING COMPANY REGULATION\nThe Company and its second-tier holding company are bank holding companies registered under the BHCA and are subject to supervision by the Federal Reserve Board. As bank holding companies, they are required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may make examinations of the Company or any of its nonbanking subsidiaries. The Federal Reserve Board has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and management 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 the Bank during periods of financial stress or adversity.\nAcquisitions by Bank Holding Companies\nThe BHCA prohibits the Company from acquiring direct or indirect control of more than 5.0% 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. Similar restrictions apply to acquisition of control of shares of stock of the Company or its second-tier holding company by other bank holding companies.\nThe Texas Banking Act permits out-of-state bank holding companies to acquire certain existing banks and bank holding companies in Texas. One of the conditions for such acquisitions is that after the acquisition, the out-of-state bank holding company may not control national or state banks in Texas whose aggregate deposits exceed 20% of the total deposits held by all national and state banks domiciled in Texas. Acquisitions of state and national banks by out-of-state bank holding companies have increased and likely will continue to increase the competition that the Company faces in acquiring depository institutions in Texas.\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 provides for the acquisition of banks by out-of-state holding companies regardless of state laws concerning such acquisitions (except for certain age and deposit concentration limits) and permits interstate branching beginning on June 1, 1997. States have the ability to opt-out of the interstate branching, but\nnot the interstate banking provisions of the Act. Texas has passed legislation to opt out of interstate branching.\nThe BHCA prohibits the Company from engaging in, or from acquiring ownership or control of, more than 5.0% of the outstanding shares of any class of voting stock of any company engaged in a nonbanking activity unless such activity has been determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. The BHCA does not place territorial restrictions on the activities of such nonbanking-related activities.\nCapital Adequacy\nThe Federal Reserve Board has adopted a system using the internationally consistent risk-based capital adequacy guidelines to evaluate the capital adequacy of bank holding companies. In addition to the risk-based capital guidelines, the Federal Reserve Board, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (\"FDIC\") have adopted the use of a leverage ratio as an additional tool to evaluate the capital adequacy of banks and bank holding companies.\nUnder 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. 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 stockholders' equity, qualifying perpetual preferred stock and minority interests in consolidated subsidiaries. \"Tier 2\" capital includes, with certain limitations, perpetual preferred stock, capital instruments, and the reserve for possible loan losses.\nThe guidelines require a minimum ratio of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0% should be in the form of \"Tier 1\" capital elements). At December 31, 1995, the Company's ratio of total capital-to-risk-weighted assets was approximately 16.3%, 15.3% of which was \"Tier 1\" capital. Both ratios significantly exceed regulatory minimums.\nThe leverage ratio is defined to be a company's \"Tier 1\" capital\ndivided by its adjusted average total assets. The leverage ratio adopted by the federal banking agencies requires a 3.0% \"Tier 1\" capital-to-adjusted-total-assets for institutions with a CAMEL rating of 1. All other institutions are expected to maintain a 100 to 200 basis point cushion; i.e., these institutions are expected\nto maintain a leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31, 1995, was 8.8%, exceeding the regulatory minimum.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") required the Federal Reserve Board to revise its risk-based capital standards to take into account interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as to reflect the actual performance and expected risk of loss on multi-family mortgages.\nDividends\nFederal Reserve Board policy discourages the payment of dividends by a bank holding company from borrowed funds as well as payments that would adversely affect capital adequacy. In addition, FDICIA provides that the appropriate federal banking agency may prohibit a bank holding company controlling a \"significantly undercapitalized\" institution (as referenced below) from paying dividends without prior approval by the Federal Reserve Board.\nBANK REGULATION\nDeposits in the Bank are insured by the FDIC. The Bank is not a member of the Federal Reserve system and is a state-chartered institution; therefore, the Bank is subject to supervision and regulation by both the FDIC and the Texas Department of Banking.\nCapital Adequacy\nThe FDIC has adopted regulations establishing minimum requirements for the capital adequacy of insured institutions such as the Bank. The requirements address both risk-based capital and leverage ratios, and are essentially parallel to those for the Company.\nThe FDIC's risk-based capital guidelines require state banks to have a ratio of \"Tier 1\" or core capital-to-total risk-weighted assets of 4.0% and a ratio of total capital-to-total risk-weighted assets of 8.0%. As of December 31, 1995, the Bank's ratio of \"Tier 1\" capital-to-total risk-weighted assets was 15.26% and its ratio of total capital-to-total risk-weighted assets was 16.26%. These ratios have decreased from 17.45% and 18.58%, respectively, as of December 31, 1994.\nThe FDIC's leverage capital guidelines require that state banks maintain \"Tier 1\" capital of no less than 5.0% of total adjusted assets, except in the case of certain highly rated banks for which the requirement is 3.0% of total adjusted assets. As of December 31, 1995, the Bank's ratio of \"Tier 1\" capital-to-total adjusted assets was 8.76%. This ratio has increased from 8.67% as of December 31, 1993.\nThe FDIC may, in certain circumstances, establish higher minimum requirements than those described above; for example, when a bank has been receiving special regulatory attention or has a high susceptibility to interest rate risk. In any event, banks with capital ratios below the required minimums are subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.\nPrompt Corrective Action\nPursuant to FDICIA, each federal banking agency has specified by regulation the levels at which an insured institution would be considered \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" In addition, 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).\nUndercapitalized institutions, as well as significantly and critically undercapitalized institutions, are required to submit capital restoration plans to their appropriate federal regulator and are subject to restrictions on operations, including prohibitions on branching, engaging in new activities, paying management fees, making capital distributions such as dividends, and growing without regulatory approval. Moreover, in order for an undercapitalized institution's capital restoration plan to be accepted by its federal regulator, a company controlling such undercapitalized depository institution will be required to guarantee its subsidiary's compliance with the capital restoration plan up to an amount equal to the lesser of 5.0% of such subsidiary institution's assets or the amount of the capital deficiency when such institution first fails to meet the plan. The Company is a controlling company of the Bank for these purposes. Increasingly stringent restrictions on operations are made applicable to an institution if it becomes significantly or critically undercapitalized, or if it does not submit, or comply with, an acceptable capital restoration plan.\nThe Bank is considered \"well capitalized\" for prompt corrective action purposes.\nBank Dividends\nDividends paid by the Bank provide substantially all of the Company's cash flow. Under Texas law, a state-chartered bank may pay dividends from undivided profits, the part of equity capital equal to the balance of its net profit, income, gains and losses since the date of formation minus subsequent distributions to shareholders, and transfer to surplus or capital under share dividends or by board resolution. At December 31, 1995, there was an aggregate of approximately $72.3 million available for the payment of dividends by all subsidiaries to the Company without prior regulatory approval.\nThe payment of dividends by the Bank may be affected by other regulatory requirements, such as the maintenance of adequate capital, FDICIA specifically prohibits the payment of dividends by an insured bank, if after the payment, the bank would be \"undercapitalized.\"\nDeposit Insurance Assessments\nIn 1993, the FDIC began implementing a risk-related assessment scheme for all insured depository institutions. Assessments are based on capital and supervisory measures, with the strongest institutions presently paying $.04 for every $100 of deposits and the weakest institutions paying $.27 for every $100 of deposits. In November 1995, the FDIC Board of Governors voted to reduce the insurance premiums paid on deposits covered by the Bank Insurance Fund for the highest rated institutions to an annual minimum of $2,000 effective for the first semiannual period of 1996.\nUnder the risk-related scheme, the FDIC assigns 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 assigns 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 \"well capitalized\" institutions may be placed in the lowest assessment category. The Bank has been notified by the FDIC that its assessment rate for 1996 will remain at the lowest risk-based premium available.\nSTATISTICAL INFORMATION\nThe following statistical and other information is provided as part of the Management Discussion and Analysis of the Financial Condition and Results of Operations on the pages indicated.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nThe principal offices of the Bank are located in One O'Connor Plaza, which the Bank leases, and 120 Main Place, which the Bank owns free and clear of any mortgage. The Company's offices are located in One O'Connor Plaza. The Company and its subsidiaries occupy approximately 83% of the 134,000 square feet of rentable floor space contained in 120 Main Place. The balance of the space is leased to other tenants. The Company owns adequate facilities for each of its branch office locations.\nThe Bank leases all of One O'Connor Plaza, a twelve-story office building, under a net lease, with a remaining primary lease term of 15 years, from Plaza Associates, a Texas general partnership. The principal partners of Plaza Associates consist of seven children or grandchildren and three trusts for the benefit of children or grandchildren of certain principal shareholders of the Company. The lease commenced in 1985, and is a long-term triple net lease, with a primary term of 25 years and six renewal terms of five years each, exercisable at the option of the Bank, with annual rentals of approximately $2.5 million during the first 15 years and approximately $3.0 million during the next ten years and rentals for renewal terms at fair market value. The Bank has an option at the end of the primary term and each renewal term to purchase the property at its fair market value. The Bank occupies approximately 68% of the 157,000 rentable square feet in the building and subleases the remaining space to other tenants. A portion (21%) of the building is subleased to the principal shareholders of the Company. The Company believes that the terms of its lease from Plaza Associates, and the sublease to principal shareholders of the Company, are as favorable as those which could have been obtained from an unaffiliated third party.\nThe Bank provides both commercial and consumer lending services, banking services, including checking and savings\naccounts, and safe deposit facilities. The Bank's facilities include parking garages adjacent to One O'Connor Plaza and 120 Main Place. The Bank's branch office located in north Victoria provides six drive-in banking lanes, which include one lane for commercial customers and one drive-up automatic teller machine. The fourth local branch office is located in northeast Victoria, and it has seven drive-in banking lanes, which include one lane for commercial customers and one drive-up automatic teller machine.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nThe Company is involved in various legal actions that are in various stages of litigation and investigation by the Company and its legal counsel. Some of these actions allege various \"lender liability\" claims on a variety of theories and claim substantial actual and punitive damages. After reviewing all actions pending or threatened involving the Company, management believes that while the resolution of any matter may have an impact on the financial results of the period in which the matter is settled, their ultimate resolution will not have a material adverse effect upon the business or consolidated financial position of the Company. However, these matters are in various stages of proceedings and future developments could cause management to revise its assessment of these matters. No material legal actions 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 security holders of the Company during the fourth quarter of the fiscal year covered by this Report.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCertain information concerning the Common Stock of the Company is included on page 74 herein.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nSelected financial data is presented below. The selected financial data should be read in conjunction with Management's Discussion and Analysis of the Financial Condition and Results of Operations of the Company presented elsewhere herein.\nSELECTED FINANCIAL DATA VICTORIA BANKSHARES, INC. AND SUBSIDIARIES - ------------------------------------------------------------------------------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) (NOT COVERED BY REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS) - -------------------------------------------------------------------------------\nITEM 7","section_7":"ITEM 7\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nThe following discussion highlights the major changes affecting the operations and financial condition of the Company for the two years ended December 31, 1995. Unless the context otherwise requires, the \"Company\" refers to Victoria Bankshares, Inc., and its subsidiaries. The discussion should be read in conjunction with the consolidated financial statements, accompanying notes, and selected financial data appearing elsewhere in this report.\nOVERVIEW OF OPERATIONS\nThe Company reported net income of $15.1 million for the year ended 1995 compared to net income of $17.0 million reported for the year ended 1994. Earnings per share were $1.83 for 1995 compared to $2.05 for 1994. The decline in net income is primarily attributable to pressures on the net interest margin resulting from increased funding costs and higher noninterest expenses due to acquisition related expenses.\nA special meeting of the shareholders of the Company will be held on April 2, 1996, to consider and vote upon a proposal to approve the Agreement and Plan of Merger dated November 12, 1995, between the Company and Norwest. The Plan of Merger has been approved by the boards of both companies and is pending regulatory approval. Norwest will issue 1.05 shares of Norwest common stock in exchange for each share of the Company's common stock. The exchange will be tax-free for the Company's shareholders and will be accounted for by Norwest as a pooling-of-interests.\nNorwest is a $72.1 billion company providing banking, mortgage, investments, insurance, and other financial services through 3,042 stores in all 50 states, Canada, the Caribbean, Central America, and elsewhere internationally.\nThe Company continues to be well capitalized. At December 31, 1995, the Company's ratio of total capital-to-risk-weighted-assets was 16.26% and its leverage ratio was 8.76%, both of which significantly exceed the minimum regulatory requirements.\nNET INTEREST INCOME\nNet interest income is the difference between income earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. The interest income on certain loans and investment securities is not subject to Federal income tax. For analytical purposes, at December 31, 1995 and December 31, 1994 and 1993, the interest income and rates on these types of assets are adjusted to a \"fully taxable equivalent\" basis, net of the\neffect of any interest expense disallowed. The fully taxable equivalent adjustment was calculated using the Company's statutory Federal income tax rate of 35%. Adjusted interest income is as follows (in thousands):\nThe net interest spread is the difference between the average rates on interest-earning assets and the average rates on interest-bearing liabilities. The interest rate margin represents net interest income divided by average earning assets. These ratios can also be used to analyze net interest income. Since a significant portion of the Company's funding is derived from interest-free sources, primarily demand deposits and total stockholders' equity, the effective rate paid for all funding sources is lower than the rate paid on interest-bearing liabilities alone. As the following table illustrates, the interest rate spread decreased 16 basis points to 3.29% in 1995 from 3.45% in 1994 and the interest rate margin decreased 1 basis point to 4.15% in 1995 from 4.16% in 1994 (dollars in thousands).\n________________________________\n(1) Includes interest-bearing deposits with other banks. (2) Interest and rates on loans and securities which are nontaxable for Federal income tax purposes are presented on a taxable equivalent basis using a rate of 35%. (3) The 1995 and 1994 average balance has been adjusted to exclude the effect of Statement of Financial Accounting Standards No. 115.\nThe level of net interest income is the result of the relationship between the total volume and mix of interest-earning assets and the rates earned, and the total volume and mix of interest-bearing liabilities and the rates paid. The rate and volume components associated with interest-earning assets and interest-bearing liabilities can be segregated to analyze the year-to-year changes in net interest income. Changes due to rate\/volume variances have been allocated between changes due to average volume and changes due to average rate based on the percentage of each to the total change of both categories. Because of changes in the mix of the components of interest-earning assets and interest-bearing liabilities, the computations for each of the components do not equal the calculation for interest-earning assets as a total and interest-bearing liabilities as a total. The following table analyzes the changes attributable to the rate and volume components of net interest income (in thousands):\nCHANGES DUE TO VOLUME\nThe increase in net interest income due to the change in average volume is attributable primarily to the growth in loan volume from 36.3% of average interest-earning assets at December 31, 1994, to 38.9% at December 31, 1995. This increase was partially offset by the increase in the average volume of time deposits. Time deposits, typically the highest cost of the deposit category, increased from 39.7% of average interest-bearing liabilities at December 31, 1994, to 45.2% at December 31, 1995.\nCHANGES DUE TO RATES\nThe increase in net interest income due to the change in average rates occurred even though the net interest spread\ndecreased as the effect of rates on interest income was larger than the effect of rates on interest expense. This is due to the average balance of interest-earning assets being proportionately larger than the average balance of interest-bearing liabilities.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses is an amount added to the allowance against which loan losses are charged. Management determines an appropriate provision for loan losses based upon the size, quality, and concentration characteristics of the loan portfolio using both historical quantitative trends and Management's evaluation of qualitative factors including economic and industry outlooks. The provision for loan losses for 1995 was $165 thousand and for 1994 was $15 thousand. The increase over 1994 was primarily due to the increase in the size of the portfolio. Relatively low levels of nonperforming loans and net charge-offs should continue. However, the provision for loan losses may need to be increased in the future if loan growth continues as expected.\nDuring 1995, the Company recorded net charge-offs to the allowance for loan losses of $557 thousand, up from a net recovery of $35 thousand in 1994. The allowance for loan losses at December 31, 1995, was 1.5% of loans, net of unearned discount, compared to 1.7% at December 31, 1994. The allowance as a percent of nonperforming loans was 125.2% at December 31, 1995, as compared to 98.4% a year earlier.\nNONINTEREST INCOME\nNoninterest income totaled $29.6 million in 1995, up $2.1 million or 7.7% from December 31, 1994. The following table presents a comparative analysis of the major components of noninterest income (in thousands):\nService charges and other fees increased 5.3% in 1995 resulting mainly from the acquisition of Cattlemen's during the second quarter of 1995 and income from a new ATM surcharge that began in the fourth quarter of 1994.\nTrust services income increased 24.3% during 1995 as the assets under management increased $70.0 million to $1.1 billion. The increase in income can be attributed primarily to a full year's effect on income from the acquisition of the former Ameritrust Texas National Association office located in Corpus Christi from Texas Commerce Bank National Association (\"Corpus Christi Trust\") during the third quarter of 1994.\nData processing income decreased 14.2% as a result of a decrease in the level of customers serviced by the Company's data processing subsidiary.\nSecurities gains totaled $57 thousand during 1995 as compared to losses of $796 thousand in 1994. The gains in 1995 resulted from the sales of equity investments by the Company's Small Business Administration (\"SBA\") licensed subsidiary and in-substance maturities of securities held to maturity. The losses in 1994 were due mainly to losses of $446 thousand on dispositions of two equity investments held by the SBA licensed subsidiary. Also contributing to the 1994 losses were sales of securities held as available for sale in order to improve total return.\nOther operating income, which includes investment product income, mortgage banking income, and safe deposit income, decreased 10.8% in the aggregate during 1995. The decrease in investment product income is attributable to decreases in total commissions from a lower level of sales of fixed income securities and mutual funds. Mortgage banking income decreased, even though mortgage origination increased, as fees from the sale of mortgage loans into secondary markets decreased. This occurred as the Company retained a higher percentage of the loans it originated mainly in a newly introduced three-year adjustable rate product. These decreases were partially offset by a slight increase in safe deposit income as a result of the acquisition of Cattlemen's.\nNONINTEREST EXPENSE\nTotal noninterest expense increased $5.8 million or 8.5% to $74.2 million in 1995 from $68.4 million in 1994. This increase resulted primarily from acquisition expenses, including conversions of Cattlemen's in the second quarter of 1995 and a full year's expense related to the acquired Corpus Christi Trust in the third quarter of 1994. Excluding expenses related to acquisitions, total noninterest expense increased 4.2%. The following table presents a comparative analysis of the major components of noninterest expense (in thousands):\nSalaries and wages increased 7.5% during 1995 as a result of the 1995 acquisition of Cattlemen's, the 1994 acquisition of Corpus Christi Trust, and normal merit increases.\nRetirement and other employee benefits increased 19.4% during 1995 primarily due to increased health care expenses as a result of rising health care costs and increased claims, as well as the acquisitions mentioned above.\nNet occupancy expense increased 2.9% during 1995 primarily as a result of the timing of the 1994 Corpus Christi Trust acquisition and the 1995 Cattlemen's acquisition.\nEquipment rental, depreciation, and maintenance expense increased 4.2% during 1995 resulting primarily from the installation of a Platform system at branch offices in 1995 and increased expenses related to acquisitions.\nFDIC insurance expense decreased $1.6 million or 47.6% during 1995 due to a partial refund received in September 1995 from the FDIC on assessments paid for the second quarter of 1995 and a reduction in the assessment rate paid for the third quarter of 1995. The Bank has been notified by the FDIC that its assessment rate for 1996 will remain at the lowest level risk-based premium available. This assessment level requires the Bank to be both well capitalized, as defined by the FDIC, and in good standing with its regulators. In November 1995, the FDIC Board of Directors voted to reduce the insurance premiums paid on deposits covered by the Bank Insurance Fund for the highest rated institutions to an annual minimum of $2,000 effective for the first semiannual period of 1996.\nTaxes other than income, primarily Texas franchise tax, increased 43.0% during 1995 primarily as a result of increased\ntaxable capital (as defined by law) at the Company and the 1995 acquisition of Rosenberg.\nOperating supplies, communication, and postage expenses all increased during 1995 as a result of the 1994 acquisition of Corpus Christi Trust and the 1995 acquisition of Cattlemen's.\nOutside service expense increased 26.9% during 1995 primarily due to the 1995 expenses incurred as a result of the conversion relating to the 1995 acquisitions of Rosenberg, Cattlemen's, and the impending merger with Norwest.\nAmortization of intangible assets increased 43.2% primarily as a result of the 1995 acquisition of Cattlemen's and the full year's effect of the 1994 acquisition of Corpus Christi Trust.\nAll other noninterest expense increased 14.3% due primarily to increases in software license and maintenance expenses and seminars and training expenses.\nINCOME TAXES\nFor the year ended December 31, 1995, the Company's provision for federal income taxes was $7.6 million compared to $8.8 million for the year ended December 31, 1994.\nThe Company had a net deferred tax liability of $709 thousand as of December 31, 1995. This net deferred tax liability is composed of the expected tax payments from the reversal of the temporary differences between tax and book net income and the gross-up of core deposit intangibles acquired from Cattlemen's. The existing net temporary differences will reverse during future periods.\nCAPITAL MANAGEMENT\nThe Federal Reserve Board has adopted a system using the internationally consistent 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\"\nelements). 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 stockholders' 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 allowance for loan losses.\nAt December 31, 1995, the Company's ratios of \"Tier 1\" and total capital to risk-weighted assets were 15.25% and 16.26%, 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 Federal Reserve Board and the FDIC use 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 average total assets. The leverage ratio adopted by the federal banking agencies requires a ratio of 3.0% for banks with a CAMEL rating of 1. All other institutions will be expected to maintain 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 8.8%, which also significantly exceeds the regulatory minimum.\nThe FDIC maintains final rules on capital adequacy ranging in five categories from critically undercapitalized to well-capitalized. A well-capitalized company is one that maintains total capital to risk-weighted assets of at least 10%, a \"Tier 1\" total capital to risk-weighted assets of at least 6%, and a leverage ratio of 5%. The Company's ratios substantially exceed the regulatory minimums required under the well-capitalized category.\nLIQUIDITY MANAGEMENT\nTo a business enterprise, liquidity is the ability to generate cash to meet financial obligations and opportunities. For a banking organization, these obligations arise from a wide variety of sources, most prominent among them being withdrawals of deposits, repayment upon maturity of purchased funds, payment of operating expenses, and payment of dividends.\nThe Company's sources of liquidity as a whole include cash and cash equivalents, available for sale securities and federal funds sold (\"liquid assets\"), as well as new deposits, proceeds of additional borrowings, and proceeds from additional sales of stock.\nSources of liquidity are also maintained to enable the Company to take advantage of opportunities in loan and investment markets and to provide substantial flexibility against unforeseeable cash requirements that can occur in times of volatile financial markets. The Company believes it has adequate sources of liquidity.\nThe Company paid cash dividends of $6.0 million and $4.1 million to holders of common stock during 1995 and 1994, respectively. The Company has paid cash dividends for fifteen consecutive quarters. In March 1994, cash dividends were increased from $.10 per share to $.13 per share, representing a 30% increase. In January 1995, the Company declared a $.16 per share quarterly dividend, an increase of 23%, and a special $.09 per share dividend. In each subsequent quarter of 1995 the Company paid a $.16 per share quarterly dividend. In January 1996, the Company declared a $.16 per share dividend and a special $.09 per share dividend which was paid on February 22, 1996.\nThe Parent Company, as of December 31, 1995, has $13.7 million in short-term and medium-term securities which can be used to provide liquid resources as well as currently unanticipated capital needs of its subsidiaries.\nAn integral part of the Company's liquidity management is the funding of the Bank, which derives its source of fundings predominately from deposits within its marketing area. The customer base for deposits is diversified among correspondent banks, individuals, partnerships and corporations, and public entities. This diversification helps the Company avoid dependence on large concentrations of funds. The Company does not, as a matter of policy, place certificates of deposit through brokers. The Company's percentage of time certificates of deposit over $100,000 to time deposits increased to 20.2% in 1995 from 19.8% in 1994. This increase was the result of customers moving funds into time deposits as interest rates increased during 1995.\nThe table below sets forth the maturity distribution of certificates of deposit of $100,000 or more issued by the Bank (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 rise, such a position will have a positive effect on net interest income. Conversely, in a liability sensitive position, where liabilities reprice more quickly than assets in a given period, a rise in rates will have an adverse effect on net interest income.\nOne way to analyze interest rate risk is to evaluate the balance of the interest rate sensitivity position. A mix of assets and liabilities that are roughly equal in volume and repricing represents a matched interest rate sensitivity position. Any excess of assets or liabilities in a particular period results in an interest rate sensitivity gap. The following table presents the interest rate sensitivity position of the Company at December 31, 1995 (dollars in thousands).\nThe Company had an asset sensitivity gap position in the 30-day period of $122.0 million. The cumulative rate sensitive gap position at one year was an asset sensitive position of $93.8 million, which indicates that the Company may benefit from rising interest rates; conversely falling interest rates may have a negative impact upon the Company.\nThe Company undertakes this interest rate sensitivity analysis to monitor 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 position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of assets and liabilities equally or at the same time.\nThe Company's Asset and Liability Committee reviews monthly the consolidated rate sensitivity positions along with simulation and duration models, and makes adjustments as needed to control the Company's interest rate risk position.\nThe Company's investment policy does not permit the use of derivative financial instruments or the purchase of structured notes.\nLOAN PORTFOLIO\nThe Company's loans are widely diversified by borrower and industry group. The following summary shows the composition of the loan portfolio for the five years ended December 31, 1995 (dollars in thousands):\nMaturities in the Company's loan portfolio at December 31, 1995, are summarized below (in thousands):\nThe maturities presented above are based upon contractual maturities. The Company has no set rollover policy. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness. The total amount of loans due after one year which have fixed, floating, or adjustable rates is as follows (in thousands):\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses represents Management's estimate necessary to provide for losses incurred in the loan portfolio. In making this determination, Management analyzes the ultimate collectibility of the Company's loan portfolio, incorporating feedback provided by the internal loan review staff and provided by examinations performed by regulatory agencies. Management makes an ongoing evaluation as to the adequacy of the allowance for loan losses. To establish the appropriate level of the allowance, all loans (including nonperforming loans), commitments to extend credit and standby letters of credit are reviewed and classified as to potential loss exposure. Specific allowances are then established for those loans, commitments to extend credit or standby letters of credit with identified loss exposure and an additional allowance is maintained based upon the size, quality, and concentration characteristics of the remaining loan portfolio using both historical quantitative trends and Management's evaluation of qualitative factors including future economic and industry outlooks.\nThe determination by Management of the appropriate level of the allowance amounted to $10.6 million at December 31, 1995. The allowance for loan losses is based on estimates, and ultimate losses will vary from the current estimates. These estimates are reviewed monthly and as adjustments, either positive or negative, become necessary they are reported in earnings in the periods in which they become known. A detailed analysis of the Company's allowance for loan losses for the past five years is shown below (in thousands):\nThe following table reflects certain historical statistics of the Company relating to the relationship among loans (net of unearned discount), net charge-offs, and the allowance for loan losses (dollars in thousands):\nThe table below shows an allocation of the allowance for loan losses by major categories of loans for the five years ended December 31, 1995. Definitions of types of loans are based on bank regulatory agency instructions for \"Call Reports.\" Historically, the allowance for loan losses related to commitments to extend credit and standby letters of credit has not been material. Allocations as of year-end, which are not indicative of conditions at any other date and do not restrict or dictate allocations at future dates, are as follows (dollars in thousands):\nAll percentages are calculated using loans net of unearned discount.\nNONPERFORMING ASSETS\nThe Company's nonperforming assets consist of nonperforming loans, other real estate, and other repossessed assets.\nNONPERFORMING LOANS\nThe Company's nonperforming loans consist of impaired loans, nonaccrual loans, troubled debt restructurings, and loans 90 days past due and still accruing.\nThe Company adopted Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS 114\") as amended by Statement of Financial Accounting Standards No. 118 \"Accounting by Creditors for Impairment of a Loan\/Income Recognition and Disclosure\" (\"SFAS 118\") on January 1, 1995.\nThe Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is identified as impaired and\/or placed on a nonaccrual basis. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company classifies loans as impaired when there are serious doubts regarding the collectibility of principal and interest or when payments become past due 90 days, except loans which are well secured and in the process of collection. The standards require that when a loan is impaired a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, on a loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company considers consumer loans with balances less than $50,000 to be smaller-balance homogeneous loans which are exempt from SFAS 114. The Company has measured the impairment related to all of its impaired loans using the fair value of the loan's collateral. Amounts received on impaired loans are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected. When collection of an impaired loan is considered remote, the loan is charged-off against the allowances for loan losses.\nTroubled debt restructurings are those for which concessions, including reduction of interest rates or deferral of interest or principal, have been granted, due to the borrower's weakened financial condition. Interest on restructured loans is generally accrued at the restructured rates when it is anticipated that no loss of original principal will occur. As of December 31, 1995, all restructured loans were performing in accordance with the restructured terms.\nLoans 90 days past due and still accruing are well secured and in the process of collection.\nOTHER NONPERFORMING ASSETS\nOther nonperforming assets, which are carried at the lower of cost or fair value, less estimated costs to sell, consist of other real estate acquired through loan foreclosures and other workout situations and other assets acquired through repossession. In addition, other nonperforming assets include loans which the Company has not taken possession of the collateral, although not formally foreclosed, are unlikely to be repaid through means other than foreclosure and sale of the collateral. According to Company policy all other real estate and in-substance foreclosures valued over $100 thousand are appraised on an annual basis by an independent appraisal service.\nIn accordance with SFAS 114, as amended, loan balances and income\/expense related to loans previously classified as in-substance foreclosure, but for which the Company had not taken possession of the collateral, have been reclassified to loans for all periods presented. As of the periods presented, there were no in-substance foreclosures for which the Company had taken possession of the collateral included in foreclosed assets.\nThe following table discloses information regarding nonperforming assets for each of the last five years (in thousands):\n(1) See also Note 5 of Notes to Financial Statements for interest foregone. (2) For 1995, these loans are not considered impaired since they are part of a small balance homogeneous portfolio which are exempt from SFAS 114. (3) For 1995, these troubled debt restructurings were performing in accordance with their restated terms as of the date of adoption of SFAS 114.\nTotal nonperforming assets, which include nonperforming loans and other nonperforming assets, totaled $10.1 million or 1.4% of total loans and other nonperforming assets at December 31, 1995, as compared with $11.7 million or 2.0% of total loans and other nonperforming assets at December 31, 1994. Total nonperforming assets represented 0.5% and 0.6% of the total assets at December 31, 1995 and December 31, 1994, respectively. The total\namount of loans past due 90 days or more and still accruing, totaled $469 thousand at December 31, 1995, compared to $427 thousand at December 31, 1994.\nLOAN CONCENTRATIONS AND REGIONAL ECONOMY\nThe economy of the market area served by the Company is characterized by petroleum and natural gas production and sales of related supplies and services, petrochemical operations, light and medium manufacturing operations, agribusiness, and tourism. The agricultural businesses are highly diversified, including beef and dairy cattle, poultry, cotton, and a variety of grain crops. Also, through the acquisition of the Bryan Bank in 1993 and Cattlemen's in 1995, the Company expanded into areas positively affected by a major educational centers. In general, real estate values, as well as real estate development and sales activities, tend to reflect a region's economic environment. The Texas real estate environment continues to show improvement. Management believes that the loans in the real estate portfolio are generally adequately supported by market prices or other credit factors. The Company has no foreign loans, and, therefore, is not directly affected by current international developments.\nReal estate loans totaling $314.0 million comprised approximately 43.9% of the loan portfolio at December 31, 1995, of which 2.1% was nonperforming. At December 31, 1994, real estate loans totaled $263.7 million comprising 43.8% of the loan portfolio, of which 3.1% was nonperforming. The majority of the Company's real estate loans are secured by property located in the nonmetropolitan areas in which the Company operates. The Company's real estate loan portfolio is comprised of interim construction, residential, commercial building, farm acreage, vacant lot, and land development loans. Permanent residential loans make up approximately 44% of the total real estate loans.\nConsumer loans totaled $211.6 million at December 31, 1995 (approximately 29.6% of the loan portfolio), 0.3% of which were nonperforming. These consumer loans include approximately $106.6 million in loans originated through automobile dealers. At December 31, 1994, consumer loans totaled $175.9 million (approximately 29.2% of the loan portfolio), 0.5% of which were nonperforming.\nAgricultural loans, exclusive of loans secured by farm acreage which are categorized by the Company as real estate loans, totaled $40.4 million at December 31, 1995, or approximately 5.7% of the Company's loan portfolio, of which 0.5% were nonperforming. At December 31, 1994, agricultural loans totaled $38.1 million comprising approximately 6.3% of the Company's loan portfolio, of which 0.5% were nonperforming. Risks in this area revolve around price fluctuations and possible crop failures brought on by severe weather.\nThe Company's energy loans, included in the commercial and industrial loan category, were approximately $1.5 million at December 31, 1995, or 0.2% of the loan portfolio of which all were performing. At December 31, 1994, energy loans totaled $1.7 million comprising approximately .3% of the loan portfolio, of which 2.3% were nonperforming. The majority of the Company's energy loan portfolio are loans to energy service companies as opposed to loans secured by oil and gas reserves.\nINVESTMENT SECURITIES\nThe book and market values of investment securities held by the Company as of the dates indicated are summarized as follows (in thousands):\n_____________________\n(1) Includes Federal Reserve Stock, other bonds, and corporate stocks.\nThe investment portfolio, which is the largest segment of the Company's earning asset base (48%), is being managed to minimize interest rate risk, maintain sufficient liquidity and maximize return. Investment securities held to maturity are purchased with the intent and ability of the Company to hold them to maturity as evidenced by the strong capital position of the Company and short maturity of the portfolio. The Company's financial planning anticipates income streams based on normal maturity and reinvestment. The short duration of the portfolio provides adequate liquidity through normal maturities. Investment securities available for sale are purchased with the intent to provide liquidity and to increase returns. The Company does not engage in trading in either the investment securities held to maturity or investment securities available for sale categories.\nHeld to maturity securities with unrealized gains at December 31, 1995, constituted 64.2% of the portfolio, securities with unrealized losses constituted 35.1% of the portfolio with the remaining portfolio consisting of securities with no unrealized gains or losses. At December 31, 1994, securities with unrealized gains constituted 13.8% of the portfolio, securities with unrealized losses constituted 86.1% of the portfolio, and the remaining portfolio consisted of securities with no unrealized\ngains or losses. At December 31, 1995, available for sale securities had an aggregate unrealized holding loss of $431 thousand. The unrealized holding losses, net of tax, of $279 thousand are recorded in stockholders equity. At December 31, 1994, available for sale securities had an aggregate unrealized holding loss of $3.0 million. The unrealized holding losses, net of tax, of $2.0 million are recorded in stockholders' equity. See Note 4 to the Financial Statements.\nThe average maturity of the portfolio was 1.70 years at December 31, 1995, compared to 1.73 years at December 31, 1994. These average maturities take into consideration both expected prepayments and cash flows. The relative short duration of the portfolio improves the liquidity of the Company and minimizes the interest rate risk associated with a longer maturity portfolio. All of the securities are investment grade or better with over 84% of the portfolio being U.S. Government or Government Agency obligations.\nThe following table shows as of December 31, 1995, the distribution and yields of the Company's investment securities. These values represent contractual maturities, but actual repayments and yields are dependent upon monthly cash flows and prepayments. The yields have been calculated using weighted average amortized cost and are not presented on a fully taxable equivalent basis (dollars in thousands).\nACQUISITIONS\nOn June 30, 1995, United Bancshares, Inc., parent company of Rosenberg Bank & Trust, merged with and into the Company. The merger was consummated through the exchange of 306,383 shares of\nthe Company's common stock for all of the outstanding shares of common stock of United. This transaction increased consolidated assets by approximately $65 million and increased consolidated deposits by approximately $61 million. The acquisition was accounted for as a pooling-of-interests. The Company's prior period consolidated financial statements have been restated to include the accounts of United. All intercompany accounts have been eliminated.\nOn August 25, 1995, the Company acquired Cattlemen's Financial Services, Inc. The transaction was accounted for as a purchase. The Company acquired approximately $100 million in assets and assumed $93 million in liabilities, paying a premium of $6.7 million over the book value of the net assets. The principal subsidiary of Cattlemen's Financial Services, Inc., is Cattlemen's State Bank. Cattlemen's State Bank has two branches and a mortgage production office, all of which are located in Austin, Texas.\n1994 COMPARED TO 1993\nThe following discussion highlights the major changes affecting the operations and financial condition of the Company for the two years ended December 31, 1994. Unless the context otherwise requires, the \"Company\" refers to Victoria Bankshares, Inc., and its subsidiaries. The discussion should be read in conjunction with the consolidated financial statements, accompanying notes, and selected financial data appearing elsewhere in this report.\nOVERVIEW OF OPERATIONS\nFor the year ended December 31, 1994, the Company reported earnings of $17.0 million compared to $19.1 million for the year ended December 31, 1993, a decrease of 11.4%. Primary earnings per share were $2.05 for 1994 compared to $2.32 for 1993. Excluding the recognition of two nonrecurring items in 1993, core earnings for the year ended 1994 increased $1.1 million or 6.8% compared to 1993. The nonrecurring items in 1993 included the recognition of a $4.8 million benefit recorded as a result of the adoption of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" and a $2.8 million ($1.8 million after-tax) restructuring charge. The primary factors contributing to the 1994 core earnings were an increase in net interest income resulting from improved asset quality, loan growth, and the growth of noninterest income mainly as a result of the acquisition of a $365 million trust portfolio.\nOn February 28, 1993, the Company acquired from the Federal Deposit Insurance Corporation (\"FDIC\") the New First City Bryan\/College Station (\"Bryan Bank\"). This acquisition, the largest in the Company's history, increased loans by approximately 32.6%, core deposits by approximately 17.9%, and trust assets under management by approximately 27.3%. Also, on October 8, 1993, the\nCompany acquired from another bank holding company a branch office in Richmond (\"Richmond Branch\"). Even though smaller in size ($41 million in deposits and $16 million in loans) the potential of this acquisition results from the expansion into Fort Bend County which has been one of the fastest growing counties in the United States during the 80's and 90's. The Bryan Bank acquisition had a greater effect on the financial results of 1993 than the Richmond Branch acquisition due to size and timing during the year.\nThe Company continues to be well-capitalized. At December 31, 1994, the Company's ratio of total capital-to-risk-weighted-assets was 18.58% and its leverage ratio was 8.7%, both of which significantly exceed the minimum regulatory requirements.\nNET INTEREST INCOME\nNet interest income and net interest spread is the difference between income earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. For analytical purposes, net interest income for 1994 and 1993 is adjusted to a \"fully taxable equivalent\" basis to recognize the income tax savings on tax-exempt items. Net interest income increased to $66.6 million in 1994, an increase of 2.8% from the $64.7 million reported in 1993.\nInterest income foregone on nonperforming loans declined to $82 thousand in 1994 as compared to $359 thousand in 1993.\nAs the table presented on page 19 illustrates, the interest rate margin increased 10 basis points to 4.16% in 1994 from 4.06% in 1993.\nThe table presented on page 20 analyzes the changes attributable to the rate and volume components of net interest income.\nChanges Due to Volume\nThe increase in net interest income due to the change in average volume is attributable primarily to the growth in loan volume from 30.9% of average interest-earning assets at December 31, 1993, to 36.3% at December 31, 1994. This increase was partially offset by the decrease in the average volume of total investments and federal funds sold and short-term investments. Average interest-bearing transaction accounts, typically the lowest cost of the interest-bearing liability category, increased from 48.3% of average interest-bearing liabilities at December 31, 1993, to 51.8% at December 31, 1994. Overall, average interest-earning assets grew 0.3% from December 31, 1993, to December 31, 1994, while average interest-bearing liabilities decreased 1.2% for the same period. Average noninterest-bearing liabilities and stockholders' equity, by comparison, grew 4.7% from December 31, 1993, to December 31, 1994.\nCHANGES DUE TO RATES\nThe decrease in net interest income due to the change in average rates results from the change in average rates on loans being more sensitive to the increase in market rates than was the change due to average rates on interest- bearing deposits. Additionally, the increase in interest income due to the change in average rates was reduced as a result of the decreasing investment portfolio yield as maturing securities were reinvested at lower rates.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses was $15 thousand in 1994 as compared to $155 thousand in 1993. This decrease was due to decreases in nonperforming loans and net charge-offs.\nDuring 1994, the Company recorded net recoveries of $35 thousand, up from net charge-offs of $562 thousand in 1993. The ratio of net recoveries to average loans, net of unearned discount, for 1994 was .01%, up from .11% in net charge-offs to average loans net of unearned discount in 1993. Reflecting improved loan portfolio quality, the allowance for loan losses at December 31, 1994, was 1.7% of loans, net of unearned discount, compared to 1.8% at December 31, 1993. The allowance as a percent of nonperforming loans was 98.4% at December 31, 1994, as compared to 76.3% a year earlier.\nNONINTEREST INCOME\nNoninterest income totaled $27.5 million in 1994, up $0.5 million or 1.7% from December 31, 1993. The following table presents a comparative analysis of the major components of noninterest income (in thousands):\nService charges and other fees increased 4.8% in 1994 resulting mainly from a full year's effect on income from the acquisitions of the Richmond Branch on October 8, 1993, and the Bryan Bank on February 28, 1993. These acquisitions, therefore, only affected the income for three months and ten months, respectively, during 1993.\nTrust services income increased 31.3% during 1994 as the assets under management increased $338.5 million to $1.0 billion. This increase can be attributed to the acquisition of the former Corpus Christi Trust which added approximately $365 million in trust assets during the third quarter of 1994 and $1.0 million in trust fees during 1994. Also contributing to the increase was the timing of the acquisition of the Bryan Bank as mentioned above.\nSecurities losses totaled $796 thousand during 1994 as compared to gains of $103 thousand in 1993 due mainly to losses of $446 thousand on dispositions of two equity investments held by the Company's SBA licensed subsidiary. Also contributing to the losses were sales of securities held as available for sale in order to improve total return.\nOther operating income, which includes investment product income, safe deposit income, and mortgage banking income, decreased 8.4% in the aggregate during 1994. The decrease in investment product income was attributable to decreases in total commissions from a lower level of sales of fixed income securities and mutual funds due to the softness in the bond and equity markets offset partially by increased income from annuity sales to customers. Mortgage banking income decreased due to the decreased refinancings resulting from increases in interest rates. These decreases were partially offset by increased safe deposit income as a result of the timing of 1993 acquisitions.\nNONINTEREST EXPENSE\nTotal noninterest expense decreased $1.7 million or 2.4% to $68.4 million in 1994 from $70.0 million in 1993. This decrease resulted primarily from the 1993 restructuring charge offset partially by a full year's effect in 1994 of expenses from the 1993 acquisition of the Bryan Bank and Richmond Branch and the 1994 acquisition of the Corpus Christi Trust. The 1993 restructuring charge consisted of $2.6 million in retirement and other employee benefits and $0.2 million in salaries and wages. This restructure resulted in excess of $2.0 million of expense growth savings in 1994. The following table presents a comparative analysis of the major components of noninterest expense (in thousands):\nThe previously mentioned restructuring resulted in expense growth savings in salaries and wages in 1994. These savings, however, were offset due to staffing increases related to the timing of the 1993 acquisitions, the 1994 acquisition, and normal merit increases.\nRetirement and other employee benefits decreased 30.8% during 1994 primarily as a result of the nonrecurring restructuring charge in 1993 for expenses relating to an early retirement program and decreased employee health care expense as a result of an overfunding of the health care plan at year-end 1993.\nNet occupancy expense increased 4.5% during 1994 primarily as a result of the timing of the 1993 acquisitions and the 1994 acquisition.\nEquipment rental, depreciation, and maintenance expense increased 6.4% during 1994 resulting primarily from an increase in equipment rental expenses due to upgrades and increased capacity by the data processing subsidiary to accommodate the growth from acquisitions. The timing of the 1993 acquisitions and the 1994 acquisition also contributed to this increase.\nFDIC insurance expense increased $193 thousand or 6.1% during 1994 due to increased deposits obtained in the 1993 acquisitions.\nTaxes other than income decreased 11.8% during 1994 as a result of decreases in ad valorem taxes on premises and personal property due to a refund for prior year taxes and a reduction of current year taxes, both resulting from a correction of the appraised tax values on various bank assets.\nMarketing, operating supplies, communication, and postage expenses all increase during 1994 as a result of the timing of acquisitions.\nOutside service expense decreased 9.5% during 1994 primarily due to the 1993 expenses incurred as a result of the conversions relating to the 1993 acquisitions.\nAmortization of intangible assets increased 38.9% primarily as a result of the 1994 acquisition of the Corpus Christi Trust and the full year's effect of the 1993 acquisitions.\nAll other noninterest expense decreased 5.0% due primarily to a reduction in expenses related to other loan related assets as a result of a decrease in the level of foreclosed property.\nINCOME TAXES\nFor the year ended December 31, 1994, the Company's provision for federal income taxes was $8.8 million compared to $7.2 million for the year ended December 31, 1993. On January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes,\" resulting in the Company recording a deferred tax asset of $4.8 million at the beginning of 1993. After recognition of these deferred tax assets, the Company returned to a statutory tax rate.\nCUMULATIVE EFFECT OF CHANGE IN ACCOUNTING METHOD\nDuring 1993, the Company recognized $4.8 million as the cumulative effect of change in accounting method as the result of the adoption of Financial Accounting Standards No. 109 discussed earlier.\nCAPITAL MANAGEMENT\nAt December 31, 1994, the Company's ratios of \"Tier 1\" and total capital to risk-weighted assets were approximately 17.45% and 18.58%, respectively. Both ratios significantly exceed regulatory minimums.\nThe following table summarizes the Company's Tier 1 and Total Capital (dollars in thousands):\nThe Company's leverage ratio at December 31, 1994, was 8.7%, which also significantly exceeds the regulatory minimum. The Company's ratios substantially exceed levels required under the well-capitalized category.\nLIQUIDITY MANAGEMENT - CONSOLIDATED COMPANY\nTo a business enterprise, liquidity is the ability to generate cash to meet financial obligations and opportunities. For a banking organization, these obligations arise from a wide variety of sources, most prominent among them being withdrawals of deposits, repayment upon maturity of purchased funds, payment of operating expenses, and payment of dividends.\nThe Company's sources of liquidity as a whole include cash and cash equivalents, available for sale securities and federal funds sold (\"liquid assets\"), as well as new deposits, proceeds of additional borrowings, and proceeds from additional sales of stock.\nSources of liquidity are also maintained to enable the Company to take advantage of opportunities in loan, deposit, and securities markets and to provide substantial flexibility against unforeseeable cash requirements that can occur in times of volatile financial markets. The Company believes it has adequate sources of liquidity.\nAn integral part of the Company's liquidity management is the funding of the banking subsidiary. The banking subsidiary derives its source of fundings predominately from deposits within its marketing area. The customer base for deposits is diversified between correspondent banks, individuals, partnerships and corporations, and public entities. This diversification helps the Company avoid dependence on large concentrations of funds. The Company does not, as a matter of policy, place certificates of deposit through brokers. The Company's percentage of time certificates of deposit over $100,000 to time deposits decreased to 19.8% in 1994 from 18.8% in 1993. These decreases were the result of customers moving funds into more liquid interest-bearing demand deposit accounts or other forms of investments.\nThe table below sets forth the maturity distribution of certificates of deposit of $100,000 or more issued by the Bank (in thousands):\nLIQUIDITY MANAGEMENT - PARENT COMPANY\nThe liquidity of a bank holding company is dependent upon the ability of its subsidiaries to pay dividends, intercompany charges for actual services rendered by the holding company, and the holding company's access to capital markets through equity offerings, borrowings, and similar traditional funding sources. The ability of a holding company's subsidiaries to pay such amounts is dependent upon their future earnings.\nThe Parent Company, as of December 31, 1994, has $12.4 million in short-term and medium-term government securities which can be used to provide liquid resources as well as currently unanticipated capital needs of its subsidiaries.\nDividends from subsidiaries are dependent on future earnings. The amount of retained earnings available to the Parent Company from subsidiaries for payment of dividends without prior regulatory approval was approximately $68,706,000 at December 31, 1994. The Parent Company received $5.5 million in dividends in 1994 from subsidiaries. Cash dividends of $4.1 million and $2.9 million were paid by the Parent Company to holders of common stock during 1994 and 1993, respectively. The Company has paid dividends for eleven consecutive quarters. During the first quarter of 1994, the Company declared a dividend of $.13 per share representing a 30% increase.\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 rate sensitivity position. A mix of assets and liabilities that are roughly equal in volume and repricing represents a matched interest rate sensitivity position. Any excess of assets or liabilities results in an interest rate sensitivity gap.\nThe following table presents the interest rate sensitivity position of the Company at December 31, 1994 (dollars in thousands).\nThe Company had a negative interest rate sensitivity gap position in the 30-day period of $16.9 million. The cumulative rate sensitive gap position at one year was a positive $43.4 million, which indicates that the Company may benefit from rising interest rates; conversely falling interest rates may have a negative impact upon the Company.\nThe Company undertakes this analysis to monitor 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 position, 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 Company's Asset and Liability Committee reviews monthly the Company's consolidated rate sensitivity positions, and makes adjustments as needed to control the amount of interest rate risk the Company is willing to bear during changing economic cycles and to improve its overall profit potential.\nLOAN PORTFOLIO\nThe Company's loans are widely diversified by borrower and industry group. The summary presented on page 29 presents information on the composition of the loan portfolio.\nMaturities in the Company's loan portfolio at December 31, 1994, are summarized below (in thousands):\nThe maturities presented above are based upon contractual maturities. The Company has no set rollover policy. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness. The total amount of loans due after one year which have fixed, floating, or adjustable rates is as follows (in thousands):\nNONPERFORMING ASSETS\nThe Company's nonperforming assets consist of nonaccrual loans and troubled debt restructurings, other real estate, other assets which have been repossessed or acquired through workout situations, and loans foreclosed in- substance.\nTotal nonperforming assets, which include nonperforming loans and other nonperforming assets, totaled $11.7 million or 2.0% of total loans and other nonperforming assets at December 31, 1994, as compared with $18.9 million or 3.3% of total loans and other nonperforming assets at December 31, 1993. Total nonperforming assets represented 0.6% and 1.0% of the total assets at December 31, 1994 and December 31, 1993, respectively. The total amount of loans past due 90 days or more and still accruing, totaled $427 thousand at December 31, 1994, compared to $472 thousand at December 31, 1993.\nLOAN CONCENTRATIONS\nReal estate loans totaling $263.7 million comprised approximately 43.8% of the loan portfolio at December 31, 1994, of which 3.1% was nonperforming. At December 31, 1993, real estate loans totaled $246.4 million comprising 43.4% of the loan portfolio, of which 4.4% was nonperforming. The majority of the Company's real estate loans are secured by property located in the nonmetropolitan areas in which the Company operates. The Company's real estate loan portfolio is comprised of interim construction, residential, commercial building, farm acreage, vacant lot, and land development loans. Permanent residential loans make up approximately 40% of the total real estate loans.\nConsumer loans totaled $175.9 million at December 31, 1994 (approximately 29.2% of the loan portfolio), .5% of which were nonperforming. These consumer loans include approximately $84.5 million in loans originated through automobile dealers. At December 31, 1993, consumer loans totaled $167.1 million (approximately 29.4% of the loan portfolio), 0.6% of which were nonperforming. Student loans were $2.7 million and loans originated through automobile dealers were approximately $72.1 million of this category in 1993.\nAgricultural loans, exclusive of loans secured by farm acreage which are categorized by the Company as real estate loans, totaled $38.1 million at December 31, 1994, or approximately 6.3% of the Company's loan portfolio, of which 0.5% were nonperforming. At December 31, 1993, agricultural loans totaled $35.5 million comprising approximately 6.3% of the Company's loan portfolio, of which 1.6% were nonperforming. Risks in this area revolve around price fluctuations and possible crop failures brought on by severe weather.\nThe Company's energy loans, included in the commercial and industrial loan category, were approximately $1.7 million at December 31, 1994, or .3% of the loan portfolio, of which 2.3% were nonperforming. At December 31, 1993, energy loans totaled $1.6 million comprising approximately 0.3% of the loan portfolio, of which all were performing. The majority of the Company's energy loan portfolio are loans to energy service companies as opposed to loans on oil and gas reserves.\nINVESTMENT SECURITIES\nSecurities with unrealized gains at December 31, 1994, constituted 13.8% of the portfolio, unrealized losses constituted 86.1% of the portfolio with the remaining portfolio consisting of securities with no unrealized gains or losses. The unrealized holding losses, net of tax, of $1.5 million are recorded in stockholders' equity. At December 31, 1993, unrealized gains constituted 62.5% of the portfolio, unrealized losses constituted\n21.1% of the portfolio, and the remaining portfolio consisted of securities with no unrealized gains or losses.\nThe average maturity of the portfolio was 1.73 years at December 31, 1994, compared to 1.78 years at December 31, 1993. These average maturities take into consideration both expected prepayments and cash flows. The relative short duration of the portfolio improves the liquidity of the Company and minimizes the interest rate risk associated with a longer maturity portfolio. All of the securities are investment grade or better with over 83% of the portfolio being U.S. Government or Government Agency obligations.\nThe following table shows as of December 31, 1995, the distribution and yields of the Company's investment securities. These values represent contractual maturities, but actual repayments and yields are dependent upon monthly cash flows and prepayments. The yields have been calculated using weighted average amortized cost and are not presented on a fully taxable equivalent basis (dollars in thousands).\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PART IV\n(a) 1. Financial Statements\nREPORT OF MANAGEMENT\nThe Management of Victoria Bankshares, Inc. is responsible for the preparation, integrity, and objectivity of the consolidated financial statements of the Company. The financial statements and notes have been prepared by the Company in accordance with generally accepted accounting principles and, in the judgment of Management, present fairly and consistently the Company's financial position and results of operations. The financial information contained elsewhere in this annual report is consistent with that in the financial statements. The financial statements and other financial information in this annual report include amounts that are based on Management's best estimates and judgments and give due consideration to materiality.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with Management's authorization and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles.\nThe Internal Audit Division of the Company reviews, evaluates, monitors, and makes recommendations on both administrative and accounting controls, which acts as an integral, but independent, part of the system of internal controls.\nThe Company's independent accountants were engaged to perform an audit of the consolidated financial statements. This audit provides an objective outside review of Management's responsibility to report operating results and financial condition. Working with the Company's internal auditors, they review and make tests as appropriate of the data included in the financial statements.\nThe Board of Directors discharges its responsibility for the Company's financial statements through its Audit Committee, which is composed solely of outside directors. The Audit Committee meets periodically with the independent accountants, internal auditors, and Management. Both the independent accountants and internal auditors have direct access to the Audit Committee to discuss the scope and results of their work, the adequacy of internal accounting controls, and the quality of financial reporting.\nCharles R. Hrdlicka Gregory Sprawka Chairman of the Board Chief Financial Officer\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and the Board of Directors of Victoria Bankshares, Inc.\nWe have audited the accompanying consolidated balance sheets of Victoria Bankshares, Inc. (a Texas corporation) 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 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 Victoria Bankshares, Inc., 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 discussed in Note 1 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109.\nHouston, Texas Arthur Andersen LLP January 22, 1996\nCONSOLIDATED BALANCE SHEETS - ------------------------------------------------------------------------------ VICTORIA BANKSHARES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS)(NOTE 1) - ------------------------------------------------------------------------------\n________________________________________________________________________________\nThe Accompanying Notes to Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS - ------------------------------------------------------------------------------- VICTORIA BANKSHARES, INC. AND SUBSIDIARIES (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)(NOTE 1) - -------------------------------------------------------------------------------\n________________________________________________________________________________\nThe Accompanying Notes to Financial Statements are an integral part of these statements.\nSTATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------- VICTORIA BANKSHARES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS)(NOTE 1)\nThe Accompanying Notes to Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS - ------------------------------------------------------------------------------- VICTORIA BANKSHARES, INC. AND SUBSIDIARIES (IN THOUSANDS)(NOTE 1) - -------------------------------------------------------------------------------\nThe Accompanying Notes to Financial Statements are an integral part of these statements.\nNOTES TO FINANCIAL STATEMENTS VICTORIA BANKSHARES, INC. AND SUBSIDIARIES\nNOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accounting and reporting policies of Victoria Bankshares, Inc. and its subsidiaries (the Company) conform to generally accepted accounting principles; the more significant of these policies are described below.\nPrinciples of Consolidation--\nThe consolidated financial statements include the accounts of Victoria Bankshares, Inc., its subsidiary bank, and nonbanking subsidiaries consolidated in accordance with generally accepted accounting principles. All major items of income and expense are recorded on the accrual basis of accounting and all significant intercompany accounts and transactions have been eliminated.\nIn 1995, the Company recorded an acquisition accounted for as a pooling-of-interests. See Note 15. Acquisitions. All information in prior period consolidated financial statements has been restated to include this event.\nNature of Operations--\nThe Company operates 42 branch offices in 33 communities and 22 counties in south central Texas. The Company derives its sources of funds predominantly from deposits within its market area. The Company offers a full range of banking services including checking and savings accounts, business loans, personal loans, residential mortgage loans, other consumer oriented financial services, safe deposit, and night depository facilities.\nInvestment Securities--\nOn December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" Under the Statement, securities are classified in one of three categories:\n-- Held to Maturity\nThese securities are stated at cost adjusted for amortization of premium and accretion of discount on a level yield basis. Temporary changes in the market value of these investment securities are not recognized since it is Management's intention and the Company has the ability to hold these securities to maturity.\n-- Available for Sale\nThese securities are stated at market value. Unrealized gains and losses created by changes in the market values of these securities are recognized as an adjustment to stockholders' equity, net of tax. The specific historical cost method is used in determining realized gains and losses from the sale of securities.\n-- Trading Accounts\nTrading account assets are carried at market value. Realized and unrealized gains and losses on trading account assets are recognized currently in other operating income.\nProvision for Loan Losses--\nA provision for loan losses is included in expense based upon Management's evaluation of the loan portfolio under existing economic conditions. The provision for loan losses 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.\nPremises and Equipment--\nBanking premises and equipment are stated at cost, less accumulated depreciation, computed on a straight-line basis over the estimated useful lives of the related assets, ranging from one to forty years. Upon the sale or retirement of banking premises and equipment, the cost and accumulated depreciation applicable thereto are removed from the accounts and the resulting profit or loss is reflected in income. Repairs, maintenance, and minor improvements are charged to operations as incurred.\nGoodwill and Acquired Intangible Assets--\nAssets and liabilities related to business combinations accounted for as purchase transactions are recorded at their respective fair values. Acquired intangible assets include core deposit and trust relationships. The excess of purchase price over such fair values (goodwill and acquired intangible assets) totaling $39,332,000 less accumulated amortization of $7,196,000 at December 31, 1995, and $30,927,000 less accumulated amortization of $4,809,000 at December 31, 1994, is included in other assets. The core deposit intangibles acquired from Cattlemen's Financial Services, Inc. (\"Cattlemen's\") is being amortized using the sum-of-the-years' digit method over eight years. Goodwill and other acquired intangible assets are being amortized using the straight-line method over periods which range from 15 to 20 years. The amortization expense of goodwill and identifiable intangibles was $2.4 million for 1995, $1.7 million for 1994, and $1.2 million for\n1993. As of the end of each accounting period, the Company employs both quantitative and qualitative factors including current profitability, current economic conditions, and projected profitability in assessing the recoverability of goodwill.\nIncome Taxes--\nThe Company files a consolidated federal income tax return using the accrual basis of accounting. On January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes.\" As a result of this adoption, the Company recorded a deferred tax asset of $4.8 million in January 1993. Deferred taxes are provided for temporary differences in income and expense items that are recognized differently for tax purposes than for financial reporting purposes.\nNonperforming Loans--\nOn January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS 114\"), as amended by Statement of Financial Accounting Standards No. 118 \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure\" (\"SFAS 118\"). Together, these standards require that when a loan is impaired, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, the fair value of the collateral if the loan is collateral dependent or the loan's observable market price. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The adoption of this accounting standard did not have a material effect on the Company's financial position or results of operations since the Company's previous recognition and measurement policies regarding nonperforming loans were materially consistent with the accounting requirements for impaired loans.\nOther Real Estate--\nReal estate acquired in settlement of loans is carried at the lower of fair value minus estimated costs to sell or cost. This determination is made on an individual asset basis. A valuation allowance is used to record deficiencies between cost and fair values minus estimated selling costs. Increases or decreases in the valuation allowance are charged to expense. As mentioned above, the Company adopted SFAS 114 as amended by SFAS 118 effective January 1, 1995. As a result, loans classified as \"in-substance foreclosure\" were reclassified to nonperforming loans at that time.\nStatements of Cash Flows--\nFor purposes of the statements of cash flows, the Company defines cash and due from banks and interest-bearing deposits with banks as cash and cash equivalents. Investment securities classified as held to maturity sold within 90 days of the stated maturity have been treated as in-substance maturities. Also treated as in-substance maturities are the investment securities in which the Company has collected at least 85% of the principal outstanding at acquisition due either to prepayments on debt security or to scheduled payments on a debt security payable in installments over its term.\nReclassifications--\nCertain reclassifications have been made to previously reported amounts to make them consistent with current reporting.\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 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 2 - PARENT COMPANY FINANCIAL STATEMENTS\nCondensed financial information for Victoria Bankshares, Inc. (Parent Company only) was as follows:\nCONDENSED BALANCE SHEETS (IN THOUSANDS) - -------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS) - -------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nNOTE 3. RELATED PARTY TRANSACTIONS\nApproximately 39% of the Company's outstanding stock was owned and controlled by officers, directors, and principal stockholders of the Company at December 31, 1995.\nIt has been, and is, the policy of the bank subsidiary to extend credit to executive officers, directors, principal stockholders and their affiliated entities to meet their business and personal requirements on terms and conditions comparable to other loans of like quality and risk. The aggregate amounts of such loans, including indirect amounts guaranteed by such persons and entities, totaled $6,293,000 and $2,008,000 at December 31, 1995 and 1994, respectively.\nIn 1984, Victoria Bank & Trust Company, the principal subsidiary of the Company, leased a twelve-story office building under a net lease, with a lease term of 25 years, from a general\npartnership. The partners consist of individuals and three trusts related to principal stockholders of the Company. Presently, principal stockholders serve as trustees for the trusts. The lease rates are $2.5 million per annum through 1999 and $3.0 million per annum from 2000 through 2009. A portion of the building is subleased to the principal stockholders of the Company.\nNOTE 4. INVESTMENT SECURITIES\nSecurities with an approximate par value of $220,116,000 and $162,125,000 at December 31, 1995 and 1994, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law.\nThe amortized cost and market values of the investment securities held to maturity and available for sale, by type, together with unrealized gains and losses, were as follows (in thousands): - ------------------------------------------------------------------------------\nDuring 1995, the Company had proceeds from sales of investment securities available for sale of $113.4 million. There was $107.0 million in investment securities transferred from the held to maturity category to the available for sale category on December 27, 1995, as allowed by the Financial Accounting Standards Board. Also transferred from the held to maturity category to the available for sale category was approximately $10.4 million of securities acquired in 1995 subsidiary acquisitions. The securities were then subsequently sold because they did not fall within the Company's investment policy guidelines. There were no\nsignificant gains or losses recognized on the sale of these securities. The Company recorded gross realized gains of $57 thousand resulting from the disposition of two equity investments by the Company's Small Business Administration (\"SBA\") licensed subsidiary and the loss on the sales of available for sale U.S. Treasury Notes that were sold in order to improve total return. During 1994, the Company had proceeds from sales of investment securities of $48.9 million, which included gross realized losses of $796 thousand which resulted from the sale of two equity securities held by the SBA licensed subsidiary.\nThe following table shows, as of December 31, 1995, the distribution of the Company's investment securities (in thousands):\nThe information provided above is based on contractual maturity. Expected maturities will differ from actual maturities because issuers may have the right to call or prepay obligations without penalty. There was no investment concentration of a single issuer, except the United States Government and its Agencies, that exceeded 10% of equity as of December 31, 1995 and 1994.\nNOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES AND ALLOWANCE FOR FORECLOSED ASSETS\nOn January 1, 1995, the Company adopted SFAS 114 as amended by SFAS 118. These standards require that when a loan is impaired, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, on a loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company considers consumer loans with balances less than $50,000 to be smaller-balance homogeneous loans which are exempt from SFAS 114. The Company has measured the impairment related to all of its impaired loans using the fair value of the loan's collateral. The Company classifies loans as impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans which are 90 days or over past due are considered impaired loans unless they are well secured and are in the process of collection. Amounts received on impaired loans are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected. When collection of an impaired loan is considered remote, the loan is charged-off against the\nallowance for loan losses. The Company had previously measured the allowance for loan losses using methods similar to the prescribed method in SFAS No. 114. As a result, no additional provision was required by the adoption of this pronouncement.\nAt December 31, 1995, the recorded investment in loans that are considered impaired was $6.8 million. Included in this amount were $1.9 million of impaired loans for which the related allowance for loan losses was $0.9 million. Impaired loans of $4.9 million were carried at the lower of cost or fair value and as a result do not have a related allowance for loan losses. The average recorded investment in impaired loans during the twelve months ended December 31, 1995, was approximately $8.4 million.\nAt December 31, 1995 and 1994, the Company had $569 thousand and $617 thousand, respectively, of loans that resulted from troubled debt restructurings.\nAn analysis of the loans outstanding follows (in thousands):\nThe Company's loan portfolio concentrations are described in this paragraph. At December 31, 1995, the Company's loans secured primarily by real estate consisted of (i) loans for commercial and residential construction and land development (none of which are located in major Texas metropolitan areas) which constituted 2.8% of the total loan portfolio and (ii) other real estate loans (including loans for 1-4 family, multi-family, and nonfarm\/nonresidential properties) which constituted 41.1% of the total loan portfolio. The remaining loan portfolio categories and the percentage of each to the total loan portfolio at December 31, 1995, consisted of the following: loans to oil and gas producers and related service businesses, 0.2%; agricultural loans (other than loans secured by agricultural real property), 5.7%; other commercial and industrial loans, 20.4%; consumer loans, 29.6%; and all other loans (including loans to financial institutions), 0.5%.\nAn analysis of the allowance for loan losses follows (in thousands):\nAn analysis of the allowance for foreclosed assets follows (in thousands):\nForeclosed assets are comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure. In accordance with SFAS 114 as amended, loan balances and income\/expense related to loans previously classified as in-substance foreclosure, but for which the Company had not taken possession of the collateral, have been reclassified to loans for all periods presented. As of the periods presented, there were no in-substance foreclosures for which the Company had taken possession of the collateral included in foreclosed assets.\nThe balance and the effect on interest income of impaired loans for 1995, nonaccrual loans for 1994 and 1993, and restructured loans for all years are shown below. Due to the performing status in accordance with the restated terms of the troubled debt restructurings as of the adoption of SFAS 114, they are not considered impaired and, therefore, are presented separately.\nNOTE 6. PREMISES AND EQUIPMENT Premises and equipment consisted of the following (in thousands):\nNOTE 7. LEASE COMMITMENTS\nIn the normal course of business, the Company and its subsidiaries have entered into operating leases for real property and equipment. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. The aggregate future minimum lease payments by year, under noncancelable operating leases with initial or remaining terms of one year or more, at December 31, 1995, are as follows (in thousands):\nTotal net rental expense on operating leases for the years ended December 31, 1995, 1994, and 1993 was $2,369,000, $2,149,000 and $2,000,000, respectively. See Note 3.\nNOTE 8. TIME DEPOSITS\nTime certificates of deposit of $100,000 and over aggregated $126,064,000 and $99,987,000 at December 31, 1995 and 1994, respectively. Interest expense on this type of deposit amounted to $2,447,000, $3,535,000, and $3,729,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nNOTE 9. FEDERAL FUNDS PURCHASED AND SHORT-TERM BORROWINGS\nInformation with respect to federal funds purchased and short-term borrowings is as follows (in thousands):\nNOTE 10. COMMON STOCK AND RETAINED EARNINGS\nPer share information was computed using the weighted average number of shares of common stock outstanding. The weighted average number of shares was 8,274,085 for the year ended December 31, 1995, 8,244,358 for the year ended December 31, 1994, and 7,730,155 for the year ended December 31, 1993.\nPrimary earnings per share were computed using the weighted average number of shares of common stock outstanding. For the stock options (see Note 13), the amount of dilution to be included in earnings per share data is computed using the treasury stock method. The stock options did not have a material dilutive effect on the calculation of earnings per share and were, therefore, not included.\nPreferred stock dividends of $22,000, $44,000, and $43,000 for 1995, 1994, and 1993, respectively, were deducted from net income in computing primary earnings per share.\nThe amount of undistributed retained earnings of the Company's subsidiaries was approximately $81,372,000 at December 31, 1995. Dividends paid by the Company's subsidiary bank are subject to restrictions by certain regulatory agencies. The amount of retained earnings available to the Parent Company from subsidiaries for payment of dividends without prior regulatory approval was approximately $72,396,000 at December 31, 1995.\nDuring 1994, the Company's articles of incorporation were amended to increase the authorized number of shares of capital stock to 36,000,000, consisting of 1,000,000 shares of Preferred Stock and 35,000,000 shares of Common Stock, and to change the par value from $10 per share to $1 per share.\nNOTE 11. FEDERAL INCOME TAX\nThe provision for Federal income tax was as follows (in thousands):\nThe significant temporary differences between tax and financial reporting include allowances for loan losses, provisions\/write-downs of foreclosed property, accelerated depreciation and the core deposit intangible gross-up.\nThe amounts were different from the amounts computed by applying the U. S. Federal income tax statutory rate for the reasons noted below (in thousands):\nThe components of and changes in the net deferred tax asset (liability) were as follows (in thousands):\nNOTE 12. COMMITMENTS AND CONTINGENCIES\nIn the normal course of the subsidiaries' business, there are various outstanding commitments and contingent liabilities, such as\ncommitments to extend credit, which are not reflected in the accompanying financial statements. These instruments involve elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets, but are limited to their notional amounts. At December 31, 1995, the Company had outstanding standby letters of credit of $4,247,000 and commitments to extend credit were $171,917,000, of which $67,750,000 included commitments to correspondent banks for federal fund lines. The credit risks involved in these instruments are similar to those involved in extending loan facilities to customers. The Company uses the same credit policies in making commitments and conditional obligations as it does for normal balance sheet instruments. The Company also has a contingent liability with respect to the remaining balance of $5.9 million in student loans that the Company sold with recourse in 1993. The Company has provided for possible credit risk in these transactions in its allowance for loan losses and does not anticipate losses in excess of such allowance as a result of these transactions.\nThe Company is involved in various legal actions that are in various stages of litigation and investigation by the Company and its legal counsel. Some of these actions allege various \"lender liability\" claims on a variety of theories and claim substantial actual and punitive damages. After reviewing all actions pending or threatened involving the Company, Management believes that, while the resolution of any matter may have an impact on the financial results of the period in which the matter is settled, the ultimate resolution of these matters will not have a material adverse effect upon the business or consolidated financial position of the Company. However, many of these matters are in various stages of proceedings and further developments could cause Management to revise their assessment of these matters.\nNOTE 13. EMPLOYEE BENEFITS\nThe Company participates in a pension plan covering substantially all employees with one or more years of service. The benefits are based on years of service and the employee's compensation during the last five years of employment. The Company's funding policy is to contribute annually an amount to maintain the current minimum funding standard or higher. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. In 1992, the Company amended its pension plan to provide a fixed supplemental pension benefit payment to current retirees and future retirees in lieu of providing company-paid retiree health coverage. The formula provides a payment in addition to normal pension payments based on years of service and not on level of compensation. Benefits paid will have no relationship to the current or future costs of health insurance. Total pension cost was approximately $839,000, $623,000, and $808,000, respectively, for the years ended December 31, 1995, 1994, and 1993.\nThe following table sets forth the plan's funded status and amounts recognized in the Company's financial statements at December 31, 1995 and 1994 (in thousands):\nNet periodic pension cost for the years ended December 31, 1995, 1994, and 1993, included the following components (in thousands):\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.0% at December 31, 1995 and 7.50% at December 31, 1994 and 6.75% at December 31, 1993. The rate of increase in future compensation levels was 5.0% at December 31, 1995, December 31, 1994 and December 31, 1993. The expected long-term rate of return on assets was 8.5% at December 31, 1995 and 1994 and 8.0% at December 31, 1993.\nIn 1990, the Company and its subsidiaries established a nonqualified supplemental executive retirement plan for certain executive officers to restore pension benefits to a pre-1986 Tax Reform Act level. The cost related to the plan was approximately $200,000 for 1995, $140,000 for 1994, and $49,000 for 1993.\nThe Company and its subsidiaries have a contributory, trusteed 401(k) plan and a noncontributory profit-sharing plan covering substantially all employees with one or more years of service. The\nrate of employer contribution is 25% of the employee contribution up to 5% of eligible salaries, with additional incentive contributions based on earnings of the Company. Contributions to these plans by the Company during the three years ended December 31, 1995, 1994 and 1993 were $1,766,000, $1,868,000, and $2,050,000, respectively.\nIn addition to providing retirement benefits, the Company and its subsidiaries provide access to health care and life insurance benefits for retired employees. Substantially all of the Company's employees may become eligible to purchase health care benefits if they reach normal retirement age while working for the Company; life insurance coverage ceases at the age of 65. Those and similar benefits for active employees are provided through a self-insured fund which has reinsured individual and aggregate stop-loss amounts. Annual premium amounts are based on the claims experience of the plan and costs of reinsurance. The premiums for the three years ended December 31, 1995, 1994 and 1993, were $2,647,000, $1,740,000, and $2,095,000, respectively.\nThe Company maintains a 1991 Stock Option Plan, pursuant to which a total of 300,000 shares of the Company's common stock has been reserved for issuance. The option price is 100% of the fair market value of the Company's common stock on the date of grant. The Plan is administered by a Stock Option Committee comprised of nonparticipating outside directors of the Company. The following table shows the history of the plan:\nNOTE 14. 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, SHORT-TERM INVESTMENTS, AND SHORT-TERM BORROWINGS\nFor those short-term instruments, the carrying amount is a reasonable estimate of fair value.\nINVESTMENT SECURITIES HELD TO MATURITY, INVESTMENT SECURITIES AVAILABLE FOR SALE, AND TRADING ACCOUNT ASSETS\nFor all types of securities, 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 market prices for similar securities.\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.\nDEPOSITS\nThe fair value of demand deposits and interest-bearing transactional accounts is the carrying amount payable at the reporting date. The fair value of fixed-maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.\nLONG-TERM DEBT\nThe long-term debt of the Company is at a fixed rate. The fair value is estimated by the current redemption value of this debt.\nCOMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT, AND FINANCIAL GUARANTEES WRITTEN\nThe fair value of commitments is estimated using fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. Included in the commitment to extend credit are $67.8 million and $76.0 million at December 31, 1995 and December 31, 1994, respectively, of variable rate federal fund lines for which no fees are assessed as all are secured by U. S. Treasury securities. 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.\nThe estimated fair values of the Company's financial instruments are as follows (in thousands):\nNOTE 15. ACQUISITIONS\nOn June 30, 1995, United Bancshares, Inc. (\"United\"), parent company of Rosenberg Bank & Trust (\"Rosenberg\"), merged with and into the Company. The merger was consummated through the exchange of 306,383 shares of the Company's common stock for all of the outstanding shares of common stock of United. This transaction increased consolidated assets by approximately $65 million and increased consolidated deposits by approximately $61 million. The acquisition was accounted for as a pooling-of-interests. The Company's prior period consolidated financial statements have been restated to include the accounts of United. All intercompany accounts have been eliminated.\nOn August 25, 1995, the Company acquired Cattlemen's Financial Services, Inc. (\"Cattlemen's\"). The transaction was accounted for as a purchase. The Company acquired approximately $100 million in assets and assumed $93 million in liabilities, paying a premium of $6.7 million over the book value of the net assets. The principal subsidiary of Cattlemen's Financial Services, Inc., was Cattlemen's State Bank.\nNOTE 16. PENDING MERGER\nA special meeting of the shareholders of the Company will be held on April 2, 1996, to consider and vote upon a proposal to approve the Agreement and Plan of Merger dated November 12, 1995, between the Company and Norwest. The Plan of Merger has been\napproved by the boards of both companies and is pending regulatory approval. Norwest will issue 1.05 shares of Norwest common stock in exchange for each share of the Company's common stock. The exchange will be accounted for by Norwest as a pooling-of-interests.\nNOTE 17. SUMMARY OF QUARTERLY FINANCIAL RESULTS (UNAUDITED)\nConsolidated operating results for the Company for each quarter of 1995 and 1994 are summarized as follows (in thousands except per share amounts):\n- ------------------------------------------------------------------------------- QUOTATIONS AND CASH DIVIDENDS ON CAPITAL STOCK (Not covered by Report of Independent Public Accountants)\nThe common stock, symbol VICT, of Victoria Bankshares, Inc. is traded in the over-the-counter market and is quoted in the National Market System (NMS) of NASDAQ, the nationwide network of the National Association of Securities Dealers Automated Quotations System. As of December 31, 1995, there were 2,983 holders of record of common stock.\nThe following table shows the range of high and low prices per share of common stock of the Company in the over-the-counter market, as reported by NASDAQ.\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\nDIRECTORS\nThe names of the directors, their present offices with the Company, the principal occupation or employment of each, the year each director first became a director of the Company or of the Bank, if earlier, and the number and percentage of shares of Common Stock of the Company beneficially owned by each director at March 15, 1996, are set forth below. Beneficial ownership of Common Stock is direct and the named director has sole voting and investment power with respect to the shares reflected as owned by him unless otherwise specified.\n_______________ * Less than 1%.\n(1) Messrs. Dennis O'Connor, Tom O'Connor, Jr., Braman, Hewitt and Gilster have various interests in a number of closely held partnerships, joint ventures and corporations engaged in either cattle-raising or oil and gas operations in which the O'Connor-Braman family interests are involved.\n(2) Includes 106,949 shares owned by one trust for the benefit of Mr. Braman's child, of which Mr. Braman is trustee and with respect to which he exercises sole voting and investment power. Mr. Braman disclaims beneficial ownership of all such shares.\n(3) Includes (i) 144 shares held by Mr. Hewitt as custodian for Mr. James N. Stofer's child, as to which Mr. Hewitt exercises sole voting and investment power, and (ii) 1,456 shares owned by Mr. Hewitt's wife. Mr. Hewitt disclaims beneficial ownership of all such shares.\n(4) Includes 290 shares owned by Mr. Dentler's wife, as to which he disclaims beneficial ownership.\n(5) Includes 230,327 shares owned by two trusts for the benefit of Mr. Gilster's two sisters, of which Mr. Gilster is co-trustee and with respect to which he exercises shared voting and investment power. Mr. Gilster disclaims beneficial ownership of these shares.\nEach of the above-named directors has been engaged in the principal occupation or employment indicated above for more than the past five years. All directors have served continuously for more than five years, except for Mr. Gilster, who was elected a director during 1994, and Mr. Smith, who was elected in 1995.\nDennis O'Connor and Tom O'Connor, Jr. are brothers, Mr. Braman is their nephew, Mr. Hewitt is the son of Dennis O'Connor, and Mr. Gilster is the grandson of Tom O'Connor, Jr.\nThe Board of Directors of the Company held four regular meetings and eight special meetings during the last fiscal year. During the last fiscal year each of the incumbent directors of the Company, except for Dennis O'Connor and Tom O'Connor, Jr., attended at least seventy-five percent of the total number of Board meetings and the total number of meetings held by the committees of the Board on which he served.\nThe Company has an Audit Committee of the Board of Directors of which Messrs. Morrison (Chairman), Briggs and Hewitt are the members. The functions of the Audit Committee include reviewing the scope and results of the annual audit, annual FDICIA requirements, and making inquiries as to the adequacy of the Company's accounting, financial and operating controls. The Audit Committee met one time during the past fiscal year.\nThe Company has a Compensation Committee of the Board of Directors of which Messrs. Hewitt (Chairman), Briggs and Morrison are members. The Committee has the responsibility for reviewing overall compensation of the Company, including employee benefits and stock options. The Committee met three times during 1995.\nThe Company has a Nominating Committee of the Board of Directors of which Messrs. Hewitt (Chairman), Briggs and Morrison are members. The Committee met one time during 1995. The Committee is responsible for (i) considering and recommending to the shareholders directors for election as director, (ii) considering and recommending to the Board of Directors persons to fill director vacancies and newly created directorships, (iii) recruiting potential director candidates, (iv) recommending changes to the whole Board of Directors concerning the responsibilities and composition of the Board of Directors and its committees, and (v) reviewing shareholders' suggestions of directors that are submitted in accordance with the Bylaws of the Company.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe names, ages, and positions of the executive officers of the Company and its subsidiaries are set forth below.\nEach executive officer has served for more than five years as an executive officer of the Company or the Bank except for Mr. Freeman. Mr. Freeman served as Senior Vice President and Regional Manager with Bank United in Houston prior to his election as Executive Vice President - General Banking Group in 1995.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nBased solely on a review of Forms 3 and 4 and amendments thereto furnished to the Company during its most recent fiscal year and Form 5 and amendments thereto furnished to the Company with respect to its most recent fiscal year, and written representations from reporting persons that no Form 5 was required, the Company believes that all reporting was done on a timely basis, except for a Form 4 for T. Michael O'Connor, a director of the Bank, which was filed eight days late.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nCOMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION(1)\nOVERVIEW AND COMPENSATION PHILOSOPHY\nThe Compensation Committee of the Board of Directors of the Company (the \"Committee\") is composed of R. J. Hewitt (who serves as the Chairman of the Committee), R. W. Briggs, Jr. and Jack R. Morrison. All three of these members are outside directors, and each has served on the Committee since its formation in 1988.\nThis Committee Report is intended to describe in general terms the process the Committee undertakes and the matters it considers in determining the appropriate compensation for the Company's executive officers, including the executive officers that are named in the enclosed Summary Compensation Table (the \"Named Executives\"). This Report also describes these processes and considerations in more detail with respect to the 1995 compensation of Charles R. Hrdlicka, the Chairman of the Board, President, and Chief Executive Officer of the Company.\nThe Company believes that compensation of its executive officers should reflect and support the Company's strategic goals, the primary goal being the creation of long-term value for the Company's shareholders, consistent with protecting the interests of Victoria's depositors. The Committee believes that these goals are best supported by:\n* Rewarding individuals for outstanding contributions to the Company's success.\n* Compensating its executive officers competitively with the compensation of similarly situated executive officers, in order to attract and retain well-qualified executive officers.\n* More closely aligning the interest of the executive officers with those of the Company's shareholders, consistent with protecting the interests of Victoria's depositors.\n- -------------------------------\n(1) Notwithstanding filings by the Company with the Securities and Exchange Commission (\"SEC\") that have incorporated or may incorporate by reference other SEC filings in their entirety, this Compensation Committee Report on Executive Compensation shall not be incorporated by reference into such filings and shall not be deemed to be \"filed\" with the SEC except as specifically provided otherwise or to the extent required by Item 402 of Regulation S-K.\nCOMPONENTS OF EXECUTIVE OFFICER COMPENSATION\nThe Committee regularly reviews the various components of the Company's executive compensation to ensure that they are consistent with the Company's objectives, as described above. The principal elements of the compensation program for executive officers are explained below:\nBASE SALARY -- The Committee, in determining the appropriate base salaries of its executive officers, generally considers the recent performance of the Company and its long and short term outlook (taking into account general business and industry conditions, among other things), and the roles of the individual executive officers with respect to such performance and outlook. Aspects of the Company's performance that the Committee considers particularly important in setting compensation include earnings, earnings per share, expense control, regulatory compliance, operating efficiency, improved net interest margins, stock price and market share. The Committee also considers the particular executive officer's specific responsibilities, and the performance of such officer and the Company in those areas of responsibility. Also significant in the Committee's deliberations is the level of compensation paid by similarly situated financial institutions.\nDuring the third quarter of 1994, the Committee, in conjunction with the full Board of Directors, increased the base salaries of Messrs. Jones, Smith, and Sprawka. These increases were in recognition of additional responsibilities assumed by these officers as a result of a Company management reorganization related to the retirement and resignations of three executive officers during 1994.\nIn setting 1995 executive officer compensation, the Committee requested that the Chairman of the Board of the Company make recommendations to the Committee regarding the advisability and proposed amount of adjustments to the base salaries for the Company's executive officers (other than the Chairman of the Board), including the Named Executives.\nAt the Committee meeting of December 20, 1994, the Committee considered the following in recommending base salary increases for the Company's executive officers, including the Named Executives:\no The Chairman of the Board's recommendations for base salary increases.\no The Company's solid performance during 1994 with respect to virtually all of the above-mentioned criteria. The Committee recognized the effect of 1993's nonrecurring items (i.e. the change in the method of accounting for income taxes and the one-time restructuring charge) and the Company's positioning for the future.\no A study completed during 1993 by a task force of senior officers, which established job grades and compensation ranges for all positions Company-wide. A national consulting firm, Hewitt Associates (not associated with Mr. R. J. Hewitt), was engaged to assist the task force with sources of external information and lend objectivity to the process.\no Market salary survey data from the Financial Institution Compensation Survey by Watt Company for 1994.\nBONUSES -- Bonuses are based in large part on the same considerations as are applicable to base salary -- i.e., the desire to remain competitive with compensation paid by similarly situated companies, and the desire to recognize and reward, and thereby encourage, good performance by the Company and its executive officers. At its November 30, 1995 meeting, the Committee reviewed the Chairman of the Board's recommendation for 1995 bonuses and the performance of the Company during 1995. Noting the continued solid performance of the Company related to many of the above-mentioned criteria, specifically regulatory compliance, net margins, and improved net interest margins and stock price, the Committee granted bonuses to the executive officers to reflect their contribution to the success of the Company during 1995.\nSTOCK OPTION PROGRAM -- The Committee believes that the best way to more closely align the interests of the Company's executive officers with those of its shareholders is to encourage the ownership of stock in the Company by its executive officers. This objective is accomplished in part through the Company's 1991 Stock Option Plan which was approved by the Company's shareholders at the 1992 annual meeting. Pursuant to the 1991 Stock Option Plan, executive officers are eligible to receive stock options from time to time, giving them the right to purchase shares of Common Stock of the Company at a specified price in the future. The Committee determined that in light of the number of stock options granted to the Named Executives in 1993, it recommended the grant of stock options only to newly Named Executive John H. Freeman in 1995.\nOTHER ITEMS -- The Committee also is charged with determining the annual profit threshold that the Company is required to meet before the Company will contribute profit-sharing amounts to the Company's 401(k) Profit Sharing Plan. This Plan is open to participation by all employees of the Company who have been employed by the Company for at least one year, and not just to executive officers. In addition, the Committee has certain responsibilities with respect to the Company's Supplemental Executive Retirement Plan, which is designed to provide to the Company's executive officers benefits that, but for the operation of certain restrictions imposed by ERISA, they would have been entitled to receive pursuant to the Company's qualified defined benefit pension plan (as described herein). At the November 30, 1995 meeting, the Committee determined to limit covered\ncompensation under this Plan to the executive officers' 1996 base salary, effective January 1, 1996.\nDISCUSSION OF 1995 COMPENSATION FOR THE CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER\nIn determining the appropriate base salary for Mr. Hrdlicka, the Chairman, President and Chief Executive Officer of the Company, the Committee generally undertook the same process and considered the same factors as are described above with respect to executive officers generally.\nAt the February 1995 meeting a raise of $25,000 was recommended for 1995 by the Committee. Mr. Hrdlicka has led the Company effectively during a difficult period in the Texas banking industry and through the Company's restructuring. Consequently, the Committee determined it was important to compensate Mr. Hrdlicka in a manner commensurate with his performance in order to encourage his continued service to the Company.\nThe Committee awarded Mr. Hrdlicka a bonus of $35,000 at the November 1995 meeting. This bonus recognized the Company's performance during 1995 as described earlier, specifically regulatory compliance and the additional responsibilities Mr. Hrdlicka has performed since he was named President on June 24, 1994.\nMr. Hrdlicka's Total Cash Compensation (Base Salary and Bonus) in 1995 was between the 50th and 75th percentile of Total Compensation of chief executive officers of financial institutions of similar size to the Company. The Committee believes Mr. Hrdlicka's compensation package is reasonable and competitive by industry standards.\nMEMBERS OF THE COMPENSATION COMMITTEE R. J. Hewitt, Chairman R. W. Briggs, Jr. Jack R. Morrison\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nMessrs. Hewitt, Briggs and Morrison are the only persons who have served on the Compensation Committee of the Board of Directors at any time during the 1995 fiscal year. No member of the Compensation Committee was, during the 1995 fiscal year, an officer or employee of the Company or any of its subsidiaries, or was formerly an officer of the Company or any of its subsidiaries or had any relationships with the Company requiring disclosure by the Company under Item 404 of Regulation S-K, except that Mr. Morrison was formerly employed by the Bank as the head of the Trust Division. He retired from the Bank on June 1, 1984, and is currently receiving pension benefits from the Company.\nDuring the Company's 1995 fiscal year, no executive officer of the Company served as (i) a member of the Compensation Committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on the Company's Compensation Committee, (ii) a director of another entity, one of whose executive officers served on the Company's Compensation Committee, or (iii) a member of the Compensation Committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a director of the Company.\nCOMPENSATION OF EXECUTIVE OFFICERS\nA summary of the compensation of the Named Executives is provided as follows:\nSUMMARY COMPENSATION TABLE\n(1) These amounts represent the cost of group life insurance coverage in excess of $50,000 and club dues. In addition, these amounts include the non-business portion of car allowance paid in 1995 which was $5,197, $7,077, $5,527, $8,181, $7,485 and $6,981 for Messrs. Hrdlicka, Jones, Freeman, Duke, Sprawka and Smith, respectively. Also, these amounts include $16,228 and $360 paid to Mr. Hrdlicka and Mr. Jones, respectively, pursuant to the decision by the Company to pay highly compensated executive officers in cash their portion of the Company's 40l(k) Profit Sharing contributions which could not be deferred because of restrictions imposed by the Employee Retirement Income Security Act (\"ERISA\"). Also $11,400 was paid to Mr. Freeman for relocation expenses.\n(2) Includes the Company's contribution to the 401(k) profit-sharing defined contribution plan (described below) for profits and 25% match to participants' contribution.\nThe following table shows options granted to Named Executives for fiscal year 1995 and the potential value at their expiration date (10 years), assuming annual increases of 5% and 10%, respectively.\nOPTIONS GRANTED IN LAST FISCAL YEAR\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES\n(1) Options were issued June 18, 1991 and vested on June 18, 1994. The exercise price of each of the options is $10.75. (2) Options were issued November 24, 1993 and vest on November 24, 1996. The exercise price of each of the options is $26.75. (3) See \"Options Granted in Last Fiscal Year.\"\n401(k) PROFIT SHARING DEFINED CONTRIBUTION PLAN\nFor many years the Company maintained a profit sharing plan in which substantially all of the employees of the Company and its subsidiaries were eligible to participate upon completion of one year of employment. The Company adopted a Section 401(k) defined contribution plan effective January 1, 1987, for the benefit of employees of the Company and its subsidiaries who elect to participate. Effective January 1, 1990, the profit sharing and 401(k) plans were merged into a single plan and will be referred to as the \"401(k) profit sharing plan\" or the \"plan\".\nThe plan provides for the making of contributions by the Company from its current and accumulated earnings in such amount as is determined by the Company. Such Company contributions are allocated to participating employees on the basis of covered compensation. Generally, covered compensation is all compensation paid to an employee for services rendered, including overtime and 401(k) salary reductions but excluding bonuses and commissions. During 1994, the plan was amended to include all compensation, including bonuses and commissions, for non-highly-compensated employees as defined by the Internal Revenue Service up to the current dollar threshold established by the Internal Revenue Service. The 1995 limit was $66,000.\nEmployees may elect to (i) reduce their covered compensation by an amount equal to from one percent to fifteen percent thereof, and (ii) have the Company contribute such amount to the plan as salary deferral contributions on behalf of the employee. The Company provides supplemental contributions to the plan on behalf of the participant equal to a maximum of 25% of the first 5% of the salary deferral contributions made on his behalf, such percentage to be determined annually by the Board.\nA participant's right to salary deferral contributions made on his behalf is fully vested at all times. Employee contributions which were made to the profit sharing plan in prior years became vested immediately upon contribution. Employer contributions vest in annual increments of 20%, beginning upon the completion of three years of active service, or if earlier, upon death, retirement, attainment of age 65 or disability. Generally, amounts may not be withdrawn from the plan by a participant until death, total disability, termination of employment or retirement. The plan was amended in 1995 to provide for vesting of all participants upon change of control.\nPENSION PLAN\nFor many years, the Company and its participating subsidiaries have maintained a qualified defined benefit pension plan in which all regular employees participate. The full expense of the pension plan is borne by the Company and its subsidiaries. The aggregate contribution which the Company and its subsidiaries elected to\ncontribute to the pension plan for 1994 was 5.0% of the covered compensation of plan participants. Covered compensation is the compensation of plan participants for the prior fiscal year, including base salary, overtime, and salary reductions contributed to the 401(k) plan, but excluding bonuses and commissions. During 1994, the plan was amended to include all compensation, including bonuses and commissions for non-highly-compensated employees as defined by the Internal Revenue Service up to the current dollar threshold established by the Internal Revenue Service. The 1995 limit was $66,000.\nBenefits payable under the qualified pension plan become vested upon the completion of five years of accredited service or upon reaching age 62, whichever first occurs. The amount of benefit payable is based upon a participant's age, years of accredited service and compensation. Effective January 1, 1989, the plan's benefit formula was amended to comply with the Tax Reform Act of 1986 (the \"1986 Act\"). Upon termination or retirement, a participant will be entitled to the greater of the benefit computed based upon (i) a formula based on accredited service and final average compensation and (ii) a formula based on accredited service, final average compensation as of December 31, 1988, and career average compensation on and after January 1, 1989.\nThe Company established a nonqualified deferred compensation plan for highly compensated executives. Pursuant to such plan, pension benefit shortfalls under the qualified pension plan resulting from the Internal Revenue Code Section 415 limitation on maximum annual benefits, the Section 401(a)(17) limitation on annual compensation and the Section 401(1) provisions on permitted integration are generally restored to pre-1986 Act levels. Benefit eligibility conditions and payment forms are identical to those contained in the qualified pension plan. The plan was amended effective January 1, 1994 to provide for a pension benefit equal to 2% of the latest annual salary up to a maximum of 20 years of service. This is reduced by the benefits received from the qualified pension plan. Additionally, upon change in control the plan terminates all participants will be vested in their accrued plan benefits, and the plan will be liquidated. The amount set aside for the plan for the year 1995 was $200,000 for all participants in the plan (22 persons including the executive officers of the Company). Also, voluntary deferral of salary and bonuses by the participants in the plan will be allowed. The plan was amended during 1995 to terminate the deferral of salary and bonus portions of the plan.\nThe following table sets forth, on a straight life annuity basis, estimated annual retirement benefits payable in aggregate under the qualified and nonqualified pension plans to persons in specified compensation and years-of-service categories. Computation of the estimated annual pension benefit is based on the Social Security law in effect at January 1, 1994, and assumes the employee retires at age 65 (the normal retirement age under the\nplan) in 2005. As Social Security benefits increase, the amounts shown in the table will decrease.\nAs of December 31, 1995, the following executive officers had the following years of accredited service under the pension plans: Mr. Hrdlicka--9; Mr. Duke--8; Mr. Jones--5; Mr. Freeman--0; Mr. Smith--8; and Mr. Sprawka--8.\nEXECUTIVE RETENTION\/SEVERANCE AGREEMENTS\nOn September 5, 1995, the Company entered into executive retention\/severance agreements with its six executive officers including Messrs. Charles R. Hrdlicka, Chairman and Chief Executive Officer; David Jones, Executive Vice President - Trust and Investments; John H. Freeman III, Executive Vice President - General Banking; Malcolm Duke, executive Vice President - Operations and Administration; Dugan Smith, Executive Vice President - Credit Administration; and Gregory Sprawka, Executive Vice President and Chief Financial Officer - Finance and Treasury. The executive retention\/severance agreements are intended to reward the officers for continued service to the Company, including continued cooperation and effort to accommodate and facilitate a change in corporate control of the Company. In consideration for this continued cooperation and effort to accommodate a change of control, the agreements provide for the payment of a cash bonus in an amount equal to one-half the officer's base compensation and severance benefits in the event of an involuntary termination of employment other than by reason of death, disability, or for cause as such terms are defined in the executive retention\/severance agreements, or termination of employment by the officer for good cause as such term is defined in the executive retention\/severance agreements. Upon any such termination of employment, in addition to compensation benefits already earned, the officer will be entitled to receive two times the officer's annual base pay as of the Effective Time. No such payments, however, can exceed the amount deductible for income tax purposes under the Code.\nUpon a change of control, the bonuses due Messrs. Hrdlicka, Jones, Duke, Freeman, Smith, and Sprawka will be $187,500, $81,375, $77,500, $78,500, $68,600, and $68,500, respectively. If pursuant to the provisions described above, severance payments are required to be made to Messrs. Hrdlicka, Jones, Duke, Freeman, Smith, and Sprawka, the amounts of such payments will be $750,000, $325,000, $310,000, $314,000, $274,000, and $274,000, respectively.\nOTHER EMPLOYEE BENEFITS\nThe Company provides a group health insurance plan, a flexible benefit plan (Section 125 Plan) along with the normal vacation and sick pay benefits.\nTOTAL INVESTMENT RETURNS TO SHAREHOLDERS\nThe chart shown below depicts the total return to shareholders during the period beginning December 31, 1989, and ending December 31, 1995, and compares these returns against two indices. The definition of total return includes appreciation in market value of the stock as well as the actual cash dividends paid to shareholders. The comparative indices utilized are the Standard & Poor's Composite -- 500 Stock Index, which is a broad nationally recognized index of stock performance, and the NASDAQ Bank Stock Index, which includes all companies listed on NASDAQ having the industry classification of banks. The chart assumes that the value of the investment in the Company's Common Stock and in each of the two indices was $100 on December 31, 1990, and that all dividends were reinvested.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of March 22, 1996, the number of shares and percentage of Company stock beneficially owned by each of the directors of the Company are set forth on page 76. As of March 22, 1996, the number of shares and percentage of Company stock beneficially owned by each of the Named Executives and the directors and executive officers of the Company as a group are listed below.\n_______________ * Less than 1%.\nPRINCIPAL HOLDERS OF SECURITIES\nAs of March 15, 1996, the following persons were known by the Company to own beneficially more than five percent of the Company's outstanding Common Stock, the only class of voting securities outstanding:\n_______________ (1) See \"Directors\" for further information.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSome of the Company's officers and directors and members of their families are, as they have been in the past, customers of the Bank, and some of the Company's officers and directors, and\nmembers of their families, are directors, officers, or principals in entities which are, as they have been in the past, customers of the Bank. As such customers, they have had transactions in the ordinary course of business with the Bank, including borrowings, all of which were 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 a normal risk of collectibility or present any other unfavorable features to the Bank.\nThe Bank leases office space from Plaza Associates, a Texas general partnership, the owner of the twelve-story One O'Connor Plaza office building and the land on which it is located in Victoria, Texas. The principal general partners of Plaza Associates are two children of D. H. Braman, Jr., five grandchildren of Tom O'Connor, Jr. and three trusts for the benefit of two grandchildren of Tom O'Connor, Jr. and one child of D. H. Braman, Jr. D. H. Braman, Jr. and Ralph R. Gilster, III serve as trustees for certain of these trusts. See \"Directors and Executive Officers of Registrant\" and \"Principal Holders of Securities\" for information regarding the relationships of Messrs. Braman and Gilster to the Company. The Bank's lease on One O'Connor Plaza covers the entire office building. The lease commenced in 1985, is a long-term triple net lease with a primary term of 25 years and six renewal terms of five years each, exercisable at the option of the Bank, with annual rentals of $2,540,208 during the first 15 years and $2,989,580 during the next ten years and rentals for renewal terms at fair market value. The Bank has an option at the end of the primary term and each renewal term to purchase the property at its fair market value.\nApproximately 21% of the space in One O'Connor Plaza is subleased by the Bank to a partnership, of which Dennis O'Connor, Tom O'Connor, Jr. and D. H. Braman, Jr. are partners, under a sublease with a three-year term commencing in August 1, 1985 with an option for 17 additional months, and annual rentals of $770,742, subject to adjustment based upon the actual costs of operating the building.\nApproximately 3% of the space in 120 Main Place, Victoria, Texas, owned by the Bank, is leased to The Fordyce Company, of which R. W. Briggs, Jr. is Chairman, at an annual rental of $58,762, which expires in 1997.\nThe firm of Anderson, Smith, Null, Stofer & Murphree (\"ASNS&M\"), of which Munson Smith is a partner, received $236,372 for legal services rendered to the Company and its subsidiaries during the year ended December 31, 1995. ASNS&M also subleases approximately 6% of One O'Connor Plaza from the Bank. The sublease, effective February 1, 1995 and expiring January 31, 1997 with three one-year options to renew, calls for annual lease payments of $151,739, subject to adjustments based on actual cost.\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K\n(a)1. Financial Statements are provided on pages 49 through 74 herein.\n2. Financial Statement Schedules\nAll financial statement schedules have been omitted because the information is either not applicable or presented in the related financial statements.\n3. Exhibits\n2.1 - Agreement and Plan of Merger between the Company, Norwest Corporation and Norwest Sub Corporation dated November 12, 1995 (incorporated by reference to Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 [File No. 0-8037]).\n3.1 - Restated Articles 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, 1994 [File No. 0-8037]).\n**3.2 - Amended and Restated Bylaws of the Company adopted April 18, 1995.\n10.1 - Dividend Reinvestment and Stock Purchase Plan of the Company (incorporated by reference to the Prospectus included in the Registration Statement of the Company on Form S-3 filed with the Commission on September 5, 1985 [File No. 33-00091]).\n**10.2 - Lease Agreement, dated July 18, 1995, between Victoria Bank & Trust Company and the Estate of Thos. O'Connor.\n10.3 - Purchase and Sale Agreement, dated as of December 21, 1984, between Victoria Bank & Trust Company and Plaza Associates (incorporated by reference to Exhibit 10(d) to the Registration Statement of the Company on Form S-15 filed with the Commission on January 25, 1985 [File No. 2-95482]).\n10.4 - Lease Agreement, effective November 1, 1992, between Victoria Bank & Trust Company and The Fordyce Company (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 [File No. 0-8037]).\n**10.5 - Lease Agreement, dated February 1, 1995, between Victoria Bank & Trust Company and Anderson, Smith, Null, Stofer & Murphee, LLP.\n**10.6 - Amended and Restated Nonqualified Deferred Compensation Plan of the Company, effective December 19, 1995.*\n10.7 - Trust agreement by and between Victoria Bankshares, Inc., and Victoria Bank & Trust Company effective January 1, 1994 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 [File No. 0-8037]).\n10.8 - Stock Option Plan of the Company (incorporated by reference to Exhibit 20 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991 [File No. 0-8037]).*\n**10.9 - Form of Executive Retention\/Severance Agreement entered into on September 5, 1995, with Messrs. Hrdlicka, Jones, Freeman, Duke, Sprawka, and Smith.*\n**21 - List of Subsidiaries of the Company as of March 22, 1996.\n**23.1 - Consent of Independent Public Accountants - Arthur Andersen LLP.\n**27 - Financial Data Schedule\n____________________ *Management contract or compensatory plan or arrangement. **Filed herewith.\n(b) Reports on Form 8-K: None.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVICTORIA BANKSHARES, INC.\nBy: \/s\/ Gregory Sprawka ------------------------------- Gregory Sprawka Executive Vice President and Chief Financial Officer and Secretary-Treasurer\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 date indicated.\nINDEX TO EXHIBITS\n2.1 - Agreement and Plan of Merger between the Company, Norwest Corporation and Norwest Sub Corporation dated November 12, 1995 (incorporated by reference to Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 [File No. 0-8037]).\n3.1 - Restated Articles 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, 1994 [File No. 0-8037]).\n**3.2 - Amended and Restated Bylaws of the Company adopted April 18, 1995.\n10.1 - Dividend Reinvestment and Stock Purchase Plan of the Company (incorporated by reference to the Prospectus included in the Registration Statement of the Company on Form S-3 filed with the Commission on September 5, 1985 [File No. 33-00091]).\n**10.2 - Lease Agreement, dated July 18, 1995, between Victoria Bank & Trust Company and the Estate of Thos. O'Connor.\n10.3 - Purchase and Sale Agreement, dated as of December 21, 1984, between Victoria Bank & Trust Company and Plaza Associates (incorporated by reference to Exhibit 10(d) to the Registration Statement of the Company on Form S-15 filed with the Commission on January 25, 1985 [File No. 2-95482]).\n10.4 - Lease Agreement, effective November 1, 1992, between Victoria Bank & Trust Company and The Fordyce Company (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 [File No. 0-8037]).\n**10.5 - Lease Agreement, dated February 1, 1995, between Victoria Bank & Trust Company and Anderson, Smith, Null, Stofer, and Murphee, LLP.\n**10.6 - Amended and Restated Nonqualified Deferred Compensation plan of the Company effective December 19, 1995.*\n10.7 - Trust agreement by and between Victoria Bankshares, Inc., and Victoria Bank & Trust Company, effective January 1, 1994 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 [File No. 0-8037]).\n10.8 - Stock Option Plan of the Company (incorporated by reference to Exhibit 20 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991 [File No. 0-8037]).*\n**10.9 - Form of Executive Retention\/Severance Agreement entered into on September 5, 1995, with Messrs. Hrdlicka, Jones, Freeman, Duke, Sprawka, and Smith.*\n**21 - List of Subsidiaries of the Company as of March 22, 1996.\n**23.1 - Consent of Independent Public Accountants - Arthur Andersen LLP.\n**27 - Financial Data Schedule\n____________________ *Management contract or compensatory plan or arrangement. **Filed herewith.","section_15":""}
{"filename":"42888_1995.txt","cik":"42888","year":"1995","section_1":"Item 1. Business\nGeneral Information. Graco Inc. (\"Graco\" or \"the Company\") supplies technology and expertise for the management of fluids in both industrial and commercial settings. Based in Minneapolis, Minnesota, Graco serves customers around the world in the manufacturing, processing, construction and maintenance industries. It designs, manufactures and markets systems and equipment to move, measure, control, dispense and apply fluid materials. The Company helps customers solve difficult manufacturing problems, increase productivity, improve quality, conserve energy, save expensive materials, control environmental emissions and reduce labor costs. Primary uses of the Company's equipment include the application of coatings and finishes to various industrial and commercial products; the mixing, metering, dispensing and application of adhesive, sealant and chemical bonding materials; the application of paint and other materials to architectural structures; the lubrication and maintenance of vehicles and industrial machinery; and the transferring and dispensing of various fluids. Graco is the successor to Gray Company, Inc., which was incorporated in 1926 as a manufacturer of auto lubrication equipment, and became a public company in 1969.\nIt is Graco's goal to become the highest quality, lowest cost, most responsive supplier in the world for its principal products. In working to achieve these goals to become a world class manufacturer, Graco has been converting its Minneapolis manufacturing operations to focused factories organized around team-directed manufacturing cells, a process expected to be completed in 1997. Substantial investments in new manufacturing technology have reduced cycle time and improved quality.\nThe Company operates in one industry segment, namely the design, manufacture, marketing, sale and installation of systems and equipment for the management of fluids. Financial information concerning geographic operations and export sales for the last three fiscal years is set forth in Note B of the Notes to Consolidated Financial Statements.\nRecent Developments. In December, 1995, George Aristides was named Chief Executive Officer of the Company to succeed David A. Koch, who had held the position since 1962. Mr. Koch will remain as Chairman of the Board. During 1995, the Company continued the restructuring and consolidation of its operations in Europe and Japan. Management of its European operations was centralized at the Company's recently expanded facility in Maasmechelen, Belgium. In 1995, Graco implemented recommendations generated by an intensive evaluation of its marketing and sales groups worldwide. Field sales groups were restructured and investments in globally-focused marketing resources were increased. A Customer Support Team, combining customer service, technical assistance, product service and national account program management, was created in the Lubrication Equipment Division and an in-house telemarketing team was organized in the Contractor Equipment Division. The size of the Russell J. Gray Technical Center was more than doubled in 1995 to house additional testing and product development activities and personnel. During 1995, the Company's increased product development efforts resulted in the introduction of approximately 110 new products. Graco recently announced the construction of a world-class manufacturing facility and global distribution center in Rogers, Minnesota, to provide additional production capacity for projected growth. All distribution operations currently being conducted by the Company at its distribution center in Brooklyn Center, Minnesota will be transferred to the new Rogers facility, together with the engineering and manufacturing groups for the Contractor Equipment Division and final assembly operations for Industrial pumps. Manufacturing capacity met the Company's production requirements during 1995, with excess capacity in the last half of the year due to efforts to reduce inventories and the slowdown in incoming orders.\nProducts. Graco Inc. manufactures a wide array of specialized pumps, applicators, regulators, valves, meters, atomizing devices, replacement parts, and accessories, which are used in industrial and commercial applications in the movement, measurement, control, dispensing and application of many fluids and semi-solids, including paints, adhesives, sealants, and lubricants. In addition, it offers an extensive line of portable equipment which is used in construction and maintenance businesses for the application of paint and other materials. Graco fluid systems incorporate sophisticated paint circulating and fluid application technology.\nCommercial and industrial equipment offered by Graco includes specialized pumps, air and airless spray units, manual finishing equipment and fluid handling systems. A variety of pumps provide fluid pressures ranging from 20 to more than 6,000 pounds per square inch and flow rates from under 1 gallon to 140 gallons per minute. In 1995, Graco introduced a new generation of pumps, which produce higher pressures, have improved corrosion resistance and are easier to service than existing products.\nThe Company sells accessories for use with its equipment, including hoses, couplings, regulators, valves, filters, reels, meters, and gauges, as well as a complete line of spray guns, tips and applicators. These accessories increase the flexibility, efficiency\nand effectiveness of Graco equipment. Packings, seals, hoses and other parts, which must be replaced periodically in order to maintain efficiency and prevent loss of material, are also sold by the Company.\nSales of replacement parts and accessories have averaged 46.5 percent of the Company's consolidated net sales and approximately 52.3 percent of gross profits during the last three years. The following table summarizes the consolidated net sales and gross profits (net sales less cost of products sold) by the Company's principal product groups for that same period.\nProduct Group Sales and Gross Profit\nMarketing and Distribution. Graco's operations are organized to allow its full line of products and systems to be offered in each major geographic market: the Americas, Europe and Asia Pacific. The Industrial Equipment Division, the Automotive Equipment Division, the Contractor Equipment Division, and the Lubrication Equipment Division provide worldwide marketing direction and product design and application assistance to each of these geographic markets.\nGraco's equipment is sold worldwide principally through the Company's international sales subsidiaries, direct sales personnel and distributors. Manufacturers' representatives are used with some product lines. In the Americas and Europe, the Company maintains a specialized direct sales force, which handles sales of large systems and sales to certain corporate accounts.\nIn 1995, Graco's net sales in the Americas were $238,874,000 or approximately 62 percent of the Company's consolidated net sales; in Europe (including the Middle East and Africa) net sales were $82,552,000 or approximately 21 percent; and in the Asia Pacific region, net sales were $64,888,000 or approximately 17 percent.\nResearch, Product Development and Technical Services. Graco's research, development and engineering activities focus on new product design, product improvements, applied engineering and strategic technologies. A dedicated support group of application engineers and technicians also provides specialized technical assistance to customers in the design and evaluation of fluid transfer and application systems. It is one of Graco's financial goals to generate 30 percent of each year's sales from products introduced in the prior three years. To achieve this goal, Graco substantially increased its new product design and application engineering staff, and more than doubled the size of the Russell J. Gray Technical Center to provide space for engineering, testing and laboratory activities. Occupancy of the new wing of the Technical Center was completed in May 1995. Total research and development expenditures were $15,715,000, $14,591,000 and $12,382,000 for the 1995, 1994 and 1993 fiscal years, respectively.\nIntellectual Property. Graco owns a number of patents and has patent applications pending both in the United States and in foreign countries, licenses its patents to others, and is licensed under patents owned by others. In the opinion of the Company, its business is not materially dependent upon any one or more of these patents or licenses. The Company also owns a number of trademarks in the United States and foreign countries, including the registered trademarks for \"GRACO,\" several forms of a capital \"G\" and various product trademarks which are material to the business of the Company inasmuch as they identify Graco and its products to its customers.\nCompetition. Graco faces substantial competition in all of its markets. The nature and extent of this competition varies in different markets due to the diversity of the Company's products. Product quality, reliability, design, customer support and service, specialized engineering and pricing are the major competitive factors. Although no competitor duplicates all of\nGraco's products, some competitors are larger than the Company, both in terms of sales of directly competing products and in terms of total sales and financial resources. Graco believes it is one of the world's leading producers of high-quality specialized fluid management equipment and systems. It is impossible, because of the absence of reliable industry-wide figures, to determine its exact relative market position.\nEnvironmental Protection. During the fiscal year ending December 29, 1995, the amounts incurred to comply with federal, state and local legislation pertaining to environmental standards did not have a material effect upon the capital expenditures or earnings of the Company.\nEmployees. As of December 29, 1995, the Company employed approximately 1,945 persons on a full-time basis. Of this total, approximately 351 were employees based outside the United States, and 763 were hourly factory workers in the United States. Although Graco's U.S. employees are not covered by collective bargaining agreements, various national industry-wide labor agreements apply to certain employees in Europe. The Company believes it has a good relationship with its employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal operations that occupy more than 10,000 square feet are conducted in the following facilities:\nAn 80,000 square foot expansion of the Company's Russell J. Gray Technical Center in Minneapolis was completed and occupied during the first quarter of 1995. An expansion of 8,800 square feet to the Maasmechelen facility was completed in 1995 to accommodate the relocation of European headquarters operations from France to Belgium.\nThe Company's distribution operations, currently located in 123,800 square feet of space in a Minneapolis suburb under a lease which expires at the end of 1996, will be transferred to a manufacturing and global distribution center under construction in Rogers, Minnesota. The Rogers facility will have 324,000 square feet of space, including office, engineering, research and development, manufacturing, and distribution.\nA 55,000 square foot building in Farmington Hills, Michigan and a 57,000 square foot building in Wixom, Michigan were sold during the last quarter of 1995.\nThe Company leases space for subsidiary sales or liaison offices around the world, some of which have demonstration areas and\/or warehouse space.\nGraco's facilities are in satisfactory condition, suitable for their respective uses and are sufficient and adequate to meet current needs, with the recent and planned expansions.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is engaged in routine litigation incident to its business, which management believes will not have a material adverse effect upon its operations or consolidated financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo issues were submitted to a vote of security holders during the fourth quarter of 1995.\nExecutive Officers of the Company\nThe following are all the executive officers of the Company as of March 8, 1996. There are no family relationships between any of the officers named.\nDavid A. Koch, 65, is Chairman of the Board, a position he has held since 1985. Prior to January 1, 1996, he was also the Chief Executive Officer of the Company, a position he had held since 1962. He joined the Company in 1956 and held various sales and marketing positions with the Company prior to assuming the office of President in 1962. For a five month period from January to June 1993, he also held the office of President. He has served as a director of the Company since 1962.\nGeorge Aristides, 60, was elected President and Chief Executive Officer effective January 1, 1996. He became President and Chief Operating Officer in June 1993. From March 1993 to June 1993, he was Executive Vice President, Industrial\/Automotive Equipment Division, Manufacturing, Distribution and Eurafrican Operations. From 1985 until 1993, he was Vice President, Manufacturing Operations and Controller. He joined the Company in 1973 as Corporate Controller and became Vice President and Controller in 1980. He has served as a director of the Company since 1993.\nJames A. Graner, 51, was elected Vice President and Controller in February 1994. He became Treasurer in May 1993. Prior to becoming Assistant Treasurer in 1988, he held various managerial positions in the treasury, accounting and information systems departments. He joined Graco in 1974.\nClyde W. Hansen, 63, was elected Vice President, Human Resources and Quality Management Systems, in December 1993. He joined the Company in 1984 as Employee Relations Director, a position he held until his election.\nJohn L. Heller, 59, was elected Vice President, Latin America & Developing Markets, effective January 4, 1996. From July 1993 to December 1995, he was Senior Vice President and General Manager - Contractor Equipment Division. He became Vice President, Far East Operations and Latin America, in 1992. Prior to becoming Vice President, Far East Operations in 1984, he held various management and staff positions in sales and human resources. He joined the Company in 1972.\nRoger L. King, 50, was named Vice President & General Manager, European Operations, effective January 4, 1996. From July 1993 to December 1995, he was Senior Vice President and General Manager - International Operations. He became Senior Vice President and Chief Financial Officer in March 1993, and Vice President and Treasurer in 1987. Prior to becoming Vice President, Treasurer and Secretary in 1980, he held the position of Treasurer and Secretary and various treasury management positions with Graco. He joined the Company in 1970.\nDavid M. Lowe, 40, was elected to the position of Treasurer in February 1995. Prior to joining the Company, he was employed by Ecolab Inc., where he held various positions in the Treasury Department, including Manager-Corporate Finance; Director, Corporate Finance and most recently Director, Corporate Development.\nRobert M. Mattison, 48, was elected Vice President, General Counsel and Secretary, in January 1992. Prior to joining the Company, he held various legal positions with Honeywell Inc., most recently as Associate General Counsel.\nRobert A. Wagner, 45, was elected Vice President, Asia Pacific, of Graco Inc. and President, Graco K.K. effective January 1995. He became Vice President and Treasurer, Graco Inc., in February 1994. He joined the Company in December 1991, as Vice President, Corporate Development and Planning. Prior to joining the Company, he was employed by Texas Instruments for nearly five years, where he held various managerial positions, most recently as Vice President and Manager, Corporate Development.\nClayton R. Carter, 57, was appointed to the position of Vice President, Worldwide Lubrication Equipment Division, effective January 1, 1995. He became Director, Vehicle Services Division, in February 1994. He joined the Company in 1962 and has held various sales management positions, most recently in the Contractor Equipment Division.\nThomas J. Fay, 45, was appointed to the position of Vice President, Worldwide Automotive Equipment Division, effective January 4, 1996. During 1995, he was Vice President, European Operations. Prior to becoming General Manager of European Operations in March 1994, he held the position of General Manager, Region III, in Europe. Mr. Fay joined the Company in 1984 and held various sales management positions before moving to Europe in 1990.\nCharles L. Rescorla, 44, is Vice President, Manufacturing Operations, a position to which he was appointed on January 1, 1995. Prior to becoming the Director of Manufacturing in March 1994, he was the Director of Engineering, Industrial Division, a position which he assumed in 1988 when he joined the Company.\nWith the exception of Clayton R. Carter, Thomas J. Fay, and Charles L. Rescorla, the officers identified were elected by the Board of Directors on May 2, 1995, to hold office until the next annual meeting of directors or until their successors are elected and qualify. George Aristides was elected to the office of President and Chief Executive Officer on December 15, 1995, effective January 1, 1996. Additionally, John L. Heller was elected to the office of Vice President, Latin America & Developing Markets, and Roger L. King was elected to the office of Vice President & General Manager, European Operations on December 15, 1995 effective January 4, 1996. Messrs. Carter, Fay, and Rescorla were appointed to their positions by management effective January 1, 1995, January 4, 1996, and January 1, 1995, respectively.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Stockholder Matters\nGraco Common Stock. Graco common stock is traded on the New York Stock Exchange under the ticker symbol \"GGG.\" As of March 8, 1996, there were 17,434,828 shares outstanding and 1,800 common shareholders of record, with another estimated 3,000 shareholders whose stock is held by nominees or broker dealers.\nAbove information includes Lockwood Technical, Inc. (LTI) and Graco Robotics Inc. (GRI), former wholly-owned subsidiaries, sold in 1992 and 1991, respectively.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nMANAGEMENT'S REVIEW AND DISCUSSION\nThe following is Management's Review and Discussion and is not covered by the Independent Auditors' Report. All per share data has been restated for the three-for-two stock splits declared December 15, 1995 and December 17, 1993 and paid February 7, 1996 and February 2, 1994, respectively.\nGraco's net earnings of $27.7 million in 1995 are 81 percent higher than the $15.3 million earned in 1994 and are significantly higher than the $9.5 million recorded in 1993. The large increases in 1995 and 1994 primarily reflect higher global sales and enhanced profit margins. Operating costs include increased product development expenditures and restructuring charges.\nThe following table indicates the percentage relationship between income and expense items, included in the Consolidated Statements of Earnings for the three most recent fiscal years and the percentage changes in those items for such years.\nNET SALES\nIn 1995, Graco posted a year of record net sales, with a 7 percent increase over 1994 to $386 million. The 1995 increase was principally due to higher worldwide sales in all divisions except Contractor Equipment. Geographically, net sales in the Americas of $239 million in 1995 decreased by 1 percent when compared to 1994. With improving economies and strong currencies during most of the year, European sales increased 25 percent in 1995 to $82 million (a 15 percent volume increase and a 10 percent gain due to foreign currency exchange rates). Sales in Asia Pacific were up 23 percent in 1995 to $65 million (a 15 percent volume increase and an 8 percent gain due to foreign currency exchange rates). The impact of foreign currency exchange rate translations on sales was not significant in 1994 when compared to 1993.\nConsolidated backlog at December 29, 1995 was $20 million compared to $25 million at the end of 1994 and $20 million at the end of 1993.\nSales increased 7 percent in 1995 when compared to 1994 and 12 percent in 1994 compared to 1993.\nCOST OF PRODUCTS SOLD\nThe cost of products sold, as a percent of net sales, declined in 1995 to 50.9 percent from 51.7 percent in 1994. This decrease was the result of a combination of factors, including modest price increases. In 1994, cost of products sold, as a percent of net sales, declined from 52.6 percent in 1993, primarily due to manufacturing efficiencies gained from continued investment in state-of-the-art manufacturing technology and increased manufacturing volumes.\nPeriodic price increases have generally permitted the Company to recover increases in the cost of products sold. The Company's most recent U.S. price increase was effective in January of 1996, and represented an average 4 percent increase from its January 1995 price lists. The January 1995 price change was an average 2 percent increase from April 1994 prices.\nOPERATING EXPENSES\nOperating expenses in 1995 decreased 2.2 percent from 1994, due primarily to the impact of Graco's worldwide cost restructuring initiatives and reduced restructuring charges in 1995. Operating expenses in 1994 increased 8.4 percent from 1993, due primarily to continuing investment in product development and ongoing restructuring initiatives. In 1994, restructuring and workforce reduction charges accounted for over half of the increase from 1993 operating expenses.\nProduct development expenses in 1995 increased 7.7 percent over 1994 to $15.7 million. In 1994, product development costs were 17.8 percent higher than 1993. These increases reflect Graco's commitment to expanding sales through new product introductions.\nFOREIGN CURRENCY EFFECTS\nThe costs of the Company's products are generally denominated in U.S. dollars, with approximately 16 percent sourced in non-U.S. currencies. A greater proportion of sales, approximately 38 percent, is denominated in currencies other than the U.S. dollar. As a result, a weakening of the U.S. dollar increases sales more than costs and expenses, improving the Company's gross margin and operating profits. During both 1995 and 1994, the U.S. dollar was generally weaker against other major currencies.\nThe gains and losses that resulted from the translation of the financial statements for all non-U.S. subsidiaries and the gains and losses on the forward and option contracts the Company uses to hedge these exposures, are included in Other income (expense).\nIn total, the effect of the changes in foreign currency exchange rates on operating profits and the gains and losses included in Other income (expense) increased earnings before income taxes by $3.5 million in 1995 when compared to 1994, and by $2.3 million in 1994 when compared to 1993.\nOTHER INCOME (EXPENSE)\nThe Company's interest expense grew in 1995, reflecting an increase in the average levels of debt during the year and slightly higher interest rates. This increase was principally used to support the funding of Graco's working capital requirements and capital expenditures during the first half of the year. Strong cash flows from operations during the second half of the year resulted in long term debt (including the current portion thereof) declining to $12 million as compared to $32 million at the end of 1994 and $19 million at the end of 1993.\nOther income of $0.7 million, and other expense of $1 million and $0.8 million for 1995, 1994, and 1993, respectively, include, among other things, the foreign currency exchange gains and losses discussed above and a $0.9 million gain from the sale of unutilized real estate in 1995.\nINCOME TAXES\nThe Company's net effective tax rate of 36 percent in 1995 is 1 percentage point higher than the 1995 U.S. federal tax rate of 35 percent. The increase from the 35 percent effective tax rate in 1994 was due primarily to the reduced relative effect of U.S. general business tax credits. The effective tax rate of 31 percent in 1993 was less than the 1994 rate of 35 percent, principally as a result of a non-recurring tax benefit. Detailed reconciliations of the U.S. federal tax rate to the effective rates for 1995, 1994, and 1993 are discussed in Note D to the consolidated financial statements.\nEARNINGS\nIn 1995, earnings increased by 81 percent to $27.7 million, or $1.59 per share as compared to 1994, when earnings increased by 61 percent to $15.3 million or $.88 per share as compared to 1993.\nSTOCK BASED COMPENSATION\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation,\" which encourages a fair value based method of accounting for stock based compensation plans and requires adoption of disclosure provisions no later than fiscal years beginning after December 15, 1995. Graco 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 this new standard will have no effect on Graco's cash flows.\nOUTLOOK\nGraco is cautiously optimistic about improved financial performance in 1996 given softness in the North American and German economies. Graco has successfully undertaken significant restructuring efforts in recent years and anticipates implementing additional measures in 1996. These efforts have resulted in improving customer service and profit margins along with providing resources that will be used for investments in product development and capital additions.\nMargins are expected to improve slightly in 1996, subject to fluctuations in the U.S. dollar and increased sales volumes. Operating expenses as a percentage of net sales are expected to decline, even though product development expenses will increase as the Company continues to invest in its long-term strategic initiatives in product development.\nDIVIDEND ACTIONS\nPeriodically, the Company initiates measures aimed at enhancing shareholder value, broadening common stock ownership, improving the liquidity of its common shares, and effectively managing its cash balances. A summary of recent actions follows:\n- a three-for-two stock split declared in 1995; - a 13 percent increase in the regular dividend in 1995; - a 14 percent increase in the regular dividend in 1994; - a three-for-two stock split declared in 1993; - a special one-time dividend of $1.80 per post-split share declared in 1993 ($31.2 million in total); and - a 10 percent increase in the regular dividend in 1993.\nASSETS\nThe following table highlights several key measures of asset performance.\nAverage inventory balances increased during 1995 when compared to 1994; however, year-end inventory decreased 17.5 percent to $41.7 million. The year-end decline in inventories was primarily due to shipments of several large engineered systems in the last quarter and efforts to bring inventory levels in line with reduced sales volume. Accounts receivable decreased 3.2 percent to $73.2 million. The decrease was due to a combination of factors, including lower sales during the last quarter of 1995.\nLIABILITIES\nDuring 1995, total debt (notes payable plus long-term debt, including the current portion) was reduced by $27.1 million. At the end of 1995, the Company's long-term debt (including the current portion thereof) was 10 percent of capital (long-term debt plus shareholders' equity) compared to 28 percent in 1994 and 21 percent in 1993. The Company's total debt to total capital (notes payable plus long-term debt plus shareholders' equity) fell to 14 percent at the end of 1995; down from 35 percent in 1994. The Company had $67.5 million in unused credit lines available at December 29, 1995. While the Company believes that available credit lines plus operating cash flows are adequate to fund its short and long-term initiatives, additional credit lines may be arranged from time to time as deemed necessary.\nSHAREHOLDERS' EQUITY\nShareholders' equity totaled $103.6 million on December 29, 1995, $21.7 million higher than 1994, and $28.9 million higher than 1993.\nCASH FLOWS FROM OPERATING ACTIVITIES\nDuring 1995, the Company's operating cash flow of $51.7 million increased significantly over 1994 due to higher net earnings and changes in working capital requirements. Cash flow from operating activities in 1994 was $8.6 million, $14.5 million less than the $23.1 million recorded in 1993.\nCash flows from operating activities have been, and are expected to be, the principal source of funds required for future additions to property, plant and equipment, and working capital, as well as for other corporate purposes.\nCASH FLOWS FROM INVESTING ACTIVITIES\nCapital expenditures were $19.8 million in 1995, $23.1 million in 1994, and $16.2 million in 1993. These expenditures have enhanced the Company's engineering and manufacturing capabilities, improved product quality, increased capacity, and lowered costs. Substantial expenditures in 1995 included the completion of the Russell J. Gray Technical Center expansion located in Minneapolis, Minnesota and the addition of major manufacturing equipment assets.\nThe Company expects to spend approximately $35 million on capital improvements in 1996. This amount includes approximately $17 million for the construction of the new manufacturing and distribution facility in Rogers, Minnesota. The balance of capital expenditures in 1996 will be primarily for manufacturing equipment and cellular manufacturing initiatives.\nDuring 1995, the Company realized cash proceeds of $3.0 million from sales of unutilized real estate. In 1994, the Company sold its marketable securities to fund a special one-time dividend of $31.2 million paid to shareholders on March 21, 1994.\nCASH FLOWS FROM FINANCING ACTIVITIES\nThe amount of common stock issued represents the funds received for shares sold through the Company's dividend reinvestment plan, its Employee Stock Purchase Plan, and the distribution of shares pursuant to its Long Term Stock Incentive Plan, more fully described in Note F to the Consolidated Financial Statements.\nGraco offers an Automatic Dividend Reinvestment Plan, which provides shareholders with a simple and convenient way to reinvest quarterly cash dividends in additional shares of Graco common stock. Brokerage and service charges are paid by the Company.\nAll Graco employees in the U.S. participate in the Graco Employee Stock Ownership Plan. Eligible employees may also purchase Graco common stock through the Company's Employee Stock Purchase Plan.\nFrom time to time, the Company may make open market purchases of its common shares. On February 25, 1994, the Company's Board of Directors authorized management to repurchase up to 600,000 shares for a period not to exceed two years. As of December 29, 1995, under this repurchase program, the Company has repurchased 380,100 shares at an average price per share of $11.96. No shares were acquired in 1995. On February 23, 1996, the Board of Directors authorized management to repurchase up to 800,000 shares for a period ending on February 28, 1998.\nGraco is currently paying 12 cents per share as its regular quarterly dividend. Annual cash dividends paid on the Company's common and preferred stock, including a special one-time dividend of $31.2 million paid on March 21, 1994, were $7.5 million in 1995, $37.7 million in 1994, and $5.9 million in 1993. The Company expects to continue paying regular quarterly dividends to its common shareholders at amounts which will be adjusted periodically to reflect earnings performance and management expectations.\nIn 1995, the Company redeemed all of its 5 percent cumulative preferred stock for approximately $1.5 million.\nDuring 1995, debt was reduced by $27.1 million, reflecting strong cash flows from operations attributable to higher net income and lower working capital requirements.\nItem 8. Financial Statements and Supplementary Data Page - Responsibility for Financial Reporting 14 - Independent Auditors' Report 14 - Consolidated Statements of Earnings for fiscal years 1995, 1994 and 1993 15 - Consolidated Statements of Changes in ShareholdersO Equity Accounts (See Footnote F, Notes to Consolidated Financial Statements) 22 - Consolidated Balance Sheets for fiscal years 1995, 1994 and 1993 16 - Consolidated Statements of Cash Flows for fiscal years 1995, 1994 and 1993 17 - Notes to Consolidated Financial Statements 18 - Selected Quarterly Financial Data (See Part II, Item 5, Market for the Company's Common Stock and Related Stockholder Matters) 8\nResponsibility For Financial Reporting\nManagement is responsible for the accuracy, consistency, and integrity of the information presented in this annual report on Form 10-K. The consolidated financial statements and financial statement schedules have been prepared in accordance with generally accepted accounting principles and, where necessary, include estimates based upon management's informed judgment.\nIn meeting this responsibility, management believes that its internal control structure provides reasonable assurance that the Company's assets are safeguarded and transactions are executed and recorded by qualified personnel in accordance with approved procedures. Internal auditors periodically review the internal control structure. Deloitte & Touche LLP, independent certified public accountants, are retained to audit the consolidated financial statements, and express an opinion thereon. Their opinion follows.\nThe Board of Directors pursues its oversight role through its Audit Committee. The Audit Committee, composed of directors who are not employees, meets twice a year with management, internal auditors, and Deloitte & Touche LLP to review the internal control structure, accounting practices, financial reporting, and the results of auditing activities.\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Graco Inc. Minneapolis, Minnesota\nWe have audited the accompanying consolidated balance sheets of Graco Inc. and Subsidiaries (the \"Company\") as of December 29, 1995, December 30, 1994, and December 31, 1993, and the related consolidated statements of earnings and consolidated cash flows for each of the three years in the period ended December 29, 1995. Our audit also included the financial statement schedule listed in the Index at 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 the consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 Graco Inc. and Subsidiaries as of December 29, 1995, December 30, 1994, and December 31, 1993, 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. 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\nDeloitte & Touche LLP Minneapolis, Minnesota January 23, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS GRACO INC. & Subsidiaries Years Ended December 29, 1995, December 30, 1994, and December 31,\nA. Summary of Significant Accounting Policies\nFISCAL YEAR. The Company's fiscal year is 52 or 53 weeks, ending on the last Friday in December.\nBASIS OF STATEMENT PRESENTATION. The consolidated financial statements include the accounts of the parent company and its subsidiaries after elimination of all significant intercompany balances and transactions. As of December 29, 1995, all subsidiaries are 100 percent owned. Subsidiaries outside North America have been included principally on the basis of fiscal years ended November 30 to effect more timely consolidated financial reporting. The U.S. dollar was the functional currency for all foreign subsidiaries. Prior to 1995, the local currency was the functional currency for Graco K.K. (Japan), and prior to 1994 for Graco N.V. (Belgium).\nCASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES. All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents. Marketable securities include debt securities of various maturities. Realized gains and losses are computed based on the specific identified cost method. At December 31, 1993, the securities were reported at fair value, which approximated cost.\nINVENTORY VALUATION. Inventories are stated at the lower of cost or market. The last-in, first-out (LIFO) cost method is used for valuing all U.S. inventories. Inventories of foreign subsidiaries are valued using the first-in, first-out (FIFO) cost method.\nCURRENCY HEDGES. The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. Subsequently, the Company enters into forward contracts, borrowings in various currencies, or options, in order to hedge its net monetary positions. Consistent with financial reporting requirements, these hedges of net monetary positions are recorded at current market values and the gains and losses are included in Other income (expense). The Company believes it uses strong financial counterparties in these transactions and that the resulting credit risk under these hedging strategies is not significant. The notional amounts (which do not represent credit or market risk) of such contracts were (in U.S. dollars) $10,226,000, $9,086,000, and $15,258,000, at December 29, 1995, December 30, 1994, and December 31, 1993, respectively.\nPROPERTY, PLANT AND EQUIPMENT. For financial reporting purposes, plant and equipment are depreciated over their estimated useful lives, primarily by using the straight-line method as follows: Buildings and improvements 10 to 30 years Leasehold improvements 3 to 10 years Manufacturing equipment and tooling 3 to 10 years Office, warehouse and automotive equipment 4 to 10 years\nREVENUE RECOGNITION. Revenue is recognized on large contracted systems using the percentage-of-completion method of accounting. The Company recognizes revenue on other products when title passes, which is usually upon shipment.\nINCOME TAXES. The Company provides taxes on unremitted earnings of subsidiaries.\nEARNINGS PER COMMON SHARE. The Board of Directors approved three-for-two stock splits on December 15, 1995 and on December 17, 1993 effected in the form of 50 percent stock dividends payable February 7, 1996 and February 2, 1994, respectively, to shareholders of record on January 3, 1996 and January 5, 1994, respectively. All share and per share data has been restated to reflect the splits. Earnings per common share are computed on earnings reduced by dividend requirements on preferred stock and based upon the weighted average number of common shares and common equivalent shares, consisting of the dilutive effect of stock options outstanding during each year. Earnings per common share, assuming full dilution, are substantially the same.\nSTOCK BASED COMPENSATION. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation,\" which encourages a fair value based method of accounting for stock based compensation plans and requires adoption of disclosure provisions no later than fiscal years\nbeginning after December 15, 1995. The new standard encourages 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. 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 would have no effect on the Company's cash flows.\nB. INDUSTRY SEGMENT AND FOREIGN OPERATIONS\nThe Company operates in one industry segment, namely the design, manufacture, marketing, sale and installation of systems, and equipment for the management of fluids.\nThe Company's operations by geographical area for the last three years are shown below.\nNet earnings (loss) for subsidiaries operating outside the U.S. were $12,506,000, ($5,624,000), and ($2,261,000) for 1995, 1994, and 1993, respectively.\nRetained earnings for subsidiaries operating outside the U.S. were $4,373,000, $8,860,000, and $9,760,000 for 1995, 1994, and 1993, respectively.\nTransaction and translation net gains or losses, included in Other income (expense), net were $528,000, $366,000, and ($1,294,000) for 1995, 1994, and 1993, respectively.\nC. INVENTORIES\nMajor components of inventories for the last three years were as follows:\nInventories valued under the LIFO method were $23,783,000, $32,743,000, and $19,700,000 for 1995, 1994, and 1993, respectively. The balance of the inventory was valued on the FIFO method.\nIn 1995 and 1993, certain inventory quantities were reduced, resulting in liquidation of LIFO inventory quantities carried at different costs from prior years. The effect was to decrease net earnings in 1995 by approximately $100,000 and increase net earnings in 1993 by approximately $900,000.\nD. INCOME TAXES\nEarnings before income tax expense consists of:\nIncome tax expense consists of:\nIncome taxes paid were $16,019,000, $12,136,000, and $4,620,000 in 1995, 1994, and 1993, respectively.\nA reconciliation between the U.S. federal statutory tax rate and the effective tax rate is as follows:\nDeferred income taxes are provided for all temporary differences between the financial reporting and the tax basis of assets and liabilities. The deferred tax assets (liabilities) resulting from these differences are as follows:\nNet non-current deferred tax assets above are included in other assets. Total deferred tax assets were $23,040,000, $22,506,000, and $18,637,000, and total deferred tax liabilities were $8,942,000, $6,801,000, and $7,509,000 on December 29, 1995, December 30, 1994, and December 31, 1993, respectively. A valuation allowance of $5,015,000, $6,893,000, and $2,740,000 has been recorded as of December 29, 1995, December 30, 1994, and December 31, 1993, respectively, primarily related to the uncertainty of obtaining tax benefits for subsidiary operating losses, which expire beginning in 1998 in Japan and in later years for other subsidiaries. The effect of these allowances has been considered in \"Foreign earnings with (lower) higher tax rates\" in the Company's tax rate reconciliation.\nE. DEBT\nLong-term debt consists of the following:\nAggregate annual scheduled maturities of long-term debt for the next five years are as follows: 1996, $1,935,000; 1997, $1,781,000; 1998, $1,798,000; 1999, $3,433,000; 2000, $1,202,000. Interest paid on debt during 1995, 1994, and 1993\namounted to $2,179,000, $1,923,000, and $3,230,000, respectively. The fair value of the Company's long-term debt at December 29, 1995, December 30, 1994, and December 31, 1993, is not materially different than its recorded value.\nThe Company has an interest rate swap agreement in place whereby it fixed the interest rate of the remaining principal amounts of the Company's previously variable interest rate revenue bond debt at 4.65 percent through 1997, at which time the debt will revert back to a variable interest rate. The cash flows related to the swap agreement are recorded as income when received and expense when paid. Market and credit risk are not significant.\nOn December 29, 1995, the Company had lines of credit with U.S. and foreign banks of $71,697,000, including a $25,000,000 revolving credit agreement. The unused portion of these credit lines was $67,521,000 at December 29, 1995. Borrowing rates under these facilities vary with the prime rate, rates on domestic certificates of deposit, and the London interbank market. The weighted short-term borrowing rates were 2.2 percent, 5.6 percent, and 4.4 percent at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. The Company pays commitment fees of up to 3\/16 percent per annum on the daily average unused amounts on certain of these lines. No compensating balances are required.\nThe Company is in compliance with the financial covenants of its debt agreements. Under the most restrictive terms of the agreements, approximately $18,669,000 of retained earnings were available for payment of cash dividends at December 29, 1995.\nF. SHAREHOLDERS' EQUITY\nDuring 1995, the Company redeemed all 14,740 outstanding shares of cumulative preferred stock at the call price of $105 per share, plus accrued and unpaid dividends. Prior to the redemption, the holders of the cumulative preferred stock were entitled to fixed cumulative dividends of 5 percent per annum on the par value before cash dividends were paid or declared on common stock. At December 29, 1995, the Company has 22,549 authorized, but not issued, cumulative preferred shares.\nThe Company has authorized, but not issued, a separate class of 3,000,000 shares of preferred stock, $1 par value.\nThe Company has a leveraged Employee Stock Ownership Plan (ESOP) under which outstanding debt was $600,000, $900,000, and $1,200,000 at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. This is also the remaining balance of a concurrent loan to the ESOP Trust from the Company on the same terms. The Company's loan is included in long-term debt with the receivable from the ESOP in a like amount recorded as a reduction of shareholders' equity reflected in the Other, net category. The Company is obligated to make annual contributions to the ESOP Trust through 1997 sufficient to repay the loan and interest thereon.\nThe Board of Directors approved three-for-two stock splits on December 15, 1995, and on December 17, 1993, effected in the form of 50 percent stock dividends payable February 7, 1996 and February 2, 1994, respectively, to shareholders of record on January 3, 1996 and January 5, 1994, respectively. Accordingly, December 29, 1995, and December 31, 1993 balances reflect the splits with an increase in common stock and reduction in retained earnings of $5,754,000 and $3,817,000, respectively. All stock option, share, and per share data has been restated to reflect the splits.\nOn December 17, 1993, the Board of Directors approved a special one-time dividend of $1.80 per common share to be paid March 21, 1994, on post-split shares to shareholders of record on March 7, 1994. Dividends payable at December 31, 1993, reflect the special one-time dividend.\nOn May 3, 1994, the shareholders approved a Nonemployee Director Stock Plan which enables individual nonemployee directors of the Company to elect to receive all or part of a director's annual retainer in the form of shares of the Company's common stock instead of cash. For the year ended December 29, 1995, the Company has issued 485 shares under this plan. No shares were issued during 1994.\nUnder the Company's Employee Stock Purchase Plan, 3,150,000 common shares have been authorized for sale to employees, 478,219 of which remained unissued at the end of 1995. The purchase price of the shares under the plan is the lesser of 85 percent of the fair market value on the first day or the last day of the plan year.\nThe Company maintains a plan in which one preferred share purchase right (Right) exists for each common share of the Company. Each Right will entitle its holder to purchase one one- hundredth of a share of a new series of junior participating preferred stock at an exercise price of $80, subject to adjustment. The Rights are exercisable only if a person or group\nacquires beneficial ownership of 20 percent or more of the Company's outstanding common stock. The Rights expire in March 2000 and may be redeemed earlier by the Board of Directors for $.01 per Right.\nThe Company has a Long Term Stock Incentive Plan, under which a total of 2,475,000 common shares have been reserved for issuance, with 1,158,167 shares remaining reserved at December 29, 1995. Grants under this plan are in the form of restrictive share awards and stock options. Restrictive share awards of 597,609 common shares have been made to certain key employees under the plan, with 48,551 shares still restricted for disposition, such restrictions lapse in 1996 and 1997. Unearned compensation expense relating to the remaining restricted shares is $256,000 at December 29, 1995, and is included as a reduction of shareholders' equity in the Other, net category.\nStock options for 1,349,577 common shares have also been granted under the plan. The option price is the market price at the date of grant. Options become exercisable at such time and in such installments as set by the Company, and expire in five to ten years from the date of grant.\nIn 1993, the Company granted Stock Appreciation Rights (SARs) to certain key employees, utilizing a portion of the above options. Upon exercise of the SARs, the employee will surrender the unexercised related option and will receive a cash payment equal to the excess of the fair market value at the time of exercise over the price of the related option. Compensation expense related to the SARs is not significant.\nShares and options on common shares granted and exercisable, as well as the exercise price, are shown for the last three years in the table below:\nThe changes in shareholders' equity accounts are as follows:\nG. RETIREMENT BENEFITS\nThe Company has a defined contribution plan, under Section 401(k) of the Internal Revenue Code, which provides additional retirement benefits to all U.S. employees who elect to participate. Currently, the Company matches employee contributions at a 50 percent rate, up to 3 percent of the employee's compensation. Employer contributions were $852,000 in 1995, $850,000 in 1994, and $819,000 in 1993.\nThe Company has non-contributory defined benefit pension plans covering substantially all U.S. employees and directors and most of the employees of the Company's non-U.S. subsidiairies. For the U.S. plans, the benefits are based on years of service and the highest five consecutive years' earnings in the ten years preceding retirement. The Company funds these plans annually in amounts consistent with minimum funding requirements and maximum tax deduction limits and invests primarily in common stocks and bonds, including the Company's common stock. The market value of the plan's investment in the common stock of the Company was $9,188,000, $6,550,000, and $7,305,000 at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. The expenses for these plans consist of the following components:\nThe status of the Company's plans and the amounts recognized in the financial statements are:\nMajor assumptions at year-end:\nIn addition to providing pension benefits, the Company pays part of the health insurance costs for its retired U.S. employees and their dependents.\nThe cost of retiree health benefit expense for 1995, 1994 and 1993 was as follows:\nThe Company's policy is to fund these benefits on a pay-as-you-go basis. The actuarial present value of these health benefit obligations and the amounts recognized in the consolidated balance sheets were as follows:\nThe Company's retirement medical benefit plan limits the annual cost increase that will be paid by the Company. In measuring the Accumulated postretirement benefit obligation (APBO), a 6 percent maximum annual trend rate for healthcare costs was assumed for the year ended December 29, 1995. This rate is assumed to remain constant through the year 2001, decline by 1\/2 percent for each of the following three years to 4.5 percent and remain at that level thereafter. The discount rate assumption at year-end for 1995, 1994, and 1993 was 7.0 percent, 7.5 percent, and 7.5 percent, respectively. If the assumed healthcare cost trend rate changed by 1 percent, the APBO as of December 29, 1995 would change by 8.6 percent. The effect of a 1 percent change in the cost trend rate on the service and interest cost components of the net periodic postretirement benefits expense would be a change of 10.3 percent.\nH. COMMITMENTS AND CONTINGENCIES\nLEASE COMMITMENTS:\nAggregate annual rental commitments at December 29, 1995, under operating leases with noncancelable terms of more than one year, were $10,051,000, payable as follows:\nTotal rental expense was $4,722,000 for 1995, $4,103,000 for 1994, and $4,276,000 for 1993.\nCONTINGENCIES:\nIn 1993, the U.S. District Court for the Southern District of Texas awarded the Company $2,750,000 in a patent infringement judgment. A subsequent ruling has disallowed treble damages and attorneys' fees, significantly reducing the potential recovery. The Company no longer considers this event material.\nItem 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nPart III, Items 10, 11, 12 and 13, except for certain information relating to Executive Officers included in Part I, is omitted as the Company intends to file with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 29, 1995, a definitive proxy statement containing such information pursuant to Regulation 14A of the Securities Exchange Act of 1934 and such information shall be deemed to be incorporated herein by reference from the date of filing such document.\nThe Company knows of no contractual arrangements which may, at a subsequent date, result in a change in control of the Company.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements See Part II\n(2) Financial Statement Schedule Page - Schedule II - Valuation and Qualifying Accounts 28\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto.\n(3) Management Contract, Compensatory Plan or Arrangement. 30 (See Exhibit Index) Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements.\n(b) Reports on Form 8-K There were no reports on Form 8-K for the thirteen weeks ended December 29, 1995.\n(c) Exhibit Index. 30\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.\nGraco Inc.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer (Principal Executive Officer)\n\\David M. Lowe March 18, 1996 ------------------------------------- -------------- David M. Lowe Treasurer (Principal Financial Officer)\n\\James A. Graner March 18, 1996 ------------------------------------- -------------- James A. Graner Vice President and Controller (Principal Accounting Officer)\nD. A. Koch Director, Chairman of the Board G. Aristides Director, President and Chief Executive Officer R. O. Baukol Director J. R. Lee Director R. D. McFarland Director L. R. Mitau Director M. A.M. Morfitt Director D. R. Olseth Director C. M. Osborne Director G. C. Planchon Director W. G. Van Dyke Director\nGeorge Aristides, by signing his name hereto, does hereby sign this document on behalf of himself and each of the above named directors of the Registrant pursuant to powers of attorney duly executed by such persons.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides (For himself and as attorney-in-fact)\nExhibit Index\nExhibit Number Description\n3.1 Restated Articles of Incorporation. See also Exhibit 4.3.\n3.2 Restated Bylaws. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated January 12, 1988.)\n3.3 Bylaws Amendment. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 1, 1990.)\n4.1 Credit Agreement dated October 1, 1990, between the Company and First Bank National Association. (Incorporated by reference to Exhibit 5 to the Company's Report on Form 10-Q for the thirty-nine weeks ended September 28, 1990.)\n4.2 Amendment 1 dated June 12, 1992, to Credit Agreement dated October 1, 1990, between the Company and First Bank National Association; and Amendment 2 dated December 31, 1992, to the same Agreement. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 11, 1993.) Amendment 3 dated November 8, 1993, and Amendment 4, dated February 8, 1994. (Incorporated by reference to Exhibit 4.2 to the Company's 1993 Annual Report on Form 10-K.) Amendment 5, dated April 10, 1995.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Company and its subsidiaries are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries. The Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request.\n4.3 Rights Agreement dated as of March 9, 1990, between the Company and Norwest Bank Minnesota, National Association, as Rights Agent, including as Exhibit A the form of the Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Shares. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 19, 1990.)\n*10.1 1995 Corporate and Business Unit Annual Bonus Plan. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 30, 1995.)\n*10.2 Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.3 Executive Deferred Compensation Agreement. Form of supplementary agreement entered into by the Company which provides a retirement benefit to executive officers, as amended by Amendment 1, effective September 1, 1990. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.4 Chairman's Award Plan. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.5 Executive Long Term Incentive Agreements. Form of restricted stock award agreement used for awards to executive officers. (Incorporated by reference to Attachment B to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.) Form of restricted stock award agreement used for awards to Chairman. (Incorporated by reference to Attachment A to Item 5 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 28, 1991.)\n*10.6 Executive Long Term Incentive Agreement. Form of agreement used for restricted stock awards to two new officers. (Incorporated by reference to Attachment B to Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.7 Executive Long Term Incentive Agreement. Form of agreement used for one year restricted stock award to one officer. (Incorporated by reference to Exhibit 2 to Company's Report on Form 10-Q for the twenty-six weeks ended June 25, 1993.)\n*10.8 Long Term Stock Incentive Plan (Incorporated by reference to Attachment C to the Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.9 Retirement Plan for Non-Employee Directors. (Incorporated by reference to Attachment C to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.)\n*10.10 Deferred Compensation Plan for Non- Employee Directors. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.11 Restoration Plan, restating Excess Benefit Plan, effective as of July 1, 1988. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 10-Q for the thirteen weeks ended March 26, 1993.)\n*10.12 Stock Option Agreement. Form of agreement used for incentive stock option\/alternative stock appreciation right award to selected officers, dated February 25, 1993. (Incorporated by reference to Exhibit 10.14 to the Company's 1993 Annual Report on Form 10-K.)\n*10.13 Stock Option Agreement. Form of agreement used for non-incentive stock option\/alternative stock appreciation right award to selected officers, dated May 4, 1993. (Incorporated by reference to Exhibit 10.15 to the Company's 1993 Annual Report on Form 10-K.)\n*10.14 Nonemployee Director Stock Plan (Incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.15 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated May 2, 1994. (Incorporated by reference to Exhibit 10.3 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.16 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to selected officers, dated December 15, 1994, December 27, 1994 and February 23, 1995. (Incorporated by reference to Exhibit 10.16 to the Company's 1994 Annual Report on Form 10-K.)\n*10.17 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1995. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the thirteen weeks ended March 31, 1995.)\n*10.18 Stock Option Agreement. Form of agreement used for award of non-incentive stock option to one executive officer, dated December 15, 1995.\n*10.19 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1996.\n*10.20 Salary protection arrangement with one executive officer.\n*10.21 Form of salary protection arrangement between the Company and executive officers.\n11 Statement of Computation of Earnings per share included herein on page 33.\n21 Subsidiaries of the Registrant included herein on page 34.\n23 Independent Auditor's Consent included herein on page 34.\n24 Power of Attorney included herein on page 35.\n27 Financial Data Schedule (EDGAR filing only).\n*Management Contracts, Compensatory Plans or Arrangements.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nMANAGEMENT'S REVIEW AND DISCUSSION\nThe following is Management's Review and Discussion and is not covered by the Independent Auditors' Report. All per share data has been restated for the three-for-two stock splits declared December 15, 1995 and December 17, 1993 and paid February 7, 1996 and February 2, 1994, respectively.\nGraco's net earnings of $27.7 million in 1995 are 81 percent higher than the $15.3 million earned in 1994 and are significantly higher than the $9.5 million recorded in 1993. The large increases in 1995 and 1994 primarily reflect higher global sales and enhanced profit margins. Operating costs include increased product development expenditures and restructuring charges.\nThe following table indicates the percentage relationship between income and expense items, included in the Consolidated Statements of Earnings for the three most recent fiscal years and the percentage changes in those items for such years.\nNET SALES\nIn 1995, Graco posted a year of record net sales, with a 7 percent increase over 1994 to $386 million. The 1995 increase was principally due to higher worldwide sales in all divisions except Contractor Equipment. Geographically, net sales in the Americas of $239 million in 1995 decreased by 1 percent when compared to 1994. With improving economies and strong currencies during most of the year, European sales increased 25 percent in 1995 to $82 million (a 15 percent volume increase and a 10 percent gain due to foreign currency exchange rates). Sales in Asia Pacific were up 23 percent in 1995 to $65 million (a 15 percent volume increase and an 8 percent gain due to foreign currency exchange rates). The impact of foreign currency exchange rate translations on sales was not significant in 1994 when compared to 1993.\nConsolidated backlog at December 29, 1995 was $20 million compared to $25 million at the end of 1994 and $20 million at the end of 1993.\nSales increased 7 percent in 1995 when compared to 1994 and 12 percent in 1994 compared to 1993.\nCOST OF PRODUCTS SOLD\nThe cost of products sold, as a percent of net sales, declined in 1995 to 50.9 percent from 51.7 percent in 1994. This decrease was the result of a combination of factors, including modest price increases. In 1994, cost of products sold, as a percent of net sales, declined from 52.6 percent in 1993, primarily due to manufacturing efficiencies gained from continued investment in state-of-the-art manufacturing technology and increased manufacturing volumes.\nPeriodic price increases have generally permitted the Company to recover increases in the cost of products sold. The Company's most recent U.S. price increase was effective in January of 1996, and represented an average 4 percent increase from its January 1995 price lists. The January 1995 price change was an average 2 percent increase from April 1994 prices.\nOPERATING EXPENSES\nOperating expenses in 1995 decreased 2.2 percent from 1994, due primarily to the impact of Graco's worldwide cost restructuring initiatives and reduced restructuring charges in 1995. Operating expenses in 1994 increased 8.4 percent from 1993, due primarily to continuing investment in product development and ongoing restructuring initiatives. In 1994, restructuring and workforce reduction charges accounted for over half of the increase from 1993 operating expenses.\nProduct development expenses in 1995 increased 7.7 percent over 1994 to $15.7 million. In 1994, product development costs were 17.8 percent higher than 1993. These increases reflect Graco's commitment to expanding sales through new product introductions.\nFOREIGN CURRENCY EFFECTS\nThe costs of the Company's products are generally denominated in U.S. dollars, with approximately 16 percent sourced in non-U.S. currencies. A greater proportion of sales, approximately 38 percent, is denominated in currencies other than the U.S. dollar. As a result, a weakening of the U.S. dollar increases sales more than costs and expenses, improving the Company's gross margin and operating profits. During both 1995 and 1994, the U.S. dollar was generally weaker against other major currencies.\nThe gains and losses that resulted from the translation of the financial statements for all non-U.S. subsidiaries and the gains and losses on the forward and option contracts the Company uses to hedge these exposures, are included in Other income (expense).\nIn total, the effect of the changes in foreign currency exchange rates on operating profits and the gains and losses included in Other income (expense) increased earnings before income taxes by $3.5 million in 1995 when compared to 1994, and by $2.3 million in 1994 when compared to 1993.\nOTHER INCOME (EXPENSE)\nThe Company's interest expense grew in 1995, reflecting an increase in the average levels of debt during the year and slightly higher interest rates. This increase was principally used to support the funding of Graco's working capital requirements and capital expenditures during the first half of the year. Strong cash flows from operations during the second half of the year resulted in long term debt (including the current portion thereof) declining to $12 million as compared to $32 million at the end of 1994 and $19 million at the end of 1993.\nOther income of $0.7 million, and other expense of $1 million and $0.8 million for 1995, 1994, and 1993, respectively, include, among other things, the foreign currency exchange gains and losses discussed above and a $0.9 million gain from the sale of unutilized real estate in 1995.\nINCOME TAXES\nThe Company's net effective tax rate of 36 percent in 1995 is 1 percentage point higher than the 1995 U.S. federal tax rate of 35 percent. The increase from the 35 percent effective tax rate in 1994 was due primarily to the reduced relative effect of U.S. general business tax credits. The effective tax rate of 31 percent in 1993 was less than the 1994 rate of 35 percent, principally as a result of a non-recurring tax benefit. Detailed reconciliations of the U.S. federal tax rate to the effective rates for 1995, 1994, and 1993 are discussed in Note D to the consolidated financial statements.\nEARNINGS\nIn 1995, earnings increased by 81 percent to $27.7 million, or $1.59 per share as compared to 1994, when earnings increased by 61 percent to $15.3 million or $.88 per share as compared to 1993.\nSTOCK BASED COMPENSATION\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation,\" which encourages a fair value based method of accounting for stock based compensation plans and requires adoption of disclosure provisions no later than fiscal years beginning after December 15, 1995. Graco 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 this new standard will have no effect on Graco's cash flows.\nOUTLOOK\nGraco is cautiously optimistic about improved financial performance in 1996 given softness in the North American and German economies. Graco has successfully undertaken significant restructuring efforts in recent years and anticipates implementing additional measures in 1996. These efforts have resulted in improving customer service and profit margins along with providing resources that will be used for investments in product development and capital additions.\nMargins are expected to improve slightly in 1996, subject to fluctuations in the U.S. dollar and increased sales volumes. Operating expenses as a percentage of net sales are expected to decline, even though product development expenses will increase as the Company continues to invest in its long-term strategic initiatives in product development.\nDIVIDEND ACTIONS\nPeriodically, the Company initiates measures aimed at enhancing shareholder value, broadening common stock ownership, improving the liquidity of its common shares, and effectively managing its cash balances. A summary of recent actions follows:\n- a three-for-two stock split declared in 1995; - a 13 percent increase in the regular dividend in 1995; - a 14 percent increase in the regular dividend in 1994; - a three-for-two stock split declared in 1993; - a special one-time dividend of $1.80 per post-split share declared in 1993 ($31.2 million in total); and - a 10 percent increase in the regular dividend in 1993.\nASSETS\nThe following table highlights several key measures of asset performance.\nAverage inventory balances increased during 1995 when compared to 1994; however, year-end inventory decreased 17.5 percent to $41.7 million. The year-end decline in inventories was primarily due to shipments of several large engineered systems in the last quarter and efforts to bring inventory levels in line with reduced sales volume. Accounts receivable decreased 3.2 percent to $73.2 million. The decrease was due to a combination of factors, including lower sales during the last quarter of 1995.\nLIABILITIES\nDuring 1995, total debt (notes payable plus long-term debt, including the current portion) was reduced by $27.1 million. At the end of 1995, the Company's long-term debt (including the current portion thereof) was 10 percent of capital (long-term debt plus shareholders' equity) compared to 28 percent in 1994 and 21 percent in 1993. The Company's total debt to total capital (notes payable plus long-term debt plus shareholders' equity) fell to 14 percent at the end of 1995; down from 35 percent in 1994. The Company had $67.5 million in unused credit lines available at December 29, 1995. While the Company believes that available credit lines plus operating cash flows are adequate to fund its short and long-term initiatives, additional credit lines may be arranged from time to time as deemed necessary.\nSHAREHOLDERS' EQUITY\nShareholders' equity totaled $103.6 million on December 29, 1995, $21.7 million higher than 1994, and $28.9 million higher than 1993.\nCASH FLOWS FROM OPERATING ACTIVITIES\nDuring 1995, the Company's operating cash flow of $51.7 million increased significantly over 1994 due to higher net earnings and changes in working capital requirements. Cash flow from operating activities in 1994 was $8.6 million, $14.5 million less than the $23.1 million recorded in 1993.\nCash flows from operating activities have been, and are expected to be, the principal source of funds required for future additions to property, plant and equipment, and working capital, as well as for other corporate purposes.\nCASH FLOWS FROM INVESTING ACTIVITIES\nCapital expenditures were $19.8 million in 1995, $23.1 million in 1994, and $16.2 million in 1993. These expenditures have enhanced the Company's engineering and manufacturing capabilities, improved product quality, increased capacity, and lowered costs. Substantial expenditures in 1995 included the completion of the Russell J. Gray Technical Center expansion located in Minneapolis, Minnesota and the addition of major manufacturing equipment assets.\nThe Company expects to spend approximately $35 million on capital improvements in 1996. This amount includes approximately $17 million for the construction of the new manufacturing and distribution facility in Rogers, Minnesota. The balance of capital expenditures in 1996 will be primarily for manufacturing equipment and cellular manufacturing initiatives.\nDuring 1995, the Company realized cash proceeds of $3.0 million from sales of unutilized real estate. In 1994, the Company sold its marketable securities to fund a special one-time dividend of $31.2 million paid to shareholders on March 21, 1994.\nCASH FLOWS FROM FINANCING ACTIVITIES\nThe amount of common stock issued represents the funds received for shares sold through the Company's dividend reinvestment plan, its Employee Stock Purchase Plan, and the distribution of shares pursuant to its Long Term Stock Incentive Plan, more fully described in Note F to the Consolidated Financial Statements.\nGraco offers an Automatic Dividend Reinvestment Plan, which provides shareholders with a simple and convenient way to reinvest quarterly cash dividends in additional shares of Graco common stock. Brokerage and service charges are paid by the Company.\nAll Graco employees in the U.S. participate in the Graco Employee Stock Ownership Plan. Eligible employees may also purchase Graco common stock through the Company's Employee Stock Purchase Plan.\nFrom time to time, the Company may make open market purchases of its common shares. On February 25, 1994, the Company's Board of Directors authorized management to repurchase up to 600,000 shares for a period not to exceed two years. As of December 29, 1995, under this repurchase program, the Company has repurchased 380,100 shares at an average price per share of $11.96. No shares were acquired in 1995. On February 23, 1996, the Board of Directors authorized management to repurchase up to 800,000 shares for a period ending on February 28, 1998.\nGraco is currently paying 12 cents per share as its regular quarterly dividend. Annual cash dividends paid on the Company's common and preferred stock, including a special one-time dividend of $31.2 million paid on March 21, 1994, were $7.5 million in 1995, $37.7 million in 1994, and $5.9 million in 1993. The Company expects to continue paying regular quarterly dividends to its common shareholders at amounts which will be adjusted periodically to reflect earnings performance and management expectations.\nIn 1995, the Company redeemed all of its 5 percent cumulative preferred stock for approximately $1.5 million.\nDuring 1995, debt was reduced by $27.1 million, reflecting strong cash flows from operations attributable to higher net income and lower working capital requirements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data Page - Responsibility for Financial Reporting 14 - Independent Auditors' Report 14 - Consolidated Statements of Earnings for fiscal years 1995, 1994 and 1993 15 - Consolidated Statements of Changes in ShareholdersO Equity Accounts (See Footnote F, Notes to Consolidated Financial Statements) 22 - Consolidated Balance Sheets for fiscal years 1995, 1994 and 1993 16 - Consolidated Statements of Cash Flows for fiscal years 1995, 1994 and 1993 17 - Notes to Consolidated Financial Statements 18 - Selected Quarterly Financial Data (See Part II, Item 5, Market for the Company's Common Stock and Related Stockholder Matters) 8\nResponsibility For Financial Reporting\nManagement is responsible for the accuracy, consistency, and integrity of the information presented in this annual report on Form 10-K. The consolidated financial statements and financial statement schedules have been prepared in accordance with generally accepted accounting principles and, where necessary, include estimates based upon management's informed judgment.\nIn meeting this responsibility, management believes that its internal control structure provides reasonable assurance that the Company's assets are safeguarded and transactions are executed and recorded by qualified personnel in accordance with approved procedures. Internal auditors periodically review the internal control structure. Deloitte & Touche LLP, independent certified public accountants, are retained to audit the consolidated financial statements, and express an opinion thereon. Their opinion follows.\nThe Board of Directors pursues its oversight role through its Audit Committee. The Audit Committee, composed of directors who are not employees, meets twice a year with management, internal auditors, and Deloitte & Touche LLP to review the internal control structure, accounting practices, financial reporting, and the results of auditing activities.\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Graco Inc. Minneapolis, Minnesota\nWe have audited the accompanying consolidated balance sheets of Graco Inc. and Subsidiaries (the \"Company\") as of December 29, 1995, December 30, 1994, and December 31, 1993, and the related consolidated statements of earnings and consolidated cash flows for each of the three years in the period ended December 29, 1995. Our audit also included the financial statement schedule listed in the Index at 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 the consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 Graco Inc. and Subsidiaries as of December 29, 1995, December 30, 1994, and December 31, 1993, 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. 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\nDeloitte & Touche LLP Minneapolis, Minnesota January 23, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS GRACO INC. & Subsidiaries Years Ended December 29, 1995, December 30, 1994, and December 31,\nA. Summary of Significant Accounting Policies\nFISCAL YEAR. The Company's fiscal year is 52 or 53 weeks, ending on the last Friday in December.\nBASIS OF STATEMENT PRESENTATION. The consolidated financial statements include the accounts of the parent company and its subsidiaries after elimination of all significant intercompany balances and transactions. As of December 29, 1995, all subsidiaries are 100 percent owned. Subsidiaries outside North America have been included principally on the basis of fiscal years ended November 30 to effect more timely consolidated financial reporting. The U.S. dollar was the functional currency for all foreign subsidiaries. Prior to 1995, the local currency was the functional currency for Graco K.K. (Japan), and prior to 1994 for Graco N.V. (Belgium).\nCASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES. All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents. Marketable securities include debt securities of various maturities. Realized gains and losses are computed based on the specific identified cost method. At December 31, 1993, the securities were reported at fair value, which approximated cost.\nINVENTORY VALUATION. Inventories are stated at the lower of cost or market. The last-in, first-out (LIFO) cost method is used for valuing all U.S. inventories. Inventories of foreign subsidiaries are valued using the first-in, first-out (FIFO) cost method.\nCURRENCY HEDGES. The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. Subsequently, the Company enters into forward contracts, borrowings in various currencies, or options, in order to hedge its net monetary positions. Consistent with financial reporting requirements, these hedges of net monetary positions are recorded at current market values and the gains and losses are included in Other income (expense). The Company believes it uses strong financial counterparties in these transactions and that the resulting credit risk under these hedging strategies is not significant. The notional amounts (which do not represent credit or market risk) of such contracts were (in U.S. dollars) $10,226,000, $9,086,000, and $15,258,000, at December 29, 1995, December 30, 1994, and December 31, 1993, respectively.\nPROPERTY, PLANT AND EQUIPMENT. For financial reporting purposes, plant and equipment are depreciated over their estimated useful lives, primarily by using the straight-line method as follows: Buildings and improvements 10 to 30 years Leasehold improvements 3 to 10 years Manufacturing equipment and tooling 3 to 10 years Office, warehouse and automotive equipment 4 to 10 years\nREVENUE RECOGNITION. Revenue is recognized on large contracted systems using the percentage-of-completion method of accounting. The Company recognizes revenue on other products when title passes, which is usually upon shipment.\nINCOME TAXES. The Company provides taxes on unremitted earnings of subsidiaries.\nEARNINGS PER COMMON SHARE. The Board of Directors approved three-for-two stock splits on December 15, 1995 and on December 17, 1993 effected in the form of 50 percent stock dividends payable February 7, 1996 and February 2, 1994, respectively, to shareholders of record on January 3, 1996 and January 5, 1994, respectively. All share and per share data has been restated to reflect the splits. Earnings per common share are computed on earnings reduced by dividend requirements on preferred stock and based upon the weighted average number of common shares and common equivalent shares, consisting of the dilutive effect of stock options outstanding during each year. Earnings per common share, assuming full dilution, are substantially the same.\nSTOCK BASED COMPENSATION. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation,\" which encourages a fair value based method of accounting for stock based compensation plans and requires adoption of disclosure provisions no later than fiscal years\nbeginning after December 15, 1995. The new standard encourages 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. 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 would have no effect on the Company's cash flows.\nB. INDUSTRY SEGMENT AND FOREIGN OPERATIONS\nThe Company operates in one industry segment, namely the design, manufacture, marketing, sale and installation of systems, and equipment for the management of fluids.\nThe Company's operations by geographical area for the last three years are shown below.\nNet earnings (loss) for subsidiaries operating outside the U.S. were $12,506,000, ($5,624,000), and ($2,261,000) for 1995, 1994, and 1993, respectively.\nRetained earnings for subsidiaries operating outside the U.S. were $4,373,000, $8,860,000, and $9,760,000 for 1995, 1994, and 1993, respectively.\nTransaction and translation net gains or losses, included in Other income (expense), net were $528,000, $366,000, and ($1,294,000) for 1995, 1994, and 1993, respectively.\nC. INVENTORIES\nMajor components of inventories for the last three years were as follows:\nInventories valued under the LIFO method were $23,783,000, $32,743,000, and $19,700,000 for 1995, 1994, and 1993, respectively. The balance of the inventory was valued on the FIFO method.\nIn 1995 and 1993, certain inventory quantities were reduced, resulting in liquidation of LIFO inventory quantities carried at different costs from prior years. The effect was to decrease net earnings in 1995 by approximately $100,000 and increase net earnings in 1993 by approximately $900,000.\nD. INCOME TAXES\nEarnings before income tax expense consists of:\nIncome tax expense consists of:\nIncome taxes paid were $16,019,000, $12,136,000, and $4,620,000 in 1995, 1994, and 1993, respectively.\nA reconciliation between the U.S. federal statutory tax rate and the effective tax rate is as follows:\nDeferred income taxes are provided for all temporary differences between the financial reporting and the tax basis of assets and liabilities. The deferred tax assets (liabilities) resulting from these differences are as follows:\nNet non-current deferred tax assets above are included in other assets. Total deferred tax assets were $23,040,000, $22,506,000, and $18,637,000, and total deferred tax liabilities were $8,942,000, $6,801,000, and $7,509,000 on December 29, 1995, December 30, 1994, and December 31, 1993, respectively. A valuation allowance of $5,015,000, $6,893,000, and $2,740,000 has been recorded as of December 29, 1995, December 30, 1994, and December 31, 1993, respectively, primarily related to the uncertainty of obtaining tax benefits for subsidiary operating losses, which expire beginning in 1998 in Japan and in later years for other subsidiaries. The effect of these allowances has been considered in \"Foreign earnings with (lower) higher tax rates\" in the Company's tax rate reconciliation.\nE. DEBT\nLong-term debt consists of the following:\nAggregate annual scheduled maturities of long-term debt for the next five years are as follows: 1996, $1,935,000; 1997, $1,781,000; 1998, $1,798,000; 1999, $3,433,000; 2000, $1,202,000. Interest paid on debt during 1995, 1994, and 1993\namounted to $2,179,000, $1,923,000, and $3,230,000, respectively. The fair value of the Company's long-term debt at December 29, 1995, December 30, 1994, and December 31, 1993, is not materially different than its recorded value.\nThe Company has an interest rate swap agreement in place whereby it fixed the interest rate of the remaining principal amounts of the Company's previously variable interest rate revenue bond debt at 4.65 percent through 1997, at which time the debt will revert back to a variable interest rate. The cash flows related to the swap agreement are recorded as income when received and expense when paid. Market and credit risk are not significant.\nOn December 29, 1995, the Company had lines of credit with U.S. and foreign banks of $71,697,000, including a $25,000,000 revolving credit agreement. The unused portion of these credit lines was $67,521,000 at December 29, 1995. Borrowing rates under these facilities vary with the prime rate, rates on domestic certificates of deposit, and the London interbank market. The weighted short-term borrowing rates were 2.2 percent, 5.6 percent, and 4.4 percent at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. The Company pays commitment fees of up to 3\/16 percent per annum on the daily average unused amounts on certain of these lines. No compensating balances are required.\nThe Company is in compliance with the financial covenants of its debt agreements. Under the most restrictive terms of the agreements, approximately $18,669,000 of retained earnings were available for payment of cash dividends at December 29, 1995.\nF. SHAREHOLDERS' EQUITY\nDuring 1995, the Company redeemed all 14,740 outstanding shares of cumulative preferred stock at the call price of $105 per share, plus accrued and unpaid dividends. Prior to the redemption, the holders of the cumulative preferred stock were entitled to fixed cumulative dividends of 5 percent per annum on the par value before cash dividends were paid or declared on common stock. At December 29, 1995, the Company has 22,549 authorized, but not issued, cumulative preferred shares.\nThe Company has authorized, but not issued, a separate class of 3,000,000 shares of preferred stock, $1 par value.\nThe Company has a leveraged Employee Stock Ownership Plan (ESOP) under which outstanding debt was $600,000, $900,000, and $1,200,000 at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. This is also the remaining balance of a concurrent loan to the ESOP Trust from the Company on the same terms. The Company's loan is included in long-term debt with the receivable from the ESOP in a like amount recorded as a reduction of shareholders' equity reflected in the Other, net category. The Company is obligated to make annual contributions to the ESOP Trust through 1997 sufficient to repay the loan and interest thereon.\nThe Board of Directors approved three-for-two stock splits on December 15, 1995, and on December 17, 1993, effected in the form of 50 percent stock dividends payable February 7, 1996 and February 2, 1994, respectively, to shareholders of record on January 3, 1996 and January 5, 1994, respectively. Accordingly, December 29, 1995, and December 31, 1993 balances reflect the splits with an increase in common stock and reduction in retained earnings of $5,754,000 and $3,817,000, respectively. All stock option, share, and per share data has been restated to reflect the splits.\nOn December 17, 1993, the Board of Directors approved a special one-time dividend of $1.80 per common share to be paid March 21, 1994, on post-split shares to shareholders of record on March 7, 1994. Dividends payable at December 31, 1993, reflect the special one-time dividend.\nOn May 3, 1994, the shareholders approved a Nonemployee Director Stock Plan which enables individual nonemployee directors of the Company to elect to receive all or part of a director's annual retainer in the form of shares of the Company's common stock instead of cash. For the year ended December 29, 1995, the Company has issued 485 shares under this plan. No shares were issued during 1994.\nUnder the Company's Employee Stock Purchase Plan, 3,150,000 common shares have been authorized for sale to employees, 478,219 of which remained unissued at the end of 1995. The purchase price of the shares under the plan is the lesser of 85 percent of the fair market value on the first day or the last day of the plan year.\nThe Company maintains a plan in which one preferred share purchase right (Right) exists for each common share of the Company. Each Right will entitle its holder to purchase one one- hundredth of a share of a new series of junior participating preferred stock at an exercise price of $80, subject to adjustment. The Rights are exercisable only if a person or group\nacquires beneficial ownership of 20 percent or more of the Company's outstanding common stock. The Rights expire in March 2000 and may be redeemed earlier by the Board of Directors for $.01 per Right.\nThe Company has a Long Term Stock Incentive Plan, under which a total of 2,475,000 common shares have been reserved for issuance, with 1,158,167 shares remaining reserved at December 29, 1995. Grants under this plan are in the form of restrictive share awards and stock options. Restrictive share awards of 597,609 common shares have been made to certain key employees under the plan, with 48,551 shares still restricted for disposition, such restrictions lapse in 1996 and 1997. Unearned compensation expense relating to the remaining restricted shares is $256,000 at December 29, 1995, and is included as a reduction of shareholders' equity in the Other, net category.\nStock options for 1,349,577 common shares have also been granted under the plan. The option price is the market price at the date of grant. Options become exercisable at such time and in such installments as set by the Company, and expire in five to ten years from the date of grant.\nIn 1993, the Company granted Stock Appreciation Rights (SARs) to certain key employees, utilizing a portion of the above options. Upon exercise of the SARs, the employee will surrender the unexercised related option and will receive a cash payment equal to the excess of the fair market value at the time of exercise over the price of the related option. Compensation expense related to the SARs is not significant.\nShares and options on common shares granted and exercisable, as well as the exercise price, are shown for the last three years in the table below:\nThe changes in shareholders' equity accounts are as follows:\nG. RETIREMENT BENEFITS\nThe Company has a defined contribution plan, under Section 401(k) of the Internal Revenue Code, which provides additional retirement benefits to all U.S. employees who elect to participate. Currently, the Company matches employee contributions at a 50 percent rate, up to 3 percent of the employee's compensation. Employer contributions were $852,000 in 1995, $850,000 in 1994, and $819,000 in 1993.\nThe Company has non-contributory defined benefit pension plans covering substantially all U.S. employees and directors and most of the employees of the Company's non-U.S. subsidiairies. For the U.S. plans, the benefits are based on years of service and the highest five consecutive years' earnings in the ten years preceding retirement. The Company funds these plans annually in amounts consistent with minimum funding requirements and maximum tax deduction limits and invests primarily in common stocks and bonds, including the Company's common stock. The market value of the plan's investment in the common stock of the Company was $9,188,000, $6,550,000, and $7,305,000 at December 29, 1995, December 30, 1994, and December 31, 1993, respectively. The expenses for these plans consist of the following components:\nThe status of the Company's plans and the amounts recognized in the financial statements are:\nMajor assumptions at year-end:\nIn addition to providing pension benefits, the Company pays part of the health insurance costs for its retired U.S. employees and their dependents.\nThe cost of retiree health benefit expense for 1995, 1994 and 1993 was as follows:\nThe Company's policy is to fund these benefits on a pay-as-you-go basis. The actuarial present value of these health benefit obligations and the amounts recognized in the consolidated balance sheets were as follows:\nThe Company's retirement medical benefit plan limits the annual cost increase that will be paid by the Company. In measuring the Accumulated postretirement benefit obligation (APBO), a 6 percent maximum annual trend rate for healthcare costs was assumed for the year ended December 29, 1995. This rate is assumed to remain constant through the year 2001, decline by 1\/2 percent for each of the following three years to 4.5 percent and remain at that level thereafter. The discount rate assumption at year-end for 1995, 1994, and 1993 was 7.0 percent, 7.5 percent, and 7.5 percent, respectively. If the assumed healthcare cost trend rate changed by 1 percent, the APBO as of December 29, 1995 would change by 8.6 percent. The effect of a 1 percent change in the cost trend rate on the service and interest cost components of the net periodic postretirement benefits expense would be a change of 10.3 percent.\nH. COMMITMENTS AND CONTINGENCIES\nLEASE COMMITMENTS:\nAggregate annual rental commitments at December 29, 1995, under operating leases with noncancelable terms of more than one year, were $10,051,000, payable as follows:\nTotal rental expense was $4,722,000 for 1995, $4,103,000 for 1994, and $4,276,000 for 1993.\nCONTINGENCIES:\nIn 1993, the U.S. District Court for the Southern District of Texas awarded the Company $2,750,000 in a patent infringement judgment. A subsequent ruling has disallowed treble damages and attorneys' fees, significantly reducing the potential recovery. The Company no longer considers this event material.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nPart III, Items 10, 11, 12 and 13, except for certain information relating to Executive Officers included in Part I, is omitted as the Company intends to file with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 29, 1995, a definitive proxy statement containing such information pursuant to Regulation 14A of the Securities Exchange Act of 1934 and such information shall be deemed to be incorporated herein by reference from the date of filing such document.\nThe Company knows of no contractual arrangements which may, at a subsequent date, result in a change in control of the Company.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements See Part II\n(2) Financial Statement Schedule Page - Schedule II - Valuation and Qualifying Accounts 28\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto.\n(3) Management Contract, Compensatory Plan or Arrangement. 30 (See Exhibit Index) Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements.\n(b) Reports on Form 8-K There were no reports on Form 8-K for the thirteen weeks ended December 29, 1995.\n(c) Exhibit Index. 30\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.\nGraco Inc.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer (Principal Executive Officer)\n\\David M. Lowe March 18, 1996 ------------------------------------- -------------- David M. Lowe Treasurer (Principal Financial Officer)\n\\James A. Graner March 18, 1996 ------------------------------------- -------------- James A. Graner Vice President and Controller (Principal Accounting Officer)\nD. A. Koch Director, Chairman of the Board G. Aristides Director, President and Chief Executive Officer R. O. Baukol Director J. R. Lee Director R. D. McFarland Director L. R. Mitau Director M. A.M. Morfitt Director D. R. Olseth Director C. M. Osborne Director G. C. Planchon Director W. G. Van Dyke Director\nGeorge Aristides, by signing his name hereto, does hereby sign this document on behalf of himself and each of the above named directors of the Registrant pursuant to powers of attorney duly executed by such persons.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides (For himself and as attorney-in-fact)\nExhibit Index\nExhibit Number Description\n3.1 Restated Articles of Incorporation. See also Exhibit 4.3.\n3.2 Restated Bylaws. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated January 12, 1988.)\n3.3 Bylaws Amendment. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 1, 1990.)\n4.1 Credit Agreement dated October 1, 1990, between the Company and First Bank National Association. (Incorporated by reference to Exhibit 5 to the Company's Report on Form 10-Q for the thirty-nine weeks ended September 28, 1990.)\n4.2 Amendment 1 dated June 12, 1992, to Credit Agreement dated October 1, 1990, between the Company and First Bank National Association; and Amendment 2 dated December 31, 1992, to the same Agreement. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 11, 1993.) Amendment 3 dated November 8, 1993, and Amendment 4, dated February 8, 1994. (Incorporated by reference to Exhibit 4.2 to the Company's 1993 Annual Report on Form 10-K.) Amendment 5, dated April 10, 1995.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Company and its subsidiaries are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries. The Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request.\n4.3 Rights Agreement dated as of March 9, 1990, between the Company and Norwest Bank Minnesota, National Association, as Rights Agent, including as Exhibit A the form of the Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Shares. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 19, 1990.)\n*10.1 1995 Corporate and Business Unit Annual Bonus Plan. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 30, 1995.)\n*10.2 Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.3 Executive Deferred Compensation Agreement. Form of supplementary agreement entered into by the Company which provides a retirement benefit to executive officers, as amended by Amendment 1, effective September 1, 1990. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.4 Chairman's Award Plan. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.5 Executive Long Term Incentive Agreements. Form of restricted stock award agreement used for awards to executive officers. (Incorporated by reference to Attachment B to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.) Form of restricted stock award agreement used for awards to Chairman. (Incorporated by reference to Attachment A to Item 5 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 28, 1991.)\n*10.6 Executive Long Term Incentive Agreement. Form of agreement used for restricted stock awards to two new officers. (Incorporated by reference to Attachment B to Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.7 Executive Long Term Incentive Agreement. Form of agreement used for one year restricted stock award to one officer. (Incorporated by reference to Exhibit 2 to Company's Report on Form 10-Q for the twenty-six weeks ended June 25, 1993.)\n*10.8 Long Term Stock Incentive Plan (Incorporated by reference to Attachment C to the Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.9 Retirement Plan for Non-Employee Directors. (Incorporated by reference to Attachment C to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.)\n*10.10 Deferred Compensation Plan for Non- Employee Directors. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.11 Restoration Plan, restating Excess Benefit Plan, effective as of July 1, 1988. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 10-Q for the thirteen weeks ended March 26, 1993.)\n*10.12 Stock Option Agreement. Form of agreement used for incentive stock option\/alternative stock appreciation right award to selected officers, dated February 25, 1993. (Incorporated by reference to Exhibit 10.14 to the Company's 1993 Annual Report on Form 10-K.)\n*10.13 Stock Option Agreement. Form of agreement used for non-incentive stock option\/alternative stock appreciation right award to selected officers, dated May 4, 1993. (Incorporated by reference to Exhibit 10.15 to the Company's 1993 Annual Report on Form 10-K.)\n*10.14 Nonemployee Director Stock Plan (Incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.15 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated May 2, 1994. (Incorporated by reference to Exhibit 10.3 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.16 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to selected officers, dated December 15, 1994, December 27, 1994 and February 23, 1995. (Incorporated by reference to Exhibit 10.16 to the Company's 1994 Annual Report on Form 10-K.)\n*10.17 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1995. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the thirteen weeks ended March 31, 1995.)\n*10.18 Stock Option Agreement. Form of agreement used for award of non-incentive stock option to one executive officer, dated December 15, 1995.\n*10.19 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1996.\n*10.20 Salary protection arrangement with one executive officer.\n*10.21 Form of salary protection arrangement between the Company and executive officers.\n11 Statement of Computation of Earnings per share included herein on page 33.\n21 Subsidiaries of the Registrant included herein on page 34.\n23 Independent Auditor's Consent included herein on page 34.\n24 Power of Attorney included herein on page 35.\n27 Financial Data Schedule (EDGAR filing only).\n*Management Contracts, Compensatory Plans or Arrangements.","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:\n(1) Financial Statements See Part II\n(2) Financial Statement Schedule Page - Schedule II - Valuation and Qualifying Accounts 28\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto.\n(3) Management Contract, Compensatory Plan or Arrangement. 30 (See Exhibit Index) Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements.\n(b) Reports on Form 8-K There were no reports on Form 8-K for the thirteen weeks ended December 29, 1995.\n(c) Exhibit Index. 30\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.\nGraco Inc.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides President and Chief Executive Officer (Principal Executive Officer)\n\\David M. Lowe March 18, 1996 ------------------------------------- -------------- David M. Lowe Treasurer (Principal Financial Officer)\n\\James A. Graner March 18, 1996 ------------------------------------- -------------- James A. Graner Vice President and Controller (Principal Accounting Officer)\nD. A. Koch Director, Chairman of the Board G. Aristides Director, President and Chief Executive Officer R. O. Baukol Director J. R. Lee Director R. D. McFarland Director L. R. Mitau Director M. A.M. Morfitt Director D. R. Olseth Director C. M. Osborne Director G. C. Planchon Director W. G. Van Dyke Director\nGeorge Aristides, by signing his name hereto, does hereby sign this document on behalf of himself and each of the above named directors of the Registrant pursuant to powers of attorney duly executed by such persons.\n\\George Aristides March 18, 1996 ------------------------------------- -------------- George Aristides (For himself and as attorney-in-fact)\nExhibit Index\nExhibit Number Description\n3.1 Restated Articles of Incorporation. See also Exhibit 4.3.\n3.2 Restated Bylaws. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated January 12, 1988.)\n3.3 Bylaws Amendment. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 1, 1990.)\n4.1 Credit Agreement dated October 1, 1990, between the Company and First Bank National Association. (Incorporated by reference to Exhibit 5 to the Company's Report on Form 10-Q for the thirty-nine weeks ended September 28, 1990.)\n4.2 Amendment 1 dated June 12, 1992, to Credit Agreement dated October 1, 1990, between the Company and First Bank National Association; and Amendment 2 dated December 31, 1992, to the same Agreement. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 11, 1993.) Amendment 3 dated November 8, 1993, and Amendment 4, dated February 8, 1994. (Incorporated by reference to Exhibit 4.2 to the Company's 1993 Annual Report on Form 10-K.) Amendment 5, dated April 10, 1995.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Company and its subsidiaries are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries. The Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request.\n4.3 Rights Agreement dated as of March 9, 1990, between the Company and Norwest Bank Minnesota, National Association, as Rights Agent, including as Exhibit A the form of the Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Shares. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 19, 1990.)\n*10.1 1995 Corporate and Business Unit Annual Bonus Plan. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 30, 1995.)\n*10.2 Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.3 Executive Deferred Compensation Agreement. Form of supplementary agreement entered into by the Company which provides a retirement benefit to executive officers, as amended by Amendment 1, effective September 1, 1990. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 11, 1993.)\n*10.4 Chairman's Award Plan. (Incorporated by reference to Exhibit 3 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.5 Executive Long Term Incentive Agreements. Form of restricted stock award agreement used for awards to executive officers. (Incorporated by reference to Attachment B to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.) Form of restricted stock award agreement used for awards to Chairman. (Incorporated by reference to Attachment A to Item 5 to the Company's Report on Form 10-Q for the twenty-six weeks ended June 28, 1991.)\n*10.6 Executive Long Term Incentive Agreement. Form of agreement used for restricted stock awards to two new officers. (Incorporated by reference to Attachment B to Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.7 Executive Long Term Incentive Agreement. Form of agreement used for one year restricted stock award to one officer. (Incorporated by reference to Exhibit 2 to Company's Report on Form 10-Q for the twenty-six weeks ended June 25, 1993.)\n*10.8 Long Term Stock Incentive Plan (Incorporated by reference to Attachment C to the Company's Report on Form 10-Q for the thirteen weeks ended March 27, 1992.)\n*10.9 Retirement Plan for Non-Employee Directors. (Incorporated by reference to Attachment C to Item 5 to the Company's Report on Form 10-Q for the thirteen weeks ended March 29, 1991.)\n*10.10 Deferred Compensation Plan for Non- Employee Directors. (Incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated March 7, 1988.)\n*10.11 Restoration Plan, restating Excess Benefit Plan, effective as of July 1, 1988. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 10-Q for the thirteen weeks ended March 26, 1993.)\n*10.12 Stock Option Agreement. Form of agreement used for incentive stock option\/alternative stock appreciation right award to selected officers, dated February 25, 1993. (Incorporated by reference to Exhibit 10.14 to the Company's 1993 Annual Report on Form 10-K.)\n*10.13 Stock Option Agreement. Form of agreement used for non-incentive stock option\/alternative stock appreciation right award to selected officers, dated May 4, 1993. (Incorporated by reference to Exhibit 10.15 to the Company's 1993 Annual Report on Form 10-K.)\n*10.14 Nonemployee Director Stock Plan (Incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.15 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated May 2, 1994. (Incorporated by reference to Exhibit 10.3 to the Company's Report on Form 10-Q for the twenty-six weeks ended July 1, 1994.)\n*10.16 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to selected officers, dated December 15, 1994, December 27, 1994 and February 23, 1995. (Incorporated by reference to Exhibit 10.16 to the Company's 1994 Annual Report on Form 10-K.)\n*10.17 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1995. (Incorporated by reference to Exhibit 10 to the Company's Report on Form 10-Q for the thirteen weeks ended March 31, 1995.)\n*10.18 Stock Option Agreement. Form of agreement used for award of non-incentive stock option to one executive officer, dated December 15, 1995.\n*10.19 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated March 1, 1996.\n*10.20 Salary protection arrangement with one executive officer.\n*10.21 Form of salary protection arrangement between the Company and executive officers.\n11 Statement of Computation of Earnings per share included herein on page 33.\n21 Subsidiaries of the Registrant included herein on page 34.\n23 Independent Auditor's Consent included herein on page 34.\n24 Power of Attorney included herein on page 35.\n27 Financial Data Schedule (EDGAR filing only).\n*Management Contracts, Compensatory Plans or Arrangements.","section_15":""}
{"filename":"728249_1995.txt","cik":"728249","year":"1995","section_1":"ITEM 1. BUSINESS.\nINTRODUCTION\nInterphase Corporation (\"Interphase\" or the \"Company\") designs, develops, manufactures, markets and supports high performance network and mass storage products based on advanced technologies for some of today's most powerful computer systems. Interphase's network and mass storage products include high performance network adapters, and computer network operating system software drivers, Fiber Distributed Data Interface (\"FDDI\") concentrators, and mass storage controllers. The Company's network products implement high speed networking technologies such as FDDI, Asynchronous Transfer Mode (\"ATM\"), fast ethernet (both 100 VG-AnyLAN and 100 Base T), as well as the older more established ethernet (10Base T) and Token Right technologies that facilitate the high speed movement of information across computer networks. The Company's mass storage controllers are currently based on Small Computer Systems Interface (\"SCSI\") technology and in 1996 will include products based upon the emerging high speed Fibre Channel technology to facilitate the movement of data to and from mass storage devices. Fibre Channel can also be used for a high speed interconnect in clustered applications. The Company's products are designed to not only comply with the appropriate open system technical standards but also optimize the performance of the customers network and mass storage environments.\nThe Company's network adapters and mass storage controllers consist of both hardware and software. The hardware is essentially printed circuit boards which plug into the backplane of a computer and incorporate industry standard bus architectures of the most popular client\/server platforms such as VMEbus, Sbus, EISA, NIO, GIO, Micro Channel Architecture and the emerging industry standard PCI bus, as well as input-output front-ends for many performance oriented computer systems. The Company's network adapters support a variety of media including fiber optic cabling and unshielded twisted pair (\"UTP\") and shielded twisted pair (\"STP\") copper wire. The Company's software consists of drivers for the most popular client\/server operating systems such as Windows NT, Netware, HP-UX, IRIX, O\/S2, Solaris, SunO\/S, AIX and certain real-time operating systems. In addition the software may include diagnostics, station management (\"SMT\") and in certain cases off-loads the processing of the protocol stack from the server to the adapter card. The Company's FDDI concentrator products are stand-alone network devices which serve as a single point of connection for multiport local area networks as well as perform certain network traffic management tasks. The mass storage controllers provide a high-speed connection to computer peripheral devices, such as disk drives, tape drives and printers. The Company's products are used in a wide range of computer applications including graphics workstations, high performance work groups, CPU clusters, medical imaging, telephone switching, on-line transaction processing and financial services networks.\nWith respect to the client\/server computer market, the majority of the Company's products have been installed in the server (or \"host\") as opposed to the client (or \"desktop\"). This reflects the Company's historical focus on the development of high-performance, fully featured products that are targeted for the most demanding computer networks. Given the recent emergence of more powerful desktop\ncomputing environments and a growth in demand for data intensive applications, the Company believes that its strengths in certain network and mass storage technologies will create significantly more opportunities for desktop installations of its products in future years.\nThe Company believes that its success in gaining significant market share in its selected markets is dependent upon not only the development and manufacturing of high performance, high quality products but also in establishing and maintaining the appropriate distribution channels. The Company has original equipment manufacturer (\"OEM\") agreements with some of the best known companies in the computer business for its network products and mass storage controllers. The Company's customers include OEM's of computer systems and network switches, systems integrators, value added resellers (\"VAR\"), distributors and end-users. The Company believes that it must maintain an ongoing synergistic relationship with its customers and demonstrate technology leadership coupled with sophisticated manufacturing and customer support capabilities. The Company's manufacturing and development activities are certified under the ISO 9001 international quality standard. This standard, considered the most comprehensive of the ISO 9000 standards, applies to not only manufacturing quality, but design, development and support quality systems as well. Certain companies in the United States and Europe now require ISO certification of their key suppliers. The Company's headquarters and manufacturing facilities are located at its Dallas, Texas location.\nThe Company, a Texas corporation, was founded in 1977.\nPRODUCT OVERVIEW\nThe bus structure of a computer system is the pathway over which data flows among the system's components, such as the central processing units (\"CPU\"), disk or tape drives and network adapters. The bus structure of a computer coordinates the timing and routing of data, as well as defines the system architecture for components which interface with each other. The Company develops and sells products based on high performance bus architectures such as the VMEbus, SBus, EISA bus, Multibus, and the new emerging industry standard PCI bus. These bus architectures were developed by computer system manufacturers and are considered \"open systems\" since certain specifications of the architecture are published. The concept of open systems has gained significant momentum in recent years and has allowed end-users to configure a computing and network environment that incorporates desired technology, features, scalibility and support from a variety of product and service providers.\nThe CPU of a computer performs basic arithmetic, local memory access and input\/output functions for communication with peripheral equipment as well as other functions associated with data transfers within a network such as protocol processing. When commanded by the CPU, a network adapter facilitates the high- speed communication of data among computer systems over a network as well as validates data completeness and integrity. Network adapters also perform varying levels of protocol processing and network management tasks. A network protocol is the set of rules or conventions used to govern the exchange of information between networked nodes or LANs. Most computer applications require immediate access to a greater volume of data than can be stored in the computer's local memory. This necessitates external data storage capacity provided by disk or tape drives. A disk\ncontroller directs the data storage and retrieval operations of the disk drive and controls the flow of data between the CPU and disk drive. The disk controller locates and formats the data stored on the disk, performs data validity checking, data error detection and correction and informs the CPU of the status of these operations and of the controller itself. A tape controller performs the same functions as a disk controller but interfaces with a tape drive. Multifunction controllers operate like a disk controller but allow the CPU to access disk drives and tape drives simultaneously.\nIntelligent controllers designed by the Company incorporate proprietary firmware (i.e., programs developed by the Company and stored in memory on the product) and software to perform these functions simultaneously and independently from the CPU, which allows the CPU to perform other operations at the same time as network communications, data storage or retrieval occurs.\nNETWORK PRODUCTS\nOver the past several years the Company has developed a diverse line of network products targeted for the VMEbus, Sbus, MCA and EISA bus marketplace. The majority of these products are sold directly to OEMs but a substantial portion are also sold to VAR's, system integrators, distributors and large end-users. Revenues derived from network products represented approximately 61%, 58% and 53% of revenues during the years ended October 31, 1995, 1994 and 1993, respectively. List prices for these products range from approximately $650 to $25,000.\nThe Company's products included within this broad grouping can be further divided into board level controller (adapter) products and stand-alone network devices such as the fiberHUB 1600, M800, and M400 FDDI Concentrator.\nBOARD LEVEL PRODUCTS-\nFDDI PRODUCT LINE-\nFDDI is a stable, standardized, 100Mbit per second technology. Its combination of speed and stability make FDDI ideal for reliable high-performance workgroup connections. FDDI high performance adapters are often used for movement of large graphical images such as color prepress and medical imaging applications. These adapters are also used in enterprise servers for high-demand transaction processing networks in corporate systems.\nThe V\/FDDI 5211 represents a third generation FDDI network adapter from Interphase. This host based product is capable of supporting varying types of media (e.g. fiber or copper) and contains an optical bypass control. It can be used in VME64 systems and is capable of link level or on-board protocol processing. Its RISC-based architecture can be configured for either single or dual attachment to an FDDI network and is available in a 9U or 6U form factor (refers to standard form factors of the printed circuit board).\nThe V\/FDDI 4211 is a second generation FDDI network adapter for VMEbus systems. Its RISC-based architecture can be configured for either single or dual attachment and is available in a 9U form factor as well as a 6U form factor. It also contains an optical bypass switch control.\nThe S\/FDDI 4611 is a high performance FDDI network adapter for SBus systems. It contains many of the same features as the VMEbus FDDI products such as support for various media. The Solaris or SunOS software driver included with this product contains native TCP\/IP support and integrated Station Management (SMT).\nThe E\/FDDI 4811 is a high performance FDDI network adapter for EISA bus systems. It provides for full implementation of FDDI Station Management (SMT) on-board, freeing the host CPU to execute applications and upper level protocols.\nETHERNET AND TOKEN RING PRODUCT LINE-\nThe V\/Ethernet 4207 provides a connection to an ethernet network for VMEbus systems. It is a high performance protocol processor that is capable of data rate transfers of over 30 Mbytes\/second.\nThe V\/Ethernet 3207 is considered to be a cost effective controller designed for less complex local area ethernet networks.\nThe V\/Token Ring Owl Is a VMEbus controller for both 4 and 16 Mbits\/second Token Ring local area networks. It has an on-board COMMprocessor and is available in either a 6U or 9U form factor.\nFAST ETHERNET (100VG-ANYLAN AND 100BASE-T)-\n100VG-AnyLAN is a high performance ethernet LAN standard that supports all of the network design rules and topologies of the popular 10Base-T ethernet and token ring networks. Because of this, it allows organizations to leverage their existing network and cable infrastructures while upgrading to higher transmission speeds.\nInterphase is currently shipping the 4622 SBus 100VG-AnyLan adapter, which is the industry's only 100VG product for Sun platforms, as well as the 5022 PMC.\nThe 100Base-T Standard supports 100Mbps of bandwidth using the 802.3 Ethernet Media Access Control (\"MAC\") sublayer operating at 100 Mbps instead of 10Mbps. Interphase is currently in development of 100Base-T network adapter, with first product shipments expected in mid 1996.\nATM PRODUCT LINE-\nATM is the newly emerging, scalable network technology capable of providing enhanced quality of service in managing video, audio and data transmissions compared to other existing network technologies. The scalable capability of ATM allows the deployment of products with data transfer rates of 25 Mb, 51 Mb, 100 Mb, and 622 Mb, based upon the same core technology and operating\nwithin the same network. ATM will also provide enhanced network management capabilities and is expected to be suitable for many desktop and server computing environments. This developing industry standard is expected to gain wide acceptance among both network and computer system manufacturers as well as large cable system operations and telecommunications firms (by whom it was initially developed and promoted). The ATM adapter market is anticipated to grow rapidly over the next several years. These adapters can connect stations over ATM using multimode fiber, single-mode fiber, or Category 5 Unshielded Twisted Pair copper cable.\nThe 5515 PCI ATM adapter provides full duplex ATM connectivity for most PCI- compliant systems.\nThe 4615 SBus ATM adapter provides full duplex ATM connectivity for virtually all Sun Sbus platforms.\nThe 4815 EISA ATM adapter provides full duplex ATM connectivity for many EISA- compliant systems .\nThe 5215 VME ATM adapter provides full duplex ATM connectivity for SGI Onyz and Challenge systems running the IRIX operating system.\nThe 4915 GIO ATM adapter provides full duplex ATM connectivity for virtually all Silicon Graphics GIO-based platforms.\nThe 4515 PMC ATM adapter provides reliable, high performance ATM connectivity for PMC-based systems.\nSTAND ALONE NETWORK DEVISES-\nThe M1600 FDDI Concentrator provides multiport connectivity to an FDDI network. It supports up to 16 master ports and facilitates high speed FDDI networking between a variety of computing devices and across different types of FDDI media including fiber and copper. This device is \"hot swappable\" meaning that individual modules may be replaced, removed or added without interrupting the entire network. Other fault tolerance features include an external optical bypass control and an optional redundant power supply, making the M1600 well suited for demanding FDDI backbone environments.\nThe M800 FDDI Concentrator contains many of the same high performance features as the M1600 FDDI Concentrator but is designed for smaller workgroups with large data transfer requirements. It is available in a table top or rack mountable design.\nThe M400 FDDI Concentrator is a compact, fixed port concentrator ideal for small workgroup cluster. Available in either 4 or 8 port configurations, the M400 provides options for fiber or copper media connectivity and the ability to select managed or unmanaged operations.\nMASS STORAGE CONTROLLER PRODUCTS\nRevenues derived from mass storage controller products represented approximately 34%, 39% and 47% of consolidated revenues during the years ended October 31, 1995, 1994 and 1993, respectively. The Company's mass storage product line includes products that function in VMEbus, EISA bus and Multibus systems. During 1995 and 1994 the vast majority of mass storage revenues were derived from SCSI products. Presently, SCSI is the most popular mass storage technology for both desktop and server applications since it is \"device independent\" whereas many technologies prior to SCSI were not. Device independent refers to the fact that the controller can access and send data to and from a variety of peripheral devices (e.g. disk drives, tape drives or printers). List prices for these products range from approximately $285 to $5,000. Historically, the primary market for these products has been computer system OEM's.\nThe V\/SCSI-2 4220 is designed for VMEbus and VME64 systems. It complies with the industry standard SCSI-2 interface. It also contains two channels that support up to 14 SCSI-1 or SCSI-2 devices. It is capable of data rates of up to 10 MBytes\/second in the synchronous mode and 5 MBytes\/second in the asynchronous mode. This product is available in either a 6U or 9U form factor. Additionally, an optional daughter card is available which allows for a connection to an Ethernet network. The incorporation of an Ethernet daughter card with a SCSI adapter in this manner utilizes only one slot in a computer backplane.\nThe V\/SCSI 4210 is a high performance dual channel SCSI host adapter for VMEbus applications. It supports up to seven SCSI devices per channel and can be configured with one or two independent SCSI channels. By utilizing the BUSpacket Interface it can provide transfer rates of up to 5 MBytes\/second in synchronous mode and up to 1.5 MBytes\/second in the asynchronous mode. This product is available in either a 6U or 9U form factor.\nFibre Channel is the new, emerging high bandwidth architecture used for concurrent communications among computers and peripheral devices. It is 10 to 250 times faster than existing technologies, including SCSI, capable of transmitting at rates of one gigabit per second simultaneously in both directions. This kind of performance is a practical necessity when sizable files containing x-rays or MRI scans are retrieved from a storage device. Fibre Channel can also operate over distances up to 10 km. For disaster recovery purposes it is an ideal technology for backing up mission critical data to mass storage device at a secure remote location. The Company will introduce its first Fibre Channel products during 1996.\nRESEARCH AND NEW PRODUCT DEVELOPMENT\nThe markets for the Company's products are characterized by rapid technological development, evolving industry standards, frequent new product introductions and relatively short product life cycles. The Company's success is substantially dependent upon its ability to anticipate and react to these changes, maintain its technological expertise, expand and enhance its product offerings in existing technologies, and to develop in a timely manner new products in emerging technologies, such as ATM-based networking, which achieve market acceptance. The Company believes it must offer products to\nthe market which not only meet ever-increasing performance and quality standards, but also provide compatibility and interoperability with products and architectures offered by various computer and network systems vendors. The continued utility of the Company's products can be adversely affected by products or technologies developed by others.\nThe Company has been engaged in the development of new products and the refinement of its existing products since its inception. Interphase has been active in the formulation of industry standards sanctioned by groups such as the IEEE and ANSI and is a member of the ATM Forum, VME International Trade Association (VITA), Fibre Channel Association, RAID Advisory Board, PCI Bus Consortium, Fast Ethernet Alliance, SCSI Committee, the LADDIS Group, ONC\/NFS Consortium, University of New Hampshire FDDI Interoperability Lab, FC-Open (Fibre Channel) Consortium, and ANTC Consortium for FDDI interoperability testing.\nDuring 1995, the Company has applied the majority of its engineering development resources to products for the emerging ATM market. This network technology provides for the integration of voice, video and data transmission in local area networks and wide area networks, significant improvements in network manageability, and scalability of speed from 25 mega bits per second (\"Mbps\") to 51, 100, 155 and 622 Mbps. This focus has resulted in a number of accomplishments by the Company including: the introduction of over 25 ATM network interface cards during 1995, its PCI ATM adapter card being selected as one of three finalist for \"Best of Show\" at the Spring 1995 Networld\/Interop show, the announcement of the industry's lowest priced ATM card in February 1995, and the joint announcement with Bay Networks of the first complete, standards based, open ATM solution in December 1994.\nDuring fiscal 1995, the Company has continued to introduce new FDDI products, including PCI, GIO, and Sbus FDDI adapter cards and the M400 low cost four or eight port FDDI concentrator with copper or fiber connectivity and optional SNMP management. The Company also introduced the industry's first Sbus 100 VG-AnyLAN adapter and is developing the Company's first Fibre Channel mass storage controller for introduction in 1996.\nDuring the three years in the period ended October 31, 1995, the Company's research and development expenses were approximately $7,327,000, $7,862,000 and $8,772,000, respectively. The decrease in absolute spending in 1995 and 1994 is the result of certain cost reduction actions which are more fully described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of this document. At October 31, 1995, the Company had approximately 51 employees engaged in research and product development activities on a full-time basis.\nMARKETING AND CUSTOMERS\nThe Company's standard products are sold to OEM's for inclusion in scientific, industrial, medical, engineering workstations, printing, mini-supercomputer, graphics and other computer applications. These purchasers incorporate the Company's products in proprietary systems for resale to distributors, system integrators and VAR's (which add specially designed software) prior to resale to end-users. Also, the Company sells products directly to sophisticated end-users such as large corporations,\nuniversities and scientific research organizations. During the year ended October 31, 1995, sales to Pyramid Corporation accounted for $7,039,000 or 15% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenues. During the year ended October 31, 1994, two customers accounted for more than 10% of consolidated revenues, Sequent Computer and Motorola Systems, with revenues of $4,125,000 and $4,082,000, respectively, each of which equaled approximately 10% of consolidated revenues. During the year ended October 31, 1993, sales to Siemens Nixdorf Information Systems were $4,517,000 or 12% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenuers.\nIn 1989, Motorola purchased 660,000 shares of common stock of the Company at a price of $11.00 per share. In addition, Motorola received warrants to purchase an additional 660,000 shares of common stock at an exercise price of $15.40 per share. The warrants are exercisable only upon the occurrence of certain events, including (i) a change of control of the Company or (ii) Motorola's purchase of the Company's products achieving certain levels. The warrants expire in March 1996 and contain certain antidilution provisions. Sales to Motorola approximated 6%, 10% and 8% of the Company's revenues for the years ending October 31, 1995, 1994 and 1993, respectively.\nThe Company markets its products through its own sales organization and, to a lesser extent, through a network of independent sales representatives. In addition to the Company's headquarters in Dallas, Texas, the Company has sales offices located in or near Santa Clara, California; Boston, Massachusetts; Portland, Oregon; Phoenix, Arizona; Minneapolis, Minnesota; Nashua, New Hampshire; Tokyo, Japan; and London, England. The Company's sales personnel market products directly to key customers as well as support the sales representative network. During 1995, the Company has been successful in establishing new alliances with key computer and network switch OEM's for its ATM products, including Bay Networks, UB Networks, NEC, Agile Networks, and Hewlett Packard. In addition, the Company has entered into distribution agreements with key national and international distribution partners, including Anixter, Fuji-Xerox, Gates\/Arrow and Westcon.\nInterphase emphasizes its extensive product support, training and field support to its customers. The Company's products are generally sold with a one year warranty covering components and labor. After the expiration of the warranty period, support services are generally provided by the Company for a stated flat fee.\nEuropean sales in fiscal 1995, 1994 and 1993 accounted for approximately $3,818,000 or 8% of consolidated revenues, $6,277,000 or 16% of total revenues and $9,801,000 or 25% of total revenues, respectively. The Company believes these declines are attributable to certain product development and marketing strategies taken by the Company's European customer base which resulted in fewer business opportunities for the Company as well as the persistent and continuing general economic weakness in many European economies. In addition certain of the Company's U.S. customers purchase and integrate products in the U.S., then sell directly into the European markets and have been increasing market share in Europe during these time frames. In the latter part of fiscal 1995 the Company reorganized its European operations with the anticipation that European sourced revenues will begin to reverse the recent downward trend during 1996.\nThe Company and its customers generally enter into written agreements specifying, among other items standard in commercial agreements, product specifications, failure rates, shipping requirements, shipment rescheduling terms, price\/volume schedules and manufacturer warranties. Substantially all of these agreements do not contain determinable purchase commitments of the customers, providing instead that actual purchase and shipments of products be made by specific purchase order. Accordingly, any shipment rates stated in such contracts are subject to rescheduling and\/or cancellation, and therefore are not indicative of the future purchase orders to be submitted by such customer. In addition, the actual terms of the contracts tend to be modified in the ordinary course of business by means of subsequent purchase order terms and by course of dealing.\nThe Company does not believe that the level of backlog of orders is either material or indicative of future results, since its contracts are subject to revision through subsequent purchase orders and since its customers are generally permitted to cancel purchase orders, within certain parameters, prior to shipment without penalty.\nThe majority of the Company's sales are to OEMs with payment terms typically being net 30-45 days from date of invoice.\nMANUFACTURING AND SUPPLIES\nAll manufacturing operations are currently conducted at the Company's headquarters in Dallas, Texas. The Company's products consist primarily of various integrated circuits, other electronic components and firmware assembled onto an internally designed printed circuit board.\nThe Company uses sole-sourced, internally designed, applications specific integrated circuits (\"ASIC\") on most of its products as well as standard off- the shelf items presently available from two or more suppliers. Historically the Company has not experienced any significant problems in maintaining an adequate supply of these parts sufficient to satisfy customer demand, and the Company believes that it has good relations with its vendors. However, during the latter part of fiscal 1995, the Company began to experience difficulty in the timely delivery of a certain ASIC from a vendor with whom the Company has had a long standing relationship. The Company believes this problem arose in part because of the significant increase in worldwide demand for semiconductor components during 1995 as well as the vendor's production problems associated with the transfer of this particular ASIC from one production facility to another. Should this shortage continue or other shortages occur the Company's revenue levels would likely be adversely affected and, potentially, relationships with its customers could be impaired.\nThe Company generally does not manufacture products to stock in finished goods inventory, as substantially all of the Company's production is dedicated to specific customer purchase orders. As a result, the Company does not have any material requirements to maintain significant inventories or other working capital items.\nINTELLECTUAL PROPERTY AND PATENTS\nWhile the Company believes that its success is ultimately dependent upon the innovative skills of its personnel and its ability to anticipate technological changes, its ability to compete successfully will depend, in part, upon its ability to protect proprietary technology contained in its products. The Company does not currently hold any patents relative to its current product lines. Instead, the Company relies upon a combination of trade secret, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in its products. The development of alternative, proprietary and other technologies by third parties could adversely affect the competitiveness of the Company's products. Further, the laws of some countries do not provide the same degree of protection of the Company's proprietary information as do the laws of the United States. Finally, the Company's adherence to industry-wide technical standards and specifications may limit the Company's opportunities to provide proprietary product features capable of protection.\nThe Company is also subject to the risk of litigation alleging infringement of third party intellectual property rights. Infringement claims could require the Company to expend significant time and money in litigation, pay damages, develop non-infringing technology or acquire licenses to the technology which is the subject of asserted infringement.\nThe Company has entered into several nonexclusive software licensing agreements that allow the Company to incorporate software into its product line thereby increasing its functionality, performance and interoperability.\nEMPLOYEES\nAt October 31, 1995, the Company had 193 full-time employees, of which 76 were engaged in manufacturing and quality assurance, 51 in research and development, 35 in sales, sales support, service and marketing and 31 in general management and administration.\nThe Company's success to date has been significantly dependent on the contributions of a number of its key technical and management employees. The Company does not maintain life insurance policies on its key employees and, except for a few executive officers, does not have employment agreements with key employees. The loss of the services of one or more of these key employees could have a material adverse effect on the Company. In addition, the Company believes that its future success will depend in large part upon its ability to attract and retain highly skilled and motivated technical, managerial, sales and marketing personnel. Competition for such personnel is intense.\nNone of the Company's employees are covered by a collective bargaining agreement and there have been no work stoppages. Additionally, the Company considers its relationship with its employees to be good.\nCOMPETITION\nThe computer network industry is intensely competitive and is significantly affected by product introductions and market activities of industry participants. The Company expects substantial competition to continue. The Company's competition includes vendors specifically dedicated to the mass storage controller and computer network product markets. Traditionally the Company's major OEM customers have chosen not to manufacture adapters for their products or do not manufacture sufficient quantities or types of controllers to meet their needs. Increased competition could result in price reductions, reduced margins and loss of market share.\nMany of the Company's current and potential competitors have significantly greater financial, technical, marketing and other resources and larger installed bases than the Company. Several of the Company's competitors have been acquired by major networking companies. These acquisitions are likely to permit the Company's competitors to devote significantly greater resources to the development and marketing of new competitive products and the marketing of existing competitive products to their larger installed bases. The Company expects that competition will increase substantially as a result of these and other industry consolidations and alliances, as well as the emergence of new competitors. The Company believes that it has been able to compete as a result of its perceived technological leadership within the Company's market segment and its reputation for high product performance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases a 96,000 square foot facility located in Farmers Branch, Texas, a suburb of Dallas. The facility includes approximately $2.8 million in leasehold improvements that were made by the Company. The lease, inclusive of renewal options, extends through 2009. The Company believes that its facilities and equipment are in good operating condition and are adequate for its operations. The Company owns most of the equipment used in its operations. Such equipment consists primarily of engineering equipment, manufacturing and test equipment, and fixtures.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn January 22, 1996, the Company filed a lawsuit in the 160th Judicial District Court of Texas against Rockwell International Corporation and related parties seeking damages for breach of contract in connection with a proposed acquisition by the Company of a division of Rockwell. The Company is unable to predict with any certainty the outcome of this litigation. Also See Note 8 of the notes to consolidated financial statements of this document entitled \"Acquired Product Rights\". Other than the foregoing, there are no other legal proceedings, pending or threatened, against the Company that, in management's opinion, could 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.\nNot applicable\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nSince January 1984 shares of the Company's common stock have been traded in The Nasdaq Stock Market under the symbol INPH. The following table summarizes its high and low price for each fiscal quarter during 1995 and 1994 as reported by Nasdaq.\nAs of January 4, 1996, the Company had 111 record owners of its common stock.\nThe Company has not paid dividends on its Common Stock since its inception. The Board of Directors does not anticipate payment of any dividends in the foreseeable future and intends to continue its present policy of retaining earnings for reinvestment in the operations of the Company.\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.\nCONSOLIDATED STATEMENTS OF OPERATIONS PERCENTAGE OF REVENUES\nRESULTS OF OPERATIONS\nREVENUES: Total revenues in 1995 were $47,368,000 as compared to $40,303,000 in 1994 and 38,496,000 in 1993. This represents a growth in revenues of 18% from 1994 to 1995. The improvement in revenues was led by a 33% increase in sales of the Company's FDDI (Fiber Distributed Data Interface) product line, a 9% increase in SCSI products and partially offset by a decrease of 17% in sales of older ethernet products. FDDI revenues approximated 45% of total revenues in 1995, SCSI 33% and ethernet 12%. Asynchronous Transfer Mode (\"ATM\") products were 4% of total revenues in 1995 and reflected the fastest rate of growth throughout the year. Networking products in total comprised 61% of total revenues for 1995, while mass\nstorage product revenues approximated 34% of total revenue. North American revenues grew 29%, Pacific Rim revenues grew 15%, and European revenues declined 40% compared to 1994 The increase in revenue from 1993 to 1994 was $1,807,000, which represents a growth of approximately 5%. This growth is due primarily to a 44% increase in revenue from the Company's FDDI product largely offset by declines in ethernet and to a lesser extent by SCSI product revenues. In 1994 FDDI revenues approximated 39% of total revenues, SCSI 36%, Ethernet 17% and ATM 1%. In 1994 network products in total comprised 58%, and mass storage product revenues approximated 39%, of total revenues.\nCOST OF SALES: Cost of Sales expressed as a percentage of revenues was 50%, 50% and 51% for the years ended October 31, 1995, 1994 and 1993, respectively. In 1995, the FDDI and SCSI products experienced slightly lower cost of sales as a percentage of revenues compared to 1994, due primarily to product mix changes. Ethernet cost of sales as a percentage of revenues in 1995 was unchanged from 1994, and ATM cost of sales as a percentage of revenues continued to be very high, typical of a first year technology. In 1994, the cost of sales as a percentage of revenues declined compared to 1993 by 1% due to cost reduction actions described more fully below in \"Special Charges\" and the positive impact of higher production volumes. In 1996, the overall cost of sales as a percentage of revenues is expected to increase due to the anticipated growth of ATM products.\nRESEARCH AND DEVELOPMENT: The Company's investment in the development of new products through research and development was $7,327,000, $7,862,000 and $8,772,000 in 1995, 1994, and 1993, respectively. As a percentage of revenue, research and development expenses were 16%, 20% and 23% for 1995, 1994, and 1993, respectively . The decrease in absolute spending in 1995 and 1994 is a deliberate focus by the Company to expend resources more effectively, and the cost reduction actions taken in 1994. The Company has continued to focus its developmental efforts on ATM and FDDI products. As a percent of revenue research and development expense are expected to remain essentially flat for 1996, as compared to 1995.\nSALES AND MARKETING: Sales and marketing expenses were $8,583,000, $7,599,000 and $9,087,000 in 1995, 1994, and 1993, respectively. As a percentage of revenue, sales and marketing expenses were 18%, 19% and 24% for 1995, 1994, and 1993, respectively. The increase in spending from 1994 to 1995 is primarily related to the increase in revenues over 1994. The decrease in absolute spending from 1993 to 1994 is due to cost reduction actions taken in 1994.\nSPECIAL CHARGES: In the first quarter of 1994 the Company recorded a $1,148,000 provision for strategic realignment related to a 15% reduction in workforce, consolidation of the California engineering activities to Dallas and the write- off of nonproductive assets. This cost reduction initiative followed a similar action taken in the third quarter of 1993 when the Company recorded a $1,172,000 charge also related to a similar reduction in workforce and the write-off of nonproductive assets. Each of these actions were implemented as part of a strategy to regain profitable quarterly financial performance by adjusting spending to near-term revenue expectations while preserving the Company's key strengths. These two efforts have been referred\nto throughout as the \"cost reduction actions\". Finally, in the third quarter of 1993, the Company recorded a $1,275,000 loss associated with the write-off of certain acquired product rights from Intellectual Systems, Inc. This matter has resulted in litigation and is discussed further in Note 8 to the Consolidated Financial Statements.\nGENERAL AND ADMINISTRATIVE: The expenses for general and administrative were $4,004,000, $4,146,000 and $4,847,000 in 1995, 1994, and 1993, respectively. As a percentage of revenue, general and administrative expenses were 9%, 10% and 13% for 1995, 1994, and 1993, respectively. The decreases in spending in both 1995 and 1994 were a result of cost reduction actions as discussed above.\nINTEREST INCOME: Interest Income was $586,000, $309,000 and $463,000 in 1995, 1994, and 1993, respectively. The increase in interest income for 1995 compared to 1994 is related to the increase in funds available for investment. The decrease in interest income in 1994 is due to a decline in funds available for investment and a one-time gain that was recognized in 1993 for the early liquidation of certain marketable securities that had increased in value as a result of the change in market interest rates.\nPROVISION (BENEFIT) FOR INCOME TAXES: The Company's provision for income taxes in 1995, 1994, and 1993 is made up of the federal statutory rate of 34% as well as a provision for state and foreign taxes paid but not available for credit in the United States. Therefore the rate is slightly higher than 34%.\nNET INCOME (LOSS): The net income for the Company was $2,759,000 in 1995, compared to a net loss of $280,000 in 1994 and a net loss of $4,201,000 in 1993. 1995 profit is a result the 18% growth in revenues while, maintaining a gross margin of 50% and reducing operating expenses by 4% from 1994, resulting in a net income as a percentage of revenues of approximately 6%. The decrease in net loss from 1993 to 1994 is attributable to the reduction in normal operating expenses resulting from the cost reduction actions as discussed above.\nADOPTION OF ACCOUNTING STANDARDS: Effective November 1, 1993, the Company adopted Financial Accounting Standards Board Statement (\"SFAS\") No. 109, \"Accounting for Income Taxes\". SFAS No. 109 utilizes the liability method, and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax law. As permitted by the Statement, prior year financial statements have not been restated and the result of the change was not material to the Consolidated Financial Statements.\nOn November 1, 1993, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with the requirements of the Statement, the Company has determined that all of its marketable securities should be classified as \"available-for-sale\" securities and reported at fair value. Unrealized gains and losses are excluded from earnings and reported in a separate component of shareholders' equity, net of related\ndeferred taxes. The Company's results of operations will continue to include earnings from such securities as calculated on a yield-to-maturity basis.\nRECENTLY ISSUED ACCOUNTING POLICIES: In 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 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill. Adoption is required in financial statements for fiscal years beginning after December 15, 1995. The Company does not expect the adoption of SFAS No. 121 to have any material effect on the consolidated financial statements of the Company.\nIn November 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation\". This statement becomes effective for the Company in fiscal year 1997. This statement requires companies to provide additional disclosures related to employee stock-based compensation plans, or allows companies to change the accounting for compensation expense associated with its stock-based compensation. The Company has not yet determined the impact, if any, on the results of operations of the Company due to adoption of this statement.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash, cash equivalents and marketable securities aggregated $12,686,000, and $11,534,000 and $8,291,000 at October 31, 1995, 1994, and 1993, respectively. The increase of $1,152,000 in 1995 was primarily due to the level of profitability in 1995 partially offset by the growth in accounts receivable and inventories, both a refection of the growth of the business during the year. Expenditures for equipment and purchased software were nearly the same as depreciation and amortization expenses in 1995. From 1993 to 1994 the increase in cash, cash equivalents and marketable securities was $3,243,000. This increase is the result of generating $4,575,000 in cash from operations coupled with a reduction in capital outlays of over 40% from the prior year, pursuant to the cost reductions actions implemented in early 1994. Expenditures for equipment and purchased software were $2,728,000, $1,492,000 and $2,777,000 in 1995, 1994 and 1993, respectively. The Company expects that its cash, cash equivalents and marketable securities will be adequate to meet foreseeable needs in 1996. At October 31, 1995, the Company had no material commitments to purchase capital assets. The Company's only significant long-term obligation is its operating lease on its Dallas facility. The Company has not paid any dividends since its inception and does not anticipate paying any dividends in 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee Item 14 (a) 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 REGISTRANT.\nDIRECTORS\nSee information regarding the Directors and nominees for director under the heading \"Election of Directors\" of the Proxy Statement for the Annual Meeting of Shareholders to be held in March 1996, which is incorporated herein by reference.\nEXECUTIVE OFFICERS\nAs of January 4, 1996, the executive officers of the Company, their respective ages, positions held and tenure as officers are listed below:\nR. STEPHEN POLLEY joined the company as President and Chief Operating Officer in November 1993 and was elected a director by the Board of Directors in November 1993. In June 1994, Mr. Polley was named Chief Executive Officer of the Company and appointed Chairman of the Board of Directors. From August 1992 to February 1993, Mr. Polley acted as a consultant in strategic and management matters and as a director for Computer Automation, Inc. Computer Automation provided various products and services for use in facsimile management systems, minicomputers and microcomputers. From 1987 to April 1992, Mr. Polley served as President, Chief Executive Officer and a director of Intellicall, Inc., a diversified supplier of telecommunications products and services including private pay telephones and microprocessor-based automated operator systems.\nROBERT L. DRURY joined the company as Vice President of Finance and Chief Financial Officer in December 1992. In June 1994, Mr. Drury was also named Treasurer for the Company. From 1988 through 1992, Mr. Drury was Chief Financial Officer of the Ben Hogan Company, a manufacturer of golf related products.\nJAMES C. GLEASON joined the company in 1986 as Manufacturing Operations Manager. Since that time he has served as Vice President of Sales and Marketing (1993), Vice President of Operations (1992) and Vice President of Manufacturing (1988).\nERNEST E. GODSEY joined the company as Vice President of Business Development in December 1992. From October 1991 through December 1992, Mr. Godsey was Vice President of Engineering and Marketing for Mizar, Inc., a supplier of various products for the microcomputer OEM marketplace. From 1986 through October 1991, Mr. Godsey was employed by the Company in various marketing capacities, the last being that of Vice President of Marketing.\nPAULA E. D. JANDURA has served as Vice President of Administration since 1986.\nJOHN E. TUDER joined the company as Vice President of Engineering in 1995. Prior to joining Interphase Mr. Tuder was Director of Product Development for the Broadband Products Division of DSC Communications Corporation, from 1993 through 1995, and prior to that with Intergraph in Huntsville, Alabama, from 1980 through 1993.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is in the Proxy Statement for the Annual Meeting of Shareholders to be held in March 1996, which 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 in the Proxy Statement for the Annual Meeting of Shareholders to be held in March 1996, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item is in the Proxy Statement for the Annual Meeting of Shareholders to be held in March 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.\n(a) (i) and (ii) Financial Statements and Schedules.\nReference is made to the listing on page of all financial statements and schedules filed as a part of this report.\n(iii) Exhibits.\nReference is made to the Index to Exhibits on page E-1 for a list of all exhibits filed during the period covered by this report.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K have been filed by the Registrant during the quarter ended October 31, 1995.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nReport of Independent Public Accountants - ARTHUR ANDERSEN LLP\nConsolidated Balance Sheets - October 31, 1995 and 1994\nConsolidated Statements of Operations - Years Ended October 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity - Years Ended October 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended October 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements to\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of Interphase Corporation:\nWe have audited the accompanying consolidated balance sheets of Interphase Corporation (a Texas corporation) and subsidiary as of October 31, 1995 and 1994, and the related consolidated statements of operations, shareholder's 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 financial position of Interphase Corporation and subsidiary 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.\nAs discussed in Note 1 to the consolidated financial statements, effective November 1, 1993, the Company changed its method of accounting for certain debt and equity securities.\nARTHUR ANDERSEN LLP\nDallas, Texas December 4, 1995\nINTERPHASE CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT NUMBER OF SHARES)\nThe accompanying notes are an integral part of these consolidated financial statements.\nINTERPHASE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nINTERPHASE CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nINTERPHASE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nINTERPHASE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the financial statements of Interphase Corporation (\"the Company\") and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated.\nCASH AND CASH EQUIVALENTS: The Company considers marketable securities with original maturities of less than three months, as well as interest bearing money market accounts, to be cash equivalents.\nMARKETABLE SECURITIES: As of October 31, 1995 and 1994, the fair market value of marketable securities was $9,366,000 and $7,720,000 respectively. In accordance with the requirements of the Financial Accounting Standards Board Statement No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\", all marketable securities are deemed to be classified as \"available-for-sale securities\" and reported at fair value. Unrealized gains and losses are excluded from earnings and reported in a separate component of shareholders' equity, net of related deferred taxes. The Company's results of operations will continue to include earnings from such securities as calculated on a yield-to-maturity basis. During 1995 the Company realized a net loss of $14,000 from the sale of securities. As of October 31, 1995, the Company had recorded a valuation loss of $42,000 with respect to certain available-for-sale securities ($29,000 net of taxes). During 1994 the Company realized a gain of $1,000 from the sale of securities. As of October 31, 1994, the Company had recorded a valuation loss of $225,000 with respect to its available-for-sale securities ($148,000 net of taxes).\nALLOWANCE FOR DOUBTFUL ACCOUNTS: As of October 31, 1995, 1994 and 1993 the balance for allowance for doubtful accounts was $238,000, $240,000 and $242,000. The activity for this account for the three years ended October 31, 1995 was as follows: (in thousands)\nINVENTORIES: Inventories are valued at the lower of cost or market and include material, labor and manufacturing overhead. Cost is determined on a first-in, first-out basis: (in thousands)\nPROPERTY AND EQUIPMENT: Property and equipment are recorded at cost. Depreciation and amortization are provided over the estimated useful lives of depreciable assets using primarily the straight-line method. When property and equipment are sold or otherwise retired, the cost and accumulated depreciation applicable to such assets are eliminated from the accounts, and any resulting gain or loss is reflected in current operations.\nThe depreciable lives of property and equipment are as follows:\nCAPITALIZED SOFTWARE: Capitalized software at October 31, 1995 represents various software licenses purchased by the Company and utilized in connection with the Company's network and mass storage products as well as the general operations of the Company. Capitalized software is amortized over 3-5 years utilizing the straight-line method. Related amortization expense was approximately $400,000, $508,000 and $410,000 in 1995, 1994 and 1993, respectively. Accumulated amortization at the end of 1995, 1994 and 1993 was $1,441,000, $1,309,000 and $803,000, respectively.\nREVENUE RECOGNITION: Revenue from product sales is recorded only when the earnings process has been completed, which is generally at the time of shipment.\nCONCENTRATION OF CREDIT RISK: Financial instruments which potentially expose the Company to concentrations of credit risk, as defined by Statement of Financial Accounting Standards (SFAS) No. 105 consist primarily of trade accounts receivable. The majority of the Company's sales have been to original equipment manufacturers of computer systems. The Company conducts credit evaluations of its customers' financial condition and limits the amount of trade credit extended when necessary. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information.\nRESEARCH AND DEVELOPMENT: Research and development costs are charged to expense as incurred.\nFOREIGN EXCHANGE: The Company has established the U.S. Dollar as the functional currency of its foreign operations. Therefore, monetary assets and liabilities of the Company's foreign operations are translated into U.S. Dollars at the exchange rates in effect at the end of the year. Nonmonetary assets and liabilities are translated at historical rates whereas revenue and expense transactions are translated using the average exchange rates that prevailed during the year. The resulting gains and losses are included in the Company's results of operations.\nINCOME TAXES: Effective November 1, 1993, the Company adopted the SFAS No. 109, \"Accounting of Income Taxes\". Statement No. 109 utilizes the liability method to determine deferred taxes. Deferred tax liability is based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of enacted tax law. The Company's consolidated financial statements include deferred income taxes arising from the recognition of revenues and expenses in different periods for income tax and financial reporting purposes. The adoption of SFAS No. 109 is not material to the Company's operating results or financial position.\nNET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE: Net income (loss) per common and common equivalent share is computed using the weighted average number of outstanding common and dilutive common equivalent shares outstanding during the periods presented. The dilutive impact of outstanding stock options and warrants has been considered under the treasury stock method. In 1994 and 1993, the impact of outstanding stock options and warrants was anitdilutive and, therefore, has been excluded from the computations of net loss per share related to those years.\nShares used in the computation of net income (loss) per common and common equivalent share are summarized below.\nWeighted average common and common equivalent shares: (in thousands)\nRECENTLY ISSUED ACCOUNTING POLICIES: In 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 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill. Adoption is required in financial statements for fiscal years beginning after December 15, 1995. The Company does not expect the adoption of SFAS No. 121 to have any material effect on the consolidated financial statements of the Company.\nIn November 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation\". This statement becomes effective for the Company in fiscal year 1997. This statement requires companies to provide additional disclosures related to employee stock-based compensation plans, or allows companies to change the accounting for compensation expense associated with its stock-based compensation. The Company has not yet determined the impact, if any, on the results of operations of the Company due to adoption of this statement.\nCERTAIN RECLASSIFICATIONS: Certain amounts previously reported in the 1994 financial statements have been reclassified to conform with the 1995 presentation.\n2. INCOME TAXES\nThe provision (benefit) for income taxes for each period presented was as follows: (in thousands)\nTax effect of temporary differences that give rise to significant components of the deferred tax assets as of October 31, 1995 and 1994 are presented as follows: (in thousands)\nThe Company has not recorded a valuation allowance with respect to the various deferred tax assets as management believes it is more likely than not that these assets will be realized. Management periodically reviews the realization of the Company's deferred tax assets, as appropriate, when existing conditions change the probability of realization.\nThe differences between the provision (benefit) for income taxes computed on income before income taxes at the U.S. federal statutory income tax rate (34%) and the amount shown in the Consolidated Statements of Operations are presented below: (in thousands)\n3. SHAREHOLDERS' EQUITY\nAMENDED AND RESTATED STOCK OPTION PLAN: In fiscal 1995, the Company amended and restated its Stock Option Plan which, as amended, authorizes the issuance to employees of incentive stock options (as defined in section 422 of the Internal Revenue Code of 1986, as amended) and nonqualified stock options to purchase up to 1,350,000 shares of common stock. The exercise price of incentive stock options must be at least equal to the fair market value of the Company's common stock on the date of the grant, while the exercise price of nonqualified stock options may be less than fair market value on the date of grant, as determined by the board. Options generally vest ratably over a 5 year period from the date of grant. The term of option grants may be up to 10 years. Grants prior to June 1994 expire after 6 years. Options are canceled upon the lapse of three months following termination of employment except in the event of death or disability, as defined. The following table summarizes the transactions under the Stock Option Plan: (in thousands, except option prices)\nSTOCK OPTION SUB-PLAN: This plan was adopted in 1988 for the benefit of the Company's employees located in the United Kingdom. This plan authorizes the issuance of options to purchase common stock of the Company at prices at least equal to the fair market value of the common stock on the date of the grant. The options vest after 3 years and expire after 10 years. The options are canceled upon termination of employment, except in the event of death, retirement or injury, as defined. As of October 31, 1995 options to purchase 3,000 common shares were outstanding and exercisable under this plan with exercise prices ranging from $5.63-$10.56 per share.\nDIRECTOR STOCK OPTIONS: In May 1994, the Company formalized its (\"directors' plan\") program of granting stock options for up to 500,000 common shares to its directors. Future grants pursuant to the directors' plan will vest within one year and have a term of 5 years. As of October 31, 1995, options to directors for 184,000 common shares with exercise prices ranging from $4.38-16.88 per share were outstanding. Of these shares, approximately 144,000 were exercisable with exercise prices ranging from $4.38-$10.25. Options outstanding under the directors' plan were issued in 1990, 1994 and 1995, and expire between 1996, 1999 and 2000. The exercise prices related to these options were equal to the market value of the Company's stock on the date of grant.\n4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nAccounts payable and accrued liabilities consisted of the following: (in thousands)\n5. RELATED PARTY TRANSACTIONS\nThe Company paid approximately $397,000, $328,000 and $190,000 during each of the three years in the period ended October 31, 1995, 1994 and 1993, respectively, to certain outside directors of the Company or their firms for remuneration for their professional services.\n6. TRANSACTIONS WITH MOTOROLA, INC.\nIn 1989, the Company and Motorola, Inc. executed an agreement whereby Motorola purchased, for cash, 660,000 newly issued shares of the Company's common stock at a price of $11 per share. In addition, Motorola received warrants to purchase an additional 660,000 shares of common stock at an exercise price of $15.40 per share. The warrants may be exercised only upon the occurrence of certain events, including (i) a change in control of the Company or (ii) Motorola's purchase of the Company's product achieving certain levels. The warrants expire in March 1996, contain certain antidilutive provisions and are subject to repurchase by the Company under certain conditions. The Company also granted Motorola registration rights with respect to all common stock that Motorola owns. Pursuant to the terms of the agreement, the Company elected a designee of Motorola to its Board of Directors. Shipments to Motorola comprised 6%, 10%, and 8% of the Company's revenues during the years ended October 31, 1995, 1994 and 1993, respectively.\n7. EMPLOYEE BENEFIT PLAN\nThe Company maintains a defined contribution plan for those employees who meet the plan's length of service requirements. Under the defined contribution plan, employees may make voluntary contributions to the plan, subject to certain limitations, and the Company accrued between 4% to 7% of the employees' annual compensation. The total expenses under this plan for the years ended October 31, 1995, 1994 and 1993 were approximately $507,000, $662,000 and $780,000, respectively. The Company makes contributions to the plan equal to the amount accrued. The Company offers no postretirement or postemployment benefits.\n8. OTHER FINANCIAL INFORMATION\nMAJOR CUSTOMERS: The Company had one customer in 1995, two customers in 1994 and one customer in 1993 accounting for more than 10% of the Company's consolidated revenues. Net revenues resulting from these customers were as follows: (in thousands)\nCOMMITMENTS: The Company leases its office, research and development and manufacturing facility under a noncancelable operating lease. Rent expense related to the lease is recorded on a straight-line basis and has resulted in the deferred lease obligation in the accompanying balance sheet. As of October 31, 1995, operating lease commitments having noncancelable terms of more than one year are as follows: (in thousands)\nTotal rent expense for operating leases was approximately as follows: (in thousands)\nGEOGRAPHIC INFORMATION: The Company operates principally in the United States, Europe and the Pacific Rim. During 1995, the Company eliminated its European general and administrative functions, but continues to maintain sales offices in Europe and Japan. Currently, records are maintained on a consolidated basis at the corporate headquarters in Dallas. As a result, results of operations are no longer discernible on a geographical basis. In 1995, the amount of identifiable assets employed in the Company's European and Japanese operations were not material. A geographic detail of revenue is as follows: (in thousands)\nIn 1994, cost of sales from European operations expressed as a percentage of revenues was 51% as compared to 50% generated by Domestic operations. In 1993, cost of sales from European operations expressed as a percentage of revenues was 46% as compared to 53% generated by Domestic operations. The amount of identifiable assets employed in the Company's European operations were not material other than cash, cash equivalents and trade accounts receivable which aggregated $1,599,000 and $2,238,000 as of October 31, 1994 and 1993, respectively.\n9. ACQUIRED PRODUCT RIGHTS\nIn March 1992, the Company entered into a Licensing, Joint Development and Marketing Agreement with Intellectual Systems, Inc. (\"ISI\"). Pursuant to the agreement, the Company paid $1,000,000 for a nonexclusive license to manufacture and sell future products that would incorporate technology that was owned by ISI. Also, in 1992, the Company paid ISI $275,000 for certain other development work to be performed by ISI related to use of the original licensed technology. As a result of a dispute between the parties regarding ISI's compliance with the agreement, and after an unsuccessful attempt by the parties to negotiate a termination of the agreement, in October 1993 the Company filed a suit in the District Court for Dallas County, Texas, which sought monetary damages from ISI and one of its officers. The suit alleged, among other things, breach of contract and conspiracy to defraud. ISI and its officer responded to the claims by filing a suit containing a general denial and a counter claim seeking unspecified damages from Interphase for breach of contract. In November 1994, the district court denied ISI's pleading and issued an interlocutory default judgment against ISI for $1,275,000. Subsequent to the district court ruling, ISI filed for protection under Chapter 11 of the federal bankruptcy code. Even prior to the bankruptcy filing, the Company had considerable doubt as to ISI's ability to satisfy a judgment in the Company's favor. Therefore, in 1993 the Company recorded a non-cash write-off of $1,275,000, related to the acquired product rights. To the extent the Company ultimately receives any payment from ISI, such amount will be recorded as income in the period received.\n10. STRATEGIC REALIGNMENT\nIn June 1993, the Company announced a strategic restructuring and rightsizing and recorded a related provision of $1,172,000. In January 1994, the Company announced a similar action and recorded a provision of $1,148,000. Each of these actions included a 15% reduction in workforce and reduced operating expenses in all functional areas of the Company. The respective provisions reflected in the accompanying consolidated statements of operations include expenses associated with severance benefits, the consolidation of the California Engineering activities in Dallas, the write-off of nonproductive assets and other expenses associated with the restructuring. Each of these actions represented efforts to adjust the Company's spending and organization structure to expected revenue levels and renewed emphasis on investment in certain technologies that the Company deemed critical to its long term success. Included in accrued liabilities as of October 31, 1995, and 1994 were approximately $27,000 and $274,000, respectively, of the total provisions for strategic realignment.\n11. QUARTERLY FINANCIAL DATA (UNAUDITED)\nOperating results in the first quarter of 1994 included a $1,148,000 provision for strategic realignment.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTERPHASE CORPORATION\nDate: January 24, 1996 By: \/s\/ R. Stephen Polley -------------------------- R. Stephen Polley 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 January 24, 1996.\nNAME TITLE ---- -----\nChairman of the Board of Directors, Chief Executive Officer, Chief Operating Officer and President \/s\/ R. Stephen Polley (Principal executive officer) -------------------------------- R. Stephen Polley Chief Financial Officer, Vice President of Financial and Treasurer \/s\/ Robert L. Drury (Principal financial officer) -------------------------------- Robert L. Drury\n\/s\/ Michael E. Cope Director -------------------------------- Michael E. Cope\n\/s\/ Dale Crane Director -------------------------------- Dale Crane\n\/s\/ James F. Halpin Director -------------------------------- James F. Halpin\n\/s\/ Paul N. Hug Director -------------------------------- Paul N. Hug\n\/s\/ Robert H. Lyon Director -------------------------------- Robert H. Lyon\n\/s\/ David H. Segrest Director -------------------------------- David H. Segrest\n\/s\/ S. Thomas Thawley Director -------------------------------- S. Thomas Thawley\nINDEX TO EXHIBITS\nExhibits - -------- 3 (a) Certificate of Incorporation of the registrant. (1) 3 (b) Amended and Restated Bylaws of the registrant adopted on December 5, 1995. (4) 10(b) Registrant's Amended and Restated Stock Option Plan and Amendment No. 1 thereto. (4) 10(c) Registrant's Incentive Stock Option Sub-Plan. (2) 10(d) Directors Stock Option Plan and Amendment No.1 thereto. (4) 10(e) Stock Purchase Warrant issued to Motorola, Inc. (3) 23(a) Consent of Independent Public Accountants. (4) _______________________\n(1) Filed as an exhibit to Registration Statement No. 2-86523 on Form S-1 and incorporated herein by reference. (2) Filed as an exhibit to Report on Form 10-K for the year ended October 31, 1988 and incorporated herein by reference. (3) Filed as an exhibit to Report on Form 10-Q for the quarter ended April 30, 1989 and incorporated herein by reference. (4) Filed herewith.\nE-1","section_15":""}
{"filename":"276077_1995.txt","cik":"276077","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":"860673_1995.txt","cik":"860673","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nDominguez Services Corporation (Company) is a holding company created in 1990 through an Agreement of Merger with Dominguez Water Corporation. Dominguez Services Corporation's principal business is the ownership of all the common stock of Dominguez Water Corporation. The holding company structure provides operational and financial flexibility and allows the Company to engage in non- utility activities. Currently, Hydro-Metric Service Corporation is the Company's only non-utility subsidiary. Substantially all of the Company's revenue and profits in 1995 were from Dominguez Water Corporation.\nDominguez Water Corporation (Dominguez), a public utility, produces and supplies water for residential, commercial, public authority, business and industrial customers. It is comprised of a South Bay division and the utility subsidiaries Antelope Valley Water Company (Antelope Valley), Arden Water Company, Kernville Domestic Water Company, Lakeland Water Company and Split Mountain Water Company. The last four companies noted above, and their subsidiaries, collectively make up the Kern River Valley Water Companies (Kern River Valley).\nDominguez was organized in 1937 as successor to Dominguez Water Company. Its South Bay division is the largest service area with 32,092 customers encompassing most of the City of Carson, one-third of Torrance, and portions of the cities of Compton, Long Beach and Harbor City. Antelope Valley , with 1,228 customers, has four distinct service areas in northern Los Angeles County whereas Kern River Valley, located in Kern County around Isabella Lake, has nine distinct service areas and 3,419 customers.\nOPERATIONS\nIn 1995, Dominguez supplied 12,371 million gallons of water to 36,739 customers, compared to 12,071 million gallons of water to 36,371 customers in 1994. The South Bay division produced 11,890 million gallons of water in 1995. Although Dominguez has a diversified customer base, 53% of 1995 water sales were derived from business and industrial. Furthermore, a single customer, a refinery, accounted for 37% of these business and industrial sales.\nHydro-Metric Service Cooperation operates a large meter test and repair business in Southern California.\nWATER SUPPLY\nThe water supplies for Dominguez are from its own groundwater wells plus two water wholesalers of imported water.\nAll service areas obtain either a portion of or all of their supply from groundwater wells. The quantity that the South Bay division is allowed to pump over a year's time is fixed by court adjudication. The adjudication established distinct groundwater basins which are managed by a court appointed watermaster. The groundwater management fixes the safe yield of the basins and ensures the replenishment of the basins by utilizing impounded storm water and purchased water when necessary. Groundwater basins have not been adjudicated in the subsidiary areas of Kern River Valley and the Antelope Valley.\nOverall groundwater conditions continue to remain at adequate levels. Dominguez continues to drill new wells, so that it can maximize pumping its total adjudicated rights when called upon.\nThe South Bay division and Leona Valley service area of Antelope Valley also purchase water from wholesalers to supplement groundwater. The South Bay division purchase imported water from the Metropolitan Water District (MWD) of Southern California. The Leona Valley service area purchases its imported water from Antelope Valley - East Kern Water Agency (AVEK). Both of these wholesale suppliers obtain water from the California State Water Project (SWP), and MWD also obtains water from the Colorado River.\nAs of March 1996, the water supply outlook is very favorable. Winter rains have filled SWP reservoirs to above average levels. MWD also indicates that a full compliment of Colorado River water is available. Dominguez expects an ample supply of import water to be at hand for the next several years.\nLong-term imported water supplies are dependent upon the outcome of several factors. Dominguez's future dependency on imported water will be subject to the availability of reclaimed water in the region as well as customers' long-term water conservation efforts. Dominguez has been and will continue to promote long-term water conservation efforts. Dominguez will continue to be an industry leader in the promotion of wise water use.\nDominguez anticipates that the West Basin Municipal Water District Reclamation Project will be delivering reclaimed water into the South Bay division by 1997. Dominguez will make the reclaimed water (which is priced lower and more economically) available to its customers. Dominguez's margins will remain equal to that of replaced potable sales. This project is expected to be a major step in drought-proofing the South Bay division.\nLegislative actions continue to alter the amount of SWP water available from Northern California, and MWD anticipates losing two-thirds of the water normally imported from the Colorado River around the beginning of the next century. The reduced availability of imported water supplies and an annual population growth of 400,000 in Southern California could create future drought conditions which may require water rationing by all water agencies, including Dominguez.\nWATER QUALITY\nWater quality is a primary concern for Dominguez. Groundwater requires only minimal treatment with chlorine for disinfecting, with the exception of minor water supplies in Kern River Valley that are filtered for iron and manganese. Purchased water has already gone through an extensive treatment process before receives it.\nBoth groundwater and purchased water are subjected to extensive quality analysis. With the occasional bacteriological minor exception, Dominguez meets all current primary water standards. Dominguez has an ongoing groundwater monitoring program and South Bay division participates in an area-wide water quality program administered by the association representing the groundwater basins.\nUnder the federal Safe Drinking Water Act (SDWA), Dominguez is subject to regulation by the United States Environmental Protection Agency (EPA) and the California Department of Health Services for the quality of water it supplies. The EPA is required by SDWA to continue establishing new maximum contaminant levels for additional chemicals. The costs of future compliance are currently unknown and Dominguez's water sources may require additional treatment. Management believes that Dominguez's resources are sufficient to meet these anticipated challenges.\nREGULATORY AFFAIRS\nIn August 1995, Dominguez increased revenues by $1,400,000 annually, or 6.2%, to recover the increased cost of water production in our South Bay division.\nThis rate increase substantially recovered the total cost increase of $1,500,000 for higher purchased water costs and an increased pump tax. However, due to Dominguez's high earnings at this time, the total cost increase was not recoverable in rates. Dominguez expects to recover the difference, $100,000, in the balancing account in the future. This rate increase does not increase the earnings to Dominguez but rather offsets the effects of higher water production costs to Dominguez.\nIn 1995, the California Public Utilities Commission (CPUC) undertook a strategic planning process referred to as Vision 2000. This planning process was done in response to hearings held by the California Legislature concerning the organization\nof the CPUC and the effects that deregulation in other utility industries will have on the CPUC. The CPUC held workshops throughout the state. Dominguez participated in these workshops and submitted comments. The CPUC's Vision 2000 has been presented to the California Legislature. In 1996, the California Legislature will assess Vision 2000 plan and decide if further legislative action is needed.\nDiscussions regarding Vision 2000 indicate that Dominguez will continue to be subject to traditional regulatory policies and practices. The regulation may be modified to include performance standards. Using performance-based rate making, the utility and the CPUC would agree to a set of operating efficiency ratios. If the efficiency ratios are exceeded, the shareholders would get to keep a portion of the cost savings as increased profits.\nNON-UTILITY SUBSIDIARY\nHydro-Metric Service Corporation is a service company specializing in field testing and repair of large water meters.\nEMPLOYEE RELATIONS\nAs of December 31, 1995 there were a total of 82 employees in utility and non-utility operations. None of the employees is represented by a labor organization, and there has never been a work stoppage or interruption due to a labor dispute. In general, wages, hours, and conditions of employment are equivalent to those found in the industry. Dominguez considers its relations with its employees as excellent. All employees receive paid annual vacations and sick leave. Dominguez provides and pays the cost of group life, disability, medical and dental insurance, as well as pensions for its employees.\nENVIRONMENTAL MATTERS\nDominguez's operations are subject to pollution control and water quality control as discussed in the \"Water Quality\" section.\nOther state and local environmental regulations apply to Dominguez operations and facilities. These regulations are primarily related to the handling, storage and disposal of hazardous materials. Dominguez is currently in compliance with all other state and local regulations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nDominguez general administrative and executive offices are located on 5 1\/2 acres of company-owned property at 21718 South Alameda Street, Long Beach, California. The offices and shops were completed in April 1972.\nThe South Bay division has 14 wells, some of which are located on its own land and some on leased sites. Well sites under lease expire between 1996 and 2010 and require aggregate annual payments of approximately $100,000. South Bay division water storage, all on owned property, consists of a 5 million gallon steel tank, four 3-1\/2 million gallon steel tanks, one 750,000 gallon elevated steel storage tank and other smaller storage tanks. Kern River Valley and Antelope Valley operate approximately 45 wells and utilize approximately 20 storage tanks ranging in size from 40,000 to 300,000 gallons.\nThe South Bay division has prior rights to lay distribution mains and for other uses on much of the public and private lands in its service area. Dominguez' claim of prior rights is derived from the original Spanish land grant covering the Dominguez service area. For this reason, Dominguez, unlike most other public utilities, generally receives compensation from the appropriate public authority when the relocation of its facilities is necessitated by the construction of roads or other projects. It is common for public utilities to bear the entire cost of such relocation.\nSubstantially all of the property of Dominguez is subject to the lien of the Trust Indenture dated August 1, 1954, as supplemented and amended, to Chemical Trust Company of California, as Trustee, securing the three outstanding series of Dominguez' First Mortgage Bonds.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn or about November 20, 1995, Dominguez's insurance carrier settled the claims of a former employee who filed a complaint in Los Angeles Superior Court alleging, among other things, that he had been wrongfully terminated by Dominguez. The terms of the settlement will have no adverse financial impact on Dominguez.\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 PRICE FOR COMMON SHARES Reference is made to Page 27 of the Annual Report to Shareholders.\n(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON SHARES\nThe NASDAQ Stock Market maintenance standards require that NASDAQ National Market companies have at least 400 shareholders or at least 300 shareholders of round lots. As of December 31, 1995, the company complies with the standard with 336 common shareholders of record and more than 300 beneficial shareholders, who have chosen to hold their shares in street name.\n(c) FREQUENCY AND AMOUNT OF ANY DIVIDENDS DECLARED Reference is made to Page 27 of the Annual Report to Shareholders.\n(d) DIVIDEND RESTRICTION Reference is made to page 23, Note 5 of Notes to Consolidated Financial Statements of the Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nReference is made to Page 14 and 15 of the Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.\nReference is made to Page 16 of the Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFinancial statements incorporated by reference from the Annual Report to Shareholders: - Consolidated Balance Sheets - December 31, 1995 and 1994; - Consolidated Statements of Income 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; - Report of Independent Public Accountants.\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 following table sets forth the names and ages of all directors and executive officers, indicating the positions and offices presently held by each.\nThere is no \"family relationship\" between any of the executive officers.\nInformation responding to Item 10 is included in a proxy statement pursuant to Regulation 14A and is incorporated by reference herein pursuant to General Instruction G(3).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation responding to Item 11 was included in a proxy statement (page 7) pursuant to Regulation 14A and is incorporated by reference herein pursuant to General Instruction G(3).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation responding to Item 12 was included in a proxy statement (page 3) pursuant to Regulation 14A and is incorporated by reference herein pursuant to General Instruction G(3).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation responding to Item 13 was included in a proxy statement (page 8) pursuant to Regulation 14A and is incorporated by reference herein pursuant to General Instruction G(3). Other information is included in Note 12 of the Notes to Consolidated Financial Statements of the Annual Report to Shareholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 9-K.\n(a) Exhibits: The following exhibits are incorporated as part of this report by reference to Registration Statement No. 33-33401, Form S-4 dated February 13, 1990.\n3. by-laws of Dominguez Services Corporation Articles of Incorporation and Amendment of Dominguez Services Corporation.\n22. Subsidiaries of the registrant.\n(b) Schedule II not included in the Annual Report to Shareholders, and related report of independent public accountants are included after Item 14 in Part IV.\n(c) Schedules Omitted:\nAll other schedules have been omitted as they are not applicable, not material, or the required information is given in the Financial Statements or Notes.\n(d) Reference is made to the Financial Statements incorporated herein in Item 8.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nBoard of Directors Dominguez Services Corporation Long Beach, California\nWe have audited in accordance with generally accepted auditing standards the consolidated financial statements included in the 1995 Annual Report to Shareholders of Dominguez Services Corporation, incorporated by reference in this Form 10-K, and have issued our report thereon dated March 6, 1996. Our audits of the consolidated financial statements were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The supplemental schedule listed in Part IV of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and regulations, and is not part of the basic consolidated financial statements. This supplemental 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\nLos Angeles, California March 6, 1996\nDOMINGUEZ SERVICES CORPORATION And Subsidiaries\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nNotes:\n(1) Receipts on accounts previously written off.\n(2) Accounts receivable write 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.\nDOMINGUEZ SERVICES CORPORATION:\nBy -------------------------------------- Brian J. Brady, Chief Executive Officer\nBy -------------------------------------- John S. Tootle, Chief Financial Officer\nBy -------------------------------------- C.W. Rose, Corporate Secretary\nBy -------------------------------------- Martin Booth, Chief Accountant\nPursuant to the requirements of the Securities Exchange Act of 1934, 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:\n---------------------------------------- D. C. BAUM Date\n---------------------------------------- R. M. Cannon Date\n---------------------------------------- T. M. Gloege Date\n---------------------------------------- T. W. Houston Date\n---------------------------------------- C. B. Olson Date\n---------------------------------------- L. Owen Date\n---------------------------------------- C. W. Porter\n---------------------------------------- D. L. Reed Date","section_15":""}
{"filename":"843368_1995.txt","cik":"843368","year":"1995","section_1":"ITEM 1. BUSINESS\nNorthland Cable Properties Eight Limited Partnership (the \"Partnership\") is a Washington limited partnership consisting of one general partner and approximately 969 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\").\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 cable television systems owned by 6 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 September 21, 1988 and began operations in 1989 with the acquisition of a cable television system serving various communities and contiguous areas surrounding the Santiam Valley, Oregon (the \"Santiam System\"). In May 1989, the Partnership acquired the cable television systems serving the communities and surrounding areas of La Conner, Washington (the \"La Conner System\") and the cable television systems serving the community of and contiguous areas surrounding Elko County and Carlin, Nevada (the \"Elko System\"). In April 1991, the Partnership sold the systems located in Elko County and Carlin, Nevada. In November 1994, the Partnership purchased a cable television system serving Aliceville, Alabama and several surrounding communities (the \"Aliceville System\"). In June 1995, the Partnership sold the Santiam System. As of December 31, 1995, the total number of basic subscribers served by the Systems was 9,336, and the Partnership's penetration rate (basic subscribers as a percentage of homes passed) was approximately 86% 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 15 non-exclusive franchises to operate the Systems. These franchises, which will expire at various dates through the year 2044 (with one franchise extending to 2044), have been granted by local and county authorities in the areas in which the Systems operate. Annual franchise fees are paid to the granting authorities. These fees vary between 3% and 5% and are generally based on the respective gross revenues of the Systems 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 La Conner, Washington and Aliceville, Alabama. The following is a description of these areas:\nLa Conner, WA: The La Conner System serves communities within three counties in northwestern Washington along Puget Sound. La Conner was predominately a fishing and farming community when founded in the late 1800's and temporarily became a major trading port. Today, La Conner has become a popular tourist area, with surrounding landscapes of pastoral farms and tulip fields. Its main street, featuring wooden decks and courtyards, runs along the Swinomish slough. The Swinomish Indian Reservation is located on the outskirts of La Conner. Certain information regarding the La Conner, WA System as of December 31, 1995 is as follows:\nBasic Subscribers 2,262 Tier Subscribers 1,101 Premium Subscribers 563 Estimated Homes Passed 2,630\nAliceville, AL: The Aliceville system serves the communities in west central Alabama. The communities, located south and west of Tuscaloosa, include Aliceville, Carrollton, Pickensville, Reform, Gordo, Millport, Kennedy, Eutaw and Marion. Certain information regarding the Aliceville, AL system as of December 31, 1995 is as follows:\nBasic Subscribers 7,074 Premium Subscribers 2,262 Estimated Homes Passed 8,250\nThe Partnership had 13 employees as of December 31, 1995. Management of these systems is handled through offices located in the towns of La Conner, Washington and Aliceville, Alabama. Pursuant to the Agreement of Limited Partnership, the Partnership reimburses the General Partner for time spent by the General Partner's accounting staff on Partnership accounting and bookkeeping matters. (See Item 13(a) below.)\nThe Partnership's cable television business is 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 the 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 certain satellite 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\". COMPETITION\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 the 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. Satellite 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 are 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 such 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. The 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 authorities 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, other 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 FCC'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 penetration 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 systems 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 La Conner, Washington and Aliceville, Alabama. 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 headend sites and buildings. The Partnership's cable plant passed approximately 10,880 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.)\nOn June 30, 1995, the Partnership sold the operating assets and franchise rights of its cable television systems serving eight communities in northwestern Oregon. This sale represented all of the Partnership's operations in the State of Oregon. The sales price was $5,800,000 which was received in cash by the Partnership on June 30, 1995.\nOn January 5, 1996, the Partnership acquired substantially all operating assets and franchise rights of the cable television system serving approximately 3,100 subscribers, in and around Swainsboro, Georgia. The purchase price was $6,056,326 of which $5,751,326 was paid at the closing date and the balance of $305,000 was deposited into an escrow account. Final payment from the escrow account, net of any purchase price adjustments, is due no later than May 4, 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNone. PART 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:\nLimited Partners: 969\nGeneral Partners: 1\n(c) During 1995 and 1994, the Partnership made no cash distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1995 AND 1994\nTotal revenue reached $3,529,252 for the year ended December 31, 1995, representing an increase of approximately 74% over 1994. This increase is primarily attributable to a full year of operations in the Aliceville, AL system in 1995. This revenue increase is offset by the disposition of the Santiam, OR system in June 1995. Of the 1995 revenue, $2,764,771 (78%) is derived from subscriptions to basic services, $325,894 (9%) from subscriptions to premium services, $60,241 (2%) from subscriptions to tier services, $98,881 (3%) from installation charges, $43,332 (1%) from service maintenance revenue, and $236,133 (7%) 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 $425,346 for the year ended December 31, 1995, representing an increase of approximately 97% over 1994. This increase is due to a full year of operations in the Aliceville, AL system offset by the disposition of operations in the Santiam, OR system in June 1995. The Aliceville, AL system represents approximately 74% of operations after giving effect of the Santiam, OR system disposition. Increases in salary and benefit costs also contributed to the overall increase in operating expenses. 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 the future.\nGeneral and administrative expenses totaled $923,079 for the year ended December 31, 1995, representing an increase of approximately 63% over 1994. This increase is due to a full year of operations in the Aliceville, AL system offset by the disposition of operations in the Santiam, OR system in June 1995.\nProgramming expenses totaled $761,428 for the year ended December 31, 1995, representing an increase of approximately 88% over 1994. This increase is due to a full year of operations in the Aliceville, AL system offset by the disposition of operations in the Santiam, OR system in June 1995. The remaining increase is due to higher agency sales commissions and increased costs charged by various program suppliers. As these costs are based on the number of subscribers served, future subscriber increases will cause the trend of programming expense increases to continue. In addition, rate increases from program suppliers, as well as new fees due to the launch of additional channels, will contribute to the trend of increased programming costs.\nDepreciation and amortization expense increased from $1,150,674 in 1994 to $1,372,628 in 1995 (approximately 19%). This is primarily due to a full year of depreciation and amortization on plant, equipment and intangible assets of the Aliceville, AL system offset by the reduction of depreciation and amortization expense on plant, equipment and intangible assets of the Santiam, OR system. Interest expense increased from $377,385 in 1994 to $775,213 in 1995 (approximately 105%). The Partnership's average bank debt balance increased from approximately $7,412,000 in 1994 to $8,109,000 in 1995, mainly due to the increased borrowings to finance the acquisition of the Aliceville, AL system. In addition, the Partnership's effective interest rate increased from 5.09% in 1994 to 9.55% in 1995.\nIn 1995, the Partnership generated net income of $2,669,199, including a gain of $3,391,978 from the sale of the Santiam system. Exclusive of this gain, the Partnership had a net loss of $722,779. The operating losses incurred by the Partnership historically are a result of significant non-cash charges to income for depreciation and amortization. Prior to the deduction for these non-cash items, the Partnership has generated positive operating income in each year in the three year period ending December 31, 1995. Management anticipates that this trend will continue, and that the Partnership will continue to generate net operating losses after depreciation and amortization until a majority of the Partnership's assets are fully depreciated.\n1994 AND 1993\nTotal revenue reached $2,030,906 for the year ended December 31, 1994, representing an increase of approximately 20% over 1993. This increase is primarily due to the acquisition of the Aliceville, AL system in November 1994. The partnership experienced a 3% increase in revenue exclusive of the activity for the Aliceville, AL system which is attributable to an approximate 3% increase in subscribers and a significant increase in service maintenance revenue. Of the 1994 revenue, $1,589,391 (78%) is derived from subscriptions to basic services, $201,365 (10%) from subscriptions to premium services, $57,939 (3%) from installation charges, $32,002 (1%) from subscriptions to tier services, $56,637 (3%) from service maintenance revenue, and $93,572 from other sources.\nOperating expenses totaled $215,405, representing an increase of approximately 23% over 1993. Approximately 20% of the increase is due to the addition of employees from the purchase of the Aliceville System and the remaining increase is attributable to higher salary and benefit costs.\nGeneral and administrative expenses totaled $566,674 for the year ended December 31, 1994, representing an increase of approximately 17% over 1993. Approximately 13% of the increase is due to the addition of employees from the purchase of the Aliceville System. The remaining net increase is attributable to higher salary and benefit costs offset by the transfer of employees from the LaConner System to an affiliate. The major components of general and administrative expense are salaries and benefits, and revenue based expenses such as management fees, copyright expenses and franchise fees. Therefore, as the Partnership's revenue increases, general and administrative expenses are expected to increase.\nProgramming expenses totaled $405,377 for the year ended December 31, 1994, representing an increase of approximately 39% over 1993. Approximately 20% of the increase is due to the higher costs charged by various program suppliers. Programming expenses mainly consist of payments made to the suppliers of various cable programming services.\nDepreciation and amortization expense increased from $1,094,460 in 1993 to $1,150,674 in 1994 (approximately 5%). This is mainly due to depreciation and amortization on plant, equipment and intangible assets acquired from the purchase of the Aliceville, AL system offset by certain intangible assets becoming fully amortized.\nInterest expense increased from $266,350 in 1993 to $377,385 in 1994 (approximately 42%). The Partnership's average bank debt balance increased from approximately $4,387,000 during 1993 to approximately $7,412,000 in 1994, mainly due to increased borrowing to finance the acquisition of the Aliceville, AL System. In addition, the Partnership's effective interest rate decreased from approximately 6.07% in 1993 to approximately 5.09% 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 subject 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 44% for the twelve months ended December 31, 1993 to 42% 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 12% of total subscribers have elected to certify and no formal requests for rate justifications have been received from franchise authorities. Based on Management's analysis, the rates charged by these systems are within the maximum rates allowed under FCC rate regulations.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995, the Partnership's primary source of liquidity was cash flow from operations and the sale of the Santiam system. 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. Proceeds from the system sale were used primarily to repay bank debt. 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.\nOn January 4, 1996, the Partnership refinanced its senior debt with its current lender to finance the acquisition of the Swainsboro, GA system. The amended credit facility increases the maximum available borrowings to $11,925,000. Under the terms of the agreement, no principal payments are required until March 31, 1998. Prior to this date, the outstanding balance cannot exceed specified levels which reduce quarterly through December 31, 1997. Quarterly principal payments will begin March 31, 1998 with a final payment due December 31, 2001.\nAs of the date of this filing, the Partnership's term loan balance was $11,675,000. Certain fixed rate agreements in effect as of September 30, 1995 expired during the fourth quarter of 1995, and the Partnership entered into new fixed rate agreements. Currently, the interest rates on the credit facility are as follows: $10,600,000 fixed at 8.86% under the terms of a swap agreement with the Partnership's lender, expiring January 11, 1998; and $1,075,000 at Libor based rate of 9.00% expiring June 30, 1996.\nAt December 31, 1995, the Partnership was required under the terms of its credit agreement to maintain certain financial ratios, including a Funded Debt to Annualized Cash Flow Ratio of 5.50 to 1 and Cash flow to Debt Service Ratio of 1.25 to 1, among other restrictions. 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. CAPITAL EXPENDITURES\nDuring 1995, the Partnership incurred approximately $480,000 in capital expenditures. These expenditures included channel additions, line extensions and initial phases of a system upgrade to 450 MHz in the LaConner, WA system. In the Aliceville, AL system, the capital expenditures included the addition of ad insertion equipment and headend equipment and the initial phases of a fiber optic interconnect of the Aliceville and Reform headends.\nManagement estimates that the Partnership will spend approximately $500,000 on capital expenditures in 1996. These expenditures include the purchase of ad insertion equipment and vehicle replacement in the LaConner, WA system. In the Aliceville, AL system, the capital expenditures include the completion of the Aliceville\/Reform fiber interconnect, the addition of new channels and the purchase of a vehicle. In the Swainsboro, GA system the capital expenditures include the addition of computer equipment for billing purposes.\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. PART 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 Yankees, 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. GARY 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 and 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 General Partner and affiliates during 1995 as indicated in Note 3 to the Notes to Financial Statements--December 31, 1995 (see Items 14(a)(1) and 13(a) below).\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 plus a preferred return. The natural person who exercises voting and\/or investment control over these interests is John S. Whetzell.\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 revolving credit and 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 5% of the gross revenues of the Partnership, not including revenues from any sale or refinancing of the Partnership's System. The Managing General Partner also receives reimbursement of normal operating and general and administrative expenses incurred on behalf of the Partnership.\nThe Partnership had an operating management agreement with Northland Cable Properties Seven Limited Partnership (\"NCP-Seven\"), an affiliated partnership organized and managed by Northland. Under the terms of this agreement, the partnership serves as the exclusive managing agent for one of NCP-Seven's cable systems and is reimbursed for certain operating and administrative costs.\nDuring 1994, NCP-Seven began serving as the executive managing agent for one of the Partnership's cable television systems and is reimbursed for certain operating and administrative expenses.\nCable Television Billing, Inc. (\"CTB\"), an affiliate of Northland, provides software installation and billing services to the Partnership's Systems.\nNorthland Investment Corporation (\"NIC\"), also an affiliate of Northland, acted as managing underwriter for the sale of the Partnership's limited partnership units. The Partnership paid NIC commissions, due diligence fees and other costs then distributed the remaining balance to selected broker-dealers which it had retained to sell the limited partnership units.\nSee Note 3 of the Notes to Financial Statements--December 31, 1995 for disclosures regarding transactions with the General Partner 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 Partner and its 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 Partner has 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 Partner specifying in general terms the subjects to be considered. In the event of a dispute between the General Partner 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. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) DOCUMENTS FILED AS A PART OF THIS REPORT:\nSEQUENTIALLY NUMBERED PAGE ------------ (1) FINANCIAL STATEMENTS:\nAuditors' 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 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--December 31, 1995................................................____\n(2) EXHIBITS:\n4.1 Amended and Restated Agreement of Limited Partnership(1)\n4.2 Amendment to Agreement of Limited Partnership dated December 20, 1990(4)\n10.1 Agreement of Purchase and Sale with Santiam Cable Vision, Inc.(1)\n10.2 Agreement for Sale of Assets between Valley Cable T.V., Inc. and Northland Telecommunications Corporation(1)\n10.3 Form of Services and Licensing Agreement with Cable Television Billing, Inc.(1)\n10.4 Management Agreement with Northland Communications Corporation(1)\n10.5 First, Second and Third Amendment to Agreement of Purchase and Sale with Santiam Cable Vision, Inc.(1)\n10.6 Operating Management Agreement with Northland Cable Properties Seven Limited Partnership(1)\n10.7 Assignment and Transfer Agreement with Northland Telecommunications Corporation for the purchase of the La Conner System(2)\n10.8 Gates Franchise(1)\n10.9 Stayton Franchise(1)\n10.10 Mill City Franchise(1)\n10.11 Detroit Franchise(1)\n10.12 Idanha Franchise(1) 10.13 Lyons Franchise(1)\n10.14 Marion County Franchise(1)\n10.15 Turner Franchise(1)\n10.19 Amendment dated August 4, 1989 to Revolving Credit and Term Loan Agreement with Security Pacific Bank of Washington, N.A.(3)\n10.20 Revolving Credit and Term Loan Agreement with National Westminster Bank USA dated as of December 20, 1990(4)\n10.21 Note in the principal amount of up to $7,000,000 to the order of National Westminster Bank USA(4)\n10.22 Borrower Assignment with National Westminster Bank USA(4)\n10.23 Borrower Security Agreement with National Westminster Bank USA(4)\n10.24 Agreement of Purchase and Sale with TCI Cablevision of Nevada, Inc.(4)\n10.25 First Amendment dated May 28, 1992 to Revolving Credit and Term Loan Agreement with National Westminster Bank USA.(5)\n10.26 Franchise Agreement with the City of Turner, OR effective March 21, 1991(5)\n10.27 Franchise Agreement with the City of Lyons, OR effective April 8, 1991(5)\n10.28 Franchise Agreement with the City of Idanha, OR effective November 3, 1992(5)\n10.29 Agreement of Purchase with Alabama Television Cable Company(6)\n10.30 Credit Agreement between Northland Cable Properties Eight Limited Partnership and U.S. Bank of Washington, National Association and West One Bank, Washington dated November 10, 1994(6)\n10.31 Franchise Agreement with City of Aliceville, AL - Assignment and Assumption Agreement dated July 26, 1994.(7)\n10.32 Franchise Agreement with City of Carrollton, AL - Assignment and Assumption Agreement dated August 16, 1994.(7)\n10.33 Franchise Agreement with City of Eutaw, AL - Assignment and Assumption Agreement dated July 26, 1994.(7)\n10.34 Franchise Agreement with City of Gordo, AL - Assignment and Assumption Agreement dated August 1, 1994.(7)\n10.35 Franchise Agreement with Greene County, AL - Assignment and Assumption Agreement dated November 10, 1994.(7)\n10.36 Franchise Agreement with Town of Kennedy, AL - Assignment and Assumption Agreement dated August 15, 1994.(7)\n10.37 Franchise Agreement with Lamar County, AL - Assignment and Assumption Agreement dated August 8, 1994.(7) 10.38 Franchise Agreement with City of Marion, AL - Assignment and Assumption Agreement dated August 1, 1994.(7)\n10.39 Franchise Agreement with Town of Millport, AL - Assignment and Assumption Agreement dated August 18, 1994.(7)\n10.40 Franchise Agreement with Pickens County, AL - Assignment and Assumption Agreement dated July 26, 1994.(7)\n10.41 Franchise Agreement with Town of Pickensville, AL - Assignment and Assumption Agreement dated August 2, 1994.(7)\n10.42 Franchise Agreement with City of Reform, AL - Assignment and Assumption Agreement dated August 1, 1994.(7)\n10.43 Asset Purchase and Sale Agreement between SCS Communications and Security, Inc. and Northland Cable Properties Eight Limited Partnership dated April 14, 1995.(8)\n10.44 Asset Purchase Agreement between Northland Cable Properties Eight Limited Partnership and TCI Cablevision of Georgia, Inc. dated November 17, 1995.(9)\n- --------------- (1)Incorporated by reference from the Partnership's Form S-1 Registration Statement declared effective on March 16, 1989 (No. 33-25892).\n(2)Incorporated by reference from the Partnership's Form 10-Q Annual Report for the period ended June 30, 1989.\n(3)Incorporated by reference from the Partnership's Form 10-K Annual Report for the year ended December 31, 1989.\n(4)Incorporated by reference from the Partnership's Form 10-K Annual Report for the year ended December 31, 1990\n(5)Incorporated by reference from the Partnership's Form 10-K Annual Report for the year ended December 31, 1992.\n(6)Incorporated by reference from the Partnership's Form 8-K dated November 11, 1994.\n(7)Incorporated by reference from the Partnership's Form 10-K Annual Report for the year ended December 31, 1994.\n(8)Incorporated by reference from the Partnership's Form 10-Q Annual Report for the period ended March 31, 1995.\n(9)Incorporated by reference from the Partnership's Form 8-K dated January 5, 1996.\n(B) REPORTS ON FORM 8-K. No Partnership reports on Form 8-K have been filed during the fourth quarter of the fiscal year ended December 31, 1995. 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.\nNORTHLAND CABLE PROPERTIES EIGHT 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 EIGHT LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994 TOGETHER WITH AUDITORS' REPORT [ARTHUR ANDERSEN LLP LOGO]\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Northland Cable Properties Eight Limited Partnership:\nWe have audited the accompanying balance sheets of Northland Cable Properties Eight 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 Eight 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 ANDERSEN LLP\nSeattle, Washington, January 24, 1996 NORTHLAND CABLE PROPERTIES EIGHT 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. NORTHLAND CABLE PROPERTIES EIGHT 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. NORTHLAND CABLE PROPERTIES EIGHT 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. NORTHLAND CABLE PROPERTIES EIGHT LIMITED PARTNERSHIP\nBALANCE SHEETS -- DECEMBER 31, 1995 AND 1994\nASSETS\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes are an integral part of these balance sheets. NORTHLAND CABLE PROPERTIES EIGHT LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n1. ORGANIZATION AND PARTNERS' INTERESTS:\nFormation and Business\nNorthland Cable Properties Eight Limited Partnership (the Partnership), a Washington limited partnership, was formed on September 21, 1988. The Partnership was formed to acquire, develop and operate cable television systems. The Partnership began operations on March 8, 1989 by acquiring cable systems serving various communities southeast of Salem, Oregon. Additional acquisitions include systems serving the city of La Conner, Washington and certain surrounding areas; and Aliceville, Alabama and certain surrounding areas. The Partnership has 15 nonexclusive franchises to operate these cable systems for periods which will expire at various dates through 2019, with one franchise extending to the year 2044.\nNorthland Communications Corporation is the General Partner of the Partnership (the General Partner or Northland). Certain affiliates of the Partnership also own and operate other cable television systems. In addition, Northland manages cable television systems for other limited partnerships for which it is General Partner.\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.\nNorthland contributed $1,000 to acquire its 1% interest in the Partnership.\nPursuant to the Partnership Agreement, brokerage fees of $1,004,693 paid to an affiliate of the General Partner and other offering costs of $156,451 paid to the General Partner were recorded as a reduction of limited partners' capital.\nOrganization Costs\nOrganization costs originally included reimbursements of $113,913 to the General Partner for costs incurred on the Partnership's behalf and a fee of $621,952 as compensation for selecting and arranging for the purchase of the cable television systems. Amounts recorded as organization costs have been reduced subsequent to the sale of certain cable television systems. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nDepreciation\nDepreciation of property and equipment is provided using the straight-line method over the following estimated service lives:\nBuildings 20 years Distribution plant 10 years Other equipment 5-10 years\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 noncompetition agreements and other intangibles and franchise costs; then the excess was allocated to goodwill.\nIntangible Assets\nCosts assigned to franchise and noncompetition agreements, organization costs and goodwill are being amortized using the straight-line method over the following estimated useful lives:\nFranchise agreements 2-40 years Organization costs 5 years Noncompetition agreements and other intangibles 2-10 years Goodwill 40 years\nRevenues\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 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. 3. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES:\nManagement Fees\nThe General Partner receives a fee for managing the Partnership equal to 5% 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 $175,475, $101,545 and $84,742 for 1995, 1994 and 1993, respectively.\nIncome Allocation\nAs defined in the limited partnership agreement, the General Partner is allocated 1% and the limited partners are allocated 99% of partnership net income, net losses, deductions and credits from operations until such time as the limited partners receive aggregate cash distributions equal to their aggregate capital contributions, plus the limited partners' preferred return. Thereafter, the General Partner will be allocated 20% and the limited partners will be allocated 80% of partnership net income, net losses, deductions and credits from operations. Cash distributions from operations will be allocated in accordance with the net income and net loss percentages then in effect. Prior to the General Partner receiving cash distributions from operations for any year, the limited partners must receive cash distributions in an amount equal to the lesser of i) 50% of the limited partners' allocable share of net income for such year or ii) the federal income tax payable on the limited partners' allocable share of net income on the then highest marginal federal income tax rate applicable to such net income.\nThe limited partners' total initial contributions to capital were $9,568,500 ($500 per limited partnership unit). As of December 31, 1995, the Partnership has repurchased $12,500 of limited partnership units (50 units at $250 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 $225,798, $144,956 and $125,461 for 1995, 1994 and 1993, respectively.\nIn 1995, 1994 and 1993, the Partnership paid software installation charges and billing service fees to an affiliate, amounting to $27,336, $30,025 and $13,641, respectively. For approximately three months in 1994 and all of 1993, the Partnership had an operating management agreement with an affiliate managed by the General Partner. Under the terms of the agreement, the Partnership served as the executive managing agent for the affiliate's cable television systems and was reimbursed for certain operating and administrative expenses. The Partnership received $81,750 and $195,994 under the terms of this agreement during 1994 and 1993, respectively.\nBeginning in 1994, the Partnership has entered into an operating management agreement with an affiliate managed by the General Partner. Under the terms of this agreement, the affiliate serves as the executive managing agent for certain of the Partnership's cable television systems and is reimbursed for certain operating and administrative expenses. The Partnership paid $12,394 and $13,135 under the terms of this agreement during 1995 and 1994, 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 the management and training of local sales staffs. CAC billed the Partnership $5,294 and $0 in 1995 and 1994, respectively, for these services. Additionally, in 1995, the Partnership was billed $35,409 for equipment purchased by CAC on its behalf.\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:\nReplacements, renewals and improvements are capitalized. Maintenance and repairs are charged to expense as incurred.\n5. NOTES PAYABLE:\nNotes payable consist of the following:\nOn January 4, 1996, the Partnership entered into an amended and restated credit agreement to increase its existing debt with U.S. Bank of Washington National Association to $11,925,000. The Partnership will use the additional proceeds to finance the acquisition of a cable system in Swainsboro, Georgia (the Swainsboro System), and provide working capital (see Note 8).\nThe balance outstanding under the credit facility, including the purchase of the Swainsboro System is $11,675,000. Under the terms of the agreement, no principal payments are required until March 31, 1998. Prior to this date, the outstanding balance cannot exceed specified levels (currently $11,925,000), which reduce quarterly through December 31, 1997 to $10,925,000. Based on the current outstanding balance of $11,675,000, the Partnership would be required to pay $750,000 by December 31, 1997.\nAnnual maturities of notes payable after December 31, 1995 are as follows:\nUnder the terms of the amended and restated credit agreement, the Partnership has agreed to restrictive covenants which require the maintenance of certain ratios, including a Funded Debt to Annualized Cash Flow Ratio of 5.50 to 1 and Cash Flow to Debt Service Ratio of 1.25 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 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.\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 loss to the limited partners was approximately $2,335,000, $382,000 and $696,000 in 1995, 1994 and 1993, respectively, 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 loss 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. No losses will be allocated to limited partners with negative basis.\nIn addition, 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 $80,138, $41,308 and $32,171 in 1995, 1994 and 1993, respectively.\nMinimum lease payments to the end of the lease terms are as follows:\nEffects 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. On 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 affect 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.\n8. CABLE TELEVISION SYSTEM ACQUISITION AND DISPOSITION:\nIn November 1994, the Partnership completed its purchase of certain operating assets and franchises of cable television systems owned by Alabama Television Cable Company (ATCC). These systems currently serve the communities of Millport, Kennedy, Aliceville, Pickinsville, Carrollton, Reform, Gordo, Eutaw, Marion and other nearby areas in Lamar, Pickens, Perry and Greene counties. The purchase price was $7,175,000. At the time of closing, the Partnership paid $6,375,000 to ATCC. The remaining purchase price was in the form of an unsecured, subordinated, non-interest bearing, hold-back note payable. In June 1995, the Partnership paid approximately $606,000, net of purchase price adjustments, to settle the note payable.\nOn June 30, 1995, the Partnership sold the operating assets and franchise rights of its cable television system serving eight communities in northwestern Oregon (the Oregon systems). This sale represented all of the Partnership's operations in the state of Oregon. The sales price was $5,800,000 and the proceeds were used to reduce the outstanding credit facility, repay the unsecured, subordinated, non-interest bearing, hold-back seller note and noncompete agreement related to the acquisition of the Aliceville, Alabama system, and reimburse the General Partner for deferred management fees and operating costs.\nPro forma, operating results of the Partnership for 1995 and 1994, assuming the acquisition and disposition of the systems described above had been made at the beginning of the respective periods, follow. Since the ATCC systems were owned by the Partnership for all of 1995 the only pro forma adjustments made to the 1995 results were to reflect the sale of the Oregon systems.\n9. SUBSEQUENT TRANSACTION:\nOn November 17, 1995, the Partnership entered into an agreement to acquire certain operating assets and franchise rights of the cable television systems in or around the community of Swainsboro, Georgia. The Swainsboro System was owned by TCI Cablevision of Georgia, Inc. The assets were acquired on January 5, 1996 for the purchase price of $6,056,326. Of the total purchase price, $5,751,326 was paid at the closing date and the balance of $305,000 was deposited into an escrow account, which shall be available to the seller 120 days after the closing date, net of any purchase price adjustments.\nPro forma, operating results of the Partnership for 1995 and 1994, assuming the acquisition of the system described above had been made at the beginning of the respective periods, follow. These pro forma results also include the pro forma effect of the acquisition and disposition described in Note 8, above.","section_15":""}
{"filename":"792969_1995.txt","cik":"792969","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nThe Company was incorporated in 1976 and is one of the leading independent companies specializing in the design, manufacture, packaging, marketing and distribution of guest amenity programs to the travel and lodging industry in the United States and abroad. The Company's guest amenity programs feature a wide variety of nationally branded toiletries, personal care products and accessories which travel and lodging establishments provide for the comfort and convenience of their guests.\nThe Company is also a leader in providing customized sample-size and unit-of-use packaging products and services to companies in the toiletries, cosmetics, pharmaceuticals and household products industries for such purposes as marketing promotions and retail sales.\nMarietta American, Inc. (\"Marietta American\"), a wholly owned subsidiary of the Company, is one of the largest manufacturers of private label miniature bar soaps for the travel and lodging industry. Marietta American specializes in customized soap products for the lodging, airline and cruise ship markets. In addition, Marietta American sells soap products to the cosmetics, consumer goods and healthcare industries and to institutional and industrial markets including health spas, schools and restaurants.\nThe Company also has a wholly owned Canadian subsidiary, Marietta Canada Inc. (\"Marietta Canada\"), which services the Canadian marketplace in a way which is similar to the operations of Marietta in the United States. In fiscal 1995 and 1994, net sales for Marietta Canada were less than 10% of the Company's total sales. Net sales for Marietta Canada in fiscal 1993 were approximately 10% of total sales for Marietta. See Note 13 of Notes to Consolidated Financial Statements.\nUnless otherwise noted, all references herein to \"Marietta\" or the \"Company\" include Marietta and its wholly owned subsidiaries, Marietta American and Marietta Canada.\nPRODUCTS AND SERVICES\nThe Company's guest amenity programs include hair care products, soaps, lotions, bath products, fragrances, mouthwash and other dental care products, sewing kits, shoe care products, shower caps and decorative display units. Well-known nationally-branded products are integral components of Marietta's amenities programs. These include Flex & Go(TM) Shampoo and Conditioner (Revlon), Vaseline(R) Intensive Care(R) Lotion (Chesebrough-Pond's), Listermint(R) Mouthwash (Warner-Lambert), Woolite Cold Water Wash (Reckitt & Coleman Household Products), Andrew Jergens soaps, and H\\\\2\\\\O Plus(R) (H\\\\2\\\\O Plus) hair and cleansing bar products.\nCustomized guest amenity programs marketed by Marietta to major hotel chains assist in providing a uniform theme throughout the chain. Such programs typically consist of several items packaged and presented in Company-designed bottles, tubes, packets and boxes that display the name and logo of the hotel establishment.\nThe Company also provides customized guest amenity programs for major hotel chain franchisees having independent buying power as well as for independent hotel establishments. Such programs generally entail design and packaging to complement the guest room decor and the image of the particular lodging establishment.\nAs an alternative to customized guest amenity programs, Marietta markets its own lines of guest amenity programs, including a broad line of 20 items under the \"Fleur de Lis\" label and over 40 products under Marietta's \"Lord and Mayfair(R),\" \"Leisure,\" \"The Executive Collection\" and \"Sun and Sand\" labels. Such\nPage 3 of 65\nprograms are suitable for a variety of decors and adequate inventory is maintained and available for prompt delivery.\nMarietta produces an extensive assortment of customized packages, and performs a variety of packaging services, for companies primarily in the toiletries, cosmetics, household products and over-the-counter pharmaceuticals industries. Marietta's products and services are used by such companies principally for new product introductions, promotional purposes and retail distribution. The Company's services permit consumer products companies to limit their market risks and capital expenditures while employing a variety of sampling methods and packaging alternatives.\nMarietta creates, designs and manufactures packages, such as flexible packets, bottles, tubes and die-cut packets, for many products including creams, flakes, liquids, lotions, ointments, powders, pills and tablets. Marietta works with its customers to design attractive, durable and easily usable customized packages which retain the integrity of the products being packaged. The Company also manufactures and fills packages requiring innovative and specialized equipment and tooling. Marietta has successfully developed manufacturing technologies in connection with its sample-size and unit-of-use packaging and services. Such technologies enable Marietta to produce die-cut packets in a multiple of shapes and sizes, to produce \"magazine insert\" packets able to withstand pressure of up to 3000 pounds per square inch, to pump difficult products and to develop packaging materials for \"hard-to-hold\" products. Marietta uses bulk products supplied primarily by major consumer products companies except that the bar soap produced by Marietta American is used to fill most of the Company's soap requirements.\nFor the fiscal years 1995, 1994, and 1993 the portion of the Company's net sales attributable to guest amenities was 62.6%, 59.0%, and 57.4%, respectively, and the portion of the Company's net sales attributable to customized sample-size and unit-of-use packaging products and services, and soap manufacturing for consumer products companies, was 37.4%, 41.0%, and 42.6%, respectively.\nMarietta American has been a leader in creative packaging of bar soap for the travel and lodging industry and offers a wide variety of soap formulations, colors, fragrances, and bar shapes and sizes, as well as packaging options including cellophane wrap and tissue pleat packaging.\nThe Company's manufacturing takes place at its facilities in Cortland, New York, Olive Branch, Mississippi, and Toronto, Ontario, Canada under strict quality assurance procedures. At its Cortland facility, Marietta uses sophisticated machinery designed and engineered by the Company. Marietta American's facility in Olive Branch uses technologically advanced equipment for both the processing and the finishing of its soap products. Marietta Canada allows Marietta to provide manufacturing operations in one location in Toronto similar to those in the United States. Management believes that the Company has sufficient production capacity to meet its current needs and its anticipated growth.\nCUSTOMERS\nMarietta's guest amenity customers are national and international hotel chains, franchisees of hotel chains, independent hotels, cruise lines, hospitals and other health care facilities and schools. Marietta provides its services to many of the major hotel chains including Best Western, Choice Hotels, Days Inn, Embassy Suites, Holiday Inns, Howard Johnson, Marriott Hotels, Radisson Hotels, Red Lion Inns and Sheraton Hotels. Many independent hotels are also among the Company's customers including Bally's(TM) Casino Hotels, Kingsmill Resort in Virginia, El Dorado Hotel & Casino in Nevada, and the Royal Waikoloan. The Company's contracts with its customers generally provide for terms ranging from six months to two years, for fixed prices with escalation clauses for increases in costs of raw materials and for specified shipments over the life of the contract.\nMany major consumer product companies rely upon independent packagers such as Marietta to provide high quality, economical packaging services to meet the demand for distributable samples at retail outlets, by mail or as magazine, brochure or catalog inserts. The demand for sample-size and unit-of-use packages by such companies has had a favorable impact on the market for Marietta's products and services.\nPage 4 of 65\nMarietta has designed and customized sample-size and unit-of-use packaging and services for many of the nation's leading consumer products companies. Included among its customers are Chesebrough-Pond's, Cosmair, Colgate-Palmolive Co., Coty, Eastman Kodak, Estee Lauder, Johnson & Johnson, Procter & Gamble, Revlon, Schering-Plough and Warner Lambert.\nMARKETING AND SALES\nThe Company's marketing strategy emphasizes sales of guest amenity programs and sample-size and unit-of-use packaging and products and services on a single source basis utilizing the cost efficient technology and systems developed by the Company. Marietta believes it has a reputation for designing and manufacturing innovative products of superior quality and for providing prompt, professional customer service.\nThe Company's marketing activities with respect to its guest amenity programs are coordinated by its Vice President of Marketing who is responsible for Guest Amenity direct sales personnel at corporate headquarters and throughout the country. The Company markets to over 350 independent distributors in the western hemisphere through the Company's sales personnel whose activities are coordinated by the National Sales Manager of Guest Amenity Sales who reports to the Vice President of Marketing. The Company employs a separate sales force for Marietta Canada consisting of a sales manager and three sales representatives. Marietta advertises its products and services in trade publications and catalogs and engages in direct mail solicitation. The Company also employs a telemarketing effort to contact individual hotels and attends trade shows.\nThe Company's marketing and sales activities with respect to its sample-size and unit-of-use packaging and services are coordinated by its Senior Vice President of Marketing and Sales who is responsible for direct sales personnel. Marietta Canada employs a separate sales force for its sample-size and unit-of-use products consisting of a member of senior management and one sales representative.\nDESIGN\nThe Company considers its package and graphics design capabilities to be an integral element of its business. Marietta has developed several important design innovations that have made it a recognized leader in its field. Marietta's designers assist customers in the creation and development of the components, graphics, colors, products and presentation methods used in their guest amenity programs.\nThe Company consults with its consumer products customers to design customized packaging which is attractive, durable, easily usable and which retains the integrity of the products being packaged. Marietta also engineers and adapts its machinery to create innovative packaging and to develop filling capabilities which meet customers' specialized requirements.\nSUPPLY CONTRACTS\nThe Company has agreements with certain manufacturers of personal care products to package, market and distribute their products to the travel and lodging industry. The Company believes that there are adequate alternative sources of supply available for all products it manufactures, packages and distributes. Moreover, Marietta believes that its success is determined more by the overall quality of its products and services than by the availability of any specific brand-name products.\nQUALITY ASSURANCE\nMarietta believes that maintaining the highest standards of quality is important to generating customer satisfaction and to maintaining its competitive position. The Company's operations are subject to regular quality inspections by its personnel. In addition, the Cortland plant, equipment, personnel and record keeping are periodically reviewed and inspected by United States Food and Drug Administration (\"F.D.A.\") officials, as well as by the Company's customers. The Company's Canadian operation is periodically reviewed by the Canadian Health Protection Branch (\"H.P.B.\"). The Company's procedures include strict adherence to the current Good Manufacturing Practices of the F.D.A. and the H.B.P.\nPage 5 of 65\nMarietta's commitment to quality assurance includes sampling and laboratory testing of bulk products prior to packaging and of finished goods prior to delivery.\nCOMPETITION\nMarietta has many competitors in the guest amenity and customized sample-size and unit-of-use packaging businesses, some of which have more extensive production and marketing capabilities, as well as substantially greater financial resources, than the Company. In addition, many consumer products companies have in-house packaging capabilities to meet their sample-size and unit-of-use packaging and services requirements; however, the Company believes that major consumer products companies will continue to use independent packagers such as Marietta for the promotion of their products in order to minimize capital expenditures and maximize production flexibility.\nMarietta believes that the factors which affect its business include price, cost, packaging expertise, quality assurance standards, research and development, and distribution capabilities. Such factors are relevant to both the Company's guest amenity and customized sample-size and unit-of-use packaging products and services. The Company believes that its creative approach to the design, manufacture, marketing and distribution of its products and services, its quality assurance standards, its research and development capabilities and the combination of such elements enable it to compete effectively. In addition, Marietta endeavors to competitively price all of its products and services.\nThe Company believes that the continuous modernization and expansion of its manufacturing facilities has been an important factor in enabling its guest amenity and customized sample-size and unit-of-use packaging products and services to remain competitive.\nREGULATORY REQUIREMENTS\nThe Company is subject to the jurisdiction of the F.D.A., the New York State Department of Agriculture and Markets, the United States Environmental Protection Agency, and the H.P.B. The Company also complies with the laws and regulations of the States of New York and Mississippi and the province of Ontario relating to land use in connection with its manufacturing and packaging operations. The Company believes that it is in material compliance with applicable regulatory requirements including applicable environmental laws.\nEMPLOYEES\nAs of September 30, 1995, the Company employed a total of 721 full-time employees of whom 58 were in sales and marketing, 600 were in manufacturing, quality assurance and distribution, and 63 were in general administration. The Company considers its relationship with its employees to be good.\nSEASONALITY\nThe Company's guest amenity business is subject to some fluctuation in results reflecting the seasonal nature of the travel and lodging industry. As a consequence, the revenues from the Company's guest amenity business in its third and fourth fiscal quarters tend to be higher than during the rest of the year.\nPage 6 of 65\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nMarietta utilizes approximately 164,000 square feet of manufacturing, warehouse and office space in three connected buildings located on approximately five acres of land in Cortland, New York. The Company owns two buildings of approximately 37,000 and 52,000 square feet and leases the third building of approximately 75,000 square feet from the Cortland County Industrial Development Agency, a public benefit corporation (the \"Agency\"). The lease was entered into in December 1986 in connection with a fifteen year $2,500,000 Industrial Revenue Bond (the \"1986 IRB\") financing extended by the Agency to assist the Company in constructing, on its land, a new facility of approximately 75,000 square feet which provided the Company with expanded manufacturing, warehouse and office facilities. The lease provides for rental payments equal to the debt service payments required under the 1986 IRB financing and for the purchase of the premises by the Company for $1.00 at the end of the lease term, which expires in December 2001. The Company believes it is utilizing its facilities to meet effectively its current production requirements.\nMarietta American utilizes approximately 176,000 square feet of manufacturing, warehouse and office space at its facility located on approximately ten acres in Olive Branch, Mississippi. Marietta American owns a 72,600 square foot building and leases from DeSoto County, Mississippi (\"DeSoto County\") a 103,800 square foot building at such location. The lease was entered into in connection with the refinancing, through the issuance of $4,875,000 aggregate principal amount of DeSoto County Industrial Development Revenue Bonds (the \"1988 Bonds\"), of all of the then outstanding Industrial Development Revenue Bonds issued by DeSoto County in 1985 (the \"1985 Bonds\"). The 1985 Bonds were issued to finance the expansion of Marietta American's manufacturing facility. The lease provides for basic rental payments equal to the debt service payments on the 1988 Bonds and supplemental rental payments equal to the expenses, liabilities and obligations with respect to the facility for which Marietta American is responsible under the lease. The lease further provides for the purchase by the Company of the financed addition to the facility for $100 at the end of the lease term which expires on December 1, 2008.\nThe Company leases approximately 90,000 square feet of manufacturing, warehouse and office space in Toronto, Ontario, Canada for the operations of Marietta Canada. The current lease is a five year lease commencing January 1, 1995 and expiring December 31, 1999.\nThe Company leases a sales office in Parsippany, New Jersey.\nThe Company believes that it has sufficient production capacity to meet its anticipated growth for the foreseeable future. See Item 1. - \"Business - Products and Services.\"\nThe property, plant and equipment of the Company are subject to various liens securing the Company's long-term debt. See Note 5 of Notes to Financial Statements.\nPage 7 of 65\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn or about November 24, 1992, an action was filed in the United States District Court for the Western District of Tennessee by Donald M. Rowe (\"Rowe\"), a former officer and director of the Company and a former shareholder of Marietta American, J. Donald Rowe, Masella B. Rowe, and California Soap Co. Inc. (\"Plaintiffs\") against the Company and John S. Nadolski (former President, Chief Executive Officer and a director of the Company). The complaint alleges, among other things, violations of certain federal and state securities and other laws as a result of alleged misrepresentations contained in or facts omitted from certain statements made by the Company in various documents, including documents filed with the Securities and Exchange Commission, and communications allegedly made in connection with the Company's acquisition of Marietta American and Plaintiffs' acquisition of shares of the Company's securities. The complaint also alleges breaches of Rowe's contractual rights and seeks money damages in an undetermined amount. Although no claims have been asserted by Huey L. Holden, a former shareholder of Marietta American, the Company has tolled the statute of limitations with respect to any claim by Mr. Holden against the Company arising from the acquisition of Marietta American.\nOn or about July 29, 1994, an action was commenced in the United States District Court for the Western District of Tennessee by Valley Products Co., Inc. (\"Valley Products\"), a vendor of guest amenity products, against Landmark, a division of Hospitality Franchise Systems, Inc., Hospitality Franchise Systems, Inc., (\"HFS\"), the Company, Guest Supply, Inc., Days Inn of America, Inc., Howard Johnson Franchise System, Inc., Ramada Franchise Systems, Inc., Super 8 Motels, Inc., Park Inns International, Inc., and TM Acquisitions, Inc. In the action it is alleged, among other things, that a preferred vendor agreement entered into by the Company and HFS (as the parent corporation of the franchisors named as defendants in the action) pursuant to which HFS agreed to recommend the Company to franchisees of such franchisors in the Western hemisphere as a preferred vendor of logoed guest amenity products, tortiously interfered with Valley Product's contracts and constituted an illegal tying and exclusive dealing arrangement in violation of federal and Tennessee state anti- trust laws, including Sections 1 and 2 of the Sherman Act and Sections 4 and 16 of the Clayton Act. The action seeks, among other things, a temporary injunction and a declaratory judgment prohibiting the enforcement of the preferred vendor agreement between the Company and HFS and money damages in an amount not less than $10 million dollars, to be trebled pursuant to Section 4 of the Clayton Act.\nOn or about September 12, 1994, B.N.P. Industries, Inc. d\/b\/a Savannah Soaps, also a vendor of guest amenity products, filed an action, similar to the action commenced by Valley Products, against the Company and the same other principal parties, in the United States District Court for the Southern District of Georgia, seeking money damages in an amount in excess of $100,000, to be trebled pursuant to Section 4 of the Clayton Act. This case was consolidated with the action commenced by Valley Products in the United States District Court for the Western District of Tennessee.\nA motion by the Company together with the other defendants to dismiss the action was granted by the District Court on or about December 22, 1994. The plaintiffs (Valley Products and Savannah Soaps), appealed the decision of the District Court. On or about July 27, 1995, Savannah Soap's motion to voluntary dismiss its appeal was granted.\nSee Note 15 of Notes to Financial Statements.\nPage 8 of 65\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\n(a) On August 31, 1995, Registrant held its Annual Meeting of Shareholders.\n(b) Dickstein Partners Inc. commenced a solicitation in opposition to management's nominees, but withdrew such solicitation prior to the Company's Annual Meeting of Shareholders.\n(c) At the Company's Annual Meeting of Shareholders, all of management's nominees were elected to the Board of Directors. The result of such vote was as follows:\n(d) Not applicable.\nPage 9 of 65\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 NASDAQ National Market System under the symbol MRTA. The table below sets forth the range of the high and low sale prices, as reported by the National Association of Securities Dealers, during each of the last two fiscal years.\n__________________________\nThe prices set forth above reflect inter-dealer prices without adjustment for retail markups, markdowns or commissions, and do not necessarily represent actual transactions.\nThe approximate number of holders of record of Marietta's Common Stock as of December 18, 1995 was 299.\nNo dividends have been declared with respect to the Company's Common Stock and the Company has no intention to pay cash dividends in the foreseeable future. Pursuant to one of the Company's loan agreements, the Company is limited in the amount of cash dividends it may declare to 50% of the Company's cumulative net income for each fiscal year commencing with its 1993 fiscal year.\nPage 10 of 65\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial information is derived from and should be read in conjunction with the financial statements, including the notes thereto, appearing in Item 8. - \"Financial Statements and Supplementary Data.\"\nPage 11 of 65\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nNet sales increased 6.1% in fiscal 1995 as compared to fiscal 1994. The increase of $4,176,000 was attributable to an increase in guest amenity sales of $5,095,000 partially offset by a decrease in custom packaging sales of $919,000. The increase in guest amenity sales was the result of increased sales volume. The decrease in custom packaging sales was attributable to a decrease in pricing and a change in product mix. Net sales increased 3.6% in fiscal 1994 compared to fiscal 1993. The increase of $2,386,000 was attributable to an increase in guest amenity sales of $2,468,000 with a slight decrease in custom packaging sales of $82,000. The increase in guest amenity sales from fiscal 1993 to 1994 was the result of increased sales volume.\nThe Company's gross profit decreased to 23.0% of sales in fiscal 1995 from 28.0% in fiscal 1994. Material cost for guest amenities increased significantly in fiscal 1995 as compared to 1994. This increase was attributable to higher than anticipated component costs for tallow, corrugate, bottles and packing film. In order to offset the resulting decline in gross profit, a price increase was put into effect on August 15, 1995. In addition, the Company's gross profit percentage decreased slightly as a result of a mechanical breakdown of certain of its soap manufacturing equipment during the second quarter of fiscal 1995. This necessitated the purchase of soap chips on the open market at higher costs to the Company. The Company also experienced delays in receiving customer- supplied materials for custom packaging which caused delays in shipment of finished product and resulted in reduced overhead absorption. In addition, changes in the product mix negatively impacted gross profits. The Company's gross profit increased to 28.0% of sales in fiscal 1994 from 26.7% in fiscal 1993. The increase was primarily due to product mix and the Company's continued efforts in improving production efficiencies. In particular, the Company's Canadian subsidiary operated at significantly improved margins.\nSelling, general and administrative expenses, as a percentage of sales, increased to 23.4% in fiscal 1995 from 22.1% in fiscal 1994. During fiscal 1995 the Company expensed $1,000,000 in connection with its retention of Goldman, Sachs & Co. as the Company's financial advisor and incurred additional legal and professional fees of approximately $763,000, primarily in connection with matters relating to the unsolicited proposal by Dickstein Partners to acquire the Company. Excluding the fee of the financial advisor and the additional legal and professional fees, selling, general and administrative expense would have been 21.0% of sales, or 1.1% lower than in fiscal 1994. This decrease was mainly attributable to the increase in sales. Selling, general and administrative expenses were 22.1% of sales in 1994 compared to 21.1% in fiscal 1993. This 1993 percentage is before giving effect to a non-recurring charge of $1,333,333 resulting from the settlement of a litigation. The increase in fiscal 1994 was primarily due to an increase in freight out expense associated with guest amenity sales and an increase in marketing expense due to a renewed focus in marketing. Selling, general and administrative expense for 1993, including such non-recurring charge, was 23.1% of sales.\nOther expense (income), net represents the netting of interest expense, investment income and other income and expense items. Other expense (income), net resulted in net income of $185,000 in fiscal 1995 compared to a net expense of $520,00 in fiscal 1994. This change is primarily attributable to a charge in fiscal 1994 of $713,000 resulting from a decline in the market value of certain cash equivalents and marketable securities. Investment income of $661,000 in fiscal 1995 compares favorably with $544,000 in fiscal 1994. This 21.5% increase was attributable to both higher funds available for investment and to better yields. Interest expense increased to $514,000 in fiscal 1995 compared to $447,000 in fiscal 1994. This increase was attributable to interest paid in connection with the settlement of a state income tax audit and to higher rates on the Marietta American's Industrial Development Bonds. Net miscellaneous income in fiscal 1995 was $38,000 as compared to $96,000 in fiscal 1994. Other expense, net resulted in a net expense of $520,000 in fiscal 1994 compared to a net income of $92,000 in fiscal 1993. This change is\nPage 12 of 65\nprimarily attributable to a charge of $713,000 resulting from the decline in market value of certain cash equivalents and marketable securities. Investment income of $544,000 in fiscal 1994 compares favorably with $508,000 in fiscal 1993. Interest expense increased slightly in fiscal 1994 to $447,000 compared to $438,000 in fiscal 1993. This increase was attributable to an increase in interest rates. Net miscellaneous income in fiscal 1994 was $96,000 as compared to $22,000 in fiscal 1993. This increase is primarily attributable to the sale of excess inventory components.\nThe Company's effective tax rate (benefit) for federal, state and foreign taxes was a 104.2% effective tax benefit in fiscal 1995 compared to an effective tax rate of 35.3% in 1994. In fiscal 1995 tax benefits were derived from the Company's foreign sales corporation, a change in the valuation allowance as relates to Marietta Canada, and Marietta Canada's net operating income not currently being taxed. The Company's effective tax rate was 41.1% in fiscal 1993. This rate was impacted by state and provincial franchise\/equity taxes and the inability to utilize a foreign loss as a carryback.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital decreased to $23,622,000 at September 30, 1995 from $25,142,000 at October 1, 1994. Cash provided by operating activities for 1995 and 1994 was $1,443,000 and $3,554,000 respectively. The $2,111,000 reduction in cash provided by operating activities in 1995 as compared to 1994 was caused primarily by the decrease in net income of $2,613,000 and the decrease in the cash collected on accounts receivable in 1995 compared to 1994, partially offset by the increase in accounts payable and accrued expenses. The cash used in investing activities in 1995 is comparable to 1994 and results primarily from capital expenditures. The increase in cash used in financing activities in 1995 compared to 1994 was caused by the purchase of treasury stock in 1995 of $56,000 and the collection of a common stock note receivable in 1994 (with no corresponding collection 1995) partially offset by a decrease in payments on long-term debt of $73,000.\nThe Company has a $12,000,000 revolving credit facility all of which was available as of September 30, 1995. The revolving credit portion of the facility expires in October 1996. Borrowings under the facility bear interest at the prime rate or, if elected by the Company, at an interest rate 1.1% above the LIBOR rate.\nManagement believes that the Company is in sound financial condition as evidenced by its total shareholders' equity of $46,498,000 versus its long-term debt of $7,129,000. Management believes that its current assets plus funds provided by operations and the Company's existing lines of credit and debt capacity are adequate to meet its anticipated capital and short-term needs. Management also believes that inflation has not had a material effect on its business. It is the Company's practice to review on an on-going basis the marketability of its inventory and the Company makes provision for inventory obsolescence as it deems appropriate.\nIn fiscal 1996 the Company expects to undertake capital improvements of approximately $3,000,000. In addition, the Company expects to enter into capital leases on a new computer system totalling approximately $1,500,000.\nThe Company is unable to determine the impact upon the Company's financial condition of an adverse determination, if any, in any action, proceeding or investigation arising out of the events discussed in Note 15 of the Notes to Financial Statements.\nPage 13 of 65\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage 14 of 65\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Marietta Corporation Cortland, New York\nWe have audited the accompanying consolidated balance sheets of Marietta Corporation and its subsidiaries as of September 30, 1995 and October 1, 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 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 Marietta Corporation and its subsidiaries as of September 30, 1995 and October 1, 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 discussed in Note 15 to the consolidated financial statements, there are legal proceedings that exist. The outcome of these matters and their impact on the consolidated financial statements cannot presently be determined.\nDeloitte & Touche LLP Rochester, New York November 14, 1995\nPage 15 of 65\nMARIETTA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of the financial statements.\nPage 16 of 65\nMARIETTA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the financial statements.\nPage 17 of 65\nThe accompanying notes are an integral part of the financial statements.\nPage 18 of 65\nMARIETTA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the financial statements.\nPage 19 of 65\nMARIETTA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF BUSINESS\nThe Company specializes in the design, manufacture, packaging, marketing and distribution of guest amenity programs to the travel and lodging industry. The Company also provides customized sample-size and unit-of-use packaging products and services to major consumer products companies for such purposes as marketing promotions and retail sales.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Marietta Corporation and its subsidiary companies, all of which are wholly owned. All significant inter-company balances and transactions have been eliminated.\nFISCAL YEAR END\nThe Company uses a 52-53 week fiscal year ending on the Saturday closest to September 30. Fiscal years for the financial statements included herein ended on September 30, 1995 (52 weeks), October 1, 1994 (52 weeks), and October 2, 1993 (53 weeks).\nFOREIGN CURRENCY TRANSLATION\nThe balance sheet of Marietta Canada Inc. has been translated into U.S. dollars at year end exchange rates while its income statement has been translated at average rates in effect during the year. Adjustments resulting from financial statement translations are included as an equity adjustment from foreign currency translation in shareholders' equity. Gains and losses from foreign currency transactions are included in other income.\nCASH EQUIVALENTS AND MARKETABLE SECURITIES\nThe Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nEffective October 2, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires that investments in debt and marketable equity securities be designated as held-to-maturity, trading, or available-for-sale.\nAll of the Company's marketable securities are classified as available-for-sale and are carried at fair value with the unrealized holding gains and losses, net of tax, reported as a separate component of shareholders' equity.\nCost is determined by the average cost method when computing realized gains or losses.\nThere is no cumulative effect resulting from the adoption of Statement of Financial Accounting Standards No. 115.\nINVENTORIES\nInventories are stated at lower of cost or market. Cost is determined on the first-in, first-out method.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is recorded at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the respective assets. When assets are retired or disposed of, the cost\nPage 20 of 65\nof accumulated depreciation is removed from the accounts and any resulting gain or loss is recognized in the period of disposal.\nAMORTIZATION\nThe Company is amortizing closing costs incurred relating to the Industrial Revenue Bonds, non-compete agreements with former officers of Marietta American Inc., direct acquisition costs, including the costs of certain\nlicensing and distribution contracts associated with the purchase of Marietta Canada, and the excess of cost over net assets acquired associated with the purchases of Marietta American and Marietta Canada. These costs are being amortized on the straight-line method over their respective lives, with the excess of cost over net assets acquired being amortized over 35 years. Amortization expense charged to operations amounted to $306,080, $413,975 and $402,651 for the fiscal years 1995, 1994, and 1993, respectively.\nINCOME TAXES\nEffective October 3, 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 tax rates in effect for the year in which the differences are expected to reverse. The cumulative effect of this accounting change for income taxes was to increase income by $336,596 ($0.09 per share) for the year ended October 1, 1994.\nPrior to fiscal 1994 the provision for income taxes, computed under APB Opinion 11, was based on earnings and expenses included in the accompanying consolidated statements of earnings. Deferred taxes were provided to reflect the tax effects of reporting earnings, expenses and tax credits in different periods for financial accounting purposes than for income tax purposes.\nInvestment tax credits are recognized on the flow-through method in the year they are utilized.\nEARNINGS PER SHARE\nEarnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding during the periods. No significant dilutive effect would result from the exercise of outstanding stock options, warrants, or convertible subordinated notes.\n2. MARKETABLE SECURITIES\nEffective October 2, 1994, the Company adopted the provisions of Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires certain investments in marketable debt and equity securities to be classified as either held-to-maturity, trading or available- for-sale.\nAt September 30, 1995, the Company's marketable securities were classified as available-for-sale and are stated at fair value with an unrealized holding gain of $191,772 less taxes of $65,202, included as a separate component of shareholders' equity until realized. The fair value of marketable securities is based on quoted market prices.\nAt October 1, 1994, marketable securities were reflected at the lower of cost or market.\nAs of October 1, 1994 marketable securities totaling $2,219,823 were reclassified from current to non-current since it was management's intention to hold these investments on a long term basis. The aggregate cost of these investments exceeded their aggregate market value by $670,681 at October 1, 1994 and, accordingly, the results of operations for 1994 include a net unrealized loss in that amount.\nPage 21 of 65\n3. INVENTORIES\nInventories consisted of the following:\nSEPTEMBER 30, 1995 OCTOBER 1, 1994 ------------------ --------------- Raw materials and supplies $ 4,568,609 $ 4,082,839 Finished goods 8,582,080 7,843,727 ----------- ----------- $12,626,817 $11,926,566 ----------- -----------\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of the following:\nSEPTEMBER 30, 1995 OCTOBER 1, 1994 ------------------ ---------------\nLand and land improvements $ 613,385 $ 604,935 Building and improvements 11,707,584 10,483,077 Computer and office equipment 3,555,721 3,383,597 Machinery and equipment 23,497,735 21,247,367 Molds 2,578,497 2,058,627 Vehicles 65,479 43,650 Construction in progress 174,396 558,466 ------------ ------------ 42,192,797 38,379,719\nAccumulated depreciation and amortization 19,030,213 16,192,235 ------------ ------------ $ 23,162,584 $ 22,187,484 ------------ ------------\nDepreciation expense charged to operations amounted to $3,010,358, $2,894,769, and $2,746,603 for the fiscal years 1995, 1994, and 1993, respectively. Computer and office equipment at September 30, 1995 and October 1, 1994 includes assets acquired under capital leases totaling $800,000. Accumulated depreciation relating to these assets was $680,000 and $520,000 respectively.\n5. LONG-TERM DEBT\nLong-term debt consisted of the following:\nSEPTEMBER 30, 1995 OCTOBER 1, 1994 ------------------ ---------------\nIndustrial Development Bonds, at various interest rates ranging from 5.5% to 7.35%, payable annually, due December 2001. $ 1,600,000 $ 1,775,000\nIndustrial Development Bond, interest at a percentage of prime (prime at October 1, 1994 was 7.75%), due December 2008. 4,875,000 4,875,000\nNew York State Urban Development loan, 3% interest rate, payable monthly through April 2001. 176,194 184,935\nCity of Cortland small cities community development block program, 6% interest rate, payable monthly through July 2011. 59,469 61,656\nHewlett Packard leases, early buyout option, interest rates ranging from 7.35% to 8.06% payable monthly through July 1996. 140,371 315,407\nOther 0 930 - ----- ------------ ------------ 6,851,034 7,212,928 Less: Current maturities (336,699) (361,894) - -------------------------- ------------ ------------ Net long-term debt $ 6,514,335 $ 6,851,034 ------------ ------------\nPage 22 of 65\nAs of September 30, 1995 the Company had available a $12,000,000 revolving line of credit facility. This facility charges an administrative fee of $15,000, and shall bear interest at the prime rate or, if elected by the Company, at an interest rate 1.1% above the London Interbank Offered Rate (\"LIBOR\").\nThe Company has, as of September 30, 1995, stand-by letters of credit outstanding with two banks for $1,734,019 and $5,125,428 which guarantee Industrial Development Bonds.\nThe Company has pledged as collateral under its various debt obligations certain of its assets, primarily property, plant and equipment.\nThe industrial revenue bonds and revolving credit loan agreement contain various restrictions which require the Company to obtain bank consent for capital acquisitions above certain levels and to maintain certain minimum ratios. Pursuant to the revolving credit loan agreement, the Company is limited in the amount of cash dividends it may declare. Relating to the Marietta American Industrial Development Bonds, the Company is required to deposit $100,000 quarterly with a bank. All amounts are restricted as to withdrawal by the Company until the $4,875,000 bonds have been repaid.\nThe aggregate annual maturities on long-term debt are as follows:\n6. CONVERTIBLE SUBORDINATED NOTE\nIn March 1989, in connection with the acquisition of Marietta American, the Company issued a 7% convertible subordinated note due March 17, 1999 in the principle amount of $300,000. The carrying value of the convertible subordinated note is $278,040 which represents the unamortized value of the original note discounted using an effective interest rate of 10%. The discount is being amortized over the life of the note using the interest method. Interest expense incurred on the note was $25,320 for each of fiscal years 1995, 1994, and 1993. Included in these amounts are amortization of bond discount of $4,320 in 1995, 1994 and 1993. The note is convertible into shares of common stock of the Company at $15 per share (subject to certain anti-dilution rights). If the note is not converted, the Company is required to make three equal annual installments of $100,000 in 1997, 1998 and 1999.\n7. STOCK OPTIONS, WARRANTS AND PURCHASE PLANS\nThe Company has in effect a 1986 Incentive Stock Option Plan, a 1986 Stock Option Plan and a 1986 Employee Stock Purchase Plan.\nUnder the 1986 Incentive Stock Option Plan, grants may be made to key management employees prior to April 1996, and the term of each option granted shall not exceed ten years from the date of grant.\nPage 23 of 65\nUnder the 1986 Stock Option Plan, grants may be made to key employees and independent contractors of the Company prior to April 1996, and the term of each option granted shall not exceed ten years from the date of grant. Stock options are granted at prices not less than 100% of the fair market value of common shares at the date of grant. In the case of options granted to holders of 10% or more of the Company's voting stock, the price will not be less than 110% of the fair market value at the date of grant.\nThe Company adopted the 1986 Employee Stock Purchase Plan for eligible employees of the Company. The purchase price of shares to employees will be 85% of the fair market value on the date the right to purchase is granted.\nThe number of options granted, exercised and forfeited during each of the three years in the period ended September 30, 1995 and the number of options exercisable and available for grant under these plans at September 30, 1995 are as follows:\nOf the 52,012 shares currently exercisable under the 1986 Stock Option Plan, 32,640 shares are exercisable at $12.25 per share, 3,333 shares are exercisable at $8.25 per share, 14,539 shares are exercisable at $8.00 per share and 1,500 shares are exercisable at $6.75 per share.\nPursuant to a \"Cash Bonus Agreement,\" the Company granted to its Chief Executive Officer cash-only stock appreciation rights for 90,000 shares of Common Stock, having a term of 10 years, (expiring in November, 2004), and based on an increase in the market value of the Common Stock above $7.00 per share. The maximum amount payable to the Chief Executive Officer pursuant to the Rights is $630,000. The rights vest through November 1997. All of the Rights would become exercisable immediately upon the occurrence of certain events, including the termination by the Company of the Chief Executive Officer's employment without cause or by reason of his death or disability, or upon a Change in Control of the Company. During fiscal 1995, the Company expensed $53,663 related to these stock appreciation rights.\nPursuant to a \"Shareholders' Rights Plan,\" on September 11, 1989 the Board of Directors of the Company declared a dividend distribution of one Right for each outstanding share of the common\nPage 24 of 65\nstock to shareholders of record at the close of business on September 11, 1989. In addition, new common stock certificates issued after September 11, 1989 will also have a Right attached to them. Each Right entitles the registered holder to purchase from the Company a unit consisting of one one-hundredth of a share (a \"Unit\") of Series A Participating Preferred Stock, par value $.01 per share (the \"Series A Preferred\"), at a Purchase Price of $110 per Unit, subject to certain anti-dilution provisions. The Rights will separate from the common stock only in the event it is determined an adverse person or group of affiliated or associated persons (as defined) has acquired, or obtained the right to acquire, beneficial ownership of a significant amount (as defined) of common stock of the Company. Each Right will then entitle the holder to receive, upon exercise, $220 worth of common stock (or in certain circumstances, cash, property or other securities of the Company). The Rights will expire on September 11, 1999 and may be redeemed by the Company in whole, but not in part, at a price of $.01 per Right. These Rights, which have a potentially dilutive effect, have been excluded from the weighted average shares computation since conditions related to the exercise of such Rights were not satisfied.\nIn 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 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.\nPursuant 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.\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.\n8. INCOME TAXES\nThe components of income (loss) before income taxes and the provision for income taxes by taxing jurisdiction were as follows:\nPage 25 of 65\nDeferred tax provision (credit):\nU.S. Federal $(365,031) $ (4,226) $ (104,700) Canadian Federal (160,218) - - --------- ---------- ---------- (525,249) (4,226) (104,700) --------- ---------- ---------- Total income tax provision (credit) $(135,696) $1,243,221 $1,007,498 --------- ---------- ----------\nExpenses in 1995, 1994 and 1993 for research and development costs were approximately $638,000, $682,000 and $1,098,000 respectively.\nThe effective federal income tax differs from the statutory federal income tax as follows:\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" effective October 3, 1993. This statement supersedes APB No. 11, \"Accounting for Income Taxes,\" which had been used by the Company since its inception. The cumulative effect of adopting SFAS No. 109 on the Company's financial statements was to increase income by $336,596 ($.09 per share) for the year ended October 1, 1994.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effect of significant items comprising the Company's net deferred tax liability as of September 30, 1995 and October 1, 1994 are as follows:\nPage 26 of 65\nThe change in the valuation allowance for deferred tax assets was a decrease of $160,200 and relates to benefits of tax depreciation at Marietta Canada. Management believes that it is more likely than not that these benefits will be realized.\nThe components of the deferred tax provision under APB No. 11 for 1993 are as follows:\n--------- Accelerated depreciation $(109,893) Inventory obsolescence reserve 267,030 Deferred compensation (85,046) Inventory uniform capitalization 46,896 Other, net (14,287) --------- Deferred tax provision: $ 104,700 ---------\nThe Internal Revenue Service has examined U.S. Federal income tax returns for the years 1988 through 1992, agreements have been reached for all material adjustments, and such adjustments have been included in the provision for income taxes.\nAt September 30, 1995, the Company had investment tax credit carryforwards for New York State purposes of approximately $775,000. These credits expire through September 2010.\nFor fiscal 1995, Marietta Canada utilized loss carryforwards of approximately $150,000 for federal income tax purposes. In addition, it began recognizing tax depreciation expenses of approximately $530,000 which was deferred until a period where its use was beneficial.\nUndistributed earnings of the Canadian subsidiary will not be subject to U.S. tax until distributed as dividends. Since it is the intention of management that all earnings be indefinitely reinvested in the foreign subsidiary, no provision will be made for any income tax on any such earnings.\nPage 27 of 65\n9. LEASES\nThe future minimum lease payments for operating lease agreements as of September 30, 1995 are as follows:\n1996 $347,579 1997 201,285 1998 107,340 1999 75,803 2000 16,490\nRent expense incurred under operating leases was $393,459, $584,655 and $766,306 for the fiscal years 1995, 1994, and 1993 respectively.\n10. COMMITMENTS AND CONTINGENCIES\nThe Company has employment agreements with certain officers and key employees which expire at various dates through December 1998. The aggregate commitment for future salaries at September 30, 1995, excluding bonuses, was approximately $1,965,000.\nPursuant to an employment agreement between the Company and a former officer, the former officer was to have received $553,000 as additional compensation when the agreement expired on February 9, 1994. This amount was fully accrued for as of that date, and remains fully accrued as of September 30, 1995. The Company and the former officer continue to defer without prejudice the payment of such amount pending the conclusion of the review of certain matters by the Board of Directors. If such additional compensation is paid to the former officer, the Company has agreed to pay interest thereon at a variable rate per annum equal to 1.35% above the three-month LIBOR in effect on the first business day of each calendar quarter, from February 10, 1994 through the day of payment.\nFor a period of five years ending in February 1994, the Company was required to make contingency payments to the former owners of Marietta American based upon Marietta American's profits on the sale of glycerine and its earnings before interest and taxes, in each case above certain threshold levels. Any payment would result in a direct increase in the amount of goodwill recorded in the transaction. No amounts were paid pursuant to these calculations for any of the last three years. In an action commenced by Donald M. Rowe, one of the former owners of Marietta American, and certain other persons, the calculations made by the Company are being contested. See Note 15 \"Legal Proceedings\".\n11. OTHER EXPENSE (INCOME), NET\nOther expense consisted of: 1995 1994 1993 --------- --------- ---------\nOther expenses (income): Investment income $(658,726) $(543,481) $(508,386) Interest expense 514,074 446,549 437,627 Unrealized loss on marketable securities - 713,490 - Miscellaneous income (40,649) (96,500) (20,807) --------- --------- --------- $(185,301) $ 520,058 $ (91,566) --------- --------- ---------\nPage 28 of 65\n12. COMMON STOCK - NOTES RECEIVABLE\nOn February 9, 1989 the Company sold shares of common stock held in treasury to certain officers and directors of the Company. The price per share was $12.25 and was paid to Marietta primarily by the delivery of promissory notes bearing interest, payable semi-annually, at a rate of 9% per annum with principal payable in one installment on February 9, 1994.\nThe Company has extended the maturity date of the promissory notes ($607,500) until February 9, 1996. Interest shall accrue on these promissory notes at a variable rate per annum equal to 1.35% above the three-month LIBOR in effect on the first business day of each calendar quarter. Interest on one note ($364,500 of principal) is payable in full on February 9, 1996, while interest on the other two notes ($243,000 of principal) is payable semi-annually.\n13. FOREIGN OPERATIONS\nInformation concerning the Company's domestic and Canadian operations after translation into U.S. dollars are summarized as follows for fiscal years 1995, 1994 and 1993:\n14. EMPLOYEE BENEFITS\nThe Company and its subsidiaries have a defined contribution plan for their employees. The Plan provides for voluntary employee contributions with limited matching contributions. The Company's matching contributions to the Plan for the fiscal years 1995, 1994 and 1993 were approximately $73,100, $83,900, and $90,200 respectively. The Company does not provide post-retirement benefits to its employees.\nThe Company and its subsidiaries have a Profit Sharing Incentive Program. Under the terms of this Program, which is based on net income before taxes, the Company's employees received approximately $0, $196,000 and $255,300 for the fiscal years 1995, 1994 and 1993 respectively.\nThe Company was required to adopt Statement of Financial Accounting Standard\nNO. 112, \"Employee's Accounting for Postemployment Benefits,\" for fiscal year 1995. This statement requires recognition of benefits provided by an employer to former or inactive employees after employment, but before retirement. The impact of adopting this standard did not have a material impact on the Company's financial position or results of operations.\nPage 29 of 65\n15. LEGAL PROCEEDINGS\nAn action has been commenced by a former owner of Marietta American (formerly American Soap Company, Inc.), and by California Soap, Inc. and two of its shareholders. This complaint alleges, among other things, misrepresentations and omissions in connection with the Company's acquisition of Marietta American, misrepresentations in and omissions from various financial and other statements made by the Company, breaches of contract and other violations of federal and state laws. This action seeks an unspecified amount of damages. No assurance can be given as to the outcome of this action, which could have a material adverse effect on the Company.\nOn or about July 29, 1994, an action was commenced in the United States District Court for the Western District of Tennessee by Valley Products Co., Inc. (\"Valley Products\"), a vendor of guest amenity products, against Landmark, a division of Hospitality Franchise Systems, Inc., Hospitality Franchise Systems, Inc., (\"HFS\"), the Company, Guest Supply, Inc., Days Inn of America, Inc., Howard Johnson Franchise System, Inc., Ramada Franchise Systems, Inc., Super 8 Motels, Inc., Park Inns International, Inc., and TM Acquisitions, Inc. In the action it is alleged, among other things, that a preferred vendor agreement entered into by the Company and HFS (as the parent corporation of the franchisors named as defendants in the action) pursuant to which HFS agreed to recommend the Company to franchisees of such franchisors in the Western hemisphere as a preferred vendor of logoed guest amenity products, tortiously interfered with Valley Product's contracts and constituted an illegal tying and exclusive dealing arrangement in violation of federal and Tennessee state anti- trust laws, including Sections 1 and 2 of the Sherman Act and Sections 4 and 16 of the Clayton Act. The action seeks, among other things, a temporary injunction and a declaratory judgment prohibiting the enforcement of the preferred vendor agreement between the Company and HFS and money damages in an amount not less than $10 million dollars, to be trebled pursuant to Section 4 of the Clayton Act.\nOn or about September 12, 1994, B.N.P. Industries, Inc. d\/b\/a Savannah Soaps, also a vendor of guest amenity products, filed an action, similar to the action commences by Valley Products, against the Company and the same other principle parties, in the United States District Court for the Southern District of Georgia, seeking money damages in an amount in excess of $100,000, to be trebled pursuant to Section 4 of the Clayton Act. This case was consolidated with the action commenced by Valley Products in the United States District Court for the Western District of Tennessee.\nA motion by the Company together with the other defendants to dismiss the action was granted by the District Court on or about December 22, 1994. The plaintiffs (Valley Products and Savannah Soaps), appealed the decision of the District Court. On or about July 27, 1995, Savannah Soap's motion to voluntary dismiss its appeal was granted. The remaining parties have submitted their respective briefs on the appeal. Oral argument has not yet been scheduled.\nOn October 27, 1995, an employee of the Company filed an action against the Company alleging race and sex discrimination. In the complaint, the employee seeks reinstatement to employee's former position with full back pay and benefits in an amount to be determined at trial; actual and compensatory damages of $150,000; punitive damages of $150,000; and reimbursement of all reasonable costs related to this action.\n16. MERGER AGREEMENT\nOn January 17, 1995, Dickstein Partners, Inc. made an unsolicited proposal to acquire the Company. Following the announcement of this proposal, the Board of Directors retained Goldman Sachs & Co. to assist the Company in reviewing financial alternatives available to the Company.\nThe agreement with Goldman Sachs & Co. requires the payment of at least $1,500,000. Of this amount, $1,000,000 has been expensed in fiscal 1995, $250,000 of which was paid upon signing and\nPage 30 of 65\n$750,000 of which is accrued as of September 30, 1995. The remaining minimum amount due of $500,000 is not accrued as of September 30, 1995 and will be provided for in fiscal 1996.\nOn August 26, 1995 the Company entered into an Agreement and Plan of Merger with corporations controlled by Barry W. Florescue. Under the terms of the agreement, all of the Company's outstanding stock (other than those shares beneficially owned by Mr. Florescue) will be acquired for $10.25 per share in cash.\nThe closing of this transaction is subject to several conditions, including: Mr. Florescue obtaining the financing necessary to complete the transaction; approval of the transaction by holders of at least 66 2\/3% of the Company's shares; and the Company having met certain specified levels of inventory and net current assets. As of September 30, 1995, this last condition has been satisfied. The agreement has a termination date of February 15, 1996.\nPage 31 of 65\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Marietta Corporation Cortland, New York\nWe have audited the consolidated financial statements of Marietta Corporation and its 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 14, 1995, which report includes an explanatory paragraph as to uncertainties because of legal proceedings; such report is included elsewhere in his Form 10-K. Our audits also included the consolidated financial statement schedule of Marietta Corporation and its subsidiaries, listed in Item 14(A)2. 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, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDeloitte & Touche LLP Rochester, New York November 14, 1995\nPage 32 of 65\nMARIETTA CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1995, OCTOBER 1, 1994 AND OCTOBER 2, 1993 _______\n(1) Change in Canadian exchange rate.\nPage 33 of 65\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ---------------------------------------------- ON ACCOUNTING AND FINANCIAL DISCLOSURE. --------------------------------------\nNone.\nPage 34 of 65\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT. ----------------------------------------------\n(a) DIRECTORS\nThe table below sets forth the names and ages of all the directors of the Company as of December 15, 1995. The term of each director expires at the next Annual Meeting of Shareholders and upon his successor being duly elected and qualified.\n___________________________\n(1) Member of the Audit Committee (2) Member of the Compensation Committee (3) Member of the Executive Committee (4) Member of the Nominating Committee (5) Member of the Stock Option Committee\nDuring the course of negotiations with Barry W. Florescue relating to the Merger, Mr. Florescue requested representation on the Board of Directors of the Company. See \"Item 12. - Security Ownership of Certain Beneficial Owners and Management -- Changes in Control.\" The Company believed that in light of Mr. Florescue's significant investment in the Company it was appropriate to offer Mr. Florescue representation on the Board of Directors. Accordingly, the Board determined to offer Mr. Florescue the opportunity to propose two nominees (acceptable to the Board of Directors) to a Board of Directors that would be expanded to nine members. Mr. Florescue accepted such offer and the Board of Directors agreed to nominate Mr. Florescue and Charles W. Miersch for election at the Company's 1995 Annual Meeting of Shareholders held on August 31, 1995. See Item 4. -\"Submission of Matters to a Vote of Security Holders.\"\nPage 35 of 65\nBusiness Experience for the past five years for the Company's directors is as follows:\nRobert C. Buhrmaster has been President, Chief Executive Officer and a director of Jostens, Inc., a publicly held manufacturer of school and recognition products, since 1994. From 1993 to 1994, he was President, Chief Operating Officer and a director of Jostens, Inc.; and from 1992 to 1993, he was Executive Vice President and Chief Staff Officer of Jostens, Inc. Until 1992, he was Senior Vice President of Corning, Inc., a manufacturer of specialty glass and related inorganic materials.\nRonald C. DeMeo has been Senior Vice President of Marketing and Sales of the Company since 1988, and Secretary of the Company since 1991.\nBarry W. Florescue is an independent businessman and private investor in a variety of industries. He has been Chairman of the Board, BMD Management Company, a management, accounting, and administrative services company since its inception in 1987; Chairman of the Board of Century Financial Group, Inc., a bank holding company (the owner of Century Bank, FSB a federal savings bank based in Sarasota, Florida), since 1989; and Chairman of the Board and Director of International Poultry Corporation, Inc., a publicly held operator and franchisor of retail prepared foods specializing in poultry, since August 1995.\nDominic J. La Rosa is President, Chief Executive Officer and a director of Lamour Division of EHS, Inc., a consumer products company. He was President, Chief Executive Officer and a director of J.B. Williams Co., Inc., a consumer products company, from 1993 until July 1995, and was President and Chief Executive Officer from 1993 to March 1995. From 1992 until 1993, he was a Management Consultant. From 1989 to 1992, he served as President, Aromatic Industries Division of The Mennen Company, a manufacturer of health and beauty aids.\nFrank Magrone has been Executive Vice President and Director of Maidenform Worldwide, Inc., a manufacturer of women's intimate apparel, since April 1995; prior to April 1995 he was President, Chief Operating Officer and a director of NCC Industries, Inc., a publicly held manufacturer of women's intimate apparel.\nCharles W. Miersch has been an Associate Dean of the University of Rochester (New York), since 1984. He has been Chairman of Century Bank, FSB, a federal savings bank based in Sarasota, Florida, since September 1991, and a Director of Century Financial Group, Inc., a bank holding company, since September 1991.\nLeonard J. Sichel is retired. He served as a director of the Company from 1992 to 1993. From 1989 to 1992, he was Vice Chairman and Chief Financial Officer of The Mennen Company, a manufacturer of health and beauty aids. Until 1989, he was Executive Vice President and Chief Financial Officer of The Mennen Company.\nStephen D. Tannen has been the Company's President and Chief Executive Officer since November 1994. He was a Management Consultant in 1994, served as President and Chief Operating Officer of Riddell Sports Inc., a publicly held manufacturer of athletic equipment, from 1992 to 1994, was a Management Consultant from 1990 to 1992, and was President, Chief Executive Officer and a director of TSS Ltd., a provider of in-store marketing services to consumer products companies, from 1988 to 1990.\nThomas D. Walsh has been the Company's Chairman of the Board since August 1995. He has been an Associate with Huver and Associates, Inc., a structured settlement company, since 1993. Prior to 1993, Mr. Walsh served as a Vice President of Tucker Anthony Incorporated, a stock brokerage firm.\nPage 36 of 65\n(b) EXECUTIVE OFFICERS OF THE REGISTRANT\nThe table below sets forth certain information regarding the executive officers of the Company as of December 15, 1995:\nEach of the executive officers serves at the pleasure of the Board of Directors and until his successor is elected and qualified subject, in certain cases, to the terms of employment agreements.\nBusiness experience for the past five years for the executive officers is as follows:\nStephen D. Tannen has been the Company's President and Chief Executive Officer since November 1994 and a Director since 1992. He was a Management Consultant in 1994, served as President and Chief Operating Officer of Riddell Sports Inc., a publicly held manufacturer of athletic equipment from 1992 to 1994, was a Management Consultant from 1990 to 1992, and was President, Chief Executive Officer and a Director of TSS Ltd., a provider of in-store marketing services to consumer products companies, from 1988 to 1990.\nRonald C. DeMeo has been Senior Vice President of Marketing and Sales and a Director of the Company since 1988, and Secretary of the Company since 1991.\nDavid P. Hempson has been Executive Vice President of Operations of the Company since 1993. Prior to 1993 he was Vice President of Operations of the Company.\nPhilip A. Shager has been a Vice President since 1995 and Chief Accounting Officer and Treasurer of the Company since 1993. Prior to 1993 he served as Group Controller of Pall Corporation, a publicly held manufacturer of industrial filtration products.\nThomas M. Fairhurst has been Vice President of Marketing of the Company since March 1994. He served as Director of Licensing and Rights Development of Western Publishing Company, Inc., a publisher of children's books and a manufacturer of children's games and toys from 1991 to 1994, was Director of Marketing for Creative Edge, Inc., a manufacturer of children's educational items from 1990 to 1991, and Director, New Ventures for Fisher-Price Toys, a publicly held manufacturer of children's toys, from 1988 to 1990.\nWallace B. Bruce has been Vice President of the Company and the general manager of Marietta American since October 1994. He served as President of Valley Products Co., Inc. a vendor of guest amenity products, in 1993 and was Executive Vice President of Valley Products Co. prior to 1993.\n(c) FAMILY RELATIONSHIPS\nThere are no family relationships among any of the directors or executive officers of the Company.\nPage 37 of 65\n(d) INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS\nMr. Florescue was an executive officer of eight affiliated entities that operated a total of nine fast food franchise restaurants. On January 31, 1991, such entities filed for protection under Chapter 11 of the United States Bankruptcy Code. With respect to two of such entities, the bankruptcy proceeding was dismissed and the restaurants closed. The franchisor repurchased six restaurants from five of such entities pursuant to confirmed plans of reorganization. One entity was reorganized and continues to operate a franchise.\n(e) COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\nBased solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Company by each person who, at any time during the fiscal year ended September 30, 1995, was a director, executive officer or beneficial owner of more than 10% of the Company's common stock, par value $.01 per share (the \"Common Stock\") with respect to the fiscal year ended September 30, 1995, and Forms 5 and amendments thereto furnished to the Company by such persons with respect to such fiscal year, and written representations from certain of such persons that no Forms 5 were required for those persons, the Company believes that during and with respect to the fiscal year ended September 30 1995, all filing requirements under Section 16(a) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), applicable to its directors, executive officers and the beneficial owners of more than 10% of the Company's Common Stock were complied with.\nPage 38 of 65\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ----------------------\nSUMMARY COMPENSATION TABLE\nThe following table sets forth the compensation paid by the Company for each of the Company's last three completed fiscal years to the two persons serving as Chief Executive Officer of the Company during fiscal year 1995 and the Company's other four most highly compensated executive officers at the end of fiscal year 1995 (such two persons serving as Chief Executive Officer of the Company and such other four executive officers being hereinafter referred to as the \"Named Executive Officers\"):\nSUMMARY COMPENSATION TABLE\n(1) The Company did not provide restricted stock awards or long-term incentive payouts to the Named Executive Officers during its last three completed fiscal years. (2) Amounts in this column for fiscal year 1995 represent (i) the Company's matching contributions under its 401(k) plan for fiscal year 1995 for Messrs. DeMeo, Hempson, Shager and Fairhurst in the amounts of $2,328, $1,760, $1,652, and $622, respectively, and (ii) premium payments on Company-provided term life insurance for fiscal year 1995 for Messrs. Seibert, Tannen, DeMeo, Hempson, Shager and Fairhurst in the amounts of $210, $875, $469, $739, $630, and $473, respectively. (3) Mr. Seibert resigned as Chief Executive Officer on November 11, 1994. (4) Mr. Tannen was elected Chief Executive Officer of the Company on November 14, 1994.\nPage 39 of 65\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table provides information concerning the grants of stock options and stock appreciation rights (\"SARs\") to each of the Named Executive Officers during fiscal year 1995:\n(1) The SARs granted to Mr. Tannen vest in three equal installments on November 8, 1995, November 8, 1996 and November 8, 1997. The maximum amount payable to Mr. Tannen pursuant to such SARs is $630,000. See \"Employment Agreements with Executive Officers\" below. The options granted to Mr. Fairhurst vest in three equal installments on April 5, 1996, April 5, 1997 and April 5, 1998, and were not awarded with tandem stock appreciation rights. Such options are non-qualified and were granted under the Marietta Corporation 1986 Stock Option Plan. Upon a change in control of the Company, such SARs and options shall be immediately exercisable. The number of shares of Common Stock subject to such SARs and options may be subject to adjustment in the event of certain changes in the Common Stock. (2) During fiscal year 1995, the Company granted to employees (i) options to purchase a total of 5,000 shares of Common Stock and (ii) SARs for 90,000 shares of Common Stock. (3) These assumed rates of appreciation are provided in order to comply with requirements of the Securities and Exchange Commission, and do not represent the Company's expectation as to the actual rate of appreciation of the Common Stock. The actual value of the options will depend upon the performance of the Common Stock, and may be greater or less than the amounts shown.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION\/SAR VALUES\nThe following table provides information concerning the exercise of stock options and stock appreciation rights during fiscal year 1995 by each of the Named Executive Officers and the fiscal year-end value of unexercised options and SARs held by each of the Named Executive Officers:\nPage 40 of 65\n(1) The amounts listed in these columns indicate the number and value of unexercised options and SARs held by each of the Named Executive Officers as of September 30, 1995. (2) Options are \"in-the-money\" if, on September 30, 1995, the market price per share of the Common Stock exceeded the exercise price per share of such options. On September 30, 1995, the market price per share, as reported on the NASDAQ National Market System, was $8.125 per share. The value of such in-the- money options is calculated by determining the difference between the aggregate market price of the Common Stock covered by the options or SARs on September 30, 1995, and the aggregate exercise price of the options and SARs. (3) Upon his resignation as Chairman of the Company on January 30, 1995, Mr. Seibert forfeited all options previously granted to him.\nCOMPENSATION OF DIRECTORS\nDirectors who are not employees of the Company receive $500 per month plus $300 for each meeting attended of the Board or any committee of the Board and are reimbursed for all travel expenses to and from meetings. Directors who are also full-time employees of the Company do not receive any compensation for serving as directors of the Company.\nEMPLOYMENT AGREEMENTS WITH EXECUTIVE OFFICERS\nEffective upon Chesterfield F. Seibert Sr.'s appointment on February 14, 1994 as Chairman of the Board and Chief Executive Officer of the Company and until his resignation as Chief Executive Officer on November 11, 1994, the Company agreed to pay him an annual base salary of $200,000. Prior to such appointment, the Company paid $1,500 to Mr. Seibert for each day that he performed duties on behalf of the Company in his then-capacity as the Company's Chairman, pro tem.\nStephen D. Tannen is employed as a senior executive by the Company under an employment agreement for a three-year term which commenced November 16, 1994. The agreement provides for an annual base salary of $250,000, plus annual cost- of-living increases. It also provides that Mr. Tannen will be entitled to receive incentive compensation for the 1995 fiscal year in the amount of $75,000. For the fiscal years 1996 and 1997 Mr. Tannen is entitled to receive incentive compensation in amounts based on formulas and goals set forth in a business plan which shall be approved by the Board of Directors of the Company prior to the commencement of each such fiscal year. Mr. Tannen may also receive additional compensation, whether in base salary, by bonus or otherwise, as the Board of Directors shall deem advisable. If, immediately after a Change in Control (as defined below) of the Company, (x) Mr. Tannen's employment is terminated other than for cause, or (y) Mr. Tannen is not offered a position which is substantially equivalent to his position prior to such Change in Control and which is at a location within 25 miles of the location he performed such duties prior to such Change in Control, and he elects to terminate his employment agreement, Mr. Tannen is entitled to receive a severance benefit equal to the greater of (i) his base salary then in effect, and (ii) the balance of his base salary then in effect through the expiration of his employment agreement. Upon a termination of Mr. Tannen's employment by reason of his disability, he is entitled to receive a severance benefit equal to his base salary then in effect.\nIn connection with Mr. Tannen's employment by the Company, on December 6, 1994, the Stock Option Committee of the Board granted him options (the \"Options\"), subject to shareholder approval, to purchase 90,000 shares of Common Stock. Subsequently, Mr. Tannen and the Company agreed that in the event that the grant of the Options were not approved by the shareholders he would receive cash-only stock appreciation rights (the \"Rights\") for 90,000 shares of Common Stock, having a term of 10 years, and based on an increase in the market value of the Common Stock above $7.00 per share. The maximum amount payable to Mr. Tannen pursuant to the Rights is $630,000. The Rights would vest through November 1997. All of the Rights would become exercisable immediately upon the occurrence of certain events, including the termination by the Company of Mr. Tannen's employment\nPage 41 of 65\nwithout cause or by reason of his death or disability, or upon a Change in Control of the Company. During June 1995, Mr. Tannen and the Company determined to terminate the Options. Accordingly, the Company and Mr. Tannen agreed that the Rights would be deemed granted.\nRonald C. DeMeo is employed as a senior executive by the Company under an employment agreement which expires on September 30, 1996. The agreement provides for automatic renewals for one-year periods commencing October 1, 1996 unless prior notice of termination is given in accordance with such agreement. Pursuant to the employment agreement, Mr. DeMeo receives an annual base salary of $115,000. Mr. DeMeo also receives commissions based on the net sales of the custom packaging sales force. If, immediately after a Change in Control of the Company, (x) Mr. DeMeo's employment is terminated other than by reason of his death, disability or for cause, or (y) Mr. DeMeo is not offered a position which is substantially equivalent to his position prior to such Change in Control and which is at a location within 25 miles of the location he performed such duties prior to such Change in Control, and he elects to terminate his employment agreement, Mr. DeMeo is entitled to receive a severance benefit equal to two months base salary multiplied by his years of employment with the Company (currently 14 years). Upon a termination of Mr. DeMeo's employment by reason of DeMeo's death, disability or expiration of the term of his employment agreement, he is entitled to receive a severance benefit equal to two months base salary multiplied by his years of employment with the Company (currently, 14 years).\nPhilip A. Shager is employed as a senior executive by the Company under an employment agreement commencing May 10, 1993 and expiring October 10, 1997. Pursuant to his employment agreement, Mr. Shager receives an annual base salary of $147,000 plus annual cost of living increases. Mr. Shager will receive guaranteed bonuses of $20,911.66 during each of 1994, 1995 and 1996 (provided that each such bonus shall be paid immediately upon (i) the termination of Mr. Shager's employment by reason of his death or disability, or (ii) the payment of a severance benefit as described below), and is also entitled to receive additional bonus compensation as the Board of Directors shall deem advisable. Upon a termination of Mr. Shager's employment without cause or by reason of his not being offered a substantially equivalent position after a Change in Control of the Company, he is entitled to receive a severance benefit equal to the greater of (i) his base salary then in effect multiplied by two, and (ii) his base salary then in effect through the expiration of his employment agreement. If, immediately after a Change in Control of the Company, (x) Mr. Shager's employment is terminated other than for cause, or (y) Mr. Shager is not offered a position which is substantially equivalent to his position prior to such Change in Control and which is at a location within 25 miles of the location he performed such duties prior to such Change in Control, and he elects to terminate his employment agreement, Mr. Shager is entitled to receive a severance benefit equal to the greater of (i) his base salary then in effect multiplied by two, and (ii) the balance of his base salary then in effect through the expiration of his employment agreement. Upon a termination of Mr. Shager's employment by reason of his disability, he is entitled to receive a severance benefit equal to his base salary then in effect.\nDavid P. Hempson is employed as a senior executive by the Company under an employment agreement which commenced February 9, 1994 and expires December 31, 1998. Pursuant to his employment agreement, Mr. Hempson receives an annual base salary of $170,000 plus annual cost of living increases. Mr. Hempson is also entitled to receive bonus compensation as the Board of Directors shall deem advisable.\nThomas M. Fairhurst is employed as a senior executive by the Company under an employment agreement which commenced October 11, 1994 and expires October 10, 1997. Pursuant to his employment agreement, Mr. Fairhurst receives an annual base salary of $110,000 plus annual cost of living increases. Mr. Fairhurst is also entitled to receive bonus compensation as the Board of Directors shall deem advisable. Upon a termination of Mr. Fairhurst's employment by reason of his not being offered a substantially equivalent position after a Change in Control of the Company, he is entitled to receive a severance benefit equal to the greater of (i) one years base salary then in effect or (ii) his base salary then in effect through the expiration of his employment agreement. Upon a termination of\nPage 42 of 65\nMr. Fairhurst's employment by reason of his disability, he is entitled to receive a severance benefit equal to his base salary then in effect.\nA \"Change in Control\" is deemed to have occurred if: (a) following either (i) the acquisition of 30% of the voting securities of the Company by any person or persons (together with all affiliates of such person or persons), whether by tender or exchange offer or otherwise, (ii) a proxy contest for the election of directors of the Company, or (iii) a merger, consolidation or other disposition of all or substantially all of the business or assets of the Company, the persons constituting the Board of Directors of the Company immediately prior to the initiation of such event cease to constitute a majority of the Board of Directors of the Company upon the occurrence of such event or within eighteen months after such event, and such change in the persons constituting the Board of Directors of the Company shall not have been approved by the persons constituting the Board of Directors immediately prior to the initiation of such event; or (b) a sale, transfer or other disposition of all or substantially all of the business or assets of the Company to a person or entity not controlled by or under common control with the Company shall have been consummated.\nThe total cost of satisfying the Company's Change in Control obligations under all outstanding options and cash only stock appreciation rights (based upon an assumed market price of the Common Stock of $10.25), is $383,676. A Change in Control will not entitle any executive officer of the Company to receive any payment from the Company. However, the employment agreements of certain executive officers provide that under specified circumstances (such as the Company's failure to offer such executive officer a position substantially equivalent to his position prior to the Change in Control), such executive officers will be entitled to a payment from the Company. The aggregate cost of satisfying all such obligations would be $1,291,017.\nAll employment agreements require the Company to furnish health, life and disability insurance and, in the event the employee becomes disabled, to provide for salary continuation to supplement disability payments provided by insurance.\nPROFIT SHARING INCENTIVE PROGRAM\nIn October 1985, the Company adopted a Profit Sharing Incentive Program. Under the terms of this program, when the Company's net income for any quarter exceeds 6% of the Company's net sales, the Company will pay to each eligible employee, during the next succeeding quarter, an amount equal to the product of one-half of the employee's quarterly salary and the net profit percentage. For the purposes of the Profit Sharing Incentive Program, net profit percentage is defined to be equal to net income as defined divided by net sales. Net income is defined to be equal to the Company's net income as shown on its financial statements before accrual for either income taxes or for additional salary payable to employees who are compensated on a performance basis. The Company retains the right to terminate the Profit Sharing Incentive Program at any time in its sole discretion. For the fiscal year ended September 30, 1995, the Company's employees received no payments from the Profit Sharing Incentive Program.\nEXECUTIVE INCENTIVE COMPENSATION AND MANAGEMENT STOCK GRANTS\nIn November 1993, the Board of Directors approved an Executive Incentive Compensation and Management Stock Grants Program which was recommended to it by the Company's Compensation Committee. Under this program, the executive officers of the Company and certain other officers of the Company are entitled to cash and equity-based bonuses in an aggregate amount equal to 5% of the Company's operating profit during the applicable fiscal year. The President of the Company is entitled to 40% of the yearly bonus payments distributed pursuant to this program and the other participating officers of the Company are entitled to share the remaining 60% of such bonus payments on a pro rata basis based on their respective salaries. Any share of the aggregate bonus payable under this program not paid to an officer otherwise eligible to participate in this program is not paid to the other\nPage 43 of 65\nparticipating officers by the Company. Pursuant to the employment agreement between the Company and Stephen D. Tannen, the Company's President and Chief Executive Officer, for fiscal year 1995 Mr. Tannen will receive a bonus pursuant to a formula set forth in his employment agreement in lieu of any bonus pursuant to this program. In addition, the Senior Vice President of Marketing and Sales, pursuant to the terms of his employment agreement with the Company, receives commissions based on the net sales of the custom packaging sales force in lieu of any bonus pursuant to this program. Sixty percent of the bonus provided to each participating officer under the program is payable in cash. The remaining 40% of each such bonus is paid by a grant of shares of Common Stock of the Company based on the market value of such shares on the date of such grant. Effective for the 1994 fiscal year, if in any fiscal year the Company's operating profit does not exceed its operating profit for the immediately preceding fiscal year, no bonuses will be paid to officers of the Company pursuant to this program in respect of such fiscal year. Accordingly, for the 1995 fiscal year, no bonuses were paid pursuant to this program.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Compensation Committee is composed of Barry W. Florescue, Dominic J. La Rosa, Frank Magrone and Thomas D. Walsh, none of whom has ever served as an officer or employee of the Company. Chesterfield F. Seibert Sr., Chief Executive Officer of the Corporation from February 14, 1994 until November 11, 1994 and Chairman of the Company from April 1992 until January 30, 1995, served on the Compensation Committee until his resignation on January 30, 1995. No executive officer of the Company served during fiscal year 1995 (i) as a member of the compensation committee or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors of another entity, one of whose executive officers served on the Compensation Committee of the Company; (ii) as a director of another entity, one of whose executive officers served on the Compensation Committee of the Company; or (iii) as a member of the compensation committee or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors of another entity, one of whose executive officers served as a director of the Company.\nOn February 9, 1989, Chesterfield F. Seibert Sr. and Thomas D. Walsh each purchased 10,000 shares of Common Stock, previously held by the Company in its treasury, pursuant to stock purchase agreements between the Company and each of them. The purchase price of $122,500 was paid by each of Messrs. Seibert and Walsh by the payment of $1,000 in cash and the delivery of a promissory note in the principal amount of $121,500. Each of their promissory notes bore interest, payable semi-annually, at the rate of 9% per annum and was due and payable in one installment on February 9, 1994. The Company agreed with each of Messrs. Seibert and Walsh to extend the maturity date of such promissory notes to February 9, 1996, except that in the event that Mr. Seibert or Mr. Walsh resigns his position on the Board of Directors of the Company or refuses to stand for re-election, his promissory note becomes due and payable 30 days after such resignation or refusal to stand for re-election and, in the event of his death or disability, his promissory note becomes due and payable six months after such event. The Company has further agreed with each of Messrs. Seibert and Walsh that until maturity, interest shall accrue on the promissory notes at a variable rate per annum equal to 1.35% above the three-month LIBOR in effect on the first business day of each calendar quarter, and such interest shall be payable semiannually. Following Mr. Seibert's resignation as Chairman on January 30, 1995, the Company agreed to extend the maturity date of his promissory note beyond the 30 day due date to August 9, 1995. Subsequently, the Board determined to extend the maturity date of such note to February 9, 1996.\nPage 44 of 65\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 with respect to persons known by the Company to own of record or beneficially more than five percent (5%) of the Company's outstanding Common Stock as of December 1, 1995.\n- ----------\n(1) Unless otherwise indicated address is that of the Company set forth above. (2) All persons listed have sole voting and investment power with respect to their shares unless otherwise indicated. (3) Based on the number of Shares issued and outstanding at, or acquirable within 60 days of, December 1, 1995. (4) Information as to the holdings of Mentor Partners L.P. (\"Mentor\"), is based on a report on a Schedule 13D filed on or about August 8, 1995, as amended. Such report was filed with the SEC on behalf of Mentor with respect to Shares owned by Mentor and Mentor Offshore Fund Limited. The general partner of Mentor is WTG & Co., L.P. (\"WTG\") and the general partner of WTG is D. Tisch & Co., Inc., all of the common stock of which is owned by Daniel R. Tisch. (5) Information as to the holdings of Elliot Associates, L.P. (\"Elliot\"), is based upon a report on Amendment No. 2 to Schedule 13D filed on or about July 21, 1995. Such report was filed with the SEC jointly by Elliot, Westgate International, L.P. (\"Westgate\") and Martley International, Inc. (\"Martley\"). Paul E. Singer (\"Singer\") and Braxton Associates, L.P., a New Jersey limited partnership (\"Braxton\"), which is controlled by Singer, are the general partners of Elliot. Hambledon, Inc., a Cayman Island corporation (\"Hambledon\"), is the sole general partner of Westgate. Martley is the investment manager for Westgate. (6) Information as to the holdings of John S. Nadolski is based upon Amendment No. 5, dated February 3, 1994, to a report on Schedule 13G, dated April 28, 1989, filed with the SEC by Mr. Nadolski. Mr. Nadolski is a former director and chief executive officer of the Company. On February 14, 1994, Mr. Nadolski resigned as a director and was granted a leave of absence as an executive officer of the Company following a Grand Jury indictment. On October 5, 1994, he was convicted of violations of the federal securities laws relating to false statements contained in financial reports of the Company for the first quarter of fiscal 1989 and for the fiscal year ended September 30, 1989 and fraud in connection with the purchase and sale of securities. Mr. Nadolski resigned from the Company in February 1995. (7) Includes 8,000 Shares held by the two children of Mr. Nadolski, as to which Mr. Nadolski disclaims beneficial ownership.\nSECURITY OWNERSHIP OF MANAGEMENT\nThe following information is furnished with respect to shares of Common Stock of the Company beneficially owned as of December 1, 1995 by each director of the Company, by each of the Named Executive Officers, and by all directors and executive officers of the Company as a group:\nPage 45 of 65\n(1) All persons listed have sole voting and investment power with respect to their shares unless otherwise indicated. (2) Based on the number of shares of Common Stock of the Company outstanding at, or subject to stock options exercisable on or within 60 days of, December 1, 1995. (3) Includes options to purchase 8,160 shares of Common Stock granted on February 9, 1989 to each of Messrs. Magrone, DeMeo, Hempson, Seibert and Walsh, all of which are currently exercisable. (4) Includes options to purchase 8,308 shares of Common Stock granted on December 1, 1993 to each of Messrs. Magrone and Seibert, all of which are currently exercisable. (5) Includes options to purchase 4,154 shares of Common Stock granted on December 1, 1993 to Messrs. DeMeo, Walsh, Buhrmaster, La Rosa and Tannen, all of which are currently exercisable. (6) Includes 400 shares of Common Stock held by the two children of Mr. Hempson, as to which Mr. Hempson disclaims beneficial ownership, and includes 300 shares of Common Stock held by Mr. Hempson jointly with his spouse. (7) See Item 11. - \"Executive Compensation -- Compensation Committee Interlocks and Insider Participation\" for a discussion of certain transactions and loans between the Company and certain of its executive officers and directors. (8) Includes options to purchase 5,000 shares of Common Stock granted on May 10, 1993 to Mr. Shager, 3,333 of which are currently exercisable. (9) Includes Mr. Seibert, who does not presently serve as an executive officer or director of the Company. (10) Less than 1.0%.\nCHANGES IN CONTROL\nSee \"Introductory Note.\"\nPage 46 of 65\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ----------------------------------------------\nSee Item 11. - \"Executive Compensation -- Compensation Committee Interlocks and Insider Participation\" for a discussion of certain transactions and loans between the Company and certain of its executive officers and directors.\nSee \"Introductory Note\" and Item 12. - \"Security Ownership of Certain Beneficial Owners and Management - Changes in Control\" with respect to the Merger of the Company with an affiliate of Barry W. Florescue, a director of the Company.\nPursuant to an agreement relating to Barry W. Florescue joining the Board of Directors of the Company, Mr. Florescue and his affiliates agreed not to increase their ownership of the Company's Common Stock above 14.99% or to commence a tender offer, proxy contest or other similar action unless consented to by the Board of Directors of the Company. Such agreement has a term of two years, subject to earlier termination in certain cases.\nPage 47 of 65\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:\nSchedules other than those listed above have been omitted because they are not applicable or the required information is shown on the financial statements or the Notes thereto.\n3. Exhibits:\nThe Exhibit Index begins on page 50.\n(b) Reports on Form 8-K. The Company filed a Form 8-K on August 30, 1995, in which the Company disclosed (pursuant to Item 5) that (i) it had entered into an Agreement and Plan of Merger with affiliates of Barry W. Florescue, the beneficial owner of 8.7% of the Company's Common Stock, (ii) in an agreement relating to Mr. Florescue's joining the Board of Directors of the Company, Mr. Florescue and his affiliates agreed not to increase their ownership of the Company's shares above 14.99% or to take certain other actions for a period of two years, and (iii) the Company had consented to a final judgment and order in settlement of a Securities and Exchange Commission investigation.\n(c) See Exhibit Index on page 50.\n(d) NONE\nPage 48 of 65\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the 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 27, 1995 MARIETTA CORPORATION (Registrant)\nBY: \\s\\ ---------------------------------------- Stephen D. Tannen President and Chief Executive Officer\nBY: \\s\\ ---------------------------------------- Philip A. Shager Vice President, Chief Accounting Officer and Treasurer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDated: December 27, 1995 \\s\\ -------------------------------- Robert C. Buhrmaster, Director\nDated: December 27, 1995 \\s\\ -------------------------------- Ronald C. DeMeo, Director\nDated: December 27, 1995 \\s\\ -------------------------------- Barry W. Florescue, Director\nDated: December 27, 1995 \\s\\ --------------------------------- Frank Magrone, Director\nDated: December 27, 1995 \\s\\ --------------------------------- Charles W. Miersch, Director\nDated: December 27, 1995 \\s\\ --------------------------------- Leonard J. Sichel, Director\nDated: December 27, 1995 \\s\\ --------------------------------- Stephen D. Tannen, Director\nDated: December 27, 1995 \\s\\ --------------------------------- Thomas D. Walsh, Director\nPage 49 of 65\nEXHIBIT INDEX\nPage 50 of 65\nPage 51 of 65\nPage 52 of 65\nPage 53 of 65\nPage 54 of 65\nPage 55 of 65\nPage 56 of 65","section_15":""}
{"filename":"23111_1995.txt","cik":"23111","year":"1995","section_1":"ITEM 1. BUSINESS ---------\nComputer Task Group, Incorporated (Company or CTG or Registrant) was incorporated in Buffalo, New York on March 11, 1966, and its corporate headquarters are located at 800 Delaware Avenue, Buffalo, New York 14209 (716-882-8000). CTG is an information technology services company. CTG employs approximately 5,000 people and serves customers through an international network of offices in North America and Europe. The Company has four operating subsidiaries: Computer Task Group of Canada, Inc.; Computer Task Group (U.K.) Ltd.; Computer Task Group Nederland B.V.; and Computer Task Group Belgium N.V. As of July 1, 1994, the Company sold its petroleum industry subsidiaries, Profimatics, Inc. and Profimatics & Co., GmbH.\nBACKGROUND - ----------\nThe Company operates in one area of the computer industry -- providing information technology services. A typical customer is a Fortune 500-size organization with large, complex information and data processing requirements. CTG's customer base is large and diverse, consisting of approximately 900 customers. The Company serves approximately 35 percent of the Fortune 100.\nCTG works with customers to develop effective business solutions through information systems and technology. The Company's professional staff may support a customer's software development team on a specific application or project or may manage the project entirely for the customer. The Company's range of services extends from flexible staffing provided on a per diem basis to managing multi-million dollar technology projects. Approximately 51 percent of the Company's services are provided to customers in the service sector, followed by 23 percent in the manufacturing industry, 9 percent in the banking and finance sector and 17 percent in other industries. Most of CTG's services are provided on-site at the customer's facilities. CTG's network of offices provides wide geographical coverage with the capability of servicing large companies with multiple locations.\nIn 1993, the Company completed an extensive reengineering of its operations, resulting in a new business strategy and a complementary organization. CTG's business strategy is based upon the concept of a strategic variable workplace, being cost competitive while being responsive in supplying qualified staff to work on client engagements. CTG's services are sold and delivered on a local level through its network of geographically dispersed delivery teams made up of sales managers, resource managers and business consultants. The Company has a staff of over 90 recruiting specialists located in five regional locations who utilize an electronic recruiting database to screen and qualify individuals who are available to work on CTG's clients' information technology needs. The Company maintains a qualified database of over 160,000 candidates available for assignments.\nIn the 1980's, CTG's growth strategy included expansion via geographic acquisitions primarily in North America. The Company also completed two acquisitions in Europe, one in 1986 and the other in 1990. In total, between 1979 and 1990, CTG acquired 21 firms ranging in size from $1 million to approximately $30 million in revenue. CTG has not made an acquisition in the last five years, but instead has focused on internal growth and divesting small non-strategic businesses. Future growth will come from internal growth and strategic investments.\nInternational Business Machines Corporation (IBM) is CTG's largest customer. CTG provides services to various IBM divisions in approximately 50 locations. In 1995, CTG was awarded a two year contract to be one of IBM's nine national technical service providers. IBM accounted for $80 million or 23.7 percent of CTG's 1995 revenue, $68 million or 22.7 percent of CTG's 1994 revenue, and $80 million or 27.1 percent of CTG's 1993 revenue. The Company expects to continue to derive a significant portion of its business from IBM in 1996 and to actively pursue new business with IBM. A significant decline in revenues from IBM could have a material adverse impact on the Company's revenues and profits. Because of the diversity of the projects performed for IBM and the number of locations and divisions involved, the Company\nbelieves the simultaneous loss of all IBM business is unlikely to occur. IBM accounted for approximately 24.2 percent of North American revenue and 7.3 percent of European revenue during 1995. In addition, the Company continues to expand its non-IBM business, which grew 11 percent or $25.8 million in 1995 compared to 1994.\nIn 1989, CTG entered into an agreement with IBM where IBM purchased 1,448,276 shares of CTG Series B Preferred Stock. On February 25, 1994, IBM converted all of its CTG Series B Preferred Stock into common stock and CTG repurchased 500,000 of its common shares from IBM for $3,515,000. This repurchase reduced IBM's ownership of the Company to approximately 9.2 percent. IBM subsequently sold 550,000 CTG common shares on the open market. The Company and its Stock Employee Compensation Trust repurchased IBM's remaining 398,276 shares in December 1994 for $2,950,000.\nThe Company holds no patents, trademarks, or service marks other than its registered name and logo. It has entered into agreements with various software and hardware vendors from time to time in the normal course of business, none of which are material to the business.\nSERVICES - --------\nCTG operates in one area of the Information Technology (IT) industry, the services area. Segment information is included in CTG's 1995 Annual Report to Shareholders on page 24 and is incorporated herein by reference.\nMost companies follow a continuous process to create business solutions. The business solution life cycle begins with planning, as companies design strategies to meet overall business objectives using IT. Planning is followed by development, in which companies develop and implement IT solutions using their newly devised plans. Finally, managing and maintaining ensure systems and technologies are supported to preserve their effectiveness. CTG provides services in each of these three areas as follows:\nBusiness Consulting. Business Consulting focuses on the planning phase of the IT life cycle. CTG's consultants help a customer develop the plan to reengineer its business processes, assess its technology needs, and choose the appropriate technology.\nDevelopment & Integration. Development & Integration supports the implementation phase of the IT life cycle, including software package implementation, application development, and client\/server development.\nManaged Support. Managed Support addresses the maintenance segment of the IT life cycle. It encompasses service offerings such as operations and network support (running or maintaining a customer's systems), application support (maintaining a company's programs and documentation) and setting-up and maintaining a Help Desk.\nSALES AND MARKETING - --------------------\nCTG's marketing efforts span all strata of the organization, involving virtually all of the Company's professionals.\nOn the corporate and regional level, management performs strategic, tactical and operational sales planning to assess industry and customer needs and target markets.\nCustomers are served by local teams, comprised of Sales Managers, Business Consultants and Resource Managers who work together -- the first two focused on identifying an engagement and the latter focused on finding appropriate, high quality professionals for an engagement. Supporting these local teams are sourcing specialists backed by a national electronic database of professional computer consultants and programmers -- to improve effectiveness at locating qualified IT candidates. In addition, Project Managers are responsible for profitability, client satisfaction and risk management in the project delivery of consulting offerings.\nSales Managers are full-time employees who receive a base salary and are paid commissions based on objectives such as the amount and profitability of the business they sell. Each Sales Manager is assigned a sales quota and is paid in relationship to this quota. Sales Managers, and the professionals serving our customers, continually seek to identify new opportunities with existing and prospective customers. CTG publishes brochures that explain its services, produces informative customer newsletters, advertises in trade publications, participates in trade shows, and encourages employees to author articles, which keeps the CTG name in front of clients.\nThe Internet and the World Wide Web (Web) are also key components of the Company's communications infrastructure, called CTGNet. The Web is the foundation of an ongoing knowledge exchange effort and the Company is currently refining and building new Web functionality to continuously provide current information to its customers, suppliers, investors and potential employees. The Internet and the Web present important opportunities for new business and CTG is currently developing Internet tools to support its clients. Internally, the Company is at the leading edge of using the Internet to exchange knowledge. CTG has been using the Internet and the Web for two years as a communications tool, to connect wide-spread employees, and as a resource tool for recruiting, marketing and service delivery.\nPRICING AND BACKLOG - -------------------\nCTG provides the majority of its business on a time and materials basis. Rates vary based on the type and level of skill required by the customer. Consulting services are more specialized; therefore, they generally command higher rates. Agreements for work performed on a per diem basis generally do not specify any dollar amount because services are rendered on an \"as required\" basis, and are subject to cancellation without penalty on thirty days' notice.\nThe Company performs project business on either a fixed-price or time and materials basis. These contracts generally have different terms and conditions regarding cancellation and warranties, and are usually negotiated based on the unique aspects of the project. Approximately 4 percent of the Company's 1995 revenue is from fixed-price contracts accounted for under the percentage of completion method, compared to 5 percent in 1994. Revenue from all fixed price contracts, including those accounted for under the percentage of completion method and managed support contracts, totaled 13 percent in 1995, compared to 8 percent in 1994. As of December 31, 1995 and 1994, the backlog for fixed-price and managed support contracts was approximately $51 million and $55 million, respectively. Approximately 42 percent of the December 31, 1995 backlog is expected to be earned in 1996. Revenue is subject to seasonal variations, with a minor downturn in months of high vacation and legal holidays (July, August and December). The backlog is not seasonal.\nCOMPETITION - -----------\nThe IT services market is highly competitive. The market is also highly fragmented among many providers with no single competitor maintaining clear market leadership. The Company's competition varies from city to city and by the type of service provided. Competition comes from four primary channels: a customer's internal data processing staff; small local firms or individuals specializing in specific programming services or applications; hardware vendors and suppliers of packaged software systems; and large national or international vendors, including major accounting and consulting firms, which offer a variety of development services to a broad spectrum of commercial customers. CTG competes against all four of these for its share of the market.\nManagement believes the Company's customers have different buying values. In order to compete for their business, the Company believes that it must quickly respond to customers with high quality skills at a low cost, utilizing CTG's strategic variable workforce. Customers demand the ability to solve business problems, backed by a defined approach and experience. CTG's organization is designed to allow it to compete in the IT services industry.\nCTG has implemented a Total Quality Management Program, with a goal to achieve continuous, measured improvements in services and deliverables. As part of this program, CTG has developed specific methodologies for providing value added services which result in unique solutions and specified deliverables for its clients. The Company believes these methodologies will enhance its ability to compete.\nMANAGEMENT AND PROFESSIONAL STAFF - ---------------------------------\nAs of December 31, 1995, CTG employed 5,014 people, of which 4,402 were professional technical staff.\nCTG's long-term profitability and growth depend on its ability to attract qualified information systems professionals with the skills to fulfill customer requirements. Qualified systems engineers and professionals with computer-related skills are in great demand and the Company faces considerable competition in attracting such individuals. Competing employers include not only computer-related professional services companies, but also businesses with internal data processing staffs.\nThe Company offers several employment options to enable it to attract professional staff. The Company pays its employees on either a salaried or hourly basis. Management has developed a professional staff resources database. This database provides a pipeline of quality professional resources to assist management in providing customers with responsive, dependable and cost-effective service to fulfill the needs required.\nCTG's service agreements with its customers generally state that neither party may hire the other's personnel for the term of the project and a stated period thereafter. The Company's employees are required to sign non-solicitation and non-disclosure agreements which state they will not accept employment directly or indirectly with a customer or solicit or hire another employee, for a specified period after termination of employment. The agreements also provide that the employee will not use or disclose Company or client confidential information. In addition, entry level staff who attend the Company's systems training course and more experienced staff who complete new technology training sign agreements to reimburse the Company for the cost of the training if they voluntarily terminate their employment within a defined period from the date the training program starts.\nNo employees are covered by a collective bargaining agreement or are represented by a labor union. CTG is an equal opportunity employer.\nTECHNICAL AND MANAGEMENT TRAINING - ---------------------------------\nFor a services company, amounts spent on education and training for staff to keep abreast of technology are similar to research and development expense. CTG recognizes that its ability to remain competitive depends on its ability to offer customers services that make the highest and best use of emerging new technologies. The Company provides ongoing educational programs so that its technical staff has the skills needed to respond to today's new demands. Classroom and distributed training, using videos and computer-based training courses, are utilized.\nCTG also offers its employees management and sales training. These courses offer the latest marketing and management practices and serve both as refresher courses and as training vehicles to ensure that the technical staff has the skills necessary for promotion. They also provide a forum for imparting Company policies to ensure consistency in the quality of services throughout the Company's organization.\nCTG believes its training and continuing education programs keep its technical staff current and provide the Company with the necessary management and marketing personnel to support future growth. CTG invested approximately $4.0 million, $4.4 million and $4.5 million, on education in 1995, 1994, and 1993, respectively, including compensation paid to technical staff while in training.\nFINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS - -----------------------------------------------------------------\nExecutive Officers of the Company ---------------------------------\n- --------------- [FN]\n(1) Business Experience -------------------\nMs. Fitzgerald was appointed Chairman of the Board and chief executive officer as of October 3, 1994 and President and chief operating officer as of July 1, 1993. She joined the Company in May 1991 as Senior Vice President responsible for the Company's Northeastern U.S. and Canadian operations. She was previously Vice President, Professional Services at International Business Machines Corporation (IBM), where she had worked for 18 years in various management positions.\nMr. Ballou was promoted to Vice President in November 1993 and has been employed by the Company for 12 years. He has held a variety of technical and management positions and is presently responsible for the operations of the Company's Mid-Atlantic and South regions.\nMr. Barbour was promoted to Vice President in November 1993 and has been employed by the Company for 16 years. He has held a variety of management positions and is presently responsible for the operations of the Company's Mid-West region.\nMr. Boldt joined the Company as a Vice President in February 1996. He was previously Vice President of Finance, Secretary and Chief Financial Officer of Pratt and Lambert United, Inc., where he worked for 20 years in a variety of management positions. He is currently responsible for the Company's Finance, Accounting and Internal Audit functions.\nMr. Boyle joined the Company as an officer in July 1994, and currently serves as Vice President and Chief Information Officer. He was Manager, Northern New England Consulting Practice with Coopers & Lybrand from 1992 to June 1994 and held a variety of technical consulting and management positions prior to that.\nMs. Cole was promoted to Vice President in November 1993 and has been employed by the Company since 1980. She has held a variety of technical and management positions and is presently responsible for the operations of the Company's Northeast region.\nMs. DeRocco joined the Company as a Vice President in April 1995. She previously held a variety of management positions at IBM and is presently responsible for the operations of the Company's West region.\nMr. Grich was promoted to Vice President in February 1995 and has been employed by the Company since 1991. He has held a variety of sales and management positions and is presently responsible for the operations of the Company's Central region. Prior to joining the Company, he was employed by Cap Gemini as Northeastern Director for Sales and Marketing. He also spent 20 years with IBM where his last position was Branch Manager for IBM's Hartford Professional Services office.\nMr. Hoffman was promoted to Vice President in November 1990 and is currently responsible for the operations of the Company's National Delivery Team, which focuses primarily on IBM. Prior to joining the Company in March 1990, he worked 13 years at IBM where his last position was IBM's Buffalo branch manager.\nMr. Makowski was promoted to Vice President in September 1993. He has served as Secretary and General Counsel since September 1989. He has served as the Company's Corporate Counsel since 1985.\nMr. Molenaar was promoted to Vice President in January 1996 and has been employed by the Company since 1988. He has held a variety of management positions and is presently responsible for the Company's European operations.\nMr. Megregian joined the Company as an officer in January, 1994 and currently serves as Vice President, Offerings and Performance. Most recently, Mr. Megregian was an independent business consultant with KWR Information Systems for two years. Prior to that, he was with IBM for 27 years where he had held various management and technical positions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe Company occupies a headquarters building (approximately 40,000 square feet) at 800 Delaware Avenue, Buffalo, New York, under a Lease Agreement with the Erie County Industrial Development Agency (Agency), dated as of September 1, 1978. At the end of the term of the Lease Agreement in 1996, the Company has the right to purchase its headquarters building and the real property on which it is situated for $1.00. Until such time, the building and real property are encumbered by a mortgage held by the trustee for the purchaser of the industrial revenue bond issued by the Agency to finance its purchase of the building and real property.\nThe Company also occupies an office building at 700 Delaware Avenue, Buffalo, New York under a Lease Agreement with the Agency, dated April 1, 1990. The building consists of approximately 39,000 square feet and is occupied by the Company's Buffalo sales office and corporate administrative operations. At the end of the Lease Agreement in 2001, the Company has the right to purchase the building and the real property on which it is situated for $10.00. There is no mortgage on this building.\nThe Company also owns a 37,000 square foot building in Melbourne, Florida and a 24,000 square foot office and operations facility in Pittsburgh, Pennsylvania, which was financed by an industrial revenue bond.\nThree of the four properties are currently on the market as the Company looks for more efficient space. The buildings are still in use while they are on the market, and the Company does not expect to incur a loss on the sale of these buildings. The Melbourne, Florida building, with a net book value of $1.8 million, is leased to a third party under a five year lease.\nThe remainder of the Company's locations are leased facilities. Most of these facilities serve as sales and support offices and their size varies, generally in the range of 1,000 to 12,000 square feet, with the number of people employed at each office. The Company's lease terms generally vary from periods of less than a year to five years and generally have flexible renewal options. The Company believes that its present owned and leased facilities are adequate to support its current and future 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 STOCK AND RELATED SHAREHOLDER MATTERS --------------------------------------------------------------------\nInformation relating to the market and market prices of the Company's Common Stock, the approximate number of Company shareholders and the Company's dividend history for the past two years is included under the caption \"Stock Market Information\" in the Company's Annual Report to Shareholders for the year ended December 31, 1995, submitted herewith as an exhibit, and incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nA ten-year summary of certain financial information relating to the financial condition and results of operations of the Company is included under the caption \"Consolidated Summary - Ten-Year Selected Financial Information\" in the Company's Annual Report to Shareholders for the year ended December 31, 1995, submitted herewith as an exhibit, and 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 included in the Company's Annual Report to Shareholders for the year ended December 31, 1995, submitted herewith as an exhibit, and incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe consolidated financial statements of the Company and the supplementary data information are included in the Company's Annual Report to Shareholders for the year ended December 31, 1995, submitted herewith as an exhibit, and incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nOn October 16, 1995, the Company engaged KPMG Peat Marwick LLP (KPMG) as the principal accountants to audit the Company's financial statements for the fiscal year ending December 31, 1995, and dismissed Price Waterhouse LLP (Price Waterhouse). The Company did not consult with KPMG regarding accounting advice prior to its engagement.\nPrice Waterhouse had been engaged since 1977 as the principal accountants to audit the Company's financial statements. Price Waterhouse's report on the financial statements of the Company as of December 31, 1994 and 1993 and for the years then ended contained no adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles. Also, during the aforementioned period, there occurred no \"reportable event\" within the meaning of Item 304(a)(1)(v) of Regulation S-K of the Commission.\nThe decision to change accountants was approved by the Board of Directors of the Company. During the Company's two most recent fiscal years and any subsequent interim period preceding the dismissal, there were no disagreements between the Company and Price Waterhouse on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which if not resolved to the satisfaction of Price Waterhouse would have caused Price Waterhouse to make reference to the subject matter of the disagreement in connection with its report.\nII-1 10\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ---------------------------------------------------\nThe information in response to this item is incorporated herein by reference to the information set forth on pages 2 and 5 in the Company's definitive Proxy Statement filed pursuant to Regulation 14A and used in connection with the Company's 1996 annual meeting of shareholders to be held on April 24, 1996, except insofar as information with respect to executive officers is presented in Part I, Item 1 hereof pursuant to General Instruction G(3) of Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nThe information in response to this item is incorporated herein by reference to the information under the caption \"Information about Management\" presented in the Company's definitive Proxy Statement filed pursuant to Regulation 14A and used in connection with the Company's 1996 annual meeting of shareholders to be held on April 24, 1996, excluding the Compensation Committee Report on Executive Compensation and the Company's Performance Graph as set forth in the Company's definitive Proxy Statement dated March 27, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nThe information in response to this item is incorporated herein by reference to the information under the caption \"Security Ownership of the Company's Common Shares by Certain Beneficial Owners and by Management\" presented in the Company's definitive Proxy Statement filed pursuant to Regulation 14A and used in connection with the Company's 1996 annual meeting of shareholders to be held on April 24, 1996, as set forth in the Company's definitive Proxy Statement dated March 27, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nThe information in response to this item is incorporated herein by reference to the information under the captions \"Indebtedness of Management\" and \"Compensation Committee Interlocks and Insider Participation\" presented in the Company's definitive Proxy Statement filed pursuant to Regulation 14A and used in connection with the Company's 1996 annual meeting of shareholders to be held on April 24, 1996, excluding the Compensation Committee Report on Executive Compensation and the Company's Performance Graph as set forth in the Company's definitive Proxy Statement dated March 27, 1996.\nIII-1 11\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ---------------------------------------------------------------\n(A) Index to Financial Statements and Financial Statement Schedules ---------------------------------------------------------------\nThe 1995, 1994 and 1993 consolidated financial statements, and the report of KPMG Peat Marwick LLP dated February 9, 1996, on the consolidated balance sheet as of December 31, 1995 and the related consolidated statements of income, shareholder's equity and cash flows for the year then ended, appearing in 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 Parts I and II, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this report. The following financial statement schedule should be read in conjunction with the financial statements in such 1995 Annual Report to Shareholders. All other financial statement schedules have been omitted because they are not material or the required information is shown in the financial statements or the notes thereto.\n(B) Form 8-K --------\nFiling on Form 8-K was made October 16, 1995 in regard to the change in certifying accountants from Price Waterhouse LLP to KPMG Peat Marwick LLP.\n(C) Exhibits --------\nThe Exhibits to this Form 10-K Annual Report are listed on the attached Exhibit Index appearing on pages E-1 to E-4.\nIV-1 12\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors and Shareholders of Computer Task Group, Incorporated\nIn our opinion, the consolidated balance sheet and the related consolidated statements of income, of cash flows and of changes in stockholders' equity as of and for each of the two years in the period ended December 31, 1994 (appearing on pages 11 though 25 of the Computer Task Group, Incorporated Annual Report to Shareholders which has been included in this Form 10-K Annual Report) present fairly, in all material respects, the financial position, results of operations and cash flows of Computer Task Group, Incorporated and its subsidiaries as of and 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 Computer Task Group, Incorporated for any period subsequent to December 31, 1994.\nPRICE WATERHOUSE LLP\nBuffalo, New York February 10, 1995\nIV-2 13\nREPORT OF INDEPENDENT ACCOUNTANTS ON ------------------------------------ FINANCIAL STATEMENT SCHEDULE ----------------------------\nTo the Board of Directors and Stockholders of Computer Task Group, Incorporated\nUnder date of February 9, 1996, we reported on the consolidated balance sheet of Computer Task Group, Incorporated and subsidiaries as of December 31, 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended, 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 audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule, insofar as it relates to the year ended December 31, 1995, as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.\nIn our opinion, such financial statement schedule, insofar as it relates to the year ended December 31, 1995, 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\nBuffalo, New York February 9, 1996\nIV-3 14\nREPORT OF INDEPENDENT ACCOUNTANTS ON ------------------------------------ FINANCIAL STATEMENT SCHEDULE ----------------------------\nTo the Board of Directors of Computer Task Group, Incorporated\nOur audits of the consolidated financial statements referred to in our report dated February 10, 1995 appearing on page IV-2 included in this Annual Report on Form 10-K also included an audit of the Financial Statement Schedule for 1994 and 1993 listed in Item 14. (A) of this Form 10-K. In our opinion, this Financial Statement Schedule for 1994 and 1993 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nBuffalo, New York February 10, 1995\nIV-4 15\nCOMPUTER TASK GROUP, INCORPORATED SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (amounts in thousands)\n- --------------- [FN]\n(A) Includes additions charged to costs and expenses less accounts written off and translation adjustments.\n(B) Utilization of foreign net operating losses that were previously offset completely by the valuation allowance.\n(C) Includes benefit of unrealized capital loss carryforward that was realized during the year.\n(D) Includes additions charged to costs and expenses for net operating loss carryforwards that are not expected to be realized.\nIV-5 16\nIV-6 17\nEXHIBIT INDEX --------------\nE-1 18\nEXHIBIT INDEX (Continued) -------------\nE-2 19\nEXHIBIT INDEX (Continued) -------------\nE-3 20\nEXHIBIT INDEX (Continued) -------------\nE-4 21","section_15":""}
{"filename":"702902_1995.txt","cik":"702902","year":"1995","section_1":"Item 1. Business.\nHistory and Business - --------------------\nHarleysville National Corporation (the \"Corporation\"), a Pennsylvania business corporation, was incorporated in June 1982. On January 1, 1983, the Corporation acquired all of the outstanding common stock of Harleysville National Bank and Trust Company (\"Harleysville\") at which time Harleysville became a wholly-owned subsidiary of the Corporation. On February 13, 1991, the Corporation acquired all of the outstanding common stock of The Citizens National Bank of Lansford (\"Citizens\"). On June 1, 1992, the Corporation acquired all of the outstanding stock of Summit Hill Trust Company (\"Summit Hill\"). On September 25, 1992, Summit Hill merged into Citizens and is now operating as a branch office of Citizens. On September 7, 1995, the Corporation, Citizens and Farmers and Merchants Bank (\"Farmers\") executed an Agreement and Plan of Reorganization and an Agreement and Plan of Merger. On March 1, 1996, the Corporation acquired all of the outstanding stock of Farmers and merged it with and into Citizens. On July 1, 1994 the Corporation acquired all of the outstanding stock of Security National Bank (\"Security\"). The Corporation is a three-bank holding company providing financial services through its Bank subsidiaries. Since commencing operations, the Corporation's business has consisted primarily of managing Harleysville, Citizens and Security (collectively the \"Banks\"), and its principal source of income has been dividends paid by the Banks. The Corporation is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"Bank Holding Company Act\"). As of December 31, 1995, the Company had total consolidated assets, deposits and shareholders' equity of $874,145,992, $741,218,395 and $77,516,176 respectively.\nHarleysville, which was established in 1909, Citizens, which was established in 1903, and Security, which was established in 1988, are national banking associations under the supervision of the Comptroller of the Currency of the United States of America. The Corporation's and Harleysville's legal headquarters are located at 483 Main Street, Harleysville, Pennsylvania 19438. Citizens' legal headquarters is located at 13-15 West Ridge Street, Lansford, Pennsylvania 18232. Security's legal headquarters is located at One Security Plaza, Pottstown, Pennsylvania 19464.\nThe Banks engage in the full-service commercial banking and trust business, including accepting time and demand deposits, making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and performing corporate pension and personal trust services. Their deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the maximum extent provided by law.\nThe Banks enjoy a stable base of core deposits and are leading community banks in their service areas. The Banks believe they have gained their position as a result of a customer oriented philosophy and a strong commitment to service. Senior management has made the development of a sales orientation throughout the Banks one of their highest priorities and emphasizes this objective with extensive training and sales incentive programs that the Company believes are unusual for community banks. The Banks maintain close contact with the local business community to monitor commercial lending needs and believes they respond to customer requests quickly and with flexibility. Management believes these competitive strengths are reflected in the Corporation's results of operations.\nThe Banks have twenty-two (22) offices located in Montgomery, Bucks and Carbon Counties, 12 of which are owned by the Banks and 10 of which are leased from third parties.\nAs of December 31, 1995, the Corporation and the Banks employed approximately 350 full-time and full-time equivalent persons. The Corporation provides a variety of employment benefits and considers its relationships with its employees to be satisfactory.\nCompetition - -----------\nThe Banks compete actively with other eastern Pennsylvania financial institutions, many larger than the Banks, as well as with financial and non-financial institutions headquartered elsewhere. The Banks are generally competitive with all institutions in their service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. At December 31, 1995, Harleysville's legal lending limit to a single customer was $9,650,000 and Citizens' and Security's legal lending limits to a single customer were $1,815,000 and $590,000, respectively. Many of the institutions with which the Banks compete are able to lend significantly more than these amounts to a single customer.\nSupervision and Regulation - The Registrant - -------------------------------------------\nThe Registrant is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the \"Bank Holding Company Act\"), and to supervision by the Federal Reserve Board. The Bank Holding Company Act requires the Registrant to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than five percent (5%) of the voting shares or substantially all of the assets of any institution, including another bank. In addition, the Bank Holding Company Act has been amended by the Riegle-Neal Interstate Banking and Branching Efficiency Act which permits bank holding companies to acquire a bank located in any state subject to certain limitation and restrictions which are more fully described below.\nA bank holding company is prohibited from engaging in or acquiring direct or indirect control of more than five percent (5%) 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.\nFederal law also prohibits acquisitions of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of the bank or bank holding company or to vote twenty-five percent (25%) or more of any class of voting securities.\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 of the bank holding company and on taking of such stock or securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower.\nPermitted Activities - --------------------\nThe Federal Reserve Board permits bank holding companies to engage in certain activities so closely related to banking or managing or controlling banks as to be proper incident thereto. Other than making an equity investment in a low to moderate income housing limited partnership, the Registrant does not at this time engage in any other permissible activities, nor does the Registrant have any current plans to engage in any other permissible activities in the foreseeable future.\nLegislation and Regulatory Changes - ----------------------------------\nFrom time to time, legislation is enacted which 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 Registrant and its subsidiaries. Certain changes of potential significance to the Registrant which have been enacted recently and others which are currently under consideration by Congress or various regulatory or professional agencies are discussed below.\nThe passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act may have a significant impact upon the Corporation. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. Since September 1995, bank holding companies may acquire banks in other states without regard to state law. In addition, banks can merge with other banks in another state beginning in June 1997. States may adopt laws preventing interstate branching but, if so, no out-of-state bank can establish a branch in such state and no banks in such state may branch outside the state. Pennsylvania recently amended the provisions of its banking code to authorize full interstate banking and branching under Pennsylvania law and to facilitate the operations of interstate banks in Pennsylvania. As a result of legal and industry changes, management predicts that consolidation will continue as the financial services industry strives for greater cost efficiencies and market share. Management believes that such consolidation may enhance its competitive position as a community bank.\nThe Interstate Banking and Branching Act also amends the International Banking Act to allow a foreign bank to establish and operate a federal branch or agency upon approval of the appropriate federal and state banking regulator. As a national bank, the Bank currently can relocate its main office across state lines by utilizing a provision in the National Bank Act which permits such relocation to a location not more than thirty miles from its existing main office. In effect, a national bank can thereby move across state lines as long as the relocation does not exceed thirty miles and also retain as branches the offices located in the original state.\nThe Federal Reserve Board, the FDIC, and the Comptroller of the Currency (\"Comptroller\") have issued certain risk-based capital guidelines. See pages 34 and 35 of Registrant's 1995 Annual Report, which is incorporated by reference herein, for information concerning the Registrant's capital.\nPending Legislation - -------------------\nVarious congressional bills and other proposals have proposed a sweeping overhaul of the banking system, including provisions for: limitations on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; expanding the power of banks by removing the restrictions on bank underwriting activities; tightening the regulation of bank derivatives activities; allowing commercial enterprises to own banks; and permitting bank holding companies to own affiliates that engage in securities, mutual funds and insurance activities.\nThere are numerous proposals before Congress to modify the financial services industry and the way commercial banks operate. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Except as specifically described on page 35 of the 1995 Annual Report to Shareholders, management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources, and results of operations of the Corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation which, if they were implemented, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the Corporation's results of operations.\nEffects of Inflation - --------------------\nInflation has some impact on the Corporation's and the Banks' operating costs. Unlike many industrial companies, however, substantially all of the Banks' assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Corporation's and the Banks' performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.\nEffect of Government Monetary Policies - --------------------------------------\nThe earnings of the Registrant are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. An important function of the Federal Reserve System is to regulate the money supply and interest rates. Among the instruments used to implement those objectives are open market operations in United States 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, and their use may also affect rates charged on loans or paid for deposits.\nThe Banks are members of the Federal Reserve System and, therefore, the policies and regulations of the Federal Reserve Board have a significant effect on its deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Banks' operations in the future. The effect of such policies and regulations upon the future business and earnings of the Corporation and the Banks cannot be predicted.\nEnvironmental Regulations - -------------------------\nThere are several federal and state statutes which regulate the obligations and liabilities of financial institutions pertaining to environmental issues. In addition to the potential for attachment of liability resulting from its own actions, a bank may be held liable under certain circumstances for the actions of its borrowers, or third parties, when such actions result in environmental problems on properties that collateralize loans held by the bank. Further, the liability has the potential to far exceed the original amount of the loan issued by the Bank. Currently, neither the Corporation nor the Banks are a party to any pending legal proceeding pursuant to any environmental statute, nor is the Corporation and the Banks aware of any circumstances which may give rise to liability under any such statute.\nSupervision and Regulation - Banks - ----------------------------------\nThe operations of the Banks are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the Federal Deposit Insurance Corporation. The Banks' operations are also subject to regulations of the Comptroller of the Currency (Comptroller), the Federal Reserve Board and the FDIC. The primary supervisory authority of the Banks is the Comptroller, who regularly examines the Banks. The Comptroller has authority to prevent a national bank from engaging in unsafe or unsound practices in conducting its business.\nFederal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, loans a bank makes and collateral it takes, the maximum interest rates a bank may pay on deposits, the activities of a bank with respect to mergers and consolidations and the establishment of branches.\nAs a subsidiary bank of a bank holding company, the Banks are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, or investments in the stock or other securities as collateral for loans. The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.\nFDIC - ----\nUnder the Federal Deposit Insurance Act, the Comptroller possesses the power to prohibit institutions regulated by it (such as the Banks) from engaging in any activity that would be an unsafe and unsound banking practice or would otherwise be in violation of the law.\nCRA - ---\nUnder the Community Reinvestment Act of 1977, as amended (\"CRA\"), the Comptroller is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low and moderate income neighborhoods) which they serve and to take this record into account in its evaluation of any application made by any of such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 amended the CRA to require, among other things, that the Comptroller make publicly available the evaluation of a bank's record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation will include a descriptive rating (\"outstanding\", \"satisfactory\", \"needs to improve\" or \"substantial noncompliance\") and a statement describing the basis for the rating. These ratings are publicly disclosed.\nBSA - ---\nUnder the Bank Secrecy Act (\"BSA\"), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions of which the bank is aware in any one day that aggregate in excess of $10,000. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report.\nFDICIA - ------\nCapital Categories: On December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") became law. Under FDICIA, institutions must be classified, based on their risk-based capital ratios into one of five defined categories, as illustrated below (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized).\nTotal Tier 1 Under a Risk- Risk- Tier 1 Capital Based Based Leverage Order or Ratio Ratio Ratio Directive\nCAPITAL CATEGORY Well capitalized >10.0 >6.0 >5.0 NO Adequately capitalized > 8.0 >4.0 >4.0* Undercapitalized < 8.0 <4.0 <4.0* Significantly Under- capitalized < 6.0 <3.0 <3.0 Critically Under- capitalized <2.0\n*3.0 for those banks having the highest available regulatory rating.\nPrompt Corrective Action: In the event an institution's capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval.\nOperational Controls: Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards to be developed by Federal Reserve Board regulations. FDICIA also requires the regulators to issue new rules establishing certain minimum standards to which an institution must adhere including standards requiring a minimum ratio of classified assets to capital, minimum earnings necessary to absorb losses and minimum ratio of market value to book value for publicly held institutions. Additional regulations are required to be developed relating to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and excessive compensation, fees and benefits.\nExaminations and Audits: Annual full-scope, on site regulatory examinations are required for all the FDIC- insured institutions except institutions with assets under $100 million which are well capitalized, well-managed and not subject to a recent change in control, in which case, the examination period is every eighteen (18) months. Banks with total assets of $500 million or more, as of the beginning of fiscal year 1993, are required to submit to their supervising federal and state banking agencies a publicly available annual audit report. The independent accountants of such bank are required to attest to the accuracy of management's report. The accountants also are required to monitor management's compliance with governing laws and regulations. In addition, such banks also are required to have 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 bank regulatory agencies. If the independent accountants resign or are dismissed, written notification must be given to the bank's supervising government banking agencies. These accounting and reporting reforms do not apply to an institution such as a bank with total assets at the beginning of its fiscal year of less than $500 million, such as Citizens or Security.\nReal Estate Loans: FDICIA also requires that banking agencies reintroduce loan-to-value (\"LTV\") ratio regulations which were previously repealed by the 1982 Act. LTVs limit the amount of money a financial institution may lend to a borrower, when the loan is secured by real estate, to no more than a percentage, set by regulation, of the value of the real estate.\nTruth-In-Savings: A separate subtitle within FDICIA, called the \"Bank Enterprise Act of 1991\", requires \"truth-in- savings\" on consumer deposit accounts so that consumers can make meaningful comparisons between the competing claims of banks with regard to deposit accounts and products. Under this provision, the Bank is required to provide information to depositors concerning the terms of their deposit accounts, and in particular, to disclose the annual percentage yield. The operational cost of complying with the Truth-In-Savings law had no material impact on liquidity, capital resources or reported results of operations.\nWhile the overall impact of fully implementing all provisions of the FDICIA cannot be accurately calculated, Management believes that full implementation of the FDICIA had no material impact on liquidity, capital resources or reported results of operation in future periods.\nOther: From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restriction on, the business of the Banks. It cannot be predicted whether any such legislation will be adopted or, if adopted, how such legislation would affect the business of the Banks. As a consequence of the extensive regulation of commercial banking activities in the United States, the Banks' business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.\nStatistical Data - ----------------\nThe information for this Item is incorporated by reference to pages 23 through 37 of the Company's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to this Form 10-K Report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - -------------------\nThe principal executive offices of the Company and of Harleysville are located in Harleysville, Pennsylvania in a two-story office building owned by Harleysville which was built in 1929. Harleysville also owns the buildings in which nine of its branches are located and leases space for the other seven branches from unaffiliated third parties under leases expiring at various times through 2012. The principal executive offices of Citizens are located in Lansford, Pennsylvania in a two-story office building owned by Citizens. Citizens also owns the buildings where the Summit Hill and Lehighton branches are located. The principal executive offices of Security are located in Pottstown, Pennsylvania in a building leased by Security. Security also leases its East End and North End Branches.\nOffice Office Location Owned\/Leased Harleysville 483 Main Street Owned Harleysville Pa\nSkippack Route 73 Owned Skippack Pa\nLimerick Ridge Pike Owned Limerick Pa\nNorth Penn Welsh & North Wales Rd Owned North Wales Pa\nGilbertsville Gilbertsville Shopping Leased Gilbertsville Pa\nHatfield Snyder Square Leased Hatfield Pa\nNorth Broad North Broad Street Owned Lansdale Pa\nMarketplace Marketplace Shopping Leased Lansdale Pa\nNormandy Farms Morris Road Leased Blue Bell Pa\nHorsham Babylon Business Center Leased Horsham Pa\nMeadowood Route 73 Leased Worcester Pa\nCollegeville 364 Main Street Owned Collegeville Pa\nSellersville 209 North Main St Owned Sellersville Pa\nTrainers Corner Trainers Corner Center Leased Quakertown Pa\nQuakertown Main 224 West Broad St Owned Quakertown PA\nRed Hill 400 Main Street Owned Red Hill PA\nCitizens 13-15 West Ridge Street Owned Lansford PA\nSummit Hill 2 East Ludlow Street Owned Summit Hill PA\nLehighton 904 Blakeslee Blvd Owned Lehighton PA\nPottstown One Security Plaza Leased Pottstown PA\nPottstown 1450 East High Street Leased Pottstown PA\nPottstown Charlotte & Mervine Sts. Leased Pottstown PA\nAll of the above properties are in good condition and are adequate for the Registrant's and the Banks' purposes.\nItem 3.","section_3":"Item 3. Legal Proceedings. - --------------------------\nManagement, based on consultation with the Corporation's legal counsel, is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Company. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its subsidiaries - Harleysville National Bank and Trust Company, The Citizens National Bank of Lansford and Security National Bank. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and the Banks by government authorities.\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 holders of the Company's Common Stock.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters. - -------------------------------------------------------------\nThe information for this Item is incorporated by reference to pages 8 and 18 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to this Form 10-K Report.\nItem 6.","section_6":"Item 6. Selected Financial Data. - --------------------------------\nThe information for this Item is incorporated by reference to pages 23 and 37 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to this Form 10-K Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. - ------------------------------------------------------------------------\nThe information for this Item is incorporated by reference to pages 23 through 36 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to this Form 10-K Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - ----------------------------------------------------\nThe information for this Item is incorporated by reference to pages 8 through 22 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to this Form 10-K Report.\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 to pages 18 and 19 of the Registrant's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 9, 1996.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. - ------------------------------------------------------------\nThe information for this Item with respect to the Corporation's directors is incorporated by reference to pages 3 through 7 of the Corporation's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 9, 1996.\nExecutive Officers of Registrant - -------------------------------- Name Age Position\nWalter E. Daller, Jr. 56 President and Chief Executive Officer of the Company and of Harleysville\nJames W. Hamilton 49 Senior Vice President and Senior Trust Officer of Harleysville\nDemetra M. Takes 45 Executive Vice President and Chief Operating Officer of Harleysville\nFrank J. Lochetto 48 Senior Vice President and Senior Lending Officer of Harleysville\nVernon L. Hunsberger 47 Treasurer of the Company, Senior Vice President\/CFO and Cashier of Harleysville\nFred C. Reim, Jr. 52 Senior Vice President of Harleysville since August 1993; Senior Vice President of First Valley Bank from December 1990 to August 1993\nHenry R. Gehman 60 Vice President of Harleysville\nJo Ann M. Bynon 44 Secretary of the Company\nDennis L. Detwiler 48 Vice President of Harleysville\nBruce D. Fellman 49 Vice President of Harleysville\nThomas L. Spence 49 Vice President of Harleysville\nRobert L. Reilly 46 Vice President of Harleysville\nDavid R. Crews 45 Vice President of Harleysville\nLarry E. Nolt 50 Vice President and Trust Officer of Harleysville since July 1993; Trust Officer of Harleysville from August 1991 to July 1993; Trust Officer of Union National Bank of Souderton for 4 years prior thereto\nMikkalya W. Walton 40 Vice President of Loan Administration of Harleysville since July 1994; Vice President Security National Bank September 1991 to June 1994; Assistant Vice President Mellon Bank January 1990 to August 1991\nGregg J. Wagner 35 Vice President and Comptroller of Harleysville National Bank since December 1994; Senior Vice President Security National Bank March 1992 to November 1994; Vice President and Comptroller Bryn Mawr Trust Company December 1989 to February 1992\nHarry T. Weierbach 51 Vice President of Investments of Harleysville since December 1995; Assistant Vice President of Harleysville from June 1994 to December 1995; Vice President of Investments of Continental Bank from\nThomas D. Oleksa 42 President and Chief Executive Officer of Citizens\nMartha A. Rex 47 Vice President and Cashier of Citizens\nMaurice Infante 56 Vice President Consumer Lending of Citizens since April 1994; Assistant Vice President Consumer Lending of Citizens December 1991 to March 1994; Vice President Home Savings Association of Pennsylvania January 1988 to November 1991\nRaymond H. Melcher 44 President and Chief Executive Officer of Security since November 1994; Executive Vice President, Chief Operating Officer Hi-Tech Connections 1990 to 1994; Executive Vice President Keystone Financial 1988 to 1990\nAllen R. Loeb 47 Vice President of Lending of Security since April 1995; Vice President of Lending National Penn Bank from April 1994 to April 1995\nItem 11.","section_11":"Item 11. Executive Compensation. - --------------------------------\nThe information for this Item is incorporated by reference to pages 7 through 13 of the Corporation's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 9, 1996.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. - ------------------------------------------------------------------------\nThe information for this Item is incorporated by reference to pages 3 through 4 of the Corporation's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 9, 1996.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - --------------------------------------------------------\nThe information for this Item is incorporated by reference to page 18 of the Corporation's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 9, 1996, and to page 16 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, which is included as Exhibit (13) to 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) Financial Statements, Financial Statement Schedules and Exhibits Filed:\n(1) Consolidated Financial Statements Page\nHarleysville National Corporation and Subsidiary: Consolidated Balance Sheets as of December 31, 1995 and 1994 9* Consolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 10* Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 11* Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 12* Notes to Consolidated Financial Statements 13-22* Independent Auditors' Report 8*\n(2) Financial Statement Schedules\nNone\nAll other schedules are omitted since they are not required, not applicable or the information is included in the consolidated financial statements or notes thereto.\n- ---------------------------------------------------------------- *Refers to the respective page of Harleysville National Corporation's 1995 Annual Report to Shareholders. The Consolidated Financial Statements and Notes to Consolidated Financial Statements and Auditor's Report thereon on pages 8 to 22 are incorporated by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and in Items 1, 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part of this Form 10-K Report or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\n(3) Exhibits\nExhibit No. Description of Exhibits - ---------- -----------------------\n(3.1) Articles of Incorporation as amended were previously filed with the Commission on December 14, 1995 as Exhibit 3a to Registration Statement 33-65021 and is hereby incorporated by reference\n(3.2) Amended By-laws of the Registrant were previously filed with the Commission on December 14, 1995 as Exhibit 3b to registration statement 33-65021 and is hereby incorporated by reference\n(13) 1995 Annual Report to Shareholders (this document is filed only to the extent of pages 8 through 37 which are incorporated by reference herein.)\n(21) Subsidiaries of Registrant\n(23) (a) Consent of Grant Thornton LLP Independent Certified Public Accountants\n(b) Consent of KPMG Peat Marwick LLP Independent Certified Public Accountants\n(27) Financial Data Schedule.\n(99) Additional Exhibits\n(a) Report of Independent Certified Public Accountants - Grant Thornton LLP\n(b) Report of Independent Certified Public Accountants - KPMG Peat Marwick LLP\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1995, the Registrant 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.\nHARLEYSVILLE NATIONAL CORPORATION\nDate: March 14, 1996 By: \/s\/ Walter E. Daller, Jr. Walter E. Daller, 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 dates indicated.\nSignatures Title Date ---------- ----- -----\n\/s\/ John W. Clemens Director March 14, 1996 John W. Clemens\n\/s\/ Walter E. Daller, Jr. President, Chief March 14, 1996 Walter E. Daller, Jr. Executive Officer and Director (Princi- pal Executive Officer)\n\/s\/ Martin E. Fossler Director March 14, 1996 Martin E. Fossler\n\/s\/ Harold A. Herr Director March 14, 1996 Harold A. Herr\n\/s\/ Vernon L. Hunsberger Treasurer (Princi- March 14, 1996 Vernon L. Hunsberger pal Financial and Accounting Officer)\n\/s\/ Howard E. Kalis, III Director March 14, 1996 Howard E. Kalis, III\n\/s\/ Bradford W. Mitchell Director March 14, 1996 Bradford W. Mitchell\n\/s\/ Walter F. Vilsmeier Director March 14, 1996 Walter F. Vilsmeier\n\/s\/ William M. Yocum Director March 14, 1996 William M. Yocum\nEXHIBIT INDEX -------------\n(13) 1995 Annual Report to Shareholders (this document is filed only to the extent of pages 8 through 37 which are incorporated by reference herein)\n(21) Subsidiaries of Registrant\n(23) Consent of Grant Thornton LLP Independent Certified Public Accountants\n(99) Additional Exhibits\n\/TEXT>","section_15":""}
{"filename":"902791_1995.txt","cik":"902791","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nBarrett Business Services, Inc. (\"Barrett\" or the \"Company\"), was incorporated in the state of Maryland in 1965. Barrett, a professional employer organization, provides light industrial, clerical and technical employees to a wide range of businesses through staff leasing, contract staffing, site management and temporary staffing arrangements. The Company's staff leasing and staffing services are provided through a network of 14 branch offices, eight of which are located throughout Oregon, two in northern California, two in Maryland, and two in Washington. The Company also operates 19 smaller recruiting and placement offices in its general market areas which are managed by a branch office. The Company provides employees to a diverse set of customers, including among others, forest products and agriculture- based companies, electronics manufacturers, transportation and shipping enterprises, professional firms and general contractors. See Item 6 of this report for information regarding the Company's revenues from staffing services and staff leasing services.\nGrowth Strategy\nBarrett's strategic plan continues to include (1) acquisition of additional personnel-related businesses, both in its existing markets and in other strategic geographic areas, (2) the further expansion of its business at existing branch offices primarily through its ongoing marketing and sales program and (3) accelerating the growth of professional employer services through innovative products and cost-effective services.\nRecent Acquisitions\nOn July 17, 1995, the Company purchased certain assets of Mid-Del Employment Service, Inc.; Sussex Employment Services, Inc.; PPI (Prestige Personnel) - Salisbury, Inc.; and Del-Mar-Va Nurses-On-Call Inc. (collectively, the \"Maryland and Delaware companies\") for $950,000 in cash. These companies, with combined 1994 revenues of approximately $4.1 million, were engaged in the temporary staffing business in eastern Maryland and Delaware.\nEffective December 11, 1995, the Company purchased certain assets of Strege & Associates, Inc., a company, with 1994 revenues of approximately $2.4 million, specializing in providing highly skilled tradesmen to various industries for maintenance and supplemental labor purposes in Portland, Oregon. Of the $1,141,000 purchase price (inclusive of acquisition-related costs of $4,000), the Company paid $230,000 in cash and issued 67,443 shares of its common stock with a then-fair market value of $911,000.\nThe Company reviews acquisition opportunities on an ongoing basis. While growth through acquisition is a major element of the Company's overall strategic growth plan, there can be no assurance that any additional acquisitions will be completed in the foreseeable future.\nStaffing Services\nGeneral. Staffing services enable businesses to meet peak or extraordinary demands caused by such factors as seasonality, increased customer demand, vacations, illnesses, parental leave and special projects without incurring the ongoing expense and administrative responsibilities associated with recruiting, hiring and retaining additional permanent employees. The use of staffing services allows businesses to utilize the \"just-in-time\" approach to their personnel needs. By maintaining a core of permanent employees to satisfy minimum requirements and managing increased demand through greater use of a flexible workforce, companies are able to convert a portion of their fixed personnel expense to variable expense, in\naddition to reducing costs related to recruiting, training, payroll, benefits, severance compensation, recordkeeping and other personnel matters.\nThe Company's Staffing Services. The Company provides light industrial, clerical and technical workers through a variety of arrangements to a broad range of businesses, including forest products and agriculture-based companies, electronics manufacturers, transportation and shipping companies, professional firms, and construction contractors.\nCustomers utilize the Company's staffing services, which accounted for approximately 55% of total 1995 revenues, through a number of arrangements, including contract staffing, site management and temporary staffing. Contract staffing typically involves employee placements for an indefinite period. A site management arrangement locates Barrett management personnel on site at a customer's place of business. Barrett then conducts all recruiting, screening, interviewing, testing, hiring and employee placement functions at the customer's facility. The Company has full responsibility for all personnel matters of the customer. Temporary staffing is defined as employee assignments which are typically less than three months in duration.\nLight industrial workers perform such tasks as operation of machinery, loading and shipping, site preparation for special events, construction-site cleanup and janitorial services. The light industrial category generated approximately 63% of the Company's 1995 staffing services revenues. Clerical workers, which accounted for approximately 11% of 1995 staffing services revenues, include primarily secretaries, receptionists and office clerks. Technical personnel include electronic parts assembly workers and designers and drafters of electronic parts; these workers represented approximately 26% of the Company's 1995 staffing services revenues.\nThe Company's staffing services customers range in size from small local firms to large national companies which use Barrett's services on a local basis. None of the Company's staffing services customers individually accounted for more than 10% of its total annual revenues for 1995.\nBusiness Strategy. The Company emphasizes prompt, personalized service in assigning quality, trained, drug-free personnel at competitive rates to users of its staffing services. Since 1980, the Company has relied on internally developed computer databases of employee skills and availability to match customer needs with available qualified employees. As a local company operating in selected market areas, Barrett believes it has an understanding of the unique requirements of its clientele that allows it to offer a \"money- back\" guarantee to the customer if it is not satisfied with the employees Barrett places through its staffing services.\nBarrett provides training to its branch office managers and sales personnel to develop and maintain a high level of customer service. The Company's ongoing training program includes Barrett University (an intensive one-week in-house training program), various seminars and video instruction. The Company's sales staff is compensated through a combination of base salary and an incentive sales commission. Sales commissions are earned by new business development and the retention of existing customers. Sales commissions may represent one-third to two-thirds of a salesperson's total compensation. In addition, branch office staff participate in the Company's non-qualified profit-sharing program. See \"Employees and Employee Benefits,\" below.\nRecruiting. The Company utilizes a variety of methods to recruit its workforce for staff services, including among others, newspaper advertising and marketing brochures distributed at colleges and vocational schools. In addition, a substantial number of new employees are hired through referrals by Barrett's existing employees. The Company believes it is easier to recruit and retain qualified personnel during periods of higher unemployment and therefore must devote more resources to recruiting and training new employees during periods of lower unemployment in its market areas. The Company may be unable to pass on the full amount of such increased recruiting and personnel costs in the form of higher prices for staffing services, which in turn could result in lower profit margins.\nThe employee application process includes an interview, skills assessment test, reference verification and drug test. The skills test and reference verification determine level of ability and an insight into prior job performance. Following hire and placement, performance is reviewed with customers to assure their satisfaction.\nThe Company believes that its employee wage and benefit package, customer base, and opportunities for part-time and flexible scheduling have contributed significantly to its success in recruiting and retaining quality, trained, drug-free personnel in numbers sufficient to meet customer demand. See \"Employees and Employee Benefits,\" below.\nSales and Marketing. The Company markets its staffing services primarily through direct sales presentations by its branch office managers and trained sales staff and, to a lesser extent, through advertising in various publications, including local newspapers and the Yellow Pages. Barrett also benefits from referrals by existing staffing services customers and from the periodic needs of the Company's staff leasing clients.\nFollowing the development of a preliminary profile of a prospective customer's needs, a Company salesperson typically schedules a meeting with the customer's personnel manager to explain Barrett's services. Based on this information, Barrett develops a market-competitive hourly charge for its staffing services. The actual cost to the customer for staffing services may range from 135% to 150% of the base wage rate. This composite rate includes all payroll taxes, employee benefits, workers' compensation coverage, and administrative costs, and takes into account the number and availability of employees and length of the service agreement.\nThe Company believes it has been able to maintain a price advantage due to the lower costs associated with its self-insured workers' compensation program when compared to the cost of workers' compensation insurance. The Company's marketing and sales efforts have generally increased during periods of economic decline, when demand for staffing services decreases. As a result of this reduced demand, the higher costs associated with marketing, sales and training typically cannot be recovered through price increases, which may result in lower profitability.\nBilling. The Company prepares weekly customer invoices immediately following the preparation of each payroll through the centralized payroll and billing operations at the Company's corporate headquarters. Barrett has not experienced significant problems in collecting its accounts receivable, which the Company attributes to customer satisfaction, a thorough analysis of a customer's credit history prior to agreeing to provide services and the weekly monitoring of account aging by each branch manager.\nProfessional Employer (Staff Leasing) Services\nGeneral. Many businesses, particularly those with a limited number of employees, find personnel administration requirements to be unduly complex and time consuming. These businesses often cannot justify the expense of a full- time human resources staff. In addition, the escalating costs of health and workers' compensation insurance in recent years, coupled with the increased complexity of laws and regulations affecting the workplace, have created a compelling alternative for small to mid-sized businesses to outsource these managerial burdens through staff leasing. The increasing trend of outsourcing numerous business functions enables management to fully devote the enterprise's resources to its core competencies.\nThe Company's Staff Leasing Services. In a staff leasing arrangement, Barrett enters into a contract to become a co-employer of the client company's existing workforce. Pursuant to this contract, Barrett assumes responsibility for some or all of the personnel-related matters, including payroll and payroll taxes, employee benefits, health insurance, workers' compensation coverage, employee risk management and related administrative responsibilities. Barrett also hires and fires leased employees, although the client company remains responsible for day-to-day assignments, supervision and training and, in most cases, recruiting.\nThe Company began offering staff leasing services to Oregon customers in 1990 and expanded these services to Maryland and Washington in the first and third quarters, respectively, of 1994, and to Delaware and California in the second quarter of 1995. The Company has entered into staff leasing arrangements with a wide variety of clients, including companies involved in reforestation, moving and shipping, professional firms, construction, retail, manufacturing and distribution businesses. Staff leasing clients are typically small to mid-sized businesses with up to 50 employees. None of the Company's staff leasing clients individually accounted for more than 5% of its total annual revenues during 1995.\nThe number of Barrett's staff leasing clients increased from approximately 520 at December 31, 1994, to approximately 531 at year-end 1995. Due to management's concerns regarding several worksite risk management issues, the Company terminated or did not renew approximately 140 staff leasing contracts during 1995, which resulted in slower growth in the overall number of client companies, but also resulted in a noticeable reduction in workers' compensation claims and related expenses.\nBusiness Strategy. The Company believes that it has attracted significant numbers of new staff leasing clients since 1990 by demonstrating the potential for cost reductions offered by the Company's self-insured workers' compensation program. Equally important, Barrett also offers a variety of employee benefits and services, which it can generally provide on a cost-effective basis due to its substantially larger employee base as compared to its clients. The employee benefits and human resource management services offered by the Company include a full range of health, life and disability insurance, a Section 125 cafeteria plan, a Section 401(k) savings plan, credit union participation, direct deposit for payroll or preferred payroll checks, mandatory drug testing, and advisory services related to hiring, employee evaluations and termination guidelines, among others. See \"Regulatory and Legislative Issues -- Employee Benefit Plans.\" The Company believes these benefits and services are cost effective and reduce employee turnover, thereby increasing the appeal of staff leasing arrangements to most small to mid-sized business owners. The overall cost to the client for its leased employees is typically at or below the cost per employee that the client would otherwise incur if it was the sole employer of its workforce.\nThe Company's standard staff leasing agreement provides for services indefinitely, until notice of termination is given by either party. The agreement permits cancellation by either party upon 35 days' prior written notice. In addition, the Company may terminate the agreement at any time for specified reasons, including nonpayment or failure to follow Barrett's workplace safety program. The agreement also provides for indemnification of the Company by the client against losses arising out of any default by the client under the agreement, including failure to comply with any employment- related, health and safety or immigration laws or regulations.\nSales and Marketing. The Company markets its staff leasing services through its branch office sales staff. Coincident with the Company's self- insured employer status for workers' compensation purposes in California, the Company commenced its marketing of staff leasing services in California during the second quarter of 1995. The Company also obtains referrals from existing clients and other third parties, and places advertisements in the Yellow Pages. Prior to entering into a staff leasing arrangement, the Company performs an analysis of the potential client's actual personnel and workers' compensation costs based on information provided by the customer. Barrett also introduces its workplace safety program and makes recommendations as to improvements in procedures and equipment following a safety inspection of the customer's facilities. Once the client has agreed to implement the Company's safety program, the Company proposes a staff leasing arrangement at a price which is typically at or below the client's current overall personnel costs. Barrett also offers significant financial incentives to clients to maintain a safe work environment, thus enabling clients to achieve additional savings. Barrett strongly advocates that its client companies share these safe-work incentives with their leased employees.\nBilling. Through centralized operations at the Company's headquarters in Portland, Oregon, payroll checks are prepared for each staff leasing client on a frequency consistent with their typical payperiods, weekly or bi-weekly, and delivered by courier. The Company invoices its clients following the end of each payroll period. Such invoices are due upon receipt and are generally paid within five business days. The costs of health insurance coverage and Barrett's cafeteria plan are passed through to its staff leasing clients based on the number of participating employees. The Company often requires a deposit from its staff leasing clients to cover a portion of the anticipated billing for one payroll period. The Company has had generally favorable results with collecting accounts receivable, which it attributes to customer satisfaction, the prompt payment of receivables, its analysis of potential clients' credit histories, and weekly monitoring of account aging by each branch manager.\nSelf-Insured Workers' Compensation Program\nThe Company believes that its self-insured workers' compensation program is an important contributor to its growth in revenue and profitability. Significant elements contributing to the success of the workers' compensation program include the regulatory climate surrounding workers' compensation, the Company's workplace safety program and the aggressive claims management approach taken by the Company and its third-party administrators, all of which are described in detail below.\nElements of Workers' Compensation System. State law generally mandates that an employer reimburse its employees for the costs of medical care and other specified benefits for injuries or illnesses incurred in the course and scope of employment. The benefits payable for various categories of claims are determined by state regulation and vary with the severity and nature of the injury or illness and other specified factors. In return for this guaranteed protection, workers' compensation is an exclusive remedy and employees are generally precluded from seeking other damages from their employer for workplace injuries. Most states require employers to maintain workers' compensation insurance or otherwise demonstrate financial responsibility to meet workers' compensation obligations to employees. In many states, employers who meet certain financial and other requirements are permitted to self-insure.\nSelf-Insurance for Workers' Compensation. In August 1987, the Company became a self-insured employer for workers' compensation coverage in Oregon. The Company subsequently obtained self-insured employer status for workers' compensation in four additional states, Maryland in November 1993, Washington in July 1994, Delaware in January 1995 and California in March 1995. In addition, in May 1995, the Company became self-insured by the United States Department of Labor for longshore and harbor (\"USL&H\") workers coverage. Regulations governing self-insured employers in each state typically require the employer to maintain surety deposits of cash, government securities or other financial instruments to cover workers' claims in the event the employer is unable to pay for such claims.\nPursuant to its self-insured status, the Company's workers' compensation expense is tied directly to the incidence and severity of workplace injuries to its employees. Barrett also maintains excess workers' compensation insurance for individual claims exceeding $350,000 (except for $300,000 in Maryland and $500,000 for USL&H coverage) in an unlimited amount pursuant to annual policies with major insurance companies. The excess-insurance policies contain standard exclusions from coverage, including punitive damages, fines or penalties in connection with violation of any statute or regulation and losses covered by other insurance or indemnity provisions.\nWorkplace Safety Program. In the late 1980's, the Company identified an opportunity to market to small and mid-sized Oregon employers its safety program designed to assist clients in managing workplace injuries and reducing workers' compensation claims. The Company's program begins with an on-site safety inspection by one of its risk managers. Barrett then designs a safety program for the client, including employee and supervisor safety training and regular meetings between management and employees to discuss safety issues and precautionary actions. Among other safety measures, the Company encourages clients to provide on-site first aid care and to make improvements in workplace procedures and equipment to further reduce the risk of injury. The Company's third-party administrators for workers' compensation claims also assist the Company in performing safety inspections of client worksites and provide technical advice regarding workplace safety measures.\nA key factor to the success of the Company's safety program is its system of financial incentives to reward safe-work practices which result in reductions in the number and severity of work-related injuries. If the annual cost of claims is less than agreed upon amounts, the Company pays an annual cash incentive based on a percentage of the staff leasing client's payroll. Barrett's business philosophy strongly encourages its client companies to share these incentives with their employees. Staff leasing clients and their leased employees are thus provided an economic incentive to maintain a safer work environment and to reduce the frequency of fraudulent claims for work- related injuries. Barrett also maintains a mandatory corporate-wide pre- employment drug testing program. Results of the program are believed to include a reduction in the frequency of fraudulent claims and in accidents in which the use of illegal drugs appears to have been a contributing factor.\nClaims Management. The Company also seeks to contain its workers' compensation costs through an aggressive approach to claims management. Barrett uses managed-care systems to reduce medical costs and keeps time-loss costs to a minimum by assigning injured workers, whenever possible, to temporary assignments which accommodate the worker's physical limitations. The Company believes that these temporary assignments minimize both time actually lost from work and covered time-loss costs. Barrett has also engaged third-party administrators to provide additional claims management expertise. Typical management procedures include performing thorough and prompt on-site investigations of claims filed by employees, working with physicians to encourage efficient medical management of cases, denying questionable claims and negotiating early settlements to eliminate future case development and costs.\nElements of Self-Insurance Costs. The costs associated with the Company's self-insured workers' compensation program include loss and loss adjustment expense payments with respect to claims made by employees, fees payable to the Company's third-party administrators, assessments payable to state workers' compensation regulatory agencies, premiums for excess workers' compensation insurance and safety incentive payments. Although not directly related to the size of the Company's payroll, the number of claims and correlative loss payments may be expected to increase with growth in the total number of employees. Third-party administrator fees also vary with the number of claims administered. The state assessments are typically based on payroll amounts and to a limited extent, the amount of permanent disability awards during the previous year. Excess insurance premiums are also based in part on the size of the Company's payroll. Safety incentives expense may increase as the number of the Company's staff leasing employees rises, although increases will only occur for any given client company if such client's claims costs are below agreed upon amounts.\nWorkers' Compensation Claims Experience and Reserves\nIn connection with its workers' compensation self-insurance program, the Company is liable for loss and loss adjustment expense payments under the workers' compensation laws of Oregon, Washington, Maryland, and most recently, Delaware and California. Several months may elapse between the occurrence of a workers' compensation loss, the reporting of the claim to the Company and the Company's payment of that claim. The Company recognizes its liability for the ultimate payment of all incurred claims and claims adjustment expenses by accruing liabilities which represent estimates of future amounts necessary to pay claims and related expenses with respect to covered events that have occurred.\nWhen a claim involving a probable loss is reported, the Company's third- party administrator establishes a case reserve for the estimated amount of its ultimate loss. The estimate reflects an informed judgment based on established case reserving practices and the experience and knowledge of Barrett's third-party administrators regarding the nature and expected value of the claim, as well as the estimated expense of settling the claim, including legal and other fees and expenses of administering claims. Additionally, on an aggregate basis, the Company has established a provision for losses incurred but not reported and future development in excess of case reserves on existing reported claims (\"IBNR\").\nAs part of the case reserving process, historical data is reviewed and consideration is given to the anticipated effect of various factors, including known and anticipated legal developments, inflation and economic conditions. Reserve amounts are necessarily based on management's estimates, and as other data becomes available, these estimates are revised, which may result in increases or decreases to existing case reserves. As of December 31, 1995, the Company's total accrued workers' compensation claims liabilities totaled $2,705,000, compared to $2,522,000 at year-end 1994. The total number of self-insured claims reported in 1995 was 1,132, compared to 1,080 for 1994. Barrett has engaged a nationally-recognized, independent actuary to periodically review the Company's total workers' compensation claims liability and reserving practices. Based in part on such review, the Company believes its total accrued workers' compensation claims liabilities are adequate. There can, however, be no assurance that the Company's actual future workers' compensation obligations will not exceed the amount of its accrued liabilities, with a corresponding negative effect on future earnings, due to such factors as unanticipated loss development of known claims and incurred but not reported claims.\nEmployees and Employee Benefits\nAt December 31, 1995, the Company had approximately 13,325 employees, including approximately 8,800 staffing services employees, approximately 4,300 leased employees and approximately 225 managerial, sales and administrative employees. The number of employees at any given time can vary significantly due to business conditions at customer or client companies. Less than 0.1% of the Company's employees are covered by a collective bargaining agreement. Each of Barrett's managerial, sales and administrative employees has entered into a standard form of employment agreement which, among other things, contains covenants not to engage in certain activities in competition with the Company for 18 months following termination of employment and to maintain the confidentiality of certain proprietary information. Barrett believes its employee relations are good.\nBenefits offered to Barrett's staffing services employees include group health insurance, a Section 125 cafeteria plan which permits employees to use pre-tax earnings to fund various services, including medical, dental and child care, and a Section 401(k) savings plan pursuant to which employees may begin making contributions upon reaching 21 years of age and completing 1,000 hours of service in any consecutive 12-month period. The Company may also make contributions to the savings plan, which vest over seven years and are subject to certain legal limits, at the sole discretion of the Company's board of directors. Leased employees may participate in the Company's benefit plans, provided that the group health insurance premiums may, at the client's option, be paid by payroll deduction. Barrett also maintains a nonqualified profit- sharing plan for its managerial and administrative personnel. See \"Regulatory and Legislative Issues -- Employee Benefit Plans\" below.\nRegulatory and Legislative Issues\nBusiness Operations\nThe Company is subject to the laws and regulations governing self- insured employers under the workers' compensation systems in Oregon, Washington and Maryland and, beginning in 1995, Delaware, California, and the United States Department of Labor for longshore and harbor workers. In addition, legislation was adopted in Oregon in 1993 requiring a staff leasing company, such as Barrett, to be licensed by the Workers' Compensation Division of the Oregon Department of Consumer and Business Services. Temporary staffing companies are expressly exempt from the legislation. Oregon staff leasing companies are also required to ensure that each leasing client provides adequate training and supervision for its employees to comply with statutory requirements for workplace safety and to give 30 days' written notice in the event of a termination of its obligation to provide workers' compensation coverage for leased employees and other subject employees of a leasing client. Although compliance with the legislation has caused Barrett to make certain changes in its staff leasing operations and contracts in Oregon, which has resulted in additional financial risk, particularly with respect to those clients who breach their payment obligations to the Company, compliance with the legislation has not had a material impact on its business operations, financial condition or operating results.\nWhile it is impossible to predict if, when and in what form any health care reform will be enacted on a state or national level, elements of such reform may have a material adverse effect on the Company's operations and its self-insured workers' compensation program.\nEmployee Benefit Plans\nThe Company's operations are affected by numerous federal and state laws relating to labor, tax and employment matters. By entering into a co-employer relationship with employees who are assigned to work at client company locations (sometimes referred to as \"worksite employees\"), the Company assumes certain obligations and responsibilities of an employer under these federal and state laws. Because many of these federal and state laws were enacted prior to the development of nontraditional employment relationships, such as professional employer, temporary employment, and outsourcing arrangements, many of these laws do not specifically address the obligations and responsibilities of nontraditional employers. In addition, the definition of \"employer\" under these laws is not uniform.\nAs an employer, the Company is subject to all federal statutes and regulations governing its employer-employee relationships. Subject to the issues discussed below, the Company believes that its operations are in compliance in all material respects with all applicable federal statutes and regulations.\nThe Company offers various employee benefit plans to its employees, including its worksite employees. These employee benefit plans include a savings plan under Section 401(k) of the Internal Revenue Code of 1986, as amended (the \"Code\"), a cafeteria plan under Code Section 125, a group health plan, a group life insurance plan, a group disability insurance plan and an employee assistance plan. Generally, employee benefit plans are subject to provisions of both the Code and the Employee Retirement Income Security Act (\"ERISA\"). In order to qualify for favorable tax treatment under the Code, qualified plans must be established and maintained by an employer for the exclusive benefit of its employees. For a discussion of the current status of the Company's plans, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- \"Results of Operations.\"\nCompetition\nThe staff leasing and staffing services businesses are characterized by rapid growth and intense competition. The staffing services market includes competitors of all sizes, including several, such as Manpower, Inc., Kelly Services, Inc., The Olsten Corporation, Interim Services, Inc., and Adia Services, Inc., which are national in scope and have substantially greater financial and marketing resources than the Company. In addition to national companies, Barrett competes with numerous regional and local firms for both customers and employees. The Company estimates that at least 100 firms provide staffing services in Oregon. There are relatively few barriers to entry into the staffing services business. The principal competitive factors in the staffing services industry are price, the ability to provide qualified workers in a timely manner and the monitoring of job performance. The Company attributes its growth in staffing services revenues to the cost-efficiency of its operations, which permits the Company to price its services competitively, and to its ability through its branch office network to understand and satisfy the needs of its customers with competent personnel.\nAlthough there are believed to be approximately 2,000 staff leasing companies currently operating in the United States, many of these potential competitors are located in states in which the Company presently does not operate. Barrett believes that at least 30 staff leasing firms are operating in Oregon, but that the Company has the largest presence in the State. The Company may face additional competition in the future from new entrants to the field, including other staffing services companies, payroll processing companies and insurance companies. Certain staff leasing companies operating in areas in which Barrett does not now, but may in the future, offer its services have greater financial and marketing resources than the Company. Competition in the staff leasing industry is based largely on price, although service and quality are also important. Barrett believes that its growth in staff leasing revenues is attributable to its ability to provide small and mid-sized companies with the opportunity to provide enhanced benefits to their employees with a concomitant reduction in the clients' overall personnel administration and workers' compensation costs. The Company's competitive advantage may be adversely affected by a substantial increase in the costs of maintaining its self-insured workers' compensation program or by a general market decrease in the level of workers' compensation insurance premiums.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company provides staffing services and staff leasing through all 14 of its branch offices. The following table shows the locations of the Company's branch offices and the year in which each branch was opened or acquired. The Company's Oregon branches accounted for 68% of its total revenues in 1995. The Company also leases office space in 19 other locations in its market areas which it uses to recruit and place employees.\nIn May 1993, Barrett purchased an office building in Portland, Oregon, with approximately 9,200 square feet of office space, for a total purchase price of $925,000. The Company's corporate headquarters were relocated to the new building in June 1993. The building is subject to a mortgage loan with a principal balance of approximately $629,000 at December 31, 1995.\nThe Company also owns another office building in Portland, Oregon, in which its headquarters were previously located. The building is subject to a mortgage loan with a principal balance at December 31, 1995, of approximately $279,000 and has approximately 7,000 square feet of office space. Barrett moved its Portland (Bridgeport) branch office to this building in September 1993.\nBarrett leases office space for its other branch offices. At December 31, 1995, such leases had expiration dates ranging from less than one year to eight years, with total minimum payments through 1999 of approximately $1,360,000.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere were no legal proceedings requiring disclosure pursuant to this item pending at December 31, 1995, or at the date 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 Company's stockholders during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding Barrett's executive officers appears in Item 10 of this report.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol \"BBSI.\" At February 1, 1996, there were 67 stockholders of record and approximately 1,700 beneficial owners of the Company's common stock. The Company has not declared or paid any cash dividends since the closing of its initial public offering of its common stock on June 18, 1993, and has no present plan to pay any cash dividends in the foreseeable future. The following table presents the high and low sales prices of the Company's common stock for each quarterly period during the last two fiscal years, as reported by The Nasdaq Stock Market:\n1994 High Low - ---- ------ ------ First Quarter $ 16.00 $ 6.875 Second Quarter(1) 14.75 8.25 Third Quarter 12.25 8.00 Fourth Quarter 16.25 11.00\n- ---- First Quarter $ 19.50 $ 13.50 Second Quarter 15.00 10.50 Third Quarter 15.75 13.50 Fourth Quarter 15.50 12.25\n(1) All per share prices prior to the second quarter of 1994 have been restated to reflect a 2-for-1 stock split effective May 23, 1994.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the Company's financial statements and the accompanying notes presented in Item 8 of this report.\n- ------------------------- (1) Effective July 1, 1987, the Company elected to be treated as a corporation subject to taxation under Subchapter S of the Internal Revenue Code, pursuant to which the net earnings of the Company were taxed directly to the Company's stockholders rather than to the Company. The Company terminated its election on April 30, 1993, and recognized a cumulative net deferred tax asset of $505,000. The amounts shown reflect a pro forma tax provision as if the Company had been a Subchapter C corporation subject to income taxes for all periods presented.\n(2) All share and per share amounts have been restated to reflect the 2- for-1 stock split effective May 23, 1994.\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 percentages of total revenues represented by selected items in the Company's Statements of Operations for the years ended December 31, 1995, 1994 and 1993, included in Item 8","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n(a) The following audited financial statements of Barrett Business Services, Inc., and related documents are set forth herein on the pages indicated:\nPage\nReport of Independent Accountants. . . . . . . . . . . . . . . . . . . . . .22\nBalance Sheets at December 31, 1995 and 1994 . . . . . . . . . . . . . . . .23\nStatements of Operations for the years ended December 31, 1995, 1994, and 1993. . . . . . . . . . . . . . . . . . . . .24\nStatements of Stockholders' Equity for the years ended December 31, 1995, 1994, and 1993. . . . . . . . . . . . . . .25\nStatements of Cash Flows for the years ended December 31, 1995, 1994, and 1993. . . . . . . . . . . . . . . . . . . . .26\nNotes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . .27\nOther financial statement schedules are omitted because they are not applicable or not required.\nReport of Independent Accountants\nFebruary 9, 1996\nTo the Stockholders and Board of Directors of Barrett Business Services, Inc.\nIn our opinion, the accompanying balance sheets and the related statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Barrett Business Services, 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.\nPRICE WATERHOUSE LLP Portland, Oregon\nBarrett Business Services, Inc. Balance Sheets (In thousands) December 31, 1995 1994 ---- ---- Assets Current assets: Cash and cash equivalents $ 3,218 $ 2,214 Trade accounts receivable, net 13,151 9,631 Prepaid expenses and other 478 599 Deferred tax assets (Note 13) 937 914 -------- --------\nTotal current assets 17,784 13,358 Intangibles, net (Note 4) 6,452 4,936 Property and equipment, net (Notes 5 and 8) 2,261 2,110 Restricted marketable securities and workers' compensation deposits (Note 6) 4,681 4,196 Other assets 95 65 -------- -------- $ 31,273 $ 24,665 ======== ========\nLiabilities and Stockholders' Equity Current liabilities: Current portion of long-term debt (Notes 8 and 11) $ 33 $ 31 Accounts payable 378 218 Accrued payroll, payroll taxes and related benefits 5,797 5,057 Accrued workers' compensation claim liabilities (Note 6) 2,383 2,358 Customer safety incentives payable 776 805 -------- -------- Total current liabilities 9,367 8,469 Long-term debt, net of current portion (Notes 8 and 11) 875 908 Customer deposits 675 669 Long-term workers' compensation liabilities (Note 6) 322 164 -------- -------- 11,239 10,210 -------- --------\nCommitments and contingencies (Notes 9, 10 and 15)\nStockholders' equity: Common stock, $.01 par value; 20,500 shares authorized,6,551 and 6,367 shares issued and outstanding(Notes 12 and 14) 66 64 Additional paid-in capital 10,437 8,978 Retained earnings 9,531 5,413 -------- -------- 20,034 14,455 -------- -------- $ 31,273 $ 24,665 ======== ========\nThe accompanying notes are an integral part of these financial statements.\nBarrett Business Services, Inc. Statements of Operations (In thousands, except per share amounts)\nYear ended December 31, 1995 1994 1993 ---- ---- ---- Revenues: Staffing services $ 99,233 $ 71,148 $ 41,755 Professional employer services 80,572 69,404 58,512 ------- ------- ------- 179,805 140,552 100,267 ------- ------- -------\nCost of revenues: Direct payroll costs 136,174 105,515 75,171 Payroll taxes and benefits 16,088 12,758 9,911 Workers' compensation (Note 6) 6,073 5,069 4,591 Safety incentives 981 1,103 598 ------- ------- ------- 159,316 124,445 90,271 ------- ------- -------\nGross margin 20,489 16,107 9,996\nSelling, general and administrative expenses 13,657 10,302 6,450 Amortization of intangibles (Note 4) 564 430 370 ------- ------- ------- Income from operations 6,268 5,375 3,176 ------- ------- ------- Other (expense) income: Interest expense (75) (106) (86) Interest income 400 224 161 Other, net 32 78 133 ------- ------- ------- 357 196 208 ------- ------- -------\nIncome before provision for taxes 6,625 5,571 3,384\nProvision for income taxes (Note 13) 2,507 2,105 437 ------- ------- -------\nNet income $ 4,118 $ 3,466 $ 2,947 ======= ======= =======\nNet income per share $ .62 $ .53 $ - ======= ======= ======= Unaudited pro forma information (Note 13): Income before provision for income taxes $ 3,384 Pro forma provision for income taxes 1,324 -------\nPro forma net income $ 2,060 =======\nPro forma net income per share $ .39 =======\nWeighted average number of shares outstanding 6,680 6,591 5,260 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nBarrett Business Services, Inc. Statements of Stockholders' Equity (In thousands)\nCommon stock Additional --------------- paid-in Retained Shares Amount capital earnings Total ------ ------ ------- -------- -----\nBalance, December 31, 1992 2,000 $ 20 $ 190 $ 1,364 $ 1,574\nCommon stock issued 1,152 12 6,816 6,828 Net income 2,947 2,947 Distributions to stockholders (869) (869) Reclassification of retained earnings on issuance of common stock 2,332 (2,332) - ----- ----- ------ ----- ------ Balance, December 31, 1993 3,152 32 8,469 1,979 10,480\nCommon stock issued for acquisitions 29 468 468 Common stock issued on exercise of options 22 41 41 Net income 3,466 3,466 Reclassification of retained earnings for stock split 3,164 32 (32) - ----- ----- ------ ----- ------ Balance, December 31, 1994 6,367 64 8,978 5,413 14,455\nCommon stock issued for acquisitions 67 1 910 911 Common stock issued on exercise of options and warrants 124 1 549 550 Net income 4,118 4,118 Contribution of common stock (Note 11) (7) - ----- ----- ------ ----- ------\nBalance, December 31, 1995 6,551 $ 66 $10,437 $ 9,531 $20,034 ===== ===== ====== ===== ======\nThe accompanying notes are an integral part of these financial statements.\nBarrett Business Services, Inc. Statements of Cash Flows (In thousands)\nYear ended December 31, 1995 1994 1993 ---- ---- ----\nCash flows from operating activities: Net income $ 4,118 $ 3,466 $ 2,947 Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization 812 637 530 Gain on sales of marketable securities (42) - (112) Provision for doubtful accounts (38) 136 160 Deferred taxes (23) (20) (894) Changes in certain assets and liabilities: Trade accounts receivable (3,482) (4,813) (969) Prepaid expenses and other 121 (454) 2 Income taxes payable - (79) 79 Accounts payable 160 127 (135) Accrued payroll, payroll taxes and related benefits 740 1,834 658 Accrued workers' compensation claim liabilities 183 88 1,097 Customer safety incentives payable (29) 278 (8) Customer deposits, other liabilities and other assets, net (24) 115 60 ----- ----- ------ Net cash provided by operating activities 2,496 1,315 3,415 ----- ----- ------ Cash flows from investing activities: Cash paid for acquisitions, including other direct costs (1,199) (4,737) (10) Purchases of fixed assets, net of amounts purchased in acquisitions (369) (308) (1,280) Proceeds from sales of marketable securities 1,862 8,619 8,413 Purchases of marketable securities (2,305) (3,713) (15,938)\nNet cash used by investing activities (2,011) (139) (8,815)\nCash flows from financing activities: Distributions to stockholders - - (869) Proceeds from debt issued - - 752 Payments on long-term debt (31) (130) (196) Proceeds from issuance of common stock - - 6,828 Proceeds from the exercise of stock options and warrants 550 41 - ----- ----- ------\nNet cash provided (used) by financing activities 519 (89) 6,515 ----- ----- ------\nNet increase in cash and cash equivalents 1,004 1,087 1,115\nCash and cash equivalents, beginning of year 2,214 1,127 12 ----- ----- ------\nCash and cash equivalents, end of year $ 3,218 $ 2,214 $ 1,127 ===== ===== ======\nThe accompanying notes are an integral part of these financial statements.\nBarrett Business Services, Inc. Notes to Financial Statements\n1. Summary of Operations and Significant Accounting Policies\nNature of operations Barrett Business Services, Inc. (\"Barrett\" or the \"Company\"), a Maryland corporation, is engaged in providing staffing and professional employer services to a diversified group of customers through a network of branch offices throughout Oregon, Washington, northern California, Maryland and Delaware. Approximately 68%, 78% and 92%, respectively, of the Company's revenues during 1995, 1994 and 1993 was attributable to its Oregon operations.\nRevenue recognition The Company recognizes revenue as the services are rendered by its work force. Staffing services are engaged by customers to meet short-term fluctuations in personnel needs. Professional employer services are normally used by organizations to satisfy ongoing personnel needs and typically involve contracts with a minimum term of one year, renewable annually, which cover all employees at a particular work site.\nCash and cash equivalents The Company considers nonrestricted short-term investments which are highly liquid, readily convertible into cash and have original maturities of less than three months to be cash equivalents for purposes of the statements of cash flows.\nAllowance for doubtful accounts The Company had an allowance for doubtful accounts of $25,000 and $62,500 at December 31, 1995 and 1994, respectively.\nMarketable securities The Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective December 31, 1994. At December 31, 1995 and 1994, marketable securities consisted primarily of governmental debt instruments with maturities generally from 90 days to 30 years (see Note 6). Marketable equity and debt securities have been categorized as held-to-maturity and, as a result, are stated at amortized cost. Realized gains and losses on sales of marketable securities are included in other, net on the Company's statements of operations.\nIntangibles Intangible assets consist primarily of identifiable intangible assets acquired and the cost of acquisition in excess of the fair value of net assets acquired (goodwill). Intangible assets acquired are recorded at their estimated fair value at the acquisition date.\nThe Company uses a fifteen-year estimate as the useful life of goodwill. This life is based on an analysis of industry practice and the factors influencing the acquisition decision. Other intangible assets are amortized on the straight-line method over their estimated useful lives, ranging from two to fifteen years. (See Note 4.)\n1. Summary of Operations and Significant Accounting Policies (Continued)\nIntangibles (continued) The Company reviews for asset impairment at the end of each quarter or more frequently when events or changes in circumstances indicate that the carrying amount of intangible assets may not be recoverable. To perform that review, the Company estimates the sum of expected future undiscounted net cash flows from the intangible assets. If the estimated net cash flows are less than the carrying amount of the intangible asset, the Company recognizes an impairment loss in an amount necessary to write down the intangible asset to a fair value as determined from expected future cash flows. No write-down for impairment loss was recorded for the years ended December 31, 1995, 1994 and 1993.\nProperty and equipment Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operating expense as incurred and expenditures for additions and betterments are capitalized. The cost of assets sold or otherwise disposed of and the related accumulated depreciation are eliminated from the accounts, and any resulting gain or loss is reflected in the statements of operations.\nDepreciation of property and equipment is calculated using either straight-line or accelerated methods over estimated useful lives which range from 3 years to 31.5 years.\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 Company will adopt the statement in 1996; however, the adoption is not expected to have a significant impact on the Company's financial statements.\nCustomer safety incentives payable Safety incentives are paid annually to professional employer services clients if the cost of workers' compensation claims is less than agreed upon amounts; amounts paid are based on a percentage of payroll. The Company accrues the amounts payable under this program on a monthly basis.\nIncome taxes Effective July 1, 1987, the Company elected to be treated as an S Corporation under certain provisions of the Internal Revenue Code. As such, the income or losses of the Company were attributable to its stockholders in their individual tax returns. Effective April 30, 1993, the Company terminated its S Corporation status. A pro forma provision for income taxes that would have been recorded if the Company had been a C Corporation for the year ended December 31, 1993 is provided for comparative purposes in the statements of operations.\nCustomer deposits The Company requires deposits from certain professional employer services customers to cover a portion of its accounts receivable due from such customers in event of default of payment.\n1. Summary of Operations and Significant Accounting Policies (Continued)\nCommon stock split and change in authorized shares The Company's stockholders approved a 7,968-for-1 split of its common stock, an increase in authorized common shares and the authorization of preferred stock which became effective March 25, 1993. Additionally, the par value of common stock was changed to $.01 from $10 per share. Common stock and additional paid-in capital as of December 31, 1992 have been adjusted to reflect this change. On April 20, 1994, the Company's board of directors approved a 2-for-1 stock split in the form of a stock dividend, paid May 23, 1994, to holders of record of its common stock at the close of business on May 2, 1994 (the \"Record Date\"), at the rate of one new share for each share outstanding on the Record Date.\nCommon stock split and change in authorized shares (continued) All earnings per share amounts have been adjusted to reflect these transactions for all periods presented.\nA special meeting of stockholders was held on August 10, 1994, pursuant to which the stockholders approved an amendment to the Company's charter to increase the number of authorized shares of common stock from 7,500,000 shares to 20,500,000 shares.\nStatements of cash flows The Company has recorded the following non-cash transactions:\nDuring 1994, the Company issued common stock with an aggregate fair market value of $468,000 in connection with the acquisition of certain assets of Personnel Management & Consulting, Inc. and Construction Workforce (see Note 2).\nDuring 1995, the Company issued 67,443 shares of common stock with an aggregate fair market value of $911,000 in connection with the acquisition of certain assets of Strege & Associates, Inc. (see Note 2).\nDuring 1995, the President and Chief Executive Officer of the Company contributed 7,400 shares of common stock of the Company with a then-fair market value of $111,000 to the Company in settlement of a personal guarantee of a receivable from an insolvent customer (see Note 11).\nInterest paid during 1995, 1994 and 1993 did not materially differ from interest expense.\nIncome taxes paid by the Company in 1995 and 1994 totaled $2,510,700 and $2,144,800, respectively.\nNet income per share Net income per share for the years ended December 31, 1995 and 1994 are computed based on the weighted average number of common stock and common stock equivalents outstanding during the periods. For the year ended December 31, 1993, such pro forma computation was made without giving effect to securities that would otherwise be considered to be common stock equivalents, because such securities aggregated less than 3% of shares outstanding and thus were not considered dilutive. Outstanding stock options and warrants, net of assumed buy-back, are considered common stock equivalents.\n1. Summary of Operations and Significant Accounting Policies (Continued)\nAccounting estimates The preparation of the Company's financial statements in conformity with generally accepted accounting principles (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 reported periods.\n2. Acquisitions\nPersonnel Management & Consulting, Inc. On February 27, 1994 the Company purchased substantially all of the assets of Personnel Management & Consulting, Inc., a company engaged in the temporary staffing business in Maryland and Delaware. Of the $270,000 purchase price, the Company paid $42,000 in cash and issued 12,000 shares of its common stock with a then-fair market value of $228,000. The acquisition was accounted for under the purchase method of accounting which resulted in approximately $241,000 of intangible assets and $29,000 of fixed assets.\nGolden West Temporary Services On March 7, 1994, the Company purchased certain assets of Golden West Temporary Services (Golden West), a company in the temporary staffing business with four offices in northern California. The cash purchase price of $4,514,000 was paid by liquidating a portion of the Company's short-term marketable securities. The Company accounted for the acquisition under the purchase method of accounting which resulted in approximately $4,425,000 of intangible assets and $89,000 of fixed assets.\nConstruction Workforce On December 26, 1994, the Company purchased certain assets of Max Johnson Enterprises, Inc., operating as Construction Workforce, a company located in Spokane, Washington which specializes in providing highly skilled temporary craftsmen to the commercial construction industry. Of the $300,000 purchase price, the Company paid $60,000 in cash and issued 17,142 shares of its common stock with a then-fair market value of $240,000. The acquisition was accounted for under the purchase method of accounting which resulted in $285,000 of intangible assets and $15,000 of fixed assets.\nAdvanced Temporary Systems, Inc. On December 29, 1994, the Company purchased, for $51,000 in cash, certain assets of Advanced Temporary Systems, Inc., a company engaged in the temporary staffing business in Kent, Washington. The Company accounted for the acquisition under the purchase method of accounting which resulted in $51,000 of intangible assets.\nMid-Del Employment Service, Inc.; Sussex Employment Services, Inc.; PPI (Prestige Personnel) - Salisbury, Inc.; and Del-Mar-Va Nurses-On-Call Inc.\n2. Acquisitions (Continued)\nOn July 17, 1995, the Company purchased certain assets of Mid-Del Employment Service, Inc.; Sussex Employment Services, Inc.; PPI (Prestige Personnel) - Salisbury, Inc.; and Del-Mar-Va Nurses-On-Call Inc. (collectively, the Maryland and Delaware companies). These companies are engaged in the temporary staffing business in eastern Maryland and Delaware. The all-cash purchase price of $969,000 (inclusive of acquisition-related costs of $19,000) was accounted for under the purchase method of accounting which resulted in $944,000 of intangible assets and $25,000 of fixed assets.\nStrege & Associates, Inc. Effective December 11, 1995, the Company purchased certain assets of Strege & Associates, Inc., a company specializing in providing highly skilled tradesmen to various industries for maintenance and supplemental labor purposes in Portland, Oregon. Of the $1,141,000 purchase price (inclusive of acquisition-related costs of $4,000), the Company paid $230,000 in cash and issued 67,443 shares of its common stock with a then- fair market value of $911,000. The acquisition was accounted for under the purchase method of accounting which resulted in $1,136,000 of intangible assets and $5,000 of fixed assets.\nPro forma results of operations (unaudited) The operating results of each of the above acquisitions are included in the Company's results of operations from the respective date of acquisition. The following unaudited pro forma summary presents the combined results of operations as if the Personnel Management & Consulting, Golden West, Maryland and Delaware companies, and Strege & Associates acquisitions had occurred at the beginning of 1994, after giving effect to certain adjustments for the amortization of intangible assets, taxation and cost of capital.\nThe other acquisitions are not included in the pro forma information as their effect is not material. Year ended December 31, 1995 1994 ---- ---- (in thousands, except per share amounts)\nRevenue $ 183,776 $ 151,861 ======= ======= Net income $ 4,314 $ 3,725 ======= ======= Net income per share $ .64 $ .56 ======= =======\nThe unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisitions been made as of that date or of results which may occur in the future.\n3. Fair Value of Financial Instruments and Concentration of Credit Risk\nAll of the Company's significant financial instruments are recognized in its balance sheet. Carrying values approximate fair market value of most financial assets and liabilities. The fair market value of certain financial instruments was estimated as follows:\n- Marketable securities - Marketable securities primarily consist of U.S. Treasury bills and municipal bonds. The interest rate on the Company's marketable security investments approximate current market rates for these types of investments; therefore, the recorded value of the marketable securities approximates fair market value.\n- Long-term debt - The estimated fair market value of the Company's long-term debt, based upon interest rates at December 31, 1995 for similar obligations with like maturities, was approximately $1,022,000 and was carried at $875,000.\nFinancial instruments that potentially subject the Company to concentration of credit risk consist primarily of temporary cash investments, marketable securities and trade accounts receivables. The Company restricts investment of temporary cash investments and marketable securities to financial institutions with high credit ratings and to investments in governmental debt instruments. Credit risk on trade receivables is minimized as a result of the large and diverse nature of the Company's customer base. At December 31, 1995, the Company had significant concentrations of credit risks as follows:\n- Trade receivables - $2,276,000 of trade receivables were with one customer at December 31, 1995 (17% of trade receivables outstanding at December 31, 1995);\n- Marketable securities - $2,210,000 of marketable securities at December 31, 1995 consisted of Oregon State Housing & Community Service Bonds.\n4. Intangibles\nIntangibles consist of the following (in thousands): December 31, 1995 1994 ---- ---- Covenants not to compete $ 1,614 $ 1,490 Goodwill 6,826 4,870 Customer lists 358 358 ----- ----- 8,798 6,718 Less accumulated amortization 2,346 1,782 ----- ----- $ 6,452 $ 4,936 ===== =====\n5. Property and Equipment\nProperty and equipment consist of the following (in thousands):\nDecember 31, 1995 1994 ---- ----\nOffice furniture and fixtures $ 1,908 $ 1,509 Buildings 1,175 1,175 Vehicles 41 41 ----- ----- 3,124 2,725 Less accumulated depreciation 1,171 923 ----- ----- 1,953 1,802 Land 308 308 ----- -----\n$ 2,261 $ 2,110 ===== =====\n6. Accrued Workers' Compensation Claim Liabilities\nIn August 1987, the Company became a self-insured employer with respect to workers' compensation coverage for all its employees working or living in Oregon. The Company also became a self-insured employer for workers' compensation coverage in the states of Maryland effective November 1993, Washington effective July 1994, Delaware effective January 1995, and California effective March 1995. Effective May 1995, the Company also became self-insured for workers' compensation purposes by the United States Department of Labor for longshore and harbor (USL&H) workers' coverage.\nThe Company has provided $2,705,000 and $2,522,000 at December 31, 1995 and 1994, respectively, as an estimated liability for unsettled workers' compensation claims. This estimated liability represents management's best estimate which includes, in part, an evaluation of information provided by the Company's third-party administrators and its independent actuary. Included in the claims liabilities are case reserve estimates for reported losses, plus additional amounts based on projections for incurred but not reported claims, anticipated increases in case reserve estimates and additional claims administration expenses. These estimates are continually reviewed and adjustments to liabilities are reflected in current operations as they become known. The Company believes that the difference between amounts recorded at December 31, 1995 for its estimated liability and the possible range of costs of settling related claims is not material to results of operations; nevertheless, it is reasonably possible that adjustments required in future periods may be material to results of operations.\nThe United States Department of Labor and the states of Oregon, Maryland, Washington, and California require the Company to maintain specified investment balances or other financial instruments, totaling $5,974,000 at December 31, 1995 and $3,802,000 at December 31, 1994, to cover potential claims losses. In partial satisfaction of these requirements, at\n6. Accrued Workers' Compensation Claim Liabilities (Continued)\nDecember 31, 1995, the Company has provided a letter of credit in the amount of $1,572,000 and a $300,000 surety bond guaranteed by an irrevocable standby letter of credit. The investments are included in restricted marketable securities and workers' compensation deposits in the accompanying balance sheets.\nLiabilities incurred for work-related employee fatalities are recorded either at an agreed lump-sum settlement amount or the net present value of future fixed and determinable payments over the actuarially determined remaining life of the beneficiary, discounted at a rate that approximates a long-term high quality corporate bond rate. The Company has obtained excess workers' compensation insurance to limit its self-insurance exposure to $350,000 per occurrence ($300,000 for claims before December 31, 1993) in all states, except for $300,000 in Maryland, and $500,000 per occurrence for USL&H exposure. The excess insurance provides coverage up to $10 million per occurrence for claims through December 31, 1993 and unlimited excess coverage after that date. At December 31, 1995, the Company has recorded $322,000 for work-related fatalities in long-term workers' compensation liabilities in the accompanying balance sheet.\nThe workers' compensation expense in the accompanying statement of operations consists of $5,802,000, $4,254,000 and $4,075,000 for self-insurance expense for 1995, 1994 and 1993, respectively. Premiums in the insured states were $271,000, $815,000 and $516,000 for 1995, 1994 and 1993, respectively.\n7. Credit Facility\nOn August 12, 1993, the Company entered into a loan agreement (the \"Agreement\") with a major bank, which provides for (a) an unsecured revolving credit facility for working capital purposes and (b) a term real estate loan (Note 8). The Agreement, as amended, expires on May 30, 1996 and currently permits total borrowings of up to $4,000,000 under the revolving credit facility. The interest rates available on outstanding balances under the revolving credit facility include Prime Rate, Federal Funds Rate plus 1.75%, or Adjusted Eurodollar Rate plus 1.25%. Under the amended loan agreement, the Company is required to maintain (i) a ratio of total liabilities to tangible net worth of not more than 2.0 to 1.0, (ii) positive quarterly income before taxes, (iii) tangible net worth of not less than $6,000,000, (iv) a minimum debt coverage ratio of 1.20 to 1.00 at the end of each fiscal year, and (v) a zero outstanding balance against the revolving credit facility for a minimum of 60 consecutive days during each year. The Company is also prohibited from pledging any of its assets other than existing mortgages on its real property. There were no borrowings outstanding under the revolving credit facility at December 31, 1995 or 1994.\nThere were no borrowings on the revolving credit facility during 1995. During the years ended December 31, 1994 and 1993, the maximum balances outstanding under the revolving credit facility were $1,500,069 and\n7. Credit Facility (Continued)\n$1,189,000, respectively; the average balances outstanding were $165,000 and $59,000, respectively; and the weighted average interest rates during the period were 6.9% and 6.6%, respectively. The weighted average interest rate during the periods was calculated using daily weighted averages.\n8. Long-Term Debt\nLong-term debt consists of the following: December 31, 1995 1994 ---- ---- (in thousands)\nMortgage note payable in monthly installments of $2,784, including interest at 11% per annum through 1998, with a principal payment of $269,485 due in 1998, secured by land and building $ 279 $ 281 Mortgage note payable in monthly installments of $6,730, including interest at 8.15% per annum through 2003, with a principal payment of $366,900 due in 2003, secured by land and building (Note 7) 629 658 ----- ----- 908 939\nLess portion due within one year 33 31 ----- -----\n$ 875 $ 908 ===== =====\nMaturities on long-term debt are summarized as follows at December 31, 1995 (in thousands):\nYear ending December 31, ------------\n1996 $ 33 1997 36 1998 308 1999 36 2000 40 Thereafter 455 -----\n$ 908 =====\n9. Savings Plan\nOn April 1, 1990, the Company established a Section 401(k) employee savings plan for the benefit of its eligible employees. All employees 21 years of age or older, except those covered under a co-employer (leasing) contract, become eligible to participate in the savings plan upon completion of 1,000 hours of service in any consecutive 12-month period following the initial date of employment. Employees covered under a co- employer (leasing) contract are eligible to participate in the savings plan beginning with their respective dates of employment. The determination of Company contributions to the plan, if any, is subject to the sole discretion of the Company. Participants' interests in Company contributions to the plan vest over a 7-year period. Company contributions to the plan were $142,000, $103,000 and $44,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nRecent attention has been placed by the Internal Revenue Service (the IRS) and the staff leasing industry on IRC Section 401(k) plans sponsored by staff leasing companies. As such, the tax-exempt status of the Company's plan is subject to continuing scrutiny and approval by the IRS and to the Company's ability to support to the IRS the Company's employer-employee relationship with leased employees. In the event the tax-exempt status were to be discontinued and the plan were to be disqualified, the operations of the Company could be adversely affected. The Company has not recorded any provision for this potential contingency, as neither the likelihood of disqualification nor the resulting range of loss, if any, is currently estimable.\n10. Commitments\nLease commitments The Company leases its branch offices under operating lease agreements which require minimum annual payments as follows (in thousands): Year ending December 31, ------------\n1996 $ 466 1997 402 1998 257 1999 171 2000 64 -----\nTotal minimum payments $ 1,360 =====\nRent expense for the years ended December 31, 1995, 1994 and 1993 was approximately $607,000, $423,000 and $295,000, respectively.\n11. Related Party Transactions\nDuring 1995, 1994 and 1993, the Company recorded revenues of $3,753,000, $3,261,000 and $2,404,000, respectively, and cost of revenues of $3,661,000, $3,112,000 and $2,316,000, respectively, for providing services to a company of which a director of the Company is president and majority stockholder. At December 31, 1995 and 1994, Barrett had trade receivables from this company of $160,000 and $140,000, respectively.\nDuring 1994 and 1993, the Company recorded revenues of $119,000 and $480,000, respectively, and cost of revenues of $110,000 and $475,000, respectively, for providing professional employer services to a company owned by Barrett's President and Chief Executive Officer. At December 31, 1993, Barrett had recorded a receivable of $35,000 from this company.\nAt December 31, 1993, the President and Chief Executive Officer of the Company, pursuant to the approval of a majority of the disinterested outside directors, agreed to personally guarantee, at no cost to the Company, the repayment of a $111,000 receivable from an unrelated, insolvent customer. During 1995, pursuant to this agreement, the Company exercised its right to the personal guarantee provided by the Company's Chief Executive Officer. Accordingly, the Chief Executive Officer surrendered to the Company 7,400 shares of common stock of Barrett Business Services, Inc. with a then-fair market value of $111,000 or $15.00 per share in satisfaction of the guarantee. The Company subsequently retired the shares, and the par value of the shares was reclassified to additional paid-in capital. The uncollectible account was included in the Company's provisions for doubtful accounts during 1993 and 1994.\nThrough June 1995, a director of the Company was Vice Chairman of the board of directors of the bank that provides the Company's unsecured revolving credit facility and certain mortgage financing. In addition to providing other banking services, the bank serves as the transfer agent for the Company's common stock. See Notes 7 and 8.\n12. Public Stock Offering\nIn June 1993, the Company completed an initial public offering of 1,000,000 shares of common stock at $7.00 per share. In July 1993, the underwriters exercised an option to purchase 150,000 additional shares at $7.00 per share to cover over-allotments. Total net proceeds to the Company were $6,828,000 after deducting the underwriting discount and offering expenses.\n13. Income Taxes\nIn conjunction with the Company's public offering, the Company terminated its S Corporation status effective April 30, 1993. Accordingly, unaudited pro forma income tax information is presented below, which would have been recorded if the Company had been a C Corporation during all periods presented, based on tax laws in effect during those periods, as calculated under Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\"\n13. Income Taxes (Continued)\nThe provisions for income taxes are as follows (in thousands):\nYear ended December 31, 1995 1994 1993 ---- ---- ---- (unaudited pro forma) Current: Federal $ 2,067 $ 1,750 $ 1,439 State 463 375 284 ----- ----- -----\n2,530 2,125 1,723 ----- ----- ----- Deferred: Federal (19) (17) (338) State (4) (3) (61) ----- ----- -----\n(23) (20) (399) ----- ----- -----\nTotal provision $ 2,507 $ 2,105 $ 1,324 ===== ===== =====\nThe actual provision for income taxes for the first eight months of operation as a C Corporation (May 1, 1993 to December 31, 1993) is as follows (in thousands):\nCurrent: Federal $ 1,110 State 221 ----- 1,331 -----\nDeferred: Federal (327) State (62) ----- (389) -----\nProvision before recognition of cumulative deferred tax asset 942\nRecognition of cumulative deferred tax asset (505) -----\n$ 437 =====\nThe provision for income taxes for the year ended December 31, 1993 is partially offset by recognition of a cumulative net deferred tax asset of $505,000 associated with the termination of the Company's S Corporation status on April 30, 1993, in accordance with SFAS 109.\n13. Income Taxes (Continued)\nDeferred tax assets (liabilities) are comprised of the following components (in thousands): December 31, 1995 1994 ---- ----\nAccrued workers' compensation claim liabilities $1,053 $ 982 Allowance for doubtful accounts 10 25 Tax depreciation in excess of book depreciation (126) (93) ----- -----\n$ 937 $ 914 ===== =====\nThe effective tax rate differed from the U.S. statutory federal tax rate due to the following: Year ended December 31, 1995 1994 1993 ---- ---- ---- (unaudited pro forma)\nStatutory federal tax rate 34.0 % 34.0% 34.0% State taxes, net of federal benefit 4.6 4.4 4.3 Goodwill amortization .1 .2 .5 Federal tax-exempt interest income (1.3) (1.1) -- Other, net .6 .3 .3 ---- ---- ----\n38.0 % 37.8 % 39.1 % ==== ==== ====\n14. Stockholders' Equity\nAs of March 1, 1993, the Company adopted the 1993 Stock Incentive Plan (the \"Plan\") which provides for stock-based awards to the Company's employees, non-employee directors, and outside consultants or advisers. As of April 20, 1994, the Company increased the number of shares of common stock reserved for issuance under the Plan from 500,000 to 800,000.\n14. Stockholders' Equity (continued)\nThe following table summarizes option activity under the Plan:\nOptions Range of prices ------- ---------------\nOutstanding at March 1, 1993 -\nOptions granted 166,500 $ 3.50 to $ 4.69 Options exercised - Options canceled or expired (6,000) ------- Outstanding at December 31, 1993 160,500\nOptions granted 233,500 $ 9.50 to $ 13.56\nOptions exercised (22,175) $ 3.50 Options canceled or expired (65,250) ------- Outstanding at December 31, 1994 306,575\nOptions granted 221,500 $ 11.50 to $ 16.36 Options exercised (13,950) $ 3.50 to $ 9.50 Options canceled or expired (17,500) -------\nOutstanding at December 31, 1995 496,625 =======\nExercisable at December 31, 1995 94,375 =======\nAvailable for grant at December 31, 1995 263,250 =======\n14. Stockholders' Equity (Continued)\nThe options listed in the table generally become exercisable in four equal annual instalments beginning one year after the date of grant. The number of options and the price per share have been restated to reflect the 2- for-1 stock split effective May 23, 1994.\nIn connection with the initial public offering, the Company issued 200,000 warrants to its underwriters and related parties for the purchase of shares of the Company's common stock exercisable in whole at any time or in part from time to time commencing June 11, 1994 at $4.20 per share, after giving effect for the 2-for-1 stock split. A total of 110,000 warrants was exercised in January 1995 for proceeds of $462,000.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which allows companies to choose whether to account for stock-based compensation under the current intrinsic value method as prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, or under the fair value method permitted by the new pronouncement, effective for years beginning after December 15, 1995. The new pronouncement will also require additional disclosures regarding the pro forma effect of fair value accounting for stock options on net income and net income per share. The Company plans to continue to follow the provisions of APB Opinion No. 25. As a result, management does not believe the implementation of this pronouncement in 1996 will have a material impact on future earnings.\n15. Litigation\nThe Company is subject to legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to currently pending or threatened actions will not materially affect the financial position or results of operations of the Company.\n16. Quarterly Financial Information (Unaudited)\nFirst Second Third Fourth quarter quarter quarter quarter ------- ------- ------- ------- (in thousands, except per share amounts)\nYear ended December 31, 1993: Revenues $ 20,535 $ 25,386 $ 28,076 $26,270 Cost of revenues 18,501 22,931 25,147 23,692 Pro forma net income 389 488 Pro forma net income per share .09 .11 Net income 702 481 Net income per share .11 .08\nYear ended December 31, 1994: Revenues 27,067 35,136 41,149 37,200 Cost of revenues 24,096 31,217 36,107 33,025 Net income 608 765 1,235 858 Net income per share .09 .12 .19 .13\nYear ended December 31, 1995: Revenues 39,298 44,564 49,636 46,306 Cost of revenues 35,819 39,645 43,378 40,474 Net income 344 1,039 1,513 1,223 Net income per share .05 .16 .23 .18\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table identifies, as of February 1, 1996, each director and executive officer of the Company. Directors serve until the next annual meeting of stockholders, or until their successors are elected and qualified. Executive officers serve at the discretion of the Board of Directors.\nWilliam W. Sherertz has acted as Chief Executive Officer of the Company since 1980. He has also been a director of the Company since 1980, and was appointed President of the Company in March 1993. Mr. Sherertz also serves as Acting Chairman of the Board of Directors.\nRobert R. Ames has served as a director of the Company since 1993. Mr. Ames currently is actively engaged in numerous real estate development ventures. From 1992 to 1995, he was the Vice Chairman of the Board of Directors of First Interstate Bank of Oregon, N.A. From 1983 to 1991, Mr. Ames served as President of the Bank.\nJeffrey L. Beaudoin has served as a director of the Company since 1993. He is presently the President and a director of Rose City Moving and Storage Co., of Portland, Oregon, a staff leasing client of the Company.\nStephen A. Gregg was elected to the Company's Board of Directors in February 1995. He is currently a principal in The Alternare Group, a national provider of alternative medicine services. From 1985 to 1994, Mr. Gregg was Chairman and Chief Executive Officer of The Ethix Corporation, a national provider of health care programs headquartered in Portland, Oregon.\nAnthony Meeker has served as a director of the Company since 1993. He has been a Vice President with Spears Benzak Salomon & Farrell, Portland, Oregon, an investment research firm, since 1993. From 1987 to 1993, Mr. Meeker was Treasurer of the State of Oregon. He has also been President and Chief Executive Officer and a director of Meeker Seed & Grain Co. since 1975.\nStanley G. Renecker has been a director of the Company since 1993. Mr. Renecker is currently Vice President-Acquisitions of The Campbell Group, a timberland management firm, where he has been employed since 1989.\nMichael D. Mulholland joined the Company in August 1994 as Vice President-Finance and Secretary. From 1988 to 1994, Mr. Mulholland was employed by Sprouse-Reitz Stores Inc., a former Nasdaq-listed retail company, serving as its Executive Vice President, Chief Financial Officer and Secretary. In November 1991, Sprouse-Reitz filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. Its plan of reorganization was confirmed by the Bankruptcy Court in June 1992. Subsequently, Mr. Mulholland was appointed to the additional position of Acting Chief Executive Officer prior to Sprouse's filing of a voluntary petition in connection with a prepackaged liquidating Chapter 11 in November 1993.\nChristopher J. McLaughlin joined the Company in May 1993 and was appointed Corporate Operations Manager in December 1993. Mr. McLaughlin is currently Vice President - Operations, a position held since July 1994. Prior to joining the Company, Mr. McLaughlin owned and operated an organizational development consulting firm.\nMichael K. Barrett joined the Company as Vice President-Business Development in December 1995. Prior to joining the Company, Mr. Barrett was Vice President of Marketing for Your Staff, Inc., a wholly-owned staff leasing subsidiary of Kelly Services, Inc., from May 1994 to December 1995. From November 1989 to May 1994, Mr. Barrett owned and operated an advertising firm.\nJames D. Miller joined the Company in January 1994 as Controller. From 1991 to 1994, he was the Corporate Accounting Manager for Christensen Motor Yacht Corporation. Mr. Miller, a certified public accountant, was employed by Price Waterhouse from 1987 to 1991.\nSection 16 of the Securities Exchange Act of 1934 (\"Section 16\") requires that reports of beneficial ownership of Barrett common stock and changes in such ownership be filed with the Securities and Exchange Commission (\"SEC\") by Section 16 \"reporting persons,\" including directors, executive officers, and certain holders of more than 10% of the outstanding common stock or trusts of which reporting persons are trustees. To the Company's knowledge, all Section 16 reporting requirements applicable to known reporting persons were complied with for transactions and stock holdings during 1995, except that William W. Sherertz, who is an executive officer of the Company, filed a report of the grant of a stock option two days after the filing deadline.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following Summary Compensation Table sets forth for the years indicated the compensation awarded or paid to, or earned by, the Company's chief executive officer and the Company's other executive officers whose salary level and bonus in 1995 exceeded $100,000:\nSUMMARY COMPENSATION TABLE\nLong-Term Compensation Awards ------------ Annual Compensation Securities ------------------- Underlying Name and Principal Salary Bonus Options (2) Position Year ($) ($) (#) ----------------- ---- ------ ----- ------------\nWilliam W. Sherertz 1995 $144,000 -- 70,000 President and 1994 144,000 -- 77,000 Chief Executive Officer 1993 144,000 -- 70,000\nMichael D. Mulholland 1995 115,000 $42,550 30,000 Vice President-Finance 1994 42,486(1) -- 20,000 and Secretary; Chief 1993 -- -- -- Financial Officer\nChristopher J. McLaughlin 1995 90,000 33,300 26,000 Vice President-Operations 1994(3) 79,583 39,300 20,000 1993 -- -- --\n- --------------------------\n(1) Mr. Mulholland's annual salary of $115,000 became effective with his date of employment, August 17, 1994. (2) Option grants do not include stock appreciation rights (\"SARs\"). (3) Mr. McLaughlin became an executive officer during 1994; the amounts shown are for the full fiscal year.\nStock Option Data\nThe following table provides information as to options to purchase Barrett common stock granted to Messrs. Sherertz, Mulholland and McLaughlin during 1995.\n- -------------------------\n(1) Options become exercisable cumulatively in four equal annual installments beginning one year after the date of grant; provided that the option will become exercisable in full upon the officer's death, disability or retirement, or in the event of a change in control of the Company. A change in control is defined in the option agreements to include (i) any occurrence which would be required to be reported as such by the proxy disclosure rules of the Securities and Exchange Commission, (ii) the acquisition by a person or group (other than the Company or one of its employee benefit plans) of 30% or more of the combined voting power of its voting securities, (iii) with certain exceptions, the existing directors' ceasing to constitute a majority of the Board of Directors, (iv) certain transactions involving the merger, or sale or transfer of a majority of the assets, of the Company, or (v) approval by the stockholders of a plan of liquidation or dissolution of the Company. The options include a feature which entitles an optionee who tenders previously-acquired shares of common stock to pay all or part of the exercise price of the option, to receive a replacement option (a \"reload option\") to purchase a number of shares equal to the number of shares tendered at an exercise price equal to the fair market value of the common stock on the date of exercise. No SARs were granted to Messrs. Sherertz, Mulholland or McLaughlin during 1995.\n(2) The values shown have been calculated based on the Black-Scholes option pricing model and do not reflect the effect of restrictions on transferability or vesting. The values were calculated based on the following assumptions: (i) expectations regarding volatility of 50% were based on monthly stock price data for the Company; (ii) the risk- free rate of return was assumed to be the Treasury Bond rate whose maturity corresponds to the maturity of the option granted; and (iii) no dividends on the Barrett common stock will be paid during the option term. The values which may ultimately be realized will depend on the market value of the common stock during the periods during which the options are exercisable, which may vary significantly from the assumptions underlying the Black-Scholes model.\nInformation concerning each exercise of stock options and the fiscal year-end value of unexercised options held by Messrs. Sherertz, Mulholland and McLaughlin as of December 31, 1995 is summarized in the table below.\n- -------------------------- (1) Messrs. Sherertz, Mulholland and McLaughlin did not exercise any SARs during 1995 and did not hold any SARs at December 31, 1995.\n(2) The values shown have been calculated based on the difference between $14.75, which was the closing sale price of Barrett common stock reported on The Nasdaq Stock Market on December 29, 1995, and the per share exercise price of unexercised options.\nDirectors' Compensation\nUnder the standard arrangement in effect at the end of 1995, directors (other than directors who are full-time employees of the Company, who do not receive directors' fees) are entitled to receive a fee of $500 for each Board meeting attended and each meeting of a committee of the Board attended other than a committee meeting held on the same day as a Board meeting.\nIn June 1993, concurrent with the closing of the Company's initial public offering, each person who was then a non-employee director of the Company received a nonqualified option, as adjusted for the May 1994 two-for- one stock split, to purchase 3,000 shares of the Company's common stock at an exercise price of $3.50. Also, a nonqualified option for 1,000 shares of common stock (adjusted for the stock split) is granted automatically to each non-employee director whose term begins on or continues after the date of each annual meeting of stockholders at an exercise price equal to the fair market value of the common stock on the date of the meeting. Accordingly, on May 18, 1995, Messrs. Ames, Beaudoin, Gregg, Meeker and Renecker each received an option for 1,000 shares at an exercise price of $11.50 per share.\nPayment of the exercise price of options granted to non-employee directors may be in cash or in previously-acquired shares of Barrett common stock. Each option includes a reload option feature to the extent that previously-acquired shares are used to pay the exercise price. Non-employee director options (other than reload options) become exercisable in four equal annual installments beginning one year after the date of grant. Reload options become exercisable six months following the date of grant. All options granted to a non-employee director will be exercisable in full upon the director's death, disability or retirement, or in the event of a change in control of the Company. The option term will expire three months following the date upon which the holder ceases to be a director other than by reason of death, disability or retirement; in the event of death or disability, the option will expire one year thereafter, while non-employee director options will expire five years after retirement.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table gives certain information regarding the beneficial ownership of Barrett common stock as of February 1, 1996, by each director, by each executive officer named in Item 11 above, and by all directors and executive officers of the Company as a group. In addition, it gives information about each person or group known to the Company to own beneficially more than 5% of the outstanding shares of its common stock. Information as to beneficial stock ownership is based on data furnished by the persons concerning whom such information is given. Unless otherwise indicated, all shares listed as beneficially owned are held with sole voting and dispositive power.\nAmount and Name and Nature of Percent Address of Beneficial of Beneficial Owner Ownership Class ---------------- ---------- -----\nRobert R. Ames 2,000(1) *\nJeffrey L. Beaudoin 6,900(1)(2) *\nStephen A. Gregg 1,000 *\nChristopher J. McLaughlin 14,400(1) *\nAnthony Meeker 2,450(1) *\nMichael D. Mulholland 5,000(1) *\nStanley G. Renecker 2,000(1) *\nNancy B. Sherertz 27023 Rigby Lot Road Easton, Maryland 21601 1,659,000 25.3%\nWilliam W. Sherertz 4724 S.W. Macadam Avenue Portland, Oregon 97201 1,841,600(1) 27.8%\nWasatch Advisors, Inc. 68 South Main Street Suite 400 Salt Lake City, Utah 84101 548,675(3) 8.4%\nAll directors and executive officers as a group (10 persons) 1,880,350(1) 28.3%\n* Less than 1% of the outstanding shares of Common Stock.\n(1) Includes options to purchase Barrett common stock which are presently exercisable as follows: Mr. Ames, 2,000 shares; Mr. Beaudoin, 2,000 shares; Mr. McLaughlin, 12,000 shares; Mr. Meeker, 2,000 shares; Mr. Mulholland, 5,000 shares; Mr. Renecker, 2,000 shares; Mr. Sherertz, 59,500 shares; and all directors and executive officers as a group, 89,500 shares.\n(2) Includes 400 shares owned by Mr. Beaudoin's wife as to which he shares voting and dispositive powers.\n(3) A registered investment advisor who has filed a report of beneficial ownership on Schedule 13G reporting sole voting and dispositive power as to the indicated shares.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nWilliam W. Sherertz agreed, at December 31, 1993, to personally guarantee, at no cost to the Company and pursuant to the approval of a majority of the disinterested outside directors, the repayment of a $111,000 account receivable from an unrelated, insolvent customer. The Company exercised its right to the personal garantee during 1995 and accordingly, Mr. Sherertz surrendered to the Company 7,400 shares of the Company's common stock with a then-fair market value of $111,000 or $15.00 per share in satisfaction of the guarantee.\nRobert R. Ames, a director of the Company, was Vice Chairman of the board of directors of First Interstate Bank of Oregon, N.A. through June 1995, which bank has provided an unsecured revolving credit facility in the amount of $4,000,000 and mortgage financing totaling approximately $629,000 to the Company.\nCompensation Committee Interlocks and Insider Participation\nThe members of the compensation committee of the board of directors of the Company during 1995 were Jeffrey L. Beaudoin, Stephen A. Gregg and Anthony Meeker. During 1995, the Company provided services to Rose City Moving & Storage Co., of which Mr. Beaudoin, a Barrett director and a member of its compensation committee, is President and a majority stockholder. Barrett recorded revenues and cost of revenues during 1995 related to such services of $3,753,000 and $3,661,000, respectively. At December 31, 1995, the Company's assets included trade accounts receivable totaling $160,000 with respect to the above services; the highest amount of such receivables outstanding at any time during 1995 was $187,000 as of September 30, 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 financial statements listed in the index set forth in Item 8 of this report are filed as part of this report.\n(b) 3. Exhibits are listed in the Exhibit Index beginning on page 51 of this report. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report is listed under Item 10, \"Executive Compensation Plans and Arrangements and Other Management Contracts,\" in the Exhibit Index.\n(c) Reports on Form 8-K.\nNo Current Reports on Form 8-K were filed by the Registrant 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.\nBARRETT BUSINESS SERVICES, INC. -------------------------------------- Registrant\nDate: March 26, 1996 By: \/s\/William W. Sherertz William W. Sherertz President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 26th day of March, 1996.\nPrincipal Executive Officer and Director:\n\/s\/William W. Sherertz President and Chief Executive Officer William W. Sherertz and Director\nPrincipal Financial Officer:\n\/s\/Michael D. Mulholland Vice President-Finance and Michael D. Mulholland Secretary\nPrincipal Accounting Officer:\n\/s\/James D. Miller Controller James D. Miller\nOther Directors:\n* Director Robert R. Ames\n* Director Jeffrey L. Beaudoin\n* Director Stephen A. Gregg\n* Director Anthony Meeker\n* Director Stanley G. Renecker\n* By \/s\/Michael D. Mulholland Michael D. Mulholland Attorney-in-fact\nEXHIBIT INDEX\nExhibits\n3.1 Charter of the registrant, as amended. Incorporated by reference to Exhibit 3 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994. 3.2 Bylaws of the registrant, as amended. Incorporated by reference to Exhibit 3.2 to the registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4.1 Loan Agreement between the registrant and First Interstate Bank of Oregon, N.A., dated August 12, 1993 (\"Loan Agreement\"). Incorporated by reference to Exhibit 10 to the registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. 4.2 First Amendment to Loan Agreement dated March 29, 1994. Incorporated by reference to Exhibit 4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994. 4.3 Second Amendment to Loan Agreement dated May 31, 1994, together with Optional Advance Note dated May 31, 1994. Incorporated by reference to Exhibit 4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994. 4.4 Third Amendment to Loan Agreement dated January 3, 1995, together with Optional Advance Note dated January 3, 1995. Incorporated by reference to Exhibit 4.4 to the registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4.5 Fourth Amendment to Loan Agreement dated June 1, 1995, together with Optional Advance Note dated June 1, 1995 and Interest Rate Option Agreement dated June 1, 1995. Incorporated by reference to Exhibit 4.4 to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995. The registrant has incurred other long-term indebtedness as to which the amount involved is less than 10 percent of the registrant's total assets. The registrant agrees to furnish copies of the instruments relating to such indebtedness to the Commission upon request. 10 Executive Compensation Plans and Arrangements and Other Management Contracts. 10.1 1993 Stock Incentive Plan of the registrant as amended March 8, 1994. Incorporated by reference to Exhibit 10.1 to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993. 10.2 Form of Indemnification Agreement with each director of the registrant. Incorporated by reference to Exhibit 10.8 to the registrant's Registration Statement on Form S-1 (No.33-61804). 11 Statement of Calculation of Average Common Shares Outstanding. 23 Consent of Price Waterhouse LLP, independent accountants. 24 Power of attorney of certain officers and directors. 27 Financial Data Schedule. Other exhibits listed in Item 601 of Regulation S-K are not applicable.","section_15":""}
{"filename":"46653_1995.txt","cik":"46653","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral. C.H. Heist Corp. and its subsidiaries (the \"Company\") are engaged in two industry segments; industrial maintenance and temporary staffing. The Company operates in both segments in the United States and indusrial maintenance in Canada. Other than the opening or closing of certain service facilities and temporary staffing offices in the normal course of business, the Company expects to continue its operations as presently conducted.\nIndustrial Maintenance Services\nThe Company performs high-pressure water maintenance cleaning services, primarily by the use of mobile high-pressure water pumping units, on industrial and chemical equipment and facilities. The Company's services also include sandblasting, industrial painting, and the vacuuming of wet and dry industrial wastes. The Company installs, maintains and sells insulation for commercial applications. The Company also engages in the business of exchanger extraction and insertion, shell side cleaning, tube cleaning and field service repairs of heat exchangers for the same client base as the Company. The services are performed through the use of specialized automated mechanical equipment which is generally regarded as state of the art. business.\nThe Company's principal customers include oil refineries, petrochemical, chemical, ferrous and non-ferrous metal plants, mining installations, governmental authorities, nuclear and fossil fuel electric generating plants and pulp and paper mills.\nSales of industrial maintenance services to one customer, E. I. Dupont De Nemours and Company, accounted for approximately 12.9% of the Company's sales during its fiscal year ended December 31, 1995. The total amount of services purchased by this customer is an aggregate of services provided at a number of separate plants. Plant managers at the respective plants generally make the decisions as to whether or not to use the Company's services, and no single plant accounts for 10% or more of the Company's sales. If the contracts with this customer were not renewed, it would have a substantial impact on the Company's operations.\nMany of the Company's industrial maintenance services are performed outdoors, but the Company does not consider its business to be seasonal. However, due in part to weather factors, the first quarter of the Company's fiscal year has historically produced the lowest levels of revenue and profitability.\n- 3 -\nThe Company from time to time investigates and develops new equipment components, tools and methods for use in the conduct of its operations. Most of the components in its equipment are designed to the Company's specification. The amounts expended for such activities, all of which were performed at a Company facility, during the fiscal years ended December 31, 1995, December 25, 1994 and December 26, 1993 amounted to $182,542, $154,417 and $235,065 respectively. During the fiscal year ended December 31, 1995, these services were performed primarily by seven individuals who were employed by the Company on a full-time basis.\nThe Company competes with numerous other companies engaged in high-pressure water maintenance cleaning services, industrial painting, maintenance-cleaning of heavy industrial equipment through the use of mechanical, chemical and other methods, the vacuum removal of dry and wet industrial waste, and the installation and maintenance of insulation. The Company does not believe that any single competitor is dominant in any of these services.\nThe Company is not aware of any material changes in the competitive condition in this industry segment which occurred during the 1995 fiscal year. Competition is primarily based upon quality of services and price.\nThe Company is subject to various statutes and regulations respecting control of noise, air, water and land pollution. In addition, its customers may be subject to other environmental protection statues and regulations relating to some of the industrial maintenance services rendered by the Company. From time to time modifications or improvements have been required in the Company's equipment in order to comply with government regulations, including those relating to safety and noise reductions. Such modifications or improvements have not resulted in any material capital expenditures nor are any anticipated for such purpose in the foreseeable future.\nTemporary Help Services\nThe Company also supplies temporary employees in the U.S. through Ablest Service Corp. (\"Ablest\"), a wholly owned subsidiary of the Company. Ablest is a temporary staffing organization with 25 offices located in the Eastern United States with the capability to supply temporary employees for the clerical, industrial and technical needs of their customers. Ablest does not have any principal customers, nor does it service any specific industry or field. Instead, its services are provided to a broad based customer list.\nThe temporary staffing business is highly competitive. There are numerous local, regional and national firms principally engaged in offering such services. The primary competitive factors in the temporary staffing field are reliability, personnel and price.\n- 4 -\nIndustry Segments and Service Activities. The following table is a summary of information relating to the Company's operations in its two industry segments for each of the Company's last three fiscal years:\n* These sales figures do not include intersegment sales of approximately $134,000, $152,000 and $141,000 in 1995, 1994 and 1993, respectively.\nThe following table sets forth the approximate amounts of total sales and revenues by service activity within the Company's dominant industry segment (industrial maintenance) for each of the Company's last three fiscal years:\n- 5 -\nWorking Capital. By virtue of the nature of the Company's business segments and the size and financial status of its customers, the attainment and maintenance of high levels of working capital is not required, other than to meet debt requirements as disclosed in Note 4 to the Consolidated Financial Statements on page 15 of the Company's Annual Report to Shareholders which is incorporated herein by reference.\nBacklog. In view of the fact that the Company's services are primarily furnished pursuant to purchase orders or on a call basis, backlog is not material.\nEmployees. On December 31, 1995, the Company employed approximately 3,600 persons of whom 251 persons were employed on a full-time basis and the remainder were part-time and temporary employees. Some of the Company's industrial maintenance employees are represented by unions. The Company considers its employee relations to be good.\nCanadian Operations. The following table sets forth the relative contributions in U.S. dollars to sales, operating income and identifiable assets attributable to the Company's Canadian operations for the last three fiscal years:\nThere were no export sales during any period. Reference is made to the \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" in Part II Item 7 hereof, for a discussion of the decline in operating income for 1993. The operating loss was due to a loss on a contract painting job.\n- 6 -\nExecutive Officers of Registrant\n(a) Identification. The Company's executive officers are:\n- 7 -\n(b) Family Relationships. None of the officers has any family relationship with any other officer of the Company.\n(c) Arrangements and Understandings. There are no arrangements or understandings pursuant to which the above officers were elected.\n(d) Business Experience. Messrs. Charles H. Heist, John L. Rowley, W. David Foster, Frank C. Trotter, Duane F. Worthington, Andrew R. Crowe, Jr. and John D. Biehl have been employees of the Company for more than five years. Mr. Snitzer is a partner in the Buffalo, New York, law firm of Borins, Setel, Snitzer & Brownstein, and its predecessors, which firm has served as general counsel to the Company, for more than five years. Kurt R. Moore joined Ablest Service Corp. in June of 1991. From May 1989 through May 1991, Mr. Moore was an area Vice President of Talent Tree, a temporary help company in Houston, Texas, and for the seven years prior thereto, he was a District Manager for Norrell Corp., a temporary help company in Atlanta, Georgia. Thomas Boisture joined the Company on June 28, 1993 when OMSI was acquired. Mr. Boisture from 1987 to joining Ohmstede Mechanical Services, Inc., in 1989 was a manager for a mechanical contracting company in Houston, Texas. For thirteen years prior to that Mr. Boisture served in management at Exxon, a major U.S. oil refining company, in mechanical, operational, environmental and technical positions.\n(e) Involvement in Certain Legal Proceedings. None.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's Ablest Service Corp. subsidiary owns the executive office facilities for C.H. Heist Corp. and Ablest Service Corp. in Clearwater, Florida. The Company owns and leases properties in Buffalo, New York which house its administrative offices, warehouse and Methods and Development facilities. The leased facilities in Buffalo are leased from persons who are affiliates of certain officers and directors. See Part III, Item 13 \"Certain Relationships and Related Transactions\", below, the response to which is incorporated by reference.\nThe daily operations of the Company are currently operated out of 24 service facilities and 25 temporary help offices as well as six Regional Centers. The Regional Centers are covered by short term leases. Eighteen service facilities and 25 temporary help offices are located in the continental United States and six service facilities are located within Canada. With respect to the service facilities, 12 are owned by the Company, and twelve service areas and all of the temporary help offices are subject to leases with various expiration dates. The Company considers its service facilities, temporary help offices and Regional Centers suitable and adequate for servicing its customers. Two additional owned service facilities are vacant and for sale.\n- 8 -\nIn meeting the requirements of its industrial maintenance customers, the Company relies on its extensive, specially designed and equipped (to Company's specifications) mobile equipment, which must be kept in good repair and replaced from time to time. The Company considers this equipment adequate for current operations. Each of the Company's active service facilities has mobile equipment permanently assigned to it by the Company.\nCertain of the properties owned by the Company are subject to mortgages. Reference is made to Note 4 to the Consolidated Financial Statements on page 15 in the Company's Annual Report to Shareholders, which is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders of the Company 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 in response to this item is hereby incorporated by reference to the information presented on page 20 and 21 of the Company's 1995 Annual Report to Shareholders which appears as Exhibit 13 to this Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information in response to this item is hereby incorporated by reference to the information presented at page 8 in the Company's 1995 Annual Report to Shareholders which appears as Exhibit 13 to this Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information in response to this item is hereby incorporated by reference to the information presented at pages 9 through 10 in the Company's 1995 Annual Report to Shareholders which appears as Exhibit 13 to this Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information and independent auditors report required in response to this item is hereby incorporated by reference to pages 10 through 20 in the Company's 1995 Annual Report to Shareholders which appears as Exhibit 13 to this Form 10-K.\n- 9 -\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 in response to this item is hereby incorporated by reference to the information under the caption \"Nominees for Directors\" presented in the Company's definitive proxy statement to be filed with the Securities and Exchange Commission and used in connection with the solicitation of proxies for the Company's annual meeting of shareholders to be held on May 10, 1996, except insofar as information with respect to executive officers is presented in Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information in response to this item is hereby incorporated by reference to the information under the caption \"Compensation of Executive Officers\" presented in the Company's definitive proxy statement to be filed with the Securities and Exchange Commission and used in conjunction with the solicitation of proxies for the Company's annual meeting of shareholders to be held on May 10, 1996; provided, however, that information appearing under the headings \"Report on Executive Compensation by the Compensation Committee and Board of Directors\" and \"Common Stock Performance\" is not incorporated herein and should not be deemed to be included in this document for any purposes.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information in response to this item is hereby incorporated by reference to the information under the caption \"Security Ownership of Certain Beneficial Owners and Management\" presented in the Company's definitive proxy statement to be filed with the Securities and Exchange Commission and used in connection with the solicitation of proxies for the Company's annual meeting of shareholders to be held on May 10, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information in response to this item is hereby incorporated by reference to the information under the caption \"Certain Transactions\" presented in the Company's definitive proxy statement to be filed with the Securities and Exchange Commission and used in connection with the solicitation of proxies for the Company's annual meeting of shareholders to be held on May 10, 1996.\n- 10 -\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 and Schedules\nSee Index to Financial Statements and Schedules at page 13.\n(2) Exhibits\nExhibits identified below are filed herewith or incorporated herein by reference to the documents indicated in parentheses.\nExhibit Number Description\n3.1 Restated Certificate of Incorporation of Registrant dated January 19, 1983. (Exhibit to the Company's Form 10-K Report for the year ended June 25, 1989).\n3.2 Certificate of Amendment of Certificate of Incorporation of the Company (Appendix A to the Company's definitive Proxy Statement in connection with its Annual Meeting held on May 11, 1992).\n3.3 Amended By-laws of the Registrant adopted August 27, 1990 (Exhibit to the Company's Form 10-K Report for the year ended June 24, 1990).\n10.1 Lease Agreement dated December 1, 1974, and related Amendment of Lease, dated March 1, 1985, between the Company and the Trust under the Will of Helen J. Heist relating to property located at Cheektowaga, New York. (Exhibit to the Company's Form 10-K Report for the year ended June 25, 1989).\n10.2 Lease, dated November 15, 1983, and related Extension Agreement dated February 18, 1987, between the Company and certain Officers, Directors and Security holders of the Company relating to property located at Marietta, Ohio. (Exhibit to the Company's Form 10-K Report for the year ended June 25, 1989).\n10.3 Lease, dated December 1, 1970, and related Extension Agreement, dated December 18, 1985, between certain Officers, Directors and Security holders of the Company and the Company relating to property located at Oregon, Ohio. (Exhibit to the Company's Form 10-K Report for the year ended June 25, 1989).\n10.4 Business Loan Agreement with Manufacturers and Traders Trust Company dated April 2, 1979, together with related extensions and renewals. (Exhibit to the Company's Form 10-K Report for the year ended June 1989).\n- 11 -\n10.5 Letter Agreement with Manufacturers and Traders Trust Company dated December 22, 1987 (Exhibit to the Company's Form 10-K for the year ended June 26, 1988).\n10.6 Consulting Agreement, dated November 15, 1988, between the Company and Willard F. Foster. (Exhibit to the Company's Form 10-K Report for the year ended June 25, 1989).\n10.7 Purchase Agreement, dated as of May 19, 1989, with Pipe & Boiler Insulation, Inc. (Exhibit to the Company's Form 8-K Report dated July 31, 1989).\n10.8 Letter Agreement, dated October 22, 1990, with Manufacturers and Traders Trust Company. (Exhibit to the Company's Form 10-K Report for the Transition Period ended December 30, 1990).\n10.9 Letter Agreement, dated April 24, 1992, with Manufacturers and Traders Trust Company. (Exhibit to the Company's Form 10-K Report for the year ended December 27, 1992.)\n10.10 Management Incentive Plan of the Company dated August 17, 1992. (Exhibit to the Company's Form 10-K Report for the year ended December 27, 1992.)\n10.11 Amendment to Business Loan Agreement dated October 29, 1993. (Exhibit to the Company's Form 10-K Report for the year ended December 28, 1993) 10.12 Business loan agreement with Manufacturers and Traders Trust Company dated December 28, 1993. (Exhibit to the Company's Form 10-K Report for the year ended December 28, 1993.)\n10.13 Purchase agreement, dated June 28, 1993, with Ohmstede Mechanical Services, Inc. (Exhibit to the Company's Form 8-K Report dated June 28, 1993.)\n10.14 Business Loan Agreement with Manufacturers and Traders Trust Company dated December 22, 1994.\n10.15 * Corporate Revolving Term Loan Agreement with Manufactures and Traders Trust Company dated August 21, 1995.\n13 * 1995 Annual Report to Shareholders.\n21 Subsidiaries of the Registrant. (Exhibit to the Company's Form 10-K Report for the Transition Period ended December 30, 1990).\n23 * Consent of KPMG Peat Marwick LLP to incorporation of reports into Form S-8 No. 33-48497.\n27.1 * Financial Data Schedule (for SEC use only) - --------------------\n* Filed herewith.\n- 12 -\n(b) No reports on Form 8-K were filed by the Company during the quarter ended December 31, 1995.\nThe Company will furnish, without charge to a security holder upon request, a copy of the documents portions of which are incorporated by reference (1995 Annual Report to Security Holders) and will furnish any other exhibit at cost.\n- 13 -\nC.H. HEIST CORP. AND SUBSIDIARIES\nIndex to Financial Statements and Schedules\nForm 10-K Items 8, 14(a)(1) and (2)\nSchedules other than those listed above are omitted because the conditions requiring their filing do not exist or because the required information is provided in the consolidated financial statements, including the notes thereto.\n- 14 -\nIndependent Auditors' Report\nThe Board of Directors C.H. Heist Corp.:\nUnder date of February 16, 1996, we reported on the consolidated financial statements of C.H. Heist Corp. and subsidiaries as listed in the accompanying index. 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 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\nBuffalo, New York February 16, 1996\n-15-\nSchedule II\nC.H. HEIST CORP. AND SUBSIDIARIES\nValuation Account\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.\nDate: March 4, 1996\nC. H. HEIST CORP.\nBy: \/s\/ John L. Rowley ------------------------ John L. Rowley Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and as of the date indicated:\nC. H. HEIST CORP.\nBy: \/s\/ Charles H. Heist By: \/s\/ John L. Rowley --------------------- --------------------------------- Charles H. Heist John L. Rowley, Director and Vice Chairman of the Board President-Finance-Chief Financial and President Officer-Asst. Secretary\nBy: \/s\/ Willard F. Foster By: \/s\/ Chauncey D. Leake, Jr. --------------------- --------------------------------- Willard F. Foster Chauncey D. Leake, Jr. Director Director\nBy: \/s\/ Richard J. O'Neil By: \/s\/ Charles E. Scharlau --------------------- --------------------------------- Richard J. O'Neil Charles E. Scharlau Director Director\nMarch 4, 1996\nEXHIBIT INDEX\n10.13 Purchase agreement dated June 28, 1993 with (6) Ohmstede Mechanical Services, Inc.\n10.14 Business Loan Agreement with Manufacturers and (8) Trades Trust Company dated December 22, 1994.\n10.15 Corporate Revolving Term Loan Agreement with (9) Manufactuers and Traders Trust Company dated August 21, 1995.\n13 1995 Annual Report to Shareholders (9)\n21 Subsidiaries of the Registrant (4)\n23 Consent of KPMG Peat Marwick LLP to incorporation of reports into Form S-8 No. 33-48497 (9)\n27 Financial Data Schedule (for SEC use only)\n- ----------------------\n(1) Filed as an Exhibit to the Registrant's Form 10-K Report for the year ended June 25, 1989 and incorporated herein by reference.\n(2) Filed as Appendix A to the Registrant's definitive Proxy Statement in connection with its Annual Meeting of Shareholders held on May 11, 1992.\n(3) Filed as an Exhibit to the Registrant's Form 10-K Report for the year ended June 26, 1988 and incorporated herein by reference.\n(4) Filed as an Exhibit to the Registrant's Form 10-K Report for the Transition Period ended December 30, 1990 and incorporated herein by reference.\n(5) Filed as an Exhibit to the Registrant's Form 10-K Report for the period ended December 27, 1992 and incorporated herein by reference.\n(6) Filed as an Exhibit to the Registrant's Form 8-K Report dated June 28, 1993 and incorporated herein by reference.\n(7) Filed as an Exhibit to the Registrant's Form 10-K Report for the period ended December 26, 1993 and incorporated herein by reference.\n(8) Filed as an exhibit to the registrant form 10-K report for the period ended December 25, 1994 and incorporated herein by reference.\n(9) Filed as an Exhibit to this report.","section_15":""}
{"filename":"72020_1995.txt","cik":"72020","year":"1995","section_1":"Item 1. Business\nNICOR Inc. (NICOR), incorporated in 1976, is a diversified holding company and through its wholly owned subsidiaries is engaged in gas distribution (Northern Illinois Gas) and containerized shipping (Tropical Shipping). NICOR had approximately 3,400 employees at year-end 1995.\nGas distribution, NICOR's primary segment, accounted for approximately 90 percent of NICOR's assets at December 31, 1995, 1994 and 1993. Northern Illinois Gas' operating income ranged from 90 percent to 95 percent of consolidated operating income during the three years ended December 31, 1995. NICOR provides financial information on both of its business segments in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 10 through 20.\nThe mailing address of the company's general office is P.O. Box 3014, Naperville, Illinois 60566-7014. The telephone number is (708) 305-9500.\nGAS DISTRIBUTION\nGeneral\nNorthern Illinois Gas, formed in 1954, is one of the nation's largest gas distribution utilities, serving more than 1.8 million customers. The company has approximately 2,300 employees, of which about 70 percent are covered by provisions of a collective bargaining agreement which expires on February 28, 1997. The company's service territory spans over 17,000 square miles, covering more than 600 communities and adjacent areas in 35 counties and encompasses most of the northern third of Illinois, excluding the city of Chicago. Northern Illinois Gas maintains franchise agreements with 475 municipalities with terms ranging up to 50 years. More than 50%, or approximately 250 franchise agreements, will expire in 20 years or more. Only seven agreements, or approximately 1%, will expire in less than five years. These agreements allow the company to construct, operate and maintain distribution facilities in the municipalities served.\nThe Northern Illinois Gas service territory has a stable economic base that provides strong and balanced demand among residential, commercial and industrial customers. Residential customers account for about 45 percent of the company's total gas deliveries, while industrial and commercial customers account for approximately 30 percent and 25 percent of deliveries, respectively (refer to Operating Statistics on page 17). In addition, the company's industrial and commercial customer base is well-diversified, lessening the impact of industry-specific swings.\nGas deliveries are seasonal since nearly 50 percent are used for space heating. Typically, 70 to 75 percent of deliveries and revenues occur from October 1 to March 31.\nNICOR Inc. Page 2\nItem 1. Business (continued)\nCustomer Services\nIn addition to gas sales to all customer classes, Northern Illinois Gas provides transportation, storage and backup services to commercial and industrial customers who purchase their own gas supplies. Transportation service provides customers the opportunity to lower their overall costs by purchasing gas directly and transporting it to their facilities through the company's distribution system. The company provides transportation customers with supply backup which may vary from zero to 100 percent.\nNorthern Illinois Gas continues to make additional underground storage capacity available to its transportation customers. About 21 Bcf, or 15 percent of company-owned storage capacity, is available under the company's two existing programs and approximately 4,500 customers, brokers and marketers contracted to use the company's storage-for-fee services during the 1995-1996 heating season. In addition to these two programs, in 1995 the company entered into one-year agreements to lease 2 Bcf of storage capacity to two gas marketers.\nNorthern Illinois Gas is continuing to explore ways of enhancing profitability through nontraditional opportunities that benefit ratepayers and shareholders alike. During 1995, these nontraditional activities included: selling storage services for a fee to various customers as noted above; providing transportation service to pipelines and gas distribution companies adjacent to its facilities; owning a hub which serves as a market center for various transactions between buyers and sellers of natural gas and related services; selling space for advertising material to be inserted in gas bill envelopes; and offering account management services to transportation customers. While the combined operating results from these activities are modest, these ventures demonstrate the company's commitment to developing nontraditional sources of income.\nSources of Gas Supply\nAs a result of FERC Order 636, Northern Illinois Gas contracts separately for gas supply, pipeline transportation and leased storage services. The company purchases gas supplies on a deregulated basis directly from producers, marketers and affiliates of pipelines. Pipeline transportation and storage services are contracted for at rates regulated by the FERC. For further information on FERC Order 636, see page 30.\nNorthern Illinois Gas owns extensive underground storage facilities located within its service territory. The company's gas supply, pipeline transportation and storage service contracts, when combined with company- owned storage, were sufficient to meet peak day, seasonal and annual requirements during 1995.\nNorthern Illinois Gas has been able to obtain sufficient supplies of natural gas to meet customer requirements. The company, however, is unable to make specific representations as to natural gas supply availability, but believes supply will be sufficient to meet market demands in the foreseeable future.\nNICOR Inc. Page 3\nItem 1. Business (continued)\nGas supply. Northern Illinois Gas maintains a diversified portfolio of gas supply contracts. Firm direct gas supply contracts are diversified by supplier, producing region, quantity, available transportation, contract length and contract expiration date. Contract pricing is generally tied to published price indices so as to approximate current market rates for spot gas. The contracts also generally provide for the payment of fixed demand charges to ensure the availability of supplies on any given day. At the end of 1995, the company had approximately 40 firm direct gas supply contracts with terms generally ranging from three months to five years. Nearly 60 percent of the contracted volumes expire in 1996. The company also purchases gas supplies on the spot market to fulfill its supply requirements or to take advantage of favorable short-term pricing.\nThe sources of gas purchased for the past three years were:\nYear ended December 31 1995 1994 1993 Source Bcf % Bcf % Bcf %\nFirm direct supply 237.4 78.2 246.8 84.6 139.3 46.8 Spot gas 66.2 21.8 44.8 15.4 115.8 38.9 Pipeline suppliers - - - - 42.8 14.3\n303.6 100.0 291.6 100.0 297.9 100.0\nThe company's transportation customers also purchase gas supplies. Nearly 45 percent of the gas that the company delivered in 1995 was purchased by transportation customers directly from producers and marketers rather than from the company.\nPipeline transportation contracts. Northern Illinois Gas is directly connected to five interstate pipelines which provide access to most of the major natural gas producing regions in the United States and Canada. The company's primary firm transportation contracts with these pipelines are summarized below:\nTotal maximum Year of service daily contract agreement capacity Major pipelines expiration (Bcf)\nNatural Gas Pipeline Company of America (NGPL) 2000 .92(a) Midwestern Gas Transmission Company (Midwestern) 2000 .33 Northern Natural Gas Company (Northern Natural) 1997 .19\n1.44 (a) Excludes .49 Bcf of delivered storage service.\nNICOR Inc. Page 4\nItem 1. Business (continued)\nThe company contracts for transportation capacity necessary to meet peak day requirements. Contracted capacity that is not needed during off-peak periods can be released to other shippers under FERC-mandated capacity release provisions, with proceeds directly reducing the company's cost of gas charged to customers.\nStorage. Northern Illinois Gas owns and operates seven underground gas storage facilities. This storage system is one of the largest in the gas distribution industry and is able to meet up to 60 percent of the company's peak day deliveries and approximately 30 percent of its normal winter deliveries. On an annual basis, the company cycles about 130 Bcf in and out of storage. In addition to the company-owned facilities, Northern Illinois Gas leases about 43 Bcf of storage from interstate pipelines and other storage facility operators. Storage facilities provide supply flexibility, improve reliability of deliveries and help reduce costs.\nIn 1994 and 1995, the company significantly enhanced its transmission and storage capabilities with construction of the Elgin-Volo project, a two- year, $65 million system improvement. The project improved withdrawal capacities at its storage field in Troy Grove, Illinois and added 17 miles of parallel main to increase the capacity of the transmission system that delivers gas from Troy Grove to the market. In addition, 28 miles of transmission main was added in the northern region of the company's service territory.\nCompetition\/Demand\nNorthern Illinois Gas is one of the largest utility energy suppliers in Illinois, delivering about one-third of all utility energy consumed in the state. More than 95 percent of all single-family homes in Northern Illinois Gas' service territory are heated with natural gas. The company's gas services compete with other forms of energy, such as electricity and oil. Demand for gas may be influenced by such factors as weather, the economy, new sources and uses of energy, customer conservation efforts, technological advances, pricing of gas and competitive fuels, environmental considerations, state and federal regulatory policies and the customers' overall expectations about the future.\nChanges are expected to occur in the electric utility industry, the result of which will lead to more competitive pricing between natural gas and electric utilities. Retail prices for electricity will become more market driven and vary based on such factors as demand, available capacity and the variable costs associated with bringing incremental generating capacity on line. Customers will benefit from the increase in competition, and the energy providers that fare well will be the ones that provide the best service at the lowest cost.\nAdditional information on competition and demand is presented in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on pages 12 through 14.\nNICOR Inc. Page 5\nItem 1. Business (continued)\nRegulation\nNorthern Illinois Gas is regulated by the Ill.C.C., which establishes the rules and regulations governing utility rates and services in Illinois. Rates are designed to allow Northern Illinois Gas to recover its costs and provide an opportunity to earn a fair return on investment.\nThe cost of gas the company purchases for customers is recovered through a monthly gas supply charge, which accounts for approximately 70 percent of a typical residential customer's annual bill. The company's cost of gas is passed on to the customer with no markup.\nOn May 8, 1995, Northern Illinois Gas filed with the Ill.C.C. for a 5.4 percent, $73 million general rate increase. For further information, see Rate Proceeding on page 29.\nProperties\nThe gas distribution, transmission and storage system includes approximately 28,000 miles of steel, plastic and cast iron main; approximately 24,000 miles of steel, plastic\/aluminum composite, plastic and copper service pipe connecting the mains to customers' premises; and seven underground storage fields. Other properties include buildings, land, motor vehicles, meters, regulators, compressors, construction equipment, tools, and communication, computer and office equipment.\nThe principal real properties are held under easements, permits, licenses or in fee. Land in fee is owned for essentially all administrative offices and for certain transmission mains and underground storage fields. Substantially all properties are subject to the lien of the indenture securing the company's first mortgage bonds.\nNorthern Illinois Gas Operating Statistics\nYear ended December 31 1995 1994 1993 Percent of customers with gas space heating 97% 97% 97% Peak-day sendout (Bcf) 3.8 4.6 3.4 Average temperature on peak day (degrees in Fahrenheit) 3 (14) 6 Degree days* (Normal 6,117) 6,111 5,865 6,129 Customers per employee (average) 777 775 748\n* Degree days - The number of degrees by which the daily mean temperature falls below 65 degrees Fahrenheit.\nSee Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, page 17, for operating revenues, deliveries and customers by class.\nNICOR Inc. Page 6\nItem 1. Business (concluded)\nSHIPPING\nTropical Shipping transports containerized freight between the Port of Palm Beach, Florida and 23 ports in the Caribbean and Central America. The company is one of the largest transportation companies in the region, carrying cargo primarily southbound to markets which are heavily dependant upon the tourist industry and northbound for export trade. The company also provides additional related services including inland transportation and cargo insurance.\nTropical Shipping's owned fleet consists of 14 vessels with a container capacity totaling approximately 3,100 TEUs. Whenever practical, excess capacity in Tropical Shipping's fleet is chartered out on a short-term basis. In addition, the company owns containers, container-handling equipment, chassis and other equipment. Real property, a significant portion of which is leased, includes office buildings, cargo handling facilities and warehouses located in the United States, as well as in some of the ports served. Tropical Shipping also has sales offices in Canada and England.\nAdditional information about factors affecting Tropical Shipping's business is presented in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on pages 14 and 15.\nNICOR NEW VENTURES\nNICOR has developed several new nonutility ventures that build on the company's strengths, expertise and market presence in the gas distribution business. Additional information is presented in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on page 15.\nENVIRONMENTAL MATTERS\nInformation with respect to environmental matters is presented in the Contingencies section of the Notes to the Consolidated Financial Statements on page 37.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nInformation with respect to this item concerning NICOR and its subsidiaries' properties is included in Item 1, Business, above, and is incorporated herein by reference. These properties are suitable, adequate and utilized in the company's operations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn December 20, 1995, Northern Illinois Gas filed suit against certain insurance carriers in the Circuit Court of Cook County. This suit seeks to declare the insurance carriers liable under policies in effect primarily between the years 1954 and 1985 for costs associated with environmental cleanup of former manufactured gas plant sites.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nNICOR Inc. Page 7\nExecutive Officers of the Registrant\nName Age Current Position and Background\nThomas L. Fisher 51 Chairman, NICOR and Northern Illinois Gas (January 1996), Chief Executive Officer, NICOR (since 1995) and Northern Illinois Gas (since 1988), President, NICOR (since 1994) and Northern Illinois Gas (since 1988) and Chief Operating Officer, NICOR (1994).\nDavid L. Cyranoski 52 Senior Vice President, NICOR and Northern Illinois Gas (since 1995), Secretary, NICOR (since 1992) and Northern Illinois Gas (since 1993), Controller, NICOR (since 1992) and Northern Illinois Gas (since 1984) and Vice President, NICOR (1992-1995) and Northern Illinois Gas (1984-1995).\nThomas A. Nardi 41 Senior Vice President Nonutility Operations and Business Development, NICOR (since 1995), and Senior Vice President Business Development, Northern Illinois Gas (since 1995), Vice President Business Development, NICOR (1994- 1995), Vice President Supply and Business Development, Northern Illinois Gas (1994-1995), Vice President Rates and Supply, Northern Illinois Gas (1993-1994), Vice President Rates and Personnel and Secretary, Northern Illinois Gas (1991-1992) and Vice President and Secretary, Northern Illinois Gas (1990-1991).\nJohn C. Flowers 57 Vice President Personnel, Northern Illinois Gas (since 1993) as well as Vice President Human Resources, NICOR (since 1984).\nDonald W. Lohrentz 59 Treasurer, NICOR (since 1987), Vice President, Northern Illinois Gas (since 1985) and Treasurer, Northern Illinois Gas (1990-1993, 1984-1988).\nEdwin M. Werneke 57 Vice President Supply Ventures, NICOR (since 1995), Vice President Supply Administration, Northern Illinois Gas (since 1995) and Assistant Vice President, Northern Illinois Gas (1980-1995).\nExecutive officers of the company are elected annually by the Board of Directors.\nNICOR Inc. Page 8\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nNICOR common stock is listed on the New York and Chicago Stock Exchanges. At February 29, 1996, there were approximately 43,000 common stockholders of record. On March 6, 1996, the Board of Directors declared a quarterly common stock dividend of 33 cents per share, payable May 1, 1996, to stockholders of record March 29, 1996. This payment represents an annual rate of $1.32 per share.\nThe common stock price range and dividends declared per common share by quarter for 1995 and 1994, are as follows:\nStock price Dividends Quarter High Low declared First $25-3\/8 $21-3\/4 $ .32 Second 27-7\/8 24-1\/2 .32 Third 28-1\/2 25-1\/8 .32 Fourth 28-1\/2 24-7\/8 .32\nFirst $29-1\/4 $25-1\/8 $.315 Second 28-1\/4 25-1\/8 .315 Third 26-1\/2 23-5\/8 .315 Fourth 25 21-7\/8 .315\nNICOR Inc. Page 10\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe purpose of this financial review is to explain changes in NICOR's operating results and financial condition from 1993 to 1995. This review also discusses business trends and uncertainties that might affect NICOR. A summary of operating performance during this period is presented below, followed by a more detailed discussion. Certain abbreviations used herein are defined on page i.\nSUMMARY\nNICOR's two major business segments are gas distribution and shipping. Gas distribution is NICOR's primary business, accounting for approximately 90 percent of consolidated assets at December 31, 1995 and 1994. NICOR previously conducted operations in the oil and gas business, which were classified as discontinued in the first quarter of 1993. The sale of oil and gas operations was completed in 1993.\nNICOR's 1995 income from continuing operations of $99.8 million declined 9 percent from 1994 as lower operating results in the gas distribution segment were partially offset by a substantial improvement in operating results in the shipping segment. A higher effective tax rate also had a negative impact on 1995 earnings. In 1994, NICOR's income from continuing operations of $109.5 million was essentially unchanged from 1993 as lower operating income basically offset improvements in nonoperating items.\nEarnings per common share from continuing operations were $1.96 in 1995 compared with $2.07 in 1994 and $1.97 in 1993. Earnings per common share including discontinued operations were $1.96, $2.07 and $2.01 for the same years. Per share results benefitted from about 4 percent fewer average shares outstanding in 1995 compared with 1994 and about 5 percent fewer average shares in 1994 compared with 1993. Dividends declared per common share were $1.28, $1.26 and $1.22 for 1995, 1994 and 1993, respectively.\nGas distribution operating income decreased to $170.7 million in 1995 from $179.1 million in 1994 due mainly to higher depreciation and higher operating and maintenance expenses. Also, prior year operating results included the impact of a $4.2 million nonrecurring gain on the sale of interests in oil and gas properties. Partially offsetting these factors was the impact of a 6 percent increase in deliveries of natural gas, reflecting weather that was 4 percent colder than in 1994. In 1994, gas distribution operating income decreased $8.5 million to $179.1 million as higher operating and maintenance expenses and depreciation more than offset a $4.2 million gain on the sale of oil and gas property interests. Further, deliveries increased 2 percent due to additional deliveries for electric power generation, but the related operating income benefit was more than offset by decreased demand associated with 4 percent warmer weather.\nShipping operating income rose 26 percent in 1995 to $23.4 million due to higher revenue per unit related to an improved mix of cargo shipped. In 1994, shipping operating income was $18.6 million, up $3.1 million or 20 percent. The improvement resulted from an improved cargo mix, increased chartering activity and additional volumes shipped.\nNICOR Inc. Page 11\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nOn May 8, 1995, Northern Illinois Gas filed with the Ill.C.C. for a 5.4 percent, $73 million general rate increase. The filing requested a rate of return on original-cost rate base of 10.67 percent, reflecting a 12.95 percent cost of common equity. The increase is needed to recover costs associated with enhancements to the company's transmission and storage system, other capital costs and rising operating costs. The filing also proposes revisions to some services provided to commercial and industrial customers. The last time the company filed for a general rate increase was 1981.\nOn January 12, 1996, the Ill.C.C. hearing examiners issued a proposed order under which Northern Illinois Gas would receive a general rate increase of approximately $31 million, of which $12 million is due to the proposed change in the company's depreciation rate. The proposed order reflects a rate of return on original-cost rate base of 9.77 percent and an 11.3 percent cost of common equity. The Ill.C.C. is expected to issue a final decision by April 4, 1996, which could be different from the proposed order.\nIn October 1994, NICOR initiated a common stock buyback program totaling $50 million. In July 1994, the company completed a $100 million common stock buyback program initiated in 1993. During the last three years, the company has repurchased and retired 5.5 million common shares at an approximate cost of $145 million.\n(Millions) 1995 1994 1993\nOperating revenues Gas distribution $ 1,312.7 $ 1,455.0 $ 1,533.3 Shipping 163.6 153.0 140.5 Other 3.8 1.4 .1\n$ 1,480.1 $ 1,609.4 $ 1,673.9\nDepreciation expense Gas distribution $ 98.8 $ 90.1 $ 83.7 Shipping 12.9 13.0 12.8 Other .1 - -\n$ 111.8 $ 103.1 $ 96.5\nOperating income (loss) Gas distribution $ 170.7 $ 179.1 $ 187.6 Shipping 23.4 18.6 15.5 Other (4.3) (4.0) (5.0)\n$ 189.8 $ 193.7 $ 198.1\nNICOR Inc. Page 12\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nFACTORS AFFECTING BUSINESS PERFORMANCE\nThe following factors can impact year-to-year comparisons and may affect the future performance of NICOR's businesses.\nGas distribution. Since nearly 50 percent of gas deliveries are used for space heating, fluctuations in weather can have a significant impact on year-to-year comparisons of operating income and cash flow. In addition, significant changes in gas prices or economic conditions can impact gas usage. However, Northern Illinois Gas' large residential customer base provides relative stability during weak economic periods. Also, the industrial and commercial customer base is well-diversified, lessening the impact of industry-specific economic swings.\nNorthern Illinois Gas competes with other suppliers of energy based on such factors as price, service and reliability. The company is well-positioned to deal with the possibility of fuel switching by customers because it has rates and services designed to compete against alternative fuels, and because of its competitively priced supply of gas. In addition, the company has a rate which allows negotiation with potential bypass customers, and no customer has bypassed since the rate became effective in 1987. Northern Illinois Gas also offers commercial and industrial customers flexibility and alternatives in rates and service, increasing its ability to compete in these markets.\nDirect connection to five interstate pipelines and extensive underground storage capacity allow the company to maintain rates that are among the lowest in the nation, while providing transportation customers with direct access to gas supplies and storage services. In 1995, Northern Illinois Gas' storage capabilities enabled the company to reduce purchases of premium-cost pipeline services. In addition, in an effort to ensure supply reliability, the company purchases gas from several different producing regions under varied contract terms.\nGas Distribution Operating Statistics\n1995 1994 1993\nYear-end customers (Thousands) 1,833.5 1,802.7 1,769.8 Margin per Mcf delivered $ .83 $ .87 $ .88 Average gas cost per Mcf sold 2.52 3.14 3.26 Degree days (Normal 6,117) 6,111 5,865 6,129\nIn April 1992, the FERC issued Order 636. This order, which required implementation by the pipelines for the 1993-1994 heating season, substantially restructured the interstate sale and transportation of gas. For further information, see page 30, FERC Order 636.\nNorthern Illinois Gas has significantly enhanced its transmission and storage capabilities with the Elgin-Volo project. The project improved withdrawal capacities at the company's storage field in Troy Grove, Illinois, and added 17 miles of parallel main to increase the capacity of\nNICOR Inc. Page 13\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nthe transmission system that delivers gas from Troy Grove to the market. In addition, 28 miles of main was added in the northern region of the Northern Illinois Gas service territory between the towns of Elgin, Crystal Lake and Volo. The project is expected to provide an estimated $28 million in annual gas cost savings to customers, enable the company to meet future demand and provide the opportunity to sell additional transportation and storage services.\nNorthern Illinois Gas has been able to increase gas deliveries in recent years in part because of more diversified uses of natural gas. While the majority of the company's growth in the past has been driven by customer additions, diversified uses, such as electric power generation, large- tonnage gas air conditioning and gas-fired cogeneration, are expected to continue to account for a significant portion of Northern Illinois Gas' growth in deliveries.\nIn 1993, Northern Illinois Gas began a 10-year contract to transport natural gas for electric generation. Deliveries under this contract, which may vary widely from year to year depending on demand for electricity, operation of other plants and the cost of natural gas relative to other fuels, contributed significantly to the overall growth in deliveries in each of the last two years. Northern Illinois Gas delivered 34.4 Bcf and 31.4 Bcf of gas for electric power generation in 1995 and 1994, respectively.\nBeyond efforts to increase natural gas deliveries in its service territory, Northern Illinois Gas is working to increase profitability through nontraditional opportunities. During 1995, these nontraditional activities included: selling storage services for a fee to various customers; providing transportation service to pipelines and gas distribution companies adjacent to its facilities; owning a hub which serves as a market center for various transactions between buyers and sellers of natural gas and related services; selling space for advertising materials to be inserted in gas bill envelopes; and offering account management services to transportation customers. These activities generated approximately $6 million in pretax income in 1995 and 1994, and approximately $3 million in 1993. These ventures demonstrate the company's commitment to developing nontraditional sources of income.\nNorthern Illinois Gas is examining its operations in light of the changing regulatory environment. With efficiency and customer service in mind, the company has made several organizational changes. The company's sales and marketing departments were centralized to enhance the level of service to existing markets and to focus resources on markets with the most potential to increase natural gas deliveries. In field operations, Northern Illinois Gas has reorganized from a \"division\" structure based on geography to a company-wide \"process\" approach based on closely related activities and customer services. The more centralized structure improves the planning and prioritization of work throughout the company's service territory, leading to increased efficiency on service calls, maintenance of the operating system and installation of new services and main. The company has also taken steps to streamline its gas storage and transmission operations and is in the process of reviewing its support and administrative functions.\nNICOR Inc. Page 14\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nNorthern Illinois Gas also initiated a program in 1994 to reduce the level of capital expenditures on an ongoing basis while continuing to maintain a high level of service and reliability. The company made progress toward this objective in 1995 as spending on capital items other than the Elgin- Volo project was significantly below the 1994 level.\nNorthern Illinois Gas is regulated by the Ill.C.C. which establishes the rules and regulations governing utility rates and services in Illinois. Rates are designed to allow the company to recover its costs and provide an opportunity to earn a fair return for its investors. Changes in the regulatory environment could affect the longer-term performance of Northern Illinois Gas.\nAs a result of a bill passed by the Illinois legislature in 1995, performance-based ratemaking is now allowed in the state on an experimental basis. Northern Illinois Gas' rate case filing in 1995 was based on the traditional cost-of-service approach, but the company is studying performance-based rate opportunities and is considering appropriate actions.\nShipping. Tropical Shipping's financial results can be significantly affected by general economic conditions in the United States and the Caribbean. Most of the markets served by the company depend on imports of food and other essential provisions. Tourism is a key element in their economies.\nTropical Shipping continues its efforts to be competitive and profitable in the Caribbean region, which is characterized by modest market growth, intensifying price competition and increasing service parity. The company intends to take advantage of opportunities in the region by expanding services to selected destinations and initiating service to new areas in the Caribbean region. Additional growth is expected in high margin services, such as handling of less-than-container load shipments and providing service via other carriers to ports not served by Tropical vessels.\nIn September 1995, two hurricanes caused extensive damage on several of the Caribbean islands served by Tropical Shipping. The hurricanes have had a negative impact on tourist-based cargo shipments, but the impact has been more than offset by an increase in shipments of construction materials and supplies to rebuild the affected areas. Hurricane-recovery activity is expected to continue into 1996.\nAt present, all shipping companies engaged in the foreign commerce of the United States are required to file their rates and tariff terms with the Federal Maritime Commission (FMC). The U.S. House of Representatives has passed legislation that would dismantle the FMC and deregulate the \"common carrier\" shipping industry as early as 1997. That legislation, as well as other alternative deregulation measures, is currently being reviewed by the U.S. Senate. If enacted, deregulation will allow shipping companies to negotiate confidential service contracts with individual shippers for liner services rather than providing services on a fixed tariff basis.\nNICOR Inc. Page 15\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nDeregulation should initially increase direct competition for larger customers. Tropical's competitive rates and service levels should allow the company to meet the challenges of the increased competition; however, the full impact of such change is uncertain at this time.\nShipping Operating Statistics 1995 1994 1993 TEUs shipped (Thousands) Southbound 76.2 75.2 75.3 Northbound 15.7 16.7 16.1 Interisland 5.0 4.0 2.4\n96.9 95.9 93.8\nPorts served 23 22 22 Vessels owned 14 14 14\nNICOR New Ventures. In order to maximize the potential from a growing number of opportunities, NICOR has developed several new nonutility ventures that build on the company's strengths, expertise and market presence in the gas distribution business. NICOR's new ventures offer good long-term growth prospects and are expected to move toward overall profitability over the next several years. Currently, these new ventures include: offering a variety of maintenance and repair contracts for residential and commercial heating, air conditioning and water heating equipment; developing, administering and operating natural gas market-area hubs; developing turnkey natural gas fleets and fueling services in the Chicago metropolitan area; and assisting clients in the area of natural gas product development, testing and consulting.\nContingencies. The company is conducting environmental investigations at a barge-cleaning facility and former gas manufacturing plant sites. Although unable to determine the outcome of these contingencies, management believes that appropriate accruals have been recorded. Final disposition of these matters is not expected to have a material impact on the company's financial condition or results of operations. For further information, see page 37, Contingencies.\nRESULTS OF OPERATIONS\nDetails of various financial and operating information by segment can be found in the tables throughout this review. The following discussion summarizes the major items impacting NICOR's earnings.\nRevenues. In 1995, NICOR's operating revenues decreased 8 percent to $1,480.1 million. Gas distribution revenues of $1,312.7 were down 10 percent as a result of the recovery from customers of lower gas costs. Shipping revenues rose 7 percent to $163.6 million due to an improved cargo mix, additional volumes shipped and increased charter activity.\nNICOR Inc. Page 16\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nIn 1994, NICOR's operating revenues decreased 4 percent to $1,609.4 million. In the gas distribution segment, revenues of $1,455 million declined 5 percent as a result of the recovery from customers of lower gas costs, customers switching from sales to transportation service and the effect of 4 percent warmer weather. Shipping revenues rose 9 percent to $153 million due to an improved cargo mix, increased charter activity and additional volumes shipped.\nMargin. Gas distribution margin, defined as operating revenues less cost of gas and revenue taxes which are both passed directly through to customers, rose $6 million in both 1995 and 1994 to $442.3 million and $436.3 million, respectively. Factors contributing to the change in margin included the positive impact of increased deliveries unrelated to weather, the effect of variations in weather and a nonrecurring $4.2 million gain on the sale of interests in oil and gas properties in 1994. Margin per Mcf delivered in 1995 and 1994 was adversely affected by increases in lower margin deliveries for electric power generation.\nOperating and Maintenance. In 1995, operating and maintenance expenses were $287.3 million, up $14.6 million from the prior year. The gas distribution segment accounted for $6.1 million of the increase due to several factors, including a higher pension provision, increased expenditures for information technology and the incurrence of costs associated with the company's rate filing. The shipping segment was $5.8 million higher because of shore and vessel costs relating to higher volumes shipped.\nIn 1994, operating and maintenance expenses were $272.7 million, up $16.6 million from the prior year. The shipping segment increase of $8.7 million was due primarily to higher volume-related operating expenses and the cost of an early retirement program. The gas distribution segment increase of $7.6 million related to several items, the largest being payroll, a new system maintenance program and damage claims.\nDepreciation. Depreciation rose 8 percent in 1995 to $111.8 million, and 7 percent in 1994 to $103.1 million, mainly as a result of plant additions in the gas distribution segment.\nNonoperating items. Other income decreased $.8 million in 1995 to $6.2 million as the change in interest on income tax adjustments more than offset higher interest income, resulting from higher interest rates.\nIn 1995, interest expense rose $1.7 million due to the impact of higher interest rates. Interest expense declined $1.3 million in 1994 to $40.1 million because of reduced borrowing levels.\nEffective income tax rates were 35.3 percent, 31.8 percent and 33.1 percent for 1995, 1994 and 1993, respectively. The increase in 1995 was primarily the result of a higher state tax provision and less excess deferred taxes turning around. The decrease in 1994 was due primarily to a lower state tax provision.\nNICOR Inc. Page 17\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nGas Distribution Operating Statistics\n1995 1994 1993 Gas distribution margin (Millions) Sales Residential $ 849.8 $ 939.2 $ 989.2 Commercial 217.8 260.0 292.1 Industrial 35.9 50.2 55.4 1,103.5 1,249.4 1,336.7 Transportation Commercial 50.3 41.8 38.8 Industrial 62.5 51.2 48.1 112.8 93.0 86.9 Revenue taxes and other 96.4 112.6 109.7 Operating revenues 1,312.7 1,455.0 1,533.3 Cost of gas (787.2) (924.9) (1,007.1) Revenue taxes (83.2) (93.8) (95.9)\n$ 442.3 $ 436.3 $ 430.3\nDeliveries (Bcf) Sales Residential 231.4 215.8 222.7 Commercial 59.3 60.5 67.0 Industrial 10.5 12.4 13.7 301.2 288.7 303.4 Transportation Commercial 64.0 54.2 50.0 Industrial 165.6 156.9 135.4 229.6 211.1 185.4\n530.8 499.8 488.8\nYear-end customers (Thousands) Sales Residential 1,660.6 1,632.0 1,601.2 Commercial 141.7 141.5 141.7 Industrial 11.6 11.6 11.6 1,813.9 1,785.1 1,754.5 Transportation Commercial 17.1 15.3 13.2 Industrial 2.5 2.3 2.1 19.6 17.6 15.3\n1,833.5 1,802.7 1,769.8\nNICOR Inc. Page 18\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nDiscontinued operations. In April 1993, NICOR announced its intention to divest its oil and gas segment. U.S. exploration and production operations were sold in the second quarter of 1993, and the Canadian gas gathering operations were sold in October 1993, with no effect on net income. This completed the sale of oil and gas operations.\nThe company has been evaluating its discontinued operations reserve and it appears that a positive adjustment may be appropriate in the near future.\nAccounting pronouncements. In 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, and Statement No. 123, Accounting for Stock-Based Compensation. Implementation of these statements is not expected to have a material impact on the company's financial condition or results of operations. For further information, see New Accounting Pronouncements on page 29.\nFINANCIAL CONDITION AND LIQUIDITY\nOverall, NICOR's financial condition is sound. Long-term debt continues to be about 40 percent of capitalization.\nThe company believes it has access to adequate resources to meet planned capital expenditures, debt and stock redemptions, dividends and working capital needs. These resources include net cash flow from operating activities, access to capital markets, unused lines of credit and short-term investments.\nOperating. Net cash flow from continuing operations, NICOR's primary source of cash, was $276.3 million in 1995, $298.4 million in 1994 and $221.9 million in 1993. The changes between years were due primarily to the timing of the recovery of gas costs from customers.\nThe working capital component of net cash flow from operating activities can swing sharply from year to year due primarily to certain gas distribution factors, including weather, the timing of collections from customers and gas-purchasing practices. The company generally relies on short-term financing to meet temporary increases in working capital needs.\nIn 1996, net cash flow from continuing operations is expected to decrease significantly because of working capital changes. Factors contributing to this decrease include the impact of an increase in company storage requirements, timing of gas cost recoveries, a return to normal levels of customer advance payments and the impact of a 1995 gas pipeline refund.\nInvesting. NICOR's capital expenditures, which are mainly in the gas distribution segment, were $156.9 million in 1995 compared with $172.1 million in 1994 and $141.6 million in 1993. Capital expenditures in 1995 and 1994 included amounts related to construction of the Elgin-Volo project, a two-year, $65 million transmission and storage system improvement. In 1995, capital spending in the gas distribution segment on projects other than the Elgin-Volo project was below historical levels, reflecting, in\nNICOR Inc. Page 19\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\npart, efforts to reduce capital expenditures. The decline in 1995 capital spending in the shipping segment relates primarily to the delay in certain equipment purchases.\nCapital spending in 1996 is anticipated to be about $130 million, with $115 million for gas distribution. Capital expenditures in the gas distribution segment are expected to decrease as a result of the completion of the Elgin- Volo project and company-wide efforts to reduce capital expenditures. In the shipping segment, capital spending is expected to return to more typical levels.\nThe U.S. exploration and production and the Canadian gas gathering operations were sold in several transactions in 1993 for approximately $140 million. Net proceeds from the sales were used to fund working capital requirements and the 1993 common stock buy-back program.\nFinancing. NICOR's long-term debt outstanding was $468.7 million at December 31, 1995 and $458.9 million for the years ended December 31, 1994 and 1993. Long-term debt as a percentage of capitalization was 40.2 percent, 39.9 percent and 38.9 percent at year-end 1995, 1994 and 1993, respectively.\nLong-term debt. In October 1995, Northern Illinois Gas issued $50 million of 7.26% First Mortgage Bonds due in 2025. The net proceeds of the sale replenished corporate funds which were used for the maturity of $50 million of 5-1\/2% unsecured notes due in July 1995.\nIn September 1995, Tropical Shipping issued $22.5 million of 6.83% unsecured senior notes due in September 2000. Proceeds from the sale were used for replacement of a $12.5 million promissory note due in December 1996 and for general corporate purposes.\nIn August 1994, Northern Illinois Gas issued $50 million of 8-1\/4% First Mortgage Bonds due in 2024, which represented the remaining $50 million of a December 1992 shelf registration statement. The net proceeds from the sale of the bonds were used for general corporate purposes, including construction programs.\nIn July 1994, Northern Illinois Gas redeemed $50 million of 8.70% First Mortgage Bonds due in 1995 with proceeds from the issuance of $50 million of 5-1\/2% unsecured notes due in July 1995.\nIn April 1994, Northern Illinois Gas filed a $225 million First Mortgage Bond shelf registration statement with the Securities and Exchange Commission, of which $175 million remained available for issuance at December 31, 1995. The net proceeds from any securities issued are expected to be used for the refinancing of certain outstanding debt, for construction programs to the extent not provided by internally generated funds and for general corporate purposes.\nDuring 1993, the company refinanced about half of consolidated long-term debt at lower interest rates, reducing annual interest expense by approximately $5.5 million on the portion of the debt refinanced.\nNICOR Inc. Page 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (concluded)\nIn 1996, Northern Illinois Gas anticipates issuing, depending upon market conditions, $50 million of debt to finance maturing debt and $25 million of debt to replenish funds used in 1995 to finance the Elgin-Volo project.\nShort-term debt. NICOR and its gas distribution subsidiary maintain short- term credit agreements with major domestic and foreign banks. At December 31, 1995, these agreements, which serve as backup for the issuance of commercial paper, totaled $340 million and the company had $198.8 million and $243.9 million of commercial paper outstanding at year-end 1995 and 1994, respectively. At December 31, 1995, the unused lines of credit under these credit agreements were $141.2 million\nPreference stock. In May 1994, NICOR redeemed its 7.90% preference stock at a price of $505 per share.\nCommon stock. In October 1994, NICOR initiated a stock repurchase program having an aggregate market value of up to $50 million. The repurchases are being financed with existing financial assets, cash flow and utilization of short-term borrowings. Under this program, NICOR purchased and retired common shares at a cost of approximately $30 million and $15 million in 1995 and 1994, respectively.\nIn July 1994, NICOR completed a $100 million common stock buy-back program initiated in 1993. Under this program, NICOR purchased and retired common shares at a cost of $48 million and $52 million in 1994 and 1993, respectively. These repurchases were financed with a portion of the proceeds from the 1993 sales of NICOR's oil and gas operations, existing financial assets, cash flow and utilization of short-term borrowings.\nThe company increased its quarterly common stock dividend rate during 1995 for the eighth consecutive year. The company paid dividends of $65.2 million, $66.9 million and $68.1 million in 1995, 1994 and 1993, respectively.\nOther. Restrictions imposed by regulatory agencies and loan agreements limiting the amount of subsidiary net assets that can be transferred to NICOR are not expected to have a material impact on the company's ability to meet its cash obligations.\nEstimated Actual (Millions) 1996 1995 1994 1993 Capital Expenditures Gas distribution $ 115 $ 152.2 $ 160.3 $ 127.4 Shipping 15 4.5 11.8 14.1 Other - .2 - .1 $ 130 $ 156.9 $ 172.1 $ 141.6\nIdentifiable assets at December 31 Gas distribution $2,080.3 $2,011.7 $2,016.1 Shipping 164.3 180.6 204.5 Other 14.5 17.6 1.5 $2,259.1 $2,209.9 $2,222.1\nNICOR Inc. Page 21\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage\nReport of Independent Public Accountants 22\nFinancial Statements:\nConsolidated Statement of Income 23\nConsolidated Statement of Cash Flows 24\nConsolidated Balance Sheet 25\nConsolidated Statement of Capitalization 26\nConsolidated Statement of Common Equity 27\nNotes to the Consolidated Financial Statements 28\nNICOR Inc. Page 22\nReport of Independent Public Accountants\nTo the Shareholders and Board of Directors of NICOR Inc.:\nWe have audited the accompanying consolidated balance sheet and statement of capitalization of NICOR Inc. (an Illinois corporation) and subsidiary companies as of December 31, 1995 and 1994, and the related consolidated statements of income, common 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 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 NICOR 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 the accompanying index (page 40) 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 Arthur Andersen LLP\nChicago, Illinois January 24, 1996\nNICOR Inc. Page 28\nNotes to the Consolidated Financial Statements\nNICOR Inc. is a holding company with its principal business being Northern Illinois Gas, one of the nation's largest gas distribution companies. Northern Illinois Gas serves over 1.8 million customers in a service territory that encompasses most of the northern third of Illinois, excluding the city of Chicago. NICOR also owns Tropical Shipping, which transports containerized freight between the Port of Palm Beach, Florida, and 23 ports in the Caribbean and Central America.\nACCOUNTING POLICIES\nConsolidation. The consolidated financial statements include the accounts of NICOR Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated. The preparation of the consolidated financial statements requires management to make estimates that affect the reported amounts. Actual results could differ from those estimates. Certain reclassifications were made to conform the prior years' financial statements to the current year presentation.\nOperating revenues and gas costs. The cost of gas purchased, adjusted for inventory activity, is reflected in volumetric charges to customers through operation of the Uniform Purchased Gas Adjustment Clause (PGA). Any difference between PGA revenues and recoverable gas costs is deferred or accrued with a corresponding decrease or increase in cost of gas. This difference is amortized as it is collected from or refunded to customers through the PGA.\nDepreciation. Property, plant and equipment are depreciated over estimated useful lives on a straight-line basis. The gas distribution plant composite depreciation rate is 3.7 percent. The useful life estimates of vessels range from 15 to 25 years.\nIncome taxes. Deferred income taxes are provided for temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. Although the federal investment tax credit has been eliminated, Northern Illinois Gas continues to amortize prior deferred amounts to income over the lives of the applicable properties. Income taxes have not been provided on approximately $90 million of cumulative undistributed foreign earnings through December 31, 1986, which are considered indefinitely reinvested in foreign operations.\nCash and cash equivalents. The company considers investments purchased with a maturity of three months or less to be cash equivalents.\nReceivable credit risk. Each NICOR subsidiary has a diversified base of customers, typical for its industries, and prudent creditworthiness policies which limit risk.\nNICOR Inc. Page 29\nNotes to the Consolidated Financial Statements (continued)\nNEW ACCOUNTING PRONOUNCEMENTS\nImpairment of long-lived assets. 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. This statement requires recognition of impairment losses on long-lived assets when an asset's book value exceeds its expected future undiscounted cash flows. This statement requires adoption no later than the company's 1996 fiscal year and must be adopted as a cumulative effect of a change in accounting principle. The company adopted Statement No. 121 on January 1, 1996. Implementation of this statement is not expected to have a material impact on the company's financial condition or results of operations.\nStock-based compensation. In October 1995, the FASB issued Statement No. 123, Accounting for Stock-Based Compensation. This statement requires companies to either recognize compensation costs attributable to employee stock options or similar equity instruments in net income, or, in the alternative, provide pro forma footnote disclosure on net income and earnings per share. Implementation of this statement is required no later than the company's 1996 fiscal year. The company anticipates electing the pro forma footnote disclosure provisions of this statement in 1996. This statement is not expected to have a material impact on pro forma net income or earnings per share.\nCASH FLOW INFORMATION\nIncome taxes paid, net of refunds, and interest paid, net of amounts capitalized, for the periods ended December 31 were:\n(Millions) 1995 1994 1993\nIncome taxes paid $ 52.9 $ 77.7 $ 71.5 Interest paid 41.6 39.5 44.5\nREGULATORY MATTERS\nRate proceeding. On May 8, 1995, Northern Illinois Gas filed with the Ill.C.C. for a 5.4 percent, $73 million general rate increase. The filing requested a rate of return on original-cost rate base of 10.67 percent, reflecting a 12.95 percent cost of common equity. The increase is needed to recover costs associated with enhancements to the company's transmission and storage system, other capital costs and rising operating costs. The filing also proposes revisions to some services provided to commercial and industrial customers. The last time the company filed for a general rate increase was 1981.\nOn January 12, 1996, the Ill.C.C. hearing examiners issued a proposed order under which Northern Illinois Gas would receive a general rate increase of approximately $31 million, of which $12 million is due to the proposed change in the company's depreciation rate. The proposed order reflects a rate of return on original-cost rate base of 9.77 percent and an 11.3 percent cost of common equity. The Ill.C.C. is expected to issue a final decision by April 4, 1996, which could be different from the proposed order.\nNICOR Inc. Page 30\nNotes to the Consolidated Financial Statements (continued)\nFERC Order 636. In April 1992, the FERC issued Order 636. This order, which required implementation by the pipelines for the 1993-1994 heating season, substantially restructured the interstate sale and transportation of gas. The FERC also authorized pipelines to recover transition costs, such as gas supply realignment and certain other costs, caused by compliance with Order 636. The company estimates that the total transition costs from all pipeline transporters could exceed $300 million. However, the ultimate level of costs is dependent upon the future market price of natural gas, pipeline negotiations with producers and other factors. Approximately $171 million of such costs has been recorded, of which $151 million has been paid to the pipeline transporters, subject to refund. Since 1994, the company has been recovering these costs through the PGA in accordance with Ill.C.C. authorization.\nThe company believes that the changes required by Order 636 will not have a material impact on its financial condition or results of operations.\nGAS IN STORAGE\nBased on the average cost of gas purchased in December 1995 and 1994, the estimated current replacement cost of gas in inventory at December 31, 1995 and 1994 exceeded the last-in, first-out cost by approximately $161 million and $236 million, respectively.\nINCOME TAXES\nThe components of income tax expense are presented below:\n(Millions) 1995 1994 1993\nCurrent Federal $ 52.7 $ 74.8 $ 63.1 State 7.1 11.2 7.3 59.8 86.0 70.4 Deferred Federal (2.3) (24.9) (12.1) State (.8) (7.8) (1.8) (3.1) (32.7) (13.9)\nAmortization of ITC, net (2.7) (2.4) (2.3) Foreign taxes .4 .2 -\nIncome tax expense $ 54.4 $ 51.1 $ 54.2\nNICOR Inc. Page 31\nNotes to the Consolidated Financial Statements (continued)\nThe temporary differences which gave rise to significant portions of the net deferred tax liability at December 31, 1995 and 1994 were as follows:\n(Millions) 1995 1994\nDeferred tax liabilities Property, plant and equipment $ 237.7 $ 233.3 Investment in foreign subsidiaries 8.2 15.1 Other 20.8 16.6 266.7 265.0 Deferred tax assets Unamortized investment tax credits 33.6 35.2 Regulatory income tax liability 21.0 21.7 Other 46.4 50.2 101.0 107.1\nNet deferred tax liability $ 165.7 $ 157.9\nThe effective combined federal and state income tax rate was 35.3 percent, 31.8 percent and 33.1 percent in 1995, 1994 and 1993, respectively. Differences between federal income taxes computed using the statutory rate and reported income tax expense are shown below:\n(Millions) 1995 1994 1993\nFederal income taxes using statutory rate $ 54.0 $ 56.2 $ 57.3 State income taxes, net 4.7 2.5 3.8 Amortization of investment tax credits (2.6) (2.7) (2.7) Other, net (1.7) (4.9) (4.2)\nIncome tax expense $ 54.4 $ 51.1 $ 54.2\nDISCONTINUED OPERATIONS\nIn April 1993, NICOR announced its intention to divest its oil and gas segment. U.S. exploration and production operations were sold in the second quarter of 1993, and the Canadian gas gathering operations were sold in October 1993, with no additional effect on net income. This completed the sale of the oil and gas operations.\nSummarized financial results of the discontinued operations were:\n(Millions) 1993\nOperating revenues $ 15.9\nIncome before income taxes $ 3.5 Income taxes 1.2\nIncome from discontinued operations $ 2.3\nNICOR Inc. Page 32\nNotes to the Consolidated Financial Statements (continued)\nPOSTEMPLOYMENT BENEFITS\nPension benefits. Northern Illinois Gas maintains noncontributory defined benefit pension plans covering substantially all employees. Pension benefits consider job level or the highest average salary earned during five consecutive years of employment and years of service. The plans are funded currently to the extent deductible for federal income tax purposes. Plan assets are invested primarily in corporate and government securities.\nNet periodic pension cost (benefit) included:\n(Millions) 1995 1994 1993\nService cost $ 6.4 $ 7.0 $ 6.7 Interest cost 19.3 18.5 20.4 Loss (return) on plan assets (61.5) (17.1) (41.9) Net amortization and deferral 27.0 (19.4) 3.7\n$ (8.8) $(11.0) $(11.1) Expected long-term rate of return on plan assets 9.0% 8.5% 8.5%\nThe following table reflects the funded status of the pension plans at October 1, 1995 and 1994 reconciled to amounts recorded in the financial statements at December 31, 1995 and 1994, respectively:\n(Millions) 1995 1994\nVested benefits $ 217.8 $ 202.9 Nonvested benefits 25.7 21.2 Accumulated benefit obligation 243.5 224.1 Effect of assumed increase in compensation level 32.5 29.4 Projected benefit obligation 276.0 253.5 Plan assets at market value 379.4 352.0 Plan assets in excess of projected benefit obligation 103.4 98.5 Unrecognized net gain (40.7) (42.5) Unrecognized net transition asset (23.9) (27.8) Unrecognized prior service cost 4.5 5.0 Other 3.4 2.9\nPrepaid pension cost $ 46.7 $ 36.1\nWeighted average discount rate 7.5% 8.0% Rate of compensation increase 4-5 4-5\nNICOR Inc. Page 33\nNotes to the Consolidated Financial Statements (continued)\nNorthern Illinois Gas has historically amended the collectively bargained pension plan every two to three years so that such pension benefits are based on the most current wages. Northern Illinois Gas intends, subject to collective bargaining, to continue making similar amendments to the plan. These future amendments have been anticipated and are reflected in the projected benefit obligation and pension expense.\nOther postretirement benefits. Health care and life insurance benefits are provided for retired employees if they become eligible for retirement while working for Northern Illinois Gas. The plans are funded currently to the extent deductible for federal income tax purposes. Plan assets are invested primarily in corporate and government securities.\nNet periodic postretirement benefit cost included:\n(Millions) 1995 1994 1993\nService cost $ 2.3 $ 2.3 $ 1.9 Interest cost 9.0 8.1 7.5 Loss (return) on plan assets (1.8) (.4) (1.0) Amortization of transition obligation 3.7 3.7 3.7 Net amortization and deferral 1.0 (.1) .3\n$ 14.2 $ 13.6 $ 12.4 Expected long-term rate of return on plan assets 9.0% 8.5% 8.5%\nThe following table reflects the funded status of the postretirement health care and life insurance plans at October 1, 1995 and 1994 reconciled to amounts recorded in the financial statements at December 31, 1995 and 1994, respectively:\n(Millions) 1995 1994\nAccumulated postretirement benefit obligation (APBO): Retirees $ 76.9 $ 71.2 Fully eligible active plan participants 16.9 17.2 Other active plan participants 29.6 28.0 Total APBO 123.4 116.4 Plan assets at market value 11.5 9.7 APBO in excess of plan assets (111.9) (106.7) Unrecognized transition obligation 63.5 67.3 Unrecognized prior service cost (1.2) (1.3) Unrecognized net loss 12.8 11.9 Other (2.1) (2.3)\nAccrued postretirement benefit cost $ (38.9) $ (31.1)\nWeighted average discount rate 7.5% 8.0% Rate of compensation increase 4-5 4-5\nNICOR Inc. Page 34\nNotes to the Consolidated Financial Statements (continued)\nThe health care cost trend rate for pre-Medicare benefits was assumed to be 10 percent for 1996, gradually declining to 5 percent for 2001 and remaining at that level thereafter. The health care cost trend rate for post-Medicare benefits was assumed to be 7 percent for 1996, gradually declining to 5 percent for 1998 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rate by 1 percentage point would increase the APBO as of December 31, 1995, by about $16 million, the aggregate of the service and interest cost components of 1995 net postretirement health care costs by $1.9 million, and operating expense by $1.4 million, after capitalization.\nSHORT- AND LONG-TERM DEBT\nThe company's short-term borrowings included:\n1995 1994 1993\nBalance at year-end (Millions) Commercial paper $ 198.8 $ 243.9 $ 301.5 Bank loans - 2.5 2.5\nWeighted average interest rate on year-end balance Commercial paper 5.69% 5.95% 3.25% Bank loans - 6.55 4.60\nThe company establishes lines of credit with major domestic and foreign banks to support outstanding commercial paper to satisfy short-term borrowing needs. At December 31, 1995, lines of credit totaled $340 million, of which $198.8 million served as backup for commercial paper borrowings. Commitment fees of up to 1\/10 percent per annum were paid on these lines. All credit agreements have variable interest-rate options tied to short-term markets.\nBank cash balances averaged about $4.1 million during 1995, which partially compensated for the cost of maintaining accounts and other banking services. Such demand balances may be withdrawn at any time.\nFirst mortgage bonds are secured by liens on substantially all gas distribution property and franchises.\nInterest on debt was net of amounts capitalized of $.9 million, $.2 million and $.3 million in 1995, 1994 and 1993, respectively.\nNICOR Inc. Page 35\nNotes to the Consolidated Financial Statements (continued)\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe recorded amount of short-term investments and short-term borrowings approximates fair value because of the short maturity of the instruments. Based on quoted market interest rates, the recorded amount of the long-term debt outstanding, including current maturities, also approximates fair value.\nSINKING FUND AND MATURITIES\nThe amounts necessary to fulfill mandatory sinking fund requirements and maturities are shown below:\n(Millions) 1996 1997 1998 1999 2000\nLong-term debt $ 50.0 $ 25.0 $ 25.0 $ 25.0 $ 72.5 Preferred stock - .2 .5 .5 .5\n$ 50.0 $ 25.2 $ 25.5 $ 25.5 $ 73.0\nREDEEMABLE PREFERRED STOCK\nA description of redeemable preferred stock follows:\nOptional Annual cumulative redemption sinking fund and requirement liquidation Series Shares Price price\n4.48% 6,000 $ 50.50 $ 51.06 5.00 4,000 50.50 51.00\nThe default provisions of the preferred shares generally state that no redemption may take place unless all shares of each respective series are redeemed. They also provide that no shares may be purchased except pursuant to offers of sale made by holders of shares in response to an invitation for tenders.\nSTOCK OPTIONS\nNICOR has a plan which permits the granting of stock options, alternate stock rights and restricted stock to key executives and managerial employees. The stock option purchase price may not be less than the fair market value on the date of grant. Under the plan, 2,500,000 shares of the company's common stock were available for grant.\nNICOR Inc. Page 36\nNotes to the Consolidated Financial Statements (continued)\nA summary of stock option activity follows:\nNumber Option price of shares per share\nDecember 31, 1992 488,400 $13.3125 -21.375 Granted 163,400 28.9375 Exercised (220,400) 13.3125 -21.375 Cancelled (2,600) 28.9375\nDecember 31, 1993 428,800 15.875 -28.9375 Granted 144,700 27.50 Exercised (13,500) 15.875 -21.375 Cancelled (1,400) 28.9375\nDecember 31, 1994 558,600 15.875 -28.9375 Granted 240,300 24.625 Exercised (39,500) 15.875 -21.375 Cancelled (2,000) 24.625\nDecember 31, 1995 757,400 $15.875 -28.9375\nOptions exercisable at December 31, 1995 215,000\nAt December 31, 1995, 2,000 shares of restricted stock were outstanding and 1,240,000 shares remained available for future grant under the plan. For information on FASB Statement No. 123, Accounting for Stock-Based Compensation, see New Accounting Pronouncements on page 29.\nCHANGE IN COMMON SHARES\nChanges in common shares outstanding are summarized below:\n(Thousands) 1995 1994 1993\nBeginning of year 51,540 53,959 55,770 Issued and converted 75 43 330 Reacquired and cancelled (1,313) (2,462) (2,141) End of year 50,302 51,540 53,959\nNICOR repurchased 1,237,800 shares in 1995, 2,406,549 shares in 1994 and 1,877,575 shares in 1993, under common stock repurchase programs.\nNICOR Inc. Page 37\nNotes to the Consolidated Financial Statements (continued)\nRETAINED EARNINGS\nIn 1985, pursuant to a Board of Directors' resolution and in accordance with the Illinois Business Corporation Act, the deficit in retained earnings was charged against paid-in capital.\nINDUSTRY SEGMENT INFORMATION\nSee Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, for industry segment information regarding operating revenues, depreciation, operating income, identifiable assets and capital expenditures.\nCONTINGENCIES\nThe company is involved in legal or administrative proceedings before various courts and agencies with respect to rates, taxes and other matters.\nCurrent environmental laws require treatment of certain waste materials on sites owned by NICOR that may have been generated by two barge-cleaning facilities previously owned and operated by certain discontinued businesses of the company. NICOR has remediated one site in accordance with the approved closure plan and began the three-year post-closure monitoring period in 1995. The cost of evaluation and cleanup of the other site is currently estimated to range from $5 million to $15 million. The company is evaluating whether any of these costs will be recoverable from insurance or other sources.\nUntil the early 1950s, manufactured gas facilities were operated in the Northern Illinois Gas service territory. Manufactured gas is now known to have created various by-products that may still be present at these sites. Current environmental laws may require cleanup of these former manufactured gas plant sites (\"MGPs\"). The company has identified up to 40 properties in its service territory believed to be the location of such sites. Of these 40 properties, Northern Illinois Gas currently owns 15 and formerly owned or leased 13. The remaining 12 were never owned or leased by the company. Information has been presented regarding preliminary reviews of the company's currently owned and formerly owned or leased properties to the Illinois Environmental Protection Agency. More detailed investigations are currently in progress or planned at many of these sites. At four of the sites, the current owners are seeking to allocate cleanup costs to all former owners or lessees, including Northern Illinois Gas.\nThe results of continued testing and analysis should determine to what extent remediation is necessary and may provide a basis for estimating any additional future costs, which based on industry experience, could be significant. Costs are currently being recovered pursuant to Ill.C.C. authorization.\nIn December 1995, Northern Illinois Gas filed suit against certain insurance carriers seeking recovery of environmental cleanup costs of former MGPs. Presently, management cannot predict the timing or outcome of this lawsuit. Any recoveries from such litigation or other sources will be flowed back to the company's customers.\nNICOR Inc. Page 38\nNotes to the Consolidated Financial Statements (concluded)\nAlthough unable to determine the outcome of these contingencies, management believes that appropriate accruals have been recorded. Final disposition of these matters is not expected to have a material impact on the company's financial condition or results of operations.\nQUARTERLY RESULTS (Unaudited)\nQuarterly results fluctuate due mainly to the seasonal nature of the gas distribution business.\n(Millions, except 1995 Quarter ended per share data) Mar. 31 June 30 Sept. 30 Dec. 31\nOperating revenues $ 609.8 $ 246.9 $ 157.1 $ 466.3 Operating income 74.1 34.1 17.8 63.8 Net income 40.9 17.1 6.1 35.7 Earnings per share .80 .34 .12 .71\n1994 Quarter ended Mar. 31 June 30 Sept. 30 Dec. 31\nOperating revenues $ 780.3 $ 267.6 $ 166.0 $ 395.5 Operating income 85.2 30.9 18.2 59.4 Net income 51.3 15.9 7.5 34.7 Earnings per share .95 .30 .14 .67\nNICOR Inc. Page 39\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\nInformation on directors and executive compensation is contained on pages 2 through 6 and 8 through 17 of the Definitive Proxy Statement, dated March 20, 1996, and is incorporated herein by reference. Information relating to the executive officers of the registrant is provided on page 7 in Part I of this document.\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation regarding security ownership of certain beneficial owners, directors and executive officers of the company is contained on pages 6 through 8 of the Definitive Proxy Statement, dated March 20, 1996, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone.\nNICOR Inc. Page 40\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K\n(a) 1) Financial Statements:\nFor the following information, see Part II, Item 8 on page 21.\nReport of Independent Public Accountants Consolidated Financial Statements: As of December 31, 1995 and 1994 - Balance Sheet Statement of Capitalization For the years ended December 31, 1995, 1994 and 1993 - Statement of Income Statement of Cash Flows Statement of Common Equity Notes to the Consolidated Financial Statements\n2) Financial Statement Schedule:\nSchedule Number Page\nReport of Independent Public Accountants 22 II Valuation and Qualifying Accounts 41\nSchedules other than those listed are omitted because they are either not required or not applicable.\n3) Exhibits Filed:\nSee Exhibit Index on pages 43 through 47 filed herewith.\n(b) The company did not file a report on Form 8-K during the fourth quarter of 1995.\nNICOR Inc. Page 42\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNICOR Inc.\nDate March 22, 1996 By DAVID L. CYRANOSKI David L. Cyranoski Senior Vice President, 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 indicated.\nSignature Title Date\nTHOMAS L. FISHER Chairman, President, Chief Thomas L. Fisher Executive Officer and Director\nDAVID L. CYRANOSKI Senior Vice President, David L. Cyranoski Secretary and Controller and Principal Financial Officer\nROBERT M. BEAVERS, JR.* Director\nJOHN H. BIRDSALL, III* Director\nW. H. CLARK* Director\nJOHN E. JONES* Director March 22, 1996\nDENNIS J. KELLER* Director\nCHARLES S. LOCKE* Director\nSIDNEY R. PETERSEN* Director\nDANIEL R. TOLL* Director\nPATRICIA A. WIER* Director\n*By THOMAS D. GREENBERG Thomas D. Greenberg (Attorney-in-fact)\nNICOR Inc. Page 43\nExhibit Index\nExhibit Number Description of Document\n3.01 * Articles of Incorporation of the company. (File No. 2-55451, Form S-14 for March 1976, NICOR Inc., Exhibit 1-03 and Exhibit B of Amendment No. 1 thereto.)\n3.02 * Amendment to Articles of Incorporation of the company. (File No. 2-68777, Form S-16 for August 1980, NICOR Inc., Exhibit 2-01.)\n3.03 * Amendment to Articles of Incorporation of the company. (File No. 1-7297, Form 10-K for 1985, NICOR Inc., Exhibit 3-03.)\n3.04 * Amendment to Articles of Incorporation of the company. (File No. 1-7297, Form 10-Q for March 1987, NICOR Inc., Exhibit 19-01.)\n3.05 * Amendment to Articles of Incorporation of the company. (File No. 1-7297, Form 10-K for 1992, NICOR Inc., Exhibit 3-06.)\n3.06 * Amendments to Articles of Incorporation of the company. (Proxy Statement dated March 9, 1994, NICOR Inc., Exhibit A-1 and Exhibit B thereto.)\n3.07 * By-Laws of the company as amended by the company's Board of Directors on May 3, 1995. (File No. 1-7297, Form 10-Q for March 1995, NICOR Inc., Exhibit 3(ii).01.)\n4.01 * Indenture of Commonwealth Edison Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 1995, Northern Illinois Gas Company, Exhibit 4.01.)\n4.02 * Indenture of Adoption of Northern Illinois Gas Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, dated February 9, 1954. (File No. 1-7296, Form 10-K for 1995, Northern Illinois Gas Company, Exhibit 4.02.)\n4.03 * Supplemental Indenture, dated June 1, 1963, of Northern Illinois Gas Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-21490, Form S-9, Northern Illinois Gas Company, Exhibit 2-8.)\n4.04 * Supplemental Indenture, dated May 1, 1966, of Northern Illinois Gas Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-25292, Form S-9, Northern Illinois Gas Company, Exhibit 2-4.)\nNICOR Inc. Page 44\nExhibit Index (continued)\nExhibit Number Description of Document\n4.05 * Supplemental Indenture, dated June 1, 1971, of Northern Illinois Gas Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-44647, Form S-7, Northern Illinois Gas Company, Exhibit 2-03.)\n4.06 * Supplemental Indenture, dated April 30, 1976, between the company and Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-56578, Form S-9, Northern Illinois Gas Company, Exhibit 2-25.)\n4.07 * Supplemental Indenture, dated April 30, 1976, of Northern Illinois Gas Company to Continental Illinois National Bank and Trust Company of Chicago, Trustee, under Indenture dated as of January 1, 1954. (File No. 2-56578, Form S-9, Northern Illinois Gas Company, Exhibit 2-21.)\n4.08 * Supplemental Indenture, dated July 1, 1989, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 8-K for June 1989, Northern Illinois Gas Company, Exhibit 4-01.)\n4.09 * Supplemental Indenture, dated August 15, 1991, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 8-K for August 1991, Northern Illinois Gas Company, Exhibit 4-01.)\n4.10 * Supplemental Indenture, dated July 15, 1992, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1992, Northern Illinois Gas Company, Exhibit 4-01.)\n4.11 * Supplemental Indenture, dated February 1, 1993, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-K for 1992, Northern Illinois Gas Company, Exhibit 4-17.)\n4.12 * Supplemental Indenture, dated March 15, 1993, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for March 1993, Northern Illinois Gas Company, Exhibit 4-01.)\nNICOR Inc. Page 45\nExhibit Index (continued)\nExhibit Number Description of Document\n4.13 * Supplemental Indenture, dated May 1, 1993, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for March 1993, Northern Illinois Gas Company, Exhibit 4-02.)\n4.14 * Supplemental Indenture, dated July 1, 1993, of Northern Illinois Gas Company to Continental Bank, National Association, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for June 1993, Northern Illinois Gas Company, Exhibit 4-01.)\n4.15 * Supplemental Indenture, dated August 15, 1994, of Northern Illinois Gas Company to Continental Bank, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for September 1994, Northern Illinois Gas Company, Exhibit 4.01.)\n4.16 * Supplemental Indenture, dated October 15, 1995, of Northern Illinois Gas Company to Bank of America Illinois, Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296, Form 10-Q for September 1995, Northern Illinois Gas Company, Exhibit 4.01.)\nOther debt instruments are omitted in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K. Copies of such agreements will be furnished to the Commission upon request.\n10.01 * Security Payment Plan. (File No. 1-7297, Form 10-K for 1980, NICOR Inc., Exhibit 10-09.)\n10.02 * 1984 NICOR Officers' Capital Accumulation Plan Participation Agreement. (File No. 1-7297, Form 10-K for 1988, NICOR Inc., Exhibit 10-10.)\n10.02(a)* 1985 NICOR Officers' Capital Accumulation Plan Participation Agreement. (File No. 1-7297, Form 10-K for 1988, NICOR Inc., Exhibit 10-10(a).)\n10.03 * 1984 NICOR Directors' Capital Accumulation Plan Participation Agreement. (File No. 1-7297, Form 10-K for 1983, NICOR Inc., Exhibit 10-13.)\n10.03(a)* 1985 NICOR Directors' Capital Accumulation Plan Participation Agreement. (File No. 1-7297, Form 10-K for 1984, NICOR Inc., Exhibit 10-13(a).)\n10.04 * Directors' Deferred Compensation Plan. (File No. 1-7297, Form 10-K for 1983, NICOR Inc., Exhibit 10-16.)\nNICOR Inc. Page 46\nExhibit Index (continued)\nExhibit Number Description of Document\n10.05 * Restricted Stock and Supplemental Pension Agreement dated July 10, 1985, between Richard G. Cline and the company. (File No. 1-7297, Form 10-Q for September 1985, NICOR Inc., Exhibit 19-03.)\n10.06 * Directors' Pension Plan. (File No. 1-7297, Form 10-K for 1985, NICOR Inc., Exhibit 10-18.)\n10.07 * Flexible Spending Account for Executives. (File No. 1-7297, Form 10-K for 1986, NICOR Inc., Exhibit 10-20.)\n10.08 * Amendment and Restatement of the Northern Illinois Gas Company Incentive Compensation Plan. (File No. 1-7297, Form 10-K for 1986, NICOR Inc., Exhibit 10-21.)\n10.09 * NICOR Inc. 1989 Long-Term Incentive Plan. (Filed with NICOR Inc. Proxy Statement, dated April 20, 1989, Exhibit A.)\n10.10 * Supplemental Benefit Agreement, dated September 13, 1989, between Richard G. Cline and the company. (File No. 1-7297, Form 10-Q for September 1989, NICOR Inc., Exhibit 19-01.)\n10.11 * NI-Gas Supplementary Retirement Plan. (File No. 1-7297, Form 10-K for 1989, NICOR Inc., Exhibit 10-24.)\n10.12 * NI-Gas Supplementary Savings Plan. (File No. 1-7297, Form 10-K for 1989, NICOR Inc., Exhibit 10-25.)\n10.13 * NICOR Salary Deferral Plan. (File No. 1-7297, Form 10-K for 1989, NICOR Inc., Exhibit 10-29.)\n10.14 * 1995 NICOR Incentive Compensation Plan. (File No. 1-7297, Form 10-K for 1994, NICOR Inc., Exhibit 10.18.)\n10.15 * 1995 NI-Gas Incentive Compensation Plan. (File No. 1-7297, Form 10-K for 1994, NICOR Inc., Exhibit 10.19.)\n10.16 * 1995 Long-Term Incentive Program. (File No. 1-7297, Form 10-K for 1994, NICOR Inc., Exhibit 10.20.)\n10.17 1996 NICOR Incentive Compensation Plan.\n10.18 1996 NI-Gas Incentive Compensation Plan.\n10.19 1996 Long-Term Incentive Program.\n10.20 * Summary of 1995 Directors' Stock Grant Program. (Included in NICOR Inc. Proxy Statement dated March 22, 1995, pages 6 and 7.)\nExhibits 10.01 through 10.20 constitute management contracts and compensatory plans and arrangements required to be filed as exhibits to this Form pursuant to Item 14(c) of Form 10-K.\nNICOR Inc. Page 47\nExhibit Index (concluded)\nExhibit Number Description of Document\n21.01 Subsidiaries.\n23.01 Consent of Independent Public Accountants.\n24.01 Powers of Attorney.\n27.01 Financial Data Schedule.\n* These exhibits have been previously filed with the Securities and Exchange Commission as exhibits to registration statements or to other filings with the Commission and are incorporated herein as exhibits by reference. The file number and exhibit number of each such exhibit, where applicable, are stated, in parentheses, in the description of such exhibit.\nUpon written request, the company will furnish free of charge a copy of any exhibit. Requests should be sent to Investor Relations at the corporate headquarters.","section_15":""}
{"filename":"276477_1995.txt","cik":"276477","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Hillhaven Corporation, a Nevada corporation (\"Hillhaven,\" the \"Registrant\" or the \"Company\"), operates nursing centers, pharmacies and retirement housing communities. Hillhaven was incorporated in May 1989 by National Medical Enterprises, Inc., now known as Tenet Healthcare Corporation (together with its subsidiaries, \"Tenet\") in anticipation of a spin-off by Tenet of substantially all of its domestic long term care operations in a dividend distribution of Hillhaven common stock to Tenet shareholders that was effected in January 1990.\nBased upon the number of beds in service and net revenues, Hillhaven is the second largest long term care provider in the United States and believes that it is one of the leading providers of subacute medical and rehabilitation services. At May 31, 1995, the Company operated 287 nursing centers (of which 202 were owned, 70 were leased and 15 were managed for others) with 36,161 licensed beds. The nursing centers are located in 33 states and range in capacity from 42 to 692 beds. For the year ended May 31, 1995, average nursing center occupancy was 92.8%. Pharmacy operations are conducted through the Company's subsidiary, Medisave Pharmacies, Inc. (\"Medisave\"), which, as of May 31, 1995, consisted of 36 institutional pharmacies and 20 retail pharmacies located in 18 states. The Company also operates 19 retirement housing communities containing an aggregate of 2,679 apartment units located in 14 states.\nThe Company provides a wide range of diversified health care services, including long term care and specialty care services. Specialty care services is comprised of Alzheimer's care, pharmacy services and subacute medical and rehabilitation services, such as physical, occupational and speech therapies, wound care, oncology treatment, brain injury care, stroke therapy and orthopedic therapy. Subacute medical and rehabilitation services are offered at all of the Company's nursing centers and are the fastest growing component of the Company's nursing center operations, constituting approximately 29.6% of nursing center net operating revenues in fiscal 1995, 24.7% in fiscal 1994 and 19.4% in fiscal 1993. Hillhaven believes that it is also one of the largest providers of physical, occupational and speech therapies in the United States. In addition, the Company currently provides long term care to residents of the Company's nursing centers with Alzheimer's disease through 69 Alzheimer's care units with 2,158 beds. The Company does not presently maintain designated beds for specialty care services, other than for Alzheimer's care, where most patients benefit from segregated facilities. The Company's experience has been that subacute medical and rehabilitation services, particularly rehabilitation, can be effectively and successfully integrated into its standard nursing center operations at the majority of its centers, in most cases with little physical reconfiguration of or modification to the facilities.\nNursing center net operating revenues, comprised primarily of net patient revenues, accounted for 85.6% and 84.2% of Hillhaven's total net operating revenues for fiscal 1995 and 1994, respectively. In fiscal 1995, the Company derived 46.5% of its net patient revenues from Medicaid, 26.3% from private pay and other sources and 27.2% from Medicare. In fiscal 1994, the comparable figures were 50.2%, 26.8% and 23.0%, respectively. Subacute medical and rehabilitation services accounted for 30.3% of the Company's net patient revenues in 1995 compared to 25.5% in 1994. Pharmacy operations accounted for 12.1% and 13.5% of Hillhaven's total net operating revenues for fiscal 1995 and 1994, respectively. In fiscal 1995, institutional pharmacy operations constituted approximately 92% of Medisave's total net revenues, compared to 79% in fiscal 1994. Retirement housing operations represented 2.3% of Hillhaven's total net revenues for both fiscal 1995 and 1994. Under segment reporting criteria, Hillhaven believes its only material business segment is \"health care,\" which contributed substantially all of the Company's net revenues and substantially all of its operating profits for fiscal 1995.\nTHE PROPOSED VENCOR MERGER\nOn April 23, 1995, the Company signed a definitive Agreement and Plan of Merger (the \"Merger Agreement\"), which was amended and restated as of July 31, 1995, under which Vencor, Inc. (\"Vencor\") will acquire the Company and its affiliated corporations and partnerships (the \"Merger\"). The Merger\nAgreement provides for a business combination between Vencor and Hillhaven in which Hillhaven will be merged with and into Vencor and the holders of Hillhaven common stock will be issued Vencor 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. In the Merger, each outstanding share of Hillhaven common stock will be converted into a fraction of a share of Vencor common stock (the \"Conversion Number\") determined by dividing $32.25 by the average closing price on the New York Stock Exchange of Vencor common stock for the ten consecutive trading days ending with the second trading day immediately preceding the effective time of the Merger, except that the Conversion Number will not be less than 0.768 or greater than 0.977 except in certain limited circumstances, and each share of Hillhaven's Series C Preferred Stock, par value $.15 per share, and Hillhaven's Series D Preferred Stock, par value $.15 per share, will be converted into the right to receive $900 in cash, plus accrued and unpaid dividends up to the effective time of the Merger. As a result of the Merger, except in certain limited circumstances, holders of Hillhaven common stock immediately prior to the Merger will own between approximately 49% and 55% of the Vencor common stock on a primary basis after the Merger, depending upon the Conversion Number. Hillhaven's Board of Directors has recommended the Merger and a special meeting of shareholders of Hillhaven common stock is scheduled to take place on September 27, 1995, to vote on the Merger. If the shareholders vote in favor of the Merger, the Merger is expected to close before the end of 1995. If the Merger is successfully consummated, there are likely to be changes to the Company's existing operations, its management and its business strategy as described herein. See Section \"Operations and Management After the Merger\" on pages 44-49 of the Joint Proxy Statement\/Prospectus filed as part of Vencor's Registration Statement on Form S-4 (Registration No. 33-59345). A copy of this Section is attached hereto as Exhibit 99.01.\nTHE NATIONWIDE CARE, INC. ACQUISITION\nOn June 30, 1995, the Company acquired Nationwide Care, Inc. (\"Nationwide\") and its affiliated corporations and partnerships through (i) a share exchange between Nationwide, Phillippe Enterprises, Inc., Meadowvale Skilled Care Center, Inc. and the Company, and (ii) the assignment of all of the outstanding partnership interests in Camelot Care Centers to Nationwide and Evergreen Woods, Ltd. to the Company's wholly owned subsidiary, First Healthcare Corporation. The consideration for the share exchange was 5.0 million shares of the Company's common stock, $0.75 par value per share (the \"Company's Common Stock\"). The transaction was structured as a pooling of interests for accounting purposes and as a tax-free reorganization under Section 368(a) of the Code.\nNationwide operates long term health care centers located in Indiana, Ohio and Florida. Nationwide's operations include 23 nursing centers with a total of 3,257 licensed beds, two retirement centers with a total of 240 units, two assisted living centers totaling 162 units and 40 additional assisted living units located in one of the retirement centers. Of Nationwide's 27 centers, 14 are owned, 11 are leased and two are managed for other parties. Twenty-one of Nationwide's centers are located in Indiana, three are located in Ohio and three are located in Florida.\nCREATION OF THE GRANTOR TRUST\nThe Company established The Hillhaven Corporation Grantor Stock Trust (the \"Trust\") as of January 16, 1995, and, as of that same date, entered into an agreement (the \"Stock Purchase Agreement\") with Wachovia Bank of North Carolina, N.A. (the \"Trustee\") to sell to the Trustee on behalf of the Trust an aggregate of 4.2 million shares of the Company's Common Stock (the \"Shares\"), at a purchase price equal to the then current market price of the Shares. The Shares are to be used to fund various of the Company's employee benefit plans, including, but not limited to, certain stock-based plans.\nINDUSTRY TRENDS\nThe Company believes that several industry trends will contribute to growth opportunities. These trends include an aging population, the increasing shift of patients from acute care and rehabilitation hospitals to nursing centers due to the nationwide emphasis on health care cost containment, the growth in demand for long term care services and centers currently exceeding the growth in supply and the increasing complexity of\nand more burdensome operating standards for the delivery of pharmaceutical products and services to nursing centers and other institutions.\nAging Population. People over the age of 65 are the primary users of long term care. Based on U.S. Census Bureau data, this segment of the population in the United States has grown from approximately 25 million in 1980 to approximately 31 million in 1990. This age group is expected to increase to approximately 35 million by the year 2000. The fastest growing segment of the United States population is the over-85 age group, which is expected to increase from approximately 3.4 million in 1991 to approximately 4.6 million in 2000. Advances in medical technology have increased life expectancies; as a result, an increasing number of elderly patients require a high level of care not historically available outside an acute care hospital.\nEarlier Hospital Discharge to Nursing Centers. Based on reports in health care industry journals, in recent years, average lengths of stay in hospitals have been decreasing, in part as a result of governmental and private pay sources attempting to control health care costs by adopting reimbursement strategies that encourage earlier discharge from hospitals. Many patients leaving hospitals require skilled nursing care and rehabilitation services of the type that the Company provides.\nHealth Care Cost Containment. In an effort to combat increasing health care costs, governmental entities and insurance companies are considering ways to contain costs, including adjusting Medicaid eligibility requirements and encouraging patients to obtain treatment from lower cost providers. The Company believes that, as a low cost provider of subacute medical and rehabilitation services, it is well-positioned to benefit from these reforms.\nNursing Center Supply\/Demand Imbalance. Based on reports in long term care industry journals, while demand for nursing center beds has increased in recent years, the supply has remained relatively unchanged. Construction and expansion of nursing centers is regulated in most states, and the ability to obtain financing for these activities in the past was adversely affected by lending limitations imposed by the financial institutions industry.\nIncreasing Complexity of Institutional Pharmaceutical Requirements. The Company believes that the implementation of the Omnibus Budget Reconciliation Act of 1987 (\"OBRA\") in October 1990 has further increased the demand for the Company's pharmaceutical services. Nursing centers are responsible for complying with more stringent standards of care established by OBRA, which include planning, monitoring and reporting the progress of prescription drug therapy. Based on reports in long term care industry journals, nursing center administrators and directors of nursing now seek sophisticated and experienced pharmacies with trained consultant pharmacists and computerized documentation programs to help ensure regulatory compliance. Retail pharmacies, which generally lack the breadth of service and do not focus on the special requirements of nursing centers, are being replaced with institutional pharmacies that can more effectively serve this market.\nBUSINESS STRATEGY\nOperating Strategy\nThe Company's operating strategy is designed to take advantage of several important industry trends, a number of which are favorable, and includes expanding higher revenue specialty care services, increasing private pay and Medicare census, maintaining high occupancy levels and expanding Medisave's institutional pharmacy operations.\nExpansion of Specialty Care Services. Hillhaven intends to continue to expand its specialty care programs and services. These services generally produce higher revenues than do routine nursing care services and serve to differentiate the Company's facilities from others in a given market. The Company is focusing on the expansion of its subacute medical and rehabilitation services, which include physical, occupational and speech therapies, wound care, oncology treatment, brain injury care, stroke therapy and orthopedic therapy. The expansion of these services is designed to increase private pay and Medicare revenues which are higher than reimbursement rates for traditional long term care services.\nIncreasing Private Pay and Medicare Census. Hillhaven is also working to increase private pay and Medicare census by further developing and maintaining relationships with traditional referral sources and by entering into contracts with private insurance companies to provide subacute medical and rehabilitation services to their insureds. Increasing the number of managed care patients in the Company's nursing centers is an increasingly important component of the Company's marketing strategy. Hillhaven's subacute medical and rehabilitation services offer a less expensive alternative to hospital care for patients who need specialized nursing care but do not require many of the other services provided in an acute care hospital. As of May 31, 1995, the Company was operating under 141 such managed health care contracts.\nMaintaining High Occupancy Levels. The Company strives to maintain high occupancy levels in existing facilities through (i) an enhanced emphasis on local marketing efforts in which nursing center employees are charged with actively marketing their services within the community, (ii) broadening the scope and character of services provided in each nursing center and (iii) favorable demographic trends. The Company believes that maintaining high occupancy levels enables it to realize greater economies of scale. In fiscal 1995, Hillhaven had an average occupancy in its nursing centers of 92.8%.\nExpansion of Institutional Pharmacy Business. The Company is a leading provider of comprehensive pharmacy services to nursing centers and their patients. Medisave has a growth strategy which includes (i) continued penetration of existing markets, (ii) expansion into selected new markets and (iii) increasing infusion and enteral therapy revenues by targeting specific health care providers.\nGrowth Strategy\nThe Company's growth strategy is designed to increase the equity base of the Company over time and to provide flexibility to capitalize on attractive business opportunities. The key elements of this strategy include reducing or refinancing indebtedness and acquiring additional nursing centers and related businesses.\nReducing or Refinancing Indebtedness. The Company's plan to reduce or refinance indebtedness is designed to improve the Company's debt-to-equity ratio, reduce the overall interest rates on indebtedness (including guarantee fees) and extend the maturities and amortization of the Company's indebtedness.\nAcquisition of Nursing Centers and Related Businesses. With its improved balance sheet, the Company intends to expand its operations and increase its equity base through the acquisition of nursing centers and related businesses, such as pharmacy operations, in exchange for shares of the Company's Common Stock. See \"Business -- The Nationwide Care, Inc. Acquisition.\"\nNURSING CENTERS\nHillhaven's nursing center operations provide long term care and subacute medical and rehabilitation services in 287 nursing centers in 33 states. At May 31, 1995, Hillhaven owned 202 and leased 70 nursing centers. These nursing centers had a total of 34,194 licensed beds, with individual nursing center capacities ranging from 42 to 692 beds. In addition, Hillhaven had 50% interests in six partnerships and joint ventures that own or lease nursing centers managed by Hillhaven, and Hillhaven manages nine nursing centers for Tenet and other third parties for management fees usually based upon a percentage of nursing center revenues.\nHillhaven is a leading provider of rehabilitation services, including physical, occupational and speech therapies. Rehabilitation services are provided in all of the Company's nursing centers. The majority of patients in rehabilitation programs stay for eight weeks or less. Patients in rehabilitation programs generally provide for higher revenues than other nursing center patients because they use a higher level of ancillary services. In addition, management believes that Hillhaven is one of the leading providers of care for patients with Alzheimer's disease. At May 31, 1995, the Company offered treatment in approximately 2,158 beds in 69 nursing centers for patients suffering from Alzheimer's disease. Most of these patients reside in separate units within the nursing centers and are cared for by teams of professionals specializing in the unique problems experienced by Alzheimer's patients.\nMarketing\nThe factors which affect consumers' selection of a nursing center vary from community to community and include competition and a provider's relationships with local referral sources. Competition creates the standards against which nursing centers in a given market are judged by various referral sources, which include physicians, hospital discharge planners, community organizations and families. Therefore, Hillhaven's marketing efforts are conducted at the local market level by the nursing center administrators, admissions coordinators and others. Nursing center personnel are assisted in carrying out their marketing strategies by regional marketing staffs. The Company's marketing efforts are directed toward improving the payor mix at the nursing centers by increasing the census of private pay patients, patients covered by managed care contracts and Medicare patients. To this end, the Company is working to educate the various referral sources about the value of Hillhaven's nursing centers as an attractive lower cost alternative to acute care and rehabilitation hospitals for subacute medical and rehabilitation services.\nOperations\nEach nursing center is managed by a state licensed administrator who is supported by other professional personnel, including a director of nursing, staff development professional (responsible for employee training), activities director, business office manager and, in general, physical, occupational and speech therapists. The directors of nursing are state licensed nurses who supervise nursing staffs which include registered nurses, licensed practical nurses and nursing assistants. Staff size and composition vary depending on the size and occupancy of each nursing center and on the level of care provided by the nursing center. The nursing centers contract with physicians who serve as medical directors and serve on quality assurance committees.\nThe nursing centers are supported by regional staff in the areas of nursing, dietary and rehabilitation services, maintenance, human resources, marketing and financial services. In addition, corporate staff in Tacoma, Washington provide other services in the areas of marketing assistance, human resource management, state and federal reimbursement, state licensing and certification, legal, finance and accounting support. Financial control is maintained principally through fiscal and accounting policies established at the corporate level for use at the nursing centers.\nQuality of care is monitored and enhanced by quality assurance committees, regional quality assurance teams and family satisfaction surveys. The quality assurance committees oversee patient health care needs and resident and staff safety. Additionally, physicians serve on the quality assurance committees as medical directors and advise on health care policies and practices. Regional consultants visit each nursing center periodically to review practices and recommend improvements where necessary in the level of care provided and to assure compliance with requirements under applicable Medicare and Medicaid regulations. Surveys of residents' families are conducted from time to time in which the families are asked to rate various aspects of service and the physical condition of the nursing centers. These surveys are reviewed by nursing center administrators to help ensure quality care.\nHillhaven provides training programs for nursing center administrators, managers, nurses and nursing assistants. These programs are designed to provide career opportunities for employees and to maintain high levels of quality patient care.\nApproximately 99% of the nursing centers are currently certified to receive benefits provided under Medicare and Medicaid programs. Medicare is a federal health insurance program primarily for the elderly. Medicaid is a joint federal\/state program providing medical assistance to the indigent. A nursing center's qualification to participate in such programs depends upon many factors, including, among other things, accommodations, equipment, services, safety, personnel, physical environment and adequate policies and procedures.\nOccupancy Level\nThe following table sets forth for the periods indicated data with respect to numbers of owned or leased nursing centers operated by Hillhaven, numbers of beds and occupancy levels. (Data with respect to facilities managed by the Company for partnership and joint ventures in which the Company has an equity interest and for third parties are not included. See \"Facilities.\")\nSOURCES OF REVENUES\nNet patient care revenues are derived principally from Medicare and Medicaid programs and from private pay patients. Consistent with the nursing home industry generally, changes in the mix of Hillhaven's patient population among these three categories significantly affect the profitability of Hillhaven's operations. Although the level of cost reimbursement for Medicare and other high acuity patients generally produces the most revenue per patient day, profitability is reduced by the costs associated with the higher level of nursing care and other services required by such patients. The Company believes that private pay patients generally constitute the most profitable and Medicaid patients generally constitute the least profitable category.\nThe tables below set forth certain data for the periods shown with respect to the payor mix and the services mix of owned or leased nursing centers that were operated by Hillhaven. (Data with respect to facilities managed by the Company for partnerships and joint ventures in which the Company has an equity interest and for third parties are not included. See \"Facilities.\")\nBoth governmental and private third-party payors have employed cost containment measures designed to limit payments made to health care providers such as the Company. Those measures include the adoption of initial and continuing recipient eligibility criteria which may limit payment for services, the adoption of coverage criteria which limit the services that will be reimbursed and the establishment of payment ceilings which set the maximum reimbursement that a provider may receive for services. Furthermore, government reimbursement programs are subject to statutory and regulatory changes, retroactive rate adjustments, administrative rulings and government funding restrictions, all of which may materially increase or decrease the rate of program payments to the Company for its services. There can be no assurance that payments under governmental and private third-party payor programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs. In addition, there can be no assurance that facilities owned, leased or managed by the Company, or the provision of services and supplies by the Company, will meet the requirements for participation in such programs. The\nCompany could be adversely affected by the continuing efforts of governmental and private third-party payors to contain the amount of reimbursement for health care services. In an attempt to limit the federal budget deficit, there have been, and the Company expects that there will continue to be, a number of proposals to limit Medicare and Medicaid reimbursement for health care services.\nMedicare\nThe Medicare Part A program provides reimbursement for extended care services furnished to Medicare beneficiaries who are admitted to skilled nursing centers after at least a three-day stay in an acute care hospital. Covered services include supervised nursing care, room and board, social services, physical and occupational therapies, pharmaceuticals, supplies and other necessary services provided by skilled nursing centers.\nUnder the Medicare program, skilled nursing center reimbursement is based upon actual costs incurred as reported by each nursing center at the end of each annual reporting period. Revenues under this program are subject to audit and retroactive adjustment. Provisions for estimated third-party payor settlements are provided for in the period the related services are rendered and are adjusted as final settlements are determined. To date, these settlements have not resulted in material adjustments to earnings.\nMedicaid\nMedicaid is a state-administered program financed by state funds and matching federal funds. The program provides for medical assistance to the indigent and certain other eligible persons. Although administered under broad federal regulations, states are given flexibility to construct programs and payment methods consistent with their individual goals. These programs, therefore, differ from state to state in many respects.\nFederal law requires Medicaid programs to pay rates that are reasonable and adequate to meet the costs incurred by an efficiently and economically operated nursing center providing quality care and services in conformity with all applicable laws and regulations. However, despite these federal requirements, disagreements frequently arise between nursing centers and states regarding the adequacy of Medicaid payments. In addition, the Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy by the state agencies and certain government funding limitations, all of which may materially increase or decrease the level of program payments to nursing centers operated by Hillhaven. Management believes that, at present, the payments under these programs are not sufficient on an overall basis to cover the costs of serving residents participating in these programs. Furthermore, OBRA mandates an increased emphasis on ensuring quality patient care, which has resulted in additional expenditures by nursing centers.\nThere can be no assurance that the payments under these state programs will remain at levels comparable to current levels or, in the future, will be sufficient to cover the costs incurred in serving residents participating in such programs. Hillhaven provides to eligible individuals Medicaid-covered services consisting of nursing care, room and board and social services. In addition, states may at their option cover other services such as physical, occupational and speech therapies and pharmaceuticals.\nPrivate Payment and Medicare Patients\nHillhaven seeks private payment and Medicare patients and has specific marketing and referral programs aimed at enhancing its private census. In particular, the Company has implemented a strategy to increase the number of managed care patients. Private payment patients typically have financial resources (including insurance coverage) to pay for their monthly services and therefore do not rely on Medicaid for support. Private payment billings are sent monthly, with any collection efforts handled primarily through the nursing centers. Patients either pay directly or funds are received from family members, insurance companies, health maintenance organizations or other private third-party payors.\nCompetition\nHillhaven's nursing centers compete on a local and regional basis with other long term care providers. Hillhaven's competitive position varies from nursing center to nursing center within the various communities served. Hillhaven believes that the quality care provided, reputation, location and physical appearance of its nursing centers and, in the case of private patients, the rates or charges for services are significant competitive factors. There is limited, if any, price competition with respect to Medicare and Medicaid patients, since revenues received for services provided to such patients are strictly controlled and based on fixed rates or cost reimbursement principles.\nThe long term care industry is divided into a variety of competitive areas which market similar services. These competitors include nursing centers, hospitals, extended care centers, retirement housing facilities and communities, home health agencies and similar institutions. The industry includes government-owned, church-owned, secular not-for-profit and for-profit institutions.\nFacilities\nThe following table lists, by state, the number of nursing centers operated by the Company for its own account as of May 31, 1995. Fifteen nursing centers, accounting for 1,967 beds, managed at that date for partnerships and joint ventures in which the Company has an equity interest and for others are not included in the table.\n---------------\n(1) These states have Certificate of Need regulations. See \"Business -- Government Regulation.\"\nIn addition to its interests in nursing centers, as described above, as of May 31, 1995, Hillhaven had 50% interests in six partnerships and joint ventures that own nursing centers managed by Hillhaven with an aggregate of 652 beds in five states. Hillhaven also manages nine nursing centers owned by Tenet and other third parties. These nursing centers are managed by Hillhaven for varying management fees. The aggregate net revenues received in connection with the management of these facilities was $4.6 million in fiscal 1995 and $5.7 million in fiscal 1994.\nPHARMACIES\nThrough Medisave, the Company provides institutional and retail pharmacy services. As of May 31, 1995, Medisave operated 36 institutional pharmacies and 20 retail pharmacies in 18 states. In fiscal 1995, Medisave's net operating revenues were $190.6 million, representing 12.1% of the Company's net operating revenues. Medisave's net operating revenues of $198.6 million accounted for 13.5% of Hillhaven's net operating revenues in fiscal 1994, compared to 14.1% in fiscal 1993.\nThe institutional pharmacy division focuses on providing a full array of pharmacy services to approximately 735 nursing centers and specialized care centers. Institutional pharmacy sales encompass a wide variety of products including prescription medication, prosthetics, respiratory and infusion services and enteral therapies. In addition, Medisave provides a variety of pharmaceutical consulting services designed to assist nursing centers in program administration. Institutional pharmacy operations accounted for approximately 92% of total pharmacy revenues and approximately 95% of Medisave's operating profits in fiscal 1995. In fiscal 1994, the comparable figures were 79% and 91%, respectively, and in fiscal 1993, the comparable figures were 66% and 81%, respectively.\nMedisave's retail pharmacy operations consist of discount retail pharmacy and optical stores in leased facilities. In 1993 and 1994, the Company terminated leases of 36 retail outlets in Wal-Mart stores. The leases of the remaining 14 Wal-Mart outlets were terminated in the 1995 first quarter. The termination of these leases has not had a material effect on pharmacy operating income. Retail operations accounted for approximately 8% of Medisave's total pharmacy revenues and approximately 5% of its operating profits in fiscal 1995. In fiscal 1994, the comparable figures were 21% and 9%, respectively.\nThe following table lists by state the number of pharmacies operated by Medisave as of May 31, 1995.\nRETIREMENT HOUSING COMMUNITIES\nHillhaven's retirement housing operations consist of 19 retirement housing communities. These centers include 2,679 apartment units and are located in 14 states. Of the total number of retirement housing centers, 15 are owned by Hillhaven, one is leased by Hillhaven, one is managed by Hillhaven for a third party and two are owned by partnerships in which Hillhaven has an equity interest. Retirement housing operations\nrepresented approximately 2.3%, 2.3% and 2.0% of Hillhaven's total net revenues for fiscal 1995, 1994 and 1993, respectively.\nRetirement housing communities serve more independent and self-sufficient residents than do the nursing centers. A retirement housing community consists of studio, one-bedroom and two-bedroom apartment units. Residents typically receive weekly housekeeping and linen service, local transportation, 24-hour emergency call system and daily food service.\nResidents are responsible for monthly fees which typically are paid by the resident or the resident's family members. Retirement housing operations do not presently qualify for reimbursement under Medicare, Medicaid or Veterans Administration health care programs because they do not offer the levels of care required under such programs. Monthly fees paid by residents are based upon the resident's apartment size, the number of meals the resident elects to purchase and the level of personal care required by the resident.\nThe following table lists, by state, the number of retirement housing communities operated by the Company as of May 31, 1995.\n---------------\n(1) Includes retirement housing communities owned by partnerships in which Hillhaven has a limited and\/or general partnership interest that are managed by Hillhaven for such partnerships.\nGOVERNMENT REGULATION\nThe federal government and all states in which the Company operates regulate various aspects of the Company's business. In particular, the development and operation of long term care facilities and retirement communities and the provision of health care services are subject to federal, state and local laws relating to the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, fire prevention, rate-setting and compliance with building codes and environmental laws. Long term care facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with various standards, their continued licensing under state law, certification under the Medicare and Medicaid programs and continued participation in the Veterans Administration program. Retirement communities and their owners are subject to periodic inspection by governmental authorities to assure compliance with various standards including standards relating to the financial condition of the owners of such communities. The failure to obtain or renew any required regulatory approvals or licenses could adversely affect the Company's operations.\nEffective October 1, 1990, OBRA increased the enforcement powers of state and federal certification agencies. Additional sanctions were authorized to correct noncompliance with regulatory requirements, including fines, temporary suspension of admission of new patients to nursing centers and, in extreme circumstances, decertification from participation in the Medicare or Medicaid programs.\nNursing centers managed and operated by Hillhaven are licensed either on an annual or bi-annual basis and certified annually for participation in Medicare and\/or Medicaid by the respective states through various regulatory agencies which determine compliance with federal, state and local laws. These legal requirements relate to the quality of the nursing care provided, the qualifications of the administrative personnel and nursing staff, the adequacy of the physical plant and equipment and continuing compliance with the laws and regulations governing the operation of nursing centers. Hillhaven endeavors to comply with federal, state and local regulatory requirements for the maintenance and operation of its nursing centers. From time to time Hillhaven's nursing centers receive statements of deficiencies from regulatory agencies. In response, Hillhaven implements plans of correction with respect to these nursing centers to address the alleged deficiencies. Hillhaven believes that its nursing centers are in material compliance with all applicable regulations or laws.\nIn certain circumstances, federal law mandates that conviction of certain abusive or fraudulent behavior with respect to one health care facility may subject other facilities under common control or ownership to disqualification for participation in Medicare and Medicaid programs. In addition, some state regulations provide that all facilities under common control or ownership within a state are subject to delicensure if any one or more of such facilities is delicensed.\nChanges in federal regulations from the Omnibus Budget Reconciliation Act of 1987 became effective July 1, 1995. These federal regulations affect the survey process for nursing facilities and the authority of state survey agencies and the Health Care Financing Administration to impose sanctions on facilities based upon noncompliance with requirements for participation in the Medicare and Medicaid programs. Available sanctions include imposition of civil monetary penalties, temporary suspension of payment for new admission, appointment of a temporary manager, suspension of payment for eligible patients and suspension or decertification from participation in the Medicare and\/or Medicaid programs. The process of implementing these regulatory changes has only recently been addressed by the federal and state regulators. Each state will be allowed some discretion in their implementation of the changes, but the scope of this discretion is evolving through instructions issued by federal regulators and is not yet finalized. The Company is unable to project how these regulatory changes and their implementation will affect the Company.\nIn addition to license requirements, many states in which Hillhaven operates have statutes that require a Certificate of Need to be obtained prior to the construction of a new nursing center, the addition of new beds or services or the incurring of certain capital expenditures. Certain states also require regulatory approval prior to certain changes in ownership of a nursing center. A total of eight states in which Hillhaven operates have eliminated their Certificate of Need programs and a number of other states are considering alternatives to their Certificate of Need programs. To the extent that Certificates of Need or other similar approvals are required for expansion of Company operations, either through facility acquisitions or expansion or provision of new services or other changes, such expansion could be adversely affected by the failure or inability to obtain the necessary approvals, changes in the standards applicable to such approvals or possible delays and expenses associated with obtaining such approvals.\nPharmaceutical operations are subject to regulation by the various states in which the Company conducts its business as well as by the federal government. The Company's pharmacies are regulated under the Food, Drug and Cosmetic Act and the Prescription Drug Marketing Act, which are administered by the United States Food and Drug Administration. Under the Comprehensive Drug Abuse Prevention and Control Act of 1970, which is administered by the United States Drug Enforcement Administration (\"DEA\"), dispensers of controlled substances must register with the DEA, file reports of inventories and transactions and provide adequate security measures. Failure to comply with such requirements could result in civil or criminal penalties.\nThe Company is also subject to federal and state laws which govern financial and other arrangements between health care providers. These laws often prohibit certain direct and indirect payments or fee-splitting\narrangements between health care providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. Such laws include the anti-kickback provisions of the federal Medicare and Medicaid Patients and Program Protection Act of 1987. These provisions prohibit, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare and Medicaid patients. In addition, some states restrict certain business relationships between physicians and pharmacies, and many states prohibit business corporations from providing, or holding themselves out as a provider of, medical care. Possible sanctions for violation of any of these restrictions or prohibitions include loss of licensure or eligibility to participate in reimbursement programs as well as civil and criminal penalties. These laws vary from state to state and have seldom been interpreted by the courts or regulatory agencies.\nINSURANCE COVERAGE AND AVAILABILITY\nThe Company has liability insurance policies providing insurance coverage which it believes to be adequate. There can be no assurance, however, that claims in excess of the Company's insurance coverage or claims not covered by the Company's coverage will not be asserted against the Company. In addition, the Company's insurance policies must be renewed annually. Although the Company has obtained various insurance coverages at a reasonable cost in the past, there can be no assurance that it will be able to do so in the future. All matters arising after May 31, 1994 are insured through the Company's captive insurance company, Cornerstone Insurance Company.\nOTHER REAL PROPERTY\nThe Company owns unimproved real property with a book value of approximately $11.3 million at May 31, 1995.\nEMPLOYEES\nAs of May 31, 1995, Hillhaven employed approximately 42,000 individuals, of whom approximately 27,500 full-time and 11,300 part-time employees work at Hillhaven's nursing centers, approximately 900 employees work at the corporate and regional offices, approximately 1,300 employees work in Hillhaven's pharmacy operations and approximately 1,000 employees work in the retirement housing communities. Among its professional staff, Hillhaven employs approximately 3,500 registered nurses, 5,000 licensed practical nurses and 3,600 licensed therapists. Hillhaven has 21 collective bargaining agreements covering approximately 3,500 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe response to this item is included in Item 1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn January 1995, Horizon Healthcare Corporation (\"Horizon\") proposed a transaction in which holders of Hillhaven common stock would receive common stock of Horizon valued by Horizon at $28. Horizon also had entered into an agreement with Tenet pursuant to which Tenet indicated that it was supportive of Horizon's proposal. A formal proposal was presented by Horizon to Hillhaven and was rejected by a special committee (the \"Special Committee\") of the Hillhaven Board for, among other reasons, the belief that the arrangements between Horizon and Tenet had caused Horizon to become the \"beneficial owner\" of Tenet's Hillhaven common stock. Because Nevada law prohibits a merger for three years between Hillhaven and any person acquiring beneficial ownership or more than 10% of Hillhaven common stock without prior Hillhaven approval, the Horizon proposal could not be consummated. The Special Committee authorized Hillhaven to commence litigation seeking a determination that Horizon could not effect a merger with Hillhaven in compliance with Nevada law.\nOn February 6, 1995, Hillhaven filed a complaint against Horizon in the United States District Court for the District of Nevada seeking injunctive and declaratory relief that a business combination between Horizon\nand Hillhaven is prohibited by the Nevada statute regarding business combinations with interested stockholders (NRS Sections 78.411 through 78.444) by reason of Horizon's arrangements with Tenet. On February 27, 1995, Horizon filed an answer and a counterclaim alleging that, among other things, Hillhaven and all of its directors (other than Messrs. de Wetter and Andersons) have breached their fiduciary duties to Hillhaven's stockholders in connection with their consideration of Horizon's acquisition proposal and certain actions taken by Hillhaven, including the formation of a grantor trust and the amendment of Hillhaven's stockholder rights plan. The counterclaim seeks injunctive and declaratory relief and compensatory and punitive damages in unspecified amounts. Hillhaven has answered the counterclaim and believes Horizon's claims are without merit. By stipulation of the parties, all proceedings in these actions have been stayed until October 31, 1995.\nHillhaven and its directors are named as defendants in several putative class action complaints filed on behalf of Hillhaven's stockholders in Nevada state court (the \"Nevada State Court Actions\") and California state court (the \"California State Court Actions\"). These complaints raise allegations that Hillhaven's directors have breached their fiduciary duties to Hillhaven's stockholders in connection with the consideration of Horizon's acquisition proposal and certain corporate actions also cited in Horizon's counterclaim. These actions seek declaratory and injunctive relief and, in California, compensatory damages in unspecified amounts. The plaintiffs in the Nevada State Court Actions have moved to dismiss their complaints, which dismissal has been opposed by Hillhaven and its directors. Consideration of this motion has been suspended without date. In addition, Tenet filed a complaint against Hillhaven and two of its directors, Mr. Busby and Mr. Marker (the \"Tenet Action\"), in the state court of California seeking declaratory and injunctive relief and alleging, among other things, that they have breached their fiduciary duties to Tenet and Hillhaven's other stockholders in connection with their consideration of Horizon's acquisition proposal and certain other corporate actions cited in the Horizon and putative class action complaints. The Service Employees International Union (AFL-CIO), and Joann Sforza, a Hillhaven employee and union member, are seeking to intervene as party plaintiffs in the Tenet Action and in one of the putative class actions brought on behalf of Hillhaven's stockholders, alleging that their interests as stockholders and employees of Hillhaven are not adequately represented. Hillhaven has opposed this intervention. Hillhaven believes all these actions are without merit.\nBy stipulation of the parties, the proceedings in the Tenet Action have been stayed until the consummation of the Merger, at which time Hillhaven and Tenet have agreed to dismiss with prejudice all pending claims with respect to Horizon's acquisition proposal or the Merger. The stay of the California State Court Actions expired July 5, 1995 and the stay in the Nevada State Court Actions expired on June 22, 1995. No schedule has been established with respect to further proceedings in these actions.\nThere are no other material legal proceedings pending to which the Registrant is a party, or to which any of its property is subject, nor is such litigation threatened, other than ordinary routine litigation which is incidental to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended May 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt May 31, 1995, there were approximately 9,665 holders of record of the Company's common stock. Approximately 33,300 additional stockholders held shares under beneficial ownership in nominee name or within clearing house positions of brokerage firms and banks. The Company's common stock has been listed and traded on the New York Stock Exchange since November 2, 1993 and was previously listed and traded on the American Stock Exchange under the symbol \"HIL.\" The stock prices below are the high and low sales prices as reported on the composite tape as adjusted to reflect a one-for-five reverse stock split.\nThe Company has not paid a common dividend and does not anticipate declaring a common dividend in the near future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data have been derived from the Consolidated Financial Statements of The Hillhaven Corporation and its subsidiaries (\"Hillhaven\" or the \"Company\"). The data set forth below 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\" which follow.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands)\nThe following material should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements of the Company and the related notes thereto. All references in this section to years are to fiscal years of the Company ended May 31 of such year.\nMERGERS AND ACQUISITIONS\nIn the 1995 fourth quarter, Hillhaven entered into the Merger Agreement with Vencor, Inc. (\"Vencor\") pursuant to which Hillhaven will be merged with and into Vencor (the \"Merger\"). Holders of Hillhaven common stock will be issued Vencor common stock in a business combination intended to qualify as a pooling of interests and as a tax-free reorganization for federal income tax purposes. Vencor operates a network of health care services for patients who suffer from cardiopulmonary disorders. The foundation of Vencor's network is a nationwide chain of long term intensive care hospitals. The Merger will create what Vencor and Hillhaven believe, based upon net operating revenues and the number of beds in service, will be one of the nation's largest providers of health care services primarily focusing on the needs of the elderly. With operations in 38 states, the merged company (including Nationwide Care, Inc. as discussed below) will conduct business in states containing more than 80% of the nation's population, with 35 long term intensive care hospitals and 311 nursing centers with more than 42,000 beds, 55 retail and institutional pharmacy outlets and 23 retirement housing communities with approximately 3,000 apartments. Health care services provided through this network of facilities will include long term intensive hospital care, long term nursing care, contract respiratory therapy services, acute cardiopulmonary care, subacute and post-operative care, inpatient and outpatient rehabilitation therapy, specialized care for Alzheimer's disease, hospice care, pharmacy services and retirement and assisted living. Consummation of the Merger is contingent upon the affirmative vote of Vencor's and Hillhaven's stockholders and certain governmental and regulatory approvals and is expected to occur in the 1996 second quarter.\nOn February 27, 1995, Hillhaven signed a definitive agreement to acquire Nationwide Care, Inc. (\"Nationwide\") and its affiliated corporations and partnerships. The transaction closed on June 30, 1995. The consideration for the Nationwide acquisition was 5,000,000 shares of the Company's Common Stock, valued at approximately $141,000. The transaction was structured as a pooling of interests and as a tax-free reorganization for federal income tax purposes.\nThe following summarized pro forma operating data give effect to the Nationwide acquisition as if it had occurred on June 1, 1992:\nOn October 31, 1994, the Company acquired closely-held CPS Pharmaceutical Services, Inc. and Advanced Infusion Systems, Inc. (\"CPS\/AIS\") in a business combination accounted for as a pooling of interests. CPS and AIS, which provide diversified pharmaceutical and infusion services through locations in Northern California, became part of the Company's Medisave Pharmacies, Inc. subsidiary (\"Medisave\") through the exchange of 1,262,062 shares of the Company's Common Stock valued at approximately $29,000. The accompanying financial information for 1995 is presented on the basis that the companies were combined for the entire period, and financial statements of the prior years have been restated to give effect to the combination.\nRESULTS OF OPERATIONS\nNet operating revenues were $1,576,282 in 1995, $1,471,190 in 1994 and $1,378,466 in 1993. Net income was $51,289, $58,418 and $39,239 in 1995, 1994 and 1993, respectively. Net income for 1994 includes the\n$21,904 pretax restructuring credit arising from unused loss reserves remaining at the conclusion of the Company's facility disposition program.\nThe following table identifies the Company's sources of net operating revenues.\nNursing center net operating revenues, comprised primarily of patient revenues, increased 8.8% in 1995 to $1,348,940 and 7.1% in 1994 to $1,239,317 from $1,156,766 in 1993. These increases were due primarily to the increases in revenues per patient day. The increases in revenue per patient day were the result of (i) rate increases received from Medicare and Medicaid and increases in private pay rates, (ii) increases in the volume of services provided to patients, such as additional therapies and subacute care services, and (iii) shifts in the patient mix toward subacute medical and rehabilitation care. Patients using these services are of higher acuity levels than traditional long term care patients, resulting in higher reimbursement rates. Nursing center net revenues for 1994 include a gain on the sale of 13 nursing centers in the amount of $5,102.\nThe decrease in average occupancy in 1995 is due primarily to higher patient turnover associated with the increase in subacute medical and rehabilitation services.\nPatient revenues are affected by changes in Medicare and Medicaid reimbursement rates, private pay and other rates charged by Hillhaven, occupancy levels, the nature of services provided and the payor mix. Data for nursing center operations with respect to sources of net patient revenues and patient mix by payor type are set forth below. Included in private and other revenues are amounts received under managed care contracts.\nThe Company is continuing its strategy of improving its quality mix of private pay and Medicare patients by expanding its subacute medical and rehabilitation services. These higher revenue services include such care as physical, occupational and speech therapies, stroke therapy, wound care, oncology treatment, brain injury care and orthopedic therapy. The Company has increased the number of managed care contracts it maintains with insurance companies and other payors to provide subacute medical and rehabilitation care to their insureds, offering a less expensive alternative to acute care hospitals. The average daily number of managed care patients in Hillhaven's nursing centers, including long term care patients, was approximately 534 in 1995 compared to 435 in 1994 and 211 in 1993.\nNet operating revenues from pharmacy operations amounted to $190,638 in 1995, $198,634 in 1994 and $194,935 in 1993. Included in 1995 net operating revenues is a gain on the sale of the Company's interest in a closely-held institutional pharmacy amounting to $8,077. Pharmacy revenues were impacted by the disposition of 75 marginally performing retail outlets during the period from late 1993 through the first quarter of 1995.\nInstitutional revenues, accounting for approximately 92% of pharmacy net revenues in 1995, versus 79% in 1994 and 66% in 1993, increased by 11.9% and 21.0% to $175,119 and $156,444 in 1995 and 1994, respectively, from $129,312 in 1993. The growing contribution from institutional operations reflects the Company's increasing focus on the nursing center market and the disposition of retail outlets. Institutional revenues related to CPS\/AIS amounted to $27,425, $22,456 and $15,636 in 1995, 1994 and 1993, respectively. The increase in institutional revenues is due to an increase in the number of nursing center beds serviced and higher sales volumes per bed. The increase in per bed sales reflects the Company's strategy of aggressively marketing higher margin ancillary products and services, such as respiratory and intravenous therapies and enteral and urological supplies.\nOn February 1, 1995, Hillhaven formed the MediLife Pharmacy Network Partnership (\"MediLife\"), a joint venture between Medisave and Life Care Centers of America (\"Life Care\") and began providing pharmaceutical and consulting services to certain of Life Care's long term and subacute care facilities. Medisave contributed five of its existing institutional pharmacies to the joint venture and accounts for its 50% ownership interest by the equity method. Medisave receives a management fee for managing MediLife. As a result of its contribution of five pharmacies to the joint venture, subsequent to February 1, 1995, the Company reported a decrease in pharmacy net operating revenues. However, this transaction did not result in a material decrease in income for the Company for the year ended May 31, 1995.\nNet operating revenues from retirement housing operations increased to $36,704 in 1995 from $33,239 in 1994 and $26,765 in 1993. These increases are due to increases in rates charged as well as increases in medical and assisted living services provided. Retirement housing occupancy averaged 94.6% in 1995 compared to 96.1% in 1994 and 92.0% in 1993.\nGeneral and administrative expenses of the Company's nursing centers increased by 10.1% in 1995 to $1,169,811 and by 7.1% in 1994 to $1,062,442 from $992,149 in 1993. These increases were attributable primarily to the expansion of subacute medical and rehabilitation services. Labor and related benefits, which represented approximately 76% of nursing center general and administrative expenses in 1995, increased by 8.7% in 1995 to $891,772 and by 7.2% in 1994 to $820,065 from $765,276 in 1993. These increases were the result of an increase in the number of therapists in the Company's nursing centers to accommodate the increase in the number of medically complex patients, as well as general wage rate increases. Hillhaven employed approximately 4,600 therapists at May 31, 1995 compared to 3,400 and 2,400 at May 31, 1994 and 1993, respectively. Nursing wages and benefits, accounting for approximately 52% of total nursing center labor costs in 1995, increased by 3.6% in 1995 and by 2.0% in 1994. Hillhaven employed approximately 8,500 nurses at May 31, 1995 compared to approximately 7,700 and 7,800 at May 31, 1994 and 1993, respectively.\nThe increases in the non-labor components of general and administrative expenses, including ancillary and pharmaceutical supplies and contract therapy services, reflect the higher costs associated with caring for higher acuity patients. Nursing center supplies increased by 14.5% in 1995 to $60,765 and by 17.9% in 1994 to $53,069 from $45,005 in 1993.\nInterest expense decreased by 9.5% to $50,839 in 1995 and by 11.7% to $56,178 in 1994 due to the refinancing of certain of the Company's indebtedness in connection with its September 1993 recapitalization program (the \"Recapitalization\"). Rent expense decreased by 4.8% in 1995 to $53,571 due to the purchase of previously leased nursing centers, as discussed below.\nAs a result of the refinancing of certain of the Company's indebtedness, extraordinary charges of $570, $1,062 and $565 (net of income taxes) were reported in 1995, 1994 and 1993, respectively, due primarily to the write-off of previously capitalized financing costs.\nEffective June 1, 1992, Hillhaven adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). Adoption of SFAS 109 resulted in a charge of $1,103 to the\n1993 statement of income. Including the impact of this charge, the effect of the adoption of SFAS 109 in 1993 was a reduction of net income tax expense and an increase in net income of $7,710 as compared to amounts that would have been reported under APB Opinion No. 11. The Company has recorded net deferred tax assets of $11,428 at May 31, 1995, the realization of which is dependent in part upon future pretax earnings.\nStatement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS 114), establishes standards to determine in what circumstances a creditor should measure impairment based on either the present value of expected future cash flows related to the loan, the market price of the loan or the fair value of the underlying collateral. Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\" (SFAS 118), amends SFAS 114 to allow creditors to use existing methods for recognizing interest income on an impaired loan. SFAS 114 and SFAS 118 relate to the Company's portfolio of notes receivable. The Company anticipates that the adoption of SFAS 114 and SFAS 118 on the required application date of June 1, 1995 will not have a material adverse impact on Hillhaven's financial position or results of operations.\nCASH FLOWS AND FINANCIAL CONDITION\nCash provided by operations in 1995 totalled $80,656 compared to $75,127 in 1994 and $66,852 in 1993. These increases are due primarily to higher operating income before property-related expenses and restructuring items. Working capital at May 31, 1995 amounted to $64,273 compared to $37,673 and $78,886 at May 31, 1994 and 1993, respectively. The decrease in working capital in 1994 is due primarily to a decrease in cash and an increase in the current portion of long-term debt resulting from the Recapitalization.\nNet cash used in investing activities amounted to $62,664 in 1995 compared to $9,949 in 1994 and $3,212 in 1993. The increase in 1995 is due primarily to increases in cash used for capital expenditures and purchases of previously leased nursing centers and decreases in proceeds from sales of property and equipment and collection of notes receivable.\nIn 1995, capital expenditures for routine replacements and refurbishment of facilities and capital additions amounted to $50,276 compared to $44,277 in 1994 and $30,779 in 1993. The increases in 1995 and 1994 are due primarily to the expansion of certain nursing centers to accommodate the growth in subacute medical and rehabilitation programs, and the construction of a new nursing center and an assisted living center. Capital expenditures of approximately $80,000 are budgeted for 1996, the majority of which are anticipated to be funded from cash flow from operations.\nIn 1995, Hillhaven purchased six previously leased nursing centers for an aggregate purchase price of $17,355. In 1994, the Company purchased the remaining 23 nursing centers leased from Tenet Healthcare Corp. (\"Tenet\") (formerly National Medical Enterprises, Inc.) for an aggregate purchase price of $111,800. The purchase was financed with the proceeds from the Recapitalization. Also in 1994, the Company sold 13 nursing centers and received cash for the $15,594 aggregate sales price.\nIn 1993, Hillhaven purchased 62 nursing centers previously leased from Tenet for an aggregate purchase price of $179,890. The purchase was financed with the proceeds from the sale of $74,750 of 7 3\/4% Convertible Subordinated Debentures due 2002 (the \"Debentures\"), the assumption of underlying debt amounting to $4,825 and Tenet financing in the amount of $92,256, with the balance settled in cash. The Company also acquired seven previously leased nursing centers from third parties in 1993 for an aggregate purchase price of $26,791. These transactions were partially financed by the assumption of underlying debt and borrowings aggregating $15,095, with the balance settled in cash. During this same period, the Company disposed of 47 nursing centers and a retirement housing facility for an aggregate sales price of $59,355. Hillhaven provided financing for $36,338 of the total sales price and received cash for the balance.\nNet cash used in financing activities totalled $20,633 in 1995, $88,543 in 1994 and $36,438 in 1993. The Recapitalization included, in addition to the purchase of nursing centers from Tenet, the repayment of all existing debt payable to Tenet in the aggregate principal amount of $147,202. The Recapitalization was financed through (i) the issuance to Tenet of $120,000 of payable-in-kind Series D Preferred Stock, (ii) the incurrence of a $175,000 five-year term loan with a syndicate of banks (the \"Bank Term Loan\"), (iii) the\nissuance of $175,000 of 10 1\/8% Senior Subordinated Notes due 2001, (iv) borrowings of $30,000 under an accounts receivable-backed credit facility and (v) the use of approximately $39,000 of cash. The bank financing (the \"Credit Agreement\") also included a $100,000 letter of credit facility and an $85,000 revolving bank line of credit. The Credit Agreement was subsequently amended to change the amounts available under the Bank Term Loan, the letter of credit facility and the revolving bank line of credit to $165,000, $70,000 and $85,000, respectively. At May 31, 1995, the Bank Term Loan had an outstanding principal balance of $144,500 and borrowings under the revolving bank line of credit amounted to $24,000.\nHillhaven participates in a $40,000 accounts receivable-backed credit facility financed by a bank line of credit. At May 31, 1995, borrowings under this facility amounted to $5,000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements are contained on pages through of this report and are incorporated 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\nSet forth below are the names, ages, titles and present and certain past positions of the directors and executive officers of Hillhaven.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\nSection 16(a) of the Securities Exchange Act of 1934 requires that the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Company's equity securities, 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 same persons are also required by SEC regulation to furnish the Company with copies of all Section 16(a) forms that they file.\nTo the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the fiscal year ended May 31, 1995, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table shows the remuneration paid or accrued by the Company to the Company's Chief Executive Officer and to the four other most highly paid executive officers of the Company for the three fiscal years ended May 31, 1995.\nSUMMARY COMPENSATION TABLE\n---------------\n(1) Includes amounts paid pursuant to the Company's Annual Incentive Plan (the \"AIP\"). Under the AIP, annual cash incentive awards are made to selected key employees in positions which significantly impact the Company's operations. Individual awards are based on salary, corporate and operating unit financial performance goals and other key operating factors determined by the Compensation Committee.\n(2) Mr. Napoli's \"Other Annual Compensation\" includes early withdrawal of his Deferred Compensation as well as life and health insurance premiums for 1993, 1994 and 1995.\n(3) Restricted Shares are granted without charge to the recipient and are subject to forfeiture if continued employment for specified periods or other conditions as the Compensation Committee may establish are not met. Dividends, if any, are paid currently. Restrictions as to one-fourth of the shares awarded to Mr. Napoli in fiscal year 1995 and as to one-fifth of the shares awarded in fiscal year 1993 lapse yearly on each anniversary date of the awards. The number and value of the aggregate restricted stock holdings of Mr. Napoli at the end of the 1995 fiscal year (based on the Fair Market Value of the Company's Common Stock on the last day of fiscal 1995) was 15,000 and $429,375 respectively.\n(4) The Company has a Long Term Incentive Plan for key management employees which provides for cash awards that are to be paid only if Hillhaven achieves predetermined performance objectives over the length of a performance cycle, which must be a period of two or more fiscal years. Target awards are established for each participant, which will be the amount ultimately paid if goals are met or exceeded.\nCash payments under the Long Term Incentive Plan were discontinued after the three-year period ending May 31, 1993 and were replaced with Options and Performance Shares under the Company's 1990 Stock Incentive Plan. Consequently, the last performance award cycle scheduled under the Long Term Incentive Plan encompassed the three-year period ending May 31, 1993. A portion of Mr. Busby's Long Term Incentive Plan award ($54,359 for the period ended May 31, 1993) was paid by his previous employer with respect to service before Mr. Busby became a director and executive officer of Hillhaven.\n(5) Hillhaven maintains a non-qualified Deferred Compensation Plan (the \"DCP\") for executive officers and certain key management employees, which permits deferral of up to the maximum amount permissible\nunder applicable law of base salary or salary plus bonus until retirement, death or disability. The Company will make a matching contribution to a participant's account of up to 4% of a participant's total compensation. Vesting in the matching contributions occurs on a graduated basis, with full vesting after seven years of service or upon the participant attaining the age of 60. Amounts disclosed reflect Company matching contributions and interest credited to deferred compensation plan accounts. The amounts disclosed also include the economic value of Company-paid split dollar life insurance premiums as follows: Mr. Busby, $50,048; Mr. Marker, $42,498; Mr. McKain, $16,544; Mr. Pacquer, $17,323 and Mr. Napoli, $20,169.\n(6) Effective July 19, 1994, Mr. Napoli was appointed Chief Executive Officer and Director of Medisave.\nOPTION\/SAR GRANTS IN THE LAST FISCAL YEAR\n---------------\n(1) Options were granted on July 26, 1994 at a purchase price per share of 100% of the fair market value of the Company's common stock on that date. The options vest 100% on the first anniversary of the grant date. All grants have a ten-year term. Upon the occurence of certain events which may constitute a change in control of the Company, the right of the holder to exercise the options will accelerate.\n(2) Based on total grants during the fiscal year of 216,790 shares.\n(3) The dollar amounts under this column represent the result of calculations using the Black-Scholes based option valuation model. The valuation assumes an expected volatility of .5135, a 0% dividend yield, a 10-year exercise term, a risk-free rate of 7.505% reflecting the yield on a zero coupon U.S. Treasury security for the term of the option, and a grant price and exercise price of $18.00. No adjustments have been made for non-transferability or risk of forfeiture. The actual value of the options, if any, will depend on the extent to which the market value of the common stock exceeds the price of the option on the date of exercise.\n(4) Less than 1%.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION\/SAR VALUES\n---------------\n(1) These amounts include exercisable and unexercisable investment options under the Company's Performance Investment Plan (the \"PIP Plan\"). Unlike traditional stock options, these options were acquired by the named individuals with their personal funds and represent those individuals' personal investment decisions. The option price paid by a participating key employee will be refunded without premium if an outstanding option remains unexercised on May 29, 1999.\nThe options are evidenced by investment agreements which contain provisions governing the rights of participants to purchase the PIP Debentures, that are convertible in two steps into shares of the Company's common stock. Such investment agreements provide that the PIP Debentures may not be purchased prior to December 10, 1993, unless vesting is accelerated. Beginning on that date, the right of the holder to purchase the PIP Debentures vests at the rate of 25% per year so that the PIP Debentures are purchasable in full on December 10, 1996. Upon the occurrence of certain events which may constitute a change in control of the Company, the performance conditions may be deemed to be satisfied and the right of a holder to purchase the PIP Debentures will become fully vested. The effective conversion price of the PIP Debentures issued under the PIP Plan is $16.5375 (resulting in a $15.71 exercise price after the crediting of the initial $5,264 option purchase price), subject to adjustment.\nThese options may be exercised through the Company's cashless option exercise program in which the shares acquired on exercise are immediately sold into the market and the exercise price and applicable taxes are deducted from the proceeds of such sale.\n(2) Based on Fair Market Value of $28.625 on the last trading day of fiscal 1995.\nLONG TERM INCENTIVE PLAN AWARDS IN LAST FISCAL YEAR (1)\n---------------\n(1) This table describes declaration of eligibility to receive performance shares under the Company's 1990 Stock Incentive Plan to the five named executive officers during the last fiscal year. These shares are distinct from the stock options set forth in the table describing Option\/SAR grants above.\n(2) Awards of Performance Shares are provided under the 1990 Stock Incentive Plan. For the period indicated, the target awards of Performance Shares for Messrs. Busby, Marker, McKain and Pacquer were based upon (i) the number of restricted stock awards previously granted to each officer and (ii) similar awards given to executive officers of other healthcare companies and other public companies of similar size. In order to be eligible to receive these Performance Shares each year, participants must have retained at least 50% of the Performance Shares awarded in the previous year and must still be an employee of the Company. The financial target is the Company's budgeted earnings per share for each performance period.\n(3) For the indicated period, Mr. Napoli's target award of Performance Shares was determined by first deriving an amount equal to a percentage determined by the Compensation Committee of the sum of his base salary plus any AIP award earned in the year prior to commencement of the performance period. This amount was then divided by a number approved by the Compensation Committee which approximated the fair market value of the Company's Common Stock over a specified period to determine the number of Performance Shares. The financial target is the sum of all-business pretax income for annual target awards under the Company's AIP for each performance period. Amounts payable at the close of each performance cycle are determined with respect to the composite of the pretax income from ongoing operations and from properties held for sale for the length of the performance cycle, subject to the final approval of the Compensation Committee.\n(4) Under the terms of the award, each named executive officer is eligible to receive one-fifth of the total award indicated in July following the end of each fiscal year.\n(5) Subject to the Compensation Committee's sole discretion to award all or any portion of the Performance shares, these officers may receive shares of common stock ranging from zero to 100% of the number of Performance Shares set forth under the heading \"Number of Shares, Units or Other Rights\" above, based upon actual performance in relation to earnings per share targets. The Threshold column represents a zero payout in the event the actual earnings per share are less than the earnings per share target. The Target and Maximum amounts assumes 100% of the number of Performance Shares is actually awarded. To be eligible for the awards in the Target and Maximum columns, earnings per share must equal or exceed the earnings per share target.\n(6) Subject to the Compensation Committee's sole discretion to award all or any portion of the Performance Shares, Mr. Napoli may receive shares of Common Stock in amounts ranging from zero to 150% of the number of Performance Shares set forth under the heading \"Number of Shares, Units or Other Rights\" above, based upon actual performance in relation to financial performance targets. The Threshold column represents a zero payout in the event financial performance is equal to or less than the financial target. Target amounts assume 100% of the number of Performance Shares is actually awarded and Maximum amounts assume 150% of the number of Performance Shares is actually awarded. To be eligible for the awards in the Target and the Maximum columns, financial performance must exceed financial targets.\nSUPPLEMENTAL EXECUTIVE RETIREMENT PLAN\nThe Supplemental Executive Retirement Plan (the \"SERP\") provides executive officers and certain other management employees with supplemental deferred benefits in the form of retirement payments for life.\nAt retirement, the monthly benefit paid to participants will be a product of four factors: (i) the participant's highest average monthly earnings for any consecutive 60-month period during the ten years preceding retirement; (ii) the number of years of service to the Company to a maximum of 20 years (participants will receive a percentage credit for years of service prior to enrollment in the plan which increases gradually from 25% during the first year to 100% after five years from the date of enrollment); (iii) a vesting factor; and (iv) a percentage factor not to exceed 2.7% reduced to reflect the projected benefit from other Company retirement plans available to a participant and from Social Security. The monthly benefit is adjusted in the event of early retirement or termination of employment with the Company. The first day on which unreduced retirement benefits are available is age 62. In the event of the death of a participant, before\nor after retirement, one-half of the benefit earned as of the date of death will be paid to the surviving spouse for life or to the participant's children until the age of 21.\nWith respect to participants, the Company has purchased life insurance policies to provide for certain obligations under the SERP relating to such individuals.\nIn the event of a change of control of the Company (as defined under the SERP), participants will be deemed fully vested in the SERP without regard to actual years of service and will be entitled to the normal retirement benefits without reduction on or after age 60.\nThe following table presents the estimated maximum annual retirement benefits payable on a straight-life annuity basis to participating executives under the Company's SERP in the earnings and years of service classifications indicated.\nPENSION PLAN TABLE\n\"Earnings\" as defined by the SERP is the participant's base salary excluding bonuses and other cash and non-cash compensation. Earnings, for purposes of the plan, are limited to increase at a rate not to exceed 8% per annum measured from the participant's earnings at his or her plan entry date. As of May 31, 1993, the earnings covered by the plan for Mr. Busby and Mr. McKain differed by more than 10% from the salaries set forth in the Summary Compensation Table. In November 1993, the Compensation Committee determined to rectify this inequity by amending the definition of Projected Earnings under the SERP as to Messrs. Busby and McKain to mean actual earnings of such officers on the effective date of their promotions plus an assumed increase of 8% per annum.\nAs of May 31, 1995, the estimated credited years of service for the individuals named in the Summary Compensation Table were as follows: Mr. Busby, 25.9 years; Mr. Marker, 7.2 years; Mr. McKain, 15.6 years; Mr. Pacquer, 13.4 years and Mr. Napoli, 32.9 years.\nEMPLOYMENT AGREEMENTS\nMr. Marker has a contract with the Company and Tenet which requires Hillhaven to pay Mr. Marker a severance benefit (the payment of which is guaranteed by Tenet) of one year's base salary should he be terminated from the position of President.\nSEVERANCE AGREEMENTS\nEffective May 24, 1994, the Company entered into agreements with each of the named executive officers, providing for the payment of severance compensation upon termination of employment consisting of a lump-sum payment of two years' base salary in the event of a change in control as defined in the agreement. The agreement with Mr. Marker provides that he will receive payment of a severance benefit of no more than two\nyears' base salary from the operation of such agreement in combination with his other agreement with the Company and Tenet.\nREMUNERATION OF DIRECTORS\nDirectors who are not employees of the Company were paid at a rate of $24,000 a year for serving on the Board of Directors as well as an attendance fee of $1,000 for attending each Board meeting. In addition, directors receive $1,000 for attending each meeting of any committee on which they serve. Non-employee directors serving on the Executive Committee also receive a monthly fee of $500. Each non-employee Committee Chairman receives a fee of $2,000 per year for each committee for which he or she serves as Chairman. Directors also are reimbursed for travel expenses and other out-of-pocket costs incurred in attending meetings. Directors who are officers or employees of the Company do not receive any fees for Board or Board Committee service.\nDIRECTORS' STOCK OPTION PLAN\nDirectors who are not officers or employees of Hillhaven participate in the Directors' Stock Option Plan (the \"Directors Plan\"). Such directors are not eligible to participate in the 1990 Stock Incentive Plan. Under the Directors Plan, all members of the Board who are not officers or employees of the Company are granted an option to acquire 2,000 shares of Common Stock of the Company on the last Thursday of March of each year if serving as a director on that date. The number of shares of Hillhaven Common Stock that may be issued under the Directors Plan is 1% of the number of shares then outstanding. Options may be granted under the Directors Plan through December 31, 2005, unless the plan is terminated prior to such date.\nThe options granted under the Directors Plan are non-qualified options. The basic term of an option expires not later than 15 years from the date of grant, and options are fully exercisable one year after the date of grant. The option price is the fair market value of a share of Hillhaven Common Stock on the date of the grant. The option price may be paid: (i) in cash; (ii) at the discretion of the Compensation Committee, by (a) exchanging Common Stock owned by the optionee or (b) executing a promissory note bearing interest at a rate determined by the Compensation Committee (currently 8.75%) and secured by shares of Hillhaven Common Stock; or (iii) by a combination of the above.\nGenerally, if an optionee ceases to be an outside director of the Company due to any reason other than death, disability or retirement, the option will expire three months after the date service as a director ceases. If the optionee ceases to be a director due to retirement, the option will expire three years after the date service as a director ceases. If the optionee dies or becomes permanently disabled while serving as an outside director of the Company, the option will expire three years after the date of such death or disability.\nIn the event of any change in the capitalization of the Company, such as a stock dividend or stock split, the Compensation Committee may make an appropriate adjustment to the outstanding awards and the number of shares reserved for issuance under the Directors Plan.\nThe Company believes that the Directors Plan promotes the interest of the Company and its stockholders by strengthening the Company's ability to attract, motivate and retain outside directors with training, experience and ability and by encouraging the highest level of director performance by providing such persons with a proprietary interest in the Company.\nDuring the year ended May 31, 1995, Ms. Jacobs and Messrs. Beran, Burns, de Wetter, Andersons and Vance were each granted options under the Directors Plan for 2,000 shares of the Company's Common Stock. The Fair Market Value of a share of Hillhaven Common Stock on the date of the grant was $27.25.\n\"Fair Market Value\" means the average of the high and the low trading prices of a share of Common Stock on the New York Stock Exchange on the date as of which Fair Market Value is to be determined, or if no such sales were made on such date, the closing price of such shares on the New York Stock Exchange on the next preceding date on which there were such sales.\nDIRECTORS RETIREMENT PLAN\nThe Directors Retirement Plan (the \"Retirement Plan\") provides the members of the Board of Directors who are not employees of the Company with supplemental deferred benefits in the form of retirement payments for ten years following the later of each such member's termination of service or reaching the age of 65.\nAt retirement, the annual benefit paid to each participant will equal the lesser of (i) 100% of his or her Final Annual Board Retainer (as defined in the Retirement Plan) or (ii) $24,000, increased by a compounded rate of 6% per year from 1995 to the year of the participant's termination of service, subject in both cases to a vesting factor. The retirement benefits will be paid in equal monthly installments. In the event of the death of a participant, before or after retirement, the benefits earned as of the date of death will be paid to the surviving spouse or the participant's children under the age of 21 for the remainder of the ten-year term.\nIn the event of a change of control of the Company (as defined in the Retirement Plan), participants will be deemed fully vested in the Retirement Plan without regard to actual years of service and will be entitled to full retirement benefits without reduction on or after age 65.\nCOMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION FOR FISCAL YEAR 1995\n1. COMPENSATION COMMITTEE DUTIES AND EXECUTIVE COMPENSATION PHILOSOPHY\nThe Compensation Committee is responsible for ensuring that the Company establishes and implements compensation and benefit programs which drive improvement in Company business performance (measured in terms of quality of care, total revenues, occupancy, census mix, operating margins and productivity, net income and earnings per share) in order to create greater shareholder value.\nHillhaven's executive compensation programs are designed to attract, motivate and retain the high calibre executives who are required to successfully implement the Company's short and long term business strategies and promote long-term growth in shareholder value. The Committee reviews the Company's business and financial performance targets, established through the Company's annual planning process, to ensure that they represent a significant challenge for that fiscal year and the three-year strategic cycle, and are an appropriate basis for performance-based compensation as described below.\nEffective January 1, 1994, compensation payments in excess of $1 million to the Chief Executive Officer or the other four most highly compensated officers are subject to a limitation on deductibility for the Company under Section 162(m) of the Internal Revenue Code of 1986, as amended (the \"Code\"). Certain performance-based compensation is not subject to the limitation on deductibility. Compensation to the Chief Executive Officer or any other executive officer which is subject to the limitation has never exceeded $1 million and the Compensation Committee does not expect compensation subject to the limitation in 1995 to any such officers to be in excess of $1 million. If compensation subject to the limitation were, however, to exceed $1 million, the Company could not deduct the amount in excess of $1 million. In such event, the Compensation Committee intends to consider the advisability of amending the Company's plans in the future.\nEach member of the Compensation Committee is an outside Director with significant professional experience in linking business performance and executive compensation. No member of the Compensation Committee is a former or current officer of the Company or any of its subsidiaries.\n2. SPECIFIC COMPONENTS OF EXECUTIVE OFFICER COMPENSATION\nThe Company's executive officer compensation program is based upon a \"total compensation\" approach and requires that a significant and appropriate amount of compensation be \"at risk\" and dependent on the Company achieving aggressive financial and operating performance targets. Incentives are not paid unless Company and individual results significantly exceed these performance targets, result in the satisfactory delivery of quality services and are achieved in compliance with Company ethics policies.\nThe Company's executive officer compensation program consists of three primary components: (1) base salary; (2) an annual incentive plan with cash award; and (3) long-term, stock-based awards. In determining increases to base salaries and maximum cash and stock awards, the Compensation Committee establishes compensation levels designed to be competitive with compensation paid to officers in comparable positions with competitor companies in health care and other similar businesses. Whether maximum salary increases and incentive award amounts are ultimately paid is contingent upon the achievement of established Company performance targets discussed below and, in part, upon individual performance.\nBase salaries are determined from salary ranges established to position maximums at the 75th percentile of general and comparable industry salaries. Companies that are regularly reviewed to determine \"comparable industry salaries\" include various long term, subacute, acute and for profit health care providers, and are often regional or national competitors of Hillhaven. Some of these companies are included in the S&P Health Care Composite Index. Salary increases are based upon improved business results, as measured by growth in total revenues, \"all-business pretax income\" and earnings per share, and upon individual performance. These performance measures were exceeded in fiscal 1995.\nCash incentives are utilized to clearly focus executive officers on significant year-to-year improvement in Company financial performance and earnings per share. Awards may range from 0% to 75% of an executive's base salary. The performance targets are established through the Company's annual business and financial planning process, and are based on substantial improvements beyond budget in \"all-business pretax income\", which drives improvements in earnings per share. In addition, incentives can be, and will be, eliminated if certain service quality or ethical standards are not met. These performance targets were exceeded in fiscal 1995.\nLonger-term improvements in business performance and shareholder value are driven through stock-based incentive plans. The Committee believes that equity incentives align the economic interests of executive officers with the interests of all shareholders, which further drives shareholder value. Long-term incentives are provided through grants of Stock Options, \"Restricted Shares\" and \"Performance Shares\", and are awarded for achieving significant growth in shareholder value.\nStock Options are awarded at fair market value on the date of grant and must be held for at least one year before they can be exercised.\n\"Restricted Shares\" are subject to forfeiture if employment does not continue for a specified period (three to five years). Certain restricted shares are subject to forfeiture if performance targets are not met. The Compensation Committee believes that these awards drive significant improvement in business performance and shareholder value and also are important in the retention of the key senior executives required to lead continued improvement in Company performance.\n\"Performance Shares\" represent the eligibility to receive shares of Common Stock in the future if Company performance exceeds a specified financial target for the succeeding three-year period. The first three-year cycle for potential performance share awards ended May 31, 1995.\nThe Company's five-year award cycle of restricted stock awards established to retain and motivate senior executive officers ended with restrictions lapsing in January through March 1995. The Committee determined that this type of program provides significant retention value and further aligns executive officers with shareholder interests. The Committee also determined that significant stock grants continued to be appropriate for senior executive officers to ensure competitive total compensation. The Committee determined that the further use of restricted awards would have significant impact on earnings this year, and that Company performance in future years should be a major factor in making stock awards to senior executive officers.\nIn December 1994, the Committee recommended, and the Board of Directors approved, a five-year award cycle of performance share awards for senior executive officers. Unlike the expired restricted stock award program for senior executive officers, awards of performance shares will only be made if company performance exceeds specific financial and earnings per share targets. The first awards under this program are scheduled for July 1996, based upon the Company's performance for fiscal year 1996. The Committee retains\nthe authority to determine each year if any awards will be made, and the size of the awards, based upon Company performance.\nThe Compensation Committee continues to determine the potential equity awards for each eligible executive officer, and the actual award will only be paid if the financial target has been met or exceeded. In determining the size of these awards, the Committee reviews the Company's performance for the respective fiscal year (focusing on all-business pretax income and earnings per share), the contribution of each of the Company's executive officers and the amount of equity then held by each executive officer. The financial targets are monitored throughout the period to ensure that there has been an appropriate improvement in earnings per share to justify any awards.\nIn addition to the incentive plans noted above, in May 1992, the Company, with the approval of its shareholders and the Board of Directors, implemented the Company's Performance Investment Plan. While the primary purpose of this plan was to raise capital at favorable rates, a significant component of the plan involved investment by officers of personal funds to acquire options to purchase the Company's convertible debentures, which are convertible into the Company's Common Stock. The exercise price of these options was set at 135% of the stock price at the time the options were purchased. While this plan is administered by a separate committee of outside directors, the Compensation Committee believes that it should be noted in this report (even though not viewed as compensation), since it also serves to closely align executives with the interests of all shareholders. Officers will only realize gains under the plan if the price of the Company's Common Stock appreciates, thereby benefiting all shareholders.\n3. COMPANY PERFORMANCE\nIn evaluating the Company's performance for fiscal year 1995, for the purpose of making executive officer compensation decisions, the Compensation Committee has reviewed a number of aspects of the Company's performance. The Compensation Committee has particularly noted the Company's continued success in creating a more competitive and profitable enterprise focused on improved core business performance and higher margin subacute health services, rehabilitative care and pharmacy services.\nThe Company has been able to improve its operating margins in its traditional long term care business by increasing total occupancy and the amount of revenues from higher revenue business such as subacute care and rehabilitative services. Occupancy continued to be strong, with an average rate for nursing center beds of 92.8% for the fiscal year.\nFor fiscal year 1995, normalized pretax income from operations grew to $70.4 million from normalized $56.3 million in fiscal year 1994, for a 25% increase. Net income significantly increased from a normalized $36.6 million in fiscal year 1994 to $47.1 million in fiscal year 1995. Earnings per share were $1.40 (fully diluted) for fiscal year 1995, a normalized improvement of 26%.\nTotal net operating revenues for fiscal year 1995 increased by 7%, as institutional pharmacy revenues increased 12%, retirement housing revenues grew 10%, and specialty service programs (physical, occupational and speech rehabilitation therapies, and subacute care) grew 30% to $399 million. The Company's revenues from subacute medical and rehabilitation services improved from 26% of patient care revenues in fiscal year 1994 to 30% in fiscal year 1995.\nSignificant gains have been achieved again in fiscal year 1995 in service quality and the effective management of the Company's workforce. Workers' compensation lost time claims decreased 21.2% from the previous fiscal year.\nAlso during fiscal year 1995, the Company began to leverage its strategic growth opportunities, as follows:\no acquired a significant infusion therapy\/pharmacy business\no entered into a definitive agreement to acquire Nationwide Care, Inc. and its related entities (27 nursing and assisted living centers)\no opened a new 120 bed nursing center in Ft. Myers, Florida\no spent $63.3 million on routine facility renovation, maintenance, and internal development of nursing centers through licensed beds, rehabilitation and assisted living additions, and on the acquisition of previously leased facilities.\nFrom May 1990 through May 31, 1995, the Company has outperformed the S&P 500 Index and the S&P Health Care Composite Index as illustrated in the Comparison of Cumulative Total Returns. The Committee views the Comparison of Cumulative Total Returns as a longer-term view of the Company's progress in becoming a competitive investment, and it will not necessarily directly relate to year-to-year compensation decisions.\n4. CEO COMPENSATION\nFor fiscal year 1995, Mr. Busby was paid a base salary of $445,193. Mr. Busby's base salary is in the median range of base salaries of CEO's of companies of similar size in health care and other similar businesses.\nIn determining the amount of Mr. Busby's annual incentive plan award of $337,500, and in determining the number of Performance Shares, which Mr. Busby is eligible to receive commencing July 1996, the Compensation Committee considered the significant improvement in financial and operating performance which the Company has experienced in fiscal year 1995 and the previous three fiscal years, as well as the significant growth in pretax income and earnings per share under Mr. Busby's leadership, as previously noted in Section 3 of this Report. During fiscal year 1995, the Company has met or exceeded challenging business performance targets for net income, earnings per share, new business development and cash flow. These achievements represent significant improvement from fiscal year 1994. Additionally, the Company has continued to make substantial improvements in the quality of services provided and in the effective management of its workforce.\nAdditionally, the Committee considered Mr. Busby's excellent governance in various merger and acquisition opportunities. These important matters were appropriately handled while also ensuring that the Company continued to achieve excellent operating results, as noted above.\nThe Compensation Committee believes that Mr. Busby's leadership is key to these excellent business results and that he has earned his compensation in leading the Company to such performance in fiscal year 1995.\nThe Compensation Committee has determined that executive officer compensation will continue to track Company performance. If Company performance and earnings per share do not continue to improve, total compensation for Mr. Busby and other executive officers will be adjusted accordingly.\nCOMPENSATION COMMITTEE: Peter de Wetter, Chairman Dinah Jacobs Jack O. Vance\nCOMPARISON OF CUMULATIVE TOTAL RETURNS\nTHE HILLHAVEN CORPORATION, S & P 500 INDEX AND S & P HEALTH CARE COMPOSITE\nThe following performance graph compares the total returns (assuming reinvestment of dividends) of The Hillhaven Corporation Common Stock, the S & P 500 Index and the S & P Health Care Composite. The graph assumes $100 invested on February 2, 1990 for Hillhaven (the first day of regular way trading of the Company's Common Stock on the American Stock Exchange) and on February 1, 1990 for the S & P 500 Index and the S & P Health Care Composite and shows the cumulative total return as of each May 31 thereafter.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nPRINCIPAL STOCKHOLDERS\nThe following table shows the name, address, number of shares held, and percentage of shares held as of August 17, 1995 by each person or entity known by the Company to beneficially own more than 5% of the Company's outstanding Common Stock, based upon publicly available information as of August 17, 1995.\n---------------\n(1) Based on information furnished to the Company by representatives of such beneficial owners.\n(2) Excludes 35,000 shares of Series C Preferred Stock and 65,430 shares of Series D Preferred Stock held by Tenet which have no voting rights.\nSTOCK OWNERSHIP TABLE\nThe table below presents the Common Stock ownership of all directors, the Chief Executive Officer and the four next most highly compensated executive officers, and all executive officers and directors as a group as of August 17, 1995. Except as otherwise indicated, each individual named has sole investment and voting power with respect to the securities beneficially owned.\n---------------\n* Less than 1%\n(1) Includes options to purchase an aggregate of 22,946 shares of Common Stock granted pursuant to the 1990 Stock Incentive Plan and options to purchase an aggregate of 305,528 shares of Common Stock granted pursuant to the Performance Investment Plan.\n(2) Includes options to purchase an aggregate of 18,357 shares of Common Stock granted pursuant to the 1990 Stock Incentive Plan, options to purchase an aggregate of 241,876 shares of Common Stock granted pursuant to the Performance Investment Plan and 3,200 shares held by a charitable remainder trust of which Mr. Marker and his wife control investment and voting power as trustees.\n(3) Does not include the right to vote certain shares held by The Hillhaven Corporation Grantor Trust (the \"Trust\"). Under the terms of the Trust Agreement, the voting of the shares held by the Trust is passed through to participants in Hillhaven's stock-based benefit plans who either have purchased shares pursuant to the Company's Employee Monthly Stock Investment Plan (the \"EMSIP\") during the last 12 months or currently hold vested, unexercised options (the \"Eligible Participants\"). Each Eligible Participant has the right to direct the vote with respect to a number of shares held by the Trust as determined by the following formula: multiply the shares held by the Trust by a fraction for each Eligible Participant who has given voting instructions. The numerator of such fraction equals the sum of (1) shares purchased pursuant to the EMSIP by the participant during the preceding 12 months, and (2) the total vested, unexercised options held by the participant; the denominator equals the total number of shares purchased pursuant to the EMSIP during the preceding 12 months by all Eligible Participants who have exercised their voting rights plus the total number of vested, unexercised options held by all Eligible Participants who have exercised their voting rights. As of August 17, 1995, the Trust held 4,025,169 shares; the denominator for the fraction would be 3,827,388 shares if all Eligible Participants voted and the numerator for the fraction would be 328,474 for Mr. Busby and 260,233 for Mr. Marker.\n(4) Includes 1,200 shares owned by spouse.\n(5) Includes options to purchase 10,000 shares of Common Stock granted pursuant to the 1990 Directors Stock Option Plan.\n(6) Includes options to purchase 6,000 shares of Common Stock granted pursuant to the 1990 Directors Stock Option Plan.\n(7) Includes options to purchase an aggregate of 16,464 shares of Common Stock granted pursuant to the 1990 Stock Incentive Plan and options to purchase an aggregate of 89,112 shares of Common Stock granted pursuant to the Performance Investment Plan.\n(8) Includes options to purchase an aggregate of 6,924 shares of Common Stock granted pursuant to the 1990 Stock Incentive Plan and options to purchase an aggregate of 101,842 shares of Common Stock granted pursuant to the Performance Investment Plan.\n(9) Includes options to purchase an aggregate of 3,720 shares of Common Stock granted pursuant to the 1990 Stock Incentive Plan, options to purchase an aggregate of 57,286 shares of Common Stock granted pursuant to the Performance Investment Plan, 2,000 shares which Mr. Napoli owns jointly with his wife, and 500 shares held in Mr. Napoli's wife's name in an IRA account.\n(10) Includes (a) options to purchase the aggregate amount of 78,468 shares of Common Stock granted to certain executive officers pursuant to the 1990 Stock Incentive Plan, (b) options to purchase an aggregate of 954,772 shares of Common Stock granted pursuant to the Performance Investment Plan, and (c) options to purchase 38,000 shares of Common Stock granted pursuant to the 1990 Directors' Stock Option Plan.\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:\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.\n---------------\n* Management contracts and compensatory plans or arrangements required to be filed as an Exhibit to comply with Item 14(a)(3).\n(b) Reports filed on Form 8-K:\n1. A Form 8-K, dated April 23, 1995, was filed during the quarter to disclose an agreement to merge with Vencor, Inc. as follows:\nOn April 23, 1995, The Hillhaven Corporation (the \"Company\") signed a definitive merger agreement under which Vencor, Inc. (\"Vencor\") will acquire the Company and its affiliated corporations and partnerships (the \"Merger\"). In consideration for the Merger, the Company's stockholders will receive $32.25 in value in Vencor common stock for each share owned of the Company's common stock. Based upon the closing price of $37.00 per share of Vencor's shares on Friday, April 21, 1995, the terms equate to an exchange ratio of 0.872 shares of Vencor common stock for each share of the Company's common stock. The agreement specifies that the exchange ratio can be adjusted under certain circumstances, depending upon Vencor's market price prior to closing, but under no circumstances can the ratio be adjusted down to less than 0.768 nor higher than 0.977. The transaction will be structured as a pooling of interests and as a tax-free reorganization under Section 368(a) of the Internal Revenue Code. The closing is scheduled during the third calendar quarter of 1995.\nNo financial statements were filed with the Form 8-K.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE HILLHAVEN CORPORATION\nBy: \/s\/ BRUCE L. BUSBY ----------------------------------- Bruce L. Busby Chief Executive Officer\nDate: August 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.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders of The Hillhaven Corporation:\nWe have audited the accompanying consolidated balance sheets of The Hillhaven Corporation and subsidiaries (Hillhaven) as of May 31, 1995 and 1994 and the related consolidated statements of income, cash flows and stockholders' equity for each of the years in the three-year period ended May 31, 1995. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the index on page 36 of this annual report. These consolidated financial statements are the responsibility of the management of Hillhaven. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the aforementioned consolidated financial statements present fairly, in all material respects, the financial position of The Hillhaven Corporation and subsidiaries as of May 31, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended May 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 7 to the consolidated financial statements, effective June 1, 1992 Hillhaven changed its method of providing income taxes by adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\".\nKPMG PEAT MARWICK LLP\nSeattle, Washington July 7, 1995\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(IN THOUSANDS, EXCEPT SHARE INFORMATION)\nASSETS\nSee accompanying Notes to Consolidated Financial Statements.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(IN THOUSANDS, EXCEPT SHARE INFORMATION)\nSee accompanying Notes to Consolidated Financial Statements.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nSee accompanying Notes to Consolidated Financial Statements.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED MAY 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT SHARE INFORMATION)\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)\nYEARS ENDED MAY 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT SHARE INFORMATION)\nSee accompanying Notes to Consolidated Financial Statements.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation. The consolidated financial statements include the accounts of The Hillhaven Corporation and its wholly owned subsidiaries (\"Hillhaven\" or the \"Company\"). Significant intercompany transactions and balances have been eliminated.\nIn October 1994, the Company acquired CPS Pharmaceutical Services, Inc. (CPS) and Advanced Infusion Systems, Inc. (AIS) in a business combination accounted for as a pooling of interests (Note 2). Accordingly, the accompanying financial statements for the year ended May 31, 1995 are presented on the basis that the companies were combined for the entire year, and prior years have been restated to give effect to the combination.\nCertain reclassifications of prior years' amounts have been made to conform to 1995 classifications.\nNet Operating Revenues. Revenues are recognized when services are provided and products are delivered.\nNet operating revenues consist primarily of patient care revenues which are reported at the net amounts realizable from residents, third-party payors and others for services provided. A provision for estimated uncollectible patient accounts and notes receivable is included in general and administrative expenses and was $5,516, $8,391 and $4,346 for the years ended May 31, 1995, 1994 and 1993, respectively.\nApproximately 74%, 73% and 73% of net patient care revenues for the years ended May 31, 1995, 1994 and 1993, respectively, are from participation of the nursing centers in Medicare and Medicaid programs. Revenues under these programs are subject to audit and retroactive adjustment. Provisions for estimated third-party payor settlements are provided in the period the related services are rendered and are adjusted as final settlements are determined. Accounts receivable from Medicare and Medicaid amounted to $35,038 and $61,837, respectively, at May 31, 1995, and $16,189 and $64,022, respectively, at May 31, 1994.\nNet operating revenues also include revenues from pharmacy operations of $190,638, $198,634 and $194,935 for the years ended May 31, 1995, 1994 and 1993, respectively.\nIncome Per Share. Primary income per share is calculated by dividing net income, after deducting dividends on preferred stock, by the weighted average number of common shares and equivalents outstanding for the period. Common stock equivalents are stock purchase warrants and employee stock options. Fully diluted income per share further assumes conversion of the Company's convertible debentures. Conversion of the debentures was not assumed for the 1993 calculation because the exercise prices of the debentures exceeded the market price at May 31, 1993.\nCash Equivalents. Highly liquid investments with maturities of three months or less at the date of acquisition are considered cash equivalents. Interest earned on these investments amounted to $866, $1,027 and $911 for the years ended May 31, 1995, 1994 and 1993, respectively.\nInventories. Inventories, which are stated at the lower of cost (first-in, first-out) or market, are comprised of the following:\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nNotes Receivable. Notes receivable consist primarily of notes originated upon the sale of nursing centers to third parties. Generally the notes are secured by mortgages and deeds of trust on the properties sold. See Note 12.\nProperty and Equipment. Owned land, buildings, leasehold improvements and equipment are stated at cost. Capitalized leases are stated at the lower of the present value of minimum lease payments or fair value at the inception of the lease. Depreciation and amortization are computed using the straight-line method over the useful lives of the assets, estimated as follows: buildings, 20-45 years; leasehold improvements and certain capitalized leases, over the lesser of the estimated useful life or the lease term; and equipment, 5-10 years.\nIntangible Assets. Costs incurred in obtaining long-term financing are amortized over the terms of the related indebtedness, primarily using the straight-line method. Costs related to the acquisition of leases are amortized over the lease term using the straight-line method.\nHillhaven recorded extraordinary charges of $851 ($570 net of tax), $1,543 ($1,062 net of tax) and $743 ($565 net of tax) for the years ended May 31, 1995, 1994 and 1993, respectively, in connection with the early retirement or refinancing of long-term debt.\n2. ACQUISITIONS\nOn October 31, 1994, the Company acquired closely-held CPS and AIS in a business combination accounted for as a pooling of interests. CPS and AIS, which provide pharmaceutical and infusion services, became part of the Company's Medisave Pharmacies subsidiary through the exchange of 1,262,062 shares of Hillhaven's common stock valued at approximately $29,000.\nSummarized results of operations of the separate companies for the period from June 1, 1994 through October 31, 1994 are as follows:\nFollowing is a reconciliation of restated net operating revenue and net income to amounts previously reported for the years ended May 31, 1994 and 1993:\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n3. STATEMENTS OF CASH FLOWS\nSupplemental disclosures of cash flow information are as follows:\n4. INVESTMENTS IN UNCONSOLIDATED PARTNERSHIPS\nHillhaven has 50% ownership interests in a number of unconsolidated general and limited partnerships. These investments are accounted for by the equity method and are included in other noncurrent assets. All of these partnerships own or lease real and personal property and operate nursing centers. Combined summarized unaudited financial information for these partnerships is as follows:\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nHillhaven manages six nursing centers for partnerships in which the Company has an equity interest. Management fees earned are usually based upon a percentage of revenues, ranging from 7% to 9%.\n5. PROPERTY AND EQUIPMENT\nProperty and equipment at May 31 is comprised of the following:\nProperty and equipment includes buildings acquired under capital leases in the amount of $1,997 at both May 31, 1995 and 1994. Related accumulated depreciation and amortization amounted to $1,861 and $1,776 at May 31, 1995 and 1994, respectively.\n6. LONG-TERM DEBT\nThe Recapitalization. In September 1993, Hillhaven completed a recapitalization plan (the \"Recapitalization\") which included the modification of the Company's relationship with Tenet Healthcare Corporation (\"Tenet\") (formerly National Medical Enterprises, Inc.) (Note 8) to (i) purchase 23 nursing centers leased from Tenet for a purchase price of $111,800, (ii) repay all existing debt to Tenet in the aggregate principal amount of $147,202, (iii) release Tenet guarantees on approximately $400,000 of debt, (iv) limit the annual fee payable to Tenet to 2% of the remaining amount guaranteed and (v) amend existing agreements to eliminate obligations of Tenet to provide additional financing to the Company. The Recapitalization was financed through (i) the issuance to Tenet of $120,000 of payable-in-kind Series D Preferred Stock, (ii) the incurrence of a $175,000 term loan under a secured credit facility with a syndicate of banks, (iii) the issuance of $175,000 of 10 1\/8% Senior Subordinated Notes due 2001, (iv) borrowings of $30,000 under an accounts receivable-backed credit facility and (v) the use of approximately $39,000 of cash.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nLong-term debt at May 31 is comprised of the following:\n---------------\n(1) Under Hillhaven's 1991 Performance Investment Plan, on May 29, 1992, the Company privately placed $65,053 of convertible debentures (the \"PIP Debentures\") to a wholly owned, special purpose subsidiary. The subsidiary financed 95% of the purchase with three-year term loans from a syndicate of commercial banks and 5% from the sale to key employees of options to acquire the PIP Debentures. In September 1993, Hillhaven refinanced the term loans using its term loan facility. These borrowings, together with the outstanding balance of the options, are classified as floating rate convertible debentures in the above table. The interest rate was 7.1875% at May 31, 1995. Interest is not payable on the options. The PIP Debentures mature and the options terminate on May 29, 1999, and both the PIP Debentures and options are subject to mandatory redemption on that date or upon the occurrence of certain events. The options permit the holder to purchase PIP Debentures at 95% of their face value and to ultimately convert them into shares of common stock at an effective conversion price of $16.5375 per share. The options vest 25% per year beginning in December 1993, with accelerated vesting in certain events. The Company may repurchase the options at any time after May 29, 1997 by paying a redemption premium. As options are exercised, the Company's taxable income will be reduced by any excess of the fair market value of the common stock at the date of conversion over the principal amount of the PIP Debentures redeemed.\n(2) On November 4, 1992, the Company sold $74,750 of its 7 3\/4% Convertible Subordinated Debentures (the \"Debentures\") due 2002. The Debentures are convertible into common stock at the option of the holder at any time prior to maturity at a conversion price of $16.795 per share. On or after November 1, 1995, the Company may redeem the Debentures, in whole or in part, at specified redemption prices. The Debentures are unsecured and subordinated to all other indebtedness of Hillhaven.\n(3) In connection with the Recapitalization, Hillhaven entered into a credit agreement with a syndicate of banks. The credit agreement, as amended in October 1994, includes a $165,000 term loan facility, an $85,000 revolving credit facility and a $70,000 IRB letter of credit facility (collectively, the \"Facilities\"). Borrowings under the credit agreement are secured by 86 nursing centers, certain accounts receivable and the stock of certain subsidiaries of the Company. The Facilities bear interest at either a base rate plus zero to .625% or the London Interbank Offered Rate (\"LIBOR\") plus .625% to 1.625%, the spreads being dependent on the type of facility and leverage ratios. The Facilities will mature on October 28,\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1999. Commitment fees are required on the unused portions of the term loan, revolving credit facility and IRB letter of credit facility and are paid at a rate of .25% to .50%, depending on leverage ratios. At May 31, 1995, $144,500 was outstanding under the term loan facility, including $53,600 as substituted debt for the PIP Debentures, with interest payable at 7.1875%. The term loan is subject to scheduled principal repayments. Borrowings under the revolving credit facility amounted to $24,000 at May 31, 1995, with interest payable at 7.1875%. Letters of credit outstanding at May 31, 1995 under the IRB letter of credit facility totalled $68,668 and under the revolving credit facility totalled $4,250.\n(4) Mortgage notes, industrial revenue bonds and the majority of other notes are principally secured by Hillhaven's property and equipment. Mortgage notes include non-interest bearing resident mortgage bonds related to a retirement housing facility amounting to $31,254 and $30,543 at May 31, 1995 and 1994, respectively. The industrial revenue bonds were issued by various governmental authorities to finance the construction or acquisition of nursing centers and retirement housing facilities. The use of escrowed funds of $3,249 and $6,156 at May 31, 1995 and 1994, respectively, is limited to specific facility capital improvements or payment of principal and interest on the bonds. These amounts are included in other noncurrent assets. Average interest rates for the mortgage notes (excluding resident mortgage bonds), industrial revenue bonds and other notes at May 31, 1995 were 9.0%, 5.0% and 9.3%, respectively.\nHillhaven participates in a $40,000 accounts receivable-backed credit facility whereby eligible Medicaid receivables of selected nursing centers are sold to a wholly owned subsidiary of Hillhaven, formed specifically for the purpose of such transactions. The purchase of receivables by the subsidiary may be financed by a bank line of credit with interest payable at either LIBOR plus 3\/4% or the lenders' cost of funds. At May 31, 1995, borrowings under this facility totalled $5,000 with interest payable at 9.0%. At May 31, 1995, the subsidiary had total assets of approximately $72,160, which cannot be used to satisfy claims against Hillhaven or any of its subsidiaries.\nCertain loan agreements have, among other requirements, restrictions on cash dividends, investments and borrowings and require maintenance of specified operating ratios, levels of working capital and net worth. Management believes that Hillhaven is in compliance with all material covenants. There are no compensating balance requirements for any of the credit lines or borrowings.\nFuture maturities of convertible debentures and long-term debt are as follows:\n7. INCOME TAXES\nEffective June 1, 1992, Hillhaven adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). The implementation of SFAS 109 changed the Company's method of accounting for income taxes from the deferred method of APB Opinion No. 11 (\"APB 11\") to an asset and liability approach. Under the asset and liability method of SFAS 109, deferred tax assets and\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nliabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.\nDeferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nAdoption of SFAS 109 resulted in a charge of $1,103 to the 1993 statement of income as the cumulative effect of a change in accounting principle. Including the impact of this charge, the effect on the year ended May 31, 1993 of the adoption of SFAS 109 was a reduction of net income tax expense and an increase in net income of $7,710 as compared to amounts that would have been reported under APB 11.\nIncome tax (expense) benefit on income from operations before income taxes, extraordinary charge and cumulative effect of accounting change consists of the following amounts:\nAn analysis of Hillhaven's effective income tax rate is as follows:\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe tax effects of temporary differences that give rise to significant portions of the federal and state deferred tax assets (liabilities) are comprised of the following:\nThe decrease in the valuation allowance for deferred tax assets of $3,104 and $1,090 for 1995 and 1994, respectively, was attributable to taxable income earned in the years ended May 31, 1995 and 1994 and, to a lesser extent, an increase in the estimate of future income to be earned. Realization of net deferred tax assets is dependent in part upon future pretax earnings. Although the Company believes such pretax earnings will be achieved, a lack of earnings could result in an increased provision for income taxes.\nThe Tax Reform Act of 1986 enacted an alternative minimum tax system for corporations. The alternative minimum tax is assessed at a rate of 20% on alternative minimum taxable income. Alternative minimum taxable income is determined by making statutory adjustments to the Company's regular taxable income. For the years ended May 31, 1995, 1994 and 1993, utilization of regular tax credits was limited by alternative minimum tax expense of $13,913, $11,043 and $5,400, respectively.\n8. TRANSACTIONS WITH TENET HEALTHCARE CORPORATION\nLending and Related Agreements. In connection with the spin-off from Tenet in January 1990 (the \"Spin-off\"), Hillhaven entered into certain financial arrangements with its former parent company. Hillhaven issued unsecured notes to Tenet in the aggregate amount of $145,859. The Company used the proceeds from the sale of both the 8 1\/4% Series C Preferred Stock to Tenet and the PIP Debentures to repay $96,800 of these notes (Note 6). Tenet also provided mortgage financing to Hillhaven on certain nursing centers purchased by the Company from Tenet. In fiscal 1994, Hillhaven repaid all of the Tenet notes in the aggregate principal\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\namount of $147,202 with proceeds from the Recapitalization (Note 6). The Company also repaid debt which was guaranteed by Tenet in the aggregate amount of $266,737.\nInterest expense on Tenet notes totalled $3,696 and $7,061 for the years ended May 31, 1994 and 1993, respectively.\nGuarantee Reimbursement Agreement. Tenet and Hillhaven entered into a guarantee reimbursement agreement providing for the payment by Hillhaven of a fee in consideration of Tenet's guarantee of certain Hillhaven obligations. At May 31, 1995 and 1994, an aggregate total of approximately $182,000 and $279,000, respectively, of long-term debt (Note 6), leases (Note 9) and contingent liabilities (Note 11) were subject to this agreement. Guarantee fees totalled $4,588, $6,684 and $9,644 for the years ended May 31, 1995, 1994 and 1993, respectively.\nInsurance. Through May 31, 1994, substantially all of the professional and general liability risks of Hillhaven were insured by an insurance company which is owned by Tenet. Such insurance expense amounted to $7,627 and $7,344 for the years ended May 31, 1994 and 1993, respectively. Beginning June 1, 1994, Hillhaven obtained separate coverage for its professional and general liability exposure (Note 11).\nLeases. At the time of the Spin-off, Hillhaven leased 115 nursing centers from Tenet. During the three years ended May 31, 1993, the Company purchased 92 of the leased nursing centers for an aggregate purchase price of $346,900. At May 31, 1993, Hillhaven leased 23 nursing centers from Tenet which were recorded as capital leases at the aggregate purchase option price of $135,400. As part of the Recapitalization, the Company purchased the remaining 23 nursing centers leased from Tenet for an aggregate purchase price of $111,800. Interest expense on the Tenet leases for the years ended May 31, 1994 and 1993 amounted to $3,401 and $19,889 respectively.\nHillhaven is leasing certain nursing centers from Health Care Property Partners, a joint venture in which Tenet has a minority interest. Lease payments to this joint venture amounted to $9,574, $9,923 and $9,699 for the years ended May 31, 1995, 1994 and 1993, respectively.\nEquity Ownership. On November 30, 1991, Tenet purchased 35,000 shares of Hillhaven's 8 1\/4% cumulative nonvoting Series C Preferred Stock. The proceeds, $35,000, were used to reduce notes payable to Tenet. Tenet is entitled to a cumulative dividend, payable quarterly, at the annual rate of 8 1\/4% of the $35,000 liquidation value. The Series C Preferred Stock is redeemable at the option of the Company at any time, in whole or in part.\nIn connection with the Recapitalization, Hillhaven issued to Tenet $120,000 of cumulative nonvoting payable-in-kind Series D Preferred Stock. On February 28, 1994, Tenet tendered shares of the Series D Preferred Stock in the amount of $63,300 to exercise its warrants to purchase 6,000,000 shares of Hillhaven common stock.\nTenet is entitled to receive cumulative quarterly dividends on the Series D Preferred Stock at an annual rate of 6 1\/2% of the liquidation value which, as of May 31, 1995, was $64,416. The dividends are payable in additional shares of Series D Preferred Stock, compounded annually, until September 1998, when the dividends will be payable in cash. The Company may, at its option, redeem the Series D Preferred Stock at any time, in whole or in part, subject to restrictions included in certain loan agreements.\nManagement Agreement. Hillhaven provides management, consulting and advisory services in connection with the operation of seven nursing centers owned or leased by Tenet or its subsidiaries. In return for such services, Hillhaven receives a management fee and is reimbursed for certain costs and expenses. Hillhaven earned $2,535, $2,543 and $2,440 for such services during fiscal 1995, 1994 and 1993, respectively. Management fees receivable from Tenet amounted to $636 at May 31, 1995 and $610 at May 31, 1994.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n9. LEASES\nAs of May 31, 1995, Hillhaven leases 112 nursing centers, 70 of which are operated by the Company. Most lease agreements cover periods from 10 to 20 years and contain renewal options of 5 to 40 years. Hillhaven's pharmacy outlets are leased under terms generally ranging from three to five years with three-year renewal options.\nMinimum lease payments under noncancelable leases and related sublease income are as follows:\nRent expense under operating leases is as follows:\n10. BENEFIT PLANS\nHillhaven's 1990 Stock Incentive Plan (the \"1990 Plan\") provides for incentive stock option, nonqualified stock option, restricted stock, stock appreciation right and cash bonus awards to certain executive officers and other key employees of Hillhaven. Incentive stock options are granted at an exercise price equal to the fair market value of the shares on the date of grant, and nonqualified stock options are granted at an exercise price of not less than 50% of fair market value on the date of grant. Restricted shares are issued at no cost to the employee, and restrictions on such shares generally lapse over five years from the date of the award as long as the employee continues to be employed by Hillhaven.\nIn addition, Hillhaven has replaced its long-term cash bonus plan with performance share awards (\"Performance Shares\") under the 1990 Plan. The Compensation Committee of the Board of Directors identified key management employees who are eligible to receive Performance Shares. Performance Shares represent potential rights to receive common stock based upon the Company achieving specified financial targets over a three- to five-year period. Subject to the Compensation Committee's sole discretion to award all or any portion of the Performance Shares, participants may receive shares of common stock based upon actual performance in relation to the financial targets. Performance Shares granted during the year ended May 31,\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1995 amounted to 1,015,000, which may be awarded over the next five years subject to the aforementioned conditions.\nThe fair market value on the date of award of restricted shares and the excess of the fair market value of the Hillhaven shares on the date of grant of nonqualified stock options over the exercise price represents compensation which is deferred and charged to operations as the forfeiture restrictions lapse and as the nonqualified options vest. An estimate of the fair market value of Performance Shares expected to be awarded also represents compensation and is deferred and charged to operations over a three- to five-year period. Unearned compensation is recorded as a deduction from stockholders' equity. No stock appreciation rights or cash bonuses have been awarded under the 1990 Plan. At May 31, 1995, there were 1,030,161 shares of common stock available under the 1990 Plan for future awards.\nHillhaven also has a Directors' Stock Option Plan (the \"Directors' Plan\") for directors who are not employees of Hillhaven and are not eligible to participate in the 1990 Plan. Nonstatutory options to purchase 2,000 shares of common stock are granted each year to each qualified director at the fair market value of the shares on the date of grant.\nInformation regarding stock option plans follows:\nShares of common stock issued in the last three fiscal years in connection with employee and director compensation and benefit plans, including the 1991 Performance Investment Plan (Note 6), were 348,234 in 1995, 212,356 in 1994 and 135,079 in 1993. Restricted shares forfeited and retired in the last three fiscal years amounted to zero in 1995, 16,000 in 1994 and 39,670 in 1993.\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nIn January 1995, the Company established a grantor trust to pre-fund future obligations under Hillhaven's employee stock plans. The grantor trust is a vehicle for supporting its existing stock plans including the 1990 Plan, the Performance Investment Plan and the Employee Stock Purchase Plan, and does not change those plans or the amount of stock to be issued under those plans. Hillhaven transferred 4,200,000 newly issued shares of its common stock to the grantor trust, of which 4,067,473 shares remained in the trust at May 31, 1995.\nIn March 1995, the Company established a second grantor trust to pre-fund future obligations under its nonqualified deferred compensation plans. This trust does not change the status of the plans or benefits to be received by participants in the plans. Hillhaven transferred to the trust, life insurance policies with an aggregate cash value of $5,356,897 at May 31, 1995 (included in other noncurrent assets), as well as 500,000 newly issued shares of the Company's common stock. The Company may withdraw these shares of common stock at any time prior to a change of control, as defined, and therefore they are not considered outstanding shares.\nHillhaven maintains defined contribution retirement plans covering substantially all full-time employees, whereby employee contributions to the plans are matched by Hillhaven up to certain limits. Defined contribution pension expense totalled $4,993, $3,938 and $4,556 for the years ended May 31, 1995, 1994 and 1993, respectively.\nHillhaven also maintains supplemental retirement plans covering outside directors, executive officers and certain other management employees under which benefits are determined based primarily upon the participants' compensation and length of service to the Company. Expense under these plans amounted to $1,142, $730 and $262 for the years ended May 31, 1995, 1994 and 1993, respectively. Accrued benefits under the plans amounted to $3,668 and $2,518 at May 31, 1995 and 1994, respectively, and are included in other long-term liabilities.\n11. COMMITMENTS AND CONTINGENCIES\nHillhaven is contingently liable at May 31, 1995 for $23,698 primarily as a guarantor of indebtedness of partnerships in which Hillhaven has an ownership interest (Note 4) or with which it has a management agreement. Tenet has guaranteed $3,880 of these obligations for which Hillhaven has agreed to indemnify Tenet under the terms of the Guarantee Reimbursement Agreement (Note 8).\nThe Company maintains insurance coverage for its workers' compensation exposure. The estimated retrospective premiums (included in other receivables or other accrued liabilities and other long term assets or liabilities) is based on actuarially projected estimates discounted at an 8.0% average rate to their present value, which amounted to a $5,861 receivable at May 31, 1995 and a $8,619 liability at May 31, 1994.\nThe Company currently insures all of its professional and general liability risks through a wholly owned insurance subsidiary. Risks in excess of $500 per occurrence are reinsured with major independent insurance companies. The estimated liability for the self-insured portion of professional and general liability claims (included in other accrued liabilities and other long-term liabilities) is based on actuarially projected estimates which amounted to $6,436 at May 31, 1995. Included in cash at May 31, 1995 is $7,129 which is restricted for the payment of claims. Through May 31, 1994, the Company's professional and general liability risks were insured by an insurance company which is owned by Tenet (Note 8).\nOn January 25, 1995, Horizon Healthcare Corporation (\"Horizon\") made a proposal to acquire Hillhaven in a stock merger valued by Horizon at $28.00 per share. On February 5, 1995, a Special Committee of Hillhaven's Board of Directors (the \"Special Committee\") considered the proposal with its\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nadvisors and concluded that the proposal was inadequate. On March 7, 1995, Horizon made another offer to acquire Hillhaven in a stock merger valued by Horizon at $31.00 per share.\nIn light of the March 7, 1995 Horizon proposal and expressions of interest received by Hillhaven from other parties desiring to explore an acquisition transaction, on March 20, 1995, the Special Committee instructed Merrill Lynch, Pierce, Fenner and Smith Incorporated to explore strategic alternatives, including the possible sale of Hillhaven to a third party. The Special Committee established a process to evaluate all alternatives available to Hillhaven.\nAs part of this process, Hillhaven engaged in discussions with certain parties interested in acquiring Hillhaven, and invited Horizon to participate in this process. Horizon announced that its proposal expired on March 21, 1995. On April 24, 1995, Hillhaven announced that it had entered into a definitive merger agreement with Vencor, Inc. (\"Vencor\"). See Note 13.\nA number of legal actions have resulted from Horizon's January and March proposals to acquire Hillhaven.\nOn February 6, 1995, Hillhaven filed a complaint against Horizon in the United States District Court for the District of Nevada seeking injunctive and declaratory relief that a business combination between Horizon and Hillhaven is prohibited by the Nevada statute regarding business combinations with interested stockholders by reason of certain arrangements between Horizon and Tenet. On February 27, 1995, Horizon filed an answer and a counterclaim alleging that, among other things, Hillhaven and all of its directors (other than Messrs. de Wetter and Andersons) had breached their fiduciary duties to Hillhaven's stockholders in connection with their consideration of Horizon's acquisition proposal and certain actions taken by Hillhaven, including the formation of a grantor trust, the amendment of Hillhaven's stockholder rights plan and the filing of a shelf registration statement with the Commission. The counterclaim seeks injunctive and declaratory relief and compensatory and punitive damages in unspecified amounts. Hillhaven has answered the counterclaim and believes Horizon's claims are without merit. By stipulation of the parties, all proceedings in these actions have been stayed until October 31, 1995.\nHillhaven and its directors are named as defendants in a number of putative class action complaints filed on behalf of Hillhaven's stockholders in Nevada state court (the \"Nevada State Court Actions\") and California state court (the \"California State Court Actions\"). These complaints raise allegations that Hillhaven and its directors have breached their fiduciary duties to Hillhaven's stockholders in connection with the consideration of Horizon's acquisition proposal and certain corporate actions also cited in Horizon's counterclaim. These actions seek declaratory and injunctive relief and, in California, compensatory damages in unspecified amounts. The Service Employees International Union (AFL-CIO) and a Hillhaven employee and union member are seeking to intervene as party plaintiffs in both the Nevada and California putative class actions brought on behalf of Hillhaven's stockholders, alleging that their interests as stockholders and employees of Hillhaven are not adequately represented. Hillhaven has opposed this intervention. In addition, Tenet filed a complaint against Hillhaven and two of its directors, Mr. Busby and Mr. Marker, in state court in California seeking declaratory and injunctive relief and alleging, among other things, that they have breached their fiduciary duties to Tenet and Hillhaven's other stockholders in connection with their consideration of Horizon's acquisition proposal and certain of the other corporate actions cited in the Horizon and putative class action complaints (the \"Tenet Action\"). The plaintiffs in the Nevada State Court Actions have moved to dismiss their complaints, which dismissal has been opposed by Hillhaven and its directors. Consideration of this motion has been suspended without date. Hillhaven believes these actions are without merit.\nBy stipulation of the parties, the proceedings in the Tenet Action have been stayed until the consummation of the merger with Vencor, at which time Hillhaven and Tenet have agreed to dismiss with\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nprejudice all pending claims with respect to Horizon's acquisition proposal or the Merger. The stay of the California State Court Actions expired July 5, 1995, and the stay in the Nevada State Court Actions expired on July 22, 1995. No schedule has been established with respect to further proceedings in these actions.\nHillhaven is subject to various other claims and lawsuits in the ordinary course of business which are covered by insurance or adequately provided for in Hillhaven's financial statements. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on Hillhaven's results of operations or liquidity.\n12. FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe carrying amounts and fair values of Hillhaven's financial instruments at May 31 are as follows:\nThe estimated fair values of Hillhaven's financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. Because no market exists for a significant portion of Hillhaven's financial instruments, considerable judgment is necessarily required in interpreting the data to develop the estimates of fair value. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe fair value of performing notes receivable is calculated by discounting the projected cash flows using estimated market discount rates that reflect the credit and interest rate risk inherent in the notes and using specific borrower information. Fair values for notes with no set maturity are determined based on individual circumstances and are valued net of specific reserves.\nThe fair values of the Company's long-term borrowings is estimated based on quoted market prices or by discounting future cash flows at current rates offered to the Company for debt of comparable types and maturities. It is not practicable to estimate the fair value of the Company's off-balance sheet obligations (Note 11).\n13. RESTRUCTURING\nOn December 5, 1991, Hillhaven announced a restructuring plan designed to improve its long-term financial strength and operating performance. The plan included the disposition of 82 nursing centers over an estimated 24-month period. In the second quarter of fiscal 1992, the Company recorded a $90,000 pretax charge, comprised of $25,700 for the projected losses from operations of the 82 nursing centers during the disposition period and $64,300 for estimated losses from the dispositions. Also as part of the restructuring, Hillhaven exercised options to purchase nine nursing centers leased from Tenet, modified terms of the remaining leases with Tenet and sold preferred stock to Tenet in the amount of $35,000, the proceeds of which were used to prepay debt owed to Tenet (Note 8).\nAs of November 30, 1993, the Company had completed the disposition of 50 of these nursing centers, as well as three retirement housing facilities which, prior to March 1, 1992, had been recorded as discontinued operations. During the three months ended November 30, 1993, the Company reviewed its asset disposition\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nprogram. Because of improvements in reimbursement rates and results of operations, the Company decided not to pursue the sales of the remaining nursing centers and a retirement housing facility. In addition, several parcels of land which had been held for development have been reclassified to other noncurrent assets. Assets related to the Company's restructuring program were as follows:\nAccrued loss reserves remaining at the date of reinstatement were comprised of $17,668 for losses from operations and $36,882 for estimated future losses on sale. Pretax losses charged to the reserve were as follows:\nRevenues and expense related to the 32 nursing centers and other properties previously held for disposition were reclassified to ongoing operations in the consolidated statements of income for all periods presented. Total revenues and expenses of these facilities were as follows:\nNet assets of these facilities as of September 1, 1993, less adjustments to asset carrying values and remaining accrued restructuring costs aggregating $32,646, were reclassified from net assets held for disposition to appropriate balance sheet accounts.\nOn December 31, 1993, Hillhaven completed the sale of 13 nursing centers for an aggregate sales price of $15,594. Nine of these nursing centers had previously been held for disposition. The sale resulted in a gain of $5,102, which is included in net operating revenues.\n14. SUBSEQUENT EVENTS\nIn April 1995, Hillhaven entered into a definitive merger agreement with Vencor, pursuant to which Hillhaven will be merged with and into Vencor (the \"Merger\"). Holders of Hillhaven common stock will be issued Vencor common stock in a business combination intended to qualify as a pooling of interests and as a tax-free reorganization for federal income tax purposes. Vencor operates a network of health care services for\nTHE HILLHAVEN CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\npatients who suffer from cardiopulmonary disorders. The foundation of Vencor's network is a nationwide chain of long term intensive care hospitals. With operations in 38 states, the merged company (including Nationwide Care, Inc., discussed below) will consist of 36 long term intensive care hospitals and 311 nursing centers with more than 42,000 beds, 55 retail and institutional pharmacy outlets and 23 retirement housing communities with approximately 3,000 apartments. Health care services provided through this network of facilities will include long term intensive hospital care, long term nursing care, contract respiratory therapy services, acute cardiopulmonary care, subacute and post-operative care, inpatient and outpatient rehabilitation therapy, specialized care for Alzheimer's disease, hospice care, pharmacy services and retirement and assisted living. Consummation of the Merger is contingent upon the affirmative vote of Vencor's and Hillhaven's stockholders and certain governmental and regulatory approvals and is expected to occur in the 1996 second quarter.\nOn February 27, 1995, Hillhaven signed a definitive agreement to acquire Nationwide Care, Inc. (\"Nationwide\") and its affiliated corporations and partnerships. The transaction closed on June 30, 1995. The consideration for the Nationwide acquisition was 5,000,000 shares of the Company's Common Stock valued at approximately $141,000. The transaction was structured as a pooling of interests and as a tax-free reorganization for federal income tax purposes.\nThe following summarized pro forma data give effect to the acquisition had it occurred on June 1, 1992:\nTHE HILLHAVEN CORPORATION\nQUARTERLY FINANCIAL SUMMARY (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n---------------\n(1) Amounts for periods prior to November 1, 1994 have been restated to reflect the acquisition of CPS and AIS (Note 2).\n(2) Includes a $21,904 restructuring credit recorded in the 1994 second quarter.\n(3) Adjusted to reflect a one-for-five reverse stock split effected in November 1993.\nSCHEDULE VIII\nTHE HILLHAVEN CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n---------------\n(1) Prior year information had been restated to reflect the acquisitions of CPS and AIS.\n(2) Write-off of accounts and notes receivable.\n(3) Provision related to nursing centers and retirement housing facilities held for disposition was charged to the reserve for loss on assets held for disposition.\n(4) Operating losses related to nursing centers and retirement housing facilities held for disposition were charged to the reserve.\n(5) Elimination of loss reserve upon reinstatement of assets held for disposition.\nS-1\nINDEX TO EXHIBITS","section_15":""}
{"filename":"36047_1995.txt","cik":"36047","year":"1995","section_1":"ITEM 1. BUSINESS.\nTHE COMPANY\nThe First American Financial Corporation was organized in 1894 as Orange County Title Company, succeeding to the business of two title abstract companies founded in 1889 and operating in Orange County, California. In 1924, the Company commenced issuing title insurance policies. In 1986, the Company began a diversification program by acquiring and developing financial service businesses closely related to the real estate transfer and closing process. The Company is a California corporation and has its executive offices at 114 East Fifth Street, Santa Ana, California 92701-4699. The Company's telephone number is (714) 558-3211. Unless the context otherwise indicates, the \"Company,\" as used herein, refers to The First American Financial Corporation and its subsidiaries.\nGENERAL\nThe Company, through its subsidiaries, is engaged in the business of providing real estate related financial and information services, including title insurance, real estate tax monitoring, mortgage credit reporting, flood zone determination, property information and home warranty services, to real property buyers and mortgage lenders. The Company also provides trust and limited banking services. Financial information regarding each of the Company's primary business segments is included in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Item 8. Financial Statements and Supplementary Data\" of Part II of this report. Although industry-wide data for 1995 are not currently available, the Company believes that its wholly owned subsidiary, First American Title Insurance Company (\"First American\"), was the second largest title insurer in the United States, based on gross title fees, and its wholly owned subsidiary, First American Real Estate Information Services, Inc., was the nation's largest provider of flood determinations, based on the number of flood determination reports issued, and the nation's second largest provider of tax monitoring services, based on the number of loans under service. The Company also believes that its majority owned subsidiary, First American Home Buyers Protection Corporation, was the third largest provider of home warranties in the United States, based on the number of home protection contracts under service. Substantially all of the Company's title insurance, tax monitoring, credit reporting, flood zone determination and property information business results from resales and refinancings of real estate, including residential and commercial properties, and from the construction and sale of new properties. The Company's home warranty business results from residential resales and does not benefit from refinancings or commercial transactions. Resales and refinancings of residential properties constitute the major sources of the Company's revenues. Real estate activity is cyclical in nature and is affected greatly by the cost and availability of long term mortgage funds. Real estate activity and, in turn, the Company's revenue base, can be adversely affected during periods of high interest rates and\/or limited money supply. However, this adverse effect is mitigated in part by the continuing diversification of the Company's operations into areas outside of its traditional title insurance business.\nOVERVIEW OF TITLE INSURANCE INDUSTRY\nTitle insurance has become increasingly accepted as the most efficient means of determining title to, and the priority of interests in, real estate in nearly all parts of the United States. Today, virtually all real property mortgage lenders require their borrowers to obtain a title insurance policy at the time a mortgage loan is made.\nTitle Policies. Title insurance policies are insured statements of the condition of title to real property, showing priority of ownership as indicated by public records, as well as outstanding liens, encumbrances and other matters of record, and certain other matters not of public record. Title insurance policies are issued on the basis of a title report, which is prepared after a search of the public records, maps, documents and prior title policies to ascertain the existence of easements, restrictions, rights of way, conditions, encumbrances or other matters affecting the title to, or use of, real property. In certain instances, a visual inspection of the property is\nalso made. To facilitate the preparation of title reports, copies of public records, maps, documents and prior title policies may be compiled and indexed to specific properties in an area. This compilation is known as a \"title plant.\"\nThe beneficiaries of title insurance policies are generally real estate buyers and mortgage lenders. A title insurance policy indemnifies the named insured and certain successors in interest against title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from its provisions. The policy typically provides coverage for the real property mortgage lender in the amount of its outstanding mortgage loan balance and for the buyer in the amount of the purchase price. Coverage under a title insurance policy issued to a real property mortgage lender generally terminates when the mortgage loan is repaid. Coverage under a title insurance policy issued to an owner generally terminates upon the sale of the insured property unless the owner carries back a mortgage or makes certain warranties as to the title.\nUnlike other types of insurance policies, title insurance policies do not insure against future risk. Before issuing title policies, title insurers seek to limit their risk of loss by accurately performing title searches and examinations. The major expenses of a title company relate to such searches and examinations, the preparation of preliminary reports or commitments and the maintenance of title plants, and not from claim losses as in the case of property and casualty insurers.\nThe Closing Process. Title insurance is essential to the real estate closing process in most transactions involving real property mortgage lenders. In a typical residential real estate sale transaction, title insurance is generally ordered on behalf of an insured by a real estate broker, lawyer, developer, lender or closer involved in the transaction. Once the order has been placed, a title insurance company or an agent conducts a title search to determine the current status of the title to the property. When the search is complete, the title company or agent prepares, issues and circulates a commitment or preliminary title report (\"commitment\") to the parties to the transaction. The commitment summarizes the current status of the title to the property, identifies the conditions, exceptions and\/or limitations that the title insurer intends to attach to the policy and identifies items appearing on the title that must be eliminated prior to closing.\nThe closing function, sometimes called an escrow in western states, is often performed by a lawyer, an escrow company or by a title insurance company or agent (such person or entity, the \"closer\"). Once documentation has been prepared and signed, and mortgage lender payoff demands are in hand, the transaction is \"closed.\" The closer records the appropriate title documents and arranges the transfer of funds to pay off prior loans and extinguish the liens securing such loans. Title policies are then issued insuring the priority of the mortgage of the real property mortgage lender in the amount of its mortgage loan and the buyer in the amount of the purchase price. The time lag between the opening of the title order and the issuance of the title policy is usually between 30 and 90 days.\nIssuing the Policy: Direct vs. Agency. A title policy can be issued directly by a title insurer or indirectly on behalf of a title insurer through agents which are not themselves licensed as insurers. Where the policy is issued by a title insurer, the search is performed by or at the direction of the title insurer, and the premium is collected and retained by the title insurer. Where the policy is issued by an agent, the agent performs the search, examines the title, collects the premium and retains a portion of the premium. The remainder of the premium is remitted to the title insurer as compensation for bearing the risk of loss in the event a claim is made under the policy. The percentage of the premium retained by an agent varies from region to region. A title insurer is obligated to pay title claims in accordance with the terms of its policies, regardless of whether it issues its policy directly or indirectly through an agent.\nPremiums. The premium for title insurance is due and earned in full when the real estate transaction is closed. Premiums are generally calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from state to state.\nBecause the policy insures against matters that have occurred prior to its issuance (rather than future occurrences, as with most other types of insurance), the major portion of the premium is related to the service performed in ascertaining the current status of title to the property.\nTHE COMPANY'S TITLE INSURANCE OPERATIONS\nOverview. The Company, through First American and its subsidiaries, transacts the business of title insurance through a network of more than 300 branch offices and over 4,000 independent agents. Through its branch office and agent network, the Company issues policies in all states (except Iowa), the District of Columbia, Puerto Rico, Guam, the U.S. Virgin Islands, the Bahama Islands, Canada, Mexico, Bermuda and the United Kingdom. In Iowa, the Company provides abstracts of title only, because title insurance is not permitted. Through acquisitions and start-ups during the mid-1980s, the Company has grown from a large regional company to a nationwide company, becoming less dependent on operating revenues from any one state or region.\nThe following table illustrates the Company's and the industry's growth based on gross title fees in the ten largest title insurance markets (and all states combined) during the ten year period from 1985 to 1994, and the increase in the Company's share of the national title insurance market from 12.2% to 19.5% over the same period.\n- -------- (1)Source: American Land Title Association (2)Based on gross title fees as statutorily defined. (3)Includes all 50 states (except Iowa) and the District of Columbia.\nBased on industry statistics showing gross title fees in the major areas in which the Company operates, in 1994 the Company had the largest or second largest share of the title insurance market in 33 states, including California, New York and Pennsylvania, which are three of the five largest markets in the United States, and in the District of Columbia. Industry statistics for 1995 are not currently available.\nThe Company plans to continue increasing its share of the title insurance market through strategic acquisitions and further development of its existing branch office and agency operations. The Company also will continue to focus on expanding its share of the higher margin title insurance business conducted on behalf of commercial clients. While commercial title business has been slow for several years, the Company believes its national commercial market share has grown through programs directed at major developers, lenders and law firms.\nSales and Marketing. The Company markets its title insurance services to a broad range of customers. The Company believes that its primary source of business is from referrals from persons in the real estate community, such as independent escrow companies, real estate brokers, developers, mortgage brokers, mortgage bankers, financial institutions and attorneys. In addition to the referral market, the Company markets its title insurance services directly to large corporate customers and certain mortgage lenders. As title agents contribute a large portion of the Company's revenues, the Company also markets its title insurance services to independent agents. The Company's marketing efforts emphasize the quality and timeliness of its services and its national presence.\nWhile virtually all personnel in the Company's title insurance business assist in marketing efforts, the Company maintains a sales force of approximately 1,000 persons dedicated solely to marketing. This sales force is located throughout the Company's branch office network. The Company provides its sales personnel with training in selling techniques, and each branch manager is responsible for hiring the sales staff and ensuring that sales personnel under his or her supervision are properly trained. In addition to this sales force, the Company has 22 sales personnel in its national accounts department. One of the responsibilities of the national accounts department sales personnel is the coordination of marketing efforts directed at large real estate lenders and companies developing, selling, buying or brokering properties on a multistate basis. The Company also supplements the efforts of its sales force through general advertising in various trade and professional journals.\nThe Company's increased commercial sales effort during the past decade has enabled the Company to expand its commercial business base. Because commercial transactions involve higher coverage amounts and yield higher premiums, commercial title insurance business generates greater profit margins than does residential title insurance business. Although the commercial real estate economy has been slow during the past several years, in particular with respect to new construction, and may continue to be slow in the near future, the Company has recently experienced an increase in commercial real estate activity from workouts, refinancings and purchases driven by depressed commercial real estate values. Because of this increase in activity and the Company's belief that new commercial construction will eventually increase, the Company plans to continue to emphasize its commercial sales program.\nAlthough sales outside of the United States account for a small percentage of the Company's revenues, the Company believes that the acceptance of title insurance in foreign markets has increased in recent years. Accordingly, the Company plans to continue its international sales efforts, particularly in Canada.\nUnderwriting. Before a title insurance policy is issued, a number of underwriting decisions are made. For example, matters of record revealed during the title search may require a determination as to whether an exception should be taken in the policy. The Company believes that it is important for the underwriting function to operate efficiently and effectively at all decision making levels so that transactions may proceed in a timely manner. To perform this function, the Company has underwriters at the branch level, the regional level and the national level. Based on the low turnover and longevity of First American's employees and its continuing training programs, the Company believes that its underwriting personnel are among the most experienced and well trained in the title insurance industry.\nAgency Operations. The relationship between the Company and each agent is governed by an agency agreement which states the conditions under which the agent is authorized to issue title insurance policies on behalf of the Company. The agency agreement also prescribes the circumstances under which the agent may be liable to the Company if a policy loss is attributable to error of the agent. Such agency agreements typically have a term of one to five years and are terminable immediately for cause.\nDue to the high incidence of agency fraud in the title insurance industry during the late 1980s, the Company instituted measures to strengthen its agent selection and audit programs. In determining whether to engage an independent agent, the Company investigates the agent's experience, background, financial condition and past performance. The Company maintains loss experience records for each agent and conducts periodic audits of its agents. The Company has also increased the number of agent representatives and agent auditors that it employs. Agent representatives periodically visit agents and examine their books and records. In addition to periodic audits, a full agent audit will be triggered if certain \"warning signs\" are evident. Warning signs that can trigger an audit include the failure to implement Company required accounting controls, shortages of escrow funds and failure to remit underwriting fees on a timely basis.\nTitle Plants. The Company's network of title plants constitutes one of its principal assets. A title search is conducted by searching the public records or utilizing a title plant. While public records are indexed by reference to the names of the parties to a given recorded document, most title plants arrange their records on a geographic basis. Because of this difference, records of a title plant are generally easier to search. Most title plants also index\nprior policies, adding to searching efficiency. Many title plants are computerized. Certain offices of the Company utilize jointly owned plants or utilize a plant under a joint user agreement with other title companies. The Company believes its title plants, whether wholly or partially owned or utilized under a joint user agreement, are among the best in the industry.\nThe Company's title plants are carried on its balance sheet at original cost, which includes the cost of producing or acquiring interests in title plants or the appraised value of subsidiaries' title plants at dates of acquisition for companies accounted for as purchases. Thereafter, the cost of daily maintenance of these plants is charged to expense as incurred. A properly maintained title plant has an indefinite life and does not diminish in value with the passage of time. Therefore, in accordance with generally accepted accounting principles, no provision is made for depreciation of these plants. Since each document must be reviewed and indexed into the title plant, such maintenance activities constitute a significant item of expense. The Company is able to offset title plant maintenance costs at its plants through joint ownership and access agreements with other title insurers and title agents.\nReserves for Claims and Losses. The Company provides for title insurance losses based upon its historical experience by a charge to expense when the related premium revenue is recognized. Historically, major claims (i.e., claims greater than $0.5 million) were charged to expense as they became known because the unique circumstances surrounding most major claims made it inherently impractical to predict the incidence and amount of such claims. In the fourth quarter 1995, the Company determined, with the assistance of an actuarial study, that sufficient major claims data now exists to reasonably estimate a reserve for incurred but not reported claims. Accordingly, the reserve for incurred but not reported claims at December 31, 1995, includes major claims. The reserve for known claims and incurred but not reported claims reflects management's best estimate of the total costs required to settle all claims reported to the Company and claims incurred but not reported, and is considered by the Company to be adequate for such purpose.\nIn settling claims, the Company occasionally purchases and ultimately sells the interest of the insured in the real property or the interest of the claimant adverse to the insured. The assets so acquired are carried at the lower of cost or estimated realizable value, net of any indebtedness thereon. Notes, real estate and other assets purchased or otherwise acquired in settlement of claims, net of valuation reserves, totaled $12.3 million, $5.8 million and $7.5 million, respectively, as of December 31, 1995.\nReinsurance and Coinsurance. The Company assumes and distributes large title insurance risks through mechanisms of reinsurance and coinsurance. In reinsurance agreements, in consideration for a portion of the premium, the reinsurer accepts that part of the risk which the primary insurer cedes to the reinsurer over and above the portion retained by the primary insurer. The primary insurer, however, remains liable for the total risk in the event that the reinsurer does not meet its obligation. As a general rule, the Company does not retain more than $25 million of coverage on any single policy. Under coinsurance agreements, each coinsurer is jointly and severally liable for the risk insured, or for so much thereof as is agreed to by the parties. The Company's reinsurance activities account for less than 1% of its total title insurance operating revenues.\nCompetition. The title insurance business is highly competitive. The number of competing companies and the size of such companies varies in the different areas in which the Company conducts business. Generally, in areas of major real estate activity, such as metropolitan and suburban localities, the Company competes with many other title insurers. Approximately 90 title insurance underwriters are members of the American Land Title Association, the title insurance industry's national trade association. The Company's major nationwide competitors in its principal markets include Chicago Title and Trust Company (which also includes Ticor Title Insurance Company and Security Union Title Insurance Company), Commonwealth Land Title Insurance Company, Lawyers Title Insurance Company, Stewart Title Guaranty Company, Old Republic Title Insurance Group and Fidelity National Title Insurance Company. In addition to these nationwide competitors, numerous agency operations throughout the country provide aggressive competition on the local level.\nThe Company believes that competition for title insurance business is based primarily on the quality and timeliness of service, because parties to real estate transactions are usually concerned with time schedules and costs associated with delays in closing transactions. In those states where prices are not established by regulatory authorities, the price of title insurance policies is also an important competitive factor. The Company believes that it provides quality service in a timely manner at competitive prices.\nTHE COMPANY'S RELATED BUSINESSES\nAs an adjunct to its title insurance business, in 1986 the Company embarked on a diversification program by acquiring and developing financial service businesses closely related to the real estate transfer and closing process. These businesses included tax monitoring, home warranty, flood zone determination, and reporting of credit and property information. The development of these businesses has allowed the Company to become one of the nation's leading companies offering a full range of services to real property buyers and mortgage lenders. The Company also operates a trust and banking business in southern California.\nThe Real Estate Information Service Business. The real estate information service business encompasses tax monitoring, mortgage credit reporting, flood zone determination and other property information services.\nThe tax monitoring service, established by the Company in 1987, advises real property mortgage lenders of the status of property tax payments due on real estate securing their loans. With the acquisition of TRTS Data Services, Inc., (now named First American Real Estate Information Services, Inc.) in November 1991, the Company believes that it is the second largest provider of tax monitoring services in the United States.\nUnder a typical contract, a tax service provider monitors, on behalf of a mortgage lender, the real estate taxes owing on properties securing such lender's mortgage loans for the life of such loans. In general, providers of tax monitoring services, such as the Company's tax service, indemnify mortgage lenders against losses resulting from a failure to monitor delinquent taxes. Where a mortgage lender requires that tax payments be impounded on behalf of borrowers, providers of tax monitoring services, such as the Company's tax service, may be required to monitor and oversee the transfer of these monies to the taxing authorities and provide confirmation to lenders that such taxes have been paid.\nThe Company's tax service business markets its product through a nationwide sales staff which calls on servicers and originators of mortgage loans. The Company's primary source of tax service business is from large multistate mortgage lenders. The Company's only major nationwide competitor in the tax service business is Transamerica Real Estate Tax Service. Because of its broad geographic coverage and the large number of mortgage loans not being serviced by a third party tax service provider, the Company believes that it is well positioned to increase its market share in the tax service market.\nThe fee charged to service each mortgage loan varies from region to region, but generally falls within the $55 to $80 price range and is paid in full at the time the contract is executed. The Company recognizes approximately 70% of this fee in the year the contract is executed. The remaining 30% of the fee is deferred over the remaining life of the contract. However, income taxes are paid on the entire fee in the year the fee is received. The Company maintains extremely small reserves for losses relating to its tax monitoring services because historically the Company's losses relating to such services have been negligible, and the Company is not presently aware of any reason why its historical loss experience will not continue at current levels.\nThe Company's mortgage credit reporting service provides credit information reports for mortgage lenders throughout the United States. These reports are derived from two or more credit bureau sources and are summarized and prepared in a standard form acceptable to mortgage loan originators and secondary mortgage purchasers. The Company's mortgage credit reporting service has grown primarily through acquisitions. In 1994, the Company acquired all of the minority interests in its lower tier subsidiaries Metopolitan Credit Reporting Services, Inc., and Metropolitan Property Reporting Services, Inc. In 1994, the Company also acquired California Credit Data, Inc., and Prime Credit Reports, Inc., and in 1995, the Company acquired Credco, Inc. (now named\nFirst American Credco, Inc.). With the acquisition of First American Credco, Inc., the Company believes that it is now the largest mortgage credit reporting service in the United States.\nIn January 1995, the Company acquired Flood Data Services, Inc. (now named First American Flood Data Services, Inc.). This business furnishes to mortgage lenders flood zone determination reports, which provide information on whether or not property securing a loan is in a governmentally delineated special flood hazard area. Federal legislation passed in 1994 requires that most mortgage lenders obtain a determination of the current flood zone status at the time each loan is originated and obtain updates during the life of the loan. First American Flood Data Services, Inc., is the largest provider of flood zone determinations in the United States.\nThe Home Warranty Business. The Company's home warranty business commenced operations in 1984, in part with the proceeds of a $1.5 million loan from the Company which was, in 1986, converted to a majority equity interest. The Company currently owns 79% of its home warranty business, which is operated as a second tier subsidiary, with the balance owned by management of that subsidiary. The Company's home warranty business issues one-year warranties which protect homeowners against defects in household systems and appliances, such as plumbing, water heaters and furnaces. The Company's home warranty subsidiary currently charges approximately $245 to $295 for its basic home warranty contract. Optional coverage is available for air conditioners, pools, spas, washers, dryers and refrigerators for charges ranging from approximately $25 to $125. For an additional charge, coverage is renewable annually at the option of the homeowner upon approval by the home warranty subsidiary. Home warranties are marketed through real estate brokers and agents. This business is conducted in certain counties of Arizona, California, Nevada, Texas and Washington. The principal competitor of the Company's home warranty business is American Home Shield, a subsidiary of Service Master L.P. Fees for these warranties are paid at the closing of the home purchase and are recognized monthly over a twelve month period.\nThe Trust Business. Since 1960, the Company has conducted a general trust business in California, acting as trustee when so appointed pursuant to court order or private agreement. In 1985, the Company formed a banking subsidiary into which its subsidiary trust operation was merged. As of December 31, 1995, the trust operation was administering fiduciary and custodial assets having a market value of approximately $915 million.\nThe Thrift Business. During 1988, the Company, through a majority owned subsidiary, acquired an industrial loan corporation (the \"Thrift\") that accepts thrift deposits and uses deposited funds to originate and purchase loans secured by commercial properties in southern California. As of December 31, 1995, the Thrift had approximately $43.4 million of demand deposits and $46.1 million of loans outstanding.\nThe loans made by the Thrift currently range in amount from $4,000 to $825,000, with an average loan balance of $230,000. Loans are made only on a secured basis, at loan-to-value percentages no greater than 65%. The Thrift specializes in making commercial real estate loans, installment loans to individuals and financing commercial equipment leases. In excess of 90% of the Thrift's loans are made on a variable rate basis. The average yield on the Thrift's loan portfolio as of December 31, 1995, was 12%. A number of factors are included in the determination of average yield, principal among which are loan fees and closing points amortized to income, prepayment penalties recorded as income, and amortization of discounts on purchased loans. The Thrift's primary competitors in the southern California commercial real estate lending market are other thrift and loan companies and, to a lesser extent, commercial banks. In recent years, many of the commercial banks operating in southern California have significantly reduced their involvement in the commercial real estate lending market as a result of the regulatory requirements to which they are subject. As a result, the Company has been able to enhance its competitive position in this market and obtain relatively high yields on its loan portfolio. In addition, the Company believes that many borrowers who might be eligible for loans from commercial banks use thrift and loan companies, such as the Thrift, because, in general, thrift and loan companies offer longer maturity loans than do commercial banks, which typically offer one-year renewable loans. There is, however, a higher degree of risk associated with longer term loans than shorter term loans. The Thrift's average loan is 60 months in duration.\nThe performance of the Thrift's loan portfolio is evaluated on an ongoing basis by management of the Thrift. The Thrift places a loan on nonaccrual status when two payments become past due. When a loan is placed on nonaccrual status, the Thrift's general policy is to reverse from income previously accrued but unpaid interest. Income on such loans is subsequently recognized only to the extent that cash is received and future collection of principal is probable. Interest income on nonaccrual loans which would have been recognized during the year ended December 31, 1995, if all of such loans had been current in accordance with their original terms, totalled $232,000. Interest income actually recognized on these nonaccrual loans for the year ended December 31, 1995, was $76,000. The following table sets forth the amount of the Thrift's nonperforming loans as of the dates indicated.\nBased on a variety of factors concerning the creditworthiness of its borrowers, the Thrift determined that it had $1,565,000 of potential problem loans in existence as of December 31, 1995.\nThe Thrift's allowance for loan losses is established through charges to earnings in the form of provision for loan losses. Loan losses are charged to, and recoveries are credited to, the allowance for loan losses. The provision for loan losses is determined after considering various factors, such as loan loss experience, maturity of the portfolio, size of the portfolio, borrower credit history, the existing allowance for loan losses, current charges and recoveries to the allowance for loan losses, the overall quality of the loan portfolio, and current economic conditions, as determined by management of the Thrift, regulatory agencies and independent credit review specialists. While many of these factors are essentially a matter of judgment and may not be reduced to a mathematical formula, the Company believes that, in light of the collateral securing its loan portfolio, the Thrift's current allowance for loan losses is an adequate allowance against foreseeable losses.\nThe following table provides certain information with respect to the Thrift's allowance for loan losses as well as charge-off and recovery activity.\nThe adequacy of the Thrift's allowance for loan losses is based on formula allocations and specific allocations. Formula allocations are made on a percentage basis which is dependent on the underlying collateral, the type of loan and general economic conditions. Specific allocations are made as problem or potential problem loans are identified and are based upon an evaluation by the Thrift's management of the status of such loans. Specific allocations may be revised from time to time as the status of problem or potential problem loans changes.\nThe following table shows the allocation of the Thrift's allowance for loan losses and the percent of loans in each category to total loans at the dates indicated.\nACQUISITIONS\nCommencing in the 1960s, the Company initiated a growth program with a view to becoming a nationwide provider of title insurance. This program included expansion into new geographic markets through internal growth and selective acquisitions of over 100 local and regional title companies. During the mid- 1980's, the Company began expanding into other real estate related financial services.\nSince 1980, the Company has made strategic acquisitions designed to expand not only its direct title operations, but also the range of services it can provide to real property buyers and mortgage lenders. The following lists some of the key acquisitions made in furtherance of this strategy:\n- -------- (1)Unless otherwise indicated, all entities listed are wholly owned by the Company. (2)99% owned. (3)Subsequently merged into First American. (4)80% owned. (5)99% owned. (6)Asset acquisition. (7)79% owned.\nREGULATION\nThe title insurance business is heavily regulated by state insurance regulatory authorities. These authorities generally possess broad powers with respect to the licensing of title insurers, the types and amounts of investments that title insurers may make, insurance rates, forms of policies and the form and content of required annual statements, as well as the power to audit and examine title insurers. Under state laws, certain levels of capital and surplus must be maintained and certain amounts of securities must be segregated or deposited with appropriate state officials. Various state statutes require title insurers to defer a portion of all premiums in a reserve for the protection of policyholders and to segregate investments in a corresponding amount. Further, most states restrict the amount of dividends and distributions a title insurer may make to its shareholders.\nThe National Association of Insurance Commissioners has recently announced that it intends to increase efforts to have its model insurance code adopted by state legislatures. The model insurance code contains restrictions limiting the ability of insurance companies to pay dividends to their shareholders. The dividend limitations in the model code are more restrictive than those set forth in most state insurance codes currently in effect, including the California Insurance Code which governs First American. The Company cannot predict whether the model insurance code or any provision thereof will be adopted in California.\nThe Company's home warranty business also is subject to regulation by insurance authorities in the states in which it conducts such business. The Company's trust company and industrial loan company are both subject to regulation by the Federal Deposit Insurance Corporation. In addition, the Company's trust company is regulated by the California Superintendent of Banks and the Company's industrial loan company is regulated by the California Commissioner of Corporations.\nINVESTMENT POLICIES\nThe Company invests primarily in cash equivalents, federal and municipal governmental securities, mortgage loans and investment grade debt and equity securities. The largely fixed income portfolio is classified in the Company's financial statements as \"available for sale.\" In addition to the Company's investment strategy, state laws impose certain restrictions upon the types and amounts of investments that may be made by the Company's regulated subsidiaries.\nAdditionally, on April 21, 1992, the Company entered into a $65 million Credit Agreement with a syndicate of banks that includes The Chase Manhattan Bank (National Association) as both lender and agent for the syndicate (the \"Credit Agreement\"). Under the terms of the Credit Agreement, a term loan of $65 million was made to the Company on April 27, 1992, and the proceeds thereof were used to retire approximately $63 million of demand and term indebtedness. The Credit Agreement, as amended, contains investment restrictions limiting the types and amounts of investments that the Company and its subsidiaries may make. Such restrictions limit the investments in and advances to subsidiaries and affiliated companies that the Company may make and generally limit the Company's other investments to investment grade securities, such as U.S. Treasury securities, insured bank time deposits or certificates of deposit, repurchase obligations secured by U.S. Treasury securities, bank commercial paper and secured money market funds. The Company is, however, permitted to make certain additional investments not in excess of 25% of stockholders' equity, of which no more than 60% may be in equity securities and no more than $5 million may be with any one issuer.\nEMPLOYEES\nThe following table provides a summary of the total number of employees of the Company as of December 31, 1995:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns two adjacent office buildings in Santa Ana, California, which house its executive offices, its trust and banking subsidiary and the Orange County title insurance branch operations. This complex, which contains approximately 105,000 square feet of floor space and an enclosed parking area, comprises one city block. The Company also owns an 18,000 square foot office building, located across the street from its main offices, that will provide space for expansion of its home office operations.\nThe Company's title insurance subsidiary, First American, and its subsidiaries, own or lease buildings or office space in more than 400 locations throughout the United States and Canada, principally for their respective title operations.\nThe Company's real estate information subsidiary, First American Real Estate Information Services, Inc. (\"FAREISI\"), owns a building in Irving, Texas, which houses its national operations center. This building contains 70,000 square feet of office space and was purchased in September 1992. FAREISI's corporate headquarters are housed in a leased office building located in St. Petersburg, Florida. In addition, FAREISI and its subsidiaries lease office space in more than 75 locations throughout the United States, principally for their respective operations.\nThe Company's home warranty subsidiary owns 1.7 acres of land in Van Nuys, California, which contains a 20,000 square foot office building, a 7,000 square foot warehouse and a parking lot.\nEach of the office facilities occupied by the Company or its subsidiaries is in good condition and adequate for its intended use.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSet forth below is a brief description of material pending legal proceedings, other than ordinary routine litigation incidental to the Company's businesses, to which the Company or any of its subsidiaries is a party or of which any of their properties is the subject. Due to the nature of its businesses described in Item 1 above, the Company is involved in numerous routine legal proceedings incidental to such businesses. Some of these proceedings involve claims for damages in material amounts. At this time, however, the Company does not anticipate that the resolution of any of these proceedings will materially and adversely affect its financial condition.\nOn April 13, 1990, a civil action entitled Brown, et al. v. Ticor Title Insurance Co., et al., Case No.Civ 90-0577 (PHX-SMM) (U.S. Dist. Ct. Ariz.), was filed in the U.S. District Court in Phoenix, Arizona, by Walter Thomas Brown and Jeffrey L. Dziewit, as purported representatives of title insurance purchasers in Arizona and Wisconsin, alleging violation by First American Title Insurance Company (\"First American\") and other title insurers of federal antitrust laws in the alleged fixing of rates for title insurance and for search and examination services by reason of defendants' participation in state-regulated rating bureaus in the two states.\nOn October 11, 1994, the Judicial Panel on Multi-district Litigation ordered that an action entitled Segall, et al. v. Stewart Title Guaranty Co., et al., be transferred from the U.S. District Court for the Eastern District of Wisconsin to the District of Arizona for coordinated or consolidated pretrial proceedings with Brown. These two actions are now consolidated and part of MDL-94-1027, under the title \"In Re:Title Search and Examination Services Antitrust Litigation.\" Segall is a civil suit filed on behalf of a purported class of purchasers of title insurance in Wisconsin against certain title insurance companies and individuals. The Segall suit alleges that the defendants violated federal antitrust laws by reason of the defendants' participation in the state-regulated rating bureau in Wisconsin. The purported plaintiff class includes the Wisconsin plaintiff class members alleged in Brown as well as some additional purported class members. The Company does not believe that the ultimate resolution of this litigation will materially and adversely affect its financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nCOMMON STOCK MARKET PRICES AND DIVIDENDS\nThe Company's common stock began trading on the New York Stock Exchange (ticker symbol FAF) on December 3, 1993. Prior to December 3, 1993, The Company's common stock was traded over-the-counter on the NASDAQ National Market System. The approximate number of record holders of common stock on February 29, 1996 was 3,274.\nHigh and low stock prices and dividends for the last two years were:\nWhile the Company expects to continue its policy of paying regular quarterly cash dividends, future dividends will be dependent on future earnings, financial condition and capital requirements. The payment of dividends is subject to the restrictions described in Notes 2 and 8 to the consolidated financial statements included in \"Item 8. Financial Statements and Supplementary Data\" of Part II of this report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\n- -------- Note A--See Note 10 to the consolidated financial statements for description of a change in accounting for income taxes.\nNote B--Per share information relating to net income is based on the weighted average number of shares outstanding for the years presented. Per share information relating to stockholders' equity is based on shares outstanding at the end of each year.\nNote C--Title order volumes are those processed by the direct title operations of the Company and do not include orders processed by agents.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.\nRESULTS OF OPERATIONS\nOVERVIEW--As with all providers of real estate-related financial and informational services, the Company's revenues depend, in large part, upon the level of real estate activity and the cost and availability of mortgage funds. The majority of the Company's revenues for the title insurance and real estate information segments result from resales and refinancings of residential real estate, and to a lesser extent, from commercial transactions and the construction and sale of new properties. Revenues for the Company's home warranty segment result solely from residential resale activity and do not benefit from refinancings. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, numerous actions taken by the Federal Reserve Board during 1992 and 1993 to stimulate economic recovery caused unusual fluctuations in the traditional pattern of real estate activity. During 1993 mortgage interest rates fell to their lowest level in 25 years. This decline in rates caused an unprecedented volume of refinance transactions and the Company's title insurance and real estate information segments processed record order volumes. Due to inflationary concerns, the Federal Reserve Board began a succession of interest rate increases in February 1994. The resulting increase in mortgage interest rates adversely affected the Company's revenue base in the second half of 1994 (primarily the fourth quarter) as refinance activity came to a virtual halt. This, coupled with the persistently poor real estate economy in California and a return of the traditional seasonal real estate cycle, resulted in a low inventory of open transactions going into 1995. As a result, 1995 first quarter operating revenues experienced a 30% decline when compared with the same period of the prior year. In response to the severe decline in new orders, the Company instituted personnel reductions totaling 26% of the work force from March 1994 through February 1995. However, the cost cutting measures lagged the revenue declines resulting in a fourth quarter 1994 loss of $.25 per share and a first quarter 1995 loss per share of $1.11. Mortgage interest rates peaked in January 1995 and decreased throughout the remainder of the year and into 1996 helped by an easing of monetary policy by the Federal Reserve Board. During the last half of 1995, the national real estate markets improved and refinancing activity began to increase. These factors contributed to a 26% improvement in operating revenues in the last half of 1995 when compared to the first half of 1995 and resulted in earnings per share of $1.68 compared with a loss per share of $1.01.\nOPERATING REVENUES--A summary by segment of the Company's operating revenues is as follows:\nOperating revenues from direct title operations decreased 8.0% in 1995 as compared with 1994. This decrease was primarily attributable to a 7.7% decrease in the number of title orders closed by the Company's direct operations. The Company's direct title operations closed 667,200 title orders during 1995, as compared with 722,900 title orders closed during 1994. This decrease was attributable to higher interest rates and inclement weather which resulted in reduced national real estate activity in the first half of 1995. Operating revenues from direct title operations decreased 11.0% in 1994 as compared with 1993. The decrease was primarily attributable to a 22.5% decline in the number of title orders closed, offset in part by an increase in the average revenues per order closed. The decrease in orders closed was due to a decline in refinance activity, the subsiding real estate economy in California (a state highly concentrated with direct title operations) and the return of the traditional,\nseasonal real estate cycle in the fourth quarter 1994. The average revenues per order closed were $778 for 1994 as compared with $678 for 1993. The increase reflected a change in the Company's business mix from predominantly lower margin refinance transactions in 1993 to a more balanced mix in 1994, including higher margin resale transactions. Operating revenues from agency title operations, which are more concentrated in the midwestern and eastern sectors of the country, decreased 21.5% in 1995 from 1994. The decrease reflects a slow first half of 1995 as discussed above, compounded by the inherent delay in reporting by agents of the resurgence in business for the latter part of 1995. Operating revenues from agency title operations increased 6.6% in 1994 over 1993. This increase was primarily attributable to the high level of orders closed with our agents during the fourth quarter 1993 and not reported to the Company until the beginning of 1994, as well as the increase in resale activity, offset in part by the decline in refinance transactions.\nReal estate information operating revenues increased 53.7% in 1995 when compared with 1994. This increase was primarily attributable to $59.8 million of operating revenues contributed by new acquisitions, partially offset by the same economic factors affecting title insurance mentioned above. Operating revenues remained relatively constant for 1994 when compared with 1993; this constant level of revenues, in spite of a significant fourth quarter 1994 revenue reduction, was primarily attributable to the heavy volume of refinance transactions that continued through the end of 1993 and into the beginning of 1994, as well as approximately $6.0 million of revenues contributed by companies acquired during 1994.\nHome warranty operating revenues increased 15.7% in 1995 over 1994 and 25.5% in 1994 over 1993. These increases were primarily attributable to improvements in certain of the residential resale markets in which this segment operates, successful geographic expansion, increased consumer awareness and an increase in the number of annual renewals.\nINVESTMENT AND OTHER INCOME--Investment and other income increased 18.4% in 1995 over 1994 and 4.3% in 1994 over 1993. The increase in the current year was primarily attributable to gains on the sale of certain investments, a $.7 million fire insurance recovery and increased equity in earnings of affiliates of $.5 million, offset in part by a 9.3% decrease in the average investment portfolio balance. The increase in 1994 over 1993 was due to a 22.2% increase in the average investment portfolio balance, offset in part by a reduction of $1.4 million in equity in earnings of affiliates. See Note 9 to the consolidated financial statements for additional details on investment and other income.\nSALARIES AND OTHER PERSONNEL COSTS--A summary by segment of the Company's salaries and other personnel costs is as follows:\nThe Company's title insurance segment is labor intensive; accordingly, a major variable expense component is salaries and other personnel costs. The expense component is affected by two competing factors: The need to monitor personnel changes to match corresponding or anticipated new orders, and the need to provide quality service. Commencing in the second quarter 1994 through the first quarter 1995, the Company's ability to match cost reductions with order declines was hampered by the continual upward adjustment of interest rates by the Federal Reserve Board. In addition, the Company's growth in operations servicing builder and lender business has created ongoing fixed costs required to service accounts, even when market conditions are producing fewer new orders.\nTitle insurance personnel expenses decreased 4.4% in 1995 from 1994. The decrease relates directly to the Company's intensified efforts during the latter part of 1994 and the beginning of 1995 to adjust personnel and related expense levels commensurate with new order counts. This cost-containment process stabilized the cost of the labor base at a more acceptable level as business improved during the second quarter 1995. This decrease was offset, in part, by acquisition activity and modest personnel increases in the second half of 1995. Personnel expenses increased 4.2% in 1994 over 1993. This increase was primarily attributable to the additional personnel needed to service the heavy volume of title orders (predominately refinance transactions) that continued through the end of 1993 into the first quarter of 1994 and, to a lesser extent, acquisition activity. This increase was partially offset by the effects of personnel reductions that commenced during the beginning of the second quarter 1994, and continued throughout the rest of 1994 in response to significantly reduced order counts; although, due to the costs associated with terminations, expense declines lagged behind personnel reductions.\nReal estate information personnel expenses increased 60.1% in 1995 over 1994. This increase was primarily due to $20.0 million of personnel costs associated with acquisitions, and to a lesser extent, in-house development of a new electronic communications delivery system for information based products. This was offset in part by personnel reductions associated with the decline in new tax service contracts which began in the last half of 1994 and continued into the first half of 1995. Personnel expenses increased 34.9% in 1994 over 1993. This increase was primarily due to personnel costs incurred servicing the heavy volume of business during the first half of 1994, costs associated with developing new and enhancing existing computer software to better service customer needs and $2.9 million of costs attributable to company acquisitions. This increase was partially offset by a 13.8% reduction in personnel in the last half of 1994, although, due to personnel separation costs, expense declines lagged behind personnel reductions.\nHome warranty personnel expenses increased 9.0% in 1995 over 1994 and 16.5% in 1994 over 1993. The increases were primarily due to the additional personnel required to service the increased business volume in the states the segment currently services, as well as new geographic expansion and modest salary increases. These increases were offset in part by ongoing efforts of management to maximize personnel efficiencies.\nIn December 1990, the Financial Accounting Standards Board (FASB) issued Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" This standard became effective in 1993 and requires the Company to accrue the cost of providing postretirement health care and life insurance benefits over the service lives of employees. Compliance with this standard did not materially affect the Company's results of operations or financial condition. In November 1992, the FASB issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" This standard became effective in 1994 and requires employers to accrue an obligation if the benefits are attributable to service already rendered, the benefits accumulate or vest, payment is probable, and the amounts can be reasonably estimated. Compliance with the standard did not materially affect the Company's results of operations or financial condition.\nPREMIUMS RETAINED BY AGENTS--A summary of agent retention and agent revenues is as follows:\nThe premium split between underwriter and agents is in accordance with their respective agency contracts and can vary from region to region due to divergencies in real estate closing practices as well as rating structures. The decrease in the percentage amount of title premiums retained by agents was the direct result of changes in the geographic mix of agency revenues.\nOTHER OPERATING EXPENSES--A summary by segment of the Company's other operating expenses is as follows:\nTitle insurance other operating expenses remained relatively constant for the last three years. The modest percentage changes noted are due in part to marginal price level increases by vendors and acquisition activity, partially offset by successful cost-containment programs. Other operating expenses were also impacted by changes in incremental costs (i.e., office supplies, document reproduction, messenger services, plant maintenance and title search costs) associated with the relative changes in open order counts.\nReal estate information other operating expenses increased 63.2% in 1995 over 1994 and 26.8% in 1994 over 1993. The increase in 1995 was primarily attributable to $28.8 million relating to acquisitions, offset in part by cost-containment programs in light of a reduction in new tax service contracts in 1995. The increase in 1994 was attributable to the incremental costs incurred servicing the heavy volume of business during the first half of 1994, costs associated with developing and enhancing computer software, costs incurred in assimilating and expanding the mortgage credit reporting operations, and $2.0 million of other operating expenses attributable to acquisitions.\nPROVISION FOR TITLE LOSSES AND OTHER CLAIMS--A summary by segment of the Company's provision for title losses and other claims is as follows:\nThe provision for title insurance losses expressed as a percentage of title insurance operating revenues was 6.6% in 1995, 7.6% in 1994, and 8.9% in 1993. The decreases were primarily attributable to an ongoing improvement in the Company's claims experience, as well as a reduction in major claims activity. The Company anticipates that the improvement over the past several years will continue in 1996. The provision for home warranty losses as a percentage of home warranty operating revenues was 58.0% in 1995, 53.4% in 1994, and 52.5% in 1993. These increases were primarily attributable to increases in the average number of claims per contract experienced during these periods, resulting from the home warranty operations offering extended coverages on its warranties.\nDEPRECIATION AND AMORTIZATION--Capital expenditures as well as depreciation and amortization are summarized in Note 14 to the consolidated financial statements.\nINTEREST--Interest expense remained relatively unchanged in 1995 when compared with 1994 primarily as the result of an average outstanding debt balance and comparable average interest rates. Interest expense increased 41.8% in 1994 over 1993 primarily due to $1.5 million of interest expense attributable to a\nDecember 1993 trust deed note, which was paid off in November of 1994, and a higher average interest rate, offset in part by a 3.7% decrease in the average outstanding debt balance. The Company, at its option, has a reduced interest rate option on the variable rate indebtedness portion of the Company's credit facility. This agreement is described in Note 8 to the consolidated financial statements.\nMINORITY INTERESTS--Minority interests in net income of consolidated subsidiaries decreased 27.6% in 1995 from 1994 and 44.1% in 1994 from 1993. The decrease in 1995 over 1994 was primarily attributable to the Company's purchases of shares from minority shareholders. The decrease in 1994 over 1993 was due to a decline in the profitability of the Company's less than 100% owned subsidiaries, the August 1994 sale of the Company's remaining interest in North American Title Insurance Company and the purchases of shares from minority shareholders.\nPRETAX PROFITS--A summary by segment of the Company's pretax profits is as follows:\nThe Company's profit margins and pretax profits vary according to a number of factors, including the volume, composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. For example, in title insurance operations, commercial transactions tend to generate higher revenues and greater profit margins than residential transactions. Further, profit margins from refinancing activities are lower than those from resale activities because in many states there are premium discounts on, and cancellation rates are higher for, refinancing transactions. Cancellations of title orders adversely affect pretax profits because costs are incurred and expensed in opening and processing such orders but revenues are not generated. Also, the Company's direct title insurance business has significant fixed costs in addition to its variable costs. Accordingly, profit margins from the Company's direct title insurance business improve as the volume of title orders closed increases. Title insurance profit margins are also affected by the percentage of operating revenues generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Real estate information pretax profits are generally unaffected by the type of real estate activity but increase as the volume of residential real estate loan transactions increases. Home warranty pretax profits improve as the volume of residential resales increases. In general, the title insurance business is a lower margin business when compared to the Company's other segments. The lower margins reflect the high fixed cost of producing title evidence whereas the corresponding revenues are subject to regulatory and competitive pricing constraints.\nPREMIUM TAXES--A summary by pertinent segment of the Company's premium taxes is as follows:\nInsurers are generally not subject to state income or franchise taxes. However, in lieu thereof, a \"premium\" tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of title insurance and home warranty operating revenues. Premium taxes for title insurance decreased 12.5% in 1995 from 1994 and 13.1% in 1994 from 1993. These changes correspond to the relative decreases in title insurance operating revenues. Premium taxes as a percent of title insurance operating revenues remained relatively constant at approximately 1.2%. Premium taxes for home warranty increased 5.3% in 1995 over 1994 and 16.5% in 1994 over 1993. These changes reflect the level of home warranty premiums written during the respective periods.\nINCOME TAXES--The Company's effective income tax rate, which includes a provision for state income and franchise taxes for non-insurance subsidiaries, was 45.0% for 1995, 41.2% for 1994 and 40.3% for 1993. The increases in effective rate were primarily attributable to the reduction in the deductibility of certain business expenses, as mandated by the Revenue Reconciliation Act of 1993, and increases in state income and franchise taxes which resulted from the Company's non-insurance subsidiaries' contribution to pretax profits. The increase in effective rate for 1994 was partially offset by the utilization of $1.8 million of capital loss carryforwards, for which the Company had previously established a valuation allowance, pursuant to Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Information regarding items included in the reconciliation of the effective rate with the federal statutory rate is contained in Note 10 to the consolidated financial statements.\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes,\" which became effective for 1993. This statement prescribes the use of the liability method of accounting for income taxes, whereby deferred tax assets and liabilities are calculated at the balance sheet date using current tax laws and rates in effect. The cumulative effect of this change in accounting principal was recognized in the first quarter of 1993 in the form of a one-time benefit totaling $4.2 million.\nNET INCOME--Net income and per share information are summarized as follows:\nLIQUIDITY AND CAPITAL RESOURCES\nCash provided by operating activities amounted to $30.4 million, $53.9 million and $105.7 million for 1995, 1994 and 1993, respectively, after claim payments of $66.6 million, $87.6 million and $77.3 million, respectively. The principal non-operating uses of cash and cash equivalents for the three-year period ended December 31, 1995, were for additions to the investment portfolio, capital expenditures, company acquisitions and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were from proceeds from the sales and maturities of certain investments, and in 1994, proceeds from the sale of property and equipment and proceeds from the issuance of debt. The net effect of all activities on total cash and cash equivalents was a decrease of $8.3 million in 1995 and increases of $23.9 million and $10.5 million in 1994 and 1993, respectively.\nNotes and contracts payable as a percentage of total capitalization as of December 31, 1995, was 19.1% as compared with 22.1% as of the prior year end. The decrease was primarily attributable to a $12.4 million net\ndecrease in debt. As part of the Company's strategy to extend the maturity of, and provide a long-term amortization schedule for, its outstanding demand and term indebtedness, the Company entered into a credit agreement with the Chase Manhattan Bank as agent on April 21, 1992. Under the terms of the credit agreement, the company borrowed $65.0 million on April 27, 1992, and used the proceeds thereof to retire approximately $63 million of demand and near-term indebtedness. During 1994, the Company amended the credit agreement to borrow an additional $20.0 million of variable rate indebtedness to pay off an existing higher rate trust deed note. In addition, the amendment provided for a $30.0 million revolving line of credit which remained unused as of December 31, 1995. This credit agreement is more fully described in Note 8 to the consolidated financial statements.\nPursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to the Company in 1996 from its principle subsidiary, First American Title Insurance Company, is $44.6 million. Such restrictions have not had, nor are they expected to have, an impact on the Company's ability to meet its cash obligations.\nDue to the Company's significant liquid asset position and its consistent ability to generate cash flows from operations, management believes that its resources are sufficient to satisfy its anticipated cash requirements. The Company's strong financial position will enable management to react to future opportunities for acquisitions or other investments in support of the Company's continued growth and expansion.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSeparate financial statements for subsidiaries not consolidated and 50% or less owned persons accounted for by the equity method have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary.\nFinancial statement schedules not listed above are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or in the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ON THE CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nIn our opinion, the consolidated financial statements and financial statement schedules listed in the index on page 22 present fairly, in all material respects, the financial position of The First American Financial 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 fiscal years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. 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. 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 10 to the consolidated financial statements, the Company changed its method of accounting for income taxes in fiscal year 1993.\nPRICE WATERHOUSE LLP\nCosta Mesa, California February 28, 1996\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee Notes to Consolidated Financial Statements\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF INCOME\nSee Notes to Consolidated Financial Statements\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES:\nThe consolidated financial statements include the accounts of The First American Financial Corporation and all majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain 1993 and 1994 amounts have been reclassified to conform with the 1995 presentation.\nCash equivalents\nThe Company considers cash equivalents to be all short-term investments which have an initial maturity of 90 days or less and are not restricted for statutory deposit or premium reserve requirements. The carrying amount for cash equivalents is a reasonable estimate of fair value due to the short-term maturity of these investments.\nInvestments\nDeposits with savings and loan associations and banks are short-term investments with initial maturities of more than 90 days. The carrying amount of these investments is a reasonable estimate of fair value due to their short-term nature.\nDebt securities are carried at fair value and consist primarily of investments in obligations of the United States Treasury, various corporations and certain state and political subdivisions.\nEquity securities are carried at fair value and consist primarily of investments in marketable common and preferred stocks of corporate entities in which the Company's ownership does not exceed 20%.\nOther long-term investments consist primarily of investments in affiliates, which are accounted for under the equity method of accounting, and notes receivable, which are carried at the lower of cost or estimated realizable value.\nRealized gains and losses on investments are determined using the specific identification method. Unrealized gains or losses on debt and equity securities are included, net of related tax effects, as a separate component of stockholders' equity.\nProperty and equipment\nDepreciation on buildings and furniture and equipment is computed using the declining balance and straight-line methods over estimated useful lives of 25 to 45 and 3 to 10 years, respectively.\nTitle plants and other indexes\nTitle plants and other indexes are carried at original cost. Appraised values are used in conjunction with the acquisition of purchased subsidiaries. The cost of daily maintenance (updating) of these plants and other indexes are charged to expense as incurred. Because properly maintained title plants and other indexes have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation.\nAssets acquired in connection with claim settlements\nIn connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property, or judgment liens. These assets, sometimes referred to as \"salvage assets,\" are carried at the lower of cost or estimated realizable value, net of any indebtedness thereon. Judgment liens primarily represent funds expended by the Company to purchase judgments to satisfy title claims.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nGoodwill and other intangibles\nGoodwill recognized in business combinations is amortized over its estimated useful life ranging from 30 to 40 years. Other intangibles, which include customer lists, covenants not to compete and organization costs, are amortized over their estimated useful lives, ranging from 3 to 20 years.\nDeferred policy acquisition costs\nDeferred policy acquisition costs are directly related to the procurement of home warranty and tax service contracts. These costs are deferred and amortized to expense in the same pattern as contract fees are recognized as revenues.\nReserve for known and incurred but not reported claims\nThe Company provides for title insurance losses based upon its historical experience by a charge to expense when the related premium revenue is recognized. Historically, major claims (i.e., claims greater than $0.5 million) were charged to expense as they became known because the unique circumstances surrounding most major claims made it inherently impractical to predict the incidence and amount of such claims. In the fourth quarter 1995, the Company determined, with the assistance of an actuarial study, that sufficient major claims data now exists to reasonably estimate a reserve for incurred but not reported claims. Accordingly, the reserve for incurred but not reported claims at December 31, 1995, includes major claims. The inclusion of major claims did not have a material effect on the Company's financial condition or results of operations. Title insurance losses and other claims associated with ceded reinsurance are provided for as the company remains contingently liable in the event that the reinsurer does not satisfy its obligations. The reserve for known and incurred but not reported claims reflects management's best estimate of the total costs required to settle all claims reported to the Company and claims incurred but not reported. The process applied to estimate claims costs is subject to many variables, including changes and trends in the type of title insurance policies issued, the real estate market and the interest rate environment. It is reasonably possible that a change in the estimate will occur in the future.\nThe Company provides for claim losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per claim is calculated using the average of the most recent twelve months of claims experience.\nOperating revenues\nTitle premiums on policies issued directly by the Company are recognized on the effective date of the title policy and escrow fees are recorded upon close of the escrow. Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent.\nRevenues from tax service contracts are recognized proportionately over the estimated duration of the contracts as the related servicing costs are estimated to occur. The majority of the servicing costs, approximately 70%, is incurred in the year the contract is executed, with the remaining 30% incurred over the remaining service life of the contract.\nRevenues from home warranty contracts are recognized ratably over the 12- month duration of the contracts.\nInterest on loans with the Company's thrift subsidiary is recognized on the outstanding principal balance on the accrual basis. Loan origination fees and related direct loan origination costs are deferred and recognized over the life of the loan.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPremium taxes\nTitle insurance and home warranty companies, like other types of insurers, are generally not subject to state income or franchise taxes. However, in lieu thereof, most states impose a tax based primarily on insurance premiums written. This premium tax is reported as a separate line item in the consolidated statements of income in order to provide a more meaningful disclosure of the taxation of the Company.\nIncome taxes\nTaxes are based on income for financial reporting purposes and include deferred taxes applicable to temporary differences between the financial statement carrying amount and the tax basis of certain of the Company's assets and liabilities.\nUse of Estimates\nCertain amounts and disclosures included in the consolidated financial statements require management to make estimates which could differ from actual results.\nFiduciary assets and liabilities\nAssets and liabilities of the trusts and escrows administered by the Company are not included in the consolidated balance sheets.\nNOTE 2. STATUTORY RESTRICTIONS ON STOCKHOLDERS' EQUITY AND INVESTMENTS:\nPursuant to insurance and other regulations of the various states in which the Company's title insurance subsidiary, First American Title Insurance Company (FATICO), operates, the amount of dividends, loans and advances available to the parent company from FATICO is limited, principally for the protection of policyholders. Under such statutory regulations, the maximum amount of dividends, loans and advances available to the parent company from FATICO in 1996 is $44.6 million.\nInvestments carried at $12.8 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 1995.\nFATICO maintained statutory capital and surplus of $205.6 million and $212.5 million at December 31, 1995 and 1994, respectively. Statutory net income for the years ended December 31, 1995, 1994 and 1993 was $11.4 million, $15.5 million and $83.0 million respectively.\nFATICO, domiciled in the state of California, prepares its statutory financial statements in accordance with prescribed accounting practices which include a variety of publications of the National Association of Insurance Commissioners, state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed.\nNOTE 3. DEBT AND EQUITY SECURITIES:\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This standard requires that all debt and equity securities, other than those that the Company has the ability and intent to hold to maturity, be carried at fair value. The Company has classified its securities portfolio as available-for-sale and, in accordance with SFAS No. 115, has included fair value adjustments as a separate component of stockholders' equity, net of tax. Prior to January 1, 1994, the Company reported only its equity securities at fair value with adjustments included, net of tax, as a separate component of stockholders' equity.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe amortized cost and estimated fair value of investments in debt securities are as follows:\nThe amortized cost and estimated fair value of debt securities at December 31, 1995, by contractual maturities, are as follows:\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe cost and estimated fair value of investments in equity securities are as follows:\nSales of debt and equity securities resulted in realized gains of $1,316,000, $108,000 and $332,000 and realized losses of $358,000, $457,000 and $38,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The fair value of debt and equity securities was estimated using quoted market prices.\nNOTE 4. LOANS RECEIVABLE:\nLoans receivable are summarized as follows:\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nReal estate loans are secured by properties located in Southern California. The average yields on the Company's loan portfolio for the years ended December 31, 1995 and 1994, were 12% and 11%, respectively. Average yields are affected by amortization of discounts on loans purchased from other institutions, prepayment penalties recorded as income, loan fees amortized to income, and the market interest rates charged by thrift and loan institutions.\nThe fair value of loans receivable was $47.2 million and $41.7 million at December 31, 1995 and 1994, respectively, and was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality.\nThe allowance for loan losses is maintained at a level that is considered appropriate by management to provide for known and inherent risks in the portfolio.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 114, \"Accounting by Creditors for Impairment of a Loan.\" SFAS No. 114 became effective in the current year. This standard requires that an impaired loan be measured at the present value of expected future cash flows discounted at the loan's effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral dependent. Adoption of this standard did not have a materially adverse effect on the Company's financial condition or results of operations.\nNOTE 5. ASSETS ACQUIRED IN CONNECTION WITH CLAIM SETTLEMENTS:\nThe above amounts are net of valuation reserves of $11.2 million and $12.4 million at December 31, 1995 and 1994, respectively.\nThe fair value of notes receivable was $12.0 million and $9.7 million at December 31, 1995 and 1994, respectively, and was estimated based on the discounted value of the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit quality.\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 will become effective for the Company's 1996 fiscal year and requires companies to assess for potential impairments of long-lived assets and certain identifiable intangibles when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. The Company believes that adoption of this standard will not have a materially adverse effect on its financial condition or results of operations.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe activity in the valuation reserve is summarized as follows:\nNOTE 6. DEMAND DEPOSITS:\nPassbook and investment certificate accounts are summarized as follows:\nThe fair value of investment certificate accounts was $31.6 million and $25.6 million at December 31, 1995 and 1994, respectively, and was estimated based on the discounted value of the future cash flows using a discount rate approximating current market for similar liabilities. The carrying value of the passbook account approximates fair value due to the short-term nature of this liability.\nNOTE 7. RESERVE FOR KNOWN AND INCURRED BUT NOT REPORTED CLAIMS:\nActivity in the reserve for known and incurred but not reported claims is summarized as follows:\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n\"Other\" primarily represents reclassifications to the reserve for assets acquired in connection with claim settlements. Included in \"Other\" for 1995 is $10.0 million in purchase accounting adjustments. Claims activity associated with reinsurance is not material and, therefore, not presented separately.\nNOTE 8. NOTES AND CONTRACTS PAYABLE:\nAt December 31, 1995, the Company's borrowings under its bank credit agreement consisted of $7.6 million of fixed rate indebtedness ($8.4 million at December 31, 1994), maturing in April 1999 and bearing interest at 9.38% per annum; and $41.6 million of variable rate indebtedness ($52.6 million at December 31, 1994), maturing in October 2000 and bearing interest at the higher of Chase Manhattan Bank's prime lending rate or the federal funds rate plus 1\/2%. The Company may, at its election, use a reduced interest rate option of LIBOR plus 1 1\/4% for the majority of the variable rate indebtedness.\nDuring November 1994, the Company amended the credit agreement to borrow an additional $20.0 million of variable rate indebtedness to pay off an existing higher rate trust deed note. In addition, the amendment provided for a $30.0 million revolving line of credit which was unused as of December 31, 1995.\nIn February 1996, the Company further amended the credit agreement to provide for more favorable pricing for its LIBOR option. The applicable margins range from .50% to 1.00% depending on claims paying or financial strength ratings or the Company's adjusted leverage ratio. The amendment also provides for the elimination and\/or relaxation of certain restrictive covenants.\nThe terms of the amended credit agreement provide for quarterly amortization of all credit agreement indebtedness. The minimum quarterly payment is $1.7 million and the maximum quarterly payment is $3.0 million. The Company has the right to prepay the variable rate indebtedness but may prepay the fixed rate indebtedness only with the consent of the holder thereof. In addition, pursuant to the terms of the credit agreement, the Company must satisfy a number of financial convenants and has agreed to be bound by certain restrictive covenants. These covenants include, among others, limitations on the incurrence of additional indebtedness and\/or liens, as well as restrictions on defined investments, acquisitions, dispositions, payments of dividends and capital expenditures. Further, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt to equity ratios and fixed charge coverage ratios.\nAs security for its obligations to the lenders under the credit agreement, the Company has pledged the capital stock of its direct wholly owned operating subsidiaries, First American Title Insurance Company, First American Trust Company and First American Real Estate Information Services, Inc., which, in the aggregate, represent substantially all of its assets.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1995, are as follows (in thousands):\nThe fair value of notes and contracts payable was $77.7 million and $86.0 million at December 31, 1995 and 1994, respectively, and was estimated based on the current rates offered to the Company for debt of the same remaining maturities. The weighted average interest rate for the Company's notes and contracts payable was 7 1\/2% and 8% at December 31, 1995 and 1994, respectively.\nNOTE 9. INVESTMENT AND OTHER INCOME:\nThe components of investment and other income are as follows:\nNOTE 10. INCOME TAXES:\nIncome taxes are summarized as follows:\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIncome taxes differ from the amounts computed by applying the Federal income tax rate of 35%. A reconciliation of this difference is as follows:\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 provides that deferred tax assets and liabilities be recognized for temporary differences between the financial statement carrying amount and the tax basis of certain of the Company's assets and liabilities. In addition, SFAS No. 109 requires that deferred tax assets and liabilities be measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The impact on deferred taxes of changes in tax rates and laws, if any, is reflected in the financial statements in the period of enactment. In some situations, SFAS No. 109 permits the recognition of expected benefits of utilizing net operating loss and tax credit carryforwards.\nPursuant to the method prescribed under Accounting Principles Board Opinion (APB) No. 11, \"Accounting for Income Taxes,\" which was effective for years ending prior to January 1, 1993, deferred income taxes were recognized for income and expense items reported in different periods for financial reporting and income tax purposes using the applicable tax rate for the year in which the differences originated. Deferred taxes under APB No. 11 were not permitted to be adjusted for subsequent changes in tax rates.\nThe Company did not restate its financial statements for prior years since such restatement is not required under SFAS No. 109. Instead, the Company recognized a benefit of $4.2 million, or $.37 per share, representing the cumulative effect of a change in accounting for income taxes. The cumulative effect represented the adjustment of previously recorded deferred tax assets and liabilities to reflect lower prevailing tax rates, and the related adjustment of certain other balance sheet accounts. The effect of the adjustments to other balance sheet accounts was to increase deferred revenue by $11.5 million, accrued expenses by $3.0 million and reserves for claims by $0.8 million, and to decrease goodwill by $1.9 million.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe primary components of temporary differences which give rise to the Company's net deferred tax asset are as follows:\nThe Company has federal net operating loss carryforwards of approximately $3.6 million at December 31, 1995, that expire in 1999. The utilization of these net operating losses is limited to future federal taxable income of First American Real Estate Information Services, Inc., a wholly owned subsidiary of the Company. The utilization of the loss carryforward is also subject to limitations prescribed by Section 382 of the Internal Revenue Code.\nThe Company maintains a valuation allowance for certain temporary differences for which it is more likely than not the Company will not receive benefits.\nNOTE 11. EMPLOYEE BENEFIT PLANS:\nThe Company has pension and other retirement benefit plans covering substantially all employees. The Company's principal pension plan, amended to be noncontributory effective January 1, 1995, is a qualified defined benefit plan with benefits based on the employee's years of service and the highest five consecutive years' compensation during the last ten years of employment. The Company's policy is to fund all accrued pension costs. Contributions are intended to provide not only for benefits attributable to past service, but also for those benefits expected to be earned in the future. The Company also has non-qualified unfunded supplemental benefit plans covering certain key management personnel. Benefits under these plans are intended to be funded with proceeds from life insurance policies purchased by the Company on the lives of the executives.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNet pension cost for the Company's pension and other retirement benefit plans includes the following components:\nThe following table sets forth the plans' status at:\nThe rates of increase in future compensation levels for the plans of 4 1\/2% and 5% and the weighted average discount rates of 7 3\/4% and 8 1\/4% were used in determining the actuarial present value of the projected benefit obligation at December 31, 1995 and 1994, respectively. The majority of pension plan assets are invested in U.S. government securities, time deposits and common stocks with projected long-term rates of return of 9%.\nThe Company's principal profit sharing plan was amended effective January 1, 1995, to discontinue future contributions. The plan holds 1,675,000 and 1,844,000 shares of the Company's common stock, representing 15% and 16% of the total shares outstanding at December 31, 1995, and 1994, respectively. Contributions to the Company's profit sharing plans totaled $2.0 million and $3.0 million for 1994 and 1993, respectively.\nThe Company also has a Stock Bonus Plan for key employees pursuant to which 65,000, 55,000 and 46,000 common shares were awarded for 1995, 1994 and 1993, respectively, resulting in a charge to operations of $1.2 million, $1.9 million and $1.2 million respectively. The Plan, as amended December 9, 1992, provides that a total of up to 200,000 common shares may be awarded in any one year.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nEffective January 1, 1995, the Company adopted The First American Financial Corporation 401(k) Savings Plan (\"The Savings Plan\"), which is available to substantially all employees. The Savings Plan allows for employee elective contributions up to the maximum deductible amount as determined by the Internal Revenue Code.\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This standard was effective for 1993 and focuses principally on postretirement health care and life insurance benefits and requires accrual of the expected cost of providing those benefits over the service lives of the employees. Compliance with this standard did not have a materially adverse effect on the Company's financial condition or results of operations.\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" This standard was effective for 1994 and focuses principally on benefits provided to former or inactive employees after employment but before retirement. Compliance with this standard did not have a materially adverse effect on the Company's financial condition or results of operations.\nNOTE 12. COMMITMENTS:\nThe Company leases certain office facilities, automobiles and equipment under operating leases, which for the most part are renewable. The majority of these leases also provide that the Company will pay insurance and taxes. In December 1994, the Company entered into a sale-leaseback agreement with regard to certain furniture and equipment with a net book value of $22.4 million. Proceeds from the sale amounted to $31.4 million and a gain of $9.0 million has been included in deferred revenue and will be amortized over the life of the lease. Under the agreement, the Company has agreed to lease the equipment for four years with minimum annual lease payments of $8.3 million.\nFuture minimum rental payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1995, are as follow (in thousands):\nTotal rental expense for all operating leases and month-to-month rentals was $58.6 million, $50.1 million and $46.0 million for 1995, 1994 and 1993, respectively.\nNOTE 13. LITIGATION:\nOn April 13, 1990, a class action was filed in the United States District Court in Phoenix, Arizona, against First American Title Insurance Company and a number of other title insurers. This action seeks damages and injunctive relief based on the defendants' participation in rating bureaus in Arizona and Wisconsin.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe case is now before the District Court for coordinated or consolidated pretrial proceedings with an action that was filed in the United States District Court for the Eastern District of Wisconsin. The Wisconsin federal action presents claims on behalf of a purported class of purchasers of title insurance in Wisconsin, and seeks damages and other forms of relief, similar to those involved in the federal action filed in Arizona, with respect to participation in the rating bureau in Wisconsin.\nThe Company does not believe that the ultimate resolution of these actions will have a materially adverse effect on its financial condition or results of operations.\nThe Company is involved in various routine legal proceedings related to its operations. While the ultimate disposition of each proceeding is not determinable, the Company does not believe that any of such proceedings will have a materially adverse effect on its financial condition or results of operations.\nNOTE 14. SEGMENT FINANCIAL INFORMATION:\nThe Company's operations include four reportable segments: title insurance, real estate information, home warranty and trust and banking. The title insurance segment issues policies which are insured statements of the condition of title to real property. The real estate information segment provides to lender customers the status of tax payments on real property securing their loans, credit information derived from at lease two credit bureau sources and flood zone determination reports which provide information on whether or not a property is in a special flood hazard area. The home warranty segment issues one-year warranties which protect homeowners against defects in home fixtures. The trust and banking segment provides full-service trust and depository services, accepts deposits and makes real estate secured loans.\nThe title insurance and real estate information segments operate through networks of offices nationwide. The Company offers its title services through both direct operations and agents throughout the Unites States. It also provides title services abroad in the Bahama Islands, Bermuda, Canada, Guam, Mexico, Puerto Rico, the U.S. Virgin Islands, and the United Kingdom. Home warranty services are available in Arizona, California, Nevada, Texas and Washington. The trust, banking and thrift businesses operate in Southern California.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSelected financial information about the Company's operations by segment for each of the past three years is as follows:\nCorporate consists primarily of unallocated interest expense, minority interests, equity in earnings of affiliated companies, employee benefit contributions and personnel and other operating expenses associated with the Company's home office facilities.\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nThe Company's primary business segments are cyclical in nature, with the spring and summer months historically being the strongest. However, interest rate adjustment by the Federal Reserve Board during the last few years have caused unusual fluctuations in the Company's quarterly operating results. See Management's Discussion and Analysis on page 15 of this report for further discussion of the Company's results of operations.\nSCHEDULE I 1 OF 1\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nSUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES\nDECEMBER 31, 1995\nSCHEDULE II 1 OF 4\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nPARENT COMPANY BALANCE SHEETS\nASSETS\nSee Notes to Parent Company Financial Statements\nSCHEDULE II 2 OF 4\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nPARENT COMPANY STATEMENTS OF INCOME\nSee Notes to Parent Company Financial Statements\nSCHEDULE II 3 OF 4\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nPARENT COMPANY STATEMENTS OF CASH FLOWS\nSee Notes to Parent Company Financial Statements\nSCHEDULE II 4 OF 4\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nNOTES TO PARENT COMPANY FINANCIAL STATEMENTS\nNOTE A\nThe composition of the Notes and Contracts Payable consists of:\nThe aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1995, are $14,803,000, $14,450,000, $12,324,000, $10,667,000, and $7,302,000 respectively.\nNOTE B\nThe parent company files a consolidated tax return with its subsidiary companies in which it owns 80% or more of the outstanding stock. The current and cumulative tax effects relating to the operations of the parent company are reflected in the accounts of First American Title Insurance Company.\nSCHEDULE III 1 OF 2\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nSUPPLEMENTARY INSURANCE INFORMATION\nBALANCE SHEET CAPTIONS\nSCHEDULE III 2 OF 2\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nSUPPLEMENTARY INSURANCE INFORMATION\nINCOME STATEMENT CAPTIONS\nSCHEDULE IV 1 OF 1\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nREINSURANCE\nSCHEDULE V 1 OF 3\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED DECEMBER 31, 1995\nNote A--Amount represents accounts written off, net of recoveries. Note B--Amount represents $10,023,000 in purchase accounting adjustments, net of a reclassification of $3,019,000 to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and\/or revaluation of the related asset. Note E--Amount represents elimination of reserve in connection with the expiration of the related temporary differences.\nSCHEDULE V 2 OF 3\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED DECEMBER 31, 1994\nNote A--Amount represents accounts written off, net of recoveries. Note B--Amount represents a reclassification to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and\/or revaluation of the related asset. Note E--Amount represents elimination of reserve in connection with utilization of the related temporary differences.\nSCHEDULE V 3 OF 3\nTHE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED DECEMBER 31, 1993\nNote A--Amount represents accounts written off, net of recoveries. Note B--Amount represents a reclassification to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and\/or revaluation of the related asset. Note E--Amount represents the valuation allowance established for certain temporary differences for which it is more likely than not the Company will not receive future benefits. The valuation allowance is in accordance with the provisions set forth in SFAS 109, which was adopted by the Company in the current year.\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 this report is set forth in the sections entitled \"Security Ownership of Certain Beneficial Owners,\" \"Election of Directors,\" \"Security Ownership of Management,\" \"Executive Compensation,\" \"Report of the Compensation Committee on Executive Compensation,\" \"Comparative Cumulative Total Return to Shareholders,\" \"Executive Officers\" and \"Compliance With Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive proxy statement, which sections are incorporated in this report and made a part hereof by reference. The definitive proxy statement will be filed no later than 120 days after close of Registrant's fiscal year.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. & 2. Financial Statements and Financial Statement Schedules\nThe Financial Statements and Financial Statement Schedules filed as part of this report are listed in the accompanying index at page 20 in \"Item 8\" of Part II of this report.\n3. Exhibits (Each management contract or compensatory plan or arrangement in which any director or named executive officer of The First American Financial Corporation, as defined by Item 402(a)(3) of Regulation S-K (17 C.F.R. (S)229.402(a)(3)), participates that is included among the exhibits listed below is identified by an asterisk (*).)\n(3) (a) Restated Articles of Incorporation of The First American Financial Corporation dated November 8, 1989, incorporated by reference herein from Exhibit 3.1 of Amendment No. 3, dated October 16, 1992, to Registration Statement on Form S-2.\n(3) (b) Certificate of Amendment of Restated Articles of Incorporation of The First American Financial Corporation dated September 21, 1992, incorporated by reference herein from Exhibit 3.2 of Amendment No. 3, dated October 16, 1992, to Registration Statement on Form S-2.\n(3) (c) Bylaws, as amended.\n(4) (a) Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992, incorporated by reference herein from Exhibit (4) of Amendment No. 1, dated July 26, 1993, to Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.\n(4) (b) Amendment No. 1 dated as of March 31, 1994, to Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992, incorporated by reference herein from Exhibit (4) of Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.\n(4) (c) Amendment No. 2 dated as of November 22, 1994, to Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992, incorporated by reference herein from Exhibit (4) of Current Report on Form 8-K dated December 14, 1994.\n(4) (d) Amendment No. 3 dated as of March 31, 1995, to Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992, incorporated by reference herein from Exhibit (4) of Quarterly Report on Form 10-Q for the quarter ended March 31, 1995.\n(4) (e) Amendment No. 4 dated as of June 1, 1995, to Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992, incorporated by reference herein from Exhibit (4) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.\n(4) (f) Amendment No. 5 dated as of February 16, 1996, to Amendment and Restatement dated as of April 28, 1993, of Credit Agreement dated as of April 21, 1992.\n*(10) (a) Description of Stock Bonus Plan, as amended, incorporated by reference herein from Exhibit 10(a) of Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n*(10) (b) Executive Supplemental Benefit Plan dated April 10, 1986, and Amendment No. 1 thereto dated October 1, 1986, incorporated by reference herein from Exhibit (10)(b) of Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n*(10) (c) Amendment No. 2, dated March 22, 1990, to Executive Supplemental Benefit Plan, incorporated by reference herein from Exhibit (10)(c) of Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n*(10) (d) Management Supplemental Benefit Plan dated July 20, 1988, incorporated by reference herein from Exhibit (10) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n*(10) (e) Pension Restoration Plan (effective as of January 1, 1994).\n(10) (f) Pledge Agreement dated as of April 27, 1992, incorporated by reference herein from Exhibit (2) of Current Report on Form 8-K dated May 8, 1992.\n(21) Subsidiaries of the registrant.\n(27) Financial Data Schedule\n(b)Reports on Form 8-K\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE FIRST AMERICAN FINANCIAL CORPORATION (Registrant)\nBy:\/S\/ PARKER S. KENNEDY ---------------------------------------------------------------------------- Parker S. Kennedy, President (Principal Executive Officer) Date: March 28, 1996 ----------------------------------------------------------------------------\nBy:\/S\/ THOMAS A. KLEMENS ---------------------------------------------------------------------------- Thomas A. Klemens, Vice President, Chief Financial Officer (Principal Financial and Accounting 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 date indicated. By\/S\/ D.P. KENNEDY ---------------------------------------------------------------------------- D.P. Kennedy, Chairman and Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ PARKER S. KENNEDY ---------------------------------------------------------------------------- Parker S. Kennedy, President and Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ THOMAS A. KLEMENS ---------------------------------------------------------------------------- Thomas A. Klemens, Vice President, Chief Financial Officer Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ GEORGE L. ARGYROS ---------------------------------------------------------------------------- George L. Argyros, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ J. DAVID CHATHAM ---------------------------------------------------------------------------- J. David Chatham, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy ---------------------------------------------------------------------------- William G. Davis, Director Date ----------------------------------------------------------------------------\nBy\/S\/ JAMES L. DOTI ---------------------------------------------------------------------------- James L. Doti, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ LEWIS W. DOUGLAS, JR. ---------------------------------------------------------------------------- Lewis W. Douglas, Jr., Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ PAUL B. FAY, JR. ---------------------------------------------------------------------------- Paul B. Fay, Jr., Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ ROBERT B. MCLAIN ---------------------------------------------------------------------------- Robert B. McLain, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ ANTHONY R. MOISO ---------------------------------------------------------------------------- Anthony R. Moiso, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy ---------------------------------------------------------------------------- Rudolph J. Munzer, Director Date ----------------------------------------------------------------------------\nBy\/S\/ FRANK O'BRYAN ---------------------------------------------------------------------------- Frank O'Bryan, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ ROSLYN B. PAYNE ---------------------------------------------------------------------------- Roslyn B. Payne, Director Date March 28, 1996 ----------------------------------------------------------------------------\nBy\/S\/ VIRGINIA UEBERROTH ---------------------------------------------------------------------------- Virginia Ueberroth, Director Date March 28, 1996 ----------------------------------------------------------------------------\nEXHIBIT INDEX","section_15":""}
{"filename":"278138_1995.txt","cik":"278138","year":"1995","section_1":"ITEM 1 - BUSINESS\nFIRST EVERGREEN CORPORATION\nFirst Evergreen Corporation (\"First Evergreen\") is a bank holding company organized in 1977 under the laws of the State of Delaware. First Evergreen owns all the outstanding common stock of First National Bank of Evergreen Park (\"Evergreen Bank\"), a national banking association organized in 1948 under the laws of the United States. First Evergreen does not engage in any activities other than providing administrative services for and acting as a holding company for its subsidiary bank.\nSUBSIDIARY BANK\nEvergreen Bank provides a complete range of retail banking services to individuals and small and medium-size businesses at each of its five banking locations--Evergreen Park (main office), Evergreen Bank-Oak Lawn Office, Evergreen Bank-Clearing Office, Evergreen Bank-Orland Park Office and Evergreen Bank-Physician's Pavilion. These services include checking, savings, NOW and Money Market deposit accounts, business loans, personal loans, residential mortgage loans, home improvement loans, loans for education, other consumer oriented financial services including IRA and Keogh accounts, and safe deposit and night depository facilities. Additionally, Evergreen Bank provides 24-hour banking services to its customers.\nEvergreen Bank's Trust Department offers fiduciary, investment management and advisory services to individuals and small corporations. It also administers (as trustee and in other fiduciary and representative capacities) pension, profit-sharing and other employee benefit plans and personal trusts and estates.\nEvergreen Bank employs 565 people on a full time equivalent basis and provides a variety of employment benefits. Management believes that relationships with employees are good.\nSUPERVISION AND REGULATION\nFIRST EVERGREEN\nFirst Evergreen 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 \"Federal Reserve\"). The Act requires every bank holding company to obtain prior approval of the Federal Reserve 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. However, the Federal Reserve may not approve any acquisition if it is prohibited by State law.\nThe Illinois Bank Holding Company Act of 1957, as amended, permits bank holding companies located in states other than Illinois to acquire banks and bank holding companies in Illinois, if such other states have passed legislation granting similar privileges to Illinois banks and bank holding companies. On the federal level, in September 1994 Congress passed the Interstate Banking and Branching Efficiency Act, which authorizes after September 29, 1995, a bank holding company to acquire a bank located outside of its home state so long as certain criteria are satisfied. After June 1, 1997, this enactment authorizes the merger of banks located in different states so long as certain criteria are satisfied. States are currently evaluating the ramifications and issues which arise from the enactment of this law. Moderate activity by out-of-state entities has occurred in First Evergreen's market area.\nThe Act also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. Bank holding companies, however, may engage in, and may own shares of companies engaged in certain businesses determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be properly incident thereto. The Act does not place territorial restrictions on the activities of bank holding companies or their non-bank subsidiaries.\nUnder the Act, First Evergreen is required to file annual reports of its operations and such additional information as the Federal Reserve may require and is subject, along with its subsidiary, to examination by the Federal Reserve. The Federal Reserve has jurisdiction to regulate the terms of certain debt issues of bank holding companies, including the authority to impose reserve requirements.\nSUBSIDIARY BANK\nEvergreen Bank is a national bank and is a member of the Federal Deposit Insurance Corporation (\"FDIC\"), and as such, is subject to the provisions of the Federal Deposit Insurance Act. All national banks are members of the Federal Reserve System and are subject to applicable provisions of the Federal Reserve Act. Evergreen Bank is subject to regulation and regular examination by the Comptroller of the Currency.\nThe federal and state laws and regulations generally applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the nature and amount of collateral for loans, and include restrictions on the number of banking offices and activities which may be performed at such offices.\nSubsidiary banks of bank holding companies are subject to certain restrictions under the Federal Reserve Act and the Federal Deposit Insurance Act on loans and extensions of credit to the bank holding company or to its other subsidiaries, investments in the stock or other securities of the bank holding company or its other subsidiaries, or advances to any borrower collateralized by such stock or other securities.\nGOVERNMENTAL MONETARY POLICIES\nRevenue of Evergreen Bank, and therefore a majority of First Evergreen's revenue, is affected by general economic conditions and also by the fiscal and monetary policies of the Federal Government and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the reserve requirements of member and non-member banks and the discount rate on bank borrowings. Its policies have a direct effect on the amount of bank loans and deposits and interest rates charged and paid thereon. Consequently, federal regulations have a significant impact on banking revenue.\nFirst Evergreen cannot fully predict the nature or the extent of any effect which such fiscal and monetary policies may have on its business and earnings.\nCOMPETITION\nEvergreen Bank encounters intense competition in all aspects of its business. Evergreen Bank competes vigorously with other financial institutions in its local communities, and banks in downtown Chicago. The historical restrictions in Illinois applicable to the ability of an Illinois located bank to establish bank offices have been virtually eliminated. Accordingly, any bank capable of doing business in Illinois has the legal right to establish an office in Evergreen Bank's market area. Thus, banking competition has increased, and will continue to increase, with First Evergreen's market.\nDIVIDENDS\nFirst Evergreen uses funds derived primarily from payment of dividends by Evergreen Bank for, among other things, the cost of operations and payment of dividends to its stockholders. Various contractual and statutory limitations exist with respect to the ability of Evergreen Bank to pay dividends to First Evergreen. Under certain circumstances, Evergreen Bank would need the approval of the Comptroller of the Currency to pay dividends. All dividends are restricted by capital adequacy requirements imposed by federal regulations.\nFINANCIAL INFORMATION\nDisclosure of financial information, including assets, revenue and operating gain or loss, on pages 7 and 8 of the annual report to stockholders for the year ended December 31, 1995, is incorporated herein by reference.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nFirst Evergreen owns no properties and requires minimal office space in one of the facilities of Evergreen Bank. All but one of the facilities of Evergreen Bank are owned. Evergreen Bank's sole leased facility, which accounts for less than 2% of total deposits, is leased through May, 2001. Each facility is sufficient to meet its operations and is periodically remodeled to meet and exceed customer service demands.\nOFFICE LOCATION OWNERSHIP SQUARE FOOTAGE - ------ -------- --------- --------------\nMain Office 3101 W. 95th Street Owned 64,000 Evergreen Park, Illinois\nOak Lawn 9400 S. Cicero Avenue Owned 85,000 Oak Lawn, Illinois\n4900 W. 95th Street Owned 24,000 Oak Lawn, Illinois\n9430 S. Cicero Avenue Owned 8,500 Oak Lawn, Illinois\nClearing 5235 W. 63rd Street Owned 23,000 Chicago, Illinois\nOrland Park 15330 S. Harlem Ave. Owned 15,000 Orland Park, Illinois\nPhysician's 4400 W. 95th Street Leased 1,700 Pavilion Oak Lawn, Illinois\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThere are no material legal proceedings pending against First Evergreen. However, as Evergreen Bank acts as a depository of funds, it is named as a defendant in numerous lawsuits (such as garnishment proceedings) involving claims to the ownership of funds in particular accounts. Evergreen Bank is also involved in litigation brought by it to collect delinquent loans and enforce collateral provisions of security documents. All such litigation is in the ordinary course of business. Management of the bank believes that no litigation is threatened which will materially affect the bank's financial position as presented herein.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (DURING THE FOURTH QUARTER OF 1995)\nNone\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCommon Stock Information and Dividends on page 23 of the annual report to stockholders for the year ended December 31, 1995 is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nFinancial Review and Selected Financial Data on page 24 of the annual report to stockholders for the year ended December 31, 1995, are incorporated herein by reference.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's Discussion and Analysis of Financial Condition and Results of Operations on pages 25 through 32 of the annual report to stockholders for the year ended December 31, 1995, are incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated Financial Statements and Notes thereto on pages 7 through 22, and Independent Public Accountants Report on page 23 of the annual report to stockholders for the year ended December 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\nInformation concerning Directors of the Registrant on page 2 of the proxy statement for the annual stockholders' meeting to be held on April 25, 1996 is incorporated herein by reference.\nEXECUTIVE OFFICERS\nKENNETH J. OZINGA\nMr. Ozinga has been President and a Director of First Evergreen since 1986 and President of First National Bank of Evergreen Park since 1985. Additionally, Mr. Ozinga has served as a Director of First National Bank of Evergreen Park or a subsidiary bank since 1982. Mr. Ozinga is 44 years old.\nSTEPHEN M. HALLENBECK\nMr. Hallenbeck is Secretary\/Treasurer and Chief Financial Officer of First Evergreen. Additionally, he is an Executive Vice President of First National Bank of Evergreen Park since 1985, and Secretary\/Director of First National Bank of Evergreen Park. Mr. Hallenbeck joined First Evergreen as a Director of a subsidiary bank in 1979. Mr. Hallenbeck is 54 years old.\nROBERT C. WALL\nMr. Wall is Vice President of First Evergreen. Additionally, he is an Executive Vice President of First National Bank of Evergreen Park and a Director of First National Bank of Evergreen Park since 1975. Mr. Wall joined First National Bank of Evergreen Park in 1977. Mr. Wall is 60 years old.\nRICHARD H. BROWN\nMr. Brown is Executive Vice President of First National Bank of Evergreen Park. Mr. Brown joined First National Bank of Evergreen Park in 1986. Mr. Brown is 41 years old.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nCOMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS\nA director who is an employee of Evergreen Bank is not compensated for service as a member of First Evergreen's Board of Directors or any committee of the Board. During 1995, the two outside directors received retainers totaling $17,400.\nThe following \"Summary of Compensation Table\" provides shareholders a concise, comprehensive overview of compensation awarded, earned and paid in the reporting period.\nSUMMARY COMPENSATION TABLE\n* Other annual compensation received by Messrs. Ozinga, Hallenbeck, Wall and Brown represent company contributions to a defined contribution plan.\nMessrs. Ozinga, Hallenbeck, Wall and Brown are compensated by Evergreen Bank and not First Evergreen. Compensation considerations include, but are not limited to, industry standards and practices as well as practical issues such as affordability and financial impact. Compensation of the Chief Executive Officer also follows industry standards and practices and is not directly correlated with First Evergreen's or Evergreen Bank's financial performance. Neither First Evergreen nor Evergreen Bank provides an equity incentive program.\nCOMPENSATION INTERLOCKS AND INSIDER PARTICIPATION\nFirst Evergreen has no compensation committee or committees performing the functions of such. The entire Board of Directors of First Evergreen engages in the process and is responsible for setting compensation of First Evergreen's Chief Executive Officer. The directors of First Evergreen during 1995 were Alfred E. Bleeker, Jerome J. Cismoski, Stephen M. Hallenbeck, Kenneth J. Ozinga and Martin F. Ozinga. Kenneth J. Ozinga was, during 1995, the President, Chief Executive Officer and Chairman of the Board of Directors of First Evergreen. Stephen M. Hallenbeck was, during 1995, the Secretary and Treasurer of First Evergreen. The entire Board of Directors of Evergreen Bank engages in the process of, and is responsible for, setting the compensation of Messrs. Hallenbeck, Wall and Brown. The directors of Evergreen Bank, during 1995, were Davis Boyd, Daniel Butler, Jr., James R. Cismoski, Jerome J. Cismoski, Stephen M. Hallenbeck, Kenneth J. Ozinga, Martin F. Ozinga, Ronald W. Ozinga, Thomas Palmisano and Robert C. Wall. Kenneth J. Ozinga was, during 1995, the President and Chairman of the Board of Evergreen Bank. Stephen M. Hallenbeck, during 1995, was the Secretary and Executive Vice President of Evergreen Bank. Robert C. Wall, during 1995, was a Vice President of First Evergreen and an Executive Vice President of Evergreen Bank. Martin F. Ozinga, during 1995, was a Sr. Vice President of Evergreen Park.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning Security Ownership of Certain Beneficial Owners and Management of the Registrant on page 3 of the proxy statement for the annual stockholders' meeting to be held on April 25, 1996 is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDirectors and officers of First Evergreen and their associates were customers of and had transactions with First Evergreen and Evergreen Bank in the ordinary course of business during 1995. It is anticipated that similar transactions may occur in the future. Such transactions in 1995 included payments by First Evergreen and Evergreen Bank for services furnished and were not material relative to the gross revenues of either First Evergreen or the directors' companies. In management's opinion, all loans and commitments included in such transactions were made at 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 any unfavorable features.\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 of independent public accountants of First Evergreen and subsidiary, included in the annual report of the Registrant to its stockholders for the year ended December 31, 1995, are incorporated by reference in Item 8:\nReport of independent public accountants Consolidated statements of condition - 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, 1993, 1994 and 1995 Consolidated statements of cash flows - Years ended December 31, 1995, 1994 and 1993 Notes to consolidated financial statements - December 31, 1995, 1994 and 1993\n(2) Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are omitted since they are either not applicable or the required information is shown in the financial statements or notes thereto.\n(3) Exhibits\nExhibit 13 - Annual report to stockholders for the year ended December 31, 1995 Exhibit 16 - Letter regarding change in certifying accountant Exhibit 27 - Financial Data Schedule Exhibit 99 - Notice of Annual Meeting and Proxy Statement\n(b) Report on Form 8-K under Section 13 or 15(d) of the Securities Exchange Act of 1934 was filed on December 22, 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 Village of Evergreen Park, State of Illinois, on March 19, 1996.\nFirst Evergreen Corporation (The Registrant)\n\/s\/KENNETH J. OZINGA __________________________ Chairman of the Board of Directors and President Kenneth J. Ozinga (Principal Executive Officer)\n\/s\/STEPHEN M. HALLENBECK _________________________ Secretary\/Treasurer Stephen M. Hallenbeck (Principal Financial and Accounting Officer)\n\/s\/ALFRED E. BLEEKER __________________________ Director Alfred E. Bleeker\n\/s\/JEROME J. CISMOSKI __________________________ Director Jerome J. Cismoski\n\/s\/MARTIN F. OZINGA __________________________ Director Martin F. Ozinga\nBeing a majority of the Registrant's Board of Directors","section_15":""}
{"filename":"814500_1995.txt","cik":"814500","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company was organized in 1972 as Leasing Dynamics, Inc., an Ohio corporation. In October 1986, LDI Corporation, a Delaware corporation, became a holding company for Leasing Dynamics, Inc. and certain of its affiliated corporations. Subsequently, the Company completed an internal realignment pursuant to which most of its subsidiaries were merged into the Company pursuant to applicable parent-subsidiary merger statutes.\nDuring the year ended January 1994, the Board of Directors determined the need to commence preparation of a new long-term strategic business plan for the Company. The plan included the sale or other divestiture of certain product lines and non-strategic businesses, the consolidation of facilities and other measures to increase the Company's overall profitability. The plan is discussed in more detail in this Item 1, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and in \"Notes to Consolidated Financial Statements.\"\nDuring the year ended January 1995, the Company completed the strategic realignment, including the sale or divestiture of all non-strategic businesses, consolidated its Cleveland-based facilities and hired Floyd S. Robinson as the President and Chief Executive Officer of the Company. The Company is currently focusing on the development of its previously identified \"core\" businesses including Leasing Services, Technology Services and PC Rental Services as described below.\nAll references herein to the \"Company,\" \"LDI\" or the \"Registrant\" refer to LDI Corporation and its subsidiaries, unless the context otherwise requires.\nGENERAL\nDuring the year ended January 31, 1995, LDI implemented a strategic plan to focus on its historical strength of equipment leasing, maintenance and technical support services related to computer and other high technology equipment and short-term computer (PC) rentals. These services were previously identified as LDI's \"core\" businesses and represent the foundation of the ongoing LDI corporate operations.\nThe Company operations are managed in three product lines: Leasing Services, Technology Services and PC Rentals. Leasing Services provides customers with selected high technology and data processing equipment, telecommunications products, and other capital equipment through sale or lease transactions. Technology Services provides technical support services, including system installation, integration, maintenance and other system support related services both in house and at customer locations. PC Rentals provides state-of-the-art personal computer technology to corporate customers for short-term rentals, normally ranging from one week to one year.\nLEASING SERVICES\nLDI leases a diverse range of equipment, including computer and telecommunication systems and related peripheral devices, production and manufacturing machinery, and medical and diagnostic systems.\nThe Company leases equipment manufactured by a wide variety of companies to meet the specific requirements of its customers. LDI also remarkets this equipment if it is returned at lease expiration. By emphasizing a full selection of equipment options from many manufacturers, LDI increases its leasing and remarketing opportunities while mitigating risk through a diversified portfolio.\nOngoing market dynamics in the computer industry, such as the continued decline in demand for mainframe computer equipment, have prompted a shift to smaller systems, peripheral equipment, and related services to meet the changing needs of customers. Recognizing this, LDI has increased its portfolio of mid-range systems and peripheral devices, integrated network computing and cross-platform systems integration.\nEven though LDI has shifted growth emphasis to other computer product lines, it recognizes that the mainframe will continue to be used, sometimes in new and different roles. In the near term, the Company believes that many organizations will continue to use mainframe systems for certain processing-intensive functions. Also, these systems are becoming primary back-up devices for information storage.\nLDI also offers its customers lease financing for capital equipment acquisitions, resulting in an alternative funding source for a significant portion of their equipment needs. Production equipment, manufacturing systems and medical equipment are often equipped with technology components that are improved with new product offerings. This continued introduction of new technology increases the demand for leasing as customers demand the flexibility to utilize new technology in their operations. LDI negotiates upgrades to the equipment which results in amending the existing lease or replacing the equipment and initiating a new lease contract.\nThe Company purchases new equipment directly from the manufacturer and obtains used equipment from its customer base and from the nationwide secondary market for used data processing and telecommunications equipment. LDI's active presence in this secondary market, coupled with its large portfolio of equipment under lease and its technical capabilities to upgrade and refurbish used equipment, allow it to combine new and used equipment configurations at competitive prices. Similarly, the Company is often able to facilitate new lease or sale transactions by either buying, remarketing, or trading a prospective customer's existing equipment. Management believes that the Company's ability to fully integrate high-technology products and services represents a competitive advantage and differentiates it from most of its competitors.\nLDI's customers are medium to large corporations and other organizations that have significant information processing and production equipment needs that meet the Company's credit standards. LDI's principal objective is to selectively engage in lease transactions with customers whose creditworthiness permits the Company to maximize the use of long term nonrecourse financing. No customer accounts for more than 5% of the Company's total revenues, and the Company does not believe that it is dependent on any single customer.\nLDI's equipment lease terms generally range from monthly to seven years, with information processing and telecommunications equipment lease terms typically from two to five years. The majority of the Company's leases are capital leases. Capital leases have less risk than shorter-term operating leases, since a higher percentage of the cost of the equipment is returned in the form of rental receipts during the initial lease term. Substantially all leases are noncancellable and place the risk of damage to the equipment on the lessee. Approximately one-half of the dollar amount of LDI's lease portfolio is comprised of small and medium-size transactions ranging from $50,000 to $200,000. Lessees typically use a significant amount of high-technology equipment and have multiple capital leases with the Company with varying expiration dates.\nLDI's marketing activities historically have been directed toward the Midwest and Northeast, although it has equipment on lease throughout the United States. As of January 31, 1995, LDI employed leasing services sales representatives in sales offices located in the following metropolitan areas: Boston, Cincinnati, Chicago, Cleveland, Columbus, Dallas, Detroit, New York and New Jersey. The sales representatives market the Company's services primarily through personal sales calls, telemarketing and direct mailing.\nTECHNICAL SERVICES\nLDI's Technology Services operation provides hardware and software maintenance and other support services for large, medium, and small computer systems, personal computers, point-of-sale equipment, and telecommunications equipment produced by various manufacturers. The operation provides many types of hardware, software, and support services at the customers' facilities from its five district operation centers. The largest of these centers is located in Cleveland at LDI's headquarters. The other operations are located in Columbus, Cincinnati, Detroit, and Ithaca. Service programs provided include on-site hardware and software maintenance contracts, depot repair and return, and time and material contracts as well as tailored agreements to accommodate the needs of customers. Qualified field engineers and technicians are available twenty-four hours a day, seven days a week. In addition, LDI provides advanced engineering support and high-technology remote diagnostic and repair services.\nAs of January 31, 1995, the Company had 169 employees in its Technology Services operation, including 94 field engineers and bench technicians. Certain field engineers perform on-site repair and maintenance services for mainframe central processing units and larger peripheral devices. Bench technicians perform repair service functions on various types of equipment, which include personal computers, telecommunications equipment, and point-of-sale devices. Because of the Company's participation in the secondary market for used data processing equipment, the Company is often able to supply a customer with replacement equipment while repairing their equipment, particularly with respect to personal computers, terminals, and small items of peripheral equipment.\nLDI refurbishes used information processing, telecommunications and other electronic equipment in connection with its remarketing activities and also contracts to refurbish used equipment from others. The refurbishing activities may include enhancing existing computer equipment by adding features that make systems more powerful or capable of performing additional functions. The Company believes that these refurbishing capabilities contribute to LDI's ability to remarket used equipment. Additionally, they are an important component of LDI's objective of developing long-term relationships with its customers by meeting their high-technology equipment support and services needs, thereby differentiating LDI from its competitors.\nRENTAL SERVICES\nLDI provides short and intermediate term rentals of personal computers, peripherals and software to corporate customers nationwide. LDI rents desktop and notebook computers sourced from leading manufacturers such as IBM, Compaq, Dell, AST and Apple. Printers rented include those manufactured by Hewlett-Packard, Epson and Apple. Other products rented include scanners, plotters, data projection equipment, CD ROM, large screen monitors and external hard drives.\nLDI provides its computer rental services nationwide. To support this level of service, LDI has offices in the following locations: Cleveland, Detroit, Chicago, Cincinnati, Dallas, Houston and Atlanta. These offices include a local sales force, technical staff, and inventory. This structure enables LDI to provide same day delivery, installation and on-site service. This full-service strategy differentiates LDI from the majority of its competitors, who primarily provide box shipping services.\nLDI's target customers include rapidly growing companies, service companies such as financial, accounting, engineering and consulting firms, and companies which have a large installed base of personal computers. Customers rent personal computers for many reasons, including access to new technology, special projects, peak work loads, training, disaster recovery and minimizing long term capital expenditures. LDI markets its services primarily through Yellow Pages advertising, telemarketing and outside sales representatives calling on Fortune 1,000 companies. At January 31, 1995, the Company had 40 employees in its personal computer rentals operation.\nCORE BUSINESS REVENUES AND ASSETS\nRevenues and assets of LDI's core business of leasing, maintenance and technical services and personal computer rentals for the years ended January 31, 1994, and January 31, 1995, are as follows:\n(IN MILLIONS)\n(A) % of consolidated amounts including discontinued operations.\nCOMPETITION\nThe information processing industry is fragmented and characterized by many different, but related, markets. The Company competes in a number of these markets with many different competitors. In the mainframe and mid-range computer equipment leasing business, the Company competes with equipment manufacturers, leasing companies and large financial institutions, many of which are substantially larger than the Company and possess significantly greater capital. Among those are IBM Credit Corporation, General Electric Capital Corporation and Comdisco, Inc. In the technical support services marketplace, the Company competes with equipment manufacturers as well as several large technical organizations. For computer rentals, primary competition comes from companies offering computer rentals on a national basis. These include GE Rental\/Lease, AT&T and Personal Computer Rentals (PCR).\nDISCONTINUED AND NON-STRATEGIC BUSINESSES\nThe businesses LDI identified as discontinued or non-strategic were generally characterized as being transactional in nature, commodity oriented and not conducive to building long-term customer relationships. These attributes translated into low-margin, low-return businesses which did not match LDI's new strategy. The Company's core business emphasizes exceptional customer service, building long-term customer relationships and providing value-added services that can translate into higher margins and acceptable financial returns. These core business attributes, in conjunction with the completed facilities consolidation and other cost saving measures, are expected to result in higher margins and financial returns in future years.\nEMPLOYEES\nAs of January 31, 1995, the Company had 330 full time employees. This represents a 63% decrease from the prior year employment levels and is attributable to the implementation of the strategic realignment. Management believes that the remaining employees are sufficient to support the Company's ongoing core business. The Company also believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDuring the fiscal year ended January 31, 1995, the Company moved its executive offices and its leasing and corporate operations previously located in downtown Cleveland and Westlake, Ohio, respectively, to its recently expanded Technology Center located in Cleveland. Other facilities eliminated during the year ended January 31, 1995, related to the implementation of the Company's strategic realignment and included the closing of three \"LDI Computer Superstores\" in Cleveland and Pittsburgh and the buyout of a lease in Solon, Ohio for office and warehouse space. Although no longer operating a \"Superstore,\" LDI is leasing one of the former superstore facilities in Cleveland to an office supplies and equipment retailer. The Company also leases other sales offices and maintenance centers in various locations throughout the United States.\nThe Company believes that its offices and facilities are adequately insured and sufficient to service their present purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no pending legal proceedings which require disclosure pursuant to Item 103 of Regulation S-K.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF REGISTRANT\nThere is hereby incorporated by reference the information with respect to executive officers of LDI 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 STOCK 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 LDIC. The following schedule sets forth, for the periods indicated, the range of the high and low sales prices on the NASDAQ National Market System.\nAs of March 31, 1995, the Company's common stock was held by 510 stockholders of record.\nDuring the year ended January 31, 1994, the Company paid quarterly cash dividends on its common stock of $.04 per share. During the year ended January 31, 1995, the Company paid no cash dividends on its common stock.\nThe Company is prohibited from paying cash dividends under the covenants of certain of its financing agreements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following schedule sets forth selected consolidated financial data regarding the Company for the periods indicated, derived from the Company's consolidated financial statements. The Company's consolidated financial statements as of and for each of the five years in the period ended January 31, 1995, have been audited by Deloitte & Touche LLP, the Company's independent auditors. The information set forth in the following table should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing in Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nACCOUNTING PRACTICES\nRefer to Note 1 of \"Notes to Consolidated Financial Statements\" for a discussion of the Company's significant accounting practices.\nRESULTS OF OPERATIONS\nThe following schedule presents the amounts and relative percentages of total revenues represented by major revenue and expense items for each of the three years in the period ended January 31, 1995.\nLEASING\nA summary of the operating results from leasing for the three years ended January 31, is as follows:\nFor the year ended January 31, 1995 leasing revenues decreased 34% as compared to the 21% decline experienced in the previous year. The results reflect an overall change in the mix of leases being written by the Company as a result of changing market conditions. During 1993, 69% of total leased equipment cost was recorded as sales-type leases, which recognize the major portion of lease revenue at lease commencement. For the years ended January 31, 1994 and 1995 the percentages of leased equipment cost under sales-type classification decreased to 51% and 37%, respectively. Over the same period the Company saw its percentage of leased equipment cost recorded as direct-finance leases increase from 5% in 1993 to 29% in 1994 and 54% in 1995. Direct finance leases spread income recognition over the term of the lease. Based upon current market dynamics and related factors, the Company anticipates its future mix of lease transactions will parallel recent trends.\nThe Company also experienced a significant decrease in the cost of equipment placed under lease as compared to the prior year, which had a direct influence on leasing revenue. A key factor underlying the decline was a continued market shift toward less expensive, more powerful mid-range computers and personal computer networks.\nDuring the quarters ended January 31, 1994 and 1995 the Company recorded charges which increased cost of leasing (see Note 3 of \"Notes to Consolidated Financial Statements\"). The charges, primarily related to provisions for estimated future residual value writedowns, were precipitated by deteriorating customer credit\nquality and\/or a significant decline in the market value of classes of leased equipment. These charges are described below and aggregated $21.5 million in 1994 and $21.2 million in 1995.\nAsset valuation writedowns of off-lease equipment can occur when the lessee elects not to renew, extend, or reconfigure the lease, while lease renewals tend to maintain the in-place value of leased equipment. Leased equipment is recorded at the lower of cost or fair market value when equipment is received from lessees at the end of the lease. The Company also reviews residual values periodically during the lease and, if necessary, reduces the estimated residual to be realized at the termination of the lease. During the quarter ended January 31, 1994, several major customers decided not to renew their leases and negotiated to purchase or return the equipment. These sales and returns during the quarter resulted in a $7 million charge. The Company also recorded charges of $14.5 million for equipment valuation writedowns primarily for lessees in bankruptcy or with deteriorating credit conditions.\nDuring the quarter ended January 31, 1995 the Company recorded charges of $13.3 million to revise residual values of certain categories of leased equipment, both for leases terminated in the quarter and similar equipment leases which will expire in the future. The Company also recorded charges of $5.1 million to adjust residual values and other assets for equipment leased to customers with deteriorating credit quality and $2.8 million to reduce the valuation of PC rental equipment and other inventories.\nAlthough asset valuation adjustments are considered normal operating costs of the leasing business, the Company believes the amount of the off-lease writedowns taken in each of the two most recent fiscal years were unusual and related to specific situations with certain customers and\/or included significant changes in prevailing market conditions for specific classes of equipment in the Company's lease portfolio. While the Company cannot provide assurance that future results will not be impacted by similar events, it does believe that the strategic initiatives announced and implemented during the year ended January 31, 1995 will result in more predictable gross leasing margins in the future.\nDIRECT SALES\nA summary of the operating results from direct sales for the three years ended January 31, is as follows:\n(1) Core operations include: Leasing Services, Technology Services, and PC Rentals which were identified in the strategic plan as those product lines that constitute the ongoing business of the Company.\n(2) Restructured operations include the results of business units which are, for financial statement presentation purposes only, considered to be a part of reported operations. As discussed in Note 4 of \"Notes to Consolidated Financial Statements,\" the restructured operations were determined to be non-strategic to the future operations of the Company and as such, were either sold or substantially liquidated during the first half of the year ended January 31, 1995.\nFor the year ended January 31, 1994 direct sales from core operations increased $2.4 million (7%) due primarily to higher levels of sales of equipment coming off lease. For the year ended January 31, 1995 direct sales increased $6.2 million (16%) due primarily to the sale, prior to the end of the initial term, of equipment to lessees. Gross direct sales margin percentages increased in both years due to more in place sales of equipment, which normally command higher margins.\nThe increase in direct sales of restructured operations for the year ended January 31, 1994 of $10.3 million was due primarily to sales of microcomputers to commercial accounts. The decrease in direct sales of restructured operations for the year ended January 31, 1995 of $37.3 million was due to the sale, effective May 31, 1994, of LDI's corporate microcomputer sales organization.\nTECHNICAL SERVICES\nA summary of the operating results from technical services for the three years ended January 31, is as follows:\nFor the year ended January 31, 1994, technical services revenues decreased 12% from the prior year. This was primarily due to a decline of $3.1 million in disaster recovery services as a result of an agreement, effective May 1, 1993, to form a strategic marketing relationship with SunGard Recovery Services Inc. The Company's contract base of business recovery customers and two \"hot site\" recovery centers were transferred to SunGard and are operated by SunGard as part of the agreement. Increased consulting revenues partially offset the decline in services revenues.\nFor the year ended January 31, 1995, technical services revenues decreased 6% from the prior year. This decrease is also due primarily to the strategic marketing relationship with SunGard Recovery Services, Inc. A decline of $1.0 million in revenues occurred as a result of this transaction.\nFor the year ended January 31, 1994, the gross margin declined due to lower revenues, a $1.2 million write-off of obsolete and excessive maintenance inventories during the fourth quarter, and the absence, beginning in the second quarter, of disaster recovery operations, which bore higher direct costs per revenue dollar. In the year ended January 31, 1995, the gross margin increased by 34% and there was a significant improvement in the gross margin percentage due principally to lower parts costs and increased labor efficiency in the maintenance operations.\nINTEREST EXPENSE\nFor the years ended January 31, 1994 and 1995, interest expense decreased $8.2 million (20%) and $5.1 million (15%), respectively. These decreases resulted primarily from lower interest rates and reductions in the average amount of debt outstanding during the year ended January 31, 1994, and reduction in the average amount of debt outstanding offset by higher interest rates in the year ended January 31, 1995.\nDEBT FINANCING FEES\nDebt financing fees increased $0.4 million (31%) and $1.7 million (99%) for the years ended January 31, 1994 and 1995, respectively. The increase for the year ended January 31, 1994, primarily represents a full year of fees from a $50 million installment note completed in August 1992. The increase for the year ended\nJanuary 31, 1995, was primarily due to a $1.7 million amortization of the $2.4 million of costs related to the restructuring of LDI's senior credit agreements in July 1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nFor the year ended January 31, 1994, selling, general and administrative expenses increased by $4.4 million (12%), and as a percent of total revenue from 11.9% to 14.9%. The increase was primarily attributable to additional bad debt reserves ($4.8 million or 1.8% of revenue) resulting from losses for credit and collection-related situations with several customers and the decline in leasing revenues discussed in the \"Leasing Section of Management's Discussion and Analysis\".\nFor the year ended January 31, 1995, selling, general and administrative expenses decreased $9.5 million (23.6%), but as a percent of revenue increased from 14.9% to 16.8%. The gross dollar decrease was due to the implementation of the strategic business plan which included facility consolidation, reduction of work force and the completion of the divestiture or sale of non-core businesses. This decrease was partially offset by bad debt charges of $2.7 million recorded during the fourth quarter ended January 31, 1995. The increase as a percentage of revenue was due to the decline in leasing revenues discussed in the \"Leasing Section of Management's Discussion and Analysis\".\nSelling, general and administrative expenses are expected to decrease in the year ending January 31, 1996, as the cost savings from facility consolidation and reduction in workforce will be in effect for the entire year.\nSTRATEGIC BUSINESS PLAN\nDuring the year ended January 31, 1994, the Company initiated a strategic business plan that included the sale or other divestiture of certain product lines and non-core businesses, the closing of facilities, and other cost reduction measures to improve the Company's profitability. The Company completed the strategic realignment, including divestitures of non-strategic businesses, during the year ended January 31, 1995.\nThe businesses the Company identified as discontinued or non-strategic were generally characterized as transactional in nature, commodity oriented and not conducive to building long-term customer relationships. These attributes translated into low-margin, low-return businesses which did not match the Company's new strategy of focusing on a core business emphasizing exceptional customer service, building long-term customer relationships and providing value-added services.\nRESTRUCTURING CHARGES\nUnder the strategic plan implemented during the year ended January 31, 1995, businesses sold or closed (other than those included in Discontinued Operations) included: (1) LDI Retail Services, which provided hardware, software, and system integration for retail chain stores; (2) LDI Computer Systems, which sold microcomputers and related equipment to commercial accounts; (3) SeaTech Communications, a ship-to-shore satellite telecommunications venture; and (4) LDI Canada, Ltd., a leasing subsidiary based in Toronto, Canada.\nThe cost of implementing the plan was $6.6 million, recorded in the Company's fourth quarter ended January 31, 1994 ($4.1 million after-tax, or $.62 per share). The costs included $4.3 million attributable to disposing of the above businesses, $1.7 million for employee severance and termination costs and $0.6 million for closing facilities. There were no additional costs incurred during the implementation of the plan in the year ended January 31, 1995.\nINCOME TAXES\nThe Company's effective income tax benefit rate for continuing operations decreased to 37.3% for the year ended January 31, 1994, from a tax expense rate of 38.5% for the prior year due to the effect of the Federal tax rate change.\nThe effective tax benefit rate for continuing operations increased to 38.3% for the year ended January 31, 1995, due to the effect in the prior year of the Federal tax rate change.\nDISCONTINUED OPERATIONS\nUnder the restructuring plan, discontinued segments included (1) LDI Computer Superstores, the retail PC superstores; (2) LDI Computer Outlets, the retail PC outlet stores; (3) LDI Distribution Supply, a catalog distribution business selling PC peripheral equipment and modems; and (4) LDI Open Software, a distributor of software for UNIX-based systems.\nAs a result of discontinuing these businesses the Company recorded during its fourth quarter ended January 31, 1994, a charge of $11.7 million ($7.1 million after-tax), consisting of $10.8 million for estimated operational losses during the phase-out period and $0.9 million for employee severance and termination costs.\nDuring the three months ended July 31, 1994, the Company recorded an additional loss from discontinued operations of $5.0 million (after tax $3.1 million). This loss was due to additional costs related to the liquidation and closing of the Company's retail computer superstores and retail PC outlets.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company uses a combination of credit facilities, term loans and internally generated cash flow to finance, on an interim basis, the acquisition of equipment for lease or sale. Upon completion of lease documentation, the Company generally finances the present value of future lease rentals by the assignment of such rentals to banks, insurance companies, or other lenders on a discounted, nonrecourse basis. In this manner, a substantial portion of the equipment cost is financed on a long-term basis and the Company limits its risk, if any, to its equity investment in the equipment. In December 1994, the Company completed a $50 million expansion of the capacity of one of its securitized lease receivable financing programs from $75 million to $125 million (see Note 12 of \"Notes to Consolidated Financial Statements\").\nThe Company enters into interest rate swap and cap agreements to manage exposure to changes in interest rates for portions of its recourse and nonrecourse debt. The agreements generally involve the exchange of fixed or floating rate interest payments without the exchange of the underlying principal amounts. The notional amount of interest rate swaps outstanding at January 31, 1995 was $125 million with a weighted average interest rate payable of 5.8%. The agreements have maturities from one to four years.\nDuring the year ended January 31, 1995, cash generated from operating activities (including discontinued operations) was $171 million as compared to $190 million for the year ended January 31, 1994. This $19 million decrease is primarily attributable to the following: decrease in cash inflows from the sale or disposal of inventory and off-lease equipment ($83 million); lower cash outflows for purchases of inventory for resale ($26 million); incremental cash inflows from changes in assets and liabilities of discontinued operations ($21 million); and the reduction in accounts receivable balances as compared with an increase in the prior year ($18 million). Cash used in investing activities was $66 million for the year ended January 31, 1995 as compared to $151 million for the year ended January 31, 1994. This decrease of $85 million was due primarily to a $71 million reduction in equipment purchased for lease and the receipt of $12 million in proceeds from the sale of noncore businesses and properties. Cash used in financing activities was $102 million for the year ended January 31, 1995 as compared to $35 million for the year ended January 31, 1994. This $67 million increase was primarily the result of incremental payments of $40 million on revolving credit facilities and term loans and incremental net payments of $28 million on nonrecourse lease financings.\nAs discussed in Note 11 of \"Notes to Consolidated Financial Statements,\" the Company's senior secured revolving credit facility and senior secured term notes were scheduled to mature on April 30, 1995. Pending finalization of a new agreement, the lenders have extended the maturity date of the credit facility and term notes through May 31, 1995. Additionally, due to the operating results for the year ended January 31, 1995, the Company was in noncompliance with certain financial covenants of its senior debt agreements and subordinated notes as described in Notes 11 and 13. The Company has obtained amendments or waivers through May 31, 1995 for noncompliance with these covenants.\nThe Company is negotiating with its lenders to refinance its senior secured recourse debt and with the holder of its subordinated notes to effect permanent amendments of the financial covenants. The Company's ability to continue to meet its liquidity requirements is dependent upon its ability to successfully complete these negotiations and, in the meantime, upon the willingness of its creditors to continue to grant extensions and waivers or otherwise not demand immediate payment with respect to such indebtedness. Based upon the status of the negotiations to date, management believes that a new senior debt agreement will be finalized and the subordinated notes will be amended. The Company expects, however, that the effective interest rate of the new senior debt agreement, including interest expense and debt financing fees, may be higher than the effective interest rate of the existing senior credit facility and term loans for the year ended January 31, 1995.\nThe Company is also currently negotiating a new financing program which, if completed, would provide nonrecourse financing of lease equipment purchases until the related lease documentation is finalized and permanent nonrecourse funding is obtained. Management believes that cash generated from operations, cash obtained from this new nonrecourse interim financing program, borrowings under the new senior credit facility, financing from existing nonrecourse programs and other sources and, if necessary, proceeds from sales of leases or other assets will provide sufficient funds to meet the Company's reasonably foreseeable liquidity needs.\nNet assets of discontinued operations decreased from January 31, 1994, to January 31, 1995, due primarily to sales of inventory and collections of accounts receivable of the retail computer superstores and the retail PC outlets and the sale of certain assets of the Company's catalog distribution and software distribution businesses.\nInventories decreased from January 31, 1994, to January 31, 1995, by approximately $7.4 million primarily due to the sale of inventories of non-strategic business units.\nAccounts receivable decreased from January 31, 1994, to January 31, 1995, by approximately $18.6 million due primarily to the collection and\/or sale of receivables of non-strategic business units.\nThe Company does not have any material commitments for capital expenditures. The Company believes that inflation has not been a significant factor in its business.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLDI CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nLDI CORPORATION:\nWe have audited the accompanying consolidated balance sheets of LDI Corporation and its subsidiaries as of January 31, 1994 and 1995, and the related statements of consolidated earnings, cash flows, and shareholders' equity for each of the three years in the period ended January 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LDI Corporation and its subsidiaries at January 31, 1994 and 1995, 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. 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.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the accompanying consolidated financial statements, the Company has incurred significant net losses for each of the two years in the period ended January 31, 1995. As discussed in Note 2 to the consolidated financial statements, the Company's senior secured revolving credit facility and senior secured term notes, which before extension had a scheduled maturity of April 30, 1995, may become due and payable after May 31, 1995, unless the debt is refinanced or the existing agreements are further extended. Additionally, as discussed in Note 2, the Company was in noncompliance with certain financial covenants of its senior debt agreements and subordinated notes and has obtained amendments or waivers through May 31, 1995. 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 accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ Deloitte & Touche LLP\nCleveland, Ohio May 15, 1995\nSee the accompanying notes to consolidated financial statements.\nSee the accompanying notes to consolidated financial statements.\nSee the accompanying notes to consolidated financial statements.\nSee the accompanying notes to consolidated financial statements.\nLDI CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN THOUSANDS EXCEPT WHERE INDICATED)\nFOR THE YEARS ENDED JANUARY 31, 1993, 1994, AND 1995\nNOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. An investment in a 50 percent owned affiliate is accounted for using the equity method.\nLease Accounting - The Company's lease transactions are classified as either sales-type, direct financing, or operating leases at the inception of the lease in accordance with Statement of Financial Accounting Standards (SFAS) No. 13. Sales-type and direct financing leases are those leases (capital leases) which transfer substantially all of the costs and risks of ownership of the equipment to the lessee. Generally, the Company classifies a lease as a capital lease if either (a) the lease term is at least 75 percent of the estimated economic life of the leased equipment at lease inception or (b) the present value of the rental payments is at least 90 percent of the fair market value of the leased equipment at lease inception. Operating leases are those leases in which substantially all the benefits and risks of ownership of the equipment are retained by the Company. Generally, the leases that do not meet conditions (a) or (b) described above are classified as operating leases.\nThe lease accounting methods used by the Company are:\nSales-Type Leases: At lease inception, the present value of rentals over the lease term is recorded as leasing revenues. The cost of the equipment less the present value of the estimated residual value is recorded as leasing costs and a dealer profit is recognized at the inception. The present values of future rentals and of the residual are recorded as leased assets. Unearned interest income, consisting of the excess of the gross rentals and of the residual over their present values, is amortized to leasing revenues over the lease term to produce a constant percentage return on the investment.\nDirect Financing Leases: At lease inception, the present values of future rentals and of the residual are recorded as leased assets. Unearned interest income is amortized to leasing revenues over the lease term to produce a constant percentage return on the investment.\nOperating Leases: The monthly rental is recorded as leasing revenue. The cost of equipment is recorded as leased assets and is depreciated over the lease term to an estimated residual value.\nResidual Values: The estimated residual values used in leases are reviewed periodically and reduced if necessary.\nInitial Direct Costs: Sales commissions and other direct costs incurred in producing direct financing and operating leases are deferred and amortized over the lease term.\nNonrecourse Financing - The Company assigns the rentals under most of its leases to financial institutions and other lenders on a nonrecourse basis, for which the Company receives a cash amount equal to a discounted value of the lease rentals. In the event of a default by a lessee, the lender has a security interest in the underlying leased equipment but has no recourse against the Company. Proceeds from refinancing are recorded on the balance sheet as nonrecourse lease financing. Under capital leases, nonrecourse lease financing and leased assets are\nreduced as lessees make rental payments under the leases. Under operating leases, leasing revenue is recorded monthly as lessees are billed. Receivables and nonrecourse lease financing are reduced as lessees make rental payments.\nDirect Sales - Revenues and costs of direct sales of equipment are recorded at the time title to the equipment transfers to the customer.\nOther Revenues - Other revenues include fees earned for arranging leases between unrelated parties and for selling equity interests in lease transactions. The fees are recognized at the closing of such transactions. In addition to these fees, the Company also may be entitled at lease termination to fees equal to a portion of the net proceeds from the subsequent lease or sale of the equipment. The Company's portion of such net proceeds, if any, is reported as income at the time of the subsequent lease or sale of the equipment.\nInventory - Inventory is valued at the lower of cost or market, using primarily a first-in, first-out method.\nBuildings, Equipment, And Furniture - Buildings, equipment, and furniture are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.\nIncome Taxes - Income taxes are determined under SFAS No. 109. Deferred income taxes are provided to give effect to temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as determined by tax laws and regulations. Principal differences are capital leases, which are accounted for as sales-type and direct financing leases for financial reporting purposes and as operating leases for tax purposes, and certain reserves and liabilities recorded for financial reporting purposes that are not deductible for tax purposes until paid.\nStatement of Consolidated Cash Flows - For the purposes of this statement, the Company considers all highly liquid short term investments that have an original maturity when purchased of ninety days or less to be cash equivalents.\nDebt Financing Fees - The Company capitalizes costs incurred to establish recourse and nonrecourse debt agreements. These costs are amortized on a straight line basis over the term of the agreement.\nInterest Rate Swap and Cap Agreements - The Company enters into interest rate swap and cap agreements to manage exposure to changes in interest rates for portions of its recourse and nonrecourse debt. The agreements involve the exchange of fixed or floating rate interest payments without the exchange of the underlying principal amounts. The differential to be paid or received is accrued as interest rates change and is recognized over the life of the agreements as an adjustment to interest expense. Gains or losses as a result of termination of swaps and caps are deferred and amortized over the maturity of the terminated agreement.\nEarnings Per Share - Primary earnings per share are computed on the basis of the weighted average number of common shares outstanding during each year. For the year ended January 31, 1993, fully diluted earnings per share were computed on the basis of the weighted average number of common shares outstanding and the dilutive effect of the assumed conversion of the convertible notes from the date of issuance, with related interest expense reduced accordingly, and the assumed exercise of stock options and warrants. For the years ended January 31, 1994 and 1995, fully diluted earnings per share are not shown since the effect would be anti-dilutive.\nThe number of common shares used for computing earnings per share are as follows:\nNOTE 2 LIQUIDITY AND DEBT REFINANCING\nAs discussed in Note 11, the Company's senior secured revolving credit facility and senior secured term notes were scheduled to mature on April 30, 1995. Pending finalization of a new agreement, the lenders have extended the maturity date of the credit facility and term notes through May 31, 1995. Additionally, due to the operating results for the year ended January 31, 1995, the Company was in noncompliance with certain financial covenants of its senior debt agreements and subordinated notes as described in Notes 11 and 13. The Company has obtained amendments or waivers through May 31, 1995 for noncompliance with these covenants.\nThe Company is negotiating with its lenders to refinance its senior secured recourse debt and with the holder of its subordinated notes to effect permanent amendments of the financial covenants. The Company's ability to continue to meet its liquidity requirements is dependent upon its ability to successfully complete these negotiations and, in the meantime, upon the willingness of its creditors to continue to grant extensions and waivers or otherwise not demand immediate payment with respect to such indebtedness. Based upon the status of the negotiations to date, management believes that a new senior debt agreement will be finalized and the subordinated notes will be amended. The Company expects, however, that the effective interest rate of the new senior debt agreement, including interest expense and debt financing fees, may be higher than the effective interest rate of the existing senior credit facility and term loans for the year ended January 31, 1995.\nThe Company is also currently negotiating a new financing program which, if completed, would provide nonrecourse financing of lease equipment purchases until the related lease documentation is finalized and permanent nonrecourse funding is obtained. Management believes that cash generated from operations, cash obtained from this new nonrecourse interim financing program, borrowings under the new senior credit facility, financing from existing nonrecourse programs and other sources and, if necessary, proceeds from sales of leases or other assets will provide sufficient funds to meet the Company's reasonably foreseeable liquidity needs.\nThe Company'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. Until a new senior secured recourse debt agreement is finalized and the subordinated notes are amended, there is substantial doubt concerning the Company's ability to continue as a going concern for a reasonable period of time. The consolidated financial statements do not include any adjustments relating to the recoverability of assets that may result should the Company be unable to continue as a going concern.\nNOTE 3 RESULTS OF CONTINUING OPERATIONS\nDuring the years ended January 31, 1994 and 1995, results of continuing operations were adversely impacted by charges recorded during the fourth quarter. These charges were in addition to those discussed in Note 4 related to the restructuring of the Company, and those discussed in Note 5 related to discontinued operations.\nDuring the fourth quarter ended January 31, 1994, the Company recorded charges of $21.5 million to leasing costs. Approximately $7.0 million of these charges related to off-lease writedowns primarily for end of lease buyouts or settlements negotiated during the quarter. Approximately $14.5 million of these charges related to\nequipment valuation writedowns primarily for lessees in bankruptcy or with deteriorating credit conditions. The Company also recorded technical service expenses of $1.2 million to write-off obsolete or excessive maintenance inventories. Additionally, $4.8 million of bad debt charges were recorded to selling, general and administrative expenses. These charges were receivable reserves for lessees in bankruptcy or with deteriorating credit quality.\nDuring the fourth quarter ended January 31, 1995, the Company recorded charges of $21.2 million to leasing costs. Approximately $13.3 million of these charges resulted from revisions to residual values of certain categories of leased equipment, both for leases terminated in the quarter and similar equipment leases which will expire in the future. These charges also include $5.1 million to adjust residual values for equipment leases to customers with deteriorating credit quality and $2.8 million to reduce the valuation of PC rental equipment and other inventories. Additionally, selling, general and administrative expenses include $2.7 million of bad debt charges which were recorded for lessees in bankruptcy or with deteriorating credit quality.\nNOTE 4 RESTRUCTURING CHARGES\nDuring the year ended January 31, 1994, the Board of Directors determined the need to commence a strategic realignment of operations of the Company and to discontinue certain business segments (see Note 5). The strategic plan included the sale or other divestiture of certain product lines and non-strategic businesses, the closing of facilities, and other measures to improve the Company's overall profitability. The cost of implementing the plan was $6.6 million, recorded in the Company's fourth quarter ended January 31, 1994 (after-tax $4.1 million, or $.62 per share).\nThe costs included $4.3 million attributable to disposing of certain product lines and businesses, $1.7 million to employee severance and terminations and $0.6 million to the closing of facilities. No additional costs were incurred during the year ended January 31, 1995. There were reserves and liabilities at January 31, 1994 and 1995, of $3.6 and $2.0 million, respectively, relating to these items.\nSummary financial information for the years ended January 31, 1994 and 1995 for operations subject to sale or other divestiture (exclusive of discontinued business segments) were as follows:\nRevenues and operating income of the non-strategic businesses for the year ended January 31, 1995, represent the results of operations through the sale or divestiture dates. All of the non-strategic businesses were sold or otherwise disposed of during the year.\nNOTE 5 DISCONTINUED OPERATIONS\nDuring the year ended January 31, 1994, management of the Company initiated a comprehensive plan to exit the retail computer superstores, retail PC outlet stores, catalog distribution, and software distribution business segments. The software distribution segment was sold in March 1994, and all retail outlet stores were closed in April 1994. The Company sold the catalog distribution segment in May 1994 and completed the liquidation of the retail computer superstores in the third quarter ended October 31, 1994.\nThe Company recorded in the fourth quarter ended January 31, 1994, a charge of $11.7 million (after-tax, $7.1 million), consisting of $10.8 million for estimated losses during the planned phase-out period and $0.9 million for employee severance and termination costs. At January 31, 1994, there were reserves and liabilities of $3.9 million relating to these items.\nDuring the second quarter ended July 31, 1994, the Company recorded an additional loss from discontinued operations of $5.0 million (after-tax $3.1 million). This loss was related to incremental costs for the liquidation and closing of the Company's retail computer superstores and retail PC outlets.\nCombined revenues of the four discontinued segments were $40 million, $65 million, and $19 million during the years ended January 31, 1993, 1994, and 1995, respectively. Assets of the discontinued operations, consisting primarily of accounts receivable and inventory at January 31, 1994, are reported on the balance sheets as net assets of discontinued operations. The consolidated financial statements disclose the operating results of discontinued operations separately from continuing operations.\nNOTE 6 ACQUISITIONS\nDuring the year ended January 31, 1994, the Company acquired the assets of companies engaged in sales of microcomputers and related equipment to commercial accounts, short-term rentals of computer equipment, and the distribution of communications products. The aggregate consideration for these acquisitions was $3.3 million.\nThese acquisitions have been accounted for using the purchase method and, accordingly, the results of operations of these companies have been included in the consolidated results of operations from the date of acquisition. The operations of the companies prior to acquisition were not material in relation to the consolidated amounts.\nCertain of these businesses were determined to be non-strategic and were sold during the year ended January 31, 1995, as discussed in Notes 4 and 5.\nNOTE 7 RECEIVABLES\nNOTE 8 LEASING ACTIVITIES\nAssets leased under capital leases consist of:\nFuture minimum lease rentals are:\nNoncancelable leases are extended automatically on a month-to-month basis for a minimum of usually 120 days unless the Company or the lessee provides written notice of termination.\nNOTE 9 INCOME TAXES\nThe provision (benefit) for income taxes consists of:\nThe following is a reconciliation between the federal statutory tax rate and the Company's effective tax rate for continuing operations:\nPrincipal components of the deferred income tax assets and liabilities are as follows:\nAt January 31, 1995, the Company has investment tax credit carryforwards for income tax purposes of $2.9 million that expire in various amounts beginning in 1999 and has tax loss carryforwards for income tax purposes of $88.3 million. These tax loss carryforwards expire in future years as follows: 2004 ($19 million), 2005 ($19 million), 2006 ($4.5 million), 2007 ($18.1 million), 2008 ($2.6 million) and 2010 ($25.1 million).\nThe Company expects to realize fully its deferred tax assets and, accordingly, has made the determination that recording a valuation allowance is not required. The primary component of the net operating loss carryforwards results from the temporary differences in the accounting for sales-type leases (see Note 1). Based on management's review of the current lease portfolio, the majority of existing sales-type lease differences will reverse in the next three years, resulting in recognition of taxable income. Management also projects that sales-type lease volume in future years will decline. Other actions which the Company could take to generate taxable income to utilize the carryforwards include the election of straight-line, rather than accelerated, tax depreciation for equipment purchased for lease, and structuring of partnerships and joint ventures which would purchase lease transactions from the Company.\nThe Omnibus Budget Revenue Reconciliation Act of 1993, enacted in August 1993, included a one percent increase in the Federal tax rate for corporations, which was effective retroactive to January 1, 1993. Under the provisions of SFAS No. 109, the effect on taxes currently payable and deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Accordingly, deferred tax liabilities as of February 1, 1993, increased by $541,000 as a result of the new law.\nNOTE 10 ACCRUED AND OTHER LIABILITIES\nAccrued liabilities consist of:\nAs of January 31, 1995, the Company had a $103.0 million senior secured revolving credit facility with a group of banks that provides for a floating interest rate based on either LIBOR or the prime rate. The facility amortized to $102.6 million at its scheduled maturity on April 30, 1995. As described in Note 2, the maturity date of the facility has been extended through May 31, 1995. At January 31, 1995, $103.0 million was outstanding on this facility at an interest rate of 8.5%. This facility resulted from the consolidation on May 2, 1994 of a senior unsecured $130 million revolving credit facility and a four year senior unsecured $50 million term loan. This facility was subsequently modified on July 29, 1994, to include restrictions on the amounts of borrowings under the facility based on the amounts of certain assets as defined in the agreements. At January 31, 1994, $129.8 million was outstanding on the former revolving credit facilities at an interest rate of 4.3% and $38.8 million was outstanding on the former unsecured term loan.\nSubsequent to January 31, 1994 and 1995, $32.7 million and $2.7 million, respectively, of the borrowings under the revolving credit facilities were refinanced on a nonrecourse basis. Accordingly, the refinanced amounts have been included in nonrecourse lease financing at January 31, 1994 and 1995.\nThe Company also had an $8.3 million revolving credit facility which was converted on May 2, 1994, to a secured amortizing term loan. This facility had an outstanding balance of $1.4 million at January 31, 1995, and was paid in full, as scheduled, on May 10, 1995.\nOn May 2, 1994, senior unsecured installment notes of $9.7 million were changed to senior secured term notes with modifications made to the principal repayment schedule to proportionately match the principal amortization of the senior secured revolving credit facility. These notes aggregated $6.1 million at January 31, 1995, and were scheduled to mature on April 30, 1995. The maturity date of the notes has been extended through May 31, 1995, and certain waivers have been obtained from the holders as described in Note 2. Additionally, $2.6 million of unsecured installment notes were changed to secured notes, and paid in full, as originally scheduled, on August 31, 1994.\nThe installment notes consist of fixed rate notes with interest rates ranging from 9.7 percent to 10.0 percent.\nUnder the terms of the above debt agreements, the Company is required to maintain certain liquidity, leverage, and net worth ratios. The covenants also prohibit the payment of cash dividends and place restrictions on the amount of borrowings under the facilities based on the amounts of certain assets as defined in the agreements. The loan agreements are secured by receivables, inventories and substantially all other unpledged assets of the Company. As described in Note 2, at January 31, 1995, the Company was in noncompliance with certain financial covenants and has obtained amendments or waivers of them through May 31, 1995.\nNOTE 12 NONRECOURSE LEASE FINANCING\nNonrecourse discounted lease rentals include fixed rate capital obtained from financial institutions on a nonrecourse basis. The lender has a security interest in the lease rental stream and the underlying assets, but has no recourse to the Company in the case of default by the lessee.\nThe Company also established two asset-backed financing programs to fund lease transactions on a nonrecourse basis through the use of commercial paper secured by lease rental receivables. The programs are rated A-1 by Standard &\nPoor's and P-1 by Moody's. These ratings represent the highest attainable ratings available under the respective classification systems.\nUnder one of the programs, the Company sold lease receivables to a wholly owned special purpose corporation that issues commercial paper backed by an annually renewing five year letter of credit. At January 31, 1994 and 1995, $43.8 million and $26.1 million of commercial paper was outstanding under this program at average interest rates of 3.4% and 6.3%, respectively. Effective May 1, 1994, the letter of credit under this program was not extended; however, leases funded previously continue to amortize under the terms of the existing agreement.\nA second securitized program provides for the financing of lease receivables through an independent corporation which issues commercial paper. This program is backed by a surety bond. On June 3, 1994, the Company executed a letter agreement to increase the availability to finance under this program from $75 million to $125 million in two steps. The first $25 million of additional capacity became available on September 9, 1994, and the remaining $25 million became available December 1, 1994. Effective with the December increase, the program began operating through a wholly owned subsidiary of the Company to which the Company sells lease receivables and transfers the related equipment. The subsidiary then transfers the receivables to the independent corporation to support the issuance of commercial paper, which is nonrecourse to the Company. At January 31, 1994 and 1995, $70.3 million and $82.1 million of commercial paper was outstanding under this program at average interest rates of 3.3% and 6.0%, respectively.\nContractual payments of principal and interest required on nonrecourse lease financings are:\nThe average interest rate on all nonrecourse lease financing was 7.2% and 6.5% for the years ended January 31, 1994 and 1995, respectively.\nNOTE 13 SUBORDINATED NOTES\nThe Company has $10 million of 9.375 percent subordinated notes, with interest payable semiannually, maturing in August 2000. Prior to May 1994, the notes were convertible into shares of the Company's common stock. The notes require annual repayments of $2.5 million beginning in August 1997. The notes are callable by the Company at a premium of 109 3\/8 beginning August 1994, with the premium declining ratably to par in August 1999.\nIn conjunction with the issuance of the notes, the Company also issued 45,496 warrants. Each warrant is exercisable by the holder through August 15, 1996, into one share of the Company's common stock. The exercise price is subject to adjustment for stock dividends, splits and certain other issuances of common stock.\nOn May 2, 1994, the notes were amended to eliminate the conversion feature, to adjust the exercise price of the outstanding warrants to $6.35 per share, and to issue 1,529,307 additional warrants with the same exercise price, terms,\nand expiration date as the previously issued warrants. In exchange, the holder of the notes agreed to permit the Company to grant security interests to its recourse lenders as described in Note 11. Additionally, the Company and the holder agreed to modify certain other terms and conditions of the notes.\nAs described in Note 2, at January 31, 1995, the Company was in noncompliance with certain financial covenants and has obtained amendments or waivers of them through May 31, 1995.\nNOTE 14 SHAREHOLDERS' EQUITY\nEMPLOYEE STOCK OPTION PLAN - The Company has a stock option plan for officers and key employees and has reserved 1,500,000 shares of common stock for distribution under the plan. Options are exercisable beginning not less than one year after the date of grant and expire ten years after the date of grant. Options are granted at market value and become exercisable at the rate of 20 percent per year. Options granted under the plan may qualify as incentive stock options under the Internal Revenue Code or may be non-qualified stock options. Options issued to date, except for those granted during the year ended January 31, 1995, have qualified as incentive stock options.\nStock option transactions during the three years ended January 31, 1995, are:\nAt January 31, 1995, there were 499,304 options available for grant and 144,341 options were exercisable.\nRESTRICTED STOCK PLAN - The Company also has a restricted stock plan for officers and key employees and has reserved 55,000 shares of common stock for distribution under the plan in amounts and at times as determined by the Board of Directors. Common stock awarded becomes vested at such time as specified by the Board. On March 21, 1994, the Board of Directors approved an acceleration of vesting with respect to the 10,000 shares granted in 1990, which were originally scheduled to vest at the rate of 5,000 shares each on February 1, 1995 and 1996. The plan shall continue until terminated by the Board. However, no awards may be granted after January 31, 1999, and all awards shall vest no later than January 31, 2004.\nRETIREMENT SAVINGS PLAN - The Company has a Section 401(k) retirement savings plan for eligible employees and has reserved 275,000 shares of common stock for distribution under the plan.\nDIRECTOR STOCK OPTION PLAN - On March 27, 1995, the Board of Directors adopted a stock option plan, subject to the approval of the Company's shareholders, for non-employee directors and reserved 150,000 shares of common stock for distribution under the plan. Each eligible director on the date of adoption of the plan was granted options to purchase 10,000 shares, and each future eligible director will be granted options to purchase 10,000 shares upon joining the Board. Each eligible director will also receive options to purchase an additional 10,000 shares on each third anniversary of that director's initial grant, if he remains an eligible director on that anniversary. Options are granted at market value and become exercisable six months after the date of grant. They expire ten years after the date of grant.\nIn June 1991, the shareholders approved the grant of options to purchase 10,500 shares to a non-employee director with an option price of $13.81 per share. The options are currently exercisable and expire nine years after the date of grant.\nPREFERRED STOCK - The Board of Directors is authorized to issue 2,000,000 shares of preferred stock, $.01 par value, with terms as may be subsequently determined by the Board of Directors without further action by the shareholders of the Company. At January 31, 1995, none of the shares were outstanding.\nNOTE 15 EMPLOYEE RETIREMENT BENEFIT PLANS\nThe Company had two defined contribution employee retirement benefit plans: the LDI Corporation Pension Plan and Trust and the LDI Corporation Retirement Savings Plan. These plans provided retirement benefits for eligible employees who meet certain service requirements. The Company's annual contributions under the pension provision are determined each year by the Board of Directors. The Company's contributions under the retirement savings provision are based on various percentages of the voluntary pretax contributions of the participants, up to a maximum contribution of 2.75 percent of the participant's annual compensation. Effective June 30, 1994, in conjunction with the strategic realignment of the Company and in an effort to improve the administrative efficiencies and the overall return on investments, the Board of Directors of the Company elected to merge the plans. The Board of Directors did not authorize a contribution to the Pension Plan for the fiscal year ended January 31, 1994.\nCosts for the plans maintained by the Company for the years ended January 31, 1993, 1994, and 1995 were $1.4 million, $1.0 million, and $0.5 million, respectively.\nNOTE 16 RELATED PARTY TRANSACTIONS\nThe Company has engaged in certain transactions with entities owned or controlled by certain of its principal shareholders.\n(a) The Company rented office, technical and warehouse facilities from a related partnership under leases which had a scheduled expiration in 2000. During the year ended Jan. 31, 1995, an agreement was reached whereby the Company assigned its interest in a sublease arrangement to the partnership and the Company was released from further obligation under the leases. Rental payments made to the partnership during the years ended January 31, 1993, 1994, and 1995 were $587, $343, and $355, respectively.\n(b) The Company contracted with the related partnership for building management and maintenance services, and paid the partnership other specified consulting fees. Expenditures under these agreements aggregated $325, $156, and $40 during the years ended January 1993, 1994, and 1995, respectively.\n(c) On May 31, 1994, the Company sold to the predecessor of MRK Technologies, Ltd. (\"MRK\") substantially all of the assets of a subsidiary and a division of the Company engaged in the businesses of selling computer systems and software and related equipment, network connectivity products and related services. Michael R. Kennedy, who is a principal shareholder of the Company, is the Chairman and\nChief Executive Officer and one of the principal members of MRK. The purchase price paid by MRK for the assets consisted of cash and short-term notes in the aggregate amount of approximately $8.5 million and a subordinated note in the original principal amount of $2 million payable in installments through 1999. The note is subordinated to certain commercial financing arrangements of MRK, is guaranteed by Mr. Kennedy and is secured by Mr. Kennedy's pledge to the Company of shares of the Company held by him. The unpaid principal amount of the note and accrued interest at January 31, 1995, was $2.1 million. In connection with the sale, the Company leases to MRK certain furniture, fixtures and equipment used in the business. The lease provides for aggregate rentals of approximately $796 over a term of thirty-six months and gives MRK the option to purchase the leased equipment at the end of the lease term for a nominal amount. Rentals earned for the year ended January 31, 1995, by the Company under the terms of the lease were $177. On March 31, 1994, the Company sold to Open Software, Inc. substantially all of the assets of the Company's open systems software distribution business. The purchase price consisted of $100 in cash and certain percentage amounts based on software revenues during the two months following the closing. Mr. Kennedy was the Chairman and Chief Executive Officer and one of the principal stockholders of Open Software, Inc., which is now a part of MRK.\n(d) During the year ended January 31, 1995, the Company purchased computer equipment which was leased to its customers and acquired other products and services from MRK. The aggregate amount of these purchases was $5.3 million, for which the Company owed MRK $145 at January 31, 1995. In addition, the Company provided $180 of goods and services to MRK during the year. At January 31, 1995, the Company was owed approximately $360 from MRK for goods and services, and custodial funds held by MRK.\n(e) The Company is reimbursed for expenses paid on behalf of its 50 percent owned affiliate. At January 31, 1994, accounts receivable from the affiliate were $72. In addition the Company advanced the affiliate $3.5 million during the year ended January 31, 1995, with interest at 8%. The note was secured by all unencumbered assets of the affiliate and was repaid in full, including $136 of accrued interest. The Company has also guaranteed the repayment of certain indebtedness of the affiliate under two credit arrangements in an aggregate amount not to exceed the lesser of $12.5 million or 50% of such indebtedness. At January 31, 1995, the amount guaranteed by the Company was $5.5 million.\nNOTE 17 LEASE OBLIGATIONS\nIn addition to the lease obligations described in Note 16, the Company leases office, technical, and other facilities from unrelated third parties. Rent expense for these leases was $941, $969, and $605 for the years ended January 31, 1993, 1994, and 1995, respectively. Annual rentals are subject to increases for escalation in operating costs.\nAdditionally, the Company leases data processing equipment under agreements classified as capital leases (as a lessee) and subleases this equipment to third parties (as a lessor) under agreements classified as capital or operating leases. Rent payments for these leases were $156, $45, and $54 for the years ended January 31, 1993, 1994, and 1995, respectively.\nA summary of the Company's commitments with respect to capital and operating leases is:\nAt January 31, 1995, future minimum rentals to be received under noncancelable subleases for facilities included in the Company's obligations under operating leases above totaled $4,349.\nNOTE 18 FINANCIAL INSTRUMENTS\nCredit loss exposure of interest rate swap and cap agreements in the event of nonperformance by the other party is limited to the amount of net cash payments due under the swap or cap agreements. Collateral is not obtained from counterparties to swap or cap agreements. Terms of the swaps and caps as of January 31, 1995, are set forth in the table below.\nThe estimated fair value amounts have been determined by the Company, using current available market information as of each balance sheet date and appropriate valuation methods. Considerable judgment is necessary in interpreting market data to develop the estimates of fair value. The use of different market assumptions and\/or methods of estimation may have a material effect on the estimated fair value amounts. Accordingly, the estimates presented are not necessarily indicative of the amounts that the Company could realize in a current market exchange or the value that ultimately will be realized by the Company upon maturity or disposition.\nGenerally accepted accounting principles exclude certain items from its disclosure requirements such as the Company's investment in leased assets. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the net assets of the Company.\nThe carrying amounts for cash, receivables, accounts payable, accrued liabilities, and revolving and line of credit notes payable approximate fair value because of the short maturity of these instruments or, as to trade notes receivable, bear interest rates that approximate current market rates.\nThe estimated fair values of the Company's other financial instruments are assets (liabilities) as follows:\nThe fair values of nonrecourse lease financing, term loans and notes and subordinated notes are estimated based on market rates of comparable debt for similar remaining maturities at year end. The fair values of interest rate swaps and caps, and the letter of credit are estimated based on pricing models or formulas using current assumptions.\nThe fair value estimates presented herein are based on pertinent information available to management as of January 31, 1994 and 1995. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.\nNOTE 19 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION\nThe amounts below reflect the total cash paid by the Company and are not restated for the discontinued entities.\n(1) The allowance for uncollectible future lease rentals is included in the caption \"Leased Assets - Capital Leases\" in the accompanying consolidated balance sheet.\n(2) The reserve for inventory valuation is included in the caption \"Inventory held for lease or sale\" in the accompanying consolidated balance sheet.\n(3) The reserve for residual valuation is included in the caption \"Leased Assets - Capital Leases\" in the accompanying consolidated balance sheet.\nPART III\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe description of the directors of the Registrant is incorporated hereby by reference from the section of the Proxy Statement for the 1995 Annual Meeting of Stockholders (the \"Proxy Statement\"), entitled \"Election of Directors.\"\nA description of the executive officers of the Registrant follows:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by referenced from the section of the Proxy Statement entitled \"Executive Compensation.\"\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.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from the section of the Proxy Statement entitled \"Executive Compensation -- 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 The following consolidated financial statements and related notes of the Registrant and its subsidiaries are included herein: Independent Auditors' Report Consolidated Balance Sheets, as of January 31, 1994 and 1995 Statements of Consolidated Earnings for the Years Ended January 31, 1993, 1994, and 1995 Statements of Consolidated Cash Flows for the Years Ended January 31, 1993, 1994, and 1995 Statements of Consolidated Shareholders' Equity for the Years Ended January 31, 1993, 1994, and Notes to Consolidated Financial Statements for the Years Ended January 31, 1993, 1994, and 1995\n(a)(2) Financial Statement Schedule: The following financial statement schedule is included herein: Schedule VIII -- Valuation and Qualifying Accounts\n(a)(3) Exhibits:\n(b) Reports on Form 8-K: On March 22, 1995, the Registrant filed a report on Form 8-K with respect to certain special charges to be recorded as of January 31, 1995.\n(c) Exhibits: The Exhibits listed in Item 14 are included and submitted with this report.\n(d) Financial Statement Schedules: The financial statement schedules required to be filed with this report are included in Item 8 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.\nLDI CORPORATION\nDate: May 16, 1995 By: \/s\/Floyd S. Robinson --------------------- Floyd S. Robinson, 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 and on the date indicated.","section_15":""}
{"filename":"764579_1995.txt","cik":"764579","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company\nCAS Medical Systems, Inc. (CAS) was organized in 1984 primarily to serve neonatal and pediatric units in hospitals. Today, CAS is engaged in the business of developing, manufacturing and distributing diagnostic equipment and medical products for use by adults and children in many areas of the health care industry.\nThe Company has developed and is manufacturing a full line of non-invasive blood pressure monitors, blood pressure cuffs for both adult and neonatal patients, silver\/silver chloride electrodes for neonatal hospital intensive care units, and a line of disposable products for neonatal use. These products are being sold by the Company directly through its own sales force via distributors and pursuant to original equipment manufacturer (OEM) agreements in Europe and the United States. The Company has agreements to supply its blood pressure monitors, cuffs and electrodes to companies for distribution in major segments of the international market. The Company also has OEM agreements to supply custom versions of its blood pressure measuring technology in the form of plug-in modules for patient monitoring systems. The Company has several other products in various stages of development which it believes are applicable to both adult and neonatal\/pediatric medicine.\nNarrative Description of Business\nPrincipal Products and Services\nOscilloMate Blood Pressure Monitors\nThe Company manufactures a complete line of state-of-the-art blood pressure monitors which it has developed. Distribution is to the hospital and professional markets through its sales force and distributors, and through international distributors and OEM agreements.\nPedisphyg, Safe-Cuff, Tuff-Cuff and PAPERCUFF Blood Pressure Cuffs\nThe Company manufactures and sells complete lines of disposable and multi-use blood pressure cuffs for hospital use. These cuffs are based on design criteria developed from scientific studies to ensure the highest degree of accuracy. They can be used with all of the blood pressure monitors currently available in hospitals, thus permitting hospitals to standardize with one company for blood pressure cuffs.\nKlear-Trace Electrodes\nThe Company manufactures and sells prewired, X-ray translucent electrocardiographic electrodes. They utilize a conductive solid-gel adhesive that allows them to remain on the patient for extended periods of time without causing skin irritation.\nNeoGuard Reflectors, Klear-Temp Disposable Temperature Probes\nThe Company manufactures and sells thermal reflectors to shield temperature probes while in use within radiant warmers. They perform an important role in maintaining the proper thermal environment for neonates while assuring that no skin irritation takes place. Klear-Temp disposable skin temperature probes are designed to be a standard replacement part in all incubators and radiant warmers.\nNeoGuard Limboard Arm Boards\nThe Company manufactures and sells a line of neonatal arm boards used to immobilize and support intravenous sites with minimal patient skin trauma.\nThe electrodes, arm boards, and reflectors utilize a polymeric solid gel adhesive to minimize damage to neonatal skin.\nSales and Marketing\nThe Company conducts its sales in the domestic hospital market by means of exclusive distributors managed by full time sales managers. Sales to emergency medical services are managed nationwide by a single company sales manager. OEM sales and international sales are conducted by personnel located within the Company.\nDomestic sales are conducted by 25 distributors across the country each of whom has exclusive sales rights in a limited geographic area.\nThe Company has sales agreements with several distributors internationally. These agreements provide for distribution of products within an assigned territory. Other agreements are being negotiated to allow for expanded international distribution.\nThe Company sells its non-invasive blood pressure technology, in the form of sub-assemblies to be joined to multi-parameter hospital monitors, to several firms operating on both a domestic and international basis. The Company is in the process of negotiating other agreements for the use of its technology as components in other medical monitoring systems.\nFinancial Information Relating to Sales Year Ended December 31,\n1995 1994 1993\nDomestic Sales $4,273,483 $3,431,374 $3,529,335 Export (Including Licensing Revenues) 2,155,748 1,463,974 1,516,524 _________ _________ _________\n$6,429,231 $4,895,348 $5,045,859 _________ _________ _________\nCompetition\nThe Company competes in the hospital market where there are many suppliers with greater financial and personnel resources with full service commodity products and dedicated selling capability. Neonatal and pediatric intensive care units are such areas. Here, the Company has been supplying competitively priced, uniquely designed products responsive to this market in which no major company currently focuses its total effort.\nIn both the hospital and emergency medical service markets, the Company's line of non-invasive blood pressure monitoring equipment has significant advantages over competitive products. It is compact, portable, lightweight and user-friendly. The monitors maintain a high professional standard of accuracy and quality in demanding environments such as those encountered in hospital and transport situations.\nWith respect to all of its products, the Company competes on the basis of price, features, product quality, promptness of delivery and customer service.\nCustomers\nDuring 1995, 1994 and 1993, the Company had sales to one customer which in the aggregate accounted for approximately 12%, 13% and 13% of sales, respectively.\nResearch and Development\nIn 1995, 1994 and 1993, the Company spent approximately $405,000, $335,000 and $329,000, respectively, on activities relating to the development of new products and the improvement of existing products.\nThe Company is building on its base of non-invasive blood pressure technology by developing a family of next-generation patient-monitoring equipment.\nEmployees\nAs of December 31, 1995, the Company had 46 employees of whom 44 were full-time. The Company has no collective bargaining agreements and believes that relations with its employees are good. The Company maintains employee benefit plans providing for disability income, life insurance and medical and hospitalization coverage. The Company sponsors a 401(K) benefit plan for its employees which generally allows participants to make contributions by salary deductions up to allowable internal revenue service limits on tax-deferred basis and discretionary contributions by the Company. The Company did make discretionary contributions in 1995.\nGovernment Regulation\nMedical products of the type currently being marketed and under development by the Company are subject to regulation under the Food, Drug and Cosmetic Act (the \"FDA Act\") as amended in the Medical Device Amendments of 1976 (the \"1976 Amendments\") and the 1990 \"Safe Medical Devices Act\", as well as additional regulations promulgated thereto. Under the 1976 Amendments, the Company must be a registered device manufacturer and must comply with Good Manufacturing Practice Regulations for Medical Devices.\nIn addition, depending upon product type, the Company must also comply with those regulations governing the Conduct of Human Investigations, Pre-Market Approval Regulations and other requirements, as promulgated by the Food and Drug Administration (FDA). The FDA is authorized to inspect a device, its labeling and advertising, and the facilities in which it is manufactured in order to ensure that the device is not manufactured or labeled in a manner which could cause it to be injurious to health.\nUnder the 1976 Amendment and the Safe Medical Device Act, the FDA has adopted regulations which classify medical devices based upon the degree of regulation it believes is necessary to assure safety and efficacy. A device is classified as a Class I, II, or III device. Class I devices are subject only to general controls. Class II devices, in addition to general controls, are or will be subject to \"performance standards.\" Most devices are subject to the 501(K) pre-market notification provision. In addition, some Class III devices require FDA pre-market approval before they may be marketed commercially because their safety and effectiveness cannot be assured by the general controls and performance standards of Class I or II devices. The Company's products are mostly Class II devices. Several of them have required FDA notification under Section 510(k) of the FDA Act.\nThe FDA has the authority to, among other things: deny marketing approval until all regulatory protocols are deemed acceptable; halt the shipment of defective products; and seize defective products sold to customers. Adverse publicity from the FDA, if any, could have a negative impact upon sales. To date, the Company has had no FDA oversight problems, and none are pending to its knowledge.\nManufacturing and Quality Assurance\nThe Company assembles its products at its facility. The various components for the products, which include plastic sheeting, plastic moldings, wire, semi-conductor circuits, electronic and pneumatic components and power supplies are obtained from outside vendors. The Company does not anticipate any difficulties in obtaining the components necessary to manufacture its products.\nQuality control procedures are performed by the Company at its facility and occasionally at its suppliers' facilities to standards set forth in the \"Good Manufacturing Practices\". These procedures include the inspection of components and full testing of finished goods. The Company has a controlled clean environment where the final assembly of single-patient-use products is conducted. The Company has charted a course to becoming certified to ISO 9000 and relevent European Union Directives in order to broaden European markets and make domestic quality system improvements.\nBacklog\nThe Company's practice is to ship its products upon receipt of a customer's order or pursuant to customer-requested ship dates. On December 31, 1995, the Company had a backlog of orders from customers for products with requested ship dates in 1996 totaling approximately $880,000, deliverable throughout 1996, as compared to $691,000 as of December 31, 1994. During the first quarter of 1996, the Company will fulfill approximately $273,000 of this backlog.\nTrademarks, Patents and Copyrights\nCertificates of Registration have been issued to the Company by the United States Department of Commerce Patent and Trademark Office for the following marks: CAS (Registered trademark), Pedisphyg (Registered trademark), OscilloMate (Registered trademark), NeoGuard (Registered trademark), Tuff-Cuff (Registered trademark), Limboard (Registered trademark), Klear-Trace (Registered trademark), and the heart shaped mark for use as a thermal reflector and the Company's corporate logo. The Company continues to use the PAPERCUFF (Trademark) and Safe-Cuff (Trademark) trademark.\nThe Company filed a patent application on behalf of an employee covering the method of operation of its blood pressure measurement monitor. This patent was issued under Patent Number 4,796,184 and assigned to the Company. The Company also holds Patent Number 4,966,992 which covers the design of a blood pressure monitor for use with hyperbaric chambers. The Company holds Patent Number 5,101,830 which covers the design of a blood pressure cuff.\nThe Company has copyright protection for the software used in its blood pressure monitors.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has leased new facilities comprising approximately 17,500 square feet of office, laboratory and assembly space, including a controlled clean environment, located at 21 Business Park Drive, Branford, Connecticut 06405. Minimum annual rentals under the Company's lease agreement are:\n1996 $101,000 1997 $104,000 1998 $110,000\nThese amounts are in addition to the Company's share of increases in real estate taxes and certain utility costs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNo material legal proceedings involving the Company are pending 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 THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\n(a) The Common Stock of the Company is traded over-the-counter. The following table shows the high and low bid quotations for the Company's Common Stock for each quarterly period for the last three years. These prices do not represent actual transactions and do not include retail mark-ups, mark-downs or commissions.\nPeriod Ended High Low\nMarch 31, 1993 5\/8 1\/2 June 30, 1993 3\/8 1\/4 September 30, 1993 5\/16 1\/8 December 31, 1993 1\/4 1\/8 March 31, 1994 3\/8 1\/4 June 30, 1994 5\/16 1\/4 September 30, 1994 1\/4 1\/8 December 31, 1994 1\/4 3\/16 March 31, 1995 9\/32 1\/8 June 30, 1995 19\/32 9\/32 September 30, 1995 15\/32 19\/32 December 31, 1995 1 5\/8 15\/16\n(b) The following table sets forth the approximate number of holders of record of Common Stock of the Company on December 31, 1995.\nTitle of Class Number of Shareholders\nCommon Stock, $.004 par value 400\nPreferred Stock, $.001 par value 1\n(c) No cash dividends have been declared on the Company's common stock for 1995, 1994 and 1993.\n(d) Cash dividends were declared and paid during 1995, 1994 and 1993, in the amount of $40,000, $50,000 and $50,000 respectively, on the Series C cumulative preferred stock.\n(1) Based on weighted average number of shares outstanding during the years.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFinancial Condition, Liquidity and Capital Resources\nAs of December 31, 1995, the Company's cash and cash equivalents totaled $1,082,003, compared to $301,472 at December 31, 1994 (an increase of 359%), and the Company's working capital totaled $2,087,687 on December 31, 1995, compared to $1,506,332 on December 31, 1994. The Company's increased cash position is due to cash provided by operating activities in 1995. As a result of improved liquidity in 1995, the Company was able to internally finance approximately $70,000 of property and equipment additions and paid the outstanding debt in full.\nThe Company's working capital ratio improved from 4.17 at December 31, 1994 to 4.23 at December 31, 1995.\nAt December 31, 1994, the Company had a line of credit with a Connecticut bank totaling $500,000. On August 1, 1995, this line was extended through August 1, 1996. Borrowings under the line bears interest at prime plus 1.5%. At December 31, 1995, there were no borrowings outstanding under this line.\nOn July 27, 1994, the Company entered into a new four year licensing agreement with a major manufacturer of patient monitors, granting a nonexclusive license to use the Company's blood pressure technology for a specific application, and allowing the exchange of technical know-how. Under this agreement, the Company will receive $750,000 over the initial four year\nterm, plus royalties. The manufacturer has the option to extend the license for an additional three year period upon payment of an additional $600,000 plus royalties over the extended term. This agreement replaces a prior licensing agreement with the manufacturer. License fees are being recognized on a straight line basis over the contract period.\nThe Company believes that existing funds together with internally generated funds from 1996 operations and its existing line of credit arrangement will provide the Company with adequate liquidity and capital resources to meet its 1996 financial requirements.\nResults of Operations\n1995 Compared to 1994\nThe Company earned $849,000 ($.08 per common share) in 1995, compared to $301,000 ($.03 per common share) in 1994. The 1995 earnings performance was favorably impacted by incremental gross margin generated by higher sales volume and an increase in licensing fee revenues partially offset by additional sales support costs.\nThe Company's revenues increased by 31 percent to approximately $6,429,000 for 1995 compared to revenues of approximately $4,895,000 for the previous year. Sales of NIBP modules to Original Equipment Manufacturers (\"OEM\") who utilize the Company's technology in their systems, were responsible for approximately $862,000 of the growth in overall sales revenues. Sales of our blood pressure monitors were 33 percent higher than the same period in 1994. The Company expects continued improvement in overall sales next year.\nTotal cost of product sales decreased as a percentage of net product sales from 49.5 percent to 45.9 percent when comparing the current year to 1994. The decrease in cost reflects an on-going quality and cost reduction efforts and a more profitable product mix.\nResearch and development expenses increased by 21 percent during 1995 to approximately $405,000 compared to $335,000 for the same period of 1994, primarily due to development cost of new products.\nSelling, general and administrative expenses increased to approximately $2,272,000 for the year ended December 31, 1995 compared to the prior year of approximately $1,898,000, an increase of 20 percent. However, as a percentage of net revenues, 1995 decreased to 35 percent from 39 percent in 1994. The increase in expenses was primarily due to salaries and related expenses, legal fees for patent applications for new product and telemarketing expenses for various products.\nThe Company's strong cash position enabled all outstanding debt to be paid in full and resulted in excess cash. The Company earned approximately $19,000 from various investment accounts.\nDuring 1995, the Company utilized approximately $874,000 of net operating loss carryforwards to reduce its provision for taxes for financial reporting purposes. The tax benefit associated with this utilization of net operating loss carryforwards was approximately $297,000 or $.03 per common share. As of December 31, 1995, the company has utilized substantially all of its net operating loss carryforwards.\n1994 Compared to 1993\nThe Company earned $301,000 ($.03 per common share) in 1994, compared to $475,000 ($.05 per common share) in 1993. The 1994 earnings performance was impacted by softness in sales of certain of the Company's product lines partially offset by an increase in licensing fee revenues.\nThe Company's revenues decreased from $5,045,859 in 1993 to $4,895,348 in 1994, a decrease of $150,511. The decrease in revenues reflects a decrease in international product sales attributed primarily to delays in shipments of non-invasive blood pressure modules and declines in domestic sales of disposable products due to increased competition. This decrease in product revenues was partially offset by an increase in licensing fee revenues from $40,000 in 1993 to $220,833 in 1994 as a result of a new licensing agreement.\nCost of product sales increased as a percent of net product sales from 45 percent in 1993 to 49 percent in 1994. This increase mainly reflects under absorption of overhead expenses due to decreased sales and production.\nSelling, general and administrative expenses decreased to $1,898,039 in 1994 from $1,934,808 in 1993, a decrease of $36,769. The decrease is due primarily to a reduction in payroll costs beginning in the second quarter of 1994, and reimbursement of certain professional fees and expenses upon signing of the license agreement previously discussed.\nNet interest expense decreased in 1994 to $29,869 from $33,721 in 1993. The decrease was due to net debt principal reductions of approximately $130,500 during 1994.\nDuring 1994, the Company utilized approximately $290,000 of net operating loss carryforwards to reduce its provision for taxes for financial reporting purposes. The tax benefit associated with this utilization of net operating loss carryforwards was approximately $104,000 or $.01 per common share.\nITEM 8.","section_7A":"","section_8":"ITEM 8. INDEX TO FINANCIAL STATEMENTS\nReport of Independent Public Accountants\nBalance Sheets - December 31, 1995 and 1994 to\nStatements of Income for the Years Ended December 31, 1995, 1994 and 1993\nStatements of 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 to\nNotes to Financial Statements to\nSchedules 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.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS 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\nReference is made to the section entitled \"Election of Directors\" in the Registrant's definitive proxy statement to be mailed to shareholders on or about April 22, 1996, and filed with the Securities and Exchange Commission.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the sections entitled \"Compensation of Executive Officers\" and \"Election of Directors\" in the Registrant's definitive proxy statements to be mailed to shareholders on or about April 22222996, and filed with the Securities and Exchange Commission.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND STOCKHOLDERS\nReference is made to the sections entitled \"Principal Stockholders\" and \"Election of Directors\" in the Registrant's definitive proxy statements to be mailed to shareholders on or about April 22, 1996, and filed with the Securities and Exchange Commission.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOn September 17, 1990, by agreement, the Company and Dr. Myron L. Cohen amended Dr. Cohen's employment contract and provided that he shall be employed as Executive Vice President of the Company until December 31, 1995 in accordance with the terms of the agreement. Compensation for 1995 is approximately $165,862. On January 1, 1996, the Company extended Dr. Myron L. Cohen's employment contract to December 31, 1996.\nIn September of 1993, the Company entered into a three year employment agreement with Louis P. Scheps as President and Chief Executive Officer. Compensation is approximately $175,000 for 1995.\nDeferred Revenue from Related Party\nIn June 1989, the Company and a majority preferred shareholder, (the \"Shareholder\"), entered into an agreement, whereby the Shareholder agreed to fund $100,000 for the Company's purchase of certain components needed to establish an electrode manufacturing facility (\"the System\"). In exchange, the Company agreed to pay the Shareholder an amount equal to five percent of the net invoice price of all electrodes manufactured and sold by the Company using the System, during a period of five years.\nThe System became fully operational and the five year period commenced on January 8, 1990. The agreement expired as of December 31, 1994, there fore there were no earning expenses relating to royalties during 1995. During 1994 and 1993, royalties earned by the shareholder to the agreement totaled $78,181 and $91,807, respectively. The Company recognized revenue on a straight-line basis over the agreement period ($20,000 per year). Net royalty expense was $58,181 and $71,807 during 1994 and 1993, respectively.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) 1.The financial statements and schedules listed in the accompanying index to financial statements are filed as a part of this report.\n2. See (a) 1 above.\n3. (a) Certificate of Incorporation of Registrant*\n(b) By-Laws of Registrant*\n* Incorporated by reference from the Exhibits filed in the Registrant's Prospectus, dated April 15, 1985, filed with the Securities and Exchange Commission.\n(B) Reports on Form 8-K None filed.\nCAS MEDICAL SYSTEMS, INC.\nReport of Independent Public Accountants\nBalance Sheets -- December 31, 1995 and 1994 to\nStatements of Income for the Years Ended December 31, 1995, 1994 and 1993\nStatements of 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 to\nNotes to Financial Statements to\nSchedules 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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of CAS Medical Systems, Inc.:\nWe have audited the accompanying balance sheets of CAS Medical Systems, Inc. (a Delaware corporation) as of December 31, 1995 and 1994, and the related 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 CAS Medical Systems, 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.\nARTHUR ANDERSEN LLP\nStamford, Connecticut, January 23, 1996\nCAS MEDICAL SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n(1) The Company:\nCAS Medical Systems, Inc. (the \"Company\") is engaged in the business of developing, manufacturing and distributing diagnostic equipment and medical products for use in the healthcare and medical industry. These products are sold by the Company through its own sales force, via distributors and pursuant to original equipment manufacturer agreements internationally and in the United States. The Company's operations and manufacturing facilities are located in the United States. During 1995, 1994 and 1993, the Company had sales to one customer which in the aggregate accounted for approximately 12%, 13% and 13% of sales, respectively, and had export sales principally to Europe, including licensing fee revenues, of $2,155,748, $1,463,974 and $1,516,524, respectively.\n(2) Summary of Significant Accounting Policies:\nProperty and Equipment-\nProperty and equipment are stated at cost. Furniture and equipment are depreciated using the straight-line method based on the estimated useful lives of the assets, which range from two to five years. Leasehold improvements are amortized over the life of the lease.\nRevenue Recognition-\nRevenues from product sales are recognized upon passage of title, generally upon shipment. Revenues from licensing fees are recognized over the term of the agreement (see Note 6).\nNet Income per Common Share-\nNet income per common share has been computed by dividing net income available for common stock, after cumulative preferred dividends earned, by the weighted average number of common shares outstanding. Weighted average shares outstanding includes the common equivalent shares calculated for outstanding stock options and warrants under the treasury stock method.\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.\nRecently Issued Accounting Pronouncements-\nThe Company does not believe any recently issued accounting standards will have a material impact on its financial condition or results of operations. The Company plans to 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 Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation\" (\"FAS 123\"), beginning in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's consolidated financial statements.\nReclassifications-\nCertain reclassifications were made to prior year amounts to conform to current year presentation.\n(3) Inventories:\nInventories include costs of materials, labor and manufacturing overhead.\nInventories are stated at the lower of first-in, first-out (FIFO) cost or market and consist of the following:\n1995 1994\nRaw materials $505,159 $575,915 Work in process 160,215 112,782 Finished goods 177,930 122,291 -------- -------- $843,304 $810,988 ________ ________\n(4) Debt:\nAt December 31, 1995, the Company's line of credit arrangement allowed for maximum borrowings of $500,000, all of which was available. The line of credit arrangement expires on August 1, 1996, and bears interest at the prime rate (8.50% at December 31, 1995) plus 1.5%. During 1995, 1994 and 1993, the maximum month end borrowings outstanding under this line were $50,000, $200,000 and $115,000, the weighted average borrowings were approximately $4,167, $92,100 and $25,500, and the weighted average interest rates on amounts outstanding were 10.3%, 8.3% and 7.5%, respectively. The bank has a first security interest in all assets of the Company and requires a compensating balance equal to 20% of the line of credit ($100,000 at December 31, 1995).\n(5) Debt to Related Parties:\nDuring the fourth quarter of 1990, a majority preferred shareholder exchanged a 10% convertible note for a new term note which matured and was repaid in December 1995. The holder of the 10% term note was the Series C preferred shareholder and had a security interest in all tangible and intangible assets of the Company.\n(6) License Agreements:\nIn June 1989, the Company and a majority preferred shareholder (the \"Shareholder\") entered into an agreement, whereby the Shareholder agreed to fund $100,000 for the Company to purchase certain components needed to establish an electrode manufacturing facility (\"the System\"). In exchange, the Company agreed to pay the Shareholder an amount equal to five percent of the net invoice price of all electrodes manufactured and sold by the Company using the System for a period of five years. The System became fully operational and the five year period commenced on January 8, 1990. The agreement expired as of December 31, 1994, and, accordingly, there were no related royalty revenues or expenses during 1995. During 1994 and 1993, royalties earned by the Shareholder pursuant to this agreement totaled $78,181 and $91,807, respectively. The Company recognized revenue on a straight-line basis over the agreement period ($20,000 per year), and, accordingly, net royalty expense was $58,181 and $71,807 during 1994 and 1993, respectively.\nOn July 27, 1994, the Company entered into a four year licensing agreement with a major European manufacturer of medical equipment, canceling and superseding a prior licensing agreement with this customer. The agreement granted a nonexclusive license to use the Company's blood pressure technology for a specific application. As part of this agreement, the Company will receive $750,000 plus royalties over the initial four year term, of which $300,000 has been received through December 31, 1995. The manufacturer has the option to extend the license for an additional three year period upon payment of an additional $600,000 plus royalties over the extended term. License fees from this agreement and deferred revenue of $140,000 from the prior license agreement are being recognized on a straight line basis over the new contract period.\n(7) Capital Stock:\nHolders of the Series C cumulative preferred stock are entitled to a cumulative dividend, payable quarterly, at the annual rate of $10 per share. The Company has the right to redeem the preferred stock in whole or in part, at a price equal to $100 per share plus all accrued and unpaid dividends. On July 1, 1995, 2,000 shares of the Company's Series C preferred stock were redeemed at $100 per share plus all dividends accrued at that time. Upon redemption, the shares were retired and the Company filed with the State of Delaware a certificate of reduction of stated capital. No dividends may be paid on common stock unless all accumulated dividends have been paid on the Series C cumulative preferred stock. Dividends in the amount of $40,000, $50,000 and $50,000 were paid on these shares in 1995, 1994 and 1993, respectively.\nOn January 17, 1996, the remaining 3,000 shares of the Company's Series C preferred stock were redeemed at $100 per share.\n(8) Employee Benefit Programs: Stock Options-\nIn December 1984, the Board of Directors and stockholders adopted an Employee Incentive Stock Option 1984 Plan (the \"1984 Plan\"). The exercise price for common stock issued under the 1984 Plan is to be no\nless than the fair market value of the stock at the grant date of the options. Pursuant to the 1984 Plan, 750,000 shares of common stock have been reserved for employee (including officers and directors) purchase. An option granted under the 1984 Plan becomes exercisable in two equal annual installments, commencing one year from the date of the grant of the option. Options begin to expire between five and ten years from the date of grant, depending on the optionholder's percentage of ownership of the Company. In the event employment is terminated, the employee no longer has the right to exercise his or her options unless expressly permitted by the Board of Directors.\nIn June 1994, the Board of Directors and stockholders adopted the 1994 Employees' Incentive Stock Option Plan (the \"1994 Plan\"). Pursuant to the 1994 Plan, 250,000 shares of common stock have been reserved for employee (including officers and directors) purchase. The 1994 Plan is the successor to the 1984 Plan and contains provisions which are similar to those of the 1984 Plan.\nTransactions in stock options under the Plans are summarized as follows:\nExercise Price Shares per Option Outstanding at December 31, 1992 973,400 $.20 to $.75 Exercised (17,500) .25 Canceled (35,000) .375 to .75 -------- Outstanding at December 31, 1993 920,900 $.20 to $.75 Granted 120,000 .31 Canceled (50,000) .275 -------- Outstanding at December 31, 1994 990,900 $.20 to $.75 Granted 75,000 .82 Canceled\/Exercised (85,000) .25 to .75 -------- Outstanding at December 31, 1995 980,900 $.20 to $.82 ________ Exercisable at December 31, 1995 845,900 $.20 to $.75 ________\nIn 1993, the Company granted a warrant to purchase 750,000 shares of common stock to an officer of the Company. The exercise price ($.31 per share) was equal to the fair market value of the stock at the grant date of the warrant. The warrant has no expiration date.\nLife Insurance-\nDuring 1995, 1994 and 1993, the Company paid life insurance premiums of approximately $10,000 for life insurance policies on the lives of two officers of the Company. The policies are in the face amounts of $1,000,000 and $650,000. The beneficiaries of $250,000 and $150,000, respectively, of the policies are designated by the insured. The Company is the beneficiary of the balance.\n401(k) Plan-\nDuring 1992, the Company established a 401(k) benefit plan for its employees which generally allows participants to make contributions by salary deductions up to allowable Internal Revenue Service limits on a tax-deferred basis and discretionary contributions by the Company. The 1995 contribution was $28,166. The Company did not make discretionary contributions in 1994 or 1993.\nThe Company does not provide other post-retirement benefits.\n(9) Income Taxes:\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), which requires the recognition of deferred tax assets and liabilities for future tax consequences resulting from differences between the book and tax basis of existing assets and liabilities. In addition, SFAS 109 requires the recognition of future tax benefits of net operating loss carryforwards to the extent that realization of such benefit is more likely than not. This change in accounting had no significant effect on the Company's financial position or results of operations.\nThe 1995, 1994 and 1993 provisions for income taxes of $85,000, $20,000 and $17,000, respectively, represent state income taxes and in 1994 and 1993 federal alternative minimum taxes, and are net of tax benefits of net operating loss carryforwards utilized in 1995, 1994 and 1993 of $874,000, $104,000, and $253,000, respectively. As of December 31, 1995, the Company has utilized substantially all of its net operating loss carryforwards. The 1995 provision for income taxes includes deferred tax benefits of approximately $25,000 due to temporary differences related primarily to certain accruals not currently deductible for income tax purposes.\n(10) Commitments and Contingencies:\nEmployment Agreements-\nThe Company is committed under employment agreements with certain officers aggregating $175,000 and which expire in 1996.\nOther Commitments-\nMinimum annual rentals under the Company's noncancelable lease agreement covering its principal office space, which expires on December 31, 1998 and includes escalations for real estate taxes, are as follows:\n1996 $101,000 1997 104,000 1998 110,000 -------- $315,000 ________\nRent expense was approximately $102,000, $105,000 and $62,000 for the years ended December 31, 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.\nCAS MEDICAL SYSTEMS, INC. (Registrant)\nMarch 25, 1996 Louis P. Scheps Date Louis P. Scheps President and Chief Executive Officer 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 Registrant and in the capacities and on the dates indicated.\nMarch 25, 1996 Myron L. Cohen Date Myron L. Cohen Executive Vice President\nMarch 25, 1996 Lawrence Burstein Date Lawrence Burstein Director\nMarch 25, 1996 Stanley Josephson Date Stanley Josephson Director\nMarch 25, 1996 Jerome Baron Date Jerome Baron Director\nMarch 25, 1996 Jay Haft Date Jay Haft Director\nMarch 25, 1996 Saul Milles Date Saul Milles Director","section_15":""}
{"filename":"34408_1995.txt","cik":"34408","year":"1995","section_1":"ITEM 1. BUSINESS\nThe original predecessor of Family Dollar Stores, Inc., was organized in 1959 to operate a self-service retail store in Charlotte, North Carolina. In subsequent years, additional stores were opened, and separate corporations generally were organized to operate these stores. Family Dollar Stores, Inc. (together with its subsidiaries referred to herein as the \"Company\"), was incorporated in Delaware in 1969, and all existing corporate entities became wholly-owned subsidiaries. Additional stores continued to be opened and operated in wholly-owned subsidiaries organized in the states where the stores were located. Four wholly-owned subsidiaries organized as North Carolina corporations provide distribution, trucking, operations, marketing and other services to the Company.\nThe Company now operates a chain of self-service retail discount stores. As of November 1, 1995, there were 2,451 stores in 38 states and the District of Columbia as follows:\nThe number of stores operated by the Company at the end of each of its last five fiscal years is as follows: 1,759 stores on August 31, 1991; 1,885 stores on August 31, 1992; 2,035 stores on August 31, 1993; 2,215 stores on August 31, 1994; and 2,416 stores on August 31, 1995.\nDuring the fiscal year ended August 31, 1995, 12 stores were closed, 10 stores were relocated within the same shopping center or market area and 18 stores were expanded in size. In addition, the Company contin- ued its program of periodic improvements in selected existing stores. All of the stores are occupied under leases, except 144 stores owned by the Company. (See \"Properties\" herein.) The Company has announced plans to open approximately 235 stores and close approximately 35 stores during the current fiscal year. Such plans are continually reviewed and subject to change depending on economic conditions and other factors. From September 1, 1995, through November 1, 1995, the Company opened 41 new stores, closed 6 stores and expanded 1 store. All stores opening in the fiscal year ending August 31, 1996, will have a new interior store layout that features increased emphasis on promotional goods, improved presentation\nof merchandise, lower fixtures and wider aisles for an attractive, customer- friendly shopping environment. Ten existing stores have been remodeled to the new prototype, and the Company will consider remodeling additional stores in the second half of the fiscal year.\nAs of November 1, 1995, the Company had in the aggregate approxi- mately 18,600,000 square feet of total store space (including receiving rooms and other non-selling areas). The typical store has approximately 6,000 to 8,000 square feet of total area. The stores are in both rural and urban areas, and they are typically freestanding or located in shopping centers with adequate parking available. As of November 1, 1995, there were approximately 1,275 stores located in communities with populations of less than 15,000; approximately 460 stores in communities with populations of 15,000 to 50,000; and approximately 716 stores in communities with populations of over 50,000. All stores are similar in appearance and display highly visible red and white \"Family Dollar Stores\" or \"Family Dollar\" signs.\nThe Company's stores are operated on a self-service, cash-and- carry basis, and low overhead permits the sale of merchandise at a relatively moderate markup. During the fiscal year ended August 31, 1994, in the face of increasing competition, the Company began to change its merchandising strategy away from promotional pricing and towards everyday low prices. In December 1993, prices were reduced on a limited number of items in 400 stores and in June 1994, this program was expanded to 1,000 stores. In September and October 1994, the number of stores with merchandise at reduced prices increased to 1,800, and the number of stockkeeping units with price reductions increased from approximately 500 to approximately 2,500. A lesser number of price reductions were taken in the balance of the stores in less competitive markets. No single store accounted for more than one-fifth of one percent of sales during the fiscal year ended August 31, 1995. Most of the stores are open six evenings a week, and many remain open on Sunday afternoons.\nThe stores offer a variety of merchandise including men's, women's, boys', girls' and infants' clothing, shoes, household products, health and beauty aids, domestics, toys, school supplies, candy and snack food, electronics, housewares, paint and automotive supplies. During the fiscal year ended August 31, 1995, soft goods, including wearing apparel, shoes, linens, blankets, bedspreads and curtains, accounted for approx- imately 39 percent of the Company's sales. During the fiscal year ended August 31, 1995, nationally advertised brand merchandise accounted for approximately 25 percent of sales, Family Dollar label merchandise accounted for approximately 6 percent of sales and merchandise sold under other labels, or which was unlabeled, accounted for the balance of sales. Irregular merchandise accounted for approximately 2 percent of sales during such period. The Company does not accept credit cards or extend credit.\nThe Company has a policy of uniform pricing of items in the majority of its stores. A zone pricing system in which selected merchandise in stores in less competitive markets carries higher prices is utilized in approximately 250 stores. The Company advertises through circulars which are inserted in newspapers or mailed directly to consumers' residences, and also advertises to a limited degree in newspapers and on radio in portions of its operating area. As part of the Company's plan to reduce expenses to support the program of price reductions on merchandise in its stores, in\nthe fiscal year ended August 31, 1995, the number of advertising circulars distributed to consumers' homes was cut from 22 to 15. All seven adver- tising coupon booklets that were distributed in the fiscal year ended August 31, 1994, also were eliminated. In the fiscal year ending August 31, 1996, the plan is to reduce the number of advertising circulars distributed to consumers' homes from 15 to 14, and to again distribute no coupon booklets. Advertising circulars that are passed out in the stores will be utilized. An unadvertised internal maximum price policy is followed, and the policy currently is to price most items of merchandise under $17.99. In the fiscal year ended August 31, 1995, as part of the Company's emphasis on the sale of lower priced merchandise, the Company reduced the average price point of merchandise sold in its stores.\nThe Company purchases its merchandise from approximately 1,400 suppliers and generally has not experienced difficulty in obtaining adequate quantities of merchandise. Approximately 55 percent of the merchandise is manufactured in the United States and substantially all such merchandise is purchased directly from the manufacturer. Purchases of imported merchandise are made directly from the manufacturer or from importers. No single supplier accounted for more than 2.5 percent of the merchandise sold by the Company in the fiscal year ended August 31, 1995. Each of the Company's 17 buyers specializes in the purchase of specific categories of goods.\nDuring the fiscal year ended August 31, 1995, approximately 2.5 percent of the merchandise purchased by the Company was shipped directly to its stores by the manufacturer or importer. Most of the balance of the merchandise was received at the Company's Distribution Centers in Matthews, North Carolina, and West Memphis, Arkansas. Merchandise is delivered to the stores from the Distribution Centers in Matthews and West Memphis by Company-owned trucks and by common and contract carriers. During the last fiscal year, approximately 65 percent of the merchandise delivered was by common or contract carriers. The average distance between the Distribution Center in Matthews and the approximately 1,516 stores served by that facility on August 31, 1995, is approximately 390 miles. The average distance between the Distribution Center in West Memphis and the approximately 900 stores served by that facility on August 31, 1995, is approximately 440 miles.\nThe Company also operates satellite distribution buildings in Salisbury, North Carolina, and Memphis, Tennessee. High volume, bulk items of merchandise are shipped by vendors directly to these facilities and then delivered to the stores by contract carriers. During the fiscal year ended August 31, 1995, the Company also utilized public freight handlers to a limited degree to receive from vendors, store and then ship to the Company's stores selected merchandise.\nThe business in which the Company is engaged is highly competi- tive. The principal competitive factors include location of stores, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service. The Company competes for sales and store locations in varying degrees with national and local retailing estab- lishments, including department stores, discount stores, variety stores, dollar stores, discount clothing stores, drug stores, grocery stores, outlet stores, warehouse stores and other stores. Many of the largest retail merchandising companies in the nation have stores in areas in which\nthe Company operates. The relatively small size of the Company's stores permits the Company to open new units in rural areas and small towns, as well as in large urban centers, in locations convenient to the Company's low and low-middle income customer base. As the Company's sales are focused on low priced, basic merchandise, the stores offer customers a reasonable selection of competitively priced merchandise within a relatively narrow range of price points.\nGenerally, in a typical store the highest monthly volume of sales occurs in December, and the lowest monthly volume of sales occurs in January and February.\nThe Company maintains a substantial variety and depth of basic and seasonal merchandise inventory in stock in its stores (and in distribution centers for weekly store replenishment) to attract customers and meet their shopping needs. Vendors' trade payment terms are negotiated to help finance the cost of carrying this inventory. The Company must balance the value of maintaining high inventory levels to meet customers' demands with the cost of having inventories at levels that exceed such demands and that must be marked down in price in order to sell.\nThe Company has registered with the U. S. Patent and Trademark Office the name \"Family Dollar Stores\" as a service mark.\nOn August 31, 1995, the Company had approximately 10,000 full- time employees and approximately 8,500 part-time employees. Approximately 900 additional employees were hired on a temporary basis for the 1994 Christmas season. None of the Company's employees are covered by collective bargaining agreements. The Company considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of November 1, 1995, the Company operated 2,451 stores in 38 states and the District of Columbia. See \"Business\" herein. With the exception of 144 stores owned by the Company, all of the Company's stores were occupied under lease. Most of the leases are for fixed rentals. A large majority of the leases contain provisions which may require additional payments based upon a percentage of sales or property taxes, insurance premiums or common area maintenance charges.\nOf the Company's 2,307 leased stores at November 1, 1995, all but 97 leases contain options to renew for additional terms; in most cases for a number of successive five-year periods. The following table sets forth certain data, as of November 1, 1995, concerning the expiration dates of all leases with renewal options:\nOf the 144 Company-owned stores, 18 are located in Texas, 16 in North Carolina, 13 each in Georgia and Virginia, 12 in Indiana, 11 in Illinois, 8 in Tennessee, 7 in Michigan, 6 in Ohio, 5 each in Alabama and Arkansas, 4 each in South Carolina, West Virginia, Florida, Kentucky and Louisiana, 3 in Mississippi, 2 each in Iowa and Oklahoma and one each in New Jersey, Missouri and Kansas. In these owned stores, there are approximately 1,150,000 total square feet of space.\nThe Company also owns its Executive Offices and Distribution Center which are located on a 64.5 acre tract of land in Matthews, North Carolina, just outside of Charlotte, in a building containing approximately 810,000 square feet of which approximately 740,000 square feet are used for the Distribution Center which includes receiving, warehousing and shipping facilities, and approximately 70,000 square feet are used for Executive Offices.\nDuring the fiscal year ended August 31, 1995, the Company leased buildings in Salisbury, North Carolina (approximately 300,000 square feet) and Memphis, Tennessee (approximately 270,000 square feet) to serve as satellite distribution facilities, and a buiding in Charlotte, North Carolina (approximately 57,000 square feet) to serve as a reclamation facility for merchandise returned from the stores. These leases continue in effect in the fiscal year ending August 31, 1996.\nIn 1992, the Company purchased a 75 acre parcel of land in West Memphis, Arkansas, and construction began in 1993 on a 550,000 square foot full-service distribution center. This facility became operational in the spring of 1994, and currently serves approximately 900 stores. The approximate $25 million cost for the land, building and equipment was financed with cash flow from current operations and short-term borrowing under the Company's bank lines of credit. In October 1995, construction began on a 300,000 square foot addition to this facility. It is presently anticipated that construction will be completed by the end of the Company's fiscal year on August 31, 1996. The estimated $15 million cost for the expansion and the related equipment is expected to be financed in the same manner as the financing of the original facility.\nThe Company owns and operates a fleet of tractor-trailers and trucks to distribute its merchandise.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company knows of no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company is a party or of which any of its property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during the fourth quarter of the fiscal year ended August 31, 1995, to a vote of security holders through the solicitation of proxies or otherwise.\nITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is furnished with respect to each of the executive officers of the Company as of November 1, 1995:\n(1) Mr. Leon Levine founded the Company's business in 1959 and was its President, Chief Executive Officer and Treasurer from 1959 until September 1977 when he was elected Chairman of the Board, Chief Executive Officer and Treasurer.\n(2) Mr. John D. Reier was employed by the Company as Senior Vice President-General Merchandise Manager in August 1987, and was promoted to Senior Vice President-Merchandising and Advertising in that month. He was elected President in November 1994.\n(3) Mr. George R. Mahoney, Jr. was employed by the Company as General Counsel in October 1976. He was elected Vice President-General Counsel and Secretary in April 1977, Senior Vice President-General Counsel and Secretary in January 1984 and Executive Vice President-General Counsel and Secretary in October 1991.\n(4) Mr. R. David Alexander, Jr. was employed by the Company as Senior Vice President-Distribution and Transportation in August 1995. Prior to his employment by the Company, he was employed by Northern Automotive Co., Inc., a chain of discount automotive supply stores, from June 1993 to August 1995, where he was Senior Vice President-Distribution and Transportation. Prior to his employment by Northern Automotive Co., Inc., he was employed by Best Products Co., Inc., a chain of catalogue showroom stores, from June 1985 to May 1993 where he was Senior Vice President-Distribution and Transportation.\n(5) Mr. Albert S. Rorie was employed by the Company in various capacities in the Data Processing area from March 1973 through January 1981, including employment as Director of Data Processing. Mr. Rorie was self-employed as a data processing consultant from January 1981 through May 1982, when he rejoined the Company and was elected Vice President-Data Processing. He was elected Senior Vice President-Data Processing in January 1988.\n(6) Mr. C. Martin Sowers was employed by the Company as an Accountant in October 1984 and was promoted to Assistant Controller in January 1985. He was elected Controller in January 1986, Vice President-Controller in July 1989 and Senior Vice President-Finance in December 1991.\n(7) Mr. Phillip W. Thompson was employed by the Company in January 1984 in the Store Operations Department. He was elected Vice President-Store Operations in January 1985, and Senior Vice President-Store Operations in January 1992.\n(8) Mr. Edward L. Zimmerlin was employed by the Company in March 1995 as Senior Vice President-Merchandising and Advertising. For more than five years prior to his employment by the Company, he was employed by Hills Stores, a chain of discount stores, where he was Vice President- Merchandising.\n(9) Mr. Daniel R. Burns was employed by the Company as Vice President-Loss Prevention in October 1994. For more than five years prior to his employment by the Company, he was employed by Kay-Bee Toy Stores where he was Vice President- Loss Prevention and Shortage Control.\n(10) Mr. Terry A. Cozort was employed by the Company as Director of Human Resources in April 1988. He was elected Vice President-Human Resources in July 1989.\n(11) Mr. Owen R. Humphrey was employed by the Company in August 1979, and was promoted to Distribution Center Operations Manager in December 1983. Mr. Humphrey was promoted to Director of Distribution in January 1988, and was elected Vice President-Distribution and Transportation in July 1989.\n(12) Mr. Gilbert A. LaFare was employed by the Company in August 1992 as Vice President-Real Estate. For more than five years prior to his employment by the Company, he was Vice President-Real Estate with Little Caesars Enterprises, Inc., a restaurant chain.\n(13) Mr. Edgar L. Paxton was employed by the Company in December 1985 as Director of Advertising. He was elected Vice President-Advertising and Sales Promotion in January 1988.\n(14) Mr. Kenneth T. Smith was employed by the Company as a financial analyst in October 1990. Mr. Smith was promoted to Director of Information Services-Operations in February 1992 and to Director of Accounting in October 1992. He was elected Vice President-Controller in October 1995.\nAll executive officers of the Company are elected by 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\nThe information required by this item is included in the Company's Annual Report to Stockholders for the fiscal year ended August 31, 1995, on page 16 under the captions \"Market Price and Dividend Information\" and \"Market Prices and Dividends\" 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 fiscal year ended August 31, 1995, on pages 14 and 15 under the caption \"Summary of Selected Financial Data\" and is incorporated herein by reference. The Company did not have any long- term debt at the end of each of its last five fiscal years.\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 fiscal year ended August 31, 1995, on pages 14 through 16 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 Company's Annual Report to Stockholders for the fiscal year ended August 31, 1995, on pages 17 through 24 and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item as to Directors is included in the Company's proxy statement dated November 22, 1995, on pages 5 and 6 under the caption \"Election of Directors\" and is incorporated herein by reference. The information required by this item as to executive officers is included in Item 4A in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is included in the Company's proxy statement dated November 22, 1995, on pages 6 through 12 under the caption \"Executive Compensation\" 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 dated November 22, 1995, on pages 3 and 4 under the caption \"Ownership of the Company's Securities\" 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 dated November 22, 1995, on page 12 under the caption \"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) Documents filed as part of this report:\n1 and 2. Financial Statements and Financial Statement Schedules:\nThe consolidated financial statements of Family Dollar Stores, Inc., and subsidiaries which are incorporated by reference to the Annual Report to Stockholders for the fiscal year ended August 31, 1995, are set forth in the index on page 16 of this report.\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, are inapplicable or the information is included in the consolidated financial statements, and therefore, have been omitted.\nThe financial statements of Family Dollar Stores, Inc. (Parent Company) are omitted because the registrant is primarily an operating company and all subsidiaries included in the consoli- dated financial statements being filed, in the aggregate, do not have minority equity and\/or indebtedness to any person other than the registrant or its consolidated subsidiaries in amounts which together exceed 5 percent of the total assets as shown by the most recent year-end consolidated balance sheet.\n3. Exhibits:\nExhibits incorporated by reference:\n3(a)(i) Certificate of Incorporation, dated November 24, 1969, (filed as Exhibit 3(a) to the Company's Registration Statement on Form S-1, No. 2-35468).\n(ii) Certificate of Amendment, dated February 2, 1972, of Certificate of Incorporation (filed as Exhibit 3(a)(ii) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1980).\n(iii) Certificate of Amendment, dated January 23, 1979, of Certificate of Incorporation (filed as Exhibit 2 to the Company's Form 10-Q (File No. 1-6807) for the quarter ended February 28, 1979).\n(iv) Certificate of Amendment, dated January 20, 1983, of Certificate of Incorporation (filed as Exhibit 4(iv) to the Company's Registration Statement on Form S-3, No. 2-85343).\n(v) Certificate of Amendment, dated January 16, 1986, of Certificate of Incorporation (filed as Exhibit 3(a)(v) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1986).\n(vi) Certificate of Amendment, dated January 15, 1987, of Certificate of Incorporation (filed as Exhibit 3(a)(vi) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1987).\n(b) By-Laws, as amended as of November 6, 1987 (filed as Exhibit 3(b) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1987).\n* 10 (i) Incentive Profit Sharing Plan (filed as Exhibit 13(b) to the Company's Registration Statement on Form S-1, No. 2-35468).\n* 10 (ii) 1979 Non-Qualified Stock Option Plan, amended as of April 17, 1991 (filed as Exhibit 10(vii) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1991).\n* 10 (iii) 1989 Non-Qualified Stock Option Plan, amended as of April 17, 1991 (filed as Exhibit 10(viii) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1991).\n* 10 (iv) Savings and Retirement Plan and Trust of Family Dollar Stores, Inc. adopted as of August 1, 1986 (filed as Exhibit 10(ix) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1986).\n* 10 (v) Amendment No. One dated August 18, 1988, to Savings and Retirement Plan and Trust of Family Dollar Stores, Inc. adopted August 1, 1986 (filed as Exhibit 10 (xi) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1988).\n10 (vi) Revolving\/Term Loan Agreement dated as of February 28, 1993, between the Company and NationsBank of North Carolina, N.A., as amended by letter agreement dated March 31, 1993 (filed as Exhibit 10(vii) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1993).\n* 10 (vii) Employment Agreement dated November 10, 1994, between the Company and John D. Reier (filed as Exhibit 10 (viii) to the Company's Form 10-K (File No. 1-6807) for the year ended August 31, 1994).\nExhibits filed herewith:\n* 10 (viii) Family Dollar Employee Savings and Retirement Plan and Trust, amended and restated as of January 1, 1987.\n11 Statement Re: Computations of Per Share Earnings.\n13 Annual Report to Stockholders for the fiscal year ended August 31, 1995 (only those portions specifically incorporated by reference herein shall be deemed filed).\n21 Subsidiaries of the Company.\n27 Financial Data Schedule\n* Exhibit represents a management contract or compensatory plan.\n(b) No reports on Form 8-K have been filed by the Company during the last quarter of the period covered by this report.\nFAMILY DOLLAR STORES, INC., AND SUBSIDIARIES\nIndex\nThe consolidated financial statements of Family Dollar Stores, Inc., and subsidiaries together with the report of Price Waterhouse LLP incorporated in this report appear on the following pages of the Annual Report to Stockholders for the fiscal year ended August 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.\nFAMILY DOLLAR STORES, INC. (Registrant)\nDate November 16, 1995 By LEON LEVINE LEON LEVINE Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nSignature Title Date\nLEON LEVINE Chairman of the Board and November 16, 1995 LEON LEVINE Director (Chief Executive Officer and Chief Financial Officer)\nJOHN D. REIER President and Director November 16, 1995 JOHN D. REIER\nGEORGE R. MAHONEY, JR. Executive Vice President November 16, 1995 GEORGE R. MAHONEY, JR. and Director\nC. MARTIN SOWERS Senior Vice President- November 16, 1995 C. MARTIN SOWERS Finance\nKENNETH T. SMITH Vice President-Controller November 16, 1995 KENNETH T. SMITH (Principal Accounting Officer)\nTHOMAS R. PAYNE Director November 16, 1995 THOMAS R. PAYNE\nMARK R. BERNSTEIN Director November 16, 1995 MARK R. BERNSTEIN\nJAMES H. HANCE, JR. Director November 16, 1995 JAMES H. HANCE, JR.","section_15":""}
{"filename":"771249_1995.txt","cik":"771249","year":"1995","section_1":"ITEM 1. BUSINESS\nEffective December 31, 1995, Brainerd International, Inc. (\"Brainerd\") merged with and into The Colonel's International, Inc. (the \"Company\"), pursuant to an agreement and plan of reorganization (the \"Merger\"). The Company was the surviving corporation and the separate existence of Brainerd ceased at the effective time of the Merger. Prior to the Merger, Brainerd was a Minnesota corporation. The Company is a Michigan corporation.\nPrior to the Merger, Brainerd common stock was traded on the National Association of Securities Dealers, Inc. (\"Nasdaq\") SmallCap Market. Effective January 2, 1996, Brainerd common stock (trading symbol \"BIRI\") was delisted from the Nasdaq SmallCap Market and common stock of the Company (trading symbol \"COLO\") was listed on the SmallCap market.\nPursuant to a separate agreement and plan of merger, Brainerd Merger Corporation, a wholly owned subsidiary of Brainerd, was merged with and into The Colonel's, Inc., a Michigan corporation (\"The Colonel's\"). The Colonel's was the surviving corporation in that merger and the separate existence of Brainerd Merger Corporation ceased at the effective time of that merger. Shares of common stock in The Colonel's were converted into the right to receive an aggregate amount of 23,500,000 shares of common stock in the Company.\nAs a result of these transactions, The Colonel's became a wholly owned subsidiary of the Company. Brainerd transferred all of its operating assets to Brainerd International Raceway, Inc., a Minnesota corporation and a wholly owned subsidiary of the Company (\"Brainerd International Raceway\"). The Company is a holding company with no significant operations of its own. The Company has two wholly owned subsidiaries, which are The Colonel's and Brainerd International Raceway. A description of the business of these two subsidiaries follows.\nTHE COLONEL'S, INC.\nGENERAL. The Colonel's is a leading domestic manufacturer of plastic replacement bumpers and facias for the automotive aftermarket industry in North America. The Colonel's designs, manufactures and distributes plastic bumpers, facias, support beams and brackets for application as replacement collision parts for domestic automobile models. In addition, The Colonel's purchases and resells plastic replacement bumpers and facias for use as replacement collision parts on import automobile models and for models manufactured domestically by foreign-based automobile manufacturers, and manufactures parts for these models to a limited extent. In late\n1995, The Colonel's also began production of pickup truck bedliners. The Colonel's manufactures its products through the use of reaction injection molding, plastic injection molding and thermoforming technology at its manufacturing facilities in Michigan.\nThe Colonel's distributes its products through warehouses operated by The Colonel's located in Michigan, Texas, Arizona and Arkansas. The Colonel's sells its products through a network of independent distributors located in all fifty states, The District of Columbia, Puerto Rico, Canada, Mexico and The Bahamas.\nThe Colonel's strategy is to provide a readily available, high quality, low cost alternative to original equipment manufacturer (\"OEM\") replacement bumpers, facias, truck bedliners and other plastic components through The Colonel's streamlined manufacturing process and extensive distribution network.\nAs of December 31, 1995, The Colonel's had 243 employees.\nPRODUCTS. The Colonel's designs, manufactures and distributes plastic bumpers, facias, support beams and brackets for application as replacement collision parts for current, high volume, domestic automobile models. The Company has added the design and manufacture of pickup truck bedliners, tailgate covers and rail kits. The Colonel's also purchases and resells plastic bumpers and facias for application as replacement collision parts on current, high volume, import automobile models, including automobiles manufactured domestically by foreign-based companies. The products manufactured and sold by The Colonel's are primarily plastic molded front and rear bumper panels designed for application to specific automobile makes and models. The Colonel's products are sold for distribution to collision repair shops, dealers and others in the automobile aftermarket collision industry and are used for the replacement of damaged automobile bumpers and related components.\nThe table set forth below shows The Colonel's sales for the years ended December 31, 1995, 1994 and 1993 divided between products that are manufactured by The Colonel's and products that are purchased by The Colonel's from other manufacturers and marketed by The Colonel's:\nEach product manufactured or distributed by The Colonel's is designed for application to an automobile of a specific make, model and year. Certain products may have more than one application because different but similarly designed automobile models may have identical bumpers or plastic molded components or because different years of the same model automobile may have identical bumpers or plastic molded components. In selecting products to manufacture and distribute, The Colonel's targets high volume automobile models and models that statistically incur a higher frequency of accidents, since these models support a higher volume of product sales for each dollar invested in production tooling.\nA majority of the specified parts manufactured by The Colonel's are produced to meet the design standards and engineering tolerances of the Certified Auto Parts Association (\"CAPA\"), a national standard setting organization. A sticker acknowledging compliance with these standards and tolerances is affixed to each certified part manufactured by The Colonel's. CAPA is an independent association that publishes specifications for high quality aftermarket automobile body parts and certifies specific products as equivalent to factory built service and replacement body parts. CAPA only certifies parts for domestic automobile models. Approximately 72% of the automotive components manufactured by The Colonel's are examined and tested by CAPA and are certified as equivalent or superior to comparable OEM replacement parts in terms of fit, form, function and material grade. The Colonel's certified products are listed in the nationally distributed CAPA Directory of Certified Competitive Auto Parts and the CAPA certification of The Colonel's products is generally relied upon throughout the automobile aftermarket industry and the automobile insurance industry as an assurance of quality and dependability.\nAs of December 31, 1995, The Colonel's manufactured and distributed molded plastic replacement components for a total of 415 automotive applications and purchased and distributed replacement components for approximately 1,300 automotive applications. The Colonel's anticipates continuing to manufacture and distribute replacement components for an equal or greater number of applications in future operations. Although The Colonel's has no specific plans at this time to manufacture additional types of plastic automotive replacement components, The Colonel's believes that there are numerous additional automobile applications for its manufacturing process including doors, hoods, fenders and other body or interior components and believes that plastic components will continue to be utilized in an increased number of applications by automobile OEMs. Only new tooling for the injection presses and certification of new products need be obtained to add additional applications to existing lines. Additionally, The Colonel's existing manufacturing facilities have the capacity to produce an increased volume of products through the addition of work shifts.\nThe Colonel's present inventory of new bumpers covers 415 different bumper applications. According to their most recent sales brochures and literature, none of The Colonel's domestic competitors offer more than 98 applications and none of its foreign competitors\noffer more than 190. Although The Colonel's believes that it is number one in sales of non-OEM aftermarket automotive bumpers, specific sales information is not available on The Colonel's competitors because they are privately held companies and do not publicly report sales information.\nThe Colonel's believes it maintains a significant market advantage by offering its automotive replacement components at lower prices than those offered by OEMs for comparable replacement components. The Colonel's believes that its products are equivalent in quality, durability and function to OEM manufactured replacement components, but are generally sold at prices which are less than the OEM suggested list price. Furthermore, The Colonel's believes its competitive pricing secures a significant market advantage for its products in the aftermarket collision industry. Competitive pricing of collision parts is generally believed to be particularly important to automobile insurance companies which fund the purchase of a significant percentage of automotive crash replacement parts.\nThe Colonel's provides a limited lifetime warranty against defects in material and workmanship and guarantees that the products generally meet or exceed factory and industry specifications.\nThe Colonel's has two patents with respect to its products. The patents relate to the manufacture of bedliners.\nMANUFACTURING. In Milan, Michigan, The Colonel's uses two distinct chemical processes to manufacture its plastic products. The production cycle for each process is similar. Raw materials are introduced into a machine press that contains a machined tool or mold. Heat and pressure are applied to the raw materials, forcing them into the shape of the mold. The resulting plastic molded part is then removed from the molds to an adjacent work station where small amounts of excess plastic are trimmed from each part. After trimming, the part is cleaned and placed on a conveyor belt leading to the paint application room. There, the part is typically painted with a water-based black primer finish. After the finish is dried in infrared ovens on the conveyor belt, each part is then labeled and placed in a plastic bag, packaged in boxes of five and shipped or stored for shipment.\nIn Owosso, Michigan, The Colonel's uses extruders to form plastic pellets into large sheets that are then used by a thermoformer to mold the sheets into bedliner products. In this process, the sheets are heated into a very flexible state. The hot plastic is then placed over a mold where the plastic is drawn into the mold using vacuum pressure. The bedliner and tailgate are made at one time. The parts are then hand-trimmed and stacked on a skid for shipment.\nThe Colonel's primarily uses custom molding machines manufactured by Cincinnati Milacron, which management believes are generally recognized as state-of-the-art for the industry. The toolings are primarily made of zinc alloy, aluminum, or steel and are built to The Colonel's custom specifications. The Colonel's presently maintains over 330 specially designed tools, enabling production of approximately 415 different automotive applications.\nThe primary manufacturing process used by The Colonel's is referred to as Reaction Injection Molding or the \"RIM\" process. Because the RIM process is a low-temperature, low-pressure operation, The Colonel's can use zinc alloy tools for a majority of its manufacturing. Zinc alloy tools are less expensive to build than conventional steel injection molds.\nThe raw materials for the RIM process, consisting of polyol and polyisocyanate, are available from several sources. The materials are stored in two large closed tanks and are distributed to the presses by a computer-regulated flow monitoring system. In the RIM process, two reactive streams (a polyol containing extenders, catalysts and a blowing agent; and a polyisocyanate) are mixed together under controlled temperature and pressure while being injected into the tooling attached to each press.\nThe RIM tool is filled to approximately 90% of capacity during the injection process. A chemical reaction causes the material to heat and expand, forcing air out through a vent, and allowing the material to fill the mold completely. The result is a microcellular plastic elastomeric or polyurethane part. The polyurethane part produced is lightweight, corrosion resistant, and will recover its original form after minor impact, lessening the likelihood of automobile body damage at very low speeds.\nAn alternative process used by The Colonel's is referred to as injection molding. In injection molding, small pellets containing reactive polymers and catalysts are melted through heat and pressure. The melted material is forced into the mold until it is completely filled. The result is a thermoplastic olefin polypropylene part. A significant benefit of this process is that excess plastic can be reused after it has been trimmed off a completed part. Additionally, a part manufactured using this injection molding process that is damaged in production or rejected as scrap for quality-control reasons can be reground into pellets and completely recycled and used as raw material in the injection molding process. The recycling ability offered by the injection molding process appears increasingly important with steadily rising solid waste disposal costs.\nAt the end of each production run, the tooling and the last part produced by the tooling are inspected by production personnel. Preventive maintenance and repair of the tooling are performed on-site\nby The Colonel's tool and die personnel in order to minimize waste, reduce down-time, prolong tooling life, and maintain product quality.\nThe Colonel's manufacturing facility in Milan, Michigan houses 7 reaction injecting molding machines and 6 injection molding machines. Those machines had the combined capacity to produce the number of units sold in 1995 without operating a second or third shift. The Colonel's believes that it will be able to fully meet all of its customers' 1996 and 1997 orders by running a first shift year round and a limited second shift workforce during the four-month period of time preceding and during the winter months, when demand for automotive crash parts is traditionally the greatest.\nThe manufacturing facility in Owosso houses two large extruders and six large thermoforming machines. It is management's best estimate that those machines are expected to produce enough units to meet anticipated customer demands running two shifts.\nThe Colonel's has purchased raw materials from three primary suppliers, Dow Chemical Company, Montel, Inc. (formerly Himont Advanced Materials) and Phillips Petroleum on open credit terms for over ten years. The Colonel's does not maintain any fixed quantity or requirements contract with either supplier. The Colonel's is not contractually obligated to purchase any minimum quantity from either supplier and neither supplier is obligated to sell product to The Colonel's at any predetermined quantity or any predetermined price. The Colonel's generally estimates and orders raw materials for production by individual purchase orders at approximately ten-day to two-week intervals. Similarly, The Colonel's orders molding machines and tooling from Cincinnati Milicron by individual purchase order and does not maintain any agreement with Cincinnati Milicron, HPM or Brown Machinery concerning the purchase of manufacturing equipment. The Colonel's has not experienced any material difficulties in obtaining raw materials or equipment for production as needed and management of The Colonel's believes that the absence or unavailability of any current source of raw materials or equipment for production would not have a material adverse effect on The Colonel's because an adequate number of alternative sources for both raw materials and production equipment exist to satisfy production requirements in a timely manner.\nDISTRIBUTION AND SALES; PROPERTIES. The Colonel's products are distributed nationally from The Colonel's manufacturing facilities and from affiliated warehouse facilities. The Colonel's manufacturing facilities are located in Milan and Owosso, Michigan. Products are shipped by The Colonel's directly from its manufacturing facilities to customers or to distribution warehouses operated by The Colonel's or its distributors. The Colonel's does not maintain any fixed quantity or requirement contracts (or distributor agreements) with any customers. All sales are made in response to individual orders from customers and distributors. Price terms are determined by the volume\neach customer buys during each calendar month and credit terms are standard. The Colonel's believes that its success has been achieved in part because of an emphasis on rapid delivery of customer orders. To accomplish this, The Colonel's maintains large inventories of the products it manufactures. The Colonel's, Inc. fills orders from existing inventory stock and does not build parts to fill a particular customer's order. Customer orders are generally filled and shipped within 48 hours after their receipt. For these reasons, The Colonel's has virtually no backlog of product orders.\nThe Milan manufacturing plant is a 350,000 square foot facility (plus a 45,000 square foot covered crane bay) situated on a 62 acre site on the outskirts of Milan, Michigan. Milan is located approximately 10 miles south of Ann Arbor, Michigan, 60 miles west of Detroit, and 25 miles northwest of Toledo, Ohio. There is sufficient room to expand the physical plant. The Milan plant manufactures the aftermarket bumper fascias. This facility is leased from a company owned by Donald and Patsy Williamson.\nThe new Owosso manufacturing facility occupies a 210,000 square foot building located on 27 acres on the outskirts of Owosso, Michigan. The Colonel's former manufacturing plant (lost due to a fire in 1993) was located at the other end of town. Owosso is located about 100 miles north west of Milan, Michigan and about 30 miles north east of Lansing, Michigan. The building has power capacities exceeding current use and would permit expansion if necessary. This plant manufactures the truck accessories. This facility is leased from a company owned by Donald and Patsy Williamson.\nThe Colonel's Sales Manager and a staff of four sales personnel have responsibility for sales and distribution of The Colonel's products, promotion and advertising. The sales staff is located in Milan, Michigan.\nThe Colonel's operates a warehouse distribution facility in Houston, Texas. The distribution facility is approximately 25,410 square feet in size, has four full-time employees of The Colonel's and is leased by The Colonel's pursuant to a lease agreement having a term through July 1998.\nThe Colonel's operates a second warehouse distribution facility in Dallas, Texas. This distribution facility is approximately 25,000 square feet in size, has five full-time employees of The Colonel's and is leased by The Colonel's pursuant to a lease agreement having a term through September 1998.\nThe Colonel's operates a third warehouse distribution facility in Phoenix, Arizona. This distribution facility is approximately 52,360 square feet in size, has four full-time employees of The Colonel's and is leased by The Colonel's pursuant to a lease agreement having a term through January 2000.\nThe Colonel's fourth warehouse is in West Memphis, Arkansas. This warehouse and distribution facility of approximately 45,000 square feet and six full-time employees sells chrome-plated steel bumpers and custom chrome trim pieces. The Colonel's Factory Outlet of Arkansas, Inc., an Arkansas corporation, occupies a 55,000 square foot manufacturing facility which manufactures chrome-plated steel bumpers and its products are sold to The Colonel's Distribution Warehouses and to many of the same customers as The Colonel's. Donald J. Williamson, President and Chief Executive Officer of the Company, owns all of the issued and outstanding capital stock of The Colonel's Factory Outlet of Arkansas, Inc.\nThe Colonel's bedliner division operates out of a newly renovated 219,000 square foot building in Owosso, Michigan. This division of The Colonel's manufactures bedliners and leases the building from a company owned by Donald and Patsy Williamson.\nThe Colonel's maintains a fleet of 26 trucks for the transportation and distribution of its products. The Colonel's trucks are maintained pursuant to capital and operating equipment leases and are operated by 17 full-time drivers employed by The Colonel's. Approximately 68% of The Colonel's products are delivered by The Colonel's trucks. The balance of The Colonel's products are shipped by common carrier FOB to customer's location at the customer's expense. The means of delivery utilized by The Colonel's in combination with fairly flexible manufacturing processes, allows orders to be filled on a substantially faster basis than by OEM competitors. Plastic replacement parts for import model automobiles purchased by The Colonel's internationally, for domestic resale, are generally transported to distribution warehouse facilities at The Colonel's expense.\nThe Colonel's products are principally marketed through independent sales representatives and are sold primarily to automobile collision body shops, automobile aftermarket supply stores and to regional and national chain stores that sell automobile aftermarket parts. There are approximately 180 independent sales representatives for The Colonel's products who are located in all 50 states, The District of Columbia, Puerto Rico, Canada, Mexico and The Bahamas. Independent sales representatives for The Colonel's are not limited to exclusive sales of The Colonel's products and The Colonel's does not have any written agreements with its independent sales representatives. Compared with OEMs that generally sell only their own parts to service departments in a dealership network, The\nColonel's offers a relatively full line of replacement bumpers and facias for multiple automobile models and sells directly to distributors, body shops, automobile service centers and retail customers.\nThe Colonel's sold products to over 205 customers throughout the United States, Canada, Mexico and the Caribbean during 1995. The Colonel's customer base has grown in each of the last ten years. In each of the last three years, at least 94% of the prior year's customers have continued to order products from The Colonel's. None of The Colonel's 305 active customers represent more than 10% of total sales.\nThe Colonel's participates in industry and automotive trade shows each year, including Automobile Body Parts Association, Bumper Recyclers Association of North America and NACE, at which The Colonel's promotes its lines of plastic bumpers, facias, support beams and brackets. The Colonel's products are reviewed in national industry publications such as COLLISION PARTS JOURNAL, BODY LANGUAGE, and VOICE OF THE AUTOMOTIVE BODY PARTS ASSOCIATION and approximately 72% of The Colonel's products are listed in the Certified Automotive Parts Association Directory of Aftermarket Body Parts. The Colonel's also promotes its products through advertisements in specialized trade and consumer magazines, through distribution of various professionally prepared product catalogs and brochures and through publication of a quarterly newsletter distributed to customers. In addition, The Colonel's sponsors an annual conference and golf outing with its major customers and suppliers in order to strengthen customer and supplier relations and facilitate feedback with respect to product performance, emerging technology and current market demands.\nCOMPETITION. The automotive aftermarket for plastic replacement bumpers and facias is highly competitive. The market is dominated by OEMs such as General Motors Corporation, Ford Motor Company, Chrysler Corporation, Toyota Motor Sales, U.S.A. Inc. and Nissan Motor Corp., U.S.A. These OEMs are more established and have greater financial resources than The Colonel's. These larger OEMs, however, also generally charge higher prices than The Colonel's for their products and generally distribute their products through their own automobile dealership networks rather than through independent distributors and body shops. Automobile insurance companies have successfully advocated the use of less expensive parts by body shops, and OEMs have lost market share in the collision parts market as a result. This may lead OEMs to reduce their prices or pursue such strategies as industrial rights litigation against aftermarket parts competitors.\nIn addition, The Colonel's competes with other non-OEM manufacturers of plastic bumpers for the automotive aftermarket industry in North America. The Colonel's believes it is larger and offers a wider selection of products than any of its non-OEM\ncompetitors. Recycling companies and auto salvage companies also compete with The Colonel's; however, The Colonel's believes that such competitors are generally small in size, service only local or regional markets, and offer products of varying quality.\nThere are also a number of potential competitors to The Colonel's for the non-OEM market. Certain Asian-based companies manufacture replacement plastic automobile bumpers and facias for imported and domestically made foreign automobiles. The major Asian-based companies that offer competing products for sale in North America are Tan Yang and Legion Mold, Tool & Manufacturing Co., Ltd. There can be no assurance that these foreign-based companies that manufacture plastic automotive replacement parts will not enter the domestic replacement bumper and facia market and directly compete with The Colonel's products.\nPLANT FIRE AND INSURANCE SETTLEMENT; PROPERTIES. On June 1, 1993, The Colonel's leased facility in Owosso, Michigan, which included its headquarters, sales offices, and principal manufacturing and warehouse facilities, was destroyed by a fire. The fire caused a complete loss of the 280,000 square foot leased facility and damaged inventory, equipment and other contents therein. As a result of the fire, The Colonel's transferred certain of its headquarters personnel and production to its production facility located in Sarasota, Florida, on an interim basis, to supplement a portion of the lost production of the Owosso facility.\nIn November 1993, the Company relocated its principal operations and headquarters to Milan, Michigan, and is leasing a 350,000 square foot facility from a company owned by Donald and Patsy Williamson. The Colonel's began production at the Milan facility in December 1993 and was producing the company's full range of products by August 1994. Subsequently, The Colonel's has ceased manufacturing operations in Florida and all manufacturing is now conducted at the Milan facility. The Colonel's believes the Milan manufacturing facility is suitable for the company's requirements and has adequate capacity to accommodate foreseeable production demands. In addition to The Colonel's manufacturing facility located in Milan, a description of all other manufacturing, sales and distribution facilities used by is The Colonel's contained under \"Distribution and Sales; Properties.\"\nThe Colonel's finalized negotiations with its insurance carrier for amounts to be received on all coverages in effect at the date of the fire. Total insurance proceeds received for the replacement cost of lost property, lost profits, and other direct costs of the fire were approximately $31,000,000, of which approximately $6,630,000 was due to a shareholder as indemnification of damages to the Owosso facility. The Colonel's recognized in other income a net gain of approximately $9,082,000 and $9,043,000 in 1994 and 1993,\nrespectively, which represents the amount by which The Colonel's insurance proceeds of $24,370,000 exceeded the sum of the net book value of the assets destroyed and the liabilities resulting from the fire.\nBRAINERD INTERNATIONAL RACEWAY, INC.\nBecause Brainerd International Raceway is a new corporation that has acquired substantially all of the assets of its predecessor, Brainerd, much of the following discussion describes the activities of Brainerd prior to the Merger. However, it is anticipated that Brainerd International Raceway will continue the business conducted by Brainerd prior to the Merger.\nGENERAL OPERATIONS. Brainerd International Raceway organizes and promotes various spectator events such as road and drag races, including races for sports cars, stock cars, motorcycles, and go-karts, and derives a substantial portion of its revenues from ticket sales and spectator attendance. In addition, Brainerd International Raceway permits the use of its racing facility by others who organize and promote racing events, and by individuals or commercial organizations who may use the Brainerd International Raceway for things such as automobile road testing or filming. All racing events, whether or not organized by Brainerd International Raceway, are conducted over a two to four-day period, usually encompassing a weekend.\nBrainerd International Raceway derives its revenues from four principal sources: (i) ticket sales; (ii) camping fees, concession sales, and track rentals; (iii) entry fees; and (iv) sponsorship fees. Sponsorship fees were received in 1995 from commercial businesses such as Viking Coca-Cola, Inc., Anheuser-Busch (Budweiser), Pontiac Motor Division, Champion Auto Stores, and R.J. Reynolds Company which promote their names and products at and in connection with the racing events. Sponsorship fees are contracted for and often paid in whole or in part several months prior to the commencement of each racing season. Entry fees are received from race participants.\nBrainerd International Raceway permits overnight camping during racing events within the area surrounded by the Brainerd International Raceway track, which will accommodate tents, trailers, and motor homes. In 1995, Brainerd (as predecessor of Brainerd International Raceway) charged from $10 per person to $16 per person for each weekend, or from $5 per person to $14 per person for one day, for use of the camping facilities. Material revenues from camping were received by Brainerd with respect to only six spectator events in 1995. Brainerd International Raceway uses a local nonprofit organization to manage the camping activities during the principal\nspectator events. The nonprofit organization is currently paid 20% of the camping revenues generated by the events in exchange for which the organization supplies personnel to staff the gates to collect camping fees.\nBeer, soft drinks, candy, and fast food items such as hot dogs are served at concession stands at various locations around the raceway, but principally near the grandstand area. Brainerd allowed both for-profit and nonprofit organizations to operate the concession stands for the six principal spectator events in 1995. For all other 1995 events, Brainerd permitted a single for-profit organization to operate the concession stands. Brainerd International Raceway receives a percentage of the gross sales of all concessions, but neither Brainerd International Raceway nor any of its affiliates operates any of the concession stands. Brainerd International Raceway currently plans to continue its practice of allowing independent for-profit and nonprofit organizations to operate the concession stands.\nBrainerd International Raceway rents the raceway to other organizations to conduct races, hold driving schools, or to test or film motor vehicle operations. It has also rented the raceway for use as the site of a camping convention. The fee charged for such use varies and is negotiated in each case.\nFor the calendar years 1995, 1994, and 1993, the percentage of revenues derived from Brainerd's various revenue sources were as follows:\nDuring 1995, Brainerd organized and promoted seven major spectator events, including two drag races (the \"Winston Drag Racing Series\" and the \"NHRA\/Champion Auto Stores Nationals\"), two special events (the \"Champion Auto Stores Show & Go\" and the \"Champion Auto Stores Muscle Car Shootout\"), one motorcycle race (the \"Suzuki Classic\"), one road race by stock cars (the \"Pontiac Excitement 300\") and one snowmobile race (the \"ISOC\/McDonald's 100\").\nThe Winston Drag Racing Series, held on June 3 and 4, 1995, was a drag racing event sponsored nationally by R.J. Reynolds Tobacco Company of Winston-Salem, North Carolina. A drag race is generally conducted between two vehicles from a standing start over a one-quarter\nmile track, using sophisticated starting and timing systems. The Winston Drag Racing Series was sanctioned by the National Hot Rod Association (the \"NHRA\") and was one of a series of five events in the Central States Division of the NHRA. The Winston Drag Racing series was organized and promoted jointly by Brainerd and the NHRA, and included both professional and amateur drivers who paid Brainerd an entry fee. A similarly sponsored event has been held at the Brainerd International Raceway annually since 1977, with the exception of 1984, when there was a scheduling conflict. The Sponsorship Agreement with R.J. Reynolds Tobacco Company for this event will expire in December 1996, subject to the option of R.J. Reynolds Tobacco Company to extend the agreement for an additional two years. This event drew approximately 3,500 paid spectators in 1995, as compared to approximately 3,300 in 1994 and 3,100 in 1993. The event is scheduled for June 1 and 2, 1996.\nThe Pontiac Excitement 300, held on June 24 and 25, 1995, was a 300 kilometer (180 mile) road race by stock cars driven by professional drivers and sanctioned by the American Speed Association (the \"ASA\"). The event was one of only two road races included in the ASA's AC-Delco Challenge Series. Most stock car races, including the remaining sixteen races in the AC-Delco Challenge Series, are held on oval tracks. The event in 1994 was sponsored by the Pontiac Motor Division of General Motors and was nationally televised on the Nashville Network cable television program. Management of Brainerd estimates that it realized operating losses of $63,700 and $154,000 on the event in 1994 and 1993, respectively. In 1995 the event was held with the ASA acting as the promoter of the event. Under such arrangement, Brainerd was paid rent in the amount of $10,000 and allowed to retain certain concession revenue from the event. This event is not scheduled for 1996.\nThe Champion Auto Stores Show & Go event, held on July 1 and 2, 1995, was sponsored by Champion Auto Stores under an agreement which extends through 1998. This event featured \"street rods,\" \"street machines,\" antiques, and other classic cars that participated in both a car show and drag races emphasizing a \"back-to-the-fifties\" style. The drag racing portion of the event was sanctioned by the NHRA. The event had approximately 7,500 paid spectators in 1995 and 7,300 and 7,000 in 1994 and 1993, respectively. The event is scheduled for July 6 and 7, 1996.\nThe Champion Auto Stores Muscle Car Shootout was held on July 22 and 23, 1995. As with the Show & Go event, this event is both a car show and a drag race. The Muscle Car Shootout involves 1974 to 1995 model year vehicles. The event is subject to the same sponsorship agreement as the Champion Auto Stores Show & Go event. The event had approximately 6,800 paid spectators in 1995 and 6,200 and 6,100 paid spectators in 1994 and 1993, respectively. The event is scheduled for August 3 and 4, 1996.\nThe Suzuki Classic, held on July 14, 15, and 16, 1995, was one of a series of nine races conducted throughout the United States pursuant to the sanction of the American Motorcyclist Association (the \"AMA\"). The event featured six races of motorcycles operating on the road course. The races involved motorcycles of 250cc, 600cc, 750cc, and the Harley Davidson Twin Sport and Superbike classes. The event had approximately 8,600 paid spectators in 1995 compared to approximately 9,200 in 1994 and 7,200 in 1993. This event is scheduled this year for July 12, 13, and 14, 1996.\nThe Champion Auto Stores Nationals event, held on August 17, 18, 19, and 20, 1995, was sponsored by Champion Auto Stores under an agreement with the NHRA. This event features all professional drivers, most of whom have national reputations, and was one of a series of nineteen drag races conducted throughout the United States in 1993 under the national sponsorship of the R.J. Reynolds Tobacco Company and the sanction of the NHRA. The Champion Auto Stores Nationals are organized and promoted by the NHRA. The NHRA leases the Brainerd International Raceway for a rental equal to one-half of the net profit of this event as defined in the lease agreement. Such profit is earned primarily through the receipt of promotional fees and ticket sales. Brainerd's responsibilities in this event are, among other things, to provide the Brainerd International Raceway, ticket sellers and takers and security personnel, as well as assisting in the management and operation of the event. The lease agreement with the NHRA is currently scheduled to terminate upon completion of the 1996 racing season, but is subject to an option of the NHRA to extend the term of the lease through the 2001 racing season. Under the lease agreement, Brainerd is not permitted to conduct any drag races at the Brainerd International Raceway that are not sanctioned by the NHRA. Champion Auto Stores has agreed to sponsor the event through the 2001 racing season. The Champion Auto Stores Nationals drew approximately 48,200 paid spectators in 1995. The event, which has been held at the Brainerd International Raceway since 1982, drew approximately 45,100 paid spectators in 1994 and 42,500 in 1993. The event is scheduled for August 15 through 18, 1996.\nAdditionally, during the New Year's weekend of December 30, 1994, through January 2, 1995, Brainerd held the Brainerd 200 snowmobile race at the Brainerd International Raceway. The race was one of eight races on the International Series of Champions and featured Pro 500, Semi-Pro, and Stock classes of snowmobiles competing in 200 kilometer races on a cross country course. The race was sponsored by McDonald's, Skidoo, Polaris, and Arctic Cat. The races were held on a prepared track constructed adjacent to the road course. The event drew approximately 3,800 paid spectators. Management of Brainerd believes attendance was adversely affected by the limited snowfall preceding the event. The event which had been scheduled for December 30 and 31, 1995 was canceled due to inadequate sponsorship support.\nBrainerd also organized and sponsored five weekend drag racing \"bracket\" events in 1995, primarily for non-professional drivers from Minnesota and surrounding states. In bracket racing, each driver attempts to predict his car's performance, and whether he wins or loses a particular race will depend partially on how much his actual time over a one-quarter mile distance exceeds his predicted time. While spectators are encouraged to attend these drag racing events, and Brainerd receives revenues from ticket sales, camping fees, and concessions, they are not highly promoted. Brainerd has scheduled four bracket races for 1996.\nIn addition to the spectator events and the bracket races discussed above, there are racing events conducted on approximately 21 other weekends that are primarily for nonprofessional drivers and are often organized and sponsored by local and regional racing clubs some of which may be members of or affiliated with national sanctioning organizations. While spectators attend these events, Brainerd does not receive any revenues from ticket sales from, or engage in any significant promotion of these events.\nIn 1995, two weekend events involved sports car racing and were sponsored by the \"Land O' Lakes\" regional affiliate of The Sports Car Club of America (the \"SCCA\") which sanctions these events. In addition, in 1995, four motorcycle racing events were held, each of which was sponsored by the Central Roadracing Association, a club located in the Minneapolis\/St. Paul, Minnesota area and associated with the AMA. During 1995, the Northland Region Karting Association, affiliated with the World Karting Association, (the \"WKA\"), organized and sponsored seven go-kart racing events, and the Nord Stern Regional Club of the Porsche Club of America organized four weekend racing events for Porsche cars. A similar schedule has been established for 1996.\nBrainerd International Raceway will rent the raceway to various individuals or organizations for their own unsanctioned events and driving schools, or to test or film the operation of various motor vehicles. In July 1992, Brainerd leased the raceway to the National Campers and Hikers Association for use as the site for a camping convention. Only the camping areas and the grandstand, which was used for a country music concert, were used.\nIn addition to attempting to continue to schedule the events discussed above, other than the Brainerd 200 snowmobile race, Brainerd is also seeking to establish additional revenue producing uses for the Brainerd International Raceway. Events under consideration include additional spectator racing events, a street rod show, snowmobile events and music festivals.\nIn January 1995, Brainerd (as predecessor of Brainerd International Raceway) entered into an agreement with the International Motor Sport Association (\"IMSA\") for the Brainerd International Raceway to be the site of endurance road races featuring domestic and foreign sports cars in 1995, 1996 and 1997. The inaugural event was scheduled for August 4, 5 and 6, 1995. On June 16, 1995, IMSA announced that it had canceled the events it had scheduled to be held at the Brainerd International Raceway as well as at a site in Portland, Oregon. Under its agreement with IMSA, Brainerd was to be paid a track rental fee of $20,000 and be reimbursed, on an accountable basis, for the expenses it incurred in connection with the event. In February 1996, the Company agreed to settle claims against the IMSA relating to termination of the agreement for $65,000. The terms of the settlement call for scheduled payments to be received by Brainerd International Raceway throughout 1996.\nMost racing events conducted at the Brainerd International Raceway, including the seven principal spectator events held by Brainerd in 1995, are sanctioned by an organization which establishes, publishes, and enforces rules relating to a specific class or type of participating vehicle. These rules generally relate to the specifications which each class of car or other vehicle must meet in order to be eligible to race, and to driver conduct and other racing matters. Brainerd enters into agreements annually with the various applicable sanctioning bodies with respect to each race it organizes and promotes. These agreements provide that the appropriate sanctioning organization will sanction the race and provide personnel to interpret and enforce its rules. The sanctioning bodies include the SCCA (governing sports cars), the NHRA (governing drag racing), the AMA (governing motorcycles), the ASA (governing stock cars), and the WKA (governing go-karts).\nBrainerd International Raceway promotes its principal spectator events (discussed under \"Events and Activities\" above) primarily through radio and television advertising in Minnesota, through mailings made to selected potential spectators from a list developed by Brainerd, and through racing posters placed in service stations and auto parts and accessory stores. Brainerd also attends five auto shows in Minnesota, where it promotes all of its events. In a few instances, sponsoring organizations may also promote these events. When undertaken, such sponsor promotion is generally through newspaper or point of sale advertising.\nTicket sales are made at various locations by ticket agents, at Brainerd's offices primarily by mail, and at the Brainerd International Raceway. Brainerd sells three types of tickets: a Sunday only ticket, a weekend ticket, and a Super Weekend ticket that includes all days of each event as well as paddock admission and camping. Ticket agents are located throughout Minnesota and include\nthe retail outlets of Champion Auto Stores. Most ticket agents receive a commission equal to 9% of the ticket prices. Ticket prices for the six principal racing events scheduled for 1996 will range from $8 to $95 per ticket, depending primarily on the event and the number of days the event is held.\nBrainerd estimates that over 60% of Brainerd's ticket sales are made to residents of the Minneapolis\/St. Paul, Minnesota metropolitan area, and that approximately 25% of Brainerd's ticket sales are by mail. Advance sales of tickets represent approximately 50% of all ticket sales.\nAs of December 31, 1995, Brainerd International Raceway had 4 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company is a holding company with no operations of its own. The properties of the Company's two wholly-owned subsidiaries, which are The Colonel's and Brainerd International Raceway, are addressed below.\nTHE COLONEL'S. The properties of The Colonel's are discussed in \"Item 1 - -The Colonel's--Distribution and Sales; Properties\" and \"Plant Fire and Insurance Settlement; Properties.\"\nBRAINERD INTERNATIONAL RACEWAY. Brainerd International Raceway owns and operates a three mile race track including a one-quarter mile drag strip (referred to herein as the \"Brainerd International Raceway\"), located approximately six miles northwest of Brainerd, Minnesota. The Brainerd International Raceway was initially constructed and first utilized for competitive racing in 1968. The site of the Brainerd International Raceway consists of approximately 600 acres. The terrain of the site is slightly rolling and partially wooded. The track and various access roads are composed of blacktop.\nThe Brainerd International Raceway is enclosed by a five foot high chain link fence. The site provides camping facilities and parking for approximately 12,000 vehicles. The Brainerd International Raceway contains several buildings including a four-story tower containing twelve executive viewing suites, a control tower, various single story buildings containing concession stands, restrooms, and storage and service facilities located throughout the property. The buildings are concrete or wood frame and constructed for warm weather use only. Grandstand bleachers for approximately 18,000 spectators are primarily located along the dragstrip.\nIn 1995, Brainerd made additional improvements to the Brainerd International Raceway with an approximate total cost of $309,000. The improvements included the installation of additional restrooms, privacy fencing and landscaping to a portion of the perimeter of the raceway, a new pedestrian bridge over the road course and an above-ground gasoline storage tank. Brainerd International Raceway's executive offices are located at 17113 Minnetonka Boulevard, Suite 214, Minnetonka, Minnesota, where Brainerd leases approximately 1,100 square feet of office space. The lease term expires in February 1997.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are involved in litigation and various legal matters arising in the normal course of business. Having considered facts that have been ascertained and opinions of counsel handling these matters, the Company does not believe the ultimate resolution of such litigation will have a material adverse effect on the Company's financial position.\nLITIGATION\nThe Company has reserved a total of $1,250,000 at December 31, 1995 against claims asserted by opposing parties in six unrelated lawsuits:\n1. The Colonel's is a defendant and counterplaintiff in a suit filed December 5, 1991, in the United States District Court, Eastern District of Michigan, Flint, Michigan, in a private action seeking damages under the Federal Antitrust statutes. The Colonel's had made a formal offer of judgment for $160,000 in 1994. Based upon the plaintiff's latest admissions of no damages on all but two of its previously pled claims, The Colonel's believes that amount is more than sufficient to cover any liability arising from the alleged sale of 1,900 bumpers at a price below their average variable cost. The Colonel's believes that any damages that would result from an adverse jury verdict on that aspect of the case would be more than offset by damages that The Colonel's is seeking for the opposing party's actions in concert with other named parties to force The Colonel's to stop selling products to another company competing with those parties.\n2. The Colonel's was a party in a construction lien action brought by an unpaid creditor of a company that contracted with The Colonel's to design, fabricate and install a $1.125 million automated paint line system at The Colonel's's Milan manufacturing facility. This suit was filed against the vendor on July 15, 1994, in Monroe County Circuit Court, Monroe, Michigan. The vendor partially performed its contract, but abandoned the project after its unpaid labor and material bills exceeded the remaining balance owed to it as future progress payments. The Colonel's was required to replace or repair some of the work that had been performed and to complete the project through new contracts. The Colonel's bypassed the contractor and settled directly with all fourteen unpaid subcontractors for $270,000 and a release of all liens.\n3. The Colonel's is a plaintiff and counterdefendant in a suit filed on February 14, 1994, in the United States District Court, Eastern District of Michigan, Detroit, Michigan. The underlying controversy arose because a machine, as delivered, did not have the capacities promised at the time that The Colonel's issued a purchase order for it. The trial court has issued an interim ruling that The Colonel's cannot introduce evidence regarding those promises unless they were incorporated in a writing signed by the defendant. The defendant sold the rejected machine to another buyer for more money than The Colonel's purchase order required it to pay, but has filed a counterclaim seeking its costs for finding another buyer and for lost profits. The vendor recently was found not to be entitled to damages. The Colonel's is appealing the trial court's ruling regarding its damages.\n4. A former supplier, Teran Products, filed suit against The Colonel's in the Shiawassee County Circuit Court in November, 1995 for alleged losses that the supplier suffered when materials it had stored at the former Owosso manufacturing facility, but which The Colonel's had not accepted, were destroyed in the June 1, 1993 fire and for packaging materials that Teran had purchased in anticipation that The Colonel's would order those products for use in ongoing production at its Sarasota, Florida facility. Those materials had not been ordered by The Colonel's at the time that it closed its Sarasota facility. Management does not believe The Colonel's has a legal responsibility for Teran's casualty loss of Teran's own property or for Teran's decision to purchase materials for Sarasota prior to any commitment by The Colonel's to purchase those materials from Teran. The Colonel's filed a counterclaim for an accounting of prices charged by Teran, after an investigation revealed that Teran may have failed to pass on discounts and price reductions as promised.\n5. In September of 1990, an action, Jane Doe v. Brainerd International, Inc. and North Country Security, Inc., was commenced in the District Court for Hennepin County, Minnesota, against Brainerd by a person who allegedly was sexually assaulted in August 1988 in connection with her participation in a wet T-shirt contest held at the Brainerd International Raceway by individuals not associated with Brainerd. The action called for compensatory damages of an unspecified amount in excess of $50,000. Brainerd's insurer accepted defense of the claim. The trial court granted summary judgment in favor of Brainerd and its co-defendant, which had provided security services for Brainerd during the event when the incident occurred. The trial court found that the plaintiff had entered the contest voluntarily, that Brainerd had not consented to the contest, and that the plaintiff had assumed the risks of the injuries resulting from her conduct. The plaintiff appealed the summary judgment. In April 1994, the Minnesota Court of Appeals reversed the trial court decision finding that issues of fact existed for a jury to resolve and a\nstatutory obligation for Brainerd to prevent a minor from engaging in this type of activity. Brainerd appealed the Court of Appeals' opinion to the Minnesota Supreme Court. On June 30, 1995, the Minnesota Supreme Court reversed the opinion of the Court of Appeals and reinstated the trial court's grant of summary judgment in favor of Brainerd.\n6. In June 1994, an action, Wade Jung v. Brainerd International, Inc. and XYZ, Inc. (case number PI 94-19690), was commenced against Brainerd and Brainerd's security contractor in the District Court for Hennepin County, Minnesota, by a minor and his parent. The action alleges that the minor was injured in July 1993 while attending a motorcycle race at the Brainerd International Raceway when he fell into a campfire while intoxicated. The plaintiffs allege Brainerd and its security contractor were negligent in failing to prevent the minor from engaging in the conduct which resulted in his injuries. The action calls for compensatory damages of an unspecified amount in excess of $50,000. Brainerd's insurer has accepted defense of this claim.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOn November 21, 1995, the annual meeting (the \"Meeting\") of shareholders of Brainerd (as predecessor to the Company) was held for the purposes of considering and voting on the following: (1) a proposal to adopt an agreement and plan of merger between Brainerd Merger Corporation, a wholly owned subsidiary of Brainerd, and The Colonel's; (2) a proposal to change the state of incorporation of Brainerd from Minnesota to Michigan, adopt new articles of incorporation to change the name of the corporation to \"The Colonel's International, Inc.\", and to increase the number of shares of common stock, par value $.01 per share, of Brainerd which Brainerd is authorized to issue from 10,000,000 to 35,000,000 shares; (3) a proposal to authorize the transfer of all of the operating assets of Brainerd to Brainerd International Raceway; (4) a proposal to adopt the Company's 1995 Long-Term Incentive Plan; (5) the election of directors; and (6) a proposal to confirm the appointment of Deloitte & Touche LLP as the independent auditors of the Company for the year ending December 31, 1995.\nAt the Meeting, the following persons were elected to the Company's Board of Directors: (1) Donald J. Williamson; (2) Richard L. Roe; (3) Gary Moore; (4) Ted M. Gans; (5) J. Daniel Frisina; and (6) Lisa K. Alexander. The Company's articles of incorporation provide that the Board of Directors is divided into three classes. Messrs. Williamson and Gans were elected to terms that expire at the Company's 1998 annual meeting of shareholders. Messrs. Moore and Frisina were\nelected to terms that expire at the Company's 1997 annual meeting of shareholders. Finally, Mr. Roe and Ms. Alexander were elected to terms that expire at the Company's 1996 annual meeting of shareholders.\nThe results of voting were as follows. At the Meeting, a total of 677,830 shares of Brainerd voting common stock were entitled to vote and a total of 642,474 shares of common stock were represented in person or by proxy. With respect to the first proposal, the acquisition of The Colonel's, Inc., 560,861 shares were voted in favor, 300 shares were votes in opposition, and 81,313 shares abstained from voting.\nWith respect to the second proposal, the reincorporation of Brainerd in Michigan, 565,017 shares were voted in favor, 482 shares were votes in opposition, and 76,975 shares abstained from voting.\nWith respect to the third proposal, the transfer of assets to Brainerd International, Raceway, Inc., 563,364 shares were voted in favor, 315 shares were votes in opposition, and 78,795 shares abstained from voting.\nWith respect to the fourth proposal, the adoption of the incentive plan, 551,139 shares were voted in favor, 15,758 shares were votes in opposition, and 75,577 shares abstained from voting.\nWith respect to the election of directors, each director received the number of votes set opposite his or her respective name:\nFinally, with respect to the sixth proposal, the appointment of independent auditors, 631,651 shares were voted in favor, 10,100 shares were votes in opposition, and 723 shares abstained from voting.\nThe Company did not enter into any settlement terminating any solicitation subject to Rule 14a-11 under the Securities Exchange Act of 1934 relating to the Meeting.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Company's common stock has been traded on the Nasdaq SmallCap Market since January 2, 1996. The number of holders of record of Common Stock in the Company on March 25, 1996 was 252.\nPrior to the Merger, Brainerd common stock was traded on the Nasdaq SmallCap Market. Effective January 2, 1996, Brainerd common stock was delisted from the Nasdaq SmallCap Market. The table below sets forth the high and low transaction prices by calendar quarter for 1995 and 1994 of Brainerd common stock, prior to its delisting. Such prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions Because of the Merger, these prices may not reflect the value of a share of common stock in the Company after the Merger.\nFor the two fiscal years prior to the Merger, Brainerd did not pay any cash dividends on its common stock. The Company does not anticipate paying any dividends in the near future. Management intends to apply earnings, if any, to the development of the business of its subsidiaries.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial data shown below for the Company for each of the five years in the period ended December 31, 1995, has been derived from consolidated financial statements of the Company, which have been audited by the Company's independent auditors, Deloitte & Touche LLP. The following data 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 Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBACKGROUND\nAs discussed in Item 1 of this Report on Form 10-K, effective December 31, 1995, Brainerd merged with and into the Company. The Company was the surviving corporation in the Merger. Prior to the Merger, Brainerd had 677,830 shares of its common stock outstanding and traded on the Nasdaq SmallCap Market (symbol BIRI). Pursuant to the Merger, these shares were converted into the same number of shares of common stock in the Company.\nAlso effective December 31, 1995, Brainerd Merger Corporation, a Michigan corporation and a wholly owned subsidiary of Brainerd, merged with and into The Colonel's, Inc. The Colonel's was the surviving corporation in this merger. In consideration of this merger, the Company issued 23,500,000 shares of its common stock to Donald J. Williamson and Patsy L. Williamson, who were the sole shareholders in The Colonel's. In addition, Brainerd transferred all of its operating assets to its newly formed subsidiary, Brainerd International Raceway.\nAs a result of these transactions, the Company now has two wholly owned subsidiaries: The Colonel's and Brainerd International Raceway.\nFor accounting purposes, the transaction was treated as a recapitalization of the Company with the Company as the acquiror (a reverse acquisition). The effective date of the merger of Brainerd and the Company was December 31, 1995. Therefore, the assets acquired and liabilities assumed are included in the Company's balance sheet at December 31, 1995. The historical financial statements prior to December 31, 1995 are those of the Company only and do not include any operating results of Brainerd. Refer to \"Note 3 - Business Combination\" in the Notes to Consolidated Financial Statements for proforma selected financial information.\nTHE COLONEL'S, INC.\nThe Colonel's was organized in 1982 and began producing and selling plastic bumpers and facias in 1983. By the start of 1996, The Colonel's had grown through acquisitions, joint ventures, and normal expansion to two manufacturing plants, four distribution warehouses and a network of independent distributors that sell The Colonel's products throughout the United States, Canada, Mexico, Puerto Rico, Bahamas, and the District of Columbia. The start up of a new truck accessory division (the \"Truck Accessory Division\") that will manufacture and sell pickup truck bedliners and tail gate covers, and the formation of Brainerd International Raceway as a subsidiary of the Company, represents efforts by the Company to begin to diversify into other areas outside the automotive collision parts industry.\nThe Colonel's designs, manufactures and distributes plastic bumpers, facias, support beams and brackets for the automotive collision parts industry. The Colonel's also purchases and resells replacement steel and chrome bumpers, facias, header panels, steel bumpers, rebars, step bumpers, paint, and body shop repair supplies through its distributors as replacement collision parts for most domestic and imported automobiles and light trucks.\nThe Colonel's is a leading domestic manufacturer of plastic replacement bumpers and facias for the automotive and light truck after market industry. The Colonel's competes with the original equipment manufacturers (\"OEMs\"), other domestic and import manufacturers for the aftermarket who offer new replacement bumpers, and the recycled and junk yard industry who repairs and resells previously damaged or salvaged automotive parts.\nThe Truck Accessory Division will sell new pickup truck bedliners, tail gate covers, trim pieces, and other items and will compete in the growing pickup truck and sport utility liner market. Newly installed custom built equipment will make the Owosso manufacturing facility one of the world's most modern bedliner production plants. The Company believes that the Truck Accessory Division can effectively compete in the market because it has the ability to manufacture its own plastic sheet stock instead of purchasing it from outside vendors and it has specialized tooling with a dedicated mold for each part. The Company registered two patents on this specialized tooling, which required extensive development. The products of the Truck Accessory Division will be sold through a world wide distributor network.\nThe Colonel's participates in the Certified Auto Parts Association (CAPA) certification program. This independent association inspects and promulgates guidelines that form strict standards for quality. CAPA works closely with the insurance carriers to relate their concerns and quality issues to the manufacturing sector. The manufacturing sector places CAPA certification stickers on each of the parts that have been tested and certified. The serial number of the certification sticker is the means for CAPA to trace the part back to its original manufacturer. A non-conforming part may cause CAPA to call for an inspection of the part or facility and may lead to the de-certification of that part or part lot. Any part that is decertified has to start over with the certification process in order to be re-certified. A CAPA catalogue is distributed quarterly listing all certified and decertified parts or lots. Additionally, CAPA issues monthly bulletins to keep everyone advised of the status of all the parts in its program. Currently, The Colonel's has 202 applications that are certified by CAPA. At the present time, CAPA only has a certification program for the Reaction Injection Molding (RIM) process. It does not have a certification program for the 56\nparts made by the injection molding (IM) process. It would be expected that once CAPA has incorporated this process into its certification program that The Colonel's may spend resources for certification of the parts it produces from the IM process.\nThe Colonel's competes mainly on quality, price and delivery. Prices are driven by the pricing levels that the respective OEM is currently charging. The Colonel's considers price adjustments whenever an OEM changes its prices. The Colonel's made general price changes in September 1995 in an effort to stabilize market share and boost sales exposure. The Colonel's believes that it can stay competitive with OEM pricing because of its extensive distributor network, which allows it to bring products to market with less cost or markup than the OEM. OEM price changes cannot be anticipated and could have a major impact either favorably (price increase) or unfavorably (price reduction) on The Colonel's competitive position.\nThe Colonel's produces consistent quality products using state of the art, domestically made machinery, domestically engineered raw materials, and local labor forces. The Colonel's proudly displays \"Made in USA\" on all of its products, packaging materials, and literature. The manufacturing process, plant and parts are checked and certified by an independent quality agency (CAPA) to assure that parts meet or exceed acceptable industry standards.\nBRAINERD INTERNATIONAL RACEWAY, INC.\nFrom the time of its formation in 1982, Brainerd has operated a motor sports facility located approximately six miles northwest of Brainerd, Minnesota. As of 1996, this facility is now operated by Brainerd International Raceway, a subsidiary of the Company. Substantially all of Brainerd International Raceway's revenues have been obtained from motor sports racing events at the raceway. Historically, Brainerd International Raceway has scheduled racing and other events to be held at the racetrack during weekends in the months of May through September each year. However, Brainerd International Raceway conducted a snowmobile racing event during the 1994-1995 New Year's weekend.\nWhile Brainerd International Raceway has scheduled approximately 35 events during each season, a limited number of the major spectator events provide a substantial portion of Brainerd International Raceway's revenues with one event, the Champion Auto Stores Nationals, having provided approximately 56% of Brainerd International Raceway's operating revenue for the past three years. Revenues from the major spectator events are provided from the sale of admissions to the event, the sale of concessions, and fees paid by the spectators and participants for camping access on the grounds of Brainerd International Raceway. The receipt of such revenues is affected by\nweather conditions. Even if an event is not canceled due to rain or other adverse conditions, poor weather will reduce the attendance and the sale of concessions.\nIn addition to spectator-related revenues, Brainerd International Raceway receives: (i) sponsorship fees from businesses which promote their products and services at Brainerd International Raceway; (ii) entry fees from participants in the races and other events; and (iii) rent for use of the track for private racing events, driving schools and the testing or filming of motor vehicle operations.\nMAJOR FIRE LOSS AND INSURANCE CLAIM\nThe Colonel's suffered the loss of the former Owosso manufacturing plant on June 1, 1993 to a fire that totally consumed the building and the finished inventory stored in its warehouse area, a significant percentage of the plant's machinery and equipment, as well as many of The Colonel's's production molds. The Colonel's settled the resulting insurance claim for all insured losses caused by the fire for $31,000,000 in January 1995. That settlement caused The Colonel's to recognize as \"other income\" net gains of approximately $9,082,000 and $9,043,000 in 1994 and 1993 respectively. Those gains represent the amount by which The Colonel's portion of insurance proceeds of $24,370,000 exceeded the sum of the net book value of assets destroyed by the fire. The Colonel's paid $6,630,000 for the building's loss to the landlord. The Colonel's secured short term bridge loans from its primary lender to enable the Company to begin the rebuilding process. After consulting with government investigators and concluding its own private investigation, The Colonel's insurer unconditionally accepted coverage for the fire on November 11, 1993. Once the insurance company began paying partial claims, the bridge loans were repaid.\nImmediately after the fire, The Colonel's increased the output of its Sarasota, Florida manufacturing operations to minimize any loss of sales and income. Sarasota's production was increased to and kept at near capacity while salvageable machinery and equipment from Owosso were moved to a newly leased facility in Milan, Michigan. By the end of July 1994, the Milan plant was producing The Colonel's pre-fire full line of products and inventory levels had been rebuilt to a point where The Colonel's could resume full truck load deliveries to its customers.\nBecause the combination of new and restored presses and an improved layout at the Milan manufacturing facility afforded The Colonel's more production capacity than it had enjoyed in Owosso, management decided in October, 1994 to reduce manufacturing overhead by closing the Sarasota facility which had been leased on a month-to-month basis. Sarasota's inventory was reduced through normal sales and shipments of remaining units went to Milan. Sarasota's machinery and\nequipment was either sold or moved to another Colonel's operation. The equipment designated for sale has been reclassified as \"assets held for sale\" and valued at its estimated net realizable value at the end of 1994. All of the production molds at the Sarasota facility were acquired as part of The Colonel's's 1991 purchase of the assets of a competitor, NuPar, Inc. That purchase resulted in some duplicate molds. These duplicates, with net book value of $1,034,000, were written off in 1994 and scrapped as a result of the close of operations in Sarasota.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's consolidated current assets were reduced from $14,568,000 in 1994 to $11,483,000 in 1995. This was due mainly to the $4,352,000 collection of an insurance receivable at December 31, 1994. The Company reduced its current liabilities from $16,051,000 in 1994 to $15,026,000 in 1995. The improvement in working capital was due mainly to the retirement and refinancing of long-term debt. The Company's subsidiaries made all of their scheduled payments on long-term debt in 1995.\nAccounts receivable were reduced by approximately $182,000 by offering early payment discounts and incentives for prompt payments. The $4,352,000 insurance accounts receivable that The Colonel's recorded in 1994 was for the final settlement amounts received in early 1995.\nInventories were increased by $1,100,000 because of the start up of The Colonel's new warehouse in West Memphis, Arkansas, and the introduction of 29 new bumper lines. The Colonel's purchased the existing inventory and one building from The Colonel's Factory Outlet of Arkansas, Inc. in exchange for the forgiveness of debt due to The Colonel's. This purchase reduced the related party notes receivable to The Colonel's. See \"Note 13 - Related Party Transactions\" in the Notes to the financial statements. The tools to produce the large inventory of bumpers are located in the Company's Milan, Michigan facility and the increase in inventory is due to initial stocking of the parts.\nAs a result of the Merger, The Colonel's tax status was changed from an \"S\" corporation to a \"C\" corporation to conform with the rules of the Internal Revenue Service. The $3,097,000 in deferred net taxes represents the effect of temporary differences between book and tax bases as a result of this change in tax status and the acquisition of Brainerd. The effect of changing the Company's tax status was a $2,333,000 charge to income, primarily resulting from temporary differences in depreciation methods. The deferred tax liability\nassumed in the acquisition of Brainerd was primarily due to book and tax bases differences in the assets acquired. Deferred compensation was reduced because of a termination of a long-term employment contract.\nApproximately $275,000 of the property placed in assets held for sale at the end of 1994 was sold in 1995. The remaining balance of $75,000 is still for sale. The values reflect current estimated equipment values.\nPlant property and equipment increased by over $8 million in 1995 compared to 1994 because of the acquisition of assets related to Brainerd International Raceway and The Colonel's capital leases signed for the Truck Accessory Division plant equipment. Brainerd International Raceway's $4.8 million in assets were valued at appraised value with adjustments for depreciation and additions since the appraisal date. These asset additions will begin to be depreciated in 1996 based on their average useful life. The Colonel's's capital leases accounted for $2,700,000 and the balance of $2,600,000 was spent for additional tooling.\nNotes receivable have dropped by $2,300,000 because of the repayment of a related party note receivable. The Company has one remaining related party loan of $490,000 which is performing and being paid back at $20,000 per month plus interest. The Colonel's sold property during 1995 which was financed through note receivables due the Company at year end. These were subsequently paid in full in February 1996.\nThe Colonel's deposits on tools and machinery increased by $3,500,000 to $4,757,000 in 1995 because the additional equipment purchased for the start up of the Truck Accessory Division. The Company treats advance deposits made toward machinery as separate from regular assets until the equipment has been delivered, made operational, and placed \"in service\". $1,600,000 of the balance for tool deposits is for tools manufactured overseas. Although the Company anticipates that such tooling will be delivered as ordered, some risk of default by the manufacturers does exist.\nAs a result of the merger, the value paid for Brainerd International Raceway exceeded the value of its assets by $425,000. The excess has been booked as goodwill. Other assets were reduced from $525,000 in 1994 to $184,802 in 1995 because property that had been on the market for several years was leased to an unrelated tenant for a lease term expiring in July 1998. As a result, this property was transferred to operating assets.\nOUTSTANDING LOANS\nThe Colonel's has a $4,500,000 line of credit secured by accounts receivable and inventory with a term that expires in August 1996. The Colonel's expects to negotiate a renewal with the current lending institution. Interest is paid at prime on a monthly basis. The outstanding balance on the line of credit was $4,180,000 at December 31, 1995. Brainerd International Raceway has a $300,000 line of credit which is secured by all of its assets, of which $93,000 was outstanding at year end.\nThe Colonel's received new financing of $6,000,000 in April 1995, under a facility which calls for payments of $200,000 in principal plus interest on a monthly basis calculated at 1\/2 percent over prime on the outstanding balance. The money received from this new loan partially funded the purchase of the new equipment at the Owosso facility and paid off all other outstanding term loans. The loan is secured by machinery and equipment and had a balance of $4,800,00 at December 31, 1995. If the need arose in the future, the Company believes it could obtain additional financing by using these assets as collateral.\nBrainerd International Raceway has a term loan in the amount of $450,000 which is secured by property. The loan requires quarterly interest payments at 2 percent above prime and a single principal payment of $50,000 per year through 2004.\nThe former Owosso manufacturing facility was encumbered by a real estate mortgage in the amount of approximately $1,800,000 at the time of the fire. That mortgage included a pre-payment penalty that would have been triggered if the insurance proceeds had retired it in 1994. That penalty could have been passed back to The Colonel's because of loss indemnification provisions in the lease. The landlord paid The Colonel's an amount equal to the balance of that mortgage and The Colonel's assumed the mortgage. The Colonel's used the cash paid from the landlord to reduce indebtedness having a shorter maturity than the mortgage thereby automatically extending the repayment of needed capital. The mortgage is cross collateralized by essentially all the assets as are all the loans with the primary lender. The mortgage will be fully paid by 1998.\nThe Colonel's entered into a capital lease to finance equipment for the new Owosso, Michigan location. The Colonel's leased $2,689,000 worth of that equipment under a six-year agreement that calls for monthly payments of $41,000 and includes an option for the Company to purchase the equipment for $1.00 upon expiration of the lease term. That amount represents principal and interest at rates between 7.5 and 8.5 percent. The leases are collateralized by the machinery. In addition, The Colonel's has also financed additional interim equipment orders with\nleases in the amount of $2,087,000, which has been deposited with the machinery manufacturers as advance payments. Upon final acceptance of the machinery by The Colonel's, the leasing company will advance the remaining amount on the machinery of $650,000. Once the equipment has been accepted and paid for, The Colonel's will convert the interim leases to long-term capital leases with similar terms.\nThe lending institutions of both Brainerd International Raceway and The Colonel's consented to the Merger and related transactions and allowed assignments of the loans to the entities under the new structure.\nRESULTS OF OPERATIONS\nAs discussed in \"Background\" above, the financial statements contain only the operations of the Company prior to December 31, 1995 and do not include any results of operations of Brainerd. Refer to \"Note 3 - Business Combination\" in the Notes to Consolidated Financial Statements for proforma selected financial information.\nRevenues for The Colonel's were $28,504,000, $28,492,000, and $25,175,000 for the years ending 1995, 1994 and 1993, respectively. The slower growth in 1995 was primarily due to selective product discounts that were offered during the first nine month to customers in an effort to obtain a larger percentage of their business. In addition, The Colonel's offered free freight on truck-load purchases. This was the first major sales effort The Colonel's put forth since its fire in 1993. The Colonel's continues to aggressively market its products through improved quality, services and delivery.\nCost of sales have risen $601,000 over the three-year period from $19,397,000 in 1993 to $19,998,000 in 1995. Although general economic increases in supplies and labor have increased over the past three years, The Colonel's is offsetting these by operating more efficiently. Gross profits climbed from 22.95 percent in 1993 to 31.21 percent in 1994 and decreased to 29.84 percent in 1995.\nSelling and general and administrative expenses have significantly decreased from $6,318,000 in 1993 to $5,101,000 in 1994 and $3,534,000 in 1995. In 1993 selling and general and administrative expense was 25.1 percent of sales. This dropped to 18 percent in 1994 and 12.4 percent in 1995. This was primarily due to the closing and consolidation of the Sarasota plant in late 1994, and the consolidation of the Flint sales office to Milan in 1995. The duplicated services that were performed at each site were eliminated.\nThe one-time charges of $1,389,000 in 1994 were for the costs of closing the Sarasota manufacturing facility. These charges include the write off of duplicated tools and equipment which were scrapped and the cost of dismantling, moving and closing the plant.\nInterest expense rose from $786,000 in 1994 to $972,000 in 1995, due mainly to increased debt which was used to finance the new equipment for the Truck Accessory Division. Interest expense dropped from 1993 to 1994 by $80,000 because of scheduled principal payments.\nInterest income was up slightly in 1995 over 1994 by $13,000 but is down from 1993 by $87,000. As The Colonel's received fire proceeds in 1993, it invested the money until it was needed, resulting in increased interest income. The Colonel's interest income is normally generated by customer finance charges and notes receivable.\nThe gain on insurance settlement of $9,082,000 and $9,043,000 in 1994 and 1993, respectively, represented the excess of insurance proceeds over carrying value of the underlying property. Refer above to \"Major Fire Loss and Insurance Claim.\"\nThe Colonel's net income before income taxes in 1995 was $4,195,000 or 14.72% of sales. Adjusting the 1994 net income by removing the insurance proceeds leaves operational income of $1,806,000 or 6.34% of sales.\nThe Colonel's operated as an \"S\" corporation until the Merger and related transactions, which took place on December 31, 1995. As a result of the Merger, The Colonel's changed its status to a \"C\" corporation. This status change resulted in a change to income of $2,333,000 which represents the net amount of deferred taxes recorded at December 31, 1995.\nSUBSEQUENT EVENTS\nTwo Notes Receivable totaling $270,000 that were recorded as open at year end 1995 were paid in full in February 1996.\nThe Colonel's is in the process of negotiating a lease for a fifth warehouse on the East coast. The lease is expected to be signed before April 1, 1996. The warehouse is expected to operate in a manner similar to that of the warehouses in Dallas, Houston, Phoenix, and West Memphis.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements required under Item 8 are set forth in Appendix A of this Annual Report on Form 10-K and are here incorporated by reference. The supplementary financial information required under Item 8 is set forth below.\nThe following tabulation presents the Company's unaudited quarterly results of operations for 1995 and 1994. Pro forma per share data is calculated using the current number of shares outstanding (24,177,830) as if that number of shares were outstanding during 1994 and 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.\nBOARD OF DIRECTORS. The members of the Company's Board of Directors are:\nDonald J. Williamson (63). Mr. Williamson is a Director, President and Chief Executive Officer of the Company, which positions he has held since November 21, 1995. He is also the Founder of The Colonel's and currently serves as Chairman of the Board, Chief Executive Officer, Treasurer, Secretary, and a Director of The Colonel's. In addition, he serves as Chairman, Secretary, Treasurer and a Director of Brainerd International Raceway. His term as a Director of the Company expires in 1998.\nRichard L. Roe (58). Mr. Roe is a Director of the Company as well as a Director of Brainerd International Raceway. Mr. Roe served as Vice President of Brainerd (1988-1995), Secretary of Brainerd (1989-1995); President of Brainerd (1982 to 1987); and Treasurer of Brainerd (1985 to 1986). His term as a Director of the Company expires in 1996.\nGary Moore (46). Mr. Moore is a Director of the Company and also serves as a Director of Brainerd International Raceway. Mr. Moore also serves as director of operations for Brainerd International Raceway and as a sales consultant for The Colonel's. Mr. Moore's principal occupation is the position of National Sales & Accounts Manager for Tremco Division of B.F. Goodrich (since 1987). From April through November 1995, Mr. Moore served as Chairman of the Board and Chief Executive Officer of Brainerd. His term as a Director of the Company expires in 1997.\nTed M. Gans (60). Mr. Gans is a Director of the Company and also serves as Chairman of the Company's Audit Committee. Mr. Gans's principal occupation since 1965 has been as the President and Director of Ted M. Gans, P.C., a law firm in Bloomfield Hills, Michigan of which he is the sole owner. Mr. Gans also serves as a Director of Williamson Lincoln Mercury Inc., Williamson Chrysler Plymouth Dodge, Inc.; Blain Buick-GMC Truck, Inc.; and Williamson Chevrolet-Geo Cadillac, Inc. All three of these companies are 100-percent owned by Patsy L. Williamson, the wife of Donald J. Williamson. Mr. Gans's term as a Director of the Company expires in 1988.\nJ. Daniel Frisina (47). Mr. Frisina is a Director of the Company, a Director of The Colonel's, and a Director of Brainerd International Raceway. Mr. Frisina's principal occupation is Director of Global Development for Cheng Hong Legion Co., Ltd. where he has previously served as a consultant (since 1992). He served as President of The Colonel's from 1989 through 1991. Prior to the\nMerger, he served as Treasurer and Chief Financial Officer of Brainerd during 1995. His term as a Director of the Company expires in 1997.\nLisa K. Alexander (35). Ms. Alexander is a Director and Treasurer of the Company. She is also the Secretary and Treasurer of American Personnel, Inc. She has served as Vice President of Sales and Secretary of The Colonel's since 1989. Her term as a Director of the Company expires in 1996. Ms. Alexander is the step-daughter of Donald J. Williamson.\nEXECUTIVE OFFICERS. As mentioned above, Mr. Williamson is a Director, President, and Chief Executive Officer, and Ms. Alexander is a Director and Treasurer of the Company. The two additional executive officers of the Company are:\nJeffrey A. Chimovitz (50). Mr. Chimovitz is Vice President, Secretary and General Counsel of the Company. In addition, he serves as Assistant Secretary of The Colonel's, and Assistant Secretary of Brainerd International Raceway. Mr. Chimovitz became General Counsel of The Colonel's, Inc. in 1993. From 1990 to 1993, he was a Partner in the law firm of Jaffe, Raitt, Heuer & Weiss.\nRichard S. Schoenfeldt (40). Mr. Schoenfeldt is Vice President-Finance and Chief Financial Officer of the Company. Since 1994, he has served as controller and Chief Financial Officer of The Colonel's. From 1991 through 1994, he was Controller of The Colonel's and from 1987 through 1991 he was Operations Manager of The Colonel's.\nINVOLVEMENT OF DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS IN CERTAIN LEGAL PROCEEDINGS.\nThe Company does not believe that any of its directors, executive officers, promoters, or control persons are involved in legal proceedings within the meaning of Item 401(f) of SEC Regulation S-K.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.\nSection 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors and officers, and persons who own more than 10% of the Company's common stock, to file reports of ownership and changes in ownership with the SEC and Nasdaq. Directors, officers and greater than 10% beneficial owners are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nTo the best of the Company's knowledge, no director, officer, or beneficial owner of more than 10% of the Company's outstanding shares failed to file on a timely basis any report required by Section 16(a) of the Securities Exchange Act with respect to the year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nCOMPENSATION SUMMARY\nThe following Summary Compensation Table shows certain information concerning the compensation earned during each of the three fiscal years in the period ended December 30, 1995, of the Chief Executive Officer of the Company during the last completed fiscal year, and the Company's most highly compensated executive officers who served in positions other than Chief Executive Officer at the end of the last completed fiscal year and were compensated in excess of $100,000 for their services as officers of the Company and\/or its subsidiaries during the 1995 fiscal year.\nSTOCK OPTIONS\nNo stock options or stock appreciation rights (\"SARs\") were awarded by the Company, or by Brainerd (as predecessor of the Company) during the fiscal year ended December 31, 1995. No executive officer of the Company or Brainerd (as predecessor of the Company) exercised any stock option or SAR during the fiscal year ended December 31, 1995. In addition, no executive officer of the Company or Brainerd (as predecessor of the Company) held any unexercised options or SARs as of the end of the 1995 fiscal year.\nLONG-TERM INCENTIVE AWARDS\nThe Company has established its 1995 Long-Term Incentive Plan (the \"LTIP\") pursuant to which the Company may award cash and shares of restricted stock to plan participants conditioned upon the achievement of certain corporate performance goals over a three-year performance period. No awards were made under the LTIP during the fiscal year ended December 31, 1995. For a discussion of the LTIP, see below under the heading \"Board Report on Executive Compensation--Long-Term Incentive Plan.\"\nPENSION PLAN\nThe Company does not have a pension plan, a defined benefit plan or an actuarial plan.\nCOMPENSATION OF DIRECTORS\nNo compensation was paid to any director of the Company or Brainerd (as predecessor of the Company) for services rendered in such\ncapacity during the fiscal year ended December 31, 1995. Directors of the Company who are not employees of the Company may be reimbursed for expenses incurred in attending meetings of the Board of Directors. John B. Welch, a director of Brainerd, received consulting fees of $500 per month until his resignation from the Brainerd Board on February 23, 1995.\nEMPLOYMENT AGREEMENTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS\nThe Company does not have any employment agreements, termination-of-employment agreement, or change-in-control agreements with any executive officer.\nIn 1992, Lisa Alexander (at the time Lisa Morrow) and The Colonel's entered into a ten-year employment contract by which Ms. Alexander would be paid an annual salary of $104,000, in addition to benefits in conformity with benefits awarded to other executive officers. On February 6, 1996 Ms. Alexander and The Colonel's entered into an agreement terminating Ms. Alexander's employment contract.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's current directors were elected on November 21, 1995. Although the Board of Directors has authorized a Compensation Committee, no appointments were made to the Compensation Committee in 1995. The Board will appoint members of the Compensation Committee in early 1996. During 1995, Donald Williamson participated in deliberations of the Board of Directors concerning executive officer compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe Company's Board of Directors has fixed March 1, 1996 as the record date for determining the information set forth below. On that date, 24,177,830 shares of the Company's common stock were issued and outstanding. Shareholders are entitled to one vote on each matter presented for shareholder action for each share of common stock registered in their names at the close of business on the record date.\nThe following table contains information with respect to ownership of Company common stock by all directors, all nominees for election as directors, executive officers, all directors and executive officers as a group, and by each person known to the Company to own beneficially more than 5 percent of the Company's outstanding common stock. The content of this table is based upon information supplied\nby the Company's officers, directors and nominees for election as directors, and represents the Company's understanding of circumstances in existence as of March 1, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Colonel's is a party to certain transactions with related parties which are summarized below.\nLEASE OF MILAN, MICHIGAN, FACILITY. In June of 1993, The Colonel's began leasing its Milan, Michigan, facility from an affiliated company 620 Platt Road, LLC. Donald J. Williamson and Patsy L. Williamson are the sole members of 620 Platt Road, LLC. The term of the current lease is for three years beginning June 18, 1993 with an option for The Colonel's to renew the lease for an additional three year term. Rent expense to The Colonel's for the Milan facility was $840,000 in 1995, $840,000 in 1994, and $490,000 in 1993.\nTHE COLONEL'S FACTORY WAREHOUSE OF ARKANSAS, INC. Donald J. Williamson owns all of the outstanding capital stock of The Colonel's Factory Warehouse of Arkansas, Inc. (\"The Colonel's Arkansas\"). The Colonel's Arkansas is located in West Memphis, Arkansas, and is primarily engaged in manufacturing chrome plated bumpers for sale as aftermarket replacement parts. The Colonel's engages in certain transactions with The Colonel's Arkansas including sales and purchases of inventory and payment for and reimbursement of payroll expenses of The Colonel's Arkansas. During 1995, sales of inventory by The Colonel's to The Colonel's Arkansas were in the amount of $346,000 and purchases of inventory were in the amount of $744,600.\nAt December 31, 1994, The Colonel's held a note receivable from The Colonel's Arkansas in the amount of $2,138,186. In 1995, The Colonel's received from The Colonel's Arkansas $425,976 in inventory, $473,477 in other property and equipment, and $1,000,000 in satisfaction of this note.\nBLAIN BUICK-GMC, INC. Patsy L. Williamson owns all of the outstanding capital stock of Blain Buick-GMC, Inc. (\"Blain Buick\"). Blain Buick is an automobile dealership located in Flint, Michigan. The Colonel's engages in certain transactions with Blain Buick, including the purchase of automobiles, parts, and automotive service and the lease of certain property from which rental income is earned. During 1995, purchases of automobiles, parts, and services by The Colonel's from Blain Buick were in the amount of $73,500 and rental income paid by Blain Buick to The Colonel's was in the amount of $11,000. As of December 31, 1995, The Colonel's held a note receivable from Blain Buick in the amount of approximately $490,000. The note bears interest at 1% above the prime rate.\nTRANSACTIONS WITH DIRECTORS. Ted M. Gans is a Director of Brainerd and practices law with Ted M. Gans, P.C. During the past year, The Colonel's retained Ted M. Gans, P.C. for certain legal services and it is anticipated that the Company may retain Ted M. Gans, P.C. to render certain legal services during the current year. Gary Moore is currently serving as a director of the Company and Brainerd International Raceway, as director of operations for Brainerd International Raceway, as a sales consultant for The Colonel's and is a National Sales and Accounts Manager for the Tremco Division of B.F. Goodrich. During the past year, The Colonel's purchased paint from Tremco in the ordinary course of business and it is anticipated that The Colonel's will continue to purchase paint from Tremco during the current year. J. Daniel Frisina is Director of Global Development for Cheng Hong Legion Co., Ltd., which sells among other products, automotive body replacement parts to The Colonel's as well as other customers in the automotive crash parts industry.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\nITEM 14(A)(1). FINANCIAL STATEMENTS. Attached as Appendix A.\nThe following consolidated financial statements of The Colonel's International, Inc. and subsidiaries are filed as a part of this report:\n* Report of Independent Auditors * Consolidated Balance Sheets as of December 31, 1995 and 1994 * Consolidated Statements of Income for years ended December 31, 1995, 1994 and 1993 * Consolidated Statements of Stockholders' Equity for years ended December 31, 1995, 1994 and 1993 * Consolidated Statements of Cash Flows for years ended December 31, 1995, 1994 and 1993 * Notes to Consolidated Financial Statements for years ended December 31, 1995, 1994 and 1993\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES. Financial statement schedules have not been filed because such schedules are either not applicable or full disclosure has been made in the financial statements and notes thereto.\nITEM 14(A)(3). EXHIBITS. The following exhibits are filed as part of this report.\nEXHIBIT NUMBER EXHIBIT\n2.1 Agreement and Plan of Merger between The Colonel's, Inc. and Brainerd Merger Corporation and joined in by Brainerd International, Inc. Incorporated by reference from Exhibit A to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n2.2 Agreement and Plan of Reorganization among Brainerd International, Inc. and The Colonel's Holdings, Inc. Incorporated by reference from Exhibit D to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n3.1 Articles of Incorporation of the Company, as amended. Incorporated by reference from Exhibit E to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n3.2 Certificate of Amendment to the Articles of Incorporation changing name from \"The Colonel's Holdings, Inc.\" to \"The Colonel's International, Inc.\"\n3.3 Bylaws of the Company. Incorporated by reference from Exhibit F to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n4.1 Articles of Incorporation. See Exhibit 3(a) above.\n10.1 The Company's 1995 Long-Term Incentive Plan. Incorporated by reference from Exhibit G to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n10.2 Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.3 Form of Non-Statutory Stock Option Agreement used under the Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.4 Form of Incentive Stock Option Agreement used under the Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.5 Office Lease Agreement dated January 23, 1991 between Brainerd International, Inc. and Woodland Office Partnership. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1990.\n10.6 Amendment dated December 11-12, 1991 to Office Lease Agreement (see Exhibit 10(e) above) between Brainerd International, Inc. and Woodland Office Partnership. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.7 $404,700 Promissory Note dated January 1, 1992, from Brainerd International, Inc. payable to Gene Snow and James W. Littlejohn. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.8 Lease Agreement between Issuer and National Hot Rod Association, Inc. consisting of March 17, 1984 Lease Agreement; April 28, 1986 letter extending term to 1991; March 12, 1987 Letter of Amendment; and April 7, 1992 letter extending term to 1996 and amending agreement. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.9 November 8, 1988 Sponsorship Agreement between Champion Auto Stores, Inc. and National Hot Rod Association, Inc. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.10 June 22, 1992 Title Rights Sponsorship Agreement between Champion Auto Stores, Inc. and National Hot Rod Association, Inc. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.11 February 16, 1994 Loan Agreement with American National Bank of Brainerd; $550,000 Promissory Note; and $300,000 Line of Credit Note. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.12 December 21, 1993 Agreement among Issuer, Motor Stadium, Inc. and Gene M. Snow providing for termination of March 23, 1993 Financing Agreement, dissolution of Motor Sports Stadium, Inc. and grant of interest by Mr. Snow in potential future project. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.13 Amendment dated February 1, 1994 to Office Lease Agreement (See Exhibits 10(e) and 10(f)). Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.14 September 1994 Stock Purchase Agreement among Gene M. Snow, James W. Littlejohn and Donald J. Williamson. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.15 December 1994 Letter of Intent between Issuer and The Colonel's, Inc. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.16 Addendum to Lease dated December 16, 1994 (See Exhibits 10(e), 10(f) and 10(m)). Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.17 Variable Rate-Installment Note ($6,000,000) between The Colonel's and Comerica Bank dated April 14, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.18 Master Revolving Note ($4,500,000) between The Colonel's and Comerica Bank dated May 1, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.19 Security Agreement between The Colonel's and Comerica Bank (f\/k\/a Manufacturers National Bank of Detroit) dated December 4, 1991. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.20 Amended and Restated Security Agreement between The Colonel's and Comerica Bank (f\/k\/a Manufacturers National Bank of Detroit) dated December 4, 1991. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.21 Amended and Restated Guaranty between Donald and Patsy Williamson and Comerica Bank dated October 8, 1992. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.22 Lease Agreement between 620 Platt Road, Inc. and The Colonel's dated June 18, 1993 (for Milan, Michigan manufacturing facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.23 First Amendment to Lease Agreement between 620 Platt Road, L.L.C. (f\/k\/a 620 Platt Road, Inc.) and The Colonel's dated June 16, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.24 Industrial\/Warehouse Lease between JMB\/Warehouse Associates Limited Partnership and The Colonel's dated August 1, 1993 (for Houston, Texas warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.25 Lease Agreement between Industrial Properties Corporation and The Colonel's dated September 15, 1992 (for Dallas, Texas warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.26 Standard Industrial Lease between Revco D.S., Inc. and The Colonel's dated February 5, 1993 (for Phoenix (Glendale), Arizona warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.27 Interim Equipment Lease Schedule ($2,729,370) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.28 Interim Equipment Lease Schedule ($2,044,000) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.29 Interim Equipment Lease Schedule ($383,468) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.30 Lease Schedule ($3,464,557) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.31 Interim Lease Schedule ($960,000) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.32 Interim Lease Schedule ($542,811) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.33 Interim Lease Schedule ($85,800) between The Colonel's, Inc. and Comerica Leasing Corporation dated January 26, 1996.\n10.34 Interim Lease Schedule ($52,556) between The Colonel's, Inc. and Comerica Leasing Corporation dated February 16, 1996.\n10.35 Interim Lease Schedule ($584,250) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.36 Interim Lease Schedule ($364,650) between The Colonel's, Inc. and Comerica Leasing Corporation dated January 26, 1996.\n10.37 Interim Lease Schedule ($178,200) between The Colonel's, Inc. and Comerica Leasing Corporation dated February 16, 1996.\n11.1 Computation of Per Share Earnings.\n21.1 Subsidiaries of the Registrant.\n24.1 Powers of Attorney.\n27.1 Financial Data Schedule.\nITEM 14(B). REPORTS ON FORM 8-K.\nOn December 5, 1995, Brainerd (as predecessor to the Company) filed a Report on Form 8-K with the SEC and Nasdaq (the \"Report\"). The Report reports the change in control of Brainerd that occurred as a result of the Merger and related transactions, and the submission of matters to a vote of security holders at the Meeting. Neither Brainerd nor the Company filed other reports on Form 8-K during the fourth quarter of the fiscal 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.\nTHE COLONEL'S INTERNATIONAL, INC.\nDated: March 28, 1996 By: *\/S\/ DONALD J. WILLIAMSON Donald J. Williamson 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.\nSIGNATURE TITLE DATE\n*\/S\/DONALD J. WILLIAMSON President, Chief Executive March 28, 1996 Donald J. Williamson Officer, and Director (Principal Executive Officer)\n*\/S\/RICHARD SCHOENFELDT Vice President-Finance, and March 28, 1996 Richard Schoenfeldt Chief Financial Officer (Principal Financial and Accounting Officer)\n*\/S\/LISA K. ALEXANDER Treasurer and Director March 28, 1996 Lisa K. Alexander\n_______________________ Director Richard L. Roe\n*\/S\/J. DANIEL FRISINA Director March 28, 1996 J. Daniel Frisina\n*\/S\/TED M. GANS Director March 28, 1996 Ted M. Gans\n*\/S\/GARY MOORE Director March 28, 1996 Gary Moore\n*By \/S\/ JEFFREY A. CHIMOVITZ Jeffrey A. Chimovitz Attorney-in-fact\nAPPENDIX A\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders of The Colonel's International, Inc. Milan, Michigan\nWe have audited the accompanying consolidated balance sheets of The Colonel's International, Inc. (the \"Company\") 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 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 as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/S\/ DELOITTE & TOUCHE LLP Ann Arbor, Michigan March 4, 1996\nTHE COLONEL'S INTERNATIONAL, INC.\nSee notes to consolidated financial statements.\nTHE COLONEL'S INTERNATIONAL, INC.\nSee notes to consolidated financial statements.\nTHE COLONEL'S INTERNATIONAL, INC.\nSee notes to consolidated financial statements.\nTHE COLONEL'S INTERNATIONAL, INC.\nTHE COLONEL'S INTERNATIONAL, INC.\nSee note to consolidated financial statements. THE COLONEL'S INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION\nThe Colonel's International, Inc. (\"CII\") is a holding company for two wholly-owned subsidiaries, The Colonel's, Inc. (\"The Colonel's\") and Brainerd International Raceway, Inc. (\"BIRI\") (See Note 3). The Colonel's was incorporated in Michigan in 1982 and principally designs, manufactures and distributes plastic automotive bumper fascias and miscellaneous reinforcement beams and brackets, as replacement collision parts to the automotive aftermarket industry in North America. The Colonel's manufactures its products using reaction injection molding and plastic injection molding technology and sells its products throughout North America through its warehouses and a network of distributors. BIRI was incorporated in Minnesota in 1982 and operates a multi-purpose motor sports facility in Brainerd, Minnesota. BIRI organizes and promotes various spectator events relating to road and drag races.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of CII and its subsidiaries, the Colonel's and BIRI, from the date of acquisition. All significant intercompany accounts and transactions have been eliminated.\nINVENTORIES are stated at the lower of cost or market, and cost is determined by the first-in, first-out (FIFO) method.\nPROPERTY, PLANT AND EQUIPMENT is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:\nLeasehold improvements are amortized over the shorter of the life of the lease or their estimated useful life of 10-25 years.\nExpenditures for major renewals and betterments that extend the useful life of the related property, plant and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. When properties are retired or sold, the related cost and accumulated depreciation are removed from the accounts and any gain or loss on disposition is recognized.\nREVENUE RECOGNITION - Sales and trade accounts receivable are recognized at the time the product is shipped to the Company's customers.\nASSETS HELD FOR SALE - Assets held for sale include certain machinery, equipment and real estate not needed in CII's operations. These assets have been valued at the lower of cost or net realizable value, and are classified as short or long term based on the anticipated time of sale.\nGOODWILL - Goodwill is being amortized using the straight-line method over 15 years, the estimated period of benefit.\nACCRUED LEGAL FEES - Anticipated legal and other professional fees are accrued in the same period that the related legal matters are accrued.\nACCRUED ENVIRONMENTAL COSTS - CII accounts for environmental costs when environmental assessments or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincide with the earlier of a feasibility study or CII's commitment to a plan of action based on the known facts. Accruals are recorded based on existing technology available, presently enacted laws and regulations, and without giving effect to insurance proceeds. Such accruals are not discounted. As assessments and cleanups proceed, environmental accruals are periodically reviewed and adjusted as additional information becomes available as to the nature or extent of contamination, methods of remediation required, and other actions by governmental agencies or private parties.\nINCOME TAX - Effective December 31, 1995, The Colonel's changed its tax status from an S Corporation to a C Corporation for federal income tax purposes. As a result this change from a non-taxable entity to a taxable entity, The Colonel's recorded a $2,333,000 charge to income, to reflect the tax consequences of differences between the tax bases of The Colonel's assets and liabilities at that date. Prior to December 31, 1995, The Colonel's income was not taxable to the company and was passed through to its stockholders.\nFINANCIAL INSTRUMENTS - The carrying value of financial instruments included in the balance sheets approximate fair value.\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 operating period. Actual results could differ from those estimates.\nRECLASSIFICATIONS - Certain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation.\n3. BUSINESS COMBINATION\nEffective December 31, 1995, CII completed its merger with The Colonel's. CII issued 23,500,000 shares of its common stock in exchange for all of the outstanding common stock of The Colonel's. For accounting purposes, the acquisition has been treated as a recapitalization of The Colonel's with The Colonel's as the acquirer (\"reverse acquisition\"). The historical financial statements prior to December 31, 1995 are those of The Colonel's. In addition, the weighted average common shares outstanding for purposes of calculating the earnings per share have been retroactively restated to give effect to the recapitalization.\nThe purchase price was $3,953,000 based on the fair value of CII at the consummation date of the acquisition, which was allocated to the assets acquired and liabilities assumed based on the estimated fair values at the date of acquisition. The excess of the purchase price over the estimated fair values of the net assets acquired has been recorded as goodwill, which will be amortized over 15 years. The estimated fair value of assets and liabilities acquired are summarized as follows:\nThere are no operating results of this acquisition included in CII's consolidated results of operations since the date of acquisition was December 31, 1995. The following unaudited proforma summary presents the consolidated results of operations as if the acquisition had\noccurred at the beginning of the period presented, giving effect to certain adjustments for the amortization of goodwill and the effect of income taxes. These proforma 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 the period presented or of results that may occur in the future.\n4. INVENTORIES\nInventories at December 31 are summarized as follows:\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31 is summarized by major classifications as follows:\nIncluded in the amounts above are trucks and equipment under capital leases with a net book value of $2,666,598 and $228,629 at December 31, 1995 and 1994, respectively.\n6. NOTES RECEIVABLE\nNotes receivable at December 31 are summarized as follows:\n7. NOTES PAYABLE\nNotes payable at December 31 consist of the following short-term credit facilities:\nCII's has a line of credit with a bank which provides for maximum borrowings of $4,500,000, based upon eligible accounts receivable and inventories. Remaining availability under the line of credit at December 31, 1995 was $320,000. The line of credit expires August 1, 1996.\nCII also has a second line of credit with a bank which provides for maximum borrowings of $300,000 with interest at prime plus 1-1\/2% (effective rate of 10% at December 31, 1995), of which none was outstanding at December 31, 1995.\nThe short-term credit facilities are with the same bank as the term note (Note 8) and are secured by the same collateral. The weighted average interest rate on the short-term credit facilities were 8.81% and 7.25% in 1995 and 1994, respectively.\n8. LONG-TERM OBLIGATIONS\nLong-term obligations at December 31 consist of the following:\nThe term note is part of a bank loan agreement that includes CII's short-term credit facilities (Note 7). This bank loan agreement is guaranteed by certain stockholders of CII and collateralized by a first priority security interest in substantially all CII's assets and by all of CII's issued and outstanding shares of common stock and contains certain covenants which requires CII to maintain minimum levels of net worth and not to exceed certain debt ratios.\nThe bridge financing from a bank represents amounts advanced to CII for the purchase of tooling and machinery that CII expects to refinance as capital leases on a long-term basis.\nIn 1994, CII assumed the outstanding mortgage payable of approximately $2,100,000 on CII's Owosso facility from its stockholders. The assumption of the mortgage was treated as a distribution to the stockholders in the 1994 financial statements.\nThe scheduled future repayments of long-term obligations at December 31, 1995 are as follows:\n9. ACCRUED EXPENSES\nAccrued expenses at December 31 consist of the following:\n10. INCOME TAXES\nEffective December 31, 1995, The Colonel's changed its tax status from a non-taxable entity to a taxable entity. The tax provision for 1995 reflects the charge to income for the changes in The Colonel's tax status. CII expects its future effective tax rate to approximately 37%, at 34% statutory federal rate and 3% state tax rate, net of federal benefit. The temporary differences at December 31, 1995 that give rise to the recorded deferred taxes, including amounts acquired in the acquisition (Note 3) are as follows:\nAt December 31, 1995, CII has net operating loss carryforwards for tax purposes as follows:\nCII has put a valuation allowance on 100% of these amounts because management believes it is more likely than not that the net operating loss carryforwards will not be utilized due to limitations in existing tax laws\non their use. Should such net operating losses be utilized, the effect will be a reduction in the amount of goodwill.\n11. COMMITMENTS\nCII leases trucks and equipment under capital leases (see Notes 5 and 8). CII also leases warehouse space under noncancelable operating agreements. The warehouse leases require that CII pay the taxes, insurance and maintenance expense related to the leased property. Minimum future lease payments under noncancelable leases at December 31, 1995 are summarized as follows:\nRent expense, including month to month rentals, was approximately $1,447,000, $2,242,000 and $2,072,000 for the three years ended December 31, 1995, 1994 and 1993, respectively. Included in rent expenses are amounts paid to the related parties of CII for rental of its principal operating facilities (see Note 13).\nCII had a ten-year employment agreement ending in 1997 with a key employee who is related to the CII's majority stockholder. CII recorded a liability and related deferred costs for the remaining compensation due under the terms of the agreement based upon the net present value of such payments. In 1995, the employee terminated the agreement and relinquished these rights to further compensation.\nCII entered into a ten-year consulting agreement beginning January 1, 1994, with the former president of the Company. The agreement guarantees him $52,000 per year. CII may terminate this agreement, but is obligated to pay the remaining compensation due under the terms of the agreement. CII\nrecorded a liability and related deferred costs for the remaining compensation due under the terms of the agreement based upon the net present value of such payments. The deferred cost amount is being amortized to operations over the term of the agreement.\n12. STOCK OPTIONS\nCII has an incentive stock option plan that provides for up to 3,000,000 shares of common stock options to key employees, executive officers and outside directors, and also permits the grant or award of restricted stock, stock appreciation rights or stock awards. There have been no issuances under this plan.\n13. RELATED PARTY TRANSACTIONS\nThe primary parties related to the Company are as follows:\n- The majority stockholders, with whom various transactions are made, including payment of monthly rent for the Owosso facility through March 1994;\n- 620 Platt Road, Inc. (\"Platt\"), a company affiliated through common ownership, to which rental payments are made for the Milan facility;\n- The Colonel's Factory Outlet of Arkansas, Inc. (\"Arkansas\"), a company affiliated through common ownership, with which various transactions are made, including sales and purchases of inventory, and payment for and reimbursement of Arkansas' expenses; and\n- Blain Buick - GMC, Inc. (\"Blain\"), a company affiliated through common ownership, from which automobiles, parts, and service are purchased, and rental income is earned.\nA summary of transactions with these related parties is as follows:\n14. PLANT FIRE\nIn 1993, CII's leased facility in Owosso, Michigan which included its headquarters, sales offices and the principal manufacturing and warehouse facilities, was destroyed by a fire. The fire caused a complete loss of the approximate 280,000 square foot facility and damaged inventory, equipment and other contents therein. In late 1993, CII relocated its principal operations and headquarters to Milan, Michigan and is leasing a 350,000 square foot facility from a company owned by certain stockholders of CII.\nIn 1994, CII finalized negotiations with its insurance carrier for amounts to be received on all coverages in effect at the date of the fire. Total insurance proceeds received for the replacement cost of lost property, lost profits and other direct costs of the fire were approximately $31,000,000, of which approximately $6,630,000 was due\nto a stockholder as indemnification of damages to the Owosso facility. CII has recognized in other income a net gain of approximately $9,082,000 and $9,043,000 in 1994 and 1993, respectively, which represents the amount by which CII's insurance proceeds of $24,381,000 exceeded the sum of the net book value of the assets destroyed and the liabilities resulting from the fire.\n15. PLANT CLOSING\nIn 1994, CII ceased operations and took the steps necessary to close its Florida facility. At December 31, 1994, CII accrued estimated costs required to close the facility. Such costs include approximately $1,034,000 for the write down of assets to their net realizable value of $350,000 and $355,000 for costs of the storage, dismantling and disposing of the equipment, and other related expenses. Assets held at the facility that are not expected to be transferred to the Milan facility have been classified as short-term assets held for sale. At December 31, 1995, approximately $75,000 of such assets remain.\n16. LITIGATION\nIn connection with the acquisition of a facility in Florida (known as \"NuPar\"), CII signed employment agreements with the former NuPar stockholders for the three year period beginning December 1991. In 1994, the former NuPar stockholders filed a lawsuit against CII for $1,800,000 claiming they had met the conditions of the agreements and are therefore entitled to the payments thereunder. In July 1995, CII settled these actions for $1.4 million, payable in installments through January 1997, and has accrued for remaining compensation of $900,000 at December 31, 1995.\nA suit was filed against CII in 1992 claiming CII violated anti-trust laws and alleging that CII has engaged in predatory pricing, monopolization and anti-competitive acquisitions. Discovery has narrowed the plaintiffs' theories of recoveries and the allegedly offending predatorily priced sales at issue to only two bumper models of which fewer than 2,000 parts were sold during the relevant period. CII has offered to settle this dispute for $160,000. CII has accrued its best estimate of the cost of litigation based on known facts. It is possible that this estimate may change in the near term as the lawsuit progresses. Although the final resolution of any such matters could have a material effect on CII's operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, CII believes that any resulting liability should not materially affects its financial position.\nThe outside designer and installer of the automated paint line system for the CII's Milan, Michigan facility abandoned the project before it was completed, leaving his suppliers and subcontractors owed more than\nCII owed to the installer under the sales contract if he had finished it. CII arranged with third parties to have the installation completed. CII bypassed the contractor and settled directly with all of the 14 unpaid subcontractors for $270,000 and a release of all liens. CII still has a damage claim against the main contractor.\nCII is involved in various other legal proceedings which have arisen in the normal course of its operations. CII has accrued its best estimate of the cost of litigation based on known facts. It is possible that this estimate may change in the near term as the lawsuits progress. Although the final resolution of any such matters could have a material effect on CII's operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, CII believes that any resulting liability should not materially affects its financial position.\n17. ENVIRONMENTAL REMEDIATION\nCII is responsible for the remediation of hazardous materials and ground contamination located at the Owosso facility as a result of the fire (see Note 14). In August 1993, the Michigan Department of Natural Resources required that CII perform a complete hydrogeological study of this site to determine the extent of the contamination. CII plans to engage environmental consultants in the summer of 1996 to determine the extent of the hazardous materials located at this site, if any, and the cost of any remediation. CII has accrued its best estimate of the cost of remediation based on known facts. It is possible that this estimate may change in the near term as the project progresses. Although the final resolution of any such matters could have a material effect on CII's operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, CII believes that any resulting liability should not materially affects its financial position.\nAs part of the lease agreement with a related party for the Milan, Michigan facility, CII is also responsible for the remediation of hazardous material, up to an amount of $2,000,000, which existed at this site prior to CII entering into the lease in June 1993. CII has accrued for estimated remediation costs based on an environmental study of the site. CII has accrued its best estimate of the cost of remediation based on known facts. It is possible that this estimate may change in the near term as the project progresses. Although the final resolution of any such matters could have a material effect on CII's operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, CII believes that any resulting liability should not materially affects its financial position.\n18. PROFORMA EARNINGS PER SHARE (UNAUDITED)\nThe following unaudited proforma earnings per share has been derived from the income statement of CII for the year ended December 31, 1995, adjusted to give effect to the change in tax status of The Colonel's as if such change had occurred at the beginning of the period.\n* * * * * *\nEXHIBIT NUMBER EXHIBIT INDEX\n2.1 Agreement and Plan of Merger between The Colonel's, Inc. and Brainerd Merger Corporation and joined in by Brainerd International, Inc. Incorporated by reference from Exhibit A to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n2.2 Agreement and Plan of Reorganization among Brainerd International, Inc. and The Colonel's Holdings, Inc. Incorporated by reference from Exhibit D to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n3.1 Articles of Incorporation of the Company, as amended. Incorporated by reference from Exhibit E to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n3.2 Certificate of Amendment to the Articles of Incorporation changing name from \"The Colonel's Holdings, Inc.\" to \"The Colonel's International, Inc.\"\n3.3 Bylaws of the Company. Incorporated by reference from Exhibit F to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n4.1 Articles of Incorporation. See Exhibit 3(a) above.\n10.1 The Company's 1995 Long-Term Incentive Plan. Incorporated by reference from Exhibit G to the Proxy Statement of Brainerd International, Inc. for the Annual Meeting of Shareholders of Brainerd International, Inc. held on November 21, 1995.\n10.2 Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.3 Form of Non-Statutory Stock Option Agreement used under the Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.4 Form of Incentive Stock Option Agreement used under the Incentive Stock Option Plan. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1987.\n10.5 Office Lease Agreement dated January 23, 1991 between Brainerd International, Inc. and Woodland Office Partnership. Incorporated by reference from the Annual Report on Form 10-K of Brainerd International Inc. for the fiscal year ended December 31, 1990.\n10.6 Amendment dated December 11-12, 1991 to Office Lease Agreement (see Exhibit 10(e) above) between Brainerd International, Inc. and Woodland Office Partnership. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.7 $404,700 Promissory Note dated January 1, 1992, from Brainerd International, Inc. payable to Gene Snow and James W. Littlejohn. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.8 Lease Agreement between Issuer and National Hot Rod Association, Inc. consisting of March 17, 1984 Lease Agreement; April 28, 1986 letter extending term to 1991; March 12, 1987 Letter of Amendment; and April 7, 1992 letter extending term to 1996 and amending agreement. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.9 November 8, 1988 Sponsorship Agreement between Champion Auto Stores, Inc. and National Hot Rod Association, Inc. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.10 June 22, 1992 Title Rights Sponsorship Agreement between Champion Auto Stores, Inc. and National Hot Rod Association, Inc. Incorporated by reference from Brainerd International, Inc.'s Registration Statement on Form S-1 (Registration No. 33-055876).\n10.11 February 16, 1994 Loan Agreement with American National Bank of Brainerd; $550,000 Promissory Note; and $300,000 Line of Credit Note. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.12 December 21, 1993 Agreement among Issuer, Motor Stadium, Inc. and Gene M. Snow providing for termination of March 23, 1993 Financing Agreement, dissolution of Motor Sports Stadium, Inc. and grant of interest by Mr. Snow in potential future project. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.13 Amendment dated February 1, 1994 to Office Lease Agreement (See Exhibits 10(e) and 10(f)). Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.14 September 1994 Stock Purchase Agreement among Gene M. Snow, James W. Littlejohn and Donald J. Williamson. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.15 December 1994 Letter of Intent between Issuer and The Colonel's, Inc. Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.16 Addendum to Lease dated December 16, 1994 (See Exhibits 10(e), 10(f) and 10(m)). Incorporated by reference from Brainerd International, Inc.'s Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.\n10.17 Variable Rate-Installment Note ($6,000,000) between The Colonel's and Comerica Bank dated April 14, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.18 Master Revolving Note ($4,500,000) between The Colonel's and Comerica Bank dated May 1, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.19 Security Agreement between The Colonel's and Comerica Bank (f\/k\/a Manufacturers National Bank of Detroit) dated December 4, 1991. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.20 Amended and Restated Security Agreement between The Colonel's and Comerica Bank (f\/k\/a Manufacturers National Bank of Detroit) dated December 4, 1991. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.21 Amended and Restated Guaranty between Donald and Patsy Williamson and Comerica Bank dated October 8, 1992. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.22 Lease Agreement between 620 Platt Road, Inc. and The Colonel's dated June 18, 1993 (for Milan, Michigan manufacturing facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.23 First Amendment to Lease Agreement between 620 Platt Road, L.L.C. (f\/k\/a 620 Platt Road, Inc.) and The Colonel's dated June 16, 1995. Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.24 Industrial\/Warehouse Lease between JMB\/Warehouse Associates Limited Partnership and The Colonel's dated August 1, 1993 (for Houston, Texas warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.25 Lease Agreement between Industrial Properties Corporation and The Colonel's dated September 15, 1992 (for Dallas, Texas warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.26 Standard Industrial Lease between Revco D.S., Inc. and The Colonel's dated February 5, 1993 (for Phoenix (Glendale), Arizona warehouse distribution facility). Incorporated by reference from Amendment No. 1 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.27 Interim Equipment Lease Schedule ($2,729,370) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.28 Interim Equipment Lease Schedule ($2,044,000) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.29 Interim Equipment Lease Schedule ($383,468) between The Colonel's and Comerica Leasing Corporation dated July 27, 1995. Incorporated by reference from Amendment No. 2 to Brainerd International, Inc.'s Registration Statement on Form S-4 (Registration No. 33-91374).\n10.30 Lease Schedule ($3,464,557) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.31 Interim Lease Schedule ($960,000) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.32 Interim Lease Schedule ($542,811) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.33 Interim Lease Schedule ($85,800) between The Colonel's, Inc. and Comerica Leasing Corporation dated January 26, 1996.\n10.34 Interim Lease Schedule ($52,556) between The Colonel's, Inc. and Comerica Leasing Corporation dated February 16, 1996.\n10.35 Interim Lease Schedule ($584,250) between The Colonel's, Inc. and Comerica Leasing Corporation dated December 27, 1995.\n10.36 Interim Lease Schedule ($364,650) between The Colonel's, Inc. and Comerica Leasing Corporation dated January 26, 1996.\n10.37 Interim Lease Schedule ($178,200) between The Colonel's, Inc. and Comerica Leasing Corporation dated February 16, 1996.\n11.1 Computation of Per Share Earnings.\n21.1 Subsidiaries of the Registrant.\n24.1 Powers of Attorney.\n27.1 Financial Data Schedule.","section_15":""}
{"filename":"50716_1995.txt","cik":"50716","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nInstron Corporation (\"Instron\" or the \"Company\") designs, develops, manufactures, markets, and services materials testing systems, software, and accessories for evaluating the mechanical properties of materials, components and structures. The Company's products are used principally in research and development, and quality control applications to test the strength, elasticity, hardness and other properties of various materials including metals, plastics, textiles, composites, ceramics and rubber.\nInstron offers a comprehensive range of microprocessor and computer based materials testing systems. In the worldwide market for these systems, Instron is a leading producer of static (electromechanical), dynamic (servohydraulic) and hardness testing systems.\nInstron's products typically are assembled from a number of company- designed standard hardware and software modules and accessories, selected and configured for the customer's specific application. Additional hardware, software and accessories may be added to the system at a later date. The systems have the ability to interface with microcomputers and personal computers which enhance control of the testing process, data collection and analysis.\nThe Company has sales and service offices in 12 United States cities and 16 foreign countries. Approximately 60% of the Company's revenues are derived from sales outside the United States. Principal manufacturing facilities are located in the United States and the United Kingdom.\nPRINCIPAL MARKET\nThe Company's principal market is comprised of industry, educational institutions and governments who need to understand the characterization and properties of materials as they perform research and development, and quality control applications.\nMost major industries use some form of materials testing for research and development and\/or quality control. Industrial research focuses upon the development of new materials, substitute materials, or new uses of existing materials, to reduce manufacturing or operating costs and to improve product quality and durability. Industrial quality control applications involve the testing of finished products as well as materials purchased for the manufacturing process.\nEducational institutions use Instron products in basic research as well as for instruction in materials science. The Company places particular emphasis on educational institutions because scientists and engineers trained on Instron equipment may influence additional sales of the Company's products later in their careers.\nGovernment and government agency use principally involves the testing of products to support defense and space programs, to ascertain compliance with safety and other legal requirements and to conduct research on new materials and emerging technologies.\nPRINCIPAL PRODUCTS\nInstron offers a comprehensive range of general purpose materials testing systems, application software, and accessories within two principal product lines; static systems and dynamic systems. Static and dynamic systems use different drive systems to push, pull or twist the material being tested. Static systems typically elongate or compress the material sample at selected speeds or rates of strain. Dynamic systems allow repeated deformation of the sample to simulate in-use conditions of the product over an extended period of time. The type of test determines which product line is appropriate to the needs of a customer.\nSTATIC: Static (electromechanical) systems and related accessories accounted for approximately 69%, 71%, and 68% of the Company's revenue in 1995, 1994 and 1993, respectively. These systems consist of a frame, a moving crosshead, a load cell, grips, and electronic modules to control the test and analyze the test data. Static systems typically elongate or compress the material being tested at a user selected, constant speed which ranges from fractional microns per minute to one meter per minute. These systems continuously measure the precise force being applied and the resulting deformation of the material at various time intervals. They also analyze the results of the test, and either print, graph or electronically display them.\nInstron's static product offerings include hardness testing machines, the cost effective Series 4400 product line, and the high-performance Series 5500 product line. The Series 5500 systems are usually used for research and development and are equipped with software and many accessories. Quality Control applications usually require fewer accessories and less breadth of application capability. The prices of electromechanical systems generally range from $15,000 to $150,000, and prices of hardness testing machines range from $2,000 to $20,000.\nDYNAMIC: Dynamic (servohydraulic) systems and related accessories accounted for approximately 31%, 29% and 32% of the Company's sales in 1995, 1994 and 1993, respectively. These systems utilize a servo-controlled hydraulic actuator, a load cell, grips, and electronic modules to control the test and analyze the test data. Many of the elements have the same function, and in some cases are the same actual elements, as those of static test machines. The major distinction between a dynamic system and a static system is the means used to apply force to the test specimen. The former uses a\nservo-controlled, hydraulic actuator and the latter a screw-driven, moving crosshead. Many tests can be carried out equally well with either a static or dynamic test machine. However, if the test requires extremely rapid rates of loading, or if it is a test of endurance in which the material is subjected to rapidly fluctuating loads, then the dynamic (servohydraulic) test machine is appropriate.\nSoftware, computer control and data analysis are features routinely added to basic dynamic systems. The computer is often used to command actuator motion to simulate real-life loading conditions. It is also used to record, analyze and display parameters of performance and endurance for test material or test components. Machines can be configured not only to elongate or compress the material being tested, but to simultaneously twist it or subject it to other forms of complex loading.\nThe dynamic product line includes structural testing systems which are used to test products and assemblies. They typically consist of several actuators which push and pull the product at different points, and sensors which collect data and transmit it to a central measuring device. Utilizing the Company's engineering expertise, dynamic systems are often customized to fit the need of a customer's particular test application.\nInstron's dynamic product offerings vary with the force capacity of the machines, the complexity of the actuator system, the sophistication of the control electronics, and the computer system and software. The prices of servohydraulic systems generally range from $40,000 to $400,000 with very complex structures systems ranging as high as several million dollars.\nSERVICE\nIn recent years, the Company has invested in new service offerings, including calibration, extended warranties, software support, upgrade contracts and telephone support. The service business accounted for approximately 15%, 15%, and 14% of the Company's total revenue in 1995, 1994, and 1993, respectively. The service revenue is included in the percentage amounts for static and dynamic systems set forth above.\nOTHER PRODUCTS AND ACCESSORIES\nThe Company develops and sells Laboratory Information Management Systems (LIMS) for PC-based networks, through its U.S. subsidiary, Laboratory MicroSystems, Inc. The LIMS software manages the flow of information in a laboratory so that resources can be optimally employed in achieving the laboratory's primary goals of high quality analysis and fast turnaround.\nThe Company has license agreements with third parties for the exclusive sale of certain products, including software, in the material testing industry.\nAccessories can be included with the initial purchase or subsequently purchased in order to expand the capability of the original machine. Typical accessories include application software, grips, fixtures, optical\/video extensometers which measure precisely the deformation of material being tested without actually contacting it and robotic devices which automatically feed test specimens to the systems. The Company also manufactures and sells environmental control accessories. Other products and accessories for static and dynamic equipment purchased separately from the original sale of equipment are included in the percentage amounts for static and dynamic systems set forth above.\nNEW PRODUCTS\nDuring 1995, Instron expanded the Series 4400 and Series 5500 electromechanical product lines. These new machines have been redesigned using the latest electronics technology and sharing common parts, making them easier and less costly to build and to service. The new machines are easier to operate, with easy to understand control panels and software interfaces, and ergonomic design features that minimize operator fatigue, reduce errors and increase productivity. Servohydraulic dynamic test software was enhanced with new Fast Track and Wavemaker for Windows products. The Fast Track software includes LabView drivers that make it possible for users to write their own applications and Wavemaker allows greater flexibility for sophisticated fatigue test requirements.\nRESEARCH AND DEVELOPMENT\nThe Company maintains research and development staffs at their U.S. and U.K. manufacturing facilities, as well as the Wolpert operation in Germany. These development staffs often work directly with industrial and government researchers and the materials science departments of universities to create leading edge solutions to materials testing applications.\nInstron is a pioneer in the development and application of electronic measurement and drive systems techniques in materials testing systems. The Company has continuously designed, developed, and marketed state-of-the-art testing systems, software, and accessories, including digitally controlled static and dynamic systems, low-cost static systems for the quality control market, software, and microprocessor-based system controllers to be used in conjunction with its entire product line.\nIn 1995, the Company expensed $8,782,000 on research and development activities, compared with $8,062,000 in 1994, and $7,248,000 in 1993. In addition, the Company has capitalized certain software development costs of $1,315,000, $792,000, and $1,882,000 during 1995, 1994 and 1993, respectively. Had these costs been included as expenses during such periods, research and development expenses would have increased by 14% in 1995, decreased by 3% in 1994 and increased by 4% in 1993, respectively. The Company, in recent years, has focused its research and development expenditures on revitalizing the electromechanical and servohydraulic product lines, developing new hardness testing machines, developing new software and enhancements, and redesigning products to reduce manufacturing costs. These new products and enhancements do not, in the Company's opinion, present a significant risk that on-hand inventory, which supports existing models, will be made obsolete because of the interchangability of parts and the lead time available before the introduction of new products. In addition, the Company allocated funds, in 1995, for development projects that show potential for new applications and market opportunities utilizing the Company's core technological competencies. Two projects were identified as having product potential for 1996; applications in asphalt testing and a motion base system to be used in the new market of motion-based simulation games for the entertainment and training industries.\nCOMPETITIVE CONDITIONS\nThe Company competes with a number of other manufacturers, some of whom have greater financial, technical and marketing resources than the Company. The intensity of the competition varies by product line and by geographic area. Competition in the United States is greatest in the dynamic line where the Company has one major domestic competitor, MTS Systems Corporation. Competition in foreign markets is greatest in Germany and Japan, where there are major local manufacturers. The principal competitive factors are engineering excellence, the quality and technical capability of the equipment, responsiveness to customer needs, quality of service, and price performance.\nBACKLOG\nAt December 31, 1995, the Company's backlog of orders was approximately $36,136,000 compared with $32,687,000 at December 31, 1994. The Company anticipates that essentially the entire backlog at December 31, 1995 will be shipped during 1996.\nRAW MATERIALS\nThe Company orders most of its purchased component parts from vendors who either manufacture them or supply them as off-the-shelf items. While the Company is dependent upon a limited number of suppliers for certain components, it has not experienced significant problems in procurement or delivery of any essential materials, parts or components. Substantially all purchasing is accomplished on a competitive basis while maintaining a level of inventory sufficient to provide support of customer servicing requirements and meet scheduled delivery dates.\nPATENTS AND TRADEMARKS\nThe Company has several patents in the United States and in foreign countries. The Company relies basically on engineering and technological capability rather than on these patents to maintain its position in the industry. The trademark \"Rockwell\" and \"Instron\" and the device mark are registered trademarks of the Company. Under current law, these trademarks may be renewed indefinitely as long as they are maintained in use.\nENVIRONMENTAL CONSIDERATIONS\nCompliance with federal, state and local provisions relating to protection of the environment has not had, and is not expected to have, any material adverse effects upon the production, capital expenditures, earnings, and competitive position of the Company and its subsidiaries.\nNUMBER OF EMPLOYEES\nAt December 31, 1995, the Company employed 1,145 people worldwide.\nSEASONALITY\nHistorically, the Company's sales are highest in the fourth quarter of each year due to the ordering pattern of its customers, which favors fourth quarter deliveries before budget authorizations expire. This is particularly true overseas where the order mix usually consists of larger systems than domestic orders. Sales in the first quarter are usually low as it takes time to rebuild in-process inventory levels after the heavy fourth quarter delivery requirements have been satisfied. Also, third quarter sales are generally low due to vacation patterns of both Company production workers and customer technical personnel needed for acceptance testing. The seasonal factors affecting sales are usually reflected in quarterly net income.\nFOREIGN OPERATIONS\nForeign operations represent a significant portion of the Company's business. The Company's branches and subsidiaries outside of the United States accounted for 60% of the Company's total revenue in 1995, 60% in 1994 and 59% in 1993. The Company believes that the business and political risk of operating in its current foreign markets is not, in the aggregate, materially greater than the risk undertaken by the Company in the United States. The Company's principal foreign assets are located in the United Kingdom.\nForeign exchange fluctuations can have a significant impact on the Company's consolidated net assets and results of operations as reported in U.S. dollars. However, the Company believes that these fluctuations generally have not had, and it does not expect them to have, a significant economic effect on the Company's business since foreign operations are generally\nfinanced, and revenues and expenses are, for the most part, paid in local currencies, except for intercompany purchases which are closely monitored. Financial information concerning domestic and foreign operations appears in Notes 1 and 2 in the \"Notes to Consolidated Financial Statements\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations \", included as part of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters and principal United States manufacturing facility is located on 66 acres of Company-owned land at the junction of Routes 128 and 138 in Canton, Massachusetts, approximately 15 miles from Boston. This facility provides 140,500 square feet of office and manufacturing space.\nThe Company's principal foreign facility provides 120,000 square feet of office and manufacturing space located on seven acres of Company-owned land in High Wycombe, England, approximately 30 miles west of London.\nThe Company has 32 sales offices and demonstration centers which are located throughout the United States and in 16 foreign countries. The Company believes that all properties are adequate and suitable for its present needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe registrant and its subsidiaries are not involved in 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 the fourth quarter of the year ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe number of holders of record of the Company's Common Stock at December 31, 1995 was 542. This number does not include shareholders for whom shares are held in a \"nominee\" or \"street\" name.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nInstron reported net income of $5.0 million, or 78 cents per share, for the year ended December 31, 1995, an increase of 10% over 1994. The improvement in net income was principally due to the growth of 1995 revenues.\nTotal revenue of $150,571,000 in fiscal 1995 increased by 11% from total revenue of $136,192,000 in fiscal 1994. This revenue growth was attributable to increases in structural and custom material testing systems, hardness testing equipment, which included the operations of Shore Instruments acquired January 5, 1995, and higher revenues of the Company's service business. Total revenue in fiscal 1994 increased by 11% over fiscal 1993 on the strength of the Company's new electromechanical line of products, increased service business and a full year of revenue from the Wolpert operation, which was acquired in August of 1993. Total foreign revenue accounted for approximately 60% of total 1995 revenue, compared with 60% in 1994 and 59% in 1993.\nTotal bookings of new orders increased by 12% to $155,092,000 in fiscal 1995 due to significant growth in the Asia\/Latin America market, including Japan, and increases in the Company's European operation. In 1994, total bookings increased by 11% due principally to strong North America bookings and the inclusion of the Wolpert operation.\nThe Company's backlog was $36,136,000 at December 31, 1995, an increase of 11% from the 1994 year-end backlog. Strong fourth quarter bookings in the Company's European and Asian markets contributed to the higher backlog. Order backlog at December 31, 1994, increased by 12% over the 1993 year-end backlog due to strong Domestic and European bookings during the latter part of 1994.\nThe 1995 gross profit margin decreased to 41.5% from 43.4% in 1994 and 43.6% in 1993. The decrease in gross margin was due to higher than expected costs at the LMS software division, a mix of lower margin products and competitive pricing pressures partially offset by improved service profitability. As anticipated, the Company shipped several large structural and material testing systems with lower gross margins than traditional systems business, which had the effect of reducing gross margin during 1995. In contrast, service margins improved to 29% in 1995 compared to 25% in 1994 and 19% in 1993. The Company's service business has realized efficiencies by fully integrating the Wilson and Wolpert service organizations and has leveraged the increase in service revenues into higher profit margins.\nSelling and administrative expense growth was held to 4% in fiscal year 1995 and 1994. Selling and administrative expenses continued to decline as a percentage of revenue to 29.7% in 1995 compared to 31.5% in 1994 and 33.6% in 1993. In 1995, the increase in selling and administrative expenses was primarily related to the inclusion of Shore's operations and costs associated\nwith the implementation of new information systems. In 1994, the increase in selling and administrative expenses resulted from the inclusion of a full year of expenses of Wolpert and higher incentive compensation expenses.\nResearch and development expenses increased by 9% in 1995, compared to an 11% increase in 1994. During the three years ended December 31, 1995, the Company has capitalized certain software development costs (see Note 1 of Notes to Consolidated Financial Statements). Had these costs been included as period expenses, research and development expenses would have increased by 14% in 1995, decreased by 3% in 1994 and increased by 4% in 1993. As a percentage of total revenue, research and development expenditures (including capitalized software costs) represented 6.7%, 6.5% and 7.4% in 1995, 1994 and 1993, respectively. The Company, in recent years, has focused its research and development expenditures on revitalizing the electromechanical and servohydraulic product lines, developing new hardness testing machines, developing new software and enhancements, and redesigning products to reduce manufacturing costs. These new products and enhancements do not, in the Company's opinion, present a significant risk that on-hand inventory, which supports existing models, will be made obsolete because of the interchangability of parts and the lead time available before the introduction of new products. In addition, the Company allocated funds, in 1995, for development projects that show potential for new applications and market opportunities utilizing the Company's core technological competencies. Two projects were identified as having product potential for 1996; applications in asphalt testing and a motion base system to be used in the new market of motion-based simulation games for the entertainment and training industries.\nOperating income increased from $8,082,000 in 1994 to $8,921,000 in 1995, representing 5.9% of total revenue in both years. Operating income was $5,034,000 or 4.1% of total revenue in 1993.\nNet interest expense increased by 34% in 1995 and by 35% in 1994. In both years, the increase was due to higher interest rates and higher average borrowings. The foreign exchange gains of $186,000 in 1995 were mainly attributable to the stronger Japanese yen versus the U.S. dollar and British pound and to the strengthening of certain European currencies against the British pound. In 1993, the foreign exchange losses of $367,000 were due to the weakening of certain European currencies versus the British pound. The effect of changes in foreign currency translation rates did not have a significant impact on the components of net income for each of the three years in the period ended December 31, 1995.\nIncome before taxes was 5.1% of total revenue in 1995 and 1994, and 3.2% in 1993. The consolidated effective tax rate was 35.0% in 1995 compared to 35.0% in 1994 and 36.0% in 1993. A detailed reconciliation of the Company's effective tax rate and the United States statutory tax rate appears in Note 8 of Notes to the Consolidated Financial Statements.\nFINANCIAL CONDITION\nThe Company's primary source of funds in 1995 and 1994 was net cash generated by operations. The net cash generated by operations in 1995 consisted primarily of net income, as adjusted for the noncash effect of depreciation and amortization expense, and an increase in accounts payable and accrued expenses partially reduced by an increase in accounts receivable and inventories. The operating cash flows of $6.4 million and additional bank borrowings of $2.2 million were largely used to fund capital expenditures.\nAccounts receivable of $47.5 million at year-end 1995 increased 15% from $41.4 million at year-end 1994. This increase reflects the higher fourth quarter revenues in 1995 of which a significant amount of revenue was recognized in the last month of the quarter.\nInventories rose $2.5 million or 11% over 1994 to $24.3 million at the end of 1995. The inventory turnover ratio increased to 2.90 from 2.77 at the end of 1994.\nThe Company's principal investment activities during 1995 included capital expenditures of $4.5 million consisting mainly of machinery and equipment and building improvements; the purchase of Shore Instruments for $2.7 million and the development of software products of $1.3 million. The Company currently plans to make capital expenditures of approximately $6.0 million in fiscal 1996. In addition, the Company plans to continue to develop and enhance its software products and pursue its strategy of acquisitions.\nThe Company's total debt outstanding at year-end 1995 was $19.9 million compared to $17.8 million at the end of 1994. The ratio of total debt to debt plus equity, at year-end 1995 increased to 26.2% from 25.5% in 1994.\nThe Company maintains a multicurrency revolving credit and term loan facility that provides for borrowings of up to $25.0 million through April 1998. At December 31, 1995 and 1994, respectively, the Company had outstanding borrowings of $11.2 million and $11.0 million under this facility which were classified as long-term. The Company has additional overdraft and borrowing facilities for allowing advances of approximately $27.0 million of which $8.7 million and $6.8 million were outstanding and classified as short-term borrowings at December 31, 1995 and 1994, respectively. The Company believes its present capital resources and anticipated operating cash flows are\nsufficient to meet its current and future cash requirements to finance operations, capital expenditures and acquisitions.\nOn March 8, 1995, the Board of Directors of Instron Corporation voted to increase the regular quarterly dividend from three cents per share to four cents per share. As a result, the total cash dividends declared were fifteen cents per share compared to twelve cents per share in 1994.\nAs previously announced, the Company continues to explore the opportunities for disposing of its real estate assets in Canton, Massachusetts.\nIn January of 1996, the Company signed a non-binding Letter of Intent with Carl Schenck AG of Darmstadt, Germany, to enter into negotiations concerning the formation of a joint venture in the area of structures testing and the acquisition by Instron of Schenck's materials testing business. No assurances can be made that an agreement will be reached.\nThe Company's future success is dependent upon a number of factors including business conditions within the materials testing market, the ability of the Company to maintain acceptable price levels and its ability to continue to develop, manufacture, market and service the high quality products demanded by its customers.\nINSTRON CORPORATION ANNUAL REPORT ON FORM 10-K YEAR ENDED DECEMBER 31, 1995 ITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF INSTRON CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Instron Corporation 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 consolidated financial position of Instron Corporation as of December 31, 1995 and 1994, and the consolidated 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.\n\/s\/ COOPERS & LYBRAND L.L.P. ---------------------------- COOPERS & LYBRAND L.L.P. Boston, Massachusetts February 22, 1996\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.\n1. SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of all domestic and foreign subsidiaries. Significant intercompany transactions and balances are eliminated. Certain reclassifications were made to prior years' amounts to conform with the 1995 presentation.\nUSE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that effect 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 periods. Actual results could differ from those estimates.\nFOREIGN CURRENCY TRANSLATION Assets and liabilities of the Company's principal foreign operations are translated at exchange rates prevailing at the end of the period. Income statement items are translated using average quarterly exchange rates. Translation adjustments are recorded directly in stockholders' equity and are included in income only if the underlying foreign investment is sold or liquidated.\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nCONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to a concentration of credit risk principally consist of cash, cash equivalents and trade receivables. The Company places its temporary cash investments with major banks throughout the world, in high quality, liquid instruments. The Company sells to a broad range of customers throughout the world and performs ongoing credit evaluations to minimize the risk of loss. The Company makes use of various devices such as letters of credit to protect its interests, principally on sales to foreign customers.\nINVENTORIES Inventories are valued at the lower of cost or market (net realizable value). The last-in, first-out (LIFO) method of determining cost is used for inventories in the United States and the Asian branches. The Company uses the first-in, first-out (FIFO) method for all other locations.\nPROPERTY, PLANT AND EQUIPMENT Depreciation is computed principally using the straight-line method over the estimated useful lives of 10 to 25 years for land improvements, 10 to 40 years for buildings and improvements and 3 to 15 years for machinery and equipment. Maintenance and repairs are expensed as incurred. Depreciation expense was $4,719,000, $4,108,000 and $3,698,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nSOFTWARE DEVELOPMENT COSTS Certain software development costs and purchased software are capitalized and then amortized over future periods. Amortization of capitalized software costs, for both internally developed and purchased software products, is computed on a product-by-product basis over the estimated economic life of the product, generally three years. Unamortized software costs included in other assets were $2,679,000, $2,580,000 and $2,880,000 at December 31, 1995, 1994 and 1993, respectively. Software development costs of $1,315,000, $792,000, and $1,882,000 were capitalized during 1995, 1994 and 1993, respectively. The amounts amortized and charged to expense in 1995, 1994 and 1993 were $1,216,000, $1,092,000, and $481,000, respectively.\nREVENUE RECOGNITION Revenue from product sales are recognized at time of shipment. Revenue from services are recognized as services are performed and ratably over the contract period for service maintenance contracts.\nINCOME TAXES Deferred income taxes are provided using the liability method, which estimates future tax effects of differences between financial statement carrying amounts and the tax basis of existing assets and liabilities.\nProvisions are made for the U.S. income tax liability on earnings of foreign subsidiaries except for locations where the Company has designated earnings to be permanently invested. Such earnings amounted to approximately $22,006,000 at year-end 1995.\nNET INCOME PER SHARE Net income per share is based on the weighted average number of common shares and common share equivalents outstanding. The number of outstanding shares and equivalents utilized in the per share computations were 6,431,882, 6,339,547 and 6,345,431 in 1995, 1994 and 1993, respectively.\n2. INDUSTRY SEGMENT AND FOREIGN OPERATIONS\nThe Company operates in one industry segment, that being the design, production, marketing and servicing of precision systems, software and accessories, for evaluating the mechanical properties and performance of various materials, components and structures.\n2. INDUSTRY SEGMENT AND FOREIGN OPERATIONS (continued)\nSales between geographic areas in 1995, 1994 and 1993, respectively, consisted primarily of $10,534,000, $10,755,000 and $10,386,000 from the United States and $11,998,000, $8,921,000 and $8,472,000 from European operations. Transfers between geographic areas are at manufacturing cost plus a markup factor.\n3. INVENTORIES\nInventories valued at LIFO amounted to $9,721,000 and $8,913,000 at December 31, 1995 and 1994, respectively. The excess of current cost over stated LIFO value was $4,535,000 at December 31, 1995 and $4,339,000 at December 31, 1994. During 1994, certain inventories were reduced, resulting in the liquidation of LIFO inventory layers carried at lower costs prevailing in prior years as compared with the current cost of inventory. The effect of this inventory liquidation was to reduce cost of revenue by $184,000 in 1994.\n4. PROPERTY, PLANT AND EQUIPMENT\n5. BORROWING ARRANGEMENTS\nThe Company maintains a multicurrency revolving credit and term loan facility that provides for borrowings of up to $25,000,000 through April 1998. Borrowings outstanding as of April 1998 convert to a term loan payable in sixteen equal quarterly installments. Interest on borrowings under the agreement is based upon either base rates, LIBOR, or other short-term borrowing rates.\nCommitment fees under this agreement are 3\/8 of 1% per annum on the unused portion. The Company has met the various covenants in the agreement, the most restrictive of which requires a minimum level of tangible net worth. At December 31, 1995 and 1994, respectively, outstanding domestic borrowings of $9,900,000 and $9,500,000 with a weighted average interest rate of 6.13% and 6.56%, and outstanding European borrowings of $1,325,000 and $1,518,000 with a weighted average interest rate of 6.44% and 7.69%, were classified as long-term debt. Long-term debt maturing under the credit agreement in each of\n5. BORROWING ARRANGEMENTS (continued)\nthe five years subsequent to December 31, 1995, assuming outstanding borrowings at December 31, 1995 are unchanged at April 1998, is $2,104,688 in 1998 and $2,806,250 in 1999 and 2000.\nThe Company's subsidiaries have other overdraft and borrowing facilities allowing advances up to approximately $27,000,000. At December 31, 1995, the outstanding portion of these facilities was $8,650,000, due currently. Bank guarantees outstanding at December 31, 1995, for which the Company is contingently liable, amounted to $5,159,000 and relate principally to performance contracts.\n6. OPERATING LEASE COMMITMENTS\n7. EMPLOYEE PENSION AND RETIREMENT PLANS\nThe Company maintains qualified noncontributory defined benefit pension plans covering United States employees and employees of Instron's United Kingdom subsidiary. The benefits are based on years of service and final average compensation at the date of retirement. The Company's general policy is to fund the pension plans to the extent such contributions are deductible under standards established by the Internal Revenue Service in the U.S. and the Inland Revenue in the U.K. Plan assets in the U.S. consist of mutual funds which invest primarily in common stocks, corporate bonds, U.S. government notes and temporary cash investments. In the U.K., plan assets are invested in funds whose assets consist primarily of common stocks, bonds and other securities. Employees of the Japan subsidiary receive lump sum payments as a multiple of annual salary at retirement or termination, based on years of service. These Japanese benefits are unfunded.\n7. EMPLOYEE PENSION AND RETIREMENT PLANS (continued)\nThe expense of all pension plans for 1995, 1994 and 1993 was $2,276,000, $1,743,000, and $2,063,000, respectively. The Company also sponsors a Savings and Security Plan for all U.S. employees. The plan (in accordance with section 401(k) of the Internal Revenue Code) offers participating employees a program of regular savings and investment, funded by their own contributions and those of the Company. The amount charged to operating expense for this plan was $535,000, $498,000 and $447,000 in 1995, 1994 and 1993, respectively.\n8. INCOME TAXES\nA valuation reserve has been established where, based upon available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The net change in the valuation allowance in 1995 was a decrease of $110,000 relative to foreign tax benefits now realized. The valuation allowance as of December 31, 1995 related primarily to foreign tax benefits.\n8. INCOME TAXES (continued)\nAt December 31, 1995 there were no foreign tax credit carryforwards for financial reporting purposes or for tax reporting purposes.\n9. STOCK OPTION PLANS\nAt December 31, 1995, 510,781 shares were exercisable at $7.88 to $13.13 per share and 105,490 shares were available for future options.\nIn 1995, the Financial Accounting Standards Board issued the Statement of Financial Accounting Standards (\"SFAS\") 123, Accounting for Stock Based Compensation. SFAS 123 provides the alternative of either accounting for stock based compensation at fair market value determined by an option pricing or other appropriate model (\"market value method\") or retaining the existing method of accounting, but disclosing the pro-forma effect of the market value method in a footnote (\"disclosure alternative\"). The company plans to adopt the disclosure alternative which is effective for fiscal 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 response to this item is contained in part under the caption, \"Executive Officers of the Registrant\", in Part I hereof, and the remainder is contained under the captions, \"Information Regarding the Board of Directors' Nominees and Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Registrant's definitive proxy statement relating to its 1996 Annual Meeting of Stockholders and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - ------- ----------------------\nThe information contained under the caption \"Election of a Class of Directors\" in the Registrant's definitive proxy statement relating 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 - ------- --------------------------------------------------------------\nThe information contained under the caption \"Information Regarding the Board of Directors' Nominees and Directors\" in the Registrant's definitive proxy statement relating to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ----------------------------------------------\nThe information contained under the caption \"Information Regarding the Board of Directors' Nominees and Directors\" in the Registrant's definitive proxy statement relating to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K - ------- --------------------------------------------------------------\n(a)1. Financial Statements\nThe following consolidated financial statements are included in Item 8:\nConsolidated statements of income for the years ended December 31, 1995, 1994 and 1993\nConsolidated balance sheet at December 31, 1995 and 1994\nConsolidated statements of cash flows 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\nNotes to consolidated 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, including the accompanying notes.\n(b) Report on Form 8-K\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINSTRON CORPORATION (Registrant)\nBy \/s\/ James M. McConnell By \/s\/ Linton A. Moulding ----------------------------------- ------------------------------- James M. McConnell Linton A. Moulding President and Chief Executive Officer Chief Financial Officer (Principal Executive Officer) (Principal Financial and Accounting Officer)\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF INSTRON CORPORATION\nOur report on the consolidated financial statements of Instron Corporation as of and for each of the three years in the period ended December 31, 1995 has been included in this Annual Report on Form 10-K. In connection with our audit of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a) of this Form 10-K.\nIn our opinion, this 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. Boston, Massachusetts February 22, 1996\nSCHEDULE II","section_15":""}
{"filename":"46640_1995.txt","cik":"46640","year":"1995","section_1":"ITEM 1. BUSINESS.\nH. J. Heinz Company was incorporated in Pennsylvania on July 27, 1900. In 1905, it succeeded to the business of a partnership operating under the same name which had developed from a food business founded in 1869 at Sharpsburg, Pennsylvania by Henry J. Heinz. H. J. Heinz Company and its consolidated subsidiaries (collectively, the \"Company\" or the \"Registrant\" unless the context indicates otherwise) manufacture and market an extensive line of processed food products throughout the world. The Company's products include ketchup, tuna and other seafood products, baby food, frozen potato products, pet food, lower-calorie products (frozen entrees, frozen desserts, frozen breakfasts, dairy and other products), soup (canned and frozen), sauces\/pastes, condiments and pickles, beans, coated products, pasta, bakery products, chicken, frozen pizza and pizza components, full calorie frozen dinners and entrees, vegetables (frozen and canned), ice cream and ice cream novelties, edible oils, vinegar, margarine\/shortening, juices and other processed food products. The Company operates principally in one segment of business--processed food products--which represents more than 90% of consolidated sales. The Company also operates and franchises weight control classes and operates other related programs and activities. The Company intends to continue to engage principally in the business of manufacturing and marketing processed food products and the ingredients for food products.\nThe Company's products are manufactured and packaged to provide safe, stable, wholesome foods which are used directly by consumers and foodservice and institutional customers. Many products are prepared from recipes developed in the Company's research laboratories and experimental kitchens. Ingredients are carefully selected, washed, trimmed, inspected and passed on to modern factory kitchens where they are processed, after which the finished product is filled automatically into containers of glass, metal, plastic, paper or fiberboard which are then closed, processed, labeled and cased for market. Finished products are processed by sterilization, homogenization, chilling, freezing, pickling, drying, freeze drying, baking or extruding. Certain finished products and seasonal raw materials are aseptically packed into sterile containers after in-line sterilization.\nThe Company has three classes of similar products, each of which has accounted for 10% or more of consolidated sales in one or more of the prior three fiscal years listed below. The following table shows sales, as a percentage of consolidated sales, for each of these classes of similar products for each of the last three fiscal years.\nThe Company manufactures its products from a wide variety of raw foods. Pre- season contracts are made with farmers for a substantial portion of raw materials such as tomatoes, cucumbers, potatoes, onions and some other fruits and vegetables. Dairy products, meat, sugar, spices, flour and other fruits and vegetables are purchased on the open market.\nTuna is obtained through direct negotiations with tuna vessel owners, negotiated contracts directly with the owners or through the owners' cooperatives and by bid-and-ask transactions. In some instances, in order to insure the continued availability of adequate supplies of tuna, the Company assists, directly or indirectly, in financing the acquisition and operation of fishing vessels. The provision of such assistance is not expected to affect materially the operations of the Company. The Company also engages in the tuna fishing business through wholly and partially owned subsidiaries.\nThe Marine Mammal Protection Act of 1972, as amended (the \"Act\"), and regulations thereunder (the \"Regulations\") regulate the incidental taking of dolphin in the course of fishing for yellowfin tuna in the eastern tropical Pacific Ocean, where a portion of the Company's light-meat tuna is caught. In 1990, the Company voluntarily adopted a worldwide policy of refusal to purchase tuna caught in the eastern tropical Pacific Ocean through the intentional encirclement of dolphin by purse seine nets and reaffirmed its policy of not purchasing tuna caught anywhere using gill nets or drift nets. Also in 1990, the Dolphin Protection Consumer Information Act (the \"Dolphin Information Act\") was enacted which regulates the labeling of tuna products as \"dolphin\nsafe\" and bans the importation of tuna caught using high seas drift nets. \"Dolphin Safe\" labels appear on the Company's StarKist tuna products in grocery stores throughout the United States. The Act was amended in 1992 to further regulate tuna fishing methods which involve marine mammals. Compliance with the Act, the Regulations, the Dolphin Information Act, the Company's voluntary policy, and the 1992 amendments has not had, and is not expected to have, a material adverse effect on the Company's operations.\nIn recent years, the supply of raw tuna has been variable causing a fluctuation in raw fish prices; however, such variation in supply has not affected materially, nor is it expected to affect materially, the Company's operations.\nThe Company has participated in the development of certain of its food processing equipment, some of which is patented. The Company regards these patents as important but does not consider any one or group of them to be materially important to its business as a whole.\nThe Company's products are widely distributed around the world. Many of the Company's products are marketed under the \"Heinz\" trademark, principally in the United States, Canada, the United Kingdom, other western European countries, Australia, Venezuela, Japan, the People's Republic of China, the Republic of Korea and Thailand. Other important trademarks include \"Star-Kist\" for tuna products, \"Ore-Ida\" for frozen potato products, \"Bagel Bites\" for pizza snack products, \"Moore's\" for coated vegetables and \"Rosetto\" and \"Domani\" for frozen pasta products, all of which are marketed in the United States. \"9 Lives\" is used for cat foods, \"Kibbles N' Bits\", \"Ken-L-Ration\" and \"Reward\" for dog food, \"Jerky Treats\", \"Meaty Bones\", \"Snausages\" and \"Pup- Peroni\" for dog snacks, all of which are marketed in the United States and Canada. \"Amore\" and \"Kozy Kitten\" is used for cat foods, \"Cycle\", \"Gravy Train\", \"Skippy Premium\", \"Recipe\" and \"Vets\" for dog food, \"Pounce\" for cat treats, all of which are marketed in the United States. \"Chef Francisco\" is used for frozen soups and \"Omstead\" is used for frozen vegetables, frozen coated products and frozen fish products, both of which are marketed in the United States and Canada. \"Pablum\" is used for baby food products marketed in Canada. \"Plasmon\", \"Nipiol\" and \"Dieterba\" are used for baby food products, \"Misura\" for dietetic products for adults, \"Ortobuono\" for pickled vegetables and fruit in syrup, \"Mare D'Oro\" for seafood and \"Mr. Foody\" for table and kitchen sauces \"Bi-Aglut\", \"Aproten\", \"Polial\" and \"Dialibra\" for nutraceutical products, all of which are mainly marketed in Italy. \"Petit Navire\" is used for tuna and mackerel products, \"Marie Elisabeth\" for sardines and tuna and \"Orlando\" and \"Guloso\" for tomato products, all of which are marketed in various European countries. \"Wattie's\" is used for various grocery products and frozen foods, \"Tip Top\" for ice cream and frozen desserts and \"Tegel\" for poultry products, all of which are marketed in New Zealand, Australia and the Asia\/Pacific region. \"Farley's\" and \"Farex\" are used for baby food products marketed in Europe, India, Australia and New Zealand. \"Glucon D\" and \"Complan\" are used for nutritional drink mixes marketed in India and in the case of \"Complan\" also Latin America. \"Weight Watchers\" is used in numerous countries in conjunction with owned and franchised weight control classes, programs, related activities and certain food products. \"Budget Gourmet\" is used on frozen entrees and dinners. The Company also markets certain products under other trademarks and brand names and under private labels.\nAlthough crops constituting some of the Company's raw food ingredients are harvested on a seasonal basis, most of the Company's products are produced throughout the year. Seasonal factors inherent in the business have always influenced the quarterly sales and net income of the Company. Consequently, comparisons between quarters have always been more meaningful when made between the same quarters of different years.\nThe products of the Company are sold under highly competitive conditions, with many large and small competitors. The Company regards its principal competition to be other manufacturers of processed foods, including branded, retail products, foodservice products and private label products, that compete with the Company for consumer preference, distribution, shelf space and merchandising support. Product quality and consumer value are important areas of competition. The Company's Weight Watchers International, Inc. subsidiary also competes with a wide variety of weight control programs.\nThe Company's products are sold through its own sales force and through independent brokers and agents to chain, wholesale, cooperative and independent grocery accounts, to pharmacies, to foodservice distributors and to institutions, including hotels, restaurants and certain government agencies. The Company is not dependent on any single customer or a few customers for a material part of its sales.\nCompliance with the provisions of national, state and local environmental laws and regulations has not had a material effect upon the capital expenditures, earnings or competitive position of the Company. The Company's estimated capital expenditures for environmental control facilities for the remainder of fiscal year\n1996 and the succeeding fiscal year are not material and will not materially affect either the earnings or competitive position of the Company.\nThe Company's factories are subject to inspections by various governmental agencies, and its products must comply with the applicable laws, including food and drug laws, of the jurisdictions in which they are manufactured and marketed.\nThe Company employed, on a full-time basis as of May 3, 1995, approximately 42,200 persons around the world.\nFinancial segment information by major geographic area for the most recent three fiscal years is set forth on page 36 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995. Such information is incorporated herein by reference.\nIncome from international operations is subject to fluctuation in currency values, export and import restrictions, foreign ownership restrictions, economic controls and other factors. From time to time exchange restrictions imposed by various countries have restricted the transfer of funds between countries and between the Company and its subsidiaries. To date, such exchange restrictions have not had a material adverse effect on the Company's international operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company has 45 food processing plants in the United States and its possessions, of which 39 are owned and six are leased, as well as 50 food processing plants in foreign countries, of which 47 are owned and three are leased, including ten in New Zealand, six in Canada, four in the United Kingdom, four in Italy, three in Australia, three in Spain, two in Greece, two in Portugal, two in Zimbabwe, one in Botswana, one in France, one in Ireland, one in The Netherlands, one in Venezuela, one in Japan, one in the People's Republic of China, one in Ghana, one in the Republic of Korea, one in Thailand, one in Ecuador, one in India, one in Hungary and one in Russia. The Company also leases one can-making factory in the United States. The Company and certain of its subsidiaries also own or lease office space, warehouses and research and other facilities. The Company's food processing plants and principal properties are in good condition and are satisfactory for the purposes for which they are being utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nWith respect to the antitrust litigation against the Company and its two principal competitors in the United States baby food industry which was previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended April 27, 1994, see Note 14 to the Consolidated Financial Statements on page 55 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995, which is incorporated herein by reference. The Company continues to believe that all of the suits and claims are without merit and is defending itself vigorously against them.\nAs previously reported in the Company's Form 10-Q for the three month period ended July 27, 1994, Mayaguez Water Treatment Company, Inc. (\"MWTC\"), an indirectly 70% owned subsidiary of the Company, had been advised that the Puerto Rico Environmental Quality Board (\"EQB\") was contemplating initiating proceedings against MWTC which could have resulted in fines being assessed in excess of $100,000 as a consequence of violations of an administrative order relating to MWTC's NPDES permit at its Mayaguez, Puerto Rico facility. The EQB has not initiated proceedings to date. A Puerto Rican environmental group, however, filed a lawsuit in the U.S. District Court for the District of Puerto Rico (Mayaguezanos por la Salud y el Ambiente, Inc. v. Mayaguez Water Treatment Company, Inc.; Star-Kist Caribe, Inc.; Bumble Bee International Inc.) in November, 1994 against MWTC and its shareholders, Star-Kist Caribe, a wholly-owned subsidiary of the Company, and Bumble Bee International. The complaint alleges that MWTC failed to comply with its NPDES permit and failed to submit the compliance plan requested by the U.S. Environmental Protection Agency in an administrative order against MWTC and that the shareholders of MWTC are jointly liable with MWTC for such violations. Plaintiffs are requesting an injunction ordering MWTC to cease violating its NPDES permit; civil penalties for MWTC's violations which may exceed $100,000; and plaintiff's costs. Discovery in this matter has commenced. Although the EQB and the U.S. Environmental Protection Agency each have the right to join the lawsuit which could result in a fine being assessed in excess of $100,000, to date, neither agency has joined.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company has not submitted any matters to a vote of security holders since the last annual meeting of shareholders on September 13, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the names and ages of all of the executive officers of the Company indicating all positions and offices with the Company held by each such person and each such person's principal occupations or employment during the past five years. All the executive officers have been elected to serve until the next annual election of officers or until their successors are elected, or until their earlier resignation or removal. The annual election of officers is scheduled to occur on September 12, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation relating to the Company's common stock is set forth on page 35 under the caption \"Stock Market Information\" and on page 55 in Note 13, \"Quarterly Results (Unaudited),\" of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995. Such information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table presents selected consolidated financial data for the Company and its subsidiaries for each of the five fiscal years 1991 through 1995. All amounts are in thousands except per share data.\nDuring 1995, the Company invested approximately $1.2 billion in acquisitions, the most significant of which was the North American pet food businesses of The Quaker Oats Company. See Notes 2 and 6 to the Consolidated Financial Statements, beginning on pages 43 and 47, respectively, of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\nResults recorded in 1994 include gains from the sale of the confectionery business of Heinz Italy and the sale of Heinz U.S.A.'s Near East specialty rice business. See Note 3 to the Consolidated Financial Statements on page 44 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\nDuring 1993, the Company adopted the provisions of FAS No. 106 and elected immediate recognition of the cumulative effect. See Note 11 to the Consolidated Financial Statements on pages 52 and 53 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\nNet income and net income per share for 1993 includes restructuring charges. See Note 4 to the Consolidated Financial Statements on page 45 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\nIn 1992, restructuring charges of $88.3 million on a pretax basis ($0.20 per share) were reflected in operating income to provide for the consolidation of functions, staff reductions, organizational reform and plant modernizations and closures.\nResults recorded in 1992 also include a pretax gain of $221.5 million on the sale of The Hubinger Company of Keokuk, Iowa to Roquette Freres, a major worldwide producer of corn starches. Hubinger is a producer of corn derivatives, including corn syrup, starch and ethanol.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThis information is set forth in the Management's Discussion and Analysis section on pages 28 through 36 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995. Such information 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 May 3, 1995 and April 27, 1994 and the related Consolidated Statements of Income, Retained Earnings and Cash Flows for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993, together with the related Notes to Consolidated Financial Statements, included in the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995, are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere is nothing to be reported under this item.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation relating to the Directors of the Company is set forth under the captions \"Information Regarding Nominees for Election of Directors\" and \"Additional Information--Director and Officer Securities Reports\" in the Company's definitive Proxy Statement in connection with the Annual Meeting of Shareholders to be held September 12, 1995. Such information is incorporated herein by reference. Information relating to the executive officers of the Company is set forth under the caption \"Executive Officers of the Registrant\" in Part I above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation relating to executive compensation is set forth under the caption \"Executive Compensation\" in the Company's definitive Proxy Statement in connection with its Annual Meeting of Shareholders to be held September 12, 1995. 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 of the Company by certain beneficial owners and management is set forth under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the Company's definitive Proxy Statement in connection with its Annual Meeting of Shareholders to be held September 12, 1995. Such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation relating to certain relationships with a beneficial shareholder and certain related transactions is set forth under the caption \"Certain Business Relationships\" and \"Additional Information--Transactions with Beneficial Shareholders\" in the Company's definitive Proxy Statement in connection with its Annual Meeting of Shareholders to be held September 12, 1995. Such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) The following financial statements and report included in the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995 are incorporated herein by reference:\nConsolidated Balance Sheets as of May 3, 1995 and April 27, 1994 Consolidated Statements of Income for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993 Consolidated Statements of Retained Earnings for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993 Consolidated Statements of Cash Flows for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993 Notes to Consolidated Financial Statements Independent Accountants' Report of Coopers & Lybrand L.L.P. dated June 19, 1995, on the Company's consolidated financial statements for the fiscal years ended May 3, 1995, April 27, 1994 and April 28,\n(2) The following report and schedule is filed herewith as a part hereof:\nIndependent Accountants' Report of Coopers & Lybrand L.L.P. dated June 19, 1995, on the Company's consolidated financial statement schedule filed as a part hereof for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993.\nSchedule II (Valuation and Qualifying Accounts and Reserves) for the three fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993.\nAll other schedules are omitted because they are not applicable or the required information is included herein or is shown in the consolidated financial statements or notes thereto incorporated herein by reference.\n(3) Exhibits required to be filed by Item 601 of Regulation S-K are listed below and are filed as a part hereof. Documents not designated as being incorporated herein by reference are filed herewith. The paragraph numbers correspond to the exhibit numbers designated in Item 601 of Regulation S-K.\n3(i) The Company's Articles of Amendment dated July 13, 1994, amending and restating the Company's amended and restated Articles of Incorporation in their entirety are incorporated herein by reference to Exhibit 3(i) to the Company's Annual Report on Form 10-K for the fiscal year ended April 27, 1994.\n3(ii) The Company's By-Laws, as amended effective October 12, 1994.\n4. Except as set forth below, there are no instruments with respect to long-term debt of the Company that involve indebtedness or securities authorized thereunder exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to file a copy of any instrument or agreement defining the rights of holders of long-term debt of the Company upon request of the Securities and Exchange Commission.\n(a) Form of Indenture between the Company and The First National Bank of Chicago dated as of July 15, 1992, is incorporated herein by reference to Exhibits 4(a) and 4(c) to the Company's Registration Statement on Form S-3 (Reg. No. 33-46680) and the supplements to such Indenture are incorporated herein by reference to the Company's Form 8-Ks dated September 21, 1992, October 29, 1992 and January 27, 1993 relating to the Company's $250,000,000 5 1\/2% Notes due 1997, $300,000,000 6 3\/4% Notes due 1999 and $200,000,000 6 7\/8% Notes due 2003, respectively.\n10(a) Permit No. 408 (lease) granted by the City of Los Angeles to Star- Kist Foods, Inc. dated September 6, 1979 for premises located at Terminal Island, California is incorporated herein by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended April 29, 1981.\n(b) Lease of Land in American Samoa, dated as of September 17, 1983, by and between the American Samoa Government and Star-Kist Samoa, Inc. is incorporated herein by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1984.\n(c) Management contracts and compensatory plans:\n(i) 1986 Deferred Compensation Program for H. J. Heinz Company and affiliated companies is incorporated herein by reference to Exhibit 10(p) to the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1986\n(ii) H. J. Heinz Company's 1982 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(iii) H. J. Heinz Company's 1984 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(n) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(iv) H. J. Heinz Company's 1987 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(v) H. J. Heinz Company's 1990 Stock Option Plan is incorporated herein by reference to Appendix A to the Company's Definitive Proxy Statement dated August 3, 1990\n(vi) H. J. Heinz Company's 1994 Stock Option Plan is incorporated herein by reference to Appendix A to the Company's Proxy Statement dated August 5, 1994\n(vii) H. J. Heinz Company Supplemental Executive Retirement Plan, as amended, is incorporated herein by reference to Exhibit 10(c)(ix) to the Company's Annual Report on Form 10-K for the fiscal year ended April 28, 1993\n(viii) H. J. Heinz Company Executive Deferred Compensation Plan is incorporated herein by reference to Exhibit 10(c)(x) to the Company's Annual Report on Form 10-K for the fiscal year ended April 27, 1994\n(ix) H. J. Heinz Company Incentive Compensation Plan is incorporated herein by reference to Appendix B to the Company's Proxy Statement dated August 5, 1994\n(d) Agreement for the Registration of Stock among H. J. Heinz Company and Howard Heinz Endowment, Vira I. Heinz Endowment, Heinz Family Foundation, H. John Heinz III Revocable Trust No. 1 and H. John Heinz III Descendants' Trust (No. 1) dated June 22, 1995 is incorporated herein by reference to Exhibit 10 to the Company's Form 8-K dated July 7, 1995.\n11. Computation of net income per share.\n13. Pages 28 through 56 of the H. J. Heinz Company Annual Report to Shareholders for the fiscal year ended May 3, 1995, portions of which are incorporated herein by reference. Those portions of the Annual Report to Shareholders that are not incorporated herein by reference shall not be deemed to be filed as a part of this Report.\n21. Subsidiaries of the Registrant\n23. The following Exhibit is filed by incorporation by reference to Item 14(a)(2) of this Report:\n(a) Consent of Coopers & Lybrand L.L.P.\n24. Powers-of-attorney of the Company's directors.\n27. Financial Data Schedule\nCopies of the exhibits listed above will be furnished upon request to holders or beneficial holders of any class of the Company's stock, subject to payment in advance of the cost of reproducing the exhibits requested.\n(b) A report on Form 8-K (as amended by Form 8-K\/A filed May 30, 1995) was filed with the Securities and Exchange Commission on March 29, 1995 reporting the completion by the Company of the acquisition of all of the North American pet food businesses of the Quaker Oats Company. A report on Form 8-K was filed with the Securities and Exchange Commission on July 10, 1995 reporting that on June 23, 1995, the Howard Heinz Endowment, the Vira I. Heinz Endowment, the Heinz Family Foundation and certain Heinz family trusts announced their intention to diversify their investment portfolios by selling a portion of their common stock holdings in H. J. Heinz Company through an underwritten secondary offering for up to an aggregate of approximately 13.5 million shares. The offering will be made by means of a prospectus only and is expected to occur in August 1995. H. J. Heinz Company has agreed to file a registration statement with the Securities and Exchange Commission to facilitate the offering.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on July 31, 1995.\nH. J. HEINZ COMPANY (Registrant)\n\/s\/ David R. Williams By...................................... DAVID R. WILLIAMS Senior Vice President-Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, on July 31, 1995.\nSignature Capacity --------- --------\n\/s\/ Anthony J. F. O'Reilly Chairman of the Board, ............................. President and Chief ANTHONY J. F. O'REILLY Executive Officer (Principal Executive Officer)\n\/s\/ David R. Williams Senior Vice President-Finance and Chief ............................. Financial Officer (Principal Financial DAVID R. WILLIAMS Officer)\n\/s\/ Tracy E. Quinn Corporate Controller ............................. (Principal Accounting TRACY E. QUINN Officer)\nAnthony J. F. O'Reilly Director Joseph J. Bogdanovich Director Nicholas F. Brady Director Richard M. Cyert Director Thomas S. Foley Director Edith E. Holiday Director Samuel C. Johnson Director William R. Johnson Director Donald R. Keough Director Albert Lippert Director \/s\/ Lawrence J. McCabe Lawrence J. McCabe Director By......................................... Luigi Ribolla Director LAWRENCE J. MCCABE Herman J. Schmidt Director Director and Attorney-in-Fact David W. Sculley Director Eleanor B. Sheldon Director William P. Snyder III Director William C. Springer Director S. Donald Wiley Director David R. Williams Director\nINDEPENDENT ACCOUNTANTS' REPORT\nThe Shareholders H. J. Heinz Company:\nOur report on the consolidated financial statements of H. J. Heinz Company and Subsidiaries has been incorporated by reference in this Annual Report on Form 10-K from the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995 and appears on page 56 therein. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a) of this Annual Report on 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.\nPittsburgh, PA June 19, 1995 ---------------\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the Registration Statements of H. J. Heinz Company on Form S-8 (Registration Nos. 2-51719, 2-45120, 2- 79306, 33-00390, 33-19639, 33-32563, 33-42015 and 33-55777) of our reports dated June 19, 1995, on our audits of the consolidated financial statements and financial statement schedules of H. J. Heinz Company and Subsidiaries as of May 3, 1995 and April 27, 1994 and for the fiscal years ended May 3, 1995, April 27, 1994 and April 28, 1993, which reports are included or incorporated by reference in this Annual Report on Form 10-K.\nCoopers & Lybrand L.L.P.\nPittsburgh, PA July 31, 1995\nSCHEDULE II\nH. J. HEINZ COMPANY AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES FISCAL YEARS ENDED MAY 3, 1995, APRIL 27, 1994 AND APRIL 28, 1993 (THOUSANDS OF DOLLARS)\nNotes: (1) Principally reserves on assets sold, written-off or reclassified.\n(2) Represents amounts reclassified as a result of consolidation of certain fishing vessel operations.\n(3) The net change in the valuation allowance for deferred tax assets was an increase of $20.6 million. The increase is primarily due to increases in the valuation allowance related to additional deferred tax assets for foreign tax credit carryforwards ($25.3 million) and loss carryforwards ($2.9 million). This increase was partially offset by the recognition of the realizability of certain other deferred tax assets in future years ($3.1 million) and the utilization of loss carryforwards ($4.5 million). See Note 5 to the Consolidated Financial Statements on pages 45 and 46 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\n(4) The net change in the valuation allowance for deferred tax assets was a decrease of $56.2 million. The decrease was primarily due to the utilization of loss carryforwards ($2.8 million) and recognition of the realizability of certain other deferred tax assets in future years ($57.3 million). An increase in the valuation allowance related to the deferred tax asset for loss carryforwards ($4.7 million) partially offset the decrease. See Note 5 to the Consolidated Financial Statements on pages 45 and 46 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\n(5) The net change in the valuation allowance for deferred tax assets was a decrease of $54.9 million. The decrease was primarily due to the utilization of loss carryforwards ($5.3 million), amortization of asset revaluations ($10.7 million) and recognition of the realizability of certain other deferred tax assets in future years ($41.8 million). An increase in the valuation allowance related to the deferred tax asset for loss carryforwards ($5.0 million) partially offset the decrease. See Note 5 to the Consolidated Financial Statements on pages 45 and 46 of the Company's Annual Report to Shareholders for the fiscal year ended May 3, 1995.\nEXHIBIT INDEX\nExhibits required to be filed by Item 601 of Regulation S-K are listed below and are filed as a part hereof. Documents not designated as being incorporated herein by reference are filed herewith. The paragraph numbers correspond to the exhibit numbers designated in Item 601 of Regulation S-K.\nEXHIBIT\n3(i) The Company's Articles of Amendment dated July 13, 1994, amending and restating the Company's amended and restated Articles of Incorporation in their entirety are incorporated herein by reference to Exhibit 3(i) to the Company's Annual Report on Form 10-K for the fiscal year ended April 27, 1994.\n3(ii) The Company's By-Laws, as amended effective October 12, 1994.\n4. Except as set forth below, there are no instruments with respect to long-term debt of the Company that involve indebtedness or securities authorized thereunder exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to file a copy of any instrument or agreement defining the rights of holders of long-term debt of the Company upon request of the Securities and Exchange Commission.\n(a) Form of Indenture between the Company and The First National Bank of Chicago dated as of July 15, 1992, is incorporated herein by reference to Exhibits 4(a) and 4(c) to the Company's Registration Statement on Form S-3 (Reg. No. 33-46680) and the supplements to such Indenture are incorporated herein by reference to the Company's Form 8-Ks dated September 21, 1992, October 29, 1992 and January 27, 1993 relating to the Company's $250,000,000 5 1\/2% Notes due 1997, $300,000,000 6 3\/4% Notes due 1999 and $200,000,000 6 7\/8% Notes due 2003, respectively.\n10(a) Permit No. 408 (lease) granted by the City of Los Angeles to Star-Kist Foods, Inc. dated September 6, 1979 for premises located at Terminal Island, California is incorporated herein by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended April 29, 1981.\n(b) Lease of Land in American Samoa, dated as of September 17, 1983, by and between the American Samoa Government and Star-Kist Samoa, Inc. is incorporated herein by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1984.\n(c) Management contracts and compensatory plans:\n(i) 1986 Deferred Compensation Program for H. J. Heinz Company and affiliated companies is incorporated herein by reference to Exhibit 10(p) to the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1986\n(ii) H. J. Heinz Company's 1982 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(iii) H. J. Heinz Company's 1984 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(n) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(iv) H. J. Heinz Company's 1987 Stock Option Plan, as amended, is incorporated herein by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the fiscal year ended May 2, 1990\n(v) H. J. Heinz Company's 1990 Stock Option Plan is incorporated herein by reference to Appendix A to the Company's Definitive Proxy Statement dated August 3, 1990\n(vi) H. J. Heinz Company's 1994 Stock Option Plan is incorporated herein by reference to Appendix A to the Company's Proxy Statement dated August 5, 1994\n(vii) H. J. Heinz Company Supplemental Executive Retirement Plan, as amended, is incorporated herein by reference to Exhibit 10(c)(ix) to the Company's Annual Report on Form 10-K for the fiscal year ended April 28, 1993\nEXHIBIT\n(viii) H. J. Heinz Company Executive Deferred Compensation Plan is incorporated herein by reference to Exhibit 10(c)(x) to the Company's Annual Report on Form 10-K for the fiscal year ended April 27, 1994\n(ix) H. J. Heinz Company Incentive Compensation Plan is incorporated herein by reference to Appendix B to the Company's Proxy Statement dated August 5, 1994\n(d) Agreement for the Registration of Stock among H. J. Heinz Company and Howard Heinz Endowment, Vira I. Heinz Endowment, Heinz Family Foundation, H. John Heinz III Revocable Trust No. 1 and H. John Heinz III Descendants' Trust (No. 1) dated June 22, 1995 is incorporated herein by reference to Exhibit 10 to the Company's Form 8-K dated July 7, 1995.\n11. Computation of net income per share.\n13. Pages 28 through 56 of the H. J. Heinz Company Annual Report to Shareholders for the fiscal year ended May 3, 1995, portions of which are incorporated herein by reference. Those portions of the Annual Report to Shareholders that are not incorporated herein by reference shall not be deemed to be filed as a part of this Report.\n21. Subsidiaries of the Registrant\n23. The following Exhibit is filed by incorporation by reference to Item 14(a)(2) of this Report:\n(a) Consent of Coopers & Lybrand L.L.P.\n24. Powers-of-attorney of the Company's directors.\n27. Financial Data Schedule","section_15":""}
{"filename":"317093_1995.txt","cik":"317093","year":"1995","section_1":"Item 1 - Business\nGeneral\nAndrew Corporation (\"Andrew\" or the \"Company\") was reincorporated in Delaware in 1987. The Company previously was incorporated in Illinois in 1947 as the successor to a partnership founded in 1937. Its executive offices are located at 10500 West 153rd Street, Orland Park, Illinois, 60462, which is approximately 25 miles southwest of Chicago's loop. Unless otherwise indicated by the context, all references herein to Andrew include Andrew Corporation and its subsidiaries.\nAndrew is a multinational supplier of communications products and systems to worldwide commercial, industrial, governmental and military customers. Its principal products include coaxial cables, microwave antennas for point-to- point communication systems, special purpose antennas for commercial, government and military end use, antennas and complete earth stations for satellite communication systems, electronic radar systems, communication reconnaissance systems, connectivity devices for use in communication systems, and related ancillary items and services. These products are frequently sold as integrated systems rather than as separate components. Andrew conducts manufacturing operations, primarily from ten locations in the United States and from four locations in other countries. Sales by non-U.S. operations and export sales from U.S. operations accounted for approximately 45% of Andrew's net sales in 1995, 44% in 1994, and 41% in 1993.\nDuring the year the Company operated in three strategic business areas, Commercial, Government and Network. The Commercial business supplies coaxial cable and antenna system equipment to telecommunications companies and agencies. The Government business supplies specialized antenna systems, electronic radar systems, communication reconnaissance systems, coaxial cable, standard antennas, and fully integrated systems to various United States government agencies and friendly foreign governments. The Network business supplies products and services through value added and other resellers to data processing organizations that support the interconnectivity needs of computer networks.\nInformation concerning Andrew's net sales (intersegment sales are insignificant), operating profit and assets employed attributable to each business area for fiscal 1995, 1994, and 1993, is included in the \"Industry Segment Information\" note to Consolidated Financial Statements included on page 33 of the 1995 Annual Report to Stockholders and incorporated herein by reference.\nProducts and Services\nThe following table sets forth net sales and percentages of total net sales represented by Andrew's principal products during the last three years:\nSales for the Company's business areas during the last three years were as follows:\nPRINCIPAL PRODUCTS\nCommercial Business\nCoaxial Cable Systems and Bulk Cables:\nCoaxial cable is a two-conductor, radio frequency transmission line with the smaller of the two conductors centrally located inside the larger, tubular conductor. It is principally used to carry radio frequency signals at frequencies up to 2 GHz.\nWaveguides are tubular conductors, the dimensions and manufacturing tolerances of which are related to operating frequency. Waveguides find greatest application at frequencies above 2 GHz, although they are also used in UHF-TV broadcasting at frequencies in hundreds of megahertz. Andrew manufactures waveguides with rectangular, circular and elliptical cross-sections. Most of Andrew's waveguides are sold as part of its antenna systems.\nAndrew sells its semi-flexible cables and waveguides under the trademark HELIAX(R).\nMicrowave Antenna Systems:\nA \"microwave antenna system,\" as this term is used by Andrew, consists of one or more microwave antennas, waveguides or coaxial cables connecting antennas to transmitters or receivers, a tower to support the antennas, an equipment shelter to house transmitters and receivers, various ancillary items, and field installation services. If sold without a supporting tower, equipment shelter or field installation, microwave antennas with their connecting cables or waveguides are still considered by Andrew to be \"microwave antenna systems.\"\nLand-based microwave radio networks are commonly used by telecommunications companies for intercity telephone, telex, video and data transmission. They are also used for more specialized purposes by pipeline companies, electric utilities and railroads.\nSpecial Antennas and Other:\nAndrew also manufactures and sells several types and configurations of special application antennas. Applications include cellular systems, navigation, FM and television broadcasting, multipoint distribution services and instructional television. As with microwave antennas, Andrew considers sales of special antennas and other various components used in the cellular market (shelters and towers) and the installation of these components to be part of a \"cellular system.\"\nThe company also designs and installs its proprietary distributed communication systems. These systems permit in-building and enclosed area access for all types of wireless communications. These systems utilize the company's semi-flexible coaxial cable sold under the tradename RADIAX(R).\nEarth Station Antennas:\nEarth station antenna systems manufactured by Andrew are used at earth terminals to receive signals from, and transmit signals to, communication satellites in equatorial orbit. System elements include an antenna, from 6 to 40 feet in diameter, and may also include electronic controllers, waveguides, polarizers, combiners, special mounting features, motor drives, position indicators, transmitters and receivers. Andrew earth station antenna systems in all sizes are used in various countries to broadcast and transmit programs, both to CATV operators and to VHF or UHF broadcast stations, as well as long distance transmission of conventional telecommunications traffic.\nGovernment Business\nDefense Electronics:\nAndrew manufactures electronic scanning and communication receiver systems, which are designed to search and monitor the electromagnetic spectrum from 20 MHz to 40 GHz. These systems are purchased primarily for intelligence gathering in strategic surveillance operations which emphasize highly sensitive reception of weak signals as well as accuracy of signal analysis data. The Company's highly automated receiver systems are subsystems that are incorporated into fully-integrated systems which, in addition to the Company's receiving and analyzing equipment, include antennas and other equipment necessary to carry out the overall electronic reconnaissance operation.\nThe Company is also engaged in the supply of fully integrated electronic surveillance systems, both for military radar reconnaissance and for non-military communications monitoring. These surveillance systems are custom designed by the Company's engineering staff to meet customer requirements.\nOther Products:\nThe Company also supplies specialized microwave antenna systems to governmental agencies and the military. In addition, coaxial cables are used in military countermeasure devices, radar and specialized instrumentation applications.\nEarth station antenna systems and special application antennas are used for broadcasting programs and operational traffic to military bases and telemetry traffic associated with widely dispersed environmental monitoring stations.\nAndrew also manufactures pedestals and electronic controls for radio frequency and optical systems used in military and defense markets.\nNetwork Business\nAndrew designs, manufactures and markets advanced connectivity solutions for IBM mainframe, and token ring systems. Products include protocol convertors, local area network (LAN) gateways, terminal emulators, file transfer software, multistation access units, adapter cards, repeaters, bridges and routers. In addition, Andrew supplies channel interface products which provide direct channel links between IBM or plug-compatible host computers and non-IBM devices and networks, terminal to mainframe computer adapters and emulators for PCs and printers, emulation for Macintosh devices and wiring products such as baluns and star panels that provide cost-effective wiring connections for network communications equipment.\nINTERNATIONAL ACTIVITIES\nAndrew's international operations represent a substantial portion of its overall operating results and asset base. Manufacturing facilities are located in Canada, Australia, and the United Kingdom. Andrew's plants in the United States also ship significant amounts of manufactured goods to export markets. In Russia, Andrew participates in joint ventures that operate fiber optic telecommunication networks and manufacture sophisticated microwave antennas.\nDuring fiscal 1995 sales of products exported from the United States or manufactured abroad were $282,169,000 or 45% of total sales compared with $244,785,000 (44%) in fiscal 1994 and $175,811,000 (41%) in fiscal 1993. Exports from the United States amounted to $103,090,000 in fiscal 1995, $101,829,000 in fiscal 1994, and $54,253,000 in fiscal 1993.\nSales and income before income taxes on a country-by-country basis can vary considerably year to year. Further information on Andrew's international operations is contained in the note \"Geographic Area Information\" to Consolidated Financial Statements included on page 32 of the 1995 Annual Report to Stockholders, incorporated herein by reference.\nAndrew's international operations are subject to a number of risks including currency fluctuations, changes in foreign governments and their policies, and expropriation or requirements of local or shared ownership. Andrew believes that the geographic dispersion of its sales and assets tends to mitigate these risks.\nMARKETING AND DISTRIBUTION\nCommercial Business\nSales engineering functions, including product application assistance, are performed by a staff of highly trained applications engineers located at each manufacturing facility. In addition, field sales engineers are located at or near Atlanta, Dallas, Los Angeles, New York, San Francisco, Washington, D.C., Essen and Munich (Germany), Hong Kong (China), London (England), Madrid (Spain), Mexico City (Mexico), Milan (Italy), Paris (France), Tokyo (Japan), and Zurich (Switzerland). Unlike most of its competitors, Andrew uses its own sales and sales engineering staffs to service its principal markets, but follows the traditional practice of using commissioned sales agents in countries with modest sales potential.\nApproximately one-half of Andrew's products are sold directly to end users. Most of the remainder is sold to radio equipment companies which install Andrew's products as part of a total system, with the balance being sold through dealers and jobbers. Small or medium-size orders are normally shipped from inventory; delivery schedules on larger orders are negotiated, but seldom exceed five months. Andrew's sales are principally standard, proprietary items although unique specifications or features are incorporated for special order situations.\nBecause most of Andrew's business is derived from large telecommunications system operators and the radio equipment manufacturers who supply this industry, Andrew has tailored its business strategy to serve the needs of technically sophisticated buyers. In particular, Andrew has emphasized the compatibility of antennas, transmission lines and related components in order to optimize their performance as an integrated subsystem.\nGovernment Business\nThe specialized needs of the Company's customers and the technology required to meet those needs change constantly. Accordingly, the Company stresses its engineering, installation, service and other support capabilities to its government and military customers. To provide close communication with these customers and to discern developments and trends in procurement requirements, the Company has established a team of sales engineers located in five offices in the United States and one office in the United Kingdom. The Company also utilizes sales representatives in the United Kingdom, Germany and the Middle East. In addition, technical program support and direct sales engineering are performed at each location. The Company places great emphasis in its marketing on extensive personal contact and continuous consultation with its customers in an attempt to meet current technical requirements and anticipated future requirements and to learn of upcoming procurement programs in which its products may have application.\nNetwork Business\nThe Company's Network business emphasizes support of three major computer connectivity market segments: mainframe interface, microcomputer to IBM midrange access, and token ring local area networking (LAN). Due to the specialized customer needs within these markets, each area has distinct marketing and distribution channels. Mainframe products are sold to Original Equipment Manufacturers (OEMs) and a select group of specialized system integrators whose focus is on the mainframe computer user. In the midrange area, the Company concentrates on a large group of highly specialized midrange computer dealers, and Value-Added Resellers (VARs). LAN products are sold through a distribution network of VARs, resellers and telesales. In addition, Andrew maintains business partner relationships with a select group of systems integrators in order to provide strong high-end product support channels for customers. Service and technical support is an integral part of the Company's sales program for all product groups and is provided either by the VAR or directly by the factory.\nMAJOR CUSTOMERS\nAndrew serves more than 6,000 customers in more than 100 countries. In the last three years, aggregate sales to the ten largest customers averaged approximately 24% of aggregate consolidated sales. No single customer has accounted for over 10% of consolidated annual sales in any of the last three years.\nIn fiscal 1995, 1994 and 1993 direct and indirect sales to U.S. governmental agencies amounted to $22,337,000, $27,840,000, and $31,257,000, respectively.\nMANUFACTURING AND RAW MATERIALS\nAndrew generally develops, designs, fabricates, manufactures and assembles the products which it sells. In the Commercial business, cable and waveguide products are produced at its plants in Illinois and the United Kingdom. Parabolic antenna reflectors are manufactured primarily in Texas. Self-supporting and guyed towers are also manufactured in Texas. Equipment shelters are manufactured in Georgia and California.\nAndrew's defense electronic products are manufactured in plants located in Texas. The Company's products are manufactured from both standard components and parts that are built to the Company's specifications by other manufacturers. A large number of the Company's products contain multiple microprocessors for which proprietary machine readable software is designed by the Company's engineers and technicians.\nNetwork products are produced at plants in California. The production process principally entails assembly of electronic components.\nAndrew considers its sources of supply for all raw materials to be adequate and is not dependent upon any single supplier for any significant portion of materials used in its products.\nRESEARCH AND DEVELOPMENT\nAndrew believes that the successful marketing of its products depends upon its research, engineering and production skills. Research and development activities are undertaken for new product development and for product and manufacturing process improvement. In fiscal 1995, 1994 and 1993 Andrew spent $23,771,000, $25,707,000, and $22,011,000, respectively on research and development activities.\nAndrew holds approximately 255 active patents expiring at various times between 1996 and 2012, relating to its products and attempts to obtain patent protection for significant developments whenever possible. The Company does not consider patents to be material to its operations nor would the loss of any patents have a materially adverse effect on operations.\nCOMPETITION\nCommercial\nMany large manufacturers of electrical or radio equipment, some of which have substantially greater financial resources than Andrew, compete with a portion of Andrew's antenna systems equipment and coaxial cable product lines. In addition, there are a number of small independent companies that compete with portions of these product lines. Andrew has traditionally focused on specific specialized fields within the marketplace which require sophisticated technology and support services. Andrew competes principally on the basis of product quality, service, and continual technological enhancement of its products.\nGovernment\nThere are numerous manufacturers of electronic radar systems, communication reconnaissance systems and specialized antenna systems that supply their equipment to United States government agencies and friendly foreign governments. There is substantial competition within the market and the Company is not a major competitor. Due to fixed-price contracts and pre-defined contract specifications prevalent within this market, the Company competes primarily on the basis of its ability to provide state-of-the-art solutions in this technologically demanding marketplace while maintaining its competitive pricing.\nNetwork\nWithin the corporate network communications market, Andrew's principal competitor is IBM which provides similar products across Andrew's product line. There are also numerous other manufacturers that compete with portions of Andrew's product line. Andrew's principal bases of competition within this market are product quality and reliability and product support.\nBACKLOG AND SEASONALITY\nThe following table sets forth the backlog of orders believed to be firm in each of Andrew's businesses (government orders included herein are funded orders):\nIn the Commercial and Government businesses, Andrew can experience quarterly fluctuations in the level of sales. The variability in recent years has been demonstrated by typically higher sales and net income in the second six months of the fiscal year, particularly in the fiscal fourth quarter. The primary reason for this pattern is the need of northern hemisphere customers to complete installations during warm weather months. The fiscal fourth quarter can also be affected by the timing of sales to U.S. governmental agencies. Other factors which can cause quarterly fluctuations in net sales and net income include variability of shipments under large contracts and variations in product mix and in profitability of individual orders. These variations can be expected to continue in the future. Consequently, it is more meaningful to focus on annual rather than interim results.\nENVIRONMENT\nThe Company engages in a variety of activities to comply with various federal, state and local laws and regulations involving the protection of the environment. Compliance with such laws and regulations does not currently have a significant effect on the Company's capital expenditures, earnings, or competitive position. In addition, the Company has no knowledge of any environmental condition(s) which might individually or in the aggregate have a material adverse effect on the Company's financial condition.\nEMPLOYEES\nAt September 30, l995, Andrew had 3,345 employees, of whom 2,593 were located in the United States. None of Andrew's employees are subject to collective bargaining agreements. As a matter of policy, Andrew seeks to maintain good relations with employees at all locations and believes that such relations are good.\nREGULATION\nAndrew is not directly regulated by any governmental agency in the United States. Most of its customers and the telecommunications industry generally, are subject to regulation by the Federal Communications Commission (the \"FCC\"). The FCC controls the allocation of transmission frequencies and the performance characteristics of earth station antennas. As a result of these controls, Andrew's antenna design specifications must be conformed on an ongoing basis to meet FCC requirements. This regulation has not adversely affected Andrew's operations.\nOutside of the United States, where many of Andrew's customers are government owned and operated entities, changes in government economic policy and communications regulation have affected in the past, and may be expected to affect in the future, the volume of Andrew's non-U.S. business. However, the effect of regulation in countries other than the U.S. in which Andrew does business has generally not been detrimental to Andrew's non-U.S. operations taken as a whole.\nGOVERNMENT CONTRACTS\nAndrew performs work for the United States Government primarily under fixed-price prime contracts and subcontracts. Under fixed-price contracts, Andrew realizes any benefit or detriment occasioned by lower or higher costs of performance. Total direct and indirect sales to agencies of the United States Government, which are generally fixed-price contracts, were $22,337,000 in 1995, $27,840,000 in 1994, and $31,257,000 in 1993. These contracts are typically less than 12 months in duration.\nAndrew, in common with other companies which derive a portion of their revenues from the United States Government, is subject to certain basic risks, including rapidly changing technologies, changes in levels of defense spending, and possible cost overruns. Recognition of profits is based upon estimates of final performance which may change as contracts progress. Contract prices and costs incurred are subject to Government Procurement Regulations, and costs may be questioned by the Government and are subject to disallowance.\nAll United States Government contracts contain a provision that they may be terminated at any time for the convenience of the Government. In such event, the contractor is entitled to recover allowable costs plus any profits earned to the date of termination.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nAndrew has fourteen manufacturing facilities, thirty-four engineering and sales administration locations and two distribution facilities. All are equipped with appropriate office space. Andrew's executive offices are located at the facility in Orland Park, Illinois. The following table sets forth certain information regarding significant facilities:\nAndrew owns a total of 664 acres of land. Of this total, 565 acres are unimproved, including 181 acres in Orland Park, Illinois, 137 acres in Floyd, Texas, l43 acres in Denton, Texas, and 98 acres in Ashburn, Ontario, Canada. Andrew also leases sales offices and facilities in the United States and in eleven countries outside the United States.\nItem 3","section_3":"Item 3 - Legal Proceedings\nAndrew is not involved in any pending legal proceedings which are expected to have a materially adverse effect on its financial position, nor is it aware of any proceedings of this nature or relating to the protection of the environment contemplated by governmental authorities.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders\nThere were no matters which required a vote of security holders during the three months ended September 30, l995.\nPART II\nItem 5","section_5":"Item 5 - Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Company's Common Stock is traded over-the-counter on the Nasdaq National Market.\nThe Company had 3,523 holders of common stock of record at December 22, 1995.\nInformation concerning the Company's stock price during the years ended September 30, l995 and 1994 is incorporated herein by reference from the l995 Annual Report to Stockholders, page 34. All prices represent high and low sales prices as reported by the Nasdaq National Market.\nIt is the present policy of Andrew's Board of Directors to retain earnings in the business to finance the Company's operations and investments; and the Company does not anticipate payment of cash dividends in the foreseeable future.\nLong-term debt agreements include restrictive covenants which, among other things, provide restrictions on dividend payments. At September 30, l995, $201,097,000 was not restricted for purposes of such payments.\nItem 6","section_6":"Item 6 - Selected Financial Data\nSelected financial data for the last five fiscal years is incorporated herein by reference from the l995 Annual Report to Stockholders, pages 36 and 37.\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\nInformation concerning this item is incorporated herein by reference from the l995 Annual Report to Stockholders, pages 16 through 20.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nThe Consolidated Financial Statements of the Company, Notes to Consolidated Financial Statements, Selected Quarterly Financial Information, and the report thereon of the independent auditors are incorporated herein by reference from the 1995 Annual Report to Stockholders, pages 21 through 35.\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nNone\nPART III\nItem l0-Directors and Executive Officers of the Registrant\nInformation concerning directors and executive officers of the Registrant is incorporated herein by reference from the Company's l995 Proxy Statement under the captions \"Election of Directors\" and \"Executive Officers.\"\nItem ll-Executive Compensation\nInformation concerning management compensation is incorporated herein by reference from the Company's l995 Proxy Statement under the caption \"Executive Compensation.\"\nItem l2-Security Ownership of Certain Beneficial Owners and Management\nInformation concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's l995 Proxy Statement under the caption \"Security Ownership.\"\nItem 13","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"Item 13 - Certain Relationships and Related Transactions\nInformation concerning certain relationships and related transactions is incorporated herein by reference from the Company's 1995 Proxy Statement under the caption \"Security Ownership.\"\nPART IV\nItem l4-Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) (1)The following consolidated financial statements of Andrew Corporation and subsidiaries, included in the l995 Annual Report to Stockholders, are incorporated by reference in Item 8:\nConsolidated Statements of Income years ended September 30, l995, 1994 and l993.................page 21\nConsolidated Balance Sheets September 30, l995 and 1994...........................pages 22 and 23\nConsolidated Statements of Cash Flows years ended September 30, l995, l994 and l993.................page 24\nConsolidated Statements of Stockholders' Equity years ended September 30, l995, 1994 and l993.................page 25\nNotes to Consolidated Financial Statements..........pages 26 through 33\nSelected Quarterly Financial Information........................page 34\nReport of Independent Auditors..................................page 35\n(2)The following consolidated financial statement schedule of Andrew Corporation and subsidiaries is included in Item l4(d):\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 inapplicable and, therefore, have been omitted.\nItem 14","section_14":"Item 14 cont.\n(3)Exhibit Index:\n(b) There were no reports on Form 8-K filed during the three months ended September 30, 1995.\nREPORT OF INDEPENDENT AUDITORS\nTo the Stockholders and Board of Directors Andrew Corporation\nWe have audited the consolidated financial statements and related schedule of Andrew Corporation and subsidiaries listed in Item 14(a)(1) and (2) of the annual report on Form 10-K of Andrew Corporation for the year ended September 30, 1995. These financial statements and related schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and related schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and related 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 related schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Andrew 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 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 November 3, 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 December 20, 1995.\nAndrew Corporation\nBy \\s\\ Floyd L. English ------------------------ Floyd L. English Chairman, President, and Chief Executive Officer\nBy \\s\\ Charles R. Nicholas --------------------------- Charles R. Nicholas Executive Vice President and Chief Financial Officer\nBy \\s\\ Gregory F. Maruszak --------------------------- Gregory F. Maruszak Vice President and Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on December 20, 1995, by the following persons on behalf of the Registrant in the capacities indicated.\n\\s\\ John G. Bollinger \\s\\ Donald N. Frey ------------------------ --------------------- John G. Bollinger Donald N. Frey Director Director\n\\s\\ Jon L. Boyes \\s\\ Carole M. Howard ------------------- ----------------------- Jon L. Boyes Carole M. Howard Director Director\n\\s\\ George N. Butzow \\s\\ Ormand J. Wade ----------------------- --------------------- George N. Butzow Ormand J. Wade Director Director\n\\s\\ Kenneth J. Douglas ------------------------- Kenneth J. Douglas Director\nANDREW CORPORATION\nEXHIBIT INDEX","section_15":""}
{"filename":"929498_1995.txt","cik":"929498","year":"1995","section_1":"Item 1. Business. GENERAL\nThe Travelers Life and Annuity Company (the Company) is a wholly owned subsidiary of The Travelers Insurance Company (TIC), which is an indirect wholly owned subsidiary of Travelers Group Inc. (Travelers). The Company is a stock insurance company chartered in 1973 in the State of Connecticut and has been continuously engaged in the insurance business since that time. The Company is licensed to conduct life insurance business in a majority of the states of the United States, and intends to seek licensure in the remaining states, except New York.\nThe Company primarily writes single premium group annuity close-out contracts and individual structured settlement annuities. The single premium group annuity contracts are typically purchased by employer-sponsored pension plans upon termination of the plan, asset reversion or other significant plan changes. As a result, sales activity can vary significantly from period to period.\nThe individual structured settlement contracts are purchased by affiliates, The Travelers Indemnity Company and its subsidiaries, in connection with the settlement of certain of their policyholder obligations. All structured settlement contracts are issued through a separate account of the Company. Accordingly, the Company's other revenues include structured settlement policyholder revenues net of the related benefits and expenses.\nIn 1995, the Company commenced writing individual life and deferred annuity business in certain states and is in the process of obtaining further regulatory approvals to write these products in additional states.\nThe Company is an indirect wholly owned subsidiary of Travelers, a financial services holding company engaged, through its subsidiaries, principally in four business segments: (i) Investment Services; (ii) Consumer Finance Services; (iii) Life Insurance Services; and (iv) Property & Casualty Insurance Services. The periodic reports of Travelers provide additional business and financial information concerning that company and its consolidated subsidiaries.\nInsurance Regulations\nThe National Association of Insurance Commissioners (the NAIC) risk-based capital (RBC) requirements are used as early warning tools by the NAIC and states to identify companies that merit further regulatory action.\nFor this purpose, an insurer's surplus is measured in relation to its specific asset and liability profiles. A company's risk-based capital is calculated by applying factors to various asset, premium and reserve items, where the factor is higher for those items with greater underlying risk and lower for less risky items.\nThe formula for life insurers calculates baseline life risk-based capital (LRBC) as a mathematical combination of amounts for the following four categories of risk: asset risk (i.e., the risk of asset default), insurance risk (i.e., the risk of adverse mortality and morbidity experience), interest rate risk (i.e., the risk of loss due to changes in interest rates) and business risk (i.e., normal business and management risk). Fifty percent of the baseline LRBC calculation is defined as Authorized Control Level RBC. The insurer's ratio of adjusted capital to Authorized Control Level RBC (the RBC ratio) can then be calculated from data contained in the annual statement. Adjusted capital is defined as the sum of statutory capital, statutory surplus, asset valuation reserve, voluntary investment reserves and one-half of the policyholder dividend liability.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nWithin certain ratio ranges, regulators have increasing authority to take action as the RBC ratio decreases. There are four levels of regulatory action. The first of these levels is the \"company action level.\" The RBC ratio for this level is less than 200% but greater than 150%. Insurers within this level must submit a comprehensive plan (an RBC plan) to the commissioner. The next level is the \"regulatory action level.\" The RBC ratio for this level is less than 150% but greater than 100%. An insurer within this level must submit an RBC plan, is subject to an examination of assets, liabilities and operations by the commissioner, and is subject to provisions of any corrective order subsequently issued by the commissioner. The third level is the \"authorized control level.\" The RBC ratio for this level is less than 100% but greater than 70%. At this level, the commissioner takes action as described under \"regulatory action level\" and may cause the insurer to be placed under regulatory control if such action is deemed to be in the best interests of policyholders. The fourth level is the \"mandatory control level.\" The RBC ratio for this level is less than 70%, and the commissioner takes actions necessary to place the insurer under regulatory control.\nThe RBC formula has not been designed to differentiate among adequately capitalized companies which operate with higher levels of capital. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank such companies. At December 31, 1995, the Company had adjusted capital in excess of amounts requiring any regulatory action at any of the four levels.\nThe Company is domiciled in the State of Connecticut. Connecticut law requires notice to and prior approval by the Connecticut Insurance Department for the declaration or payment of any dividend, which together with other distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net gain from operations for the twelve-month period ending on the preceding December 31st, in each case determined in accordance with statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. Dividend payments from the Company to its parent are limited to $16 million in 1996 without prior approval of the Connecticut Insurance Department.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nTIC, the Company's parent, owns buildings containing approximately 1,426,000 square feet of office space located in Hartford, Connecticut and vicinity, serving as the home office of The Travelers Insurance Group Inc. (TIGI).\nTIC also owns a building in Norcross, Georgia. TIGI's information systems department occupies the entire building which is approximately 147,000 square feet of space.\nIn addition, as of December 31, 1995, TIC leases a total of approximately 4,950,000 square feet of office space at 247 locations throughout the United States.\nManagement believes that these facilities are suitable and adequate for the Company's current needs. The Company reimburses TIC for use of this space on a cost allocation method based generally on estimated usage by department.\nThe foregoing discussion does not include information on investment properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is a defendant or co-defendant in various litigation matters. Although there can be no assurances, as of December 31, 1995, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on its results of operations, financial condition or liquidity.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nOmitted pursuant to General Instruction J(2)(c) of Form 10-K.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe Company has 100,000 authorized shares of common stock, of which 30,000 are issued and outstanding as of December 31, 1995. All shares are held by TIC, and there exists no established public trading market for the common equity of the Company. The Company paid no dividends to its parent in 1995 and 1994. See Note 5 of Notes to Consolidated Financial Statements for dividend restrictions.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nOmitted pursuant to General Instruction J(2)(a) of Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nManagement's narrative analysis of the results of operations is presented in lieu of Management's Discussion and Analysis of Financial Condition and Results of Operations, pursuant to General Instruction J(2)(a) of Form 10-K.\nRESULTS OF OPERATIONS\nThe Company primarily writes single premium group annuity close-out contracts and individual structured settlement annuities. The single premium group annuity contracts are typically purchased by employer-sponsored pension plans upon termination of the plan, asset reversion or other significant plan changes. As a result, sales activity can vary significantly from period to period.\nThe individual structured settlement contracts are purchased by affiliates, The Travelers Indemnity Company and its subsidiaries, in connection with the settlement of certain of their policyholder obligations. All structured settlement contracts are issued through a separate account of the Company. Accordingly, the Company's other revenues include structured settlement policyholder revenues net of the related benefits and expenses.\nIn 1995, the Company commenced writing individual life and deferred annuity business in certain states and is in the process of obtaining further regulatory approvals to write these products in additional states.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nNet income for 1995 was $28.9 million, compared to $18.3 million for 1994. Excluding realized investment gains and losses, operating earnings decreased from $19.8 million in 1994 to $16.8 million in 1995, reflecting decreased net investment income yields on the invested assets supporting both structured settlement and group annuity contracts, and an increase in administrative expenses largely associated with expansion of distribution channels, partially offset by improved mortality experience.\nPremiums and deposits amounted to $41.6 million for 1995, level with the $41.1 million of production for 1994, reflecting the writing of new business, partially offset by a decline in structured settlement and group annuity sales. (Deposits relate to universal life, individual deferred annuity and separate account receipts, and are excluded from revenue).\nPolicyholder benefit reserves, which includes future policy benefits, contractholder funds and separate accounts, aggregated $1.540 billion at December 31, 1995, up from $1.499 billion at December 31, 1994 primarily as a result of accumulated growth in the structured settlement separate account and 1995 sales of individual life and deferred annuity products.\nAt December 31, 1995 and 1994, the Company had real estate held for sale and mortgage loan investments totaling $134.8 million and $159.2 million, respectively. The Company is continuing its strategy to dispose of these real estate assets and some of the mortgage loans and to reinvest the proceeds to obtain current market yields. Underperforming assets include delinquent mortgage loans, loans in the process of foreclosure, foreclosed loans and loans modified at interest rates below market. In 1995 and 1994, the Company had sales of real estate held for sale and mortgage loans of approximately $4.7 million and $6.3 million, respectively.\nOUTLOOK\nThe Company should benefit from the growth in the aging population who are becoming more focused on the need to accumulate adequate savings for retirement, to protect these savings and to plan for the transfer of wealth to the next generation. The Company is well-positioned to benefit from the favorable long-term demographic trends through its strong financial position, widespread brand name recognition and array of competitive life and annuity products.\nHowever, competition in both product pricing and customer service is intensifying. While there has been some consolidation within the industry, other financial services organizations are increasingly involved in the sale and\/or distribution of insurance products. Deregulation of the banking industry, including possible reform of restrictions on entry into the insurance business, will likely accelerate this trend. In order to strengthen its competitive position, The Company expects to maintain a current product portfolio, further diversify its distribution channels, and retain its healthy financial position through strong sales growth in a cost-efficient manner.\nIn addition, during the past year significant tax reform discussions have occurred. Some of the proposed discussions could reduce or eliminate the need for tax deferral features and thus the need for products that are currently in the Company's portfolio. New legislation could also create the need for new products or increase the demand for some existing products. At this time it is not clear what the eventual outcome of this national debate will be or what impact, if any, it may have on the Company's sales and business retention.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nFUTURE APPLICATION OF ACCOUNTING STANDARDS\nStatement of Financial Accounting Standards No. 121, \"Accounting for Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" 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 the write down to fair value when long-lived assets to be held and used are impaired. It also requires long-lived assets to be disposed of (e.g., real estate held for sale) to be carried at the lower of cost or fair value less cost to sell and does not allow such assets to be depreciated. The adoption of this statement, effective January 1, 1996, did not have a material effect on results of operations, financial condition or liquidity.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (FAS 123). This statement addresses alternative accounting treatments for stock-based compensation, such as stock options and restricted stock. FAS 123 permits either expensing the value of stock-based compensation over the period earned, or disclosing in the financial statement footnotes the pro forma impact to net income as if the value of stock-based compensation awards had been expensed. The value of awards would be measured at the grant date based upon estimated fair value, using option pricing models. The requirements of this statement will be effective for 1996 financial statements, although earlier adoption is permissible if an entity elects to expense the cost of stock-based compensation. The Company, along with affiliated companies, participates in stock option and incentive plans sponsored by Travelers. The Company is currently evaluating the disclosure requirements and expense recognition alternatives addressed by this statement.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY\nANNUAL REPORT ON FORM 10-K\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIndex\nIndependent Auditors' Report\nThe Board of Directors and Shareholder of The Travelers Life and Annuity Company:\nWe have audited the accompanying balance sheet of The Travelers Life and Annuity Company as of December 31, 1995 and 1994, and the related statements of operations and 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 financial position of The Travelers Life and Annuity 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 3 to the financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" in 1994.\n\/s\/KPMG Peat Marwick LLP Hartford, Connecticut January 16, 1996\nReport of Independent Accountants\nTo the Board of Directors and Shareholder of The Travelers Life and Annuity Company:\nWe have audited the statements of operations and retained earnings and cash flows of The Travelers Life and Annuity Company for the year ended December 31, 1993. These financial statements are the responsibility of Company management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of The Travelers Life and Annuity Company for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\n\/s\/ COOPERS & LYBRAND L.L.P. Hartford, Connecticut September 16, 1994\nTHE TRAVELERS LIFE AND ANNUITY COMPANY STATEMENT OF OPERATIONS AND RETAINED EARNINGS\nSee notes to financial statements.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY BALANCE SHEET\nSee notes to financial statements.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY STATEMENT OF CASH FLOWS Increase (Decrease) in Cash\nSee notes to financial statements.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS\n1. NATURE OF OPERATIONS\nThe Travelers Life and Annuity Company (the Company) is a wholly owned subsidiary of The Travelers Insurance Company (TIC), which is an indirect, wholly owned subsidiary of Travelers Group Inc. (Travelers).\nThe Company primarily writes single premium group annuity close-out contracts and individual structured settlement annuities. The single premium group annuity contracts are typically purchased by employer-sponsored pension plans upon termination of the plan, asset reversion or other significant plan changes. The individual structured settlement contracts are purchased by affiliates, The Travelers Indemnity Company and its subsidiaries, in connection with the settlement of certain of its policyholder obligations. In 1995, the Company also commenced writing individual life and deferred annuity business.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nSignificant accounting policies used in the preparation of the accompanying financial statements follow.\nBasis of presentation\nIn December 1992, Primerica Corporation (Primerica) acquired approximately 27% of The Travelers Corporation's common stock (the 27% Acquisition). The 27% Acquisition was accounted for as a purchase. Effective December 31, 1993, Primerica acquired the approximately 73% of The Travelers Corporation common stock which it did not already own, and The Travelers Corporation was merged into Primerica, which was renamed Travelers Group Inc. This was effected through the exchange of .80423 shares of Travelers common stock for each share of The Travelers Corporation common stock (the Merger). All subsidiaries of The Travelers Corporation were contributed to The Travelers Insurance Group Inc. (TIGI).\nThe 27% Acquisition and the Merger were accounted for as a \"step acquisition\", and the purchase accounting adjustments were \"pushed down\" as of December 31, 1993 to the subsidiaries of TIGI, including the Company, and reflect adjustments of assets and liabilities of the Company to their fair values determined at each acquisition date (i.e., 27% of values at December 31, 1992 as carried forward and 73% of the values at December 31, 1993). These assets and liabilities were recorded at December 31, 1993 based upon management's then best estimate of their fair values at the respective dates. Evaluation and appraisal of assets and liabilities, including investments, the value of insurance in force, other insurance assets and liabilities and related deferred federal income taxes was completed during 1994. The excess of the 27% share of assigned value of identifiable net assets over cost at December 31, 1992, which was allocated to the Company through \"pushdown\" accounting, was approximately $1.3 million and is being amortized over ten years on a straight-line basis.\nThe statements of operations and retained earnings and of cash flows and the related accompanying notes for the years ended December 31, 1995 and 1994, which are presented on a purchase accounting basis, are separated from the corresponding 1993 information, which is presented on a historical accounting basis, to indicate the difference in valuation bases.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued\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 benefits and expenses during the reporting period. Actual results could differ from those estimates.\nCertain prior year amounts have been reclassified to conform with the 1995 presentation.\nInvestments\nFixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities are valued based upon quoted market prices, or if quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. Fixed maturities are classified as \"available for sale\" and are reported at fair value, with unrealized gains and losses, net of income taxes, charged or credited directly to shareholder's equity.\nEquity securities, which include common and nonredeemable preferred stocks, are carried at market values that are based primarily on quoted market prices. Changes in market values of equity securities are charged or credited directly to shareholder's equity, net of applicable income taxes.\nMortgage loans are carried at amortized cost. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair market value of the underlying collateral. Impaired loans were insignificant at December 31, 1995.\nReal estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Fair value was established at time of foreclosure by appraisers, either internal or external, using discounted cash flow analyses and other acceptable techniques. Thereafter, an allowance for losses on real estate held for sale is established if the carrying value of the property exceeds its current fair value less estimated costs to sell. There was no such allowance at December 31, 1995.\nAccrual of income is suspended on fixed maturities or mortgage loans that are in default, or on which it is likely that future payments will not be made as scheduled. Interest income on investments in default is recognized only as payment is received.\nInvestment Gains and Losses\nRealized investment gains and losses are included as a component of pretax revenues based upon specific identification of the investments sold on the trade date and, prior to the Merger, included adjustments to investment valuation reserves. These adjustments reflected changes considered to be other than temporary in the net realizable value of investments. Also included are gains and losses arising from the remeasurement of the local currency value of foreign investments to U.S. dollars, the functional currency of the Company.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued\nSeparate Accounts\nSeparate account liabilities primarily represent structured settlement annuity obligations, which provide guaranteed levels of return or benefits to contractholders. The separate account assets supporting these obligations, which are legally segregated and are not subject to claims that arise out of any other business of the Company, are carried at amortized cost. Earnings on structured settlement contracts, generally net investment income less policyholder benefits and operating expenses, are included in other revenues.\nIn addition, the Company has other separate accounts, representing funds for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholders. Each of these accounts have specific investment objectives. The assets and liabilities of these accounts are carried at market value, and amounts assessed to the contractholders for management services are included in revenues. Deposits, net investment income and realized investment gains and losses for these accounts are excluded from revenues, and related liability increases are excluded from benefits and expenses.\nDeferred Acquisition Costs and Value of Insurance In Force\nCosts of acquiring individual life insurance and annuity business, principally commissions and certain expenses related to policy issuance, underwriting and marketing, all of which vary with and are primarily related to the production of new business, are deferred. Acquisition costs relating to traditional life insurance are amortized over the period of anticipated premiums; universal life in relation to estimated gross profits; and annuity contracts employing a level yield method. A 10- to 25-year amortization period is used for life insurance, and a 10- to 15-year period is employed for annuities. Deferred acquisition costs are reviewed periodically for recoverability to determine if any adjustment is required.\nThe value of insurance in force represents the actuarially determined present value of anticipated profits to be realized from annuities contracts at the date of the Merger using the same assumptions that were used for computing related liabilities where appropriate. The value of insurance in force was the actuarially determined present value of the projected future profits discounted at an interest rate of 16% for the business acquired. The value of the business in force is amortized over the contract period using current interest crediting rates to accrete interest and using an amortization method based on a level yield method. The value of insurance in force is reviewed periodically for recoverability to determine if any adjustment is required.\nFuture Policy Benefits\nBenefit reserves represent liabilities for future insurance policy benefits. Benefit reserves for life insurance and annuity policies have been computed based upon mortality, morbidity, persistency and interest assumptions applicable to these coverages, which range from 4.5% to 7.5%, including a provision for adverse deviation. These assumptions consider Company experience and industry standards and may be revised if it is determined that the future experience will differ substantially from that previously assumed. The assumptions vary by plan, age at issue, year of issue and duration.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued\nContractholder Funds\nContractholder funds represent receipts from the issuance of universal life and certain individual annuity contracts. Such receipts are considered deposits on investment contracts that do not have substantial mortality or morbidity risk. Account balances are also increased by interest credited and reduced by withdrawals, mortality charges and administrative expenses charged to the contractholders. Calculations of contractholder account balances reflect lapse, withdrawal and interest rate assumptions based on contract provisions, the Company's experience and industry standards. Interest rates credited to contractholder funds range from 4.2% to 6.5%.\nPermitted Statutory Accounting Practices\nThe Company, domiciled in the State of Connecticut, prepares statutory financial statements in accordance with the accounting practices prescribed or permitted by the State of Connecticut Insurance Department. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The impact of any permitted accounting practices on the statutory surplus of the Company is not material.\nPremiums\nPremiums are recognized as revenues when due. Reserves are established for the portion of premiums that will be earned in future periods.\nOther Revenues\nOther revenues include surrender, mortality and administrative charges and fees as earned on investment and other insurance contracts. Other revenues also include structured settlement policyholder revenues, which relate to contracts issued through a separate account of the Company, net of the related policyholder benefits and expenses.\nFederal Income Taxes\nThe provision for federal income taxes is comprised of two components, current income taxes and deferred income taxes. Deferred federal income taxes arise from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities. The deferred federal income tax asset is recognized to the extent that future realization of the tax benefit is more likely than not, with a valuation allowance for the portion that is not likely to be recognized.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued\nAccounting Standards not yet Adopted\nStatement of Financial Accounting Standards No. 121, \"Accounting for Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" 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 the write down to fair value when long-lived assets to be held and used are impaired. It also requires long-lived assets to be disposed of (e.g., real estate held for sale) to be carried at the lower of cost or fair value less cost to sell and does not allow such assets to be depreciated. The adoption of this statement, effective January 1, 1996, did not have a material effect on results of operations, financial condition or liquidity.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (FAS 123). This statement addresses alternative accounting treatments for stock-based compensation, such as stock options and restricted stock. FAS 123 permits either expensing the value of stock-based compensation over the period earned or disclosing in the financial statement footnotes the pro forma impact to net income as if the value of stock-based compensation awards had been expensed. The value of awards would be measured at the grant date based upon estimated fair value, using option pricing models. The requirements of this statement will be effective for 1996 financial statements, although earlier adoption is permissible if an entity elects to expense the cost of stock-based compensation. The Company, along with affiliated companies, participates in stock option and incentive plans sponsored by Travelers. The Company is currently evaluating the disclosure requirements and expense recognition alternatives addressed by this statement.\n3. CHANGES IN ACCOUNTING PRINCIPLES\nAccounting by Creditors for Impairment of a Loan\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" which describe how impaired loans should be measured when determining the amount of a loan loss accrual. These statements amended existing guidance on the measurement of restructured loans in a troubled debt restructuring involving a modification of terms. Their adoption did not have a material impact on the Company's financial condition, results of operations or liquidity.\nAccounting for Certain Debt and Equity Securities\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (FAS 115), which addresses accounting and reporting for investments in equity securities that have a readily determinable fair value and for all debt securities. Investment securities have been classified as \"available for sale\" and are reported at fair value, with unrealized gains and losses, net of income taxes, charged or credited directly to shareholder's equity. Previously, securities classified as available for sale were carried at the lower of aggregate cost or market value. Initial adoption of this standard resulted in an increase of approximately $530 thousand (net of taxes) to net unrealized gains in shareholder's equity. See note 12 for additional disclosures.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n4. REINSURANCE\nThe Company participates in reinsurance in order to limit losses, minimize exposure to large risks, provide capacity for future growth and to effect business-sharing arrangements. The Company remains primarily liable as the direct insurer on all risks reinsured.\nLife insurance in force ceded to affiliates at December 31, 1995 and 1994 was $97.7 million and $106.0 million, respectively. At December 31, 1995 and 1994, $601.2 million and $0, respectively, was ceded to non-affiliates.\n5. SHAREHOLDER'S EQUITY\nUnrealized Investment Gains (Losses)\nAn analysis of the change in unrealized gains and losses on investments is shown in note 12.\nAdditional Paid-in Capital\nAs a result of the finalization of the evaluations and appraisals used to assign fair value to assets and liabilities under purchase accounting, additional paid-in capital was increased by $1.3 million in 1994. It was decreased by $70.4 million in 1993 based upon the initial evaluations and appraisals.\nShareholder's Equity and Dividend Availability\nStatutory net income was $23.0 million and $5.7 million for the years ended December 31, 1995 and 1994, respectively. Statutory net loss was $23.0 million for the year ended December 31, 1993.\nStatutory capital and surplus was $257.8 million and $233.0 million at December 31, 1995 and 1994, respectively.\nThe Company is currently subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to its parent without prior approval of insurance regulatory authorities. Statutory surplus of $16.4 million is available in 1996 for dividend payments by the Company without prior approval of the Connecticut Insurance Department.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n6. DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company has, in the normal course of business, provided fixed rate loan commitments and commitments to partnerships. The Company does not hold or issue derivative instruments for trading purposes.\nThe off-balance-sheet risks of fixed rate loan commitments, commitments to partnerships and forward contracts were not significant at December 31, 1995 and 1994.\nFair Value of Certain Financial Instruments\nThe Company uses various financial instruments in the normal course of its business. Fair values of financial instruments which are considered insurance contracts are not required to be disclosed and are not included in the amounts discussed.\nAt December 31, 1995, investments in fixed maturities had a carrying value and a fair value of $724.6 million, compared with a carrying value and a fair value of $559.1 million at December 31, 1994. See note 12.\nAt December 31, 1995 and 1994, mortgage loans had a carrying value of $125.8 million and $152.4 million, respectively, which approximates fair value. In estimating fair value, the Company used interest rates reflecting the higher returns required in the real estate financing market.\nThe carrying values of $1.9 million and $2.4 million of financial instruments classified as other assets approximated their fair values at December 31, 1995 and 1994, respectively. The carrying values of $55.3 million and $14.2 million of financial instruments classified as other liabilities also approximated their fair values at December 31, 1995 and 1994, respectively. Fair value is determined using various methods including discounted cash flows, as appropriate for the various financial instruments.\nThe assets of separate accounts providing a guaranteed return had a carrying value and a fair value of $869.1 million and $923.0 million, respectively, at December 31, 1995, compared to a carrying value and a fair value of $820.4 million and $757.2 million, respectively, at December 31, 1994. The liabilities of separate accounts providing a guaranteed return had a carrying value and a fair value of $839.1 million and $766.3 million, respectively, at December 31, 1995, compared to a carrying value and a fair value of $808.2 million and $681.4 million, respectively, at December 31, 1994.\nThe carrying values of short-term securities and investment income accrued approximated their fair values.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n7. COMMITMENTS AND CONTINGENCIES\nFinancial Instruments with Off-Balance-Sheet Risk\nSee note 6 for a discussion of financial instruments with off-balance- sheet risk.\nLitigation\nThe Company is a defendant in various litigation matters. Although there can be no assurances, as of December 31, 1995, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on its results of operations, financial condition or liquidity.\n8. BENEFIT PLANS\nPension Plans\nThe Company participates in qualified and nonqualified, noncontributory defined benefit pension plans sponsored by an affiliate. Benefits for the qualified plan are based on an account balance formula. Under this formula, each employee's accrued benefit can be expressed as an account that is credited with amounts based upon the employee's pay, length of service and a specified interest rate, all subject to a minimum benefit level. This plan is funded in accordance with the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. For the nonqualified plan, contributions are based on benefits paid. The Company's share of net pension expense was not significant for 1995, 1994 or 1993.\nOther Benefit Plans\nIn addition to pension benefits, the Company provides certain health care and life insurance benefits for retired employees through a plan sponsored by TIGI. Covered employees may become eligible for these benefits if they reach retirement age while working for the Company. These retirees may elect certain prepaid health care benefit plans. Life insurance benefits generally are set at a fixed amount. The cost recognized by the Company for these benefits represents its allocated share of the total costs of the plan, net of employee contributions. The Company's share of the total cost of the plan for 1995, 1994 and 1993 was not significant.\nThe Merger resulted in a change in control of The Travelers Corporation as defined in the applicable plans, and provisions of some employee benefit plans secured existing compensation and benefit entitlements earned prior to the change in control, and provided a salary and benefit continuation floor for employees whose employment was affected. These merger-related costs were assumed by TIGI.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n8. BENEFIT PLANS\nSavings, Investment and Stock Ownership Plan\nUnder the savings, investment and stock ownership plan available to substantially all employees of TIGI, the Company matches a portion of employee contributions. Effective April 1, 1993, the match decreased from 100% to 50% of an employee's first 5% contribution and a variable match based on the profitability of TIGI and its subsidiaries was added. The Company's matching obligation was not significant for 1995, 1994 or 1993.\n9. RELATED PARTY TRANSACTIONS\nThe principal banking functions, including payment of salaries and expenses, for certain subsidiaries and affiliates of TIGI, including the Company, are handled by TIC. Settlements for these functions between TIC and its affiliates are made regularly. TIC provides various employee benefit coverages to certain subsidiaries of TIGI. The premiums for these coverages were charged in accordance with cost allocation procedures based upon salaries or census. In addition, investment advisory and management services, data processing services and claims processing services are provided by affiliated companies. Charges for these services are shared by the companies on cost allocation methods based generally on estimated usage by department.\nTIGI and its subsidiaries maintain a short-term investment pool in which the Company participates. The position of each company participating in the pool is calculated and adjusted daily. At December 31, 1995 and 1994, the pool totaled approximately $2.2 billion and $1.5 billion, respectively. The Company's share of the pool amounted to $49.5 million and $44.5 million at December 31, 1995 and 1994, respectively, and is included in short-term securities in the balance sheet.\nThe Company's TTM Modified Guaranteed Annuity Contracts are subject to a limited guarantee agreement by TIC in a principal amount of up to $100 million. TIC's obligation is to pay in full to any owner or beneficiary of the TTM Modified Guaranteed Annuity Contracts principal and interest as and when due under the annuity contract to the extent that the Company fails to make such payment. In addition, TIC guarantees that the Company will maintain a minimum statutory capital and surplus level.\nThe Company sells structured settlement annuities to its affiliates, The Travelers Indemnity Company and its subsidiaries. Such deposits were $36.6 million, $37.6 million and $48.4 million for 1995, 1994 and 1993, respectively.\nThe Company began marketing variable annuity products through its affiliate, Smith Barney, Inc., in 1995. Deposits related to these products were $20.5 million in 1995.\nMost leasing functions for TIGI and its subsidiaries are handled by TIC. Leasing expenses are shared by the companies on a cost allocation method based generally on estimated usage by department.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n10. FEDERAL INCOME TAXES\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n10. FEDERAL INCOME TAXES, Continued\nThe net deferred tax assets at December 31, 1995 and 1994 were comprised of the tax effects of temporary differences related to the following assets and liabilities:\nStarting in 1994 and continuing for at least five years, TIC and its life insurance subsidiaries, including the Company, will file a consolidated federal income tax return. Federal income taxes are allocated to each member on a separate return basis adjusted for credits and other amounts required by the consolidation process. Any resulting liability will be paid currently to TIC. Any credits for losses will be paid by TIC to the extent that such credits are for tax benefits that have been utilized in the consolidated federal income tax return.\nA net deferred tax asset valuation allowance of $2.1 million has been established to reduce the deferred tax asset on investment losses to the amount that, based upon available evidence, is more likely than not to be realized. Reversal of the valuation allowance is contingent upon the recognition of future capital gains in the Company's consolidated life insurance company federal income tax return through 1998, and the consolidated federal income tax return of Travelers commencing in 1999, or a change in circumstances which causes the recognition of the benefits to become more likely than not. There was no change in the valuation allowance during 1995. The initial recognition of any benefit provided by the reversal of the valuation allowance will be recognized by reducing goodwill.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n10. FEDERAL INCOME TAXES, Continued\nIn management's judgment, the $41.2 million \"net deferred tax asset after valuation allowance\" as of December 31, 1995, is fully recoverable against expected future years' taxable ordinary income and capital gains. At December 31, 1995, the Company has no ordinary or capital loss carryforwards.\nThe \"policyholders surplus account\", which arose under prior tax law, is generally that portion of the gain from operations that has not been subjected to tax, plus certain deductions. The balance of this account, which, under provisions of the Tax Reform Act of 1984, will not increase after 1983, is estimated to be $2.0 million. This amount has not been subjected to current income taxes but, under certain conditions that management considers to be remote, may become subject to income taxes in future years. At current rates, the maximum amount of such tax (for which no provision has been made in the financial statements) would be approximately $700 thousand.\n11. NET INVESTMENT INCOME\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES)\nRealized investment gains (losses) for the periods were as follows:\nChanges in net unrealized investment gains (losses) that are included as a separate component of shareholder's equity were as follows:\nThe initial adoption of FAS 115 resulted in an increase of approximately $530 thousand (net of taxes) to net unrealized investment gains in 1994.\nFixed Maturities\nProceeds from sales of fixed maturities classified as available for sale were $460.0 million and $41.7 million in 1995 and 1994, respectively. Gross gains of $7.9 million and $869 thousand and gross losses of $10.3 million and $1.9 million in 1995 and 1994, respectively, were realized on those sales.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nPrior to December 31, 1993, fixed maturities that were intended to be held to maturity were recorded at amortized cost and classified as held for investment. Proceeds from sales of such securities were $16.4 million in 1993, resulting in gross realized gains of $617 thousand.\nPrior to December 31, 1993, the carrying values of the trading portfolio fixed maturities were adjusted to market value as it was likely they would be sold prior to maturity. Sales of trading portfolio fixed maturities were $96.6 million in 1993, resulting in gross realized gains of $12.4 million.\nThe amortized cost and market values of investments in fixed maturities were as follows:\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nThe amortized cost and market value of fixed maturities available for sale at December 31, 1995, by contractual maturity, are shown below. 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.\nThe Company makes significant investments in collateralized mortgage obligations (CMOs). CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The Company's investment strategy is to purchase CMO tranches which are protected against prepayment risk, primarily planned amortization class (PAC) tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of scenarios. The Company does invest in other types of CMO tranches if a careful assessment indicates a favorable risk\/return tradeoff. The Company does not purchase residual interests in CMOs.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nAt December 31, 1995 and 1994, the Company held CMOs with a market value of $68.6 million and $55.5 million, respectively. Approximately 94% and 96% of the Company's CMO holdings are fully collateralized by GNMA, FNMA or FHLMC securities at December 31, 1995 and 1994, respectively. Virtually all of these securities are rated AAA.\nEquity Securities\nThe cost and market values of investments in equity securities were as follows:\nProceeds from sales of equity securities were $11.8 million and $9.4 million in 1995 and 1994, respectively. Gross gains of $4.9 million and $2.8 million and gross losses of $474 thousand and $369 thousand in 1995 and 1994, respectively, were realized on those sales.\nMortgage loans and real estate held for sale\nUnderperforming assets include delinquent mortgage loans, loans in the process of foreclosure, foreclosed loans and loans modified at interest rates below market. The Company continues its strategy, adopted in conjunction with the Merger, to dispose of these real estate assets and some of the mortgage loans and to reinvest the proceeds to obtain current market yields.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nAt December 31, 1995 and 1994, the Company's mortgage loan and real estate held for sale portfolios consisted of the following:\nAggregate annual maturities on mortgage loans at December 31, 1995 are as follows:\nConcentrations\nAt December 31, 1995 and 1994, the Company had no concentration of credit risk in a single investee exceeding 10% of shareholder's equity.\nThe Company participates in a short-term investment pool maintained by TIGI and its subsidiaries. See note 9.\nIncluded in fixed maturities are below investment grade assets totaling $59.0 million and $51.1 million at December 31, 1995 and 1994, respectively. The Company defines its below investment grade assets as those securities rated \"Ba1\" or below by external rating agencies, or the equivalent by internal analysts when a public rating does not exist. Such assets include publicly traded below investment grade bonds and certain other privately issued bonds that are classified as below investment grade loans.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nThe Company also had significant concentrations of investments, primarily fixed maturities, in the following industries:\nBelow investment grade assets included in the totals of the previous table were as follows:\nConcentrations of mortgage loans by property type at December 31, 1995 and 1994 were as follows:\nThe Company monitors creditworthiness of counterparties to all financial instruments by using controls that include credit approvals, limits and other monitoring procedures. Collateral for fixed maturities often includes pledges of assets, including stock and other assets, guarantees and letters of credit. The Company's underwriting standards with respect to new mortgage loans generally require loan to value ratios of 75% or less at the time of mortgage origination.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n12. INVESTMENTS AND INVESTMENT GAINS (LOSSES), Continued\nInvestment Valuation Reserves\nThere were no investment valuation reserves at December 31, 1995, 1994 and 1993. Investment valuation reserve activity during 1993 was as follows:\nIncreases in the investment valuation reserves were reflected as realized investment losses.\nNonincome Producing\nInvestments included in the balance sheets that were nonincome producing for the preceding 12 months were insignificant.\nRestructured Investments\nThe Company had mortgage loan and debt securities which were restructured at below market terms totaling approximately $17.7 million and $17.4 million at December 31, 1995 and 1994, respectively. At December 31, 1993, the Company's restructured assets were recorded at purchase accounting value. The new terms typically defer a portion of contract interest payments to varying future periods. The accrual of interest is suspended on all restructured assets, and interest income is reported only as payment is received. Gross interest income on restructured assets that would have been recorded in accordance with the original terms of such assets amounted to $4.9 million in 1995 and $5.2 million in 1994. Interest on these assets, included in net investment income, aggregated $2.0 million in 1995 and $1.4 million in 1994.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS, Continued\n13. LIFE AND ANNUITY DEPOSIT FUNDS AND RESERVES\nAt December 31, 1995, the Company had $683.0 million of life and annuity deposit funds and reserves. Of that total, $671.2 million were not subject to discretionary withdrawal based on contract terms. The remaining $11.8 million were life and annuity products that were subject to discretionary withdrawal by the contractholders. Included in the amount that is subject to discretionary withdrawal were $8.2 million of liabilities that are surrenderable with market value adjustments. An additional $3.6 million of the life insurance and individual annuity liabilities are subject to discretionary withdrawals with an average surrender charge of 6.6%. The life insurance risks would have to be underwritten again if transferred to another carrier, which is considered a significant deterrent for long-term policyholders. Insurance liabilities that are surrendered or withdrawn from the Company are reduced by outstanding policy loans and related accrued interest prior to payout.\n14. RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES\nThe following table reconciles net income to net cash provided by (used in) operating activities:\n15. NONCASH INVESTING AND FINANCING ACTIVITIES\nSignificant noncash investing and financing activities include: a) the transfer of $2.6 million and $5.6 million of mortgage loans and real estate held for sale from one of the Company's separate accounts to the general account in 1995 and 1994, respectively; b) acquisition of real estate through foreclosures of mortgage loans amounting to $10.3 million and $7.7 million in 1994 and 1993, respectively; and c) increases in investment valuation reserves in 1993 for mortgage loans and real estate held for sale (see note 12).\nTHE TRAVELERS LIFE AND ANNUITY COMPANY\nGLOSSARY OF INSURANCE TERMS\nANNUITY - A contract that pays a periodic income benefit for the life of a person (the annuitant), the lives of two or more persons or for a specified period of time.\nCLAIM - Request by an insured for indemnification by an insurance company for loss incurred from an insured peril.\nCONTRACTHOLDER FUNDS - Receipts from the issuance of universal life, pension investment and certain individual annuity contracts. Such receipts are considered deposits on investment contracts that do not have substantial mortality or morbidity risks.\nDEFERRED ACQUISITION COSTS - Commissions and other selling expenses, which vary with and are primarily related to the production of business, are deferred and amortized to achieve a matching of revenues and expenses when reported in financial statements prepared in accordance with GAAP.\nDEFINED BENEFIT PLANS - Type of pension plan under which benefits are fixed in advance by formula, and contributions vary.\nDEPOSITS AND OTHER CONSIDERATIONS - Consist of cash value deposits and charges for mortality risk and expenses associated with universal life insurance, annuities and group pensions.\nGENERAL ACCOUNT - All of an insurer's assets other than those allocated to separate accounts.\nINSURANCE - Mechanism for contractually shifting burdens of a number of risks by pooling them.\nMORBIDITY - The rate at which people become diseased, mentally or physically, or physically impaired.\nMORTALITY - The rate at which people die.\nREINSURANCE - The practice whereby one insurer, called the reinsurer, in consideration of a premium paid to such insurer, agrees to indemnify another insurer, called the ceding company, for part or all of the liability assumed by the ceding company under one or more policies or contracts of insurance which it has issued.\nRETENTION - The amount of exposure an insurance company retains on any one risk or group of risks.\nSEPARATE ACCOUNTS - Funds for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholders. The assets of these separate accounts are legally segregated and not subject to claims that arise out of any other business of the insurance company.\nSTATUTORY ACCOUNTING PRACTICES - The rules and procedures prescribed or permitted by United States state insurance regulatory authorities for recording transactions and preparing financial statements. Statutory accounting practices generally reflect a modified going concern basis of accounting.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY\nSTATUTORY CAPITAL AND SURPLUS - As determined under statutory accounting practices, the amount remaining after all liabilities, including loss reserves, are subtracted from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by a state to be taken into account in determining the insurer's financial condition for statutory purposes. Statutory surplus is also referred to as \"surplus\" or \"surplus as regards policyholders\" for statutory accounting purposes.\nSTRUCTURED SETTLEMENTS - Periodic payments to an injured person or survivor for a determined number of years or for life, typically in settlement of a claim under a liability policy.\nUNDERWRITING - The insurer's or reinsurer's process of reviewing applications for insurance coverage, and the decision whether to accept all or part of the coverage and determination of the applicable premiums; also refers to the acceptance of such coverage.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K 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.\nOmitted pursuant to General Instruction J(2)(c) of Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation.\nOmitted 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.\nOmitted pursuant to General Instruction J(2)(c) of Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nOmitted pursuant to General Instruction J(2)(c) of Form 10-K.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the 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) Documents filed (1) Financial Statements. See index on page 6 of this report. (2) Financial Statement Schedules. See index on page 37 of this report. (3) Exhibits. See Exhibit Index on page 43.\n(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, on the 28th day of March, 1996.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY (Registrant)\nBy: \/s\/Jay S. Fishman ----------------- Jay S. Fishman Vice Chairman 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 registrant and in the capacities indicated on the 28th day of March, 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: NONE\nNo Annual Report to Security Holders covering the registrant's last fiscal year or proxy material with respect to any meeting of security holders has been sent, or will be sent, to security holders.\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are inapplicable for this filing.\n* See index on page 6\nIndependent Auditors' Report\nThe Board of Directors and Shareholder of The Travelers Life and Annuity Company:\nUnder date of January 16, 1996, we reported on the balance sheet of The Travelers Life and Annuity Company as of December 31, 1995 and 1994, and the related statements of operations and retained earnings and cash flows for each of the years in the two-year period ended December 31, 1995, as contained in this Form 10-K. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedules appearing on pages 40, 41 and 42 in this Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic 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, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" in 1994.\n\/s\/ KPMG PEAT MARWICK LLP\nHartford, Connecticut January 16, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholder of The Travelers Life and Annuity Company:\nIn connection with our audit of the statements of operations and retained earnings and cash flows of The Travelers Life and Annuity Company for the year ended December 31, 1993, which financial statements are included in this Form 10-K, we have also audited those portions of the financial statements schedules listed in the index on page 37 of this Form 10-K which pertain to the operations of The Travelers Life and Annuity Company for the year ended December 31, 1993.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ COOPERS & LYBRAND L.L.P.\nHartford, Connecticut January 24, 1994\nSCHEDULE I THE TRAVELERS LIFE AND ANNUITY COMPANY Summary of Investments - Other Than Investments in Related Parties December 31, 1995 (in thousands)\n(1) Determined in accordance with methods described in notes 2 and 12 on pages 12 and 24 of the notes to the financial statements.\nSCHEDULE III\nTHE TRAVELERS LIFE AND ANNUITY COMPANY\nSupplementary Insurance Information\n1993-1995 (in thousands)\n(a) Includes contractholder funds. (b) Expense allocations are determined in accordance with the guidelines and principles published in Regulation 33 from the Insurance Department of the State of New York. This regulation makes a reasonable allocation of all expenses to those product lines with which they are associated.\nSCHEDULE IV THE TRAVELERS LIFE AND ANNUITY COMPANY Reinsurance (in thousands)\nTHE TRAVELERS LIFE AND ANNUITY COMPANY ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 1995\nEXHIBIT INDEX","section_15":""}
{"filename":"812075_1995.txt","cik":"812075","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nGENERAL AND DEVELOPMENTS DURING FISCAL YEAR 1995\nThe Company owns and operates or franchises a total of 150 restaurants, including 80 owned and 60 franchised casual dining, full-service restaurants under the name \"Pizzeria Uno...Chicago Bar & Grill.\" The Pizzeria Uno restaurants offer a diverse, high-quality menu at moderate prices in a casual, friendly atmosphere. The restaurants feature the Company's signature Chicago-style deep- dish pizza and a selection of entrees, including thin crust pizza, pasta, fajitas, ribs, steak and chicken, as well as a variety of appetizers, salads, sandwiches and desserts. The Company's restaurants average approximately 6,200 square feet with seating for an average of approximately 180 guests. For the fiscal year ended October 1, 1995, Company-owned restaurants averaged $1,925,000 in sales. Company-owned restaurants are located predominantly in the Northeast and Mid- Atlantic states, and franchised restaurants are located throughout the United States.\nIn fiscal 1993, the Company began implementing strategic initiatives intended to strengthen its position in casual dining and to distinguish its restaurants from quick service pizza, pizza and pasta, and full-service Italian restaurants. As part of this strategy, during fiscal 1994, the Company invested approximately $2.5 million in new kitchen capabilities, including saute stations, grills and fryers, for its Company-owned restaurants enabling the Company to enhance the quality, breadth and appeal of its non-pizza menu items. To better communicate its concept and broadened menu to consumers, the Company refined the name of its restaurants to Pizzeria Uno ...Chicago Bar & Grill and upgraded the design and decor of its restaurants to be consistent with its casual dining theme. In addition, in fiscal 1993, the Company increased the size of its deep-dish pizzas to provide greater value and added additional restaurant managers in many of its higher volume units to improve overall service. The Company believes these strategic initiatives directly contributed to an increase in its average guest check and increases in comparable store sales of 3.3% in fiscal 1995.\nThe Company recently has been expanding its channels of distribution to capitalize on the Pizzeria Uno brand name and the appeal of its signature Chicago- style deep-dish pizza. Currently, the Company is distributing refrigerated and frozen Chicago-style deep-dish pizza to approximately 900 supermarkets, primarily in New England, for sale in their fresh deli counters and frozen food sections. Since January 1993, the Company has also been supplying frozen Pizzeria Uno brand, Chicago-style deep-dish pizza to American Airlines for service on its flights. Approximately 1.7 million Pizzeria Uno brand pizzas were served aboard American Airlines flights during fiscal 1995. The Company is testing a similar pizza product at Pizzeria Uno kiosks in 14 General Cinema theaters. The Company also operates four neighborhood, limited-seating take-out units under the name \"Uno...Pizza Takery.\" These units are located in strip centers, occupy approximately 2,000 square feet and offer limited seating for up to 40 customers.\nThe Company acquired the rights to the name \"Pizzeria Uno\" from the late Ike Sewell, who opened the original Pizzeria Uno restaurant in Chicago, Illinois in 1943 and is considered the originator of Chicago-style deep-dish pizza. The Company opened its first Pizzeria Uno restaurant in 1979.\nDuring the fiscal year ended October 1, 1995, the Company opened 16 full-service Company-owned restaurants, and exchanged ownership of its restaurant in Fairview Heights, Illinois for a competitor s restaurant in Orlando, Florida. Five franchised restaurants opened during the fiscal year, and five closed.\nDuring the fiscal year ending September 29, 1996, the Company anticipates opening up to 12 Company-owned full-service restaurants and up to 10 franchised restaurants. The timing of these planned openings is subject to various factors, including locating satisfactory sites and negotiating leases and franchise agreements.\nIn December, 1994, the Company purchased three Bay Street Grill restaurants located in Schaumburg, Illinois; Woodbridge, New Jersey; and Philadelphia, Pennsylvania. The three full-service, casual dining restaurants, which specialize in seafood, generated total annual sales of $6.6 million during fiscal 1995. The Company has no current plans to open additional Bay Street Grill restaurants.\nIn December 1994, the Company obtained a $50 million unsecured, revolving credit and term loan facility through Fleet Bank. The new facility replaced a $20 million unsecured revolving credit facility. The new revolving credit facility will convert to a three year term loan in December 1997, and advances under this agreement will accrue interest at either the bank's prime rate plus .25%, or alternatively, at 100-150 basis points above LIBOR.\nOn October 26, 1995, the Company entered into a five year interest rate swap agreement with Fleet Bank involving the exchange of floating rate interest payment obligations for fixed rate interest payment obligations. The notional amount of this interest rate swap agreement was $20 million. The Company entered into this agreement in order to manage interest costs and risks associated with fluctuating interest rates.\nThe Board of Directors of the Company declared a 25% stock split on November 15, 1994 payable in the form of a stock dividend on February 28, 1995 to the stockholders of record of the Company on February 8, 1995. The stock split resulted in one additional share of Common Stock being issued for each four shares of Common Stock issued and outstanding on the record date. Cash was issued in lieu of fractional shares.\nDuring June 1995, the Company completed a secondary public equity offering of 2.3 million shares of its Common Stock underwritten by Montgomery Securities. The Company received $22.6 million in net proceeds from the offering.\nIn October 1995, the Board of Directors of the Company authorized the repurchase of up to a total of 1.5 million shares of the Company s Common Stock in the market from time to time during the subsequent six months. This superseded the Board of Directors previous authorization in July 1995 for the repurchase of up to a total of 500,000 shares of the Company's Common Stock. As of November 30, 1995, the Company had repurchased a total of 494,100 shares of its Common Stock at prices between $7.00 and $8.25 per share.\nRESTAURANT CONCEPT AND MENU\nPizzeria Uno restaurants are full-service, casual dining restaurants, featuring the Company's signature Chicago-style deep-dish pizza and a diverse menu of high quality, moderately-priced menu items. The Company's target market is middle to upper-middle income individuals in the 17 to 49 year-old age group. The restaurants are\ngenerally open from 11:00 a.m. to midnight, seven days per week.\nThe restaurants feature the Company's signature Chicago-style deep-dish pizzas and a selection of entrees, including thin crust pizza, pastas, fajitas, ribs, steak and chicken, as well as a variety of appetizers, salads, sandwiches and desserts. The Company's signature product, its Chicago-style, deep-dish pizza, filled with ingredients such as fresh meats, spices, vegetables and real cheeses, is baked according to proprietary recipes. The Company believes that its proprietary recipes produce a superior pizza that is difficult to duplicate. In fiscal 1994, the Company invested approximately $2.5 million in new kitchen capabilities, including saute stations, grills and fryers, for its Company-owned restaurants enabling the Company to enhance the quality, breadth and appeal of its non-pizza items. At the end of fiscal 1995, the Company's average check per guest for full service Company-owned restaurants was approximately $9.50. For fiscal 1995, sales of alcoholic beverages accounted for approximately 18% of total restaurant sales.\nRESTAURANT DESIGN AND SITE SELECTION\nThe Company has recently upgraded the design and decor of its restaurants to be consistent with its theme as \"Pizzeria Uno...Chicago Bar & Grill.\" Pizzeria Uno restaurants are designed and decorated to provide a friendly and comfortable atmosphere expected of full-service, casual dining restaurants and distinguished from typical pizza restaurants. The decor of each restaurant emphasizes quality with wood, brick and brass. To ensure quality and compliance with Company standards, preliminary exterior design and complete interior and kitchen design for all Company-owned and franchised restaurants are prepared by the Company. The Company's current prototype free-standing restaurant occupies approximately 6,400 square feet, with a seating capacity of approximately 200 customers.\nThe Company considers the specific location of a restaurant to be critical to its long-term success and devotes significant effort to the investigation and evaluation of potential sites. One or more of the Company's executive officers inspect and approve the site for each Company-owned and franchised restaurant. Within each target market area, the Company evaluates population density and demographics, major retail and office concentration and traffic patterns. In addition, the Company evaluates visibility, accessibility, proximity to direct competition and various other site specific factors. Pizzeria Uno restaurants are located in both urban and suburban markets, in free-standing buildings, strip centers and malls. Restaurant development is currently targeted at high profile, free-standing locations.\nHistorically, the Company has leased most of its restaurants to minimize investment costs. Since fiscal 1992, however, the Company began selectively purchasing real estate to develop new restaurants where available and when the expected long-term cost of owning the real estate is less than the cost of leasing. Of the 88 Company-owned restaurants open as of November 30, 1995, 74 are located in leased facilities and 14 are fee owned properties. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe Company owns a 30,000 square foot production plant in Brockton, Massachusetts. The production plant produces frozen product for service aboard American Airlines flights, as well as fresh, refrigerated pizzas that are sold at deli counters in approximately 900 supermarkets in New England, New York, New Jersey, Pennsylvania and Ohio. This facility provides sufficient capacity to support double the level of sales achieved in fiscal 1995. See \"ITEM 1. Other Business Development.\"\nPrior to fiscal 1992, all Company-owned restaurants were located in leased space. However, during fiscal 1992, the Company purchased real estate to develop new restaurants in Portland, Maine, Lynnfield, Massachusetts and Hyannis, Massachusetts, and also purchased the real estate related to its three urban Chicago restaurants; during fiscal 1993 the Company purchased real estate to develop new restaurants in Orlando, Florida; during fiscal 1994 in Amherst, New York, and Paoli and Franklin Mills, Pennsylvania; and in fiscal 1995, in Potomac, Virginia, Schaumburg, Illinois, Denver, Colorado and Williamsburg, Virginia. During fiscal 1996, the Company intends to purchase approximately four additional restaurant properties.\nThe leases for Company-owned restaurants typically have initial terms of 20 years with certain renewal options and provide for a base rent plus real estate taxes, insurance and other expenses, plus additional percentage rents based on revenues of the restaurant. All of the Company's franchised restaurants are in space leased from parties unaffiliated with the Company, with the exception of one franchised restaurant which is subleased from the Company. Franchised restaurant leases typically have lease terms through the initial term of the franchise agreements.\nOne of the Company-owned restaurants in Boston, Massachusetts is located on the first floor of a six-story office building owned by Aaron D. Spencer, Chairman and Chief Executive Officer of the Company. Mr. Spencer has leased the entire building to the Company pursuant to a five-year lease, ending on March 29, 1997, at a rent of $162,000 per year. The rent will be increased by 12% of the cost of any improvements to the building made by Mr. Spencer. The Company is responsible for all taxes, utilities, insurance, maintenance and repairs. The lease may be terminated by either the Company or Mr. Spencer upon six months prior notice. If Mr. Spencer or the Company terminates the lease, a new lease between the Company and Mr. Spencer relating only to the restaurant space of the building will become effective immediately. The new lease will have a five-year term with two five-year renewal options. Rent under the new lease will be 6.5% of total restaurant revenues but with a minimum rent, determined by independent appraisal, equal to the fair market rent at the time the new lease becomes effective. The Company currently sublets all but the restaurant space at rents which approximate the $162,000 annual rent that it is obligated to pay Mr. Spencer. Management believes that the terms of both the existing lease and the new lease which will become effective upon termination of the existing lease are comparable to those otherwise available in the real estate market.\nThe Company's executive offices are located in two adjacent buildings in West Roxbury, Massachusetts. The first, a three-story building owned by Mr. Spencer, is leased to the Company pursuant to a five-year lease, commencing on March 30, 1987, with options to renew for two additional five-year periods. Rent during the initial term of the lease was $30,000 per year. Currently, the first of the two five-year options has been exercised at a rate of $36,000 per year. During the final option period, rent will be equal to fair market rent, but may not be less than the rent under the lease during the immediately preceding term. The value of any leasehold improvements made by the Company will not be considered in determining fair market\nvalue rent. The Company added the third floor to the building. The Company is responsible for all taxes, utilities, insurance, maintenance and repairs. The second, a two-story building owned by Mr. Spencer's children, is also leased to the Company pursuant to a 15 year lease commencing on February 1, 1990, with options to renew for three additional five-year periods. Rent during the first five years of the initial term of the lease was $106,800 per year, increasing to $128,160 per year for the next five years, and to $153,792 for the final five years of the initial term of the lease. The Company is responsible for all taxes, utilities, insurance, maintenance and repairs. Rent during any option period will be 120% of the rent for the prior term of the lease. Management believes that the terms of the leases for the two offices are as favorable as otherwise available in the real estate market. With the two buildings, the executive offices currently consist of approximately 25,000 square feet and house the Company's executive, administrative and clerical offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nAs of November 30, 1995, the Company was not a party to any material pending legal proceedings other than ordinary routine litigation incidental to the Company's business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNone.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------\nNUMBER OF STOCKHOLDERS\nAs of October 1, 1995, there were approximately 4,300 beneficial owners of the Company's Common Stock.\nDIVIDENDS\nThe Company has never paid any cash dividends on its Common Stock and for the foreseeable future intends to continue its policy of retaining earnings to finance the development and growth of the Company. The Board of Directors may reconsider this policy from time to time in light of conditions then existing, including the Company's earnings performance, financial condition and capital requirements. Pursuant to both the private placement in June 1990 of $10 million of senior, unsecured notes with a major insurance company, and a $50 million unsecured revolving and term credit agreement obtained in December 1994, the Company became subject to various financial and operating covenants, including limitations on the payment of cash dividends. The most restrictive limitations, in general, preclude the Company from paying cash dividends, if such payment, when aggregated with certain other payments, would exceed 35% of net income for the then most recent four-quarter period or would cause certain net tangible asset and debt ratios to be exceeded.\nOn November 15, 1994, the Board of Directors declared a five-for-four stock split effected in the form of a stock dividend paid in shares of the Company s Common Stock on February 28, 1995 to stockholders of record on February 8, 1995.\n- 19 -\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS ---------------------\nFISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994\nTotal revenues increased 28% to $158.7 million in fiscal 1995 from $124.1 million the prior year. Company-owned restaurant sales increased 29.7% to $146.1 million due primarily to a 21.4% increase in operating weeks of full-service Pizzeria Uno restaurants resulting from the addition of 16 restaurants during the past four quarters, as well as the purchase of three Bay Street Grill restaurants in December 1994. The increase in restaurant sales was also due to a 3.3% increase in comparable store sales for the 52 weeks ended October 1, 1995.\nConsumer product sales increased 14.3% to $8.5 million from $7.4 million in fiscal 1994 due to higher sales of Pizzeria Uno brand and private label refrigerated pizza, as well as increased shipments of frozen pizza for tests by customers outside New England.\nFranchise income increased 3.9% to $4.1 million in fiscal 1995 from $4.0 million the prior year. Royalty income increased 4.7% to $4.0 million principally due to an increase in comparable store sales of 2.4% for the year. Initial franchise fees totaled $125,000 for fiscal 1995 compared to $150,000 in fiscal 1994.\nCost of food and beverages as a percentage of restaurant and consumer product sales increased to 25.5% for fiscal 1995 from 25.1% the prior year. This percentage cost increase primarily reflected changes in sales mix toward a larger percentage of higher-cost non-pizza menu items.\nLabor and benefits as a percentage of restaurant and consumer product sales decreased slightly to 30.6% for fiscal 1995 from 30.8% the prior year, principally due to the leverage of higher comparable store sales.\nOccupancy costs as a percentage of restaurant and consumer product sales declined to 14.8% for fiscal 1995 from 15.8% the prior year, primarily due to an increased number of owned restaurant properties and the operating leverage provided by the increase in comparable store sales noted above.\nOther operating costs declined as a percentage of restaurant and consumer product sales to 8.8% for fiscal 1995 from 9.0% the prior year, principally due to the operating leverage provided by the increase in comparable store sales.\nGeneral and administrative expenses decreased as a percentage of total revenues to 7.1% for fiscal 1995 from 7.5% the prior year as a result of allocating certain fixed expenses over a larger revenue base.\nDepreciation and amortization expenses as a percentage of restaurant and consumer product sales increased to 7.0% for fiscal 1995 from 6.4% the prior year, principally due to increased amortization of pre-opening costs associated with the higher rate of unit growth.\nOperating income increased 30.0% to $13.4 million for fiscal 1995 compared to $10.3 million in fiscal 1994. The operating profit margin improved slightly to 8.4% from 8.3%, primarily as a result of the increase in Company-owned restaurants and comparable store sales.\nOther expense increased to $1,944,000 or 1.2% as a percentage of total revenues in fiscal 1995 from $845,000 or .7% of total revenues the prior year. This increase was due to higher interest expense associated with the increased level of debt used to fund the Company's accelerated expansion plan and its ownership of an increasing number of restaurant properties. In addition, other expense in the comparable period in 1994 was favorably affected by a $312,000 gain on the sale of a restaurant to a franchisee.\nThe effective income tax rate declined to 37% for fiscal 1995 from 39.1% in fiscal 1994, primarily due to the effect of the FICA tip tax credit, which became effective on January 1, 1994 and generally lower state income taxes.\nFISCAL YEAR 1994 COMPARED TO FISCAL YEAR (53 WEEKS) 1993\nTotal revenues increased 13.9% to $124.1 million in fiscal 1994 from $108.9 million in the prior year. Company-owned restaurant sales increased 14.7% to $112.7 million in fiscal 1994 due primarily to a 9.4% increase in operating weeks of full-service restaurants resulting from the addition of eight new restaurants, and a 6.5% increase in comparable store sales.\nConsumer product sales increased 4.9% to $7.4 million in fiscal 1994 from $7.1 million in the prior year primarily due to expanded sales of private label, thin-crust pizzas to several supermarket chains in New England. Initial shipments\nof both refrigerated and frozen Pizzeria Uno brand pizzas commenced in fiscal 1994 to new customers in New York, New Jersey, Pennsylvania and Ohio in order to expand the Company's regional presence beyond New England.\nFranchise income increased 9.2% to $4.0 million in fiscal 1994 from $3.6 million in the prior year. Royalty income increased 9.5% to $3.8 million in fiscal 1994 from $3.5 million in the prior year primarily due to an increase of 7.1% in average unit sales. Initial franchise fees totaled $150,000 in fiscal 1994 compared to $147,500 in fiscal 1993.\nCost of food and beverages as a percentage of restaurant and consumer product sales increased to 25.1% in fiscal 1994 from 24.7% in the prior year, reflecting primarily changes in sales mix toward a larger percentage of higher cost non-pizza menu items.\nLabor and benefits as a percentage of restaurant and consumer product sales decreased slightly to 30.8% in fiscal 1994 from 31.3% in the prior year, principally due to the leverage of higher comparable store sales.\nOccupancy costs as a percentage of restaurant and consumer product sales declined to 15.8% in fiscal 1994 from 16.4% in the prior year, resulting from the Company's purchase of the real estate for several restaurants since fiscal 1992, and the operating leverage provided by the increase in comparable store sales.\nOther operating costs as a percentage of restaurant and consumer product sales were 9.0% for fiscal 1994, remaining relatively unchanged from 8.7% in the prior year.\nGeneral and administrative expenses decreased as a percentage of total revenues to 7.5% in fiscal 1994 from 7.6% in the prior year, principally due to the allocation of certain fixed expenses over a larger revenue base.\nDepreciation and amortization expenses as a percentage of restaurant and consumer product sales decreased to 6.4% in fiscal 1994 from 6.8% in the prior year principally due to the increase in comparable store sales.\nOperating income increased 27.3% to $10.3 million in fiscal 1994 from $8.1 million for the prior year. The operating profit margin increased to 8.3% in fiscal 1994 from 7.4% in the prior year, principally due to an increase in Company-owned restaurants and comparable store sales.\nOther expense declined to $845,000 in fiscal 1994 from $1.1 million in the prior year, principally due to a $312,000 gain on the sale of a restaurant to a franchisee in fiscal 1994.\nThe effective income tax rate declined to 39.1% in fiscal 1994 from 40.5% in fiscal 1993, primarily due to the FICA tip credit, which became effective on January 1, 1994.\nHistorically, the Company has leased most of its restaurant locations and pursued a strategy of controlled growth, financing its expansion principally from operating cash flow, equity offerings and from the sale of senior, unsecured notes and short-term borrowing under revolving lines of credit. During fiscal 1995, the Company's investment in property, equipment and leasehold improvements was $39.9 million.\nThe Company opened 16 restaurants during fiscal 1995 and currently plans to open up to 12 restaurants in fiscal 1996. The Company expects that the average cash investment required to open a full-service Pizzeria Uno restaurant, excluding land and pre-opening costs, will be approximately $1.5 million.\nAs of October 1, 1995, the Company had outstanding indebtedness of $21.8 million under its unsecured, revolving line of credit, $3.3 million of senior, unsecured notes and $820,000 in capital lease obligations. In December 1994, the Company obtained a $50.0 million unsecured revolving credit facility to replace its then existing $20.0 million revolving credit facility. The new revolving credit facility will convert to a three year term loan in December 1997. Advances under the revolving credit facility will accrue interest at either the bank's prime rate plus .25%, or alternatively, at 100-150 basis points above LIBOR. The Company anticipates using the revolving credit facility in the future for repayment of the $3.3 million of principal outstanding under its senior, unsecured notes, for the development of additional restaurants, and for working capital.\nOn October 26, 1995, the Company entered into a five year interest rate swap agreement involving the exchange of floating rate interest payment obligations for fixed rate interest payment obligations. The notional amount of this interest rate swap agreement was $20 million. The Company entered into this agreement in order to manage interest costs and risks associated with fluctuating interest rates.\nDuring June 1995, the Company completed a secondary public equity offering of 2.3 million shares of its Common Stock underwritten by Montgomery Securities. The Company received $22.6 million in net proceeds from the offering.\nIn October 1995, the Board of Directors of the Company authorized the repurchase of up to a total of 1.5 million shares of the Company's Common stock in the market from time to time during the subsequent six months. This superseded the Board of Directors previous authorization in July 1995 for the repurchase of up to a total of 500,000 shares of the Company's Common Stock. As of November 30, 1995, the Company had repurchased a total of 494,100 shares of its Common Stock at prices between $7.00 and $8.25 per share.\nThe Company believes that existing cash balances, cash generated from operations and borrowings under its revolving line of credit will be sufficient to satisfy the Company's working capital and capital expenditure requirements through fiscal 1996.\nIMPACT OF INFLATION\nInflation has not been a major factor in the Company's business for the last several years. The Company believes it has historically been able to pass on increased costs through menu price increases, but there can be no assurance that it will be able to do so in the future. Future increases in local area construction costs could adversely affect the Company's ability to expand.\nSEASONALITY\nThe Company's business is seasonal in nature, with revenues and, to a greater degree, operating income being lower in its first and second quarters than its other quarters due to reduced winter volumes.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe financial statements and supplementary data are listed under Part IV, Item 14 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 information required by this Item 10 is hereby incorporated by reference to the text appearing under Part I, Item 1 - Business, under the caption \"Executive Officers of the Registrant\" at page 13 of this Report, and by reference to the Company's definitive Proxy Statement which is expected to be filed by the Company within 120 days after the close of its fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nThe information required by this Item 11 is hereby incorporated by reference to the Company's definitive Proxy Statement which is expected to be filed by the Company 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 this Item 12 is hereby incorporated by reference to the Company's definitive Proxy Statement which is expected to be filed by the Company 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 this Item 13 is hereby incorporated by reference to the Company's definitive Proxy Statement which is expected to be filed by the Company 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 - --------------------------------------------------------------------------\n2. 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.\n3. EXHIBITS --------\n(3) Articles of Incorporation and By-laws. --------------------------------------\n(a) Restated Certificate of Incorporation, as amended, filed as Exhibit 3.1 to the Company s Quarterly Report on Form 10-Q for the fiscal quarter ended April 2, 1995 (the \"April 2, 1995 Form 10-Q\").*\n(b) By-laws filed as Exhibit 3.2 to the April 2, 1995 Form 10-Q.*\n(4) Instruments Defining the Rights of Security Holders, including -------------------------------------------------------------- Indentures. -----------\n(a) Specimen Certificate of Common Stock filed as Exhibit 4(a) to the Company's Annual Report on Form 10-K for the fiscal year ended September 29, 1991 (the \"1991 Annual Report on Form 10-K\").*\n(b) Note Purchase Agreement dated as of June 1, 1990 between the Company, Uno Restaurants, Inc., Connecticut General Life Insurance Company, CIGNA Property and Casualty Insurance Company on behalf of one or more separate accounts, Insurance Company of North America and Life Insurance Company of North America, filed as Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended July 1, 1990,* and First Amendment to Note Purchase Agreement dated as of July 31, 1991, filed as Exhibit 4(b) to the 1991 Annual Report on Form 10-K,* and Second\nAmendment to Note Purchase Agreement dated as of April 30, 1992, filed as Exhibit 4(b) to the 1992 Annual Report on Form 10-K,* and Third Amendment to Note Purchase Agreement dated as of February 15, 1993, filed as Exhibit 4(b) to the 1993 Annual Report on Form 10-K.*\n(10) Material Contracts. -------------------\n(a) Lease between the Company and Aaron D. Spencer dated March 30, 1987 for premises in West Roxbury, Massachusetts, filed as Exhibit 10.2 to the 1987 Registration Statement.*\n(b) Lease between the Company and Aaron D. Spencer dated March 30, 1987 for premises in Boston, Massachusetts, filed as Exhibit 10.3 to the 1987 Registration Statement.*\n(c) Lease between Uno Restaurants, Inc. and Lisa S. Cohen and Mark N. Spencer dated February 1, 1990 for premises in West Roxbury, Massachusetts, filed as Exhibit 10(d) to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1990 (the \"1990 Annual Report on Form 10-K\").*\n(d) Form of Franchise Agreement and Area Franchise Agreement, filed as Exhibit 10.5 to the Registration Statement on Form S-2 (Registration No. 33-38944) (the \"1991 Registration Statement\").*\n(e) Uno Restaurant Corporation 1987 Employee Stock Option Plan, as amended, filed as Exhibit A to the Company's Proxy Statement for the Annual Meeting of Stockholders held on February 22, 1994.* **\n(f) Uno Restaurant Corporation 1989 Non-Qualified Stock Option Plan for Non-Employee Directors, filed as Exhibit A to the Company's Proxy Statement for the Annual Meeting of Stockholders held on February 8, 1995.* **\n(g) Uno Restaurant Corporation 1993 Non-Qualified Stock Option Plan for Non-Employee Directors, filed as Exhibit A to the Company's Proxy Statement for the Annual Meeting of Stockholders held on March 2, 1993.* **\n(h) Form of Indemnification Agreement between the Company and its Directors filed as Exhibit 10.6 to the 1987 Registration Statement.* **\n(i) Variable Royalty Plan for Franchises, filed as Exhibit 10(l) to the 1991 Annual Report on Form 10-K.*\n(j) $50,000,000 Revolving Credit and Term Loan Agreement dated as of December 9, 1994 by and among Uno Restaurants, Inc., as Borrower, Uno Foods Inc., Pizzeria Uno Corporation, URC Holding Company, Inc. and Uno Restaurant Corporation, as Guarantors, and Fleet Bank of Massachusetts, N.A. as Agent (without exhibits) filed as Exhibit 10(p) to the 1994 Annual Report on Form 10-K,* and First Amendment to Revolving Credit and Term Loan Agreement dated as of January 30, 1995, and Second Amendment to Revolving Credit and Term Loan Agreement dated as of November 7, 1995.\n(k) Interest Rate Swap Agreement between Fleet Bank of Massachusetts, N.A. and Uno Restaurants, Inc. dated October 25, 1995.\n(l) Asset Purchase Agreement dated September 1, 1994, by and among Bay Street Restaurants, Inc., Bay Street of Philadelphia, Pennsylvania, Inc., Bay Street of Woodbridge, New Jersey, Inc., Bay Street of Schaumburg, Illinois, Inc. and Bay Street Services, Inc. (collectively, the \"Seller\"), and UNO Bay, Inc., B.S. of Woodbridge, Inc., B.S. of Schaumburg, Inc. and B.S. Intangible Asset Corp. (collectively, the \"Purchaser\") filed as Exhibit 10(q) to the 1994 Annual Report on Form 10-K.*\n(m) Change in Control Protection Agreements dated January 6, 1994 between Uno Restaurant Corporation and each of its named executive officers, Mr. Spencer, Mr. Miller, Mr. Brown, Mr. Fox and Mr. Gallucci filed as Exhibit 10(r) to the 1994 Annual Report on Form 10-K.* **\n(n) Master Lease-Purchase Agreement between ORIX Credit Alliance, Inc., as Lessor, and Massachusetts Industrial Finance Agency, as Lessee, dated April 19, 1994, and Master Sublease-Purchase Agreement between Massachusetts Industrial Finance Agency, as Sublessor, and Uno Foods, Inc. as Sublessee, dated April 19, 1994 filed as Exhibit 10(s) to the 1994 Annual Report on Form 10-K.*.\n(11) Statement Re: Computation of Per Share Earnings\n(21) Subsidiaries of the Registrant\n(23) Consent of Ernst & Young LLP, Independent Auditors\n(27) Financial Data Schedule\n- -------------------------- * In accordance with Rule 12b-23 and Rule 12b-32 under the Securities Exchange Act of 1934, as amended, reference is made to the documents previously filed with the Securities and Exchange Commission, which documents are hereby incorporated by reference.\n** Management Contract\n(B) REPORTS ON FORM 8-K -------------------\nDuring the fiscal quarter ended October 1, 1995, the Company did not file any Current Reports on Form 8-K.\nReport of Independent Auditors\nThe Board of Directors Uno Restaurant Corporation\nWe have audited the accompanying consolidated balance sheets of Uno Restaurant Corporation and subsidiaries (the Company) as of October 1, 1995 and October 2, 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended October 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Uno Restaurant Corporation and subsidiaries at October 1, 1995 and October 2, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 1, 1995, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nBoston, Massachusetts November 1, 1995\nUno Restaurant Corporation and Subsidiaries\nSee accompanying notes.\nUno Restaurant Corporation and Subsidiaries\nSee accompanying notes.\nUno Restaurant Corporation and Subsidiaries\nSee accompanying notes.\nUno Restaurant Corporation and Subsidiaries\nSee accompanying notes.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements\nOctober 1, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Uno Restaurant Corporation and its wholly-owned subsidiaries (the Company). All intercompany accounts and transactions have been eliminated in consolidation. Company-owned restaurants are located predominately in the Northeast and Mid-Atlantic states and franchised restaurants are located throughout the United States.\nFISCAL YEAR\nThe Company's fiscal year ends on the close of business on the Sunday closest to September 30 in each year. The fiscal year ended October 3, 1993 included 53 weeks of operations.\nINVENTORY\nInventory, which consists of food, beverages and store supplies, is stated at the lower of cost (first-in, first-out method) or market.\nPROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nProperty, equipment and leasehold improvements are recorded at cost. The Company provides for depreciation of buildings and equipment over their estimated useful lives using the straight-line method. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the lease using the straight-line method.\nREVENUE RECOGNITION - FRANCHISE FEES\nThe Company defers franchise fees until the franchisee opens the restaurant and all services have been substantially performed; at that time, the entire amount of the fee is recorded as income. Royalty income is recorded as earned based on rates provided by the\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nrespective franchise agreements. Expenses related to franchise activities amounted to approximately $1,889,000, $1,427,000 and $1,210,000 in fiscal years 1995, 1994 and 1993, respectively.\nPRE-OPENING COSTS\nCosts relating to the opening of new restaurants are deferred until the restaurants open and are amortized over 12 months from that point using the straight-line method.\nINCOME TAXES\nIn fiscal years 1995 and 1994, deferred income taxes are recognized for temporary differences between financial statement and income tax bases of assets and liabilities for which income tax benefits and obligations will be realized in future years. In fiscal year 1993, the provision for deferred income taxes represents the tax effect of differences in the timing of income and expense recognition for tax and financial statement purposes.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nEARNINGS PER COMMON SHARE\nEarnings per common share amounts are calculated based upon the weighted-average number of shares outstanding, giving effect to the dilutive effect of stock options. Average shares outstanding and all per share amounts included in the accompanying consolidated financial statements and notes thereto are based on the increased number of shares, giving retroactive effect to the five-for-four stock split in fiscal year 1995 (see Note 7).\nRECLASSIFICATIONS\nCertain amounts in the accompanying 1994 and 1993 financial statements have been reclassified to permit comparison with 1995.\n2. BUSINESS ACQUISITIONS AND DISPOSITIONS\nIn December 1994, the Company completed an agreement with Bay Street Restaurants, Inc. to purchase the net assets of three restaurants located in Illinois, New Jersey and Pennsylvania. In December 1993, the Company acquired the leasehold improvements and equipment of three franchised restaurants in Connecticut. These acquisitions have been accounted for under the purchase method of accounting. The results of operations of the acquired companies prior to the dates of acquisition would not have a material impact on the consolidated results of operations in fiscal years 1995, 1994 and 1993.\nDuring 1995, the Company assigned its leasehold interest in its Fairview Heights, Illinois restaurant to an unaffiliated party in exchange for the leasehold interest in that unaffiliated party's restaurant located in Orlando, Florida. The Company recorded the transaction at fair market value, and wrote off the net book value of equipment no longer usable.\nOn November 8, 1993, the Company sold to a franchisee for $2,500,000 a Pizzeria Uno restaurant in Lake Buena Vista, Florida and recorded a gain of $312,000, which has been included in other income in fiscal year 1994.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n3. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nProperty, equipment and leasehold improvements consist of the following:\n4. RELATED-PARTY TRANSACTIONS\nThe Company leases three buildings from its principal shareholder for a restaurant and for corporate office space. Rent expense in the amount of approximately $442,000 was charged to operations in each of the fiscal years presented. The Company believes that the terms of these leases approximate fair rental value.\nThe Company's President and his brother own and operate three franchised restaurants. Additionally, the Chairman of the Company owns a 50% interest in a franchised pizza takery, and one of the directors of the Company has a partnership interest in a franchised restaurant. These franchisees pay royalties to the Company under standard franchise agreements, with the exception of the pizza takery, which is being operated as a test concept and, as a result, is not currently being charged royalties.\n5. LEASES\nThe Company conducts the majority of its operations in leased facilities, which are accounted for as capital or operating leases. The leases typically provide for a base rent plus real estate taxes, insurance and other expenses, plus additional contingent rent based\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\nTotal expenses for all leases were as follows:\nCertain operating lease agreements contain free rent inducements and scheduled rent increases which are being amortized over the terms of the agreements, ranging from 15 to 20 years, using the straight-line method. The deferred rent liability, included in other liabilities, amounted to $3,296,000 at October 1, 1995 and $2,659,000 at October 2, 1994.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\nThe Company has a $50,000,000 unsecured revolving line of credit which converts to a three-year term loan in December 1997. The Company is entitled to borrow at its discretion amounts which accrue interest at variable rates based on either the LIBOR or prime rate. At October 1, 1995, interest on outstanding borrowings ranged from 6.87% to 8.75%. A commitment fee of approximately .33% is accrued on unused borrowings under the credit agreement. The note agreements contain certain financial and operating covenants, including maintenance of certain levels of net worth and income.\nThe Company made cash payments of interest of $2,445,000, $1,465,000 and $1,219,000 during fiscal years 1995, 1994 and 1993, respectively. The Company capitalized interest during the construction period of newly constructed restaurants amounting to $509,000 in fiscal year 1995, $228,000 in fiscal year 1994 and $186,000 in fiscal year 1993 and included those amounts in leasehold improvements.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n6. FINANCING ARRANGEMENTS (CONTINUED)\nThe Company provides certain limited lease financing to qualified franchisees through an agreement with an unaffiliated finance company. The Company's maximum guarantee under the agreement was $1,993,000 at October 1, 1995. The Company has also guaranteed up to a maximum of $431,000 of future lease payments in the event of default by specific franchisees.\nThe Company has an outstanding letter of credit in the amount of $150,000 at October 1, 1995, which expires in December 1996.\n7. COMMON STOCK TRANSACTIONS\nOn November 15, 1994, the Board of Directors of the Company declared a five-for-four stock split payable to shareholders on February 28, 1995. In the third quarter of fiscal 1995, the Company obtained $22.6 million in exchange for 2.3 million shares of common stock in connection with a secondary common stock offering.\nIn July 1995, the Board of Directors authorized the purchase of up to 500,000 shares of the Company's common stock in the open market. Under this arrangement, the Company purchased 358,100 shares as treasury stock during fiscal year 1995. Subsequent to year end, the Board of Directors increased its authorization to purchase up to a total of 1.5 million shares of the Company's common stock in the open market.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n9. ACCRUED EXPENSES\nAccrued expenses consist of the following:\n10. EMPLOYEE BENEFIT PLANS\nThe Company maintains a 401(k) Savings and Employee Stock Ownership Retirement Plan (the Plan) for all of its eligible employees. The Plan is maintained in accordance with the provisions of Section 401(k) of the Internal Revenue Code and allows all employees with at least six months of service to make annual tax-deferred voluntary contributions up to 15% of their salary. Under the Plan, the Company matches a specified percentage of the employees' contributions, subject to certain limitations, and makes annual discretionary contributions of the Company's Common Stock. Total contributions made to the plans were $153,000, $110,000 and $25,000 in fiscal years 1995, 1994 and 1993, respectively.\nThe Company sponsors a Deferred Compensation Plan which allows officers to defer up to 20% of their annual compensation. These assets are placed in a rabbi trust and are presented as assets of the Company in the accompanying balance sheet as they are available to the general creditors of the Company in the event of the Company's insolvency. The related liability of $426,000 at October 1, 1995 is included in other liabilities in the accompanying balance sheet. Deferred compensation expense in the amounts of $173,000 and $265,000 were recorded in fiscal year 1995 and 1994, respectively.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n11. INCOME TAXES\nEffective October 4, 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 109 (Statement 109). As permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. The effect of the change on net income for fiscal 1994, as well as the cumulative effect, was not material.\nDeferred taxes are attributable to the following temporary differences:\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n11. INCOME TAXES (CONTINUED)\nThe Company made income tax payments of $3,667,000, $3,779,000 and $2,826,000 during fiscal years 1995, 1994 and 1993, respectively.\n12. STOCK OPTION PLANS\nThe 1987 Employee Stock Option Plan (the Plan) provides for up to 1,875,000 shares of common stock issuable upon exercise of options granted under the Plan. Options may be granted at an exercise price not less than fair market value on the date of grant. All options vest at a rate of 20% per year beginning one year after the date of grant, with the exception of 93,750 and 62,500 options granted to the President and Chairman of the Company, respectively, which vest immediately at the date of grant. All options terminate ten years after the date of grant, with the exception of the 175,000 options granted to the Chairman, which terminate five years after the date of grant. Options outstanding at October 1, 1995 are non-qualified stock options.\nThe 1989 and 1993 Non-Qualified Stock Option Plans for Non-Employee Directors (the Directors Plans) provide for up to 101,563 shares of Common Stock issuable upon exercise of options granted under the Directors Plans. The 1989 and 1993 Directors Plans terminate on November 10, 1999 and August 17, 2002, respectively, but such termination shall not affect the validity of options granted prior to the dates of termination. Options are to be granted at an exercise price equal to the fair market value of the shares of Common Stock at the date of grant. Options granted under the Directors Plans may be exercised commencing one year after the date of grant and ending ten years from the date of grant.\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n13. QUARTERLY FINANCIAL DATA (UNAUDITED)\nUno Restaurant Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n14. SUBSEQUENT EVENT\nOn October 26, 1995, the Company entered into a five year interest rate swap agreement involving the exchange of floating rate interest payment obligations for fixed rate interest payment obligations. The notional amount of this interest rate swap agreement was $20 million. The Company entered into this agreement in order to manage interest costs and risks associated with fluctuating interest rates. In the event that a counterparty fails to meet the terms of the interest rate swap agreement, the Company's exposure is limited to the interest rate differential. The Company has executed this agreement with a creditworthy institution and considers the risk of nonperformance to be remote.\nConsent of Independent Auditors\nWe consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-80584 and Post-Effective Amendment No. 2 to Form S-8 No. 33-22875) pertaining to the Uno Restaurant Corporation 1987 Employee Stock Option Plan (Form S-8 No. 33-80586) pertaining to the Uno Restaurant Corporation 1989 Non-Qualified Stock Option Plan for Non-Employee Directors and (Form S-8 No. 33-80664) pertaining to the Uno Restaurant Corporation 1993 Non-Qualified Stock Option Plan for Non-Employee Directors of our report dated November 1, 1995, with respect to the consolidated financial statements of Uno Restaurant Corporation included in the Annual Report (Form 10-K) for the year ended October 1, 1995.\nERNST & YOUNG LLP\nBoston, Massachusetts December 18, 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.\n(Registrant) Uno Restaurant Corporation -----------------------------------------","section_15":""}
{"filename":"103595_1995.txt","cik":"103595","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns the sites of five of its supermarkets (containing 304,000 square feet of total space), all of which are free-standing stores, except the Egg Harbor store, which is part of a shopping center. The Company also owns the site of the former Easton and Maplewood stores. The Maplewood property is under contract for sale to the current tenant and the Easton store is currently being marketed. The remaining eighteen supermarkets (containing 800,000 square feet of total space) are leased, with initial lease terms generally ranging from 20 to 30 years, usually with renewal options. Eleven of these leased stores are located in strip shopping centers and the remaining seven are free-standing stores. Except with respect to one lease between the Company and certain related parties, none of the Company's leases expire before 1997. The annual rent, including capitalized leases, for all of the Company's leased facilities for the year ended July 29, 1995 was approximately $5,700,000. The Company is a limited partner in two partnerships, each of which owns a shopping center in which one of the Company's leased supermarkets is located. The Company also is a general partner in a general partnership that is a lessor of one of the Company's free-standing supermarkets.\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\nNo matters submitted to shareholders in the fourth quarter.\nITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT\nIn addition to the information regarding directors incorporated by reference to the Company's definitive Proxy Statement in Part III, Item 10, the following is provided with respect to executive officers who are directors:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe information required by this Item is incorporated by reference from Information appearing on Page 16 in the Company's Annual Report to Shareholders for the fiscal year ended July 29, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference from Information appearing on Page 1 in the Company's Annual Report to Shareholders for the fiscal year ended July 29, 1995.\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 from Information appearing on Pages 4 and 5 in the Company's Annual Report to Shareholders for the fiscal year ended July 29, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference from Information appearing on Page 1 and Pages 6 to 16 in the Company's Annual Report to Shareholders for the fiscal year ended July 29, 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 is incorporated by reference from the Company's definitive Proxy Statement to be filed on or before November 3, 1995, in connection with its Annual Meeting scheduled to be held on December 8, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is incorporated by reference from the Company's definitive Proxy Statement to be filed on or before November 3, 1995, in connection with its Annual Meeting scheduled to be held on December 8, 1995.\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 from the Company's definitive Proxy Statement to be filed on or before November 3, 1995, in connection with its annual meeting scheduled to be held on December 8, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is incorporated by reference from the Company's definitive Proxy Statement to be filed on or before November 3, 1995, in connection with its annual meeting scheduled to be held on December 8, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nConsolidated Balance Sheets - July 29, 1995 and July 30, 1994 Consolidated Statements of Operations - years ended July 29, 1995; July 30, 1994 and July 31, 1993 Consolidated Statements of Shareholders' Equity - years ended July 29, 1995; July 30, 1994 and July 31, 1993 Consolidated Statements of Cash Flows - years ended July 29, 1995; July 30, 1994 and July 31, 1993 Notes to consolidated financial statements\nThe financial statements above and Independent Auditors' Report have been incorporated by reference from the Company's Annual Report to Shareholders for the fiscal year ended July 29, 1995.\n2. Financial Statement Schedules\nIndependent Auditors' Report on Schedules\nSchedule V - Property, Equipment and Fixtures\nSchedule VI - Accumulated depreciation and amortization of property, equipment and fixtures\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 INDEX\nExhibit No. 3 - Certificate of Incorporation and By-Laws *\nExhibit No. 4 - Instruments defining the rights of security holders;\n4.1 Note Purchase Agreement dated August 20, 1987 *\n4.2 Loan Agreement dated March 29, 1994*\n4.3 Amendment No. 1 to Loan Agreement*\nExhibit No. 10 - Material Contracts:\n10.1 Wakefern By-Laws *\n10.2 Stockholders Agreement dated February 20, 1992\nbetween the Company and Wakefern Food Corp. *\n10.3 Voting Agreement dated March 4, 1987 *\n10.4 1987 Incentive and Nonstatutory Stock Option Plan*\nExhibit No. 13 - Annual Report to Security Holders\nExhibit No. 22 - Subsidiaries of Registrant\nExhibit No. 23 - Consent of KPMG Peat Marwick LLP\nExhibit No. 27 - Article 5 Financial Data Schedule\nExhibit No. 28 a - Press release dated October 3, 1995\nExhibit No. 28 b - Third Quarter Report to Shareholders\n* The following exhibits are incorporated by reference from the following previous filings:\nForm 10-K for 1994: 4.3 Form 10-K for 1993: 3, 4.1, 10.1, 10.2, 10.3 and 10.4 Form 10-Q for April 23, 1994: 4.2\n(b) No reports on Form 8-K were filed during the fourth quarter of fiscal 1995.\nIndependent Auditors' Report on Financial Statement Schedules\nThe Board of Directors Village Super Market, Inc.:\nUnder date of September 29, 1995, we reported on the consolidated balance sheets of Village Super Market, Inc. as of July 29, 1995 and July 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 July 29, 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.\nKPMG Peat Marwick LLP\nShort Hills, New Jersey September 29, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nVillage Super Market, Inc.\nBy: \/S\/ Kevin Begley By: \/S\/ Perry Sumas Kevin Begley Perry Sumas (Chief Financial & (Chief Executive Officer) Principal Accounting Officer)\nDate: October 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 dates indicated:\n\/S\/ Perry Sumas \/S\/ James Sumas Perry Sumas, October 25, 1995 James Sumas, October 25, 1995 (Director) (Director)\n\/S\/ Robert Sumas \/S\/ William Sumas Robert Sumas, October 25, 1995 William Sumas, October, 25, 1995 (Director) (Director)\n\/S\/ John P. Sumas \/S\/ John J. McDermott John P. Sumas, October 25, 1995 John McDermott, October 25, 1995 (Director) (Director)\n\/S\/ George Andresakes \/S\/ Norman Crystal George Andresakes, October 25, 1995 Norman Crystal, October 25, 1995 (Director) (Director)\nSUBSIDIARIES OF REGISTRANT\nThe Company currently has one wholly-owned subsidiary, Village Liquor, Inc. This corporation is organized under the laws of the State of New Jersey. The Financial statements of this subsidiary are included in the Company's consolidated financial statements.\nIndependent Auditors' Consent\nThe Board of Directors Village Super Market, Inc.:\nWe consent to incorporation by reference in the Registration Statement (No. 2-86320) on Form S-8 of Village Super Market, Inc. of our reports dated September 29, 1995, relating to the consolidated balance sheets of Village Super Market, Inc. and subsidiaries as of July 29, 1995 and July 30, 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows and related schedules for each of the years in the three year period ended July 29, 1995, which reports appear in or are incorporated by reference in the July 29, 1995 annual report on Form 10-K of Village Super Market, Inc.\nOur report refers to a change in the method of accounting for income taxes.\nKPMG Peat Marwick LLP\nShort Hills, New Jersey October 27, 1995","section_15":""}
{"filename":"354884_1995.txt","cik":"354884","year":"1995","section_1":"Item 1. Business\nPaine Webber Income Properties Four Limited Partnership (the \"Partnership\") is a limited partnership formed in July 1981 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 including shopping centers, office buildings and apartment complexes. The Partnership sold $25,698,000 in Limited Partnership Units (the \"Units\"), representing 25,698 Units at $1,000 per Unit, during the offering period pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration No. 2-73602). Limited Partners will not be required to make any additional capital contributions.\nAs of September 30, 1995, the Partnership had three operating property investments, which were owned through joint venture partnerships, as set forth below:\nName of Joint Venture Date of Name and Type of Property Acquisition Location Size of Interest Type of Ownership (1) - ----------------------- ---- ----------- ---------------------\nCharter Oak Associates 284 6\/8\/82 Fee ownership of land and Charter Oak Apartments units improvements (through Creve Coeur, Missouri joint venture)\nArlington Towne Oaks 320 8\/23\/82 Fee ownership of land and Associates units improvements (through Arlington Towne Oaks joint venture) Apartments Arlington, Texas\nBraesridge 305 545 9\/30\/82 Fee ownership of land and Associates (2) units improvements (through Braesridge joint venture) Apartments Houston, Texas\n(1) See Notes to the Financial Statements filed with this Annual Report for a description of the long-term mortgage indebtedness secured by the Partnership's operating property investments, and for a description of the agreements through which the Partnership has acquired these real estate investments.\n(2) Subsequent to year-end, on December 29, 1995, the Partnership sold its interest in the Braesridge 305 Associates joint venture to an affiliate of its co-venture partners for net cash proceeds of $1,000,000, as further discussed in Item 7.\nThe Partnership originally owned interests in five operating investment properties. The Partnership agreed to transfer title to the Yorktown Office Center to the mortgage lender in March of 1991. The decision to forfeit the Partnership's interest in the Yorktown Office Center, a 99,000 square foot building located in a suburb of Chicago, Illinois, was based on the property's inability to generate sufficient income to cover its debt service obligations. The inability of the Yorktown joint venture to meet the debt service requirements of the mortgage loan resulted from the significant oversupply of competing office space in the local suburban real estate market and its negative impact on occupancy and rental rates. Management did not foresee any improvement in the local real estate market for the next several years and believed that the use of cash reserves to fund operating deficits would still not enable the Partnership to recover any meaningful portion of its remaining investment in Yorktown Office Court. As a result of the transfer of title, the Partnership no longer has any ownership interest in this property. In addition, the venture which owned the Glenwood Village Shopping Center, a 41,000 square foot strip center in Raleigh, North Carolina, sold the property to a third party on September 23, 1991. The property was sold for $4,300,000 and, after repaying the outstanding mortgage loan and paying transaction costs, the Partnership's share of the net proceeds was $1,650,000.\nThe Partnership's original investment objectives were to:\n(i) provide the Limited Partners with cash distributions which, to some extent, will not constitute taxable income; (ii) preserve and protect the Limited Partners' capital; (iii) obtain long-term appreciation in the value of its properties; and (iv) provide a build-up of equity through the reduction of mortgage loans on its properties.\nThrough September 30, 1995, the Limited Partners had received cumulative cash distributions totalling approximately $9,492,000, or approximately $387 per original $1,000 investment for the Partnership's earliest investors. Of this amount, approximately $4,497,000, or $175 per original $1,000 investment, represents proceeds distributed from the refinancing of the Charter Oak Apartments in fiscal 1986 and from the sale of the Glenwood Village Shopping Center in November 1991. The remaining distributions have been paid from operating cash flow. A substantial portion of these distributions paid to date has been sheltered from current taxable income. The Partnership suspended the payment of regular quarterly distributions of excess cash flow in fiscal 1987. As of September 30, 1995, the Partnership retained its ownership interest in three of its five original investment properties. Due to the fiscal 1996 sale of the interest in the Braesridge joint venture, which represented 31% of the Partnership's original investment portfolio, for an amount which is substantially lower than the Partnership's investment in Braesridge, combined with the fiscal 1991 foreclosure loss of the Yorktown investment, which represented 16% of the Partnership's original investment portfolio, in all likelihood the Partnership will be unable to return the full amount of the original capital contributed by the Limited Partners. The amount of capital which will be returned will depend upon the proceeds received from the final liquidation of the two remaining 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.\nAll of the properties securing the Partnership's remaining 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. As in all markets, the apartment project also competes with the local single family home market for prospective tenants. The continued availability of low interest rates on home mortgage loans has increased the level of this competition over the past few years. However, the impact of the competition from the single-family home market has been offset by the lack of significant new construction activity in the multi-family apartment market over this period.\nThe Partnership has no real estate investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore, presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser\"), which is responsible for the day-to-day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\").\nThe general partners of the Partnership (the \"General Partners\") are Fourth Income Properties Fund, Inc. and Properties Associates. Fourth Income Properties Fund, Inc., a wholly-owned subsidiary of PaineWebber, is the Managing General Partner of the Partnership. 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. 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 September 30, 1995, the Partnership had interests in three operating properties through joint venture partnerships. The joint venture partnerships and the related properties are referred to under Item 1 above to which reference is made for the name, location and description of each property.\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 1995 12\/31\/94 3\/31\/95 6\/30\/95 9\/30\/95 Average\nCharter Oak Apartments 92% 95% 95% 96% 95%\nArlington Towne Oaks Apartments 87% 91% 94% 94% 92%\nBraesridge Apartments 96% 96% 95% 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 Fourth Income Properties 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 PaineWebber Income Properties Four Limited Partnership, PaineWebber, Fourth Income Properties 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 PaineWebber Income Properties Four Limited Partnership, also allege that following the sale of the partnership interests, PaineWebber, Fourth Income Properties Fund, Inc. and PA misrepresented financial information about the Partnership's value and performance. The amended complaint alleges that PaineWebber, Fourth Income Properties Fund, 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 Fourth Income Properties Fund, Inc., PA and their affiliates for costs and liabilities in connection with this litigation. The Managing General Partner intends to vigorously contest the allegations of the action, and believes 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.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt September 30, 1995 there were 2,064 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.\nThe Partnership made no cash distributions to the Limited Partners during fiscal 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data Paine Webber Income Properties Four Limited Partnership For the years ended September 30, 1995, 1994, 1993, 1992 and 1991 (In thousands, except per Unit data)\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (1)\nRevenues $ 1,656 $ 1,496 $ 1,531 $ 1,577 $ 1,522\nOperating loss $ (427) $ (518) $ (322) $ (222) $ (333)\nPartnership's share of unconsolidated ventures' operations $ 174 $ 34 $ (353) $ (299)$ (605)\nLoss before extraordinary gains $ (253) $ (484) $ (675) $ (521)$ (938)\nExtraordinary gains - - - - $ 2,499\nNet income (loss) $ (253) $ (484) $ (675) $ (521)$ 1,561\nPer Limited Partnership Unit: Loss before extraordinary gains $ (9.75) $(18.65) $(26.01) $ (20.09)$ (36.13)\nExtraordinary gains - - - - $ 96.26\nNet income (loss) $ (9.75) $(18.65) $(26.01) $(20.09) $ 60.13\nCash distribution from sale proceeds - - - $ 58.00 -\nTotal assets $ 9,962 $ 10,410 $ 8,849 $ 9,364 $11,089\nLong-term debt $ 4,915 $ 4,973 $ 3,337 $ 3,486 $ 3,623\n(1) The extraordinary gains recognized in fiscal 1991 related to the foreclosure of the Yorktown Office Court in March of 1991 and the extinguishment of a second mortgage loan secured by the Towne Oaks Apartments.\nThe above selected financial data should be read in conjunction with the financial statements and the related notes appearing elsewhere in this Annual Report.\nThe above per Limited Partnership Unit information is based upon the 25,698 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 December 1981 to December 1982 pursuant to a Registration Statement filed under the Securities Act of 1933. Gross proceeds of $25,698,000 were received by the Partnership and, after deducting selling expenses and offering costs, approximately $22,336,000 was originally invested in five operating investment properties through joint ventures. Through September 30, 1995, one of these properties had been lost to foreclosure and another had been sold to a third party. The Partnership does not have any commitments for additional investments but may be called upon to fund its portion of operating deficits or capital improvements of the joint ventures in accordance with the respective joint venture agreements.\nSubsequent to year end, on December 29, 1995, the Partnership sold its interest in the Braesridge joint venture to an affiliate of the co-venture partners for net cash proceeds of $1 million. Management had been actively marketing the Braesridge Apartments for sale during fiscal 1995 and received several offers from prospective purchasers. The purchase contract signed with the co-venture partners was at a price which exceeded all third party offers. The net sale price for the Partnership's equity interest was based on an agreed upon fair value of the property of approximately $11.7 million. The agreed upon fair market value is supported by management's most recent independent appraisal of the Braesridge Apartments and by the marketing efforts to third-parties which were conducted during fiscal 1995. Under the terms of the Braesridge joint venture agreement, the co-venture partner had the right to match any third-party offer to purchase the property. Accordingly, a negotiated sale to the co-venturer at the appropriate market price represented the most expeditious and advantageous way for the Partnership to sell this investment. The original cash investment by the Partnership for its interest in the Braesridge joint venture was approximately $6,879,000 (including an acquisition fee of $725,000 paid to the Adviser of the Partnership). The property was originally subject to an institutional nonrecourse first mortgage of approximately $8,500,000 at the time of acquisition. Subsequent to acquisition, the venture was forced to modify the terms of the mortgage loan because the property did not generate sufficient cash flow to service the debt. The effect of such deferrals was that the total amount of the mortgage loan obligation increased over the several years covered by the modification agreements to a total of approximately $10 million. The inability of the Braesridge joint venture to service its mortgage debt obligations during the late 1980s was the result of overbuilding which precipitated a severe real estate recession. Such conditions, which existed throughout the country, were compounded in Houston by the collapse of the domestic crude oil production industry. These factors put severe downward pressure on occupancy levels and rental rates. The occupancy level of the Braesridge Apartments averaged 68% over the five-year period from fiscal 1985 through fiscal 1989. The estimated market value of the Braesridge Apartments had declined to approximately one-half of the outstanding debt obligation at the height of this real estate slump.\nConditions in the markets for multi-family residential properties across the country have demonstrated gradual improvement over the past few years. The absence of significant new construction activity has allowed the oversupply which existed in many markets as a result of the overbuilding of the late 1980s to be absorbed. The results of this absorption have been stabilized occupancy levels and a gradual improvement in rental rates, which have had a positive impact on cash flow levels and, consequently, property values. The Braesridge Apartments achieved a 96% average occupancy level in fiscal year 1995, improved from a level of 93% attained in the prior year. The high occupancy levels in the Houston market over the last two years, combined with significantly increased rental rates, are now sufficient to justify the construction of new apartment units which could limit Braesridge's long-term performance. Because of the potential apartment development, as well as the attractive, assumable financing obtained in October 1994, management believed that now was the appropriate time to market the Braesridge Apartments for sale and complete a transaction which would enable the Partnership to realize a partial recovery of its initial investment in this property. Despite recovering less than 15% of its original cash investment in Braesridge, the Partnership will recognize a gain for financial reporting purposes in fiscal 1996 in connection with the sale of this venture interest because the losses recorded in prior years under the equity method of accounting have exceeded the Partnership's initial investment amount. The Partnership expects to distribute approximately $500,000 of the net sale proceeds, or approximately $20 per original $1,000 investment, in a special distribution to the Limited Partners to be made by February 15, 1996. The remaining net sale proceeds would be retained by the Partnership as additional working capital reserves.\nDue to the fiscal 1996 sale of the interest in the Braesridge joint venture, which represented 31% of the Partnership's original investment portfolio, for an amount which is substantially lower than the Partnership's investment in Braesridge, combined with the fiscal 1991 foreclosure loss of the Yorktown investment, which represented 16% of the Partnership's original investment portfolio, in all likelihood the Partnership will be unable to return the full amount of the original capital contributed by the Limited Partners. The amount of capital which will be returned will depend upon the proceeds received from the final liquidation of the two remaining 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. The improving market conditions referred to above for multi-family apartment properties, combined with the significant capital improvement programs which are in the process of being implemented at both of the two remaining investment properties, may result in favorable opportunities to sell the Partnership's remaining investments within the next 2-to-3 years. The implementation of capital improvements made possible by the recent refinancings of the Charter Oak and Towne Oaks properties, as discussed further below, are expected to support management's ability to increase rents and add value to these properties. Accordingly, management will likely defer any considerations of engaging in concerted sales efforts with respect to Charter Oak and Towne Oaks for the next 12-to-18 months until the respective capital improvement programs are substantially completed and the effects of the improvements are fully reflected in the rental rate structures for the apartment units.\nAs part of the refinancing of the mortgage loan secured by the Towne Oaks Apartments in fiscal 1994, the joint venture was required to establish an escrow account for a replacement reserve and other capital repairs. The balance of these restricted reserves totalled approximately $1.5 million at the time of the loan closing. Subsequent to the refinancing, the Partnership has implemented a program to use these funds, along with cash flow from property operations, to repair and upgrade the Towne Oaks Apartments property. To date, over $1.8 million of capital expenditures have been incurred to complete the installation and painting of new exterior siding on all buildings and to begin the process of upgrading the apartment interiors. The exterior portion of the capital improvement program is substantially completed. Apartment interiors are being upgraded on a turnover basis and will continue over the next 3 years until all of the units have been upgraded. The property improvements were necessary in order to improve the average occupancy levels and rental rates at this 20-year old facility, which had declined during fiscal 1993 and 1994 due to competitive conditions existing in the property's Arlington, Texas submarket. The initial impact of the renovation program is reflected in the property's occupancy level which had increased to 94% as of September 30, 1995 from a low of 84% experienced one year earlier. The Partnership hired a new management firm to oversee the implementation of the property rehabilitation program and to manage the day-to-day operations of the apartment complex under the direction of the Managing General Partner. Management is confident that the capital improvement program will allow the property to remain competitive in its marketplace. Further increases in occupancy levels and rental rates are expected in fiscal 1996. As planned rental rate increases are implemented, the property should begin to generate excess cash flow in the fairly near future.\nDuring fiscal 1995, the Partnership received total distributions of $409,000 from Charter Oak Associates, which included an operating cash flow distribution and the release of certain excess reserves. The positive cash flow from the venture is a direct result of the HUD refinancing which took place in August 1993. As part of the HUD insured loan program, the joint venture was required to establish an escrow account for a replacement reserve and other required repairs which totalled approximately $1.7 million at the time of the loan closing. The balance of these restricted escrow deposits totaled approximately $780,000 as of September 30, 1995. These escrows have provided the capital necessary to address certain deferred maintenance and capital improvement items that have significantly upgraded individual units and the property as a whole. The capital improvements during fiscal 1995 were principally comprised of the renovation of individual apartment units which, as with Towne Oaks, is being done on a turnover basis and will continue until all of the apartments have been upgraded. The Charter Oak Apartments property has achieved a 4% increase in its average occupancy level over the past 3 years, improving to 95% for fiscal 1995 from a level of 91% experienced in fiscal 1992. The increase in the occupancy level over the past three consecutive years has been accomplished while simultaneously raising rental rates on the apartment units, which has allowed rental income to increase by an average of 6% per year. The suburban St. Louis submarket has not experienced any substantial new development activity in several years and management is not aware of any significant plans for major development activity in the near future. For fiscal 1996 management plans to continue the unit renovation program and address additional landscaping enhancements.\nAt September 30, 1995 the Partnership and its consolidated joint venture had available cash and cash equivalents of $129,000. Such cash and cash equivalents, combined with the proceeds to be retained from the sale of the Braesridge joint venture interest, as discussed above, will be utilized for the working capital requirements of the Partnership and, if necessary, to fund property operating deficits and capital improvements of the joint ventures in accordance with the respective joint venture agreements. The source of future liquidity and distributions to the partners is expected to be through cash generated from operations of the Partnership's investment properties and proceeds from the sales or refinancing of such properties.\nResults of Operations 1995 Compared to 1994\nThe Partnership reported a net loss of $253,000 for the year ended September 30, 1995, as compared to a net loss of $484,000 recognized in the prior year. The decrease in net loss resulted from a decrease in the Partnership's operating loss of $91,000 and an increase in the Partnership's share of unconsolidated ventures' income of $140,000. The decrease in the Partnership's operating loss, which includes the results of the consolidated Towne Oaks joint venture, is primarily the result of an increase in rental revenues from the Towne Oak Apartments. Rental revenues increased by $187,000 for fiscal 1995, when compared to fiscal 1994, due to the impact of the capital improvements discussed above on occupancy and rental rates. The increase in revenues at Towne Oaks was partially offset by increases in the consolidated venture's interest expense, depreciation expense and real estate taxes. Interest expense on the Towne Oaks debt increased by $42,000 as a result of the higher principal balance and interest rate on the new mortgage loan subsequent to the fiscal 1994 refinancing transaction. Depreciation expense increased by $25,000 due to the additional depreciation on the capital improvements at the Towne Oaks Apartments. In addition, real estate tax expense on the Towne Oaks property increased by $14,000 in fiscal 1995.\nThe improvement in the Partnership's share of unconsolidated ventures' income during fiscal 1995 is primarily due to an increase in rental revenues at both the Charter Oak and Braesridge joint ventures. As discussed further above, rental rates have increased at Charter Oak in conjunction with the capital improvement program and Braesridge experienced increases in both average occupancy and rental rates during fiscal 1995. Average occupancy at the Braesridge Apartments was 96% for fiscal 1995, as compared to 93% for fiscal 1994. The resulting increase in combined rental revenues, of $243,000, was partially offset by increases in repairs and maintenance expense at the Braesridge joint venture along with an increase in depreciation and amortization expense at the Charter Oak joint venture as a result of additional depreciation on the capital improvements.\n1994 Compared to 1993\nThe Partnership reported a net loss of $484,000 for the year ended September 30, 1994, which represented a decrease in net loss of $191,000 when compared to fiscal 1993. This favorable change was primarily the result of an improvement in the net operating results of the Partnership's unconsolidated joint ventures (Braesridge and Charter Oak) during fiscal 1994. The Partnership recognized income of $34,000 from its share of unconsolidated ventures' operations in 1994, as compared to a loss of $353,000 in fiscal 1993. This improvement was primarily the result of increased rental income from the Braesridge Apartments and lower mortgage interest and operating expenses of the Charter Oak joint venture. Rental revenues from Braesridge increased by $263,000 in fiscal 1994, which was partially offset by increases in salaries and repairs and maintenance expenses. As discussed further above, the Charter Oak joint venture refinanced its debt on August 31, 1993. This resulted in a decrease in the venture's interest expense of $242,000 during fiscal 1994. In addition, real estate taxes and maintenance expenses of the Charter Oak joint venture decreased by $39,000.\nThe favorable change in the Partnership's share of unconsolidated ventures' operations was partially offset by an increase in the Partnership's operating loss. The increase in the Partnership's operating loss, of $196,000, was primarily the result of an increase in interest expense, coupled with a slight decline in rental revenues, from the Towne Oaks Apartments. The decrease in rental revenues can be attributed to the decline in occupancy at the Towne Oaks Apartments during the renovation period of the apartment complex, as discussed further above. Interest expense on the Towne Oaks debt increased by $110,000 as a result of the higher principal balance and interest rate on the new mortgage loan. An increase in Partnership general and administrative expenses of $63,000 also contributed to the increase in operating loss for fiscal 1994. The increase in general and administrative expenses resulted mainly from certain expenditures incurred in connection with an independent valuation of the Partnership's operating properties which was commissioned during fiscal 1994 in conjunction with management's ongoing refinancing efforts and portfolio management responsibilities.\n1993 Compared to 1992\nThe Partnership reported a net loss of $675,000 for the year ended September 30, 1993 as compared to a net loss of $521,000 for fiscal 1992. This increase in net loss resulted from an increase in the Partnership's operating loss of $100,000, coupled with an increase in the Partnership's share of unconsolidated ventures' losses of $54,000.\nThe increase in the Partnership's operating loss was primarily a result of a decrease in rental revenues and an increase in property operating expenses reported by the consolidated Towne Oaks joint venture. The decrease in rental revenues can be attributed to a decline in occupancy at the Towne Oaks Apartments while the increase in operating expenses resulted mainly from an increase in repairs and maintenance expense incurred to upgrade the property and address certain deferred maintenance items. This was partially offset by an increase in other income at the Towne Oaks Apartments, along with a slight decrease in interest expense due to principal pay downs on the outstanding mortgage note. A decrease in interest income due to lower average outstanding cash reserve balances also contributed to the increase in operating loss for fiscal 1993.\nThe Partnership's share of unconsolidated ventures' losses increased by 18% primarily due to an overall increase in property operating expenses at both unconsolidated joint ventures, which was partially offset by an increase in rental revenues due to improved occupancy at both the Charter Oak and Braesridge apartment properties during fiscal 1993. The Partnership's share of losses from the Charter Oak joint venture decreased by $111,000 as a result of higher revenues which were partially offset by an increase in real estate tax expense as a result of a refund received in fiscal 1992. The Partnership's share of losses from the Braesridge joint venture increased by $165,000 mainly due to certain leasing and marketing expenses incurred as part of efforts to further increase occupancy.\nInflation\nThe Partnership completed its thirteenth full year of operations in fiscal 1995 and the effects of inflation and changes in prices on revenues and expenses to date have not been significant.\nInflation in future periods may cause an increase in revenues, as well as operating expenses, at the Partnership's operating investment properties. Tenants at the Partnership's apartment properties have short-term leases, generally of six-to-twelve months in duration. Rental rates at these properties can be adjusted to keep pace with inflation, as market conditions allow, as the leases are renewed or turned over. Such increases in rental income would be expected to at least partially offset the corresponding increases in Partnership and property operating expenses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nNone.\nIII-4 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 Fourth Income Properties 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 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 principal executive officers of the Managing General Partner of the Partnership are as follows: Date elected Name Office Age to Office\nLawrence A. Cohen President and Chief Executive Officer 42 8\/30\/88 Albert Pratt Director 84 6\/12\/81 * 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 6\/12\/81 * 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 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 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 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 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 September 30, 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 Partnership cash distributions and a share of profits and losses. These items are described in Item 13.\nThe Partnership has not paid cash distributions to the Unitholders from operations over the past five years. Furthermore, 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, Fourth Income Properties Fund, Inc., is owned by PaineWebber. Properties Associates, the Associate General Partner, is a Massachusetts general partnership, certain general partners of which are officers of the Adviser and 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) Neither 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 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 Fourth Income Properties 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. 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 and disposition of Partnership investments. In connection with investing Partnership capital, the Adviser received acquisition fees paid by the joint ventures and sellers.\nAll distributable cash, as defined, for each fiscal year shall be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. All sale or refinancing proceeds shall 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 losses of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Taxable income or tax losses 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 and tax losses 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 Partners 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 day-to-day operations of the Partnership, and to report periodically the performance of the Partnership to the Managing General Partner. The Adviser is paid a basic management fee (4% of adjusted cash flow, as defined) and an incentive management fee (5% of adjusted cash flow subordinated to a noncumulative annual return to the limited partners equal to 6% based upon their adjusted capital contribution) for services rendered. The Adviser did not earn any management fees during the year ended September 30, 1995 due to the lack of distributable cash flow.\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 September 30, 1995 is $86,000 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 $1,000 (included in general and administrative expenses) for managing the Partnership's cash assets during the year ended September 30, 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 listed on the accompanying index to exhibits at Page IV-3 are filed as part of this Report.\n(b) No Current 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.\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nBy: Fourth Income Properties 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: January 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 Partnership in the capacity and on the dates indicated.\nBy:\/s\/ Albert Pratt Date:January 9, 1996 Albert Pratt Director\nBy: \/s\/ J. Richard Sipes Date January 9, 1996 J. Richard Sipes Director\nANNUAL REPORT ON FORM 10-K Item 14(a)(3)\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nINDEX TO EXHIBITS\nPage Number in the Exhibit No. Description of Document Report or Other Reference - ---------------- ----------------------------------- ---------------------\n(3) and (4) Prospectus of the Registrant dated Filed with the December 22, 1991, as supplemented Commission pursuant with particular reference to the Rule 424(c) and Restated Certificant and Agreement incorporated herein of Limited Partnership. by reference.\n(10) Material contracts previously filed as Filed with the exhibits to registration to statements Commission pursuant and amendments thereto of the registrant Section 13 or together with all such contracts filed 15(d) of the as exhibits of previously filed Securities Exchange Forms 10-K and hereby incorporated Act of 1934 and herein by reference. incorporated herein by reference.\n(13) Annual Report to Limited Partners No Annual Report for the year ended September 30, 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 1 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 and Financial Statement Schedules required by Item 14.\nANNUAL REPORT ON FORM 10-K\nItem 14(a) (1) and (2) and 14(d)\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nReference Paine Webber Income Properties Four Limited Partnership:\nReport of independent auditors\nConsolidated balance sheets as of September 30, 1995 and 1994\nConsolidated statements of operations for the years ended September 30, 1995, 1994 and 1993\nConsolidated statements of changes in partners' capital (deficit) 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\nNotes to consolidated financial statements\nSchedule III - Real Estate and Accumulated Depreciation\nCombined Joint Ventures of Paine Webber Income Properties Four Limited Partnership:\nReport of independent auditors\nCombined balance sheets as of September 30, 1995 and 1994\nCombined statements of operations and changes in venturers' deficit for the years ended September 30, 1995, 1994 and 1993\nCombined statements of cash flows for the years ended September 30, 1995, 1994 and 1993\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\nThe Partners of Paine Webber Income Properties Four Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of PaineWebber Income Properties Four Limited Partnership as of September 30, 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 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 Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Paine Webber Income Properties Four Limited Partnership 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, presents fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nBoston, Massachusetts December 29, 1995\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS September 30, 1995 and 1994 (In thousands, except per Unit data)\nASSETS\n1995 1994 Operating investment property: Land $ 1,400 $ 1,400 Buildings, improvements and equipment 12,468 11,829 --------- --------- 13,868 13,229 Accumulated depreciation (4,436) (4,016) --------- --------- 9,432 9,213\nCash and cash equivalents 129 24 Tax escrow deposit 110 156 Repair escrow 59 794 Prepaid and other assets 57 39 Deferred financing costs, net of accumulated amortization of $13 ($4 in 1994) 175 184 ------- ------ $ 9,962 $10,410 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable and other liabilities $ 144 $ 484 Accrued real estate taxes 101 93 Mortgage interest payable 37 38 Tenant security deposits 58 56 Equity in losses of unconsolidated joint ventures in excess of investments and advances 974 780 Long-term debt 4,915 4,973 --------- -------- Total liabilities 6,229 6,424\nPartners' capital: General Partners: Capital contributions 1 l Cumulative net loss (100) (97) Cumulative cash distributions (51) (51)\nLimited Partners ($1,000 per unit; 25,698 Units issued): Capital contributions, net of offering costs 23,194 23,194 Cumulative net loss (9,819) (9,569) Cumulative cash distributions (9,492) (9,492) -------- --------- Total partners' capital 3,733 3,986 -------- --------- $ 9,962 $10,410 ======= =======\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS For the years ended September 30, 1995, 1994 and 1993 (In thousands, except per Unit data)\n1995 1994 1993 ---- ---- ----\nRevenues: Rental revenue $ 1,613 $ 1,426 $1,454 Interest income 8 8 9 Other income 35 62 68 ----------- ---------- --------- 1,656 1,496 1,531\nExpenses: Property operating expenses 820 811 852 Mortgage interest and other financing costs 458 416 298 Depreciation and amortization 420 395 358 Real estate taxes 134 120 136 General and administrative 251 272 209 --------- --------- --------- 2,083 2,014 1,853 -------- -------- --------\nOperating loss (427) (518) (322)\nPartnership's share of unconsolidated ventures' operations 174 34 (353) ---------- --------- --------\nNet loss $ (253) $ (484) $ (675) ======== ======= ==========\nNet loss per Limited Partnership Unit $ (9.75) $(18.65) $(26.01) ======== ======= ========\nThe above net loss per Limited Partnership Unit is based upon the 25,698 Limited Partnership Units outstanding during each year.\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended September 30, 1995, 1994 and 1993 (In thousands)\nGeneral Limited Partners Partners Total\nBalance at September 30, 1992 $(135) $5,280 $ 5,145\nNet loss (7) (668) (675) -------- ------- -------\nBalance at September 30, 1993 (142) 4,612 4,470\nNet loss (5) (479) (484) -------- ------- -------\nBalance at September 30, 1994 (147) 4,133 3,986\nNet loss (3) (250) (253) -------- -------- --------\nBalance at September 30, 1995 $ (150) $ 3,883 $ 3,733 ====== ======= =======\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended September 30, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (In thousands)\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities: Net loss $ (253) $ (484) $ (675) Adjustments to reconcile net loss to net cash provided by (used for) operating activities: Depreciation and amortization 420 395 358 Amortization of deferred financing costs 9 18 - Partnership's share of unconsolidated ventures' operations (174) (34) 353 Changes in assets and liabilities: Tax escrow deposit 46 (18) (37) Accrued interest and other receivables - 1 - Prepaid and other assets (18) 5 (27) Accounts payable and other liabilities (3) 5 21 Accounts payable - affiliate - (25) 9 Accrued real estate taxes 8 (8) - Mortgage interest payable (1) 13 (1) Tenant security deposits 2 (4) 10 ----------- ----------- ---------- Total adjustments 289 348 686 --------- --------- --------- Net cash provided by (used for) operating activities 36 (136) 11\nCash flows from investing activities: Distributions from unconsolidated joint ventures 409 125 - Additional investments in unconsolidated joint ventures (41) - (82) Additions to buildings, improvements and equipment (976) (795) (46) Decrease in (deposits to) repair escrow 735 (794) - Net cash provided by (used for) investing activities 127 (1,464) (128)\nCash flows from financing activities: Payment of deferred financing costs - (188) - Proceeds from issuance of long-term debt - 5,000 - Principal repayments on long-term debt (58) (3,364) (149) ------ ------ ----- Net cash provided by (used for) financing activities (58) 1,448 (149)\nNet increase (decrease) in cash and cash equivalents 105 (152) (266)\nCash and cash equivalents, beginning of year 24 176 442 --------- -------- ---------\nCash and cash equivalents, end of year $ 129 $ 24 $ 176 ========= =========== ========\nCash paid during the year for interest $ 450 $ 370 $ 299 ========= ========== ========\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP Notes To Consolidated Financial Statements\n1. Organization\nPaine Webber Income Properties Four Limited Partnership (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Delaware in July 1981 for the purpose of investing in a diversified portfolio of income-producing properties. The Partnership authorized the sale of units (the \"Units\") of partnership interest (at $1,000 per Unit) of which 25,698 were subscribed and issued between December 1981 and December 1982.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements include the Partnership's investments in three joint venture partnerships which own operating properties. As further discussed in Note 5, subsequent to year-end, the Partnership sold its interest in the Braesridge joint venture for $1,000,000. Except as described below, the Partnership accounts for its investments in joint venture partnerships using the equity method because the Partnership does not have a voting control interest in the ventures. Under the equity method the investment in a joint 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 unconsolidated joint venture partnerships.\nAs further discussed in Note 4, effective December 31, 1990, the co-venture partner of Arlington Towne Oaks Associates assigned its general partnership interest to Fourth Income Properties Fund, Inc., the Managing General Partner of the Partnership (see Note 3). The assignment gave the Partnership control over the affairs of the joint venture. Accordingly, the accompanying financial statements present the financial position, results of operations and cash flows of this joint venture on a consolidated basis. All transactions between the Partnership and the joint venture have been eliminated in consolidation.\nThe operating investment property owned by the consolidated joint venture is 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 Partnership's investment through expected future cash flows on an undiscounted basis, which may exceed the property's market value. The Partnership's operating investment property is considered to be held for long-term investment purposes as of September 30, 1995 and 1994. Depreciation on the operating investment property is computed using the straight-line method over an estimated useful life of forty years for the buildings and improvements and five years for the equipment. Acquisition fees paid to an affiliate in connection with the investment in the Towne Oaks joint venture have been capitalized and are included in the cost of the operating investment property.\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.\nDeferred financing costs represent loan financing fees and other long-term debt acquisition costs which have been capitalized and are being amortized, on a straight-line basis, over the term of the consolidated joint venture's mortgage loan. Amortization of deferred financing costs is included in mortgage interest expense and related financing costs on the accompanying statements of operations.\nThe consolidated joint venture leases apartment units under leases with terms usually of one year or less. Rental income is recorded on the accrual basis as earned. Security deposits typically are required of all tenants.\nFor purposes of reporting cash flows, the Partnerships 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. Upon sale or disposition of the Partnership's investments, the taxable gain or the taxable loss incurred will be allocated among the partners. In cases where the disposition of the investment involves the lender foreclosing on the investment, taxable income could occur without distribution of cash. This income would represent passive income to the partners which could be offset by each partners' existing passive losses, including any passive loss carryovers from prior years.\n3. The Partnership Agreement and Related Party Transactions\nThe General Partners of the Partnership are Fourth Income Properties 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. 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. 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.\nAll distributable cash, as defined, for each fiscal year shall be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. All sale or refinancing proceeds shall 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 losses of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Taxable income or tax losses 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 and tax losses 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 Partners 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 day-to-day operations of the Partnership, and to report periodically the performance of the Partnership to the Managing General Partner. The Adviser is paid a basic management fee (4% of adjusted cash flow, as defined) and an incentive management fee (5% of adjusted cash flow subordinated to a noncumulative annual return to the limited partners equal to 6% based upon their adjusted capital contribution) for services rendered. The Adviser did not earn any basic management fees during the three-year period ended September 30, 1995 due to the lack of distributable cash flow. No incentive management fees have been paid to date.\nIn connection with the sale of each property, the Adviser may receive a disposition fee in an amount equal to 3\/4% based on the selling price of the property, subordinated to the payment of certain amounts to the Limited Partners. No such fees have been earned to date.\nThe 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 operation of the Partnership's real estate investments.\nIncluded in general and administrative expenses for the years ended September 30, 1995, 1994 and 1993 is $86,000, $98,000 and $110,000, 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 $1,000 (included in general and administrative expenses) for each of the years ended September 30, 1995, 1994 and 1993 for managing the Partnership's cash assets. 4. Operating Investment Property\nOperating investment property at September 30, 1995 and 1994 represents the land, buildings and equipment of Arlington Towne Oaks Associates, a joint venture in which the Partnership has a controlling interest, as described below.\nOn August 23, 1982 the Partnership acquired an interest in Arlington Towne Oaks Associates, a Texas general partnership organized to purchase and operate Towne Oaks Apartments, a 320-unit apartment complex in Arlington, Texas. The Partnership's original co-venture partner was an affiliate of the Trammell Crow organization. Effective December 31, 1990, the co-venture partner of Arlington Towne Oaks Associates withdrew from the venture and assigned its interest to the Managing General Partner of the Partnership in return for a release of any further obligations. As a result of the assignment, the Partnership assumed control over the affairs of the joint venture.\nThe aggregate cash investment by the Partnership for its interest was approximately $5,258,000 (including an acquisition fee of $550,000 paid to the Adviser). The apartment complex was acquired subject to two mortgages: an institutional nonrecourse first mortgage with a balance of $4,435,000 at the time of closing and a second mortgage from the seller of the property with a balance of $1,650,000 at the time of closing. The second mortgage was extinguished in fiscal 1991. The venture refinanced its first mortgage loan during fiscal 1994. The new nonrecourse first mortgage loan had an outstanding principal balance of approximately $4,915,000 as of September 30, 1995.\nThe joint venture agreement provides that the Partnership will receive from cash flow, to the extent available, a non-cumulative preferred return, payable monthly, of $483,000 for each year. After the Partnership's preferred return requirements are met, the co-venturer is then entitled to receive quarterly, non-cumulative subordinated returns of $14,000 for each quarter thereafter. The next $300,000 of available annual cash flow in any year is to be distributed 90% to the Partnership and 10% to the co-venturer. The next $200,000 of cash flow in any year is to be distributed 80% to the Partnership and 20% to the co-venturer. Any remaining cash flow is to be used to liquidate any unpaid principal and accrued interest on any notes made by the joint venture to any partners, and any remaining cash flow is to be distributed 70% to the Partnership and 30% to the co-venturer.\nDistributions of sale and\/or refinancing proceeds will be as follows, after the payment of mortgage debts and to the extent not previously returned to each partner: 1) payment of notes and accrued interest payable to partners, 2) to the Partnership in an amount equal to the Partnership's gross investment, 3) to the manager for any unpaid subordinated management fees, 4) the next $3,000,000 to the Partnership and co-venturer allocated 90% and 10%, respectively, 5) the next $2,000,000 to the Partnership and co-venturer allocated 80% and 20%, respectively, 6) the next $2,000,000 to the Partnership and co-venturer allocated 70% and 30%, respectively (increased by $200,000 for each year or partial year succeeding the fifth year of ownership by the Partnership), 7) remaining balance to the Partnership and co-venturer allocated 60% and 40%, respectively.\nTax profits, as defined, will be allocated to the Partnership and the co-venturer in amounts equal to cash distributions, with the balance of the taxable income allocated 70% to the Partnership and 30% to the co-venturer. Tax losses, as defined, are allocated 80% to the Partnership and 20% to the co-venturer. Profits resulting from the sale or refinancing of the Operating Investment Property will be allocated as follows: 1) to the Partnership and the co-venturer on a proportionate basis to restore any negative capital accounts to zero, 2) any remaining gain equal to the excess of the capital proceeds, as defined, over the aggregate capital balances of all partners, to the Partnership and the co-venturer on a proportionate basis, and 3) to the Partnership and the co-venturer in a manner similar to cash distributions described in the preceding paragraph. Losses from the sale or refinancing of the Operating Investment Property will be allocated as follows: 1) losses equal to the excess of the aggregate positive capital accounts of all partners who have positive capital balances over the capital proceeds, as defined, to the Partnership and the co-venturer on a proportionate basis and 2) remaining losses 70% to the Partnership and 30% to the co-venturer. Internal Revenue Service regulations require partnership allocations of income and loss to the respective partners to have \"substantial economic effect\". This requirement resulted in the joint venture's net loss for the years ended September 30, 1995, 1994 and 1993 being allocated in a manner different from that provided in the joint venture agreement, as set forth above, such that no loss was allocable to the co-venturer. Allocations of the venture's operations between the Partnership and the co-venturer for financial accounting purposes have been made in conformity with the actual allocations of taxable income or tax loss.\nIf additional cash is required for any reason in connection with the venture, the Partnership and the co-venturer shall loan the required funds to the venture in the proportions of 70% and 30%, respectively. In the event a partner defaults in its obligations to make a loan, the other partner may make all or any part of the loan required by the defaulting partner. Cumulative loans advanced to the joint venture by the Partnership totalled $1,551,000 as of September 30, 1995. Such loans bear interest at the lesser of 12% per annum or the prime rate and are repayable only from the venture's net cash flow or sale or refinancing proceeds.\nThe following is a summary of property operating expenses for the years ended September 30, 1995, 1994 and 1993 (In thousands). 1995 1994 1993 ---- ---- ---- Property operating expenses: Salaries $ 263 $ 241 $ 230 Repairs and maintenance 241 175 274 Utilities 105 150 150 Insurance 10 26 25 Management fees 78 69 62 Administrative and other 123 150 111 ------ ------ ------ $ 820 $ 811 $ 852 ===== ===== =====\n5. Investments in Unconsolidated Joint Ventures\nAt September 30, 1995 and 1994, the Partnership had investments in two unconsolidated joint ventures, Charter Oak Associates and Braesridge 305 Associates, which own operating investment properties. The unconsolidated joint ventures are accounted for on the equity method in the Partnership's financial statements. Under the equity method, the assets, liabilities, revenues and expenses of the joint ventures do not appear in the Partnership's financial statements. Instead, the investments are carried at cost adjusted for the Partnership's share of the ventures' earnings, losses and distributions. Condensed combined financial statements of the unconsolidated joint ventures follow.\nCondensed Combined Balance Sheets September 30, 1995 and 1994 (in thousands)\nAssets 1995 1994\nCurrent assets $ 1,221 $ 1,903 Operating investment property, net 18,216 17,943 Other assets, net 292 276 ----------- ---------- $ 19,729 $20,122 ======== =======\nLiabilities and Venturers' Deficit\nCurrent liabilities (including current portion of mortgage notes payable) $ 2,052 $ 2,070 Long-term mortgage debt, less current portion 19,854 20,054\nPartnership's share of combined deficit (1,575) (1,406) Co-venturers' share of combined deficit (602) (596) ----------- ---------- $ 19,729 $20,122 ======== =======\nReconciliation of Partnership's Investment September 30, 1995 and 1994\n1995 1994\nPartnership's share of combined deficit, as shown above $ (1,575) $(1,406) Partnership's share of current liabilities and long-term debt 511 531 Excess basis due to investment in joint ventures, net (1) 90 95 ------- ------- Equity in losses of unconsolidated joint ventures in excess of investments and advances $ (974) $ (780) ========= ========\n(1) At September 30, 1995 and 1994, the Partnership's investment exceeds its share of the combined joint venture capital and liabilities by approximately $90,000 and $95,000, respectively. This amount, which relates to certain expenses incurred by the Partnership in connection with acquiring its joint venture investments, is being amortized on a straight-line basis over the estimated useful life of the properties.\nCondensed Combined Summary of Operations For the years ended September 30, 1995, 1994 and 1993 (in thousands)\n1995 1994 1993 ---- ---- ----\nRental income $ 5,168 $ 4,925 $ 4,546 Interest and other income 129 132 100 --------- --------- --------- 5,297 5,057 4,646\nInterest expense and related financing fees 1,779 1,790 1,910 Property operating expenses 2,663 2,646 2,583 Depreciation and amortization 640 565 544 -------- ---------- --------- 5,082 5,001 5,037 -------- -------- -------- Net income (loss) $ 215 $ 56 $ (391) ======== ========= =========\nNet income (loss): Partnership's share of combined operations $ 179 $ 39 $ (348) Co-venturers' share of combined operations 36 17 (43) --------- -------- --------- $ 215 $ 56 $ (391) ========= ========= =========\nReconciliation of Partnership's Share of Operations\n1995 1994 1993 ---- ---- ----\nPartnership's share of combined operations, as shown above $ 179 $ 39 $ (348) Amortization of excess basis (5) (5) (5) ----------- ---------- ----------- Partnership's share of unconsolidated ventures' income (losses) $ 174 $ 34 $ (353) ======== ========= =========\nEquity in losses of unconsolidated joint ventures in excess of investments and advances on the balance sheet is comprised of the following equity method carrying values:\n1995 1994\nCharter Oak Associates $ 32 $ 200 Braesridge 305 Associates (1,006) (980) --------- ------- $ (974) $ (780) ========= ======\nThese joint ventures are subject to partnership agreements which determine the distribution of available funds, the disposition of the venture's assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the venture. Substantially all of the Partnership's investments in these joint ventures are restricted as to distributions.\nA description of the unconsolidated ventures' properties and the terms of the joint venture agreements are summarized below:\na) Charter Oak Associates\nOn June 8, 1982, the Partnership acquired an interest in Charter Oak Associates, a Missouri general partnership organized to purchase and operate Charter Oak Apartments, a 284-unit apartment complex in Creve Coeur, Missouri. The Partnership is a general partner in the joint venture. The Partnership's co-venture partner is an affiliate of the Paragon Group.\nThe aggregate cash investment by the Partnership for its interest was approximately $5,289,000 (including an acquisition fee of $530,000 paid to the Adviser). The apartment complex was acquired subject to an institutional nonrecourse first mortgage with a balance of $5,036,000 at the time of closing. At September 30, 1985, Charter Oak Associates refinanced the first mortgage loan on the Charter Oak apartment complex. A new non-recourse first mortgage in the amount of $8,600,000 was obtained at that time. The mortgage loan had a term of seven years and bore interest at the rate of 11.3% per year. The proceeds from the refinancing were used to repay the remaining balance on the existing first mortgage loan of $4,670,000, to pay expenses of closing the new loan and for distributions to the joint venture partners. Refinancing proceeds of $3,000,000 and $600,000 were distributed to the Partnership and the co-venturer, respectively, on September 30, 1985. During fiscal 1993, the property's existing debt was refinanced again through the receipt of a loan issued in conjunction with an insured loan program of the U.S. Department of Housing and Urban Development (HUD). The new loan, which had an initial principal balance of $10,262,000, is a nonrecourse obligation secured by the operating investment property and an assignment of rents and leases. The loan, which is fully assumable, has a 35-year maturity and bears interest at a fixed rate of 7.35% . As part of the HUD insured loan program, the operating investment property was required to establish an escrow account for a replacement reserve and other required repairs. The excess loan proceeds, after repayment of the outstanding indebtedness, were used to pay transaction costs and to fund certain of the aforementioned capital reserve requirements.\nThe joint venture agreement and an amendment thereto (the \"Agreement\") dated September 30, 1985 provides that the first distribution of cash flow for any year shall be used collectively to reduce the other partner's deficit. The other partner's deficit is defined to be an amount equal to 10% of the excess aggregate amount required to be loaned to Charter Oak over the aggregate amount actually so loaned to Charter Oak by such partner. During fiscal 1993, the Partnership advanced 100% of the funds required to close the refinancing transaction referred to above, which totalled approximately $25,000. The joint venture agreement provides that the next $220,000 of net cash flow be distributed to the Partnership, on a noncumulative annual basis, payable monthly (preference return of the Partnership) and that the next $19,000 of cash flow be distributed to the co-venturer on a noncumulative annual basis, payable quarterly (preference return of the co-venturer); the next $213,000 of annual cash flow will be distributed 85% to the Partnership and 15% to the co-venturer, and any remaining annual cash flow will be distributed 70% to the Partnership and 30% to the co-venturer. The amount and timing of actual cash distributions are restricted by the Computation of Surplus Cash, Distributions and Residual Receipts as defined under the HUD financing agreement. During fiscal year 1995, the joint venture distributed $409,000 to the Partnership.\nDepreciation and an amount of gross taxable income equal to the amount paid to amortize the indebtedness of Charter Oak Associates shall be allocated 94% to the Partnership and 6% to the co-venturer. Any remaining taxable income or tax loss shall be allocated in the same proportions as cash is distributed. Allocations of the venture's operations between the Partnership and co-venturer for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nAny proceeds arising from a refinancing, sale, exchange or other disposition of property will be distributed first to the payment of unpaid principal and accrued interest on any outstanding mortgage loans. Any remaining proceeds will be distributed according to the September 30, 1985 Amendment to the Agreement in the following order: repayment of unpaid principal and accrued interest on all outstanding operating notes; $2,230,000 to the Partnership; $200,000 to the co-venturer; $4,000,000 to the Partnership and the co-venturer in the proportions of 85% and 15%, respectively; with the remaining balance to the Partnership and the co-venturer in the proportions of 70% and 30%, respectively, unless distributions of net cash flow and certain proceeds have reached specified levels, in which case the remaining balance is distributed equally.\nIf additional cash is required in connection with Charter Oak Associates, it may be provided by the Partnership and the co-venturer as loans to Charter Oak Associates. The agreement calls for such loans to be provided 70% by the Partnership and 30% by the co-venturer.\nThe joint venture entered into a property management contract with an affiliate of the co-venturer, cancelable at the option of the Partnership upon the occurrence of certain events. The management fee is 5% of gross rental revenues.\nb) Braesridge 305 Associates\nOn September 30, 1982 the Partnership acquired an interest in Braesridge 305 Associates (Braesridge), a Texas general partnership organized to purchase and operate Braesridge Apartments, a 545-unit apartment complex. The apartment complex is located in Houston, Texas. The Partnership is a general partner in the joint venture. The Partnership's co-venture partners are Stanford Capital Corporation and certain individuals.\nSubsequent to year end, on December 29, 1995, the Partnership sold its interest in Braesridge to an affiliate of the co-venture partners for net cash proceeds of $1 million. Management had been actively marketing the Braesridge Apartments for sale during fiscal 1995 and received several offers from prospective purchasers. The purchase contract signed with the co-venture partners was at a price which exceeded all third party offers. The net sale price for the Partnership's equity interest is based on an agreed upon fair value of the property of approximately $11.7 million. The agreed upon fair market value is supported by management's most recent independent appraisal of the Braesridge Apartments and by the marketing efforts to third-parties which were conducted during fiscal 1995. Under the terms of the Braesridge joint venture agreement, the co-venture partner had the right to match any third-party offer to purchase the property. Accordingly, a negotiated sale to the co-venturer at the appropriate market price represented the most expeditious and advantageous way for the Partnership to sell this investment. The Partnership's investment in the Braesridge Apartments represented 31% of the original investment portfolio. Despite recovering less than 15% of its original cash investment in Braesridge, the Partnership will recognize a gain in fiscal 1996 in connection with the sale of this venture interest because the losses recorded in prior years under the equity method have exceeded the Partnership's initial investment amount. The Partnership expects to distribute approximately $500,000 of the net sale proceeds, or approximately $20 per original $1,000 investment, in a Special Distribution to be made by February 15, 1996. The remaining net sale proceeds would be retained by the Partnership as additional working capital reserves. The sale of the Partnership's interest in Braesridge, as discussed further above, terminates the Partnership's rights to any share of future cash flow or sale or refinancing proceeds.\nThe aggregate cash investment by the Partnership for its interest was approximately $6,879,000 (including an acquisition fee of $725,000 paid to the Adviser of the Partnership). The property was originally subject to an institutional nonrecourse first mortgage of approximately $8,500,000 at the time of closing. Subsequent to acquisition, the venture was forced to modify the terms of the mortgage loan because the property did not generate sufficient cash flow to service the debt. The initial debt modification provided for the deferral of a portion of the debt service payments through August 1, 1994. Effective August 1, 1994, the Braesridge joint venture completed a further modification of its mortgage obligation. The modified note, in the initial principal amount of $10,058,000, is secured by the operating investment property and requires principal and interest payments of $84,000 on the first day of each month beginning September 1994. The interest rate on the modified obligation is 9% with provisions to adjust the rate after the first 7 years of the note. The term of the mortgage obligation is not to exceed 25 years. Additionally, under the loan agreement the venture is required to make property maintenance escrow payments of $16,667 each month that the escrow does not maintain a balance of $300,000. Amounts in the property maintenance escrow are to be used, subject to approval by the lender, for major repairs, replacements, and renovations to the property or to offset operating deficits incurred in connection with the property. The venture is also required to make real estate tax escrow payments.\nIf additional cash was required in connection with the operating investment property, it was to be provided by the venture partners equally as loans to the joint venture after an initial $100,000 special operating loan from the co-venturers. During 1995, the venture partners loaned an additional $82,000 to the joint venture in accordance with these terms. As of September 30, 1995, total operating loans of $290,750 and $178,250 were payable to the co-venturers and the Partnership, respectively. Total accrued interest on such loans aggregated $357,000 as of September 30, 1995.\nTaxable income or tax loss of the joint venture through the date of the sale of the Partnership's interest shall be allocated in the same proportion as cash is distributed and if no cash is distributed, 100% to the Partnership. Allocations of the venture's operations among the Partnership and co-venturers for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nThe joint venture entered into a property management contract with an affiliate of the co-venturers for fees equal to 4% of the gross receipts from operations of the complex.\n6. Long-term Debt\nLong-term debt at September 30, 1995 and 1994 relates to the consolidated joint venture, Arlington Towne Oaks Associates, and is summarized as follows (in thousands):\n1995 1994 9.08% mortgage note due March 1, 2019, payable in monthly installments of $42, including interest, collateralized by the operating investment property. $ 4,915 $4,973 ======== ======\nScheduled maturities of long-term debt are summarized as follows (in thousands):\n1996 $ 63 1997 69 1998 75 1999 83 2000 91 Thereafter 4,534 ------- $4,915 7. 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.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners of Paine Webber Income Properties Four Limited Partnership:\nWe have audited the accompanying combined balance sheets of the Combined Joint Ventures of PaineWebber Income Properties Four Limited Partnership as of September 30, 1995 and 1994, and the related combined statements of operations and changes in venturers' deficit 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 Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Partnership's management, as well as evaluating the overall financial statement presentation. We believe that our 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 Combined Joint Ventures of Paine Webber Income Properties Four Limited Partnership at September 30, 1995 and 1994 and the combined 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.\nERNST & YOUNG LLP\nBoston, Massachusetts November 16, 1995\nCOMBINED JOINT VENTURES OF PAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCOMBINED BALANCE SHEETS September 30, 1995 and 1994 (In thousands)\nAssets\n1995 1994 ---- ----\nCurrent assets: Cash and cash equivalents $ 262 $ 265 Escrow deposits 882 1,619 Property maintenance escrow 19 - Prepaid expenses 58 19 ------------ --------- Total current assets 1,221 1,903\nOperating investment properties, at cost: Land 3,119 3,119 Buildings, improvements and equipment 22,706 21,793 --------- -------- 25,825 24,912 Less accumulated depreciation (7,609) (6,969) --------- -------- 18,216 17,943 Deferred expenses, net of accumulated amortization of $25 ($131 in 1994) 292 276 ---------- ---------- $19,729 $20,122\nLiabilities and Venturers' Deficit\nCurrent liabilities: Accounts payable and other liabilities $ 114 $ 134 Accrued real estate taxes 293 298 Accrued interest 494 512 Tenant security deposits 119 116 Distributions payable to venturers 305 336 Operating loans from venturers 516 459 Other current liabilities 11 13 Current portion of long-term debt 200 202 --------- ------- Total current liabilities 2,052 2,070\nLong-term debt 19,854 20,054\nVenturers' deficit (2,177) (2,002) --------- -------- $19,729 $20,122\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF OPERATIONS AND CHANGES IN VENTURERS' DEFICIT\nFor the years ended September 30, 1995, 1994 and 1993 (In thousands)\n1995 1994 1993 ---- ---- ---- Revenues: Rental income $ 5,168 $ 4,925 $ 4,546 Interest and other income 129 132 100 --------- --------- -------- 5,297 5,057 4,646\nExpenses: Interest expense and related financing fees 1,779 1,790 1,910 Salaries and related costs 719 738 648 Depreciation and amortization 640 565 544 Repairs and maintenance 629 558 507 Real estate taxes 385 390 447 Utilities 360 386 348 Management fees 235 223 228 General and administrative 254 271 310 Insurance 81 80 95 ---------- ---------- ---------- 5,082 5,001 5,037 -------- -------- -------- Net income (loss) 215 56 (391)\nDistributions to venturers (390) (448) -\nVenturers' deficit, beginning of year (2,002) (1,610) (1,219) --------- -------- ---------\nVenturers' deficit, end of year $ (2,177) $(2,002) $(1,610) ======== ======= ========\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF CASH FLOWS For the years ended September 30, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (in thousands)\n1995 1994 1993 ---- ---- ---- Cash flows from operating activities: Net income (loss) $ 215 $ 56 $ (391) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 640 565 544 Amortization of deferred financing costs 20 40 41 Original issue discount interest - (144) (181) Changes in assets and liabilities: Escrow deposits 718 430 15 Accounts receivable - - 2 Prepaid expenses (39) 135 (72) Accounts payable and other liabilities (20) (146) 163 Accrued real estate taxes (5) (7) (3) Accrued interest (18) 116 114 Tenant security deposits 3 7 4 Other current liabilities (2) (9) (24) ------------ --------- ---------- Total adjustments 1,297 987 603 Net cash provided by operating activities 1,512 1,043 212\nCash flows from investment activities: Capital expenditures (913) (699) (79)\nCash flows from financing activities: Distributions to venturers (421) (125) - Issuance of operating loans from venturers 82 - 131 Repayment of operating loans from venturers (25) - - Restricted escrows funded by debt proceeds - - (1,678) Increase in deferred expenses (36) (59) (247) Proceeds from long-term debt - - 10,262 Principal payments on long-term debt (202) (65) (8,526) --------- ---------- ------- Net cash used for financing activities (602) (249) (58) --------- --------- ---------\nNet increase (decrease) in cash and cash equivalents (3) 95 75\nCash and cash equivalents, beginning of year 265 170 95 --------- --------- ----------\nCash and cash equivalents, end of year $ 262 $ 265 $ 170 ======== ======== ========\nCash paid during the year for interest $ 1,726 $ 1,675 $ 2,003 ======= ======= =======\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINE WEBBER INCOME PROPERTIES FOUR LIMITED PARTNERSHIP Notes to Combined Financial Statements\n1. Summary of significant accounting policies\nOrganization\nThe accompanying financial statements of the Combined Joint Ventures of Paine Webber Income Properties Four Limited Partnership (PWIP4) include the accounts of PWIP4's two unconsolidated joint ventures investees as of September 30, 1995. Charter Oak Associates was organized on June 8, 1982 in accordance with a partnership agreement between PWIP4 and Paragon\/Charter Oak Associates, Ltd. The Charter Oak Associates joint venture was organized to purchase and operate an apartment complex in St. Louis County, Missouri. Braesridge 305 Associates was formed as a general partnership on September 30, 1982, for the purpose of acquiring and operating an apartment complex, including two phases, Braesridge I and Braesridge II. On the same date, Braesridge 305 Associates acquired from a partner the assets, subject to certain liabilities, of Braesridge I and the adjacent site for Braesridge II, which was completed in August 1983. The apartment complex is located in Houston, Texas. PWIP4 has two co-venturer partners in the Braesridge joint venture, Stanford Capital Corporation (\"Stanford\") and Braesridge Apartments. The financial statements of the Combined Joint Ventures are presented in combined form due to the nature of the relationship between the co-venturers and PWIP4, which owns a majority financial interest in both joint ventures.\nBasis of presentation\nThe records of the two Combined Joint Ventures are maintained on the income tax basis of accounting and adjusted to generally accepted accounting principles (GAAP) for financial reporting purposes, principally for depreciation.\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 venture's investment through expected future cash flows on an undiscounted basis, which may exceed the property's market value. The net realizable value of a property held for sale approximates its current market value. Both of the operating properties owned by the Combined Joint Ventures were considered to be held for long-term investment purposes as of September 30, 1995 and 1994.\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 believe this new pronouncement will not have a material effect on the financial statements of the Combined Joint Ventures.\nThe Combined Joint Ventures capitalized property taxes and interest incurred during the construction period of the projects along with the costs of identifiable improvements. Professional fees and other costs relating to the formation of the joint ventures have also been capitalized and are included in the cost of the properties. Depreciation expense is computed on a straight-line basis over the estimated useful life of the buildings, improvements and equipment, generally, 5 to 40 years.\nDeferred expenses\nDeferred expenses consist of capitalized loan costs which are being amortized over the terms of the related loan agreements. Amortization of deferred loan costs is included in interest expense on the accompanying statements of operations.\nRevenue Recognition\nThe Combined Joint Ventures lease space at the apartment properties under short-term operating leases. Rental revenues are recognized on an accrual basis as earned pursuant to the terms of the leases. Security deposits are generally required of all tenants.\nReclassifications\nCertain prior year balances have been reclassified to conform to the current year presentation.\nIncome tax matters\nThe Combined Joint Ventures consists of entities which are not taxable and accordingly, the results of their operations are included on the tax returns of the various partners. Accordingly no income tax provision is reflected in the accompanying combined financial statements.\nCash and cash equivalents\nFor purposes of 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.\nEscrow Deposits\nEscrow deposits consist primarily of amounts to be used for the payment of property taxes, insurance premiums and reserves for replacements to the operating investment properties. Amounts in the property replacement reserves are to be used, subject to the approval by the lender, for major repairs, replacements and renovations to the properties. As of September 30, 1995, approximately $718,000 of these reserves relates to escrow accounts for property taxes, insurance premiums and a reserve for replacements as required by the U.S. Department of Housing and Urban Development (HUD) which insures the long-term debt of Charter Oak Associates Joint Venture. Use of these funds must be approved by HUD.\n2. Related Party Transactions\nAffiliates of Stanford provided property repair and maintenance services for the Braesridge Apartments totalling $65,000, $154,000 and $128,000 during the years ended September 30, 1995, 1994 and 1993, respectively. Additionally, management fees and fees for accounting services rendered totalling $136,000, $138,000 and $133,000 were paid by Braesridge 305 Associates to Stanford and affiliates of Stanford for the years ended September 30, 1995, 1994 and 1993, respectively. Both joint ventures have property management contracts with affiliates of the co-venture partners. The management fees paid to the property managers range from 4% to 5% of certain gross revenues.\nAs provided for in the Braesridge joint venture agreement, the first $100,000 of deficit funding from the venture partners is to be treated as a special operating loan. The special operating loans from partners accrue interest on principal only at 16%. Any deficit funding thereafter is to be treated as an operating loan which shall accrue interest on principal only at the greater of Bank of Boston prime plus 1% or 12%. Operating loans totaling $107,000 and $17,625 were made by the partners to the Braesridge 305 Associates joint venture in accordance with the joint venture agreement during fiscal 1993 and 1992, respectively. During 1995 the partners loaned an additional $82,000 to the Partnership under the same terms, as stated above. Of the total special and operating loans at September 30, 1995, $224,000, $178,000 and $67,000 is payable to Braesridge Apartments, PWIP4 and Stanford, respectively. Interest incurred on these operating loans totaled $57,000, $51,000 and $48,000 for the years ended September 30, 1995, 1994 and 1993, respectively.\nAs part of the refinancing of the long-term debt of Charter Oak Associates in fiscal 1993, PWIP4 provided an unsecured operating note in the amount of $25,000 which bore interest at the lower of 12% or the prime rate (8.75% at September 30, 1995) per year. The operating note and related accrued interest are payable only from refinancing or sales proceeds as defined by the agreement, including funds set aside in an escrow account to be released at some later date. During fiscal 1995, Charter Oaks repaid the operating loan plus accrued interest from certain funds released from escrow by the mortgage lender.\nIncluded in the balance of other current liabilities at September 30, 1995 and 1994 is $11,000 and $13,000, respectively, which represents the balance in an intercompany account maintained between Charter Oak Associates and the related property manager.\n3. Joint Venture Agreements\nCharter Oak Associates\nThe joint venture owns and operates the Charter Oak Apartments, a 284-unit apartment complex in Creve Coeur, Missouri. As discussed further in Note 4, the mortgage debt of Charter Oak Associates matured on October 1, 1992, and was refinanced during fiscal 1993 through the receipt of a loan issued in conjunction with an insured loan program of the U.S. Department of Housing and Urban Development (HUD).\nThe joint venture agreement and an amendment thereto dated September 30, 1985 (collectively, the Agreement) provides that the cash flow for any year shall first be distributed to a partner in the amount of the other partner's deficit. The other partner's deficit is defined to be an amount equal to 10% of the excess aggregate amount required to be loaned to the joint venture over the aggregate amount actually so loaned to the joint venture by such partner. Cash flow for any year shall next be distributed to PWIP4 in the amount of $220,000 on a non-cumulative annual basis, payable monthly. The next $19,000 will be distributed to the co-venturer on a non-cumulative annual basis, payable quarterly. The next $213,000 of annual cash flow will be distributed 85% to PWIP4 and 15% to the co-venturer, and any remaining annual cash flow will be distributed 70% to PWIP4 and 30% to the co-venturer. The timing and amount of actual distributions to the venture partners is restricted by the Computation of Surplus Cash, Distributions and Residual Receipts as defined under the HUD financing agreement. During fiscal year 1995, the joint venture distributed $385,000 to the Partnership.\nDepreciation and an amount of gross income equal to the amount paid to amortize the indebtedness of the joint venture shall be allocated 94% to PWIP4 and 6% to the co-venturer. Any remaining taxable income or tax losses shall be allocated in the same proportions as cash is distributed. Allocations of income or loss for financial reporting purposes have been made in accordance with the allocations of taxable income and tax loss.\nAny proceeds arising from a refinancing, sale, exchange or other disposition of property will be distributed first to the payment on unpaid principal and accrued interest on any outstanding mortgage notes. Any remaining proceeds will be distributed in the following order: repayment of unpaid principal and accrued interest on all outstanding operating notes; $2,230,000 to PWIP4; $200,000 to the co-venturer; $4,000,000 to PWIP4 and the co-venturer in the proportions of 85% and 15%, respectively; with any remaining balance to PWIP4 and the co-venturer in the proportions of 70% and 30%, respectively, unless distributions of net cash flow and certain proceeds have reached specified levels, in which cash the remaining balance is distributed equally.\nIf additional cash is required in connection with the joint venture, it may be provided by PWIP4 and the co-venturer as loans (evidenced by operating notes) to the joint venture. The agreement calls for such loans to be provided 70% by PWIP4 and 30% by the co-venturer. PWIP4 funded 100% of the operating note required by the venture in fiscal 1993. Charter Oak Associates repaid the 1993 operating note plus accrued interest during fiscal 1995.\nBraesridge 305 Associates\nThe joint venture owns and operates the 545-unit Braesridge apartment complex located in Houston, Texas. The joint venture agreement provides that the Net Cash Flow (as defined), after certain adjustments, shall be distributed monthly as a preferred return to PWIP4 from the date of the agreement as follows: September 30, 1983 - $510,000, September 30, 1984 - $555,000; September 30, 1985 and thereafter - $600,000. Any such amounts not distributed prior to the sale of the property will be distributed as a preference item to PWIP4 upon dissolution of the joint venture. Unpaid amounts at September 30, 1995 total $6,300,000. If any net cash flow remains after the payment to PWIP4 and payment of interest on the special operating loans for years subsequent to September 30, 1991, a noncumulative annual preferred return of up to $200,000 will be paid to Stanford Capital Corporation and Braesridge Apartments (the \"remaining partners\") on a quarterly basis. Any net cash flow remaining after payment of the preferred returns subsequent to September 30, 1991 will be distributed annually as follows: the first $100,000 distributed 75% to PWIP4 and 25% to the remaining partners, and any remaining distributed 50% to PWIP4 and 50% to the remaining partners.\nIf there is a sale, exchange, or refinancing of the encumbered operating investment property, the first payment (after repayment of any operating loans, including accrued interest, payable to the venture partners) will be to PWIP4 to the extent of its gross investment (presently $6,775,000); the next will be to pay any accrued interest on and principal of any outstanding special operating loans; the next $2,250,000 will be to the remaining partners; the next $1,000,000 will be to PWIP4; and the next $500,000 will be to the remaining partners. Any excess will be distributed 50% to PWIP4 and 50% to the remaining partners.\nTaxable income or tax loss in each year shall be allocated in accordance with the partners' tax basis interests in the joint venture. Allocations of the venture's income or loss for financial reporting purposes have been made in accordance with the allocations of taxable income and tax loss.\nAdditional working capital required in connection with operations of the property prior to September 30, 1986 was to be provided by the remaining partners. Working capital required subsequent to September 30, 1986 is to be provided by the partners equally as loans to the joint venture (see Note 2).\nOn October 27, 1995 PWIP 4 entered into a partnership interest purchase agreement with Braesridge 1995 Equity (Braesridge), an affiliate of the co-venturers, calling for the sale of PWIP4's entire partnership interest to Braesridge for $1,000,000. On this date, Braesridge paid PWIP a $200,000 nonrefundable deposit which is to be credited against the purchase price at closing. Under the terms of the assignment, PWIP4 will relinquish all rights and obligations associated with its interest in the joint venture, including any loans outstanding and interest related thereto. 4. Mortgage Notes Payable\nLong-term debt at September 30, 1995 and 1994 consists of the following (in thousands):\n1995 1994\n7.35% nonrecourse mortgage secured by the Charter Oak operating investment property; payable from October 1, 1993 through August 1, 2028, in principal and interest installments of $68 per month and the last installment to be due and payable on September 1, 2028. See discussion below. $ 10,127 $10,197\n1995 1994\nMortgage note secured by the Braesridge Apartments; principal and interest payments of $84 are due on the first day of each month beginning September 1994. The loan bears interest at a rate of 9% with provisions to adjust the rate after the first 7 years of the note. The term of the mortgage obligation is not to exceed 25 years. See discussion regarding modification below. 9,927 10,059 20,054 20,256 Less current portion (200) (202) -------- ------- $ 19,854 $20,054 ======== =======\nAnnual debt service payments on the Braesridge mortgage loan were scheduled to increase by approximately $130,000 effective August 1, 1992. Commencing August 1, 1992 monthly principal and interest payments of $95,000 were to have been payable until August 1, 1994 at which time a balloon payment of $9,800,000 was to have been due. The venture's cash flow was not expected to be sufficient to cover these increased payments in fiscal 1993. As a result, management initiated discussions with the lender during fiscal 1992, which resulted in an agreement for a further modification of the loan terms. Under the terms of the modification agreement, dated December 2, 1992, the lender agreed to defer the scheduled principal payments through the remaining term of the loan, which matured on August 1, 1994, until which the loan required interest-only payments on a monthly basis at a rate of 10% per annum. The mortgage note was modified again on August 1, 1994 under the terms set forth above. The agreement contains a call option that, with six months advance written notice on either the 7th, 14th, or 21st anniversary date of the note, would require the payment of the unpaid principal and accrued interest. Given 30 days advance written notice, the Partnership is allowed to make prepayments of up to 10% of the original principal on any interest paying date during the first 7 years of the note without prepayment consideration. The entire balance may be prepaid during the six full calendar months immediately preceding the 7th, 14th, and 21st anniversary date of the note or immediately preceding the maturity date of August 1, 2019 given 30 days advance written notice. In addition, the venture is required to make property maintenance escrow payments of $16,667 each month that the escrow does not maintain of balance of $300,000. Amounts in the property maintenance escrow are to be used, subject to approval by the lender, for major repairs, replacements and renovations to the property or to offset operating deficits incurred in connection with the property. The venture is also required to make real estate tax escrow payments.\nInterest expense on the Braesridge loan through August 1, 1994 was adjusted to reflect the original issue discount on the basis of a constant annual interest rate of 8%. This additional liability was recorded as accrued original issue discount interest and totalled $144,000 at September 30, 1993. Such amount was fully amortized during fiscal 1994.\nThe loan secured by the Charter Oak Apartments is insured by the U.S. Department of Housing and Urban Development (HUD). In addition to the monthly principal and interest payment, the Charter Oak joint venture submits monthly escrow deposits of $19,000 for tax and insurance escrows and replacement reserves. Under the HUD loan program, the venture is required to obtain mortgage insurance to cover the outstanding principal balance of the loan. Mortgage insurance premiums paid during fiscal 1995 and 1994 totalled $84,000 and $103,000, respectively, and are included in interest expense and related financing fees on the accompanying statement of operations.\nMaturities of the long-term debt for each of the next five years and thereafter are as follows (in thousands):\n1996 $ 200 1997 217 1998 236 1999 257 2000 279 Thereafter 18,865 $20,054","section_15":""}
{"filename":"801449_1995.txt","cik":"801449","year":"1995","section_1":"Item 1. Business\nThe Partnership, Outlook Income Fund 9, was formed on August 29, 1986 as a limited partnership under the California Revised Limited Partnership Act. The Partnership's public offering commenced on January 12, 1987 and concluded on January 11, 1988, having raised a total of $40,971,400, of which $5,228,800 was raised from the sale of Participating Notes. These totals include the proceeds of the private sale of notes to the former general partner in the amount of $543,500. The Partnership's operations began on March 5, 1987, the date when impound requirements were met. The former general partner of the Partnership was Outlook Financial Partners, a California general partnership. On May 8, 1992, Glenborough Realty Corporation, as Managing General Partner, and Robert Batinovich, as co-General Partner, (collectively \"Glenborough\" or the \"General Partner\") were substituted as the general partners following the May 1, 1992 receipt of consents from limited partners owning a majority in interest of the outstanding limited partner units. With limited exceptions, Glenborough has exclusive control over the business of the Partnership, including the right to manage the Partnership's assets.\nThe Partnership's primary business is to invest in and operate existing income-producing properties (or interests therein), which are expected to generate cash from rentals in excess of that required to meet the operating expenses of the respective properties, as well as the expenses of the Partnership.\nThe Partnership sold units of limited partnership interest (\"Equity Units\") and Participating Notes with income deferred (\"Notes\"). The Notes are nonrecourse, unsecured obligations of the Partnership. The Notes bear stated interest at the rate of 12% per annum, noncompounded, and all payments of interest will be deferred until the date of maturity of the Notes (December 31, 1997, or a date not later than December 31, 1998 if the General Partner extends the maturity date) or the sale or refinancing of the Partnership's properties. The holders of the Notes are entitled to receive contingent interest if, after the sale of all of the Partnership's properties, the Partnership has met certain earnings tests. In addition to the proceeds from the sale of the Notes, the Partnership has borrowed funds from both affiliated and unrelated lenders. The total indebtedness of the Partnership, including the Notes and accrued interest to the latest possible maturity date (excluding contingent interest) and any third-party financing which is secured by liens on the Partnership's properties, may not exceed 85% of the aggregate purchase price of properties which have not been refinanced plus 85% of the aggregate fair market value as determined by the lender as to all properties which have been refinanced, plus certain reserves.\nOn June 15, 1993, the Partnership purchased the Participating Notes ($545,300) and accrued interest thereon ($309,800), held by\nPage 2 of 53\nthe former general partner, for $425,000. The difference between the carrying value of the liabilities to the former general partner and the purchase price was recorded as an extraordinary gain in the Partnership's 1993 consolidated statement of operations. The Notes and accrued interest thereon are being held in trust for the benefit of the Partnership.\nIn January 1994, the Partnership sent a \"Conditional Offer to Purchase 12% Participating Notes\" (\"the Offer\") to all Note investors. The Offer was made to Noteholders in an effort to reduce the impact of the Notes' accrued interest on the value of the Equity Units. Buying back these notes provides a significant interest savings to the Partnership, which benefits the Equity Unit investors (whose returns are subordinated to the Noteholders' receiving a return of principal plus 12% simple deferred interest per annum).\nApproximately 45% of the Noteholders accepted the offer and the repurchase occurred in March 1995. The repurchase totalled $2,102,000 in original Note principal. The related accrued interest on these Notes was $1,915,000, which was not paid and represented the discount the Partnership received in the buyback. The Partnership used the proceeds from a $2,000,000 short-term loan to fund the repurchase (further discussion follows). The forgiveness was recognized as an extraordinary gain on the Partnership's 1995 statement of operations. The Notes and accrued interest will be held in trust for the benefit of the Partnership.\nOn June 9, 1995, in accordance with the Participating Notes Indenture and as a result of the sale of Millwood Estates, the Partnership retired $637,000 in notes and $592,000 in related accrued interest. Of this amount, the Partnership paid $609,000 ($314,000 of Participating Notes principal and accrued interest of $295,000) to outside Noteholders, the remainder represented a retirement of notes held in trust for the Partnership.\nIn June 1995, the Partnership sent a second \"Conditional Offer to Purchase 12% Participating Notes\" (the \"second Offer\") to the remaining Noteholders. The second Offer is for the repurchase of the Notes for a price equal to 135% of the Noteholders original investment (i.e. the purchase price for each Note will be $1.35 compared to an approximate current Note and accrued interest value of $1.95). The second Offer expired October 31, 1995, but the Partnership extended the expiration to December 31, 1995. As of February 1996, 177 Noteholders accepted the offer. The result will be $1,104,000 in notes which will be bought at a purchase price of $1,491,000 in 1996. Through March 27, 1996, the partnership repurchased $863,000 in notes for a purchase price of $1,166,000. The Partnership borrowed an additional $1,100,000 on the $2,000,000 line of credit with an unaffiliated lender to fund the repurchase.\nThe General Partners have filed with the Securities and Exchange Commission a Registration Statement proposing a consolidation by merger of several entities, not including the Partnership.\nPage 3 of 53\nHowever, the Registration Statement discloses that, if the merger is completed, the merged entity intends to purchase from the Partnership the Memphis and Tempe hotel properties for a purchase price of $8.7 million, subject to the General Partners obtaining the approval of a majority of the limited partner voting interest in the Partnership. At December 31, 1995, this process has been delayed.\nCompetition\nThe Managing General Partner believes that characteristics influencing the competitiveness of a real estate project are the geographic location of the property, the professionalism of the property manager and the maintenance and appearance of the property, in addition to external factors such as general economic circumstances, trends, and the existence of new, competing properties in the vicinity. Additional competitive factors with respect to commercial and industrial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and the ability to provide rent concessions and additional tenant improvements commensurate with local market conditions. Such competition may lead to rent concessions that could adversely affect the Partnership's cash flow. Although the Managing General Partner believes the Partnership Properties are competitive with comparable properties as to those factors within the Partnership's control, continued over-building and other external factors could adversely affect the ability of the Partnership to attract and retain tenants. The marketability of the Properties may also be affected (either positively or negatively) by these factors as well as by changes in general or local economic conditions, including prevailing interest rates. Depending on market and economic conditions, the Partnership may be required to retain ownership of its Properties for periods longer than anticipated at acquisition, or may need to sell earlier than anticipated or restructure a property, at a time or under terms and conditions that are less advantageous than would be the case if unfavorable economic or market conditions did not exist.\nWorking Capital\nThe Partnership's practice is to maintain cash reserves for normal repairs, replacements, working capital and other contingencies. The Partnership knows of no statistical information which allows comparison of its cash reserves to those of its competitors.\nOther Factors\nFederal, state and local statutes, ordinances and regulations which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment do not presently have a material effect on the operations of the Properties nor on the capital expenditures, earnings or competitive position of the Partnership. Although asbestos was found in the acoustical\nPage 4 of 53\nceiling spray in the offices at one of the Partnership's commercial properties, the level was within complete compliance with applicable law and management is in the process of removing it. There can be no assurance that such regulations will not change or have some material effect on the partnerships in the future.\nThe Partnership does not directly employ any individuals. All regular employees rendering services on behalf of the Partnership are employees of Glenborough or its affiliates.\nThe business of the Partnership to date has involved only one industry segment. The Partnership has no foreign operations and the business of the Partnership is not seasonal.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAt December 31, 1995, the Partnership had interests in the following properties:\nLake Mead Estates Apartments\nOn April 30, 1987, the Partnership acquired its first property, Lake Mead Estates, a 160-unit apartment complex located at 2068 North Nellis Boulevard, Las Vegas, Clark County, Nevada. The property is situated on one of Las Vegas's major north\/south arteries providing a direct route between the city center and Nellis Air Force Base, southern Nevada's largest employer. Total consideration of $5,912,400 was paid in cash.\nThe property was completed in October 1986 and consists of ten wood frame and stucco two-story buildings. The property contains 40 one-bedroom, one-bath units of 633 square feet each, and 120 two-bedroom, two-bath units of 919 square feet. Each unit has a balcony, air conditioning, frost-free refrigerator, and washer\/dryer. Common areas include: a swimming pool and spa, exercise room, picnic\/barbecue area, basketball and volleyball courts, and a separate children's play area. Each unit is assigned a carport for parking.\nThe Clark County economy experienced a slow-down during the early 90's due to the effects of the recession. Lower interest rates attracted first time home buyers away from apartment renting and the local defense department has been down-sizing due to cut- backs. Despite these conditions, occupancy was maintained at or near mid-90% through 1994. In 1995, Nellis Air Force Base completed renovation on its base housing. Occupancy began to drop as military personnel returned to base housing or received military orders to be stationed overseas. At December 31, 1995 the occupancy was 88%. According to research conducted by the Partnership's property manager, during 1995, the average apartment complex occupancy in Clark County was 94%, and the average apartment complex occupancy for the property's competitive area was estimated at approximately 95%. Subsequent to the Partnership's year end, the occupancy has risen to 96%.\nPage 5 of 53\nThe occupancy level at December 31, expressed as a percentage of the total apartments available for rent and the average rental rates for the apartments for the last five years were:\n1995 1994 1993 1992 1991 Occupancy rate 88% 98% 94% 96% 96%\nRental rate: One bedroom \/one bath units $503 $482 $476 $462 $457 Two bedroom \/two bath units $612 $585 $564 $546 $546\nIn the opinion of management, the property is adequately covered by insurance.\nIn 1995, the annual real estate tax rate was approximately 2.60% based upon 100% of the assessed market value, resulting in annual taxes of approximately $54,000.\nOn September 19, 1988, the Partnership obtained a loan from American National Insurance Company in the original amount of $4,000,000, secured by a note and first deed of trust secured by the property. The note requires monthly principal and interest payments of $34,000 at an annual interest rate of 9.625% and matures on October 1, 2018. At December 31, 1995, the outstanding balance of the note was $3,764,000.\nBryant Lake Business Center - Phases I & II\nOn January 28, 1988, the Partnership acquired a ninety percent (90%) general partner interest in Bryant Lake Associates, Phases I and II, A California Limited Partnership (the \"Joint Venture\"), in order to acquire Phases I and II of the Bryant Lake Business Center, a business center located in Eden Prairie, Minnesota. Total consideration paid by the Partnership, in cash, was $4,890,000. On November 30, 1990, the Partnership purchased the 10% limited partnership interest for $180,000; $75,000 paid upon closing and $50,000 and $55,000 paid on January 31, 1991 and January 31, 1992, respectively. As a consequence of the purchase, the Joint Venture was dissolved and the assets and liabilities of the Joint Venture were transferred to the Partnership.\nThe property consists of three single-story buildings totalling 80,011 square feet of office\/showroom and office\/warehouse space located on approximately 6.375 acres on Valley View Road near the intersection of Interstate Highway 494 and U.S. Highway 169-212 in Eden Prairie, Minnesota, a southeastern suburb of Minneapolis.\nThe property was completed in two phases. Phase I, consisting of two buildings containing 60,757 rentable square feet, was completed in 1984. Phase II, consisting of one building containing 19,254 rentable square feet, was completed in 1985. The buildings each have brick facades with decorative metal\nPage 6 of 53\naccent features. All buildings have truck loading docks and are equipped with a fire sprinkler system.\nAccording to research conducted by the Partnership's property manager, the Twin Cities area and its surrounding suburban economy has been characterized by diversity, stability and long term growth trends. Unemployment has been relatively low and industrial expansion has continued with moderation through the early 90's. Industrial and office market absorption had softened slightly since 1990 but tightened in 1992 after a recent wave of build-to-suit property construction.\nThe property was 100% leased at year end 1995 with a major tenant lease expiration occurring in December 1996. Management is in negotiations to renew, however the space will also be marketed for lease if necessary. The property is in excellent physical condition and no capital improvements are planned for 1996.\nThe occupancy level at December 31, expressed as a percentage of the total net rentable square feet, and the average annual effective rent per square foot for the last five years were:\nOccupancy Level Average Annual Effective Year Percentage Rent Per Square Foot 1995 100% $6.81 1994 100% 6.48 1993 96% 6.67 1992 100% 6.48 1991 95% 6.04\nAt December 31, 1995, annual effective rental rates ranged from $4.40 to $11.33 per square foot.\nThree tenants occupy greater than ten percent of the leasable space of the property. The principal provisions of their leases and the nature of the tenants' businesses are: Data Collection Zytec Vicom, Inc. Systems, Inc.\nNature of business Office\/lab Office\/ Office\/ warehouse warehouse computer systems\nLease term 13 years 7 years 7 years\nExpiration date 9\/30\/97 12\/31\/96 3\/31\/01\nSquare feet 25,796 13,815 19,300 (% of total) 32% 17% 24%\nAnnual effective rent $161,999 $113,877 $91,675\nRent increases CPI Fixed Fixed Increases Increases\nPage 7 of 53\nRenewal options 1-3 year None 1-5 year option option\nIn the opinion of management, the property is adequately covered by insurance.\nIn 1995, the annual real estate tax rate was approximately 6.31% based upon 100% of the assessed market value, resulting in annual taxes of approximately $186,000.\nAs part of the 1990 workout of the Bryant Lake Phase III mortgage (see further discussion which follows), the lender received as additional security a first lien on the Bryant Lake Phases I and II property, but at any time, the Partnership may furnish a letter of credit to the lender, and upon the lender's acceptance of the letter of credit, the lender will release its first lien on the Bryant Lake Phases I and II property.\nBryant Lake Business Center - Phase III\nOn January 28, 1988, the Partnership acquired a fifty percent (50%) general partnership interest in Bryant Lake Associates, Phase III, a California limited partnership ( the \"Joint Venture\"), in order to acquire Phase III of the Bryant Lake Business Center. Total consideration paid by the Partnership of $3,251,900 included $826,900 in cash and assumption of 50% of the existing $4,850,000 commercial development revenue bonds secured by a first deed of trust.\nOn November 30, 1990, the Partnership purchased the remaining 50% limited partnership interest. As consideration for the purchase, the sellers will be entitled to 25% of net cash flow, if any, from operations and ultimate disposition of the property, as provided in the purchase agreement. Through December 31, 1995, no net cash flow payments have been due or payable to the seller. As a consequence of the purchase, the Joint Venture was dissolved and the assets and liabilities of the Joint Venture were transferred to the Partnership.\nThe property consists of three single-story buildings totalling approximately 91,732 square feet of office\/showroom and office\/warehouse space located on approximately 8.038 acres on Valley View Road near the intersection of Interstate Highway 494 and U.S. Highway 169-212 in Eden Prairie, Minnesota, a southeastern suburb of Minneapolis.\nThe buildings, completed in 1986, have brick facades and decorative metal accent features. All buildings have truck loading docks and are equipped with fire sprinkler systems.\nThe occupancy level at December 31, expressed as a percentage of the total net rentable square feet, and the average annual effective rent per square foot for the last five years were:\nOccupancy Level Average Annual Effective Rent Year Percentage Per Square Foot\nPage 8 of 53\n1995 100% $7.16 1994 96% 6.68 1993 97% 6.35 1992 91% 5.16 1991 82% 6.30\nAt December 31, 1995, annual effective rental rates ranged from $5.20 to $8.88 per square foot.\nThree tenants occupy ten percent or more of the leasable square footage of the property. The principal provisions of their leases and the nature of the tenants' businesses are:\nSeasonal Keomed, Specialties Inc. SalesForce\nNature of business Office Office\/ Office\/ warehouse warehouse\nLease term 8 years 6 years 6 years\nExpiration date 12\/31\/00 5\/31\/97 3\/31\/97\nSquare feet 13,802 10,083 17,455 (% of total) 15% 11% 19%\nAnnual effective rent $64,036 $73,320 $155,040\nRent increases None None after None June 1994\nRenewal options None None None\nIn the opinion of management, the property is adequately covered by insurance.\nIn 1995, the annual real estate tax rate was approximately 6.35% based upon 100% of the assessed market value, resulting in annual taxes of approximately $218,000.\nThe Partnership obtained a loan in the original amount of $4.850,000 secured by first deeds of trust on the Bryant Lake Phase III and Bryant Lake Phases I and II properties. The note requires monthly interest-only payment of $35,000 through November 1, 2000.\nCountry Suites By Carlson - Memphis\nOn August 1, 1988, the Partnership purchased the Country Suites By Carlson - Memphis, a 121-suite hotel located at 4300 American Way in Memphis, Tennessee. Total consideration paid of $5,502,700 included a cash payment of $4,131,700 and a note in the original amount of $1,371,000 to which the property is subject.\nPage 9 of 53\nThe property is situated on the north side of American Way, west of the intersection of American Way & Cherry Road, approximately nine miles east of the Memphis Central Business District and 1- 1\/2 miles northeast of Memphis International Airport. The property was completed in February 1988 and consists of four three-story buildings containing 121 hotel suites. Each suite is furnished and features a complete kitchen facility, except the mini suites, each of which contains a microwave and small refrigerator. Amenities include a centrally located swimming pool and spa, guest laundry facilities and conference rooms above the lobby area. An atrium located at the rear of the office\/registration area, overlooks the courtyard area. An elevator located adjacent to the courtyard area, services the three-story hotel.\nDuring 1993, the hotel underwent significant improvements including internal and external painting, landscaping and the installation of a new computer system at a total cost of $156,300 in order to meet the Country Suites By Carlson standards. By upgrading the hotel's physical and aesthetic appeal, management has not only met the Country Suites By Carlson franchise standards but also improved the potential average room rates which was apparent during 1994. In 1995, improvements included new mattresses, televisions, carpet, sleeper sofas, HVAC units and general room upgrades in some of the rooms. Similar improvements are proposed for 1996 in order to stay competitive with new hotels in the area.\nThe target market is small corporate business, larger contract accounts and government\/military business; each of which provides a strong base of week-day revenues. In addition, transient business and discounted leisure groups provide on-going week-end revenues. Marketing efforts will continue to focus on new account development within the business and government sector to build a strong base of week-day clients. The franchise reservation system, which books the highest rated room rates, has matured and helps to aid the property in earning a higher average daily room rate. With a strengthening of the local economy, including the addition of nearby gaming hotels and boats, the supply has now outpaced the demand for hotel rooms and occupancy has begun to drop.\nThe 121 suites are summarized as follows:\nSq. Ft. Total No. Description Per Ste. Sq. Ft. 17 Twins 367 6,239 42 1 Bedroom 367 15,414 6 Kings 367 2,202 56 Studio 248 13,888 121 37,743\nAtrium lounge and office 2,429 Laundry and storage 1,515 Meeting rooms 1,300 Total enclosed area 42,987\nPage 10 of 53\nThe property's average occupancy level and average daily room rate for the past five years were:\n1995 1994 1993 1992 Average occupancy level 72% 75% 75% 72% 69% Average daily room rate $52.68 $53.21 $49.40 $50.80 $51.75\nThe above rates are for 1-7 night stays and include any extended stay, corporate or military discounts.\nCompeting hotels in the area quoted average daily room rates from $55.00 for a weekday stay to $149.00 for a weekend stay, double occupancy, according to research conducted by Partnership's General Manager. Rates quoted include extended or commercial stays or senior or military discounts.\nIn the opinion of management, the property is adequately covered by insurance.\nIn 1995, the annual real estate tax rate was approximately 3.16% based upon 40% of the assessed market value, resulting in annual taxes of approximately $175,000.\nThe property is owned by the Partnership in fee, subject to a note and first deed of trust in the original amount of $1,371,000 payable to GLENFED Service Corporation. In July 1992, the Partnership negotiated a restructure of the original note. The new note bears interest at a fixed 9% rate, payable in monthly principal and interest installments of $29,000 until the note matures in July 1999, when all principal and interest is due and payable. The outstanding principal balance of the restructured note at December 31, 1995, was $3,504,000.\nCountry Suites By Carlson - Tempe\nOn August 1, 1988, the Partnership acquired an undivided seventy- five percent (75%) interest as Tenants in Common with Outlook Income Fund 10, A California Limited Partnership (\"OIF 10\"), in a 138-suite hotel known as Country Suites By Carlson - Tempe, located at 1660 East Elliot Road and Harl Avenue, in Tempe, Arizona. OIF 10 was an affiliate of the Partnership with similar investment objectives. Total consideration paid by the Tenancy in Common for the property was $7,786,800, which included a cash payment of $5,927,800 and a promissory note in the original amount of $1,859,000, to which the property was subject.\nOn November 4, 1993, the Partnership finalized the purchase of the minority interest in the consolidated joint venture from OIF 10 and Country Suites By Carlson - Tempe has since then been 100% owned by the Partnership. The total purchase price of $1,225,000 included a cash payment of $950,000 plus the cancellation of the\nPage 11 of 53\n$275,000 note receivable from OIF 10 originally owed to an affiliate of the former general partner which was purchased by the Partnership in June 1993.\nThe property contains 2.532 acres of level, irregularly shaped land, at the intersection of Elliot Road and Harl Road, with 468.94 feet of frontage along Harl Road and 175 feet of frontage along Elliot Road. It is located one quarter mile east of Interstate 10, south of Phoenix, in the I-10 Commerce Center. The property was completed in May 1988 and consists of five three-story buildings containing 138 hotel suites. Each suite is furnished and features a complete kitchen facility, except the studio units, each of which contains a microwave oven and refrigerator. Amenities include a centrally located swimming pool and spa; two guest laundry facilities; 1,000 square feet of meeting rooms and two heated pools including a constant depth child pool. An atrium located adjacent to the office\/registration area, overlooks the courtyard area.\nThe hotel is well located within the high tech, government and business strip in the fourth largest and most progressive city in the valley (according to research conducted by the property's General Manager). Although the local economy is fairly strong, low visibility from the freeway and the effects of the recession on travel had curbed the hotel's profitability. Furthermore, city government will not approve a larger sign to improve visibility of the hotel, so management is considering other options to attract \"walk-in\" business. Despite these local factors, management used aggressive marketing and a strong reservations network which resulted in an improvement in average occupancy and room rates during the course of the year.\nThe target markets included tour groups which resulted in a good portion of revenues. Management also continued to develop commercial accounts to provide a base for non-tourist season. In addition, an account executive has been hired to focus on direct sales calls to maximize new account development. Furthermore, the franchise reservation system, which books the highest rated room rates, has matured and helps to aid the property in earning a higher average daily room rate. The discount segment constituted the largest base of revenues.\nDuring 1993, a total of $81,700 was invested in capital improvements to enhance the interior and exterior building's physical appearance and comply with A.D.A. requirements. In addition, a new computer hardware and software package was installed to accommodate the industry's most sophisticated processing capabilities. A total of $111,600 in capital improvements was paid in 1994 to replace dated soft goods in the rooms as well as to complete major landscaping, replace carpeting, flooring and furniture. In 1995, $155,000 was spent on improvements necessary to upgrade some of the rooms and $103,000 is budgeted for similar improvements in 1996.\nThe 139 suites are summarized as follows:\nPage 12 of 53\nSq. Ft. Total No. Description Per Ste. Sq. Ft. 29 Queens 361 10,469 24 1 Bedroom 361 8,664 13 Kings 418 5,434 71 Studio 196 13,916 2 Handicap 361 722 139 39,205\nOffice, laundry and storage, Elevator, meeting rooms 5,240 Total enclosed area 44,445\nThe property's average occupancy level and average daily room rate for the last five years were:\n1995 1994 1993 1992 1991\nAverage occupancy level 87% 85% 70% 53% 54%\nAverage daily room rate $49.82 $44.60 $43.70 $45.80 $47.63\nThe above rates are for 1-7 night stays and include any extended stay, corporate or military discounts.\nCompeting hotels in the area quoted average daily room rates from $55.00 for a weekday stay to $140.00 for a weekend stay, double occupancy, according to research conducted by the Partnership's General Manager. Rates quoted include extended or commercial stays or senior or military discounts.\nIn the opinion of management, the property is adequately covered by insurance.\nIn 1995, the annual real estate tax rate was approximately 14.95% based upon 25% of the assessed market value, resulting in annual taxes of approximately $107,000.\nThe Partnership owns the property subject to a note and first deed payable to GLENFED Service Corporation. The note bears interest at a fixed 9% rate, payable in monthly principal and interest installments of $22,500 until the note matures in July 1999, when all principal and interest will be due and payable. The outstanding principal balance of the note at December 31, 1995, was $2,727,000.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe response to this item is incorporated by reference to Note 4 of the Notes to Consolidated Statements contained in Part II, Item 8.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nPage 13 of 53\nDuring the fourth quarter of fiscal year 1995, no matters were submitted to a vote of security holders through the solicitation of proxies or otherwise.\nPage 14 of 53\nPART II\nItem 5.","section_5":"Item 5. Market for Partnership's Common Equity and Related Stockholders Matters\nMarket Information\nThe units of limited partnership interest in the Partnership (the \"Units\") have limited transferability. There is no public market for the Units and it is not expected that any will develop. There are restrictions upon the transferability of Units, including requirements as to the minimum number of Units which may be transferred, and that the General Partners must consent to any transferee becoming a substituted limited partner (which consent may be granted or withheld at the sole discretion of the General Partner). In addition, restrictions on transfer may be imposed under certain state securities laws. Consequently, holders of Units may not be able to liquidate their investments and the Units may not be readily acceptable as collateral.\nHolders\nAs of December 31, 1995, 2,573 holders of record held 35,742,572 Equity Units and 409 holders of record held 4,591,000 Notes, including 2,329,000 Participating Notes purchased by the Partnership.\nCash Distributions\nThe Partnership paid distributions to the Equity Unit investors at a 9% annualized rate from inception through the quarter ended December 31, 1988 (except the quarter ended June 30, 1988, which was 8%), a 6% rate from January 1, 1989 through the quarter ended December 31, 1989 and a 3% rate for 1990. All such distributions paid to partners have represented return of capital.\nIn order to rebuild reserves and provide cash for capital and leasing expenses, distributions were suspended beginning with the first quarter of 1991. Management is unable to predict when distributions will be resumed.\nFunds are not expected to become available for distribution to the owners of the Notes until the properties acquired by the Partnership are either refinanced or sold and all specified priority entitlements have been satisfied under the terms of the Notes. However, the Partnership may prepay principal and the accrued 12% per annum non-compounded interest at any time. Any partial prepayments must be made pro rata to Noteholders. At maturity, December 31, 1997, all remaining principal and interest, excluding contingent interest, must be paid in full, unless at the sole discretion of the General Partner, the due date is extended to a date no later than one year after stated maturity.\nAt December 31, 1995, holders of Equity Units had an original capital balance of $35,742,600 and cumulative priority returns of\nPage 15 of 53\napproximately $19,208,100. Holders of the Notes had a principal balance of $4,591,800 (including Participating Notes of $2,329,000 purchased by the Partnership and held in trust for the benefit of the Partnership) and accrued interest of approximately $4,582,000 (including accrued interest of $2,297,000 relating to the Participating Notes purchased by the Partnership). The capital accounts of the Equity Unitholders continue to accrue priority returns at a rate of 9% per annum. The cumulative priority returns of the Equity Unitholders do not represent obligations of the Partnership, but only represents amounts which must be paid before any distributions can be paid to other partners. The principal balance of the Notes continues to accrue interest at a rate of 12%. Reference should be made to the Partnership's partnership agreement for a more complete description of preferential distributions.\nIn January, 1995 and June, 1993, the Partnership purchased a portion of the original Participating Notes at a discounted rate for a total of $2,109,000 and $425,000, respectively, which resulted in a gain of $1,915,000 and $428,000, respectively (see the accompanying consolidated statements of operations).\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following is selected data for the five years ended December 31, 1995 (in thousands, except per Unit data).\nThe financial data should be read in conjunction with the financial statements and related notes contained elsewhere in this report. This financial data is not covered by the reports of the independent public accountants. 1995 1994 1993 1992 1991 Revenue $8,202 $10,061 $ 9,913 $ 9,642 $ 9,384\nNet loss before extraordinary gain (1) $(1,134)$(2,893) $(3,949)$(2,646)$ (2,708)\nNet loss before extraordinary gain per Unit $(0.03) $ (0.08) $ (0.11)$ (0.07)$ (0.08)\nNet income (loss) $ 969 $(2,893) $(3,521)$(2,646)$ (2,708)\nNet income (loss) per Unit $ 0.03 $ (0.08) $ (0.10)$ (0.07)$ (0.08)\nDistributions per Unit: From net income $ --- $ --- $ --- $ --- $ --- Representing return of capital $ --- $ --- $ --- $ --- $ 0.01\nPage 16 of 53\nTotal assets $24,047 $38,279 $41,761 $45,910 $47,795\nSecured notes payable $15,345 $26,076 $27,223 $26,451 $26,740\nParticipating Notes $4,591 $ 5,229 $ 5,229 $ 5,229 $ 5,229\n(1) Please see the discussion regarding the 1993 impairment writedown included in Note 3 of the Notes to Financial Statements and discussion regarding the extraordinary gain included in Note 7 of the Notes to Financial Statements.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nOutlook Income Fund 9 was formed to invest in improved, income- producing real estate with the following objectives: (i) preserve and protect capital, (ii) provide substantially tax- sheltered distributions to Equity Unitholders, and (iii) offer the potential for appreciation in value.\nThe Partnership's original plan was to pay 9% current distributions to the Equity Unit investors. The primary source for these distributions was to be two-fold: First, income warranties given by sellers to maintain property income at a high level while the properties were in their start-up phase; and second, deferred interest debt that allowed the Partnership to use borrowed money without having to make current loan payments. Most of the Partnership's debt, including the Notes, was of this type. Thus, the income warranties subsidized the property income, and the deferred interest debt allowed cash flow that would normally have been required for debt service to be used for distributions. By using these techniques, the Partnership was able to pay distributions at a high level in the hope that the actual property cash flow and value of the properties would increase enough that, (i) when the income warranties and interest deferrals expired, the property cash flow would be able to make the new loan payments without reducing distributions, and (ii) when the property was sold, the value would have increased enough to absorb the higher mortgage balance without eroding the original equity. It is now evident that the original overall plan will not be realized. All distributions made by the Partnership to its investors have represented return of capital.\nThe Partnership historically paid more in distributions than it earned, and had depleted its reserves. Additionally, all income warranties expired prior to December 31, 1991 and in 1992, the deferred interest debt was restructured and loan payments commenced (see Note 5 in notes to financial statements). During 1993, the Partnership paid approximately $768,700 in capital improvements, leasing expenses and loan fees and in 1994, $577,000 was paid for these costs. In light of these events and management's intent to rebuild reserves to a level of at least $2,000,000, the suspension of distributions was essential. The Partnership's December 31, 1995 cash balance was $591,000. For the year ended December 31, 1995, the Partnership realized\nPage 17 of 53\npositive cash flows from operations after capital improvements, leasing commissions and debt service. At this time, management is unable to predict when distributions will resume.\nOn May 6, 1993, Glenborough Corporation and certain of its affiliates entered into a settlement of a lawsuit that had been brought by the seller on November 13, 1991. The lawsuit alleged that, in connection with the prior general partner's termination of the seller as operator and franchisor of the Partnership's hotels, Glenborough and its affiliates had defamed the seller and interfered with its contractual relationship with the Partnership. A majority of the amount paid to the seller under the settlement was funded by Glenborough's insurance carriers, but a portion of the settlement amount was funded by Glenborough. Pursuant to Glenborough's indemnity rights as manager of the Partnership (and as general partner of other Outlook partnerships that own hotels), Glenborough was entitled to reimbursement of this portion of the settlement payment. The Partnership's share of this reimbursement together with the legal fees associated with this settlement was $64,900 representing litigation settlement expenses in the statements of operations.\nWhen the Partnership was originally formed, the former general partner purchased a large block of the Participating Notes issued by the Partnership. In 1993, the Partnership negotiated a heavily discounted purchase of those Notes from the former general partner. On June 15, 1993, the Partnership purchased the Notes, representing a combined principal and accrued interest of $853,300, for a price of $425,000. The difference of $428,300 represented an extraordinary gain from the Participating Notes purchase in the 1993 statement of operations. These Notes continue to accrue interest thereon and are being held in trust for the benefit of the Partnership.\nOn October 29, 1993, the Partnership obtained a loan in the amount of $950,000 through a note and first deed of trust secured by Branford Business Park. The note bore interest at a rate of 8%; payable in monthly interest only installments of $6,500 until maturity on May 5, 1994. The note included an option to extend the loan term upon written agreement between the Partnership and the lender, and on April 8, 1994, the Partnership made a principal paydown in the amount of $250,000 as required by the lender in order to extend the maturity date of the note to November 7, 1994 to allow sufficient time to close the sale of the property. The remaining balance of $700,000 was paid off with the proceeds from the sale of the property on November 15, 1994 (see Note 3).\nIn December 1993, management determined that the carrying value of Branford Business Park had been permanently impaired due to conditions existing in the property's local market. As a result, the Partnership recorded a write-down of $1,697,400 to reduce the carrying value of the property. Subsequent to December 31, 1993, the Partnership became involved in activities related to the sale of the property. See Note 3 of the Notes to Financial Statements for a complete discussion.\nPage 18 of 53\nIn January 1994, the Partnership sent a \"Conditional Offer to Purchase 12% Participating Notes\" (\"the Offer\") to all Note investors. The Offer was being made to Noteholders in an effort to reduce the impact of the Notes' accrued interest on the value of the Equity Units. The Offer was contingent upon selling one or more properties or otherwise obtaining financing to raise the cash needed to repurchase the Notes at a discount. The Offer originally expired December 1, 1994 but was extended an additional 60 days. Approximately 45% of the Noteholders accepted the offer. Buying back these notes will provide a significant interest savings to the Partnership, which will benefit the Equity Unit investors (whose returns are subordinated to the Noteholders' receiving a return of principal plus 12% simple deferred interest per annum).\nIn anticipation of the Regency Residence property being assigned to the bank by a deed-in-lieu of foreclosure in 1995 as discussed in Note 3 of the Notes to Financial Statements, the Partnership recorded a realizable value reserve in the amount of $835,900 at December 31, 1994. This brought the net book value of the property down to the amount outstanding (principal and accrued interest) on the note secured by the property.\nOn November 15, 1994, the Partnership sold Branford Business Park to an unaffiliated third party for $2,675,000, out of which $700,000 was used to payoff the outstanding note secured by the property. The Partnership financed a $2,000,000 note at 8.5% interest with interest-only payments due until maturity on November 11, 1999. Since the cash received from the transaction was used to payoff the outstanding note, the Partnership was responsible for paying $166,000 in closing costs. The Partnership incurred a loss on the sale in the amount of $257,000.\nOn March 28, 1995, the Partnership sold Millwood Estates Apartments to an unaffiliated third party for $10,400,000, out of which $7,572,400 was used to payoff the outstanding note secured by the property. In addition, sales proceeds were used to payoff the $2,000,000 note payable used to repurchase Participating Notes (as discussed in Note 9). The Partnership recognized a gain on sale on its 1995 Statement of Operations in the amount of $154,000. In anticipation of the sale of the property, management reclassified the net book value of Millwood Estates Apartments to \"Property held for sale\" on the Partnership's December 31, 1994 balance sheet.\nThe General Partners filed with the Securities and Exchange Commission a Registration Statement proposing a consolidation by merger of several entities, not including the Partnership. However, the Registration Statement discloses that, if the merger is completed, the merged entity intends to purchase from the Partnership the Memphis and Tempe hotel properties for a purchase price of $8.7 million, subject to the General Partners obtaining the approval of a majority of the limited partner voting interest in the Partnership. As of December 31, 1995, this process has been delayed.\nIn the fourth quarter of 1995, the Partnership adopted Statement of Financial Accounting Standards No. 121 (SFAS 121) \"Accounting\nPage 19 of 53\nfor Impairment of Long-Lived Assets and Long-Lived Asset to be Disposed of\". There was no impact on the financial position or results of operations of the Partnership from the initial adoption of SFAS 121.\nManagement's ongoing business plan for the Partnership is to preserve capital and rebuild reserves. As previously discussed, management has restructured its deferred interest debt which has lowered interest expense and stabilized payments. By attempting to build reserves, suspending distributions, and prudent day to day management of income and expenditures, management is striving to maintain stable operations and endure the challenge of the market.\nResults of Operations\n1995 versus 1994\nRental revenues in 1995 decreased $2,214,000 or 23% compared to 1994 primarily as a result of the disposition of the Millwood and Regency Residence properties which accounted for a decrease of $1,369,000 and $911,000, respectively.\nInterest and other revenues of $438,000 decreased by $56,000 in 1995 compared to 1994 due to lower prevailing interest rates and average invested cash balances during 1995.\n1995 operating expenses decreased by $1,402,000 or 21% compared to 1994 primarily as a result of the disposition of the Millwood and Regency Residence properties which accounted for a decrease of $665,000 and $845,000, respectively.\nThe 1995 decrease in depreciation and amortization of $345,000 or 18% from 1994 is a result of the decrease in depreciable assets resulting from the disposition of the Millwood and Regency Residence properties.\nThe decrease in interest expense of $1,021,000 or 33% from 1995 to 1994 is a result of the disposition of the Millwood and Regency Residence properties and their related notes payable which accounted for a $554,000 and $214,000 decrease, respectively. In addition, $170,000 of the decrease relates to the combination of the repurchase and the paydown of the Participating Notes by the Partnership.\nAs discussed in Note 3 of the Notes to Financial Statements, the sale of Millwood Estates resulted in a gain of $154,000 and is included on the Partnership's 1995 statement of operations.\nAs discussed in Note 3 of the Notes to Financial Statements, the Regency Residence deed-in-lieu of foreclosure resulted in a gain of $188,000 and is included on the Partnership's 1995 statement of operations.\nAs discussed in Note 7 of the Notes to Financial Statements, the repurchase of Participating Notes and the forgiveness of the related accrued interest resulted in a gain of $1,915,000 and is included on the Partnership's 1995 statement of operations.\nPage 20 of 53\n1994 versus 1993\nRental revenues increased by $269,000, or 3%, in 1994 over 1993 primarily as a result of increased revenue at Country Suites by Carlson - Tempe, Country Suites by Carlson - Memphis and Lake Mead, partially offset by decreases in revenue at Branford Business Park and Regency Residence. The increase in revenues at the Tempe property was due to an increase in occupancy (85% in 1994 compared to 70% in 1993) and a slightly higher average daily room rate in 1994 (which is attributable to the franchise reservation system booking higher rated business). Although the average occupancy at the Memphis property remained unchanged from 1993 to 1994 at 75%, the benefit of the franchise reservation system was apparent, shown by the increase in the average daily room rate from $49.40 in 1993 to $53.21 in 1994. This rate increase was the reason for the increase in revenue in 1994 over 1993. Both increased occupancy and increased average rent resulted in increased revenues at Lake Mead. Average occupancy in the area continues to be high, mostly due to the shortage of housing on the local Air Force base forcing personnel to seek off-site housing. Branford Business Park revenues continued to decrease from 1993 to 1994, until the property was sold on November 15, 1994, as a result of a 57% occupancy rate at the time of the sale and rent concessions given in the current year to attract tenants. Regency Residence revenues decreased in 1994 compared to 1993 as a result of a decrease in occupancy from 86% in 1993 to 79% in 1994.\nInterest and other revenues of $494,000 increased by $136,000 in 1994 over 1993 due primarily to the receipt of a non-refundable deposit formerly held in escrow in the amount of $100,200 relating to the original plan for the sale of Branford in April 1994 that did not close.\nOperating expenses in 1994 increased by $234,000, or 4%, over 1993, primarily as a result of an increase in variable costs at the Country Suites by Carlson-Tempe property associated with the increase in occupancy.\nGeneral and administrative expenses decreased by $68,000, or 11% from $639,000 in 1993 to $571,000 in 1994. The 1993 expenses included an additional billing by an affiliate for underbilled 1992 general and administrative expenses.\nDepreciation and amortization decreased by $161,000 from $2,042,000 in 1993 to $1,881,000 in 1994 as a result of acquisition items that have been fully depreciated since 1993 at the Memphis and Tempe properties and the December 1993 write-down of the carrying value of Branford Business Park.\nIn anticipation of the Regency Residence property being assigned to the bank by a deed-in-lieu of foreclosure in 1995 as discussed in Note 3 of the Notes to Financial Statements, the Partnership recorded a provision to reduce the carrying value of real estate in the amount of $835,900 at December 31, 1994. This brought the net book value of the property down to the amount outstanding (principal and accrued interest) on the note secured by the property.\nPage 21 of 53\nPage 22 of 53\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nPage\nReport of Independent Public Accountants . . . . . . . . 24\nFinancial Statements: Consolidated Balance Sheets at December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . 25\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 . . . . . 26\nConsolidated Statements of Partners' Equity for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . 27\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 . . . . . 28\nNotes to Consolidated Financial Statements . . . . . . 30\nFinancial Statement Schedules: Schedule III - Consolidated Real Estate Investments and Related Accumulated Depreciation and amortization at December 31, 1995 . . . . . . . . . . 45\nFinancial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in this report.\nPage 23 of 53\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of OUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP:\nWe have audited the accompanying consolidated balance sheets of OUTLOOK INCOME FUND 9, A CALIFORNIA 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. These consolidated financial statements and the schedule referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of OUTLOOK INCOME FUND 9, 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.\nOur audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to consolidated financial statements and schedule is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nSan Francisco, California, March 27, 1996\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Balance Sheets (in thousands, except Unit amounts) December 31, 1995 and 1994\nAssets 1995 1994 Real estate investments, at cost: Land $ 4,192 $ 4,192 Building and improvements 25,903 25,510 30,095 29,702 Less accumulated depreciation (9,543) (8,479) Net real estate investments 20,552 21,223 Property held for sale, net --- 9,282 Property held pending foreclosure, net --- 3,591 Cash and cash equivalents 591 801 Notes receivable 2,000 2,000 Accounts receivable, net 177 87 Prepaid expenses and other assets 159 280 Deferred financing costs and other fees, (net of accumulated amortization of $1,225 and $1,014 in 1995 and 1994, respectively) 568 1,015 Total assets $ 24,047 $ 38,279\nLiabilities and Partners' Equity (Deficit) Notes payable - secured $ 15,345 $ 26,076 Participating notes: Notes issued 4,591 5,229 Accrued interest, thereon 4,582 4,582 Less: Notes held in trust (2,329) (544) Accrued interest, thereon (2,297) (413) Net due to outside holders 4,547 8,854\nNote payable - unsecured --- 7 Accrued interest payable 719 785 Accounts payable --- 152 Accrued expenses 380 247 Deferred income and security deposits 63 134 Total liabilities 21,054 36,255\nPartners' equity (deficit): General Partner (397) (407) Limited Partners, 35,742,572 Equity Units outstanding 3,390 2,431 Total partners' equity 2,993 2,024 Total liabilities and partners' equity $ 24,047 $ 38,279\nThe accompanying notes are an integral part of these consolidated financial statements.\nPage 25 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Operations (in thousands, except per unit amounts)\nFor the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Revenues: Rental $ 7,610 $ 9,824 $ 9,555 Interest and other 438 494 358 Gain (loss) on sale of asset 154 (257) ---\nTotal revenues 8,202 10,061 9,913\nExpenses: Operating (including $1,798, $2,618 and $2,525 paid to affiliates for the years ended December 31, 1995, 1994 and 1993, respectively) 5,183 6,585 6,351 General and administrative (including $458, $468 and $497 paid to affiliates in 1995, 1994, and 1993, respectively) 557 571 639 Depreciation and amortization 1,536 1,881 2,042 Interest 2,060 3,081 3,068 Litigation expense --- --- 65 Provision to reduce carrying value of real estate to estimated realizable value --- 836 1,697\nTotal expenses 9,336 12,954 13,862\nLoss before extraordinary items (1,134) (2,893) (3,949)\nExtraordinary items:\nGain on debt forgiveness 188 --- --- Gain from Participating Notes purchased 1,915 --- 428\nTotal extraordinary items 2,103 --- 428\nNet income (loss) $ 969 $(2,893)$(3,521)\nNet income (loss) per Equity Unit $ 0.03 $ (0.08)$ (0.10)\nDistributions per Equity Unit $ --- $ --- $ ---\nThe accompanying notes are an integral part of these consolidated financial statements.\nPage 26 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Partners' Equity (Deficit) (in thousands)\nFor the Years Ended December 31, 1995, 1994 and 1993\nTotal General Limited Partners' Partner Partners Equity\nBalance at December 31, 1992 $ (343) $ 8,781 $ 8,438\nNet loss (35) (3,486) (3,521)\nBalance at December 31, 1993 $ (378) $ 5,295 $ 4,917\nNet loss (29) (2,864) (2,893)\nBalance at December 31, 1994 $ (407) $ 2,431 $ 2,024\nNet income 10 959 969\nBalance at December 31, 1995 $ (397) $ 3,390 $ 2,993\nThe accompanying notes are an integral part of these consolidated financial statements.\nPage 27 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Cash Flows (in thousands)\nFor the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Cash flows provided by operating activities: Net income (loss) $ 969 $ (2,893) $(3,521) Adjustments to reconcile net loss to net cash provided by operating activities: Extraordinary gain from Participating Notes purchased --- --- (428) Provision for impairment 836 1,697 Depreciation and amortization 1,536 1,881 2,042 Loss on sale of property 257 --- Gain on sale of asset (154) --- --- Gain on debt forgiveness (188) --- --- Gain from Participating Notes purchased (1,915) --- --- Changes in certain assets and liabilities Accounts receivable (90) --- 94 Prepaid expenses and other assets 89 (47) 83 Deferred financing and other fees (121) (28) (74) Accounts payable (155) (33) 153 Accrued expenses 268 --- --- Accrued interest payable 358 633 705 Deferred income and security deposits (11) (70) (16)\nNet cash provided by (used for) operating activities 586 536 735\nCash flows used for investing activities: Acquisitions of and additions to real estate (439) (496) (661) Proceeds for the sale of Millwood 9,557 --- --- Purchase of minority interest in consolidated joint venture (950) Closing costs on sale of Branford --- (166) ---\nNet cash used for investing activities 9,118 (662) (1,611)\nCash flows provided by (used for) financing activities: Borrowings on secured notes payable --- --- 950 Notes payable principal payments (7,689) (448) (178) Repayment of unsecured note payable (2,007) --- --- Borrowings on unsecured notes payable 2,500 --- 10 Purchase of notes receivable --- --- (275) Payment of Participating Notes and accrued interest from Millwood sale (609) --- --- Buy-back of Participating Note units-discounted (2,109) --- (425) Distributions of minority interest on consolidated joint venture --- --- (50) Net cash used for financing activities (9,914) (448) 32\n(Continued)\nPage 28 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Cash Flows (in thousands) - continued For the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nNet decrease in cash and cash equivalents (210) (574) (844)\nCash and cash equivalents at beginning of period 801 1,375 2,219\nCash and cash equivalents at end of period $ 591 $ 801 $1,375\nSupplemental disclosure of cash flow information: Cash paid for interest $ 2,026 $2,247 $2,271\nSupplemental disclosure of non-cash transactions: Reduction of accrued interest payable resulting from purchase of Participating Notes at discount $ 1,915 $ --- $---\nPurchase of Participating Notes: Reduction of accrued interest payable resulting from purchase of Participating Notes at discount $ --- $ --- $310\nReduction of participating notes resulting from purchase of Participating Notes at discount $ --- $ --- $119 Purchase of minority interest in consolidated joint venture: Repayment of note receivable by reduction of cash proceeds for purchase of minority interest $ --- $ --- $275\nReduction of real estate investments resulting from purchase of minority interest in joint venture $ --- $ --- $123\nReceipt of Notes receivable in sale of property $ --- $2,000 $---\nProceeds from sale used to paydown note payable $ --- $ 700 $---\nThe accompanying notes are an integral part of these consolidated financial statements.\nPage 29 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nNote 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization - Outlook Income Fund 9, A California Limited Partnership, (the \"Partnership\") was organized on August 29, 1986 in accordance with the provisions of the California Revised Limited Partnership Act for the purpose of purchasing, holding, operating, leasing and selling various properties. The Partnership commenced operations on March 5, 1987. Through a registered public offering, 60,000,000 units of limited partnership interest (the \"Equity Units\") at $1.00 per unit, were authorized for sale. The sale of Equity Units was concluded on January 11, 1988, when 35,742,572 Equity Units had been sold. The Partnership also raised funds by selling $5,228,811 in non- recourse Participating Notes (the \"Notes\") (see Note 9). The former general partner of the Partnership was Outlook Financial Partners, a California general partnership. On May 8, 1992, Glenborough Realty Corporation and Robert Batinovich were substituted for Outlook Financial Partners, as the general partners (collectively, the \"General Partner\").\nThe Partnership Agreement provides for varying allocations of net income or net loss and distributions (see Note 10).\nReclassifications - Certain items in the 1993 financial statements have been reclassified to conform to the 1994 financial statement presentation.\nConsolidation and Joint Venture - A joint venture in which the Partnership had an interest of greater than 50% has been consolidated in the accompanying consolidated financial statements. Transactions and balances between the Partnership and this joint venture have been eliminated in consolidation.\nPervasiveness of 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 results of operations during the reporting period. Actual results could differ from those estimates.\nNew Accounting Pronouncement - In March, 1995, the Financial accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (SFAS 121), \"Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of.\" The Partnership adopted SFAS 121 in the fourth quarter of fiscal 1995. SFAS 121 requires that an evaluation of\nPage 30 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nan individual property for possible impairment must be performed whenever events or changes in circumstances indicate that an impairment may have occurred. There was no impact from the initial adoption of SFAS 121.\nRental Property to be Held and Used - Rental properties are stated at cost and include the related land unless events or circumstances indicate that cost cannot be recovered in which case carrying value is reduced to estimated fair value. Estimated fair value: (i) is based upon the Partnership's plans for the continued operation of each property; (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and\/or the use of capitalization rates multiplied by annualized rental income based upon the age, construction and use of the building, and (iii) does not purport, for a specific property, to represent the current sales price that the Partnership could obtain from third parties for such property. The fulfillment of the Partnership's plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Partnership to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, it is reasonably possible that the actual results of operating and disposing of the Partnership's properties could be materially different than current expectations.\nDepreciation is provided using the straight line method over the useful lives of the respective assets (see Note 3).\nDepreciation of buildings and their components is computed using the straight-line method over useful lives ranging from five to thirty years. Major replacements and improvements are capitalized, and repairs and maintenance are charged to operations as incurred.\nCash Equivalents - The Partnership considers short-term investments (including certificates of deposit) with a maturity of three months or less at the time of purchase to be cash equivalents.\nDeferred Financing and Other Fees - Fees paid to the former general partner, its affiliates and the brokers in connection with the issuance of Notes have been capitalized and amortized using the straight-line method over the term of the related Notes. Wholesaling and underwriting commissions relating to Equity Units are charged directly to partners' equity. Other fees such as loan fees and leasing commissions are amortized using the straight-line method over the term of the related notes\nPage 31 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\npayable or leases.\nRevenues - All leases are classified as operating leases. Rental income is recognized on the straight-line basis over the terms of the leases. At December 31, 1995, no tenant's revenues represented greater than 10% of the Partnership's total revenues.\nNet Loss and Distributions Per Equity Unit - Net loss and distributions per limited partnership unit are based on 35,742,572 weighted average Equity Units outstanding during all years presented.\nIncome Taxes - Federal and state income tax laws provide that income or loss of the Partnership is reportable by the partners in their tax returns. Accordingly, no provisions for such taxes have been made in the accompanying consolidated financial statements. The Partnership reports certain transactions differently for tax and financial reporting purposes.\nNote 2. TRANSACTIONS WITH AFFILIATES\nIn accordance with the Limited Partnership Agreement, the Partnership paid the General Partner and its affiliates compensation for services provided to the Partnership. Glenborough Corporation provides property management services and has been compensated as follows:\n1995 1994 1993 Property management fees $ 157,200 $ 235,900 $ 235,700 Property salaries (reimbursed) 177,400 333,600 335,500 Hotel management fees 234,500 269,500 251,700 Hotel salaries (reimbursed) 1,228,700 1,778,900 1,702,500\nThe Partnership reimbursed Glenborough Corporation for expenses incurred for services provided to the Partnership such as accounting, investor services, data processing, duplicating and office supplies, legal and administrative services, and the actual costs of goods and materials used for or by the Partnership. Glenborough was reimbursed $458,400, $467,600 and $496,600 for such expenses in 1995, 1994 and 1993, respectively.\nIn accordance with the Partnership Agreement, the General Partner or its affiliates are entitled to property disposition compensation equal to 3% of the gross sales price of the property. Glenborough Corporation was paid $312,000 in 1995 and $80,250 in 1994 associated with the sale of Millwood Estates and Branford Business Park, respectively.\nPage 32 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nPage 33 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nNote 3. REAL ESTATE INVESTMENTS\nThe cost and accumulated depreciation and amortization of real estate investments as of December 31, 1995 and 1994 are as follows (in thousands): Building and Land Improvements Total 1995: Lake Mead Estates Apartments $ 772 $ 5,230 $ 6,002 Bryant Lake Business Center-Phases I & II 945 4,587 5,532 Bryant Lake Business Center-Phase III 1,004 4,792 5,796 Country Suites By Carlson - Memphis 542 5,071 5,613 Country Suites By Carlson - Tempe 929 6,223 7,152 4,192 25,903 30,095 Less accumulated depreciation and amortization --- (9,543) (9,543) $ 4,192 $16,360 $20,552 Building and Land Improvements Total 1994: Lake Mead Estates Apartments $ 772 $ 5,230 $ 6,002 Bryant Lake Business Center-Phases I & II 945 4,578 5,523 Bryant Lake Business Center-Phase III 1,004 4,728 5,732 Country Suites By Carlson - Memphis 542 4,907 5,449 Country Suites By Carlson - Tempe 929 6,067 6,996 4,192 25,510 29,702 Less accumulated depreciation and amortization - (8,479) (8,479) $ 4,192 $ 17,031 $ 21,223\nProperty held pending foreclosure: Regency Residence Apartments, net $ 762 $ 2,829 $ 3,591 Property held for sale: Millwood Estates Apartments, net $ 1,859 $ 7,423 $ 9,282\nPage 34 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nLake Mead Estates Apartments\nOn April 30, 1987, the Partnership acquired Lake Mead Estates, an apartment complex located in Las Vegas, Nevada. The property is encumbered by an all-inclusive trust deed note in the original amount of $4,000,000 (see Note 5).\nBranford Business Park\nOn June 10, 1987, the Partnership acquired two industrial office buildings collectively known as Branford Business Park, located in Arleta, California. The property was encumbered by a first deed of trust in the original amount of $950,000. On April 8, 1994, the Partnership made a principal payment in the amount of $250,000 as required by the lender in order to extend the maturity date from May 5, 1994 to November 7, 1994. The outstanding principal balance of $700,000 at that time was paid off with the proceeds from the sale of the property on November 15, 1994.\nIn March 1993, management listed Branford Business Park for sale with an asking price approximately equal to the book value of the property. Management wanted to test the market to determine if the sale of the property would provide sufficient proceeds to aid in the possible buyback of more Participating Notes (as discussed in Note 9). No offers were received in 1993 at the original asking price. In December 1993, based upon the deterioration of the local market as seen in the steady decline of occupancy, market rents and net operating income from 1991, and based on the unsuccessful attempt at generating interest in the Branford property at an asking price approximately equivalent to the book value of the property, management determined that the carrying value of Branford Business Park had been impaired. As a result, the Partnership recorded a writedown of $1,697,400 to reduce the carrying value of the property to its estimated net realizable value.\nOn November 15, 1994, the Partnership sold Branford Business Park to an unaffiliated third party for $2,675,000, out of which $700,000 was used to payoff the outstanding note secured by the property. The Partnership financed a $2,000,000 note at 8.5% interest with interest-only payments due until maturity on November 11, 1999. Since the cash received from the transaction was used to payoff the outstanding note, the Partnership was responsible for paying $166,000 in closing costs. The Partnership incurred a loss on the sale in the amount of $257,000.\nRegency Residence Apartments\nPage 35 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nOn September 30, 1987, the Partnership acquired Regency Residence, a retirement apartment complex located in Port Richey, Florida. The property is encumbered by an all-inclusive trust deed note to GLENFED Service Corporation in the original amount of $2,470,000 which was restructured during 1992 (see Note 6). The seller gave the Partnership an income warranty which covered the four-year period following closing. Under the terms of the income warranty agreement, the Partnership was guaranteed a specified minimum quarterly income from the property during the warranty period. The seller's obligations under the income warranty were satisfied in full as of December 31, 1991. The cost basis for the property was adjusted accordingly.\nBased on the continued low occupancy due to market saturation, and on the property's inability to meet debt service payments, management is negotiated a deed-in-lieu of foreclosure with the lender on the Regency Residence property. The partnership paid all net cash flow (defined as all income collected less operating expenses) to the lender from November 1994 until title to the property passed on May 26, 1995. The principal balance of the note secured by the property on May 26, 1995 was $3,538,986, with a accrued interest in the amount of $98,700.\nThe Partnership recorded a write-down of $835,900 to reduce the carrying value of the property to the balance of the note payable and accrued interest at December 31, 1994.\nThe Partnership recognized a gain on deed-in-lieu of foreclosure in the amount of $188,000 primarily due to the write-off of accrued property taxes that the property was unable to pay. The gain is included on the Partnership's 1995 statement of operations.\nMillwood Estates Apartments\nOn December 2, 1987, the Partnership acquired Millwood Estates Apartments, an apartment complex located in Lynnwood, Washington. The property is encumbered by an all-inclusive trust deed note to the seller in the original amount of $8,000,000 (see Note 5).\nOn March 28, 1995, the Partnership sold Millwood Estates Apartments to an unaffiliated third party for $10,400,000, out of which $7,572,400 was used to payoff the outstanding note secured by the property. In addition, sales proceeds were used to payoff the $2,000,000 note payable used to repurchase Participating Notes (as discussed in Note 9). The Partnership recognized a gain on sale on its 1995 Statement of Operations in the amount of $154,000. In anticipation of the sale of the property, management reclassified the net book value of Millwood Estates\nPage 36 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nApartments to \"Property held for sale\" on the Partnership's December 31, 1994 balance sheet.\nBryant Lake Business Center - Phases I & II\nOn January 28, 1988, the Partnership purchased a 90% general partnership interest in Bryant Lake Associates - Phases I & II, an unaffiliated California Limited Partnership (the \"Joint Venture\") which owned Bryant Lake Business Center - Phases I & II, a business center located in Eden Prairie, Minnesota. Under the terms of two of the agreements, the Partnership was guaranteed a minimum monthly gross income from certain spaces for a 12 and 24 month period from the date of purchase. Under the terms of the third agreement, the seller guaranteed that all rent and other amounts due under certain lease agreements would be paid on a timely basis. The seller's obligations under the income warranties were satisfied in full as of December 31, 1989.\nOn November 30, 1990, the Partnership purchased the 10% limited partnership interest for $180,000; $75,000 paid upon closing and $50,000 and $55,000 paid on January 31, 1991 and January 31, 1992, respectively. As a consequence of the purchase, the Joint Venture was dissolved and the assets and liabilities of the Joint Venture were transferred to the Partnership. Since the seller of the 10% limited partnership interest had a book value basis in the Joint Venture which exceeded the consideration paid by the Partnership,\nthe cost basis of the related land and buildings and improvements were reduced pro rata upon transfer to the Partnership.\nBryant Lake Business Center - Phase III\nOn January 28, 1988, the Partnership purchased a 50% general partnership interest in Bryant Lake Associates - Phase III, an unaffiliated California Limited Partnership, (the \"Joint Venture\") which owned Bryant Lake Business Center--Phase III, a business center located in Eden Prairie, Minnesota, for a purchase price of $3,225,000. Total consideration of $3,251,900 included a cash investment of $826,900 and the assumption of 50% of existing $4,850,000 commercial development revenue bonds secured by a first deed of trust and a security agreement.\nOn November 30, 1990, the Partnership purchased the remaining 50% limited partnership interest. As consideration for the purchase, the sellers will be entitled to 25% of net cash flow from the operation and ultimate disposition of the property, if any, as provided in the purchase agreement. Through December 31, 1995,\nPage 37 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nno net cash flow payments have been due or payable to the seller. As a consequence of the purchase, the Joint Venture has been dissolved and the assets and liabilities of the Joint Venture have been transferred to the Partnership.\nPage 38 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nCountry Suites By Carlson - Memphis\nOn August 1, 1988, the Partnership acquired a 121-unit hotel known as Country Suites By Carlson - Memphis, located in Memphis, Tennessee. A promissory note secured by a first deed of trust in the original amount of $1,371,000, payable to GLENFED Service Corporation encumbered the property. The original note was restructured during 1992 (see Note 5).\nCountry Suites By Carlson - Tempe\nOn August 1, 1988, the Partnership purchased an undivided 75% Tenancy in Common interest in Country Suites By Carlson - Tempe, a 138-unit hotel located in Tempe, Arizona. The Partnership originally purchased its 75% interest as part of a joint venture with Outlook Income Fund 10 (\"OIF 10\"), A California Limited Partnership, an affiliated partnership with similar investment objectives and the same General Partner as the Partnership. The property was encumbered by a promissory note and first deed of trust in the original amount of $1,859,000 secured by a deed of trust and assignment of rents and payable to GLENFED Service Corporation. The note payable was restructured during 1992 (see Note 5).\nOn November 4, 1993, the Partnership finalized the purchase of the minority interest in the consolidated joint venture from OIF 10 and Country Suites By Carlson - Tempe is now 100% owned by the Partnership. The total purchase price of $1,225,000 included a cash payment of $950,000 plus the cancellation of the $275,000 note receivable from OIF 10 originally owed to an affiliate of the former general partner which was purchased by the Partnership in June 1993.\nThe Partnership leases its commercial and industrial property under noncancellable operating lease agreements. Future minimum rents to be received under operating leases as of December 31, 1995 are as follows:\n1996 $ 1,224,000 1997 817,000 1998 538,000 1999 305,000 2000 299,000 Thereafter 35,000 Total $ 3,218,000\nPage 39 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nNote 4. LITIGATION SETTLEMENT EXPENSE\nOn May 6, 1993, Glenborough Corporation and certain of its affiliates entered into a settlement of a lawsuit that had been brought by the seller and former manager of the hotels on November 13, 1991. The lawsuit alleged that, in connection with the prior general partner's termination of the seller as operator and franchisor of the Partnership's hotels, Glenborough and its affiliates had defamed the seller and interfered with its contractual relationship with the Partnership. A majority of the amount paid to the seller under the settlement was funded by Glenborough's insurance carriers, but a portion of the settlement amount was funded by Glenborough. Pursuant to Glenborough's indemnity rights as General Partner of the Partnership (and as general partner of other Outlook partnerships that own hotels), Glenborough is entitled to reimbursement of this portion of the settlement payment. The Partnership's share of this reimbursement together with the legal fees associated with this settlement was $64,900.\nNote 5. NOTES PAYABLE\nA summary of notes payable at December 31, 1995 and 1994 follows (in thousands):\n1995 1994 9.625% note payable related to Lake Mead Estates Apartments, secured by a first deed of trust; payable in monthly principal and interest installments of $34,000 through October 1, 2018, at which time all remaining principal and interest will be due and payable. $ 3,764 $ 3,807\n10.75% note payable, secured by the assignment of a $2,000,000 note and deed of trust on 12970-12990 Branford, payable in monthly interest only installments of Prime plus 2% through May 28, 1996, at which time all remaining principal and interest will be due and payable. 500 ---\nPage 40 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n1995 1994 9.0% note payable to GLENFED Service Corporation, related to the Regency Residence Apartments and secured by a first deed of trust; payable in monthly principal and interest installments of $26,900 through July 1, 1999, at which time all remaining principal and interest will be due and payable. --- 3,539\n9.625% note payable related to Millwood Estates Apartments, secured by a first deed of trust; payable in monthly principal and interest installments of $68,000 through July 1, 2018, at which time all remaining principal and interest will be due and payable. --- 7,594\n8.652% bonds payable related to Bryant Lake-Phase III, secured by first deeds of trust on Bryant Lake-Phase III and Bryant Lake- Phases I and II; payable in monthly interest only installments of $35,000 through October 1, 2015, at which time all remaining principal and interest will be due and payable. The interest rate adjusts to market\nat November 1, 2000. 4,850 4,850\n9.0% note payable to GLENFED Service Corporation, related to the Country Suites by Carlson-Memphis and secured by a first deed of trust; payable in monthly principal and interest installments of $26,800 through July 1, 1999, at which time all principal will be due and payable. 3,504 3,535\n9.0% note payable to GLENFED Service Corporation, related to the Country Suites By Carlson - Tempe\nPage 41 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nand secured by a first deed of trust; payable in monthly principal and interest installments of $22,500 through July 1, 1999, at which time\n1995 1994\nall principal and interest will be due and payable. 2,727 2,751\nTotal notes payable. $ 15,345 $ 26,076\nOn April 8, 1994, the Partnership made a principal payment in the amount of $250,000 on the note secured by the Branford property as required by the lender in order to extend the maturity date from May 5, 1994 to November 7, 1994. On November 15, 1994, using the proceeds from the sale of Branford, the remaining note payable in the amount of $700,000 was paid off.\nPrincipal maturities of these notes payable are as follows:\n1996 $ 607,000 1997 118,000 1998 129,000 1999 6,099,000 2000 70,000 Thereafter 8,322,000 Total $15,345,000\nNote 6. TAXABLE INCOME\nThe Partnership's tax returns, the qualification of the Partnership as a partnership for Federal income tax purposes, and the amount of income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes to Partnership profits or losses, the tax liability of the partners could be changed accordingly.\nPage 42 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe following is a reconciliation for the years ended December 31, 1995, 1994 and 1993, of the net income for financial reporting purposes to the taxable income determined in accordance with accounting practices used in preparation of Federal income tax returns (in thousands).\n1995 1994 1993 Net loss per financial statements $ 969 $(2,893) $(3,521) Amortization and depreciation 20 (60) 77 Interest income --- 70 101 Gain from note repurchase (241) Guaranteed income --- --- 950 Prepaid income --- --- 35 Bad debt expense\/reserve 3 (4) 26 Property tax expense 7 5 8 Interest expense (60) (133) 25 Management fee --- --- 100 Partnership income adjustment --- --- 75 Loss on sale of assets (3,837) (1,870) --- Valuation reserve --- 836 --- Net loss for Federal income tax purposes $ (3,139) $ (4,049) $ (2,124)\nThe following is a reconciliation as of December 31, 1995 and 1994 of partners' capital for financial reporting purposes to partners' equity for Federal income tax purposes (in thousands):\n1995 1994 Partner's Equity per financial statements $ 2,993 $ 2,024 Amortization and depreciation 887 (455) Provision for doubtful accounts 5 2 Interest accrued 211 509 Income from joint ventures --- --- Basis adjustments 1,801 6,144 Valuation allowance --- 836 Other 76 53 Partner's Equity for Federal income tax purposes $ 5,973 $ 9,113\nNote 7. PARTICIPATING NOTES\nThe Partnership was authorized to offer up to $40,000,000 in Equity Units and non-recourse unsecured Participating Notes (the \"Notes\"). The Partnership had sold $5,228,800 in Notes, of which $543,500 were acquired in 1988 by GLENFED Service Corporation (\"Glenfed\"). The Notes bear stated interest at the rate of 12% per annum, non-compounded, with payment of principal and stated interest deferred until the earlier of the maturity date of the\nPage 43 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nNotes or the sale or refinancing of Partnership properties. At both December 31, 1995 and 1994, $4,582,000 of interest was accrued on the Notes. The Noteholders will also receive payments of contingent interest if, following the sale of all of the Partnership properties, the Partnership realizes net profits after the payment of all Partnership obligations and the distribution of certain base amounts to the Limited Partners. The amount of the Noteholders' contingent interest participation in net profits varies between 0% and 24%, depending upon the relative amounts invested in Notes and Equity Units and the total amount of interest received by Noteholders as defined in the Partnership Agreement. In no event, however, will the aggregate amount of all interest, including contingent interest, paid on the Notes exceed simple interest at the rate of 18% per annum on the original principal balance of the Notes from date of issuance until the date that all principal on the Notes is paid in full.\nThe Partnership may prepay principal and stated interest at any time. Partial prepayments must be made pro rata to all noteholders. Upon the sale or refinancing of a Partnership property, the Partnership will pay or prepay some or all of the principal and interest allocated to that property under the terms of the Notes. If not previously paid, the Notes mature and all remaining principal and interest, excluding contingent interest, must be paid in full on December 31, 1997, unless the General Partner extends the due date of the Notes, in its sole discretion, to a date which is not later than December 31, 1998. The payment of all principal and stated interest does not extinguish the right to contingent interest which may accrue or become payable following the sale of all of the Partnership properties.\nOn June 15, 1993, the Partnership purchased the Participating Notes ($545,300) and accrued interest thereon ($309,800), held by the former general partner, for $425,000. The difference between the carrying value of the liabilities to the former general partner and the purchase price was recorded as an extraordinary gain in the Partnership's 1993 consolidated statement of operations. The Notes and accrued interest thereon are being held in trust for the benefit of the Partnership.\nIn January 1994, the Partnership sent a \"Conditional Offer to Purchase 12% Participating Notes\" (\"the Offer\") to all Note investors. The Offer was made to Noteholders in an effort to reduce the impact of the Notes' accrued interest on the value of the Equity Units. Buying back these notes provides a significant interest savings to the Partnership, which benefits the Equity Unit investors (whose returns are subordinated to the Noteholders' receiving a return of principal plus 12% simple deferred interest per annum).\nPage 44 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nApproximately 45% of the Noteholders accepted the offer and the repurchase occurred in March 1995. The repurchase totalled $2,102,000 in original Note principal. The related accrued interest on these Notes was $1,915,000, which was not paid and represented the discount the Partnership received in the buyback. The Partnership used the proceeds from a $2,000,000 short-term loan to fund the repurchase (further discussion follows). The forgiveness was recognized as an extraordinary gain on the Partnership's 1995 statement of operations. The Notes and accrued interest will be held in trust for the benefit of the Partnership.\nOn January 27, 1995, the Partnership borrowed $2,000,000 from an unaffiliated lender to facilitate the repurchase of Notes as discussed above. Since the Partnership was relying on the proceeds from the sale of a property to fund the purchase of the Notes, which would not be available until the sale of Millwood Estates, the Partnership borrowed the money necessary to facilitate the purchase in order to meet the deadline required by the offer. The loan requires interest-only payments at a variable interest rate (11% at March 28, 1995) and matures June 26, 1995. However, the loan was paid off on March 28, 1995 with a portion of the proceeds from the sale of Millwood Estates Apartments (discussed in Note 4).\nOn June 9, 1995, in accordance with the Participating Notes Indenture and as a result of the sale of Millwood Estates, the Partnership retired $637,000 in notes and $592,000 in related accrued interest. Of this amount, the Partnership paid $609,000 ($314,000 of Participating Notes principal and accrued interest of $295,000) to outside Noteholders, the remainder represented a retirement of notes held in trust for the Partnership.\nIn June 1995, the Partnership sent a second \"Conditional Offer to Purchase 12% Participating Notes\" (the \"second Offer\") to the remaining Noteholders. The second Offer is for the repurchase of the Notes for a price equal to 135% of the Noteholders original investment (i.e. the purchase price for each Note will be $1.35 compared to an approximate current Note and accrued interest value of $1.95). The second Offer expired October 31, 1995, but the Partnership extended the expiration to December 31, 1995. As of February 1996, 177 Noteholders accepted the offer. The result will be $1,104,000 in notes which will be bought at a purchase price of $1,491,000 in 1996. Through March 27, 1996, the partnership repurchased $863,000 in notes for a purchase price of $1,166,000. The Partnership borrowed an additional $1,100,000 on the $2,000,000 line of credit with an unaffiliated lender to fund the repurchase.\nPage 45 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nNote 8. PARTNERSHIP ALLOCATIONS AND DISTRIBUTIONS\nThe Partnership Agreement provides generally that losses are allocated 1% to the General Partner and 99% to the Limited Partners. Net income will be allocated among the Partners first to restore negative capital accounts and then in accordance with their rights to future cash distributions.\nThe source and amount of all Partnership distributions is determined by the General Partner at its sole discretion. Distributions may not be made if the cash reserves of the Partnership have fallen below 3% of the capital raised from the sale of Equity Units and Notes.\nThe Partnership Agreement provides that cash available for distributions shall be distributed 97% to the Limited Partners and 3% to the General Partner until the Limited Partners have received aggregate distributions equal to a cumulative non- compounded return of 9% on their adjusted capital investment. Thereafter, distributions from operational cash flow shall be distributed to the General Partner until the General Partner has received the full amount of its deferred subordinated partnership incentive fee as defined in the Partnership Agreement, and thereafter 10% to the General Partner and 90% to the Limited Partners.\nDistributions of net cash from sources other than operational cash flow shall be distributed 1% to the General Partner and 99% to the Limited Partners until the amounts distributed to the Limited Partners from all sources equal a complete return of their adjusted capital investment and a 9% per annum cumulative non-compounded return on their capital investment. Thereafter, distributions from sources other than operational cash flow shall be distributed to the General Partner until the General Partner has received the full amount of its deferred subordinated partnership incentive fee as defined in the Partnership Agreement, and thereafter 10% to the General Partner and 90% to a net profits account. Distributions from the net profits account will be made to the Limited Partners and Noteholders (see Note 6) based on amounts invested in Equity Units and Notes pursuant to the Partnership Agreement.\nPage 46 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nSchedule III insert\nPage 47 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPage 48 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nGeneral Partners\nThe Partnership has no directors or executive officers. The general partners of the Partnership are Glenborough Corporation (\"GC\", the \"Managing General Partner\", formerly known as Glenborough Realty Corporation) and Robert Batinovich.\nRobert Batinovich was the President, Chief Executive Officer and Chairman of Glenborough Corporation from its inception in 1987 until his resignation effective January 10, 1996. On August 31, 1994, Mr. Batinovich was elected Chairman, President and Chief Executive Officer of Glenborough Realty Trust Incorporated (\"GRT\"), a newly created Real Estate Investment Trust, which began trading on the New York Stock Exchange on January 31, 1996. He was a member of the Public Utilities Commission from 1975 to January 1979 and served as it President from January 1977 to January 1979. He is a member of the Board of Directors of Farr Company, a publicly held company that manufactures industrial filters. He has extensive real estate investment experience. Mr. Batinovich's business background includes managing and owning manufacturing, vending and service companies and a national bank.\nFor informational purposes, the following are the names and a brief description of the background and experience of each of the controlling persons, directors and executive officers of the Managing General Partner as of March 1, 1996:\nName Age Position\nAndrew Batinovich 37 Chief Executive Officer and Chairman of the Board\nRobert E. Bailey 34 Secretary and Corporate Counsel\nSandra L. Boyle 47 President and Chief Operating Officer\nJune Gardner 44 Director\nTerri Garnick 35 Chief Financial Officer\nJudy Henrich 50 Vice President\nWallace A. Krone Jr. 64 Director\nPage 49 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nAndrew Batinovich was elected Chairman of the Board and Chief Executive Officer of GC on January 10, 1996. He has been employed by GC since 1983, and had functioned since 1987 as Chief Operating Officer and Chief Financial Officer. Mr. Batinovich also serves as Executive Vice President, Chief Operating Officer, Chief Financial Officer and Director of GRT. He holds a California real estate broker's license and is a Member of the National Advisory Council of BOMA International. He received his B.A. in International Finance from the American University of Paris. Prior to joining Glenborough, Mr. Batinovich was a lending officer with the International Banking Group and the Corporate Real Estate Division of Security Pacific National Bank.\nRobert E. Bailey joined GC in 1989 as Associate Counsel and was elected Secretary of GC on May 15, 1995. He is responsible for all landlord\/tenant documentation, tenant litigation, corporate and partnership matters and employment matters. In 1984, he received his Bachelor of Arts degree from the University of California at Santa Barbara and his Juris Doctor degree from Vermont Law School in 1987. From 1987 to 1989, Mr. Bailey was an associate with the law firm of Pedder, Stover, Hesseltine & Walker, where he specialized in business litigation. He is a member of the State Bar of California.\nSandra L. Boyle has been associated with GC or its associated entities since 1984 and has served as President and Chief Operating Officer of GC since January 10, 1996. She was originally responsible for residential marketing, and her responsibilities were gradually expanded to include residential leasing and management in 1985, and commercial leasing and management in 1987. She was elected Vice President in 1989, and continues to supervise marketing, leasing, property management operations and regional offices. Ms. Boyle also serves as a Senior Vice President of GRT. Ms. Boyle holds a California real estate broker's license and a CPM designation, and is a member of the National Advisory Council and Finance Committee of BOMA International; and Board of Directors of BOMA San Francisco and BOMA California.\nJune Gardner was elected a director of GC on January 10, 1996. She was associated with GC from 1984 through 1995, as Senior Vice President, Corporate Controller with responsibilities in the areas of corporate financial planning, reporting, accounting and banking relationships. Before joining GC, Ms. Gardner was Assistant Vice President of JMB Realty Corporation from 1977 to 1984, with responsibilities in the areas of financial management and reporting.\nTerri Garnick has served as Chief Financial Officer of GC since\nPage 50 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nJanuary 10, 1996. She is also Senior Vice President, Chief Accounting Officer and Treasurer of GRT. Ms. Garnick is responsible for property management accounting, financial statements, audits, Securities and Exchange Commission reporting, and tax returns. Prior to joining GBC in 1989, Ms. Garnick was a controller at August Financial Corporation from 1986 to 1989 and was a Senior Accountant at Deloitte, Haskins and Sells from 1983 to 1986. She is a Certified Public Accountant and has a Bachelor of Science degree from San Diego State University.\nJudy Henrich is a Vice President of GC, effective January 10, 1996 and is responsible for the coordination of all due broker- dealer and investor communications for partnerships managed by GC. Prior to joining GC, Ms. Henrich, was associated with Rancon Financial Corporation from 1981 through early 1995, as Senior Vice President since 1985, with responsibilities similar to those at GC. Ms. Henrich also served as Executive Vice President of Rancon Securities Corporation from 1988 to 1991, and thereafter as its Chief Executive Officer. Prior to joining Rancon, Ms. Henrich was manager of public relations and advertising for Kaiser Development Company, a diversified real estate holding company.\nWallace A. Krone has been an entrepreneur in the restaurant business since 1965, and owns a number of Burger King restaurants in the San Francisco area. Mr. Krone has been associated with GC since 1982 as an investor in one or more partnerships, and has been a member of the board of directors of GC since 1989.\nPage 51 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Partnership has no executive officers. For information relating to fees, compensation, reimbursements and distributions paid to related parties, reference is made to Item 13 below.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Owners and Management\nTo the best knowledge of the Partnership, no person owned of record or beneficially more than five percent (5%) of the outstanding Units at December 31, 1995.\nThe Partnership, as an entity, does not have any directors or officers. At December 31, 1995, no Units were owned of record or beneficially by any officers or directors of the General Partner.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(a) AFC, an affiliate of the former general partner, had made loans to the Partnership to fund working capital and investment needs. Until July 1, 1992, the notes payable bore interest at a rate of prime (6% at December 31, 1993) plus 1-1\/2% and were due on demand. The unpaid aggregate principal balance of the notes was $2,090,000 at June 30, 1992. Effective July 1, 1992, the note was added to the principal balances of the restructured notes as discussed below.\nAdditionally, the Partnership is indebted to GLENFED Service Corporation, a California corporation and a wholly owned subsidiary of Glendale Federal Savings and Loan Association and parent-company of August Financial Corporation, for three deferred interest loans secured by first deeds of trust on three of the Partnership's properties as follows:\nOriginal December 31, 1995 Principal Principal Balance Balance Note payable related to the: Regency Resident Apartments $ 2,470,000 $ --- Country Suites By Carlson-Memphis 1,371,000 3,504,000 Country Suites By Carlson-Tempe 1,859,000 2,727,000 $ 5,700,000 $ 6,231,000\nThe secured notes bear interest at 9% compounded monthly with equal monthly payments of principal and interest commencing on August 1, 1992 in an amount necessary to fully amortize the principal and accrued interest over a 30-year period, with the entire unpaid principal and interest due and payable on July 1, 1999. In 1995, the Partnership paid $625,000 for interest on\nPage 52 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nthese notes.\n(b) An affiliate of the General Partner earned compensation for specific services provided to the Partnership. The Partnership reimbursed Glenborough Corporation for expenses incurred for services provided to the Partnership such as accounting, investor services, data processing, duplicating and office supplies, legal and administrative services, and the actual costs of goods and materials used for or by the Partnership. Glenborough was reimbursed $458,400, $467,600 and $496,600 for such expenses in 1995, 1994 and 1993, respectively.\nIn accordance with the Limited Partnership Agreement, the Partnership paid the General Partner and its affiliates compensation for services provided to the Partnership. Glenborough Corporation provides property management services and has been compensated as follows:\n1995 1994 1993 Management fees $ 391,700 $ 505,400 $ 487,400 Property management salaries (reimbursed) 177,400 333,600 335,500 Hotel salaries (reimbursed) 1,228,700 1,778,900 1,702,500\nIn accordance with the Partnership Agreement, Glenborough Corporation was paid $312,000 in 1995 and $80,250 in 1994 as a 3% property disposition compensation associated with the sales of Millwood Estates and Branford Business Park, respectively (as discussed in Note 7).\n(c) None of the members of the General Partner were indebted to the Partnership during this fiscal year.\n(d) Compensation received by the General Partner and affiliates is disclosed under Item 11.\nPage 53 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\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 contained in Item 8.\n(2) Financial Statement Schedules - See Item 14(d) below.\n(3) Exhibits - No exhibits necessary.\n(b) Reports on Form 8-K - No reports on Form 8-K were filed by the registrant in the fourth quarter of 1995.\n(c) Financial Statement Schedules - The following financial statement schedules of the Partnership are included in Item 8:\nSchedule III - Real Estate Investments and Related Accumulated Depreciation and Amortization.\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.\nPage 54 of 53\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nSIGNATURES\nPursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nBy: By: Glenborough Corporation, Robert Batinovich a California corporation, General Partner (formerly knows as Glenborough Realty Corporation, a California Corporation)\nDate: By: Andrew Batinovich Chief Executive Officer and Chairman of the Board\nDate:\nBy: Terri Garnick Chief Financial Officer\nDate:\nBy: June Gardner Director\nDate:\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(A Majority of the Board of Directors of the General Partner)\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nSIGNATURES\nPursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nBy: \/s\/ Robert Batinovich By:Glenborough Corporation, Robert Batinovich a California corporation, General Partner (formerly knows as Glenborough Realty Corporation, a California Corporation)\nDate: By: \/s\/ Andrew Batinovich Andrew Batinovich Chief Executive Officer and Chairman of the Board\nDate:\nBy: \/s\/ Terri Garnick Terri Garnick Chief Financial Officer\nDate:\nBy: \/s\/ June Gardner June Gardner Director\nDate:\nOUTLOOK INCOME FUND 9, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(A Majority of the Board of Directors of the General Partner)","section_15":""}
{"filename":"726294_1995.txt","cik":"726294","year":"1995","section_1":"ITEM 1 - BUSINESS\nBELMONT BANCORP.\nBelmont Bancorp. is a bank holding company which was organized under the laws of the State of Ohio in 1982. On April 4, 1984, Belmont Bancorp. acquired all of the outstanding capital stock of Belmont National Bank (formerly Belmont County National Bank), a banking corporation organized as a national banking association. Belmont National Bank provides a variety of financial services. In addition to Belmont National Bank, the Corporation owns Belmont Financial Network, Inc., a non-bank subsidiary.\nBELMONT NATIONAL BANK\nBelmont National Bank resulted from the merger on January 2, 1959, of the First National Bank of St. Clairsville, and the First National Bank of Bridgeport. Both banks were organized as national associations prior to the turn of the century. Belmont National Bank operates through a network of ten branches located in Belmont, Harrison and Tuscarawas Counties in Ohio. The main office is located in the city of St. Clairsville. Other branch locations in Belmont County include Bridgeport, Lansing, Shadyside, and the Ohio Valley Mall. Branches in Harrison County are located in Jewett and Cadiz, Ohio. Branches in Tuscarawas County are located in New Philadelphia, Ohio. The three New Philadelphia offices were acquired on October 2, 1992, when Belmont National Bank acquired the deposits and loans of these offices from Diamond Savings and Loan.\nBelmont National Bank provides a wide range of retail banking services to individuals and small to medium-sized businesses. These services include various deposit products, business and personal loans, credit cards, residential mortgage loans, home equity loans, and other consumer oriented financial services including IRA and Keogh accounts, safe deposit and night depository facilities. Belmont National Bank also owns automatic teller machines located at the Ohio Valley Mall and in New Philadelphia, Ohio providing 24 hour banking service to our customers. Belmont National Bank belongs to MAC, a nationwide ATM network with thousands of locations nationwide. Belmont National Bank offers a wide variety of fiduciary services. The trust department of the Bank administers pension, profit-sharing, employee benefit plans, personal trusts and estates.\nBELMONT FINANCIAL NETWORK\nOn July 1, 1985, Belmont Bancorp. formed a subsidiary corporation, Belmont Financial Network, Inc.(BFN). The purpose of the subsidiary was primarily to engage in lease consulting for personal or real property. Changes to the federal tax code that eliminated new investment tax credits as of December 31, 1987 adversely affected the leasing business. The daily operations of Belmont Financial Network were suspended during 1989 to reduce overhead costs. The leases formerly serviced by Belmont Financial Network are presently administered by Belmont National Bank. BFN was inactive throughout 1995.\nBELMONT INVESTMENT AND FINANCIAL SERVICES, INC.\nDuring 1988, Belmont National Bank began the operations of Belmont Investment and Financial Services, Inc., a wholly-owned subsidiary of the Bank. Belmont Investment and Financial Services, Inc. was organized so that the Bank's customers would have available to them a wider array of financial products as well as sound investment and financial planning. Through Belmont Investment and Financial Services, Inc., customers can purchase government or corporate bonds, and mutual fund products. In 1990, the services provided by the Corporation, other than advisory services, were reorganized into a department of the Bank.\nSUPERVISION AND REGULATION\nBelmont Bancorp. is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"Act\"). The Act requires the prior approval of the Federal Reserve Board for a bank holding company to acquire or hold more than a 5% voting interest in any bank, and restricts interstate banking activities. The Act restricts Belmont's non-banking activities to those which are closely related to banking. The Act does not place territorial restrictions on the activities of nonbank subsidiaries of bank holding companies. Belmont's banking subsidiary is subject to limitations with respect to intercompany loans and investments. A substantial portion of Belmont's cash revenues is derived from dividends paid by its subsidiary bank. These dividends are subject to various legal and regulatory restrictions as summarized in Note 15 of the financial statements.\nThe Bank is subject to the provisions of the National Banking Act and the regulations of the Federal Reserve Board and the Federal Deposit Insurance Corporation. Under the Bank Holding Company Act of 1956, as amended, and under regulations of the Federal Reserve Board pursuant thereto, a bank holding company is prohibited from engaging in certain tie-in arrangements in connection with extensions of credit.\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 and future monetary policies and the effect of such policies on the future business and earnings of Belmont Bancorp. and its subsidiary bank cannot be predicted.\nFOREIGN OPERATIONS\nBelmont Bancorp. has no foreign operations.\nEXECUTIVE OFFICERS\nFor information concerning executive officers of Belmont Bancorp. and Belmont National Bank, see Item 10 of Form 10-K.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nDESCRIPTION ON PROPERTIES\nThe principal executive offices of Belmont National Bank are located in St. Clairsville, Ohio, the seat of Belmont County. This office consists of a two story brick building owned by the Bank with attached drive-in facilities. The building consists of 9,216 square feet which houses the commercial bank operations and the executive, marketing and human resources offices. In addition, the Bank transacts business in the following branch locations:\nMall Office-This office is located at the Ohio Valley Mall, a major shopping mall located two miles east of St. Clairsville, Ohio, and consists of a 4,000 square foot office inside the mall proper, plus a stand alone drive-in facility at the perimeter of the Mall. Automatic teller machines are located at the drive-in location and inside the branch office.\nLansing Office-This 1,352 square foot office is located in Lansing, Ohio, a small community approximately six miles east of St. Clairsville on US. Route 40. The facility is a masonry building with adjoining drive-in facilities.\nBridgeport Office-This office is located in Bridgeport, Ohio, a community located on the Ohio\/West Virginia border, approximately 10 miles east of St. Clairsville. This 5,096 square foot facility is a recently remodeled masonry building with adjoining drive-in facilities.\nShadyside Office-This 1,792 square foot office is located in Shadyside, a village located on Ohio State Route 7. The facility is a masonry building with accompanying drive-in facilities.\nJewett Office-This office is located in Harrison County approximately twenty-six miles north of St. Clairsville, across from Cross Street, the intersection of State Routes 9 and 151. The building is constructed of masonry brick and contains 2,400 square feet with an accompanying drive-in facility.\nCadiz Office-This office is located in Cadiz, Ohio in Harrison County, approximately seventeen miles north of St. Clairsville at the intersection of State Routes 9 and 22. The brick and tile building contains 1,800 square feet with an accompanying drive-in facility.\nNew Philadelphia Office-This office, located at 152 North Broadway Avenue, is a 33,792 square foot site improved with two inter-connected, two story brick office buildings with a total building area of 13,234 square feet. Part of the office space is leased to other businesses. This location also has a drive-in facility and an automatic teller machine.\nNew Philadelphia Office-This office, located at 2300 East High Avenue, is comprised of a one story, 1,605 square foot brick structure with a 783 square foot drive-thru canopy.\nNew Philadelphia Office-This office, located at 525 Wabash Avenue, is comprised of a 14,250 square foot site with a 246 square foot drive-thru banking facility.\nAll offices are owned by the Bank except for the Mall Office. The lease at the Mall location is in effect until the year 1996 with options to renew thereafter.\nWheeling, WV Office - In January 1996, Belmont National Bank relocated its corporate headquarters to Wheeling, WV. The office is a leased facility located at 980 National Road, Wheeling, WV.\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 THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDERS' MATTERS\nThe number of shareholders of record for the Corporation's stock as of March 6, 1996 was 614. The latest available market price based on an actual trade price was $27.25 per share on March 13, 1996.\nBelmont Bancorp.'s common stock has a par value of $0.50 and, since October 1994, has been traded on the Nasdaq SmallCap market.\nThe tables above show its high and low market prices and dividend information for the past two years. Prior to the Nasdaq listing in October 1995, market prices were based on actual trades known to the Corporation due to lack of an established market. Market prices and cash dividends paid per share have been restated to reflect the effect of a 10% common stock dividend paid in January 1994, a 25% common stock dividend paid in July 1994 and a 2-for 1 split paid in May 1995.\nInformation regarding the limitations on dividends available to be paid can be located in Footnote 15 of the Notes to the Consolidated Financial Statements in the Corporation's Annual Report (Exhibit B).\nTreasury stock is accounted for using the cost method. There were 832 shares held in treasury on December 31, 1995 and 424 shares in treasury on December 31 1994.\nITEM 6.","section_6":"ITEM 6.-SELECTED FINANCIAL DATA\nThe Summarized Quarterly Financial Information and the Consolidated Five Year Summary of Operations contained in the Corporation's annual report (Exhibit B) are hereby incorporated by reference.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe data presented in this discussion should be read in conjunction with the audited consolidated financial statements.\nRESULTS OF OPERATIONS\nSUMMARY\nFor 1995, net income increased 30.06% from the previous year; net income for the year ended 1994 increased 25.89% compared to 1993. Net income per common share for 1995 was $1.95 compared to $1.49 per common share in 1994 and 1.18 in 1993. The Corporation's net income to average assets, referred to as return on assets, increased to 1.35% for the year ended 1995 from 1.12% last year and 0.96% during 1993. Operating income consists of earnings before income taxes, minus net investment and trading gains or plus net investment and trading losses. Operating income increased by $1,113,000 or 25.74% from 1994 to 1995. The table below summarizes earnings performance for the past three years.\n1995 1994 compared compared % Increase from previous year to 1994 to 1993 Operating income 25.74% 112.80% Net income 30.06% 25.89%\nNET INTEREST REVENUE\nA major share of the Corporation's income results from the spread between income on interest earning assets and interest expense on the liabilities used to fund those assets, known as net interest income. Net interest income is affected by changes in interest rates and amounts and distributions of interest earning assets and interest bearing liabilities outstanding. Net interest margin is net interest income divided by the average earning assets outstanding. A third frequently used measure is net interest rate spread which is the difference between the average rate earned on assets and the average rate incurred on liabilities without regard to the amounts outstanding in either category.\nThe Consolidated Average Balance Sheets and Analysis of Net Interest Income Changes included in the Corporation's annual report (Exhibit B), compare interest revenue and interest earning assets outstanding with interest cost and liabilities outstanding for the years ended December 31, 1995, 1994, and 1993, and computes net interest income, net interest margin and net interest rate spread for each period. All three of these measures are reported on a taxable equivalent basis.\nThe Corporation's net interest income grew by $1,764,000 on a taxable equivalent basis during 1995 compared to the same period last year, a 15.30% increase. The increase in net interest income was primarily attributable to the increase in average earning assets and improved net interest margins. During 1995, the Corporation's average interest-earning assets grew by approximately $20.9 million, up 7.68% from 1994.\nThe yield on interest earning assets improved from 7.49% during 1994 to 8.28% during 1995, an increase of 79 basis points. (A basis point (bp) is equivalent to .01%.) However this increase was offset by an increase in the cost of interest bearing liabilities of 57 basis points from 1994 to 1995. Consequently, the net interest rate spread increased from 3.87% during 1994 to 4.09% during 1995.\nThe Analysis of Net Interest Income Changes, separates the dollar change in the Corporation's net interest income into three components: changes caused by (1) an increase or decrease in the average assets and liability balances outstanding (volume); (2) the changes in average yields on interest earning assets and average rates for interest bearing liabilities (yield\/rate); and (3) combined volume and yield\/rate effects (mix).\nThis table shows that the increase in the Corporation's net interest income during the year-to-date periods presented from 1994 to 1995 was generated by growth in the levels of earning assets and average interest bearing liabilities outstanding (depicted by the volume column).\nOTHER OPERATING INCOME\nOther operating income excluding securities gains and losses, increased 30.47% and totaled $1,683,000 in 1995, compared to $1,290,000 in 1994 and $1,193,000 in 1993. The table below shows the dollar amounts and growth rates of the components of other operating income.\nDuring the fourth quarter of 1995, the Corporation recovered $189,000 for settlement of a class action lawsuit arising out of the issuance and sale of taxable municipal bonds. This accounts for nearly half of the increase in Noninterest income.\nAnother significant increase in Noninterest income is attributable to gains on sale of loans which increased $113,000 from 1994 to 1995. The Corporation utilized the secondary mortgage market during 1995 to divest itself of fixed rate mortgage loans with rates below a target rate for purposes of managing the interest rate risk associated with these loans. Servicing rights were retained on the loans sold. The Corporation continues to utilize the secondary market as a means of offering competitively priced mortgage loan products without retaining the interest rate risk associated with long term, fixed rate product.\nTrust income increased 21.11% from 1994 to 1995 and 24.45% from 1993 to 1994. This is an area that the Corporation expects to continue to develop and aggressively grow in the future.\nLosses on investments held in the maturity portfolio during 1995 and 1994 occurred as a result of calls on municipal bonds in the portfolio. These losses totaled $11,000 during 1995 and 9,000 during 1994. Net gains were realized on securities available for sale during 1995 totaling $113,000 compared to losses of $55,000 during 1994 and gains of $1,264,000 during 1993.\nThe related income taxes on securities transactions, including trading and securities available for sale, were $25,000 and $67,000 for the years ended 1995 and 1993, respectively. A tax credit of $15,000 was attributable to securities transactions for 1994.\nOPERATING EXPENSES\nSuccessful expense control is an essential element in maintaining the Corporation's profitability. The table below details the percentage changes in various categories of expense for the three years ended 1995, 1994, and 1993.\nSalaries and wages included incentive performance bonuses tied to earnings performance totalling $343,000 in 1995, $247,000 during 1994 and $129,000 during 1993. The increase in employee benefits from 1994 to 1995 was impacted by a higher contribution to the employees' profit sharing plan and by the purchase of personal computers for use by employees and directors at home. A goal of the Corporation's subsidized purchase of personal computers for its employees was to enhance their proficieny and skill on personal computers and translate that into added productivity in the workplace.\nA commonly used measure of operating efficiency is the amount of assets managed per full time equivalent employee (FTE). The table below depicts assets managed per FTE for each of the last 3 years compared to the Corporation's peer group as measured by the most recently available Uniform Bank Performance Report.\nEquipment expense increased from 1994 to 1995 due an increase in depreciation expense and repair and maintenance expense associated with the Corporation's in-house data processing system. During most of 1994 and all of 1993, the Corporation utilized a third party data processing servicer; payments for these services were included in other operatng expenses.\nOther noninterest operating expense includes FDIC insurance assessments. The premiums paid during 1995 were impacted by a reduction of the FDIC insurance premium rate in September and December on deposits insured by the Bank Insurance Fund (BIF). Approximately 70% of the Corporation's deposits are insured by the BIF. As a result FDIC and other insurance included in other operating expenses were $430,000, $616,000 and $581,000 in 1995, 1994 and 1993 respectively.\nApproximately 30% of the Corporation's deposits are insured through the Savings Association Insurance Fund (SAIF) of the FDIC and continue to be assessed at 23 cents per $100. These deposits had been acquired from a thrift in 1992. However Congress is currently considering a special, one-time assessment on SAIF- insured deposits. If enacted, this assessment could result in a one-time, pretax charge of up to $500,000, which could be offset by lower ongoing insurance costs in the future.\nFINANCIAL CONDITION\nSECURITIES\nThe book values of investments as of December 31, 1995 and 1994 are detailed in Footnote 3 of the Notes to the Consolidated Financial Statements in the Corporation's annual report (Exhibit B).\nThe investment portfolio consists largely of fixed and floating rate mortgage related securities, predominantly underwritten to the standards of and guaranteed by the government agency GNMA and by the government-sponsored agencies of FHLMC and FNMA. These securities differ from traditional debt securities primarily in that they have uncertain maturity dates and are priced based on estimated prepayment rates on the underlying mortgages.\n(a) Taxable equivalent yields (b) Maturities of mortgage-backed securities are based on estimated average life.\nThe mortgage derivative securities consist solely of collateralized mortgage obligations (CMOs) including one principal-only CMO issued by FNMA with a book value of $267,000 and a market value of $209,000. The remaining CMOs are privately issued. Credit risk on privately issued CMOs is evaluated based upon independent rating agencies and on the underlying collateral of the obligation. At December 31, 1995, the Corporation held one CMO issued by Prudential Home Mortgage with a book value of $3,046,000 and a market value of $3,073,000.\nThe state and political subdivision portfolio includes approximately $1.9 million zero coupon revenue bonds. These bonds are purchased at a significant discount to par value and the income recognized on the bonds is derived from the accretion of the discount using a method that approximates a level yield.\nMARKETABLE EQUITY SECURITIES\nThe Corporation held marketable equity securities in its investment portfolio as of December 31, 1995. In accordance with regulatory requirements, all equity securities were transferred to Securities Available for Sale on January 1, 1994 because these securities do not have a stated maturity. Current accounting principles require that marketable equity securities be recorded at the lower of cost or market value with a corresponding adjustment to reduce shareholders' equity if market value is lower than cost. At December 31, 1995 and 1994, estimated market values approximated original cost.\nLOANS AND LEASES\nThe following table shows the history of commercial and consumer loans and leases by major category at December 31.\nAn analysis of maturity and interest rate sensitivity of business loans at the end of 1995 follows:\nPROVISION AND ALLOWANCE FOR POSSIBLE LOAN LOSSES\nThe Corporation, as part of its philosophy of risk management, has established various credit policies and procedures intended to minimize the Corporation's exposure to undue credit risk. Credit evaluations of borrowers are performed to ensure that loans are granted on a sound basis. In addition, care is taken to minimize risk by diversifying specific industry. Credit risk is continuously monitored by Management through the periodic review of individual credits to ensure compliance with policies and procedures. Adequate collateralization, contractual guarantees, and compensating balances are also utilized by Management to mitigate risk.\nManagement determines the appropriate level of the allowance for possible loan losses by continually evaluating the quality of the loan portfolio. The reserve is allocated to specific loans that exhibit above average credit loss potential based upon their payment history and the borrowers' financial conditions. Management maintains a watch list of substandard loans for monthly review. Although several of these loans are not delinquent and may be adequately secured, Management believes that due to location, size, or past payment history, it is necessary to monitor these loans monthly.\nThe allowance for possible loan losses totaled $2,703,000, or 1.69% of total loans and leases at December 31, 1995. At the end of the previous year, the allowance for possible loan losses was $1,537,000, or 1.04% of total loans and leases. The provision charged to expense during 1995 was $1,150,000 compared to $805,000 in the year ago period.\nManagement's allocation of the allowance for possible loan losses for the past four years based on estimates of potential future loan loss is set forth in the table below:\nThe allocation of the loan loss reserve in the manner described above is not available for 1991.\nThe following table sets forth the five year historical information on the reserve for loan losses:\nThe following schedule shows the amount of under-performing assets and loans 90 days or more past due but accruing interest.\nIn addition to the above schedule of non-performing assets, Management prepares a watch list consisting of loans over $100,000 which Management has determined require closer monitoring to further protect the Corporation against loss. The balance of loans classified by Management as substandard due to delinquency and a change in financial position at the end of 1995 and not included in the table above was $787,000. There are no other loans classified for regulatory purposes that would materially impact future operating results, liquidity or capital resources or which management doubts the ability of the borrower to comply with loan repayment terms.\nDEPOSITS\nPrimarily core deposits are used to fund interest-earning assets. The Corporation has a lower volume of interest-free checking accounts than its peer group which is typical for its market area. This results in an overall higher cost of funds than peer average. The accompanying tables show the relative composition of the Corporation's average deposits and the change in average deposit sources during the last three years.\nAverage deposits increase 1.99% from 1994 to 1995. The mix of deposits is directly affected by the interest rate environment. During periods of low interest rates, customers tend to maintain their balances in savings accounts. As deposit rates increase, funds flow from savings deposits to time deposits. As part of its asset\/liability strategy during 1995, the Corporation offered several certificate of deposit promotions to extend maturities on deposits. This resulted in a decrease in average savings balances and an increase in average time balances.\nBORROWINGS\nOther sources of funds for the Corporation include short- term repurchase agreements and Federal Home Loan Bank borrowings. Borrowings at the Federal Home Loan Bank are utilized to match the maturities of selected loans and to leverage the capital of the Corporation to enhance profitability for shareholders.\nCAPITAL RESOURCES\nAt December 31, 1995, shareholders' equity was $25,164,000 compared to $20,214,000 at December 31, 1994, an increase of $4,950,000 or 24.49%. The increase in capital during 1995 was due to retention of earnings and the increase in market value of Securities Available for Sale.\nThe Federal Reserve Board has adopted risk-based capital guidelines that assign risk weightings to assets and off- balance sheet items. The guidelines also define and set minimum capital requirements (risk-based capital ratios). Banks are required to have core capital (Tier 1) of at least 4.0% of risk-weighted assets and total capital of 8.0% of risk- weighted assets. Tier 1 capital consists principally of shareholders' equity less goodwill, while total capital consists of core capital, certain debt instruments and a portion of the reserve for loan losses. At December 31, 1995, the Corporation had a Tier 1 capital ratio of 13.07% and a total capital ratio of 14.59%, well above the regulatory minimum requirements.\nThe following table shows several capital and liquidity ratios for the last three years:\nNational banks must maintain a total assets leverage ratio of at least 3.0%. The total assets leverage ratio is calculated by dividing capital less intangibles into assets, net of intangibles. In many cases, regulators require an additional cushion of at least 1.0% to 2.0%. At December 31, 1995, the Corporation's Tier One leverage ratio was 7.39%.\nThe following table presents dividend payout ratios for the past three years.\nCurrently there are no known trends, events or uncertainties that would have a material effect on the Corporation's liquidity, capital resources or results of operations.\nLIQUIDITY AND INTEREST RATE SENSITIVITY\nThe Corporation meets its liability based needs through the operation of Belmont National Bank's branch banking network that gathers demand and retail time deposits. The Bank also acquires funds through repurchase agreements and overnight federal funds that provide additional sources of liquidity. Total deposits decreased by $9.1 million, or 3.55%, from the end of 1994 to 1995. Short term borrowings increased by $3.2 million over the same period. Average deposits increased 1.99% during 1995 compared to 1994.\nThe Corporation also has unused lines of credit with various correspondent banks totaling $10.4 million which may be used as an alternative funding source.\nINTEREST RATE SENSITIVITY\nThe Corporation's net interest revenue can be vulnerable to wide fluctuations arising from a change in the general level of interest rates to the degree that the average yield on assets responds differently to such a change than does the average cost of funds. To maintain a consistent earnings performance, the Corporation actively manages the repricing characteristics of its assets and liabilities to control net interest income rate sensitivity.\nThe mismatching of asset and liability repricing characteristics in specific time frames is referred to as interest rate sensitivity gaps. Mismatching or \"gapping\" can be profitable when the term structure of interest rates (the yield curve) is positive, i.e. short term yields are lower than long term yields, but gapping entails an element of risk, particularly in volatile markets. An institution is said to have a negative gap when its liabilities reprice in a shorter time period than its assets. A positive gap exists when assets reprice more quickly than liabilities. A negative gap in a period when the general level of interest rates is declining will produce a larger net interest income spread than would be the case if all assets and liabilities were perfectly matched. Conversely, net interest income will be adversely affected by a negative gap position in a period when the general level of interest rates is rising. Gaps, therefore, must be prudently managed.\nThe Corporation examines its interest rate sensitivity position by categorizing the balance sheet into respective repricing time periods similar to those shown on the accompanying table. Repricing of certain assets, such as installment loans, mortgage loans and leases, is based upon contractual amortization or repricing, although experience indicates that they reprice more quickly due to early payoffs. Mortgage-backed securities are included in maturity\/repricing categories based upon historical prepayment speeds. Based upon historical deposit rate relationships, savings and interest bearing checking are partially included in the non-rate sensitive category since rate changes on these products are not completely sensitive to fluctuations in the interest rate environment.\nAsset\/liability management encompasses both interest rate risk and liquidity management. The resulting net cumulative gap positions reflect the Corporation's sensitivity to interest rate changes over time. The calculation is a static indicator and is not a net interest income predictor of a dynamic business in a volatile environment. As a static indicator, the gap methodology does capture major trends.\nInterest bearing checking and savings deposits that have no contractual maturity are scheduled in the table above according to Management's best estimate of their repricing sensitivity to changes in market rates. If all of these deposits had been included in the 1-30 days category above, the cumulative gap as a percentage of earning assets would have been negative 36.02%, 36.84%, 41.03%, 42.68%, 26.32% and positive 12.43%, respectively, for the 1-30 days, 31-90 days, 91-180 days, 181-365 days, 1-5 years, and greater than 5 years categories at December 31, 1995.\nIn January 1996, the maturity of $10 million included in short term borrowings was extended to one year and an additional $10 million was extended to two years.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS & SUPPLEMENTARY DATA\nThe annual report of Belmont Bancorp. is hereby incorporated by reference and appears as Exhibit B. Management's report on their responsibility for financial reporting is included in the Corporation's annual report.\nITEM 9","section_9":"ITEM 9 - DISAGREEMENT OF ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information appearing in Belmont Bancorp.'s definitive proxy statement dated March 15, 1996 (Exhibit C) is incorporated by reference in response to this item.\nEXECUTIVE OFFICERS OF THE REGISTRANT AS OF JANUARY 1, 1996:\nName Age Position J. Vincent Ciroli, Jr. 50 President and Chief Executive, Officer, Belmont Bancorp. & Belmont National Bank\nWilliam Wallace 40 Vice President, Belmont Bancorp.; Executive Vice President & Chief Operating Officer, Belmont National Bank\nJane R. Marsh 34 Secretary, Belmont Bancorp.; Senior Vice President, Controller & Cashier, Belmont National Bank\nEach of the officers listed above has been an executive officer of the Corporation or one of its subsidiaries during the past five years.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information appearing in Belmont Bancorp.'s definitive proxy statement dated March 15, 1996 (Exhibit C) is incorporated by reference in response to this item.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing in Belmont Bancorp.'s definitive proxy statement dated March 15, 1996 (Exhibit C) is incorporated by reference in response to this item.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing in Belmont Bancorp.'s definitive proxy statement dated March 15, 1996 (Exhibit C) is incorporated by reference in response to this item.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 19, 1996.\nBy Terrence A. Lee, Chairman BELMONT BANCORP Terrence A. Lee, Chairman (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 in the capacities and on the date indicated.\nJohn A. Belot John A. Belot Director Vincent Ciroli, Jr. J. Vincent Ciroli, Jr. Director,President & CEO. Belmont Bancorp., Belmont National Bank Samuel Mumley Samuel Mumley Director Mary L. Holloway Haning Mary L. Holloway Haning Director Charles J. Kaiser, Jr. Charles J. Kaiser, Jr. Director John H. Goodman, II John H. Goodman, II Director Dana Lewis Dana Lewis Director Jane R. Marsh Jane R. Marsh Secretary, Belmont Bancorp. and Sr. Vice President, Controller & Cashier, Belmont National Bank James Miller James Miller Director W. Quay Mull, II W. Quay Mull, II Director Tom Olszowy Tom Olszowy Director Keith Sommer Keith Sommer Director William Wallace William Wallace Director & Vice President, Belmont Bancorp.; Executive Vice President & COO, Belmont National Bank Charles A. Wilson, Jr. Charles A. Wilson, Jr. Vice Chairman\nTerrence A. Lee Chairman of the Board Terrence A. Lee March 19, 1996\nINDEX TO EXHIBITS\nExhibit 1 - Consent of Independent Certified Public Accountants Exhibit 2 - Belmont Bancorp.'s 1995 Annual Report to Shareholders Exhibit 3 - Belmont Bancorp.'s Proxy Statement to Shareholders, dated March 15, 1996 Exhibit 27 - Financial Data Schedule","section_14":"","section_15":""}
{"filename":"778423_1995.txt","cik":"778423","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nAmerihost Properties, Inc. was incorporated under the laws of the State of Delaware on September 19, 1984. Amerihost Properties, Inc. and its subsidiaries (collectively, where appropriate, \"Amerihost,\" the \"Company\" or \"API\") are primarily engaged in the development and ownership\/operation of mid-market hotels. The Company also provides hotel management and employee leasing services for mid-market hotels. The Company's expertise includes the development and construction of new hotels from inception to completion, hotel renovation, hotel management and operation, and employee leasing. This expertise is utilized in the development and operation of Consolidated Hotels and provided to non-controlled entities (minority-owned entities) and unaffiliated third parties on a fee-for-service or contract basis. For purposes of this document, Consolidated Hotels includes all hotels in which the Company has a controlling (typically, over 50%) ownership or leasehold interest. The Company's principal office is located at 2400 East Devon Avenue, Suite 280, Des Plaines, Illinois 60018.\nAmerihost entered the hotel industry in 1987 primarily as a hotel developer and manager. Through 1993, the Company acquired and renovated several distressed hotel properties at below market prices through partnerships in which the Company is a general partner, typically with a minority ownership interest. These hotels were operated as part of a national or regional franchise system, including Days Inn and Holiday Inn. In 1993, as the hotel industry began to rebound from the oversupply of hotels built in the mid 1980's, the Company began focusing on balancing hotel ownership with hotel development, allowing the Company to rely less on the one-time transactional fees associated with hotel development and construction while generating long-term revenues and potential profits from hotel operations. The Company also ceased to aggressively pursue management contracts with unaffiliated third parties, focusing on managing and operating hotels where the Company has ownership. In addition, during 1994 and 1995, the number of existing hotels which could be profitably acquired, renovated and operated declined significantly. The increased hotel ownership in 1994 and 1995 was achieved primarily through the development and construction of new hotels, whereby the Company built hotels for its own account (majority or wholly-owned), or maintained a minority ownership position through joint ventures.\nThe first AmeriHost Inn, the Company's signature brand, which opened in 1989, was built by the Company through a joint venture, with the Company maintaining a minority ownership interest. The AmeriHost Inns have achieved occupancy and average daily rates which were significantly higher than those realized by other hotels managed by the Company which were not AmeriHost Inns, including those operated under a national franchise affiliation. The favorable operating results experienced by the AmeriHost Inns prompted the Company to focus on expanding this brand. During 1994, the Company began construction on seven AmeriHost Inns, out of a total of 15 hotel construction starts, while in 1995, 19 of the Company's 20 hotel construction starts were AmeriHost Inns. With one exception, all of the AmeriHost Inns have been newly constructed by the Company using the same prototype design. As of December 31, 1995, 30 AmeriHost Inns were open or under construction. Except for one hotel, the Company has an ownership interest, ranging from 15.0% to 100.0%, in all of the AmeriHost Inns. The Company plans to continue developing the AmeriHost Inn brand as its primary product for its own account and through joint ventures in an effort to maximize revenues and profits in all business segments while building a critical mass of AmeriHost Inns.\nThe typical AmeriHost Inn hotel is located near an interstate highway, a major traffic artery or airport, or other demand generator such as an office\/industrial park, university, casino, or shopping mall and contains from 60 to 120 guest rooms. The Company has targeted secondary and tertiary markets (with average room rates from $40 to $60 per night), usually in smaller communities where there is minimal competition or where new hotels have not been built for a number of years, as the principal location for the development and construction of AmeriHost Inn hotels. The AmeriHost Inn is positioned to attract both business and leisure travelers seeking quality rooms at reasonable rates.\nThe AmeriHost Inn offers a variety of amenities and services typically not found on a consistent basis in the markets in which the Company targets. These amenities and services include 24-hour front desk and message service, facsimile machines, personal computers, complimentary expanded continental breakfast, 24-hour hot coffee, an indoor swimming pool, whirlpool suites, sauna, and exercise room. The AmeriHost Inn prototype features indoor corridors and electronic card-key locks for added comfort and security, and an efficient layout designed to minimize operating costs. AmeriHost Inns do not contain food and beverage facilities associated with full-service hotels. Food service to hotel guests generally is provided by adjacent free-standing restaurants, which are independently owned and operated by national or regional restaurant operators. All of the AmeriHost Inns are managed by the Company in accordance with strict operating guidelines with respect to the amenities and services provided. The Company believes this high degree of consistency is critical to guest satisfaction and repeat business as the AmeriHost Inn brand is expanded. By focusing on hotel operations and providing a wide variety of amenities on a consistent basis, Amerihost believes it is able to operate profitable hotels while offering an excellent value at an attractive price to its guests.\nHotels which are owned, operated and\/or managed by the Company as part of a national or regional franchise system, or independent of any brand affiliation, are also located in secondary and tertiary markets, with nearby demand generators similar to those of AmeriHost Inn hotels. These hotels also generate average room rates in the $40 to $60 per night range, and generally do not contain food and beverage facilities. In an effort to enhance occupancy and average daily rate at these hotels, a variety of amenities and services are provided similar to those provided by the AmeriHost Inns.\nFor all AmeriHost Inns, same room revenues increased 13.7% in 1995 compared to 1994, while same room revenue per available room (\"RevPar\") increased $4.70, both attributable to an increase of $1.77 in average daily rate and a 9.9% increase in occupancy. For all hotels in which the Company has ownership which are not AmeriHost Inn hotels, same room occupancy increased 4.7% and same room average daily rate increased $0.58 from 1994 to 1995, resulting in a 4.7% increase in same room revenues.\nAs of December 31, 1995, the Company owned or managed 58 hotel properties in 13 states. The Company had ownership or leasehold interests, ranging from 5.0% to 100.0%, in 48 hotels at December 31, 1995 versus 43 at December 31, 1994, translating into a 27.8% increase in equivalent owned rooms. The remaining 10 properties are managed for unaffiliated owners.\nThe following table summarizes the composition of owned and managed hotels, excluding hotels under construction, at:\nDuring 1995, the Company began construction on 20 hotels, and completed construction of twelve hotels, nine of which began construction in 1994, leaving 17 hotels under construction at December 31, 1995. Of the 29 hotels completed in 1995 or under construction at year end, the Company has an ownership position in 26, including nine wholly-owned Consolidated Hotels. The Company had a record year in 1995 for hotel construction starts, surpassing the level achieved in 1994, when the Company began construction on a total of 15 hotels. In addition, the Company acquired additional ownership interests in hotels in which the Company already held a minority ownership interest, of which five such acquisitions resulted in majority ownership positions. Consistent with the Company's balanced strategy, the Company plans to continue increasing hotel ownership through new construction for its own account as well as for minority-owned entities, thereby generating revenues and profits from the operation of Consolidated Hotels and from the development of hotels for minority-owned and unrelated third parties.\nThe Company's revenues increased to a record $52.0 million in 1995 from $43.3 million in 1994, an increase of 19.9%. Revenues are generated by the Company's two primary business segments, hotel operations and hotel development, and also by the hotel management and employee leasing segments. Hotel operations revenues increased 57.9% to $24.4 million in 1995 from $15.4 million in 1994, primarily due to a net increase of ten Consolidated Hotels in 1995. Revenues from hotel development were $12.2 million in 1995, increasing 1.7% from $12.0 million in 1994. Although the Company started construction on more hotels in 1995 compared to 1994 for unaffiliated or minority-owned entities, many of the 1995 starts began in the fourth quarter. Consequently, the majority of revenues from these contracts will be realized in 1996 when the projects are completed. Hotel management revenues increased 11.0% in 1995 compared to 1994 due primarily to an increase in same room revenues and incentive management fees. Employee leasing revenues decreased slightly as a result of fewer contracts with third parties and minority-owned entities.\nThe Company reported record net income of $2.1 million in 1995, increasing 274.2% from $571,421 in 1994. Operating income increased to a record $4.3 million in 1995 from $1.5 million in 1994, while earnings before interest\/rents, taxes and depreciation\/amortization increased to a record $9.5 million in 1995 from $4.6 million in 1994.\nINDUSTRY\nThe Company believes that the hotel industry is in a strong rebound. After a difficult period caused by an oversupply of hotel rooms and a weak U.S. economy in the late 1980's and early 1990's, the lodging industry continued to show progress in 1994 and 1995. Industry-wide room demand increased 3.9% in 1994 according to industry analyst Coopers & Lybrand, more than quadrupling their estimated .9% increase in supply. Industry-wide room demand is estimated to have increased 2.2% in 1995 according to Coopers & Lybrand, while supply continued to lag behind, increasing by 1.0%. Coopers & Lybrand also reported that industry-wide occupancy reached 64.9% in 1994, its highest level since the early 1980's, improving to 65.7% in 1995, while industry-wide average daily rate increased by 3.7% in 1994, the first time in six years it surpassed the consumer price index, and 4.6% in 1995.\nCoopers & Lybrand expects the positive trends to continue in 1996. They expect industry-wide room demand to remain strong, averaging 2.5% annual increases through 1998, while supply increases should continue to lag behind, around 2.0% per year during this same period. Occupancy for the industry is expected to surpass 66% in 1996 while average daily rates are expected to increase 4.5% in 1996.\nBUSINESS SEGMENTS\nThe Company's business is organized into four business segments: hotel operations; hotel development; hotel management; and employee leasing. See Note 13 to the Consolidated Financial Statements under Item 14 for financial data regarding each of the Company's business segments.\nHOTEL OPERATIONS\nThe hotel operations segment is comprised of the revenues and profits generated from the operations of the Consolidated Hotels.\nAt December 31, 1995, the hotel operations segment contained 24 Consolidated Hotels. An additional three wholly-owned hotels were also under construction at year-end with projected opening dates through the second quarter of 1996. These hotels will be included in the hotel operations segment after opening.\nThe Company constructed its first hotel in 1987, a 60 room Days Inn in Sullivan, Indiana. The Company maintained a controlling ownership interest in this hotel and has consolidated the operations of this hotel in its financial statements since August 1987, when the hotel began operations. Beginning in 1992, the Company has substantially increased its hotel operations segment through the acquisition of controlling ownership and leasehold interests in hotels, with 14 Consolidated Hotels at December 31, 1994. The Company continued to expand its hotel operations in 1995 through the development and construction of Consolidated Hotels, as well as the acquisition of majority ownership positions in hotels which had previously been minority-owned. During 1995, the Company completed construction of six Consolidated Hotels, while acquiring a majority ownership or leasehold interest in five existing hotels which had previously been minority-owned. In addition, one hotel lease was terminated by the Company pursuant to the sale of the hotel by the lessor.\nPresented below is a recap of all Consolidated Hotels included in the Company's hotel operations segment, including hotels under construction at December 31, 1995:\nAll of the acquired hotels listed above were renovated by the Company and repositioned in their respective marketplace after obtaining a national franchise license. The revenues and expenses from the operation of the above hotels are included in the Company's consolidated financial statements, or will be included upon opening. Hotels under construction at December 31, 1995 are included in the Company's consolidated balance sheet as construction-in-progress.\nThis segment achieved record revenues and operating income in 1995. Hotel operations revenue increased 57.9% to $24.4 million in 1995 from $15.4 million in 1994, while operating income increased 36.8% to $3.4 million in 1995 from $2.5 in 1994. These results were due primarily to the net addition of ten Consolidated Hotels, improving industry fundamentals, and a strong management effort in establishing and marketing the newly constructed hotels. For all hotels included in this segment, same room average daily rate increased $1.19 from 1994 to 1995, resulting in a 2.4% increase in revenues.\nThe Company's hotel operations segment is subject to seasonal variations. The Consolidated Hotels are located primarily in the Midwest and typically experience lower revenues in the first and fourth quarters. The impact of seasonality has become more pronounced with the addition of owned hotels in the Midwest, however if the Company further increases its ownership in hotels located in warmer climates, this impact may be diminished.\nThe Company is constantly analyzing market conditions to determine the appropriate time to sell an owned property. Amerihost may realize profits and cash flow from the disposition of owned hotels. Increases in value created through the Company's development and management activities, as well as any overall real estate appreciation are not reflected in the consolidated financial statements until a property is sold.\nHOTEL DEVELOPMENT\nThe hotel development segment is comprised of the revenues and profits derived from new construction, acquisition\/lease, and renovation activities performed for third parties and entities in which the Company has a minority interest. The hotel development segment includes the activities of Amerihost Development, Inc. and Amerihost Renovations, Inc., wholly-owned subsidiaries of Amerihost Properties, Inc.\nNew Construction\nAmerihost offers \"turn-key\" development services for new construction projects. The Company has the in-house expertise to complete a project from beginning to end, including market research, site selection, architectural services, the securing of financing, and construction management.\nFor new construction, the Company targets secondary and tertiary markets, typically in smaller communities where there is little or no competition or where new hotels have not been built for a number of years, as the principal location for the development and construction of new hotels. The Company has developed a number of prototypes to meet the needs of hotel operators. Each of these prototypes is designed to be a 60 - 80 room limited service, mid- market hotel which does not provide food or banquet services. Each prototype is built to meet or exceed the standards required to qualify for a national hotel franchise and may be easily modified up to 120 rooms.\nThe construction contracts entered into between the Company and the ownership entity of the property have generally been one of two types. The first type of contract provides for the Company to receive cost plus developers' and construction overhead fees. Under this type of contract, the Company's costs are fully recoverable. The second type of contract provides for the Company to receive a fixed fee. Under this type of contract, the Company attempts to limit its risk by providing for allowances for certain site costs to be performed by third parties, such as excavation, sewage, sanitation costs and tap fees, as these costs can vary from project to project. Any costs in excess of the allowed amounts are borne directly by the ownership entity.\nUnder both types of contracts, the Company typically performs the actual construction of the hotel through the use of a general contractor hired by the Company for a fixed fee. Since the Company builds its own prototypes, its in-house drafting and design personnel make any required changes or modifications to hotel blueprints through the use of its computer assisted drafting (\"CAD\") equipment, which minimizes architects' fees.\nThrough the years, the Company has developed relationships with suppliers of the furniture, fixtures and equipment used in its prototype hotels. Because of its experience and relationships with these suppliers, the Company has been able to appropriately budget for these items over the years. The Company believes that its relationships with these suppliers are good and that the loss of any particular supplier will not have a material adverse effect on the Company.\nExcluding Consolidated Hotels, during 1995, the Company completed six hotels which began construction in 1994, and began construction on 14 hotels, all of which were under construction at December 31, 1995. During 1994, the Company began construction on 10 hotels, four of which were completed in 1994, leaving six hotels under construction at December 31, 1994 which were completed in 1995. The hotel development and construction activity performed for minority-owned entities and third unaffiliated parties is summarized as follows:\nThe Company's hotel development segment generated revenues of $12.2 million in 1995 compared to $12.0 million in 1994. This 1.7% increase was due to increased development activity performed for third parties and entities in which the Company has a minority interest. In addition to the hotels currently under construction, the Company has several projects in various stages of development.\nAcquisitions, Leases and Renovations\nIn prior years, the Company had been successful in acquiring hotels through partnerships in which the Company is a general partner, renovating the properties and repositioning them in their respective marketplace. The revenues and profits from these acquisitions and renovations performed for unaffiliated third parties or minority-owned partnerships were included in the Company's hotel development segment.\nThe Company has also acquired fee simple title or leasehold interests in certain hotels in which it has a 100% or majority ownership interest. Since the Company has a controlling or 100% leasehold interest in these hotels, all development and renovation revenues and profits have been eliminated in consolidation. The operations of these hotels are included in the Company's hotel operations segment.\nThe Company periodically performs renovations on the hotels it manages. The revenues and profits from renovations performed for unaffiliated and minority-owned hotels are included in the Company's hotel development segment.\nIn 1995, the Company experienced a decrease in hotel acquisition activity while focusing primarily on new construction. The shift from acquisition to new construction was primarily the result of two factors. First, the Company believes that the number of existing hotels which can be profitably acquired and renovated has declined significantly after most were sold at depressed prices during a difficult period in the industry. The Company intends to acquire additional properties only if the terms are considered favorable. Second, the availability of financing for new construction has increased as the industry showed significant improvements in occupancy and average daily rate. Both of these factors are the result of improved industry fundamentals. Industry-wide hotel room demand was estimated to have increased 2.2% in 1995, more than doubling the estimated 1.0% increase in room supply.\nThe construction industry can be seasonal, depending upon the geographic location of the construction projects. As of December 31, 1995, the Company has new construction projects primarily in the Midwest and Southeast. Construction activity in the Midwest can be slower in the first and fourth quarters. However, the Company makes a concerted effort to schedule its construction activity to minimize the effect of this seasonality. Other types of revenue recognized in the hotel development segment are not as seasonal. Renovations performed by the Company are typically cosmetic in nature and usually pertain to hotel interiors. Other fees recognized from the acquisition of hotels and the sale of leasehold interests are not seasonal in nature, as these types of transactions can occur at any time during the year.\nHOTEL MANAGEMENT\nThe hotel management segment is comprised of the revenues and profits generated from management services performed for third parties and entities in which the Company has a minority interest. This segment includes the activity of Amerihost Management, Inc., a wholly-owned subsidiary of Amerihost Properties, Inc.\nThe Company provides complete operational and financial management services. The Company has developed centralized systems and procedures which allow it to manage the hotels effectively and efficiently. Management and financial services include sales, marketing, quality control, training, purchasing, and accounting. As of December 31, 1995, the Company provided management services to 58 hotels. The Company's revenues from hotel management activities were over $3.0 million in 1995, compared to $2.7 million in 1994.\nUnder most of its management contracts, the Company is responsible for all operational and financial management. However, under some management contracts, its joint venture partners (discussed below) are responsible for the day-to-day operational management, while the Company provides full financial management, operational consulting and assistance.\nThe Company has designed a financial management system whereby all accounting information is processed in the Company's centralized accounting office at its headquarters in Des Plaines, Illinois. The system includes cash management, accounts payable and generation of monthly financial statements. The Company provides each managed property with standardized forms and procedures so that financial reporting for all managed hotels is uniform. The Company's financial management computer system enhances the quality and timing of internal financial reports used by the Company, its partners, third party owners, and financial institutions.\nThe Company's operational management activities are overseen by two Vice Presidents of Operations who supervise regional and area managers, who in turn oversee general managers at each property. These managers are responsible for maintaining smooth day-to-day operations at all hotels. In addition to these managers, the Company has in-house marketing personnel who assist and direct the general managers and on-site personnel in marketing the property. The Company also has a team of auditors who examine each hotel at least three times per year. These audits include tests of financial items such as cash and receivables, as well as operational and information systems and security matters. The audit team is also responsible for conducting the various general manager and staff training seminars.\nThe Company is currently managing or co-managing with its joint venture partners all properties in which it has a minority equity interest, as well as managing a number of properties for third party owners for fees equal to a percentage of total gross revenues. The terms of most of the Company's management contracts typically range from one to ten years, with optional renewal periods of equal length.\nDuring 1993 and continuing through 1994 and 1995, the Company began to focus on increasing hotel ownership, primarily through the construction of hotels where the Company has either a minority interest or controlling interest (Consolidated Hotels). Managing Consolidated Hotels does not contribute to the hotel management segment, however the Company does recognize fees from the management of hotels in which it has a minority interest. During 1995, the Company built and opened three minority-owned hotels, one hotel for an unrelated third party, and had 13 minority-owned projects under construction at December 31, 1995. The Company intends to grow this segment primarily through the construction of minority-owned hotels. While the Company does not intend to actively pursue management contracts with third parties, it does intend to continue managing properties for third parties under its current management contracts and may manage additional hotels for third parties if the terms are favorable. The Company expects the hotel management segment to grow as the number of minority-owned hotels increases, which is consistent with the Company's balanced strategy.\nThe following is a list of hotel properties under the Company's management at December 31, 1995 by state:\nIn addition to the above referenced management contracts, the Company has a financial services contract with a 150 room Best Western hotel near O'Hare Airport that is partially owned by an officer of the Company. Under this contract, the Company processes payables and prepares monthly financial statements for a fixed monthly fee.\nBecause the hotel industry is seasonal, the revenues generated by the hotels managed by the Company will increase or decrease depending upon the time of year. Since the Company's management fees are based upon a percentage of the hotels' total gross revenues, the Company is susceptible to these seasonal variations. Given the location of the properties the Company manages, the revenues are typically lower in the first and fourth quarters of each year. The impact of the seasonal variation may diminish if the Company expands further into warmer climates.\nEMPLOYEE LEASING\nThe employee leasing segment is comprised of employee leasing activities whereby the Company leases its employees to unaffiliated hotels and hotels in which the Company has a minority interest. The Company employs all the personnel working at the hotels and leases them to the hotels pursuant to written agreements. The Company has entered into employee leasing agreements with all the hotels it manages. Similar to the management contracts, the employee leasing agreements typically contain terms of one to ten years, with optional renewal periods of equal length. The Company generally receives fees from each hotel in an amount equal to the gross payroll, including all related taxes and benefits plus a percentage of the gross payroll. The employee leasing segment consists of the activities of Amerihost Staffing, Inc., a wholly-owned subsidiary of Amerihost Properties, Inc.\nDuring 1995, the Company's employee leasing segment generated approximately $12.4 million in gross revenues for the Company. While the ratio of operating income to revenues is not as significant as the Company's other business segments, employee leasing did contribute approximately $216,000 to the Company's operating income in 1995. This business segment provides the Company with greater control and security over the payroll, while allowing the hotels to benefit from significant economies of scale on all personnel related costs.\nJOINT VENTURES\nDuring 1995, the Company continued to develop new properties through joint venture arrangements. These joint ventures are arrangements formalized in agreements whereby the Company and other investors agree to jointly undertake the development, construction, acquisition or renovation of a hotel property. Each party has specific responsibilities for which it receives certain fees.\nMost joint ventures are formed for a particular project or projects, but the Company has entered into one joint venture arrangement for the future development and management of hotel properties which have not been identified. As of December 31, 1995, the Company had completed 26 projects with joint venture partners.\nCOMPETITION\nThere is significant competition in the mid-market hotel industry. There are numerous hotel chains that operate on a national or regional basis, as well as other hotels, motor inns and other independent lodging establishments throughout the United States. Competition is primarily in the areas of price, location, quality and services. Many of the Company's competitors have recognized trade names, greater resources and longer operating histories than the Company. However, the Company believes that its management is sufficiently experienced, and the markets which the Company targets for development typically contain minimal competition, enabling the Company to compete successfully.\nThere are a number of companies which develop, construct and renovate hotels. Some of these companies perform these services only for their own account, while others actively pursue contracts for these services with third party owners. The Company believes that it can develop, construct and renovate hotels at costs which are competitive. The Company also believes that its ability to offer additional services, such as hotel management, provides some competitive advantages.\nThere are many hotel management companies which provide management services to hotels similar to the services provided by the Company. While the quantity of competition may be high, the Company believes that the quality of its services, including its information and management systems and employee leasing operations, will enable the Company to compete successfully. The Company believes that its focus on secondary and tertiary markets also lessens competition for the types of services provided by the Company.\nFRANCHISE LICENSING\nThe majority of hotels operated and managed by the Company are part of a national or regional franchise system, such as Days Inns and Holiday Inns. Franchises in certain locations are important in maintaining occupancy levels, which is accomplished through the franchise's national reservation systems as well as through brand name recognition. The importance of national franchises is amplified for highway locations. The typical term of a franchise agreement is twenty years for newly developed and constructed hotels and ten years for the conversion of an existing hotel. The Company believes that the loss of any one of its franchise agreements would not have a material adverse effect on the Company.\nEMPLOYEES\nAs of December 31, 1995, the Company and its subsidiaries had approximately 1,800 full and part-time employees: Hotel Management: Operations 19 Accounting and finance 17 Property general managers 58\nHotel Development: 35\nHotel Operations: 562\nCorporate: General and administrative 9 Officers 4\nEmployee Leasing: General and administrative 4 Operations(1) 1,130 1,838\n(1) Does not include 622 employees who are employed by ASI and leased to other subsidiaries of the Company. These employees are reflected in the table under hotel management and hotel operations.\nThe Company believes that its relationship with its employees is good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's corporate offices and the offices of its wholly-owned subsidiaries are located in approximately 17,085 square feet of space at 2400 East Devon Avenue, Suite 280, Des Plaines, Illinois 60018. These offices are occupied under a lease that expires on December 31, 2000.\nAt December 31, 1995, the Company had a controlling ownership or leasehold interest in 24 operating hotels and three hotels under construction, located in nine states. The land, building, furniture, fixtures and equipment and construction in progress for these hotels is reflected in the Company's Consolidated Balance Sheet at December 31, 1995. These assets were substantially pledged to secure the related long-term mortgage debt. See Item 1 and Note 7 to the Consolidated Financial Statements under Item 14.\nIn addition to the foregoing, the Company has an equity interest in partnerships which own and\/or lease property. See Note 4 to Consolidated Financial Statements under Item 14.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to claims and suits in the ordinary course of business. In management's opinion, currently pending legal proceedings and claims against the Company will not, individually or in the aggregate, have a material adverse effect on the Company's financial condition, 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 security holders of the Company during the fourth quarter of the fiscal year ended December 31, 1995. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock is traded on the Nasdaq National Market under the symbol HOST. As of March 15, 1996, there were 1,576 holders of record of the Company's Common Stock. The following table shows the range of reported high and low closing prices per share.\nThe Company has not declared or paid any cash dividends on its Common Stock. The Company currently intends to retain any earnings for use in its business and therefore does not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay cash dividends will be made by the Board of Directors in light of the Company's earnings, financial position, capital requirements and such other factors as the Board of Directors deems relevant. In addition, pursuant to the terms of the Company's 7% Subordinated Notes (the \"7% Notes\"), no dividends may be paid on any capital stock of the Company until the 7% Notes have been paid in full. (See Notes 8 and 10 to Consolidated Financial Statements under Item 14.)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected consolidated financial data presented below have been derived from the Company's consolidated financial statements. The consolidated financial statements for all years presented have been audited by the Company's independent auditors, whose report on such consolidated financial statements for the three years ended December 31, 1995, 1994 and 1993 is included herein under Item 14. The information set forth below should be read in conjunction with the consolidated financial statements and notes thereto under Item 14 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.\nGENERAL\nThe Company is primarily engaged in the development and ownership\/operation of mid-market hotels, with a focus on its own AmeriHost Inn brand. The consolidated financial statements include the operations of all hotels in which the Company has a 100% or controlling ownership interest (\"Consolidated Hotels\"). Investments in other entities in which the Company has a minority ownership interest are accounted for using the equity or cost method. The Company also provides hotel development, hotel management and employee leasing services to unrelated third parties and non-controlled entities in which the Company has a minority ownership interest on a fee-for-service or contract basis.\nThe year ended December 31, 1995 resulted in record revenues, net income, operating income and earnings before interest\/rents, taxes and depreciation\/amortization (\"EBITDA\"). Revenues increased to $52.0 million, or 19.9% from $43.3 million in 1994. Net income increased to $2.1 million in 1995 from $571,421 in 1994, while earnings per share increased from 10 cents to 35 cents. Operating income increased from $1.5 million in 1994 to $4.3 million in 1995. The Company uses a supplemental performance measure along with net income to report its operating results. EBITDA is not defined by generally accepted accounting principles, but the Company believes it provides relevant information about its operations and is necessary for an understanding of the Company's operations. For purposes of EBITDA, the Company considers leasehold rents - hotels to be financing costs similar to interest. EBITDA increased to $9.5 million in 1995 from $4.6 million in 1994, or an increase of $4.9 million.\nThe improved performance was primarily attributable to hotel operations and hotel development. The Company intends for the AmeriHost Inn brand to be used whenever feasible in expanding its hotel operations segment. In addition, the AmeriHost Inn prototype is the primary product being developed through the hotel development segment. All of the hotels which began construction in 1995 were AmeriHost Inns except for one hotel developed for an unrelated third party. As of December 31, 1995, 14 AmeriHost Inns were open, 16 were under construction, and several additional were in the pre- construction development phase. The AmeriHost Inn brand features several amenities including an indoor pool area, whirlpool suites, an exercise room, and an expanded continental breakfast which assist the property in obtaining favorable occupancy and average daily rates, and an efficient layout designed to control operating costs. For all AmeriHost Inns, same room revenues increased 13.7% in 1995 compared to 1994 as RevPar increased $4.70, both attributable to an increase of $1.77 in average daily rate and a 9.9% increase in occupancy. For all other hotels in which the Company has an ownership interest which are not AmeriHost Inns, same room revenues increased 4.7% in 1995 compared to 1994, as occupancy increased 4.7% and average daily rate increased $0.58.\nThe Company continued constructing hotels for both its own account (Consolidated Hotels) as well as for unaffiliated and minority-owned entities. The Company began construction on six Consolidated Hotels (all AmeriHost Inns) and another 14 hotels (13 of which are AmeriHost Inns) for unaffiliated parties and minority-owned entities in 1995, and was in the development stage of several additional projects at the end of 1995 which are expected to break ground in 1996. Constructing Consolidated Hotels contributes to the hotel operations segment when the hotels are opened. Developing and constructing hotels for unrelated third parties and entities in which the Company has a minority equity interest contributes to the hotel development segment and provides capital necessary to develop hotels for the Company's own account.\nAmerihost had an ownership interest in 48 hotels at December 31, 1995 versus 43 hotels at December 31, 1994 (excluding hotels under construction), increasing equivalent owned rooms by 27.8% from 2,086 at December 31, 1994 to 2,666 at December 31, 1995. These figures include an increase in Consolidated Hotels from 14 at December 31, 1994 to 24 at December 31, 1995. This increased ownership was achieved primarily through the development of hotels for the Company's own account and for minority-owned entities.\nRESULTS OF OPERATIONS\nThe following table sets forth the percentages of revenues of the Company represented by components of net income for 1995, 1994 and 1993.\n1995 compared to 1994\nRecord revenues of $52.0 million in 1995 increased 19.9% from revenues of $43.3 million in 1994. This increase was due primarily to a significant increase in revenues from hotel operations. Hotel operations revenue increased 57.9% to $24.4 million in 1995, compared to $15.4 million in 1994. This increase was attributable to the net addition of ten Consolidated Hotels to the hotel operations segment during 1995, and a 2.4% increase in same room revenue realized by the Consolidated Hotels. The Company held a minority ownership position in five of these ten hotels prior to these hotels becoming Consolidated Hotels in 1995 when additional ownership interests were acquired. The hotel operations segment included 24 Consolidated Hotels comprising 2,516 rooms and the end of 1995, compared to 14 Consolidated Hotels comprising 1,543 rooms at the end of 1994, or an increase of 63.1% in total rooms. Same room occupancy for all Consolidated Hotels increased 2.8% in 1995, while same room average daily rate increased $1.19, or 2.5%.\nHotel development activity is summarized as follows:\nThe Company does not recognize revenues from the development and construction of Consolidated Hotels. Excluding the Consolidated Hotels, the Company had 20 hotels under construction during 1995, versus 10 hotels in 1994 for unaffiliated parties and entities in which the Company holds a minority ownership interest. In addition, the Company had several projects in various stages of pre-construction development at the end of 1994 and 1995. Hotel development revenue increased 1.7% in 1995 from $12.0 million in 1994 to $12.2 million in 1995. Although the number of hotels under construction was significantly greater in 1995, total segment revenues did not increase accordingly since 12 of the 14 hotels which began construction in 1995 were not started until the fourth quarter, resulting in the recognition of only a minor portion of the total contracted revenues on these projects.\nHotel management and employee leasing revenues are recognized from hotels which are owned by unrelated third parties and entities in which the Company holds a minority ownership interest. While the number of Consolidated Hotels increased from 14 to 24, the number of hotels managed for third parties and minority owned entities decreased from 39 hotels at the end of 1994 to 34 hotels at the end of 1995. The addition of four management contracts in 1995 was offset by the loss of one management contract with a unaffiliated third party, three management contracts with minority-owned entities as a result of a hotel\/investment sale or temporary closing during renovation, and the five minority-owned hotels which became Consolidated Hotels in 1995 due to the Company acquiring additional ownership interests in these hotels. The Company does not recognize management and employee leasing revenues from Consolidated Hotels. Hotel management revenues increased 11.0% from $2.7 million in 1994 to $3.0 million in 1995. The decrease resulting from the changes noted above, were more than offset by an increase in same room revenue for managed hotels and incentive management fees received in 1995 which were not present in 1994 from certain managed hotels. Employee leasing revenues, which are based on actual employee costs, decreased 6.2% from $13.2 million in 1994 to $12.4 million in 1995 as a result of the decrease in employee leasing contracts with minority-owned entities and an unaffiliated third party as noted above.\nOperating costs and expenses increased 11.4% to $41.3 million (79.5% of total revenues) in 1995 from $37.1 million (85.5% of total revenues) in 1994. Operating costs and expenses in the hotel operations segment increased 63.2% from $10.5 million in 1994 to $17.1 million in 1995, resulting primarily from the net addition of ten Consolidated Hotels to this segment and is directly related to the 57.9% increase in segment revenue. Operating costs and expenses in the hotel development segment decreased from $11.3 million in 1994 to $10.1 million in 1995, due to the lower level of construction costs recognized in 1995 relative to 1994, as the Company had started construction on a significant number of hotels in the fourth quarter of 1995 which had not yet incurred significant construction costs in 1995. Hotel management segment operating costs and expenses decreased 12.5% to $2.0 million in 1995 from $2.3 million in 1994, primarily due to the write-off of a contract termination fee note receivable in 1994. Employee leasing operating costs and expenses decreased 6.8% from $13.0 million in 1994 to $12.1 million in 1995. This decrease is attributable to the decrease in segment revenue as well as operational efficiencies.\nDepreciation and amortization expense increased 98.8% to $2.3 million in 1995 compared to $1.1 million in 1994. This increase was primarily attributable to the addition of ten Consolidated Hotels to the hotel operations segment and the resulting depreciation and amortization therefrom.\nLeasehold rents - hotels increased 19.0% to $2.0 million in 1995 from $1.7 million in 1994. This increase was due to the addition of three leased Consolidated Hotels to the hotel operations segment (the Company had held a minority ownership position in these hotels prior to 1995 when additional ownership interests were acquired), partially offset by the termination of a lease agreement for one hotel.\nCorporate general and administrative expenses increased 4.9% from $2.0 million in 1994 to $2.1 million in 1995, and can be attributed to the Company's overall growth.\nThe Company had $4.3 million in operating income in 1995 increasing 194.7% from $1.5 million in 1994, or an increase of $2.8 million. Operating income from the hotel operations segment increased 36.8% from $2.5 million in 1994 to $3.4 million in 1995, resulting primarily from an increase in Consolidated Hotels from 14 at December 31, 1994 to 24 at December 31, 1995. Operating income from the hotel operations segment as a percentage of segment revenue decreased during 1995 compared to 1994 due to a greater number of newly constructed Consolidated Hotels operating during their initial stabilization period, when revenues are generally lower. The hotel development segment operating income increased 194.2% from $711,032 in 1994 to $2.1 million in 1995 as operating income as a percentage of segment revenues also increased due to a higher level of pre-construction development activity realized in 1995 which has lower revenues and a higher gross margin than construction activity. Hotel management segment operating income increased from $250,118 in 1994 to $831,007 in 1995, due primarily to the increase in same room revenues for managed hotels, incentive management fees received in 1995, and the write-off of a contract termination fee note receivable in 1994. Employee leasing operating income increased from $149,305 in 1994 to $216,075 in 1995, or $66,770, due primarily from operational efficiencies.\nEBITDA increased $4.9 million to a record $9.5 million in 1995 compared to $4.6 million in 1994, or an increase of 105.4%. The significant changes resulting in the increase in EBITDA from 1994 to 1995 are discussed above.\nInterest expense increased to $1.8 million in 1995 versus $854,880 in 1994, primarily attributable to an increase in Consolidated Hotels with mortgage financing.\nThe Company's share of equity in the operating results of affiliates increased to $387,439 in 1995 from $31,511 in 1994. This increase was due primarily to a 10.2% increase in same room revenues for all minority owned hotels and the gain on the sale of one hotel, which translated into a 392% increase in net income for these hotels. Distributions from affiliates increased 32.2% to $505,410 in 1995 from $382,229 in 1994.\nThe Company recorded income tax expense of $1.3 million in 1995 compared to income tax expense of $381,000 in 1994, which increase is directly attributable to the increase in pre-tax income.\n1994 Compared with 1993\nRevenues increased 26.5% in 1994 to $43.3 million from $34.3 million in 1993. This increase was attributable to the Company's hotel operations and hotel development segments.\nHotel operations revenue increased 69.7% to $15.4 million in 1994 compared to $9.1 million in 1993. This increase was attributable to a significant increase in average daily rates and the addition of five Consolidated Hotels to this segment. Hotel operations included fourteen Consolidated Hotels comprising 1,543 rooms at the end of 1994 versus nine Consolidated Hotels comprising 1,100 rooms at the end of 1993, or an increase of 40.3% in total rooms. Same room average daily rates for Consolidated Hotels increased $5.37 to $44.16 in 1994 from $38.79 in 1993.\nHotel development revenue increased 72.7% to $12.0 million in 1994 compared to $7.0 million in 1993. This increase was attributable to a significant level of hotel development and construction activity during 1994. The Company began construction on 15 hotels in 1994 while completing construction on eight hotels, including two hotels which began construction in 1993. Ten of these construction starts were pursuant to contracts with unaffiliated third parties (four) and entities in which the Company has a minority ownership interest (six) whereby the Company recognized revenues from their development and construction. The remaining five construction starts were for Consolidated Hotels. In 1993, the Company completed construction on two minority-owned hotels which began construction in 1992, started construction on two Consolidated Hotels which were completed in 1994, and substantially completed the pre-construction development phase of four projects for unaffiliated and minority-owned entities which were also completed in 1994.\nThe increases in hotel operations and hotel development revenues were partially offset by decreases in hotel management and employee leasing revenues. The revenue generated from these segments is directly related to the number of properties managed for unaffiliated hotel owners and entities in which the Company has a minority interest. Although the number of minority-owned and managed hotels increased from 26 at the end of 1993 to 29 at the end of 1994, the number of properties managed for unaffiliated third parties decreased from 14 to 10 during this same period, more than offsetting the increase in minority-owned hotels. As a result, management fee revenues, which are based on the managed hotel's revenue, decreased 4.8% in 1994 to $2.7 million, compared to $2.8 million in 1993. Employee leasing revenues, which are based on actual employee costs, decreased 14.3% from $15.4 million in 1993 to $13.2 million in 1994 due to the decrease in properties managed for unaffiliated third parties and contract revisions for properties located in one state which resulted in a more favorable tax treatment.\nOperating costs and expenses increased 22.0% in 1994 to $37.1 million in 1994 from $30.4 million in 1993, and is directly related to the 26.5% increase in total revenues. Operating costs and expenses for the hotel operations segment increased to $10.5 million in 1994 from $6.8 million in 1993, or 54.3%, primarily attributable to the addition of five Consolidated Hotels in 1994. Hotel development operating costs and expenses increased 85.1% from $6.1 million in 1993 to $11.3 million in 1994 due to the significant level of new construction activity. Hotel management segment operating costs and expenses remained consistent at $2.3 million in both 1994 and 1993 as the total number of properties managed remained relatively constant. Employee leasing segment operating costs and expenses decreased 14.4% from $15.2 million in 1993 to $13.0 million in 1994 as a result of contract revisions for properties located in one state. Total operating costs and expenses for the Company as a percentage of total revenues decreased from 88.7% in 1993 to 85.5% in 1994.\nDepreciation and amortization increased 23.0% to $1.1 million in 1994 from $927,527 in 1993, primarily attributable to the addition of five Consolidated Hotels offset by a decrease in the amortization of management contracts acquired. Depreciation and amortization in the hotel operations segment increased from $308,384 in 1993 to $854,743 in 1994, an increase of 177.2%, resulting from the additional Consolidated Hotels. Depreciation and amortization decreased by 64.1% in the hotel management segment in 1994 from $480,855 in 1993 to $172,753 in 1994 due to the amortization in 1993 of the remaining acquisition costs associated with the termination of the Grand American Hotel Management, Inc. management contracts.\nLeasehold rents - hotels remained stable at $1.7 million in 1994 and 1993. Leasehold rents - hotels was increased by the acquisition of a 100% leasehold interest in a hotel during the first quarter of 1994. This increase was offset by a decrease in leasehold rents for five hotels pursuant to a lease amendment which provided for reduced lease payments and extended the termination date to December 31, 1999.\nCorporate general and administrative expense increased from $1.8 million in 1993 to $2.0 million in 1994, or 12.9%. This increase was primarily attributable to the overall growth of the Company as evidenced by the 26.5% increase in total revenue.\nThe Company had $1.5 million in operating income in 1994 compared to an operating loss of $477,636 in 1993, or an increase of $1.9 million. Operating income from the hotel operations segment increased nearly seven- fold from $352,309 in 1993 to $2.5 million in 1994, resulting primarily from the addition of five Consolidated Hotels as well as a significant increase in same room revenues for the existing Consolidated Hotels. Operating income in the hotel management segment increased from $72,229 in 1993 to $250,118 in 1994, due primarily to the decrease in amortization of management contract acquisition costs. Hotel development operating income decreased from $851,903 in 1993 to $711,032 in 1994. Hotel development activity reached significant levels in 1994, however a significant portion of this development was for Consolidated Hotels whereby revenues and profits are not recognized by the Company. In addition, 1994 consisted of a larger volume of construction activity which has a lower gross profit margin than pre- construction development activity. In 1993, the Company completed a significant portion of the pre-construction development phase on four projects built in 1994 for unaffiliated third parties and entities in which the Company has a minority ownership interest. Operating income in the employee leasing segment was approximately $150,000 in 1994 and 1993.\nEBITDA for 1994 was $4.6 million compared to $2.6 million in 1993. EBITDA for 1993 does not include a non-cash debt acceleration charge of $485,411 related to the prepayment of subordinated notes. The significant changes resulting in the increase in EBITDA from 1993 to 1994 are discussed above.\nInterest expense was $854,880 in 1994 compared to $589,945 in 1993. This increase is primarily attributable to an increase in mortgage financing of newly constructed Consolidated Hotels. This increase was partially offset by a decrease in interest expense relating to the 7% Subordinated Notes.\nThe Company's share of equity in net income of affiliates increased to $31,511 in 1994 from $29,836 in 1993. Excluding a non-operational distribution resulting from the refinancing of one property in 1993, distributions from affiliates decreased slightly to $382,229 in 1994 from $417,486 in 1993.\nThe Company recorded income tax expense of $381,000 in 1994 compared to an income tax benefit of $295,600 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nOver the years, the Company has financed its growth through a combination of cash provided from operations, long-term debt financing and public and private issuances of Common Stock. During 1995, the Company experienced an increase in cash from operations of $1.9 million, compared to an increase of $2.2 million in 1994, and $693,334 in 1993. The decrease in cash flow from operations during 1995 can be attributed to the significant level of hotel construction activity in 1994. Although a greater number of hotels began construction in 1995, a significant number of projects were started during the fourth quarter, and the majority portion of the construction fees will not be received until 1996 when the hotels are completed. This decrease was partially offset by an increase in hotel ownership and operation activity and improvements in occupancy and average daily rates over 1994. In addition to the positive cash flow from operations of $1.9 million, the Company received $7.8 million through the financing of Consolidated Hotel projects, net of principal repayments, and net proceeds of $2.3 million from the Company's line-of-credit. These increases to cash were more than offset by the use of $13.5 million in cash for investing activities during 1995, primarily for the construction of Consolidated Hotel properties. As a result, cash decreased $1.7 million during 1995.\nThe Company has four main sources of cash from operating activities: revenues from hotel operations; fees from development, construction and renovation projects; fees from management contracts; and fees from employee leasing. Cash from hotel operations is typically received at the time the guest checks out of the hotel. A portion of the Company's hotel operations revenues is generated through other businesses and contracts and are usually paid within 30 to 45 days from billing. Hotel operations experienced operating income of $3.4 million during 1995 compared to $2.5 million during 1994. Fees from development, construction and renovation projects are typically received within 15 to 45 days from billing. Due to the procedures in place for processing its construction draws, the Company typically does not pay its contractors until the Company receives its draw. During 1995, development, construction and renovation projects contributed $2.1 million to the Company's operating income compared to $711,032 in 1994. Management fee revenues are typically received by the Company within five working days from the end of each month. The hotel management segment contributed $831,007 to the Company's operating income in 1995 compared to $250,118 in 1994. Cash from the Company's employee leasing segment is typically received 24 to 48 hours prior to the pay date. The employee leasing segment contributed $216,075 and $149,305 in operating income during 1995 and 1994, respectively.\nDuring 1995, the Company used $13.5 million in investing activities compared to $8.8 million during 1994. The Company invests cash in three principal areas: the purchase of property and equipment through the construction and renovation of Consolidated Hotels; the purchase of minority equity interests in hotels; and loans to affiliated and non-affiliated hotels for the purpose of construction, renovation and working capital. In 1995, the Company used $12.5 million to purchase property and equipment for Consolidated Hotels, used $332,800 for the purchase of minority equity interests in hotels, and used $946,857 for loans to affiliates, net of loan collections. In 1994, the Company used $7.9 million to purchase property and equipment for Consolidated Hotels, used $349,015 for the purchase of minority equity interests in hotels, and used $607,225 for loans to affiliates, net of loan collections. In addition, the Company received distributions from investments in hotels of $505,410 in 1995 compared to $382,229 in 1994. The Company enters into agreements with contractors for the construction of Consolidated Hotels, including hotels under construction at December 31, 1995, after both the construction and long-term mortgage financing is in place. A significant portion of the notes receivable from affiliates is for construction advances which will be collected as the construction of the hotels progresses and the equity and debt financing becomes available to the affiliate through the draw process. Typically, investments in hotels generate positive cash flow after a stabilization period ranging from 90 to 180 days depending upon the geographic location of the hotel and time of year the hotel is opened. As an equity holder, additional cash proceeds can be realized by the Company upon the sale of the properties.\nCash received from financing activities was $9.9 million in 1995 compared to $7.7 million in 1994. In 1995, the primary factors were proceeds of $7.8 million from the mortgage financing of Consolidated Hotels, net of principal repayments, and $2.3 million in net proceeds from the Company's operating line-of-credit. In 1994, the contributing factor was proceeds of $7.1 million from the mortgage financing of Consolidated Hotels, net of principal repayments. The Company's line-of-credit was increased effective May 1, 1995 to $3,500,000 and expires on May 1, 1996. The Company's operating line-of- credit had a balance of $2.3 million at December 31, 1995. In December of 1995, the same bank providing the operating line-of-credit approved a $7.5 million line-of-credit to be used for construction financing on projects which have firm commitments for permanent mortgage financing when the construction is completed. There was no outstanding balance on the construction line-of-credit as of December 31, 1995. On February 1, 1996, the Company secured an additional $1.5 million line-of-credit from the same bank under terms and conditions similar to its existing operating line-of- credit.\nThe Company expects cash from operations to be sufficient to pay all operating expenses and debt service in 1996.\nSEASONALITY\nRevenues from all of the Company's business segments are heavily dependent on hotel occupancy, which results in significant seasonal variations in the Company's revenues, with lower revenues usually in the first and fourth quarters of each year. The impact of seasonality may be diminished if the Company expands further into warmer climates.\nINFLATION Management does not believe that inflation has had, or is expected to have, any significant adverse impact on the Company's financial condition or results of operations for the periods presented.\nIMPACT OF NEW 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.\" 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 requires that companies adopt this standard for fiscal years beginning after December 15, 1995. The Company adopted this standard on January 1, 1996. Management believes that the impact of SFAS No. 121 on the 1996 financial statements will not be material.\nPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995\nAll statements contained herein that are not historical facts, including but not limited to, statements regarding the Company's plans for future development and operation of AmeriHost Inn hotels are based on current expectations. These statements are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: the availability of sufficient capital to finance the Company's business plan on terms satisfactory to the Company; competitive factors, such as the introduction of new hotels or renovation of existing hotels in the same markets; changes in travel patterns which could affect demand for the Company's hotels; changes in development and operating costs, including labor, construction, land, equipment and capital costs; general business and economic conditions; and other risk factors described from time to time in the Company's reports filed with the Securities and Exchange Commission. The Company wishes to caution readers not to place undue reliance on any such forward looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995, and as such, speak only as of the date made.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements filed as a part of this Form 10-K are included under \"Exhibits, Financial Statements and Reports on Form 8-K\" under Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been no disagreements on accounting and financial disclosure matters which are required to be described by Item 304 of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Company's executive officers and directors are:\nName Age Position\nH. Andrew Torchia 52 Chairman of the Board and Director\nMichael P. Holtz 39 President, Chief Executive Officer and Director\nRichard A. D'Onofrio 52 Executive Vice President and Director\nRussell J. Cerqua 39 Senior Vice President of Finance, Secretary, Treasurer, Chief Financial Officer and Director\nReno J. Bernardo 64 Director\nRobert L. Barney 59 Director\nH. Andrew Torchia, a co-founder of the Company, has been a Director of the Company since its inception in 1984. Mr. Torchia was President and Chief Executive Officer of the Company from 1985 until 1989, when he became Chairman of the Board of the Company. As Chairman, Mr. Torchia's primary areas of responsibility include business development, corporate finance and strategic and financial planning. Mr. Torchia is also the President and 51% stockholder of Urban 2000 Corp. (\"Urban\"), a hotel development consulting firm and franchise broker, which was initially the 100% parent of the Company and is currently a principal stockholder. See \"Principal Stockholders\" under Item 12. Mr. Torchia is also the Secretary of AHMCO Corporation (\"AHMCO\"), a hotel management company in which Mr. Torchia owns a 50% interest which manages only one property, the Best Western at O'Hare. Mr. Torchia has had 27 years of experience in hotel development, operations and franchising as head of regional development for Best Western International, and as a head of independent franchise sales organizations for Quality Inns International and Days Inns.\nMichael P. Holtz has been a Director of the Company since August 1985. From 1985 to 1988, Mr. Holtz served as the Company's Treasurer and Secretary. In 1986, Mr. Holtz was promoted to Chief Operating Officer of the Company with direct responsibility for the Company's day to day operations. In 1988, Mr. Holtz was elected President and Chief Executive Officer of the Company. Mr. Holtz is responsible for development and implementation of all Company operations including hotel development, finance and management. Mr. Holtz has over 20 years experience in hotels operations, management and renovations. Mr. Holtz earned a Masters Degree in Business Administration and a Bachelor of Science degree from Wright State University in Dayton, Ohio.\nRichard A. D'Onofrio, a co-founder of the Company, has been a Director of the Company since its inception in 1984. From 1985 to 1989, Mr. D'Onofrio served as Vice President of the Company. In 1989, Mr. D'Onofrio was promoted to Executive Vice President. His principal areas of responsibility include corporate finance, corporate marketing, investments, and the Company's relationships with the financial community. Mr. D'Onofrio has been involved in various capacities within the hotel and related industries, including the conceptualization and development of franchised restaurants. In addition, Mr. D'Onofrio owned and operated the Quality Inn in Youngstown, Ohio, through 1987. Mr. D'Onofrio acquired 49% of Urban 2000 Corp. (\"Urban\") during 1994, a hotel development consulting firm and franchise broker, which was initially the 100% parent of the Company and is currently a principal stockholder. See \"Principal Stockholders\" under Item 12.\nRussell J. Cerqua has been the Senior Vice President of Finance of the Company since 1987, and Treasurer and a Director of the Company since 1988. In 1989, in addition to his other responsibilities, Mr. Cerqua was elected Secretary of the Company. His primary responsibilities include internal and financial reporting, corporate and property financing, development of financial management systems, hotel accounting for managed properties and financial analysis. Prior to joining the Company, Mr. Cerqua was an audit manager with Laventhol & Horwath, the Company's former independent certified public accountants, and was responsible for the Company's annual audits. Mr. Cerqua was involved in public accounting for over 9 years, with experience in auditing, financial reporting and taxation. Mr. Cerqua is a Certified Public Accountant, and a member of the American Institute of Certified Public Accountants and the Illinois CPA Society.\nReno J. Bernardo served as the Senior Vice President of Construction of the Company from 1987 through March 1994, when he went on disability. In 1989, Mr. Bernardo became a Director of the Company and continues to serve in this capacity. His primary responsibilities included managing construction of new properties and directing renovation projects. From 1985 to 1986, Mr. Bernardo was Vice President of Construction with Devcon Corporation, a hotel construction company. From 1982 to 1985, Mr. Bernardo was Project Superintendent with J.R. Trueman and Associates, a hotel construction company, and a subsidiary of Red Roof Inns. His responsibilities included supervision of the development and construction of several Red Roof Inns.\nRobert L. Barney is currently the sole shareholder, President and Chief Executive Officer of Rolling Meadows Golf Club & Estates in Columbus, Ohio. Mr. Barney was a director of Wendy's International, Inc. (\"Wendy's\"), a restaurant company, when it was founded in 1969. In July 1971, Mr. Barney was appointed President and Chief Operating Officer and in February 1980 became the Chief Executive Officer in which capacity he served until February 1989. Mr. Barney also served as Chairman of the Board of Wendy's from September 1982 until retiring in May 1990, and continued to consult Wendy's until May 1992. Prior to his affiliation with Wendy's, Mr. Barney held positions with Kentucky Fried Chicken and Arthur Treacher's Fish & Chips while owning several franchises for these two restaurant chains. Since December 1991, Mr. Barney has served as a director of Quantum Restaurant Group, Inc., owner of four restaurant chain concepts including Mortons Steak House. Mr. Barney has been a Director of the Company since July 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth certain information concerning the annual and long-term compensation for services as officers to the Company for the fiscal years ended December 31, 1995, 1994 and 1993, of those persons who were, at December 31, 1995 (i) the chief executive officer, and (ii) the other two most highly compensated executive officers of the Company (the \"Named Officers\"). See \"Compensation of Directors\" under Item 11.\nBONUS PLANS\nIn April of each year, the Company issues restricted Common Stock to its employees as an incentive for their continued employment. The Company's management determines those employees who are entitled to receive such Common Stock bonus. During 1995, the Company issued 6,775 shares of Common Stock, none of which were issued to the Named Officers reflected above.\nOPTIONS\nThe options described in the following tables have been granted other than pursuant to the Incentive Stock Plan or Non-Qualified Plan. There were no options exercised by the Named Officers in 1995.\nOPTION GRANTS IN LAST FISCAL YEAR\nOPTION EXERCISES AND YEAR-END VALUE TABLE\nCOMPENSATION OF DIRECTORS\nEach Director of the Company receives an annual retainer fee of $9,000 ($750 per month). Each Director of the Company also receives $250 for each Board of Directors meeting attended in person, $150 for each Board of Directors meeting conducted by telephone and $150 for each committee meeting. In addition, each Director is reimbursed for all out-of-pocket expenses related to attendance at Board meetings.\nMr. Torchia, a Director of the Company, also receives indirect compensation through a consulting agreement between the Company and Urban which commenced in January 1991. Under the terms of the consulting agreement, Urban receives a monthly consulting fee of $20,000 for the provision of business development services to the Company. The Company also paid Urban $236,138 in additional fees in 1995, for transactions brought to the Company. In addition, Urban received $82,400 in transactional fees in 1995, directly from partnerships in which the Company is a general partner. See \"Certain Relationships and Related Transactions\" under Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of March 15, 1996, by (i) each person who is known by the Company to own beneficially more than 5% of the Company's Common Stock, (ii) each of the Company's Directors, (iii) each of the Named Officers and (iv) all Directors and executive officers as a group.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nUrban 2000 Corp. (\"Urban\") is a principal shareholder of the Company and is owned 51% by H. Andrew Torchia, the Chairman of the Board and a Director of the Company, and 49% by Richard D'Onofrio, the Executive Vice President and a Director of the Company. Urban, a licensed franchise broker, through December 1993, was working with HFS, Inc. under a franchise brokerage agreement, whereby Urban received commissions for the sale of franchises, including sales to the Company and its affiliates. Urban and Torchia were also entitled to referral fees for sales of HFS, Inc. system franchises to unaffiliated third parties under certain circumstances. The Company's affiliates previously have purchased HFS, Inc. system franchises through Urban; however, such purchases have never been a significant expense to the Company. The prices for such franchise license agreements were at least as favorable as the prices the Company would have paid to a comparable franchising company. The Company's relationship with Urban has provided the Company with access to leads for hotel development projects. Many of the Company's development projects, acquisitions, management contracts and relationships with investors, developers and third party owners have been established through Urban's contacts.\nUrban and Mr. Torchia provide business development and consulting service to the Company under a consulting agreement with Urban which commenced in January 1991. Under the terms of this agreement, Urban receives a monthly consulting fee of $20,000 plus the use of the Company's telephone system. No additional amounts are paid to Urban for reimbursement of expenses. As part of this arrangement, Mr. Torchia no longer receives compensation for the services he provides to the Company in his capacity as an Officer of the Company. Consistent with standard industry practices, the Company pays Urban additional fees for transactions brought to the Company. During 1995, Urban received $236,138 in additional fees from the Company and received $82,400 in other transactional fees directly from partnerships in which the Company is a general partner.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K.\nFinancial Statements: The following consolidated financial statements are filed as part of this Report on Form 10-K for the fiscal year ended December 31, 1995.\n(a)(1) Financial Statements:\nReport of Independent Certified Public 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 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(a)(3) Exhibits:\nThe following exhibits were included in the Registrant's Report on Form 10-K filed on March 26, 1993, and are incorporated by reference herein:\nExhibit No. Description\n3.1 Amended and Restated Certificate of Incorporation of Amerihost Properties, Inc. 3.2 By-laws of Amerihost Properties, Inc. 4.2 Specimen Common Stock Purchase Warrant for Employees 4.3 Specimen 7% Subordinated Note 4.4 Specimen Common Stock Purchase Warrant for 7% Subordinated Noteholders 4.5 Form of Registration Rights Agreement for 7% Subordinated Noteholders 10.1 Non-Qualified Stock Option Plan 10.2 Incentive Stock Option Plan\nThe following exhibits were included in the Registrant's Report on Form 10-K filed on March 25, 1994, and are incorporated by reference herein:\nExhibit No. Description\n10.4 Urban 2000 Corp. Consulting Agreement\nThe following exhibits are included in this Report on Form 10-K dated March 19, 1996:\nExhibit No. Description\n21.1 Subsidiaries of the Registrant 23.1 Consent of BDO Seidman, LLP 27.0 Financial Statement Schedule Reports on Form 8-K:\nThere were no reports on Form 8-K 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.\nAMERIHOST PROPERTIES, INC.\nBy: \/s\/ Michael P. Holtz\nMichael P. Holtz Chief Executive Officer\nBy: \/s\/ Russell J. Cerqua\nRussell J. Cerqua Chief Financial Officer\nBy: \/s\/ James B. Dale\nJames B. Dale Corporate Controller March 19, 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. Andrew Torchia \/s\/ Michael P. Holtz H. Andrew Torchia, Director Michael P. Holtz, Director March 19, 1996 March 19, 1996\n\/s\/ Russell J. Cerqua \/s\/ Richard A. D'Onofrio\nRussell J. Cerqua, Director Richard A. D'Onofrio,Director March 19, 1996 March 19, 1996\n\/s\/ Reno J. Bernardo \/s\/ Robert L. Barney Reno J. Bernardo, Director Robert L. Barney, Director March 19, 1996 March 19, 1996\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo The Board of Directors of Amerihost Properties, Inc.\nWe have audited the accompanying consolidated balance sheets of Amerihost Properties, 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Amerihost Properties, 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.\nBDO Seidman, LLP\nChicago, Illinois February 29, 1996\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31,\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,\nAMERIHOST PROPERTIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nOrganization:\nChicagoland Concessions, Inc. (the \"Company\") was incorporated under the laws of Delaware on September 19, 1984, to operate concession stands in the Chicago metropolitan area. On September 19, 1985, the Company changed its name to America Pop, Inc.\nIn December, 1986, the Company ceased its operations of all concession stand facilities and during 1987, repositioned itself into hotel\/motel development, construction and ownership\/operation. In order to more appropriately reflect the nature of the Company's business, on August 21, 1987, the Company changed its name to Amerihost Properties, Inc. (\"API\").\nPrinciples of consolidation:\nThe consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and partnerships in which the Company has a controlling ownership interest. Significant intercompany accounts and transactions have been eliminated.\nConstruction accounting:\nDevelopment fee revenue from construction\/renovation projects is recognized using the percentage-of-completion method over the period beginning with the execution of contracts and ending with the commencement of construction\/renovation.\nConstruction fee revenue from construction\/renovation projects is recognized on the percentage-of-completion method, generally based on the ratio of costs incurred to estimated total contract costs. Revenue from contract change orders is recognized to the extent costs incurred are recoverable. Profit recognition begins when construction reaches a progress level sufficient to estimate the probable outcome. Provision is made for anticipated future losses in full at the time they are identified.\nConstruction period interest in the amount of $119,749 and $37,222 was capitalized in 1995 and 1994, respectively, and included in property and equipment.\nCash equivalents:\nThe Company considers all investments with a maturity of three months or less to be cash equivalents.\nConcentration of credit risk:\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments, accounts receivable and notes receivable. The Company invests temporary cash balances in financial instruments of highly rated financial institutions generally with maturities of less than three months. A substantial portion of accounts receivable are from hotels located in the midwestern United States, where collateral is generally not required, and from hotel operators for the development and construction of hotels pursuant to written contracts. Notes receivable are primarily from hotel operating entities generally located in the midwestern and southern United States, and two of the Company's officers.\nFair value of financial instruments:\nThe carrying values reflected in the consolidated balance sheet at December 31, 1995 reasonably approximate the fair values for cash and cash equivalents, accounts and contracts receivable and payable, and variable rate long-term debt. The majority of the notes receivable are collateralized by shares of the Company's common stock, investments in hotels, a second mortgage on a hotel property, and personal guarantees. Construction\/renovation and working capital notes are repaid to the Company within a relatively short period after their origination. The notes receivable bear interest at rates approximating the current market rates and the carrying value approximates their fair value. The Company estimates that the fair value of its fixed rate long-term debt at December 31, 1995 approximates the carrying value considering the property specific nature of the notes and in certain cases, the subordinated nature of the debt. In making such assessments, the Company considered the current rate at which the Company could borrow funds with similar remaining maturities and discounted cash flow analysis as appropriate.\nInvestments:\nInvestments are accounted for using the equity method, under which method the original investment is increased (decreased) by the Company's share of earnings (losses), and is reduced by dividends or distributions when received. Other investments are recorded at cost.\nProperty and equipment:\nProperty and equipment are stated at cost. Depreciation is being provided for assets placed in service by use of the straight-line and accelerated methods over their estimated useful lives. Leasehold improvements are being amortized by use of the straight-line method over the term of the lease.\nFor each classification of property and equipment, depreciable periods are as follows:\nBuilding 31.5-39 years Furniture, fixtures and equipment 5-7 years Leasehold improvements 3-10 years\nCosts of management contracts acquired:\nThe costs of management contracts acquired includes amounts paid to acquire management contracts and pre-opening costs incurred in connection with new management contracts. These amounts are being amortized by use of the straight-line method over periods ranging from two to five years.\nOther assets:\nCost in excess of net assets of subsidiaries:\nCost in excess of net assets of subsidiaries are amortized on a straight-line basis over a period of 31.5 years.\nOrganization costs:\nOrganization costs are being amortized by use of the straight-line method over a period of five years.\nInvestment in leases:\nInvestment in leases represents the amounts paid for the acquisition of leasehold interests for certain hotels. These costs are being amortized by use of the straight-line method over the terms of the leases.\nDeferred subordinated note costs:\nDeferred subordinated note costs represent the costs incurred in issuing the 7% subordinated notes. These costs are being amortized by use of the straight-line method over the life of the debt.\nFranchise fees:\nFranchise fees represent the initial franchise fees paid to franchisors for certain hotels and are being amortized by use of the straight-line method over the term of the franchise licenses, ranging from 10 to 20 years.\nDeferred income:\nDeferred income represents that portion of fees earned from entities in which the Company holds an ownership interest, which is equal to the Company's proportional ownership interest in the entity. The balance of the fees are recorded in income as earned. The deferred income is being amortized over the life of the operating assets owned by the affiliated entity.\nAlso included in deferred income is the unamortized portion of loan points collected from a loan made to an unaffiliated party in connection with the acquisition of management contracts. These are being amortized into interest income over the life of the loan. (Note 2)\nIncome taxes:\nDeferred income taxes are provided on the differences in the bases of the Company's assets and liabilities determined for tax and financial reporting purposes.\nEarnings (loss) per share:\nComputations of earnings per share of common stock are computed by dividing net income by the weighted average number of shares of common stock and dilutive common stock equivalents. Net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock. Common stock equivalents include stock options and warrants. The weighted average number of shares used in the computations were equal to 6,124,750, 5,624,478 and 5,037,918 for the years ended December 31, 1995, 1994 and 1993, respectively.\nAdvertising:\nThe costs of advertising, promotion and marketing programs are charged to operations in the year incurred. These costs were approximately $462,000, $218,000, and $167,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nEstimates:\nThe accompanying consolidated financial statements include estimated amounts and disclosures based on management's assumptions about future events. Actual results may differ from those estimates.\nReclassifications:\nCertain reclassifications have been made to the 1993 and 1994 financial statements in order to conform to the 1995 presentation.\n2. MANAGEMENT CONTRACTS:\nDiversified\nOn November 9, 1991, the Company entered into agreements with Diversified Innkeepers, Inc., its shareholders and various affiliates (\"Diversified\") to acquire management contracts for eleven properties in the Southeastern United States for cash and stock in the total amount of $548,772, which is being amortized over the term of the management contracts which have been renewed through September 30, 2000. In addition, the Company issued warrants to acquire 125,000 shares of the Company's Common Stock, and agreed to loan Diversified a total of $1,500,000 (Note 3).\nGrand\nOn May 21, 1992, the Company entered into agreements with Grand American Hotel Management, Inc. (\"Grand\"), its shareholders and certain other entities owned by the shareholders of Grand to acquire seven management contracts for cash and stock in the amount of $401,676. In addition, the Company issued warrants to acquire 210,050 shares of the Company's Common Stock, which were subsequently exercised, and agreed to loan the shareholders of Grand a total of $800,000 (the \"Original Note\") with interest at the rate of 10% per annum. The note was collateralized by 165,784 shares of the Company's Common Stock.\nDuring 1993, the Company and Grand agreed to terminate the Company's management of the seven properties. In connection with the termination agreement, the terms of the Original Note were revised as of June 1, 1993 providing for an additional $190,000 note (the \"Termination Note\") due to the Company for a management contract termination fee, a reduced interest rate on the Original Note, and monthly principal payments on both notes through April 1995 with a final payment of $736,000 on May 31, 1995. The Company did not receive any payments for principal or interest in 1994. The Termination Note was written off in 1994.\nIn November 1994, the Company notified Grand of its intention to take the 165,784 shares of common stock in lieu of the $800,000 note and $156,292 in related receivables. Prior to taking possession of the stock, in December 1994, two of the Company's officers executed notes in the amount of $956,292 to the Company for the purchase of the Original Note and related receivables, and the 165,784 shares of the Company's stock held as collateral on the Original Note. The officer notes provide for annual payments of interest only at 8% per annum, with the principal balance due December 31, 1997 and are collateralized by a total of 273,369 shares of the Company's Common Stock. The officers have the option to pay interest and principal with shares of the Company's Common Stock, whereby the number of shares offered must have a fair market value at time of payment equal to the amount then due. These notes receivable have been classified as a reduction of shareholders' equity on the accompanying balance sheets.\n3. NOTES RECEIVABLE:\nRelated parties:\nOn June 20, 1990, the Company loaned $150,000 to the Hammond, Indiana 490 Partnership, which leases and operates the Ramada Inn Hammond. The note is due on demand and provides for interest at the rate of 10% per annum. The balance of this note was $122,493 at December 31, 1995 and 1994. During 1995, the Hammond, Indiana 490 Partnership contributed its leasehold interests and other assets to a newly formed LLC in exchange for a 35.0% interest. The LLC has since closed the Ramada Inn, razed a portion of the building and begun renovation of the 86 remaining rooms. This new hotel is scheduled to open in March 1996 as an AmeriHost Inn. In March 1996, the Company exchanged the note receivable for an additional 49% ownership interest in the Hammond, Indiana 490 Partnership.\nDuring 1993 the Company loaned $723,843, with interest at the rate of 10% per annum, to Euless, TX 1192 General Partnership to be used for the acquisition, renovation and operation of the Ramada Inn Euless, Texas. The loan and interest are to be paid from priority distributions from the partnership. Additional amounts of $120,348 and $318,769 were loaned during 1995 and 1994, respectively.\nDuring 1994 the Company loaned $525,000, with interest at a rate of 10%, to Macomb, IL 994 Limited Partnership to be used for the development and construction of the Amerihost Inn Macomb, Illinois. The entire loan and accrued interest were repaid during 1995 using the proceeds from the syndication of the limited partnership interests.\nThe Company has advanced a total of $1,832,788 and $1,220,184 at December 31, 1995 and 1994, respectively, to other partnerships in which the Company has a minority ownership interest for working capital and construction purposes. The advances bear interest rates ranging from 10% to prime plus 3% and are due on demand. The Company expects the partnerships to repay these advances through cash flow generated from hotel operations and mortgage financings.\nOther:\nAs part of the purchase of management contracts from Diversified Innkeepers, Inc. in November, 1991, the Company entered into a financing agreement whereby the Company provided financing to the shareholders of Diversified in the total amount of $1,500,000, collateralized by 125,000 shares of the Company's common stock, a limited partnership interest in a hotel, a second mortgage on another hotel property, and a personal guarantee by the shareholders. The loan provided for interest only payments to be made at the rate of 12% per annum for a period of two years ending January 1995. Beginning February 6, 1995, the note provided for monthly payments of principal and interest in accordance with a fifteen-year amortization schedule, with all remaining principal and accrued interest due on December 31, 1999. In October, 1995, the note was modified to reduce the interest rate to 10% per annum and extend the term to the earlier of the termination of the related management contracts or September 30, 2000. The monthly payments of principal and interest were also modified to $16,250 per month. The balance of the note at December 31, 1995 was $1,467,886. The Company received a $60,000 financing fee which is being amortized into interest income over the life of the loan.\nIn connection with the Diversified transaction, the Company also issued 125,000 stock options which were exercised in January 1993, in consideration for a secured promissory note in the amount of $436,875 with interest at 6.5% per annum. The total principal balance is due April 30, 1997, unless the stock is sold, and is collateralized by limited partnership interests. This note receivable has been classified as a reduction of shareholders' equity on the accompanying balance sheets.\nDuring 1993 and 1994 the Company loaned $100,000 and $13,000 to a co- partner in ten partnerships. The loans provide for interest rates ranging from prime to prime plus 2% per annum and are due on demand. The $100,000 loan is secured by the co-partner's shares of partnership interests in two hotels.\n4. COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS:\nInformation regarding contracts-in-progress is as follows at December 31, 1995 and 1994:\n5. INVESTMENTS:\nInvestments at December 31, 1995 and 1994, are comprised of the following, including the name of the investee, the nature of the investment and the property owned by the investee:\nDuring 1995, The Company acquired additional partnership interests in five hotels for a total of 278,081 shares of the Company's common stock. In conjunction with the acquisitions, liabilities were assumed as follows:\nFair value of assets acquired $6,952,183 Issuance of common stock (932,306) Liabilities assumed 6,019,877\nThe following represents tax basis unaudited condensed financial information for all of the Company's investments in affiliated companies accounted for under the equity method at December 31, 1995, 1994 and 1993.\n6. OTHER ASSETS:\nOther assets, net of accumulated amortization, at December 31, 1995 and 1994 are comprised of the following:\n7. NOTES PAYABLE:\nThe Company has a $3,500,000 bank operating line-of-credit that expires May 1, 1996. Interest is payable at the bank's base lending rate (8.5% at December 31, 1995) plus three-quarters of one percent with a floor of 7.5%. This line is collateralized by a security interest in the Company's assets, including its interests in various partnerships. In December 1995, the bank providing the operating line-of-credit approved a $7.5 million line-of-credit to be used for construction financing on projects which have firm commitments for permanent mortgage financing when the construction is completed. Interest is payable at the bank's base lending rate plus one percent. There was no outstanding balance on the construction line-of-credit as of December 31, 1995. An additional $1,500,000 bank line-of-credit was obtained on February 1, 1996 under the same terms and conditions as the operating line-of-credit with the exception of the interest rate which is 1% over the bank's base lending rate.\n8. LONG-TERM DEBT:\nThe aggregate maturities of long-term debt, excluding construction loans payable in the amount of $2,330,545 at December 31, 1995, are approximately as follows:\n9. SHAREHOLDERS' EQUITY:\nReverse stock split:\nDuring 1989, the Company effected a 1-for-50 reverse stock split. Each holder of the Company's Common Stock was entitled to receive one new share for every 50 shares held as of the close of business on August 22, 1989. Any fractional shares resulting from the reverse split were acquired by the Company and retired.\nAuthorized shares:\nThe Company's corporate charter authorizes 15,000,000 shares of Common Stock and 100,000 shares of Preferred Stock without par value. The Preferred Stock may be issued in series and the Board of Directors shall determine the voting powers, designations, preferences and relative participating optional or other special rights and the qualifications, limitations or restrictions thereof.\nDividend restrictions:\nPursuant to the terms of the Company's subordinated notes (Note 10), no dividends may be paid on any capital stock of the Company until such notes have been paid in full.\nLimited partnership conversion:\nThe Company is a general partner in three partnerships where the limited partners have the right at certain times and under certain conditions to convert their limited partnership interests into 243,750 shares of the Company's common stock.\nPublic offering:\nIn May 1993 the company completed a public offering of 1,550,000 shares of the Company's Common Stock at an offering price of $7.125 per share led by the underwriting of Rodman & Renshaw, Inc. The proceeds less underwriting discounts and all other costs amounted to $9,572,544. A portion of the proceeds were used to pay the required prepayment of the 7% subordinated notes (Note 10) and repay the outstanding balance of the Company's line of credit.\nWarrant net exercise:\nIn 1993, the Company offered to all of its holders of warrants to purchase its shares of Common Stock, a right to exercise their warrants on a cash-free basis (the \"Cashless Exercise\"). Under the terms of the Cashless Exercise, the holder of the warrant would receive shares of the Company's Common Stock in an amount equal to a percentage of the number of warrants they held without payment of any cash to the Company. The percentage was computed by dividing the spread (defined as the difference between the \"ask\" price for the Company's Common Stock on January 14, 1993 (the \"market price\") and the exercise price of the warrant held by the investor) by the market price. The number of shares subject to the warrant was multiplied by this percentage. The result was the number of shares to be issued to each warrantholder. The holders of warrants to purchase 1,973,800 shares of the Company's Common Stock exercised this right and the Company issued 1,315,790 shares of its Common Stock in exchange for the warrants. (See Note 14 for further discussion of Stock Options and Warrants).\n10. SUBORDINATED DEBENTURES:\nIn 1992, the Company issued $4,500,000 of unsecured 7% subordinated notes due October 9, 1999, with interest payable quarterly. In connection with a public offering of the Company's common stock completed in 1993, the Company was required to make prepayments of 50% of the outstanding principal balance plus accrued interest thereon. As a result, the Company incurred a debt acceleration charge of $485,411 in 1993, representing a pro-rata portion of the unamortized note discount and other deferred note issuance costs.\nFor each $1,000 principal amount loaned to the Company, the noteholder also received 375 common stock purchase warrants, representing the right to purchase 375 shares of the Company's Common Stock at an exercise price of $4.00 per share for a period of five years from the date of issuance of the warrants. Warrants to purchase a total of 1,687,500 shares were issued, of which 46,875 are outstanding at December 31, 1995.\n11. TAXES ON INCOME:\nThe provision for (benefit from) income taxes in the consolidated statements of operations is as follows:\nTemporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to a net deferred tax asset relate to the following:\nDeferred income tax assets of $511,000 and $731,000, less a valuation allowance of $128,000 and $244,000, are included in other assets in the accompanying consolidated balance sheets at December 31, 1995 and 1994, respectively.\nThe following reconciles income tax expense (benefit) at the federal statutory tax rate with the effective rate:\n12. RELATED PARTY TRANSACTIONS:\nThe following table summarizes related party revenue from various unconsolidated partnerships in which the company has an ownership interest:\nIn January 1991, the Company entered into an agreement with Urban 2000 Corp. (\"Urban\"), a company owned by the Chairman and another Officer\/Director of the Company. This agreement provides for the payment to Urban of $20,000 per month for business development consulting services. No additional amounts are paid to Urban for reimbursement of expenses. Consistent with its standard industry practice, the Company will pay additional fees for transactions brought to the Company by Urban.\nUrban received $236,138, $289,915, and $352,082 from the Company in 1995, 1994 and 1993, respectively, and also received $82,400 and $28,200 in 1995 and 1994, respectively in other transactional fees directly from partnerships in which the Company is a general partner. The Chairman is not compensated by the Company in his capacity as an officer.\n13. BUSINESS SEGMENTS:\nThe Company's business is primarily involved in four segments: (1) hotel operations, consisting of the operations of all hotels in which the Company has a controlling ownership or leasehold interest, (2) hotel development, consisting of development, construction and renovation activities, (3) hotel management, consisting of hotel management activities and (4) employee leasing, consisting of the leasing of employees to various hotels.\nResults of operations of the Company's business segments are reported in the consolidated statements of operations. The following represents revenues, operating costs and expenses, operating income, identifiable assets, capital expenditures and depreciation and amortization for each business segment:\n14. STOCK OPTIONS AND WARRANTS:\nOn January 2, 1992, the Board of Directors authorized the issuance 200,000 stock options to certain employees of the Company. These options are exercisable by the employees at any time during the five years ending January 2, 1997, at an option price of $3.00 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nOn June 1, 1992, the Board of Directors authorized the issuance of 103,125 stock options to Urban and a former director in connection with loans made to the Company. These options are exercisable at any time prior to October 9, 1999 at an option price of $4.375 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nOn February 12, 1992, in connection with a financial advisory agreement executed in 1992 with a former director, the Board of Directors authorized the issuance of 75,000 stock options at an option price of $3.521 per share exercisable at any time prior to February 12, 1997. The option holder has the right to require the Company to file a registration statement with the Securities and Exchange Commission to register the underlying shares, up to a maximum of four times during the seven year period commencing August 15, 1992. Any such registration must be for a minimum of 10,000 shares.\nOn December 16, 1992, the Board of Directors authorized the issuance of 268,750 stock options to certain employees of the Company. The options are exercisable at any time through September 16, 1997. These options vest and are exercisable by the employees in accordance with the following schedule:\nOn March 22, 1993, the Board of Directors authorized the issuance of 40,419 stock options to certain shareholders who executed agreements not to sell their shares of common stock in connection with the public offering completed by the Company in May 1993 (Note 9). These options are exercisable by the holder at any time during the five years ending March 22, 1998, at an exercise price of $6.875.\nOn October 5, 1994, the Board of Directors authorized the issuance of 150,000 stock options to certain employees of the Company. These options are exercisable by the employees at any time during the ten years ending October 5, 2004, at an option price of $4.125 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nOn October 5, 1994, the Board of Directors authorized the issuance of 33,500 stock options to certain employees of the Company. These options are exercisable by the employees at any time during the five years ending October 5, 1999, at an option price of $4.75 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock. On January 1, 1995, the Board of Directors authorized the issuance of 620,000 stock options to officers of the Company. The options are exercisable at any time over a ten year period beginning on the vesting date, expiring January 1, 2005 through January 1, 2007. The shares issued upon exercise of the options are Rule 144 restricted common stock. These options vest and are exercisable by the employees in accordance with the following schedule:\nOn January 1, 1995, the Board of Directors authorized the issuance of 20,000 stock options to a co-partner in seven of the Company's hotel investments. These options are exercisable by the holder at any time during the three years ended January 1, 1998, at an option price of $7.125 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nOn January 6, 1995, the Board of Directors authorized the issuance of 10,000 stock options to a co-partner in four of the Company's hotel investments. These options are exercisable by the holder at any time during the four years ended January 6, 2000, at an option price of $3.56 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nOn September 27, 1995, the Board of Directors authorized the issuance of 145,500 stock options to certain employees of the Company. The options are exercisable at any time through September 27, 2005. The shares issued upon exercise of the options are Rule 144 restricted common stock. These options vest and are exercisable by the employee in accordance with the following schedule:\nOn December 1, 1995, the Board of Directors authorized the issuance of 133,333 stock options to certain employees of the Company. These options are exercisable by the holder at any time during the ten years ended December 31, 2005, at an option price of $6.50 per share. The shares issued upon exercise of the options are Rule 144 restricted common stock.\nThe following table summarizes the shares granted, exercised and options outstanding:\nIn July 1990, the Company adopted an Incentive Option Plan and a Non- Qualified Stock Option Plan. A total of 125,000 shares of Common Stock have been reserved for issuance under each of the plans. No options have been granted under either plan as of December 31, 1995.\n15. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS:\nKey-person life insurance:\nThe Company maintains term life insurance on three key officers of the Company. Each policy provides for a death benefit of $1,000,000 for which the Company is the beneficiary. The Company paid annual premiums of $14,314 for the policy periods ending April 24, 1994, 1995 and 1996.\nOffice lease:\nThe Company entered into an operating lease for its existing office facilities which commenced in October 1994 and expires December 2000. The Company may cancel the lease effective December 1, 1998 with a 180- day notice and payment of a $67,230 cancellation penalty. Rent expense, including real estate taxes, insurance and repair costs associated with the operating lease was approximately $180,700, $145,000 and $111,800 in 1995, 1994 and 1993, respectively. Total future minimum rent due under the operating lease is approximately as follows:\nYear ending December 31, Amount\n1996 182,000 1997 188,000 1998 190,000 $ 560,000\nHotel leases:\nOn December 1, 1992, the Company renewed agreements to lease or sub-lease five hotels which it had been managing in Schiller Park, Shorewood, Niles and Richmond, Illinois and Portage, Indiana. The Company leases or sub-leases the hotels from five partnerships which currently own the hotels or lease the hotels from unrelated third parties. The Company owns an equity interest in these partnerships, ranging from 5% to 16.33%. The leases and sub-leases are triple net leases which were scheduled to expire December 31, 1996. During 1994, the leases were amended providing for reduced rent payments and extending the terms through December 31, 1999. In July 1992, the Company entered into a lease agreement for a Holiday Inn in Menomonee Falls, Wisconsin. The lease is a triple net lease expiring September 30, 1997. The rent payments are based upon percentages of gross room revenues ranging from 15% to 20%, with a monthly minimum of $14,583.\nThe Company entered into an agreement to lease a hotel in Lafayette, Indiana, effective February 1, 1994. The lease expires on December 31, 1998. Monthly lease payments are 15% of gross guest room revenues, with a monthly minimum of $10,000 beginning January 1, 1995.\nIn connection with the purchase of limited partnership interests in certain hotels during 1995, the Company obtained a majority ownership position in three hotels which held leasehold interests as follows:\nThe Days Inn Findlay operates under a triple net lease calling for payments of $7,500 per month expiring March 31, 1996. The Company exercised its five year renewal option, extending the termination date to March 31, 2001. The lease provides for monthly payments of $8,500 for the first three years of the renewal term, increasing to $10,000 for the final two years, plus additional rent payments of 5% of annual guest room revenues in excess of $750,000.\nOn January 1, 1995, the Days Inn Dayton amended its triple net lease providing for an additional term of ten years expiring December 31, 2004. The lease provides for monthly payments ranging from $17,000 to $23,000 through December 31, 1998. Beginning in 1999, monthly payments are the greater of $23,000 or 15% of room revenue. The Company has agreed to guarantee the hotel's performance under the lease up to $50,000.\nThe Days Inn New Philadelphia operates under a triple net lease expiring June 3, 1997 which provides for minimum monthly payments of $6,000, plus additional rent of 12.5% of annual gross room revenue in excess of $550,000.\nMinimum rent payments under hotel leases are as follows:\nYear ending December 31, Amount\n1996 $ 1,786,000 1997 1,739,000 1998 1,596,000 1999 1,490,000 2000 396,000 $ 7,007,000\nGuarantees:\nThe Company has provided approximately $9.9 million in guarantees on mortgage loan obligations and operating leases for nineteen of its affiliated partnerships. Other partners have also guaranteed portions of the same obligations. The partners of two of the partnerships have entered into cross indemnity agreements whereby each partner has agreed to indemnify the others for any payments made by any partner in relation to these guarantees in excess of their ownership interest.\nOn February 4, 1993, the Company began management of a 383 room hotel in Daytona Beach, Florida. As part of the management contract, the Company was to receive 10% of all cash distributions from the hotel and the Company guaranteed a $500,000 note payable to Hospitality Franchise Systems, Inc. In July 1993, the Company ceased managing this property and, in 1995 the Company received a final termination settlement of $27,000. The balance of the note which continues to be guaranteed by the Company is approximately $154,000.\nThe Company is secondarily liable for the obligations and liabilities of the limited partnerships in which it holds general partnership interests as described in Note 5.\nConstruction in progress:\nAt December 31, 1995, the Company had approximately $13.1 million remaining to pay contractors for the completion of fourteen hotels, a portion of which is included in accounts payable. These commitments will be funded through construction and long-term mortgage financing currently in place.\nEmployment agreements:\nThe Company entered into three year employment agreements with the executive officers effective January 1, 1995, one of which includes an automatic three year renewal option. The agreements provide for base salaries totaling $679,000 in 1996 and $751,700 in 1997, plus shares of the Company's common stock based on the attainment of certain financial performance criteria totaling 40,000 shares in 1996 and 52,500 shares in 1997, if all the objectives are met. The employment agreements provide for severance pay should the officer be terminated without cause.\nLegal matters:\nThe Company and certain of its subsidiaries are defendants in various litigation matters arising in the ordinary course of business. In the opinion of management, the ultimate resolution of all such litigation matters is not likely to have a material effect on the Company's financial condition, results of operation or liquidity.\n16. SUPPLEMENTAL CASH FLOW DATA:\nThe following represents the supplemental schedule of noncash investing and financing activities for the years ended December 31, 1995, 1994 and 1993:\n17. SELECTED FOURTH QUARTER FINANCIAL DATA (UNAUDITED):\nA summary of selected fourth quarter information for 1995 and 1994 is as follows:","section_15":""}
{"filename":"276331_1995.txt","cik":"276331","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company is engaged in manufacturing a wide variety of specialty metal products using sophisticated metallurgical technology and metalworking processes. The Company operates in three industry segments: (1) uranium services and recycling of low-level contaminated steel; (2) fabrication of a large assortment of specialty metal products using foundry, extrusion, and machining capabilities; including the manufacture of high-purity, spherically shaped metal powders; and (3) manufacture of depleted uranium penetrators.\nThe Company participates in the uranium services and recycling industry segment through its wholly-owned subsidiary, Carolina Metals, Inc. (CMI) located in Barnwell, South Carolina. The uranium services and recycling segment of the Company's market segments include: (1) the manufacture of uranium tetrafluoride (UF(4)) and depleted uranium metal through chemical conversion processes; and (2) the recycling of various metals from decommissioned nuclear sites. (SEE INDUSTRY SEGMENT INFORMATION).\nIn 1995, the Company redefined its business to combine the former Metal Powders and Fabricated Specialty Metal Products into Specialty Products. In 1995 the Company also added the new and growing business segment Uranium Services and Recycling. The manufacture of depleted uranium products (non-penetrator) and the recycle of low-level radioactive metal, which were previously included in other business segments, have been classified as part of this segment. Uranium Services and Recycle also includes additional new business described further in the segment descriptions.\nAs of September 30, 1995 the Company had 200 employees.\nINDUSTRY SEGMENT FINANCIAL INFORMATION\nThe following table sets forth certain information regarding the revenue, operating profit and identifiable assets attributable to the three industry segments in which the Company operates. The change in industry segments from prior years have been restated.\nYEAR ENDED ------------------------------------ RECLASSIFIED ------------------- SEPT. 30, SEPT. 30, SEPT. 30, 1995 1994 1993 ------- ------- ------- (IN THOUSANDS)\nNet Sales and Contract Revenues: Uranium Services & Recycle $ 4,969 $ 4,752 $ -- Specialty Products 12,102 7,284 10,258 Depleted Uranium Penetrators 1,713 6,968 6,761\nOperating Profit(Loss): Uranium Services & Recycle $ (996) $(5,409) $ -- Specialty Products (341) (162) (2,816) Depleted Uranium Penetrators (237) (5,033) (7,330)\nIdentifiable Assets: Uranium Services & Recycle $16,609 $16,772 $18,090 Specialty Products 5,140 5,646 7,297 Depleted Uranium Penetrators 12,158 9,862 11,697\nSee Note 14 of Notes to Consolidated Financial Statements.\n- ------------------------------------------------\nThe Company does not have any foreign operations. The Company does have export sales to EECU which accounted for 33% of net sales for the fiscal year ended September 30, 1995. In the prior two fiscal years, 1994 and 1993, the export sales to Common Market countries were 37% and less than 10%, respectively.\nThe following is a general description of the Company's three business segments. The business segments have been restated to properly reflect the Company's changing product mix. For additional information concerning developments in these business segments during fiscal 1995, reference is made to pages 4 through 11 of the Company's\n1995 Annual Report, which is incorporated herein by reference and is included as Exhibit 13.\nURANIUM SERVICES & RECYCLE\nThe Company's Uranium Services and Recycle segment includes the manufacture of depleted uranium and of uranium tetrafluoride, the recycle of various low-level radioactive metals, and the supply of depleted uranium alloy material for use in United States Enrichment Company's (USEC) Atomic Vapor Laser Isotope Separation (AVLIS) program.\nThe Company currently is manufacturing depleted uranium from Uranium Tetraflouride (UF(4)). A large-scale production contract from a foreign customer for depleted uranium metal, produced at the CMI facility, will be completed in 1996.\nThe Company has successfully completed a program with Westinghouse Savannah River Company to demonstrate the beneficial reuse of contaminated stainless steel from the Department of Energy (DOE). The program demonstrated the technical feasibility and economic soundness of recycling radioactively contaminated steel into storage drums and boxes for containment of various radioactive wastes at DOE sites. This pilot program is significant due to the large number of facilities within the DOE that were engaged in production of nuclear materials for our national defense that have substantial quantities of contaminated stainless steel that would benefit from the beneficial reuse program.\nThese DOE facilities contain millions of tons of carbon steel and stainless steel in the form of structural components and various types of processing equipment. During production of nuclear materials, the carbon and stainless steels became radioactively contaminated. In order to manage decommissioning activities in a cost-effective and environmentally sound manner, the DOE's Savannah River Site has initiated a program to demonstrate the recycling of low-level radioactively contaminated stainless steel scrap. Through beneficial reuse of contaminated steel scrap, the DOE will be able to reduce the volume of low-level radioactive waste in a cost effective manner. In addition to the DOE facilities, it is estimated that an additional several million tons of low-level contaminated steel will be generated as a result of decommissioning the more than 100 currently operating commercial nuclear power plants over the next 30 years. Services currently are being offered to remelt slightly contaminated steel at the Company's CMI location.\nThe Company supplies Depleted Uranium (DU) alloy material to the USEC for use as AVLIS feed material. AVLIS is expected to replace the current Gaseous Diffusion process for separating the fissionable isotope, U(235), from natural uranium within the next ten years. The Company also supplies conversion services to the USEC for converting Depleted Uranium Hexaflouride (UF(6)) to Uranium Tetraflouride (UF(4)). This\nwork is performed at the Company's CMI facility. The Company believes that USEC has a need for conversion of approximately 15-20 million pounds annually.\nRadioactively contaminated steel remelt services are offered at only two other facilities in the United States. The Company continues to be the primary supplier of AVLIS feed material, however, other companies are attempting to compete for future business. The Company's South Carolina facility is the Country's only active facility for converting UF(6) to UF(4).\nSPECIALTY METAL PRODUCTS\nThe Company has several specialty metal products, including: beryllium products; specialty, medical, and aerospace powders; and a variety of advanced metal products and services for aerospace, energy, and commercial applications.\nThe Company has completed major development activities to fully utilize its patented Beralcast-Registered Trademark- investment cast beryllium aluminum alloy for production applications. Beralcast-Registered Trademark-, a registered trademark, is a new engineering material used in electronic and secondary structural applications for advanced missiles, helicopters, and a variety of other aerospace and avionics applications. Cost and weight pressures on today's design engineers demand a transition to lightweight, strong, and high stiffness materials such as NMI's patented Beralcast-Registered Trademark-. The alloy offers 3 1\/2 times the stiffness of aluminum with 22% less weight and is investment castable to net and near net shape. Lockheed Martin Corporation continues to view NMI's Beralcast-Registered Trademark- hardware for the Electro Optic Sensor System (EOSS) as the highest priority for provision of Comanche program funding.\nHigh performance applications for Beralcast-Registered Trademark- where cost premiums are permissible might include: Comanche (Advanced Attack Helicopter), (Advanced Tactical Fighter), PAC-3 (the updated Patriot missile), the French Rafael (Advanced Fighter Aircraft), and many others. Design engineers at these and other aerospace, computer, and electronic firms, are designing this new engineering material into their systems. Commercial uses for Beralcast -Registered Trademark- will be introduced as production costs, which include the current high cost of beryllium input metal, are reduced. The Company also continues to produce seamless beryllium tubes for satellite applications. Introduction of extruded Beralcast-Registered Trademark- tubing for satellites is a unique opportunity to supplant expensive graphite composites. The Company's extrusion technology has been successfully demonstrated in the recent manufacture of tubing struts for the Comanche EOSS.\nHighly reliable Bi-metallic tubes, manufactured by a proprietary NMI process, are used by aerospace and nuclear companies to join dissimilar metals. Extruded tubes, bars, castings, and shapes of a variety of metals and alloys are used as finished products or for further processing in a variety of industrial applications.\nThe Company uses its large capacity for fabrication of depleted uranium components to produce shielding for cancer therapy units, Industrial Radiography, and Commercial\/Government Nuclear applications. The Company also recycles DU armor scrap for remelt into rolling slabs for the Amy's M1A2 Main Battle Tank Program.\nThe Company manufactures metal powders by proprietary processes called the Rotating Electrode Process-TM- (REP) and the Plasma Rotating Electrode Process-TM- (PREP), which produce spherical metal particles within a relatively controllable size range.\nManagement believes that the spherical metal particles produced by this manufacturing process offer significant advantages for certain product applications compared with metal powders produced by other processes. In particular, the process produces inherently \"cleaner\" powders, more uniformly spherical particles and a higher percentage of particles within the desired size range from a given amount of raw material.\nThe Company holds three U.S. patents relating to developments in REP production equipment, which provide patent rights through the year 2001. These patents also are filed and effective in the principal industrialized European countries, Canada, Israel and Japan. Management believes that, although the original patent on the REP machine expired in July 1980, the development patents continue to benefit the Company's competitive position in the Metal Powders market. It is also the opinion of management that the technical expertise which has evolved from the development and manufacture of metal powders is of equal importance in maintaining the Company's competitive position.\nThe metal powders produced by the Company include steel, titanium alloy and several nickel and cobalt-base alloys generally known in the industry as specialty powders.\nManagement believes that the markets for titanium alloy and specialty powders represent significant business opportunities for the Company's powder making capability, especially under the Government's Technology Reinvestment Program. This program is designed to assist defense contractors with transitioning their products for commercial use by funding fifty percent (50%) of the cost of transition.\nThe principal markets for the Company's metal powders are medical applications (titanium and cobalt-based alloy powders), which use the powder as a porous coating on medical prostheses, and original equipment manufacturers (steel, titanium alloy and specialty powders), which fabricate metal parts from the powder through various processes. In addition, the Company continues to produce steel powders for the photocopy industry, and as a carrier for toner in copy machines and high-performance laser printers.\nKey competitive factors in the metal powders market are price and the ability to meet exact dimensional, metallurgical and other specifications. The steel powder marketed by the Company for photocopy applications competes with powders produced by larger manufacturers. The Company believes that the quality of its\npowder in the photocopy processes in which it is used helps to offset any price advantage that may exist for powders from other producers.\nThe principal raw material for the Company's steel powder is cold-rolled steel bars, which are readily available. Other metal powders are manufactured to customer specifications, and the metals for these powders are generally available for purchase in job lots from specialty metal suppliers.\nDEPLETED URANIUM PENETRATORS\nThe Company believes it is a technological leader in the manufacture of depleted uranium (DU) penetrators. DU is a dense, heavy metal that is 68% heavier than lead for a given volume. Because of its density and workability DU is an effective low-cost material for anti-armor ammunition and is used in numerous United States Government and foreign government weapons systems. DU is a low-level radioactive material that is a by-product of the production of enriched uranium for nuclear fuel and weapons.\nThe Company is one of two domestic manufacturers. Competition to supply penetrators is price sensitive. The principal DU products manufactured by the Company, referred to as penetrators, have application in various military gun systems. The Company generally sells penetrators directly to prime ammunition contractors. The U.S. Government has funded and owns a portion of the manufacturing machinery and equipment used by the Company for producing penetrators.\nIn fiscal 1995, the Company was awarded an M829A2 penetrator production contract with options extending production to the year 1999. This contract is subject to appropriations by the Government. Management strongly believes the Government will exercise all options on the contract. The Company will continue to pursue both domestic and foreign military depleted uranium penetrator production requirements.\nThe Company believes that foreign military sales of the U.S. ABRAMS tank could result in additional foreign military requirements for DU penetrators in future fiscal years. Additionally, the Company expects continuing orders for DU products from a foreign customer to support its foreign based manufacture of tank ammunition containing DU penetrators.\nSIGNIFICANT CUSTOMERS\nCogema, of France, is a significant customer of the Company's Uranium Services & Recycle segment. In fiscal 1995, sales to Cogema accounted for 19% of net sales. The Company currently is under contract to provide Cogema with depleted uranium through December, 1996. The loss of Cogema as a customer would have a material adverse effect of the Company's Uranium Services & Recycle segment.\nLockheed Martin Corporation (LMC) is a significant customer of the Company's Specialty Products segment. In fiscal 1995, sales to LMC accounted for 18% of sales. The Company is currently under several contracts with LMC to provide Beralcast-Registered Trademark- hardware for the Comanche Helicopter Program. The loss of LMC as a customer would have a material adverse effect on the Company.\nOlin Corporation is a significant customer of the Company's Depleted Uranium Penetrator segment. In fiscal 1995, sales to Olin accounted for 8% of net sales. The Company currently is under contract to provide Olin with 120MM penetrators for the U.S. Army's ABRAMS Tank program with options extending another four years. If Olin were lost as a customer, this would have a material adverse effect on the Company.\nLockheed Idaho Technology Company (LITCO) is another significant customer of the Company's Specialty Metals Products segment. In fiscal 1995, sales to LITCO accounted for 9% of net sales (See Note 2 of Notes to Consolidated Financial Statements). The Company currently is under contract with Lockheed Idaho Technology Company to produce, from furnished DU recycle metal, DU castings for the U.S. Army's heavy armor tank program. This contract continues to have options for several additional years. The loss of LITCO as a customer would have a material adverse effect on the Company.\nMARKETING\nThe Company relies on a variety of marketing strategies including advertising and direct sales. Technical papers given at industry symposia are also used as a marketing vehicle for the Company's advanced metal products and services. Strategic Partnerships are being developed with several key customers to strengthen the Company's customer and product base into the future. These Partnerships provide sharing in research and development costs and marketing efforts.\nUnderstanding the importance of Design-To-Cost principles, especially those of LMC, is tantamount to Strategic Teaming with our Beralcast-Registered Trademark- customers. Concentrated efforts on cost reduction in the form of Concurrent Engineering, low cost Beryllium input metal production, and many others, add value for future sales volumes. NMI has introduced Nucast, our Beralcast-Registered Trademark- teammate, to these cost reduction ideas which will form the basis for improved costs competitiveness in the future. Direct marketing efforts are increasing.\nCommitments by the Company to expanding the product and customer base for our metal powders will pay both near and longer term dividends. Market demands for clean metal powders, for re-consolidation or incorporation into metal matrix composites, are on the rise and we are positioning ourselves to exploit these opportunities. Novel product requirements for our advanced metal products and\nservices will continue to receive the utmost attention for expansion of our product base. Efforts to enhance the Company's reputation as a supplier with high value products are being strengthened through improved service, added advertising and increased presence in the marketplace.\nBACKLOG\nThe following table sets forth certain information with respect to the backlog of the Company's business segments at September 30, 1995 and September 30, 1994 including the portions thereof represented by orders from the Company's principal customers, COGEMA, Lockheed Martin, Lockheed Idaho and Olin Corporation. The backlog for the Company is affected by the timing of orders from these customers. The Company believes all orders in backlog are firm. The Company expects to fill orders for approximately $19,193,000 in fiscal year 1996.\n1995 1994 ------- ------- (In Thousands)\nUranium Services & Recycle COGEMA $ 4,262 $ 7,097 Other 84 876 ------- ------- Total 4,346 7,973 ------- -------\nSpecialty Metal Product Lockheed Martin $ 5,951 $ 941 Lockheed Idaho 1,053 632 Other 5,052 2,696 ------- ------- Total 12,056 5,017 ------- -------\nDepleted Uranium Penetrators Olin Corp. 14,299 1,282 Other 8 240 ------- ------- Total 14,307 1,522 ------- -------\nCompany Total $30,709 $14,512 ------- ------- ------- -------\nA significant portion of the Company's business is dependent on the award of contracts or subcontracts for the supply of products and materials to governmental departments and agencies. Payments to the Company of all or a portion of the amounts called for under such contracts or subcontracts, is often subject to legislative funding appropriations, government agency purchasing requirements and other conditions and factors beyond the Company's control. Accordingly, the Company's performance under such contracts may be delayed or may not commence at all, in which case the payments thereunder may be recognized later than anticipated at the time of the contract award or not at all in cases in which the Company is not called upon to perform. As a result, the timing and amount of revenues under such government contracts is uncertain and subject to change, which may result in fluctuations in the Company's operating results and cash flows.\nRESEARCH AND DEVELOPMENT ACTIVITIES\nThe Company engages in research and development activities for departments and agencies of the U.S. Government and commercial customers. During the last two fiscal years, such work has been performed for the development and characterization of beryllium-aluminum alloys for investment casting and extrusion, investigation of methods for producing net shape titanium components from metal powder, improving techniques for making finer metal powders for use in metal matrix composites, recycling processes for radioactively contaminated steel scrap and uranium production of AVLIS feedstock. A portion of the research and product development effort is performed through funded contracts. The Company also funds research and development activities, and funds other work through cost partnership arrangements collaborated with selected customers where there is potential for utilizing proprietary technology or specialized resources not directly available to the Company. Internal research and development funding has the objective of improving manufacturing techniques and developing new products. The cost for Company-sponsored research and development activities was $439,000 in fiscal 1995, $575,000 in fiscal 1994 and $1,031,000 in fiscal 1993. Total revenues from customer-funded research and development were $557,000 in fiscal 1995, $792,000 in fiscal 1994 and $503,000 in fiscal 1993. These revenues are included in the revenues of the industry segment to which the research and development relates.\nENVIRONMENTAL, SAFETY AND REGULATORY MATTERS\nIN GENERAL\nTwo of the materials regularly processed by the Company, depleted uranium and beryllium, have characteristics considered to be health or safety hazards by various federal, state or local regulatory agencies. Processing of these materials requires a high level of safety consciousness, personnel monitoring devices and special equipment. Depleted uranium is a low-level radioactive material, and the Company is subject to regulation by the United States Nuclear Regulatory Commission (NRC). Depleted uranium in the finely divided state, such as grinding dust or machine turnings, is combustible at room temperature and requires special handling for safe operations and disposal of process wastes. Beryllium is known to cause lung disease following significant exposure by inhalation of airborne particles. Processing this material requires use of extensive ventilation and dust collecting systems. Management believes that the experience gained in its many years of working with these metals has resulted in capabilities for dealing effectively with their special characteristics.\nThe presence and use in the Company's operations of materials with hazardous characteristics subjects the Company to regulation and scrutiny by various governmental agencies. Management believes that the Company is presently in compliance in all material respects with existing federal, state and local regulations and has no knowledge of any threatened actions against the Company for violations of any such laws, statutes or regulations, except as described below under \"Concord Site Remediation\" and in Item 3 below. However, the potential effects of evolving legislation and regulations affecting the Company's business cannot be predicted.\nIn the process of manufacturing depleted uranium products, the Company generates small amounts of low-level radioactive waste materials that must be disposed of at sites licensed by federal, state, and local governments. With the closing of the Barnwell, South Carolina, low-level radioactive waste repository to out-of-region generators in July 1994, the Company began storing waste on site in Concord. Interim storage is permitted under the Company's NRC license. At present, the Barnwell repository remains available for use by the Company's Carolina Metals, Inc. facility. The Company has made provision to accommodate an extended period of interim storage of waste within existing buildings in Concord as the state government works toward a regional solution. At the same time, the Company has made significant progress in developing and instituting alternatives to disposal of its waste. The Company intends to continue the development of technologies and processes aimed at eliminating the generation of waste materials associated with its manufacturing process.\nFor a number of years, ending in 1985, the Company deposited spent acid and associated depleted uranium waste and other residual materials by neutralizing with lime and discharging the neutralized mixture to a holding basin on its premises in Concord, Massachusetts. In 1986 the holding basin was covered with Hypalon, an impervious material used to prevent rain and surface run-off water from leaching through the holding basin. The Company now uses a proprietary \"closed loop\" process that it developed to discontinue such discharges. The Company believes that both practices were and are in compliance with all applicable regulations.\nCONCORD SITE REMEDIATION\nThe Commonwealth of Massachusetts, Department of Environmental Protection (\"DEP\"), has designated the Concord site including the holding basin as a \"priority\" remediation site. The DEP, in conjunction with the Company and its consultants, are developing a comprehensive evaluation and risk assessment. This risk assessment originally scheduled for completion during calendar year 1995 has been delayed. Additional information needed for the risk assessment has been collected and is currently being evaluated with the current expectation that completion of the risk evaluation will occur in 1996. The Company continues to believe that the results of\nthese studies will establish that the holding basin does not present an environmental risk consistent with its designation as a \"priority site\".\nThe vast majority (approximately 96%) of the material in the holding basin is the by-product of manufacturing processes conducted by the Company under Government contracts using Government furnished material. Management believes, based on advice from legal counsel and discussions with the Army, that this material continues to be Government owned and that the Government has a responsibility for any required remediation of the site. The Company has no written commitment from the Government to fund any remediation costs, however, existing contracts provide the basis for Government responsibility for these costs. In September 1995, the Company submitted a request for funding for the full remediation of the basin under Public Law 85-804. The Army currently is reviewing the submittal and is expected to provide their recommendations to the Company early in 1996. The Army has not denied the Government's responsibility to pay the costs of removal of the material from the holding basin. Management of the Company considers it unlikely that the Army will not pay the appropriate costs for remediation. Also, the Government has demonstrated a general practice of paying its portion of site remediation costs by the funding of other remediation projects.\nIn fiscal 1992 the Company established a $1.3 million reserve against any potential administrative, legal, research or other costs of remediating the holding basin that are not paid by the Government. In fiscal 1994 this reserve was increased by $1.5 million. The Company believes this amount to be adequate for any residual costs that may be incurred beyond the Government's portion of the holding basin.\nThe Company has developed a range of cost estimates based on differing assumptions as to how much gravel should be removed and that all material will be buried at licensed sites. Significant costs include excavation, transportation and burial of the holding basin material as well as back fill and grading at the Concord site. Under these assumptions, the estimated costs of the burial option range from $4 million to $9 million on a pretax basis. In developing these estimates, the uncertainty as to future burial rates that will be charged at the licensed sites is the predominant reason for the wide range of potential costs. These burial costs are affected by, among other things, the various regulatory agencies, the regulations imposed by these agencies and the volume of waste disposed at individual licensed sites.\nIn developing these estimates, the Company has not assumed any offset based on Government funding or insurance claims. Further, the Company assumes that the recommendations of the Company's outside experts as to how much gravel should be removed will be accepted by the regulatory authorities and that none of the material in the holding basin will be recycled.\nThe Company believes its portion of the cost of such remediation will not have a material impact on its results of operations or financial position.\nDECOMMISSIONING PLANNING REQUIREMENTS\nThe Company is in the process of renewing certain licenses issued by the NRC which are required by the Company in order to possess and process depleted uranium materials. Under applicable licensing regulations, the Company was required to submit and did submit a Decommissioning Funding Plan (DFP) to provide for the possible future decommissioning of its Concord facility. The Company is also required to provide financial assurance for such decommissioning.\nApproximately 96% of the depleted uranium materials which generated the DFP requirements were processed for the United States Government. Accordingly, the Company believes that its financial assurance is only for the balance of the cost. The estimated cost of decommissioning NMI facilities and the holding basin in 1995 was $13.7 million. On the basis of this estimate the Company's share, approximately 4%, would be $550,000. The Company has provided and maintains financial assurance in the form of a letter of credit from its commercial bank in the amount of $750,000. With declining depleted uranium penetrator production, the Company has removed significant volumes of contaminated equipment from service in 1995. As allowed under the NRCOs rules governing decommissioning cost estimating, the Company is currently preparing a new estimate of the cost associated with decommissioning its remaining facilities. Management believes that estimated decommissioning costs will decline as the Company removes no longer needed or obsolete equipment from its facilities. Company representatives met several times with NRC staff members during the year to discuss meetings with the Army and consultants on specific decommissioning issues.\nThe outcome of a December, 1994 NRC enforcement conference with respect to what the NRC described as the Company's apparent lack of compliance with the decommissioning financial assurance regulations has resulted in the Company submitting a request to the NRC for exemption to certain aspects of the decontamination and disposal (D&D) regulations. The exemption request includes alternate financial funding mechanisms not specifically called out in the regulations. These funding mechanisms when coupled with Government contractual obligations will collectively satisfy the decommissioning funding obligations of the Company. In filing the exemption, the Company reiterated its long standing position that the United States Government is obligated, by policy and by contract, to bear the balance of decommissioning costs at the Concord site. As a practical matter, the Company is not able to provide private financial assurance for the Government's costs of decommissioning. The Company expects NRCOs response to the exemption request early in 1996.\nManagement believes that based on progress made to date on the holding basin remediation (as described above) along with the submission of a request for partial exemption to the D&D rules, escalated enforcement action by NRC regarding decommissioning funding compliance, although possible, will not occur. Escalated enforcement action could take the form of a civil penalty, license suspension or license revocation. A license action, such as a suspension or revocation would have a material and adverse impact on results of operations and financial position.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are:\nNAME AGE POSITION WITH THE COMPANY George J. Matthews 65 Chairman of the Board of Directors, CEO and Treasurer Robert E. Quinn 42 President Wilson B. Tuffin 64 Vice Chairman of the Board of Directors Douglas F. Grotheer 37 Vice President, Engineering & Programs William T. Nachtrab 42 Vice President, Technology James M. Spiezio 47 Vice President, Finance & Administration Frank J. Vumbaco 42 Vice President, Health\/Safety Bruce E. Zukauskas 45 Vice President, Operations\nThe term of office for each executive officer of the Company is one year or until a successor is chosen and qualified. The Executive officers are elected by the directors at their first meeting following the annual meeting of stockholders. There are no family relationships among the directors and executive officers.\nGEORGE J. MATTHEWS has been Chairman of the Board of Directors since 1972. He is employed by Matthews Associates Limited, a Massachusetts corporation. Matthews Associates Limited is engaged in the business of investing in and providing management consultation and assistance to small and medium sized businesses. Mr. Matthews devotes approximately 75% of his time to the Company's affairs. Mr. Matthews was elected CEO and Treasurer on November 30, 1994.\nROBERT E. QUINN was elected President of the Company on November 30, 1994. Prior to November 30, 1994 he held the position of Vice President, Sales with the Company for over five years.\nWILSON B. TUFFIN has been Vice Chairman of the Board of Directors since November 1994. From 1972 to November 1994, he held the positions of President, Chief Executive Officer and Treasurer of the Company.\nDOUGLAS F. GROTHEER has held the position of Vice President, Engineering and Programs since July 1994. Prior to July 1994, he was Manager, Engineering and Programs for two years, and Manager, Ordnance Programs for more than three years.\nWILLIAM T. NACHTRAB, Ph.D. has held the position of Vice President, Technology with the Company since May 1993. Prior to May 1993 he was Manager, Research & Development for the prior five years.\nJAMES M. SPIEZIO has been the Vice President, Finance since October 1993. Prior to October 1993, he was Controller, and prior to April 1989, he served as Manager of Business Planning.\nFRANK J. VUMBACO has held the position of Vice President, Health\/Safety with the Company since November 1993. Prior to November 1993, he was Manager of Health\/Safety for over five years.\nBRUCE E. ZUKAUSKAS has held the position of Vice President, Operations since October 1994. Prior to October 1994, he was Quality Manager for over five years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe majority of the Company's activities are conducted at a Company- owned site in Concord, Massachusetts. The site comprises approximately 46.4 acres and is improved by a steel and masonry building originally constructed in 1958 and subsequently enlarged. The building contains approximately 180,000 square feet used for manufacturing activities, offices and warehousing.\nDuring fiscal 1995 the Company sold its 15,000 square feet office building located in Acton, Massachusetts.\nCarolina Metals, Inc., the Company's wholly-owned subsidiary, is located on 321 acres of land in Barnwell, South Carolina. This 109,000 square foot facility houses two manufacturing units. One unit provides the capability of converting chemical gas (UF(6)) to chemical salt (UF(4)). The second unit houses a reduction process to convert chemical salt (UF(4)) to metallic depleted uranium. In December 1991, the Company completed a 70,000 square foot DU Recycle Technology Center adjacent to the manufacturing facility in Barnwell, S.C. The Center provides the technology and facilities required to provide recovery and recycle of depleted uranium and other useful materials. In addition, Carolina Metals, Inc. maintains a full scale analytical laboratory.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is named as a Potentially Responsible Party (PRP) in regard to the Maxey Flats, Kentucky, Superfund Site. This site was used until 1977 as a licensed and approved low-level radioactive waste disposal site. A committee of PRP's including the Company has submitted a remedial investigation and feasibility study report to the Environmental Protection Agency. The current expectation is that all parties will agree to site remediation with the formal entering of the consent agreement by the Department of Justice early in calendar year 1996. The agreement signed by the settling parties in July 1995, outlines the responsibilities of all parties and states that the PRP's will undertake the initial remedial phase (IRP) of the site remediation at an estimated cost of $60 million. The Company's liability is not expected to exceed approximately $80,000 over 10 years. The cost to the Company in fiscal 1995 was $8,455.\nThe Company is in the process of renewing certain licenses issued by the United States Regulatory Commission (NRC) which are required by the Company in order to possess and process depleted uranium materials. Under applicable licensing regulations, the Company was required to submit and did submit, on July 1, 1993, a Decommissioning Funding Plan (DFP) to provide for the possible future decommissioning of its Concord facility. The Company believes that decommissioning would occur only in the future if the Company were to cease functioning in the capacity of handling radioactive materials. The Company has no short or long term plans or intention to cease this activity. The Company is required to provide financial assurance for such potential decommissioning costs and the Company believes it has satisfied this requirement. Approximately 96% of the depleted uranium materials which generated the DFP requirements were processed for the United States Government, and a similar percentage of material which remains at the facility is the property of the United States Government. Accordingly, the Company believes that its decommissioning obligation and, therefore, its obligation to provide financial assurance, is, only for the balance of the costs. The total estimated cost of decommissioning the NMI facility is $13.7 million. The Company's share, approximately 4%, would be $550,000. The Company has provided financial assurance in the form of a letter of credit in the amount of $750,000.\nIn August 1995, the Company submitted a request to the NRC for partial exemption to the decommissioning regulation. The NRC has not responded to to the Company. A violation of the applicable regulations which the Company believes is unlikely, could result in the revocation of the NRC licenses, which would have a material and adverse affect on the Company's operations. The Company responded to the NRC's Demand for Information, renewing\nits position that its total obligation with respect to the decommissioning is not in excess of 4% of the total cost. In support of its position, the Company indicated that the Government has demonstrated a practice of funding actual remediation of sites contaminated with Government furnished materials on a case-by-case basis, without prior written commitments.\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 required by this item is incorporated by reference to the Section entitled \"Common Stock Information\" in the Registrant's 1995 Annual Report to Stockholders, which is included in this Report as Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated by reference to the section entitled \"Selected Financial Data\", pages 12 and 13, in the Registrant's 1995 Annual Report to Stockholders, which is included in this Report as Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS\nThe information required by this item is incorporated by reference to the section entitled \"Management's Discussion and Analysis of Operations\", pages 14 - 16, in the Registrant's 1995 Annual Report to Stockholders, which is included in this Report as Exhibit 13.\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 Consolidated Financial Statements at September 30, 1995 and notes thereto in the Registrant's 1995 Annual Report to Stockholders, which is included in this Report as Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of Form 10-K and instruction 3 to Item 401(b), the information required by this item concerning executive officers is set forth in Part I, Item 1 under the heading \"Executive Officers of the Registrant\".\nThe following table sets forth certain information concerning the directors of the Company:\nINFORMATION ABOUT THE BOARD OF DIRECTORS AND COMMITTEES\nThe Board of Directors met six times during the fiscal year ended September 30, 1995. There was no director who during the fiscal year attended fewer than 75 percent of the aggregate of all board meetings and all meetings of committees on which he served.\nThe Board of Directors has a three-member Audit Committee which is reconstituted at the first meeting of the Board following the annual meeting of stockholders. The Audit Committee, which met two times during fiscal 1995, meets with the Company's independent auditors and principal financial personnel to review the scope and results of the annual audit and the Company's financial reports. The Audit Committee also reviews the scope of audit and non-audit services performed by the independent public accounts, reviews the independence of the independent public accountants, and reviews the adequacy and effectiveness of internal accounting controls. The present members of the Audit Committee\nare Messrs. Brenton and Smith.\nThe \"disinterested\" directors, for purposes for Rule 16b-3 under the Securities Exchange Act of 1934, Messrs. Brenton and Smith, acting as a Stock Option Committee, have the authority, subject to the express provisions of the Company's Employees' Stock Option Plan and Non-Qualified Stock Option Plan (the \"Plans\"): to determine the employees of the Company to receive options, the number of shares to be optioned, and the terms of the options granted; to construe and interpret the Plans and outstanding options; and to make all other determinations that they deem necessary and advisable for administering the Plans. The Board of Directors as a whole has corresponding authority with respect to options issued under the Directors' Stock Option Plan.\nThe Board of Directors does not have standing committees on compensation or nominations.\nDIRECTORS' COMPENSATION AND STOCK OPTION PLAN\nEach outside director of the Company receives an annual fee of $15,000.\nOn November 20, 1995, the Board of Directors adopted a Director's Stock Option Plan (the \"Plan\") in order to enhance the Company's ability to attract and retain skilled and competent members of its Board of Directors. Only outside (non-management) directors of the Company and its subsidiaries are eligible to receive options under the Plan, and the maximum number of shares as to which such directors' options may be granted is 35,000 shares (subject to adjustments for stock splits, stock dividends and the like). Pursuant to the Plan, each director eligible to participate in the Plan, upon first election to office at the annual meeting of stockholders and for each subsequent period of three years of service, receives an option to purchase 1,000 shares of Common Stock of the Company at an exercise price equal to fair market value on the date of grant. Options granted under the Plan are exercisable for a period of ten years and vest over a three-year period. Options to purchase 4,000 shares of Common Stock at an exercise price of $14.00 were granted to each of Messrs. Brenton, Smith and Vokey on December 15, 1994 under the Directors Stock Option Plan which preceded the Plan. No options were granted pursuant to the Plan during fiscal 1995.\nDuring fiscal year 1995, Matthews Associates Limited, of which Mr. Matthews is sole owner, received compensation from the Company in connection with consulting services provided to the Company pursuant to a management agreement between the Company and Matthews Associates Limited. See \"Executive Compensation\" and \"Executive Agreements.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table and notes present the compensation provided by the Company during the last three fiscal years to its chief executive officer and the four most highly compensated executive officers of the Company (other than the chief executive officer) who were serving as executive officers at the Company's fiscal year end of September 30, 1995.\n(1) The Company's fiscal year ends on September 30th of each year.\n(2) Excludes perquisites in amounts less than the threshold level required for reporting.\n(3) Mr. Matthews is assigned as a consultant to the Company pursuant to a management agreement between Matthews Associates Limited and the Company. All compensation under the agreement is paid by the Company to Matthews Associates Limited. See \"Executive Agreements.\"\n(4) Mr. Tuffin's compensation for the fiscal year ended September 30, 1995 was determined pursuant to his Employment and Consulting Agreement. See \"Executive Agreements.\"\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table shows all options granted to each of the named executive officers of the Company during the fiscal year ended September 30, 1995 and the potential value at stock price appreciation rates, 5% and 10%, over the ten year term of the options. The 5% and 10% rates of appreciation are not intended to forecast possible future actual appreciation, if any, in the Company's stock prices. The Company did not use an alternative present value formula because the Company is not aware of any such formula that can determine with reasonable accuracy the present value based on future unknown or volatile factors.\n(1) These options were first exercisable on November 16, 1995 at which time the options were 33% vested with options vesting in additional 33% increments in two annual installments commencing on November 16, 1996.\n(2) These options are first exercisable on August 1, 1996 at which time the options will be 33% vested with options vesting in additional 33% increments in two annual installments commencing on August 1, 1997.\n(3) These options were first exercisable on December 14, 1995 at which time the options were 33% vested with options vesting in additional 33% increments in two annual installments commencing on December 14, 1996.\n(4) The exercise price per share is the market price of the underlying Common Stock on the date of grant.\n(5) Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. These gains are based upon assumed rates of share price appreciation set by the Securities and Exchange Commission of five percent and ten percent compounded annually from the date the respective options were granted to their expiration date. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise. Actual gains, if any, are dependent on the performance of the Common Stock and the date on which the option is exercised. There can be no assurance that the amounts reflected will be achieved.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table sets forth information with respect to the exercise of options by the executive officers named in the Summary Compensation Table during the last fiscal year and unexercised options held as of the end of the fiscal year.\n(1) Value realized equals fair market value on the date of exercise, less the exercise price, times the number of shares acquired, without deducting taxes or commissions paid by employee.\n(2) Value of unexercised options equals fair market value of the shares underlying in-the-money options at September 30, 1995 ($13.50 per share), less the exercise price, times the number of options outstanding.\nPENSION PLAN TABLE\nThe following table sets forth the aggregate annual benefit payable upon retirement at normal retirement age for each level of remuneration specified at the listed years of service.\nThe Company has a defined benefit plan (the \"Pension Plan\") designed to provide retirement benefits for employees and ancillary benefits to their beneficiaries, joint annuitants and spouses. All employees of the Company become participants in the Pension Plan after attaining the later of age 21 or a year of service with the Company. The Pension Plan provides retirement benefits based on years of service and compensation. An employee's benefits under the Pension Plan generally become fully vested after five years of service. At normal retirement (the later of age 65 and five years of Plan participation), participants are entitled to a monthly benefit for the remainder of their life in an amount equal to one-twelfth of the sum of their \"Annual Credits\" for their last 30 years or lesser period of employment with the Company and its predecessors. An employee's \"Annual Credit\" is 1.25% of the portion of his annual compensation that is subject to Social Security tax and two percent (2%) of the balance of his annual compensation. Participants with five\nyears of service are entitled to retirement at age 55, but the monthly benefit payable under the Pension Plan is reduced by 0.5% for each month that early retirement precedes normal retirement but not to less than $100 per month if the Participant has ten or more years of service. The surviving spouse of a retiree under the Plan is entitled to receive benefits equal to one-half the amount the retiree had been receiving. Alternative benefit payments that are equivalent to the benefit described above are also available to participants. Benefits payable under the plan are not reduced by Social Security payments to the retiree. Amounts shown assume benefits commence at age 65. Benefit amounts shown are straight-life annuities. The executive officers named in the Summary Compensation Table have the following years of credited service for pension plan purposes: Robert E. Quinn-20 years, Wilson B. Tuffin-22 years; James M. Spiezio-10 years; and William Nachtrab-6 years. On February 1, 1995, Mr. Tuffin began to receive benefit payments under the Plan. Mr. Matthews does not participate in the Pension Plan.\nEXECUTIVE AGREEMENTS\nEMPLOYMENT AGREEMENT WITH MR. TUFFIN\nIn November 1994, the Company entered into an employment and consulting agreement (the \"Employment and Consulting Agreement\") with Mr. Tuffin. Pursuant to the Employment and Consulting Agreement, Mr. Tuffin received initial compensation at the annual rate of $210,000 through January 1995, and $105,000 as a consultant thereafter, subject to such annual increases as the Board of Directors may from time to time determine. The Employment and Consulting Agreement amends and supersedes the employment agreement which Mr. Tuffin had previously entered into with the Company.\nMANAGEMENT AGREEMENT WITH MATTHEWS ASSOCIATES LIMITED\nThe Company has entered into a management agreement with Matthews Associates Limited, a Massachusetts corporation (\"MAL\"), of which Mr. George J. Matthews, Director and Chairman of the Board of Directors of the Company, is sole owner. The agreement expires on February 28, 1999, subject to renewal thereafter from year to year. Pursuant to the agreement, Matthews Associates Limited provides professional management services as a consultant to the Company through a senior executive whose duties include (i) financial management, (ii) serving, subject to election, as a director, as Chairman of the Board of Directors and as an officer of the Company and (iii) marketing and other advice to the Company including placement and modification of financing and contact with major customers, suppliers and governmental agencies. Mr. Matthews is the senior executive assigned to the Company under the agreement. Under the management agreement, Mr. Matthews devotes approximately 30 hours per week to the Company.\nMAL was paid $350,000 by the Company in fiscal 1995 for services under the management agreement and is to be paid a minimum of $350,000 in fiscal 1996 for all services under the agreement. The management agreement provides that the Company may terminate the agreement if a majority of the directors determines in good faith that the MAL representative has willfully refused to perform any services under the management agreement or has been convicted of a crime of moral turpitude, and in such event or in the event of termination by MAL without \"good reason\" as defined therein, the obligation of the Company to make future payments to MAL shall cease. The management agreement may be terminated by MAL for \"good reason\" as defined therein. In the event of termination by MAL for \"good reason\" or in the event of termination by the Company for reasons other than those described above, the Company is obligated to pay to MAL all of the amounts due under the agreement for the remaining term. In the event of termination by MAL without \"good reason,\" the Company is obligated to continue to make payment to MAL for one year from the date of such termination. In the event of Mr. Matthews' death, the management agreement automatically terminates and the Company is obligated to continue to make payments to the estate of Mr. Matthews for the lesser of one year from such termination or the end of the scheduled term of the agreement.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring the fiscal year ended September 30, 1995, the Board of Directors of the Company was responsible for establishing executive compensation (other than stock option compensation). Messrs. Quinn and Matthews participated in the deliberations of the Company's Board of Directors concerning executive officer compensation. No executive officer of the Company served as a director or member of a compensation committee, or its equivalent, of another entity, one of whose executive officers served as director of the Company.\nNOTWITHSTANDING ANYTHING TO THE CONTRARY SET FORTH IN ANY OF THE COMPANY'S FILINGS UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THAT MIGHT INCORPORATE FUTURE FILINGS, IN WHOLE OR IN PART, THE FOLLOWING REPORT ON COMPENSATION AND THE STOCK PERFORMANCE GRAPH CONTAINED ELSEWHERE HEREIN SHALL NOT BE INCORPORATED BY REFERENCE INTO ANY SUCH FILINGS NOR SHALL THEY BE DEEMED TO BE SOLICITING MATERIAL OR DEEMED FILED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.\nREPORT OF THE BOARD OF DIRECTORS AND STOCK OPTION COMMITTEE ON EXECUTIVE COMPENSATION\nDuring the fiscal year ended September 30, 1995, the Board of Directors of the Company was responsible for establishing and administering the policies which govern annual compensation (other than stock option compensation) for the Company's executive officers. The Stock Option Committee was responsible for considering stock option compensation for the Company's executive officers.\nOVERVIEW\nThe Board of Directors has historically established levels of executive compensation that provide for a base salary intended to allow the Company to hire, motivate and retain qualified executive officers. From time to time, the Board has also, on occasion, approved annual cash incentive bonuses based on the Company's performance or on the performance of the executive in question. In fiscal 1995, the Board approved cash incentive bonuses to certain executive officers based on their performance. From time to time, the Stock Option Committee also grants stock options to executive officers and key employees in order to bring the stockholders' interests more sharply into the focus of such officers and employees.\nThe Board of Directors establishes the annual salary and bonus of each of the executive officers other than the Chief Executive Officer, based on the recommendations made by the Chief Executive Officer. In determining the recommendations for salary and bonus for each of the other executive officers, the Chief Executive Officer considers each officer's individual performance, attainment of individual goals and the contribution to the overall attainment of the Company's goals.\nSTOCK OPTIONS AND OTHER COMPENSATION\nLong term incentive compensation for executive officers consists exclusively of stock options granted under the Company's Stock Option Plans (the \"Plans\"). Executive officers as well as other key employees of the Company participate in the Plans. During fiscal 1995, the Stock Option Committee granted options only to certain newly appointed executive officers and those executive officers whose duties and responsibilities had increased since the prior fiscal year as a result of promotions or departmental restructuring. The Company also believes that its Pension Plan is an attractive feature for all employees.\nBASIS FOR THE COMPENSATION OF THE CHIEF EXECUTIVE OFFICER\nThe compensation of Mr. Matthews, the Company's Chief Executive Officer during fiscal 1995, was determined pursuant to a management agreement between Matthews Associates Limited and the Company. All compensation under the agreement is paid by the Company to Matthews Associates Limited.\nTHE BOARD OF DIRECTORS\nGeorge J. Matthews Robert E. Quinn Wilson B. Tuffin Kenneth A. Smith Frank H. Brenton\nSTOCK OPTION COMMITTEE\nKenneth A. Smith Frank H. Brenton\nCOMPARISON OF FIVE YEAR CUMULATIVE RETURN\nSet forth below is a line graph comparing the five-year cumulative total return of the Company's Common Stock against the cumulative total return of the NASDAQ Stock Market (U.S.) Index and the Dow Jones Aerospace and Defense Index. Cumulative total return is measured assuming an initial investment of $100 and reinvestment of dividends.\nCOMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN * AMONG NUCLEAR METALS, INC., THE NASDAQ STOCK MARKET-US INDEX AND THE DOW JONES AEROSPACE & DEFENSE INDEX\nD O L L A R S\nSep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 \"NUCLEAR METALS, INC\" 100 90 85 93 296 171 NASDAQ STOCK MARKET-US 100 157 176 231 233 319 D J AEROSPACE & DEFENSE 100 134 124 170 200 321\n* $100 INVESTED ON 09\/30\/90 IN STOCK OR INDEX- INCLUDING REINVESTMENT OF DIVIDENDS. FISCAL YEAR ENDING SEPTEMBER 30.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information as of December 30, 1995 with respect to the Common Stock of the Company owned or deemed beneficially owned as determined under the rules of the Securities and Exchange Commission, directly or indirectly, by each stockholder known to the Company to own beneficially more than 5% of the Company's Common Stock, by each director, by the executive officers named in the Summary Compensation Table elsewhere herein, and by all directors and executive officers of the Company and its subsidiaries as a group. In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended, a person is deemed to be the beneficial owner, for purposes of this table, of any shares of Common Stock of the Company if he or she has or shares voting power or investment power with respect to such security or has the right to acquire beneficial ownership at any time within 60 days of December 30, 1995. As used herein \"voting power\" is the power to vote or direct the voting of shares, and \"investment power\" is the power to dispose of or direct the disposition of shares. Except as indicated in the notes following the table below, each person named has sole voting and investment power with respect to the shares listed as being beneficially owned by such person.\nCOMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED\nSection 16(a) of the Securities Exchange Act of 1934 requires directors, executive officers and stockholders who own more than 10% of the outstanding common stock of the Company to file with the Securities and Exchange Commission and NASDAQ reports of ownership and changes in ownership of voting securities of the Company and to furnish copies of such reports to the Company. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company, during the fiscal year ended September 30, 1995 or written representations in certain cases, all Section 16(a) filing requirements were complied with except that two reports were not timely filed.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn November 1994, the Company entered into an employment and consulting agreement (the \"Employment and Consulting Agreement\") with Mr. Wilson B. Tuffin. Pursuant to the Employment and Consulting Agreement, Mr. Tuffin received initial compensation at the annual rate of $210,000 through January 1995, and $105,000 as a consultant thereafter, subject to such annual increases as the Board of Directors may from time to time determine. The Employment and Consulting Agreement amends and supersedes the employment agreement which Mr. Tuffin had previously entered into with the Company.\nThe Company has entered into a management agreement with Matthews Associates Limited, a Massachusetts corporation (\"MAL\"), of which Mr. George J. Matthews, Director and Chairman of the Board of Directors of the Company, is sole owner. The agreement expires on February 28, 1999, subject to renewal thereafter from year to year. Pursuant to the agreement, Matthews Associates Limited provides professional management services as a consultant to the Company through a senior executive whose duties include (i) financial management, (ii) serving, subject to election, as a director, as Chairman of the Board of Directors and as an officer of the Company and (iii) marketing and other advice to the Company including placement and modification of financing and contact with major customers, suppliers and governmental agencies. Mr. Matthews is the senior executive assigned to the Company under the agreement. Under the management agreement, Mr. Matthews devotes approximately 30 hours per week to the Company.\nMAL was paid $350,000 by the Company in fiscal 1995 for services under the management agreement and is to be paid a minimum of $350,000 in fiscal 1996 for all services under the agreement. The management agreement provides that the Company may terminate the agreement if a majority of the directors determines in good faith that the MAL representative has willfully refused to perform any services under the management agreement or has been convicted of a crime of moral turpitude, and in such event or in the event of termination by MAL without \"good reason\" as defined therein, the obligation of the Company to make future payments to MAL shall cease. The management agreement may be terminated by MAL for \"good reason\" as defined therein. In the event of termination by MAL for \"good reason\" or in the event of termination by the Company for reasons other than those described above, the Company is obligated to pay to MAL all of the amounts due under the agreement for the remaining term. In the event of termination by MAL without \"good reason,\" the Company is obligated to continue to make payment to MAL for one year from the date of such termination. In the event of Mr. Matthews' death, the management agreement automatically terminates and the Company is obligated to continue to make payments to the estate of Mr. Matthews for the lesser of one year from such termination or the end of the scheduled term of the agreement.\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, included in the Company's 1995 Annual Report, are filed as part of this report:\nAuditors' Report Consolidated Balance Sheets - September 30, 1995 and September 30, 1994. Consolidated Statements of Income for the years ended September 30, 1995, September 30, 1994 and September 30, 1993. Consolidated Statements of Stockholders' Equity for the years ended September 30, 1995, September 30, 1994 and September 30, 1993. Consolidated Statements of Cash Flows for the years ended September 30, 1995, September 30, 1994 and September 30, 1993. Notes to Consolidated Financial Statements\n2. FINANCIAL STATEMENT SCHEDULE FOR THE THREE YEARS ENDED SEPTEMBER 30, 1995 Auditors' Report on Schedule II- Valuation and Qualifying Accounts\n3. EXHIBITS:\nITEM NO.* DESCRIPTION\n3(a) Articles of Organization, as amended, of the Registrant, incorporated by reference to File No. 2-62266, Part II, Exhibit 3(a).\n3(b) By-laws, as amended, of the Registrant, incorporated by reference to File No. 2-62266, Part II, Exhibit 3(b).\n4(a) Financing Agreement, dated May 11, 1982, among Barnwell County, South Carolina, Registrant and Carolina Metals, Inc. (a\nITEM NO. DESCRIPTION\nwholly owned subsidiary) relating to Barnwell County, South Carolina Industrial Development Revenue Bond (Nuclear Metals, Inc. project) 1982, incorporated by reference to File No. 2-70044, Part II, Exhibit 4(d).\n4(b) Financing Agreement, dated September 27, 1984 among Barnwell County, South Carolina, Registrant and Carolina Metals, Inc. (a wholly owned subsidiary) relating to Barnwell County, South Carolina Industrial Development Revenue Bond (Nuclear Metals, Inc. project) 1984, incorporated by reference to File No. 0-8836, Part II, Exhibit 4(e).\n4(c) Financing Agreement, dated June 1, 1985 among Massachusetts Industrial Finance Agency and the Registrant relating to Massachusetts Industrial Development Revenue Bond (NMI - 1985 Concord Issue) incorporated by reference to File No. 0-8836, Part II, Exhibit 4(f)\n4(d) Nuclear Metals, Inc. Non-Qualified Stock Option Plan as amended. (1)\n4(e) Nuclear Metals, Inc. Restated Employees' Stock Option Plan as amended. (1)\n4(f) Nuclear Metals, Inc. Directors' Stock Option Plan.**\n4(h) Warrant to Purchase 25,000 shares of the Company's Common Stock issued to State Street Bank and Trust Company.**\n10(a) Agreement, effective March 1, 1993, between the Registrant and Matthews Associates Limited. (2)\n10(b) Agreement, effective March 1, 1993, between the Registrant and Wilson B. Tuffin, as amended November 17, 1994. (2)\n10(c) Agreement with Olin Corporation regarding large caliber penetrators. (Confidential treatment has been granted for certain portions of this Exhibit). (3)\n10(d) Credit Agreement dated March 31, 1995 among the Company, Carolina Metals, Inc. and State Street Bank and Trust Company.(4)\n10(e) First Amendment to Credit Agreement dated as of June 30, 1995 among the Company, Carolina Metals, Inc. and State Street Bank and Trust Company.**\nITEM NO. DESCRIPTION\n10(f) Revolving Credit Note dated March 31, 1995 of the Company and Carolina Metals, Inc. (5)\n10(g) Amendment to Revolving Credit Note dated as of June 30, 1995 among the Company, Carolina Metals, Inc. and State Street Bank and Trust Company. **\n10(h) Term Note dated March 31, 1995 of the Company and Carolina Metals, Inc. payable to State Street Bank and Trust Company.(6)\n10(i) Line of Credit Demand Note dated September 26, 1995 of the Company and Carolina Metals, Inc. to State Street Bank and Trust Company.**\n10(j) Letter Agreement dated September 26, 1995 among State Street Bank and Trust Company, Carolina Metals, Inc. and the Company.**\n10(k) Letter Agreement dated September 26, 1995 among State Street Bank and Trust Company, Carolina Metals, Inc. and the Company.**\n10(l) Joint Security Agreement dated as of March 31, 1995 among the Company, Carolina Metals, Inc. and State Street Bank and Trust Company.**\n10(m) First Amendment to Joint Security Agreement dated September 26, 1995 among the Company, Carolina Metals, Inc. and State Street Bank and Trust Company.**\n10(n) Patent Assignment of Security dated September 26, 1995 between the Company and State Street Bank and Trust Company.**\n10(o) Trademark Assignment of Security dated September 26, 1995 between the Company and State Street Bank and Trust Company.**\n10(p) Purchase order dated August 23, 1995 between the Company and Olin Corporation. (Confidential treatment requested as to certain portions)**\n10(q) Forbearance and Amendment Agreement dated as of January 11, 1996 between the Company, Carolina Metals, Inc. and State Street Bank and Trust Company.**\n13 Nuclear Metals, Inc. 1995 Annual Report to Stockholders.**\n21 Subsidiaries of the Registrant.**\n23(a) Consent of Independent Public Accountants.**\n23(b) Consent of Independent Public Accountants.**\n27 Financial Data Schedule.**\n(b) REPORTS ON FORM 8-K\nNone\n- ------------------------------------------------------------------------------\n* Item numbers correspond to Exhibit Table, Item 601, Regulation S-K ** Indicates an exhibit filed herewith (1) Incorporated by reference to the similarly numbered Exhibit filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1992. (2) Incorporated by reference to the similarly numbered Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. (3) Incorporated by reference to Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993. (4) Incorporated by reference to Exhibit 10A to the Registrant's Form 10-Q for the Quarter ended March 31, 1995. (5) Incorporated by reference to Exhibit 10B to the Registrant's Form 10-Q for the Quarter ended March 31, 1995. (6) Incorporated by reference to Exhibit 10C to the Registrant's Form 10-Q for 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.\nNuclear Metals, Inc.\nBy \/s\/ Robert E. Quinn ------------------------------------------------------------------------- Robert E. Quinn, President\nDate January 16, 1996 -------------------------------------------------------------------------\nBy \/s\/ James M. Spiezio ------------------------------------------------------------------------- James M. Spiezio, Vice President, Finance and Administration & Controller\nDate January 16, 1996 -------------------------------------------------------------------------\nBy \/s\/ Rebecca L. Perry ------------------------------------------------------------------------ Rebecca L. Perry, Assistant Controller\nDate January 16, 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\/ George J. Matthews ----------------------------------------------------------- George J. Matthews, Chairman of the Board of Directors, CEO and Treasurer\nDate January 16, 1996 -----------------------------------------------------------\nBy \/s\/ Frank H. Brenton ----------------------------------------------------------- Frank H. Brenton, Director\nDate January 16, 1996 -----------------------------------------------------------\nBy \/s\/ Kenneth A. Smith ----------------------------------------------------------- Kenneth A. Smith, Director\nDate January 16, 1996 -----------------------------------------------------------\nBy \/s\/ Wilson B. Tuffin ----------------------------------------------------------- Wilson B. Tuffin, Vice Chairman\nDate January 16, 1996 -----------------------------------------------------------\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nIndependent Auditors' Report\nSchedule II - Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of Nuclear Metals, Inc.:\nWe have audited the accompanying consolidated balance sheets of Nuclear Metals, Inc. (a Massachusetts Corporation) and subsidiaries as of September 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 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nuclear Metals, Inc. 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 6 to the financial statements, on January 11, 1996 the Company reached an agreement with its lender to amend certain terms of its debt, including the extension of certain maturity dates; the lender's waiver of past violations of debt covenants and the revision of certain financial covenants. The Company's ability to meet its revised debt service requirements in 1996 is dependent upon the receipt of a specific order and the related proceeds from a certain customer. As of January 11, 1996 the Company's customer has not been able to obtain funding to complete the purchase. This matter 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 1. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of the financial statements is presented for 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\nour opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements as a whole.\nBoston, Massachusetts Arthur Andersen LLP November 22, 1995 (except for Notes 1 and 6 for which the date is January 11, 1996)\nNUCLEAR METALS, INC. AND SUBSIDIARIES SCHEDULE II- VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED SEPTEMBER 30, 1995\nADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END CLASSIFICATION OF YEAR EXPENSES DEDUCTIONS OF YEAR - -------------- ---------- ---------- ---------- ---------\nYEAR ENDED SEPTEMBER 30, 1995: Allowance for doubtful accounts $1,290,000 $ 400,000 $807,000 $ 883,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ---------- Inventory Reserves $1,522,000 $ -- $ -- $1,522,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ----------\nYEAR ENDED SEPTEMBER 30, 1994: Allowance for doubtful accounts $1,670,000 $ -- $380,000 $1,290,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ---------- Inventory Reserves $2,000,000 $ -- $442,000 $1,522,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ----------\nYEAR ENDED SEPTEMBER 30, 1993: Allowance for doubtful accounts $ 300,000 $1,536,000 $166,000 $1,670,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ---------- Inventory Reserves $ 570,000 $1,872,000 $442,000 $2,000,000 ---------- ---------- -------- ---------- ---------- ---------- -------- ----------","section_15":""}
{"filename":"89041_1995.txt","cik":"89041","year":"1995","section_1":"Item 1. Business\nIntroduction\nConsolidated Technology Group Ltd. (the \"Company\" or \"Consolidated\"), through its wholly-owned or controlled subsidiaries, is engaged in various businesses, most of which are service related. Consolidated's principal source of revenue for the year ended December 31, 1995 was generated by its contract engineering and medical diagnostics subsidiaries representing 57% and 25% respectively of total revenue. The principal source of revenue for the year ended December 31, 1994 and the fiscal years ended July 31, 1994 and 1993, was generated by its contract engineering subsidiaries representing 66%, 65% and 16% respectively of total revenue, which are operated by Trans Global Services, Inc. (\"Trans Global\"). Trans Global provides engineers, designers and technical personnel on a temporary basis pursuant to contracts with major corporations. In September 1994 and October 1994, the Company, through wholly-owned subsidiaries, acquired nine magnetic resonance imaging centers and one multi-modality diagnostic center and International Magnetic Imaging, Inc. (\"IMI\"), which manages the operations of the Centers, and the assets of J. Sternberg and S. Schulman M.D. Corp., (\"MD Corp.\"), which provides the services of radiologists to the Centers. References in this Report to \"International Magnetic Imaging, Inc.\" or \"IMI\" refer collectively to the business operated by the Centers, IMI and MD Corp.\nThe Company also manufactures and sells electro-mechanical and electro-optical products by Sequential Electronic Systems, Inc. (\"Sequential\") and avionics equipment and specialized vending machines by S-Tech, Inc. (\"S-Tech\"). Additionally, the Company manufactures and sells professional audio loudspeakers by WWR Technology, Inc. (\"WWR\"). Through ARC Networks, Inc. (\"ARC Networks\"), which was acquired in December 1993, the Company offers a range of telecommunications services to meet the requirements of its customers. ARC Networks has a national contract with Teleport Communications Group, Inc. (\"TCG\") pursuant to which it may resell local loop telephone service offered by TCG. In June 1994, the Company also acquired Creative Socio-Medics Corp. (\"CSM\"), which, together with Carte Medical Corporation, whose name was changed to CSM Corp. (\"CSMC\") and in February 1996 CSMC's name was changed to Netsmart Technologies, Inc., offers computerized health information systems and related services to specialty care health organizations, such as substance abuse (drug and alcohol), mental retardation, psychiatric and rehabilitation treatment facilities, and entitlement programs in the United States. Through 3D Technology, Inc., which was acquired in early 1993, and Computer Design Services, Inc. (\"CDS\"), which was acquired in November 1994, the Company markets and sells three dimensional imaging products of both software and hardware and provides related services. Consolidated is engaged in negotiations to acquire other businesses which it believes will be compatible with its present businesses, however, no assurance can be given that such acquisitions will be consummated or that they will be profitable to Consolidated.\nConsolidated provides its subsidiaries with management, marketing, accounting, administrative support and financing. Consolidated's revenue and net loss reflect the consolidated revenue and results of operations of its subsidiaries.\nSet forth below is a description of Consolidated's principal subsidiaries. Consolidated owns a majority or controlling interest in each of its subsidiaries, either directly or through one or more subsidiaries. In certain of the subsidiaries, the management of the subsidiary owns an interest, which does not exceed 20% in any subsidiary. In other subsidiaries, non-affiliated investors own a portion of the stock. Such investors include DLB, Inc. (\"DLB\"), a corporation controlled by the wife of Lewis S. Schiller, chairman and chief executive officer of Consolidated. Mr. Schiller disclaims any beneficial interest in DLB or any of the securities owned by DLB. Consolidated owns 49.6% of the common stock of Netsmart Technologies, Inc., formerly Carte Medical Corporation, which has filed a registration statement with respect to a proposed initial public offering of its stock.\nCONTRACT ENGINEERING SERVICES\nSince May 1995, the principal business of Trans Global Services, Inc. (\"TGS\") has been contract engineering service, In performing such services, TGS, through its two subsidiaries, Avionics Research Holdings, Inc. (\"Holdings\"), and Resource Management International, Inc. (\"RMI\"), addresses the current trend of major corporations in \"downsizing\" and \"outsourcing\" by providing engineers, designers and technical personnel on a temporary contract assignment basis pursuant to contracts with major corporations. The engagement may relate to a specific project or may cover an extended period based on the client's requirements. TGS believes that the market for outsourcing services such as those offered by TGS results from the trend in employment practices by major corporations in the aerospace, electronics, energy, engineering and telecommunications industries to reduce their permanent employee staff and to supplement their staff with temporary personnel on an as-needed basis. TGS seeks to offer its clients a cost-effective means of work force flexibility and the elimination of the inconvenience associated with the employment of temporary personnel, such as advertising, initial interviewing, fringe benefits and record keeping. Although the employees provided by TGS are on temporary contract assignment, they work with the client's permanent employees; however, they receive different compensation and benefits than permanent employees.\nIn providing its services, TGS engages the employees, pays the payroll and related costs, including FICA, worker's compensation and similar Federal and state mandated insurance and related payments. TGS charges its clients for services based upon the hourly payroll cost of the personnel. Each temporary employee submits to TGS a weekly time sheet with work hours approved by the client. The employee is paid on the basis of such hours, and the client is billed for those hours at agreed upon billing rates.\nTGS also offers its clients a range of integrated logistical support services which are performed at TGS's facilities. These services, which are ancillary to a project, include the management of technical documents involving technical writing, preparation of engineering reports, parts provisioning documents and test equipment support documents, establishing maintenance concepts and procedures, and providing manpower and personnel support. In performing these services, TGS hires the necessary employees for its own account and would work with the client in developing and preparing the documentation. The payment would be made pursuant to a purchase order form the client on a project basis and not as a percentage of the cost of the employees. To date, the integrated logistics support business has not generated more than nominal revenue, and no assurance can be given that TGS\nwill generate any significant revenue or profit from such services. TGS's strategy has been directed at increasing its customer base and providing additional services, such as integrated logistics support, to its existing customer base. TGS believes that the key to profitability is to provide a range of services to an increased customer base. In this connection, TGS is increasing its marketing effort both through its own personnel and in marketing efforts with other companies that offer complementary services.\nTGS Services Corp., a wholly-owned subsidiary of TGS (\"TGSC\") was formed in January 1995 to hold the stock of Holdings and RMI, which perform the same services for their clients. Prior to January 1995, the stock of Holdings and RMI was held by SIS Capital Corp. (\"SISC\"), which is a wholly-owned subsidiary of the Company. Holdings was formed to acquire the stock of two related companies, Avionics Research Corporation of New York and Avionics Research Corp. of Florida (collectively, \"Avionics\") in December 1993 as well as the stock of a third company engaged in an unrelated business which is not conducted by Avionics. Holdings engages in business only through Avionics.\nTGS's largest clients for 1995 were Northrop Grumman Corporation, The Boeing Corporation and Lockheed Ft. Worth Company which accounted for revenues of $19 million, $9 million and $6 million respectively or 54% of the total revenue of TGS.\nAvionics' largest clients for both 1994 and 1993 were Northrop Grumman Corporation and Martin Marietta Corp., which accounted for approximately $14.5 million and $2.0 million, respectively, which represented approximately 57% and 8% of the Company's revenue for the year ended December 31, 1994, and approximately $9 million and $3 million, respectively, which represented approximately 65% and 22% of Avionics' revenue for the year ended December 31, 1993.\nRMI was formed in 1994 to acquire assets of Job Shop Technical Services, Inc. (\"Job Shop\") in November 1994. RMI conducts business under the name The RMI Group. During 1994, six clients of RMI and Job Shop accounted for aggregate revenues of $32 million, or approximately 90% of their combined revenue for the year. The Boeing Company and Lockheed Ft. Worth Company, which accounted for revenues of $10 million and $7.5 million, or 22% and 17% of such combined revenue for 1994, were the only clients which accounted for more than 10% of their combined revenue. Four other clients, three of which are in the aerospace industry, accounted for aggregate revenue of $14.7 million, or 51% of the combined revenue of RMI and Job Shop for 1994.\nTGS is a Delaware corporation, incorporated in September 1993. TGS was formed under the name Concept Technologies Group, Inc., and, in March 1996, its corporate name was changed to Trans Global Services, Inc. Its executive offices are located at 1770 Motor Parkway, Hauppauge, New York 11788, telephone (516) 582-9000. TGS is a holding company. All business activities are conducted by its operating subsidiaries, Avionics and RMI. Reference to TGS includes all of its subsidiaries, unless the context indicated otherwise, and includes the business of Avionics and RMI prior to their acquisition by TGS. Avionics has been in the contract engineering business since its organization in 1954, and RMI commenced such business in November 1994, with the acquisition of assets from Job Shop.\nIn May 1995, TGS acquired all of the issued and outstanding stock of TGSC, which was then known as Trans Global Services, Inc., in exchange for a\ncontrolling interest in TGS. During 1995, TGS sold the stock of WWR Technology, Inc. (\"WWR\") to an affiliated party.\nMarkets and Marketing\nThe market for TGS's services is comprised of major corporations in such industries as aerospace, electronics, energy, engineering, computer services and telecommunications, where \"downsizing\" and \"outsourcing\" have become an increasingly important method of cost reduction. Typically, a client enters into an agreement with one or a small number of companies to serve as employer of record for its temporary staff, and its agreements are terminable by the client without significant notice.\nTGS maintains a computerized data base of technical personnel based upon their qualifications and experience. The data base, which contains more than 100,000 names, is generated through employees previously employed by TGS, referrals and responses to advertisements placed by TGS in a variety of local media, including newspapers, yellow pages, magazines and trade publications. Part of its responsibilities for any engagement is the recruitment and initial interviewing of potential employees, with the client conducting any final interviews it deems necessary. The majority of work performed by TGS's employees is performed at the client's premises and under the client's direction, although TGS is the employer of record.\nTGS markets its services to potential clients through its officers, management and recruitment personnel who seek to provide potential clients with a program designed to meet the client's specific requirements. The marketing effort utilizes referrals from other clients, sales calls, mailings and telemarketing. TGS also conducts an ongoing program to survey and evaluate the clients' needs and satisfaction with the TGS's services, which it uses as part of its marketing effort.\nAlthough TGS has eight offices, including its main office in Long Island, New York, throughout the United States, there are no limited geographic markets for the Company's services. TGS has in the past established offices in new locations when it receives a contract in the area and it cannot effectively service such contract from its existing offices. TGS intends to continue to establish new offices as necessary to meet the needs of its customers.\nA client will utilize contract engineering services such as those provided by TGS when it requires a person with specific technical knowledge or capabilities which are not available from the client's permanent staff or to supplement its permanent staff for specific project or to meet peek load requirements. When the client requires personnel, it provides TGS with a detailed job description. TGS then conducts an electronic search in its computerized resume data base for candidates matching the job description. In addition, each branch office maintains a file of active local resumes for candidates available for assignment in the vicinity of the branch office. The individuals are then contacted by telephone by TGS's recruiters, who interview interested candidates. If the candidate is acceptable to TGS and interested in the position, TGS refers the candidate to the client. An employment agreement is executed by the employee with TGS prior to the commencement of employment.\nTGS serves primarily the aerospace and electronics industries as well as the telecommunications, banking and computer science industries and public utilities along with numerous manufacturing companies. TGS is expanding its\neffort to address the general trend of \"downsizing\" and \"outsourcing\" by major corporations on a national basis. To meet this goal, TGS has commenced a national sales campaign addressing a broad spectrum of Fortune 500 companies, offering a managed staffing service to those companies in the process of downsizing and outsourcing specific functions. Since companies engaged in downsizing seek to focus on its core business needs with its in-house staff, TGS seeks to identify and address the needs of a specific task or department not part of the core business for which outsourcing would be an appropriate method of addressing the needs. In addressing these needs, TGS has conducted marketing efforts with Manpower International, Inc., TAD Resources International, Inc. and Olsten Corporation. TGS's contracts are generally terminable by the client on short notice, generally 30 days.\nCompetition\nThe business of providing employees on either a permanent or temporary basis is highly competitive and is typically local in nature. TGS competes with numerous technical service organizations, a number of which are better capitalized, better known, have more extensive industry contracts and conduct extensive advertising campaigns aimed at both employers and job applicants. TGS believes that the ability to demonstrate a pattern of providing reliable qualified employees is an important aspect of developing new business and retaining existing business.\nGovernment Regulations\nThe technical services industry, in which TGS is engaged, does not require licensing as a personnel or similar agency. However, as a provider of personnel for other corporations, it is subject to Federal and state regulations concerning the employment relationship, including those relating to wages and hours and unemployment compensation. It also maintains 401(k) plans for its employees and is subject to regulations concerning such plans.\nTGS does not have contracts with the government agencies. Contracts with its clients, including major defense contractors, are based on hourly billing rates for each technical discipline. The contracts are not subject to renegotiation or cancellation for the convenience of the government. However, the manpower needs of each of its clients are based on the client's own requirements and the clients needs are affected by any modification in the client's requirements, including reductions in staffing resulting from cancellation or modification of government contracts.\nEmployees\nAt December 31, 1995, TGS had 1008 employees, of which 970 were contract service employees who performed services on the client's premises and 38 were executive and administrative. Each of TGS's offices is staffed by recruiters and sales managers. Each contract service employee enters into a contract with TGS which sets forth the client for whom and the facility at which the services are to be performed and the rate of pay. If an employee ceases to be required by TGS's clients for any reason, TGS has no further obligation to the employee. Although assignments can be for as short as 90 days, in some cases, it has been for several years. The average assignment is in the range of six to nine months. TGS's employees are not represented by a labor union, and TGS believes that its employee relations are good.TGS does not have any rights to\nany patents or other proprietary technology developed by its employees. Under its agreement with the client, all of such rights are retained by the client. In addition, the client typically requires the employee to sign its standard agreement dealing with confidentiality and rights to proprietary developments.\nMEDICAL DIAGNOSTICS\nOn September 30, 1994, Consolidated, through wholly-owned subsidiaries, acquired eight magnetic resonance imaging (\"MRI\") centers and one multi-modality diagnostic center and in January 1995, it acquired a ninth MRI Center, (collectively, the \"Centers\").\nMagnetic resonance imaging (\"MRI\") systems enhance the diagnosis of disease and medical disorders, frequently eliminating the need for exploratory surgery and often reducing the amount and cost of care required to evaluate and treat a patient. Since its introduction in the early 1980's, the use of MRI has experienced rapid growth due to the technology's ability to provide anatomical images of exceptional contrast and detail without the use of radiation or x-ray based technologies. MRI employs high-strength magnetic fields, high frequency radio waves and high-speed computers to process data. In addition, the development of pharmaceutical contrast agents, software advancements and new hardware peripherals continue to expand the clinical applications and throughput efficiency of MRI technology.\nMRI, which does not utilize x-ray or other radiation based technologies, employs high-strength magnetic fields, high frequency radio waves and high-speed computers to obtain clear, multi-planar images of the body's internal tissues without exploratory surgery or biopsy. In addition, MRI is able to image a multi-planar slice of the body at any angle. These images are then displayed on film or on the video screen of an MRI system's console in the form of a multi-planar image of the organ or tissue. This information can be stored on magnetic media for future access, or \"printed\" on film for interpretation by a physician and retention in the patient's files, enabling health care professionals to study the patient's internal conditions in detail. The superiority of MRI image quality compared to other imaging modalities generally makes possible a more accurate diagnosis and often reduces the amount and cost of care needed to evaluate and treat a patient.\nThe major components of an MRI system are (I) a large, cylindrical magnet, (ii) radio wave equipment, and (iii) a computer for data storage and image processing. During an MRI study, a patient lies on a table which is then placed into the magnet. Although patients have historically spent 30 to 45 minutes inside the magnet during which time images of multiple planes are acquired, new software applications allow patients to spend significantly less time inside the magnet. Additional time is required for computer processing of the images.\nOutpatient Services and Customer Base\nEach Center is a fixed-site, outpatient facility that is designed, equipped and staffed to provide physicians and health care providers with high quality MRI services that historically were available only at teaching hospitals. The Company schedules patients, prepares all patient billing and is responsible for the collection of all charges. The Company is also responsible for related administrative and record-keeping functions. The Company typically staffs its Centers with technical and administrative support personnel who\nassist physicians in obtaining MRI diagnostic scans. The Centers are designed to offer a pleasant environment where patients are not subjected to the admission complexities and institutional atmosphere of most hospitals.\nMany physicians and other health care providers who have a need for MRI services and equipment do not have the ability or desire to own their own equipment. As a result, such providers use outpatient MRI facilities such as the Centers for the following reasons, among others: (I) ability to receive comprehensive MRI services, including qualified technologists, equipment maintenance, insurance and equipment upgrades; (ii) desire to obtain quick access to MRI services; (iii) lack of sufficient scan volume to justify the capital cost of purchasing an MRI unit; (iv) desire to use an MRI unit to become familiar with MRI technology; (v) lack of financial capability to purchase an MRI unit, and (vi) inability to obtain required regulatory approval to purchase or operate an MRI unit.\nIn addition, many health care providers with sufficient patient utilization and resources to justify in-house MRI unit ownership prefer to use independent facilities such as IMI's Centers in order to: (i) obtain the use of an MRI system without capital investment; (ii) eliminate the need to recruit, train and manage qualified technologists; (iii) retain the flexibility to take advantage of all technological developments; (iv) avoid future uncertainty as to reimbursement policies, and (v) provide additional imaging services when patient demand exceeds in-house capacity.\nSet forth below is information relating to IMI's Centers.\nMonth and Year Center Location Service commenced - ------------------ --------------------- ----------------- Pine Island Plantation, FL December 1986 North Miami Beach North Miami Beach, FL January 1988 Boca Raton Boca Raton, FL November 1988 South Dade Miami, FL December 1989 Oakland Oakland Park, FL January 1990 San Juan San Juan, PR October 1990 Arlington Arlington, VA December 1990 Kansas City Overland Park, KS October 1991 Orlando Orlando, FL September 1992\nIn addition, IMI operates Physicians Outpatient Diagnostic Center, Ltd., a multi-modality diagnostic center, located in Plantation, Florida.\nThe decision to refer a patient to one of IMI's facilities generally begins with the treating physician, HMO\/PPO or other health care provider. IMI is then responsible for patient scheduling and billing the patient or third party payor directly. IMI also arranges for board-certified radiologists to interpret IMI's scans and returns the test results to the referring physician. IMI is not itself engaged in the practice of medicine.\nEach Center generally has a full-time staff of seven to eleven employees, typically consisting of MRI technicians, file clerks, a marketing representative, a transcriptionist, one or more receptionists and a center administrator. IMI's Centers are open at such hours as are appropriate for the local medical community. Most are open from 7:00 a.m. to 9:00 p.m. each weekday, and many of the Centers offer extended evening and weekend hours.\nEach Center is supervised by a center administrator. Each Center charges patients a fee for providing MRI studies on a per procedure or per study basis. IMI pays radiologists providing diagnostic readings of a Center's MRI scans.\nIMI markets its services through open houses, lectures, symposia, direct mail and individual visits to area physicians. Each Center uses one or more marketing representatives, the Center's administrator and certain radiologists who interpret IMI's scans to market its services to the local medical community, while IMI's national accounts manager focuses on managed care providers and third party payors.\nThe profitability of IMI is based substantially on the degree to which IMI can utilize its equipment. IMI believes that a typical center must generally average eleven to thirteen scans per day before its revenue exceeds its expenses and that, as new referring physicians and other customers become familiar with MRI technology and its applications, their rate of usage generally increases. However, to the extent that competitive pressures and third party reimbursement rates have a downward effect on IMI's revenue, the number of daily scans necessary to operate profitably will have to increase.\nGovernment Regulations\nThe operation of MRI centers is subject to numerous government regulations on both a Federal and state level. Since IMI provides services to patients on Medicare and Medicaid, it is subject to numerous regulations affecting such services. In addition, each state has its own regulations which may impact IMI's operations, including regulations dealing with the corporate practice of medicine, the referral of patients and the requirements for a certificate of need. IMI believes that it is in compliance in all material respects with applicable regulations and that the acquisition by IMI of the Centers was made in compliance with applicable laws.\nCompetition\nThe health care industry, including the market for MRI diagnostic imaging services, is highly competitive and IMI anticipates that competition, particularly for patient referrals, will intensify in substantially all of the areas in which the Centers are located. IMI competes with other MRI centers as well as regional hospitals and medical centers which also offer such services. To a lesser extent, IMI competes with mobile MRI service providers. Because of the cost of equipping and staffing an MRI center, MRI is rarely offered by a sole practitioner or by a small group practice or by a large group practice that does not have a substantial demand for such services. Each of IMI's Centers is dependent upon referrals from local physicians as well as from health maintenance organizations and other providers. IMI believes that hospitals are its most significant competitors and have certain competitive advantages, including their established community position, physician loyalty and convenience for physicians making rounds at the hospitals. Competition is based upon such factors as the reputation of the Center and reliability of the physicians who read the MRI scans, the fees charged, the Center's participation in an insurance or health plan which covers the patient, the ability to offer up-to-date MRI equipment, the convenience to the patient in terms of both proximity to the patient and the hours of service. MRI believes that its services are competitive with those offered by others in the area serviced by its Centers.\nEmployees\nAs of December 31, 1995, IMI had 165 employees, 128 of whom were involved in Center operations, 12 of whom were involved in sales and marketing, 12 of whom were executive and management and 13 of whom were involved in billing and other administrative activities. None of IMI's employees are represented by a labor organization, and IMI believes that its employee relations are good.\nELECTRO-MECHANICAL AND ELECTRO-OPTICAL PRODUCTS MANUFACTURING\nSequential Electronic Systems, Inc.\nSequential is engaged in the manufacture and marketing of various electro-mechanical and electro-optical products. The principal products manufactured by Sequential are optical encoders, encoded motors and limit programmers.\nOptical Encoders - Optical encoders are utilized in almost every manufacturing process where measurement is required as a part of the manufacturing process. Optical shaft angle encoders, like those produced by SES, are the types of encoders used in such manufacturing processes. SES furnishes encoders to the military for such applications as the launch systems for the Patriot Missile Defense System used in \"Desert Storm\". SES also furnishes encoders used in the latest state of the art NEXRAD weather system. High resolution encoders are also used as part of a telemetric tracking antenna for the National Aeronautics and Space Administration (\"NASA\").\nEncoded Motors - Encoded motors are used as a tape drive motor for use in state of the art instrumentation tape recorders. These recorders are used by the government in anti-submarine warfare detection systems and are utilized in seismic measurement recordings as well as other classified applications where the data reproduction is extremely critical.\nLimit Programmers - Limit programmers are utilized to replace mechanical CAM sequencing systems for the manufacture of various consumer products.\nS-Tech, Inc.\nS-Tech, Inc. (\"S-Tech\") is a design and manufacturing facility which has two unique and specialized product lines which consist of, specialized vending machines and avionics equipment. Specialized vending is used to describe a vending product which includes sophisticated electronic circuitry and or computer software. The vending products presently being manufactured under contract include prepaid telephone debit card machines, bill payment centers, information kiosks and stamp machines.\nAvionics Equipment - The Avionics equipment manufactured by S-Tech consists primarily of various cockpit instruments and oil pressure transmitters. The majority of these products require a qualified product list designation (\"QPL\"). The QPL list consists of qualified products, with a limited number of approved sources, which are purchased by the Department of Defense, contractors and subcontractors. In many instances this QPL designation places the company in highly advantageous competitive position as it pertains to government contracts by limiting the number of qualified bidders. In addition, S-Tech responds to \"build-to-print\" solicitations which are subject to competitive bidding. These products are manufactured in accordance with\ndrawings and data packages provided by the Department of Defense or other procuring agencies.\nSpecialized vending machines - In the vending line S-Tech designs, manufactures and markets stamp machines and stamp booklet machines, token vending machines and is designing and marketing vending machines for other specialty uses, including a pre-paid telephone calling card. The Prepaid Telephone Calling Card Vending Machines are presently in production. S-Tech is under contract to manufacture a Self Service Bill Payment Machine for Consolidated Edison of New York and an Information Kiosk, as a subcontractor to Objectsoft Corporation, for the City of New York.\nAs a manufacturer of products purchased by the Department of Defense or its contractors, S-Tech is subject to the provisions of the procurement regulations of the Department of Defense. These regulations generally provide the government with the right to terminate the contract for the convenience of the Department of Defense, and, in certain cases may include provisions for renegotiation. The Department of Defense also has regulations pursuant to which the Department may inspect a contractor's or subcontractor's manufacturing facilities. Such an inspector is present at S-Tech's facility on a regular basis. In addition, certain products may be subject to export restrictions, which require obtaining a permit before making any sales to non-United States purchasers.\nAUDIO VISUAL MANUFACTURING AND SERVICES\nWWR Technology, Inc.\nWWR Technology, Inc. (\"WWR\") was acquired in May 1995 in connection with the acquisition of Trans Global Services, Inc. WWR was originally incorporated in 1992 for the purpose of acquiring the professional products business segment of the Klipsch(tm) loudspeaker line from Klipsch and Associates, Inc. (\"KA\"). WWR acquired the inventory, tooling, equipment and certain licenses from KA as part of such purchase. The predecessor to KA was founded in the mid 1940's by Paul W. Klipsch and has established itself as a leader in loudspeaker design and innovation. KA's primary market traditionally has been the home high fidelity loudspeaker business. Concurrently, it has developed a reputation as a manufacturer of rugged, well designed loudspeakers for the professional, commercial and theater sound markets. The acquisition of the Klipsch(tm) Professional product line gives WWR one of the most long-established and, WWR believes, recognizable brand names in the industry. After WWR's acquisition of the Klipsch(tm) professional loudspeaker line from KA, KA continued to manufacture products and provide other related services to WWR pursuant to a manufacturing agreement between WWR and KA. In August 1994, WWR entered into a lease for a manufacturing facility in Hope, Arkansas and between August and October 1994 moved all of its manufacturing and related services into the newly leased facility. In connection with the completion of this move, the manufacturing agreement with KA was terminated; however' KA continues to supply certain component parts to WWR.\nThe nature of WWR's business is to market and sell loudspeakers and related products to the professional audio market. The professional audio market is defined as any application for loudspeakers other than those used for home and automotive entertainment purposes. Generally, this is a definition of the difference between \"home entertainment\" and commercial sound reproduction. As part of the future development of commercial sound reproduction, WWR believes\nthat the application of digitally controlled and processed signals to control and enhance the performance of professional loudspeakers will become a significant factor in the marketplace. WWR believes it has access to the resources needed, on an as-needed contractual basis with original equipment manufacturers, to successfully develop these products although there can be no assurance that it will be able to do so.\nSales, Markets and Marketing\nProducts are sold through a network of domestic and international independent manufacturers' representatives who are compensated on a commission basis to retailers, distributors, sound contractors installers and occasionally to end users. WWR assumed the responsibility for international sales from KA in the spring of 1993, and such sales currently constitute a significant portion of WWR's total sales. For the 12 months ended December 31, 1993, 1994 and 1995 international sales constituted approximately 20%, 23% and 25% of total sales, respectively. International sales are made to appointed distributors in individual countries and the distributors resell and service the products within their respective countries.\nThe Markets for the products include, but are not limited to: contractor installation of sound systems, paging systems, musical instrument sound re-enforcement, public address, concert sound, fixed installation, touring sound, theater and sound re-enforcement. End users of the products include: churches, synagogues, stadiums, concert halls, restaurants, schools, musical performers, movie theaters and all other applications where information and\/or entertainment is presented to the public in a commercial venue.\nThe contractor installation market is comprised of customers of WWR. These customers bid on installation of audio systems based on specifications provided by acoustical consultants in the process of designing or renovating commercial properties, restaurants, nightclubs, churches, concert halls, stadiums and other similar buildings. The requirements for each project vary according to the need and purpose of the facility and the sound systems and the types of loudspeakers range from small speakers for simple paging systems to very large speakers for concert halls, theaters or stadiums. WWR sees this market as having significant growth potential for its products and has developed and continues to develop products targeted to the various needs of this market.\nThe musical instrument market include retail sale of products to professional and amateur musicians. Loudspeakers in this market have two general purposes: (1) the reproduction of amplified or electronic instruments, and (2) the re-enforcement of voice and acoustic instruments. A portion of WWR's product line is targeted specifically to this product and the product line for this market has been expanded by WWR with new loudspeakers introduced in 1994 and plans to continue to introduce additional new products in 1995.\nThe motion picture theater market has improved over the past few years as a result of the increase in the number of motion pictures including digital film sound tracks. Digital based sound reproduction systems were subsequently introduced in motion picture theaters and while there has been little new construction of movie theaters, the current trend is to upgrade the sound reproduction systems in current theaters. WWR is upgrading its motion picture product line to meet the needs of this market. The concert and touring sound market is comprised of two segments: (1) the tours of the \"big\" name\nentertainers handled by major international touring sound companies, and (2) the smaller regional or national sound companies that provide services to lesser known performers and events. While there are significant sales in the major international touring sound companies market as a whole, the loudspeaker portion is dominated by the proprietary enclosure (cabinet) designs of the large touring sound companies using the raw frame components made by original equipment manufacturers (\"OEMs\"), including WWR. WWR has a number of raw frame component drivers that have significant potential in this market. Success in this portion of the market must be viewed as a marketing tool; by having its products selected for use on major tours, WWR has the opportunity to be associated with the success of the tour and\/or the artist. The smaller regional touring companies represent a greater opportunity for WWR as these customers are not as likely to be building their own enclosures and, therefore, purchase whole speaker systems.\nNew products\nWWR is engaged in market research to determine the specific needs of the end user so as to develop new market oriented products. Two new trapezoidal shaped loudspeakers have been introduced for use in various commercial applications. Currently under development are the following: a new line of loudspeakers designed for the musical instrument market, two new medium format (size) horns for use in fixed installations and updating of the motion picture product line utilizing newly developed components. A line of loudspeakers designed for the musical instrument market were put into production and became available for purchase in October 1994 and it is expected that the new construction techniques and materials for this line of loudspeakers will enable WWR to achieve higher gross profit margins.\nCompetition\nThe industry is comprised of a large number of competing manufacturers, the majority of which are of little overall impact in the market. Generally, the smaller firms specialize in selected portions of the market as opposed to offering a wide array of products. However, there are two dominant competitors in the overall professional loudspeaker industry - Harmon International Industries, Inc. (Harmon) which owns a number of product lines including JBL and Mark IV industries, Inc. which owns Electro Voice (EV), Altec Lansing (Altec) and University Sound (University). Other competitors include, but are not limited to, Bose Corporation, Peavey Electronics, Inc., Apogee Sound, Inc., Meyer Sound Laboratories, Inc. and Eastern Acoustic Works, Inc. WWR provides high quality products for all segments of the market but, due to the relatively smaller size of the product line offered by WWR, it is not able to compete with JBL and EV on a model by model basis. It is the plan of WWR to continue niche marketing, while expanding is product offerings as business conditions allow. WWR's general pricing policy and distribution is to offer its high quality products at competitive prices and to limit the distribution of Klipsch(tm) Professional products to a selected group of retail and contractor customers. By doing so, WWR is able to position Klipsch(tm) Professional as a \"limited distribution\" product line offering the contractor and retailer the opportunity to differentiate themselves in the range of products they offer and to further enhance their profit margins by offering products that are not as easily \"shopped for price\".\nLicenses\nAs part of the purchase of substantially all of the assets of the Klipsch(tm) Professional loudspeaker business from KA, WWR received a non-exclusive trademark license for the use of KA's trademark \"Klipsch(tm)\" in conjunction with various professional loudspeaker products (\"Licensed Products\") provided that the trademark is used only in combination with the terms \"Professional Loudspeakers,\" \"Professional Products,\" \"Pro Loudspeakers,\" Pro Products\" or a similar designation pre-approved by KA. WWR also has agreed to indicate that \"Klipsch(tm)\" is a registered trademark of KA. The licenses are world-wide and royalty free, and KA has agreed not to grant licenses and\/or otherwise permit others to use in the professional market the trademarks and certain design patents licensed to WWR. However, the licenses are terminable if WWR defaults in certain of their respective obligations to KA, becomes bankrupt or insolvent or reorganizes or ceases to use the \"Klipsch(tm)\" trademark for 18 or more consecutive months. The loss of these licenses would effectively eliminate the ability of WWR to continue to sell under the Klipsch(tm) Professional brand, however it would not prohibit WWR from seeking other professional loudspeaker products to distribute through its distribution network. WWR believes that WWR's relationship with KA is good, there can be no assurance that there will be no future developments which will cause a termination of the licenses.\nEmployees\nAs of December 31, 1995 WWR had 35 employees, 23 of whom were involved in production, 3 of whom were involved in sales and marketing, 1 was involved in research and development, 3 were involved in technical support and maintenance and 5 were involved in administration and management. None of WWR's are represented by a labor organization, and WWR believes that its employee relations are good.\nMEDICAL INFORMATION SYSTEMS\nNetsmart Technologies, Inc.\nNetsmart Technologies, Inc. was formed in September 1992 under the name Medical Services Corp., a holding company, whose operations were conducted by its wholly-owned subsidiary, Carte Medical Corp. In October 1993, Medical Services Corp. merged its subsidiary into itself and changed its name to Carte Medical Corporation. In June 1995, Carte Medical Corporation's name was changed to CSMC Corporation, and in February 1996 CSMC Corporation's name was changed to Netsmart Technologies, Inc.\nSubstantially all of Netsmart's revenue through December 31, 1995 was generated by it's health information systems and related services which are marketed by it's subsidiary Creative Socio-Medics Corp. (\"CSM\") which was acquired by Carte Medical Holdings, Inc. (\"Holdings\") from a nonaffiliated party in June 1994. In September of 1995 the stock of CSM was transferred by Holdings to Netsmart. Netsmart offers these systems and related services to specialty care health organizations and entitlement programs in the United States.\nNetsmart Technologies, Inc. (\"Netsmart\") develops, markets and supports computer software designed to enable organizations to provide a range of services in a network computing environment. A network computing environment is a computer system that provides multiple users with access to a common database and functions. A network system can be a local system, such as a\nlocal area network, known as a LAN, which operates within an office or facility, or a distributed system which provides simultaneous access to a common data base to many users at multiple locations.\nThere are typically three parties in Netsmart's network systems - the sponsor (the party that maintains the data base, and may be a managed care organization, a university or a financial institution), the users (the users are the individuals who use the system, and may be the subscribers of a managed care organization, the students at a university or the bank card or credit card holders of a financial network) and the service providers (the service providers are those who provide goods or services to the users, and may be physicians, pharmacies, banks and merchants who provide goods, services or funds to bank card or credit card holders).\nNetsmart has developed proprietary network technology utilizing smart cards which it markets in the health care, financial and education fields as the CarteSmart System.\nA smart card is a plastic card about the size of a standard credit card which contains a single embedded microprocessor chip with both data storage and computing capabilities. The smart card software provides access to the information stored in the chip, the ability to update stored information and includes security elements to restrict unauthorized access to or modification of certain information stored on the card utilizing a smart card reader system. The smart card reader system and the software provides the ability to include information on both the smart card and the organization's computer system. Netsmart also supplies network applications which use telecommunications rather that than smart cards to obtain access to and manage data.\nHealth Information Systems and Services\nSince the acquisition of CSM, Netsmart has offered its customers a range of products and services principally based open the health information systems which were developed and marketed by CSM prior to the acquisition. Users typically purchase one of the health information systems, in the form of a perpetual license to use the system, as well as contract services, maintenance and third party hardware and software which Netsmart offers pursuant to arrangements with the hardware and software vendors. The contract services include project management, training, consulting and software development services, which are provided either on a time and materials basis or pursuant to a fixed-price contract. The software development services may require CSM to adapt one of its health information systems to meet the specific requirements of the customer.\nAlthough the health information systems constituted the basis of CSM's business, revenue from the license of such systems has not represented a major component of its revenues. The typical price for a license for CSM's health information systems ranges from $10,000 to $30,000. During the years ended December 31, 1995, 1994 and 1993, CSM installed health information systems with eleven, thirteen and twelve customers, respectively. Revenue from the licensing of such systems represented approximately $162,000, $375,000 and $135,000, in the years ended December 31, 1995, 1994 and 1993, respectively, accounting for approximately 22%, 74% and 5% of revenue for such periods.\nNetsmart offers software systems developed by CSM which are designed to meet\nthe requirements of providers of long-tern specialty care treatment. Certain of its systems were developed to meet the requirements of Federally funded target cities projects and is installed in Baltimore, Los Angeles, Atlanta and Cuyahoga County (Cleveland), Ohio.\nA customer's purchase order may also include third party hardware or software. For the years ended December 31, 1995, 1994 and 1993, revenue from hardware and third party software accounted for approximately $2.0 million, $900,000 and $1.0 million, representing 26.7%, 18.1% and 19.6%, respectively, of revenues in such periods.\nIn addition to its health information systems and related services, CSM offers specialty care facilities a data center, at which its personnel perform data entry and data processing and produce operations reports. These services are typically provided to smaller substance-abuse clinics. During the years ended December 31, 1995, 1994 and 1993, CSM's service bureau operation generated revenue of approximately $1.7 million, $1.6 million and 1.7 million, respectively, representing approximately 23.6%, 32.5% and 33.6% of CSM's revenues for such periods. The largest user of the service bureau is the State of New York Office of Alcohol and Substance Abuse Services, which uses CSM's service bureau to maintain its statewide database of methadone users, however, such customer accounted for less than 4% of CSM's revenues in the years ended December 31, 1995, 1994 and 1993. Netsmart intends to augment the marketing effort for the service bureaus, although no assurance can be given that such operations will continue to be profitable.\nMaintenance services have generated increasing revenue and are becoming a more significant portion of CSM's business. Since purchasers of health information system licenses typically purchase maintenance service. Maintenance revenue increases as new customers obtain licenses for its health information services. Under its maintenance contracts, which are executed on an annual basis, CSM maintains its software and provides certain upgrades. Its obligations under the maintenance contract may require CSM to make any modifications necessary to meet new Federal reporting requirements. CSM does not maintain the hardware and third party software sold to its customers.\nThe CarteSmart System\nNetsmart's CarteSmart System software was designed to operate on industry-standard computer networks and smart cards. A smart card is a plastic card the size of a standard credit card which contains an embedded microprocessor chip. The card has data storage and computing capabilities and the smart card software includes security elements to restrict unauthorized access to or modification of certain information contained on the card. A smart card may also include a magnetic stripe to allow it to be used in networks that do not include smart card functionality. The smart cards are designed to be issued only by the sponsor organization, such as a managed care organization, specialty care facility, administrator of an entitlement program or other similar organization, a university or a bank or credit card organization.\nThe CarteSmart software consists of components which allow Netsmart to develop network applications for sponsors with less effort that would be required if those network applications were developed from scratch. The CarteSmart software consists of an Application Program Interface (\"API\") and an API Generator which shows fast customization of the API for specific network\napplications. The API is a set of software modules that provide the common functions required to support a computer network using smart cards. By using the API, Netsmart or a sponsor may develop network systems more quickly than if all of the software necessary to Implement the network were custom written for a particular network application. The API Generator is a tool developed by Netsmart that it designed to allow Netsmart or a network sponsor to develop a custom API for a particular network and reduce the effort required to build network systems.\nThe CarteSmart System is designed to operate on file servers and personal computers which utilize the DOS, Windows 3.1, Windows 95, Windows MT or UNlX operating systems, depending upon the application. The software used in the smart card can be used or adapted for use in most commercially available smart cartSmart cards generally meet international standards and are considered commodity products, although each manufacturer has its own software to interface with a computer. Accordingly, Netsmart believes that a manufacturer would provide any necessary assistance in order to market its cards.\nAlthough Netsmart's CarteSmart System software has general applications, its experience with each of its four CarteSmart clients reflects a need to customize the software to meet the specific need of the client. Although the customization need not be significant, each user has its unique requirements that must be met. These requirements may include the need to enable the CarteSmart System to interface with the client's existing systems to the development of a range of software products to meet needs which are not presently being served.\nNetsmart's initial applications were designed to meet the needs of managed care organizations and entitlement programs, and Netsmart developed a smart card interface to its health management systems. Each time a patient visits a participating health care provider, the health care provider adds to the patient's data base information concerning the visit, including the date, procedures performed and diagnosis. At the time of the first visit to a participating physician, the physician enters information relating to the diagnosis and treatment given on that visit together with such information relating to chronic conditions, such as allergies and medication, as the physician deems important. Netsmart does not anticipate that the health care provider will be expected to include information relating to earlier diagnosis or treatment; however, the organization which provides the smart card may require additional information to be input at the initial visit. This information is input into the patient's smart card and may also be transmitted to the managed care organization's central data base, where, unless dissemination of such information has been restricted by the patient other health care providers will have access to the information. The health care provider can read information from, and write information onto, the smart card through a card interface device, which is standard computer peripheral equipment readily available from composer outlets and can be easily connected to a personal computes. The information transferred to the smart card is first input by the health care provider on a computer and includes the date of service, diagnosis, treatment including any prescribed medication, and any other information which the health care provider determines.\nAt the time of the visit, The health care provider inputs the standard codes for use diagnosis and procedures performed. Errors in inputting the diagnosis and the procedure code delay payment or affect the amount of payment. The SmartCard System can be integrated with the health care provider's existing\npractice management system, without incurring any additional personnel. The CarteSmart System software has integrated within it an easy to use diagnosis and procedure code look-up capability, as well as error checking and other safeguards which assist the health care provider in inputting the proper codes based upon normal medical terminology.\nThe smart card stores only a limited amount of information, and is intended to reflect current medical conditions and not a record of medical treatment from birth. When the storage capacity of the card, which is equivalent to approximately ten typed pages, is reached, items are deleted on a chronological basis, with the earliest items being deleted first, although there is an override procedure by which certain crucial medical information, such as allergies and chronic conditions, can be retained, regardless of the date when the patient was diagnosed or treated for the condition. The card also includes information on each prescription which the patient is taking. A smart card is different from a magnetic stripe card, such as is used at Virginia Commonwealth University (\"VCU\"), in that it has an updatable data storage capacity, which a magnetic stripe card does not.\nTo date, Netsmart has licensed its CarteSmart software in conjunction with pilot projects for San Diego County and the Albert Einstein School of Medicine, which involved the issuance of smart cards to approximately 1,200 mental health patients participating in the California MediCal Managed Care Initiative. Netsmart is presently negotiating for an expansion of the program to include substance abuse and acute care as well as mental health for the county's total health care population. Netsmart is also marketing its CarteSmant System to other entitlement programs and managed care organizations; however, except for the pilot project in San Diego County, Netsmart has not entered into any agreements with any such organizations, and no assurance can be given that Netsmart will enter into any such agreements.\nIn November 1995, Netsmart entered into an agreement with the Albert Einstein School of Medicine to add the CarteSmart System to its existing system to provide smart card network capabilities for use in its clinics and out-patient facilities. Installation of the smart card network is scheduled for the second quarter of 1996. Netsmart is presently customizing the CarteSmart health care application software to meet the requirements of the Albert Einstein School of Medicine, including the ability to interface with its present computer systems in addition to the health information system licensed from Netsmart.\nDuring 1995, Netsmart commenced marketing its CarteSmart based products to markets other than the health care field. In July 1995, Netsmart entered into an agreement pursuant to which it installed a magnetic stripe identification system which uses CarteSmart technology to provide for the centralized issuance of a single card to all persons allowed access to the facility and its services. The card contains the individual's name, photo, signature and unique card identification number, which defines the holder's entitlement to food service and library services. Approximately 20,000 students are using the system. Netsmart is negotiating with respect to an agreement to expand the program to support additional services, however, no assurance can be given that the program will be expanded. A magnetic card differs from a smart card since it does not have an independent updatable data storage capability. Netsmart believes that a major market for its smart card technology is the financial services industry, including banks and credit card issuers. Commencing in May 1995, Netsmart entered into a series of letter agreements\nwith IBN for services and CarteSmart software licenses for the implementation of a satellite based distributed network of automatic teller machines and off-line point of sale terminals using smart cards for the former Soviet Union. Netsmart is negotiating a definitive agreement to develop the system and license the system to IBN. IBN is a New York-based company which has rights to install such systems in the former Soviet Union. Netsmart's agreement with IBM is not contingent upon the success of IBN's installations in the former Soviet Union, although the extent of its revenues from royalties will be based on the number of cards issued and may be adversely affected by political developments in the former Soviet Union. The system being delivered to IBN includes Oasis Technologies IST\/Share Financial Transaction System software and other third party software which Netsmart is integrating with its CarteSmart software to complete the IBN system. Through February 1, 1996, Netsmart has generated approximately $600,000 of consulting services revenue from IBN.\nIn developing the CarteSmart System for the financial services industry, Netsmart is using networking technologies that use telecommunications networks as well as smart cards. In addition, Netsmart, through a subsidiary, is purchasing the SATC Software, which processes retail plastic card transactions and merchant transactions. The purchase price is $650,000, of which $325,000 was paid by Netsmart and the remaining $325,000 is to be paid by Oasis, although Netsmart remains obligated for the balance if Oasis fails to make the payment. The SATC Software is designed to perform functions required by credit card issuers, including applications processing and tracking credit evaluations, credit authorization and the printing of statements. In the event the final payment is not made, the subsidiary will not acquire title. Netsmart has an agreement with Oasis pursuant to which Oasis is to make the remaining payments and it is negotiating an agreement with Oasis pursuant to which the subsidiary will become a joint venture corporation owned 50% by Netsmart and 50% by Oasis and\/or its principals.\nMarkets and Marketing\nAlthough the market for smart card systems includes numerous applications where a secure distributed data base processing system is important, CSM's initial marketing efforts were directed to the health and human services market, including managed care organizations and entitlement programs. In the United States alone, CSM believes that there are presently more than 75 million persons who participate in managed care programs, which are sponsored by almost 600 organizations or health insurers. Because of the relationship between the organization and the participating medical care providers and patients, the organization can institute a smart card system without the need for CSM to conduct a separate marketing effort directed at the medical care providers. Although independent health insurers which do not operate a managed care organization may, in the future, be a market for a smart card system, because the relationship between the insurer and the medical care provider is different from that of the managed care organization and its participating medical care providers, CSM is not treating independent insurance companies as a market for the CarteSmart System, and no assurance can be given that it will ever become a market for the system.\nThe market for CSM's health information systems and related services is comprised of various providers of specialty care involving long-term treatment of a repetitive nature rather that short-term critical care, such as medical and surgical hospitals or clinics. CSM believes that there are approximately\n15,000 providers of such treatment programs in the United States, including public and private hospitals, private and community-based residential facilities and Federal, state and local governmental agencies. Of these facilities, approximately 200 are customers of CSM.\nNetsmart believes that the acquisition of the CSM business and assets complements its CarteSmart business and personnel. Following the acquisition, Netsmart developed the graphical and smart card interface to the CSM health information system and commenced a marketing effort directed to the Netsmart's customer base. The two smart card agreements, San Diego County and the Albert Einstein School of Medicine, represent amendments to existing contracts to include smart card services.\nNetsmart's health information systems are marketed principally to specialized care facilities, many of which are operated by government entities and include entitlement programs. During the years ended December 31, 1995, 1994 and 1993, approximately 54%, 49% and 47%, respectively, of CSM's revenues was generated from contracts with government agencies. Contracts with government agencies generally include provisions which permit the contracting agency to cancel the contract at its convenience.\nFor the year ended December 31, 1995, one customer accounted for more than 5% of Netsmart's revenue. The State of Colorado generated revenue of approximately 1.4 million, representing 18.5% of revenue for the year. At January 31, 1996, this contract was substantially completed. Percentage of completion is based on the percentage of work performed by such date. CSM's largest customer for 1994 was Cuyahoga County (Cleveland) Ohio, from which CSM recognized revenue of $250,000, or 7.0% of revenue. During 1993, CSM had two customers which accounted for at least 5% of its revenue. Its largest customer for 1993 was the City of Baltimore, which entered into a contract with CSM for approximately $8OO,000 for software licenses and various contract services, maintenance, hardware and software. CSM's revenue from the Baltimore contract accounted for $312,000, or 63% of revenue, in 1993. The contract was completed in July 1994, and revenue from the contract in 1994 was substantially less than such revenue was in 1993. A contract with the City of Los Angeles accounted for 52% of revenue for 1993.\nNetsmart believes that the CarteSmart software has applications beyond the health and human services market and is seeking to market the software to educational institutions and in the financial services industry. In April 1995, Netsmart entered into a joint marketing agreement with Oasis, pursuant to which each company markets the software of the other company. Oasis, an independent software developer, has developed and markets a transaction processing system, known as IST\/Share, designed for high volume users in the financial services industry. Mr. Storm R. Morgan, a director of and consultant to Netsmart, is an officer of, and has an equity interest in Oasis. Netsmart believes that its agreement with Oasis will enhance its ability to market and introduce its product to the financial services industry where Oasis has an existing client base.\nNetsmart may enter into negotiations with other companies which have business, product lines or products which are compatible with Netsmart's business objectives. However, no assurance can be given as to the ability of Netsmart to enter into any agreement with such a company or that any agreement will result in licenses of the CarteSmart System.\nAt December 31, 1995, Netsmart had a backlog of orders, including ongoing maintenance and data center contracts, in the aggregate amount of $4.2 million, substantially all of which are expected to be filled during 1996. Such orders and contracts relate to health information sales and services.\nNetsmart's sales force is comprised of three full-time sales representatives, as well as Mr. Leonard M. Luttinger, chief operating officer, John F. Phillips, president of CSM, and SMI, a consultant to Netsmart. Mr. Storm R. Morgan's services include activities relating to the marketing of the CarteSmart System to industries outside of the medical field. His present efforts are devoted principally to the financial services industry. In addition Mr. Luttinger and other members of Netsmart's technical staff are available to assist in market support, especially for proposals which contemplate the use of smart card transaction processing networks.\nProduct Development\nNetsmart is continuing the development and enhancement of the CarteSmart System, and six of its employees are engaged in such activities, for the year ended December 31, 1995 and the year ended December 31, 1994, research and development expenses were $699,000 and $367,000, respectively, representing a 90.4% increase. The increase reflects research and development for smart card and related products and the graphical interface for Netsmart's health information systems. Netsmart intends to expand its development activities following completion of its public offering of stock. Netsmart intends to develop a product based on both the SATC Software and its own technologies including the CarteSmart System, and to develop a network support tool for the financial services industry. The proposed enhancements include an increased language capability so that it can be multilingual, an interface with the CarteSmart System and an interface with Oasis' IST\/Share, which is a transaction processing system for high volume users in the financial services industry.\nCompetition\nNetsmart is in the business of licensing software to entitlement programs and managed care organizations, specialty care institutions and other major computer users who have a need for access to a distributed data network and marketing health information systems software to specialty care organizations. The software industry in general is highly competitive, in addition, with technological developments in the communications industry, it is possible that communications as well as computer and software companies may offer similar or compatible services. Although Netsmart believes that it can provide a health care facility or managed care organization with software to enable it to perform its services more effectively, other companies, including major computer and communications companies have the staff and resources to develop competitive systems, and users, such as insurance companies, have the ability to develop software systems in house. Because of the large subscriber base participating in the major managed care organizations, the inability of Netsmart to license any such organizations could have a materially adverse effect upon its business. Furthermore, various companies have offered smart card programs, by which a person can have his medical records stored and software vendors and insurance companies have developed software to enable a physician or other medical care provider to have direct access to the insurer's computer and other software designed to maintain patient health and\/or medication records. The market is very cost sensitive. In marketing\nsystems such as the CarteSmart System, Netsmart must be able to demonstrate the ability of the network sponsor to provide enhanced services at lower effective cost. Major systems and consulting vendors, such as Unisys, AT&T Corp. and Andersen Worldwide may offer packages which include smart cards and other network services. No assurance can be given that Netsmart will be able to compete successfully with such competitors. Netsmart believes the health insurance industry is developing switching software to be used in transmitting claims from health care providers to the insurers, and insurers or managed care organizations may also develop or license or purchase from others the software to process such clams, which would compete with certain functions of the CarteSmart System. The health information systems business is highly competitive, and is serviced by a number of major companies and a larger number of smaller companies, many of which are better capitalized, better known and have better marketing staffs than Netsmart, and no assurance can be given that Netsmart will be able to compete effectively with such companies. Major vendors of health information systems include Shared Medical Systems Corp. and HBO Corp. Netsmart believes that price competition is a significant factor in its ability to market its health information systems and services, and was a factor in the decline in CSM's revenue from 1992 to lower levels in 1994 and 1993, although such revenue increased during 1995.\nNetsmart also faces intense competition as it seeks to enter the education and financial services markets. Competition for the education market includes not only major and minor software developers, but credit card issuers and telecommunications companies. In marketing its CarteSmart-based products to educational institutions, Netsmart can focus on the benefits to the university of providing an all-purpose card to ease administration and reduce costs. Major credit card issuers and communications companies, such as American Express, AT&T and MCI, can offer similar services by permitting the university to link their cards with the university's services. Such organizations can also use these marketing efforts so a part of their overall corporate marketing strategy to familiarize the students with their particular cards and services in hopes of attracting the students as a long-term user of their cards and services. As part of a marketing plan, rather than a profit center, such card issuers may be able to offer the universities services similar to Netsmart, but at a lower cost to the university. In this context, it is possible that, unless Netsmart can enter into a marketing arrangement with a major card issuer or telecommunications company, Netsmart may not be able to compete successfully in marketing its CarteSmart products to educational institutions.\nThe financial services industry is served by numerous software vendors. In addition, major banks, credit card issuers and other financial services companies have the resources to develop networking software in house. At present, most financial institutions use magnetic stripe cards rather than smart cards. Netsmart believes that its CarteSmart System together with the SATC Software and its joint marketing agreement with Oasis, which presently serves the financial services industry, will assist Netsmart in selling and licensing its products and services in the financial services industry. However, to the extent that smart cards become more important in the financial services industry, more companies in the financial services industry, as well as the major computer and software companies, all of whom are better known and substantially better capitalized than Netsmart, and numerous smaller software developers, are expected to play in increasingly active role in developing and marketing smart card based products. No assurance can be given as to the ability of Netsmart to compete in this industry.\nGovernment Regulations\nThe Federal and state governments have adopted numerous regulations relating to the health care-industry, including regulations relating to the payments to health care providers for various services. The adoption of new regulations can have a significant effect upon the operations of health care providers and insurance companies. Although Netsmart's business is aimed & meeting certain of the problems resulting from government regulations and from efforts to reduce the cost of health care, the effect of future regulations by governments and payment practices by government agencies or health insurers, including reductions in the funding for or scope of entitlement programs, cannot be predicted. Any change in, the structure of health care in the United States can have a material effect on companies providing services, including those providing software. Although Netsmart believes that one likely direction which may result from the current study of the health care industry would be an increased trend to managed care programs, which is the market to which Netsmart is seeking to license its CarteSmart System. No assurance can be given that Netsmart's business will benefit from any changes in the industry structure. Even if the industry does evolve toward more health care being provided by managed care organizations, it is possible that there will be substantial concentration in a few very large organizations, which may seek to develop their own software or obtain software from other sources. To the extent that the health care industry evolves with greater government sponsored programs and less privately run organizations, Netsmart's business may be adversely affected. Furthermore, to the extant that each state changes its own regulations in the health care field, it may be necessary for Netsmart to modify its health information systems to meet any new record-keeping or other requirements imposed by changes in regulations, and no assurance can be given that Netsmart will be able to generate revenues sufficient to cover the costs of developing the modifications.\nA substantial percentage of CSM's business has been with government agencies, including specialized care facilities operated by, or under contract with, government agencies. The decision on the part of a government agency to enter into a contract is dependent upon a number of factors, including economic and budgetary problems affecting the local area, and government procurement regulations, which may include the need for approval by more than one agency before a contract is signed. In addition, contracts with government agencies generally include provisions which permit the contracting agency to cancel the contract at its convenience.\nIntellectual Property Rights\nhe CarteSmart System is a proprietary system developed by Netsmart, and its health information system software is proprietary software developed by CSM. Netsmart has no patent rights for the CarteSmart System or health information system software, but it relies upon non-disclosure and secrecy agreements with its employees and third parties to whom Netsmart discloses information. No assurance can be given that Netsmart will be able to protect its proprietary rights to its system or that any third party will not claim rights in the system. Disclosure of the codes used in the CarteSmart System or in any proprietary product, whether or not in violation of a non-disclosure agreement, could have a materially adverse affect upon Netsmart, even if Netsmart is successful in obtaining injunctive relief, and no assurance can be given that Netsmart will be able to obtain injunctive relief. Furthermore, Netsmart may not be able to enforce its rights in the CarteSmart System in certain foreign countries. Prior to joining Netsmart, Messrs., Leonard M. Luttinger and Thomas L. Evans, chief operating officer and vice president, respectively, of Netsmart, were employed by Onecard Corporation (\"Onecard\"), a corporation which was engaged in the development of smart card technology. Netsmart developed its CarteSmart technology independent of Onecard, and no Onecard technology was incorporated in the CarteSmart technology.\nSource of Supply\nSince Netsmart does not provide any of the hardware or the smart cards it is the responsibility of the licensee to obtain the hardware smart cards and other supplies. Netsmart's software operates on computer hardware and smart cards manufactured by a number of suppliers.\nPotential Business Agreements\nFollowing completion of it's anticipated public offering in 1996, Netsmart may enter into joint ventures, acquisitions or other arrangements, such as joint marketing arrangements and licensing agreements, which Netsmart believes would further Netsmart's growth and development. In negotiating such agreements or arrangements, Netsmart anticipates that such agreements would he based upon the manner in which Netsmart's business can be expanded, the extent to which either Netsmart's technology can be introduced or developed in fields not then being addressed by Netsmart or the extent to which additional channels can be developed for Netsmart's products and technology. Netsmart is a participant in a joint marketing vehicle by which Netsmart's products can be marketed by other parties to the marketing arrangement, including IBM, and Netsmart would have access to customers of the marketing partners. Netsmart's proposed joint venture with Oasis to purchase the SATC Software and its joint marketing agreement with Oasis are other examples of such agreements. Although Netsmart is engaged in negotiations and performing its due diligence investigations, with respect to a potential acquisition, Netsmart has not entered into any letters of intent or agreements with respect to any such arrangements or transactions. Furthermore, no assurance can be given that any agreement which Netsmart enters into will generate any revenue to Netsmart. To the extent that Netsmart enters into an agreement with an affiliated party, the terms and conditions of such agreement will be on terms at least as favorable to Netsmart as those Netsmart could achieve in negotiations at arm's length with an independent third party. If any such agreement is with an affiliated party, Netsmart will seek the approval of a majority of the directors who have no affiliation with the other party.\nEmployees\nAs of December 31, 1995, Netsmart had 72 employees, including five executive, seven marketing and marketing support, 54 technical and six clerical and administrative employees. The chief executive officer and the president of Netsmart devote only a portion of their time to the business of Netsmart. If a public offering is completed, Netsmart intends to hire additional personnel as needed.\nTHREE DIMENSIONAL PRODUCTS AND SERVICES\n3D Technology, Inc.\n3DT is engaged in the development and marketing of products based on three-dimensional imaging and digitizing technology. Three-dimensional digitizing is the process of constructing a digital image of an object. Three dimensional digitizing products are used in various phases of the development and manufacture of a product, including rapid prototyping, manufacturing of components and quality control. 3DT's scanning products can generate digitized images which can be input into computer assisted design or computer assisted manufacturing (\"CAD\/CAM\") software systems.\n3DT was founded to develop solutions using three-dimensional imaging technology in response to a perceived need by the manufacturing and metrology industries for products to enable them to develop and introduce new products and to improve the quality control and maintenance operations. As a result of developments in laser and other imaging technologies, it became possible in many instances for a manufacturer to design products more efficiently using three-dimensional imaging technology either by itself or combined with CAD\/CAM systems. It also became easier to duplicate products for which the manufacturer did not have drawings of the molds. Similarly in metrology, which is the science of measuring, it became possible to determine rapidly whether a product or part meets the specifications and tolerances, either at the manufacturing facility at the time of production or in the field as part of continued maintenance.\nCAD\/CAM systems are software systems used to design products and to generate the necessary computerized instructions for the manufacture of an object in accordance with the computerized design. The resulting computer instructions can be translated into instructions for computerized numeric control (\"CNC\") or computerized measuring machines (\"CMM\") or stored as a data base for future reference. CNC equipment is manufacturing or milling equipment which is programmed to manufacture a part or component based on computerized instructions. The computerized instructions can be generated by either CAD\/CAM systems or directly from scanning equipment. CMM equipment is used in quality control to ascertain whether the finished product conforms to the specification.\nRapid prototyping is the generation of a physical model of a product. The model can be either designed on a CAD system or produced from digital information generated by a scan of the object. Scanning equipment, such as 3DT's OpticaTM laser scanner, can generate a digitized image of an object in a form which can be input into a CAD program and modified in the CAD system to meet the design requirements of the manufacturer. The use of rapid prototyping systems is intended to reduce the development time of a product. Rapid prototyping systems are used in industries such as the automotive, aviation and medical fields which devote substantial resource to product design.\nIn the manufacturing process, a laser scanner can be mounted directly onto manufacturing equipment, principally CNC equipment, which uses the digitized information to generate an object having the same outside dimensions as the scanned object. In addition, in the same manner as rapid prototyping, the scanned image can be used as the basis for the further development of a product, and the data generated can be used either to make the product or to make the molds and dies used in the manufacture of the product. 3DT's Optical laser scanner is designed to enable a manufacturer to perform these functions.\nSince the scanning operations generate a computer file setting forth the\ndimensions and other measurements of an object, this information can be used in quality control and maintenance to determine whether the object being scanned meets the required specifications and tolerances. 3DT's Lazer TracerTM is designed to be used by quality control and maintenance personnel to determine whether the finished product complies with the specifications.\n3DT is the exclusive distributor in Europe and Israel of the SurfacerTM software product lines, which 3DT markets pursuant to an agreement with Imageware, Inc. (\"Imageware\"). The Surfacer software is designed to convert the mathematical information generated by a laser sensor or other imaging device into a useful computer format. While the digitized data can be input into and can be recognized by CAD\/CAM systems, the image generated consists of lines and points, but does not show any surface or covering on the image. The Surfacer software converts the mathematical data into an image with a surface having the tension and other characteristics set by the user. Using Surfacer, the CAD\/CAM system can project a three-dimensional image of the object as a completed product on the computer screen, and the operator of the system can work with the generated object.\n3DT also distributes VisiCad and VisiCam software pursuant to an exclusive distribution agreement with Vero International Software Srl, an Italian corporation. VisiCad is a PC-based surface and solids modeling and design package which is used to create three-dimensional designs. VisiCam is a PC-based multi-axis, multi-surface, milling and turning and EDM CAM package which can use information generated by Surfacer or VisiCad to complete the manufacturing of a product.\nIn addition to the hardware and software products which 3DT markets, 3DT offers scanning and digitizing services for customers who do not require a scanning system but can use a folio which can be used in the customer's CAD\/CAM systems or which can be input directly into the customer's CNC equipment.\n3DT has completed the development of a foot digitizer, which is used to develop shoes and shoe-lasts for a person based upon the digitized image of his foot. 3DT has an informal agreement with a manufacturer of non-laser scanners, to develop an initial prototype of a foot digitizer. 3DT is discussing with four major shoe companies the potential of marketing the foot digitizer system for custom shoe and orthopedic shoe applications.\nThree Dimensional Products and Services\nOptical Laser Scanner and Lazer Tracer\n3DT has developed two laser scanning products -- its Optical laser scanner which can be either mounted on CNC or CMM equipment or interfaced with CAD\/CAM equipment, and its Lazer Tracer, which is a hand-held countour-measuring system designed to be used for quality control. The computerized instructions can be either generated by CAD\/CAM equipment or directly from scanning equipment. 3DT introduced both the Optical laser scanner and the Lazer Tracer in spring 1994. However, 3DT has not generated any significant revenue from these products. The Lazer Tracer is based on certain patents (\"GE patent rights\") being acquired by 3DT from General Electric Company (\"GE\") pursuant to a January 1994 agreement. Pursuant to the agreement with GE, 3DT acquired four uncompleted prototypes for the Lazer Tracer and is required to complete the development of the prototypes and to deliver them to GE.\n3DT's Optical laser sensor takes a three-dimensional picture of a solid object by recording the reflection of a beam of light that is \"reflected\" off the solid object and is recorded by a special camera that converts the light emitted by the laser and projected onto the object's surface into electrical impulses and digitizes the input. It enables a user to reconstruct a physical object by converting the image generated by the sensor into a three-dimensional replication by identifying the points on the surface of the object into a series of mathematical x, y and z coordinates. These coordinates represent the height, width and depth of each point on a three-dimensional grid. The proposed laser scanner, is designed to interface with most standard CNC controllers and can be mounted directly onto a CNC machine. The digitizing software incorporated into the laser scanner can generate data in formats which are accepted by standard CAD\/CAM software. Once the data is input into a CAD\/CAM system, it can be modified to meet the manufacturers specific needs. The Optical laser scanners are manufactured by a nonaffiliated company, which is using its own base technology to meet 3DT's specific needs. However, 3DT does not have any long-term agreement with the supplier.\nThe principal uses for 3DT's Optical laser scanner include rapid prototyping and reverse engineering, duplication of parts or components for which there is no CAD design. The software in the scanner enables the user to see a virtual image of the product on a computer screen in addition to producing a physical model of the product. By being able to visualize and feel a model of a product, a manufacturer can save substantial time and effort and introduce the product to market earlier than would otherwise be the case. In cases where the manufacturer has a part, but not a computer design, the scanner can be used to produce a virtual image that is needed to create a CAD model from which a die or mold can be produced. Using this method, a manufacturer can make an exact duplicate of almost any item ranging from antique furniture to plastic bottles and containers to automobile and aircraft parts.\n3DT's Lazer Tracer, which is based on a GE patent, is designed for the metrology industry and uses laser technology to measure geometric features such as radii, angles and curves. Unlike the Optical laser scanner, which can also perform measuring tasks, the Lazer Tracer is hand held and is designed for use on the assembly lines and in maintenance operations where the continued performance of a part is important. The Lazer Tracer is designed to measure the various parameters against stored information as to the specifications and permissible tolerances. The unit is intended to be used in any environment and will provide quick indications whether the product meets the specifications. The quality control functions can be used in any facility where it is important to know rapidly whether the product complies with the specifications, especially when it is difficult for another measuring device to determine whether the product conforms to specifications. The unit has applications in field maintenance where precision is crucial to determining whether the object continues to conform to specifications. One such application is aircraft maintenance where another measuring device may have difficulty in determining whether the blade of a jet engine continues to meet specifications. The patents cover hand scanning devices which can be used inthe metrology industry. 3DT commenced marketing both the Optical laser scanner and the Lazer Tracer during summer of 1995, however, no such efforts have resulted in significant revenue.\nThe laser sensors and other laser based products are subject to regulation by Federal Bureau of Radiation Health (\"BRH\") of the Occupational Safety and\nHealth Administration, which requires that all such products meet certain standards. 3DT has filed with the BRH applications with respect to its laser products, and 3DT may sell the products in the United States. Other countries, including Canada, also may subject laser products to regulation. 3DT intends to make application under applicable laws to market its products in Canada.\nSurfacer Software\nThe Surfacer software is a software environment for working with three-dimensional data. The data can be generated by any source, including three-dimensional scanners utilizing laser and other technology, medical and other imaging systems. While the digitized data can be input into and can be recognized by a CAD\/CAM system, the image generated consists of lines and points, but does not show any surface or covering on the image. This software is designed to convert the information generated by a laser sensor or other imaging device into a mathematical representation of the model. Using Surfacer, the CAD\/CAM system can project a three- dimensional image of the object on the computer screen, and the operator of the system can work with the generated object.\n3DT and Imageware believe that the Surfacer software can be used in numerous industrial and other applications, especially in industries where the appearance of a product is important, such as the automobile industry. Using scanning and the Surfacer software, an automobile manufacturer can develop and evaluate a model of a new automobile in a much shorter time period and can improve the quality of the assembly process.\nPursuant to its agreement with Imageware, dated as of February 1, 1993, Imageware appointed 3DT as its exclusive distributor for the Surfacer software in Europe and Israel. 3DT has the right to sell software licenses to end users in the territory. In addition, Imageware has the right to market the Surfacer software to original equipment manufacturers (\"OEM\"); however, Imageware has the sole right to approve an OEM arrangement, which is made directly between 3DT's customer and Imageware.\nThe agreement continues until March 31, 1997; however, Imageware has the right to terminate the agreement prior to such date in the event that 3DT fails to meet its sales quotas for two consecutive calendar quarters. The agreement provides that 3DT's quotas for each calendar quarter, commencing with the quarter ending September 30, 1994, are based on Imageware's sales of its Surfacer software in the United States. The termination of the Imageware agreement would have a material adverse effect upon 3DT.\n3DT's customers for the Surfacer software include major European manufacturing companies in such industries as automotive, aerospace and manufacturing. 3DI, a subsidiary of 3DT, has received an order from Audi and BMW of Germany, Rover of the United Kingdom and Saab of Sweden.\nVisiCad and VisiCam\nVisiCad is a state-of-the-art PC-based surface and solids modeling software and design package used to create three dimensional models using both MS-Windows 95 and MS-Windows NT software environments. The different VisiCad modules allow a designer to elaborate on models be using a flexible and intelligent sketcher without the need for concentration on choosing detailed\ngeometry commands. For example, in constructing a line that connects two other elements, VisiCad presents all tangency and separation possibilities according to the position of the cursor line without recourse to the menus.\nVisiCam is a state-of-the-art PC-based multi-axis, multi-surface milling, turning and EDM CAM software package which uses information generated by Surfacer or VisiCad, or other CAD system, to complete the manufacturing of a product. VisiCam offers surfacing, milling and editing modules. VisiCam is an easy to use series of software packages featuring pop-down menus and dialogue boxes and powerful commands, all available by clicking a mouse. It also offers a range of CNC applications and an integrated geometry generation and machine tool simulation package.\nDigitizing and Design Services\n3DT has recently begun to offer imaging, digitizing and product development services at its Connecticut and Belgium offices. These services involve the digitizing of an object provided by the client, the use of the Surfacer software to generate an image with the desired surface and the delivery of a computer file which can be used in any CAD\/CAM system. In addition, 3DT can deliver a prototype of a scanned model. 3DT offers these services both as an independent source of revenue and as a part of its marketing program for its products and services. These services have generated only minimal revenue through December 31, 1994, and no assurance can be given that 3DT will ever generate meaningful revenue from this service or that the service will assist it in promoting its products and services.\nFoot Digitizer\n3DT has an informal agreement with a nonaffiliated West German manufacturer of non-laser based three- dimensional scanning equipment pursuant to which such manufacturer has developed for 3DT a prototype of the Foot Digitizer. The Foot Digitizer is a three-dimensional scanner which rapidly scans a human foot. The resulting scan is designed to be used to develop shoe molds which are custom designed for the scanned foot. The Foot Digitizer is expected to be marketed to manufacturers of orthopedic shoes and custom made footwear. The ability of 3DT to market the Foot Digitizer will be dependent upon 3DT's ability to demonstrate to custom shoe manufacturers that the Foot Digitizer represents a method of increasing revenues and gross profit, as to which no assurance can be given.\nPresently, this system is going through clinical testing at the Norway Orthopedic Center for European FDA approval. 3DT, through its offices in Belgium filed an EEC project during March 1995, with other industrial market leaders from Europe, to make a total system that will be utilized to produce foot casts automatically from a digitized foot. Upon approval, the EEC may fund this project on an installment basis. 3DT would manage the project and establish worldwide marketing and distribution channels\nOther Products\nIn addition to its products and software, 3DT has marketing rights with respect to CAD\/CAM software and hardware. As a result, 3DT is able to market an integrated system to meet the specific needs of its clients. Such a system could include an Optical scanner or Lazer Tracer, the Surfacer software, CAD\/CAM software and hardware. 3DT has received a purchase order for one such\nsystem at a price of approximately $110,000.\nMarkets and Marketing\nThe market for three-dimensional scanning equipment and the Surfacer software includes a range of manufacturing and industrial companies in industries as varied as the automotive and aircraft, manufacturers of molds and dies for plastic containers, toys and any industry or application where the creation of a product requires the development of an accurate three-dimensional model. Another aspect of the market for three-dimensional scanning is the metrology market, where precise measurements are required to determine whether a product meets the specifications.\nTo date, 3DT's marketing effort has been directed principally to marketing the Surfacer software in Europe. 3DT's European marketing staff operates from its European headquarters in Belgium, and it has sales agencies in the United Kingdom and Germany. Its marketing effort for the Surfacer is conducted by both an in-house sales and service staff and a network of representatives. With the recent market introduction of the Optical laser scanner and the Lazer Tracer, 3DT has commenced marketing its products both directly to end users, including customers who would purchase the products on an OEM or VAR basis, and it is seeking to establish a network of representatives.\nCompetition\n3DT's products compete with other laser scanning products as well as products which scan objects using technologies which are not laser based. Competition is based on the cost and safety or perceived safety of the equipment, the specific requirements of the user, the compatibility of the scanning equipment with the user's CAD\/CAM and manufacturing equipment and the cost savings expected to be realized from the purchase of the equipment. 3DT's competitors include a number of small and medium sized companies that offer products that are designed for certain specific applications. No assurance can be given that 3DT will be able to compete successfully with such competitors.\nIntellectual Property Rights\nIn January 1994, 3DT entered into an agreement with GE pursuant to which it agreed to purchase from GE a patent and patent application relating to the technology used in the Lazer Tracer. The agreement requires 3DT to pay the purchase price of $175,000 as follows: $25,000 on signing the contract, which payment has been made, and three payments of $50,000 due at various times after 3DT has delivered the fourth Lazer Tracer unit, or earlier based upon 3DT's sales of Lazer Tracer units. The agreement also grants 3DT a license to use certain GE technology relating to the Lazer Tracer. The agreement also gives GE a non-exclusive irrevocable rights to use the GE patent rights. Under the agreement, until the purchase price is paid, 3DT has a revocable license to use the GE patent rights. Upon payment of the balance of the purchase price, 3DT will receive title to the GE patent rights, subject to any licenses previously granted by GE. GE has agreed to give 3DT notice prior to granting any such licenses, which will enable 3DT to take title to the GE patent rights prior to the grant of any license by GE. No assurance can be given that the GE patent rights will be effective in limiting the development of competing products by others who could design around the patents. Except for the GE patent rights, 3DT has no other patent or copyrights on its products. Although 3DT has signed non-disclosure agreements with its\nemployees and others to whom it disclose proprietary information, no assurance can be given that such protection will be sufficient. The unauthorized use or disclosure of 3DT's proprietary software and other proprietary information may have a materially adverse effect upon its business.\nTELECOMMUNICATIONS\nARC Networks, Inc.\nARC Networks was acquired by the Company in December 1993 at the same time as the Company acquired Avionics. ARC Networks was formed by the senior officers of Avionics in 1993 to market a range of telecommunications services to meet the specific needs of its customers. In performing these services, ARC Networks analyzes the client's current telecommunications services and its anticipated short and medium term requirements and seeks to design and implement a telecommunications program to meet such needs. Such services may include designing a client's internal voice, video and\/or data communications network or a local area network for intra-office voice and data communications or a wide area network to enable each office to communicate internally, locally, nationally and internationally through one or more local or long-distance carriers. As a distributor of Ericsson Business Communications, Inc. equipment, ARC Networks can offer a range of telecommunications switching and other telecommunications equipment, which could be included as part of a total telecommunications package.\nIn 1993, ARC Networks entered into a ten-year national agreement with Teleport Communications Group, Inc. (\"TCG\") pursuant to which ARC Networks can resell local telephone service offered by TCG, which utilizes its own fiber optic network to bypass the service presently offered by the local telephone companies. Until recently, only the local telephone company could offer local telephone service; however, TCG is presently providing local telephone service, which was made possible in New York by rulings of the New York Public Service Commission to deregulate local telephone services. TCG was founded by Merrill Lynch in 1983 to provide long-distance communications for its own use and other corporations based in lower Manhattan in New York City. ARC Networks is marketing local telephone service as an enhancement to a telecommunications services program which ARC Networks designs to enable a customer to minimize the customer's exposure to telecommunications downtime.\nCurrently, ARC Network, under the agreement is operating in New York and has a new customer in San Francisco. Additionally, ARC Network plans to market to 40 principal cities throughout the United States.\nUnder the agreements with TCG, ARC Networks has the right to resell point-to-point and local telephone services in every city served by TCG. ARC Networks purchases minutes of telephone time at discounted bulk rates from TCG and resells those minutes at a premium over cost to its clients. ARC Networks does not believe its contractual obligations to purchase telephone usage from TCG represents a material commitment.\nARC Networks believes that it can enhance its position with its clients by offering a value added consulting and telephone management service. The local telephone service in each city is presently dominated by the local telephone companies, who are expected to compete vigorously with resellers. Furthermore, other companies, including long-distance carriers and other telephone companies, may seek to offer local telephone service.\nARC Networks markets its service to high volume commercial users of telecommunications service through a small in-house sales staff and independent telecommunications consultants, some of whom may also perform consulting services for potential customers. It presently provides its services to 40 accounts.\nARC Networks competes with numerous consulting firms, including major international firms, consulting divisions of major accounting firms, consulting divisions of equipment manufacturers and numerous independent firms, some of which may have ongoing relationships with the potential clients, including relationships resulting from a prior employment or other affiliation. The ability of ARC Networks to generate profitable business is dependent upon its ability to distinguish itself from the other firms offering similar services, including and no assurance can be given as to their ability to generate profitable operations. The ability of ARC Networks to complete successfully as a provider of local telephone telecommunications service is dependent upon both its ability to include such services as part of an integrated telecommunications package and, in such capacity, to be able to offer such users local telecommunications service of a quality comparable to that offered by the local telephone companies and other major suppliers of local telephone service at rates which are lower that the rates offered by the local telephone operating company and other providers of local telephone service. The market for local telephone service may be analogous to the market for long-distance service. When competition was permitted in long-distance telephone service, a large number of companies offered such service, including many resellers. However, as the market matured, it became dominated by a small number of long-distance carriers. Similarly, local telephone service may become dominated by a small number of well-capitalized companies and the competition among such companies may inhibit the growth of resellers. Furthermore, local telephone service may become subject to governmental regulations on a Federal, state and local basis. Accordingly, no assurance can be given that ARC Networks can or will ever operate profitably or that there will be a long-term market for the resale of local telephone service.\nTelecommunications services are subject to Federal, state and local regulation. Although there has been considerable deregulation in the telecommunications industry, there continue to be regulations affecting local telephone service, both as to rates and nature of service provided and telecommunications equipment.\nBUSINESS CONSULTING SERVICES\nSIS Capital Corporation\nSISC was organized by Consolidated for the purposes of making investments in or advancing funds to companies in which Consolidated has or proposes to obtain an equity position. SISC or one of SISC's subsidiaries holds the Company's equity and debt position in all of the operating subsidiaries. SISC has also advanced approximately $1,072,000 to a nonaffiliated company which was a debtor in possession pursuant to a Chapter 11 proceeding under the Bankruptcy Act and for which the Company was also performing consulting services. Effective March 1995 the bankruptcy trustee's plan was confirmed in which the Company has a super priority lien on the advances and has the right to name a director to the debtor. If the debtor goes into default to any creditor, the Company has the right to assume the operations of the debtor\nand to convert the debt to equity and at the election of the Company, may receive additional shares of the debtor as a partial reduction of the secured debt enabling the Company to have up to a 95% equity interest in the debtor.\nThe Trinity Group, Inc.\nTrinity provides management and related services both to Consolidated's subsidiaries as well as nonaffiliated entities. Trinity's management services include management, finance, accounting, operations, marketing and other services, which are typically rendered pursuant to a consulting agreement. In the early stages of the subsidiaries' development, Trinity's officers, may serve as senior executive officers of the subsidiaries. In addition, Consolidated, either through Trinity or one of the other subsidiaries, may provide or arrange financing for the subsidiaries. To the extent that the subsidiaries are not generating an operating profit, Trinity may defer the receipt of payment until the subsidiary has the resources to pay the fee.\nIn addition to performing services for its subsidiaries, Trinity provides similar management services for other companies which are not affiliated with Consolidated. Services for both the subsidiaries and non-affiliated companies are performed principally by Lewis S. Schiller, chairman of the board, president and chief executive officer of Consolidated. Other services may be performed by other officers of Trinity or Consolidated or by independent consultants who are engaged on an ad hoc basis. The fee structure, which is set prior to the engagement, may be paid in cash or securities. Trinity does not conduct any advertising or any active marketing program. Typically, Trinity is engaged as a result of personal contacts by Mr. Schiller.\nTrinity competes with numerous consulting firms, including major international firms, consulting divisions of major accounting firms, consulting divisions of equipment manufacturers and numerous independent firms, some of which may have ongoing relationships with the potential clients, including relationships resulting from a prior employment or other affiliation. Trinity's ability to compete successfully in providing consulting services is presently dependent upon the personal contacts of Mr. Lewis S. Schiller, and no assurance can be given that Trinity can or will be able to perform services for nonaffiliated entities. To the extent that the services of Mr. Schiller are required for the management, operation and funding of Consolidated's subsidiaries, Trinity's ability to perform services for nonaffiliated parties is now significantly limited.\nResearch and Development\nThe Company's research and development and product development activities are conducted by 3DT, CSM and Sequential, including its subsidiary S-Tech. The Company's research and development expenses for the twelve month periods ended December 31, 1995 and December 31, 1994 and the fiscal years ended July 31, 1994 and 1993 were approximately $893,000, $4,842,000, $1,902,000 and $396,000, respectively. All research and development activities were performed by the subsidiaries and were company-financed. The Company's research and development and product development efforts could be adversely affected by the lack of available funds.\n3DT's development effort has related principally to the development of software which integrated laser sensors with computerized numerical control equipment and other equipment and in connection with the development of its\nproposed new products, including the proposed hand sensor and foot digitizing system.\nEmployees\nAs of December 31, 1995, the Company employed an aggregate of 365 persons on a full-time basis, of whom 102 were executive, managerial and administrative, 32 were sales and marketing, 45 were manufacturing and 186 were technical. The Company's manufacturing employees all work for either Sequential, S-Tech or WWR and its technical personnel are employed by Netsmart, IMI, 3DT, and Trans Global. In addition, at such date, Trans Global employed approximately 970 individuals who were employed by Trans Global performing work on a temporary basis for, and on the premises of, its clients. The number of persons who are employed by Trans Global varies from period to period, depending on the requirements of their respective clients. All of the employees working for Trans Global's clients are employed on a temporary basis. None of the Company's employees are represented by a union, and the Company believes that its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Property\nConsolidated and its subsidiaries, other than 3D International, IMI, Sequential, S-Tech and WWR Technology, occupy an aggregate of approximately 7,000 square feet of office space, principally in New York City and Long Island, New York and Connecticut.\n3D International presently has offices in three cities in Europe, where it leases an aggregate of approximately 4,000 square feet.\nSequential occupies approximately 15,000 square feet of office and manufacturing space in Elmsford, New York.\nS-Tech occupies approximately 6,500 square feet of manufacturing and office space in West Babylon, New York.\nIMI owned four of its Centers and leased the facilities for the remaining centers. Each Center consists of 3,000 to 5,000 square feet, generally located in a shopping plaza or suburban office park in close proximity to major medical facilities. IMI also leases approximately 5,000 square feet for its executive and administrative headquarters in Boca Raton, Florida.\nWWR Technology occupies approximately 70,000 feet of usable manufacturing, office and storage space located in Hope, Arkansas.\nThe aggregate amount of annual rent payable by the Company, based on leases in effect as of December 31, 1995, is approximately $1,600,000. The Company believes that its present space is adequate to meet its present needs and that additional space is available at suitable locations and on reasonable terms.\nItem 3.","section_3":"Item 3. Legal Proceedings\nHolding Company:\nThe Company has been named as a defendant in a lawsuit filed by a company it was contemplating acquiring in January 1995 for alleged unauthorized use of proprietary information specific to that line of business. Outside counsel handling this case has advised the Company that it has meritorious defenses to obtain a dismissal of the lawsuit.\nContract Engineering Services:\nThe Government Printing Office wrote a subsidiary of the Company asking to be reimbursed a total of $296 for unauthorized timework on two programs. The subsidiary has been in contact with the Department of Justice which has stated that they were declining prosecution of the subsidiary regarding this matter. Management believes these claims are without merit and intends to contest these claims vigorously if reasserted by the Government Printing Office and believe that the ultimate disposition of this matter will not have a material adverse effect on the financial position of the Company.\nItem 3. Legal Proceedings (continued)\nThe United States Department of Labor (\"DOL\") has filed a complaint against Job Shop Technical Services, Inc. (\"Job Shop\"}, a company from which a subsidiary of the Company purchased certain assets and assumed certain obligations, and its former principal shareholder for civil violations of ERISA resulting from the failure of Job Shop to deposit employee contributions to Job Shop's 401(k) retirement plan. A similar complaint was filed by former employees of Job Shop against Job Shop, its former principal shareholder and others. At November 21, 1994, the amount due to the Job Shop 401(k) plan was approximately $3,000, which amount may have increased since such date as a result of interest and penalties. Neither the Company nor RMI, which is the subsidiary which acquired assets and assumed certain obligations of Job Shop in November 1994, has been named as a defendant in either of such actions. The DOL has raised with the Company the possibility that RMI may be liable with respect to Job Shop's ERISA liability as a successor corporation or purchaser of plan assets, even though RMI may did not assume such obligations and paid value for those assets which it did purchase. Although the Company believes that RMI is not a successor corporation to Job Shop and is not responsible for Job Shop's ERISA violations, the DOL may take a contrary position. If the DOL takes such a position and prevails, it would have a material adverse effect upon the operations of RMI and possibly the Company as a whole.\nMedical Information Services:\nAn action was commenced against a subsidiary of the Company by the filing of a summons with notice in the Supreme Court of the State of New York, County of New York. The action was commenced by Jacque W. Pate, Jr., Melvin Pierce, Herbert A. Meisler, John Gavin, Elaine Zanfini, individually and derivatively as shareholders of Onecard Health Systems Corporation and Onecard Corporation, which corporations are collectively referred to as \"Onecard\". The named defendants include, in addition to the subsidiary, officers and directors of the subsidiary and the Company. A complaint was filed on November 15, 1995. The complaint makes broad claims respecting alleged misappropriation of Onecard's trade secrets, corporate assets and corporate opportunities, breach of fiduciary relationship, unfair competition, fraud, breach of trust and other similar allegations, apparently arising at the time of, or in connection with the organization of the subsidiary in September 1992. The complaint seeks injunctive relief and damages, including punitive damages of $130,000. Management believes that the action is without merit, and it will vigorously defend the action. Nevertheless, due to uncertainties in the legal process, it is at least reasonably possible that management's view of the outcome will change in the near term and there exists the possibility that there could be a material adverse impact on the operations of the Company.\nItem 3. Legal Proceedings (continued)\nAudio Visual Manufacturing and Services:\nThere is an action pending against a subsidiary of the Company alleging claims against the subsidiary for unauthorized use of the Klipsch trademark. The Company denies these allegations and asserts there has been no material breach of contract. The case is currently in the discovery phase and the amount of any liability, if any, cannot be estimated. Management intends to defend vigorously the claims alleged against the subsidiary. Nevertheless, due to uncertainties in the legal process, it is at least reasonably possible that management's view of the outcome will change in the near term and there exists the possibility that there could be a material adverse impact on the operations of the subsidiary.\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 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 traded on the Nasdaq SmallCap Market under the symbol COTG. Set forth below is the reported high and low bid prices of the Common Stock for the fiscal quarters and transition period listed. Such prices are as reported by Nasdaq since January 1994 and by National Quotation Bureau derived from the pink sheets or OTC Bulletin Board for prior periods. Such bid quotations reflect interdealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nQuarter Ending High Bid Low Bid -------------- -------- -------\nMarch 31, 1994 6.62 5.75 June 30, 1994 6.62 3.25 September 30, 1994 4.50 0.87 December 31, 1994 1.25 0.50\nMarch 31, 1995 1.28 0.63 June 30, 1995 1.19 0.88 September 30, 1995 0.94 0.50 December 31, 1995 0.63 0.25\nAs of December 31, 1995, there were approximately 19,300 holders of record of the Company's common stock.\nNo cash dividends have been paid to the holders of the Common Stock during the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data\nYear Ended Fiscal Year Ended July 31, ------------------ ---------------------------- 1995 1994 1994 1993 1992 ---- ---- ---- ---- ---- (in 000's except per share data) Selected Statements of Operations Data:\nRevenues $110,097 $41,578 $15,742 $ 3,839 $ 4,533 ======= ====== ====== ====== ====== Income (Loss) from Operations ($ 11,112) ($10,464) ($10,566) ($ 1,403) $ 59 ======= ====== ====== ====== ======\nIncome (Loss) before Extraordinary Item ($ 11,360) ($11,428 ($10,772) $ 594 ($ 122)\nExtraordinary Item - Net of Tax -- -- -- 146 -- ------- ------ ------ ------ ------ Net Income (Loss) ($ 11,360) ($11,428) ($10,772) $ 740 ($ 122) ======= ====== ====== ====== ======\nNet Income (Loss) per Common Share ($0.51) ($0.80) ($1.35) $0.18 ($0.03) ==== ==== ==== ==== ====\nSelected Balance Sheet Data:\nTotal Assets $ 66,312 $68,089 $25,070 $ 7,381 $ 4,775 ======= ====== ====== ====== ====== Long-term Obligations: Long-term Debt and Capital Lease Obligations $ 8,408 $11,183 $ 298 -- -- Subordinated Debt 5,003 17,926 -- -- -- ------- ------ ------ Total Long-term Obligations $ 13,411 $29,109 $ 298 -- -- ======= ====== ====== Cash Dividends Declared per Common Share -- -- -- -- --\nThe following factors make the above selected financial data non comparable for the following indicated periods and reasons:\n1) The fiscal year ended July 31, 1993 includes unusual income of $1,523.\n2) The fiscal year ended July 31, 1994 includes expense of $7,140 from the issuance of stock options to consultants.\nItem 6. Selected Financial Data (continued):\n3) The year ended December 31, 1994 includes expense of $4,140 from the issuance of stock options to consultants.\n4) The year ended December 31, 1995 includes expense of $3,869 from the issuance of stock options to consultants.\n5) In December 1993, the Company acquired ARC Acquisition Group, Inc. and ARC Networks, Inc. and in June 1994, the Company acquired Creative Socio-Medics, Inc. Such acquisitions resulted in: (i) an increase in assets of approximately $13,000 as of July 31, 1994; (ii) an increase in revenues of approximately $11,000 for the fiscal year ended July 31, 1994 and $14,400 for the year ended December 31, 1994; and (iii) a net increase in net loss of approximately $173 for the fiscal year ended July 31, 1994 and $1,600 for the year ended December 31, 1994.\n6) In September 1994 the Company acquired International Magnetic Imaging, Inc. and in November 1994, the Company acquired Job Shop Technical Services and Computer Engineering Services. Such acquisitions resulted in: (i) an increase in assets of approximately $47,200 as of December 31, 1994; (ii) an increase in revenues of approximately $11,500 for the year ended December 31, 1994; and (iii) a net decrease in net loss of approximately $270 for the year ended December 31, 1994.\n7) In May 1995 the Company acquired Concept Technologies resulting in: (i) an increase in assets of approximately $1,780 as of December 31, 1995; (ii) an increase in revenues of approximately $2,149 for the year ended December 31, 1995; and (iii) an increase in net loss of approximately $553 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 (in 000's except share data)\nFinancial Condition Liquidity and Capital Resources\nThe Company's principal working capital consists of cash and cash equivalents. Cash and cash equivalents were $1,636 at December 31, 1995 compared to $1,727 at December 31, 1994. During the year ended December 31, 1995, the Company's net cash provided by operations was $1,999 of which $5,950 related to the operations of International Magnetic Imaging, Inc., (\"IMI\") which means that all other entities used a net amount of $3,951 in operations. As such it is clear that on a consolidated basis, the Company's principal source of cash was from the operations of IMI. Pursuant to an IMI financing agreement with a creditor, restrictions exist on the distributions of IMI funds whereby IMI may not make payments out of the ordinary course of IMI operations and specifically, not to the parent company, (Consolidated), or any subsidiary or affiliate. The other segments are thereby required to operate on their own cash flows and as of December 31, 1995 the most significant impact from these restrictions is on the Three Dimensional Products and Services and Medical Information Services segments which are currently unable to operate without significant cash infusions from the parent company, (Consolidated). If these segments do not obtain alternative sources of funding (i.e. equity offerings, creditor financing or increased volume), it is uncertain whether these segments will continue as operating groups. The remaining segments have been able to offset the cash used in operations by obtaining cash from financings and subsidiary level equity offerings.\nSources of funds during the year ended December 31, 1995, other than from operations includes $1,664 from debt financings, $5,181 from the issuance of stock and the exercise of stock options, $504 of cash from an acquired subsidiary, $530 from the sale of common stock investments and $220 from the sale of fixed assets. The principal use of cash, other than to fund operations, includes $8,103 for payment on debt and capital lease obligations, $983 for the acquisition of a subsidiary, $684 for the purchase of fixed assets and $129 for offering costs. Net other uses of cash amounted to $290.\nWorking capital assets, other than cash, increased by $2,559. Receivables increased by $2,396 of which approximately $293 is due to acquisitions and the remainder to increased sales volumes. Excess of accumulated costs over related billings increased by $1,002 which is offset by a corresponding increase in excess of billings over accumulated costs on projects in progress. Notes receivable decreased by $967 due primarily to payments received in cash and common stock on the Fingermatrix loan. The remaining increase in working capital assets is due primarily to acquisitions. Working capital liabilities increased by $17,492. Accounts payable and accrued expenses increased approximately $5,332 of which $687 is from acquisitions while the remainder is due primarily to a build up of slow paying trade accounts payable. Current portions of debt and capital lease obligations increased by $11,114 due primarily to the scheduled balloon payments due in 1996 on the subordinated debt.\nIn January 1996, the Company refinanced a significant portion of the current subordinated debt that was to be paid in 1996. Such financings consist of a term loan of $2,000, a revolver loan of $6,000 and the extension of approximately $7,600 of subordinated balloon payments from a 1996 due date to\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nFinancial Condition Liquidity and Capital Resources (continued)\na 2000 due date. The effects of this refinancing has reduced current debt from $24,086 to $8,378 and has alleviated a significant portion of the Company's working capital deficit. However, even after the above financing, the Company continues to have a working capital deficit of $4,439 on a pro forma basis as of December 31, 1995. The Company's plans to reduce the working capital deficit includes attempts to increase the profitability of the underlying subsidiaries and the continued efforts to sell equity in the non public subsidiaries via initial public offerings. The Company currently has a letter of intent with an underwriter for the sale of one subsidiary's stock and in connection therewith, obtained investor financing of $500. There remains a substantial doubt as to whether any attempted public offerings of subsidiary stock will be successful and the Company currently has no other plans if such offerings are not ultimately consummated.\nFurthermore, the Company is in default on loans aggregating $1,058 as of December 31, 1995. $530 of such defaulted debt relates to the late payment of interest only payments which have been subsequently paid. It is currently not expected that the lender will demand early payment on the loan which is due in November of 1997 per the original terms of the financing. The remaining loans in default of $528 are a result of non payment of principal on the scheduled due dates. Such defaults have not had, and are not expected to have a significant impact on the operations of the related segments as the creditors have not called such loans and are working under extended repayment terms. However, if the creditors exercised their right to call the loans in default, it would have a material adverse impact on the operations of the Company as a whole and no assurances can be made that such creditors will continue to work under extended payment terms.\nResults of Operations\nThe consolidated loss of the Company for the year ended December 31, 1995, which includes a full year of operations for substantially all of the segments except Audio Visual Manufacturing and Services was $11,360. Included in the consolidated loss are noncash expenses of $7,602 from depreciation and amortization, $6,083 from the exercise of stock options and $470 from the write-off of obsolete and slow moving inventory. These non cash expenses are offset to a degree by the minority interest loss of $3,724 related to the operations of a publicly held subsidiary that has reduced the net loss by $3,724. While it is expected that the level of depreciation and amortization will only decrease nominally in future periods, it is not currently expected that noncash expenses from the exercise of stock options will be of a recurring nature.\nConsolidated revenues, gross profit and selling, general and administrative expenses for the year ended December 31, 1995 compared to the year ended December 31, 1994 increased primarily to the fact that subsidiaries acquired during the year ended 1994 are included for the entire year during 1995 and only a portion of the year in 1994. Consolidated revenues, gross profit and selling, general and administrative expenses for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nsignificantly due to the operations of subsidiaries that were not acquired until after July 31, 1993. The percentage of relative contribution to revenues, gross profit, and selling general and administrative expenses by industry segment is shown in the following tables. Changes within the individual industry segments themselves is discussed further within the respective industry segment discussions. Percentage of Total --------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ------------------ Segments 1995 1994 1994 1993 - -------- ---- ---- ---- ---- Revenues: Contract Engineering Services 57% 60% 65% 16% Medical Diagnostics 25% 15% -- -- Electro-Mechanical and Electro-Optical Products Manufacturing 4% 9% 22% 80% Medical Information Services 7% 7% 1% 1% Telecommunications 3% 6% 7% -- Three Dimensional Products and Services 1% 2% 2% 2% Audio Visual Manufacturing and Services 2% -- -- -- Business Consulting Services 1% 1% 3% 1%\nGross Profit: Contract Engineering Services 19% 27% 46% 4% Medical Diagnostics 59% 43% -- -- Electro-Mechanical and Electro-Optical Products Manufacturing 5% 2% 7% 85% Medical Information Services 9% 10% 1% 3% Telecommunications 3% 10% 13% -- Three Dimensional Products and Services 3% 5% 6% 5% Audio Visual Manufacturing and Services 1% -- -- -- Business Consulting Services 1% 3% 27% 3%\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued) Percentage of Total --------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ------------------ Segments 1995 1994 1994 1993 - -------- ---- ---- ---- ---- Selling, General and Administrative Expenses: Contract Engineering Services 14% 11% 8% 6% Medical Diagnostics 21% 10% -- -- Electro-Mechanical and Electro-Optical Products Manufacturing 6% 10% 9% 24% Medical Information Services 13% 13% 5% 9% Telecommunications 4% 5% 2% -- Three Dimensional Products and Services 9% 11% 7% 6% Audio Visual Manufacturing and Services 2% -- -- -- Business Consulting Services 1% 4% 3% 7% Corporate and Other 30% 36% 66% 48%\nDiscussion of Operations by Segment:\nContract Engineering Services:\nDuring the year ended December 31, 1995 and 1994 and July 31, 1994, substantially all of the revenues were from the operations of Trans Global. Revenues and gross margins for 1995 compared to 1994 increased $37,861 or 150% and $2,355 or 144%, respectively, due primarily to the acquisition of an additional subsidiary in this segment in November 1994. Selling, general and administrative expenses increased by $2,693 or 154% from 1994 to 1995 due primarily to the inclusion of a subsidiary acquired in November 1994 which had selling, general and administrative expense of $3,261 in 1995 and $321 in 1994. Other expenses for 1995 compared to 1994 increased by $866 or 500% as a result of increased interest expense. The increased interest expense is due primarily to the inclusion of a subsidiary acquired in November 1994. This segment finances its payroll obligations by borrowing from a receivable factor at an interest rate of 2% in excess of prime in addition to a commission fee of .3% of the face of the invoice amounts financed.\nRevenues, gross margins and selling, general and administrative expenses were $10,221, $1,007 and $1,028, respectively for the year ended July 31, 1994. Revenues, gross margin and selling, general and administrative expenses were $611, $51 and $141, respectively, for fiscal year ended July 31, 1993 and were from Universal, a subsidiary in which the Company no longer includes in consolidation because a significant portion of the business was sold. Due to the change in companies operating in this segment, operating results for the years ended July 31, 1994 and 1993 are not comparable.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nThis segment operates in a highly competitive environment with low margins. Revenues from the contract engineering services segments is based on the hourly cost of payroll plus a percentage. The success of the segment is dependent upon its ability to generate sufficient revenues to enable it to cover its fixed costs and other operating expenses, and to reduce its variable costs. Under its agreements with its customers, this segment is required to pay its employees and pay all applicable Federal and state withholding and payroll taxes prior to receipt of payment from clients. Furthermore, the segment's payments from its clients are based upon the hourly rate paid to the employee, without regard to when payroll taxes are payable with respect to the employees. Accordingly, the segment's cost of service are greater during the first part of the year, when Federal Social Security taxes and state unemployment and related taxes, which are based on a specific level of compensation are due. Thus, until the segment satisfies its payroll tax obligations, it will have lower gross margins. Management believes that with this segments current selling, general and administrative structure it can improve its operating income and generate profitable operations by increasing revenue. The segment is seeking to reduce its interest costs by negotiating with other receivable factors. This segment also intends to increase its equity base through the sale of equity securities which would allow the segment to reduce its borrowing base. However, there can be no assurance that the segment can or ever will be able to operate at profitable levels.\nMedical Diagnostics:\nThis segment consists of a medical diagnostic imaging company, which primarily performs MRI and other diagnostic modalities, that was purchased in September 1994 and as such the prior periods are not comparable to the year ended December 31, 1995. During 1995, this segment had revenues of $28,044, gross margins of $12,235 and income from operations of $5,367. During 1994, from the period of acquisition at September 30, 1994 through December 31, 1994, this segment had revenues, gross margins and income from operations of $6,557, $2,661 and $1,036, respectively. Gross margins as a percentage of revenues increased from 41% in 1994 to 44% in 1995 due primarily to cost containment efforts which offset the effects of declining reimbursement rates. Selling, general and administrative expenses as a percentage of revenues remained level at 25%. During 1995, management of the medical diagnostics segment implemented a cost reduction plan which included the centralization of billing and collections operations, renegotiation's with significant vendors and a reduction of overall salary and wage levels. This cost reduction plan allowed the selling, general and administrative expenses to remain level on a percentage basis while the volumes of the company increased and the reimbursement rates decreased. Management anticipates that scan volume will increase 5% during 1996; however, due to the volatility of reimbursement rates in the medical industry, there is no assurance that revenues will increase at the same level. During 1995, interest expense was $2,565 and is expected to increase during 1996 due to the issuance of additional debt during January of 1996. Overall profitability of the medical diagnostics segment is expected to remain relatively level for 1996.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nElectro-Mechanical and Electro-Optical Products Manufacturing:\nRevenues for the year ended December 31, 1995 compared the same period in 1994 increased $618 or 17% and gross margins increased $929 or 780% for the same periods. The significant increase in gross margins is due to the following: (i) in 1995 the segment sold product lines with a greater margin percentage, (ii) in 1995 obsolete inventory write-offs were $100 less than in the prior year and (iii) this segment formed an additional operating entity which generated gross margins of $82. Selling, general and administrative expenses increased by $227 or 14% due to the formation of an additional operating entity in this segment which had operating expense of $216 that did not exist in the prior year. The operating expenses of the previously existing entities in this segment remained relatively level from 1995 to 1994. Loss from operations decreased by $702 or 46% due to the above noted increase in gross margins and the fact that in 1994 the company wrote-off goodwill of approximately $285.\nRevenues for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased $416 or 14% while gross profit decreased $839 or 84% and profitability decreased $1,380 or 361%. During the fiscal year ended July 31, 1994 an acquired subsidiary (S-Tech) in this segment became operational which is the primary reason for the increase in revenues. The decrease in gross margins is due to the fact that S- Tech had negative gross margins due primarily to the write-down of obsolete inventories. Additionally, the previously existing company (Sequential Electronic Systems) in this segment operated at a lower margin ratio than in the prior comparable period. S-Tech's selling, general and administrative expenses, as a percentage of revenues, were significantly higher than Sequential Electronic Systems which accounts for the significant increase in such expenditures.\nA portion of the revenues in this segment are generated from government sales and while there exists a possibility that there will be reversals in government spending cutbacks, it is more likely that defense and military spending will remain sluggish through 1996. Management plans to continue placing more emphasis on sales to the private sector and overall it is anticipated that revenues and operating profits will remain relatively stable in this segment.\nMedical Information Services:\nDuring June 1994, the Company acquired a subsidiary (CSM) which accounted for all of the revenues and gross margin in this segment for the year ended December 31, 1994. Since CSM was not a part of the consolidated operations until July 1, 1994, the prior periods operating results are not comparable to those of the year ended December 31, 1995.\nDuring the year ended December 31, 1995 revenues were $7,381. The largest component of revenue was $2,000 from the sale of third party hardware and software. A significant portion of such revenue was related to services pursuant to a purchase order form the State of Colorado for its Department of Human Services. Revenues generated from turnkey systems and data center\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\naccounted for $1,800 and $1,700, respectively. Maintenance revenue accounted for $1,100 and the remainder of the revenue was generated from the CarteSmart technology operations. The gross margin in 1995 was $1,974 which is 27% of revenues. Selling, general and administrative expenses were $4,247 and included research and development costs of $699 and the write-off of deferred offering costs of $863. Interest expense amounted to $533 and is expected to increase in the subsequent years due to additional financings in 1996.\nDuring the year ended December 31, 1994 revenues were $2,925 and included $913 from third party hardware and software sales, $1,000 from turnkey systems and data center operations, and the remainder from maintenance revenues. Gross margins were $601 representing 21% of revenues, and selling, general and administrative expenses were $2,129 including $367 of research and development expenses. Interest expense was $245 for the year ended December 31, 1994 which includes on six months of interest since CSM was not acquired until June 1994. During the fiscal years ended July 31, 1994, and 1993 the medical information services segment consisted of a single development stage subsidiary and revenues and gross margins were minimal.\nThis segment is addressing its continuing losses through the development and implementation of an integrated marketing plan for both its CarteSmart system and health information systems and services and the development of enhancements to its health information systems and the development and implementation of a marketing plan directed at the financial services industry and educational institutions. The segment has obtained its initial contracts for its products in both areas with agreements with IBN (financial services) and Virginia Commonwealth University (educational institution). Furthermore, it believes that the acquisition, through a joint venture corporation, of the SATC Software, and further development of such software will provide it with a significant product for the financial services industry. However, notwithstanding the segment's product development and marketing efforts, losses may continue, and no assurance can be given that the segment will be successful in these efforts.\nTelecommunications:\nIn December of 1993 the Company acquired ARC Networks which is the only entity operating in this segment. During the year ended December 31, 1995 compared to the year ended December 31, 1994, revenues, gross margins and selling, general and administrative expenses increased by $984, $55, and $416, respectively. The increased revenue is attributed to an increased sales force which has also increased the selling, general and administrative expenses which consist primarily of salaries and commissions. This segment operates in a highly competitive industry at low margins and in order for this segment to become a viable operating entity, it will need to significantly increase revenue volume. As of December 31, 1995 management is unable to determine whether this segment will ever operate at a level that is profitable.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nThree Dimensional Products and Services:\nRevenues and gross profit for the year ended December 31, 1995 compared to the year ended December 31, 1994 increased $926 or 109% and $359 or 121%, respectively, while losses from operations increased $687 or 44%. During November 1994 an additional subsidiary was acquired that operates in this segment and a full years operations from such subsidiary accounted for increases of revenues, gross margin and loss from operations of $226, $18 and $677, respectively. The remainder of operating increases were primarily a result of this segment's European operations which had increased operating activity in Belgium, the United Kingdom and Germany. Selling, general and administrative expenses increased $1,045 or 57% which reflects this segment's continued product development costs.\nRevenues for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased $212 or 264%, while gross profit and loss from operations increased $63 or 114% and $657 or 606%, respectively. During the fiscal years ended July 31, 1994 and 1993 the three dimensional products and services segment was in the development stage and as such the revenues and gross margins were minimal while the selling, general and administrative expenses have been significant and account for the majority of the net operating losses.\nThis segment continues to generate significant losses and has been unable to generate revenues at a volume from any of its products and services sufficient to cover its ongoing product development costs. During 1996, management is evaluating the organizational structure of its domestic and overseas operations and is in the process of formulating a plan to reduce selling, general and administrative expenses which may include the closure of certain offices in the United States, as well as Europe, in order to streamline operations without significantly impacting the segment's ability to grow revenues and gross margins. Even in the event that a cost reduction plan is formalized and implemented, this segment will need a significant infusion of capital in order to sustain operations. Currently, there are no firm commitments for obtaining such capital. As such, there is substantial doubt about this segment's ability to continue as an operating entity and it is doubtful whether this segment will ever become profitable.\nAudio Visual Manufacturing and Services:\nThis segment consists of one operating entity which was acquired in the second quarter of 1995. As such, the operations reported herein reflect only the results from the date of acquisition through December 31, 1995 and there are no prior comparable periods. Since the date of acquisition through December 31, 1995 revenues, gross margins and losses from operations were $2,149, $202 and $492, respectively. Approximately 75% of this segment's revenue were generated from domestic sales, approximately 12% were from sales in the far east and approximately 13% from other foreign markets. The gross margins as a percentage of revenues were 9% which is substantially lower than the margins required to operate profitably. Included in direct costs is $70 of inventory obsolesence write-offs which represents a 3% incremental decrease in the gross\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nmargins. A significant cause of the low margins relates to idle plant capacity and an outdated production machine. Management is attempting to obtain financing to purchase a new production machine which would produce products significantly faster and additionally, reduce the need to purchase assembly parts from an outside source since the new production machine would be able to produce such parts on a timely basis. Additionally, the segment needs to obtain a line of credit to fund current working capital needs as the segment's vendors have been extended to the point where parts shipments have been negatively impacted. Selling, general and administrative expenses were $694 from the date of acquisition through December 31, 1995 and exceed gross margins by $492. This excess of expenses over gross margins is a reflection of the volume problem of this segment. Management believes that this segment has a viable and proven product that has been an industry standard since 1940 and with the appropriate financing and capitalization this segment would be able to produce revenues at a volume that would generate profits and at December 31, 1995 the segment has a backlog of orders of approximately $350. However, due to the uncertainties surrounding the ability of the segment to obtain adequate financing, management is unable to determine at this time whether the segment will ever be profitable.\nBusiness Consulting Services:\nFor the years ended December 31, 1995 and 1994, revenues and gross margins of the business consulting operations were not significant which is consistent with management's decision to concentrate time and resources managing internal operations of the preexisting and newly acquired companies. Selling, general and administrative expenses were also not significant for the year ended December 31, 1995 but amounted to $623 for the year ended December 31, 1994 which is a factor of the significant acquisition activity that occurred during 1994. Income from operations for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased 226%. During the fiscal year ended July 31, 1993, consulting fee revenue was minimal and during the fiscal year ended July 31, 1994 the selling, general and administrative expenses did not increase at the same rate as revenues, which accounts for the significant percentage increase in profitability. During 1996, management anticipates that consulting revenues and related expenses will not be a significant portion of the Company's operations.\nCorporate and Other:\nSelling, general and administrative expenses increased by $3,470 or 56% from $6,192 for the year ended December 31, 1994 to $9,662 for the year ended December 31, 1995. Included in the selling, general and administrative expenses is noncash consulting fee expenses incurred upon the issuance of non employee directors and consultants stock options of $6,083 and $4,140, respectively, for the years ended December 31, 1995 and 1994. The remaining increases are due primarily to increased legal and accounting fees to outside\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (in 000's except share data)\nResults of Operations (continued)\nfirms, increased financial support staff and increased outside consulting fees. Such increases were necessitated by the acquisition activity during the related periods.\nSelling, general and administrative expense for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased 573%. The most significant portion of this increase is $7,140 of noncash consulting fee expenses incurred upon the issuance of non employee directors and consultants stock options. Additionally, costs were incurred as a part of acquiring and managing the new subsidiaries purchased since July 31, 1993.\nDuring 1996, it is anticipated that corporate selling, general and administrative expense levels will be a factor of the activity of additional acquisitions and capitalization activities which cannot be quantified on a prospective basis.\nDiscussion of Other Significant Financial Line Items:\nInterest Expense:\nFor the year ended December 31, 1995 compared to the year ended December 31, 1994, interest expense increased $2,863 or 235%, and for the fiscal year ended July 31, 1994 compared to the fiscal year ended July 31, 1993 increased $261 or 114%. The increased interest expense for both comparable periods is due to the issuance of debt instruments in connection with the acquisition of International Magnetic Imaging, Inc. and affiliated entities, (\"IMI\"). During the years ended December 31, 1995 and 1994, interest expense related to IMI was $2,565 and $703, respectively. The significant increase is due to the fact that IMI was not acquired until September 1994 and as such the interest expense for the year ended December 31, 1994 reflects only three months of interest expense.\nGain (Loss) from Security Sales:\nDuring the year ended December 31, 1995, losses on investment activity were nominal. For the year ended December 31, 1995 the loss on sales of securities consisted primarily of the recognition of investments that were determined to have a permanent decline in market value and as such, the decline was recognized in that period and is no longer included in the unrealized loss from marketable securities in the equity section of the balance sheet.\nDuring the fiscal year ended July 31, 1994, losses on investment activity were nominal. During the fiscal year ended July 31, 1993, the Company had a significant gain on the sale of a company's stock that was held for investment purposes.\nSecurity sales vary from period to period based on, among other things, market activity and cash needs, and management cannot estimate the amount of future security sales gains or losses, if any, that will be generated from such transactions.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nUnusual Item:\nFor the fiscal year ended July 31, 1993, the unusual item consists of income of $1,522,878 related to the settlement of a lawsuit and a gain on the repurchase of the assets of a subsidiary. See further discussion of this item in the footnotes to the financial statements.\nIncome Taxes:\nThe Company's provision for income taxes were (1.5%), (0.06%), 0%, and 4% of income before taxes for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993, respectively. The Company will have a net operating loss carryforward of approximately $44,882. The net operating loss carryforwards expire beginning in 1996 through 2010. Investment tax credit and job tax credit carryforwards of approximately $105 are available to reduce future income taxes. These credits expire beginning in various years through 1999. These credits have been reduced to reflect changes made by the \"Tax Reform Act of 1986\". See Note 12 To the Financial Statements.\nImpact of Inflation:\nThe Company is subject to normal inflationary trends and anticipates that any increased costs would be passed on to its customers.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data begin on page of this Form 10-K.\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 and Executive Officers of the Registrant\nSet forth below is information concerning the executive officers of the registrant.\nName Age Position ---- --- -------- Lewis S. Schilller 65 Chairman of the Board, President, and Chief Executive Officer George W. Mahoney 35 Chief Financial Officer Norman J. Hoskin 61 Director Grazyna B. Wnuk 32 Secretary\nMr. Schiller has been the Registrant's chief executive officer for more than the past five years. Mr. Schiller also serves as a senior executive officer of the Registrant's subsidiaries. On December 11, 1989, Mr. Schiller was elected as chairman and chief executive and financial officer of General Technologies Group, Ltd. (\"GTG\"), a corporation in which Consolidated was a stockholder and a major creditor.\nMr. Mahoney has been chief financial officer of Registrant since October 1994. From December 1991 until September 1994, Mr. Mahoney was chief financial officer of IMI and IMI's affiliated entities. Consolidated acquired the assets of IMI and certain of its affiliated entities during 1994. From April to December 1991, he was chief financial officer of Labor World USA, Inc., a labor leasing company, and for more than three years prior thereto, he was chief financial officer of Guardian Bank.\nMr. Hoskin has been a director of the Registrant since September 1992. He is the former chairman of Republic Holdings Corporation of West Palm Beach, Florida and chairman of Executive Express Travel of New York, NY since 1989. He has previously served as the founder and president of Hoskin Leasing, Inc., chairman of Potomac Financial Equities, Inc., chairman of CSB\/First Florida Leasing, Inc., as president of National Bank of Florida Corporation, and as senior vice president of Rentar Industries Group, Inc., the parent company of Emery Freight Systems and Interstate Truck Lines. He is also a director of Trinitech Systems, Inc., a company which markets communications and related products principally to the banking and securities industries.\nMs. Wnuk has been the secretary of the registrant since 1991. Prior thereto she served as a secretary for the registrant and as a sales associate in Bloomingdales in New York City.\nOfficers are elected by, and serve at the pleasure of, the board of directors. Pursuant to an employment agreement dated October 1, 1994, the Company has agreed to employ Mr. Schiller as its chief executive during the term of the agreement, which continues until December 31, 2000. Pursuant to an employment agreement dated October 1, 1994 and superseded by an agreement dated March 21, 1995, the Company has agreed to employ Mr. Mahoney as its chief financial officer during the term of the agreement, which continues until December 31, 1999.\nItem 11.","section_11":"Item 11. Executive Compensation (in 000's except share data)\nSet forth below is information concerning the Registrant's chief executive officer and chief financial officer of the Registrant who are the only executive officers of the Registrant who received or accrued compensation from the Registrant and its subsidiaries in excess of $100 (on an annualized basis) during the years ended December 31, 1995 and 1994 and the fiscal years ended July 31, 1994 and 1993.\nSummary Compensation Table (in 000's except share data):\nAnnual Compensation Awards Payouts --------------- ----------------- ------- Securi- ties Restr- Under- icted lying Name and Principal Stock Options\/ LTIP Position Salary Bonus Awards SARs(#) Payouts - ------------------------- ------ ----- ------ ------- ------- Year Ended December 31, 1995: Lewis S. Schiller, CEO[1] $ 250 -- -- -- -- ===== George W. Mahoney, CFO[2] $ 177 $ 36 -- -- -- ===== =====\nYear Ended December 31, 1994: Lewis S. Schiller, CEO[1] $ 199 -- -- --[3] -- ===== George W. Mahoney, CFO[2] $ 50 750,000[4] -- ===== =======\nYear Ended July 31, 1994: Lewis S. Schiller, CEO[1] $ 182 -- -- -- -- =====\nYear Ended July 31, 1993: Lewis S. Schiller, CEO[1] $ 175 -- -- -- -- =====\n[1] Mr. Schiller has an employment agreement dated October 1, 1994 with the Company pursuant to which it employs him as chief executive officer through December 31, 1998 at an annual salary of $250, subject to an annual cost of living increase. Mr. Schiller is also entitled to a bonus equal to 10% of the Company's consolidated income before income taxes in excess of $250. No bonus was payable for the year ended December 31, 1995. The Company also granted to Mr. Schiller a five-year option to acquire 10% of the Company's securities portfolio at 110% of the Company's cost.\nItem 11. Executive Compensation (continued) (in 000's except share data)\n[2] Mr. Mahoney has an employment agreement dated October 1, 1994, and superseded by an agreement dated March 21, 1995, with the Registrant pursuant to which it employs him as chief financial officer through December 31, 1999. Mr. Mahoney will receive a base salary of $165, $177, $189, $202 and $220 for the years ending December 31, 1995, 1996, 1997, 1998 and 1999, respectively. Additionally, Mr. Mahoney shall also receive incentive compensation equal to the greater of one percent of the net pretax profits or net cash flow of the Registrant, plus the greater of one percent of the net pretax profit or net cash flow of IMI (a wholly-owned subsidiary of the Registrant), subject to a maximum of twice Mr. Mahoney's base salary for the respective year.\n[3] Pursuant to a stock purchase plan dated December 15, 1994, Mr. Schiller received the right to purchase 2,500,000 unregistered shares at the fair market value on that date ($.50 per share). Mr. Schiller did not exercise his right to purchase such shares and such rights have expired as of December 31, 1995.\n[4] On December 15, 1994, Mr. Mahoney received options to purchase 750,000 shares of unregistered stock at an exercise price of $.50 per share (the fair market value on that date).\nOption Table:\nPotential Realized Value at Assumed Annual Rates of Individual Grants Stock Price ------------------------------------------- Appreciation % of Total for Options Exercise Expira- Option Term Number of Granted to Price piration ----------- Name Securities Employees ($\/Sh) Date 5% 10% - ----------------- ---------- ---------- -------- -------- ---- ---- George W. Mahoney 750,000 43% $0.50 12\/14\/98 $19 $38 ======= === ==== == ==\nNo other officers or directors have employment agreements with the Registrant.\nNo officers or directors hold options to purchase any of the Registrant's common stock.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNo person or group known to the Registrant owns 5% or more of any of the Registrant's voting securities as of April 10, 1996, except as set forth below with respect to the Registrant's Series A Redeemable Convertible Preferred Stock (Series A Preferred Stock). No officers or directors of the Registrant own any of the Registrant's Common Stock as of April 25, 1995. The following table sets forth, as of April 10, 1996, the number and percentage of rights to shares of outstanding Common Stock owned by each person owning at least 5% of the Registrant's Series A Preferred Stock, each director owning stock and all directors and officers as a group:\nAmount and Nature of Name and Address[1] Beneficial Ownership[2] Percent of Series - --------------------------- ----------------------- ----------------- Lewis S. Schiller 4,480 5.8% Norman J. Hoskin 1,280 1.7% Joel M. Brown 1,536 2.0% All officers and directors as a group (four individuals owning stock) 11,520 14.8%\n[1] - The address of each person is c\/o Consolidated Technology Group Ltd., 160 Broadway, New York, NY 10038.\n[2] - Each person named has the sole voting and sole investment power and has direct beneficial ownership of the shares.\nItem 13.","section_13":"Item 13. Certain relationships and Related Transactions\nLoan Receivable from an Officer of a Subsidiary:\nDuring the year ended December 31, 1995 a subsidiary of the Company loaned $45 to the chief executive officer of such subsidiary. The loan has no fixed due dates or terms.\nLoan Receivable from Sale of Common Stock Investments to an Officer:\nDuring 1995, the chief executive officer of the Company exercised an option to purchase common stock investments held by the Company at 110% of the book value of such investments. The purchase of such investments was consummated in a noncash transaction and such officer has issued a note in favor of the Company with interest at 9% and said note matures five years from the date of the purchase. Total amounts outstanding under such receivables was $72 at December 31, 1995. The gain realized by the Company on the sale of these investments approximated $7.\nIn February 1996, a subsidiary of the Company loaned $300 to an officer of the subsidiary. The principal is due in 1998 and requires interest only payments at a rate of 5.5%, payable annually.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n1. Financial Statements Report of Mortenson and Associates, P.C. Independent Certified Accountants & Consolidated Balance Sheets as of December 31, 1995 and 1994 Consolidated Statements of Operations for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 - Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 - Consolidated Statements of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 - Notes to Consolidated Financial Statements\n2. Financial Statement Schedules\nNone\n3. Reports on Form 8-K\nNone\n4. Exhibits\n3.1 Certificate of Incorporation[1] 3.2 By-laws[1] 10.1 Agreements relating to the acquisition and financing of International Magnetic Imaging, Inc. and its affiliated companies.[2] 10.2 Plan and agreement of reorganization dated as of April 13, 1994 by and among the Registrant, CSM Acquisition Corp., Carte medical Corporation, Creative Socio-Medics Corp. and Advanced Computer Techniques, Inc., as amended.[3] 10.3 Agreement dated December 2, 1993, among Registrant, SIS Capital Corp., SES Holdings Corp., Arc Acquisition Group, Inc. and the stockholders of Arc Acquisition Group, Inc.[4] 10.4 Agreement dated December 2, 1993 among the Registrant, SIS Capital Corp., Arc Networks, Inc., Joseph G. Sicinski and Peter F. Parrinello.[4] 10.5 Employment agreement dated March 21, 1995, between the Registrant and George W. Mahoney.[6] 10.6 Employment agreement dated October 1, 1994, between the Registrant and Lewis S. Schiller.[6] 10.7 Agreement dated as of March 31, 1995 among SIS Capital Corp., DLB, Inc., Joseph G. Sicinski and Concept Technologies Group, Inc., including exhibits and disclosure letters.[5] 11.1 Calculation of earnings per share 21.1 List of Subsidiaries of Registrant. 27 Financial Data Schedule.[7] 99.1 Stock Purchase Agreement.[6]\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (continued)\n[1] Filed as an exhibit to the Company's annual report on Form 10-K for the fiscal year ended July 31, 1994 and incorporated herein by reference. [2] Included as exhibits to the Registrant's report on Form 8-K, as amended, dated July 19, 1994, and incorporated herein by reference. [3] Included as exhibits to the Registrant's report on Form 8-K, as amended, dated June 16, 1994, and incorporated herein by reference. [4] Included as exhibits to the Registrant's report on Form 8-K, dated December 22, 1993, and incorporated herein by reference. [5] Filed as exhibit to the Company's report on Form 8-K, dated April 19, 1995, and incorporated herein by reference. [6] Filed as an exhibit to the Company's annual report on Form 10-K for the five month transition period from August 1, 1994 to December 31, 1994. [7] File only to the SEC in electronic format.\n........................................\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders Consolidated Technology Group, Ltd. New York, New York\nWe have audited the accompanying consolidated balance sheets of Consolidated Technology Group, Ltd. and its subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the two years ended December 31, 1995 and each of the two fiscal years ended July 31, 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 Consolidated Technology Group, Ltd. and its 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 and 1994 and each of the two fiscal years in the period ended July 31, 1994, in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements, the Company incurred a net loss of $11,360,000 for the year ended December 31, 1995, and has an accumulated deficit to that date of $40,648,000. 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 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/S\/ ------------------------------ MORTENSON AND ASSOCIATES, P.C. Certified Public Accountants\nCranford, New Jersey March 27, 1996\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Balance Sheets (in 000's)\nDecember 31, ------------------------ 1995 1994 ------------ -------- Assets: Current assets: Cash and cash equivalents $ 1,636 $ 1,727 Receivables, net of allowances 19,216 16,820 Inventories 3,701 3,466 Loans receivable 396 1,363 Prepaid expenses and other current assets 436 412 Excess of accumulated costs over related billings 1,002 -- Investments in common stock 20 151 ------ ------ Total current assets 26,407 23,939 ------ ------\nProperty, plant and equipment, net 11,034 12,911 ------ ------\nOther assets: Capitalized software development costs 502 1,064 Goodwill, net 11,881 12,623 Covenant not to compete, net 2,168 3,451 Customer lists, net 11,684 12,770 Deferred offering costs -- 331 Receivables, long-term 219 -- Receivables, related parties 544 160 Trademark, net 383 -- Investments in common stock, long-term 405 384 Other Assets 1,085 456 ------ ------ Total other assets 28,871 31,239 ------ ------\nTotal Assets $66,312 $68,089 ====== ======\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Balance Sheets (in 000's)\nDecember 31, ------------------------ 1995 1994 ------------ -------- Liabilities and Shareholders' Equity: Current liabilities: Accounts payable and accrued expenses $11,095 $ 6,741 Accrued payroll and related expenses 2,332 1,774 Accrued interest 284 113 State taxes payable 269 20 Excess of billings over accumulated costs 1,701 655 Notes payable, related parties 290 183 Current portion of long-term debt 9,080 8,096 Current portion of subordinated debt 13,354 3,437 Current portion of capitalized lease obligations 1,362 1,256 ------ ------ Total current liabilities 39,767 22,275 ------ ------ Long-term liabilities: Long-term debt 6,210 8,512 Capitalized lease obligations 2,198 2,671 Subordinated debt 5,003 17,926 ------ ------ Total long-term liabilities 13,411 29,109 ------ ------ Commitments and contingencies\nMinority interest 2,087 -- ------ ------\nShareholders' Equity: Preferred stock 70 81 Additional paid-in capital, preferred stock 266 311 Common stock (50,000,000 shares authorized, 26,655,071 and 17,577,260 shares issued and outstanding as of December 31, 1995 and 1994, respectively) 267 176 Additional paid-in capital, common stock 51,020 45,597 Accumulated deficit (40,648) (29,288) Unrealized loss on exchange translation (17) (33) Net unrealized gain (loss) on long- term investments in common stock 89 (139) ------ ------ Total shareholders' equity 11,047 16,705 ------ ------ Total Liabilities and Shareholders' Equity $66,312 $68,089 ====== ======\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Operations for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data) ----------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ------------------ ------------------ 1995 1994 1994 1993 ------ ------ ------ ------\nRevenues $110,097 $41,578 $15,742 $ 3,839\nDirect costs 89,175 35,428 13,560 2,664 ------- ------ ------ ------ Gross profit 20,922 6,150 2,182 1,175\nSelling, general and administrative 32,034 16,614 12,748 2,578 ------- ------ ------ ------ Income (Loss) from operations (11,112) (10,464) (10,566) (1,403) ------- ------ ------ ------ Other income (expense): Interest expense (4,084) (1,221) (490) (229) Other income (expense) 373 448 69 (46) Gain (loss) from security sales (35) (299) 13 694 Unusual items -- -- -- 1,523 ------- ------ ------ ------ Total other income (expense) (3,746) (1,072) (408) 1,942 ------- ------ ------ ------ Income (Loss) before income taxes and minority interest (14,858) (11,536) (10,974) 539\nIncome Taxes (226) (24) -- (21)\nMinority Interest in Loss of Subsidiaries 3,724 132 202 76 ------- ------ ------ ------ Income (loss) before extraordinary item (11,360) (11,428) (10,772) 594\nExtraordinary Item -- -- -- 146 ------- ------ ------ ------ Net Income (Loss) ($11,360) ($11,428) ($10,772) $ 740 ======= ====== ====== ====== Earnings (Loss) per Share: Income (loss) before extraordinary item ($0.51) ($0.80) ($1.35) $0.14 Extraordinary item -- -- -- 0.04 ------- ------ ------ ------ Net income (loss) per share ($0.51) ($0.80) ($1.35) $0.18 ======= ====== ====== ====== Weighted average number of common shares 22,423,035 14,205,789 7,972,594 4,224,260 ========== ========== ========= =========\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\n----------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ------------------ ------------------ 1995 1994 1994 1993 ------ ------ ------ ------ Cash Flows from Operating Activities: Income (loss) before extraordinary item ($11,360) ($11,428) ($10,772) $ 594 ------ ------ ------ ------ Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and Amortization 7,602 2,187 290 40 Minority interest in loss of consolidated subsidiaries (3,724) (132) (202) (75) Write-off goodwill -- 338 -- -- Write-off inventory 470 307 -- -- Bad debt expense 1,225 83 23 68 Noncash expenses paid with the issuance of stock 114 97 -- -- Noncash expenses paid with the issuance of a subsidiary's stock 11 -- -- -- Deferred charges on option exercise 3,869 4,140 7,140 -- Deferred charges on option exercise of a subsidiary 2,214 -- -- -- Additional compensation -- 135 135 -- Unusual item -- -- -- (1,523) Extraordinary item -- -- -- 146 Write-down fixed assets to fair value -- 225 225 -- Write-off of loans receivable -- 280 279 562 (Gain) loss on sale of common stock investments 35 299 (13) (694) Loss on sale of fixed assets 60 -- -- -- Change in current assets and current liabilities: (Increase) decrease in in current assets: Receivables (3,301) (1,900) (2,747) 52 Inventories 107 482 460 (57) Prepaid expenses and other current assets (10) 559 (388) (107) Excess of accumulated costs over billings (1,002) -- -- -- (continued)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\n----------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ------------------ ------------------ 1995 1994 1994 1993 ------ ------ ------ ------ Adjustments to reconcile net loss to net cash provided by operating activities (continued): Increase (Decrease) in current liabilities: Accounts payable and accrued expenses 3,666 2,263 680 103 Accrued payroll and related expenses 558 (968) (868) 361 Accrued interest 172 (532) (184) 76 Income taxes payable 249 (7) (5) 25 Interim billings in excess of costs and estimated profits 1,046 (90) -- -- ------ ------ ------ ------ Total adjustments 13,359 7,766 4,825 (1,023) ------ ------ ------ ------ Net cash provided by (used) in operating activities 1,999 (3,662) (5,947) ( 429) ------ ------ ------ ------ Cash Flows from Investing Activities: (Increase) decrease in other assets (464) (667) (795) 30 Capital expenditures (684) (2,150) (205) (60) Proceeds from sale of fixed assets 220 -- -- -- Capitalized software development costs (20) (337) (581) (404) Investments in common stock (7) (392) (658) (95) Proceeds from sale of common stock investments 530 45 195 749 Acquisition of subsidiary (983) (8,358) (500) -- Cash of company acquired 504 2,422 145 4 Cash of company sold -- (6) (6) -- Cash escrow -- -- (2,000) -- Payments for loans made (3,022) (1,493) (1,194) (320) Collections from repayment of loans made 3,223 106 -- 31 ------ ------ ------ ------ Net cash used in investing activities (703) (10,830) (5,599) (65) ------ ------ ------ ------ (continued) See notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\n----------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ------------------ ------------------ 1995 1994 1994 1993 ------ ------ ------ ------ Cash Flows from Financing Activities: Deferred offering costs (129) (331) (171) -- Net advances from factor 367 550 1,936 -- Proceeds from issuance of long-term debt 1,297 7,169 605 752 Repayment of long-term debt (6,909) (2,452) (1,976) (644) Payments on capital leases (1,194) (165) (8) (3) Issuance of preferred stock -- -- -- 40 Issuance of common stock 250 8,161 8,161 -- Issuance of a subsidiary's common stock 2,990 -- -- -- Exercise of stock options 1,225 3,000 4,600 -- Exercise of subsidiary stock options 716 -- -- -- ------ ------ ------ ------ Net cash provided by (used in) financing activities (1,387) 15,932 13,147 145 ------ ------ ------ ------\nNet Increase (Decrease) in Cash and Cash Equivalents (91) 1,440 1,599 (349)\nCash and Cash Equivalents at Beginning of Period 1,727 287 174 523 ------ ------ ------ ------ Cash and Cash Equivalents at End of Period $ 1,636 $ 1,727 $ 1,773 $ 174 ====== ====== ====== ======\nSupplemental Disclosures of Cash Flow Information: Cash paid for interest $ 3,912 $ 1,062 $ 116 $ 143 ====== ====== ====== ====== Cash paid for income taxes $ 22 -- -- $ 1 ====== ====== ====== ====== (concluded)\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSupplemental Disclosures of Noncash Investing and Financing Activities:\nDuring the year ended December 31, 1995, the Company: (1) Acquired equipment under capital lease obligations with a net present value of $817. (2) Received common stock in lieu of cash payments for notes receivable and accrued interest receivable with a book value of $217. (3) Pursuant to an acquisition of another entity by one of the Company's subsidiaries, in a transaction accounted for as a reverse merger: (a) Reduced the Company's equity ownership in such subsidiary which resulted in an increase in minority interest of $5,811. (b) Acquired net assets with a book value of $983. (4) Issued stock with a discounted value of $114 in lieu of cash payment for services rendered. (5) Incurred $3,869 in noncash expense from the issuance and exercise of 6,500,000 stock options\nDuring the year ended December 31, 1994, the Company: (1) Purchased equipment in the amount of $185 and assumed capital lease obligations for $137 and notes payable for $48. (2) Acquired capitalized software costs in the amount of $150 and assumed notes payable for the full amount. (3) Acquired equipment in the amount of $35 and assumed notes payable for the full amount. (4) Acquired a covenant not to compete in the amount of $800 and assumed notes payable for the full amount. (5) Acquired Creative Socio-Medics and in connection therewith assumed long-term debt approximating $530. (6) Acquired International Magnetic Imaging and in connection therewith assumed subordinated debt approximating $19,800, long-term debt approximating $12,000, capital lease obligations approximating $3,700 and issued stock with a value of $2,920. (7) Acquired Job Shop Technical Services and Computer Engineering Services and in connection therewith assumed subordinated debt approximating $1,500, long-term debt approximating $2,600 and issued stock with a value of $900. (8) Issued stock with a discounted value of $97 in lieu of cash payment for services rendered. (9) Incurred $4,140 in noncash expense from the issuance and exercise of 1,500,000 stock options\nDuring the fiscal year ended July 31, 1994, the Company: (1) Purchased capital assets in the amount of $49 and assumed notes payable for the full amount. (2) Acquired ARC Acquisition Corp. and in connection therewith assumed long-term debt approximating $1,400. (3) Acquired Creative Socio-Medics and in connection therewith assumed long-term debt approximating $530. (4) Incurred $7,140 in noncash expense from the issuance and exercise of 3,000,000 options.\nSee notes to consolidated financial statements.\nConsolidated Technology Group Ltd. and Subsidiaries Consolidated Statement of Cash Flows for the Years Ended December 31, 1995 and 1994 and July 31, 1994 and 1993 (in 000's except per share data)\nSupplemental Disclosures of Noncash Investing and Financing Activities (continued):\nDuring the fiscal year ended July 31, 1993, the Company: (1) Purchased capital assets in the amount of $48 and assumed capital lease obligations for the full amount. (2) Procured insurance coverage valued at $20 and assumed debt for the full amount. (3) Through its subsidiary, S-Tech, purchased certain assets of General Technologies Group, Ltd. which resulted in a one time gain of $1,523. (4) Converted debt in the amount of $349 into 69,711 shares of Series A preferred stock.\nSee notes to consolidated financial statements.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's, except per share data) - ------------------------------------------------------------------------------ (1) Summary of Significant Accounting Policies\nGeneral - Effective September 1, 1993, the Company's name was changed from Sequential Information Systems, Inc. to Consolidated Technology Group Ltd.\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and all of its majority-owned subsidiaries. Investments in 20% to 50% owned companies are accounted for on the equity method. All significant intercompany balances and transactions have been eliminated.\nAccounting Period - Effective December 31, 1994, the Company changed to a calendar year. Prior to 1994 the Company utilized a fiscal year ending July 31 of each year. The accompanying financial statements include balance sheets for the year ended December 31, 1995 and 1994 and statements of operations, cash flows and changes in stockholder's equity for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993.\nCash and Cash Equivalents - The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. International Magnetic Imaging, Inc. (\"IMI\"), a wholly owned subsidiary of the Company, has cash balances of $1,412 and $1,471 at December 31, 1995 and 1994, respectively, which represents 86% and 85% of total cash for the same respective periods. The use of IMI's cash is restricted pursuant to an IMI financing agreement with a creditor, whereby IMI may not make payments out of the ordinary course of IMI operations and specifically, not to the parent company, (Consolidated), or any subsidiary or affiliate.\nInventories - Inventories are valued at the lower of cost or market. Cost is determined by the first-in, first out method with the exception of the audio visual manufacturing and services segment which values inventory a standard which approximates first-in, first out. Costs accumulated under government contracts are net of progress payments.\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost less allowances for accumulated depreciation. The cost of furniture and equipment held under capital leases is equal to the lower of the net present value of the minimum lease payments or the fair value of the leased property at the inception of the lease. Depreciation is computed generally by the straight-line method at rates adequate to allocate the cost of applicable assets over their expected useful lives. Leasehold improvements are amortized over periods not in excess of applicable lease terms. Amortization of capitalized leases and leasehold improvements is included with depreciation expense.\nResearch and Development - The Company's research and product development activities are conducted by the Electro-Mechanical and Electro-Optical Manufacturing and Services, Medical Services, Audio Visual Manufacturing and Services and Three Dimensional Products and Services segments. The Company's research and development expenses for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993 approximated $893, $4,842, $1,902 and $396, respectively. All of the Company's research and development activities were\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's, except per share data) - ------------------------------------------------------------------------------ (1) Summary of Significant Accounting Policies (continued)\nperformed by the subsidiaries and were company financed. Research and development costs are expensed as incurred.\nCapitalized Software Development Costs - Capitalization of computer software development costs begins upon the establishment of technological feasibility. Technological feasibility for the Company's computer software products is generally based upon achievement of a detail program design free of high risk development issues. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized computer software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological feasibility, anticipated future gross revenues, estimated economic life and changes in software and hardware technology.\nAmortization of capitalized software development costs commences when the related products become available for general release to customers. Amortization is provided on a product by product basis using the straight-line method over the estimated economic life of the product, estimated to be approximately 2-3 years. Research and development costs incurred to establish technological feasibility are expensed as incurred. Accumulated amortization was $845 and $262 at December 31, 1995 and 1994 ,respectively. For the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993, amortization of capitalized software development costs approximated $582, $262, $13, and $0, respectively.\nIntangible Assets - Intangible assets consist of goodwill, covenants not to compete, customer lists and trademarks. The Financial Accounting Standards Board has issued Statement 121 addressing the accounting for the impairment of long-lived assets that will be held and used, including certain identifiable intangibles, and the goodwill related to those assets. The statement is effective for calendar-year 1996 financial statements.\nGoodwill - Goodwill represents the excess of the cost of companies acquired over the fair value of their net assets at dates of acquisition and is being amortized over a twenty year period on the straight-line method. Management of the Company evaluates the period of goodwill amortization to determine whether latter events and circumstances warrant revised estimates of useful lives. This evaluation is done by comparing the carrying value of goodwill to the value of projected discounted net cash flows from related operations. Impairment is recognized if the carrying value of goodwill is greater than the projected discounted cash flows from related operations.\nCovenants Not to Compete - The capitalized value of covenants not to compete are being amortized on the straight-line basis over their contractual lives which range from three to five years.\nCustomer Lists - Customer lists are being amortized over twelve to fifteen years on the straight-line basis.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (1) Summary of Significant Accounting Policies (continued)\nTrademark - The trademark, which was acquired as a part of a reverse merger in May 1995, relates to the Audio Visual Manufacturing and Services segment and has a cost basis of $429 which represents the net present value of the payments for such trademark at the time it was acquired. This trademark gives the Company a nonexclusive trademark license for use of the \"Klipsch\" name for use with various professional loudspeaker products provided that the trademark is used only in connection with professional grade speakers. The Klipsch name and related speakers were developed in the 1940's and is an established name as a leader in loudspeaker design and innovation. The Company believes that the acquisition of the Klipsch trademark gives the Company one of the most long-established and recognizable brand names in the industry. The trademark is being amortized over 25 years on a straight line basis. Accumulated amortization at December 31, 1995 is $46 and amortization expense since the Company's acquisition of the trademark in May 1995 through December 31, 1995 approximated $3.\nDeferred Offering Costs - Deferred offering costs represents amounts paid or accrued for costs associated with an anticipated public offering for a subsidiary of the Company in the medical services segment amounted to $129, $331 and $172 for the years ended December 31, 1995 and 1994 and July 31, 1994. These costs would have been recorded as a reduction of the net proceeds of the anticipated offering, however; the total accumulated amount of such costs of $460 was expensed during the year ended December 31, 1995 since the offering was not consummated.\nInvestments in Common Stock -The Company adopted Statement of Financial Accounting Standards (\"SFAS\") 115 \"Accounting for Certain Investments in Debt and Equity Securities\", in the five-month period ended December 31, 1994. SFAS 115 requires certain investments that have readily determinable fair values to be categorized as either trading, available-for-sale, or held-to-maturity. All of the Company's equity investments in common stock are categorized as available-for-sale and are recorded at fair value with unrealized gains and losses recorded as a separate component of stockholders' equity. Additionally, available-for-sale investments that are deemed to be permanently impaired are written down to fair market value and such write down is charged to earnings as a realized loss. The adoption of this standard has not impacted the Company's financial statements since previous unrealized losses on such investments were already reflected as a separate component of stockholders' equity.\nMinority Interest - For consolidated subsidiaries that are not wholly owned, the Company eliminates the minority interest portion of the related profits and losses. The allocable losses of such minority interests is in excess of the Company's investment in such subsidiaries by approximately $1,132 and $684 at December 31, 1995 and 1994.\nRevenue Recognition - Revenue for the service sector is recognized as services are provided. Revenue from the manufacturing sector is recognized primarily under fixed price type contracts and are accounted for under the unit of delivery method. Anticipated losses on contracts in progress are charged to\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (1) Summary of Significant Accounting Policies (continued)\noperations as soon as losses can be determined. Revenues from fixed price software development contracts and revenue under license agreements which require significant modification of the software package to the customer's specification, are recognized on the estimated percentage-of-completion method. Revisions in cost estimates and recognition of losses on these contracts are reflected in the accounting period in which the facts become known. Revenue from the software package license agreements without significant vendor obligations is recognized upon delivery of the software. Information processing revenues are recognized in the period in which the service is provided. Net patient service revenues are reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including provisions for estimated contractual adjustments under reimbursement agreements with third-party payors. The Medical Diagnostic Segment has historically not provided any significant amount of charity care. Maintenance contract revenue is recognized on a straight-line basis over the life of the respective contract. Software development revenues from time-and-materials contracts are recognized as services are performed.\nContract terms which provide for billing schedules that differ from revenue recognition give rise to costs and estimated profits in excess of billings and billings in excess of costs and estimated profits. Costs, estimated profits, and billings on uncompleted contracts are summarized as follows:\nCosts incurred on uncompleted contracts $ 2,697 Estimated profits 490 ------ Total 3,187 Billings to date 3,604 ------ Net ($ 699) ======\nIncluded in the accompanying balance sheet under the following captions:\nExcess of accumulated costs over related billings $ 1,002 Excess of billings over accumulated costs 1,701 ------ Net ($ 699) ======\nEarnings (Loss) Per Share - Earnings (loss) per share are computed by dividing the net income (loss) for the year by the weighted average number of common shares outstanding. For purposes of computing weighted average number of common shares outstanding the Company has common stock equivalents consisting of stock options and warrants and Series \"A\" Preferred Convertible Stock. The Series \"A\" Preferred Stock was deemed to be a common stock equivalent when issued. The common stock equivalents are assumed converted to common stock, when dilutive. During periods of operations in which losses were incurred,\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (1) Summary of Significant Accounting Policies (continued)\ncommon stock equivalents were excluded from the weighted average number of common shares outstanding because their inclusion would be anti-dilutive.\nFair Value of Financial Instruments - The fair value of cash and cash equivalents, accounts receivable and accounts payable is the carrying amount because of the short maturity of such instruments. The fair value of investments in common stock is based on quoted market prices which is also the carrying amount of such instruments (see Note 1 Investments in Common Stock). Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of notes payable and long-term debt is estimated to approximate the carrying amount.\nConcentration of Credit Risk - Financial instruments which potentially subject the Company to concentrations of credit risk are cash and cash equivalents and accounts receivable arising from normal business activities. The Company routinely assesses the financial strength of its customers and based upon factors surrounding the credit risk of its customers, establishes an allowance for uncollectible accounts, and as a consequence, believes that its accounts receivable credit risk exposure beyond such allowances is limited. The Company places its cash and cash equivalents with high credit quality financial institutions. The amount on deposit in any one institution that exceeds federally insured limits is subject to credit risk. The Company believes no significant concentration of credit risk exists with respect to these cash investments. For the year ended December 31, 1995, the Company did not receive revenues from any one customer that was significant to total revenues as a whole\nReclassifications - Certain year ended December 31, 1994 and July 31, 1994 and 1993 items have been reclassified to conform to the December 31, 1995 presentation.\n(2) Going Concern\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements, the Company incurred a net loss of $11,360,000 for the year ended December 31, 1995, and has an accumulated deficit to that date of $40,648,000. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the success of the Company's subsidiary's marketing efforts and their efforts to obtain sufficient funding to enable them to continue operations. Management's plan is to continue efforts to raise capital through initial public offerings of the underlying subsidiary's equity and to manage them to profitable levels once adequate funding is in place. The failure of the subsidiaries to raise capital by equity offerings of their stock may force the Company to reduce operations via the closure of certain segments of operations and could ultimately force the Company as a whole to cease operations.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (3) Receivables\nReceivables consist of the following: December 31, --------------------- 1995 1994 ------ ------ Receivables $22,433 $19,670 Less: Allowance for bad debts (3,217) (2,850) ------ ------ Receivables, net $19,216 $16,820 ====== ======\nThe Company finances certain receivables to a factor under agreements entered into in August 1994. The agreements are renewable annually and have a maximum availability of funds of $5,500. Funds can be advanced in an amount equal to 85% of the total face amount of outstanding and unpaid receivables, with the factor having the right to reserve 15% of the outstanding and unpaid receivables financed. The interest rate is equal to the base lending rate of an agreed upon bank, which was 8.25% and 7.65% at December 31, 1995 and 1994, respectively, plus 2% and 4% for the respective periods and a commission of 0.3% and 1% of the receivables financed for the respective periods. The factor has a security interest in all accounts receivables, contract rights, personal property, fixtures and inventory of the company. At December 31, 1995 and 1994 the total amount advanced by the factor was $4,386 and $4,019, respectively.\nThe changes in the allowance for bad debts are as follows:\nDecember 31, --------------------- 1995 1994 ------ ------\nBalance at beginning of period $ 2,850 $ 2,933 Provision for the period (1,225) (83) Write-offs for the period 1,592 -- ------ ------ Balance at end of period $ 3,217 $ 2,850 ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------\n(4) Inventories\nInventories consist of the following: December 31, --------------------- 1995 1994 ------ ------ Finished goods $ 98 -- Work-in-process 1,336 $ 1,373 Raw materials and parts 2,617 2,214 ------ ------ Subtotal 4,051 3,587 Less: Progress payments -- (121) ------ ------ Subtotal 4,051 3,466 Allowance for obsolesence (350) -- ------ ------ Total inventories $ 3,701 $ 3,466 ====== ======\nThe work-in-process represents accumulated costs of raw materials, direct labor and factory overhead expenses on current work orders. Finished goods represent computer software inventory purchased for resale. During the years ended December 31, 1995 and 1994 approximately $470 and $307 of inventory was written-off due to obsolesence.\n(5) Loans Receivable\nLoans receivable consist of the following: December 31, --------------------- 1995 1994 ------ ------ Fingermatrix $ 621 $ 1,439 Other 169 275 ------ ------ Total 790 1,714 Less: Allowance for doubtful accounts (175) (351) ------ ------ Loans receivable, net 615 1,363 Long-term portion 219 -- ------ ------ Current portion $ 396 $ 1,363 ====== ======\nFingermatrix was in Chapter 11 pursuant to a petition filed on September 11, 1993 and whose plan was confirmed in March of 1995. The bankruptcy court has classified the Company as having a first security in the assets of the debtor. On March 31, 1995, Fingermatrix emerged out of bankruptcy and the Company received its first payment of $250 on its secured debt and its initial payment\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (5) Loans Receivable (continued)\nof $2 on its unsecured debt. The Company received 150,000 common shares and 250,000 warrants equaling less than 5% of the emerging debtor upon confirmation. The common shares and warrants received were recorded at $240 which was the book value of the receivable and the related accrued interest exchanged for the receipt of such common stock and warrants. The allowance for doubtful accounts relates to notes receivable other than the Fingermatrix loan.\n(6) Receivables from Related Parties\nRelated party receivables consist of the following: December 31, --------------------- 1995 1994 ------ ------ Unconsolidated affiliate - Loan consists of cash advances and has no fixed due dates or terms. $ 427 $ 160 Officers: Due from an officer of a subsidiary and has no fixed due dates or terms. 45 -- Due from the chief executive officer of the Company and such officer executed a note with interest at 9% payable quarterly and matures in the year 2000. 72 -- ------ ------ Total $ 544 $ 160 ====== ======\n(7) Investments in Common Stock\nInvestments in common stock consist of the following:\nDecember 31, --------------------- 1995 1994 ------ ------ Cost basis $ 336 $ 674 Net unrealized gain (loss) included as a reduction of shareholders' equity 89 (139) ------ ------ Market Value 425 535 Current portion 20 151 ------ ------ Long-term portion $ 405 $ 384 ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (7) Investments in Common Stock (continued)\nThe unrealized gain (loss) on investments in common stocks consists of the following: December 31, --------------------- 1995 1994 ------ ------ Balance at beginning of period ($ 139) ($ 270) Adjustments of investments to fair market value 172 131 Realization of previously unrealized loss 56 -- ------ ------ Balance at end of period $ 89 ($ 139) ====== ======\nGain (loss) on the sale of securities consists of the following:\nFiscal Year Ended Year Ended December 31, July 31, ---------------- ---------------- 1995 1994 1994 1993 ------ ------ ------ ------\nProceeds from security sales $ 530 $ 45 $ 195 $ 749 Cost of securities sold 565 344 182 55 ------ ------ ------ ------ Gain (loss) on security sales ($ 35) ($ 299) $ 13 $ 694 ====== ====== ====== ======\n(8) Property, Plant and Equipment\nProperty, plant and equipment consist of the following:\nDecember 31, --------------------- 1995 1994 ------ ------ Land $ 664 $ 664 Buildings 3,242 3,234 Medical equipment 14,590 15,919 Machinery and equipment 2,019 2,283 Tools and dies 601 145 Furniture and equipment 4,097 3,429 Vehicles 25 25 Leasehold improvements 1,504 1,334 ------ ------ Total 26,742 27,033 Less: Accumulated depreciation (18,110) (16,842) ------ ------\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (8) Property, Plant and Equipment (continued)\nDecember 31, --------------------- 1995 1994 ------ ------ Sub-total 8,632 10,191 ------ ------ Equipment held under capital leases 6,843 6,227 Less: Accumulated depreciation (4,441) (3,507) ------ ------ Sub-total 2,402 2,720 ------ ------ Property, plant and equipment, net $11,034 $12,911 ====== ======\nDepreciation expense charged to operations was $3,472, $952, $127 and $40 for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993, respectively.\n(9) Intangible Assets\nIntangible assets consist of the following:\nDecember 31, --------------------- 1995 1994 ------ ------ Goodwill $12,901 $13,005 Less: Accumulated amortization (1,020) (382) ------ ------ Goodwill, net $11,881 $12,623 ====== ======\nCovenant not to compete $ 3,954 $ 3,954 Less: Accumulated amortization (1,786) (503) ------ ------ Covenant not to compete, net $ 2,168 $ 3,451 ====== ======\nCustomer lists $13,046 $13,046 Less: Accumulated amortization (1,362) (276) ------ ------ Customer lists, net $11,684 $12,770 ====== ======\nTrademarks $ 429 -- Less: Accumulated amortization ( 46) -- ------ ------ Trademarks, net $ 383 -- ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (9) Intangible Assets (continued)\nAmortization expense charged to operations was $3,009, $982, $163, and $0 for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993. During the year ended December 31, 1994 the Company wrote-off approximately $623 of goodwill cost that was deemed to be impaired.\n(10) Debt\nNotes Payable - Related Parties consists of the following:\nDecember 31, --------------------- 1995 1994 ------ ------ Notes payable to stockholders for cash received and office equipment contributed by these stockholders in 1992. The loans are noninterest bearing and have no fixed due date. $ 183 $ 183\nNote payable to an employee for cash advances, due in March 1996 with interest at 9%. 107 --\n------ ------ Total notes payable, related parties $ 290 $ 183 ====== ======\nLong-term debt consists of the following: December 31, --------------------- 1995 1994 ------ ------ Bank and installment loans - with interest rates ranging from 6% - 12.5%. Collateralized by certain assets and stock of subsidiaries of the Company. $232 is currently in default, $2,980 is due in 1996 and $4,364 is due through 1999. $ 6,134 $ 7,576\nFormer stockholders of an acquired subsidiary, due September 1996 with interest at 7%. 138 280\nEquipment loans - payable in various monthly installments at interest rates ranging from 7.75% to 11.5%, collateralized by the related equipment, due through 2000. 1,629 1,741\nBuilding mortgages - payable in various monthly installments at interest rates ranging from 9.25% to 9.75% due through September 2000, collateralized by the related buildings. 1,711 1,940\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (10) Debt (continued)\nDecember 31, --------------------- 1995 1994 ------ ------ Investor loans - interest at 10% on $362 and 13.5% on $530. $362 was due on 1995 and is in default and $530 is due in 1997 and is in default for failure to make timely interest payments. 825 362\nLoans payable to factor - $3,679 carries base interest rates of 8.25 and 7.65% at December 31, 1995 and 1994, respectively, plus an additional 2% and 4% for the respective periods and a 0.3% and 1% commission for the respective periods. $707 of new factor debt during 1995 carries interest at prime plus 8% to a maximum of 18%, an effective rate of 15% at December 31, 1995. Collateralized by accounts receivable, contract rights, personal property, fixtures and inventory. 4,386 4,019\nNote payable - covenants not-to-compete, payable in monthly installments of $22. The notes are noninterest bearing and mature September 1997. 467 690 ------ ------ Total 15,290 16,608 Current portion 9,080 8,096 ------ ------ Long-term portion $ 6,210 $ 8,512 ====== ======\nSubordinated debt consists of the following:\nDecember 31, --------------------- 1995 1994 ------ ------ Subordinated notes payable issued in connection with acquisitions - payable in various quarterly installments at interest rates ranging from 4% to 7%. The notes are unsecured and as of December 31, 1995 include balloon payments in September 1996 and September 1997. Subsequent to December 31, 1995, a portion of these notes have been refinanced and a portion have been renegotiated to extend the payment terms (see subsequent events footnote) $17,657 $19,863\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (10) Debt (continued) December 31, --------------------- 1995 1994 ------ ------ Internal Revenue Service for payment of taxes that were past due at the time that the Company purchased a subsidiary in 1994, payable in 15 monthly installments of, $100, maturing through July 31, 1996. 700 1,500 ------ ------ Total 18,357 21,363 Current portion 13,354 3,437 ------ ------ Long-term portion $ 5,003 $17,926 ====== ======\nMaturities of debt, including subordinated and related party debt, are as follows:\nYears Ended December 31, Amount ------------------------ ------ 1996 $22,724 1997 5,809 1998 2,824 1999 2,355 2000 225 ------ Total $33,937 ======\n(11) Lease Obligations\nCapitalized Lease Obligations - The Company leases equipment under noncancelable capital leases, the last of which expires in 2000. For some of the leases, a balloon payment representing the buyout of the leased equipment is due at the end of the lease term. Capitalized lease obligations are collateralized by leased equipment which has a net book value of $2,402 at December 31, 1995.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (11) Lease Obligations (continued)\nFuture minimum payments under capital lease obligations are as follows at December 31, 1995:\nYears Ended December 31, Amount ------------------------ ------ 1996 $ 1,663 1997 1,089 1998 932 1999 358 2000 77 ------ Total minimum lease payments 4,119 Less: Amount representing interest (559) ------ Present value of net minimum lease payments 3,560 Current portion 1,362 ------ Long-term portion $ 2,198 ======\nOperating Lease Obligations - The Company leases real estate for certain of its operational and administrative facilities under noncancelable operating leases expiring during the next fifteen years. The real estate leases contain clauses which permit adjustments of lease payments based upon changes in the \"Consumer Price Index\", options to renew the leases for periods up to an additional fifteen years and additional payments for a proportionate share of real estate taxes and common area operating expenses. The Company's present executive offices are located at 160 Broadway, New York, New York 10038, which it occupies pursuant to a lease expiring February 28, 1999. The current base rent for such premises is $7 per month. The Company's subsidiaries occupy various facilities pursuant to leases expiring through 2001 The current base rent for such premises approximates $123 per month.\nMinimum future rental payments under noncancelable operating leases having a remaining term in excess of one year are as follows:\nYears Ended December 31, Amount ------------------------ ------ 1996 $ 1,302 1997 1,235 1998 1,195 1999 886 2000 440 Thereafter 180 ------ Total minimum future rental payments $ 5,238 ======\nRent expense for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993 approximated $1,560, $569, $357 and $258, respectively.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (12) Income Taxes\nUnder SFAS No. 109 \"Accounting for Income Taxes\", deferred 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 composing the Company's net deferred tax liability as of December 31, 1995 and 1994 are as follows:\nDecember 31, ---------------- 1995 1994 ------ ------ Deferred Tax Liabilities: Difference between book and tax amortization $ 150 -- Book basis of assets in excess of tax basis 4,424 -- Other 3 -- ------ ------ 4,577 -- ------ ------ Deferred Tax Assets: Allowance for doubtful accounts not currently deductible 1,231 1,100 Note and loan receivable allowances 71 253 Difference between book and tax depreciation 4,527 676 Accrued vacation pay 61 82 Accrued warranty expense 11 -- Accrued sales returns 6 -- Accrued sales discounts 10 -- Inventory reserves not currently deductible 137 -- Federal net operating loss carryforward 13,758 5,197 State net operating loss carryforward 4,418 1,151 Other -- 19 ------ ------ 24,230 8,478 ------ ------ Valuation allowance 19,653 8,478 ------ ------ Net Deferred Tax Liability $ -- $ -- ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (12) Income Taxes (continued)\nThe Company's deferred tax asset valuation allowance was $19,653, $8,478 and $4,700 as of December 31, 1995 and 1994 and July 31, 1994, respectively. The increase in the valuation allowance of $11,175 for the year ended December 31, 1995 is comprised of the following:\nDifference between book and tax depreciation $ 3,851 Difference between book and tax amortization (150) Book basis of assets in excess of tax basis (4,424) Allowance for doubtful accounts not currently deductible 131 Note and loan receivable allowances (182) Accrued vacation pay (21) Accrued warranty expense 11 Accrued sales returns 6 Accrued sales discounts 10 Inventory reserves not currently deductible 137 Federal net operating loss carryforward 8,561 State net operating loss carryforward 3,267 Other (22) ------ Total Increase $11,175 ======\nThere was no valuation allowance as of July 31, 1993 since SFAS No. 109 was initially adopted for the fiscal year ended July 31, 1994.\nIncome Taxes:\nThe current and deferred income tax components of the provision (benefit) for income taxes consist of the following:\nYear Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- 1995 1994 1994 1993 ------ ------ ------ ------ Current: Federal $ -- -- -- -- State 144 $ 19 -- 21 Puerto Rico 83 5 -- -- ------ ------ ------ ------ 227 24 -- 21\nDeferred -- -- -- -- ------ ------ ------ ------ $ 227 $ 24 -- $ 21 ====== ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (12) Income Taxes (continued)\nThe provision for income taxes varies from the amount computed by applying the statutory rate for the reasons below:\nYear Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- 1995 1994 1994 1993 ------ ------ ------ ------ Provision based on statutory rate 35.0% 35.0% 35.0% 34.0% Benefit of graduated rates (1.0) (1.0) (1.0) n\/a Other income taxes (net of federal benefit) (0.5) -- n\/a n\/a State taxes (net of federal benefit) (1.0) (0.6) -- 4.0 Valuation allowance (34.0) (34.0) (34.0%) n\/a Net Operating Loss n\/a n\/a n\/a (34.0) ------ ------ ------ ------ (1.5%) (0.6%) -- 4.0% ====== ====== ====== ======\nThe Company's provision for income taxes is comprised of state and Puerto Rico income taxes for the year ended December 31, 1995 and 1994. The provision for income taxes for the fiscal year ended July 31, 1993 is comprised of state income tax. The Company will have a federal net operating loss carryforward of approximately $44,882 and a state net operating loss carryforward of approximately $44,881. The federal net operating loss carryforwards expire in years 1996 through 2010 and the state net operating loss carryforwards expire in years 1996 through 2010 (the expiration dates vary based on individual state income tax laws).\n(13) Capital Stock\nCommon Stock\nReverse Split - Effective September 1, 1993, the capitalization of the Company changed from 300,000,000 shares of common stock, $.01 par value, into 50,000,000 shares of common stock, $.01 par value. Effective the same time, the presently issued and outstanding shares of common stock were reverse split on the basis of one (1) new share for each sixty (60) issued and outstanding shares. All share data has been adjusted retroactively.\nStock Options - On August 20, 1993, the Company authorized a stock option plan for Non Employee Directors, Consultants and Advisors to provide compensation for services rendered to the Company in lieu of cash payment. At various times the Company has registered and granted options pursuant to the plan. During the years ended December 31, 1995 and 1994 and July 31, 1994, options to purchase 6,500,000 shares, 1,500,000 shares and 3,000,000 shares, respectively, were granted and exercised.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (13) Capital Stock (continued)\nAcquisitions - Common stock was issued to acquire subsidiaries as follows: (i) In December, 1993 issued 850,000 shares in connection with the acquisitions of Arc Acquisition Group, Inc. and ARC Networks, Inc. (ii) In August 1993, issued 120,000 shares in connection with the acquisition of the remaining 20% of S-Tech. (iii) In June 1994, issued 840,000 in connection with the acquisition of Creative Socio-Medics Corp. (iv) In September 1994 issued 3,343,000 shares in connection with the acquisition of the International Magnetic Imaging, Inc. and affiliated entities. (v) In November 1994 issued 1,500,000 shares in connection with the acquisition of Job Shop Technical Services, Inc. and Computer Engineering Services, Inc.\nStock Issued for Services Rendered - For the years ended December 31, 1995 and 1994 the Company issued 130,004 shares and 200,000 shares, respectively, for in connection with consulting and financing services valued at $114 and $97, respectively.\nRegulation S Offerings - Pursuant to offerings in October 1995 and March 1994 made under Regulation S of the Securities Act of 1933, the Company received net proceeds of $250 and $8,162, respectively, in conjunction with the respective issuance of 1,000,000 shares and 3,500,000 shares of common stock.\nConversion of Series A Preferred Stock - During the year ended December 31, 1995, the Company issued 1,447,807 shares of common stock upon the conversion of 11,117 shares of series A preferred stock.\nStock Purchase Rights - On December 15, 1994, the board of directors of a subsidiary approved the sale of 4,000,000 shares of Common Stock owned by such subsidiary to seven individuals who are officers, directors and\/or key employees of the Company or it subsidiaries. The purchase price is $.50 per share, which was the fair market value of such stock on December 15, 1994. An initial payment of $.01 per share is due not later than July 31, 1995, and the balance is to be represented by the purchasers' nonrecourse 8% promissory notes due December 31, 1999. Payment may be made in cash or in securities. Payment of the notes is secured by a pledge of the shares. The shares are to be issued pursuant to stock purchase agreements dated as of December 15, 1994 between the subsidiary and the purchasers. None of the individuals receiving the rights to purchase such stock exercised such right as of July 31, 1995 and all such rights have expired.\nPreferred Stock - Effective September 1, 1993, the authorized number of shares of undesignated preferred stock, par value $1.00 per share, was increased from 1,000,000 to 2,000,000 shares.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (13) Capital Stock (continued)\nSeries A - The series A convertible preferred stock, which was all issued during the period April 1993 through July 1993, bears a cumulative dividend of 6%, is redeemable at any time at the option of the Company at a redemption price of $10 per share, and is convertible at the option of the holder at any time commencing two years from the date of issuance, unless sooner called for redemption by the Company at the rate of 130.208 (7,812.5 prior to 60:1 reverse split) shares of common stock for each share of preferred stock if and when sufficient shares of common stock are available for issuance. No dividends were declared for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993. As of December 31, 1995 and 1994 a $.30 per share dividend totaling $27 and $23, respectively, is in arrears. During the year ended December 31, 1995 11,117 shares of series A preferred stock was converted into 1,447,807 shares of common stock.\nSeries B - The Series B subordinated preferred stock is redeemable at the option of the Company at the issue price of $87.50 per share. The stock is entitled to a $3.50 annual dividend which is contingent upon after tax earnings in excess of $200. In the event of involuntary liquidation, the holders may receive $87.50 per share and all dividends. No dividends were declared for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993.\nSeries E - The Series E preferred stock is entitled to an annual dividend of $.10 per share contingent upon after tax earnings being in excess of $200. No dividends were declared for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993.\nSeries F - As consideration for granting extensions on former debts, the Company issued, in 1984, 2,700 shares of preferred stock at $1.00 per share. The nonvoting preferred stock, designated Series F, with a dividend rate of $8.00 per share is redeemable at the option of the Company after July 1993 for $1.00 per share. One share will be issued for each $100 (one hundred dollars) of principal indebtedness owed. The dividend will be noncumulative and is payable within 100 days from the close of any year where net income after tax exceeds $500, and all dividends due on the Series B preferred stock are paid or provided for. No dividends were declared for the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993.\n(14) Stock Options and Warrants\nEmployee Stock Options\nPursuant to a Board of Directors meeting on December 15, 1994 certain individuals received options to purchase an aggregate of 1,750,000 shares of unregistered common stock. The options have an exercise price of $.50 per share, being the fair market value per share of Consolidated common stock on the date of the meeting, being the date of grant, and being exercisable at any time and from time to time during the four year period ended December 14, 1998.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (14) Stock Options and Warrants (continued)\nNon-Employee Directors, Consultants and Advisors Stock Options:\nOn August 20, 1993, the Company authorized a stock option plan for Non-Employee Directors, Consultants and Advisors to provide compensation for services rendered to the Company in lieu of cash payments.\nPursuant to the plan, in October 1993, January 1994 and March 1994, the Company registered 1,500,000 shares, 1,000,000 shares and 1,500,000 shares, respectively. During the same time periods, options for 3,000,000 shares were granted, of which 1,400,000 were exercised at $1.00 per share and 1,600,000 exercised at $2.00 per share, resulting in $7,140 of expenses computed as follows:\nShares 3,000,000 Value of stock at date of grant $4.8917* ------ 14,675 20% discount (2,935) ------ 11,740 Exercise proceeds (4,600) ------ Expense $ 7,140 ======\n* - Represents weighted average.\nIn accordance with the agreements relating to the various parties involved, for the years ended December 31, 1994 and July 31, 1994 $4,140 and $7,140 was charged as consulting services in the determination of income from operations. A 20% discount was utilized because the shares issued represents a large block of stock.\nPursuant to the plan during the year ended December 31, 1995, 6,500,000 shares were granted and exercised of which 1,500,000 were exercised at $0.25 per share, 1,000,000 were exercised at $0.35 per share 1,000,000 were exercised at $0.50 per share and 3,000,000 were exercised at $0.00 per share, resulting in $3,869 of consulting costs computed as follows:\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (14) Stock Options and Warrants (continued)\nShares 6,500,000 Value of stock at date of grant $0.9796* ------ 6,367 20% discount (1,273) ------ 5,094 Exercise proceeds (1,225) ------ Total consulting costs 3,869 Portion expensed at issuance 1,556 ------ Portion deferred at issuance $ 2,313 Amortization during 1995 404 ------ Write-off of deferred portion at December 31, 1995 $ 1,909 ======\n* - Represents weighted average.\nIn accordance with the agreements relating to the various parties involved, $1,556 was charged as consulting expense at the time of issuance and the remainder was to be amortized over the life of the contracts. During the year ended December 31, 1995 $404 was amortized and charged as consulting expense. Additionally, at December 31, 1995 it was determined that the parties relating to the deferred portion were no longer able to perform the services required by the contracts and as such the balance of $1,909 was written-off to consulting expense. A 20% discount was utilized because the shares issued represents a large block of stock.\nSeries A Common Stock Purchase Warrant:\nOn September 30, 1994, in conjunction with the financing of the IMI acquisition, the Company issued to a financing company, a warrant to purchase 1,000,000 shares of the Company's common stock at an exercise price of $0.75 per share. This warrant is exercisable on or before September 30, 1999 and expires on October 1, 1999. The number and kind of securities purchasable upon the exercise of this warrant and the exercise price is subject to adjustment from time to time upon the happening of (a) certain stock reclassification, consolidation or merger events; (b) certain stock split transactions; or (c) certain dividend declarations, such that the value of shares that would have been received upon exercise of the warrant immediately prior to the above events is equivalent to the value of shares receivable upon exercise of the warrant immediately subsequent to the above events.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (15) Industry Segments\nThe Company currently classifies its operations into eight business segments: (i) Contract Engineering Services consists of subsidiaries that provide engineers, designers and technical personnel on a temporary basis pursuant to contracts with major corporations; (ii) Medical Diagnostics consists of a subsidiary that performs magnetic resonance imaging and other medical diagnostic services; (iii) Electro-Mechanical and Electro- Optical Products Manufacturing consists of subsidiaries that manufacture and sell products such as devices that measure distance and velocity, instrumentation devices, debit card vending machines and industrial lighting products; (iv) Medical Information Services consists of subsidiaries that provide medical information database services, health care industry related software packages and the SmartCard medical identification cards and related software program; (v) Telecommunications consists of a subsidiary that, among other things, installs telephonic network systems and buys and resells local telephone service; (vi) Three Dimensional Products and Services consists of subsidiaries that provide three dimensional imaging services that are used in a variety of applications, such as prototype building and reverse engineering; (vii) Audio Visual Manufacturing and Services consists of a subsidiary that manufactures and sells a professional line of loudspeakers, and (viii) Business Consulting Services consists of subsidiaries that provide a variety of financial and business related services. Corporate and Other consists of the operating activities of the holding company entities. Previously, the segmentation consisted of (i) Manufacturing, which is now included in the\nElectro-Mechanical and Electro-Optical segment; (ii) Fees and Services, which included the subsidiaries that are now classified in the Contract Engineering Services, Telecommunications and Business Consulting Services segments; and (iii) Development Stage which previously included Medical Information Services and Three Dimensional Products and Services. Inter segment sales and sales outside the United States are not material. Information concerning the Company's business segments is as follows:\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (15) Industry Segments (continued)\n--------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- Segments 1995 1994 1994 1993 - -------- ------ ------ ------ ------ Revenues: Contract Engineering Services $63,152 $25,291 $10,221 $ 611 Medical Diagnostics 28,044 6,557 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing 4,223 3,605 3,475 3,059 Medical Information Services 7,381 2,925 7 50 Telecommunications 3,253 2,269 1,131 -- Three Dimensional Products and Services 1,776 850 292 80 Audio Visual Manufacturing and Services 2,149 -- -- -- Business Consulting Services 119 81 616 39 ------ ------ ------ ------ Total Revenues $110,097 $41,578 $15,742 $ 3,839 ====== ====== ====== ======\nGross Profit: Contract Engineering Services $ 3,995 $ 1,640 $ 1,007 $ 51 Medical Diagnostics 12,235 2,661 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing 1,048 119 157 996 Medical Information Services 1,974 601 7 33 Telecommunications 695 640 277 -- Three Dimensional Products and Services 654 296 119 56 Audio Visual Manufacturing and Services 202 -- -- -- Business Consulting Services 119 193 615 39 ------ ------ ------ ------ Total Gross Profit $20,922 $ 6,150 $ 2,182 $ 1,175 ====== ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (15) Industry Segments (continued)\n--------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- Segments 1995 1994 1994 1993 - -------- ------ ------ ------ ------ Income (Loss) from Operations: Contract Engineering Services ($ 446) ($ 108) ($ 21) ($ 90) Medical Diagnostics 5,367 1,036 -- -- Electro-Mechani cal and Electro- Optical Products Manufacturing (841) (1,543) (998) 382 Medical Information Services (2,274) (1,529) (678) (195) Telecommunications (504) (144) 42 -- Three Dimensional Products and Services (2,242) (1,555) (765) (108) Audio Visual Manufacturing and Services (492) -- -- -- Business Consulting Services (21) (430) 225 (148) Corporate and other (9,659) (6,191) (8,371) (1,244) ------ ------ ------ ------ Total Income (Loss) from Operations ($11,112) ($10,464) ($10,566) ($ 1,403) ====== ====== ====== ======\nNet Income (Loss): Contract Engineering Services ($ 1,312) ($ 252) $ 69 ($ 129) Medical Diagnostics 2,682 449 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing (1,002) (1,530) (1,021) 394 Medical Information Services (2,803) (1,601) (629) (222) Telecommunications (573) (150) 37 -- Three Dimensional Products and Services (2,285) (1,792) (809) (108) Audio Visual Manufacturing and Services (553) -- -- -- Business Consulting Services 9 (442) 215 (148) Corporate and Other (5,523) (6,110) (8,634) 953 ------ ------ ------ ------ Total Net Income (Loss) ($11,360) ($11,428) ($10,772) $ 740 ====== ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (15) Industry Segments (continued)\n--------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- Segments 1995 1994 1994 1993 - -------- ------ ------ ------ ------ Depreciation and Amortization: Contract Engineering Services $ 706 $ 324 $ 139 $ 1 Medical Diagnostics 4,988 1,294 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing 37 24 43 5 Medical Information Services 1,333 372 6 2 Telecommunications 30 30 15 -- Three Dimensional Products and Services 417 133 81 29 Audio Visual Manufacturing and Services 74 -- -- -- Business Consulting Services 2 2 2 1 Corporate and Other 15 8 4 2 ------ ------ ------ ------ Total Depreciation and Amortization $ 7,602 $ 2,187 $ 290 $ 40 ====== ====== ====== ======\nCapital Expenditures[1]: Contract Engineering Services $ 110 $ 2 $ 18 $ 6 Medical Diagnostics 226 12,417 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing 71 1 -- 450 Medical Information Services 138 1,103 1,004 23 Telecommunications 3 -- -- -- Three Dimensional Products and Services 50 495 142 255 Audio Visual Manufacturing and Services 439 -- -- -- Business Consulting Services -- 2 4 7 Corporate and Other 21 61 59 -- ------ ------ ------ ------ Total Capital Expenditures $ 1,058 $14,081 $ 1,227 $ 741 ====== ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (15) Industry Segments (continued) --------------------------------------- As of As of December 31, July 31, ---------------- ----------------- Segments 1995 1994 1994 1993 - -------- ------ ------ ------ ------\nIdentifiable Assets: Contract Engineering Services $ 9,559 $ 9,984 $ 5,509 $ 116 Medical Diagnostics 39,872 40,912 -- -- Electro-Mechanical and Electro- Optical Products Manufacturing 3,714 4,502 4,647 4,983 Medical Information Services 6,936 6,652 6,822 374 Telecommunications 1,362 1,256 1,042 -- Three Dimensional Products and Services 1,559 2,327 1,446 849 Audio Visual Manufacturing and Services 1,780 -- -- -- Business Consulting Services 251 1,425 444 450 Corporate and Other 1,279 1,031 5,160 609 ------ ------ ------ ------ Total Identifiable Assets $66,312 $68,089 $25,070 $ 7,381 ====== ====== ====== ======\n[1] For the years ended December 31, 1995 capital expenditures for the audio visual manufacturing and services segment include $374 for amounts allocated to property and equipment from the acquisition of certain net assets of WWR Technology related to the reverse merger with Trans Global Services. For the year ended December 31, 1994 the contract engineering services, medical diagnostics, medical services and three dimensional products and services segments include $2, $10,903, $1,004 and $208, respectively, for amounts allocated to property and equipment from the acquisition of certain net assets of Job Shop Technical Services, Inc., International Magnetic Imaging, Inc., Creative Socio-Medics, Inc. and Computer Engineering Services, Inc. For the fiscal year ended July 31, 1994, capital expenditures for the technical employee leasing and medical information services segments include $18 and $1,004 for amounts allocated to property and equipment from the acquisition of certain net assets of Arc Acquisitions Group, Inc. and Creative Socio-Medics, Inc. For the fiscal year ended July 31, 1993, capital expenditures for the electro-mechanical and electro-optical products manufacturing and three dimensional products and services segments include $450 and $182, respectively, for amounts allocated to property and equipment from the acquisition of certain net assets of General Technologies Group. Ltd. and Robotics and Designs, Inc.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (16) Sale and Reacquisition of Subsidiary\nPursuant to an Agreement dated June 4, 1987, by and among General Aero Products Corp., now called General Technologies Group Ltd. (\"GTG\"), the Company, and a subsidiary, Sequential Electronic Systems, Inc. (\"SES\"), the Company sold all of the then issued and outstanding common stock of SES (100 shares) to GTG. The Company received 1,500,000 shares of GTG common stock and a ten year, 10.5% promissory note in the principal amount of $2,000 which note was subsequently written down by $500 and the return by the Company of 500,000 shares of GTG common stock .This write down and return of shares was in settlement of a fraudulent claim made by GTG against the Company. The Company also loaned $500 to GTG evidenced by GTG's 8% Convertible Debenture. Subsequent to the above transactions, a Chapter 11 petition was filed on December 14, 1989 by GTG.\nDuring the fiscal year ended July 31, 1993, the Company, through its wholly-owned subsidiary, SIS Capital Corp., completed a settlement agreement with a financial institution. The agreement includes the purchase by the Company of the 100 shares of SES common stock held by the financial institution for $25 cash and a note of $75. In addition, S-Tech, Inc., a subsidiary of the Company acquired from the financial institution, certain net assets of GTG in the amount of $1,523 (which represents the appraised value of the assets) for $100 cash and note of $270. The cost of the purchase of the 100 shares of SES stock is included in the expenses and losses recovered by the Company through the acquired assets of GTG. In conjunction with the agreement, an adversary proceeding, commenced against GTG in its pending bankruptcy proceedings in the Bankruptcy Court-Eastern District of New York was settled. The Company's claim for rescission of the sale of certain SES stock and damages for fraud, and the financial institution's separate adversary proceeding for an order voiding issuance of the nine hundred (900) shares of SES stock have all been discontinued. There are no other claims either by or against the Company pending in those proceedings. The Company has paid for its purchase of one hundred (100) shares of stock to the financial institution as part of its settlement of all claims by and against the financial institution.\n(17) Related Party Transactions\nLoans Payable to Officers and Former Shareholders:\nThe Company is indebted to stockholders for cash received and office equipment contributed by these stockholders in 1992. The loans are noninterest bearing and have no fixed due date. The amount due at December 31, 1995 and 1994 was $183.\nThe Company is indebted to an employee for cash received from such employee during 1995. The loan bears interest at 9% and is due in 1996. The amount due at December 31, 1995 was $107.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (17) Related Party Transactions (continued)\nApproximately $969 and $1,067 at December 31, 1995 and 1994, respectively, of the subordinated debt issued in connection with the acquisition of IMI is payable to an officer of IMI. The officer was a shareholder in IMI prior the acquisition.\nDuring the fiscal year ended July 31, 1994, the Company and certain of its subsidiaries had outstanding indebtedness to DLB, Inc. (\"DLB\"), a corporation owned by the wife of Mr. Lewis S. Schiller, chairman of the board, president and chief executive officer of the Company. Mr. Schiller disclaims any beneficial interest in DLB. The obligations were secured by assets and stock of certain subsidiaries. The largest amount outstanding during the period was approximately $381. In addition, DLB had purchased preferred stock in one of the Company's subsidiaries for $24. In April 1994, the Company paid approximately $343 in principal and $36 in interest to DLB and issued to DLB shares of common stock in certain subsidiaries in full payment of all its and its subsidiaries' obligations to DLB and paid DLB $24 for DLB's preferred stock in a subsidiary, representing DLB's cost of such preferred stock. Since such repayment, DLB has not lent money to, or purchased stock in, the Company or any of its subsidiaries, except that, in August 1994, DLB advanced the Company approximately $35, which was paid without interest in October 1994. The largest amount outstanding during the year ended December 31, 1994 was $35.\nSale of a Subsidiary to Employees:\nEffective January 1, 1994, the Company transferred to four employees of a subsidiary, including Ms. Grazyna B. Wnuk, secretary of the Company, 61% of the common stock of the subsidiary, for nominal consideration. In connection with such transfers, Ms. Wnuk received a 31% interest in the subsidiary. The operations of such subsidiary did not represent a significant portion of the Company's business during the years ended July 31, 1994 or December 31, 1994.\nPurchase of a Portion of a Subsidiary from Employees:\nTrans Global Services, Inc. (\"Trans Global\") was organized by SIS Capital Corp. (\"SISC\") in January 1995 to hold all of the stock of Avionics Research Holdings, Inc. (\"Holdings\"), (formerly ARC Acquisition Group, Inc.), which was acquired by SISC in December 1993, and Resource Management International, Inc. (\"RMI\"),(formerly ITS Management Corp.), which was acquired by SISC in November 1994. Trans Global also issued to SISC warrants to purchase shares of its common stock. The Trans Global stock and warrants were issued to SISC in consideration for the transfer of the stock of Holdings and RMI and the advances made by SISC. All of the Trans Global stock and warrants owned by SISC are held subject to the right of Mr. Lewis S. Schiller, chairman of the board and chief executive officer of the Company, to purchase 10% of SISC's equity position for 110% of SISC's cost. In connection with the organization of Trans Global, Trans Global also issued a 3.4% interest to Mr. Joseph G. Sicinski, president of Trans Global, in exchange for certain rights Mr. Sicinski has with respect to the stock of Holdings.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (17) Related Party Transactions (continued)\nIn connection with the organization of Trans Global in January 1995, SISC transferred a 5% interest in its common stock and warrants in Trans Global to DLB in exchange for DLB's 10% interest in another subsidiary of Consolidated.\nAt the time of the organization of Trans Global, Trans Global issued to SISC, in consideration for the equity consideration issued by Consolidated in connection with the acquisitions of Holdings and RMI, 500 shares of Series A 5% Redeemable Cumulative Preferred Stock.\nDuring 1995, SISC, DLB, Inc. and Mr. Joseph G. Sicinski, the stockholders of Trans Global, entered into an agreement (the \"Trans Global Agreement\") with Concept Technologies Group, Inc. (\"Concept\") pursuant to which they would transfer to Concept all of the issued and outstanding capital stock of Trans Global in exchange for a controlling equity interest in Concept.\nPursuant to the Trans Global Agreement, Concept issued to SISC in respect of its Trans Global Common Stock, preferred stock and warrants, 850,000 shares of Concept Common Stock, two-year warrants (the \"Concept Warrants\") to purchase 475,000 shares of Concept Common Stock, 23,750 shares of Concept's Series A Participating Convertible Preferred Stock (\"Series A Preferred Stock\"), which are convertible into 1,900,000 shares of Concept Common Stock upon the filing of an amendment to Concept's certificate of incorporation which increases its capital stock, 23,750 shares of each of Concept's Series B and C Preferred Stock, which are convertible into an aggregate of 2,375,000 shares of Concept Common Stock if certain levels of income before income tax are met, and 25,000 shares of Concept's Series D 5% Redeemable Cumulative Preferred Stock (\"Series D Preferred Stock\"), which is not convertible and which is redeemable after three years for an aggregate of approximately $1.7 million. The Series D Preferred Stock is also redeemable from the sale by Concept of its equity securities, including the sale of stock upon exercise of options and warrants. The Concept Warrants become exercisable until the Warrants included in the Units either expire or are exercised in full. The exercise price of the Concept Warrants is $3.50 per share or the exercise price of the warrants included in a proposed private placement by Concept, whichever is lower.\nPursuant to the Trans Global Agreement, Concept issued to DLB in respect of its Trans Global stock and warrants, 50,000 shares of Concept Common Stock, Concept Warrants to purchase 25,000 shares of Concept Common Stock, 1,250 shares of Concept's Series A Preferred Stock, which are convertible into 100,000 shares of Common Stock, and 1,250 shares of each of Concept's Series B and C Preferred Stock, which are convertible into in aggregate of 125,000 shares of Concept Common Stock if certain levels of income before income taxes are attained. Pursuant to the Trans Global Agreement, Concept issued to Mr. Sicinski in respect of his Trans Global Stock, 100,000 shares of Concept Common Stock.\nThe Trans Global Agreement provides SISC and DLB with certain registration rights with respect to their Concept warrants and the underlying common stock and provides Mr. Sicinski with certain registration rights with respect to the 100,000 shares of Common Stock issued to him pursuant to the Trans Global\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (17) Related Party Transactions (continued)\nAgreement. Mr. Sicinski's shares are subject to a one-year lockup agreement, subject to earlier release under certain conditions.\nAll of the Trans Global stock and warrants owned by SISC are held subject to the right of Mr. Lewis S. Schiller, chairman of the board and chief executive officer of the Company, to purchase 10% of SISC's equity position for 110% of SISC's cost. In connection with the transaction contemplated by the Trans Global Agreement, Mr. Schiller's option will be converted to an option to purchase 10% of SISC's interest in the Concept equity securities at a price equal to 110% of SISC's cost.\nAdvances to a Company that was Subsequently Acquired:\nDuring the fiscal year ended July 31, 1994, the Company made advances to a company that was acquired on September 30, 1994. Advances receivable from this company at July 31, 1994 amounted to $347.\nAdvances to an Unconsolidated Subsidiary:\nThe Company has made advances to a 39% owned subsidiary from time to time in various amounts. These advances have no fixed due dates or terms and $145 of such advances have been written-off. The outstanding balances owed to the Company from this subsidiary was $427 and $160 at December 31, 1995 and 1994 and the greatest amount outstanding to such subsidiary during the years ended December 31, 1995 and 1994 and July 31, 1994 and 1993 was $427. Ms. Grazyna B. Wnuk, the Company's secretary, owns a 31% interest in the subsidiary receiving such advances.\nLoan Receivable from an Officer of a Subsidiary:\nDuring the year ended December 31, 1995 a subsidiary of the Company loaned $45 to the chief executive officer of such subsidiary. The loan has no fixed due dates or terms.\nLoan Receivable from Sale of Common Stock Investments to an Officer:\nDuring 1995, the chief executive officer of the Company exercised an option to purchase common stock investments held by the Company at 110% of the book value of such investments. The purchase of such investments was consummated in a noncash transaction and such officer is to issue a note in favor of the Company with interest at prevailing rates and maturing five years from the date of the purchase. Total amounts outstanding under such receivables was $72 at December 31, 1995. The gain realized by the Company on the sale of these investments approximated $7.\nConsulting Arrangement with Former Board Member:\nThe Company entered into a consulting agreement with Irving Hertz (now deceased), upon his resignation from the Board and as Chief Executive Officer of the Company. Under this agreement, all of the fringes Mr. Hertz had as\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (17) Related Party Transactions (continued)\nCEO, including a leased car, would continue to be provided by the Company. The services to be performed, for which Mr. Hertz received a monthly retainer, were investment banking and financial consulting on various situations in which the Company was interested. The Company paid $66,828 to Mr. Hertz under this agreement during the fiscal year ended July 31, 1993. Upon Mr. Hertz's death, the Company settled all claims his estate had against the Company for $175, during the fiscal year ended July 31, 1994. As of July 31, 1994, all such amounts were paid in full. In addition, consulting fees were paid to other individuals and firms that were not related parties at the time such fees were paid and any such fees are not deemed to be material.\n(18) Litigation\nAlthough the Company is a party to certain legal proceedings which have occurred in the ordinary course of business, the Company does not believe such proceedings to be of a material nature with the exception of the following:\nHolding Company:\nThe Company has been named as a defendant in a lawsuit filed by a company it was contemplating acquiring in January 1995 for alleged unauthorized use of proprietary information specific to that line of business. Outside counsel handling this case has advised the Company that it has meritorious defenses to obtain a dismissal of the lawsuit.\nContract Engineering Services:\nThe Government Printing Office wrote a subsidiary of the Company asking to be reimbursed a total of $296 for unauthorized timework on two programs. The subsidiary has been in contact with the Department of Justice which has stated that they were declining prosecution of the subsidiary regarding this matter. Management believes these claims are without merit and intends to contest these claims vigorously if reasserted by the Government Printing Office and believe that the ultimate disposition of this matter will not have a material adverse effect on the financial position of the Company.\nThe United States Department of Labor (\"DOL\") has filed a complaint against Job Shop Technical Services, Inc. (\"Job Shop\"}, a company from which a subsidiary of the Company purchased certain assets and assumed certain obligations, and its former principal shareholder for civil violations of ERISA resulting from the failure of Job Shop to deposit employee contributions to Job Shop's 401(k) retirement plan. A similar complaint was filed by former employees of Job Shop against Job Shop, its former principal shareholder and others. At November 21, 1994, the amount due to the Job Shop 401(k) plan was approximately $3,000, which amount may have increased since such date as a result of interest and penalties. Neither the Company nor RMI, which is the subsidiary which acquired assets and assumed certain obligations of Job Shop in November 1994, has been named as a defendant in either of such actions. The DOL has raised with the Company the possibility that RMI may be liable with respect to Job Shop's ERISA liability as a successor corporation\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (18) Litigation (continued)\nor purchaser of plan assets, even though RMI did not assume such obligations and paid value for those assets which it did purchase. Although the Company believes that RMI is not a successor corporation to Job Shop and is not responsible for Job Shop's ERISA violations, the DOL may take a contrary position. If the DOL takes such a position and prevails, it would have a material adverse effect upon the operations of RMI and possibly the Company as a whole.\nMedical Information Services:\nAn action was commenced against a subsidiary of the Company by the filing of a summons with notice in the Supreme Court of the State of New York, County of New York. The action was commenced by Jacque W. Pate, Jr., Melvin Pierce, Herbert A. Meisler, John Gavin, Elaine Zanfini, individually and derivatively as shareholders of Onecard Health Systems Corporation and Onecard Corporation, which corporations are collectively referred to as \"Onecard\". The named defendants include, in addition to the subsidiary, officers and directors of the subsidiary and the Company. A complaint was filed on November 15, 1995. The complaint makes broad claims respecting alleged misappropriation of Onecard's trade secrets, corporate assets and corporate opportunities, breach of fiduciary relationship, unfair competition, fraud, breach of trust and other similar allegations, apparently arising at the time of, or in connection with the organization of the subsidiary in September 1992. The complaint seeks injunctive relief and damages, including punitive damages of $130,000. Management believes that the action is without merit, and it will vigorously defend the action. Nevertheless, due to uncertainties in the legal process, it is at least reasonably possible that management's view of the outcome will change in the near term and there exists the possibility that there could be a material adverse impact on the operations of the Company.\nAudio Visual Manufacturing and Services:\nThere is an action pending against a subsidiary of the Company alleging claims against the subsidiary for unauthorized use of the Klipsch trademark. The Company denies these allegations and asserts there has been no material breach of contract. The case is currently in the discovery phase and the amount of any liability, if any, cannot be estimated. Management intends to defend vigorously the claims alleged against the subsidiary. Nevertheless, due to uncertainties in the legal process, it is at least reasonably possible that management's view of the outcome will change in the near term and there exists the possibility that there could be a material adverse impact on the operations of the subsidiary.\n(19) New Authoritative Pronouncements\nThe following describes new authoritative pronouncements that are expected to be applicable to the accounting of the Company's operations:\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (19) New Authoritative Pronouncements (continued)\nThe Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets to Be Disposed Of\", in March of 1995. SFAS 121 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 is effective for financial statement issued for fiscal years beginning after December 15, 1995. Adoption of SFAS No. 121 may have a material impact on the Company and require significant write-downs of intangible assets\nThe FASB has also issued SFAS No. 123, \"Accounting for Stock-Based Compensations,\" in October 1995. SFAS No. 123 uses a fair value based method of accounting for stock options and similar equity instruments as contrasted to the intrinsic valued based method of accounting prescribed by Accounting Principles Board (\"APB\") Opinion No. 25, \"Accounting for Stock Issued to Employees.\" The Company has not determined whether it will adopt SFAS No. 123 or continue to apply APB Opinion No. 25 for financial reporting purposes. SFAS No. 123 will have to be adopted for financial note disclosure purposes in any event. The accounting requirements of SFAS No. 123 are effective for transactions entered into in fiscal years that begin after December 15, 1995; the disclosure requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning after December 15, 1995.\n(20) Acquisitions\n(i) - On December 22, 1993, the Company, acquired for 600,000 shares valued at $1,440 (through a 90% owned subsidiary) Arc Acquisition Group, Inc., in a business combination accounted for as a purchase. On the same date, the Company also acquired for 250,000 shares valued at $600 (through a wholly owned subsidiary) 80% of the outstanding voting common stock and 50.1% of the outstanding non voting stock of ARC Networks, Inc., in a business combination also accounted for as a purchase. The purchase price of these two acquisitions exceeded the fair value of the net assets of ARC Acquisition Group, Inc. and ARC Networks, Inc. by $2,543, consisting of Goodwill of $543 and Customer Lists of $2,000. Goodwill and Customer Lists will be amortized over 20 years and 15 years, respectively, under the straight line method. For accounting purposes, the results of operations of ARC Acquisition and ARC Networks are included with the results of the Company from January 1, 1994 onward.\n(ii) - On June 16, 1994, a subsidiary of the Company, Carte Medical Holdings (\"CMH\"), through a wholly-owned subsidiary, CSM Acquisition Corp. (\"Acquisition Corporation\"), acquired the assets and assumed liabilities of Creative Socio-Medics Inc. (\"CSM\") pursuant to a plan and agreement of reorganization dated as of April 13, 1994, as amended (the \"Purchase Agreement\"), among the Company, Carte Medical Corp. (\"Carte\"), Acquisition Corporation, CSM and Advanced Computer Techniques, Inc. (\"ACT\"), the parent of\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (20) Acquisitions (continued)\nCSM. The Company is the parent of SISC, which is the parent of CMH. In connection with the purchase, (i) Acquisition Corporation purchased the assets and assumed liabilities of CSM in exchange for 800,000 shares of the Company's common stock and $500 which was advanced by Carte to Acquisition Corporation from the proceeds of a loan made by SISC, (ii) CMH transferred the stock of Acquisition Corporation to Carte, (iii) in consideration for the transfer of the Acquisition Corporation stock, Carte is to issue to CMH an aggregate of 1,000,000 shares of common stock, of which 450,000 shares are issuable on or about the date Carte receives the proceeds from an initial public offering, and (iv) Acquisition Corporation changed its corporate name to Creative Socio-Medics Corp. At the time of the execution of the Purchase Agreement, SISC granted to former officers of ACT and CSM, options to purchase an aggregate of 202,560 shares of Carte's common stock owned by SISC. The shares of common stock owned by SISC were transferred to CMH subject to the options. The options are exercisable at an exercise price of $.174 per share during the five-year period commencing on June 16, 1994, the date the acquisition of CSM was consummated. At the closing of the acquisition, the Company issued to such individuals an aggregate of 40,000 shares of its common stock. The purchase price of this acquisition included $3,851 for customer lists of CSM which will be amortized over 15 years under the straight line method. For accounting purposes, the results of operations of CSM are included with the results of the Company from July 1, 1994 onward.\n(iii) - As of September 30, 1994, the Company acquired International Magnetic Imaging, Inc. and its affiliated entities (\"IMI, Inc.\") in a business combination accounted for as a purchase. The principal operations of IMI, Inc. Are in the establishment and operation of outpatient diagnostic centers providing MRI services and other diagnostic modalities. The results of operations of IMI, Inc. are included in the accompanying combined financial statements since the date of acquisition. The total cost of the acquisition was $31,872 which exceeded the fair value of net assets of IMI, Inc. By $11,069. The excess purchase price, or goodwill, will be amortized by the straight-line method over 20 years.\nThe other intangibles, specifically restrictive covenants and customer lists, will be amortized by the straight-line method over 3 years and 15 years, respectively.\nThe following summarizes the purchase price allocated to acquired assets at fair value.\nCash $ 6,960 Subordinated Debt 19,863 Stock (3,343,000) 2,920 Notes [Covenants] 800 Acquisition Costs 1,329 ------ Purchase Cost $31,872 ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (20) Acquisitions (continued)\nAllocated to: Cash $ 2,350 Other Assets 421 Covenants-Not-to-Compete 3,303 Property, Plant and Equipment 10,903 Accounts Receivable 7,379 Managed Care Contracts - Customer Lists 5,656 Liabilities Assumed ( 9,209) Goodwill 11,069 ------ Total $31,872 ======\nThe cash portion of the purchase price was subsequently refinanced through DVI. The notes issued in connection with the acquisition of the centers balloon primarily in September 1996, with notes in the principal amount of $860 maturing in September 1997. The notes issued to acquire the management and radiology company, balloon and mature in September 1997 and 1999, respectively. In connection with this acquisition, the Company, through its subsidiaries, borrowed an aggregate of approximately $7.1 million on a secured, term-loan basis over 60 months pursuant to loan and security agreements among the Company's subsidiaries and DVI Financial Services, Inc. dba DVI Capital. For accounting purposes, the results of operations of IMI are included with the results of the Company from October 1, 1994 onward.\n(iv) - In November 1994, the Company acquired the assets of two businesses, Job Shop Technical Services, Inc. (\"Job Shop\") and Computer Engineering Services, Inc. (\"CES\"). Job Shop provides engineers, designers and technical personnel on a temporary basis, which is similar to the business performed by Avionics Research Corporation, a subsidiary of the Company. CES is engaged in the business of performing CAD (computer aided design) and CAM (computer aided manufacturing) related services and the marketing and sale CAD\/CAM software.\n(a) - Pursuant to an asset purchase agreement dated as of August 19, 1994 among ITS Management Corp., a Delaware Corporation and wholly-owned subsidiary of the Company (\"ITS\"), Job Shop and the sole stockholder of Job Shop, ITS acquired substantially all of the assets of Job Shop in exchange for 750,000 shares of the Company's common stock valued at $450, and the assumption of certain scheduled liabilities. The principal liability assumed was a $2 million obligation due to the Internal Revenue Service pursuant to a settlement arrangement which Job Shop had negotiated. The initial $500 payment was made in November, 1994. The balance is due in 15 monthly installments of $100, commencing May, 1995.\n(b) - Pursuant to a plan and agreement of reorganization among CDS Acquisition Corp. (\"CDS\"), a Delaware corporation and wholly-owned subsidiary of the Company, CES and the sole stockholder of CES, CDS acquired substantially all of the assets of CES in exchange for 750,000 shares of the Company's common stock valued at $450, and the assumption of certain scheduled liabilities.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (20) Acquisitions (continued)\nPrior to the acquisition, the businesses of Job Shop and CES were operated as divisions of the same company, along with one other division which was not acquired by the Company. For accounting purposes the results of operations of ITS and CDS are included with the results of the Company from November 22, 1994 onward.\n(v) - In May 1995, SIS Capital Corp., a wholly-owned subsidiary of the Company (\"SISC\"), entered into an agreement among SISC, DLB, Inc. (\"DLB\"), Joseph G. Sicinski and Concept Technologies Group, Inc. (\"Concept\"), pursuant to which SISC, DLB and Mr. Sicinski transferred to Concept all of the issued and outstanding common stock of Trans Global, in exchange for a controlling interest in Concept. Concepts common stock and warrants are traded on the NASDAQ Small Cap Market. Trans Global's common stock was owned by SISC (91.6%), DLB (5.0%) and Mr. Sicinski (3.4%). DLB is owned by Ms. Carol Schiller, wife of Mr. Lewis S. Schiller, the Company's chairman of the board, president and chief executive officer. Mr. Schiller disclaims all beneficial interest in the securities owned by DLB. Mr. Sicinski is president of Trans Global. Trans Global, which operates through two subsidiaries, ARC and RMI is engaged in the business of providing engineers, designers and other technical personnel to its clients, which include major companies in the aerospace, electronics and computer industries. Concept owns and operates Klipsch Loudspeaker business, and, through a subsidiary, is the developer and owner of proprietary technologies with applications in environmental noise cancellation, medical monitoring, defense and communications. Following the consummation of the transaction, the business of Trans Global became Concept's principal business.\nThe following pro forma unaudited results assume the above four acquisitions had occurred at the beginning of the indicated periods:\n--------------------------------------- Year Ended Fiscal Year Ended December 31, July 31, ---------------- ----------------- 1995 1994 1994 1993 ------ ------ ------ ------ Net revenues $110,761 $98,687 $101,939 $88,939 ======= ====== ====== ====== Net income (loss) ($11,421) ($11,948) ($ 8,662) $ 632 ====== ====== ====== ======\nIncome (loss) per share ($ 0.51) ($ 0.76) ($ 1.09) $ 0.15 ====== ====== ====== ======\nThe pro forma information is not necessarily indicative of either the results of operations that would have occurred had the acquisition been effective at the beginning of the indicated periods or of the future results of operations.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (21) Sale of Majority Interest of Subsidiary\nEffective January 1, 1994, the Company disposed of 61% if its interest in Universal International, Inc., (\"Universal\"), through its wholly-owned subsidiary, SIS Capital Corp.; which owned 100% of Universal. The sale was accounted for as a disposal of a portion of a line of business that is not considered a business segment. Other subsidiaries continue to operate in the business segment. The sale resulted in a loss of approximately $33 which is included in other income (expense). The revenues, gross profits and net loss of Universal at December 31, 1993 were approximately $160, $48 and ($40), respectively. Subsequent to December 31, 1993, the investment in Universal is being accounted for under the equity method.\nFollowing is a summary of net assets and results of operations of Universal International, Inc. as of January 31, 1994 and July 31, 1993 and for the periods ended January 31, 1994 and July 31, 1993 and 1992:\nJanuary 31, July 31, ---------------------- 1994 1993 -------- --------\nCash $ 2 $ 6 Receivables - Net 45 59 Property, Plant and Equipment - Net 20 24 Other Assets 8 28 ------ ------ Total Assets 75 117\nAccounts Payable and Accrued Expenses 41 44 Accrued Payroll Taxes 105 97 Loans Payable 166 170 ------ ------ Net Assets ($ 237) ($ 194) ====== ======\nPeriod from August 1, 1993 For the For the through Year ended Year ended January 31, July 31, July 31, 1994 1993 1992 -------- -------- --------\nRevenues $ 195 $ 611 $ 727 Costs and Expenses 238 740 793 ------ ------ ------ Net [Loss] ($ 43) ($ 129) ($ 66) ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (22) Disposal of a Portion of a Line of Business\nOn July 31, 1991, the Company sold its 50.1% interest in Trinity Holding Corp. to one of the minority shareholders (Hugh Murphy) of the Trinity Holding Corp. in exchange for one dollar and the waiver of significant emoluments granted by the Company's Board in 1989. At the date, liabilities exceeded assets by $823. The excess of net liabilities over the net investment in Trinity Holding Corp. of $767 has been recorded as a gain on disposal of a segment. During the fiscal year ended July 31, 1993, $562 in notes and loans receivable from Trinity Holding Corp. were written off by the Company.\nFollowing is a summary of net assets of Trinity Holding Corp. as of July 30, 1991:\nCash $ 37 Receivables - Net 52 Property, Plant and Equipment - Net 7 Other Assets 17 ------ Total Assets 113\nAccounts Payable and Accrued Expenses 86 Accrued Payroll Taxes 278 Notes Payable - Other 572 ------ Net Assets ($ 823) ======\n(23) Extraordinary Item - Debt Restructuring\nDuring the fiscal years ended July 31, 1993, certain creditors agreed to forgive debt totaling $153. The debt of $285 which was primarily owed to a related party was included in additional paid-in capital at July 31, 1991. The $146 forgiven in 1993, which was due to non-related entities, is reported as an extraordinary item. In addition, in 1993, debt in the amount of $348 owed to the above entities, as well as others, was converted into Series A preferred stock at a price of $5.00 per share (69,711 shares).\n(22) Unusual Item\nIn May 1993, the Company, through its wholly-owned subsidiary, SISC, completed an agreement with a major financial institution settling a $6 million lawsuit for damages filed against the institution and General Technologies Group Ltd., (\"GTG\"), pursuant to a RICO action undertaken by Mr. Lewis S. Schiller, CEO of the Company, alleging ongoing fraud and conspiracy to defraud the Company in connection with the Sequential Electronics Systems, Inc., (\"SES\"), transaction of June 3, 1987. The agreement gives the Company clear title to all the shares of SES and includes the purchase of certain net assets and the operations of GTG by S-Tech, Inc., a subsidiary of the Company. The purchase\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (23) Unusual Item (continued)\nby S-Tech, Inc. was completed June 30, 1993, and resulted in the Company acquiring net assets of $1,523 (representing appraised values). To the extent that the Company recorded losses in prior periods through the write-down of assets, the write-off of receivables, and other related expenses, in its prior sale agreement with GTG (in excess of $1,600), the Company has recorded a one time gain on the acquisition. S-Tech, Inc. remains liable on a note to the financial institution arising from the above purchase.\n(24) Subsequent Events\nHolding Company:\nRegulation S Offerings - Pursuant to an offering in January 1996 made under Regulation S of the Securities Act of 1933, the Company received net proceeds of $500 in conjunction with the issuance of 5,000,000 shares of common stock.\nConversion of Series A Preferred Stock - During the first quarter of 1996, the Company issued 3,635,379 shares of common stock upon the conversion of 27,914 shares of series A preferred stock.\nDuring January 1996, the Company\nContract Engineering Services:\nIn January 1996, a publicly held subsidiary of the Company sold 500,000 shares of its common stock pursuant to Regulation S of the Securities Act of 1933 and received net proceeds of $500. The impact of this transaction on the Company will be an increase in minority interest on the balance sheet of approximately $500 and a dilution of ownership of approximately 2%. Such dilution is not expected to be material in relationship to the financial statements as a whole.\nIn March 1996, a publicly held subsidiary of the Company held its annual meeting of stockholders at which time, among other things, the authorized preferred stock was increased from 100,000 shares to 2,000,000 shares and the authorized common stock was increased from 4,000,000 shares to 20,000,000 shares. The Company is due to receive an additional 1,510,000 shares of the public subsidiary's stock pursuant to the reverse merger agreement discussed in footnote (18),(v), above and this will increase the Company's ownership by approximately 25%. Had this stock been received during 1995, the minority interest in the loss of consolidated subsidiaries would have decreased by approximately $1,000 which would have increased the consolidated loss by approximately $1,000.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (24) Subsequent Events (continued)\nMedical Diagnostics:\nIn January 1996, a subsidiary of the Company obtained financing consisting of a term loan of $2,000 and a revolver loan of $6,000. The majority of the proceeds were used to pay current subordinated debt. In addition, other current subordinated debt was reclassified to long-term per the loan agreements. The pro forma effect of this financing on the December 31, 1995 balance sheet would be as follows:\nCurrent assets $26,965 Property and equipment, net 11,034 Other assets 29,416 ------ Total assets $67,415 ======\nCurrent liabilities $31,404 Long-term liabilities 22,995 ------ Total liabilities 54,399 Minority interest 2,087 Stockholders' equity 10,929 ------ Total liabilities and stockholders' equity $67,415 ======\nIn February 1996, a subsidiary of the Company loaned $300 to an officer of the subsidiary. The principal is due in 1998 and requires interest only payments at a rate of 5.5%, payable annually.\nMedical Information Services:\nIn February 1996 a subsidiary of the Company executed an agreement to purchase an application software product known as SATC Software which processes retail plastic card transactions and merchant transactions for $650 of which $325 was paid in February 1996 with the balance due in three installments in 1996. Additionally, the subsidiary entered into a joint venture with a company in which the joint venture partner will pay the remaining balance for the SATC Software as its contribution to the joint venture. The joint venture agreement has not been finalized and the subsidiary remains liable for the remaining $325 in any event. The Company has also guaranteed the subsidiary's repayment of such amount.\nA subsidiary of the Company intends to enter into an agreement with a consulting company pursuant to which the subsidiary would pay $25-$59 per month for management level services. The agreement will continue to the year 2000 and also provides for payment of a percentage of smart card and related revenues generated by the subsidiary. Pursuant to the agreement, the subsidiary is to pay the consulting company $250 for prior services rendered.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (24) Subsequent Events (continued)\nIn 1996, a subsidiary of the Company signed a letter of intent with an underwriter for the sale of its securities through an initial public offering. Additionally, in January 1996, the subsidiary borrowed $500 from four accredited investors. In connection with such loans, the subsidiary issued its 8% promissory notes due January 31, 1997, which are payable from the proceeds of the subsidiary's initial public offering. The subsidiary also agreed that if the initial public offering is completed prior to January 31, 1997, it would register, pursuant to the Securities Act and issue to the note holders one unit for each $2.00 principal amount of notes. The unit to be issued to the note holders will mirror the units to be issued in the initial public offering.\nIn January 1996, a subsidiary of the Company issued 11,250 shares of common stock to its vice president for services rendered by him. The fair value of such shares will be treated as compensation in 1996.\nIn March 1996, a subsidiary's agreement with a receivable factor was modified to allow borrowings up to 80% of eligible receivables to a maximum of $1,000. In consideration, the subsidiary will pay the factor (i) an annual fee of $10 and (ii) a monthly fee of $10. If the subsidiary receives equity funds by the way of an initial public offering or a private placement of at least $350, the original borrowing availability will be reinstated and the subsidiary shall pay the factor a $25 fee and issue it 25,000 shares of the subsidiary's common stock.\n(25) Commitments\nMr. Schiller has an employment agreement dated October 1, 1994 with the Company pursuant to which it employs him as chief executive officer through December 31, 1998 at an annual salary of $250, subject to an annual cost of living increase or 5%, whichever is greater. Mr. Schiller is also entitled to a bonus equal to 10% of the Company's consolidated income before income taxes in excess of $250. No bonus was payable for the year ended December 31, 1995. The Company also granted to Mr. Schiller a five-year option to acquire 10% of the Company's securities portfolio at 110% of the Company's cost.\nMr. Mahoney has an employment agreement dated October 1, 1994, and superseded by an agreement dated March 21, 1995, with the Company pursuant to which it employs him as chief financial officer through December 31, 1999. Mr. Mahoney will receive a base salary of $165, $177, $189, $202 and $220 for the years ending December 31, 1995, 1996, 1997, 1998 and 1999, respectively. Additionally, Mr. Mahoney shall also receive incentive compensation equal to the greater of one percent of the net pretax profits or net cash flow of the Company, plus the greater of one percent of the net pretax profit or net cash flow of IMI (a wholly-owned subsidiary of the Company), subject to a maximum of twice Mr. Mahoney's base salary for the respective year. Mr. Mahoney's bonus for the year ended December 31, 1995 approximates $35.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (26) Restatements of Prior Period Financial Statements\nThe years ended December 31, 1994 and July 31, 1994 and 1993 financial statements have been restated. The following summarizes and describes impact of the restatement.\nYear Ended ------------------------------------------ December 31, July 31, ------------ ------------------------ 1994 1994 1993 -------- -------- -------- Income (Loss) from Operations: Prior to Restatement ($ 5,965) ($ 3,851) ($ 841) Prior Period Adjustments: Decrease in discount on shares issued for stock options [1] (3,540) (5,870) -- Reclass loss from discontinued operations to operating activity [2] -- -- (562) Reclass stock option expense from unusual to selling, general and administrative expenses [3] (300) (845) -- Decrease in discount on shares issued in lieu of cash payment for services rendered [4] (36) -- -- Decrease in discount on shares issued for acquisitions [5] (338) -- -- Reclass goodwill write-off from other expense to selling, general and administrative expenses [6] (285) -- -- ------ ------ ------ As restated ($10,464) ($10,566) ($ 1,403) ====== ====== ======\nOther Income (Expense): Prior to Restatement ($ 1,657) ($ 1,253) $ 1,942 Prior Period Adjustments: Reclass stock option expense from unusual to selling, general and administrative expenses [3] 300 845 -- Reclass goodwill write-off from other expense to selling, general and administrative expenses [6] 285 -- -- ------ ------ ------ As restated ($ 1,072) ($ 408) $ 1,942 ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (26) Restatements of Prior Period Financial Statements (continued)\nYear Ended ------------------------------------------ December 31, July 31, ------------ ------------------------ 1994 1994 1993 -------- -------- --------\nLoss from Discontinued Operations: Prior to Restatement -- -- ($ 562) Prior Period Adjustments: Reclass loss from discontinued operations to operating activity [2] -- -- $ 562 ------ ------ ------ As restated -- -- -- ====== ====== ======\nNet Income (Loss): Prior to Restatement ($ 7,514) ($ 4,902) $ 740 Prior Period Adjustments: Decrease in discount on shares issued for stock options [1] (3,540) (5,870) -- Decrease in discount on shares issued in lieu of cash payment for services rendered [4] (36) -- -- Decrease in discount on shares issued for acquisitions [5] (338) -- -- ------ ------ ------ As restated ($11,428) ($10,772) $ 740 ====== ====== ======\nAccumulated Deficit: Prior to Restatement ($23,044) ($18,932) ($14,030) Prior Period Adjustments: Decrease in discount on shares issued for stock options [1] (5,870) (5,870) -- Decrease in discount on shares issued in lieu of cash payment for services rendered [4] (36) -- -- Decrease in discount on shares issued for acquisitions [5] (338) -- -- ------ ------ ------ As restated ($29,288) ($24,802) ($14,030) ====== ====== ======\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (26) Restatements of Prior Period Financial Statements (continued)\nYear Ended ------------------------------------------ December 31, July 31, ------------ ------------------------ 1994 1994 1993 -------- -------- --------\nAdditional Paid-in Capital, Common Stock: Prior to Restatement $39,353 $35,861 $16,752 Prior Period Adjustments: Decrease in discount on shares issued for stock options [1] 5,870 5,870 -- Decrease in discount on shares issued in lieu of cash payment for services rendered [4] 36 -- -- Decrease in discount on shares issued for acquisitions [5] 338 -- --\n------ ------ ------ As restated $45,597 $41,731 $16,752 ====== ====== ======\n[1] - The Company originally used a 60% discount for valuing shares issued and exercised pursuant to a Non Employee Directors, Consultants and Advisors Stock Plan and it was subsequently determined that only a 20% discount should be used resulting in an increase in noncash expenses of $3,540 for the year ended December 31, 1994 and $5,870 for the year ended July 31, 1994.\n[2] - The Company originally presented $562 of losses from the discontinuation of a part of a line of business as a discontinued item and such losses are now included in income (loss) from operations.\n[3] - The Company originally included $845 of noncash expenses from the issuance and exercise of stock options pursuant to a Non Employee Directors, Consultants and Advisors Stock Plan as an unusual expense in other income and expense. Such expense has been reclassified as an operating expense of $300 for the year ended December 31, 1994 and $845 for the year ended July 31, 1994.\n[4] - The Company originally used a 50% discount for valuing shares issued in lieu of cash payment for services rendered and it was subsequently determined that only a 20% discount should be used resulting in an increase in noncash expenses of $36 for the year ended December 31, 1994.\n[5] - The Company originally used a 50% discount for valuing shares issued in connection with the acquisition of a subsidiary and it was subsequently determined that only a 20% discount should be used resulting in an increase in noncash expenses of $338 for the year ended December 31, 1994.\nConsolidated Technology Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (in 000's except per share data) - ------------------------------------------------------------------------------ (26) Restatements of Prior Period Financial Statements (continued)\n[6] - The Company originally included $285 of goodwill write-offs in other income and expense. Such expense has been reclassified as an operating expense for the year ended December 31, 1994.\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.\nCONSOLIDATED TECHNOLOGY GROUP, LTD.\nDate: April 10, 1996 \/S\/ ------------------------ Lewis S. Schiller 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\/ President and Director April 10, 1996 - -------------------- (Principal Executive Lewis S. Schiller Officer)\n\/S\/ Chief Financial Officer April 10, 1996 - -------------------- (Principal Financial and George W. Mahoney Accounting Officer)\n\/S\/ Director April 10, 1996 - -------------------- Norman J. Hoskin\nConsolidated Technology Group Ltd. and Subsidiaries Index to Exhibits December 31, 1995\nEX-11.1 Calculation of earnings per share.\nEX-21.1 List of Subsidiaries of Registrant.\nEX-27 Financial Data Schedule (filed only to the SEC in electronic format)\nConsolidated Technology Group, Ltd. and Subsidiaries December 31, 1995 EX-11.1 Calculation of Earnings per Share - ----------------------------------------------------------------------------\nYear Ended December 31, ------------\nNet Loss ($11,360,000) ==========\nLoss per Share:\nLoss per share - Note 1 $(0.51) ====\nLoss per Share - assuming full dilution - Note 2 $(0.33) ====\nNote 1:\nComputed by dividing the net loss for the period by the weighted average number of common shares outstanding (22,423,035 for the year ended December 31, 1995). No stock options, warrants or preferred convertible stock are assumed to be exercised because they are anti-dilutive for the periods. The weighted average number of common shares outstanding is calculated by weighting common shares issued during the period by the actual number of days that such shares are outstanding for the period.\nNote 2:\n(i) Assumes that the 6,000,000 common shares issued pursuant to the exercise of stock options were outstanding as of the beginning of the year.\n(ii) Assumes that a warrant to purchase 1,000,000 common shares at $0.75 per share was exercised at the beginning of the year, and that all proceeds from such exercise were used to purchase treasury stock at a price equal to the average market price of the Company's common shares for the respective period as quoted on the NASD.\n(iii) Assumes that at the beginning of the year, the 66,596 remaining shares of preferred convertible stock were converted to common shares at the conversion rate of 130.20833 shares of common for each share of convertible preferred stock.\nConsolidated Technology Group, Ltd EX 21.1 List of Subsidiaries of the Registrant\nState of Company Incorporation - -------------------------------------- ------------- Consolidated Technology Group Ltd. New York SIS Capital Corp. Delaware The Trinity Group Inc. Delaware Carte Medical Holdings Delaware Carte Medical Corp. Delaware Creative Socio-Medics Delaware IMI Acquisition Corp. Delaware International Magnetic Imaging Florida MD Corp. Florida MRI-Net Florida IMI Acquisition of Pine Island Corporation Florida IMI Ltd. Partner Acq. of Pine Island, Inc. Florida IMI Acquisition of North Miami Beach Corporation Florida IMI Ltd. Partner Acq. of North Miami, Inc. Florida IMI Acquisition of Boca Raton Corporation Florida IMI Ltd. Partner Acq. of Boca Raton, Inc. Florida IMI Acquisition of South Dade Corporation Florida IMI Ltd. Partner Acq. of South Dade, Inc. Florida IMI Acquisition of Oakland Park Corporation Florida IMI Ltd. Partner Acq. of Oakland, Inc. Florida IMI Acquisition of Orlando Corporation Florida IMI Ltd. Partner Acq. of Orlando, Inc. Florida PODC Acquisition Corporation Florida PODC Ltd. Partner Acq. Corporation Florida IMI Acquisition of Puerto Rico Incorporated Puerto Rico IMI Acquisition of Arlington Corp. Virginia IMI Acquisition of Kansas Corporation Kansas MD Acquisition Corporation Delaware MD Ltd. Partner Acq. Corporation Delaware TeleVend, Inc. Delaware ARC Networks Corp. New York Trans Global Services, Inc. Delaware Resource Management International, Inc. Delaware ARC Acquisition Group, Inc. New York Avionics Research Corp. New York Avionics Research Corporation of Florida Florida SES Holdings Corp. Delaware Sequential Electronic Systems, Inc. Delaware S-Tech, Inc. Delaware Industry Lighting, Inc. Delaware 3D Holdings, Inc. Delaware CDS Acquisition Corp. Delaware CDS, Inc. Delaware 3D Technology, Inc. Delaware 3D Imaging International, Inc. Delaware Universal International, Inc. Delaware Universal International of Orlando, Inc. Florida WWR Technology, Inc. Delaware Audio Animation, Inc. Delaware Prime Access, Inc. Delaware TGS Services Corp. Delaware Concept Technologies Group, Inc. Delaware","section_15":""}
{"filename":"200533_1995.txt","cik":"200533","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThere were no material changes in the nature of the business conducted by Moyco Industries, Inc. during the fiscal year ended June 30, 1995. The Company manufacturers and sells commercial abrasive materials, dental materials and supplies and repacks and sells other disposable materials.\nThe Company's net sales, operating profit, and identifiable assets for each of the two aforementioned business segments is detailed in Note 5 and Item 6 to the financial statements.\nUpon the donation of the Philadelphia, Pennsylvania building to charity, the operations were moved to the company's two other facilities in York, Pennsylvania, and Montgomeryville, Pennsylvania.\nPage 2 of 40\nBusiness Segments\nCommercial Abrasive Materials\nThe Registrant is engaged through its Ultralap Division in the manufacture and sale of commercial abrasive materials under the name \"Flex-I- Grit.\" \"Flex-I-Grit\" is sold by a master distributor and other repackers to approximately 45 accounts, five of these accounted for 76% of total sales for this division.\nThe Registrant further is engaged through its Ultralap Division in the manufacture and sale of fine polishing agents and abrasives sold under the trade name \"Ultralap.\" The \"Ultralap\" products are sold by in-house salesmen to approximately 465 customers, six of these customers accounted for over 36% of the total sales of these products. During the last fiscal year, the sale of \"Ultralap\" products accounted for approximately 74% of the total sales of this division.\nDental Supplies\nThe Registrant through its dental division is engaged in the manufacture and sale of dental supplies such as waxes, abrasives, medicaments, dental mirrors, endodontic materials and equipment, sundry dental items as well as a repacker of other disposable materials. During the last fiscal year the sale of a steel-backed dental abrasive manufactured by Registrant and sold under the trade name of \"Lightning\" accounted for 5% of the total sales of the dental division.\nAll sales are made from existing inventory by six salaried salespersons to approximately 400 dental supply wholesalers and distributors in the United States and Overseas. During the last fiscal year foreign sales represented approximately 10% of the total sales of the dental division. Two customers accounted for more than 19% of the total sales of this division.\nApproximately 2% of the dental supply and repacking business of the Registrant was done with the United States Government for the fiscal year ended June 30, 1995.\nBacklog\nThere is a backlog of orders in the aggregate of $1,416,388 as of June 30, 1995. There had been a backlog of $1,083,437 as of June 30, 1994. Approximately 28% of the backlog at June 30, 1995 was for dental supplies and materials.\nPage 3 of 40\nSources and Availability of Supplies\nThe Company procures its raw materials and supplies from various sources and does not expect to have any difficulty in procurement during the coming year or during the foreseeable future.\nIt is intended that the Company will continue in its existing lines of dental supplies and commercial abrasive materials during the current fiscal year.\nResearch and Development\nThe Company engages in minimal research activities and has two employees devoting part of their time to this activity. Such research as is conducted is directed toward the development of new products related to current product lines and the improvement and enhancement of existing products.\nCompetition\nAll of the lines of business in which the Registrant is presently engaged are highly competitive. There are numerous other manufacturers of dental supplies, polymer backed abrasives, other abrasives and repackers, many of which are larger and have greater financial reserves and more sales representatives.\nEmployees\nThe Registrant employs approximately 150 persons, of whom 113 are involved in manufacturing abrasives and other products of the Ultralap and Dental divisions, and 37 are engaged in administration, sales, engineering, supervision and clerical work. The Registrant has had no work stoppages during the past 11 years and considers its employee relations to be good.\nOther\nMoyco did not experience any curtailment of supplies of electricity, gas, oil or water during the fiscal year ended June 30, 1995 and does not expect any curtailment in the current fiscal year.\nIn as much as the Company believes it produces no significant discharges of waste or pollutants into the air, there are no significant effects on the company in complying with current Federal, State and local environmental laws and regulations.\nMoyco Industries, Inc. as of June 30, 1995 was in compliance with the enactment of the Clean Air Act, effective August 1992.\nPage 4 of 40\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant is the owner of two buildings. The Montgomeryville, Pennsylvania facility was a one-story cinder block building containing approximately 26,000 square feet of which approximately 13,000 square feet were used for manufacturing; 11,750 square feet for warehousing and distribution; and 1,250 square feet for offices. This facility is primarily used for the manufacture of precision coated abrasives for commercial and industrial use. During the year, the registrant expanded its Montgomeryville, Pennsylvania facility to 40,125 square feet of which 14,250 square feet are used for manufacturing; 19,875 square feet for warehousing and distribution; and 6,000 square feet for offices. The York, Pennsylvania facility is 68,995 square feet of which approximately 45,807 square feet are used for manufacturing; 16,542 for warehousing and 6,646 for offices. There are mortgages on both properties. Moyco's facilities are suitable for their respective uses and are in general, adequate for Moyco's present needs.\nDuring the year the registrant donated the five story brick building in Philadelphia, Pennsylvania containing approximately 88,000 square feet of which approximately 59,928 square feet was used for manufacturing, 22,968 square feet for warehousing and distribution, and 5,104 square feet for offices to a qualified charity.\nThe Registrant leased 27,671 square feet of space in a building in Emigsville, Pennsylvania. Initial lease term began September 30, 1991 and ended March 31, 1992 at $5,283 per month. Renewal rate at the then prevailing market rate $6,646, per month. This facility was utilized in connection with the dental supply segment. The lease was terminated in December of 1994 when the registrant moved to its newly constructed building in York, Pennsylvania.\nThe registrant has completed two capital projects. 30% of the total $1,000,000 expansion of the Montgomeryville facility was financed over 15 years with the Pennsylvania Industrial Development Authority at an interest rate of 2%, 50% of the project cost was financed by the bank over 15 years at 8 3\/4% for 5 years and a variable rate for 10 years thereafter and the remaining 20% by the registrant. The Montgomeryville project was completed in March of 1995. Construction of a new building in York, Pennsylvania to replace the leased facility was completed during December 1994. 37% of the total project cost of $2,700,000 was financed by the Pennsylvania Industrial Development Authority at 2%, 53% of the cost was financed by the bank at 9.25% for 5 years and at prime plus 1% thereafter, and the remaining 10% by the registrant.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has filed suit against two defendants in one action for patent infringement. The proceedings are continuing and the company's attorneys were not able to estimate the likelihood of the outcome in this matter.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nN O N E\nPage 5 of 40\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nPrice Range of Common Stock:\nThe following table shows the range of low and high prices for the common stock in the over-the-counter market for the quarterly periods indicated according to the Company's records. The quotations represent prices in the over-the-counter market between dealers in securities and do not include retail markup, markdown or commission and do not necessarily represent actual transactions.\nLow High ---- ---- First quarter ended September 30, 1994 1.00 1.00\nSecond quarter ended December 31, 1994 .94 .94\nThird quarter ended March 31, 1995 .85 .85\nFourth quarter ended June 30, 1995 2.06 2.13\nFirst quarter ended September 30, 1993 1.00 1.75\nSecond quarter ended December 31, 1993 .50 1.50\nThird quarter ended March 31, 1994 1.25 2.00\nFourth quarter ended June 30, 1994 1.00 3.00\nThere were no dividends paid during the fiscal year ended June 30, 1995. The number of shareholders of record on June 30, 1995 was 701.\nPage 6 of 40\nITEM 6.","section_6":"ITEM 6. SELECTED STATEMENT OF OPERATIONS AND BALANCE SHEET DATA\nSelected statement of operations data:\nPage 7 of 40\nITEM 6. SELECTED STATEMENT OF OPERATIONS AND BALANCE SHEET DATA (Continued)\nSelected statement of operations data:\nPage 8 of 40\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSummary\nThe following table sets forth for the periods indicated (i) percentages which certain items reflected in the financial data bear to net sales of the Company and (ii) the percentage increase (decrease) of such items as compared to the indicated prior period:\nPage 9 of 40\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations\nYear Ended June 30, 1995 Compared to Year Ended June 30, 1994\nNet sales increased $1,848,843. The increase in net sales is related to increased pricing, and more directly to increased unit sales in both our abrasive and dental divisions.\nGross profit increased $518,935 and is directly related to the increased sales.\nOperating expenses increased $191,851 as a result of the increase in operating activity, increase in costs, as well as increases caused by the closing of the Philadelphia facility and opening of the new facilities.\nInterest expense increased $207,402 as a result of the increased long- term borrowings related to the two capital projects in fiscal year end June 30, 1995.\nOperating profit growth will be driven by new products, increased market demand (domestic and global) and economies of scale the Company is able to achieve based upon reaching a critical mass in sales volume. Sales and profit can be accelerated further by a synergistic acquisition and\/or a strategic alliance which the Company is actively pursuing.\nAll of our lines of business are in highly competitive markets with others, domestically and internationally, having greater resources. The dental domestic market remains relatively flat as the economic recession continues. Our abrasive division continues to enter new markets, however, our high tech products are subject to sale swings as a result of technological changes as well as purchasing practices by our customers. We are not aware of any conditions in the purchasing of raw material and\/or labor markets that can effect the profitability of the Company. There is continued need for sales growth as a result of putting in line new facilities and equipment, inflationary costs, and general operating expense increases.\nPage 10 of 40\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations\nYear Ended June 30, 1994 Compared to Year Ended June 30, 1993\nNet sales decreased $1,205,871. The reduction in net sales is related to the dental inventory liquidation placed in the market by the Receiver in the bankruptcy of Healthco International, the world's largest dental dealer. We believe this process is completed and the Healthco customer base has been absorbed by other dental dealers. In addition, our abrasive sales were reduced as a result of a technology change of one of our high tech customers. These two factors substantially impacted our net sales greater than the actual year to date comparisons.\nGross profit decreased $393,596. This is a direct result of the decrease in net sales.\nOperating expenses decreased $449,669. Commission expenses and bad debts were less in the current year which were directly related to the decrease in net sales as explained above.\nInterest expense decreased $62,739. Lower rates and less debt through the fiscal year account for this change.\nOperating profit growth will be driven by new products, increased market demand (domestic and global) and economies of scale the Company is able to achieve based upon reaching a critical mass in sales volume. Sales and profit can be accelerated further by a synergistic acquisition and\/or a strategic alliance which the Company is actively pursuing.\nAll of our company lines of business are in highly competitive markets with others, domestically and internationally, having greater resources. The dental market remains relatively flat as the economic recession continues. Our abrasive division continues to enter new markets, however, our high tech products are subject to sale swings as a result of technological changes as well as purchasing practices by our customers. We are not aware of any conditions in the purchasing of raw material and\/or labor markets that can effect the profitability of the Company. There is continued need for sales growth as a result of putting in line new facilities and equipment, inflationary costs, and general operating expense increases.\nPage 11 of 40\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources\nThe Company uses a number of measures of liquidity for internal management purposes. These measures include working capital and activity ratios, all of which are set forth below:\nYear Ended June 30 ------------------------------------- 1995 1994 1993 ------ ------ ------\nWorking capital, the ability to meet short-term obligations:\nWorking Capital $4,589,745 $3,003,840 $3,490,282\nWorking Capital Ratio 3.39:1 2.01:1 2.74:1\nActivity ratios, which should be helpful in evaluating liquidity:\nCalendar days to convert sales to cash 60 58 61\nInventory turnover 2.33 2.07 2.50\nInventory as a percent of working capital 70.1 93.8 76.8\nSales to working capital 2.59 3.34 3.22\nThe Company's working capital at June 30, 1995 was $4,589,745 compared to $3,003,840, in 1994 representing an increase in the amount of $1,585,905. The component differences are reflected in the statement in cash flows.\nCurrent assets increased $541,404 and current liabilities decreased $1,044,501.\nDuring the fiscal years 1993 and 1994 the primary use of funds was the acquisition of additional equipment and lease of additional facilities located in Emigsville, Pennsylvania. This facility produced dental supplies under the name Moyco\/Union Broach. During 1994, capital projects were commenced in Montgomeryville and York, Pennsylvania requiring additional funds. These projects were completed in the fiscal year ended June 30, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nResponsibility for Preparation of Financial Statements:\nThe management of Moyco Industries, Inc. is responsible for the integrity and objectivity of the financial statements. The financial statements and related notes were prepared by the Company using generally accepted accounting principles which were considered appropriate for the circumstances and necessarily include amounts based upon our best estimates and judgment. Financial data found elsewhere in this Annual Report is consistent with these financial statements.\nPage 12 of 40\n[LETTERHEAD]\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors and Shareholders Moyco Industries, Inc.\nWe have audited the balance sheets of Moyco Industries, Inc. as of June 30, 1995 and 1994 and the related statements of operations, changes in shareholders' equity and cash flows for each of the three years ended June 30, 1995. Our audits also included the financial statement schedule on page 38. 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 Moyco Industries, Inc. 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. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.\nAs described in Note 7 to the financial statements, the company changed its method of accounting for income taxes as required by the provisions of Statements of Financial Accounting Standards No. 109.\nPhiladelphia, Pennsylvania August 25, 1995, except for Note 14, which is dated August 29, 1995\nPage 13 of 40\nMOYCO INDUSTRIES, INC.\nBALANCE SHEETS\nASSETS (Note 3)\nSee accompanying notes to financial statements.\nPage 14 of 40\nMOYCO INDUSTRIES, INC.\nBALANCE SHEETS\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee accompanying notes to financial statements.\nPage 15 of 40\nMOYCO INDUSTRIES, INC.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nPage 16 of 40\nMOYCO INDUSTRIES, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nSee accompanying notes to financial statements.\nPage 17 to 40\nSee accompanying notes to financial statements.\nPage 18 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 1: Summary of Significant Accounting Policies\nNature of Business\nThe Company manufactures dental waxes, dental supplies, endodontic material and equipment, pharmaceuticals, precision abrasives, commercial abrasives, and is a repacker of other disposable products for commercial and industrial use and sells to both domestic and international customers.\nPrinciples of Accounting\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.\nValuation of Inventories\nInventories are stated at the lower of cost or market. Costs of raw materials and cartons are determined by the first-in, first-out method. Labor and overhead included in work-in-process and finished goods are determined at average cost.\nDepreciation\nDepreciation is computed by the straight-line method over the assets expected useful lives as follows:\nBuilding and Improvements 10-25 Years Machinery, Equipment, Furniture and Fixtures 5-10 Years Automotive Equipment 3 Years\nDepreciation charged to expense for the years ended June 30, 1995, 1994, and 1993 was $531,376, $418,891, and $382,372 respectively.\nPatents and Trademarks\nThe costs of patents and trademarks are capitalized and amortized to operations over their estimated useful lives or statutory lives, whichever is shorter. Amortization is computed by the straight-line method.\nMortgage Costs\nMortgage costs are being amortized over the terms of the related mortgages.\nIncome Taxes\nThe Company currently accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Prior to fiscal 1994, the Company accounted for income taxes in accordance with Accounting Principles Board Opinion No. 11. The cumulative effect of this change in accounting principle decreased net earnings for fiscal 1994 by $60,168 as discussed in Note 7.\nPage 19 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 1: Summary of Significant Accounting Policies (Continued)\nReclassifications\nCertain accounts in the prior-year financial statements have been reclassified for comparative purposes to conform with the presentation in the current-year financial statements.\nResearch and Development\nResearch and development costs are charged to expense as incurred. The amounts charged for the years ended June 30, 1995, 1994, and 1993 were $35,718, $19,583, and $3,493, respectively.\nEarnings Per Common Share\nEarnings per common share have been computed by dividing earnings for each year by the weighted average number of common shares outstanding during each period.\nAdvertising Costs\nAdvertising costs are charged to expense as incurred. The amounts charged for the years ended June 30, 1995, 1994, and 1993 were $251,984, $243,748, and $245,069, respectively.\nNote 2: Inventories\nThe components of inventories are as follows:\nJune 30 ------------------------ 1995 1994 ----------- ---------- Raw materials $ 813,185 $ 792,493 Work-in-process 755,992 668,234 Finished goods 1,477,032 1,208,648 Cartons 171,868 149,399 ---------- ---------- $3,218,077 $2,818,774 ========== ==========\nPage 20 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 3: Long-Term Debt\nLong-term debt is summarized as follows:\nPage 21 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 3: Long-Term Debt (Continued)\nSubstantially all of the Company's assets are pledged as collateral for the long-term debt.\nAs of June 30, 1995 long-term debt matures as follows:\nTwelve Months Ending June 30,\n1996 $ 526,954 1997 719,136 1998 1,231,908 1999 885,298 2000 899,479 Thereafter 2,999,639 ---------- $7,262,414 ==========\nPage 22 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 4: Employee Benefit Plans\nEffective July 1, 1979, the Company adopted a non-contributory profit sharing plan for it's eligible employees. The contribution to the plan is determined on an annual basis by the Board of Directors and cannot exceed the maximum amount which would constitute an allowable deduction for federal income tax purposes. The contribution expense for the years ended June 30, 1995, 1994 and 1993 was $15,000, $25,000 and $25,000, respectively.\nIn addition to the above, on January 1, 1985 Moyco's Board of Directors established a tax deferred employee savings and protection plan under Section 401(K) of the Internal Revenue Code for all eligible employees. This plan allows employees to contribute between 3% and 10% of their salary, including overtime pay, bonus and commissions to the plan and these contributions are not subject to current federal income taxes. The Company will contribute 50% of the employee's contribution, to a maximum of 6% of the employee's salary subject to the deferral limit (IRC Sec. 401 (a)(30)). Participants are at all times fully vested in their contributions and the Company contributions become vested to the participant at various percentages based on the employee's years of service with 20% vested after three years of service and 20% for each year thereafter.\nThe Company's contribution aggregated $62,220, $58,606, and $44,919 for the years ended June 30, 1995, 1994, and 1993 respectively.\nNote 5: Business Segments\nThe Company operates within two business segments: dental supplies and precision abrasives. Through its dental supplies division the Company manufactures and sells dental supplies such as waxes, abrasives, medicaments, sundry dental items and endodontic materials and equipment. Through its precision abrasive division the Company manufactures and sells commercial abrasive materials and fine polishing agents.\nFinancial information concerning the operations in each of the Company's business segments for the years ended June 30, 1995, 1994 and 1993 is as follows:\nPage 23 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 5: Business Segments (Continued)\nFor the years ended June 30, 1995, 1994 and 1993 net sales to various agencies of the U.S. Government represented 1% of the Company's total net sales.\nPage 24 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 6: Quarterly Results (Unaudited)\nThe following tables summarize quarterly financial data for the fiscal year's ended June 30, 1995 and 1994:\nPage 25 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 6: Quarterly Results (Unaudited) (Continued)\n* During the current year, the first three quarters' inventory computation was based on the prior year's gross profit percentages, which overall was 43.3%. The year end actual inventory valuation resulted in a 40.9% gross profit percentage. Therefore, fourth quarter results reflect the entire years percentage decrease. The gross profit percentage decrease was a result of increased costs due to expansion and construction of two facilities in the year ended June 30, 1995.\nPage 26 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995, 1994 AND 1993\nNote 7: Income Taxes\nThe provision for income taxes consists of the following:\n1995 1994 1993 -------- -------- -------- Currently payable: Federal (net of tax credits) $314,442 $275,215 $183,076 State 128,483 113,144 75,170 -------- -------- --------\n442,925 388,359 258,246 -------- -------- --------\nDeferred: 35,419 20,479 - -------- -------- --------\nIncome taxes before cumulative effect of accounting change $478,344 $408,838 $258,246 ======== ======== ========\nDeferred income taxes result from the tax effect of transactions which are recognized in different periods for financial and tax reporting purposes. Significant components of deferred income taxes and their related impact on deferred income tax expense are as follows:\n1995 1994 1993 -------- -------- --------\nCumulative effect of accounting change $ - $ 60,168 $ - Accelerated depreciation 26,935 44,486 ( 6,185) Contributions carry over ( 333) - - Other 8,817 ( 24,007) 6,185 -------- -------- --------\n$ 35,419 $ 80,647 $ - ======== ======== ========\nA reconciliation of the U.S. Federal Income Tax rate to the effective income tax rate is as follows:\n1995 1994 1993 ---- ---- ---- Federal taxes at graduated rates from 15% to 39% 31.0% 32.0% 23.8% ===== ===== ===== State taxes 12.7% 13.1% 9.8% ===== ===== =====\nEffective income tax rate 43.7% 45.1% 33.6% ===== ===== =====\nEffective July 1, 1993, the Company adopted Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes. The cumulative effect of the change in accounting principle amounted to $60,168 and is included in determining net income for year ended June 30, 1994. Financial statements for prior years have not been restated.\nPage 27 of 40\nMOYCO INDUSTRIES, INC.\nNOTES TO FINANCIAL STATEMENTS\nJUNE 30, 1995 AND 1994\nNote 8: Commitments and Contingencies\nThere are no material pending or contemplated legal proceedings against the Company or of which any of its property is subject.\nNote 9: Shareholders' Equity\nOn December 17, 1986, the shareholders approved an increase in the authorized capital to 15,000,000 shares of common stock and 2,500,000 shares of preferred stock, each with a par value of $.005 per share, and authorized the shares of preferred stock to be issued in one or more classes, and in one or more series within a class, with such voting rights, designations, powers, preferences, qualifications, privileges, limitations, options, conversion rights, restrictions and other special rights as may be established from time to time by resolution of the board of directors of the Company at or prior to the time of issuance of shares of such class or series.\nSubsequent to June 30, 1995 the aggregate market value of the outstanding common shares increased significantly.\nNote 10: Notes Payable, Bank\nThe Company has an unsecured line of credit with a Bank in the amount of $2,000,000 with interest of 1% above the bank's prevailing prime interest rate. There was 0 and $1,000,000 drawn upon the line of credit at June 30, 1995 and 1994 respectively. This line of credit matures October 31, 1995.\nNote 11: Letters of Credit - Bank\nThe Company has two letters of credit with a bank. $50,000 issued December 6, 1994 expiring December 6, 1997, $100,000 issued May 1, 1995 expiring May 2, 1996 whose beneficiaries are the Montgomery County Industrial Authority and the Pennsylvania Industrial Development Authority. The beneficiaries are both holders of mortgages on part of the Company's buildings. At June 30, 1995 there were no funds drawn on these letters of credit.\nPage 28 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 12: Bad Debt\nOn June 9, 1993 Healthco International, Inc. a major customer of Moyco Industries Inc. filed for bankruptcy under Chapter 11 of the Bankruptcy code. Moyco has determined that the amount due from Healthco International, Inc. is noncollectible and accordingly the balance due at June 30, 1993 of $212,109 has been written off.\nNote 13: Legal Proceedings\nThe Company has filed suit against two defendants in one action for patent infringement. The proceedings are continuing and the Company's attorneys were not able to estimate the likelihood of the outcome in this matter.\nNote 14: Subsequent Events\nThe Company filed a civil suit in July of 1995 against a research and development company for breach of express contract, and fraud and misrepresentation. The company seeks to recover the amount paid of $25,000 per the contract and $500,000 to recover economic losses associated with the nonperformance of this contract, plus interest, the cost of the suit, and attorneys fees. As of August 25, 1995 the outcome of this suit could not be determined.\nThe Company signed a letter of intent with Integrated Process Equipment, Corporation, (IPEC) towards an exclusive distribution and representation agreement dated August 29, 1995. The agreement provides that Moyco will manufacture and\/or distribute for IPEC and its Customers a proprietary tungsten abrasive slurry used in a state of the art chemical mechanical polishing tungsten process system developed by IPEC, which employs IPEC equipment and Moyco abrasive slurries to polish semiconductors.\nOn July 11, 1995 the Company signed a letter of intent to acquire the assets of a Dental Products Company with approximately $500,000 in annual sales. The purchase price will be based on current assets, net fixed assets less liabilities for cash outlay, plus shares of Moyco Industries, Inc. common stock, the number of which is to be negotiated, for intellectual property, patents, trademarks, and \"know how\". The assets stated above are subject to due diligence evaluation not yet begun.\nPage 29 of 40\nMOYCO INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994\nNote 15: Stock Option\nThe Company adopted an incentive stock option plan on October 30, 1992. The plan provides that key employees and directors may be awarded options not to exceed 200,000 shares of the Company's stock. Under the plans, options are granted at a price not less than the fair market value at the grant date and generally become exercisable upon date of grant. In all cases, options expire ten years after grant. Of the total shares authorized for issuance, 93,500 shares had been granted and 6,400 shares have been exercised. During the year 1,600 shares of those granted were cancelled.\nThe following summarizes the stock option transactions during the year ended June 30, 1995.\nShares available for future grant were 108,100 shares at June 30, 1995.\nNote 16: Concentration of Credit Risk\nThe Company had funds in one bank in excess of federally insured limits of $876,351 at June 30, 1995.\nNote 17: Building Donation\nIn March 1995 the Company donated its Philadelphia building to a qualified charity. At the time of the donation the book value of the building was $96,323 which is reflected in these financial statements as donation expense as part of other expense. The fair market value of the building was appraised at $125,000 at the time of the donation.\nNote 18: Capitalized Interest\nThe Company capitalized $70,225 of interest costs paid as part of their two construction projects completed during the year ended June 30, 1995.\nPage 30 of 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\n(1) Executive Officers of the Registrant:\n(a) The names, ages and positions with the Registrant of all of the executive officers of the Registrant, none of whom are related by blood, marriage or adoption to each other, are as follows:\n(b) The executive officers hold their respective offices until the first meeting of newly elected directors following the next annual meeting of the Company and the election of successor officer unless otherwise terminated by the Board of Directors.\nPage 31 of 40\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (Continued)\n(c) The following is a brief account of the business experience of the executive officers of the Registrant:\nMr. Marvin E. Sternberg joined the Registrant in March of 1974, as a Management Consultant and was elected President of the Registrant on August 9, 1974. From 1965 to 1973, Mr. Sternberg was Trustee and Operating Officer for the Robinson Trust, Philadelphia, Pennsylvania. From 1965 to present, Mr. Sternberg has been a partner and\/or director in a number of other companies in the Philadelphia, Pennsylvania and Fort Lauderdale, Florida areas.\nMr. Jerome Lipkin joined the Registrant on June 12, 1974 as assistant to the Vice-President. He was elected to Vice-President in charge of operations on March 20, 1978.\nMr. William Woodhead joined the Registrant on January 7, 1985 as Controller. He was elected Secretary\/Treasurer on December 18, 1985.\n(2) Directors of the Registrant:\n(a) The following table sets forth the name of each director of the Registrant and all offices presently held by him. The term of each director will expire on such date as the Annual Meeting of Shareholders is held and his successor is duly elected and qualified.\nPage 32 of 40\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (Continued)\n(2) Directors of the Registrant: (Continued)\n(b) There are no family relationships between any director or executive officer of the Registrant.\nIrvin Paul, D.D.S., has engaged in the practice of Dentistry, with offices in Upper Darby, Pennsylvania, for more than thirty years.\nMarvin Cravetz, D.D.S., was engaged in the practice of Dentistry, with offices in Hatboro, Pennsylvania for more than twenty years.\nThe business experience of the other directors during the past six years is reported under Item 10(1) EXECUTIVE OFFICERS OF THE REGISTRANT.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following table shows for fiscal years ending June 30, 1995, 1994 and 1993, the cash compensation as well as certain other compensation paid to the named executive officers:\nSUMMARY COMPENSATION TABLE\nPage 33 of 40\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nProfit Sharing Plan\nEffective July 1, 1979, the Company adopted a non-contributory profit sharing plan for its employees who have completed one full year of service and have attained the age of 21. The contribution to the plan is determined on an annual basis by the Board of Directors and cannot exceed the maximum amount which will constitute an allowable deduction for federal income tax purposes and is based on the Company's profitability and shall be paid from the Company's net earnings and\/or retained earnings. The Company's contributions shall be based on the ratio of each eligible employee's compensation for the year to total compensation for all eligible employees limited to the lesser of $36,875 or 25% of the eligible employee's compensation.\nA participating employee's full account becomes payable upon normal retirement, or upon retirement at any age due to disability, or upon death to the employee's designated beneficiary. In the event employment is terminated before normal retirement, a portion of the Company's contribution is forfeited unless the employee has at least ten full years of service.\nAll officers and employee-directors participate in the program on the same terms as other salaried employees.\nEmployee Savings Plan\nEffective January 1, 1985 Moyco's Board of Directors established a tax deferred employee savings and protection plan under Section 401(K) of the Internal Revenue Code for all eligible employees. This plan allows an employee to contribute between 3% and 10% of his salary, including overtime pay, bonus and commissions, to the plan and these contributions are not subject to current federal income taxes. The Company will contribute 50% of the employee's contributions, to a maximum of 6% of the employee's salary subject to the deferral limit (IRC Sec. 401 (a)(30)). Participants are at all times fully vested in their contributions and the Company contributions become vested to the participant at various percentages based on the employee's years of service with 20% vested after three years of service and 20% for each year thereafter.\nAll officers and employee-directors participate in the program on the same terms as other salaried employees.\nDirector Compensation\nDirectors do not receive any compensation for serving as directors.\nPage 34 of 40\nITEM 11. STOCK OPTIONS (Continued)\nThe following table shows stock options exercised and fiscal year end values for the named exective officers under the Moyco Industries, Inc. stock option plan. The plan does not permit the grant of stock appreciation rights (\"SARs\"). There have been no stock options granted in the current fiscal year.\nAggregated Option\/SAR Exercises in Last Fiscal Year and FY-End Option\/SAR Values\n(1) Upon exercise of an option, the optionee must pay the exercise price in cash. (2) Represents the difference between the fair market value of the common stock underlying the option and the exercise price at exercise, or fiscal year-end, respectively.\nPage 35 of 40\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) The following table sets forth information as of June 30, 1995 with respect to any person who is known to the Registrant to be the beneficial owner of more than 5% of any class of Registrant's voting securities:\n(1) Of these shares 2,408,365 shares are held by Marvin E. Sternberg, legally and beneficially in his own name; 16,900 shares by Susan Sternberg, wife of said Marvin E. Sternberg, legally and beneficially in her own name; and 497,310 shares are held by said Susan Sternberg together with T. Allen Lipsky in trusts consisting of 165,770 shares each for the respective beneficial interests of Joseph S. Sternberg, Mark E. Sternberg and Janet L. Sternberg, children of said Marvin E. Sternberg and Susan Sternberg.\n(2) None of Marvin E. Sternberg, Susan Sternberg or T. Allen Lipsky claim any beneficial interests in the shares herein described which are not reported here for his or her respective legal and beneficial interest.\n(b) The following table sets forth information, as of June 30, 1995, as to each class of equity securities of the Registrant beneficially owned, directly or indirectly, by all directors and officers of the Registrant, as a group:\n(1) Refer to Footnotes (1) and (2) of previous table.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNo director or officer had any material interest, direct or indirect, in any business transaction of the Company during the period July 1, 1994 through June 30, 1995, or in any such proposed transaction.\nPage 36 of 40\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPage No. -------- (a) 1. Financial statements\nIncluded in Part II of this report\nReport of independent certified public accountants 13 Balance sheets at June 30, 1995 and 1994 14-15 Statements of operations for the three years ended June 30, 1995 16 Statements of changes in shareholders' equity for the three years ended June 30, 1995 17 Statements of cash flows for the three years ended June 30, 1995 18 Notes to financial statements 19-30\n2. Financial statement schedules\nIncluded in Part IV of this report\nFor the three years ended June 30, 1995 Schedule II - Valuation and qualifying accounts 38\n(b) 1. Exhibit I 39\n2. Reports on Form 8-K - NONE\nAll other schedules and notes specified under Regulation S-X are omitted because they are either not applicable, not required or the information called for therein appears in the financial statements or notes thereto.\nPage 37 of 40\nSCHEDULE VIII -------------\nMOYCO INDUSTRIES, INC.\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED JUNE 30, 1995\n===============================================================================\nColumn A Column B Column C Column D Column E -------- -------- --------- -------- -------- Additions Balance --------- Balance at Accounts at Beginning Charged to Written End of of Period Expense Off (1) Period --------- ---------- -------- ------- Allowance for doubtful receivables:\nJune 30, 1995 $58,990 $ 20,084 $ 84 $78,990 ======= ======== ======== =======\nJune 30, 1994 $70,351 $ - $ 11,361 $58,990 ======= ======== ======== =======\nJune 30, 1993 $70,351 $212,109 $212,109 $70,351 ======= ======== ======== =======\n(1) Represents accounts written off against the reserve.\nPage 38 of 40\nMOYCO INDUSTRIES STOCK OPTION PLAN FOR THE YEAR ENDED JUNE 30, 1995\nEXHIBIT I\nThe Company adopted an incentive stock option plan on October 30, 1992. The plan provides that key employees and directors may be awarded options not to exceed 200,000 shares of the Company's stock. Under the plans, options are granted at a price not less than the fair market value at the grant date and generally become exercisable upon date of grant. In all cases, options expire ten years after grant. Of the total shares authorized for issuance, 93,500 shares had been granted and 6,400 shares have been exercised. During the year 1,600 shares of those granted were cancelled.\nThe following summarizes the stock option transactions during the year ended June 30, 1995.\nShares available for future grant were 108,100 shares at June 30, 1995.\nPage 39 of 40\nSIGNATURES\nPursuant to the requirements of Section 13 and 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMOYCO INDUSTRIES, INC.\nBY: \/s\/ Marvin E. Sternberg ------------------------------------- Marvin E. Sternberg President and Chief Executive Officer Chairman of the Board\nDated: September 14, 1995 ----------------------\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.\n\/s\/ Marvin E. Sternberg ------------------------- President and Chief Executive Officer Marvin E. Sternberg\nDated: September 14, 1995 -------------------------\n\/s\/ Jerome Lipkin ------------------------- Vice President and Director Jerome Lipkin Executive Officer\nDated: September 14, 1995 -------------------------\n\/s\/ William Woodhead ---------------------- Secretary\/Treasurer and William Woodhead Director\nDated: September 14, 1995 -------------------------\nPage 40 of 40","section_15":""}
{"filename":"723926_1995.txt","cik":"723926","year":"1995","section_1":"ITEM 1. BUSINESS\nSecurity Chicago Corp. (Corporation), is a one-bank holding company engaged in the business of providing banking services through its wholly-owned subsidiary, First Security Bank of Chicago (Bank). The Corporation, a Delaware corporation, was incorporated in September 1983 at the direction of the Board of Directors of the Bank and, pursuant to the approval of the Board of Governors of the Federal Reserve System (Federal Reserve Board), became the holding company owning all of the outstanding stock of the Bank on September 28, 1983.\nThe Bank was organized under the laws of the State of Illinois on August 31, 1976, and commenced operations on November 23, 1976. Its deposits are insured pursuant to the Federal Deposit Insurance Act. The Bank's equity securities consist of one class of common stock, $5.00 par value, of which there were 240,000 shares issued and outstanding as of December 31, 1995. All of the common stock of the Bank is owned by the Corporation.\nThe Bank conducts a general commercial banking and safe deposit business. The Bank does not offer trust services. The Bank's main office is located at 196 East Pearson, Chicago, Illinois 60611, on the southeast corner of the ground level of Water Tower Place, a shopping, hotel and apartment complex, the main address of which is 835 North Michigan Avenue. The Bank also has a convenience center for paying and receiving services located on the mezzanine level in Water Tower Place and a full-service branch, opened on June 1, 1987, at 446 East Ontario, Chicago, Illinois, approximately one-half mile southeast of the main banking premises. Office space is also leased by the Bank on the tenth floor at 446 East Ontario. The Bank has 34 full-time equivalent employees.\nOn May 25, 1995, the Bank entered into a contract to purchase a building to house its main office at 190 E. Delaware, Chicago. The Bank is committed to advance approximately $2,800,000 for the purchase of the land and building and management anticipates advancing an additional $1,500,000 for the remodeling and refurbishing of the building. Management intends to fund the purchase and remodeling with cash and cash equivalents. The $2,800,000 land and building purchase occurred on January 4, 1996. Management anticipates moving into the new building in December 1996 at the time the current lease expires.\nThe Bank provides a complete range of banking services to individuals and small and medium-sized businesses. These services include checking and savings accounts, interest-bearing deposit instruments, business loans, personal loans, home and condominium mortgage loans, cooperative apartment loans and other consumer-oriented financial services and night depository facilities. In addition, customers are provided 24-hour banking services by means of three automatic teller machines which are part of Cash Station, Inc., a regional, shared ATM network.\nThe Corporation also owns 144,623 shares (less than 1%) of the outstanding common shares of AMCORE Financial, Inc. (AMCORE), a $2 billion multi-bank holding company located in northern Illinois. The Corporation acquired its common stock interest in AMCORE in August 1994 as part of an exchange of stock in which the Corporation surrendered its common stock holding in First State Bancorp of Princeton, Illinois, Inc. (Princeton) pursuant to a merger\nagreement negotiated between AMCORE and Princeton. Further information regarding this exchange of stock is set forth in Note 1 of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference.\nA review of the financial performance of the Corporation is contained under the captions \"Financial Review\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the 1995 Annual Report To Shareholders, which is incorporated herein by reference.\nCOMPETITION\nVigorous competition exists in the major market area where the Corporation and the Bank are presently engaged in business. Competition includes not only commercial banks but also other financial institutions including savings and loan associations, money market and other mutual funds, mortgage companies, leasing and finance companies and a variety of financial services and advisory companies. The principal methods of competition in the banking and financial services industry are quality of services to customers, ease of access to facilities and pricing of services (including interest rates paid on deposits, interest rates charged on loans and fees charged for other non-loan or non- deposit services).\nSUPERVISION AND REGULATION\nGENERAL\nBanks and their holding companies are regulated under both federal and state laws. Consequently, the Corporation and the Bank may be materially affected by applicable statutes, regulations and policies promulgated by regulatory agencies with jurisdiction over the Corporation and the Bank, such as the Federal Reserve Board (FRB), Federal Deposit Insurance Corporation (FDIC), and the Illinois Commissioner of Banks and Trust Companies. The effects of such statutes, regulations and policies may be significant and are often unpredictable because they change from time to time. Furthermore, such statutes, regulations and policies are intended to protect the Bank's depositors and the FDIC's deposit insurance fund, not the Company's or the Bank's stockholders.\nBanks and their holding companies are subject to enforcement actions by their regulators for violations of the applicable regulatory statutes, regulations and policies. In addition to compliance with regulatory limitations concerning financial and operating matters, the Corporation and the Bank must file periodic reports and information with their regulators and are subject to examination by each of their regulators.\nThe statutory requirements applicable to the regulatory supervision of bank holding companies and banks have increased significantly and undergone substantial change in recent years. To a great extent, these changes are embodied in the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), enacted in August 1989, the Federal Deposit\nInsurance Corporation Improvement Act of 1991 (FDICIA), enacted in December 1991, and the regulations promulgated under FIRREA and FDICIA.\nUnder recently enacted interstate banking legislation, 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. 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. This 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 this 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; Community Reinvestment Act (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 Office of the Comptroller of Currency (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 Corporation 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 Corporation.\nThe following discussion constitutes a brief summary of the current regulatory framework affecting the Corporation and the Bank. The discussion is not a complete statement of all legal restrictions and requirements applicable to the Corporation and the Bank. Reference should be made to applicable statutes, regulations and other regulatory pronouncements for a complete understanding of this framework.\nREGULATION OF BANK HOLDING COMPANIES\nThe Corporation is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (BHCA). As such, the Corporation is subject to regulation, supervision and examination by the FRB. The Corporation is also subject to the limitations and requirements of the Illinois Bank Holding Company Act (IBHCA). The business and affairs of the Corporation are regulated in a variety of ways, including limitations on acquiring control of other banks and bank holding companies, on activities and investments, on interstate acquisitions, on regulatory capital requirements and on payment of dividends. Also, the FRB expects a bank holding company to act as a source of financial strength to banks that it owns or controls. As a result, the FRB could require the Corporation to commit resources to support the Bank in circumstances in which the Corporation might not otherwise do so.\nACQUISITION OF BANKS AND BANK HOLDING COMPANIES\nUnder the BHCA, a bank holding company generally may not (1) acquire, directly or indirectly, more than 5% of the outstanding shares of any class of voting securities of a bank or bank holding company; (2) acquire control of a bank or another bank holding company; (3) acquire all or substantially all the assets of a bank; or (4) merge or consolidate with another bank holding company, without first obtaining FRB approval. In considering an application with respect to any such transaction, the FRB is required to consider a variety of factors, including the potential anti-competitive effects of the transaction, the financial condition and future prospects of the combining and resulting institutions, the managerial resources of the resulting institutions, the convenience and needs of the communities the combined organization would serve, the record of performance of each combining organization under the Community Reinvestment Act and the Equal Credit Opportunity Act, and the prospective availability to the FRB of information appropriate to determining ongoing regulatory compliance with applicable banking laws. In addition, both the federal Change in Bank Control Act and the Illinois Banking Act (IBA) would impose limitations on the ability of one or more individuals or other entities to acquire control of the Corporation or the Bank.\nThe BHCA generally imposes certain limitations on extensions of credit and other transactions by and between banks that are members of the Federal Reserve System and other banks and non-bank companies in the same holding company. Under the BHCA and the FRB's regulations, a bank holding company and its subsidiaries are prohibited from engaging in\ncertain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nThe BHCA prohibits a bank holding company from acquiring control of a bank whose principal office is located outside of the state in which its principal place of business is located unless specifically authorized by applicable state law. The IBHCA permits Illinois bank holding companies to acquire control of banks in any state and permits bank holding companies whose principal place of business is in another state to acquire control of Illinois banks or bank holding companies if that state affords reciprocal rights to Illinois bank holding companies and certain other requirements are met.\nThe restrictions described above represent limitations on expansion by the Corporation and the Bank, the acquisition of control of the Corporation by another company and the disposition by the Corporation of all or a portion of the stock of the Bank or by the Bank of all or a substantial portion of its assets.\nPERMITTED NON-BANKING ACTIVITIES\nThe BHCA generally prohibits a bank holding company from engaging in activities or acquiring or controlling, directly or indirectly, the voting securities or assets of any company engaged in any activity other than banking, managing or controlling banks and bank subsidiaries or another activity that FRB has determined, by regulation or otherwise, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Subject to certain exceptions, before making any such acquisition or engaging in any such activity, a bank holding company must obtain the approval of the FRB as provided in applicable regulations.\nIn evaluating such applications, the FRB will consider, among other relevant factors, whether permitting the bank holding company to engage in the activity in question can reasonably be expected to produce benefits to the public (such as increased convenience, competition or efficiency) that outweigh any possible adverse effects (such as undue concentration of resources, decreased or unfair competition, conflicts of interest or safety and soundness concerns).\nNotwithstanding applicable restrictions on acquisition of control of banks, bank assets, bank holding companies and companies engaged in permitted non-banking activities, a bank holding company may acquire, without the prior approval of the FRB, 5% or less of the outstanding shares of any class of voting securities of a company, assuming the investment does not otherwise result in control of such company. The BCHA prohibits bank holding companies, with certain exceptions, from acquiring direct or indirect ownership of more than 5% of the voting securities of any company that is not a bank or does not engage in any of the activities described in the first paragraph of this subsection.\nCAPITAL REQUIREMENTS\nRegulatory capital requirements applicable to all regulated financial institutions, including bank holding companies and banks, have increased significantly in recent years and further increases are possible in future periods. The FRB has adopted risk-based capital standards for\nbank holding companies. The articulated objectives of Congress and the FRB in establishing a risk-based method of measuring capital adequacy are (i) to make regulatory capital requirements applicable to bank holding companies more sensitive to differences in risk profiles among bank holding companies; (ii) to factor off-balance-sheet liabilities into the assessment of capital adequacy; (iii) to reduce disincentives for bank holding companies to hold liquid, low risk assets; and (iv) to achieve greater consistency in the evaluation of capital adequacy of major banking organizations throughout the world by conforming to the framework developed jointly by supervisory authorities from countries that are parties to the so-called \"Basle Accord\" adopted by such supervisory authorities in July 1988.\nThe FRB requires bank holding companies to maintain a minimum ratio of risk- weighted capital to total risk-adjusted assets. Banking organizations, however, generally are expected to operate well above the minimum risk-based ratios. Risk-adjusted assets include a \"credit equivalent amount\" of off-balance-sheet items, determined in accordance with conversion formulae set forth in the FRB's regulations. Each asset and off-balance-sheet item, after certain adjustments, is assigned to one of four risk-weighting categories, 0%, 20%, 50% or 100%, and the risk-adjusted values then are added together to determine risk-weighted assets.\nA bank holding company must meet two risk-based capital standards, a \"core\" or \"Tier 1\" capital requirement and a total capital requirement. The current regulations require that a bank holding company maintain Tier 1 capital equal to 4% of risk-adjusted assets and total capital equal to 8% of risk-adjusted assets. Tier 1 capital must represent at least 50% of total capital and may consist of those items defined in applicable regulations as core capital elements. Core capital elements include common stockholders' equity; qualifying noncumulative, nonredeemable perpetual preferred stock; qualifying (i.e., up to 25% of total Tier 1 capital) cumulative, nonredeemable perpetual preferred stock; and minority interests in the equity accounts of consolidated subsidiaries. Core capital excludes goodwill, other intangible assets required to be deducted in accordance with applicable regulations, and the effect of unrealized net gains (losses) on available-for-sale securities.\nTotal capital represents the sum of Tier 1 capital plus \"Tier 2\" capital, less certain deductions. Tier 2 or \"supplementary\" capital consists of allowances for loan and lease losses; perpetual preferred stock (to the extent not included in Tier 1 capital); hybrid capital instruments; perpetual debt; mandatory convertible debt securities; term subordinated debt; and intermediate term preferred stock, in each case subject to applicable regulatory limitations. The maximum amount of Tier 2 capital that may be included in an organization's qualifying total capital cannot exceed 100% of Tier 1 capital. In determining total capital, a bank holding company must deduct from the sum of Tier 1 and Tier 2 capital its investments in unconsolidated subsidiaries; reciprocal holdings of certain securities of banking organizations; and other deductions required by regulation or determined on a case-by-case basis by the appropriate supervisory authority.\nAnother capital measure, the Tier 1 leverage ratio, is defined as Tier 1 capital divided by average total assets (net of allowance for losses and goodwill). The minimum leverage ratio is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk (including no undue interest rate risk), excellent asset quality, high liquidity and good earnings. Other banking organizations are expected to have ratios of at least 4%-5%, depending upon their particular condition and growth plans. Higher capital ratios could be\nrequired if warranted by the particular circumstances or risk profile of a given banking organization.\nThe failure of a bank holding company to meet its risk-weighted capital ratios may result in supervisory action, as well as inability to obtain approval of any regulatory applications and, potentially, increased frequency of examination. The nature and intensity of the supervisory action will depend upon the level of noncompliance. Under the IBHCA, no bank holding company may acquire control of a bank if, at the time it applies for approval or at the time the transaction is consummated, its ratio of total capital to total assets as determined in accordance with then applicable FRB regulations, is or will be less than 7%.\nBanks and bank holding companies are required to comply with regulatory risk- based capital guidelines. Since the Corporation has consolidated assets of less than $150 million, regulatory minimum capital tests are applied primarily to the subsidiary bank.\nRisk-based capital ratios focus principally on broad categories of credit risk and do not incorporate factors that can affect the Corporation's financial condition, such as overall interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, investment or loan portfolio concentrations, the quality of loans and investments, the effectiveness of loan and investment policies and management's ability to monitor and control financial and operating risks. For this reason, the overall financial health of the Corporation and the Bank and the assessment of the Corporation and the Bank by various regulatory agencies may differ from conclusions that might be drawn solely from the level of the Corporation's or the Bank's risk-based capital ratios.\nDIVIDENDS\nThe 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 which exceed its net income or which could only be funded in ways that would weaken its financial health, such as by borrowing. The FRB also may impose limitations on the payment of dividends as a condition to its approval of certain applications, including applications for approval of mergers and acquisitions.\nREGULATION OF BANKS\nThe Bank is a banking corporation organized under the IBA. As such it is subject to regulations, supervision and examination by the Illinois Commissioner of Banks and Trust Companies (Commissioner). The Bank is a member of the Federal Reserve System and, therefore, subject to regulation, supervision and examination by the FRB. The deposit accounts of the Bank are insured up to the applicable limits by the FDIC's Bank Insurance Fund (BIF). Thus, the Bank is also subject to regulation, supervision and examination by the FDIC.\nThe business affairs of the Bank are regulated in a variety of ways. Regulations apply to, among other things, insurance of deposit accounts, the Bank's capital ratios, payment of dividends, liquidity requirements, the nature and amount of the investments that the Bank may make, transactions with affiliates, community and consumer lending laws, internal policies and controls, reporting by and examination of the Bank and changes in control of the Bank.\nDEPOSIT INSURANCE\nAs an FDIC-insured institution, the Bank is required to pay deposit insurance premiums to the FDIC. FDICIA authorized the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this requirement, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which each insured depository institution was placed into one of nine categories and assessed insurance premiums accordingly. These premiums ranged from .23% to .31% of deposits included in an institution's \"assessment base,\" depending upon its level of capital and evaluation of other supervisory factors. A bank's assessment base generally includes all of its demand, time and savings deposits, regardless of whether they are FDIC insured.\nInstitutions classified as \"well-capitalized\" (SEE \"Regulation of Banks--Capital Requirements,\" below) and part of a supervisory subgroup of financially sound institutions with a few minor weaknesses would pay the lowest premium while institutions that are \"undercapitalized\" (SEE \"Regulation of Banks--Capital Requirements,\" below) and considered of substantial supervisory concern would pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. A permanent risk-based assessment system became effective on January 1, 1994. The permanent risk-based assessment system adopted by the FDIC was substantially the same as the transitional system.\nThe FDIC Bank Insurance Fund (BIF) reached its congressionally mandated level during the second quarter of 1995. In September, new assessment rates were retroactively put into effect as of June 1, 1995. As a result, all BIF insured institutions received refunds representing the difference between the old and new rates plus interest. On September 15, 1995, the Bank received a refund of approximately $35,000. The Bank continues to pay the lowest assessment rate, reduced to .04% of average deposits as of June 1, 1995, and to zero as of January 1, 1996, from the previous level of .23% of average deposits. The lowest assessment rate is applied to well capitalized institutions in the supervisory group representing the least risk.\nThe FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after hearing, that the institution has engaged or is engaging in unsafe or\nunsound banking practices, is in a condition that is unsafe or unsound for the continuation of operations or otherwise has violated any applicable law, regulation or order, or any condition imposed in writing by or in a written agreement with the FDIC. The FDIC also may suspend deposit insurance temporarily during the pendency of a proceeding to terminate 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 Bank.\nCAPITAL REQUIREMENTS\nThe FRB regulations establish the same three minimum capital standards for insured state banks as they do for bank holding companies. Under the FRB regulations, the Bank's capital ratios are computed in a manner substantially similar to the manner in which bank holding company capital ratios are determined (SEE \"Regulation of Bank Holding Companies--Capital Requirements,\" above). The FRB capital requirements are minimum requirements and higher levels of capital will be required if warranted by the particular circumstances or risk profile of an individual bank.\nFDICIA provided 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.\" Under regulations adopted by the federal banking regulators, a bank would be considered \"well capitalized\" if it (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has 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 (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk- based capital ratio of 4% or greater, (iii) has a leverage ratio of 4% or greater (or 3% in the case of a bank with the highest composite regulatory examination rating that is not experiencing or anticipating significant growth) 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 composite regulatory examination rating that is not experiencing or anticipating significant growth); (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 regulations would permit the appropriate federal banking regulator to downgrade a bank to the next lower category if the regulator determines (i) after notice and opportunity for hearing or response, that the bank is in an unsafe or unsound condition or (ii) that the bank has received (and not corrected) a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent exam.\nAs of December 31, 1995, the Bank qualified as \"well capitalized,\" with a total risk-based capital ratio of 22.34%, a Tier 1 risk-based capital ratio of 21.15% and leverage ratio of 9.10%.\nDepending upon the capital category to which an institution is assigned, the regulators' corrective powers, many of which are mandatory in certain circumstances, include prohibition\non capital distributions; prohibition of payment of management fees to controlling persons; requiring the submission of a capital restoration plan; placing limits on asset growth; limiting acquisitions, branching or new lines of business; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rates that the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and, ultimately, appointing a receiver for the institution.\nDIVIDENDS\nUnder the IBA, the Bank is permitted to declare and pay dividends in amounts up to the amount of its accumulated net profits, provided that it shall retain in its surplus at least one-tenth of its net profits since the date of the declaration of its most recent previous dividend until said additions to surplus, in the aggregate, equal at least the paid-in-capital of the Bank. In no event may the Bank, while it continues its banking business, pay dividends in excess of its net profits then on hand (after deductions for losses and bad debts).\nThe FRB permits a state member bank such as the Bank to pay dividends, while it continues its banking operations, in an amount not greater than its net profits then on hand, after deducting therefrom its losses and bad debts. No state member bank may pay as a dividend a portion of its paid-in capital and no state member bank may pay dividends if its accumulated losses equal or exceed its undivided profits then on hand. The FRB policy statement described above (SEE \"Regulation of Bank Holding Companies--Dividends,\" above) also applies to the payment of dividends by state member banks. Accordingly, it is the FRB's view that a state member bank experiencing earnings weaknesses should not pay cash dividends exceeding current net income or that only can be funded in ways that weaken the bank's financial health, such as by borrowing.\nINSIDER AND AFFILIATE TRANSACTIONS\nThe Bank is subject to certain restrictions imposed by the Federal Reserve Act and the IBA on, among other transactions, any extensions of credit to the Corporation and its subsidiaries, on investments in the stock or other securities of the Corporation and its subsidiaries and on the acceptance of the stock or other securities of the Corporation or its subsidiaries as collateral for loans made by the Bank.\nCertain limitations and reporting requirements also are placed on extensions of credit by the Bank to principal stockholders of the Corporation and to directors and certain executive officers of the Corporation, its non-bank subsidiaries and the Bank and to \"related interests\" of such principal stockholders, directors and officers. In addition, any director or officer of the Corporation or the Bank or principal stockholder of the Corporation may be limited in his or her ability to obtain credit from banks with which the Bank maintains a correspondent relationship.\nCOMMUNITY INVESTMENT AND CONSUMER PROTECTION LAWS\nIn connection with its lending activities, the Bank is subject to a variety of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. Included among these are the Federal Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, Truth-in- Lending Act, the Equal Credit Opportunity Act, Fair Credit Reporting Act and the CRA and is subject to similar Illinois laws applicable to, among other things, usury, credit discrimination and business practices.\nThe CRA requires banks to define the communities that they serve, identify the credit needs of those communities and adopt and implement a \"Community Reinvestment Act Statement\" pursuant to which they offer credit products and take other actions that respond to the credit needs of the community. Under FIRREA, the responsible banking regulatory agency must conduct annual CRA examinations of insured financial institutions and to assign to them a CRA rating of \"outstanding,\" \"satisfactory,\" \"needs improvement\" or \"unsatisfactory.\"\nThe federal banking regulatory agencies will take into account the CRA ratings of combining organizations and their level of compliance with the Equal Credit Opportunity Act in connection with acquisitions involving the change and control of a financial institution and, if any of the combining institutions have CRA ratings of \"needs improvement\" or \"unsatisfactory,\" the agency in question may deny the application on CRA grounds or require corrective action as a condition of its approval. In 1995, the Bank's CRA rating was \"satisfactory.\"\nANNUAL AUDIT, REPORTING AND MANAGERIAL CONTROL REQUIREMENTS\nUnder FDICIA, the FDIC was required to promulgate regulations requiring FDIC- insured financial institutions over a certain size to have an annual independent audit of their financial statements in accordance with generally accepted auditing standards, to have an independent audit committee of outside directors, and to file with the FDIC and their respective primary federal regulators annual reports, attested to by their independent auditors, as to their internal control structure and compliance with certain designated laws and regulations (including laws and regulations governing insider transactions and payment of dividends). The FDIC's regulations apply these requirements to insured depository institutions with total assets of $500 million or more. The requirements can be satisfied by audit procedures adhered to by a parent entity such as the Corporation that is consolidated with the Bank for financial reporting purposes.\nBROKERED DEPOSITS\nThe FDIC has issued a rule regarding the ability of depository institutions to accept brokered deposits, i.e., deposits obtained through a deposit broker. The rule provides that (i) an \"undercapitalized\" institution is prohibited from accepting, renewing or rolling over brokered deposits, (ii) an \"adequately capitalized\" institution must obtain a waiver from the FDIC before accepting, renewing or rolling over brokered deposits and is subject to limitations on the rate of interest payable on brokered deposits, and (iii) a \"well capitalized\" institution may accept, renew or roll over brokered deposits without restriction. At December 31, 1995, the Bank was\n\"well capitalized\" for purposes of this rule, and the Corporation does not anticipate that the brokered deposit rule will have an adverse effect on its operations.\nOTHER FDICIA RULES\nOther rules adopted or currently proposed to be adopted pursuant to FDICIA include: (i) real estate lending standards for banks, which provide guidelines concerning loan-to-value ratios for various types of real estate loans; (ii) revisions to the risk-based capital rules to account for interest rate risk, concentration of credit risk and the risks posed by \"non-traditional activities\"; (iii) rules requiring depository institutions to develop and implement internal procedures to evaluate and control credit and settlement exposure to their correspondent banks; (iv) rules implementing the FDICIA provision prohibiting, with certain exceptions, state member banks from making equity investments of types and amounts not permissible for national banks; and (v) rules addressing various \"safety and soundness\" issues, including operations and managerial standards, standards for asset quality, earnings and stock valuations, and compensation standards for the officers, directors, employees and principal shareholders of the depository institution.\nCHANGE IN CONTROL\nAs an Illinois bank, the Bank is subject to the rules regarding change in control of Illinois banks contained in the IBA. The Corporation is also subject to these rules by virtue of its control of the Bank. Generally, the IBA provides that no person or entity or group of affiliated persons or entities may, without the Commissioner's consent, directly, or indirectly, acquire control of an Illinois bank. Such control is presumed if any person owns or controls 20% or more of the outstanding stock of an Illinois bank or such lesser amount as would enable the holder or holders, by applying cumulative voting, to elect one director of the bank.\nIn evaluating an application for acquisition of control of an Illinois bank or bank holding company, in addition to the Commissioner's consideration of other factors deemed relevant, the Commissioner must find that the character of the proposed management of the bank, after the change in control, will assure reasonable promise of successful, safe and sound operation; that the future earnings prospects of the bank after the proposed change in control are favorable; and that any prior involvement that the proposed controlling persons or the proposed management of the institution after the change in control have had with any other financial institution has been conducted in a safe and sound manner.\nCONSOLIDATED FINANCIAL AND STATISTICAL PROFILE\nThe financial and statistical data presented in the following pages follows the Industry Guide 3 requirements as promulgated by the Securities and Exchange Commission. This data should be read in conjunction with the Consolidated Financial Statements, the Notes to Consolidated Financial Statements, and the discussion included in the \"Financial Review\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" sections, all of which are included in the 1995 Annual Report to Shareholders and are incorporated herein by reference. The statistical data provided herein is unaudited. All tabular\ninformation is in thousands (000's). There were no foreign activities by the Corporation or the Bank during any of the periods shown.\nDISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL\nThe Schedule on page 16 sets forth the Corporation's consolidated average balance sheets, interest rates and yields, net interest income and net interest margin for the three years ended December 31, 1995. Interest income on loans includes loan fees. The Corporation's investment in Princeton, together with the earnings thereon, are presented in the Schedule as a component of \"Investments\".\nThe Schedule on page 17 sets forth the variances in net interest income which are due to changes in volume and rate. Changes in net interest income which are due to both volume and rate are allocated to changes in volume and changes in rate on an absolute basis. Non-accrual loans, which are not considered material by management, are included in the loan volumes presented.\nTABLE 1 ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES For the Years Ended December 31, 1995, 1994 and 1993\n(1) Interest income on loans includes loan origination and other fees of $93 for 1995, $95 for 1994 and $150 for 1993. (2) Securities income is reflected on a fully tax equivalent basis utilizing a 34% rate for municipal securities and a 70% rate for dividends received. (3) Non-accrual loans are included in average loans. (4) Average balances are derived from the average daily balances. (5) The 1995 and 1994 rate information was calculated based upon average amortized costs for securities. (6) The 1995 average balance information includes an average valuation allowance for taxable securities of $(217).\nThe components of the changes in net interest income are shown in Table 2. Table 2 allocates changes in net interest income between amounts attributed to changes in rate and changes in volume for the various categories of interest- earning assets and interest-bearing liabilities.\nTABLE 2 ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE\nProvision for Loan Losses\nCredit quality and collection experience continued to be good in 1995, resulting in no provision for loan losses during the year compared to a modest $2,000 provision for loan losses in 1994. See additional discussion under \"Financial Condition\" below.\nNoninterest Income\nAs discussed in note 2 to the accompanying consolidated financial statements, in August 1994 the Corporation received shares in AMCORE in exchange for previously owned shares of Princeton pursuant to a merger of these entities, and recorded a gain of $1.5 million. In 1995, the Corporation received $103,000 in dividend income from its AMCORE investment. This is included in interest and dividend income in the December 31, 1995 consolidated income statement. In 1994, the Corporation recognized $127,000 of income on its investment in Princeton as equity income in an unconsolidated non-affiliate and $58,000 of dividend income from its AMCORE investment. The equity income from Princeton is included in other income in the consolidated income statement and the dividend income from AMCORE is included in interest and dividend income.\nSECURITIES PORTFOLIO\nThe following tables show the maturity distribution of the securities portfolio and the weighted average yield of the portfolio at December 31, 1995. The carrying amounts of the portfolio at December 31, 1995 and 1994 are found in Note 2 of the Notes to Consolidated Financial Statements included in the Annual Report to Shareholders, which is incorporated herein by reference.\nThe maturity distribution and weighted average yield data presented above have been completed on the basis of contractual maturity or call date, if applicable. With respect to mortgage-backed securities, maturities and yields have been presented based on the year of final contractual maturity because scheduled principal repayments in earlier periods are not readily available. However, individual borrowers within these mortgage-backed securities have the right to prepay obligations, which will cause expected maturities to differ from contractual maturities.\nThe weighted average yield has been computed by dividing annualized interest revenue, including the accretion of discounts and the amortization of premiums, by the carrying value of securities. The weighted average yield of tax exempt obligations has been calculated on a taxable equivalent basis using the maximum statutory tax rate (34%) available to the Corporation.\nThe investment policy of the Corporation requires securities to be U.S. Government direct obligations, U.S. Government agency obligations, approved issuers of Commercial Paper, certificates and time deposits of approved commercial banks, general obligations of at least \"A\"-rated municipalities, corporate securities, and certain mortgage-backed securities and collateralized mortgage obligations. Investments in revenue or special purpose municipal obligations are not purchased for the portfolio. The policy emphasizes the purchase of short and intermediate term securities.\nOn August 1, 1994, First State Bancorp of Princeton, Illinois, Inc., which was an unconsolidated non-affiliate, 20% owned by the Corporation, was acquired by AMCORE. In the acquisition, the Corporation received 194,623 shares of AMCORE common stock in exchange for 106,062 shares of Princeton. On the date of the exchange of shares, the Corporation recorded a gain of $1,509,907 to adjust the carrying value of its Princeton investment to the fair value of the AMCORE shares received. The AMCORE shares are classified as available-for-sale and are carried at fair value. Prior to August 1, 1994, the Corporation used the equity method of accounting to account for its interest in Princeton. Under this method, the original investment was recorded at cost and adjusted by the Company's share of undistributed earnings or losses of Princeton.\nAs of December 31,1995, the carrying value of AMCORE exceeded 10% of stockholders' equity. Because the AMCORE investment is designated as an available-for-sale security, it is carried at market value ($2,836,304 at December 31, 1995). The Corporation's amortized cost basis in the AMCORE investment at year end 1995 was $2,980,927. The Corporation had no other significant concentrations of investments (greater than 10% of stockholders' equity) in any individual security issue except for U.S. Treasury securities and obligations of U.S. Government agencies and corporations as of December 31, 1995. In addition, the Corporation holds no securities issued by municipalities of any state which in the aggregate exceed 10% of stockholders' equity at December 31, 1995.\nLOAN PORTFOLIO\nThe major classifications of the Corporation's loan portfolio can be found in Note 4 of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference. The Corporation has no foreign loans, real estate development, or oil and gas exploration or development loans.\nThe major emphasis of the Corporation's lending policy is lending for the purposes of acquiring and holding real estate or the making of loans for other purposes, which are secured by real estate. Loans are usually made in the Bank's primary market area. The policy addresses the types of loans to be made, the advances against value and the desirable maturities and amortization schedules.\nMaturities (based on contractual terms) in the Corporation's commercial and construction loan portfolio and an analysis of the interest rate sensitivity at December 31, 1995 are summarized below:\nThe total amount of commercial and construction loans maturing after one year which have fixed rates of interest is $2.1 million, while the total amount due after such date which have floating rates of interest is $1.8 million.\nLoan Portfolio-Risk Elements\nThe Corporation's nonperforming assets include: impaired loans; non-accrual loans; renegotiated loans; accruing loans which are ninety or more days past due; and real estate acquired in satisfaction of indebtedness. Loans are placed in a non-accrual status at such time as scheduled payments of principal or interest become 90 days past due and such loans are not both well secured and in the process of collection or, alternatively, when in management's opinion, there is reasonable doubt as to the timely collectibility of interest. Interest income is recorded on non-accrual loans to the extent of cash interest payments received, assuming the loan is well secured and in the process of collection as prescribed by the banking regulations.\nStatements of Financial Accounting Standards (SFAS) No. 114 and No. 118 became effective January 1, 1995 and consider a loan impaired if full principal or interest payments are not anticipated. Impaired loans are carried at the present value of expected cash flows discounted at the loan's effective interest rate or at the fair value of the collateral, if the loan is collateral dependent. The Bank did not have any impaired loans during the year; therefore, no portion\nof the allowance for loan losses was specifically allocated for impaired loans at December 31, 1995.\nThe Board of Directors and management conduct a quarterly review of loan quality and, as part of this process, review monthly all impaired loans, other non-accrual loans, past due loans and other real estate owned.\nThe nonperforming assets of the Corporation as of December 31, 1995 and 1994 are indicated below:\nNONPERFORMING ASSETS ($000)\nThe effect of non-accrual loans upon interest income is not deemed to be material by management.\nThere are no loan concentrations in any one industry which exceed 10% of outstanding loans. There are no other assets which are required to be disclosed as having a \"risk element\".\nSUMMARY OF LOAN LOSS EXPERIENCE\nManagement and the Board of Directors evaluate the loans in the portfolio against many criteria, including current economic conditions, a borrower's financial position, certain financial ratios, cash flow, net worth, value of collateral and guarantees. It is against these, and other criteria, that a loan is evaluated for possible charge off as an uncollectible debt. In evaluating the adequacy of the allowance for loan losses, management relies on its quarterly review of the loan portfolio to ascertain whether there are probable losses which must be written off and to assess the risk characteristics and the probability of loss in the portfolio taken as a whole.\nAs mentioned previously, SFAS No. 114 and SFAS No. 118 were adopted in January 1995. The standards require management to value impaired loans based on discounted expected cash flows or collateral values. A portion of the allowance for loan losses is then allocated to each impaired loan. The effect of adopting these standards in 1995 did not impact the Corporation's provision for loan losses.\nLoan loss experience for the two years ended December 31, 1995 is summarized as follows:\nAllowance For Loan Loss Activity ($ 000) - --------------------------------\nALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES\nManagement has determined, that due to the relatively small size of the Corporation's loan portfolio and related credit losses, there are no analytical procedures that will result in an accurate allocation of the allowance account. Accordingly, management does not have a specific allocation of the allowance account. However, management does consider the various elements of the portfolio and it recommends to the Board of Directors each quarter the amount by which the allowance account should be augmented in order to account for, among other things, changes in the makeup of the portfolio, changing economic conditions, the number and amount of risk elements identified in the portfolio, and any other circumstances which may have an impact upon the allowance account.\nDEPOSITS\nThe distribution of the major components of deposits as of December 31, 1995 and 1994 are summarized in Note 6 of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference. The following is a maturity distribution of time certificates of deposit of $100,000 or more at December 31, 1995.\nSHORT TERM BORROWINGS\nThe Corporation had no short-term borrowings at December 31, 1995 and 1994.\nSELECTED FINANCIAL DATA\nSelected financial information and key ratios commonly used in analyzing bank holding company financial statements are set forth in the following table (Dollars in thousands except per share data):\nNote i -- Computations used in 1995 and 1994 exclude impact of net unrealized gain (loss) on available-for-sale securities. Note ii -- Stockholders' equity used in 1995, 1994 and 1993 computations includes impact of net unrealized gain (loss) on available-for-sale securities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe main office and the principal executive offices of the Corporation as well as those of the Bank are located at 196 E. Pearson Street, Chicago, Illinois 60611 in a building known as Water Tower Place. This building is located in the near-north side district of the city, approximately one mile north of the downtown business district. The premises that the Corporation and the Bank occupy are leased under a lease agreement, which expires in December 1996 and which provides for the use of approximately 7,500 square feet of space (7,000 of which is located at the ground and second levels of Water Tower Place at the southeast corner of the building and 500 of which is located on the mezzanine level of Water Tower Place.) Additionally, in 1986 a lease, which expires in April 1997, was signed for the use of 1,850 square feet at 446 E. Ontario Street, Chicago, Illinois as a full-service branch. In 1989, another lease, which also expires in April 1997, was executed at the 446 E. Ontario Street location for an additional 2,150 square feet of office space. Annual rentals of the leased premises, as well as the aggregate future rental payments due under the leases, are in Note 10 of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference.\nAs discussed in Note 5 to the Consolidated Financial Statements, the Bank entered into a contract to purchase a building at 190 E. Delaware, Chicago to house its main office. The purchase occurred on January 4, 1996. Management anticipates moving into the new building in December 1996 at the time the current lease expires.\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 EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Corporation acts as its own Transfer Agent and Registrar. Communications may be made to Ms. Yolanda Zarnowska, Corporate Secretary, Security Chicago Corp., 196 East Pearson, Chicago, Illinois 60611.\nThe Corporation's common stock is held by approximately 621 stockholders of record as of March 15, 1996. The common stock of the Corporation is not traded on any national or regional exchange nor in the over-the-counter market. Accordingly, there is no established market for the Corporation's stock. However, there are trades of the Corporation's stock as a result of private negotiations not involving any broker or dealer. The stock activity known to have occurred during 1995 and 1994 is shown, along with the dividends paid, in the following table.\nNote A -- The dividend declared in the fourth quarter of 1994 was payable January 3, 1995. It was comprised of a $0.40 per share regular dividend and a $0.10 per share special dividend.\nNote B -- The dividend declared in the fourth quarter of 1995 was payable December 15, 1995. It was comprised of a $0.40 per share regular dividend and a $0.15 per share special dividend.\nThe Corporation's ability to pay dividends to stockholders is impacted by the ability of the Bank to pay dividends to the Corporation. Restrictions on the Bank's ability to pay dividends are discussed under \"Supervision and Regulation - - Dividends\" in Item 1 and in Note 13 of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nA summary of the Corporation's results of operations, certain per share data, and a summary of the Corporation's balance sheets for the five years ended December 31, 1995, can be found in the table of Selected Financial Data as previously set forth on pages 24 through 26 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 (MD&A)\nThe MD&A information in the 1995 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 the Corporation as of December 31, 1995 and 1994 and for the three years ended December 31, 1995 set forth in the 1995 Annual Report to Shareholders are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information appearing under \"Nominees,\" \"Continuing Directors,\" \"Other Executive Officers\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" under the caption \"DIRECTORS AND EXECUTIVE OFFICERS\" in the Corporation's definitive Proxy Statement for its 1996 Annual Meeting of Stockholders (\"Proxy Statement\"), is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under \"Executive Compensation\" under the caption \"DIRECTORS AND EXECUTIVE OFFICERS\" in the Proxy Statement, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing under the caption \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\" and \"SECURITY OWNERSHIP OF MANAGEMENT,\" in the Proxy Statement, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under the caption \"Transactions With Management\" under the caption \"DIRECTORS AND EXECUTIVE OFFICERS\" in the Proxy Statement, is incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nDESCRIPTION OF DOCUMENT\n(a) 1. The following financial statements and notes to consolidated financial statements can be found on the pages noted of the 1995 Annual Report to Shareholders, which are incorporated herein by reference.\nAnnual Report to Shareholders Page No. --------\nFINANCIAL STATEMENTS OF THE CORPORATION\nReport of Independent Auditors . . . . . . . . . . . . . . . . . . 15 Consolidated Balance Sheets as of December 31, 1995 and 1994 . . . 16 Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . 17 Consolidated Statements of Changes in Stockholders' 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 Consolidated Financial Statements . . . . . . . . . . . . 22-38\nFINANCIAL STATEMENTS AND SCHEDULES\n(a) 2. The following schedules are included herein as required by Item 8 and Item 14(d) of Form 10-K: See Note 12, \"Related Party Transactions\", of the Notes to Consolidated Financial Statements included in the 1995 Annual Report to Shareholders, which note is incorporated herein by reference.\n(a) 3. EXHIBITS\n3(a) Restated Certificate of Incorporation and By-Laws, as amended, of the Corporation (Exhibit 3 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1986, and December 31, 1987, respectively, incorporated herein by reference) (File #0-11401)\n10(a) Information pertaining to the leases of the Bank's premises, are contained in Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990 incorporated herein by reference (File #0-11401)\n10(b) \"Indemnity Agreement\", as approved at 1992 Annual Shareholders Meeting, between Security Chicago Corp. and each of the Directors of the Corporation is contained in Exhibit 10(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31,1992 incorporated herein by reference (File #0-11401)\n13 Annual Report to Shareholders for the year ended December 31, 1995.\n21 A list of all subsidiaries of the Corporation\n23 Consent of KPMG Peat Marwick as of December 31, 1993 and for the year then ended\n(b) REPORTS ON FORM 8-K\nNone.\n(c) EXHIBITS\nSee Item 14 (a)(3) above.\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.\nSECURITY CHICAGO CORP.\n---------------------------- James D. Polivka Chief Executive Officer\n---------------------------- Sarah G. O'Sullivan Vice President Principal Financial 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 in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\n- ------------------------- Director March 29, 1996 James D. Polivka\n- ------------------------- Director March 29, 1996 Thomas R. Beverlin\n- ------------------------- Director March 29, 1996 Richard S. Bull, Jr.\n- ------------------------- Director March 29, 1996 Ronald A. Landsman\n- ------------------------- Director March 29, 1996 Carol Ware\n- ------------------------- Director March 29, 1996 Wallis L. Weinper\n- ------------------------- Director March 29, 1996 Frank W. Fernandes\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSECURITY CHICAGO CORP.\n\/s\/ James D. Polivka -------------------------------------- James D. Polivka Chief Executive Officer\n\/s\/ Sarah G. O'Sullivan -------------------------------------- Sarah G. O'Sullivan Vice President Principal Financial 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 in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ James D. Polivka Director March 29, 1996 - ------------------------- James D. Polivka\n\/s\/ Thomas R. Beverlin Director March 29, 1996 - ------------------------- Thomas R. Beverlin\n\/s\/ Richard S. Bull, Jr. Director March 29, 1996 - ------------------------- Richard S. Bull, Jr.\n\/s\/ Ronald A. Landsman Director March 29, 1996 - ------------------------- Ronald A. Landsman\n\/s\/ Carol Ware Director March 29, 1996 - ------------------------- Carol Ware\n\/s\/ Wallis L. Weinper Director March 29, 1996 - ------------------------- Wallis L. Weinper\n\/s\/ Frank W. Fernandes Director March 29, 1996 - ------------------------- Frank W. Fernandes\nEXHIBIT INDEX\nExhibit No. Description Page No ----------- ----------- -------\n3(a) Restated Certificate of Incorporation and By-Laws, as amended, of the Corporation (Exhibit 3 to on Form 10-K for the year ended December 31, 1986, and December 31, 1987, respectively, incorporated herein by reference) (File #0-11401)\n10(a) Information pertaining to the leases of the Bank's premises, are contained in Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990 incorporated herein by reference (File #0-11401)\n10(b) \"Indemnity Agreement\", as approved at 1992 Annual Shareholders Meeting, between Security Chicago Corp. and each of the Directors of the Corporation is contained in Exhibit 10(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 incorporated herein by reference (File #0-11401)\n13 Annual Report to Shareholders for year ended December 31, 1995 35\n21 A list of all subsidiaries of the Corporation 73\n23 Consent of KMPG Peat Marwick as of December 31, 1993 and for the year then ended 74\n27 Financial Data Schedule\ni","section_15":""}
{"filename":"312583_1995.txt","cik":"312583","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nRocky Mountain Minerals, Inc. (the \"Registrant\") was incorporated under the laws of the State of Wyoming on February 21, 1974, and commenced operations on May 19, 1978. The Registrant has been engaged primarily in the acquisition, development, exploration and operation of mineral properties through the location, lease, or purchase of patented and unpatented lode mining and placer mining claims. The Registrant has no proven mineral reserves. In prior years and to a lesser extent, the Registrant was engaged in the acquisition, development and sale of oil and gas properties. However, during the year ended October 31, 1982, the Registrant disposed of the majority of its oil and gas properties.\nSince the beginning of the 1995 fiscal year, the Registrant was not involved in any bankruptcy, receivership or similar proceedings, nor did it engage in any material reclassification, merger or consolidation, nor did it acquire or dispose of any material amount of assets otherwise than in the ordinary course of business, except as set forth below.\nDuring fiscal year 1995 the Registrant did not acquire, develope, operate or explore for any mineral properties. The Company's only active participation in the mineral industry was through its Mineral Lease Agreement, dated February, 1993 for the development of the Registrant's Rochester property located in Madison County, Montana (see Item 1 (c)(1)(i) Mineral Exploration). The Rochester property is being evaluated by another party for the potential development, operation and recovery of gold and silver. There is no assurance this mineral property will be developed or produce gold or silver.\n(a)(2) Not applicable.\n(b) Financial Information About Industry Segments\nNot applicable.\n(c) Narrative Description of Business\nGlossary of Terms\nCarried Working Interest: A working interest which is not required to pay its share of costs of operations when incurred, but which does not participate in production until its share of the costs advanced by another party has been recovered by such party out of the carried party's share, subject to its proportionate burden of royalties.\nCyanide Process or Circuit: A process utilized to remove certain metals (such as gold and silver) from metal-bearing material by dissolving the gold in a cyanide solution then removing the free metals from the solution by electrolysis.\nDump: A pile of rock that has been extracted from a mine which was not considered to be commercial when mined and which has not been subjected to the milling process.\nFarmout: An agreement whereby the owner of a working interest agrees to assign his interest while retaining some interest (such as an overriding royalty interest or production payment) subject to the performance of specified work on the property. The owner substantially reduces his interest in the property unless he pays some of the costs of exploration.\nGross Acre: A gross acre is an acre in which a working interest is owned. The number of gross acres is the total number of acres in which a working interest is owned.\nJoint Venture: A business activity entered into and carried on by two or more parties who participate and share in costs and profits on a negotiated basis.\nLode Mining Claim: Deposits subject to lode claims include classic veins or lodes having well-defined boundaries, rock in place bearing valuable minerals and broad zones of mineralized rock.\nMill: A mineral treatment plant in which crushing, wet grinding and further treatment of mineralized material is conducted to concentrate the minerals.\nMineralization. The overall ore genesis process resulting from the deposit of mineral traces within a rock or other geological structure. Mineralization may be an indication of a commercial ore body but generally is not economically viable unless such an ore body is found.\nMineralized (or Metal-Bearing) Material: Rock containing gold, silver, copper, lead and\/or other metals. If the rock contains enough metal to have commercial value, it is referred to as ore.\nNet Acre: A net acre is deemed to exist when the sum of the fractional ownership of working interests in gross acres equals one. The number of net acres is the sum of the fractional working interests owned in gross acres, expressed as whole numbers and fractions thereof.\nNon-Ferrous: Metals other than iron and its alloys in steel.\nOre Body: An ore body is an economically recoverable deposit of minerals, the extent of which has been defined through extensive sampling by drilling or otherwise.\nOre Concentrate: The valuable mineral extracted from the host rock which has been subjected to one or more metallurgical processes to cause the ores to separate from the worthless host rock.\nOverriding Royalty: An interest in the gross production from a property allocable to the working interest which is paid out of such production. An override does not bear expenses of operation, development or maintenance and is a burden on the working interest in addition to the landowner's royalty.\nPatented Mining Claim: A claim, lode or placer, for which the federal government has given deed or passed its title to the claimant. No assessment work is required on patented claims. It is not necessary to have a patent to mine and remove minerals from a valid mining claim, but a patent will give claimant exclusive title to the locatable minerals and, in most cases, the use of the surface and all other resources.\nPlacer Mining Claim: Deposits subject to placer claims are all those not subject to lode claims. These include the \"true\" placer deposits of sand and gravel containing free gold (such as those which have accumulated in the unconsolidated sediment of a stream bed) and also include many nonmetallic bedded deposits.\nProven Reserves: Proven reserves represent those reserves that, under presently anticipated conditions, will be commercially recoverable from known mineral deposits with a high degree of certainty.\nRoyalty: The landowner's or mineral owner's share of production, free of any costs of development or operation, reserved in connection with the creation or transfer of a mineral interest.\nTailings or Tailing Ponds: Waste materials which remain from earlier milling processing which, after milling, were not considered to be of commercial value at the time of milling and were discharged into holding ponds.\nUnpatented Mining Claim: A claim, possessory title to which is maintained by payment of $200 fee for assessment labor on each claim by August 31 of each year.\nWorking Interest: An interest in a claim (or oil and gas lease) which entitles its holder to conduct exploratory and mining (or drilling) operations; to bear the costs of such operations, including its proportionate share of the burden of royalties; and to share any production to the extent of the interest.\n(c)(1)(i) Mining Operations Segment\nContract with Rochester Enterprises - Madison County, Montana\nOn April 16, 1980, the Registrant entered into an agreement to acquire from the partners of Rochester Enterprises, Ltd. (\"Rochester\"), an unaffiliated Montana limited partnership, 11 patented mining claims in Madison County, Montana, together with dumps and tailings, an ore mill located thereon and heavy mining equipment. The property was burdened by an aggregate of 10.5% net smelter return royalty and 10.5% net profits interest in the 11 claims and the mill, respectively, in which certain persons, including past and present officers and\/or directors of the Registrant, participate. On November 30, 1981 the Registrant consummated the purchase of the Rochester properties. During the year ended October 31, 1988, the Registrant purchased an aggregate of 7.125% of the net smelter return royalty and net profits interests referred to above, for cash of $47,500 and the issuance of 2,425,000 shares of the Registrant's common stock. (See Note 2 to the Financial Statements.)\nThe Registrant's principal business activities in its mining operations segment have been the construction and operation of an ore mill facility on mining property acquired from Rochester. The Registrant has produced both gold and silver which were sold by the Registrant to a refiner for \"spot\" market gold and silver prices. However, during the fiscal years 1984 through October 31, 1995 the Company has not operated its ore mill facility.\nFuture activities will require substantial additional financing through arrangements with industry partners or through the formation of limited partnerships of which the Registrant would be general partner. The Registrant has no such arrangements at the present time. The Registrant, through its February, 1993 Mineral Lease Agreement with Rouetel, Inc. (see Mineral Exploration below), has performed assessment work on its unpatented mining claims located in Madison County, Montana during fiscal 19943. The annual assessment obligation was $6,600. The total annual assessment obligation for all of the Registrant's mining claims for the year ended October 31, 1995 was $6,600.\nMineral Exploration\nOn September 2, 1983, the Registrant entered into an Exploration Agreement with Option to Lease and Lease Agreement with Searle Brothers Construction, Inc., of Rock Springs, Wyoming, on the Registrant's Continental Gold Prospect located in Fremont County, Wyoming. This agreement gave Searle Brothers Construction, Inc., the right to explore on the Registrant's property, consisting of nearly 10,000 acres, for a period of up to ten months. Searle Brothers declined the option to lease this property on April 8, 1984. They processed 97 samples from 97 test sites.\nOn March 7, 1985, the Registrant entered into a Mining Lease and Agreement with Hecla Mining Company of Wallace, Idaho, on the Registrant's Continental Gold Prospect. The Agreement calls for Hecla to spend $50,000, $75,000, $100,000, $125,000, $150,000, $175,000 and $200,000 annually commencing in 1986 and running through 1992, respectively. During the term of the lease, the Company retains a 5% net profits interest in production from the property, which increases to a 20% net profits interest after Hecla has recouped certain costs. In April 1988, Hecla returned a portion of the claims to the Registrant. The Registrant carried out an exploration program on this portion of the property for fiscal 1989. Hecla carried out an exploration program on the remaining portion of this property for fiscal 1989 in accordance with the Mining Lease and Agreement. On June 5, 1990, under the terms of the 1985 Mining Lease and Agreement, Hecla returned the remaining mining claims to the Registrant. The Registrant carried out an exploration program on these mining claims for fiscal 1991. The property was dropped by the Registrant in 1992.\nOn January 9, 1990, the Registrant entered into a Mineral Lease Agreement with FMC Minerals Corporation of Reno, Nevada, on the Registrant's Rochester Gold Project. The Agreement calls for FMC to spend $100,000, $125,000, $150,000, $250,000 and $375,000 annually commencing in 1990 and running through 1995, respectively. FMC is obligated to pay the Registrant minimum annual advance royalties of $20,000, $25,000, $35,000, $35,000 and $40,000 commencing in 1990 and running through 1994. Advance royalties of $50,000 per year will be paid annually thereafter. During the term of the lease, the Registrant retains a 3% production royalty of operating profits, which increases to a 20% production royalty after FMC has recouped certain allowed costs. FMC has the right to terminate the Mineral Lease Agreement at any time by giving the Registrant thirty days prior written notice. The Mineral Lease Agreement was terminated May. 1992 and the property returned to the Registrant.\nOn February 19, 1993, the Registrant entered into a Mineral Lease Agreement with Rouetel, Inc. of Spokane, Washington on the Rochester Gold Project. The Agreement calls for Rouetel, Inc. to spend a minimum of $50,000 per year in direct exploration and development work, or in mining or milling operations and also maintain the unpatented mining claims by the expenditure of $6,600 annually. Rouetel, Inc. is required to pay the Registrant minimum advance royalties of $20,000 in 1993 and $25,000 annually thereafter. During the Agreement, the Registrant shall retain a five percent (5%) net smelter return. Rouetel, Inc. has the right to terminate this Agreement at any time by giving the Registrant thirty (30) days prior written notice.\nDuring fiscal year 1996, the Registant intends to apply a large portion of the minimum advance royalty money received from Rouetel, Inc. towards the evaluation and acquisition of gold bearing mineral properties. The Registrant intends to explore for gold mineralization in areas where it believes attrative mineral properties exist, supervising its own acreage acquisition programs and to negotiate for such properties.\nSee Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nMining Properties\nMadison County, Montana\nThe Registrant has acquired 31 patented and 66 unpatented lode mining claims, comprising approximately 660 and 1,320 acres, respectively, in Madison County, Montana, adjacent to and in the vicinity of the 11 claims purchased from Rochester, which includes the Watseca Mine. There are no proven reverses on any of these properties. Gross acreage does not allow for overlapping or conflicting claims. The claims are located in the Rochester Mining district, which is accessible by a county highway one and a half miles from Twin Bridges, Montana, and ten miles by a county-maintained road. The Rochester Mining District and the Watseca Mine have been the subject of reports and maps prepared by government agencies and others and the Registrant has acquired the original assay records and underground maps pertaining to the past production history of the Watseca Mine from approximately 1898-1904.\nThe Watseca Mine was the most important in the Rochester Mining District for gold production. The Watseca lode was discovered in the late 1860's and production began in 1868, reaching full production in 1898. Assay and production records indicate the mine produced more than 89,873 ounces of gold until it was closed in 1904. From 1898-1904, the mine was continuously operated by the Watseca Gold Mining Company, with a reported average recovery of gold estimated at approximately 1.75 ounces per ton of ore. It should be noted that these production and recovery figures are based upon old records; the Registrant cannot ascertain the completeness or accuracy of these records. There is no assurance any underground mining which the Registrant may at some later date conduct in this mine will yield any valuable mineralized material. Most of the ore mined before 1902 was treated by amalgamation, gravity concentration and primitive cyanidation in a nearby mill. During the latter part of 1902, a new and larger mill was constructed near the mine, but the mine was closed in late 1904 because an inefficient coal-fired pumping system was unable to keep the mine clear of water. Both of these old mills have been removed from the property.\nClaims. The following table sets forth the names and dates of acquisition of the Registrant's claims in the Rochester Mining district.\nPATENTED CLAIMS Date of Date of Name Acquisition Name Acquisition Agnes (1).............. May 15, 1980 Independence (2)...... August 21, 1980 Beacon Light (1)....... May 15, 1980 Big Rock (2).......... August 2l, 1980 Anoka (1).............. May 15, 1980 Paymaster (2)......... August 2l, 1980 Taft (1)............... May 15, 1980 Idler (2)............. August 2l, 1980 Dixie Queen (2)..... August 21, 1980 Watseca Trio (4),(5) November 30, 198l Dead Beat (2)....... August 21, 1980 Paucippa (4)........ November 30, 198l Black Rock (2)...... August 21, 1980 Julia Holmes (4).... November 30, 198l Virginia (2)........ August 21, 1980 Vienna (4).......... November 30, 198l Leona (2)........... August 21, 1980 Climax (4).......... November 30, 198l Carrie B. (2)....... August 21, 1980 Carlton (4)......... November 30, 198l Caulsa (2).......... August 21, 1980 May Queen (4)....... November 30, 198l Watseca Gold Hill(2) August 21, 1980 Concentrator (4),(6) November 30, 198l Silver Note (2)..... August 21, 1980 Cleopatra (4),(7)... November 30, 198l UNPATENTED CLAIMS Date of Date of Name Acquisition Name Acquisition Gold Bug (2)........ August 21, 1980 Celesta (4)......... November 30, 198l Gold Bug Annex(2)... August 21, 1980 Cumberland (4)...... November 30, 198l Picard.............. November 30, 198l Alice (2)........... August 25, 1980 Emma (2), (3)....... August 25, 1980 Emma Extension (2).. August 25, 1980 Galena 2)........... August 25, 1980 R. Rand (2)......... August 25, 1980 Sunbeam................. July 21, 1980 Montrose (2)........ August 25, 1980 Sunbeam 1............... July 21, 1980 Montrose 2 (2)...... August 25, 1980 Sunbeam 2............... July 21, 1980 Montrose 3 (2)...... August 25, 1980 Sunbeam 3............... July 21, 1980 Carl Carlson (2).... August 25, 1980 Germania................ June 22, 1980 Jeannie L. (2)...... August 25, 1980 Germania 1 through 9.... June 22, 1980 Alicia A (2)........ August 25, 1980 Germania South.......... June 22, 1980 Klondike (2)........ August 25, 1980 Germania South #l....... June 22, 1980 AAl - AA7.............. July 7, 1980 Bluebird 1-5............. May 19, 1980 Camar (2)........... August 25, 1980 Silverbird 1-2........... May 19, 1980 Camearl (2)......... August 25, 1980 Eli 1-3.................. May 19, 1980 Easton (2).......... August 25, 1980 Nephi (2)........... August 25, 1980 Phyllis (2)......... August 25, 1980 Full House.............. June 30, 1980 CC 1 through CC 28..... June 9, 1980 Full House 1-7.......... June 30, 1980 ID 1 through ID 8...... June 9, 1980\n(1) Purchased from an unaffiliated person for $12,500 (62.49 gross and net acres).\n(2) Purchased from an unaffiliated person for $30,000. The patented claims comprise 263.97 gross (248.94 net) acres; the unpatented claims comprise 340 gross (330 net) acres.\n(3) Approximately 9,000 tons of dumps and 6,000 tons of tailings are located on the Emma claim. See \"Business - Dumps and Tailings.\"\n(4) Purchased from Rochester Enterprises, Ltd. for $3,000,000 and 2,500,000 shares of restricted common Stock. The patented claims comprise 122 net acres, and include a 250 ton per day gravity flotation milling facility. The property is burdened by an aggregate 3.375% royalty and 3.375% net profits interests in the 11 claims and the mill, respectively, in which certain persons, including a former officer and director of the Company participate.\n(5) Approximately 63,000 tons of dumps and 28,000 tons of tailings are located on the Watseca Trio Claim.\n(6) Approximately 27,000 tons of tailings are located on the Concentrator claim.\n(7) Approximately 32,000 tons of dumps are located on the Cleopatra claim.\nThe Registrant incurred costs of $24,603 plus 1981 acquisition costs in the staking of the unpatented claims. A total of $13,200 of assessment work will be required by September 1, 1993 and each year thereafter to retain the total of 66 unpatented claims. The Registrant may reduce it's mineral holdings by not spending the required funds to maintain this property.\nASSESSMENT WORK TABLE*\n1995 Amount Required* Number Royalty assessment to be spent Name of of or other to be as of claims Location claims burden performed by August 31, 1995\nVarious Rochester Mining 66 3 3\/8% Rouetel, Inc. 6,600 (See page 8 District, Madison for list of County, Montana __________ Claims) $ 6,600\n* Registrant is presently, and will continue to, actively attempt to \"farm out\" its properties. It is anticipated that any such farm out agreement would hold lessee or purchaser of a property liable for performing annual assessments.\nTitles\nThe Registrant's interest in all of its mining claims, except for 31 patended lode mining claims in Madison County, Montana, which it owns are held under unpatented lode mining claims. Unpatented mining claims are created under the mining laws of the United States and the laws of the state in which the lands are situated. The validity of the titles to such claims depends upon the legal availability of the land for exploration, the validity of the mineral discovery within the boundaries of the claim, compliance with applicable laws relating to location procedures, the good faith of the original locators and performance of the necessary assessment work. Since several of these factors involve fact determination, the validity of title to any given claim cannot be determined by an examination of public records.\nTo maintain ownership of the possessory title created by an unpatented mining claim against possible subsequent locators, the locator must pay $200.00 per claim for assessment labor on each unpatented mining claim by August 31 of each year. Statements as to the assessment work performed must be filed with the Bureau of Land Management and with the appropriate county clerk's office. In the opinion of the Registrant, the Registrant has performed assessment work on all of its claims as required prior to August 1, 1994.\nTo the best knowledge of Registrant's management, claims held by the Registrant are valid claims. It should be recognized, however, that there is some degree of uncertainty with respect to the validity of unpatented claims. The Registrant has not obtained attorney's title opinions or title insurance on any of its oil and gas leases or mining claims, except that an attorney's opinion has been prepared for the Registrant with respect to title to the 11 patented lode mining claims which the Registrant has purchased from Rochester, which opinion indicated that Rochester had good title, subject to the satisfaction of an outstanding mortgage lien which was paid by Rochester at the closing and to the satisfaction of other minor matters prior to closing as suggested by such counsel. The Registrant has reviewed the land status of its unpatented mining claims in the Bureau of Land Management's office and searched the records of the various county clerks' offices in the counties in which its claims are located.\nThe Registrant has the right to enter on and to use the surface of all properties in which it holds exploration and mining rights subject to the claims of the surface owners for any damages caused by or resulting from exploration or mining operations. None of the Registrant's mining claims are within a designated wilderness area.\nAs stated in the above-referenced Assessment Work Table the cost of annual assessment work for the year ending August 31, 1995 required on unpatented mining claims held by the Registrant was $6,600 and this costs was paid for by Rouetel, Inc. under the terms of the Mineral Lease Agreement.\nOil and Gas Properties\nCampbell County, Wyoming. The Registrant owns minor overriding royalty interests in three oil and gas properties located in the Powder River Basin of Campbell County, Wyoming. The Registrant owns a .0160% overriding royalty in the Muddy \"B\" area (4,626.48 acres) of the Sandbar Unit, a .0261% overriding royalty in the Muddy Sand Unit (8,100.13 acres) and a one percent overriding royalty in 160 acres in the Kitty Field. The Registrant has received nominal royalties from these properties which are principally nonproducing.\nMcCone County, Montana. On June 3, 1982, the Registrant sold its 320 acre exploratory fee lease in McCone County, Montana, for $24,000. The Registrant retained a four percent overriding royalty interest in the lease. To date, to the Registrant's knowledge, this lease has not been drilled.\nKit Carson County, Colorado. On August 27, 1982, the Registrant sold 1,826.536 net acres of its exploratory fee oil and gas leases in Kit Carson County, Colorado, for an aggregate of $36,531. The Registrant retained overriding royalty interests ranging from 1.875% to 9.375% on the various leases sold. To date, to the Registrant's knowledge, this lease has not been drilled.\nItem 3.","section_3":"Item 3. Legal Proceedings - None.\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 of the Registrant.\nPART II\nItem 5.","section_5":"Item 5. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters\n(a) Market Information\nThe principal market on which the Registrant's Common Stock is traded is the over-the-counter market. The stock was first listed on the National Association of Securities Dealers Automated Quotation System during the Registrant's third fiscal quarter 1988. Prior to this period the quotations were derived from the National Quotation Bureau, Incorporated's \"Pink Sheets\". These over-the-counter market quotations reflect inter- dealer prices without retail markup, markdown or commissions and may not necessarily represent actual transactions.\n*The above bid and ask prices are estimated by the Registant based on the limited trading of the Company's securities.\n(b) Holders\nThe number of record holders of the Registrant's common stock on October 31, 1995 was approximately 3,720.\n(c) Dividends\nThe Registrant has paid no dividends with respect to its common stock. There are no contractual restrictions on the Registrant's present or future ability to pay dividends. The Registrant's Preferred Stock bears dividends at a rate of $.015 per share per annum (an annual aggregate of $384,082 as of October 31, 1992) and has full priority over dividends on the common stock. These dividends are cumulative and payable annually in cash, in shares of common stock or in kind, at the Registrant's option. Dividends of $.0l5 on the Preferred Stock were due on July 1, 1982, through 1994. The Registrant has deferred payment of these dividends ($4,608,981) until such time as revenues permit payment thereof. It is uncertain when, if ever, the Registrant will receive sufficient revenues which will enable it to begin to pay the dividends on the Preferred Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data (1)\nYears Ended October 31,\n* Less than $.01 per share.\n(1) The selected financial data should be read in conjunction with the related financial statements and notes thereto included under Items 8, 14(a)(1) and (2), and 14(d).\n(2) Loss per share is based on the weighted average number of shares of common stock and equivalents (Convertible Preferred Stock) outstanding during each year; (95,475,000 in 1991, 95,475,000 in 1992, 95,475,000 in 1993 and 95,475,000 in 1994 and 95,475,000 in 1995).\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nThe Registrant began operations on May 19, 1978 and is considered to be a mining company in the exploratory stage and has had no significant revenues. During the 1987 and 1988 fiscal years, the Registrant generated only limited revenues, as it was substantially inactive during such periods. During the 1988 fiscal year the Registrant consummated a stock purchase agreement and has resumed mineral exploration and waste management activities, which it continued during the 1995 fiscal year.\nGeneral and administrative expenses remained approximately the same during the fiscal year 1995, as compared to the previous fiscal year.\nDuring 1989 the Registrant settled prior obligations resulting in extraordinary gain of $4,235 and incurred a net loss of ($167,195). During 1990, the Company recorded a charge to expense of $1,037,669 representing the excess of net book value over the estimated recoverable value of the Rochester Mill, and incurred a net loss for the year of ($1,187,324). During 1991, the Company recorded an additional charge to expense of $146,285 representing the excess net book value over the estimated recoverable value of the Mill, settled prior obligations resulting in extraordinary gain of $17,054, and incurred a net loss of $(181,956). During fiscial year 1995 the Company conducted only limited operations due to financial restrictions.\nLiquidity and Capital Resources\nThe following table reflects the Registrant's working capital positions at October 1995 and 1994:\nAs of October 31, 1993 the Registrant had a working capital deficit of $7,747. Working capital increased from fiscal year 1994 to 1995 as the result of the reclassification of certain assets at the Rochester Mill, as assets held for sale at net realizable value. The Registrant will continue the evaluation of it's present mineral properties and other additional mineral properties in Western U.S. and Australia, as well as pursue other non-mineral business opportunities.\nThe Registrant has used a significant portion of the proceeds from the April 27, 1988 sale of stock to Quillium to maintain it's mineral property inventory and conduct additional geologic studies. In addition, the Registrant conducted exploratory programs and geologic studies on other precious and base mineral properties both in the western U.S. and Australia. During 1992 the Registrant acquired a 38% equity interest in Zonia Landfill, Inc., a company engaged in the waste management business. Zonia Landfill, Inc. owns and operates a solid waste transfer and recycling facility and a garbage collection company in Yavapai County, Arizona.\nIn December of 1990, the Company decided to sell certain personal property assets at the Rochester Mill, with the exception of the developed mine dumps and tailings. At October 31, 1992 a portion of the net assets had been sold while the remainder are expected to be sold in the future. The remaining net assets have been reclassified to net assets held for sale and are stated at their net realizable value.\nManagement's plans for funding continued operations include attempting to obtain additional outside funding either through the sale of common stock, debt, and\/or possible sales of undeveloped properties or its existing equipment and mill facility at the Rochester property.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial statements and supporting schedules reporting supplementary financial information are listed in the Index to Financial Statements filed as a part 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, Executive Officers, Promoters and Control Persons of the Registrant\n(a, b, e) Identification of Directors and Executive Officers and Their Business Experience Name Age Position, Tenure and Business Experience\nErnest Geoffrey Albers 51 Chairman and Director of the Registrant since April 1988, Mr. Albers is a 1968 graduate of the University of Melbourne, Victoria, Australia with a Bachelor of Law degree. He commenced practice in 1969 as the principal of his own firm immediately upon admission as a barrister and solicitor of the Supreme Court of Victoria. In 1972 he ceased full time practice to pursue his private investment activities, his master investment company now being Great Missenden Group Pty., Ltd. He formed Cue Energy Resources N.L. in New Zealand in 1981 and is its major shareholder. In Australia he is chairman of Bass Strait Group N.L. which he formed in 1978 and Estates Holdings Ltd. which he formed in 1971. In New Zealand he is also on the board of Southern Petroleum N.L. He is a member of the Petroleum Exploration Society of Australia and is a member of the Australian Institute of Directors.\nRichard Douglas Fraser 43 Director of the Registrant since April 1988, Mr. Fraser obtained an Associateship in Mining Engineering from the Western Australian School of Mines in 1974. He has had extensive practical experience in mine operations prior to obtaining a Western Australian First Class Mine Manager's Certificate of Competency in 1979 as a manager of a below ground mine for New South Wales in 1981. Between 1975 and 1980 he was employed by the WA Department of Mines as a mining engineer - special inspector of mines. Prior to establishing his own consultancy he was employed for two years by Newmont Holdings including a period as certified quarry manager and assistant to the manager at the Telfer Mine. In 1982 he established his consultancy, Fraser Mining and Construction Pty. Ltd., which has carried out consulting projects in all states of Australia and has been instrumental in establishing new mines in the Solomon Islands and Ghana. In 1986 he formed the Federation Resources Group which plans to develop new mines at Rushworth and Costerfield in Victoria. Mr. Fraser is an associate member of the Australian Institute of Mining and Metallurgy.\nRichard H. Bain 51 President, Treasurer, Mr. Bain has a B.A. from Rice University in Commerce and Business and a graduate degree from the University of Houston in Fine Arts. Since 1970, Mr. Bain has been active in fields of research, education, political science, geo-physics and global economics with emphasis on financial markets. Mr. Bain currently teaches social and political science in the Houston Community College and public school system.\nDonald C. Knaute, Jr. 49 Mr. Knaute is a gradute of Michigan State University with a B.S. degree in Marketing\/Marketing Research. Since 1973, after 5 years service in the U.S. Navy Supply Corps, Mr. Knaute has been involved in computer distribution, application programming, consulting, hardware design and systems implementation. Mr. Knaute is currently president of Civilized Systems, Inc., a computer solutions firm in Houston.\n(c) Identification of Certain Significant Employees\nNone\n(d) Family Relationships\nNone\n(f) Involvement in Certain Legal Proceedings\nNone\n(g) Promoters and Control Persons\nNot applicable.\nItem 11.","section_11":"Item 11. Executive Compensation\n(a)(1) Cash Compensation\nCash compensation for the fiscal year ended October 31, 1995 was as follows:\nName of individual or number Capacities in Cash of persons in group which served compensation\nAll executive Officers and\/or $- 0 - officers as a group directors (two persons)\n(a)(2) Bonuses and Deferred Compensation\nNone\n(b)(1) Compensation Pursuant to Plans\nThe registrant has no annuity, pension, retirement or profit sharing plan in effect and none is presently contemplated.\n(b)(2) Pension Table\nNot applicable.\n(b)(3) Alternative Pension Plan Disclosure\nNot applicable.\n(b)(4) Stock Option and Stock Appreciation Right Plans\nThe Registrant has adopted a 1987 Stock Option Plan (the \"Plan\") reserving an aggregate of 25,000,000 shares of the Registrant's common stock for issuance pursuant to the exercise of stock options (the \"Options\") which may be granted to officers, directors and employees (either full-time or part-time) of the Registrant or any subsidiary. The Plan is for a ten year term. The Plan is designed to provide additional incentive for such persons to promote the success of the Registrant, and to encourage the ownership of the common stock of the Registrant by such persons. No options have been granted to any person under the Plan.\nThe Plan is administered by the Board, or at their discretion by a stock option committee (the \"Committee\") consisting of not less than three directors. Members of the Committee are eligible to participate in the Plan. In addition to determining who will be granted options, the Board has the authority and discretion to determine when options will be granted and the number of options to be granted. The Committee may determine which options may be options intended to qualify for special treatment under the Internal Revenue Code of 1986 (\"Incentive Stock Options\") or non-qualified options (\"Non-Qualified Stock Options\") which are not intended to so qualify. The Board also may determine the time or times when each option becomes exercisable, the duration of the exercise period for Options and the form or forms of the instruments evidencing Options granted under the Plan. No options can have a term of more than ten years. Incentive Stock Options may not be granted to directors who are not also employees.\nThe Committee has broad discretion to determine the number of shares with respect to which Options may be granted to participants. The maximum aggregate fair market value (determined as of the date of grant) of the shares as to which Incentive Stock Options become exercisable for the first time during any calendar year may not exceed $100,000.\nThe Plan provides that the purchase price per share for each Option on the date of grant may not be less than 100%, in the case of Incentive Stock Options, and 80%, in the case of Non-Qualified Stock Options, of its fair market value which is defined for this purpose to be the average of the bid and asked prices of the Registrant's Common Stock on the date of exercise as reported by the National Quotation Bureau, Inc.'s \"Pink Sheets.\" In the absence of a reported price on the date of exercise, the Board, at its discretion, may select any reasonable method for the valuation of the shares.\nOptions granted under the plan will be nontransferable during the life of the optionee and terminate within three months upon the cessation of the optionee's employment, unless employment is terminated for cause, in which case the option terminates immediately.\n(c) Other Compensation\nNone.\n(d) Compensation of Directors\nNone.\n(e) Termination of Employment and Change of Control Arrangement\nNone.\nItem l2. Security Ownership of Certain Beneficial Owners and Management\n(a), (b) Security Ownership of Certain Beneficial Owners and Management\nThe following table shows the security ownership of those persons known by the Registrant to be the beneficial owners of more than five percent of the Registrant's common stock and of the directors, and the officers and directors as a group as of October 31, 1995: Amount and Nature of percent Title of Name and address beneficial of class of beneficial owner ownership (1) class (4)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nCumulative amounts For the year ended from October 31, inception\n*Less than $.01 per share Capital in Deficit excess accumulated Preferred Common of during the Stock Stock par development Shares Amount Shares Amount value stage Conversion of preferred stock into common stock (Note 4) - - - - - -\nNet (loss) gain for the year ended October 31, 1993 - - - - - (11)\nBalance, [C] [C] [C] [C] [C] [C] [C] [C] [C] October 31, 1993 25,605 1,280 85,433 85 4,339 (2,991)\nConversion of preferred stock into common stock (Note 4) - - - - - -\nNet (loss) gain for the year ended October 31, 1994 - - - - _ 2\nBalance, October 31, 1994 25,605 1,280 85,433 85 4,339 (2,993)\nConversion of preferred stock into common stock (Note 4) - - - - - -\nNet (loss) gain for the year ended October 31, 1995 - - - - - (186)\nBalance, October 31, 1995 25,605 1,280 85,433 85 4,339 (3,179)\nCumulative amounts from\n1. Organization and summary of significant accounting policies\nOrganization:\nRocky Mountain Minerals, Inc. (the Company) was incorporated on February 21, 1974, and began operations on May 19, 1978 (inception) and is considered to be a mining company in the exploratory stage and a development stage company as defined by SFAS No. 7, and since inception, has been engaged in the acquisition of mineral interests, oil and gas properties and leases, financing activities, and initiated milling of the Company's mine tailings in 1983. In January, 1984, the Company discontinued milling. Prior to 1983, the Company operated in two business segments, mining operations and oil and gas operations. During the year ended October 31, 1982, the Company disposed of the majority of its oil and gas properties, and subsequently has only had mining operations.\nBasis of presentation:\nThe financial statements have been prepared on a going concern basis which contemplates the realization of assets and liquidation of liabilities in the ordinary course of business. As shown in the accompanying financial statements, the Company has incurred significant losses since its inception. In addition, as discussed in Notes 13 and 14, the Company has made a significant cash investment in a related entity. As a result, substantial doubt exists about the Company's ability to continue to fund future operations using its existing resources.\nManagement's plans for funding continued operations include attempting to obtain additional outside funding either through the sale of common stock, debt, and\/or possible sales of undeveloped properties or its existing equipment and mill facility at the Rochester property (Notes 2 and 13). The financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.\nA summary of the significant accounting policies is as follows:\nDepreciation, depletion and amortization:\nDepreciation is provided by the Company on the straight-line and declining balance methods.\nDepletion of producing oil and gas royalties is computed by the unit-of- production method based on estimated recoverable reserves of oil and gas, by lease.\nDepletion of developed mineral interests (mine dumps and tailings) is computed by the unit-of-production method based on estimated recoverable quantities of gold and silver.\nUndeveloped mineral interests and oil and gas properties:\nThe Company utilizes the \"successful efforts\" method of accounting for undeveloped mineral interests and oil and gas properties. Capitalized costs are charged to operations at the time the Company determines that no economic reserves exist.\nCosts of carrying and retaining undeveloped properties are charged to expense when incurred.\nProceeds from the sale of undeveloped properties are treated as a recovery of cost. Proceeds in excess of the capitalized cost realized in the sale of any such properties, if any, are to be recognized as gain to the extent of the excess.\nInvestment in affiliated company:\nThe investment in affiliated company is carried on the equity basis (Note 3).\nIncome taxes:\nIncome taxes are provided on all revenue and expense items included in income, regardless of the period in which such items will be recognized for tax purposes, except for those items representing a permanent difference between pre-tax accounting income and taxable income. Investment tax credits are accounted for as reductions of income tax expense under the \"flow- through\" method.\nStatement of Financial Accounting Standards No.96, \"Accounting for Income Taxes\" was issued in late 1987. The Company has chosen not to elect early adoption, as management of the Company believes that adoption will not have a material effect on financial position or results of operations.\nCapitalization of interest:\nTo accurately reflect the costs of developing certain mining properties, the Company capitalizes interest on funds borrowed directly or indirectly to develop such properties. Interest of $33,828 has been capitalized during the period from inception (May 19, 1978) through October 31, 1983. No additional interest has been capitalized subsequent to October 31, 1983.\nCash equivalents:\nFor 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.\n2.Purchase of Rochester mining properties\nIn October, 1980, the Company entered into an agreement with certain individuals, including officers and directors of the Company, whereby the Company sold each of them a certain number of shares of its common stock (1,400,000 in the aggregate); a percentage of the net profits, if any, on an accumulated basis (10.5% in the aggregate) from the operations of the mill being acquired from Rochester; and a perpetual non-participating royalty interest in the patented mining claims being acquired from Rochester (10.5% aggregate). The Company valued the shares issued under the agreements at $.28225 per share which represented approximately 60% of the quoted market \"bid\" price on October 28, 1980. The balance of the amount received from the \"private placement\" ($348,400) was deferred until closing of the agreement with Rochester, at which time, the amount deferred was credited to the total purchase price of the properties. During 1987 and 1988, the Company had repurchased 7.125% (aggregate) of both of the net profits and royalty interests for a total of $47,500 in cash and the issuance of 2,425,000 shares of its common stock ($.01 per share).\nOn November 30, 1981, the Company closed the agreement with Rochester Enterprises, a Montana limited partnership, acquiring 11 patented lode mining claims, certain improvements, buildings and machinery, and certain mill tailings and mine dumps located in Montana (see Notes 13 and 14) for a purchase price totalling $3,029,765 and 2,530,000 shares of the Company's common stock. Pursuant to the agreement, the Company has agreed, on a one- time basis only, to prepare and file a registration statement under the Securities Act of 1933, as amended, or a notification of exemption pursuant to Regulation A, if available, from such act at its expense to sell or otherwise dispose of any of the shares issued to Rochester under the agreement, upon the request of any one or more of the partners of Rochester.\n3.Investment in affiliated company\nOn June 28, 1988, the Company acquired a 50% interest in American Horizon Resources, Inc. (American Horizon) for cash consideration of $15,000. American Horizon, a privately owned Colorado corporation, is considered to be a mining company in the development stage, and as of October 31, 1993 has commenced only limited exploration operations. A principal shareholder of the Company owns the remaining 50% interest in American Horizon. In July of 1989, the Company agreed to fund 50% of American Horizon's subsequent budgeted mining exploration expenditures in Tasmania, which funding commitment terminated on June 30, 1991. At October 31, 1992 $35,410 had been advanced to American Horizon on behalf of the Company. During fiscal year 1992 the Company acquired a 38% interest in a waste management company which owns and operates a solid waste transfer and recycle facility and a solid waste and collection company. The equity interest acquired by the Company represents a direct cash investment of $198,477 and an indirect investment credit of $216,000 which represents management and administrative fees credited to the Company. Significant shareholders and officiers and directors of the Registrant are affiliated with the Company.\n4.Preferred stock\nDuring fiscal 1981, the stockholders voted to amend and re-amend the Articles of Incorporation to authorize the issuance of Preferred Stock having a par value of $.05. The Board of Directors designated 44,000,000 shares of the Preferred Stock as $.015 Cumulative Convertible Preferred Stock (hereinafter referred to as \"Preferred Stock\"). The holders of the Preferred Stock are entitled to receive $.015 per share annual dividends, and $.10 per share, plus accrued but unpaid dividends, upon liquidation, dissolution or winding up of the Company. The dividends are payable annually if and when declared by the Board of Directors only from earned surplus. Cumulative dividends in arrears as of October 31, 1995 amount to $5,377,144 ($.21 per share). Each share of the Preferred Stock is convertible by the holder, at his option, into .4 shares of common stock. The Preferred Stock may be called for redemption at $.15 per share, plus accrued but unpaid dividends.\n5.Common stock\nIn connection with a stock purchase agreement consummated on April 22, 1988, with Quillium Nominees Pty., Ltd. (Quillium) pursuant to which 33,333,000 shares of the Company's restricted common stock were issued, the Company has agreed to prepare and file a registration statement under the Securities Act of 1933, as amended, for the 33,333,000 shares issued under the agreement.\n6.Stock options\nIn connection with the stock purchase agreement discussed in Note 5, the Company granted to Quillium options to purchase an additional 33,333,000 shares of its common stock at $.05 per share, which expired on January 31, 1991. In addition, an unrelated individual was granted an option to purchase 500,000 shares of the Company's common stock, exercisable at $.05 per share, which expired on April 22, 1989.\nEffective December 4, 1987, 25,000,000 shares of the Company's common stock were reserved for issue to officers, directors and employees of the Company, pursuant to the terms of the Stock Option Plan adopted on that date. As of October 31, 1994, no options have been granted and no charges to income have been made in connection with the above noted stock options.\n7.Extraordinary items\nDuring the years ended October 31, 1989 and 1991, the Company settled prior accounts payable of $4,982 and $17,054, respectively, resulting in extraordinary gain, net of applicable income taxes of $747 (1989) and $2,258 (1991), in the amounts of $4,235 (1989) and $14,796 (1991). Extraordinary credit from the utilization of net operating loss carryforwards was generated by these transactions, in the amounts of $747 and $2,258, respectively.\n8.Income taxes\nNo provision for income taxes is required for the years ended October 31, 1993, 1994 and 1995, because the Company has net operating losses (exclusive of extraordinary items) for the periods, there are not previous earnings to which such losses may be carried back, and there are no recorded income tax deferrals to be eliminated. Utilization of net operating losses from prior years offset extraordinary gain on extinguishment of debt in the amounts of $4,982 in 1989 and $17,054 in 1991 (See Note 7).\nAt October 31, 1995, the Company had net operating loss carryforwards for tax purposes of approximately $3,190,000, of which $2,477,000 is limited as to the amount which may be used in one year. If not used to offset future taxable income, the carryforwards will expire as follows:\nFiscal Year of expiration Amount\nAt October 31, 1995, the Company had investment tax credit carryovers of approximately $58,000, which, if not used, will expire in fiscal years 1994 through 1998, and are also limited as to the amount which may be used in any one year.\n9. Loss per common share\nLoss per common share information is based on the weighted average number of shares of common stock and equivalents (convertible preferred stock) outstanding during each year, 95,671,000 shares in 1982, 95,630,000 shares in 1993, 95,475,000 shares in 1991, and 49,664,000 shares for the period from May 19, 1978 through October 31, 1995).\n10. Commitments and contingencies\nUnpatented lode mining claims:\nIn connection with unpatented lode mining claims, the Company must perform, or cause to be performed, approximately $13,200 of assessment work, by August 31, 1995, in order to retain possessory title for the ensuing year (See Note 11).\nExploration funding:\nOn July 13, 1989, the Board of Directors authorized funding 50% of the budgeted mineral exploration expenditures of its 50% owned subsidiary, American Horizon (Note 3). As indicated in Note 3, a significant shareholder of the Company owns 50% of American Horizon, and has agreed to fund the remaining 50% of the above noted expenditures.\nInsurance: The Company is, to a significant degree, without insurance pertaining to various potential risks with respect to its Rochester mill and related mining property and equipment, including general liability and fire, because it is presently not able to obtain insurance for such risks at rates and on terms which it considers reasonable. The financial position of the Company in future periods could be adversely affected if uninsured losses were to be incurred.\n11.Mineral lease agreement\nOn February 19, 1993, the Registrant entered into a Mineral Lease Agreement with Rouetel, Inc. of Spokane, Washington on the Rochester Gold Project. The Agreement calls for Rouetel to spend a minimum of $50,000 per year in direct exploration and development work, or in mining or milling operations. Rouetel, Inc. is required to pay the Registrant minimum advance royalties of $20,000 in 1993 and $25,000 annually thereafter. During the Agreement, the Registrant shall retain a five percent (5%) net smelter return. Rouetel, Inc. has the right to terminate this Agreement at any time by giving the Registrant thirty (30) days prior written notice.\nRouetel, Inc. is also required to perform all required assessment work to maintain title to the unpatented mining claims. During 1995, Rouetel complied with the assessment requirements by spending a minimum of $6,600 on these unpatented claims.\n12.Related party transactions\nOn September 1, 1988, the Board of Directors authorized a loan by the Company to its President, as evidenced by a promissory note as of that date, in the amount of $40,000. Interest at 12% is payable quarterly and the principal was originally due September 1, 1989. During fiscal 1995 this note, plus accrued interest of $17,664, was forgiven as a result of past services for the years 1991 - 1995.\nAt October 31, 1994, the Company had made cash advances of $239,493 and paid certain expenses ($7,503) on behalf of various entities which are affiliated with certain officers\/directors and significant shareholders. As of October 31, 1991 an additional $16,135 had been advanced to these entities and $54,480 has been repaid (see Note 10), accordingly $198,477 is reflected as due from affiliates at October 31, 1991. In 1992 the Company converted the cash advances into equity.\nIn January of 1984, the Company suspended milling operations at its Rochester property (Note 2), which remains idle at October 31, 1994. During the fourth quarter of 1990, the Company recorded a charge to expense of $1,037,669 representing the excess of net book value over the estimated recoverable value of the Rochester Mill (the Mill), resulting in an increase in the net loss for 1990 of $(.01) per share. In the fourth quarter of 1991 and 1993, pursuant to current property appraisals, the Company recorded an additional charge to expense of $146,285 and $53,872, representing excess net book value over the estimated recoverable value of the Mill.\nIn December of 1990, the Company decided to sell certain assets at the Mill, with the exception of the developed mine dumps and tailings, which are subject to the Mineral Lease Agreement discussed in Note 11.\n14.Realization of assets\nThe Company has substantial investments in mining properties that are in the exploratory stage. The ultimate realization of these assets (aggregate cost $402,220) may be dependent upon commercial development of the mining properties in sufficient quantity for the Company to recover its investments.\nThe ultimate realization of the Company's remaining investment in the developed mine dumps and tailings ($1,838,807 aggregate net book value) is dependent upon a favorable interrelationship between future economic events, including the market price and quantity of minerals in the existing dumps and tailings, commercially viable milling of such minerals, and the cost to the Company to undertake milling activities.\nAs a result of the above, a further write-down of all or part of undeveloped mining properties, mill and related property and advances to affiliates may ultimately be required. The impact on the Company's financial position and results of operations cannot be determined at this time, therefore no provision for any possible revaluation of these assets has been made in the financial statements.\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nBalance Other at changes Balance beginning Additions add at end Classification of period at cost (deduct) of period\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION\nSIGNATURES\nPursuant to the requirements of Section 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.\nROCKY MOUNTAIN MINERALS, INC. BY: \/s\/ Richard Bain Richard Bain, President\nDATED:1\/15\/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 date indicated.\nDATED:1\/15\/96 BY: \/s\/ Richard Bain Richard Bain Treasurer and Director (Principal Executive, Financial and Accounting Officer)\nDATED:1\/15\/96 BY: \/s\/ E. Geoffrey Albers E. Geoffrey Albers, Director\nDATED:1\/15\/96 BY: \/s\/ Richard Fraser Richard Fraser, Director\nDATED:1\/15\/96 BY: \/s\/ Don Knaute Don Knaute, Director","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"727510_1995.txt","cik":"727510","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nEnzon, Inc. (\"Enzon\" or the \"Company\") is a biopharmaceutical company that develops, manufactures and markets enhanced therapeutics for life-threatening diseases through the application of its proprietary technologies, PEG Modification or the PEG Process and Single-Chain Antigen-Binding (SCA) proteins. The Company is primarily engaged in the research, development and commercialization of its proprietary technologies in the areas of blood substitutes, genetic diseases and oncology.\nThe Company has received marketing approval from the United States Food and Drug Administration (\"FDA\") for two of its products: (i) ONCASPAR, approved in February 1994 for the indication of acute lymphoblastic leukemia (\"ALL\") in patients who are hypersensitive to native forms of L-asparaginase and (ii) ADAGEN, the first successful application of enzyme replacement therapy for an inherited disease, approved in March 1990 to treat a rare form of Severe Combined Immunodeficiency Disease (\"SCID\"), commonly known as the Bubble Boy Disease.\nThe Company manufactures both ADAGEN and ONCASPAR in its South Plainfield, New Jersey facility and markets ADAGEN on a worldwide basis. ONCASPAR is marketed in the U.S. by Rhone-Poulenc Rorer Pharmaceuticals, Inc. (\"RPR\"). The Company received $6,000,000 from RPR related to the granting of this license (of which $500,000 and $5,500,000 were paid to the Company during the fiscal years ended June 30, 1995 and 1994, respectively). Under the license, which was amended in January 1995, the Company is also entitled to royalties on the sales of ONCASPAR in the U.S. by RPR of 10% to 23.5% in 1995 and 23.5% to 43.5%, thereafter, based on the sales level of ONCASPAR. During 1995, RPR paid the Company $3,500,000 in advance royalties. Royalties due under the RPR agreement will be offset against a credit of $5,970,000, which represents the royalty advance plus reimbursement of certain amounts due RPR under the original agreement and interest expense. The Company has also granted exclusive licenses to sell ONCASPAR in Canada and Mexico to RPR in exchange for royalty payments on future sales. The Company is currently pursuing additional licenses for marketing and distribution rights outside North America. During November 1994, ONCASPAR was approved in Germany for use in patients with ALL who are hypersensitive to natural forms of L-asparaginase.\nONCASPAR is the enzyme L-asparaginase modified by the PEG Process and ADAGEN is the enzyme adenosine deaminase modified by the PEG Process. The PEG Process involves chemically attaching polyethylene glycol (\"PEG\"), a relatively non-reactive and non-toxic polymer, to proteins and certain other pharmaceuticals for the purpose of enhancing their therapeutic value. Attachment of PEG helps to disguise the proteins and to reduce their recognition by the immune system, thereby generally lowering potential immunogenicity. Both the increased molecular size and lower immunogenicity result in extended circulating blood life, in some cases from minutes to days.\nIn addition to its approved products, the Company is conducting research and developing additional drugs. In the blood substitutes area, the Company has undertaken the development of a hemoglobin based oxygen carrier, utilizing the protein hemoglobin modified by the PEG Process. In addition to its use as a blood substitute, the Company's product PEG-hemoglobin, may act as a radiosensitizer in cancer therapy. Enzon has chosen to base PEG-hemoglobin on bovine hemoglobin, due to its superior oxygen-carrying properties, relative stability, availability and low cost. The Company is currently conducting a Phase I clinical trial in healthy volunteers and has administered PEG- hemoglobin to 28 subjects up to a dose of approximately 45 grams or the equivalent of approximately 1.5 units of whole blood. The Company is compiling the results of this trial for submission to the FDA. The Company plans to conduct future clinical trials utilizing PEG-hemoglobin in patients receiving radiation treatment for solid hypoxic tumors and as a blood substitute (resuscitation fluid) for trauma patients. The Company is discussing the protocols for these trials with the FDA. The Company currently manufactures and plans to manufacture PEG-hemoglobin for future trials in a pilot plant facility located in South Plainfield, New Jersey.\nIn the area of genetic diseases, the Company's lead product under development is a PEG-modified version of the enzyme glucocerebrosidase to treat Gaucher disease, a genetic disorder that results in the lack of beta- glucocerebrosidase, an enzyme instrumental in the breakdown and disposal of complex fatty substances in the bloodstream. These substances then accumulate in the spleen, liver and bone marrow, resulting in anemia, weakened bones, enlargement of the spleen and liver and sometimes early death. An estimated 15,000 people suffer from Gaucher disease in the United States, of whom 2,000 to 3,000 require medical attention. During September 1994, the Company began a Phase I clinical trial in Gaucher patients. Currently, two patients are enrolled in this trial and additional patients are anticipated to be added when clinical trial material becomes available.\nThe Company has several products under development in the area of oncology which are all in the early research stage. These products include PEG-modified anti-cancer compounds and a novel chemical compound.\nThe Company is pursuing a dual strategy for commercializing its proprietary technologies. In addition to developing, manufacturing and marketing the Company's proprietary products, the Company has established strategic alliances in which Enzon licenses its proprietary technologies in exchange for milestone payments, manufacturing revenues and\/or royalties.\nThe Company licensed exclusive worldwide marketing rights to Sanofi Winthrop Inc. (\"Sanofi\"), formerly Sterling Winthrop, Inc., for PEG-Superoxide dismutase (\"PEG-SOD\"), which is the enzyme superoxide dismutase (\"SOD\") modified by the PEG Process. SOD destroys oxygen free radicals that may damage tissue during reperfusion associated with myocardial infarction, organ transplant and trauma. Generally, Enzon will be entitled to 40% of the net profits from sales of PEG-SOD in the United States during the life of the basic U.S. PEG patent covering this product, with agreed-upon limits on the amount of expenses that can be deducted by Sanofi from revenues before calculating the profit split. Sanofi is presently developing PEG-SOD, which it has trademarked as DISMUTEC, for closed head trauma. Sanofi has advised the Company that it is currently conducting an expanded Phase III clinical trial on PEG-SOD, which is expected to be completed during the fourth quarter of 1995. A smaller, double blind, Phase III study with approximately 460 patients has been completed. This study showed that patients receiving DISMUTEC showed 18% and 16% relative improvement in favorable neurological outcomes compared to patients receiving a placebo, three and six months after injury, respectively. Published sources indicate that the FDA has granted PEG-SOD \"fast track\" status in the FDA's new drug approval process. The Company and Research Corporation Technologies Inc. (\"RCT\") signed agreements seeking to extend the PEG patent for this product. See \"Research Corporation License Agreements\".\nThe Company is also developing a PEG version of a Schering Corporation (\"Schering\") product, INTRON A (interferon alfa 2b). During the fiscal year ended June 30, 1995, the Company amended its agreement with Schering and agreed to transfer proprietary know-how and manufacturing rights to Schering for $3,000,000, of which $2,000,000 was received during the fiscal year ended June 30, 1995. The Company also sold to Schering, 847,000 shares of unregistered, newly issued Common Stock for gross proceeds of $2,000,000. The Company is also entitled to additional payments of approximately $5,550,000, subject to the achievement of certain milestones in the product's development, and royalties on worldwide sales of PEG INTRON A, if any. The Company has the option, upon FDA approval, to be Schering's exclusive manufacturer of PEG INTRON A for the U.S. market.\nThe Company has an extensive licensing program for its SCA technology. SCA proteins are genetically engineered proteins designed to overcome the problems hampering the diagnostic and therapeutic use of conventional monoclonal antibodies. Pre-clinical studies have shown that SCA proteins target and penetrate tumors more readily than conventional monoclonal antibodies. Currently, there are five SCA proteins in Phase I clinical trials by various organizations, including a product developed by the Company, SCA- CC49. The Company believes these organizations will have to obtain a license from the Company under its SCA patents to commercialize these products. See \"Patents\". The Company believes that SCA proteins may be useful in the development of therapeutics in the area of oncology.\nThe Company has granted SCA licenses to six companies, including Bristol- Myers Squibb, Inc. (\"Bristol-Myers\"), Baxter Healthcare Corporation (\"Baxter\") and Eli Lilly & Co. (\"Eli Lilly\"). These licenses generally provide for upfront payments, milestone payments and royalties on sales of FDA approved products.\nPRODUCTS ON THE MARKET\nThe Company currently has two products on the market, ONCASPAR and ADAGEN. The Company received marketing approval from the FDA for ONCASPAR in February 1994 and for ADAGEN in March 1990.\nONCASPAR\nONCASPAR, the enzyme L-asparaginase modified by the PEG Process, is used in conjunction with other chemotherapeutics to treat patients with ALL who are hypersensitive (allergic) to native (unmodified) forms of L-asparaginase.\nL-asparaginase is an enzyme which depletes the amino acid asparagine, a non-essential amino acid upon which certain leukemic cells are dependent for survival. Accordingly, the depletion of plasma asparagine levels selectively starves these leukemic cells. L-asparaginase is a component of standard pediatric ALL remission induction therapies. Unmodified L-asparaginase is currently marketed as Elspar. Erwinase, another form of unmodified L-asparaginase, is also available in the United States on a compassionate use basis, but is not FDA approved.\nThe therapeutic value of unmodified L-asparaginase is limited by two inherent features of the enzyme. First, its short half-life in blood (less than 1.5 days) requires every-other-day injections, causing significant discomfort and inconvenience to patients. Secondly, the enzyme's non-human source makes it inherently immunogenic, resulting in a high incidence of allergic reactions, some of which may be severe, necessitating the discontinuance of the L-asparaginase therapy.\nThrough PEG Modification, Enzon believes ONCASPAR offers significant therapeutic advantages over unmodified L-asparaginase. Namely, ONCASPAR has a significantly increased half-life in blood (greater than five days), allowing every-other-week administration, making its use more tolerable to patients than unmodified L-asparaginase. PEG Modification also disguises the enzyme's foreign nature, generally reducing its immunogenicity, and accordingly, the incidence of allergic reactions.\nONCASPAR was launched in the United States by RPR during March 1994. The Company has granted RPR an exclusive license (\"the RPR License Agreement\") in the United States to sell ONCASPAR, and any other PEG-asparaginase product (the \"Product\") developed by Enzon or RPR during the term of the License Agreement. Under this agreement, Enzon is entitled to licensing payments totaling $6,000,000, of which $500,000 and $5,500,000 were paid during the fiscal years ended June 30, 1995 and 1994, respectively. During January 1995, the Company amended the RPR License Agreement. Under the amended RPR License Agreement, Enzon will earn a base royalty of 10% for the year ending December 31, 1995 and 23.5% thereafter, until 2008, on net sales of ONCASPAR up to agreed upon amounts, as opposed to 50% of net profits under the original agreement. Additionally, Enzon will earn a super royalty of 23.5% for the year ending December 31, 1995 and 43.5% thereafter, until 2008, on net sales of ONCASPAR which exceed the agreed upon amounts, with the limitation that the total royalties earned for any such year shall not exceed 33% of net sales. The revision eliminates RPR's requirement to make certain minimum advertising, promotional and clinical expenditures. Future decisions regarding clinical development will be at RPR's discretion. The amended RPR License Agreement also provides for a payment of $3,500,000 in advance royalties, which was received in January 1995.\nThe payment of base royalties to Enzon under the amended RPR License Agreement will be offset by a credit of $5,970,000, which represents the royalty advance plus reimbursement of certain amounts due to RPR under the original RPR License Agreement and interest expense. Super royalties will be paid to the Company when earned. The royalty advance is shown as a long term liability, with the corresponding current portion included in accrued expenses on the Consolidated Balance Sheet as of June 30, 1995. The royalty advance will be reduced as base royalties are recognized under the agreement.\nThe amended RPR License Agreement prohibits RPR from selling a competing PEG-asparaginase product anywhere in the world during the term of such agreement and for five years thereafter. The amended RPR License Agreement terminates in December 2008, subject to early termination by either party due to a default by the other or by RPR at any time on one year's prior notice to Enzon. Upon any termination all rights under the amended RPR License Agreement revert to Enzon.\nThe Company has also granted exclusive licenses to sell ONCASPAR in Canada and Mexico to RPR. These agreements provide for RPR to obtain marketing approval of ONCASPAR in Canada and Mexico and for the Company to receive royalties on sales of ONCASPAR in these countries, if any. The Company is currently pursuing other licenses for marketing and distribution rights for ONCASPAR outside North America. A separate supply agreement with RPR requires RPR to purchase from Enzon all of RPR's requirements for the Product for sales in North America.\nIn November 1994, the Company received approval in Germany for therapeutic use of ONCASPAR in patients with ALL who are hypersensitive to natural forms of L-asparaginase. The Company is currently not selling ONCASPAR in Germany. The Company is pursuing marketing and distribution agreements in countries outside of North America, including Germany.\nADAGEN\nADAGEN, the Company's first FDA approved product, is currently being used to treat 43 patients in six countries. ADAGEN represents the first successful application of enzyme replacement therapy for an inherited disease. ADAGEN's Orphan Drug designation under the Orphan Drug Act provides the Company with marketing exclusivity in the United States through March 1997.\nADAGEN, the enzyme adenosine deaminase (\"ADA\") modified through the PEG Process, was developed by the Company for the treatment of ADA deficiency associated with SCID. Commonly known as the \"bubble boy\" disease, SCID is a congenital disease that results in children being born without fully functioning immune systems, leaving them susceptible to a wide range of infectious diseases. Injections of unmodified ADA would not be effective because of its short circulating blood life (less than thirty minutes) and the potential for immunogenic reactions to a bovine-sourced enzyme. The attachment of PEG to ADA allows ADA to achieve its full therapeutic effect by increasing its circulating life and masking the ADA to avoid immunogenic reactions.\nADAGEN is being marketed on a worldwide basis and sold in the United States by the Company. Distribution of ADAGEN in Europe is being handled by a European firm. Enzon believes many newborns with ADA-deficient SCID go undiagnosed, and is therefore focusing its marketing efforts for ADAGEN on new patient identification. Its marketing efforts include targeted advertising, educational presentations and publications designed to encourage early diagnosis and subsequent ADAGEN treatment.\nSales of ADAGEN for the fiscal years ended June 30, 1995, 1994 and 1993 were $8,305,000, $7,601,000, and $5,788,000, respectively. Sales of ADAGEN are expected to continue to be limited due to the small patient population worldwide.\nRESEARCH AND DEVELOPMENT\nThe Company's primary source of new products is its internal research and development activities. Research and development expenses for the fiscal years ended June 30, 1995, 1994 and 1993 were approximately $12,084,000, $17,665,000, and $17,710,000, respectively. During fiscal 1995, research and development expenses were divided as follows: 17% for research; 42% for clinical and regulatory affairs; and 41% for pre-clinical activities.\nThe Company's research and development activities during fiscal 1995 concentrated primarily on the continued development of two products, PEG-hemoglobin and PEG-glucocerebrosidase. These activities related principally to Phase I clinical testing, scale up and process development and pre-clinical testing. Research and development activities also included early stage development of several oncology products and enhancements to the Company's proprietary technologies.\nTECHNOLOGIES AND CAPABILITIES\nPEG-MODIFICATION\nEnzon's proprietary technology, PEG Modification or the PEG Process, involves chemically attaching PEG to proteins and certain other pharmaceuticals. PEG is a relatively non-reactive and non-toxic polymer typically used in many food and drug products. Attachment of PEG disguises the proteins, and reduces their recognition by the immune system, thereby generally lowering potential immunogenicity and extending their circulating life, in some cases from minutes to days. Enzon believes that proteins modified by the PEG Process may offer significant advantages over their unmodified forms. These advantages include: (i) extended circulating life, (ii) reduced incidence of allergic reactions, (iii) reduced dosages with corresponding lower toxicity without diminished efficacy, (iv) increased drug stability, and (v) enhanced drug solubility. Modification of proteins with the PEG Process often causes these proteins to have characteristics which significantly improve their therapeutic performance, and in some cases enables proteins to be therapeutically effective which, in their unmodified forms, have proven to be unacceptably toxic or non-efficacious.\nThe Company and its senior scientists have developed proprietary know-how which significantly improves the PEG Process over that described in the original patent covering this technology. This proprietary know-how enables the Company to tailor the PEG Process in order to produce the targeted results for the particular substance being modified. This know-how includes, among other things, proprietary linkers for the attachment of PEG to the protein, the selection of the appropriate attachment sites on the surface of the protein, and the amount and type of PEG used. The Company has filed patent applications and has received patents for numerous improvements to the PEG Process. See \"Patents\".\nSINGLE-CHAIN ANTIGEN-BINDING (SCA) PROTEINS\nEnzon's proprietary SCA proteins are genetically engineered proteins designed to overcome the problems associated with the therapeutic uses of monoclonal antibodies. SCA proteins have the binding specificity and affinity of monoclonal antibodies, but Enzon believes that SCA proteins offer at least five significant advantages over conventional monoclonal antibodies: (i) greater tumor penetration for cancer imaging and therapy, (ii) more specific localization to target sites in the body, (iii) a significant decrease in the immunogenic problems associated with monoclonals due to the SCA protein's small size and rapid clearance from the body, (iv) easier and more cost effective scale-up for manufacturing, and (v) enhanced screening capabilities which allow for the testing of SCA proteins for desired specificities using simple screening methods.\nEnzon's research and development capabilities for engineering SCA proteins include: (i) using computer modeling to design linker peptides to connect the two protein chains, and (ii) linking the two protein chains that make up the antigen-binding region of a natural antibody with such designed peptides, producing a single-chain protein that preserves the structural and functional integrity of the binding region. The resulting protein chain is approximately one-sixth the size of a natural antibody. The SCA protein has a binding specificity and affinity nearly identical to that of a single binding region of the monoclonal antibody from which the SCA protein was derived.\nThe binding specificity of SCA proteins has been demonstrated through the preparation and in vitro testing of more than a dozen different SCA proteins by Enzon. In addition, the Company, in collaboration with Dr. Jeffrey Schlom of the Laboratory of Tumor Immunology and Biology at the National Cancer Institute (\"NCI\"), has shown in published pre-clinical studies that SCA proteins localize to specific tumors and rapidly penetrate the tumors.\nThe Company intends to commercialize its SCA protein technology by licensing the technology to other companies. To date, the Company has granted SCA licenses to six companies, including Bristol-Myers, Baxter and Eli Lilly. These licenses generally provide for upfront payments, milestone payments and royalties on sales of FDA approved products. See \"Strategic Alliances and License Agreements\".\nCurrently, there are five SCA proteins in Phase I clinical trials by various organizations, including a product developed by the Company, SCA-CC49. The Company believes these organizations will have to obtain a license from the Company to commercialize these products.\nPRODUCTS UNDER DEVELOPMENT\nEnzon's development of its proprietary products is focused in three major areas: (i) blood substitutes, (ii) genetic diseases, and (iii) oncology.\nBLOOD SUBSTITUTES\nHEMOGLOBIN BASED OXYGEN CARRIER\nThe main function of human blood is to transport and deliver oxygen throughout the body. Between 12 and 14 million units of donated human blood are transfused to patients suffering from acute blood loss each year in the United States. Without this source, many surgical and trauma patients would be at high risk for mortality. Also, the use of donated blood, while effective in supplying oxygen to patients suffering from acute blood loss, has several limitations: (i) donated blood spoils in an hour or two if not refrigerated, (ii) transfused blood can only be used in patients having a compatible blood type, and (iii) donor blood can cause mortal risk of its own due to contamination by blood borne diseases which are difficult to detect and for which there may be a delay between exposure and detectability. Such viruses include hepatitis and Human Immunodeficiency Virus (\"HIV\") which causes AIDS. Delays in treatment of patients resulting from the need to type donated blood before transfusion, limited supply of certain types of blood and the relatively short shelf life of donor blood, limits the availability of donated blood for treatment of patients with acute blood loss.\nCurrently, there is no commercially available blood substitute that addresses these problems. Products that could be used as adjuncts or alternatives to the transfusion of red blood cells obtained from human donors have been under development for many years. One developmental approach has utilized hemoglobin derived from red blood cells. Hemoglobin is the oxygen- carrying component of the red blood cell.\nEnzon has undertaken the development of PEG-hemoglobin, a hemoglobin based oxygen carrier, which the Company believes can be developed with product specifications consistent with FDA guidelines and which can be commercialized on a cost effective basis. The Company's goals for its blood substitute program include the development of a product which (i) sufficiently binds and delivers oxygen in required quantities during, or after, blood loss, (ii) achieves FDA standards of purity and homogeneity, (iii) is safe, and (iv) is cost effective and convenient to use.\nHemoglobin by itself is very toxic and has a short circulation life. Many of the undesirable effects historically associated with hemoglobin based blood substitutes, such as vasoconstriction, kidney dysfunction, liver dysfunction and gastrointestinal distress are a result of these properties. The Company believes that hemoglobin, modified through its PEG Process, will overcome the well-documented problems of toxicity and short circulating blood life associated with other forms of blood substitutes that have been developed. Enzon has chosen to develop PEG-hemoglobin utilizing bovine hemoglobin, based upon its superior oxygen-carrying properties, relative stability, availability and low cost.\nIn addition to PEG-hemoglobin's potential usefulness as an oxygen carrier in such indications as trauma and elective surgery, recent pre-clinical studies suggest that PEG-hemoglobin may act as a radiosensitizer in cancer therapy. In 1994, the FDA published a paper entitled \"Points to Consider in the Development of a Hemoglobin-Based Oxygen Carrier\" that discusses the problems associated with determining clinical endpoints that will demonstrate efficacy of a hemoglobin-based oxygen carrier. The paper recommends the following indications that will simplify such endpoints: regional perfusion (radiosensitization), acute hemorrhagic shock and perioperative applications. The endpoint used for radiosensitization (regional perfusion) will be the same as the endpoints established for cytotoxic agents, a reduction in tumor size. Approximately 800,000 patients in the U.S. each year are diagnosed with solid hypoxic tumors, such as head and neck, lung, mammary, colon, prostate, bladder, fibrous histiocytoma, brain metastases and glioma. Pre-clinical testing suggests that multiple doses of PEG-hemoglobin have delivered oxygen to solid hypoxic tumors, thereby enhancing the effects of radiotherapy (radiation) which significantly decreased the size of the tumor.\nThe Company is currently conducting a Phase I clinical trial in healthy volunteers and has administered PEG-hemoglobin to 28 subjects up to a dose of approximately 45 grams or the equivalent of approximately 1.5 units of whole blood. The Company is compiling the results of this trial. The Company plans to conduct future clinical trials in patients receiving radiation treatment for solid hypoxic tumors and as a blood substitute (resuscitation fluid) in trauma patients. The Company is currently discussing the protocols for these trials with the FDA. The Company anticipates that patients receiving radiation treatment will receive multiple doses of PEG-hemoglobin of less than 1.5 units per dose over the course of treatment.\nSuccessful commercialization of an artificial blood substitute will require an adequate supply of raw material. The Company's main competitors in the development of a hemoglobin based oxygen carrier utilize either outdated human blood or recombinant hemoglobin produced through fermentation. Each source of hemoglobin has various problems associated with it. The use of outdated human donor blood relies on a hemoglobin source which is at risk, both in terms of safety and supply availability. In the case of non-human or mutant (genetically engineered) hemoglobin, there is a risk of eliciting an immunogenic or allergic response to what the body considers to be a foreign protein. The Company believes that the use of genetic engineering techniques to produce a safe hemoglobin in commercial quantities will require the development of manufacturing capabilities which to date have generally not been demonstrated. The Company's product utilizes bovine (cow) hemoglobin, which can be obtained at relatively low cost. The Company currently obtains its raw hemoglobin from a small herd of cattle which is isolated from other animals and receives constant veterinary care and testing, which should insure that the herd remains disease free. In addition to keeping the herd virus free, the Company's manufacturing process provides or will provide virus removal, inactivation and filtration steps. Enzon believes it can supply the potential market demand for PEG-hemoglobin through a relatively small number of animals.\nIn addition to the benefit of eliminating the possibility of disease transmissions, the Company believes that PEG-hemoglobin overcomes the limitation of donor blood with regard to compatibility. The benefits of universal compatibility include the ability to use PEG-hemoglobin before a patient blood type is determined, which eliminates problems associated with mistakes in blood typing, which could result in mortality. PEG-hemoglobin also has advantages over donated blood in shelf life. PEG-hemoglobin's unrefrigerated shelf life (25c) is approximately seven days, as compared to hours for whole blood. PEG-hemoglobin also has a frozen shelf life (-20c) in excess of 18 months and is ready to use immediately after thawing.\nThe Company uses a proprietary process for the separation of and purification of the bovine hemoglobin and the attachment of PEG to the hemoglobin molecule. Enzon presently produces PEG-hemoglobin in a pilot plant at its facilities in South Plainfield, New Jersey. This plant is expected to supply the quantities of PEG-hemoglobin needed for all ongoing research and development through Phase II clinical trials.\nThe Company estimates that development of a PEG-hemoglobin product will take several years and require substantial additional funds. There can be no assurance that a PEG-hemoglobin product can be successfully developed and brought to market. Due to the significant costs associated with the development and marketing of a blood substitute product, the Company is currently exploring potential collaborative arrangements with one or more established pharmaceutical companies. To date, no such agreements have been concluded and there can be no assurance that any such agreements will be consummated. Furthermore, there can be no assurance of market acceptability of a hemoglobin-based oxygen carrier produced from bovine hemoglobin.\nGENETIC DISEASES\nThere are diseases which are due solely to genetic defects or inborn errors of metabolism resulting in certain enzyme deficiencies, such as SCID, Gaucher disease and Fabry's disease. The Company believes that the PEG Process can be used to successfully replace essential enzymes which patients are lacking as a result of such genetic disorders. The PEG Process has made enzyme replacement therapy a viable option for the treatment of genetic diseases.\nPEG-GLUCOCEREBROSIDASE\nThe Company is developing a treatment for Gaucher disease by applying the PEG Process to a recombinant form of glucocerebrosidase licensed on an exclusive basis from the National Institutes of Health (\"NIH\"). Gaucher disease is a genetic disorder that results in the lack of beta- glucocerebrosidase, an enzyme instrumental in the breakdown and disposal of complex fatty substances in the bloodstream. These substances then accumulate in the spleen, liver and bone marrow, resulting in anemia, weakened bones, enlargement of the spleen and liver and sometimes early death. An estimated 15,000 people suffer from Gaucher disease in the United States, of whom 2,000 to 3,000 require medical attention. Genetically-engineered glucocerebrosidase is designed to replace the missing enzyme. Enzon and scientists at the National Institute of Mental Health, a division of the NIH, have been working on a PEG-modified version of glucocerebrosidase under a November 1991 Cooperative Research and Development Agreement (\"CRADA\"). During September 1994, the Company began a Phase I clinical trial in Gaucher patients. Currently, two patients are enrolled in this trial and additional patients are anticipated to be added when clinical trial material becomes available.\nONCOLOGY\nThe Company has several products under development in the area of oncology, all of which are in the early research stage. These products include PEG modified anti-cancer compounds and a novel chemical compound.\nSTRATEGIC ALLIANCES AND LICENSE AGREEMENTS\nEnzon develops and manufactures, under joint arrangements with other pharmaceutical and biopharmaceutical companies, protein-based products utilizing its proprietary PEG and SCA technologies. Enzon believes that its technologies can be used to improve products which are already on the market or that are under development, thus producing therapeutic products which will provide a safer, more effective and more convenient therapy.\nEnzon's agreements with its strategic alliance partners provide, in most cases, for Enzon's partners to pay the costs of development, clinical testing, obtaining regulatory approval and commercialization of the products. The alliance partner receives marketing rights, and in some cases manufacturing rights, to the products developed. Enzon receives milestone payments, manufacturing revenues and\/or royalty payments based on product sales. The following is a list of certain of the Company's strategic alliance partners:\nSANOFI AGREEMENT\nIn June 1989, Enzon granted to Sanofi (the \"Sanofi Agreement\") the exclusive worldwide marketing rights, foreign regulatory approval responsibility and foreign manufacturing rights for PEG-SOD, which is the enzyme SOD modified by the PEG Process. SOD destroys oxygen free radicals that may damage tissue during reperfusion associated with myocardial infarction, organ transplant and trauma. Generally, Enzon will be entitled to 40% of the net profits from sales of PEG-SOD in the United States during the life of the basic U.S. PEG patent covering the product, with agreed-upon limits on the amount of expenses that can be deducted by Sanofi from revenues before calculating the profit split. Sanofi is presently developing PEG-SOD, which it has trademarked as DISMUTEC, for closed head trauma. Sanofi has advised the Company that it is currently conducting an expanded Phase III clinical trial on PEG-SOD, which is expected to be completed during the fourth quarter of 1995. A smaller, double blind, Phase III study with approximately 460 patients has been completed. This study showed that patients receiving DISMUTEC showed 18% and 16% relative improvement in favorable neurological outcomes compared to patients receiving a placebo three and six months after injury, respectively. Published sources indicate that the FDA has granted PEG-SOD \"fast track\" status in the FDA's new drug approval process.\nUnder the Sanofi Agreement, Enzon is entitled to manufacture PEG-SOD for United States sales by Sanofi; however, Sanofi has the right to take over such manufacturing or have such manufacturing performed on its behalf in consideration for the payment, under certain circumstances, of an additional royalty. Sanofi is manufacturing the PEG-SOD utilized in its clinical trials and the Company expects that Sanofi will manufacture the product for U.S. sales if it is approved by the FDA. All development and regulatory approval costs for PEG-SOD, including the cost of unmodified enzymes for the product used in pre-approval testing are to be borne by Sanofi.\nThe Sanofi Agreement terminates on a country by country basis upon the expiration of the last to expire of the patents licensed to the Company under its license agreement with RCT. The United States patent licensed to Enzon under its agreement with RCT expires in December 1996. The Company has entered into an agreement with RCT to seek an extension of this patent for up to five years. The foreign patents covered by this license expired in earlier years, see \"Patents\". Upon such patent expiration or termination of the Sanofi Agreement due to the Company's breach of the agreement or bankruptcy, the license granted to Sanofi automatically converts to a non-exclusive, royalty- free, paid-up license, except that Sanofi may maintain an exclusive license with respect to PEG-SOD by paying the Company a reduced royalty on Sanofi's sales of PEG-SOD. Sanofi has the right to terminate the Sanofi Agreement at any time with respect to any or all of the countries which are covered by the agreement with no further obligation to the Company, in which case all rights terminated by Sanofi in this manner shall revert to the Company.\nFor information regarding certain agreements between Enzon and RCT with respect to the extension of the patent which is the subject of Enzon's license agreement with Sanofi, see \"Patents\".\nSCHERING AGREEMENT\nIn November 1990, Enzon and Schering Corporation (\"Schering\"), a subsidiary of Schering-Plough Corporation, signed an agreement (the \"Schering Agreement\") to apply the PEG Process to Schering's INTRON A (interferon alfa 2b), a genetically-engineered anticancer and antiviral drug. According to published sources, INTRON A, as it is currently formulated, must be administered at least three times a week by injection and can produce side effects such as fever and occasionally depressed blood count. A PEG form of INTRON A would be designed to improve the administration regimen by increasing the product's blood circulating life.\nINTRON A is currently approved in the United States for use in chronic hepatitis B, chronic hepatitis C, AIDS-related Kaposi's sarcoma, venereal warts and hairy cell leukemia. It is approved for use in 65 countries for a total of 16 disease indications. Schering-Plough Corporation reported 1994 INTRON A sales of $426,000,000 worldwide. In August 1992, a Phase I human clinical trial began using PEG-INTRON A for the indication of hepatitis. The protocol for that trial was completed. Schering and Enzon amended the Schering Agreement to develop a PEG-INTRON A formulation having improved performance characteristics. Pursuant to the amended agreement, the Company has prepared and delivered several PEG-INTRON A formulations for Schering's evaluation for additional clinical trials.\nOn June 30, 1995, the Company and Schering further amended the Schering Agreement pursuant to which Enzon agreed to transfer proprietary know-how and manufacturing rights for PEG-INTRON A to Schering for $3,000,000, of which $2,000,000 was paid on June 30, 1995 and $1,000,000 will be paid upon completion of the know-how transfer, as defined in such amended agreements. In connection with the amendment, the Company also sold to Schering approximately 847,000 shares of unregistered, newly issued Common Stock for $2,000,000 in gross proceeds. Under the current Schering Agreement, Enzon retained an option to become Schering's exclusive manufacturer of PEG-INTRON A for the United States market upon FDA approval of such product.\nUnder the Schering Agreement, Enzon is entitled to receive sequential payments, totalling approximately $6,000,000, subject to the achievement of certain milestones in the product's development program, as well as payments for the clinical material it produces. During the year ended June 30, 1992, the Company received the first milestone payment of $450,000 related to the filing of an Investigational New Drug Application. The Company will also receive royalties on worldwide sales of PEG-INTRON A, if any. Schering will be responsible for conducting and funding the clinical studies, obtaining regulatory approval and marketing the product worldwide on an exclusive basis.\nThe Schering Agreement terminates, on a country-by-country basis, upon the expiration of the last to expire of any future patents covering the product which may be issued to Enzon, or 15 years after the product is approved for commercial sale, whichever shall be the later to occur. This agreement is subject to Schering's right of early termination if the product does not meet specifications, or if Enzon fails to obtain or maintain the requisite product liability insurance, or if Schering makes certain payments to Enzon. If Schering terminates the agreement because the product does not meet specifications, Enzon may be required to refund certain of the milestone payments.\nBRISTOL-MYERS AGREEMENT\nIn September 1993, the Company and Bristol-Myers signed a license agreement for Enzon's SCA protein technology granting Bristol-Myers a world- wide, semi-exclusive license for a particular antigen. Bristol-Myers will apply the technology to develop cancer therapies based on antibodies targeting certain cancer cells. Under the agreement, Enzon is entitled to receive certain upfront payments and sequential payments, subject to the achievement of certain milestones in the development program. Bristol-Myers will have the right to manufacture and market products which it develops and Enzon will receive certain royalties on Bristol-Myers sales, if any. In July 1994, Bristol-Myers paid $1,800,000 to Enzon and exercised an option under the contract to acquire a world-wide non-exclusive license for SCA protein technology. The non-exclusive license is for all therapeutic fields.\nBAXTER AGREEMENT\nIn November 1992, Enzon and Baxter signed an agreement granting Baxter a non-exclusive worldwide license to Enzon's SCA protein technology. It is anticipated that Baxter will use the SCA proteins in its cancer research programs focusing on human stem cell isolation and gene therapy.\nUnder the agreement, Enzon is entitled to receive certain upfront payments and sequential payments, subject to the achievement of certain milestones in the development programs. Baxter will have the exclusive worldwide right to manufacture and market any products which it develops and Enzon will receive certain royalties on Baxter's sales, if any.\nELI LILLY (HYBRITECH) AGREEMENT\nIn December 1992, Enzon and Hybritech Incorporated (\"Hybritech\"), a subsidiary of Eli Lilly, signed an agreement granting Hybritech a non-exclusive worldwide license to Enzon's SCA protein technology. Hybritech subsequently assigned this agreement to Eli Lilly. Under the agreement, Enzon is entitled to certain upfront payments totaling $1,200,000, of which $700,000 and $500,000 were received during the fiscal years ended June 30, 1994 and 1993, respectively, and is entitled to receive certain royalties on sales of products that may be developed using Enzon's SCA protein technology.\nMARKETING\nOther than ADAGEN, which the Company markets on a worldwide basis to a small patient population, the Company does not engage in the direct commercial marketing of any of its products and therefore does not have an established sales force. For certain of its products, the Company has provided exclusive marketing rights to its corporate partners in return for royalties to be received on sales. With respect to ONCASPAR, the Company has granted RPR exclusive marketing rights in North America pursuant to the agreements described in \"Products on the Market - ONCASPAR\".\nThe Company expects to retain marketing partners to market ONCASPAR in other foreign markets and is currently pursuing arrangements in this regard. There can be no assurance that the Company will conclude any such arrangements. Regarding the marketing of certain of the Company's other future products, the Company expects to evaluate whether to create a sales force to market certain products in the United States or to continue to enter into license and marketing agreements with others for United States and foreign markets. These agreements generally provide that all or a significant portion of the marketing of these products will be conducted by the Company's licensees or marketing partners. In addition, under certain of these agreements, the Company's licensee or marketing partner may have all or a significant portion of the development and regulatory approval responsibilities.\nRAW MATERIALS AND MANUFACTURING\nIn the manufacture of its products, the Company couples activated forms of PEG to the unmodified proteins. In the case of PEG, the Company does not have a long-term supply agreement, but maintains what it believes to be an adequate inventory which should provide the Company sufficient time to find an alternate supply of PEG, in the event it becomes necessary, without material disruption of its business.\nWith respect to Enzon's manufacturing facilities, prior to the approval of both ADAGEN and ONCASPAR, the Company's manufacturing facility was inspected by the FDA for compliance with its guidelines for current good manufacturing practices.\nAlthough the Company is currently producing many of the unmodified proteins utilized in products it has under development, including purified bovine hemoglobin for use in its PEG-hemoglobin product, it may be required to obtain supply contracts with outside suppliers for certain unmodified proteins. The Company does not produce the unmodified adenosine deaminase used in the manufacture of ADAGEN and the unmodified L-asparaginase used in the manufacture of ONCASPAR and has a supply contract with an outside supplier for each of these unmodified proteins. The supply contract for unmodified L- asparaginase contains minimum purchase requirements. Under the Sanofi Agreement, in the event Sanofi decides to have the Company manufacture PEG-SOD, which the Company believes is unlikely, it will be the responsibility of Sanofi to provide the Company with unmodified SOD as needed. Schering is required under the Schering Agreement to provide the Company with unmodified INTRON A if the Company exercises its option to manufacturer PEG-INTRON A for the United States market.\nThe Company currently manufactures the unmodified protein used in PEG- glucocerebrosidase, which is currently in clinical trials. There can be no assurance that the unmodified protein used in the manufacture of PEG- glucocerebrosidase can be produced in the amounts necessary to expand the current clinical trials.\nDelays in obtaining or an inability to obtain any unmodified protein which the Company does not produce, including unmodified adenosine deaminase or L-asparaginase, could have a material adverse effect on the Company. In the event the Company is required to locate an alternate supplier for an unmodified protein utilized in a product which is being sold commercially or which is in clinical development, the Company will likely be required to do additional testing, which could cause delay and additional expense, to demonstrate that the alternate supplier's material is biologically and chemically equivalent to the unmodified protein previously used. Such evaluations could include one or all of the following: chemical, pre-clinical and clinical studies. Requirements for such evaluations would be determined by the stage of the product's development and the reviewing division of the FDA. If such alternate material is not demonstrated to be chemically and biologically equivalent to the previously used unmodified protein, the Company will likely be required to repeat some or all of the pre-clinical and clinical trials with such protein. The marketing of an FDA approved drug could be disrupted while such tests are conducted. Even if the alternate material is shown to be chemically and biologically equivalent to the previously used protein, the FDA may require the Company to conduct additional clinical trials with such alternate material.\nGOVERNMENT REGULATION\nThe manufacturing and marketing of pharmaceutical products in the United States requires the approval of the FDA under the Federal Food, Drug and Cosmetic Act. Similar approvals by comparable agencies are required in most foreign countries. The FDA has established mandatory procedures and safety standards which apply to the clinical testing, manufacture and marketing of pharmaceutical products. Obtaining FDA approval for a new therapeutic may take several years and involve substantial expenditures. Pharmaceutical manufacturing facilities are also regulated by state, local and other authorities.\nAs an initial step in the FDA regulatory approval process, pre-clinical studies are conducted in animal models to assess the drug's efficacy and to identify potential safety problems. The results of these studies are submitted to the FDA as a part of the Investigational New Drug Application (\"IND\"), which is filed to obtain approval to begin human clinical testing. The human clinical testing program may involve up to three phases. Data from human trials are submitted to the FDA in a New Drug Application (\"NDA\") or Product License Application (\"PLA\"). Preparing an NDA or PLA involves considerable data collection, verification and analysis.\nONCASPAR and ADAGEN received FDA marketing approval in February 1994 and March 1990, respectively. None of the Company's other products has received FDA marketing approval. Difficulties or unanticipated costs may be encountered by the Company or its licensees or marketing partners in their respective efforts to secure necessary governmental approvals, which could delay or preclude the Company or its licensees or marketing partners from marketing their products.\nWith respect to patented products, delays imposed by the government approval process may materially reduce the period during which the Company will have the exclusive right to exploit them. See \"Patents\".\nCOMPETITION\nMany established biotechnology and pharmaceutical companies with greater resources than the Company are engaged in activities that are competitive with those of Enzon and may develop products or technologies which compete with those of the Company. Although Enzon believes that the experience of its personnel in biotechnology, the patent under which the Company has a license from Research Corporation, other patents which have been licensed by or issued to the Company and the proprietary know-how developed by the Company provide it with a competitive advantage in its field, there can be no assurance that the Company will be able to maintain any competitive advantage, should it exist, in view of the greater size and resources of many of the Company's competitors. Research Corporation has in the past, and may in the future, license to other parties products under the original patent which are not already licensed or reserved for license to the Company.\nEnzon is aware that other companies are conducting research on chemically modified therapeutic proteins and that certain companies are modifying pharmaceutical products, including proteins, by attaching PEG. While the Company believes that products modified with its PEG Process are superior to these other products, there is no assurance that this will prove to be the case. Other than the Company's products ONCASPAR and ADAGEN, the Company is unaware of any PEG-modified therapeutic proteins which are currently available commercially for therapeutic use. Nevertheless, other drugs or treatment modalities which are currently available or that may be developed in the future, and which treat the same diseases as those which the Company's products are designed to treat, may be competitive with the Company's products.\nPrior to the development of ADAGEN, the Company's first FDA approved product, the only treatment available to patients afflicted with SCID was bone marrow transplants. Completing a successful transplant depends upon finding a matched donor, the probability of which is low. More recently, researchers at the NIH have been attempting to treat SCID patients with gene therapy, which if successfully developed, would compete with, and could eventually replace ADAGEN as a treatment. The theory behind gene therapy is that cultured T-lymphocytes injected back into the patient will express permanently and at normal levels, adenosine deaminase, the deficient enzyme in people afflicted with SCID. To date, gene therapy clinical trials have not been conclusive. Those patients currently being treated with gene therapy have continued to be treated with ADAGEN.\nCurrent standard treatment of patients with ALL includes administering unmodified L-asparaginase along with the drugs vincristine, prednisone and daunomycin. Recent studies have shown that long-term treatment with L-asparaginase increases the disease free survival in high risk patients. ONCASPAR, the Company's PEG-modified L-asparaginase product, is used to treat patients with ALL who are hypersensitive (allergic) to unmodified forms of L-asparaginase. The long-term survival and cure of ALL patients depends upon achieving a sustainable first remission. Currently, there are two unmodified forms of L-asparaginase available in the United States -- Elspar and Erwinase. The Company believes that ONCASPAR has the following two advantages over these unmodified forms of L-asparaginase: increased circulating blood life and generally reduced immunogenicity.\nSeveral companies are actively pursuing the development of a blood substitute and certain of these products are currently also being tested in clinical trials. Companies developing a hemoglobin-based product have researched the use of human, bovine, genetically engineered and transgenic hemoglobin. Each source of hemoglobin has various problems associated with it. The use of outdated human donor blood relies on a hemoglobin source which is at risk, both in terms of safety and supply availability. In the case of non-human or mutant (genetically engineered) hemoglobin, there is a risk of eliciting an immunogenic or allergic response to what the body considers to be a foreign protein. The Company believes that the use of genetic engineering techniques to produce a safe hemoglobin in commercial quantities will require the development of manufacturing capabilities which to date have generally not been demonstrated. Enzon believes its PEG-hemoglobin product will address the problems of immunogenicity and transfer of human disease, and further enable the Company to manufacture large quantities of the product. The Company is also aware of competitors who have conducted clinical trials on bovine-based hemoglobin-based oxygen carriers. There can be no assurance that such competing products will not be approved for sale by the FDA before the Company's product.\nCertain of the Company's competitors are attempting to develop oxygen carriers using perfluorocarbons (\"PFC\"). The FDA has allowed PFC trials only for very limited applications where benefits may be realized from localized, short-term use of very small amounts of the substance. PFCs are currently approved by the FDA for limited use in angioplasty patients. Clinical trials of PFC-based oxygen carriers for treatment of anemia were halted prior to completion.\nPEG-glucocerebrosidase is being developed by the Company and is intended to treat Gaucher disease. The FDA has granted Orphan Drug designation for the Company's PEG-glucocerebrosidase. In the event PEG-glucocerebrosidase is developed successfully, it would compete with CEREDASE, an FDA approved product, which is derived from human placental tissue, marketed by Genzyme Corporation (\"Genzyme\"), for the treatment of Gaucher disease. Genzyme received FDA approval for CEREDASE in April 1991. Genzyme also has received FDA marketing approval for a recombinant glucocerebrosidase. PEG-glucocerebrosidase would be designed to reduce the frequency of dosage and improve the method of administration by increasing the product's blood circulating life.\nThere are several technologies which compete with the Company's SCA technology, including chimeric antibodies, humanized antibodies, human monoclonal antibodies, recombinant antibody FAB fragments, low molecular weight peptides and mimetics. These competing technologies can be categorized into two areas: (i) those modifying the monoclonal to minimize immunological reaction to a foreign protein, which is the strategy employed with chimerics, humanized antibodies and human monoclonal antibodies, and (ii) those creating smaller portions of the monoclonal which are more specific to the target and have fewer side effects, as is the case with FAB fragments and low molecular weight peptides. Enzon believes that the smaller size of its SCA proteins should permit better penetration into the tumor, result in rapid clearance from the blood and cause a significant decrease in the immunogenic problems associated with conventional monoclonal antibodies. A number of companies have active programs in SCA proteins. The Company believes that its patent position on SCA proteins will require these other companies to obtain licenses from Enzon, in order to commercialize their products, but there can be no assurance that this will prove to be the case.\nRESEARCH CORPORATION LICENSE AGREEMENTS\nOn December 18, 1979, the United States Patent and Trademark Office issued a patent encompassing the PEG Process (Non-Immunogenic Polypeptides, Patent No. 4,179,337) to one of the Company's co-founders, Frank F. Davis, Ph.D., and two other inventors who are unaffiliated with the Company. Dr. Davis and his co-inventors were all professors at Rutgers University in New Brunswick, New Jersey at the time the patent was issued. The patent was transferred from Rutgers University to RCT, a not-for-profit corporation, pursuant to an agreement between Rutgers University and RCT requiring such transfer in return for RCT's paying the costs associated with obtaining the patent and making certain royalty payments to the inventors. RCT then granted certain licenses under the patent to Enzon, which was formed by Dr. Abraham Abuchowski and Dr. Davis to commercialize the PEG Process.\nUnder the license agreement between the Company and RCT, dated August 25, 1985, and as amended on May 3, 1989, RCT granted the Company an exclusive license, with the right to sublicense, to make, use and sell certain products utilizing the PEG Process as set forth in the original patent held by RCT in countries in which a patent exists or a patent application has been filed by RCT. Under this license agreement, the Company has obtained such a license for seven specific products, has the right to use limited research quantities of non-licensed enzymes, and has the option to include all other enzymes, except allergens and lymphokines, under this license by paying RCT an option fee. The Company has certain diligence obligations to obtain regulatory approval of the licensed products in those countries in which patents covering the PEG Process have been issued, including obtaining FDA approval in the United States, and to sell the licensed products once such approvals are obtained. Enzon entered into another license agreement with RCT in September 1989, under which Enzon was granted an exclusive license under the patent covered by the License Agreement, with the right to sublicense, to make, use, and sell products in eight additional fields. The Company also has the option to license several other products. The Company has exercised this option for PEG- glucocerebrosidase and PEG-alpha-galactosidase. The terms of this license agreement are similar to the terms of the original license agreement, except that the Company has expanded rights to enforce the licensed patents for these products. See \"Patents\".\nThe Company and RCT have signed agreements seeking to extend the PEG patent for PEG-SOD. Under United States patent laws, interim patent extension is available for PEG-SOD, provided a NDA is filed before scheduled expiration of the patent at the end of 1996, and other requirements of the law are met. A final extension is available upon FDA approval of the product. Under the agreements with RCT, Enzon will also pay RCT a royalty on sales of ONCASPAR until 1999.\nRCT has in the past, and may in the future, license products to other parties under the original patent covered by its license agreement with the Company which are not already licensed or reserved to the Company. PATENTS\nThe Company has licensed, and been issued, a number of patents in the United States and other countries and has other patent applications pending to protect its proprietary technology. Although the Company believes that its patents provide adequate protection for the conduct of its business there can be no assurance that such patents will be of substantial protection or commercial benefit to the Company, will afford the Company adequate protection from competing products, will not be challenged or declared invalid, or that additional United States patents or foreign patent equivalents will be issued to the Company. The degree of patent protection to be afforded to biotechnological inventions is uncertain and the Company's products are subject to this uncertainty. The Company is aware of certain issued patents and patent applications, and there may be other patents and applications, containing subject matter which the Company or its licensees or collaborators may require in order to research, develop or commercialize at least some of the Company's products. There can be no assurance that licenses under such subject matter will be available on acceptable terms. One such patent is U.S. Patent No. 5,084,558, which issued on January 28, 1992, and is entitled \"Extra Pure Semi-Synthetic Blood Substitute\". It could be asserted that this patent includes claims which would cover the Company's PEG-hemoglobin product. In the opinion of the Company and the Company's outside patent counsel, Lerner, David, Littenberg, Krumholz and Mentlik, the Company's PEG-hemoglobin product does not infringe any claim of such patent which would be held valid if litigated. However, there can be no assurance that a court would find any of the claims of such patent to be invalid, that a court would not hold that the Company's PEG-hemoglobin product does infringe one or more valid claims of such patent, or that a license could be obtained under such patent on acceptable terms. The Company expects that there may be significant litigation in the industry regarding patents and other proprietary rights and, if Enzon were to become involved in such litigation, it could consume a substantial amount of the Company's resources. In addition, the Company relies heavily on its proprietary technologies for which pending patent applications have been filed and on unpatented know-how developed by the Company. Insofar as the Company relies on trade secrets and unpatented know-how to maintain its competitive technological position, there can be no assurance that others may not independently develop the same or similar technologies. Although the Company has taken steps to protect its trade secrets and unpatented know-how, third-parties nonetheless may gain access to such information.\nRCT holds the original patents upon which the PEG Process is based. The Company's ability to market certain of its PEG products is dependent upon its license agreements with RCT under these patents. Although the Company has licensed certain products covered by the patents held by RCT, there can be no assurance that these patents will enable the Company or RCT to prevent infringement or that competitors will not develop competitive products outside the protection that may be afforded by these patents. RCT's patent in the United States expires in December 1996 and its patents in certain foreign countries have expired or will expire in the remainder of 1995. The Company is aware that others have also filed patent applications and have been granted patents in the United States and other countries with respect to the application of PEG to proteins. The Company is permitted, under certain circumstances, to enforce the patents for certain of the products covered by the license agreements with RCT. Generally, however, under the terms of its license agreements with RCT, the Company cannot commence any action to prosecute any infringement of the patents and must rely upon RCT to do so. If RCT is unwilling or unable to bring such a suit, the Company may be precluded from doing so and its business may be materially adversely affected. Even if the Company were permitted under its agreements with RCT to prosecute a patent infringement action, it may not have the resources to do so.\nIn the field of SCA proteins, the Company has several United States and foreign patents and patent applications, including a patent granted in August 1990 covering the genes needed to encode SCA proteins. Creative BioMolecules, Inc. (\"Creative\") provoked an interference with the patent and on June 28, 1991, the United States Patent and Trademark Office entered summary judgment terminating the interference proceeding and upholding the Company's patent. Creative subsequently lost its appeal of this decision in the United States Court of Appeals. Creative did not file a petition for review of this decision by the United States Supreme Court within the required time period.\nIn November 1993, Enzon and Creative signed collaborative agreements in the field of Enzon's SCA protein technology and Creative's Biosynthetic Antibody Binding Site (BABS) protein technology. Under the agreements, each company is free, under a non-exclusive, worldwide license, to develop and sell products utilizing the technology claimed by both companies' antigen binding engineering patents, without paying royalties to the other. Each is also free to market products in collaboration with third parties, but the third parties will be required to pay royalties on products covered by the patents which will be shared by the companies, except in certain instances. Enzon has the exclusive right to market licenses under both companies' patents other than to Creative's collaborators. In addition, the agreements provide for the release and discharge by each company of the other, from any and all claims based on past infringement of the technology which is the subject of the agreements. The agreement also provides for any future disputes between the companies, regarding new patents in the area of engineered monoclonal antibodies, to be resolved pursuant to agreed upon procedures.\nAlthough the Company believes that its patents provide adequate protection for the conduct of its business as described herein, there can be no assurance that such patents will be of substantial protection from competing products, will not be challenged or declared invalid, or that additional United States patents or foreign patent equivalents will be issued to the Company.\nEMPLOYEES\nAs of June 30, 1995, Enzon employed 123 persons, of whom 61 were engaged in research and development activities, 36 were engaged in manufacturing, and 26 were engaged in administration and management. As of June 30, 1995, the Company had 25 employees who hold Ph.D. degrees. The Company believes that it has been highly successful in attracting skilled and experienced scientific personnel; however, competition for such personnel is intensifying. None of the Company's employees are covered by a collective bargaining agreement. All of the Company's employees are covered by confidentiality agreements. Enzon considers relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns no real property. The following are all of the facilities that Enzon currently leases:\nAPPROX. APPROX. PRINCIPAL SQUARE ANNUAL LEASE LOCATION OPERATIONS FOOTAGE RENT EXPIRATION\n20 Kingsbridge RoadResearch & Development56,000$440,000(1) June 16, 2007 Piscataway, NJ and Administrative\nS. Plainfield, NJDevelopment, Pilot Scale Manufacturing\nS. Plainfield, NJ\n(1) Under the terms of the lease, annual rent increases over the term of the lease from $440,000 to $581,000.\n(2) Net of subrental income of $242,000; the sublease is for approximately 24,312 square feet.\n(3) Net of subrental income of $48,000; the sublease is for approximately 6,000 square feet.\nThe Company believes that its facilities are well maintained and generally adequate for its present and future anticipated needs.\nDuring fiscal 1995, the Company terminated its lease for its 40 Kingsbridge Road facility which was scheduled to expire in 2007, in return for the surrender of the $600,000 security deposit on the building.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere is no material litigation pending 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\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 in the over-the-counter market and is quoted on the NASDAQ National Market System under the trading symbol \"ENZN\".\nThe following table sets forth the high and low sale prices for the Common Stock for the years ended June 30, 1995 and 1994, as reported by the NASDAQ National Market System. The quotations shown represent inter-dealer prices without adjustment for retail mark-ups, mark downs or commissions, and may not necessarily reflect actual transactions.\nHIGH LOW Year Ended June 30, 1995 First Quarter 3 1\/4 2 1\/8 Second Quarter 3 1\/8 1 1\/2 Third Quarter 2 1\/2 1 11\/16 Fourth Quarter 2 7\/8 1 3\/4\nYear Ended June 30, 1994 First Quarter 6 3\/8 4 1\/8 Second Quarter 6 1\/4 4 3\/8 Third Quarter 5 5\/8 4 1\/8 Fourth Quarter 4 3\/8 2\nAs of September 15, 1995 there were 3,235 holders of record of the Common Stock.\nThe Company has paid no dividends on its Common Stock since its inception and does not plan to pay dividends on its Common Stock in the foreseeable future. Except as may be utilized to pay dividends payable on the Company's outstanding Series A Cumulative Convertible Preferred Stock (\"Series A Preferred Shares\" or \"Series A Preferred Stock\"), any earnings which the Company may realize will be retained to finance the growth of the Company. In addition, no dividends may be paid or set apart for payment on the Common Stock unless the Company shall have paid in full, or made appropriate provision for the payment in full of, all dividends which have then accumulated on the Series A Preferred Shares.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSet forth below is the selected financial data for the Company for the five fiscal years ended June 30, 1995.\nCONSOLIDATED STATEMENT OF OPERATIONS DATA:\nYEAR ENDED JUNE 30,\nDividends on\nCONSOLIDATED BALANCE SHEET DATA:\nJUNE 30,\nLong-Term\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nREVENUES. The components of revenues for the last three fiscal years have principally been sales and contract revenues.\nRevenues for the fiscal year ended June 30, 1995 increased by 7% to $15,826,000 as compared to $14,797,000 for fiscal 1994. Sales increased by 35% to $11,024,000 for the year ended June 30, 1995 as compared to $8,182,000 for the prior year, due to the shipment of clinical material to Schering, an increase in patients receiving ADAGEN and increased ONCASPAR revenues from RPR. The Company has no firm orders for additional clinical supplies from Schering. ADAGEN sales for the years ended June 30, 1995 and 1994 were $8,305,000 and $7,601,000, respectively. Contract revenue for the year ended June 30, 1995 decreased by 27% to $4,802,000, as compared to $6,616,000 for fiscal 1994. The decrease was principally due to a one time payment received during fiscal 1994 from RPR related to the FDA approval of ONCASPAR. The decrease was offset in part by a payment of $1,800,000 recorded in fiscal 1995 from Bristol-Myers Squibb related to the exercise of its option under an agreement dated September 1993, to acquire a worldwide non-exclusive license for all therapeutic indications for the Company's SCA protein technology and $2,000,000 received related to the amendment of the Company's agreement with Schering. During the fiscal years ended June 30, 1995 and 1994, the Company had export sales of $2,105,000 and $2,085,000, respectively. Sales in Europe were $1,841,000 and $1,957,000 for the years ended June 30, 1995 and 1994, respectively.\nRevenues for fiscal 1994 increased by 76% to $14,797,000 as compared to $8,414,000 for fiscal 1993. Sales increased by 15% to $8,182,000 for fiscal 1994 as compared to $7,113,000 for the prior year, due primarily to an increase in patients receiving ADAGEN. The increase in sales of ADAGEN was offset in part by a reduction in shipments of clinical supplies to a collaborative partner, and a decrease in sales of the Company's software subsidiary, Symvex Inc., which was shut down during the year. ADAGEN sales for the fiscal years ended June 30, 1994 and 1993 were $7,601,000 and $5,788,000, respectively. During the fiscal years ended June 30, 1994 and 1993, the Company had export sales of $2,085,000 and $1,631,000, respectively. Sales in Europe were $1,957,000 and $1,346,000 for the fiscal years ended June 30, 1994 and 1993, respectively. Contract revenue for fiscal year 1994 increased by $5,405,000 to $6,616,000, primarily due to $5,500,000 in one time licensing fees received related to the FDA's approval of ONCASPAR under the Company's exclusive U.S. marketing rights license with RPR.\nCOST OF SALES. Cost of sales, as a percentage of sales, for fiscal 1995 was 26% as compared to 27% in fiscal 1994. An increase in the charge to cost of goods sold related to idle capacity at the Company's manufacturing facility was offset by a decrease in the write-off of excess raw material (PEG). Prior to the approval of ONCASPAR, the Company's first FDA approved drug for a potentially large patient population, idle capacity was charged to research and development expense. During the fiscal year ended June 30, 1995, the Company utilized approximately 36% of its manufacturing capacity for its approved products, ADAGEN and ONCASPAR, as well as clinical material for its collaborative partner, Schering Corporation.\nCost of sales, as a percentage of sales, increased to 27% in fiscal 1994 as compared to 15% in fiscal 1993. The increase was due to (i) the write-off of excess raw material (PEG), which would expire in the next year, and (ii) a charge in the fourth quarter for idle capacity at the Company's manufacturing facility. In the fourth quarter of fiscal 1994, the Company began classifying idle capacity as cost of sales. Prior to the fourth quarter of 1994, idle capacity was charged to research and development expense.\nRESEARCH AND DEVELOPMENT. Research and development expenses in fiscal 1995 decreased by 32% to $12,084,000 as compared to $17,665,000 in fiscal 1994. The majority of the Company's research and development expenditures related to the continued development and clinical trials for PEG-hemoglobin and PEG- glucocerebrosidase. The decrease was principally due to (i) reductions in personnel, principally in the clinical and scientific administration areas, and related costs such as payroll taxes and benefits, (ii) decreased research facility and occupancy costs, (iii) the charging of idle capacity to cost of sales, rather than research and development, as was the case in the first nine months of fiscal 1994, and (iv) other cost containment measures implemented by the Company. The decreases in research facility and occupancy costs related to a one time credit received from one of the Company's landlords, the sublease of certain facilities and the termination of one of the Company's long-term facility leases and the resulting consolidation of its operations.\nResearch and development expenses in fiscal 1994 remained relatively constant at $17,665,000 compared to $17,710,000 in fiscal 1993. Increased costs in the areas of (i) contracted services related to toxicology studies, (ii) wages and related benefits, and (iii) research facility and occupancy costs were offset by a reduction in the amount of idle manufacturing capacity during the first nine months of fiscal 1994 and other cost containment measures taken by the Company. Idle capacity was charged to research and development prior to the launch of ONCASPAR.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses for fiscal 1995 decreased by 41% to $6,916,000 from $11,710,000 for fiscal 1994. The decrease was due to (i) reductions in personnel and related costs, such as payroll taxes and benefits, (ii) decreased marketing and advertising costs for ONCASPAR as a result of the Company's license agreement with RPR, and (iii) other cost containment measures taken by the Company. Under the Company's exclusive U.S. marketing rights license, RPR is responsible for all marketing and advertising costs related to ONCASPAR.\nSelling, general and administrative expenses for fiscal 1994 decreased by 22% to $11,710,000 from $14,933,000 in fiscal 1993. The decrease was due to (i) reductions in personnel and related costs, such as payroll taxes and benefits, due to staff reductions, (ii) decreased marketing and advertising costs for ONCASPAR as a result of the RPR license agreement, (iii) a reduction in facility costs due to the closing of the Company's Gaithersburg, Maryland facility, and (iv) other cost containment measures taken by the Company. RESTRUCTURING EXPENSE. During the quarter ended March 31, 1995, the Company reduced its workforce by 22 employees. As a result of these reductions, the Company was able to terminate its lease for its administrative headquarters at 40 Kingsbridge Road, Piscataway, New Jersey. These operations were consolidated into the Company's research and development facility. As part of the termination agreement, the landlord was able to draw down on a $600,000 letter of credit that served as a security deposit on both of the buildings the Company occupied on Kingsbridge Road in Piscataway. This termination payment and severance related to the staff reduction as well as the write-off of leasehold improvements, moving expenses and commissions due the Company's real estate broker were recorded as restructuring expense during the year ended June 30, 1995.\nOTHER INCOME\/EXPENSE. Other income\/expense increased to $994,000 for fiscal 1995 as compared to $250,000 for fiscal 1994. The increase was principally due to an insurance settlement received during fiscal 1995 related to ADAGEN that was destroyed in shipment.\nOther income\/expense decreased by 64% in fiscal 1994 as compared to the previous year, primarily due to a reduction in interest-bearing investments as well as a decrease in interest rates.\nLIQUIDITY AND CAPITAL RESOURCES\nEnzon had $8,103,000 in cash and cash equivalents as of June 30, 1995. The Company invests its excess cash in a portfolio of high-grade marketable securities and United States government-backed securities.\nThe Company's cash reserves as of June 30, 1995 increased by $2,372,000 from June 30, 1994. The increase in cash reserves was attributable to the proceeds from the Company's public offering of its Common Stock, the sale\/leaseback of certain research and development equipment, the private sale of Common Stock to Schering, and a royalty advance of $3,500,000 received related to the renegotiation of the Company's exclusive U.S. marketing rights license with RPR. These increases were offset in part by the funding of operations for fiscal 1995.\nDuring January 1995, the Company amended its exclusive U.S. marketing rights license with RPR for ONCASPAR. Under the amended agreement, Enzon will earn a royalty on net sales of ONCASPAR as opposed to 50% of net profits provided for under the original agreement. The amended agreement provides for a payment of $3,500,000 in advance royalties, which was received in January 1995. Royalties due under the amended agreement will be offset against a credit of $5,970,000, which represents the royalty advance plus reimbursement of certain amounts due RPR under the previous agreement and interest expense, before cash payments will be made for base royalties, as defined under the agreement. The royalty advance is shown as a long term liability, with the corresponding current portion included in accrued expenses, on the Consolidated Balance Sheet as of June 30, 1995 and will be reduced as royalties are recognized under the agreement.\nThe Company's agreement with Sanofi requires a credit to Sanofi for monies not expended for the development of PEG-SOD under the Company's March 1987 stock purchase agreement with Eastman Kodak Company (\"Kodak\"), pursuant to which Kodak advanced the Company $9,000,000 to fund all activities to obtain FDA approval for this product and purchased 2,000,000 shares of the Company's Common Stock for $6,000,000. The Company believes that under the agreement, Sanofi may only apply the credit, shown as a current liability in the Consolidated Balance Sheet, against the purchase of clinical supplies and the Company has no other obligation to repay the credit to Sanofi. Sanofi has notified the Company that it does not require future clinical supplies from the Company and, therefore, the Company has no further obligation under the agreement to supply PEG-SOD to Sanofi.\nAs of June 30, 1995, 940,808 shares of Series A Preferred Stock had been converted into 3,093,411 shares of Common Stock. Accrued dividends on the converted Series A Preferred Stock in the aggregate of $1,792,000 were settled by the issuance of 232,383 shares of Common Stock. The Company does not presently intend to pay cash dividends on the Series A Preferred Stock. As of June 30, 1995, there were $1,149,000 of accrued and unpaid dividends on the Series A Preferred Stock. Dividends accrue on the outstanding Series A Preferred Stock at the rate of $218,000 per year.\nTo date, the Company's sources of cash have been the proceeds from the sale of its stock through public and private placements, sales of ADAGEN, sales of ONCASPAR, sales of its products for research purposes, contract research and development fees and technology transfer and license fees. The Company's current sources of liquidity are its cash, cash equivalents and interest earned on such cash reserves, sales of ADAGEN, sales of ONCASPAR, sales of its products for research purposes and license fees. Management believes that its current sources of liquidity will be sufficient to meet anticipated cash requirements through fiscal year end 1996.\nUpon exhaustion of the Company's current cash reserves, the Company's continued operations will depend on, among other things, its ability to realize significant revenues from the commercial sale of its products, raise additional funds through equity or debt financing, or obtain significant licensing, technology transfer or contract research and development fees. There can be no assurance that these sales, financings or revenue generating activities will be successful.\nIn management's opinion, the effect of inflation on the Company's past operations has not been significant.\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\nThe 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) 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).\n* Previously filed as an exhibit to the Company's Registration Statement on Form S-2 (File No. 33-34874) and incorporated herein by reference thereto.\n** Previously filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 and incorporated herein by reference thereto.\n*** Previously filed as an exhibit to the Company's Registration Statement on Form S-18 (File No. 2-88240-NY) and incorporated herein by reference thereto.\n**** Previously filed as exhibits to the Company's Registration Statement on Form S-1 (File No. 2-96279) filed with the Commission and incorporated herein by reference thereto.\n+ Previously filed as an exhibit to the Company's Registration Statement on Form S-1 (File No. 33-39391) filed with the Commission and incorporated herein by reference thereto.\n++ Previously filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1992 and incorporated herein by reference thereto.\n+++ Previously filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1985 and incorporated herein by reference thereto.\n# Previously filed as an exhibit to the Company's Current Report on Form 8- K dated April 5, 1994 and incorporated herein by reference thereto.\n## Previously filed as an exhibit to the Company's Registration Statement on Form S-3 (File No. 33-80790) and incorporated herein by reference thereto.\n### Previously filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1994 and incorporated herein by reference thereto. #### Previously filed as an exhibit to the Company's quarterly report on Form 10-Q for the quarter ended December 31, 1994.\n~ Previously filed as an exhibit to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1995.\n(b) Reports on Form 8-K\nOn July 20, 1995, the Company filed with the Commission a Current Report on Form 8-K dated June 30, 1995, related to the Company and Schering executing an amendment to the license and development agreement between the Company and Schering, and the Company and Schering entering into a stock purchase agreement pursuant to which Schering purchased shares of the Company's Common Stock (Item 5).\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nENZON, INC.\nDated: September 25, 1995 \/S\/ PETER G. TOMBROS By: Peter G. Tombros President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nNAME TITLE DATE\n\/S\/ PETER G. TOMBROS President, Chief September 25, 1995 Peter G. Tombros Executive Officer and Director (Principal Executive Officer)\n\/S\/ KENNETH J. ZUERBLIS Vice President, Finance September 25, 1995 Kenneth J. Zuerblis (Principal Financial and Accounting Officer)\n\/S\/ ABRAHAM ABUCHOWSKI Chairman of the Board September 25, 1995 Abraham Abuchowski\nDirector September 25, 1995 Rosina B. Dixon\n\/S\/ ROBERT LEBUHN Director September 25, 1995 Robert LeBuhn\n\/S\/ A.M. \"DON\" MACKINNON Director September 25, 1995 A.M. \"Don\" MacKinnon\n\/S\/ RANDY H. THURMAN Director September 25, 1995 Randy H. Thurman\nENZON, INC. AND SUBSIDIARIES\nIndex\nPAGE\nIndependent Auditors' Report\nConsolidated Financial Statements: Consolidated Balance Sheets - June 30, 1995 and 1994 Consolidated Statements of Operations - Years ended June 30, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity - Years ended June 30, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - Years ended June 30, 1995, 1994 and 1993 Notes to Consolidated Financial Statements - Years ended June 30, 1995, 1994 and 1993\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Enzon, Inc:\nWe have audited the consolidated financial statements of Enzon, Inc. 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 Enzon, 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.\n\/S\/KPMG PEAT MARWICK LLP KPMG Peat Marwick LLP\nNew York, New York September 21, 1995\nENZON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, 1995 and 1994\nThe accompanying notes are an integral part of these consolidated financial statements.\nENZON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years ended June 30, 1995, 1994 and 1993\nYEARS ENDED JUNE 30,\nThe accompanying notes are an integral part of these consolidated financial statements.\nENZON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended June 30, 1995, 1994 and\nThe accompanying notes are an integral part of these consolidated financial statements. (continued) ENZON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended June 30, 1995, 1994 and\nThe accompanying notes are an integral part of these consolidated financial statements.\nENZON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended June 30, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nENZON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\nYears ended June 30, 1995, 1994 and 1993\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\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.\nINVESTMENTS\nCash equivalents include investments which consist primarily of debt securities and time deposits. The Company invests its excess cash in a portfolio of marketable securities of institutions with strong credit ratings and U.S. Government backed securities.\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (SFAS No. 115) on July 1, 1994. Under SFAS No. 115, the Company classifies its investment securities as held-to-maturity. Held- to-maturity securities are those securities which the Company has the ability and intent to hold to maturity. Held-to-maturity securities are recorded at cost which approximated the fair value of the investments at June 30, 1995.\nINVENTORY COSTING AND IDLE CAPACITY\nInventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and includes the cost of raw materials, labor and overhead.\nCosts associated with idle capacity at the Company's manufacturing facility are charged to cost of sales as incurred. Prior to the fourth quarter of the year ended June 30, 1994 and the approval of ONCASPAR, the Company's first FDA approved drug for a potentially large patient population, costs associated with idle capacity at the Company's manufacturing facility were charged to research and development expenses.\nPATENTS\nPatents related to the acquisition of Enzon Labs Inc., formerly Genex Corporation, were recorded at their fair value at the date of acquisition and are being amortized over the estimated useful lives of the patents. Accumulated amortization as of June 30, 1995 and 1994 was $588,000 and $428,000, respectively.\nCosts related to the filing of patent applications related to the Company's products and technology are expensed as incurred.\nPROPERTY AND EQUIPMENT\nProperty and equipment are carried at cost. Depreciation is computed using the straight-line method. 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 recognized in operations for the period. The cost of repairs and maintenance is charged to operations as incurred; significant renewals and betterments are capitalized.\nREVENUE RECOGNITION\nReimbursement from third party payors for ADAGEN is handled on an individual basis due to the high cost of treatment and limited patient population. Because of the uncertainty of reimbursement and the Company's commitment of supply to the patient regardless of whether or not the Company will be reimbursed, revenues for the sale of ADAGEN are recognized when reimbursement from third party payors becomes likely.\nRevenues from the sale of the Company's other products that are sold are recognized at the time of shipment and provision is made for estimated returns.\nRevenues related to programming services are recorded as sales when services are performed.\nContract revenues are recorded as the earnings process is completed.\nRoyalties under the Company's license agreement with Rhone-Poulenc Rorer Pharmaceuticals, Inc. (\"RPR\") (see note 10), related to the sale of ONCASPAR by RPR, are recognized when earned.\nRESEARCH AND DEVELOPMENT\nResearch and development costs are expensed as incurred.\nCASH FLOW INFORMATION\nThe Company considers all highly liquid securities with original maturities of three months or less to be cash equivalents.\nCash payments for interest were approximately $4,000 in 1995, $5,000 in 1994, and $7,000 in 1993. There were no income tax payments made for the years ended June 30, 1995, 1994, and 1993.\nDuring the year ended June 30, 1995, the Company issued 100,000 shares of unregistered Common Stock in order to acquire an option to purchase the facility it currently leases in Piscataway, New Jersey. During the years ended June 30, 1994 and 1993, 8,000 and 14,000 shares of Series A Cumulative Convertible Preferred Stock were converted to 22,000 and 42,000 shares of Common Stock, respectively. Accrued dividends of $64,000 and $84,000 on the Series A Cumulative Convertible Preferred Stock that was converted were settled by issuing 7,000 and 10,000 shares of Common Stock and cash payments totalling $9 and $3 for fractional shares for the years ended June 30, 1994 and 1993, respectively. There was no conversion of the Series A Cumulative Convertible Preferred Stock during the year ended June 30, 1995. These transactions are non-cash financing activities.\nManagement believes that its sources of liquidity will be sufficient to meet anticipated cash requirements through fiscal year end 1996. Upon exhaustion of these sources of liquidity, the Company's continued operations will depend on, among other things, its ability to realize significant revenues from the commercial sale of products, raise additional funds through equity or debt financing or obtain significant licensing, technology transfer or contract research and development fees. There can be no assurance that the Company will be able to obtain additional funding when it is needed or that such funding, if available, will be obtainable on terms favorable to the Company.\nNET LOSS PER COMMON SHARE\nNet loss per common share is based on net loss for the relevant period, adjusted for cumulative, undeclared preferred stock dividends of $218,000, $230,000 and $254,000 for the years ended June 30, 1995, 1994 and 1993, respectively, divided by the weighted average number of shares issued and outstanding during the period. Stock options, warrants and Common Stock issuable upon conversion of the preferred stock are not reflected as their effect would be antidilutive for both primary and fully diluted earnings per share computations.\nRECLASSIFICATIONS\nCertain prior year balances were reclassified to conform to the 1995 presentation.\n(2) RESTRUCTURING EXPENSE\nDuring the quarter ended March 31, 1995, the Company reduced its workforce by approximately 22 employees. As a result of these reductions, the Company was able to move its general and administrative operations into its existing research and development facility at 20 Kingsbridge Road in Piscataway, New Jersey.\nOn March 31, 1995, the Company terminated its lease for 83,000 square feet at 40 Kingsbridge Road in Piscataway, New Jersey, its former general and administrative facility. As part of the termination agreement, the landlord was able to draw down on a $600,000 letter of credit that served as the security deposit for both buildings that the Company occupied on Kingsbridge Road in Piscataway. The termination payment, severance related to staff reductions, write-off of leasehold improvements, moving expenses and the commission due the Company's real estate broker related to the termination of the 40 Kingsbridge lease were recorded as a restructuring charge during the year ended June 30, 1995. Approximately $227,000 of the restructuring expense represents severance related to the staff reduction and the remaining $966,000 represents expenses incurred in conjunction with the lease termination. As part of the commission due the Company's real estate broker, 150,000 five-year warrants to purchase the Company's Common Stock at $2.50 per share were issued in August 1995. The termination of the Company's 40 Kingsbridge Road facility lease reduces the Company's future minimum lease payments by $650,000, $729,000 and $729,000 for the fiscal years ending June 30, 1996, 1997 and 1998, respectively, and an aggregate of $7,161,000 for the years thereafter. As of June 30, 1995, approximately $758,000 of the restructuring charge was unpaid and recorded in accrued expenses in the Consolidated Balance Sheet. The Company anticipates that the unpaid restructuring charge will be settled prior to December 31, 1995.\n(3) RELATED PARTY TRANSACTIONS\nThe Company has license agreements with Research Corporation and its successor, Research Corporation Technologies, Inc. (\"RCT\"), related to the original PEG-Process patent. The PEG-Process was developed at Rutgers University in New Brunswick, New Jersey by Dr. Frank Davis, one of the Company's original founders, and two other inventors not affiliated with the Company. These agreements granted the Company an exclusive license to make, use and sell specific patented processes and products in countries in which a patent has been granted, or in which an application is pending, for the life of the patent. Under the terms of the agreements, the Company has the obligation to diligently develop, obtain regulatory approval for, and market these products.\nThe Company is obligated under its agreement with RCT to pay a license maintenance fee of $75,000 each year during the term of this agreement, which shall be creditable by the Company against earned royalties payable, if any. As of June 30, 1995 and 1994, the Company had approximately $286,000 and $270,000 related to such agreements recorded as accrued expenses in the Consolidated Balance Sheets.\nDuring August 1992, the Company entered into a license agreement with two employees of the Company and an unrelated party to license a protein related technology. The Company paid $20,000 to each of the parties upon signing of the agreement and agreed to pay royalties of between 3% and 6% of net sales. The agreement also provides for a yearly maintenance fee of $15,000 commencing on January 30, 1993 and terminating on the first to occur of January 30, 1998 or the January 30th immediately preceding the date of the first sale of a licensed product. The agreement also requires aggregate minimum royalties of $25,000 beginning at the earlier of January 30, 1999 or the January 30th immediately following the date of the first sale of a licensed product and between $35,000 and $50,000 for subsequent years. The agreement terminates on the date on which the licensed patent having the latest expiration date expires, after accounting for extensions thereof. In both January 1995 and 1994, the Company paid yearly maintenance fees of $15,000.\n(4) COMMITMENTS AND CONTINGENCIES\nThe Company has a long-term supply agreement for unmodified L- asparaginase, one of the raw materials used in ONCASPAR, under which the Company is required to purchase minimum quantities of this raw material on an annual basis. Under the agreement, which was amended during the fiscal year ended June 30, 1995, the Company is currently required to purchase $3,639,000 in raw material during the term of the contract, which expires on December 31, 1997. During the year ended June 30, 1995, the Company purchased approximately $186,000 related to this contract. The Company is required to purchase an additional $1,514,000 prior to December 31, 1995. The purchase requirements for the years ending December 31, 1996 and 1997 are $850,000 and $1,275,000, respectively. The Company has the option to satisfy $870,000 of the purchase requirement for the year ending December 31, 1995, without taking delivery of the product, by making a payment of $350,000.\nThe Company has agreements with certain members of its upper management which provide for payments following a termination of employment occurring after a change in control of the Company.\n(5) INVENTORIES\nInventories consist of the following:\nJUNE 30,\n1995 1994 Raw materials $398,000 $407,000 Work in process 134,000 289,000 Finished goods 260,000 244,000 $792,000 $940,000\n(6) PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\nDepreciation and amortization charged to operations, relating to property and equipment, were $2,317,000, $2,636,000 and $2,397,000 for the years ended June 30, 1995, 1994 and 1993, respectively.\n(7) STOCKHOLDERS' EQUITY\nSERIES A CUMULATIVE CONVERTIBLE PREFERRED STOCK\nThe Company's Series A Cumulative Convertible Preferred Stock (\"Series A Preferred Shares\") is convertible into Common Stock at an annually increasing rate per share with a maximum conversion rate of $11 per share. As of June 30, 1995 and 1994, the conversion rates were $11 and $10 per share, respectively. The value of the Series A Preferred Shares for conversion purposes is $25 per share. Holders of the Series A Preferred Shares are entitled to an annual dividend of $2 per share, payable semiannually, but only when and if declared by the Board of Directors, out of funds legally available. Dividends on the Series A Preferred Shares are cumulative and accrue and accumulate but will not be paid, except in liquidation or upon conversion, until such time as the Board of Directors deems it appropriate in light of the Company's then current financial condition. No dividends are to be paid or set apart for payment on the Company's Common Stock, nor are any shares of Common Stock to be redeemed, retired or otherwise acquired for valuable consideration unless the Company has paid in full or made appropriate provision for the payment in full of all dividends which have then accumulated on the Series A Preferred Shares. Holders of the Series A Preferred Shares are entitled to one vote per share on matters to be voted upon by the stockholders of the Company. As of June 30, 1995 and 1994 undeclared accrued dividends in arrears were $1,149,000 or $10.54 per share and $931,000 or $8.54 per share, respectively. All common shares are of junior rank to the Series A Preferred Shares with respect to the preferences as to dividends, distributions and payments upon the liquidation, dissolution or winding up of the Company.\nDuring the years ended June 30, 1994 and 1993, 8,000 and 14,000 Series A Preferred Shares were converted to 22,000 and 42,000 shares of Common Stock. There were no conversions of Series A Preferred Shares during the year ended June 30, 1995.\nCOMMON STOCK\nOn January 22, 1993, the Company sold 3,175,000 shares of Common Stock in a public offering at a price of $6.50 per share, resulting in net proceeds to the Company of $18,484,000.\nOn February 8, 1993, the stockholders voted to increase the number of authorized shares of Common Stock from 30,000,000 to 40,000,000.\nOn February 1, 1994, an option to purchase 150,000 shares of the Company's Common Stock became exercisable. This option was granted to the Company's Chairman of the Board in 1989 and became exercisable upon the FDA's approval of ONCASPAR. The approval of ONCASPAR resulted in a non-cash compensation charge representing the difference between the exercise price of the option and the market value of the underlying Common Stock.\nOn May 26, 1994, the Company sold 785,000 shares of Common Stock to Susquehanna Brokerage Services, Inc. (\"Susquehanna\") in a public shelf offering at a weighted average price of $2.55 per share, resulting in net proceeds to the Company of approximately $1,632,000.\nDuring the year ended June 30, 1995, the Company sold to Susquehanna, in a public shelf offering, an additional 954,000 shares of newly issued Common Stock. The shares were sold at a weighted average price of $2.06 per share, resulting in net proceeds to the Company of approximately $1,752,000. On January 5, 1995 the Company terminated its stock purchase agreement with Susquehanna.\nOn April 1, 1995, the Company issued 100,000 shares of newly issued, unregistered Common Stock, valued at $2.25 per share, in consideration for an option to purchase the facility it currently leases in Piscataway, New Jersey.\nOn June 30, 1995, in conjunction with the license of know-how related to PEG-INTRON A, the Company sold 847,000 shares of newly issued, unregistered Common Stock to Schering Corporation, resulting in net proceeds of approximately $1,983,000 (see note 10).\nHolders of shares of Common Stock are entitled to one vote per share on matters to be voted upon by the stockholders of the Company.\nAs of June 30, 1995, the Company has reserved its common shares for special purposes as detailed below:\nSERIES A PREFERRED STOCK WARRANTS\nIn connection with the private placement of the Series A Preferred Shares, the Company issued warrants to purchase 82,000 Series A Preferred Shares. Prior to the year ended June 30, 1995, 22,000 warrants were exercised. During the year ended June 30, 1995, the remaining warrants expired.\nENZON LABS WARRANTS\nIn connection with the acquisition of Enzon Labs Inc., the Company agreed to issue warrants to purchase 583,000 shares of Common Stock. Prior to the year ended June 30, 1995, 100 warrants were exercised. During the year ended June 30, 1995, the remaining warrants expired.\n(8) NON-QUALIFIED STOCK OPTION PLAN\nIn November 1987, the Company's Board of Directors adopted a Non- Qualified Stock Option Plan (the \"Plan\"). On December 7, 1993, the stockholders voted to increase the number of shares reserved for issuance under the Plan from 4,000,000 to 5,000,000. Under the Plan, as amended, 4,477,000 shares of Common Stock as of June 30, 1995 are reserved for issuance pursuant to options which may be granted to employees, non- employee directors or consultants to the Company. The exercise price of the options must be at least 100% of the fair market value of the stock at the time the option is granted and an option may be exercised for a period of up to ten years from the date it is granted. The other terms and conditions of the options generally are to be determined by the Board of Directors, or an option committee appointed by the Board, at their discretion.\nA summary of the activity relating to the Plan follows:\nAt June 30, 1995, 2,257,000 options were exercisable at prices per share ranging from $2.00 to $14.88.\nOn August 24, 1994, the Compensation Committee of the Board of Directors of the Company extended the exercise period of all outstanding five year options to ten years under the Plan. None of the options extended had exercise prices less than the fair market value of the Company's Common Stock on August 24, 1994, and accordingly, no compensation expense was recorded.\n(9) INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109 (SFAS No. 109), \"Accounting for Income Taxes\" as of July 1, 1993. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The effects of adopting SFAS No. 109 were not material to the financial statements at July 1, 1993.\nAt June 30, 1995 and 1994, the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows: 1995 1994 Deferred tax assets: Inventories $57,000 $450,000 Investment valuation reserve 86,000 86,000 Contribution carryover 10,000 9,000 Compensated absences 103,000 138,000 Excess of financial statement over tax depreciation146,000 - Royalty advance - RPR 1,340,000 - Sanofi liability 524,000 524,000 Non-deductible expenses 457,000 424,000 Federal and state net operating loss carryforwards35,816,000 35,054,000 Research and development and investment tax credit carryforwards5,770,000 5,688,000\nTotal gross deferred tax assets 44,309,000 42,373,000\nLess valuation allowance (43,597,000) (41,410,000)\nNet deferred tax assets 712,000 963,000\nDeferred tax liabilities: Excess of tax over financial statement depreciation - (231,000) Step up in basis of assets related to acquisition of Enzon Labs Inc. (712,000) (732,000)\nTotal gross deferred tax liabilities (712,000) (963,000)\nNet deferred tax $0 $0\nA valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance for deferred tax assets as of July 1, 1993 was $34,053,000. The net change in the total valuation allowance for the years ended June 30, 1995 and 1994 were increases of $2,187,000 and $7,357,000, respectively. Subsequently recognized tax benefits for the years ended June 30, 1995 and 1994 of $940,000 and $1,025,000 relating to the valuation allowance for deferred tax assets will be allocated to additional paid-in capital.\nAt June 30, 1995, the Company had federal net operating loss carryforwards of approximately $90,627,000 for tax reporting purposes, which expire in the years 1997 to 2010. The Company also has investment tax credit carryforwards of approximately $30,000 and research and development tax credit carryforwards of approximately $5,740,000 for tax reporting purposes which expire in the years 1998 to 2010.\nAs part of the Company's acquisition of Enzon Labs Inc., the Company acquired the net operating loss carryforwards of Enzon Labs Inc. of $67,949,000 which expire between October 31, 1994 and October 31, 2006. As a result of the change in ownership the utilization of these carryforwards is limited to $613,000 per year.\n(10) SIGNIFICANT AGREEMENTS\nRHONE-POULENC RORER AGREEMENT\nThe Company has granted RPR an exclusive license (\"the License Agreement\") in the United States to sell ONCASPAR, and any other PEG- asparaginase product (the \"Product\") developed by Enzon or RPR during the term of the License Agreement. Under this agreement, Enzon was entitled to licensing payments totaling $6,000,000, of which $500,000 and $5,500,000 were paid during the fiscal years ended June 30, 1995 and 1994, respectively.\nDuring January 1995, the Company amended its exclusive U.S. marketing rights license with RPR for ONCASPAR. Under the amended agreement, Enzon will earn a base royalty of 10% for the year ending December 31, 1995 and 23.5% thereafter, until 2008, on net sales of ONCASPAR up to agreed upon amounts, as opposed to 50% of net profits provided for under the original agreement. Additionally, Enzon will earn a super royalty of 23.5% for the year ending December 31, 1995 and 43.5% thereafter, until 2008 on net sales of ONCASPAR which exceed the agreed upon amounts, with the limitation that the total royalties earned for any such year shall not exceed 33% of net sales. The amendment eliminates RPR's requirement to make certain minimum advertising, promotional and clinical expenditures. Future decisions regarding clinical development will be at RPR's discretion. The amended agreement also provides for a payment of $3,500,000 in advance royalties, which was received in January 1995.\nBase royalties due under the amended agreement will be offset against a credit of $5,970,000 (which represents the royalty advance plus reimbursement of certain amounts due to RPR under the previous agreement and interest expense) before cash payments for base royalties will be made. Super royalties will be paid to the Company when earned. The royalty advance is shown as a long term liability, with the corresponding current portion included in accrued expenses on the Consolidated Balance Sheet as of June 30, 1995. The royalty advance will be reduced as base royalties are recognized under the agreement.\nThe agreement prohibits RPR from selling a competing PEG-asparaginase product anywhere in the world during the term of the License Agreement and for five years thereafter. The revised License Agreement terminates in December 2008, subject to early termination by either party due to a default by the other or by RPR at any time on one year's prior notice to Enzon. Upon any termination all rights under the License Agreement revert to Enzon.\nThe Company has also granted exclusive licenses to sell ONCASPAR in Canada and Mexico to RPR. These agreements provide for RPR to obtain marketing approval of ONCASPAR in Canada and Mexico and for the Company to receive royalties on sales of ONCASPAR in these countries, if any. The Company is currently pursuing other licenses for marketing and distribution rights for ONCASPAR outside North America. A separate supply agreement with RPR requires RPR to purchase from Enzon all of RPR's requirements for the Product for sales in North America.\nSANOFI WINTHROP AGREEMENT\nIn June 1989, the Company, Sanofi Winthrop, Inc. (\"Sanofi\"), formerly Sterling Winthrop, Inc. and Eastman Kodak Company (\"Kodak\") signed a license agreement (the \"Sanofi Agreement\") which supersedes the Company's March 1987 license agreement with Kodak (the \"Kodak License Agreement\"). Sterling Winthrop, Inc., a subsidiary of Kodak, was sold in 1994 to Sanofi Pharmaceuticals. The Company received $5,000,000 and $2,000,000 under the Sanofi Agreement during the years ended June 30, 1989 and 1990, respectively, and transferred to Sanofi all responsibilities for development and regulatory approval in the United States for PEG- superoxide dismutase (\"PEG-SOD\") and certain technological know-how for the product. All future development and regulatory approval costs for PEG-SOD, including the cost of unmodified enzymes for the product used in pre-approval testing, will be borne by Sanofi.\nUnder the agreement, Sanofi has the exclusive worldwide marketing rights, foreign regulatory approval responsibility and foreign manufacturing rights for PEG-SOD. Generally, the Company will be entitled to 40% of the net profits from sales of PEG-SOD in the United States during the life of the basic U.S. patent covering the product, with agreed-upon limits on the amount of expenses that can be deducted by Sanofi from revenues, if any, before calculating the profit split. Under the Sanofi Agreement, Enzon is entitled to manufacture PEG-SOD for United States sales by Sanofi; however, Sanofi has the right to take over such manufacturing or have such manufacturing performed on its behalf in consideration for the payment, under certain circumstances, of an additional royalty. Sanofi is manufacturing the PEG-SOD utilized in its clinical trials and the Company expects that Sanofi will manufacture the product for U.S. sales if it is approved by the FDA.\nThe Sanofi Agreement terminates on a country by country basis upon the expiration of the last to expire of the patents licensed to the Company under its License Agreement with RCT. The United States patent licensed to Enzon under the RCT Agreement expires in December 1996. The Company has entered into an agreement with RCT to extend this patent for up to five years. Upon such patent expiration or termination of the Sanofi Agreement due to the Company's breach of the agreement or bankruptcy, the license granted to Sanofi automatically converts to a non-exclusive, royalty-free, paid-up license, except that Sanofi may maintain an exclusive license with respect to PEG-SOD by paying the Company a reduced royalty on Sanofi's sales of PEG-SOD. Sanofi has the right to terminate the Sanofi Agreement at any time with respect to any or all of the countries which are covered by the agreement with no further obligation to the Company, in which case all rights terminated by Sanofi in this manner shall revert to the Company.\nUnder the original Kodak License Agreement signed in March 1987, the Company issued 2,000,000 shares of its Common Stock to Kodak for a cash payment of $6,000,000. The Company also received $9,000,000 under this agreement to fund all activities to obtain FDA approval of PEG-SOD. The Sanofi Agreement requires a credit to Sanofi (the \"shortfall\") for monies not expended for the development of PEG-SOD under the Kodak Agreement. The shortfall balance as of June 30, 1995 and 1994, was $1,313,000, and is shown as a current liability in the Consolidated Balance Sheets. The shortfall may be applied by Sanofi as a credit against amounts owed the Company by Sanofi for clinical supplies. Sanofi has notified the Company that it does not require future clinical supplies from the Company and, therefore, the Company has no further obligation under the agreement to supply PEG-SOD to Sanofi.\nSCHERING AGREEMENT\nIn November 1990, Enzon and Schering Corporation (\"Schering\") signed an agreement (the \"Schering Agreement\") to apply the PEG Process to Schering's INTRON A (interferon alfa 2b), a genetically-engineered anticancer and antiviral drug. In August 1992, a Phase I human clinical trial began using PEG-INTRON A for the indication of hepatitis. The protocol for that trial has been completed. Schering and Enzon amended the Schering Agreement to develop a PEG-INTRON A formulation having improved performance characteristics. Enzon has prepared and delivered clinical batches of the new PEG-INTRON A formulations to Schering for additional clinical trials.\nOn June 30, 1995, the Company and Schering further amended the Schering Agreement pursuant to which Enzon agreed to transfer proprietary know-how and manufacturing rights for PEG-INTRON A to Schering for $3,000,000, of which $2,000,000 was paid on June 30, 1995 and $1,000,000 will be paid upon completion of the know-how transfer, as defined in such amended agreements. In connection with the amendment, the Company also sold to Schering 847,000 shares of unregistered, newly issued Common Stock for $2,000,000 in gross proceeds. Under the current Schering Agreement, Enzon retained an option to become Schering's exclusive manufacturer of PEG-INTRON A for the United States market upon FDA approval of such product.\nUnder the Schering Agreement, Enzon is entitled to receive sequential payments, totalling approximately $6,000,000, subject to the achievement of certain milestones in the product's development program, as well as payments for the clinical material it produces. During the year ended June 30, 1992, the Company received the first milestone payment of $450,000 related to the filing of an Investigational New Drug Application. The Company will also receive royalties on worldwide sales of PEG-INTRON A, if any. Schering will be responsible for conducting and funding the clinical studies, obtaining regulatory approval and marketing the product worldwide on an exclusive basis.\nThe Schering Agreement terminates, on a country-by-country basis, upon the expiration of the last to expire of any future patents covering the product which may be issued to Enzon, or 15 years after the product is approved for commercial sale, whichever shall be the later to occur. This agreement is subject to Schering's right of early termination if the product does not meet specifications, or if Enzon fails to obtain or maintain the requisite product liability insurance, or if Schering makes certain payments to Enzon. If Schering terminates the agreement because the product does not meet specifications, Enzon may be required to refund certain of the milestone payments.\nBAXTER AGREEMENT\nIn November 1992, Enzon and Baxter Healthcare Corporation (\"Baxter\") signed an agreement granting Baxter a non-exclusive worldwide license to Enzon's SCA protein technology. It is anticipated that Baxter's biotech group will use the SCA proteins in its cancer research programs focusing on human stem cell isolation and gene therapy.\nUnder the agreement, the Company received $350,000 during the year ended June 30, 1993 for the execution of the agreement and is entitled to additional sequential payments, subject to the achievement of certain milestones in the products' development of $500,000 for each product developed up to a maximum of $2,500,000. Baxter will have the exclusive worldwide rights to manufacture and market any products which it develops and Enzon will receive certain royalties on Baxter's sales, if any.\nELI LILLY (HYBRITECH) AGREEMENT\nIn December 1992, Enzon and Hybritech Incorporated (\"Hybritech\"), a subsidiary of Eli Lilly & Co., signed an agreement granting Hybritech a non-exclusive worldwide license to Enzon's SCA protein technology. Under the agreement, Enzon is entitled to certain upfront payments totalling $1,200,000, of which $700,000 and $500,000 were received during the years ended June 30, 1994 and 1993, respectively, and will receive certain royalties on Hybritech sales of products, if any, that may be developed using Enzon's SCA protein technology.\nBRISTOL-MYERS SQUIBB\nIn September 1993, the Company and Bristol-Myers Squibb (\"Bristol-Myers\") signed a license agreement for Enzon's SCA protein technology granting Bristol-Myers a worldwide, semi-exclusive license for a particular antigen. Under the agreement, Enzon is entitled to receive certain upfront payments and sequential payments, subject to the achievement of certain milestones in the development program. Bristol-Myers will have the right to manufacture and market products which it develops and Enzon will receive certain royalties on Bristol-Myers sales, if any. Enzon also granted Bristol-Myers options to take non-exclusive licenses under patent rights for other applications\/fields for certain additional payments. During the year ended June 30, 1994, Enzon received $200,000 under this agreement. In July 1994, Bristol-Myers paid $1,800,000 to Enzon and exercised its option to acquire a worldwide non-exclusive license for SCA protein technology. The non-exclusive license is for all areas of drug development.\n(11) LEASES\nThe Company has several leases for office, warehouse, production and research facilities and equipment.\nFuture minimum lease payments, net of subleases, for noncancellable operating leases (with initial or remaining lease terms in excess of one year) and the present value of future minimum capital lease payments as of June 30, 1995 are:\nYear ending Capital Operating JUNE 30, LEASES LEASES 1996 $2,000 $1,592,000 1997 2,000 1,699,000 1998 2,000 1,710,000 1999 - 1,130,000 2000 - 497,000 Later years, through 2007 - 3,878,000 Total minimum lease payments$6,000 $10,506,000\nRent expense amounted to $1,642,000, $2,181,000 and $2,469,000 for the years ended June 30, 1995, 1994 and 1993, respectively.\nThe Company currently subleases a portion of two of its facilities. For the years ended June 30, 1995 and 1994, rent expense is net of subrental income of $353,000 and $101,000, respectively. There were no subleases in the year ended June 30, 1993.\n(12) CASH SURRENDER VALUE OF LIFE INSURANCE\nAs of June 30, 1995, the Company maintains a split-dollar life insurance for its Chairman of the Board with a face value of $3,000,000. Under the split-dollar agreement, in the event of death, the Company will receive the greater of the cash accumulation value or the premiums paid. The remainder of the death benefit, as defined, paid by the insurance company, will be paid to the named beneficiaries of the insured. The Company also maintains key man life insurance policies with a face value of $1,000,000 on both the President and Chief Executive Officer and the Chairman of the Board.\nIn July 1992, the Company took a loan against the split dollar life insurance policy for $674,000. At June 30, 1995 and 1994, the cash surrender value of $847,000 and $1,155,000, respectively, less the outstanding loan balance and accrued interest of $847,000 and $782,000, respectively, is recorded in other assets in the Consolidated Balance Sheets.\nDuring the year ended June 30, 1995, the Company cancelled a separate single premium key man life insurance policy on its Chairman of the Board and received the cash surrender value of $305,000.\n(13) RETIREMENT PLANS\nThe Company maintains a defined contribution, 401(k), pension plan for substantially all its employees. Effective July 1, 1991, the Company revised the plan to provide for a match of employee contributions to the plan. The Company matches 25% of the employee's contribution up to 6% of compensation, as defined. Effective, January 1, 1995, the Company's match is invested solely in a fund which purchases the Company's Common Stock in the open market. Total Company contributions for the years ended June 30, 1995, 1994 and 1993 were $80,000, $94,000 and $93,000, respectively.\n(14) ACCRUED EXPENSES\nAccrued expenses consist of: JUNE 30, 1995 1994\nAccrued wages and vacation $398,000 $1,260,000 Reserve for product returns 298,000 600,000 Accrued employee medical claims278,000 537,000 Accrued Medicaid rebates 813,000 435,000 Accrued restructuring costs 758,000 - Current portion of royalty advance - RPR 400,000 - Other 1,100,000 1,406,000 $4,045,000 $4,238,000\n(15) FOURTH QUARTER INFORMATION\nDuring the fourth quarter of the year ended June 30, 1994, the Company recorded a charge to operations for excess raw material (PEG) of $618,000.\n(16) SALES INFORMATION\nDuring the years ended June 30, 1995, 1994 and 1993, the Company had export sales of $2,105,000, $2,085,000, and $1,631,000, respectively. Sales to Europe represented $1,841,000, $1,957,000 and $1,346,000 during the years ended June 30, 1995, 1994 and 1993, respectively.\nApproximately 42%, 28% and 15% of the Company's ADAGEN sales for the years ended June 30, 1995, 1994 and 1993, respectively, were made to Medicaid patients.\n(17) OTHER INCOME\nDuring the year ended June 30, 1995, the Company received approximately $645,000 for an insurance settlement related to ADAGEN that was destroyed in shipment.\nEXHIBIT INDEX\nExhibit Page NUMBERS DESCRIPTION NUMBER\n10.17 Amendment to Employment Agreement with Peter G. Tombros dated as of May 15, 1995 E1 21.0 Subsidiaries of Registrant E2 23.0 Consent of KPMG Peat Marwick LLP E3 23.1 Consent of Lerner, David, Littenberg, Krumholz & MentlikE4","section_15":""}
{"filename":"793245_1995.txt","cik":"793245","year":"1995","section_1":"Item 1. Business. America First Tax Exempt Mortgage Fund 2 Limited Partnership (the \"Registrant\" or the \"Partnership\") was formed as a limited partnership on September 30, 1986, 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 and commercial properties. 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.\n\t The Registrant registered a total of 5,350,000 Beneficial Unit Certificates (BUCs) representing assignments of limited partnership interests with the Securities and Exchange Commission and sold a total of 5,245,623 BUCs at $20 per BUC for a total net capital contribution of $97,778,413 after the payment of certain organization and offering costs.\n\t The Registrant acquired nine tax-exempt mortgage loans with an aggregate principal amount equal to $90,765,000. At December 31, 1995, the Registrant continued to hold three of these mortgage loans with a carrying value, net of allowance for loan losses, equal to $31,566,526 and five real estate properties acquired in foreclosure or in lieu thereof with a depreciated cost, net of a valuation allowance, of $25,890,570. The remaining mortgage loan was prepaid by the borrower in 1988.\n\t The tax-exempt mortgage loans that the Registrant acquired were issued by various state and local housing authorities to provide for the construction and\/or permanent financing of eight multifamily housing properties and one commercial property located in eight states. The Registrant subsequently acquired five of the properties through foreclosure or in lieu of foreclosure or through the acquisition of an indirect ownership interest. 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 it owns or which secures its remaining mortgage loans. For this reason, the Registrant's investments are dependent on the economic performance of 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.\n\t A description of the three 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. A description of the real estate acquired by the Registrant appears in Note 6 of the Notes to Financial Statements. For further information regarding these properties, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation.\n\t The Registrant is engaged solely in the business of providing financing for the acquisition and improvement of real estate and the operation of real estate acquired in foreclosure. 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.\n\t The 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..\n\t Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. The Registrant had invested in eight mortgage loans collateralized by first mortgages on multifamily housing properties and one mortgage loan collateralized by a first mortgage on a commercial property. Foreclosure proceedings and other actions were instituted with respect to five of the properties which has resulted in the Registrant owning or indirectly owning five properties at December 31, 1995. One mortgage loan was prepaid by the borrower in 1988. Descriptions of the properties collateralizing mortgage loans held by the Registrant at December 31, 1995, appear in Note 5 to the Notes to Financial Statements filed in response to Item 8 hereof, and a description of real estate acquired in settlement of loans appears in Note 6 to the Notes to Financial Statements filed in response to Item 8 hereof.\n\t Item 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.\n\t Item 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.\n\t PART II\n\t Item 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\n\t (a)\tMarket Information. The BUCs trade on The NASDAQ Stock Market under the trading symbol \"ATAXZ.\" 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\t (b)\tBUC Holders. The approximate number of BUC holders on December 31, 1995, was 3,515.\n\t (c)\tDistributions. 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 $3,934,217. The cash distributions paid per BUC during the fiscal years ended December 31, 1995, and December 31, 1994, were as follows:\n\t See Item 7, Management 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 levels 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 thereto filed in response to Item 8 hereof.\t\t\t\t\t\t\t\t\t\t\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 nine tax-exempt mortgage loans, the proceeds of which were used to provide construction and\/or permanent financing for eight multifamily housing properties and one commercial property. During 1988, one tax-exempt mortgage loan was prepaid in full. At December 31, 1995, the Partnership continued to hold three of these tax-exempt mortgage loans with a carrying value, net of allowance for loan losses, of $31,566,526 and five real estate properties acquired through foreclosure or deed in lieu of foreclosure with a depreciated cost, net of a valuation allowance, of $25,890,570.\nThe following table shows the various occupancy levels of the properties financed or owned by the Partnership at December 31, 1995:\n(1) Property acquired through foreclosure or deed in lieu of foreclosure. (2) Represents square feet.\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. The base interest payments received on the tax-exempt mortgage loans and net rental income earned on properties owned represent the principal sources of the Partnership's income and distributable cash. The Partnership has not received any contingent interest on its mortgage loans during 1995. The Partnership also earns income on temporary cash investments. The Partnership may draw on reserves to pay operating expenses or to supplement cash distributions to Beneficial Unit Certificate (BUC) Holders.\nDuring the year ended December 31, 1995, $280,319 of undistributed income was placed in reserves. The total amount held in reserves at December 31, 1995, was $1,118,898. Future distributions to BUC Holders will depend upon the amount of base and contingent interest and net rental income the Partnership receives, the size of 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:\nAsset Quality\nIt is the policy of the Partnership to make a periodic review of the real estate collateralizing the Partnership's mortgage loans or real estate acquired by the Partnership in order to establish, when necessary, valuation reserves on mortgage loans and real estate. A reserve for the mortgage loans is established for the difference between the recorded investment in the mortgage loan and the fair value of the underlying collateral. The valuation allowance on real estate acquired is established for declines in the estimated fair value of each property subsequent to acquisition. The fair value of the underlying collateral for the loans and the real estate acquired 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 allowances are periodically reviewed and adjustments are made to the allowances when there are significant changes in the estimated net realizable value of the underlying collateral for the loans or the real estate acquired.\nBased on the foregoing methodology, valuation and reviews performed during 1995 indicated that the mortgage loans and real estate recorded on the balance sheet at December 31, 1995, required no adjustments to the carrying amounts.\nAt December 31, 1995, two of the Partnership's three 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.\nJackson Park Place\nJackson Park Place Apartments, located in Fresno, California, had an average occupancy rate of 96% during 1995 compared to 95% during 1994. Interest of $744,600 earned on the mortgage loan in 1995 and 1994 represents the full amount of base interest due for the respective year. No contingent interest was earned in 1995 or 1994. The net cash flow generated by this property, excluding interest, was approximately $14,000 higher in 1995 compared to 1994.\nJefferson Place\nJefferson Place Apartments, located in Olathe, Kansas, had an average occupancy rate of 97% during 1995 and 1994. Interest is recognized as income on this loan on a modified cash basis. Interest earned in 1995 was $873,694 compared to $883,159 in 1994 and was approximately $214,000 less than the amount needed to pay the base interest in 1995. The decrease in interest earned from 1995 compared to 1994 was due to a slight decrease in the net cash flow generated by the property, excluding interest.\nAvalon Ridge\nAvalon Ridge Apartments, located in Renton, Washington, had an average occupancy rate of 84% during 1995 and 1994. Interest is recognized as income on this loan on a cash basis. Interest earned in 1995 was $616,316 compared to $824,441 in 1994 and was approximately $978,000 less than the amount needed to pay the base interest in 1995. An affiliate of the Partnership's general partner began managing this property in September of 1994. Since that time, the property manager has implemented a plan to improve the tenant profile through more stringent resident qualifications. In addition, management has been working to evict some of the current problem tenants which has resulted in a higher than normal turnover of units. The increase in tenant turnover caused an increase of approximately $175,000 in repairs and maintenance expense and property improvements. The majority of the increase was due to expenses incurred to prepare apartment units for new rentals. In order to attract new tenants, the property manager has had to decrease rental rates which resulted in a decrease in rental income of $137,000 from 1994 to 1995. This decrease in rental income and the $175,000 increase in repairs and maintenance expenses were partially offset by a decrease of $53,000 in other operating expenses, primarily property taxes. Thus, net cash flow generated by the property, excluding interest, decreased approximately $259,000 from 1994 to 1995. Management believes that its efforts will improve future operating results of the property.\nCovey at Fox Valley\nCovey at Fox Valley Apartments, located in Aurora, Illinois, had an average occupancy rate of 94% during 1995 compared to 95% during 1994. This property generated net cash flow of $1,142,000 in 1995 compared to $909,000 in 1994. This increase is attributable primarily to property tax refunds of approximately $262,000 that were received in 1995. In addition, the property experienced an increase in revenue resulting from increased rental rates which was partially offset by an overall increase in real estate operating expenses.\nThe Park at Fifty Eight\nThe Park at Fifty Eight Apartments, located in Chattanooga, Tennessee, had an average occupancy rate of 97% during 1995 compared to 96% during 1994. This property generated net cash flow of $215,000 in 1995 compared to $239,000 in 1994. This decrease is attributable primarily to an increase in real estate operating expenses, primarily personnel expenses, repairs and maintenance expenses and property improvements that more than offset increased rental revenues from higher average occupancy.\nShelby Heights\nShelby Heights Apartments, located in Bristol, Tennessee, had an average occupancy rate of 95% during 1995 compared to 97% during 1994. This property generated net cash flow of approximately $323,000 in 1995 and 1994.\nCoral Point\nCoral Point, located in Mesa, Arizona, had an average occupancy rate of 96% during 1995 compared to 97% during 1994. This property generated net cash flow of $971,000 in 1995 compared with $1,026,000 in 1994. This decrease is attributable primarily to an increase in revenues resulting from increased rental rates being more than offset by an increase in real estate operating expenses due to painting the exterior of the property.\nThe Exchange at Palm Bay\nThe Exchange at Palm Bay, located in Palm Bay, Florida, is an office\/warehouse facility. This property continues to experience low occupancy due to the large amount of similar commercial real estate in the surrounding area. However, the property increased its leased space to approximately 56% at December 31, 1995, due to leasing more space in December 1995. This compares with leased space of approximately 40% at December 31, 1994. Despite the low occupancy, the property was able to generate operating cash flow of approximately $105,000 in 1995 compared to $64,000 in 1994. The increase in cash flow is due to an increase in rental income due to increased occupancy and a decrease in repairs and maintenance expenses and property improvements.\nResults of Operations\nThe tables below compare the results of operations for each year shown.\nMortgage investment income decreased $217,590 from 1994 to 1995 as a result of decreases in the cash flow received from Avalon Ridge of $208,125 and Jefferson Place of $9,465. The decrease in the cash flow received from Avalon Ridge was primarily due to increases in repairs and maintenance expenses and property improvements and to a decrease in rental income. Mortgage investment income increased $124,695 from 1993 to 1994. This increase was a result of an increase in the cash flow received from Jefferson Place of $150,423 offset by a decrease in cash flow received from Avalon Ridge of $25,728. See the discussion of each property in the Asset Quality section for additional information.\nRental income increased $166,409 from 1994 to 1995 and $382,961 from 1993 to 1994 due primarily to higher rental rates on properties acquired by the Partnership in foreclosure. Real estate operating expenses decreased $37,240 from 1994 to 1995 due primarily to property tax refunds of approximately $252,000 received by Covey at Fox Valley in 1995. This decrease was partially offset by increases in property improvements, repair and maintenance expenses and salaries expense at Coral Point and slight increases in overall expenses at the other properties. Real estate operating expenses increased $128,815 from 1993 to 1994 due primarily to increases in taxes, insurance and property improvements at various properties. Depreciation increased $13,902 from 1994 to 1995 and $11,344 from 1993 to 1994 as a result of capital improvements made in 1992 through 1995. See the discussion of each property in the Asset Quality section for additional information.\nInterest income on temporary cash investments increased $18,417 from 1994 to 1995 due primarily to additions made to Partnership reserves during 1994 and 1995 and to slightly higher interest rates. Interest income on temporary cash investments decreased $6,204 from 1993 to 1994 due primarily to less cash being invested on a temporary basis because of withdrawals made from Partnership reserves during 1993 to supplement distributions to BUC Holders.\nGeneral and administrative expenses increased $102,313 from 1994 to 1995. This increase is 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 $29,733 from 1993 to 1994 due to overall expense reductions.\nThe table below segregates the results of operations for the Partnership's real estate operations and tax-exempt mortgage lending activities for each year shown.\n\t Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. The Financial Statements and supporting schedules of the Registrant are set forth in Item 14 hereof and are incorporated herein by reference. In addition, the Financial Statements of Jefferson Place, L.P. and Sunpointe Associates Limited Partnership (Avalon Ridge) are set forth in Item 14 hereof and are incorporated by reference. The financial statements of Jefferson Place, L.P. and Sunpointe Associates Limited Partnership are included pursuant to SAB Topic 1I.\n\t Item 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.\n\t PART III\n\t Item 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 Four (\"AFCA\"), and its general partner, America First Companies L.L.C. The following individuals are managers and officers of America First Companies L.L.C., and each serves for a term of one year: \t \t\n\t \t Michael B. Yanney, 62, is the Chairman and President of America First Companies L.L.C. 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 Santa Fe Corporation, Forest Oil Corporation, MFS Communications Company, Inc., Lozier Corporation, Mid-America Apartment Communities, Inc. and PKS Information Services, Inc..\n\t Michael Thesing, 41, has been Vice President and Chief Financial Officer of affiliates of America First Companies L.L.C. 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.\n\t William 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).\n\t George 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.\n\t Martin 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.\n\t Alan Baer, age 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, before its acquisition, was 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.\n\t Gail 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.\n\t Item 11.","section_11":"Item 11. Executive Compensation. Neither the Registrant nor AFCA has any managers 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 AFCA pursuant to the terms of its limited partnership agreement during the period ending December 31, 1995, is described in Note 7 of the Notes to the Financial Statements filed in response to Item 8 hereof.\n\t Item 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\t (b)\tNo manager or officer of America First Companies L.L.C. and no partner of AFCA owns any BUCs.\n\t (c)\tLB I 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 LB I 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.\n\t There 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.\n\t Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions. The general partner of the Fund is AFCA and the sole general partner of AFCA is America First Companies L.L.C.\n\t Except 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.\n\t During 1995, the Registrant paid or reimbursed AFCA or America First Companies L.L.C. $556,015 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 7 to Notes to Financial Statements filed in response to Item 8 hereof for a description of these costs and expenses.\n\t AFCA is entitled to an administrative fee from the Registrant in the event that the Registrant becomes the equity owner of a property by reason of foreclosure. AFCA earned, and the Registrant incurred $226,200 in such administrative fees during 1995.\nAFCA received from property owners administrative fees of $8,066 for the year ended December 31, 1995. Since these fees are not Partnership expenses, they have not been reflected in the accompanying financial statements.\nThe general partner of the property partnership which owns Jefferson Place is principally owned by an employee of America First Companies L.L.C.. Such employee has a nominal interest in America First Companies L.L.C.. AFCA and an affiliated mortgage fund also own small interests in the general partner. The general partner has a nominal interest in the property partnership's profits, losses and cash flow which is subordinate to the interest of the Registrant and the mortgage loan. The general partner received no cash distributions from the property partnership in 1995.\n\t An affiliate of AFCA has been retained to provide property management services for Covey at Fox Valley, The Park at Fifty Eight, Shelby Heights, Coral Point, Jefferson Place and Avalon Ridge. The fees for such services totaled $382,143 during 1995 which represents the lower of (i) the cost incurred while providing such management services or (ii) the customary fees for such services determined on a competitive basis.\n\t PART IV\n\t Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) The following documents are filed as part of this report:\n\t\t 1A.\tFinancial Statements of the Registrant. The following financial statements of the Registrant are included in response to Item 8 of this report:\n\t\t Independent Accountants' Report dated March 22, 1996.\n\t\t Balance Sheets of the Registrant as of December 31, 1995, and December 31, 1994.\n\t\t Statements of Income of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\n\t\t Statements of Partners' Capital of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\n\t\t Statements of Cash Flows of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\n\t\t Notes to Financial Statements of the Registrant.\n\t\t Schedule III--Real Estate and Accumulated Depreciation for the years ended December 31, 1995 and December 31, 1994.\n\t\t B.\tFinancial Statements of Jefferson Place L.P. (\"Jefferson\"). The following financial statements of Jefferson are included in response to Item 8 of this report:\n\t\t Independent Accountants' Report dated January 26, 1996.\n\t\t Balance Sheet of Jefferson as of December 31, 1995.\n\t\t Statement of Income of Jefferson for the year ended December 31, 1995.\n\t\t Statement of Partners' Capital of Jefferson for the year ended December 31, 1995.\n\t\t Statement of Cash Flows of Jefferson for the year ended December 31, 1995.\n\t\t Notes to Financial Statements of Jefferson.\n\t\t C.\tFinancial Statements of Sunpointe Associates Limited Partnership (\"Sunpointe\"). The following financial statements of Sunpointe are included in response to Item 8 of this report:\n\t\t Independent Accountants' Report dated January 26, 1996.\n\t\t Balance Sheet of Sunpointe as of December 31, 1995.\n\t\t Statement of Income of Sunpointe for the year ended December 31, 1995.\n\t\t Statement of Partners' Capital of Sunpointe for the year ended December 31, 1995.\n\t\t Statement of Cash Flows of Sunpointe for the year ended December 31, 1995.\n\t\t Notes to Financial Statements of Sunpointe.\n\t\t\t 2.\tFinancial Statement Schedules. The information required to be set forth in the financial statement schedule is included in the Financial Statements filed in response to Item 8 hereof.\n\t\t 3.\tExhibits. 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:\n\t\t\t 3.\tArticles of Incorporation and Bylaws of America First Fiduciary Corporation Number Eight (incorporated by reference to Form S-11 Registration Statement filed May 8, 1986, with the Securities and Exchange Commission by America First Tax Exempt Mortgage Fund 2 Limited Partnership (Commission File No. 33-5521)).\n\t\t\t 4(a).\tAgreement of Limited Partnership dated October 15, 1986, (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 2 Limited Partnership (Commission File No. 0-15329)).\n\t\t\t 4(b).\tForm of Certificate of Beneficial Unit Certificate (incorporated by reference to Form S-11 Registration Statement filed May 8, 1986, with the Securities and Exchange Commission by America First Tax Exempt Mortgage Fund 2 Limited Partnership (Commission File No. 33-5521)).\n\t\t\t 10(a).\t$18,755,000 Washington State Housing Finance Commission Multifamily Housing Mortgage Revenue Note (Sunpointe Apartments Projects) Series 1987 (incorporated herein by reference to Form 10-K dated December 31, 1987, filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 by America First Tax Exempt Mortgage Fund 2 Limited Partnership (Commission File No. 0-15329)).\n\t\t\t 10(b).\tLender Loan Agreement and Indenture of Trust among Washington State Housing Finance Commission, the Registrant and FirsTier Bank, National Association, dated September 1, 1987, (incorporated herein by reference to Form 10-K dated December 31, 1987, filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 by America First Tax Exempt Mortgage Fund 2 Limited Partnership (Commission File No. 0-15329)).\n\t\t\t 10(c).\tConstruction Loan Agreement between the Registrant and Sunpointe Associates Limited Partnership, dated September 1, 1987, (incorporated herein by reference to Form 10-K dated December 31, 1987, filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 by America First Tax Exempt Mortgage Fund 2 Limited Partnership (Commission File No. 0-15329)).\n\t\t\t 24.\tPower of Attorney.\n\t (b)\tThe 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 2 Limited Partnership:\nWe have audited the accompanying balance sheets of America First Tax Exempt Mortgage Fund 2 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 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 financial statements referred to above present fairly, in all material respects, the financial position of America First Tax Exempt Mortgage Fund 2 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.\nOmaha, Nebraska March 22, 1996\t\t\t\t\t\t\t\t\t Coopers & Lybrand L.L.P.\nTo the Partners America First Tax Exempt Mortgage Fund 2 Limited Partnership\nOur report on the financial statements of America First Tax Exempt Mortgage Fund 2 Limited Partnership is included in this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14.\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 aspects, the information required to be included therein.\nOmaha, Nebraska March 22, 1996 Coopers & Lybrand L.L.P.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP BALANCE SHEETS\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP STATEMENTS OF INCOME\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP STATEMENTS OF PARTNERS' CAPITAL FROM DECEMBER 31, 1992, TO DECEMBER 31, 1995\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. Organization\nAmerica First Tax Exempt Mortgage Fund 2 Limited Partnership (the Partnership) was formed on September 30, 1986, 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, including multifamily residential apartments and commercial properties. The Partnership will terminate on December 31, 2016, unless terminated earlier under the provisions of the Partnership Agreement. The General Partner of the Partnership is America First Capital Associates Limited Partnership Four (AFCA 4).\n2. Summary of Significant Accounting Policies\nA) Financial Statement Presentation 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) Real Estate Acquired in Settlement of Loans Property acquired through foreclosure, deed in lieu of foreclosure, or foreclosure in substance is recorded at the lower of the unpaid loan balance or estimated net realizable value at the date of acquisition.\nD) Allowance for Loan Losses and Valuation Allowance on Real Estate Acquired 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 Partnerhsip's financial statements.\nThe valuation allowance on real estate acquired is a valuation reserve which has been established for declines in the estimated fair value of each property subsequent to acquisition.\nThe fair value of the collateral for the loans and the real estate acquired 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 allowances are periodically reviewed and adjustments are made to the allowances when there are significant changes in the estimated net realizable value of the underlying collateral for the loans or the real estate acquired. AMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nE) Depreciation Depreciation of real estate acquired in settlement of loans is based on the estimated useful life of the property (27-1\/2 years or 31-1\/2 years on The Exchange at Palm Bay) using the straight-line method. Depreciation of real estate improvements is based on the term of the related lease agreement using the straight-line method.\nF) Income Taxes No provision has been made for income taxes since 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 $11,731,916 and $11,635,996 at December 31, 1995, and December 31, 1994, respectively.\nG) Temporary Cash Investments Temporary cash investments are invested in federally tax-exempt securities purchased with an original maturity of three months or less.\nH) Net Income per BUC Net income per BUC has been calculated based on the number of BUCs outstanding (5,245,623) for all years presented.\nI) New Accounting Pronouncement The Financial Accounting Standards Board has 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\". Among other things, 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 circumstances indicate that the carrying value of an asset may not be recoverable. The Partnership plans to adopt this Statement in 1996 and anticipates that the adoption of this Statement will not have a material impact on the financial statements.\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 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 4 until the BUC Holders have received distributions of Net Interest Income equal to a cumulative noncompounded annual return of 10% 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 4.\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 10% on their Adjusted Capital Contributions. Any remaining Net Residual Proceeds representing contingent interest will be distributed 100% to AFCA 4 until the amount so distributed is equal to 10% of the Net Residual Proceeds representing contingent interest distributed to all parties. Thereafter, any remaining Net Residual Proceeds representing contingent interest will be distributed 1% to BUC Holders and 99% to AFCA 4 until AFCA 4 receives an amount equal to .25% per annum of the outstanding principal amount of the mortgage loans for each year beginning January 1, 1989, and thereafter, 90% to the BUC Holders and 10% to AFCA 4.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nLiquidation Proceeds, as defined in the Limited Partnership Agreement, remaining after repayment of any debts or obligations of the Partnership (including loans from AFCA 4) and after the establishment of any reserve AFCA 4 deems necessary, will be distributed to AFCA 4 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 4 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.\n4. Partnership Reserve Account\nThe Partnership maintains a reserve account which totaled $1,118,898 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, real estate acquired 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 and\/or permanent financing 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 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, and out of a portion of the sale or refinancing proceeds from a property, 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 a property. 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 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nDescriptions of the tax-exempt mortgages owned by the Partnership at December 31, 1995, are as follows:\n(1) In addition to the base interest rate shown, the notes bear additional contingent interest as defined in each revenue note which, when combined with the interest shown, is limited to a cumulative, noncompounded amount not greater than 13% per annum. The Partnership did not receive any additional contingent interest in 1995, 1994 or 1993.\n(2) Nonperforming loans are loans which are not fully current as to interest payments. The amount of foregone interest on nonperforming loans was $1,192,165 for 1995, $974,575 for 1994, and $1,099,270 for 1993.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nUnauditied combined condensed financial information of the properties collateralizing the Partnership's investment in tax-exempt mortgage loans is as follows:\n6. Real Estate Acquired in Settlement of Loans\nReal estate acquired in settlement of loans at December 31, 1995, is comprised of the following:\n(1) Represents square feet.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n7.\tTransactions with Related Parties\nSubstantially all of the Partnership's general and administrative expenses are paid by AFCA 4 or an affiliate and reimbursed by the Partnership. The amounts of such expenses reimbursed to AFCA 4 or an affiliate are shown below. The reimbursed expenses are presented on a cash basis and do not reflect accruals made at the end of each year.\nAFCA 4 received from property owners administrative fees of $8,066 for the year ended December 31, 1995. AFCA 4 did not receive any administrative fees from property owners in 1994 or 1993. Since these fees are not Partnership expenses, they have not been reflected in the accompanying financial statements. Pursuant to the Limited Partnership Agreement, AFCA 4 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 4 was $226,200 in each of the years ended December 31, 1995, 1994 and 1993.\nThe general partner of the property partnership which owns Jefferson Place is principally owned by an employee of an affiliate of AFCA 4. Such employee has a nominal interest in the affiliate. AFCA 4 and an affiliated mortgage fund also own small interests in the general partner. The general partner has a nominal interest in the property partnership's profits, losses and cash flow which is subordinate to the interest of the Partnership and the mortgage loan. The general partner received no cash distributions from the partnership in 1995, 1994, or 1993.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nAn affiliate of AFCA 4 was retained to provide property management services for Covey at Fox Valley, The Park at Fifty Eight and Shelby Heights, (all since August 1992), Coral Point (beginning in March 1993) Jefferson Place (beginning in May 1993) and Avalon Ridge (beginning in September 1994). 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 $382,143 in 1995, $297,836 in 1994 and $222,445 in 1993.\n8.\tSummary of Unaudited Quarterly Results of Operations\t\t\t\t\t\t\t\t\t\t\t\t\nThe BUCs are quoted on the NASDAQ National Market System under the symbol ATAXZ. The high and low quarterly prices of the BUCs shown represent the final sales prices and were compiled from the Monthly Statistical Reports provided to the Partnership by the National Association of Securities Dealers, Inc. \t\t\t\t\t\t\t\t\t\t\t\t\nSchedule III\nTAX EXEMPT MORTGAGE FUND 2 REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\n(a) \tThe Partnership has no encumbrances against these properties. (b) \tReconciliation of Real Estate:\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\n(c) \tReconciliation of Accumulated Depreciation:\t\t\t\t\t\t\t\t\n(a) \tThe Partnership has no encumbrances against these properties.\t (b) \tReconciliation of Real Estate:\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\n(c) \tReconciliation of Accumulated Depreciation:\t\t\t\t\t\t\t\t\nThe Notes to Financial Statements are an integral part of this statement.\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995\n\t The Notes to Financial Statements are an integral part\tof this statement.\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) STATEMENT OF CHANGES IN PARTNERS' EQUITY (DEFICIT) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part of this statement.\n\t\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part\tof this statement.\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) NOTES TO FINANCIAL STATEMENTS\nNOTE 1\t ORGANIZATION\nJefferson Place, L.P., a Missouri limited partnership, (the \"Partnership\"), was formed on April 18, 1985, pursuant to the terms of an Agreement of Limited Partnership for the purpose of acquiring and operating the Jefferson Place Apartments complex (the \"Project\"), a 352-unit apartment complex located in Olathe, Kansas. The Partnership will dissolve on December 31, 2033, unless sooner dissolved pursuant to any provision of the Partnership agreement.\nOn October 1, 1990, pursuant to the Second Amended and Restated Agreement of Limited Partnership, DRI Equity Corporation withdrew from the Partnership as general partner and became a Class B limited partner with a .13% interest. DRI assigned its interest to JHC Corporation as the general partner with a 1% interest. Liberty Associates IV L.P. is the Partnership's special limited partner with a 1% interest and has the authority, among other things, to remove the general partner under certain circumstances and to consent to the sale of the Partnership's assets. The Partnership has three other Class B limited partners, Mark D. Rose (.65%), Susan L. Rose (.65%), and Chase Properties, Inc., a Missouri corporation (11.57%), as well as a Class A limited partner, Liberty Tax Credit Plus III L.P., a Delaware limited partnership who owns an 85% interest.\nNOTE 2 \tSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nMethod of Accounting\nThe accompanying financial statements have been prepared on the accrual basis of accounting. The Partnershp also reports its operating results for income tax purposes on the accrual 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.\nSecurity Deposits\nThe security deposit liability exceeds the security deposit cash account by $37,434. Management has stated that this deficiency will be funded from the operating cash account as cash flow becomes available.\nBad Debts\nThe Partnership records bad debts using the direct write off method which is not materially different from the allowance method. No bad debt expense was recorded for the period ended December 31, 1995.\nProperty and Equipment\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. \t\nDepreciation is calculated using the straight-line method over estimated useful lives ranging from 5 to 19 years. The total depreciation expensed in 1995 was $578,958.\nConcentration of Credit Risk\nThe Partnership 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 Partnership's uninsured cash balances totaled $16,585.\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3\tSTATEMENT OF CASH FLOWS\nFor 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 includes cash and security deposits.\nCash paid during the year for:\nInterest\t $\t\t863,758\nNOTE 4\tRESTRICTED 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 Partnership and in an interest-bearing account with a federally insured financial institution.\nDisbursements from the escrow are for real estate taxes and insurance premiums. Interest earned on the funds is transferred to the operating cash account quarterly.\nNOTE 5\tMORTGAGE PAYABLE\nThe Partnership financed the construction of the Project with Multi-Family Housing Revenue Notes (\"Notes\") issued by the City of Olathe, Kansas (\"City\") in the face amount of $12,800,000. On December 1, 1986, the Notes were purchased by America First Tax-Exempt Mortgage Fund 2 Limited Partnership (\"America First\"). The Notes are nonrecourse obligations of the owners of the Partnership. The Notes are not an obligation to the City, nor is the taxing power of the City pledged to the payment of principal and interest on the Notes. The net cash flow of the Partnership and the proceeds from the sale or refinancing of the Partnership are the sole source of funds to pay principal and interest on the Notes. The Notes are collateralized by all real and personal property of the Partnership and an assignment of rents. The principal balance of the Notes is due in a lump sum on December 1, 2010. Base interest on the Notes accrues at 8.5% per annum.\nIn connection with the reorganization of the Partnership on October 1, 1990, the terms of the Notes were amended pursuant to a mortgage modification agreement. The mortgage modification agreement was to induce America First to waive defaults under the original Note and to induce the new limited partners to infuse additional capital. The mortgage modification agreement provides, among other provisions, for the following:\n1) America First agrees not to declare a default under the Notes, mortgage and related documents during the term of the modification agreement, which expires December 31, 2002.\n2) America First agrees to accept the monthly cash flow from the Partnership as partial payment of base interest. If the monthly cash flow is less than the amount of base interest due for each month, the unpaid base interest accrues and will be paid from excess cash flow in future months. The difference between the base interest on the Notes and the payments to America First from available monthly cash flow will bear interest at 8.5% per annum until paid. At December 31, 1995, mortgage interest expense included additional interest on accrued base interest of $188,370.\n3) The mortgage modification agreement also specifies the allocation of sale or refinancing proceeds of the Partnership among the partners and payment of accrued interest to America First.\nJEFFERSON PLACE, L.P. (a Missouri Limited Partnership) NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6\tACCRUED INTEREST PAYABLE\nAccrued interest payable as of December 31, 1995 consisted of the following:\nNOTE 7\tCONTINGENT INTEREST\nIn addition to base interest, the Notes provide for the payment of additional contingent interest that is payable only to the extent the Partnership generates excess net cash flows or from the sale or refinancing proceeds of the Partnership, subject to various priority payments. Contingent interest during the construction period (December 1, 1986 through August 31, 1987) at 3.5% per annum totaled $118,890. Contingent interest at 4.5% per annum, excluding contingent construction period interest, totaled $4,800,000 through December 31, 1995. Contingent interest amounts have not been accrued in the accompanying financial statements.\nNOTE 8\tRELATED PARTY TRANSACTIONS\nManagement Fees\nOn May 1, 1993, America First Properties Management, Inc., an affiliate of the general partner, took over management of the Partnership. Their fee is 5% of collected receipts, effective July, 1995. Management fees for 1995 are $83,866. The Partnership owed America First Properties Management, Inc. $4,564 at December 31, 1995.\nAdministrative Fees\nUnder the terms of the Notes, the Partnership accrues administrative fees of $6,400 per month to an affiliate of America First. Under the terms of the Second Amended and Restated Agreement of Limited Partnership, the Partnership accrues additional administrative fees of $1,000 per month to Liberty Associates IV, L.P. Administrative fees totaled $88,800 in 1995. Accrued and unpaid administrative fees totaled $679,219 at December 31, 1995.\nAdministrative fees payable to America First are to be paid solely from the proceeds of a sale or refinancing. Administrative fees payable to Liberty Associates IV, L.P. are paid from excess cash flow after the payment of all operating expenses except interest.\nNOTE 9\tCONTINGENCIES\nPursuant to a Tax Credit Guaranty Agreement signed on October 1, 1990, the Partnership and America First guarantee Liberty Tax Credit Plus III, L.P. (\"Liberty\") specified minimum amounts of tax credits to be generated by the Partnership through the rental of apartments to qualified tenants. If the Partnership fails to generate tax credits of approximately $131,000 annually for years 1991 through 1997 for the benefit of Liberty, America First and the Partnership will be required to pay Liberty an amount equal to $.633 for each $1 of credits below the specified minimum amounts.\nTax credits generated by the Partnership in 1995 were in excess of the minimum amount of such credits specified in the Tax Credit Guaranty Agreement.\nNOTE 10\tGOING CONCERN CONSIDERATIONS\nThe Partnership has consistently been unable to generate sufficient cash flow from operations to pay base interest on the mortgage payable. The Partnership has, however, generated cash flows sufficient to cover the cost of operations and partially pay base interest on the mortgage payable. As more fully described in Note 5, America First (the mortgagee) has agreed not to declare a default under the terms of the mortgage payable.\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (A Washington Limited Partnership)\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995\nPAGE\nAUDITORS' REPORT\t\t 1\nFINANCIAL STATEMENTS\n\tBALANCE SHEET\t\t 2\n\tSTATEMENT OF INCOME (UNAUDITED)\t\t 3\n\tSTATEMENT OF CHANGES IN PARTNERS' \t\tEQUITY (DEFICIT) (UNAUDITED)\t\t 4\n\tSTATEMENT OF CASH FLOWS (UNAUDITED)\t\t 5\nNOTES TO FINANCIAL STATEMENTS\t\t 6-7\nTo the Partners Sunpointe Associates Limited Partnership Omaha, Nebraska\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying balance sheet of Sunpointe Associates Limited Partnership, (a Washington 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 the 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 in the first paragraph presents fairly, in all material respects, the financial position of Sunpointe Associates Limited Partnership as of 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. As shown in the financial statements, the Partnership incurred a net loss of $1,761,506 during the year ended December 31, 1995, and, as of that date, had a net worth of $(12,376,449). As discussed in Note 7 to the financial statements, the Partnership has suffered recurring losses from its operations and has a net capital deficiency that raises substantial doubt about the Partnership's ability to continue as a going concern. The 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\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) BALANCE SHEET DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part\tof this statement.\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) STATEMENT OF INCOME (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part\tof this statement.\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) STATEMENT OF CHANGES IN PARTNERS' EQUITY (DEFICIT) (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part\tof this statement.\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) STATEMENT OF CASH FLOWS (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part\tof this statement.\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) NOTES TO FINANCIAL STATEMENTS\nNOTE 1\tORGANIZATION\nSunpointe Associates Limited Partnership, a Washington Limited Partnership, (the \"Partnership\"), was formed on September 3, 1987, pursuant to the terms of an Agreement of Limited Partnership for the purpose of acquiring and operating the Avalon Ridge Apartments complex, a 356-unit apartment complex located in Renton, Washington (the \"Project\"). The Partnership will dissolve on December 31, 2037, unless sooner dissolved pursuant to any provision of the Partnership Agreement.\nThe Agreement of Limited Partnership which was amended on June 30, 1991, and December 31, 1991, admitted a new general partner and changed the profit and loss allocation percentages to the partners. The general partner of the Partnership is Sunset Terrace Investments, Inc. (the \"General Partner\"), a California corporation. The limited partners of the Partnership are Shelter Corporation of Canada Limited and Shelter American Holding, Inc. which are Canadian corporations and the Axelrod Company, a Washington corporation.\nNOTE 2\tSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nMethod of Accounting\nThe accompanying financial statements have been prepared on the accrual basis of accounting. The Partnership also reports its operating results for income tax purposes on the accrual 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 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 revenue and expenses during the reporting period. Actual results could differ from estimated amounts.\nBad Debts (Unaudited)\nThe Partnership records bad debts using the direct write-off method which is not materially different from the allowance method. No bad debt expense was recorded for the period ended December 31, 1995.\nProperty 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. \t\nDepreciation is calculated using the straight-line method over estimated useful lives ranging from 7 to 27.5 years. The total depreciation expensed in 1995 was $529,273.\nNOTE 3\tSTATEMENT OF CASH FLOWS (UNAUDITED)\nFor 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.\nCash paid during the year for:\nInterest\t\t $\t\t658,666\nSUNPOINTE ASSOCIATES LIMITED PARTNERSHIP (a Washington Limited Partnership) NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4\tRESTRICTED 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 Partnership and 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.\nNOTE 5\tMORTGAGE PAYABLE\nThe Partnership entered into a $1,245,000 mortgage payable agreement with America First Participating\/Preferred Equity Mortgage Fund on September 1, 1987. The note bears base interest at the rate of 10%, due on the fifteenth day of each month. Maximum construction period deferred interest is due during the first interest period, which extends from the date of inception to August 17, 1989, in an amount equal to 3% per annum. The maximum construction period deferred interest shall be paid, to the extent possible, from 50% of the net sale or refinancing proceeds. Contingent interest and deferred interest is due during the second interest period, which extends from August 18, 1989, to the date of full payment, at an annual rate of 3% on the outstanding principal amount. Contingent interest and deferred interest shall be paid from 50% of the net cash flow. Deferred interest and contingent interest is due on the first day of each February, May, August, and November. The note matures on September 1, 1999.\nPursuant to a promissory note dated September 1, 1987, the Partnership owes Washington Mortgage Corporation $18,755,000 plus interest. The interest of Washington Mortgage Corporation was purchased and assigned to Washington State Housing Finance Commission under the Assignment of Developer Documents dated September 1, 1987. Part of the interest of Washington State Housing Finance Commission has been assigned to FirsTier Bank, National Association, as Trustee under the Lender Loan Agreement and Indenture of Trust dated September 1, 1987. The note bears base interest at the rates of 9.5% per annum and 8.5% per annum during the first and second interest periods, respectively. The note bears deferred contingent interest in amounts equal to 3.5% per annum and 4.5% per annum during the first and second interest periods, respectively. During the third interest period, the note bears contingent interest at an annual rate of 4.5% on the outstanding principal amount. The note matures on September 1, 2011.\nNOTE 6\tRELATED PARTY TRANSACTIONS\nManagement Fees\nOn August 20, 1994, America First Properties Management, Inc., an affiliate of the general partner, took over management of the Partnership. Their fee is 3% of gross receipts when net operating income is less than $97,000; 3.75% when net operating income is between $97,001 and $103,000; and 4.5% when net operating income is greater than $103,000. Management fees for 1995 are $74,072. The Partnership owed America First Properties Management, Inc. $6,008 at December 31, 1995.\nDue to Limited Partner\nThe Partnership has outstanding operating deficit loans borrowed from the limited partner of $90,000 at December 31, 1995.\nNOTE 7\tGOING CONCERN CONSIDERATIONS\nThe Partnership's operations have produced a cumulative deficit of $12,376,449 since commencement of rental operations in 1987, as well as recurring operating losses. These considerations raise substantial doubt about the Partnership's ability to continue as a going concern. The Partnership has expended operating funds to upgrade the resident profile and reposition the property for the future. Significant cash flow has been reinvested in the Project to pursue this repositioning.\n\t SIGNATURES\n\t Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n\t AMERICA FIRST TAX EXEMPT MORTGAGE \t FUND 2 LIMITED PARTNERSHIP\n\t By\tAmerica First Capital Associates Limited \t\t\t Partnership Four, general partner \t\t of the Registrant\n\t By\tAmerica First Companies L.L.C., \t\t general partner of America First Capital \t\t Associates Limited Partnership Four\n\t By\t\/s\/ Michael Thesing\t \t\t Michael Thesing, Vice President\nDate: March 27, 1996\n\t Pursuant 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\t By\t\/s\/ Michael B. Yanney*\t \t\t Michael B. Yanney \t\t Chairman of the Board, President, Chief Executive Officer and Manager\nDate: March 27, 1996\t By\t\/s\/ Michael Thesing\t \t\t Michael Thesing \t\t\t\t Vice President, Secretary, Treasurer and Manager (Chief Financial and Accounting Officer)\nDate: March 27, 1996\t By\t\/s\/ William S. Carter, M.D.*\t \t\t William S. Carter, M.D. \t\t Manager\nDate: March 27, 1996\t By \t\t George Kubat \t\t Manager\nDate: March 27, 1996\t By\t\/s\/ Martin Massengale*\t \t\t Martin Massengale \t\t Manager\nDate: March 27, 1996\t By\t\/s\/ Alan Baer*\t \t\t Alan Baer \t\t Manager\nDate: March 27, 1996\t By\t\/s\/ Gail Walling Yanney*\t \t\t Gail Walling Yanney \t\t Manager\n\t *By Michael Thesing Attorney in Fact\n\/s\/ Michael Thesing\t\t 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":"818969_1995.txt","cik":"818969","year":"1995","section_1":"ITEM 1. BUSINESS\nProvident Bankshares Corporation (\"the Corporation\"), a Maryland corporation, was organized in 1987 by the management of Provident Bank of Maryland (\"the Bank\"), and registered as a bank holding company under the Bank Holding Company Act of 1956. Through a reorganization dated December 22, 1987, the Corporation became the sole stockholder of the Bank. The reorganization allowed the Bank to convert from a Maryland chartered mutual savings bank, the form in which it had operated since 1886, to a Maryland chartered stock commercial bank. At December 31, 1995, the Bank was the second largest commercial bank chartered under the laws of the State of Maryland in terms of assets. For the discussion regarding lending and investment activities as well as sources of funds of the Corporation, see pages 15 through 22.\nMORTGAGE BANKING ACTIVITIES\nProvident Mortgage Corp. (\"PMC\"), a subsidiary of the Bank, was formed in 1992 in conjunction with the acquisition of Consolidated Mortgage Corporation, (\"CMC\") which occurred during July 1992. The purpose of PMC is to offer a broad range of mortgage lending products to consumers and thereby enhance the Corporation's mortgage banking operations.\nBANKING SERVICES ACTIVITIES\nProvident Investment Center Inc. (\"PIC\"), a subsidiary of the Bank, was formed in 1993 to provide consumers a competitive range of banking products, such as purchased annuities and mutual funds.\nINSURANCE ACTIVITIES\nBankSure Insurance Corporation (\"BankSure\"), a subsidiary of the Bank, was formed by the Bank in 1985 for the purpose of offering insurance products to its loan customers and thereby enhancing the Bank's lending product lines.\nREAL ESTATE ACTIVITIES\nThe Bank owns approximately 49,000 square feet of real estate adjacent to the Corporation's headquarters building. Management plans to utilize this real estate to meet future space requirements of the Corporation.\nEMPLOYEES\nAt December 31, 1995, the Corporation and its subsidiaries had 1,141 employees. The Corporation currently maintains what management considers to be a comprehensive, competitive employee benefits program. Employees are not represented by a collective bargaining unit and management considers its relationship with its employees to be good.\nCOMPETITION\nThe Corporation encounters substantial competition in all areas of its business. There are four commercial banks based in Maryland with assets in excess of $1 billion. The Bank also faces competition from savings and loan associations, savings banks, mortgage banking companies, credit unions, insurance companies, consumer finance companies, money market and mutual funds and various other financial services firms. Current federal law allows acquisitions of bank holding companies nationwide. Further, Maryland law in some instances allows aquisitions among banks in Maryland with banks in other states, provided that the other jurisdiction has approved reciprocal interstate banking legislation. As a consequence of these developments, competition in the Bank's principal market may increase, and a consolidation of financial institutions in Maryland may occur.\nREGULATION\nThe Corporation is registered as a bank holding company, under the Bank Holding Company Act of 1956. As such, the Corporation is subject to regulation and examination by the Federal Reserve Board, and is required to file periodic reports and any additional information that the Federal Reserve Board may require. The Bank Holding Company Act imposes certain restrictions upon the Corporation regarding the acquisition of substantially all of the assets of or direct or indirect ownership or control of any bank of which it is not already the majority owner; or, with certain exceptions, of any company engaged in non-banking activities.\nThe Bank is subject to supervision, regulation and examination by the Bank Commissioner of the State of Maryland and the Federal Deposit Insurance Corporation. Asset growth, deposits, reserves, investments, loans, consumer law compliance, issuance of securities, payment of dividends, establishment of branches, mergers and consolidations, changes in control, electronic funds transfer, management practices and other aspects of operations are subject to regulation by the appropriate federal and state supervisory authorities. The Bank is also subject to various regulatory requirements of the Federal Reserve Board applicable to FDIC insured depository institutions.\nMONETARY POLICY\nThe Corporation and the Bank are affected by fiscal and monetary policies of the federal government, including those of the Federal Reserve Board, which regulates the national money supply in order to mitigate recessionary and inflationary pressures. Among the techniques available to the Federal Reserve Board are engaging in open market transactions of U.S. Government securities, changing the discount rate and changing reserve requirements against bank deposits. These techniques are used in varying combinations to influence the overall growth of bank loans, investments and deposits. Their use may also affect interest rates charged on loans and paid on deposits. The effect of governmental policies on the earnings of the Corporation and the Bank cannot be predicted.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn December 1990, the Bank sold its corporate headquarters located at 114 East Lexington Street, Baltimore, Maryland, and simultaneously leased back these facilities for an initial twelve year lease term. The Bank has 44 offices located throughout the Baltimore metropolitan area. The Bank owns 6 and leases 38 of its offices. Most of these leases provide for the payment of property taxes and other costs by the Bank and include one or more renewal options ranging from five to ten years. Some of the leases also contain a purchase option. In 1993, the Bank renewed a long-term agreement to lease a one-story building large enough to consolidate operations and support functions. The Bank currently leases all of the building's 80,000 square feet of space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nRefer to Note 12 of Item 8. -- \"Financial Statements and Supplementary Data\" on page 43.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of Provident Bankshares Corporation is traded over-the-counter and is quoted in the NASDAQ Stock Market. 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. The NASDAQ symbol is PBKS. The trading range of Provident's common stock for the years 1995 and 1994 is shown in the table of Consolidated Quarterly Results of Operations, Market Prices and Dividends contained on page 13 of Management's Discussion and Analysis (Item 7). At January 31, 1996, there were approximately 2,493 holders of record of the Corporation's common stock. For the year 1995, the Corporation declared and paid dividends of $.58 per share of common stock outstanding. See Note 10 of Notes to Consolidated Financial Statements of Provident Bankshares Corporation and Subsidiaries for a discussion of the effect of the liquidation account of the Bank on the ability of the Corporation to pay dividends. Certain provisions of Maryland banking law impose limitations on the amount of dividends payable by the Corporation, but none is as restrictive as the liquidation 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\nFINANCIAL REVIEW\nThe principal objective of this Financial Review is to provide an overview of the financial condition and results of operations of Provident Bankshares Corporation and its subsidiaries for the three years ended December 31, 1995, 1994 and 1993. The outlook for the Corporation based upon current trends and actions taken during the year is also included. This discussion and tabular presentations should be read in conjunction with the accompanying financial statements and notes. Provident Bankshares Corporation (\"the Corporation\"), through its wholly-owned subsidiary, Provident Bank of Maryland (\"the Bank\"), offers consumer and commercial banking services throughout central Maryland. The Bank offers related financial services through its wholly-owned subsidiaries, including mortgages through Provident Mortgage Corp. (PMC), and mutual funds and annuities through Provident Investment Center (PIC). The Corporation recorded significantly improved operating results in 1995, as earnings totaled $18 million or $2.20 per share, a 44% increase over the $12.5 million or $1.72 (adjusted for 5% stock dividend) per share earned in 1994. The growth in net earnings was attributable to an $11.1 million rise in tax-equivalent net interest income and a $4.4 million increase in retail service charges. These increases more than offset a $3.8 million increase in operating expenses. These variances are discussed in more detail beginning on the following pages.\nFINANCIAL TRENDS\n[The following tables are representative of graphs shown on page 6 of the Annual Report.]\nRESULTS OF OPERATIONS _____________________\nNET INTEREST INCOME\nThe Corporation's principal source of revenue is net interest income, the difference between interest income on earning assets and interest expense on deposits and borrowings. Interest income, for purposes of analysis, is presented on a tax-equivalent basis to recognize associated tax benefits as this presentation provides a basis for comparison of yields with taxable earning assets. The discussion on net interest income should be read in conjunction with the \"Analysis of Changes in Net Interest Income\" and \"Consolidated Average Balances -- Income and Expense and Yields and Rates\" on pages 9 and 10. Tax-equivalent net interest income for 1995 increased $11.1 million or 15.3% from 1994 as average earning assets grew $480 million over the prior year. Net interest margin dropped by 35 basis points primarily caused by the leveraging through investment security purchases of additional capital raised during the fourth quarter of 1994. These margins are lower than is traditionally earned through the generation of loan balances. Provident's interest income increased $45.9 million or 34% during the year primarily due to the growth in average earning assets and a 45 basis point increase in yield. The rise in yield was mainly due to a higher interest rate environment. The increase in average earning assets resulted from a $176 million increase in the loan portfolios and a $321 million increase in the investment portfolio offset in part by a $21 million decrease in mortgage loans held for sale. Consumer loan growth accounted for the majority of the increase in average loans during 1995. The commercial business portfolio also experienced growth. Interest income earned on the loan portfolio increased $21.7 million reflecting higher loan outstandings and a 58 basis point increase in yield. Average investments increased $325 million during the period due to the leveraging described above. The yield on investments and loans held for sale rose 44 basis points and 68 basis points, respectively. Interest lost from non-accruing loans was $302 thousand compared to $384 thousand in 1994. Interest expense increased $34.8 million from 1994 resulting in an 87 basis point increase in overall cost of funds and a $441 million growth in average interest bearing liabilities. The rise in cost of funds was caused by the general increase in interest rates during the year for borrowed funds and term deposits. The average rate paid on borrowed funds increased 115 basis points during 1995. This represented a $20.8 million increase in interest expense. The increase in average interest bearing liabilities reflects a $271 million rise in borrowed funds and a $169 million increase in interest bearing deposits. Non-interest bearing demand deposit accounts grew by $16 million or 16%. Future growth in net interest income will depend upon consumer and commercial loan demand and the general level of interest rates. Please refer to the section entitled \"Interest Sensitivity Management\" on page 23 for further discussion of the impact of current trends on net interest income in 1995.\nANALYSIS OF CHANGES IN NET INTEREST INCOME\nCONSOLIDATED AVERAGE BALANCES, INCOME AND EXPENSE AND YIELDS AND RATES\nProvident Bankshares Corporation and Subsidiaries\nCONSOLIDATED AVERAGE BALANCES, INCOME AND EXPENSE AND YIELDS AND RATES (continued)\nProvident Bankshares Corporation and Subsidiaries\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses increased $1 million to $1.5 million in 1995. The increase was the result of loan growth in the consumer loan and commercial loan portfolios as total average loans outstanding grew by $176 million. The corporation continues to emphasize quality underwriting as well as aggressive management of prior charge-offs and potential problem loans. Net charge-offs were $976 thousand in 1995 compared to $58 thousand in 1994. Net charge-offs as a percentage of average loans was .07% in 1995. Non-accrual and past due loans ended the year at $14.1 million, $8.5 million of which is residential mortgage loans. Seventy-three percent of the non-performing residential mortgage loans are guaranteed or insured by government agencies. A further discussion of the allowance for loan losses, net charge-offs and non-performing assets appears on pages 18 and 19.\nNON-INTEREST INCOME\nNon-interest income is principally derived from fee-based services, mortgage banking activities and gains on investment securities sales. In 1995, non-interest income also included interest income of $5.8 million derived from federal income tax refunds. This interest income allowed the Corporation to defer planned sales of mortgage servicing rights to future periods and to reposition part of the investment portfolio. Total non-interest income increased 7.2% to $29.2 million. Excluding net securities gains (losses), interest income from federal income tax refund and gains for mortgage servicing rights, non-interest income increased $3.6 million or 18%. The table below presents a comparative analysis of the major components of non-interest income. Deposit service charges rose 55% over the prior year due to a 63% or $3.6 million increase in retail demand deposit service fees. Average interest-bearing demand deposits grew $14.3 million or 13% over last year while average noninterest-bearing deposits increased $16 million or 16%. These increases are the result of continued promotion and sales efforts of new retail deposit products developed in 1993. Income from mortgage banking activities fell $4.9 million, $4.1 million due to lower gains on the sale of mortgage servicing rights. The remaining decline is due to lower origination fee income as mortgage originations during the year declined $88 million to $417 million. This drop in originations reflects an overall decline in the mortgage industry. During 1993, Provident Bank of Maryland started Provident Investment Center with the purpose of offering annuities and mutual funds through an affiliation with a securities broker-dealer. For the year 1995, income associated with these products decreased by $900 thousand to $1.1 million. This decline is believed to be associated with customer preference for certificates of deposit versus annuities as rates for these products were more attractive in 1995.\nNON-INTEREST INCOME\nNON-INTEREST EXPENSE\nNON-INTEREST EXPENSE\nNon-interest expense is composed primarily of costs associated with employees' salaries and benefits, bank facilities, external data processing and regulatory fees. Provident's non-interest expense of $83.1 million represented a 4.8% increase, compared to a 4.7% increase in 1994. Salaries and benefits declined $336 thousand during the year. Compensation and payroll taxes increased $712 thousand while health insurance and pension expense declined $897 thousand and $267 thousand, respectively. The rise in compensation and associated payroll taxes is attributable to merit increases, new supermarket branches and staffing our new Fast'N Friendly Check Cashing centers. The lower pension cost is due to improved investment yield on plan assets. Improved health care claim experience led to the decline in health insurance expense. Full time equivalent employees ended the year at 1,141 compared to 955 for the prior year. Occupancy costs grew $428 thousand or 5.9% over last year. Much of this increase is due to additional mortgage and supermarket branches as well as additional space requirements at our headquarters and operations buildings. Total furniture and equipment expense increased $760 thousand due to upgrading of technology in the bank's office automation and branch platform systems. External processing increased $1.2 million or 19%, as new branch locations were added. Other expenses increased by $1.8 million mainly associated with settlement of a lawsuit in connection with termination of an acquisition and write-off of personal computer equipment not compatible with a newly installed local area network system. In addition, advertising costs increased $575 thousand or 12% compared to the prior year. This increase was attributable to promotion of retail products.\nINCOME TAXES\nProvident recorded income tax expense of $9.5 million on pre-tax income of $27.5 million for an effective tax rate of 34.5%. This compares with a 36.3% effective tax rate for 1994. The reduction in the effective tax rate was caused by favorable resolution of state tax issues and the recognition of deferred tax items at a higher rate as the current marginal federal rate is higher than when the items were originally deferred.\nFOURTH QUARTER RESULTS\nProvident recorded net income of $5.1 million or $.61 per share in the fourth quarter of 1995, an increase of $1.5 million or 41% over the $3.6 million or $.45 per share recorded in the same period last year. The higher earnings are principally due to a 15.4% increase in net interest income and higher non-interest income. Higher operating expenses and loan loss provision partially offset these increases. Tax-equivalent net interest income in the fourth quarter rose $3 million to $22.2 million as the net interest margin declined 9 basis points to 3.64% and average earning assets grew $373 million to $2.4 billion. The decrease in the net interest margin primarily reflected a lower interest rate environment as well as the leveraging of additional capital through investment security purchases. This resulted in lower margins than is traditionally earned through the generation of loan balances.\nThe Corporation recorded a provision for loan losses of $1.0 million during the quarter to provide for loan growth in the portfolio. Non-interest income increased 34 percent to $9.0 million. The increase is derived from fee based services as a result of higher account volumes and higher mortgage banking income. Fee income from retail fees increased $1.4 million and mortgage banking income increased $746 thousand. Mortgage banking income rose because of higher gains from the sale of mortgage servicing rights. Non-interest income was also higher by $493 thousand due to the recognition of interest income from a federal income tax refund. Non-interest expense increased $2.2 million to $22.1 million because of higher compensation, advertising and promotion, and external processing expense. Compensation expense was higher due to expenses associated with the decision to outsource our mortgage processing operations and temporary help used to prepare mortgage files for securitization. Advertising increased $462 thousand as a result of promotions of bank products and services during the fourth quarter of 1995. External processing costs rose $459 thousand due to increased account volume. In addition to the above, the Corporation wrote off $336 thousand of fixed assets associated with an upgrade of technology to a local area network.\nThe following table presents quarterly trend data for 1995 and 1994.\nCONSOLIDATED QUARTERLY RESULTS OF OPERATIONS, MARKET PRICES AND DIVIDENDS\nFINANCIAL CONDITION ___________________\nSOURCE AND USE OF FUNDS\nDEPOSITS\nThe following table presents information concerning the Bank's average deposits and rates for the respective years.\nThe table below presents information at December 31, 1995, with respect to the maturity of Certificates of Deposit of $100,000 or more.\nDEPOSITS (in billions)\n[The following table is representative of the graph shown on the top of page 15 of the Annual Report.]\nA major portion of Provident's funding comes from core deposits which consist of consumer and commercial transaction accounts and consumer savings and time deposits. These deposits are generated through the Bank's 44 branch banking locations. At December 31, 1995, core deposits represented 85% of total deposits and 56% of total liabilities. Provident's future funding growth is expected to be generated from deposit growth through strategies outlined below. The branch network strategy includes traditional full service branch locations supplemented with supermarket branches. Provident Bank of Maryland as of December 31, 1995, had 34 traditional branch locations and 10 supermarket branches. The Corporation has an agreement with Super Rite Corporation to operate branches in their Metro and Basic supermarkets in the Baltimore Metropolitan area. As of December 31, 1995, Provident operated 10 supermarket branches with 6 more planned for 1996. Provident will selectively look for additional branch opportunities complementary to existing locations when the cost of entry is reasonable. Provident continues to attract increased commercial and retail deposits. Average retail demand deposit balances were up $29.2 million or 20% compared to 1994. During 1995, the Bank opened three Fast'N Friendly Check Cashing centers with the purpose of offering alternative banking services. The Corporation has four new centers planned for 1996. The table on page 14 presents the average deposit balances and rates paid for the five years ended December 31, 1995. As this table indicates, Provident has a stable base of consumer savings deposits. During 1995, average deposits grew $185 million or 14% compared to 1994. Demand deposits increased $30.2 million or 14.6%. This growth reflects Provident's emphasis on full banking relationships with its retail and commercial customers. Average time deposits increased $178.9 million or 45%, $130.3 million dollars of which is attributable to brokered deposits. Brokered deposits are utilized as a cheaper source of funds compared to other available sources of borrowed money. Savings and money market deposits declined $24.1 million as customers shifted their funds to higher priced products such as time deposits.\nCREDIT RISK MANAGEMENT\nMuch of the fundamental business of Provident is based upon understanding, measuring and controlling credit risk. Credit risk entails both general risk, which is inherent in the process of lending, and risk specific to individual borrowers. Each consumer and residential lending product has a generally predictable level of credit loss. For example, loans with generally low credit loss experience include home mortgage and home equity loans. Loans with medium credit loss experience are primarily secured products such as auto and marine loans. The category with high credit loss experience includes unsecured products such as personal revolving credit. In commercial lending, losses as a percentage of outstanding loans can vary widely from period to period and are particularly sensitive to changing economic conditions. The evaluation of specific risk is a basic function of underwriting and loan administration, involving analysis of the borrower's ability to service debt as well as the value of pledged collateral. Policies and procedures have been developed which specify the appropriate credit approval and monitoring for the various types of credit offered. The Bank employs prudent lending practices and adheres to regulatory requirements including loan to value ratios and legal lending limits. These procedures are modified periodically in order to reflect changing conditions and new products. The Bank's lending and loan administration staffs are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower's circumstances which may affect the ability to repay debt or the value of pledged collateral. In order to assess and monitor the degree of risk in the loan portfolio, credit risk identification and review processes are utilized. Credit risk analysis assigns a grade to each commercial loan based upon an assessment of the borrower's financial capacity to service the debt and the presence and value of collateral for the loan. An independent loan review function tests risk assessment and determines the adequacy of the allowance for loan losses. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 114\/118 -- \"Accounting by Creditors for Impairment of a Loan\" which became effective for the Corporation in 1995. This statement requires creditors to evaluate the collectibility of contractually due principal and interest on commercial credits to assess the need for providing for losses. The Corporation's credit procedures require monitoring of commercial credits to determine the collectibility of such credits. If a loan is identified as impaired, it will be placed on non-accrual status and recorded according to the provisions of the SFAS No. 114\/118. As of December 31, 1995, the Corporation had $140 thousand in commercial loans which were in non-accrual status and therefore considered to be impaired.\nLOANS\nThe following table sets forth information concerning the Bank's loan portfolio by type of loan at December 31.\nLOANS (in billions)\n[The following table is representative of the graph shown on the middle of page 16 of the Annual Report.]\nProvident offers a diversified mix of residential and commercial real estate, business and consumer loans. As shown in the table above, the mix of loans outstanding has shifted to more consumer orientation over the past five years. Growth in 1995 was experienced in all categories except residential mortgage where $281 million were securitized. Provident's residential mortgage lending includes the origination, sale and servicing of fixed and variable rate mortgage loans. Loans are originated through the loan production offices of Provident Mortgage Corp. The first half of 1995 experienced a continued slow down in mortgage origination activity with improved activity during the second half of the year as rates decreased. Originations totaled $417 million in 1995 compared to $505 million in 1994. In 1996, originations are projected to exceed 1995's production as the mortgage environment is expected to be better than 1995. The residential real estate mortgage loan balance at December 31, 1995 was $123 million compared to $417.5 million at the end of the prior year. This decline was the result of securitizing $281 million and transferring these assets to the investment portfolio. The securitization improved liquidity and the risk profile. (See page 22.) The servicing of residential mortgage loans may be retained or sold. During 1995, $301 million of servicing was sold contributing $2.5 million to the total mortgage banking revenues. The mortgage servicing portfolio ended the year at $1 billion. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 122 -- \"Accounting for Mortgage Servicing Rights\" -- which becomes effective for the Corporation in 1996. This statement requires mortgage banking enterprises that acquire mortgage servicing rights through either the purchase or origination of mortgage loans, and sells or securitizes those loans with servicing retained, to allocate the cost of the mortgage loans to the mortgage servicing rights and the loans. This statement is not expected to have any material affect on the results of the Corporation as it is the intent of the Corporation to sell all mortgage loans and servicing rights shortly after originating each loan. Provident offers a wide range of loans to consumers including installment loans, home equity loans, and personal lines of credit. In addition, the Bank may purchase portfolios of quality consumer loans from other financial institutions. All purchased portfolios go through a thorough due diligence process prior to a purchase commitment. Provident's portfolio of acquired loans increased $29 million on average, ending the year at $283.2 million, and is predominately comprised of second mortgages.\nConsumer credit originated by Provident ended the year with a balance of $495.3 million, an increase of 68%. The majority of the increase is the result of a new line of business started during the first quarter of 1995. The Bank makes automobile loans through a network of auto dealerships in Maryland, Delaware, Pennsylvania and Virginia. The Bank originated $169 million of auto loans during 1995 through this network. It is the Bank's intention to begin securitizing and selling these loans during 1996 to limit the concentration of this product as well as fund continued demand. Marine loan balances grew $20 million during 1995 totaling $134.7 million at year-end, and were produced primarily through correspondent brokers. Home equity lines of credit increased $11 million during the year and totaled $136.4 million at the end of 1995. The growth in home equity loans is attributable to a competitive line of products that has been well received in the market. Provident's focus in commercial real estate lending has been on financing commercial and residential construction, as well as on intermediate-term commercial mortgages. Properties securing the loans include office buildings, shopping centers, apartment complexes, warehouses, residential building lots and developments. Commercial real estate mortgage loans increased $13 million or 9.7% and commercial construction loans increased $4.2 million or 54%. Residential construction loans increased $16.4 million or 33% to end the year at $65.9 million. Provident's commercial loan portfolio consists of general business loans, including asset-based loans, primarily to small and medium sized businesses in the central Maryland region. The Bank stresses the importance of asset quality as well as the development of new marketing programs. Outstandings for the commercial loan portfolio were $205.9 million, an increase of $27.2 million from December 31, 1994. Provident has minimal exposure to highly leveraged transactions. HLTs totaled $18.8 million as of year-end, and all are performing in accordance with their contractual terms.\nNON-PERFORMING AND PAST DUE LOANS\n(as a percentage of period end loans)\n[The following table is representative of the graph shown at the top of page 17 of the Annual Report.]\nNon-performing assets include loans on which interest is no longer accrued, loans that are 90 days or more past due as of December 31 and still accruing interest because they are well secured and in the process of collection, and real estate and other assets that have been acquired through foreclosure or repossession. Information with respect to non-performing assets and past due loans is presented on page 18 for the years indicated. As shown in the table, total non-performing assets and past due loans increased $7.0 million ending the year at $14.8 million, compared to $7.8 million at December 31, 1994, mainly in the consumer and residential loan portfolios. Non-performing consumer loans increased $3.6 million as a result of a $294 million or 61% growth in the consumer loan portfolio. (See the discussion under LOANS.) Of the $8.5 million in non-performing residential mortgage loans, 73% or $6.2 million are guaranteed or insured by an agency of United States government and no significant loss is anticipated. Non-performing commercial business loans decreased $1 million to $60 thousand despite $27.2 million in loan growth. The ratio of total non-performing and past due loans to year-end loans grew to 1.06% from .57% at the end of 1994. Part of the increase is attributable to the securitization of $281 million of mortgage loans, thereby reducing the amount of outstanding loans. Presented below is interest income that would have been recorded on all non-accrual loans if such loans had been paid in accordance with their original terms and the interest income on such loans that was actually collected for the year.\nNON-PERFORMING ASSETS AND PAST DUE LOANS\nALLOWANCE FOR LOAN LOSSES\nProvident maintains an allowance for loan losses which is available to absorb potential losses. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. Determination of the adequacy of the allowance, which is performed quarterly, is accomplished by assigning specific reserves to individually identified problem credits and general reserves, based on historic and anticipated loss experience, to all other loans. The continued emphasis on loan quality and close monitoring of potential problem credits has resulted in a strong credit portfolio. As a result, the loan loss provision and net charge-offs remained at very acceptable levels throughout 1995. Senior managers meet at least monthly to review the credit quality of the loan portfolios and at least quarterly with Executive Management to review the adequacy of the allowance for loan losses. The allowance is determined by management's evaluation of the composition and risk characteristics of the loan portfolio. Based upon the evaluation of credit risk, provisions, in the form of charges to operations, are made to bring the allowance up to a level management believes is adequate. An analysis of the loan portfolio was performed at December 31, 1995, and expected losses have been provided for in the allowance for loan losses. During 1995 the loan loss allowance increased $569 thousand to $21.5 million at year-end. The allowance as a percentage of total loans decreased from 1.64% to 1.61%, primarily from the growth in loans during the year. The allowance for loan losses as a percentage of non-accrual and past due loans was 152% at December 31, 1995, compared to 290% the prior year. This decrease is attributable to the increase in non-performing and past due loans as discussed on page 17. The portion of the allowance which is allocated to non-performing loans is determined by estimating the potential loss on each credit after giving consideration to the value of underlying collateral.\nALLOCATION OF ALLOWANCE FOR LOAN LOSSES\nProvident maintains a loan classification and review system to identify those loans with a higher than normal risk of uncollectibility. Estimated potential losses from internally criticized loans have been provided for in determining the allowance for loan losses. The table above reflects the allocation of the allowance for loan losses to the various loan categories as required by the Securities and Exchange Commission. The entire allowance for loan losses is available to absorb losses from any type of loan.\nINVESTMENT SECURITIES PORTFOLIO\nThe following table sets forth information concerning the Bank's investment securities portfolio at December 31.\nProvident's investment activities include management of the $1.05 billion investment securities portfolio. The investment securities portfolio includes mortgage-backed securities, U.S. Government securities, municipals and other debt securities. In addition to investment securities, the Corporation invests in federal funds sold, reverse repos, mortgage loans held for sale and other short-term investments (referred to in total as the investment portfolio). The strategies employed in the management of these portfolios depend upon the liquidity, interest sensitivity and capital objectives and requirements of the Corporation. The Treasury Division executes these strategies. During 1995, Provident continued to enjoy a strong capital position, a high degree of liquidity, and a substantial level of core deposits. Management's principal objectives for the investment portfolio during 1995 were to maintain an appropriate level of quality, to insure sufficient liquidity in various interest rate environments while maximizing yield and to increase net income by utilizing excess capital. To successfully achieve these objectives, the Corporation employs off balance sheet and on balance sheet strategies. Total investment securities increased $188 million during 1995 as a result of securitizing $281 million of first mortgage loans while leveraging additional capital raised through the Corporation's dividend reinvestment plan. This increase was offset by funding needs for loan growth. The Corporation applies the provisions of Statement of Financial Accounting Standards No. 115 which requires investment securities to be segregated into three categories: 1) held to maturity, 2) trading, and 3) available for sale. Based on the provisions of the standard, all securities in the available for sale category must be measured at fair market value. The resulting gain or loss is excluded from revenue but is shown as a change in shareholders' equity. Trading securities must be measured at fair value and changes included in income for the period. Securities designated as held to maturity are carried at amortized cost. During 1995, the Financial Accounting Standards Board issued a special report on SFAS No. 115, which provided an opportunity to reclassify securities among trading account securities, securities available for sale and securities held to maturity. The permitted reclassification resulting from this one-time assessment does not call into question the intent of the Corporation's future investment classifications. On December 31, 1995, the Corporation transferred $400 million of securities from Held to Maturity to Securities Available for Sale. This transfer was the result of management's intention to maximize its flexibility to take advantage of future business opportunities. These securities were transferred at fair value and the respective holding gains\/losses were recognized as a separate component of stockholder's equity. As of December 31, 1995, $1.02 billion of the Corporation's $1.05 billion investment securities portfolio was classified as available for sale. At December 31, 1995, the available for sale portfolio included net unrealized gains of approximately $11.1 million, compared to net unrealized losses of $5.1 million at December 31, 1994. In addition to unrealized gains and losses, Provident realized $836 thousand in gains and $3.5 million in losses from the sale of securities from the available for sale portfolio in 1995. These sales were the result of management's continuous monitoring of the investment securities portfolio in terms of both credit quality and interest sensitivity. As of December 31, 1995, the Corporation had no investments classified as trading securities.\nLIQUIDITY AND SENSITIVITY TO INTEREST RATES ___________________________________________\nMATURITIES OF INVESTMENT SECURITIES PORTFOLIO\nThe following table presents the maturities of the Bank's investment securities portfolio at December 31, 1995.\nLIQUIDITY\nAn important component of the Bank's asset\/liability structure is the level of liquidity available to meet the needs of customers and creditors. Traditional sources of bank liquidity include deposit growth, loan repayments, maturities of investment securities and money market investments, asset sales, borrowings and interest received. Provident's Asset\/Liability Management Committee has established general guidelines for the maintenance of prudent levels of liquidity. The Committee continually monitors the amount and source of available liquidity, the time required to obtain it and its cost. Management believes the Bank has sufficient liquidity to meet funding needs in the foreseeable future. The primary sources of liquidity at December 31, 1995, were loans held for sale, securities available for sale and held to maturity securities maturing within one year, which totaled $1.10 billion. This represents 46% of total liabilities compared to 24% at December 31, 1994. Maturities of investment securities, as the table above indicates, is expected to generate $178 million in funds in 1996 and $663 million, or 63%, of the portfolio within the next five years. Another source of liquidity is scheduled loan repayments within one year, which totaled $465 million or 35% of loans as the table on page 23 indicates. Core deposits are valuable in assessing liquidity needs because they tend to be stable with little net short or intermediate-term withdrawal demands by customers. At year-end, core deposits represented $1.3 billion, or 56%, of total liabilities. An important element in liquidity management is the availability of borrowed funds. At December 31, 1995, short-term borrowings totaled $518 million, or 22%, of liabilities in contrast to $479 million, or 22%, of liabilities at December 31, 1994. This increase was used to fund growth in earning assets. The average maturity of short-term borrowings at the end of the current year was 2 months. These borrowings are fully collateralized by US government or mortgage-backed securities owned by the Bank. Long-term borrowings consisted of variable and fixed-rate advances from the Federal Home Loan Bank and totaled $268 million as of December 31, 1995. It is anticipated that Provident will continue to have access to the repurchase market and fed fund lines as well as short and long-term variable and fixed-rate funds from the Federal Home Loan Bank.\nLOAN MATURITIES AND RATE SENSITIVITY\nThe following table presents loan maturities and sensitivity at December 31, 1995.\nINTEREST SENSITIVITY MANAGEMENT\nThe nature of the banking business, which involves paying interest on deposits at varying rates and terms and charging interest on loans at other rates and terms, creates interest rate risk. As a result, earnings are subject to fluctuations which arise due to changes in the level and directions of interest rates. Management's objective is to minimize this risk. Measuring and managing interest rate risk is a dynamic process which is performed regularly as an important component of management's analysis of the impact of changes in asset and liability portfolios. Control of Provident's interest sensitivity position is accomplished through the structuring of the investment and funding portfolios, securitizing loans for possible sale, the use of variable rate loan products and off-balance sheet derivatives. Management does not try to anticipate changes in interest rates. Its principal objective is to maintain interest margins in periods of both rising and falling rates. Traditional interest sensitivity gap analyses alone do not adequately measure an institution's exposure to changes in interest rates because gap models are not sensitive to changes in the relationship between interest rates charged or paid and do not incorporate balance sheet trends and management actions. Each of these factors can affect an institution's earnings. Accordingly, in addition to performing gap analysis, management also evaluates the impact of differing interest rates on net interest income using an earnings simulation model. The model incorporates the factors not captured by gap analysis by projecting income over a twelve month horizon under a variety of interest rate scenarios. As of December 31, 1995, Provident's interest sensitive liabilities exceeded interest sensitive assets within a one year period by $370 million or 14% of assets. The Bank's savings products are structured to give management the ability to reset the rates paid on a monthly basis. This causes the Bank to become more liability sensitive. If interest rates rise, the rate paid on savings deposits may follow, and the Corporation's net interest margin may decline. Management continues to take steps to protect the Bank from possible increases in interest rates. In 1995 these steps included lengthening the maturities on purchased funds and certificates of deposits and shortening asset maturities with straight forward interest rate swaps and caps. Management monitors the interest rate environment and employs appropriate off balance strategies to address potential changes in interest rates. These strategies lower the net interest margin but are designed to maintain an acceptable margin in a rising rate environment. During 1995, off-balance sheet strategies had the effect of lowering interest income by $1.9 million and decreasing interest expense by $2.8 million. The current forward yield curve indicates that short-term rates will decrease by 75 basis points and long term rates are expected to decline 15 basis points over the next twelve months. The Corporation's analysis indicates that if management does not adjust its December 31, 1995 off-balance sheet positions and the current forward yield curve assumptions become reality, off-balance sheet positions will decrease net interest income by $1.6 million for the year 1996.\nSTOCKHOLDERS' EQUITY\nIt is necessary for banks to maintain a sufficient level of capital in order to sustain growth, absorb unforeseen losses and meet regulatory requirements. In addition, the current economic and regulatory climate places an increased emphasis on capital strength. In this environment, Provident continues to maintain a strong capital position. At December 31, 1995, total stockholders' equity was $184 million, a $34 million increase over the prior year. In addition to the ordinary adjustments to stockholders' equity of net income and dividends paid, additional capital was raised through the dividend reinvestment plan of $3.3 million and capital increased by $15.3 million during 1995 as a result of appreciation in securities classified as available for sale. During the second quarter of 1995, the Corporation issued a 5% stock dividend and all earnings per share figures have been adjusted for this dividend. Provident exceeds all regulatory capital requirements as of December 31, 1995. The standards used by federal bank regulators to evaluate capital adequacy are the risk-based capital and leverage ratio guidelines. Equity for regulatory purposes does not include market value adjustments for available for sale securities. Risk-based capital ratios measure core and total stockholders' equity against risk-weighted assets. Provident's core capital is equal to its common stock, capital surplus and retained earnings less treasury stock. The calculation of Provident's total stockholders' equity, for these purposes, is equal to the above plus the allowance for loan losses subject to certain limitations. Risk-weighted assets are determined by applying a weighting to asset categories and certain off-balance sheet commitments based on the level of credit risk inherent in the assets. At December 31, 1995, Provident's total capital ratio was 10.57% compared to the minimum regulatory guideline of 8%. In addition, core common stockholders' equity (Tier 1 Capital) must be at least 4% of risk-weighted assets. At year-end, Provident's Tier 1 Capital ratio was 9.43%. This ratio declined from 1994 as a result of significant favorable loan growth. The leverage ratio represents core capital, as defined above, divided by average total assets. Guidelines for the leverage ratio require the ratio of core stockholders' equity to average total assets to be 100 to 200 basis points above a 3% minimum, depending on risk profiles and other factors. Provident's leverage ratio of 7.08% at December 31, 1995, was well in excess of this requirement.\nCAPITAL COMPONENTS AND RATIOS\nFINANCIAL REVIEW 1994\/1993 __________________________\nFor the year ended December 31, 1994, Provident recorded net income of $12.5 million or $1.72 per share on a fully diluted basis, compared to $8.1 million or $1.17 per share reported in 1993. The per share amounts have been adjusted for a 5% stock dividend issued in 1995. This improvement in earnings was attributable to an $8.2 million rise in tax equivalent net interest income and a reduction of $1.0 million in the provision for loan losses. In addition, non-interest income, net of securities gains and the 1993 sale of the credit card portfolio, increased 35% or $6.9 million. These increases more than offset a $3.5 million increase in operating expense. Net interest income on a tax-equivalent basis for 1994 increased $8.2 million or 13% from 1993, the result of a 7 basis point increase in net interest margin and a $177 million increase in average interest earning assets. The increase in net interest margin was primarily a function of deposit rate increases lagging behind the changes in prime rate as well as an $11.9 million increase in non-interest-bearing liabilities. The provision for loan losses was $500 thousand in 1994 compared with $1.5 million in 1993. This decrease was the result of continued emphasis on quality underwriting and aggressive management of prior charge-offs and potential problem loans during the year. Non-interest income increased $158 thousand to $27.3 million in 1994. Excluding net securities gains and the 1993 sale of the credit card portfolio, non-interest income increased $6.9 million or 35%. Deposit service charges rose 43% over the prior year due to a 62% or $2.3 million increase in retail demand deposit service fees. Income from mortgage banking activities rose $4.0 million or 40% due mainly to a $6.5 million increase from the sales of mortgage servicing rights offset in part by a decline of $1.5 million in origination fee income. Income from sales of annuities and mutual funds through an affiliation with a securities broker-dealer increased $1.2 million to $2.0 million for 1994. Trading account profits decreased $416 thousand as there was no trading activity during 1994. Provident's non-interest expense rose 4.7% in 1994 over 1993. The 1993 operating expenses included $2 million in costs for the employee stock ownership plan (ESOP), most of which was related to the early payoff of the ESOP indebtedness. Net of the charges, 1994 operating expenses increased $5.6 million or 7.5%. Salaries and benefits net of the ESOP charges rose $2.2 million or 5.4% during the year. Compensation and payroll taxes account for $1.6 million of the increase and pension expense rose $542 thousand. Occupancy costs grew $310 thousand or 4.5% over 1993. The decision to close one branch accounted for $681 thousand of the expenses in 1993. Net of this charge, occupancy expenses increased $991 thousand or 15.8% caused mainly by the opening of additional mortgage and supermarket branches. Advertising costs increased $355 thousand or 8.1% largely due to promotion of new as well as existing consumer loan products. Provident recorded an income tax expense of $7.1 million in 1994 based on pre-tax income of $19.7 million, which represented an effective tax rate of 36.3%. This compares with a 36.2% effective tax rate for 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED STATEMENT OF INCOME Provident Bankshares Corporation and Subsidiaries\nCONSOLIDATED STATEMENT OF CONDITION Provident Bankshares Corporation and Subsidiaries\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY Provident Bankshares Corporation and Subsidiaries\nCONSOLIDATED STATEMENT OF CASH FLOWS Provident Bankshares Corporation and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Provident Bankshares Corporation and Subsidiaries\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following summary of significant accounting policies of Provident Bankshares Corporation and its subsidiaries (the \"Corporation\") is presented to assist the reader in understanding the financial and other data presented in this report. The accounting and reporting policies of the Corporation are in accordance with generally accepted accounting principles and conform to general practice within the banking industry. Certain prior years' amounts in the Consolidated Financial Statements have been reclassified to conform with the presentation used for the current year.\nCONSOLIDATION POLICIES\nThe Consolidated Financial Statements include the accounts of Provident Bankshares Corporation and its wholly owned subsidiary, Provident Bank of Maryland (the \"Bank\") and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nINVESTMENT SECURITIES\nThe Corporation adopted the provisions of Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\") effective December 31, 1993. Under SFAS No. 115, the Corporation divides the investment portfolio among three categories: securities held to maturity, securities available for sale and trading account securities (refer to section below, \"Trading Account Securities\"). Debt securities that the Corporation has the intent and ability to hold to maturity are included in securities held to maturity and, accordingly, are carried at cost adjusted for amortization of premiums and accretion of discounts using the interest method. Securities available for sale are securities the Corporation does not have the intent and ability to hold to maturity nor does it intend to trade actively as part of any trading account activity. Available for sale securities are reported at fair value with any unrealized appreciation or depreciation in value reported directly as a separate component of stockholders' equity as unrealized gain (loss) on debt securities which is reflected net of applicable taxes, and therefore, have had no effect on the reported earnings of the Corporation. Prior to December 31, 1993, securities available for sale (previously noted as Securities Held for Sale) were carried at the lower of aggregate cost or market value. This classification did not result in any charges to operations during its application. Gains and losses from sales of securities available for sale are recognized by the specific identification method.\nTRADING ACCOUNT SECURITIES\nTrading account securities are carried at market value. Realized and unrealized gains and losses are included in trading account profits.\nLOANS AND ALLOWANCE FOR LOAN LOSSES\nInterest on loans is accrued at the contractual rate and credited to income based upon the principal amount outstanding. It is the policy of management to discontinue the accrual of interest and reverse previously accrued but unpaid interest when the quality of the credit has deteriorated to the extent that collectibility of all interest and\/or principal cannot be reasonably expected or when it is 90 days past due unless it is well secured and in the process of collection. The Corporation adopted the provisions of Statement of Financial Accounting Standards No. 114\/118 \"Accounting by Creditors for Impairment of a Loan (\"SFAS No. 114\/118\") on January 1, 1995. Under SFAS No. 114\/118, the Corporation considers a loan impaired when, based on available information, it is probable that the Corporation will be unable to collect principal and interest when due in accordance with the contractual terms of the loan agreement. The measurement of impaired loans may be based on the present value of expected future cash flows discounted at the historical effective interest rate or based on the fair value of the underlying collateral. Impairment criteria are applied to the loan portfolio exclusive of smaller balance homogeneous loans such as residential mortgage and consumer loans which are evaluated collectively for impairment. The allowance for loan losses includes reserves for these loans. Collections of interest and principal on loans in nonaccrual status and considered impaired are generally applied as a reduction to the outstanding principal. Once future collectibility has been established, interest income may be recognized on a cash basis. The Corporation defers and amortizes loan origination fees and related costs over the life of the loan using the interest method. Net amortization of fees and costs are recognized in interest income as a yield adjustment and are, accordingly, reported as Interest and Fees on Loans in the Consolidated Statement of Income.\nThe Corporation's allowance for loan losses is based upon management's continuing review and evaluation of the loan portfolio and is intended to maintain an allowance adequate to absorb potential losses on loans outstanding. The level of the allowance is based on an evaluation of the risk characteristics of the loan portfolio and considers such factors as past and expected future loan loss experience, the financial condition of the borrower, current economic conditions and other relevant factors. Adjustments to the allowance due to changes in measurement of impaired loans are incorporated in the provision for loan losses. The adoption of SFAS No. 114\/118 has not resulted in any additional provision for loan losses for the year ended December 31, 1995.\nPREMISES AND EQUIPMENT\nPremises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the assets or, for leasehold improvements, the lives of the related leases, if shorter.\nSTOCKHOLDERS' EQUITY\nDuring 1995, the Corporation declared a five percent stock dividend on the Corporation's common stock to stockholders of record on May 1, 1995, payable on May 12, 1995. The stock dividend resulted in the distribution of 369,977 common shares with a par value of $1.00 per share. Accordingly, $370 thousand and $7.9 million was transferred from retained earnings to common stock and capital surplus, respectively. Earnings and dividends per share amounts and stock option data in the financial statements and accompanying notes have been restated to reflect the impact of the stock dividend.\nINCOME TAXES\nThe Corporation uses the liability method to determine deferred tax amounts and the related income tax expense or benefit. Using this method, deferred taxes are calculated by applying enacted statutory tax rates to temporary differences consisting of items of income and expense that are accounted for in financial reporting periods which differ from income tax reporting periods. The resultant deferred tax assets and liabilities represent future taxes to be recovered or remitted when the related assets and liabilities are recovered or settled. The deferred tax assets are reduced by a valuation allowance for that portion of the tax deferred assets which are unlikely to be realized.\nDERIVATIVE FINANCIAL INSTRUMENTS\nThe Corporation uses a variety of derivative financial instruments as part of its interest rate risk management strategy, (See Note 12). The Corporation does not hold or issue derivative financial instruments for trading purposes. The derivative products used are interest rate swaps and caps or floors, used separately or in combination to suit the hedge objective and are classified as hedges. To qualify as a hedge, 1) the asset or liability to be hedged exposes the Corporation to interest rate risk, 2) the derivatives act to move the Corporation to a rate insensitive position should interest rates change, and 3) the derivative is designed and is effective as a hedge of a balance sheet item. Interest rate swaps are agreements between two parties which agree to exchange fixed and floating rates on a notional principal amount without the actual exchange of principal for a specified period of time. The notional amounts are not reflected on the Consolidated Statement of Condition because they are merely a unit of measure to determine the effect of the swap. Income and expense on interest rate swaps associated with designated balance sheet items is recognized using the accrual method over the life of the agreement(s) as an adjustment to the income or expense on the designated balance sheet item. Premiums associated with interest rate floor\/cap\/corridor arrangements are reflected in the Consolidated Statement of Condition and amortized over their life using the straight-line method and included as an adjustment to interest income\/expense associated with the balance sheet item. Payments due to or from counterparties under these agreements are accrued as an adjustment to interest income or expense associated with the designated balance sheet item. The Corporation continually monitors each derivative position to ensure the proper relationship between the designated balance sheet item hedged and the derivative position. Any significant divergence between this relationship which results in interest income or expense exceeding projected parameters results in the hedge being marked-to-market with the resultant gain or loss included in earnings. Terminated derivative positions with the designated assets or liabilities retained have the resulting gain or loss deferred and amortized over the estimated remaining life of the hedge. Interest rate swaps used to hedge available for sale debt securities have their fair value included in stockholders' equity which is consistent with the fair value treatment of the available for sale securities. Interest accruals associated with the swap are included as an adjustment to interest income on the associated securities. Derivative products terminated prior to the sale of the related security have the respective gain or loss amortized over the life of the swap as long as the Corporation retains the security. Upon sale of the security, the deferred gain or loss on the derivative is reflected in income at the time of sale. Derivatives associated with liquidated hedged assets or liabilities are marked-to-market and have subsequent changes in their fair value reflected in earnings as the derivative is considered speculative in nature.\nPENSION PLAN\nThe Corporation has a defined benefit pension plan which covers substantially all employees. The cost of this noncontributory pension plan was computed and accrued using the projected unit credit method. Prior service cost is amortized on a straight-line method over the average remaining service period of employees expected to receive benefits under the plan.\nEARNINGS PER SHARE\nPrimary and fully diluted net income per common share are based upon the weighted average number of common shares outstanding and common stock equivalents for each year, as applicable.\nSTATEMENT OF CASH FLOWS\nFor purposes of reporting cash flows, cash equivalents are composed of cash and due from banks and short-term investments.\nNOTE 2 -- RESTRICTIONS ON CASH AND DUE FROM BANKS\nThe Federal Reserve requires banks to maintain cash reserves against certain categories of deposit liabilities. Such reserves averaged approximately $16.5 million and $14.2 million during the years ended December 31, 1995 and 1994, respectively. In order to cover the costs of services provided by correspondent banks, the Corporation maintains compensating balance arrangements at these correspondent banks or elects to pay a fee in lieu of such arrangements. During 1995 and 1994, the Corporation maintained average compensating balances of approximately $2.4 million and $2.1 million, respectively. In addition, the Corporation paid fees totaling $317 thousand in 1995 and $285 thousand in 1994 in lieu of maintaining compensating balances.\nNOTE 3 -- INVESTMENT SECURITIES\nThe aggregate amortized cost and market values of the investment securities portfolio at December 31 were as follows:\nThe aggregate amortized cost and market values of the investment securities portfolio by contractual maturity at December 31, 1995 and 1994, are shown below. Expected maturities on mortgage-backed securities may differ from the contractual maturities as borrowers have the right to prepay the obligation without prepayment penalties.\nProceeds from sales of securities available for sale during 1995 were $203.0 million resulting in the realization of gross gains of $800 thousand and gross losses of $3.5 million on such sales. For 1994, sales of securities yielded proceeds of $201.9 million which resulted in gross realized gains of $2.0 million and gross losses of $1.4 million.\nDuring 1995, the Financial Accounting Standards Board issued a special report on SFAS No. 115 which provided an opportunity to reclassify from securities held to maturity to securities available for sale. The permitted reclassification resulting from this one-time assessment does not call into question the intent of the Corporation's future investment classifications. On December 31, 1995, the Corporation transferred $385.2 million of securities from Securities Held to Maturity to Securities Available for Sale. The transfer was the result of management's intention to maximize its flexibility to take advantage of future business opportunities. These securities were transferred at fair value and the respective holding gains\/(losses) were recognized as a separate component of stockholders' equity. At December 31, 1995, a net unrealized gain of $6.8 million on the securities portfolio was reflected as a separate component of stockholders' equity in the Consolidated Statement of Condition as compared to a net unrealized loss of $8.5 million at December 31, 1994. The December 31, 1994, amount includes a $3.1 million unrealized loss attributable to the securities available for sale. The remaining $5.4 million unrealized loss was attributable to securities transferred to the securities held to maturity classification from the securities available for sale caption during 1994. The transfer occurred as a result of lower liquidity needs caused by declining credit demand. The securities were transferred at their fair value at the date of transfer. The unrealized loss was amortized over the remaining life of the securities using the level yield method. This amortization expense was offset by the amortization of the related discount on these securities created at the time of transfer and results in no net charge to earnings. The $5.4 million portion of the 1994 unrealized loss was reversed in 1995 due to the aforementioned transfer of securities from held to maturity to available for sale during 1995. The aggregate book and estimated market values of investment securities which exceed ten percent of capital at December 31, 1995, are indicated below.\nSecurities with a book value of $525.0 million and $505.5 million at December 31, 1995 and 1994, respectively, were pledged as collateral for public funds, certain short-term borrowings and for other purposes required by law.\nNOTE 4 -- ALLOWANCE FOR LOAN LOSSES\nA summary of the activity in the allowance for loan losses for the three years ended December 31 is presented below:\nAt December 31, 1995, 1994 and 1993, the recorded investment in loans which are in non-accrual status and therefore considered impaired totaled $140 thousand, $1.1 million and $137 thousand, respectively. There was no additional allowance required for these loans under the provisions of SFAS No. 114\/118. Interest income of $378 thousand, $35 thousand and $203 thousand was recognized on these loans in 1995, 1994 and 1993, respectively. Had these loans performed in accordance with their original terms, interest income of $680 thousand in 1995, $294 thousand in 1994 and $417 thousand in 1993 would have been recorded. For the year ended December 31, 1995, the average recorded investment in impaired loans was approximately $757 thousand.\nNOTE 5 -- PREMISES AND EQUIPMENT\nReal estate and equipment holdings at December 31 are presented in the table below. Real estate owned and used by the Corporation consists of six branches and other facilities in the metropolitan Baltimore area which are used primarily for the operations of the Bank.\nProperty Held for Future Expansion represents approximately 49,000 square feet of real estate adjacent to the Corporation's headquarters building which is currently being used for employee and public parking. Following an assessment of occupancy requirements, management determined that this property would be necessary to meet the Corporation's growing office and parking requirements. In December 1990, the Corporation entered into a sale and leaseback agreement whereby its headquarters building was sold to an unrelated third party which then leased the building back to the Corporation. In association with the sale, the Corporation financed $6.0 million of this arrangement with a market rate note which has recourse to other assets of the acquiror. The twelve year lease has two renewal options of five years each and contains an escalation clause which acts to increase rental payments throughout the lease term up to specified limits.\nThe associated gain of $2.6 million from the sale has been deferred and will be recognized in proportion to the gross rental expense incurred over the term of the lease. The associated lease payments and sublease rental income are included in the table below. The Corporation also maintains non-cancelable operating leases associated with Bank premises. Most of these leases provide for the payment of property taxes and other costs by the Bank and include one or more renewal options ranging up to ten years. Some of the leases also contain purchase options at market value. Annual rental commitments under all long-term non-cancelable operating lease agreements consisted of the following at December 31, 1995.\nRental expense for premises and equipment was $5.0 million in 1995, $4.8 million in 1994 and $4.5 million in 1993.\nNOTE 6 -- MORTGAGE BANKING ACTIVITIES\nThe Corporation engages in sales of mortgage loans, which are originated internally or purchased from third parties. Mortgage loans held for sale are carried at the aggregate lower of cost or market value. Gains or losses on sales of these mortgage loans are recorded as a component of Non-Interest Income in the Consolidated Statement of Income. Unpaid principal balances of loans serviced for others not included in the accompanying Consolidated Statement of Condition were $813.0 million and $465.9 million at December 31, 1995 and 1994, respectively. Acquisition costs of purchased mortgage servicing rights are capitalized and subsequently amortized over the estimated period of and in proportion to net servicing revenue. The following is an analysis of purchased and excess mortgage servicing rights for the years ended December 31, 1995, 1994, and 1993, respectively.\nRelative to purchased mortgage servicing rights, effective January 1, 1993, the Corporation altered its accounting practices to recognize the value of these rights at the lower of cost or discounted estimated future net servicing revenue. Prior to this date these assets were valued at the lower of cost or undiscounted estimated future net servicing revenue. The Corporation believes this change is preferable as it recognizes the changes in value associated with unanticipated prepayment of mortgages related to such rights on a more timely basis and is consistent with the required method for regulatory purposes. The cumulative effect of this change for the period prior to January 1, 1993, was $733 thousand after an income tax benefit of $461 thousand and is shown separately in 1993.\nNOTE 7 -- SHORT-TERM BORROWINGS\nAt December 31, the detail of short-term borrowings were as follows:\nSecurities sold under repurchase agreements at December 31, 1995, are detailed below by due date:\nNOTE 8 -- LONG-TERM DEBT\nLong-term debt consisted of Federal Home Loan Bank Advances of $267.9 million and $187.2 million at December 31, 1995 and 1994, respectively. The principal maturities of long-term debt at December 31, 1995, are presented below.\nThe Federal Home Loan Bank Advances to the Bank mature in varying amounts through 2000. These advances are composed of $177.1 million fixed rate advances with an average interest rate of 5.75% and $90.8 million variable rate advances with an average rate of 5.67%. These advances in addition to those included in short-term borrowings are collateralized by investment securities and certain real estate loans with carrying values of $281.4 million and $142.0 million, respectively, at December 31, 1995. During 1993, the Bank paid off the debt associated with the Employee Stock Ownership Plan (\"ESOP\") thereby eliminating the guarantee requirement for the Corporation.\nNOTE 9 -- INCOME TAXES\nThe components of income tax expense and the sources of deferred income taxes for the three years ended December 31 are presented below.\nTax expense (benefit) associated with investment securities gains\/(losses) was $(1.1) million in 1995, $223 thousand in 1994 and $1.2 million in 1993. During 1988, the Corporation sold its entire portfolio of adjustable rate preferred stocks which resulted in approximately a $12.4 million capital loss for financial reporting and income tax purposes. As a result of the tax rules applicable to capital losses, no corresponding tax benefit was recorded in 1988. During the period 1990 through 1993, the Corporation utilized all of the approximately $12.4 million of the capital loss carryforward. The primary sources of temporary differences that give rise to significant portions of the deferred tax asset and liability at December 31, 1995, are presented below.\nAt December 31, 1995 and 1994, no valuation allowance was required with respect to deferred tax assets. The combined federal and state effective tax rate for each year is different than the statutory federal income tax rate. The reasons for these differences are set forth below:\nNOTE 10 -- STOCKHOLDERS' EQUITY\nThe Corporation has a Stock Option Plan (the \"Option Plan\") which covers a maximum of 890 thousand shares of common stock that have been reserved for issuance under the Option Plan. The Option Plan provides for the granting of nonqualified stock options to certain key employees and directors of Bankshares and the Bank, as designated by the Board of Directors and have a maximum duration of ten years. Options are granted under the Option Plan at an exercise price not less than the fair market value of the underlying shares of common stock on the date of the grant and therefore have no associated expense. At December 31, 1995 and 1994, 366,555 and 27,906 shares were available for the granting of options under the Option Plan, respectively.\nThe following table presents share data related to options.\nAt the time of the Corporation's reorganization, a liquidation account was established by the Bank for the benefit of all eligible deposit account holders as of December 31, 1986 who maintain their accounts in the Bank subsequent to the Reorganization. The liquidation account provides these deposit account holders with an interest in the retained earnings of the Bank prior to any distribution to stockholders in the sole event of a complete liquidation. The deposit account holders' interest in the liquidation account decreases as the related deposit account decreases and will never increase. The liquidation account does not restrict the use or application of stockholders' equity of the Bank except that the Bank may not declare or pay a cash dividend on, or repurchase any of its capital stock if, as the result of such dividend or repurchase, the Bank's stockholders' equity would be less than the amount then required for the liquidation account. At December 31, 1995, the balance of the liquidation account was $14.3 million.\nNOTE 11 -- EMPLOYEE BENEFIT PLANS\nPENSION PLAN\nThe Corporation's non-contributory defined benefit pension plan covers substantially all full-time employees with at least one year of service and provides monthly benefits upon retirement to participants based on average career earnings and length of service. The Corporation's 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, as amended, plus such additional amounts as the Corporation deems appropriate. The following table sets forth the defined benefit plan's funded status at January 1:\nThe actuarially estimated net pension cost for the year ended December 31 includes the following components:\nThe Corporation revises the rates applied in the determination of the actuarial present value of the projected benefit obligation to reflect the anticipated performance of the plan and changes in compensation levels.\nPlan assets are primarily comprised of equity securities, and short-term and long-term debt securities. The unrecognized net asset arising at transition is being amortized over 15.6 years. The plan held no shares of the Corporation's common stock at December 31, 1995, 1994 and 1993.\nRETIREMENT SAVINGS PLAN\nThe Retirement Savings Plan is a defined contribution plan which is qualified under Section 401(a) of the Internal Revenue Code of 1986. The plan generally allows all employees who complete 500 hours of employment during a six month period and elect to participate, to receive matching funds from the Corporation for pre-tax retirement contributions made by the employee. The annual contribution to this plan is at the discretion of and determined by the Board of Directors of the Corporation. Contributions to this plan amounted to $441 thousand, $403 thousand and $369 thousand for the years ended December 31, 1995, 1994 and 1993, respectively.\nEMPLOYEE STOCK OWNERSHIP PLAN\nThe Employee Stock Ownership Plan (\"ESOP\") is a defined contribution plan which is qualified under Section 401(a) of the Internal Revenue Code of 1986. This plan covered all employees 21 years of age or older and employed as of December 31, 1993. Under the Plan, the ESOP purchased 457 thousand shares of the Corporation's common stock with borrowed funds (see Note 8). A portion of the common stock was held in the ESOP and released to the participants' accounts each year, based upon the reduction in the ESOP indebtedness during the year. The amount of released common stock was allocated to each participant's account based upon their salary in the respective year. The Bank incurred compensation expense based on cash contributed to the ESOP, the purpose of which was to service the related debt which was retired during 1993. Presented below is data for 1993 with respect to the ESOP.\nThe ESOP was terminated during 1995 and benefits were distributed to participants.\nPOSTRETIREMENT BENEFITS\nIn addition to providing pension benefits, the Corporation provides certain health care and life insurance benefits to retired employees. Substantially all employees of the Corporation that reach retirement age may become eligible for these benefits, generally contingent upon the completion of twenty years of service. The health care plan is contributory where the retiree is responsible for all premiums in excess of the Corporation's contribution. The Corporation's contribution is capped at a growth rate of 4% per year. The cost of life insurance benefits provided to the retiree is borne by the Corporation. At December 31, 1995 and 1994, this plan is unfunded. As of January 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\"). Under the prospective transition approach, the transition obligation is amortized over a twenty-year period. The following tables set forth the plan's funded status reconciled with amounts reported in the Corporation's financial statements at December 31:\nThe actuarially estimated net postretirement benefit cost for the year ended December 31:\nNOTE 12 -- OFF-BALANCE SHEET RISK\nIn the normal course of business, the Bank offers various financial products to its customers to meet their credit and liquidity needs. These instruments involve, to varying degrees, the elements of credit and market risk which may exceed any amount recognized in the financial statements. Risks that are inherent in normal banking services also exist in some of these financial instruments. Contract amounts of the instruments indicate the maximum exposure the Bank has in each class of financial instruments discussed in the following paragraphs. These commitments and contingencies are not reflected in the accompanying financial statements. Unless noted otherwise, the Bank does not require collateral or other securities to support financial instruments with credit risk. Subject to its normal credit standards and risk monitoring procedures, the Bank makes contractual commitments to extend credit. Commitments to extend credit in the form of consumer, commercial real estate and commercial business loans amounted to $273.3 million and $246.9 million at December 31, 1995 and 1994, respectively. Commitments typically have fixed expiration dates or other termination clauses. The total of commitments does not necessarily represent future cash requirements as many commitments may expire without being exercised. Collateral and amounts thereof are obtained, if necessary, based upon management's evaluation of each borrower's financial condition. Required collateral may be in the form of cash, accounts receivable, inventory, property, plant and equipment and income generating commercial properties and residential properties. The Bank is obligated under various recourse provisions related to sales of residential mortgage loans. The maximum potential recourse obligation was $ 21.5 million and $30.3 million at December 31, 1995 and 1994, respectively. No losses have been incurred under these recourse provisions. Conditional commitments are issued by the Bank in the form of performance stand-by letters of credit which guarantee the performance of a customer to a third party. These letters of credit are typically included in the amount of funds committed by the Bank to complete associated construction projects. At December 31, commitments under outstanding performance stand-by letters of credit aggregated $ 18.5 million in 1995 and $ 13.2 million in 1994. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank enters into agreements for the delivery of securitized mortgage pools at a future date at a specified price or yield. The inability of counterparties to meet the terms of these contracts and movements in the value of securities and interest rates imposes risk on the Bank. Forward contracts aggregated $ 110.1 million and $80.1 million at December 31, 1995 and 1994, respectively, however management does not feel that any significant amounts are at risk with regard to these contracts. The Bank enters into various derivative financial instruments to manage its interest rate risk exposure (see Note 1). The two major types used are interest rate swaps and interest rate floor\/cap\/corridor arrangements. These derivative financial instruments use notional amounts to represent a unit of measure but not the amount subject to accounting loss, which is much smaller. Risks in these transactions involve nonperformance by counterparties under the terms of the contract (counterparty credit risk) and, for interest rate swaps, the possibility that interest rate movements or general market volatility could result in losses on open off-balance sheet positions (market risk). Credit risk is controlled by dealing with well-established brokers which are highly rated by independent sources. Market risk on interest rate swaps is minimized by using these instruments as hedges, actively managing interest rate risk and by continually monitoring these positions. Market risk associated with the interest rate floor\/cap\/corridor arrangements only exist when premiums are amortized into interest expense without receiving any compensation from third parties. Unamortized premiums paid and outstanding for floor\/cap\/corridor arrangements were $ 1.9 million at December 31, 1995, and $3.1 million at December 31, 1994.\nNotional amounts of interest rate swaps and interest rate floor\/cap\/ corridor arrangements are detailed below by amounts outstanding, average interest rates\/fees and market values at December 31, 1995 and 1994.\nFor the year ended December 31, 1995, $73.0 million of the interest rate swaps hedged the exposure that the securities available for sale had to declining market values as a result of increasing interest rates. The remaining $82.3 million in swaps was utilized to hedge the interest rate risk inherent in short-term borrowings. The interest rate corridors protect the net interest margin from the impact of increases in savings deposit rates during periods of rising interest rates. The interest rate floors were purchased to hedge the impact of loan repricing on net interest income in future years.\nThe following is an analysis of the activity with regards to interest rate swaps and interest rate floor\/cap\/corridor arrangements for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995, the Corporation had deferred gains of $3.1 million and deferred losses of $10.7 million related to terminated contracts. These deferred gains and losses will be amortized over 1.3 and 2.5 years, respectively. The Corporation had deferred gains of $6.6 million and deferred losses of $13.8 million related to terminated contracts which were amortized as a yield adjustment over 2.3 and 3.9 years, respectively, at December 31, 1994. The notional maturities of the interest rate swaps and interest rate floor\/cap\/corridor arrangements at December 31, 1995, are presented below.\nIn addition to the previously mentioned commitments and contingencies, there are various legal proceedings against the Bank. Management believes that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the consolidated financial position of the Corporation.\nNOTE 13 -- CONCENTRATIONS OF CREDIT RISK\nThe Corporation's investment portfolio contains mortgage-backed securities amounting to $920.4 million and $709.8 million at December 31, 1995 and 1994, respectively. The underlying collateral for these securities is in the form of pools of mortgages on residential properties. The majority of the securities are either directly or indirectly guaranteed by U.S. Government agencies or corporations. Management is of the opinion that credit risk is minimal. Construction and mortgage loan receivables from real estate developers represent $217.7 million and $190.5 million of the total loan portfolio at December 31, 1995 and 1994, respectively. Substantially all loans are collateralized by real property or other assets. These loans are expected to be repaid from the proceeds received by the borrowers from the retail sales or rentals of these properties to third parties.\nNOTE 14 -- OTHER NON-INTEREST INCOME AND EXPENSE\nThe components of other non-interest income and other non-interest expense for the three years ended December 31 were as follows:\nNOTE 15 -- FAIR VALUE OF FINANCIAL INSTRUMENTS\nDuring 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107 \"Disclosure about Fair Value of Financial Instruments.\" This statement requires all entities to disclose the fair value of recognized and unrecognized financial instruments on a prospective basis, where practicable, in an effort to provide financial statement users with information in making rational investment and credit decisions. To estimate the fair value of each class of financial instrument, the Corporation applied the following methods using the indicated assumptions:\nCASH AND DUE FROM BANKS AND SHORT-TERM INVESTMENTS\nCarrying amount of those investments is used to estimate fair value.\nMORTGAGE LOANS HELD FOR SALE\nFair value for mortgage loans held for trading or sale was determined using forward contract commitment pricing for the majority of these loans. Loans not specifically allocated to a forward commitment have been priced using quoted prices for commitments into which these mortgages would be placed in the future.\nSECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY\nThe fair values of the securities are based on quoted market prices or dealer quotes for those investments.\nLOANS\nFair value of loans which have homogeneous characteristics, such as residential mortgages and installment loans, was estimated using discounted cash flows. All other loans were valued using discount rates which reflected credit risks of the borrower, types of collateral and remaining maturities.\nDEPOSIT LIABILITIES\nFair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nSHORT-TERM BORROWINGS AND LONG-TERM DEBT\nRates currently available to the Corporation for borrowings and debt with similar terms and remaining maturities are used to estimate fair value of the existing debt.\nINTEREST RATE ARRANGEMENTS\nThe fair value of interest rate swaps and floor\/cap\/corridor arrangements, which the Corporation uses for hedging purposes, is the estimated amount the Corporation would receive or pay to terminate the arrangements at the reporting date, taking into account the current interest rates and the current credit worthiness of the counterparties.\nCOMMITMENTS TO EXTEND 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 credit worthiness of the borrowers. Fixed-rate loan commitments also take into account the difference between current levels of interest rates and committed rates.\nThe estimated fair values of the Corporation's financial instruments at December 31 are as follows:\nNOTE 16 -- PARENT COMPANY FINANCIAL INFORMATION\nThe condensed statements of income, financial condition and cash flows for Provident Bankshares Corporation (parent only) are presented below.\nSTATEMENT OF INCOME\nREPORT OF COOPERS & LYBRAND L.L.P., INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Provident Bankshares Corporation Baltimore, Maryland\nWe have audited the accompanying consolidated statement of condition of Provident Bankshares Corporation and subsidiaries (Corporation) as of December 31, 1995, and 1994, and the related consolidated statement 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. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Provident Bankshares 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. As discussed in Note 1 and Note 6 to the consolidated financial statements, the Corporation changed its method of accounting for certain debt securities at December 31, 1993, and purchased mortgage servicing rights in the year ended December 31, 1993.\n\/s\/ Coopers & Lybrand L.L.P. Coopers & Lybrand L.L.P. Baltimore, Maryland January 18, 1996\nFINANCIAL REPORTING RESPONSIBILITY\nCONSOLIDATED FINANCIAL STATEMENTS\nProvident Bankshares Corporation (the \"Corporation\") is responsible for the preparation, integrity and fair presentation of its published consolidated financial statements as of December 31, 1995, and the year then ended. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and, as such, include amounts, some of which are based on judgements and estimates of management.\nINTERNAL CONTROL STRUCTURE OVER FINANCIAL REPORTING\nManagement maintains a system of internal control over financial reporting, including controls over safeguarding of assets against unauthorized acquisition, use or disposition which is designed to provide reasonable assurance to the Corporation's management and board of directors regarding the preparation of reliable published financial statements and such asset safeguarding. The system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified. This system encompasses activities that control the preparation of the Corporation's Annual Report\/10-K financial statements prepared in accordance with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time. Management assessed its internal control structure over financial reporting as of December 31, 1995. This assessment was based on criteria for effective internal control over financial reporting described in \"Internal Control--Integrated Framework\" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that Provident Bankshares Corporation maintained an effective internal control structure over financial reporting as of December 31, 1995.\nCOMPLIANCE WITH LAWS AND REGULATIONS\nManagement is also responsible for compliance with the federal and state laws and regulations concerning dividend restrictions and federal laws and regulations concerning loans to insiders designated by the FDIC as safety and soundness laws and regulations. Management assessed its compliance with the designated laws and regulations relating to safety and soundness. Based on this assessment, management believes that Provident Bank of Maryland, the wholly owned subsidiary of Provident Bankshares Corporation complied, in all significant respects, with the designated laws and regulations related to safety and soundness 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\nThe text and tables under \"Election of Directors\" in the Corporation's 1996 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe text and tables under \"Compensation of Officers and Directors\" in the Corporation's 1996 Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEIFCIAL OWNERS AND MANAGEMENT\nThe text and tables under \"Voting Securities and Principal Holders Thereof\" and \"Election of Directors\" in the Corporation's 1996 Proxy Statement are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe text under \"Certain Transactions with Management\" in the Corporation's 1996 Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL SATEMENT 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. PROVIDENT BANKSHARES CORPORATION (Registrant)\nJanuary 30, 1996 BY \/s\/Carl W. Stearn ______________________________________________ Carl W. Stearn 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 capacity and on the dates indicated.\nPrincipal Executive Officer:\nJanuary 30, 1996 BY \/s\/Carl W. Stearn ______________________________________________ Carl W. Stearn Chairman of the Board and Chief Executive Officer\nPrincipal Financial Officer:\nJanuary 30, 1996 BY \/s\/James R. Wallis ______________________________________________ James R. Wallis Chief Financial Officer\nPrincipal Accounting Officer:\nJanuary 30, 1996 BY \/s\/R. Wayne Hall ______________________________________________ R. Wayne Hall Treasurer\nA Majority of the Board of Directors* Robert B. Barnhill, Jr., Melvin A. Bilal, Dr. Calvin W. Burnett, Charles W. Cole, Jr., M. Jenkins Cromwell, Jr., Pierce B. Dunn, Clivie C. Haley, Jr., Mark K. Joseph, Norman J. Louden, Peter M. Martin, Ronald L. Mason, Sr., Sister Rosemarie Nassif, C. William Pacy, Francis G. Riggs, Sheila K. Riggs, Carl W. Stearn, Thomas J.S. Waxter, Jr.\nJanuary 30, 1996 *BY \/s\/R. Wayne Hall _____________________________________________ R. Wayne Hall Attorney-in-fact","section_15":""}
{"filename":"846801_1995.txt","cik":"846801","year":"1995","section_1":"Item 1 - Business\nThe principal executive offices of People's Savings Financial Corp. (the \"Company\") and of The People's Savings Bank of New Britain (the \"Bank\") are located at 123 Broad Street, New Britain, Connecticut 06053. The telephone number of the Company and the Bank is (203)224-7771.\nThe Company was organized as a corporation under the laws of the State of Connecticut on February 22, 1989, to operate principally as a bank holding company for the Bank. The Bank's shareholders approved the acquisition by the Company of all of the outstanding common stock of the Bank (the \"Bank Common Stock\") in exchange for shares of common stock of the Company (the \"Company Common Stock\"). The Bank is the sole subsidiary of the Company and its principal asset. As of December 31, 1995, the Company had total consolidated assets of $410.2 million, total consolidated deposits of $339.4 million, consolidated net loans of $236.8 million and consolidated shareholders' equity of $44.7 million. As of December 31, 1994, the Bank had total assets of $402.1 million, total deposits of $321.7 million, net loans of $226.3 million and shareholders' equity of $41.2 million.\nThe Bank was originally organized in 1907 as a Connecticut-chartered mutual savings bank, and converted to a Connecticut-chartered capital stock savings bank on August 27, 1986. The Bank currently offers general banking services, including accepting deposits from the general public and lending or investing those funds and also offers trust services. In addition to its main office, the Bank operates seven banking branches located in New Britain, Southington, Newington, Rocky Hill, and Plainville, Connecticut. The Bank will open its eight branch in Meriden, CT in early spring 1996.\nPrincipal Market Area\nThe Bank's principal market encompasses the City of New Britain and the Towns of Berlin, Newington, Southington, Rocky Hill, Plainville and Meriden. Although traditionally servicing the banking needs of New Britain's Polish community, the Bank has expanded its customer base over the past several years. The Bank intends to continue to focus its marketing efforts in the next several years on other segments of the New Britain community and upon residents of other towns in its market area.\nThe City of New Britain is evolving from a primarily industrial economy to an industrial-commercial-service economy. The surrounding communities are largely residential but also have significant industrial and commercial activities. The transfer of several major manufacturing facilities to other areas of the country continues to affect adversely the New Britain area labor market.\nLending and Investment Activities\nThe Bank provides personalized financial services to its existing customers and intends to achieve growth by increasing its customer base in New Britain and by increasing its services to, and expanding its customer base in, the communities surrounding New Britain. The Bank's principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. A substantial portion of the loans and investments originated over the last five years has been on a short-term or variable-rate basis, although origination of more traditional fixed-rate mortgage loans increased during the low interest rate environment in 1993. The Bank has originated more adjustable rate loans with the rise in interest rates during 1994 and 1995. During 1991 through 1995, maturities on both mortgages and investments were extended to take advantage of higher yields on longer maturities. Fixed rate mortgages and loans are originated with 8 to 30 year maturities, while maturities on some investments were extended to 5 to 7 years. The Bank sold the majority of the 30-year fixed rate mortgages which it originated during 1994 and 1995 in order to reduce the Bank's interest rate risk exposure. The Bank's activities in this regard will vary in degree from time to time depending upon investment opportunities, economic and rate conditions, liability strategy and the Bank's efforts to maintain an adequate net interest spread.\nSince the conversion to a capital stock savings bank, the Bank has regulated its efforts to increase future deposit growth based on its assessment of the profitability of the investment options then available for such funds.\nThe Bank also seeks to expand existing and develop additional fee-based services. Current fee-based product lines include mortgage originations, selling and servicing mortgages (the income from which is not considered a significant part of the Bank's operations), checking accounts, and Savings Bank Life Insurance.\nDuring 1993, the Bank also added a Trust Department and an Investment Services Department to increase fee income. In November 1994, the Bank purchased the New Meriden Trust Co., a trust company with $179,000,000 in trust assets from the FDIC. In May, 1995 the Bank opened a trust office in Middletown, CT. Trust assets grew to $310 million at December 31, 1995.\nAverage Balance Sheets; Analysis of Net Interest Income; and Analysis of Changes in Interest Income and Interest Expense\nThe supplementary information required by Item I of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to average balance sheets; an analysis of net interest income; and an analysis of increases and decreases in interest income and expense in terms of changes in volume and interest rates appears on pages 19 and 20 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nLending Activities\nThe supplementary information required by Item III.A. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to the composition of the loan portfolio appears on page 13 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nThe Bank's net loan portfolio totaled $236.8 million, excluding loans held for sale, as of December 31, 1995, representing 57.7% of total assets. The Bank's principal lending activity consists of the origination of mortgage loans on residential property.\nThe Bank's consumer loans continue to be an important aspect of its lending activities, representing 13.6% of the Bank's total loan portfolio.\nIn order to diversify its loan products the Bank established a commercial loan department to provide traditional commercial loans and Small Business Administration loans. The void resulting from industry consolidation and downsizing has created an opportunity for the Bank to respond to the credit needs of small and medium size business in a timely manner with practical and effective solutions. The Bank hired a team of experienced commercial lending officers to build a conservative, high-quality commercial loan portfolio. As of December 31, 1995, the commercial mortgage portfolio totaled approximately $5.9 million, representing 2.5% of the Bank's total loan portfolio.\nThe lending activities of the Bank are heavily influenced by economic trends affecting the availability of funds and by general interest rate levels. In originating loans, the Bank must compete with other savings banks, savings and loan associations, commercial banks, mortgage companies, insurance companies and other financial intermediaries.\nResidential Mortgage Loans. The Bank actively solicits residential mortgage loan applications from existing customers, builders and Realtors. Almost all of the Bank's residential mortgage loans are made to borrowers who occupy the properties securing their loans. While the Bank is authorized to make loans secured by real estate located either within or outside the State of Connecticut, its policy is to concentrate on loans secured by properties located within Connecticut, particularly in its primary market area. The Bank originates residential real estate loans through all eight of its offices. The Bank's mortgage originations decreased by 25% from 1994 to 1995, primarily due to a sluggish real estate market and increased competition. As of December 31, 1995 residential mortgage loans were 80.6% of the Bank's total loans.\nFor its own portfolio, the Bank originates adjustable-rate and selected fixed-rate first mortgage loans secured by residential properties. In 1993 and 1992 the Bank sold a significant number of its 30-year, 20-year and 15-year fixed-rate mortgage loans and in 1994 and 1995 sold some of its 30-year and 20-year fixed rate loans generated in those years. Points are charged on all residential mortgage loans unless the borrower elects to pay a higher interest rate to offset points.\nDuring 1994 the Bank started offering adjustable-rate loans that are fixed for the first three, five or seven years and then adjust every year after the fixed period. In 1995 the Bank started offering adjustable-rate loans that are fixed for the first ten years and then adjust every year after the fixed period. Adjustable-rate mortgages carry an interest rate cap which limits the Bank's ability to vary the rate at the time of adjustment and over the life of the loan. The annual interest rate cap is 2% and the lifetime cap is 6%, although the Bank in the past had an adjustable rate mortgage loan program with an 8% lifetime cap. Interest rate caps limit both increases and decreases in rate. The Bank bases its adjustable-rate mortgages on indices that are best matched to the repricing of its liabilities.\nFixed-rate first mortgage loans constituted approximately 37.3% of net loans as of December 31, 1995, down from 40.8% as of December 31, 1994.\nThe volume of first mortgage loan originations since 1990 is shown in the following table:\nYear Ended Number of Total Loans December 31, Loans Originated ------------ ----- ----------\n1991 397 44,344,000 1992 795 81,485,000 1993 721 73,072,000 1994 432 47,237,000 1995 305 35,338,000\nDespite the benefits of adjustable-rate mortgages to the Bank's asset\/liability management program, they do pose potential additional risks, primarily because as interest rates rise, the underlying payments by the borrower rise, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. It is difficult to quantify the risks resulting from increased costs to the borrower as a result of periodic repricing of adjustable-rate mortgages. The risk associated with holding fixed rate mortgages in the Bank's loan portfolio is that during periods of rising interest rates, their value decreases and the initial positive spread over the Bank's cost of funds may become negative. The benefits of holding fixed rate mortgages include a larger initial positive spread, increased cash flows and the average life of the loans are usually shorter than the stated maturity.\nIn its residential real estate lending, the Bank follows the underwriting requirements of Federal National Mortgage Association and Federal Home Loan Mortgage Corporation. The Bank lends up to 95% of the appraised value of owner-occupied property and up to 70% of the value of non-owner-occupied property. Under a special program for first time home buyers the Bank has lent up to 97% of the appraised value of the owner-occupied property. Residential borrowers are required to obtain private mortgage insurance covering any excess on loans with over 80% loan-to-value ratios. All conventional first mortgages include \"due-on-sale\" clauses, which give the lender the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property that secures the loan.\nLoans Held for Sale. At December 31, 1995, loans held for sale totaled $927,000, with a market value of $927,000.\nCommercial Loans. As of December 31, 1995, commercial and commercial real estate loans totaled $519,000, compared to $329,000 at December 31, 1994. Commercial loans constituted 0.2% of the Bank's total loans as of December 31, 1995.\nThe Bank's commercial mortgage loans are directly originated and consist of loans made on multifamily homes (more than four units) and loans collateralized by non-residential properties. Commercial mortgage loans collateralized by non-residential properties as of December 31, 1995 totaled $5.9 million, compared to $4.2 million as of December 31, 1994. Commercial mortgage loans collateralized by non-residential properties constituted 2.5% of total loans as of December 31, 1995. Loans made on multifamily homes constituted 1.6% of total loans, or $3.9 million, as of December 31, 1995, compared to $3.9 million at December 31, 1994. The Bank lends up to 80% of the appraised value of commercial property. Generally, the size of commercial mortgage loans is less than $300,000, with the largest loan totaling $737,000.\nConstruction Loans. As of December 31, 1995, residential construction loans totaled approximately $3.9 million, or 1.6% of the Bank's total loans, compared to $3.1 million, or 1.4% of total loans as of December 31, 1994. The Bank's limited construction loan investments are generally short-term (1-2 years) and are presently limited to residential properties in Connecticut. Construction loan applications are underwritten as if they were applications for permanent financing, obviating the need for a commitment for permanent financing at the close of the construction period.\nConsumer Loans. Connecticut savings banks are authorized by statute to invest their assets in secured and unsecured consumer loans without limitation. Connecticut savings banks may also invest their assets, without restriction as to a percentage of assets, in lines of credit, overdraft loans, and credit card outstandings. The Bank's consumer loans include home improvement loans, automobile and boat loans and loans to pay for medical or vacation expenses. In October of 1994 the Bank started offering its own MasterCard and Visa credit cards. The Bank originates both fixed and adjustable rate second mortgage loans for its own portfolio and offers a variable rate pre-approved consumer line of credit product secured by the equity in the consumer's home.\nThe Bank also is authorized to make educational loans under the Connecticut Guaranteed Student Loan Program. The interest on loans in this program is partially subsidized and is fully guaranteed by the federal government. At December 31, 1995, the Bank had sold substantially all of its education loans to the Student Loan Marketing Association (Sallie Mae) prior to conversion of such loans to amortizing loans.\nTotal consumer loans (excluding credit card loans) increased from $29.0 million at December 31, 1994 to $30.8 million at December 31, 1995. Although not classified as collateral loans, approximately 99% of the Bank's installment loans are secured by mortgages on real property or security interests in personal property. Collateral loans, secured by either regular savings accounts, marketable securities, or certificates of deposit, amounted to approximately $1.9 million at December 31, 1995 and December 31, 1994. Credit card loans totaled $1.3 million at December 31, 1995 as compared to $.5 million at December 31, 1994.\nInterest Rates. Interest rates charged by the Bank on its loans are primarily determined by the cost of funds to the Bank, competitors' rates and\ncomparable investment alternatives available to the Bank. Federal law preempts state usury limits on interest, origination fees and all related charges for federally related mortgage loans secured by first liens on residential real property, and no action has been taken by the Connecticut legislature (as permitted by Federal law) to reimpose such state limits.\nThe supplementary information required by Item III.B. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to maturities and sensitivities of loans to changes in interest rates appears on page 16 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nLoan Commitments. The Bank's commitments to make mortgage loans on existing residential and commercial real property are made for periods of up to 120 days from the date of commitment. Such commitments are generally made at the market rate of interest prevailing at the time that the commitment is made to the customer. The rate on the commitment is guaranteed for a period of 60 days.\nLoan Origination Fees and Other Fees. In addition to interest earned on loans, the Bank receives loan origination fees for originating residential and commercial mortgage loans. These fees, commonly called \"points\", are paid by borrowers from their own funds and are not netted from the face amount of a mortgage loan. Loan origination fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the loan's yield over the life of the loan. Origination fees on loans sold by the Bank are taken into income currently.\nThe Bank also receives other fees and charges relating to existing loans, which include primarily late charges. In connection with its mortgage loan origination activities, the Bank also receives application fees. These fees do not constitute a material source of income to the Bank.\nRisk Elements in the Loan Portfolio. The Bank's loans are regularly reviewed by management. If contractually due principal and interest payments on any loan are not received 15 days after the due date of the overdue payment, the Bank institutes monitored efforts to restore such loan to current status. Loans are classified as non-accrual and placed on a cash basis for purposes of income recognition when the collectibility of interest and principal becomes uncertain. All loans past due 90 days are treated as non-accrual loans. Generally, payments received are recorded as principal only after the interest is brought current. Continued unsuccessful collection efforts lead to initiation of foreclosure or other legal proceedings.\nProperties carried as foreclosed real estate have either been acquired through foreclosure or by deed in lieu of foreclosure, and is carried at the lower of (1) carrying value of loan, including costs of foreclosure, or (2) estimated fair value of the real estate acquired less estimated cost to sell. At the time of foreclosure, the excess, if any, of the loan value over the estimated fair value of the property acquired is charged to the allowance for loan losses. Subsequent to the time of foreclosure, reductions in the carrying value of foreclosed properties due to further declines in fair value or losses on their sale are recognized through charges to foreclosed real estate expense. Costs relating to the subsequent development or improvement\nof the property are capitalized; and holding costs are charged to foreclosed real estate expense in the period in which they are incurred.\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 114\") which was later amended in October of 1994 by SFAS 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.\" SFAS 114 and SFAS 118, which the Bank adopted in 1995, requires creditors to evaluate the collectibility of both contractual interest and contractual principal of all loans when assessing the need for a loss accrual. When a loan is impaired, a creditor shall measure impairment based on the present value of the expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral, less estimated selling costs, if the loan is collateral-dependent and foreclosure is probable. The creditor shall recognize an impairment by creating a valuation allowance. The adoption of these pronouncements did not have a material impact on the Bank's financial condition or results of operations.\nThe supplementary information required by Item III.C. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to the discussion and statistical disclosure of non-accrual, past due and restructured loans appears on pages 14 and 15 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nThe Company has not made loans to borrowers outside the United States. At December 31, 1995, there were no concentrations of loans exceeding 10% of total loans. A concentration of loans is defined as an amount loaned to multiple borrowers engaged in similar activities which would cause them to be similarly affected by economic or other conditions.\nPotential problem loans are not disclosed as non-accrual, 90 days past due, or restructured, but are loans which are monitored because of known information about possible credit problems of borrowers or because they are more than 30 days but less than 90 days past due. Management assesses the potential for loss on these loans when evaluating the adequacy of the allowance for loan losses on a regular basis. As of December 31, 1995, monitored loans not disclosed as non-accrual, 90 days past due, or restructured that were current totaled $168,000 ($57,000 residential real estate loans, and $110,000 commercial real estate loans); monitored loans 30 days delinquent totaled $3,117,000 ($2,673,000 residential real estate loans, $224,000 second mortgage loans, $171,000 commercial real estate loans, and $49,000 installment loans); and monitored loans 60 day's delinquent totaled $791,000 ($404,000 residential real estate loans, $369,000 second mortgage loans, and $18,000 installment loans).\nSummary of Loan Loss Experience\nManagement's determination as to the adequacy of the allowance for loan losses takes into account a variety of factors, including (a) management's analysis of individual loans and the overall risk characteristics of the loan portfolio, (b) past loan loss experience, (c) the results of the statutorily mandated examination of the loan portfolio by regulatory agencies and independent reviews and evaluations of loans by the Loan Committee of the Bank's Board of Directors, (d) current and expected economic conditions, and (e) other relevant factors.\nThe supplementary information required by Items IV.A. and IV.B. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to an analysis of the allowance for loan losses and an allocation for loan losses by loan category appears on pages 14 and 15 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nInvestment Activities\nSavings banks chartered in the State of Connecticut have authority to make a wide range of investments deemed to be prudent by their boards of directors. Subject to various restrictions, they may own commercial paper, bonds of government agencies (including states and municipalities), corporate bonds, mutual fund shares, debt and equity obligations issued by creditworthy entities (whether traded on public securities exchanges or placed privately for investment purposes) and interests in real estate located within or outside Connecticut without limitations as to use.\nIt has been the Bank's practice to utilize a variety of investment vehicles to better match deposit maturities. In addition to providing for liquidity requirements, the Bank maintains investment portfolios to employ funds not currently required for its various lending activities. Having a portion of assets in short-term securities has proved beneficial to the Bank during periods of rapidly rising interest rates. During such periods, as short-term securities mature, the proceeds can be reinvested in securities at market rates. In a declining rate environment, loans are likely to have higher yields than debt securities. Management considers the overall rate-sensitivity of the Bank's earning assets when investing in securities.\nBecause of the shortened maturity of its deposit base and increasing sensitivity to the interest rate cycle, the Bank has invested a substantial amount of its cash flow in short-term or interest-sensitive money market assets, including the use of federal funds, debt obligations with maturities no longer than 5 years of companies rated \"A\" or better, US Treasury obligations, and similar instruments. In addition to providing a match of rates on the interest rate cycle, such a shift of funds into money market instruments provides the Bank with the liquidity it deems necessary for normal operations.\nA majority of the Bank's investments in 1995, excluding mortgage-backed securities, were purchased with three to five year maturities, although some of the Bank's investments purchased in 1995 were purchased with maturities\ngreater than five years in order to obtain higher yields. Mortgage-based securities were purchased with fifteen and thirty year maturities. Mortgage- backed securities pay monthly principal and interest payments providing for a return of principal earlier than that of a regular bond with the same maturity.\nThe supplementary information required by Item II.A. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to the maturity and composition of the Bank's investment portfolio appears on pages 10 through 12 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nAt December 31, 1995, the Bank had invested approximately $15.6 million, or 3.8% of its assets, in marketable preferred and common stocks and mutual funds. This portion of the Bank's portfolio generates dividend income and also may produce capital gains and losses. Dividends received by the Bank are entitled to the 70% dividends-received deduction on federal income taxes.\nThe Bank sold no equity securities during 1995. The Bank had net gains from the sale of equity securities of $779,000 in 1994. In the event of a decline in the market for equity securities, the value of the Bank's equity portfolio, and hence its capital, may be reduced. During the past five years, the largest amount that the Bank had invested at any one time in the equity securities of a single company was $730,000. The investment in this company was sold in 1994. See \"Federal Reserve System Regulation\" below for further discussion relating to this investment.\nIn 1991, the Bank revised its investment strategy, hired new outside investment advisors and transferred $4.2 million in equity securities and $835,000 in cash to the trading account in order to create a balanced investment portfolio managed by professional investment advisors with investment objectives to match or outperform several investment indices. In February of 1995 the Bank liquidated it's trading account because of volatility in the investment markets and the uncertainty of earnings generated from this account. Net gains in this account in 1995 amounted to $49,000.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991, which is discussed in detail below under the caption \"Regulation and Supervision\", generally limits the equity investments of state non-member banks to investments which are permissible for a national bank. An insured state bank is also prohibited from engaging as principal in any type of activity that is not permissible for a national bank, unless the Federal Deposit Insurance Corporation (the \"FDIC\") determines that the activity would not pose a significant risk to the insurance fund and the bank is in compliance with applicable capital standards. As of December 19, 1992, a subsidiary of a state bank may not engage as principal in an activity which is not permissible for a subsidiary of a national bank, unless the same conditions are met. See \"FDIC Regulation\" below for further discussion relating to these investment and activities limitations.\nDeposits and Other Sources of Funds\nDeposits. Deposits have traditionally been the Bank's major source of funds, and will continue to be a major source of funds in the foreseeable future. However, the Bank may rely on borrowings from the Federal Home Loan Bank in the future (if available) as long as interest rates are favorable. See \"Borrowing\" below. The Bank also derives funds from loan amortizations, loan prepayments, interest and dividend income and sales of assets deemed appropriate by Bank management.\nThe Bank offers a wide variety of retail deposit accounts designed to attract both short- and long-term funds. Time deposits were the primary source of new funds for the Bank during 1995 due to customer preference, and represent the largest component of deposits (representing 61.6% of total deposits at December 31, 1995). Certificates of deposit currently offered by the Bank have maturities that range from 91 days to five years. The Bank also offers tax-deferred retirement savings programs (IRA accounts and Simplified Employee Pension Plans) and other types of plans for its customers. In determining the rate of interest to pay on deposits, the Bank considers its cash flow requirements, rates paid by competitors and the Bank's income and growth objectives.\nManagement expects competition for deposits in the Bank's market area to continue for the foreseeable future. As of December 31, 1995, the aggregate amount of savings accounts at the Bank was $109.2 million and the interest rate paid on such accounts was 2.0%.\nThe Bank's deposit marketing strategy includes continually monitoring rates to insure competitiveness while providing a high level of service at all of the branch offices. Branch employees participate in sales training programs. The Bank has been able to attract reasonable deposit growth without having to match the most competitive rates being offered in its market area.\nSubstantially all of the Bank's depositors are residents of New Britain and the contiguous communities. The Bank plans to continue its marketing and service efforts in the other communities within its market area. Until recently, such efforts had been hampered by the lack of any Bank branches outside New Britain. The Bank does not solicit deposits outside Connecticut, nor does it solicit deposits through deposit brokers.\nThe supplementary information required by Item V.A. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to average amounts of, and average rates paid on, deposits appears on page 15 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nThe decrease in average savings deposits from 1994 to 1995 was due to customer preference and the rate structure of deposit products. The Bank believes that its high capital ratios and financial strength have attracted new deposit customers. The increase in average time deposits from 1994 to 1995 was the result of customer preference and the rate structure of deposit products. The overall increase in average rates paid on deposits from 1994 to 1995 is consistent with rising interest rates through 1994 and the beginning of 1995, even though rates decreased in the second half of 1995, because of\nthe normal time lag for the Bank's balance sheet to react to market interest rates.\nThe supplementary information required by Item V.D. of \"Guide 3. Statistical Disclosure by Bank Holding Companies\" relating to the maturity distributions of time certificates of deposit issued in amounts of $100,000 or more appears on page 16 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. Such information should be read in conjunction with the related financial statements and notes thereto incorporated by reference herein under Item 8.\nBorrowing. The Bank has been a member of the Federal Home Loan Bank (\"FHLB\") of Boston since 1980, and as a member may borrow from the FHLB to secure additional funds. At December 31, 1995, the Bank had outstanding $19.0 million in loans from the FHLB of Boston, a decrease of $14.5 million from $33.5 million outstanding at December 31, 1994. The primary reason for the decrease was maturities of borrowings. Borrowing from the FHLB of Boston may be at interest rates and under terms and conditions which vary from time to time.\nThe Bank also has access to a pre-approved line of credit with the FHLB of Boston of $8,042,000, and has sufficient qualified collateral to borrow up to an additional $222 million. This arrangement allows the Bank to obtain advances from the FHLB of Boston rather than relying on commercial bank lines of credit. The Bank's interest expense on advances was $1,253,000, $1,455,176, and $471,767, for the years ended December 31, 1995, 1994 and 1993, respectively.\nCompetition\nThe Bank's most direct competition for deposits has historically come from other thrift institutions and commercial banks located in its principal market area, many of which have greater resources than the Bank. There are numerous other banks, credit unions and financial institutions located in the City of New Britain and surrounding areas that also compete with the Bank. The Bank faces significant additional competition for investors' funds from short-term money market funds of securities firms and other financial institutions and from other corporate and government securities yielding higher interest rates than those paid by the Bank.\nThis increased competition has, and is expected to continue to have, an effect on the Bank's cost of funds. However, the Bank has not experienced and does not expect to experience any substantial adverse effect on the stability of its deposit base as a result of increased competition. The Bank competes for deposits by offering depositors a high degree of personal service, convenient locations and hours, and other services. The Bank does not rely upon any individual or entity for a material portion of its deposits, nor does it obtain any deposits through deposit brokers. A substantial portion of the Bank's customer and deposit base traditionally has been and continues to be the large Polish community in New Britain.\nThe Bank's competition for real estate loans comes principally from mortgage banking companies, other thrift institutions, commercial banks, insurance companies and other institutional lenders. The Bank competes for loan originations primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers, real\nestate brokers and builders. Factors that affect competition include, among other things, the general availability of lendable funds and credit, general and local economic conditions, current interest rate levels, and volatility in the mortgage markets.\nCompetition is expected to increase as a result of legislation adopted in recent years at the Federal and State of Connecticut levels which effectively provide, subject to minimal limitations, for full interestate banking and branching. As a result of this legislation and increasingly aggressive merger activity in the Company's market area, competition from larger institutions with resources much greater than the Company's, is expected to continue into the future.\nCertain legislative and regulatory proposals that could affect the Company and the Bank and the banking business in general are pending, or may be introduced, before the United States Congress, the Connecticut General Assembly, and various governmental agencies. These proposals include measures that may further alter the structure, regulation, powers, and competitive relationship of financial institutions and that may subject the Company and the Bank to increased regulation, disclosure, and reporting requirements. In addition, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce existing legislation. It cannot be predicted whether or in what form any legislation or regulations will be enacted or the extent to which the business of the Company and the Bank will be affected thereby.\nEmployees\nAs of December 31, 1995, the Company and the Bank employed 132 employees, 113 of whom are full-time, including 31 officers. Management considers the Bank's relations with its employees to be good. The Bank's employees are not represented by any collective bargaining group.\nREGULATION AND SUPERVISION\nConnecticut Regulation\nAs a state-chartered capital stock savings bank, the Bank is subject to applicable provisions of Connecticut law and the regulations adopted thereunder by the Connecticut Banking Commissioner (the \"Commissioner\"). The Commissioner administers Connecticut banking laws, which contain comprehensive provisions for the regulation of savings banks. The Bank derives its lending and investment powers from these laws, and is subject to periodic examination by and reporting to the Commissioner.\nSavings banks in Connecticut are empowered by statute to conduct a general banking business and to exercise all incidental powers necessary thereto. Subject to limitations expressed in the statutes, permissible activities include taking savings and time deposits, including NOW checking accounts, paying interest on such deposits and accounts, accepting demand deposits, making loans on residential and other real estate, making consumer\nand commercial loans, exercising trust powers, investing, with certain limitations, in equity securities and debt obligations of banks and corporations, and issuing credit cards. In addition, savings banks may engage in certain other enumerated activities, including the establishment of an insurance department to sell life insurance and annuities. Connecticut savings banks, in general, have powers identical to those enjoyed by Connecticut commercial banks.\nThe Bank is prohibited by Connecticut banking law from paying dividends, except from its net profits. Net profits are defined as the remainder of all earnings from current operations. The total of all dividends declared by the Bank in any calendar year may not, unless specifically approved by the Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. These provisions limit the amount of dividends payable to stockholders of the Company, since dividends received from the Bank are the primary source of funds for the Company to pay dividends. As of December 31, 1995, approximately $666,000 was available for payment of dividends by the Bank to the Company.\nUnder Connecticut banking law, no person may acquire the beneficial ownership of more than 10% or 25% or more of any class of voting securities of a bank chartered by the State of Connecticut or having its principal office in Connecticut or a bank holding company thereof unless the Commissioner approves such acquisition.\nFull statewide branching is available to all Connecticut depository institutions. This legislation expands the branching opportunities of the Bank to other towns while allowing virtually unrestricted branching expansion by other institutions into New Britain. Legislation passed in 1990 requires the Commissioner to consider significant additional criteria when reviewing branch applications. While this legislation may result in increased administrative review of bank branching applications, the Company does not anticipate at this time that the criteria to be considered by the Commissioner will adversely impact the Company's future branching activities or that any such review will materially deter financial institutions which desire to open branches in New Britain from doing so.\nSee \"Competition\" above for a discussion of Connecticut interstate banking statutes.\nFDIC Regulation\nThe Bank's deposit accounts are insured by the FDIC, up to a maximum of $100,000 per insured depositor. The FDIC issues regulations, conducts periodic examinations, requires the filing of reports and generally supervises the operations of its insured banks. The approval of the FDIC is required prior to any merger or consolidation or the establishment or relocation of an office facility. This supervision and regulation is intended primarily for the protection of depositors. Any insured bank which does not operate in accordance with or conform to FDIC regulations, policies and directives may be sanctioned for noncompliance. Under FDIC regulations, the Bank is a member of the Bank Insurance Fund (\"BIF\") and is required to pay annual insurance premiums, currently 0.00% of its deposits. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"Improvement Act\"), the FDIC has adopted regulations establishing a risk-based assessment system for insurance premiums. Under this system, a depository institution's semi-annual assessment will fall within a range of 0.00% to 0.27% of domestic deposits, based in part on the probability that the deposit insurance fund will incur a loss with respect to that institution. In setting assessments for a bank, the FDIC is required to take into account the revenue needs of the insurance fund and to set the assessments in a manner that will be sufficient to maintain the insurance fund's required reserve ratio. Insured depository institutions are required to file with the FDIC certified statements containing all information required by the FDIC for the determination of the semi-annual assessment. Each institution has been or will be notified of its risk classification based on its capital ratios. The FDIC has the authority to assess penalties against an institution that fails to make an accurate certified statement. These provisions of the Improvement Act have not affected the Bank's assessment. Under this system, the Bank, as a well capitalized institution, is required currently to pay annual insurance premiums of 0.00% of its deposits.\nThe FDIC also requires FDIC-insured, state-chartered banks that are not members of the Federal Reserve System to meet certain minimum capital requirements. The FDIC amended its minimum requirements for capital as a percentage of total assets to define capital in a manner consistent with the risk-based capital categories described below and to require a minimum leverage standard of 3 percent Tier 1 (or core) capital to total assets (as defined in FDIC regulations) for the most highly rated banks that are not anticipating or experiencing any significant growth. All other state banks that are not members of the Federal Reserve System would be required to meet a minimum leverage ratio that is at least 100 to 200 basis points above this minimum -- that is, an absolute minimum leverage ratio of not less than 4 percent for those banks that are not highly rated or that are anticipating or experiencing significant growth. \"Tier 1 capital\" is generally defined as common stockholders' equity, minority interests in consolidated subsidiaries and non-cumulative perpetual preferred stock. Tier 1 capital generally excludes goodwill and other intangibles and investments in subsidiaries that the FDIC determines should be deducted from capital. As of December 31, 1994, the Bank's leverage ratio was approximately 9.35%, exceeding the FDIC requirements.\nThe FDIC has also adopted supplementary capital regulations based on international risk-based capital standards. The other United States bank regulatory agencies have also adopted similar guidelines based on these international standards. The guidelines, as adopted, supplement the minimum leverage ratios described in the immediately preceding paragraph. The guidelines set forth (i) a definition of \"capital\" for risk-based capital\npurposes; (ii) a system for calculating risk-weighted assets by assigning assets and certain off-balance sheet items to broad risk categories; and (iii) a schedule, including transitional arrangements during a phase-in period, for achieving a minimum supervisory ratio of capital to risk-weighted assets. In general, the risk-weighting imposes \"zero percent\" risk-weighting for cash; balances due from Federal Reserve banks; direct claims on (including securities), and the portions of claims unconditionally guaranteed by, the United States treasury and United States government agencies; and gold bullion; \"twenty percent\" for cash items in the process of collection; all claims on, and portions of claims guaranteed by, United States depository institutions, United States government agencies and United States government-sponsored agencies; general obligation claims on, and the portions of claims that are guaranteed by, the full faith and credit of states or other political subdivisions of the United States; and the portions of claims that are collateralized by securities issued or guaranteed by the United States treasury, governmental agencies or government-sponsored agencies; \"fifty percent\" for loans fully secured by first liens on one to four family residential properties written in accordance with prudent underwriting standards and certain privately issued mortgage-backed securities; and \"one hundred percent\" risk-weighting for assets not included in one of the other categories, including fixed assets, premises, other real estate owned and equity investments. Basically, the higher percentage of riskier assets an institution has, the more capital it must have to satisfy the risk-based guidelines; the lower the risk, the lower the required capital. The guidelines do not address other bank \"risk\" areas, such as interest rate, liquidity, funding and market risks, the quality and level of earnings, investment or loan portfolio concentrations, the quality of loans and investments, the effectiveness of loan and investment policies and management's ability to monitor and control financial and operating risks. The current minimum risk- based ratio is 8%. The Bank's total risk-based ratio as of December 31, 1995 was 18.38%. The Bank does not believe that the implementation of the risk-based guidelines has had or will have a material adverse effect on its prospective business or require capital-raising efforts in the foreseeable future. In January 1995, the risk-based capital standards were amended to require analysis of the Bank's and Company's concentration of credit risks and certain risks from non-traditional activities in assessing the institution's overall capital adequacy. The Company and Bank believe that these amended regulations will not materially affect the Company's and Bank's capital ratios or adequacy.\nThe Improvement Act increases the supervisory powers of the FDIC and the other federal regulatory agencies with regard to undercapitalized depository institutions, and changes the capital rules applicable to the Company and the Bank. As of December 19, 1992, banking regulators adopted regulations which define five capital categories of institutions: institutions that are well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The purpose of these categories is to allow federal regulatory agencies to monitor undercapitalized institutions more closely in order to take appropriate and prompt regulatory action to minimize the potential for significant loss to the deposit insurance fund. Institutions in the first two categories will operate with few restrictions. Institutions in the other three categories may be required to raise additional capital, curtail growth, limit interest rates paid, divest subsidiaries and limit executive compensation. Regulators are also be empowered to remove top management and call for new elections of directors. The Improvement Act also allows for the appointment of a conservator or receiver of an insured depository institution if the institution is\nundercapitalized and either has no reasonable prospect of becoming adequately capitalized, fails to become adequately capitalized as required, or fails to submit or materially implement a capital plan. In addition, the Improvement Act requires a holding company of a failing institution to guarantee that the institution will comply with a capital restoration plan to the extent of 5% of the institution's total assets or the amount needed to achieve the required minimum capital levels. See pages 17 and 18 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital\". The Bank is currently categorized as a \"well capitalized\" institution under the Improvement Act.\nAfter notice and hearing, FDIC insurance of deposits may be terminated by the FDIC upon a finding by the FDIC that the insured institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule or order of, or conditions imposed by, the FDIC. Neither the Company nor the Bank is aware of any practice, condition or violation that might lead to termination of its deposit insurance.\nThe Improvement Act also generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. These restrictions became effective on December 19, 1992, although the restrictions dealing with equity investments became effective upon enactment of the Improvement Act on December 19, 1991. In October 1992, the FDIC issued final regulations to implement the restrictions on equity investments and indicated its intention to propose regulations addressing the activities limitations at a later date. Under the regulations dealing with equity investments, an insured state bank generally may not acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. In addition, an insured state bank (i) that is located in a state which authorized as of September 30, 1991 investment in common or preferred stock listed on a national securities exchange (\"listed stock\") or shares of a registered investment company (\"registered shares\"), and (ii) which during the period beginning September 30, 1990 through November 26, 1991 (\"measurement period\") made or maintained investments in listed stocks and registered shares, may retain whatever shares that were lawfully acquired or held prior to December 19, 1991 and continue to acquire listed stock and registered shares, provided that the bank does not convert its charter to another form or undergo one of four types of specified transactions which generally deal with changes in control. In order to acquire or retain any listed stock or registered shares, however, the bank must file a one-time notice with the FDIC which meets specified requirements and which sets forth the bank's intention to acquire and retain stocks or shares, and the FDIC must determine that acquiring or retaining the listed stocks or registered shares will not pose a significant risk to the deposit insurance fund of which the bank is a member. The Bank filed a notice of intention to invest in listed stocks and registered shares with the FDIC on December 11, 1992. On March 15, 1993, the FDIC granted its approval to the Bank to continue to hold or acquire listed stocks and registered shares, subject to the following conditions: (a) the maximum investment in listed stocks and registered shares may not exceed 100% of the Bank's Tier 1 capital; (b) the Bank must follow reasonable procedures limiting concentrations in listed stocks and registered shares so as to provide for diversification of risk; and (c) the FDIC may alter, suspend or withdraw its approval should any development warrant such action. At December 31, 1995, the Bank held $.2 million of listed stocks and registered shares.\nThe Community Reinvestment Act of 1977 (\"CRA\") was enacted to encourage every financial institution to help meet the credit needs of its entire community, including low and moderate-income neighborhoods, consistent with the institution's safe and sound operation. Under CRA, state and federal regulators are required, when examining financial institutions and when considering applications for approval of certain merger, acquisition or other transactions, to take into account the institution's record in helping to meet the credit needs of its entire community, including low and moderate-income neighborhoods. In reviewing an institution's CRA record for this purpose, state and federal regulators will consider reports of regulatory examination, comments received from interested members of the public or community groups, and the description of the institution's CRA activities in its publicly available CRA statement, supplemented, as necessary, by the institution. The Federal Reserve Board has the power to disapprove proposed merger or acquisition transactions involving banking organizations that are deemed by the Federal Reserve Board to have unsatisfactory examination records of CRA compliance. Following its most recent CRA examination as of August 24, 1995, the Bank received a \"Satisfactory\" rating regarding its compliance with CRA.\nFederal Reserve System Regulation\nFederal Reserve Board regulations require the Bank to maintain reserves against its transaction accounts and non-personal time deposits. These regulations generally require that reserves of 3% be maintained against transaction accounts (other than non-personal time deposits and Eurocurrency liabilities) totaling $54.0 million or less (except that $4.2 million in the transaction accounts is exempt from the reserve requirement) and a reserve of 10% be maintained against that portion of total transaction accounts in excess of $54.0 million. Effective December 19, 1995, the Federal Reserve Board adjusted these amounts so that reserves of 3% are required to be maintained against transaction accounts totaling $52.0 million or less (except that $4.3 million is exempt) and a reserve of 10% is required to be maintained against that portion of total transaction accounts in excess of $52.0 million. These amounts and percentages are subject to further adjustment by the Federal Reserve Board. The Bank also has authority to borrow from the Federal Reserve Bank of Boston \"discount window.\"\nThe Federal Reserve Board's capital adequacy guidelines for bank holding companies are similar to the FDIC leverage ratio requirements described above. This standard establishes a minimum level of Tier 1 capital to total assets of 3% for all bank holding companies with consolidated assets of $150 million or more. Except with respect to the most highly-rated institutions, this standard requires bank holding companies to maintain an additional cushion of 100 to 200 basis points depending upon the institution's financial condition and risk profile. Additionally, the Federal Reserve Board has adopted risk-based capital guidelines, similar to those adopted by the FDIC as described above, that are applicable to all bank holding companies. Management believes that the Company currently is, and expects to continue to be, in full compliance with applicable capital requirements.\nThe Company is subject to regulation by the Federal Reserve Board as a registered bank holding company. The Bank Holding Company Act of 1956, as amended (the \"BHCA\"), under which the Company is registered, limits the types of companies that the Company may acquire or organize and the activities in which it or they may engage. In general, the Company and its subsidiaries are prohibited from engaging in or acquiring direct control of any company engaged\nin non-banking activities unless such activities are so closely related to banking or managing or controlling banks or savings associations as to be a proper incident thereto. Subject to various limitations, the Federal Reserve Board has determined by regulation a number of activities that qualify without the need for specific FRB approval. The Company believes that neither it nor the Bank is engaged in any activities which would be prohibited under the BHCA.\nUnder the BHCA, the Company is required to obtain the prior approval of the Board of Governors of the Federal Reserve System to acquire, with certain exceptions, more than 5% of the outstanding voting stock of any bank, to acquire all or substantially all of the assets of a bank or to merge or consolidate with another bank holding company.\nUnder the BHCA, the Company, the Bank and any other subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of any property or services. The Bank is also subject to certain restrictions imposed by the Federal Reserve Act on issuing any extension of credit to the Company or any of its subsidiaries, or making any investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower.\nThe Company is required under the BHCA to file an annual report of its operations with the Federal Reserve Board, and it and the Bank and any other subsidiaries are subject to examination by the Federal Reserve Board. In addition, the Company, as a bank holding company, is required to register with, submit reports to and be examined by the Commissioner under the Connecticut Bank Holding Company and Bank Acquisition Act.\nEffect of Government Policy\nBanking is a business that has historically depended primarily on interest rate differentials. In general, the difference between the interest rates received by the Bank on loans to its customers and securities held in the Bank's portfolio and the interest rate paid by the Bank on its deposits and its other borrowings will comprise the major portion of the Bank's earnings. The value and yields of its assets and the rates paid on its liabilities are sensitive to changes in prevailing market rates of interest. Thus, the earnings and growth of the Bank will be influenced by general economic conditions, the monetary and fiscal policies of the federal government, and policies of regulatory agencies, particularly the Federal Reserve Board, which implement national monetary policy. The nature and impact of any future changes in monetary policies is beyond the control of the Bank and cannot be predicted.\nThe FDIC is required to conduct annual FDIC examinations of all insured depository institutions unless they are well or adequately capitalized, not less than $250 million in assets, and have an \"outstanding\" composite condition (or \"good\" if a bank has less than $100 million in assets); such institutions may be examined every eighteen months. The Improvement Act also requires each insured depository institution to submit a publicly available annual audit report to its federal regulators. The report is required to be prepared in accordance with generally accepted accounting principles and to contain any information that federal regulators may require. The report must contain management's statement of its responsibilities for preparing financial statements, establishing and maintaining internal controls, complying with banking laws and regulations and assessing the institution's results in these\nareas during the past year. The institution's independent public accountants must also attest to, and report separately on, management's statement. The federal regulatory agencies are also required to adopt regulations requiring each insured depository institution to have an independent audit made of its financial statements. These audited financial statements will be included in the institution's annual reports. The Company and the Bank have always had an annual independent audit.\nAs discussed above, the Improvement Act allows the regulatory agencies to take prompt regulatory action for institutions falling into one of the lower three of five capital categories (see \"FDIC Regulation\") and restricts an institution's ability to accept brokered deposits unless the institution is well capitalized. Restrictions on loans to insiders are also strengthened under the Improvement Act. Total aggregate loans to all insiders (including directors and executive officers) and their related interests are generally restricted to the amount of a bank's unimpaired capital and surplus. Unimpaired capital and surplus is defined by regulation to mean the sum of (1) the bank's total equity capital as reported on the bank's most recent consolidated report of condition, (2) any subordinated notes and debentures approved as an addition to the bank's capital structure by the appropriate federal banking agency, and (3) any valuation reserves created by charges to the bank's income as reported on its most recent consolidated report of condition. The Federal Reserve Board may, by regulation, make the restrictions on aggregate loans to insiders more stringent. In addition, certain restrictions on types and amounts of loans that can be made to executive officers of financial institutions have been added to federal regulations in addition to the existing restrictions in state law on loans to executive officers. Loans to individual directors, executive officers, principal shareholders and their related interests also may not exceed specified percentages of the Bank's unimpaired capital and surplus (generally, 15% for loans not \"fully secured\", and 10% additional for loans that are \"fully secured\", with certain limited exceptions). Because the level of the Bank's loans to insiders is significantly below the amount permitted under the Improvement Act, the Company does not expect these regulations to adversely impact the Company or the Bank.\nThe Improvement Act has also resulted in federal regulatory agencies to adopt regulations setting forth safety and soundness standards relating to internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate exposure; asset growth; and officers and employees compensation, fees and benefits. The Bank and the Company do not expect these regulations will materially adversely affect them.\nThe regulations establish a standard for the ratio of classified assets to total capital and loan loss allowances at no greater than 100%; and an earnings\/capital standard which provides that a bank's capital will be sufficient if the bank's last four quarters of earnings history, projected over the next four quarters, would leave the bank with capital meeting the applicable minimum capital requirements. If the FDIC were to find that the Bank violated either of the standards, the Bank would be required to submit a compliance plan, which must be approved by the FDIC, describing the steps it would take to cure the deficiency. However, the Company and the Bank currently comply with and expect to continue to comply with these standards.\nThe present bank regulatory scheme has undergone and continues to undergo significant change, both as it affects the banking industry itself and as it affects competition between banks and non-banking financial\ninstitutions. There have been significant regulatory changes in the bank merger and acquisition area, in the products and services banks can offer, and in the non-banking activities in which bank holding companies can engage. Banks are now actively competing with other types of depository institutions and with non-bank financial institutions, such as money market funds, brokerage firms, insurance companies, and other financial services enterprises. It is not possible at this time to assess what impact these changes in the regulatory scheme will ultimately have on the Bank.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nIn addition to the main office of the Company and the Bank, located at 123 Broad Street, New Britain, Connecticut, the Bank has seven banking branches located in New Britain, Southington, Newington, Rocky Hill, and Plainville, Connecticut. The following table sets forth certain information regarding the Bank's banking offices.\nOwned Lease or Expiration Office Location Leased Date - ------ -------- ------ ---- Main Office 123 Broad Street Owned Not applicable New Britain, CT 06050\nFarmington Avenue 553 Farmington Avenue Owned Not applicable New Britain, CT 06050\nColumbus Plaza 150 Columbus Boulevard Leased October 1999 New Britain, CT 06050\nLafayette Square 450 Main Street Leased July 2001 New Britain, CT 06050\nSouthington Office 405 Queen Street Leased August 2002 Southington, CT 06489\nNewington Office 36 Fenn Road Leased January 2003 Newington, CT 06111\nRocky Hill Office 2270 Silas Deane Highway Owned Not applicable Rocky Hill, CT 06067\nPlainville Offic 275C New Britain Avenue Leased June 2004 Plainville, CT 06062\nTotal lease payments for all of the Bank's leased offices for 1995 amounted to $442,892.\nItem 3","section_3":"Item 3 - Legal Proceedings\nThere are no pending legal proceedings to which the Company or the Bank is a party, other than ordinary routine litigation in the normal course of business. No such proceeding is material to the Company or the Bank.\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 shareholders of the Company.\nExecutive Officers of the Registrant\nThe following persons are the executive officers of the Company:\nRichard S. Mansfield, age 55, has been the President and Chief Executive Officer and a director of the Company since its incorporation in February 1989. Mr. Mansfield has been President and Chief Executive Officer and a director of the Bank since 1986 and was Executive Vice President and Vice President in charge of mortgage lending at the Bank since 1980. Mr. Mansfield's 1986 employment agreement with the Bank provides for a term of three years with automatic one year renewals each January 1st, unless either party gives written notice of his or its intention not to extend the agreement.\nJohn G. Medvec, age 49, has been the Executive Vice President and Treasurer of the Company since its incorporation in February 1989. Mr. Medvec has been Executive Vice President and Treasurer of the Bank since 1986 and has served in various executive positions with the Bank since 1971. Mr. Medvec's 1986 employment agreement with the Bank provides for a term of three years with automatic one year renewals each January 1st, unless either party gives written notice of his or its intention not to extend the agreement.\nThere is no relationship by blood, marriage or adoption between any executive officer or director of the Company and any other executive officer or director of the Company.\nPART II\nItem 5","section_5":"Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters\nAs of February 29, 1996, the Company had 1,924,363 shares of Common Stock issued and outstanding and approximately 1,404 shareholders of record. The Company's stock is traded over-the-counter and is quoted on The NASDAQ National Market under the symbol \"PBNB\".\nThe market price information regarding the Company Common Stock and the information relating to the payment of dividends required by Item 5 appears on page 46 of the Company's 1995 Annual Report to Shareholders under the captions \"Common Stock Information\" and \"Dividend Policy\", and is incorporated herein by reference. Dividends are paid by the Company from its assets, which are mainly provided by dividends from the Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances and such restrictions may materially limit the Company's ability to pay dividends to its shareholders.\nIn connection with the Bank's conversion from a mutual savings bank to a capital stock savings bank, 2,444,324 shares of Common Stock were initially offered to depositors of the Bank in a subscription offering, with the remaining shares sold in a public offering. As part of the subscription\noffering, the Bank established a liquidation account for a ten-year period for the benefit of eligible depositors who maintain their accounts with the Bank after the conversion. In the event of a complete liquidation (and only in such an event), each eligible account holder will be entitled to receive a liquidation distribution from the liquidation account before any liquidation distribution may be made with respect to Bank Common Stock. The Bank may not declare or pay a cash dividend on or repurchase any of its Common Stock if the effect thereof would cause the capital accounts to be reduced below the amount required for the liquidation account, which was approximately $913,000 as of December 31, 1995.\nConnecticut capital stock savings banks, such as the Bank, may not declare cash dividends in excess of \"net profits\". \"Net profits\" are statutorily defined as \"the remainder of all earnings from current operations.\" In addition, the total of all cash dividends declared in any calendar year may not, without the specific approval of the Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.\nThe present intention of the Board of Directors of the Company is to continue the practice of declaring and paying cash dividends on a quarterly basis. However, the payment and size of any future Company dividend will depend on the future earnings of the Company and the Bank.\nItem 6","section_6":"Item 6 - Selected Financial Data\nThe information required by Item 6 appears on page 1 of the Company's 1995 Annual Report to Shareholders under the caption \"Selected Financial Highlights\", and is incorporated by reference herein.\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required by Item 7 appears on pages 9 through 24 of the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and is incorporated by reference herein. See Note 18 \"Recent Accounting Pronouncements\" on page 42 of the Company's 1995 Annual Report to Shareholders and the caption notes to the Consolidated Financial Statements contained therein.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nThe information required by Item 8 is indexed in Item 14 of this Annual Report on Form 10-K, and portions thereof appearing on pages 23 through 45 of the Company's 1995 Annual Report to Shareholders are incorporated by reference herein.\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 - Directors and Executive Officers of the Registrant\nThe information required by Item 10 relating to the identification of directors and executive officers of the Company and their business experience appears on pages 3 through 14 of the Company's definitive Proxy Statement dated March 22, 1996 under the caption \"Election of a Class of Directors (Proposal 1) - - Information on Nominees and Directors\", and in Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant\", and is incorporated by reference herein.\nItem 11","section_11":"Item 11 - Executive Compensation\nThe information required by Item 11 relating to the compensation paid and benefits provided to directors and executive officers of the Company appears on pages 8 through 14 of the Company's definitive Proxy Statement under the captions \"Election of a Class of Directors (Proposal 1) - Compensation of Directors\" and \"Election of a Class of Directors (Proposal 1) - Compensation of Executive Officers\", and is incorporated by reference herein.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 relating to the ownership of the Company's securities by certain beneficial owners and management appears on pages 2 through 7 of the Company's definitive Proxy Statement under the captions \"Principal Stockholders\", \"Election of a Class of Directors (Proposal 1) - Information on Nominees and Directors\" and \"Election of a Class of Directors (Proposal 1) - Ownership of Shares by Directors and Officers\", and is incorporated by reference herein.\nItem 13","section_13":"Item 13 - Certain Relationships and Related Transactions\nThe information required by Item 13 relating to transactions between the Company and management, directors and certain beneficial owners of the Company's securities appears on pages 13 through 15 of the Company's definitive Proxy Statement under the caption \"Transactions with Management and Others\", and is incorporated by reference herein.\nPART IV\nItem 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents, filed as part of this report, are included herein or are incorporated by reference from the indicated pages of the Company's 1995 Annual Report to Shareholders:\n1. Financial Statements:\nPage(s) in Annual Report ------------- Report of Independent Auditors 23 Consolidated Balance Sheets 24 Consolidated Statements of Income 25 Consolidated Statements of Stockholders' Equity 26 Consolidated Statements of Cash Flows 27 Notes to Consolidated Financial Statements 28-45\n2. Financial Statement Schedules:\nAll Schedules to the Consolidated Financial Statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n3. Exhibits:\nExhibit No. Description ----------- ----------- 3.1 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 fiscal year ended December 31, 1991).\n3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n4 Instruments Defining the Rights of Security Holders are filed as Exhibits 3.1 and 3.2.\n*10.1 Employment Agreement dated August 1, 1986 between the Bank and Richard S. Mansfield (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.2 Employment Agreement dated August 1, 1986 between the Bank and John G. Medvec (incorporated by reference to Exhibit 10.2 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.3 Employment Agreement dated August 1, 1986 between the Bank and Florence Zaniewski (incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.4 1986 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.5 1986 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.6 Pension Plan of The People's Savings Bank of New Britain, as amended (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.7 Change of Control Agreement, dated as of September 17, 1991, between the Bank and Florence K. Gagnon (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.8 Change of Control Agreement, dated as of September 18, 1991, between the Bank and Teresa Sasinski (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.9 Change of Control Agreement, dated as of September 23, 1991, between the Bank and Edward E. Bohnwagner, III (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.10 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Walter D. Blogoslawski, as amended January 1, 1987 (incorporated by reference to\nExhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.11 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Matthew P. Duksa, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.12 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Stanley P. Filewicz, as amended January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.13 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Robert A. Gryboski, M.D., as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.14 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Edward Januszewski, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.15 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Roland L. LeClerc, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.16 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Walter J. Liss, as amended January 1, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.17 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Henry R. Poplaski, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.18 Directors' Voluntary Deferral Agreement, dated January 20, 1987, between the Bank and Anthony R. Puskarz, Jr. (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991)\n*10.19 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Eugene M. Rosol, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.20 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Chester S. Sledzik, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.20 to the\nCompany's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.21 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Robert A. Story, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.22 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Joseph A. Welna, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.23 People's Savings Financial Corp. Dividend Reinvestment Plan and Stock Purchase Plan (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for this fiscal year ended December 31, 1992).\n*10.24 People's Savings Financial Corp. Savings and Investment Plan (incorporated by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993).\n*10.25 Change of Control Agreement, dated as of January 17, 1995, between the Bank and Daniel Hurley (incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n*10.26 Change of Control Agreement, dated as of January 17, 1995, between the Bank and Earl Young (incorporated by reference to Exhibit 10.26 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n*10.27 The People's Savings Financial Corp. 1995 Stock Option and Incentive Plan for Outside Directors (incorporated by reference to Exhibit A to the Company's Proxy Statement for the 1995 Annual meeting of Stockholders).\n*10.28 The People's Savings Financial Corp. 1995 Stock Option and Incentive Plan (for Employees) (incorporated by reference to Exhibit B to the Company's Proxy Statement for the 1995 Annual meeting of Stockholders).\n11 Statement Concerning Computation of Per Share Earnings\n13 1995 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n24 Consent of Independent Accountants\n25 Power of Attorney - ------ * Management contracts or compensatory plans, contracts or arrangements.\n(b) Reports on Form 8-K. No report on Form 8-K was filed during the fourth quarter of 1995.\n(c) The exhibits required by Item 601 of Regulation S-K are filed as a separate 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.\nPEOPLE'S SAVINGS FINANCIAL CORP.\nBy \/s\/ RICHARD S. MANSFIELD ------------------------------------- Richard S. Mansfield 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\/ RICHARD S. MANSFIELD President and Chief March 19, 1996 - -------------------------- Executive Officer Richard S. Mansfield (Principal Executive Officer)\n\/s\/ JOHN G. MEDVEC Executive Vice March 19, 1996 - -------------------------- President and John G. Medvec Treasurer (Principal Financial Officer and Principal Accounting Officer)\n* Director March 19, 1996 - -------------------------- Joseph A. Welna\n* Director March 19, 1996 - -------------------------- Robert A. Gryboski\n* Director March 19, 1996 - -------------------------- Walter J. Liss\n* Director March 19, 1996 - -------------------------- Robert A. Story\n* Director March 19, 1996 - -------------------------- Walter D. Blogoslawski\n* Director March 19, 1996 - -------------------------- Stanley P. Filewicz\n* Director March 19, 1996 - -------------------------- Roland L. LeClerc\n* Director March 19, 1996 - -------------------------- Chester S. Sledzik\n* Director March 19, 1996 - -------------------------- Henry Poplaski\n* Director March 19, 1996 - -------------------------- A. Richard Puskarz, Jr.\nBy \/c\/ JOHN G. MEDVEC - -------------------------- John G. Medvec Attorney-in-Fact\nEXHIBIT INDEX\nExhibit Page Number Description Number ------ ----------- ------ 3.1 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 fiscal year ended December 31, 1991).\n3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n4 Instruments Defining the Rights of Security Holders are filed as Exhibits 3.1 and 3.2.\n*10.1 Employment Agreement dated August 1, 1986 between the Bank and Richard S. Mansfield (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.2 Employment Agreement dated August 1, 1986 between the Bank and John G. Medvec (incorporated by reference to Exhibit 10.2 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.3 Employment Agreement dated August 1, 1986 between the Bank and Florence Zaniewski (incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.4 1986 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.5 1986 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.6 Pension Plan of The People's Savings Bank of New Britain, as amended (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-4 (No. 33-27219) filed on February 23, 1989).\n*10.7 Change of Control Agreement, dated as of September 17, 1991, between the Bank and Florence K. Gagnon (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.8 Change of Control Agreement, dated as of September 18, 1991, between the Bank and Teresa Sasinski (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.9 Change of Control Agreement, dated as of September 23, 1991, between the Bank and Edward E. Bohnwagner, III (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.10 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Walter D. Blogoslawski, as amended January 1, 1987 (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.11 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Matthew P. Duksa, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.12 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Stanley P. Filewicz, as amended January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.13 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Robert A. Gryboski, M.D., as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.14 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Edward Januszewski, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.15 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Roland L. LeClerc, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.16 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Walter J. Liss, as amended January 1, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.17 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Henry R. Poplaski, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.18 Directors' Voluntary Deferral Agreement, dated January 20, 1987, between the Bank and Anthony R. Puskarz, Jr. (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.19 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Eugene M. Rosol, as amended January 1, 1987 and January 20, 1987 (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.20 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Chester S. Sledzik, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.21 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Robert A. Story, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.22 Directors' Voluntary Deferral Agreement, dated January 1, 1985, between the Bank and Joseph A. Welna, as amended January 1, 1987, January 20, 1987 and February 10, 1989 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n*10.23 People's Savings Financial Corp. Dividend Reinvestment Plan and Stock Purchase Plan (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n*10.24 People's Savings Financial Corp. Savings and Investment Plan (incorporated by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993).\n*10.25 Change of Control Agreement, dated as of January 17, 1995, between the Bank and Daniel Hurley (incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n*10.26 Change of Control Agreement, dated as of January 17, 1995, between the Bank and Earl Young (incorporated by reference to Exhibit 10.26 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n*10.27 The People's Savings Financial Corp. 1995 Stock Option and Incentive Plan for Outside Directors. Incentive Plan for Outside Directors (incorporated by reference to Exhibit A to the Company's Proxy Statement for the 1995 Annual meeting of Stockholders).\n*10.28 The People's Savings Financial Corp. 1995 Stock Option and Incentive Plan for Outside Directors. Incentive Plan (for Employees), (incorporated by reference to Exhibit B to the Company's Proxy Statement for the 1995 Annual meeting of Stockholders).\n11 Statement Concerning Computation of Per Share Earnings\n13 1995 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n24 Consent of Independent Auditors\n25 Power of Attorney\n- ------ * Management contracts or compensatory plans, contracts or arrangements.","section_15":""}
{"filename":"750304_1995.txt","cik":"750304","year":"1995","section_1":"ITEM 1. BUSINESS\nHousing Programs Limited (the \"Partnership\") is a limited partnership which was formed under the laws of the State of California on May 15, 1984. On September 12, 1984, the Partnership offered 3,000 units consisting of 6,000 Limited Partnership Interests and warrants to purchase a maximum of 6,000 Additional Limited Partnership Interests through a public offering.\nThe general partners of the Partnership are Housing Programs Corporation II, National Partnership Investments Corp. (\"NAPICO\"), 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 Charles H. Boxenbaum, as limited partner. The business of the Partnership is conducted primarily by its general partners as Housing Programs Limited has no employees of its own.\nCasden Investment Corporation 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. LBI Group Inc. owns all of the stock of Housing Programs Corporation II.\nThe Partnership holds limited partnership interests in eighteen local limited partnerships as of December 31, 1995. National Partnership Investments Associates II (\"NPIA II\"), a limited partnership formed under the California Limited Partnership Act and consisting of Messrs. Charles H. Boxenbaum, general partner, and Nicholas G. Ciriello, limited partner, hold a general partnership interest in ten of the local limited partnerships. Each of the local partnerships owns 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 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 remains, however, significant risks. The long-term nature of investments in government assisted housing limits the ability of the Partnership 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 Partnership became the limited partner in the local limited partnerships pursuant to arm's-length negotiations with the local limited partnerships' general partners who are often the original project developers. In certain other cases, the Partnership invested in newly formed local limited partnerships which, in turn, acquired the projects. As a limited partner, the Partnership's liability for obligations of the local limited partnership is limited to its investment. The general partner of the local limited partnership retains responsibility for maintaining, operating and managing the project. Under certain circumstances, the Partnership has the right to replace the general partner of the limited partnerships.\nAlthough each of the partnerships in which the Partnership 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.\nDuring 1995, all of the projects in which the Partnership 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 the Partnership has invested.\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH HOUSING PROGRAMS LIMITED HAS AN INVESTMENT DECEMBER 31, 1995\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH HOUSING PROGRAMS LIMITED HAS AN INVESTMENT DECEMBER 31, 1995\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThrough its participation in local limited partnerships, the Partnership 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, NAPICO was a plaintiff or defendant in several lawsuits. None of these suits are related to the Partnership. In addition, the Partnership is involved in the following lawsuits. In the opinion of management and NAPICO, the claims will not result in any material liability to the Partnership.\nThe Montecito local partnership had been operating at a deficit, and the General Partner was unsuccessful in its attempt to negotiate a mortgage modification with the lender to improve the situation. No mortgage payments to the lender were made subsequent to May 1994. A Notice of Default and Election To Sell Under the Deed of Trust was filed for record on October 27, 1994 in the LA County Recorder's office. On October 26, 1994, the loan servicer, on behalf of the lender, filed a complaint for Specific Performance for Appointment of Receiver and Judicial Foreclosure against the Partnership. The request for an appointment of a receiver was approved on November 10, 1994. Representatives of the Montecito local partnership and the General Partner met with the loan servicer on November 2, 1994 and on February 22, 1995 to discuss a loan modification proposal. However, the lender rejected all mortgage modification proposals submitted and foreclosed upon the property on July 18, 1995. The Partnership's original investment in the Montecito local partnership represents approximately 5% of the Partnership's total capital raised. The Partnership's financial statements reflect no investment in Montecito at December 31, 1995 and 1994.\nHousing Programs Corporation II, a general partner of the Partnership, and certain of its affiliates, on their own behalf and on behalf of the Partnership and certain other partnerships with which they are associated (collectively, the \"Plaintiff Partnerships\"), and NAPICO, and certain of its affiliates, have entered into a Memorandum of Understanding dated August 11, 1995. In addition to establishing certain Partnership controls, the Memorandum of Understanding resolves and settles various management and control issues which were under discussion for some time and various claims which were raised in a lawsuit filed in the Los Angeles Superior Court on June 9, 1995 by Housing Programs Corporation II, the Partnership, and others against, among others , NAPICO (\"the Lawsuit\"). All parties entered into the Memorandum of Understanding without any admission of wrongdoing or liability by any defendant as to any claim in the Lawsuit, in a desire to avoid continued litigation that would be expensive, time consuming and complex.\nBy virtue of the Memorandum of Understanding, the parties thereto have agreed, among other things, that:\n1. An analysis was to be prepared of the books and records of the Partnership including an analysis of the books and records of the master disbursement account maintained by an affiliate of NAPICO. The analysis has recently been completed. NAPICO agreed that it and its affiliates will pay to the Partnership any amounts (with interest thereon) properly determined to be owed to the Partnership as a result of the analysis.\n2. HAPI Management, Inc. (\"HAPI\"), an affiliate of NAPICO shall continue to manage the five Partnership properties it currently manages, subject to various agreed-upon modifications to the existing management agreements, and HAPI will not manage the other properties of the Partnership. All future management arrangements with HAPI will be subject to Housing Programs Corporation II's reasonable approval.\n3. The Partnership will reimburse Housing Programs Corporation II for professional fees paid on behalf of the Partnership in connection with issues raised in the Memorandum of Understanding.\n4. The Partnership will employ an independent Cash Manager, designated by Housing Programs Corporation II, and approved by NAPICO, to perform cash management services, including maintenance of the Partnership's bank accounts and reserves, payment of property management fees and other accounts payable, payments to affiliates of NAPICO, and payment of cash distributions, if any, to the Limited Partners. NAPICO has agreed to prepare detailed annual budgets to be approved by Housing Programs Corporation II and thereafter used by the Cash Manager as a guide and control over Partnership operations. The Cash Manager has not yet been implemented.\n5. The parties to the Memorandum of Understanding agreed to enter into a formal Settlement Agreement and, concurrently therewith, (a) the plaintiffs in the Lawsuit will execute a special release of the defendants with respect to the allegations contained in the Lawsuit, (b) the defendants in the Lawsuit will execute a special release of each plaintiff in the Lawsuit that is a general partner of a Plaintiff Partnership with respect to all claims which would have been compulsory counterclaims thereunder, and (c) the defendants will execute a special release of any claims, other than those regarding specifically scheduled contractual relations, which any defendant may have had against this Partnership or any of the other Plaintiff Partnerships.\n6. Upon the uncured breach of certain provisions of the Memorandum of Understanding, or upon a future breach of NAPICO's fiduciary duties, Housing Programs Corporation II could cause NAPICO to resign as a general partner of the Partnership and become a limited partner thereof.\nAs of April 8, 1996, certain of the foregoing items enumerated above had yet to be fully implemented. The parties have had discussions regarding their respective positions and have agreed to participate in a settlement conference. If these matters cannot be resolved by agreement, then the parties will submit their respective positions to arbitration.\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, and it is not anticipated that any public market will develop for the purchase and sale of any Limited Partnership Interest. Limited Partnership Interests may be transferred only if certain requirements are satisfied. Currently, there are 2,870 registered holders of Limited Partnership Interests in the Partnership. 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 dispositions of its investments in limited partnerships.\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\nThe Partnership's primary sources of funds include interest income on money market accounts and certificates of deposit and distributions from local partnerships 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.\nCAPITAL RESOURCES\nThe Partnership received $30,920,000 in subscriptions for units of Limited Partnership Interests (at $5,000 per unit) during the period September 12, 1984, to June 30, 1986, pursuant to a registration statement filed on Form S-11.\nThe Partnership made 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 were fulfilled. The Partnership has no further capital commitments to the local limited partnerships.\nIn 1993, three limited partnerships (Oxford House, Round Barn Manor and Westwood Terrace) refinanced their mortgages with taxable and tax-exempt bonds issued by the Illinois Housing Development Authority. Proceeds from the refinancing were utilized to retire two secondary mortgages including principal and accrued interest of $1,811,000 and $1,785,000 for Oxford House and Round Barn Manor, respectively. The third secondary mortgage of Westwood Terrace was paid down and has a remaining principal balance of approximately $442,000. After retiring and paying down the secondary mortgages, the Partnership received excess cash proceeds of more than $1,467,000 from the refinancings. The three limited partnerships obtained new mortgage amounts of $5,641,352, $5,318,893 and $3,172,370 financed for a term of 25 years at a taxable rate of 7.6 percent and a tax-exempt rate of 6.3 percent.\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 the Partnership has invested could produce losses for as long as 20 years from the date of the Partnership investment. Tax 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. The Partnership has sought to defer income taxes from capital gains by not selling any projects or project interests.\nEach individual limited partner's situation varies and limited partners should contact their personal tax advisors for an understanding of his or her tax situation.\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. Equity in income (loss) of limited partnerships has significantly been affected as a result of the Partnership not recognizing losses on the limited partnerships after their respective investment balances have been reduced to zero, in accordance with the equity method of accounting.\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 partnerships owning government assisted projects. Available cash is invested providing interest income as\nreflected in the statements 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.\nThe Montecito local partnership had been operating at a deficit, and the General Partner was unsuccessful in its attempt to negotiate a mortgage modification with the lender to improve the situation. No mortgage payments to the lender were made subsequent to May 1994. A Notice of Default and Election To Sell Under the Deed of Trust was filed for record on October 27, 1994 in the LA County Recorder's office. On October 26, 1994, the loan servicer, on behalf of the lender, filed a complaint for Specific Performance for Appointment of Receiver and Judicial Foreclosure against the Partnership. The request for an appointment of a receiver was approved on November 10, 1994. Representatives of the Montecito local partnership and the General Partner met with the loan servicer on November 2, 1994 and on February 22, 1995 to discuss a loan modification proposal. However, the lender rejected all mortgage modification proposals submitted and foreclosed upon the property on July 18, 1995. The Partnership's original investment in the Montecito local partnership represents approximately 5% of the Partnership's total capital raised. The Partnership's financial statements reflect no investment in Montecito at December 31, 1995 and 1994.\nA recurring Partnership expense is the management fee. The fee is payable monthly to the general partners of the Partnership and is calculated as a percentage of the Partnership's invested assets. The management fee is paid to the general partners for their continuing management of Partnership affairs. The fee is payable beginning with the month following the Partnership's initial investment in a local partnership.\nOperating expenses of the Partnership consist substantially of professional fees for services rendered to the Partnership, management fees payable to the general partners and accrued interest on the notes payable. Operating expenses have remained relatively consistent for 1995, 1994 and 1993, except for legal fees which increased as a result of the Montecito foreclosure.\nThe Partnership, as a Limited 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:\nNot applicable.\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nFINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS DECEMBER 31, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Housing Programs Limited (A California limited partnership)\nWe have audited the accompanying balance sheets of Housing Programs Limited (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (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 30 percent and 34 percent of total assets as of December 31, 1995 and 1994, respectively, and the equity in income (loss) of these limited partnerships represent 15 percent, 11 percent and 17 percent of the total net 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit 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 Housing Programs Limited 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\nHOUSING PROGRAMS LIMITED (A CALIFORNIA LIMITED PARTNERSHIP)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nHOUSING PROGRAMS LIMITED (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statement\nHOUSING PROGRAMS LIMITED (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIENCY) FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statem\nHOUSING PROGRAMS LIMITED (A CALIFORNIA 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 financial statements.\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nHousing Programs Limited (the \"Partnership\"), formed under the California Uniform Limited Partnership Act, was organized on May 15, 1984. The Partnership was formed to invest primarily in other limited partnerships which own or lease and operate federal, state or local government-assisted housing projects. The general partners of the Partnership are Housing Programs Corporation II, National Partnership Investments Corp. (NAPICO), and Coast Housing Investment Associates (CHIA), a limited partnership. LBI Group Inc. owns 100 percent of the stock of Housing Programs Corporation II. Casden Investment Corp. owns 100 percent of NAPICO's stock. The limited partner of CHIA is an officer of NAPICO.\nThe Partnership offered and issued 6,184 units of limited partnership interests through a public offering. Each unit was comprised of two limited partnership interests and one warrant, which entitled the investor two additional limited partnership interests. An additional 6,184 of 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 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, 2034) from the date of the formation of the Partnership or upon the occurrence of various other events as described in the terms of 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 partners' 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.\nMethod of Accounting for Investments in Limited Partnerships\nThe investments in local limited partnerships are accounted for on the equity method. Acquisition, selection and other costs related to the acquisition of the projects have been capitalized to the investment\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\naccount and are being amortized on a straight line basis over the estimated lives of the underlying assets, which is generally 30 years.\nNet Loss Per Limited Partnership Interest\nNet loss per limited partnership interest was computed by dividing the limited partners' share of net loss by the number of limited partnership interests outstanding during the year. The number of limited partnership interests was 12,368 for all years presented.\nCash and Cash Equivalents\nCash and cash equivalents consist of cash and bank certificates of deposit with an original maturity of three months or less.\nShort Term Investments\nShort term investments consist of bank certificates of deposit and other securities 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 18 limited partnerships. The partnerships own residential rental projects consisting of 2,686 apartment units. The mortgage loans of these projects are insured by various governmental agencies.\nThe Partnership, as a limited partner, is entitled to 99 percent of the profits and losses of the limited partnerships.\nEquity in losses of limited partnerships is recognized in the financial statements until the limited partnership investment account is reduced to a zero balance. Losses incurred after the investment account is reduced to zero are not recognized. The cumulative amount of unrecognized equity in losses of certain limited partnerships was approximately $10,273,000 and $8,837,000 as of December 31, 1995 and 1994, respectively.\nDistributions from the limited partnerships are recognized as a reduction of capital until the investment balance has been reduced to zero or to a negative amount equal to further capital contributions required. Subsequent distributions are recognized as income.\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\nThe following is a summary of the investments in limited partnerships and reconciliation to the limited partnership accounts:\nThe difference between the investment per the accompanying balance sheets at December 31, 1995 and 1994, and the equity per the limited partnerships' combined financial statements is due primarily to cumulative unrecognized equity in losses of certain limited partnerships, costs capitalized to the investment account and cumulative distributions recognized as income.\nSelected financial information from the combined financial statements of the limited partnerships at December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 is as follows:\nBalance Sheets\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\nStatements of Operations\nAn affiliate of NAPICO is the general partner in 10 of the limited partnerships included above in 1995 and 1994, and another affiliate receives property management fees of approximately 5 to 6 percent of revenues from five of these partnerships. The affiliate received property management fees of $234,903, $236,149 and $235,859 in 1995, 1994 and 1993, respectively. The following sets forth the significant data for these partnerships, reflected in the accompanying financial statements using the equity method of accounting:\nThe Montecito local partnership had been operating at a deficit, and the general partner was unsuccessful in its attempt to negotiate a mortgage modification with the lender to improve the situation. No mortgage\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\npayments to the lender were made subsequent to May 1994. A Notice of Default and Election To Sell was filed for record on October 27, 1994 in the LA County Recorder's office. On October 26, 1994, the loan servicer, on behalf of the lender, filed a complaint for Specific Performance for Appointment of Receiver and Judicial Foreclosure against the Partnership. The request for an appointment of a receiver was approved on November 10, 1994. Representatives of the Montecito local partnership and the general partner met with the loan servicer on November 2, 1994 and on February 22, 1995 to discuss a loan modification proposal. However, the lender rejected all mortgage modification proposals submitted and foreclosed upon the property on July 18, 1995. The Partnership's original investment in the Montecito local partnership represents approximately 5% of the Partnership's total capital raised. The Partnership's financial statements reflect no investment in Montecito at December 31, 1995 and 1994.\nIn 1993, three limited partnerships (Oxford House, Round Barn Manor and Westwood Terrace) refinanced their mortgages with taxable and tax-exempt bonds issued by the Illinois Housing Development Authority. Proceeds from the refinancing were utilized to retire two secondary mortgages including principal and accrued interest of $1,811,000 and $1,785,000 for Oxford House and Round Barn Manor, respectively. The third secondary mortgage of Westwood Terrace was paid down and has a remaining principal balance of approximately $442,000. After retiring the secondary mortgages, the Partnership received excess cash proceeds of more than $1,467,000 from the refinancing. The three limited partnerships now have new mortgage amounts of $5,641,352, $5,318,893 and $3,172,370 financed for a term of 25 years at a taxable rate of 7.6 percent and a tax-exempt rate of 6.3 percent.\n3. NOTES PAYABLE\nCertain of the Partnership's investments involved purchases of partnership interests from partners who subsequently withdrew from the operating partnership. The Partnership is obligated for non-recourse notes payable of $10,169,743, bearing interest at 9.5 and 12.5 percent, to the sellers of the partnership interests. The interest rate for a note of $1,500,000 changed in 1995 to 12.5 percent per terms of the note. The notes have principal maturity dates ranging from October 1996 to December 2001 or upon sale or refinancing of the underlying partnership properties. These obligations and the related interest are collateralized by the Partnership's investment in the investee limited partnerships and are payable only out of cash distributions from the investee partnerships, as defined in the notes. Unpaid interest is due at maturity of the notes.\nThe Partnership is currently negotiating for the sale of Deep Lake Hermitage, the property that the $1,500,000 note payable and accrued interest of $1,402,846 due in 1996 relate to. Based on an offer received, there would not be adequate funds to pay approxiamtely $1,800,000 of the note payable and related accrued interest. Because the notes and interest payable are non-recourse liabilities, no loss is expected to be realized by the Partnership if the investment is foreclosed upon by the lender.\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n3. NOTES PAYABLE (CONTINUED)\nMaturity dates on the notes and related acrrued interest payable are as follows:\n4. FEES AND EXPENSES DUE GENERAL PARTNERS\nUnder the terms of the Restated Certificate and Agreement of the Limited Partnership, the Partnership is obligated to the general partners for an annual management fee equal to .5% of the original invested assets of the limited 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 interest in the capital accounts of the respective limited partnerships.\nAs of December 31, 1995, the fees and expenses due the general partners exceeded the Partnership's cash. The general partners, during the forthcoming year, will not demand payment of amounts due in excess of such cash or such that the Partnership would not have sufficient operating cash.\nThe Partnership reimburses NAPICO for certain expenses. The reimbursement to NAPICO was $29,845, $28,764, and $29,252 in 1995, 1994 and 1993, respectively, and is included in operating expenses.\n5. 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. 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.\nHOUSING PROGRAMS LIMITED (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n6. CONTINGENCIES\nNAPICO is a plaintiff in various lawsuits and has also been named as a defendant in other lawsuits arising from transactions in the ordinary course of business. In the opinion of management and NAPICO, the claims will not result in any material liability to the Partnership.\n7. 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 notes payable are collateralized by the Partnership's investments in investee limited partnerships and are payable only out of cash distributions from the investee partnerships. The operations generated by the investee limited partnerships, which account for the Partnership's primary source of revenues, are subject to various government rules, regulations and restrictions which make it impracticable to estimate the fair value of the 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.\n8. 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 financial statements is based primarily upon audited financial statements of the investee limited partnerships. The difference, approximately $31,935, between the estimated nine-month equity in income and the actual year-to-date equity in loss has been recorded in the fourth quarter.\nSCHEDULE (CONTINUED)\nHOUSING PROGRAMS LIMITED INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nHOUSING PROGRAMS LIMITED INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nHOUSING PROGRAMS LIMITED INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nHOUSING PROGRAMS LIMITED INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTES: 1. Equity in income (losses) of the limited partnerships represents the Partnership's allocable share of the net income (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 on 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.\nSCHEDULE III HOUSING PROGRAMS LIMITED REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH H P L HAS INVESTMENTS DECEMBER 31, 1995\nSCHEDULE III (CONTINUED)\nHOUSING PROGRAMS LIMITED REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH HPL HAS INVESTMENTS DECEMBER 31, 1995\nNOTES: 1. Each local limited partnership has developed, owns and operates the housing project. Substantially all project costs, including construction period interest expense, were capitalized by the local limited 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 from 25 to 40 years.\n3. Investments in property and equipment - limited partnerships:\nSCHEDULE III (CONTINUED)\nHOUSING PROGRAMS LIMITED REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH HPL HAS INVESTMENTS DECEMBER 31, 1995\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:\nHOUSING PROGRAMS LIMITED (the \"Partnership\") has no directors or executive officers of its own.\nThe general partners of the Partnership are National Partnership Investments Corp. (\"NAPICO\"), Coast Housing Investments Associates (an affiliate of NAPICO) and Housing Programs Corporation II. NAPICO is a wholly-owned subsidiary of Casden Investment Company, an affiliate of The Casden Company. Housing Programs Corporation II is a wholly-owned subsidiary of LBI Group Inc. The following biographical information is presented for the directors and executive officers of NAPICO and officers of Housing Programs Corporation II 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 Corporation. 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.\nMr. 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.\nMr. 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 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 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, Melvoin & 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.\nPATRICIA 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.\nROCCO F. ANDRIOLA, 37, serves as President and Chief Financial Officer of Housing Programs Corporation II and Senior Vice President of Lehman Brothers Inc. in its Diversified Asset Group. He has held such position with Lehman since June 1991. From June 1989 through May 1991, Mr. Andriola held the position of First Vice President in Lehman's Capital Preservation and Restructuring Group. From November 1986 through May 1989, Mr. Andriola held the position of Vice President in the Corporate Transactions Group with the General Counsel's Office of Lehman. From September 1982 through October 1986, Mr. Andriola was employed by the law firm of Donovan Leisure Newton & Irvine as a corporate and securities attorney. Mr. Andriola graduated summa cum laude from Fordham University in 1979 with a B.A. degree in Economics and Political Science. Mr. Andriola received a J.D. degree and an LL.M degree in Corporate Law from New York University School of Law in 1982 and 1986, respectively.\nJOHN H. NG, 45, is a Vice President of Housing Programs Corporation II and Vice President of Lehman Brothers Inc. He has been employed by Lehman since November 1977. He is an asset manager of the Diversified Asset Group of Lehman and has held such position since 1985. From 1980 to 1985, Mr. Ng served as Senior Financial Analyst in the Corporate Planning and Development Department and from 1977 to 1980 he was an analyst in the Controller's Department. Prior to joining Lehman, he served as a Teaching Assistant in Finance and Economics at the University of Minnesota. Mr. Ng received an M.B.A. with a concentration in Corporate Finance from the University of Minnesota in 1977 and a B.A. magna cum laude in Economics with a specialization in Monetary Economics from Moorhead State University in 1975.\nMARK J. MARCUCCI, 33, is a Vice President of Housing Programs Corporation II and Vice President of Lehman Brothers Inc. in its Diversified Asset Group. Since joining Lehman Brothers in 1988, Mr. Marcucci's responsibilities have been concentrated in the restructuring, asset management, leasing, financing, refinancing and disposition of commercial office and residential real estate. Prior to joining Lehman Brothers, Mr. Marcucci was employed in a corporation lending capacity at Republic National Bank of New York. Mr. Marcucci received a B.B.A. in Finance from Hofstra University and a Master of Science in Real Estate from New York University. In addition, Mr. Marcucci holds both Series 7 and Series 63 securities licenses.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS:\nHousing Programs Limited 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 general partners an annual management fee. The annual management fee is approximately equal to .5% 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 lcoal partnership. In addition, the Partnership reimburses NAPICO for certain expenses.\nAn affiliate of NAPICO is responsible for the on-site property management 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 Housing Programs Limited. 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 NAPICO, none of the officers or directors of NAPICO own directly or beneficially any limited partnership interests in the Partnership.\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 general partners. The transactions with the general partners are primarily in the form of fees paid by the Partnership to the general partners for services rendered to the Partnership, as discussed in Item 11 and in the notes to the accompanying financial statements.\nITEM 14.","section_14":"ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORT ON FORM 8-K:\nFINANCIAL STATEMENTS\nReports of Independent 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' Equity (Deficiency) 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 APPLICABLE TO HOUSING PROGRAMS LIMITED AND LIMITED PARTNERSHIPS IN WHICH HOUSING PROGRAMS LIMITED HAS INVESTMENTS\nSchedule - Investments in Limited Partnerships for the years ended December 31, 1995, 1994 and 1993.\nSchedule III - Real Estate and Accumulated Depreciation of Property Held by Local Limited Parnterships, December 31, 1995.\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.\nEXHIBITS\n(3) Articles of incorporation and bylaws: The registrant is not incorporated. The Partnership Agreement was filed with Form S-11 #2-92352 incorporated herein by reference.\n(10) Material contracts: The registrant is not party to any material contracts, other than the Restated Certificate and Agreement of Limited Partnership dated May 15, l984, and the nineteen contracts representing the partnership's investment in local limited partnerships as previously filed at the Securities Exchange Commission, File #2-92352 which is hereby incorporated by reference.\n(13) Annual report to security holders: Pages ____ to ____.\nReports on Form 8-K\nNo reports on Form 8K were filed during the year ended December 31, 1995.","section_15":""}
{"filename":"803095_1995.txt","cik":"803095","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Dyco Oil and Gas Program 1986-X Limited Partnership (the \"Program\") is a Minnesota limited partnership engaged in the production of oil and gas. The Program commenced operations on Decem- ber 12, 1986 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)\nAs of December 31, 1995\nGross productive wells(2): Oil 1 Gas 10 -- Total 11\nNet productive wells(3): Oil .24 Gas 1.51 ---- Total 1.75\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) 398 567 671 Gas (Mcf)(2) 94,215 107,064 116,203\nOil and gas sales: Oil $ 6,685 $ 8,909 $ 11,410 Gas 127,800 170,095 213,572 ------- ------- ------- Total $134,485 $179,004 $224,982 ======= ======= =======\nTotal direct operating expenses $ 67,844 $ 61,076 $ 63,352 ======= ======= =======\nDirect operating expenses as a percentage of oil and gas sales 50.4% 34.1% 28.2%\nAverage sales price: Per barrel of oil $16.80 $15.71 $17.00 Per Mcf of gas 1.36 1.59 1.84\nDirect operating expenses per equivalent Mcf of gas(3) $ .70 $ .55 $ .53\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\nvalue 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 higher 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\nAs of December 31, 1995\nEstimated proved reserves: Natural gas (Mcf) 316,119 Oil and liquids (Bbls) 1,114\nNet present value (discounted at 10% per annum) $271,571\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 4 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 11 gross (1.75 net) productive wells in which the Program owned a working interest. The Program owned a non-working interest in one additional gross well. Affiliates of the Program operate 9 (75%) of its total wells. As of December 31, 1995, the Program's net interests in its properties resulted in estimated total proved reserves of 316,119 Mcf of natural gas and 1,114 barrels of oil, with a present value (discounted at 10% per annum) of estimated future net cash flow of $271,571. 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.\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\nTo 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 Program'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 $106 $ - Second Quarter 88 30 Third Quarter 88 - Fourth Quarter 63 25\n1995: First Quarter $ 63 $ - Second Quarter 108 - Third Quarter 88 20 Fourth Quarter 88 -\n1996: First Quarter $ 88 (1)\n- - ----------\n(1) To be declared in March 1996.\nThe Program has 2,021 Units outstanding and approximately 678 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 General -------\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 24.9% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily due to decreases in both the volumes of oil and natural gas sold and the average price of natural gas sold. Volumes of oil and natural gas sold decreased 169 barrels and 12,849 Mcf, respectively, for the year ended December 31, 1995 as compared to the year ended December 31, 1994. The decrease in the volumes of oil and natural gas sold was primarily due to a fluid loading problem on one well. Average oil prices increased to $16.80 per barrel for the year ended December 31, 1995 from $15.71 per barrel for the year ended December 31, 1994, while average natural gas prices decreased to $1.36 per Mcf for the year ended December 31, 1995 from $1.59 per Mcf for the year ended December 31, 1994.\nOil and gas production expenses (including lease operating expenses and production taxes) increased 11.1% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase was primarily due to surface and subsurface repair and maintenance expenses and compression expenses incurred on a few wells during 1995 in order to improve the recovery of reserves. As a percentage of oil and gas sales, these expenses increased to 50.4% for the year ended December 31, 1995 from 34.1% for the year ended December 31, 1994. This percentage increase was primarily due to (i) the decrease in oil and gas sales and (ii) the dollar increase in oil and gas production expenses discussed above.\nDepreciation, depletion, and amortization of oil and gas properties decreased $15,060 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily due to upward revisions of previous reserve estimates. As a percentage of oil and gas sales, this expense decreased to 12.9% for the year ended December 31, 1995 from 18.1% for the year ended December 31, 1994. This percentage decrease was primarily due to the dollar decrease in depreciation, depletion, and amortization of oil and gas properties, partially offset by the decrease in oil and gas sales.\nGeneral and administrative expenses increased $1,519 for the year ended December 31, 1995 as compared to the year ended December 31, 1994 primarily due to an increase in both professional fees and printing and postage expenses. As a percentage of oil and gas sales, these expenses increased to 16.1% for the year ended December 31, 1995 from 11.3% for the year ended December 31, 1994. This percentage increase was primarily due to the decrease in oil and gas sales.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993 -------------------------------------\nTotal oil and gas sales decreased 20.4% for the year ended Decem- ber 31, 1994 as compared to the year ended December 31, 1993. This decrease was due to decreases in the volumes and average prices of oil and natural gas sold. Volumes of oil and natural gas sold decreased slightly by 104 barrels and 9,139 Mcf, respectively, for the year ended December 31, 1994 as compared to the similar period in 1993. Average oil and natural gas prices decreased to $15.71 per barrel and $1.59 per Mcf for the year ended December 31, 1994 from averages of $17.00 per barrel and $1.84 per Mcf for the year ended December 31, 1993.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased slightly by 3.6% 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 34.1% for the year ended December 31, 1994 compared to 28.2% for the year ended December 31, 1993. This percentage increase was due primarily to the decreases in the average prices of oil and natural gas sold and the fixed nature of a portion of oil and gas production expenses.\nDepreciation, depletion, and amortization of oil and gas properties decreased by $6,997 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease was primarily due to the decreases in volumes of oil and natural gas sold. As a percentage of oil and gas sales, this expense remained relatively constant at 18.1% for the year ended December 31, 1994 compared to 17.5% for the year ended December 31, 1993.\nGeneral and administrative expenses decreased by $4,447 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This dollar decrease was primarily due to a decrease in professional fees during the year ended December 31, 1994 as compared to the similar period in 1993. As a percentage of oil and gas sales, these expenses remained relatively constant at 11.3% for the year ended December 31, 1994 compared to 11.0% for the year ended December 31, 1993.\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 3.4 years for gas reserves and 2.8 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 1986-X LIMITED PARTNERSHIP\nWe have audited the financial statements of the Dyco Oil and Gas Program 1986-X 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 1986-X 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 1986-X LIMITED PARTNERSHIP Balance Sheets December 31, 1995 and 1994\nASSETS ------ 1995 1994 -------- --------\nCURRENT ASSETS: Cash and cash equivalents $ 18,661 $ 10,512 Accrued oil and gas sales, including $23,100 and $27,140 due from related parties 25,685 27,521 ------- -------\nTotal current assets $ 44,346 $ 38,033\nNET OIL AND GAS PROPERTIES, utilizing the full cost method 82,402 98,980\nDEFERRED CHARGE 13,956 5,563 ------- -------\n$140,704 $142,576 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\nCURRENT LIABILITIES: Accounts payable $ 4,622 $ 4,007 ------- ------- Total current liabilities $ 4,622 $ 4,007\nACCRUED LIABILITY $ 9,719 $ -\nPARTNERS' CAPITAL: General Partner, issued and outstanding, 21 Units $ 1,263 $ 1,385 Limited Partners, issued and outstanding, 2,000 Units 125,100 137,184 ------- ------- Total Partners' capital $126,363 $138,569 ------- -------\n$140,704 $142,576 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1986-X LIMITED PARTNERSHIP Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------- -------- --------\nREVENUES: Oil and gas sales, including $125,252, $170,094, and $210,574 of sales to related parties $134,485 $179,004 $224,982 Interest 681 1,066 720 ------- ------- -------\n$135,166 $180,070 $225,702\nCOSTS AND EXPENSES: Lease operating $ 58,323 $ 48,015 $ 47,258 Production taxes 9,521 13,061 16,094 Depreciation, depletion, and amortization of oil and gas properties 17,395 32,455 39,452 General and administrative 21,713 20,194 24,641 ------- ------- -------\n$106,952 $113,725 $127,445 ------- ------- -------\nNET INCOME $ 28,214 $ 66,345 $ 98,257 ======= ======= =======\nGENERAL PARTNER (1%) - NET INCOME $ 282 $ 663 $ 983 ======= ======= =======\nLIMITED PARTNERS (99%) - NET INCOME $ 27,932 $ 65,682 $ 97,274 ======= ======= =======\nNET INCOME per Unit $ 14 $ 33 $ 49 ======= ======= =======\nUNITS OUTSTANDING 2,021 2,021 2,021 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1986-X 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 $2,266 $224,326 $226,592 Cash distributions ( 1,415) ( 140,055) ( 141,470) Net income 983 97,274 98,257 ----- ------- -------\nBalances at December 31, 1993 $1,834 $181,545 $183,379 Cash distributions ( 1,112) ( 110,043) ( 111,155) Net income 663 65,682 66,345 ----- ------- -------\nBalances at December 31, 1994 $1,385 $137,184 $138,569 Cash distributions ( 404) ( 40,016) ( 40,420) Net income 282 27,932 28,214 ----- ------- -------\nBalances at December 31, 1995 $1,263 $125,100 $126,363 ===== ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1986-X 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 $ 28,214 $ 66,345 $ 98,257 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 17,395 32,455 39,452 Decrease in accrued oil and gas sales 1,836 7,193 3,047 Increase in deferred charge ( 8,393) ( 1,090) ( 4,473) Increase (decrease) in accounts payable 615 161 ( 61) Increase in accrued liability 9,719 - - ------- ------- ------- Net cash provided by operating activities $ 49,386 $105,064 $136,222 ------- ------- -------\nCASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties ($ 817) $ - ($ 2,411) ------- ------- -------\nNet cash used by investing activities ($ 817) $ - ($ 2,411) ------- ------- -------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($ 40,420) ($111,155) ($141,470) ------- ------- -------\nNet cash used by financing activities ($ 40,420) ($111,155) ($141,470) ------- ------- -------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 8,149 ($ 6,091) ($ 7,659)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 10,512 16,603 24,262 ------- ------- -------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 18,661 $ 10,512 $ 16,603 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1986-X 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 1986-X Limited Partnership (the \"Program\"), a Minnesota limited partnership, commenced operations on December 12, 1986. Dyco Petroleum Corporation (\"Dyco\") is the General Partner of the Program. Affiliates of Dyco owned 501.15 (24.8%) 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 $0.18, $0.29, and $0.33, 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 24,432 Mcf, resulting in prepaid lease operating expenses of $13,956. 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 12,191 Mcf, resulting in prepaid lease operating expenses of $5,563.\nAccrued Liability\nAccrued Liability 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 17,015 Mcf, resulting in accrued lease operating expenses of $9,719. There was no such amount recorded at December 31, 1994.\nOil and Gas Sales\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 and 1994, no such liability was recorded.\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. 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 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 $21,713, $20,194, and $24,641, respectively, of which $16,080, $16,080, and $15,924, 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 $125,252, $170,094, and $210,574, respectively. At December 31, 1995 and 1994 accrued oil and gas sales included $23,100 and $27,140, respectively, due from Premier.\n3. MAJOR CUSTOMERS\nThe following purchaser individually accounted for more than 10% of the combined oil and gas revenues of the Program for the years ended December 31, 1995, 1994, and 1993:\nPurchaser 1995 1994 1993 --------- ----- ----- -----\nPremier 93.1% 95.0% 93.6%\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. 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 $9,193,178 $9,192,361\nUnproved properties, not subject to depreciation, depletion, and amortization - - --------- ---------\n$9,193,178 $9,192,361\nLess accumulated depreciation, depletion, amortization, and valuation allowance ( 9,110,776) ( 9,093,381) --------- ---------\nNet oil and gas properties $ 82,402 $ 98,980 ========= =========\nCosts 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 817 - 2,411 ----- ----- -----\nTotal costs incurred $ 817 $ - $2,411 ===== ===== =====\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.\nPART 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, 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) $16,080 $16,080 $15,924\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 substantial majority 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 $125,252, $170,094, and $210,574, 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 501.15 (24.8%)\nAll directors, officers, and affiliates of Dyco as a group and Dyco (8 persons) 501.15 (24.8%)\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 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 the 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 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 November 25, 1986 for Dyco Drilling Program 1986-X, a Limited Part- nership, by and between Dyco Oil and Gas Program 1986-X and Dyco Petroleum Corporation filed as Exhibit 4.1 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n4.2 Program Agreement dated November 25, 1986 for Dyco Oil and Gas Program 1986-X 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 1, 1992 and is hereby incorporated by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1986-X dated December 31, 1989 filed as Exhibit 4.3 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1986-X Limited Partnership filed as Exhibit 4.4 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1986-X 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. DYCO OIL AND GAS PROGRAM 1986-X LIMITED PARTNERSHIP\nBy: DYCO PETROLEUM CORPORATION General Partner February 20, 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. 20, 1996 ------------------- Officer, President, C. Philip Tholen and Chairman of the Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice Feb. 20, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice Feb. 20, 1996 ------------------- President - Jack A. Canon General Counsel and Director\n\/s\/Patrick M. Hall Senior Vice Feb. 20, 1996 ------------------- President - Patrick M. Hall Controller (Principal Accounting Officer)\n\/s\/Annabel M. Jones Secretary Feb. 20, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer Feb. 20, 1996 ------------------- Judy F. Hughes\nINDEX TO EXHIBITS\nExhibit Number Description - - ------- -----------\n4.1 Drilling Agreement dated November 25, 1986 for Dyco Drilling Program 1986-X, a Limited Partnership, by and between Dyco Oil and Gas Program 1986-X and Dyco Petroleum Corporation filed as Exhibit 4.1 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n4.2 Program Agreement dated November 25, 1986 for Dyco Oil and Gas Program 1986-X 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 1, 1992 and is hereby incorporated by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1986-X dated December 31, 1989 filed as Exhibit 4.3 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1986-X Limited Partnership filed as Exhibit 4.4 to Annual Report on Form 10-K for the year ended Decem- ber 31, 1991 on April 1, 1992 and is hereby incorporated by reference.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1986-X Limited Partnership's financial statements as of December 31,1995 and for the year ended December 31, 1995.","section_15":""}
{"filename":"719220_1995.txt","cik":"719220","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nS&T Bancorp, Inc. (Company) was incorporated on March 17, 1983 under the laws of the Commonwealth of Pennsylvania as a bank holding company and has two wholly owned subsidiaries, S&T Bank and S&T Investment Company, Inc. The Company is registered as a bank holding company with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act, as amended.\nAs of December 31, 1995, the Company had $1.4 billion in total assets, $167 million in total shareholders' equity and $980 million in total deposits. Deposits are insured by the Federal Deposit Insurance Corporation to the full extent provided by law.\nTotal trust assets were approximately $416 million at December 31, 1995. Trust services include services as executor and trustee under wills and deeds, and as guardian and custodian of employee benefit trusts.\nS&T Bank is a full service bank with its main office at 800 Philadelphia Street, Indiana, Pennsylvania, providing service to its customers through a branch network of thirty-four offices located in Armstrong, Allegheny, Indiana, Jefferson, Clearfield and Westmoreland counties.\nS&T Bank's services include accepting time and demand deposit accounts, making secured and unsecured commercial and consumer loans, providing letters of credit, and offering discount brokerage services, personal financial planning and credit card services. S&T 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). S&T Bank does not experience significant fluctuations in deposits.\nEmployees\nAs of December 31, 1995, S&T Bank had a total of 572 full-time equivalent employees. S&T provides a variety of employment benefits and considers its relationship with its employees to be good.\nSupervision and Regulation\nThe Company is under the jurisdiction of the Securities and Exchange Commission and of state securities commissions for matters relating to the offering and sale of its securities. The Company is subject to the Securities and Exchange Commission's rules and regulations relating to periodic reporting to its shareholders, insider trading and proxy solicitation.\nThe Company is also subject to the provisions of the Bank Holding Company Act of 1956 (the Act), as amended and to supervision by the Federal Reserve Board. The Act requires the company to secure the prior approval of the Federal Reserve Board before it can acquire more than 5% of the voting shares of any bank other than its existing subsidiary. The Act also prohibits acquisition by the Company of more than 5% of the voting shares of, or interest in, or all or substantially all of the assets of any bank located outside Pennsylvania unless such an acquisition is specifically authorized by the laws of the state in which such bank is located.\nBUSINESS --Continued\nA bank holding company is prohibited under the Act from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking 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 determinations, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public which outweigh possible adverse effects. See Permitted NonBanking Activities.\nAs a bank holding company, the Company is required to file with the Federal Reserve Board annual reports or any additional information as the Federal Reserve Board may require pursuant to the Act. The Federal Reserve Board also makes regular examinations of the Company and its subsidiaries.\nSubsidiary banks of a bank holding company are subject to certain restrictions imposed by the Act on any extension 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 or its subsidiaries, and on the taking of such stock or securities as collateral for loans to any borrower.\nPermitted NonBanking Activities\nThe Federal Reserve Board permits bank holding companies to engage in nonbanking activities so closely related to banking or managing or controlling banks so as to be a proper incident thereto. The types of permissible activities are subject to change by the Federal Reserve Board.\nThe Company is presently engaged in two nonbanking activities. The first one is S&T Investment Company, Inc., which is an investment holding company incorporated in the state of Delaware. S&T Investment Company, Inc. was formed in June 1988 for the purpose of holding and managing a group of investments which were previously owned by S&T and to give the Company additional latitude to purchase other investments, such as corporate preferred stocks. The second is Commonwealth Trust Credit Life Insurance Company which is located in Phoenix, Arizona. The company, which is a joint venture with a local financial institution, acts as a reinsurer for credit life, accident and health insurance policies sold by the respective banks. At December 31, 1995, S&T's share of the company's total assets and net income for the year was $2,346,223 and $346,532, respectively.\nFederal Reserve Board approval is required before the Company or a nonbank subsidiary of the Company may begin to engage in any of the above activities and before any such business may be acquired. The Federal Reserve Board is empowered to differentiate between activities which are initiated by a bank holding company or a subsidiary and activities commenced by acquisition of a going concern.\nLegislation\nAs a state chartered bank, S&T is subject to regulations of the Federal Deposit Insurance Corporation (FDIC) and the Pennsylvania Department of Banking (PADB). As an insured bank under the Federal Deposit Insurance Act, S&T is also regulated by the FDIC. Some of the aspects of the lending and deposit business of S&T which are regulated include personal lending, mortgage lending, and interest rates, both as they relate to lending and interest paid on deposits and reserve requirements. Representatives of the FDIC and PADB regularly conduct examinations of S&T's affairs and records, and S&T must furnish quarterly reports to the FDIC and the PADB.\nBUSINESS--Continued\nCompetition\nAll phases of S&T Bank's business are highly competitive. S&T Bank's market area is western Pennsylvania, with a representation in Indiana, Armstrong, Allegheny, Jefferson, Clearfield and Westmoreland counties. S&T Bank competes with those local commercial banks which have branches and customer calling programs in its market area. S&T Bank considers its major competitors to be National Bank of the Commonwealth, headquartered in Indiana, Pennsylvania; PNC Bank, N.A. headquartered in Pittsburgh, Pennsylvania; Laurel Bank, headquartered in Johnstown, Pennsylvania; People's Bank, headquartered in Ford City, Pennsylvania; Indiana First Savings Bank headquartered in Indiana, Pennsylvania; Deposit Bank, headquartered in DuBois, Pennsylvania; Clearfield Bank and Trust Company, headquartered in Clearfield, Pennsylvania and Marion Center National Bank, headquartered in Marion Center, Pennsylvania. The proximity of Indiana to metropolitan Pittsburgh results in a significant impact on the S&T market because of media influence and penetration by larger financial institutions.\nUnder the Community Reinvestment Act of 1977, the FDIC is required to assess the records of all financial institutions regulated by it to determine if these institutions meet the credit needs of the community (including low and 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.\nAs a consequence of the extensive regulation of commercial banking activities in the United States, S&T's business is particularly susceptible to being affected by federal and state legislation and regulations which may have the effect of increasing the costs of doing business.\nA subsidiary bank of a bank holding company, such as S&T, is 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 investment in the stock or other securities of the bank holding company or its subsidiaries, and on the taking of such stock or securities as collateral for loans to any borrower. Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a bank holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Furthermore, federal legislation prohibits acquisition of control of a bank holding company without prior notice to the Federal Reserve Board.\nMonetary Policy\nThe earnings of S&T are affected by the policies of regulatory authorities including the Board of Governors of the Federal Reserve System, the FDIC and PADB. An important function of the Federal Reserve System is to provide an environment that is conducive to stable economic growth. Among the instruments used to implement these objectives are open market operations in U.S. Government securities, changes in reserve requirements against bank deposits and limitations on interest rates that banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid deposits.\nThe policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on S&T's deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect S&T's operations in the future. The effect of such policies and regulations upon the future business and earnings of S&T cannot accurately be predicted.\nBUSINESS--Continued\nDistribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential.\nThe following discussion and analysis is presented so that shareholders may review in further detail the financial condition and results of operations of S&T Bancorp, Inc. and subsidiaries (S&T). This discussion and analysis should be read in conjunction with the consolidated financial statements, selected financial data and management's discussion and analysis incorporated by reference. References to assets and liabilities and changes thereto represent daily average balances for the periods discussed, unless otherwise noted.\nNet interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the volume of interest-earning assets and interest-bearing liabilities and changes in interest yields and rates. Interest on loans to and obligations of state, municipalities and other public entities is not subject to federal income tax. As such, the stated (pre-tax) yield on these assets is lower than the yields on taxable assets of similar risk and maturity. In order to make the pre-tax income and resultant yields comparable to taxable loans and investments, a taxable equivalent adjustment was added to interest income in the tables below. This adjustment has been calculated using the U.S. federal statutory income tax rate of 35% for 1995, 1994 and 1993. The following table demonstrates the amount that has been added to interest income per the summary of operations.\nBUSINESS - Continued\nAverage Balance Sheet and Net Interest Income Analysis\n(1) For the purpose of these computations, nonaccruing loans are included in the daily average loan amounts outstanding. Loan fees are included in the interest amounts and are not material.\nItem 1. BUSINESS--Continued\nThe following tables set forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:\n(1) The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.\nItem 1. BUSINESS--Continued\nINFLATION AND CHANGING INTEREST RATES\nThe majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventory. Fluctuations in interest rates and the efforts of the Federal Reserve Board to regulate money and credit conditions have a greater effect on a financial institution's profitability than do the effects of higher costs for goods and services. Through its asset\/liability management function, S&T is positioned to cope with changing interest rates and inflationary trends.\nInterest rate risk at a given point in time is portrayed by the interest rate sensitivity position (\"gap\"). The cumulative gap represents the net position of assets and liabiities subject to repricing in specified time periods. The gap presented at any point in time is one measure of the risk inherent in the existing balance sheet structure as it relates to potential changes in net interest income. Gap alone does not accurately measure the magnitude of changes in net interest income since changes in interest rates do not affect all categories of assets and liabilities equally or simultaneously. The following table shows the Company's gap position at December 31, 1995.\nInterest Rate Sensitivity\nItem 1. BUSINESS-- Continued\nDuring the fourth quarter of 1995, management reclassified the securities portfolio allowed by the \"one time\" amnesty per Financial Accounting Standards Board Statement No. 115. The reclassified securities were from the held to maturity category to the available for sale category. The transfered securities had an amortized cost of $154.2 million and a market value of $159.5 million. The resulting net of tax effect of the reclassification to S&T's equity was $3.4 million.\nThe following table sets forth the maturities of securities at December 31, 1995, and the weighted average yields of such securities (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security). Tax-equivalent adjustments (using a 35% federal income tax rate) for 1995 have been made in calculating yields on obligations of state and political subdivisions.\nItem 1. BUSINESS-- Continued\nLoan Portfolio\nThe following table shows the Company's loan distribution at the end of each of the last five years:\nThe following table shows the maturity of loans (excluding residential mortgages of 1-4 family residences and installment loans) outstanding as of December 31, 1995. Also provided are the amounts due after one year classified according to the sensitivity to changes in interest rates.\nItem 1. Business - Continued\nThe following table summarizes the Company's nonaccrual, past due and restructured loans:\nDecember 31 1995 1994 1993 1992 1991 (In thousands of dollars)\nNonaccrual loans $2,844 $1,922 $2,481 $2,983 $3,915\nAccruing loans past due 90 days or more $0 $0 $323 $605 $1,178\nAt December 31, 1995, $2,844,000 of nonaccrual loans were secured. Interest income that would have been recorded under original terms totaled $242,000. No interest income was recorded on these loans. It is the Company's policy to place loans on nonaccrual status when the interest and principal is 90 days or more past due. There are no foreign loan amounts required to be included in this table. There were no restructured loans in the periods presented.\nPotential Problem Loans\nAt December 31, 1995, the Company had no known mataerial loans where payments were presently current or less than 90 days past due, yet the borrowers were experiencing severe financial difficulties. Management continues to review and evaluate all loans with Senior Loan Committee on an ongoing basis so that potential problems can be addressed immediately.\nBUSINESS--Continued Summary of Loan Loss Experience\nThis table summarizes the Company's loan loss experience for each of the five years ended December 31:\nManagement evaluates the degree of loss exposure based on continuous detailed reviews of commercial and real estate loans. Problem loans which are identified are monitored very closely by S&T management. Installment and mortgage loans are monitored using delinquency levels, nonaccrual loan balances and current charge-offs. These analyses and continuous monitoring of other risk elements such as nonaccrual and past due loans are factors considered in determining the amount of the allowance for loan losses.\nManagement completes the aforementioned review and analysis to determine the adequacy of the allowance for loan losses on a quarterly basis. The provision for loan losses represents an amount that is sufficient to maintain the reserve at a level necessary to meet present and potential risk characteristics of the loan portfolio. Based on continual evaluation of loan quality and assessment of risk characteristics, management believes that the allowance for loan losses is adequate to absorb probable loan losses.\nItem 1. BUSINESS--Continued\nThis table shows allocation of the allowance for loan losses as of the end of each of the last five years:\nDeposits\nThe daily average amount of deposits and rates paid on such deposits is summarized for the periods indicated in the following table:\nMaturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1995, are summarized as follows:(In thousands of dollars)\nItem 1. BUSINESS--Continued\nReturn on Equity and Assets\nThe table below shows consolidated operating and capital ratios of the Company for each of the last three years:\nShort-Term Borrowings\nThe following table shows the distribution of the Company'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.\nS&T defines repurchase agreements with its retail customers as retail REPOs; wholesale REPOs are those transacted with other banks and brokerage firms with terms normally ranging from 1 to 14 days.\nItem 1. BUSINESS-Continued\nCAPITAL\nThe leverage ratio of total equity to total assets and allowance for loan losses, one measure of capital adequacy, was 10.4% in 1995 and 10.2% in 1994. The 1995 regulatory minimum guideline leverage ratio is 3.0%. S&T's risk based capital Tier I and Tier II ratios were 13.7% and 15.0%, respectively, at December 31, 1995, which places S&T well above the Federal Reserve Board's risk-based capital guidelines of 4.0% and 8.0% for Tier I and Tier II, respectively. In addition, management believes that S&T has the ability to raise additional capital if necessary.\nS&T sponsors an Employee Stock Ownership Plan (ESOP). The ESOP shares are allocated to employees as part of S&T's contribution to its employee thrift and profit sharing plans. At December 31, 1995, 34,000 unallocated shares were held by the ESOP. During the fourth quarter of 1994, S&T announced a program to annually acquire up to 3% of its common stock as treasury shares. In 1995, S&T acquired 97,689 treasury shares on the open market and used 74,820 treasury shares to fund the employee stock option plan, its dividend reinvestment plan for shareholders and other general corporate purposes. The stock repurchase program was also reaffirmed in the fourth quarter of 1995 for 1996.\nS&T adopted an Incentive Stock Plan in 1992 (Stock Plan) that provides for for granting incentive stock options, nonstatutory stock options and stock appreciation rights (SARs). On October 17, 1994, the Stock Plan was amended to include outside directors. The Stock Plan covers a maximum of 600,000 shares of S&T stock and expires ten years from the date of board approval. The following table summarizes the changes in nonstatutory stock options outstanding during 1995, 1994, 1993 and 1992:\nAs of December 31, 1995, 165,000 nonstatutory stock options are not excercisable.\nRisk-Based Capital and Leverage Ratios (as defined by federal regulators) (In thousands of dollars) December 31:\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company operates thirty-four banking offices in Indiana, Armstrong, Allegheny, Jefferson, Clearfield, Westmoreland and surrounding counties in Pennsylvania. The Company owns land and banking offices at the following locations: 800 Philadelphia Street, 645 Philadelphia Street and 2175 Route 286, South in Indiana; Route 119 South & Lucerne Road and 34 North Main Street in Homer City; 539 West Mahoning Street, 100 West Mahoning Street and 232 North Hampton Avenue in Punxsutawney; 133 Philadelphia Street in Armagh; Route 119 South in Black Lick; 256 Main Street and Route 36 & I-80 in Brookville; 456 Main Street in Brookway; Route 28 & Carrier Street in Summerville; 602 Salt Street in Saltsburg; 12-14 West Long Avenue, 35 West Scribner Avenue, Treasure Lake and 614 Liberty Boulevard in DuBois; 418 Main Street in Reynoldsville; 205 East Market Street in Blairsville; 85 Greensburg Street in Delmont; 100 Chestnut Street in Derry; Second Avenue and Hicks Street in Leechburg; 109 Grant Avenue in Vandergrift and 100 South Fourth Street in Youngwood. Land is leased where the Company owns the banking office at 1107 Wayne Avenue and remote ATM building at 435 South Seventh Street and 1176 Grant Street, all in Indiana. In addition, the Company leases land and banking offices at the following locations: Chestnut Ridge Plaza in Blairsville; 324 North Fourth Street and 2850 Route 286 South in Indiana; the Mall Office in DuBois, 229 Westmoreland Mall; 2320 Route 286 in Holiday Park; Route 268 Hilltop Plaza in Kittanning and a remote ATM location at the Main Street Mall in DuBois.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe nature of the Company's business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, in the opinion of management, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if detemined adverse, would be material in relation to its shareholders' equity or financial condition. In addition,no material proceedings are pending nor are known to be threatened or contemplated against the Company by governmental authorities or other parties.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters during the fourth quarter of the fiscal year covered by this report that were submitted to a vote of the security holders through solicitation of proxies of otherwise.\nPART II Item 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nStock Prices and Dividend Information on page 47 and Dividend and Loan Restrictions on page 40 of the Annual Report for the year ended December 31, 1995, are incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSelected Financial Data on page 47 of the Annual Report 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 Financial Condition and Results of Operations on pages 49 through 58 of the Annual Report 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 Consolidated Financial Statements, Report of Independent Auditors and Quarterly Selected Financial Data on pages 28 through 46 and 48 of the Annual Report for the year ended December 31, 1995, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThere have been no changes in accountants or disagreements with accountants on accounting and financial disclosures.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nElection of Directors on pages 12 through 13 of the proxy statement for the April 15, 1996 annual meeting of shareholders are incorporated herein by reference.","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"783008_1995.txt","cik":"783008","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nFalcon Cable Systems Company, a California limited partnership (the \"Partnership\"), is engaged in the ownership, operation and development of cable television systems in small to medium sized communities and suburban and rural areas. The Partnership's cable television systems generally are located in areas that do not receive a wide variety of clear broadcast television reception because of distance from broadcasters or interference by mountains or other geographic features. The Partnership offers cable service in four regions in California and in three regions in Western Oregon. The California regions are in and around the City of Gilroy (near San Jose) and Northern Monterey County, the high-desert area of San Bernardino County (Hesperia), San Luis Obispo County and Tulare County. The Partnership's Oregon regions are principally in and around the City of Springfield (near Eugene), the City of Dallas (near Salem), and the Cities of Coos Bay, Reedsport and Florence. As of December 31, 1995, the Partnership had approximately 219,000 Subscribers1 and served approximately 135,000 homes subscribing to cable service in communities located in California and Oregon. The Partnership or its predecessors have managed cable systems since 1975. The Partnership is presently scheduled to terminate on December 31, 1996. See Item 13. \"Certain Relationships and Related Transactions - Recent Developments.\" See \"Description of the Partnership's Systems.\"\nA cable television system receives television, radio and data signals at the system's \"headend\" site by means of over-the-air antennas, microwave relay systems and satellite earth stations. These signals are then modulated, amplified and distributed, primarily through coaxial and fiber optic distribution systems, to customers who pay a fee for this service. Cable television systems may also originate their own television programming and other information services for distribution through the system. Cable television systems generally are constructed and operated pursuant to non-exclusive franchises or similar licenses granted by local governmental authorities for a specified term of years.\nThe Partnership's cable television systems, (the \"systems\"), offer customers various levels (or \"tiers\") of cable services consisting of broadcast television signals of local network, independent and educational stations, a limited number of television signals from so-called \"super stations\" originating from distant cities (such as WTBS, WGN and WOR), various satellite-delivered, non-broadcast channels (such as Cable News Network (\"CNN\"), MTV: Music Television (\"MTV\"), the USA Network (\"USA\"), ESPN and Turner Network Television (\"TNT\"), programming originated locally by the cable television system (such as public, governmental and educational access programs) and informational displays featuring news, weather, stock market and financial reports and public service announcements. A number of the satellite services are also offered in certain packages. For an extra monthly charge, the systems also offer \"premium\" television services to their customers. These services (such as Home Box Office (\"HBO\"), Showtime, The Disney Channel and selected regional sports networks) are satellite channels that consist\n1 The Partnership reports subscribers for the Systems on an equivalent subscriber basis and, unless otherwise indicated, the term \"SUBSCRIBERS\" means equivalent subscribers, calculated by dividing aggregate basic service revenues by the average lowest basic service rate within an operating entity, adjusted to reflect the impact of regulation. Basic service revenues include charges for basic programming, bulk and commercial accounts and certain specialized \"packaged programming\" services, including the appropriate components of new product tier revenue, and excluding premium television and non-subscription services. Consistent with past practices, Subscribers is an analytically derived number which is reported in order to provide a basis of comparison to previously reported data. The computation of Subscribers has been impacted by changes in service offerings made in response to the 1992 Cable Act. See \" Description of the Partnership's Systems\" for additional information about Subscribers and homes subscribing to cable service.\nprincipally of feature films, live sporting events, concerts and other special entertainment features, usually presented without commercial interruption. See \"Legislation and Regulation.\"\nA customer generally pays an initial installation charge and fixed monthly fees for basic, expanded basic, other tiers of satellite services and premium programming services. Such monthly service fees constitute the primary source of revenues for the systems. In addition to customer revenues, the systems receive revenue from additional fees paid by customers for pay-per-view programming of movies and special events and from the sale of available advertising spots on advertiser-supported programming. The systems also offer to their customers home shopping services, which pay the systems a share of revenues from sales of products in the systems' service areas, in addition to paying the systems a separate fee in return for carrying their shopping service.\nThe Partnership was formed as a general partnership in 1982 when Falcon Communications, a California partnership, separated the ownership and operations of its non-urban systems located in Northern and Central California, which are now operated by the Partnership, from its urban systems located in Southern California. On October 30, 1986, the Partnership amended its partnership agreement to change its form to that of a limited partnership and added Falcon Cable Investors Group, a California limited partnership (the \"General Partner\"), as general partner and Falcon Assignor Limited Partner, Inc. (the \"Assignor Limited Partner\") as a limited partner. On December 31, 1986, the Partnership issued and sold 4,000,000 units representing the assignment by the Assignor Limited Partner of limited partnership interests in the Partnership (the \"Units\") in a primary initial public offering. On June 30, 1987, the Partnership sold an additional 600,000 Units. Through 1992, the general partner of the General Partner was Falcon Holding Group, Inc., a California corporation (\"FHGI\"). In March 1993, a newly-formed entity, Falcon Holding Group, L.P. (\"FHGLP\"), was organized to effect the consolidation of the ownership of various cable television businesses previously operated by FHGI. In such consolidation, FHGLP became the general partner of the General Partner, succeeding FHGI in that role. The management of FHGLP is substantially the same as that of FHGI. See Item 13., \"Certain Relationships and Related Transactions.\"\nThe General Partner receives a management fee from the Partnership for managing the cable television operations. See Item 11., \"Executive Compensation.\" For more detailed information, see the Amended and Restated Agreement of Limited Partnership of the Partnership, dated as of December 15, 1986, as amended by the first and second amendments thereto (hereinafter referred to as the \"Partnership Agreement\"), which are exhibits to this report on Form 10-K and are hereby incorporated by reference.\nThe Partnership Agreement provides that the General Partner shall use its best efforts to cause the Partnership to sell all of the Partnership's cable systems between December 31, 1991 and December 31, 1996, the \"termination date\" of the Partnership. The Partnership has stated in prior public reports and filings that, from time to time, it may enter into discussions regarding the sale of its cable systems to affiliates or other parties. See Item 13., \"Certain Relationships and Related Transactions - Recent Developments.\"\nLed by Chairman of the Board and Chief Executive Officer, Marc B. Nathanson, and President and Chief Operating Officer, Frank J. Intiso, the Partnership's senior management has on average over seventeen years of experience in the industry and has worked together for over a decade. Mr. Nathanson, a 26-year veteran of the cable business, is a member of the Executive Committee of the Board of Directors of the National Cable Television Association and a past winner of the prestigious Vanguard Award from the National Cable Television Association for outstanding contributions to the growth and development of the cable television industry. Mr. Intiso is an 18-year veteran of the cable industry. He is also Chairman of the California Cable Television Association and is active in various industry boards including the Board of the Community Antenna Television Association (\"CATA\"). The principal executive offices of the Partnership, and its general partner, FHGLP, are located at 10900 Wilshire Boulevard, 15th Floor, Los Angeles, California 90024, and their telephone number is (310) 824-9990.\nBUSINESS STRATEGY\nThe Partnership's business strategy has focused on serving small to medium-sized communities and the suburbs of certain cities, including San Jose and San Luis Obispo, California, and Portland and Eugene, Oregon, that have favorable demographic and geographic characteristics. The Partnership believes that its cable television systems generally involve less risk of increased competition than systems in large urban cities. (Cable television service is necessary in many of the Partnership's markets to receive a wide variety of broadcast and other television signals.) In addition, these markets typically offer fewer competing entertainment alternatives than large cities. As a result, the Partnership's cable television systems generally have a higher basic penetration rate (the number of homes subscribing to cable service as a percentage of homes passed by cable) with a more stable customer base than systems in large cities. Nonetheless, the Partnership believes that all cable operators will face increased competition in the future from alternative providers of multi-channel video programming services. See \"- Competition.\"\nOn March 30, 1994, the Federal Communications Commission (the \"FCC\") adopted significant amendments to its rules implementing certain provisions of the 1992 Cable Act. The Partnership believes that compliance with these amended rules has had a negative impact on the Partnership's revenues and cash flow. These rules are subject to further amendment to give effect to the Telecommunications Act of 1996 (the \"1996 Telecom Act\"). The 1996 Telecom Act is expected to have a significant affect on all participants in the telecommunications industry, including the Partnership. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nClustering\nThe Partnership has sought to acquire cable television systems in communities that are proximate to other owned or affiliated systems in order to achieve the economies of scale and operating efficiencies associated with regional \"clusters\" of systems. The Partnership believes clustering can reduce marketing and personnel costs and can also reduce capital expenditures in cases where cable service can be delivered to a number of systems within a single region through a central headend reception facility. Without the benefits of clustering, the value of the Partnership's systems would most likely be less than the values of other more clustered systems.\nCapital Expenditures\nPrior to 1993, the equipment and services in certain of the Partnership's Oregon systems were upgraded. At December 31, 1995, substantially all of the homes subscribing to cable service in the Partnership's regions had access to various new service options and a minimum 35-channel capacity. In connection with its installation of addressable converters for most systems in these regions, the Partnership began marketing additional services such as advertising, pay-per-view and home shopping. However, as noted in \"Description of the Partnership's Systems,\" many of the regions have almost no available channel capacity with which to add new channels or to further expand their use of pay-per-view offerings to customers. As a result, significant amounts of capital for future upgrades will be required in order to increase available channel capacity, improve quality of service and facilitate the marketing of additional new services such as advertising, pay-per-view, new unregulated tiers of satellite-delivered services and home shopping, so that the systems remain competitive within the industry.\nAs discussed in prior reports, the Partnership postponed a number of rebuild and upgrade projects that were planned for 1993 and 1994 because of the uncertainty related to implementation of the 1992 Cable Act and the impact thereof on the Partnership's business and access to capital. The Partnership's access to capital remains severely constrained due not only to the adverse effect of re-regulation but also because of the limited remaining life of the Partnership. As a result, even after giving\neffect to certain upgrades and rebuilds expected to be completed in early 1996, the Partnership's systems will be significantly less technically advanced than had been expected prior to the implementation of re-regulation. The Partnership believes that the delays in upgrading many of its systems will, under present market conditions, most likely have an adverse effect on the value of those systems compared to systems that have been rebuilt to a higher technical standard. As discussed below, the Partnership has obtained limited financing flexibility from its bank group to upgrade certain portions of its cable plant during 1995 and 1996. Anticipated upgrades contemplate the utilization of addressable technology and fiber optic cable in order to increase channel capacity and to seek to position the few systems that can be upgraded prior to the termination of the Partnership to benefit from the further development of advertising, pay-per-view, home shopping and other possible new services. In addition to these potential revenue opportunities, plant upgrades enhance picture quality and system reliability, reduce operating costs and improve overall customer satisfaction. The Partnership's management has selected a technical standard that mandates a 750 MHz fiber to the feeder architecture for the majority of all its systems that are to be rebuilt. A system built to a 750 MHz standard can provide approximately 95 channels of analog service. Such a system will also permit the introduction of high speed data transmission and telephony services in the future after incurring incremental capital expenditures related to these services. Currently, the Partnership's systems have an average capacity of 41 channels, (substantially all of which is presently utilized), and approximately 82% of their customers are served by systems that utilize addressable technology. See \"Technological Developments.\"\nOn March 13, 1995, the Partnership executed an amendment to its Bank Credit Agreement that permits it to pursue a limited number of plant rebuilds and upgrades totaling approximately $12 million in 1995 and 1996. Approximately $10.1 of this amount was spent in 1995. The Partnership's projected 1996 capital expenditures are $6.9 million, including $1.8 million to extend its plant to new service areas and $1.9 million to complete the rebuild and upgrade projects that were started in 1995. These amounts assume the Partnership operates for the full year and is not terminated prior to December 31, 1996. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nDecentralized Management\nThe Partnership's seven regions are managed on a decentralized basis. The Partnership believes that its decentralized management structure, by enhancing management presence at the system level, increases its sensitivity to the needs of its customers, enhances the effectiveness of its customer service efforts, eliminates the need for maintaining a large centralized corporate staff and facilitates the maintenance of good relations with local governmental authorities.\nMarketing\nThe Partnership has made substantial changes in the way in which it packages and sells its services and equipment in the course of its implementation of the FCC's rate regulations promulgated under the 1992 Cable Act. Historically, the Partnership had offered four programming packages in its upgraded addressable systems. These packages combined services at a lower rate than the aggregate rates for such services purchased individually on an \"a la carte\" basis. The new rules 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. On November 10, 1994, the FCC announced the adoption of further significant amendments to its rules. One amendment allows cable operators to create new tiers of program services which the FCC has chosen to exclude from rate regulation, so long as the programming is new to the system. In addition, the FCC decided that discounted packages of non-premium \"new product tier\" services will be subject to rate regulation in the future. However, in applying this new policy to new product tier packages such as those already offered by the Partnership and numerous other cable operators, the FCC decided that where only a few services were moved from regulated tiers to the new product tier package, the package will be treated as if it were a tier\nof new program services as discussed above. Substantially all of the new product tier packages offered by the Partnership have received this desirable treatment. These amendments to the FCC's rules have allowed the Partnership to resume its core marketing strategy and reintroduce programmed service packaging. As a result, in addition to the basic service package, customers in substantially all of the Systems may purchase an expanded basic service, additional unregulated packages of satellite-delivered services and premium services on either an a la carte or a discounted packaged basis. See \"Legislation and Regulation.\"\nThe Partnership has employed a variety of targeted marketing techniques to attract new customers by focusing on delivering value, choice, convenience and quality. The Partnership employs direct mail, radio and local newspaper advertising, telemarketing and door-to-door selling utilizing demographic \"cluster codes\" to target specific messages to target audiences. In many systems, the Partnership offers discounts to customers who purchase premium services on a limited trial basis in order to encourage a higher level of service subscription. The Partnership also has a coordinated strategy for retaining customers that includes televised retention advertising that reinforces the value associated with the initial decision to subscribe and that encourages customers to purchase higher service levels.\nCustomer Service and Community Relations\nThe Partnership places a strong emphasis on customer service and community relations and believes that success in these areas is critical to its business. The Partnership has developed and implemented a wide range of monthly internal training programs for its employees, including its regional managers, that focus on the Partnership's operations and employee interaction with customers. The effectiveness of the Partnership's training program as it relates to the employees' interaction with customers is monitored on an on-going basis, and a portion of the regional managers' compensation is tied to achieving customer service targets. The Partnership also conducts an extensive customer survey on an annual basis and uses the information in its efforts to enhance service and better address the needs of its customers. In addition, the Partnership is participating in the industry's recently announced Customer Service Initiative which emphasizes an on-time guarantee program for service and installation appointments. The Partnership's corporate executives and regional managers lead the Partnership's involvement in a number of programs benefiting the communities the Partnership serves, including, among others, Cable in the Classroom, Drug Awareness, Holiday Toy Drive and the Cystic Fibrosis Foundation. Cable in the Classroom is the cable television industry's public service initiative to enrich education through the use of commercial-free cable programming. In addition, a monthly publication, Cable in the Classroom magazine, provides educational program listings by curriculum area, as well as feature articles on how teachers across the country use the programs.\nDESCRIPTION OF THE PARTNERSHIP'S SYSTEMS\nThe Partnership's cable television systems currently are located in seven regions: the Gilroy, Hesperia, San Luis Obispo and Tulare regions in California, and the Springfield, Dallas and Coos Bay regions in Oregon.\nThe table below sets forth selected statistics on these regions as of December 31, 1995.\n1 Homes passed refers to estimates by the Partnership of the approximate number of dwelling units in a particular community that can be connected to the distribution system without any further extension of principal transmission lines. Such estimates are based upon a variety of sources, including billing records, house counts, city directories and other local sources.\n2 Homes subscribing to cable service as a percentage of homes passed by cable.\n3 Premium service units include only single channel services offered for a monthly fee per channel and do not include tiers of channels offered as a package for a single monthly fee.\n4 Premium service units as a percentage of homes subscribing to cable service. A customer may purchase more than one premium service, each of which is counted as a separate premium service unit. This ratio may be greater than 100% if the average customer subscribes for more than one premium service.\n5 Average monthly revenue per home subscribing to cable service has been computed based on revenue for the year ended December 31, 1995\n6 The Partnership reports subscribers for the Systems on an equivalent subscriber basis and, unless otherwise indicated, the term \"SUBSCRIBERS\" means equivalent subscribers, calculated by dividing aggregate basic service revenues by the average lowest basic service rate within an operating entity, adjusted to reflect the impact of regulation. Basic service revenues include charges for basic programming, bulk and commercial accounts and certain specialized \"packaged programming\" services, including the appropriate components of new product tier revenue, and excluding premium television and non-subscription services. Consistent with past practices, Subscribers is an analytically derived number which is reported in order to provide a basis of comparison to previously reported data. The computation of Subscribers has been impacted by changes in service offerings made in response to the 1992 Cable Act.\nGILROY REGION\nThe Gilroy and Hollister systems in the Gilroy region have been operated by the Partnership or its predecessors since 1975. The Gilroy region, the Partnership's largest region, extends from immediately south of San Jose to King City with the exception of Salinas, and also serves portions of the Carmel Valley including Laguna Seca and the Carmel Highlands area. This region contains numerous high technology industries in the City of San Jose and other parts of the Silicon Valley area. The Partnership's franchises in this region encompass relatively large undeveloped areas of southern Santa Clara, San Benito and northern Monterey counties.\nThe historically high level of construction of new homes, shopping centers and industrial parks in many communities within the Gilroy region has been adversely impacted by the recession in California which resulted in high levels of unemployment, and by governmental no-growth policies. The economy was also impacted by the 1993 closure of a military facility (Fort Ord) located near the region. Agricultural activities continue to play a significant role in the economic base of the area. The region contains wineries and attracts tourists because of its relative proximity to San Francisco, Monterey and Carmel.\nAt December 31, 1995, the Gilroy region had 58,184 Subscribers. This region is the first in which the Partnership installed addressable converters in a majority of its systems and offered new programming and other services. At December 31, 1995, the penetration rate was 59% and addressable technology was available to approximately 88% of the customers of this region. All systems in this region currently utilize approximately 100% of their channel capacity and, on average, have 35 channels of service.\nHESPERIA REGION\nThis group of systems is composed of the unincorporated areas of San Bernardino County known as Oak Hills and Silver Lakes and the Cities of Adelanto and Hesperia and unincorporated areas of Kern County including the communities of Mojave, Rosamond and Boron. Hesperia is located 40 minutes by automobile from Ontario International Airport and 90 minutes from downtown Los Angeles. At December 31, 1995, the Hesperia region had 32,966 Subscribers.\nAll systems in this region, except for the Boron system which has a fully utilized 28-channel capacity, have 42-channel capacity of which 99% is utilized. At December 31, 1995, the penetration rate was 66% and addressable technology was available to approximately 78% of the customers of this region. In 1990, the Hesperia region began receiving eight Los Angeles signals from its own site on Blue Ridge mountain and transmitting them via microwave to Hesperia, Adelanto and Silver Lakes, thus eliminating the need to purchase the signals from another supplier. The Adelanto and Rosemond areas of this region have seen growth from new home developments designed for the first time home buyer, and have attracted many young families from the Los Angeles area.\nSAN LUIS OBISPO REGION\nThe San Luis Obispo region has been operated by the Partnership or its predecessors since 1977. The region is located approximately halfway between Los Angeles and San Francisco. All systems in the region, except for the Los Alamos system which was acquired in 1988, are served by a single reception facility. The Partnership's franchise areas are located throughout the unincorporated areas of San Luis Obispo County and include the cities of Atascadero (the second largest city in San Luis Obispo County), Guadalupe and in the northern part of Santa Barbara County, Los Alamos. This region attracts tourists and retirees who enjoy the mild climate. Clear off-air television reception in most of the region is limited to two network-affiliated television stations.\nThe Partnership had previously upgraded these systems, except for the City of Los Alamos, increasing the system channel capacity from 21 channels to 37 channels, and had also expanded and repackaged program offerings. In connection with a recent renewal of the franchise agreement in San Luis Obispo County, the Partnership is currently rebuilding the system serving all areas except the cities of Atascadero, Guadalupe and Los Alamos. The rebuild utilizes fiber optic cable and is designed at 750 MHz, which will increase channel capacity to approximately 95 channels and significantly improve picture quality and system reliability. The rebuild will cost approximately $5.5 million, and was substantially completed in 1995.\nAt December 31, 1995, the San Luis Obispo region had 20,855 Subscribers and a penetration rate of 60%, and addressable technology was available to approximately 98% of the customers of this region. The region currently utilizes 82% of the available channels. FHGLP has established a regional advertising sales group in the region that serves all of the Partnership's, as well as other affiliated, systems in California.\nTULARE REGION\nThe Partnership or its predecessors have been operating in the Tulare region since 1977. The Tulare region is located approximately 60 miles southeast of Fresno and 180 miles north of Los Angeles at the foothills of the Sierra Nevada Mountains and on the eastern slope of the San Joaquin Valley. This region is near the center of one of California's major agricultural regions. Included in the region are many small communities that surround the city of Porterville, the region's largest community. The region attracts tourists because of the proximity of Sequoia National Forest and Kings Canyon National Park. In 1991, Wal-Mart constructed its western distribution center in the City of Porterville. This region has, however, recently suffered from high levels of unemployment due to the recession in California. The region is served by wireless cable and by a Primestar DBS distributor.\nSubstantially all of the systems in this region provide at least 42-channel capacity, of which 38 channels are currently in use. At December 31, 1995, the Tulare region had 20,081 subscribers and a penetration rate of 37%. Substantially all of the Partnership's existing systems in the region are served by a single reception facility located in Porterville. At December 31, 1995, addressable technology was available to approximately 98% of the customers of this region and the systems utilize 98% of available channel capacity.\nIn December of 1990, the Tulare region began receiving three Los Angeles signals from its own site on Breckenridge mountain and transmitting them via microwave to Porterville where they are distributed to other sites, thus eliminating the need to purchase the signals from another supplier.\nIn addition to the Los Angeles signals, the region also is transmitting California State University at Bakersfield's Instructional Television classes to Porterville Junior College via the same microwave link. In 1991, the link was expanded to include Porterville High School and some individual homes.\nSPRINGFIELD REGION\nThe Springfield region is comprised of 13 small communities and unincorporated areas of Lane and Douglas Counties surrounding the Eugene metropolitan area, with the exception of Cave Junction located in southern Oregon. Seven communities are served from a common headend, and six communities are served by stand alone headends. Communities in the central Oregon region rely on tourism, agriculture and the lumber industry.\nIn recent years the area has attracted new industry as the Sony Corporation has built a plant to produce CD's and is planning to expand its facilities. In addition, Hyundai Corporation is in the final stages of building the largest producing electronics plant on the West Coast.\nIn 1995 the Partnership completed the rebuild of its Veneta and Cave Junction systems and plans to introduce addressable technology and offer a wider selection of programming than was previously available. The channel line-up has been expanded in all of the Region's systems.\nAt December 31, 1995, the region had 22,453 Subscribers and a penetration rate of 54%. At December 31, 1995, addressable technology was available to approximately 70% of the customers of this region. The systems in this region have used 80% to 100% of their available channel capacity and, on average, have 38 channels of service.\nDALLAS REGION\nThe systems in the Dallas region consist of a cluster of five cable systems which are fed via three microwave links originating from Dallas, Oregon and had 25,887 Subscribers at December 31, 1995. Systems with approximately 18,840 Subscribers are located near Salem, Oregon's state capital, off Interstate 5, the major north\/south artery through the state. On average, the systems have a penetration rate of 72%.\nAlso included in this region are the coastal communities of Rockaway, Garibaldi, Bay City, Manzanita, Nehalem, Wheeler and Cannon Beach. These communities have fishing and tourist economies. There are many people who live in Portland and have a second home in these coastal villages because of their proximity to Portland.\nIn February, 1996, certain of the Region's systems suffered significant physical damage due to flooding the area experienced. The Partnership is insured against both physical loss of plant and business interruption\/loss of revenue.\nOn September 1, 1989, the Partnership acquired the assets of a cable television system in the City of Tillamook, located near the coastal communities discussed above. This system has become a focal point for operations for the coastal communities, serving as the dispatch center for customers from Tillamook north to Cannon Beach. On March 1, 1994, the Partnership acquired the assets of a cable television systems in several communities adjacent to Tillamook. The Partnership intends to rebuild these systems, upgrading the acquired plant from its current 200 MHz capacity and connecting these systems to the Tillamook headend, thereby significantly increasing the number of services offered to the customers in these systems.\nAt December 31, 1995, addressable technology was available to approximately 77% of the customers of this region. Approximately 98% of the region's systems currently utilize 100% of their channel capacity; the remaining systems utilize approximately 98% of their channel capacity. FHGLP has established a regional advertising sales group in the region that serves all of the Partnership's, as well as other affiliated, systems in Oregon.\nCOOS BAY REGION\nCoos Bay is located on the south central Oregon coast and is the only deep water coastal port between San Francisco and Seattle. Historically, the area's main industries have been timber, fishing and shipping related, but due to recent economic downturns, tourism and service related businesses have assumed greater relative significance. The area has a wide variety of recreational opportunities including water sports, sport fishing, hunting and hiking and offers easy access to many miles of ocean beaches and sand dunes. During 1995, the Partnership's Florence, Oregon region was added to the Coos Bay Region.\nAt December 31, 1995, the expanded region (Coos Bay and Florence) had approximately 38,843 Subscribers in 12 communities served by seven headends and a penetration rate of 69%, with the Coos Bay portion consisting of 30,202 subscribers in ten communities served by five headends with a penetration rate of 76%. Clear off-air reception for most of the communities is limited, which accounts for the region's high penetration rate of cabled homes. The Coos Bay region is the Partnership's largest region in Oregon.\nIn 1991, the Partnership began a rebuild of 120 miles of plant serving the cities of Coos Bay and North Bend. This rebuild was completed in early 1992 utilizing fiber optic design and equipment, and was the first phase of the Partnership's overall rebuild plans for the region. During 1992, an additional 115 miles of rebuild utilizing fiber optics were completed in the rural areas surrounding Coos Bay and North Bend. The completion of this portion of the system brought the total rebuilt miles to 235 miles. In addition to the use of fiber optics, the Partnership introduced addressable technology to the Coos Bay area, leading to pay-per-view capability for events such as movies, boxing, wrestling and concerts. The Partnership expanded its channel line-up to include 20 additional channels, thus providing the Coos Bay area customers with a wider selection of programming services than previously available and providing the Partnership the opportunity to expand advertising sales revenues. At December 31, 1995, addressable technology was available to approximately 60% of the customers of this portion of the region. The channel lineup utilized approximately 90% of available channel capacity and had, on average, 56 channels of service. During 1994, the region experienced a steady growth in the areas of pay-per-view and advertising sales revenues.\nThe systems which make up the Florence portion of the Coos Bay region were acquired in 1990. The Florence systems provide service to customers in the coastal cities of Florence, Dunes City and Mapleton and certain unincorporated areas of Lane County, Oregon. These systems are located approximately 40 miles north of Coos Bay and 60 miles west of the Eugene - Springfield metropolitan area.\nThe area's economy is primarily comprised of tourism, the lumber industry and a high proportion of active retired citizens. Due to the high seasonal influence of tourists and its retired citizens, the city is attempting to diversify its economy. Florence has developed a 14-acre industrial park near its airport. Sites will be sold for light industries with preference given to those who will provide the most jobs, thereby increasing the population base. To date, the expansion of this industrial park has progressed very slowly.\nA rebuild of the Florence system was completed in the first quarter of 1993. The Florence systems now have 62-channel capacity, with 56 channels available to the customer, including two pay-per-view channels. Ad insertion capability was instituted in March of 1993, with four channels available for ad sales. At December 31, 1995, the Florence systems had 8,641 subscribers, a penetration rate of 50% and addressable technology was available to approximately 95% of its customers. The average monthly revenue per home subscribing to cable service for the Florence systems of $39.63 is substantially higher than that of the Partnership's other regions. This is due primarily to the fact that this area has a significantly higher amount of advertising sales and commercial account revenue per average home subscribing to cable service than the other regions, and to the fact that the Partnership has not reduced its service rates under the 1992 Cable Act, based on its cost of service filing that is pending with the local franchising authorities and the FCC.\nOTHER ACTIVITIES\nThe Partnership is engaged primarily in the business of owning, operating and developing cable television systems. The Partnership did not participate in any other activities in fiscal 1993, 1994 or 1995, and based on its limited access to capital and the short remaining term of the Partnership, does not anticipate undertaking any such activities in the foreseeable future. As a result of the Revenue Act of 1987, the Partnership cannot add a substantial new line of business without losing its tax status as a partnership. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nCUSTOMER RATES AND SERVICES\nThe Partnership's cable television systems offer customers packages of services that include the local area network, independent and educational television stations, a limited number of television signals from distant cities, numerous satellite-delivered, non-broadcast channels (such as CNN, MTV, USA, ESPN and TNT) and certain information and public access channels. For an extra monthly charge, the Systems provide certain premium television services, such as HBO, Showtime, The Disney Channel and regional sports networks.\nThe Partnership also offers other cable television services to its customers, including pay-per-view programming and, in certain test markets, the Sega Channel. For additional charges, in most of the Systems, the Partnership also rents remote control devices and VCR compatible devices (devices that make it easier for a customer to tape a program from one channel while watching a program on another).\nThe service options offered by the Partnership vary from system to system, depending upon a system's channel capacity and viewer interests. Rates for services also vary from market to market and according to the type of services selected.\nPrior to the adoption of the 1992 Cable Act, the systems generally were not subject to any rate regulation, i.e., they were adjudged to be subject to effective competition under then-effective FCC regulations. The 1992 Cable Act, however, substantially changed the statutory and FCC rate regulation standards. Under the new definition of effective competition, nearly all cable television systems in the United States have become subject to local rate regulation of basic service. The 1996 Telecom Act expanded this definition to include situations where a local telephone company, or anyone using its facilities, offers comparable video service by any means except direct broadcast satellite (\"DBS\"). In addition, the 1992 Cable Act eliminated the 5% annual basic rate increases previously allowed by the 1984 Cable Act without local approval; allows the FCC to review rates for nonbasic service tiers other than premium 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; and adopted regulations to establish, on the basis of actual costs, the price for installation of cable television service, remote controls, converter boxes, and additional outlets. The FCC implemented these rate regulation provisions on September 1, 1993, which affected all the Partnership's systems which are not deemed to be subject to effective competition under the FCC's definition. The FCC substantially amended its rate regulation rules on February 22, 1994 and again on November 10, 1994. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act. See \"Legislation and Regulation.\"\nAt December 31, 1995, the Partnership's monthly rates for basic cable service for residential customers, excluding special senior citizen discount rates, ranged from $10.00 to $25.14 and premium service rates ranged from $10.45 to $11.95, excluding special promotions offered periodically in conjunction with the Partnership's marketing programs. A one-time installation fee, which the Partnership may wholly or partially waive during a promotional period, is usually charged to new customers. The Partnership, prior to September 1, 1993, generally charged monthly fees for additional outlets, converters, program guides and descrambling and remote control tuning devices. As described above, these charges have either been eliminated or altered by the implementation of rate regulation, and as a result of such implementation under the FCC's guidelines, the rates for basic cable service for residential customers correspondingly increased in 1993 in some cases. As a result, while many customers experienced a decrease in their monthly bill for all services, some customers experienced an increase. Substantially all the Partnership's customers did, however, receive a decrease in their monthly charges in July 1994 upon implementation of the FCC's amended rules. Commercial customers, such as hotels, motels and hospitals, are charged a negotiated, non-recurring fee for installation of service and monthly fees based upon a standard discounting procedure. Most multi-unit dwellings are offered a negotiated bulk rate in exchange for single-point billing and basic service to all units. These rates are also subject to regulation.\nThe Partnership markets its cable television services by a combination of telemarketing, direct mail advertising, radio and local newspaper advertising and door-to-door selling. In addition to marketing efforts to attract new customers, the Partnership conducts monthly campaigns to encourage existing customers to purchase higher service levels.\nEMPLOYEES\nAs of February 12, 1996, the Partnership had approximately 159 full-time employees and 10 part-time employees, all of whom work in the seven regional offices. The Partnership believes that its relations with its employees are good.\nTECHNOLOGICAL DEVELOPMENTS\nAs part of its commitment to customer service, the Partnership emphasizes high technical standards and prudently seeks to apply technological advances in the cable television industry to its systems on the basis of cost effectiveness, capital availability, enhancement of product quality and service delivery and industry-wide acceptance. Currently, the Partnership's systems have an average channel capacity of 44, approximately 95% of which is presently utilized. The Partnership believes that system upgrades would enable it to provide customers with greater programming diversity, better picture quality and alternative communications delivery systems made possible by the introduction of fiber optic technology and by the possible future application of digital compression. However, as previously discussed, the Partnership will be significantly limited in the number of systems that can be rebuilt or upgraded in 1996 due to, among other things, the adverse impact of the 1992 Cable Act on the Partnership's business and its access to capital, as well as the short remaining life of the Partnership. As a result, the Partnership expects to incur additional delays in the implementation of its technological development plan on a wide scale. See \"Business Strategy - Capital Expenditures,\" \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe use of fiber optic cable as an alternative to coaxial cable is playing a major role in expanding channel capacity and improving the performance of cable television systems. Fiber optic cable is capable of carrying hundreds of video, data and voice channels and, accordingly, its utilization is essential to the enhancement of a cable television system's technical capabilities. The Partnership's current policy to utilize fiber optic technology in substantially all rebuild projects which it undertakes is based upon the benefits that the utilization of fiber optic technology provides over traditional coaxial cable distribution plant, including lower per mile rebuild costs due to a reduction in the number of required amplifiers, the elimination of headends, lower ongoing maintenance and power costs and improved picture quality and reliability.\nAs of December 31, 1995, approximately 82.3% of the Partnership's customers were served by systems that utilize addressable technology. Addressable technology permits the cable operator to activate from a central control point the cable television services to be delivered to a customer if that customer has also been supplied with an addressable converter box. To date, the Partnership has supplied addressable converter boxes to customers of the systems utilizing addressable technology who subscribe to one or more premium services and, in selected regions, to customers who subscribe to new product tier services. As a result, if the system utilizes addressable technology and the customer has been supplied with an addressable converter box, the Partnership can upgrade or downgrade services immediately, without the delay or expense associated with dispatching a technician to the home. Addressable technology also reduces pay service theft, is an effective enforcement tool in collecting delinquent payments and allows the Partnership to offer pay-per-view services.\nDIGITAL COMPRESSION\nThe Partnership has been closely monitoring developments in the area of digital compression, a technology which is expected to enable cable operators to increase the channel capacity of cable television systems by permitting a significantly increased number of video signals to fit in a cable television system's existing bandwidth. The Partnership believes that the utilization of digital compression technology in the future could enable its systems to increase channel capacity in certain systems in a manner that could be more cost efficient than rebuilding such systems with higher capacity distribution plant. The use of digital compression in its systems also could expand the number and types of services these systems offer and enhance the development of current and future revenue sources. Equipment vendors are beginning to market products to provide this technology, but the Partnership's management has no plans to install it at this time based on its present understanding of the costs as compared to the benefits of the digital equipment currently available.\nPROGRAMMING\nThe Partnership has various contracts to obtain basic and premium programming for its Systems from program suppliers whose compensation is generally based on a fixed fee per customer or a percentage of the gross receipts for the particular service. Some program suppliers provide volume discount pricing structures or offer marketing support to the Partnership. The Partnership's programming contracts are generally for a fixed period of time and are subject to negotiated renewal. The Partnership does not have long-term programming contracts for the supply of a substantial amount of its programming. Accordingly, no assurance can be given that the Partnership's programming costs will not increase substantially, or that other materially adverse terms will not be added to the Partnership's programming contracts. Management believes, however, that the Partnership's relations with its programming suppliers generally are good.\nThe Partnership's cable programming costs have increased in recent years and are expected to continue to increase due to additional programming being provided to basic customers, the requirements to add channels under retransmission carriage agreements entered into with certain programming sources, increased costs to produce or purchase cable programming generally, inflationary increases and other factors. Under the FCC rate regulations, increases in programming costs for regulated cable services occurring after the earlier of March 1, 1994, or the date a system's basic cable service became regulated, may be passed through to customers. See \"Legislation and Regulation - - Federal Regulation - Carriage of Broadcast Television Signals.\" Generally, programming costs are charged among systems on a per customer basis.\nFRANCHISES\nCable television systems are generally constructed and operated under non-exclusive franchises granted by local governmental authorities. These franchises typically contain many conditions, such as time limitations on commencement and completion of construction; conditions of service, including number of channels, types of programming and the provision of free service to schools and certain other public institutions; and the maintenance of insurance and indemnity bonds. The provisions of local franchises are subject to federal regulation under the 1984 Cable Act, the 1992 Cable Act and the 1996 Telecom Act. See \"Legislation and Regulation.\"\nAs of December 31, 1995, the Partnership held 69 franchises. These franchises, all of which are non-exclusive, provide for the payment of fees to the issuing authority. Annual franchise fees imposed on the Partnership systems range up to 5% of the gross revenues generated by a system. The 1984 Cable Act prohibits franchising authorities from imposing franchise fees in excess of 5% of gross revenues and also permits the cable system operator to seek re-negotiation and modification of franchise requirements if warranted by changed circumstances.\nThe following table groups the franchises of the Partnership's cable television systems by date of expiration and presents the number of franchises for each group of franchises and the approximate number and percentage of homes subscribing to cable service (as a percentage of the Partnership total), for each group as of December 31, 1995.\nThe Partnership operates numerous cable television systems which serve multiple communities and, in some circumstances, portions of such systems extend into jurisdictions for which the Partnership believes no franchise is necessary. In the aggregate, approximately 9,151 homes subscribing to cable service, comprising approximately 6.8% of the Partnership's customers, are served by such unfranchised portions of the Partnership's systems. In general, the Partnership does not believe that the loss of any single franchise would cause a substantial reduction in the economies of scale discussed above. In certain instances, however, where a single franchise comprises a large percentage of the customers in an operating region, the loss of such franchise could decrease the economies of scale achieved by the Partnership's clustering strategy. The Partnership has never had a franchise revoked for any of its systems and believes that it has satisfactory relationships with substantially all of its franchising authorities.\nThe 1984 Cable Act provides, among other things, for an orderly franchise renewal process in which franchise renewal will not be unreasonably withheld or, if renewal is withheld, the franchise authority must pay the operator the \"fair market value\" for the system covered by such franchise. In addition, the 1984 Cable Act establishes comprehensive renewal procedures which require that an incumbent franchisee's renewal application be assessed on its own merit and not as part of a comparative process with competing applications. See \"Legislation and Regulation.\"\nCOMPETITION\nCable television systems compete with other communications and entertainment media, including over the 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 a 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 television system's ability to provide an even greater variety of programming than that available over the air or through competitive alternative delivery sources. In addition, certain provisions of the 1992 Cable Act and the 1996 Telecom Act are expected to increase competition significantly in the cable industry. See \"Legislation and Regulation.\"\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 for which the consumer must pay a fee. 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 Viewer Copyright Act of 1988, which became effective January 1, 1989 for an initial 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.\"\nTelevision programming is now also being delivered to individuals by high-powered direct broadcast satellites (\"DBS\") utilizing video compression technology. This technology has the capability of providing more than 100 channels of programming over a single high-powered DBS satellite with significantly higher capacity available if multiple satellites are placed in the same orbital position. Video compression technology may also be used by cable operators in the future to similarly increase their channel capacity. 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 ability of DBS operators to obtain access to programming, 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 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 license for the retansmission 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 statutes of several states 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 preexisting compatible easements,\ncable 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. Under the 1996 Telecom Act, SMATV systems can interconnect non-commonly owned buildings without having to comply with local, state and federal regulatory requirements that are imposed upon cable systems providing similar services, as long as they do not use public rights-of-way. 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 cables to interconnect separately owned and managed buildings if its lines use or cross any public right-of-way. 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. 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.\nThe 1996 Telecom Act eliminates the restriction against ownership and operation of cable systems by local telephone companies within their local exchange service areas. Telephone companies are now free to enter the retail video distribution business through any means, such as DBS, MMDS, SMATV or as traditional franchised cable system operators. Alternatively, the 1996 Telecom Act authorizes local telephone companies to operate \"open video systems\" without obtaining a local cable franchise, although telephone companies operating such systems can be required to make payments to local governmental bodies in lieu of cable franchise fees. Up to two-thirds of the channel capacity on an \"open video system\" must be available to programmers unaffiliated with the local telephone company. The open video system concept replaces the FCC's video dialtone rules. The 1996 Telecom Act also includes numerous provisions designed to make it easier for cable operators and others to compete directly with local exchange telephone carriers. With certain limited exceptions, neither a local exchange carrier nor a cable operator can acquire more than 10% of the other entity operating within its own service area.\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\nattractive 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.\nLEGISLATION AND REGULATION\nThe cable television industry is regulated by the FCC, some state governments and substantially all local governments. In addition, various legislative and regulatory proposals under consideration from time to time by the Congress and various federal agencies have in the past, and may in the future materially affect the Partnership and 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.\nRECENT DEVELOPMENTS\nOn February 8, 1996, the President signed the 1996 Telecom Act, into law. This statute substantially amended the Communications Act of 1934 (the \"Communications Act\") by, among other things, removing barriers to competition in the cable television and telephone markets and reducing the regulation of cable television rates. As it pertains to cable television, the 1996 Telecom Act, among other things, (i) ends the regulation of certain nonbasic programming services in 1999; (ii) expands the definition of effective competition, the existence of which displaces rate regulation; (iii) eliminates the restriction against the ownership and operation of cable systems by telephone companies within their local exchange service areas; and (iv) liberalizes certain of the FCC's cross-ownership restrictions. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act. See \"Business - Competition\" and \"-Federal Regulation-Rate Regulation.\"\nThe Partnership believes that the regulation of its industry remains a matter of interest to Congress, the FCC and other regulatory authorities. There can be no assurance as to what, if any, future actions such legislative and regulatory authorities may take or the effect thereof on the Partnership.\nCABLE COMMUNICATIONS POLICY ACT OF 1984\nThe 1984 Cable Act became effective on December 29, 1984. This federal statute, which amended the Communications Act, creates 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\nOn October 5, 1992, Congress enacted the 1992 Cable Act. This legislation has 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 required the FCC to initiate a number of rulemaking proceedings to implement various provisions of the statute, virtually all of which have been completed. The 1992 Cable Act allows for a greater degree of regulation of 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\nrequirements; (vii) franchise renewals; (viii) television broadcast signal carriage and retransmission consent; (ix) technical standards; (x) customer 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 television systems by allowing municipalities to own and operate their own cable television 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.\nA constitutional challenge to the must-carry provisions of the 1992 Cable Act is still ongoing. On April 8, 1993, a three-judge district court panel granted summary judgment for the government upholding the must-carry provisions. That decision was appealed directly to the U.S. Supreme Court which remanded the case back to the district court to determine whether there was adequate evidence that the provisions were needed and whether the restrictions chosen were the least intrusive. On December 12, 1995, the district court again upheld the must-carry provisions. The Supreme Court has again agreed to review the district court's decision.\nOn September 16, 1993, a constitutional challenge to the balance of the 1992 Cable Act provisions was rejected by the U.S. District Court in the District of Columbia which upheld 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). An appeal from that decision is pending before the U.S. Court of Appeals for the District of Columbia Circuit.\nFEDERAL REGULATION\nThe FCC, the principal federal regulatory agency with jurisdiction over cable television, has heretofore promulgated regulations covering such areas as the registration of cable television systems, cross-ownership between cable television 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 television 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. The 1992 Cable Act required the FCC to adopt additional 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. The 1996 Telecom Act requires certain changes to various of these regulations. A brief summary of certain of these federal regulations as adopted to date follows.\nRATE REGULATION\nThe 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 previous statutory and FCC rate regulation standards. The 1992 Cable Act\nreplaced 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 resulted in nearly all cable television systems becoming subject to local rate regulation of basic service. The 1996 Telecom Act expands the definition of effective competition to cover situations where a local telephone company or its affiliate, or any multichannel video provider using telephone company facilities, offers comparable video service by any means except DBS. Satisfaction of this test deregulates both basic and nonbasic tiers. Additionally, the 1992 Cable Act 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; allowed 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; prohibited cable television 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; 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 1996 Telecom Act ends FCC regulation of nonbasic tier rates on March 31, 1999.\nThe FCC adopted rules designed to implement the 1992 Cable Act's rate regulation provisions on April 1, 1993, and then significantly amended them on reconsideration on February 22, 1994. The FCC's regulations contain standards for the regulation of basic and nonbasic cable service rates (other than per-channel or per-program services). The FCC's original rules became effective on September 1, 1993. The rules have been further amended several times. The rate regulations adopt a benchmark price cap system for measuring the reasonableness of existing basic and nonbasic service rates, and a formula for calculating additional 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 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.\nLocal franchising authorities and\/or the FCC are empowered to order a reduction of existing rates which exceed the maximum permitted level for either basic and\/or nonbasic cable services and associated equipment, and refunds can be required, measured from the date of a complaint to the FCC challenging an existing nonbasic cable service rate or from September 1993, for existing basic cable service rates under the original rate regulations, and from May 15, 1994, under the February 22, 1994 amendments thereto. In general, the reduction for existing basic and nonbasic cable service rates under the original rate regulations would 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 17 percent, adjusted forward for inflation, 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 channels. Amendments adopted on November 10, 1994 incorporated an alternative method for adjusting the rate charged for a regulated nonbasic tier when new services are added. Cable operators can increase rates for such tiers by as much as $1.50 over a two year period to reflect the addition of up to six new channels of service on nonbasic tiers (an additional $0.20 for a seventh channel is permitted in the third year). 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 existing tiers to the new tier. These provisions currently provide limited benefit to the Partnership's systems due to the lack of channel capacity previously discussed. There is also a streamlined cost-of-service methodology available to justify a rate increase on basic and regulated nonbasic tiers for \"significant\" system rebuilds or upgrades.\nFranchising authorities have become certified by the FCC to regulate the rates charged by the Partnership for basic cable service and for associated basic cable service equipment. In addition, a number of the Partnership's customers have filed complaints with the FCC regarding the rates charged for non-basic cable service.\nThe Partnership has adjusted its regulated programming 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 applicable benchmark or equipment and installation cost levels. The Partnership also implemented a program in substantially all of its systems under which a number of the Partnership's satellite-delivered and premium services are now 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.\nThe FCC, in its reconsideration of the original rate regulations, stated that it was going to take a harder look at the regulatory treatment of such a la carte packages on an ad hoc basis. Such 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 regulation. There have been no FCC rulings related to systems owned by the Partnership. There have been two rulings, however, on such packages offered by affiliated partnerships managed by FHGLP. In one case, the FCC's Cable Services Bureau ruled that a nine-channel a la carte package was an evasion of rate regulation and ordered this package to be treated as a regulated tier. In the other case, a six-channel package was held not to be an evasion, but rather is to be considered an unregulated new product tier under the FCC's November 10, 1994 rule amendments. The deciding factor in all of the FCC's decisions related to a la carte tiers appears to be the number of channels moved from regulated tiers, with six or fewer channels being deemed not to be an evasion. Almost all of the Partnership's systems moved six or fewer channels to a la carte packages. Under the November 10, 1994 amendments, any new a la carte package created after that date will be treated as a regulated tier, except for packages involving traditional premium services (e.g., HBO).\nIn December 1995, the Partnership, and all of its affiliated partnerships, filed petitions with the FCC seeking a determination that they are eligible for treatment as \"small cable operators\" for purposes of being able to utilize the FCC's streamlined cost-of-service rate-setting methodology. If such relief is granted, many of the Partnership's systems would be able to increase their basic and\/or nonbasic service tier rates.\nOn March 11, 1993, the FCC adopted regulations pursuant to the 1992 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\nThe 1992 Cable Act contains new signal carriage requirements. These new rules allowed 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.\nThe 1992 Cable Act also eliminated, effective December 4, 1992, the FCC's regulations requiring the provision of input selector switches. The must-carry provisions for non-commercial stations became effective on December 4, 1992. Implementing must-carry rules for non-commercial and commercial stations and retransmission consent rules for commercial stations were adopted by the FCC on March 11, 1993. All commercial stations entitled to carriage were to have been carried by June 2, 1993, and any non-must-carry stations (other than superstations) for which retransmission consent had not been obtained could no longer be carried after October 5, 1993. A number of stations previously carried by the Partnership's cable television systems elected retransmission consent. The Partnership was 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 Partnership 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 operator, and for which it pays monthly fees to the service providers, as it does with other satellite providers. The next election between must-carry and retransmission consent for local commercial television broadcast stations will be October 1, 1996.\nNONDUPLICATION OF NETWORK PROGRAMMING\nCable television systems that have 1,000 or more customers 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\nFCC 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\nAlthough franchising authorities may impose franchise fees under the 1984 Cable Act, such payments cannot exceed 5% of a cable system's annual gross revenues. Under the 1996 Telecom Act, franchising authorities may not exact franchise fees from revenues derived from telecommunications services. 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\nThe 1984 Cable Act established renewal procedures and criteria designed to protect incumbent franchisees 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 his 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 substantially comply 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 denial of renewal based on procedural violations found to be \"harmless error.\"\nA recent federal court decision could, if upheld and if adopted by other federal courts, make the renewal of franchises more problematical in certain circumstances. The United States District Court for the Western District of Kentucky held that the statute does not authorize it to review a franchising authority's assessment of its community needs to determine if they are reasonable or supported by any evidence. This result would seemingly permit a franchising authority which desired to oust an existing operator to set cable-related needs at such a high level that the incumbent operator would have difficulty in making a renewal proposal which met those needs. This decision has been appealed. The Partnership was not a party to this litigation.\nCHANNEL SET-ASIDES\nThe 1984 Cable Act permits local franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The 1984 Cable Act further requires cable television 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.\nCOMPETING FRANCHISES\nQuestions 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\nof 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 television systems and permits franchising authorities to operate their own cable television systems without franchises.\nOWNERSHIP\nThe 1984 Cable Act codified existing FCC cross-ownership regulations, which, in part, prohibit local exchange telephone companies (\"LECs\") from providing video programming directly to customers within their local exchange telephone service areas, except in rural areas or by specific waiver of FCC rules. This restriction had been ruled unconstitutional in several court cases, and was before the Supreme Court for review, when the 1996 Telecom Act was passed. That statute repealed the rule in its entirety.\nThe 1984 Cable Act and the FCC's rules 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 a television station's significant signal strength as defined by the FCC's rules) covers any portion of the community served by the cable system. The 1996 Telecom Act eliminates the statutory ban and directs the FCC to review its rule within two years. 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. The 1996 Telecom Act eliminates this prohibition. Finally, in order to encourage competition in the provision of video programming, the FCC adopted a rule prohibiting the common ownership, affiliation, control or interest in cable television systems and MDS facilities having overlapping service areas, except in very limited circumstances. The 1992 Cable Act codified this restriction and extended it to co-located SMATV systems. Permitted arrangements in effect as of October 5, 1992 are grandfathered. The 1996 Telecom Act exempts cable systems facing effective competition from this restriction. The 1992 Cable Act permits states or local franchising authorities to adopt certain additional restrictions on the ownership of cable television 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% 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 entity which owns the cable system has an attributable interest. The limit is 40% of all activated channels.\nEEO\nThe 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\nThe 1984 Cable Act imposes a number of restrictions on the manner in which cable system operators can collect and disclose data about individual system customers. The statute also requires that the system operator periodically provide all customers with written information about its policies regarding the collection and handling of data about customers, their privacy rights under federal law and their enforcement rights. In the event that a cable operator is found to have violated the customer privacy provisions of the 1984 Cable Act, it could be required to pay damages, attorneys' 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.\nFRANCHISE TRANSFERS\nThe 1992 Cable Act precluded cable operators from selling or otherwise transferring ownership of a cable television system within 36 months after acquisition or initial construction, with certain exceptions. The 1996 Telecom Act repealed this restriction. 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\nPrior 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\nHistorically, 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 revised such standards and made them applicable to all classes of channels which carry downstream National Television System Committee (NTSC) video programming. 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 the technical standards and signal leakage limits is required. The 1992 Cable Act requires the FCC to periodically update its technical standards to take into account changes in technology. Under the 1996 Telecom Act, local franchising authorities may not prohibit, condition or restrict a cable system's use of any type of subscriber equipment or transmission technology.\nThe 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. The 1996 Telecom Act directs the FCC to set only minimal standards to assure compatibility between television sets, VCRs and cable systems, and to rely on the marketplace. The FCC must adopt rules to assure the competitive availability to consumers of customer\npremises equipment, such as converters, used to access the services offered by cable systems and other multichannel video programming distributors.\nPOLE ATTACHMENTS\nThe FCC currently regulates the rates and conditions imposed by certain public utilities for use of their poles unless state public service commissions are able to demonstrate that they regulate the rates, terms and conditions of cable television pole attachments. A number of states 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. The 1996 Telecom Act directs the FCC to adopt a new rate formula for any attaching party, including cable systems, which offer telecommunications services. This new formula will result in significantly higher attachment rates for cable systems which choose to offer such services.\nOTHER MATTERS\nFCC regulation pursuant to the Communications Act, as amended, 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; obscenity and indecency; home wiring and limitations on advertising contained in nonbroadcast children's programming.\nThe 1996 Telecom Act establishes a process for the creation and implementation of a \"voluntary\" system of ratings for video programming containing sexual, violent or other \"indecent\" material and directs the FCC to adopt rules requiring most television sets manufactured in the United States or shipped in interstate commerce to be technologically capable of blocking the display of programs with a common rating. The 1996 Telecom Act also requires video programming distributors to employ technology to restrict the reception of programming by persons not subscribing to those channels. In the case of channels primarily dedicated to sexually-oriented programming, the distributor must fully block reception of the audio and video portion of the channels; a distributor that is unable to comply with this requirement may only provide such programming during a \"safe harbor\" period when children are not likely to be in the audience, as determined by the FCC. With respect to other kinds of channels, the 1996 Telecom Act only requires that the audio and video portions of the channel be fully blocked, at no charge, upon request of the person not subscribing to the channel. The specific blocking requirements applicable to sexually-oriented programming are being challenged in court on constitutional grounds.\nCOPYRIGHT\nCable 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. Requests to adjust the rates were made in January, 1996 and are pending before the Copyright Office.\nCable operators are liable for interest on underpaid and unpaid royalty fees, but are not entitled to collect interest on refunds received for overpayment of copyright fees.\nThe Copyright Office has commenced a proceeding aimed at examining its policies governing the consolidated reporting of commonly owned and contiguous cable television systems. The present\npolicies governing the consolidated reporting of certain cable television 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 television 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 television system acquisitions.\nVarious bills have been introduced into Congress over the past several years that would eliminate or modify the cable television compulsory license. Without the compulsory license, cable operators would have to negotiate rights from the copyright owners for all of the programming on the broadcast stations carried by cable systems. Such negotiated agreements would likely 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) is 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, both ASCAP and BMI now offer \"through to the viewer\" licenses to the cable networks which cover the retransmission of the cable networks' programming by cable systems to their customers.\nCopyrighted music performed by cable systems themselves on local origination channels, in advertisements inserted locally on cable networks, et cetera, must also be licensed. A blanket license is available from BMI. Cable industry negotiations with ASCAP are still in progress.\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 customer 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 television 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 television systems. Moreover, franchising authorities are immunized from monetary damage awards arising\nfrom regulation of cable television 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. The 1996 Telecom Act prohibits a franchising authority from either requiring or limiting a cable operator's provision of telecommunications services.\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.\nThe attorneys general of approximately 25 states have announced the initiation of investigations designed to determine whether cable television systems in their states have acted in compliance with the FCC's rate regulations.\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 can be predicted at this time.\nREVENUE ACT OF 1987\nThe Revenue Act of 1987 provides that certain publicly traded partnerships which were publicly traded on December 17, 1987 (such as the Partnership) will be treated as corporations for federal income tax purposes for taxable years beginning on the earlier of January 1, 1998 or upon a Partnership's adding a substantial new line of business. The Partnership may continue to acquire cable systems without assuming corporate tax status so long as such acquisitions do not constitute the addition of a substantial new line of business of the Partnership. The Revenue Act of 1987 also restricts the ability of Unitholders to deduct their allocable share of net losses of the Partnership to the extent that such losses exceed the Unitholders' passive income from the Partnership. Thus, passive losses generated by the Partnership will not be available to offset income from other passive activities or investment. This provision is effective for tax years beginning January 1, 1987. The Partnership is presently scheduled to terminate on December 31, 1996. See \"Item 1. Business -- Introduction\" and \"Item 13. Certain Relationships and Related Transactions -- Recent Developments.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owns or leases parcels of real property for signal reception sites (antenna towers and headends), microwave facilities and business offices, and owns most of its service vehicles. The Partnership believes that its properties, both owned and leased, are in good condition and are suitable and adequate for the Partnership's business operations. The Partnership owns the land and building that currently serves as the office and warehouse for the Gilroy region and in 1986 built a new regional office in the City of Atascadero. See Item 13., \"Certain Relationships and Related Transactions.\"\nThe Partnership owns substantially all of the assets related to its cable television operations, including its program production equipment, headend (towers, antennae, electronic equipment and satellite\nearth stations), cable plant (distribution equipment, amplifiers, customer drops and hardware), converters, test equipment, tools and maintenance equipment and vehicles.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a party to various legal proceedings. Such legal proceedings are ordinary and routine litigation proceedings that are incidental to the Partnership's business and management believes that the outcome of all pending legal proceedings will not, in the aggregate, have a material adverse effect on the financial condition of the 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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs of February 1, 1996, the approximate number of holders of record of Units was 523.\nThe Units are listed on the American Stock Exchange and the quarterly high and low sales prices for the years ended December 31, 1994 and 1995 were as follows:\nAs previously announced, under the terms of the Partnership's amended and restated Bank Credit Agreement, the Partnership is generally prohibited from paying distributions to Unitholders. On March 14, 1995, the Partnership did, however, declare a special one-time distribution of $.386 per unit, payable on March 31, 1995. This distribution was permitted under an amendment to the Bank Credit Agreement executed March 13, 1995.\nUnder the Partnership Agreement, all distributions each year, if any, will be made 99% to the Unitholders and one percent to the General Partner until Unitholders have received cash equal to the Preferred Return (an 11%, or $2.20 per Unit, non-compounded cumulative annual return on the $20.00 initial public offering price of each Unit computed for the period commencing from December 31, 1986). Any distributions in any year in excess of the Preferred Return (\"Excess Distributions\") are to be made 99% to the Unitholders and one percent to the General Partner until such time as the aggregate amount of Excess Distributions to Unitholders equals the initial public offering price of the Units. Thereafter, Excess Distributions will be made 70% to Unitholders and 30% to the General Partner until the Unitholders have received a 17%, or $3.40 per Unit, non-compounded cumulative annual return on the initial public offering price of the Units (computed from the period commencing from December 31, 1986), after which Excess Distributions shall be made 50% to the Unitholders and 50% to the General Partner.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n1 As previously announced, under the terms of the Partnership's amended and restated bank credit agreement, the Partnership is prohibited from paying distributions to Unitholders. The last distribution prior to the effectiveness of this restriction was the payment of the $.21 per Unit distribution for the fourth quarter of 1992. That distribution, which aggregated $1,357,400, was paid in February 1993. Under the terms of an amendment to the restated bank credit agreement executed March 13, 1995, the Partnership declared on March 14, 1995 a special one-time distribution of $.386 per unit, or $2,495,600 in the aggregate, payable on March 31, 1995.\n2 Operating income before depreciation and amortization. The Partnership measures its financial performance by its EBITDA, among other items. Based on its experience in the cable television industry, the Partnership believes that EBITDA and related measures of cash flow serve as important financial analysis tools for measuring and comparing cable television companies in several areas, such as liquidity, operating performance and leverage. This is evidenced by the covenants in the primary debt instruments of the Partnership, in which EBITDA-derived calculations are used as a measure of financial performance. EBITDA should not be considered by the reader as an alternative to net income as an indicator of the Partnership's financial performance or as an alternative to cash flows as a measure of liquidity.\n3 Excluding acquisition purchase prices.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nCompliance with the rules adopted by the Federal Communications Commission (the \"FCC\") to implement the rate regulation provisions of the 1992 Cable Act has had a significant negative impact on the Partnership's revenues and cash flow. Based on certain FCC decisions that have been released, however, the Partnership's management presently believes that revenues for 1995 reflect the impact of the 1992 Cable Act in all material respects. Moreover, recent policy decisions by the FCC make it more likely that in the future the Partnership will be permitted to increase regulated service rates in response to specified cost increases, although certain costs may continue to rise at a rate in excess of that which the Partnership will be permitted to pass on to its customers. The FCC has recently adopted a procedure under which cable operators may file abbreviated cost of service showings for system rebuilds and upgrades, the result of which would be a permitted increase in regulated rates to allow recovery of a portion of those costs. The FCC has also proposed a new procedure for the pass-through of increases in inflation and certain external costs, such as programming costs, under which cable operators could increase rates based on actual and anticipated cost increases for the coming year. In addition to these FCC actions, on February 8, 1996, President Clinton signed into law the 1996 Telecom Act. The 1996 Telecom Act revises, among other things, certain rate regulation provisions of the 1992 Cable Act. Given events since the enactment of the 1992 Cable Act, there can also be no assurance as to what, if any, future action may be taken by the FCC, Congress or any other regulatory authority or court, or the effect thereof on the Partnership's business. Accordingly, the Partnership's historical annual financial results as described below are not necessarily indicative of future performance. See \"Legislation and Regulation\" and \"Liquidity and Capital Resources.\"\nThe following table sets forth the relative percentages that selected income statement data bear to total revenues:\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nThe Partnership's revenues were approximately $52.9 million during both 1995 and 1994. The net increase of $39,000 was comprised of approximately $1.2 million related to increases in the number of subscriptions for services, approximately $448,000 related to an increase in regulated service rates implemented in April 1995, approximately $292,000 related to increases in other revenue producing items, approximately $166,000 related to an increase in premium service rates implemented during the fourth quarter of 1994 and approximately $58,000 related to a system acquired in March 1994. These increases were offset by approximately $2.1 million related to decreases in rates implemented in September 1994 to comply with the 1992 Cable Act. As of December 31, 1995, the Partnership had approximately 135,500 homes subscribing to cable service and 52,800 premium service units.\nService costs increased from $15.3 million to $16.2 million, or by 6.2%, during 1995 compared to 1994. Service costs represent costs directly attributable to providing cable services to customers. Of the $949,000 increase in service costs, $519,000 related to increases in programming fees (including primary satellite fees), $437,000 related to increased personnel costs and $385,000 related to increases in other service costs. The increase in programming fees was due to a combination of higher rates charged by program suppliers and expanded programming usage relating to channel line-up restructuring and retransmission consent arrangements implemented to comply with the 1992 Cable Act. Personnel costs increased primarily due to cost of living increases and to lower capitalized labor due to increased use of construction contractors. These increases were partially offset by decreases of $392,000 in copyright fees.\nGeneral and administrative expenses decreased from $8.4 million to $8.2 million, or by 2.1%, during 1995 compared to 1994. Of the $180,000 decrease, $207,000 related to refunds and reductions of insurance costs primarily due to adjustments to workers compensation premiums, $80,000 related to decreased marketing costs and $70,000 related to reductions in audit costs. These decreases were partially offset by increases of approximately $74,000 in customer billing and postage costs, $67,000 in personnel costs and $36,000 related to increases in other general and administrative expenses.\nGeneral Partner management fees and reimbursed expenses were approximately $4.6 million during both 1995 and 1994. See \"Liquidity and Capital Resources.\"\nDepreciation and amortization expense decreased from $17.3 million to $16.8 million, or by 3.0%, during 1995 compared to 1994. The $520,000 decrease related primarily to certain tangible and intangible assets becoming fully amortized.\nOperating income decreased from $7.3 million to $7.1 million, or by 2.8%, during 1995 compared to 1994. Of the $204,000 decrease, $949,000 related to increased service costs, primarily programming fees and personnel related costs. These increases were partially offset by decreases of $520,000 in depreciation and amortization and $180,000 in general and administrative costs.\nInterest expense net, including the effects of interest rate hedging agreements, increased from $14.3 million to $16.8 million, or by 17.4 %, during 1995 compared to 1994. Higher average interest rates (9.6% during 1995 compared to 8.2% in 1994) resulted in higher interest expense of approximately $2.6 million partially offset by $150,000 of interest expense on lower average borrowings\nduring 1995 compared to 1994. The hedging agreements resulted in additional interest expense of $0.9 million during 1995 compared to additional interest expense of $2.9 million in 1994.\nOther income, net of expense, increased approximately $6.1 million during 1995 compared to 1994. Of the $6.1 million increase, $7.6 million ($1.17 per limited partnership unit) was due to a non-recurring gain from the sale of marketable securities, as discussed in Note 3 to Financial Statements. This income was partially offset by non-cash charges of $1.4 million as required by generally accepted accounting principles to record the fair value of interest rate swap contracts maturing beyond the Partnership's expiration date of December 31, 1996, as discussed in Notes 3 and 4 to Financial Statements, by $75,000 associated with the exploration of alternatives related to the partnership's required termination and by $49,000 related to reductions in the cost of generating tax basis accounting information for the Unitholders.\nDue to the factors described above, the Partnership's net loss decreased from $7.2 million to $3.8 million, or by 47%, during 1995 compared to 1994.\n1994 COMPARED TO 1993\nThe Partnership's revenues decreased from $53.7 million to $52.9 million, or by 1.6%, during 1994 compared to 1993. Of the $847,000 net decreases in revenue, approximately $1.5 million was estimated to be due to decreases in rates mandated by the 1992 Cable Act. This decrease was partially offset by increases of approximately $370,000 in other revenue producing items and $283,000 from an acquisition. As of December 31, 1994, the Partnership had approximately 133,200 homes subscribing to cable service and 59,700 premium service units.\nService costs increased from $14.4 million to $15.3 million, or by 5.8%, during 1994 compared to 1993. Service costs represent costs directly attributable to providing cable services to customers. Of the $835,000 increase in service costs, $1.2 million related to increases in programming fees (including primary satellite fees). The increase in programming fees was due to a combination of higher rates charged by program suppliers and expanded programming usage relating to channel line-up restructurings and retransmission consent arrangements implemented to comply with the 1992 Cable Act. Increases of $174,000 related to copyright and franchise fee costs that increased as a result of the service restructurings mentioned above and due to franchise renewals, and $305,000 related to other service costs. These increases were partially offset by decreases of $461,000 related to property taxes resulting from assessment reductions and related refunds from prior periods in two Oregon counties and by decreases in personnel costs and other costs of $383,000. Personnel cost reductions were primarily the result of group insurance premium reductions and capitalization of a greater percentage of labor costs due to higher construction activity.\nGeneral and administrative expenses increased from $8.0 million to $8.4 million, or by 4.8%, during 1994 compared with 1993. Of the $381,000 increase, $540,000 was related to increased marketing costs, $66,000 was related to insurance costs, $50,000 was related to costs associated with re-regulation by the FCC and $76,000 related to other general and administrative expenses. These increases were partially offset by decreases of $203,000 in personnel related expenses (primarily due to the result of group insurance premium reductions and costs incurred in 1993 involving an employee incentive plan) and to a $148,000 reduction in bad debt expense.\nGeneral partner management fees and reimbursed expenses decreased from $4.7 million to $4.6 million, or by 2.5%, during 1994 compared with 1993. Of the $117,000 decrease, $42,000 relates to\ndecreases in management fees based on the Partnership's revenue and $75,000 relates to decreases in reimbursable operating expenses of the general partner.\nDepreciation and amortization expense decreased from $17.2 million to $16.5 million, or by 4.5%, during 1994 compared with 1993, primarily due to the effect of assets becoming fully depreciated.\nOperating income decreased from $9.4 million to $8.2 million, or by 12.5%, during 1994 compared to 1993. The $1.2 million decrease was due primarily to decreased revenues of $847,000 and increases of $835,000 in service related costs and $381,000 in general and administrative related costs, partially offset by decreases of $772,000 in depreciation and amortization and $117,000 in fees paid to the general partner. Interest expense net, including the effects of interest rate hedging agreements, decreased from $14.5 million to $14.3 million, or by 1.4%, during 1994 compared to 1993. The average interest rate in both 1994 and 1993 was 8.2%. The decrease of $136,000 was due to lower average borrowings during 1994 compared to 1993 and to $64,000 of interest income related to property tax refunds. The hedging agreements resulted in additional interest expense of $2.9 million during 1994 compared to additional interest expense of $3.8 million in 1993.\nOther expense increased from $350,000 to $1.1 million during 1994 compared to 1993. Of the $769,000 increase, $894,000 related to losses on the retirement of fixed assets. The primary item offsetting this increase was a decrease of $92,000 related to reductions in the cost of generating tax basis accounting information for the Unitholders.\nDue to the factors described above, the Partnership's net loss increased from $5.5 million to $7.2 million, or by 31.7%, during 1994 compared to 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe FCC's amended rate regulation rules were implemented during the quarter ended September 30, 1994. Compliance with these rules has had a significant negative impact on the Partnership's revenues and cash flow. See \"Legislation and Regulation.\"\nThe Partnership's primary need for capital has been to finance plant extensions, rebuilds and upgrades and to add addressable converters to certain cable systems. The Partnership spent $8.3 million during 1994 and $14.9 million during 1995 on non-acquisition capital expenditures, and also spent approximately $1.7 million to acquire a cable system in Oregon in March 1994. The Partnership had planned to spend approximately $19 million during 1994 for upgrades of certain of its regions, line extensions and new equipment. As previously discussed, the Partnership postponed a number of rebuild and upgrade projects that were planned for 1993 and 1994 because of the uncertainty related to implementation of the 1992 Cable Act and the impact thereof on the Partnership's business and access to capital. The Partnership's access to capital remains severely restrained due not only to the adverse effect of re-regulation but also because of the limited remaining life of the Partnership. As a result, even after giving effect to certain upgrades and rebuilds expected to be completed in early 1996, the Partnership's systems will be significantly less technically advanced than had been expected prior to the implementation of re-regulation. The Partnership believes that the delays in upgrading many of its systems will, under present market conditions, most likely have an adverse effect on the value of those systems compared to systems that have been rebuilt to a higher technical standard.\nThe Partnership's management currently intends to spend approximately $6.9 million in 1996 for capital expenditures, including $1.8 million to extend its plant to new service areas and $1.9 million to complete rebuild and upgrade projects that were started in 1995. These amounts assume the Partnership operates for the full twelve months of 1995. However, the Partnership's ability to fund these capital expenditures will continue to be dependent on it's ability to remain in compliance with the financial covenants contained in the amended Bank Credit Agreement, of which there can be no assurance.\nAt December 31, 1995, the amount outstanding under the Bank Credit Agreement was $165 million. As of December 31, 1995, borrowings under the Bank Credit Agreement bore interest at an average rate of 9.6% (including the effect of interest rate hedging transactions). The amended Bank Credit Agreement has fixed the pricing at 1.375% over prime or 2.375% over LIBOR, or 2.5% over the CD rate.\nThe amended agreement also provides that if no transaction to dissolve the Partnership is approved as of April 1, 1996, the interest rates outlined above will increase by 0.25%; and further provides that if no such transaction is approved by July 1, 1996, the interest rates will be increased an additional 0.25%. The Partnership has entered into interest rate hedging agreements aggregating a net notional amount at December 31, 1995 of $290 million, $165 million of which are in effect at December 31, 1995. The remaining $125 million of contracts are scheduled to become effective as certain of the existing contracts mature during 1996 and 1997. The agreements serve as a hedge against interest rate fluctuations associated with the Partnership's variable rate debt. These agreements expire through July 19, 1999, which is beyond the scheduled termination date of the Partnership. GAAP accounting requires treating the majority of the contracts that expire after December 31, 1996 as speculative derivative financial investments recorded at fair value rather than hedges. (See discussion above in \"Results of Operations\"). These contracts are assignable to other affiliated entities managed by FHGLP. See Notes 3 and 4 to Notes to Financial Statements.\nThe Bank Credit Agreement also places certain restrictions on the annual amount of management fees and reimbursed partnership expenses that the Partnership may pay in cash, with any excess deferred. During 1995, the Partnership deferred additional payments of approximately $1.6 million of fees and reimbursed expenses charged by its General Partner in order to maintain compliance with certain cash flow covenants. Total management fees and reimbursed expenses deferred as of December 31, 1995 amounted to approximately $4.6 million. The Partnership will continue to defer a portion of such fees and expenses during 1996, and will be obligated to pay these cumulatively deferred management fees and reimbursed expenses at the point in time the restrictions imposed by the Bank Credit Agreement are removed, which will coincide with the termination of the Partnership.\nThe Bank Credit Agreement also contains various restrictions relating to, among other things, mergers and acquisitions, investments, capital expenditures, a change in control and the incurrence of additional indebtedness, and also requires compliance with certain financial covenants. The Partnership believes that it was in compliance with all such requirements as of December 31, 1995.\nOn February 10, 1995, the Partnership received net proceeds of approximately $7.8 million upon the acquisition of the Partnership's shares in QVC, Inc. pursuant to a tender offer by Liberty Media Corporation and Comcast Corporation for $46.00 per share. The net proceeds of approximately $5.3 million (after a $2.5 million special distribution paid to Unitholders in March 1995) were used to temporarily pay down bank debt.\nThe Partnership entered into an agreement as part of the consideration paid for the cable systems acquired in Oregon in February 1994. Under the terms of the agreement, the Partnership is required to make seven annual installments of $85,715 on March 1st. The discounted present value of the annual installments is $434,000 at December 31, 1995.\nThe Partnership issued a $3,000,000 installment note as part of the consideration paid for three cable television systems acquired in 1990. The note bore interest at 15 percent until April 1, 1995 at which time the rate increased to 20 percent. The note is payable, with accrued interest, in January 1997. The principal amount of the note is increased each August 1st to reflect accrued but unpaid interest for the prior twelve months. At December 31, 1995, the outstanding amount of the note was $6.2 million.\nThe Partnership Agreement, as amended on January 23, 1990, provides that without the approval of a majority of interests of limited partners, the Partnership may not incur any borrowings unless the amount of such borrowings together with all outstanding borrowings (less cash and cash equivalents)\ndoes not exceed 65% of the greater of the aggregate cost or current fair market value of the Partnership's assets as determined by the General Partner. The Partnership may encounter difficulty complying with this provision depending upon the ultimate impact of the 1992 Cable Act and the 1996 Telecom Act on the fair market value of cable properties. In addition, as disclosed in the Partnership's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 12, 1996, the Partnership has obtained certain appraisals of the Partnership's cable systems for purposes of a possible sale of the cable systems to the General Partner in accordance with the terms of the Partnership Agreement. Based on these appraisals, as of December 31, 1995, the \"appraised value\" (as defined in the Partnership Agreement) of all of the cable systems owned by the Partnership is $247.4 million. If it were to be assumed that the current fair market value of the Partnership's assets as determined by the General Partner is not in excess of the \"appraised value\" as so determined, the Partnership would not be permitted to incur any additional borrowings. If the Partnership should be unable to incur additional borrowings because of the limitation in the Partnership Agreement, the Partnership's liquidity and operations could be adversely effected.\nThe Partnership Agreement provides that the General Partner shall use its best efforts to cause the Partnership to sell all of the Partnership's cable systems between December 31, 1991 and December 31, 1996, the \"termination date\" of the Partnership. See Item 13 - \"Certain Relationships and Related Transactions.\"\n1995 COMPARED TO 1994\nCash provided by operating activities decreased from $11.1 million for the year ended December 31, 1994 to $9.5 million for the year ended December 31, 1995, a decrease of $1.7 million. The decrease resulted primarily from a non-cash gain on the sale of securities of $7.6 million, an increase of $2.4 million in other operating items (receivables, cable materials and supplies, payables, accrued expenses and customer deposits and prepayments) and a decrease in the net loss of $3.4 million.\nCash used in investing activities decreased from $9.6 million for the year ended December 31, 1994 to $7.5 million during the year ended December 31, 1995, or a change of $2.1 million. The decrease was due primarily to approximately $7.8 million of net proceeds received by the Partnership upon the sale of its shares of QVC, Inc. as discussed above, partially offset by an increase of approximately $6.7 million in capital expenditures. In addition, the 1994 period included $1.1 million to acquire cable television systems. There were no acquisitions in 1995. Cash used in financing activities increased by approximately $3.2 million during the year ended December 31, 1995 due to a $2.5 million distribution to Partners, a decrease in net borrowings of approximately $452,000 and an increase in deferred loan costs of approximately $253,000.\nOperating income before depreciation and amortization (\"EBITDA\") as a percentage of revenue decreased from 46.6% during 1994 to 45.2% in 1995. The decrease was primarily caused by higher rates charged by suppliers of programming and increased personnel costs as described above. EBITDA decreased from $24.6 million to $23.9 million, or by 2.8%, during 1995 compared to 1994.\n1994 COMPARED TO 1993\nCash provided by operating activities decreased from $14.4 million for the year ended December 31, 1993 to $11.1 million for the year ended December 31, 1994, a decrease of $3.3 million. The decrease resulted principally from an increase in the net loss of $1.8 million, a decrease of $772,000 in non-cash depreciation and amortization, a decrease of $1.7 million in other operating items (receivables,\ncable materials and supplies, payables, accrued expenses and customer deposits and prepayments) and an increase of $896,000 in non-cash losses on retirement of assets.\nCash used in investing activities increased by $1.3 million during the year ended December 31, 1994 due to a net increase in spending of $217,000 for capital expenditures and intangibles, and the acquisition of cable television systems in the amount of $1.1 million. Cash provided from financing activities increased by $6.0 million during the year ended December 31, 1994 due to net additional borrowings in the amount of $4.9 million, a reduction in distributions paid to Partners in the amount of $1.4 million and an increase of $275,000 paid for deferred loan costs.\nOperating income before depreciation and amortization (EBITDA) as a percentage of revenues decreased from 49.5% during 1993 to 46.6% in 1994. The decrease was primarily caused by the decrease in revenues, higher rates charged by suppliers of programming and increased marketing costs as described above. EBITDA decreased from $26.6 million to $24.6 million, or by 7.3%, during 1994 compared to 1993.\nRECENT ACCOUNTING PRONOUNCEMENTS\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. In such cases, impairment losses are to be recorded based on estimated fair value, which would generally approximate discounted cash flows. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Partnership 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.\nINFLATION\nCertain of the Partnership's expenses, such as those for wages and benefits, equipment repair and replacement, and billing and marketing generally increase with inflation. However, the Partnership does not believe that its financial results have been, or will be, adversely affected by inflation in a material way, provided that it is able to increase its service rates periodically, of which there can be no assurance. See \"Legislation and Regulation.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe financial statements and related financial information required to be filed hereunder are indexed 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 Partnership Agreement provides that the General Partner shall manage the business and affairs of the Partnership. The business and affairs of the General Partner are managed by its general partner, FHGLP. FHGI serves as the sole general partner of FHGLP. As such, FHGI is ultimately responsible for the management of the business and operations of the Partnership. The officers and directors are subject to certain conflicts of interest relating to time and services devoted to the Partnership. See Item 13., \"Certain Relationships and Related Transactions - Conflicts of Interest.\"\nEXECUTIVE OFFICERS AND DIRECTORS\nThe directors and executive officers of FHGI and Falcon Cable Group, the operating division of the Partnership, are as follows:\nThe following sets forth certain biographical information with respect to the directors and executive officers of FHGI and Falcon Cable Group:\nMARC B. NATHANSON, 50, has been Chairman of the Board and Chief Executive Officer of FHGI and its predecessors since 1975, and prior to September 19, 1995 also served as President. Prior to 1975, Mr. Nathanson was Vice President of Marketing for Teleprompter Corporation, then the largest MSO in the United States. He also held executive positions with Warner Cable and Cypress Communications Corporation. He is a former President of the California Cable Television Association and a member of Cable Pioneers. He is currently a Director of the National Cable Television Association (\"NCTA\") and serves on its Executive Committee. At the 1986 NCTA convention, Mr. Nathanson was honored by being named the recipient of the Vanguard Award for outstanding contributions to the growth and development of the cable television industry. Mr. Nathanson is a 26-year veteran of the cable television industry. He is a founder of the Cable Television Administration and Marketing Society (\"CTAM\") and the Southern California Cable Television Association. Mr. Nathanson has also served as Chairman of the Board, Chief Executive Officer and President of Enstar Communications Corporation (\"Enstar\"), since October 1988. Mr. Nathanson is also a Director of T.V. Por Cable Nacional, S.A. de C.V. and Chairman of the Board and Chief Executive Officer of Falcon International Communications, LLC (\"FIC\"). Mr. Nathanson was appointed by President Clinton and confirmed by the U.S. Senate for a three year term on the Board of Governors of International Broadcasting of the United States Information Agency.\nFRANK J. INTISO, 49, was appointed President and Chief Operating Officer of FHGI in September 1995, and between 1982 and that date held the positions of Executive Vice President and Chief Operating Officer. Mr. Intiso is responsible for the day-to-day operations of all cable television systems under the management of Falcon Cable Group, and has served as President and Chief Operating Officer of Falcon Cable Group since its inception, and has also served as Executive Vice President and as a Director of Enstar since October 1988. Mr. Intiso has a Masters Degree in Business Administration from the University of California, Los Angeles and is a Certified Public Accountant. He serves as Chair of the California Cable Television Association and is on the boards of the Cable Advertising Bureau, Cable in the Classroom, Community Antenna Television Association and California Cable Television Association. He is a member of the American Institute of Certified Public Accountants, the American Marketing Association, the American Management Association and the Southern California Cable Association.\nSTANLEY S. ITSKOWITCH, 57, has been a Director of FHGI and its predecessors since 1975, and Senior Vice President and General Counsel from 1987 to 1990 and has been Executive Vice President and General Counsel since February 1990. He has been President and Chief Executive Officer of F.C. Funding, Inc. (formerly Fallek Chemical Company), which is a marketer of chemical products, since 1980. He is a Certified Public Accountant and a former tax partner in the New York office of Touche Ross & Co. (now Deloitte & Touche). He has a J.D. Degree and an L.L.M. Degree in Tax from New York University School of Law. Mr. Itskowitch has also served as Senior Vice President or Executive Vice President and as a Director of Enstar since October 1988. Mr. Itskowitch is also Executive Vice President and General Counsel of FIC.\nMICHAEL K. MENEREY, 44, has been Chief Financial Officer and Secretary of FHGI and its predecessors since 1984 and has been Chief Financial Officer and Secretary of Falcon Cable Group since its inception. Mr. Menerey is a Certified Public Accountant and is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants, and he was formerly associated with BDO Seidman. Mr. Menerey has also served as Chief Financial Officer, Secretary and as a Director of Enstar since October 1988.\nJOE A. JOHNSON, 51, has been Executive Vice President of Operations of FHGI since September 1995, and between January 1992 and that date was a Senior Vice President of Falcon Cable Group. He was a Divisional Vice President of FHGI between 1989 and 1992 and a Divisional Vice President of Falcon Cable Group from its inception until 1992. From 1982 to 1989, he held the positions of Vice President and Director of Operations for Sacramento Cable Television, Group W Cable of Chicago and Warner Amex. From 1975 to 1982, Mr. Johnson held Cable System and Regional Manager positions with Warner Amex and Teleprompter.\nJON W. LUNSFORD, 36, has been Vice President - Finance and Corporate Development of FHGI since September 1994. From 1991 to 1994, he served as Director of Corporate Finance at Continental Cablevision, Inc. Prior to 1991, Mr. Lunsford was a Vice President with Crestar Bank.\nOTHER OFFICERS OF FALCON\nThe following sets forth, as of December 31, 1995, certain biographical information with respect to additional members of the management of Falcon Cable Group:\nJAMES V. ASHJIAN, 51, has been Controller of FHGI and its predecessors since October 1985 and Controller of Falcon Cable Group since its inception. Mr. Ashjian is a Certified Public Accountant and was a partner in Bider & Montgomery, a Los Angeles-based CPA firm, from 1978 to 1983, and self-employed from 1983 to October 1985. He is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.\nLYNNE A. BUENING, 42, has been Vice President of Programming of Falcon Cable Group since November 1993. From 1989 to 1993, she served as Director of Programming for Viacom Cable, a division of Viacom International Inc. Prior to that, Ms. Buening held programming and marketing positions in the cable, broadcast, and newspaper industries.\nOVANDO COWLES, 42, has been Vice President of Advertising Sales and Promotion of Falcon Cable Group since January 1992. From 1988 to 1991, he served as a Director of Advertising Sales and Production at Cencom Cable Television in Pasadena, California. He was an Advertising Sales Account Executive at Choice Television from 1985 to 1988. From 1983 to 1985, Mr. Cowles served in various sales and advertising positions.\nHOWARD J. GAN, 49, has been Vice President of Regulatory Affairs of FHGI and its predecessors since 1988 and Vice President of Corporate Development and Government Affairs of Falcon Cable Group since its inception. He was General Counsel at Malarkey-Taylor Associates, a Washington, D.C.-based telecommunications consulting firm, from 1986 to 1988. Mr. Gan was Vice President and General Counsel at the Cable Television Information Center from 1978 to 1983. In addition, he was an attorney and an acting Branch Chief of the Federal Communications Commission's Cable Television Bureau from 1975 and 1978.\nR.W. (\"SKIP\") HARRIS, 48, has been Vice President of Marketing of Falcon Cable Group since June 1991. He is a member of the CTAM Premium Television Committee. Mr. Harris was National Director of Affiliate Marketing for the Disney Channel from 1985 to 1991. He was also a sales manager, regional marketing manager and director of marketing for Cox Cable Communications from 1978 to 1985.\nJOAN SCULLY, 60, has been Vice President of Human Resources of FHGI and its predecessors since May 1988 and Vice President of Human Resources Falcon Cable Group since its inception. From 1987 to May 1988, she was self-employed as a Management Consultant to cable and transportation companies. She served as Director of Human Resources of a Los Angeles based cable company from 1985 through 1987. Prior to that time, she served as a human resource executive in the entertainment and aerospace industries. Ms. Scully holds a Masters Degree in Human Resources Management from Pepperdine University.\nMICHAEL D. SINGPIEL, 48, was appointed Vice President of Operations of Falcon Cable Group in March 1996. Mr. Singpiel joined Falcon in October 1992 as Divisional Vice President of Falcon's Eastern Division. From 1990 to 1992, Mr. Singpiel was Vice President of C-Tec Cable Systems in Michigan. Mr. Singpiel held various positions with Comcast in New Jersey and Michigan from 1980 to 1990.\nRAYMOND J. TYNDALL, 48, has been Vice President of Engineering of Falcon Cable Group since October 1989. From 1975 to September 1989, he held various technical positions with Choice TV and its predecessors. From 1967 to 1975, he held various technical positions with Sammons Communications. He is a certified National Association of Radio and Television Engineering (\"NARTE\") engineer in lightwave, microwave, satellite and broadband.\nIn addition, Falcon Cable Group has six Divisional Vice Presidents who are based in the field. They are Ron L. Hall, Michael E. Kemph, Nicholas A. Nocchi, Larry L. Ott, Robert S. Smith and Victor A. Wible.\nADVISORY COMMITTEE\nPursuant to the Partnership Agreement the General Partner has formed a seven member Advisory Committee. Four members of the Advisory Committee are unaffiliated with the General Partner or the Partnership. Members of the Advisory Committee are appointed by and serve at the pleasure of the General Partner, and meet periodically to review the operations of the Partnership and to advise\nmanagement. The Advisory Committee may be called upon from time to time to resolve conflicts of interest not specifically covered by the Partnership Agreement. Advisory Committee members, with the exception of Marc B. Nathanson and Stanley S. Itskowitch, receive compensation of $500 per meeting and $6,000 per annum. The members of the Advisory Committee are: Marc B. Nathanson, Stanley S. Itskowitch, Burt I. Harris, Bruce Karatz, Daniel L. Brenner, Bruce Corwin and Neil Goldschmidt.\nDaniel L. Brenner. Mr. Brenner is Vice President for Law and Regulatory Policy at the National Cable Television Association. From 1986 to 1992, he was Director of the Communications Law Program and Adjunct Professor of Law at the UCLA School of Law. From 1979 to 1986, he worked for the Federal Communications Commission in various capacities, including Senior Legal Advisor to the Chairman. He is author of the treatise \"Cable and Other Nonbroadcast Video: Law and Policy.\"\nBruce Corwin. Mr. Corwin has been President of Metropolitan Theaters Corporation for thirty years. Metropolitan Theaters is a major theater exhibition company operating over 100 screens in the State of California. He is a past Chairman of the Los Angeles Children's Museum and the Coro Foundation and is the President of Temple Emanuel of Beverly Hills.\nBurt I. Harris. Mr. Harris is President and Chief Executive Officer of Harriscope Corporation, as well as the Chief Executive Officer of KWHY-TV, Los Angeles, California. He is a former President and Chairman of Harris Cable Corporation and a former Vice-Chairman of Warner Cable. He has been a member of the National Cable Television Association (NCTA) for over 25 years and was Chairman of the NCTA from 1976 to 1977. In 1979, he was presented with \"The Vanguard Award,\" the highest recognition of an individual in the cable television industry. He is the director of numerous corporations and a member of the Advisory Committee for Falcon Classic Cable Income Properties, L.P.\nBruce Karatz. Mr. Karatz is Chairman, President and Chief Executive Officer of Kaufman and Broad Home Corporation, the largest home builder in the Western United States and one of the largest residential builders in metropolitan Paris, France. Mr. Karatz is a director of Honeywell, Inc., National Golf Properties, Inc., and is a Trustee of the RAND Corporation.\nNeil Goldschmidt. Mr. Goldschmidt has been an attorney and consultant specializing in international policy, trade and strategic planning for selected clientele since 1991. From 1987 to 1991, Mr. Goldschmidt served as Governor of the State of Oregon. Prior to his 1986 gubernatorial campaign, he was an executive of NIKE Inc., serving as International Vice President from 1981 to 1985 and President of NIKE Canada from 1986 to 1987. Mr. Goldschmidt served as Secretary of Transportation for President Carter from 1979 to 1981. From 1972 to 1979, he was Mayor of the city of Portland, Oregon. Mr. Goldschmidt is a graduate of the University of Oregon and earned a law degree from the University of California's Boalt Hall School of Law.\nThe Partnership Agreement provides that members of the Advisory Committee will not be liable to the Partnership, its limited partners or Unitholders for errors in judgment or other acts or omissions performed or omitted in good faith if the conduct did not amount to gross negligence or fraud. See Item 13., \"Certain Relationships and Related Transactions - Fiduciary Responsibility and Indemnification of the General Partner\" below.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following summarizes compensation, fees and distributions that may or will be paid by the Partnership to the General Partner. For more detailed information, see the Partnership Agreement.\nMANAGEMENT FEE\nThe General Partner, pursuant to the Partnership Agreement, manages all aspects of daily operations of the Partnership's systems, including engineering, maintenance, programming, advertising, marketing and sales programs, preparation of financial reports, budgets and reports to governmental and regulatory agencies and liaison with federal, state and local government officials. Since December 31, 1986, the Partnership has engaged the General Partner to manage the operations of the Partnership. The Partnership pays the General Partner a management fee of 5% of the gross revenues of the Partnership, excluding revenues from the sale or disposition of any cable television system. Such fee is computed and payable in cash on a monthly basis. The Partnership's Bank Credit Agreement contains various covenants which, among other things, limit the payment in cash of management fees to no more than approximately $1.5 million per year in 1995 and to approximately $765,000 in 1996, so long as aggregate borrowings under the bank agreement exceed $87.5 million. In addition, the General Partner is entitled to reimbursement on a monthly basis from the Partnership for its direct and indirect expenses allocable to the operation of the Partnership which include, but are not limited to, reimbursement for expenses related to the performance of the management functions described above, including office rent, supplies, telephone, travel, copying charges and compensation of any officers and any other full or part-time employees. The amount of reimbursed expenses that the Partnership may pay in cash to the General Partner is limited by the terms of the Partnership's Bank Credit Agreement to $1.9 million per annum. Any management fees or reimbursed expenses earned in excess of the limitations noted above are deferred. The Partnership will be obligated to pay all deferred fees and reimbursed expenses at the point in time the restrictions imposed by the Bank Credit Agreement are removed. Furthermore, the Bank Credit Agreement contains various financial covenants which may effectively limit the amount of management fees and reimbursed expenses that may be paid by the Partnership. Notwithstanding the foregoing, the Partnership may not reimburse the General Partner for the salaries of Mr. Nathanson or Mr. Intiso. For the year ended December 31, 1995, the management fees and reimbursed expenses totaled $4.6 million.\nPARTICIPATION IN DISTRIBUTIONS\nThe General Partner is entitled to share in distributions from, and profits and losses in, the Partnership. See Item 5., \"Market for Registrant's Common Equity and Related Stockholder Matters.\"\nDISPOSITION FEE\nPursuant to the Partnership Agreement upon the sale of any cable television system to any person (including any sale to the General Partner or any affiliate of the General Partner, as provided for in the Partnership Agreement), the Partnership must pay the General Partner 2-1\/2% of the gross proceeds from the sale less any amounts paid as brokerage or similar fees to third parties. Notwithstanding the foregoing, if such amount payable to the General Partner is a negative number, the General Partner shall neither be paid anything by, nor owe anything to, the Partnership.\nNO ACQUISITION FEE The Partnership is not required to pay any fee to the General Partner in connection with the acquisition of cable television systems already acquired or to be acquired.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of March 14, 1996, the beneficial ownership of Units of each director of FHGI, of all directors and executive officers of FHGI as a group and each person who, to the knowledge of the General Partner, owned more than 5% of the outstanding Units of limited partnership interest of the Partnership and the percentage of all Units outstanding held by such persons.\n(1) Unless otherwise indicated, the address of each Unitholder is: c\/o Falcon Cable TV, 10900 Wilshire Boulevard, Suite 1500, Los Angeles, California 90024.\n(2) Reported beneficial ownership includes 569,783 Units held directly by Marc Nathanson and 1,260,530 Units held by Advance TV of California, Inc. Reported beneficial ownership also includes an aggregate of 18,600 Units held either directly by Marc B. Nathanson's children or trusts for the benefit of his children, and 34,000 Units held by trusts for the benefit of Greg A. Nathanson's children of which Marc B. Nathanson is the sole trustee.\n(3) Reported beneficial ownership consists of 1,260,530 Units held by Advance TV of California, Inc. and an aggregate of 34,000 Units held by trusts for the benefit of Greg A. Nathanson's children.\n(4) Reported beneficial ownership consists of 1,260,530 Units held by Advance TV of California Inc. Marc B. Nathanson is the sole beneficiary of Nathanson Testamentary Trust B and Greg A. Nathanson is the sole beneficiary of Nathanson Testamentary Trust B II.\n(5) Nathanson Testamentary Trust B and Nathanson Testamentary Trust B II each own 42.5%, and Marc B. Nathanson and Greg A. Nathanson own 10% and 5%, respectively, of the common stock of Advance TV of California, Inc.\n(6) Less than 1%.\n(7) Based solely on a review of a Schedule 13D filed with the Partnership as of January 29, 1996. Reported beneficial ownership includes The Baupost Group, Inc., 500,200 (7.8% ) Units held, Cumberland Associates, 378,900 (5.9%) Units held, Tweedy, Browne Company L.P., 290,040 (4.5%) Units held, Harvest Capital, L.P., 170,000 (2.7%) Units held and Arthur Zankel, 89,500 (1.4%) Units held. See \"Item 13","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCERTAIN TRANSACTIONS\nFHGLP and its affiliates, including Marc B. Nathanson and other members of the senior management team, currently own varying interests in and operate additional cable television systems, currently manage additional cable television systems for the accounts of others, and, subject to the terms of the Partnership Agreement, may form, jointly or separately, other limited partnerships or entities to acquire, develop and operate other cable television systems. The current management activities of FHGLP's senior management are primarily on behalf of certain affiliated cable television partnerships, for which FHGLP receives management fees. As a result of such relationships, however, conflicts of interest may arise at various stages with respect to the allocation of time, personnel and other resources of FHGI, FHGLP and such other affiliates and members of senior management.\nUpon acquiring the Porterville system in November 1985 (see Item 1., \"Business-Description of the Partnership's Systems-Tulare Region\"), the Partnership assumed a lease for the Porterville system office facilities, which are used to operate the systems of the Tulare region. In March 1986, Marc B.\nNathanson together with his wife purchased the leased property. The present lease, which was renewed in January 1995 and expires on March 29, 1999, currently calls for rental payments of $3,248 per month, which will remain unchanged through December 31, 1996. After this date, the payments will be indexed for inflation. The General Partner believes that the terms of the lease are consistent with leases between unaffiliated parties involving similarly situated properties.\nFHGLP leases certain office space for its corporate financial center (located in Pasadena, California) from a partnership owned by Marc B. Nathanson and his wife (the \"Pasadena Lease\"). The Pasadena Lease commenced on October 1, 1990 and was for a term of five years. The Partnership is in the process of negotiating a new lease and currently pays rent on a month to month basis. The base rent is currently approximately $33,000 per month. FHGLP believes that the terms of the new Pasadena lease will be consistent with leases between unaffiliated parties involving similarly situated properties.\nCONFLICTS OF INTEREST\nIn March 1993, FHGLP, a new entity, assumed the management services operations of FHGI. Effective March 29, 1993, FHGLP began receiving management fees and reimbursed expenses which had previously been paid by the General Partner, as well as the other affiliated entities mentioned above, to FHGI. The management of FHGLP is substantially the same as that of FHGI.\nFHGLP also manages domestic and international cable operations owned by it as well as the operations of Falcon Classic Cable Income Properties, LP, Falcon Video Communications and, through its management of the operation of Falcon Cablevision (a subsidiary of FHGLP), the partnerships of which Enstar Communications Corporation is the corporate general partner. On September 30, 1988, Falcon Cablevision acquired all of the outstanding stock of Enstar Communications Corporation. Certain members of management of the General Partner have also been involved in the management of other cable ventures, including numerous recent international cable ventures that FHGLP and affiliated entities have entered into. FHGLP contemplates entering into other cable ventures, including ventures similar to the Partnership.\nThese affiliations and other ventures subject FHGI, FHGLP, and the General Partner and their management to certain conflicts of interest. Such conflicts of interest relate to the time and services management will devote to the Partnership's affairs and to the acquisition and disposition of cable television systems. Management or its affiliates may establish and manage other entities which could impose additional conflicts of interest.\nConflicts of interest involving acquisitions and dispositions of cable television systems could adversely affect Unitholders. For instance, the economic interests of management in other affiliated partnerships are different from those in the Partnership and this may create conflicts relating to which acquisition opportunities are preserved for which partnerships. Moreover, sales of assets of the Partnership to the entities controlled by management may give rise to conflicts of interests. The fees payable to the General Partner have not been negotiated on an arm's-length basis. The Partnership Agreement permits the General Partner to cause the Partnership to enter into joint ventures with the General Partner and its affiliates. The General Partner may cause the Partnership to purchase systems from the General Partner or an affiliate of the General Partner so long as the price paid is equal to or less than the appraised value of the systems as determined by a nationally-recognized independent appraiser. The cost of any such appraisal will be paid by the General Partner.\nThe Partnership has entered into a management agreement with the General Partner, who in turn has contracted with FHGLP to provide the management services. The Partnership may enter into future agreements, including joint ventures and agreements relating to programming services with the General Partner, FHGLP or their respective affiliates. Thus, a conflict of interest could arise among the General Partner, FHGLP or their respective affiliates and the Partnership. Although any such agreements\nwill not be negotiated at arm's length, the General Partner will cause the terms of all such transactions among the Partnership and the General Partner, FHGLP and their respective affiliates to be no less favorable to the Partnership than those which could be obtained by the Partnership from independent third parties.\nSubstantial fees are payable to the General Partner and FHGLP in connection with the Partnership. See Item 11., \"Executive Compensation.\"\nThe General Partner will resolve all conflicts of interest in accordance with its fiduciary duties. See \"Fiduciary Responsibility and Indemnification of the General Partner\" below. The Partnership Agreement does not permit the Partnership to make loans to the General Partner or any of its affiliates without the approval of a majority of interests of limited partners.\nFIDUCIARY RESPONSIBILITY AND INDEMNIFICATION OF THE GENERAL PARTNER\nA general partner is accountable to a limited partnership as a fiduciary and consequently must exercise good faith and integrity in handling partnership affairs. Where the question has arisen, some courts have held that a limited partner may institute legal action on his own behalf and on behalf of all other similarly situated limited partners (a class action) to recover damages for a breach of fiduciary duty by a general partner, or on behalf of the partnership (a partnership derivative action) to recover damages from third parties. Section 15701 of the California Corporations Code provides that any limited partner may bring a class action on behalf of all or a class of limited partners to enforce any claim common to those limited partners against a limited partnership or any or all of its general partners, without regard to the number of those limited partners, and such action shall be governed by the law governing class actions generally.\nSection 15702 of the California Corporations Code also allows a partner to maintain a partnership derivative action if certain conditions are met. The Assignor Limited Partner has assigned its rights to bring such actions to the Unitholders. Certain cases decided by federal courts have recognized the right of a limited partner to bring such actions under the Securities and Exchange Commission's Rule 10b-5 for recovery of damages resulting from a breach of fiduciary duty by a general partner involving fraud, deception or manipulation in connection with the limited partner's purchase or sale of partnership units.\nThe Partnership Agreement provides that the General Partner, members of the Partnership's Advisory Committee, FHGI and their affiliates (which includes FHGLP), officers and directors will not be liable to the Partnership, its limited partners or Unitholders for, and shall be indemnified by the Partnership for, any liability they incur on account of any act performed or omitted by such indemnitee in good faith and if the indemnitee's conduct did not amount to gross negligence or fraud. Therefore, Unitholders will have a more limited right of action than they would have absent the limitations in the Partnership Agreement. The Partnership Agreement also provides for indemnification by the Partnership of the General Partner, members of the Partnership's Advisory Committee, FHGI and their affiliates (which includes FHGLP), officers and directors for liabilities that they incur by reason of any act performed or omitted by such indemnitee in good faith and if the indemnitee's conduct did not amount to gross negligence or fraud. The General Partner has agreed to continue such indemnification of the members of the Advisory Committee following termination of the Partnership. In addition, the Partnership maintains, at its expense and in such reasonable amounts and at such reasonable prices as the General Partner shall determine, a liability insurance policy which insures the General Partner, members of the Partnership's Advisory Committee, FHGI and their affiliates (which includes FHGLP), officers and directors against liabilities which they may incur with respect to claims made against them for certain wrongful or allegedly wrongful acts, including certain errors, misstatements, misleading statements, omissions, neglect or breaches of duty. To the extent that the exculpatory provisions purport to include indemnification for liabilities arising under\nthe Securities Act of 1933, it is the opinion of the Securities and Exchange Commission that such indemnification is contrary to public policy and therefore unenforceable.\nThe foregoing summary describes in general terms the remedies available under state and federal law to limited partners for breach of fiduciary duty by a general partner and is based on statutes, rules and decisions as of the date of this report on Form 10-K. As this is a rapidly developing and changing area of the law, Unitholders who believe that a breach of fiduciary duty by the General Partner has occurred should consult their own counsel as to the evaluation of the status of the law at such time.\nRECENT DEVELOPMENTS\nThe information contained in the Current Report on Form 8-K dated March 11, 1996 of the Partnership, as amended, is hereby incorporated by reference.\nSTATEMENT UNDER THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.\nForward-looking statements in this report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties, including, without limitation, the effects of legislative and regulatory changes; the potential of increased levels of competition for the Partnership; technological changes; the Partnership's dependence upon third-party programming; the approaching termination of the Partnership (including, without limitation, the potential exercise of the Purchase Right, as described in the Partnership's Current Report on Form 8-K dated March 11, 1996, as amended); the absence of unitholders participation in the governance and management of the Partnership; limitations on borrowings by the Partnership contained in the Partnership Agreement and in the Bank Credit Agreement; the management and sales fees payable to the General Partner; the exoneration and indemnification provisions contained in the Partnership Agreement relating to the General Partner and others; potential conflicts of interest involving the General Partner and its affiliates; the potential liability of unitholders to creditors of the Partnership to the extent of such distribution made to such unitholder if, immediately after such distribution (whether or not the Partnership continues to exist), the remaining assets of the Partnership are not sufficient to pay its then outstanding liabilities of the Partnership; the risk that the Partnership might no longer be taxed as a partnership under certain circumstances; and other risks detailed from time to time in the Company's periodic reports filed with the Securities and Exchange Commission.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nReference is made to the Index to Financial Statements and Schedule on page.\n(a) 2. Financial Statement Schedules\nReference is made to the Index to Financial Statements and Schedule on page.\n(a) 3. Exhibits\nReference is made to the Index to Exhibits on Page E-1.\n(b) Reports on Form 8-K\nThe Registrant filed a Form 8-K dated January 29, 1996 reporting other events.\nThe Registrant filed a Form 8-K dated March 11, 1996, as amended, reporting 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 this 25th day of March 1996.\nFALCON CABLE SYSTEMS COMPANY, A CALIFORNIA LIMITED PARTNERSHIP\nBy Falcon Cable Investors Group, Managing General Partner\nBy Falcon Holding Group, L.P. General Partner\nBy Falcon Holding Group, Inc. General Partner\nBy \/s\/ Michael K. Menerey -------------------------- Michael K. Menerey 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 the 25th day of March 1996.\nSignature Title ------------------------- -----------------------------------------------\nDirector of Falcon Holding Group, Inc. and Chief Executive Officer of the Registrant \/s\/ Marc B. Nathanson (Principal Executive Officer) ------------------------- Marc B. Nathanson\nChief Financial Officer and Secretary of the Registrant \/s\/ Michael K. Menerey (Principal Financial and Accounting Officer) ------------------------- Michael K. Menerey\n\/s\/ Stanley S. Itskowitch Director of Falcon Holding Group, Inc. ------------------------- Stanley S. Itskowitch\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nPage ----\nReport of Independent Auditors\nReport of Independent Certified Public Accountants\nBalance Sheets - December 31, 1994 and 1995\nFinancial Statements for each of the three years in the period ended December 31, 1995:\nStatements of Operations\nStatements of Partners' Equity (Deficit)\nStatements of Cash Flows\nSummary of Accounting Policies\nNotes to Financial Statements\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules have been omitted because they are either not required, not applicable or the information has otherwise been supplied.\nREPORT OF INDEPENDENT AUDITORS\nPartners Falcon Cable Systems Company (A California Limited Partnership)\nWe have audited the balance sheets of Falcon Cable Systems Company (a California limited partnership) as of December 31, 1994 and 1995, and the related statements of operations, partners' equity (deficit) and cash flows for the years then ended. 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 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.\nAs more fully described in Note 1 and Note 10 to the financial statements, the Partnership is due to terminate on December 31, 1996, unless extended as provided for in the Partnership Agreement. In addition, substantially all of the Notes Payable are due on December 31, 1996. The General Partner has begun the process of terminating the Partnership, which could result in the eventual sale of the Partnership's assets to either affiliates of the General Partner or to third parties on or before December 31, 1996. The financial statements have been prepared on the basis that the Partnership's business will be sold as a going concern. The fair market value of the Partnership's assets and the proceeds generated from their sale may differ from amounts reported in the financial statements.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Falcon Cable Systems Company at December 31, 1994 and 1995, and the 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 for the two years ended December 31, 1995.\n\/s\/ ERNST & YOUNG LLP\nLos Angeles, California February 20, 1996, except for Note 10 as to which the date is March 22, 1996\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nFalcon Cable Systems Company\nWe have audited the accompanying statements of operations, partners' equity (deficit), and cash flows of Falcon Cable Systems Company for the year ended December 31, 1993. We have also audited the schedule listed in the accompanying index for the year ended December 31, 1993. These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on the 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 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 presentation of the financial statements and schedule. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, based on our audit, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Falcon Cable Systems Company for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\n\/s\/ BDO SEIDMAN, LLP\nLos Angeles, California February 16, 1994\nFALCON CABLE SYSTEMS COMPANY\nBALANCE SHEETS\nSee accompanying summary of accounting policies and notes to financial statements.\nFALCON CABLE SYSTEMS COMPANY\nSTATEMENTS OF OPERATIONS\nSee accompanying summary of accounting policies and notes to financial statements.\nFALCON CABLE SYSTEMS COMPANY\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nSee accompanying summary of accounting policies and notes to financial statements.\nFALCON CABLE SYSTEMS COMPANY\nSTATEMENTS OF CASH FLOWS\nSee accompanying summary of accounting policies and notes to financial statements.\nFALCON CABLE SYSTEMS COMPANY\nSUMMARY OF ACCOUNTING POLICIES\nFORM OF PRESENTATION\nFalcon Cable Systems Company, a California limited partnership (the \"Partnership\"), pays no income taxes as an entity. All of the income, gains, losses, deductions and credits of the Partnership are passed through to its partners. Congress has enacted legislation which should allow the Partnership to retain its current tax status as a partnership through December 31, 1997, or the term of the Partnership, which is scheduled to end on December 31, 1996. The basis in the Partnership's assets and liabilities differs for financial and tax reporting purposes. At December 31, 1995 the tax basis of the Partnership's net assets exceeded its book basis by $39,114,700.\nThe financial statements do not give effect to any assets that the partners may have outside of their interest in the Partnership, nor to any obligations, including income taxes, of the partners.\nCASH EQUIVALENTS\nFor purposes of the statements of cash flows, the Partnership considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents.\nCABLE MATERIALS, EQUIPMENT AND SUPPLIES\nCable materials, equipment and supplies are stated at cost using the first-in, first-out method. These items are capitalized until they are used for system upgrades, customer installations or repairs to existing systems. At such time, they are either transferred to property, plant and equipment or expensed, as appropriate.\nPROPERTY, PLANT, EQUIPMENT AND DEPRECIATION AND AMORTIZATION\nProperty, plant and equipment are stated at cost. Direct costs associated with installations in homes not previously served by cable are capitalized as part of the distribution system, and reconnects are expensed as incurred. For financial reporting, depreciation and amortization is computed using the straight-line method over the following estimated useful lives:\nCable television systems: Headend equipment 7-15 years Trunk and distribution 7-15 years Microwave equipment 7-10 years Other: Furniture and equipment 5-10 years Vehicles 3-5 years Leasehold improvements Life of lease\nFALCON CABLE SYSTEMS COMPANY\nSUMMARY OF ACCOUNTING POLICIES (CONTINUED)\nFRANCHISE COST AND GOODWILL\nThe excess of cost over the fair value of tangible assets and customer lists of cable television systems acquired represents the cost of franchises and goodwill. In addition, franchise cost includes capitalized costs incurred in obtaining new franchises. These costs (primarily legal fees) are direct and incremental to the acquisition of the franchise and are amortized using the straight-line method over the lives of the franchises, ranging up to 12 years. The Partnership periodically evaluates the amortization periods of these intangible assets to determine whether events or circumstances warrant revised estimates of useful lives. Costs relating to unsuccessful franchise applications are charged to expense when it is determined that the efforts to obtain the franchise will not be successful.\nCUSTOMER LISTS AND OTHER INTANGIBLE COSTS\nCustomer lists and other intangible costs include customer lists and organization costs which are amortized using the straight-line method over five years and covenants not to compete which are amortized over the life of the covenant.\nDEFERRED LOAN COSTS\nCosts related to borrowings are capitalized and amortized to interest expense over the life of the related loan.\nRECOVERABILITY OF ASSETS\nThe Partnership assesses on an on-going basis the recoverability of intangible assets, including goodwill, and capitalized plant assets based on estimates of future undiscounted cash flows compared to net book value. If the future undiscounted cash flow estimate were less than net book value, net book value would then be reduced to the undiscounted cash flow estimate. The Partnership also evaluates the amortization periods of assets, including goodwill and other intangible assets, to determine whether events or circumstances warrant revised estimates of useful lives.\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. In such cases, impairment losses are to be recorded based on estimated fair value, which would generally approximate discounted cash flows. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Partnership 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.\nREVENUE RECOGNITION\nRevenues from cable services are recognized as the services are provided.\nFALCON CABLE SYSTEMS COMPANY\nSUMMARY OF ACCOUNTING POLICIES (CONCLUDED)\nDERIVATIVE FINANCIAL INSTRUMENTS\nAs part of the Partnership's management of financial market risk, and as required by the Partnership's Bank Credit Agreement, the Partnership enters into various transactions that involve contracts and financial instruments with off-balance-sheet risk, including interest rate swap, interest rate cap and interest rate collar agreements. The Partnership enters into these agreements in order to manage the interest-rate sensitivity associated with its variable-rate indebtedness. The differential to be paid or received in connection with interest rate swap and interest rate cap agreements is recognized as interest rates change and is charged or credited to interest expense over the life of the agreements. Gains or losses for early termination of those contracts are recognized as an adjustment to interest expense over the remaining portion of the original life of the terminated contract.\nEARNINGS AND LOSSES PER UNIT\nEarnings and losses are allocated 99% to the limited partners and one percent to the General Partner. Earnings and losses per limited partnership unit is based on the weighted average number of limited partnership units outstanding during the period.\nRECLASSIFICATIONS\nCertain 1994 amounts 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION\nThe Partnership, or its predecessors, commenced operations in May 1975. The Partnership owns and operates cable television systems in California and Western Oregon. Falcon Cable Investors Group, a California limited partnership (the \"General Partner\"), is the general partner of the Partnership. The general partner of the General Partner is Falcon Holding Group, L.P., a Delaware limited partnership (\"FHGLP\"). The general partner of FHGLP is Falcon Holding Group, Inc., (\"FHGI\"). On December 31, 1986, the Partnership was reorganized as a Master Limited Partnership and sold 4,000,000 units of limited partnership interests. On June 30, 1987, an additional 600,000 units were sold.\nThe term of the Partnership ends on December 31, 1996, unless extended as described in the Partnership Agreement. The General Partner has begun the process of terminating the Partnership which will result in the eventual sale of the Partnership's assets to either affiliates of the General Partner or to third parties on or before December 31, 1996. The financial statements have been prepared on the basis that the Partnership's business will be sold as a going concern. The fair market value of the Partnership's assets and the proceeds generated from their sale will differ from the amounts reported in the financial statements. (See Note 10).\nNOTE 2 - PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of:\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nEffective January 1, 1994, the Partnership adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" relating to, among other things, accounting for debt and equity securities which will neither be held to maturity nor sold in the near term. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of partners' equity (deficit). The Partnership's securities requiring treatment as available-for-sale securities consisted solely of 168,780 shares of common stock of QVC Network, Inc. (\"QVC\"), with a cost basis of $202,000 and an aggregate fair value of $7,110,000 at December 31, 1994. On February 10, 1995 the Partnership received net proceeds of approximately $7,764,000 upon the acquisition of its shares in QVC pursuant to a tender offer by Liberty Media Corporation and Comcast Corporation for $46.00 per share. A special, one-time distribution to Unitholders of approximately $2,495,000 related to this transaction was declared on March 14, 1995. The remaining proceeds of $5,269,000 were used to temporarily pay down bank debt.\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 due to the short maturity of those instruments.\nAvailable-for-sale securities\nThe fair value of available-for-sale securities is based on quoted market prices.\nNotes Payable\nThe fair value of the Partnership's notes payable is based on quoted market prices for similar issues of debt with similar remaining maturities.\nInterest Rate Hedging Agreements\nThe fair value of interest rate hedging agreements is estimated by obtaining quotes from brokers as to the amount either party to the agreement would have to pay or receive in order to terminate the agreement. During 1995, as discussed in Note 4 to the financial statements, the Partnership entered into interest rate derivative contracts on notional amounts aggregating $100,000,000 with maturity dates which extend beyond the termination date of the Partnership. These contracts are not considered hedges for accounting purposes, and are recorded at fair value at December 31, 1995.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe following table depicts the fair value of each class of financial instruments for which it is practicable to estimate that value as of December 31:\n- ------------- (1) Carrying amounts represent cost basis, except for available-for-sale securities and interest rate swap agreements, which are carried at fair value.\n(2) Determined based on quoted market prices for those or similar notes.\n(3) Due to the variable rate nature of the indebtedness, the fair value approximates the carrying value.\n(4) The amount on which the interest has been computed is $135,000,000 for swaps and $20,000,000 for caps. The balance of the contract totals presented above reflect contracts entered into as of December 31, 1994 which did not become effective until 1995 and 1996 as existing contracts expire.\n(5) The amount that the Partnership estimates it would receive (pay) to terminate the hedging agreements. This amount is not recognized in the consolidated financial statements.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 - NOTES PAYABLE Notes payable consist of:\n(a) Notes to Banks\nOn November 2, 1992, the Partnership entered into an Amended and Restated Revolving Credit and Term Loan Agreement (the \"Bank Credit Agreement\") with seven banks which, as amended, provides for aggregate borrowings of $167,000,000. The Bank Credit Agreement replaced the Partnership's $200,000,000 revolving line of credit agreement and consists of a $92,000,000 term loan (the \"Term Loan\") and a $75,000,000 revolving loan (the \"Revolver\"). The original principal balance under the Term Loan of $100,000,000 was payable in twenty-eight quarterly installments, in varying amounts, commencing March 1993. The Revolver was scheduled to convert to a term loan on December 31, 1994 at which time the then outstanding balance would have become payable in twenty-four quarterly installments, in varying amounts, commencing March 1995. On March 13, 1995, the Partnership's management executed an amendment to the Bank Credit Agreement (the \"Amendment\"), that was effective as of December 31, 1994. The Amendment extended the revolving credit period through December 31, 1996 and eliminates the scheduled principal repayments in 1995 and 1996 under the Term Loan by making the entire facility due on December 31, 1996, to coincide with the scheduled termination of the Partnership. Borrowings under both facilities bear interest, at the Partnership's option, at (i) the prime rate plus 1.375%; (ii) the CD rate plus 2.50%; or (iii) LIBOR plus 2.375%. The Amendment also provides that if no transaction to dissolve the Partnership is approved as of April 1, 1996, the interest rates outlined herein will increase by 0.25%; and further provides that if no such transaction is approved by July 1, 1996, the interest rates will be increased an additional 0.25%.\nAt December 31, 1995, the weighted average interest rate on aggregate borrowings (including the effects of the interest rate hedging agreements) was 9.6%. The Partnership is also required to pay a commitment fee of 0.5% per annum on the unused portion of the Revolver. There is no additional borrowing capacity under the Revolver. Borrowings under the Bank Credit Agreement are collateralized by substantially all of the Partnership's assets. The lending banks have no recourse rights against the assets of the Unitholders or the General Partner.\nThe Bank Credit Agreement, as amended, contains various restrictions relating to, among other items, mergers and acquisitions, investments, indebtedness, contingent liabilities and sale of property.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 - NOTES PAYABLE (Continued)\nThe Bank Credit Agreement precludes the declaration or payment of distributions for periods subsequent to December 31, 1992, except for a special, one-time distribution declared on March 14, 1995 in connection with a gain on the sale of certain securities owned by the Partnership (See Note 3). The Amendment places certain additional restrictions on the annual amount of management fees and reimbursed partnership expenses that the Partnership may pay in cash.\nThe Bank Credit Agreement also contains financial covenants which may, among other things, limit the amount the Partnership may borrow. The Bank Credit Agreement as amended, currently provides that (i) the ratio of annualized cash flow to pro forma interest expense, as defined, must not be less than 1.5 to 1.0; (ii) the ratio of funded debt (borrowings less cash and equivalents) to cash flow must not exceed 6.25 to 1.0 through June 30, 1996 and 6.0 to 1.0 through December 31, 1996; (iii) capital expenditures may not exceed $12,500,000 in 1994, $19,500,000 in 1995 and $10,000,000 in 1996. Unused capital expenditures in one year may be carried over to the following year. Management believes that the Partnership was in compliance with all its financial covenants at December 31, 1995.\nThe Partnership Agreement, as amended on January 23, 1990, provides that without the approval of a majority of interests of limited partners, the Partnership may not incur any borrowings unless the amount of such borrowings together with all outstanding borrowings (less cash and cash equivalents) does not exceed 65% of the greater of the aggregate cost or current fair market value of the Partnership's assets as determined by the General Partner. (b) Other\n1) The Partnership issued a $3,000,000 subordinated installment note as part of the consideration paid for three cable television systems acquired in 1990. On February 19, 1993, the Partnership amended the note agreement and extended the maturity date until January 1997. The amended note agreement bore interest at 15% until April 1, 1995 at which time it increased to 20% until maturity. In August 1995, the note amount was increased to $6,206,000 to reflect cumulative accrued but unpaid interest in the amount of $3,206,000.\n2) In connection with the acquisition of three cable systems in 1994, the Partnership has an agreement under which it is required to make equal annual installments of $85,715 through 2001. The discounted present value of the annual installments is $433,600 at December 31, 1995.\n(c) Interest Rate Hedging Agreements\nThe Partnership utilizes interest rate hedging agreements to establish long-term fixed interest rates on variable rate debt. The Bank Credit Agreement requires that the Partnership maintain hedging arrangements with respect to at least 50% of the outstanding borrowings in order to manage the interest rate sensitivity on its borrowings. At December 31, 1995, the Partnership participated in interest rate\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 - NOTES PAYABLE (Continued)\nhedging contracts with aggregate notional principal of $155,000,000 under which the Partnership pays interest at fixed rates ranging from 5.53% to 11.08%, (weighted average rate of 6.96%), and receives interest at variable LIBOR-based rates. The Partnership has reduced this position by entering into an interest rate hedging contract with a notional amount of $30,000,000 under which it receives a fixed interest payment at 5.37% and pays interest at a variable LIBOR-based rate. At December 31, 1995 the Partnership participated in interest rate cap contracts aggregating $55,000,000 under which the Partnership will receive LIBOR-based payments if LIBOR rates exceed 7% to 8%. Of these contracts, $20,000,000 were not effective at December 31, 1995. The Partnership also participates in an interest rate contract, effective in 1996, with a notional amount of $10,000,000 under which the Partnership will pay a fixed rate of 7.12% and receive interest at a variable LIBOR-based rate.\nContracts aggregating $100,000,000 have maturity dates significantly beyond December 31, 1996, the termination date of the Partnership. The General Partner entered into the contracts, which are assignable to affiliated entities managed by FHGLP, because of favorable rates and in anticipation that the contracts will either be assigned to a successor entity managed by FHGLP or to existing entities managed by FHGLP. However, these contracts cannot be considered hedges for accounting purposes, and as previously discussed in Note 3 to the financial statements, the Partnership recorded these contracts at their fair value at December 31, 1995. FHGLP intends to assign the contracts to affiliated entities upon dissolution of the Partnership.\nThe hedging agreements resulted in additional interest expense of $4,674,000, $2,947,000 and $865,700 for the years ended December 31, 1993, 1994 and 1995, respectively. The Partnership does not believe that it has any significant risk of exposure to non-performance by any of its counterparties.\n(d) Debt Maturities\nThe Partnership's notes to banks mature contractually at December 31, 1996.\nGiven the scheduled termination of the Partnership at December 31, 1996, it is likely that all other outstanding indebtedness will be repaid on or before the Partnership's termination date.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5 - PARTNERS' EQUITY (DEFICIT)\nIncome and losses of the Partnership are allocated 99% to the Unitholders and 1% to the General Partner. At December 31, 1995, there were 6,398,913 limited partnership units outstanding. Distributions with respect to units in each year are made 99% to the Unitholders and 1% to the General Partner until Unitholders have received cash equal to the Preferred Return (an 11%, or $2.20 per unit, non-compounded cumulative annual return on the $20.00 initial public offering price of each unit computed for the period commencing from December 31, 1986). Any distributions in any year in excess of the Preferred Return (Excess Distributions) are made 99% to the Unitholders and 1% to the General Partner until such time as the aggregate amount of Excess Distributions to Unitholders equals the initial public offering price of the units. Thereafter, Excess Distributions are made 70% to Unitholders and 30% to the General Partner until the Unitholders have received a 17%, or $3.40 per unit, non-compounded cumulative annual return on the initial public offering price of the units (computed from the period commencing from December 31, 1986), after which Excess Distributions shall be made 50% to the Unitholders and 50% to the General Partner. See Note 10.\nNOTE 6 - MANAGEMENT COMPENSATION\nThe Partnership is obligated to pay the General Partner a 5% management fee based on gross revenues of the Partnership. In addition, the General Partner is entitled to reimbursement from the Partnership for certain expenses relating to the performance of management functions as described in the management agreement. The General Partner, in turn, has contracted with FHGLP to provide the management services to the Partnership. In March 1993, FHGLP assumed the operations of FHGI. As successor to the management service operations of FHGI, FHGLP receives management fees and reimbursed expenses which had previously been paid by the General Partner to FHGI.\nManagement fees and reimbursed expenses amounted to $4,742,000, $4,625,000 and $4,619,000 for the years ended December 31, 1993, 1994 and 1995. Payment of approximately $1,618,000 was deferred in 1995 pursuant to restrictions in the Bank Credit Agreement. The cumulative amount deferred as of December 31, 1995 amounted to approximately $4,621,000. As discussed in Note 4, the Amended Bank Credit Agreement requires significant additional deferrals of management fees and reimbursed expenses in 1996. The Partnership will be obligated to pay these deferred management fees and reimbursed expenses at the point in time the restrictions imposed by the Bank Credit Agreement are removed, or upon the expiration of the Partnership or the sale of the Partnership's assets prior to the distributions to the Unitholders. See Note 10.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - COMMITMENTS\nThe Partnership leases land, office space and equipment under operating leases expiring at various dates through the year 2008. Pole attachment fees are excluded from the following table since those contracts can be canceled with notice. Future minimum rentals for operating leases at December 31, 1995 are as follows:\nIn most cases, management expects that, in the normal course of business, these leases will be renewed or replaced by other leases. Rent expense for the years ended December 31, 1993, 1994 and 1995 for all facilities amounted to approximately $310,000, $329,000 and $343,000.\nIn addition, the Partnership rents line space on utility poles in some of the franchise areas it serves. These rentals amounted to $346,000, $421,000 and $342,000 for the years ended December 31, 1993, 1994 and 1995. Generally such pole rental agreements are short-term, but the Partnership expects such rentals to continue in the future.\nNOTE 8 - EMPLOYEE BENEFIT PLANS\nThe Partnership maintains a Key Executive Equity Program (the \"Program\") for certain key employees designated by the Partnership. Participants become vested over six years from the date of admission into the Program. Under the terms of the Program, participants derive benefits, as defined, in the Program based on achieving a specified operating margin percentage in conjunction with a specific percentage increase in cash flow in relation to the immediately preceding year. The effect of certain events and transactions, such as system acquisitions and dispositions, are adjusted on a pro forma basis in the determination of benefits. The Partnership incurred expenses under this Program of $222,000, $19,000 and $35,000 in 1993, 1994 and 1995, respectively. On February 14, 1995, the Board of Representatives of the General Partner approved the termination of the Program. All current participants will continue to vest in their contributions, but there will be no new participants or future contributions.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8 - EMPLOYEE BENEFIT PLANS (Continued)\nThe Partnership also has a cash or deferred profit sharing plan (the \"Profit Sharing Plan\") covering substantially all of its employees. The Profit Sharing Plan provides that each participant may elect to make a contribution in an amount up to 15% of the participant's annual compensation which otherwise would have been payable to the participant as salary. The Partnership's contribution to the Profit Sharing Plan, as determined by management, is discretionary but may not exceed 15% of the annual aggregate compensation (as defined) paid to all participating employees. There were no contributions charged against operations of the Partnership for the Profit Sharing Plan in 1993, 1994 or 1995.\nNOTE 9 - CONTINGENCIES\nThe Partnership is subject to regulation by various federal, state and local government entities. The Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") provides for, among other things, federal and local regulation of rates charged for basic cable service, cable programming services and equipment and installation services. Regulations issued in 1993 and significantly amended in 1994 by the Federal Communications Commission (the \"FCC\") have resulted in changes in the rates charged for the Partnership's cable services. The Partnership believes that compliance with the 1992 Cable Act has had a significant negative impact on its operations and cash flow. The Partnership believes that any potential future liabilities for refund claims or other related actions would not be material. The Telecommunications Act of 1996 (the \"1996 Telecom Act\") was signed into law on February 8, 1996. This statute contains a significant overhaul of the federal regulatory structure. As it pertains to cable television, the 1996 Telecom Act, among other things, (i) sunsets the regulation of certain nonbasic programming services in 1999; (ii) expands the definition of effective competition, the existence of which displaces rate regulation; (iii) eliminates the restriction against the ownership and operation of cable systems by telephone companies within their local exchange service areas; and (iv) liberalizes certain of the FCC's cross-ownership restrictions. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act.\nThe attorneys general of approximately 25 states have announced the initiation of investigations designed to determine whether cable television systems in their states have acted in compliance with the FCC's rate regulations.\nA recent federal court decision could if upheld and if adopted by other federal courts, make the renewal of franchises more problematic in certain circumstances. The United States District Court for the Western District of Kentucky held that the statute does not authorize it to review a franchising authority's assessment of its community needs to determine if they are reasonable or supported by any evidence. This result would seemingly permit a franchising authority which desired to oust an existing operator to set cable-related needs at such a high level that the incumbent operator would have difficulty in making a renewal proposal which met those needs. This decision has been appealed. The Partnership was not a party to this litigation.\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - CONTINGENCIES (Continued)\nThe Partnership has various contracts to obtain basic and premium programming for its Systems from program suppliers whose compensation is generally based on a fixed fee per customer or a percentage of the gross receipts for the particular service. Some program suppliers provide volume discount pricing structures or offer marketing support to the Partnership. The Partnership's programming contracts are generally for a fixed period of time and are subject to negotiated renewal. The Partnership does not have long-term programming contracts for the supply of a substantial amount of its programming. Accordingly, no assurances can be given that the Partnership's programming costs will not increase substantially, or that other materially adverse terms will not be added to the Partnership's programming contracts. Management believes, however, that the Partnership's relations with its programming suppliers generally are good.\nNOTE 10 - PARTNERSHIP EXPIRATION\nAs stated in Note 1 to the financial statements the Partnership expires on December 31, 1996 unless extended as described in the Partnership Agreement. The Partnership Agreement provides the General Partner or its affiliates the right to purchase for cash substantially all of the Partnership's cable systems at any time after December 31, 1991 (the \"Purchase Right\") without soliciting unaffiliated purchasers. Pursuant to the Partnership Agreement, in the event the General Partner or its affiliates exercise such right, the purchase price will be determined solely by reference to an \"appraised value\" determined pursuant to an appraisal process set forth in the Partnership Agreement (the \"Appraisal Process\"). In the event of a sale of a cable system, including a sale to the General Partner or its affiliates, the General Partner will be entitled to a fee equal to 2 1\/2% of gross proceeds from the sale less any amounts paid as brokerage or similar fees to third parties.\nThe Partnership has previously disclosed that the General Partner or its affiliates may from time to time explore the possibility of exercising the Purchase Right. As contemplated by the Partnership Agreement, the appraiser selected by the General Partner, the appraiser selected by a majority vote of the independent members of the Partnership's Advisory Committee, and the appraiser selected by the two appraisers so chosen have completed the appraisals as described above. The three appraisers are, respectively, Kane-Reece Associates, Inc., Malarkey-Taylor Associates, Inc., and Waller Capital Corporation. The gross value of the Partnership's assets, as determined by the average of the appraisers' reports and before deducting debt and other liabilities was determined to be $247,396,814. Based on this appraised value, after deducting debt and other liabilities, including fees due the General Partner, the liquidating distribution to unitholders would have been $9.08 per unit as of December 31, 1995. The ultimate amount, if the General Partner proceeds with the proposed transaction, will most likely vary from this amount.\nIn conjunction with the initiation of the Appraisal Process, certain affiliates (the \"Affiliates\") of the Partnership and its General Partner, including Marc B. Nathanson (the Chairman of the Board, Chief Executive Officer, and a director of Falcon Holding Group, Inc., the General Partner's sole general partner) have made a preliminary proposal (the \"Proposal\") to the independent members of the Partnership's\nFALCON CABLE SYSTEMS COMPANY\nNOTES TO FINANCIAL STATEMENTS (CONCLUDED)\nNOTE 10 - PARTNERSHIP EXPIRATION (Continued)\nAdvisory Committee with respect to an exchange transaction (the \"Exchange\"). Under the Proposal, the Exchange would take place immediately prior to the exercise by the General Partner or its affiliates of their right to purchase for cash substantially all of the Partnership's cable systems remaining after giving effect to the Exchange. In the Exchange, substantially all of the Units owned by the Affiliates would be exchanged for a portion (by value) of the Partnership's cable systems equal to the proportion of total outstanding Units exchanged by the Affiliates to the total units then outstanding. The Affiliates would also relieve the Partnership of an equal proportion of its total debt.\nAny decision of the General Partner or its affiliates to pursue the Proposal, the Exchange, or the sale of the cable systems of the Partnership in accordance with the rights of the General Partner under the terms of the Partnership Agreement (as described above) or otherwise, ultimately will be dependent upon numerous factors including, without limitation, (i) the receipt by the General Partner of an opinion of a qualified appraiser or other financial advisor selected by the independent members of the Partnership's Advisory Committee as to, among other things, the fairness of the Proposal as compared to a sale of all of the Partnership's cable systems (without giving effect to the Exchange) to the General Partner or its affiliates in accordance with their rights under the Partnership Agreement (as described above), or the conclusion on another basis that such fairness was otherwise established; (ii) the availability of necessary equity and debt financing on favorable terms; (iii) the relative attractiveness of available alternative business and investment opportunities; (iv) the regulatory environment for cable properties; (v) future developments relating to the Partnership and the cable industry, general economic conditions and other future developments. If the Proposal is pursued and the Exchange is consummated, the Affiliates expect that they would defer their potential tax liability as compared to a liquidation of the Partnership without effecting the Exchange.\nAlthough the foregoing reflects activities which the General Partner is currently exploring with the Partnership and the Affiliates with respect to the Partnership, the foregoing is subject to change at any time. Accordingly, there can be no assurance that the Proposal, the Exchange, or the sale of the cable systems of the Partnership in accordance with the rights of the General Partner and its affiliates under the terms of the Partnership Agreement or otherwise will be pursued or, if pursued, when and if any of them will be successfully consummated.\nIn addition, the Partnership has entered into a letter agreement with a group of holders of limited partnership interests in the Partnership (the \"Unofficial Unitholder Oversight Committee\"), consisting of the Baupost Group, Inc., Cumberland Associates, Harvest Capital, L.P., and Tweedy, Browne, Company L.P., and collectively holding approximately 1,339,000 Partnership Units (or approximately 21% of the outstanding Units). As part of this agreement, the Partnership is required by the agreement to pay 50% of the Committee's legal fees up to a maximum of $50,000.\nNOTE 11 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nDuring the years ended December 31, 1993, 1994 and 1995, the Partnership paid cash interest amounting to $15,117,000, $14,088,000 and $16,780,000.\nFALCON CABLE SYSTEMS COMPANY\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(a) Write-off uncollectible accounts\nEXHIBIT INDEX\nExhibit Number Description - ------- ------------\n3.1 Amended and Restated Agreement of Limited Partnership of the Registrant dated as of December 15, 1986.(6) 3.2 Agreement of Limited Partnership of Falcon Cable Investors Group dated as of October 30, 1986 among Falcon Holding Group, Inc., Marc Nathanson and Frank Intiso.(2) 3.3 Articles of Incorporation of Falcon Holding Group, Inc.(2) 3.4 Certificate of Amendment of Articles of Incorporation of Falcon Holding Group, Inc.(2) 3.5 Certificate of Incorporation of Falcon Assignor Limited Partner, Inc.(2) 3.6 Amended and Restated Agreement of Limited Partnership of Falcon Cable Investors Group dated as of December 8, 1986 among Falcon Holding Group, Inc., Marc Nathanson and Frank Intiso.(2) 3.7 First Amendment to the Amended and Restated Agreement of Limited Partnership of the Registrant.(7) 3.8 Second Amendment to the Amended and Restated Agreement of Limited Partnership of the Registrant.(9) The Registrant has not filed, pursuant to Item 601(b)(iii), certain instruments defining the rights of holders of long-term debt because the amount of debt thereunder does not exceed 10% of the total assets of the Registrant; the Registrant agrees to furnish a copy of any such instruments to the Commission upon request. 4.1 Amended and restated revolving credit and term loan agreement among Falcon Cable Systems Company, the several Lenders parties hereto and Toronto-Dominion (Texas), Inc. as Agent, dated as of November 2, 1992.(13) 4.2 First amendment, dated as of March 12, 1993, to the Amended and Restated Credit Agreement dated as of November 2, 1992 among Falcon Cable Systems Company, the several lenders parties thereto, and Toronto-Dominion (Texas), Inc. as agent. 4.3 Second amendment, dated as of December 12, 1993, to the Amended and Restated Credit Agreement dated as of November 2, 1992 among Falcon Cable Systems Company, the several lenders parties thereto, and Toronto-Dominion (Texas), Inc. as agent. 4.4 Third amendment, dated as of December 31, 1995, to the Amended and Restated Credit Agreement dated as of November 2, 1992 among Falcon Cable Systems Company, the several lenders parties thereto, and Toronto-Dominion (Texas), Inc. as agent\n10.1 Ordinance No. 1202 of the County of San Luis Obispo Granting a Community Antenna Television System Franchise to Cable Kor Communications Corporation, passed and adopted by the Board of Supervisors on December 13, 1971.(1)\n10.2 Ordinance No. 247 of the City of Morgan Hill Granting a Franchise to Nation Wide Cablevision, Inc., to Construct, Operate and Maintain a Community Antenna Television System, passed and adopted by the City Council on December 4, 1968.(1)\nE-1\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n10.3 Ordinance No. 779 of the City of Gilroy Granting a Franchise to Gilroy Cable T.V. to Construct, Prepare and Maintain a Community Antenna Television System, adopted by the City Council on October 24, 1966.(1) 10.4 Ordinance No. 324 of the City of Hollister Granting to Gilroy Cable T.V. a Non-Exclusive Franchise to Construct, Operate and Maintain a Community Antenna Television System, passed and adopted by the City Council on August 18, 1969.(1) 10.5 Resolution No. 73-156 of the Board of Supervisors for the County of Monterey Granting CATV License to Southern Monterey County TV Cable, Inc., adopted April 24, 1973.(1) 10.6 Resolution No. 79-303 of the Board of Supervisors for the County of Monterey Granting CATV License to Registrant, adopted June 26, 1979.(1) 10.7 Resolution No. 79-398 of the Board of Supervisors for the County of Monterey Amending CATV License for Registrant to include Oak Hills Subdivision, passed and adopted July 31, 1979.(1) 10.8 Ordinance No. 2715 of the County of Tulare Approving the Sale of a Non-Exclusive Franchise to Falcon Cable TV of Northern California, passed and adopted July 1, 1986.(2) 10.9 Resolution No. 851467 of the County of Tulare Approving Assignment of CATV License from Trans-Video Corporation, dba Cox Cable Porterville to Falcon Cable TV of Northern California, passed and adopted October 8, 1985.(2) 10.10 Assignment of Cable Television Franchise dated as of November 21, 1985 by Trans-Video Corporation, dba Cox Cable Porterville to Falcon Cable TV of Northern California.(2) 10.11 Asset Purchase Agreement dated as of November 21, 1985 between the Registrant and Trans-Video Corporation dba Cox Cable Porterville, Inc.(2) 10.12 Asset Purchase Agreement dated as of June 13, 1986 among the Registrant, Oregon Cablevision Co., Cannon Beach Cablevision, Illinois Valley Cable T.V., Inc. and Creative Cablesystems.(8) 10.13 Assignment of Falcon Cablevision dated as of November 5, 1985 by the Registrant.(1) 10.14 Agreement of Transferee Partners of Falcon Cablevision dated November 5, 1985 by Advance Corporation, Blackhawk Communications Corporation, Falpro Corporation and Stan Industries Inc.(8) 10.15 Assignment of 800 Date Street Venture dated October 31, 1985 by the Registrant.(1) 10.16 Agreement of Transferee Partners of 800 Date Street Venture dated October 28, 1985 by Advance Corporation, Blackhawk Communications Corporation, Falpro Corporation and Stan Industries Inc.(1) 10.17 Assignment and Assumption Agreement dated October 28, 1985 among the Registrant, Advance Corporation, Blackhawk Communications Corporation, Falpro Corporation and Stan Industries Inc.(1)\nE-2\nEXHIBIT INDEX\nExhibit Number Description - ------- ------------\n10.18 Partnership Grant Deed dated October 31, 1985 among the Registrant, Advance Corporation, Blackhawk Communications Corporation, Falpro Corporation and Stan Industries Inc.(1) 10.19 Asset Purchase Agreements dated as of September 20, 1988 between Apollo Cablevision, Inc., a California corporation, T.L. Robak, Inc., Thomas Robak and Charlotte J. Robak; and the Registrant.(8) 10.20 Asset Purchase Agreement dated October 1988 between Good Cable Corporation, V.E. (Bud) Seager and Diana L. Seager; and the Registrant.(8) 10.21 Asset Purchase Agreement dated December 1988 between Scott Cable Company, Inc. and the Registrant.(4) 10.22 Asset Purchase Agreement dated as of July 14, 1989 among Cooke Media Group, Inc. and Jack Kent Cooke Incorporated, Nevada corporations (\"Cooke\"), and certain direct and indirect subsidiaries of Cooke and the Registrant(5) 10.23 Franchise Ordinance and related documents thereto granting a non-exclusive community antenna television franchise for the City of Hesperia, California, adopted January 14, 1992.(11) 10.24 Resolution of the Board of Supervisors of San Luis Obispo County extending the Cable T.V. Franchise for the County of San Luis Obispo.(11) 10.25 Ordinance No. 6-92 of the Board of Commissioners of Lane County granting to Falcon Cable Systems Company a Non-Exclusive Franchise to Construct, Operate and Maintain a Community Antenna Television System, passed and adopted by the Board of Commissioners on June 24, 1992.(12) 10.26 Resolution No. 93-250 of the Board of Supervisors, County of San Luis Obispo, State of California approving a Cable Television Settlement Agreement with Falcon Cable Systems Company to Operate and Provide a Cable Television System.(14) 10.27 Cable Television Franchise Renewal Agreement between the County of San Luis Obispo, a political subdivision and one of the Counties of the State of California and Falcon Cable Systems Company, a California limited partnership.(14) 10.28 Cable Television Settlement Agreement between the County of San Luis Obispo, a political subdivision and one of the Counties of the State of California and Falcon Cable Systems Company, a California limited partnership.(14) 10.29 Lease agreement dated January 1, 1995 between the Registrant and Marc and Jane Nathanson. 10.30 City of Silverton, Oregon renewal of franchise for an additional 5 years.(16)\n16.1 Report of change in accountants (15)\n21.1 Subsidiaries: None\n99.1 Letter Agreement dated January 29, 1996, between the Unofficial Unitholder Committee and the Partnership.(17)\nE-3\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n99.2 System Appraisal of Falcon Cable Systems Company, as of December 31, 1995, by Marlarkey-Taylor Associates, Inc., dated March 8, 1996.(18)\n99.3 System Appraisal of Falcon Cable Systems Company, as of December 31, 1995, by Kane-Reece Associates, Inc., dated March 11, 1996. (18)\nE-3\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n99.4 System Appraisal of Falcon Cable System Company, as of December 31, 1995, by Waller Capital Corporation, dated March 11, 1996. (18)\nE-4\nEXHIBIT INDEX\nFOOTNOTES REFERENCES - -------------------- (1) Incorporated by reference to the exhibits to the Registrant's Registration Statement on Form S-1, Registration No. 33-1376. (2) Incorporated by reference to the exhibits to the Registrant's Registration Statement on Form S-1, Registration No. 33-9901. (3) Incorporated by reference to the exhibits to the Registrant's Registration Statement on Form S-1, Registration No. 33-14094. (4) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, File No. 1-9322 dated June 15, 1989. (5) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, File No. 1-9322 dated August 3, 1990. (6) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1986. (7) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1987. (8) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1988. (9) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1989. (10) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1990. (11) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1991. (12) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 1-9322 for the fiscal year ended December 31, 1992. (13) Incorporated by reference to the exhibits to the Registrant's Quarterly Report on Form 10-Q, File No. 1-9322 for the quarter ended March 31, 1993. (14) Incorporated by reference to the exhibits to the Registrant's Quarterly Report on Form 10-Q, File No. 1-9322 for the quarter ended June 30, 1993. (15) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, File No. 1-9322 dated October 17, 1994. (16) Incorporated by reference to the exhibits to the Registrant's Quarterly Report on Form 10-Q, File No. 1-9322 for the quarter ended March 31, 1995. (17) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, File No. 1-9322 dated January 29, 1996. (18) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, as amended, File No. 1-9322 dated March 11, 1996.\nE-5","section_15":""}
{"filename":"70793_1995.txt","cik":"70793","year":"1995","section_1":"Item 1. BUSINESS\nProducts\nNBTY, Inc. (formerly known as Nature's Bounty, Inc.) (the \"Company\"), collectively with its subsidiaries is a manufacturer and marketer of nutritional supplements in the United States. It sells more than 350 products consisting of vitamins and other nutritional supplements such as minerals, amino acids and herbs. Vitamins, minerals and amino acids are sold as a single vitamin and in multi-vitamin combinations and in varying potency levels in powder, tablet, soft gel, chewable, and hard shell capsule form. The Company's branded products are sold by independent and chain pharmacies, wholesalers, supermarkets and health food stores and by direct mail.\nMarketing and Distribution\nThe Company markets its products through different channels of distribution: wholesale-retail and direct mail.\nWholesale-Retail. The Company markets its products under various brand names to various stores including drug store chains and supermarkets, independent pharmacies, health food stores, health food store wholesalers and other retailers such as mass merchandisers and Company-owned stores. The Nature's Bounty brand is sold to drug store chains and drug wholesalers. The Company sells a full line of products to supermarket chains and wholesalers under the brand name Natural Wealth at prices designed for the \"price conscious\" consumer.\nIn addition to a complete line of vitamins and other nutritional supplements, the Company sells a comprehensive line of over-the-counter products such as cold remedies and analgesic formulas to independent pharmacies under the Hudson brand name.\nThe Company sells directly to health food stores under the brand name Good'N Natural and sells products, including a specialty line of vitamins, to health food wholesalers under the brand name American Health.\nThe Company operates 39 retail locations in fifteen states under the name Vitamin World. Such locations carry a full line of products under the Vitamin World brand name and products manufactured by others. Through direct interaction between the Company's personnel and the public, the Company is able to identify buying trends, customer preferences or dislikes, acceptances of new products and price trends in various regions of the country. This information is useful in initiating sales programs for all divisions of the Company.\nDirect Mail. The Company offers its full line of vitamins and other nutritional supplement products as well as selected personal care items under its Puritan's Pride brand name at prices which are normally at a discount from those of similar products sold in retail stores. The Company also sold personal care and other selected products under the Beautiful Visions name until the sale of this operation in October, 1995.\nSales and Advertising\nThe Company has approximately 70 sales employees located throughout the country who are paid on a salary plus commission basis. In addition, the Company sells through commissioned sales representative organizations which sell the Company's products on an exclusive basis.\nIn 1994 and 1995, the Company spent approximately $14.8 million and $19.3 million, respectively, on print and media advertising, including cooperative advertising with its customers. The Company creates its own advertising materials through a staff of approximately 22 employees. The Company expects advertising costs to increase as net sales increase.\nManufacturing, Distribution and Quality Control\nAll manufacturing is conducted in accordance with good manufacturing practice standards of the United States Food and Drug Administration and other applicable regulatory standards. The Company believes that the capacity of its manufacturing and distribution facilities is adequate to meet the requirements of its current business and, at the completion of its expansion program, will be adequate to meet the requirements of anticipated increases in net sales. The Company manufactures approximately 60% of its vitamins and other nutritional supplements and expects to increase such percentage upon completion of its manufacturing improvement program.\nThe Company's manufacturing process places special emphasis on quality control. All raw materials used in production are initially held in quarantine during which time the Company's laboratory employees assay the production against the manufacturer's certificate of analysis. Once cleared, a lot number is assigned, samples are retained and the material is processed by formulating, mixing and granulating, compression and sometimes coating operations. After the tablet is manufactured, laboratory employees test its weight, purity, potency, dissolution and stability. When a product such as vitamin tablets is ready for bottling, the Company's automated equipment counts the tablets, inserts them into bottles, adds a tamper-resistant cap with an inner safety seal and affixes a label. The Company uses computer-generated documentation for picking and packing for order fulfillment.\nThe principal raw materials used in the manufacturing process are natural and synthetic vitamins, purchased from bulk manufacturers in the United States, Japan and Europe. Although raw materials are available from numerous sources, one supplier currently provides approximately 13% of the Company's purchases, and no other single supplier accounts for more than 10% of the Company's raw material purchases.\nResearch and Development\nIn 1993, 1994 and 1995, the Company did not expend any significant amounts for research and development of new products.\nGovernment Regulation\nThe processing, formulation, packaging, labeling and advertising of the Company's products are subject to regulation by one or more federal agencies, including the United States Food and Drug Administration (the \"FDA\"), the Federal Trade Commission (the \"FTC\"), the Consumer Product Safety Commission, the United States Department of Agriculture and the Environmental Protection Agency. These activities are also regulated by various agencies of the states and localities in which the Company's products are sold. In addition, the United States Postal Service regulates advertising claims with respect to the Company's products sold by mail order.\nIn October 1994, the Dietary Supplement Health and Education Law was signed into law. This new law, which amends the Federal Food, Drug and Cosmetic Act, defines dietary supplements as a separate and distinct entity, and not as food additives. Vitamins, minerals, amino acids, herbs and other nutritional substances are included in the definition. It expressly provides for the use of third party scientific literature which shall not be regulated as labeling by the FDA, provided it is not false or misleading. The new law also delayed the FDA's requirements for extensive product label changes which were to be applied to products manufactured after July 1, 1995. It provides a set of different label requirements for ingredient content information, and directs the FDA to publish new label regulations for supplements with a mandatory effective date of December 31, 1996. It makes no modifications on the requirements and proscriptions regarding health claims for dietary supplements. The new law also introduced the concept of good manufacturing practices to the manufacture of dietary supplements. At this time, it would be premature to predict its overall impact on the dietary supplement industry.\nCompetition\nThe market for vitamins and other nutritional supplements is highly competitive in all of the Company's channels of distribution. The Company's Nature's Bounty and Natural Wealth brands compete for sales to drug store chains and supermarkets with heavily advertised national brands manufactured by large pharmaceutical companies, as well as Your Life and Nature Made brands, sold by privately-held vitamin companies, Leiner Health Products, Inc. and Pharmavite Corp, respectively. The Vitamin World stores compete with specialty vitamin stores, such as GNC Stores, health food stores and other retail stores. With respect to direct mail sales, the Company's Puritan's Pride brand is the largest seller of vitamins and other nutritional supplements and competes with a large number of smaller, usually less geographically diverse, direct mail companies, some of which manufacture their own products and some of which sell products manufactured by others.\nIt is not possible to estimate accurately the number of competitors since the nutritional supplement industry is fragmented and for the most part privately held. The Company is not capable of assessing market penetration of such competitors since they do not publish sales and marketing figures. No one company dominates the industry. However, it is the Company's belief that there may be between one and two dozen companies competing for the drug store and supermarket business. In its Vitamin World operations, the Company competes regionally with specialty vitamin stores, such as GNC Stores and local drug stores, health food stores, supermarkets, department stores and mass merchandisers.\nThe Company believes that it competes favorably with other direct mail sellers of similar products on a basis of price and customer service, including speed of delivery and new product offerings. The Company believes that it competes favorably with the large pharmaceutical companies and other companies which sell to wholesalers, on the basis of price, breadth of product line, reputation and customer service, including innovative packaging and displays and other services. The Company believes that it derives a competitive advantage from its ability to manufacture and package its own vitamin and nutritional supplement products, which affords it the flexibility to respond to the shifting demands of each channel of distribution and, consequently, the ability to achieve the manufacturing and operating efficiencies resulting from larger production runs of products which can be packaged for sale in one or more such channels.\nTrademarks\nThe Company owns trademarks registered with the United States Patent and Trademark Office and in some other major jurisdictions of the world for its Nature's Bounty, Good'N Natural, Hudson, American Health, Puritan's Pride, and Stur-Dee trademarks and has rights to use other names essential to its business. Federally registered trademarks have a perpetual life, as long as they are renewed on a timely basis and used properly as trademarks, subject to the rights of third parties to seek cancellation of the trademarks. The Company regards its trademarks and other propriety rights as valuable assets and believes they have significant value in the marketing of its products. The Company vigorously protects its trademarks against infringement.\nEmployees\nThe Company employs approximately 1,180 persons, of whom 40 are in executive and administrative capacities, approximately 80 are in sales, approximately 230 are in the Company's Vitamin World stores and the remainder are in manufacturing, shipping and packaging. None of the Company's employees is represented by a labor union. The Company believes its relationship with its employees is excellent.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company owns a total of approximately 625,000 square feet of plant facilities located at 60, 90, 105 and 115 Orville Drive in Bohemia, New York and 4320 Veterans Memorial Highway, Holbrook, New York, of which 100,000 square feet is devoted to manufacturing, 72,000 square feet is utilized for offices and the balance is or is to be used for shipping and warehouse. The Company has contracted to purchase a 62 acre plot in close proximity to its other facilities in Islip, New York in order to construct additional manufacturing capacity.\nThe Company's property at 90 Orville Drive is subject to a mortgage which collateralizes an $8.0 million taxable Industrial Development Revenue Bond due September 1, 2000 with monthly principal and interest payments of $74,821 through 2000 and a final payment of $6,891,258 on September 1, 2000. The Company's property at 115 Orville Drive is subject to a $2.4 million mortgage.\nThe Company operates 39 retail stores and kiosks in fifteen states under the name Vitamin World. The stores have an average selling area of 1,000 square feet and each kiosk has a selling area of approximately 190 square feet. Generally, the Company leases the stores and kiosks for three to five years for annual rents ranging from $12,000 to $65,000 and percentage rents in the event sales exceed a specified amount.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nL-tryptophan Litigation. The Company had been named in approximately 265 lawsuits of which approximately 255 have been settled or discontinued through September 30, 1995 at no cost to the Company. There are approximately 10 cases still pending. There were in excess of 2,000 lawsuits filed nationwide against other companies in the industry, including distributors, wholesalers and retailers claiming compensatory and punitive damages alleging personal injury and wrongful death resulting from the ingestion of L-tryptophan.\nThe Company and certain other companies in the industry, including distributors, wholesalers and retailers (the \"Indemnified Group\") have entered into an agreement with the Company's supplier of bulk L- tryptophan, Showa Denko American, Inc. (the \"Supplier\") under which the Supplier, a U.S. subsidiary of a major Japanese corporation, Showa Denko K.K., has assumed the defense of all claims against the Indemnified Group arising out of the ingestion of L-Tryptophan products and has agreed to pay the legal fees and expenses in that defense. The Supplier and Showa Denko K.K. have agreed to indemnify the Indemnified Group against any judgments and to fund settlements arising out of those actions and claims if it is determined that a cause of the injuries sustained by the plaintiffs, was a constituent in the bulk material sold by the Indemnified Group except to the extent that the Indemnified Group is found to have any part of the responsibility for those injuries.\nThe Supplier has posted a revolving, irrevocable letter of credit of $20 million to be used for the benefit of the Indemnified Group in the event that the Supplier is unable or unwilling to satisfy any claims or judgments. While not all of these suits quantify the amount demanded, it can reasonably be assumed that the amount required to either settle these cases or to pay judgments rendered therein will be paid by the Supplier.\nTo date, no cases in which the Company is a party have been reached for trial. While the outcome of any litigation is uncertain, based upon the Supplier's performance to date in settling cases, it is the opinion of management of the Company and legal counsel that it is remote that the Company will incur a material loss as a result of the L-tryptophan litigation and claims.\nShareholder Litigation. In October 1994, two lawsuits were commenced in the U.S. District Court, Eastern District of New York, against the Company and two of its officers. The Complaints allege that false and misleading statements and representations were made concerning the Company's sales and earnings estimates for the fourth fiscal quarter and for the year ended September 30, 1994. The allegations were that the Defendants failed to disclose that: (a) sales were materially declining; (b) manufacturing costs were increasing instead of decreasing; (c) profit margins were materially declining; and (d) that because of the foregoing, the Company would incur a loss in its fourth fiscal quarter. The Plaintiffs seek Class Action certification and an unspecified amount of monetary damages. The Company and its officers deny the allegations of the Complaints and intend to vigorously contest the litigation. In 1994, prior to commencement of these lawsuits, the Company purchased a directors and officers Indemnity Policy. Special counsel has been retained to represent the Company and its officers. Since the outcome of any litigation is uncertain, the Company is unable to predict (i) whether it will ultimately prevail; (ii) whether it will be fully or partially indemnified, if at all; (iii) the amount of loss, if any, that may be attributable to the above; and (iv) the amount of expense which may be incurred in the defense of these actions.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOn April 7, 1995, at the annual meeting of the shareholders, the following directors were elected: Arthur Rudolph and Glenn Cohen.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nDIVIDEND POLICY\nSince 1973, the Company has not paid any cash dividends on its Common Stock. On April 24, 1992, the Company effected a two-for-one stock split in the form of a 100% stock dividend to stockholders of record on May 8, 1992. On September 25, 1992, the Company effected a three-for-one stock split in the form of a 200% stock dividend to stockholders of record on November 2, 1992. In addition, on August 3, 1993, the Company effected a two-for-one stock split in the form of a 100% stock dividend to shareholders of record on August 13, 1993. Future determination as to the payment of cash or stock dividends will depend upon the Company's results of operations, financial condition and capital requirements and such other factors as the Company's Board of Directors may consider.\nPRICE RANGE OF COMMON STOCK\nThe Common Stock is traded in the over-the-counter market and is included for quotation on the National Association of Securities Dealers National Market System under the trading symbol \"NBTY\". The following table sets forth, for the periods indicated, the high and low closing sale prices for the Common Stock, as reported on NASDAQ\/NMS:\nFiscal year ended September 30, 1994\nOn November 16, 1995, the closing sale price of the Common Stock was $5.00. There were approximately 788 record holders of Common Stock as of November 3, 1995. The Company believes that there were in excess of 10,000 beneficial holders of Common Stock as of such date.\nItem 6.","section_6":"Item 6. SELECTED CONSOLIDATED FINANCIAL DATA\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nResults of Operations\nThe following table sets forth income statement data of the Company as a percentage of net sales for the periods indicated:\n1995 Compared to 1994\nNet Sales. Net sales for 1995 were $178.8 million, an increase of $22.7 million or 14.5% over 1994. Of the $22.7 million increase, $12.5 million was attributable to wholesale-retail sales and $10.3 million was attributable to mail order sales. In October, 1995, Beautiful Visions, a cosmetic catalog operation, was sold. Sales for such operation in 1995 were $8.3 million, a decrease of $5 million from the prior year.\nCost and Expenses. Cost of sales for 1995 was $93.9 million, an increase of $14.0 million or 17.5% over 1994. Gross profit decreased to 47.5% in 1995 from 48.8% in 1994. Such decrease as a percentage of net sales was due to various factors which included pricing pressures and write-downs for labels and unsold Beautiful Visions inventory.\nCatalog, Printing, Postage and Promotion. Catalog, printing, postage and promotion for 1995 was $19.2 million, an increase of $4.5 million or 30.3% over 1994. Such cost, as a percentage of net sales was 10.8% in 1995 compared with 9.5% in 1994. This increase was mainly due to expanded trade advertising and costs associated with promotional programs to independent stores and chain stores.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses for 1995 was $56.7 million, an increase of $7.5 million or 15.3% over 1994; as a percentage of net sales, these costs remained relatively constant at 31.7% in 1995 and 31.5% in 1994. The increase was primarily a result of increases in salaries, wages, fringe benefits and professional services.\nInterest expense. Interest expense in 1995 was $1.0 million, an increase of $.1 million.\nIncome taxes. The Company's effective tax rate was 38.7% in 1995 and 38.0% in 1994. The Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", in 1993. The impact from the implementation of SFAS No. 109 was not material to the Company's financial statements.\nSeasonality. The Company believes that its business is not seasonal except that historically it has the lowest net sales in its first fiscal quarter, slightly higher net sales in its second fiscal quarter and may have higher net sales in a quarter depending upon when it has engaged in significant promotional activities.\nLiquidity and Capital Resources.\nWorking capital was $40.7 million at September 30, 1995, compared with $39.5 million at September 30, 1994, an increase of $1.2 million.\nThe Company finances its working capital with internally-generated funds. The Company maintains an unsecured $15 million Revolving Credit Agreement (RCA) expiring on March 31, 1996 and a $10 million Master Equipment Lease Agreement (MELA) expiring December 31, 1995. As of September 30, 1995, $15 million remained available under the RCA and $8.6 million under the MELA.\nOn November 7, 1994, the Company purchased a building which it previously occupied under a long term lease. The purchase price of approximately $3.1 million was funded with $.7 million in cash and $2.4 million in a 15 year mortgage note payable.\nIn September 1990, the Company financed its plant expansion program with the proceeds of an $8 million taxable Industrial Development Revenue Bond due September 1, 2000 with monthly principal and interest payments of $74,821 through 2000 and a final payment of $6,891,258 on September 1, 2000. A portion of this loan, which is collateralized by a mortgage in favor of an insurance company, was also utilized to repay debt which was outstanding in 1989.\nThe mix of revenues among wholesale-retail and direct mail sales remained relatively constant for 1995, 1994 and 1993.\nThe Company believes that existing cash balances, internally- generated funds from operations and amounts available under the RCA and MELA will provide sufficient liquidity to satisfy the Company's working capital needs for the next 24 months and to finance anticipated capital expenditures incurred in the ordinary course of business.\nStock-based Plans\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", which establishes financial accounting and reporting standards for stock based plans. The Statement, which becomes effective in fiscal 1997, requires the Company to choose between accounting for issuances of stock and other equity instruments to employees based on their fair value or disclosing the pro forma effects such accounting would have had on the Company's net income and earnings per share. The Company has begun to gather the documentation necessary to address the impact of this Statement, although it has not yet decided which method it will utilize relating to its stock based employee plans.\n1994 Compared to 1993\nNet Sales. Net sales for 1994 were $156.1 million, an increase of $17.6 million or 12.7% over 1993. Of the $17.6 million increase, $11.7 million was attributable to wholesale sales, $4.4 million was attributable to mail order sales and $1.5 million to Company-operated retail stores and kiosks. The increase in mail order sales was comprised of an increase of $6 million for nutritional supplements and a decrease of $1.7 million in the Company's Beautiful Vision health and beauty aid catalogue operation. Substantially all of the increases in net sales were due to increased unit sales.\nCost and Expenses. Cost of sales for 1994 was $79.9 million, an increase of $11.9 million of 17.6% over 1993. Gross profit decreased to 48.8% in 1994 from 50.9% in 1993. Such decrease as a percentage of net sales was due primarily to non-recurring startup costs of the cosmetic pencil operation and softness in demand for the Company's products in the last quarter of the year.\nCatalog, printing, postage and promotion for 1994 was $14.8 million, an increase of $3.3 million or 28.5% over 1993. Such cost, as a percentage of net sales, was 9.5% in 1994 compared with 8.3% in 1993. This increase was mainly due to aggressive promotional programs to independent stores and chain stores.\nSelling, general and administrative expenses for 1994 was $49.2 million, an increase of $6.4 million or 15.0% over 1993; as a percentage of net sales, these costs increased 0.6% in 1994 compared to 1993. The increase was primarily a result of increases in salaries, wages, fringe benefits and freight costs. In addition, certain fixed costs increased in anticipation of higher sales volume which did not materialize.\nInterest Expense. Interest expense in 1994 was $.9 million, a decrease of $.3 million, as debt was decreased.\nIncome taxes. The Company's effective tax rate was 38% in 1994 and 37.8% in 1993. The Company adopted Statement of Accounting Standard (\"SFAS\") No. 109, \"Accounting for Income Taxes\", in 1993. The impact from the implementation of SFAS No. 109 was not material to the Company's financial statements.\nSeasonality. The Company believes that its business is not seasonal except that historically it has the lowest net sales in its first fiscal quarter, slightly higher net sales in its second fiscal quarter and may have higher net sales in a quarter depending upon when it has engaged in significant promotional activities.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee attached financial statements. Part IV, Item 14. 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\nSet forth below are the names and other relevant information regarding officers, directors, and significant employees of the Company as of September 30, 1995. Their stated positions are as follows:\nThe Directors of the Company are elected to serve a three year term or until their respective successors are elected and qualified. Officers of the Company hold office until the meeting of the Board of Directors immediately following the next annual shareholders meeting or until removal by the Board, whether with or without cause.\nScott Rudolph is the Chairman of the Board of Directors, President, Chief Executive and is a shareholder of the Company. He is a trustee of Dowling College, Long Island, New York. He joined the Company in 1986.\nHarvey Kamil is Executive Vice President. He joined the Company in July 1982.\nBarry Drucker is Senior Vice President of Sales. He joined the Company in 1976.\nPatricia E. Ciccarone is Vice President of Vitamin World. She joined the Company in 1988.\nJames P. Flaherty is Vice President of Advertising. He joined the Company in 1979.\nAbraham H. Kleinman is Vice President of Manufacturing. He joined the Company in December, 1973.\nJean Palladino is Vice President of The Hudson Corporation. She joined the Company in 1986.\nAbraham Rubenstein is Vice President of Mail Order. He joined the Company in January, 1985.\nWilliam J. Shanahan is Vice President of Data Processing. He joined the Company in 1980.\nRobert Silverman is Vice President of Good'N Natural. He joined the Company in 1985.\nJames E. Taylor is Vice President of Production. He joined the Company in December 1981.\nArthur Rudolph founded Arco Pharmaceuticals, Inc., the Company's predecessor, in 1960 and had served as the Company's Chief Executive Officer and Chairman of the Board of Directors since that date until his resignation in September 1993. However, he remains a member of the Board of Directors. Mr. Rudolph was responsible for the formation of the Company in 1971. He is the father of Scott Rudolph.\nAram Garabedian is, and has been since 1988, a real estate developer in Rhode Island. He had been associated with Nature's Bounty, Inc. and Arco Pharmaceuticals, Inc. for 20 years in a sales capacity and as an officer and has served as a director since 1971.\nBernard G. Owen has been President of Cafiero, Cuchel and Owen Insurance Agency for the past 25 years.\nAlfred Sacks has been President of Al Sacks, Inc., an insurance agency for the past 30 years.\nMurray Daly, formerly a Vice President of J. P. Egan Office Equipment Co., is currently a consultant to the office equipment industry.\nGlenn Cohen is the President of Glenn-Scott Landscaping, Inc.\nBud Solk is President of Bud Solk Associates, Inc., a full service advertising and marketing agency located in Chicago, Illinois, founded by him in 1958.\nNathan Rosenblatt is the President and Chief Executive Officer of Ashland Maintenance Corp., a commercial maintenance organization located in Long Island, New York.\nItem 12.","section_11":"","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners\nSecurities ownership of persons owning of record, or beneficially, 5% or more of the outstanding Common Stock, as of September 30, 1995. The Company is not aware of any other beneficial holders of 5% or more of the Common Stock. All information with respect to beneficial ownership, set forth in the foregoing stock ownership table, is based on information furnished by the shareholder, director or officer, or contained in filings made with the Securities and Exchange Commission.\n(b) Security Ownership of Management (directors and Officers)\nNature's Bounty, Inc. Profit Sharing Plan (formerly Employee Stock Ownership Plan and Trust)\nThe basic terms of the Plan are as follows:\nEligibility\nAll employees of the Company, including officers, over the age of 21 and who have been employed by the Company for one year or more are eligible participants in the Plan.\nContributions\nContributions are made on a voluntary basis by the Company. There is no minimum contribution required in any one year.\nThere will be no contributions required by an employee. All contributions will be made by the Company at the rate of up to 15% of the Company's annual payroll, at the discretion of the Company. Each eligible employee receives an account or share in the Trust and the cash and\/or shares of stock contributed to the Plan each year are credited to his or her account.\nVesting\nOnce an employee is eligible, a portion of the stock in his or her account becomes \"vested\" each year. For all participating employees after January 1, 1989, the vesting is as follows:\nDistribution\nIf an employee retires, is disabled, dies or his or her employment is otherwise terminated, that employee or that employee's estate will receive the vested portion held in trust for that employee.\nAt the end of the vesting period, the employees become full beneficial owners of the stock. There is no tax consequence attached to his or her Plan for an employee until that employee sells the shares, at which time any profit realized by the employee is taxed as a capital gain.\nDistribution is to be made only in the shares of Nature's Bounty, Inc. which shares were purchased for the Trust from the cash contributions of the Company.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this report\nPage Number ------\n1. Financial Statements\nReport of Independent Accountants\nConsolidated Balance Sheets as of September 30, 1995 and 1994\nConsolidated Statements of Income for the years ended September 30, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' 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 to\nNotes to Consolidated Financial Statements to\n2. Financial Statement Schedule\nSchedule II S-1\nSchedules not 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.\n3. Exhibits\n11. Statement Re Computation of Per Share Earnings\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: December 13, 1995 By: Scott Rudolph Scott Rudolph President, Chief Executive Officer\nDated: December 13, 1995 By: Harvey Kamil Harvey Kamil 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.\nDated: December 13, 1995 By: Scott Rudolph Scott Rudolph Chairman, President and Chief Executive Officer\nDated: December 13, 1995 By: Arthur Rudolph Arthur Rudolph, Director\nDated: December 13, 1995 By: Aram Garabedian Aram Garabedian, Director\nDated: December 13, 1995 By: Bernard G. Owen Bernard G. Owen, Director\nDated: December 13, 1995 By: Alfred Sacks Alfred Sacks, Director\nDated: December 13, 1995 By: Murray Daly Murray Daly, Director\nDated: December 13, 1995 By: Glenn Cohen Glenn Cohen, Director\nDated: December 13, 1995 By: Bud Solk Bud Solk, Director\nDated: December 13, 1995 By: Nathan Rosenblatt Nathan Rosenblatt, Director\nNBTY, INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n| Coopers | Coopers & Lybrand L.L.P. | | | &Lybrand | a professional services firm\nREPORT of INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of NBTY, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedule of NBTY, Inc. and Subsidiaries (formerly Nature's Bounty, Inc. and Subsidiaries) listed in Item 14(a) of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of NBTY, Inc. and Subsidiaries as of September 30, 1995 and 1994, and the consolidated results of its operations and cash flows for each of the three years in the period ended September 30, 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 8 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P.\nMelville, New York November 7, 1995.\nCoopers & Lybrand L.L.P. is a member of Coopers & Lybrand International, a limited liability association incorporated in Switzerland.\nNBTY, Inc. and Subsidiaries Consolidated Balance Sheets September 30, 1995 and 1994\nSee notes to consolidated financial statements.\nNBTY, Inc. and Subsidiaries Consolidated Statements of Income Years ended September 30, 1995, 1994 and 1993\nSee notes to consolidated financial statements.\nNBTY, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity Years ended September 30, 1995, 1994 and 1993\nSee notes to consolidated financial statements.\nNBTY, Inc. and Subsidiaries Consolidated Statements of Cash Flows Years ended September 30, 1995, 1994 and 1993\nNon-cash investing and financing information:\nDuring fiscal 1995, the Company entered into two capital leases for machinery and equipment aggregating $1,416,472.\nDuring fiscal 1995, options were exercised with 430,000 shares of common stock issued to certain officers and directors for $24,000 and an interest bearing note in the amount of $191,000. The promissory note, including interest, was paid by the surrender of 23,153 NBTY common shares to the Company at the prevailing market price. As a result of the exercise of these options, the Company is entitled to a compensation deduction of approximately $1,827,500 and it is estimated that such compensation deduction will ultimately result in a tax benefit of approximately $731,000 which has been recorded as an increase in capital in excess of par. In addition, the Company has adjusted its current liability to recognize the effect of this tax benefit. (See Note 10.)\nDuring fiscal 1994, options were exercised with 60,000 shares of common stock issued to certain directors for $30,000 in proceeds. As a result of the exercise of these options, the Company was entitled to a compensation deduction for tax purposes of approximately $1,140,000. Accordingly, the tax benefit of $433,200 was recorded as a reduction to its current tax liability and an increase to capital in excess of par. (See Note 10.)\nDuring fiscal 1993, options were exercised with 3,268,000 shares of common stock issued to certain key officers and a former executive officer for $2,709,875 in proceeds. The exercise of these options resulted in a tax benefit of $11,995,737 which was recorded as an increase to capital in excess of par. In addition, the Company adjusted its current liability ($5,988,205), deferred tax asset ($3,836,666) and income tax receivable ($2,170,866) accounts to recognize the effect of such benefit. (See Note 10.)\nDuring fiscal 1993, the Company's Board of Directors declared a stock split in the form of a 100% stock dividend. As a result, the common stock and capital in excess of par accounts as of September 30, 1993 were adjusted in the amount of $68,059 representing the par value of the common shares issued.\nSee notes to consolidated financial statements.\nNBTY, Inc. and Subsidiaries Notes to Financial Statements\n1. Business Operations and Summary of Significant Accounting Policies:\nBusiness operations:\nNBTY, Inc., formerly Nature's Bounty, Inc. (the \"Company\"), manufactures and distributes vitamins, food supplements and health and beauty aids. The Company has no single customer that represents more than 10% of annual net sales or accounts receivable as of September 30, 1995. The processing, formulation, packaging, labeling and advertising of the Company's products are subject to regulation by one or more federal agencies, including the Food and Drug Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the United States Department of Agriculture and the United States Environmental Protection Agency.\nPrinciples of consolidation and basis of presentation:\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated.\nRevenue recognition:\nThe Company recognizes revenue upon shipment or, with respect to its own retail store operations, upon the sale of products.\nInventories:\nInventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis. The cost elements of inventory include materials, labor and overhead.\nPrepaid catalog costs:\nMail order production and mailing costs are capitalized as prepaid catalog costs and charged to income over the catalog period, which typically approximates three months.\nProperty, plant and equipment:\nProperty, plant and equipment are carried at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets. Expenditures which significantly improve or extend the life of an asset are capitalized.\nMaintenance and repairs are charged to expense in the year incurred. Cost and related accumulated depreciation for property, plant and equipment are removed from the accounts upon sale or disposition and the resulting gain or loss is reflected in earnings.\nIntangible assets:\nGoodwill represents the excess of purchase price over the fair value of identifiable net assets of companies acquired. Goodwill and other intangibles are amortized on a straight-line basis over appropriate periods not exceeding 40 years.\nIncome taxes:\nIn 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 tax rates in effect for the year in which the differences are expected to reverse (see Note 8).\nCash and cash equivalents:\nFor 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.\nCommon shares and earnings per share:\nOn August 3, 1993, the Company's Board of Directors declared a two- for-one stock split in the form of a 100% stock dividend effective August 13, 1993.\nAll per common share amounts have been retroactively restated to account for the above stock split. In addition, stock options and the respective exercise prices have been amended to reflect these transactions (see Note 10).\nEarnings per share are based on the weighted average number of common shares outstanding during the period. Common stock equivalents are not included in income per share computations since their effect on the calculation is immaterial.\nStock-based plans:\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" which establishes financial accounting and reporting standards for stock based plans. The Statement, which becomes effective in fiscal 1997, requires the Company to choose between accounting for issuances of stock and other equity instruments to employees based on their fair value or disclosing the pro forma effects such accounting would have had on the Company's net income and earnings per share. The Company has begun to gather the documentation necessary to address the impact of this Statement, although it has not yet decided which method it will utilize relating to its stock based employee plans.\n2. Acquisition:\nOn June 1, 1993, the Company purchased certain assets from Prime Natural Health Laboratories, Inc., a distributor of vitamins and food supplements, for a cash purchase price of approximately $5,035,000. Assets acquired consisted of inventory ($2,000,000), customer mailing list ($1,303,500), accounts receivable ($891,500), covenant not to compete ($500,000), machinery and equipment ($325,000) and trademarks ($15,000).\n3. Inventories:\n4. Property, Plant and Equipment:\nDepreciation and amortization of property, plant and equipment for the years ended September 30, 1995, 1994 and 1993 was approximately $4,064,000, $3,190,000 and $2,421,000, respectively. The Company held machinery and equipment with a carrying value of $1,410,384 at September 30, 1995 under capital lease agreements.\n5. Intangible Assets:\nIntangible assets, at cost, acquired at various dates are as follows:\nAmortization included in the consolidated statements of income under the caption \"selling, general and administrative expenses\" in 1995, 1994 and 1993 was approximately $776,000, $1,054,000 and $1,549,000, respectively.\nEffective October 1, 1993, the Company changed its estimates of the lives of certain customer lists. Customer list amortization lives that previously averaged 6 years were increased to an average of 15 years. This change was made to better reflect the estimated periods during which an individual will remain a customer of the Company. The change had the effect of reducing amortization expense by approximately $500,000 and increasing the net income by $310,000 in 1994.\n6. Accrued Expenses:\n7. Long-Term Debt and Capital Lease Obligations:\n(a) The Company has a three-year $15,000,000 revolving credit facility (the \"Agreement\") with banks which expires on March 31, 1996. The Agreement requires monthly interest payments on a formula basis at varying rates ranging from below the prime lending rate to 1\/2% over prime. A commitment fee of 3\/8 of 1% per annum is charged on the unused balance of the remaining credit facility. The $5,000,000 outstanding under this credit facility at September 30, 1994 was repaid October 3, 1994.\nUnder the most restrictive covenants of the Agreement, the Company is required to maintain tangible net worth of at least $71,300,000, a current ratio of at least 1.75 to 1.00 and has a limitation on the amount of capital expenditures. In November 1995, the Company received waivers relating to noncompliance of certain covenants which existed as of September 30, 1995.\n(b) In September 1990, the Company obtained an $8,000,000 first mortgage, collateralized by the underlying building, issued through the Town of Islip, New York Industrial Development Agency. The taxable bond, held by an insurance company, has monthly principal and interest payments of $74,821 for ten years through 2000, with a final payment of $6,891,258 in September 2000.\n(c) In November 1994, the Company purchased a building which it previously occupied under a long-term lease. The purchase price of approximately $3,090,000 was funded with $690,000 in cash and the balance through a 15-year mortgage note payable. This agreement contains restrictive covenants identical to the covenants noted in (a) above.\n(d) During 1995, the Company entered into two long-term leases expiring in fiscal 2002 for certain operating machinery and equipment. The leases provide the Company with bargain purchase options at the end of such terms. For financial reporting purposes, the lease has been classified as a capital lease.\nRequired principal payments of debt and capital lease obligations are as follows:\n8. Income taxes:\nDuring fiscal 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement 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 cumulative effect of this change in accounting principle on prior years is insignificant to the Company's statement of income.\nProvision for income taxes consists of the following:\nThe following is a reconciliation of the income tax expense computed using the statutory federal income tax rate to the actual income tax expense and its effective income tax rate.\nThe components of deferred tax assets and liabilities are as follows:\nThe Company has a net operating loss carryforward of approximately $6 million for state financial and income tax reporting purposes expiring in fiscal 2007.\n9. Commitments:\nLeases:\nThe Company conducts retail operations located in enclosed malls under operating leases which expire at various dates through 2002. Some of the leases provide for additional rentals based upon sales plus certain tax and maintenance costs.\nFuture minimal rental payments under the retail location and automotive leases that have initial or noncancelable lease terms in excess of one year at September 30, 1995 are as follows:\nOperating lease rental expense, including real estate tax and maintenance costs and leases on a month to month basis, was approximately $1,248,000, $1,200,000 and $1,106,000 for the years ended September 30, 1995, 1994 and 1993, respectively.\nPurchase Commitments:\nThe Company was committed to make future purchases under various purchase order arrangements with fixed price provisions aggregating approximately $972,000 and $6,400,000 at September 30, 1995 and 1994, respectively.\nEmployment contracts:\nThe Company has employment agreements with two of its officers. The agreements, which expire in January 2004, provide for minimum salary levels, as adjusted for cost of living changes, as well as contain provisions regarding severance and changes in control of the Company. The commitment for salaries as of September 30, 1995 was approximately $727,000 per year.\n10. Stock Option Plans:\nIn December 1982, the Board of Directors of the Company adopted the Non-Qualified Stock Option Plan under which 525,000 shares of common stock were reserved for issuance. The Non-Qualified Plan was ratified by shareholders in February 1983. The Company granted options under the Non-Qualified Plan for 525,000 shares of common stock at prices ranging from $1.67 to $1.84 per share representing a price in excess of the market value at the time of grant. Such options were exercised in December 1992.\nThe Board of Directors approved the issuance of 1,608,000 non- qualified stock options on December 11, 1989, exercisable at $0.50 per share, which options terminated on December 10, 1994. The Board also approved the issuance of 2,220,000 non-qualified options on September 23, 1990, exercisable at $0.63 per share, which options terminate on September 23, 2000. In addition, on March 11, 1992, the Board of Directors approved the issuance of an aggregate of 1,800,000 non- qualified stock options to directors and officers, exercisable at $0.92 per share, and expiring on March 10, 2002. The exercise price of each of the aforementioned issuances was in excess of the market price at the date such options were granted.\nDuring fiscal 1995, options were exercised with 430,000 shares of common stock issued to certain officers and directors for $24,000 and an interest bearing note in the amount of $191,000. The promissory note, including interest, was paid by the surrender of 23,153 NBTY common shares to the Company at the prevailing market price. As a result of the exercise of these options, the Company is entitled to a compensation deduction of approximately $1,827,500 and it is estimated that such compensation deduction will ultimately result in a tax benefit of approximately $731,000 which has been recorded as an increase in capital in excess of par. In addition, the Company has adjusted its current liability to recognize the effect of this tax benefit.\nDuring fiscal 1994, options were exercised with 60,000 shares of common stock issued to certain directors for $30,000. As a result of the exercise of these options, the Company was entitled to a compensation deduction for tax purposes of approximately $1,140,000 which resulted in a tax benefit of approximately $433,200. Such benefit has been recorded as an increase to capital in excess of par. Furthermore, during fiscal 1993, options were exercised with 3,268,000 shares of common stock issued to certain key officers and a former executive officer for $2,709,875. The compensation deduction of approximately $33,000,000 resulted in a tax benefit to the Company of approximately $12,000,000.\nA summary of stock option activity is as follows:\n11. Employee benefit plans:\nThe Company maintains a defined contribution savings plan, which qualifies under Section 401(k) of the Internal Revenue Code, and an employee stock ownership plan. The accompanying financial statements reflect contributions to these plans in the approximate amount of $498,000, $103,000 and $255,000 for the years ended September 30, 1995, 1994 and 1993, respectively.\n12. Litigation:\nL-tryptophan:\nIn 1989, prior to a request from the Food and Drug Administration (\"FDA\") for a national, industry-wide recall, the Company halted sales and distribution and also ordered a recall of L-tryptophan products. Subsequently, the FDA indicated that there is a strong epidemiological link between the ingestion of L-tryptophan and a blood disorder known as eosinophilia-myalagia syndrome. The Company had been named in approximately 265 lawsuits of which approximately 255 have been settled or discontinued through September 30, 1995 at no cost to the Company. There were in excess of 2,000 lawsuits filed nationwide against other companies in the industry, including distributors, wholesalers and retailers claiming compensatory and punitive damages for alleged personal injury and alleged wrongful death. There are 10 cases still pending against the Company.\nThe Company and certain other companies in the industry, including distributors, wholesalers and retailers (the \"Indemnified Group\"), have entered into an agreement with the Company's supplier of bulk L- tryptophan (the \"Supplier\"), under which the Supplier, a U.S. subsidiary of a major Japanese corporation, has assumed the defense of all claims against the Indemnified Group arising out of the ingestion of L-tryptophan products and has agreed to pay the legal fees and expenses in that defense. The Supplier and its Japanese parent company have agreed to indemnify the Indemnified Group against any judgments and to fund settlements arising out of those actions and claims if it is determined that a cause of the injuries sustained by the plaintiffs was a constituent in the bulk material sold by the Supplier to the Indemnified Group, except to the extent that the Indemnified Group is found to have any part of the responsibility for those injuries.\nThe Supplier has posted a revolving, irrevocable letter of credit of $20 million to be used for the benefit of the Indemnified Group in the event that the Supplier is unable or unwilling to satisfy any claims or judgments. While not all of these suits quantify the amount demanded, it can reasonably be assumed that the amount required to either settle these cases or to pay judgments rendered therein will be paid by the Supplier.\nWhile the outcome of any litigation is uncertain, it is the opinion of management and legal counsel of the Company that it is remote that the Company will incur a material loss as a result of the L-tryptophan litigation and claims. Accordingly, no provision for liability, if any, that may result therefrom has been made in the Company's financial statements.\nShareholder litigation:\nIn October 1994, two lawsuits were commenced in the U.S. District Court, Eastern District of New York, against the Company and two of its officers. The complaints allege that false and misleading statements and representations were made concerning the Company's sales and earnings estimates for the fourth fiscal quarter and the year ended September 30, 1994. The allegations were that the defendants failed to disclose that: (a) sales were materially declining; (b) manufacturing costs were increasing instead of decreasing; (c) profit margins were materially declining and (d) that because of the foregoing, the Company would incur a loss in its fourth fiscal quarter. The plaintiffs seek Class Action certification and an unspecified amount of monetary damages. The Company and its officers deny the allegations of the complaints and intend to vigorously contest the litigation. In 1994, prior to commencement of these lawsuits, the Company purchased a directors and officers Indemnity Policy. Special counsel has been retained to represent the Company and its officers. Since the outcome of any litigation is uncertain, the Company is unable to predict (i) whether it will ultimately prevail; (ii) whether it will be fully or partially indemnified, if at all; (iii) the amount of loss, if any, that may be attributable to the above, and (iv) the amount of expense which may be incurred in the defense of these actions.\nOther litigation:\nThe Company is also involved in miscellaneous claims and litigation which, taken individually or in the aggregate, would not have a material adverse effect on the Company's financial position or its business.\n13. Quarterly results of operations (unaudited):\nThe following is a summary of the unaudited quarterly results of operations for fiscal 1995 and 1994 (dollars in thousands, except per share data):\n(a) 1995 year-end adjustments resulting in a charge to operations included approximately $1,475,000 for various accruals and for the write-off of certain equipment associated with the Company's cosmetic pencil operation, and $900,000 pertaining to the identification of obsolete inventory.\n(b) 1994 year-end adjustments resulting in a charge to operations included approximately $1,300,000 in start-up costs for the cosmetic pencil operation and $250,000 for an FTC settlement which was paid in fiscal 1995.\n14. Subsequent Event:\nOn October 9, 1995, the Company sold certain assets of its direct-mail cosmetics business for approximately $2,495,000. The Company received $350,000 in cash and non-interest bearing notes aggregating approximately $2,145,000 for inventory, a customer list and other intangible assets. The notes will be paid over a three-year period based on a predetermined formula with guaranteed minimum payments. A final payment for the remaining outstanding balance will be made on September 30, 1998. Revenues applicable to this marginally unprofitable business were approximately $8,284,000, $13,276,000 and $14,946,000 for fiscal 1995, 1994 and 1993, respectively.\nSchedule II\nNBTY, Inc. and Subsidiaries Valuation and Qualifying Accounts for the years ended September 30, 1995, 1994 and 1993","section_15":""}
{"filename":"21344_1995.txt","cik":"21344","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Coca-Cola Company (the \"Company\" or the \"Registrant\") was incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. The Company is the largest manufacturer, marketer and distributor of soft drink concentrates and syrups in the world. Finished soft drink products bearing the Company's trademarks, sold in the United States since 1886, are now sold in nearly 200 countries and include the leading soft drink products in most of these countries. The Company also is the world's largest marketer and distributor of juice and juice-drink products.\nThe business of the Company's \"beverages\" business sector is nonalcoholic beverages -- principally soft drinks but also noncarbonated beverages -- excluding particular beverages produced, marketed and distributed by the Company's Coca-Cola Foods business sector. Coca-Cola Foods produces, markets and distributes principally juice and juice-drink products, primarily in the United States and Canada. As used in this report, the term \"soft drinks\" refers to nonalcoholic carbonated beverages usually containing flavorings and sweeteners.\nOf the Company's consolidated net operating revenues and operating income for each of the past three years, the percentage represented by geographic area is as follows: MIDDLE AND FAR GREATER LATIN EAST AND UNITED AFRICA EUROPE AMERICA CANADA STATES ------ ------- ------- -------- ------ Net Operating Revenues 1995 3% 34% 11% 23% 29% 1994 3% 31% 12% 22% 32% 1993 2% 32% 12% 21% 33%\nOperating Income 1995 5% 28% 18% 31% 18% 1994 4% 29% 17% 29% 21% 1993 4% 29% 16% 29% 22%\nBEVERAGES BUSINESS\nGENERAL BUSINESS DESCRIPTION\nThe Company manufactures and sells soft drink and noncarbonated beverage concentrates and syrups, including fountain syrups, and some finished beverages. Syrups are composed of sweetener, water and flavoring concentrate. The concentrates and syrups for bottled and canned beverages are sold by the Company to authorized bottling and canning operations. The bottlers or canners of soft drink products either combine the syrup with carbonated water or combine the concentrate with sweetener, water and carbonated water to produce finished soft drinks. The finished soft drinks are packaged in authorized containers bearing the Company's trademarks -- cans, refillable and non-refillable glass and plastic bottles -- for sale to retailers or, in some cases, wholesalers. Finished beverages manufactured by the Company are sold by it to authorized bottlers or distributors, who in turn sell these products to retailers or, in some cases, wholesalers. Fountain syrups are manufactured and sold by the Company, principally in the United States, to authorized fountain wholesalers and some fountain retailers. (Outside the United States, fountain syrups typically are manufactured by authorized bottlers from concentrates sold to them by the Company.) Authorized fountain wholesalers (including certain authorized bottlers) sell fountain syrups to fountain retailers. The fountain retailers use dispensing equipment to mix the syrup with carbonated or still water and then sell finished soft drinks or noncarbonated beverages to consumers in cups and glasses.\nThe products of the Company's beverages business, including bottled and canned beverages produced by independent and Company- owned bottling and canning operations, as well as concentrates and syrups, include Coca-Cola, Coca-Cola classic, caffeine free Coca-Cola, caffeine free Coca-Cola classic, diet Coke (sold under the trademark Coca-Cola light in many countries outside the United States), caffeine free diet Coke, Cherry Coke, diet Cherry Coke, Fanta brand soft drinks, Sprite, diet Sprite, Mr. PiBB, Mello Yello, TAB, Fresca, Barq's root beer and other flavors, POWERaDE, Fruitopia, Minute Maid flavors, Saryusaisai, Aquarius, Bonaqa and other products developed for specific countries, including Georgia brand ready-to-drink coffees. During 1995, the Company acquired Barq's, Inc., the maker of the second largest- selling root beer in the United States. Additionally, Coca-Cola Nestle Refreshments, the Company's joint venture with Nestle S.A., produces ready-to-drink teas and coffees in certain countries.\nEffective February 1, 1996, the operating management structure for the Company's beverages business consists of five groups: the Africa Group; the Greater Europe Group; the Latin America Group; the Middle and Far East Group; and the North America Group.\nThe Company's beverages business accounted for 91% of the Company's net operating revenues in 1995, 89% in 1994 and 88% in 1993. The beverages business accounted for 100% of the Company's operating income in 1995, and 97% in 1994 and 1993. In 1995, concentrates and syrups for products bearing the trademark \"Coca-Cola\" or including the trademark \"Coke\" accounted for approximately 70% of the Company's total gallon shipments of beverage concentrates and syrups. (For purposes of comparison, physical units of concentrate have been converted in this report to their equivalents in gallons of syrup.)\nIn 1995, approximately 30% of the Company's total gallon shipments of beverage concentrates and syrups were in the United States. In 1995, the Company's principal markets outside the United States, based on gallon shipments of beverage concentrates and syrups, were Mexico, Brazil, Japan and Germany, which together accounted for approximately 27% of the Company's total gallon shipments.\nIn the United States, in 1995 the Company made approximately 63% of its total United States gallon shipments of beverage concentrates and syrups (\"U.S. gallon shipments\") to approximately 116 authorized bottler ownership groups in approximately 398 licensed territories. Those bottlers prepare and sell finished beverage products bearing the Company's trademarks for the food store and vending machine distribution channels and for other distribution channels supplying home and on-premise consumption. The remaining 37% of 1995 U.S. gallon shipments was attributable to fountain syrups sold to fountain retailers and to approximately 940 authorized fountain wholesalers, some of whom are authorized bottlers. These fountain wholesalers in turn sell the syrup to restaurants and other fountain retailers. Coca-Cola Enterprises Inc. (\"Coca-Cola Enterprises\") and its bottling subsidiaries and divisions accounted for approximately 41% of the Company's U.S. gallon shipments in 1995. As of February 16, 1996, the Company holds an ownership interest of approximately 45% in Coca-Cola Enterprises, which is the world's largest bottler of Company beverage products.\nIn addition to conducting its own independent advertising and marketing activities, the Company may choose to provide promotional and marketing services and\/or funds and consultation to its bottlers and to fountain and bottle\/can retailers. Also on a discretionary basis, the Company may develop and introduce new products, packages and equipment to assist its bottlers, fountain syrup wholesalers and fountain beverage retailers.\nThe profitability of the Company's beverages business outside the United States is subject to many factors, including governmental trade regulations and monetary policies, economic and political conditions in the countries in which such business is conducted and the risk of changes in currency exchange rates and regulations.\nBOTTLERS' AGREEMENTS AND DISTRIBUTION AGREEMENTS\nBottling contracts between the Company and each of its bottlers regarding beverages bearing the Company's trademarks (\"Company Trademark Beverages\"), subject to specified terms and conditions and minor variations, generally authorize the bottler to prepare particular designated Company Trademark Beverages, to package the same in particular authorized containers, and to distribute and sell the same in (but generally only in) an identified\nterritory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or other authorized suppliers. The Company typically agrees to refrain from selling or distributing or from authorizing third parties to sell or distribute the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, the Company typically reserves for itself or its designee the right (i) to prepare and package such beverages in such containers in the territory for sale outside the territory and (ii) to prepare, package, distribute and sell such beverages in the territory in any other manner or form.\nThe contractual arrangements between the Company and its authorized bottlers in the United States differ in certain respects from those in the nearly 200 other countries in which Company Trademark Beverages are sold. As hereinafter discussed, the principal differences involve the duration of the agreements; the inclusion or exclusion of canned beverage production rights and authorizations to manufacture and distribute fountain syrups; in some cases, the degree of flexibility on the part of the Company to determine the pricing of syrups and concentrates; and the extent, if any, of the Company's obligation to provide marketing support.\nOUTSIDE THE UNITED STATES. The bottling contracts between the Company and its authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals of the term of the contract. Generally, these contracts are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottler.\nIn many parts of the world outside the United States, the Company has not granted canned beverage production rights to the bottlers. In such instances, the Company or its designee typically sells canned Company Trademark Beverages to the bottlers for sale throughout the designated territory under can distribution agreements, often on a non-exclusive basis. A majority of the bottling contracts in force between the Company and bottlers outside the United States authorize the bottler to manufacture and distribute fountain syrups, usually on a non- exclusive basis.\nThe Company generally has complete flexibility to determine the price and other terms of sale of concentrates and syrups to bottlers outside the United States and, although it may determine in its discretion to do so, the Company typically has no obligation under such bottling contracts to provide marketing support to the bottlers.\nWITHIN THE UNITED STATES. In the United States, with certain very limited exceptions, the Company's bottling contracts for cola-flavored beverages have no stated expiration date and the contracts for other flavors are of stated duration, subject to bottler renewal rights. The bottling contracts in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default which may vary from contract to contract. The hereinafter described \"1987 Contract\" is terminable by the Company upon the occurrence of certain events including: (1) the bottler's insolvency, dissolution, receivership or the like; (2) any disposition by the bottler or any of its subsidiaries of any voting securities of any bottler subsidiary without the consent of the Company; (3) any material breach of any obligation of the bottler under the 1987 Contract; or (4) except in the case of certain bottlers, if a person or affiliated group acquires or obtains any right to acquire beneficial ownership of more than 10% of any class or series of voting securities of the bottler without authorization by the Company.\nBottlers in the United States are authorized to manufacture and distribute Company Trademark Beverages in bottles and cans, but generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to approximately 940 authorized wholesalers (including certain authorized bottlers) and some fountain retailers. The wholesalers in turn sell the syrups to restaurants and other retailers. The wholesaler typically acts as such pursuant to a non-exclusive annual letter of appointment which neither restricts the pricing of fountain syrups by the Company nor the territory in which the wholesaler may resell in the United States.\nIn the United States, the newest form of bottling contract for soft drinks (the \"1987 Contract\") gives the Company complete flexibility to determine the price and other terms of sale of soft drink concentrates and syrups for cola-flavored Company Trademark Beverages (\"Coca-Cola Trademark Beverages\") and other Company Trademark Beverages. Bottlers operating under the 1987 Contract accounted for approximately 74% of the\nCompany's total United States gallon shipments for bottled and canned beverages (\"U.S. bottle\/can gallon shipments\") in 1995. Certain other forms of the U.S. bottling contract, entered into prior to 1987, provide for soft drink concentrates or syrups for certain Coca-Cola Trademark Beverages to be priced pursuant to a stated formula. The oldest such form of contract, applicable to bottlers accounting for approximately 1% of U.S. bottle\/can gallon shipments in 1995, provides for a fixed price for Coca-Cola syrup used in bottles and cans, subject to quarterly adjustments to reflect changes in the quoted price of sugar. Bottlers accounting for the remaining approximately 25% of U.S. bottle\/can gallon shipments in 1995 have contracts for certain Coca-Cola Trademark Beverages with pricing formulas generally providing for a baseline price that may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable.\nStandard contracts with bottlers in the United States for the sale of concentrates and syrups for non-cola-flavored products in bottles and cans permit flexible pricing by the Company.\nUnder the 1987 Contract, the Company has no obligation to participate with bottlers in expenditures for advertising and marketing, but may, at its discretion, contribute toward such expenditures and undertake independent or cooperative advertising and marketing activities. Some bottling contracts that pre-date the 1987 Contract impose certain marketing obligations on the Company with respect to certain Company Trademark Beverages.\nSIGNIFICANT EQUITY INVESTMENTS AND COMPANY BOTTLING OPERATIONS\nThe Company is committed to continuing to strengthen its already strong bottler system. Over the last decade, bottling investments have represented a significant portion of the Company's investment assets. The principal objective of these investments is to ensure strong and efficient production, distribution and marketing systems in order to maximize long-term growth in volume, cash flows and share-owner value of the bottler and the Company.\nWhen considered appropriate, the Company makes equity investments in bottling companies, frequently as a minority share owner. Through these investments, the Company is able to help focus and improve sales and marketing programs, assist in the development of effective business and information systems and help establish capital structures appropriate for these respective operations. For example, the joint venture known as Coca-Cola Sabco (Proprietary) Limited (\"Coca-Cola Sabco\"), a new multinational bottling holding company in Africa, was formed in November 1995. The Company, through its subsidiary The Coca-Cola Export Corporation, is a minority share owner, with Gutsche Family Investments (Proprietary) Limited as a majority share owner. During 1995 the Company also purchased additional shares in Panamerican Beverages, Inc. (\"Panamerican Beverages\"), a holding company with bottling subsidiaries in Colombia, Brazil, Mexico and Costa Rica, thereby increasing its voting and economic interests in Panamerican Beverages to 16% and 13%, respectively. An investment agreement calls for further purchases by the Company from time to time, if and when Panamerican Beverages acquires additional bottling territories, until such time as the Company has accumulated a 25% voting interest.\nThe Company designates certain bottling operations in which it has invested as \"anchor bottlers,\" due to their level of responsibility and performance. Anchor bottlers, which include Coca-Cola Amatil Limited (\"Coca-Cola Amatil\") and Coca-Cola Enterprises, are considered to be strongly committed to the strategic goals of the Company and to furthering the interests of the Company's worldwide production, distribution and marketing systems. They tend to be large and geographically diverse and have strong financial and management resources.\nIn restructuring the bottling system, the Company occasionally has held temporary majority ownership positions in certain bottlers. The length of ownership is influenced by various factors, including operational changes, management changes and the process of identifying appropriate new investors and\/or operators.\nIn certain situations, owning a controlling interest in bottling operations is considered advantageous, compensating for limited local resources or facilitating improvements in customer relationships. For example, during 1995 the Company acquired seven bottling operations in northern Italy and six bottling plants in Venezuela.\nIn line with the Company's long-term bottling strategy, the Company will consider options for reducing its ownership interest in a consolidated bottler. One such option is to sell the Company's interest in a consolidated bottling operation to one of the Company's equity method investees. In transactions during 1995, Coca-Cola Amatil purchased the Company's wholly owned bottling operations in Poland, its 85% interests in two bottling operations in Romania and its 75% interest in a bottling operation in Croatia, for total consideration aggregating approximately U.S.$411 million, subject to adjustment.\nThe Company's consolidated bottling and fountain operations produced and distributed approximately 16% of worldwide unit case volume and, together with consolidated canning operations, generated approximately $6.4 billion in revenues in 1995. As used in this report, the term \"unit case\" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage product (24 eight-ounce servings).\nThe Company also has substantial equity positions in approximately 32 unconsolidated bottling, canning and distribution operations for its products worldwide, including bottlers representing approximately 43% of total U.S. unit case volume in 1995. Unconsolidated cost and equity method investee bottlers produced and distributed approximately 36% of the Company's worldwide unit case volume in 1995. Of these, significant equity method investee bottlers include those hereinafter described.\nCOCA-COLA ENTERPRISES. The Company's ownership interest in Coca-Cola Enterprises is approximately 45% as of February 16, 1996. Coca-Cola Enterprises is the world's largest bottler of the Company's beverage products. Net sales of concentrates and syrups by the Company to Coca-Cola Enterprises were $1.3 billion in 1995. Coca-Cola Enterprises also purchases high fructose corn syrup from the Company; however, related collections from Coca-Cola Enterprises and payments to suppliers are not included in the Company's consolidated statements of income. Coca-Cola Enterprises estimates that the territories in which it markets beverage products to retailers (which include portions of 38 states, the District of Columbia, the U.S. Virgin Islands and the Netherlands) contain approximately 54% of the United States population and 100% of the population of the Netherlands.\nIn 1995, approximately 69% of the unit case volume of Coca-Cola Enterprises (excluding products in post-mix (fountain) form) was Coca-Cola Trademark Beverages, approximately 21% of its unit case volume was other Company Trademark Beverages, and approximately 10% of its unit case volume was beverage products of other companies. Coca-Cola Enterprises' net sales of beverage products were approximately $6.8 billion in 1995.\nCOCA-COLA AMATIL. In July 1995, Coca-Cola Amatil completed a public offering in Australia of approximately 97 million shares of common stock. In connection with the offering, the Company's ownership interest in Coca-Cola Amatil was diluted from approximately 49% to approximately 40%.\nCoca-Cola Amatil is the largest bottler of the Company's beverage products in Australia and also has bottling and distribution rights, through direct ownership or joint ventures, in New Zealand, Fiji, Austria, Hungary, Papua New Guinea, the Czech and Slovak Republics, Indonesia, Belarus, Slovenia, Ukraine, Poland, Switzerland, Romania and Croatia. Coca-Cola Amatil estimates that the territories in which it markets beverage products contain approximately 99% of the population of Australia, 100% of the populations of New Zealand, Fiji, Hungary, Croatia, the Czech and Slovak Republics, Belarus, Slovenia and Ukraine, 81% of the population of Austria, 83% of the population of Papua New Guinea, 97% of the population of Indonesia, 91% of the population of Poland, 24% of the population of Switzerland and 46% of the population of Romania. In 1995, Coca-Cola Amatil's net sales of beverage products were approximately U.S.$2.2 billion.\nIn 1995, approximately 56% of the unit case volume of Coca-Cola Amatil was Coca-Cola Trademark Beverages, approximately 34% of its unit case volume was other Company Trademark Beverages, approximately 7% of its unit case volume was beverage products of Coca-Cola Amatil and approximately 3% of its unit case volume was beverage products of other companies.\nCOCA-COLA & SCHWEPPES BEVERAGES LTD. (\"CC&SB\"). The Company owns a 49% interest in CC&SB, the leading marketer of beverage products in Great Britain. CC&SB handles bottling and distribution of beverage products of the Company and Cadbury Schweppes PLC throughout Great Britain. In 1995, CC&SB's net sales of beverage products were approximately U.S.$1.4 billion.\nIn 1995, approximately 55% of the unit case volume of CC&SB was Coca-Cola Trademark Beverages, approximately 9% of its unit case volume was other Company Trademark Beverages, approximately 32% of its unit case volume was beverage products of Cadbury Schweppes PLC and approximately 4% of its unit case volume was beverage products of other companies.\nCOCA-COLA FEMSA, S.A. DE C.V. (\"COCA-COLA FEMSA\"). In 1993, the Company, through an indirect subsidiary, entered into a joint venture with Fomento Economico Mexicano, S.A. de C.V. (\"FEMSA\"), the largest \"food, beverage and tobacco\" company listed on the Mexican Stock Exchange. The Company invested approximately U.S.$195 million in exchange for a 30% economic interest in Coca-Cola FEMSA, a Mexican holding company with bottling subsidiaries in the Valley of Mexico, Mexico's southeastern region and, since 1994, in Argentina. As a result of a subsequent public offering, FEMSA now owns a 51% economic interest in Coca-Cola FEMSA, the Company owns a 30% economic interest and the remainder is owned by other investors.\nCoca-Cola FEMSA estimates that the territories in which it markets beverage products contain approximately 28% of the population of Mexico and 26% of the population of Argentina. In 1995, Coca-Cola FEMSA's net sales of beverage products were approximately U.S. $826 million. In 1995, approximately 79% of the unit case volume of Coca-Cola FEMSA was Coca-Cola Trademark Beverages, approximately 20% of its unit case volume was other Company Trademark Beverages, and approximately 1% of its unit case volume was beverage products of other companies.\nCOCA-COLA BOTTLERS PHILIPPINES, INC. (\"CCBPI\"). The Company owns a 30% interest in CCBPI, the only bottler authorized to manufacture and distribute beverage products of the Company in the Philippines. In 1995, CCBPI's net sales of beverage products were approximately U.S.$778 million.\nIn 1995, approximately 74% of the unit case volume of CCBPI was Coca-Cola Trademark Beverages, approximately 17% of its unit case volume was other Company Trademark Beverages, and approximately 9% of its unit case volume was beverage products of other companies.\nOTHER INTERESTS. Under the terms of the Coca-Cola Nestle Refreshments (\"CCNR\") joint venture involving the Company, Nestle S.A. and certain subsidiaries of Nestle S.A., the Company manages CCNR's ready-to-drink tea business and Nestle S.A. manages CCNR's ready-to-drink coffee business. The joint venture is applicable to ready-to-drink tea and coffee beverages in the United States and approximately 32 other countries.\nSEASONALITY\nSoft drink and noncarbonated beverage sales are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes in the Northern Hemisphere. The volume of sales in the beverages business may be affected by weather conditions.\nCOMPETITION\nThe Company's beverages business competes in the nonalcoholic beverages segment of the commercial beverages industry. That segment is highly competitive, consisting of numerous firms. These include firms that compete, like the Company, in multiple geographical areas as well as firms that are primarily local in operation. Competitive products include carbonates, packaged water, juices and nectars, fruit drinks and dilutables (including syrups and powdered drinks), sports and energy drinks, coffee and tea, still drinks and other beverages. Nonalcoholic beverages are sold to consumers in both ready-to-drink and not-ready-to- drink form.\nMost of the Company's beverages business currently is in soft drinks, as that term is defined in this report. The soft drink business, which is part of the nonalcoholic beverages segment, is itself highly competitive. The Company is the leading seller of soft drink concentrates and syrups in the world. Numerous firms, however, compete in that business. These consist of a range of firms, from local to international, that compete against the Company in numerous geographical areas.\nIn many parts of the world in which the Company does business, demand for soft drinks is growing at the expense of other commercial beverages. Competitive factors include pricing, advertising and sales promotion programs, product innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment and brand and trademark development and protection.\nRAW MATERIALS\nThe principal raw material used by the Company's beverages business in the United States is high fructose corn syrup, a form of sugar, which is available from numerous domestic sources and is historically subject to fluctuations in its market price. The principal raw material used by the Company's beverages business outside the United States is sucrose. The Company has a specialized sweetener procurement staff and has not experienced any difficulties in obtaining its requirements. In the United States and certain other countries, the Company has authorized the use of high fructose corn syrup in syrup for Coca-Cola and other Company Trademark Beverages for use in both fountain syrup and product in bottles and cans.\nGenerally, raw materials utilized by the Company in its beverages business are readily available from numerous sources. However, aspartame, which is usually used alone or in combination with either saccharin or acesulfame potassium in the Company's low-calorie soft drink products, is currently purchased by the Company primarily from The NutraSweet Company, a subsidiary of Monsanto Company, and from Holland Sweetener. Acesulfame potassium is currently purchased from Hoechst Aktiengesellschaft.\nCOCA-COLA FOODS\nGENERAL BUSINESS DESCRIPTION\nThe Company's Coca-Cola Foods business sector, with operations in the United States and Canada, is the world's largest marketer and distributor of juice and juice-drink products. In North America, Coca-Cola Foods produces, markets and distributes the following products: Minute Maid brand chilled ready-to-serve and frozen concentrated citrus and variety juices, lemonades and fruit punches; Minute Maid brand shelf-stable ready-to-serve juice and juice-drink products in single and multi-serve containers; Five Alive brand refreshment beverages; Bright & Early brand breakfast beverages; Bacardi brand tropical fruit mixers, which are manufactured and marketed under a license from Bacardi & Company Limited; and Hi-C brand ready-to-serve fruit drinks in single and multi-serve containers. In addition, Coca-Cola Foods manufactures Fruitopia, POWERaDE and Minute Maid Juices To Go products for the account of the Company's beverages business, as well as certain ready-to-drink tea products of CCNR, and also manages the production of such products by certain bottlers acting as contract packers.\nBoth directly and through a network of brokers, Coca-Cola Foods products are sold to retailers and wholesalers in North America and to military commissaries and exchanges in the United States and abroad. Coca-Cola Foods also distributes its products outside North America, and provides both technical and marketing assistance to other units of the Company relating to the production and marketing of branded juice and juice-drink products.\nMinute Maid Foodservice, a division of Coca-Cola Foods, provides airlines, restaurants, hotels, colleges, hospitals and other institutions with a full line of juice and juice-drink products and specialty dairy products. Minute Maid Foodservice manufactures and distributes foodservice juice products under the Minute Maid, Hi-C and other trademarks.\nIn 1995, Coca-Cola Foods unit volume declined 4% from the prior year as the foods business implemented a strategy to reduce short-term price promotions and increase long-term brand-building and marketing investments. During the year, the foods business invested heavily in new products and new packages to support its Minute Maid, Hi-C and Five Alive businesses. Coca-Cola Foods reported a modest operating loss of $14 million in 1995, due to a decline in net revenues and to a nonrecurring provision for increasing efficiencies. Minute Maid orange juice volume was down 8.5% from the prior year while volume of other juice and juice-drink products was up 0.6%.\nDuring 1995, Coca-Cola Foods initiated a series of actions intended to revitalize and build the equity of the Minute Maid and Hi-C trademarks. Actions to support Minute Maid brand products included the replacement of the 30-year-old black packaging scheme with high quality full-color designs, the addition of a screw-cap closure to 64-ounce cartons of Minute Maid products and dedicated advertising in support of Minute Maid orange juice, Minute Maid lemonade and Minute Maid Premium Choice orange juice. Hi-C trademark activities included dedicated advertising, new packaging graphics and the introduction of 7.7-ounce aluminum cans and a 10-pack for the aseptic drink box.\nSEASONALITY\nOverall demand for juice and juice-drink products does not fluctuate in any significant manner throughout the calendar year.\nCOMPETITION\nThe juice and juice-drink products produced, marketed and distributed by Coca-Cola Foods compete with a wide variety of beverages in the highly competitive commercial beverages industry, which includes other producers of regionally and nationally advertised brands of juice and juice-drink products. Significant competitive factors include advertising and trade promotion programs, new product introductions, new and more efficient production and distribution methods, new packaging and dispensing equipment, and brand and trademark development and protection.\nRAW MATERIALS\nThe citrus industry is subject to the variability of weather conditions, in particular the possibility of freezes in central Florida, which may result in higher prices and lower consumer demand for orange juice throughout the industry. Due to the Company's long-standing relationship with a supplier of high- quality Brazilian orange juice concentrate, the supply of juice available that meets the Company's standards is normally adequate to meet demand.\nPATENTS, TRADE SECRETS, TRADEMARKS AND COPYRIGHTS\nThe Company is the owner of numerous patents, copyrights and trade secrets, as well as substantial know-how and technology (herein collectively referred to as \"technology\"), which relate to its products and the processes for their production, the packages used for its products, the design and operation of various processes and equipment used in its business and certain quality assurance and financial software. Some of the technology is licensed to suppliers and other parties. The Company's soft drink and other beverage formulae are among the important trade secrets of the Company.\nThe Company owns numerous trademarks which are very important to its business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and\/or their registrations are properly maintained and they have not been found to have become generic. Registrations of trademarks can generally be renewed indefinitely as long as the trademarks are in use. The majority of the Company's trademark license agreements are included in the Company's bottler agreements. The Company has registered and licenses the right to use its trademarks in conjunction with certain merchandise other than soft drinks.\nGOVERNMENTAL REGULATION\nThe production, distribution and sale in the United States of many of the Company's products are subject to the Federal Food, Drug and Cosmetic Act; the Occupational Safety and Health Act; the Lanham Act; various environmental statutes; and various other federal, state and local statutes regulating the production, transportation, sale, safety, advertising, labeling and ingredients of such products.\nA California law requires that any person who exposes another to a carcinogen or a reproductive toxicant must provide a warning to that effect. Because the law does not define quantitative thresholds below which a warning is not required, virtually all food manufacturers are confronted with the possibility of having to provide warnings on their food products due to the presence of trace amounts of defined substances. Regulations implementing the law exempt manufacturers from providing the required warning if it can be demonstrated that the defined substances occur naturally in the product or are present in municipal water used to manufacture the product. The Company has assessed the impact of the law and its implementing regulations on its soft drink products and other products and has concluded that none of its products currently requires a warning under the law. The Company cannot predict whether, or to what extent, food industry efforts to minimize the law's impact on foods will succeed; nor can the Company predict what impact, either in terms of direct costs or diminished sales, imposition of the law will have.\nBottlers of the Company's beverage products presently offer non-refillable containers in all areas of the United States and Canada. Many such bottlers also offer refillable containers, although overall U.S. sales in refillable containers are relatively limited. Measures have been enacted in certain localities and are currently in effect in nine states which require that a deposit be charged for certain non-refillable beverage containers. Similar proposals have been introduced in other states and localities and in past sessions of Congress, and it is anticipated that similar legislation will be introduced in the current session of Congress.\nAll of the Company's facilities in the United States are subject to federal, state and local environmental laws and regulations. Compliance with these provisions has not had, and the Company does not expect such compliance to have, any material adverse effect upon the Company's capital expenditures, net income or competitive position.\nEMPLOYEES\nAs of December 31, 1995, the Company and its subsidiaries employed approximately 32,000 persons, of whom approximately 10,000 are located in the United States. The Company, through its divisions and subsidiaries, has entered into numerous collective bargaining agreements, and the Company has no reason to believe it will not be able to renegotiate any such agreements on satisfactory terms. The Company believes that its relations with its employees are generally satisfactory.\nFINANCIAL INFORMATION ON INDUSTRY SEGMENTS AND GEOGRAPHIC AREAS\nFor financial information on industry segments and operations in geographic areas, see pages 67 and 68 of the Annual Report to Share Owners for the year ended December 31, 1995, which are incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's worldwide headquarters is located on a 40-acre office complex in Atlanta, Georgia. The complex includes the approximately 480,000 square feet headquarters building, the approximately 731,000 square feet Coca-Cola USA building and, in addition, an approximately 232,000 square feet office building. Also located in the complex are several other buildings, including the technical and engineering facilities, learning center and the Company's Reception Center. The Company leases approximately 259,000 square feet of office space at Ten Peachtree Place, Atlanta, Georgia, which is owned by a joint venture of which an indirect subsidiary of the Company is a partner. The Company and its subsidiaries and divisions have facilities for administrative operations, manufacturing, processing, packaging, packing, storage and warehousing throughout the United States.\nThe Company owns 40 principal beverage concentrate and\/or syrup manufacturing plants throughout the world, including one plant currently under construction. The Company currently owns or holds a majority interest in 32 operations with 47 principal beverage bottling and canning plants located outside the United States.\nCoca-Cola Foods, whose business headquarters is located in Houston, Texas, occupies its own office building, which contains approximately 330,000 square feet. Coca-Cola Foods operates 11 production facilities throughout the United States and Canada and utilizes a system of contract packers which produce and distribute products in areas where Coca-Cola Foods does not have its own manufacturing centers or during periods when it experiences manufacturing overflow.\nThe Company directly or through wholly owned subsidiaries owns or leases additional real estate throughout the world, including a wholly owned office and retail building at 711 Fifth Avenue in New York, New York. This real estate is used as office space by the Company or, in the case of some owned property, leased to others.\nManagement believes that the facilities for the production of its beverage and food products are suitable and adequate for the business conducted therein, that they are being appropriately utilized in line with past experience and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon the seasonal demand for product. While it is not possible to measure with any degree of certainty or uniformity the productive capacity and extent of utilization of these facilities, management believes that additional production can be obtained at the existing facilities by the addition of personnel and capital equipment and, in some facilities, the addition of shifts of personnel or expansion of such facilities. The Company continuously reviews its anticipated requirements for facilities and, on the basis of that review, may from time to time acquire additional facilities and\/or dispose of existing facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn May 1993, the Company discovered that its Carolina, Puerto Rico plant was unintentionally discharging, without a permit, process wastewater to a stormwater sewer which ultimately discharged to a surface waterbody. The Company immediately remedied the unintentional discharge and reported it to appropriate environmental agencies. The plant was sold in 1994; however, the Company has agreed to retain any potential legal liability resulting from the unintentional discharge. The statutory maximum penalty which could be sought against the Company is in excess of $100,000.\nOn February 26, 1992, suit was brought against the Company in Texas state court by The Seven-Up Company, a competitor of the Company. An amended complaint was filed by The Seven-Up Company on February 8, 1994. The suit alleges that the Company is attempting to dominate the lemon-lime segment of the soft drink industry by tortious acts designed to induce certain independent bottlers of the Company's products to terminate existing contractual relationships with the plaintiff pursuant to which such bottlers bottle and distribute the plaintiff's lemon-lime soft drink products. As amended, the complaint alleges that Coca-Cola\/Seven-Up bottlers in several different territories, including Nacogdoches, Texas; Oklahoma City, Oklahoma; Fargo, North Dakota; Shreveport, Louisiana; Elkins, West Virginia; Salem, New Hampshire; Fayetteville, Arkansas; Pine Bluff, Arkansas and Vicksburg, Mississippi, were illegally induced into initiating Sprite distribution and discontinuing Seven-Up distribution. The Company is accused of using several different purportedly improper tactics to bring about those bottler decisions, including false and misleading statements by the Company about the plaintiff's past, present and future business operations, improper financial advancements and various forms of alleged coercion.\nThe complaint seeks unspecified money damages for (1) alleged tortious interference with the plaintiff's contractual relations, (2) alleged intentional tortious conduct to injure plaintiff, (3) alleged disparagement of the plaintiff and its business, and (4) alleged false and injurious statements harmful to plaintiff's interests. The complaint also seeks an injunction prohibiting future allegedly tortious conduct by the Company and seeks an award of punitive damages in the amount of at least $500 million. In 1993, the Company filed a counterclaim against The Seven-Up Company in the matter alleging that The Seven-Up Company has tortiously interfered with the Company's efforts to obtain distribution of its lemon-lime soft drink, Sprite, through bottlers of Coca-Cola.\nOn July 22, 1992, The Seven-Up Company filed a related suit in federal court in Texas alleging that the facts and circumstances giving rise to the state court suit (described above) also constitute a violation of the federal Lanham Act which, inter alia, proscribes false advertisement and disparagement of a competitor's goods and services. The suit sought injunctive relief, treble damages and attorneys' fees. In October 1994, the federal Lanham Act suit was tried and resulted in a jury verdict in favor of Seven-Up on certain of its claims. The jury awarded Seven-Up a total of $2.53 million in damages. In December 1994, the federal court entered an order setting aside that damage award and awarded judgment in favor of the Company notwithstanding the verdict. Seven-Up appealed that judgment.\nShortly after the federal court's ruling, the Company asked the state court to dismiss all of the plaintiff's remaining claims in that case based upon the judgment entered in the federal case. On February 14, 1995, the state court granted that motion and dismissed all of Seven-Up's remaining claims. Seven-Up appealed that ruling as well. The appeals in both cases have been briefed and are awaiting decisions by the United States Court of Appeals for the Fifth Circuit and the Court of Appeals for the Fifth District of Texas, respectively.\nOn April 22, 1994, Deborah A. Heller, et al., individually and as a class representative, filed a class action lawsuit against the Company and other sellers of diet beverages in the Supreme Court of the State of New York, County of Kings, which alleged that the plaintiff and other members of the purported class had been defrauded by the defendants by reason of their failure to advise consumers that the sweetness level of diet beverages sweetened with aspartame degrades over time. The initial complaint, which asserted claims based upon common law fraud and violation of New York state consumer protection statutes, did not indicate a specific damage amount in its prayer for damages. On July 27, 1994, plaintiffs filed an amended complaint adding several individually-named plaintiffs and a claim for unjust enrichment. On September 23, 1994, the Company filed a motion to dismiss plaintiffs' amended complaint in its entirety. On November 7, 1994, the plaintiffs filed a motion for summary judgment seeking from the Company damages of at least $1.187 billion based upon its sales of such diet soft drinks during the period from April 1988 through December 1993. The New York law upon which plaintiffs' claims are based allows the Court, at its discretion, to increase up to three times any damages it awards.\nOn April 4, 1995, the Court granted defendants' motion to dismiss the complaint, ruling that the Federal Food and Drug Administration has primary jurisdiction over the issue raised by plaintiffs; and that, in any event, plaintiffs had failed to state a cause of action under any of the various fraud, misrepresentation and\/or consumer protection counts of their complaint. The Court also held that plaintiffs had no unjust enrichment claim. Plaintiffs' cross motions for class action certification and partial summary judgment were deemed moot in light of the Court's other rulings and were not formally ruled upon. Plaintiffs thereafter filed a notice of appeal and also asked the Court to reconsider its earlier opinion. The latter request was denied by the Court on October 31, 1995. The case is now proceeding through the appellate stage in the Appellate Division of the New York Supreme Court.\nThe Company is involved in various other legal proceedings. The Company believes that any liability to the Company which may arise as a result of these proceedings, including the proceedings specifically discussed above, will not have a material adverse effect on the financial condition of the Company and its subsidiaries taken as a whole.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM X. EXECUTIVE OFFICERS OF THE COMPANY\nThe following are the executive officers of the Company:\nRoberto C. Goizueta, 64, is Chief Executive Officer and Chairman of the Board of Directors of the Company. In August 1980, Mr. Goizueta was elected Chief Executive Officer and Chairman of the Board effective March 1981, at which time he assumed these positions.\nM. Douglas Ivester, 48, is President and Chief Operating Officer and a Director of the Company. In January 1985, Mr. Ivester was elected Senior Vice President and Chief Financial Officer of the Company and served in that capacity until June 1989, when he was appointed President of the European Community Group of the International Business Sector. He was appointed President of Coca-Cola USA in August 1990, and was appointed President of the North America Business Sector in September 1991. He served in the latter capacity until April 1993 when he was elected Executive Vice President of the Company and Principal Operating Officer\/North America. Mr. Ivester was elected to his current positions in July 1994.\nJames E. Chestnut, 45, is Senior Vice President and Chief Financial Officer of the Company. Mr. Chestnut joined the Company in 1972 in London. In 1984, he was named Finance Manager for the Philippine Region in Manila and, in 1987, Manager of International Treasury Services, Pacific Group, in Atlanta. He was named Finance Manager for the North Pacific Division of the International Business Sector in 1989 before being elected Vice President and Controller of the Company in 1993. He was elected to his present position in July 1994.\nJack L. Stahl, 42, is Senior Vice President of the Company and President of the North America Group. In March 1985, Mr. Stahl was named Manager, Planning and Business Development and was appointed Assistant Vice President in April 1985. He was elected Vice President and Controller in February 1988 and served in that capacity until he was elected Senior Vice President and Chief Financial Officer in June 1989. He was appointed to his present position in July 1994.\nWeldon H. Johnson, 58, is Senior Vice President of the Company and President of the Latin America Group. In January 1983, Mr. Johnson was named President of Coca-Cola (Japan) Company, Limited. In April 1987, he was elected Executive Vice President of the Latin America Group of the International Business Sector. He was elected Senior Vice President in December 1987 and was appointed President of the Latin America Group of the International Business Sector in January 1988.\nE. Neville Isdell, 52, is Senior Vice President of the Company and President of the Greater Europe Group. Mr. Isdell became President of the Company's Central European Division in July 1985 and was elected Senior Vice President of the Company and appointed President of the Northeast Europe\/Africa Group effective in January 1989. Effective January 1993 he became President of the Northeast Europe\/Middle East Group of the International Business Sector. He was appointed to his present position in January 1995.\nDouglas N. Daft, 52, is Senior Vice President of the Company and President of the Middle and Far East Group. In November 1984, Mr. Daft was appointed President of Coca-Cola Central Pacific Ltd. In October 1987, he was appointed Senior Vice President of the Pacific Group of the International Business Sector. In January 1989, he was named President of Coca-Cola (Japan) Company, Limited and President of the North Pacific Division of the International Business Sector. Effective 1991 he was elected Senior Vice President of the Company and named President of the Pacific Group of the International Business Sector. He was appointed to his current position, effective January 1995.\nCarl Ware, 52, is Senior Vice President of the Company and President of the Africa Group. In 1979, Mr. Ware was appointed Vice President, Special Markets, Coca-Cola USA. In March 1982, he was appointed Vice President, Urban Affairs, of the Company. He was elected Senior Vice President and Director, Corporate External Affairs in 1986 and became Deputy Group President of the Northeast Europe\/Africa Group of the\nInternational Business Sector in July 1991, a position he held until he was named to his current position, effective January 1993.\nJoseph R. Gladden, Jr., 53, is Senior Vice President and General Counsel of the Company. In October 1985, Mr. Gladden was elected Vice President. He was named Deputy General Counsel in October 1987 and served in that capacity until he was elected Vice President and General Counsel in April 1990. He was elected Senior Vice President in April 1991.\nSergio Zyman, 50, is Senior Vice President of the Company and Chief Marketing Officer. Mr. Zyman first joined the Company in 1979 and later served as Senior Vice President of Marketing for Coca-Cola USA until 1986. After a seven year absence from the Company, during which he acted as consultant to different companies through Sergio Zyman & Co. and Core Strategy Group, he returned to assume his current position in August 1993.\nEarl T. Leonard, Jr., 59, is Senior Vice President of the Company with responsibility for Corporate Affairs. Mr. Leonard was elected to his current position in April 1983.\nAnton Amon, 52, is Senior Vice President of the Company and Manager of the Company's Product Integrity Division. Dr. Amon was named Senior Vice President of Coca-Cola USA in 1983. In 1988, he joined Coca-Cola Enterprises as Vice President, Operations. In September 1989, Dr. Amon returned to the Company as director, Corporate Quality Assurance. He was elected Vice President in October 1989. He became Manager, Product Integrity Division, in January 1992 and was elected to his current position in July 1992.\nGeorge Gourlay, 54, is Senior Vice President of the Company and Manager of the Technical Operations Division. Mr. Gourlay was named Manager, Corporate Concentrate Operations in 1986, named Assistant Vice President in 1988, and was elected Vice President in 1989. Mr. Gourlay became head of the Technical Operations Division in January 1992 and was elected to his current position in July 1992.\nRalph H. Cooper, 56, is Senior Vice President of the Company and President and Chief Executive Officer of Coca-Cola Foods. Mr. Cooper was appointed Senior Vice President of the Europe and Africa Group in July 1984 and was named Senior Vice President of Coca-Cola International and President of the Northwest European Division in January 1989. He was elected Senior Vice President of the Company and President of the European Community Group of the International Soft Drink Business Sector in August 1990. In January 1995, he was named Executive Vice President of Coca-Cola Foods and served in that capacity until he was appointed President and Chief Executive Officer of Coca-Cola Foods in July 1995.\nAll executive officers serve at the pleasure of the Board of Directors.\nThere is no family relationship between any of the executive officers of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHARE-OWNER MATTERS\n\"Financial Review Incorporating Management's Discussion and Analysis\" on pages 41 through 47, \"Selected Financial Data\" for the years 1994 and 1995 on page 48, \"Stock Prices\" on page 71 and \"Common Stock\" and \"Dividends,\" under the heading \"Share-Owner Information\" on page 75 of the Company's Annual Report to Share Owners for the year ended December 31, 1995, are incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Selected Financial Data\" for the years 1991 through 1995, on pages 48 and 49 of the Company's Annual Report to Share Owners 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\n\"Financial Review Incorporating Management's Discussion and Analysis\" on pages 41 through 47 of the Company's Annual Report to Share Owners 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 the Registrant and its subsidiaries, included in the Company's Annual Report to Share Owners for the year ended December 31, 1995, are incorporated herein by reference:\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.\nConsolidated Statements of Share-Owners' Equity -- Years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\n\"Quarterly Data (Unaudited)\" on page 71 of the Company's Annual Report to Share Owners for the year ended December 31, 1995, 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\nFor information on Directors of the Registrant, the section under the heading \"Election of Directors\" entitled \"Board of Directors\" on pages 2 through 6 of the Company's Proxy Statement for the Annual Meeting of Share Owners to be held April 17, 1996, is incorporated herein by reference. See Item X in Part I hereof for information regarding executive officers of the Registrant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section under the heading \"Election of Directors\" entitled \"Committees of the Board of Directors; Meetings and Compensation of Directors\" on pages 8 and 9 and the section entitled \"Executive Compensation\" on pages 10 through 17 of the Company's Proxy Statement for the Annual Meeting of Share Owners to be held April 17, 1996, are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe sections under the heading \"Election of Directors\" entitled \"Ownership of Equity Securities in the Company\" on pages 6 and 7 and \"Principal Share Owners\" on pages 7 and 8, and the section under the heading \"The Major Investee Companies\" entitled \"Ownership of Securities in Coca-Cola Enterprises, Coca-Cola Amatil and Coca-Cola Beverages\" on page 24 of the Company's Proxy Statement for the Annual Meeting of Share Owners to be held April 17, 1996, are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe sections under the heading \"Election of Directors\" entitled \"Committees of the Board of Directors; Meetings and Compensation of Directors\" on pages 8 and 9 and \"Certain Transactions\" on pages 9 and 10, the section under the heading \"Executive Compensation\" entitled \"Compensation Committee Interlocks and Insider Participation\" on page 23 and the section under the heading \"The Major Investee Companies\" entitled \"Certain Transactions with Investee Companies\" on pages 23 and 24 of the Company's Proxy Statement for the Annual Meeting of Share Owners to be held April 17, 1996, are incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe following consolidated financial statements of The Coca-Cola Company and subsidiaries, included in the Registrant's Annual Report to Share Owners for the year ended December 31, 1995, are incorporated by reference in Part II, 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.\nConsolidated Statements of Share-Owners' Equity -- Years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\n2. The following consolidated financial statement schedule of The Coca-Cola Company and subsidiaries is included in Item 14(d):\nSchedule II -- Valuation and Qualifying Accounts.\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.\n3. Exhibits\nEXHIBIT NO. - -----------\n3.1 Restated Certificate of Incorporation of the Registrant, effective October 1, 1993 -- incorporated herein by reference to Exhibit 3.2 of the Registrant's Form 10-Q Quarterly Report for the quarter ended September 30, 1993.\n3.2 By-Laws of the Registrant, effective April 15, 1993 -- incorporated herein by reference to Exhibit 3 of the Registrant's Form 10-Q Quarterly Report for the quarter ended June 30, 1994.\n4.1 The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any instrument defining the rights of holders of long-term debt of the Registrant and all of its consolidated subsidiaries and unconsolidated subsidiaries for which financial statements are required to be filed with the Securities and Exchange Commission.\n10.1 Long Term Performance Incentive Plan of the Registrant, as amended November 23, 1988.*\n10.2 The Key Executive Retirement Plan of the Registrant, as amended.*\n10.3 Supplemental Disability Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.3 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.4 Annual Performance Incentive Plan of the Registrant, as amended.*\n10.5 Agreement, dated February 28, 1983, between the Registrant and Roberto C. Goizueta -- incorporated herein by reference to Exhibit 10.5 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\nEXHIBIT NO. - -----------\n10.6 Amendment, dated February 10, 1984, to the Agreement dated February 28, 1983, between the Registrant and Roberto C. Goizueta -- incorporated herein by reference to Exhibit 10.6 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\n10.7 1983 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.8 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.8 1987 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.9 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.9 1991 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.9 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\n10.10 1983 Restricted Stock Award Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.11 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.11 1989 Restricted Stock Award Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.12 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.12 Performance Unit Agreement, dated December 19, 1985, between the Registrant and Roberto C. Goizueta, as amended.*\n10.13 Compensation Deferral & Investment Program, as amended, including Amendment Number Four dated November 28, 1995.*\n10.14 Restricted Stock Agreement, dated August 4, 1982, between the Registrant and Roberto C. Goizueta, as amended.*\n10.15 Incentive Unit Agreement, dated November 29, 1988, between the Registrant and Roberto C. Goizueta, as amended.*\n10.16 Special Medical Insurance Plan of the Registrant, as amended.*\n10.17 Supplemental Benefit Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.17 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.18 Retirement Plan for the Board of Directors of Registrant, as amended -- incorporated herein by reference to Exhibit 10.22 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.19 Deferral Plan for the Board of Directors of Registrant -- incorporated herein by reference to Exhibit 10.23 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1992.*\n10.20 Deferred Compensation Agreement for Officers or Key Executives of the Registrant -- incorporated herein by reference to Exhibit 10.20 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.21 Long Term Performance Incentive Plan of the Registrant, as amended February 16, 1994 -- incorporated herein by reference to Exhibit 10.21 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.22 Executive Performance Incentive Plan, as amended -- incorporated herein by reference to Exhibit 10.22 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\nEXHIBIT NO. - -----------\n10.23 Letter Agreement, dated May 3, 1994, between the Registrant and Sergio S. Zyman -- incorporated herein by reference to Exhibit 10 of the Registrant's Form 10-Q for the quarter ended March 31, 1994.*\n12.1 Computation of Ratios of Earnings to Fixed Charges for the years ended December 31, 1995, 1994, 1993, 1992 and 1991.\n13.1 Portions of the Registrant's 1995 Annual Report to Share Owners expressly incorporated by reference herein: Pages 41-69, 71, 74 (definitions of \"Dividend Payout Ratio,\" \"Economic Profit,\" \"Net Debt and Net Capital,\" \"Return on Capital,\" \"Return on Common Equity\" and \"Total Capital\") and 75.\n21.1 List of subsidiaries of the Registrant as of December 31, 1995.\n23.1 Consent of Independent Auditors.\n24.1 Powers of Attorney of Officers and Directors signing this report.\n27.1 Restated Financial Data Schedule for the year ended December 31, 1994, submitted to the Securities and Exchange Commission in electronic format.\n27.2 Financial Data Schedule for the year ended December 31, 1995, submitted to the Securities and Exchange Commission in electronic format.\n- ------------------- * Management contracts and compensatory plans and arrangements required to be filed as exhibits to this form pursuant to Item 14(c) of this report.\n(b) Reports on Form 8-K. The Registrant did not file any reports on Form 8-K during the last quarter of the period covered by this report.\n(c) Exhibits -- The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedule -- 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.\nTHE COCA-COLA COMPANY (Registrant)\nBy: \/s\/ ROBERTO C. GOIZUETA -------------------------------- Roberto C. Goizueta Chairman, Board of Directors, Chief Executive Officer and a Director\nDate: March 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.\n\/s\/ ROBERTO C. GOIZUETA * - -------------------------------- ----------------------------------- Roberto C. Goizueta Cathleen P. Black Chairman, Board of Directors, Director Chief Executive Officer and a Director March 14, 1996 (Principal Executive Officer)\nMarch 14, 1996\n\/s\/ JAMES E. CHESTNUT * - -------------------------------- ----------------------------------- James E. Chestnut Warren E. Buffett Senior Vice President and Chief Director Financial Officer (Principal Financial Officer) March 14, 1996\nMarch 14, 1996\n\/s\/ GARY P. FAYARD * - -------------------------------- ----------------------------------- Gary P. Fayard Charles W. Duncan, Jr. Vice President and Controller Director (Principal Accounting Officer) March 14, 1996 March 14, 1996\n* * - -------------------------------- ----------------------------------- Herbert A. Allen M. Douglas Ivester Director Director\nMarch 14, 1996 March 14, 1996\n* * - -------------------------------- ----------------------------------- Ronald W. Allen Susan B. King Director Director\nMarch 14, 1996 March 14, 1996\n* * - -------------------------------- ----------------------------------- Donald F. McHenry William B. Turner Director Director\nMarch 14, 1996 March 14, 1996\n* * - -------------------------------- ----------------------------------- Paul F. Oreffice Peter V. Ueberroth Director Director\nMarch 14, 1996 March 14, 1996\n* * - -------------------------------- ----------------------------------- James D. Robinson III James B. Williams Director Director\nMarch 14, 1996 March 14, 1996\n* By: \/s\/ CAROL C. HAYES -------------------------- Carol C. Hayes Attorney-in-fact\nMarch 14, 1996\nANNUAL REPORT ON FORM 10-K\nITEM 14(d)\nFINANCIAL STATEMENT SCHEDULE YEAR ENDED DECEMBER 31, 1995 THE COCA-COLA COMPANY AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nTHE COCA-COLA COMPANY AND SUBSIDIARIES YEAR ENDED DECEMBER 31, 1995 (IN MILLIONS)\n- ------------------------- Note 1 - The amounts shown in Column D consist of the following:\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nTHE COCA-COLA COMPANY AND SUBSIDIARIES YEAR ENDED DECEMBER 31, 1994 (IN MILLIONS)\n- ------------------------- Note 1 - The amounts shown in Column D consist of the following:\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nTHE COCA-COLA COMPANY AND SUBSIDIARIES YEAR ENDED DECEMBER 31, 1993 (IN MILLIONS)\n- ------------------------- Note 1 - The amounts shown in Column D consist of the following:\nEXHIBIT INDEX\nDESCRIPTION\nEXHIBIT NO. - -----------\n3.1 Restated Certificate of Incorporation of the Registrant, effective October 1, 1993 -- incorporated herein by reference to Exhibit 3.2 of the Registrant's Form 10-Q Quarterly Report for the quarter ended September 30, 1993.\n3.2 By-Laws of the Registrant, effective April 15, 1993 -- incorporated herein by reference to Exhibit 3 of the Registrant's Form 10-Q Quarterly Report for the quarter ended June 30, 1994.\n4.1 The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any instrument defining the rights of holders of long-term debt of the Registrant and all of its consolidated subsidiaries and unconsolidated subsidiaries for which financial statements are required to be filed with the Securities and Exchange Commission.\n10.1 Long Term Performance Incentive Plan of the Registrant, as amended November 23, 1988.*\n10.2 The Key Executive Retirement Plan of the Registrant, as amended.*\n10.3 Supplemental Disability Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.3 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.4 Annual Performance Incentive Plan of the Registrant, as amended.*\n10.5 Agreement, dated February 28, 1983, between the Registrant and Roberto C. Goizueta -- incorporated herein by reference to Exhibit 10.5 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\n10.6 Amendment, dated February 10, 1984, to the Agreement dated February 28, 1983, between the Registrant and Roberto C. Goizueta -- incorporated herein by reference to Exhibit 10.6 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\n10.7 1983 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.8 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.8 1987 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.9 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.9 1991 Stock Option Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.9 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\nEXHIBIT NO. - -----------\n10.10 1983 Restricted Stock Award Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.11 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.11 1989 Restricted Stock Award Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.12 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.12 Performance Unit Agreement, dated December 19, 1985, between the Registrant and Roberto C. Goizueta, as amended.*\n10.13 Compensation Deferral & Investment Program, as amended, including Amendment Number Four dated November 28, 1995.*\n10.14 Restricted Stock Agreement, dated August 4, 1982, between the Registrant and Roberto C. Goizueta, as amended.*\n10.15 Incentive Unit Agreement, dated November 29, 1988, between the Registrant and Roberto C. Goizueta, as amended.*\n10.16 Special Medical Insurance Plan of the Registrant, as amended.*\n10.17 Supplemental Benefit Plan of the Registrant, as amended -- incorporated herein by reference to Exhibit 10.17 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.18 Retirement Plan for the Board of Directors of Registrant, as amended -- incorporated herein by reference to Exhibit 10.22 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1991.*\n10.19 Deferral Plan for the Board of Directors of Registrant -- incorporated herein by reference to Exhibit 10.23 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1992.*\n10.20 Deferred Compensation Agreement for Officers or Key Executives of the Registrant -- incorporated herein by reference to Exhibit 10.20 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.21 Long Term Performance Incentive Plan of the Registrant, as amended February 16, 1994 -- incorporated herein by reference to Exhibit 10.21 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1993.*\n10.22 Executive Performance Incentive Plan, as amended -- incorporated herein by reference to Exhibit 10.22 of the Registrant's Form 10-K Annual Report for the year ended December 31, 1994.*\n10.23 Letter Agreement, dated May 3, 1994, between the Registrant and Sergio S. Zyman -- incorporated herein by reference to Exhibit 10 of the Registrant's Form 10-Q for the quarter ended March 31, 1994.*\n12.1 Computation of Ratios of Earnings to Fixed Charges for the years ended December 31, 1995, 1994, 1993, 1992 and 1991.\nEXHIBIT NO. - -----------\n13.1 Portions of the Registrant's 1995 Annual Report to Share Owners expressly incorporated by reference herein: Pages 41-69, 71, 74 (definitions of \"Dividend Payout Ratio,\" \"Economic Profit,\" \"Net Debt and Net Capital,\" \"Return on Capital,\" \"Return on Common Equity\" and \"Total Capital\") and 75.\n21.1 List of subsidiaries of the Registrant as of December 31, 1995.\n23.1 Consent of Independent Auditors.\n24.1 Powers of Attorney of Officers and Directors signing this report.\n27.1 Restated Financial Data Schedule for the year ended December 31, 1994, submitted to the Securities and Exchange Commission in electronic format.\n27.2 Financial Data Schedule for the year ended December 31, 1995, submitted to the Securities and Exchange Commission in electronic format.\n- ------------------- * Management contracts and compensatory plans and arrangements required to be filed as exhibits to this form pursuant to Item 14(c) of this report.","section_15":""}
{"filename":"823549_1995.txt","cik":"823549","year":"1995","section_1":"ITEM 1. BUSINESS.\nTenneco Inc., a Delaware corporation, is a diversified industrial company conducting all of its operations through its subsidiaries. As used herein, \"Tenneco\" refers to Tenneco Inc. and its consolidated subsidiaries.\nThe major businesses of Tenneco are the manufacture and sale of automotive exhaust system parts and ride control products; natural gas transportation and marketing; manufacture and sale of packaging materials, cartons, containers and specialty packaging products for consumer and commercial markets; and construction and repair of ships. At December 31, 1995, Tenneco also owned approximately 21% of Case Corporation, a manufacturer of farm and construction equipment.\nIn March 1995, Tenneco Inc. sold, in a public flotation primarily in the United Kingdom, all of the capital stock of Albright & Wilson plc, which is engaged in the chemical business. See Note 3 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries for additional information concerning the sale of this subsidiary.\nAt December 31, 1995, Tenneco had approximately 60,000 employees.\nCONTRIBUTIONS OF MAJOR BUSINESSES\nInformation concerning Tenneco's principal industry segments and geographic areas is set forth in Note 14 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries. The following tables summarize (i) net sales and operating revenues from continuing operations, (ii) income from continuing operations before interest expense, income taxes and minority interest and (iii) capital expenditures for continuing operations of the major business groups of Tenneco for the periods indicated.\nNET SALES AND OPERATING REVENUES FROM CONTINUING OPERATIONS\nINCOME FROM CONTINUING OPERATIONS BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST\nCAPITAL EXPENDITURES FOR CONTINUING OPERATIONS\n- -------- * In December 1994, Tenneco changed to the equity method of accounting for its farm and construction equipment segment due to a reduction in its ownership percentage in Case Corporation to below 50%. For additional information, see Notes 1 and 3 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries.\nThe interest expense, income taxes and minority interest from continuing operations that are not allocated to the major businesses were as follows:\nTENNECO AUTOMOTIVE\nThe principal business operations of Tenneco Automotive and its affiliates are Walker Manufacturing Company and Monroe Auto Equipment Company.\nWalker Manufacturing Company and its affiliates (\"Walker\") manufacture a variety of automotive exhaust systems and emission control products. In the United States, Walker operates nine manufacturing facilities and seven distribution centers, three of which are located at manufacturing facilities, and also has two research and development facilities. In addition, Walker operates 25 manufacturing facilities located in Australia, Canada, the United Kingdom, Mexico, Denmark, Germany, France, Spain, Portugal and Sweden, and also has one engineering and technical center in Germany.\nWalker's products are sold to automotive manufacturers for use as original equipment and to wholesalers and retailers for sale as replacement equipment. Sales to the original equipment market are directly dependent on new car sales, and sales to the replacement market are related to the service life of original equipment and to the level of maintenance by individual owners of their automobiles. The service life of exhaust systems has increased in recent years, resulting in a longer time period for the exhaust replacement rate.\nThe following table sets forth information relating to Walker's sales:\nIn November 1994, Walker acquired ownership of Heinrich Gillet GmbH & Co. KG and its affiliates (\"Gillet\"), a manufacturer of exhaust systems headquartered at Edenkoben, Germany. The combination of Gillet, Europe's largest original equipment exhaust supplier, and Walker's European division, which is Europe's largest replacement market supplier, increased Walker's European sales in 1995 by approximately 150%.\nMonroe Auto Equipment Company and its affiliates (\"Monroe\") are engaged principally in the design, manufacture and distribution of ride control products. Monroe ride control products consist of hydraulic shock absorbers, air adjustable shock absorbers, spring assisted shock absorbers, gas charged shock absorbers, struts, replacement cartridges and electronically adjustable suspension systems. Monroe manufactures and markets replacement shock absorbers for virtually all domestic and most foreign makes of automobiles. In addition, Monroe manufactures and markets shock absorbers and struts for use as original equipment on passenger cars and trucks, as well as for other uses. Monroe has seven manufacturing facilities in the United States and ten foreign manufacturing operations in Australia, Belgium, Brazil, Canada, Mexico, the United Kingdom, Spain and New Zealand.\nThe following table sets forth information relating to Monroe's sales:\nIn 1995, Tenneco Automotive acquired a 51% interest in a joint venture that has two ride control manufacturing facilities in India and a 51% interest in a joint venture that has one ride control manufacturing facility in China. It is anticipated that the joint venture in India will also manufacture exhaust systems.\nTenneco Automotive owns and licenses the rights under a number of domestic and foreign patents and trademarks relating to its products and businesses. It manufactures and distributes its products primarily under the names \"Walker\" and \"Monroe,\" which are well recognized in the marketplace.\nTenneco Automotive is actively pursuing opportunities to expand its business by entering additional geographic areas, including countries in Eastern Europe, Asia and South America. It is anticipated that this expansion will occur through a variety of means, including joint ventures and acquisitions.\nThe operations of Tenneco Automotive face intense competition from other manufacturers of automotive equipment.\nTENNECO ENERGY\nTenneco is engaged in the interstate and intrastate transportation and marketing of natural gas, with operations conducted by Tenneco Energy Inc. and other related subsidiaries of Tenneco Inc. (collectively, \"Tenneco Energy\"). Tenneco Energy is also engaged in related businesses that are not generally subject to regulation by the Federal Energy Regulatory Commission (\"FERC\") which Tenneco Energy believes have the potential to generate higher returns than its regulated businesses. The principal activities of these business units include the development of and participation in international natural gas pipelines, primarily in Australia, and in international and domestic gas-fired power generation projects, and the development of natural gas production and production financing programs for producers, primarily in the United States.\nINTERSTATE PIPELINE OPERATIONS\nTenneco Energy's interstate pipeline operations include the pipeline systems of Tennessee Gas Pipeline Company (\"Tennessee\"), Midwestern Gas Transmission Company (\"Midwestern\") and East Tennessee Natural Gas Company (\"East Tennessee\"), which are primarily engaged in the transportation and storage of natural gas for producers, marketers, end-users, and other gas transmission and distribution companies.\nTennessee's multiple-line system begins in gas-producing regions of Texas and Louisiana, including the continental shelf of the Gulf of Mexico, and extends into the northeastern section of the United States, including the New York City and Boston metropolitan areas. Midwestern's pipeline system extends from Portland, Tennessee, to Chicago, and principally serves the Chicago metropolitan area. East Tennessee's pipeline system serves the states of Tennessee, Virginia and Georgia.\nAt December 31, 1995, Tenneco Energy's interstate gas transmission systems included approximately 16,300 miles of pipeline, gathering lines and sales laterals, together with related facilities that include 90 compressor stations with an aggregate of approximately 1.5 million horsepower. These systems also include underground and above-ground gas storage facilities to permit increased deliveries of gas during peak demand periods. The total design delivery capacity of Tenneco Energy's interstate systems at December 31, 1995, was approximately 4,800 million cubic feet (\"MMCF\") of gas per day, and approximately 5,600 MMCF on peak demand days, which includes gas withdrawn from storage.\nTenneco Energy also has a 13.2% interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"). The 370-mile Iroquois pipeline extends from the Canadian border at Waddington, New York, to Long Island, New York, and is designed to deliver (directly or through interconnecting pipelines such as Tennessee) 818 MMCF of gas per day to local distribution companies and electric generation facilities in six states. For more information on Iroquois, see Item 3, \"Legal Proceedings.\"\nIn December 1995, Tenneco Energy sold its 50% interest in Kern River Gas Transmission Company (\"Kern River\"). This sale was a part of Tenneco's ongoing plan to redeploy assets into its primary growth\nbusinesses, which include the nonregulated natural gas operations. Kern River owns a 904-mile pipeline system extending from Wyoming to California.\nGas Sales and Transportation Volumes\nThe following table sets forth the volumes of gas, stated in billions of British thermal units (\"BBtu\"), sold and transported by Tenneco Energy's interstate pipeline systems for the periods shown.\n- -------- * These sales and transportation volumes include all natural gas sold or transported by Tenneco Energy's interstate pipeline companies. The table includes Tenneco Energy's proportionate share of transportation volumes of the joint ventures in which it had interests during 1995; of the total transportation volumes shown, 183,281 BBtu was attributable to these joint venture interests in 1995, 167,961 BBtu in 1994 and 169,871 BBtu in 1993. Intercompany deliveries of natural gas have not been eliminated from the table.\nFederal Regulation\nTenneco Energy's interstate natural gas pipeline companies are \"natural gas companies\" as defined in the Natural Gas Act of 1938, as amended (the \"Natural Gas Act\"). As such, these companies are subject to the jurisdiction of the FERC. Tenneco Energy's interstate pipeline operations are operated pursuant to certificates of public convenience and necessity issued under the Natural Gas Act and pursuant to the Natural Gas Policy Act of 1978. The FERC regulates the interstate transportation and certain sales of natural gas, including, among other things, rates and charges allowed natural gas companies, extensions and abandonments of facilities and service, rates of depreciation and amortization and the accounting system utilized by the companies.\nPrior to the FERC's industry restructuring initiatives in the 1980's, Tenneco Energy's interstate pipeline companies operated primarily as merchants, purchasing natural gas under long-term contracts and reselling the gas to customers, also under long-term contracts. Pursuant to Order 636 issued by the FERC, Tennessee implemented revisions to its tariff, effective on September 1, 1993, which restructured its transportation, storage and sales services to convert Tennessee from primarily a merchant to primarily a transporter of gas. As a result of this restructuring, Tennessee's gas sales declined while certain obligations to producers under long-term gas supply contracts continued, causing Tennessee to incur significant restructuring transition costs. Pursuant to the provisions of Order 636 allowing for the recovery of transition costs related to the restructuring, Tennessee has made filings to recover gas supply realignment (\"GSR\") costs resulting from remaining gas purchase obligations, costs related to its Bastian Bay facilities, the remaining unrecovered balance of purchased gas (\"PGA\") costs and the \"stranded\" cost of Tennessee's continuing contractual obligation to pay for capacity on other pipeline systems (\"TBO costs\").\nTennessee's filings to recover costs related to its Bastian Bay facilities have been rejected by the FERC based on the continued use of the gas production from the field; however, the FERC recognized the ability of Tennessee to file for the recovery of losses upon disposition of these assets. Tennessee has filed for appellate review of the FERC actions and is confident that the Bastian Bay costs will ultimately be recovered as transition costs under Order 636; the FERC has not contested the ultimate recoverability of these costs.\nThe filings implementing Tennessee's recovery mechanisms for the following transition costs were accepted by the FERC effective September 1, 1993; recovery is subject to refund pending FERC review and approval for eligibility: 1) direct-billing of unrecovered PGA costs to its former sales customers over a twelve-month period; 2) recovery of TBO costs, which Tennessee is obligated to pay under existing contracts,\nthrough a surcharge from firm transportation customers, adjusted annually; and 3) GSR cost recovery of 90% of such costs over a period of up to 36 months from firm transportation customers and recovery of 10% of such costs from interruptible transportation customers over a period of up to 60 months.\nFollowing negotiations with its customers, Tennessee filed in July 1994 with the FERC a Stipulation and Agreement (the \"PGA Stipulation\"), which provides for the recovery of PGA costs of approximately $100 million and the recovery of costs associated with the transfer of storage gas inventory to new storage customers in Tennessee's restructuring proceeding. The PGA Stipulation eliminates all challenges to the PGA costs, but establishes a cap on the charges that may be imposed upon former sales customers. On November 15, 1994, the FERC issued an order approving the PGA Stipulation and resolving all outstanding issues. On April 5, 1995, the FERC issued its order on rehearing affirming its initial approval of the PGA Stipulation. Tennessee implemented the terms of the PGA Stipulation and made refunds in May 1995. The refunds had no material effect on Tenneco's reported net income. The orders approving the PGA Stipulation have been appealed to the D.C. Circuit Court of Appeals by certain customers. Tennessee believes the FERC orders approving the PGA Stipulation will be upheld on appeal.\nTennessee is recovering through a surcharge, subject to refund, TBO costs formerly incurred to perform its sales function, pending FERC review of data submitted by Tennessee. The FERC subsequently issued an order requiring Tennessee to refund certain costs from this surcharge. Tennessee is appealing this decision and believes such appeal will likely be successful.\nWith regard to Tennessee's GSR costs, Tennessee, along with three other pipelines, executed four separate settlement agreements with Dakota Gasification Company and the U.S. Department of Energy and initiated four separate proceedings at the FERC seeking approval to implement the settlement agreements. The settlement resolved litigation concerning purchases made by Tennessee of synthetic gas produced from the Great Plains Coal Gasification plant (\"Great Plains\"). The FERC previously ruled that the costs related to the Great Plains project are eligible for recovery through GSR and other special recovery mechanisms and that the costs are eligible for recovery for the duration of the term of the original gas purchase agreements. On October 18, 1994, the FERC consolidated the four proceedings and set them for hearing before an administrative law judge (\"ALJ\"). The hearing, which concluded in July 1995, was limited to the issue of whether the settlement agreements are prudent. The ALJ concluded, in his initial decision issued in December 1995, that the settlement was imprudent. Tennessee has filed exceptions to this initial decision and believes that this decision will not impair Tennessee's recovery of the costs resulting from this contract. The FERC has committed to issuing a final order by December 31, 1996.\nAlso related to Tennessee's GSR costs, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. An amendment to the pleading seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee filed a motion for summary judgment, asserting that the Texas statutes of frauds precluded the plaintiffs from adding new production or acreage to the contract. On May 4, 1995, the trial court granted Tennessee's motion for summary judgment; the plaintiffs have filed a notice of appeal. Thereafter, ICA and TransTexas filed a motion for summary judgment on a separate issue involving the term \"committed reserves\" and whether Tennessee has a contractual obligation to purchase gas produced from a lease not described in the gas contract. On November 8, 1995, the trial court granted ICA's and TransTexas' motion in part. That order, which would be finalized upon conclusion of the trial, also held that ICA's and TransTexas' rights are subject to certain limitations of the Texas Business and Commerce Code. In addition to these defenses, which are to be resolved at trial, Tennessee has other defenses which it has asserted and intends to pursue. Tennessee has\nfiled a Motion to Clarify the November 8, 1995 order together with a new motion for partial summary judgment concerning the committed reserve issue. The November 8, 1995 ruling does not affect the trial court's previous May 4, 1995 order granting summary judgment to Tennessee.\nTennessee has been engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee. Although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious, Tennessee accrued amounts in the first quarter of 1995 which it believes are adequate to cover the resolution of these matters. On August 1, 1995, the Texas Supreme Court affirmed a ruling of the Court of Appeals favorable to Tennessee in one of these matters and indicated that it would remand the case to the trial court. Motions for rehearing have been filed by the producers. As of the date hereof, the court had not ruled on those motions and mandate had not been issued.\nAs of December 31, 1995, Tennessee has deferred GSR costs yet to be recovered from its customers of approximately $462 million, net of $316 million previously recovered from its customers, subject to refund. A proceeding before a FERC ALJ is scheduled to commence in early 1996 to determine whether Tennessee's GSR costs are eligible for cost recovery. The FERC has generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 provides for complete recovery by pipelines of eligible and prudently incurred transition costs, certain customers have challenged the prudence and eligibility of Tennessee's GSR costs and Tennessee has engaged in settlement discussions with its customers concerning the amount of such costs in response to the FERC and customer statements acknowledging the desirability of such settlements.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact that the resolution of these issues will have on its consolidated financial position or results of operations.\nOn December 30, 1994, Tennessee filed for a general rate increase (the \"1995 Rate Case\"). On January 25, 1995, the FERC accepted the filing, suspended its effectiveness for the maximum period of five months pursuant to normal regulatory process, and set the matter for hearing. On July 1, 1995, Tennessee began collecting rates, subject to refund, reflecting an $87 million increase in Tennessee's annual revenue requirement. Settlement discussions with the FERC staff and customers regarding 1995 Rate Case issues, including structural rate design and increased revenue requirements, are ongoing and Tennessee is reserving revenues it believes adequate to cover any refunds that may be required upon final settlement of this proceeding. A hearing is scheduled to commence in March 1996.\nCompetition\nThe regulated natural gas pipeline industry is experiencing increasing competition, which results from actions taken by the FERC to strengthen market forces throughout the industry. In a number of key markets, Tenneco Energy's interstate pipelines face competitive pressure from other major pipeline systems, enabling local distribution companies and end users to choose a supplier or switch suppliers based on the short term price of gas and the cost of transportation. Competition between pipelines is particularly intense in Midwestern's Chicago and Northern Indiana markets, in East Tennessee's Roanoke, Chattanooga and Atlanta markets, and in Tennessee's supply area, Louisiana and Texas. In some instances, Tenneco Energy's pipelines have been required to discount their transportation rates in order to maintain their market share. Additionally, transportation contracts representing approximately 70% of firm transportation capacity will be expiring over the next five years, principally in the year 2000. The renegotiation of these contracts may be impacted by these competitive factors.\nGas Supply\nWith full implementation of Order 636, Tennessee's firm sales obligations requiring maintenance of long-term gas purchase contracts have declined from over a 1.4 billion dekatherm maximum daily delivery\nobligation to less than a 200 million dekatherm maximum daily delivery obligation. As discussed above under the caption \"Federal Regulation,\" Tennessee has substantially reduced its natural gas purchase portfolio in line with these requirements through termination and assignment to third parties. Although Tennessee's requirements for purchased gas are substantially less than prior to its implementation of Order 636, Tenneco Energy is pursuing the attachment of gas supplies to Tennessee's pipeline system for transportation by others. Current gas supply activities include development of offshore and onshore pipeline gathering projects and utilization of production financing programs to spur exploration and development drilling in areas adjacent to Tennessee's system. Major gathering systems in the Gulf of Mexico were completed during the fourth quarter of 1994.\nGAS MARKETING AND INTRASTATE PIPELINES\nTenneco Energy Resources Corporation, an 80% owned subsidiary of Tenneco, and its subsidiaries (collectively, \"Tenneco Resources\") are engaged in the businesses of marketing natural gas and owning and operating approximately 1,300 miles of pipelines that serve the Texas Gulf Coast and West Texas markets. Its businesses include the buying, selling, storage and transportation of natural gas and price risk management services, including the offering of fixed, floating and other natural gas pricing for short or long terms using natural gas futures contracts or other financial instruments. These businesses serve third parties, including producers, marketers, end-users, distribution companies and gas transmission companies. During 1995 Tenneco Resources transported, processed or sold approximately 2.3 billion cubic feet of natural gas for its customers. Tenneco Resources also owns and manages gas gathering systems and natural gas liquids plants in Pennsylvania, Texas, Louisiana and the outer continental shelf of the Gulf of Mexico.\nThe following table sets forth the volumes of gas, stated in BBtu, sold and transported by subsidiaries of Tenneco Resources for the periods indicated:\nIn February 1994, a 20% interest in Tenneco Resources was sold to Ruhrgas AG, Germany's largest natural gas company.\nINTERNATIONAL\nTenneco Gas International Inc. and other subsidiaries of Tenneco (collectively, \"TGI\") was organized to extend Tennessee's traditional activities in North American pipelines to international pipeline, power, and energy-related projects, with a current focus on activities in South America, Southeast Asia, Australia and Europe. TGI was selected to construct, own and operate a 470 mile natural gas pipeline in Queensland, Australia; construction of the pipeline commenced in late 1995 with completion expected in early 1997. In June 1995, Tenneco acquired the natural gas pipeline assets of the Pipeline Authority of South Australia, which includes a 488 mile pipeline, for approximately $225 million. The purchase resulted from the privatization of Australia's natural gas industry. TGI also has interests in two consortiums pursuing the development of two natural gas pipeline projects in South America, from Argentina to Chile and from Bolivia to Brazil, including related gas-fired electric generation plants.\nIn December 1995, TGI was selected by the Beijing Natural Gas Transportation Company (\"BGTC\") to serve as technical advisor for the construction of China's first major onshore natural gas pipeline. BGTC, a joint venture between the Chinese National Petroleum Corporation and the city of Beijing, will build a 600 mile line linking the Jingbian gas field in central China's Ordos Basin with Beijing. Construction is scheduled to commence in March 1996, with an in- service date scheduled for October 1997.\nPOWER GENERATION\nTenneco Power Generation Company (\"Tenneco Power\") has a 17.5% interest in a 240 megawatt power plant in Springfield, Massachusetts and a 50% interest in two additional cogeneration projects in Florida which have a combined capacity of 200 megawatts.\nIn December 1995, Tenneco Power entered into an agreement with Energy Equity Corp., Ltd., an Australian company, to purchase 50% of two of its subsidiaries subject to satisfaction of certain conditions. The new joint venture will construct a 135 megawatt gas fired power plant.\nTENNECO VENTURES\nTenneco Gas Production Corporation (\"Tenneco Production\") and Tenneco Ventures Corporation (\"Tenneco Ventures\"), subsidiaries of Tenneco, together with institutional investors and partners, invest in oil and gas properties and finance independent producers engaged in exploration and development projects. Tenneco Ventures and Tenneco Production hold various ownership interests in oil and gas fields located primarily in the Gulf of Mexico, Texas and Louisiana. The reserves in those fields are estimated to be in excess of approximately 150 billion cubic feet of natural gas. Tenneco Ventures is also involved in TGI's international projects through exploration and development of gas reserves in Indonesia, Poland and Bolivia.\nTENNECO PACKAGING\nTenneco Packaging Inc. and other related Tenneco subsidiaries (collectively, \"Tenneco Packaging\") manufacture and sell containerboard, paperboard, corrugated shipping containers, folding cartons, plastic food storage and trash bags, stretch film, disposable plastic and aluminum containers, molded fiber products and other related products. Its shipping container products are used in the packaging of food, paper products, metal products, rubber and plastics, automotive products and point of purchase displays. Its folding cartons are used in the packaging of soap and detergent, food products and a wide range of other consumer goods. Uses for its molded fiber products include produce and egg packaging, food service items and institutional and consumer disposable dinnerware, as well as a wide range of other consumer and industrial goods. Its disposable plastic and aluminum containers are sold to the food service, food processing and related industries. Plastic food storage and trash bags, foam dinnerware and related products are sold through a variety of retail outlets. In addition to products bearing the name \"Tenneco Packaging\", Tenneco Packaging manufactures and distributes products under the names \"EZ FOIL(R),\" \"Revere Foil Containers,\" \"Dahlonega Packaging,\" \"Agri-Pak,\" \"PRESSWARE(R) International,\" \"HEFTY(R),\" \"HEFTY ONE ZIP(R),\" \"BAGGIES(R)\" and \"KORDITE(R)\".\nThe following table sets forth information with respect to Tenneco Packaging's sales during the past three years:\nAt December 31, 1995, Tenneco Packaging operated 69 container plants, seven folding carton plants and 12 corrugated containerboard and paperboard machines at six mills. Two of the mills (located in Georgia and Wisconsin), including substantially all of the equipment associated with both mills, are leased from third parties. Tenneco Packaging also has eight molded fiber products plants, one pressed paperboard plant, three lumber plants, one pole mill, three paper stock plants, and 25 disposable plastic and aluminum container plants. Tenneco Packaging's plants are located primarily in the United States. Its foreign plants are located in Great Britain, Spain, Canada, Switzerland and Germany. In the United States, Tenneco Packaging has a 50% ownership interest in a molded fiber distribution company and in a hardwood chip mill. In addition, Tenneco Packaging has a 50% interest in a folding carton plant in Dongguan, China, and a 50% interest in a folding carton plant in Bucharest, Romania.\nIn November 1995, Tenneco Packaging acquired the assets of Mobil Corporation's plastics division for $1.3 billion. The business manufactures HEFTY(R) trash bags and BAGGIES(R) food storage bags for the consumer market. It also manufactures polystyrene foam foodservice containers, plates and meat trays; clear take-out containers from thermoformed polystyrene packaging; and polyethylene film products including liners, produce and retail bags, and medical and industrial disposable packaging. The division employs 4,100 people at 11 manufacturing plants and 16 distribution centers in the United States and Canada.\nAdditionally, during 1995 Tenneco Packaging made eight other domestic acquisitions in the paperboard packaging segment in the United States and two plastics acquisitions in the United Kingdom. The total purchase price for these acquisitions was $196 million.\nTenneco Packaging owns and licenses the rights under a number of domestic and foreign patents and trademarks relating to its products and businesses. The patents, trademarks and other intellectual property owned by Tenneco Packaging are important in the manufacturing and distribution of its products.\nGenerally, Tenneco Packaging faces intense competition from numerous competitors and alternative products in each of its geographic and product markets.\nThe principal raw materials used by Tenneco Packaging in its mill operations are virgin pulp and reclaimed paper stock and, in its specialty products operations, aluminum and plastics. Tenneco Packaging obtains virgin pulp and reclaimed paper stock from independent logging contractors, from timberlands owned or controlled by it, from operation of its reclaimed paper stock collecting and processing plants and from other sources. Tenneco Packaging obtains aluminum rolling stock and plastic feed stock from various suppliers.\nAt December 31, 1995, Tenneco Packaging owned 187,000 acres of timberland in Alabama, Michigan, Mississippi and Tennessee and leased, managed or had cutting rights on an additional 808,000 acres of timberland in those states (excluding Michigan) and in Florida, Wisconsin and Georgia. During the years 1995, 1994 and 1993 approximately 31%, 20% and 22%, respectively, of the virgin fiber and timber used by Tenneco Packaging in its operations was obtained from timberlands controlled by it.\nNEWPORT NEWS SHIPBUILDING\nNewport News Shipbuilding and Dry Dock Company (\"Newport News\"), a Tenneco subsidiary located in Newport News, Virginia, is the largest privately owned shipbuilding company in the United States. Its primary business is constructing and overhauling nuclear-powered aircraft carriers for the United States Navy. Newport News also overhauls and repairs U.S. Navy and commercial vessels and refuels nuclear-powered ships. Newport News returned to the commercial shipbuilding market with the October 1994 award of product tanker contracts from a foreign owner for two ships. Options for two additional ships were exercised in June 1995. Additionally, Newport News was awarded a contract to construct five additional \"Double Eagle\" tankers which will be used in U.S. domestic trade. In February 1996, the owners secured financing guarantees from the Maritime Administration. Newport News is also pursuing international sales of its fast frigate design and is currently being considered under congressional budgets for additional submarine work. Newport News' shipbuilding facilities are located on the James River on approximately 475 acres of property which it owns.\nAt December 31, 1995, the aggregate amount of Newport News' backlog of work was approximately $4.6 billion (substantially all of which is U.S. Navy- related), a decrease from the previous backlog of $5.6 billion as of December 31, 1994. Although cuts in naval shipbuilding have continued to put pressure on the Newport News backlog, Newport News was successful in adding $1 billion in new work during 1995. Major additions to the backlog included the overhaul contract for the nuclear-powered aircraft carrier USS Eisenhower, two Double Eagle product tankers and engineering design work for aircraft carriers and submarines. At December 31, 1995, Newport News anticipated that it would complete approximately $1.5 billion of the current backlog by December 31, 1996, and an additional $1.0 billion in 1997. The December 31, 1995, backlog of Newport News included contracts for the construction of two Nimitz-class aircraft carriers, scheduled for delivery in 1998 and 2002, and two Los Angeles-class attack submarines to be delivered in 1996. The backlog also included contracts for the construction of the four product tankers, the conversion of two Sealift ships, and the Eisenhower overhaul. The present backlog extends into 2002. For information concerning the impact of the conversion work on Newport News' margins, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nNewport News has various other contracts for U.S. Navy design work and for industrial products. As is typical for similar Government contracts, all of Newport News' contracts with the U.S. Navy are unilaterally terminable by the U.S. Navy at its convenience with compensation for work completed and costs incurred.\nTo increase its competitiveness worldwide and in response to the anticipated decline in U.S. Navy budgets, Newport News has reduced its workforce by approximately 11,000 or 37% between December 31, 1990 and December 31, 1995.\nNewport News is aggressively pursuing new business opportunities and attempting to expand its business base in light of the declining U.S. Navy backlog; however, Newport News faces intense worldwide competition in its efforts to enter new markets. During 1995, Newport News entered into contracts to construct two additional product tankers. In addition it has a 40% interest in a venture that will design, construct, own and operate a shipyard in Abu Dhabi, United Arab Emirates. Construction of the shipyard is expected to be completed in 1998. While the percentage of Newport News' total business for commercial work is expected to increase, the U.S. Navy will continue to be its primary customer. Newport News is pursuing new submarine design and construction work, major U.S. Navy overhaul and repair work, new commercial construction contracts, and foreign military sales. For additional information, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nOTHER\nTenneco Credit Corporation purchases interest-bearing and noninterest-bearing trade receivables from Tenneco's operating subsidiaries. Through June 1994, it also purchased retail receivables generated primarily by retail sales of products by Case Corporation (\"Case\"). At December 31, 1995, approximately $509 million of those Case retail receivables remained outstanding and are expected to be substantially liquidated by 1999. Case services the retail receivables purchased by Tenneco Credit Corporation, for which Case receives a monthly servicing fee based on the amount of receivables outstanding at the beginning of each month. Funding for Tenneco Credit Corporation is provided through the private and public debt markets.\nBUSINESS STRATEGY\nSince September 1991, Tenneco Inc. has focused on various initiatives and taken steps designed to strengthen its financial results and improve its financial flexibility and create greater returns to its stockholders. Asset evaluation and redeployment have been and will continue to be important parts of this strategy. Tenneco Inc. continues to study opportunities for the strategic repositioning and restructuring of its operations (including through acquisitions, dispositions, divestitures, spin-offs and joint venture participation, wholly and partially, of various businesses). Tenneco Inc. has expressed an intention to act on a broad range of options--spin-offs, sales, public offerings, mergers, joint ventures and acquisitions--until it is satisfied that its strategic mix and corporate structure maximize stockholder value. These actions may include one, two or all of its businesses.\nENVIRONMENTAL MATTERS\nTenneco Inc. estimates that its subsidiaries will make capital expenditures for environmental matters of approximately $60 million in 1996 and that capital expenditures for environmental matters will range from approximately $161 million to $201 million in the aggregate for the years 1997 through 2007.\nFor information regarding environmental matters see Item 3, \"Legal Proceedings--Environmental Proceedings\" and \"--Potential Superfund Liability,\" Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Environmental Matters,\" and Note 15, \"Commitments and Contingencies\" in the \"Notes to Financial Statements.\" See also Note 1, \"Summary of Accounting Policies--Environmental Liabilities,\" in the \"Notes to Financial Statements.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nReference is made to Item 1 for a description of Tenneco's properties.\nTenneco believes that substantially all of its plants and equipment are, in general, well maintained and in good operating condition. They are considered adequate for present needs and as supplemented by planned construction are expected to remain adequate for the near future.\nTenneco Inc. is of the opinion that its subsidiaries have generally satisfactory title to the properties owned and used in their respective businesses, subject to liens for current taxes and easements, restrictions and other liens which do not materially detract from the value of such property or the interests therein or the use of such properties in their businesses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\n(1) Environmental Proceedings.\nTennessee is a party in proceedings involving federal and state authorities regarding the past use by Tennessee of a lubricant containing polychlorinated biphenyls (\"PCBs\") in its starting air systems. Tennessee has executed a consent order with the EPA governing the remediation of certain of its compressor stations and is working with the Pennsylvania and New York environmental agencies to specify the remediation requirements at the Pennsylvania and the New York stations. Tenneco believes that the ultimate resolution of this matter will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nIn Commonwealth of Kentucky, Natural Resources and Environmental Protection Cabinet v. Tennessee Gas Pipeline Company (Franklin County Circuit Court, Docket No. 88-C1-1531, November 16, 1988), the Kentucky environmental agency alleges that Tennessee discharged pollutants into the waters of the state without a permit and seeks an injunction against future discharges and a civil penalty. Counsel for Tenneco are unable to express an opinion as to its ultimate outcome. Tenneco believes that the resolution of this issue will not have a material adverse effect on its consolidated financial position or results of operations.\nA subsidiary of Tennessee owns a 13.2% general partnership interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"), which owns an interstate natural gas pipeline from the Canadian border through the states of New York and Connecticut to Long Island. The operator of the pipeline is Iroquois Pipeline Operating Company (the \"Operator\"), a subsidiary of TransCanada Pipelines, Ltd., an affiliate of TransCanada Iroquois, Ltd., which is also a partner in Iroquois. Tennessee has a contract to provide gas dispatching as well as post-construction field operation and maintenance services for the Operator of Iroquois, but Tennessee is not the Operator and is not an affiliate of the Operator.\nIroquois has been informed of investigations and allegations regarding alleged environmental violations which occurred during the construction of the pipeline. Communications have been received from U.S. Attorneys' Offices, the Enforcement Staff of the FERC's Office of the General Counsel, the Army Corps of Engineers, the Public Service Commission of the State of New York, the EPA and the Federal Bureau of Investigation. Proceedings have not been commenced against Iroquois in connection with these inquiries. However, communications have indicated possible allegation of civil and criminal violations. Iroquois has held discussions with certain of the agencies to explore the possibility of a negotiated resolution of the issues. In the absence of a negotiated resolution, Iroquois believes that indictments will be sought and, in them, substantial fines and other sanctions may be requested.\nAs a general partner, Tennessee's subsidiary may be jointly and severally liable with the other partners for the liabilities of Iroquois. The foregoing proceedings and investigations have not affected pipeline operations. Based upon information available to Tennessee, Tennessee believes that neither it nor any of its subsidiaries is a target of the criminal investigation described above. Further, while a global resolution of these inquiries could have a material adverse effect on the financial condition of Iroquois, Tenneco believes that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nOn August 2, 1993, the Department of Justice filed suit against Tenneco Packaging Inc. (\"Tenneco Packaging\") in the Federal District Court for the Northern District of Indiana, alleging that wastewater from Tenneco Packaging's molded fiber products plant in Griffith, Indiana, interfered with or damaged the Town of Griffith's municipal sewage pumping station on two occasions in 1991 and 1993, resulting in discharges by the Town of Griffith of untreated wastewater into a river. Tenneco Packaging and the Department of Justice have agreed in principle to settle the suit. A consent decree is being negotiated by Tenneco Packaging and the Department of Justice. Tenneco believes that the resolution of this matter will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\n(2) Potential Superfund Liability.\nAt December 31, 1995, Tenneco has been designated as a potentially responsible party in 55 \"Superfund\" sites. With respect to its pro rata share of the remediation costs of certain sites, Tenneco is fully indemnified by third parties. With respect to certain other sites, Tenneco has sought to resolve its liability through payments to the other potentially responsible parties. For the remaining sites, Tenneco has estimated its share of the remediation costs to be between $11 million and $69 million or 0.5% to 2.5% of the total remediation costs for those sites and has provided reserves that it believes are adequate for such costs. Because the clean-up costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, Tenneco's estimate of its share of remediation costs could change. Moreover, liability under the Comprehensive Environmental Response, Compensation and Liability Act is joint and several, meaning that Tenneco could be required to pay in excess of its pro rata share of remediation costs. Tenneco's understanding of the financial strength of other potentially responsible parties has been considered, where appropriate, in Tenneco's determination of its estimated liability. Tenneco believes that the costs associated with its current status as a potentially responsible party in the Superfund sites described above will not be material to its consolidated financial position or results of operations.\nFor additional information concerning environmental matters, see the caption \"Environmental Matters\" under Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" and the caption \"Environmental Matters\" under Note 15, in the \"Notes to Financial Statements.\"\n(3) Other Proceedings.\nOn October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. An amendment to the pleading seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee filed a motion for summary judgment, asserting that the Texas statutes of frauds precluded the plaintiffs from adding new production or acreage to the contract. On May 4, 1995, the trial court granted Tennessee's motion for summary judgment; the plaintiffs have filed a notice of appeal. Thereafter, ICA and TransTexas filed a motion for summary judgment on a separate issue involving the term \"committed reserves\" and whether Tennessee has a contractual obligation to purchase gas produced from a lease not described in the gas contract. On November 8, 1995, the trial court granted ICA's and TransTexas' motion in part. That order, which would be finalized upon conclusion of the trial, also held that ICA's and TransTexas' rights are subject to certain limitations of the Texas Business and Commerce Code. In addition to these defenses, which are to be resolved at trial, Tennessee has other defenses which it has asserted and intends to pursue. Tennessee has filed a Motion to Clarify the November 8, 1995 order together with a new motion for partial summary judgment concerning the committed reserve issue. The November 8, 1995 ruling does not affect the trial court's previous May 4, 1995 order granting summary judgment to Tennessee.\nTenneco Inc. and its subsidiaries are parties to numerous other legal proceedings arising from their operations. Tenneco Inc. believes that the outcome of these other proceedings, individually and in the aggregate, will have no material effect on Tenneco's consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders of Tenneco Inc. during the fourth quarter of the fiscal year ended December 31, 1995.\nITEM 4.1 EXECUTIVE OFFICERS OF THE REGISTRANT.\nSet forth below is a list of the executive officers of Tenneco Inc. at February 1, 1996. Each of such officers has served in the capacities indicated below with Tenneco Inc. (or prior to a corporate reorganization in 1987 with the then publicly held affiliate of Tenneco Inc. which bore the same name) since the dates indicated below:\n- -------- * Unless otherwise indicated, all offices held are with Tenneco Inc.\nEach of the executive officers of Tenneco Inc. has been continuously engaged in the business of Tenneco Inc., its subsidiaries, affiliates or predecessor companies during the past five years except that: (i) from 1986 to 1992, Dana G. Mead was employed by International Paper Co., last serving in the capacity of Executive Vice President; (ii) Theodore R. Tetzlaff has been a partner in the law firm of Jenner & Block, Chicago, for more than five years; (iii) from 1985 to 1992, Stacy S. Dick was employed by The First Boston Corporation, last serving in the capacity of Managing Director and from August 1992 to January 1996 he served as Senior Vice President--Strategy of Tenneco Inc.; (iv) from 1980 to 1992, John J. Castellani was employed by TRW Inc., last serving in the capacity of Vice President of Government Relations and from August 1992 to March 1995 he served as Vice President--Government Relations of Tenneco Inc.; (v) from 1988 until his employment by Tenneco in 1992, Barry R. Schuman was employed by Union Pacific Railroad Company, last serving in the capacity of Vice President of Human Resources; (vi) from 1990 until 1992, Arthur H. House served as Vice President, Corporate Communications of Aetna Life & Casualty Company; from June 1992 until March 1995, he served as Vice President-- Corporate Affairs of Tenneco Inc.; (vii) from 1975 to 1994, Karen R. Osar was employed by J. P. Morgan & Co., Inc., last serving in the capacity of Managing Director--Corporate Finance Group; (viii) from 1980 to 1994, Mark A. McCollum was employed by Arthur Andersen LLP, last serving as an Audit Partner and from January 1995 to May 1995 he served as Vice President--Financial Analysis and Planning of Tenneco Inc.; and (ix) from 1977 to 1993, Paul T. Stecko was employed by International Paper Co., last serving as Vice President and General Manager of Publications Papers, Bristols and Converting Papers.\nTenneco Inc.'s Board of Directors is divided into three classes of directors serving staggered three-year terms, with a minimum of eight directors and a maximum of sixteen directors. At each annual meeting of stockholders, successors to the directors whose terms expire at such meeting are elected. Officers are elected at the annual meeting of directors held immediately following the annual meeting of stockholders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe outstanding shares of Common Stock, par value $5 per share, of Tenneco Inc. (the \"Common Stock\") are listed on the New York, Chicago, Pacific, Toronto, London, Paris, Frankfurt, Dusseldorf, Basel, Geneva and Zurich Stock Exchanges.\nThe following table sets forth the high and low sale prices of Common Stock during the periods indicated on the New York Stock Exchange Composite Transactions Tape and dividends paid per share of Common Stock during such periods:\nOn December 6, 1995, Tenneco Inc.'s Board of Directors declared a dividend of $.45 per share payable on March 12, 1996, to the holders of record on February 23, 1996.\nThe number of holders of Common Stock of record as of January 31, 1996, was approximately 92,000.\nThe declaration of dividends on Tenneco Inc. capital stock is at the discretion of its Board of Directors. The Board has not adopted a dividend policy as such; subject to legal and contractual restrictions, its decisions regarding dividends are based on all considerations that in its business judgment are relevant at the time, including past and projected earnings, cash flows, economic, business and securities market conditions and anticipated developments concerning Tenneco's business and operations. For additional information concerning the payment of dividends by Tenneco Inc., see \"Years 1995 and 1994 --Liquidity and Capital Resources--Dividends on Common Stock\" in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nTenneco's cash flow and the consequent ability of Tenneco Inc. to pay any dividends on the Common Stock is substantially dependent upon Tenneco's earnings and cash flow available after its debt service and the availability of such earnings to Tenneco Inc. by way of dividends, distributions, loans and other advances. The instruments setting forth the rights of the holders of the Preferred Stock and Junior Preferred Stock contain provisions restricting Tenneco Inc.'s right to pay dividends and make other distributions on the Common Stock. Certain of Tenneco Inc.'s subsidiaries have provisions under financing arrangements and an investment agreement which limit the amount of dividends that may be paid by them to Tenneco Inc. At December 31, 1995, such amount was calculated to be approximately $3.7 billion. Tenneco Inc. is a party to credit agreements containing provisions that limit the amount of dividends paid on its common stock. At December 31, 1995, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. would be permitted to pay dividends in excess of $300 million.\nUnder applicable corporate law, dividends may be paid by Tenneco Inc. out of \"surplus\" (as defined under the law) or, if there is not a surplus, out of net profits for the year in which the dividends are declared or the preceding fiscal year. At December 31, 1995, Tenneco Inc. had surplus of approximately $2.4 billion for the payment of dividends, and Tenneco Inc. will also be able to pay dividends out of any net profits for the current and prior fiscal year.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nSELECTED CONSOLIDATED FINANCIAL INFORMATION\n(Table continued on next page)\n(Continued from previous page)\n- -------- Notes: (a) For a discussion of significant items affecting comparability of the financial information for 1995, 1994 and 1993, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" (b) During 1995 and 1994, Tenneco completed several acquisitions at its various operating segments, the most significant of which was the acquisition of the plastics division of Mobil Corporation for $1.3 billion by Tenneco Packaging in late 1995. See Note 2 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries for further information on the Tenneco acquisitions. (c) In December 1994, Tenneco changed to the equity method of accounting for its farm and construction equipment segment due to a reduction in its ownership percentage in Case Corporation to below 50%. For additional information, see Notes 1 and 3 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries. (d) For Tenneco Energy, includes a gain of $265 million related to the sale of its natural gas liquids business including its interest in an MTBE plant then under construction. Also, Tenneco Packaging recorded a gain of $42 million related to the sale of three short-line railroads. (e) Includes restructuring charge of $920 million related to farm and construction equipment in 1992 reduced by $20 million in 1993 and $16 million in 1994. Additionally, a $473 million restructuring charge was recorded in 1991, of which $461 million related to farm and construction equipment and $12 million related to other. (f) Discontinued operations reflected in the above periods includes Tenneco's chemicals and brakes operations, which were discontinued during 1994, and its minerals and pulp chemicals operations, which were discontinued in 1992. In addition, certain additional costs related to Tenneco's discontinued oil and gas operations were reflected in the 1991 results. (g) In 1994, Tenneco adopted Statement of Financial Accounting Standards (\"FAS\") No. 112, \"Employers' Accounting for Postemployment Benefits\". In 1992, Tenneco adopted FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and FAS No. 109, \"Accounting for Income Taxes.\" (h) For purposes of computing earnings per share, Series A preferred stock was included in average common shares outstanding until its conversion into common stock in December 1994; therefore, the preferred dividends paid were not deducted from net income (loss) to determine net income (loss) to common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994, 1993 and 1992. Other convertible securities and common stock equivalents outstanding during each of the five years ended December 31, 1995, 1994, 1993, 1992 and 1991 were not materially dilutive.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following review of Tenneco's financial condition and results of operations should be read in conjunction with the financial statements and related notes of Tenneco Inc. and Consolidated Subsidiaries presented on pages 38 to 72.\nYEARS 1995 AND 1994\n1995 STRATEGIC ACTIONS\nDuring 1995, Tenneco continued implementing its strategy to redeploy capital from non-core assets into less cyclical, higher-growth businesses. The following asset dispositions were completed or announced during 1995:\n. In March 1995, Tenneco completed the initial public offering of its Albright & Wilson chemicals segment, resulting in net proceeds of approximately $700 million. The loss on the sale, which was recorded in December 1994 as \"discontinued operations\", was $170 million, including income tax expense of $115 million.\n. Tenneco sold approximately 16.1 million shares of Case Corporation (\"Case\") common stock in a public offering in August 1995, reducing Tenneco's ownership in Case from 44 percent to 21 percent. The net proceeds from the offering were approximately $540 million, resulting in a pre-tax gain of $101 million. Also, in December 1995, Tenneco sold a subordinated note which had been received from Case in connection with the initial public offering (\"IPO\") of Case in June 1994. Tenneco realized a gain on the sale of the subordinated note of $32 million; net proceeds from the sale of the subordinated note were $326 million. Since Tenneco had capital loss carryforwards from the 1994 Case reorganization and IPO available to offset the taxes on these 1995 sales, no taxes were payable on these transactions.\n. In December 1995, Tenneco Energy sold its 50 percent interest in Kern River Gas Transmission Company (\"Kern River\"), a joint venture that owns a 904-mile pipeline extending from Wyoming to California. The sales price was $206 million, resulting in a pre-tax gain of $30 million.\nTenneco acquired or announced intentions to acquire several new businesses during 1995, including:\n. Tenneco Packaging acquired the plastics business of Mobil Corporation (\"Mobil\") which is the largest North American producer of polyethylene and polystyrene packaging on November 17, 1995 for $1.3 billion. Its consumer products are marketed under the HEFTY(R), KORDITE(R) and BAGGIES(R) brand names. The acquired plastics business is also a leader in polystyrene foam packaging, thermoformed polystyrene packaging and polyethylene film products for food service and industrial consumers. In addition to this acquisition, Tenneco Packaging acquired two plastics packaging operations in the United Kingdom for $25 million during 1995.\n. Tenneco Packaging also completed eight acquisitions in the paperboard packaging business during 1995 for $171 million in cash, notes and Tenneco Inc. common stock.\n. Tenneco Energy acquired the natural gas pipeline assets of the Pipeline Authority of South Australia (\"PASA\"), which includes a 488-mile pipeline, in June 1995 for approximately $225 million and a 50 percent interest in two gas-fired cogeneration plants from ARK Energy for approximately $65 million in cash and Tenneco Inc. common stock.\n. Tenneco Automotive acquired an exhaust company and a catalytic converter company in 1995 for $40 million and entered into two ride control joint ventures for $14 million. Tenneco Automotive also announced that it will acquire two additional ride control companies for $36 million in 1996.\nDuring 1995, Tenneco completed the $500 million common stock repurchase program announced in December 1994. Also, in 1995, Tenneco announced two additional share buyback programs, one for up to 3 million shares and another for 2.5 million shares. These programs are designed to offset the growth in common shares resulting from shares issued pursuant to employee benefit plans. The 3 million share repurchase program was completed in 1995. Since December 1994, Tenneco repurchased a total of 14.3 million common shares at a cost of $646 million.\nTenneco has expressed an intention to act on a broad range of options--spin- offs, sales, public offerings, mergers, joint ventures and acquisitions--until it is satisfied that its strategic mix and corporate structure maximize shareowner value. These actions may include one, two or all of its businesses.\nRESULTS OF OPERATIONS\nTenneco's income from continuing operations in 1995 of $735 million improved by 15 percent compared to $641 million in 1994. Improved results from Tenneco Packaging and Tenneco Automotive and income from sales of assets and businesses were partially offset by declines in results at Tenneco Energy and Newport News Shipbuilding, all of which are discussed below.\nEarnings per share from continuing operations improved by 19 percent to $4.16 per average common share in 1995 from $3.49 in 1994. Average common shares outstanding during 1995 were 174 million, a 3 percent decrease from 1994 primarily resulting from Tenneco's share repurchase programs.\nIn 1994, Tenneco recorded a loss of $189 million or $1.04 per share on the discontinued operations of its Albright & Wilson chemicals business and Tenneco Automotive's brake operations. An extraordinary loss of $5 million or $.03 per share was incurred in 1994 for early retirement of debt. Also, 1994 results included a charge of $39 million or $.22 per share for the adoption of a new accounting principle. No similar costs were incurred in 1995. Net income to common stock in 1995 was $723 million or $4.16 per share compared to net income to common stock of $396 million or $2.20 per share in 1994.\nNET SALES AND OPERATING REVENUES\nRevenues for farm and construction equipment (Case) are not included in Tenneco's consolidated results in 1995. Tenneco consolidated the results of Case through November 1994, when Tenneco reduced its ownership in Case to 44%. Since that time, Tenneco has recorded its share of Case's results using the equity method of accounting. Excluding Case, Tenneco's 1995 revenues increased $606 million and have benefited from strong market conditions in the packaging industry along with revenues from acquisitions made in late 1994 and 1995. These increases more than offset lower natural gas sales at Tenneco Energy. The results of each segment are discussed in detail below.\nINCOME BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST (OPERATING INCOME)\nTenneco's 1995 operating income decreased by $10 million compared with 1994. Tenneco Packaging benefited from favorable market conditions in the packaging industry and Tenneco Automotive improved as European original equipment and aftermarkets performed well. Also, Tenneco realized gains on sales of assets and businesses in 1995 that were in excess of amounts earned in 1994. These increases were offset by lower operating income at Tenneco Energy in both its regulated and nonregulated businesses and at Newport News Shipbuilding due to lower margins on conversion work, costs incurred to enter the highly competitive international commercial shipbuilding markets and a charge for staff downsizing. In addition, Tenneco's share of Case's earnings declined from $326 million in 1994 to $110 million in 1995 as Tenneco reduced its ownership in Case. The results of each segment are discussed in detail below.\nSignificant transactions affecting the comparability of operating income between 1995 and 1994 are:\n. Pre-tax gains on sales of assets and businesses of $162 million in 1995 (primarily the sale of Case common stock, a subordinated note received from Case in connection with the IPO, a mill in North Carolina and Tenneco Energy's interest in Kern River) compared with gains of $50 million in 1994 (primarily from the Case initial and secondary public offerings and the sale of a 20 percent interest in Tenneco Energy Resources Corporation (\"Tenneco Resources\")).\n. Reserves established in 1995 of $25 million for the liquidation of surplus real estate holdings and notes, $30 million for estimated regulatory and legal settlement costs at Tenneco Energy, $30 million for restructuring at Tenneco Packaging's molded fiber and aluminum foil packaging operations and $24 million in charges at Newport News Shipbuilding related to staff downsizing and costs related to entering the highly competitive international commercial markets.\n. A gain from a 1994 contract settlement between Tenneco Energy and Columbia Gas Transmission Corporation (\"Columbia Gas\") of $11 million.\n. Charges in 1994 of $22 million at Tenneco Automotive for a plant closing in Ohio and consolidations in Europe associated with the acquisition of Heinrich Gillet GmbH & Co. KG (\"Gillet\"), the German exhaust manufacturer.\nTENNECO AUTOMOTIVE\nRevenues from Tenneco Automotive's original equipment business increased during 1995 by $419 million to $1,155 million. Eighty-three percent, or $346 million, of this increase resulted from revenues of Gillet. European original equipment volumes were up significantly in 1995 where Gillet is the leading original equipment manufacturer of exhaust components. In North America, ride control sales increased eleven percent and exhaust sales increased four percent in 1995.\nOperating income in the original equipment business for 1995 decreased by $5 million to $53 million compared with 1994. The 1994 operating income included a $5 million charge recorded for a plant closing. The addition of Gillet contributed $16 million to operating income in 1995. The remainder of the operating income change in 1995 is due primarily to a high level of costs related to new product launches. Tenneco Automotive completed 68 product launches for 1996 model year vehicles in 1995, more than twice the normal levels, which strained plant capabilities and adversely affected 1995 earnings. In connection with the new product launches, Tenneco Automotive incurred additional costs of $10 million in 1995 including those related to a new process, hydroforming. Hydroforming is a liquid, high-pressure process for bending and shaping metal parts not available with traditional manufacturing technology.\nAftermarket revenues increased $71 million to $1,324 million in 1995. This increase was due primarily to higher aftermarket revenues in both the European exhaust and ride control businesses, resulting from improved economic conditions in many European countries. North American aftermarket revenues were down 5% in 1995.\nOperating income in the aftermarket business was $187 million for 1995 compared with $165 million for the prior year. Tenneco Automotive recorded a charge of $17 million in 1994 related to plant consolidations associated with the Gillet acquisition. Excluding this charge, aftermarket operating income increased $5 million compared with 1994. The positive impact of higher sales volumes in Europe was offset by the negative impact of lower North American sales. Industry-wide, the North American aftermarket experienced its sharpest decline in more than a decade. The unusually mild winter weather in 1995 in the Northeast and Midwest slowed automotive parts replacement rates.\nOUTLOOK\nThe consolidation of the exhaust operations of Walker Europe and Gillet which was undertaken during 1995 is substantially complete and is expected to result in improved earnings from the European original equipment business in 1996. Also, Tenneco Automotive's international expansion, including joint ventures in India and China, acquisitions in Spain and Australia and new international plants such as the new ride control plant in Mexico, are expected to contribute to future earnings. Tenneco Automotive anticipates higher original equipment volumes as a result of the high level of new product launches undertaken in 1995 and interest by additional customers in hydroforming technology. Tenneco also anticipates the North American aftermarket to improve to more normal activity levels in 1996.\nTENNECO ENERGY\nThe regulated portion of Tenneco Energy's business experienced a decline in revenues from $918 million in 1994 to $761 million in 1995. Lower regulated merchant gas sales along with a small decrease in transportation revenues caused the decline. Under Federal Energy Regulatory Commission (\"FERC\") Order 636, customers assume the responsibility for acquiring their gas supplies, reducing sales by the pipeline. The contract settlement reached with Columbia Gas in 1994 as part of its bankruptcy proceedings reduced its contract volume, contributing to the transportation revenue decline in 1995.\nOperating income in the regulated portion of Tenneco Energy's business was down by $27 million in 1995 as compared to 1994. The 1995 results included the $30 million pre-tax gain on the sale of Tenneco's interest in Kern River and a $21 million reserve for estimated regulatory and legal settlement costs while 1994 included the $11 million benefit from the Columbia Gas contract settlement. Excluding these transactions, Tenneco Energy's regulated business operating income decrease was primarily due to the\nreduction of revenues related to the early termination of transportation contracts and lower returns earned on regulated assets due to the operating environment created by Order 636. This decrease was partially offset by the benefit Tennessee realized through the implementation of a new rate structure in July 1995.\nRevenues in Tenneco Energy's nonregulated businesses were $1,155 million, down $305 million compared with 1994. Average natural gas prices were lower in 1995 compared with 1994, contributing approximately $175 million to the revenue decrease. Natural gas volumes declined also, contributing $148 million to the revenue decrease. Warmer weather in early 1995 resulted in lower levels of storage activity during the year, decreasing demand for natural gas and forcing prices lower. These effects were offset somewhat by $18 million in revenues earned by the PASA assets which were acquired by Tenneco Energy in June 1995.\nThe 1995 operating income for the nonregulated business decreased $55 million compared with 1994. Operating income in 1994 included a $23 million gain from the sale of a 20 percent interest in Tenneco Resources to Ruhrgas AG. The remainder of the operating income decline was due to increased startup and development costs on international programs, a $9 million reserve for estimated legal settlement costs and lower margins and volumes due to lower demand in gas marketing. Tenneco Energy operating results included $9 million in income from operating the PASA assets during the last half of 1995.\nOUTLOOK\nDuring 1995, Tenneco Energy sold its interest in Kern River and purchased the PASA assets in Australia. Tenneco Energy also began construction during 1995 of a 470-mile pipeline in Queensland, Australia, has been chosen to participate in constructing a pipeline from Bolivia to Brazil, is participating in feasibility studies for the construction of a pipeline in Taiwan and was selected as a technical advisor for the construction of China's first major onshore natural gas pipeline. Tenneco Energy and its partners continue to pursue pre- construction commitments from prospective natural gas shippers and obtaining right-of-way concessions for the construction of the Argentina to Chile pipeline. Also, Tenneco Energy has acquired a stake in GreyStar Corp., a Houston-based offshore services company that serves production and pipeline facilities in the Gulf of Mexico. These actions are intended to reduce Tenneco Energy's reliance on regulated businesses, increasing the opportunity to earn higher returns.\nThe regulated natural gas pipeline industry is experiencing increasing competition, which results from actions taken by the FERC to strengthen market forces throughout the industry. In a number of key markets, Tenneco Energy's interstate pipelines face competitive pressure from other major pipeline systems, enabling local distribution companies and end users to choose a supplier or switch suppliers based on the short term price of gas and the cost of transportation. Competition between pipelines is particularly intense in Midwestern Gas Transmission's Chicago and Northern Indiana markets, in East Tennessee Natural Gas' Roanoke, Chattanooga and Atlanta markets, and in Tennessee Gas Pipeline Company's (\"Tennessee\") supply area, Louisiana and Texas. In some instances, Tenneco Energy's pipelines have been required to discount their transportation rates in order to maintain their market share. Additionally, transportation contracts representing approximately 70 percent of firm transportation capacity will be expiring over the next five years, principally in the year 2000. The renegotiation of these contracts may be impacted by these competitive factors.\nTENNECO PACKAGING\nTenneco Packaging's paperboard business experienced excellent results during 1995. Revenues were up $399 million to $1,928 million in 1995, primarily as a result of strong pricing improvements. As a result of the move into higher margin graphics and specialty corrugated segments, Tenneco Packaging realized higher\nrevenues on comparable volumes. In addition, strong industry demand for linerboard and corrugated products served to substantially increase prices for those products in 1995 and contributed to record revenues.\nOperating income in the paperboard business improved by $260 million to $399 million in 1995. This improvement includes the 1995 pre-tax gain of $14 million on the sale of a mill in North Carolina. Effective mix management allowed Tenneco Packaging to absorb rapidly rising raw material prices for corrugated products while posting increased margins. Additionally, Tenneco Packaging continued to post new productivity gains, especially in the operation of its containerboard mills, resulting in record operating margins in 1995.\nRevenues in Tenneco Packaging's specialty packaging business increased by $169 million to $824 million during 1995. Revenues of $106 million from the recently acquired plastics business (November 1995) are included in the results of the specialty packaging business. The remainder of the revenue increase over 1994 results from price increases realized during the year.\nThe specialty packaging business earned $31 million in operating income in 1995, a $39 million decrease compared to 1994 results. Specialty packaging recorded a restructuring charge of $30 million in 1995 for its molded fiber and aluminum foil packaging operations and recognized income from the recently acquired plastics business of $15 million. Excluding these two items, the decline in operating income for specialty packaging resulted from raw material cost increases that more than offset the positive effects of the pricing increases initiated during the year. The major contributors to the raw material cost increases were higher prices for polystyrene, aluminum and old newspaper. However, these prices declined during the second half of the year and are expected to remain at their current lower levels.\nIn its restructuring actions, specialty packaging expects to complete in 1996 a realignment of molded fiber assets, enter into joint venture agreements to reduce egg packaging and fruit tray costs and close an aluminum rolling mill, whose production will be outsourced.\nOUTLOOK\nThe plastics business is expected to be a major contributor to earnings. Its revenues, combined with specialty packaging's existing business, will comprise approximately one-half of Tenneco Packaging's revenues in 1996. The plastics business is expected to generate less cyclical earnings than the paperboard segment has historically. Tenneco Packaging has also been working to reduce the cyclicality of its paperboard business. Four of the paperboard acquisitions completed in 1995 were in enhanced graphics and displays, a business less sensitive to changes in linerboard pricing. These acquisitions, along with the corrugated requirements of the recently acquired plastics business, have increased Tenneco Packaging's level of integration, reducing exposure to linerboard pricing volatility. Tenneco Packaging expects some softening in the paperboard market in the first and second quarters of 1996 followed by an improvement in the second half of the year.\nNEWPORT NEWS SHIPBUILDING\nShipbuilding revenues for 1995 increased slightly compared with 1994 due to greater levels of activity on the conversion program, offset by lower carrier and submarine program revenues. Construction activity on the Los Angeles-class submarines declined in 1995 as two of the remaining four vessels were delivered during the year. Carrier activity declined for the year as 1994 activity included the overhaul of the Enterprise;\nthe overhaul of the Eisenhower began in the third quarter of 1995 and construction activity on the Ronald Reagan replaced construction of the John C. Stennis which was delivered in the fourth quarter of 1995.\nOperating income for the Shipbuilding segment was down for the year due to lower margins for conversion work and costs of approximately $24 million incurred related to staff downsizing and Newport News' reentry into the highly competitive international commercial markets.\nOUTLOOK\nShipbuilding will continue to rely on the U.S. Navy for a significant amount of its revenue; however, Shipbuilding is actively pursuing the large, global commercial and military markets. Newport News has contracts to build four \"Double Eagle\" product tankers. Additionally, Newport News was awarded a contract to construct five additional \"Double Eagle\" tankers which will be used in U.S. domestic trade. In February 1996, the owners secured financing guarantees from the Maritime Administration. Shipbuilding is also pursuing sales of its fast frigate to Middle East and Pacific Rim countries. U.S. Navy work accounted for 95 percent of Shipbuilding revenues in 1995.\nThe shipyard's backlog was $4.6 billion at December 31, 1995 substantially all of which is U.S. Navy-related. This compares with $5.6 billion at the end of 1994. During 1995, Shipbuilding delivered one aircraft carrier (John C. Stennis) and two submarines.\nThe yearend backlog included two Los Angeles-class submarines, two Nimitz- class aircraft carriers (Harry S. Truman and Ronald Reagan), the two ship Sealift conversion contract and contracts to construct four \"Double Eagle\" product tankers. In addition, Newport News has ongoing engineering contracts as the lead design yard for the Los Angeles-class and Seawolf-class submarines. Subject to new orders, this backlog will decline as the remaining submarines are delivered in 1996 and the aircraft carriers are delivered in 1998 and 2002.\nCASE AND OTHER\nTenneco recorded $110 million in income for 1995 related to its equity ownership in Case which was approximately 44 percent through July and 21 percent for the remainder of the year. During 1994, when Tenneco owned 100 percent of Case through June, 71 percent through November and 44 percent in December, Tenneco recorded $326 million in operating income related to its farm and construction equipment segment.\nTenneco's other operations reported operating income of $96 million during 1995. This included the $101 million gain on the August 1995 sale of Case common stock, the $32 million gain on the sale of the Case subordinated note and a $25 million charge to establish a reserve for liquidation of surplus real estate holdings and notes. During 1994, other operations reported $6 million in operating income, which included pre-tax gains of $29 million from the Case initial and secondary public offerings.\nINTEREST EXPENSE (NET OF INTEREST CAPITALIZED)\nTenneco's interest expense in 1995 was $339 million compared with $407 million in 1994. Excluding the interest expense of $68 million related to Case which was included in Tenneco's 1994 income prior to deconsolidation of Case in November, interest expense was the same between periods. Interest capitalized was $9 million in 1995 compared with $6 million in 1994 due to higher levels of capital spending in 1995.\nMINORITY INTEREST\nMinority interest of $22 million in 1995 related to dividends on preferred stock of a U.S. subsidiary which was issued in December 1994. The $30 million of minority interest in 1994 resulted primarily from the minority shareholders' interest in Case's net income for the July through November period when Tenneco owned 71 percent of Case.\nINCOME TAXES\nThe 1995 effective tax rate was 26.5%, compared with 31.0% in 1994. This decline resulted primarily from recognition of $154 million in capital loss carryforwards which Tenneco was able to utilize in connection with several 1995 transactions, including the August 1995 sale of Case stock, the Case subordinated note sale and the Kern River sale.\nDISCONTINUED OPERATIONS AND EXTRAORDINARY LOSS\nIn 1994, Tenneco sold its brakes operations and announced its plan to dispose of Albright & Wilson, its chemicals segment. These businesses were accounted for as discontinued operations in 1994. Of the after-tax loss from discontinued operations, $158 million was attributable to Albright & Wilson and $31 million to the brakes operations.\nIn June 1994, Tenneco realized an extraordinary loss of $5 million, net of a $2 million tax benefit, for the redemption premium resulting from the prepayment of debt.\nCUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE\nEffective January 1, 1994, Tenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" using the cumulative catch-up method. It requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. As a result of adopting this statement, an after-tax charge of $39 million, or $.22 per average common share, was recorded in 1994.\nTenneco will adopt FAS 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. FAS No. 121 establishes new accounting standards for measuring the impairment of long-lived assets. Adoption of the new standard will not have a material effect on Tenneco's consolidated financial position or results of operations.\nIn October 1995, the Financial Accounting Standards Board issued FAS No. 123, \"Accounting for Stock-Based Compensation.\" This statement defines a fair value based method of accounting for stock issued to employees and others but also allows companies to choose to continue to measure compensation cost for such plans as it is measured currently. Tenneco has elected to continue to use the current method of accounting for stock issued to employees. Consequently, FAS No. 123 will have no impact on Tenneco's consolidated financial position or results of operations.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOW\nTenneco's operating results, combined with proceeds from sales of assets and businesses, and supplemented by short-term and long-term borrowings, have provided funds for acquisitions and capital investments in existing businesses and to repurchase its common stock. Operating cash flow for 1995 improved as Tenneco generated $858 million from the collection and sale of customer receivables compared with cash used in 1994 of $417 million. This increase was due primarily to trade receivables sold to Asset Securitization Cooperative Corporation, which were $783 million higher in 1995 compared with 1994. The increase in collections of receivables was also due in part to the collection of approximately $300 million of Case retail receivables in 1995. Operating cash flow in 1995 also benefited from lower interest and tax\npayments compared with 1994. Interest payments were $154 million lower and tax payments were $72 million lower compared with payments in 1994. Sales of businesses and assets, primarily the Albright & Wilson chemicals operations, 16.1 million shares of Case common stock and the Case subordinated note, provided an additional $1,623 million of cash during the year. Finally, Tenneco accessed its credit facilities, the commercial paper market and the long-term debt markets during 1995 for $1,016 million. Included in the $1,016 million of debt funding obtained during the year was $600 million in long-term debt issued in December 1995; $300 million issued at an interest rate of 7 1\/4% due in 2025 and $300 million issued at an interest rate of 6 1\/2% due in 2005.\nCash used for business acquisitions during 1995 totaled $1,702 million. The largest single transaction was the acquisition of the plastics business from Mobil by Tenneco Packaging for $1.3 billion. However, the Energy and Automotive segments also made acquisitions during the year. Further, Tenneco invested $976 million in capital expenditures in its existing businesses during the year. Capital expenditures during the year included $208 million for Automotive, $334 million for Energy, $316 million for Packaging, $77 million for Shipbuilding and $41 million related to Tenneco's other operations. Capital expenditures were higher at Automotive, Packaging and Shipbuilding during 1995 while Energy capital expenditures were approximately the same as the prior year.\nBesides business expansion, Tenneco used its cash flow during the year for the scheduled retirement of $513 million in long-term debt, to reacquire Tenneco Inc. common stock for $655 million and to pay $286 million in dividends on its common and preferred stock.\nDuring 1994, Tenneco's cash sources included operating cash flow of $450 million and $860 million in proceeds from sales of businesses and assets (primarily the Case initial and secondary public offerings for $694 million). During 1994, Tenneco acquired Gillet for $44 million in cash and other businesses for $7 million. Capital expenditures were $736 million for continuing operations. Tenneco had a net reduction of $111 million in debt (primarily as a result of the Case offerings and deconsolidation of Case) and paid dividends on its common and preferred stock of $318 million.\nLIQUIDITY\nTenneco and its consolidated subsidiaries had, at December 31, 1995, committed credit agreements providing for $2,522 million of borrowing capacity. Of these facilities, $2.0 billion are committed through 1999. As of December 31, 1995, $393 million of borrowings were outstanding under these facilities. The availability of borrowings under Tenneco's agreements and facilities is subject to its ability at the time to meet certain specified conditions, which Tenneco believes it currently meets. These conditions include compliance with the financial covenants and ratios required by such agreements, absence of default under such agreements, and continued accuracy of the representations and warranties contained in such agreements (including the absence of any material adverse changes since the specified dates).\nTenneco's current liabilities exceeded current assets at December 31, 1995. The decrease in working capital resulted primarily from a tax audit settlement payment made in January 1996 and the short-term debt borrowed to finance the recently acquired plastics business. The financing for this acquisition is discussed below under \"Capitalization.\"\nIn connection with the implementation of FERC Order 636 and the resolution of the GSR costs issues, Tenneco intends to put in place, as needed, financing arrangements to fund needs arising from timing differences between recovery from pipeline customers and payments for transition costs. The actual cash required will depend upon negotiations between Tennessee, its customers and suppliers.\nBased upon Tenneco's estimates of anticipated funding needs and expected results of its operations, together with anticipated market conditions and including any payments associated with the settlement of\nthe GSR issues discussed below, Tenneco expects adequate sources of funds to be available to finance its future requirements through internally generated funds, the sale of assets, the use of credit facilities, and the issuance of long-term securities.\nCAPITALIZATION\nThe primary reason for the net increase in debt outstanding is the debt issued for the acquisition of the plastics business from Mobil. Tenneco initially funded this acquisition primarily with short-term debt. In December 1995, Tenneco issued $600 million of long-term debt to refinance a portion of the purchase price.\nTenneco's ratio of debt to total capitalization at December 31, 1995 was 56.4 percent compared to 55.0 percent at December 31, 1994. Including the market value of the SECT shares, the ratio of total debt to total capitalization at December 31, 1995 was 55.0 percent compared to 52.9 percent at December 31, 1994.\nDIVIDENDS ON COMMON STOCK\nTenneco Inc. declared dividends on its common shares of $.40 per share for each quarter in 1995. In December 1995, the Board of Directors declared a dividend of $.45 per share for the first quarter of 1996, an increase of 12.5 percent over the previous indicated quarterly rate. Declaration of dividends is at the discretion of the Board of Directors. The Board has not adopted a dividend policy as such. Subject to legal and contractual restrictions, its decisions regarding dividends are based on all considerations that in its business judgment are relevant at the time, including past and projected earnings, cash flows, economic, business and securities market conditions and anticipated developments concerning Tenneco's business and operations.\nTenneco Inc. is a party to credit agreements containing provisions that limit the amount of dividends paid on its common stock. At December 31, 1995, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. had in excess of $300 million available for the payment of dividends. Tenneco does not believe that this limitation will prevent the payment of dividends on Tenneco Inc. common stock at the present annual dividend rate.\nAs a holding company, Tenneco Inc.'s ability to pay dividends is substantially dependent upon cash flow from its subsidiaries by way of dividends, distributions, loans and other advances. Under the most restrictive of their covenants, however, Tenneco Inc.'s subsidiaries would have been able to pay approximately $3.7 billion of their retained earnings as dividends to Tenneco Inc. at December 31, 1995.\nFERC MATTERS\nTennessee has deferred certain costs it has incurred associated with renegotiating gas supply contracts (\"GSR\" costs) as a result of FERC Order 636. As of December 31, 1995, Tennessee has deferred GSR costs yet to be recovered from its customers of approximately $462 million, net of $316 million previously recovered from its customers, subject to refund. A proceeding before a FERC administrative law judge is scheduled to commence in early 1996 to determine whether Tennessee's GSR costs are eligible for cost recovery. The\nFERC has generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 provides for complete recovery by pipelines of eligible and prudently incurred transition costs, certain customers have challenged the prudence and eligibility of Tennessee's GSR costs and Tennessee has engaged in settlement discussions with its customers concerning the amount of such costs in response to the FERC and customer statements acknowledging the desirability of such settlements.\nAlso related to Tennessee's GSR costs, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. An amendment to the pleading seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee filed a motion for summary judgment, asserting that the Texas statutes of frauds precluded the plaintiffs from adding new production or acreage to the contract. On May 4, 1995, the trial court granted Tennessee's motion for summary judgment; the plaintiffs have filed a notice of appeal. Thereafter, ICA and TransTexas filed a motion for summary judgment on a separate issue involving the term \"committed reserves\" and whether Tennessee has a contractual obligation to purchase gas produced from a lease not described in the gas contract. On November 8, 1995, the trial court granted ICA's and TransTexas' motion in part. That order, which would be finalized upon conclusion of the trial, also held that ICA's and TransTexas' rights are subject to certain limitations of the Texas Business and Commerce Code. In addition to these defenses, which are to be resolved at trial, Tennessee has other defenses which it has asserted and intends to pursue. Tennessee has filed a Motion to Clarify the November 8, 1995 order together with a new motion for partial summary judgment concerning the committed reserve issue. The November 8, 1995 ruling does not affect the trial court's previous May 4, 1995 order granting summary judgment to Tennessee.\nTennessee has been engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee. Although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious, Tennessee accrued amounts in the first quarter of 1995 which it believes are adequate to cover the resolution of these matters. On August 1, 1995, the Texas Supreme Court affirmed a ruling of the Court of Appeals favorable to Tennessee in one of these matters and indicated that it would remand the case to the trial court. Motions for rehearing have been filed by the producers. As of the date hereof, the court had not ruled on those motions and mandate had not been issued.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact that the resolution of these issues will have on its consolidated financial position or results of operations.\nENVIRONMENTAL MATTERS\nTenneco and certain of its subsidiaries and affiliates are parties to environmental proceedings. Expenditures for ongoing compliance with environmental regulations that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations and that do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments indicate that remedial efforts are probable and the costs can be reasonably estimated. Estimates of the liability are based upon currently available facts, existing technology, and presently enacted laws and regulations taking into consideration the likely effects of inflation and other\nsocietal and economic factors. All available evidence is considered, including prior experience in remediation of contaminated sites, other companies' cleanup experience and data released by the United States Environmental Protection Agency (\"EPA\") or other organizations. These estimated liabilities are subject to revision in future periods based on actual costs or new circumstances. These liabilities are included in the balance sheet at their undiscounted amounts. Recoveries are evaluated separately from the liability and, when recovery is assured, are recorded and reported separately from the associated liability in the financial statements.\nTennessee is a party in proceedings involving federal and state authorities regarding the past use by Tennessee of a lubricant containing polychlorinated biphenyls (\"PCBs\") in its starting air systems. Tennessee has executed a consent order with the EPA governing the remediation of certain of its compressor stations and is working with the Pennsylvania and New York environmental agencies to specify the remediation requirements at the Pennsylvania and the New York stations. Tenneco believes that the ultimate resolution of this matter will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nA subsidiary of Tennessee owns a 13.2% general partnership interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"), which owns an interstate natural gas pipeline from the Canadian border through the states of New York and Connecticut to Long Island. The operator of the pipeline is Iroquois Pipeline Operating Company (the \"Operator\"), a subsidiary of TransCanada Pipelines, Ltd., an affiliate of TransCanada Iroquois, Ltd. which is also a partner in Iroquois. Tennessee has a contract to provide gas dispatching as well as post-construction field operation and maintenance services for the Operator of Iroquois, but Tennessee is not the Operator and is not an affiliate of the Operator.\nIroquois has been informed of investigations and allegations regarding alleged environmental violations which occurred during the construction of the pipeline. Communications have been received from U.S. Attorneys' Offices, the Enforcement Staff of the FERC's Office of the General Counsel, the Army Corps of Engineers, the Public Service Commission of the State of New York, the EPA and the Federal Bureau of Investigation. Proceedings have not been commenced against Iroquois in connection with these inquiries. However, communications have indicated possible allegation of civil and criminal violations. Iroquois has held discussions with certain of the agencies to explore the possibility of a negotiated resolution of the issues. In the absence of a negotiated resolution, Iroquois believes that indictments will be sought and, in them, substantial fines and other sanctions may be requested.\nAs a general partner, Tennessee's subsidiary may be jointly and severally liable with the other partners for the liabilities of Iroquois. The foregoing proceedings and investigations have not affected pipeline operations. Based upon information available to Tennessee, Tennessee believes that neither it nor any of its subsidiaries is a target of the criminal investigation described above. Further, while a global resolution of these inquiries could have a material adverse effect on the financial condition of Iroquois, Tenneco believes that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nAt December 31, 1995, Tenneco has been designated as a potentially responsible party in 55 \"Superfund\" sites. With respect to its pro rata share of the remediation costs of certain sites, Tenneco is fully indemnified by third parties. With respect to certain other sites, Tenneco has sought to resolve its liability through payments to the other potentially responsible parties. For the remaining sites, Tenneco has estimated its share of remediation costs to be between $11 million and $69 million or 0.5% to 2.5% of the total remediation costs for those sites and has provided reserves that it believes are adequate for such costs. Because the cleanup costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, Tenneco's estimate of its share of remediation costs could change. Moreover, liability under the Comprehensive Environmental Response, Compensation and Liability Act is joint and several, meaning that Tenneco could be required to pay in excess of its pro rata share of remediation costs. Tenneco's understanding of the financial strength of other potentially responsible parties has been considered, where\nappropriate, in Tenneco's determination of its estimated liability. Tenneco believes that the costs associated with its current status as a potentially responsible party in the Superfund sites described above will not be material to its consolidated financial position or results of operations.\nYEARS 1994 AND 1993\nRESULTS OF OPERATIONS\nREVENUES\nRevenues for 1994 were $12.17 billion, down slightly from $12.29 billion in 1993. Automotive revenues were $1,989 million, a $204 million, or 11 percent increase, compared with 1993 primarily due to improved sales in both the aftermarket and original equipment market. Tenneco Energy revenues were down $484 million or 17 percent as customers shifted from sales to transportation service in the regulated business and gas prices fell in the nonregulated gas marketing business. Packaging revenues increased $142 million, or seven percent, to $2.18 billion in 1994, as prices in the paperboard business recovered from the seven-year low reached in the third quarter of 1993. Revenues for Shipbuilding decreased to $1.75 billion, or six percent, due to a drop in carrier and submarine construction work and the fourth quarter 1993 divestiture of Sperry Marine. Revenues for farm and construction equipment were $3.88 billion, compared with $3.75 billion in 1993. Tenneco excluded Case's revenues for December 1994 because of the change to the equity accounting method for Case. Case revenues were up in 1994 over 1993 due to higher sales volumes both in the European construction equipment business and the North American agricultural equipment market.\nINCOME BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST (OPERATING INCOME)\nOperating income was $1,379 million for 1994. This was an improvement of $282 million over 1993's operating income of $1,097 million. Excluding gains from asset sales and other special items including plant consolidations, 1994 operating income increased $364 million, or 37 percent, compared with 1993 primarily due to improved pricing in Packaging's containerboard business and higher volumes in the farm and construction equipment segment.\nTenneco Automotive operating income for 1994 was $223 million, compared with $222 million in 1993. The 1994 operating income included a $17 million charge for plant consolidations in Europe associated with acquiring Gillet and a $5 million charge taken in the second quarter for closing a plant in Ohio. Excluding special items, operating income increased $23 million, or 10 percent, compared with 1993. This increase is a result of higher volumes in North America and Europe and was partially offset by higher costs for new product development and new facility start-up.\nIn November 1994, Tenneco acquired Gillet for $44 million in cash and $69 million in assumed debt. Gillet is the leading manufacturer of original equipment exhaust systems and components for European auto makers.\nTenneco Energy's operating income for 1994 was $415 million, compared with $411 million in 1993. Special items, including gains on asset sales along with regulatory and litigation settlements, amounted to $34 million in 1994 and $28 million in 1993. Special items in 1994 included a $23 million gain on the sale of a 20 percent interest in Tenneco Resources to Ruhrgas AG. When non-recurring items in both years are excluded, operating income in 1994 declined slightly, compared with 1993. Significant growth in the nonregulated businesses, including an increase in Tenneco Ventures' operating income, was offset by declines in the regulated business caused by implementing Order 636.\nTenneco Packaging's operating income for 1994 was $209 million, compared with $139 million in 1993. The 1993 operating income included $29 million from gains related to asset realignment. Excluding these gains, operating income increased $99 million, or 90 percent, compared with 1993 primarily because of improved paperboard pricing.\nThe paperboard business earned $139 million, up $104 million compared with 1993, excluding the 1993 asset realignment gains. Prices rose from depressed levels in 1993 and contributed $125 million, excluding the recycling business, of increased operating income. This was partially offset by higher raw material costs of $32 million, but improved productivity helped counter rising raw material costs. Paperboard productivity rose 1.6 percent, with mill operating rates exceeding rated capacity for the full year. The specialty business operating income for 1994 declined $5 million to $70 million, excluding the asset realignment gains in 1993. Both the aluminum and plastic packaging businesses reported improved operating income. Plastic packaging volumes grew seven percent in 1994 and demand continues to be strong. Operating income for plastics rose 40 percent in 1994, reflecting increased volumes and higher pricing. The increase in operating income provided by the aluminum and plastic businesses was more than offset by weak performance in the molded fiber business, where higher raw material costs had a negative effect on operating income. Prices for recycled newspaper, a major raw material for molded fiber, rose to over $100 per ton, compared with $26 per ton in 1993.\nNewport News Shipbuilding's operating income for 1994 was $200 million compared with $225 million in 1993. Special items in 1993 included a $15 million gain on the sale of Sperry Marine and a $12 million benefit from recovering a portion of the postretirement benefit costs reserve that was established when FAS No. 106 was adopted in 1992. If these special items were excluded, operating income increased $2 million in 1994 on revenues that were six percent lower due to aggressive efforts to improve productivity and control costs.\nCase reported operating income of $326 million in 1994, a $244 million improvement, compared with the $82 million reported in 1993. Several factors contributed to this improvement in 1994. Higher sales volumes and a 16 percent increase in worldwide production along with lower discounts and better top-line pricing contributed to the operating income improvement. Cost reductions were partially offset by retooling and reconfiguration expenses at the construction equipment plant in Burlington, Iowa. Case also had higher engineering expenses to support new product growth.\nTenneco's other operations reported operating income of $6 million in 1994, compared with $18 million for 1993. The 1993 operating income included a gain of $39 million from contributing Tenneco's investment in Cummins Engine Company to the Case Corporation Pension Plan for Hourly Paid Employees, while the operating income for 1994 included gains of $29 million from the Case initial and secondary public offerings.\nINTEREST EXPENSE\nNet interest incurred declined $20 million from $427 million in 1993 to $407 million in 1994. The decrease was a result of lower debt levels, continued emphasis on managing for cash flow and working capital and changing Case reporting to the equity method of accounting in December 1994. Due to the change in the method of financing dealer receivables as a result of the Case IPO in June 1994, financing costs for Case's wholesale receivables were reported as interest expense. Before the change in financing method, the Case wholesale financing costs were reported as \"Finance Charges--Tenneco Finance.\" If the Case wholesale receivable interest was excluded for the full year, interest expense would have decreased by an additional $24 million from last year's level. Interest capitalized increased to $6 million in 1994 from $4 million in 1993 due to higher levels of major capital projects.\nFinance charges (interest expense related to finance subsidiaries classified as an operating expense) were $155 million in 1994 versus $254 million in 1993. Approximately $2.0 billion in debt of Tenneco's finance subsidiaries was retired during the year resulting in lower finance charges. Interest expense related to debt on wholesale receivables was included as interest expense rather than finance charges from July through November 1994 as indicated above. In December, the method of reporting Case changed to the equity method, and Case's debt is no longer consolidated with Tenneco's debt on the balance sheet. In addition, Tenneco's finance subsidiaries reduced debt with proceeds from issuing lower-cost asset backed securities.\nMINORITY INTEREST\nMinority interest expense was $30 million for the 1994 year. This primarily reflected the minority shareholders' interest in Case's net income for July through November 1994.\nINCOME TAXES\nIncome tax expense for 1994 was $301 million versus $257 million reported for 1993. The increased tax expense in 1994 was from higher pre-tax income. This was partially offset by tax benefits from the realization of deferred tax assets resulting from consolidation of Tenneco's German operations and the tax benefit associated with sale of businesses.\nCUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE\nEffective January 1, 1994, Tenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" As a result, an after-tax charge of $39 million, or $.22 per average common share, was recorded in 1994.\nDISCONTINUED OPERATIONS AND EXTRAORDINARY LOSS\nLoss from discontinued operations in 1994 of $189 million, net of income tax expense of $104 million, or $1.04 per average common share, resulted from the sale of Tenneco's chemicals and brakes businesses.\nIncome from discontinued operations in 1993 of $38 million, net of income tax expense of $1 million, or $.23 per average common share, was attributable to the discontinuance of Tenneco's brakes business and chemical operations in 1994. Net loss for 1993 for the brakes business was $7 million, net of income tax benefit of $4 million. Net income for the chemicals business was $45 million, net of income tax expense of $5 million.\nExtraordinary loss for 1994 was $5 million, net of income tax benefit of $2 million, or $.03 per average common share. The 1993 amount was $25 million, net of income tax benefit of $13 million, or $.15 per average common share. Both were the result of redemption premiums from prepaying high interest-bearing long-term debt.\nEARNINGS (LOSS) PER AVERAGE COMMON SHARE\nIncome from continuing operations for 1994 was $641 million, or $3.49 per average common share after preferred dividends. This compares with income from continuing operations of $413 million, or $2.36 per average common share after preferred dividends, in 1993. The average number of shares of common stock outstanding used for calculating earnings per average common share for 1994 was 180.1 million, compared with 168.8 million in 1993. Most of the increase resulted from issuing 23.5 million shares in an underwritten public offering in April 1993 and issuing treasury shares and SECT shares to employee benefit plans.\nLIQUIDITY & CAPITAL RESOURCES\nNet cash provided by operating activities was $450 million for the year 1994, compared with $1,615 million for 1993, a decrease of $1,165 million. Excluding discontinued operations, there was a decrease of $1,232 million. This decrease was due in part to lower sales of Case retail receivables in the form of asset backed securities. Proceeds from the sale of Case retail receivables in the form of asset backed securities were $850 million in 1994 compared with $1.0 billion in 1993. Also, trade receivables sold to Asset Securitization Cooperative Corporation were $313 million less in 1994 compared with 1993. Higher dealer demand for farm and construction equipment in 1994 resulting in higher receivables compared with 1993 also lowered cash from operating activities. Finally, rate refund payments of approximately $250 million were made to pipeline customers in 1994. The working capital increase of $587 million for 1994 resulted primarily from the\nreduction of the pipeline rate refund liability of approximately $250 million and lower tax accruals of $255 million. The lower tax accruals resulted from the utilization of capital losses related to the sale of assets.\nNet cash used by investing activities in 1994 was $117 million, compared with $338 million in 1993. Net proceeds from the sale of businesses and assets were $860 million in 1994, primarily due to the initial and secondary public offerings of Case for $694 million. Net proceeds from the sale of businesses in 1993 of $266 million resulted from the sales of Dean Pipeline Company, Viking Gas Transmission Company, Sperry Marine, and various international aluminum ventures.\nExpenditures for plant, property and equipment from continuing operations for 1994 were $736 million, compared with $525 million for 1993. Increased expenditures for Energy ($161 million), Automotive ($20 million), Packaging ($42 million) and Tenneco's other operations ($13 million) were partially offset by declines for Case ($18 million) and Shipbuilding ($7 million).\nCash used for financing activities for 1994 was $151 million compared with $1,166 million in 1993. In June 1994, as part of the Case reorganization and IPO, Case borrowed $983 million of terms loans and $478 million of short-term debt to acquire the net assets of Tenneco's farm and construction equipment segment. Tenneco utilized these funds to repay long-term debt. As a result of the November 1994 secondary public offering which reduced Tenneco's ownership in Case to approximately 44%, Case's debt is no longer consolidated with Tenneco's debt on the balance sheet at December 31, 1994, due to reporting Case on the equity method of accounting.\nIn December 1994, Tenneco sold a 25 percent preferred stock interest in a subsidiary which resulted in net cash proceeds of $296 million. This was included in minority interest in the balance sheet at December 31, 1994. Concurrently, $160 million was used to retire equity securities of another subsidiary which had been included in the balance sheet as minority interest.\nCapitalization totaled $7.48 billion at December 31, 1994, a decrease of $1.51 billion from December 31, 1993. The ratio of total debt to capitalization decreased from 67.6 percent at December 31, 1993, to 55.0 percent at December 31, 1994. The ratio of total debt to capitalization was 52.9 percent at December 31, 1994, including the market value of the SECT shares, compared with 64.0 percent at December 31, 1993. Total debt declined by $1.96 billion from December 31, 1993 to December 31, 1994, while shareowners' equity increased $299 million. Minority interest increased $167 million and preferred stock decreased $16 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEX TO FINANCIAL STATEMENTS OF TENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Tenneco Inc.:\nWe have audited the accompanying balance sheets of Tenneco Inc. (a Delaware corporation) and consolidated subsidiaries as of December 31, 1995 and 1994, and the related statements of income, cash flows and changes in shareowners' equity 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 Tenneco's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Tenneco Inc. and consolidated subsidiaries as of December 31, 1995 and 1994, and the results of their operations, cash flows and changes in shareowners' equity 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, effective January 1, 1994, Tenneco changed its method of accounting for postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules listed in the index to Part IV, Item 14 relating to Tenneco Inc. and consolidated subsidiaries are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. The supplemental schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements of Tenneco Inc. and consolidated subsidiaries taken as a whole.\nArthur Andersen LLP\nHouston, Texas February 8, 1996\nSTATEMENTS OF INCOME\nThe accompanying notes to financial statements are an integral part of these statements of income. Reference is made to Note 1 for definitions of \"Tenneco Industrial\" and \"Tenneco Finance.\"\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets. Reference is made to Note 1 for definitions of \"Tenneco Industrial\" and \"Tenneco Finance.\"\nSTATEMENTS OF CASH FLOWS\nNote: Cash and temporary cash investments include highly liquid investments with a maturity of three months or less at date of purchase.\nThe accompanying notes to financial statements are an integral part of these statements of cash flows. Reference is made to Note 1 for definitions of \"Tenneco Industrial\" and \"Tenneco Finance.\"\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nSTATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY\nThe accompanying notes to financial statements are an integral part of these statements of changes in shareowners' equity.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF ACCOUNTING POLICIES\nConsolidation and Presentation\nThe financial statements of Tenneco Inc. and consolidated subsidiaries (\"Tenneco\") include all majority-owned subsidiaries including wholly-owned finance subsidiaries. Investments in 20% to 50% owned companies where Tenneco has the ability to exert significant influence over operating and financial policies are carried at cost plus equity in undistributed earnings since date of acquisition (except for Tenneco's farm and construction equipment segment as noted below) and cumulative translation adjustments.\nIn June 1994, Tenneco completed an initial public offering (\"IPO\") of approximately 29% of the common stock of Case Corporation (\"Case\"), the holder of Tenneco's farm and construction equipment segment. In November 1994, a secondary offering of Case's common stock reduced Tenneco's ownership to approximately 44%. A third offering in August 1995 reduced Tenneco's ownership to approximately 21%. For the periods prior to and through November 1994, Case's financial statements were fully consolidated with Tenneco's. From July through November 1994, the financial statements reflected the 29% minority stockholders' interest in Case. Subsequent to November 1994, Case is reflected in Tenneco's financial statements using the equity method of accounting. For further information on this subject, reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss.\"\nThe accompanying financial statements also include, on a separate and supplemental basis, the combination of Tenneco's industrial companies and finance companies as follows:\nTenneco Industrial--The financial information captioned \"Tenneco Industrial\" reflects the consolidation of all majority-owned subsidiaries except for the finance subsidiaries. The finance operations have been included using the equity method of accounting whereby the net income and net assets of these companies are reflected, respectively, in the income statement caption, \"Equity in net income of affiliated companies,\" and in the balance sheet caption, \"Investment in affiliated companies.\"\nTenneco Finance--The financial information captioned \"Tenneco Finance\" reflects the combination of Tenneco's wholly-owned finance subsidiaries.\nPrior to the Case IPO, the wholesale (dealer) credit and retail credit operations of Case were financed by wholly-owned finance subsidiaries. Subsequent to the IPO, the wholesale (dealer) credit operations are being financed by Case industrial subsidiaries. As a result of this change, interest expense related to the wholesale (dealer) credit operations was reported as \"Interest expense\" rather than \"Finance charges--Tenneco Finance\" as in prior periods. If prior periods were reclassified to reflect this presentation of interest expense related to wholesale (dealer) credit operations, consolidated \"Finance charges--Tenneco Finance\" would have been reduced and \"Interest expense\" would have increased by $22 million and $69 million for 1994 and 1993, respectively, with no effect on consolidated net income.\nGains or losses on the sale by a subsidiary of its stock are included in the Statements of Income.\nAll significant intercompany transactions, including activity within and between \"Tenneco Industrial\" and \"Tenneco Finance\" business units, have been eliminated.\nDepreciation, Depletion and Amortization\nDepreciation of Tenneco's properties is provided on a straight-line basis in amounts which, in the opinion of management, are adequate to allocate the cost of properties over their estimated useful lives.\nThe excess of investment in subsidiaries over fair value of net assets at date of acquisition is being amortized over periods ranging from 15 years to 40 years. Such amortization relative to continuing operations\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) amounted to $12 million, $21 million and $15 million for 1995, 1994 and 1993, respectively, and is included in the income statement caption, \"Other income, net.\"\nTenneco has capitalized certain other intangible assets, primarily trademarks and patents, based on their estimated fair value at date of acquisition. Amortization is provided on these intangible assets on a straight-line basis over periods ranging from five to 40 years. The majority of other intangible assets at December 31, 1995, resulted from the acquisition of the plastics division of Mobil Corporation during 1995. See Note 2, \"Acquisitions,\" for further information on the acquisition.\nRevenue Recognition\nNewport News Shipbuilding and Dry Dock Company (\"Newport News\"), a wholly- owned subsidiary, reports profits on its long-term shipbuilding contracts on the percentage-of-completion method of accounting, determined on the basis of total costs incurred to date to estimated final total costs. Losses on contracts are reported when first estimated. The performance of contracts usually extends over several years, requiring periodic reviews and revisions of estimated final contract prices and costs during the term of the contracts. The effect of these revisions to estimates is included in income in the period the revisions are made.\nTenneco's other divisions recognize revenue on the accrual method when title passes to the customer or when the service is performed.\nRisk Management Activities\nTenneco has utilized financial instruments for many years to mitigate its exposure to various risks. Tenneco is currently a party to financial instruments to hedge its exposure to changes in interest rates, foreign currency exchange rates and natural gas prices. These financial instruments are accounted for on the accrual basis with gains and losses being recognized based on the type of contract and exposure being hedged. The amounts paid or received under interest rate swap agreements are recognized as an adjustment to interest expense. After-tax net gains or losses on foreign currency contracts designated as hedges of Tenneco's net investments in foreign subsidiaries are recognized in the balance sheet caption, \"Cumulative translation adjustments.\" Net gains and losses of foreign currency contracts designated as hedges of firm commitments or other specific transactions are deferred and recognized when the offsetting gains or losses are recognized on the hedged items. Net gains and losses on energy commodity contracts are deferred and recognized when the hedged transaction is consummated.\nIn the statements of cash flows, cash receipts or payments related to the financial instruments discussed above are classified consistent with the cash flows from the transactions being hedged.\nIncome Taxes\nTenneco utilizes the liability method of accounting for income taxes whereby it recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets are reduced by a valuation allowance when, based upon management's estimates, it is more likely than not that a portion of the deferred tax assets will not be realized in a future period. The estimates utilized in the recognition of deferred tax assets are subject to revision in future periods based on new facts or circumstances.\nTenneco does not provide for U.S. income taxes on unremitted earnings of foreign subsidiaries as it is the present intention of management to reinvest the unremitted earnings in its foreign operations. Unremitted\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) earnings of foreign subsidiaries is approximately $515 million at December 31, 1995. It is not practicable to determine the amount of U.S. income taxes that would be payable upon remittance of the assets that represent those earnings.\nChanges in Accounting Principles\nTenneco will adopt Statement of Financial Accounting Standards (\"FAS\") 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. FAS No. 121 establishes new accounting standards for measuring the impairment of long-lived assets. The adoption of this new standard will not have a significant effect on Tenneco's consolidated financial position or results of operations.\nEffective January 1, 1994, Tenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This new accounting rule requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. Tenneco recorded an after-tax charge of $39 million ($.22 per average common share) which was reported as a cumulative effect of change in accounting principle.\nInventories\nAt December 31, 1995 and 1994, inventory by major classification was as follows:\nInventories are stated at the lower of cost or market. A portion of inventories are valued using the \"last-in, first-out\" method (38% and 27% at December 31, 1995 and 1994, respectively). All other inventories are valued on the \"first-in, first-out\" (\"FIFO\") or \"average\" methods. If the FIFO or average method of inventory accounting had been used by Tenneco for all inventories, inventories would have been $56 million, $54 million and $47 million higher at December 31, 1995, 1994 and 1993, respectively.\nPlant, Property and Equipment, at Cost\nAt December 31, 1995 and 1994, plant, property and equipment, at cost, by major segment was as follows:\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNotes Receivable and Allowance for Doubtful Accounts and Notes\nShort-term notes receivable of $373 million and $337 million were outstanding at December 31, 1995 and 1994, respectively, of which $216 million and $289 million, respectively, related to Tenneco Finance. These notes receivable are presented net of unearned finance charges of $26 million and $43 million at December 31, 1995 and 1994, respectively, which related to Tenneco Finance. At December 31, 1995 and 1994, unearned finance charges related to long-term notes and other receivables were $23 million and $66 million, respectively, which related to Tenneco Finance.\nAt December 31, 1995 and 1994, the allowance for doubtful accounts and notes receivable was $73 million and $48 million, respectively, of which $9 million related to Tenneco Finance at December 31, 1995.\nEnvironmental Liabilities\nExpenditures for ongoing compliance with environmental regulations that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments indicate that remedial efforts are probable and the costs can be reasonably estimated. Estimates of the liability are based upon currently available facts, existing technology and presently enacted laws and regulations taking into consideration the likely effects of inflation and other societal and economic factors. All available evidence is considered including prior experience in remediation of contaminated sites, other companies' clean-up experience and data released by the United States Environmental Protection Agency or other organizations. These estimated liabilities are subject to revision in future periods based on actual costs or new circumstances. These liabilities are included in the balance sheet at their undiscounted amounts. Recoveries are evaluated separately from the liability and, when recovery is assured, are recorded and reported separately from the associated liability in the financial statements.\nFor further information on this subject, reference is made to Note 15, \"Commitments and Contingencies--Environmental Matters.\"\nEarnings Per Share\nEarnings per share of common stock are based on the average number of shares of common stock outstanding during each period. For purposes of computing earnings per share, Series A preferred stock was included in average common shares outstanding until its conversion into common stock in December 1994; therefore, the preferred dividends paid were not deducted from net income to determine net income to common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994 and 1993. Other convertible securities and common stock equivalents outstanding during each of the three years ended December 31, 1995, 1994 and 1993, were not materially dilutive.\nIn 1992, 12,000,000 shares of common stock were issued to the Stock Employee Compensation Trust (\"SECT\"). Shares of common stock issued to a related trust are not considered to be outstanding in the computation of average shares of common stock outstanding until the shares are utilized to fund the obligations for which the trust was established. During the years ended December 31, 1995, 1994 and 1993, the SECT issued 2,697,770, 2,464,721 and 2,479,425 shares, respectively.\nUnder Tenneco's stock repurchase programs, a total of 14.3 million shares of Tenneco Inc. common stock have been acquired since December 1994, and are included in \"Shares held as treasury stock, at cost\" on the balance sheet. For further information on this subject, reference is made to Note 9, \"Common Stock.\"\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nForeign Currency Translation\nFinancial statements of international subsidiaries are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and the weighted average exchange rate for each applicable period for revenues, expenses and gains and losses. Translation adjustments are reflected in the balance sheet caption \"Cumulative translation adjustments.\"\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in determining the reported amounts of Tenneco's assets, liabilities, revenues and expenses. Reference is made to the \"Revenue Recognition\" and \"Income Taxes\" sections of this footnote and Notes 6, 12, 13 and 15 for additional information on significant estimates included in Tenneco's financial statements.\nReclassifications\nPrior years' financial statements have been reclassified where appropriate to conform to 1995 presentations.\n2. ACQUISITIONS\nIn November 1995, Tenneco acquired the plastics division of Mobil Corporation for $1.3 billion. The plastics business is the largest North American producer of polyethylene and polystyrene consumer and food service packaging and became part of Tenneco Packaging.\nTenneco's acquisition of the plastics business was accounted for as a purchase; accordingly, the purchase price has been allocated to the assets purchased and the liabilities assumed based on preliminary estimates of their fair values. Final purchase price allocations will be based on more complete evaluations and may differ from the original allocation. The excess of the purchase price over the fair value of the net assets acquired is included in the balance sheet caption, \"Investment in subsidiaries in excess of fair value of net assets at date of acquisition, less amortization\" and is being amortized on a straight-line basis over 40 years. The purchase was initially financed by a combination of short-term debt and cash. In December 1995, Tenneco refinanced a portion of the purchase price through a $600 million long-term debt offering. See Note 4, \"Long-Term Debt, Short-Term Debt and Financing Arrangements.\"\nThe following unaudited pro forma information of Tenneco Inc. and consolidated subsidiaries illustrates the effect of the plastics business acquisition as if it had occurred at the beginning of 1994, after giving effect to certain pro forma adjustments including amortization of the excess purchase price, depreciation and other adjustments based on the preliminary purchase price allocation and interest expense related to financing the acquisition, together with estimates of the related income tax effects.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe summarized pro forma information has been prepared for comparative purposes only. It is not intended to be indicative of the actual operating results that would have occurred had the acquisition been consummated at the beginning of 1994, or the results which may be attained in the future.\nDuring 1995, Tenneco made various other acquisitions of assets and investments. Tenneco Energy acquired the natural gas pipeline assets of the Pipeline Authority of South Australia, which includes a 488-mile pipeline, for approximately $225 million. Tenneco Energy also acquired a 50% interest in two gas-fired cogeneration plants from ARK Energy, a privately-owned power generation company, for approximately $65 million in cash and Tenneco Inc. common stock. Tenneco Packaging completed acquisitions of 10 packaging businesses for total consideration of approximately $196 million in cash, notes and Tenneco Inc. common stock. In addition, Tenneco Automotive completed four acquisitions for approximately $54 million.\nEach of the acquisitions was accounted for as a purchase. If these assets and investments had been acquired January 1, 1995, net income would not have been significantly different from the reported amount.\nIn 1994, Tenneco Automotive acquired Heinrich Gillet GmbH & Co. KG for $44 million in cash and $69 million in assumed debt.\n3. DISCONTINUED OPERATIONS, DISPOSITION OF ASSETS AND EXTRAORDINARY LOSS\nDiscontinued Operations\nIn March 1995, Tenneco completed an initial public offering of 100% of its Albright & Wilson chemicals segment. The offering was underwritten in the United Kingdom and was offered primarily in the United Kingdom. Also in 1994, Tenneco sold its brakes operation. Net proceeds from the sales of the chemicals and the brakes operations were approximately $700 million and $18 million, respectively.\nNet assets and results from discontinued operations as of and for the years ended December 31, 1994 and 1993, are as follows:\n- -------- (a) The allocation of interest expense to discontinued operations is based on the ratio of net assets of discontinued operations to consolidated net assets plus debt.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nDisposition of Assets\nCase Common Stock\nIn June 1994, Tenneco completed an IPO of approximately 29% of the common stock of Case. In November 1994, a secondary offering of Case common stock reduced Tenneco's ownership interest in Case to approximately 44%. Combined proceeds from the two transactions was $694 million, net of commissions and offering expenses. The combined gain on the transactions was $36 million, including a $7 million tax benefit.\nIn August 1995, Tenneco sold an additional 16.1 million shares of Case common stock for net proceeds of approximately $540 million. The sale resulted in a pre-tax gain of $101 million and reduced Tenneco's ownership in Case from 44% to 21%.\nOther\nIn December 1995, Tenneco Energy sold its 50% interest in Kern River Gas Transmission Company (\"Kern River\") for a pre-tax gain of $30 million. Kern River owns a 904-mile pipeline extending from Wyoming to California. Also in 1995, Tenneco sold certain other facilities and assets, principally at its Tenneco Packaging and Tenneco Energy segments, and a subordinated note receivable for a combined pre-tax net gain of $31 million.\nDuring 1994, Tenneco disposed of several assets and investments including a facility, machinery and equipment at Tenneco Packaging and facilities and equipment at Case. Proceeds from these dispositions were $125 million resulting in a pre-tax loss of $2 million. Also in 1994, Tenneco Energy Resources Corporation, a subsidiary which operates nonregulated gas marketing and intrastate pipeline businesses, issued 50 shares of its common stock, diluting Tenneco's ownership in this subsidiary to 80%. Cash proceeds were $41 million resulting in a gain of $23 million. No taxes were provided on the gain because management expects that the recorded investment will be recovered in a tax-free manner.\nDuring 1993, Tenneco disposed of a number of assets and investments including its Newport News' Sperry Marine business; several Tenneco Packaging operations; two wholly-owned Tenneco Energy companies, Viking Gas Transmission Company and Dean Pipeline Company; and facilities and land of two foreign Case operations. The proceeds from dispositions were $266 million and the pre-tax gain was $112 million.\nExtraordinary Loss\nIn June 1994, an extraordinary loss of $5 million was recorded, net of $2 million income tax benefit, for the redemption premium resulting from the prepayment of debt.\nIn April 1993, Tenneco Inc. issued 23.5 million shares of common stock for approximately $1.1 billion. The proceeds were used to retire $327 million of short-term debt, $688 million of long-term debt and $14 million of variable- rate preferred stock. In November 1993, Tenneco retired DM250 million bonds. The redemption premium related to the retirement of long-term debt resulting from these two transactions ($25 million, net of income tax benefits of $13 million) was recorded as an extraordinary loss.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n4. LONG-TERM DEBT, SHORT-TERM DEBT AND FINANCING ARRANGEMENTS\nLong-Term Debt\nA summary of long-term debt outstanding at December 31, 1995 and 1994, is set forth in the following table:\nAt December 31, 1995 and 1994, approximately $72 million and $154 million, respectively, of gross plant, property and equipment was pledged as collateral to secure $30 million and $31 million, respectively, principal amounts of long-term debt.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe aggregate maturities and sinking fund requirements applicable to the issues outstanding at December 31, 1995, are $420 million, $521 million, $845 million, $255 million and $181 million for 1996, 1997, 1998, 1999 and 2000, respectively.\nShort-Term Debt\nTenneco uses commercial paper, lines of credit and overnight borrowings to finance its short-term capital requirements. Information regarding short-term debt for the years ended December 31, 1995 and 1994 follows:\n- -------- * Includes borrowings under both committed credit facilities and uncommitted lines of credit and similar arrangements.\nTenneco had other short-term borrowings outstanding of $41 million at December 31, 1995, and $8 million at December 31, 1994.\nFinancing Arrangements\nAs of December 31, 1995, Tenneco and its subsidiaries had arranged committed credit facilities of $2.5 billion:\n- -------- Notes:(a) Tenneco and its subsidiaries generally are required to pay commitment fees on the unused portion of the total commitment and facility fees on the total commitment. (b) In 1996, $400 million of these agreements expire; the remainder are committed through 1999. Of the total committed long-term credit facilities, $400 million are available to both Tenneco Inc. and Tenneco Finance. (c) Tenneco's committed long-term credit facilities support its commercial paper borrowings; consequently, the amount available under the committed long-term credit facilities is reduced by outstanding commercial paper borrowings.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nRestrictions on the Payment of Dividends\nTenneco Inc.'s credit agreements contain provisions that limit the amount of dividends paid on its common stock. At December 31, 1995, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. had in excess of $300 million available for the payment of dividends.\nTennessee Gas Pipeline Company (\"Tennessee\"), a wholly-owned consolidated subsidiary, is restricted as to the payment of dividends under certain of its notes and debentures. Under the provisions of such agreements, Tennessee had approximately $3.7 billion of unrestricted retained earnings at December 31, 1995 for payment of dividends. The payment of unrestricted amounts by Tennessee would not affect the amount of retained earnings of Tenneco Inc. available for dividends on common stock.\n5. FINANCIAL INSTRUMENTS\nThe carrying and estimated fair values of Tenneco's financial instruments by class at December 31, 1995 and 1994, were as follows:\nAsset and Liability Instruments\nThe fair value of cash and temporary cash investments, receivables, accounts payable, and short-term debt in the above table was considered to be the same as or was not determined to be materially different from the carrying amount. At December 31, 1995 and 1994, respectively, Tenneco's aggregate customer and long-term receivable balance was concentrated by industry segment as follows: Tenneco Automotive, 28% and 15%; Tenneco Energy, 14% and 11%; Tenneco Packaging, 9% and 11%; Newport News Shipbuilding, 9% and 8%; United States retail farm and construction equipment receivables held by Tenneco Credit Corporation, 33% and 30%; all other amounts were not significant.\nLong-term debt--The fair value of fixed-rate long-term debt was based on the market value of debt with similar maturities and interest rates; the carrying amount of floating-rate debt was assumed to approximate its fair value.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nInstruments With Off-Balance-Sheet Risk\nDerivative\nInterest Rate Swaps--The fair value of interest rate swaps was based on the cost that would have been incurred to buy out those swaps in a loss position and the consideration that would have been received to terminate those swaps in a gain position. At December 31, 1995 and 1994, Tenneco was a party to swaps with a notional value of $1.5 billion and $1.6 billion, respectively. At December 31, 1995, $750 million were in a net receivable position and $795 million were in a net payable position. At December 31, 1994, the entire $1.6 billion was in a net payable position. Notional amounts associated with these swaps do not represent future cash payment requirements. These contractual amounts are only used as a base to measure amounts to be exchanged at specified settlement dates.\nConsistent with its overall policy, Tenneco uses these instruments from time to time only to hedge known, quantifiable risks arising from fluctuations in interest rates. The counterparties to these interest rate swaps are major international financial institutions. The risk associated with counterparty default on interest rate swaps is measured as the cost of replacing, at the prevailing market rates, those contracts in a gain position. In the event of non-performance by the counterparties, the cost to replace outstanding interest rate swaps at December 31, 1995 and 1994, would not have been material.\nForeign Currency Contracts--Tenneco utilizes foreign exchange forward contracts and foreign currency interest rate swaps to hedge certain translation effects of Tenneco's investment in net assets in certain foreign subsidiaries. Pursuant to these arrangements, Tenneco recognized aggregate after-tax translation gains (losses) of $3 million, $(2) million and $5 million for 1995, 1994 and 1993, respectively, which have been included in the balance sheet caption, \"Cumulative translation adjustments.\"\nIn the normal course of business, Tenneco and its foreign subsidiaries also routinely enter into various foreign currency forward purchase and sale contracts to hedge the transaction effect of exchange rate movements on receivables and payables denominated in foreign currencies. These foreign currency contracts generally mature in one year or less.\nIn managing its foreign currency exposures, Tenneco identifies naturally occurring offsetting positions and then hedges residual exposures. The following table summarizes by major currency the contractual amounts of foreign currency contracts utilized by Tenneco:\nBased on exchange rates at December 31, 1995 and 1994, the cost of replacing these contracts in the event of non-performance by the counterparties would not have been material.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nPrice Risk Management--Tenneco uses exchange-traded futures and option contracts and over-the-counter option and swap contracts to reduce its exposure to fluctuations in the prices of natural gas. The fair value of these contracts is based upon the estimated consideration that would be received to terminate those contracts in a gain position and the estimated cost that would be incurred to terminate those contracts in a loss position. As of December 31, 1995 and 1994, these contracts, maturing through 1997 and 1996, respectively, had an absolute notional contract quantity of 321 Bcf and 187 Bcf, respectively. Since the contracts described above are designated as hedges whose fair values correlate to price movements of natural gas, any gains or losses on the contracts resulting from market changes will be offset by losses or gains on the hedged transactions. Tenneco has off-balance sheet risk of credit loss in the event of non-performance by counterparties to all over-the- counter contracts. However, Tenneco does not anticipate non-performance by the counterparties.\nNon-derivative\nGuarantees--At December 31, 1995 and 1994, Tenneco had guaranteed payment and performance of approximately $30 million and $50 million, respectively, primarily with respect to letters of credit and other guarantees supporting various financing and operating activities.\n6. FEDERAL ENERGY REGULATORY COMMISSION (\"FERC\") REGULATORY MATTERS\nRestructuring Proceedings\nPursuant to Order 636 issued by the FERC on April 8, 1992, Tennessee implemented revisions to its tariff, effective on September 1, 1993, which restructured its transportation, storage and sales services to convert Tennessee from primarily a merchant to primarily a transporter of gas. As a result of this restructuring, Tennessee's gas sales declined while certain obligations to producers under long-term gas supply contracts continued, causing Tennessee to incur significant restructuring transition costs. Pursuant to the provisions of Order 636 allowing for the recovery of transition costs related to the restructuring, Tennessee has made filings to recover gas supply realignment (\"GSR\") costs resulting from remaining gas purchase obligations, costs related to its Bastian Bay facilities, the remaining unrecovered balance of purchased gas (\"PGA\") costs and the \"stranded\" cost of Tennessee's continuing contractual obligation to pay for capacity on other pipeline systems (\"TBO costs\").\nTennessee's filings to recover costs related to its Bastian Bay facilities have been rejected by the FERC based on the continued use of the gas production from the field; however, the FERC recognized the ability of Tennessee to file for the recovery of losses upon disposition of these assets. Tennessee has filed for appellate review of the FERC actions and is confident that the Bastian Bay costs will ultimately be recovered as transition costs under Order 636; the FERC has not contested the ultimate recoverability of these costs.\nThe filings implementing Tennessee's recovery mechanisms for the following transition costs were accepted by the FERC effective September 1, 1993; recovery is subject to refund pending FERC review and approval for eligibility: 1) direct-billing of unrecovered PGA costs to its former sales customers over a twelve-month period; 2) recovery of TBO costs, which Tennessee is obligated to pay under existing contracts, through a surcharge from firm transportation customers, adjusted annually; and 3) GSR cost recovery of 90% of such costs over a period of up to 36 months from firm transportation customers and recovery of 10% of such costs from interruptible transportation customers over a period of up to 60 months.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nFollowing negotiations with its customers, Tennessee filed in July 1994 with the FERC a Stipulation and Agreement (the \"PGA Stipulation\"), which provides for the recovery of PGA costs of approximately $100 million and the recovery of costs associated with the transfer of storage gas inventory to new storage customers in Tennessee's restructuring proceeding. The PGA Stipulation eliminates all challenges to the PGA costs, but establishes a cap on the charges that may be imposed upon former sales customers. On November 15, 1994, the FERC issued an order approving the PGA Stipulation and resolving all outstanding issues. On April 5, 1995, the FERC issued its order on rehearing affirming its initial approval of the PGA Stipulation. Tennessee implemented the terms of the PGA Stipulation and made refunds in May 1995. The refunds had no material effect on Tenneco's reported net income. The orders approving the PGA Stipulation have been appealed to the D.C. Circuit Court of Appeals by certain customers. Tennessee believes the FERC orders approving the PGA Stipulation will be upheld on appeal.\nTennessee is recovering through a surcharge, subject to refund, TBO costs formerly incurred to perform its sales function, pending FERC review of data submitted by Tennessee. The FERC subsequently issued an order requiring Tennessee to refund certain costs from this surcharge. Tennessee is appealing this decision and believes such appeal will likely be successful.\nWith regard to Tennessee's GSR costs, Tennessee, along with three other pipelines, executed four separate settlement agreements with Dakota Gasification Company and the U.S. Department of Energy and initiated four separate proceedings at the FERC seeking approval to implement the settlement agreements. The settlement resolved litigation concerning purchases made by Tennessee of synthetic gas produced from the Great Plains Coal Gasification plant (\"Great Plains\"). The FERC previously ruled that the costs related to the Great Plains project are eligible for recovery through GSR and other special recovery mechanisms and that the costs are eligible for recovery for the duration of the term of the original gas purchase agreements. On October 18, 1994, the FERC consolidated the four proceedings and set them for hearing before an administrative law judge (\"ALJ\"). The hearing, which concluded in July 1995, was limited to the issue of whether the settlement agreements are prudent. The ALJ concluded, in his initial decision issued in December 1995, that the settlement was imprudent. Tennessee has filed exceptions to this initial decision and believes that this decision will not impair Tennessee's recovery of the costs resulting from this contract. The FERC has committed to issuing a final order by December 31, 1996.\nAlso related to Tennessee's GSR costs, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. An amendment to the pleading seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee filed a motion for summary judgment, asserting that the Texas statutes of frauds precluded the plaintiffs from adding new production or acreage to the contract. On May 4, 1995, the trial court granted Tennessee's motion for summary judgment; the plaintiffs have filed a notice of appeal. Thereafter, ICA and TransTexas filed a motion for summary judgment on a separate issue involving the term \"committed reserves\" and whether Tennessee has a contractual obligation to purchase gas produced from a lease not described in the gas contract. On November 8, 1995, the trial court granted ICA's and TransTexas' motion in part. That order, which would be finalized upon conclusion of the trial, also held that ICA's and TransTexas' rights are subject to certain limitations of the Texas Business and Commerce Code. In addition to these defenses, which are to be resolved at trial, Tennessee has other defenses which it has asserted and intends to pursue. Tennessee has\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) filed a Motion to Clarify the November 8, 1995 order together with a new motion for partial summary judgment concerning the committed reserve issue. The November 8, 1995 ruling does not affect the trial court's previous May 4, 1995 order granting summary judgment to Tennessee.\nTennessee has been engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee. Although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious, Tennessee accrued amounts in the first quarter of 1995 which it believes are adequate to cover the resolution of these matters. On August 1, 1995, the Texas Supreme Court affirmed a ruling of the Court of Appeals favorable to Tennessee in one of these matters and indicated that it would remand the case to the trial court. Motions for rehearing have been filed by the producers. As of the date hereof, the court had not ruled on those motions and mandate had not been issued.\nAs of December 31, 1995, Tennessee has deferred GSR costs yet to be recovered from its customers of approximately $462 million, net of $316 million previously recovered from its customers, subject to refund. A proceeding before a FERC ALJ is scheduled to commence in early 1996 to determine whether Tennessee's GSR costs are eligible for cost recovery. The FERC has generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 provides for complete recovery by pipelines of eligible and prudently incurred transition costs, certain customers have challenged the prudence and eligibility of Tennessee's GSR costs and Tennessee has engaged in settlement discussions with its customers concerning the amount of such costs in response to the FERC and customer statements acknowledging the desirability of such settlements.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact that the resolution of these issues will have on its consolidated financial position or results of operations.\nRate Proceedings\nOn December 30, 1994, Tennessee filed for a general rate increase (the \"1995 Rate Case\"). On January 25, 1995, the FERC accepted the filing, suspended its effectiveness for the maximum period of five months pursuant to normal regulatory process, and set the matter for hearing. On July 1, 1995, Tennessee began collecting rates, subject to refund, reflecting an $87 million increase in Tennessee's annual revenue requirement. Settlement discussions with the FERC staff and customers regarding 1995 Rate Case issues, including structural rate design and increased revenue requirements, are ongoing and Tennessee is reserving revenues it believes adequate to cover any refunds that may be required upon final settlement of this proceeding. A hearing is scheduled to commence in March 1996.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n7. INCOME TAXES\nThe domestic and foreign components of income from continuing operations before income taxes are as follows:\nFollowing is a comparative analysis of the components of consolidated income tax expense applicable to continuing operations:\nFollowing is a reconciliation of income taxes computed at the U.S. federal income tax rate (35% for all years presented) to the income tax expense from continuing operations reflected in the Statements of Income:\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe components of Tenneco's net deferred tax liability at December 31, 1995 and 1994, were as follows:\nAs reflected by the valuation allowance in the table above, Tenneco had potential tax benefits of $200 million and $374 million at December 31, 1995 and 1994, respectively, which were not recognized in the Statements of Income when generated. These benefits resulted primarily from tax loss carryforwards which are available to reduce future tax liabilities. During 1995, Tenneco reduced its deferred tax asset valuation allowance due to the recognition of tax loss carryforwards utilized to offset income taxes payable on asset and investment dispositions.\nAt December 31, 1995, Tenneco had tax benefits of $163 million related to U.S. capital loss carryforwards which expire in 1999 and $83 million from foreign net operating loss carryforwards which will carry forward indefinitely.\n8. INVESTMENT IN AFFILIATED COMPANIES\nTenneco holds investments in various affiliates which are accounted for on the equity method of accounting. The principal equity method investments during 1995 and 1994 were Tenneco's investment in Case common stock and its 50% investment in Kern River. As previously discussed, during 1995, Tenneco reduced its total ownership in Case from 44% to 21% and sold its investment in Kern River. Additionally, Case was not accounted for by the equity method of accounting until December 1994, when Tenneco's total ownership in Case was reduced below 50%. At December 31, 1995, the quoted market value of Tenneco's 21% investment in Case was approximately $694 million.\nAt December 31, 1995, Tenneco's retained earnings included equity in undistributed earnings and cumulative translation adjustments from equity method investments of $113 million and $(4) million, respectively; at December 31, 1994, the corresponding amounts were $154 million and $(29) million, respectively. Dividends and distributions received from affiliates accounted for on the equity method were $60 million, $50 million and $45 million during 1995, 1994 and 1993, respectively.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nSummarized financial information of Tenneco's proportionate share of 50% or less owned companies accounted for by the equity method of accounting as of December 31, 1995, 1994 and 1993, and for the years then ended is as follows:\n- -------- Note: The above table reflects Tenneco's 44% ownership in Case from December 1994 through July 1995, and the remaining 21% ownership in Case for August 1995 and subsequent periods. In addition, balance sheet amounts related to Kern River are not included in the table above as of December 31, 1995 due to the sale discussed above.\n9. COMMON STOCK\nTenneco Inc. has authorized 350 million shares ($5.00 par value) of common stock, and 191,351,615 and 191,335,193 shares were issued at December 31, 1995 and 1994, respectively. At December 31, 1995, the SECT held 4,358,084 shares which are included in the issued shares quoted above. Treasury stock held by Tenneco was 16,422,619 and 3,617,510 shares at the respective dates.\nStock Repurchase Plans\nTenneco completed the $500 million common stock repurchase program initiated in December 1994. In 1995, Tenneco announced two additional repurchase programs, one for up to 3 million shares and another for 2.5 million shares. Purchases executed through the programs were made in the open market or in negotiated purchases. Under these programs, approximately 14.3 million shares have been acquired at a total cost of $646 million and are included in \"Shares held as treasury stock, at cost\" on the balance sheet at December 31, 1995.\nReserved\nAt December 31, 1995, the shares of Tenneco Inc. common stock reserved for issuance were as follows:\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nStock Plans\n1994 Tenneco Inc. Stock Ownership Plan--In May 1994, Tenneco adopted the Stock Ownership Plan effective as of December 8, 1993. This plan provides Tenneco the latitude to grant a variety of awards, such as common stock, stock equivalent units, dividend equivalents, performance units, stock appreciation rights (\"SARs\") and stock options, to officers and key employees of the Tenneco companies. The plan requires that options and SARs be granted at not less than the fair market value of a share of common stock on the grant date. The plan also requires that no award granted shall vest in less than six months after the grant date. The Company can issue 8,400,000 shares of common stock under this plan, which will terminate December 31, 1998. At December 31, 1995, 620,030 restricted shares and 19,705 restricted units at an average price of $48.18 per share and 110,500 stock equivalent units were outstanding under this plan at an average price of $49.63 per share.\n1988 Key Employee Restricted Stock Plan--At December 31, 1995, 524,688 restricted shares and 11,895 restricted units were outstanding under this plan at an average price of $43.82 per share. These awards generally require, among other things, that the employee remain an employee of Tenneco during the restriction period. This plan was superseded by the 1994 Tenneco Inc. Stock Ownership Plan.\nUnder another arrangement, 300 shares (250 shares for years prior to 1995) of restricted stock or restricted units are issued annually to each member of the Board of Directors who is not also an officer of Tenneco. At December 31, 1995, 13,000 restricted shares and no restricted units were outstanding under this program at an average price of $45.51 per share.\nOptions and Stock Appreciation Rights--Tenneco Inc. has granted stock options and stock appreciation rights to key employees under a prior plan. The options and SARs became exercisable over four years and lapse after ten years from the date of grant. The prior plan was superseded by the 1994 Tenneco Inc. Stock Ownership Plan.\nThe following table reflects the status and activity for all stock options issued by Tenneco Inc., including those outside the option plans discussed above, for the periods indicated:\nFor the years ended December 31, 1995, 1994 and 1993, compensation expense for these stock plans was not material.\nEmployee Stock Purchase Plan--In June 1992, Tenneco initiated an Employee Stock Purchase Plan. The Plan allows U.S. and Canadian Tenneco employees to purchase Tenneco Inc. common stock at a 15% discount. Each year employees in the plan may purchase shares with a discounted value not to exceed $21,250. Tenneco reserved 5,000,000 shares of treasury stock to be issued through this plan. At December 31, 1995, 1,844,461 shares had been issued to participants and the remaining shares are held by the SECT for issuance to employees in this plan.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nStock Employee Compensation Trust\nIn November 1992, Tenneco established the SECT to fund a portion of its obligations arising from its various employee compensation and benefit plans. Tenneco issued 12,000,000 shares of treasury stock to the SECT in exchange for a promissory note of $432 million that bears interest at the rate of 7.8% per annum. The SECT has a five-year life during which it will utilize the common stock to satisfy those obligations. At December 31, 1995, 7,641,916 shares had been utilized.\nShareholder Rights Plan\nIn 1988, Tenneco Inc. adopted a Shareholder Rights Plan (\"the Plan\") to deter coercive takeover tactics and to prevent a potential acquiror from gaining control of Tenneco without offering a fair price to all Tenneco Inc. shareholders. Under the Plan, each outstanding share of Tenneco Inc. common stock received one Purchase Right, exercisable at $130, subject to adjustment. In the event a person or group acquires 20% or more of the outstanding Tenneco Inc. common stock other than pursuant to an offer for all shares of such common stock which is fair and in the best interests of Tenneco Inc. and its shareholders, or has in the judgment of the Tenneco Inc. Board of Directors acquired a substantial amount of common stock under certain motives deemed adverse to Tenneco's best interests, each Purchase Right entitles the holder to purchase shares of common stock or other securities of Tenneco Inc. or, under certain circumstances, of the acquiring person, having a value of twice the exercise price. The Purchase Rights, under certain circumstances, are redeemable by Tenneco Inc. at a price of $.02 per Purchase Right. The Plan is scheduled to terminate in 1998.\nDividend Reinvestment and Stock Purchase Plan\nUnder the Tenneco Inc. Dividend Reinvestment and Stock Purchase Plan, holders of Tenneco Inc. common stock and $7.40 preferred stock may apply their cash dividends and optional cash investments to the purchase of shares of common stock.\n10. PREFERRED STOCK\nAt December 31, 1995, Tenneco Inc. had authorized 15,000,000 shares of preferred stock. In addition, Tenneco Inc. has an authorized class of stock consisting of 50,000,000 shares of junior preferred stock, without par value, none of which has been issued. Tenneco has reserved 3,500,000 shares of junior preferred stock for the Shareholder Rights Plan.\nThe preferred stock issues outstanding at December 31, 1995, are as follows:\nIn December 1991, Tenneco issued 17,870,350 Depositary Shares, each representing one-half of a share of a new series of cumulative preferred stock designated as Series A preferred stock. On December 16, 1994, Tenneco exercised its option to call all of the outstanding shares, which were converted into shares of Tenneco Inc. common stock. In addition, $11 million was paid for dividends on the Series A preferred stock that were accrued but unpaid at the conversion date.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe $7.40 and $4.50 preferred stock issues have a mandatory redemption value of $100 per share (an aggregate of $139 million and $159 million at December 31, 1995 and 1994, respectively). Tenneco recorded these preferred stocks at their fair value at the date of original issue (an aggregate of $250 million) and is making periodic accretions of the excess of the redemption value over the fair value at the date of issue. Such accretions are included in the income statement caption \"Preferred stock dividends\" as a reduction of net income to arrive at net income to common stock.\nDuring 1993, Tenneco retired the remainder of a variable rate preferred stock issue at the redemption price of $100 per share, or $17 million.\nThe aggregate maturities applicable to preferred stock issues outstanding at December 31, 1995, are $20 million for each of the years 1996 and 1997, $19 million for 1998 and $80 million for 1999.\nChanges in Preferred Stock with Mandatory Redemption Provisions*\n- -------- * For additional information on Series A preferred stock see Statements of Changes in Shareowners' Equity.\n11. MINORITY INTEREST\nAt both December 31, 1995 and 1994, Tenneco reported minority interest in the balance sheet of $320 million. At December 31, 1995, $293 million of minority interest resulted from the December 1994 sale by Tenneco of a 25% preferred stock interest in Tenneco International Holding Corp. (\"TIHC\") to a financial investor. TIHC is a separate legal entity from Tenneco Inc. and holds certain assets including the capital stock of Tenneco Canada Inc., Monroe Europe N.V., Monroe Australia Proprietary Limited, Walker France S.A. and other subsidiaries included in the Tenneco Automotive segment. TIHC also holds financial obligations of Tenneco or guaranteed by Tenneco. For financial reporting purposes, the assets, liabilities and earnings of TIHC and its subsidiaries have continued to be consolidated in Tenneco's financial statements, and the investor's preferred stock interest has been recorded as \"Minority interest\" in the balance sheet.\nDividends on the TIHC preferred stock are based on the issue price ($300 million) times a rate per annum equal to 1.12% over LIBOR and are payable quarterly in arrears on the last business day of each quarter commencing on March 31, 1995. For 1995, the weighted average rate paid on TIHC preferred stock was 7.30%. Additionally, beginning in 1996, the holder of the 12,000,000 shares of preferred stock will be entitled to receive, when and if declared by the Board of Directors of TIHC, participating dividends based on the operating income growth rate of TIHC. For financial reporting purposes, dividends paid by TIHC to its financial investors have been recorded in Tenneco's income statement as \"Minority interest.\"\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n12. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nPostretirement Benefits\nTenneco has postretirement health care and life insurance plans which cover substantially all of its domestic employees. For salaried employees, the plans cover employees retiring from Tenneco on or after attaining age 55 who have had at least 10 years service with Tenneco after attaining age 45. For hourly employees, the postretirement benefit plans generally cover employees who retire pursuant to one of Tenneco's hourly employee retirement plans. All of these benefits may be subject to deductibles, copayment provisions and other limitations, and Tenneco has reserved the right to change these benefits.\nThe majority of Tenneco's postretirement benefit plans are not funded. In June 1994, two trusts were established to fund postretirement benefits for certain plan participants of the Tenneco Energy segment. The contributions are collected from customers in FERC approved rates. As of December 31, 1995, cumulative contributions were $10 million. Plan assets consist principally of fixed income securities.\nThe funded status of the postretirement benefit plans reconciles with amounts recognized on the balance sheet at December 31, 1995 and 1994, as follows (Note):\n- -------- Note: The accrued postretirement benefit cost has been recorded based upon certain actuarial estimates as described below. Those estimates are subject to revision in future periods given new facts or circumstances.\nIn conjunction with the Case IPO in June 1994, active Case salaried employees were transferred from the Tenneco Inc. plans to new Case salaried plans, and Case hourly retirees were transferred from the Case hourly plans to the Tenneco Inc. plans. Amendments to reduce the cost of providing future benefits for Case hourly retirees were reflected at that time.\nIn November 1994, through a secondary offering of Case stock, Tenneco's ownership in Case dropped below 50%. Therefore, all Case liabilities for the new Case plans are excluded from the Tenneco disclosure information beginning in 1994. Benefit costs for these plans have been included up to the date of the secondary offering (for all of 1993 and 11 months of 1994).\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe net periodic postretirement benefit cost from continuing operations for the years 1995, 1994 and 1993 consist of the following components:\nTenneco recorded a pre-tax loss resulting from curtailments, settlements and special termination benefits under these plans of $3 million in 1994 related primarily to restructuring at Case.\nThe initial weighted average assumed health care cost trend rate used in determining the 1995, 1994 and 1993 accumulated postretirement benefit obligation was 7%, 8% and 9%, respectively, declining to 5% in 1997 and remaining at that level thereafter.\nIncreasing the assumed health care cost trend rate by one percentage-point in each year would increase the 1995, 1994 and 1993 accumulated postretirement benefit obligations by approximately $36 million, $34 million and $47 million, respectively, and would increase the aggregate of the service cost and interest cost components of the net postretirement benefit cost for 1995, 1994 and 1993 by approximately $4 million, $5 million and $10 million, respectively.\nThe discount rates (which are based on long-term market rates) used in determining the 1995, 1994 and 1993 accumulated postretirement benefit obligations were 7.75%, 8.25% and 7.50%, respectively.\nPostemployment Benefits\nTenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" in the first quarter of 1994. This new accounting rule requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. Implementation of this new rule reduced 1994 net income by $39 million, or $.22 per share, net of income tax benefits of $26 million, which was reported as the cumulative effect of a change in accounting principle.\n13. PENSION PLANS\nTenneco has retirement plans which cover substantially all of its employees. Benefits are based on years of service and, for most salaried employees, on final average compensation. Tenneco's funding policies are to contribute to the plans amounts necessary to satisfy the funding requirements of federal laws and regulations. Plan assets consist principally of listed equity and fixed income securities.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe funded status of the plans reconciles with amounts recognized on the balance sheet at December 31, 1995 and 1994, as follows:\n- -------- Note: Assets of one plan may not be utilized to pay benefits of other plans. Additionally, the prepaid (accrued) pension cost has been recorded based upon certain actuarial estimates as described below. Those estimates are subject to revision in future periods given new facts or circumstances.\nIn December 1993, all liabilities and assets were transferred from the Case Corporation Pension Plan for Hourly-Paid Employees (\"Case Plan\") to the Tenneco Inc. Retirement Plan. In June 1994, all future accruals for the salaried and hourly active Case employees were transferred from the Tenneco Inc. Retirement Plan to new Case plans. In November 1994, through a secondary offering of Case stock, Tenneco's ownership in Case dropped below 50%. Therefore, all domestic and foreign Case liabilities and assets in the new Case plans are excluded from the Tenneco disclosure information beginning in 1994. Pension cost (income) for these plans has been included up to the date of the secondary offering (for all of 1993 and 11 months of 1994).\nNet periodic pension costs (income) from continuing operations for the years 1995, 1994 and 1993 consist of the following components:\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Pre-tax gains (losses) resulting from curtailments, settlements and special termination benefits under these plans were $(19) million and $(37) million for 1994 and 1993, respectively, all of which related primarily to restructuring at Case.\nThe weighted average discount rates (which are based on long-term market rates) used in determining the 1995, 1994 and 1993 actuarial present value of the benefit obligations were 7.8%, 8.4% and 7.6%, respectively. The rate of increase in future compensation was 5.0%, in 1995 and 1994, and 5.1% in 1993. The weighted average expected long-term rate of return on plan assets was 10.0% in 1995 and 1994 and 9.9% in 1993.\n14. SEGMENT AND GEOGRAPHIC AREA INFORMATION\nTenneco is a diversified industrial conglomerate with multinational operations. Tenneco's principal business segments are as follows:\nTenneco Automotive-- International manufacturer of exhaust system parts and ride control products for automobiles, which are sold in both the original equipment and replacement markets.\nTenneco Energy-- Transporter and marketer of natural gas, operating in both the regulated and nonregulated environments. Additionally, holds interests in international natural gas pipelines and domestic power generation projects.\nTenneco Packaging-- Manufacturer of packaging materials, cartons, containers and specialty packaging products for consumer and commercial markets.\nNewport News Primary business includes the design, Shipbuilding-- construction and repair of U.S. Naval ships and submarines, and commercial vessels.\nIn addition to the principal business segments above, Tenneco also holds a 21% ownership interest in Case, a leading manufacturer of farm and construction equipment with primary operations in the U.S. and European Union. During 1995, Tenneco sold its Albright & Wilson chemicals segment, which was involved in the production of phosphorous chemicals and surfactants, as well as a range of specialty chemicals. For more discussion of Tenneco's farm and construction equipment and chemicals segments, see Notes 1 and 3.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) The following tables summarize certain segment and geographic information of Tenneco's businesses:\nSee notes on page 69\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nSee notes on following page.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n- -------- Notes: (a) Contracts with U.S. government agencies (primarily shipbuilding contracts with the U.S. Navy) accounted for $1.7 billion, $1.8 billion and $1.9 billion for 1995, 1994 and 1993, respectively. (b) Products are transferred between geographic areas on a basis intended to reflect as nearly as possible the \"market value\" of the products. (c) Case was reflected in Tenneco's financial statements using the equity method of accounting subsequent to November 1994. Reference is made to Note 1, \"Summary of Accounting Policies--Consolidation and Presentation.\" (d) As reflected above, Tenneco's segments principally market their products and services in the United States, with significant sales in the European Union and other foreign countries.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nTenneco is engaged in the sale of products for export from the United States. Such sales are reflected in the table below:\n15. COMMITMENTS AND CONTINGENCIES\nCapital Commitments\nTenneco estimates that expenditures aggregating approximately $1.3 billion will be required after December 31, 1995, to complete facilities and projects authorized at such date, and substantial commitments have been made in connection therewith.\nPurchase Obligations\nIn connection with the financing commitments of certain joint ventures, Tenneco has entered into unconditional purchase obligations for products and services of $145 million ($106 million on a present value basis) at December 31, 1995. Tenneco's annual obligations under these agreements are $22 million for the years 1996 through 2000. Payments under such obligations, including additional purchases in excess of contractual obligations, were $26 million, $34 million and $31 million for the years 1995, 1994 and 1993, respectively. In addition, in connection with the Great Plains coal gasification project (Dakota Gasification Company), Tennessee has contracted to purchase 30% of the output of the plant's original design capacity for a remaining period of 14 years. Tennessee has executed a settlement of this contract as a part of its gas supply realignment negotiations discussed in Note 6.\nLease Commitments\nTenneco holds certain of its facilities and equipment under long-term leases. The minimum rental commitments under non-cancelable operating leases with lease terms in excess of one year are $139 million, $128 million, $126 million, $113 million and $117 million for the years 1996, 1997, 1998, 1999 and 2000, respectively, and $868 million for subsequent years. Of these amounts, $81 million for 1996, $84 million for 1997, $93 million for 1998, $86 million for 1999, $92 million for 2000 and $689 million for subsequent years are lease payment commitments to GECC, John Hancock and Metropolitan Life for assets purchased from\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Georgia-Pacific in January 1991 and leased to Tenneco Packaging. Commitments under capital leases were not significant to the accompanying financial statements. Total rental expense for continuing operations for the years 1995, 1994 and 1993, was $176 million, $197 million and $200 million, respectively, including minimum rentals under non-cancelable operating leases of $166 million, $189 million and $196 million for the corresponding periods.\nLitigation\nReference is made to Note 6, \"Federal Energy Regulatory Commission (\"FERC\") Regulatory Matters,\" for information concerning gas supply litigation. Tenneco Inc. and its subsidiaries are parties to numerous other legal proceedings arising from their operations. Tenneco believes that the outcome of these proceedings, individually and in the aggregate, will have no material effect on the financial position or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nEnvironmental Matters\nSince 1988, Tennessee has been engaged in an internal project to identify and deal with the presence of polychlorinated biphenyls (\"PCBs\") and other substances of concern, including substances on the U.S. Environmental Protection Agency (\"EPA\") List of Hazardous Substances (\"HS List\") at compressor stations and other facilities operated by both its interstate and intrastate natural gas pipeline systems. While conducting this project, Tennessee has been in frequent contact with federal and state regulatory agencies, both through informal negotiation and formal entry of consent orders, in order to assure that its efforts meet regulatory requirements.\nTenneco has established a reserve for Tennessee's environmental expenses, which includes: 1) expected remediation expense and associated onsite, offsite and groundwater technical studies, 2) legal fees and 3) settlement of third party and governmental litigation, including civil penalties. Through December 31, 1995, Tenneco has charged approximately $147 million against the environmental reserve, excluding recoveries related to Tennessee's environmental settlement as discussed below. Of the remaining reserve, $38 million has been recorded on the balance sheet under \"Payables-trade\" and $126 million under \"Deferred credits and other liabilities.\"\nDue to the current uncertainty regarding the further activity necessary for Tennessee to address the presence of the PCBs, the substances on the HS List and other substances of concern on its sites, including the requirements for additional site characterization, the actual amount of such substances at the sites, and the final, site-specific cleanup decisions to be made with respect to cleanup levels and remediation technologies, Tennessee cannot at this time accurately project what additional costs, if any, may arise from future characterization and remediation activities. While there are still many uncertainties relating to the ultimate costs which may be incurred, based upon Tennessee's evaluation and experience to date, Tenneco continues to believe that the recorded estimate for the reserve is adequate.\nFollowing negotiations with its customers, Tennessee in May 1995 filed with the FERC a separate Stipulation and Agreement (the \"Environmental Stipulation\") that addresses the recovery of environmental costs currently being recovered in its rates and also establishes a mechanism for recovering a substantial portion of the environmental costs that will be expended in the future. In November 1995, the FERC issued an order approving the Environmental Stipulation. Although one shipper on its system has filed for rehearing, Tennessee believes the Environmental Stipulation will be upheld. The effects of the Environmental Stipulation, which is effective as of July 1, 1995, have been recorded with no material effect on Tenneco's financial position or results of operations. As of December 31, 1995, the balance of the regulatory asset is $74 million.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nTenneco has completed settlements with and has received payments from the majority of its liability insurance policy carriers for remediation costs and related claims. Tenneco believes that the likelihood of recovery of a portion of its remediation costs and claims against the remaining carriers in its pending litigation is reasonably possible. In addition, Tennessee has settled its pending litigation against and received payment from the manufacturer of the PCB-containing lubricant. These recoveries have been considered in Tennessee's recording of its environmental settlement with its customers.\nTenneco has identified other sites in its various operating divisions where environmental remediation expense may be required should there be a change in ownership, operations or applicable regulations. These possibilities cannot be predicted or quantified at this time and accordingly, no provision has been recorded. However, provisions have been made for all instances where it has been determined that the incurrence of any material remedial expense is reasonably possible. Tenneco believes that the provisions recorded for environmental exposures are adequate based on current estimates.\n16. QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------- Notes: Reference is made to Notes 2, 3 and 9 for discussion of items affecting quarterly results. The sum of the quarters may not equal the total of the respective year's earnings per share due to the issuance or repurchase of shares throughout the year.\n(The preceding notes are an integral part of the foregoing financial statements.)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere has been no change in accountants during 1995 or 1994, nor has there been any disagreement on any matter of accounting principles or practices or financial disclosure which in either case is required to be reported pursuant to this Item 9.\nPART III\nItem 10, \"Directors and Executive Officers of the Registrant,\" Item 11, \"Executive Compensation,\" Item 12, \"Security Ownership of Certain Beneficial Owners and Management,\" and Item 13, \"Certain Relationships and Related Transactions,\" have been omitted from this report inasmuch as Tenneco Inc. will file with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report a definitive Proxy Statement for the Annual Meeting of Stockholders of Tenneco Inc. to be held on May 14, 1996, at which meeting the stockholders will vote upon the election of directors. The information under the caption \"Election of Directors\" in such Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nFINANCIAL STATEMENTS INCLUDED IN ITEM 8\nSee \"Index to Financial Statements of Tenneco Inc. and Consolidated Subsidiaries\" set forth in Item 8, \"Financial Statements and Supplementary Data.\"\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES INCLUDED IN ITEM 14\nSCHEDULES OMITTED AS NOT REQUIRED OR INAPPLICABLE\nSchedule III--Real estate and accumulated depreciation\nSchedule IV--Mortgage loans on real estate\nSchedule V--Supplemental Information Concerning Property-- Casualty Insurance Operations\nSCHEDULE I\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nSTATEMENTS OF INCOME\n(The accompanying notes to financial statements are an integral part of these statements of income.)\nSCHEDULE I (CONTINUED)\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nSTATEMENTS OF CASH FLOWS\n- -------- Note: Cash and temporary cash investments include highly liquid investments with a maturity of three months or less at date of purchase.\n(The accompanying notes to financial statements are an integral part of these statements of cash flows.)\nSCHEDULE I (CONTINUED)\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nBALANCE SHEETS\n(The accompanying notes to financial statements are an integral part of these balance sheets.)\nSCHEDULE I (CONTINUED)\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nNOTES TO FINANCIAL STATEMENTS\nThe financial statements of Tenneco Inc. should be read in conjunction with the financial statements of Tenneco Inc. and Consolidated Subsidiaries presented in this document.\nAccounting Policies\nMajority-owned subsidiaries and companies in which at least a 20% voting interest is owned are carried at cost plus equity in undistributed earnings since date of acquisition and cumulative translation adjustments. At December 31, 1995, equity in undistributed earnings and cumulative translation adjustments amounted to $3,890 million and $18 million, respectively; at December 31, 1994, the corresponding amounts were $3,241 million and $(199) million, respectively.\nCash dividends received from companies accounted for on an equity basis amounted to $305 million, $1 million and none for 1995, 1994 and 1993, respectively. In addition, $250 million in non-cash dividends were received in 1995.\nIncome Taxes\nTenneco Inc., together with certain of its respective subsidiaries which are owned 80% or more, have entered into an agreement to file a consolidated federal income tax return. Such agreement provides, among other things, that (1) each company in a taxable income position will be currently charged with an amount equivalent to its federal income tax computed on a separate return basis and (2) each company in a tax loss position will be currently reimbursed to the extent its deductions, including general business credits, are utilized in the consolidated return.\nTenneco Inc.'s pre-tax earnings (loss) from continuing operations (excluding equity in net income from continuing operations of affiliated companies) for the years 1995, 1994 and 1993 are principally domestic. The differences between the U.S. income tax benefit, reflected in the Statements of Income, of $192 million, $187 million and $80 million for the years 1995, 1994 and 1993 and the income tax expense (benefit), computed based on pre-tax income from continuing operations at the U.S. federal income tax rates, of $190 million, $159 million and $117 million, respectively, consisted principally of the tax effect of equity in net income from continuing operations of affiliated companies in each of the three years, realization of previously unrecognized deferred tax assets to offset taxes payable on the sale of an investment in 1995 and permanent differences on the sale of businesses in 1994.\nLong-Term Debt and Current Maturities\nThe aggregate maturities and sinking fund requirements applicable to the long-term debt issues outstanding at December 31, 1995, are $8 million, $15 million, $769 million, $250 million and $175 million for 1996, 1997, 1998, 1999 and 2000, respectively.\nFinancial Instruments\nTenneco Inc. has guaranteed the performance of certain subsidiaries pursuant to arrangements under which receivables are factored on a nonrecourse basis with Tenneco Credit Corporation. Also, Tenneco Inc. has agreed to pay to Tenneco Credit Corporation a service charge to the extent necessary so that the earnings\nSCHEDULE I (CONTINUED)\nof Tenneco Credit Corporation and its consolidated subsidiaries (before fixed charges and income taxes) are not less than 125% of the fixed charges.\n(The above notes are an integral part of the foregoing financial statements.)\nSCHEDULE II\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (MILLIONS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- -------- Note: For 1994, primarily the result of the change to the equity method of accounting for Case. For 1995, 1994 and 1993, includes uncollectible accounts written off, net of recoveries on accounts previously written off.\nREPORTS ON FORM 8-K\nTenneco Inc. filed three Current Reports on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1995: on October 2, 1995 regarding the issuance of a press release announcing that it had signed a definitive agreement to acquire the plastics division of Mobil Corporation for $1.27 billion; on November 17, 1995 regarding the issuance of a press release announcing that it had completed the acquisition of the plastics division of Mobil Corporation for $1.27 billion and filing financial statements of businesses acquired and pro forma financial information of Tenneco Inc.; and on December 13, 1995 regarding the issuance of $300,000,000 aggregate principal amount of 6 1\/2% Notes due 2005 of Tenneco Inc. and $300,000,000 aggregate principal amount of 7 1\/4% Debentures due 2025 of Tenneco Inc.\nEXHIBITS\nThe following exhibits are filed with Tenneco Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, or incorporated therein by reference (exhibits designated by an asterisk were filed with the Report; all other exhibits were incorporated by reference):\nUNDERTAKING.\nThe undersigned, Tenneco Inc., hereby undertakes, pursuant to Regulation S-K, Item 601(b), paragraph (4)(iii), to furnish to the Securities and Exchange Commission upon request all constituent instruments defining the rights of holders of long-term debt of Tenneco Inc. and its consolidated subsidiaries not filed herewith for the reason that the total amount of securities authorized under any of such instruments does not exceed 10% of the total consolidated assets of Tenneco Inc. and its consolidated subsidiaries.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nTenneco Inc.\nDana G. Mead By __________________________________ Chairman and Chief Executive Officer\nDate: February 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.\nT. R. Tetzlaff February 14, By ____________________________ 1996 Attorney-in-fact\nEXHIBIT 11\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nCOMPUTATION OF EARNINGS (LOSS) PER SHARE OF COMMON STOCK\n- -------- Notes: (a) In 1992, 12,000,000 shares of common stock were issued to the Tenneco Inc. Stock Employee Compensation Trust (\"SECT\"). Shares of common stock issued to a related trust are not considered to be outstanding in the computation of average shares of common stock until the shares are utilized to fund the obligations for which the trust was established. During each of the years ended December 31, 1995, 1994 and 1993, the SECT utilized 2,697,770, 2,464,721 and 2,479,425 shares, respectively. (b) For purposes of computing earnings per share, Series A preferred stock was converted into common stock under the Contingent Share method. The above computation includes 8,935,175 shares of Series A preferred stock which were converted into 17,342,763 shares of common stock. In December 1994, all of the outstanding shares of Series A preferred stock were converted into Tenneco Inc. common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994 and 1993. (c) These calculations are submitted in accordance with Securities and Exchange Commission requirements although not required by Accounting Principles Board Opinion No. 15 because they result in dilution of less than 3%.\nEXHIBIT 12\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nCOMBINED WITH 50% OWNED UNCONSOLIDATED SUBSIDIARIES\nCOMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN MILLIONS)\n- -------- Note: (a) For the years ended December 31, 1992 and 1991, earnings were inadequate to cover fixed charges by $550 million and $572 million, respectively.\nINDEX TO EXHIBITS\nThe following exhibits are filed with Tenneco Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, or incorporated therein by reference (exhibits designated by an asterisk were filed with the Report; all other exhibits were incorporated by reference):","section_15":""}
{"filename":"730206_1995.txt","cik":"730206","year":"1995","section_1":"ITEM 1. BUSINESS\nAll references to \"Notes\" are to Notes to Financial Statements contained in this annual report.\nThe registrant, JMB Mortgage Partners, Ltd. - II (the \"Partnership\"), is a limited partnership formed in 1983 and currently governed by the Revised Uniform Limited Partnership Act of the State of Illinois to make first mortgage loans and senior land purchase-leasebacks\/leasehold mortgage loans and, to a lesser extent, wrap-around and junior mortgage loans and land purchase-leaseback arrangements on a subordinated basis. On January 31, 1984, the Partnership commenced an offering of $50,000,000 (subject to increase by up to $50,000,000) in Limited Partnership interests (the \"Interests\") pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-87086). A total of approximately 22,585.5 Interests were sold to the public at an offering price of $1,000 per Interest before certain discounts for volume purchases (fractional interests are due to a Distribution Reinvestment Program). The holders of 7,330.5 Interests were admitted to the Partnership during the fiscal year ended October 31, 1984; the holders of 15,255 Interests were admitted to the Partnership during the fiscal year ended October 31, 1985. The offering of Interests terminated on April 30, 1985. No Limited Partner has made any additional capital contribution after such date. The Limited Partners of the Partnership share in their portion of the benefits of ownership of the Partnership's mortgage investments according to the number of Interests held.\nThe Partnership is engaged solely in the business of investing in real estate, such as residential garden apartment complexes and smaller commercial properties, through participating first mortgage loans and certain other mortgage investments. The Partnership's remaining investment, acquired through the foreclosure of one of its first mortgage investments, is located in the State of Illinois. A presentation of information about industry segments, geographic regions, raw materials or seasonality is not applicable and would not be material to an understanding of the Partnership's business taken as a whole. Pursuant to the Partnership Agreement, the Partnership is required to terminate no later than December 31, 2033. The Partnership is self-liquidating in nature. At repayment or maturity of a particular mortgage investment or at sale of a particular property acquired as a result of a non-performing loan, the net proceeds, if any, are generally distributed or reinvested in existing mortgage investments or properties held rather than invested in acquiring additional mortgage investments. As discussed further in Item 7, the marketplace in which the Partnership's remaining investment property operates and real estate markets in general are in a recovery mode. The Partnership currently expects to conduct an orderly liquidation of its remaining investment as quickly as practicable and to wind up its affairs as soon as it is feasibly possible, barring any unforeseen economic developments. (Reference is also made to Note 1.)\nThe Partnership has made real estate investments set forth in the following table:\nThe Partnership's commitments for these mortgage investments were made in fiscal years 1984, 1985 and 1986. The Partnership's funding of a participating first mortgage loan secured by the 1550 Spring Road Office Building in DuPage County, Illinois and a description of the events resulting in the Partnership ultimately obtaining legal title to and selling this property in June 1992 is described in Note 3(a). The Partnership's funding of a participating first mortgage loan secured by the Plaza at Shelter Cover shopping center in Hilton Head Island, South Carolina and the borrower's prepayment of this loan on April 28, 1995 is described in Note 3(b). The Partnership's funding of a participating first mortgage loan secured by the Valley Lo Towers apartment complex in Glenview, Illinois and a description of the prepayment of this loan in 1993 is described in Note 3(c). The Partnership's funding of a participating first mortgage loan secured by the Spring Hill Fashion Center (\"Spring Hill\") shopping center in West Dundee, Illinois and the subsequent acquisition of title to this property by the Partnership and its participating affiliated lenders is described in Note 3(d).\nThe Spring Hill investment is the Partnership's last remaining investment at December 31, 1995. The Spring Hill property is subject to competition from similar types of properties (including properties owned or advised by affiliates of the General Partners). Such competition is generally for the retention of existing tenants and for securing new tenants due to significant vacancies which are present in the local market.\nReference is made to Item 7 below for a discussion of competitive conditions and future plans of the property securing the Partnership's remaining investment. Approximate occupancy levels for the Partnership's owned investment property are set forth in the table in Item 2","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not subject to any pending material legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during 1994 and 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nAs of December 31, 1995, there were 4,637 record holders of Interests of the Partnership. There is no public market for Interests and it is not anticipated that a public market for Interests will develop. Upon request, the Corporate General Partner may provide information relating to a prospective transfer of Interests to an investor desiring to transfer his Interests. The price to be paid for the Interests, as well as any other economic aspects of the transaction, will be subject to negotiation by the investor. There are certain conditions and restrictions on the transfer of Interests, including, among other things, the requirements that the substitution of a transferee of Interests as a Limited Partner of the Partnership be subject to the written consent of the Corporate General Partner. The rights of a transferee of Interests who does not become a substituted Limited Partner will be limited to the rights to receive his share of profits or losses and cash distributions from the Partnership, and such transferee will not be entitled to vote such Interests. No transfer will be effective until the first day of the next succeeding calendar quarter after the requisite transfer form satisfactory to the Corporate General Partner has been received by the Corporate General Partner. The transferee consequently will not be entitled to receive any cash distributions or any allocable share of profits or losses for tax purposes until such succeeding calendar quarter. Profits or losses from operations of the Partnership for a calendar year in which a transfer occurs will be allocated between the transferor and the transferee based upon the number of quarterly periods in which each was recognized as the holder of Interests, without regard to the results of Partnership's operations during particular quarterly periods and without regard to whether cash distributions were made to the transferor or transferee. Profits or losses arising from the sale or other disposition of Partnership properties will be allocated to the recognized holder of the Interests as of the last day of the quarter in which the Partnership recognized such profits or losses. Cash distributions to a holder of Interests arising from the sale or other disposition of Partnership properties will be distributed to the recognized holder of the Interests as of the last day of the quarterly period with respect to which such distribution is made.\nReference is made to Item 6","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nOn January 31, 1984, the Partnership commenced an offering to the public of up to $50,000,000 (subject to increase by up to $50,000,000) pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. A total of approximately 22,585.5 Limited Partnership Interests (at a price to the public of $1,000 per Interest) were issued by the Partnership (fractional interests are due to a Distribution Reinvestment Program) through May 20, 1985, the final closing date to admit Limited Partners, from which the Partnership received $20,891,587 (net of selling commissions and discounts for volume purchases). After deducting selling expenses and other offering costs, the Partnership had approximately $19,300,000 with which to invest in real estate primarily through participating first mortgage loans, to pay for legal fees and other costs related to such investments and for working capital. Portions of such proceeds were utilized to make the mortgage investments described in Item 1 above.\nAt December 31, 1995, the Partnership had cash and cash equivalents of approximately $1,392,000. Such funds are available for distributions to partners and for working capital requirements. The Partnership distributed $350 per Interest for the second quarter of 1995 (including the General Partners' 3% share), primarily from the proceeds of the prepayment of the loan secured by the Plaza at Shelter Cove shopping center, as more fully discussed below. Because the interest from the mortgage loan secured by the Plaza at Shelter Cove shopping center comprised the major share of the Partnership's net cash receipts, the Partnership ceased making operating distributions effective with the second quarter of 1995. The General Partners had previously been deferring mortgage investment servicing fees, their share of the distributions of net cash flow from operations and repayment proceeds and reimbursement for various out-of-pocket expenses. The General Partners are currently receiving their share of these fees, distributions and expenses. At December 31, 1995, there are no deferrals in excess of that required by the Partnership Agreement. Reference is made to Note 4.\nThe principal source of future short-term and long-term liquidity and distributions is expected to be from the Partnership's investment in the Spring Hill Fashion Center joint venture, as described below.\nIn order to facilitate the condominium conversion by the borrower of the loan secured by the Valley Lo Towers Apartments, the Partnership reached an agreement with the borrower regarding a prepayment of the mortgage loan. Reference is made to Note 3(c) for a description of the prepayment of this loan in July 1993, subsequent principal payments in 1993 and 1994, and the March 1995 prepayment of the remaining balance (including accrued interest) of the promissory note received in connection with the prepayment of the loan secured by the Valley Lo Towers Apartments.\nReference is made to Note 3(b) for a description of the April 1995 prepayment of the loan secured by the Plaza at Shelter Cove shopping center and the 1994 provision for loan loss of $357,000 on this mortgage loan investment. For financial reporting purposes, the Partnership did not recognize any gain or loss on this loan prepayment as a result of the Partnership's previously recorded provision for loan loss. For Federal income tax reporting purposes, the Partnership recognized a loss on loan prepayment of approximately $454,000 in 1995.\nReference is made to Note 3(d) regarding the default by the borrower of the loan secured by Spring Hill Fashion Center, the drawing by the lenders (including the Partnership) of the two $250,000 letters of credit that were additionally securing this loan, and the January 1, 1995 assumption of property management at the Spring Hill Fashion Center by an affiliate of the General Partners of the lenders. Effective as of the management takeover date (January 1, 1995), the Partnership considered the mortgage loan to be in-substance foreclosed and has accounted for its investment as an investment in a joint venture, at equity. In early May 1995, the lenders obtained legal title to the property pursuant to a deed in lieu of foreclosure. For financial reporting purposes, the Partnership did not recognize any gain or loss from this transaction as a result of the Partnership's previously recorded provisions for loan loss (see Note 3(d)).\nFor Federal income tax reporting purposes, the Partnership recognized a loss of approximately $135,000 in 1995 as a result of this transaction. The operations of this property are expected to provide a current return which would be significantly less than the scheduled interest payments due under the original mortgage loan. Occupancy at the Spring Hill Fashion Center was 75% at December 31, 1995 due to a major tenant, which occupied approximately 24% of the leasable space at the property and which was operating under Chapter 11 bankruptcy protection, not exercising its renewal option when its current lease expired in October 1995 and vacating its space. The Partnership executed a ten-year lease (which commenced in February 1996) with a replacement tenant for this space at rental rates somewhat lower than those of the former tenant. The Partnership is actively pursuing the sale of the Spring Hill Fashion Center.\nThe Partnership is carefully scrutinizing the appropriateness of any discretionary expenditures, particularly in relation to the amount of working capital it has available. Reference is made to Note 4 for a description of certain fees and payments, the receipt of certain of which had been deferred by the General Partners of the Partnership. By conserving working capital, the Partnership will be in a better position to meet its future needs. After reviewing the remaining property and its competitive marketplace, the General Partners of the Partnership expect to be able to liquidate the remaining investment as quickly as practicable. Therefore, the affairs of the Partnership are expected to be wound up as soon as it is feasibly possible, barring unforeseen economic developments.\nRESULTS OF OPERATIONS\nReference is made to Note 3 for a description of the participating first mortgage loans funded by the Partnership.\nThe increase in cash and cash equivalents at December 31, 1995 as compared to December 31, 1994 is attributable primarily to the Partnership's suspension of operating distributions effective with the second quarter of 1995, as discussed above.\nThe decrease in interest and other receivables at December 31, 1995 as compared to December 31, 1994 is attributable primarily to a decrease in basic and gross receipts participation interest receivable on the mortgage loan secured by the Plaza at Shelter Cove Shopping Center which was prepaid in April 1995. Reference is made to Note 3(b).\nThe decrease in amount due from affiliate at December 31, 1995 as compared to December 31, 1994 is attributable to the Partnership's 1995 receipt of $35,000 from JMB Mortgage Partners, Ltd. - III, one of the other two participating lenders of the loan secured by the Spring Hill Fashion Center, such amount representing the Partnership's share of the drawn letters of credit (totaling $500,000) in December 1994 in connection with such loan. Reference is made to Note 3(d).\nThe decrease in promissory note receivable at December 31, 1995 as compared to December 31, 1994 is attributable to the Partnership's receipt in March 1995 of the entire remaining principal balance of the promissory note received in connection with the 1993 prepayment of the first mortgage loan secured by the Valley Lo Towers Apartments. Reference is made to Note 3(c).\nThe decrease in mortgage notes receivable and deferred interest receivable at December 31, 1995 as compared to December 31, 1994 is attributable primarily to the prepayment of the mortgage loan and related deferred interest secured by the Plaza at Shelter Cove shopping center in April 1995. Reference is made to Note 3(b). An additional decrease in mortgage notes receivable and deferred interest receivable at December 31, 1995 as compared to December 31, 1994 is attributable to the Partnership's recording as an investment in unconsolidated venture, at equity, effective January 1, 1995, the mortgage loan secured by the Spring Hill Fashion Center. Reference is made to Notes 1 and 3(d).\nThe increases in investment in unconsolidated venture, at equity and Partnership's share of operations of unconsolidated venture at December 31, 1995 as compared to December 31, 1994 and for the year ended December 31, 1995 as compared to the years ended December 31, 1994 and 1993, respectively, is attributable to the Partnership's recording as an investment in unconsolidated venture, at equity, effective January 1, 1995, the mortgage loan secured by the Spring Hill Fashion Center. Reference is made to Notes 1 and 3(d).\nInterest income decreased approximately $595,000 in 1995 as compared to 1994 as a result of the April 1995 prepayment of the loan secured by the Plaza at Shelter Cove shopping center and the suspension of the simple accrued interest on the loan secured by the Plaza at Shelter Cove shopping center during May 1994 (see Note 3(b)). Interest income decreased approximately $75,000 as a result of the recording as an investment in unconsolidated venture, at equity, effective January 1, 1995 of the mortgage loan secured by the Spring Hill Fashion Center (see Note 3(d)). The 1995 repayment of the remaining principal balance of the promissory note received in connection with the 1993 prepayment of the mortgage loan secured by the Valley Lo Towers Apartments (see Note 3(c)) resulted in a decrease of approximately $50,000 in interest income. Such decreases in interest income were partly offset by an increase of approximately $205,000 in interest earned on the Partnership's short-term investments in 1995, due primarily to greater average balances in such investments, which resulted primarily from the temporary investment of proceeds received from the prepayment of the loan secured by the Plaza at Shelter Cove shopping center, as described above.\nInterest income decreased approximately $615,000 in 1994 as compared to 1993 as a result of the 1993 prepayment of the loan secured by the Valley Lo Towers Apartments. Reference is made to Note 3(c). Interest income also decreased approximately $128,000 in 1994 as compared to 1993 as a result of the suspension of the simple accrued interest on the loan secured by the Plaza at Shelter Cove shopping center during May, 1994 (see Note 3(b)). An additional decrease of approximately $140,000 in interest income in 1994 as compared to 1993 is attributable to a decrease in interest income on the Partnership's short-term investments primarily as a result of smaller average outstanding balances in such investments in 1994.\nParticipation interest income in 1993 is attributable to the prepayment of the loan secured by the Valley Lo Towers Apartments. Reference is made to Note 3(c).\nMortgage investment servicing fees decreased in 1995 as compared to 1994 as a result of (i) the prepayment of the loan secured by the Plaza at Shelter Cove shopping center in April 1995, (ii) the prepayment of the promissory note received in connection with the prepayment of the loan secured by the Valley Lo Towers Apartments, and (iii) the obtaining of legal title to the Spring Hill Fashion Center in May 1995. The decrease in mortgage investment servicing fees in 1994 as compared to 1993 is attributable primarily to the prepayment of the loan secured by the Valley Lo Towers Apartments. Reference is made to Note 3.\nThe decrease in professional services in 1995 and 1994 as compared to 1993 is attributable primarily to a higher legal and other professional fees incurred in connection with certain of the Partnership's first mortgage loan investments during 1993.\nThe increase in general and administrative expenses in 1995 as compared to 1994 and 1993 is attributable primarily to an increase in reimbursable costs to affiliates of the General Partners in 1995 and the recognition of certain additional prior year reimbursable costs to such affiliates. Reference is made to Note 4.\nReference is made to Note 3(d) regarding the provisions for loan loss made in 1993 and 1994 on the loan secured by the Spring Hill Fashion Center. Reference is made to Note 3(b) regarding the provision for loan loss made in 1994 on the loan secured by the Plaza at Shelter Cove shopping center.\nDistributions made to General Partners in 1994 include payments of $256,219 of previously deferred net cash flow distributions and $401,738 of previously deferred repayment proceeds. Reference is made to Note 4. Distributions made to Limited and General Partners in 1995 include distributions totaling $390 per Interest (including the General Partners' 3% share) from the April 1995 prepayment of the loan secured by the Plaza at Shelter Cover shopping center and the March 1995 prepayment of the remaining principal balance of the promissory note received in connection with the 1993 prepayment of the loan secured by the Valley Lo Towers Apartments.\nINFLATION\nDue to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.\nInflation is not expected to significantly impact future operations due to the expected liquidation of the Partnership in the near future. However, to the extent that inflation in future periods would have an adverse impact on property operating expenses, the effect would generally be offset by amounts recovered from tenants as many of the long-term leases at the Partnership's remaining property have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, there should be little effect on operating earnings if the property remains substantially occupied. In addition, substantially all of the leases contain provisions which entitle the Partnership to participate in gross receipts of tenants above fixed minimum amounts.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nJMB MORTGAGE PARTNERS, LTD. - II (A LIMITED PARTNERSHIP)\nINDEX\nIndependent Auditors' Report\nBalance Sheets, December 31, 1995 and 1994\nStatements of Operations, years ended December 31, 1995, 1994 and 1993\nStatements of Partners' Capital Accounts (Deficits), years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\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.\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nINDEX\nIndependent Auditors' Report\nBalance Sheet, December 31, 1995\nStatement of Operations, for the year ended December 31, 1995\nStatement of Changes in Partners' Capital Accounts, for the year ended December 31, 1995\nStatement of Cash Flows, for the year ended December 31, 1995\nNotes to Financial Statements\nSCHEDULE --------\nReal Estate and Accumulated Depreciation III\nSCHEDULES NOT FILED:\nAll schedules other than the one indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners JMB MORTGAGE PARTNERS, LTD. - II:\nWe have audited the financial statements of JMB Mortgage Partners, Ltd. - II (a limited partnership) as listed in the accompanying index. These financial statements are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partners of the Partnership, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of JMB Mortgage Partners, Ltd. - II 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.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 25, 1996\nJMB MORTGAGE PARTNERS, LTD. - II (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(1) OPERATIONS AND BASIS OF ACCOUNTING\nThe Partnership holds (through a joint venture) an equity investment in commercial real estate in the state of Illinois. Business activities consist of rentals to a variety of commercial and retail companies, and the ultimate sale or disposition of such real estate. The Partnership currently expects to conduct an orderly liquidation of its remaining investment portfolio and wind up its affairs as soon as practicable.\nFor financial reporting purposes, effective January 1, 1995, the mortgage loan secured by the Spring Hill Fashion Center was determined to have been in-substance foreclosed and was reclassified as an investment in a joint venture in real estate on the equity method at its estimated fair value. In early May 1995, the lenders (including the Partnership) obtained legal title to the property (see note 3(d)). Accordingly, the accompanying financial statements do not include the accounts of the JMB\/Spring Hill Associates (\"Spring Hill\") venture.\nThe Partnership's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying financial statements have been prepared from such records after making appropriate adjustments to present the Partnership's accounts in accordance with generally accepted accounting principles (\"GAAP\"). Such GAAP adjustments are not recorded on the records of the Partnership. The effect of these items for the years ended December 31, 1995 and 1994 is summarized as follows:\nThe net earnings (loss) per limited partnership interest (\"Interest\") is based upon the number of Interests outstanding at the end of each period (22,590.5). As further described in note 2, net profits of the Partnership from operations are allocated to the General Partners in an amount equal to the greater of 1% of net profits or the amount of net cash distributions to the General Partners, with the remaining net profits allocated to the Limited Partners. The General Partners were entitled to certain cash flow distributions and repayment proceeds that had been previously deferred (see note 4). For financial reporting purposes, such distributions exceeded net profits of the Partnership for 1994 and, thus, for financial reporting purposes, 100% of the Partnership's net profits for 1994 were allocated to the General Partners. The General Partners were allocated approximately $293,000 of the Partnership's net profits for 1995, primarily as a result of receiving their share of distributions from repayment proceeds of approximately $273,000 during 1995, with the Limited Partners being allocated the remainder of net profits for 1995. Such allocations in 1995 and 1994 had no effect on total Partnership assets or net profits. Deficit capital accounts will result, through the duration of the Partnership, in net gain for financial reporting and Federal income tax purposes.\nThe preparation of financial statements in accordance with GAAP requires the Partnership to make estimates and assumptions that affect the reported or disclosed amount 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.\nStatement of Financial Accounting Standards No. 95 requires the Partnership to present a statement which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The required information has been segregated and accumulated according to the classifications specified in the pronouncement. Partnership distributions from its unconsolidated venture are considered cash flow from operating activities to the extent of the Partnership's cumulative share of net earnings. In addition, the Partnership records amounts held in U.S. Government obligations at cost, which approximates market. For the purposes of these statements, the Partnership's policy is to consider all such amounts held with original maturities of three months or less ($1,291,904 and $993,632 at December 31, 1995 and 1994, respectively) as cash equivalents, with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDeferred costs consisted of costs incurred in connection with mortgage investments which were amortized over the terms of the related agreements using the straight-line method.\nThe Partnership's participating first mortgage loan investments provided for the following components of interest: basic interest which was payable monthly; simple accrued interest which was payable upon loan prepayment or at maturity; participation interest, payable no less frequently than annually, in annual gross receipts (as defined) of the respective properties in excess of specified amounts, and participation interest in subsequent increases in the market values of the respective properties in excess of specified amounts, payable at the respective properties' sale or at maturity.\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires all entities to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its financial instruments classified as current assets and liabilities approximates SFAS 107 value due to the relatively short maturity of these instruments.\nNo provision for state or Federal income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership. However, in certain instances, the Partnership has been required under applicable law to remit directly to the taxing authorities amounts representing withholding from distributions paid to partners.\n(2) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement, net profits of the Partnership from operations are allocated to the General Partners in an amount equal to the greater of 1% of net profits or the amount of net cash distributions to the General Partners, with the remaining net profits allocated to the Limited Partners. Net losses from Partnership operations are allocated 90% to the Limited Partners and 10% to the General Partners. Profits from the repayment or other disposition of mortgage investments are allocated first to the General Partners in an amount equal to the greater of 1% of such net profits or the cash distributions to the General Partners from the proceeds of such repayment or other disposition (as described below). The remaining profits from the repayment or other disposition of mortgage investments are allocated to the Limited Partners. Net losses from any disposition of mortgage investments are to be allocated 97% to the Limited Partners and 3% to the General Partners.\nThe General Partners are not required to make any additional capital contributions except under certain limited circumstances upon dissolution and termination of the Partnership. Distributions of \"net cash flow\" of the Partnership are to be made 90% to the Limited Partners and 10% to the General Partners, with one-half of such net cash flow distributable to the General Partners in the first twelve fiscal quarters following the close of the offering subordinated to the receipt by the Limited Partners of a stipulated return on their \"current capital accounts\" on a non-cumulative basis. Distributions of \"repayment proceeds\" are to be made 97% to the Limited Partners until the Limited Partners have received repayment proceeds equal to their contributed capital plus a stipulated return thereon, with the remainder of such 97% distribution, subject to the General Partners' receipt of any deferred share of net cash flow, to be distributed 85% to the Limited Partners and 15% to the General Partners. The remaining 3% of all distributions of repayment proceeds are to be distributed to the General Partners, subject to certain limitations. Of the cumulative distributions of $37,154,837 paid to the Limited Partners as of December 31, 1995, $847,964 represents an 8.5% annual return to the Limited Partners for the period during which the Limited Partners' subscription proceeds were held in escrow through April 30, 1985, $13,942,280 represents distributions of net cash flow for periods subsequent to April 30, 1985 and $22,364,593 represents distributions of sale and repayment proceeds from the sale of the 1550 Spring Road Office Building (see note 3(a)), the prepayment of the loan secured by the Valley Lo Towers (see note 3(c)) and the prepayment of the loan secured by the Plaza at Shelter Cove shopping center (see note 3(b)). The General Partners' cumulative distributions of $1,932,819 at December 31, 1995 represents distributions of net cash flow of $1,241,131 and distributions of sale and repayment proceeds of $691,688.\n(3) MORTGAGE NOTES RECEIVABLE\n(a) 1550 SPRING RD. OFFICE BUILDING, DUPAGE COUNTY, ILLINOIS\nIn July 1984, the Partnership funded a participating first mortgage loan in the principal amount of $2,250,000, secured by the 1550 Spring Road Office Building located in DuPage County, Illinois. During August 1990, the Partnership funded an additional $35,000. The entire principal balance of the loan was scheduled to be due and payable July 27, 1994.\nDue to the vacancy level of the office building and the associated re- leasing costs, the borrower made only partial interest payments since September 1987 to the extent of cash generated by the property. In June 1992, the Partnership obtained legal title to this property and recorded its net carrying value in this mortgage investment in an amount not in excess of its estimated fair value. Also in June 1992, the Partnership sold this property to an unaffiliated third party for net sale proceeds of $1,758,452, resulting in a gain on sale of $358,035 for financial reporting purposes and a loss of approximately $527,000 for federal income tax purposes. In August 1992, the Partnership distributed proceeds of $75 per Interest to the Limited Partners from this sale. The General Partners received payment of their share of such distributions of sale proceeds in January 1994 (see note 4).\nAlthough the Partnership had been recognizing interest income only as collected (effective January 1, 1988), approximately $982,000 of basic interest due to the Partnership through the date of sale was uncollected.\nDue to the uncertainty of the realization of the simple accrued interest receivable recognized through December 31, 1987 (approximately $275,000) and the principal balance of the loan ($2,285,000), the Partnership, as a matter of prudent accounting practice and to reflect the estimated fair value of the collateral, had, for financial reporting purposes, made provisions for loan loss on this loan of $275,000 in 1990 and $885,000 in 1991.\n(b) THE PLAZA AT SHELTER COVE, HILTON HEAD ISLAND, SOUTH CAROLINA\nThe Partnership funded a $7,000,000 participating first mortgage loan secured by The Plaza at Shelter Cove shopping center located in Hilton Head Island, South Carolina, which was scheduled to mature November 7, 1995.\nIn April 1995, the Partnership received a prepayment of this mortgage loan (together with all basic interest due) pursuant to a previously negotiated prepayment agreement. For financial reporting purposes, the prepayment amount of approximately $8,204,000 consisted of the loan principal of $6,643,000 (net of provision for loan loss of $357,000), simple accrued interest of approximately $1,482,000, and the balance due of prior years' gross receipts participation interest and reimbursement of certain fees totaling approximately $79,000. The Partnership did not recognize any gain or loss on loan prepayment for financial reporting purposes as a result of the $357,000 provision for loan loss recognized by the Partnership in 1994, as described below. For Federal income tax reporting purposes, the Partnership recognized a loss on loan prepayment of approximately $454,000 in 1995.\nDue to the uncertainty of the realization of the simple accrued interest recognized through May 15, 1994 (approximately $1,482,000) and the principal balance of the loan ($7,000,000), the Partnership, as a matter of prudent accounting practice and to reflect the estimated fair value of the collateral, had, for financial reporting purposes, suspended the accrual of the simple accrued interest (which was payable at maturity) effective May 16, 1994 and made a provision for loan loss (including simple accrued interest) of $357,000 in 1994, which is reflected in the accompanying 1994 financial statements.\n(c) VALLEY LO TOWERS, GLENVIEW, ILLINOIS\nIn 1986, the Partnership funded an $8,500,000 participating first mortgage loan secured by the Valley Lo Towers luxury apartment complex located in Glenview, Illinois. The entire principal balance of the loan was scheduled to be due and payable on April 15, 1996.\nIn order to facilitate the borrower's condominium conversion, the Partnership reached an agreement with the borrower regarding a prepayment of the first mortgage loan. In July 1993, the Partnership received an initial loan payoff totaling $11,600,000 from the borrower. The remaining $1,575,000 of the total prepayment amount of $13,175,000 was represented by a modified original promissory note, which bore interest (payable monthly in arrears) at 6% per year on the unpaid principal balance, and which was prepayable (without penalty) in whole or in part at any time prior to the loan maturity date of April 15, 1996. The Partnership received principal payments totaling $330,176 in 1993 and $281,370 in 1994 (such payments representing proceeds from the sale of four designated units), thereby reducing the outstanding principal balance of the promissory note to $963,454, which balance was prepaid in full in March 1995 (together with all interest due). The promissory note was secured by a guarantee signed by the general partners of the borrower, as well as a first mortgage lien on five designated unsold units (four of which had subsequently been sold) and a junior collateral assignment on all remaining nondesignated unsold units. For financial reporting purposes, the total prepayment amount of $13,175,000 consisted of the prepayment of the first mortgage loan of $8,500,000 (replaced by the above-mentioned modified promissory note of $1,575,000), simple accrued interest on the first mortgage loan of $1,427,419, and the recognition in 1993 of the total participation interest on the first mortgage loan of $3,247,581.\n(d) SPRING HILL FASHION CENTER, WEST DUNDEE, ILLINOIS\nIn February 1986, the Partnership committed to participate in the funding of a participating first mortgage loan in the maximum amount of $11,000,000, secured by the Spring Hill Fashion Center shopping center located in West Dundee, Illinois. The total amount funded under this loan was $10,030,000 (of which the Partnership's share was $702,100 (7.0%)). The other two participating lenders are JMB Mortgage Partners, Ltd. and JMB Mortgage Partners, Ltd. - III, both of which are affiliates of the General Partners of the Partnership. As additional security for the first mortgage loan, the borrower delivered to the lenders, in January 1988, two $250,000 irrevocable and unconditional letters of credit (which were to expire December 31, 1994 and January 15, 1995, respectively), upon which the lenders could draw in the event a default occurred under the loan. The aforementioned letters of credit had been subject to yearly renewal if certain specified net operating income levels at the property were not achieved by the borrower.\nDue to the uncertainty of the realization of the simple accrued interest recognized through November 30, 1991 (approximately $104,000) and the principal balance of the loan ($702,100), the Partnership, as a matter of prudent accounting practice and to reflect the estimated fair value of the collateral, had, for financial reporting purposes, suspended the accrual of the simple accrued interest (which was payable at maturity) effective December 1, 1991 and made provisions for loan loss of $60,000 in 1992, $37,000 in 1993 and $19,000 in 1994, bringing the total provision for loan loss on this loan to $116,000, which is reflected in the accompanying balance sheet at December 31, 1994.\nThe borrower defaulted in its scheduled basic interest payments due under this loan during the fourth quarter of 1994. Consequently, the lenders (including the Partnership) drew on the above-mentioned letters of credit totaling $500,000 in late December 1994. An affiliate of the lenders took control of the property's funds in January 1995 and is currently managing the property under an agreement which provides for a fee equal to 4% of the property's gross receipts (such fee excluding compensation for leasing activity). In early May 1995, the lenders obtained legal title to the property pursuant to a deed in lieu of foreclosure. Effective as of the management takeover date (January 1, 1995), the Partnership considered the mortgage loan to be in-substance foreclosed and has accounted for its investment as an investment in a joint venture on the equity method. For financial reporting purposes, the Partnership did not recognize any gain or loss from this transaction as a result of the Partnership's previously recorded provisions for loan loss, as described above. For Federal income tax reporting purposes, the Partnership recognized a loss of approximately $135,000 in 1995 as a result of this transaction. The operations of this property are expected to provide a current return which would be significantly less than the scheduled interest payments due under the original mortgage loan.\nThe terms of Spring Hill's partnership agreement provide generally that contributions, distributions, cash flow, sale or refinancing proceeds and profits and losses will be distributed or allocated to the partners in their respective ownership percentages (7% to the Partnership).\nOccupancy of the shopping center was 75% at December 31, 1995 due to a major tenant, which occupied approximately 24% of the leasable space at the property and which was operating under Chapter 11 bankruptcy protection, not exercising its renewal option when its lease expired in October 1995 and vacating its space. The Partnership executed a ten-year lease (which commenced February 1996) with a replacement tenant for this space at rental rates somewhat lower than those of the former tenant. The Partnership is actively pursuing the sale of this property.\n(4) TRANSACTIONS WITH AFFILIATES\nThe Partnership, pursuant to the Partnership Agreement, is permitted to engage in various transactions involving the Corporate General Partner and its affiliates including the reimbursement for salaries and salary- related expenses of its employees, certain of its officers, and other direct expenses relating to the administration of the Partnership and the operation of the Partnership's investments. Fees, commissions and other expenses required to be paid by the Partnership to the General Partners and their affiliates as of December 31, 1995, 1994 and 1993 are as follows:\nThe Partnership is obligated to pay (not more often than monthly) mortgage investment servicing fees to the General Partners at an annual rate of 1\/4 of 1% of the maximum amount funded or to be funded by the Partnership on mortgage investments. The servicing fee is calculated from the date the Partnership first signs a letter of commitment for such mortgage investment, but is not payable until the funding of the mortgage investment. As all loans have been repaid or foreclosed, there were no unpaid fees at December 31, 1995.\nAlthough currently receiving their distributions of net cash flow and repayment proceeds, the General Partners had previously deferred payment of certain of their distributions of prior net cash flow and repayment proceeds from the Partnership. The Partnership paid $256,219 of such deferred cash flow distributions and $401,738 of deferred repayment proceeds to the General Partners in 1994.\nAt December 31, 1995, there are no deferrals to the General Partners in excess of that required by the Partnership Agreement. All amounts deferred or currently payable to the General Partners or their affiliates do not bear interest.\nEffective October 1, 1995, the Corporate General Partner of the Partnership engaged independent third parties to perform certain administrative services for the Partnership which were previously performed by, and partially reimbursed to, affiliates of the General Partners. Use of such third parties is not expected to have a material effect on the operations of the Partnership.\n(5) INVESTMENT IN UNCONSOLIDATED VENTURE\nSummary financial information for Spring Hill as of and for the year ended December 31, 1995 is as follows:\n------------\nCurrent assets . . . . . . . . . . . . . . . . . . . . $ 523,919 Current liabilities. . . . . . . . . . . . . . . . . . (162,532) ------------ Working capital. . . . . . . . . . . . . . . . . 361,387\nInvestment property, net . . . . . . . . . . . . . . . 9,393,468 Other assets, net. . . . . . . . . . . . . . . . . . . 9,816 Other liabilities. . . . . . . . . . . . . . . . . . . (56,735) Venture partners' equity . . . . . . . . . . . . . . . (9,028,460) ------------ Partnership's capital. . . . . . . . . . . . . . $ 679,476 ============ Represented by: Invested capital . . . . . . . . . . . . . . . . . . $ 671,920 Cumulative distributions . . . . . . . . . . . . . . (38,500) Cumulative earnings. . . . . . . . . . . . . . . . . 46,056 ------------ $ 679,476 ============\nTotal income . . . . . . . . . . . . . . . . . . . . . $ 1,451,866 ============\nExpenses applicable to operating income. . . . . . . . $ 793,930 ============\nNet earnings . . . . . . . . . . . . . . . . . . . . . $ 657,936 ============\nReference is made to notes 1 and 3(d) regarding the foreclosure of this property by the Partnership and its participating lenders in May 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Partners JMB Mortgage Partners, Ltd.-II:\nWe have audited the financial statements of JMB\/Spring Hill Associates as listed in the accompanying index. In connection with our audit of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our 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 General Partners of the Partnership, 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 JMB\/Spring Hill Associates as of December 31, 1995 and the results of its operations and its cash flows for the year 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\nChicago, Illinois March 25, 1996\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nBALANCE SHEET\nDECEMBER 31, 1995\nASSETS ------\nCurrent assets: Cash and cash equivalents (note 1) . . . . . . . . . $ 375,899 Rents and other receivables (net of allowance for doubtful accounts of $53,855). . . . . . . . . 139,643 Prepaid expenses . . . . . . . . . . . . . . . . . . 8,377 ----------- Total current assets . . . . . . . . . . . . 523,919 ----------- Investment property (notes 1 and 2) - Schedule III: Land . . . . . . . . . . . . . . . . . . . . . . . . 2,400,000 Buildings and improvements . . . . . . . . . . . . . 7,233,901 ----------- 9,633,901 Less: Accumulated depreciation. . . . . . . . . . . 240,433 ----------- Total investment property, net of accumulated depreciation. . . . . . 9,393,468 Deferred costs (net of accumulated amortization of $1,809) . . . . . . . . . . . . . . . . . . . . . 9,816 ----------- $ 9,927,203 ===========\nLIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------\nCurrent liabilities: Accounts payable . . . . . . . . . . . . . . . . . . $ 21,661 Accrued real estate taxes. . . . . . . . . . . . . . 124,203 Unearned rents . . . . . . . . . . . . . . . . . . . 16,668 ----------- Total current liabilities. . . . . . . . . . 162,532 Tenant security deposits . . . . . . . . . . . . . . . 56,735 ----------- Commitments and contingencies (notes 5 and 6) Total liabilities. . . . . . . . . . . . . . 219,267\nPartners' capital accounts (note 4): JMB Mortgage Partners, Ltd-II: Capital contributions. . . . . . . . . . . . . . . 671,920 Net earnings . . . . . . . . . . . . . . . . . . . 46,056 Cash distributions . . . . . . . . . . . . . . . . (38,500) Venture partners: Capital contributions. . . . . . . . . . . . . . . 8,928,080 Net earnings . . . . . . . . . . . . . . . . . . . 611,880 Cash distributions . . . . . . . . . . . . . . . . (511,500) ----------- Total partners' capital accounts . . . . . . 9,707,936 -----------\n$ 9,927,203 ===========\nSee accompanying notes to financial statements.\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nSTATEMENT OF OPERATIONS\nFOR THE YEAR ENDED DECEMBER 31, 1995\nIncome: Rental income. . . . . . . . . . . . . . . . . . . . $ 1,437,918 Interest income. . . . . . . . . . . . . . . . . . . 13,948 ------------ 1,451,866 ------------\nExpenses: Depreciation . . . . . . . . . . . . . . . . . . . . 240,433 Property operating expenses. . . . . . . . . . . . . 551,688 Amortization of deferred costs . . . . . . . . . . . 1,809 ------------ 793,930 ------------\nNet earnings . . . . . . . . . . . . . . . . $ 657,936 ============\nSee accompanying notes to financial statements.\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nSTATEMENT OF CASH FLOWS\nFOR THE YEAR ENDED DECEMBER 31, 1995\nCash flows from operating activities: Net earnings . . . . . . . . . . . . . . . . . . . . $ 657,936 Items not requiring (providing) cash: Depreciation . . . . . . . . . . . . . . . . . . . 240,433 Amortization of deferred costs . . . . . . . . . . 1,809 Changes in: Rents and other receivables. . . . . . . . . . . (139,643) Prepaid expenses . . . . . . . . . . . . . . . . (8,377) Accounts payable . . . . . . . . . . . . . . . . 21,661 Accrued real estate taxes. . . . . . . . . . . . 124,203 Unearned rents . . . . . . . . . . . . . . . . . 16,668 Tenant security deposits . . . . . . . . . . . . 56,735 ------------ Net cash provided by operating activities . . . . . . . . . . . 971,425 ------------ Cash flows from investing activities: Additions to investment property . . . . . . . . . (33,901) Payment of deferred costs. . . . . . . . . . . . . (11,625) ------------ Net cash used in investing activities . . . . . . . . . . . . . . . . (45,526) ------------ Cash flows from financing activities: Cash distributions paid to partners. . . . . . . . (550,000) ------------ Net cash used in financing activities . . . . . . . . . . . (550,000) ------------ Net increase in cash and cash equivalents . . . . . . . . . . . 375,899 Cash and cash equivalents, beginning of year. . . . . . . . . . . . . -- ------------ Cash and cash equivalents, end of year. . . . . . . . . . . . . . . . $ 375,899 ============ Supplemental disclosure of cash flow information: Cash paid for mortgage and other interest . . . . . . . . . . . . . . . . . . $ -- ============ Non-cash investing and financing activities: Balance due on mortgage note receivable . . . . . . . . . . . . . . . . . . $ 10,030,000 Deferred interest receivable . . . . . . . . . . 1,210,918 Provision for loan loss. . . . . . . . . . . . . (1,652,000) Capitalized costs. . . . . . . . . . . . . . . . 11,082 ------------ Net initial carrying value of investment property and partners' capital contributions (notes 1 and 2). . . $ 9,600,000 ============\nSee accompanying notes to financial statements.\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nFOR THE YEAR ENDED DECEMBER 31, 1995\n(1) OPERATIONS AND BASIS OF ACCOUNTING\nJMB\/Spring Hill Associates (\"Spring Hill\") has the exclusive purpose of owning a 100% interest in the Spring Hill Fashion Center (\"the Property\"), a 125,000 square foot shopping center located in West Dundee, Illinois. JMB Mortgage Partners, Ltd. (\"MP-I\"), JMB Mortgage Partners, Ltd.-II (\"MP-II\"), and JMB Mortgage Partners, Ltd.-III (\"MP-III\") collectively hold all of the venture interests in Spring Hill. Reference is made to Note 3(d) of Notes to Financial Statements of JMB Mortgage Partners, Ltd.-II. Such note is incorporated herein by reference.\nThe accompanying financial statements have been prepared for the purpose of complying with Rule 3.09 of Regulation S-X of the Securities and Exchange Commission. They include the accounts of the unconsolidated venture, JMB\/Spring Hill Associates, in which JMB Mortgage Partners, Ltd.- II and affiliates of the General Partners of JMB Mortgage Partners, Ltd.-II are partners.\nSpring Hill's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying financial statements have been prepared from such records after making appropriate adjustments to present Spring Hill's accounts in accordance with generally accepted accounting principles (\"GAAP\"). Such adjustments are not recorded on the records of Spring Hill. The effect of these items for the year ended December 31, 1995 is summarized as follows:\n---------------------------- TAX BASIS GAAP BASIS (Unaudited) ---------- ----------\nTotal assets . . . . . . . . . . $9,927,203 10,268,398 Partners' capital accounts . . . 9,707,936 10,066,880 Net earnings . . . . . . . . . . 657,936 651,038 ========== ==========\nThe preparation of financial statements in accordance with GAAP requires Spring Hill to make estimates and assumptions that affect the reported or disclosed amount 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.\nStatement of Financial Accounting Standards No. 95 requires Spring Hill to present a statement which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The required information has been segregated and accumulated according to the classifications specified in the pronouncement. In addition, Spring Hill records amounts held in U.S. Government obligations at cost which approximates market. For the purposes of these statements, Spring Hill's policy is to consider all such amounts held with original maturities of three months or less ($373,549 at December 31, 1995) as cash equivalents with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDepreciation on buildings and improvements has been provided over the estimated useful lives of the assets (30 years) using the straight-line method.\nMaintenance and repair expenses are charged to operations as incurred.\nSignificant betterments and improvements are capitalized and depreciated over their estimated useful lives.\nUnder Spring Hill's impairment policy, provisions for value impairment are recorded with respect to the investment property pursuant to Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" Therefore, the Partnership does not anticipate a significant effect on its financial statements upon full adoption of SFAS 121 as required in the first quarter of 1996, absent the suspension of depreciation on the Spring Hill investment property as the property will likely be categorized as held for sale at January 1, 1996. Reference is made to Note 3(d) of Notes to Financial Statements of JMB Mortgage Partners, Ltd.-II. Such note is incorporated herein by reference.\nDeferred costs consist of lease commissions incurred. Deferred leasing commissions are amortized over the terms of the related lease agreements.\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments,\" requires all entities to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its financial instruments classified as current assets and liabilities approximates SFAS 107 value due to the relatively short maturity of these instruments.\nNo provision for state or Federal income taxes has been made as the liability for such taxes is that of the partners rather than Spring Hill.\n(2) INVESTMENT PROPERTY\nA description of the acquisition of the property is contained in Note 3(d) of Notes to Financial Statements of JMB Mortgage Partners, Ltd.-II. Such note is incorporated herein by reference.\n(3) MANAGEMENT AGREEMENT\nThe property is managed by an affiliate of the General Partners of the partners of Spring Hill for a fee computed as a percentage of certain revenues.\n(4) VENTURE AGREEMENT\nSpring Hill's venture agreement provides for the partners to be allocated or distributed shares of profits and losses, cash flow from operations and sale or refinancing proceeds in proportion to their ownership interests (60.45% to MP-I, 7% to MP-II and 32.55% to MP-III). Reference is made to Note 3(d) of Notes to Financial Statements of JMB Mortgage Partners, Ltd.-II. Such note is incorporated herein by reference.\n(5) LEASES\nAs Property Lessor\nAt December 31, 1995, Spring Hill's principal asset is a shopping center. Spring Hill has determined that all leases relating to this property are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the property, excluding the cost of the land, is depreciated over the estimated useful life. Leases with tenants range in term from one to ten remaining years and provide for fixed minimum rent and partial reimbursement of operating costs. In addition, certain leases provide for either additional rent based upon percentages of tenant sales volumes or provide for annual increases in fixed minimum rents. A substantial portion of the ability of the tenant to honor their leases is dependent on the retail economic sector.\nMinimum lease payments, including amounts representing executory costs (e.g. taxes, maintenance, insurance) and any related profit, to be received in the future under the operating leases are as follows:\n1996. . . . . . . . . . . . . . . . . . . $ 1,122,000 1997. . . . . . . . . . . . . . . . . . . 1,096,000 1998. . . . . . . . . . . . . . . . . . . 1,046,000 1999. . . . . . . . . . . . . . . . . . . 1,011,000 2000. . . . . . . . . . . . . . . . . . . 883,000 Thereafter. . . . . . . . . . . . . . . . 1,870,000 ----------- $ 7,028,000 ===========\n(6) TRANSACTIONS WITH AFFILIATES\nFees, commissions and other expenses required to be paid by Spring Hill to the General Partners and their affiliates as of December 31, 1995 and for the year ended December 31, 1995 are as follows:\nUNPAID AT DECEMBER 31, 1995 1995 -------- ------------\nProperty management and leasing fees . . . . . . . . . . . $51,210 3,822 Insurance commissions. . . . . . . . 4,506 -- Reimbursement (at cost) for out-of-pocket expenses . . . . . . 359 23 ------- -----\n$56,075 3,845 ======= ======\nSCHEDULE III - CONTINUED\nJMB\/SPRING HILL ASSOCIATES (A GENERAL PARTNERSHIP)\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nNotes:\n(A) The initial cost to the Partnership represents the original carrying value of the property, as determined at the foreclosure date (note 2).\n(B) The aggregate cost of real estate owned at December 31, 1995 for Federal income tax purposes was $9,793,600.\n(C) Reconciliation of real estate owned:\n-----------\nBalance at beginning of period. . . . . . $ -- Additions during period . . . . . . . . . 9,633,901 ----------- Balance at end of period. . . . . . . . . $ 9,633,901 ===========\n(D) Reconciliation of accumulated depreciation:\nBalance at beginning of period. . . . . . $ -- Depreciation expenses . . . . . . . . . . 240,433 ----------- Balance at end of period. . . . . . . . . $ 240,433 ===========\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 during 1994 and 1995.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nThe Corporate General Partner of the Partnership is JMB Realty Corporation (\"JMB\"), a Delaware corporation, substantially all of the outstanding stock of which is owned, directly or indirectly, by certain of its officers and directors and members of their families. JMB has responsibility for all aspects of the Partnership's operations, subject to the requirement that sales of real property must be approved by the Associate General Partner of the Partnership, AGPP Associates, L.P. Effective December 31, 1995, AGPP Associates, L.P. acquired all of the partnership interests in Mortgage Associates - II, L.P., the Associate General Partner, and elected to continue the business of Mortgage Associates - II, L.P. AGPP Associates, L.P., an Illinois limited partnership with JMB as its sole general partner, continues as the Associate General Partner. The Associate General Partner is directed by a majority in interest of its limited partners (who are generally officers, directors and affiliates of JMB or its affiliates) as to whether to provide its approval of any sale of real property (or any interest therein) of the Partnership.\nThe Partnership is subject to certain conflicts of interest arising out of its relationships with the General Partners and their affiliates as well as the fact that the General Partners and their affiliates are engaged in a range of real estate activities. Certain services have been and may in the future be provided to the Partnership or its investment properties by affiliates of the General Partners, including property management services and insurance brokerage services. In general, such services are to be provided on terms no less favorable to the Partnership than could be obtained from independent third parties and are otherwise subject to conditions and restrictions contained in the Partnership Agreement. The Partnership Agreement permits the General Partners and their affiliates to provide services to, and otherwise deal and do business with, persons who may be engaged in transactions with the Partnership, and permits the Partnership to borrow from, purchase goods and services from, and otherwise to do business with, persons doing business with the General Partners or their affiliates. The General Partners and their affiliates may be in competition with the Partnership under certain circumstances, including, in certain geographical markets, for tenants for properties and\/or for the sale of properties. Because the timing and amount of cash distributions and profits and losses of the Partnership may be affected by various determinations by the General Partners under the Partnership Agreement, including whether and when to sell or refinance a property, the establishment and maintenance of reasonable reserves, the timing of expenditures and the allocation of certain tax items under the Partnership Agreement, the General Partners may have a conflict of interest with respect to such determinations.\nThe names, positions held and length of service therein of each director and the executive and certain other officers of the Corporate General Partner are as follows:\nSERVED IN NAME OFFICE OFFICE SINCE - ---- ------ ------------\nJudd D. Malkin Chairman 5\/03\/71 Director 5\/03\/71 Chief Financial Officer 2\/22\/96 Neil G. Bluhm President 5\/03\/71 Director 5\/03\/71 Burton E. Glazov Director 7\/01\/71 Stuart C. Nathan Executive Vice President 5\/08\/79 Director 3\/14\/73 A. Lee Sacks Director 5\/09\/88 John G. Schreiber Director 3\/14\/73 H. Rigel Barber Executive Vice President 1\/02\/87 Chief Executive Officer 1\/01\/95 Glenn E. Emig Executive Vice President 1\/01\/93 Chief Operating Officer 1\/01\/95 Gary Nickele Executive Vice President 1\/01\/92 General Counsel 2\/27\/84 Gailen J. Hull Senior Vice President 6\/01\/88 Howard Kogen Senior Vice President 1\/02\/86 Treasurer 1\/01\/91\nThere is no family relationship among any of the foregoing directors or officers. The foregoing directors have been elected to serve a one-year term until the annual meeting of the Corporate General Partner to be held on June 5, 1996. All of the foregoing officers have been elected to serve one-year terms until the first meeting of the Board of Directors held after the annual meeting of the Corporate General Partner to be held on June 5, 1996. There are no arrangements or understandings between or among any of said directors or officers and any other person pursuant to which any director or officer was elected as such.\nJMB is the corporate general partner of Carlyle Real Estate Limited Partnership-VII (\"Carlyle-VII\"), Carlyle Real Estate Limited Partnership-IX (\"Carlyle-IX\"), Carlyle Real Estate Limited Partnership-X (\"Carlyle-X\"), Carlyle Real Estate Limited Partnership-XI (\"Carlyle-XI\"), Carlyle Real Estate Limited Partnership-XII (\"Carlyle-XII\"), Carlyle Real Estate Limited Partnership-XIII (\"Carlyle-XIII\"), Carlyle Real Estate Limited Partnership-XIV (\"Carlyle-XIV\"), Carlyle Real Estate Limited Partnership-XV (\"Carlyle-XV\"), Carlyle Real Estate Limited Partnership-XVI (\"Carlyle- XVI\"), Carlyle Real Estate Limited Partnership-XVII (\"Carlyle-XVII\"), JMB Mortgage Partners, Ltd. (\"Mortgage Partners\"), JMB Mortgage Partners, Ltd.-III (\"Mortgage Partners-III\") JMB Mortgage Partners, Ltd.-IV (\"Mortgage Partners-IV\"), Carlyle Income Plus, Ltd. (\"Carlyle Income Plus\") and Carlyle Income Plus, Ltd.-II (\"Carlyle Income Plus-II\") and the managing general partner of JMB Income Properties, Ltd.-IV (\"JMB Income-IV\"), JMB Income Properties, Ltd.-V (\"JMB Income-V\"), JMB Income Properties,(\"JMB Income-VI\"), JMB Income Properties, Ltd.-VII (\"JMB Income-VII\"), JMB Income Properties, Ltd.-IX (\"JMB Income-IX\"), JMB Income Properties, Ltd.-X (\"JMB Income-X\"), JMB Income Properties, Ltd.-XI (\"JMB Income-XI\"), JMB Income Properties, Ltd.-XII (\"JMB Income-XII\") and JMB Income Properties Ltd.-XIII (\"JMB Income-XIII\"). JMB is also the sole general partner of the associate general partner of most of the foregoing partnerships. Most of the foregoing directors and officers are also officers and\/or directors of various affiliated companies of JMB including Arvida\/JMB Managers, Inc. (the general partner of Arvida\/JMB Partners, L.P. (\"Arvida\")), Arvida\/JMB Managers-II, Inc. (the general partner of Arvida\/JMB Partners, L.P.-II (\"Arvida-II\")), and Income Growth Managers, Inc. (the corporate general partner of IDS\/JMB Balanced Income Growth, Ltd. (\"IDS\/BIG\")). Most of such directors and officers are also partners of certain partnerships which are associate general partners in the following real estate limited partnerships: Carlyle-VII, Carlyle-IX, Carlyle-X, Carlyle-XI, Carlyle-XII, Carlyle-XIII, Carlyle-XIV, Carlyle-XV, Carlyle-XVI, Carlyle-XVII, JMB Income-VI, JMB Income-VII, JMB Income-IX, JMB Income-X, JMB Income-XI, JMB Income-XII, JMB Income-XIII, Mortgage Partners, Mortgage Partners-III, Mortgage Partners-IV, Carlyle Income Plus, Carlyle Income Plus-II and IDS\/BIG.\nThe business experience during the past five years of each such director and officer of the Corporate General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 58) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Malkin has been associated with JMB since October 1969. Mr. Malkin is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a Certified Public Accountant.\nNeil G. Bluhm (age 58) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Bluhm has been associated with JMB since August 1970. Mr. Bluhm is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nBurton E. Glazov (age 57) has been associated with JMB since June 1971, and served as an Executive Vice President of JMB until December 1990.\nHe is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nStuart C. Nathan (age 54) has been associated with JMB since July 1972. Mr. Nathan is also a director of Sportmart, Inc., a retailer of sporting goods. He is a member of the Bar of the State of Illinois.\nA. Lee Sacks (age 62) (President and Director of JMB Insurance Agency, Inc.) has been associated with JMB since December 1972.\nJohn G. Schreiber (age 49) has been associated with JMB since December 1970, and served as an Executive Vice President of JMB until December 1990.\nMr. Schreiber is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. Mr. Schreiber is President of Schreiber Investments, Inc., a company which is engaged in the real estate investing business. He is also a senior advisor and partner of Blackstone Real Estate Partners, an affiliate of the Blackstone Group, L.P. Since 1994, Mr. Schreiber has also served as a Trustee of Amli Residential Property Trust, a publicly-traded real estate investment trust that invests in multi-family properties. He is also a director of a number of investment companies advised or managed by T. Rowe Price associates and its affiliates. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business.\nH. Rigel Barber (age 46) has been associated with JMB since March 1982. He holds a J.D. degree from the Northwestern Law School and is a member of the Bar of the State of Illinois.\nGlenn E. Emig (age 48) has been associated with JMB since December, 1979. Prior to becoming Executive Vice President of JMB in 1993, Mr. Emig was Executive Vice President and Treasurer of JMB Institutional Realty Corporation. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business and is a Certified Public Accountant.\nGary Nickele (age 43) has been associated with JMB since February 1984. He holds a J.D. degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nGailen J. Hull (age 47) has been associated with JMB since March 1982.\nHe holds a Masters degree in Business Administration from Northern Illinois University and is a Certified Public Accountant.\nHoward Kogen (age 60) has been associated with JMB since March 1973. He is a Certified Public Accountant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe General Partners of the Partnership are entitled to receive a share of cash distributions, when and as cash distributions are made to the Limited Partners, and a share of profits or losses. Reference is also made to Notes 2 and 4 for a description of such transactions, distributions and allocations. Although currently receiving their distributions of net cash flow and repayment proceeds, the General Partners had previously deferred payment of certain of their distributions of prior net cash flow and repayment proceeds from the Partnership. The Partnership paid $256,219 of such deferred cash flow distributions and $401,738 of deferred repayment proceeds to the General Partners in 1994. The General Partners were allocated taxable income of $292,564 in 1995.\nThe Partnership, pursuant to the Partnership Agreement, is permitted to engage in various transactions involving the Corporate General Partner and its affiliates including the reimbursement for salaries and salary- related expenses of its employees, certain of its officers, and other direct expenses relating to the administration of the Partnership and the operation of the Partnership's investments. The relationship of the Corporate General Partner (and its directors and officers) to its affiliates is set forth in Item 10 above.\nThe Corporate General Partner and its affiliates were due reimbursement (at cost) in 1995 for accounting services, portfolio management services, legal services and for administrative charges and other out-of-pocket expenses of $29,015, $17,553, $1,165 and $19,419, respectively, of which $11,144 was unpaid at December 31, 1995. Also, during 1995, the Partnership recognized and paid certain 1994 administrative charges to the Corporate General Partner and its affiliates of approximately $33,590 that had not previously been reimbursed.\nThe Partnership is obligated to pay (not more often than monthly) mortgage investment servicing fees to the General Partners at an annual rate of 1\/4 of 1% of the maximum amount funded or to be funded by the Partnership on mortgage investments. The servicing fee is calculated from the date the Partnership first signs a letter of commitment for such mortgage investment, but is not payable until the funding of the mortgage investment. As all loans have been repaid or foreclosed, there were no unpaid fees at December 31, 1995.\nAt December 31, 1995, there are no deferrals to the General Partners in excess of that required by the Partnership Agreement. All amounts deferred or currently payable to the General Partners or their affiliates do not bear interest.\nEffective October 1, 1995, the Corporate General Partner of the Partnership engaged independent third parties to perform certain administrative services for the Partnership which were previously performed by, and partially reimbursed to, affiliates of the General Partners. Use of such third parties is not expected to have a material effect on the operations of the Partnership.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the General Partners, their affiliates or their management other than those described in Items 10 and 11 above.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this report.)\n(2) Exhibits\n3-A.* The Prospectus of the Partnership dated January 31, 1984, as supplemented July 18, 1984 and May 15, 1985 as filed with the Commission pursuant to Rules 424(b) and 424(c), is incorporated herein by reference. Copies of Pages 8-10, 46-47 and A-7 to A-11 of the Prospectus, copies of pages 1-3 of the Supplement dated July 18, 1984, and the Supplement dated May 15, 1985 are incorporated herein by reference.\n3-B.* Amended and Restated Agreement of Limited Partnership, which agreement is incorporated herein by reference to the Partnership's Prospectus as filed with the Commission in the Partnership's Registration Statement on Form S-11 (File No. 2-87086) dated January 31, 1984.\n10-A. Agreement for Deed in Lieu of Foreclosure and related agreements dated as of April 4, 1995 between borrower and lenders relating to Spring Hill Fashion Center are filed herewith.\n10-B. Agreement of General Partnership of JMB\/Spring Hill Associates dated May 1, 1995 between JMB Mortgage Partners, Ltd., JMB Mortgage Partners, Ltd.-II and JMB Mortgage Partners, Ltd.-III is filed herewith.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\n- ----------------\n* Previously filed as Exhibits 3-A and 3-B, respectively, to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0- 16252) dated March 19, 1993.\n(b) No reports on Form 8-K were required or filed since the beginning of the last quarter of the period covered by this report.\n(c) Not applicable\nNo annual report or proxy material for fiscal year 1995 has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJMB MORTGAGE PARTNERS, LTD. - II\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: 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.\nBy: JMB Realty Corporation Corporate General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Chief Financial Officer Date: March 25, 1996\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 25, 1996\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 25, 1996\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 25, 1996\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 25, 1996\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 25, 1996\nSTUART C. NATHAN* By: Stuart C. Nathan Executive Vice President and Director Date: March 25, 1996\n*By: GAILEN J. HULL Pursuant to a Power of Attorney\nGAILEN J. HULL By: GAILEN J. HULL, Attorney-in-Fact Date: March 25, 1996\nJMB MORTGAGE PARTNERS, LTD. - II\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------- ---- 3-A. Pages 8-10, 46-47 and A-7 to A-11 of the Prospectus of the Partnership dated January 31, 1984, pages 1-3 of the Supplement dated July 18, 1984, the Supplement dated May 15, 1985 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n10-A. Agreement for Deed in Lieu of Foreclosure, dated April 4, 1995 No\n10-B. General Partnership Agreement for JMB\/Spring Hill Associates, dated May 1, 1995 No\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the General Partners, their affiliates or their management other than those described in Items 10 and 11 above.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this report.)\n(2) Exhibits\n3-A.* The Prospectus of the Partnership dated January 31, 1984, as supplemented July 18, 1984 and May 15, 1985 as filed with the Commission pursuant to Rules 424(b) and 424(c), is incorporated herein by reference. Copies of Pages 8-10, 46-47 and A-7 to A-11 of the Prospectus, copies of pages 1-3 of the Supplement dated July 18, 1984, and the Supplement dated May 15, 1985 are incorporated herein by reference.\n3-B.* Amended and Restated Agreement of Limited Partnership, which agreement is incorporated herein by reference to the Partnership's Prospectus as filed with the Commission in the Partnership's Registration Statement on Form S-11 (File No. 2-87086) dated January 31, 1984.\n10-A. Agreement for Deed in Lieu of Foreclosure and related agreements dated as of April 4, 1995 between borrower and lenders relating to Spring Hill Fashion Center are filed herewith.\n10-B. Agreement of General Partnership of JMB\/Spring Hill Associates dated May 1, 1995 between JMB Mortgage Partners, Ltd., JMB Mortgage Partners, Ltd.-II and JMB Mortgage Partners, Ltd.-III is filed herewith.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\n- ----------------\n* Previously filed as Exhibits 3-A and 3-B, respectively, to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0- 16252) dated March 19, 1993.\n(b) No reports on Form 8-K were required or filed since the beginning of the last quarter of the period covered by this report.\n(c) Not applicable\nNo annual report or proxy material for fiscal year 1995 has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJMB MORTGAGE PARTNERS, LTD. - II\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: 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.\nBy: JMB Realty Corporation Corporate General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Chief Financial Officer Date: March 25, 1996\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 25, 1996\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 25, 1996\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 25, 1996\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 25, 1996\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 25, 1996\nSTUART C. NATHAN* By: Stuart C. Nathan Executive Vice President and Director Date: March 25, 1996\n*By: GAILEN J. HULL Pursuant to a Power of Attorney\nGAILEN J. HULL By: GAILEN J. HULL, Attorney-in-Fact Date: March 25, 1996\nJMB MORTGAGE PARTNERS, LTD. - II\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------- ---- 3-A. Pages 8-10, 46-47 and A-7 to A-11 of the Prospectus of the Partnership dated January 31, 1984, pages 1-3 of the Supplement dated July 18, 1984, the Supplement dated May 15, 1985 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n10-A. Agreement for Deed in Lieu of Foreclosure, dated April 4, 1995 No\n10-B. General Partnership Agreement for JMB\/Spring Hill Associates, dated May 1, 1995 No\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No","section_15":""}
{"filename":"945094_1995.txt","cik":"945094","year":"1995","section_1":"ITEM 1. BUSINESS\nGlenbrook Life and Annuity Company (hereinafter \"Glenbrook Life\" or the \"Company\"), is a stock life insurance company which was organized under the laws of the State of Illinois in 1992. The Company was originally organized under the laws of the State of Indiana in 1965. From 1965 to 1983 the Company was known as \"United Standard Life Assurance Company\" and from 1983 to 1992 the Company was known as \"William Penn Life Assurance Company of America.\" Glenbrook Life's products, group and individual annuities and life insurance, have been approved by the states where offered.\nGlenbrook Life is a wholly owned subsidiary of Allstate Life Insurance Company (\"Allstate Life\"), a stock life insurance company incorporated under the laws of Illinois. Allstate Life is a wholly owned subsidiary of Allstate Insurance Company (\"Allstate\"), a stock property-liability insurance company incorporated under the laws of Illinois. With the exception of directors' qualifying shares, all of the outstanding capital stock of Allstate is owned by The Allstate Corporation (\"Corporation\"). The Corporation was capitalized in 1993 with the contribution of all of the outstanding common stock of Allstate. Sears, Roebuck and Co. (\"Sears\") had previously been the direct owner of all the common stock of Allstate. On June 9, 1993 the Corporation completed its initial public offering of 89,500,000 common shares. On June 30, 1995, Sears distributed its remaining 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend.\nGlenbrook Life and Allstate Life entered into reinsurance agreements, effective June 5, 1992, under which Glenbrook Life reinsures substantially all of its business with Allstate Life. Under the agreements, premiums, expenses and benefits under all general account contracts are transferred to Allstate Life and the net cash flows are invested by Allstate Life, to support the liabilities assumed under the reinsurance agreements. The funds necessary to support the operations of the Company are provided by Allstate Life.\nUnder the Company's reinsurance agreements with Allstate Life, the Company reinsures all reserve liabilities with Allstate Life except for variable contracts. The Company's variable contract assets are held in legally-segregated, unitized separate accounts and are retained by the Company. Investment income and realized gains and losses of the separate account investments accrue directly to the contractholders (net of fees), and are not included in the Company's results of operations.\nGlenbrook Life's operations consist of one business segment which is the sale of life insurance and annuity products.\nGlenbrook Life's and Allstate Life's general account assets must be invested in accordance\nwith applicable state laws. These laws govern the nature and quality of investments that may be made by life insurance companies and the percentage of their assets that may be committed to any particular type of investment. Of Allstate Life's consolidated invested assets of $27,256 million on December 31, 1995, 81.5% was invested in fixed income securities, 2.9% in equities, 11.8% in mortgage loans, and 3.8% in real estate, short-term investments and other assets.\nGlenbrook Life is engaged in a business that is highly competitive because of the large number of stock and mutual life insurance companies and other entities competing in the sale of insurance and annuities. There are approximately 2,000 stock, mutual and other types of insurers in business in the United States. Several independent rating agencies regularly evaluate life insurer's claims paying ability, quality of investments and overall stability. A.M. Best Company assigns A+(Superior) to Allstate Life which automatically reinsures all net business of Glenbrook Life. A.M. Best Company also assigns Glenbrook Life the rating of A+(r) because Glenbrook Life automatically reinsures all business with Allstate Life. Standard & Poor's Insurance Rating Services assigned AA+(Excellent) to the Company's claims-paying ability and Moody's Investors Service assigned an Aa3 (excellent) financial stability rating to the Company. Glenbrook Life shares the same ratings of its parent, Allstate Life.\nAlthough the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed measures which may significantly affect the Company's insurance business relate to the taxation of insurance companies, the tax treatment of insurance products and the removal of barriers preventing banks from engaging in the insurance business.\nGlenbrook Life is regulated by the Securities and Exchange Commission (\"SEC\") as an issuer of registered products. The SEC also regulates certain Glenbrook Life Separate Accounts through which the Company issues variable annuity contracts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGlenbrook Life occupies office space provided by its parent, Allstate Life, in Northbrook, Illinois. Expenses associated with these offices are allocated on a indirect basis to Glenbrook Life.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its Board of Directors know of no material legal proceedings pending to which the Company is a party or which would materially affect the Company. The Company is involved in pending and threatened litigation in the normal course of its business in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate the ultimate liability arising from such pending or threatened litigation to have a material effect on the financial condition of the Company.\nPART II\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the Company's outstanding shares are owned by its parent, Allstate Life. Allstate Life's outstanding shares are owned by Allstate. With the exception of director's qualifying shares, all of the outstanding capital stock of Allstate is owned by The Allstate Corporation (\"Corporation\"). The Corporation was capitalized in 1993 with the contribution of all of the outstanding common stock of Allstate. Sears, Roebuck and Co. (\"Sears\") had previously been the direct owner of all the common stock of Allstate. On June 9, 1993 the Corporation completed its initial public offering of 89,500,000 common shares. On June 30, 1995, Sears distributed it's remaining 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend.\nITEM 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\nThe following highlights significant factors influencing results of operations and financial position.\nGlenbrook Life and Annuity Company (\"the Company\"), which is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), currently issues flexible premium fixed annuities, and beginning in 1995, flexible premium deferred variable annuity contracts through its Separate Accounts. The Company markets its products through banks and other financial institutions.\nThe Company reinsures all of its annuity deposits with Allstate Life, and all life insurance in force with other reinsurers. Accordingly, the financial results reflected in the Company's statements of operations relate only to the investment of those assets of the Company that are not transferred to Allstate Life or other reinsurers under the reinsurance treaties.\nSeparate Account assets and liabilities are legally segregated and carried at fair value in the statements of financial position. The Separate Account investment portfolios were initially funded with a $10 million seed money contribution from the Company in 1995. Investment income and realized gains and losses of the Separate Account investments, other than the portion related to the Company's participation, accrue directly to the contractholders (net of fees) and, therefore, are not included in the Company's statements of operations.\nRESULTS OF OPERATIONS\nNet investment income increased $2.0 million in 1995, and $1.3 million in 1994. In both years, the increases were attributable to an increased level of investments, including the Company's participation in the Separate Accounts during 1995, and a $40 million capital contribution received from Allstate Life in the third quarter of 1994. Net income increases of $1.6 million and $0.8 million reflect the change in net investment income in both years.\nRealized capital gains after tax of $0.3 million in 1995 were the result of sales of investments to fund the Company's participation in the Separate Accounts.\nFINANCIAL POSITION\n- -----------------\n(1) Unrealized net capital gains (losses) exclude the effect of deferred income taxes.\nFixed income securities are classified as available for sale and carried in the statements of financial position at fair value. Although the Company generally intends to hold its fixed income securities for the long-term, such classification affords the Company flexibility in managing the portfolio in response to changes in market conditions.\nAt December 31, 1995 unrealized capital gains were $5.2 million compared to unrealized capital losses of $1.7 million at December 31, 1994. The significant change in the unrealized capital gain\/loss position is primarily attributable to declining interest rates.\nAt December 31, 1995 both contractholder funds and amounts recoverable from Allstate Life under reinsurance treaties reflect an increase of $644 million. These increases result from sales of the Company's single and flexible premium deferred annuities partially offset by surrenders. Reinsurance recoverable from Allstate Life relates to policy benefit obligations ceded to Allstate Life.\nThe Company's participation in the Separate Accounts of $10.5 million at December 31, 1995 is included in the Separate Accounts assets. Unrealized net capital gains arising from the Company's participation in the Separate Accounts was $0.3 million, net of tax, at December 31, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nAllstate Life made a $40 million capital contribution to the Company in the third quarter of 1994.\nUnder the terms of intercompany reinsurance agreements, assets of the Company that relate to insurance in force, excluding Separate Account assets, are transferred to Allstate Life or other reinsurers, who maintain investment portfolios which support the Company's products.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements\nINDEX\nPAGE ----\nIndependent Auditors' Report 9\nFinancial Statements:\nStatements of Financial Position, December 31, 1995 and 1994 10\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 11\nStatements of Shareholder's Equity 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\nSchedule IV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 20\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND SHAREHOLDER OF GLENBROOK LIFE AND ANNUITY COMPANY:\nWe have audited the accompanying Statements of Financial Position of Glenbrook Life and Annuity Company as of December 31, 1995 and 1994, and the related Statements of Operations, Shareholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1995. Our audits also included Schedule IV -- Reinsurance. 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 financial statements present fairly, in all material respects, the financial position of Glenbrook Life and Annuity 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. Also, in our opinion, Schedule IV - -- Reinsurance, 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 financial statements, in 1993 the Company changed its method of accounting for investments in fixed income securities.\n\/s\/ DELOITTE & TOUCHE LLP\nChicago, IL\nMarch 1, 1996\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF FINANCIAL POSITION\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF OPERATIONS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS ($ IN THOUSANDS)\n1. ORGANIZATION AND NATURE OF OPERATIONS\nGlenbrook Life and Annuity Company (the \"Company\") is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), which is wholly owned by Allstate Insurance Company (\"Allstate\"), a wholly-owned subsidiary of The Allstate Corporation (the \"Corporation\"). On June 30, 1995, Sears, Roebuck and Co. (\"Sears\") distributed its 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend (the \"Distribution\").\nThe Company develops and markets flexible premium deferred variable annuity contracts and single and flexible premium deferred annuities to individuals through banks and financial institutions in the United States.\nAnnuity contracts issued by the Company are subject to discretionary withdrawal or surrender by the contractholder, subject to applicable surrender charges. These contracts are reinsured with Allstate Life (Note 4) which selects assets to meet the anticipated cash flow requirements of the assumed liabilities. Allstate Life utilizes various modeling techniques in managing the relationship between assets and liabilities and employs strategies to maintain investments which are sufficiently liquid to meet obligations to contractholders in various interest rate scenarios.\nThe Company monitors economic and regulatory developments which have the potential to impact its business. Currently there is proposed legislation which would permit banks greater participation in securities businesses, which could eventually present an increased level of competition for sales of the Company's annuity contracts. Furthermore, the federal government may enact changes which could possibly eliminate the tax-advantaged nature of annuities or eliminate consumers' need for tax deferral, thereby reducing the incentive for customers to purchase the Company's products. While it is not possible to predict the outcome of such issues with certainty, management evaluates the likelihood of various outcomes and develops strategies, as appropriate, to respond to such challenges.\nCertain reclassifications have been made to the prior year financial statements to conform to the presentation for the current year.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nLIFE INSURANCE ACCOUNTING\nThe Company sells long-duration contracts that do not involve significant risk of policyholder mortality or morbidity (principally single and flexible premium annuities) which are considered investment contracts.\nCONTRACTHOLDER FUNDS\nContractholder funds arise from the issuance of individual and group annuities that include an investment component. Payments received are recorded as interest-bearing liabilities. Contractholder funds are equal to deposits received and interest accrued to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. Credited interest rates on contractholder funds ranged from 3.0% to 7.4% for those contracts with fixed interest rates and from 4.25% to 7.9% for those with flexible rates during 1995.\nSEPARATE ACCOUNTS\nDuring 1995, the Company issued flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as assets and liabilities of the Separate Accounts (Glenbrook Life and Annuity Company Variable Annuity Account and Glenbrook Life and Annuity Company Separate Account A), unit investment trusts registered with the Securities and Exchange Commission. Assets of the Separate Accounts are invested in funds of management investment companies. For certain variable annuity contracts, the Company has entered into an exclusive distribution arrangement with distributors.\nThe assets of the Separate Accounts are carried at fair value. Unrealized gains and losses on the Company's participation in the Separate Account, net of deferred income taxes, is shown as a component of shareholder's equity. The Company's participation in the Separate Account, amounting to $10,530 at December 31, 1995, is subject to certain withdrawal restrictions which are dependent upon aggregate fund net asset values. In addition, limitations exist with regard to the maximum amount which can be withdrawn by the Company within any 30-day period.\nInvestment income and realized gains and losses of the Separate Accounts, other than the portion related to the Company's participation, accrue directly to the contractholders and, therefore, are not included in the accompanying statements of operations. Revenues to the Company from the Separate Accounts consist of contract maintenance fees, administrative fees and mortality and expense risk charges, which are entirely ceded to Allstate Life.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nREINSURANCE\nBeginning June 5, 1992, the Company reinsures all new business to Allstate Life (Note 4). Life insurance in force prior to that date is ceded to non-affiliated reinsurers.\nContract charges and credited interest are ceded and reflected net of such cessions in the statements of operations. Reinsurance recoverable and contractholder funds are reported separately in the statements of financial position.\nINVESTMENTS\nFixed income securities include bonds and mortgage-backed securities. Fixed income securities are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes, is reflected as a separate component of shareholder's equity. Provisions are made to write down the carrying value of fixed income securities for declines in value that are other than temporary. Such writedowns are included in realized capital gains and losses.\nShort-term investments are carried at cost which approximates fair value.\nInvestment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method, based on the estimated principal repayments. Accrual of income is suspended for fixed income securities that are in default or when the receipt of interest payments is in doubt. Realized capital gains and losses are determined on a specific identification basis.\nINCOME TAXES\nThe income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. Deferred income taxes also arise from unrealized capital gains or losses on fixed income securities carried at fair value.\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.\n3. ACCOUNTING CHANGE\nEffective December 31, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires that investments classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of amortized cost or fair value, determined in the aggregate. Unrealized holding gains and losses are reflected as a separate component of shareholder's equity, net of deferred income taxes. The net effect of adoption of this statement increased shareholder's equity at December 31, 1993 by $693, with no impact on net income.\n4. RELATED PARTY TRANSACTIONS\nREINSURANCE\nContract charges ceded to Allstate Life under reinsurance agreements were $1,523 and $409 in 1995 and 1994, respectively. Credited interest and expenses ceded to Allstate Life amounted to $71,905 and $26,177 in 1995 and 1994, respectively. Investment income earned on the assets which support contractholder funds is not included in the Company's financial statements as those assets were transferred to Allstate Life under the terms of reinsurance treaties. Reinsurance ceded arrangements do not discharge the Company as the primary insurer.\nBUSINESS OPERATIONS\nThe Company utilizes services and business facilities owned or leased, and operated by Allstate in conducting its business activities. The Company reimburses Allstate for the operating expenses incurred by Allstate on behalf of the Company. The cost to the Company is determined by various allocation methods and is primarily related to the level of services provided. Operating expenses, including compensation and retirement and other benefit programs, allocated to the Company were $348, $271 and $59 in 1995, 1994 and 1993, respectively. Investment-related expenses are retained by the Company. All other costs are assumed by Allstate Life under reinsurance treaties.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n4. RELATED PARTY TRANSACTIONS (CONTINUED)\nLAUGHLIN GROUP\nLaughlin Group, Inc. (\"Laughlin\"), a wholly-owned subsidiary of Laughlin Group Holdings Inc., a wholly-owned subsidiary of Allstate Life which was acquired in September 1995, is a third-party marketer which distributes the products of insurance carriers including the Company. Laughlin markets the Company's flexible premium deferred variable annuity contracts and flexible premium deferred annuities. Sales commissions paid to Laughlin subsequent to the acquisition date of $3,439 were ceded to Allstate Life.\n5. INCOME TAXES\nAllstate Life and its life insurance subsidiaries, including the Company, will file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective subsidiaries, whether or not such benefits generated by the subsidiaries would be available on a separate return basis. The Corporation and its domestic subsidiaries including the Company (the \"Allstate Group\"), will be eligible to file a consolidated tax return beginning in the year 2000.\nPrior to the Distribution, the Allstate Group joined with Sears and its domestic business units (the \"Sears Group\") in the filing of a consolidated federal income tax return (the \"Sears Tax Group\") and were parties to a federal income tax allocation agreement (the \"Tax Sharing Agreement\"). As a member of the Sears Tax Group, the Corporation was jointly and severally liable for the consolidated income tax liability of the Sears Tax Group. Under the Tax Sharing Agreement, the Company, through the Corporation, paid to or received from the Sears Group the amount, if any, by which the Sears Tax Group's federal income tax liability was affected by virtue of inclusion of the Allstate Group in the consolidated federal income tax return. Effectively, this resulted in the Company's annual income tax provision being computed as if the Company filed a separate return, except that items such as net operating losses, capital losses or similar items which might not be immediately recognizable in a separate return, were allocated according to the Tax Sharing Agreement and reflected in the Company's provision to the extent that such items reduced the Sears Tax Group's federal tax liability.\nThe Allstate Group and Sears Group have entered into an agreement which governs their respective rights and obligations with respect to federal income taxes for all periods prior to the Distribution (\"Consolidated Tax Years\"). The agreement provides that all Consolidated Tax Years will continue to be governed by the Tax Sharing Agreement with respect to the Company's federal income tax liability and taxes payable to or recoverable from the Sears Group.\nThe components of the deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\nThe components of income tax expense are as follows:\nThe Company paid income taxes of $874, $57 and $290 in 1995, 1994 and 1993, respectively, under the Tax Sharing Agreement. The Company had income taxes payable to Allstate Life of $1,637 and $605 at December 31, 1995 and 1994, respectively.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS\nFAIR VALUES\nThe amortized cost, fair value and gross unrealized gains and losses for fixed income securities are as follows:\nSCHEDULED MATURITIES\nThe scheduled maturities of fixed income securities available for sale at December 31, 1995 are as follows:\nActual maturities may differ from those scheduled as a result of prepayments by the issuers.\nUNREALIZED NET CAPITAL GAINS AND LOSSES\nUnrealized net capital gains and losses on fixed income securities and the Company's participation in the Separate Account included in shareholder's equity at December 31, 1995 are as follows:\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS (CONTINUED)\nThe change in unrealized net capital gains and losses for fixed income securities and the Company's participation in the Separate Account is as follows:\nCOMPONENTS OF NET INVESTMENT INCOME\nInvestment income by investment type is as follows:\nREALIZED CAPITAL GAINS AND LOSSES\nRealized capital gains on investments are as follows:\nPROCEEDS FROM SALES OF FIXED INCOME SECURITIES\nThe proceeds from sales of investments in fixed income securities, excluding calls, were $7,836 and $3,015, with related gross realized gains of $459 and $22 for 1995 and 1993, respectively. There were no such amounts realized in 1994.\nSECURITIES ON DEPOSIT\nAt December 31, 1995, fixed income securities with a carrying value of $10,085 were on deposit with regulatory authorities as required by law.\n7. FINANCIAL INSTRUMENTS\nIn the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The fair value of all financial assets other than fixed income securities and all liabilities other than contractholder funds approximates their carrying value as they are short-term in nature.\nFair values for fixed income securities are based on quoted market prices. The December 31, 1995 and 1994 fair values and carrying values of fixed income securities are discussed in Note 6.\nThe fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts. Reserves on investment contracts with no stated maturities (single premium and flexible premium deferred annuities) are valued at the fund balance less surrender charge. The fair value of immediate annuities with fixed terms are estimated using discounted cash flow calculations based on\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n7. FINANCIAL INSTRUMENTS (CONTINUED)\ninterest rates currently offered for contracts with similar terms and duration. Contractholder funds on investment contracts had a carrying value of $1,340,925 at December 31, 1995 and a fair value of $1,282,248. The carrying value and fair value at December 31, 1994 were $696,854 and $670,930, respectively.\n8. STATUTORY FINANCIAL INFORMATION\nThe following tables reconcile net income and shareholder's equity as reported herein in conformity with generally accepted accounting principles with statutory net income and capital and surplus, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities:\nPERMITTED STATUTORY ACCOUNTING PRACTICES\nThe Company prepares their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the insurance department of the State of Illinois. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company does not follow any permitted statutory accounting practices that have a material effect on statutory surplus or risk-based capital.\nDIVIDENDS\nThe ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in accordance with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 1996 without prior approval of both the Illinois and California Departments of Insurance is $5,220.\nGLENBROOK LIFE AND ANNUITY COMPANY SCHEDULE IV--REINSURANCE ($ IN THOUSANDS)\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report. The page number, if any, listed opposite a document indicates the page number in the sequential numbering system in the manually signed original of this Report where such document can be found.\n(1) The financial statements filed as part of this Report are listed in Item 8.\n(2) Financial Statement Schedules\nSchedule IV - Reinsurance page 20\n(3) 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.\nGLENBROOK LIFE AND ANNUITY COMPANY\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal 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 the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal Executive Officer)\nDate March 29, 1996\nBy \/s\/ Barry S. Paul Barry S. Paul Assistant Vice President and Controller (Chief Accounting Officer)\nDate March 29, 1996","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the Company's outstanding shares are owned by its parent, Allstate Life. Allstate Life's outstanding shares are owned by Allstate. With the exception of director's qualifying shares, all of the outstanding capital stock of Allstate is owned by The Allstate Corporation (\"Corporation\"). The Corporation was capitalized in 1993 with the contribution of all of the outstanding common stock of Allstate. Sears, Roebuck and Co. (\"Sears\") had previously been the direct owner of all the common stock of Allstate. On June 9, 1993 the Corporation completed its initial public offering of 89,500,000 common shares. On June 30, 1995, Sears distributed it's remaining 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend.\nITEM 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\nThe following highlights significant factors influencing results of operations and financial position.\nGlenbrook Life and Annuity Company (\"the Company\"), which is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), currently issues flexible premium fixed annuities, and beginning in 1995, flexible premium deferred variable annuity contracts through its Separate Accounts. The Company markets its products through banks and other financial institutions.\nThe Company reinsures all of its annuity deposits with Allstate Life, and all life insurance in force with other reinsurers. Accordingly, the financial results reflected in the Company's statements of operations relate only to the investment of those assets of the Company that are not transferred to Allstate Life or other reinsurers under the reinsurance treaties.\nSeparate Account assets and liabilities are legally segregated and carried at fair value in the statements of financial position. The Separate Account investment portfolios were initially funded with a $10 million seed money contribution from the Company in 1995. Investment income and realized gains and losses of the Separate Account investments, other than the portion related to the Company's participation, accrue directly to the contractholders (net of fees) and, therefore, are not included in the Company's statements of operations.\nRESULTS OF OPERATIONS\nNet investment income increased $2.0 million in 1995, and $1.3 million in 1994. In both years, the increases were attributable to an increased level of investments, including the Company's participation in the Separate Accounts during 1995, and a $40 million capital contribution received from Allstate Life in the third quarter of 1994. Net income increases of $1.6 million and $0.8 million reflect the change in net investment income in both years.\nRealized capital gains after tax of $0.3 million in 1995 were the result of sales of investments to fund the Company's participation in the Separate Accounts.\nFINANCIAL POSITION\n- -----------------\n(1) Unrealized net capital gains (losses) exclude the effect of deferred income taxes.\nFixed income securities are classified as available for sale and carried in the statements of financial position at fair value. Although the Company generally intends to hold its fixed income securities for the long-term, such classification affords the Company flexibility in managing the portfolio in response to changes in market conditions.\nAt December 31, 1995 unrealized capital gains were $5.2 million compared to unrealized capital losses of $1.7 million at December 31, 1994. The significant change in the unrealized capital gain\/loss position is primarily attributable to declining interest rates.\nAt December 31, 1995 both contractholder funds and amounts recoverable from Allstate Life under reinsurance treaties reflect an increase of $644 million. These increases result from sales of the Company's single and flexible premium deferred annuities partially offset by surrenders. Reinsurance recoverable from Allstate Life relates to policy benefit obligations ceded to Allstate Life.\nThe Company's participation in the Separate Accounts of $10.5 million at December 31, 1995 is included in the Separate Accounts assets. Unrealized net capital gains arising from the Company's participation in the Separate Accounts was $0.3 million, net of tax, at December 31, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nAllstate Life made a $40 million capital contribution to the Company in the third quarter of 1994.\nUnder the terms of intercompany reinsurance agreements, assets of the Company that relate to insurance in force, excluding Separate Account assets, are transferred to Allstate Life or other reinsurers, who maintain investment portfolios which support the Company's products.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements\nINDEX\nPAGE ----\nIndependent Auditors' Report 9\nFinancial Statements:\nStatements of Financial Position, December 31, 1995 and 1994 10\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 11\nStatements of Shareholder's Equity 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\nSchedule IV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 20\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND SHAREHOLDER OF GLENBROOK LIFE AND ANNUITY COMPANY:\nWe have audited the accompanying Statements of Financial Position of Glenbrook Life and Annuity Company as of December 31, 1995 and 1994, and the related Statements of Operations, Shareholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1995. Our audits also included Schedule IV -- Reinsurance. 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 financial statements present fairly, in all material respects, the financial position of Glenbrook Life and Annuity 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. Also, in our opinion, Schedule IV - -- Reinsurance, 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 financial statements, in 1993 the Company changed its method of accounting for investments in fixed income securities.\n\/s\/ DELOITTE & TOUCHE LLP\nChicago, IL\nMarch 1, 1996\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF FINANCIAL POSITION\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF OPERATIONS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS ($ IN THOUSANDS)\n1. ORGANIZATION AND NATURE OF OPERATIONS\nGlenbrook Life and Annuity Company (the \"Company\") is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), which is wholly owned by Allstate Insurance Company (\"Allstate\"), a wholly-owned subsidiary of The Allstate Corporation (the \"Corporation\"). On June 30, 1995, Sears, Roebuck and Co. (\"Sears\") distributed its 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend (the \"Distribution\").\nThe Company develops and markets flexible premium deferred variable annuity contracts and single and flexible premium deferred annuities to individuals through banks and financial institutions in the United States.\nAnnuity contracts issued by the Company are subject to discretionary withdrawal or surrender by the contractholder, subject to applicable surrender charges. These contracts are reinsured with Allstate Life (Note 4) which selects assets to meet the anticipated cash flow requirements of the assumed liabilities. Allstate Life utilizes various modeling techniques in managing the relationship between assets and liabilities and employs strategies to maintain investments which are sufficiently liquid to meet obligations to contractholders in various interest rate scenarios.\nThe Company monitors economic and regulatory developments which have the potential to impact its business. Currently there is proposed legislation which would permit banks greater participation in securities businesses, which could eventually present an increased level of competition for sales of the Company's annuity contracts. Furthermore, the federal government may enact changes which could possibly eliminate the tax-advantaged nature of annuities or eliminate consumers' need for tax deferral, thereby reducing the incentive for customers to purchase the Company's products. While it is not possible to predict the outcome of such issues with certainty, management evaluates the likelihood of various outcomes and develops strategies, as appropriate, to respond to such challenges.\nCertain reclassifications have been made to the prior year financial statements to conform to the presentation for the current year.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nLIFE INSURANCE ACCOUNTING\nThe Company sells long-duration contracts that do not involve significant risk of policyholder mortality or morbidity (principally single and flexible premium annuities) which are considered investment contracts.\nCONTRACTHOLDER FUNDS\nContractholder funds arise from the issuance of individual and group annuities that include an investment component. Payments received are recorded as interest-bearing liabilities. Contractholder funds are equal to deposits received and interest accrued to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. Credited interest rates on contractholder funds ranged from 3.0% to 7.4% for those contracts with fixed interest rates and from 4.25% to 7.9% for those with flexible rates during 1995.\nSEPARATE ACCOUNTS\nDuring 1995, the Company issued flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as assets and liabilities of the Separate Accounts (Glenbrook Life and Annuity Company Variable Annuity Account and Glenbrook Life and Annuity Company Separate Account A), unit investment trusts registered with the Securities and Exchange Commission. Assets of the Separate Accounts are invested in funds of management investment companies. For certain variable annuity contracts, the Company has entered into an exclusive distribution arrangement with distributors.\nThe assets of the Separate Accounts are carried at fair value. Unrealized gains and losses on the Company's participation in the Separate Account, net of deferred income taxes, is shown as a component of shareholder's equity. The Company's participation in the Separate Account, amounting to $10,530 at December 31, 1995, is subject to certain withdrawal restrictions which are dependent upon aggregate fund net asset values. In addition, limitations exist with regard to the maximum amount which can be withdrawn by the Company within any 30-day period.\nInvestment income and realized gains and losses of the Separate Accounts, other than the portion related to the Company's participation, accrue directly to the contractholders and, therefore, are not included in the accompanying statements of operations. Revenues to the Company from the Separate Accounts consist of contract maintenance fees, administrative fees and mortality and expense risk charges, which are entirely ceded to Allstate Life.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nREINSURANCE\nBeginning June 5, 1992, the Company reinsures all new business to Allstate Life (Note 4). Life insurance in force prior to that date is ceded to non-affiliated reinsurers.\nContract charges and credited interest are ceded and reflected net of such cessions in the statements of operations. Reinsurance recoverable and contractholder funds are reported separately in the statements of financial position.\nINVESTMENTS\nFixed income securities include bonds and mortgage-backed securities. Fixed income securities are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes, is reflected as a separate component of shareholder's equity. Provisions are made to write down the carrying value of fixed income securities for declines in value that are other than temporary. Such writedowns are included in realized capital gains and losses.\nShort-term investments are carried at cost which approximates fair value.\nInvestment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method, based on the estimated principal repayments. Accrual of income is suspended for fixed income securities that are in default or when the receipt of interest payments is in doubt. Realized capital gains and losses are determined on a specific identification basis.\nINCOME TAXES\nThe income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. Deferred income taxes also arise from unrealized capital gains or losses on fixed income securities carried at fair value.\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.\n3. ACCOUNTING CHANGE\nEffective December 31, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires that investments classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of amortized cost or fair value, determined in the aggregate. Unrealized holding gains and losses are reflected as a separate component of shareholder's equity, net of deferred income taxes. The net effect of adoption of this statement increased shareholder's equity at December 31, 1993 by $693, with no impact on net income.\n4. RELATED PARTY TRANSACTIONS\nREINSURANCE\nContract charges ceded to Allstate Life under reinsurance agreements were $1,523 and $409 in 1995 and 1994, respectively. Credited interest and expenses ceded to Allstate Life amounted to $71,905 and $26,177 in 1995 and 1994, respectively. Investment income earned on the assets which support contractholder funds is not included in the Company's financial statements as those assets were transferred to Allstate Life under the terms of reinsurance treaties. Reinsurance ceded arrangements do not discharge the Company as the primary insurer.\nBUSINESS OPERATIONS\nThe Company utilizes services and business facilities owned or leased, and operated by Allstate in conducting its business activities. The Company reimburses Allstate for the operating expenses incurred by Allstate on behalf of the Company. The cost to the Company is determined by various allocation methods and is primarily related to the level of services provided. Operating expenses, including compensation and retirement and other benefit programs, allocated to the Company were $348, $271 and $59 in 1995, 1994 and 1993, respectively. Investment-related expenses are retained by the Company. All other costs are assumed by Allstate Life under reinsurance treaties.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n4. RELATED PARTY TRANSACTIONS (CONTINUED)\nLAUGHLIN GROUP\nLaughlin Group, Inc. (\"Laughlin\"), a wholly-owned subsidiary of Laughlin Group Holdings Inc., a wholly-owned subsidiary of Allstate Life which was acquired in September 1995, is a third-party marketer which distributes the products of insurance carriers including the Company. Laughlin markets the Company's flexible premium deferred variable annuity contracts and flexible premium deferred annuities. Sales commissions paid to Laughlin subsequent to the acquisition date of $3,439 were ceded to Allstate Life.\n5. INCOME TAXES\nAllstate Life and its life insurance subsidiaries, including the Company, will file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective subsidiaries, whether or not such benefits generated by the subsidiaries would be available on a separate return basis. The Corporation and its domestic subsidiaries including the Company (the \"Allstate Group\"), will be eligible to file a consolidated tax return beginning in the year 2000.\nPrior to the Distribution, the Allstate Group joined with Sears and its domestic business units (the \"Sears Group\") in the filing of a consolidated federal income tax return (the \"Sears Tax Group\") and were parties to a federal income tax allocation agreement (the \"Tax Sharing Agreement\"). As a member of the Sears Tax Group, the Corporation was jointly and severally liable for the consolidated income tax liability of the Sears Tax Group. Under the Tax Sharing Agreement, the Company, through the Corporation, paid to or received from the Sears Group the amount, if any, by which the Sears Tax Group's federal income tax liability was affected by virtue of inclusion of the Allstate Group in the consolidated federal income tax return. Effectively, this resulted in the Company's annual income tax provision being computed as if the Company filed a separate return, except that items such as net operating losses, capital losses or similar items which might not be immediately recognizable in a separate return, were allocated according to the Tax Sharing Agreement and reflected in the Company's provision to the extent that such items reduced the Sears Tax Group's federal tax liability.\nThe Allstate Group and Sears Group have entered into an agreement which governs their respective rights and obligations with respect to federal income taxes for all periods prior to the Distribution (\"Consolidated Tax Years\"). The agreement provides that all Consolidated Tax Years will continue to be governed by the Tax Sharing Agreement with respect to the Company's federal income tax liability and taxes payable to or recoverable from the Sears Group.\nThe components of the deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\nThe components of income tax expense are as follows:\nThe Company paid income taxes of $874, $57 and $290 in 1995, 1994 and 1993, respectively, under the Tax Sharing Agreement. The Company had income taxes payable to Allstate Life of $1,637 and $605 at December 31, 1995 and 1994, respectively.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS\nFAIR VALUES\nThe amortized cost, fair value and gross unrealized gains and losses for fixed income securities are as follows:\nSCHEDULED MATURITIES\nThe scheduled maturities of fixed income securities available for sale at December 31, 1995 are as follows:\nActual maturities may differ from those scheduled as a result of prepayments by the issuers.\nUNREALIZED NET CAPITAL GAINS AND LOSSES\nUnrealized net capital gains and losses on fixed income securities and the Company's participation in the Separate Account included in shareholder's equity at December 31, 1995 are as follows:\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS (CONTINUED)\nThe change in unrealized net capital gains and losses for fixed income securities and the Company's participation in the Separate Account is as follows:\nCOMPONENTS OF NET INVESTMENT INCOME\nInvestment income by investment type is as follows:\nREALIZED CAPITAL GAINS AND LOSSES\nRealized capital gains on investments are as follows:\nPROCEEDS FROM SALES OF FIXED INCOME SECURITIES\nThe proceeds from sales of investments in fixed income securities, excluding calls, were $7,836 and $3,015, with related gross realized gains of $459 and $22 for 1995 and 1993, respectively. There were no such amounts realized in 1994.\nSECURITIES ON DEPOSIT\nAt December 31, 1995, fixed income securities with a carrying value of $10,085 were on deposit with regulatory authorities as required by law.\n7. FINANCIAL INSTRUMENTS\nIn the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The fair value of all financial assets other than fixed income securities and all liabilities other than contractholder funds approximates their carrying value as they are short-term in nature.\nFair values for fixed income securities are based on quoted market prices. The December 31, 1995 and 1994 fair values and carrying values of fixed income securities are discussed in Note 6.\nThe fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts. Reserves on investment contracts with no stated maturities (single premium and flexible premium deferred annuities) are valued at the fund balance less surrender charge. The fair value of immediate annuities with fixed terms are estimated using discounted cash flow calculations based on\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n7. FINANCIAL INSTRUMENTS (CONTINUED)\ninterest rates currently offered for contracts with similar terms and duration. Contractholder funds on investment contracts had a carrying value of $1,340,925 at December 31, 1995 and a fair value of $1,282,248. The carrying value and fair value at December 31, 1994 were $696,854 and $670,930, respectively.\n8. STATUTORY FINANCIAL INFORMATION\nThe following tables reconcile net income and shareholder's equity as reported herein in conformity with generally accepted accounting principles with statutory net income and capital and surplus, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities:\nPERMITTED STATUTORY ACCOUNTING PRACTICES\nThe Company prepares their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the insurance department of the State of Illinois. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company does not follow any permitted statutory accounting practices that have a material effect on statutory surplus or risk-based capital.\nDIVIDENDS\nThe ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in accordance with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 1996 without prior approval of both the Illinois and California Departments of Insurance is $5,220.\nGLENBROOK LIFE AND ANNUITY COMPANY SCHEDULE IV--REINSURANCE ($ IN THOUSANDS)\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report. The page number, if any, listed opposite a document indicates the page number in the sequential numbering system in the manually signed original of this Report where such document can be found.\n(1) The financial statements filed as part of this Report are listed in Item 8.\n(2) Financial Statement Schedules\nSchedule IV - Reinsurance page 20\n(3) 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.\nGLENBROOK LIFE AND ANNUITY COMPANY\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal 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 the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal Executive Officer)\nDate March 29, 1996\nBy \/s\/ Barry S. Paul Barry S. Paul Assistant Vice President and Controller (Chief Accounting Officer)\nDate March 29, 1996","section_6":"","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\nThe following highlights significant factors influencing results of operations and financial position.\nGlenbrook Life and Annuity Company (\"the Company\"), which is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), currently issues flexible premium fixed annuities, and beginning in 1995, flexible premium deferred variable annuity contracts through its Separate Accounts. The Company markets its products through banks and other financial institutions.\nThe Company reinsures all of its annuity deposits with Allstate Life, and all life insurance in force with other reinsurers. Accordingly, the financial results reflected in the Company's statements of operations relate only to the investment of those assets of the Company that are not transferred to Allstate Life or other reinsurers under the reinsurance treaties.\nSeparate Account assets and liabilities are legally segregated and carried at fair value in the statements of financial position. The Separate Account investment portfolios were initially funded with a $10 million seed money contribution from the Company in 1995. Investment income and realized gains and losses of the Separate Account investments, other than the portion related to the Company's participation, accrue directly to the contractholders (net of fees) and, therefore, are not included in the Company's statements of operations.\nRESULTS OF OPERATIONS\nNet investment income increased $2.0 million in 1995, and $1.3 million in 1994. In both years, the increases were attributable to an increased level of investments, including the Company's participation in the Separate Accounts during 1995, and a $40 million capital contribution received from Allstate Life in the third quarter of 1994. Net income increases of $1.6 million and $0.8 million reflect the change in net investment income in both years.\nRealized capital gains after tax of $0.3 million in 1995 were the result of sales of investments to fund the Company's participation in the Separate Accounts.\nFINANCIAL POSITION\n- -----------------\n(1) Unrealized net capital gains (losses) exclude the effect of deferred income taxes.\nFixed income securities are classified as available for sale and carried in the statements of financial position at fair value. Although the Company generally intends to hold its fixed income securities for the long-term, such classification affords the Company flexibility in managing the portfolio in response to changes in market conditions.\nAt December 31, 1995 unrealized capital gains were $5.2 million compared to unrealized capital losses of $1.7 million at December 31, 1994. The significant change in the unrealized capital gain\/loss position is primarily attributable to declining interest rates.\nAt December 31, 1995 both contractholder funds and amounts recoverable from Allstate Life under reinsurance treaties reflect an increase of $644 million. These increases result from sales of the Company's single and flexible premium deferred annuities partially offset by surrenders. Reinsurance recoverable from Allstate Life relates to policy benefit obligations ceded to Allstate Life.\nThe Company's participation in the Separate Accounts of $10.5 million at December 31, 1995 is included in the Separate Accounts assets. Unrealized net capital gains arising from the Company's participation in the Separate Accounts was $0.3 million, net of tax, at December 31, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nAllstate Life made a $40 million capital contribution to the Company in the third quarter of 1994.\nUnder the terms of intercompany reinsurance agreements, assets of the Company that relate to insurance in force, excluding Separate Account assets, are transferred to Allstate Life or other reinsurers, who maintain investment portfolios which support the Company's products.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements\nINDEX\nPAGE ----\nIndependent Auditors' Report 9\nFinancial Statements:\nStatements of Financial Position, December 31, 1995 and 1994 10\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 11\nStatements of Shareholder's Equity 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\nSchedule IV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 20\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND SHAREHOLDER OF GLENBROOK LIFE AND ANNUITY COMPANY:\nWe have audited the accompanying Statements of Financial Position of Glenbrook Life and Annuity Company as of December 31, 1995 and 1994, and the related Statements of Operations, Shareholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1995. Our audits also included Schedule IV -- Reinsurance. 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 financial statements present fairly, in all material respects, the financial position of Glenbrook Life and Annuity 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. Also, in our opinion, Schedule IV - -- Reinsurance, 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 financial statements, in 1993 the Company changed its method of accounting for investments in fixed income securities.\n\/s\/ DELOITTE & TOUCHE LLP\nChicago, IL\nMarch 1, 1996\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF FINANCIAL POSITION\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF OPERATIONS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY STATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS ($ IN THOUSANDS)\n1. ORGANIZATION AND NATURE OF OPERATIONS\nGlenbrook Life and Annuity Company (the \"Company\") is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), which is wholly owned by Allstate Insurance Company (\"Allstate\"), a wholly-owned subsidiary of The Allstate Corporation (the \"Corporation\"). On June 30, 1995, Sears, Roebuck and Co. (\"Sears\") distributed its 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend (the \"Distribution\").\nThe Company develops and markets flexible premium deferred variable annuity contracts and single and flexible premium deferred annuities to individuals through banks and financial institutions in the United States.\nAnnuity contracts issued by the Company are subject to discretionary withdrawal or surrender by the contractholder, subject to applicable surrender charges. These contracts are reinsured with Allstate Life (Note 4) which selects assets to meet the anticipated cash flow requirements of the assumed liabilities. Allstate Life utilizes various modeling techniques in managing the relationship between assets and liabilities and employs strategies to maintain investments which are sufficiently liquid to meet obligations to contractholders in various interest rate scenarios.\nThe Company monitors economic and regulatory developments which have the potential to impact its business. Currently there is proposed legislation which would permit banks greater participation in securities businesses, which could eventually present an increased level of competition for sales of the Company's annuity contracts. Furthermore, the federal government may enact changes which could possibly eliminate the tax-advantaged nature of annuities or eliminate consumers' need for tax deferral, thereby reducing the incentive for customers to purchase the Company's products. While it is not possible to predict the outcome of such issues with certainty, management evaluates the likelihood of various outcomes and develops strategies, as appropriate, to respond to such challenges.\nCertain reclassifications have been made to the prior year financial statements to conform to the presentation for the current year.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nLIFE INSURANCE ACCOUNTING\nThe Company sells long-duration contracts that do not involve significant risk of policyholder mortality or morbidity (principally single and flexible premium annuities) which are considered investment contracts.\nCONTRACTHOLDER FUNDS\nContractholder funds arise from the issuance of individual and group annuities that include an investment component. Payments received are recorded as interest-bearing liabilities. Contractholder funds are equal to deposits received and interest accrued to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. Credited interest rates on contractholder funds ranged from 3.0% to 7.4% for those contracts with fixed interest rates and from 4.25% to 7.9% for those with flexible rates during 1995.\nSEPARATE ACCOUNTS\nDuring 1995, the Company issued flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as assets and liabilities of the Separate Accounts (Glenbrook Life and Annuity Company Variable Annuity Account and Glenbrook Life and Annuity Company Separate Account A), unit investment trusts registered with the Securities and Exchange Commission. Assets of the Separate Accounts are invested in funds of management investment companies. For certain variable annuity contracts, the Company has entered into an exclusive distribution arrangement with distributors.\nThe assets of the Separate Accounts are carried at fair value. Unrealized gains and losses on the Company's participation in the Separate Account, net of deferred income taxes, is shown as a component of shareholder's equity. The Company's participation in the Separate Account, amounting to $10,530 at December 31, 1995, is subject to certain withdrawal restrictions which are dependent upon aggregate fund net asset values. In addition, limitations exist with regard to the maximum amount which can be withdrawn by the Company within any 30-day period.\nInvestment income and realized gains and losses of the Separate Accounts, other than the portion related to the Company's participation, accrue directly to the contractholders and, therefore, are not included in the accompanying statements of operations. Revenues to the Company from the Separate Accounts consist of contract maintenance fees, administrative fees and mortality and expense risk charges, which are entirely ceded to Allstate Life.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nREINSURANCE\nBeginning June 5, 1992, the Company reinsures all new business to Allstate Life (Note 4). Life insurance in force prior to that date is ceded to non-affiliated reinsurers.\nContract charges and credited interest are ceded and reflected net of such cessions in the statements of operations. Reinsurance recoverable and contractholder funds are reported separately in the statements of financial position.\nINVESTMENTS\nFixed income securities include bonds and mortgage-backed securities. Fixed income securities are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes, is reflected as a separate component of shareholder's equity. Provisions are made to write down the carrying value of fixed income securities for declines in value that are other than temporary. Such writedowns are included in realized capital gains and losses.\nShort-term investments are carried at cost which approximates fair value.\nInvestment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method, based on the estimated principal repayments. Accrual of income is suspended for fixed income securities that are in default or when the receipt of interest payments is in doubt. Realized capital gains and losses are determined on a specific identification basis.\nINCOME TAXES\nThe income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. Deferred income taxes also arise from unrealized capital gains or losses on fixed income securities carried at fair value.\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.\n3. ACCOUNTING CHANGE\nEffective December 31, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires that investments classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of amortized cost or fair value, determined in the aggregate. Unrealized holding gains and losses are reflected as a separate component of shareholder's equity, net of deferred income taxes. The net effect of adoption of this statement increased shareholder's equity at December 31, 1993 by $693, with no impact on net income.\n4. RELATED PARTY TRANSACTIONS\nREINSURANCE\nContract charges ceded to Allstate Life under reinsurance agreements were $1,523 and $409 in 1995 and 1994, respectively. Credited interest and expenses ceded to Allstate Life amounted to $71,905 and $26,177 in 1995 and 1994, respectively. Investment income earned on the assets which support contractholder funds is not included in the Company's financial statements as those assets were transferred to Allstate Life under the terms of reinsurance treaties. Reinsurance ceded arrangements do not discharge the Company as the primary insurer.\nBUSINESS OPERATIONS\nThe Company utilizes services and business facilities owned or leased, and operated by Allstate in conducting its business activities. The Company reimburses Allstate for the operating expenses incurred by Allstate on behalf of the Company. The cost to the Company is determined by various allocation methods and is primarily related to the level of services provided. Operating expenses, including compensation and retirement and other benefit programs, allocated to the Company were $348, $271 and $59 in 1995, 1994 and 1993, respectively. Investment-related expenses are retained by the Company. All other costs are assumed by Allstate Life under reinsurance treaties.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n4. RELATED PARTY TRANSACTIONS (CONTINUED)\nLAUGHLIN GROUP\nLaughlin Group, Inc. (\"Laughlin\"), a wholly-owned subsidiary of Laughlin Group Holdings Inc., a wholly-owned subsidiary of Allstate Life which was acquired in September 1995, is a third-party marketer which distributes the products of insurance carriers including the Company. Laughlin markets the Company's flexible premium deferred variable annuity contracts and flexible premium deferred annuities. Sales commissions paid to Laughlin subsequent to the acquisition date of $3,439 were ceded to Allstate Life.\n5. INCOME TAXES\nAllstate Life and its life insurance subsidiaries, including the Company, will file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective subsidiaries, whether or not such benefits generated by the subsidiaries would be available on a separate return basis. The Corporation and its domestic subsidiaries including the Company (the \"Allstate Group\"), will be eligible to file a consolidated tax return beginning in the year 2000.\nPrior to the Distribution, the Allstate Group joined with Sears and its domestic business units (the \"Sears Group\") in the filing of a consolidated federal income tax return (the \"Sears Tax Group\") and were parties to a federal income tax allocation agreement (the \"Tax Sharing Agreement\"). As a member of the Sears Tax Group, the Corporation was jointly and severally liable for the consolidated income tax liability of the Sears Tax Group. Under the Tax Sharing Agreement, the Company, through the Corporation, paid to or received from the Sears Group the amount, if any, by which the Sears Tax Group's federal income tax liability was affected by virtue of inclusion of the Allstate Group in the consolidated federal income tax return. Effectively, this resulted in the Company's annual income tax provision being computed as if the Company filed a separate return, except that items such as net operating losses, capital losses or similar items which might not be immediately recognizable in a separate return, were allocated according to the Tax Sharing Agreement and reflected in the Company's provision to the extent that such items reduced the Sears Tax Group's federal tax liability.\nThe Allstate Group and Sears Group have entered into an agreement which governs their respective rights and obligations with respect to federal income taxes for all periods prior to the Distribution (\"Consolidated Tax Years\"). The agreement provides that all Consolidated Tax Years will continue to be governed by the Tax Sharing Agreement with respect to the Company's federal income tax liability and taxes payable to or recoverable from the Sears Group.\nThe components of the deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\nThe components of income tax expense are as follows:\nThe Company paid income taxes of $874, $57 and $290 in 1995, 1994 and 1993, respectively, under the Tax Sharing Agreement. The Company had income taxes payable to Allstate Life of $1,637 and $605 at December 31, 1995 and 1994, respectively.\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS\nFAIR VALUES\nThe amortized cost, fair value and gross unrealized gains and losses for fixed income securities are as follows:\nSCHEDULED MATURITIES\nThe scheduled maturities of fixed income securities available for sale at December 31, 1995 are as follows:\nActual maturities may differ from those scheduled as a result of prepayments by the issuers.\nUNREALIZED NET CAPITAL GAINS AND LOSSES\nUnrealized net capital gains and losses on fixed income securities and the Company's participation in the Separate Account included in shareholder's equity at December 31, 1995 are as follows:\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n6. INVESTMENTS (CONTINUED)\nThe change in unrealized net capital gains and losses for fixed income securities and the Company's participation in the Separate Account is as follows:\nCOMPONENTS OF NET INVESTMENT INCOME\nInvestment income by investment type is as follows:\nREALIZED CAPITAL GAINS AND LOSSES\nRealized capital gains on investments are as follows:\nPROCEEDS FROM SALES OF FIXED INCOME SECURITIES\nThe proceeds from sales of investments in fixed income securities, excluding calls, were $7,836 and $3,015, with related gross realized gains of $459 and $22 for 1995 and 1993, respectively. There were no such amounts realized in 1994.\nSECURITIES ON DEPOSIT\nAt December 31, 1995, fixed income securities with a carrying value of $10,085 were on deposit with regulatory authorities as required by law.\n7. FINANCIAL INSTRUMENTS\nIn the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The fair value of all financial assets other than fixed income securities and all liabilities other than contractholder funds approximates their carrying value as they are short-term in nature.\nFair values for fixed income securities are based on quoted market prices. The December 31, 1995 and 1994 fair values and carrying values of fixed income securities are discussed in Note 6.\nThe fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts. Reserves on investment contracts with no stated maturities (single premium and flexible premium deferred annuities) are valued at the fund balance less surrender charge. The fair value of immediate annuities with fixed terms are estimated using discounted cash flow calculations based on\nGLENBROOK LIFE AND ANNUITY COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED) ($ IN THOUSANDS)\n7. FINANCIAL INSTRUMENTS (CONTINUED)\ninterest rates currently offered for contracts with similar terms and duration. Contractholder funds on investment contracts had a carrying value of $1,340,925 at December 31, 1995 and a fair value of $1,282,248. The carrying value and fair value at December 31, 1994 were $696,854 and $670,930, respectively.\n8. STATUTORY FINANCIAL INFORMATION\nThe following tables reconcile net income and shareholder's equity as reported herein in conformity with generally accepted accounting principles with statutory net income and capital and surplus, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities:\nPERMITTED STATUTORY ACCOUNTING PRACTICES\nThe Company prepares their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the insurance department of the State of Illinois. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company does not follow any permitted statutory accounting practices that have a material effect on statutory surplus or risk-based capital.\nDIVIDENDS\nThe ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in accordance with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 1996 without prior approval of both the Illinois and California Departments of Insurance is $5,220.\nGLENBROOK LIFE AND ANNUITY COMPANY SCHEDULE IV--REINSURANCE ($ IN THOUSANDS)\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report. The page number, if any, listed opposite a document indicates the page number in the sequential numbering system in the manually signed original of this Report where such document can be found.\n(1) The financial statements filed as part of this Report are listed in Item 8.\n(2) Financial Statement Schedules\nSchedule IV - Reinsurance page 20\n(3) 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.\nGLENBROOK LIFE AND ANNUITY COMPANY\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal 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 the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal Executive Officer)\nDate March 29, 1996\nBy \/s\/ Barry S. Paul Barry S. Paul Assistant Vice President and Controller (Chief Accounting Officer)\nDate March 29, 1996","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) The following documents are filed as part of this Report. The page number, if any, listed opposite a document indicates the page number in the sequential numbering system in the manually signed original of this Report where such document can be found.\n(1) The financial statements filed as part of this Report are listed in Item 8.\n(2) Financial Statement Schedules\nSchedule IV - Reinsurance page 20\n(3) 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.\nGLENBROOK LIFE AND ANNUITY COMPANY\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal 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 the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Louis G. Lower, II Louis G. Lower, II Chief Executive Officer and Chairman (Principal Executive Officer)\nDate March 29, 1996\nBy \/s\/ Barry S. Paul Barry S. Paul Assistant Vice President and Controller (Chief Accounting Officer)\nDate March 29, 1996","section_15":""}
{"filename":"40656_1995.txt","cik":"40656","year":"1995","section_1":"Item 1. BUSINESS\nUnless the context otherwise requires, references to the \"Company\" or \"GI\" include General Instrument Corporation and its direct or indirect subsidiaries, including General Instrument Corporation of Delaware (\"GI Delaware\"), the Company's principal operating subsidiary.\nGeneral General Instrument Corporation (the \"Company\" or \"GI\") is a world leader in developing technology, systems and product solutions for the interactive delivery of video, voice and data, as well as the development of discrete semiconductors. The Company's Broadband Communications segment, which is comprised of the GI Communications, CommScope and Next Level Communications divisions, represented 83% of the Company's consolidated sales for the year ended December 31, 1995. Broadband Communications offers a variety of products and services for the cable and satellite television industries, including active and passive electronics, subscriber terminals, coaxial and fiber optic cable and encryption\/decryption equipment for the scrambling and descrambling of satellite television programming. The Company's 1995 acquisition of Next Level Communications marks GI's entry into the telephone local loop access market. The Power Semiconductor Division represented 17% of the Company's consolidated sales for the year ended December 31, 1995, and is a world leader in the sale of power rectifiers and related transient voltage suppression components used in telecommunications, automotive and consumer electronic products. The Company was organized in 1990 in connection with the acquisition of General Instrument Corporation, then a publicly traded company, by affiliates of Forstmann Little & Co., a private investment firm. Additional information regarding the Company's industry segments appear in note 13 to the Company's consolidated financial statements included in the Annual Report to Stockholders for the year ended December 31, 1995 (the \"1995 Annual Report\"), incorporated herein by reference.\nThe Company's Broadband Communications Strategy The Company's strategy is to enhance its market leadership position as a provider of broadband systems and equipment by emphasizing the following factors:\no Technological Leadership and New Product Development. GI is a world leader in the development and implementation of new \"enabling\" technologies for advanced television signal transmission. GI has continually developed technological \"firsts,\" including digital high-definition television, advanced network development and management techniques, videoware, digital processing and transmission and signal security measures.\no Technologically Varied Products Across a Broad Cross Section of Markets. GI offers a complete end-to-end solution from the programming source, through a wireless or wired distribution network into consumers' homes. Using either analog or digital technologies, GI can deliver information and entertainment to consumers' homes via direct-to-home satellite, wireless cable and traditional cable using hybrid fiber\/coaxial architectures and fiber-to-the-curb architectures. With telecommunications reform legislation enacted in 1996, the Company believes its end-to-end product lines give it significant competitive advantages in developing new broadband technologies for cable television operators, local telephone companies, long distance companies and other telecommunications concerns.\no Increasing the Installed Base. The Company believes that it has supplied the majority of the addressable systems in use by cable television operators in the United States and abroad. GI's strategy has been to expand the number of installed systems which utilize its hardware and software to control network security, services and programming access and to increase its product content in these systems.\no Rapid International Expansion. The Company believes that the development of international markets is an important factor in its future growth due to low cable television penetration, paired with growing demand for programming. The Company believes it is poised to capture these opportunities with solutions as simple or as complex as these markets require (See \"International Markets\" below).\no Strategic Alliances. GI has formed strategic partnerships that enable GI to remain a single-sourced equipment partner for companies competing in numerous markets: wired and wireless, analog and digital, and high-end and low-end systems.\nBroadband Communications The Company's Broadband Communications segment, which represented 83%, 84% and 81% of the Company's consolidated sales for the years ended December 31, 1995, 1994 and 1993, respectively, consists of the GI Communications, CommScope and Next Level Communications divisions. The GI Communications Division is the world's leading provider of addressable systems and subscriber terminals for the cable television industry. It is also a market leader in satellite television encryption and broadband digital compression technologies, as well as a leading manufacturer in radio frequency and fiber optic distribution electronics. CommScope, which represented 20%, 22% and 25% of the Company's consolidated sales for the years ended December 31, 1995, 1994 and 1993, respectively, is a leading supplier of both coaxial and fiber optic cable to the cable television industry. Next Level Communications is designing and developing products to permit the cost-effective delivery of a suite of standard telephony and advanced services such as work-at-home, distance learning, video-on-demand and video-telephony to the home from a single access platform.\nGI Communications Division\nAnalog Terrestrial Products. The Company's principal analog terrestrial products include subscriber and distribution hardware and software. Analog terrestrial subscriber products represented 26%, 27% and 24% of the Company's consolidated sales in the years ended December 31, 1995, 1994 and 1993, respectively. Subscriber products include primarily addressable systems which permit control, through a set-top terminal, of a subscriber's cable television services from a central headend computer without requiring access to the subscriber's premises. Addressable systems also enable a cable television operator to more easily provide pay-per-view programming services and multiple tiers of programming packages. Analog terrestrial distribution products represented 11%, 13% and 11% of the Company's consolidated sales in the years ended December 31, 1995, 1994 and 1993, respectively. Distribution products include headend signal processing equipment, distribution amplifiers, fiber optic transmission equipment and passive components for wired television distribution systems.\nBeginning in mid-1992 and continuing through 1995, GI has experienced significant increases in purchase orders for its analog products both from domestic and international customers. GI's sales of analog addressable systems reached their highest levels to date in 1995 when the Company shipped more than 5.2 million analog addressable set-top terminals, an 11% increase over 1994 shipments and a 92% increase over 1993 shipments. In the U.S., GI is the market share leader in the addressable market, with more than 50% of that market. The Company believes that cable operators have sought to improve the quality, capacity and capabilities of their networks during this period by increasing their capital spending for addressable systems and distribution infrastructure upgrades. GI expects cable operators in the U.S. and abroad to continue to upgrade their basic networks and invest in new system construction primarily to compete with other television programming sources, such as direct broadcast satellite (\"DBS\") and cable networks planned by some telephone companies, and to develop, using U.S. architecture and systems, international markets where cable penetration is low and demand for entertainment programming is growing. See \"Sales and Distribution\" below. Beginning in the second quarter of 1995, the Company began shipping its CFT 2200 advanced analog terminal, which increased the functionality and features of its prior analog addressable subscriber terminals, with more than 475,000 terminals shipped in 1995. The CFT 2200 incorporates a user feature platform that allows cable operators to write applications for new services, including electronic program guides, supplementary sports and entertainment information and play-along game shows, and can be modularly upgraded to deliver digital audio, providing CD-quality simulcasts of premium services. The CFT 2200 can also be upgraded to DigiCipher II\/MPEG-2, the Company's second generation end-to-end digital television system which incorporates the Motion Picture Experts Group 2 (\"MPEG-2\") international standard for digital compression and transport. To date, GI has received commitments and letters of intent for approximately 3.5 million CFT 2200 terminals.\nDigital Terrestrial Products. The Company believes that the commercialization of advanced digital broadband systems and equipment, which provide for greatly expanded channel capacity and programming options, improved quality and security of signal transmission and the capability of delivering enhanced features and services, will be an important market for GI. The Company believes that its potential position in this developing market is significantly enhanced by GI's leadership in a key enabling technology, digital compression, which allows the broadcast of multiple digital channels in the same bandwidth occupied by one uncompressed video channel. The Company has developed a digital television system, DigiCipher, that enables satellite programmers and cable television operators to deliver over their existing networks four to ten times as much information as is possible with existing analog technology. GI's DigiCipher system was the first digital video compression system to demonstrate capabilities over cable and satellite television networks, and GI began shipping its first-generation DigiCipher I digital encoders and decoders for satellite programmers and cable television commercial headend operators in 1993 (See also \"Analog and Digital Satellite Products\" below).\nThe Company expects that cable, satellite and other broadband network operators will begin to deploy digital terminals in their customers' homes in order to take advantage of the enhanced capabilities of the digital networks. The rate of deployment will depend largely on consumer demand for new services made available through the digital network and the relative cost of the more advanced digital terminals. To date, GI has obtained commitments and letters of intent for approximately 3 million of its DigiCable(TM) digital subscriber terminals from major North American cable system operators and GTE Corporation. GI has entered into an agreement to supply network equipment, featuring CFT 2200 and DigiCable digital terminals, for the first three sites of GTE Corporation's planned hybrid fiber\/coaxial cable network. GI is working with AT&T Network Systems to bring advanced services to GTE's customers in these new video dial-tone networks.\nGI's DigiCable terminals incorporate the Motion Picture Experts Group 2 international standard, and DigiCipher II\/MPEG-2 has the capacity to carry various video, audio and data elements through a complex information infrastructure that will have an improved capability to interact with other consumer devices using MPEG-2 compression. The development of DigiCipher II\/MPEG-2 took longer than anticipated as a result of several factors, including increased system complexity, evolving international MPEG-2 standards and other system design issues. As a result, volume shipments of these advanced digital cable terminals are not expected to begin until the second half of 1996, although there can be no assurance that additional delays will not occur. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - New Technologies\" incorporated herein by reference from the 1995 Annual Report.\nAnalog and Digital Satellite Products. GI Communications markets analog and digital uplink and downlink products for commercial and consumer use. Using DigiCipher technology, GI enables commercial customers to compress their video, audio and data transmissions resulting in significant cost savings over traditional analog transmission. GI also offers state of the art Network Management and Access Control products and services allowing program packagers to efficiently and cost effectively manage customer transactions and securely transmit their content to only authorized end-users. For consumers, GI provides \"user friendly\" graphical user interfaces, excellent video quality and high-end audio reception. Satellite products represented 26%, 23% and 22% of the Company's consolidated sales for the years ended December 31, 1995, 1994 and 1993, respectively. GI is the largest manufacturer of access control and scrambling and descrambling equipment used by television programmers for the satellite distribution of proprietary programming.\nThe Company's analog satellite products are the exclusive systems for the distribution of encrypted C-Band satellite-delivered programming to cable television operators and large-diameter backyard satellite dish owners. The system consists primarily of scramblers, which are installed at the point where the programming originates, and descramblers, which are installed at the commercial headends of cable television systems or purchased by consumers for use with their backyard C-Band satellite dishes. As a result of a number of factors, including significant black-market economic incentives, the Company's first generation system, VideoCipher(TM) II, was illegally modified (\"pirated\"), beginning in the mid-1980s, by approximately 1.3 million consumers who received programming for free. In 1989, GI introduced VideoCipher II Plus(TM), a second-generation product which, to GI's knowledge, has not been \"pirated.\" In 1991, in recognition of the need to provide ongoing security enhancements, GI introduced VideoCipher RS(TM), whereby security can be upgraded by inserting a credit-card-like TVPass Card(TM) into the module instead of replacing the module. In 1993, the Company completed a two-part security upgrade program where GI replaced the VideoCipher II units of the customers of several providers of premium programming with VideoCipher RS units, and those programmers ceased transmission of the VideoCipher II programming signals. The Company believes this program restored security of the backyard C-Band satellite dish market to acceptable levels. In addition, the Company believes the security upgrade resulted in the one-time sale of more than 800,000 VideoCipher RS units between the second-quarter of 1992 and the second-quarter of 1994 to former \"pirate\" consumers who wanted to restore their access to scrambled programming. In 1995, sales of the VideoCipher RS modules were at lower levels as expected, with approximately 250,000 fewer modules shipped in 1995 as compared to 1994.\nGI Communication's digital satellite products include primarily the DigiCipher I system, the world's first digital compression, access control and encryption transport system, designed for the delivery of video entertainment signals. Comparable to the analog satellite system, the digital system relies on encoders located at the point where programming originates, and decoders, located at either commercial headends or at consumers' homes for use with their satellite dishes. The Company supplies DigiCipher I digital consumer receivers to PRIMESTAR Partners, a consortium of cable television operators and GE Americom, which offers a medium-power Ku-band direct-to-home satellite television system. Under agreements with PRIMESTAR, GI will be PRIMESTAR's exclusive provider of receivers through 1996. PRIMESTAR generally competes with Hughes Electronic Corporation's DirecTV high-power Ku-band satellite television system. GI began deployment of DigiCipher I consumer receivers to PRIMESTAR in the second quarter of 1994, and through December 31, 1995, the Company had delivered approximately 1.5 million DigiCipher I receivers to PRIMESTAR. PRIMESTAR has informed the Company that it has deferred its transition to the Company's DigiCipher II\/MPEG-2 digital transmission system, and instead, plans to expand its use of the Company's DigiCipher I digital consumer satellite receivers in 1996, expecting to purchase more than 1 million additional DigiCipher I digital consumer satellite receivers in 1996. The Company had previously anticipated delivering DigiCipher II\/MPEG-2 upgrade modules for existing receivers in use by PRIMESTAR customers in 1996. All of the DigiCipher consumer receivers that the Company supplies to PRIMESTAR are designed to accept an upgrade module, which allow the receivers to be easily upgraded to the Company's DigiCipher II\/MPEG-2 system. The Company currently has a worldwide installed base of 171 DigiCipher I digital satellite systems with the capacity to deliver 501 channels of digital programming. In addition, through the DigiCipher satellite system, GI has become a market leader in digital private satellite television networks for business communications and distance learning.\nThe Company began shipment of its DigiCipher II\/MPEG-2 system to satellite television programmers in early 1996 and has obtained commitments to deliver 58 digital satellite encoders with the capacity to transmit 290 channels of digital programming. The Company expects to begin delivery of DigiCipher II\/MPEG-2 systems to cable television operators in the second half of 1996, although there can be no assurance that additional delays will not occur. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - New Technologies\" incorporated herein by reference from the 1995 Annual Report.\nCommScope\nCommScope is the largest manufacturer and supplier of coaxial cable for cable television applications in the U.S. in terms of sales volume, with more than a 50% market share. CommScope also manufactures fiber optic cable under a non-exclusive license from AT&T Corporation for sale to cable television customers in the United States. In addition, CommScope manufactures and sells other electronic cable primarily for local area network applications in the United States.\nThe Company believes that CommScope's competitive strength in the coaxial cable market is due to its extensive coaxial cable product line and its efficient, low-cost manufacturing and delivery capability. CommScope's manufacturing facility in Catawba, North Carolina, is highly automated, operates 24 hours a day and is capable of producing approximately 400 miles of trunk and distribution coaxial cable and over 5 million feet of dropwire per day. In 1995, CommScope shipments of dropwire and distribution coaxial cable increased an average of 3% over the levels shipped in 1994. In order to meet increased demand for dropwire, in 1995 CommScope constructed a new manufacturing facility in Scottsboro, Alabama, to be used primarily for the production of dropwire.\nGrowth in demand for coaxial cable has occurred over the past several years despite the replacement of coaxial cable with fiber optic cable in the trunk portion of many cable television networks since the vast majority of coaxial cable used in a typical cable television network occurs beyond the trunk, in the distribution portion of the network, and in the dropwire into the home. The Company believes that broadband networks will have an ongoing need for coaxial cable to maintain, expand and upgrade their facilities. The Company believes that coaxial cable remains the most efficient means for the transmission of broadband signals to the home over short distances because it is less expensive to install in short lengths than fiber optic cable, has less costly electronics and has the necessary capacity to handle upstream and downstream signal transmission.\nCommScope has received orders from U.S. telephone operating companies, several of which have announced plans to install broadband networks for the delivery of video, telephone and other services to some portion, or all, of their telephone service areas. The broadband networks that are being proposed by some of the telephone companies utilize hybrid fiber optic\/coaxial cable technologies similar to those being utilized by many cable television operators. While there is no assurance that these proposed networks will be built, to the extent they are implemented, they could represent a significant incremental sales opportunity for CommScope beyond its traditional cable television customer base.\nCable produced by CommScope for local area network applications also grew significantly in 1995 with sales for these applications increasing by 46%. CommScope expanded the capacity of its Claremont, North Carolina, facility by approximately 60% in 1995 in order to meet the growing demand for local area network and other electronic cable.\nNext Level Communications\nThe Next Level Communications Division was created in September 1995 as a result of the acquisition by the Company of Next Level Communications (\"Next Level\"), which was formed to design, manufacture and market a next-generation telecommunications broadband access system for the delivery of telephony, video, and data from a telephone company central office or cable television headed to the home. Next Level's product, NLevel3, is designed to permit the cost-effective delivery of a suite of standard telephony and advanced services such as work-at-home, distance learning, video-on-demand and video-telephony to the home from a single access platform. NLevel3 is designed to work with and enhance existing telephony and cable television networks. Next Level has demonstrated NLevel3 for the seven regional bell operating companies (RBOCs), and four of the RBOCs have announced their intention to employ fiber-to-the-curb architectures using switched-digital video technology in their planned broadband networks. In addition to the cost of the acquisition of Next Level, a significant amount of research and development expenditures will be required to successfully bring NLevel3 to market. The Company does not expect Next Level to generate any revenue until at least 1997, and there can be no assurance that NLevel3 will successfully be developed and marketed. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - New Technologies\" incorporated herein by reference from the 1995 Annual Report.\nInternational Markets The Company believes that international markets represent a key growth opportunity for its sales of broadband equipment. International sales of cable television electronics and CommScope cables increased 24% for the year ended December 31, 1995 as compared to 1994 and represented 32% of total cable television electronics and CommScope cable sales in 1995 compared to 29% in 1994.\nInternational markets employ broadband technology in three ways: through broadband television systems similar to those in the United States; through Multichannel Multipoint Distribution Systems (\"MMDS\") or wireless microwave systems; and through direct broadcast satellite (\"DBS\") systems. MMDS is typically used in areas where the cost of installing a cable television distribution infrastructure is not justified due to the low density of homes, a relatively small potential subscriber base or geographic constraints. DBS systems with digital compression capabilities are expected to have significant growth internationally as programmers and satellite operators seek to maximize their limited satellite transponder capacity in order to reach geographically dispersed subscribers.\nIn certain countries, like the United Kingdom, operators have been using system architectures that rely on U.S. broadband designs partly because many of these systems are being developed by affiliates of certain U.S. cable television operators and telephone companies. The Company believes that international markets present significant opportunities because cable, wireless and satellite television penetration is low in these areas.\nThe Company believes that it enjoys significant competitive strengths in the international markets because of its leadership in the United States market for broadband communications equipment, its strong technology, its relationships with the U.S. cable operators who are building many of the systems in international markets and its ability to deliver complete systems due to its fully-integrated product line. The Company believes that, to date, it has supplied a majority of the addressable systems and equipment in use in international markets. To enhance its presence in the international marketplace, in 1995 GI entered into a letter of intent with India's largest information technology company to manufacture and sell broadband communication equipment. In addition, CommScope announced a joint venture to manufacture and distribute coaxial cable in Australia and the Asia-Pacific region. GI also entered into contracts in 1995 to supply cable and wireless television equipment in Saudi Arabia, China and Australia. However, there can be no assurance that the international markets will continue to expand and, because of the need to form alliances in order to operate effectively in many international markets and the larger number of competitors in international markets than in U.S. markets, among other factors, there can be no assurance as to the Company's future success to the extent international markets expand.\nThe Company's foreign operations are subject to the usual risks inherent in situating operations abroad, including risks with respect to currency exchange rates, economic and political destabilization, restrictive actions by foreign governments, nationalization, the laws and policies of the United States affecting trade, foreign investment and loans, and foreign tax laws. GI's cost-competitive status relative to other competitors could be adversely affected if the Mexican peso, the New Taiwan dollar or other relevant currencies appreciate relative to the United States dollar.\nPower Semiconductor Division\nThe Power Semiconductor Division (which represented 17%, 16% and 19% of the Company's consolidated sales in the years ended December 31, 1995, 1994 and 1993, respectively) is a world leader in the design, manufacture and sale of low-to-medium power rectifiers and transient voltage suppression components in axial, bridge and surface mount and array packages. These products are used throughout the electrical and electronics industries to condition current and voltage and to protect electrical circuits from power surges. Applications include components for circuits in consumer electronics, telecommunications, lighting ballasts, home appliances, computers and automotive and industrial products. The demand for increased electronic functions, global sourcing and higher reliability within these markets is adding to the growth of the Power Semiconductor Division worldwide business.\nNew products and technologies continue to play a significant role in the Power Semiconductor Division's growth. The Division's patented PAR (Passivated Anisotrophic Rectifier) process is serving to increase the reliability of many automotive electronics applications. The Division has also developed a new line of transient voltage protection and a new line of rectifiers for automotive applications. The PowerBlock autorectifier addresses automotive applications not previously served by Power Semiconductor Division product. The PowerBlock provides necessary alternator rectification, and also provides transient voltage protection for the sensitive integrated circuits now used in automotive electronics.\nThe Company believes that the competitive strengths of the Power Semiconductor Division are the quality of its products, its global sales and distribution channels and the low cost and efficiency of its operations. The Division is a leader in sales of low-to-medium power rectifiers and transient voltage suppression components in North America, Southeast Asia and Europe, with 73% of its sales for the year ended December 31, 1995 generated from customers outside of the United States.\nThe Power Semiconductor Division has undertaken a significant capacity expansion in order to meet the increased demand for its products worldwide. The Power Semiconductor Division began construction of a manufacturing facility in the Peoples' Republic of China in 1995, with production scheduled to begin in the third quarter of 1996, and plans to increase manufacturing capacity in Ireland by 100% in 1996.\nTechnology and Licensing The Company believes it is in the unique position of having produced, and of currently producing, the majority of the world's analog addressable systems, while also developing the digital technology that will eventually replace these systems. As a result, GI has sought to build upon its core enabling technologies, digital compression, encryption and conditional access and control, in order to lead the transition of the market for broadband communications networks from analog to digital systems. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - New Technologies\" incorporated herein by reference from the 1995 Annual Report.\nGI began shipment of its DigiCipher II\/MPEG-2 system to satellite television programmers in early 1996, and expects to begin delivery of DigiCipher II\/MPEG-2 systems to cable television operators in the second half of 1996, although there can be no assurance that delays will not occur. To allow for broad deployment of the DigiCipher II\/MPEG-2 system, a number of semiconductor manufacturers have received licenses, including Motorola, SGS-THOMPSON Microelectronics, LSI Logic, C-Cube Microsystems and Samsung Electronics. To ensure the availability of interoperable equipment to cable television operators and other digital providers, GI has licensed DigiCipher II\/MPEG-2 technology to Scientific-Atlanta, Hewlett-Packard and Zenith.\nThe Company has also entered into other license agreements, both as licenser and licensee, covering certain products and processes with various companies. Among those agreements, in 1993, GI granted an unaffiliated third party a license under certain GI patents regarding addressable converters pursuant to which GI will earn royalties of $1.5 million per year for five years. The Company also holds a non-exclusive worldwide license under an unaffiliated third party's patent regarding encryption and decryption of satellite television signals. This license agreement requires the payment of certain royalties which are not expected to be material to the Company's consolidated financial statements.\nResearch and Development The Company actively pursues the development of new technologies and applications. Research and development expenditures for the year ended December 31, 1995 were $147 million and are expected to be approximately $200 million for the year ending December 31, 1996, compared to $111 million and $74 million for the years ended December 31, 1994 and 1993, respectively. Research and development expenditures reflect continued development of the next generation of cable set-top terminals, which incorporate digital compression and multimedia capabilities, cable modems, telephone company access products, advanced digital systems for cable and satellite television distribution, next-generation direct broadcast satellite systems and product development through strategic alliances. Emerging research and development activities include development of broadband telephony products and interactive multimedia technologies for broadband networks.\nSales and Distribution The Company's Broadband Communications products and services are marketed primarily to cable television operators, cable and satellite television programmers and programming services, and telephone companies planning the development of cable networks. Demand for the Company's products and services depends primarily on capital spending by cable television operators for constructing, rebuilding or upgrading their systems. The amount of this capital spending and, therefore, a majority of GI's sales and profitability, are affected by a variety of factors, including general economic conditions, access by cable television operators to financing, regulation of cable television operators and technological developments in the broadband communications industry. Although GI believes that the constraining pressures on cable television capital spending have eased and that cable television capital spending has increased, there can be no assurance that such increases will continue or that such increased level of cable television capital spending will be maintained.\nBroadband Communications systems are sold primarily through the efforts of sales engineers or other sales personnel employed by the Company who are skilled in the technology of the particular system. The Company markets VideoCipher descrambling modules through an open distribution strategy, in which the Company and its licensees sell descrambling modules to manufacturers of integrated receiver\/descramblers, distributors, dealers, consumers and others. The Company's Power Semiconductor products are marketed to a wide variety of industries in the U.S. and abroad. They are sold through distributors and sales representatives as well as directly by the division's sales personnel.\nBecause a limited number of cable and satellite television operators provide services to a large percentage of television households in the U.S., the loss of some of these operators as customers could have a material adverse effect on the Company's sales. Tele-Communications, Inc., including its affiliates, accounted for 20% of GI's consolidated net sales for the year ended December 31, 1995, and was the only customer of GI which accounted for 10% or more of the Company's consolidated net sales during this period.\nPatents The Company's policy is to protect its proprietary position by, among other methods, filing U.S. and foreign patent applications to protect technology, inventions and improvements that the Company considers important to the development of its business. Although the Company believes that its patents provide a competitive advantage, the Company relies equally on its proprietary knowledge and continuing technological innovation to develop and maintain its competitive position.\nBacklog The backlog information set forth below includes only orders for products scheduled to be shipped within six months. Orders may be revised or canceled, either pursuant to their terms or as a result of negotiations; consequently, it is impossible to predict accurately the amount of backlog orders that will result in sales.\nBacklog (In millions) December 31, December 31, 1995 1994 ------------ ------------- Broadband Communications $531 $578 Power Semiconductor 248 122 ---- ---- Total $779 $700 ==== ====\nCompetition The Company's products and services compete with those of a substantial number of foreign and domestic companies, some with greater resources, financial or otherwise, than the Company, and the rapid technological changes occurring in the Company's markets are expected to lead to the entry of new competitors. The Company's ability to anticipate such changes and introduce enhanced products on a timely basis will be a significant factor in the Company's ability to expand and remain competitive. Existing competitors' actions and new entrants may have an adverse impact on the Company's operations. The Company believes that it enjoys a strong competitive position due to its large installed cable television equipment base, its strong relationships with the major cable television operators, its technology market leadership and new product development capabilities, and the likely need for compatibility of new technologies with currently installed systems. There can be no assurance, however, that competitors will not be able to develop systems compatible with, or that are alternatives to, the Company's proprietary technology or systems.\nEmployees At December 31, 1995, approximately 12,300 people were employed by GI. Of these employees, approximately 5,100, 4,300 and 2,100 were located at GI's U.S., Taiwan and Mexico facilities, respectively, with the balance located in Puerto Rico, Europe, Japan and China. GI believes its relations with its employees and, where they are represented by unions, its relations with their unions, are good. As of December 31, 1995, approximately 5,200 of GI's employees were covered by collective bargaining agreements. Of these employees, approximately 4,300 were located at GI's Taiwan facilities, approximately 500 were located at GI's Mexico facilities and the balance were located at GI's Westbury, New York, and certain European facilities.\nRaw Materials Raw materials are purchased from many sources in the U.S., as well as from sources in the Far East, Canada and Europe. The Company's products include certain components that are currently available only from single sources. The Company has in effect inventory controls and other policies intended to minimize the effect of any interruption in the supply of these components. There is no single supplier, the loss of which would have a continuing material adverse effect on GI's production.\nEnvironment The Company is subject to various federal, state, local and foreign laws and regulations governing the use, discharge and disposal of hazardous materials. The Company's manufacturing facilities are believed to be in substantial compliance with current laws and regulations. Compliance with current laws and regulations has not had, and is not expected to have, a material adverse effect on the Company's financial condition. The Company is also involved in remediation programs, principally with respect to former manufacturing sites, which are proceeding in conjunction with federal and state regulatory oversight. In addition, the Company is currently named as a potentially responsible party with respect to the disposal of hazardous wastes at three hazardous waste sites located in two states.\nThe Company engages independent consultants to assist management in evaluating potential liabilities related to environmental matters. Management assesses the input from these independent consultants along with other information known to the Company in its effort to continually monitor these potential liabilities. Management assesses its environmental exposure on a site-by-site basis, including those sites where the Company has been named a potentially responsible party. Such assessments include the Company's share of remediation costs, information known to the Company concerning the size of the hazardous waste sites, their years of operation and the number of past users and their financial viability. Although the Company estimates, based on assessments and evaluations made by management, that its exposure with respect to these environmental matters could be as high as $54 million, the Company believes that the reserve for environmental matters of $35 million at December 31, 1995 is reasonable and adequate. However, there can be no assurance that the ultimate resolution of these matters will approximate the amount reserved. Further information regarding the Company's environmental matters appears in Note 8 to the Company's consolidated financial statements included in the 1995 Annual Report, incorporated herein by reference.\nCapital Expenditures Capital expenditures were $159, $136 and $67 million in the years ended December 31, 1995, 1994 and 1993, respectively. Such expenditures were primarily in support of capacity expansion across all businesses to meet increased current and future demands for analog and digital products, coaxial cable and power rectifiers. In 1996, the Company expects to continue to expand its capacity to meet current and future demands, with capital expenditures for the year ending December 31, 1996 expected to approximate $250 million.\n--------------------------------\nFORWARD-LOOKING INFORMATION\nThe Private Securities Litigation Reform Act of 1995 provides a \"safe harbor\" for forward-looking statements. This Form 10-K, the Company's Annual Report to Shareholders, any Form 10-Q or any Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors include, but are not limited to, uncertainties relating to economic conditions, uncertainties relating to government and regulatory policies, uncertainties relating to customer plans and commitments, the Company's dependence on the cable television industry and cable television spending, signal security, the pricing and availability of equipment, materials and inventories, technological developments, the competitive environment in which the Company operates, changes in the financial markets relating to the Company's capital structure and cost of capital, the uncertainties inherent in international operations and foreign currency fluctuations. The words \"believe,\" \"expect,\" \"anticipate,\" \"project\" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.\n--------------------------------\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nGI has manufacturing, warehouse, sales, research and development and administrative facilities worldwide which have an aggregate floor space of approximately 3.6 million square feet. Of these facilities, aggregate floor space of approximately 1.1 million square feet is leased, and the remainder is owned by GI. Leases expire on various dates through the year 2020. GI operates manufacturing facilities in 11 locations worldwide containing floor space of approximately 1.9 million square feet. The Power Semiconductor Division utilizes three manufacturing facilities with an aggregate floor space of approximately .4 million square feet. GI does not believe there is any material long-term excess capacity in its facilities, although utilization is subject to change based on customer demand. GI believes that its facilities and equipment generally are well maintained, in good operating condition and suitable for GI's purposes and adequate for its present operations.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nBetween October 10 and October 27, 1995, five purported class action complaints were filed in the United States District Court for the Eastern District of Pennsylvania and seven purported class action complaints were filed in the United States Court for the Northern District of Illinois. These complaints name as defendants the Company, certain officers and directors of the Company and, in some cases, Forstmann Little & Co. Plaintiffs allege that the defendants violated federal securities laws by, among other things, making misrepresentations and omitting material facts in statements to the public, thereby allegedly causing the Company's stock price to be artificially inflated. Plaintiffs seek, among other things, unspecified monetary damages and attorneys' fees and costs, on behalf of all shareholders who purchased shares during various periods generally extending from March 21, 1995 through October 18, 1995.\nOn October 24, 1995, a purported derivative complaint on behalf of the Company was filed in the United States District Court for the Eastern District of Pennsylvania by Seymour Lazar against each of the Company's current directors, a former executive officer, Forstmann Little & Co., Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership-IV (\"MBO-IV\") and Instrument Partners. The conduct complained of generally related to the same matters alleged in the class actions described above and to the sale by directors Daniel F. Akerson, John Seely Brown, J. Tracy O'Rourke and Robert S. Strauss, as well as by MBO-IV, Instrument Partners and a former officer of the Company, of shares of the Company's stock while they were allegedly in possession of material non-public information. Plaintiff seeks, among other things, unspecified monetary damages and attorneys' fees and costs.\nOn February 20, 1996, an order was issued by the Judicial Panel on Multidistrict Litigation transferring the class and derivative actions described above to the United States Court for the Northern District of Illinois. These actions are in an early stage, with only limited discovery having commenced.\nOn February 9, 1996, a complaint was filed in the United States Court for the Northern District of California captioned BKP Partners, L.P. et al. v. General Instrument Corporation, NLC Acquisition Corp. and Next Level Communications, Inc. Plaintiffs, who are some of the former holders of preferred stock of Next Level, allege, among other things, that the defendants violated federal securities laws by making misrepresentations and omissions and breached fiduciary duties to Next Level in connection with the acquisition by the Company of Next Level Communications in September 1995. Plaintiffs seek, among other things, unspecified compensatory and punitive damages and attorneys' fees and costs. The Company has requested that this action be transferred to the United States District Court for the Northern District of Illinois because of its relationship to the other cases which have been transferred to that court.\nThe defendants intend to defend the above-described actions vigorously. The ultimate disposition of these matters, in GI's opinion, will not have a material adverse effect on the financial statements of the Company.\nOn April 10, 1995, prior to the Company's acquisition of Next Level on September 27, 1995, DSC Communications Corporation and DSC Technologies Corporation (collectively, \"DSC\") brought suit in Texas state court against Next Level, Thomas R. Eames and Peter W. Keeler (the founders of Next Level and current Next Level employees). Next Level and the individual defendants subsequently removed the case to federal court. On March 28, 1996, a jury verdict was reached in the case, entitled DSC Communications Corporation and DSC Technologies Corporation v. Next Level Communication, Thomas R. Eames and Peter W. Keeler, Case No. 4:95cv96 in the United States District Court for the Eastern District of Texas, Sherman Division. The verdict states that Messrs. Eames and Keeler breached certain employee agreements with DSC, failed to disclose and diverted a corporate opportunity of DSC, misappropriated DSC trade secrets and conspired to take certain of the foregoing actions, and that Next Level used or benefited from the diversion of corporate opportunity and misappropriation of trade secrets. The verdict would award to DSC compensatory damages against the defendants in amounts ranging between $24 million and $120 million with respect to the respective causes of action as to which the jury found liability. Although DSC has taken the position in a press release that the aggregate amount of all compensatory damages awarded is $359 million, the Company believes that the cumulation of all the amounts awarded would be improper because it would lead to multiple recoveries for the same damages. The verdict would also award punitive damages in the amount of $10 million against Next Level and $100,000 against each of Messrs. Eames and Keeler. DSC has also indicated that it intends to apply to the court for injunctive relief. Judgment has not yet been entered in the case, and the defendants intend to file a motion to set aside the verdict. The time for defendants to appeal any judgment will not begin to run until such judgment has been entered by the court. In connection with the acquisition of Next Level, the Company entered into agreements to indemnify Messrs. Eames and Keeler for any judgment that may be awarded against them in this matter, to the extent permitted by applicable law. The nature of any judgment is not reasonably determinable at this time and there is no assurance that such amount will not have a material adverse effect on the Company's financial statements. The Company believes that the verdict is not legally sustainable and intends to seek to have the verdict set aside.\nGI is involved in various other litigation matters, none of which are expected to have a material adverse effect on the Company's 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 the Company's security holders during the three months ended December 31, 1995.\nAdditional Item. EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the executive officers of the Company as of March 15, 1996. In connection with the Company's initial public offering, on April 6, 1992, each executive officer of GI Delaware as of that date, was appointed to serve as an executive officer of the Company. Certain executive officers of the Company also serve as president of the various divisions and subsidiaries of GI Delaware. Officers serve at the discretion of the Board of Directors.\nThe principal occupations and positions for the past several years of each of the executive officers of the Company are as follows:\nRichard S. Friedland has been a director of the Company since October 1993. He became President and Chief Operating Officer of the Company in October 1993, Chief Executive Officer of the Company in August 1995 and Chairman of the Board of Directors the Company in December 1995. He was Chief Financial Officer of the Company and GI Delaware from March 1992 to January 1994 and Vice President, Finance of the Company from May 1991 to October 1993. He was Vice President-Finance and Assistant Secretary of GI Delaware from October 1990 to October 1993 and Vice President and Controller of GI Delaware from November 1988 to January 1994. He is a director of Department 56, Inc.\nRichard D. Badler became Vice President-Corporate Communications in February 1996. He was an Executive Vice President and Account Director for Golin\/Harris Communications in Chicago from September 1993 to February 1996 and Director of Public Affairs for Kraft General Foods from May 1990 to September 1993. From September 1988 to May 1990, he was Director of Public Affairs for Kraft General Foods International\nPaul J. Berzenski became Controller of the Company in January 1994 and Vice President of the Company in November 1994. He was Assistant Controller of GI Delaware from January 1991 to January 1994, and a Controller in the Company's former Jerrold Communications Division from January 1988 to January 1991.\nCharles T. Dickson became Vice President and Chief Financial Officer of the Company in January 1994. He was Vice President-Finance and Administration of several divisions of MCI Communications Corporation from 1988 to 1993.\nThomas A. Dumit became Vice President, General Counsel of GI Delaware in January 1991 and Chief Administrative Officer in December 1995. From January 1988 through 1990, Mr. Dumit was Senior Vice President and General Counsel of Whitman Corporation, a diversified company. From 1986 to 1987, he was Senior Vice President and General Counsel of Household Financial Services, a consumer finance division of Household International, Inc., and from 1984 to 1985, he was Vice President and General Counsel of American Hospital Supply Corporation.\nSusan M. Meyer became Vice President and Secretary of the Company in December 1995, and has been Deputy General Counsel of the Company since February 1991. Ms. Meyer was Assistant Secretary of GI Delaware from June 1992 to December 1995. Prior to joining the Company, she held several positions with Beatrice Companies, Inc. and G.D. Searle & Co. She also practiced law at Kirkland & Ellis in Chicago and Shearman & Sterling in New York.\nRichard C. Smith has been Vice President of GI Delaware since March 1989 and Treasurer of the Company since September 1991. Mr. Smith has been Vice President and Assistant Secretary of the Company since May 1991 and has been Treasurer of the Company since March 1992. He was Assistant Treasurer of GI Delaware from June 1986 to June 1987 and from February 1991 to September 1991. From June 1986 to November 1994, he was Director of Taxes for GI Delaware and from May 1991 to November 1994, he was Director of Taxes of the Company. From June 1987 to March 1989, he was also Director-Risk Management and Customs of GI Delaware.\nClark E. Tucker has been Vice President-Human Resources of GI since May 1995. From August 1992 until November 1994, Mr. Tucker was Vice President-Human Resources for Witco Corporation; from April 1990 until August 1992, he served as a management consultant with Towers, Perrin, Forster & Crosby; from August 1989 until April 1990 he was Director, Personnel for Lederle Laboratories (a subsidiary of American Cyanamid Company); and from January 1987 until August 1989 he was Director, Compensation and Benefits for American Cyanamid Company.\nEdward D. Breen became President of GI's Communications Division, Eastern Operations, in February 1996 and Vice President of GI in November 1994. He was Executive Vice President, Terrestrial Systems, from October 1994 to January 1996 and Senior Vice President of Sales from June 1988 to October 1994.\nFrank M. Drendel served as a director of GI Delaware and its predecessors from 1987 to March 1992, when he was elected to serve as a director of the Company. He has served as Chairman and President of CommScope since 1986 and has served as Chief Executive Officer of CommScope since 1976. Mr. Drendel was Executive Vice President of the predecessor to the Company from September 1986 to November 1988. From February 1981 to September 1986, Mr. Drendel was Executive Vice President and, from July 1982 to September 1986, he was Vice Chairman of the Board of M\/A-COM, Inc.\nRonald A. Ostertag has been Vice President of GI Delaware since February 1989, and President, Power Semiconductor Division since September 1990. From April 1989 to September 1990, he was Senior Vice President-Operations for the former VideoCipher division, and from August 1984 to April 1989, was Vice President and General Manager of the Computer Products division of GI Delaware.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation required by this Item is contained in Notes 7, 11 and 14 to the consolidated financial statements included in the 1995 Annual Report, incorporated herein by reference.\nAs of March 15, 1996, the approximate number of registered stockholders of record of the Company's Common Stock was 914.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nInformation required by this Item is contained in the Five Year Summary included in the 1995 Annual Report, 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 contained in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 1995 Annual Report, incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation required by this Item is contained in the consolidated financial statements of the Company as of December 31, 1995 and 1994 and for each of the years ended December 31, 1995, 1994 and 1993, the notes to the consolidated financial statements, and the independent auditors' report thereon, and in the Company's unaudited quarterly financial data for the two year period ended December 31, 1995, filed as a part of Item 8.\nSubsequent Footnote Disclosure (Unaudited) -------------------------------------------\nSubsequent to the issuance of the financial statements, which are incorporated by reference to the Company's 1995 Annual Report herein, the following event occurred.\nOn April 10, 1995, prior to the Company's acquisition of Next Level on September 27, 1995, DSC Communications Corporation and DSC Technologies Corporation (collectively, \"DSC\") brought suit in Texas state court against Next Level, Thomas R. Eames and Peter W. Keeler (the founders of Next Level and current Next Level employees). Next Level and the individual defendants subsequently removed the case to federal court. On March 28, 1996, a jury verdict was reached in the case, entitled DSC Communications Corporation and DSC Technologies Corporation v. Next Level Communication, Thomas R. Eames and Peter W. Keeler, Case No. 4:95cv96 in the United States District Court for the Eastern District of Texas, Sherman Division. The verdict states that Messrs. Eames and Keeler breached certain employee agreements with DSC, failed to disclose and diverted a corporate opportunity of DSC, misappropriated DSC trade secrets and conspired to take certain of the foregoing actions, and that Next Level used or benefited from the diversion of corporate opportunity and misappropriation of trade secrets. The verdict would award to DSC compensatory damages against the defendants in amounts ranging between $24 million and $120 million with respect to the respective causes of action as to which the jury found liability. Although DSC has taken the position in a press release that the aggregate amount of all compensatory damages awarded is $359 million, the Company believes that the cumulation of all the amounts awarded would be improper because it would lead to multiple recoveries for the same damages. The verdict would also award punitive damages in the amount of $10 million against Next Level and $100,000 against each of Messrs. Eames and Keeler. DSC has also indicated that it intends to apply to the court for injunctive relief. Judgment has not yet been entered in the case, and the defendants intend to file a motion to set aside the verdict. The time for defendants to appeal any judgment will not begin to run until such judgment has been entered by the court. In connection with the acquisition of Next Level, the Company entered into agreements to indemnify Messrs. Eames and Keeler for any judgment that may be awarded against them in this matter, to the extent permitted by applicable law. The nature of any judgment is not reasonably determinable at this time and there is no assurance that such amount will not have a material adverse effect on the Company's financial statements. The Company believes that the verdict is not legally sustainable and intends to seek to have the verdict set aside.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 concerning directors of the Company is included in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders, filed with the Securities and Exchange Commission (the \"1996 Proxy Statement\") in the section captioned \"Election of Directors,\" and such information is incorporated herein by reference. Information required by this item concerning the executive officers of the Company is included in Part I of this Annual Report on Form 10-K under the section captioned \"Additional Item. Executive Officers of the Registrant,\" as permitted by General Instruction G(3). Information required by this Item concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is included in the 1996 Proxy Statement under the caption \"Compliance with Section 16(a) of the Exchange Act,\" and such information is incorporated herein by reference. Theodore J. Forstmann and Nicholas C. Forstmann, both of whom are directors of the Company, are brothers.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation required by this Item is included in the 1996 Proxy Statement in the section captioned \"Further Information Concerning the Board of Directors and Committees\" under the subsections captioned \"-Compensation Committee Interlocks and Insider Participation\" and \"-Director Compensation\" and in the section captioned \"Compensation of Executive Officers,\" and such information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this Item is included in the 1996 Proxy Statement in the section captioned \"Security Ownership of Certain Beneficial Owners and Management,\" and such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this Item is included in the 1996 Proxy Statement in the section captioned \"Other Related Party Transactions,\" 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. Financial Statements\nConsolidated Balance Sheets at December 31, 1995 and 1994\nFor 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\nIndependent Auditors' Report\n2. Financial Statement Schedules\nIndependent Auditors' Report I. Condensed financial information - Parent Company only II. Valuation and qualifying accounts\nAll other schedules have been omitted because they are not applicable, not required or the information required is included in the consolidated financial statements or notes thereto.\n3. Exhibits\nThe exhibits are listed in the accompanying Index to Exhibits.\n(b) Reports on Form 8-K\nNone.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of General Instrument Corporation:\nWe have audited the consolidated financial statements of General Instrument Corporation (the \"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 report thereon dated February 2, 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 schedules of General Instrument 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 consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/Deloitte & Touche LLP ------------------------- DELOITTE & TOUCHE LLP\nChicago, Illinois February 2, 1996\nNote 1: The parent company files a consolidated income tax return with its subsidiaries. The consolidated income tax provisions were $38,566, $9,714 and $23,526 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote 2: Statements of cash flows are not required since the parent company did not have any cash flows from operations. Interest income - net for the years ended December 31, 1995, 1994 and 1993 relates to intercompany transactions.\nSee notes to consolidated financial statements included in the 1995 Annual Report, 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.\nGeneral Instrument Corporation By: \/s\/Richard S. Friedland -------------------------- Richard S. Friedland Date: April 1, 1996 Chairman of the Board and Chief Executive Officer ---------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statement No.(s) 33-60498, 33-61820, 33-50911, 33-52189, 33-54923, 33-55595 and 33-57737 of General Instrument Corporation on Form(s) S-8 of our reports dated February 2, 1996 appearing in and incorporated by reference in this Annual Report on Form 10-K of General Instrument Corporation for the year ended December 31, 1995.\n\/s\/Deloitte & Touche LLP ------------------------- DELOITTE & TOUCHE LLP\nChicago, Illinois April 1, 1996\nGENERAL INSTRUMENT CORPORATION INDEX TO EXHIBITS (ITEM 14(c))\nExhibit Description\n2.1 - Agreement and Plan of Merger, dated as of July 1, 1990, among FLGI Acquisition Corp. and General Instrument Corporation.*\n3.1 - Amended and Restated Certificate of Incorporation of the Company.\n3.2 - Amended and Restated By-Laws of the Company.*****\n4.1 - Specimen Form of Company's Common Stock Certificate. ***\n4.2 - Indenture, dated as of June 15, 1993, between General Instrument Corporation and Continental Bank.****\n10.1 - Second Amended and Restated Credit Agreement, dated as of June 30, 1994, among General Instrument Corporation, the banks and other financial institutions from time to time parties thereto, Chemical Bank, as Administrative Agent for the Banks, and Chemical Bank, Continental Bank N.A., Deutsche Bank AG, The Nippon Credit Bank, Ltd., The Bank of Nova Scotia, The Toronto- Dominion Bank, National Westminster Bank PLC, and the Bank of Tokyo Trust Company, as Co-agents. *****\n10.2 - Amended and Restated Guarantee, dated as of July 7, 1994, by the Company in favor of Chemical Bank. *****\n10.3 - Amended and Restated Guarantee, dated as of July 7, 1994 by Cable\/Home Communication Corporation and CommScope, Inc. in favor of Chemical Bank. *****\n10.4 - Form of Employee Subscription Agreement, dated as of December 1990, between the Company and certain Management Investors.*+\n10.5 - Form of Employee Subscription Agreement, dated as of March 21, 1992, between the Company and certain Management Investors.*+\n10.6 - Form of Waiver of Certain Company Rights under the agreement referred to in 10.5.*+\n10.7 - Form of Stock Option Agreement, dated as of August 15, 1990, in connection with the purchase of CommScope (including form of Stockholder's Agreement).*+\n10.8 - Form of Outside Director Stock Option Agreement (including form of Outside Director Stockholder's Agreement).*+\n10.9 - Employment Agreement, dated as of November 28, 1988, between CommScope and Frank M. Drendel.*+\n10.10 - Form of Indemnification Agreement between the Company and its directors and executive officers. *****\n10.11 - Registration Rights Agreement between the Company, GI Corporation, MBO-IV and Instrument Partners.*\n10.12 - Form of Amendment to Outside Director Stock Option Agreement (including form of Outside Director Stockholder's Agreement) between the Company and each of James M. Denny, J.Tracy O'Rourke, Derald H. Ruttenberg and William C. Lowe.*+\n10.13 - The General Instrument Corporation 1993 Long-Term Incentive Plan (including form of Stock Option Agreement).****+\n10.14 - General Instrument Corporation Annual Incentive Plan*****+\n10.15 - Amendment, dated May 20, 1993, to the Employment Agreement referred to in 10.14.****+\n10.16 - GI Deferred Compensation Plan. *****+\n11. - Computation of Earnings Per Share.\n13. - Annual Report to Stockholders for fiscal year ended December 31, 1995. (The Annual Report, except for those portions thereof which are expressly incorporated by reference in this Annual Report on 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.)\n21. - Subsidiaries of the Company.\n23. - Consent of Deloitte & Touche LLP (included on page 22).\n27. - Financial Data Schedule (Filing only for the Electronic Data Gathering, Analysis and Retrieval system of the U.S. Securities and Exchange Commission.)\n99 - Forward-looking information.\nAll other Exhibits are not applicable.\n* Incorporated by reference from Registration Statement No. 33-46854. ** Incorporated by reference from Registration Statement No. 33-63152. *** Incorporated by reference from Registration Statement No. 33-50215. **** Incorporated by reference from Annual Report on Form 10-K for the fiscal year ended December 31, 1993. ***** Incorporated by reference from Annual Report on Form 10-K for the fiscal year ended December 31, 1994. + Management contract or compensatory plan","section_15":""}
{"filename":"96943_1995.txt","cik":"96943","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company* was incorporated in 1943 as a manufacturer of precision mechanical push\/pull controls for military aircraft. From this original single market, single product orientation, the Company began to emphasize products and services in a broader range of economically diverse markets to reduce its vulnerability to economic cycles. Since the mid-1970s, the Company's investments have been directed toward specific market niches employing its technical capabilities to provide solutions to specific engineering problems and, more recently toward expanding into new but related medical businesses. The continuing stream of new products and value-added product improvements that have resulted from this strategy have enabled the Company to participate in larger market segments. Several of these new products and product improvements were developed by means of an unusual investment program of the Company called the New Venture Fund. Established in 1972, the Fund directs monies representing one-half percent of sales into the development of new products and services. This concept allows for entrepreneurial risk taking in new areas by encouraging innovation and competition among the Company's managers for funds to pursue new programs and activities independent of their operating budgets. Examples of New Venture projects include the initial funding of SermeTel(R) research and most of the early seed money for certain medical products.\nThe Company's business is separated into three segments -- Aerospace Products and Services, Medical Products and Commercial Products.\nAEROSPACE PRODUCTS AND SERVICES SEGMENT\nThe Aerospace Products and Services Segment serves the commercial aerospace and turbine engine markets. Its businesses design and manufacture precision controls and cargo systems for aviation, provide coating and repair services and blade manufacturing for users of both flight and land-based turbine engines.\nThese products and services, many of which are proprietary, require a high degree of engineering sophistication and are often custom designed. External economic influences on these products and services relate primarily to spending patterns in the worldwide aerospace industry. The Aerospace Products and Services Segment consists of the Aerospace Controls (formerly Aerospace\/Defense) Group and Sermatech International.\nIn 1995 and in the first quarter of 1996 the Company sold three product lines as part of a structural realignment within the Aerospace Products and Services Segment. These businesses produced a variety of mechanical and electromechanical controls for commercial and military aircraft, ordnance and space vehicles. The sale of these product lines effectively ends most of the Company's involvement in the military\/defense sector of the aerospace industry to focus the Aerospace Controls Group on air cargo handling systems for commercial aircraft and other aircraft controls. The Company's cargo handling systems include patented digitally controlled systems to move and secure containers of cargo inside commercial aircraft. These systems are sold either to aircraft manufacturers as original installations or to airlines and air freight carriers for retrofit of existing systems. The Company also designs, manufactures and repairs electromechanical components used on both commercial and, to a lesser extent military aircraft. These other aircraft controls include flight controls, canopy and door activators, cargo winches and control valves. The Company's design engineers work with design personnel from the major aircraft manufacturers in the development of controls for use on new aircraft. In addition, the Company supplies spare parts to aircraft operators typically through distributors. This spare parts business extends as long as the particular type of aircraft continues in service.\nIn the early 1960s, aircraft manufacturers began to encounter high temperature lubrication problems in connection with mechanical controls for aircraft jet engines. Through its subsidiary, Sermatech International, the Company utilized its aerospace experience and engineering capabilities to develop a series of formulations of inorganic coatings to solve these high temperature lubrication problems. These products were further\n- ---------------\n* As used herein the \"Company\" refers to Teleflex Incorporated and its consolidated subsidiaries.\ndeveloped by the Company and sold under the trademark SermeTel(R) to provide anti-corrosion protection for compressor blades and other airfoils. Sermatech International, through a network of facilities in five countries, provides a variety of sophisticated protective coatings and other services for gas turbine engine components; highly-specialized repairs for critical components such as fan blades and airfoils; and manufacturing and high quality dimensional finishing of airfoils. The Company has added technologies through acquisition and internal development and now offers a diverse range of technical services and materials technologies to turbine markets throughout the world. In 1993 the Company acquired Mal Tool & Engineering, a manufacturer of fan blades for flight turbines, and airfoils for both flight and land-based gas turbines and steam turbines. The acquisition broadens the Company's product offering including turnkey manufactured and coated airfoils and provides another entree to major international turbine manufacturers. During the fourth quarter of 1995 the Company formed a joint venture with General Electric Aircraft Engines, Airfoil Technologies International LLC (ATI), to provide fan blade and airfoil repair services. The Sermatech repair operations were contributed to ATI which is owned 51% by the Company. ATI will provide a vehicle for the technological and geographic expansion of the Sermatech repairs services business.\nMEDICAL PRODUCTS SEGMENT\nWithin the Medical Products Segment, the Company operates three businesses: TFX OEM, Rusch International and Pilling Weck. In the late 1970s, the Company decided to apply its polymer technologies to the medical market, and began by extruding intravenous catheter tubing which it sold to original equipment manufacturers. Through TFX OEM, the Company produces standard and custom-designed semi-finished components for other medical device manufacturers using its polymer materials and processing technology. Through acquisitions the Company established the other two product lines of this segment: hospital supply and surgical devices.\nIn 1989, the acquisition of Willy Rusch AG and affiliates in Germany brought with it an established manufacturing base and distribution network, primarily in Europe. This and other smaller acquisitions designed to broaden the Company's product offerings form the base of the hospital supply business. The Company conducts its hospital supply business under the name of Rusch International. This business includes the manufacture and sale of invasive disposable and reusable devices for the urology, gastroenterology, anesthesiology and respiratory care markets worldwide. The Rusch International product offerings include, among others, latex catheters, endotracheal tubes, laryngoscopes, face masks and tracheostomy tubes.\nThe acquisitions of the Pilling Company in 1991 and Edward Weck Incorporated in 1993 became the foundation of the surgical devices business now operating as Pilling Weck. The Weck acquisition was assimilated during 1994 into the existing surgical device operations. The combination of Pilling and Weck significantly expands the product offerings, marketing opportunities and selling capabilities in the surgical devices market in the United States; and provides opportunities for increasing international sales. During 1994 and 1995, smaller acquisitions were made to balance the Company's product offerings in Europe. Pilling Weck manufactures and distributes primarily through its own sales force instruments used in both traditional (open) and minimally-invasive surgical procedures including general and specialized surgical instruments such as scissors, forceps, vascular clamps, needle holders, retractors, ligation clips, appliers, skin staples and electrosurgery products.\nCOMMERCIAL PRODUCTS SEGMENT\nThe Commercial Products Segment businesses design and manufacture proprietary mechanical controls for the automotive market; mechanical, electrical and hydraulic controls, and electronics products for the pleasure marine market; and proprietary products for the fluid transfer and outdoor power equipment markets.\nProducts in the Commercial Products Segment generally are less complex and are produced in higher unit volume, are manufactured for general distribution, as well as custom fabricated to meet individual customer needs. Consumer spending patterns generally influence the market trends for these products.\nThe Commercial Products Segment consists of three major product lines: Marine, Automotive and Industrial.\nThe Company is a leading domestic producer of mechanical steering systems for pleasure power boats. It also manufactures hydraulic steering systems, engine throttle and shift controls and electrical instrumentation and has expanded into electronic navigation, location and communication systems. In 1991 the Company acquired Marinex Industries, Ltd., a British manufacturer of marine electronics. Its Cetrek autopilots and navigational equipment complement Teleflex's hydraulic steering products which together can be sold to both the commercial and pleasure marine markets. Techsonic Industries, Inc., a manufacturer of marine information systems (electronic navigation, communication and fish location devices) sold through mass merchandisers under the Humminbird brand name, became a wholly owned subsidiary in 1992. In 1994, the Company acquired TX Controls, a Swedish manufacturer of mechanical and hydraulic steering systems, engine control systems and cables for application on marine craft and industrial vehicles. The acquisition of TX Controls, along with Marinex, enhanced the Company's access to the international marine market. Aside from the Humminbird products, the Company's marine products are sold principally to boat builders, in the aftermarket, and are used principally on pleasure craft but also have application on commercial vessels.\nThe Company is a major supplier of mechanical controls to the domestic automotive market. The principal products in this market are accelerator, transmission, shift, park lock, window regulator controls and a new heat resistant flexible fuel line. In 1995 the Company acquired the cable controls businesses of Handy & Harmon Automotive Group. This acquisition broadens the automotive product line by adding a park brake and provides a manufacturing plant in Mexico. Acceptance by the automobile manufacturers of a Company- developed control for use on a new model ordinarily assures the Company a large, but not exclusive, market share for the supply of that control. The sales of mechanical automotive controls were $139,128,000, $164,500,000 and $193,361,000 in 1993, 1994 and 1995, respectively.\nIndustrial controls and electrical instrumentation products are also manufactured for use in other applications, including agricultural equipment, outdoor power equipment, leisure vehicles and other on- and off-road vehicles. In addition, the Company produces stainless steel overbraided fluoroplastic hose for fluid transfer in such markets as the chemical, petroleum and food processing industries.\nMARKETING\nIn 1995, the percentages of the Company's consolidated net sales represented by its major markets were as follows: aerospace -- 24%; medical -- 32%; marine and industrial -- 23%; and automotive -- 21%.\nThe major portion of the Company's products are sold to original equipment manufacturers. Generally, products sold to the aerospace and automotive markets are sold through the Company's own force of field engineers. Products sold to the marine, medical and general industrial markets are sold both through the Company's own sales forces and through independent representatives and independent distributor networks.\nFor information on foreign operations, export sales, and principal customers, see text under the heading \"Business segments and other information\" on page 21 of the Company's 1995 Annual Report to Shareholders, which information is incorporated herein by reference.\nCOMPETITION\nThe Company has varying degrees of competition in all elements of its business. None of the Company's competitors offers products for all the markets served by the Company. The Company believes that its competitive position depends on the technical competence and creative ability of its engineering and development personnel, the know-how and skill of its manufacturing personnel as well as its plants, tooling and other resources.\nPATENTS\nThe Company owns a number of patents and has a number of patent applications pending. The Company does not believe that its business is materially dependent on patent protection.\nSUPPLIERS\nMaterials used in the manufacture of the Company's products are purchased from a large number of suppliers. The Company is not dependent upon any single supplier for a substantial amount of the materials it uses.\nBACKLOG\nAs of December 31, 1995 the Company's backlog of firm orders for the Aerospace Products and Services Segment was $81 million, of which it is anticipated that substantially all will be filled in 1996. The Company's backlog for Aerospace Products and Services on December 25, 1994 was $106 million. The decline in the backlog in 1995 compared with 1994 is due to the sale of two product lines in 1995 and one in the first quarter of 1996.\nAs of December 31, 1995 the Company's backlog of firm orders for the Medical Products and Commercial Products segments was $24 million and $84 million, respectively. This compares with $21 million and $74 million, respectively, as of December 25, 1994. Substantially all of the December 31, 1995 backlog will be filled in 1996. Most of the Company's medical and commercial products are sold on orders calling for delivery within no more than a few months so that the backlog of such orders is not indicative of probable net sales in any future 12-month period.\nEMPLOYEES\nThe Company had approximately 9,800 employees at December 31, 1995.\nEXECUTIVE OFFICERS\nThe names and ages of all executive officers of the Company as of March 1, 1995 and the positions and offices with the Company held by each such officer are as follows:\nMr. Boyer was elected President and Chief Executive Officer on April 28, 1995. Prior to that date he was President.\nDr. Carriker was named President and Chief Operating Officer -- TFX Aerospace on January 3, 1994. Prior to that date he was President -- Sermatech International.\nMr. Woodfield was elected President and Chief Operating Officer -- TFX Medical on March 9, 1992. Prior to that date, he was President of Empire Abrasive Equipment Corporation.\nMr. Horvath was named to the position of Vice President -- Quality and Productivity on January 4, 1996. Prior to that date he was Vice President -- Quality Management.\nMr. Boldt was named to the position of Vice President -- Human Resources on March 9, 1992. Prior to that date he was Director of Human Resources.\nMs. Dusossoit was named to the position of Vice President -- Investor Relations on March 1, 1993. From April 1, 1992 to March 1, 1993 she was Director of Investor Relations. Prior to that date she was a business consultant.\nOfficers are elected by the Board of Directors for one year terms. No family relationship exists between any of the executive officers of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's operations have approximately 90 owned and leased properties consisting of plants, engineering and research centers, distribution warehouses and other facilities. The properties are maintained in good operating condition. All the plants are suitably equipped and utilized, and have space available for the activities currently conducted therein and the increased volume expected in the foreseeable future.\nThe following are the Company's major facilities:\n- --------------- (1) The Company is the beneficial owner of these facilities under installment sale or similar financing agreements.\nIn addition to the above, the Company owns or leases approximately 600,000 square feet of warehousing, manufacturing and office space located in the United States, Canada, Europe and Asia.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTwo subsidiaries of the Company have been identified as potentially responsible parties (PRPs) in connection with the Casmalia Resources Hazardous Waste Management Facility. The Company has joined a group of other PRPs, predominately in the aerospace industry, to negotiate with the United States Environmental Protection Agency (EPA) a good faith offer to take over responsibility for a program of closure and post-closure care of the site. The PRPs from the aerospace industry are currently engaged in negotiations with a second PRP group with the aim of providing a common negotiating front with the EPA.\nIn July 1994, the North Penn Water Authority (NPWA) instituted suit against the Company in the United States District Court for the Eastern District of Pennsylvania. NPWA alleges that acts or omissions of the Company and four other defendants caused releases of chlorinated solvents that have contaminated, and continue to contaminate, one of NPWA's wells located near Lansdale, Pennsylvania. NPWA seeks injunctive relief to require defendants to abate the alleged contamination. NPWA also seeks the recovery of costs allegedly incurred because of the contamination. The Company filed an answer denying any liability to NPWA for the claims made in the complaint and is vigorously defending this action. The parties are engaged in settlement negotiations.\nIn addition, the Company has been named as a PRP by the EPA at various sites throughout the country.\nIn the opinion of the Company's management, based on current allocation formulas and the facts presently known, the ultimate outcome of these environmental matters will not result in a liability material to the Company's consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nSee \"Quarterly Financial Data\" on page 23 of the Company's 1995 Annual Report to Shareholders for market price and dividend information. Also see the Note entitled \"Borrowings and Leases\" on pages 19 and 20 of such Annual Report for certain dividend restrictions under loan agreements, all of which information is incorporated herein by reference. The Company had approximately 1,400 registered shareholders at February 1, 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee pages 24 through 27 of the Company's 1995 Annual Report to Shareholders, which pages are incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSee the text under the heading \"Financial Review\" on pages 28 through 33 of the Company's 1995 Annual Report to Shareholders, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee pages 15 through 23 of the Company's 1995 Annual Report to Shareholders, which pages are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nFor information with respect to the Company's Directors and Director nominees, see \"Election Of Directors\" and \"Additional Information About The Board Of Directors\" on pages 2 through 4 of the Company's Proxy Statement for its 1996 Annual Meeting, which information is incorporated herein by reference.\nFor information with respect to the Company's Executive Officers, see Part I of this report on pages 4 and 5, which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSee \"Additional Information About The Board of Directors\", \"Board Compensation Committee\", \"Five-Year Shareholder Return Comparison\" and \"Executive Compensation and Other Information\" on pages 3 through 8 of the Company's Proxy Statement for its 1996 Annual Meeting, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee \"Security Ownership of Certain Beneficial Owners and Management\" on pages 1 and 2 and \"Election Of Directors\" on pages 2 and 3 of the Company's Proxy Statement for its 1996 Annual Meeting, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Additional Information About The Board Of Directors\", \"Board Compensation Committee\" and \"Executive Compensation and Other Information\" on pages 3 through 8 of the Company's Proxy Statement for its 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) Consolidated Financial Statements:\nThe index to Consolidated Financial Statements and Schedules is set forth on page 10 hereof.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K have been filed during the last quarter of the period covered by this report.\n(c) Exhibits:\nThe Exhibits are listed in the Index to Exhibits.\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 2-84148 (filed June 28, 1989), 2-98715 (filed May 11, 1987), 33-34753 (filed May 10, 1990) and 33-53385 (filed April 29, 1994):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized as of the date indicated below.\nTELEFLEX INCORPORATED\nBy LENNOX K. BLACK\n------------------------------------ Lennox K. Black Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and as of the date indicated below.\nBy DAVID S. BOYER\n------------------------------------ David S. Boyer (Principal Executive Officer)\nBy HAROLD L. ZUBER, JR.\n------------------------------------ Harold L. Zuber, Jr. (Principal Financial and Accounting Officer)\nPursuant to General Instruction D to Form 10-K, this report has been signed by Steven K. Chance as Attorney-in-Fact for a majority of the Board of Directors as of the date indicated below.\nBy STEVEN K. CHANCE\n------------------------------------ Steven K. Chance Attorney-in-Fact\nDated: March 22, 1996\nTELEFLEX INCORPORATED\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated financial statements together with the report thereon of Price Waterhouse LLP dated February 13, 1996 on pages 15 to 22 of the accompanying 1995 Annual Report to Shareholders are incorporated in this Annual Report on Form 10-K. With the exception of the aforementioned information, and those portions incorporated by specific reference in this document, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this report. The following Financial Statement Schedule together with the report thereon of Price Waterhouse LLP dated February 13, 1996 on page 11 should be read in conjunction with the consolidated 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 consolidated financial statements or notes thereto.\nFINANCIAL STATEMENT SCHEDULE\nSchedule:\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Teleflex Incorporated\nOur audits of the consolidated financial statements referred to in our report dated February 13, 1996 appearing on page 22 of the 1995 Annual Report to Shareholders of Teleflex Incorporated (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nThirty South Seventeenth Street Philadelphia, Pennsylvania 19103 February 13, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 2-84148, No. 2-98715, No. 33-34753, and No. 33-53385) of Teleflex Incorporated of our report dated February 13, 1996 appearing on page 22 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 above.\nPRICE WATERHOUSE LLP\nThirty South Seventeenth Street Philadelphia, Pennsylvania 19103 March 22, 1996\nTELEFLEX INCORPORATED\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS ALLOWANCE FOR DOUBTFUL ACCOUNTS\nMARCH 22, 1996\nINDEX TO EXHIBITS\nEXHIBIT\n3 (a) - The Company's Articles of Incorporation (except for Article Thirteenth and the first paragraph of Article Fourth) are incorporated herein by reference to Exhibit 3(a) to the Company's Form 10-Q for the period ended June 30, 1985. Article Thirteenth of the Company's Articles of Incorporation is incorporated herein by reference to Exhibit 3 of the Company's Form 10-Q for the period ended June 28, 1987. The first paragraph of Article Fourth of the Company's Articles of Incorporation is incorporated herein by reference to Exhibit 3 of the Company's Form 10-Q for the period ended June 25, 1989 (filed with Form 8, dated August 23, 1989).\n(b) - The Company's Bylaws are incorporated herein by reference to Exhibit 3(b) of the Company's Form 10-K for the year ended December 28, 1987.\n10 (a) - The 1982 Stock Option Plan, incorporated herein by reference to the Company's registration statement on Form S-8 (Registration No. 2-84148), as supplemented, with amendments of April 26, 1991 incorporated by reference to the Company's definitive Proxy Statement for the 1991 Annual Meeting of Shareholders.\n(b) - The 1990 Stock Compensation Plan, incorporated herein by reference to the Company's registration statement on Form S-8 (Registration No. 33-34753), with amendments of April 28, 1995 incorporated by reference to the Company's definitive Proxy Statement for the 1995 Annual Meeting of Shareholders.\n(c) - The Salaried Employees' Pension Plan, as amended and restated in its entirety, effective July 1, 1989 and the retirement income plan as amended and restated in its entirety effective January 1, 1994 and related Trust Agreements, dated July 1, 1994 is incorporated by reference to the company's Form 10-K for the year ended December 25, 1994.\n(d) - Description of deferred compensation arrangements between the Company and its Chairman, L. K. Black, incorporated by reference to the Company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. INDEX TO EXHIBITS . . . PAGE 2\n(e) - Description of compensation arrangement between the company and its President and Chief Executive Officer, David S. Boyer, incorporated by reference to the company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders.\n(f) - Teleflex Incorporated Deferred Compensation Plan entered into as of January 1, 1995.\n(g) - Information on the Company's Profit Participation Plan, insurance arrangements with certain officers and deferred compensation arrangements with certain officers, non-qualified supplementary pension plan for salaried employees and compensation arrangements with directors is incorporated by reference to the Company's definitive Proxy Statement for the 1994, 1995 and 1996 Annual Meeting of Shareholders.\n(h) - The Company's Voluntary Investment Plan is incorporated by reference to Exhibit 28 of the Company's registration statement on Form S-8 (Registration No. 2-98715).\n13 - Pages 15 through 27 of the Company's Annual Report to Shareholders for the period ended December 31, 1995.\n22 - The Company's Subsidiaries.\n24 - Consent of Independent Accountants (see page 11 herein).\n25 - Power of Attorney.","section_15":""}
{"filename":"762848_1995.txt","cik":"762848","year":"1995","section_1":"Item 1. Business.\nBrauvin Real Estate Fund L.P. 5 (the \"Partnership\") is a Delaware limited partnership formed in 1985 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, all in greater 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 current real estate market conditions and economic trends the General Partners instead believe it to be in the best interest of the Partnership to retain the properties until such time as the General Partners reasonably believe it is appropriate to dispose of the Partnership's properties. In order to make this determination, the General Partners periodically evaluate market conditions. However, since the amended and restated limited partnership agreement (the \"Agreement\") provides that the Partnership shall terminate December 31, 2025, unless sooner terminated, the General Partners shall in no event dispose of the properties after that date.\nAs of December 31, 1995, the Partnership had acquired one rental property, a 42% interest in a joint venture which acquired a second rental property and a 53% interest in a joint venture which acquired a third rental property. A fourth rental property which the Partnership had acquired a 54% interest in a joint venture was foreclosed upon on May 15, 1995. The Partnership will not purchase any additional properties. Operations currently consist of operating the real estate properties which have been managed by Brauvin Management Company, Inc. (an affiliate of the General Partners). The focus of property management activities has seen improvement in the economic performance of the properties with the goal of maximizing value to the Partnership upon disposition.\nThe Partnership has no employees.\nMarket Conditions\/Competition\nThe Partnership faces active competition in all aspects of its business and must compete with entities which own properties\nsimilar 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 are beyond the Partnership's control, 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 and increased cost of financing, changes in zoning laws or changes in patterns of the needs of users. The marketability of the properties may also be affected by prevailing interest rates and existing tax laws. The Partnership may be required to retain ownership of its properties for periods shorter or longer than anticipated at acquisition or 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.\nMarket conditions have weakened in several markets resulting in lower cash flows than were originally anticipated. The Partnership strives to maximize economic occupancy and, as such, must adjust rents to attract and retain tenants. One measure of a market's relative strength or weakness is the current rental rate demanded by non-anchor tenants. These rates are for tenants who generally sign leases of three to five years and are an indicator of the \"spot\" rental market. Non-anchor tenant rental rates, expressed per square foot per year, have increased at the Crown Point property located in Kingsport, Tennessee, from approximately $9.00 per square foot in 1993 to approximately $11.00-$12.00 per square foot in 1995. However, the Partnership has not benefitted from these increases due to the existence of leases that were negotiated in prior years. The rates for non-anchor tenants at Sabal Palm in Palm Bay, Florida have declined from approximately $16.00 per square foot in 1990 to approximately $12.00 per square foot in 1995. Similarly, at Strawberry Fields in West Palm Beach, Florida the rates have declined from approximately $16.00 per square foot in 1988 to approximately $8.00 per square foot in 1995.\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\nthat all real estate owned by the Partnership is in full compliance with applicable environmental laws and regulations.\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. For the purpose of the information disclosed in this section, the following terms are defined as follows:\nOccupancy Rate: The occupancy rate is defined as the occupied square footage at December 31, divided by the total square footage excluding square footage of outparcels, if any.\nAverage Annual Base Rent Per Square Foot: The average annual base rent per square foot is defined as the total effective base rental income for the year divided by the average square feet occupied excluding outparcels, if any.\nAverage Square Feet Occupied: The average square feet occupied is calculated by averaging the occupied square feet at the beginning of the year with the occupied square feet at the end of the year excluding outparcels, if any.\nDuring the year ended December 31, 1995, the Partnership owned the properties described below:\n(a) Crown Point Shopping Center (\"Crown Point\")\nOn September 12, 1985, the Partnership acquired Crown Point, an approximately 71,500 square foot shopping center located in Kingsport, Sullivan County, Tennessee. Crown Point is composed of a main building, constructed in two phases, and two outparcel buildings of approximately 6,500 square feet. Phase I of Crown Point and one outparcel building were completed in 1984. Phase II of Crown Point and the other outparcel building were completed in 1985. The anchor tenant is a Food City grocery. Burger King, a division of Grand Metropolitan PLC, is located on one of the outparcel buildings which is also owned by the Partnership. Crown Point was 98% occupied at December 31, 1995.\nThe Partnership purchased Crown Point for $5,341,696 consisting of approximately $1,775,000 paid in cash at closing and the balance by assuming an existing first mortgage loan of $3,566,696. The\nlender provided the first mortgage loan through the sale of tax-exempt bonds. The loan has a 30-year term and bears interest at the rate of 9.69% per annum. The lender can call this loan on December 1, 1994 or on any subsequent fifth anniversary thereof. On November 22, 1994, the current lender, NationsBank of Tennessee, (the \"Lender\") exercised the right to call all amounts due as of March 1, 1995. On March 1, 1995, a Forbearance Agreement was executed between the Partnership and the Lender where the Lender agreed to forbear from pursuing remedies with respect to defaults through and including September 1, 1995 (the \"First Forbearance Period\"). During the First Forbearance Period the terms and conditions of the mortgage remained unchanged. Effective September 1, 1995, the Lender agreed to further forebear from pursuing remedies with respect to defaults through and including December 1, 1995 (the \"Second Forbearance Period\"). During the Second Forbearance Period the terms and conditions of the mortgage also remained unchanged. Subsequent to December 1, 1995, the Lender verbally agreed to forebear from pursuing remedies with respect to defaults through December 31, 1995 in light of the ongoing refinancing negotiations with NationsBanc Mortgage Corporation, a Texas corporation with principal offices in Charlotte, North Carolina. On December 28, 1995, the loan balance was paid in full when the Crown Point property was refinanced with NationsBanc Mortgage Capital Corporation. The refinancing resulted in a $3,275,000 non-recourse loan with a fixed interest rate of 7.55% and a maturity of January 1, 2003.\nThe occupancy rate and average annual base rent per square foot at December 31 for the last five years are as follows:\n1995 1994 1993 1992 1991\nOccupancy Rate 98% 94% 82% 81% 77%\nAverage Annual Base Rent Per Square Foot $6.73 $6.40 $7.04 $7.21 $7.79\nCrown Point has two tenants which individually occupy ten percent or more of the rentable square footage. The following is a summary of the tenant rent roll at December 31, 1995: Annual Lease Square Base Expiration Renewal Nature of Tenant Feet Rent Date Options Business Food City 39,652 $257,738 8\/2004 5\/5 yrs ea. Food Store Contel Cellular 12,800 64,000 8\/99 None Telecom- munication Services Others 17,800 140,875 Various Various Vacant 1,200 -- 71,452 $462,613\n(b) Strawberry Fields Shopping Center (\"Strawberry Fields\")\nOn December 12, 1985, the Partnership and Brauvin Real Estate Fund L.P. 4 (\"BREF 4\"), an affiliated public real estate limited partnership, formed a joint venture (the \"Strawberry Joint Venture\") to purchase Strawberry Fields located in West Palm Beach, Florida for $9,875,000. The Partnership has a 42% interest in the joint venture which owns Strawberry Fields and BREF 4 has a 58% interest in the joint venture which owns Strawberry Fields. The purchase was funded with $3,875,000 cash at closing and $6,000,000 from the proceeds of a first mortgage loan.\nIn February 1993, the Strawberry Joint Venture finalized a refinancing of the first mortgage loan on Strawberry Fields (the \"Refinancing\") with the lender. The Refinancing became effective retroactive to October 1992. Due to the Refinancing, the interest rate was reduced to 9% with monthly payments of interest only from October 1992 through November 1995. The Partnership has the option to extend the term of the loan and make monthly payments of principal and interest from December 1995 through November 1998, if it is not in default of the terms of the Refinancing. On September 18, 1995, the Strawberry Joint Venture notified Lutheran Brotherhood (the \"Strawberry Lender\") that it would exercise its option to extend the term of the Strawberry Fields loan from the original maturity of November 1, 1995 to December 1, 1998. The terms of the extension called for all provisions of the loan to remain the same except for an additional monthly principal payment of $12,500. Effective November 1, 1995, the Strawberry Joint Venture and the Strawberry Lender agreed to modify the loan by reducing the interest rate to 7.5% for November 1, 1995 through October 31, 1997 and by reducing the monthly principal payment to\n$12,000. From November 1, 1997 through the maturity date, December 1, 1998, the interest rate will revert to the original 9.0% rate.\nIn 1993, the Strawberry Joint Venture determined that an impairment to the asset value of Strawberry Fields had occurred and was the result of deteriorating market conditions caused by an excess supply of office space. As a result, market rates declined causing lower than originally anticipated rental collections. The property was written down to the Strawberry Joint Venture's best estimate of the property's fair value. A $1,000,000 provision for investment property impairment was charged to operations in 1993.\nStrawberry Fields is a neighborhood retail development constructed on an 11.87 acre site in 1985. Strawberry Fields was initially anchored by Florida Choice, a combination food, drug and general merchandise chain. In 1987, the Kroger Company (\"Kroger\") purchased Family Mart, the original lessee, and renamed the store. Kroger then closed the Florida Choice store in November 1988, however, the original lease terms remained in effect and Kroger continued to pay rent. Although Kroger is obligated to continue to pay rent through March 31, 2005 the Strawberry Joint Venture has subleased the space to Syms, a national discount clothing retailer, to sublease the space for the remainder of the original lease term. Strawberry Fields' main building contains 101,614 square feet of retail space and is complemented by two outparcel sites plus an older 5,400 square foot Uniroyal tire and automotive outlet. The outparcel sites are leased to Taco Bell, a division of PepsiCo, and Flagler National Bank. Strawberry Fields was 83% occupied at December 31, 1995.\nWith the exception of Florida Choice, all leases at Strawberry Fields are net with each tenant paying its pro rata share of operating expenses. Local tenant leases and outparcel ground leases provide for the base rent to be increased in accordance with the Consumer Price Index. Even though Florida Choice has vacated the space and the space has been sublet to Syms it is still required to pay any increases in property taxes and insurance above the level incurred in 1986 (the first year of operation). Syms is not required to share in the operating expenses.\nThe occupancy rate and average annual base rent per square foot at December 31 for the last five years are as follows:\n1995 1994 1993 1992 1991 Occupancy Rate 83% 78% 77% 72% 69%\nAverage Annual Base Rent Per Square Foot $7.47 $7.58 $7.13 $7.93 $8.22\nStrawberry Fields has one tenant which individually occupies ten percent or more of the rentable square footage. The following is a summary of the tenant rent roll at December 31, 1995:\nAnnual Lease Square Base Expiration Renewal Nature of Tenant Feet Rent Date Options Business Florida Choice (1) (sublet by Syms) 54,300 $380,100 3\/2005 8\/5 yrs ea. Discount Clothing Others 29,899 231,198 Various Various Vacant 17,415 -- 101,614 $611,298\n(1) Includes Syms and Florida Choice base rent.\n(c) Sabal Palm Square (\"Sabal Palm\")\nOn October 31, 1986, the Partnership and BREF 4 formed a joint venture to purchase Sabal Palm, a shopping center in Palm Bay, Florida, for $5,924,000. The Partnership has a 53% interest in the joint venture which owns Sabal Palm and BREF 4 has a 47% interest in the joint venture which owns Sabal Palm. The purchase was funded with $2,724,000 cash at closing and a $3,200,000 interim loan. On February 19, 1987, the joint venture obtained a first mortgage loan from an unaffiliated lender. The loan requires payments of principal and interest based on a 30-year amortization schedule. The remaining balance of the loan is payable in 1997. The Partnership consolidates the Sabal Palm Joint Venture and has recorded a minority interest balance to recognize the 47% interest of BREF 4.\nSabal Palm is a neighborhood shopping center consisting of approximately 82,000 square feet of retail space situated on\napproximately 9.7 acres of land. Sabal Palm was constructed in 1985 and is anchored by a Winn Dixie food store and Walgreens. Winn-Dixie completed an approximately 6,500 square foot expansion in the fourth quarter of 1992. Sabal Palm was 99% occupied at December 31, 1995. Sabal Palm has several outparcels, which are not owned by the Partnership, but which add to the center's appearance and customer activity.\nThe occupancy rate and average annual base rental per square foot at December 31 for the last five years are as follows:\n1995 1994 1993 1992 1991\nOccupancy Rate 99% 99% 92% 94% 90%\nAverage Annual Base Rental Per Square Foot $6.59 $6.26 $6.08 $6.18 $6.44\nSabal Palm has two tenants which individually occupy ten percent or more of the net rentable square feet. The following is a summary of the tenant rent roll at December 31, 1995:\nAnnual Lease Square Base Expiration Renewal Nature of Tenant Feet Rent Date Options Business Winn-Dixie 41,983 $142,239 4\/2005 5\/5 yrs ea. Food Store Walgreens 13,000 80,503 4\/2025 2\/5 yrs ea. Drug Store Others 32,650 355,381 Various Various Vacant 1,300 -- 88,933 $578,123\n(d) The Annex of Schaumburg (the \"Annex\")\nOn December 31, 1986, the Partnership and Brauvin Income Properties L.P. 6 (\"BIP 6\") formed a joint venture (the \"Annex Joint Venture\") to purchase the Annex, a shopping center located in Schaumburg, Illinois, for approximately $8,358,000. The Partnership had a 54% interest in the Annex Joint Venture and BIP 6 had a 46% interest. The Partnership consolidated the Annex Joint Venture and recorded a minority interest balance to recognize the 46% interest of BIP 6. The purchase was funded with approximately $3,158,000 cash at closing and $5,200,000 from the proceeds of an interim loan.\nAt the date of acquisition, the Annex was encumbered with an existing first mortgage loan of approximately $4,356,600, which bore interest at a rate of 13% per annum. The outstanding principal balance was due on February 1, 1994. As this loan was non-prepayable, the joint venture deposited approximately $4,356,600 with Stewart Title Company (the \"Title Company\") and paid a fee of approximately $293,000 to the Title Company in 1986 to service this loan.\nOn January 31, 1994, the Annex Joint Venture entered into a Reliance Agreement (the \"Agreement\") with the Title Company and agreed to, on behalf of the Title Company, by the lender, John Hancock Mutual Life Insurance Company: (i) make a $1,000,000 paydown on the loan;(ii) pay the Lender an administrative fee of 1.5% of the loan balance, after the $1,000,000 paydown; and (iii) issue title insurance as required. As a condition to the Annex Joint Venture's agreement with the Title Company, the Title Company agreed to pay the Annex Joint Venture $5,000 per month commencing February 1, 1994 through January 31, 1995 and $6,000 per month thereafter. The Title Company also agreed to equally share with the Annex Joint Venture the 2.5% interest savings after the 1.5% administrative fee was paid, which the Annex Joint Venture was expected to have been received upon maturity of the Agreement. In February 1994, the Title Company paid the Lender the $1,000,000 paydown, as required in the Agreement. In 1995 and 1994, the Annex received $5,000 and $55,000, respectively, from the Title Company, which was recorded as a reduction of interest expense on the property. The remaining amounts due from the Title Company were offset against amounts owed to the Title Company. The Partnership will not receive any additional payments under the Agreement.\nThe revised promissory note payable bore interest at a rate of 10% per annum, with monthly payments of principal and interest based upon a 30-year amortization schedule of $45,630 commencing December 1, 1989. The remaining principal balance of approximately $5,023,000 matured on November 1, 1994. The note was collateralized by a first mortgage lien on the Annex. Interest paid approximated $17,700, $270,500 and $508,800 in 1995, 1994 and 1993, respectively.\nThe Annex Joint Venture did not make its monthly mortgage payments that were due to AUSA Life Insurance Company, Inc. (\"AUSA\") on July 1, 1994, August 1, 1994, September 1, 1994 or October 1, 1994. In addition, the Annex Joint Venture did not\nrepay the mortgage loan which matured November 1, 1994, at which time the entire amount of principal and accrued interest became due and payable. On August 11, 1994, the Annex Joint Venture received a notice of default from AUSA demanding the payments due July 1, 1994 and August 1, 1994.\nOn August 23, 1994, the Annex Joint Venture filed a voluntary petition for bankruptcy (Chapter 11) in the United States Bankruptcy Court in the Northern District of Illinois. On February 10, 1995, the Bankruptcy Court ordered the dismissal of the voluntary petition for bankruptcy and AUSA filed a motion for appointment of a receiver against the Annex Joint Venture. On February 17, 1995, the motion was granted and an order was issued. The receiver had full power and authority to operate, manage and conserve the Annex pursuant to the order. On February 15, 1995, the Annex Joint Venture received an amended notice of mortgage foreclosure from AUSA. The Annex Joint Venture did not file an answer to the amended foreclosure that was due March 17, 1995. On April 3, 1995, a judgement of foreclosure and sale was entered into against the Annex Joint Venture. A sheriff's sale of the Annex was held on May 10, 1995 and on May 15, 1995 title was transferred to AUSA, in satisfaction of the Partnership's obligation on the promissory note payable.\nIn the opinion of the General Partners, the Partnership has provided for adequate insurance coverage of its real estate investment properties.\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 or percentage rent payments to the Partnership. Such defaults by one or more of the tenants could have an adverse effect on the financial situation of the Partnership. Furthermore, the Partnership may be unable to replace these tenants due to competition in the market at the time any vacancy occurs. Additionally, there are costs to the Partnership when replacing tenants such as leasing commissions and tenant improvements. Such improvements may require expenditure of Partnership funds otherwise available for distribution.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOn August 23, 1994, the Annex Joint Venture filed a voluntary petition for bankruptcy (Chapter 11) in the United States Bankruptcy Court in the Northern District of Illinois. On February 10, 1995, the Bankruptcy Court ordered the dismissal of the voluntary petition for bankruptcy and AUSA filed a motion for appointment of a receiver against the Joint Venture. On February 17, 1995, the motion was granted and an order was issued. The receiver had full power and authority to operate, manage and conserve the Annex pursuant to the order. On February 15, 1995, the Joint Venture received an amended notice of mortgage foreclosure from AUSA. The Joint Venture did not file an answer to the amended foreclosure that was due on March 17, 1995. On April 3, 1995, a judgement of foreclosure and sale was entered into against the Joint Venture. A sheriff's sale of the Annex was held on May 10, 1995 and on May 15, 1995 title was transferred to AUSA, in satisfaction of the Partnership's obligation on the promissory note payable.\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 808 Limited Partners in the Partnership. There is currently no established public trading market for the Units and it is not anticipated that a public market for the Units will develop. Bid prices quoted by \"partnership exchanges\" vary widely and are not considered a reliable indication of market value. Neither the Partnership nor Brauvin Ventures, 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 substitution of a Limited Partner.\nThere were no cash distributions to Limited Partners for 1995, 1994 and 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 Selected Income Statement Data:\nTotal Income $ 1,902,196 $ 2,261,071 $ 2,534,744\nProvision for Investment Property Impairment 2,702,083 882,709 1,500,000\nNet Income (Loss) 136,253 (803,143) (1,601,554)\nNet Income (Loss) Per Limited Partnership Unit 13.61 (80.20) (159.92)\nSelected Balance Sheet Data:\nInvestment in Affiliated Joint Venture $ 610,490 $ 712,179 $ 793,529\nTotal Assets 10,761,876 18,891,851 21,632,339\nMortgages Payable 6,388,064 11,427,743 11,524,695\nNotes Payable -- 2,929,581 4,153,194\nItem 6. Selected Financial Data - Continued.\nYear Ended Year Ended December 31, December 31, 1992 1991\nSelected Income Statement Data:\nTotal Income $ 2,685,106 $2,732,667\nNet Loss (408,339) (392,620)\nNet Loss Per Limited Partnership Unit (40.77) (39.20)\nSelected Balance Sheet Data:\nInvestment in Affiliated Joint Venture $ 1,263,802 $ 1,372,325\nTotal Assets 24,269,775 25,143,316\nMortgages Payable 11,627,774 11,719,711\nNotes Payable 4,194,591 4,231,000\nCash Distributions to Limited Partners -- 49,572\nCash Distributions to Limited Partners Per Unit -- 5.00\nItem 7.","section_7":"Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Partnership intends to satisfy its short-term liquidity needs through cash flow from the properties. Long-term liquidity needs are expected to be satisfied through refinancing of the mortgages when they mature.\nThe anchor tenant at Crown Point is Food City. The overall occupancy level at Crown Point increased to 98% at December 31, 1995. The Partnership is continuing to work to sustain the occupancy level of Crown Point.\nOn November 22, 1994, the lender to Crown Point, NationsBank of Tennessee, (the \"Lender\") exercised the right to call all amounts due as of March 1, 1995. On March 1, 1995, a Forbearance Agreement was executed between the Partnership and the Lender where the Lender agreed to forbear from pursuing remedies with respect to defaults through and including September 1, 1995 (the \"First Forbearance Period\"). During the First Forbearance Period the terms and conditions of the mortgage remained unchanged. Effective September 1, 1995, the Lender agreed to further forebear from pursuing remedies with respect to defaults through and including December 1, 1995 (the \"Second Forbearance Period\"). During the Second Forbearance Period the terms and conditions of the mortgage also remained unchanged. Subsequent to December 1, 1995, the Lender verbally agreed to forebear from pursuing remedies with respect to defaults through December 31, 1995 in light of the ongoing refinancing negotiations with NationsBanc Mortgage Corporation, a Texas corporation with principal offices in Charlotte, North Carolina. On December 28, 1995, the loan balance was paid in full when the Crown Point property was refinanced with NationsBanc Mortgage Capital Corporation. The refinancing resulted in a $3,275,000 non-recourse loan with a fixed interest rate of 7.55% and a maturity of January 1, 2003.\nThe Strawberry Joint Venture secured a replacement tenant, Syms, a national discount clothing retailer, to sublease the Kroger space at Strawberry Fields. Syms opened for business in October 1992 and signed a sublease for the remainder of the original lease term which expires March 31, 2005. Although Kroger continued to pay base rent in 1993, the Strawberry Joint Venture did not earn\nadditional percentage rent due to the absence of sales. However, customer traffic at Strawberry Fields increased with the draw of Syms, making vacant space more marketable. Although Strawberry Fields continued to generate negative operating cash flow in 1995 when compared to the negative operating cash flow in 1994 the property has shown an improvement due to the occupancy increase from 78% at December 31, 1994 to 83% at December 31, 1995. The Strawberry Joint Venture is aggressively marketing the property having engaged a prominent local brokerage firm to assist the Strawberry Joint Venture's on-site leasing representative in the marketing of the shopping center.\nIn 1993, the Strawberry Joint Venture determined that an impairment to the asset value of Strawberry Fields had occurred and was the result of deteriorating market conditions caused by an excess supply of retail rental space. As a result, market rates declined causing lower than originally anticipated rental collections. The property was written down to the Strawberry Joint Venture's best estimate of the property's fair value. A $1,000,000 provision for investment property impairment was charged to operations in 1993.\nOn September 18, 1995, the Strawberry Joint Venture notified Lutheran Brotherhood (the \"Strawberry Lender\") that it would exercise its option to extend the term of the Strawberry Fields loan from the original maturity of November 1, 1995 to December 1, 1998. The terms of the extension called for all provisions of the loan to remain the same except for an additional monthly principal payment of $12,500. Effective November 1, 1995, the Strawberry Joint Venture and the Strawberry Lender agreed to modify the loan by reducing the interest rate to 7.5% for November 1, 1995 through October 31, 1997 and by reducing the monthly principal payment to $12,000. As of November 1, 1997 and through the maturity date, December 1, 1998, the interest rate will revert to the original 9.0% rate.\nAt Sabal Palm, the Partnership and its joint venture partner are working to maintain the occupancy level of Sabal Palm which stood at 99% as of December 31, 1995. Although the Sabal Palm retail market appears to be overbuilt, the property has continued to generate positive cash flow since its acquisition in 1986.\nThe Annex Joint Venture did not make its monthly mortgage payments that were due to AUSA on July 1, 1994, August 1, 1994,\nSeptember 1, 1994 or October 1, 1994. In addition, the Annex Joint Venture did not repay the mortgage loan which matured November 1, 1994, at which time the entire amount of principal and accrued interest became due and payable. On August 11, 1994, the Annex Joint Venture received a notice of default from AUSA demanding the payments due July 1, 1994 and August 1, 1994.\nOn August 23, 1994, the Annex Joint Venture filed a voluntary petition for bankruptcy (Chapter 11) in the United States Bankruptcy Court in the Northern District of Illinois. On February 10, 1995, the Bankruptcy Court ordered the dismissal of the voluntary petition for bankruptcy and AUSA filed a motion for appointment of a receiver against the Annex Joint Venture. On February 17, 1995, the motion was granted and an order was issued. The receiver had full power and authority to operate, manage and conserve the Annex pursuant to the order. On February 15, 1995, the Annex Joint Venture received an amended notice of mortgage foreclosure from AUSA. The Annex Joint Venture did not file an answer to the amended foreclosure that was due March 17, 1995. On April 3, 1995, a judgement of foreclosure and sale was entered into against the Annex Joint Venture. A sheriff's sale of the Annex was held on May 10, 1995 and on May 15, 1995 title was transferred to AUSA, in satisfaction of the Partnership's obligation on the promissory note payable.\nIn 1994, the Partnership determined that additional impairment to the value of the Annex had occurred and was the result of deteriorating market conditions caused by an excess supply of available space and the court order of dismissal of the voluntary petition for bankruptcy. As a result of the excess supply of space, market rates declined causing lower than originally anticipated rental collections. The property was written down to the approximate outstanding nonrecourse mortgage balance as of December 31, 1994. A $882,709 provision for investment property impairment was charged to operations in 1994. In 1993, the property was written down to the best estimate of the property's fair value and a $1,500,000 provision for investment property impairment was charged to operations at that time.\nThe General Partners expect to distribute proceeds from operating cash flow, if any, and from the sale of real estate to Limited Partners in a manner that is consistent with the investment objectives of the Partnership. Management of the Partnership believes that cash needs may arise from time to time which will\nhave the effect of reducing distributions to Limited Partners to amounts less than would be available from refinancing or sale proceeds. These cash needs include, among other things, maintenance of working capital reserves in compliance with the Agreement as well as payments for major repairs, tenant improvements and leasing commissions in support of real estate operations.\nResults of Operations\nThe Partnership's revenue and expenses are affected primarily by the operations of the properties. Property operations, and in particular the components of income, demand for space and rental rates are, to a large extent, determined by local and national market conditions. These market conditions, all beyond the control of the Partnership and its General Partners, have effected the real estate industry since the late 1980's and have combined to cause severe economic hardships for real estate owners. Some of the specific market conditions are as follows:\nThe savings and loan crisis resulted in the creation of the Resolution Trust Corp. (RTC). The RTC sponsored auctions where large blocks of properties were sold at distressed prices. The low price paid by the new owners enabled them to reduce asking rental rates resulting in significantly lower market rents for all competing properties.\nThe emergence of \"Category Killer\" retailers who occupied large \"Box\" spaces in new developments known as \"Power Centers\" attracted tenants from the smaller and more traditional \"Community Centers\" resulting in increased vacancies and downward pressure on market rental rates.\nThe continuing softness in retail sales has resulted in store closings. This has in turn resulted in increased vacancies and an overall softness in demand for retail space which results in downward pressure on market rents.\nThese conditions have generally adversely impacted the Partnership's property economics. Rental and occupancy rates have generally improved over the past year at all remaining properties, however, they remain below where they were when the properties were acquired. The specific impact of these economic conditions on 1995\nand 1994 results are discussed in the section \"Results of Operations - 1995 Compared to 1994\", below.\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 to Limited Partners.\nIn certain instances and under limited circumstances, management of the Partnership entered into negotiations with lenders for the purpose of restructuring the terms of loans to provide for debt service levels that could be supported by operations of the properties. In such instances, the terms of the restructuring agreement generally provide 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 6 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 combined management and leasing fee (\"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 Partners opinion, comparable to fees that would be paid to independent third parties.\nResults of Operations - 1995 Compared to 1994 (Amounts Rounded in 000's)\nThe Partnership had net income of $136,000 in 1995 compared to a net loss of $803,000 in 1994. The $939,000 increase in net income resulted primarily from the net difference between the $3,178,000 gain recognized on the Annex foreclosure and the $2,702,000 provision for investment property impairment for the Annex.\nIn 1995 the Partnership recorded a provision for investment property impairment for the Annex in the amount of $2,702,000 compared to $883,000 in 1994. The Partnership's share of the provisions for investment property impairment recorded for the Annex were $1,459,000 and $477,000, respectively.\nThe Partnership's total income was $1,902,000 in 1995 compared to $2,261,000 in 1994, a decrease of $359,000. Rental income and other income decreased by $197,000 and $162,000, respectively. The decline in rental income and other income (primarily tenant expense reimbursements) was primarily the result of the foreclosure of the Annex on May 15, 1995. Rental income and other income declined at the Annex by $319,000 and $278,000, respectively, while the other properties showed an increase of rental income of $122,000 and tenant expense reimbursements of $116,000.\nTotal expenses (before provision for impairment) incurred in 1995 were $1,842,000 compared to $2,544,000 in the prior year, a decrease of $702,000. This decrease (before provision for impairment) of $702,000 consists primarily from a $212,000 decrease in mortgage and other interest, a $162,000 decrease in depreciation and a $320,000 decrease in real estate taxes at the Annex due to the foreclosure on May 15, 1995.\nA summary of the changes in income and expense items for the year ended December 31, 1995 compared to the year ended December 31, 1994, is detailed in the following schedule.\nYEAR ENDED DECEMBER 31, 1995 AS COMPARED TO YEAR ENDED DECEMBER 31, 1994\nIncrease (Decrease) Increase Increase in Costs (Decrease) (Decrease) and in Net in Income Expenses Income [000's Omitted] Income: Rental $(197) $ -- $ (197) Interest -- -- -- Other, primarily tenant expense reimbursements (162) -- (162) Total Income (359) -- (359)\nExpenses: Mortgages and other interest -- (217) 217 Depreciation -- (160) 160 Real estate taxes -- (315) 315 Other property operating -- (16) 16 Repairs and maintenance -- (85) 85 General and administrative -- 92 (92) Provision for investment property impairment -- 1,819 (1,819) Total Expenses -- 1,118 (1,118)\nLoss before affiliated joint venture participation, minority interests and extraordinary items (359) 1,118 (1,477) Equity interest in affiliated joint venture's net loss (4) -- (4) Minority interest's share of Sabal Palm's net income (43) -- (43) Minority interest's share of the Annex's net income (715) -- (715) Loss before extraordinary item (1,121) 1,118 (2,239) Extraordinary gain on extinguishment of debt 3,178 -- 3,178 Net Income $2,057 $1,118 $ 939\nResults of Operations - 1994 Compared to 1993 (Amounts Rounded in 000's)\nThe Partnership incurred a net loss of $803,000 in 1994 compared to a net loss of $1,601,000 in 1993. The $798,000 decrease in net loss resulted primarily from the decrease in the provisions for investment property impairment of $617,000. In 1994 the Partnership recorded a provision for investment property impairment for the Annex in the amount of $883,000 compared to $1,500,000 in 1993. The Partnership's share of the provisions for investment property impairment recorded for Annex were $477,000 and $810,000, respectively. In 1993, Strawberry Fields also recorded a provision for investment property impairment in the amount of $1,000,000, the Partnership's joint venture share of this provision is $420,000.\nThe Partnership's total income was $2,261,000 in 1994 compared to $2,535,000 in 1993, a decrease of $274,000. Rental income and other income decreased by $189,000 and $83,000, respectively. The decline in rental income and other income (primarily tenant expense reimbursements) was primarily the result of a decrease in occupancy at the Annex from 64% at December 31, 1993 to 56% at December 31, 1994. Rental income and other income declined at the Annex by $265,000 and $77,000, respectively. Partially offsetting the Annex's decline in rental income was an increase of $138,000 in percentage rental income from Sabal Palm Square.\nTotal expenses (before provision for impairment) incurred in 1994 were $2,544,000 compared to $2,879,000 in the prior year, a decrease of $335,000. This decrease (before provision for impairment) of $335,000 consists primarily from a $351,000 decrease in mortgage and other interest that was the result of the discontinuation of accruing interest on the Annex's debt effective July 1, 1994. Also contributing to the decrease in mortgage and other interest at the Annex was the receipt of defeasance payments ($55,000) from Stewart Title, which had the effect of reducing interest expense at the property. Partially offsetting the decline in mortgage and other interest expense was an increase in repairs and maintenance expense of $86,000. Repairs and maintenance increased in an effort to retain and attract new tenants at the Annex and Sabal Palm Square properties.\nA summary of the changes in income and expense items for the year ended December 31, 1994 compared to the year ended December 31, 1993, is detailed in the following schedule.\nYEAR ENDED DECEMBER 31, 1994 AS COMPARED TO YEAR ENDED DECEMBER 31, 1993\nIncrease (Decrease) (Increase) Increase in Costs Decrease (Decrease) and in Net in Income Expenses Loss [000's Omitted] Income: Rental $ (189) $ -- $(189) Interest (2) -- (2) Other, primarily tenant expense reimbursements (83) -- (83) Total Income (274) -- (274)\nExpenses: Mortgages and other interest -- (351) 351 Depreciation -- (25) 25 Real estate taxes -- (47) 47 Other property operating -- (61) 61 Repairs and maintenance -- 86 (86) General and administrative -- 63 (63) Provision for investment property impairment -- (617) 617 Total Expenses -- (952) 952\nLoss before affiliated joint venture participation and minority interests (274) (952) 678 Equity interest in affiliated joint venture's net loss 443 -- 443 Minority interest's share of Sabal Palm's net loss (13) -- (13) Minority interest's share of the Annex's net loss (310) -- (310) Net Loss $(154) $(952) $ 798\nItem 8.","section_7A":"","section_8":"Item 8.Consolidated Financial Statements and Supplementary Data.\nSee Index of Consolidated Financial Statements and Schedule on Page of this Form 10-K for consolidated financial statements and financial statement schedule, where applicable.\nThe financial information required 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.\nThere have been no changes in accountants or reported disagreement on any matter of accounting principals, practices or financial statement disclosure.\nPART III Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership.\nThe General Partners of the Partnership are: Brauvin Ventures, Inc., an Illinois corporation Mr. Jerome J. Brault, individually Mr. Cezar M. Froelich, individually\nBrauvin Ventures, Inc. was formed under the laws of the State of Illinois in 1983, with its issued and outstanding shares being owned by A.G.E. Realty Corporation, Inc. (50%), and Messrs. Jerome J. Brault (beneficially)(25%) and Cezar M. Froelich (25%).\nThe principal officers and directors of the Corporate General Partner are:\nMr. Jerome J. Brault . . . . . . . Chairman of the Board of Directors, Director and President\nMr. James L. Brault. . . . . . . . . . . .Vice President and Secretary\nMr. Robert J. Herleth. . . . . . . . . . . Vice President and Director\nMr. David W. Mesker. . . . . . . . . . . . . . . . . . . . . .Director\nMr. Thomas J. Coorsh . . . . . . . . . . . . . . . . . . Treasurer and Chief Financial Officer\nThe business experience during the past five years of the General Partners, officers and directors is 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 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 Services, Inc., Brauvin Realty Advisors, Inc., Brauvin Realty Advisors II, Inc., Brauvin Realty Advisors III, Inc., Brauvin Realty Advisors IV, Inc., Brauvin Net Lease V, Inc., and\nBrauvin Realty Advisors V, LLC, 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., Brauvin Net Lease V, Inc., and Brauvin Realty Advisors V, LLC 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 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.,\nBrauvin Realty Partners, Inc., Brauvin Ventures, Inc., and Brauvin 6, Inc. He joined A.G. Edwards & 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 Net Lease V, Inc., Brauvin Realty Advisors V, LLC, 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 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 other affiliates as described under the caption \"Compensation Table\" on pages 11 to 13 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-9 to A-13 of the Agreement attached as Exhibit A to the Partnership's Prospectus. The 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 Notes 3 of the Notes to Consolidated Financial Statements filed with this annual report for a description of such distributions and allocations.\nThe General Partners received a share of Partnership losses for 1995, 1994 and 1993.\nAn affiliate of the General Partners of the Partnership is reimbursed for its direct expenses relating to the administration of the Partnership.\nThe Partnership does not have any employees and therefore there is no compensation paid.\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 of the Partnership do not, individually or as a group, own any Units.\n(c) The Partnership is not aware of any arrangements, the operations of which may result in a change of control of the Partnership.\nNo officer or director of the Corporate General Partner possesses a right to acquire beneficial ownership of Units. The General Partners will share in the profits, losses and distributions of the Partnership as outlined in Item 11, \"Executive Compensation.\"\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 of the Partnership, as described in the section of the Partnership's Prospectus, as supplemented, entitled \"Compensation Table\" and \"Conflicts of Interest\" at pages 11 to 16 and the section of the Agreement entitled \"Rights, Duties and Obligations of General Partners\" at pages A-15 to A-18 of the Agreement. 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 principal of the law firm of Shefsky Froelich & Devine Ltd., which firm acts as securities and real estate counsel to the Partnership. Reference is made to Note 5 of the Notes to Consolidated Financial Statements filed with this annual report for a summary of transactions paid to affiliates.\nAs a precondition to the new financing at Crown Point, the lender required that ownership of the property reside in a single purpose entity (\"SPE\"). To accommodate the lender's requirements, ownership of the property was transferred to the SPE, Brauvin\/Crown Point L.P. which is owned 99% by the Partnership and 1% by an affiliate of the General Partners. Distributions of Brauvin\/Crown Point L.P. are subordinated to the Partnership which effectively\nprecludes any distributions from the SPE to affiliates of the General Partners. The creation of Brauvin\/Crown Point L.P. did not affect the Partnership's economic ownership of the Crown Point property. Furthermore, this change in ownership structure had no material effect on the financial statements of the Partnership.\n(c) No management persons are indebted to the Partnership.\n(d) There have been no transactions with promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K.\n(a) The following documents are filed as part of this report:\n(1) (2) Consolidated Financial Statements and Schedules. (See Index to Consolidated Financial Statements and Schedule filed with this annual report). (3) Exhibits required by the Securities and Exchange Commission Regulation S-K Item 601:\nExhibit No. Description *3.(a) Restated Limited Partnership Agreement *3.(b) Articles of Incorporation of Brauvin Ventures, Inc. *3.(c) By-Laws of Brauvin Ventures, Inc. *3.(d) Amendment to the Certificate of Limited Partnership of the Partnership *10.(a) Escrow Agreement *10.(b)(1) Management Agreement 27 Financial Data Schedule *28. Pages 11-16, A-9 to A-13 and A-15 to A-18 of the Partnership's Prospectus and the Agreement dated March 1, 1985, as supplemented.\n* Incorporated by reference from the exhibits filed with the Partnership's registration statement (File No. 2-95633) on Form S-11 filed under the Securities Act of 1933.\n(b) The Partnership filed the following report on Form 8-K during the fourth quarter of 1995:\n1. On December 28, 1995, the Partnership filed Form 8-K dated December 28, 1995, which reported as Item 5, the refinancing of the Crown Point Shopping Center's first mortgage.\n(c) See (a).(3). above for exhibits filed with this Form 10-K. An annual report for the fiscal year 1995 will be sent to the Limited Partners subsequent to this filing and the Partnership will furnish such reports to the Securities and Exchange Commission when it is sent at that time.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBRAUVIN REAL ESTATE FUND L.P. 5\nBY: Brauvin Ventures, Inc. Corporate General Partner\nBy: \/s\/ Jerome J. Brault Jerome J. Brault Chairman of the Board of Directors and President\nBy: \/s\/ James L. Brault James L. Brault Vice President and Secretary\nBy: \/s\/ Robert J. Herleth Robert J. Herleth Vice President and Director\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 Cezar M. Froelich\nDated: March 29,1996\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nPage\nReport of Independent Auditors . . . . . . . . . . . . . . . . .\nConsolidated Balance Sheets, December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-3\nConsolidated Statements of Operations, for the years ended December 31, 1995, 1994, and 1993. . . . . . . . . . . . .F-4\nConsolidated Statements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . .F-5\nConsolidated Statements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . .F-6\nNotes to Consolidated Financial Statements . . . . . . . . . . . .F-7\nSchedule III -- Real Estate and Accumulated Depreciation, December 31, 1995. . . . . . . . . . . . . . . . .\nAll other schedules provided for in Item 14(a)(2) of Form 10-K are either not required, or are inapplicable, and therefore have been omitted or equivalent information has been included herein.\nReport of Independent Auditors\nTo the Partners of Brauvin Real Estate Fund L.P. 5\nWe have audited the accompanying consolidated balance sheets of Brauvin Real Estate Fund L.P. 5 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. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Brauvin Real Estate Fund L.P. 5 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 general 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.\n\/s\/ ERNST & YOUNG LLP\nChicago, Illinois March 8, 1996\nCONSOLIDATED BALANCE SHEETS\nDecember 31, December 31, 1995 1994 ASSETS Cash and cash equivalents $ 142,320 $106,289 Due from affiliates -- 587 Tenant receivables (net of allowance of $18,686 in 1995 and $3,095 in 1994) 137,272 93,422 Escrow and other deposits 95,549 83,199 Other assets 109,266 12,539 Investment in affiliated joint venture 610,490 712,179 Deposit with title company -- 2,929,581 1,094,897 3,937,796 Investment in real estate, at cost: Land 2,411,849 3,716,151 Buildings 10,035,511 15,341,631 12,447,360 19,057,782 Less: accumulated depreciation (2,780,381) (4,103,727) Total investment in real estate, net 9,666,979 14,954,055 Total Assets $10,761,876 $18,891,851\nLIABILITIES AND PARTNERS' CAPITAL Liabilities Accounts payable and accrued expenses $ 79,381 $ 602,607 Due to affiliates 52,733 25,988 Security deposits 40,985 56,772 Note payable -- 2,929,581 Mortgages payable 6,388,064 11,427,743 Total Liabilities 6,561,163 15,042,691\nMinority interest in Sabal Palm 1,003,960 1,019,775 Minority interest (deficit) in the Annex -- (231,115)\nPartners' capital (deficit) General Partners (33,876) (35,239) Limited Partners (9,914.5 limited partnership units issued and outstanding) 3,230,629 3,095,739 Total Partners' Capital 3,196,753 3,060,500\nTotal Liabilities and Partners' Capital $10,761,876 $18,891,851\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 INCOME Rental $1,511,959 $1,708,963 $1,897,970 Interest 8,295 8,186 10,079 Other, primarily tenant expense reimbursements 381,942 543,922 626,695 Total income 1,902,196 2,261,071 2,534,744\nEXPENSES Mortgages and other interest 625,674 842,751 1,194,000 Depreciation 263,909 423,829 448,999 Real estate taxes 255,500 570,682 617,674 Repairs and maintenance 59,737 144,835 58,822 Other property operating 238,788 255,183 316,180 General and administrative 398,801 307,140 244,062 Provision for investment property impairment 2,702,083 882,709 1,500,000 Total expenses 4,544,492 3,427,129 4,379,737\nEquity interest in affiliated joint venture's net loss (101,689) (98,150) (541,505)\nLoss before minority interests and extraordinary item (2,743,985) (1,264,208) (2,386,498)\nMinority interest's share of Sabal Palm's net income (66,435) (22,991) (9,319)\nMinority interest's share of the Annex's net (income) loss (231,115) 484,056 794,263\nLoss before extraordinary item (3,041,535) (803,143) (1,601,554)\nExtraordinary gain on extinguishment of Annex debt 3,177,788 -- -- Net Income (Loss) $ 136,253 $ (803,143) $(1,601,554)\nNet Income (Loss) Allocated to the General Partners $ 1,363 $ (8,031) $ (16,016)\nNet Income (Loss) Allocated to the Limited Partners $ 134,890 $ (795,112) $(1,585,538)\nNet Income (Loss) Per Limited Partnership Interest Before Extraordinary Gain (9,914.5 Units) $ (303.71) $ (80.20) $ (159.92)\nNet Income (Loss) Per Limited Partnership Interest (9,914.5 Units) $ 13.61 $ (80.20) $ (159.92)\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL For the period January 1, 1993 to December 31, 1995\nGeneral Limited Partners Partners Total\nBALANCE at January 1, 1993 $(11,192) $5,476,389 $5,465,197\nNet loss (16,016) (1,585,538) (1,601,554)\nBALANCE at December 31, 1993 (27,208) 3,890,851 3,863,643\nNet loss (8,031) (795,112) (803,143)\nBALANCE at December 31, 1994 (35,239) 3,095,739 3,060,500\nNet income 1,363 134,890 136,253\nBALANCE at December 31, 1995 $(33,876) $3,230,629 $3,196,753\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\n(1) ORGANIZATION\nBrauvin Real Estate Fund L.P. 5 (the \"Partnership\") was organized on June 28, 1985. The Partnership Agreement provides for the General Partners of the Partnership to be Brauvin Ventures, Inc., Jerome J. Brault, and Cezar M. Froelich. Brauvin Ventures Inc. is owned by A.G.E. Realty Corporation (50%) and by Messrs. Brault (beneficially) (25%) and Froelich (25%). A. G. Edwards & Sons, Inc. and Brauvin Securities, Inc., affiliates of the General Partners, were the selling agents of the Partnership. The Partnership is managed by an affiliate of the General Partners.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Method\nThe accompanying consolidated financial statements have been prepared using the accrual method of accounting.\nIncome Taxes\nA partnership is not subject to the payment of Federal or State income taxes because components of its income and expenses flow through directly to the partners. For tax purposes, the net carrying value of the real estate for the Partnership is $7,232,552.\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 amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.\nConsolidation of Joint Venture Partnership\nThe Partnership owns 42% and 53% interests in joint ventures which acquired two shopping centers, Strawberry Fields (see Note 8) and Sabal Palm, respectively. The Partnership owned a 54% interest in the Annex, a shopping center, which was foreclosed upon on May\n15, 1995 (see Note 6). The accompanying financial statements have consolidated 100% of the assets and liabilities of Sabal Palm and the Annex and are reported as investments in real estate. The investment in Strawberry Fields has been recorded using the equity method and is reported as an investment in an affiliated joint venture. The minority interest of the consolidated joint ventures are recorded as minority interests and adjusted for the respective joint venture partner's share of income or loss and any cash contributions from or distributions to the joint venture partner, if any. All intercompany items and transactions have been eliminated.\nProperty\nThe Partnership's rental property is stated at cost including adjustments for acquisition costs, leasing commissions and tenant improvements. Depreciation and amortization are recorded on a straight-line basis over the estimated economic lives of the properties, which approximate 38 years, and applicable lease terms, respectively. All of the Partnership's properties are subject to liens under first mortgages.\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 Partnership's adoption of Statement No. 121 in the first quarter 1995 did not have a material effect on the financial statements.\nFair Value of Financial Instruments\nThe Partnership adopted SFAS No. 107 in 1995, which requires entities to disclose the fair value of financial assets and liabilities for which it is practicable to estimate. Fair value is defined in SFAS No. 107 as the amount at which the instrument could be exchanged in a current transactions between willing parties, other than a forced or liquidation sale. The financial\nassets and liabilities of the Partnership include cash and cash equivalents, due from affiliates, tenant receivables, investment in joint venture, accounts payable, due to affiliates and mortgages payable.\nAt December 31, 1995, the Partnership believes the carrying amount of its financial instruments, not including long-term debt or investment in joint venture, approximates the fair value due to relatively short maturity of these instruments. The mortgages payable is believed to have a fair value which approximates the carrying amount based upon current refinancing of Crown Point and interest rates offered for debt of similar instruments in the market for the remaining maturities. It was not practicable to estimate the fair value of the Partnership's investment in joint venture because of the lack of a quoted market price and the inability to estimate the fair value without incurring excessive costs. The Partnership believes the investment is not impaired. The Partnership has no other significant financial instruments.\nCash and Cash Equivalents\nThe Partnership considers all highly liquid investments with a maturity of 90 days or less when purchased to be a cash equivalent.\nReclassifications\nCertain amounts in the 1994 and 1993 financial statements have been reclassified to conform to the 1995 presentation. This has not affected the previously reported results of operations.\n(3) PARTNERSHIP AGREEMENT\nThe Partnership Agreement (the \"Agreement\") provides that 99% of the net profits and losses from operations of the Partnership for each fiscal year shall be allocated to the Limited Partners and 1% of net profits and losses from operations shall be allocated to the General Partners. The net profit of the Partnership from the sale or other disposition of a Partnership property shall be allocated as follows: first, there shall be allocated to the General Partners the greater of: (i) 1% of such net profits; or (ii) the amount distributable to the General Partners as Net Sale Proceeds from such sale or other disposition, as defined in the Partnership\nAgreement; and second, all remaining profits shall be allocated to the Limited Partners. The net loss of the Partnership from any sale or other disposition of a Partnership property shall be allocated as follows: 99% of such net loss shall be allocated to the Limited Partners and 1% of such net loss shall be allocated to the General Partners.\nThe 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 10% 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 years, then the Limited Partners shall be paid such excess Operating Cash Flow until they have 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 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. The Preferential Distribution Deficiency at December 31, 1995 equaled $7,855,758.\n(4) MORTGAGES PAYABLE\nMortgages payable at December 31, 1995 and 1994 consist of the following: Interest Date 1995 1994 Rate Due Crown Point Shopping Center (a) $3,275,000 $ 3,248,296 7.55% 1\/03 Sabal Palm Square Shopping Center (b) 3,113,064 3,138,864 9.50% 2\/97 The Annex of Schaumburg Shopping Center (c) -- 5,040,583 10.00% $6,388,064 $11,427,743\n(a) On November 22, 1994, the lender to Crown Point, NationsBank of Tennessee, (the \"Lender\") exercised the right to call all amounts due as of March 1, 1995. On March 1, 1995, a Forbearance Agreement was executed between the Partnership and the Lender where the Lender agreed to forbear from pursuing remedies with respect to defaults through and including September 1, 1995 (the \"First Forbearance Period\"). During the First Forbearance Period the terms and conditions of the mortgage remained unchanged. Effective September 1, 1995, the Lender agreed to further forebear from pursuing remedies with respect to defaults through and including December 1, 1995 (the \"Second Forbearance Period\"). During the Second Forbearance Period the terms and conditions of the mortgage also remained unchanged. Subsequent to December 1, 1995, the Lender verbally agreed to forebear from pursuing remedies with respect to defaults through December 31, 1995 in light of the ongoing refinancing negotiations with NationsBanc Mortgage Corporation, a Texas corporation with principal offices in Charlotte, North Carolina (the \"Successor Lender\"). On December 28, 1995, the loan balance was paid in full when the Crown Point property was refinanced with NationsBanc Mortgage Capital Corporation. The refinancing resulted in a $3,275,000 non-recourse loan with a fixed interest rate of 7.55% and a maturity of January 1, 2003.\nAs a precondition to the new financing, the Successor Lender required that ownership of the property reside in a single purpose entity (\"SPE\"). To accommodate the lender's requirements,\nownership of the property was transferred to the SPE, Brauvin\/Crown Point L.P. which is owned 99% by the Partnership and 1% by an affiliate of the General Partners. Distributions of Brauvin\/Crown Point L.P. are subordinated to the Partnership which effectively precludes any distributions from the SPE to affiliates of the General Partners. The creation of Brauvin\/Crown Point L.P. did not affect the Partnership's economic ownership of the Crown Point property. Furthermore, this change in ownership structure had no material effect on the financial statements of the Partnership.\nThe carrying value of Crown Point at December 31, 1995 was approximately $4,552,000.\n(b) The Partnership and its joint venture partner are required to make a balloon mortgage payment for Sabal Palm in the amount of $3,082,216 on February 1, 1997. It is the General Partners' intention to refinance this loan when it matures. There is no assurance that the General Partners will be successful in their refinancing efforts in which case the Partnership would sustain a loss on foreclosure. The financial statements do not reflect any adjustments that might result from the outcome of this uncertainty. The carrying value of Sabal Palm approximated $5,115,000 at December 31, 1995.\n(c) The Annex Joint Venture did not make its monthly mortgage payments of $45,630 that were due to AUSA Life Insurance Company, Inc. (\"AUSA\") on July 1, 1994, August 1, 1994, September 1, 1994 or October 1, 1994. In addition, the Annex Joint Venture did not repay the mortgage loan which matured November 1, 1994, at which time the entire amount of principal and accrued interest became due and payable. On August 11, 1994, the Annex Joint Venture received a notice of default from AUSA demanding the payments due July 1, 1994 and August 1, 1994. On August 23, 1994, the Annex Joint Venture filed a voluntary petition for bankruptcy (Chapter 11) in the United States Bankruptcy Court in the Northern District of Illinois. On February 10, 1995, the Bankruptcy Court ordered the dismissal of the voluntary petition for bankruptcy and also on February 10, 1995, AUSA filed a motion for appointment of a receiver against the Annex Joint Venture. On February 17, 1995, the motion was granted and an order was issued.\nOn February 15, 1995, the Annex Joint Venture received an amended notice of mortgage foreclosure from AUSA. The Annex Joint Venture did not file an answer to the amended foreclosure that was due March 17, 1995. On April 3, 1995, a judgement of foreclosure and sale was entered into against the Annex Joint Venture. A sheriff's sale of the Annex was held on May 10, 1995 and on May 15, 1995 title was transferred to AUSA in satisfaction of the Annex Joint Venture's obligation on the promissory note payable.\nThe Partnership paid interest on all of its mortgages of $652,831, $872,502 and $1,134,571 in 1995, 1994 and 1993, respectively. Each shopping center serves as collateral under its respective nonrecourse debt obligation.\nMaturities of the mortgages payable are as follows:\n1996 $ 95,094 1997 3,162,950 1998 84,364 1999 90,959 2000 98,068 Thereafter 2,856,629 $6,388,064\n(5) TRANSACTIONS WITH AFFILIATES\nThe General Partners and other affiliates provide various services to support operating activities of the Partnership. Expenses reflected in the accompanying statements of operations resulting from services provided by affiliates are detailed in the following table.\nFees and other expenses paid to the General Partners or its affiliates for the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 Management fees $94,180 $129,391 $154,200 Reimbursable office expenses 92,770 107,526 103,074 Legal fees 2,589 740 2,194\nThe Partnership believes the amounts paid to affiliates are representative of amounts which would have been paid to independent parties for similar services. The Partnership had made all payments to affiliates, except for $52,901 to Strawberry Fields and $2,728 for legal services, as of December 31, 1995.\n(6) INVESTMENT IN THE ANNEX\nOn December 31, 1986, the Partnership and Brauvin Income Properties L.P. 6 (\"BIP 6\") formed a joint venture (the \"Annex Joint Venture\") to purchase the Annex, a shopping center located in Schaumburg, Illinois, for approximately $8,358,000. The Partnership had a 54% interest in the Annex and BIP 6 had a 46% interest. The Partnership consolidated the Annex joint venture and recorded a minority interest balance to recognize the 46% interest of BIP 6. The purchase was funded with approximately $3,158,000 cash at closing and $5,200,000 from the proceeds of an interim loan.\nAt the date of acquisition, the Annex was encumbered with an existing first mortgage loan of approximately $4,356,600. The outstanding principal balance was due on February 1, 1994. As this loan was non-prepayable, the joint venture deposited approximately $4,356,600 with Stewart Title Company (the \"Title Company\") and paid a fee of approximately $293,000 to the Title Company in 1986 to service this loan.\nOn January 31, 1994, the Annex Joint Venture entered into a Reliance Agreement (the \"Agreement\") with the Title Company and agreed to, on behalf of the Title Company, by the lender, John Hancock Mutual Life Insurance Company (i) make a $1,000,000 paydown on the loan;(ii) pay the Lender an administrative fee of 1.5% of the loan balance, after the $1,000,000 paydown; and (iii) issue title insurance as required. As a condition to the Annex Joint Venture's agreement with the Title Company, the Title Company agreed to pay the Annex Joint Venture $5,000 per month commencing February 1, 1994 through January 31, 1995 and $6,000 per month thereafter. The Title Company also agreed to equally share with the Annex Joint Venture the 2.5% interest savings after the 1.5% administrative fee was paid, which the Annex Joint Venture was expected to receive upon maturity of the Agreement. In February\n1994, the Title Company paid the Lender the $1,000,000 paydown, as required in the Agreement. In 1995 and 1994, the Annex received $5,000 and $55,000, respectively, from the Title Company, which was recorded as a reduction of interest expense on the property. The remaining amounts due from the Title Company were offset against amounts owed to the Title Company. The Partnership will not receive any additional payments under the Agreement.\nOn May 15, 1995, title to the Annex, was transferred to AUSA through a sheriff's sale. As a result of reversion of the property to the lender, the Annex Joint Venture recorded a $2,702,083 provision for investment property impairment to reduce the Annex property to its estimated fair value. In addition, the Partnership recorded an extraordinary gain on the extinguishment of debt in the amount of $3,177,788, including the net reversals of approximately $632,000 of accrued expenses.\nThe Annex Joint Venture ceased operations on May 15, 1995, paid final administrative expenses, and had no other available cash to provide final distributions. The Annex Joint Venture partnership agreement provides for the dissolution of the Annex Joint Venture upon mutual agreement of the Partnership and BIP 6. Accordingly, the Partnership and BIP 6 have agreed to dissolve and will formally terminate the Annex Joint Venture in 1996.\n(7) OPERATING LEASES\nThe Partnership is the lessor in numerous operating lease agreements. The following is a schedule of future minimum rental payments due to the Partnership under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1995:\nYear ending December 31: 1996 $1,024,827 1997 850,749 1998 742,159 1999 605,158 2000 562,491 Thereafter 3,798,075 Total $7,583,459\nContingent rental income approximated $144,000, $117,000 and $124,000, in 1995, 1994 and 1993, respectively.\nCollection of future rental income under these lease agreements is subject to the financial stability of the underlying tenants. Minimum rentals received from Food City, the anchor tenant of Crown Point, approximated 24.8%, 14.2% and 14.5% of rental income for the years ended December 31, 1995, 1994 and 1993, respectively. Minimum rentals received from Winn Dixie and Walgreens, the anchor tenants of Sabal, approximated 13.7%, 9.2% and 8.0% of rental income and 7.7%, 5.0% and 4.4% of rental income for the years ended December 31, 1995, 1994 and 1993, respectively.\n(8) INVESTMENT IN AFFILIATED JOINT VENTURE\nThe Partnership owns a 42% interest in Strawberry Fields, located in West Palm Beach, Florida, and accounts for its investment under the equity method. The following are condensed financial statements for Strawberry Fields:\nBALANCE SHEETS: December 31, December 31, 1995 1994 Land, building and personal property, net $7,399,044 $7,598,408 Other assets 67,103 123,588 $7,466,147 $7,721,996\nMortgage payable $5,943,617 $5,955,617 Other liabilities 67,413 69,144 6,011,030 6,024,761 Partner's capital 1,455,117 1,697,234 $7,466,147 $7,721,996\nINCOME STATEMENTS: Years Ended December 31, 1995 1994 1993 Rental income $ 724,255 $ 730,772 $ 649,482 Other income 65,549 64,118 69,438 789,804 794,890 718,920\nMortgage and other interest 533,317 548,281 488,819 Depreciation 199,364 199,365 231,630 Operating and administrative expenses 299,240 280,934 287,769 Provision for investment property impairment -- -- 1,000,000 1,031,921 1,028,580 2,008,218\nNet loss $ (242,117) $ (233,690) $(1,289,298)","section_15":""}
{"filename":"763043_1995.txt","cik":"763043","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nBiocraft Laboratories, Inc. (the \"Company\") manufactures and markets various dosages of generic drugs. Generic drugs are the chemical and therapeutic equivalents of brand name drugs which generally have gained market acceptance while under patent protection. Although subject to strict Food and Drug Administration (\"FDA\") standards, generic drugs are sold under their chemical (generic) names, typically at prices substantially below those of their brand name equivalents.\nSales of generic drugs have increased significantly in recent years, due in part to greater awareness and acceptance of generic drugs by physicians, pharmacists and the public. Among the factors which have contributed to this increased awareness and acceptance are the modification of state laws to permit pharmacists to substitute generic drugs for brand name drugs (where authorized or not expressly prohibited by the prescribing physician), and the publication by the FDA of a list of therapeutic equivalent drugs which provides\nphysicians and pharmacists with the names of generic drug alternatives. In addition, since generic drugs are typically sold at prices significantly below the price of brand name drugs, the prescribing of generic drugs has been encouraged, and in many cases required, by various government agencies and by many private health programs as a cost-saving measure in the purchase of, or reimbursement for, prescription drugs.\nPRODUCTS AND PRODUCT DEVELOPMENT\nThe Company presently manufactures various dosages of 23 prescription drugs, and one prescription veterinary drug constituting an aggregate of 68 products. Governmental approvals were required and obtained for each of these products. The Company's products are sold in various oral dosage forms, including compressed tablets, two-piece hard-shell capsules, powders for oral solution or suspension and liquids. As of March 31, 1995, the Company was awaiting FDA approvals to market 14 generic drugs constituting 29 products. The Company intends to submit to the FDA applications to approve five new generic drugs constituting a variety of products during fiscal 1996. See \"Government Regulation.\"\nThe 24 drugs manufactured by the Company can be divided into 11 categories. The number of products in each category is shown in parentheses.\n1. Penicillin and Semi-Synthetic Penicillin Drugs (19): These antibiotic drugs include Penicillin V Potassium and the semi-synthetic penicillin drugs Amoxicillin, Ampicillin, Cloxacillin, Dicloxacillin and Oxacillin.\n2. Cephalosporin Drugs (10): These antibiotic drugs are Cephradine and Cephalexin.\n3. Other Antibiotic Drugs (6): These drugs are Cinoxacin, Clindamycin, Minocycline HCl, Neomycin and Nystatin.\n4. Analgesic Drug (3): This drug is Ketoprofen.\n5. Anti-Infective Drugs (5): These drugs are Trimethoprim and a combination of Sulfamethoxazole and Trimethoprim.\n6. Anti-Depressant Drugs (8): These drugs are Amitriptyline Hydrochloride and Imipramine Hydrochloride.\n7. Bronchial Dilator Drugs (5): These drugs are Albuterol and Metaproterenol.\n8. Cardiovascular Drug (2): This drug is Disopyramide Phosphate.\n9. Gastrointestinal Drug (3): This drug is Metoclopramide.\n10. Anti-Spasmodic Drug (2): This drug is Baclofen.\n11. Veterinary Drug (5): The drug in this category is Amoxicillin, an antibiotic sold under the registered trademark \"Biomox.\"\nIn July 1994 the Company entered into an agreement with FDA resolving outstanding regulatory issues with respect to dosage form facilities. Based on\nthe agreement, the Company suspended shipments of powder for Oral Suspension of Amoxicillin and Nystatin Oral Suspension. Previously, on its own initiative, the Company had stopped manufacturing the Oral Suspension of Ampicillin and Amiloride HCl Hydrochlorothiazide Tablets. The agreement requires expert certifications to be submitted to and approved by FDA prior to resumption of shipments. The Company resumed shipment of the Oral Suspension of Amoxicillin in September 1994 and FDA is currently reviewing expert certifications for Nystatin. See Legal Proceedings.\nThe Company manufactures the active ingredients it uses in its semi-synthetic penicillin drugs at its Waldwick, New Jersey facility and bulk form Cephalexin at its Mexico, Missouri facility. In March 1994, the Company received FDA approval to manufacture bulk form Amoxicillin and Ampicillin in its plant in Missouri. Such active ingredients are from time to time sold in bulk form, generally in small amounts. Chemical intermediates also manufactured in the Company's Mexico, Missouri facility are used in the Company's production of certain antibiotics and are also periodically sold to third parties.\nThe Company entered into a three-year supply agreement with Eli Lilly and Company, effective January 1, 1995. The agreement calls for Biocraft to supply Eli Lilly and Company with a product manufactured at Biocraft's Missouri facility. Biocraft expects this arrangement will result in Biocraft doubling its\nproduction of that product. The contract also calls for Lilly to supply Biocraft with substantial quantities of a raw material at a fixed exchange ratio.\nThe Company's research and development generally consists of activities related to new generic drug product development, clinical studies for generic and non-generic drugs and research for developing new bulk manufacturing processes. In the fiscal years ended March 31, 1993, 1994 and 1995, total research and development expenditures were approximately $8,662,000, $9,923,000 and $11,110,000, respectively.\nThe Company's primary product development strategies are to manufacture and sell in generic form antibiotic drugs for which the Company can maintain certain cost controls by manufacturing the chemical intermediates and\/or active ingredients in bulk. Generally, the Company also selects non-antibiotic drugs for which the Company anticipates initially limited competition due to such factors as extensive FDA approval requirements, complexity of manufacture or limited availability of raw materials. In all cases, the Company seeks to obtain FDA approval to market a new generic drug product by, or shortly after, the patent expiration date of the equivalent brand name drug in order to be among the first generic drug companies to offer a generic equivalent at a substantially lower price. Since the development of a generic drug product,\nincluding its formulation, testing and FDA approval, generally takes approximately three to four years, development activities for a product may begin several years in advance of the patent expiration date of the brand name drug equivalent. Consequently, the Company is presently selecting drugs it expects to market several years in the future.\nThe Company is developing certain drugs which the FDA has determined require clinical studies in order to obtain approval of a generic equivalent. Completion of these clinical studies involves larger numbers of subjects and longer periods of time and results in greater expenditures than do bioequivalency studies which are required for most generic drugs. The Company is currently awaiting FDA approval of one such drug, Sucralfate, an ulcer medication.\nThe Company is considering developing, manufacturing and selling drugs which require New Drug Applications. The process of obtaining FDA approval of these types of drugs typically requires greater expenditures by the Company than approval of most generic drugs and often takes many years to complete. To market these drugs, it will be necessary to familiarize physicians, pharmacists and the public with the effects of such drugs. Since the Company has no experience in this type of marketing, no assurance can be given that the Company will have the ability itself, or that it will be able to make arrangements with others, to market these drugs in such manner.\nMARKETING AND CUSTOMERS\nThe Company sells its products primarily through 16 salaried employees. Sales of drugs in dosage forms are made primarily to distributors, drug wholesalers, drugstore chains, mass merchandisers, other drug manufacturers, health care institutions and government agencies. More than half of the Company's gross sales of drugs in dosage form is made under its own label and the balance is made under customers' labels; however, in all cases the Company is named on the label as the manufacturer.\nThe Company sells dosage form products to approximately 300 customers. No single customer accounted for more than 10% of total net sales in fiscal 1993, 1994 or 1995.\nIn fiscal 1993, 1994 and 1995, sales of cephalosporins constituted approximately 24%, 27% and 30%, respectively, of total gross sales. For the fiscal years ended March 31, 1993, 1994 and 1995, penicillin and semi-synthetic penicillin drugs accounted for approximately 33%, 36% and 36%, respectively, of total gross sales.\nA key element of the Company's marketing strategy is to attempt to maintain sufficient inventories of products in order to meet the Company's goal of filling customer orders within a one to four week period. This strategy requires\na substantial amount of working capital to maintain inventories at a level sufficient to meet anticipated demand.\nCOMPETITION\nThe Company competes in varying degrees with numerous foreign and domestic companies in the health care industry, including other manufacturers of generic drugs (among which are several major pharmaceutical companies) and manufacturers of brand name drugs. Many of the Company's competitors have greater financial and other resources and are, therefore, able to expend more effort than the Company in areas such as marketing and product development.\nThe principal competitive factors in the generic pharmaceutical market are the ability to introduce generic versions of brand name drugs promptly after patent expiration, price, quality and customer service.\nRAW MATERIALS\nThe principal raw materials of the Company's business are active ingredients for non-penicillin drugs and bulk pharmaceutical chemicals. The bulk pharmaceutical chemicals are used to manufacture bulk form antibiotics. Both types of raw materials are generally available from multiple sources.\nBecause the FDA requires specification of raw material suppliers in applications for approval of drug products, if raw materials from a specified supplier were to become unavailable, the required FDA approval of a new supplier could cause a delay in the manufacture of the drug involved.\nEMPLOYEES\nAs of April 1, 1995, the Company had approximately 800 full-time employees. Approximately 150 administrative and professional personnel are engaged, at least part of their time, in product development of bulk and finished dosage form products, including market research, product selection and formulation, process development, and in seeking FDA approvals of new products. Approximately 280 employees are represented by a local collective bargaining unit whose agreement with the Company expires on June 1, 1997, with annual wage reopeners. Management believes that its relations with employees are satisfactory.\nGOVERNMENT REGULATION\nAll pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally by the FDA, and to a lesser extent by state and local governments. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, approval,\npricing, advertising and promotion of the Company's products. Noncompliance with applicable requirements can result in fines, recall and seizure of product, total or partial suspension of production, delays in receiving approval of new drug applications, refusal to enter into government supply contracts and criminal prosecution. The FDA also has the authority to revoke approvals of drugs.\nFDA approval is required before each dosage form of any new drug can be marketed. All applications for FDA approval must contain information relating to bioequivalency, product formulation, stability, manufacturing processes, packaging, labeling and quality control. Validation of manufacturing processes is also generally required before a Company may market new products. There are generally two types of applications currently used to obtain FDA approval of a new drug.\n1. New Drug Application (\"NDA\"). Generally, with respect to drugs with active ingredients not previously approved by the FDA, a prospective manufacturer must conduct and submit to the FDA complete clinical studies to prove that drug's safety and efficacy. An NDA may also be submitted for a drug with a previously approved active ingredient if the abbreviated procedure discussed below is not available.\n2. Abbreviated New Drug Application (\"ANDA\"). Under the ANDA procedure, which applies to most previously approved drugs, the FDA waives the requirement of conducting complete clinical studies of safety and efficacy and instead requires data illustrating that the generic drug formulation is bioequivalent to a previously approved drug. \"Bioequivalence\" indicates that the rate of absorption and the levels of concentration of a generic drug in the body needed to produce a therapeutic effect are substantially equivalent to those of the previously approved drug. In certain cases, however, the FDA may require clinical studies in order to show generic equivalence to a previously approved drug.\nAlthough antibiotic and veterinary drugs are classified separately for purposes of FDA approval, the procedure for such drugs conforms substantially to the NDA\/ANDA procedures.\nNone of the products currently marketed by the Company, other than veterinary drugs, have required a full NDA or the equivalent application.\nUnder the Federal Drug Price Competition and Patent Restoration Act of 1984 (the \"Drug Price Act\"), the effective date of approval of most generic drugs will ordinarily be delayed until the expiration of patents covering the product or until a court has determined the patent to be invalid or not infringed. If a manufacturer files an ANDA certifying that it believes a patent is invalid or not infringed and successfully defends itself in patent litigation, it may receive exclusive marketing rights for the generic version of the product for a period of 180 days. These provisions do not apply to antibiotics.\nThe Drug Price Act also created new statutory protections for brand name drugs. Under certain circumstances the term of a product or use patent can be extended for up to five years or provide an exclusivity period of two to ten years.\nThe Generic Drug Enforcement Act of 1992 was enacted in May 1992 as a result of findings of corruption in the FDA's process of approving generic drugs. The law establishes procedures to bar individuals who have been convicted of certain crimes from working for companies that manufacture or distribute such products and delays the review and approval of ANDAs submitted by or with the assistance of debarred individuals. The law also provides, under certain circumstances, for debarment of corporations and \"high managerial agents\" as defined in the Act, withdrawal of approvals of ANDAs and civil penalties for both individuals and corporations. The Company does not expect the law to have a material impact on the review or approval of the Company's ANDAs.\nAmong the requirements for new drug approvals is the requirement that the prospective manufacturer's methods conform to the FDA's current good manufacturing practices standards (\"cGMP Regulations\"). The cGMP Regulations must be followed at all times during which the approved drug is manufactured. In seeking to comply with the standards set forth in these regulations, the Company must continue to expend time, money and effort in the areas of production and quality control in order to achieve compliance. Failure to so comply risks possible FDA action such as the suspension of manufacturing, withdrawal of ANDAs or the seizure of drug products. See Legal Proceedings.\nIn November 1990, Congress passed, as part of the Omnibus Budget Reconciliation Act of 1990, The Medicaid Prudent Purchasing Act (the \"Medicaid Rebate Act\"). The Medicaid Rebate Act, with respect to generic pharmaceuticals, requires all manufacturers whose products are covered by the Medicaid Program, to rebate to each state a percentage (currently 11% in the case of products sold by the Company) of the manufacturer's average net sales price, for all products dispensed by pharmacists pursuant to Medicaid. Additional rules, which apply with respect to non-generic pharmaceuticals, are not currently applicable to the Company. In addition, several states, including New Jersey, New York, California, Pennsylvania, Washington and Connecticut, have enacted supplemental rebates and\/or similar legislation with respect to programs other than Medicaid.\nThe Company also is governed by federal, state and local laws of general applicability, such as laws regulating working conditions. In addition, the Company is subject, as are manufacturers generally, to various federal, state and local environmental protection laws and regulations, including those governing the discharge of materials into the environment. Compliance with such environmental provisions is not expected to have a material effect on the earnings, cash requirements or competitive position of the Company in the foreseeable future. See \"Legal Proceedings\" with respect to certain pending environmental matters.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices and production, laboratory and warehouse facilities of the Company occupy an aggregate of approximately 347,000 square feet in seven facilities. The Company's principal executive offices, its 49,000 square foot warehouse and distribution center are located in Fair Lawn, New Jersey.\nPenicillin and semi-synthetic penicillin dosage form production operations and a quality control laboratory are located in the Company's plant of\napproximately 37,000 square feet in Elmwood Park, New Jersey, approximately 4 miles from the executive offices. The Company's plant in Paterson, New Jersey, one mile from the Elmwood Park facility, is approximately 48,000 square feet and is used for the manufacture of dosage form products other than penicillins and cephalosporins. Dosage form cephalosporin drug products are produced at the Company's 56,000 square foot facility located in Fairfield, New Jersey, approximately 15 miles from the executive offices. It also contains a quality control laboratory.\nThe Company manufactures the active ingredients used in its semi-synthetic penicillin drugs at its plant of approximately 15,000 square feet in Waldwick, New Jersey, approximately 5 miles from the executive offices. The Waldwick plant also houses the Company's laboratories for microbiology, quality control for bulk form penicillin manufacturing and research and development for bulk form antibiotics. Raw materials and finished inventory for the Waldwick plant are stored in a warehouse of approximately 17,000 square feet which is adjacent to the Waldwick plant.\nThe Company's facility in Mexico, Missouri manufactures pharmaceutical intermediates and bulk antibiotics. The plant is approximately 125,000 square feet and contains manufacturing, laboratory, office and warehouse facilities. In addition, the complex includes a solvent recovery facility and a waste disposal plant.\nAll of the above property is owned by the Company. Management believes that the Company's facilities are suitable for its requirements. These facilities have additional capacity for expansion of production of existing and new products. The Company owns substantially all of its manufacturing equipment and believes that such equipment is well maintained and suitable for its requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn February 1986, Hoffmann-LaRoche, Inc. (Roche) obtained a declaratory judgment that the Company was not entitled to withhold royalties under a license for the right to manufacture and sell a patented drug, which patent expired in June 1988. In February 1994 this matter was settled by the Company and the case was dismissed. The Company paid Hoffmann-LaRoche, Inc. $250,000.\nIn September 1980, the Company entered into an administrative consent order with the New Jersey Department of Environmental Protection (DEP) pursuant to which the Company agreed to among other things, monitor and take certain action to remediate contamination of the groundwater beneath the Company's Waldwick, New Jersey plant by use of microbiological decontamination wells which were installed in fiscal 1981. This order has been modified to include action to be taken to monitor and, if necessary remediate, possible contamination of the\ngroundwater below the property adjacent to the Waldwick facility. The Company does not expect the continued cost of this remediation to be material.\nOn June 8, 1989, the United States Environmental Protection Agency (EPA) notified the Company that it was a potentially responsible party (PRP) along with other generators of industrial waste, the site owners and operators, and transporters of wastes to the site, for the alleged release of hazardous substances from a waste management site in Elkton, Maryland, known as the \"Spectron Site.\" The Company has participated with other PRPs in investigating and remediating the site under a Consent Order entered into with EPA in August 1989. As of March 31, 1995, the Company has paid to the PRP group approximately $224,000, all of which was paid in previous years, for its share of clean-up costs, based on volumetric allocation of waste shipments to the Spectron Site. On March 19, 1990, EPA sent another letter to the Company notifying it of potential liability for planned additional remedial work at the Spectron Site. This additional remedial work arises from alleged releases of hazardous substances at the Spectron Site during the period of 1968 to 1982, known as the Galaxy Period. The Company has decided to join with other PRPs in the negotiation of a Consent Order with EPA for the additional remedial work related to the Galaxy Period.\nThe Company is also one of more than 400 defendants in an action entitled \"Transtech Industries, Inc. et al v. A & Z Septic Clean, et al\" pending in the federal district court for New Jersey, regarding hazardous waste allegedly shipped to the Kin-Buc Landfill in New Jersey; has been notified by the North\nCarolina Department of Environment, Health and Natural Resources that it believes that the Company was one of approximately 1,500 entities that caused hazardous material to be shipped to a waste treatment facility previously operated by the Seaboard Chemical Corporation at Jamestown, North Carolina; and is one of more than 900 entities notified that it has shipped hazardous waste to a site in Caldwell County, North Carolina.\nBetween November 23 and November 29, 1993, five separate actions were commenced in the United States District Court for the District of New Jersey against the Company and Harold Snyder, Beatrice Snyder, Beryl L. Snyder, Brian S. Snyder and Jay T. Snyder, all of whom are officers and directors of the Company, and Steven J. Sklar, who is an officer of the Company, purporting to allege securities fraud and common law claims on behalf of purchasers of the Company's stock. Thereafter, pursuant to an Order of the Court, the five actions were consolidated under the caption In re Biocraft Laboratories, Inc. Securities Litigation, and a Consolidated and Amended Class Action Complaint (the \"Complaint\") was served on March 8, 1994. The Complaint purports to allege securities fraud claims under Sections 10 (b) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. ss.ss. 78(b) and 78t, and SEC Rule 10b-5, 17 C.F.R. ss.240.10b-5, as well as claims for common law fraud and negligent misrepresentation, based on alleged misrepresentations and omissions in the Company's publicly filed statements and press releases regarding the Company's compliance with the FDA concerning the Company's manufacture of its products. Plaintiffs seek compensatory and punitive damages in an unspecified amount, as\nwell as attorneys' fees and other costs of the lawsuit. In May 1994, the Company moved to dismiss the Complaint on the grounds that, among other things, it fails to state a claim upon which relief can be granted. In March 1995 the Court denied defendants' motion to dismiss.\nThe Company has not received any new drug approvals since June 1993. As previously reported, in July 1994 the Company entered into an agreement with FDA to resolve outstanding regulatory issues with respect to its dosage form facilities. The agreement requires the Company, among other things, to obtain and submit to FDA expert certifications of procedures used in the manufacturing and testing of products. The Company believes it has provided FDA with the submissions, including expert certifications required under the agreement through June 19, 1995. The Company understands that FDA has not yet completed its review of all of these submissions. Although the Company cannot predict whether FDA will ultimately find these submissions acceptable, the Company has been working closely with FDA to resolve any outstanding issues. In May 1995 FDA completed an inspection of the Company's dosage form facilities. A satisfactory inspection is necessary to obtain new product approvals. Based on the inspection, expert certifications and actions by the Company during the past year, the Company believes that it has all of the systems and procedures in place to obtain new drug approvals. Although FDA employees communicated their observations that substantial improvements in systems and procedures were\nachieved, no assurance can be given at this time that FDA will find the results of the inspection satisfactory.\nIn May 1995 an action was brought against the Company, two other generic manufacturers and a bulk pharmaceutical supplier by Eli Lilly and Company (\"Lilly\") in the U.S. District Court for the Southern District of Indiana for infringement of two patents related to Cefaclor, an antibiotic. The case relates to two process patents which expire on July 3, 1996. Lilly has filed for a preliminary injunction against all four defendants. Although the Company has filed an application for approval of this product with FDA, approval has not yet been received.\nSee also Note 11 of \"Notes to Consolidated Financial Statements\".\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE COMPANY\nName Position Age ---- -------- --- Harold Snyder Chairman, Chief Executive Officer 73 and President\nBeatrice Snyder Senior Vice President and 71 Secretary\nHarmon Aronson Vice President - 52 Quality Management\nMelvin Kaufman Vice President - Operations 56\nGerald Moskowitz Vice President - Sales 65\nSteven J. Sklar Vice President, Treasurer and 38 Chief Financial Officer\nBrian S. Snyder Vice President and Controller 36\nJay T. Snyder Vice President - 36 Research and Product Development\nBeryl L. Snyder Vice President, Assistant 38 Secretary and General Counsel\nJoy Bloodsaw Associate Vice President - 50 Purchasing\nHarvey Richards Associate Vice President - 62 Regulatory Affairs\nMcKee Moore Associate Vice President - Sales 42\nGeorge Svokos Associate Vice President - 37 Missouri Operations\nHAROLD SNYDER has been President of the Company since 1964 and in 1985 was elected Chairman and Chief Executive Officer. Prior to founding the Company in 1964, Mr. Snyder held various managerial and technical positions in the pharmaceutical industry.\nBEATRICE SNYDER has been Secretary of the Company since 1964, and was elected to the office of Senior Vice President in 1985.\nHARMON ARONSON has been Manager of the Company's non-penicillin production since 1979. He was Vice President - Non-Penicillin Dosage Operations since 1985. In 1994 he was elected the Company's Vice President - Quality Management.\nMELVIN KAUFMAN was Chief Operations Manager of the Company from July 1983 to January 1985 and was subsequently elected the Company's Vice President -\nAntibiotic Operations. In 1994 he was elected Vice President - Operations. From 1980 to July 1983 he served as Director of Bulk Manufacturing of Wyeth Laboratories, Inc., a manufacturer of pharmaceuticals and a subsidiary of American Home Products Corp.\nGERALD MOSKOWITZ has been Sales Manager of the Company since 1965 and in 1985 was elected the Company's Vice President - Sales.\nSTEVEN J. SKLAR has been Chief Financial Officer since July, 1990. He was elected the Company's Vice President and Treasurer in December 1989. Prior to joining the Company he was a partner at Botein Hays & Sklar, and through that firm, rendered professional services to the Company from 1984 through 1989. From 1985 to 1987 he was a full-time member of the faculty of New York University School of Law and he continues to teach there periodically.\nBRIAN S. SNYDER was elected the Company's Vice President and Controller in May 1990. He has been the Company's Controller since 1983. From 1977 to 1983 he held various sales and production positions with the Company.\nJAY T. SNYDER was elected the Company's Vice President - Research and Product Development in May 1990. He has been Director of Product Development since 1988. From 1982 to 1988 he was plant manager of the Company's penicillin\ndosage form facility and from 1977 to 1982 held various production positions with the Company.\nBERYL L. SNYDER was elected the Company's Assistant Secretary in August, 1993. She has been Vice President since May 1990 and General Counsel to the Company since 1984.\nJOY BLOODSAW has been with the Company since 1982 and has been Director of Purchasing since 1985. On August 19, 1992 she was elected the Company's Associate Vice President - Purchasing.\nHARVEY RICHARDS has been responsible for Regulatory Affairs at the Company since 1968 and on April 15, 1993 was elected the Company's Associate Vice President - Regulatory Affairs.\nMCKEE MOORE was elected Associate Vice President - Sales in April, 1994. He had been employed with the Company as Chief Sales Representative since 1991. Prior to this time, he was employed by Geneva Generics.\nGEORGE SVOKOS was elected the Company's Associate Vice President - Missouri Operations in January 1995. He has been with the Company since 1980. He was Assistant Plant Manager at the Waldwick, New Jersey bulk production plant. He was Project Manager and subsequently Plant Manager at the Mexico, Missouri bulk production facility.\nHarold Snyder and Beatrice Snyder are husband and wife. Beryl L. Snyder, Brian S. Snyder and Jay T. Snyder are the children of Harold and Beatrice Snyder.\nOfficers of the Company are elected by the directors for a term of one year and hold office until their respective successors are elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol \"BCL\". Set forth, for the periods indicated, are the high and low sale prices for the Common Stock on the New York Stock Exchange.\n1994 FISCAL YEAR HIGH LOW First Quarter............................... $26.50 $15.75 Second Quarter.............................. 35.00 26.13 Third Quarter............................... 37.63 18.88 Fourth Quarter.............................. 21.75 14.75\n1995 FISCAL YEAR First Quarter............................... $18.13 $13.63 Second Quarter.............................. 17.13 11.75 Third Quarter............................... 19.25 14.88 Fourth Quarter.............................. 19.25 15.25\nThere were 889 holders of record of the Company's Common Stock on June 22, 1995.\nOn August 8, 1994 the Company declared its sixth consecutive annual cash dividend of $.10 per share on its Common Stock, which was paid on November 22, 1994. The Company's fifth annual cash dividend of $.10 per share on its Common Stock was paid on November 18, 1993. The payment of dividends is subject to the discretion of the Board of Directors and will be dependent upon many factors, including the Company's earnings, its capital needs and its general financial condition.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data of the Company for the five years ended March 31, 1995, 1994, 1993, 1992 and 1991. The selected financial data for, and as of the end of, each of the years in the five year period ended March 31, 1995 are derived from the audited financial statements of the Company. Selected financial data should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the audited financial statements as of March 31, 1995 and 1994 and for each of the years in the three year period ended March 31, 1995 and related 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\nRESULTS OF OPERATIONS\nThe following table sets forth the Company's unaudited quarterly operating results for the fiscal years ended March 31, 1994 and 1995.\n*Includes $30 (less than $.01 per share) cumulative effect of change in method of accounting for income taxes. Net earnings for the quarter before the cumulative effect of this accounting change were $1,913 ($.14 per share).\nThe following table sets forth as a percentage of net sales certain items appearing in the Company's consolidated statements of operations as well as the percentage change in the dollar amount of these items as compared to the prior period.\nPeriod to Period Percentage of Sales Increase (Decrease) ------------------- ------------------- Years Ended March 31, 1994 1995 -------------------------- vs. vs. 1993 1994 1995 1993 1994 ---- ---- ---- ---- ---- Net sales .................. 100.0% 100.0% 100.0% 26.5% (1.6)% Other operating income ..... 11.5 0.1 0.1 (98.4) (50.7) Interest, dividend and other income ............. 0.4 0.4 0.3 8.2 (10.0) ----- ----- ----- Total revenue .............. 111.9 100.5 100.4 13.6 (1.7) ----- ----- ----- Cost of sales .............. 78.8 76.6 82.2 23.0 5.5 Research and development ... 7.7 6.9 7.9 14.6 2.0 Selling, general and administrative ........... 13.0 7.9 0.3 (22.7) 27.8 Interest expense ........... 4.4 3.2 3.0 (9.0) (8.5) ----- ----- ----- Total costs and expenses ... 103.9 94.6 103.4 15.3 7.4 ----- ----- ----- Earnings (loss) before income taxes (benefit) and cumulative effect of accounting change ........ 8.0 5.9 (3.0) (7.6) NM\nIncome taxes (benefit) ..... 2.8 1.6 (1.2) (28.0) NM ----- ----- ----- Net earnings (loss) before cumulative effect of accounting change ........ 5.2 4.3 (1.8) 3.7 NM\nCumulative effect of change in method of accounting for income taxes .................... -- 0.0 -- NM NM ----- ----- ----- Net earnings (loss) ....... 5.2 4.3 (1.8) 4.3 NM ===== ===== =====\nNET SALES\nNet sales declined by $2.4 million (1.6%) in the fiscal year ended March 31, 1995, after rising by $30 million (26%) in fiscal 1994. The fiscal 1995 decrease was attributable to reduced sales volume of Ketoprofen, introduced by the Company in December 1992, as well as a decrease in net selling prices of various products, including Ketoprofen. These decreases were partially offset by increased sales volume on several products, principally Cephalexin. The increase in fiscal 1994 resulted primarily from increased sales volume of Amoxicillin and Cephalexin products including Amoxicillin chewable tablets introduced by the Company in fiscal 1993. Increases of that magnitude are unlikely without further product approvals from the Food and Drug Administration (FDA). New drug approvals have been delayed pending resolution of issues under discussion with the FDA (see Note 11 of notes to consolidated financial statements).\nGROSS PROFIT\nGross profit margins were 18% in fiscal 1995, 23% in fiscal 1994 and 21% in fiscal 1993. The increase in fiscal 1994 resulted primarily from higher gross profit margins associated with the Company's newly introduced products. Although the Company initially obtains higher sales prices for new products, intensified competition typically forces the Company to lower its sales price and reduce its profit margin. As mentioned above, in fiscal 1995 sales of Ketoprofen, a relatively new product for the Company on which the Company continues to maintain a high profit margin, fell significantly resulting in a lower overall gross profit margin.\nAs announced in December, 1994, the Company signed a three-year supply agreement with Eli Lilly and Company. The agreement became effective January 1, 1995 and calls for the Company to supply Lilly with a product manufactured at its Missouri facility. The Company expects this arrangement to double its production of that product. The contract also calls for Lilly to supply the Company with substantial quantities of a raw material at a fixed exchange ratio. As a result of this contract, the Company anticipates improved gross profit margins in fiscal 1996.\nRESEARCH AND DEVELOPMENT EXPENSES\nResearch and development expenditures increased by approximately $1.2 million and $1.3 million in fiscal 1995 and 1994, respectively, compared to the\ncorresponding prior periods. The increases resulted primarily from increased activity and costs in connection with the development and approval process for new generic drugs, as well as increased costs associated with FDA regulatory requirements affecting new generic drugs.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses increased by approximately $3.1 million in fiscal 1995 after decreasing by approximately $3.3 million in fiscal 1994 compared to the corresponding prior period. The increase in fiscal 1995 was primarily attributable to costs incurred in connection with the resolution of regulatory matters with the FDA referred to above, as well as costs incurred in connection with exploring strategic options to enhance the value of the Company to its shareholders, including discussions regarding a possible sale of the Company. The decrease in fiscal 1994 was primarily due to decreased costs in connection with the manufacture of Cefixime (see \"Other Operating Income\").\nOTHER OPERATING INCOME\nOther operating income decreased by approximately $100,000 and $12.8 million in fiscal 1995 and 1994, respectively, compared to the corresponding prior periods. The decrease in fiscal 1994 was due to the expiration of the Company's agreement with American Cyanamid Company (Cyanamid) under an agreement\nwhich provided for the Company's exclusive manufacturing of Cefixime for Cyanamid at the Company's Fairfield facility. The agreement expired on January 31, 1993.\nNON-OPERATING INCOME AND INTEREST EXPENSE\nInterest, dividend and other non-operating income was approximately $500,000 in each of fiscal 1995, 1994 and 1993.\nInterest expense decreased by approximately $400,000 and $500,000 in fiscal 1995 and 1994, respectively, compared to the corresponding prior periods. The decrease in fiscal 1995 resulted primarily from the remarketing, in September 1994, of the Company's $30 million bond. The decrease in fiscal 1994 was due to reduced rates, during most of the fiscal year, on the Company's credit facilities, as well as reduced long-term debt.\nPROVISION FOR INCOME TAXES\nThe Company's effective tax rate\/benefit was 42% in fiscal 1995. The rate fell to 28% in fiscal 1994, from 36% in fiscal 1993. In fiscal 1995, the Company incurred a loss for income tax as well as financial accounting purposes and the Company's tax exempt income and tax credits therefore increased rather than decreased its income tax rate\/benefit. The lower tax rate in fiscal 1994 resulted primarily from increased research and development credits as a result of the retroactive reinstatement by Congress of this tax credit. In addition,\nadjustments relating to the conclusion of tax examinations for the fiscal years ended in 1987 through 1990 contributed to the lower rate. These items more than offset the increase in deferred tax liability as a result of the increase in the statutory tax rate to 35%. In April 1993, the Company adopted FASB Statement No. 109, \"Accounting for Income Taxes.\" The cumulative effect of the change in accounting method increased net earnings by $30,000 or less than $.01 per share for the 1994 fiscal year.\nNET EARNINGS (LOSS)\nFor the various reasons noted above, the Company incurred a net loss in fiscal 1995. The ratios of net earnings to net sales and net earnings to operating revenue, decreased from 5.2% and 4.6%, respectively, in fiscal 1993 to 4.3% (for both ratios) in fiscal 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash from operating activities was approximately $6.9 million in fiscal 1995. Funds were primarily used to finance $10 million of capital expenditures. In addition, the Company paid a $1.4 million dividend. As a result, cash and cash equivalents decreased by approximately $3.3 million during fiscal 1995. The\nCompany maintained $60 million of working capital and a current ratio of 3.7:1 as of March 31, 1995, compared to $63 million of working capital and a current ratio of 4.7:1 as of March 31, 1994. The Company's inventory fell by $1.7 million, and continues to include approximately $5 million of costs, principally raw materials, for which the Company is awaiting FDA approval. Such approvals have been delayed pending resolution of issues under discussion with FDA (see Note 11 of notes to consolidated financial statements). In the opinion of management, such inventory's fair market value equals or exceeds its cost.\nThe Company had total long-term obligations at March 31, 1995 of $56 million compared to $54 million at March 31, 1994, and its long-term obligations as a percentage of total capitalization increased to 37% at March 31, 1995 compared to 36% at March 31, 1994.\nMost of the Company's long-term obligations are comprised of its $30 million bond ($27.8 million outstanding as of March 31, 1995) issued in September 1989 in connection with the construction of its facility in Mexico, Missouri. The bonds, due September 1, 2004, were issued by the Missouri Economic Development, Export and Infrastructure Board and are secured by a Letter of Credit issued by the Bank of Tokyo, Ltd., New York Agency. The Letter of Credit\nagreement provides for a mortgage on the Mexico, Missouri facility. Principal amortization installments are in varying amounts, with an initial payment of $2.2 million made in fiscal 1995. The Company remarketed the bonds in September 1994 resulting in reduced interest expense in the second half of fiscal 1995.\nIn addition to the bonds, the Company has a $10 million revolving credit line ($9 million outstanding as of March 31, 1995) with NatWest Bank N.A. (NatWest), as well as a $2 million unsecured term loan and a $2 million mortgage. The Company also has a $10 million revolving credit line with Commerce Bank National Association (Commerce Bank) and had $7.75 million outstanding as of March 31, 1995.\nThe Company's other outstanding long-term obligations include (i) $363,000 in connection with 15-year New Jersey Economic Development Authority Revenue bonds (NJEDA bonds) issued in December 1983, used to finance the Company's Paterson, New Jersey plant and which is secured by a mortgage on that plant and the Company's Elmwood Park plant; (ii) a $210,000 term loan agreement with the Missouri Department of Economic Development (MODED) and the City of Mexico, payable in 40 equal quarterly installments of $10,000 beginning September 1, 1990; and (iii) $7.5 million ($6.6 million present value) due pursuant to a 1990 litigation settlement agreement. (See Note 5 of notes to consolidated financial statements.)\nThe credit facilities with NatWest and Commerce Bank, as well as the Letter of Credit Agreement with Bank of Tokyo and the NJEDA bonds require, among other matters, that the Company maintain certain financial covenants. The Company is in compliance with all required financial covenants.\nThe Company currently has no other significant long-term commitments and anticipates that it can satisfy its fiscal 1996 operating requirements and capital expenditure needs from its existing credit facilities as well as from internally generated funds.\nOTHER\nEffective April 1, 1994, the Company adopted FASB Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The change in accounting method increased stockholders' equity as of April 1, 1994 by approximately $87,000 (net of $53,000 of deferred income taxes) to reflect the net unrealized holding gains on securities classified as available-for-sale previously carried at the lower of amortized cost or market. In accordance with the Statement, prior period financial statements were not restated. During fiscal 1995, securities accounting for substantially all of the unrealized gain as of April 1, 1994 were sold and the gain was recognized.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements of the Company as of March 31, 1995 and 1994, and for each of the three years in the period ended March 31, 1995, related notes thereto and the financial statement schedule are included herein at pages to. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for selected quarterly financial data.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nItems 10, 11, 12 and 13 have been omitted because on or before July 29, 1995, Registrant will file with the Commission pursuant to Regulation 14A a definitive proxy statement. The information called for by these items is set forth in that proxy statement and is incorporated herein by reference.\nThe information called for by Item 10 with respect to executive officers of the Registrant appears following Item 4 under Part I of this Report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1 and 2 Financial statements and financial statement schedules - see index on page.\n3. Exhibits - see index on page I-1, I-2 and I-3.\n(b) 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.\nBIOCRAFT LABORATORIES, INC.\nDate: June 27, 1995 \/s\/Harold Snyder -------------------------- (Harold Snyder) Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Harold Snyder Director, Chairman of June 27, 1995 - ----------------------- the Board, President Harold Snyder and Chief Executive Officer (principal executive officer)\n\/s\/ Beatrice Snyder Senior Vice President, June 27, 1995 - ----------------------- Secretary and Director Beatrice Snyder\n\/s\/ Brian S. Snyder Vice President, June 27, 1995 - ----------------------- Controller and Director Brian S. Snyder\n\/s\/ Jay T. Snyder Vice President - Research June 27, 1995 - ----------------------- & Product Development Jay T. Snyder and Director\n\/s\/ Beryl L. Snyder Vice President, June 27, 1995 - ----------------------- General Counsel, Beryl L. Snyder Assistant Secretary and Director\n\/s\/ Steven J. Sklar Vice President, - ----------------------- Treasurer and Steven J. Sklar Chief Financial Officer June 27, 1995\n\/s\/ Gerard Klein Director June 27, 1995 - ----------------------- Gerard Klein\n\/s\/ James J. Rahal,Jr. Director June 27, 1995 - ----------------------- James J.Rahal,Jr.M.D.\n\/s\/ Madelon DeVoe Talley Director June 27, 1995 - ----------------------- Madelon DeVoe Talley\n\/s\/ G. Harold Welch Director June 22, 1995 - ----------------------- G. Harold Welch, Jr.\nBIOCRAFT LABORATORIES, INC.\nIndex to Financial Statements and Schedules\nPage Number ------ Auditors' Report .......................................................\nFinancial Statements:\nConsolidated Balance Sheets - March 31, 1995 and 1994 ............\nConsolidated Statements of Operations - Years ended March 31, 1995, 1994 and 1993 ..................................\nConsolidated Statements of Cash Flows - Years ended March 31, 1995, 1994 and 1993 ......................\nConsolidated Statements of Stockholders' Equity - Years ended March 31, 1995, 1994 and 1993 ......................\nNotes to Financial Statements .....................................\nFinancial Statement Schedules:\nII Valuation and Qualifying Accounts ............................\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nBIOCRAFT LABORATORIES, INC. INDEPENDENT AUDITORS' REPORT\nErnst & Young LLP\nThe Board of Directors and Stockholders Biocraft Laboratories, Inc.\nWe have audited the accompanying consolidated balance sheets of Biocraft Laboratories, Inc. as of March 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 March 31, 1995. Our audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Biocraft Laboratories, Inc. at 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. 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 financial statements, effective April 1, 1993, the Company changed its method of accounting for income taxes\nErnst & Young LLP Hackensack, New Jersey June 19, 1995\nBIOCRAFT LABORATORIES, INC. CONSOLIDATED BALANCE SHEETS March 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nBIOCRAFT LABORATORIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended March 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nBIOCRAFT LABORATORIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended March 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nBIOCRAFT LABORATORIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended March 31, 1995, 1994 and 1993 In thousands, except per share data\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1) Summary of Significant Accounting Policies\n(a) Principles of Consolidation\nThe consolidated financial statements include the accounts of Biocraft Laboratories, Inc. (the Company) and its wholly owned subsidiaries.\nThe equity method of accounting is used for investments in which the Company owns at least a 20% interest, including the Company's 25% interest in Delmarva Laboratories, Inc. (Delmarva). Delmarva is a distributor of veterinary pharmaceutical products, including products produced by the Company.\n(b) Inventories\nInventories are stated at the lower of cost (last-in, first-out (LIFO)) or market and include appropriate elements of material, labor and manufacturing overhead.\n(c) Depreciation and Amortization\nDepreciation and amortization of property and equipment are provided for under the straight-line method based on estimated useful lives as follows:\nBuildings and improvements 15 to 40 years Machinery and equipment 3 to 10 years\nExpenditures for major renewals and betterments to property and equipment are capitalized and expenditures for maintenance and repairs are charged to operations as incurred. When assets are retired or otherwise disposed of, their cost and related accumulated depreciation are eliminated from the accounts. Any resulting gain or loss is reflected in operations.\n(d) Income Taxes\nEffective April 1, 1993, the Company adopted FASB Statement No.109, \"Accounting for Income Taxes\" (Statement 109). Under Statement 109, 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 109, the Company elected not to restate the financial statements of any prior years. The cumulative effect of the change in accounting method increased net earnings by $30,000 or less than $.01 per share for the 1994 fiscal year.\n(e) Trade Receivables\nTrade receivables for the fiscal years ended March 31, 1995 and 1994 are shown net of an allowance for uncollectible accounts of $450,000 and $240,000, respectively.\n(f) Concentration of Credit Risk\nThe Company is engaged in the manufacture and sale of generic pharmaceutical products. The Company's manufacturing plants are located in New Jersey and Missouri. Its products are sold throughout the United States. The Company performs ongoing credit evaluation of its customers' financial condition and, generally, requires no collateral from its customers.\n(g) Earnings (Loss) Per Share\nEarnings (loss) per share is the Company's primary earnings (loss) per share using the treasury stock method based on the weighted average number of common shares as well as common share equivalents (stock options) to the extent dilutive, outstanding during each year. Fully-diluted earnings (loss) per share for each year are not presented because the amounts would not differ from the amounts of primary earnings (loss) per share.\n2) Cash Equivalents and Marketable Securities\nCash equivalents consist of those securities with maturities of three months or less when purchased. Interest and dividend income realized from the aggregate of all investments were approximately $500,000 during each of fiscal 1995, 1994 and 1993.\nEffective April 1, 1994 the Company adopted FASB Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The change in accounting method increased stockholders' equity as of April 1, 1994 by approximately $87,000 (net of $53,000 of deferred income taxes) to reflect the net unrealized holding gains on securities classified as available-for-sale previously carried at the lower of amortized cost or market. At March 31, 1994, investments were stated at lower of cost or market. In accordance with the Statement, prior period financial statements were not restated.\n3) Inventories\nInventories at March 31 consist of:\n1995 1994 --------- --------- (In thousands) Finished goods $ 7,461 $ 9,478 Work in process 19,219 19,498 Raw materials and supplies 17,731 18,821 --------- --------- 44,411 47,797 Excess of LIFO over FIFO 4,320 2,610 --------- --------- $ 48,731 $ 50,407 ========= =========\nAs noted above, at March 31, 1995 and 1994, the LIFO cost of inventories exceeded current cost by approximately $4.3 million and $2.6 million, respectively. Allocation of the LIFO reserve among the components of inventory is impractical. As of March 31, 1995 and 1994, inventories include approximately $5.0 million and $4.6 million, respectively, of inventory costs, principally raw materials, relating to products for which the Company is awaiting regulatory approval.\n4) Property and Equipment\nA summary of property and equipment, at cost, follows:\nMarch 31, -------- 1995 1994 ---------- ---------- (In thousands) Land $ 1,508 $ 1,508 Buildings and improvements 69,905 67,944 Machinery and equipment 59,576 51,937 Construction in progress 364 33 ---------- ---------- 131,353 121,422 Less accumulated depreciation 41,573 34,394 ---------- ---------- $ 89,780 $ 87,028 ========== ==========\n5) Long-term Obligations\nA summary of long-term obligations follows:\nMarch 31, -------- 1995 1994 ------- ------- (In thousands) NatWest mortgage due in 1997 $ 1,980 $ 2,700 Unsecured NatWest term loan and credit line 11,000 10,000 Unsecured Commerce Bank credit line 7,750 3,250 Bonds due in 2004 27,800 30,000 MODED loan due 2000 210 250 Mortgage due in 1999 363 459 Other 6,664 7,489 ------- ------- 55,767 54,148 Less current installments 4,967 5,566 ------- ------- $50,800 $48,582 ======= =======\nIn November 1992, the Company secured a $3.6 million five year term loan from NatWest Bank NA (NatWest), which is secured by a mortgage on the Company's Fair Lawn, NJ property and its warehouse in Waldwick, NJ. Principal on the\nmortgage is payable in 20 equal quarterly installments of $180,000 which commenced in February, 1993.\nIn March 1992, the Company secured a $10 million revolving credit line and a $5 million five year term loan from NatWest. Under the credit line, as amended and extended, NatWest agreed to advance up to $10 million through July 1996. Principal on the term loan is payable in 20 equal quarterly installments of $250,000 which began on May 15, 1992.\nInterest on the NatWest credit line as well as the term loans is based on market indices selected by the Company. As of March 31, 1995, the Company had outstanding $9 million under the credit line at a rate of 7.44%, the rate on the mortgage was 7.50%, and the rate on the term loan was 7.44%.\nThe Company also has a revolving credit line from Commerce Bank National Association (Commerce Bank). Under the credit line, as amended and extended, Commerce Bank agreed to advance up to $10 million through April 1996. Interest on the loan is based on market indices selected by the Company when it borrows under the credit line. As of March, 31, 1995, the Company had outstanding $7.75 million at an interest rate of 7.43% with respect to $6 million and 7.55% with respect to $1.75 million.\nBoth unused lines of credit are subject to a bank commitment fee in an amount equal to .25% per annum.\nIn September 1989, the Company completed a $30 million financing for its Mexico, Missouri facility. The project was funded primarily from the proceeds of bonds due in September 2004 issued by the Missouri Economic Development, Export and Infrastructure Board and secured by a Letter of Credit issued by the Bank of Tokyo, Ltd., New York Agency (Bank of Tokyo). The Letter of Credit agreement provides for a mortgage on the Mexico, Missouri facility. The bonds bear interest, at the Company's election, from time to time, at a variable or fixed rate. As of March 31, 1995, the interest rate was 6.4%. In addition, the Company pays an annual fee of approximately .80% per annum for the letter of credit and other fees to the underwriters and trustee. Principal amortization installments are in varying amounts which commenced in fiscal 1995.\nIn May 1990, the Company entered into a $400,000 term loan agreement with the Missouri Department of Economic Development (MODED) and the City of Mexico. This loan is payable in 40 equal quarterly installments of $10,000 beginning September 1, 1990. Such term loan bears simple interest equal to $20,000 in the aggregate over the term of the loan, payable in 10 equal installments. The loan is collateralized by certain machinery and equipment at the Company's Mexico, Missouri plant subject to the senior security interest in favor of the Bank of Tokyo.\nThe mortgage obligation due in 1999 relates to proceeds realized from New Jersey Economic Development Authority Revenue bonds (\"NJEDA bonds\") used to finance the Company's Paterson, New Jersey plant facility which was purchased from its principal officers\/stockholders. Such mortgage is payable in monthly principal installments of approximately $8,000 to January 1999, plus interest at a rate of 75% of Valley National Bank's prime rate (an interest rate of 6.75% at March 31, 1995). The mortgage obligation is secured by the Company's Elmwood Park and Paterson facilities.\nThe credit facilities with NatWest and Commerce Bank, as well as the Letter of Credit Agreement with Bank of Tokyo and the NJEDA bonds require, among other matters, that the Company meet certain financial covenants. The Company is in compliance with all such covenants.\nThe net book value of property and equipment pledged at March 31, 1995 under the aforementioned bond and mortgage obligations aggregated approximately $65 million.\nLong-term bond and bank principal payments of each revolving credit line, in each of the next five years ending March 31, 2000, are as follows: 1996-$3,467,000; 1997-$20,318,000; 1998-$2,623,000; 1999 - $2,113,000; and 2000 - - $2,240,000.\nThe Company believes that the fair value of its long-term bond and bank obligations approximates the carrying value included in the financial statements.\nOther long-term obligations are primarily the present value of the remaining payments due in connection with a litigation settlement reached in March 1990 concerning a patent on a particular form of Cefadroxil Monohydrate. Required annual payments are $1.5 million in fiscal 1996 and $3 million in both fiscal 1997 and 1998.\nInterest paid in the years ended March 31, 1995, 1994 and 1993 aggregated $3.6 million, $3.7 million and $4.1 million, respectively.\n6) Transactions with Related Parties\nCertain officers\/stockholders of the Company are also principal stockholders of Groundwater Decontamination Systems, Inc. (GDS). GDS has granted the Company a non-exclusive license to use certain of GDS's patented processes presently employed in the Company's decontamination efforts at its Waldwick plant. The license (terminable by the Company on 45 days' notice) provides for a royalty of $120,000 increasing annually by the percentage increase in the consumer price index during the preceding year.\nRoyalties paid to GDS and charged to operations for the years ended March 31, 1995, 1994 and 1993 amounted to $9,000, $12,000 and $9,000, respectively. The balance of royalties under this license have been waived by GDS for each of these years.\nCertain officers\/stockholders are the principal stockholders of HS Realty Company, Inc. (HS Realty), a company that owns property adjacent to the Company's Waldwick plant. The Company has agreed with HS Realty to extend to such property the groundwater decontamination work currently being done at the Waldwick plant. The agreement also provides that the Company will be entitled to recover its expenses of performing such work from the profits, if any, from the future sale or lease of the property.\nThe Company had a five-year employment agreement with its President, who is also a principal stockholder, which expired in March 1995. The agreement provided for annual compensation at the rate of $500,000 per annum during the first year of the term, increasing annually thereafter by the greater of 10% or the percentage increase in the consumer price index during the preceding year. The President waived any increase in compensation for each year of his employment agreement.\nThe Company owns a 25% interest in Delmarva, a distributor of veterinary pharmaceutical products (see Note 1). During fiscal 1995, 1994 and 1993, the Company recognized income (losses) of ($13,000), $39,000 and ($23,000), respectively, its proportionate share of Delmarva's net income or loss. The Company also had approximately $3.4 million, $4.5 million and $2.3 million of sales to Delmarva and earned exclusive distribution fees from Delmarva of approximately $132,000, $121,000 and $111,000 in fiscal 1995, 1994 and 1993, respectively. As of March 31, 1995 and 1994, accounts receivable from Delmarva totalled $483,000 and $662,000, respectively.\nA member of the Company's Board of Directors serves as President of B.V. Chemie Pharmacie Holland (C.P.H.). The Company purchased from or through such firm bulk pharmaceutical chemicals for approximately $7.3 million, $8.4 million and $10.6 million in the fiscal years ended March 31, 1995, 1994 and 1993, respectively.\n7) Income Taxes\nThe Company adopted Statement 109, \"Accounting for Income Taxes,\" as of April 1, 1993, which changes its method of accounting for income taxes from the deferred method (Accounting Principles Board Opinion No. 11-APB 11) to an asset and liability approach. Income taxes for fiscal 1993 are measured under APB 11.\nStatement 109 requires recognition of deferred tax liabilities and assets for the estimated future tax consequences attributable to temporary differences. Such temporary differences exist when the tax basis differs from the financial reporting amount of assets or liabilities. All tax liabilities and tax assets are measured using current tax law and applicable rates.\nStatement 109 further requires adjustment of tax balances to reflect enacted changes in tax law or rates in the period of enactment. Accordingly, fiscal 1994 results include increased tax expense resulting from the enactment of the Omnibus Budget Reconciliation Act of 1993 (the Tax Act) in August. The Tax Act increased the statutory corporate income tax rate one percent (to 35 percent) and made other changes including a retroactive reinstatement of the research and development credit.\nThe components of income tax expense (benefit) follow:\nYears ended March 31, --------------------- 1995 1994 1993 ------- ------- ------- (In thousands) Federal: Current $ (525) $ 1,498 $ 1,965 Deferred (948) 542 895 State (substantially all deferred) (262) 300 390 ------- ------- ------- $(1,735) $ 2,340 $ 3,250 ======= ======= =======\nThe computed \"expected\" tax expense (benefit) is based upon Federal statutory rates of 35% in fiscal 1995 and 1994 and 34% in fiscal 1993. Items that determine the effective rate of the provision for income taxes follow:\nYears ended March 31, --------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Computed federal expected tax expense (benefit) $(1,445) $ 2,945 $ 3,096 State taxes (benefit), net of federal income taxes (170) 200 258 Credit related to research activities (400) (639) (70) Charitable contribution expiration 200 -- -- Change in enacted tax rates 30 190 -- Tax settlement -- (293) -- Other, net 50 (63) (34) ------- ------- ------- $(1,735) $ 2,340 $ 3,250 ======= ======= ======= Effective Tax Rate 42% 28% 36% ======= ======= =======\nTemporary differences which give rise to the net deferred tax liability as of March 31, 1995 and 1994 are as follows:\n1995 1994 ---- ---- (In thousands) Deferred Tax Liabilities: Property and equipment $ 11,500 $ 10,300 Other 38 1,118 -------- -------- Total deferred tax liabilities 11,538 11,418 Deferred Tax Assets: AMT credit carryforward $ 3,863 $ 4,393 Research and development credit carryforward 1,340 295 Federal net operating loss carryforward 1,208 -- Charitable contribution deduction carryforward 231 406 State tax loss carryforwards, net of federal taxes 609 354 Inventory related adjustments 930 843 Other 385 945 -------- -------- Total deferred tax assets 8,566 7,236 -------- -------- Net deferred tax liabilities 2,972 4,182 Amounts included in other current assets 3,131 1,089 -------- -------- Deferred income taxes $ 6,103 $ 5,271 ======== ========\nThe alternative minimum tax (AMT) credit carryforwards do not expire; the research and development credit carryforwards expire in 2006 through 2010; the federal net operating loss expires in 2010; the charitable contribution deduction carryforwards expire in 1997 through 2000 and the state net operating loss carryforwards expire in 1999 through 2002. The principal sources of deferred taxes for the year ended March 31, 1993 were: litigation settlements (additional taxable income of $800,000); depreciation (lower taxable income of $7 million); a tax credit carryforward of $70,000 and an alternative minimum tax liability of $2 million. Income tax benefits related to employee and director stock plans credited directly to stockholders' equity totalled $105,000 and $63,000 in fiscal 1994 and 1993, respectively.\nIncome taxes paid in the years ended 1994 and 1993 aggregated approximately $4.4 million and $950,000, respectively. No taxes were paid in fiscal 1995 and a refundable carryback of approximately $500,000 was generated with respect to the fiscal 1995 results.\n8) Common Stock, Profit-sharing and Pension Plans\nIn January 1985, the Company adopted an incentive stock option plan (option plan) and a restricted stock purchase plan (purchase plan) pursuant to which 300,000 shares of common stock under each plan had been reserved for issuance to eligible employees. The exercise price of a stock option under the option plan could not be less than the fair market value of the common stock at the date of grant, unless designated as a non-qualified stock option by the Board of Directors; the purchase price under the purchase plan could not be less than 10% of the fair market value of the common stock at the date of grant.\nOption transactions during the fiscal years ended March 31, 1995, 1994 and 1993 are shown below:\n1995 1994 1993 -------- -------- -------- Outstanding at beginning of year 37,575 24,300 13,000 Granted 139,475 33,350 18,000 Exercised (2,025) (17,775) (5,300) Forfeited (2,175) (2,300) (1,400) -------- -------- -------- Outstanding at end of year 172,850 37,575 24,300 ======== ======== ======== Exercisable at end of year 60,975 9,200 2,900 ======== ======== ======== Average Exercise Price $ 8.96 $ 4.96 $ 4.57 ======== ======== ========\nDuring fiscal 1995, 1994 and 1993, options were granted at an exercise price of $10.00, $5.00 and $5.00 per share, respectively. Options were exercised in fiscal 1995, 1994 and 1993 at an average exercise price of $5.00, $4.50 and $4.26 per share, respectively. The options forfeited had an average per share exercise price of $10.00, $5.00 and $3.86 in fiscal 1995, 1994 and 1993, respectively.\nAmortization of deferred compensation related to such options charged to operations in the years ended March 31, 1995, 1994 and 1993 was $344,000, $325,000 and $137,000, respectively. At March 31, 1995, an aggregate of 143,000 shares of the Company's common stock was issued under the purchase plan, including approximately 32,000 shares issued during 1995, at a price of $5.00 per share. The Company subsequently repurchased 1,425 shares at an average cost of $4.58 per share in fiscal 1995. The difference between the fair market value\nand the purchase price of shares purchased under the purchase plan is charged to operations over the vesting periods. Amortization of such deferred compensation charged to operations in each of the years ended March 31, 1995 and 1994 was approximately $78,000.\nIn fiscal 1990, the Company adopted the Directors' Stock Option Plan (directors' plan) pursuant to which 150,000 shares of common stock have been reserved for issuance to directors of the Company who are not Company employees at an option price equal to the value of such shares on the date of grant. During fiscal 1994, a total of 8,000 options were exercised by directors at an exercise price of $15.50 per share. As of March 31, 1995, options to purchase 17,000 shares under the directors' plan were outstanding, of which options to purchase 15,000 shares were currently exercisable at option prices ranging from approximately $15 to $18 per share.\nThe Company has a qualified profit-sharing plan covering eligible non-union employees except certain employees hired in Missouri. The plan provides for an annual contribution as determined by the Company; such contribution is not to exceed the amount deductible as expense in accordance with the Internal Revenue Code. Profit-sharing plan contributions charged to operations for the years ended March 31, 1995, 1994 and 1993 amounted to approximately $1.4 million, $1.3 million and $1.1 million, respectively.\nIn October 1987, the Company adopted the Biocraft Money Purchase Pension Plan which provides for a mandatory employer contribution of 3% of annual compensation, excluding bonuses and overtime. Contributions to such plan charged to operations for the years ended March 31, 1995, 1994 and 1993 amounted to approximately $417,000, $384,000 and $316,000, respectively. At the same time, the Company also adopted the Employees' 401(k) Savings Plan which provides for voluntary employee salary deferrals. Employer matching of $.50 for each dollar contributed up to a maximum match of 2% of compensation is provided for those employees who do not participate in the profit-sharing plan. Matching contributions to the 401(k) Plan charged to operations amounted to $39,000, $34,000 and $20,000 in fiscal 1995, 1994 and 1993, respectively. Both plans are provided for non-union employees.\nPension contributions to a multi-employer plan in accordance with various union agreements were $334,000, $351,000 and $370,000 in 1995, 1994 and 1993, respectively.\n9) Litigation Settlement\nIn February 1986, Hoffmann-LaRoche, Inc. (Roche) obtained a declatory judgement that the Company was not entitled to withhold royalties under a license for the right to manufacture and sell a patented drug, which patent expired in June 1988. In February 1994 this matter was settled by the Company and the case was dismissed. The Company paid Roche $250,000.\nIn May 1992 the Company settled its litigation with Merck & Co., Inc. (Merck) regarding Merck's patent for Amiloride Hydrochloride with Hydrochlorothiazide, which patent was found invalid. The parties agreed to the dismissal of the Company's claim for damages and to release each other from all claims arising from the litigation and Merck paid the Company $1.3 million, which amount was included in the Company's other operating income in fiscal 1993. There was no admission of liability by Merck.\n10) Segment Information and Other Matters\nThe Company operates in one industry segment (generic pharmaceutical products). Although the Company's net sales included both finished dosage form products and bulk material, sales of bulk material constituted less than 2% of the Company's total sales for each of the fiscal years ended March 31, 1995, 1994 and 1993. No one customer accounted for 10% or more of net sales for the fiscal years ended in 1995, 1994 and 1993.\n11) Contingencies\nAt March 31, 1995, the Company was involved in certain litigation and other claims related to its operations.\nIn September 1980, the Company entered into an administrative consent order with the New Jersey Department of Environmental Protection (DEP) pursuant to which the Company agreed to among other things, monitor and take certain action to remediate contamination of the groundwater beneath the Company's Waldwick, New Jersey plant by use of microbiological decontamination wells which were installed in fiscal 1981. This order has been modified to include action to be taken to monitor and, if necessary, remediate possible contamination of the groundwater below the property adjacent to the Waldwick facility. The Company does not expect the continued cost of this remediation to be material.\nOn June 8, 1989, the United States Environmental Protection Agency (EPA) notified the company that it was a potentially responsible party (PRP) along with other generators of industrial waste, the site owners and operators, and transporters of wastes to the site, for the alleged releases of hazardous substances from a waste management site in Elkton, Maryland, known as the \"Spectron Site.\" The Company has participated with other PRPs in investigating and remediating the site under a Consent Order entered into with EPA in August 1989. As of March 31, 1995, the Company has paid approximately $224,000 to the PRP group, all of which was paid prior to fiscal 1995, for its share of clean-up costs, based on volumetric allocation of waste shipments to the Spectron Site. On March 19, 1990, EPA sent another letter to the Company notifying it of potential liability for planned additional remedial work at the Spectron Site. The additional remedial work arises from alleged releases of hazardous substances at the Spectron Site during the period of 1968 to 1982, known as the Galaxy Period. The Company has decided to join with other PRPs in the negotiation of a Consent Order with EPA for the additional remedial work related to the Galaxy Period.\nThe Company is one of over 400 defendants in an action entitled \"Transtech Industries, Inc. et al v. A & Z Septic Clean, et al\" pending in the federal district court for New Jersey, regarding hazardous waste allegedly shipped to the Kin-Buc Landfill in New Jersey; has been notified by the North Carolina Department of Environment, Health and Natural Resources that it believes that the Company was one of approximately 1,500 entities that caused hazardous material to be shipped to a waste treatment facility previously operated by the Seaboard Chemical Corporation at Jamestown, North Carolina; and is one of more than 900 entities notified that it has shipped hazardous waste to a site in Caldwell County, North Carolina. It is not possible to predict with any level of certainty the Company's potential exposure with respect to the aforementioned matters. However, considering the number of potentially responsible parties, many of which are substantial corporations, and the Company's small proportion of the total volume of waste sent to the sites in question, the Company believes\nthat its portion of such liability, if any (including any site clean-up costs), is not likely to be material to the Company.\nIn November 1993, a class action was commenced in the United States District Court for the District of New Jersey against the Company and certain officers of the Company. The action alleges misrepresentations and omissions in the Company's publicly filed statements and press releases regarding the Company's compliance with the FDA concerning the Company's manufacture of its products. Plaintiffs seek compensatory and punitive damages in an unspecified amount, as well as attorney's fees and other costs of the lawsuit.\nThe Company has not received any new drug approvals since June 1993. As previously reported, in July 1994 the Company entered into an agreement with FDA to resolve outstanding regulatory issues with respect to its dosage form facilities. The agreement requires the Company, among other things, to obtain and submit to FDA expert certifications of procedures used in the manufacturing and testing of products. The Company believes it has provided FDA with the submissions, including expert certifications required under the agreement through June 19, 1995. The Company understands that FDA has not yet completed its review of all of these submissions. Although the Company cannot predict whether FDA will ultimately find these submissions acceptable, the Company has been working closely with FDA to resolve any outstanding issues. In May 1995 FDA completed an inspection of the Company's dosage form facilities. A satisfactory inspection is necessary to obtain new product approvals. Based on the inspection, expert certifications and actions by the Company during the past year, the Company believes that it has all of the systems and procedures in place to obtain new drug approvals. Although FDA employees communicated their observations that substantial improvements in systems and procedures were achieved, no assurance can be given at this time that FDA will find the results of the inspection satisfactory.\nIn addition, the Company is also a party to other litigation incidental to its business. In management's opinion, after consulting legal counsel, it is unlikely that the ultimate resolution of such litigation and the matters discussed above will have a material adverse effect on the Company's consolidated financial position.\nSchedule II\nBIOCRAFT LABORATORIES, INC.\nValuation and Qualifying Accounts\nYears ended March 31, 1995, 1994 and 1993 (In thousands)\nBalance at Additions Balance at beginning charged to end Description of period operations Deductions of period - ----------- ---------- ---------- ---------- --------- Against trade receivables -\nYear ended March 31, 1995 Allowance for doubtful accounts $240 $ 231 $ 21 (A) $450 Allowance for cash discounts 390 2,180 2,100 470 ---- ------ ------ ---- $630 $2,411 $2,121 $920 ==== ====== ====== ====\nYear ended March 31, 1994 Allowance for doubtful accounts $230 $ 48 $ 38 (A) $240 Allowance for cash discounts 300 2,062 1,972 390 ---- ------ ------ ---- $530 $2,110 $2,010 $630 ==== ====== ====== ====\nYear ended March 31, 1993 Allowance for doubtful accounts $260 $ 44 $ 74 (A) $230 Allowance for cash discounts $170 $1,394 1,264 300 ---- ------ ------ ---- $430 $1,438 $1,338 $530 ==== ====== ====== ====\n- ---------- (A) Accounts written off.\nEXHIBIT INDEX\nNumber Page - ------ ----\n3.1 Certificate of Incorporation and Certificate of Amendment -- of Certificate of Incorporation filed as Exhibit 3.1 to Annual Report on Form 10-K for fiscal year ended March 31, 1987, which is incorporated herein by reference.\n3.2 By-Laws, as amended, filed as Exhibit 3.2 to Annual Report -- on Form 10-K for fiscal year ended March 31, 1987, which is incorporated herein by reference.\n4 Specimen Certificate of Common Stock filed as Exhibit 4 to -- Annual Report on Form 10-K for fiscal year ended March 31, 1985, which is incorporated herein by reference.\n10.1 Employees' Profit Sharing Plan filed as Exhibit 10.1 to -- Registration Statement No. 2-95660 on Form S-1, which is incorporated herein by reference.\n10.2 Biocraft Laboratories, Inc. Money Purchase Plan, filed as -- Exhibit 10.2 to Annual Report on Form 10-K for fiscal year ended March 31, 1988, which is incorporated herein by reference.\n10.3 Biocraft Laboratories, Inc. 401(K) Savings Plan, filed as -- Exhibit 10.3 to Annual Report on Form 10-K for fiscal year ended March 31, 1985, which is incorporated herein by reference.\n10.4 1985 Incentive Stock Option Plan, as amended, which is -- incorporated herein by reference.\n10.5 Restricted Stock Purchase Plan, as amended, which is -- incorporated herein by reference.\n10.6 $3,650,000 New Jersey Economic Development Authority Bond -- Financing Agreement dated December 16, 1983 filed as Exhibit 10.4 to Registration Statement No. 2-95660 on Form S-1, which is incorporated herein by reference.\n10.7 Mortgages and related Note dated December 16, 1983 from -- Harold and Beatrice Snyder to the New Jersey Economic Development Authority filed as Exhibit 10.5 to Registration Statement No. 2-95660 on Form S-1, which is incorporated herein by reference.\nI-1\nEXHIBIT INDEX (cont'd)\nNumber Page - ------ ----\n10.8 Amendment to Bond Agreement and related Consent and Waiver -- filed as Exhibit 10.6 to Registration Statement No. 33-5744 on Form S-1, which is incorporated herein by reference.\n10.9 Assumption Agreement dated April 30, 1985 between Biocraft -- Laboratories, Inc. and Harold Snyder and Beatrice Snyder filed as Exhibit 10.7 to Registration Statement No. 33-5744 on Form S-1, which is incorporated herein by reference.\n10.10 License Agreement dated January 31, 1985 between Biocraft -- Laboratories, Inc. and Groundwater Decontamination Systems, Inc. filed as Exhibit 10.9 to Registration Statement No. 2-95660 on Form S-1, which is incorporated herein by reference.\n10.11 Indenture of Trust and Loan Agreement among Missouri -- Economic Development, Export and Infrastructure Board, as Issuer, The Merchants Bank, as Trustee, and Biocraft Laboratories, Inc. as Borrower, filed as Exhibit 1 to Form 8K, dated September 28, 1989, which is incorporated herein by reference.\n10.12 Letter of Credit Agreement, dated as of September 1, 1989, -- by and between Biocraft Laboratories, Inc. and The Bank of Tokyo, Ltd., New York Agency, filed as Exhibit 2 to Form 8-K, dated September 28, 1989, which is incorporated herein by reference.\n10.13 Pledge and Security Agreement, dated as of September 1, -- 1989, between Biocraft Laboratories, Inc. and The Bank of Tokyo, Ltd., New York Agency, filed as Exhibit 3 to Form 8-K, dated September 28, 1989, which is incorporated herein by reference.\n10.14 Remarketing Agreement, dated as of September 1, 1989, by and -- between Biocraft Laboratories, Inc., the Borrower, and Prudential-Bache Securities, Inc., the Remarketing Agent, filed as Exhibit 4 to Form 8-K, dated September 28, 1989, which is incorporated herein by reference.\n10.15 Missouri Economic Development, Export and Infrastructure -- Board Bond Purchase Agreement, dated September 14, 1989, filed as Exhibit 5 to Form 8-K, dated September 28, 1989, which is incorporated herein by reference.\nI-2\nEXHIBIT INDEX (cont'd)\nNumber Page - ------ ----\n10.16 Deed of Trust, Security Agreement and Assignment of Leases, -- dated as of September 1, 1989, from Biocraft Laboratories, Inc., the Grantor, to Mark M. Budzinski, as trustee, and The Bank of Tokyo, Ltd., New York Agency, as beneficiary, filed as Exhibit 6 to Form 8-K, dated September 28, 1989, which is incorporated herein by reference.\n10.17 Employment Agreement dated March 26, 1990 between Biocraft -- Laboratories, Inc. and Harold Snyder, filed as Exhibit 10.21 to Form 10-K for the year ended March 31, 1990, which is incorporated herein by reference.\n10.18 Biocraft Laboratories, Inc. 1989 Directors' Stock Option -- Plan, filed as Exhibit 10.22 to Form 10-K for the year ended March 31, 1990, which is incorporated herein by reference.\n10.19 Revolving Credit and Term Loan Agreement, dated as of March -- 27, 1991 between Biocraft Laboratories, Inc. and Commerce Bank of Kansas City, N.A., filed as Exhibit 10.22 to Form 10-K for the year ended March 31, 1991, which is incorporated herein be reference.\n10.20 Loan Agreement, dated as of March 20, 1992, between Biocraft -- Laboratories, Inc. and National Westminster Bank NJ, which is incorporated herein by reference.\n10.21 Mortgage and Secured Term Loan Agreement, dated November 16, -- 1992, between Biocraft Laboratories, Inc. and National Westminster Bank NJ, which is incorporated herein by reference.\n10.22 Amended and Restated Revolving Credit and Term Loan -- Agreement, dated September 30, 1993, between Biocraft Laboratories, Inc. and Commerce Bank of St.Louis, National Association.\n23.1 Consent of Ernst & Young LLP I-4\n99.1 Form of Consent Decree of Permanent Injunction, dated as of -- July, 1994, filed as Exhibit 99.2 to Form 8-K, dated July 21, 1994, which is incorporated herein by reference.\nI-3","section_15":""}
{"filename":"85535_1995.txt","cik":"85535","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nGoldstripe Project - ------------------ Following cessation of the Company's operations at Goldstripe, and in connection with efforts to obtain funding for reclamation, on August 5, 1992, the U.S. Forest Service notified the Company that it had determined to initiate a response action at the Goldstripe site, under the Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\"), in order to assess the threat of a possible release of cyanide from a processed material residue pile. To date, the only action undertaken by the Forest Service in connection with the response action has been to establish four monitoring wells at the site, at an estimated cost of $27,000. Although not formally related to the response action notice, on October 5, 1992, the Company released $341,000 in cash security for a reclamation bond to fund reclamation to be performed at Goldstripe by the Forest Service. The Company believes, based on oral communications with the Forest Service, that approximately $250,000 of the $341,000 has been spent to date. The Company also believes, based on such communications, and the current status of reclamation at the site, that no\nadditional \"response action\" or other remediation is likely to be undertaken by the Forest Service under CERCLA or otherwise. See \"BUSINESS AND PROPERTIES - GOLDSTRIPE.\"\nIn August 1993, in May 1994, and again in May 1995, the Forest Service advised the Company that its reclamation activities were substantially completed (except for revegetation) and that the Forest Service believed that such activities should satisfy all outstanding permit requirements for reclamation, except for ongoing post-reclamation monitoring of water quality. However, it is possible that additional reclamation or water quality monitoring could be required, and that any such requirement could result in additional cost to the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the quarter ended June 30, 1995. Annual meeting results will be described in Item 4 to the Company's report filed on Form 10-Q, for the quarter ended December 31, 1995.\nPART II ------- Item 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Common Stock of the Company is traded in the over the counter market by the National Association of Securities Dealers under the symbol \"RGLD.\" The following table shows the high and low closing sales prices for the Common Stock for each quarter since June 30, 1993. Sales Prices ------------------ High Low Fiscal Year Closing Closing ------- ------- 1994: First Quarter (July, Aug., Sept. - 1993) $ 4 1\/2 $ 3 5\/8 Second Quarter (Oct., Nov., Dec. - 1993) $ 8 5\/8 $ 3 5\/8 Third Quarter (Jan., Feb., March - 1994) $ 9 1\/8 $ 7 5\/8 Fourth Quarter (April, May, June - 1994) $ 9 1\/8 $ 7 5\/8\nSales Prices ------------------ High Low ------- ------- 1995: First Quarter (July, Aug., Sept. - 1994) $ 9 1\/8 $ 7 1\/4 Second Quarter (Oct., Nov., Dec. - 1994) $ 8 1\/4 $ 7 1\/2 Third Quarter (Jan., Feb., March - 1995) $ 8 1\/4 $ 5 5\/8 Fourth Quarter (April, May, June - 1995) $ 8 1\/4 $ 6 1\/2\nAs of August 31, 1995 there were approximately 3,000 shareholders of record of the Company's common stock.\nDividends - --------- The Company has never paid any cash dividends on its Common Stock and does not have any current plans to pay such dividends.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nFor the Year Ended June 30, ---------------------------------------------- Selected Statement of 1995 1994 1993 1992 1991 ------ ------ ------ ------ ----- Operations Data (Amounts in thousands, except per share data) - --------------- --------------------------------------------- Bullion sales $ - $ - $ - $ - $ 213 Royalty income 470 153 150 - - Exploration expense 1,485 686 151 111 36 General and administrative expense 1,015 753 582 682 941 Net loss (2,025) (1,452) (618) (638) (8,940) Net income (loss) per share $ (.14) $ (.11) $ (.06) $ (.07) $ (1.00)\nAs of June 30, ---------------------------------------------- 1995 1994 1993 1992 1991 ------ ------ ------ ------ ------ Selected Balance Sheet Data (Amounts in thousands) - --------------------------- ---------------------------------------------- Total assets $ 10,273 $ 8,183 $ 2,727 $ 1,877 $2,609 Working capital (deficit) 8,723 6,884 1,229 (272) (236) Long-term obligations 117 131 193 453 406\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources - ------------------------------- On June 30, 1995, the Company had current assets of $8,941,000 compared to current liabilities of $218,000 for a current ratio of 41 to 1. This compares to current assets of $7,122,000 and current liabilities of $238,000, at June 30, 1994, resulting in a current ratio of 30 to 1. The Company's current assets include approximately $5,012,000 of marketable securities that consist of U.S. treasury securities with maturities of 15 months or less. The Company's initial cost of these marketable securities was $4,983,125.\nDuring fiscal 1995, liquidity needs were met from: (i) a private placement of the Company's common stock which raised net proceeds of $3.8 million, (ii) revenue from the commencement of production at the Crescent Pit, (iii) the Company's available cash resources and interest income of $369,961, (iv) cash payments of $175,000 received from advance royalties and property payments, and (v)\nearnings of $55,000 from financial and environmental consulting services. The Company's operating activities utilized approximately $2,300,000 of cash during the fiscal year ended June 30, 1995.\nThe only material commitments of the Company that cannot be terminated at the sole discretion of the Company are (i) the Union Pacific Agreement which requires approximately $200,000 to be spent on exploration during the period July 1, 1995 through December 31, 1995; (ii) employment agreements with four officers, calling for minimum payments of approximately $268,000 for through January 1996; and (iii) office lease payments of $549,535 through the lease period ending October 1999. The Union Pacific Agreement provides that the Company can extend the agreement for two additional terms of 24 and 12 months upon making additional exploration commitments of $600,000 and $1,000,000, respectively. (If the Company exercises its rights to extend, total exploration expenditures under the agreement are estimated to be $2,100,000 over the full 55-month term.)\nThe Company anticipates total expenditures for fiscal 1996 for general and administrative expenses to be approximately $1,000,000 and expenditures for exploration and property holding costs to be approximately $1,650,000 (including amounts spent under the Union Pacific Agreement). Exploration and holding cost expenditures include $700,000 for Long Valley, $280,000 for Buckhorn South, $200,000 for the Union Pacific project, and $400,000 for generative exploration. On a prospective basis, these amounts could increase or decrease significantly, based on exploration results and decisions about releasing or acquiring additional properties, among other factors.\nGold production commenced at the Crescent Pit in September 1994. Payback of Cortez's pre-production costs occurred in June 1995. During the first quarter of fiscal 1996, the Company will receive its full 20% net profits interest for the remainder of production at the Crescent Pit.\nThe Company will continue to explore its remaining properties and intends to acquire new projects, all with a view to enhancing the value of such properties prior to possible farm out to major mining company partners.\nIt is anticipated that the Company will receive proceeds of $2,867,000 from the exercise of outstanding warrants that otherwise would expire in fiscal 1996. The exercise prices on these warrants range from $2.00 to $5.75. In September 1995, the Company received $1,150,000 of this amount relating to 200,000 shares at an exercise price of $5.75.\nThe Company's current financial resources and sources of income should be adequate to cover the Company's general and\nadministrative costs for at least the next fiscal year. The Company is greatly encouraged by the development work currently being carried out at South Pipeline, and by the commencement of gold production at the Crescent Pit. These events could lead to sustained gold production over the next several years, with the consequence that the Company's long-term liquidity needs would be supported by cash flow from the South Pipeline Project. Meanwhile, if increased general and administrative costs arise from new business in the financial and environmental consulting sectors, additional revenues would also be expected.\nRESULTS OF OPERATIONS - --------------------- Fiscal Year Ended June 30, 1995 Compared with Fiscal Year Ended - --------------------------------------------------------------- June 30, 1994 - ------------- For the year ended June 30, 1995, the Company recorded a net loss of $2,025,000, or $.14 per share, as compared to a net loss of $1,452,000, or $.11 per share, for the year ended June 30, 1994. The net loss for the current period resulted mainly from exploration and ongoing administrative expense after receipt of $470,000 in royalty and other property payments.\nRoyalty income received from the Crescent Pit for the year included $183,000 in gold from the Company's net profits interest royalty, and $111,000 from the capped NSR royalty. During the current fiscal year, Cortez has also recouped $363,000 of the advance minimum royalties (\"AMR\") previously paid to the Company. At June 30, 1995, the current outstanding balance of minimum royalties to be recouped is $87,000.\nProduction at the Crescent Pit:\nCrescent Pit (100%) Tons Grade Recovery (000) oz\/tn Percent Ounces ----- ----- ------- ------- For the quarters ended:\n12\/31\/94 94.4 .124 78.4 9,105\n3\/31\/95 88.0 .156 84.4 11,591\n6\/30\/95 95.1 .240 86.3 19,727\nFor the year ended:\n6\/30\/95 277.5 .174 83.5 40,423\nRoyal Gold's Net Profits Interest Royalty at the Crescent Pit:\nNet Royal's AMR Net received Profit Net Profits Payback by Royal ------ ----------- ------- ------------ For the quarters ended:\n12\/31\/94 $582,270 $33,073 - $3,073\n3\/31\/95 $2,281,823 $121,165 - $121,165\n6\/30\/95 $5,693,916 $391,361 $362,527 $28,834(1)\nFor the year ended:\n6\/30\/95 $8,558,009 $545,599 $362,527(2) $183,072(1)\n(1) During the quarter ended June 30, 1995, Cortez received payback of its preproduction expenditures. The Company will receive its 20% full net profits interest for the remainder of the Crescent Pit production.\n(2) $87,473 of advance minimum royalties remain to be recouped by Cortez.\nCosts of operations increased over the prior year primarily due to the addition of an operations manager who is located at the Company's field office at the Cortez Gold Mines in Nevada, and increased engineering analysis of the resource identified at the South Pipeline Project.\nConsulting revenues and costs of consulting revenues increased over the prior year primarily from one consulting arrangement.\nGeneral and administrative expenses of $1,015,000, for the year ended June 30, 1995, increased from those of $753,000, for the year ended June 30, 1994, as a result of increased employee compensation. General and administrative expenses consist primarily of employee compensation and benefits, office lease expense, office equipment expenses, travel and communication costs.\nExploration costs increased from $686,000 in fiscal 1994 to $1,485,000 in fiscal 1995 due to increased drilling related expenditures at the Long Valley and Buckhorn South properties, expenditures related to the exploration on Union Pacific grounds, and increased compensation for employees allocated to exploration.\nAbandonments and impairments decreased to zero in fiscal 1995 versus $749,350 in fiscal 1994 because no capitalized properties were abandoned during the year.\nInterest and other income was $386,000 in fiscal 1995, up from $143,000 in fiscal 1994, due primarily to increased funds available for investing from private placements of common stock. At June 30, 1995, the Company had a gain of $76,000 in its U.S. Treasury securities portfolio due to the decrease in short term interest rates.\nDepreciation and amortization increased from $26,000 for fiscal 1994 to $102,000 for fiscal 1995, primarily due to the depletion associated with the Company's capped royalty at South Pipeline.\nFiscal Year Ended June 30, 1994 Compared with Fiscal Year Ended - --------------------------------------------------------------- June 30, 1993 - ------------- For the year ended June 30, 1994, the Company recorded a net loss of $1,452,000, or $.11 per share, as compared to a net loss of $618,000, or $.06 per share, for the year ended June 30, 1993. The net loss for the year ended June 30, 1994 resulted mainly from ongoing administrative expense after receipt of $155,000 in advance minimum royalty and other property payments. General and administrative costs of $753,000 for the fiscal year ended June 30, 1994.\nOther costs and expenses included $164,000 in lease maintenance and holding costs in 1994 relating to 12,520 acres, up from $17,000 in 1993. Exploration costs increased from $151,000 for the year ended June 30, 1993, to $686,000 for the year ended June 30, 1994, due to the Company's renewed emphasis on exploration projects.\nGeneral and administrative expenses of $753,000 for the year ended June 30, 1994, increased from those of $582,000 for the year ended June 30, 1993, as a result of increased staffing and increased compensation. General and administrative expenses consist primarily of employee compensation and benefits, office lease expense, office equipment expenses, travel and communication costs.\nInterest and other income was $143,000 in fiscal 1994, up from $34,000 in fiscal 1993, due primarily to increased funds available for investing from stock placements. In fiscal 1993, $48,000 was recognized for the gain on sale of investments in restricted common stock. At June 30, 1994, the Company had an unrealized loss of $47,000 in its U.S. Treasury securities portfolio.\nDepreciation and amortization declined from $37,000 for fiscal 1993 to $26,000 for fiscal 1994, due to assets which became fully depreciated during fiscal 1993, and because of assets that were sold during fiscal 1993, which did not have a full year of depreciation expense associated with them.\nDuring fiscal 1994 mining assets were written down by $749,350, primarily related to the abandonment of Goldstripe and other properties, versus none in fiscal 1993.\nDuring fiscal 1994 the Company recognized a deferred tax asset of $750,000 associated with the proven reserve at Crescent Pit versus none in fiscal 1992.\nImpact of Inflation - ------------------- The Company's operations have been subject to general inflationary pressures, which have not had a significant impact on its operating costs.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nROYAL GOLD, INC. AND SUBSIDIARIES\nPAGE\nREPORT OF INDEPENDENT AUDITORS 21\nFINANCIAL STATEMENTS\nConsolidated Balance Sheets 22 Consolidated Statements of Operations 24 Consolidated Statements of Stockholders' Equity 25 Consolidated Statements of Cash Flows 27 Notes to Consolidated Financial Statements 29\nREPORT OF INDEPENDENT AUDITORS ------------------------------\nTo the Board of Directors Royal Gold, Inc.\nWe have audited the accompanying consolidated balance sheets of Royal Gold, Inc. and Subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' 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.\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 Royal Gold, Inc. and Subsidiaries as of June 30, 1995 and 1994, and the consolidated 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.\n\/s\/ Williams, Richey & Co.\nDenver, Colorado August 28, 1995\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS as of June 30, 1995 and 1994\nASSETS\n1995 1994 -------- ------- Current Assets Cash and equivalents (including $2,234,000 and $905,000, respectively, subject to repurchase agreements) $ 3,424,094 $ 1,942,912 Marketable securities 5,011,570 4,897,626 Receivables Trade and other 171,994 113,666 Related party 35,690 77,038 Gold inventory 183,073 0 Prepaid expenses and other 89,907 65,849 Deferred income tax benefit 25,000 25,000 --------- --------- Total current assets 8,941,328 7,122,091\nProperty and equipment, at cost Mineral properties 554,588 279,588 Furniture, equipment and improvements 732,666 761,633 --------- --------- 1,287,254 1,041,221\nLess accumulated depreciation and depletion (703,061) (717,914) --------- --------- Net property and equipment 584,193 323,307\nOther Assets Restricted investments and other 22,767 12,767 Deferred income tax benefit 725,000 725,000 Total other assets 747,767 737,767 ---------- --------- Total Assets $10,273,288 $ 8,183,165 ========== =========\n(continued)\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued as of June 30, 1995 and 1994\nLIABILITIES AND STOCKHOLDERS' EQUITY\n1995 1994 ---------- ---------- Current Liabilities Accounts payable $ 145,050 $ 122,147 Current portion of note payable 27,866 55,733 Accrued liabilities Post retirement benefits 26,400 26,400 Other 19,161 33,866 ---------- --------- Total current liabilities 218,477 238,146\nNote payable, net of current portion 0 27,867 Post-retirement benefit liabilities 116,949 103,349 Commitments and contingencies (Notes 2, 6 & 7)\nStockholders' equity Common stock, $.01 par value, authorized 30,000,000 shares; issued 14,492,962 and 13,835,712 shares, respectively 144,930 138,357 Additional paid-in capital 44,314,602 40,176,895 Accumulated deficit (34,441,697) (32,416,476) ---------- --------- 10,017,835 7,898,776\nLess treasury stock, at cost (15,986 and 16,986 shares, respectively) (79,973) (84,973) --------- --------- Total stockholders' equity 9,937,862 7,813,803 ---------- --------- Total liabilities and stockholders' equity $10,273,288 $ 8,183,165 ========== =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended June 30, 1995, 1994 and 1993\n1995 1994 1993 -------- -------- -------- Royalty income $ 470,421 152,501 150,000 Consulting revenue 163,681 30,401 27,871\nCosts and expenses Costs of operations 217,109 78,351 65,797 Direct costs of consulting 108,216 19,175 23,749 General and administrative 1,014,761 752,989 582,262 Exploration, net 1,484,599 685,556 150,667 Abandonments and impairments 0 749,350 0 Lease maintenance and holding costs 189,921 163,613 16,665 Depreciation and depletion 102,398 25,518 37,132 --------- --------- -------- Total costs and expenses 3,117,004 2,474,552 876,272\nOperating loss (2,482,902) (2,291,650) (698,401)\nInterest and other income 386,035 142,819 34,080 Gain (loss)on marketable securities 75,721 (47,276) 47,565 Interest and other expense (4,075) (5,431) (1,190) ---------- ---------- -------- Income (loss) before income taxes (2,025,221) (2,201,538) (617,946)\nIncome tax benefit 0 750,000 0 ---------- --------- -------- Net income (loss) $(2,025,221)$(1,451,538) $ (617,946) ========== ========== ========\nNet loss per share $ (0.14) $ (0.11) $ (0.06)\nWeighted average shares outstanding 14,265,462 12,952,062 11,157,126\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY for the years ended June 30, 1995, 1994 and 1993\nAdditional Common Stock Paid-In Shares Amount Capital --------- ------- ---------- Balance, June 30, 1992 9,191,712 $91,917 $31,318,114\nIssuance of common stock for: Exercise of options 210,220 2,102 30,113 Exercise of warrants 1,766,000 17,660 115,715 Private placement 1,008,000 10,080 1,789,120\nNet loss for the year ended June 30, 1993 ---------- ------- ---------- Balance, June 30, 1993 12,175,932 121,759 33,253,062 ---------- ------- ---------- Issuance of common stock for: Exercise of options 133,780 1,338 302,728 Exercise of warrants 101,000 1,010 5,855 Private placement 1,425,000 14,250 6,610,750\nIssuance of treasury shares for lease bonus payment 4,500\nNet loss for the year ended June 30, 1994 ---------- ------- ---------- Balance, June 30, 1994 13,835,712 138,357 40,176,895 ---------- ------- ----------\nIssuance of common stock for: Exercise of options 139,750 1,398 314,977 Exercise of warrants 17,500 175 23,855 Private placement 500,000 5,000 3,795,000\nIssuance of treasury shares for lease bonus payment 3,875\nNet loss for the year ended June 30, 1995 ---------- ------- ---------- Balance, June 30, 1995 14,492,962 $144,930 $44,314,602 ========== ======= ==========\n(continued)\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY, Continued for the years ended June 30, 1995, 1994 and 1993\nTotal Stock- Accumulated Treasury Stock holders' Deficit Shares Amount Equity ---------- ------ ------- ------- Balance, June 30, 1992 ($30,346,992) 24,186 ($120,973) $ 942,066\nIssuance of common stock for: Exercise of options 32,215 Exercise of warrants 133,375 Private placement 1,799,200\nNet loss for the year ended June 30, 1993 (617,946) (617,946) ---------- ------ ------- --------- Balance, June 30, 1993 (30,964,938) 24,186 (120,973) 2,288,910 ---------- ------ ------- --------- Issuance of common stock for: Exercise of options 304,066 Exercise of warrants 6,865 Private placement (6,000) 30,000 6,655,000\nIssuance of treasury shares for lease bonus payment (1,200) 6,000 10,500\nNet loss for the year ended June 30, 1994 (1,451,538) (1,451,538) ---------- ------ ------ --------- Balance, June 30, 1994 (32,416,476) 16,986 (84,973) 7,813,803 ---------- ------ ------ --------- Issuance of common stock for: Exercise of options 316,375 Exercise of warrants 24,030 Private placement 3,800,000\nIssuance of treasury shares for lease bonus payment (1,000) 5,000 8,875\nNet loss for the year ended June 30, 1995 (2,025,221) (2,025,221) ---------- ------ ------ --------- Balance, June 30, 1995 ($34,441,697) 15,986 ($79,973) $9,937,862 ========== ====== ====== =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended June 30, 1995, 1994 and 1993\n1995 1994 1993 --------- --------- --------- Cash flows from operating activities Net income (loss) ($2,025,221)($1,451,538) ($617,946) --------- --------- ------- Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and depletion 102,398 25,518 37,132 Unrealized (gain) loss on marketable securities (75,721) 47,276 (47,565) Abandonments and impairments 0 749,350 0 Increase in deferred tax assets 0 (750,000) 0 Issuance of common stock for services 0 30,000 0 Non cash exploration expense 8,875 10,500 0 (Increase) decrease in: Trade and other receivables (16,980) (170,128) 15,372 Marketable securities (38,224) (4,927,547) 0 Gold inventory (183,073) 0 0 Prepaid expenses and other (24,058) 12,083 (18,373) Restricted investments (10,000) 0 341,145 Deposits and other 0 0 (3,948) Increase (decrease) in: Accounts payable and accrued liabilities 8,198 69,004 (180,022) Deferred reclamation liability 0 0 (337,101) Post retirement and other long-term liabilities (42,134) (6,248) 20,152 -------- --------- ------- Total adjustments (270,719) (4,927,547) (173,208) Net cash provided by (used in) operating activities (2,295,940) (6,361,730) (791,154) --------- --------- -------\n(continued)\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS CASH FLOWS, Continued for the years ended June 30, 1995, 1994 and 1993\n1995 1994 1993 -------- ------- --------- Cash flows from investing activities Proceeds from disposition of: Property and equipment 0 0 97,224 Mineral properties 0 2,499 0 Capital expenditures for property and equipment (363,283) (35,361) (5,734) (Increase) decrease in other assets 0 0 (3,539) Net cash provided by (used in) ------- ------ ------ investing activities (363,283) (32,862) 87,951 ------- ------ ------ Cash flows from financing activities Proceeds from issuance of common stock 4,140,405 6,935,931 1,964,790 Net cash provided by --------- --------- --------- financing activities 4,140,405 6,935,931 1,964,790 --------- --------- --------- Net increase (decrease) in cash and equivalents 1,481,182 523,984 1,261,587 --------- -------- --------- Cash and equivalents at beginning of year 1,942,912 1,418,928 157,341 --------- --------- --------- Cash and equivalents at end of year $3,424,094 $1,942,912 $1,418,928 ========= ========= =========\nSupplemental disclosure of cash flow information: Interest paid in fiscal 1995, 1994 and 1993 was $10,685, $0, and $1,190, respectively.\nSupplemental disclosure of non-cash activities:\nIn 1994, 6,000 shares of treasury stock valued at $30,000 were used as partial payment for commission on a stock placement.\nIn 1993, the Company tendered its note, in the principal amount of $83,650, to a former officer and director. This note reduced the current portion of post retirement benefits by a like amount. (See Note 4.)\nThe accompanying notes are an integral part of these consolidated financial statements.\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Operations and Summary of Significant Accounting Policies --------------------------------------------------------- Operations:\nRoyal Gold, Inc. (the \"Company\" or \"Royal\"), was incorporated under the laws of the state of Delaware on January 5, 1981, and is engaged in the gold and other precious metals business, primarily through passive and joint ownership arrangements, and is also engaged in the acquisition, exploration, development, and sale of gold properties, and in the acquisition of gold royalty interests. The Company also provides financial, operational, and environmental consulting services to companies serving the mining industry. Substantially all the Company's revenues are and can be expected to be derived from royalty interests rather than mining activity conducted by the Company.\nSummary of Significant Accounting Policies:\nBasis of Consolidation:\nThe consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and its proportionate share of the accounts of unincorporated joint ventures. All significant intercompany transactions and account balances have been eliminated in consolidation.\nCash Equivalents:\nFor purposes of the 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. At June 30, 1995 the Company held $2,348,000 of U.S. government securities under an agreement to resell in July 1995. Due to the short term nature of the agreement, the Company did not take possession of the securities which were instead held in the Company's safekeeping account by FBS Investments Services, Inc. At June 30, 1995, cash equivalents included approximately $1,060,000 of temporary cash investments in an uninsured government securities money market fund.\nMarketable securities:\nMarketable securities are classified as trading and recorded at market value. At June 30, 1995 the Company held U.S. treasury securities in a principal amount of $5,000,000. The Company acquired these securities, with\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nmaturities ranging from September 1995 to August 1996, at a cost of $4,983,125. At June 30, 1995, the market value of these securities was $5,011,570. Included in the statement of operations is the net change in unrealized gains and (losses) for the trading securities of $75,721 and $(47,246) for the years ended June 30, 1995 and 1994, respectively.\nGold Inventory:\nThe Company has elected to receive a portion of its royalty interests in the South Pipeline project on an \"in-kind\" basis. Gold inventory on the balance sheet consists of this refined gold bullion stored in safekeeping by the Company's refiner in Utah. The inventory is carried at market value with unrealized gains or losses included in the results of operations for the period.\nMineral Properties:\nAcquisition costs relating to mineral properties with a known resource are deferred until the properties are put into commercial production, sold or abandoned. Acquisition costs relating to properties without a known resource are charged to operations when incurred. Exploration costs, including an allocation of employee salaries and related costs, are charged to operations when incurred. Mine development costs incurred to develop new ore bodies, to expand or rehabilitate the capacity of operating mines, or to develop areas substantially in advance of production are deferred. For properties placed in production, the related deferred costs are depleted using the units-of-production method. Deferred costs applicable to sold or abandoned properties are charged against operations at the time of sale or abandonment of the property. On a quarterly basis, the Company evaluates the carrying value of deferred costs associated with all mineral properties to determine if the costs are in excess of their net realizable value and if an impairment provision needs to be recorded. Upon disposition of a portion of a mineral property, including equipment sales, any proceeds are treated as a reduction of the carrying value of the portion of the property retained.\nOffice Furniture, Equipment and Improvements:\nThe Company depreciates its office furniture, equipment and improvements over estimated useful lives of 3 to 15 years\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nusing the straight-line method. The cost of normal maintenance and repairs is charged to expense as incurred. Significant expenditures which increase the life of the asset are capitalized and depreciated over the estimated remaining useful life of the asset. Upon retirement or disposition of office furniture, equipment, or improvements, related gains or losses are recorded in operations.\nReclamation Costs:\nThe Company records a liability for the estimated cost to reclaim mined land based upon burdening estimated production over the life of the mine with a proportional share of such cost. The accrued reclamation liability is reduced as reclamation expenditures are incurred. The majority of reclamation expenditures will be incurred upon permanent cessation of mining operations at the property involved.\nIncome Taxes:\nEffective July 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Deferred income taxes reflect the expected future tax consequences of temporary differences between the tax basis amounts and financial statement carrying amounts of assets and liabilities at each year end and the expected future benefits of net operating loss carryforwards, tax credits and other carryforwards. General business credits are accounted for by the flow- through method.\nReclassifications:\nCertain accounts in the prior period financial statements have been reclassified for comparative purposes to conform with the presentation in the current period financial statements.\nNet Loss Per Share:\nNet loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during each year. Common stock equivalents have been excluded from the computation since the effect is antidilutive.\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. Property and Equipment ---------------------- The net carrying value of the Company's property and equipment consists of the following components at June 30, 1995 and 1994:\n1995 1994 -------- -------- Mineral Properties: South Pipeline- Net Profits Interest $ - $ - South Pipeline- Capped NSR Royalty 193,350 - Long Valley 159,478 159,478 Camp Bird 120,110 120,110 ------- ------- 472,938 279,588 Office furniture, equipment and improvements 111,255 43,719 ------- ------- Net property and equipment $ 584,193 $ 323,307 ======= =======\nAs discussed in the following paragraphs, most of the Company's properties are subject to various activities which to date have not resulted in conclusions that the carrying value of these properties will or will not be recoverable by charges against income from future mining operations or a subsequent sale of the properties. Realization of these costs is dependent upon the success of exploration programs resulting in the discovery of economically minable deposits and the subsequent development or sale of those deposits or properties or the production of gold from existing resources. The outcome of these matters is contingent upon future events which cannot be determined at this time.\nThe Company's mining operations and exploration activities are subject to various federal, state, and local laws and regulations governing protection of the environment. These laws are continually changing and, as a general matter, are becoming more restrictive. Management believes that the Company is in material compliance with all applicable laws and regulations.\nPresented below is a discussion of the status of each of the Company's currently significant mineral properties.\nA. South Pipeline Project ---------------------- The South Pipeline Project relates to a sediment-hosted gold deposit located in Lander County, Nevada, and covers over 4,000 acres of unpatented mining claims. The Company initially\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nformed the Crescent Valley Joint Venture (\"CVJV\") with Golden Bounty Resources N.L. (\"GBR\"), of Australia, in May 1987, and CVJV leased some 200 claims from ECM, Inc. (\"ECM\"). In turn, CVJV entered into an agreement (the \"Crescent\/Cortez JV\") with Cortez Gold Mines (\"Cortez\") pursuant to which CVJV could secure a 20% carried interest in the project, provided that CVJV made a $1 million expenditure for exploration by September 1991.\nEffective February 1990, the Company purchased the interest of GBR in CVJV. As purchase consideration, the Company issued 176,165 shares of its common stock held in treasury to GBR, which was valued at $1.50 per share. As a result, the Company owned all of the 20% carried interest of CVJV subject to completion of the required exploration program.\nEffective April 15, 1991, the Crescent\/Cortez JV agreement was terminated; the CVJV lease was terminated; and the Company, Cortez, and ECM entered into a new set of agreements pursuant to which the Company sold its interest in the Crescent Valley property to Placer Dome U.S. Inc. (\"PDUS\"), manager and 60% owner of Cortez, for a cash payment of $100,000, the assignment to Royal of a 1.5% net smelter return (\"NSR\") royalty (with a capped payout of $750,000), a 1.25% net proceeds royalty in the project, and a release of any further exploration obligations. The 1.5% NSR royalty interest covers the GAS Mining Claims and a block of additional mining claims leased by Cortez from ECM.\nOn December 2, 1991, the Company assigned one-half of its 1.5% NSR royalty to satisfy a debt of $209,000. On December 30, 1991, the Company, through an affiliated limited partnership, commenced a private offering to raise $400,000. In exchange for the $400,000, the limited partnership (\"Crescent Valley Partners, L.P.\") acquired the remaining one-half of the 1.5% NSR royalty, and the 1.25% net proceeds royalty, resulting in a gain on sale of $193,000. A subsidiary of the Company is the general partner of the limited partnership and has a 2% interest in the limited partnership. The limited partners also received warrants to purchase an aggregate of 2,000,000 shares of the Company's common stock, exercisable at a price of $0.0625 per share until February 28, 1997. The exercise price of the warrants exceeded the market value of the Company's common stock at the date of grant. At June 30, 1995, 1,850,000 of the warrants had been exercised. Certain partners in the limited partnership are also officers and directors of the Company.\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn June 1992, believing that PDUS had withheld material information in connection with the transaction of April 15,1991, the Company commenced litigation against PDUS in federal court in Colorado. The litigation was settled on September 18, 1992, in an agreement pursuant to which the Company re-acquired a significant new royalty interest in the South Pipeline Project, under terms calling for:\n1) The creation of the \"South Pipeline Project,\" involving a 4,000 acre claim block in Crescent Valley, Lander County, Nevada (consisting of substantially the same lands as were the subject of the CVJV\/ECM lease). The South Pipeline Project is approximately one-half mile south of the Pipeline gold discovery that was announced by PDUS in early 1992.\nUnder the South Pipeline agreement, Cortez will remain the manager and operator and has committed to an exploration and development work program. After payback, as defined in the agreement, the Company will receive a 20% net profits royalty or, at its election beginning with production and annually thereafter, an NSR royalty according to a schedule tied to indexed gold prices. The NSR royalty ranges from 2.5% for an indexed price of $350 per ounce to 5.5% for an indexed price in excess of $500 per ounce. Under either royalty arrangement, the Company may elect to take its royalty \"in- kind.\"\nDuring each of the years ended June 30, 1995, 1994 and 1993, the Company received advance royalty payments of $150,000, which are shown as royalty income in the accompanying income statements. The Company will receive additional advance royalty payments of $150,000 per year, and all such payments are to be recouped by Cortez from production royalty payments.\n2) As part of the agreement, Cortez purchased 1,000 units of Royal Gold securities at $800 per unit. The 1,000 units consist of (1) 500,000 shares of the Company's common stock, (2) the right to purchase, before March 31, 1996, 300,000 additional shares of the Company's common stock at $2.00 per share, and (3) the right to purchase, before March 31, 1996, an additional 300,000 shares of the Company's common stock at $3.00 per share, if either Cortez or the Company has first elected to put the South Pipeline Project into production. At June 30, 1995, none of the Cortez warrants had been exercised.\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3) If Cortez does not elect to put the Project into production by early 1996, then the Company may elect to put the Project into production, thereby securing 100% of the working interest therein, subject to granting a 20% production royalty to Cortez identical to the one described above. Royal would then be entitled to use, under a normal tolling arrangement and as available, the Cortez milling facilities in the vicinity, including any to be built for the Pipeline project.\n4) For a period of five years following the September 18, 1992, date of the settlement agreement, without prior approval of the Company's Board of Directors, Cortez, for itself and its affiliates, agreed not to, directly or indirectly: (i) acquire any further shares of the Company except with respect to the warrants; (ii) join with any person or group in any effort to acquire any such additional shares; (iii) propose, initiate or enter into any tender offer, business combination or change of control transaction involving the Company or its assets; (iv) solicit proxies; or (v) vote on matters relating to South Pipeline or other matters involving Cortez or its affiliates, among other matters. Cortez will not sell any of the acquired shares publicly except in accordance with Rule 144, any underwritten public offering, in a tender offer, or privately except subject to these standstill limitations by a person unaffiliated with Cortez or its affiliates.\nAs of September 1, 1994, the date of the most recent announced estimate, the cumulative resource estimate of the South Pipeline Project is 4.4 million contained ounces. As of June 30, 1995, 220,000 ounces of such estimated resource is considered a proven ore reserve, within the Crescent Pit, where production began in fiscal 1995.\nB. Union Pacific Exploration Project --------------------------------- The Company and Union Pacific Minerals (\"Union Pacific\"), Inc. have entered into an Option Agreement and Grant of Exploration Rights, dated effective May 1, 1994 (the \"Agreement\"), pursuant to which the Company has the right to evaluate all of the Union Pacific lands in Colorado and Wyoming (approximately six million acres) for gold, silver and platinum metal deposits.\nUnder the Agreement, the Company also had the right to select up to 50,000 acres of the Union Pacific lands as to which the Company may have exclusive exploration and development rights,\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nand the right to negotiate farm-out arrangements with respect to such properties.\nAt August 31, 1994, the Company had given notice of \"selection\" of approximately 49,850 acres, and had initiated geochemical sampling surveys on the ten prospects represented by such acreage position.\nUnder the Agreement, the Company was obliged to expend a minimum of $400,000 on exploration of the selected lands, such exploration to be completed on or before August 1, 1995. In addition, the Company could extend its exclusive rights for two additional twelve-month terms, upon making additional exploration commitments of $600,000 and $1,000,000, respectively. Over the possible thirty-nine-month term of the Agreement, then, projected exploration expenditures will totaled $2,000,000.\nIf the Company identifies attractive deposits on the Union Pacific lands, it has the opportunity, under the terms of agreements that have already been negotiated with Union Pacific, to assign further exploration and development rights to third parties; to develop such deposits in collaboration with Union Pacific; or to develop such deposits for Royal Gold's own account. In all circumstances, Union Pacific will retain a royalty interest, and will retain various rights to participate on a working interest basis in the development, and operation of any mineral deposit.\nBy an amendment to the Agreement dated November 30, 1994, the Company secured the rights (1) to explore Union Pacific lands in Utah and in the State Line District of Colorado and Wyoming, (2) to continue to select and substitute exploration prospects, subject to the 50,000-acre \"cap\", until December 31, 1995, (3) to extend, until December 31, 1995, the original exploration commitment, which was revised to $500,000 (As of June 30, 1995, $300,000 of this commitment has been spent.), and (4) to extend, until December 31, 1997 and December 31, 1998, respectively, each of the additional terms of the arrangement. The Agreement now entails total projected expenditures of $2,100,000 over a 55-month term.\nC. Goldstripe ---------- The Goldstripe Mine was an open pit, heap leach facility located in Plumas County, California. A subsidiary of the Company operated Goldstripe, but discontinued mining operations after the 1989 season. The Company completed required\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nreclamation work on the mine pits and at the plant facility site, and disposed of all major mining and crushing equipment.\nBy letter dated August 5, 1992, the U.S. Forest Service notified the Company that it had determined to initiate a response action, under the Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\"), in order to assess the possible threat of a release of cyanide solution contained within the 900,000 ton, processed ore residue pile. The Company disputed the propriety of the Forest Service's determination, and requested that the Forest Service explain the basis for its determination.\nTo date, the only action undertaken by the Forest Service in connection with the CERCLA notice has been to establish, in September 1992, four monitoring wells at the site of the residue pile. The Company understands that, to date, the monitoring wells have either been dry, or have yielded water that contains cyanide in concentrations that do not pose a threat to aquatic organisms.\nIf it is determined that the Forest Service has properly proceeded under CERCLA, the Company could be a \"potentially responsible party\" (\"PRP\") for all costs associated with the \"response action\" and any other remediation at the site. In addition, because the Forest Service is a co-permittee for the Goldstripe site, the Forest Service would presumably also be a PRP under CERCLA. The Company believes that no additional \"response action\" or other remediation will be undertaken by the Forest Service under CERCLA, or otherwise.\nIn response to a Forest Service request made in October 1992, approximately $341,000 in cash security that the Company had posted pursuant to the terms of the Goldstripe project reclamation bond was released to the Forest Service. The Forest Service advised the Company that it would use these funds to finance certain reclamation activities at the project site (including ground contouring, solution pond reclamation, and contouring and revegetation of the residue pile) during 1992 and 1993.\nIn August 1993, the Forest Service advised the Company that its reclamation activities at the project site were substantially completed (except for revegetation), and that the Forest Service believed that such activities should satisfy all outstanding permit requirements for reclamation, except for post-reclamation monitoring of water quality. As a result of the Forest Service's actions, approximately $341,000 in\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nrestricted investments and $337,000 in reclamation liabilities, were eliminated from the balance sheet. In May 1994 and in May 1995, the Forest Service again advised the Company that all outstanding requirements, except for post-reclamation groundwater monitoring, had been satisfied.\nAt this time, the Company believes that it will have no further reclamation liability related to the Goldstripe property, unless post-reclamation groundwater monitoring indicates unanticipated migration of residual cyanide into ground or surface waters.\nDuring the fourth quarter of fiscal 1994, the Company determined to abandon the mill site claims and to write-off its interest in Goldstripe. This resulted in a charge of $607,295, which was offset by $131,138 write-off of royalties payable associated with the residual pile resource.\nD. Long Valley ----------- In April 1989, the Company entered into a joint venture agree ment with Standard Industrial Minerals, Inc. (\"Standard\") to explore and develop a property located in Mono County, Califor nia (the \"Long Valley Project\"). The agreement provided that the Company would earn a 60% interest in the property upon expending 100% of the funds for completion of exploration, development and construction of production facilities by Decem ber 1991 (subsequently extended to May 1995). During 1989 and 1990, the Company delineated a resource (the \"South Zone\") estimated to host some 2.2 million tons of ore with an average grade of 0.023 ounces of gold per ton. Metallurgical testing and engineering analysis for a heap leach project was completed, and applications for operating permits were filed, but the Company subsequently determined to farm out its inter est in Long Valley.\nIn December 1990, the Company and its co-venturer, Standard, entered into an agreement with Battle Mountain Exploration Company (\"Battle Mountain\"). The agreement provided for a mining joint venture to be formed between the Company, Standard and Battle Mountain should Battle Mountain's exploration result in discovery of significant additional gold mineralization.\nIn March 1992, Battle Mountain indicated that it had discovered significant amounts of low grade gold mineralization, but that it proposed to restructure the agreement to bring in a fourth partner to conduct further exploration. In November 1992, Battle Mountain notified the Company that, not having been\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nsuccessful in its efforts to bring in a fourth party as a new operator, it elected to terminate its interest effective as of January 1, 1993.\nIn November 1993, the Company and Standard amended the joint venture agreement to provide for the Company's option, exercisable through December 31, 1997, to acquire the entirety of Standard's interest at Long Valley upon payment of $1,000,000. Option consideration payments aggregating $125,000 are payable each November of 1993, 1994, 1995 and 1996, with $25,000 of such sum having been paid. Up to $100,000 of such payments (the total of the payments due in 1995 and 1996) are creditable against the option exercise amount.\nThe Company has conducted substantial exploratory drilling programs at Long Valley in fiscal 1995 and has discovered additional deposits of gold mineralization.\nE. Camp Bird Mine -------------- The Camp Bird Venture (the \"Venture\") was formed in August 1986, primarily for the purpose of re-opening the Camp Bird Mine as a gold and silver mine. The Company's partner was Chipeta Mining Corporation (\"Chipeta\"). Through 1989, the Venture was primarily engaged in exploration activities and there was no significant production from the mine.\nDuring fiscal 1990, the Company reached an agreement with Chipeta to terminate the Camp Bird Venture, and thereafter terminated its mining lease and reduced the carrying value at Camp Bird to the estimated net realizable value of the equipment and certain patented mining claims.\nAt June 30, 1995, capitalized costs of $120,110 reflect the Company's ownership of patented mining claims. Management believes these claims are valuable both for their mineral and real estate potential.\nF. Other ----- During fiscal 1994, the Company determined to abandon several other properties which resulted in the write-off of $273,193.\n3. Related Party Transactions -------------------------- In October 1993, the Company granted a $75,000 loan to an officer of the Company. This note is secured by 23,348 shares of Company stock, had a term of one year, and carried a market\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ninterest rate of four percent. During each of fiscal 1994 and fiscal 1995, a portion of the note was charged to salary expense and the remaining balance was extended. The outstanding balance is currently due December 31, 1995.\nDuring fiscal 1995, the Company paid $100,000 to Behre Dolbear and Company, Inc. for technical consulting services. Mr. Dempsey is a member of the board of directors of Behre Dolbear.\n4. Post-Retirement Benefits ------------------------ In 1987, the Company's Board of Directors agreed to provide post-retirement benefits for the remaining lifetime of a former executive officer. The present value (discounted at 10%) of the estimated future payments of $2,200 per month was recorded in 1987 based on the life expectancy of the former officer.\nDuring fiscal 1993, the Company recognized an additional charge to operations of approximately $20,000 due to the increased life expectancy of the former officer and accretion of the discount.\nIn April 1993, the Company and the former officer amended the post-retirement benefits agreement. The Company recommenced paying the former officer $2,200 per month in May 1993, and issued the former officer an unsecured promissory note in the principal amount of all previously unpaid deferrals, totalling $83,600. The note accrues interest at 6.5% per annum.\nThe remaining principal maturity of the note of $27,866 is due during the year ending June 30, 1996.\nDuring fiscal 1994 and fiscal 1995, the Company recognized an additional charge to operations of approximately $20,000 and $40,000, respectively, due to the then-increased life expectancy of the former officer, decrease in the discount rate used to compute the net present value of the liability, and accretion of the discount.\n5. Income Taxes ------------ The tax effects of significant temporary differences and carryforwards which give rise to the Company's deferred tax assets and liabilities at June 30, 1995 and 1994, are as follows:\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1995 1994 --------- --------- Net operating loss carryforwards $ 8,025,000 $ 7,117,700 Mineral property basis 58,000 216,800 Capital loss carryforwards 63,000 62,600 Post retirement benefit obligation 60,000 74,700 Other 80,000 110,200 --------- --------- Total gross deferred tax assets 8,286,000 7,582,000\nValuation allowance (7,310,000) (6,625,000) --------- --------- Net deferred tax assets 976,000 957,000 --------- --------- Mineral properties (41,000) (67,500) Deferred taxable income (98,000) (135,900) Other (87,000) (3,600) -------- -------- Total deferred tax liabilities (226,000) (207,000) -------- -------- Total net deferred taxes $ 750,000 $ 750,000 ======== ========\nAt June 30, 1995, the Company has approximately $22.9 million of net operating loss carryforwards which, if unused, will expire during the years 2001 through 2010. The Company's ability to generate future taxable income to realize the benefit of its tax assets will depend primarily on the timing and amount of income from its South Pipeline interest. Based upon the determination, as of June 30, 1995, of proven gold reserves at the Crescent Pit of the South Pipeline Project (see Note 2.A.), management has estimated that it is more likely than not that the Company will have some net future taxable income within the net operating loss carryforward period. Accordingly, a valuation allowance against the deferred tax asset has been established such that operating loss carryforwards will be utilized only to the extent of estimated future taxable income and reversals of existing deferred tax liabilities.\nThe components of income tax expense (benefit) for the years ended June 30, 1995, 1994 and 1993, are as follows:\n1995 1994 1993 ------- ------- -------- Current tax expense $ - $ - $ - Deferred tax (benefit) (685,000) (766,800) (212,700) Increase in deferred tax asset valuation allowance 685,000 16,800 212,700 -------- -------- -------- $ - $ (750,000) $ - ======== ======= =======\nThe provision for income taxes for the years ended June 30, 1995, 1994 and 1993, differs from the amount of income tax determined by applying\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nthe applicable U.S. statutory federal income tax rate to pre-tax loss from operations as a result of the following differences:\n1995 1994 1993 -------- -------- -------- Total (benefit) computed by applying statutory rate $(689,000) $(749,000) $(210,100) Adjustments of valuation allowance 685,000 16,800 212,700 Other 4,000 (17,800) (2,600) -------- ------- ------- $ - $(750,000) $ - ======== ======= =======\n6. Commitments ----------- Operating Lease --------------- The Company leases office space under a lease agreement which expires October 31, 1999. Future minimum cash rental payments are as follows:\nYears ending June 30, --------------------- 1996 $ 122,300 1997 122,300 1998 128,823 1999 132,084 2000 44,028 ------- $ 549,535 =======\nThe lease may be terminated at any time after October 31, 1997, upon proper notice and payment of a termination fee equal to the next nine months ensuing rent.\nRent expense charged to operations for the years ended June 30, 1995, 1994, and 1993, amounted to $122,052, $135,936, and $122,795, respectively. The Company subleases a portion of its premises on a month-to-month basis. The Company received sublease rental income of $35,831, $67,280 and $60,667, for the years ended June 30, 1995, 1994 and 1993, respectively.\nEmployment Agreements --------------------- The Company has one-year employment agreements with four of its officers which require total minimum future compensation, at June 30, 1995, of $268,000 through January 1996. The terms of each of these agreements automatically extend, every February, for one additional year, unless\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nterminated by the Company or the officer, according to the terms of the agreements.\n7. Stockholders' Equity -------------------- Preferred Stock:\nThe Company has 10,000,000 authorized and unissued shares of $.01 par value Preferred Stock.\nPrivate Placements:\nDuring fiscal 1993, the Company completed three private placements for net proceeds of $1,799,000: (i) In July 1992, 308,000 shares of common stock were sold for $1.00 per share. In connection with the private placement, the Company also issued warrants to purchase 308,000 shares of common stock, exercisable at $1.50 per share through July 31, 1997. Certain officers and directors of the Company participated in this placement. (ii) In September 1992, 500,000 shares of common stock were sold for $1.60 per share. In connection with the private placement, two warrants were also issued, one for 300,000 shares of common stock, exercisable at $2.00 per share through March 31, 1996, and the other for 300,000 shares of common stock, exercisable at $3.00 per share through March 31, 1996. (iii) In June 1993, 200,000 shares of common stock were sold for $3.60 per share. In connection with the private placement, the Company also issued warrants to purchase 200,000 shares of common stock, exercisable at $5.75 per share through September 30, 1995.\nDuring fiscal 1994, the Company completed two private placements for net proceeds of $6,655,000 from the sales of 1.425.00 shares at prices of $4 and $6 per share.\nDuring fiscal 1995 the Company completed a private placement for net proceeds of $3,800,000 from the sale of 500,000 shares at $8.00 per share.\nStock Options and Warrants:\nDuring fiscal 1990, the Directors Stock Option Plan (\"Directors Plan\") was adopted and the Company reserved 200,000 shares of common stock for issuance under this Plan. Only non-employee directors are eligible to participate. Options granted under the Directors Plan are exercisable at prices equal to the market value of the Company's common\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nstock at the date of grant. The options are exercisable for a period of five years and terminate three months after the director resigns or is removed from office. During fiscal 1995, options were exercised for 18,750 shares for a total of $29,063. Additionally, options for an additional 30,000 shares were issued during the year. One half of these options granted are subject to stockholder approval. As of June 30, 1995, options are outstanding for 60,000 shares at an average exercise price of $5.48 per share.\nAt February 5, 1993, the Board of Directors granted to a director, who is a former president of the Company and currently a consultant to the Company, a non-incentive option to acquire up to 150,000 shares of the Company's common stock, at a price of $3.75 per share. During each of fiscal years 1995 and 1994, such director exercised options for 75,000 shares, generating proceeds to the Company, in each year, of $281,250.\nDuring fiscal 1989, an Employee Stock Option Plan (\"Employee Plan\") was adopted. In December, 1993 and 1994, shareholders approved an amendment, increasing the aggregate number of shares available for issuance under the Employee Plan to 2,150,000. Provisions of the Employee Plan provide for the issuance of stock options and stock appreciation rights. The options are exercisable at prices equal to the market value of the Company's common stock as of the date of grant, and expire ten years after the date of grant. There have been no stock appreciation rights granted under the Employee Plan. During fiscal 1995, options were exercised for 46,000 shares for a total of $5,750.\nAt June 30, 1995, under the Directors and Employee Plans and otherwise, the following options are outstanding:\nNumber of Exercise Expiration Shares Price Total Date -------- ------ -------- ------------- 15,000 2.1875 $ 32,812 December 1997 35,000 4.00 140,000 December 1998 10,000 9.125 91,250 April 1999 45,000 7.875 354,375 December 1999 907,720 .125 113,465 December 2001 15,000 4.00 60,000 December 2003 184,250 7.875 1,450,969 December 2004 --------- --------- 1,211,970 $2,242,871 ========= =========\nROYAL GOLD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAdditionally, warrants to purchase the Company's common shares are outstanding, as follows:\nNumber of Exercise Expiration Shares Price Total Date ------- ---- --------- -------------- 200,000 $5.75 $1,150,000 September 1995 170,000 1.278 217,260 January 1996 300,000 2.00 600,000 March 1996 300,000 3.00 900,000 March 1996 150,000 .0625 9,375 February 1997 287,500 1.50 431,250 July 1997 --------- --------- 1,407,500 $3,307,885 ========= =========\nThe shares and exercise prices listed above are generally subject to adjustment in accordance with anti-dilution provisions of each of the warrant agreements.\n8. Major Customers --------------- During fiscal 1995, $444,411 of the Company's royalty income was received from one source. In each of fiscal years 1994 and 1993, $150,000 of the Company's royalty income was also received from the same source. (See Note 2.A.)\n9. Simplified Employee Pension (\"SEP\") Plan ---------------------------------------- The Company maintains a SEP plan which is available to all employees. The Company contributes a minimum of 3% of an employee's compensation to an account set up for the benefit of the employee. If an employee chooses to contribute to the plan, the Company will match the contribution to a maximum of 7% of the employee's salary. During fiscal 1995 the Company contributed $50,271 to the plan.\nPART III\nItem 10:","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nStanley Dempsey - --------------- Age 56; Director Since August 1984; Term Expires 1997 Chairman of the Board and Chief Executive Officer of the Company since April 4, 1988. President and Chief Operating Officer of the Company from July 1, 1987 to April 4, 1988. Consultant to the Company from 1986 to 1987. Member of the Board of Directors of Dakota Mining Corporation, Hazen Research, Inc. and Behre Dolbear and Company, Inc. Prior to 1986, was a Vice President of AMAX, Inc., Greenwich, Connecticut and Sydney and Perth, Australia, and an attorney at law in private practice. (1)\nEdwin W. Peiker, Jr. - -------------------- Age 64; Director Since May 1987; Term Expires 1996 Director. President and Chief Operating Officer of the Company from April 4, 1988, until retirement on February 1, 1992. Vice President of Engineering of the Company from May 1987 to April 4, 1988. From 1983 to 1986, Mr. Peiker was engaged in mineral consulting activities. Mr. Peiker was also a principal in Denver Mining Finance Company from 1984 until 1986. During the period 1966-1983, Mr. Peiker was with the Climax Molybdenum division of AMAX involved in exploration activities worldwide. (1) (2)\nJohn W. Goth - ------------ Age 68; Director Since August 1988; Term Expires 1997 Director. Director of Development of the Minerals Information Institute and a consultant to the mining industry. Mr. Goth was formerly a senior executive of AMAX, Inc., and is a Director of Magma Copper Company and U.S. Gold Corporation (2) (3)\nJames W. Stuckert - ----------------- Age 57; Director Since September 1989; Term Expires 1995 Director. President and Vice Chairman of Hilliard Lyons, Inc. He had been Executive Vice President of Hilliard Lyons since 1963. Mr. Stuckert is also a Director of Hilliard, Lyons, Inc., DataBeam Corporation, McBar Medical Industries, and Lawson United Corporation. (2) (3)\nPierre Gousseland - ----------------- Age 73; Director Since June 1992; Term Expires 1995 Director. Financial Consultant. From 1977 until January 1986, Mr. Gousseland was Chairman and Chief Executive Officer of AMAX, Inc. Formerly, Director of the French American Banking Group of New York, the American International Group, Inc., Union Miniere (Belgium), Degussa AG (Germany) and IBM World Trade Europe\/Middle\nEast Africa Corporation. Mr. Gousseland has served on the Chase Manhattan and Creditanstaldt (Vienna, Austria) International Advisory Boards and is Past President of the French American Chamber of Commerce in the United States. (3)\nS. Oden Howell, Jr. - ------------------- Age 55; Director Since December 1992; Term Expires 1996 Director. Secretary and Treasurer of H&N Constructors, Inc., a contractor specializing in remodeling and rehabilitation of government facilities. From 1972 until 1988, Mr. Howell was Secretary\/Treasurer of Howell & Howell, Inc. He is currently Director of Florafax International, Inc.\nMerritt Marcus - -------------- Age 61; Director Since December 1992; Term Expires 1995 Director. President and Chief Executive Officer of Marcus Paint Company, a manufacturer of industrial coatings. Director of National Paint and Coatings Association.\nThomas A. Loucks: Age 46 - ---------------- Executive Vice President and Treasurer of the Company. From August 1985 until August 1988, Mr. Loucks was a Business Development Analyst with Newmont Mining Company.\nPeter B. Babin: Age 41 - -------------- Executive Vice President of the Company since July 1, 1995, formerly Senior Vice President from July 1993 through June 30, 1995. From 1989 until 1993, Mr. Babin was a consultant to the Company. From 1986 through 1989, Mr. Babin was Senior Vice President and General Counsel of Medserv Corporation.\nKaren P. Gross: Age 41 - -------------- Vice President of the Company since June of 1994. Corporate Secretary of the Company since 1989. From 1987 until 1989, Ms. Gross was the Assistant Secretary to the Company and Executive Assistant.\n(1) Member of Executive Committee\n(2) Member of Audit Committee\n(3) Member of Compensation Committee\nITEMS 11, 12, and 13\nThe information called for by Item 11, \"Executive Compensation,\" Item 12, \"Security Ownership of Certain Beneficial Owners and Management,\" and Item 13, \"Certain Relationships and Related Transactions,\" is incorporated by reference to the Company's definitive proxy statement to be filed with respect to the upcoming Annual Meeting of Stockholders to be held December 5, 1995, in Denver, Colorado.\nPART IV -------\nItem 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 and are included herewith (*) or have been filed previously:\n(1) Financial Statements included in Item 8.\n(2) Financial Statement schedules:\nAll Schedules are omitted because the information called for is not applicable or is not required or because the required information is set forth in the financial statements or notes thereto.\n(3) The following exhibits are filed with this annual report on Form 10-K. The exhibit numbers correspond to the numbers assigned in Item 601 of Regulation S-K. Those exhibits that have been marked with an asterisk are filed herewith; all other exhibits have been previously filed with the Commission pursuant to the Company's various reports on Forms 10-K, 10-Q, 8- K, S-1 and S-8, and are incorporated herein by reference.\nExhibit Number ------ 3 (a) Certificate of Incorporation - Exhibit (b) to the Company's Form 10-K for the fiscal year ended December 31, 1980.\n(b) Amendment to Certificate of Incorporation Exhibit (c) to the Company's Form 10-K for the fiscal year ended December 31, 1980.\n(c) By-Laws - Exhibit (d) to the Company's Form 10-K, for the fiscal year ended December 31, 1980.\n(d) Amendment to Certificate of Incorporation dated February 2, 1983 - Exhibit 3 (c) of Registration Statement on Form S-1, Registration No. 2-84642.\n(e) Amendments to Articles of Incorporation dated May 7, 1987. Exhibit (xiv) to the Company's Form 10-K for the year ended June 30, 1987.\n(f) Amendment to Articles of Incorporation dated February 2, 1988. Exhibit 3(f) to the Company's Form 10-K for the year ended June 30, 1990.\n10 (a) Employee Stock Option Plan. Exhibit 4(a) to the Company's Form S-8 dated February 6, 1990.\n(b) Directors' Stock Option Plan. Exhibit 4(b) to the Company's Form S-8 dated February 6, 1990.\n(c) Lease of premises at 1660 Wynkoop Street, Denver, Colorado, dated November 1, 1989. Exhibit 10 (c) to the Company's Form 10-K for the year ended June 30, 1990.\n(d) Termination Agreement, among Royal Gold, Inc., Royal Crescent Valley, Inc., Cortez Gold Mines, Placer Dome U.S. Inc. and ECM, Inc., dated effective as of April 15, 1991.\nExhibit 10(k) to the Company's Form 10-K for the year ended June 30, 1991.\n(e) Royalty Deed and Agreement, dated effective as of April 15, 1991, pursuant to which ECM, Inc. conveyed to Royal Crescent Valley, Inc. a 2% Net Smelter Return royalty on mineral production from the lands that had been subject to the Royal\/Cortez Joint Venture. Exhibit 10(l) to the Company's Form 10-K for the year ended June 30, 1991.\n(f) Agreement for Resolution of Disputes and Litigation and for the Formation of the South Pipeline Project, dated September 18, 1992, between Royal Crescent Valley, Inc., and Placer Dome U.S. Inc. Exhibit 10(l) to the Company's Form 10-K for the year ended June 30, 1992.\n(g) Memorandum of Royalty Interest executed September 18, 1992, by Royal Gold, Inc. and Cortez Gold Mines. Exhibit 10(m) to the Company's Form 10-K for the year ended June 30, 1992.\n(h) Mining Lease and Purchase Option, dated effective August 23, 1993, between Royal Gold, Inc. and Donald K. Jennings, relating to the \"Ferb\" claims, in Elko County, Nevada. Exhibit 10(o) to the Company's Form 10-K for the year ended June 30, 1993.\n(i) Mining Claim and Purchase Option Agreement, dated effective November 30, 1993, between Standard Industrial Minerals, Inc. and Royal Long Valley, Inc. Exhibit 10(p) to the Company's Form 10-K for the year ended June 30, 1994.\n(j) Option Agreement and Grant of Exploration Rights, dated effective May 1, 1994, between Union Pacific Minerals, Inc. and Royal Gold, Inc. Exhibit 10(q) to the Company's Form 10-K for the year ended June 30, 1994.\n*(k) Amendment to Option Agreement and Grant of Exploration Rights, dated effective November 30, 1994, between Union Pacific Minerals, Inc. and Royal Gold, Inc.\n*(l) Assignment Agreement dated effective December 1, 1994, between Royal Gold, Inc. and Santa Fe Pacific Gold Corporation, relating to the Bob Creek Project.\n22 *(a) The Company and Its Subsidiaries.\n(b) Reports on Form 8-K:\n1. None.\n* - Filed herewith.\nEXHIBIT 22\nTHE COMPANY AND ITS SUBSIDIARIES\n--------------------- | ROYAL GOLD, INC. | --------------------- -------------------------------------------------- ------- -------- -------- ------- ----- -------- ------- | ROYAL | | DENVER | | CALGOM | | ROYAL | |ROYAL| | ROYAL | | ROYAL| |TRADING| | MINING | | MINING | | LONG | |CAMP | |CRESCENT| |KANAKA| | CO. | |FINANCE | | INC. | |VALLEY,| |BIRD,| |VALLEY, | |CREEK | | (1) | |COMPANY,| | (1) (2)| | INC. | |INC. | | INC. | |CORP. | ------- | INC. | -------- | (1) | | (1) | | (1) | | (1) | | (1) | ------- ----- -------- ------ -------- ---------------- | ENVIRONMENTAL | |STRATEGIES, INC.| | (3) | ----------------\n(1) 100% owned by Royal Gold, Inc. (2) Owns a 100% interest in the Goldstripe Project. (3) 100% owned by Denver Mining Finance Company, 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.\nROYAL GOLD, INC.\nDate: September 26, 1995 By:\/S\/Stanley Dempsey ------------------ Stanley Dempsey, 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 and on the dates indicated.\nDate: September 26, 1995 By: \/S\/Stanley Dempsey ------------------ Stanley Dempsey, Chairman, Chief Executive Officer, and Director\nDate: September 26, 1995 By: \/S\/Thomas A. Loucks ------------------- Thomas A. Loucks Treasurer and chief accounting officer\nDate: September 26, 1995 By: \/S\/Edwin W. Peiker, Jr. ----------------------- Edwin W. Peiker, Jr. Director\nDate: September 26, 1995 By: \/S\/John W. Goth --------------- John W. Goth Director\nDate: September 26, 1995 By: \/S\/James W. Stuckert -------------------- James W. Stuckert Director\nDate: September 26, 1995 By: \/S\/Pierre Gousseland -------------------- Pierre Gousseland Director\nDate: September 26, 1995 By: \/S\/Merritt Marcus ----------------- Merritt Marcus Director\nDate: September 26, 1995 By: \/S\/S. Oden Howell, Jr. ---------------------- S. Oden Howell, Jr. Director","section_11":"","section_12":"","section_13":"","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 and are included herewith (*) or have been filed previously:\n(1) Financial Statements included in Item 8.\n(2) Financial Statement schedules:\nAll Schedules are omitted because the information called for is not applicable or is not required or because the required information is set forth in the financial statements or notes thereto.\n(3) The following exhibits are filed with this annual report on Form 10-K. The exhibit numbers correspond to the numbers assigned in Item 601 of Regulation S-K. Those exhibits that have been marked with an asterisk are filed herewith; all other exhibits have been previously filed with the Commission pursuant to the Company's various reports on Forms 10-K, 10-Q, 8- K, S-1 and S-8, and are incorporated herein by reference.\nExhibit Number ------ 3 (a) Certificate of Incorporation - Exhibit (b) to the Company's Form 10-K for the fiscal year ended December 31, 1980.\n(b) Amendment to Certificate of Incorporation Exhibit (c) to the Company's Form 10-K for the fiscal year ended December 31, 1980.\n(c) By-Laws - Exhibit (d) to the Company's Form 10-K, for the fiscal year ended December 31, 1980.\n(d) Amendment to Certificate of Incorporation dated February 2, 1983 - Exhibit 3 (c) of Registration Statement on Form S-1, Registration No. 2-84642.\n(e) Amendments to Articles of Incorporation dated May 7, 1987. Exhibit (xiv) to the Company's Form 10-K for the year ended June 30, 1987.\n(f) Amendment to Articles of Incorporation dated February 2, 1988. Exhibit 3(f) to the Company's Form 10-K for the year ended June 30, 1990.\n10 (a) Employee Stock Option Plan. Exhibit 4(a) to the Company's Form S-8 dated February 6, 1990.\n(b) Directors' Stock Option Plan. Exhibit 4(b) to the Company's Form S-8 dated February 6, 1990.\n(c) Lease of premises at 1660 Wynkoop Street, Denver, Colorado, dated November 1, 1989. Exhibit 10 (c) to the Company's Form 10-K for the year ended June 30, 1990.\n(d) Termination Agreement, among Royal Gold, Inc., Royal Crescent Valley, Inc., Cortez Gold Mines, Placer Dome U.S. Inc. and ECM, Inc., dated effective as of April 15, 1991.\nExhibit 10(k) to the Company's Form 10-K for the year ended June 30, 1991.\n(e) Royalty Deed and Agreement, dated effective as of April 15, 1991, pursuant to which ECM, Inc. conveyed to Royal Crescent Valley, Inc. a 2% Net Smelter Return royalty on mineral production from the lands that had been subject to the Royal\/Cortez Joint Venture. Exhibit 10(l) to the Company's Form 10-K for the year ended June 30, 1991.\n(f) Agreement for Resolution of Disputes and Litigation and for the Formation of the South Pipeline Project, dated September 18, 1992, between Royal Crescent Valley, Inc., and Placer Dome U.S. Inc. Exhibit 10(l) to the Company's Form 10-K for the year ended June 30, 1992.\n(g) Memorandum of Royalty Interest executed September 18, 1992, by Royal Gold, Inc. and Cortez Gold Mines. Exhibit 10(m) to the Company's Form 10-K for the year ended June 30, 1992.\n(h) Mining Lease and Purchase Option, dated effective August 23, 1993, between Royal Gold, Inc. and Donald K. Jennings, relating to the \"Ferb\" claims, in Elko County, Nevada. Exhibit 10(o) to the Company's Form 10-K for the year ended June 30, 1993.\n(i) Mining Claim and Purchase Option Agreement, dated effective November 30, 1993, between Standard Industrial Minerals, Inc. and Royal Long Valley, Inc. Exhibit 10(p) to the Company's Form 10-K for the year ended June 30, 1994.\n(j) Option Agreement and Grant of Exploration Rights, dated effective May 1, 1994, between Union Pacific Minerals, Inc. and Royal Gold, Inc. Exhibit 10(q) to the Company's Form 10-K for the year ended June 30, 1994.\n*(k) Amendment to Option Agreement and Grant of Exploration Rights, dated effective November 30, 1994, between Union Pacific Minerals, Inc. and Royal Gold, Inc.\n*(l) Assignment Agreement dated effective December 1, 1994, between Royal Gold, Inc. and Santa Fe Pacific Gold Corporation, relating to the Bob Creek Project.\n22 *(a) The Company and Its Subsidiaries.\n(b) Reports on Form 8-K:\n1. None.\n* - Filed herewith.\nEXHIBIT 22\nTHE COMPANY AND ITS SUBSIDIARIES\n--------------------- | ROYAL GOLD, INC. | --------------------- -------------------------------------------------- ------- -------- -------- ------- ----- -------- ------- | ROYAL | | DENVER | | CALGOM | | ROYAL | |ROYAL| | ROYAL | | ROYAL| |TRADING| | MINING | | MINING | | LONG | |CAMP | |CRESCENT| |KANAKA| | CO. | |FINANCE | | INC. | |VALLEY,| |BIRD,| |VALLEY, | |CREEK | | (1) | |COMPANY,| | (1) (2)| | INC. | |INC. | | INC. | |CORP. | ------- | INC. | -------- | (1) | | (1) | | (1) | | (1) | | (1) | ------- ----- -------- ------ -------- ---------------- | ENVIRONMENTAL | |STRATEGIES, INC.| | (3) | ----------------\n(1) 100% owned by Royal Gold, Inc. (2) Owns a 100% interest in the Goldstripe Project. (3) 100% owned by Denver Mining Finance Company, 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.\nROYAL GOLD, INC.\nDate: September 26, 1995 By:\/S\/Stanley Dempsey ------------------ Stanley Dempsey, 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 and on the dates indicated.\nDate: September 26, 1995 By: \/S\/Stanley Dempsey ------------------ Stanley Dempsey, Chairman, Chief Executive Officer, and Director\nDate: September 26, 1995 By: \/S\/Thomas A. Loucks ------------------- Thomas A. Loucks Treasurer and chief accounting officer\nDate: September 26, 1995 By: \/S\/Edwin W. Peiker, Jr. ----------------------- Edwin W. Peiker, Jr. Director\nDate: September 26, 1995 By: \/S\/John W. Goth --------------- John W. Goth Director\nDate: September 26, 1995 By: \/S\/James W. Stuckert -------------------- James W. Stuckert Director\nDate: September 26, 1995 By: \/S\/Pierre Gousseland -------------------- Pierre Gousseland Director\nDate: September 26, 1995 By: \/S\/Merritt Marcus ----------------- Merritt Marcus Director\nDate: September 26, 1995 By: \/S\/S. Oden Howell, Jr. ---------------------- S. Oden Howell, Jr. Director","section_15":""}
{"filename":"34908_1995.txt","cik":"34908","year":"1995","section_1":"Item 1. Description of Business.\n(a) General Development of Business.\n(1) The Registrant, originally incorporated in 1919, is principally engaged in the manufacture and sale of various industrial component parts. During the fiscal year for which this Annual Report is being filed, there were no material developments with respect to the Registrant's business, except for those described in Registrant's 1995 Annual Report on pages 9-12, attached hereto as Exhibit 13. This information is incorporated herein by reference.\n(2) Inapplicable.\n(b) Financial Information About Industry Segments.\n(1) (2) Industry segments.\nThe Registrant is engaged in a single business segment as described on pages 5-6 and 24 of the 1995 Annual Report of the Registrant, attached hereto as Exhibit 13. Amounts of revenue, operating profits and identifiable assets attributable to the single business segment are included on pages 13 and 14 of the 1995 Annual Report of the Registrant, attached hereto as Exhibit 13. This information is incorporated herein by reference.\n(c) Narrative Description of Business.\nThe description of the business set forth on pages 5-6, 9-12, and 24 of the Registrant's 1995 Annual Report, attached hereto as Exhibit 13, is incorporated herein by reference. The following information supplements that description:\n(1) (i) See Narrative Description cross-reference above.\n(ii) See Narrative Description cross-reference above.\n(iii) See Narrative Description cross-reference above.\n(iv) While Registrant holds a number of patents, Registrant believes that the successful continuation of its business is not dependent on any single patent or group of patents, trademarks, or licenses. (Registrant retains the rights to certain royalties related to an exclusive license agreement with semiconductor manufacturer Silicon Systems incorporated (SSi), whereunder SSi will produce and market certain phonetic speech synthesizer chips under the SSi product name. Registrant does not consider the royalty agreement to be material to Registrant's business.)\n(v) No material portion of the business of the Registrant is seasonal in nature.\n(vi) There are no practices and conditions of the Registrant or known to the Registrant relating to working capital items which are material to an understanding of the Registrant's business in the industry in which it competes.\n(vii) See Narrative Description cross-reference above.\n(viii) As of August 31, 1995, the Registrant had an estimated backlog of firm orders amounting to approximately $15,000,000, all of which are expected to be filled within the 1996 fiscal year. The comparable backlog as of August 31, 1994 amounted to approximately $14,500,000.\n(ix) No material portion of the business of Registrant is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(x) The manufacture and sale of Registrant's products is an extremely competitive business. Because industry statistics are not available, Registrant is unable to accurately determine the number of its competitors nor to state its competitive position in its principal market as a supplier of parts to automotive customers. However, Registrant believes that it is generally considered a leading producer of its principal type of product in an estimated $650 million annual market served by approximately thirty major domestic suppliers, no one of which, or no small number of which are dominant. Registrant is aware, however, that there are companies making similar products, with greater sales and resources than Registrant. Registrant is aware that in recent years the activity of foreign competitors manufacturing similar products has increased. The quality of the product, the product's price and service to customers are the principal methods of competition.\n(xi) Research and development activity expenses during each of the last three fiscal years is not deemed material.\n(xii) Registrant has experienced no material effects in complying with government environmental regulations.\n(xiii) See Narrative Description cross-reference above.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales.\nFinancial information about foreign and domestic operations and export sales are set forth on pages 5, 6, 13, 14 and 24 of the Registrant's 1995 Annual Report, attached hereto as Exhibit 13. This information is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Description of Property.\nThe description of property set forth on pages 5-6 of the Registrant's 1995 Annual Report, attached hereto as Exhibit 13, is incorporated herein by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nRegistrant is one of approximately twenty designated potentially responsible parties (PRPs) in a federal \"Superfund\" environmental clean-up proceeding involving a dump site in Rose Township, Oakland County, Michigan. Although Registrant denies responsibility for contamination of the site, it has nevertheless agreed to participate in funding clean-up of the site by paying a share of the clean-up costs which Registrant does not consider to be material. This share has been assumed primarily because of the large transactional costs expected to be incurred in defending the lawsuit against the PRPs which would have been filed by the Environmental Protection Agency if the matter had not been settled voluntarily.\nRegistrant and eleven other PRPs have signed a Consent Decree and adopted a Remedial Action Plan which has been filed in, and approved by, the U.S. District Court for the Eastern District of Michigan. The Complaint instituting the court proceeding was filed September 19, 1989. The principal parties are the United States of America, the State of Michigan, and the PRPs. On appeal, the Consent Decree has been affirmed by the United States Court of Appeals for the Sixth Circuit. The allocation of the responsibility to fund the Remedial Action Plan among the participating PRPs is set out in a written Agreement to which Registrant is a party. Settlements with two of the Registrant's insurers resulted in coverage for in excess of one half of the Registrant's share.\nThe settling defendants have submitted to the United States Environmental Protection Agency comments regarding a soil vapor extraction system report which the PRPs submitted after a pilot study at the Site. The EPA had previously concluded that neither soil flushing nor enhanced soil flushing would achieve target cleanup levels for certain materials within the time frames specified in the Remedial Action Plan attached to the Consent Decree. The Rose Township PRP Agreement provides, upon the occurrence of such an event, the participating PRPs shall meet to discuss the allocation of the costs of performing further work. No meetings have been held or scheduled to discuss any allocation of additional remediation costs. It is anticipated that even if a successful effort to reopen allocation costs is made that the Registrant's share would not be material. Selection of soil vapor extraction as an alternate remedy by the EPA may require an amendment to the Record of Decision.\nThe Registrant and other Rose Township PRPs have been notified by the EPA of potential liability at another site located in Springfield Township, Oakland County, Michigan. The PRPs have actively been engaged in negotiations with the EPA and the Michigan Department of Natural Resources in an effort to agree upon mutually acceptable remediation parameters. The PRPs have negotiated Administrative Orders on Consent Regarding Selected Response Activities and for Cost Recovery Settlement, the cost of which is not expected to have a material effect upon the Company's financial statements. The PRPs have not negotiated an overall remedy at the Site. But, interim remediation is\noccurring as the Order Regarding Selected Response Activities covers the groundwater component of the remedy. The Registrant has settled with the Michigan Department of Natural Resources the Department's past cost claims at both the Rose and at the Springfield Township Sites. The Registrant's share of the settlements was an immaterial amount. It is anticipated that the Registrant's share of any future expense at the Site will be immaterial. The Registrant liquidated its coverage claims against its insurers.\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 Stock and Related Stockholder Matters.\n(a) The information set forth under the caption \"Stock Prices\" on page 7 of Registrant's 1995 Annual Report, attached hereto as Exhibit 13, is incorporated herein by reference. On September 1, 1995, the market price for Registrant's common stock on the Nasdaq National Market was $26.25 asked, $26.25 bid.\n(b) The approximate number of record holders of common stock securities is set forth on page 27 of Registrant's 1995 Annual Report, attached hereto as Exhibit 13. This information is incorporated herein by reference. Included are individual participants in security position listings.\n(c) Cash dividends were declared in each of the four quarters during fiscal 1995 and fiscal 1994. Total cash dividends in fiscal 1995 were 80 cents per share and in fiscal 1994 were 60 cents per share. Additional information is set forth under the caption \"Dividends\" on page 10 and in \"Note 2\" to the financial statements on page 18 of the Registrant's 1995 Annual Report, attached hereto as Exhibit 13, and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth under the caption \"Selected Financial Data\" on page 8, supplemented by the discussion on pages 9-12 of Registrant's 1995 Annual Report, attached hereto as Exhibit 13, is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe information set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 9-12 of Registrant's 1995 Annual Report, attached hereto as Exhibit 13, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Financial Statements and Quarterly Data set forth on pages 7 and 13-26 of Registrant's 1995 Annual Report, attached hereto as Exhibit 13, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.\nInapplicable.\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 set forth under the caption \"Election of Directors and Security Ownership of Management\" in Registrant's Proxy Statement dated September 27, 1995 is incorporated herein by reference.\n(b) Identification of Executive Officers.\nThe following information supplements the information provided under the caption \"Election of Directors and Security Ownership of Management\" in Registrant's Proxy Statement dated September 27, 1995 which is incorporated herein by reference.\n(c) Identification of Certain Significant Employees.\nInapplicable.\n(d) Family Relationships.\nThe information set forth in footnotes (b), (c), (d) and (e) under the caption \"Election of Directors and Security Ownership of Management\" in Registrant's Proxy Statement dated September 27, 1995 is incorporated herein by reference.\n(e) Business Experience.\n(1) Included in response to paragraphs (a) and (b) of this Item 10.\n(2) The information set forth under the caption \"Election of Directors and Security Ownership of Management\" in Registrant's Proxy Statement dated September 27, 1995 is incorporated herein by reference.\n(f) Involvement in Certain Legal Proceedings.\nNone.\n(g) Promoters and Control Persons.\nInapplicable.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information set forth under the captions \"Executive Compensation,\" \"Long-Term Incentive Plan,\" \"Comparative Performance Graph,\" \"Certain Relationships and Related Transactions,\" \"Restricted Stock Bonus Plans,\" \"Retirement Supplement,\" \"Salaried Pension Plan\" and \"Board of Directors and Committees\" in Registrant's Proxy Statement dated September 27, 1995 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information set forth under the caption \"Election of Directors and Security Ownership of Management\" in the Registrant's Proxy Statement dated September 27, 1995 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information set forth under the captions \"Certain Relationships and Related Transactions\" in Registrant's Proxy Statement dated September 27, 1995 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) and (2) - The response to this item is submitted as a separate section of this report beginning on page 12.\n(3) Exhibits. The following exhibits designated with a \"+\" symbol represent the Company's management contracts or compensation plans or arrangements for directors and executive officers.\n3.1 Registrant's Articles of Incorporation were filed as an exhibit to the Registrant's 1994 Form 10-K, and are incorporated herein by reference.\n3.2 Registrant's By-Laws were filed as an exhibit to Registrant's 1989 Form 10-K and are incorporated herein by reference.\n4.1 Lease-purchase contract dated as of November 1, 1979 between the City of Big Rapids, Michigan and Federal Screw Works was filed as an exhibit to Registrant's 1993 Form 10-K and is incorporated herein by reference.\n4.2 Guarantee agreement (municipal industrial revenue bond) dated as of November 1, 1979, as previously filed, was filed as an exhibit to the Registrant's 1993 Form 10-K and is incorporated herein by reference. All waivers, amendments and modifications thereto, were filed as exhibits to the Registrant's 1989, 1993 and 1994 Forms 10-K and are incorporated herein by reference.\n4.3 Revolving Credit and Term Loan Agreement by and between Registrant and Comerica Bank, as successor in interest by reason of merger to Manufacturers National Bank of Detroit dated September 21, 1989 (the \"Comerica Loan Agreement\") was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1989 and is incorporated herein by reference. Amendment No. 1 to the Comerica Loan Agreement dated January 24, 1990 was filed as an exhibit to the Registrant's 10-Q for the quarter ended December 31, 1989 and is incorporated herein by reference. Amendment No. 2 to the Comerica Loan Agreement dated September 15, 1990 was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1990 and is incorporated herein by reference. Amendment No. 3 to the Comerica Loan Agreement, dated August 12, 1991, was filed as an exhibit to the Registrant's 10-K for the year ended June 30, 1991 and is incorporated herein by reference. Amendment No. 4 for the Comerica Loan Agreement, dated October 30, 1992, was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1992 and is incorporated herein by reference. Amendments No. 5, 6, and 7 to the Comerica Loan Agreement, respectively dated November 15, 1992, December 15, 1992, and January 20, 1993 were filed as exhibits to the Registrant's 10-Q for the quarter ended December 31, 1992 and are incorporated herein by reference. Letter agreement, dated August 31, 1994, amending the Comerica Loan Agreement, was filed as an exhibit to the Registrant's 1994 Form 10-K, and is incorporated herein by reference.\n10.1+ Supplemental retirement agreement between the Registrant and W. T. ZurSchmiede, Jr., current Chairman and CEO of the Company, dated April 1, 1986 was filed as an exhibit to Registrant's 1993 Form 10-K and is incorporated herein by reference.\n10.2+ Supplemental retirement agreement between the Registrant and Hugh G. Harness, a director and past President of the Company, dated December 21, 1978 and amended pursuant to an Amendment to Agreement dated October 23, 1986, together with an Agreement providing for the retirement and consultation of and by Mr. Harness and the Registrant dated January 7, 1994, attached to which as Exhibits B and C were agreements further amending the supplemental retirement agreement, were filed as an exhibit to Registrant's 1994 Form 10-K, and are incorporated herein by reference.\n10.3+ Indemnity agreement effective September 24, 1986, which exists between the Registrant and each director, was filed as an exhibit to Registrant's 1992 Form 10-K, and is incorporated herein by reference.\n10.4 Lease agreement between the Registrant and Equitable Life Assurance Society of the United States for the lease of the 24th floor of the Buhl Building, Detroit, Michigan, effective January 1, 1995, was filed as an exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1995, and is incorporated herein by reference.\n10.5+* Intermediate-Term Bonus Plan for the Company's Chief Executive Officer.\n10.6+* Retirement Plan for Outside Directors as amended and restated.\n13.* Registrant's Annual Report to security holders for the year ended June 30, 1995.\n27.* Financial Data Schedule.\n------------------------------------- * Filed with this report\n(b) No reports on Form 8-K have been filed by Registrant during the last quarter of the period filed 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.\nFEDERAL SCREW WORKS ---------------------------------- (Registrant)\nBy: \/s\/ W. T. ZurSchmiede, Jr. ------------------------------- (Signature)\nW. T. ZurSchmiede, Jr. Chairman and Chief Executive Officer, Chief Financial Officer, Secretary, Treasurer and Principal Accounting Officer\nDate: 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.\nDate ----\n\/s\/ Thomas W. Butler, Jr. September 25, 1995 - ---------------------------------- Thomas W. Butler, Jr. Director\n\/s\/ Hugh G. Harness September 25, 1995 - ---------------------------------- Hugh G. Harness Director\n\/s\/ John J. Slavin September 25, 1995 - ---------------------------------- John J. Slavin Director\n\/s\/ F. D. Tennent September 25, 1995 - ---------------------------------- F. D. Tennent Director\n\/s\/ W. T. ZurSchmiede, Jr. September 25, 1995 - ---------------------------------- W. T. ZurSchmiede, Jr. Director\n\/s\/ R. F. ZurSchmiede September 25, 1995 - ---------------------------------- R. F. ZurSchmiede Director\n\/s\/ W. T. ZurSchmiede, III September 25, 1995 - ---------------------------------- W. T. ZurSchmiede, III Director\nANNUAL REPORT ON FORM 10-K\nITEM 14(a)(1) and (2), (c) and (d)\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nYEAR ENDED JUNE 30, 1995\nFEDERAL SCREW WORKS\nDETROIT, MICHIGAN\nFORM 10-K - ITEM 14(a)(1) AND (2)\nFEDERAL SCREW WORKS\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following financial statements of Federal Screw Works, included in the annual report of the Registrant to its stockholders for the year ended June 30, 1995, attached hereto as Exhibit 13 are incorporated by reference in Item 8:\nBalance sheets - June 30, 1995 and 1994\nStatements of operations - Years ended June 30, 1995, 1994 and 1993\nStatements of stockholders' equity - Years ended June 30, 1995, 1994 and 1993\nStatements of cash flows - Years ended June 30, 1995, 1994 and 1993\nNotes to financial statements - June 30, 1995\nThe following financial statement schedules of Federal Screw Works are 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[Letterhead of Ernst & Young LLP]\nErnst & Young LLP Suite 1700 Phone: 313 596 7100 500 Woodward Detroit, Michigan 48226-3426\nReport of Independent Auditors\nBoard of Directors Federal Screw Works\nWe have audited the accompanying balance sheets of Federal Screw Works 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 consolidated financial position of Federal Screw Works at 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 6 to the financial statements, the Company changed its method of accounting for postretirement benefits other than pensions in the year ended June 30, 1994.\ns\/ Ernst & Young LLP\nAugust 9, 1995\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nINDEX TO EXHIBITS\nThe following exhibits designated with a \"+\" symbol represent the Company's management contracts or compensation plans or arrangements for directors and executive officers.\n3.1 Registrant's Articles of Incorporation were filed as an exhibit to the Registrant's 1994 Form 10-K, and are incorporated herein by reference.\n3.2 Registrant's By-Laws were filed as an exhibit to Registrant's 1989 Form 10-K and are incorporated herein by reference.\n4.1 Lease-purchase contract dated as of November 1, 1979 between the City of Big Rapids, Michigan and Federal Screw Works was filed as an exhibit to Registrant's 1993 Form 10-K and is incorporated herein by reference.\n4.2 Guarantee agreement (municipal industrial revenue bond) dated as of November 1, 1979, as previously filed, was filed as an exhibit to the Registrant's 1993 Form 10-K and is incorporated herein by reference. All waivers, amendments and modifications thereto, were filed as exhibits to the Registrant's 1989, 1993 and 1994 Forms 10-K and are incorporated herein by reference.\n4.3 Revolving Credit and Term Loan Agreement by and between Registrant and Comerica Bank, as successor in interest by reason of merger to Manufacturers National Bank of Detroit dated September 21, 1989 (the \"Comerica Loan Agreement\") was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1989 and is incorporated herein by reference. Amendment No. 1 to the Comerica Loan Agreement dated January 24, 1990 was filed as an exhibit to the Registrant's 10-Q for the quarter ended December 31, 1989 and is incorporated herein by reference. Amendment No. 2 to the Comerica Loan Agreement dated September 15, 1990 was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1990 and is incorporated herein by reference. Amendment No. 3 to the Comerica Loan Agreement, dated August 12, 1991, was filed as an exhibit to the Registrant's 10-K for the year ended June 30, 1991 and is incorporated herein by reference. Amendment No. 4 for the Comerica Loan Agreement, dated October 30, 1992, was filed as an exhibit to the Registrant's 10-Q for the quarter ended September 30, 1992 and is incorporated herein by reference. Amendments No. 5, 6, and 7 to the Comerica Loan Agreement, respectively dated November 15, 1992, December 15, 1992, and January 20, 1993 were filed as exhibits to the Registrant's 10-Q for the quarter ended December 31, 1992 and are incorporated herein by reference. Letter agreement, dated August 31, 1994, amending the Comerica Loan Agreement, was filed as an exhibit to the Registrant's 1994 Form 10-K, and is incorporated herein by reference.\n10.1+ Supplemental retirement agreement between the Registrant and W. T. ZurSchmiede, Jr., current Chairman and CEO of the Company, dated April 1, 1986 was filed as an exhibit to Registrant's 1993 Form 10-K and is incorporated herein by reference.\n10.2+ Supplemental retirement agreement between the Registrant and Hugh G. Harness, a director and past President of the Company, dated December 21, 1978 and amended pursuant to an Amendment to Agreement dated October 23, 1986, together with an Agreement providing for the retirement and consultation of and by Mr. Harness and the Registrant dated January 7, 1994, attached to which as Exhibits B and C were agreements further amending the supplemental retirement agreement, were filed as an exhibit to Registrant's 1994 Form 10-K, and are incorporated herein by reference.\n10.3+ Indemnity agreement effective September 24, 1986, which exists between the Registrant and each director, was filed as an exhibit to Registrant's 1992 Form 10-K, and is incorporated herein by reference.\n10.4 Lease agreement between the Registrant and Equitable Life Assurance Society of the United States for the lease of the 24th floor of the Buhl Building, Detroit, Michigan, effective January 1, 1995, was filed as an exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1995, and is incorporated herein by reference.\n10.5+* Intermediate-Term Bonus Plan for the Company's Chief Executive Officer.\n10.6+* Retirement Plan for Outside Directors as amended and restated.\n13.* Registrant's Annual Report to security holders for the year ended June 30, 1995.\n27.* Financial Data Schedule.\n------------------------------------- * Filed with this report","section_15":""}
{"filename":"800608_1995.txt","cik":"800608","year":"1995","section_1":"Item 1. Business\nGeneral\nFogelman Mortgage L.P. I (the ``Registrant''), a Tennessee limited partnership, was formed on September 4, 1986 and will terminate on December 31, 2016 unless terminated sooner under the provisions of the Second Amendment to Amended and Restated Certificate and Agreement of Limited Partnership (the ``Partnership Agreement''). The Registrant was formed to invest in mortgage loans with the proceeds raised from the initial sale of 54,200 depositary units (``Units''). The Registrant invested in two mortgage loans (the ``Mortgage Loans'') which provided construction and permanent financing for the development of two multi-family residential apartment complexes. The Registrant's fiscal year for book and tax purposes ends on December 31.\nThe Registrant is engaged solely in the business of investing in mortgage loans; therefore, presentation of industry segment information is not applicable. For more information regarding the Registrant's operations, see Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.\nGeneral Partner\nThe general partner of the Registrant is Prudential-Bache Properties, Inc. (``PBP'' or the ``General Partner'').\nMortgage Loans\nThe Registrant holds first mortgages on two properties, Pointe Royal apartments and Westmont apartments (individually, a ``Property'' and collectively, the ``Properties''). The Pointe Royal apartments were financed by the ``Royal View Loan'' and the Westmont apartments were financed by the ``Chesterfield Loan.''\nThe Pointe Royal project, which secures the Royal View Loan, is located in Overland Park, Kansas and is a townhouse apartment community consisting of 52 buildings on approximately 35 acres of land. As of December 31, 1995, the monthly rents at the Pointe Royal project range from $560 to $875.\nThe Westmont project, which secures the Chesterfield Loan, is located in Chesterfield, Missouri and is an apartment community consisting of 25 buildings on approximately 58 acres of land. As of December 31, 1995, the monthly rents at the Westmont project range from $560 to $790.\nThe interest pay rate has been modified and is equal to the net property cash flow generated by the respective Properties payable monthly (7.7% for 1995), with the difference between the amount actually paid and the original pay rate of 9.5% per annum being accounted for in a separate account for each Property, which itself bears interest at 9.5% per annum (``Unpaid Interest''). The Mortgage Loans require\ncurrent payments of interest only with balloon payments of the entire principal and Unpaid Interest amounts due from sale or refinancing proceeds or upon maturity. The ultimate collectibility of the Unpaid Interest as well as the full principal of the Mortgage Loans will depend upon the value of the underlying properties which are currently estimated, based on third party appraisals, to be less than the amounts due. However, the estimated property values exceed the Registrant's carrying amount of the Mortgage Loans. A full appraisal for both properties was obtained in 1990 which used the cost, sales comparison and income capitalization approaches to value. These reports were subsequently updated via limited appraisal reports in 1991, 1992 and 1993. Limited appraisal reports consist of an update of the income capitalization approach used to determine a property's market value. The values of Pointe Royal and Westmont estimated in the limited appraisal reports were $22,400,000 and $19,000,000, respectively, as of December 1, 1993.\nFollowing is the interest received from each of the Registrant's Mortgage Loans as a percentage of total interest received and the equity income on the underlying properties as a percentage of total equity income:\nFor summary financial statements of the underlying properties, see Note G to the financial statements in the Registrant's Annual Report to Unitholders for the year ended December 31, 1995 (``Registrant's Annual Report'') which is filed as an exhibit hereto.\nCompetition\nThe General Partner has formed various entities to engage in businesses which may be competitive with the Registrant. Both of the Properties collateralizing the Mortgage Loans are located in markets where the property manager manages other apartment complexes.\nThe Registrant's business is affected by competition to the extent that the underlying properties from which it derives interest payments are subject to competition from neighboring properties. The Westmont apartments are located in the St. Louis metropolitan area and the Pointe Royal apartments are located in the Kansas City metropolitan area. The Properties' occupancy and rental rates are comparable to their competitors. There are new complexes under construction with expected completion dates during 1996 and 1997 that could become future competitors in Pointe Royal's market.\nEmployees\nThe Registrant has no employees. Management and administrative services for the Registrant are performed by the General Partner and its affiliates pursuant to the Partnership Agreement. The General Partner receives compensation and reimbursement of expenses in connection with such activities as described in Sections 9 and 10 of the Partnership Agreement. See Note E to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant does not own or lease any property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThis information is incorporated by reference to Note F to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Unitholders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Units and Related Unitholder Matters\nAs of March 1, 1996 there were 5,553 holders of record owning 54,200 Units. A significant secondary market for the Units has not developed and it is not expected that one will develop in the future. There are also certain restrictions set forth in the Partnership Agreement limiting the ability of a Unitholder to transfer Units. Consequently, holders of Units may not be able to liquidate their investments in the event of an emergency or for any other reason.\nThe following per Unit cash distributions were paid to Unitholders during the following calendar quarters.\nThere are no material legal restrictions upon the Registrant's present or future ability to make distributions in accordance with the provisions of the Partnership Agreement. Cash distributions paid in 1995 were funded from current operations. Approximately $1,434,000 and $1,231,000 of the distributions paid to Unitholders during 1995 and 1994, respectively, represent a return of capital on a generally accepted accounting principles (GAAP) basis. The return of capital on a GAAP basis is calculated as Unitholder distributions less net income allocated to Unitholders. The Registrant currently expects that cash distributions will continue to be paid in the foreseeable future from cash generated by operations, which may be supplemented by previously undistributed cash from operations. For discussion of other factors that may affect future distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 10 through 11 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table presents selected financial data of the Registrant. This data should be read in conjunction with the financial statements of the Registrant and the notes thereto on pages 2 through 9 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis information is incorporated by reference to pages 10 and 11 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements are incorporated by reference to pages 2 through 9 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThere are no directors or executive officers of the Registrant. The Registrant is managed by the General Partner.\nThe Registrant, the Registrant's General Partner and its directors and executive officers, and any persons holding more than ten percent of the Registrant's Units are required to report their initial ownership of such Units and any subsequent changes in that ownership to the Securities and Exchange Commission on Forms 3, 4 and 5. Such executive officers, directors and Unitholders who own greater than ten percent of the Registrant's Units are required by Securities and Exchange Commission regulations to furnish the Registrant with copies of all Forms 3, 4 or 5 they file. All of these filing requirements were satisfied on a timely basis. In making these disclosures, the Registrant has relied solely on written representations of the General Partners' directors and executive officers and Unitholders who own greater than ten percent of the Registrant's Units or copies of the reports they have filed with the Securities and Exchange Commission during and with respect to its most recent fiscal year.\nThe directors and executive officers of PBP and their positions with regard to managing the Registrant are as follows:\nTHOMAS F. LYNCH, III, age 37, is the President, Chief Executive Officer, Chairman of the Board of Directors and a Director of PBP. He is a Senior Vice President of Prudential Securities Incorporated (``PSI''), an affiliate of PBP. Mr. Lynch also serves in various capacities for other affiliated companies. Mr. Lynch joined PSI in November 1989.\nBARBARA J. BROOKS, age 47, is the Vice President--Finance and Chief Financial Officer of PBP. She is a Senior Vice President of PSI. Ms. Brooks also serves in various capacities for other affiliated companies. She has held several positions within PSI since 1983. Ms. Brooks is a certified public accountant.\nEUGENE D. BURAK, age 50, is a Vice President of PBP. He is a First Vice President of PSI. Prior to joining PSI in September 1995, he was a management consultant for three years and was with Equitable Capital Management Corporation from March 1990 to May 1992. Mr. Burak is a certified public accountant.\nCHESTER A. PISKOROWSKI, age 52, is a Vice President of PBP. He is a Senior Vice President of PSI and is the Senior Manager of the Specialty Finance Asset Management area. Mr. Piskorowski has held several positions within PSI since April 1972. Mr. Piskorowski is a member of the New York and Federal Bars.\nFRANK W. GIORDANO, age 53, is a Director of PBP. He is a Senior Vice President of PSI and an Executive Vice President and General Counsel of Prudential Mutual Fund Management, Inc., an affiliate of\nPSI. Mr. Giordano also serves in various capacities for other affiliated companies. He has been with PSI since July 1967.\nNATHALIE P. MAIO, age 45, is a Director of PBP. She is a Senior Vice President and Deputy General Counsel of PSI and supervises non-litigation legal work for PSI. She joined PSI's Law Department in 1983; presently, she also serves in various capacities for other affiliated companies.\nJames M. Kelso ceased to serve as President, Chief Executive Officer, Chairman of the Board of Directors and Director effective June 30, 1995. Effective June 30, 1995, Thomas F. Lynch, III was elected President, Chief Executive Officer, Chairman of the Board of Directors and Director. Robert J. Alexander ceased to serve as Vice President effective August 25, 1995. Eugene D. Burak was elected Vice President effective October 9, 1995.\nThere are no family relationships among any of the foregoing directors or officers. All of the foregoing officers and\/or directors have indefinite terms.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant does not pay or accrue any fees, salaries or any other form of compensation to directors and officers of the General Partner for their services. Certain officers and directors of the General Partner receive compensation from affiliates of the General Partner, 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 compensation attributable to services performed for the Registrant is immaterial. See Item 13 Certain Relationships and Related Transactions for information regarding reimbursement to the General Partners for services provided to the Registrant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 1, 1996, no director or officer of the General Partner owns directly or beneficially any interest in the voting securities of the General Partner.\nAs of March 1, 1996, no director or officer of the General Partner owns directly or beneficially any of the Units issued by the Registrant.\nAs of March 1, 1996, no beneficial owners who are neither a director nor officer of the General Partner beneficially own more than five percent (5%) of the Units issued by the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Registrant has and will continue to have certain relationships with the General Partner and its affiliates. However, there have been no direct financial transactions between the Registrant and the directors or officers of the General Partner.\nReference is made to Notes A and E to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto, which identify the related parties and discuss the services provided by these parties and the amounts paid or payable for their services.\nPART IV\n(LOGO) Two World Financial Center Telephone: (212) 436-2000 New York, New York 10281-1414 Facsimile: (212) 436-5000\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Fogelman Mortgage L.P. I New York, New York\nWe have audited the financial statements of Fogelman Mortgage L.P. I (a Tennessee Limited 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 February 12, 1996; such financial statements and report are included in your 1995 Annual Report to Limited Partners and are incorporated herein by reference. Our audits also included the financial statement schedule of Fogelman Mortgage L.P. I, listed in Item 14.","section_14":"","section_15":""}
{"filename":"103730_1995.txt","cik":"103730","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nVishay Intertechnology, Inc. (together with its consolidated subsidiaries, \"Vishay\" or the \"Company\") is a leading international manufacturer and supplier of passive electronic components, particularly resistors, capacitors and inductors, offering its customers \"one-stop\" access to one of the most comprehensive passive electronic component lines of any manufacturer in the United States or Europe. Passive electronic components, together with semiconductors (integrated circuits), which the Company does not produce, are the primary elements of every electronic circuit. The Company manufactures one of the broadest lines of surface mount devices, a fast growing format for passive electronic components that is being increasingly demanded by customers. In addition, the Company continues to produce components in the traditional leaded form. Components manufactured by the Company are used in virtually all types of electronic products, including those in the computer, telecommunications, military\/aerospace, instrument, automotive, medical and consumer electronics industries.\nSince early 1985, the Company has pursued a business strategy that principally consists of the following elements: (i) expansion within the passive electronic components industry, primarily through the acquisition of other manufacturers with established positions in major markets, reputations for product quality and reliability and product lines with which the Company has substantial marketing and technical expertise; (ii) reduction of selling, general and administrative expenses through the integration or elimination of redundant sales offices and administrative functions at acquired companies; (iii) achievement of significant production cost savings through the transfer and expansion of manufacturing operations to regions, such as Israel, Mexico, Portugal and the Czech Republic, where the Company can take advantage of lower labor costs and available tax and other government-sponsored incentives; and (iv) maintaining significant production facilities in those regions where the Company markets the bulk of its products in order to enhance customer service and responsiveness.\nAs a result of this strategy, the Company has grown during the past ten years from a small manufacturer of precision resistors and strain gages to one of the world's largest manufacturers and suppliers of a broad line of passive electronic components. During this period, its revenues have increased from $57 million for fiscal year 1985 to $1.2 billion for the year ended December 31, 1995, while net profits have increased from $7.9 million to $92.7 million.\nThe Company's major acquisitions have included Dale Electronics, Inc. (United States, Mexico and the United Kingdom) in 1985, Draloric Electronic GmbH (Germany and the United Kingdom) in 1987, Sfernice S.A. (France) in 1988, Sprague Electric Company (\"Sprague\") (United States and France) in 1992, Roederstein GmbH (\"Roederstein\") (Germany, Portugal and the United States) in 1993, and Vitramon, Incorporated (\"Vitramon\") (United States, France, Germany and the United Kingdom) in 1994. In January 1995, the Company acquired a 49% equity interest in Nikkohm Co., Ltd., a Japanese manufacturer of thin film resistors and resistor networks. Nikkohm had sales of approximately $5 million in 1995. This acquisition is intended to facilitate the Company's access to the Japanese electronics market.\nThe Company currently operates as three separate business units: (i) Vishay Electronic Components, North America and Asia, which is comprised of Dale, a manufacturer and supplier of resistors, the Vishay Resistive Systems Unit, which primarily manufactures high performance foil resistors and thin film resistor networks; Sprague, which primarily manufactures tantalum capacitors; and the U.S. operations of Vitramon, which manufacture multi-layer ceramic chip (MLCC) capacitors; (ii) Vishay Electronic Components, Europe, which is comprised of Draloric\/Roederstein, German-based manufacturers and suppliers of resistors and capacitors in Europe, which includes the German operations of Vitramon; Vishay, S.A., a resistor producer in France, which includes the French operations of Vitramon; and Vishay Components (UK), a manufacturer and supplier of the Company's products in the United Kingdom, which includes the U.K. operations of Vitramon; and (iii) Measurements Group, Inc., which produces resistive sensors and other stress measuring devices in the United States.\nVishay was incorporated in Delaware in 1962 and maintains its principal executive offices at 63 Lincoln Highway, Malvern, Pennsylvania 19355-2120. The telephone number is (610) 644-1300.\nPRODUCTS\nVishay designs, manufactures and markets electronic components that cover a wide range of products and technologies. The products primarily consist of fixed resistors, tantalum, multi- layer ceramic chip (\"MLCC\") and film capacitors, and, to a lesser extent, inductors, aluminum and specialty ceramic capacitors, transformers, potentiometers, plasma displays and thermistors. The Company offers most of its product types in the increasingly demanded surface mount device form and in the traditional leaded device form. The Company believes it produces one of the broadest lines of passive electronic components available from any single manufacturer.\nResistors are basic components used in all forms of electronic circuitry to adjust and regulate levels of voltage and\ncurrent. They vary widely in precision and cost, and are manufactured in numerous materials and forms. Resistive components may be either fixed or variable, the distinction being whether the resistance is adjustable (variable) or not (fixed). Resistors can also be used as measuring devices, such as Vishay's resistive sensors. Resistive sensors or strain gages are used in experimental stress analysis systems as well as in transducers for electronic measurement loads (scales), acceleration and fluid pressure.\nVishay manufactures virtually all types of fixed resistors, both in discrete and network forms. These resistors are produced for virtually every segment of the resistive product market, from resistors used in the highest quality precision instruments for which the performance of the resistors is the most important requirement, to resistors for which price is the most important factor.\nCapacitors perform energy storage, frequency control, timing and filtering functions in most types of electronic equipment. The more important applications for capacitors are (i) electronic filtering for linear and switching power supplies, (ii) decoupling and bypass of electronic signals or integrated circuits and circuit boards, and (iii) frequency control, timing and conditioning of electronic signals for a broad range of applications. The Company's capacitor products primarily consist of solid tantalum surface mount chip capacitors, solid tantalum leaded capacitors, wet\/foil tantalum capacitors, MLCC capacitors, and film capacitors. Each capacitor product has unique physical and electrical performance characteristics that make each type of capacitor useful for specific applications. Tantalum and MLCC capacitors are generally used in conjunction with integrated circuits in applications requiring low to medium capacitance values (\"capacitance\" being the measure of the capacitor's ability to store energy). The tantalum capacitor is the smallest and most stable type of capacitor for its range of capacitance and is best suited for applications requiring medium capacitance values. MLCC capacitors, on the other hand, are more cost-effective for applications requiring lower capacitance values. The Company's MLCC capacitors are known for their particularly high reliability. Management believes that surface mounted MLCC chip capacitors, tantalum chip capacitors, and thick film resistor chips represent the fastest growing segments of the passive electronic component industry.\nThe Company believes it has taken advantage of the growth of the surface mount component market and is an industry leader in designing and marketing surface mount devices. The Company also believes that in the United States and Europe it is a market leader in the development and production of a wide range of these devices, including thick film chip resistors, thick film resistor networks and arrays, metal film leadless resistors (MELFs), molded tantalum chip capacitors, coated tantalum chip capacitors, film capacitors,\nmulti-layer ceramic chip capacitors, thin film chip resistors, thin film networks, wirewound chip resistors, power strip resistors, bulk metal foil chip resistors, current sensing chips, chip inductors, chip transformers, chip trimmers and NTC chip thermistors. The Company also provides a number of component packaging styles to facilitate automated product assembly by its customers. The Company's position in the surface mount market has been enhanced by the acquisition of Vitramon, since substantially all of Vitramon MLCC products utilize surface mount technology. Surface mount devices adhere to the surface of a circuit board rather than being secured by leads that pass through holes to the back side of the board. Surface mounting provides distinct advantages over through-hole mounting. For example, surface mounting allows the placement of more components on a circuit board, which is particularly desirable for a growing number of manufacturers who require greater miniaturization in products such as hand held computers and cellular telephones. Surface mounting also facilitates automation, resulting in lower production costs for equipment manufacturers than those associated with leaded devices.\nMARKETS\nThe Company's products are sold primarily to original equipment manufacturers (\"OEMs\"), OEM subcontractors that assemble printed circuit boards and independent distributors that maintain large inventories of electronic components for resale to OEMs. Its products are used in, among other things, virtually every type of product containing electronic circuitry, including computer-related products, telecommunications, measuring instruments, industrial equipment, automotive applications, process control systems, military and aerospace applications, consumer electronics, medical instruments and scales.\nFor the year ended December 31, 1995, 39% of the Company's net sales was attributable to customers in the United States, while the remainder was attributable to sales primarily in Europe.\nIn the United States, products are marketed through independent manufacturers' representatives, who are compensated solely on a commission basis, by the Company's own sales personnel and by independent distributors. The Company has regional sales personnel in several North American locations to provide technical and sales support for independent manufacturers' representatives throughout the United States, Mexico and Canada. In addition, the Company uses independent distributors to resell its products. Outside North America, products are sold to customers in Germany, the United Kingdom, France, Israel, Japan, Singapore, South Korea, Brazil and other European and Pacific Rim countries through Company sales offices, independent manufacturers' representatives and distributors. In order to better serve its customers, the Company\nmaintains production facilities in those regions where it markets the bulk of its products, such as the U.S., Germany, France and the U.K. In addition, to maximize production efficiencies, the Company seeks whenever practicable to establish manufacturing facilities in those regions, such as Israel, Mexico, Portugal and the Czech Republic, where it can take advantage of lower labor costs and available tax and other government-sponsored incentives.\nThe Company undertakes to have its products incorporated into the design of electronic equipment at the research and prototype stages. Vishay employs its own staff of application and field engineers who work with its customers, independent manufacturers' representatives and distributors to solve technical problems and develop products to meet specific needs.\nThe Company has qualified certain products under various military specifications, approved and monitored by the United States Defense Electronic Supply Center (\"DESC\"), and under certain European military specifications. Classification levels have been established by DESC based upon the rate of failure of products to meet specifications (the \"Classification Level\"). In order to maintain the Classification Level of a product, tests must be continuously performed, and the results of these tests must be reported to DESC. If the product fails to meet the requirements for the applicable Classification Level, the product's classification may be reduced to a less stringent level. Various United States manufacturing facilities from time to time experience a product Classification Level modification. During the time that such level is reduced for any specific product, net sales and earnings derived from such product may be adversely affected.\nThe Company is undertaking to have the quality systems at most of its major manufacturing facilities approved under the ISO 9000 international quality control standard. ISO 9000 is a comprehensive set of quality program standards developed by the International Standards Organization. Several of the Company's manufacturing operations have already received ISO 9000 approval and others are actively pursuing such approval.\nVishay's largest customers vary from year to year, and no customer has long-term commitments to purchase products of the Company. No customer accounted for more than 10% of the Company's sales for the year ended December 31, 1995.\nRESEARCH AND DEVELOPMENT\nMany of the Company's products and manufacturing processes have been invented, designed and developed by Company engineers and scientists. The Company maintains strategically located design centers where proximity to customers enables it to more easily satisfy the needs of the local market. These design centers are located in the United States (Connecticut, Maine,\nNebraska, North Carolina, Pennsylvania), in Germany (Selb, Landshut, Pfafenberg, Backnang), in France (Nice, Tours, Evry) and Israel. The Company also maintains separate research and development staffs and promotes separate programs at a number of its production facilities to develop new products and new applications of existing products, and to improve product and manufacturing techniques. This decentralized system encourages individual product development at individual manufacturing facilities that occasionally have applications at other facilities. Company research and development costs were approximately $10.4 million for 1995, $7.2 million for 1994 and $7.1 million for 1993. These amounts do not include substantial expenditures for product development and the design, development and manufacturing of machinery and equipment for new processes and for cost reduction measures. See \"Competition\".\nSOURCES OF SUPPLIES\nAlthough most materials incorporated in the Company's products are available from a number of sources, certain materials (particularly tantalum and palladium) are available only from a relatively limited number of suppliers.\nTantalum, a metal, is the principal material used in the manufacture of tantalum capacitor products. It is purchased in powder form primarily under annual contracts with domestic suppliers at prices that are subject to periodic adjustment. The Company is a major consumer of the world's annual tantalum production. There are currently three major suppliers that process tantalum ore into capacitor grade tantalum powder. Although the Company believes that there is currently a surplus of tantalum ore reserves and a sufficient number of tantalum processors relative to foreseeable demand, and that the tantalum required by the Company has generally been available in sufficient quantities to meet requirements, the limited number of tantalum powder suppliers could lead to increases in tantalum prices that the Company may not be able to pass on to its customers.\nPalladium is primarily purchased on the spot and forward markets, depending on market conditions. Palladium is considered a commodity and is subject to price volatility. The price of palladium has fluctuated in the range of approximately $104 to $130 per troy ounce during the last three years. Although palladium is currently found in South Africa and Russia, the Company believes that there are a sufficient number of domestic and foreign suppliers from which the Company can purchase palladium. However, an inability on the part of the Company to pass on increases in palladium costs to its customers could have an adverse effect on the margins of those products using the metal.\nINVENTORY AND BACKLOG\nAlthough Vishay manufactures standardized products, a substantial portion of its products are produced to meet customer specifications. The Company does, however, maintain an inventory of resistors and other components. Backlog of outstanding orders for the Company's products was $339.2 million, $305.7 million and $198.4 million, respectively, at December 31, 1995, 1994 and 1993. The increase in backlog at December 31, 1994 as compared with 1993 is attributable in large part to the acquisition of Vitramon. The increase in backlog at December 31, 1995 reflects an increase in demand for the Company's surface mounted components, particularly MLCC capacitors, tantalum capacitors and thick film resistor chips. Such demand was particularly strong during the first half of 1995. Since the last fiscal quarter of 1995, and continuing into the first quarter of 1996, the Company has experienced an overall slowdown in demand for its products. The Company believes this may be primarily a result of the unusually large build up of Vishay components in its customers' inventories during the first half of 1995.\nThe Company, however, still continues to experience capacity constraints in some of the above-mentioned products. The Company anticipates that the increase in its plant manufacturing space in Israel over the next 12 months will alleviate these constraints. In any event, the current backlog is expected to be filled during the next twelve months. Most of the orders in the Company's backlog may be cancelled by its customers, in whole or in part, although sometimes subject to penalty. To date, however, cancellations have not been significant.\nCOMPETITION\nThe Company faces strong competition in its various product lines from both domestic and foreign manufacturers that produce products using technologies similar to those of the Company. The Company's main competitors for tantalum capacitors are KEMET, AVX and NEC; for MLCC capacitors, competitors are KEMET, AVX, Murata and TDK. For thick film chip resistors, competitors are ROHM, Koa and Yageo. For wirewound and metal film resistors, competitors are IRC, ROHM and Ohmite.\nThe Company's competitive position depends on its product quality, know-how, proprietary data, marketing and service capabilities and business reputation, as well as on price. In respect of certain of its products, the Company competes on the basis of its marketing and distribution network, which provides a high level of customer service. For example, the Company works closely with its customers to have its components incorporated into their electronic equipment at the early stages of design and production and maintains redundant production sites for most of its products to ensure an uninterrupted supply of products. Further,\nthe Company has established a National Accounts Management Program, which provides the Company's largest customers with one national account executive who can cut across Vishay business unit lines for sales, marketing and contract coordination. In addition, the breadth of the Company's product offerings enables the Company to strengthen its market position by providing its customers with \"one-stop\" access to one of the broadest selections of passive electronic components available from a direct manufacturing source.\nA number of the Company's customers are contractors or subcontractors on various United States and foreign government contracts. Under certain United States Government contracts, retroactive adjustments can be made to contract prices affecting the profit margin on such contracts. The Company believes that its profits are not excessive and, accordingly, no provision has been made for any such adjustment.\nAlthough the Company has numerous United States and foreign patents covering certain of its products and manufacturing processes, no particular patent is considered material to the business of the Company.\nMANUFACTURING OPERATIONS\nThe Company strives to balance the location of its manufacturing facilities. In order to better serve its customers, the Company maintains production facilities in those regions where it markets the bulk of its products, such as the United States, Germany, France and the United Kingdom. To maximize production efficiencies, the Company seeks whenever practicable to establish manufacturing facilities in countries, such as Israel, Mexico, Portugal and the Czech Republic, where it can take advantage of lower labor and tax costs and, in the case of Israel, to take advantage of various government incentives, including grants and tax relief.\nAt December 31, 1995, approximately 40% of the Company's identifiable assets were located in the United States, approximately 42% were located in Europe, approximately 17% were located in Israel and approximately 1% in other regions. In the United States, the Company's main manufacturing facilities are located in Nebraska, South Dakota, North Carolina, Pennsylvania, Maine, Connecticut, Virginia, New Hampshire and Florida. In Europe, the Company's main manufacturing facilities are located in Selb, Landshut and Backnang, Germany and Nice and Tours, France. In Israel, manufacturing facilities are located in Holon, Dimona and rented facilities in Migdal Ha-emek. The Company also maintains major manufacturing facilities in Juarez, Mexico; Toronto, Canada; Porto, Portugal; and the Czech Republic. Recently, the Company has invested substantial resources to increase capacity and to maximize automation in its plants, which it believes will further reduce production costs.\nTo address the increasing demand for its products and in order to lower its costs, the Company has expanded, and plans to continue to expand, its manufacturing operations in Israel, where it benefits from the government's employment and tax incentive programs designed to increase employment, lower wage rates and a highly-skilled labor force, all of which have contributed substantially to the growth and profitability of the Company.\nUnder the terms of the Israeli government's incentive programs, once a project is approved, the recipient is eligible to receive the benefits of the related grants for the life of the project, so long as the recipient continues to meet preset eligibility standards. None of the Company's approved projects has ever been cancelled or modified and the Company has already received approval for a majority of the projects contemplated by its capital expenditure program. However, from time to time, the government has considered scaling back or discontinuing these programs. Accordingly, there can be no assurance that the Israeli government will continue to offer new incentive programs or that, if it does, the Company will continue to be eligible to take advantage of them. The Company might be materially adversely affected if these incentive programs were no longer available to the Company for new projects. In addition, the Company might be materially adversely affected if hostilities were to occur in the Middle East that interfere with the Company's operations in Israel. The Company, however, has never experienced any material interruption in its Israeli operations in its 26 years of production there, in spite of several Middle East crises, including wars. For the year ended December 31, 1995, sales of products manufactured in Israel accounted for approximately 17% of the Company's net sales.\nDue to a shift in manufacturing emphasis to higher automation and the relocation of some production to regions with lower labor costs, portions of the Company's work force and certain facilities may not be fully utilized in the future. As a result, the Company may incur significant costs in connection with work force reductions and the closing of additional manufacturing facilities. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nENVIRONMENT\nThe Company's manufacturing operations are subject to various federal, state and local laws restricting discharge of materials into the environment. The Company is not involved in any pending or threatened proceedings which would require curtailment of its operations. However, the Company is involved in various legal actions concerning state government enforcement proceedings and various dump site cleanups. These actions may result in fines and\/or cleanup expenses. The Company believes that any fine or cleanup expense, if imposed, would not be material. The Company continually expends funds to ensure that its facilities comply with\napplicable environmental regulations. The Company has nearly completed its undertaking to comply with new environmental regulations relating to the elimination of chlorofluorocarbons (CFCs) and ozone depleting substances (ODS) and other anticipated compliances with the Clean Air Act amendments of 1990. The Company anticipates that it will undertake capital expenditures of approximately $4,000,000 in fiscal 1996 for general environmental compliance and enhancement programs. The Company has been named a Potentially Responsible Party (PRP) at seven Superfund sites. The Company has settled three of these for minimal amounts and does not expect the others to be material. While the Company believes that it is in material compliance with applicable environmental laws, it cannot accurately predict future developments or have knowledge of past occurrences on sites currently occupied by the Company. Moreover, the risk of environmental liability and remediation costs is inherent in the nature of the Company's business and, therefore, there can be no assurance that material environmental costs, including remediation costs will not arise in the future.\nWith each acquisition, the Company undertakes to identify potential environmental concerns and to minimize the environmental matters it may be required to address. In addition, the Company establishes reserves for specifically identified potential environmental liabilities. The Company believes that the reserves it has established are adequate. Nevertheless, the Company often unavoidably inherits certain pre-existing environmental liabilities, generally based on successor liability doctrines. Although the Company has never been involved in any environmental matter that has had a material adverse impact on its overall operations, there can be no assurance that in connection with any past or future acquisition the Company will not be obligated to address environmental matters that could have a material adverse impact on its operations.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 17,900 full time employees of whom approximately 11,000 were located outside the United States. The Company hires few employees on a part time basis. While various of the Company's foreign employees are members of trade unions, a de minimus number of the Company's employees located in the United States is represented by unions. The Company believes that its relationship with its employees is excellent. However, no assurance can be given that if the Company continues to restructure its operations in response to changing economic conditions that labor unrest or strikes (especially at European facilities) will not occur.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company maintains approximately 54 manufacturing facilities. The principal locations of such facilities, along with available space including administrative offices, are:\nApprox. Available Owned Locations Space (Square Feet) - --------------- -------------------\nUnited States ------------- Columbus and Norfolk, NE* 336,000 Malvern and Bradford, PA* 215,000 Sanford, ME 225,000 Wendell and Statesville, NC* 193,000 Concord, NH 120,000 Roanoke, VA 120,000 Monroe, CT 91,000 - ---------------- * two locations\nForeign ------- Germany (10 locations) 954,000 France (7 locations) 560,000 Israel (2 locations) 430,000 Portugal 299,000\nVishay owns an additional 272,000 square feet of manufacturing facilities located in Colorado, Maryland, New York, South Dakota and Florida.\nAvailable leased facilities in the United States include 190,000 square feet of space located in California, New Jersey, South Dakota and Massachusetts. Foreign leased facilities consist of 121,000 square feet in Mexico, 188,000 square feet in France, 127,000 square feet in England, 37,000 square feet in Canada and 202,000 square feet in Germany. The Company also has facilities in Japan, Brazil, Israel and the Czech Republic.\nTo alleviate current capacity restraints, however, the Company expects to complete construction of a 250,000 square foot plant in Migdal Ha-emek, Israel and a 270,000 square foot facility in Beersheba, Israel in 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company from time to time is involved in routine litigation incidental to its business. Management believes that such matters, either individually or in the aggregate, should not have a material adverse effect on the Company's business or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders of the Company.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information regarding the executive officers of the Company as of March 18, 1996.\nName Age Positions Held - ---- --- -------------- Felix Zandman* 67 Chairman of the Board, President, Chief Executive Officer and Director\nRichard N. Grubb* 49 Vice President, Treasurer, Chief Financial Officer and Director\nRobert A. Freece* 55 Senior Vice President and Director\nAbraham Inbar 67 Vice President; President -- Vishay Israel Ltd., a subsidiary of Vishay\nHenry V. Landau 49 Vice President; President -- Measurements Group, Inc., a subsidiary of Vishay\nWilliam J. Spires 54 Vice President and Secretary\nDonald G. Alfson 50 Vice President; President - - Vishay Electronic Components, North America and Asia, President -- Dale Electronics, Inc., and Director\nGerald Paul 47 Vice President; President - - Vishay Electronic Components, Europe, Managing Director -- Draloric Electronic GmbH, and Director\n* Member of the Executive Committee of the Board of Directors.\nDr. Felix Zandman, a founder of the Company, has been President, Chief Executive Officer and a Director of the Company\nsince its inception. Dr. Zandman has been Chairman of the Board since March 1989.\nRichard N. Grubb has been a Director, Vice President, Treasurer and Chief Financial Officer of the Company since May 1994. Mr. Grubb has been associated with the Company in various capacities since 1972. He is a Certified Public Accountant who was previously engaged in private practice.\nRobert A. Freece has been a Director of the Company since 1972. He was Vice President, Treasurer, Chief Financial Officer of the Company from 1972 until 1994, and has been Senior Vice President since May 1994.\nHenry V. Landau has been a Vice President of the Company since 1983. Mr. Landau has been the President and Chief Executive Officer of Measurements Group, Inc., a subsidiary of the Company, since July 1984. Mr. Landau was an Executive Vice President of Measurements Group, Inc. from 1981 to 1984 and has been employed by the Company since 1972.\nAbraham Inbar has been a Vice President of Company since June 1994. Mr. Inbar has been the President of Vishay Israel Ltd., a subsidiary of the Company, since May 1994. Mr. Inbar was Senior Vice President and General Manager of Vishay Israel Ltd. from 1992 to 1994. Previously, Mr. Inbar was Vice President - Operations for Vishay Israel Ltd. He has been employed by the Company since 1973.\nWilliam J. Spires has been a Vice President and Secretary of the Company since 1981. Mr. Spires has been Vice President - Industrial Relations since 1980 and has been employed by the Company since 1970.\nDonald G. Alfson has been a Director of the Company since May 1992 and the President of Vishay Electronic Components North America and Asia, and President of Dale Electronics, Inc. since April 1992. Mr. Alfson has been employed by Dale since 1972.\nGerald Paul has served as a Director of the Company since May 1993 and President of Vishay Electronic Components, Europe since January 1994. Dr. Paul has been Managing Director of Draloric Electronic GmbH since January 1991. Dr. Paul has been employed by Draloric since February 1978.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's Common Stock is listed on the New York Stock Exchange under the symbol VSH. The following table sets forth the high and low sales prices for the Company's Common Stock as reported on the New York Stock Exchange Composite Tape for the quarterly periods within the 1995 and 1994 fiscal years indicated. Stock prices have been restated to reflect stock dividends and stock splits. The Company does not currently pay cash dividends on its capital stock. Its policy is to retain earnings to support the growth of the Company's business and the Company does not intend to change this policy at the present time. In addition, the Company is restricted from paying cash dividends under the terms of the Company's revolving credit and term loan agreements (see Note 5 to the consolidated financial statements). Holders of record of the Company's Common Stock totalled approximately 1,668 at March 18, 1996.\nCOMMON STOCK MARKET PRICES\nCalendar 1995 Calendar 1994\nHigh Low High Low ---- --- ---- --- First Quarter $ 28.88 $ 22.98 $ 18.15 $ 14.97 Second Quarter $ 37.88 $ 27.50 $ 19.76 $ 14.91 Third Quarter $ 44.38 $ 32.75 $ 21.55 $ 19.17 Fourth Quarter $ 42.13 $ 24.88 $ 24.94 $ 20.90\nOn November 27, 1995, the Company commenced a stock repurchase program pursuant to which the Company was authorized to repurchase up to 750,000 shares of its Common Stock for an aggregate amount not to exceed $30 million. The purchases of Common Stock by the Company under the repurchase program are made in accordance with the rules of the Securities and Exchange Commission and at the discretion of management. As of December 31, 1995 the Company had repurchased 110,000 shares at an approximate cost of $3,578,000. No repurchases were made in 1993 or 1994.\nIn addition, at March 18, 1996 the Company had outstanding 7,222,035 shares of Class B Common Stock par value $.10 per share (the \"Class B Stock\") each of which entitles the holder to ten votes. The Class B Stock generally is not transferable and there is no market for those shares. The Class B Stock is convertible, at the option of the holder, into Common Stock on a share for share basis. Substantially all such Class B Stock is beneficially owned by Dr. Felix Zandman, and a revocable trust for the benefit of Mr. Alfred P. Slaner. Dr. Felix Zandman is an executive officer and director of the Company. Mr. Slaner and his wife, Luella B. Slaner, are Trustees of the Slaner Trust, and accordingly, Mrs. Slaner, a Vishay director, may also be deemed beneficially to own such shares.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected consolidated financial information of the Company for the fiscal years ended December 31, 1995, 1994, 1993, 1992 and 1991. This table 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.\n- -------- 1 Includes the results from July 1, 1994 of Vitramon. 2 Includes the results from January 1, 1993 of Roederstein. 3 Includes the results from January 1, 1992 of the acquired Sprague businesses. 4 Adjusted to reflect 2-for-1 stock split distributed June 16, 1995 and 5% stock dividends paid on March 31, 1995, June 13, 1994 and June 11, 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION AND BACKGROUND\nThe Company's sales and net income have increased significantly in the past several years primarily as a result of its acquisitions. Following each acquisition, the Company implemented programs to take advantage of distribution and operating synergies among its businesses. This implementation is reflected in an increase in the Company's sales and in the decline in selling, general, and administrative expenses as a percentage of the Company's sales.\nFrom mid-1990 through the end of 1993, sales of most of the Company's products were adversely affected by the worldwide slowdown in the electronic components industry, which reflected general recessionary trends in all major industrialized countries. In addition, sales to defense-related industries declined from the end of the first quarter of 1991 until the second half of 1993. Despite this slowdown, Vishay realized record net earnings in each year throughout this period. This was a result of its acquisitions and focus on the bottom-line, including the implementation of operating efficiencies.\nIn 1995, the Company's growth was fueled not only by its acquisition of Vitramon, but also by the dramatic expansion in the electronic components industry. This resulted in Vishay's record net earnings of $92.7 million in 1995. Since early 1994, demand for most passive electronic components has been extremely strong and, in the case of certain products (such as tantalum capacitors), has exceeded available supply, resulting in increased backlogs and favorable pricing. During the last quarter of 1995 and into the first quarter of 1996 the Company has experienced an overall softening in demand for its products, resulting in a decrease in backlogs. The Company believes this may be primarily a result of the unusually large build up of Vishay components in its customers' inventories during the first half of 1995. The Company believes it is too early to discern whether this slowdown is indicative of a longer term trend; the Company, however, will continue to closely monitor its orders and backlog.\nThe Company's strategy includes transferring some of its manufacturing operations from countries with high labor costs and tax rates (such as the United States, France and Germany) to Israel, Mexico, Portugal and the Czech Republic in order to benefit from lower labor costs and, in the case of Israel, to take advantage of various government incentives, including government grants and tax incentives. Management believes that the Company is well positioned to reduce its costs in the event of a decline in demand by accelerating the transfer of production to countries with lower labor costs and more favorable tax environments.\nThe Company realizes 51% of its revenues outside the United States. As a result, fluctuations in currency exchange rates can significantly affect the Company's reported sales and to a lesser extent earnings. Currency fluctuations impact the Company's net sales and other income statement amounts, as denominated in U.S. dollars, including other income as it relates to foreign exchange gains or losses. Generally, in order to minimize the effect of currency fluctuations on profits, the Company endeavors to (i) borrow money in the local currencies and markets where it conducts business, and (ii) minimize the time for settling intercompany transactions. The Company does not purchase foreign currency exchange contracts or other derivative instruments to hedge foreign currency exposures.\nAs a result of the increased production by the Company's operations in Israel over the past several years, the low tax rates in Israel (as compared to the statutory rates in the United States) have had the effect of increasing the Company's net earnings. The more favorable Israeli tax rates are applied to specific approved projects and normally continue to be available for a period of ten years or, if the investment in the project is over $20 million, for a period of 15 years, which has been the case for most of the Company's projects in Israel since 1994. New projects are continually being introduced. In addition, the Israeli government offers certain incentive programs in the form of grants designed to increase employment in Israel. Future grants and other incentive programs offered to the Company by the Israeli government will likely depend on the Company's continuing to increase capital investment and the number of the Company's employees in Israel.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nNet sales for the year ended December 31, 1995 increased $236,579,000 or 23.9% from the prior year. The increase reflects the strong performance of Vitramon, acquired July 1, 1994, and Vishay's other surface mount components businesses. Net sales for the year ended December 31, 1995 includes $87,753,000 of net sales relating to Vitramon for the first six months of 1995.\nThe weakening of the U.S. dollar against foreign currencies for the year ended December 31, 1995 in comparison to the prior year resulted in an increase in reported sales of $57,128,000.\nNet sales, exclusive of foreign currency fluctuations, increased 18.2% over the prior year. Net sales, exclusive of foreign currency fluctuations and Vitramon sales for the first six months, increased 9.3% over the prior year. Net bookings for the year ended December 31, 1995 increased 7.8% over the prior year.\nIncome statement captions as a percentage of sales and the effective tax rates were as follows:\nYear Ended December 31 1995 1994 ---- ---- Costs of products sold 73.7% 75.7% Gross profit 26.3 24.3 Selling, general and administrative expenses 13.0 13.9 Operating income 12.4 9.9 Earnings before income taxes 10.0 7.5 Effective tax rate 24.6 20.5 Net earnings 7.6 6.0\nCosts of products sold for the year ended December 31, 1995 were 73.7%, of net sales, as compared to 75.7% for the prior year. The factors contributing to this decrease included: (i) the effect of the Mexican peso devaluation, which contributed approximately $4,100,000 to gross profit for 1995, (ii) the fact that gross profits for Vitramon were higher than Vishay's other operating companies, (iii) Israeli government grants of $13,243,000 for the year ended December 31, 1995, as compared to $10,999,000 for the prior year, and (iv) an increase in production in Israel where labor costs are lower than in most other regions in which Vishay manufactures. The increase in Israeli government grants resulted from a significant increase in the Company's manufacturing operations in Israel. Deferred income at December 31, 1995 relating to Israeli government grants was $30,849,000.\nSelling, general, and administrative expenses, for the year ended December 31, 1995 were 13.0% of net sales, as compared to 13.9% for the prior year. Management continues to explore additional cost-saving opportunities.\nRestructuring expenses of $4,200,000 in 1995 resulted from downsizing of some of the Company's European operations and represent employee termination benefits covering approximately 276 technical, production, administrative and support employees located primarily in France and Germany. This downsizing is expected to be completed by the end of 1996. At December 31, 1995, $3,370,000 of restructuring costs are included in accrued expenses.\nInterest costs increased by $4,664,000 for the year ended December 31, 1995 over the prior year as a result of an increase in average debt outstanding resulting from the acquisition of Vitramon in July 1994 and purchases of property and equipment.\nThe effective tax rate for the year ended December 31, 1995 was 24.6% compared to 20.5% for the prior year. The higher effective tax rate for 1995 reflects increased earnings in higher tax rate countries.\nThe effect of low tax rates in Israel (as compared to the statutory rate in the United States) has been to increase net\nearnings by $19,183,000 and $15,291,000 for the years ended December 31, 1995 and 1994, respectively. The Israeli tax effect was more pronounced in 1995 primarily as a result of increased earnings for the Israeli operations as a result of increased production.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nNet sales for the year ended December 31, 1994 increased $131,565,000 or 15.4% over the prior year. The increase reflects the acquisition of Vitramon in July 1994. Net sales of Vitramon were $72,139,000 for the six months ended December 31, 1994, an increase of 29.4% over the comparable 1993 period (prior to its acquisition by the Company). Net sales, exclusive of Vitramon, during the year ended December 31, 1994 increased by $59,426,000 or 6.9% over 1993. The weakening of the U.S. dollar against foreign currencies in 1994 resulted in an increase in reported sales of $7,208,000 over 1993.\nNet sales, exclusive of Vitramon and foreign currency effects, in the United States and Europe increased 6.1% over the prior year. Net bookings, exclusive of Vitramon, for 1994 increased by 15.5% over the prior year. Net bookings of Vitramon, for the six months ended December 31, 1994, increased by 34.5% over the comparable period of 1993 (prior to its acquisition by the Company).\nCosts of products sold for the year ended December 31, 1994 were 75.7% of net sales as compared with 77.5% for the prior year. The principal factors contributing to this decrease were: (i) the fact that gross profit margins for Vitramon are higher than those for Vishay's other operating companies, (ii) an increase of $7,575,000 or 221% in the amount of Israeli government grants recognized as a reduction of costs of products sold in 1994 over the prior year and (iii) a significant increase in production in Israel, where labor costs are generally lower than in other regions in which Vishay manufactures. The increase in Israeli government grants resulted primarily from an increase in the Company's work force and capital investment in Israel.\nSelling, general, and administrative expenses for the year ended December 31, 1994 and 1993 were 13.9% of net sales. Management continues to explore additional cost saving opportunities.\nRestructuring charges of $6,659,000 for the year ended December 31, 1993 consist primarily of severance costs related to the Company's decision to downsize its European operations, primarily in France, as a result of the European business climate. These costs were paid in 1994.\nIncome from unusual items of $7,221,000 for the year ended December 31, 1993 represents proceeds received for business interruption insurance claims principally related to operations in Dimona, Israel.\nInterest costs increased by $4,145,000 for the year ended December 31, 1994 as a result of increased rates and increased debt incurred for the acquisition of Vitramon.\nThe effective tax rate for the year ended December 31, 1994 was 20.5% compared to 16.2% for the prior year. The effective tax rate for 1993, exclusive of the effect of nontaxable insurance proceeds, was 18.6%. The higher tax rate for 1994 reflects the inclusion of Vitramon earnings in higher tax locations.\nThe effect of the low tax rates in Israel was to increase net earnings by $15,291,000 and $11,644,000 for the years ended December 31, 1994 and 1993, respectively. The Company's average income tax rate in Israel was approximately 4% for both 1994 and 1993. The Israeli pre tax grants recognized by the Company were $10,999,000 and $3,424,000 for the years ended December 31, 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 FASB Statement No. 109, \"Accounting for Income Taxes.\" The cumulative effect of adopting Statement 109 as of January 1, 1993 was to increase net income by $1,427,000. Application of the new income tax rules also decreased pretax earnings by $2,870,000 for the year ended December 31, 1993 because of increased depreciation expense as a result of Statement 109's requirement to report assets acquired in prior business combinations at their pre-tax amounts.\nThe Company also adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective January 1, 1993. The Company has elected to recognize the transition obligation on a prospective basis over a twenty-year period. In 1993, the new standard resulted in additional annual net periodic postretirement benefit costs of $1,200,000 before taxes, and $792,000 after taxes, or $0.02 per share. Prior year financial statements were not restated to apply the new standard.\nFINANCIAL CONDITION\nCash flows from operations were $115,511,000 for the year ended December 31, 1995 compared to $46,467,000 for the prior year. Included in net cash provided by operating activities for the years ended December 31, 1995 and 1994, respectively, are $16,402,000 and $16,587,000 of cash payments made for liabilities assumed in connection with acquisitions. Net purchases of property and equipment for the year ended December 31, 1995 were $165,699,000\ncompared to $91,571,000 in the prior year. This increase reflects the Company's on going program to purchase additional equipment to meet growing customer demand for surface mount components. Net cash provided by financing activities of $41,732,000 includes $230,279,000 of proceeds from a common stock offering completed in September 1995, and used to prepay bank indebtedness. Additional borrowings were used primarily to finance the additions to property and equipment.\nThe Company has established accruals relating to the Vitramon acquisition, of which $12,327,000 remains at December 31, 1995. These accruals, which are included in other accrued expenses and other liabilities, will not affect future earnings but will require cash expenditures.\nOn June 27, 1995, the Company amended its bank credit facilities. The amendment increased the Company's domestic revolving credit facility by $100 million, extended the maturity of its domestic and Deutsche Mark (\"DM\") denominated revolving credit facilities and gave the Company the right to increase its domestic revolving credit facility by an additional $100 million by prepaying its outstanding non amortizing term loan on or before July 1, 1996.\nSee Note 5 to the Company's Consolidated Financial Statements elsewhere herein for additional information with respect to Vishay's loan agreements, long-term debt and available short- term credit lines.\nThe Company's financial condition at December 31, 1995 is strong, with a current ratio of 2.8 to 1. The Company's ratio of long-term debt (less current portion) to stockholders' equity was .25 to 1 at December 31, 1995 and .71 to 1 at December 31, 1994.\nThe Company's capital expenditures for the years ended December 31, 1995, 1994 and 1993 were $165.7 million, $91.6 million and $79.4 million, respectively. Planned capital expenditures of approximately $200 million in fiscal 1996 relate principally to construction of new facilities in Israel and the purchase of equipment to increase capacity and maximize automation in the Company's plants.\nManagement believes that the Company's available sources of credit, together with cash expected to be generated from operations, will be sufficient to satisfy the Company's anticipated financing needs for working capital and capital expenditures during the next twelve months.\nINFLATION\nNormally, inflation has not had a significant impact on the Company's operations. The Company's products are not generally sold on long-term contracts. Consequently, selling prices, to the\nextent permitted by competition, can be adjusted to reflect cost increases caused by inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following Consolidated Financial Statements of the Company and its subsidiaries, together with the report of independent auditors thereon, are presented under Item 14 of this report:\nReport of Independent Auditors\nConsolidated Balance Sheets -- 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 Stockholders' Equity -- for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements -- December 31, 1995.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nInformation with respect to Items 10, 11, 12 and 13 on Form 10-K is set forth in the Company's definitive proxy statement, which will be filed within 120 days of December 31, 1995, the Company's most recent fiscal year. Such information is incor- porated herein by reference, except that information with respect to Executive Officers of Registrant is set forth in Part I, Item 4A 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 8-K\n(a) (1) All Consolidated Financial Statements of the Company and its subsidiaries for the year ended December 31, 1995 are filed herewith.\nSee Item 8 of this Report for a list of such financial statements.\n(2) All financial statement 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 -- See response to paragraph (c) below.\n(b) Reports on Form 8-K\nNone\n(c) Exhibits:\n2.1 Stock Purchase Agreement, dated July 12, 1994, between Thomas & Betts Corporation and Vishay Intertechnology, Inc. Incorporated by reference to Exhibit (2.1) to the Current Report on 8-K dated July 18, 1994.\n3.1 Composite Amended and Restated Certificate of Incorporation of the Company dated August 3, 1995. Incorporated by reference to Exhibit 3.1 to Form 10-Q for the quarter ended June 30, 1995 (the \"1995 Form 10- Q\").\n3.2 Amended and Restated Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to Registration Statement No. 33-13833 of Registrant on Form S-2 under the Securities Act of 1933 (the \"Form S-2\") and Amendment No. 1 to Amended and Restated Bylaws of Registrant Incorporated by reference to Exhibit 3.2 to Form 10-K file number 1-7416 for fiscal year ended December 31, 1993 (the \"1993 Form 10-K\").\n10.1 Performance-Based Compensation Plan for Chief Executive Officer of Registrant. Incorporated by reference to Exhibit 10.1 to the 1993 Form 10-K.\n10.2 The First Amendment dated June 27, 1995, to the Amended and Restated Vishay Intertechnology, Inc. $302,500,000 Revolving Credit and Term Loan Agreement dated as of July 18, 1994 by and among Comerica Bank, NationsBank of North Carolina, N.A., Berliner Handels-und Frankfurter Bank, Signet Bank Maryland, CoreStates Bank, N.A., Bank Hapoalim, B.M., ABN AMRO Bank N.V., Credit Lyonnais New York Branch, Meridian Bank, Bank Leumi le-Israel, B.M. and Credit Suisse (collectively, the \"Banks\"), Comerica\nBank,as agent for the Banks (the \"Agent\"), and Vishay Intertechnology, Inc. (\"Vishay\"), and the Vishay Intertechnology, Inc. $200,000,000 Acquisition Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and Vishay. Incorporated by reference to Exhibit 10.4 to the 1995 Form 10-Q.\n10.3 The First Amendment, dated June 27, 1995, to the Amended and Restated Vishay Europe GmbH DM 40,000,000 Revolving Credit and DM 9,506,000 Term Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and Vishay Europe GmbH (\"VEG\"), and the Amended and Restated Roederstein DM 104,315,990.20 Term Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and VEG. Incorporated by reference to Exhibit 10.5 to the 1995 Form 10-Q.\n10.4 Amended and Restated Vishay Intertechnology, Inc. $302,500,000 Revolving Credit and Term Loan Agreement, dated as of July 18, 1994, by and among the Banks and Vishay, Inc. (\"Vishay\"). Incorporated by reference to Exhibit (10.1) to the Current Report on Form 8-K dated July 18, 1994 (the \"July 1994 8-K\").\n10.5 Amended and Restated Vishay Beteiligungs GmbH DM 40,000,000 Revolving Credit and DM 9,506,000 Term Loan Agreement, dated as of July 18, 1994, by and among the Former Banks, the Agent and Vishay Beteiligungs GmbH (\"VBG\"). Incorporated by reference to Exhibit (10.2) to the July 1994 8-K.\n10.6 Amended and Restated Roederstein DM 104,315,990.20 Term Loan Agreement, dated as of July 18, 1994, by and among the Former Banks, the Agent, Vishay and VBG. Incorporated by reference to Exhibit (10.3) to the July 1994 8-K.\n10.7 Vishay Intertechnology, Inc. $200,000,000 Acquisition Loan Agreement, dated as of July 18, 1994, by and among the Banks, the Agent and Vishay. Incorporated by reference to Exhibit (10.4) to the July 1994 8-K.\n10.8 Amended and Restated Guaranty by Vishay to the Banks, dated July 18, 1994. Incorporated by reference to Exhibit (10.5) to the July 1994 8-K.\n10.9 Employment Agreement, dated as of March 15, 1985, between the Company and Dr. Felix Zandman. Incorporated by reference to Exhibit (10.12) to the Form S-2.\n10.10 Vishay Intertechnology 1995 Stock Option Program. Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-59609).\n10.11 1986 Employee Stock Plan of the Company. Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (No. 33-7850).\n10.12 1986 Employee Stock Plan of Dale Electronics, Inc. Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (No. 33-7851).\n10.13 Money Purchase Plan Agreement of Measurements Group, Inc. Incorporated by reference to Exhibit 10(a)(6) to Amendment No. 1 to the Company's Registration Statement on Form S-7 (No. 2-69970).\n22. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n27. Financial Data Schedule.\nReport of Independent Auditors\nBoard of Directors and Stockholders Vishay Intertechnology, Inc.\nWe have audited the accompanying consolidated balance sheets of Vishay Intertechnology, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows, and stockholders' equity for each of the three years in the period ended December 31, 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 Vishay Intertechnology, 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.\nAs discussed in the Notes to Consolidated Financial Statements, in 1993 the Company changed its methods of accounting for income taxes (Note 4) and postretirement benefits other than pensions (Note 9).\nPhiladelphia, Pennsylvania \/s\/ Ernst & Young LLP February 6, 1996 ---------------------\nVishay Intertechnology, Inc.\nConsolidated Balance Sheets\n(In thousands, except per share and share amounts)\nDECEMBER 31\n1995 1994\n------------------------------------\nAssets\nCurrent assets:\nCash and cash equivalents $ 19,584 $ 26,857\nAccounts receivable, less allowances\nof $6,915 and $8,803 180,383 165,188\nInventories:\nFinished goods 148,846 101,008\nWork in process 92,166 94,005\nRaw materials 121,180 108,594\nPrepaid expenses and other current\nassets 78,039 64,909 ------------------------------------ Total current assets 640,198 560,561\nProperty and equipment--at cost:\nLand 46,073 40,113\nBuildings and improvements 197,164 171,689\nMachinery and equipment 603,175 484,582\nConstruction in progress 76,564 48,689 ------------------------------------ 922,976 745,073\nLess allowances for depreciation (253,748) (201,671) ------------------------------------ 669,228 543,402\nGoodwill 218,102 226,534\nOther assets 15,803 14,573 ------------------------------------ $1,543,331 $1,345,070 ====================================\nDECEMBER 31\n1995 1994\n------------------------------------\nLiabilities and stockholders' equity\nCurrent liabilities:\nNotes payable to banks $22,174 $28,285\nTrade accounts payable 66,942 63,318\nPayroll and related expenses 43,790 39,155\nOther accrued expenses 51,102 64,505\nIncome taxes 7,083 1,849\nCurrent portion of long-term debt 37,821 35,127 ------------------------------------ Total current liabilities 228,912 232,239\nLong-term debt--less current portion 228,610 402,337\nDeferred income taxes 42,044 32,554\nOther liabilities 59,866 37,623\nAccrued pension costs 76,046 75,229\nStockholders' equity:\nPreferred Stock, par value $1.00 a share:\nAuthorized--1,000,000 shares; none\nissued\nCommon Stock, par value $.10 a share:\nAuthorized--65,000,000 shares;\n51,139,826 and 45,145,926 shares\noutstanding after deducting 209,881\nand 102,402 shares in treasury 5,114 2,257\nClass B convertible Common Stock, par\nvalue $.10 a share: Authorized--\n15,000,000 shares; 7,222,035 and\n7,547,544 shares outstanding after\ndeducting 229,518 and 254,128\nshares in treasury 722 377\nCapital in excess of par value 734,316 509,966\nRetained earnings 146,370 53,734\nForeign currency translation adjustment 28,487 4,584\nUnearned compensation (364) (20)\nPension adjustment (6,792) (5,810) ------------------------------------ 907,853 565,088 ------------------------------------ $1,543,331 $1,345,070 ====================================\nSee accompanying notes.\nVishay Intertechnology, Inc.\nConsolidated Statements of Operations\n(In thousands, except per share and share amounts)\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nNet sales $1,224,416 $987,837 $856,272\nCosts of products sold 902,518 748,135 663,239 --------------------------------------------- Gross profit 321,898 239,702 193,033\nSelling, general, and\nadministrative expenses 158,821 137,124 118,906\nAmortization of goodwill 6,461 4,609 3,294\nRestructuring expense 4,200 - 6,659\nUnusual items - - (7,221) --------------------------------------------- 152,416 97,969 71,395\nOther income (expense):\nInterest expense (29,433) (24,769) (20,624)\nOther (9) 916 123 --------------------------------------------- (29,442) (23,853) (20,501) --------------------------------------------- Earnings before income taxes\nand cumulative effect of\naccounting change 122,974 74,116 50,894\nIncome taxes 30,307 15,169 8,246 ---------------------------------------------\n--------------------------------------------- Earnings before cumulative\neffect of accounting change 92,667 58,947 42,648\nCumulative effect of accounting\nchange for income taxes - - 1,427 --------------------------------------------- Net earnings $92,667 $58,947 $44,075 =============================================\nEarnings per share:\nBefore cumulative effect of\naccounting change $1.71 $1.20 $0.91\nAccounting change for\nincome taxes - - 0.03 --------------------------------------------- Net earnings $1.71 $1.20 $0.94 =============================================\nWeighted average shares\noutstanding 54,329,000 49,098,000 46,806,000 =============================================\nSee accompanying notes.\nVishay Intertechnology, Inc.\nConsolidated Statements of Cash Flows\n(In thousands)\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nOperating activities\nNet earnings $92,667 $58,947 $44,075\nAdjustments to reconcile net earnings to net cash provided by operating activities:\nDepreciation and amortization 69,547 57,742 48,578\nOther 30,034 19,410 1,667\nChanges in operating assets and liabilities:\nAccounts receivable (8,147) (12,921) 2,804\nInventories (48,123) (44,195) (22,780)\nPrepaid expenses and other\ncurrent assets (14,023) (23,119) 182\nAccounts payable 998 3,023 (7,768)\nOther current liabilities (7,442) (12,420) (14,080) --------------------------------------------- Net cash provided by operating activities 115,511 46,467 52,678\nInvesting activities\nPurchases of property and equipment (165,699) (91,571) (79,377)\nPurchases of businesses, net of cash acquired - (179,847) (12,967) ---------------------------------------------\n--------------------------------------------- Net cash used in investing activities (165,699) (271,418) (92,344)\nFinancing activities\nProceeds from revolving lines of\ncredit and long-term borrowings 302,700 372,321 265,274\nPrincipal payments on revolving\nlines of credit and long-term debt (480,481) (245,711) (235,124)\nCash (used in) provided by net\nchanges in short-term borrowings (7,188) 3,879 4,873\nPurchases of common stock (3,578) - -\nProceeds from sale of common stock 230,279 109,738 - --------------------------------------------- Net cash provided by financing activities 41,732 240,227 35,023\nEffect of exchange rate changes on cash 1,183 650 (403) --------------------------------------------- Increase (decrease) in cash and cash equivalents (7,273) 15,926 (5,046)\nCash and cash equivalents at beginning of year 26,857 10,931 15,977 --------------------------------------------- Cash and cash equivalents at end of year $19,584 $26,857 $10,931 =============================================\nSee accompanying notes.\nVishay Intertechnology, Inc.\nConsolidated Statements of Stockholders' Equity\n(In thousands, except share amounts)\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nCommon Stock:\nBeginning balance $2,257 $1,763 $1,679\nShares issued (5,777,300; 5,602,500; and 7,550 shares) 576 280 -\nStock dividends (1,091; 3,915,440; and 1,679,904 shares) - 196 84\nStock split 2,275 - -\nShares repurchased (110,000 shares) (11) - -\nConversions from Class B (325,509; 349,824; and 240 shares) 17 18 - --------------------------------------------- Ending balance 5,114 2,257 1,763\nClass B convertible Common Stock:\nBeginning balance 377 359 342\nStock dividends (716,904 and 341,934 shares) - 36 17\nStock split 362 - -\nConversions to Common (325,509; 349,824; and 240 shares) (17) (18) - --------------------------------------------- Ending balance 722 377 359\nCapital in excess of par value:\nBeginning balance 509,966 288,980 253,446\nShares issued 230,534 110,012 123\nStock dividends - 110,830 35,281\nStock split (2,637) - -\nShares repurchased (3,567) - -\nTax effects relating to stock plan 20 144 130 --------------------------------------------- Ending balance 734,316 509,966 288,980\nRetained earnings:\nBeginning balance 53,734 105,849 97,156\nNet earnings 92,667 58,947 44,075\nStock dividends (31) (111,062) (35,382) --------------------------------------------- Ending balance 146,370 53,734 105,849\nForeign currency translation adjustment:\nBeginning balance 4,584 (13,109) (5,864)\nTranslation adjustment for the year 23,903 17,693 (7,245) --------------------------------------------- Ending balance 28,487 4,584 (13,109)\nUnearned compensation:\nBeginning balance (20) (60) (134)\nShares issued under stock plans (27,300; 4,000; and 7,550 shares) (519) (70) (123)\nAmounts expensed during the year 175 110 197 --------------------------------------------- Ending balance (364) (20) (60)\nPension adjustment:\nBeginning balance (5,810) (7,279) -\nPension adjustment for the year (982) 1,469 (7,279) ---------------------------------------------\nEnding balance (6,792) (5,810) (7,279) --------------------------------------------- Total stockholders' equity $907,853 $565,088 $376,503 =============================================\nSee accompanying notes.\n1994 amounts were retroactively adjusted for 5% stock dividend in March 1995.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements\nDecember 31, 1995\nVishay Intertechnology, Inc. is a leading international manufacturer and supplier of passive electronic components, particularly resistors, capacitors and inductors, offering its customers access to one of the most comprehensive passive electronic component lines of any manufacturer in the United States or Europe. Passive electronic components, together with semiconductors (integrated circuits), which the Company does not produce, are the primary elements of electronic circuits. Components manufactured by the Company are used in virtually all types of electronic products, including those in the computer, telecommunications, military\/aerospace, instrument, automotive, medical and consumer electronics industries.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements of Vishay Intertechnology, Inc. include the accounts of the Company and its subsidiaries, after elimination of all significant intercompany transactions, accounts, and profits.\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.\nINVENTORIES\nInventories are stated at the lower of cost, determined by the first-in, first-out method, or market.\nDEPRECIATION\nDepreciation is computed principally by the straight-line method based upon the estimated useful lives of the assets. Depreciation of capital lease assets is included in total depreciation expense.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements\nDecember 31, 1995\nDepreciation expense was $60,155,000, $51,301,000, and $43,493,000, for the years ended December 31, 1995, 1994, and 1993, respectively.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nCONSTRUCTION IN PROGRESS\nThe estimated cost to complete construction in progress at December 31, 1995 is $67,440,000.\nGOODWILL\nGoodwill, representing the excess of purchase price over net assets of businesses acquired, is being amortized on a straight-line basis over 40 years. Accumulated amortization amounted to $23,737,000 and $17,966,000 at December 31, 1995 and 1994, respectively. The recoverability of goodwill is evaluated at the operating unit level by an analysis of operating results and consideration of other significant events or changes in the business environment. If an operating unit has current operating losses and based upon projections there is a likelihood that such operating losses will continue, the Company will measure impairment on the basis of undiscounted expected future cash flows from operations before interest for the remaining amortization period.\nCASH EQUIVALENTS\nFor purposes of the Statement of Cash Flows, the Company considers demand deposits and all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.\nRESEARCH AND DEVELOPMENT EXPENSES\nThe amount charged to expense aggregated $10,430,000, $7,205,000, and $7,097,000 for the years ended December 31, 1995, 1994, and 1993, respectively. The Company spends additional amounts for the development of machinery and equipment for new processes and for cost reduction measures.\nGRANTS\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nGrants received from governments by certain foreign subsidiaries, primarily in Israel, are recognized as income in accordance with the purpose of the specific contract and in the period in which the related expense is incurred. Grants received from the government of Israel and recognized as a reduction of costs of products sold were $13,243,000, $10,999,000, and $3,424,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nGRANTS (CONTINUED)\nGrants receivable of $20,585,000 and $16,674,000 are included in other current assets at December 31, 1995 and 1994, respectively. Deferred grant income of $30,849,000 and $11,111,000 is included in other liabilities at December 31, 1995 and 1994, respectively. The grants are subject to conditions, including maintaining specified levels of employment for periods up to ten years. Noncompliance with such conditions could result in repayment of grants, however, management expects that the Company will comply with all terms and conditions of grants.\nSHARE AND PER SHARE AMOUNTS\nAll numbers of common shares and per share amounts have been adjusted to give retroactive effect to a 2-for-1 stock split distributed on June 16, 1995.\nEarnings per share is based on the weighted average number of common shares outstanding during the period. No material dilution of earnings per share would result if it was assumed that all outstanding stock options were exercised. Earnings per share amounts for all periods presented reflect the 2-for-1 stock split and 5% stock dividends paid on March 31, 1995, June 13, 1994, and June 11, 1993. Earnings per share for the year ended December 31, 1995 reflect the weighted effect of the issuance of 5,750,000 shares of Common Stock in September 1995. Earnings per share for the years ended December 31, 1995 and 1994 reflect the weighted effect of the issuance of 5,576,000 shares of Common Stock in August 1994.\nACCOUNTING PRONOUNCEMENT PENDING ADOPTION\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 amounts. 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.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nACCOUNTING CHANGES\nIn 1993, the Company changed its methods of accounting for income taxes (Note 4) and postretirement benefits other than pensions (Note 9).\nRECLASSIFICATIONS\nCertain prior-year amounts have been reclassified to conform with the current presentation.\n2. ACQUISITIONS\nIn July 1994, the Company purchased all of the capital stock of Vitramon, Incorporated and Vitramon Limited, U.K. (collectively, \"Vitramon\") for $184,000,000 in cash. Vitramon is a leading producer of multilayer ceramic chip capacitors with manufacturing facilities primarily in the United States, France, Germany, and the United Kingdom. In connection with the acquisition of Vitramon, the Company borrowed an aggregate of $200,000,000 from a group of banks, of which $100,000,000 was a bridge facility that was subsequently paid off with proceeds from an equity offering completed in August 1994 and $100,000,000 was a nonamortizing term loan of which $50,000,000 remains outstanding at December 31, 1995.\nDuring January 1993, Vishay exercised its option to purchase the remaining 81% of the outstanding share capital of Roederstein GmbH, a passive electronic components manufacturer with headquarters in Germany for 4,050,000 Deutsche Marks (\"DM\") ($2,502,000) pursuant to a 1992 option agreement. Vishay had acquired its initial 19% interest in Roederstein in 1992 for DM 950,000 ($577,000).\nThe acquisitions have been accounted for under the purchase method of accounting. The operating results of Vitramon and Roederstein have been included in the Company's consolidated results of operations from July 1, 1994 and January 1, 1993, respectively. Excess of cost over the fair value of net assets acquired (Vitramon--$104,582,000; Roederstein--$46,355,000) is being amortized on a straight-line basis over forty years.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n2. ACQUISITIONS (CONTINUED)\nHad the Vitramon acquisition been made at the beginning of 1993, the Company's pro forma unaudited results would have been (in thousands, except per share amounts):\nYEAR ENDED DECEMBER 31\n1994 1993\n------------------------------------\nNet sales $1,056,520 $974,666\nNet earnings 64,573 52,555\nEarnings per share $1.23 $1.00\nThe unaudited pro forma results are not necessarily indicative of the results that would have been attained had the acquisition occurred at the beginning of 1993 or of results which may occur in the future.\n3. RESTRUCTURING EXPENSE AND UNUSUAL ITEMS\nRestructuring expenses of $4,200,000 in 1995 result from downsizing of some of the Company's European operations and represent employee termination costs covering approximately 276 technical, production, administrative, and support employees located primarily in France and Germany. This downsizing is expected to be complete by the end of 1996. At December 31, 1995, $3,370,000 of restructuring costs are included in accrued expenses.\nRestructuring expenses of $6,659,000 recorded in 1993 related to a downsizing of some of the Company's European operations which was completed in 1994. Income from unusual items of $7,221,000 for 1993 represents insurance recoveries for business interruption insurance claims.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n4. 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.\" The cumulative effect of adopting Statement 109 as of January 1, 1993 was to increase net earnings by $1,427,000, or $.03 per share.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n4. INCOME TAXES (CONTINUED)\nFor financial reporting purposes, earnings before income taxes and cumulative effect of accounting change includes the following components (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nPretax income:\nDomestic $34,926 $19,650 $13,136\nForeign 88,048 54,466 37,758 --------------------------------------------- $122,974 $74,116 $50,894 =============================================\nSignificant components of income taxes are as follows (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nCurrent:\nU.S. Federal $10,578 $5,187 $3,032\nForeign 10,927 3,251 2,706\nState 1,082 882 332 ---------------------------------------------\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n--------------------------------------------- 22,587 9,320 6,070\nDeferred:\nU.S. Federal 2,247 1,889 1,960\nForeign 5,082 3,858 36\nState 391 102 180 ---------------------------------------------\n7,720 5,849 2,176 --------------------------------------------- $30,307 $15,169 $8,246 =============================================\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n4. INCOME TAXES (CONTINUED)\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows (in thousands):\nDECEMBER 31\n1995 1994\n------------------------------------\nDeferred tax liabilities:\nTax over book depreciation $71,060 $61,023\nOther--net 7,640 4,427 ------------------------------------\nTotal deferred tax liabilities 78,700 65,450 ------------------------------------\nDeferred tax assets:\nPension and other retiree obligations 25,461 23,381\nNet operating loss carryforwards 53,638 55,630\nRestructuring reserves 3,631 5,865\nOther accruals and reserves 16,368 10,842 ------------------------------------\nTotal deferred tax assets 99,098 95,718\nValuation allowance for deferred tax assets (45,700) (48,637) ------------------------------------\nNet deferred tax assets 53,398 47,081 ------------------------------------\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n------------------------------------ Net deferred tax liabilities $25,302 $18,369 ====================================\nA reconciliation of income tax expense at the U.S. federal statutory income tax rate to actual income tax expense is as follows (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nTax at statutory rate $43,041 $25,941 $17,304\nState income taxes, net of U.S. federal tax benefit 1,094 684 396\nEffect of foreign income tax rates (13,801) (13,194) (10,532)\nBenefit of net operating loss carryforwards (2,054) - -\nOther 2,027 1,738 1,078 --------------------------------------------- $30,307 $15,169 $8,246 =============================================\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n4. INCOME TAXES (CONTINUED)\nAt December 31, 1995, the Company has net operating loss carryforwards for tax purposes of approximately $115,805,000 in Germany (no expiration date), $12,154,000 in France (expire December 31, 2000), and $5,518,000 in Portugal (expire December 31, 1999). Approximately $86,893,000 of the carryforward in Germany, and $5,211,000 of the carryforward in Portugal, resulted from the Company's acquisition of Roederstein. For financial reporting purposes, a valuation allowance of $45,700,000 has been recognized to offset deferred tax assets related to foreign net operating loss carryforwards. In 1995, tax benefits recognized through reductions of the valuation allowance had the effect of reducing goodwill of acquired companies by $6,752,000. If additional tax benefits are recognized in the future through further reduction of the valuation allowance, $37,461,000 of such benefits will reduce goodwill. The valuation allowance decreased from December 31, 1994 by $2,937,000 due to the tax benefits recognized offset by foreign currency translation which had the effect of increasing the deferred tax asset for net operating loss carryforwards.\nAt December 31, 1995, no provision has been made for U.S. federal and state income taxes on approximately $280,538,000 of foreign earnings which are expected to be reinvested indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to 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 hypothetical calculation.\nIncome taxes paid were $30,272,000, $11,125,000, and $6,933,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n5. LONG-TERM DEBT\nLong-term debt consisted of the following (in thousands):\nDECEMBER 31\n1995 1994\n------------------------------------\nRevolving Credit Loan $29,722 $100,000\nTerm Loan 87,500 97,500\nTerm Loan II 50,000 100,000\nDeutsche Mark Revolving Credit Loan 27,778 25,808\nDeutsche Mark Term Loan 35,775 55,239\nUnsecured Credit Agreement -- 20,000\nOther Debt and Capital Lease Obligations 35,656 38,917 ------------------------------------ 266,431 437,464\nLess current portion 37,821 35,127 ------------------------------------ $228,610 $402,337 ====================================\nAs of December 31, 1995, five facilities were available under the Company's amended and restated Revolving Credit and Term Loan and Deutsche Mark Revolving Credit and Term Loan agreements with a group of banks; a multicurrency revolving credit loan (interest 5.46% at December 31, 1995), a U.S. term loan (interest 6.11% at December 31, 1995), an additional U.S. term loan (interest 6.11% at December 31, 1995), a Deutsche Mark revolving credit loan (interest 4.36% at December 31, 1995), and a Deutsche Mark term loan (interest 4.49% at December 31, 1995). The terms of the five facilities are\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nsummarized below. The first facility is a $350,000,000 multicurrency revolving credit facility which is available to the Company until December 31, 2000. The Company has the right to request up to three one-year renewals thereafter. This facility will increase to $400,000,000 when the additional U.S. term loan has been repaid. Interest is payable at prime or at other interest rate options. The Company is required to pay a commitment fee equal to 1\/8% per annum on the average unused line. The second facility is an $87,500,000 term loan, with interest payable at prime or at other interest rate options. Principal payments are due as follows: 1996--$10,000,000; 1997--$15,000,000; 1998--$20,000,000; 1999--$20,000,000; 2000--$22,500,000. Additional principal payments may be required based on excess cash flow as defined in the agreement. The third facility is a $50,000,000 nonamortizing term loan which was used for the purchase of Vitramon. The nonamortizing term loan is due June 30, 1996. Interest is payable at prime or at other interest rate options. The loan agreements also provide a German subsidiary of the Company with two Deutsche Mark (\"DM\") facilities. The first DM facility is a DM 40,000,000 ($27,778,000) revolving credit facility which is available\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n5. LONG-TERM DEBT (CONTINUED)\nuntil December 31, 2000. The Company has the right to request up to three one-year renewals thereafter. Interest is based on DM market rates plus .30%. The Company is required to pay a commitment fee equal to 1\/8% per annum on the average unused line. The second DM facility is a DM 51,516,000 ($35,775,000) term loan. Interest is based on DM market rates plus .43%. Principal payments of DM 37,000,000 and 14,516,000 ($25,694,000 and $10,081,000) are due on or before December 31, 1996 and 1997, respectively. Additional principal payments may be required based on excess cash flow as defined in the agreement.\nUnder the loan agreements, the Company is restricted from paying cash dividends and must comply with other covenants, including the maintenance of specific ratios. The Company is in compliance with the restrictions and limitations under the terms of loan agreements, as amended.\nOther debt and capital lease obligations include borrowings under short-term credit lines of $30,254,000 and $28,800,000 at December 31, 1995 and 1994, respectively.\nBorrowings under short-term credit lines and the payments due in 1996 relating to the nonamortizing term loan are classified as long-term based on the Company's intention and ability to refinance the obligations on a long-term basis.\nAggregate annual maturities of long-term debt, excluding payments which may be required based on excess cash flow, are as follows: 1996--$37,821,000; 1997--$26,112,000; 1998--$20,577,000; 1999--$20,912,000; 2000--$160,514,000; thereafter--$495,000.\nAt December 31, 1995, the Company has committed and uncommitted short-term credit lines with various U.S. and foreign banks aggregating $153,370,000, of which $100,942,000 was unused. The weighted average interest rate on short-term borrowings outstanding as of December 31, 1995 and 1994 was 6.31% and 6.03%, respectively.\nInterest paid was $29,459,000, $24,150,000, and $20,587,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n6. STOCKHOLDERS' EQUITY\nOn May 19, 1995, the Company's shareholders approved an increase in the number of shares of Common Stock, $.10 par value, which the Company is authorized to issue, from 35,000,000 shares to 65,000,000 shares.\nThe Company's Class B Stock carries ten votes per share while the Common Stock carries one vote per share. Class B shares are transferable only to certain permitted transferees while the Common Stock is freely transferable. Class B shares are convertible on a one-for-one basis at any time to Common Stock.\nUnearned compensation relating to Common Stock issued under employee stock plans is being amortized over periods ranging from three to five years. At December 31, 1995, 234,973 shares are available for issuance under stock plans.\nIn 1995, certain key executives of the Company were granted options to purchase 1,052,100 shares of the Company's Common Stock. These options expire March 1, 2000, with one-third exercisable at $26.49 (the closing market price of the Company's Common Stock on the date of grant), one-third exercisable at $33.33, and one-third exercisable at $47.62.\n7. OTHER INCOME\nOther income (expense) consists of the following (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nForeign exchange gains (losses) $(2,022) $440 $(1,382)\nInvestment income 1,529 229 722\nOther 484 247 783 ---------------------------------------------\n$(9) $916 $123 =============================================\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n8. EMPLOYEE RETIREMENT PLANS\nThe Company maintains various defined benefit pension plans covering substantially all full-time U.S. employees. The benefits under these plans are based on the employees' compensation during all years of participation. Participants in these plans, other than U.S. employees of Vitramon, are required to contribute an amount based on annual earnings. The Company's funding policy is to contribute annually amounts that satisfy the funding standard account requirements of ERISA. The assets of these plans are invested primarily in mutual funds and guaranteed investment contracts issued by an insurance company and a bank.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n8. EMPLOYEE RETIREMENT PLANS (CONTINUED)\nNet pension cost for the Plans included the following components (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nAnnual service cost--benefits earned for the period $3,613 $2,547 $2,233\nLess: Employee contributions 1,459 1,142 1,157 --------------------------------------------- Net service cost 2,154 1,405 1,076\nInterest cost on projected benefit obligation 5,702 5,153 4,732\nActual return on Plan assets (11,892) (1,702) (5,270)\nNet amortization and deferral 7,211 (3,349) 655 --------------------------------------------- Net pension cost $3,175 $1,507 $1,193 =============================================\nThe expected long-term rate of return on assets was 8.5% - 9.5%.\nThe following table sets forth the funded status of the Plans and amounts recognized in the Company's financial statements (in thousands):\nDECEMBER 31\n1995 1994 ------------------------------------\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nAccumulated benefit obligation, including vested benefits of $75,636 and $66,601 $75,949 $67,083 ====================================\nActuarial present value of projected benefit obligations $(82,105) $(72,144)\nPlan assets at fair value 78,686 62,513 ------------------------------------ Projected benefit obligations in excess of Plan assets (3,419) (9,631)\nUnrecognized loss 3,043 3,904\nUnrecognized prior service cost 834 1,067\nUnrecognized net obligation at transition date, being recognized over 15 years 356 466 ------------------------------------- Accrued pension liability $814 $(4,194) =====================================\nThe following assumptions have been used in the actuarial determinations of the Plans:\n1995 1994 ------------------------------------ Discount rate 7.25% 8.25% Rate of increase in compensation levels 4.5% - 5.0% 4.5% - 5.0%\n8. EMPLOYEE RETIREMENT PLANS (CONTINUED)\nMany of the Company's U.S. employees are eligible to participate in 401(k) Savings Plans, some of which provide for Company matching under various formulas. The Company's matching expense for the plans was $2,314,000, $2,282,000, and $1,996,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nThe Company provides pension and similar benefits to employees of certain foreign subsidiaries consistent with local practices. German subsidiaries of the Company have noncontributory defined benefit pension plans covering management and employees. Pension benefits are based on years\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nof service. Net pension cost for the German Plans included the following components (in thousands):\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n---------------------------------------------\nAnnual service cost--benefits earned for the period $164 $138 $682\nInterest cost on projected benefit obligation 5,267 4,496 4,521\nActual return on plan assets (854) (1,039) (796)\nNet amortization and deferral (220) 83 (86) --------------------------------------------- Net pension cost $4,357 $3,678 $4,321 =============================================\nThe expected long-term rate of return on assets was 2.0%.\nThe following table sets forth the funded status of the German Plans and amounts recognized in the Company's financial statements (in thousands):\nDECEMBER 31\n1995 1994 ------------------------------------ Accumulated benefit obligation, including vested benefits of $76,556 and $69,910 $77,445 $70,947 ====================================\nActuarial present value of projected benefit obligations $(77,791) $(71,223)\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nPlan assets at fair value 15,331 13,585 ------------------------------------ Projected benefit obligations in excess of plan assets (62,460) (57,638)\nUnrecognized loss 4,935 4,240\nUnrecognized prior service cost 571 590\nUnrecognized net asset at transition date, being recognized over 15 years (36) (37)\nAdditional minimum liability, recognized as a reduction of stockholders' equity (6,792) (5,810) ------------------------------------ Accrued pension liability $(63,782) $(58,655) ====================================\nThe following assumptions have been used in the actuarial determinations of the German Plans:\nDiscount rate 7.0%\nRate of increase in compensation levels 3.0%\n9. POSTRETIREMENT MEDICAL BENEFITS\nThe Company pays limited health care premiums for certain eligible retired U.S. employees. Effective January 1, 1993, the Company adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and elected to recognize the transition obligation, which represents the previously unrecognized prior service cost, on a prospective basis over a twenty-year period.\nNet postretirement benefit cost included the following components (in thousands):\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nYEAR ENDED DECEMBER 31\n1995 1994 1993\n--------------------------------------------- Service cost $215 $214 $351\nInterest cost 497 453 713\nNet amortization and deferral 245 230 424 --------------------------------------------- Net postretirement benefit cost $957 $897 $1,488 =============================================\nThe 1993 cost information does not include the effects of Plan amendments made at the end of 1993 which capped employer contributions for each participant at 1993 dollar amounts. The Company continues to fund postretirement medical benefits on a pay-as-you-go basis.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n9. POSTRETIREMENT MEDICAL BENEFITS (CONTINUED)\nThe status of the plan and amounts recognized in the Company's consolidated balance sheet were as follows (in thousands):\nDECEMBER 31\n1995 1994 ------------------------------------ Accumulated postretirement benefit obligation:\nRetirees $(2,075) $(2,173)\nActives eligible to retire (1,402) (1,104)\nOther actives (3,712) (2,719) ------------------------------------ Total (7,189) (5,996)\nUnrecognized loss 1,440 519\nUnrecognized transition obligation 3,635 3,849 ------------------------------------ Accrued postretirement benefit liability $(2,114) $(1,628) ====================================\nThe discount rates used in the calculations were 7.25% for 1995 and 8.25% for 1994.\n10. LEASES\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\nTotal rental expense under operating leases was $9,984,000, $8,871,000, and $7,528,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nFuture minimum lease payments for operating leases with initial or remaining noncancelable lease terms in excess of one year are as follows: 1996--$6,242,000; 1997--$4,446,000; 1998--$3,115,000; 1999--$2,082,000; 2000--$1,868,000; thereafter--$7,204,000.\n11. FINANCIAL INSTRUMENTS\nFinancial instruments with potential credit risk consist principally of accounts receivable. Concentrations of credit risk with respect to receivables are limited due to the Company's large number of customers and their dispersion across many countries and industries. At December 31, 1995 and 1994, the Company had no significant concentrations of credit risk. The amounts reported in the balance sheet for cash and cash equivalents and for short-term and long-term debt approximate fair value.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n12. CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS\nSOURCES OF SUPPLY\nAlthough most materials incorporated in the Company's products are available from a number of sources, certain materials (particularly tantalum and palladium) are available only from a relatively limited number of suppliers. Tantalum, a metal, is the principal material used in the manufacture of tantalum capacitor products. It is purchased in powder form primarily under annual contracts with domestic suppliers at prices that are subject to periodic adjustment. The Company is a major consumer of the world's annual tantalum production. There are currently three major suppliers that process tantalum ore into capacitor grade tantalum powder. Although the Company believes that there is currently a surplus of tantalum ore reserves and a sufficient number of tantalum processors relative to foreseeable demand, and that the tantalum required by the Company has generally been available in sufficient quantities to meet requirements, the limited number of tantalum powder suppliers could lead to increases in tantalum prices that the Company may not be able to pass on to its customers. Palladium is primarily purchased on the spot and forward markets, depending on market conditions. Palladium is considered a commodity and is subject to price volatility. Although palladium is currently found in South Africa and Russia, the Company believes that there are a sufficient number of domestic and foreign suppliers from which the Company can purchase palladium. However, an inability on the part of the Company to pass on increases in palladium costs to its customers could have an adverse effect on the margins of those products using the metal.\nGEOGRAPHIC CONCENTRATION\nTo address the increasing demand for its products and in order to lower its costs, the Company has expanded, and plans to continue to expand, its manufacturing operations in Israel in order to take advantage of that country's lower wage rates, highly skilled labor force, government-sponsored grants, as well as various tax abatement programs. These incentive programs have contributed substantially to the growth and profitability of the Company. The Company might be materially and adversely affected if these incentive programs were no longer available to the Company or if hostilities were to occur in the Middle East that materially interfere with the Company's operations in Israel.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n13. SEGMENT AND GEOGRAPHIC INFORMATION\nVishay operates in one line of business--the manufacture of electronic components. Information about the Company's operations in different geographic areas is as follows (in thousands):\n13. SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED)\n* Includes export sales of $123,387, $107,196, and $78,793, for the years ended December 31, 1995, 1994, and 1993, respectively.\nSales between geographic areas are priced to result in operating profit which approximates that earned on sales to unaffiliated customers. Operating profit is total revenue less operating expenses. In computing operating profit, general corporate expenses, interest expense, and income taxes were not deducted.\nVishay Intertechnology, Inc.\nNotes to Consolidated Financial Statements (continued)\n14. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nQuarterly financial information for the years ended December 31, 1995 and 1994 is as follows:\n(In thousands, except per share amounts)\n(1) Adjusted to give effect to 5% stock dividends in March 1995 and June 1994, and the 2-for-1 stock split distributed on June 16, 1995.\nSIGNATURES\nPursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVISHAY INTERTECHNOLOGY, INC.\nMarch 21, 1996 \/s\/Felix Zandman ----------------------------------- Felix Zandman, Chairman of the Board, President, 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 and in the capacities and on the dates indicated below.\nMarch 21, 1996 \/s\/Felix Zandman ----------------------------------- Felix Zandman, Chairman of the Board, Director, President and Chief Executive Officer (Principal Executive Officer)\nMarch 21, 1996 \/s\/Richard N. Grubb ----------------------------------- Richard N. Grubb Director, Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)\nMarch 21, 1996 \/s\/Donald G. Alfson ----------------------------------- Donald G. Alfson, Director and Vice President President of Vishay Electronic Components, U.S. and Asia\nMarch 21, 1996 \/s\/Avi D. Eden ----------------------------------- Avi D. Eden, Director\nMarch 21, 1996 ` \/s\/Robert A. Freece ----------------------------------- Robert A. Freece, Director, Senior Vice President\nMarch 21, 1996 \/s\/Eli Hurvitz ----------------------------------- Eli Hurvitz, Director\nMarch 21, 1996 \/s\/Gerald Paul ----------------------------------- Gerald Paul, Director and Vice President President of Vishay Electronic Components, Europe\nMarch 21, 1996 \/s\/Edward B. Shils ----------------------------------- Edward B. Shils, Director\nMarch 21, 1996 \/s\/Luella B. Slaner ----------------------------------- Luella B. Slaner, Director\nMarch 21, 1996 \/s\/Mark I. Solomon ----------------------------------- Mark I. Solomon, Director\nMarch 21, 1996 \/s\/Jean-Claude Tine ----------------------------------- Jean-Claude Tine, Director\nEXHIBIT INDEX\nPage Number in Exhibit sequentially No. Description Numbered Copy - ------- ----------- ------------- 2.1 Stock Purchase Agreement, dated July 12, 1994, between Thomas & Betts Corporation and Vishay Intertechnology, Inc. Incorporated by reference to Exhibit (2.1) to the Current Report on 8-K dated July 18, 1994.\n3.1 Composite Amended and Restated Certificate of Incorporation of the Company dated August 3, 1995. Incorporated by reference to Exhibit 3.1 to Form 10-Q for the quarter ended June 30, 1995 (the \"1995 Form 10-Q\").\n3.2 Amended and Restated Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to Registration Statement No. 33-13833 of Registrant on Form S-2 under the Securities Act of 1933 (the \"Form S- 2\") and Amendment No. 1 to Amended and Restated Bylaws of Registrant Incorporated by reference to Exhibit 3.2 to Form 10-K file number 1-7416 for fiscal year ended December 31, 1993 (the \"1993 Form 10-K\").\n10.1 Performance-Based Compensation Plan for Chief Executive Officer of Registrant. Incorporated by reference to Exhibit 10.1 to the 1993 Form 10-K.\nPage Number in Exhibit sequentially No. Description Numbered Copy - ------- ----------- ------------- 10.2 The First Amendment dated June 27, 1995, to the Amended and Restated Vishay Intertechnology, Inc. $302,500,000 Revolving Credit and Term Loan Agreement dated as of July 18, 1994 by and among Comerica Bank, NationsBank of North Carolina, N.A., Berliner Handels-und Frankfurter Bank, Signet Bank Maryland, CoreStates Bank, N.A., Bank Hapoalim, B.M., ABN AMRO Bank N.V., Credit Lyonnais New York Branch, Meridian Bank, Bank Leumi le-Israel, B.M. and Credit Suisse (collectively, the \"Banks\"), Comerica Bank, as agent for the Banks (the \"Agent\"), and Vishay Intertechnology, Inc. (\"Vishay\"), and the Vishay Intertechnology, Inc. $200,000,000 Acquisition Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and Vishay. Incorporated by references to Exhibit 10.4 to the 1995 Form 10-Q.\n10.3 The First Amendment, dated June 27, 1995, to the Amended and Restated Vishay Europe GmbH DM 40,000,000 Revolving Credit and DM 9,506,000 Term Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and Vishay Europe GmbH (\"VEG\"), and the Amended and Restated Roederstein DM 104,315,990.20 Term Loan Agreement dated as of July 18, 1994 by and among the Banks, the Agent and VEG. Incorporated by references to Exhibit 10.5 to the 1995 Form 10-Q.\nPage Number in Exhibit sequentially No. Description Numbered Copy - ------- ----------- ------------- 10.4 Amended and Restated Vishay Intertechnology, Inc. $302,500,000 Revolving Credit and Term Loan Agreement, dated as of July 18, 1994, by and among Comerica Bank, NationsBank of North Carolina, N.A., Berliner Handelsund Frankfurter Bank, Signet Bank Maryland, CoreStates Bank, N.A., Bank Hapoalim, B.M., ABN AMRO Bank N.V., Credit Lyonnais New York Branch, Meridian Bank, Bank Leumi le-Israel, B.M. and Credit Suisse (collectively, the \"Former Banks\"), Comerica Bank, as agent for the Former Banks (the \"Agent\"), and Vishay Intertechnology, Inc. (\"Vishay\"). Incorporated by reference to Exhibit (10.1) to the Current Report on Form 8-K dated July 18, 1994.\n10.5 Amended and Restated Vishay Beteiligungs GmbH DM 40,000,000 Revolving Credit and DM 9,506,000 Term Loan Agreement, dated as of July 18, 1994, by and among the Former Banks, the Agent and Vishay Beteiligungs GmbH (\"VBG\"). Incorporated by reference to Exhibit (10.2) to the Current Report on Form 8-K dated July 18, 1994.\n10.6 Amended and Restated Roederstein DM 104,315,990.20 Term Loan Agreement, dated as of July 18, 1994, by and among the Former Banks, the Agent, Vishay and VBG. Incorporated by reference to Exhibit (10.3) to the Current Report on Form 8-K dated July 18, 1994.\n10.7 Vishay Intertechnology, Inc. $200,000,000 Acquisition Loan Agreement, dated as of July 18, 1994, by and among the Banks, the Agent and Vishay. Incorporated by reference to Exhibit (10.4) to the Current Report on Form 8-K dated July 18, 1994.\nPage Number in Exhibit sequentially No. Description Numbered Copy - ------- ----------- ------------- 10.8 Amended and Restated Guaranty by Vishay to the Banks, dated July 18, 1994. Incorporated by reference to Exhibit (10.5) to the Current Report on Form 8-K dated July 18, 1994.\n10.9 Employment Agreement, dated as of March 15, 1985, between the Company and Dr. Felix Zandman. Incorporated by reference to Exhibit (10.12) to the Form S-2.\n10.10 Vishay Intertechnology 1995 Stock Option Program. Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-59609).\n10.11 1986 Employee Stock Plan of the Company. Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (No. 33-7850).\n10.12 1986 Employee Stock Plan of Dale Electronics, Inc. Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (No. 33-7851).\n10.13 Money Purchase Plan Agreement of Measurements Group, Inc. Incorporated by reference to Exhibit 10(a)(6) to Amendment No. 1 to the Company's Registration Statement on Form S-7 (No. 2-69970).\n22. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n27. Financial Data Schedule.","section_15":""}
{"filename":"772074_1995.txt","cik":"772074","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nEastpoint Mall Limited Partnership (the \"Partnership\"), a Delaware limited partnership, was formed on June 26, 1985. The affairs of the Partnership are conducted by Eastern Avenue Inc. (the \"General Partner,\" formerly Shearson Lehman Eastern Avenue Inc.), a Delaware corporation and affiliate of Lehman Brothers Inc. (\"Lehman\"). The Partnership was formed to acquire a general partnership interest in Bellwether Properties, L.P., a New York limited partnership, from Corporate Property Investors, the sole asset of which is Eastpoint Mall (the \"Mall\") located in Baltimore County, Maryland. Concurrent with the acquisition, Bellwether Properties, L.P. was reconstituted under the name of Eastpoint Partners L.P. (the \"Owner Partnership\"), and the Partnership became the managing general partner of the Owner Partnership. The Owner Partnership consists of the Partnership which holds a 90.9% interest in the Owner Partnership, the General Partner which holds a .1% interest and SFN Limited Partner ship (\"SFN\"), a Maryland limited partnership which is an affiliate of The Shopco Company which holds a 9% interest in the Mall (collectively the \"Owner Partners\"). Shopco Management Corp. has been retained by the Owner Partnership as managing and leasing agent for the Mall.\nOn November 22, 1985, the Partnership commenced investment operations with the acceptance of subscriptions of 4,575 limited partnership units, the maximum authorized by the limited partnership agreement (\"Limited Partnership Agreement\"). Upon the admittance of the additional limited partners, the initial limited partner withdrew from the Partnership.\nOn November 29, 1985, the Owner Partnership acquired the Mall by purchasing all of the general partnership interests in Bellwether Properties, L.P., for a purchase price of $28,634,598.\nIn December 1989, the Partnership obtained first mortgage financing (the \"First Mortgage Note\") in the maximum amount of $50,000,000 secured by the Mall to: (1) repay the existing indebtedness of the Owner Partnership, (ii) make certain capital improvements to the Mall, including the construction of a Sears department store and the acquisition of the underlying real estate, the creation of additional Mall shops in the area previously occupied by Hutzler's, a former anchor tenant, and an overall renovation of the Mall, and (iii) make a cash distribution to each limited partner on February 1, 1990 of $2,500 for each $5,000 interest owned. The renovation of the Mall and construction of the Sears store were completed during 1991.\nThe First Mortgage Note was scheduled to mature on December 28, 1994. In December 1993, the Partnership obtained new first mortgage financing in the amount of $51,000,000 from CBA Associates, Inc., an entity which placed the new mortgage into a pool of mortgages to be held by a Real Estate Mortgage Investment Conduit (the \"REMIC Lender\" or \"CBA Conduit, Inc.\"). For the terms of the new financing, see Note 5 to the Notes to the Consolidated Financial Statements.\n(b) Financial Information About Industry Segments\nAll of the Partnership's revenues, operating profit or loss and assets relate solely to its interest as the general partner of the Owner Partnership. All of the Owner Partnership's revenues, operating profit or losses and assets relate solely to its ownership interest in and operation of the Mall.\n(c) Narrative Description of Business\nThe Partnership's sole business is acting as the managing general partner of the Owner Partnership. The Owner Partnership's sole business is the ownership and operation of the Mall. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nEastpoint Mall is an enclosed regional shopping center located on approximately 67.1 acres in Baltimore County, Maryland, approximately one mile east of the city limits of Baltimore. The Mall consists of a central enclosed mall anchored by four major department stores - J.C Penney, Inc. (\"J.C. Penney\"), Schottenstein Stores Corporation, doing business as Value City (\"Value City\"), Sears, Roebuck, and Co. (\"Sears\") and Ames Department Stores, Inc. (\"Ames\"). The retail space in the Mall is contained on one level; J.C Penney and Value City are multi-level and there are five freestanding buildings. Office and storage areas are contained in the lower level of existing mall space, and in the lower and upper floor levels of the expansion mall space. Parking is provided for over 4,500 cars.\nThe Mall currently has gross leasable space totalling 864,993 square feet. Of this leasable space, 637,582 is owned by the Owner Partnership and 227,411 square feet of gross leasable space area is owned by the tenants who have leased portions of land pursuant to ground leases with the Owner Partnership. Upon expiration of such ground leases, ownership of the buildings thereon will revert to the Owner Partnership.\nOn December 28, 1989, the Partnership purchased 5.1 acres of land adjacent to the Mall for a contract sales price of $640,125 on which a one-story, 79,000 square foot Sears Department store and an 8,734 square foot automotive center were constructed. The Sears department store and automotive center, located adjacent to the new food court, opened in October 1991. As described below, the Partnership owns the store and leases it to Sears, which serves as a replacement anchor tenant for Hutzler's, which vacated the Mall on January 22, 1990, after expiration of its lease on July 31, 1989. The space previously occupied by Hutzler's was converted into new mall shops, a food court and seating area, and office space. The construction of the new space was completed in 1991, as was a renovation program at the Mall which replaced skylights and floors and refurbished mall common areas.\nThe total building area of the Mall is allocated as shown in the table below.\nPercent of Square Feet Total Area Anchors: J.C. Penney 168,969 20% Value City 140,000 16 Sears 87,734 10 Ames 58,442 7 Specialty Retailers(1) 344,688 39 Atrium and Office Space 65,160 8\nTotal 864,993 100%\n(1) Includes outparcel stores and outdoor tenants.\nAnchor Tenants\nJ.C. Penney leases a parcel of land pursuant to a ground lease on which it has constructed the largest of the Mall's four anchor stores, together with a freestanding store, containing an aggregate of approximately 168,969 square feet of building area, or 20% of the gross leasable building area of the Mall. Ownership of the anchor store, currently owned and occupied by J.C. Penney, and ownership of the freestanding store, currently owned by J.C. Penney and subleased to Firestone Tire and Rubber Co. and Sherwin-Williams, will revert to the Owner Partnership upon the expiration of the ground lease. The initial term of the J.C. Penney ground lease expires on August 31, 2001. Four 5-year renewal options and two 10-year renewal options are available on the same terms and conditions. The minimum rent payable thereunder is $1,500 annually plus a percentage rent of .5% of gross sales.\nThe ground lease with J.C. Penney provides that J.C. Penney does not have to operate if (i) at least 250,000 square feet of the total retail space of the Mall, including the space occupied by Value City, the space previously occupied by Hutzler's and certain other space, is not being used for retail use, or (ii) neither Schottenstein Stores Corporation (or any successor) nor Hutzler's (or any successor) are operating retail department stores in their premises. If at any time, J.C. Penney discontinues the use of its anchor store as a retail department store and assigns its lease or sublets the premises within a certain period of time, the Owner Partnership, as landlord, has the right to purchase the lease at fair market value.\nValue City, the second largest anchor store, leases approximately 140,000 square feet, or 16% of the gross leasable building area of the Mall, and is located at the western end of the Mall. The initial term of the Value City lease was scheduled to expire on November 30, 1999. On September 14, 1995, the expiration date of the lease was extended until November 30, 2009. A 10-year renewal option is available on the same terms and conditions. Per the terms of the September 14, 1995 amendment to the lease, the minimum rent payable thereunder was increased from $220,000 to $585,000 per annum, with increases based on the following increments in annual sales: 3 1\/2% of the first 4.2 million in sales; 3 1\/4% of sales in excess of $4.2 million but not in excess of $7 million; 3% of sales in excess of $7 million but not exceeding $8.4 million, and 2 1\/2% of sales in excess of $8.4 million.\nAmes (previously G.C. Murphy) leases a parcel of land pursuant to a ground lease on which it has constructed a building containing approximately 58,442 square feet of building area, or 7% of the gross leasable building area of the Mall. The initial term of the Ames ground lease expires on May 30, 2004. One 10-year renewal option is available on the same terms and conditions. Ownership of the building now owned and occupied by Ames will revert to the Owner Partnership upon the expiration of the ground lease. The minimum rent payable under the Ames ground lease is $204,000 annually with a percentage rent of .5% of gross sales above the breakpoint of $4,800,000 until January 31, 1999. Commencing on February 1, 1999, minimum rent payable will increase to $257,000 per annum. In the event that Ames exercises its renewal option, the minimum rent payable is $257,000 per year with a percentage rent of .5% of gross sales above the breakpoint of $6,000,000. Ames is not required to operate if (i) less than 150,000 square feet in the Mall is used for retail use, or (ii) any two of Value City, Hutzler's or J.C. Penney (or any successor) cease operations as an anchor store in the Mall.\nOn April 26, 1990, Ames filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. By filing its bankruptcy petition, Ames was in default under the deed of trust held by Consolidated Fidelity Life Insurance Company (\"Consolidated\") and secured by the Ames parcel. In July 1994, the Partnership entered into a settlement agreement with Consolidated regarding the Ames parcel. Please refer to Item 3, Item 7 and Note 3 to the Notes to the Consolidated Financial Statements for a description of the Ames bankruptcy and the Release Agreement negotiated by the Partnership and Consolidated.\nSears leases approximately 79,000 square feet of gross leasable area in a new anchor store opened in October 1991, together with a freestanding store, containing an aggregate of approximately 87,734 square feet of building area or 10% of the gross leasable building area of the Mall. The initial term of the lease expires on October 16, 2006. The tenant has the right to extend the lease term for seven additional periods of five years each under the same terms, by providing the landlord written notice no less than twelve months prior to the end of the lease term. Rent is based on a percentage of net sales, with the tenant paying a sum equal to 1.75% of net sales in excess of $1 but less than $16,000,000 and a sum equal to 1.5% of net sales that exceed $16,000,000.\nThe lease with Sears provides that Sears does not have to operate if (i) less than 60% of the gross leasable area of the Mall (excluding anchor stores) is not operating and (ii) at least two of the anchor stores are not operating. If such events occurred, the landlord has twelve months in which to remedy any condition which would enable Sears to terminate the lease agreement.\nMall, Outparcel Tenants and Atrium Space During 1995, 18 leases totalling 27,323 square feet of space were executed with new and existing tenants. During the third quarter of 1995, the Partnership executed a lease with H&R Block for 2,500 square feet in the Atrium office space. During the fourth quarter of 1995, the Partnership executed a lease with Ultrazone, a laser-tag entertainment concept for approximately 9,000 square feet in the lower level of the Atrium office space. Prior to the execution of these leases, the Atrium office space was unoccupied. Due to the sluggish commercial real estate market in eastern Baltimore County, the leasing of additional Atrium office space is anticipated to be a lengthy and capital intensive process. Costs associated with maintaining the space consist primarily of utility expenses which are included in property operating expenses. These costs, as well as costs associated with marketing the space for lease, are funded from the Partnership's cash flow and cash reserves.\nStaples leases an outparcel store with 36,000 square feet of building area or 4.2% of the gross leasable building area of the Mall. The primary lease term runs through the year 2004, plus two lease renewal options for five years each. The fixed minimum rent during the primary term begins at $7.50 per square foot and escalates throughout the term of the lease reaching $8.25 per square foot for years eleven through fifteen, subject to certain cost-of-living adjustments.\nDuring 1995, the retail industry, particularly apparel merchants and other mall-based retail chains, continued to suffer from changes in shoppers' buying patterns which have primarily benefitted discount retailers and superstores. The continuing difficulties in the retail industry are evidenced by the increasing number of bankruptcy filings by many companies. As of the date for which this report is filed, six tenants, or their parent corporations, at the Mall have filed for protection under the U.S. Federal Bankruptcy Code. These tenants currently occupy approximately 5% of the Mall's leasable area (exclusive of anchor tenants), and at this point their plans to remain at the Mall remain uncertain. Please refer to Item 7 for a listing of Mall tenants which have filed for bankruptcy protection.\nCompetition\nEastpoint Mall is the only regional shopping center located within a 3 mile radius from the center (the primary geographical area from which the Mall derives its repeat sales and regular customers). However, two shopping centers are directly competitive with the Mall. Golden Ring Mall, located slightly over three miles northeast of Eastpoint Mall, represents its principal competition. Golden Ring Mall is a two-story center containing 737,476 square feet of gross leasable area. Golden Ring has three anchor tenants, Hecht's, Caldor and Montgomery Ward, as well as approximately 80 smaller mall stores. Golden Ring completed a cosmetic renovation of both the interior and exterior of the center during 1992.\nWhite Marsh Mall is located approximately six miles north of the Mall and contains approximately 1,105,000 square feet of gross leasable space on two levels. Anchor stores include Macy's, J.C. Penney and Sears. There is an empty anchor space in the former site of Woodward & Lothrup. Ikea is located on a site at the mall. White Marsh contains approximately 180 stores.\nTemporary Tenants A formal temporary tenant program was instituted in November 1992 in which kiosks and vacant spaces are used as temporary retail locations. The program generated revenues of $302,815 in 1995. The temporary tenant program is managed by Shopco Management Corp., the Mall's property manager.\nItem 3.","section_3":"Item 3. Legal Proceedings\nLand leased to Ames by the Owner Partnership together with the building constructed thereon by Ames, secured a deed of trust held by Consolidated Fidelity Life Insurance Company (\"Consolidated\"). In 1990, Ames filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code, thereby defaulting on the Consolidated deed of trust. On December 18, 1992, the Bankruptcy Court confirmed a Plan of Reorganization for Ames (the \"Plan\") and the plan was subsequently consummated. Pursuant to the Plan, Ames assumed the lease of its store at the Mall and continues its operations there. In July 1994, the Partnership executed a Compromise and Mutual Release (the \"Release Agreement\") with Consolidated. Pursuant to the terms of the Release Agreement , the Partnership paid Consolidated $2 million in return for the assignment of the deed of trust and related Ames promissory note, as well as Consolidated's claim in the Ames bankruptcy case relating to such promissory note. Consolidated 's total claims, in the face amount of approximately $2.3 million, consist of the balances due on the Ames promissory note, totaling $1.7 million, and another promissory note. Pursuant to the Release Agreement, the Partnership is entitled to any recovery based on the Ames promissory note; Consolidated will receive any recovery on the other note. The trustee in bankruptcy in the Ames bankruptcy case has entered an objection to this claim, however, the Partnership is pursuing legal action to collect the claimed amount. For the year ended December 31, 1994, the Partnership recorded a note receivable in the amount of $816,000. In 1995, the note receivable was written-down by $78,000 to $738,000 which represents the amount the Partnership expects to receive from the claim pending bankruptcy court approval.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted for a vote of the Unit Holders during the fourth quarter of the year for which this report has been filed.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters\n(a) Market Price Information\nThere is no established trading market for the Units of the Partnership. The Partnership had 4,575 Units outstanding at December 31, 1995.\n(b) Holders\nThere were 1,792 Limited Partners as of December 31, 1995.\n(c) Distributions of Cash\nSince inception, Limited Partners have received cumulative distributions of $5,358.27 per unit, including a $2,500 return of capital in 1990.\nCash distributions to limited partners were suspended from the second quarter of 1991, until the second quarter of 1994, due to: (i) an increasingly competitive retail environment, which required substantial capital resources devoted to attracting and leasing space to quality, creditworthy tenants, (ii) the costs of the 1991 renovation program, (iii) the Sears construction, (iv) the potential costs of the Ames bankruptcy, and (v) potential costs associated with refinancing the Mall's First Mortgage Note. As a result of these factors, it was necessary for the Partnership to maintain increased working capital reserves. The renovation and Sears construction were completed in 1991, and the refinancing of the First Mortgage Note was completed in late 1993. Following the execution of the Consolidated Release Agreement (see Item 7), the Partnership reinstated quarterly distributions to the Limited Partners commencing with the second quarter of 1994 in the amount of $62.50 per Unit. This quarterly level was maintained through the year ended December 31, 1995. In addition the Partnership paid a special cash distribution of $218.50 per Unit on June 7, 1995 from excess cash reserves. The level, timing, and amount of future distributions, including special distributions, will be reviewed at a minimum on a quarterly basis after an evaluation of the Mall's performance and the Partnership's current and future cash needs. No assurances can be made regarding the size or continuance of future distributions.\nQuarterly Cash Distributions Per Limited Partnership Unit\n1995* 1994*\nFirst Quarter $ 62.50 $ - Second Quarter 281.00** 62.50 Third Quarter 62.50 62.50 Fourth Quarter 62.50 62.50\nTOTAL $ 468.50 $ 187.50\n* Distribution 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.\n** Includes the $218.50 per Unit special cash distribution paid on June 7, 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe 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 appearing elsewhere in this Form 10-K.\n(in thousands except per Unit data)\nAs of and for the years ended December 31,\n1995 1994 1993 1992 1991\nTotal Rental and Percentage Income $ 8,104 $ 7,907 $ 7,404 $ 6,424 $ 5,935 Escalation Income 3,585 3,143 3,049 2,898 1,940 Interest Income 406 265 80 25 133 Miscellaneous Income 113 150 210 73 5\nTotal Income 12,209 11,465 10,743 9,420 8,013\nNet Income(Loss) 1,934 915 (658) (372) 669 Net Income(Loss) per Unit (a) 418.44 198.00 (142.30) (80.40) 144.76 Cash Distributions per Unit (a)(b) 468.50(c) 187.50 - - 18.75 Total Assets 55,367 55,625 56,458 49,689 47,329 Long-term Obligations 51,000 51,000 51,000 44,650 41,295\n(a) There are 4,575 Units outstanding.\n(b) Distribution amounts are reflected in the period for which they are declared. Actual cash distributions are paid subsequent to such periods.\n(c) Includes a $ 218.50 per unit special distribution paid on June 7, 1995.\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 Partnership had a cash balance of $6,254,501, compared to $5,661,047 at December 31, 1994. The increase is primarily due to cash provided by operating activities exceeding cash distributions paid during 1995 and additions to real estate. The Partnership maintains a restricted cash account representing a loan reserve of $2,100,000 as established under the terms of its first mortgage loan. Of this balance, $1.1 million represents a portion of the proceeds of the Partnership's first mortgage loan which was withheld pending resolution of the Consolidated dispute (see \"Ames Parcel and Consolidated Release Agreement\" below). The remaining balance constitutes additional collateral which can be used for capital improvements and leasing commissions. Cash-held in escrow totaled $443,811 at December 31, 1995 compared with $370,993 at December 31, 1994. The increase is primarily attributable to additional fundings made to the insurance escrow as specified under the terms of the Partnership's first mortgage loan.\nAccounts receivable increased from $549,542 at December 31, 1994 to $638,436 at December 31, 1995. The increase during 1995 primarily reflects a decrease in allowances for doubtful accounts.\nAccrued interest receivable increased from $90,197 at December 31, 1994 to $224,567 at December 31, 1995 representing an accrual for interest earned on the loan reserve in 1995.\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. Bankruptcy Code:\nTenant Square Footage Leased Merry Go 'Round* 4,130 No Name** 2,000 Marianne 3,750 Marianne Plus 3,000 Jean Nicole* 4,700 Jeans West 2,400 Rave 2,000\n* tenant vacated in early 1996 ** anticipates vacating in early 1996\nAs of December 31, 1995, these tenants occupied 21,980 square feet, or approximately 6% of the Mall's leasable area (exclusive of anchor tenants and office space). 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 the Mall and revenues received by the Partnership depending on the Partnership's ability to replace them with new tenants at comparable rents.\nAmes Parcel and Consolidated Release Agreement On April 26, 1990, Ames filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. On December 18, 1992, the Bankruptcy Court confirmed a Plan of Reorganization for Ames (the \"Plan\") pursuant to which Ames has assumed its lease at the Mall. Land leased to Ames by the Owner Partnership together with the building constructed thereon by Ames secured a deed of trust held by Consolidated, as successor to Southwestern Life Insurance Company. By filing its bankruptcy petition, Ames was in default under the Consolidated deed of trust.\nOn July 14, 1994, the Partnership executed a Release Agreement with Consolidated. Pursuant to the terms of the Release Agreement, the Partnership paid Consolidated $2 million in return for the assignment of the deed of trust and related Ames promissory note, as well as Consolidated's claim in the Ames bankruptcy case relating to such promissory note. Consolidated's total claims, in the face amount of approximately $2.3 million, consist of the balances due on the Ames promissory note, totaling $1.7 million, and another promissory note. Pursuant to the Release Agreement, the Partnership is entitled to any recovery based on the Ames promissory note; Consolidated will receive any recovery on the other note. The bankruptcy trustee in the Ames bankruptcy case has entered an objection to this claim; however, the Partnership is pursuing legal action to collect the claimed amount. For the year ended December 31, 1994, the Partnership recorded a note receivable in the amount of $816,000. In 1995, the note receivable was written-down by $78,000 to $738,000 which represents the amount the Partnership expects to receive from the claim pending bankruptcy court approval.\nThe Partnership's mortgage lender withheld certain of the proceeds of the first mortgage loan until the Partnership resolved the Consolidated dispute. It is anticipated that these funds, which total $1.1 million, will be released to the Partnership in 1996 when the first mortgage secured by the Ames parcel, which has been retained by the Partnership pending a final decision on Consolidated's claims, is extinguished. These funds are held in escrow with interest payable to the Partnership.\nCash Distributions The Partnership reinstated quarterly distributions to the limited partners, commencing with the second quarter of 1994. On June 7, 1995, the Partnership paid a special cash distribution, funded by its cash reserves, in the amount of $218.50 per unit. A distribution for the fourth quarter of 1995, in the amount of $62.50 per Unit, was paid on February 9, 1996. The level, timing, and amount of future distributions will be reviewed on a quarterly basis after an evaluation of the Mall's performance and the Partnership's current and future cash needs.\nOn February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. \"Change of Control\" means any purchase or offer to purchase more than 10% of the Units that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a Form 8-K disclosing this resolution on February 29, 1996.\nResults of Operations\n1995 versus 1994 Net cash flow from operating activities totalled $3,732,467 in 1995 compared to $1,721,335 in 1994. The increase is primarily due to higher net income and increases in accounts payable and amounts due to affiliates partially offset by a decrease in accrued interest payable. Cash outflows from investing activities totaled $757,229 in 1995 and $1,618,843 in 1994. The decrease in cash outflows from investing activities for 1995 is due to the payment made pursuant to the Release Agreement in 1994.\nFor the year ended December 31, 1995, the Partnership recognized net income of $1,933,722 compared to $915,010 during 1994. The increase in net income is primarily attributable to increases in rental, escalation and interest income.\nThe Partnership generated total income for the year ended December 31, 1995 of $12,208,708 compared to $11,464,835 during 1994. Rental income increased for the year ended December 31, 1995 compared to 1994 reflecting lease renewals at higher rates and leases with new tenants. Escalation income represents the income received from Mall tenants for their proportionate share of common area maintenance and real estate tax expenses. Escalation income increased for the year ended December 31, 1995 compared to 1994 mainly due to credits issued to tenants during 1994 for 1993 reimbursable expenses.\nInterest income increased for the year ended December 31, 1995 compared to 1994 primarily due to an increase in cash reserves and in interest rates earned on the Partnership's invested cash.\nTotal Mall tenant sales (exclusive of anchor tenants) were $64,193,000 for the year ended December 31, 1995, improved from $63,766,000 for the year ended December 31, 1994. Sales for tenants (exclusive of anchor tenants) which operated at the Mall for each of the last two years were $59,778,000 and $59,691,000, respectively. As of December 31, 1995, the Mall was 94.1% occupied, excluding anchor tenants and office space, compared to 94.2% at December 31, 1994.\n1994 Versus 1993 Net cash flow from operating activities totaled $1,721,335 in 1994, as compared to $2,128,506 in 1993. The $407,171 decrease is primarily due to the payment of accounts payable and amounts due to affiliates which were partially offset by higher net income. Cash outflows from investing activities totaled $1,618,843 in 1994 and $888,529 in 1993. The increase in cash outflows from investing activities for 1994 is due to the payment made pursuant to the Release Agreement.\nFor the year ended December 31, 1994, the Partnership recognized net income of $915,010 compared to a net loss of $657,578 in 1993. The shift from net loss to net income is primarily due to the recognition of $812,500 in the second quarter of 1993 compared to $371,500 in 1994 for anticipated settlement costs to Consolidated attributable to the Ames bankruptcy as well as increases in rental income, escalation income and interest income, and lower interest and depreciation expense for 1994.\nThe Partnership generated total income for the periods ended December 31, 1994 and 1993 of $11,464,835 and $10,743,372, respectively. For the year ended December 31, 1994, rental and percentage income totalled $7,906,773 compared to $7,403,961 in 1993. The increase reflects increased base rents due to lease renewals, new food court tenants and an increase in temporary tenant income. Percentage rents increased due to higher 1994 tenant sales. Escalation income totalled $3,143,108 in 1994 compared to $3,049,139 in 1993. Escalation income represents the income received from Mall tenants for their proportionate share of common area maintenance and real estate tax expenses. The increase in escalation income is a result of increased property operating expenses, largely insurance expense, a portion of which is reimbursable to the Mall from tenants as escalation income. Interest income for the year ended December 31, 1994 was $265,117 compared to $79,906 for 1993. The increase in interest income is due to the Partnership's maintenance of higher average cash balances as well as increasing interest rates in the last six months of 1994. In addition, interest is also being accrued on the restricted cash balance. Miscellaneous income totaled $149,837 in 1994, compared to $210,366 in 1993. The decrease in miscellaneous income is due to the receipt in 1993 of two tenant receivables that had previously been written-off.\nTotal expenses were $10,442,942 in 1994, compared to $11,406,177 in 1993. The decrease is due primarily to the recognition of $812,500 in 1993 compared to $371,500 in 1994 for anticipated settlement costs to Consolidated attributable to the Ames bankruptcy. Additionally, depreciation and amortization decreased in 1994 to $1,904,981 from $2,312,175 in 1993. The decrease reflects the write-off of closing costs and fees associated with the old mortgage which was refinanced in 1993. Interest expense also decreased to $4,090,017 in 1994 as compared to $4,258,120 in 1993 due to the refinancing of the Partnership's first mortgage loan at a lower rate.\nTotal Mall tenant sales (exclusive of anchor tenants) were $63,766,000 for the year ended December 31, 1994, compared to $63,906,000 for the year ended December 31, 1993. Sales for tenants (exclusive of anchor tenants) who operated at the mall for each of the last two years were approximately $59,778,000 and $53,246,000, respectively. As of December 31, 1994, the Mall was 94.2% occupied, excluding anchor tenants and office space, compared to 96.7% as of December 31, 1993.\nProperty Appraisal The appraised fair market value of the Mall at January 1, 1996, as determined by Cushman & Wakefield, Inc., an independent third party appraisal firm, was $81,000,000, compared to $85,000,000 at January 1, 1995. Limited Partners should note that appraisals are only estimates of current value and actual values realizable upon sale may be significantly different. A significant factor in establishing an appraised value is the actual selling price for properties which the appraiser believes are comparable. Because of the nature of the Partnership's property and the limited market for such property, 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 could be incurred in selling the property. As a result of these factors and the illiquid nature of an investment in Units of the Partnership, the variation between the appraised value of the Partnership's property and the price at which Units of the Partnership could be sold is likely to be significant. Fiduciaries of Limited Partners which are subject to ERISA or other provisions of law requiring valuation of Units should consider all relevant factors, including, but not limited to the net asset value per Unit, in determining the fair market value of the investment in the Partnership for such purposes.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Item 14a for a listing of the Consolidated Financial Statements and Supplementary data in this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III \t \t Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe General Partner is an affiliate of Lehman and has offices at the same location as the Partnership and the Owner Partnership at 3 World Financial Center, 29th Floor, New York, NY, 10285-2900. All of the executive officers and directors of the General Partner are also officers and employees of Lehman.\nOn July 31, 1993, Shearson Lehman Brothers, Inc. (\"Shearson\") sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to 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 \"Eastern Avenue Inc.\" to delete any references to \"Shearson.\"\nCertain executive officers and directors of the General Partner are now serving (or in the past have served) as executive officers or directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought the protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nThe executive officers and directors of the General Partner as of December 31, 1995 are as follows: \t Name Age Office\nPaul L. Abbott 50 Director, President, Chief Executive Officer, Chief Financial Officer, and Chief Operating Officer Robert J. Hellman 41 Vice President Elizabeth I. Rubin 29 Vice President Joan B. Berkowitz 36 Vice President\nPaul L. Abbott is a Managing Director of Lehman Brothers. Mr. Abbott joined Lehman Brothers in August 1988, and is responsible for investment management of residential, commercial and retail real estate. Prior to joining Lehman Brothers, Mr. Abbott was a real estate consultant and a senior officer of a privately held company specializing in the syndication of private real estate limited partnerships. From 1974 through 1983, Mr. Abbott was an officer of two life insurance companies and a director of an insurance agency subsidiary. Mr. Abbott received his formal education in the undergraduate and graduate schools of Washington University in St. Louis.\nRobert J. Hellman 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.\nElizabeth I. Rubin 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.\nJoan B. Berkowitz, 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.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe directors and executive officers of the General Partner do not receive any salaries or other compensation from the Partnership. See Item 13 with respect to a description of certain transactions between the General Partner or its affiliates and the Registrant.\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 beneficially owns more than 5% of its Units.\n(b) Security ownership of management\nAs of December 31, 1995, neither the General Partner, nor any executive officer or director thereof, was the beneficial owner of any Units.\n(c) Changes in control\nThere were no changes in control during the year ended December 31, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Partnership has no directors or executive officers. Its affairs are managed by the General Partner, which receives 1% of the distributions of income, profits, cash distributions and losses of the 90.9% received from the Owner Partnership each year.\nThe Limited Partnership Agreement specifies the allocation of operating income, profits, losses and cash distributions. For a description of such terms, please refer to Note 4 to the Notes to the Consolidated Financial Statements of this report.\nThe General Partner and affiliates may be reimbursed by the Partnership for certain costs as described on page 10 and 11 of the Partnership's prospectus, which description is incorporated herein by reference thereto. First Data Investor Services Group, formerly The Shareholder Services Group, provides accounting and investor relations services for the Partnership. Prior to May 1993, these services were provided by an affiliate of the General Partner. The Partnership's transfer agent and certain tax reporting services are provided by Service Data Corporation. Both First Data Investor Services Group and Service Data Corporation are unaffiliated companies. Under the terms of the Partnership Agreement, the Partnership reimbursed the General Partner, at cost for the performance of certain administrative services provided by a third party. For the year ended December 31, 1995, costs for such services were $83,357.\nCPR Realty Brokerage, Inc. (\"CPR\"), formerly Shearson Realty Brokerage, Inc., was paid $510,000 in 1994 in conjunction with the Partnership's 1993 refinancing. CPR is an affiliate of the General Partner.\nPART IV \t Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)(i) Index to Consolidated Financial Statements\nPage\nIndependent Auditors' Report\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 Partners' Capital (Deficit) 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 the Consolidated Financial Statements\n(a)(ii) Financial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts\nSchedule III - Real Estate and Accumulated Depreciation\n(a)(iii) Exhibits\nSubject to Rule 12b-32 under the Securities Exchange Act of 1934 on incorporation by reference, listed below are the exhibits that are filed as part of this report:\nNo.\tTitle\n3.1 Restated Agreement and Certificate of Limited Partnership of the Partnership dated as of June 25, 1985 is hereby incorporated by reference to Exhibit B to the Prospectus (the \"Prospectus\") contained in Registration Statement No. 2-98786, as amended (the \"Registration Statement\"), which Registration Statement was declared effective on August 19, 1985.\n3.2 Form of Restated Agreement and Certificate of the Partnership is hereby incorporated reference to Exhibit B to the Prospectus.\n3.3 Certificate of Limited Partnership of Bellwether Properties, L.P. (\"Bellwether\"), as amended, is hereby incorporated by reference to the Registration Statement.\n3.4 Form of Amendment to Certificate of Limited Partnership of Bellwether is hereby incorporated by reference to the Registration Statement.\n3.5 Form of Amended and Restated Agreement of Limited Partnership of the Owner Partnership is hereby incorporated by reference to Exhibit C to the Prospectus.\n4.1 Form of certificate representing a limited partnership interest in the Partnership is hereby incorporated by reference to the Registration Statement.\n10.1 Subscription Agreement and Signature Page is hereby incorporated by reference to Exhibit D to the Prospectus.\n10.2 Escrow Agreement between the Partnership, Shearson Lehman Brothers Inc. (\"Shearson\") and Manufacturers Hanover Trust Company, dated as of August 12, 1985, is hereby incorporated by reference to the Registration Statement.\n10.3 Form of Property Management and Leasing Agreement dated as of November 29, 1985, between the Owner Partnership and Shopco Management Corporation is hereby incorporated by reference to the Registration Statement.\n10.4 Capital Contribution Agreement dated as of August 7, 1985, between Shearson Lehman Brothers Group Inc. and the General Partner is hereby incorporated by reference to the Registration Statement.\n10.5 Letter Agreement, dated as of June 6, 1985, amending the Contract of Sale is hereby incorporated by reference to the Registration Statement.\n10.6 Indemnification Agreement between Shearson, Shearson Holdings and the officers and directors of the General Partner is hereby incorporated by reference to the Registration Statement.\n10.7 Amended and Restated Deed of Trust and Security Agreement between Eastpoint Partners, L.P. and CBA Associates, Inc. dated December 1, 1993, 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.\n10.8 Compromise and Mutual Release Agreement dated as of July 14, 1994 by and between Eastpoint Partners, L.P. and Southwestern Life Insurance Company is hereby incorporated by reference to Exhibit 10.1 to the Partnership's report on Form 10-Q for the period ended June 30, 1994 \t 27\tFinancial Data Schedule.\n(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.\nDated: March 28, 1996\nEASTPOINT MALL LIMITED PARTNERSHIP\nBY: Eastern Avenue, Inc. General Partner\nBY: \/s\/ Paul L. Abbott Name: Paul L. Abbott Title: Director, President, Chief Executive Officer, Chief Financial 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 in the capacities and on the dates indicated.\nEASTERN AVENUE INC. General Partner\nDate: March 28, 1996 BY: \/s\/ Paul L. Abbott Paul L. Abbott Director, President, Chief Executive Officer, Chief Financial Officer and Chief Operating Officer\nDate: March 28, 1996 BY: \/s\/ Robert J. Hellman Robert J. Hellman Vice President\nDate: March 28, 1996 BY: \/s\/ Joan Berkowitz Joan Berkowitz Vice President\nDate: March 28, 1996 BY: \/s\/ Elizabeth Rubin Elizabeth Rubin Vice President\nIndependent Auditors' Report\nThe Partners Eastpoint Mall Limited Partnership:\nWe have audited the consolidated financial statements of Eastpoint Mall Limited Partnership and Consolidated Partnership (a Delaware limited partnership) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Partnership'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 Eastpoint Mall Limited Partnership and Consolidated Partnership 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 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nBoston, Massachusetts February 16, 1996\nConsolidated Balance Sheets December 31, 1995 and 1994\nAssets 1995 1994\nReal estate, at cost (notes 2, 3 and 5): Land $ 4,166,230 $ 4,166,230 Building 43,241,060 43,241,060 Improvements 7,050,087 6,354,635\n54,457,377 53,761,925\nLess accumulated depreciation and amortization (11,738,595) (9,997,420)\n42,718,782 43,764,505\nCash and cash equivalents 6,254,501 5,661,047 Restricted cash (note 5) 2,100,000 2,100,000 Cash-held in escrow (note 5) 443,811 370,993 Accounts receivable, net of allowance of $80,405 in 1995 and $294,059 in 1994 638,436 549,542 Accrued interest receivable 224,567 90,197 Deferred rent receivable 356,656 257,901 Note receivable (note 3) 738,000 816,000 Deferred charges, net of accumulated amortization of $423,597 in 1995 and $230,023 in 1994 1,510,981 1,671,299 Prepaid expenses 381,278 343,516\nTotal Assets $ 55,367,012 $ 55,625,000\nLiabilities, Minority Interest and Partners' Capital\nLiabilities: Accounts payable and accrued expenses $ 192,779 $ 169,474 Mortgage loan payable (note 5) 51,000,000 51,000,000 Accrued interest payable 340,425 340,425 Due to affiliates (notes 6 and 7) 22,226 40,251 Security deposits payable 46,819 59,656 Deferred income 415,081 417,989 Distribution payable 288,826 288,826\nTotal Liabilities 52,306,156 52,316,621\nMinority interest (344,786) (328,580)\nPartners' Capital (Deficit) (notes 4 and 9): General Partner (80,211) (77,899) Limited Partners (4,575 limited partnership units authorized, issued and outstanding) 3,485,853 3,714,858\nTotal Partners' Capital 3,405,642 3,636,959\nTotal Liabilities, Minority Interest and Partners' Capital $ 55,367,012 $ 55,625,000\nConsolidated Statements of Operations For the years ended December 31, 1995, 1994 and 1993\nIncome 1995 1994 1993\nRental income (note 3) $ 6,894,097 $ 6,724,625 $ 6,310,996 Percentage rent 1,209,752 1,182,148 1,092,965 Escalation income (note 3) 3,585,193 3,143,108 3,049,139 Interest income 406,292 265,117 79,906 Miscellaneous income 113,374 149,837 210,366\nTotal Income 12,208,708 11,464,835 10,743,372\nExpenses\nInterest expense 4,071,472 4,090,017 4,258,120 Property operating expenses 3,160,271 3,305,981 3,296,665 Settlement costs (note 3) 78,000 371,500 812,500 Depreciation and amortization 2,001,526 1,904,981 2,312,175 Real estate taxes 576,674 563,423 535,350 General and administrative 186,504 207,040 191,367\nTotal Expenses 10,074,447 10,442,942 11,406,177\nIncome (loss) before minority interest 2,134,261 1,021,893 (662,805) Minority interest (200,539) (106,883) 5,227\nNet Income (Loss) $ 1,933,722 $ 915,010 $ (657,578)\nNet Income (Loss) Allocated:\nTo the General Partner $ 19,337 $ 9,150 $ (6,576) To the Limited Partners 1,914,385 905,860 (651,002)\n$ 1,933,722 $ 915,010 $ (657,578)\nPer limited partnership unit (4,575 outstanding) $ 418.44 $ 198.00 $ (142.30)\nConsolidated Statement of Partners' Capital (Deficit) For the years ended December 31, 1995, 1994 and 1993\nLimited General Partners Partner Total\nBalance at December 31, 1992 $ 4,317,814 $ (71,809) $ 4,246,005 Net loss (651,002) (6,576) (657,578)\nBalance at December 31, 1993 3,666,812 (78,385) 3,588,427 Net income 905,860 9,150 915,010 Distributions (857,814) (8,664) (866,478)\nBalance at December 31, 1994 3,714,858 (77,899) 3,636,959 Net income 1,914,385 19,337 1,933,722 Distributions (2,143,390) (21,649) (2,165,039)\nBalance at December 31, 1995 $ 3,485,853 $ (80,211) $ 3,405,642\nConsolidated Statements of Cash Flows For the years ended December 31, 1995, 1994 and 1993\nCash Flows from Operating Activities: 1995 1994 1993\nNet income (loss) $ 1,933,722 $ 915,010 $ (657,578) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Minority interest 200,539 106,883 (5,227) Depreciation and amortization 2,001,526 1,904,981 2,312,175 Settlement costs 78,000 - - Increase (decrease) in cash arising from changes in operating assets and liabilities: Cash-held in escrow (72,818) (75,070) (295,923) Accounts receivable (88,894) (119,708) 434,853 Accrued interest receivable (134,370) (90,197) - Deferred rent receivable (98,755) (131,105) (109,595) Deferred charges (38,256) (30,413) (96,668) Prepaid expenses (37,762) (49,515) (25,257) Accounts payable and accrued expenses 23,305 (842,241) 922,584 Accrued interest payable - 340,425 (363,893) Due to affiliates (18,025) (230,352) (13,853) Security deposits payable (12,837) 9,788 - Deferred income (2,908) 12,849 26,888\nNet cash provided by operating activities 3,732,467 1,721,335 2,128,506\nCash Flows from Investing Activities:\nAdditions to real estate (757,229) (802,843) (888,529) Purchase of note receivable - (816,000) -\nNet cash used for investing activities (757,229) (1,618,843) (888,529)\nCash Flows from Financing Activities:\nRestricted cash - - (2,100,000) Deferred charges - (530,552) (1,129,655) Proceeds from mortgage loan payable - - 51,000,000 Repayment of mortgage loan payable - - (44,650,051) Distributions paid (2,165,039) (577,652) - Distributions paid-minority interest (216,745) (57,831) -\nNet cash provided by (used for) financing activities (2,381,784) (1,166,035) 3,120,294\nNet increase (decrease) in cash and cash equivalents 593,454 (1,063,543) 4,360,271\nCash and cash equivalents at beginning of period 5,661,047 6,724,590 2,364,319\nCash and cash equivalents at end of period $ 6,254,501 $ 5,661,047 $ 6,724,590\nSupplemental Disclosure of Cash Flow Information: Cash paid during the period for interest, net of amounts capitalized $ 4,071,472 $ 3,749,592 $ 4,622,013\nSupplemental Disclosure of Non-Cash Investing and Financing Activities: A finance charge and liability of $510,000 was recognized in the fourth quarter of 1993 in connection with the mortgage payable.\nNotes to the Consolidated Financial Statements December 31, 1995, 1994 and 1993\n1. Organization Eastpoint Mall Limited Partnership (the \"Partnership\") was formed as a limited partnership on June 26, 1985 under the laws of the State of Delaware. The Partnership is the managing general partner of Eastpoint Partners L.P. (the \"Owner Partnership\") a New York limited partnership, which owns Eastpoint Mall (the \"Mall\").\nThe general partner of the Partnership is Eastern Avenue Inc., (the \"General Partner\"), formerly Shearson Lehman Eastern Avenue Inc. (see below), an affiliate of Lehman Brothers Inc., formerly Shearson Lehman Brothers, Inc.\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 January 13, 1994, Shearson Lehman Eastern Avenue Inc., the General Partner, changed its name to Eastern Avenue Inc.\nThe Partnership commenced investment operations on November 22, 1985, with the acceptance of subscriptions for 4,575 limited partnership units, the maximum authorized by the limited partnership agreement (\"Limited Partnership Agreement\"). Upon the admittance of the additional limited partners, the initial limited partner withdrew from the Partnership.\nOn February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. \"Change of Control\" means any purchase or offer to purchase more than 10% of the Units that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a Form 8-K disclosing this resolution on February 29, 1996.\n2. Summary of Significant Accounting Policies Basis of Accounting The consolidated financial statements of the Partnership have been prepared on the accrual basis of accounting and include the accounts of the Partnership and Eastpoint Partners L.P. All significant intercompany accounts and transactions have been eliminated.\nReal Estate Real estate investments, which consist of land, building and improvements, are recorded at cost less accumulated depreciation and amortization. Cost includes the initial purchase price of the property plus closing costs, acquisition and legal fees and capital improvements, including capitalized interest. Depreciation of building and improvements is computed using the straight-line method based on an estimated useful life of 40 years. Depreciation of fixtures and equipment is computed using the straight-line method over an estimated useful life of 12 years. Amortization of tenant leasehold improvements is 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. Based on current circumstances, the adoption had no impact on the consolidated financial statements.\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 Deferred charges are amortized using the straight-line method over the following periods:\nPeriod\nFee for negotiating the acquisition of the ownership of the Mall 40 years Financing fees 10 years\nFees paid in connection with the acquisition of the property have been included in the purchase price of the property. Accordingly, such fees have been allocated to the basis of the land, building and improvements and are being depreciated over the estimated useful lives of the depreciable assets. Leasing commissions are amortized using the straight-line method over the lease term.\nOffering Costs Offering costs are non-amortizable and have been deducted from partners' capital.\nTransfer of Units and Distributions Net income or loss from operations is allocated to registered holders (\"Unit Holder\"). Upon the transfer of a unit, net income (loss) from operations attributable to such unit generally is 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 Unit Holder of record on the first day of the calendar month is deemed to have transferred their interest on the first day of such month.\nDistributions of operating cash flow, as defined in the Partnership Agreement, will be paid on a quarterly basis to registered Unit Holders on record dates established by the Partnership, which generally fall 45 days after quarter end.\nIncome Taxes No provision is made for income taxes since such liability is the liability of the individual partners.\nNet Income Per Limited Partnership Unit Net income per limited partnership unit is calculated based upon the number of limited partnership units outstanding during the year.\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 and cash equivalents consist of money market investment accounts which invest in short-term highly liquid investments with maturities of three months or less from the date of issuance. The carrying amount approximates fair value because of the short maturity of those investments.\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 Owner Partnership's real estate which was purchased on November 29, 1985, consists of a central enclosed mall plus five free standing buildings and is located on approximately 67.1 acres in Baltimore County, Maryland. The Mall consists of a central enclosed mall anchored by four major department stores - J.C. Penney, Inc. (\"J.C. Penney\"), Schottenstein Stores Corporation, doing business as Value City (\"Value City\"), Sears, Roebuck, and Co. (\"Sears\") and Ames Department Store, Inc. (two of which are subject to ground leases), improvements and land. The retail space in the Mall is contained on one level; J.C. Penney and Value City are multi-level. Office and storage areas are contained in the basement level and on the second floor levels of the mall. Parking is provided for over 4,500 cars.\nThe Mall currently has gross leasable space totalling 864,993 square feet. Of this leasable space, 637,582 is owned by the Owner Partnership and 227,411 square feet of the gross leasable space is owned by the tenants who have leased portions of land pursuant to ground leases with the Owner Partnership. Upon expiration of such ground leases, ownership of the buildings thereon will revert to the Owner Partnership.\nJ.C. Penney leases a parcel of land pursuant to a ground lease on which it constructed the largest of the Mall's anchor stores containing approximately 168,969 square feet of the gross leasable area. The initial term of the J.C. Penney ground lease expires on August 31, 2001.\nValue City leases approximately 140,000 square feet of the gross leasable area of the Mall. The initial term of the lease was scheduled to expire on November 30, 1999 but has been extended until November 30, 2009.\nSears leases approximately 87,734 square feet of the gross leasable area of the Mall. The initial term of the lease expires on October 16, 2006.\nAmes leases a parcel of land pursuant to a ground lease on which it has constructed a building containing approximately 58,442 square feet of the gross leasable area. The initial term of the Ames ground lease expires on May 30, 2004.\nThe following is a schedule of the remaining minimum lease payments as called for under the lease agreements:\nYears Ending December 31,\n1996 $6,349,081 1997 5,817,842 1998 5,206,305 1999 4,647,395 2000 3,859,623 Thereafter 9,343,612\n\t\t\t$35,223,858\nIn addition to the minimum lease amounts, the leases provide for percentage rents, and escalation charges to tenants for common area maintenance and real estate taxes. For the years ended December 31, 1995, 1994 and 1993, temporary tenant income amounted to $302,815, $296,938 and $228,923, respectively, and are included in rental income.\nFor the year ended December 31, 1995, one tenant accounted for approximately 10% of the Partnership's rental and percentage rental income. No single tenant accounted for 10% or more of such income for the years ended December 31, 1994 and 1993.\nOn April 26, 1990, Ames Department Store, Inc. (\"Ames\") filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. Land leased to Ames by the Owner Partnership together with the building constructed thereon by Ames secured a first priority deed of trust held by Consolidated Fidelity Life Insurance Company (\"Consolidated\") as successor to Southwestern Life Insurance Company. By filing its bankruptcy petition, Ames was in default under the Consolidated priority deed of trust. On December 18, 1992, the Bankruptcy Court confirmed a Plan of Reorganization for Ames (the \"Plan\") and the plan was subsequently consummated. Pursuant to the Plan, Ames assumed the lease of its store at the Mall and continues its operations there.\nOn December 28, 1992, the Partnership received a Notice of Default from Consolidated. The Partnership and Consolidated negotiated a Settlement Agreement (the \"Settlement Agreement\") whereby, upon approval by the Bankruptcy Court and consummation of certain further agreements reached between Consolidated and Ames, the Partnership would make a payment of $812,500 to Consolidated in complete satisfaction of all claims Consolidated may have against the Ames parcel and the Partnership. As part of the Settlement Agreement, Consolidated withdrew its Notice of Default. The Settlement Agreement was effective through December 31, 1993.\nThe Settlement Agreement expired on December 31, 1993, as Bankruptcy Court approval of the outstanding claims between Consolidated and Ames had not then been obtained. Since Consolidated and Ames (and Ames' trustee in bankruptcy) had not resolved all claims among them, there still existed defaults under the Consolidated deed of trust and therefore, Consolidated had the right to foreclose on the Ames parcel. On January 7, 1994, Consolidated delivered another notice of default to the Partnership.\nThe delivery to the Partnership by Consolidated of the new Notice of Default constituted a technical default under the new first mortgage loan of the Partnership with the REMIC Lender. However, the REMIC Lender was aware of the Consolidated claim at the time the new first mortgage loan was closed, and the REMIC Lender held certain proceeds of the new first mortgage loan in escrow until such time as the Partnership resolved the Consolidated dispute and provided a release of Consolidated's outstanding deed of trust on the Ames parcel.\nOn July 14, 1994, the Partnership executed a Compromise and Mutual Release (the \"Release Agreement\") with Consolidated. Pursuant to the terms of the Release Agreement, the Partnership paid Consolidated $2 million in return for the assignment of the deed of trust and related Ames promissory note, as well as Consolidated's claim in the Ames bankruptcy case relating to such promissory note. Consolidated's total claims, in the face amount of approximately $2.3 million, consist of the balances due on the Ames promissory note, totaling $1.7 million, and another promissory note. Pursuant to the Release Agreement, the Partnership is entitled to any recovery based on the Ames promissory note; Consolidated will receive any recovery on the other note. The bankruptcy trustee in the Ames bankruptcy case has entered an objection to this claim, however, the Partnership is pursuing legal action to collect the claimed amount. For the year ended December 31, 1994, the Partnership recorded a note re ceivable in the amount of $816,000. In 1995, the note receivable was written-down by $78,000 to $738,000 which represents the amount the Partnership expects to receive from the claim pending bankruptcy court approval.\nIn addition, the funds held in escrow by the Partnership's mortgage lender, which total $1.1 million, are expected to be released to the Partnership following the completion of certain administrative procedures required by the first mortgage lender.\nThe following is a schedule of the remaining minimum lease payments as called for under the ground lease agreements:\n\t\tYears Ending \t\tDecember 31,\n199 $ 205,500 1997 205,500 1998 205,500 1999 254,083 2000 258,500 Thereafter 879,083\n$ 2,008,166\nThe appraised fair market value of Eastpoint Mall at January 1, 1996, as determined by an independent third party appraisal firm, was $81,000,000 compared to $85,000,000 at January 1, 1995.\n4. Partnership Agreement The Partnership has a 90.9% interest in the operating income, profits and cash distributions, and a 99% interest in the operating losses of the Owner Partnership. The limited partnership agreement provides that all operating income, losses, profits, and cash distributions are allocated 1% to the General Partner and 99% to the limited partners. The proceeds of sale and interim capital transactions will be distributed 100% to the Partnership (100% to the limited partners) until the Limited Partners have received distributions equal to a return of their original capital contribution plus a 10% cumulative return on capital. Thereafter, any remaining proceeds will be allocated 86% to the Partnership (1% to the General Partner and 99% to the Limited Partners).\nWith respect to the Owner Partnership, the General Partner has a .1% interest and SFN Limited Partnership has a 9% interest in the income, profits, and cash distributions of the Mall. Losses from operations shall be allocated .1% to the General Partner, and .9% to the SFN Limited Partnership. Upon sale or interim capital transaction, the General Partner will receive 5% and SFN Limited Partnership will receive 9% after the limited partners of the Partnership receive their original capital contribution plus their 10% cumulative return.\n5. Mortgage Loan Payable\n1995 1994\n8.01% first five years, thereafter rate is equal to 2.8% above the current yield on five-year Treasury Notes. Mortgage note due December 22, 2003. Monthly payments of interest only. $ 51,000,000 $ 51,000,000\nIn December 1993, the Partnership obtained new first mortgage financing from CBA Conduit, Inc., an entity which placed the new mortgage into a pool of other mortgages to be held by a Real Estate Mortgage Investment Conduit (the \"REMIC Lender\"). The total amount of the new first mortgage is $51,000,000. After repayment of the Partnership's former first mortgage loan from Kemper Investors Life Insurance Company and the establishment of certain loan reserves and payment of expenses, approximately $3,000,000 of the proceeds were available to the Partnership for tenant improvements, leasing commissions, capital improvements and costs attributable to leasing and releasing. Escrow accounts were also established for the collection of real estate taxes and various insurance expenses. They are currently presented on the Consolidated Balance Sheet as Cash-held in escrow. Certain proceeds of the new first mortgage loan were placed into a Restricted cash account to be funded to the Partnership at such time as the Partnership obtains a release of the first mortgage outstanding to Consolidated Fidelity Life Insurance Company on the parcel of real estate currently occupied by Ames. Additionally, $1,000,000 of the loan proceeds has been placed into the Restricted cash account which constitutes additional collateral for the new first mortgage and can be used by the Partnership for leasing expenses and capital improvements. The loan is secured by a first mortgage and an assignment of leases on Eastpoint Mall.\nBased on the borrowing rates currently available to the Partnership for mortgage loans with similar terms and average maturities, the fair value of long-term debt approximates carrying value.\n6. Transactions with Related Parties CPR Realty Brokerage, Inc. (\"CPR, Inc.\") formerly Shearson Realty Brokerage, Inc. was paid $510,000 in 1994 in conjunction with the Partnership's financing.\nThe General Partner was reimbursed $99,007 during 1994 from the Partnership and $138,900 from the Owner Partnership, for professional fees paid at inception.\nUnder the terms of the Partnership Agreement, the Partnership reimburses the General Partner, at cost, for the performance of certain administrative services provided by a third party. For the years ended December 31, 1995, 1994 and 1993, costs of such services were $83,357, $76,606, and $95,452, respectively. At December 31, 1995 and 1994, $22,226 and $40,251 were due to the General Partner for the performance of these services.\nCash and Cash Equivalents Certain cash accounts reflected on the Partnership's consolidated balance sheets at December 31, 1995 and 1994 were on deposit with an affiliate of the General Partner.\n7. Management Agreement On November 29, 1985, the Partnership entered into an agreement with Shopco Management Corporation, an affiliate of SFN Limited Partnership, for the management of the property. The agreement, which expired on December 31, 1990, provided for an annual fee equal to 3.0% of the gross rents collected from the Mall, as defined, payable monthly. The Partnership and Shopco Management Corporation agreed to the terms of the new management agreement effective January 1, 1991 through December 31, 1993, which included an increase in the annual fee to 4.5% of gross rents collected from the Mall. The new management agreement which expired on December 31, 1993 is automatically renewed for successive periods of one year. The management agreement has been renewed through December 31, 1996. For the years ended December 31, 1995, 1994 and 1993, management fee expense amounted to $349,166, $389,631 and $370,812, respectively.\n8. Distributions to Limited Partners In 1995 and 1994, distributions to Limited Partners totalled $2,143,390, ($468.50 per limited partnership unit) and $857,814, ($187.50 per limited partnership unit), respectively. For the year ended December 31, 1993, distributions to Limited Partners were suspended.\n9. Reconciliation of Consolidated Financial Statement Net Income (Loss) and Partners' Capital to Federal Income Tax Basis Net Income (Loss) and Partners' Capital (Deficit)\nReconciliations of consolidated financial statement net income (loss) and partners' capital to federal income tax basis net income (loss) and partners' capital (deficit) at December 31, follow:\n1995 1994 1993\nFinancial statement net income (loss) $ 1,933,722 $ 915,010 $ (657,578) Tax basis recognition of deferred charges under (over) financial statement recognition of deferred charges (37,875) (46,334) 62,746 Tax basis recognition of deferred income over (under) financial statement recognition of deferred income (115,321) (119,650) 11,083 Tax basis depreciation over financial statement depreciation (456,095) (522,536) (683,217) Tax basis recognition of recording fees under financial statement recognition of recording fees - - 90,900 Tax basis recognition of lease retention payment under financial statements - - 738,562 Financial statement basis recognition of Settlement cost over tax basis 70,902 337,695 - Other - - 42,438\nFederal income tax basis net income (loss) $ 1,395,333 $ 564,185 $ (395,066)\n1995 1994 1993\nFinancial statement basis partners' capital $ 3,405,642 $ 3,636,959 $ 3,588,427 Current year financial statement net income (loss) over federal income tax basis net income (loss) (538,389) (350,825) 262,512 Cumulative federal income tax basis net income (loss) over cumulative financial statement net income (loss) (2,934,199) (2,583,374) (2,845,886)\nFederal income tax basis partners' capital (deficit) $ (66,946) $ 702,760 $ 1,005,053\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 respective taxing authorities.\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: $ 193,094 $ 132,139 $ 16,405 $ 308,828\nYear ended December 31, 1994: 308,828 129,193 143,962 294,059\nYear ended December 31, 1995: $ 294,059 $ 19,852 $ 233,506 $ 80,405\nEASTPOINT MALL LIMITED PARTNERSHIP AND CONSOLIDATED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nCosts Capitalized Initial Cost to Subsequent Partnership (A) To Aquisition\nLand, Building and Building and Description Encumbrances Land Improvements Improvements\nEastpoint Shopping Center, Baltimore County, MD $ 51,000,000 $ 3,497,465 $ 26,254,002 $ 24,705,910\n$ 51,000,000 $ 3,497,465 $ 26,254,002 $ 24,705,910\nEASTPOINT MALL LIMITED PARTNERSHIP AND CONSOLIDATED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nGross Amount at Which Carried at Close of Period (B)\nBuilding and Accumulated Description Land Improvements Total Depreciation\nEastpoint Shopping Center, Baltimore County, MD $ 4,166,230 $ 50,291,147 $ 54,457,377 $ 11,738,595\n$ 4,166,230 $ 50,291,147 $ 54,457,377 $ 11,738,595\n\t\t\t\t EASTPOINT MALL LIMITED PARTNERSHIP AND CONSOLIDATED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed\nEastpoint Shopping Center, Baltimore County, MD 1956-1981 11\/29\/85 Building 40 years Improvements 12 years\n(A) The initial cost of the Partnership represents the original purchase price of the property.\n(B) For Federal income tax purposes, the cost basis for the land, building and improvements at December 31, 1995 is $50,762,351.\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 $ 53,761,925 $ 52,996,871 $ 52,108,342 Additions 757,229 802,843 888,529 Dispositions (61,777) (37,789) -\nEnd of year $ 54,457,377 $ 53,761,925 $ 52,996,871\nAccumulated Depreciation:\nBeginning of year $ 9,997,420 $ 8,335,792 $ 6,760,764 Depreciation expense 1,802,952 1,699,417 1,575,028 Dispositions (61,777) (37,789) -\nEnd of year $ 11,738,595 $ 9,997,420 $ 8,335,792","section_15":""}
{"filename":"796502_1995.txt","cik":"796502","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral\nThe Company is primarily engaged in the business of designing, manufacturing and marketing marine engine and air-conditioning products. The Company was organized in 1932 and was re-incorporated in Delaware in 1986. The Company's marine products consist of diesel and gasoline engine-driven electrical generator sets, inboard propulsion engines, self-contained, reverse-cycle air-conditioners, and associated spare parts and accessories. In addition, the Company manufactures and markets electrical generator sets for use in non-marine applications. The Company markets its products throughout the United States and internationally principally for recreational marine applications. Accordingly, the market for the Company's products is dependent on the market for recreational boats, including auxiliary powered sailboats, powerboats, houseboats and other pleasure boats. The market for recreational boats, and consequently the Company's products, may be adversely affected by general economic conditions.\nProducts\nThe Company's marine engine product line consists of 17 models of electrical generator sets, 20 models of inboard propulsion engines, and associated spare parts and accessories. The Company also offers 11 models of non-marine generator sets.\nThe Company's diesel and gasoline engine-driven marine generator sets are installed in powerboats, houseboats, large sailboats and other pleasure and commercial boats to provide electricity for communication and navigational equipment, lighting, refrigeration and other galley services, and other safety, operating and convenience needs. The Company's present line of generator sets produce from 4.5 to 75 kilowatts of electricity. A generator set consists of an electrical generator and an attached diesel or gasoline engine used to drive the generator. These engines are fresh water cooled and range from two to eight cylinders and from nine to 46 horsepower.\nThe Company's propulsion engines are inboard engines, generally installed as auxiliary power systems for sailboats. The Company's propulsion engines are fresh water cooled and range from two to six cylinders and from 12 to 108 horsepower. Management believes that more than 90% of the propulsion engines produced by the Company are installed in sailboats of up to 50 feet in length. The Company's higher horsepower propulsion engines are also installed in powerboats of up to approximately 30 feet in length such as fishing boats, cruisers and work boats.\nThe Company's product line includes marine diesel auxiliary engines marketed under the Universal[register mark] name and associated spare and replacement parts and marine air-conditioning products marketed under the Rotary Aire[register mark] name. The Company manufactures and markets two self-contained, reverse-cycle air-conditioning units and accessories under the Rotary Aire[register mark] name. These units can be installed in powerboats, houseboats, sailboats and other pleasure and commercial boats.\nThe Company's product line includes 11 models of electrical generator sets which may be installed in bus-converted motor coaches, specialty vehicles, such as refrigeration trucks, and ambulances and other emergency vehicles to provide electricity for lighting, refrigeration and other safety, operating and convenience needs. These generators may also be used as stand-by or secondary power sources in the event of power outages or in locations where primary power is not readily available, such as construction sites, rural areas and less developed countries.\nThe Company offers a complete line of spare parts and accessories for its current product lines and for most discontinued models. The Company's line of spare parts includes oil and fuel filters, belts, thermostats, distributor caps, fuses, spark plugs, wiring, alternators, heat exchangers, circuit breakers, water and fuel pumps, starter motors and fuel solenoids. Many basic parts are packaged and sold as spare part kits. Accessories offered by the Company include various control and instrument panels, exhaust silencers and generator sound enclosures.\nThe Company provides its distributors, dealers and final customers with documentation covering operation, maintenance and repair procedures for its products. Management believes that the provision of current and comprehensive documentation enhances the Company's marketing and competitive effectiveness. See \"Marketing and Sales\" and \"Competition\" below.\nEach of the Company's products is covered by a one-year limited warranty covering parts and authorized labor. In addition, the Company offers a five-year limited warranty on certain marine generator sets. Many of the Company's suppliers also warrant their products for parts and labor. Some of the Company's major suppliers warrant their products for the duration of the Company's warranties. The Company has not experienced any unusual warranty claims during any of the last three fiscal years. The Company's distributors are generally responsible for administering the Company's warranties through the dealer network. See \"Marketing and Sales\" below.\nGovernmental Regulation\nIn May and November 1994, the Environmental Protection Agency (the \"EPA\") proposed emission standards for new gasoline and diesel powered marine engines and marine and industrial generators of the types manufactured by the Company. The emission standards are intended to reduce the emissions of hydrocarbons, nitrogen oxides, carbon monoxide, particulates and smoke. As proposed, the emission standards for gasoline and diesel powered engines and generators of the types manufactured by the Company would phase in over the period beginning August 1, 1996 and ending January 1, 1999. The proposed regulations include manufacturer testing requirements, selective enforcement auditing by the EPA, mandated warranty periods of up to five years or 3,000 hours of operation for emission-related parts and recall and repair authority for up to ten years or 6,000 hours of operation. Over the past year, the Company has worked with the EPA in an attempt to obtain relief from some of the proposed requirements, given what the Company believes will be the disproportionate impact these requirements would have on small businesses such as the Company. Final regulations have not yet been issued covering all of the Company's products, and, accordingly, the full impact of the final regulations on the Company cannot be assessed. In addition, effective August 1, 1995, regulations went into effect in the State of California establishing emissions standards covering most of the Company's generators and mandating certain warranty conditions and production testing requirements. In both the case of the proposed EPA regulations and the State of California regulations, if the Company cannot effect the required modifications of its products to meet the required emissions levels within the time frames allowed, the Company could be materially adversely affected. See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\" below.\nDesign and Development\nThe Company has an ongoing product improvement and development program intended to enhance the reliability, performance and longevity of existing products, and to develop new applications for existing products. A significant portion of the Company's senior management's time, as well as the efforts of the Company's six person product engineering department, is spent in this area. In prior years, the Company's product development program resulted in the introduction of the Company's line of gasoline engine-driven generator sets and propulsion engines. As part of the Company's ongoing product development program, the Company upgrades its engine products and periodically adds models to its product line. For example, as and when improvements in component parts allow, the Company may manufacture smaller or more light-weight versions of existing models. In fiscal 1995, the product engineering department focused principally on the modernization of the Company's existing product line and modifications which the Company believes will be required as a result of the emissions standards discussed above. In addition, in response to demand, the Company may expand its engine product line by manufacturing generator sets or propulsion engines with different kilowattage or horsepower than its existing models. The Company intends to introduce upgraded and new models as and when developed.\nThe Company's design and engineering focus is on reliability, ease of maintenance, compactness, operating smoothness, safety and longevity, among other technical and performance factors. The Company's technical and performance specifications are utilized by the Company's suppliers in producing certain component parts, metal and nonmetal fabrications and other peripheral equipment that the Company manufactures and assembles into finished products. Generally, the Company retains title to Company-developed plans, patterns and specifications used by these suppliers.\nFor the three fiscal years ended October 1995, the Company incurred expenses of approximately $1,549,600 for design and development activities as follows: 1995 - $678,700, 1994 - $488,300 and 1993 - $382,600. All these activities were conducted and sponsored by the Company and the major portion of these expenses was applied toward salaries and other expenses of the Company's product design and engineering personnel.\nManufacturing and Sources of Supply\nThe Company's manufacturing activities are conducted in an approximately 37,500 square foot facility owned by the Company. See \"Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive and administrative offices and manufacturing operations are located in Avon, Massachusetts in an approximately 37,500 square foot facility owned by the Company. The Company also leases a warehouse of approximately 16,000 square feet. Management believes that the Company's present facilities are sufficient for the production of its products in the foreseeable future. Any future expansion will be dependent upon future growth in demand for the Company's products. Annual warehouse rent was approximately $71,300 in fiscal 1995 and $76,200 in fiscal 1994. See Notes 8 and 10 of Notes to Consolidated Financial Statements included in \"Item 8 - Financial Statements and Supplementary Data.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFrom time to time, the Company is party to certain claims, suits and complaints which arise in the ordinary course of business. Currently, there are no such claims, suits or complaints which, in the opinion of management, would have a material adverse effect on the Company's financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock is traded in the over- the-counter market on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol WTBK. On January 22, 1996, there were approximately 190 shareholders of record. The following table sets forth the range of high and low bid quotations per share of the Company's Common Stock from October 31, 1993 through October 28, 1995, on the NASDAQ. High and low bid quotations represent prices between dealers and do not reflect retail mark-ups, mark-downs or commissions and may not represent actual transactions.\nOn January 22, 1996, the last bid and asked price quotations for the Company's Common Stock were $2.25 and $2.625, respectively.\nNo dividends have been paid or declared on the Common Stock of the Company and the Company does not expect to pay any dividends on its Common Stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFive Year Comparison of Selected Financial Data\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations:\nThe following table sets forth, for the years indicated, the percentages which the following items in the Consolidated Statements of Operations bear to Net Sales.\nFiscal 1995 compared to Fiscal 1994 - -----------------------------------\nNet sales increased $3,756,700 or 25.0% in fiscal 1995 as compared to fiscal 1994. The increase was attributable to higher unit sales of the Company's marine generators, diesel propulsion engines, and after-market parts revenues. The overall increase is primarily the result of more favorable economic conditions benefiting the pleasure boat industry.\nInternational sales were $2,279,300 in 1995, representing 12.1% of net sales, as compared to $1,708,000 in 1994, or 11.4% of net sales. The increase in 1995 is the result of higher unit sales caused by improved economies in the European countries.\nGross profit increased $893,000 or 26.3% in fiscal 1995 as compared to fiscal 1994. Gross profit as a percentage of sales increased to 22.8% in fiscal 1995 as compared to 22.6% in fiscal 1994. The increase in gross profit percentage is primarily due to increased parts revenues and improved manufacturing productivity during the year.\nSelling, general and administrative expense increased $291,200 or 13.1% in fiscal 1995 as compared to fiscal 1994. The Company incurred higher marketing and promotional expenses due to increased boat show and travel activity. Administration costs also increased primarily due to higher legal costs associated with the negotiation of supplier contracts. Employee compensation costs were also higher as a result of the Company's improved profitability.\nResearch and development expense increased $190,400 or 39.0% in fiscal 1995 as compared to fiscal 1994. The increase is due to additional engineering personnel and increased consulting costs associated with product enhancements. The Company has also realized increased costs due to the compliance with proposed federal and new state emission requirements.\nIn May and November 1994, the Environmental Protection Agency (the \"EPA\") proposed emission standards for new gasoline and diesel powered marine engines and marine and industrial generators of the types manufactured by the Company. As proposed, the emission standards would phase in over the period beginning August 1, 1996 and ending January 1, 1999. The proposed regulations include manufacturer testing requirements, selective enforcement auditing by the EPA, mandated warranty periods of up to five years or 3,000 hours of operation for emission-related parts and recall and repair authority for up to ten years or 6,000 hours of opeation. Final regulations have not yet been issued covering all of the Company's products and, accordingly, the full impact of the final regulations on the Company cannot be assessed. In addition, effective August 1, 1995, regulations went into effect in the State of California establishing emissions standards covering most of the Company's generators and mandating certain warranty conditions and production testing requirements. In both the case of the proposed EPA regulations and the State of California regulations, if the Company cannot effect the required modifications of its products to meet the required emissions levels within the time frames allowed, the Company could be materially adversely affected.\nNet interest income was $42,900 in fiscal 1995 compared to $19,000 in fiscal 1994. The increase is primarily due to increased interest income earned on higher invested cash balances during the year.\nThe Company's income tax expense in fiscal 1995 was $444,400 as compared to $275,000 in fiscal 1994.\nThe Company's net income was $697,600 as compared to $633,000 in fiscal 1994. The increase is mainly attributable to higher unit sales throughout fiscal 1995. Net income for 1994 includes $201,300 resulting from the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"Statement 109\"). Statement 109 required a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes.\nEffective October 30, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under this statement, the Company's marketable securities are classified as \"available for sale\" and are recorded at current market value with a offsetting adjustment to stockholders' equity.\nFiscal 1994 compared to Fiscal 1993 - -----------------------------------\nNet sales increased $1,626,700 or 12.1% in fiscal 1994 as compared to fiscal 1993. The increase was attributable to higher unit sales primarily to OEM customers.\nInternational sales were $1,708,000 in 1994, representing 11.4% of net sales, as compared to $1,950,100 in 1993, or 14.5% of net sales. The decrease in 1994 is the result of lower unit sales caused by a general economic slowdown in the European countries.\nGross profit increased 9.5% in fiscal 1994 as compared to fiscal 1993. Gross profit as a percentage of sales decreased to 22.6% in fiscal 1994 as compared to 23.1% in fiscal 1993. The decrease in gross profit percentage is primarily due to increased product costs as a result of price increases from key suppliers.\nSelling, general and administrative expense increased $80,300 or 3.7% in fiscal 1994 as compared to fiscal 1993. The increase is mainly due to increases in product warranty costs and customer bad debt expenses.\nResearch and development expense increased $105,700 or 27.6% in fiscal 1994 as compared to fiscal 1993. The increase is due to additional engineering personnel and increased consulting costs associated with product enhancements.\nNet interest income was $19,000 in fiscal 1994 compared to $9,600 in fiscal 1993. The increase is primarily due to lower interest expense costs associated with the Company's capital leases during the year.\nThe Company's income tax expense in fiscal 1994 was $275,000 as compared to $252,500 in fiscal 1993.\nThe Company's net income was $633,000 in fiscal 1994 as compared to $335,700 in fiscal 1993. Net income for 1994 includes $201,300 resulting from the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"Statement 109\"). Statement 109 required a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes.\nLiquidity and Capital Resources\nDuring fiscal 1995, net cash provided by operations was $336,700 as compared to net cash provided by operations of $877,800 in fiscal 1994. Cash flow provided by operations in fiscal 1995 was principally the result of net income of $697,600 and non-cash charges for depreciation and amortization of $402,500. Major uses of cash during fiscal 1995 include increases in inventories of $634,800, purchases of property, plant and equipment of $349,400, and investments in mutual funds of $313,000. The rise in inventories is primarily the result of increased demand and the timing of sales order shipments.\nDuring fiscal 1995 and 1994, the Company purchased property, plant and equipment of $349,400 and $463,600, respectively. The Company plans capital spending of approximately $250,000 for emission testing and other related emission equipment during fiscal 1996.\nOn June 4, 1992, the Company entered into a $3,000,000 line of credit agreement (the \"Credit Agreement\") with State Street Bank and Trust Company, collateralized by inventory, accounts receivable and general intangibles of the Company. The Credit Agreement was renewed on March 31, 1995, and will expire on March 31, 1996. The Company believes that it will be able to continue to extend the term of the Credit Agreement on commercially reasonable terms. As of October 28, 1995, the Company had approximately $2,902,500 in unused borrowing capacity under the Credit Agreement and approximately $97,500 committed to cover the Company's reimbursement obligations under certain letters of credit.\nManagement believes cash flow from operations and borrowings available under the Credit Agreement will provide for working capital needs, principal payments on long-term debt, and capital and operating leases through fiscal 1996.\nDomestic inflation is not expected to have a major impact on the Company's operations.\nThe costs of engine blocks and other components are subject to foreign currency fluctuations (primarily the Japanese yen). The weakening U.S. dollar relative to the yen in 1995 did result in cost increases to the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nWESTERBEKE CORPORATION AND SUBSIDIARY\n-------------------------------------\nCONSOLIDATED FINANCIAL STATEMENTS\nFor the years ended October 28, 1995, October 29, 1994 and October 30, 1993\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Westerbeke Corporation:\nWe have audited the accompanying consolidated balance sheets of Westerbeke Corporation and subsidiary as of October 28, 1995 and October 29, 1994, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended October 28, 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 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 Westerbeke Corporation and subsidiary as of October 28, 1995 and October 29, 1994, and the results of their operations and their cash flows for each of the years in the three-year 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in note 1 to the consolidated financial statements, effective October 31, 1993, the Company changed its method of accounting for income taxes by adopting the provisions of Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.\n\/s\/ KPMG PEAT MARWICK LLP\nBoston, Massachusetts December 21, 1995\nWESTERBEKE CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nWESTERBEKE CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the consolidated financial statements.\nWESTERBEKE CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nThree years ended October 28, 1995\nThe accompanying notes are an integral part of the consolidated financial statements.\nWESTERBEKE CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the consolidated financial statements.\nWESTERBEKE CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS October 28, 1995, October 29, 1994 and October 30, 1993\n1. Summary of Significant Accounting Policies:\nBasis of Presentation\nThe consolidated financial statements include the accounts of Westerbeke Corporation (the \"Company\"), and its wholly owned subsidiary, Westerbeke International, Inc. (a foreign sales corporation). Westerbeke International, Inc. was inactive during fiscal years 1995, 1994, and 1993.\nThe presentation 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.\nCash Equivalents\nAll highly liquid investments with an original maturity of three months or less are considered to be cash equivalents.\nInvestments in Marketable Securities\nMarketable investment securities at October 28, 1995 and October 29, 1994 consist of equity securities in various mutual funds. The Company adopted the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (Statement 115) at October 30, 1994. Under Statement 115, the Company classifies its marketable securities in one of two categories: trading or available-for-sale.\nTrading and available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders' equity until realized. Transfers of securities between categories are recorded at fair value at the date of transfer. Unrealized holding gains and losses are recognized in earnings for transfers into trading securities.\nA decline in the market value of any available-for-sale 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.\nDividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale are included in earnings with cost determined using the specific identification method.\nMarketable investment securities at October 28, 1995 include equity securities, principally mutual funds for which the Company has both intent and ability to hold. Equity securities are stated at the fair market value at October 28, 1995 and are stated at the lower of aggregate cost or market at October 29, 1994. The total cost of the marketable securities at October 28, 1995 was $414,900. The total cost of marketable securities at October 29, 1994 was $101,900. Gross unrealized holding gains in investment securities at October 28, 1995 and October 29, 1994 were $71,200 and $0, respectively.\nInventories\nInventories are valued at the lower of cost (determined on the last-in, first- out method) or market.\nDepreciation and Amortization\nThe Company computes depreciation and amortization expense on a straight-line basis over the following estimated useful lives:\nIntangible assets are classified in other assets. Maintenance and repairs are charged to expense in the period incurred. The cost and accumulated depreciation of assets retired or sold are removed from the accounts and any gain or loss is credited or charged to income.\nLeasehold improvements are amortized on a straight-line basis over the shorter of the life of the lease or their estimated useful lives.\nRevenue Recognition\nThe Company recognizes revenue upon shipment of product.\nProduct Warranty Cost\nThe anticipated costs related to product warranty are expensed at the time of sale of the product. Accrued warranty expense of $196,100 is included in accrued expenses and other liabilities at October 28, 1995 and October 29, 1994.\nIncome Taxes\nStatement of Financial Accounting Standards No. 109, Accounting for Income Taxes, was issued by the Financial Accounting Standards Board in February 1992. Statement 109 requires a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred taxes of a change in tax rate is recognized in income in the period that includes the enactment date.\nEffective October 31, 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 fiscal 1994 consolidated statement of operations.\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.\nNet Income (Loss) Per Share\nNet income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during each fiscal year. Common stock equivalents are not included in loss years because they are antidilutive.\n2. Business Segment\nThe Company has one business segment; the designing, manufacturing and marketing of marine engines and related products. The profitability of the Company is directly tied to the marine industry. The industry is subject to fluctuations in economic conditions that may adversely affect the Company. Four customers accounted for approximately 58% and 52% of Company revenues for the fiscal years ended 1995 and 1994, respectively. Three customers totaled 41% of Company revenues for the fiscal year ended 1993. The loss of one of these customers could adversely affect the Company's profitability.\nNet sales include export sales, primarily to customers in the Far East, Canada and Europe of approximately $2,279,300, $1,708,000 and $1,950,100 for fiscal years ended October 28, 1995, October 29, 1994, and October 30, 1993, respectively. In fiscal 1995, four customers accounted for sales in excess of 10% of net sales as follows: $3,993,600, $2,664,600, $2,171,900 and $2,011,700. In fiscal 1994, four customers accounted for sales in excess of 10% of net sales as follows: $2,667,900, $2,006,600, $1,572,000 and $1,525,300. In fiscal 1993, three customers accounted for sales in excess of 10% of net sales as follows: $2,308,100, $1,625,100 and $1,510,000.\nAt October 28, 1995, three customers accounted for trade accounts receivable in excess of 10% of net accounts receivable as follows: $267,400, $223,000, and $217,400. At October 29, 1994, three customers accounted for trade accounts receivable in excess of 10% of net accounts receivable as follows: $293,500, $288,600, and $188,200. The Company performs ongoing credit evaluations of its customers and therefore does not require collateralization of trade receivables.\n3. Inventories\nInventories consist of the following:\nThe Company uses the last-in, first-out (LIFO) method to value inventory. The Company believes the LIFO inventory method results in a better matching of costs and revenues during periods of changing prices. Inventories would have been $1,204,000 and $1,113,000 higher at October 28, 1995 and October 29, 1994, respectively, if the first-in, first-out (FIFO) method had been used. In 1993, inventory was reduced resulting in liquidation of LIFO inventory layers carried at lower costs prevailing in prior years as compared with the current cost of inventory. The effect of the inventory reductions was to reduce cost of sales by approximately $156,000 in fiscal 1993. Inventory cost determined on the FIFO method approximates replacement or current cost.\nThe basic component of the Company's engine products is a \"long block\" engine, which is a complete engine block and head assembly without peripheral equipment. The Company purchases \"long block\" engines from five foreign manufacturers. While the interruption of supply of \"long block\" engines from existing suppliers would have a material adverse effect on the Company's operations until alternative services are secured, management believes that there are adequate alternative sources of supply of \"long block\" engines available to it.\n4. Property, Plant and Equipment\nProperty, plant and equipment, at cost, consists of the following:\nThe Company incurred depreciation expense of approximately $377,300, $353,000, and $336,000 for fiscal years 1995, 1994, and 1993, respectively.\n5. Other Assets\nThe Company has entered into a split-dollar insurance arrangement with John H. Westerbeke, Jr. as part of his employment agreement (see note 10), pursuant to which the Company will pay the premium costs of certain life insurance policies. Upon surrender of the policies or payment of the death benefit, the Company is entitled to repayment of an amount equal to the cumulative premiums previously paid by the Company, with all remaining payments to be made to Mr. Westerbeke Jr. or his beneficiaries. Included in other assets at October 28, 1995 and October 29, 1994 is $801,300 and $601,300, respectively, which represents the cumulative value of insurance premiums paid to date.\n6. Note Receivable-Related Party\nThe Company holds a note receivable from John H. Westerbeke, Jr. the chairman, president and chief executive officer of the Company. The principal amount of the secured loan at October 28, 1995 and October 29, 1994 was $149,400 and $162,000, respectively. The loan was used by Mr. Westerbeke Jr. to purchase a 40 foot sailboat. The loan bears interest at 7-3\/4% per annum, is secured by a security interest in the sailboat and is payable in monthly installments over a ten year period. The Company has leased the sailboat from Mr. Westerbeke, Jr. pursuant to a lease expiring in July 1999 at a rental of $2,660 per month (see Note 10). The Company makes use of the boat to evaluate the performance of its marine engines and products and for other corporate matters.\n7. Revolving Demand Note Payable\nOn June 4, 1992, the Company entered into a $3,000,000 line of credit agreement (the \"Credit Agreement\") with State Street Bank and Trust Company, collateralized by inventory, accounts receivable and general intangibles of the Company. The Credit Agreement was renewed on March 31, 1995, and will expire on March 31, 1996. Borrowings outstanding under the agreement are limited to 80% of eligible accounts receivable and 40% of eligible inventories valued on a first-in, first-out basis with interest payable at the prime rate. At October 28, 1995, the Company had approximately $2,902,500 in unused borrowings under the Credit Agreement and approximately $97,500 committed to cover the Company's reimbursement obligations under certain open letters of credit and bankers' acceptances.\n8. Long-Term Debt\nLong-term debt consists of:\nAt October 28, 1995, the real estate mortgage note is collateralized by certain land and buildings with a net book value of approximately $711,000.\nAggregate maturities of long-term debt for each of the ensuing three years are as follows:\n9. Income Taxes\nAs discussed in Note 1, the Company adopted Statement 109 as of October 31, 1993. The cumulative effect of this change in accounting for income taxes of $201,300 is determined as of October 31, 1993 and is reported separately in the consolidated statement of operations for the year ended October 29, 1994.\nIncome tax expense attributable to income from continuing operations consists of:\nThe Company has no available book or tax net operating loss carryforwards.\nFederal income tax returns covering all taxable periods through October 31, 1984 have been examined by the Internal Revenue Service. The Internal Revenue Service has finalized a review of the Company's fiscal 1992 and 1993 tax returns. The results did not have a material effect on the financial condition of the Company.\nIncome tax expense was $444,400, $275,000, and $252,500 for the years ended October 28, 1995, October 29, 1994, and October 30, 1993, respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income as a result of the following:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at October 28, 1995, and October 29, 1994 are presented below.\nThe valuation allowance for deferred tax assets as of October 29, 1994 was $0. There was no net change in the total valuation allowance for the year ended October 28, 1995. Management believes that the realization of net deferred tax assets is more likely than not because future operations of the Company are expected to generate sufficient taxable income.\n10. Commitments and Contingencies\nLease Obligations\nThe Company has lease agreements for a warehouse and certain equipment (see note 6) expiring at various dates through 1999. Rental expense under operating leases was $91,500, $76,200, and $83,100 for the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nProperty, plant and equipment includes $116,600 of equipment under capital lease, net of accumulated amortization of $728,800 at October 28, 1995.\nThe future minimum lease payments required under capital and operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:\nLetters of Credit and Bankers' Acceptances\nCertain foreign vendors require the Company to provide letters of credit at the time purchase orders are placed. As of October 28, 1995, the Company was contingently liable for open letters of credit and bankers' acceptances of approximately $97,500 (see note 7).\nRoyalty Arrangements\nAs a result of the acquisition of Rotary Marine, Inc. of Sarasota, Florida, on January 5, 1990, the Company is required to make contingent cash payments to the sellers based upon a percentage of sales of marine air conditioning products and accessories by the Company during the fiscal years ending 1992 through 1996. No payment was made in fiscal 1995, 1994 or 1993 as the sales criteria were not met.\nEmployment Agreements\nIn March of 1993, the Company entered into an Employment Agreement (the \"Agreement\") with John H. Westerbeke, Jr., the chairman of the board, president, and chief executive officer of the Company. The Agreement calls for Mr. Westerbeke, Jr. to be paid an annual salary of $141,750, subject to increases based upon the Consumer Price Index and at the discretion of the Company. The Agreement also provides for payment of a bonus at the discretion of the board of directors of the Company. Under the Agreement, Mr. Westerbeke, Jr. may elect to have all or any part of his base salary or bonus paid as deferred compensation. Payments of deferred compensation are to be made in cash and no special fund has been established to ensure the payment of deferred compensation. The Agreement also requires the Company to pay premiums for certain life insurance policies on the life of Mr. Westerbeke, Jr. In addition, in the event of a change in control of the Company, Mr. Westerbeke, Jr. may terminate his employment during the one year period following such change in control, and in such event, the Company is required to pay him a lump sum cash payment in an amount equal to three times his average annual cash compensation during the most recent five taxable years of the Company. In addition, in such circumstances, the Company is required to continue to carry group life and health insurance for Mr. Westerbeke, Jr. for a three year period and is required to pay any premiums payable on the life insurance policies on his life for a three year period.\nUnder an employment agreement between the Company and John H. Westerbeke, Sr., a director of the Company, Mr. Westerbeke, Sr. will be paid $35,000 per year. This agreement provides that following his retirement, Mr. Westerbeke, Sr. will act as consultant to the Company at an annual consulting fee of $30,000.\n11. Stockholders' Equity\nIn June 1986, the board of directors and the stockholders of the Company adopted the Company's 1986 Stock Option Plan (the \"Option Plan\"), under which 300,000 shares of common stock have been made available. The Company has also reserved 250,000 shares of common stock for issuance in connection with a Supplemental Stock Option Plan (the \"Supplemental Plan\"). The Supplemental Plan permits acceleration of the exercisability of options in the event of a change in control of the Company with the Company retaining the right of first refusal with respect to shares issued under this plan.\nOptions under the plans may be either nonqualified stock options or incentive stock options. Options may be granted to eligible employees of the Company and members of the board of directors.\nThe price at which the shares may be granted may not be less than the lower of fair market value or tangible book value in the case of nonqualified options, or 100% of the fair market value in the case of incentive stock options. The options generally become excercisable in 20% annual increments beginning on the date of the grant and expire at the end of ten years.\nInformation for fiscal years 1993, 1994 and 1995, with respect to the Option Plan, is as follows:\nThe outstanding options expire on various dates through May 2003. Options for 122,500 shares of common stock were exercisable at October 28, 1995. Options for 92,500 shares are available for future grant under the Option Plan.\nInformation for fiscal years 1993, 1994, and 1995, with respect to the Supplemental Plan, is as follows:\nThe outstanding options expire on various dates through March 2003. Options for 120,300 shares of common stock were exercisable at October 28, 1995. Options for 94,700 shares are available for future grant under the Supplemental Plan.\nAdditionally, the Company has granted nonqualified options to a consultant to purchase 6,200 shares of common stock, all of which are exercisable at October 28, 1995.\nPreferred Stock\nAs of October 28, 1995, October 29, 1994 and October 30, 1993, 1,000,000 shares of $1.00 par value Serial Preferred Stock were authorized; none were issued or outstanding.\n12. 1986 Employee Stock Purchase Plan\nIn June 1986, the board of directors and the stockholders of the Company adopted the Company's 1986 Employee Stock Option Plan (the \"Purchase Plan\"). Under the Purchase Plan, an aggregate of 100,000 shares of common stock are available for purchase by eligible employees of the Company, including directors and officers, through payroll deductions over successive six-month offering periods. The Purchase Plan will become effective when so declared by the board of directors.\nThe Purchase Plan is intended to qualify as an \"Employee Stock Purchase Plan\" within the meaning of Section 423 of the Internal Revenue Code. The purchase price of the common stock under the Purchase Plan will be 85% of the average of the closing high bid and last asked prices per share in the over-the- counter market on either the first or last day of each six-month offering period, whichever is less. As of October 28, 1995, there has been no activity under the Purchase Plan.\n13. Employee Benefit Plan\nIn 1994, the Company began an Employee Deferred Compensation Plan that covers all employees over 18 years of age who have completed at least 3 months of service with the Company. Contributions by the Company are discretionary and are determined by the Company's board of directors. The Company has made no contributions to the plan.\n14. Quarterly Financial Data and Restatement of Fiscal 1994 First Quarter Information (Unaudited) (In thousands, except per share amounts)\nSelected quarterly financial data for the years ended October 28, 1995 and October 29, 1994 is as follows:\nSCHEDULE II WESTERBEKE CORPORATION AND SUBSIDIARY\nVALUATION AND QUALIFYING ACCOUNT For the years ended October 28, 1995, October 29, 1994 and October 30, 1993\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nCertain biographical information concerning the directors of the Company as of January 1, 1996 is set forth below. Such information was furnished by them to the Company.\nFor additional information concerning the management of the Company, see \"Item 1 - Business - Executive Officers\" contained in Part I hereof.\nThe Board of Directors of the Company consists of three classes of directors, Class A, Class B and Class C. Directors in each class are elected for a term of three years. The term of office of the Class A directors will expire at the Annual Meeting of Stockholders to be held in 1996. Class B and Class C directors will be elected at the Annual Meetings to be held in 1997 and 1998, respectively. Mr. Bench is a Class A director, Messrs. Haythe, Safford and Storey are Class B directors and Messrs. Westerbeke, Jr. and Westerbeke, Sr. are Class C directors.\nThe directors and officers of the Company other than Messrs. Bench, Haythe, Safford and Storey are active in the business on a day- to-day basis. Messrs. Westerbeke, Sr. and Westerbeke, Jr. are father and son. No other family relationships exist between any of the directors and officers of the Company.\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than ten percent of the Company's Common Stock, to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock. Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file.\nTo the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and representations that no other reports were required, during the fiscal year ended October 28, 1995 all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied with.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table sets forth information for the fiscal years ended October 28, 1995, October 29, 1994 and October 30, 1993 concerning the compensation paid or awarded to the Chief Executive Officer and the other executive officers of the Company.\nSUMMARY COMPENSATION TABLE\nThe Company did not grant any stock options to the executive officers named in the Summary Compensation Table during the fiscal year ended October 28, 1995.\nThe following table sets forth the number and value of options held by the executive officers named in the Summary Compensation Table at October 28, 1995. During the fiscal year ended October 28, 1995, none of the executive officers named in the Summary Compensation Table exercised any options or warrants to purchase Common Stock.\nOPTION VALUES AT OCTOBER 29, 1994\nEmployment Agreements - ---------------------\nThe Company has an Employment Agreement (the \"Agreement\") with John H. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company, which provides for his employment by the Company at an annual salary of $141,750, subject to increases based upon the Consumer Price Index and at the discretion of the Company. The Agreement also provides for payment of a bonus at the discretion of the Board of Directors of the Company. Under the Agreement, Mr. Westerbeke may elect to have all or any part of his base salary or bonus paid as deferred compensation in five annual installments commencing in March following the year in which he retires or ceases to be actively employed by the Company. Payments of deferred compensation are to be made in cash and no special fund has been established to ensure the payment of deferred compensation. The Agreement also requires the Company to pay premiums for certain life insurance policies on the life of Mr. Westerbeke as described below. The Agreement may be terminated by the Company upon the disability of Mr. Westerbeke, by the Company with or without cause, and by Mr. Westerbeke in the event there has occurred a constructive termination of employment by the Company. In addition, in the event of a change in control of the Company, as defined in the Agreement, Mr. Westerbeke may terminate his employment during the one year period following such change in control, and in such event, the Company will be required to pay him a lump sum cash payment in an amount equal to three times his annual cash compensation during the most recent five taxable years of the Company, less $1,000. In addition, in such circumstances, the Company is required to continue to carry group life and health insurance for Mr. Westerbeke for a three year period and is required to pay any premiums payable on the split-dollar life insurance policies on his life for a three year period. Under the Agreement, Mr. Westerbeke has agreed not to compete with the Company for a period of one year following termination of his employment.\nThe Company has entered into a split-dollar insurance arrangement with Mr. Westerbeke, Jr., pursuant to which the Company will pay the premium costs of certain life insurance policies that pay a death benefit of not less than $2,419,153 in the aggregate upon the death of Mr. Westerbeke. Upon surrender of the policies or payment of the death benefit thereunder, the Company is entitled to repayment of an amount equal to the cumulative premiums previously paid by the Company, with all remaining payments to be made to Mr. Westerbeke or his beneficiaries. See footnote (1) to the \"Summary Compensation Table\" above for further information on premium payments made by the Company.\nThe Company has an agreement with Carleton F. Bryant, III, the Executive Vice President, Treasurer and Chief Operating Officer of the Company, which provides for his employment by the Company at an annual salary of $94,500. Under a related agreement Mr. Bryant agrees not to compete with the Company for a period of three years following the termination of his employment.\nThe Company has an agreement with John H. Westerbeke, Sr., a director of the Company, which provides for his employment by the Company at an annual salary of $35,000 until Mr. Westerbeke, Sr. retires. This agreement also provides that following his retirement, Mr. Westerbeke, Sr. will act as a consultant to the Company at an annual consulting fee of $30,000. The Company paid Mr. Westerbeke, Sr. $35,000 during fiscal 1995.\nCompensation Committee Interlocks and Insider Participation - -----------------------------------------------------------\nThomas M. Haythe, a director of the Company and a member of the Compensation Committee, is a partner of the New York City law firm of Haythe & Curley, which firm acted as legal counsel to the Company during the past fiscal year. It is expected that Haythe & Curley will continue to render legal services to the Company in the future.\nCompensation of Directors - -------------------------\nThe Company pays its directors a fee of $1,000 for attending each meeting of the Board of Directors of the Company.\nTermination of Employment and Change of Control Arrangements - ------------------------------------------------------------\nSee \"Employment Agreements\" above for information concerning certain change of control arrangements with respect to John H. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe shareholders (including any \"group\" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) who, to the knowledge of the Board of Directors of the Company, owned beneficially more than five percent of any class of the outstanding voting securities of the Company as of January 1, 1996, each director and each executive officer named in the Summary Compensation Table of the Company who owned beneficially shares of Common Stock and all directors and executive officers of the Company as a group, and their respective shareholdings as of such date (according to information furnished by them to the Company), are set forth in the following table. Except as indicated in the footnotes to the table, all of such shares are owned with sole voting and investment power.\nTo the Company's knowledge, there have been no significant changes in stock ownership or control of the Company as set forth above since January 1, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Company leases a 40-foot sailboat from Mr. Westerbeke, Jr., the Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to a lease expiring in July 1999. The Company pays an annual rental to him of $31,920 and also pays approximately $10,000 to $15,000 of annual expenses in connection with the operation and maintenance of the sailboat. The Company makes use of the sailboat to evaluate the performance of its marine engine products and for other corporate purposes. In July 1994, Mr. Westerbeke, Jr. executed a promissory note payable to the Company in the principal amount of $165,000. The proceeds of the loan were used by Mr. Westerbeke, Jr. to purchase the sailboat which is leased to the Company as described above. The loan, which is due June 1, 2004, is payable in equal monthly installments which commenced on July 1, 1994, together with interest at 7.75% per annum and is secured by the sailboat. Management of the Company believes that the terms of the lease and of the secured loan are no less favorable to the Company than it could obtain from an unrelated party.\nThomas M. Haythe, a Class B director of the Company, is a partner of the New York City law firm of Haythe & Curley, which firm has acted as legal counsel to the Company (and its predecessor) for several years. It is expected that Haythe & Curley will continue to render legal services to the Company in the future.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements:\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 Consolidated Financial Statements or Notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable.\n3. Exhibits:\nThe exhibits required to be filed as part of this Annual Report on Form 10-K are listed in the attached Index to Exhibits.\n(b) Current Reports on Form 8-K:\nDuring the fiscal quarter ended October 28, 1995, the Company did not file any Current Reports on Form 8-K.\n* * *\nCopies of the exhibits filed with this Annual Report on Form 10-K or incorporated by reference herein do not accompany copies hereof for distribution to stockholders of the Company. The Company will furnish a copy of any of such exhibits to any stockholder requesting the same for a nominal charge to cover duplicating costs.\nPOWER OF ATTORNEY\nThe registrant and each person whose signature appears below hereby appoint John H. Westerbeke, Jr. and Thomas M. Haythe as attorneys-in-fact with full power of substitution, severally, to execute in the name and on behalf of the registrant and each such person, individually and in each capacity stated below, one or more amendments to this Annual Report on Form 10-K, which amendments may make such changes in this Annual Report as the attorney-in-fact acting in the premises deems appropriate and to file any such amendment(s) to this Annual Report with the Securities and Exchange Commission.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned thereunto duly authorized.\nDated: January 25, 1996\nWESTERBEKE CORPORATION\nBy \/s\/ John H. Westerbeke, Jr. John H. Westerbeke, Jr. Chairman and President\nPursuant to the requirements of the Securities and 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.\nDated: January 25, 1996\nBy \/s\/ John H. Westerbeke, Jr. John H. Westerbeke, Jr. Chairman and President and Principal Executive Officer\nDated: January 25, 1996 By \/s\/ Carleton F. Bryant III Carleton F. Bryant III Executive Vice President, Chief Operating Officer and Principal Financial and Accounting Officer\nDated: January 25, 1996 By \/s\/ Gerald Bench Gerald Bench Director\nDated: January 25, 1996 By \/s\/ Thomas M. Haythe Thomas M. Haythe Director\nDated: January 25, 1996 By \/s\/ Nicholas H. Safford Nicholas H. Safford Director\nDated: January 25, 1996 By \/s\/ James W. Storey James W. Storey Director\nDated: January 25, 1996 By \/s\/ John H. Westerbeke, Sr. John H. Westerbeke, Sr. Director\nIndex to Exhibits","section_15":""}
{"filename":"718924_1995.txt","cik":"718924","year":"1995","section_1":"Item 1. Business Background\nSpan-America Medical Systems, Inc. (the \"Company\" or \"Span-America\"), was incorporated under the laws of the state of South Carolina on September 21, 1970. The Company manufactures and distributes a variety of polyurethane foam products and contract packaging products for the medical, consumer and industrial markets.\nSpan-America commenced operations in 1975 as a manufacturer of polyurethane foam patient positioners. During the next several years, the Company expanded its product lines to produce lapidus (flat foam) and convoluted foam mattress overlays for the decubitus care market. Decubitus care products aid in the treatment or prevention of decubitus ulcers, commonly known as bed sores or pressure ulcers. In the late 1970's the Company also began producing foam products for industrial applications, primarily to utilize excess manufacturing capacity. In 1985, the Company introduced its patented Geo-Matt mattress overlay in the health care market which became the Company's leading product. At the same time, the Company began selling its mattress overlay products to the consumer market segment. Span-America's foam products (including replacement mattresses described below) made up approximately 79% of the Company's total net sales in fiscal 1995.\nTo diversify its operations and to capitalize upon its familiarity and contacts within the health care industry, Span-America entered the contract packaging business in 1987. These initial contract packaging operations were based on a three-year commitment to supply Baxter Healthcare Corporation (\"Baxter\") with all of its contract packaging requirements. This agreement expired during the first quarter of fiscal 1991. The Company currently provides contract packaging services to a variety of customers throughout the United States. During fiscal 1995, contract packaging products accounted for approximately 21% of total net sales.\nThe Company entered the replacement mattress segment of the pressure ulcer care market in fiscal 1992 through the acquisition of Healthflex, Inc. The Company is currently marketing Healthflex's PressureGuard line of replacement mattresses directly to hospitals and long-term care facilities.\nThe Company's long-term strategy is to become a leading health care manufacturer specializing in products used in the prevention and treatment of pressure ulcers. A majority of the Company's medical products are currently directed toward pressure ulcer care applications, and the Company is actively seeking to develop or\nacquire new products which are in this market segment. The Company also seeks to further develop and manufacture consumer and industrial applications of its medical products.\nThe Company's products are distributed primarily in the United States and to a lesser degree in several foreign countries. Total export sales during fiscal 1995 were approximately $954,000 or 3% of total net sales.\nIndustry Segment Data\nThe industry segment data included in Note 15 to the Company's audited consolidated financial statements for the year ended September 30, 1995, presented on page 24 of the 1995 Annual Report is incorporated herein by reference.\nMedical Products\nSpan-America's principal medical products consist of polyurethane foam mattress overlays, therapeutic replacement mattresses, and patient positioners. These products are marketed primarily to hospitals but are also marketed to long term care facilities in the United States. The Company also sells these products on a limited basis in Canada. Sales of medical products represented 45%, 47%, and 55% of sales in 1995, 1994, and 1993 respectively.\nMattress Overlays. Span-America produces a variety of foam mattress overlays, including convoluted and lapidus foam pads and its patented Geo-Matt(R) overlay. Mattress overlays comprised approximately 22% of the Company's total net sales in fiscal 1995. These products are designed to provide patients with greater comfort and assist in treating patients suffering from burns or pressure ulcers. Span-America's overlay products are mattress pads as compared to complete mattresses and are marketed as less expensive alternatives to generally higher priced air and water mattresses. The mattress overlays are designed for single patient use.\nThe Geo-Matt mattress overlay, which was introduced in 1985, represents the Company's single largest product in terms of revenues. However, Geo-Matt sales have declined in each of the last three fiscal years. Geo-Matt was designed with computer-aided equipment in conjunction with clinical studies performed by the Institute for Rehabilitation and Research at the Baylor College of Medicine. The product's patented design includes over 800 individual cells which are cut to exacting tolerances on computer controlled equipment to create a sophisticated and clinically effective mattress surface.\nThe Company's mattress overlays disperse body heat, increase air circulation beneath the patient, and reduce moisture build-up in order to prevent the development\nor promote the healing of pressure ulcers. Their convoluted or geometrically contoured construction also evenly distributes the patient's body weight, thereby minimizing the pressure that causes ulcers.\nReplacement Mattresses. Span-America's replacement mattresses consist of its PressureGuard(R) mattresses, a line of therapeutic replacement mattresses (as distinguished from overlays), acquired through the acquisition of Healthflex in February 1992. The patented PressureGuard product combines a polyurethane foam shell and static air tubes to form a replacement mattress which incorporates the comfort and pressure relieving features of both mattress overlays and more sophisticated mattresses containing dynamic features. PressureGuard mattresses are designed to replace existing hospital or long-term care mattresses and to eliminate the need for mattress overlays. The PressureGuard mattress has preventative and therapeutic features, providing orthopedically correct positioning, equalized support and weight distribution, shear reduction, and pressure dispersion. The product line is now being sold primarily to acute care hospitals in the United States through the Company's direct sales force of approximately 20 representatives. The Company is also increasing its marketing efforts for this product in Canada. During fiscal 1995 replacement mattresses and related products made up approximately 9% of total net sales.\nIn November 1993, the Company received FDA 510K marketing approval for its PressureGuard IV (PGIV) mattress system. Building on the comfort and orthopedic support of the PressureGuard II design, PressureGuard IV is a sophisticated support system that provides pressure reduction and patient comfort in a powered, dynamic mattress with turning capabilities. The mattress automatically senses the patient's weight and adjusts to the appropriate support level for each patient to minimize surface pressures. The system slowly and quietly repositions patients at angles up to 30 degrees in cycles of up to two hours, providing continuous care for effective prevention and treatment of pressure ulcers. When disconnected from a power source, the system maintains proper inflation and optimum patient support until power is restored and rotation can resume. The simplicity of the PressureGuard IV mattress system makes it easy to use and virtually maintenance free. Standard operating modes are pre-programmed, with the flexibility to customize settings for each patient's care. During fiscal 1995, PGIV and related products made up approximately 6% of total net sales.\nIn November 1994, Span-America introduced the DynaGuard alternating pressure mattress. This powered, dynamic replacement mattress is being targeted to the home care market. In June 1995, the Company introduced the CustomCare(TM) therapeutic mattress system. The CustomCare mattress uses principles of \"constant force technology\" to create a new category of non-powered, self-adjusting mattress systems for the acute care and long-term care markets.\nPatient Positioners. Span-America's specialty line of patient positioners is sold primarily under the trademark Span-Aids(R). Span-Aids accounted for approximately 8%\nof the Company's net sales in fiscal 1995. This is the original product line of the Company and consists of over 300 different foam items which aid in relieving the basic patient positioning problems of elevation, immobilization, muscle contracture, foot drop and foot or leg rotation. Span-Aids patient positioners hold the patient's body in orthopedically correct positions, provide greater patient comfort and tend to promote healing for long-term comatose patients or those with a flaccid or immobilized condition. The positioners also aid in the prevention of pressure ulcers by promoting more effective dispersion of pressure, heat and moisture. Span-Aids are intended for single-patient use throughout the patient's entire treatment program. Among the Span-Aids products presently marketed are abduction pillows, body aligners, wheelchair cushions, cast elevators and various foot and wrist positioners.\nSpan-America's patient positioners are sold primarily to hospitals and long-term care facilities by several national medical products distributors. Span-Aids are believed by the Company to be one of the most effective patient positioning devices available in the health care market, as compared to pillows, rolled towels and other similar materials traditionally used by nursing personnel to position immobilized patients. Span-Aids are constructed of open-cell polyurethane foam which allows air to circulate next to the patient's skin, thereby reducing extensive heat and moisture build-up.\nMost Span-Aids body positioners are pressure packaged to reduce the amount of storage space required by hospitals and other facilities which utilize them. This patented packaging method reduces the package size by as much as 75% while protecting the positioners from dust and contamination during transportation and storage.\nDistributor Relationship. Approximately 27% of the Company's medical foam products are sold to Baxter which distributes these products to hospitals nationwide. Span-America has maintained a distribution relationship with Baxter (formerly American Hospital Supply) for 17 years. Sales of the Company's medical foam overlay products to Baxter Healthcare Corporation, have declined during the last two fiscal years due to Baxter's decision in February 1994 to begin carrying a competing line of foam products. A continued decline in sales to Baxter could have a negative effect on the Company's earnings in fiscal 1996. However, management believes that any negative earnings impact of the decline in foam overlay sales should be offset by increases in sales of these products to other national distributors and by sales increases in the Company's other product lines. The Company's foam overlay products are now available through a number of national distributors rather than exclusively from Baxter as was the case until early 1994. Sales of medical foam products to Baxter have declined by approximately $11 million since fiscal 1993. However, during the same period, sales of these products to other national distributors have increased by $6 million, offsetting more than half of the decline in sales to Baxter.\nConsumer Products\nSpan-America's consumer products consist primarily of convoluted mattress overlays and specially designed pillows for the consumer bedding market. The Company's principal consumer mattress overlays are produced under private labels for J.C. Penney and Target Stores. The majority of the Company's consumer bedding products are marketed by Pillowtex, which sells the products to department stores and mass merchandisers throughout the United States.\nIn 1990, Span-America introduced its TerryFoam(R) comfort products which are designed to be used on all types of outdoor furniture. Formerly produced by contract manufacturers according to the Company's specifications, these products are now manufactured by the Company. They are being sold and distributed directly by Span-America to retailers nationwide.\nConsumer products represented approximately 23% of the Company's total net sales in fiscal 1995 as compared to 21% in 1994 and 19% in 1993.\nIndustrial Products\nSpan-America's industrial products consist primarily of foam packaging and cushioning materials. The Company also produces foam products which are used for flotation, sound insulation and gasketing purposes. The majority of these products are made to order according to customer specifications instead of being made to stock. To date, most of the Company's industrial sales have been in the specialty packaging segment of the industrial foam market. The Company currently has two full-time sales representatives and several manufacturers representatives selling its foam fabrication capabilities to the industrial market. Its customers represent a wide variety of markets, including the defense, electronics and sports equipment industries. The industrial foam segment of the business made up approximately 12% of the Company's net sales in fiscal 1995 as compared to 9% in 1994.\nContract Packaging Products\nSpan-America's contract packaging products are principally single-use flexible packettes containing various chemicals which are used for cleaning, sterilizing or lubricating purposes. Approximately 21% of the Company's fiscal 1995 sales were contract packaging products as compared to 22% in 1994, and 20% in 1993. Contract packaging products are generally foil pouches containing a piece of non-woven cloth which has been saturated with substances such as alcohol or iodine. The Company markets its contract packaging capabilities principally to large health care and pharmaceutical companies. Since the Company's main function is that of a contract manufacturer, it primarily relies on the distribution networks of its customers.\nThe Company's contract manufacturing facilities include a high quality water filtration system, liquid\/gel blending facilities and equipment which fills flexible packettes with a variety of chemicals, powders, gels, swab sticks and other products. Span-America utilizes high-speed horizontal and vertical \"form, fill and seal\" packaging machines to produce a significant portion of the contract packaging products. The Company also provides bottle (liquid) filling services to its customers.\nAlthough Span-America functions primarily as a contract manufacturer of flexible packaging products, it also produces a line of such products under its own Span-Care brand, consisting principally of single-use towelettes, swabs and gels. The Company employs two sales representatives to sell this Span-Care line to hospitals and alternate site facilities, including long-term care facilities and home health care distributors.\nThe Company also manufactures contract packaging products for the consumer market segment. These items consist mainly of health and beauty aid products such as towelettes, lotions and powders. Span-America acts as a contract manufacturer of these products, blending and packaging them according to customer specifications. They are sold and distributed by Span-America's customers to a variety of retail outlets in the United States.\nCompetition\nMedical. In the medical market segment, the Company faces significant competition for sales of its foam mattress overlays. The competition for convoluted mattress overlays is primarily based on price and delivery. For other foam mattress overlay products (such as the Geo-Matt overlay), the competition is based mainly on product performance and quality. However, to a lesser extent, the competition for Geo-Matt type overlays is also based on price and delivery. Competition with respect to the Company's Span-Aid products is primarily based on price. However, a secondary source of competition for patient positioners results from alternative methods such as the use of pillows and other devices to position patients.\nThe Company believes that it is among the top five suppliers of foam mattress overlays and patient positioners to the health care market. The Company's primary competitors in the health care market include Bio Clinic (division of Sunrise Medical), Dermacare, Gaymar, and DeRoyal.\nThe competition in the therapeutic replacement mattress market is based on product performance, price and durability. Potential customers typically select a product based on these criteria after conducting a formal clinical evaluation of sample mattresses for periods of one to six months. A secondary source of competition results from alternative products such as mattress overlays which are significantly less expensive than replacement mattresses.\nThe market for therapeutic replacement mattresses has developed principally during the last three years and is currently dominated by five suppliers: BG Industries, Hill-Rom, Comfortex, DermaCare, and Bio Clinic. BG Industries utilizes Baxter to distribute its mattresses primarily to hospitals. The other competitors use their own sales representatives to sell directly to hospitals, distributors, and long-term care facilities nationwide. The Company's entrance into the replacement mattress market in 1992 also placed it in direct competition with Baxter for sales of replacement mattress products. See \"Distributor Relationship\" on page 4 for further discussions regarding Baxter and the Company.\nMany of the Company's competitors in the health care segment are larger and have greater resources than Span-America.\nConsumer. In the consumer market segment, Span-America has encountered significant competition for its mattress pad and pillow products. The competition is principally based on price, which is largely determined by foam density and thickness. However, competition also exists due to variations in product design and packaging. There are presently a number of companies with the manufacturing capability to produce similar bedding products. The Company's primary competitors in this market are Comfort Clinic (a division of Sunrise Medical) and ER Carpenter, both of which are larger than Span-America.\nIndustrial. The Company also has a number of competitors in the industrial foam market, including United Foam, Hibco and Foam Design. Some of these competitors are larger and have greater resources than Span-America. The competition for industrial foam products is largely based on price. In some instances, however, design and delivery capabilities are as important as the price of the product.\nContract Packaging. A significant level of competition has been experienced in the markets into which the medical contract packaging products are sold. This competition is based mainly on price, quality and manufacturing capability. Many of the contract packaging products have the characteristics of commodity products and thus can be produced at several manufacturing facilities in the United States. The Company's chief competitors in this market are PDI\/Nice Pak, Packaging Coordinators, Paco, Marietta Packaging and Clinipad.\nThere is also significant competition for the Company's contract packaging products sold in the consumer market. The main bases for this competition are quality, capacity and breadth of manufacturing capabilities. There are currently many companies, some larger and with greater resources than Span-America, which have the capability to produce equivalent products.\nMajor Customers\nThe Company has a business relationship with Baxter Healthcare Corporation (\"Baxter\") to distribute certain of its foam and contract packaging products. In fiscal 1995, sales to Baxter amounted to approximately 12% of the Company's total net sales and approximately 27% of the Company's sales to the medical foam segment. Span-America also has a relationship with Pillowtex Corporation to distribute certain of its consumer foam products. Sales to Pillowtex during fiscal 1995 made up approximately 15% of the Company's net sales and approximately 64% of sales in the consumer foam segment. The Company has a relationship with another customer to manufacture specific contract packaging products for the consumer market segment. Sales to this customer comprised approximately 5% of the Company's fiscal 1995 net sales and 25% of the contract packaging segment sales during the same period.\nThe loss of any of the customers described above could have a material adverse effect on the Company. See \"Distributor Relationship\" on page 4, \"Consumer Products\" on page 5, and \"Competition\" on pages 6 and 7 for more information on major customers. Seasonal Trends\nSome seasonality can be identified in certain of the Company's medical foam, consumer foam and contract packaging products. However, the fluctuations have minimal effect on the Company's operations because of offsetting trends among these product lines. Span-America has not experienced any seasonal fluctuations in its industrial segment.\nThe most seasonal of the Company's products is the TerryFoam line of chaise and chair pads. Demand for shipments of these products generally is highest in January through April of each year as retail stores begin stocking their summer merchandise. The impact of this seasonality on the Company will depend largely on the volume of sales achieved for this product line. During previous fiscal years, the seasonality of TerryFoam products has had only a minor impact on the Company's operations.\nPatents and Trademarks\nThe Company holds 28 federally registered trademarks, including SPAN- AMERICA, SPAN-AIDS, GEO-MATT, SPAN-CARE AND PRESSUREGUARD. Other federal registration applications are presently pending. The Company believes that these trademarks are readily identifiable in their respective markets and add value to the Company's product lines.\nThe Company also holds 44 United States patents and 8 foreign patents relating to various components of its patient positioners, mattress overlays, and replacement\nmattresses. Additional patent applications have been filed. Management believes that these patents are important to the Company. However, while the Company has a number of products covered by patents, there are competitive alternatives available which are not covered by these patents. Therefore, the Company does not rely solely on its patents to maintain its competitive position in the marketplace.\nSpan-America's principal patents include the patents on its PressureGuard and CustomCare replacement mattress, its Geo-Matt overlay and its Span-Aids patient positioners. The Company's Geo-Matt and PressureGuard patents have remaining lives of 12 and 14 years, respectively. The Company's Span-Aids patents have remaining lives ranging from 1 to 14 years.\nCertain of the Company's patents have been assigned or exclusively licensed to the Company by Donald C. Spann, the Company's founder and former chairman, until January 1, 1996. In connection with such assignments, the Company is obligated to pay Mr. Spann royalties equal to 3% of net sales on all products covered by such patents. In the event that the Company defaulted on these royalty payments, such patents would revert to Mr. Spann. On January 1, 1996, all patents assigned or licensed to the Company by Mr. Spann will become the property of the Company, and the Company will have no further obligation to make the royalty payments.\nRaw Materials and Backlog\nPolyurethane foam, foil packaging, various chemical solutions and non-woven cloth account for approximately 80% of Span-America's raw materials. In addition, the Company uses corrugated shipping cartons, polyethylene plastic packaging material and hook-and-loop fasteners. The Company believes that its basic raw materials are in adequate supply and are available from many suppliers at competitive prices.\nAs of September 30, 1995, Span-America had unshipped orders of approximately $2.6 million which represents a 10% decrease compared to a backlog of $2.9 million at fiscal year end 1994. All orders in the current backlog will be filled in the 1996 fiscal year.\nEmployees\nOn September 30, 1995, the Company had full-time employment of 250 persons, including 5 officers. Of these employees, 25 were executive or management personnel, 12 were administrative and clerical personnel, 19 were sales personnel and 189 were manufacturing employees. The Company is not a party to any collective bargaining agreement, and has never experienced an interruption or curtailment of operations due to labor controversy. Management believes that its relations with its employees are good.\nSupervision and Regulation\nThe Federal Food, Drug and Cosmetic Act, and regulations issued or proposed thereunder, provide for regulation by the Food and Drug Administration (the \"FDA\") of the marketing, manufacture, labeling, packaging and distribution of medical devices, including the Company's products. These regulations require, among other things, that medical device manufacturers register with the FDA, list devices manufactured by them, and file various types of reports. In addition, the Company's manufacturing facilities are subject to periodic inspections by regulatory authorities and must comply with \"good manufacturing practices\" as required by the FDA and state regulatory authorities. The Company believes that it is in substantial compliance with applicable regulations and does not anticipate having to make any material expenditures as a result of FDA or other regulatory requirements.\nEnvironmental Matters\nThe Company's manufacturing operations are subject to various government regulations pertaining to the discharge of materials into the environment. Span-America believes that it is in compliance with applicable regulations. The Company does not anticipate that continued compliance will have a material effect on the Company's capital expenditures, earnings or competitive position.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal office and manufacturing facility is owned by the Company and located in Greenville, South Carolina. This facility contains approximately 125,000 square feet and is located on a 13 acre site. The Company also leases approximately 60,000 square feet of warehouse space in Greenville for $13,672 per month until the lease expires in May 1997.\nThe Company produces foam mattress overlays for the medical and consumer markets in a 40,000 square foot facility in Norwalk, California. The lease rate is $14,196 per month and increases annually over the term of the lease to $15,615 per month until the lease expires in December 1997. The Company closed its Vermont manufacturing plant in July 1994 and consolidated the operation into the South Carolina facilities.\nThe South Carolina and California facilities are considered suitable and adequate for their intended purposes.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company and its subsidiaries are from time to time parties to various legal actions arising in the normal course of business. However, management believes that as a result of legal defenses and insurance arrangements with parties believed to be financially capable, there are no proceedings threatened or pending against the Company that, if determined adversely, would have a material adverse effect on the business or financial position of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of security holders during the fourth quarter of the Company's 1995 fiscal year.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nThe stock price information contained under \"Quarterly Financial Data\" within the table and the information set forth below the table on page 11 of the Company's 1995 Annual Report is incorporated herein by reference. In addition, the information under \"Stock Information\" on the inside back cover of the Company's 1995 Annual Report is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information contained in the \"Selected Financial Information\" on page 10 of the Company's 1995 Annual Report is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Financial Analysis\nManagement's Discussion and Financial Analysis on pages 12 through 15 of the Company's 1995 Annual Report are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements of the Company included on pages 16 through 26 of the Company's 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\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nItem 11.","section_11":"Item 11. Executive Compensation\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation required under Items 10, 11, 12 and 13 of Part III is incorporated herein by reference to portions of the definitive Proxy Statement filed or to be filed with the Securities and Exchange Commission on or prior to 120 days following the end of the Company's 1995 fiscal year under the headings \"Election of Directors,\" \"Business Experience of Nominees and Directors,\" \"Executive Officers,\" \"Compensation of Directors and Executive Officers,\" \"Certain Transactions,\" and \"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) and (2) Financial Statements and Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report beginning on page.\n(3) Listing of Exhibits\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSPAN-AMERICA MEDICAL SYSTEMS, INC.\nBy: \/s\/ Brien Laing December 20, 1995 Brien Laing, 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 on the date indicated.\n\/s\/ Charles B. Mitchell President, Chief Executive Officer and Charles B. Mitchell Director (Principal Executive Officer)\n\/s\/ Richard C. Coggins Chief Financial Officer and Director Richard C. Coggins (Principal Financial Officer)\n\/s\/ Gwendolyn L. Randolph Controller Gwendolyn L. Randolph\n\/s\/ Thomas F. Grady, Jr. Director Thomas F. Grady, Jr.\n\/s\/ Douglas E. Kennemore Director Douglas E. Kennemore, M.D.\n\/s\/ Brien Laing Director Brien Laing\n\/s\/ W. Marcus Newberry Director W. Marcus Newberry, M.D.\n\/s\/ James M. Shoemaker, Jr. Director James M. Shoemaker, Jr.\n\/s\/ Raymond M. Tortolani Director Raymond M. Tortolani\n\/s\/ Robert A. Whitehorne Director Robert A. Whitehorne\n15 December 20, 1995\nAnnual Report on Form 10-K\nItems 14 (a) (1) and (2), (c) and (d)\nList of Financial Statements and Financial Statement Schedules\nCertain Exhibits\nFinancial Statement Schedules\nYear Ended September 30, 1995\nSpan-America Medical Systems, Inc.\nGreenville, South Carolina\nSpan-America Medical Systems, Inc.\nForm 10-K - Item 14(a)(1) and (2)\nList of Financial Statements and Financial Statement Schedules\nThe following consolidated financial statements of Span-America Medical Systems, Inc., included in the annual report of the registrant to its shareholders for the year ended September 30, 1995 are incorporated by reference in Item 8:\nConsolidated Balance Sheets - September 30, 1995 and October 1, 1994\nConsolidated Statements of Income - Years ended September 30, 1995, October 1, 1994 and October 2, 1993\nConsolidated Statements of Shareholders' Equity - Years ended September 30, 1995, October 1, 1994 and October 2, 1993.\nConsolidated Statements of Cash Flows - Years ended September 30, 1995, October 1, 1994 and October 2, 1993\nConsolidated Notes to Financial Statements - September 30, 1995\nThe following consolidated financial statement schedule of Span-America Medical Systems, Inc. is included in Item 14(d):\nSchedule VIII - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nSchedule VIII - Valuation and Qualifying Accounts\nSpan-America Medical Systems, Inc.","section_15":""}
{"filename":"852772_1995.txt","cik":"852772","year":"1995","section_1":"ITEM 1. BUSINESS INTRODUCTION Flagstar Companies, Inc. (\"FCI\"), through its wholly-owned subsidiary 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). 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 FCI, 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 The common stock of FCI, $.50 par value per share (the \"Common Stock\"), is currently traded on the NASDAQ National Market System using the symbol \"FLST.\" As of March 7, 1996, 42,434,606 shares of Common Stock were outstanding, and there were approximately 12,000 record and beneficial stockholders. FCI has not paid and does not expect to pay dividends on its outstanding Common Stock. Restrictions contained in the instruments governing the outstanding indebtedness of Flagstar restrict its ability to provide funds that might otherwise be used by FCI for the payment of dividends on its Common Stock. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" and Note 4 to the accompanying Consolidated Financial Statements of the Company. The closing sales prices indicated below for the Common Stock were obtained from the National Association of Securities Dealers, Inc.\nITEM 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.\n(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) For the year ended December 31, 1992, net loss includes extraordinary losses of $6.25 per share related to premiums paid to retire certain indebtedness and to charge-off the related unamortized deferred financing costs and losses of $0.72 per share for the cumulative effect of a change in accounting principle related to implementation of Statement of Financial Accounting Standards No. 106. For the year ended December 31, 1993, net loss includes extraordinary losses of $0.62 per share related to the repurchase of Flagstar's 10% Convertible Junior Subordinated Debentures Due 2014 (the \"10% Debentures\") and to the charge-off of unamortized deferred financing costs related to a prepayment of Flagstar's senior term loan; net loss for 1993 also includes a charge of $0.29 per share related to a change of accounting method pursuant to Staff Accounting Bulletin No. 92. For the year ended December 31, 1994, net income includes an extraordinary loss of $0.22 per share, as calculated for primary earnings per share, and $0.18 per share, as calculated for fully diluted earnings per share, relating to the charge off of unamortized deferred financing costs associated with the Company's prepayment of its senior term loan and working capital facility during the second quarter of 1994. For the year ended December 31, 1995, net loss includes a $0.01 per share extraordinary gain relating to the repurchase of $24,975,000 of senior indebtedness net of the charge-off of unamortized deferred financing costs. (7) Flagstar's bank credit agreement prohibits, and its public debt indentures significantly limit, distribution to FCI of funds that might otherwise be used by it to pay Common Stock dividends. See Note 4 to the accompanying Consolidated Financial Statements appearing elsewhere herein. (8) 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. (9) 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. (10) 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. The 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\nPollo 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. Revenues 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\nMexico 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 facility 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,\nrespectively, 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. At 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.\nGeneral 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 become 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\n(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, dividends on the Preferred Stock (as defined below), 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.\nAt 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 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. 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.\nFORM 11-K INFORMATION FCI, 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 Information required by this item with respect to the Company's directors and compliance by the Company's directors, executive officers and certain beneficial owners of the Company's Common Stock with Section 16(a) of the Securities Exchange Act of 1934 is furnished by incorporation by reference of all information under the captions entitled \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's Proxy Statement for its Annual Meeting of the Stockholders to be held on April 24, 1996 (the \"Proxy Statement\"). The information required by this item with respect to the Company's executive officers appears in Item I of Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant.\" ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information required by this item is furnished by incorporation by reference of all information under the caption entitled \"Executive Compensation\" in the Proxy Statement. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is furnished by incorporation by reference of all information under the caption \"General -- Ownership of Capital Securities\" in the Company's Proxy Statement. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN TRANSACTIONS The information required by this item is furnished by incorporation by reference of all information under the caption \"Certain Transactions\" in the Company's Proxy Statement. 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 was 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\nRevolving 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. The 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\nbelow) 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 defined 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.\n\"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 Restated 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.\nTHE 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 COMPANIES, INC.\nINDEPENDENT AUDITORS' REPORT FLAGSTAR COMPANIES, INC. We have audited the accompanying consolidated balance sheets of Flagstar Companies, Inc. 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 COMPANIES, INC. STATEMENTS OF CONSOLIDATED OPERATIONS (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nFLAGSTAR COMPANIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR COMPANIES, INC. STATEMENTS OF CONSOLIDATED CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR COMPANIES, INC. STATEMENTS OF CONSOLIDATED CASH FLOWS (CONTINUED) (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INTRODUCTION Flagstar Companies, Inc. (Company) was incorporated under the laws of the State of Delaware on September 24, 1988 to effect the acquisition of Flagstar Corporation (Flagstar). Prior to June 16, 1993 the Company and Flagstar had been known, respectively, as TW Holdings, Inc. and TW Services, 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\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued agreements were amortized over periods up to 40 years on the straight-line basis prior to being written-off at 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\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued the years ended December 31, 1993, 1994, and 1995 was $53.0 million, $37.4 million, and $18.9 million, respectively. (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:\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 RESTRUCTURING AND IMPAIRMENT OF LONG-LIVED ASSETS -- Continued Approximately $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. 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\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 WRITE-OFF OF GOODWILL AND CERTAIN OTHER INTANGIBLE ASSETS -- Continued 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 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.\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued Long-term debt consists of the following:\n(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\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued 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. 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. 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 $1.75 billion at December 31, 1995. Such computations are based on market quotations for the same or similar debt issues or\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued 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. 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 COMPANIES, INC. 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 COMPANIES, INC. 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 COMPANIES, INC. 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 COMPANIES, INC. 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. The 1989 Stock Option Plan permits a Committee of the Board of Directors to grant options to key employees of the Company and its subsidiaries to purchase shares of common stock of the Company at a stated price established by the Committee. Such options are exercisable at such time or times either in whole or part, as determined by the Committee. The 1989 Stock Option Plan authorizes grants of up to 6,500,000 common shares. Options of 3,308,200 and 4,302,120, respectively, were outstanding at December 31, 1994 and 1995 of which 241,610 and 728,221, respectively, were exercisable. Such options have exercise prices of between $5.13 and $17.50 per share and become exercisable between one and two years after the date of grant with an additional twenty to twenty-five percent of such options becoming exercisable each year thereafter. During 1994 and 1995 no options were exercised. If not exercised, the options expire ten years from the date of grant. On June 21, 1995, generally all of the outstanding options held by the then current employees of the Company under the 1989 Stock Option Plan were repriced to $6.00 per share, the market value of the common stock at the date of the repricing. All officer level employees were given the choice of either retaining their current options at their existing exercise prices and vesting schedule or surrendering their existing options in exchange for an option to purchase the same number of shares exercisable at a rate of 20% per annum beginning on the first anniversary date of the new grant. All non-\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS -- Continued officer employees received the new exercise price of $6.00 per share and retained their original vesting schedules for all of their outstanding options previously granted. In 1990, the Board of Directors adopted a 1990 Non-qualified Stock Option Plan (the 1990 Option Plan) for its directors who do not participate in management and are not affiliated with GTO (see Note 12). Such plan, as currently in effect, authorizes the issuance of up to 110,000 shares of common stock. The plan is substantially similar in all respects to the 1989 Option Plan described above. The Committee of the Board administering the 1990 Option Plan granted options for 30,000 shares as of July 31, 1990 at $29.05 per share, the market price per share on the date of grant. At December 31, 1994 and 1995, respectively, options outstanding under the 1990 Option Plan totalled 10,000 shares. During January 1995, the Company issued 65,306 shares of common stock and granted an option under the 1989 Stock Option Plan to purchase 800,000 shares of the Company's common stock, at market value at the date of grant, for a ten-year period. Such grant becomes exercisable at the rate of 20% per year beginning on January 9, 1996 and each anniversary thereafter. 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. 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).\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 9 SHAREHOLDERS' EQUITY (DEFICIT)\nEach share of the $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock ($2.25 Preferred Stock) is convertible at the option of the holder, unless previously redeemed, into 1.359 shares of common stock. The Preferred Stock may be exchanged at the option of the Company, in up to two parts, at any dividend payment date for the Company's 9% Convertible Subordinated Debentures (Exchange Debentures) due July 15, 2017 in a principal amount equal to $25.00 per share of $2.25 Preferred Stock. Each $25.00 principal amount of Exchange Debenture, if issued, would be convertible at the option of the holder into 1.359 shares of common stock of the Company. The $2.25 Preferred Stock may be redeemed at the option of the Company, in whole or in part, on or after July 15, 1994 at $26.80 per share if redeemed during the twelve month-period beginning July 15, 1994, and thereafter at prices declining annually to $25.00 per share on or after July 15, 2002. At December 31, 1995, there are warrants outstanding which entitle the holder, an affiliate of Kohlberg, Kravis, Roberts & Co. (KKR), a shareholder of the Company, to purchase 15 million shares of Company common stock at $17.50 per share, subject to adjustment for certain events. Such warrants may be exercised through November 16, 2000. NOTE 10 EARNINGS (LOSS) PER SHARE APPLICABLE TO COMMON SHAREHOLDERS The outstanding warrants as well as the stock options issued to management and directors are common stock equivalents. The $2.25 Preferred Stock and 10% Convertible Debentures, which are convertible into the common stock of the Company (see Note 4), are not common stock equivalents; however, such securities are considered \"other potentially dilutive securities\" which may become dilutive in the calculation of fully diluted per share amounts. The calculations of primary and fully diluted loss per share amounts for the years ended December 31, 1993 and 1995 have been based on the weighted average number of Company shares outstanding. The warrants, options, $2.25 Preferred Stock, and 10% Convertible Debentures have been omitted from the calculations for 1993 and 1995 because they have an antidilutive effect on loss per share. For the year ended December 31, 1994, the calculation of primary earnings per share has been based on the weighted average number of outstanding shares as adjusted by the assumed dilutive effect that would occur if the outstanding warrants and stock options were exercised, using the modified treasury stock method. The calculation of fully\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10 EARNINGS (LOSS) PER SHARE APPLICABLE TO COMMON SHAREHOLDERS -- Continued diluted earnings per share has been based on additional adjustments to the primary earnings per share amount for the dilutive effect of the assumed conversion of the $2.25 Preferred Stock and 10% Convertible Debentures. 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.\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. 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 COMPANIES, INC. 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:\nFLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 QUARTERLY DATA (UNAUDITED) -- Continued During 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. The effect of the Company's other potentially dilutive securities (see Note 10) on the computations of fully diluted loss per share amounts for the first, third, and fourth quarters of 1994 and 1995 quarters were anti-dilutive. Accordingly, the primary and fully diluted loss per share amounts for such quarters are equivalent. 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. 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 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. FLAGSTAR COMPANIES, INC. By: \/s\/ RHONDA J. PARISH Rhonda J. Parish (Vice President, General Counsel and Secretary) Date: 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.","section_15":""}
{"filename":"853890_1995.txt","cik":"853890","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDescriptions of properties owned or utilized by the Partnership are contained in Item 1 of this report and such descriptions are hereby incorporated by reference into this Item 2. Under the captioned \"Leases\" in notes to the Partnership's financial statements included in Item 8 herein below, additional information is presented concerning obligations for lease and rental commitments. Said additional information is hereby incorporated by reference into this Item 2.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a party to several lawsuits arising in the ordinary course of business. Subject to certain deductibles and self-insurance retentions, substantially all the claims made in these lawsuits are covered by insurance policies.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not hold a meeting of stockholders or otherwise submit any matter 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 SENIOR PREFERENCE UNITS AND RELATED UNITHOLDER MATTERS\nThe Partnership's senior preference limited partner interests (\"Senior Preference Units\") and Preference Units are listed and traded on the New York Stock Exchange. At March 15, 1996, there were approximately 1,081 Senior Preference Unitholders of record and approximately 200 Preference Unitholders of record. Set forth below are prices for Senior Preference Units and Preference Units, respectively, on the New York Stock Exchange and cash distributions per Senior Preference Unit and Preference Unit, respectively, paid for the periods indicated.\nThe Partnership has paid the Minimum Quarterly Distribution on each outstanding Senior Preference Unit for each quarter since the Partnership's inception. The Partnership has also paid the Minimum Quarterly Distribution on Preference Units with respect to all quarters since inception of the Partnership, except for the failure to pay distributions in the second, third and fourth quarters of 1991 totaling $9,323,000. All such arrearages have since been satisfied and none remain as of December 31, 1995. Prior to 1994, no distributions were paid on the outstanding Common Units, which are not entitled to arrearages in the payment of the Minimum Quarterly. In 1994, distributions totaling $1,738,000 were paid and in 1995, distributions totaling $4,582,000 were paid.\nUnder the terms of its financing agreements, the Partnership is prohibited from declaring or paying any distribution if a default exists thereunder.\nITEM 6.","section_6":"ITEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA The following table sets forth, for the periods and at the dates indicated, selected historical financial and operating data for Kaneb Pipe Line Partners, L.P. and Subsidiaries (the \"Partnership\"). The data in the table (in thousands, except per unit amounts) is derived from the historical financial statements of the Partnership and should be read in conjunction with the Partnership's audited financial statements. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n(a) Includes the operations of ST since its acquisition on March 2, 1993. (b) Includes the operations of the West Pipeline since its acquisition in February 1995 and the operations of Steuart since its acquisition in December 1995. (c) Subsequent to the acquisition of ST in March 1993, certain operations are conducted in taxable entities. (d) Net income of the Partnership for each reporting period is allocated to the Senior Preference Units (\"SPU\") and Preference Units (\"PU\") in an amount equal to the cash distributions to the SPU and PU declared for that reporting period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion should be read in conjunction with the consolidated financial statements of Kaneb Pipe Line Partners, L.P. and notes thereto and the summary historical and pro forma financial and operating data included elsewhere in this report.\nGENERAL\nIn September 1989, Kaneb Pipe Line Company (\"KPL\"), a wholly-owned subsidiary of Kaneb Services, Inc. (\"Kaneb\"), formed the Partnership to own and operate its refined petroleum products pipeline business. The Partnership operates through KPOP, a limited partnership in which the Partnership holds a 99% interest as limited partner and KPL owns a 1% interest as general partner in both the Partnership and KPOP. The Partnership is engaged through operating subsidiaries in the refined petroleum products pipeline business and, since 1993, terminaling of petroleum products and specialty liquids.\nThe Partnership's pipeline business consists primarily of the transportation through the East Pipeline and the West Pipeline, as common carriers, of refined petroleum products. The Partnership acquired the West Pipeline in February 1995 from Wyco Pipe Line Company, a company jointly owned by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition was financed by the issuance of $27 million of first mortgage notes due February 24, 2002, which bear interest at the rate of 8.37% per annum. The East Pipeline and the West Pipeline are collectively referred to as the \"Pipelines.\" The Pipelines primarily transport gasoline, diesel oil, fuel oil and propane. The products are transported from refineries connected to the Pipeline, directly or through other pipelines, to agricultural users, railroads and wholesale customers in the states in which the Pipelines are located and in portions of other states. Substantially all of the Pipelines' operations constitute common carrier operations that are subject to federal or state tariff regulations. The Partnership has not engaged, nor does it currently intend to engage, in the merchant function of buying and selling refined petroleum products.\nThe Partnership's business of terminaling petroleum products and specialty liquids is conducted under the name ST Services (\"ST\"). ST is the third largest independent terminaling company in the United States. With the acquisition of Steuart (see below), ST operates 31 facilities in 16 states and the District of Columbia with an aggregate tankage capacity of approximately 16.8 million barrels. The Texas City terminal is a deep-water facility primarily serving the Gulf Coast petrochemical industry. The Westwego terminal, purchased in June 1994 and located on the West bank of the Mississippi River across from New Orleans, handles molasses, animal and vegetable oil and fats, fertilizer, latex and caustic solutions. The Baltimore terminal is the largest independent terminal facility in the Baltimore area and handles asphalt, fructose, latex, caustic solutions and other liquids.\nST acquired the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, \"Steuart\") in December 1995 for $68 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition was financed with a $68 million bridge loan from a bank. The Steuart terminaling assets consist of seven petroleum product terminal facilities located in the District of Columbia, Florida, Georgia, Maryland and Virginia and the pipeline and terminaling facilities serving Andrews Air Force Base in Maryland. The Piney Point, Maryland terminal is the closest petroleum storage facility to Washington D.C. which has access to deep water. The Jacksonville terminal has 28 tanks with approximately 2.1 million barrels of aggregate storage capacity, which are currently used to store petroleum products. The remainder of ST's terminals primarily handle petroleum products.\nThe Partnership acquired ST in March 1993 for approximately $65 million (including $2 million in acquisition costs). In connection with the acquisition, the Partnership borrowed $65 million from a group of banks. In April 1993, the Partnership completed a public offering of 2.25 million Senior Preference Units at $25.25 per unit. The bank loan was partially repaid with $50.8 million of the proceeds from the offering, and the balance was refinanced in December 1994. The Partnership continually evaluates other potential acquisitions.\nThe Pipelines' revenues are based on volumes shipped and the distances over which such volumes are transported. Revenues increased $14.1 million and $2.0 million in 1995 and 1994, respectively. The increase in 1995 is primarily due to the acquisition of the West Pipeline. The Partnership implemented a tariff increase of approximately 5.5% in April 1994, which accounted for more than one-half of its increase in revenues in 1994 over 1993. Because tariff rates are regulated by the FERC, the Pipelines compete primarily on the basis of quality of service, including delivering products at convenient locations on a timely basis to meet the needs of its customers. Barrel miles increased 15% to 16.6 billion barrel miles in 1995 from 14.5 billion barrel miles in 1994, due primarily to the acquisition of the West Pipeline.\nOperating costs which include fuel and power costs, materials and supplies, maintenance and repair costs, salaries, wages and employee benefits, and property and other taxes, increased $4.8 million in 1995 and $1.3 million in 1994. The 1995 increase is a result of the West Pipeline acquiaition and the 1994 increase is due to increased barrel miles and utility rates, property taxes and materials, supplies and outside services due to unusually high repair and maintenance expenditures. The 1995 increase in depreciation and amortization is a direct result of the February 1995 acquisition of the West Pipeline. General and administrative costs include managerial, accounting and administrative personnel costs, office rental and expense, legal and professional costs and other non-operating costs.\nTERMINALING OPERATIONS\nThe increases in revenues are attributable to increases in prices charged for storage and tankage volumes utilized. Revenues increased 13% in 1995 and 9% in 1994. Average annual tankage utilized increased 600,000 barrels to 6.7 million barrels compared to 6.1 million barrels in 1994 primarily as a direct result of terminal acquisitions in 1994 and 1995 and increased 200,000 barrels in 1994 over 1993. Average annual revenues per barrel of tankage utilized increased by $0.13 in 1995 to $5.46 per barrel and increased $0.26 per barrel in 1994 over 1993. Total tankage capacity (16.8 million barrels at December 31, 1995) has been, and is expected to remain, adequate to meet existing customer storage requirements. Customers consider factors such as location, access to cost effective transportation and quality of service in addition to pricing when selecting terminal storage. Operating costs increased $2.2 million and $.7 million and depreciation and amortization increased $.4 and $.5 in 1995 and 1994, respectively, as a result of the terminal acquisitions in 1995 and 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nThe ratio of current assets to current liabilities was 0.9 to 1 at December 31, 1995 and 0.8 to 1 at December 31, 1994. Cash provided by operating activities was $44.5 million, $37.9 million and $37.2 million for the years 1995, 1994 and 1993 respectively. The increase in cash flow from operating activities in 1995 was primarily a result of the West Pipeline and the Westwego terminal acquisitions.\nCapital expenditures were $8.9 million, $7.1 million and $8.1 million for 1995, 1994 and 1993, respectively. During all periods, adequate pipeline capacity existed to accommodate volume growth, and the expenditures required for environmental and safety improvements were not, and are not expected in the future to be, material. Environmental damages caused by sudden and accidental occurrences are included under the Partnership's insurance coverages. Capital expenditures of the Partnership for maintenance of existing operations during 1996 are expected to be approximately $7.5 million. Capital expenditures for expansionary purposes during 1996 are expected to be approximately $2.0 million.\nThe Partnership makes distributions of 100% of its Available Cash to Unitholders and the General Partner. Available Cash consists generally of all the cash receipts less all cash disbursements and reserves. A distribution of $2.20 per unit was paid to Senior Preference Unitholders in 1995, 1994 and 1993. During 1995, 1994 and 1993, the Partnership paid distributions of $12.4 million, ($2.20 per unit), $12.3 million ($2.20 per unit) and $19.3 million ($2.20 per unit and $1.20 per unit in arrearages) to the holders of Preference Units. During 1995 and 1994, the Partnership paid distributions of $4.6 million ($1.45 per unit) and $1.7 million ($0.55 per unit) to the holders of Common Units.\nThe Partnership expects to fund future cash distributions and maintenance capital expenditures with existing cash and cash flows from operating activities. Expansionary capital expenditures and some environmental expenditures are expected to be funded through additional Partnership borrowings.\nIn 1994, a subsidiary of the Partnership issued $33 million of first mortgage notes (\"Notes\") to a group of insurance companies. Proceeds from these notes were used to refinance existing debt of the Partnership that was incurred in connection with the ST acquisition in 1993 and the terminal acquisitions in 1994. The notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, the Partnership entered into the Credit Agreement with a group of banks that provides a $15 million revolving credit facility for working capital and other partnership purposes. Borrowings under the Credit Agreement bear interest at variable rates and are due and payable in November 1997. The Credit Agreement has a commitment fee of 0.2% per annum of the unused credit facility. No amounts were drawn under this credit facility at December 31, 1995. The notes and credit facility are secured by a mortgage on the East Pipeline.\nThe Partnership acquired the West Pipeline in February 1995 from Wyco Pipe Line Company, a company jointly owned by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million. The acquisition was financed by the issuance of $27 million of Notes due February 24, 2002, which bear interest at the rate of 8.37% per annum.\nThe acquisition of the Steuart terminaling assets has been initially financed by a $68 million bank bridge loan. The bridge loan bears interest at a variable rate based on the LIBOR rate plus 50 to 100 basis points and its' maturity has been extended until March 1997. The Partnership expects to refinance this loan under terms similar to the Notes discussed above. The loan is secured, pari passu with the existing Notes and credit facility, by a mortgage on the East Pipeline.\nIn the FERC's Lakehead decision issued June 15, 1995, the FERC partially disallowed Lakehead's inclusion of income taxes in its cost of service. Specifically, the FERC held that Lakehead was entitled to receive an income tax allowance with respect to income attributable to its corporate partners, but was not entitled to receive such an allowance for income attributable to the partnership interests held by individuals. Both Lakehead and representatives of its customers have filed motions for rehearing. It is possible that either Lakehead or its customers may ultimately seek judicial review of the FERC decision. It is difficult to predict what position would be adopted by a reviewing court on the income tax issue. In another FERC proceeding that has not yet reached the hearing stage, involving a different oil pipeline limited partnership, various shippers have challenged such pipeline's inclusion of an income tax allowance in its cost of service. The FERC Staff has also filed testimony that supports the disallowance of income taxes. If the FERC were to disallow the income tax allowance in the cost of service of the Pipelines on the basis set forth in the Lakehead order, the General Partner believes that the Partnership's ability to pay the Minimum Quarterly Distribution to the holders of the Senior Preference Units, Preference Units and Preference B Units would not be impaired; however, in view of the uncertainties involved in this issue, there can be no assurance in this regard.\nNEW ACCOUNTING PRONOUNCEMENT\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 (SFAS 121). SFAS 121 is effective for financial statements for fiscal years beginning after December 15, 1995 and requires the write-down to market of certain long-lived assets. The Partnership will adopt SFAS 121 in the first quarter of 1996 and such adoption will not have a material effect on the Partnership's financial position or results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data of the Partnership begin on page of this report. Such information is hereby incorporated by reference into this item 8.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership is a limited partnership and has no directors. The Partnership is managed by the Company as general partner. Set forth below is certain information concerning the directors and executive officers of the Company. All directors of the Company are elected annually by Kaneb, as its sole stockholder. All officers serve at the discretion of the Board of Directors of the Company.\n(1) Mr. Doherty, Chairman of the Board of the Company since September 1989, is also Senior Vice President of Kaneb. In addition to the Senior Preference Units and Preference Units set forth above, Mr. Doherty owns 75,000 Common Units representing an aggregate limited partnership interest of less than one percent. (2) Mr. Hutchens assumed his current position in January 1994, having been with KPL since January 1960. Mr. Hutchens had been Vice President since January 1981. Mr. Hutchens was Manager of Product Movement from July 1976 to January 1981. (3) Mr. Easum has served the Company as Vice President of Business Development since August 1988, prior to which he was Director of Purchasing with Union Pacific Railroad Company since August 1980.\n(4) Mr. Wadsworth serves as an officer of Kaneb. Mr. Wadsworth, currently Vice President, Treasurer and Secretary, joined Kaneb in October, 1990, prior to which he served as general manager of Dorchester Hugoton, Ltd. for more than five years. (5) Mr. Harrison assumed his present position in November, 1992, prior to which he served in a variety of financial positions including Assistant Secretary and Treasurer with ARCO Pipe Line Company for approximately 19 years. (6) Mr. Barnes, a director of the Company, is also Chairman of the Board, President and Chief Executive Officer of Kaneb. In addition to the Senior Preference Units and Preference Units set forth above, Mr. Barnes owns 79,000 Common Units representing an aggregate limited partner interest of approximately 1%. (7) Mr. Cox, a director of the Company since September 1995, is also a director of Kaneb. Mr. Cox has held senior executive level positions for more than the past five years of his twenty-six year career with Fluor Daniel, Inc. (8) Mr. Ahn, a director of the Company since July 1989, is also a director of Kaneb. Mr. Ahn has been a partner of Morgan Lewis Githens & Ahn, L.P., an investment banking firm, since 1982 and currently serves as a director of Haynes International, Inc., ITI Technologies, Inc., PAR Technology Corporation, Quaker Fabric Corporation, and Stuart Entertainment, Inc. (9) Mr. Peak, a director of the Company since July 1989, is also a director of Kaneb. Mr. Peak has been General Partner of Dorchester Hugoton, Ltd., an oil and gas exploration and production partnership, for more than the past five years. (10) Mr. Whatley, a director of the Company since July 1989, is also a director of Kaneb. In addition to serving as Chairman of the Board of Directors of Kaneb from February 1981 until April 1989, Mr. Whatley was elected and served in the additional offices of President and Chief Executive Officer of Kaneb from June until October 1986. (11) Mr. Ralph Rehm, who is also a director of Kaneb, is President of Northlake Consulting Company, which provides financial consulting services. Mr. Rehm provided consulting services on behalf of one of Kaneb's subsidiaries in 1993 and 1994. Mr. Rehm previously was engaged in financial consulting services for Northlake Consultants from June 1989 to May 1990, prior to which he served as Senior Vice President of Finance and Administration of Kaneb from December 1986. (12) Mr. Biles joined the Company in November 1953 and served as President from January 1985 until his retirement at the close of 1993. (13) Units of the Partnership listed are those which are owned by the person indicated, his spouse or children living at home. None of the directors of the Company owns more than two percent of the outstanding Senior Preference Units or Preference Units, respectively, of the Partnership. Each director had sole power with respect to all or substantially all of the Units attributed to him.\nAUDIT COMMITTEE\nMessrs. Sangwoo Ahn, Ralph A. Rehm and Preston A. Peak currently serve as the members of the Audit Committee of the Company. Such Committee will, on an annual basis, or more frequently as such Committee may determine to be appropriate, review policies and practices of the Company and the Partnership and deal with various matters as to which conflicts of interest may arise.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's Board of Directors does not have a compensation committee or any other committee that performs the equivalent functions. During the fiscal year ended December 31, 1995, none of the Company's officers or employees participated in the deliberations of the Company's Board of Directors concerning executive officer compensation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no executive officers, but is obligated to reimburse the Company for compensation paid to the Company's executive officers in connection with their operation of the Partnership's business.\nThe following table sets forth information with respect to the aggregate compensation paid or accrued by the Company during the fiscal years 1995, 1994 and 1993, to the President and each of the most highly compensated executive officers and other key policy making personnel of the Company whose aggregate cash compensation exceeded $100,000.\n- ----------------------------\n(1) Does not include the values of the personal use of Company paid club memberships, nor the personal use of assets, facilities and services of Company employees. The aggregate amount of additional benefits or compensation to any of the individuals listed in the Summary Compensation Table above did not exceed 10% of the reported compensation.\n(2) Represents the Company's annual contributions in 1995 to Kaneb's defined thrift plan and the imputed value of Company-paid group term life insurance.\n(3) Represents a lump sum payment in lieu of cost-of-living salary increases in 1992 and 1993.\n(4) The Compensation for this individual is paid by Kaneb and Kaneb is reimbursed for all or substantially all of such compensation by the Company.\nRetirement Plan\nEffective April 1, 1991, Kaneb established a defined contribution thrift plan applicable to the Company that permits all full-time employees who have completed one year of service to contribute 2% to 12% of base compensation, on a pre-tax basis, into participant accounts. In addition to mandatory contribution equal to 2% of base compensation per year for each plan participant, the Company makes matching contributions from 25% to 50% of up to the first 6% of base pay contributed by a plan participant. Employee contributions, together with earnings thereon, are not subject to forfeiture. That portion of a participant's account balance attributable to Company contributions, together with earnings thereon, is vested over a five year period at 20% per year. Participants are credited with their prior years of service for vesting purposes, however, no amounts are accrued for the accounts of participants, including the Company's executive officers, for years of service previous to the plan commencement date. Participants may direct the investment of their contributions into a variety of investments, including Kaneb common stock. Plan assets are held and distributed pursuant to a trust arrangement. Because levels of future compensation, participant contributions and investment yields cannot be reliably predicted over the span of time contemplated by a plan of this nature, it is impractical to estimate the annual benefits payable at retirement to the individuals listed in the Summary Cash Compensation Table above.\nDirector's Fees. During 1995, each member of the Company's Board of Directors who was not also an employee of the Company or Kaneb was paid an annual retainer of $4,000 in lieu of all attendance fees.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAt March 15, 1996, the Company owned a combined 2% General Partner interest in the Partnership and the Operating Partnership, and owned Preference Units, Preference B Units and Common Units representing an aggregate limited partner interest of approximately 31%.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company is entitled to certain reimbursements under the Partnership Agreement. For additional information regarding the nature and amount of such reimbursements, see Notes 4 and 5 to the Partnership's financial statements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) FINANCIAL STATEMENTS\n(a) (2) FINANCIAL STATEMENT SCHEDULES\nAll schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(a) (3) LIST OF EXHIBITS\n3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1, S.E.C. File No. 33-30330 and incorporated herein by reference.\n10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 16, 1993, and said exhibit is hereby incorporated by reference.\n10.2 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.3 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lenders. Said document is on file as Exhibit 10.3 of the exhibits to Registrant's report on Form 10-K filed for the year ended December 31, 1994, and said exhibit is hereby incorporated by reference.\n10.4 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.5 Asset Purchase Agreement by and among Steuart Petroleum Company, SPC Terminals, Inc., Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. dated August 27, 1995; Piney Point Pipeline Asset Purchase Agreement by and among Piney Point Industries, Inc., Support\nTeminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. dated August 27, 1995; Purchase Agreement by and among Steuart Investment Company, Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. for Cockpit Point dated August 27, 1995; Amendment to Asset Purchase Agreements by and among Steuart Petroleum Company, SPC Terminals, Inc. Piney Point Industries, Inc., Steuart Investment Company, Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. Said documents are on file as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on January 3, 1996, and said exhibits are hereby incorporated by reference.\n10.6 Bridge Financing Agreement between Kaneb Pipe Line Operating Partnership, L.P., as Borrower, Texas Commerce Bank National Association, as Agent and Texas Commerce Bank National Association, as initial Lender, as amended, dated December 18, 1995, filed herewith.\n21 List of Subsidiaries, filed herewith.\n24 Powers of Attorney, filed herewith.\n27 Financial Data Schedule\n(b) REPORTS ON FORM 8-K - NONE.\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME DECEMBER 31, 1995 AND 1994\nSee notes to consolidated financial statements.\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee notes to consolidated financial statements.\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF PARTNERS CAPITAL YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(a) Kaneb Pipe Line Company owns a combined 2% interest in Kaneb Pipe Line Partners, L.P. as General Partner. (b) The Partnership Agreement allows for an additional issuance of up to 7.8 million senior preference units.\nSee notes to consolidated financial statements.\n1. PARTNERSHIP ORGANIZATION\nKaneb Pipe Line Partners, L.P. (the \"Partnership\"), a master limited partnership, owns and operates a refined petroleum products pipeline business and a petroleum products and specialty liquids storage and terminaling business. The Partnership operates through Kaneb Pipe Line Operating Partnership, L.P. (\"KPOP\"), a limited partnership in which the Partnership holds a 99% interest as limited partner. Kaneb Pipe Line Company (the \"Company\"), a wholly-owned subsidiary of Kaneb Services, Inc. (\"Kaneb\"), as general partner holds a 1% general partner interest in both the Partnership and KPOP. The Company's 1% interest in KPOP is reflected as the minority interest in the financial statements.\nIn April 1993, the Partnership completed a public offering of 2.25 million Senior Performance Units (\"SPU\") at $25.25 per unit. The net proceeds from the offering of $52.8 million was allocated among the equity accounts of the unitholders, general partner and minority interest based on the ownership percentages of the partnership subsequent to the offering. The Partnership believes this allocation approximates the distribution of the net assets upon liquidation, assuming the Partnership was liquidated at net book value. However, the actual distribution of the net assets upon liquidation could be significantly different as a result of the fair market value of the net assets being substantially different than the net book value of the Partnership's assets in the accompanying financial statements.\nIn September 1995, a subsidiary of the Company sold 3.5 million of the Preference Units (\"PU\") it held in a public offering and exchanged 1.0 million of its PU's for 1.0 million Preference B Units, which are subordinate to the PU's. At December 31, 1995, the Company owns an approximate 31% interest as a limited partner in the form of Preference Units, Preference B Units and Common Units, and as a general partner owns a combined 2% interest. The SPU's represent an approximate 44% interest in the Partnership and the 3.5 million publicly held Preference Units represent an approximate 22% interest. An approximate 1% ownership interest in the form of 60,500 PU's and 154,000 Common Units is held by officers of Kaneb.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following significant accounting policies are followed by the Partnership in the preparation of the consolidated financial statements. The preparation of the Partnership's 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 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.\nCASH AND CASH EQUIVALENTS\nThe Partnership's policy is to invest cash in highly liquid investments with maturities of three months or less, upon purchase. Accordingly, uninvested cash balances are kept at minimum levels. Such investments are valued at cost, which approximates market, and are classified as cash equivalents.\nPROPERTY AND EQUIPMENT\nProperty and equipment are carried at historical cost. Certain leases have been capitalized and the leased assets have been included in property and equipment. Additions of new equipment and major renewals and replacements of existing equipment are capitalized. Repairs and minor replacements that do not materially increase values or extend useful lives are expensed. Depreciation of property and equipment is provided on a straight-line basis at rates based upon expected useful lives of various classes of assets. The rates used for pipeline and storage facilities of KPOP are the same as those which have been promulgated by the Federal Energy Regulatory Commission.\nREVENUE AND INCOME RECOGNITION\nKPOP provides pipeline transportation of refined petroleum products and liquified petroleum gases. Revenue is recognized upon receipt of the products into the pipeline system.\nST provides terminaling and other ancillary services. Fees are billed one month in advance and are reported as deferred income. Revenue is recognized in the month services are provided.\nENVIRONMENTAL MATTERS\nThe operations of the Partnership are subject to federal, state and local laws and regulations relating to protection of the environment. Although the Partnership believes its operations are in general compliance with applicable environmental regulations, risks of additional costs and liabilities are inherent in pipeline and terminal operations, and there can be no assurance significant costs and liabilities will not be incurred by the Partnership. Moreover, it is possible that other developments, such as increasingly stringent environmental laws, regulations and enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of the Partnership, could result in substantial costs and liabilities to the Partnership.\nEnvironmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Partnership's commitment to a formal plan of action. The Partnership has recorded a reserve for environmental claims in the amount of $5.2 million (including $4.4 million relating to the acquisitions of the West Pipeline and Steuart - see Note 3) at December 31, 1995 in other liabilities on the accompanying balance sheet.\nThe Company has indemnified the Partnership against liabilities for damage to the environment resulting from operations of the pipeline prior to October 3, 1989 (date of formation of the Partnership). The indemnification does not extend to any liabilities that arise after such date to the extent that the liabilities result from changes in environmental laws and regulations. In addition, ST's former owner has agreed to indemnify the Partnership against liabilities for damages to the environment from operations conducted by the former owner prior to March 2, 1993. The indemnity, which expires March 1, 1998, is limited in amount to 60% of any claim exceeding $0.1 million, up to a maximum of $10 million.\nINCOME TAX CONSIDERATIONS\nIncome before income tax expense is made up of the following components:\nPartnership operations are not subject to federal or state income taxes. However, certain operations of ST are conducted through wholly-owned corporate subsidiaries which are taxable entities. The provision for income taxes for the periods ended December 31, 1995, 1994 and 1993 consists of deferred U.S. federal income taxes of $.6 million, $.6 million and $.4 million, respectively, and current federal income taxes of $.2 million in 1994. The net deferred tax liability of $1.7 million and $1.1 million at December 31, 1995 and 1994, respectively, consists of deferred tax liabilities of $6.3 million and $4.3 million, respectively, and deferred tax assets of $4.6 million and $3.2 million, respectively. The deferred tax liabilites consists primarily of tax depreciation in excess of book depreciation and the deferred tax assets consists primarily of net operating losses. The corporate operations have net operating losses for tax purposes totaling approximately $12.9 million which expire in years 2008 and 2010.\nSince the income or loss of the operations which are conducted through limited partnerships will be included in the tax return of the individual partners of the Partnership, no provision for income taxes has been recorded in the accompanying financial statements on these earnings. The tax returns of the Partnership are subject to examination by federal and state taxing authorities. If such examination results in adjustments to distributive shares of taxable income or loss, the tax liability of the partners would be adjusted accordingly.\nThe tax attributes of the Partnership's net assets flow directly to each individual partner. Individual partners will have different investment bases depending upon the timing and prices of acquisition of partnership units. Further, each partner's tax accounting, which is partially dependent upon their individual tax position, may differ from the accounting followed in the financial statements. Accordingly, there could be significant differences between each individual partner's tax basis and their proportionate share of the net assets reported in the financial statements. Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" requires disclosure by a publicly held partnership of the aggregate difference in the basis of its net assets for financial and tax reporting purposes. Management does not believe that, in the Partnership's circumstances, the aggregate difference would be meaningful information.\nALLOCATION OF NET INCOME AND EARNINGS\nNet income is allocated to the limited partnership units in an amount equal to the cash distributions declared for each reporting period and any remaining income or loss is allocated to the class of units that did not receive full distributions (if any). If full distributions are declared to all classes of units, income will be allocated pro rata based on the aggregate amount of distributions declared.\nEarnings per SPU and PU are calculated by dividing the amount of net income allocated to the SPU's and PU's by the weighted average number of SPUs and PUs outstanding, respectively.\nCASH DISTRIBUTIONS\nThe Partnership makes quarterly distributions of 100% of its Available Cash, as defined in the Partnership Agreement, to holders of limited partnership units (\"Unitholders\") and the Company. Available Cash consists generally of all the cash receipts of the Partnership plus the beginning cash balance less all of its cash disbursements and reserves. The Partnership expects to make distributions of Available Cash for each quarter of not less than $.55 per Unit (the \"Minimum Quarterly Distribution\"), or $2.20 per Unit on an annualized basis, for the foreseeable future, although no assurance is given regarding such distributions. The Partnership expects to make distributions of all Available Cash within 45 days after the end of each quarter to holders of record on the applicable record date. A distribution of $2.20 per unit was paid to Senior Preference Unitholders in 1995, 1994 and 1993. During 1995, 1994 and 1993, the Partnership paid distributions of $2.20, $2.20, and $3.41 (includes $1.21 of arrearage payments), respectively, to the Preference Unitholders. During 1995 and 1994, the Partnership paid distributions of $1.45 and $.55, respectively, per unit to the Common Unitholders. As of December 31, 1995, no arrearages existed on any class of partnership interest.\nDistributions by the Partnership of its Available Cash are made 99% to Unitholders and 1% to the Company, subject to the payment of incentive distributions to the General Partner if certain target levels of cash distributions to the Unitholders are achieved. The distribution of Available Cash for each quarter within the Preference Period, as defined, is subject to the preferential rights of the holders of the Senior Preference Units to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters, before any distribution of Available Cash is made to holders of Preference Units, Preference B Units or Common Units for such quarter. In addition, for each quarter within the Preference Period, the distribution of any amounts to holders of Common Units is subject to the preferential rights of the holders of the Preference B Units to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters. The Common Units are not entitled to arrearages in the payment of the Minimum Quarterly Distribution. In general, the Preference Period will continue indefinitely until the Minimum Distribution has been paid to the holders of the Senior Preference Units, the Preference Units, the Preference B Units and the Common Units for twelve consecutive quarters. The Minimum Quarterly distribution has been paid to all classes of Unitholders for the quarters ended September 30 and December 31, 1995. Prior to the end of the Preference Period, up to 2,650,000 of the Preference Units and the Preference B Units may be converted into Senior Preference Units on a one-for-one basis if the Third Target Distribution, as defined, is paid to all Unitholders for four full consecutive quarters. The Third Target distribution is reached when distributions of Available Cash equals $2.80 per Limited Partner (\"LP\") Unit on an annualized basis. After the Preference Period ends all differences and distinctions between the three classes of units for the purposes of cash distributions will cease.\nCHANGE IN PRESENTATION\nCertain financial statement items for 1994 and 1993 have been reclassified to conform with the 1995 presentation.\n3. ACQUISITIONS\nEffective March 1, 1993, the Partnership acquired Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company headquartered in Dallas, Texas, for approximately $65 million, including transaction costs. The acquisition was accounted for as a purchase and, accordingly, the Partnership's consolidated statements of income include the results of operations of ST since March 1, 1993. In connection with the acquisition, the Partnership borrowed $65 million from a group of banks, which was partially repaid with $50.8 million of the proceeds from a SPU offering. The remaining bank debt was refinanced in December 1994 with the issuance of first mortgage notes.\nIn February 1995, the Partnership acquired, through KPOP, the refined petroleum product pipeline assets (the \"West Pipeline\") of Wyco Pipe Line Company for $27.1 million plus transaction costs and the assumption of certain environmental liabilities. The West Pipeline was owned 60% by a subsidiary of GATX Terminals Corporation and 40% by a subsidiary of Amoco Pipe Line Company. The acquisition was financed by the issuance of $27 million of first mortgage notes. The assets acquired from Wyco Pipe Line Company did not include certain assets that were leased to Amoco Pipe Line Company and the purchase agreement did not provide for either (i) the continuation of an arrangement with Amoco Pipe Line Company for the monitoring and control of pipeline flows or (ii) the extension or assumption of certain credit agreements that Wyco Pipe Line Company had with its shareholders.\nIn December 1995, the Partnership acquired the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, \"Steuart\") for $68 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition price was financed by a $68 million bank bridge loan. The asset purchase agreement includes a provision for an earn-out payment based upon revenues of one of the terminals exceeding a specified amount for a seven-year period beginning in January 1996. The contracts also include a provision for the continuation of all terminaling contracts in place at the time of the acquisition, including those contracts with Steuart.\nThe acquisitions have been accounted for using the purchase method of accounting. The total purchase price has been allocated to the assets and liabilities based on their respective fair values based on valuations and other studies. The allocation of the Steuart purchase price presented in the consolidated financial statements is preliminary and subject to adjustment.\nThe following summarized unaudited pro forma consolidated results of operations for the years ended December 31, 1995 and 1994, assume the acquisitions occurred as of the beginning of each period presented. The unaudited pro forma financial results have been prepared for comparative purposes only and may not be indicative of the results that would have occurred if the Partnership had acquired the pipeline assets of the West Pipeline and the liquids terminaling assets of Steuart on the dates indicated or which will be obtained in the future.\n4. PROPERTY AND EQUIPMENT\nThe cost of property and equipment is summarized as follows:\n5. LONG-TERM DEBT AND LEASES\nIn 1994, a wholly-owned subsidiary of the Partnership issued $33 million of first mortgage notes (\"Notes\") to a group of insurance companies. The Notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. Also in 1994, another wholly-owned subsidiary entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable interest rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1995 or 1994. In 1995, the Partnership financed the acquisition of the West Pipeline with the issuance of $27 million of Notes due February 24, 2002 which bear interest at the rate of 8.37% per annum. The Notes and the credit facility are secured by a mortgage on substantially all of the pipeline assets of the Partnership and contain certain financial and operational covenants. The acquisition of the Steuart terminaling assets has been initially financed by a $68 million bridge loan from a bank. The bridge loan bears interest at a variable rate based on the LIBOR rate plus 50 to 100 basis points and its maturity has been extended until March 1997. The Partnership expects to refinance this obligation under terms similar to the Notes discussed above. The bridge loan is secured, pari passu with the existing Notes and credit facility, by a mortgage on the East Pipeline.\nThe following is a schedule by years of future minimum lease payments under capital and operating leases together with the present value of net minimum lease payments for capital leases as of December 31, 1995:\n(a) The capital lease is secured by certain pipeline equipment and the Partnership has accrued its option to purchase this equipment for approximately $4.1 million at the termination of the lease.\nTotal rent expense under operating leases amounted to $.9 million for each of the years ended December 31, 1995, 1994 and 1993.\nKPOP and the Company entered into a payment priority agreement related to the capital lease obligation for pipeline equipment under which the Company is primarily liable for rental payments of approximately $2.9 million per year through April 1997 and KPOP is primarily liable for the remaining rental payments. KPOP has recorded a receivable of $3.5 million at December 31, 1995 from the Company for the present value of these future lease payments. This receivable bears interest at an annual rate of 13.8%, which reflects the imputed interest rate on the capital lease. KPOP recorded interest income of $.7 million, $.9 million and $1.2 million from the Company on this receivable balance for the periods ended December 31, 1995, 1994 and 1993, respectively. The amount of the capital lease obligation that exceeds the receivable from the Company ($6.7 million at December 31, 1995) represents the present value of the lease obligation and purchase option due subsequent to April 1997.\nThe Partnership believes the carrying value of the Notes and the bank bridge loan represent their estimated fair value and it is not practicable to estimate the fair value of the capital lease obligation and the associated receivable from the general partner.\n6. RELATED PARTY TRANSACTIONS\nThe Partnership has no employees and is managed and controlled by the Company. The Company and Kaneb are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These costs, which totaled $9.5 million, $9.0 million and $8.7 million for the years ended December 31, 1995, 1994 and 1993, respectively, include compensation and benefits paid to officers and employees of the Company and Kaneb, insurance premiums, general and administrative costs, tax information and reporting costs, legal and audit fees. Included in this amount is $7.7 million, $7.0 million and $7.0 million of compensation and benefits, including pension costs, paid to officers and employees of the Company for the periods ended December 31, 1995, 1994 and 1993, respectively, which represent the actual amounts paid by the Company or Kaneb. In addition, the Partnership paid $.2 million during each of these respective periods for an allocable portion of the Company's overhead expenses. At December 31, 1995 and 1994, the Partnership owed the Company $1.0 million and $.8 million, respectively, for these expenses which are due under normal invoice terms.\n7. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly operating results for 1995 and 1994 are summarized as follows:\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Kaneb Pipe Line Partners, L.P.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 34 present fairly, in all material respects, the financial position of Kaneb Pipe Line Partners, L.P. and its subsidiaries (the \"Partnership\") 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 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\nDallas, Texas February 27, 1996\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Kaneb Pipe Line Partners, L.P. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKANEB PIPE LINE PARTNERS, L.P. By: Kaneb Pipe Line Company ----------------------- General Partner\nBy: EDWARD D. DOHERTY ------------------------- (Edward D. Doherty) Chairman of the Board and Chief Executive Officer Date: 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 Kaneb Pipe Line Partners, L.P. and in the capacities with Kaneb Pipe Line Company and on the date indicated.\nSIGNATURE TITLE DATE --------- ----- ----\nPrincipal Executive Officer EDWARD D. DOHERTY - ---------------------------- (Edward D. Doherty) Chairman of the Board and March 28, 1996 Chief Executive Officer\nPrincipal Accounting Officer JIMMY L. HARRISON - ---------------------------- (Jimmy L. Harrison) Controller March 28, 1996\nDirectors SANGWOO AHN - ---------------------------- (Sangwoo Ahn) Director March 28, 1996\nJOHN R. BARNES - ---------------------------- (John R. Barnes) Director March 28, 1996\nM.R. BILES - ---------------------------- (M.R. Biles) Director March 28, 1996\nCHARLES R. COX - ---------------------------- (Charles R. Cox) Director March 28, 1996\nEDWARD D. DOHERTY - ---------------------------- (Edward D. Doherty) Director March 28, 1996\nPRESTON A. PEAK - ---------------------------- (Preston A. Peak) Director March 28, 1996\nRALPH A. REHM - ---------------------------- (Ralph A. Rehm) Director March 28, 1996\nJAMES R. WHATLEY - ---------------------------- (James R. Whatley) Director March 28, 1996\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION ------- -----------\n3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1, S.E.C. File No. 33-30330 and incorporated herein by reference.\n10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 16, 1993, and said exhibit is hereby incorporated by reference.\n10.2 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.3 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lenders. Said document is on file as Exhibit 10.3 of the exhibits to Registrant's report on Form 10-K filed for the year ended December 31, 1994, and said exhibit is hereby incorporated by reference.\n10.4 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.5 Asset Purchase Agreement by and among Steuart Petroleum Company, SPC Terminals, Inc., Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. dated August 27, 1995; Piney Point Pipeline Asset Purchase Agreement by and among Piney Point Industries, Inc., Support Teminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. dated August 27, 1995; Purchase Agreement by and among Steuart Investment Company, Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. for Cockpit Point dated August 27, 1995; Amendment to Asset Purchase Agreements by and among Steuart Petroleum Company, SPC Terminals, Inc. Piney Point Industries, Inc., Steuart Investment Company, Support Terminals Operating Partnership, L.P. and Kaneb Pipe Line Operating Partnership, L.P. Said documents are on file as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on January 3, 1996, and said exhibits are hereby incorporated by reference.\n10.6 Bridge Financing Agreement between Kaneb Pipe Line Operating Partnership, L.P., as Borrower, Texas Commerce Bank National Association, as Agent and Texas Commerce Bank National Association, as initial Lender, as amended, dated December 18, 1995, filed herewith.\n21 List of Subsidiaries, filed herewith.\n24 Powers of Attorney, filed herewith.\n27 Financial Data Schedule","section_15":""}
{"filename":"276747_1995.txt","cik":"276747","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nRobinson Nugent, Inc. (the \"Company\"), an Indiana corporation organized in 1955, designs, manufactures and markets electronic devices used to interconnect components of electronic systems. The Company's principal products are integrated circuit sockets; connectors used in board-to-board, wire-to-board, and wire-to-wire applications; and custom molded-on cable assemblies. The Company also offers application tooling that is used in applying wire and cable to its connectors.\nThe Company's products are used in electronic telecommunication equipment including switching and networking equipment such as servers and routers, modems and PBX stations; data processing equipment such as mainframe computers, personal computers, workstations, CAD systems and peripheral equipment such as printers, disk drives, plotters and point-of-sale terminals; industrial controls and electronic instruments, both medical and industrial; consumer products; automotive electronics; and in a variety of other applications.\nMajor markets are the United States, Europe, Japan, and the southeast Asian countries including Singapore and Malaysia. Manufacturing facilities are located in New Albany, Indiana; Dallas, Texas; Kings Mountain, North Carolina; Fremont, California; Delemont, Switzerland; Sungai Petani, Malaysia; Inchinnan, Scotland; and, as of February, 1995, Hamont-Achel, Belgium.\nCorporate headquarters are located in New Albany, Indiana, which is the plant site for the Company's engineering, research and development, preproduction and testing of new products.\nRECENT DEVELOPMENTS\nIn February 1995, the company acquired Teckino Manufacturing B.V.B.A. (\"Teckino\"), a manufacturing and engineering development company located in Hamont-Achel, Belgium. The company produces connectors and other specialized electronic molded parts. The acquisition has been accounted for by the purchase method of accounting and the results of operations of Teckino have been included in the company's consolidated financial statements since the date of acquisition.\nThe Company formed ISOCON L.C., a joint venture with Components Circuits Inc. of Tempe, Arizona in May, 1995. The new company, ISOCON L.C., was established to merge the technical and marketing resources of the two companies for the development and sale of special electronic connector products. These products address the opportunities created by emerging semiconductor packaging types known as area arrays and incorporate potential technology owned by ISOCON, L.C.\nPRODUCTS\nThe Company produces a broad range of sockets that accommodate a variety of integrated circuit package styles. Sockets are offered for dual-in-line and pin grid array devices, as well as leaded and leadless chip carriers. Dual readout (DIMM) sockets were introduced in fiscal 1992. These sockets, which are designed to interconnect in-line memory modules, are among the fastest growing electronic interconnect products in world markets. The design concepts used in the Company's DIMM sockets are unique and involve features that have been protected by U.S. patents.\nSockets are used in a wide variety of applications within electronic equipment but are primarily used to interface integrated circuits, such as microprocessors and memory devices to an electronic printed circuit board. The demand for sockets is directly related to the demand for products which employ integrated circuits. In many applications, semiconductor devices are subject to replacement, which encourages the use of a socket rather than soldering the device directly to the printed circuit board.\nThe worldwide demand for dual in-line sockets is decreasing due to the maturity of the semiconductor package, while the demand for high-density and surface-mount sockets is increasing. The growing demand is due to the development of semiconductor package styles with very large counts of signal ports and new technologies such as ball grid and land grid array packages and interstitial pin patterns. The Company's newest socket products are designed to meet high-density and surface-mount requirements and contributed to the Company's sales growth in 1995.\nThe Company provides a broad range of electronic connectors, such as insulation displacement flat cable connectors (IDC), used in wire-to-wire and wire-to-board applications. The range of connectors also includes several product styles that provide for board-to-board or board-stacking (parallel- mounting) applications. The use of insulation displacement connectors in electronic hardware increases productivity by eliminating labor involved in stripping insulation from wires prior to attachment to the leads, and permits automation of the manufacture of cable assemblies.\nThe Company manufacturers a line of PCMCIA memory card sockets and headers for interconnect faxing, networking and computer expansion capabilities. In 1995, the Company broadened this line to include type III card connectors and other options which enhanced the interchangability of this product line within this industry.\nThe Company offers several product families in the two-piece style of connectors. These connectors are used to connect printed circuit boards which are positioned either at right angles, in-line, or parallel stacked at close intervals. The products offered include .025 inch square post connectors and receptacle sockets; DIN series connectors; high-density, high-pin-count connectors (HDC); half-pitch, high-density (PAK-50) connectors; 2-millimeter- spaced, high-density connectors (PAK-2); and a new higher pin count 2- millimeter-spaced connector (METPAK-Registered Trademark-2) used in backplane applications. In 1995, a new line of high density 1.0mm, .8mm and .5mm board stacking interconnects were introduced by the Company to address the growing demand for\nminiaturized connectors in the portable computer and communication equipment markets.\nThe DIN series of connectors has many variations in connecting means and pin count. The product is based on a European standard, but has gained wide acceptance in the U.S. and all world markets. While there are a large number of producers of DIN connectors in Europe, the Company is one of a limited number of manufacturers producing the product in the U.S.\nThe high-pin-count, high-density connector (HDC) includes pin counts ranging from 60 to 492 in a three- and four-row configuration. This connector family, along with DIN connectors, is widely used on backplane applications and frequently requires the terminals to be press-fit to the backplane. This is accomplished by forming a compliant section in the tails of the connector contacts that, when pressed into a plated through-hole on a backplane, forms a reliable gas-tight connection without soldering. The Company has become recognized as a leader in press-fit backplane connectors and has focused marketing efforts in promoting its products for this type of application.\nThe Company's half-pitch (PAK-50) connector family has been accepted as one of the industry's most reliable .050 inch spaced connectors. The contact design and compact shape has gained wide acceptance in applications, such as small form factor computers that require connectors that are highly reliable yet consume little space.\nThe design of a low profile, surface-mounted socket, called PAK-2 serves the requirements of miniature disk drives and PDA (personal digital assistance) sectors of this industry.\nThe METPAK-Registered Trademark-2 series of connectors includes four and five row versions of both standard and inverse configurations. The METPAK- Registered Trademark-2 is a new industry standard connector style used in board- to-board applications and over time will displace some of the more mature product types. This product line has wide acceptance in new designs, primarily in the computer workstation, communication and networking markets.\nTechnology continues to move the industry to an ever-increasing number of circuits per socket or connector to meet the increasing complexity of electronics systems or the increased capacity and processing speed of semiconductor devices. This results in increased demand for high-density connector products. Just as in sockets, the Company is focusing its new product development in connector products that meet these technology trends. High- density connector products were a major factor for the Company's growth in sales in 1994 and 1995.\nCustomers expect connector manufacturers to provide special tools required to utilize sockets and connectors. The Company offers a line of insertion and extraction tools in support of the socket, IDC, I\/O, and two-piece connector lines.\nCablelink, Incorporated, a wholly-owned subsidiary of the Company, produces cable assemblies of various types including IDC, fabricated and molded-on cable assemblies. Cablelink utilizes Robinson Nugent connectors whenever possible, but also provides cable assemblies with other\nmanufacturers' connectors if the customer is specific regarding its requirements.\nIn addition to standard products, the Company provides engineering assistance and design and manufacturing of custom and derivative products. These products may require special production tooling that, in some cases, is paid for by the customer, shared, or amortized over future orders, depending upon contractual agreements reached with the customer. In some cases, the customer supplies the Company with a complete product design, but more often the design is produced solely by Company engineers. Current trends in the market indicate a growing demand for custom and derivative products. There is also an increased demand for the Company's engineers to be involved in the early development of the customer's product design.\nRESEARCH, DEVELOPMENT AND ENGINEERING\nThe Company's engineering efforts are directed toward the development of new products to meet customer needs and improvement of manufacturing processes and adaptation of new materials to all products. New products include new creations as well as design of derivative products to meet both the needs of the general market and customer proprietary custom designs. Engineering development covers new or improved manufacturing processes, assembly and inspection equipment, and the adaptation of new plastics and metals to all products. In recent years, the Company's products have become more sophisticated and complex in response to developments in semiconductors and their application. In 1994, the Company added the engineering capability to analyze customer high-speed applications and to design connectors that reduce electrical interference that can result from very high processing speeds of newer and more powerful microprocessors. In 1995, the Company's European operation's development capabilities were expanded with the acquisition of Teckino. Teckino's developmental skills in precision miniature connecting systems and electronic molded parts will enhance Europe's ability to produce unique designs to fulfill customer requirements. The Company's expenditures for research, development and engineering were approximately $3.1 million in 1995, $2.5 million in 1994, and $2.0 million in 1993.\nThe Company's joint venture, ISOCON L.C. with Components Circuits, Inc. of Tempe, Arizona, enhances the Company's capabilities in the area array socket market. This technology is designed to connect printed circuit boards to a variety of integrated circuit packages such as land grid arrays, ball grid arrays and multichip modules without the use of solder.\nConsistent with industry direction, the Company is also active in improving manufacturing processes through automation and application of the latest technologies and designs to its proprietary assembly equipment. The Company continues to apply advanced technologies, such as laser and video devices, to automatically inspect products during the assembly process. All new assembly machines are direct microcomputer-controlled, which provides greater flexibility in the manufacturing process. The Company continues to install the latest technology in its electroplating process and replace older injection molding machines with the latest programmable controls.\nSALES AND DISTRIBUTION\nThe Company sells its products in the United States and international markets. The major market is the U.S. which produces approximately two-thirds of the consolidated sales of the Company. Its principal markets outside the U.S. are Canada, Europe, including the United Kingdom, Japan, Singapore, Malaysia, Hong Kong, and the emerging market of China. The southeast Asian countries continue to grow rapidly, and the Company has established a marketing and sales headquarters in Singapore. Sales to other Far East countries provide business opportunities and are expected to grow moderately. Sales in China have been initiated and have resulted in the Company doing business in China through its Hong Kong distributor.\nSales outside the U.S. accounted for 40 percent of total sales in fiscal 1995, 34 percent in fiscal 1994 and 33 percent in fiscal 1993. The Company believes that development of global markets is essential. This is particularly the case in Asia where the market is the fastest growing in the world and is currently considered the second largest market for electronics and connector products. The Company does not believe that its international business presents any unusual risks other than with respect to changes in currency exchange rates. The following table sets forth the percentage of Company sales by major geographical location for the periods shown:\nYEARS ENDED JUNE 30 --------------------------------------- 1995 1994 1993 ---- ---- ---- United States 60% 66% 67% Europe 25 19 22 Asia 13 14 10 Other 2 1 1 ---- ---- ---- 100% 100% 100% ---- ---- ---- ---- ---- ----\nDuring 1995, the Company had sales to a single customer in excess of 10% of total net sales. No sales to a single customer exceeded 10% of total net sales in 1994 or 1993.\nOther financial data relating to domestic and foreign operations are included in Note (16), Business Segment and Foreign Sales, of Notes to Consolidated Financial Statements and the Management's Discussion and Analysis of the Results of Operations and Financial Condition, included herein or incorporated by reference as a part of this Report.\nPrincipal markets in North America, Europe, and Asia are served by the Company's direct sales force and a network of distributors serving the electronic industry. The Company has U.S. regional offices located in the; San Francisco, California; and Chicago, Illinois metropolitan areas. Other Company sales offices are located in Japan, Singapore, England, Germany, Sweden, Netherlands, France, and Italy. These offices service customers to whom the Company sells directly, provide coordination between the plants and customers, and provide technical training and assistance to distributors and manufacturers' representatives in their respective territories. Additional marketing expertise is provided by the product marketing specialists located in New Albany, Indiana; Kings Mountain, North Carolina; London, England; and Eindhoven, Netherlands, who provide assistance and technical information in\nsupport of all field requirements. The Company increased its marketing resources and personnel in 1995 consistent with increased engineering and the launching of new products developed during the year.\nThe Company engages independent manufacturers' representative firms in the United States, Canada and several Far East countries, who are granted exclusive territories and agree not to carry competing products. These firms are paid on a commission basis on sales made to original equipment manufacturers and to distributors. All representative relationships are subject to termination by either party on short notice.\nThe Company has an international network of distributors who are responsible for serving their respective customers from an inventory of the Company's products. Approximately 35 percent of the Company's worldwide sales are made through the distributor network. No distributor is required to accept only the franchise of the Company. All distributor agreements are subject to termination by either party on short notice.\nBACKLOG\nThe Company's backlog was approximately $15.3 million at June 30, 1995, $13.6 million at June 30, 1994, and $11.3 million at June 30, 1993. These amounts represent orders with firm shipment dates acceptable to the customers. The Company does not manufacture pursuant to long-term contracts, and purchase orders are generally cancelable subject to payment by the customer for charges incurred up to the date of cancellation. With just-in-time delivery objectives, customers have reduced order quantities, but are placing orders more frequently and expecting shorter lead times from point of order to point of shipment.\nCOMPETITION\nThere is active competition in all of the Company's standard product lines. The Company's competitors include both large corporations having significantly more resources than the Company and smaller, highly specialized firms. The Company competes on the basis of customer service, product performance, quality, and price. Management believes that the Company's capabilities in service, in new product design and efforts to reduce cost of products are significant factors in maintaining the Company's competitive position.\nMANUFACTURING\nThe Company's manufacturing operations include plastic molding, electroplating and assembly. The Company designs and builds the majority of its automated and semiautomated assembly machines for use in-house and utilizes subcontractors on a limited basis for product assembly where volume does not warrant the cost of automation.\nRAW MATERIALS AND SUPPLIES\nThe Company utilizes copper alloys, precious metals, and plastics in the manufacture of its products. Although some raw materials are available from\nonly a few suppliers, the Company believes it has adequate sources of supply for its raw material and component requirements.\nUse of gold is significant, but has declined in demand over the past several years. Plating processes using ROBEX-TM-, a palladium nickel alloy, and tin have accelerated in demand from customers of the Company. As a result of a gold consignment agreement with a bank, the Company is not exposed to a significant market risk of carrying gold inventories. The Company is not required to procure its gold under this arrangement, and may acquire gold from other sources. The Company is not obligated beyond one year with any supplier.\nHUMAN RESOURCES\nAs of June 30, 1995, the Company had approximately 650 full-time employees.\nPATENTS AND TRADEMARKS\nManagement believes that success in the electronic connector industry is dependent upon engineering and production skills and marketing ability; however, there is a trend in the industry toward more patent consideration and protection of proprietary designs and knowledge. The Company has pursued patent applications more frequently. The Company reviews each new product design for possible patent application. The Company has been granted several patents over the past three years and is presently awaiting acceptance on other pending applications. The Company has obtained registration of its trade and service marks in the United States and in major foreign markets.\nENVIRONMENT\nThe Company's manufacturing facilities are subject to several laws and regulations designed to protect the environment. In the opinion of management, the Company is complying with those laws and regulations in all material respects and compliance has not had and is not expected to have a material effect upon its operations or competitive position.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe current executive officers of the Company are:\nSERVED IN PRESENT NAME AGE POSITIONS HELD CAPACITY SINCE - - ------------------- --- ----------------- ------------------ Larry W. Burke 55 President & Chief 1990 Executive Officer\nAnthony J. Accurso 45 Vice President, 1994 Treasurer & Chief Financial Officer\nW. Michael Coutu 44 Vice President of 1992 Operations\nThomas E. Merten 40 Vice President of 1991 Marketing\nThe Bylaws of the Company provide that the officers are to be elected at each Annual Meeting of the Board of Directors. Under the Indiana Business Corporation Law, officers may be removed by the Board of Directors at any time, with or without cause.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns a 36,000-square-foot building used for its executive offices, engineering department, quality assurance and administrative operations, and an adjacent 83,000-square-foot manufacturing facility located on approximately four acres in New Albany, Indiana. Manufacturing operations at New Albany were terminated on June 30, 1988 as a result of the consolidation of U.S. manufacturing of connectors and sockets in the Company's Dallas, Texas facility. A portion of the manufacturing facility is utilized by the Company's engineering, research and preproduction development groups. Manufacturing operations were reinstituted in 1990 on a limited basis and have been expanded each year thereafter. In addition, the New Albany facility is instrumental in training plant personnel on new equipment prior to release to the manufacturing facilities in New Albany, Dallas, Europe and Malaysia.\nThe Company owns a 60,000-square-foot manufacturing facility located on approximately five acres in Dallas, Texas, and a 50,000-square-foot manufacturing facility located on approximately two acres in Delemont, Switzerland. The Company's Cablelink operations are in a leased facility of approximately 40,000 square feet in Kings Mountain, North Carolina and a leased facility of approximately 10,000 square feet located in Fremont, California. In June, 1991, a new manufacturing facility with approximately 21,000 square feet was acquired under a long-term lease arrangement in Sungai Petani, Malaysia for expansion of the Cablelink operation. In February, 1992, the Company occupied a manufacturing facility with approximately 10,000 square feet in Issogne, Italy under a three-year lease in connection with the acquisition of its new cable assembly operation. The Company closed this facility in October, 1993 and relocated manufacturing operations to other plant sites.\nIn July, 1993, the Company acquired a facility with approximately 25,000 square feet in Inchinnan, Scotland under a long-term lease and relocated connector assembly operations from Delemont, Switzerland. In February, 1995, the Company acquired a manufacturing and engineering facility with approximately 14,000 square feet in Hamont-Achel, Belgium as part of the Teckino acquisition.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOther than ordinary routine litigation incidental to the business, there are no pending legal proceedings to which the Company 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 of the Company during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information included under the caption \"Share Price Range and Dividend Information\" on page 17 of the Company's 1995 Annual Report to Shareholders (the \"1995 Report\") is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information contained in the columns \"1991-1995\" in the table under the caption \"Ten-Year Financial Summary\" on pages 12 and 13 of the 1995 Report is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS.\nThe information contained under the caption \"Management's Discussion and Analysis of the Results of Operations and Financial Condition\" on pages 14 through 16 of the 1995 Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information contained in the \"Consolidated Financial Statements of the Company and Notes thereto\" and the report of independent accountants on pages 18 through 31 in the 1995 Report is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe information contained under the caption \"Ratification of Selection of Certified Public Accountants\" in the Company's definitive 1995 Proxy Statement filed pursuant to Rule 14a-6 is incorporated herein by reference.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information included under the captions \"Nominees,\" \"Business Experience of Directors,\" \"Family Relationships,\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive 1995 Proxy Statement filed pursuant to Rule 14a-6 is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information included under the captions \"Compensation of Directors,\" \"Compensation Committee Interlocks and Insider Participation,\" \"Executive Compensation,\" \"Report of the Compensation and Stock Option Committees,\" and \"Stock Performance Graph\" in the Company's definitive 1995 Proxy Statement filed pursuant to Rule 14a-6 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information contained under the captions \"Beneficial Ownership of Common Shares\" and \"Nominees\" in the Company's definitive 1995 Proxy Statement filed pursuant to Rule 14a-6 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information contained under the caption \"Certain Transactions\" in the Company's definitive 1995 Proxy Statement filed pursuant to Rule 14a-6 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 A PART OF THIS REPORT.\n(1) FINANCIAL STATEMENTS\nReports of Independent Accountants\nConsolidated Balance Sheets as of June 30, 1995, 1994, and 1993\nConsolidated Statements of Income for the years ended June 30, 1995, 1994, and 1993\nConsolidated Statements of Shareholders' 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\n(2) FINANCIAL STATEMENT SCHEDULE\nSchedule for the years ended June 30, 1995, 1994, and 1993:\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.\n(3) EXHIBITS\nSee Index to Exhibits.\n(B) REPORTS ON FORM 8-K\nThe Company did not file a Form 8-K during the last quarter of its 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.\nROBINSON NUGENT, INC.\nDate: September 21, 1995 By: \/s\/ Larry W. Burke -------------------- --------------------------------------- Larry W. Burke, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: September 21, 1995 By: \/s\/ Samuel C. Robinson ------------------- --------------------------------------- Samuel C. Robinson, Director\nDate: September 21, 1995 By: \/s\/ Larry W. Burke ------------------- --------------------------------------- Larry W. Burke, Director, President and Chief Executive Officer (Principal Executive Officer)\nDate: September 21, 1995 By: \/s\/ Patrick C. Duffy ------------------- --------------------------------------- Patrick C. Duffy, Director\nDate: September 21, 1995 By: \/s\/ Richard L. Mattox ------------------- --------------------------------------- Richard L. Mattox, Director\nDate: September 21, 1995 By: \/s\/ Diane T. Maynard ------------------- --------------------------------------- Diane T. Maynard, Director\nDate: September 21, 1995 By: \/s\/ Lawrence Mazey ------------------- --------------------------------------- Lawrence Mazey, Director\nDate: September 21, 1995 By: \/s\/ Jerrol Z. Miles ------------------- --------------------------------------- Jerrol Z. Miles, Director\nDate: September 21, 1995 By: \/s\/ James W. Robinson ------------------- --------------------------------------- James W. Robinson, Director\nDate: September 21, 1995 By: \/s\/ Richard W. Strain ------------------- --------------------------------------- Richard W. Strain, Director\nDate: September 21, 1995 By: \/s\/ Anthony J. Accurso ------------------- --------------------------------------- Anthony J. Accurso, Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)\nROBINSON NUGENT, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nJUNE 30, 1995, 1994, AND 1993\nFinancial Statement Schedule for the years ended June 30, 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.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Robinson Nugent, Inc.\nWe have audited the accompanying consolidated balance sheets of Robinson Nugent, Inc. and Subsidiaries, as of June 30, 1995, 1994 and 1993, the related consolidated statements of income, shareholders' equity and cash flows and the financial statement schedule for each of the three years then ended as listed in Item 14 of this Form 10-K for the year ended June 30, 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 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 Robinson Nugent, Inc. and Subsidiaries, as of June 30, 1995, 1994 and 1993, and the results of their operations and their cash flows for each of the three years 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 for the years ended June 30, 1995, 1994 and 1993.\nCOOPERS & LYBRAND L.L.P.\nLouisville, Kentucky August 4, 1995\nSee footnotes on following page.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (CONT'D.) ROBINSON NUGENT, INC. AND SUBSIDIARIES (IN THOUSANDS OF DOLLARS)\nROBINSON NUGENT, INC.\nFORM 10-K FOR FISCAL YEAR ENDED JUNE 30, 1995\nINDEX TO EXHIBITS\nNUMBER SEQUENTIAL ASSIGNED IN NUMBERING SYSTEM REGULATION S-K PAGE NUMBER ITEM 601 DESCRIPTION OF EXHIBIT OF EXHIBIT - - -------------- ---------------------- ----------------\n(3) 3.1 Articles of Incorporation of Robinson Nugent, Inc. (Incorporated by reference to Exhibit 3.1 to Form S-1 Registration Statement No. 2-62521.)\n3.2 Articles of Amendment of Articles of Incorporation of Robinson Nugent, Inc. filed September 1, 1978 (Incorporated by reference to Exhibit B(1) to Form 10-K Report for year ended June 30, 1980.)\n3.3 Articles of Amendment of Articles of Incorporation of Robinson Nugent, Inc. filed November 14, 1983 (Incorporated by reference to Exhibit 3.3 to Form 10-K Report for year ended June 30, 1984.)\n3.4 Amended and Restated Bylaws of Robinson Nugent, Inc. adopted November 7, 1991. (Incorporated by reference to Exhibit 19.1 to Form 10-K Report for year ended June 30, 1992).\n(4) 4.1 Specimen certificate for Common Shares, without par value. (Incorporated by reference to Exhibit 4 to Form S-1 Registration Statement No. 2-62521.)\n4.2 Rights Agreement dated April 21, 1988 between Robinson Nugent, Inc. and Bank One, Indianapolis, NA. (Incorporated by reference to Exhibit I to Form 8-A Registration Statement dated May 2, 1988.)\n4.3 Amendment No. 1 to Rights Agreement dated September 26, 1991. (Incorporated by reference to Exhibit 4.3 to Form 10-K Report for year ended June 30, 1991.)\n4.4 Amendment No. 2 to Rights Agreement dated June 11, 1992. (Incorporated by reference to Exhibit 4.4 to Form 8-K Current Report dated July 6, 1992.)\n(9) No exhibit.\n(10) 10.1 Robinson Nugent, Inc. 1983 Tax-Qualified Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10.1 to Form 10-K Report for year ended June 30, 1983.)\n10.2 Robinson Nugent, Inc. 1983 Non Tax- Qualified Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10.2 to Form 10-K Report for year ended June 30, 1983.)\n10.3 1993 Robinson Nugent, Inc. Employee and Non-Employee Director Stock Option Plan. (Incorporated by reference to Exhibit 19.1 to Form 10-K Report for the year ended June 30, 1993.)\n10.4 Summary of The Robinson Nugent, Inc. Stock Employee Stock Purchase Plan. (Incorporated by reference to Exhibit 19.2 to Form 10-K Report for the year ended June 30, 1993.)\n10.5 Deferred compensation agreement dated May 10, 1990 between Robinson Nugent, Inc. and Larry W. Burke, President and Chief Executive Officer, and related agreement dated May 10, 1990 between Robinson Nugent, Inc. and PNC Bank, Kentucky, Inc.(formerly Citizens Fidelity Bank and Trust Company of Louisville, Kentucky) as trustee. (Incorporated by reference to Exhibit 19.1 to Form 10-K Report for year ended June 30, 1990.)\n10.6 Deferred compensation agreement dated May 10, 1990 between Robinson Nugent, Inc. and Clifford G. Boggs, former Vice President, Treasurer and Chief Financial Officer, and related agreement dated May 10, 1990 between Robinson Nugent, Inc. and PNC Bank, Kentucky, Inc. (formerly Citizens Fidelity Bank and Trust Company of Louisville, Kentucky) as trustee. (Incorporated by reference to Exhibit 19.2 to Form 10-K Report for year ended June 30, 1990.)\n10.7 Summary of Robinson Nugent, Inc. Bonus 23 Plan for the fiscal year ended June 30, 1995.\n(11) No exhibit.\n(12) No exhibit.\n(13) 1995 Annual Report to Shareholders of 24 Robinson Nugent, Inc.\n(16) No exhibit.\n(18) No exhibit.\n(21) The subsidiaries of the registrant. 48\n(22) No exhibit.\n(23) Consent of Coopers & Lybrand L.L.P. 49 Independent Accountants\n(24) No exhibit.\n(27) Financial Data Schedule.\n(28) No exhibit.","section_15":""}
{"filename":"353230_1995.txt","cik":"353230","year":"1995","section_1":"ITEM 1 - BUSINESS\nBACKGROUND\nOmnicare, Inc. (the \"Company\" or \"Omnicare\") was incorporated in Delaware on May 19, 1981 to conduct certain health care businesses contributed to it by W. R. Grace & Co. and Chemed Corporation, and in July 1981 public trading of the Company's Common Stock commenced. As part of a multi-year restructuring program undertaken in 1985, the Company, through a series of divestitures and acquisitions, redeployed all of its capital in the long-term pharmacy business. As a result, Omnicare is today a leading independent provider of pharmacy services to long-term care institutions such as nursing homes, retirement centers and other institutional health care facilities. The Company operates principally in one business segment--institutional pharmacy services for the long-term care market. At December 31, 1995, Omnicare provided these services to approximately 216,500 residents in 2,500 nursing facilities located principally in the States of Alabama, Connecticut, Georgia, Illinois, Indiana, Kansas, Kentucky, Massachusetts, Michigan, Missouri, New York, North Carolina, Ohio, Oklahoma, Oregon, South Carolina, Virginia, Washington, and West Virginia. The Company does not make any export sales.\nThe Company entered the long-term care pharmacy industry in December 1988 with the acquisition of its first institutional pharmacy provider. By December 31, 1995, the Company had completed a total of 33 acquisitions in the long-term care pharmacy market at a total capital investment of approximately $290 million. In 1995 the Company acquired nine institutional pharmacy providers at an aggregate capital cost of approximately $64 million and expended an additional $11 million in cash payments relating to acquisitions completed prior to 1995.\nOn March 22, 1996, the Company sold 5,750,000 shares of its Common Stock in a public offering generating gross proceeds of $298,281,000 (before underwriting discounts and offering expenses). The proceeds will be used to fund business acquisitions and for general corporate purposes.\nPHARMACY SERVICES\nOmnicare purchases, repackages and dispenses prescription and non-prescription medication in accordance with physician orders and delivers such prescriptions at least daily to the nursing facility for administration to individual patients by the facility's nursing staff. Omnicare typically services nursing homes within a 150-mile radius of its pharmacy locations. Omnicare maintains a 24-hour, on-call pharmacist service 365 days per year for emergency dispensing and delivery or for consultation with the facility's staff or attending physician.\nUpon receipt of a prescription, the relevant patient information is entered into Omnicare's computerized dispensing and billing systems. At that time, the dispensing system will check the prescription for any potentially adverse drug interactions or patient sensitivity. When required and\/or specifically requested by the physician or patient, branded drugs are dispensed; generic drugs are substituted in accordance with applicable state and federal laws and as requested by the physician or patient. The Company also provides therapeutic interchange, with physician approval, in accordance with the Company's pharmaceutical care guidelines. See \"Omnicare Guidelines\" below.\nOmnicare provides a \"unit dose\" distribution system. Most of its prescriptions are filled utilizing specialized unit-of-use packaging and delivery systems. Maintenance medications are typically provided in 30-day supplies utilizing either a box unit dose system or unit dose punch card system. The unit dose system, preferred over the bulk delivery systems employed by retail pharmacies, improves control over drugs in the nursing facility and improves patient compliance with drug therapy by increasing the accuracy and timeliness of drug administration.\nIntegral to Omnicare's drug distribution system is its computerized medical records and documentation system. Omnicare provides to the facility computerized medication administration records and physician's order sheets and treatment records for each patient. Data extracted from these computerized records are also formulated into monthly management reports on patient care and quality assurance. The computerized documentation system in combination with the unit dose drug delivery system results in greater efficiency in nursing time, improved control, reduced drug waste in the facility and lower error rates in both dispensing and administration. These benefits improve drug efficacy and result in fewer drug-related hospitalizations.\nCONSULTANT PHARMACIST SERVICES\nFederal and state regulations mandate that nursing facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of patient care. The Omnibus Budget Reconciliation Act (\"OBRA\") implemented in 1990 seeks to further upgrade and standardize care by setting forth more stringent standards relating to planning, monitoring and reporting on the progress of prescription drug therapy as well as facility-wide drug usage.\nOmnicare provides consultant pharmacist services which help clients comply with such federal and state regulations applicable to nursing homes. The services offered by Omnicare's consultant pharmacists include: (i) comprehensive, monthly drug regimen reviews for each patient in the facility to assess the appropriateness and efficacy of drug therapies, including a review of the patient's medical records, monitoring drug reactions to other drugs or food, monitoring lab results and recommending alternate therapies or discontinuing unnecessary drugs; (ii) participation on the Pharmacy and Therapeutics, Quality Assurance and other committees of client nursing facilities as well as periodic involvement in staff meetings; (iii) monthly inspection of medication carts and storage rooms; (iv) monitoring and monthly reporting on facility-wide drug usage and drug administration systems and practices; (v) development and maintenance of pharmaceutical policy and procedures manuals; and (vi) assistance to the nursing facility in complying with state and federal regulations as they pertain to patient care.\nAdditionally, Omnicare offers a specialized line of consulting services which help nursing facilities to enhance care and reduce and contain costs as well as to comply with state and federal regulations. Under this service line, Omnicare provides: (i) data required for OBRA and other regulatory purposes, including reports on psychotropic drug usage (chemical restraints), antibiotic usage (infection control) and other drug usage; (ii) Plan of Care programs which assess each patient's state of\nhealth upon admission and monitor progress and outcomes using data on drug usage as well as dietary, physical therapy and social service inputs; (iii) counseling related to appropriate drug usage and implementation of drug protocols; (iv) on-site educational seminars for the nursing facility staff on topics such as drug information relating to clinical indications, adverse drug reactions, drug protocols and special geriatric considerations in drug therapy, and information and training on intravenous drug therapy and updates on OBRA and other regulatory compliance issues; (v) mock regulatory reviews for nursing staffs; and (vi) nurse consultant services and consulting for dietary, social services and medical records.\nOMNICARE GUIDELINES\nIn June 1994, to enhance the pharmaceutical care management services that it offers, Omnicare introduced to its client nursing facilities and their attending physicians the Omnicare GERIATRIC PHARMACEUTICAL CARE GUIDELINES(TM) (THE OMNICARE GUIDELINES(TM)) which it believes is the first clinically-based formulary for the elderly residing in long-term care institutions. THE OMNICARE GUIDELINES presents an analysis ranking specific drugs in therapeutic classes as Preferred, Acceptable or Unacceptable based solely on their disease-specific clinical effectiveness in treating the elderly in nursing facilities. The formulary takes into account such factors as pharmacology, safety and toxicity, efficacy, drug administration, quality of life and other considerations specific to the frail elderly population residing in nursing facilities. The clinical evaluations and rankings were developed exclusively for the Company by the Philadelphia College of Pharmacy and Science, an academic institution recognized for its expertise in geriatric long-term care. In addition, THE OMNICARE GUIDELINES provides relative cost information comparing the prices of the drugs to patients, their insurers or other payors of the pharmacy bill.\nAs THE OMNICARE GUIDELINES focuses on health benefits, rather than solely on cost, in assigning rankings the Company believes that use of THE OMNICARE GUIDELINES will assist physicians in making the best clinical choices of drug therapy for the patient at the lowest cost to the payor of the pharmacy bill. The Company also believes that the development of and subsequent compliance with THE OMNICARE GUIDELINES will lower costs for the patients it serves and strengthen the Company's purchasing power with pharmaceutical manufacturers.\nANCILLARY SERVICES\nOmnicare provides the following ancillary products and services to nursing facilities:\nInfusion Therapy Products and Services. With cost containment pressures in health care, nursing facilities are increasingly providing subacute care as a means of treating moderately acute but stabilized patients more cost-effectively than hospitals, provided that the nursing staff and pharmacy are capable of supporting higher degrees of acuity. Omnicare provides infusion therapy support services for such residents in its client nursing facilities and, to a lesser extent, hospice and home care patients. Infusion therapy consists of the product (a nutrient, antibiotic, chemotherapy or other drugs in solution) and the intravenous administration of the product.\nOmnicare prepares the product to be administered using proper equipment in a sterile environment and then delivers the product to the nursing home for administration by the nursing staff. Proper administration of intravenous (\"IV\") drug therapy requires a highly trained nursing staff. Omnicare's consultant pharmacists and nurse consultants operate an education and certification program on IV therapy to assure proper staff training and compliance with regulatory requirements in client facilities offering an IV program.\nBy providing an infusion therapy program, Omnicare enables its client nursing facilities to admit and retain patients who otherwise would need to be cared for in an acute-care facility. The Company believes that by providing these high acuity pharmacy services it has a competitive advantage over other pharmacy providers. The most common infusion therapies Omnicare provides are total parenteral nutrition, antibiotic therapy, chemotherapy, pain management and hydration.\nWholesale Medical Supplies\/Medicare Part B Billing. Omnicare distributes disposable medical supplies, including urological, ostomy, nutritional support and wound care products and other disposables needed in the nursing home environment. In addition, Omnicare provides direct Medicare billing services for certain of these product lines for patients eligible under the Medicare Part B program. As part of this service, Omnicare determines patient eligibility, obtains certifications, orders products and maintains inventory on behalf of the nursing facility. Omnicare also contracts to act as billing agent for certain nursing homes that supply these products directly to the patient.\nOther Services. Omnicare also provides respiratory therapy products and durable medical equipment for its clients in certain of its market areas. Omnicare continues to review the expansion of these as well as other products and services that may further enhance the ability of its client nursing facilities to care for their residents in a cost-effective manner.\nPRODUCT AND MARKET DEVELOPMENT\nOmnicare's pharmacy business engages in a continuing program for the development of new services and the marketing thereof. While new service and new market development are important factors for the growth of this business, Omnicare does not expect that any new service or marketing effort, including those in the developmental stage, will require the investment of a material portion of Omnicare's assets.\nMATERIALS\/SUPPLY\nOmnicare purchases pharmaceuticals through a wholesale distributor with whom it has a prime vendor contract and, on an increasing basis, under contracts negotiated directly with pharmaceutical manufacturers. The Company also is a member of industry buying groups which contract with manufacturers for discounted prices based on volume which are passed through to the Company by its wholesale distributor. The Company has numerous sources of supply available to it and has not experienced any difficulty in obtaining pharmaceuticals or other products and supplies used in the conduct of its business.\nPATENTS, TRADEMARKS AND LICENSES\nOmnicare's business operations are not dependent upon any material patents, trademarks or licenses.\nINVENTORIES\nOmnicare's pharmacies maintain adequate onsite inventories of pharmaceuticals and supplies to ensure prompt delivery service to its customers. Inventories on hand are not considered to be high by industry standards. The Company's primary wholesale distributor also maintains local warehousing in most major geographic markets in which the Company operates.\nCOMPETITION\nBy its nature, the long-term care pharmacy business is highly regionalized and, within a given geographic region of operations, highly competitive. In the geographic regions it serves, Omnicare competes with numerous local retail pharmacies, local and regional institutional pharmacies and pharmacies owned by long-term care facilities. Omnicare competes in this market on the basis of quality, cost-effectiveness and the increasingly comprehensive and specialized nature of its services along with the clinical expertise, pharmaceutical technology and professional support it offers.\nIn its program of acquiring institutional pharmacy providers, the Company competes with several other companies with similar acquisition strategies, some of which may have greater resources than the Company.\nNo individual customer or market group is critical to the total sales of the Company's long-term care pharmacy business.\nGOVERNMENT REGULATION\nInstitutional pharmacies, as well as the long-term care facilities they serve, are subject to extensive federal, state and local regulation. These regulations cover required qualifications, day-to-day operations, reimbursement and the documentation of activities. Omnicare continuously monitors the effects of regulatory activity on its operations.\nLicensure, Certification and Regulation. States generally require that companies operating a pharmacy within the state be licensed by the state board of pharmacy. The Company currently has pharmacy licenses in each state in which it operates a pharmacy. In addition, the Company currently delivers prescription products from its licensed pharmacies to 5 states in which the Company does not operate a pharmacy. These states regulate out-of-state pharmacies, however, as a condition to the delivery of prescription products to patients in such states. Omnicare's pharmacies hold the requisite licenses applicable in these states. In addition, Omnicare's pharmacies are registered with the appropriate state and federal authorities pursuant to statutes governing the regulation of controlled substances.\nClient nursing facilities are also separately required to be\nlicensed in the states in which they operate and, if serving Medicare or Medicaid patients, must be certified to be in compliance with applicable program participation requirements. Client nursing facilities are also subject to the nursing home reforms of the Omnibus Budget Reconciliation Act of 1987, which imposed strict compliance standards relating to quality of care for nursing home operations, including vastly increased documentation and reporting requirements. In addition, pharmacists, nurses and other health care professionals who provide services on the Company's behalf are in most cases required to obtain and maintain professional licenses and are subject to state regulation regarding professional standards of conduct.\nFederal and State Laws Affecting the Repacking, Labelling, and Interstate Shipping of Drugs. Federal and state laws impose certain repackaging, labelling, and package insert requirements on pharmacies that repackage drugs for distribution beyond the regular practice of dispensing or selling drugs directly to patients at retail. A drug repackager must register with the Food and Drug Administration. The Company holds all required registrations and licenses, and its repackaging operations are in compliance with applicable state and federal requirements.\nMedicare and Medicaid. The nursing home pharmacy business has long operated under regulatory and cost containment pressures from state and federal legislation primarily affecting Medicaid and, to a lesser extent, Medicare.\nAs is the case for nursing home services generally, Omnicare receives reimbursement from the Medicaid and Medicare programs, directly from individual residents (private pay), and from other payors such as third-party insurers. The Company believes that its reimbursement mix is in line with nursing home expenditures nationally. For the year ended December 31, 1995, Omnicare's payor mix was approximately as follows: 53% private pay and nursing homes, 42% Medicaid, 4% Medicare and 1% insurance and other private sources.\nFor those patients who are not covered by government-sponsored programs or private insurance, Omnicare generally directly bills the patient or the patient's responsible party on a monthly basis. Depending upon local market practices, Omnicare may alternatively bill private patients through the nursing facility. Pricing for private pay patients is based on prevailing regional market rates or \"usual and customary\" charges.\nThe Medicaid program is a cooperative federal-state program designed to enable states to provide medical assistance to aged, blind, or disabled individuals, or members of families with dependent children whose income and resources are insufficient to meet the costs of necessary medical services. State participation in the Medicaid program is voluntary. To become eligible to receive federal funds, a state must submit a Medicaid \"state plan\" to the Secretary of the Department of Health and Human Services (\"HHS\") for approval. The federal Medicaid statute specifies a variety of requirements which the state plan must meet, including requirements relating to eligibility, coverage of services, payment and administration.\nFederal law and regulations contain a variety of requirements relating to the furnishing of prescription drugs under Medicaid. First,\nstates are given broad authority, subject to certain standards, to limit or specify conditions to the coverage of particular drugs. Second, federal Medicaid law establishes standards affecting pharmacy practice. These standards include general requirements relating to patient counseling and drug utilization review and more specific requirements for nursing facilities relating to drug regimen reviews for Medicaid patients in such facilities. Recent regulations clarify that, under federal law, a pharmacy is not required to meet the general standards for drugs dispensed to nursing facility residents if the nursing facility complies with the drug regimen review requirements. However, the regulations indicate that states may nevertheless require pharmacies to comply with the general standards, regardless of whether the nursing facility satisfies the drug regimen review requirement, and the states in which the Company operates currently do require its pharmacies to comply therewith.\nThird, federal regulations impose certain requirements relating to reimbursement for prescription drugs furnished to Medicaid patients. In addition to requirements imposed by federal law, states have substantial discretion to determine administrative, coverage, eligibility and payment policies under their state Medicaid programs which may affect the Company's operations. For example, some states have enacted \"freedom of choice\" requirements which may prohibit a nursing facility from requiring its residents to purchase pharmacy or other ancillary medical services or supplies from particular providers that deal with the nursing home. Such limitations may increase the competition which the Company faces in providing services to nursing facility patients.\nThe Medicare program is a federally funded and administered health insurance program for individuals age 65 and over or who are disabled. The Medicare program consists of two parts: Part A, which covers, among other things, inpatient hospital, skilled nursing facility, home health care and certain other types of health care services; and Medicare Part B, which covers physicians' services, outpatient services, and certain items and services provided by medical suppliers. Medicare Part B also covers a limited number of specifically designated prescription drugs. The Medicare program establishes certain requirements for participation of providers and suppliers in the Medicare program. Pharmacies are not subject to such certification requirements. Skilled nursing facilities and suppliers of medical equipment and supplies, however, are subject to specified standards. Failure to comply with these requirements and standards may adversely affect an entity's ability to participate in the Medicare program and receive reimbursement for services provided to Medicare beneficiaries.\nThe Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, and freezes and funding reductions, all of which may adversely affect the Company's business. There can be no assurance that payments for pharmaceutical supplies and services under governmental reimbursement programs will continue to be based on the current methodology or remain comparable to present levels. In this regard, the Company may be subject to rate reductions as a result of federal budgetary legislation related to the Medicare and Medicaid programs. In addition, various state Medicaid programs periodically experience budgetary shortfalls which may result in Medicaid payment delays to the Company. To date, the Company has not experienced any material adverse effect due to any such budgetary shortfall. In addition, the failure, even if\ninadvertent, of Omnicare and\/or its client institutions to comply with applicable reimbursement regulations could adversely affect Omnicare's business. Additionally, changes in such reimbursement programs or in regulations related thereto, such as reductions in the allowable reimbursement levels, modifications in the timing or processing of payments and other changes intended to limit or decrease the growth of Medicaid and Medicare expenditures, could adversely affect the Company's business.\nReferral Restrictions. The Company is subject to federal and state laws which govern financial and other arrangements between health care providers. These laws include the federal anti-kickback statute, which was originally enacted in 1977 and amended in 1987, and which prohibits, among other things, knowingly and willfully soliciting, receiving, offering or paying any remuneration directly or indirectly in return for or to induce the referral of an individual to a person for the furnishing of any item or service for which payment may be made in whole or in part under Medicare or Medicaid. Many states have enacted similar statutes which are not necessarily limited to items and services for which payment is made by Medicare or Medicaid. Violations of these laws may result in fines, imprisonment, and exclusion from the Medicare and Medicaid programs or other state-funded programs. Federal and state court decisions interpreting these statutes are limited, but have generally construed the statutes to apply if \"one purpose\" of remuneration is to induce referrals or other conduct within the statute.\nFederal regulations establish \"safe harbors,\" which give immunity from criminal or civil penalties to parties in good faith compliance. While the failure to satisfy all criteria for a safe harbor does not mean that an arrangement violates the statute, it may subject the arrangement to review by the HHS Office of Inspector General (\"OIG\"), which is charged with administering the federal anti-kickback statute. There are no procedures for obtaining binding interpretations or advisory opinions from the OIG on the application of the federal anti-kickback statue to an arrangement or its qualification for a safe harbor upon which the Company can rely.\nThe OIG issues \"Fraud Alerts\" identifying certain questionable arrangements and practices which it believes may implicate the federal anti-kickback statute. The OIG has issued a Fraud Alert providing its views on certain joint venture and contractual arrangements between health care providers. The OIG also issued a Fraud Alert concerning prescription drug marketing practices that could potentially violate the federal statute. Pharmaceutical marketing activities may implicate the federal anti-kickback statute because drugs are often reimbursed under the Medicaid program. According to the Fraud Alert, examples of practices that may implicate the statute include certain arrangements under which remuneration is made to pharmacists to recommend the use of a particular pharmaceutical product.\nIn addition, a number of states have recently undertaken enforcement actions against pharmaceutical manufacturers involving pharmaceutical marketing programs, including programs containing incentives to pharmacists to dispense one particular product rather than another. These enforcement actions arose under state consumer protection laws which generally prohibit false advertising, deceptive trade practices, and the like.\nThe Company believes its contract arrangements with other health care providers, its pharmaceutical suppliers and its pharmacy practices are in compliance with these laws. There can be no assurance that such laws will not, however, be interpreted in the future in a manner inconsistent with the Company's interpretation and application.\nHealth Care Reform and Federal Budget Legislation. The Clinton administration and members of Congress have proposed plans to reform the health care system. Currently, Congress is considering such reforms in the context of federal budget reconciliation legislation. This legislation could result in significant reductions in payments to providers under the Medicare program and a complete restructuring and reduced payments to providers under the Medicaid program. With respect to Medicare, proposals include establishment of a prospective payment system for Skilled Nursing Facilities (\"SNFs\"); limits on payments to Medicare SNFs for certain non-routine services, including, among others, prescription drugs, diagnostic services, and physical therapy and other rehabilitative services; requiring consolidated billing by a SNF for all Part A and B claims for SNF residents; and other limits on reimbursement of costs for Medicare SNF services. If enacted, there can be no assurance that such proposals could not have a material adverse effect on the business of Omnicare. While budget negotiations are continuing, the future of any reform proposals in Congress is unknown.\nIn addition, a number of states have enacted and are considering various health care reforms, including reforms through Medicaid demonstration projects. Federal law allows HHS to authorize waivers of federal Medicaid program requirements, including requirements relating to coverage, free choice of providers and payment for health care services, in connection with state demonstration projects that promote Medicaid program objectives. HHS published procedures and public notice requirements designed to open the waiver approval process to public comment and to expedite processing. Legal actions have been initiated challenging the waiver process and the authority of HHS to approve waivers for broad-based Medicaid managed care programs. The federal budget legislation restructuring the Medicaid program would effectively eliminate Medicaid managed care demonstration projects.\nSeveral state Medicaid programs have established mandatory statewide managed care programs for Medicaid beneficiaries to control costs through negotiated or capitated rates, as opposed to traditional cost-based reimbursement for Medicaid services, and propose to use savings achieved through these programs to expand coverage to those not previously eligible for Medicaid. HHS has approved waivers for statewide managed care demonstration projects in several states, and are pending for several other states. These demonstration projects generally exempt institutionalized care, including nursing facility services, from the programs, and the Company's operations have not been adversely affected in the one state (Oregon) with a managed care demonstration project in effect. The Company is unable to predict what impact, if any, future projects might have on the Company's operations. Because there are currently various reform proposals under consideration at the federal and state levels, it is uncertain at this time what health care reform initiatives, if any, will be implemented, or whether there will be other changes in the administration of governmental health care programs or interpretations of governmental policies or other changes affecting the health care system. There can be no assurance that future health care or budget legislation or other changes will not have an adverse effect on the business of the Company.\nENVIRONMENTAL MATTERS\nIn operating its facilities, Omnicare makes every effort to comply with pollution control laws. No major difficulties have been encountered in effecting compliance. No material capital expenditures for environmental control facilities are expected. While Omnicare cannot predict the effect which any future legislation, regulations, or interpretations may have upon its operations, it does not anticipate any changes that would have a material adverse impact on its operations.\nEMPLOYEES\nAt December 31, 1995, Omnicare employed a total of 3,247 persons (including 741 part-time employees), all of whom were located within the United States.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nOmnicare has offices and distribution centers in various locations in the United States. A list of the major facilities operated by Omnicare follows. The \"owned\" property is held in fee and is not subject to any material encumbrance. Omnicare considers all of these facilities to be in good operating condition and generally to be adequate for present and anticipated needs.\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 Omnicare or any of its subsidiaries is a party or of which any of their property is the subject, and no such proceedings are known to be contemplated by governmental authorities.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nADDITIONAL ITEM - EXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company as of March 8, 1996 are as follows:\nAll of the executive officers listed above have been actively engaged in the business of the Company or its predecessors for the past five years, with the exception of Mr. Keefe and Mr. Froesel. Mr. Keefe served as Vice President of Diagnostek, Inc. from April 1992 to April 1993. From September 1990 to April 1992, he was President of HPI Health Care Services, Inc. (\"HPI\"), a subsidiary of Diagnostek which it acquired from Omnicare in August 1989. He served as Executive Vice President of HPI from August 1984 until September 1990. Mr. Froesel was Vice President of Finance and Administration at Mallinckrodt Veterinary Inc. from May 1993 to February 1996. From July 1989 to April 1993, he was worldwide corporate controller of Mallinckrodt Medical Inc.\nExecutive officers are elected for one-year terms at the annual organizational meeting of the Board of Directors which follows the annual meeting of stockholders each year.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE OF COMMON STOCK; HOLDERS OF RECORD\nThe Company's Common Stock is listed on the New York Stock Exchange. The following table sets forth the ranges of high and low closing prices\nfor the Common Stock on the New York Stock Exchange during each of the calendar quarters of l995 and l994. All prices shown have been adjusted to reflect the two-for-one stock split in June 1995.\n1995 1994 --------------- -------------- High Low High Low ---- --- ---- ---\nFirst Quarter $26.69 $20.63 $17.50 $14.50 Second Quarter 28.13 22.44 17.07 13.50 Third Quarter 39.00 26.88 20.07 16.82 Fourth Quarter 44.75 34.13 22.56 18.25\nThe number of holders of record of Omnicare Common Stock on February 29, l996 was 1,840. This figure does not include stockholders with shares held under beneficial ownership in nominee name or within clearinghouse positions of brokerage houses and banks.\nDIVIDENDS\nReflecting the Company's financial position and operating performance, on February 8, 1994 and on February 1, 1995 the Board of Directors elected to increase the quarterly cash dividend to $.0225 and $.025 per share, respectively, for an indicated annual rate of $.09 and $.10, respectively. On February 7, 1996, the quarterly cash dividend was increased to $.03 per share, for an indicated annual rate of $.12 per share in 1996. It is presently intended that cash dividends will continue to be paid on a quarterly basis; however, future dividends are necessarily dependent upon the Company's earnings and financial condition and other factors not currently determinable.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe following table summarizes certain selected financial data, which 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\" included elsewhere herein.\nFIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA (in thousands except per share data)\n[FN]\n(a) As a result of the December 1992 sale of the Veratex Group of businesses and the divestiture of Labtronics, Inc. which was completed in 1993, results have been restated to include these entities' results of operations as well as any gain or loss on dispositions as \"Discontinued Operations.\"\n(b) The Company has had an active acquisition program in effect since 1989. See Note 2 of the Notes to Consolidated Financial Statements for information concerning these acquisitions.\n(c) Includes acquisition expenses related to the specialized pooling of interests transaction of $1,292,000. Such expenses, on an aftertax basis, were $989,000, or $.04 per primary share ($.03 fully diluted). Net income, excluding these expenses, was $25,749,000, or $.98 per primary share ($.89 fully diluted).\n(d) Includes acquisition expenses related to the Evergreen pooling of interests transaction of $2,380,000. Such expenses, on an aftertax basis, were $1,860,000, or $.08 per primary share ($.07 fully diluted). Net income, excluding these expenses, was $15,391,000, or $.68 per primary share ($.66 fully diluted).\n(e) Includes a one-time cumulative tax benefit of $450,000, or $.02 per share, arising from a change in tax laws enacted in August of 1993 relating to amortization of intangibles.\n(f) Includes aftertax gain of $5,198,000, or $.25 per share, related to the sale of the Veratex Group and the divestiture of Labtronics.\n(g) Aftertax gain representing the cumulative effect of a change in accounting for income taxes.\n(h) In 1993, the Company issued $80.5 million of convertible subordinated notes due 2003 (see Note 6 of the Notes to Consolidated Financial Statements).\n(i) In 1994, the Company sold 3,247,482 shares of common stock, in a public offering, resulting in net proceeds of $59,211,000 (see Note 7 of the Notes to Consolidated Financial Statements).\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n(All share and per share data included in Management's Discussion and Analysis of Financial Condition and Results of Operations have been adjusted for the June 1995 two-for-one stock split.)\nOn June 30, 1995, the Company issued 403,185 shares of its Common Stock for all the outstanding common stock of Specialized Pharmacy Services, Inc. (\"Specialized\"). Specialized is a leading provider of institutional pharmacy services for long-term care facilities in Michigan with $32 million in sales for the year ended December 31, 1994. On September 30, 1994, the Company issued 2,222,644 shares of its Common Stock for all the outstanding common stock of Kirkland, Washington-based Evergreen Pharmaceutical, Inc., and an affiliated company (collectively, \"Evergreen\"). Evergreen had $34 million in sales for the year ended December 31, 1993. These acquisitions were accounted for as poolings of interests and, accordingly, the Company's consolidated financial statements have been restated for all periods to include the results of operations, financial position and cash flow of Specialized and Evergreen (See Note 2 to the Consolidated Financial Statements). In accordance with accounting rules for pooling of interests transactions, charges to operating income for acquisition-related expenses were recorded upon completion of these acquisitions. These pooling of interests expenses totaled $1,292,000, or $989,000 after taxes, for the Specialized acquisition and $2,380,000, or $1,860,000 after taxes, for the Evergreen acquisition.\nThe following table presents the Company's results of operations excluding certain unusual items of income and expense, which are comprised of pooling of interests expenses, the cumulative effect of an accounting change and a one-time favorable tax adjustment (in thousands except per share amounts):\nExcluding the impact of charges taken for acquisitions accounted for as pooling of interests transactions, net income for the year ended December 31, 1995 increased 67% over net income earned in 1994. Primary earnings per share, on this basis, for the full year 1995 increased 44% over 1994, and fully diluted earnings per share increased 35%.\nPro forma net income for the year ended December 31, 1994 increased 46% over 1993. Primary earnings per share, on a pro forma basis, increased 36% over 1993, and fully diluted earnings per share increased 32%. The 1994 pro forma adjustment consisted of the Evergreen pooling of interests expenses. The 1993 pro forma adjustments were comprised of $450,000 arising from a change in tax laws related to the amortization of intangibles and $280,000 related to the change in accounting for income taxes.\nNet income as reported for 1995 was $24,760,000, or $.94 per primary share ($.86 fully diluted), while 1994 net income was $13,531,000, or $.60 per primary share ($.59 fully diluted), and 1993 net income was $11,250,000, or $.53 per primary and fully diluted share.\nSales for 1995 were 30% higher than in 1994. For 1994, sales were 38% higher than in 1993. Omnicare entered the long-term pharmacy business with its first acquisition of an institutional pharmacy provider in December 1988. Omnicare has completed a total of 33 institutional pharmacy provider acquisitions - one in 1988, two in 1990, three in 1991, seven in 1992, four in 1993, seven in 1994 and nine in 1995. Except for the acquisitions of Specialized, Evergreen and Lo-Med Prescription Services, Inc. (\"Lo-Med\"), purchase accounting was used to record the acquisitions. The acquisitions of Specialized and Evergreen are included in the financial results of all years presented as these acquisitions were accounted for as poolings of interests. The acquisition of Lo-Med in 1994 was also accounted for as a pooling of interests; however, its operations were immaterial to the Company's results prior to 1994 and, therefore, prior year financial statements were not restated for this business combination. The sales increases were caused by acquisitions, (described in detail in Note 2 of the Consolidated Financial Statements), coupled with the internal growth of the businesses previously acquired.\nIncreases in gross profit over the three-year period have generally remained in line with or exceeded increases in sales, with margins of 25.7%, 26.0% and 28.0% for 1993, 1994 and 1995, respectively. Such increases were caused primarily by changes in sales mix and the Company's increasing purchasing leverage. Additionally, after excluding the aforementioned pro forma adjustments, operating income as a percent of sales has increased from 8.6% to 9.8% to 11.2% in 1993, 1994 and 1995, respectively, reflecting the increased gross profit margins.\nOver the past few years, political debate over health care reform has increasingly focused attention on containing and reducing health care costs. While the processes by which federal or state governments may pursue alternate proposals for reform of the health care system are uncertain, market forces in the form of managed care have and will continue to challenge health care providers to maintain the high quality of care provided while reducing costs. In this environment, the need to lower health care costs will drive industry consolidation, which should continue to provide the impetus for the Company's acquisition program. The Company's development of regional market positions provides opportunities for economies of scale to lower overall costs. In addition, Omnicare's proprietary geriatric formulary not only lowers costs for payors and patients, but also enhances the quality of care for the elderly.\nMoreover, demographic trends indicate that demand for long-term care will increase well into the middle of the next century. Pharmaceutical therapy is generally the most cost-effective form of treatment for chronic ailments\nafflicting the elderly and, as such, is an essential part of long-term care. Omnicare believes that it is well-positioned to be an integral part of the solution to escalating health care costs among the elderly through careful product selection (including drug formulary management), cost-effective drug purchasing and efficient delivery systems. This, coupled with Omnicare's pharmacy consulting services for nursing homes which identify, resolve and prevent drug therapy-related problems, reduces costs to the health care system while also promoting optimal patient outcomes. Thus, Omnicare should continue to show solid growth in sales and earnings in 1996, benefiting from a full year's contribution from businesses acquired in 1995, from internal growth and from the completion of additional acquisitions.\nNON-OPERATING INCOME AND EXPENSE\nInvestment income increased by 120% to $3,475,000 in 1995, as the Company received the full-year benefit of invested cash during 1995 due to receipt of $59.2 million of cash proceeds from the November 1994 stock offering. Investment income increased by 149% to $1,580,000 in 1994 from $635,000 in 1993 due to the increase in invested cash during 1994 resulting from the cash proceeds from the October 1993 offering of $80.5 million in 5.75% Convertible Subordinated Notes due 2003 (\"Notes\").\nInterest expense decreased by 9% from $6,533,000 in 1994 to $5,954,000 in 1995, due to reductions in outstanding debt associated with Specialized and Evergreen prior to acquisition by the Company. Interest expense increased by $3,709,000 in 1994 as a result of a full year's interest on the Notes as compared to only three months in 1993.\nINCOME TAXES\nThe Company's effective tax rates for 1993, 1994 and 1995 were 35.4%, 40.3% and 39.9%, respectively. The 1995 and 1994 effective tax rates are slightly higher than statutory rates due to the nondeductibility of certain acquisition costs. As a result of the Omnibus Budget Reconciliation Act of 1993, the Company was permitted to deduct from taxable income amortization of intangibles arising from certain business acquisitions retroactive to July 1991. Accordingly, the Company's effective tax rate in 1993 was favorably impacted by the tax benefit of amortization of intangibles.\nIMPACT OF INFLATION\nInflation has not materially affected Omnicare's profitability inasmuch as price increases have generally been obtained to cover inflationary drug cost increases.\nLIQUIDITY AND CAPITAL RESOURCES\nIn November 1994, the Company completed a public offering of 3,247,482 shares of Common Stock, resulting in net proceeds of $59,211,000.\nIn line with Omnicare's plan to invest in the long-term pharmacy market, acquisitions completed during 1995 required an aggregate capital investment of approximately $63.7 million. Such acquisitions were financed with cash and cash equivalents on hand as well as Common Stock of the Company. Shares of Common Stock with a market value of approximately $22.7 million (879,919 shares) were issued in connection with the 1995 acquisitions. Additionally, $10.6 million of other acquisition-related payments were made during 1995 related to businesses\nacquired prior to 1995. Additional amounts totaling $11.2 million may become payable through the year 2000 pursuant to the terms of various acquisition agreements. Omnicare ended the year with $40,137,000 in cash and cash equivalents and marketable securities as compared to $79,798,000 at year-end 1994.\nAt December 31, 1995, the Company had invested $32,522,000 in U.S. Treasury-backed repurchase agreements which represent investments under agreements to resell, usually overnight, but in no case greater than 30 days. The Company has a collateralized interest in the underlying securities which are segregated in the accounts of the counterparty bank. Management believes these investments do not create any exposure to the Company's liquidity. Omnicare's current ratio decreased to 2.9 to 1 at December 31, 1995 from 3.8 to 1 at December 31, 1994, and working capital at December 31, 1995 decreased to $106,384,000 from year-end 1994 working capital of $125,550,000. This decrease is attributable to the cash outlays required for the Company's 1995 acquisitions net of cash generated from 1995 operations. Book value per common share increased to $8.16 per share as of December 31, 1995 from $7.01 per share at the prior year-end, primarily attributable to current year net income, less dividends paid.\nOn February 7, 1996, Omnicare's Board of Directors elected to increase the quarterly cash dividend by 20% to 3 cents per share for an indicated annual rate of 12 cents per share for 1996.\nIn February 1995, the Company entered into an agreement with a consortium of six banks for a five-year $135 million revolving credit facility, replacing the prior $50 million facility. Interest rates and commitment fees for this new facility are based on the Company's level of performance under certain debt covenants. No amounts were outstanding at December 31, 1995 under the credit facility.\nThe Company believes that its sources of liquidity and capital are adequate for its operating needs. There are no material commitments outstanding, other than additional acquisition-related payments to be made (see Note 2 of the Consolidated Financial Statements). If needed, other external sources of financing are readily available to the Company.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll other financial statement schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ------------------------------------------\nTo the Stockholders and Board of Directors of Omnicare, Inc.\nIn our opinion, based on our audits and the report of other auditors with respect to 1993, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Omnicare, Inc. 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 did not audit the combined financial statements of Evergreen Pharmaceutical, Inc. and Evergreen Pharmaceutical East, Inc. (collectively, \"Evergreen\") for the year ended December 31, 1993, which statements reflect 1993 revenues of $34,130,000. 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 1993 amounts included for Evergreen, 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\nPrice Waterhouse LLP Cincinnati, Ohio February 5, 1996\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ---------------------------------------------------------\nEvergreen Pharmaceutical, Inc. and Evergreen Pharmaceutical East, Inc. Kirkland, Washington\nWe have audited the combined balance sheets of Evergreen Pharmaceutical, Inc. and Evergreen Pharmaceutical East, Inc. as of December 31, 1993, and the related combined statements of income, shareholders' equity and cash flows for the year then ended, not presented separately herein. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these 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 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, not presented separately herein, present fairly, in all material respects, the combined financial position of Evergreen Pharmaceutical, Inc. and Evergreen Pharmaceutical East, Inc. 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.\n\/s\/BDO Seidman, LLP\nBDO Seidman, LLP Seattle, Washington July 29, 1994\nCONSOLIDATED STATEMENT OF INCOME Omnicare, Inc. and Subsidiary Companies\n(In thousands except per share data)\nThe Notes to Consolidated Financial Statements are an integral part of this statement.\nCONSOLIDATED BALANCE SHEET Omnicare, Inc. and Subsidiary Companies\nThe Notes to Consolidated Financial Statements are an integral part of this statement.\nCONSOLIDATED STATEMENT OF CASH FLOW Omnicare, Inc. and Subsidiary Companies\nThe Notes to Consolidated Financial Statements are an integral part of this statement.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Omnicare, Inc. and Subsidiary Companies\nThe Notes to Consolidated Financial Statements are an integral part of this statement. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION\nOmnicare, Inc. (\"Company\") operates in one business segment which includes the distribution of pharmaceuticals, related pharmacy management services and medical supplies to long-term care institutions and their residents in the U.S. The consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries as well as 50% of the accounts of Heartland Healthcare Services, a 50\/50 partnership between the Company and Health Care and Retirement Corporation. All significant intercompany transactions are eliminated.\nCASH EQUIVALENTS AND MARKETABLE SECURITIES\nThe Company considers all investments in highly liquid instruments with maturities of three months or less at the date purchased to be cash equivalents. Investments in cash equivalents are carried at cost which approximates market value with any associated purchase discount or premium amortized over the period to maturity.\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under these rules, debt securities that the Company has both the intent and ability to hold to maturity are carried at amortized cost. Debt securities that the Company does not have the intent and ability to hold to maturity are classified either as \"available-for-sale\" or as \"trading\" and are carried at fair value. At December 31, 1995 and 1994, the Company had no investments that qualified as available-for-sale or trading. Marketable securities at December 31, 1994 consist of U.S. Treasury obligations which matured in 1995 and are stated at cost, which approximates fair value. The fair values are based on quoted market prices.\nINVENTORIES\nInventories consist primarily of purchased pharmaceuticals and medical supplies held for sale to customers and are stated at the lower of cost or market. Cost is generally determined using the average cost and first-in, first-out methods.\nPROPERTIES AND EQUIPMENT\nProperties and equipment are stated at cost. Expenditures for maintenance, repairs, renewals and betterments that do not materially prolong the useful lives of the assets are charged to expense. Depreciation of properties and equipment is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease terms, including renewal options, or their useful lives.\nGOODWILL, INTANGIBLES AND OTHER ASSETS\nIntangible assets, comprised primarily of goodwill, arising from business combinations accounted for as purchase transactions are amortized using the straight-line method over their estimated useful lives, not in excess of forty years.\nOn an annual basis, the Company reviews the recoverability of goodwill. The measurement of possible impairment is based primarily on the ability to recover the balance of the goodwill from expected future operating cash flow on an\nundiscounted basis. In management's opinion, no such impairment exists at December 31, 1995 or 1994.\nDebt issuance costs are included in other assets and are amortized using the straight-line method over the life of the related debt.\nREVENUE RECOGNITION\nRevenue is recognized when products or services are provided to the customer. A significant portion of the Company's revenues from sales of pharmaceutical and medical products are reimbursable from Medicaid and Medicare programs. The Company monitors its receivables from these reimbursement sources under policies established by management and reports such revenues at the net realizable amount expected to be received from these third-party payors.\nINCOME TAXES\nThe provision for income taxes includes federal, state and local income taxes currently payable and those deferred because of differences between income for financial reporting and income for tax purposes.\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" on a prospective basis; SFAS No. 109 requires the use of an asset and liability method of accounting for deferred income taxes.\nPER SHARE DATA\nPrimary earnings per share are computed based on the weighted average number of shares of common stock outstanding during the period and common stock equivalents, if material. Fully diluted earnings per share include common stock equivalents and assume the conversion of the 5.75% Convertible Subordinated Notes due 2003 into common stock. Additionally, interest expense and amortization of debt issuance costs arising from these convertible securities are added, net of related income taxes, to income for the purpose of calculating fully diluted earnings per share.\nThe Board of Directors declared a two-for-one split of the Company's $1 par value common stock effective June 21, 1995. As a result of the split, 12,944,180 additional shares were issued including 2,514,994 from treasury stock. Additional paid-in capital and treasury stock were reduced by $45,524,000 and $35,095,000, respectively. All references in the financial statements to share and per share amounts have been adjusted to reflect the stock split.\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 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 PRONOUNCEMENTS\nEffective January 1, 1996, the Company will adopt provisions of SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This statement establishes financial accounting and reporting standards for stock-based employee\ncompensation plans. As permitted by SFAS No. 123, the Company will continue to follow the measurement principles prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees,\" and will disclose the pro forma impact of using the fair value measurement principles of SFAS No. 123.\nEffective January 1, 1996, the Company will adopt provisions of SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of.\" This statement establishes accounting standards for recording the impairment of long-lived assets. The Company expects that adoption of this statement will not have a material impact on its results of operations or financial position.\nRECLASSIFICATIONS\nCertain reclassifications of prior year amounts have been made to conform with the current year presentation.\nNOTE 2 - ACQUISITIONS\nSince 1989, the Company has been involved in a program to acquire providers of pharmaceutical and related pharmacy management services and medical supplies to long-term care facilities and their residents.\nOn June 30, 1995, the Company issued 403,185 shares of its Common Stock for all of the outstanding common stock of Specialized Pharmacy Services, Inc. (\"Specialized\"). On September 30, 1994, the Company issued 2,222,644 shares of its Common Stock for all the outstanding common stock of Evergreen Pharmaceutical, Inc. and Evergreen Pharmaceutical East, Inc. (\"EPE\") (collectively, \"Evergreen\"). These acquisitions were accounted for as poolings of interests and, accordingly, the Company's consolidated financial statements have been restated for all periods prior to the acquisitions to include the results of operations, financial position and cash flow of Specialized and Evergreen. In accordance with accounting rules for pooling of interests transactions, charges to operating income for acquisition-related expenses were recorded upon completion of the acquisitions. These acquisition-related expenses totaled $1,292,000, or $989,000 after taxes, for the Specialized transaction and $2,380,000, or $1,860,000 after taxes, for the Evergreen transaction. Net sales and net income for Omnicare and Evergreen prior to the Evergreen transaction and Omnicare and Specialized prior to the Specialized transaction are as follows (in thousands):\n[FN]\n(a) The results of operations of Evergreen are included in the consolidated results of Omnicare for these periods.\nDuring 1995, the Company completed acquisitions of the following institutional pharmacy businesses: Shore Pharmaceutical Providers, Inc. in Westbury, New York, in January; North Shore Pharmacy Services, Inc. in Boston, Massachusetts, Genrex Nursing Home Pharmacy Division of Genovese Drug Stores, Inc. in Melville, New York and Consulting and Pharmaceutical Services, Inc. in Yakima, Washington, in March; Pioneer I.V., Ltd. in Moline, Illinois, in May; Specialized in Livonia, Michigan, in June; CPM Datascript, Corp. in Hollis, New York, in July; the nursing home pharmacy business of Rite Aid Corp. in September; and Apex Long-Term Care Pharmacy, Inc. in Hamden, Connecticut, in December. Also in September, the Company acquired a care planning software developer and marketer, the Dynatran Computer Systems Division of Health Spectrum, Inc. in Portland, Oregon.\nDuring 1994, the Company completed the acquisitions of Care Pharmaceutical Services, Inc. in Griffith, Indiana and Schaufler Prescription Pharmacy in Belleville, Illinois, in March; Weber Medical Systems, Inc. in Skokie, Illinois and Lo-Med Prescription Services, Inc. (\"Lo-Med\") in Wadsworth, Ohio, in June; UniCare, Inc. in Montgomery, Alabama, in August; and Lawrence Medical Supply, Inc. in Deerfield, Illinois and Evergreen in Kirkland, Washington, in September.\nDuring 1993, the Company completed the acquisitions of Freed's Pharmacy, Inc. in Overland Park, Kansas, in March; Kansas City Nursing Services, Inc. in Kansas City, Kansas, Enloe Drugs, Inc. in Decatur, Illinois and Anderson Medical Services, Inc., in Dover, Ohio, all in the fourth quarter.\nThe Specialized, Evergreen and Lo-Med acquisitions were accounted for as pooling of interests transactions. Prior period financial statements have been restated to include the historical results of Specialized and Evergreen. The impact of the Lo-Med transaction on the Company's historical financial statements is not significant; consequently, prior period financial statements have not been restated for this transaction. All other acquisitions have been accounted for as purchase transactions. The purchase prices have been allocated to the estimated fair value of the tangible and intangible net assets acquired. The following table summarizes the aggregate purchase price for all businesses acquired which have been accounted for under the purchase method (in thousands):\nAmounts payable in the future are subject to set-off for claims of indemnity. Amounts contingently payable totaled $11.2 million at December 31, 1995 and, if paid, will be recorded as additional purchase price, serving to increase goodwill in the period in which the contingencies are resolved. The 1995 acquisitions carry certain pre-acquisition contingencies which will be resolved within one year of the transaction and which aggregate $3.6 million at December 31, 1995. The pre-acquisition contingencies for the 1994 acquisitions totaled $1.3 million at December 31, 1994.\nCash in the above table represents payments made in the year of acquisition. This amount differs from cash paid for the acquisition of the businesses in the Consolidated Statement of Cash Flow due primarily to purchase price payments made during the year pursuant to acquisition agreements entered into in prior years.\nWarrants outstanding as of December 31, 1995 represent the right to purchase 516,000 shares of common stock and were issued in connection with certain acquisitions. These warrants can be exercised at any time through 1998 at prices ranging from $13.43 to $23.64 per share. Warrants to purchase 34,000 shares of common stock, issued in prior years, were exercised in 1995.\nThe results of operations of the companies acquired in purchase transactions have been included in the consolidated results of operations of the Company from the dates of acquisition. Unaudited pro forma data (net of the cost of capital related to the cash purchase prices) as though the Company had acquired these businesses at the beginning of each of the years are set forth below and include the pooling transactions with Specialized, Evergreen and Lo-Med (in thousands except per share data):\n(a) 1993's pro forma data do not include any businesses acquired in 1995 and, therefore, are not comparable to the 1995 and 1994 pro forma data.\nThe pro forma information does not purport to be indicative of operating results which would have occurred had the acquisitions been made at the beginning of the respective periods or of results which may occur in the future.\nNOTE 3 - CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES A summary of cash and cash equivalents and marketable securities follows (in thousands):\nRepurchase agreements represent investments in U.S. Treasury bills under agreements to resell, usually overnight, but in no case longer than 30 days. The Company has a collateralized interest in the underlying securities, which are segregated in the accounts of the bank counterparty. At December 31, 1994, Fifth Third Bank of Cincinnati, Ohio was the counterparty for $19,446,000 of the repurchase agreements, which matured on January 3, 1995.\nNOTE 4 - PROPERTIES AND EQUIPMENT\nA summary of properties and equipment follows (in thousands):\nNOTE 5 - LEASING ARRANGEMENTS\nThe Company has operating leases which cover various real and personal property. In most cases, the Company expects that these leases will be renewed or replaced by other leases in the normal course of business. There are no contingent rentals in the Company's operating leases.\nThe following is a schedule of future minimum rental payments required under operating leases that have initial or remaining noncancellable terms in excess of one year at December 31, 1995 (in thousands):\n1996 $ 2,951 1997 2,760 1998 2,426 1999 1,784 2000 1,352 Later years 3,404 ------- Total minimum payments required $14,677 ======= Total rent expense under operating leases follows (in thousands):\nFor the years ended December 31,\n1993 $3,035 1994 3,470 1995 4,567\nNOTE 6 - LONG-TERM DEBT\nA summary of long-term debt follows (in thousands):\nOn October 1, 1993, the Company issued $80,500,000 principal amount of 5.75% Convertible Subordinated Notes (\"Notes\") due 2003. The Notes are convertible into common stock at any time at the option of the holder at a price of $14.44 per share. The Notes are redeemable at the option of the Company beginning in October 1996, at redemption prices ranging from 103.83% of the principal amount in 1996 to 100.64% in 2001 and 100% thereafter. Absent conversion of the Notes into common stock or redemption by the Company at its election as described above, the Notes are due on October 1, 2003. Interest on the notes is payable semiannually, due in October and April of each year, until conversion or redemption. Debt issuance costs are included in other assets and amortized using the straight-line method over the 10 year life of the Notes. The Company amortized $310,000 of deferred debt issuance costs in both 1995 and 1994. Based on the market value of the Notes in the last over-the-counter trade prior to year-end, the estimated fair value of the Notes at December 31, 1995 was $250,000,000. The fair value of all other financial instruments of the Company approximates the amounts presented on the consolidated balance sheet.\nIn 1988, the Company established an Employee Stock Ownership Plan (\"ESOP\") which currently covers certain acquired entities' employees and corporate headquarters employees. The ESOP used proceeds from a $4 million bank loan to purchase 986,874 shares of the Company's common stock on the open market at prices ranging from $3.88 to $4.25 per share. Inasmuch as the Company has guaranteed the repayment of this obligation, it has recorded the ESOP's bank debt as long-term debt and also as a reduction of stockholders' equity in the accompanying consolidated balance sheet.\nThe ESOP services its debt with Company contributions, which were previously made to the Company's Employee Savings and Investment Plan, and dividends received on shares held by the ESOP. Principal and interest payments on the bank debt are made in increasing quarterly installments over a ten-year period, the final payment being due on December 31, 1998. The loan bears interest at the per annum rate of 7% and is secured by the unallocated shares of common stock held by the ESOP trust. These unallocated shares had a fair market value equal to $18,230,000 at December 31, 1995.\nThe Company funds ESOP expense as accrued. The components of total ESOP expense are as follows (in thousands):\nAt December 31, 1994, $3,670,000 was outstanding and $1,330,000 was available for borrowing under the Specialized line of credit. The interest rate charged equaled 1.75% over the bank's prime rate (10.25% at December 31, 1994). The weighted average interest rate charged on the Specialized line of credit was 10.25% for 1995 and 1994 and 7.75% for 1993. Amounts outstanding under the line of credit were repaid and the line was closed during 1995.\nSpecialized notes payable represented various obligations incurred specific to Specialized operations. The weighted average interest rate on the notes approximated 10.1%, 10.7% and 8.8% for 1995, 1994 and 1993, respectively. Included in Specialized notes payable are notes due to the former owners of Specialized for $379,000 as of December 31, 1994. All of these obligations were repaid in 1995.\nIn February 1995, the Company reached an agreement with a consortium of six banks for a five-year $135 million revolving line of credit. Borrowings under this agreement bear interest based upon the bank's cost of funds plus a spread of 25 to 75 basis points, dependent upon the Company's performance under certain debt covenants, or the prime rate. Additionally, a commitment fee on the unused portion of the facility is required which ranges from 10 to 25 basis points, and is also based upon the Company's performance under certain debt covenants. No amounts were outstanding under this agreement at December 31, 1995.\nThe following is a schedule by year of required long-term debt payments as of December 31, 1995 (in thousands): 1996 $ 1,051 1997 984 1998 1,100 1999 163 2000 - Later years 80,445 ------ $83,743 ======\nTotal interest payments made in 1995, 1994 and 1993 amounted to $5,421,000, $6,145,000 and $1,684,000, respectively.\nNOTE 7 - PUBLIC OFFERING OF COMMON STOCK\nIn November 1994, the Company completed a public offering of 8,280,000 shares of common stock of which 3,247,482 shares were sold by the Company resulting in net proceeds of $59,211,000 after deducting issuance costs.\nNOTE 8 - STOCK INCENTIVE PLANS\nThe Company has stock incentive plans under which it may grant stock awards or options to purchase its common stock at a price equal to the market value at the date of grant. These options become exercisable beginning one year following the date of grant in four approximately equal annual installments.\nThe changes in stock options outstanding relating to these plans are summarized below:\nAt December 31, 1995, options for 373,886 shares (1994-363,186; 1993-424,512) were exercisable and 405,986 shares (1994-5,424; 1993-107,680) were available for granting of additional stock options and awards.\nDuring 1995, the Company's Board of Directors and stockholders approved the 1995 Premium-Priced Stock Option Plan, providing options to purchase 1,260,000 shares of Company common stock available for grant at an exercise price of 125% of the stock's fair market value at the date of grant. No options have been issued under this plan.\nIn 1995 and 1994, the Company granted restricted stock awards to certain key employees covering 99,472 and 98,656 shares, respectively, of common stock. No such stock awards were granted in 1993. These shares vest over a five-to seven-year period and are restricted as to the transfer of ownership.\nIn 1995, 1994 and 1993, the Company granted unrestricted stock awards covering 3,200, 3,600 and 4,200 shares, respectively, of its common stock to members of the Board of Directors of the Company.\nNOTE 9 - RELATED PARTY TRANSACTIONS\nThe Company contracted with a subsidiary of Chemed Corporation (Chemed), a 2% stockholder, to assist in the development of a new data processing system to integrate and standardize all operational and financial reporting functions.\nThe Company also subleases its corporate offices from Chemed and is charged for the occasional use of Chemed's corporate aviation department and other incidental expenses based on Chemed's cost. The Company believes that the method by which such charges are determined is reasonable and that the charges are essentially equal to that which would have been incurred if the Company had operated as an unaffiliated entity. Charges to the Company for these services were $4,535,000, $2,951,000 and $1,624,000 in 1995, 1994 and 1993, respectively. Net amounts owed by the Company to Chemed were $667,000 and $845,000 at December 31, 1995 and 1994, respectively.\nIncluded in accounts receivable are amounts due from companies affiliated with the former owners of Evergreen. These amounts, net of payables, totaled $479,000 and $850,000 at December 31, 1995 and 1994, respectively.\nEffective May 1, 1993, Evergreen leased one of its facilities from a partnership, a partner of which is a former owner of Evergreen. Rent expense of $549,000, $569,000 and $437,000 was paid under this lease in 1995, 1994 and 1993, respectively.\nNOTE 10 - EMPLOYEE BENEFIT PLANS\nThe Company has a non-contributory, defined benefit pension plan covering certain corporate headquarters employees and the employees of a company sold by Omnicare in 1992, for which benefits ceased accruing upon the sale. Benefits accruing under this plan to corporate headquarters employees were fully vested and frozen as of January 1, 1994.\nRetirement benefits are based primarily on an employee's years of service and compensation near retirement. Plan assets are invested in U.S. Treasury obligations. The Company's policy is to fund pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.\nThe funded status of the plan was as follows (in thousands):\nThe components of the Company's pension (income) cost follow (in thousands):\nActuarial assumptions used to calculate the prepaid pension asset and pension (income) cost include a 7.25% discount rate as of December 31, 1995 (8% at December 31, 1994 and 1993), an expected long-term rate of return on assets of 8% and a 6% rate of increase in compensation levels in years prior to 1994.\nExpenses relating to the Company's defined contribution and other similar plans (including the ESOP described in Note 6) were $1,700,000, $1,536,000 and $940,000 in 1995, 1994 and 1993, respectively.\nIn 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The adoption did not have a material impact on the Company's financial position or results of operations.\nNOTE 11 - INCOME TAXES\nThe provision for income taxes is comprised of the following (in thousands):\nTax benefits related to the exercise of stock options and stock awards have been credited to paid-in capital in amounts of $1,357,000, $947,000 and $234,000 for 1995, 1994 and 1993, respectively.\nThe difference between the Company's reported income tax expense and the federal income tax expense computed at the statutory rates of 35% for 1995 and 1994 and 34% for 1993 is explained in the following table (in thousands):\nThe Omnibus Budget Reconciliation Act of 1993 permitted the Company to deduct from taxable income the amortization of intangibles arising from certain business acquisitions occurring subsequent to July 1991. The effect of this change in tax law was to reduce 1993 income tax expense by $310,000 for the period July 1991 through December 31, 1992 and by an additional $140,000 for the portion of 1993 prior to enactment of the law.\nEffective January 1, 1993, the Company adopted SFAS No. 109, which requires the use of an asset and liability method of accounting for income taxes. The cumulative effect of this adoption resulted in a gain of $280,000 ($.01 per share) and was otherwise not material to the Company's financial position or results of operations.\nIncome tax payments made in 1995, 1994 and 1993 amounted to $14,014,000, $5,569,000 and $11,412,000, respectively.\nA summary of deferred tax assets and liabilities follows (in thousands):\nThe Company has evaluated its net deferred tax asset position and has concluded that a valuation allowance is not required as these net assets are more likely than not to be realized.\nNOTE 12 - SUMMARY OF QUARTERLY RESULTS (UNAUDITED)\nThe following table presents the Company's quarterly financial information for 1995 and 1994 (in thousands except per share data):\n[FN] (a) Earnings per share is calculated independently for each quarter and the sum of the quarters may not necessarily be equal to the full year earnings per share amount.\n(b) The quarterly information presented above for periods prior to the pooling of interests with Specialized on June 30, 1995 has been restated to include Specialized's results of operations.\n(c) Includes pooling of interests expenses of $1,292,000 pretax, or $989,000 after taxes ($.04 per primary share and $.03 fully diluted). Net income, excluding this charge, for the year ended December 31, 1995 was $25,749,000 ($.98 per primary share and $.89 fully diluted).\n(d) Includes pooling of interests expenses of $2,380,000 pretax, or $1,860,000 after taxes ($.08 per primary share and $.07 fully diluted). Net income, excluding this charge, for the year ended December 31, 1994 was $15,391,000 ($.68 per primary share and $.66 fully diluted).\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nExcept for information regarding the Company's executive officers included in Part I of this Form 10-K, the information required under this Item is set forth in the Company's 1996 Proxy Statement which is incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation required under this Item is set forth in the Company's 1996 Proxy Statement which is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required under this Item is set forth in the Company's 1996 Proxy Statement which is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under this Item is set forth in the Company's 1996 Proxy Statement which is incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements\nThe 1995 Consolidated Financial Statements of Omnicare are included in Part II, Item 8.\n(a)(2) Financial Statement Schedule\nSee Index to the Financial Statement Schedule at page 21 of this Report.\n(a)(3) Exhibits\nSee Index to Exhibits at page E-1 of this Report.\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1995, the Company did not file any Report on Form 8-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on this 25 day of March 1996.\nOMNICARE, INC.\nMarch 25, 1996 \/s\/Joel F. Gemunder ---------------------------- Joel F. Gemunder, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/Edward L. Hutton Chairman and Director ---------- - ------------------- | | Edward L. Hutton (Principal Executive Officer) | | \/s\/Joel F. Gemunder President and Director | - ------------------- | Joel F. Gemunder (Principal Executive Officer) | | \/s\/David W. Froesel, Jr. Senior Vice President and | - ------------------------ | David W. Froesel, Jr. Chief Financial Officer | (Principal Financial Officer) | | \/s\/Thomas R. Marsh Vice President and Controller | - ------------------ | Thomas R. Marsh (Principal Accounting Officer) | | Ronald K. Baur, Director* --- | Kenneth W. Chesterman, Director* | | Charles H. Erhart, Jr., Director* | | Mary Lou Fox, Director* | | Thomas C. Hutton, Director* | March 25, 1996 Patrick E. Keefe, Director* | | Sandra E. Laney, Director* | | Andrea R. Lindell, Director* | | Sheldon Margen, M.D., Director* | | Kevin J. McNamara, Director* | | John M. Mount, Director* | | Timothy S. O'Toole, Director* | | D. Walter Robbins, Jr., Director* --- ----------\n* Cheryl D. Hodges, by signing her name hereto, signs this document on behalf of herself as a director and on behalf of each person indicated above pursuant to a power of attorney duly executed by such person and filed with the Securities and Exchange Commission.\n\/s\/Cheryl D. Hodges -------------------------- Cheryl D. Hodges (Attorney-in-Fact)\nSchedule II\nOMNICARE, INC. AND SUBSIDIARY COMPANIES Valuation and Qualifying Accounts (in thousands)\nS-1\nINDEX OF EXHIBITS ----------------- Previous Document or Location Herein ------------------ Number Refers to Item 601 Exhibit Regulation S-K and Type of Filing Previous Exhibit Sequence Description of Exhibit and Filing Date Page Number - -------- ----------------------- --------------- ----------------\n1 ( 3) Restated Certificate of Form S-3 E-2 - E-6 Incorporation of Omnicare, Registration Inc. No. 33-59689\n2 (3.1) By-Laws of Omnicare, Inc., Form 10-K E-4 - E-13 as amended March 26, 1993\n3 (4.1) Indenture dated as of Form 8-K E-1 - E-95 October 1, 1993 October 20, 1993 between Omnicare, Inc. and NBD Bank, N.A., Trustee, as amended October 20, 1993, for the 5-3\/4% Convertible Subordinated Notes due 2003.\n4 (5.1) Revolving Credit Agreement Form 10-Q 14 dated April 7, 1995 August 14, 1995\n5 (10.1) Executive Salary Protec- E-3 - E-8 tion Plan, as amended, May 22, 1981\n6 (10.2) 1981 Stock Incentive Plan, Form 10-K E-3 - E-14 as amended March 25, 1988\n7 (10.3) 1989 Stock Incentive Plan Proxy Statement A-1 - A-6 for 1989 Annual Meeting of Stock- holders dated April 10, 1989\n8 (10.4) 1992 Long-Term Stock Proxy Statement A-1 - A-9 Incentive Plan for 1992 Annual Meeting of Stock- holders dated April 6, 1992\n9 (10.5) 1995 Premium-Priced Proxy Statement A-1 - A-6 Stock Option Plan for 1995 Annual Meeting of Stock- holders dated April 10, 1995\n10 (10.6) Excess Benefits Plan Form 10-K E-22 - E-32 March 25, 1988\n11 (10.7) Asset Purchase Agreement Form 8-K E-1 - E-68 dated as of March 18, April 7, 1993 1993 between Omnicare, Inc. and Clar-Ron, Inc.\n12 (10.8) Asset Purchase Agreement Form 8-K E-1 - E-87 dated as of September 2, September 2, 1994 1994 between Omnicare, Inc. and Evergreen Pharmaceu- tical, Inc.\nE-1 INDEX OF EXHIBITS ------------------ Previous Document or Location Herein ------------------ Number Refers to Item 601 Exhibit Regulation S-K and Type of Filing Previous Exhibit Sequence Description of Exhibit and Filing Date Page Number - -------- ------------------------- --------------- ----------------\n13 (10.9) Form of Indemnification Proxy Statement A-1 - A-4 Agreement with Directors for 1987 Annual and Officers Meeting of Stock- holders dated April 14, 1987\n14 (10.10) Employment Agreements Form 10-K E-83 - E-126 with J. F. Gemunder and March 29, 1989 C. D. Hodges dated August 4, 1988\n15 (10.11) Amendment to Employment Form 10-K E-32 - E-35 Agreements with J. F. March 25, 1994 Gemunder and C. D. Hodges dated May 17, 1993\n16 (10.12) Employment Agreement Form 10-K E-36 - E-52 with T. R. Marsh dated March 25, 1994 August 4, 1988 and Amendment dated May 17, 1993\n17 (10.13) Employment Agreement with Form 10-K E-4 - E-18 P. E. Keefe dated March March 25,1994 4, 1993\n18 (10.14) Employment Agreement with Form 10-K E-19 - E-31 K. W. Chesterman dated March 25, 1994 May 17, 1993\n19 (10.15) Amendment to Employment Form 10-K E-3 - E-7 Agreements with J. F. March 25, 1995 Gemunder, K. W. Chesterman, P. E. Keefe, C. D. Hodges and T. R. Marsh dated May 16, 1994\n20 (10.16) Amendment to Employment E-9 - E-12 Agreements with J. F. Gemunder, K. W. Chesterman, P. E. Keefe and C. D. Hodges dated May 15, 1995\n21 (10.17) Split Dollar Agreement E-13 - E-24 with E. L. Hutton dated June 1, 1995 (Agreement in the same Form exists with J. F. Gemunder)\n22 (10.18) Split Dollar Agreement E-25 - E-35 with K. W. Chesterman dated June 1, 1995 (Agreements in the same Form exists with the following Executive Officers: C. D. Hodges and P. E. Keefe)\n23 (11) Statement re: Computation E-36 of Earnings per Common Share\n24 (12) Statement of Computation of Ratio E-37 of Earnings to Fixed Charges\n25 (21) Subsidiaries of Omnicare, Inc. E-38\n26 (23.1) Consent of Price Waterhouse LLP E-39\n27 (23.2) Consent of BDO Seidman, LLP E-40\n28 (24) Powers of Attorney E-41 - E-53\nE-2","section_15":""}
{"filename":"66895_1995.txt","cik":"66895","year":"1995","section_1":"ITEM 1. BUSINESS\nMississippi Chemical Corporation (the \"Company\") was incorporated in Mississippi on May 23, 1994, and is the successor by merger, effective July 1, 1994, to a business which was formed in 1948 as the first fertilizer cooperative in the United States (the \"Cooperative\"). The address of the Company's principal executive office is Owen Cooper Administration Building, Highway 49 East, Yazoo City, Mississippi 39194, and its telephone number is (601) 746-4131. The term \"Company\" includes Mississippi Chemical Corporation and its wholly owned subsidiaries, Mississippi Phosphates Corporation and Mississippi Potash, Inc. References to the Company's operations prior to July 1, 1994, refer to the Cooperative's operations.\nThe Cooperative was incorporated in Mississippi in September 1948 and operated as a cooperative in accordance with the applicable provisions of the Internal Revenue Code. The principal business of the Cooperative was to provide fertilizer products to its shareholders pursuant to preferred patronage rights which gave the shareholders the right to purchase fertilizer products and receive a patronage refund on fertilizer purchases. On June 28, 1994, the shareholders of the Cooperative approved a plan of reorganization (the \"Reorganization\"), pursuant to which the Cooperative was merged into the Company. Pursuant to the Reorganization, the capital stock of the Cooperative was converted into common stock and\/or cash. As a result of the Reorganization, the Company no longer operates as a cooperative, but as a regular business corporation.\nIn June 1994, the Cooperative divested a majority of its interest in Newsprint South, Inc., its newsprint manufacturing subsidiary. In fiscal 1995, the Company paid approximately $9 million to a third party as the final portion of the divestiture costs.\nNITROGEN FERTILIZER\nProducts\nThe Company produces nitrogen fertilizers at its Yazoo City, Mississippi, production facility in Yazoo City, Mississippi, and through a 50%-owned production facility at Donaldsonville, Louisiana. The Louisiana facility (\"Triad\") is operated as a joint venture by the Company and First Mississippi Corporation. In fiscal 1995, the Company sold over 1.7 million tons of nitrogen fertilizers to farmers, fertilizer dealers and distributors located primarily in the southern United States. Sales of nitrogen fertilizer products by the Company in fiscal 1995 were $240.7 million, which represented approximately 62% of net sales.\nThe Company's principal nitrogen products include ammonia; fertilizer-grade ammonium nitrate, which is sold under the Company's trade name Amtrate(R); UAN solutions, which are sold under the Company's trade name N-Sol; and urea.\nAlthough, to some extent, the various nitrogen fertilizers are interchangeable, each has its own distinct characteristics which produce agronomic preferences among end-users. Farmers decide which type of nitrogen fertilizer to apply based on the crop planted, soil and weather conditions, regional farming practices and relative nitrogen fertilizer prices.\nAmmonia. The basic nitrogen product is anhydrous ammonia, which is the simplest form of nitrogen fertilizer. Anhydrous ammonia, which is 82% nitrogen, is the most concentrated form of nitrogen fertilizer available. It is synthesized as a gas under high temperature and pressure. The raw materials used to produce anhydrous ammonia are natural gas, atmospheric nitrogen and steam.\nIn fiscal 1995, the Company produced approximately 728,000 tons of anhydrous ammonia at its Yazoo City and Triad facilities and purchased approximately 50,000 tons. The Company sold approximately 35,000 tons of anhydrous ammonia for direct-application fertilizer and industrial sales and used the balance as a raw material to manufacture its other nitrogen fertilizer products. The Company's subsidiary Mississippi Phosphates Corporation also purchased 171,000 tons of ammonia for use in its phosphate operations. See \"Phosphate Fertilizer.\"\nIn the Company's markets, ammonia is used primarily as a pre-emergent fertilizer for most row crops. Although anhydrous ammonia is the least expensive form of nitrogen, its use as a primary fertilizer has gradually declined because of the difficulties of application and the high cost of application equipment.\nAmmonium Nitrate. The Company is the largest manufacturer and marketer of ammonium nitrate fertilizer in the United States. Ammonium nitrate, which is 34% nitrogen, is produced by reacting anhydrous ammonia and nitric acid. Ammonium nitrate is less subject to volatilization (evaporation) losses than other nitrogen fertilizer forms. Due to its stable nature, ammonium nitrate is the product of choice for such uses as pastures and no-till row crops where fertilizer is spread upon the surface and is subject to volatilization losses. Although the consumption of ammonium nitrate in the U.S. has been stable in recent years, the use of conservation tillage, which reduces soil erosion, is increasing in the U.S. and should have a positive impact on ammonium nitrate demand.\nIn fiscal 1995, the Company sold approximately 857,000 tons of solid ammonium nitrate fertilizer, the majority of which was produced at the Company's Yazoo City facility, and the balance of which was purchased from third parties, primarily Air Products and Chemicals, Inc. (\"Air Products\"). The ammonium nitrate produced at the Company's Yazoo City facility is sold under the registered trade name Amtrate(R). Due to its superior shipping and storage characteristics, Amtrate(R) has established excellent brand name recognition and a reputation as a high-quality product.\nIn September 1994, the Company and Air Products concluded arrangements whereby the Company agreed to purchase all of the ammonium nitrate fertilizer produced at Air Products' Pace, Florida, facility (up to 240,000 tons per year) during the 15-year term of the agreement. Approximately 144,000 tons of ammonium nitrate were purchased in fiscal 1995 pursuant to this agreement. Air Products recently announced its intention to suspend ammonium nitrate production at its Pace facility until October 1996 due to sustained high ammonia costs.\nN-Sol. In fiscal 1995, the Company sold approximately 609,000 tons of N-Sol, the vast majority of which it produces at its Yazoo City facility. N-Sol is a 32% nitrogen product that is made by mixing urea liquor and ammonium nitrate liquor. N-Sol is used in direct application to cotton, corn, grains and pastures as well as for use in liquid fertilizer blends. Over the past 20 years, there has been a substantial shift in product preference from directly applied ammonia to UAN solutions because of the difficulties of applying and the high cost of application equipment for ammonia.\nUrea. In fiscal 1995, the Company sold approximately 171,000 tons of prilled urea and approximately 77,000 tons of urea melt which it produces at its Triad facility. Under a long-term contract with Melamine Chemicals, Inc. (\"Melamine\"), the Company is obligated to sell up to 75,000 tons per year of urea melt at prevailing market prices to Melamine's facility located adjacent to the Triad facility. Urea is synthesized by the reaction of ammonia and carbon dioxide and then solidified in prill form. At 46% nitrogen by weight, urea is the most concentrated form of dry nitrogen. Because urea undergoes a complex series of changes within the soil before the nitrogen it contains is ultimately converted into a form which can be used by plants, it is considered a long-lasting form of nitrogen. As a fertilizer product, urea is acceptable as both a direct-application material and as an ingredient in fertilizer blends. Urea consumption has increased modestly in recent years. In the Company's trade area, prilled urea is used primarily for topdressing rice. Most of the Company's prilled urea is aerially broadcast on rice crops in Arkansas, Louisiana, Mississippi and Texas.\nProduction and Properties\nYazoo City, Mississippi. The Yazoo City facility is a closely integrated, multi-plant nitrogen fertilizer production complex located on approximately 1,180 acres. The complex includes an anhydrous ammonia plant, four nitric acid plants, an ammonium nitrate plant and a UAN solutions plant. In 1993, the Company spent $32 million to expand its nitrogen production capacity at its Yazoo City facility, which increased nitric acid production capacity by approximately 300 tons per day and ammonium nitrate capacity by approximately 375 tons per day.\nThe Yazoo City ammonia plant has been continuously retrofitted to incorporate energy-saving technology and improve efficiencies. The Yazoo City facility includes a 20.5 megawatt cogeneration facility which produces significant savings by the sequential generation of electricity and process steam. The Yazoo City plant has direct access to water, rail and truck transportation and is strategically located for the purchase of competitively priced natural gas. See \"-Raw Materials-Natural Gas.\"\nDonaldsonville, Louisiana. The Triad facility is a closely integrated, multi-plant nitrogen fertilizer complex located on approximately 46 acres fronting the Mississippi River. At the Triad plant, the Company produces anhydrous ammonia and urea. The Company is entitled to one-half of the production from the Donaldsonville facility as the co-owner of Triad with First Mississippi Corporation. The Triad ammonia plant has been retrofitted on several occasions to increase production and enhance operating efficiency.\nTriad has ready access to rail and truck transportation. The plant is also equipped with a deep-water port facility on the Mississippi River, allowing access to economical barge and ship transport for its urea and ammonia products. The Triad facility is well positioned for the purchase of natural gas. See \"- Raw Materials-Natural Gas.\"\nTrinidad. In December 1994, the Company signed a letter of intent with Farmland Industries, Inc., to enter into a 50-50 joint venture, known as Farmland MissChem Limited, to construct and operate a 1,900-short-ton-per-day ammonia plant to be located on the island of Trinidad. The project is expected to cost approximately $330 million. The joint venture is in the process of finalizing its plant site, negotiating a construction contract, and completing financing arrangements. Start-up of the facility is scheduled for 1998. The Company intends to use the majority of its portion of the production from the new facility, expected to be in excess of 300,000 tons per year, primarily as a raw material for upgrading into finished fertilizer products at its existing facilities.\nMarketing and Distribution\nThe Company sells its nitrogen fertilizer products to farmers, dealers and distributors located primarily in the southern farming regions of the United States where its facilities are located. In the three-tiered fertilizer distribution chain, distributors operate as wholesalers supplying dealers who, in turn, sell directly to farmers. Larger customers (distributors and large multi-location dealers) arrange for distribution, storage and financing of nitrogen fertilizer. The majority of the Company's sales are made to distributors and large dealers. The ten states which make up the Company's primary trade area are Mississippi, Alabama, Arkansas, Texas, Louisiana, Oklahoma, Georgia, Florida, Tennessee and Kentucky.\nThe Company maintains a large and experienced field sales force strategically located throughout the southern United States. This sales force maintains close communications with the customer base and plays an important role in the marketing and distribution of the Company's products. Through regular, personal contact with its customers, the Company is able to ascertain local demand for fertilizer products and arrange to have those products available from the most cost-effective source. The Company's field sales force is also able to identify specific customer service needs which the Company can meet. Customer service helps differentiate the Company's products and enhance its position as a preferred supplier.\nThe Company transports its nitrogen products by barge, rail and truck. The Company's distribution network is complemented by owned or leased warehouses and terminals strategically placed in high-consumption areas.\nPHOSPHATE FERTILIZER\nProducts\nThe Company produces diammonium phosphate fertilizer (\"DAP\") at its facility in Pascagoula, Mississippi. In fiscal 1995, the Company sold approximately 713,000 tons of DAP, primarily into international markets. Sales of DAP by the Company in fiscal 1995 were $117.5 million, which represented approximately 30% of net sales.\nDAP is the most common form of phosphate fertilizer. DAP is produced by reacting phosphate rock with sulfuric acid to produce phosphoric acid, which is then combined with ammonia. DAP contains 18% nitrogen and 46% phosphate (P205) by weight. DAP is an important fertilizer product for both direct application and for use in blended fertilizers applied to all major types of row crops.\nProduction and Properties\nThe Company's phosphate production complex in Pascagoula, Mississippi, is located on approximately 1,500 acres. The Pascagoula facility is a closely integrated, multi-plant phosphatic fertilizer complex where the primary facilities are a phosphoric acid plant, two sulfuric acid plants and a DAP granulation plant. The plant has storage facilities for finished product (45,000 tons), as well as for the primary raw materials, phosphate rock (100,000 tons), sulfur (10,000 tons) and ammonia (25,000 tons). All of the phosphate rock used by the Company is purchased pursuant to a single supply contract with Office Cherifien des Phosphates (\"OCP\"), the national phosphate company of Morocco. See \"-Raw Materials-Phosphate Rock.\"\nThe plant site fronts a deep-water channel that provides direct access to the Gulf of Mexico. The complex contains docks and off-loading facilities for receiving shipload quantities of phosphate rock, sulfur and ammonia, and for outloading DAP. The plant's location on deep water provides the Company with an outbound freight cost advantage over central Florida DAP producers with respect to international shipments and domestic shipments along the Mississippi River system.\nMarketing and Distribution\nThe Company sells substantially all of its DAP to Atlantic Fertilizer & Chemical Corporation (\"Atlantic\"), the exclusive distributor of its DAP products. Atlantic maintains a network of sales agents in the major phosphate fertilizer-consuming nations around the world. Sales to Atlantic are made on an FOB Pascagoula basis at a price which reflects the price Atlantic charges its customers, adjusted to reflect Atlantic's commission. Sales to Atlantic for the export market are backed by standby letters of credit.\nIn fiscal 1995, approximately two-thirds of the Company's DAP was sold into international markets. The largest export markets in fiscal 1995 were India, China and countries within Central and South America. Most domestic sales are made in barge-lot quantities to major fertilizer distributors and dealers located on the Mississippi River system. The vast majority of the Company's DAP is transported by ship and barge, although truck and rail access is also available.\nPOTASH FERTILIZER\nProducts\nThe Company produces potash at its mine and related facilities near Carlsbad, New Mexico. In fiscal 1995, the Company sold approximately 357,000 tons of potash primarily in granular form. These sales were primarily to customers located west of the Mississippi River. In May 1994, the Company completed an expansion of its Carlsbad facility for $1.6 million, bringing its capacity for granular product to approximately 420,000 tons per year. Sales of potash fertilizer by the Company in fiscal 1995 were $27.4 million, which represented approximately 7% of net sales.\nThe Company's potash is mined from subterranean salt deposits containing a mixture of potassium chloride and sodium chloride. The Carlsbad, New Mexico, potash deposits are located from 800 to 1,200 feet below the surface. Potash is produced in a refining process whereby the potassium chloride is separated from the sodium chloride.\nThe Company produces red granular potash. The three principal grades of potash fertilizer are granular, coarse and standard, with granular being the largest particle size. Granular potash is used as a direct-application fertilizer and, among the various grades, is particularly well suited for use in fertilizer blends. Potash is an important fertilizer product for both direct application and for use in blended fertilizer applied to all major types of row crops.\nProduction and Properties\nThe Company's potash mine and refinery are located approximately 25 miles east of Carlsbad, New Mexico. In fiscal 1994, the Company completed a $5 million project to modernize its mining equipment, enabling it to extract a higher grade of ore which improved overall facility efficiencies. The mine supplies ore to an above-ground refinery which separates the potassium chloride from the ore. The run-of-mine refined product is then transported to the Company's nearby compaction plant for conversion to granular form. Located contiguous to the compaction facility are storage and shipping facilities from which the finished product is transported by rail and truck into domestic and export markets.\nThe Company's potash reserves are controlled under long-term federal and state potassium leases on approximately 60,000 acres. In addition, the Company holds mineral title to approximately 4,400 acres and fee title to approximately 10,000 acres. Revised estimates of potash ore reserves underlying the Carlsbad properties were compiled in 1981 and 1983. According to these estimates, the Company's reserves were estimated to contain 346.2 million tons of in situ ore with an average grade of 15.25% K20 or 297.9 million tons of recoverable ore with an average grade of 14.88% K20. Since these estimates were made, ore extracted would indicate remaining reserves of 332 million tons of in situ ore with an average grade of 15.27% K2O or 284 million tons of recoverable ore with an average grade of 14.88% K2O. This reserve base is estimated to be equivalent to 56 million tons of muriate of potash. At current production rates, the Company's reserves have a remaining life in excess of 100 years.\nMarketing and Distribution\nThe substantial majority of the Company's potash sales are in domestic markets in the southern states west of the Mississippi River where it and other Carlsbad potash producers enjoy freight cost advantages over Canadian and overseas potash producers. Consistent with the Company's strategy to maximize \"net backs\" (sales less distribution and delivery expense) and increase profit margins, domestic sales are targeted for locations along the freight route of the Santa Fe Railroad. Domestic potash marketing is performed by the Company's sales staff. The Company's export sales are made through Potash Corporation of Saskatchewan Sales Limited. While the typical primary export market for the Company's potash is Latin America, the majority of fiscal 1995 export sales were to France and Japan. Potash for export is transported by rail to terminal facilities in Houston, Texas, where it is loaded onto ocean-going vessels for shipment to export markets.\nRAW MATERIALS\nNatural Gas\nNatural gas is the primary raw material used by the Company in the manufacture of nitrogen fertilizer products. Natural gas is used both as a chemical feedstock and as a fuel to produce anhydrous ammonia which is then upgraded into other nitrogen fertilizer products. During fiscal 1995, the cost of natural gas represented approximately 73% of the Company's cost of producing ammonia. Because there are no commercially feasible alternatives for natural gas in the production of ammonia, the economic viability of the Company's nitrogen business depends upon the availability of competitively priced natural gas.\nIn today's natural gas market, the Company's total natural gas cost generally consists of two components-the market price of the natural gas in the producing area at the point of delivery into a pipeline and the fee charged by the pipeline for transporting the natural gas to the Company's plants. The cost of the transportation component can vary substantially depending on whether or not the pipeline has to compete for the business. Therefore, it is extremely important to the Company's competitiveness that it have access to multiple natural gas transportation services. In addition to the impact on transmission costs, access alternatives enable the Company to benefit from natural gas price differences that may exist from time to time in the various natural gas-producing areas. In recent years, the Company has improved the natural gas purchasing logistics of its nitrogen facilities.\nThe majority of the 54,000 Mcf per day natural gas requirements of the Yazoo City facility is currently being furnished by various producers and marketers who sell gas to the Company at various points along the pipeline system of Southern Natural Gas Company (\"Southern\"). The Company continues to utilize a long-term, interruptible transportation agreement with Southern. Although the Southern contract provides for interruptible service, the Company believes and experience dictates that curtailment of supply is unlikely because of the plant's location on Southern's system. In 1995, the Company entered into a long-term natural gas purchase agreement with Sonat Marketing Company (\"Sonat\"), an affiliate of Southern. Deliveries under the Sonat agreement are scheduled to begin on January 1, 1996. The Sonat agreement provides for market-sensitive pricing and a firm-delivery supply commitment. In addition to being connected to Southern, the Company has also secured long-term transportation capacity in the Thomasville Line (described below), which provides the plant with access to an additional interstate pipeline and a large intrastate gathering and transmission system in southern Mississippi. As a result of this multiple source access, the Company benefits from competition for the transportation and supply of natural gas.\nThe balance of the natural gas requirements of the Yazoo City facility is supplied by Shell Western E&P Inc. (\"SWEPI\"), a subsidiary of Shell Oil Company (\"Shell\"). In 1972, the Company and Shell entered into a gas purchase and sale agreement whereby Shell agreed to supply natural gas to the Yazoo City plant from its natural gas reserves located in Rankin County, Mississippi. Pursuant to its agreement with the Company, Shell constructed a 60-mile pipeline (the \"Thomasville Line\") from its reserves directly to the Yazoo City facility. The primary term of the SWEPI contract expired on March 31, 1994; however, since that date, the Company has continued purchasing the output of the Rankin County reserves (which is currently approximately 20,000 Mcf per day) at market-sensitive prices. It is anticipated that this purchase arrangement will continue for the foreseeable future.\nThe natural gas requirements of the Triad facility are approximately 50,000 Mcf per day. The Triad facility is located in one of the primary gas-producing regions of the United States. The facility is currently connected to five intrastate pipeline systems and benefits from intense competition among those suppliers. Currently, the plant's requirements are being supplied by three of the intrastate lines under various pricing arrangements. Generally, these contracts impose firm delivery obligations at market-sensitive prices. In addition, the Company purchases gas for Triad on the spot market pursuant to 30- to 90-day fixed-price contracts. As a result of Triad's favorable access to natural gas supplies, the Company believes that the loss of any particular supplier would not have a material impact on plant operations. There have been no significant supply interruptions at the Triad facility.\nNatural gas is currently available in ample quantities. Technical advancements in exploration, development and production are keeping supplies in a strong position. Efficient operation of gas storage should continue to dampen seasonal price variations, but shorter-term volatility related to minor system disturbances is expected to continue. The Company uses natural gas futures contracts to hedge against the risk of short-term market fluctuations in the cost of natural gas.\nPhosphate Rock\nPhosphate rock is one of the primary raw materials for the manufacture of DAP. The Pascagoula facility's requirements for phosphate rock are approximately 1.2 million tons per year. As of September 15, 1991, the Company entered into a ten-year contract with Office Cherifien des Phosphates (\"OCP\") to supply all of the phosphate rock requirements of the Pascagoula facility. This contract has been amended and its term extended to June 30, 2003. OCP, the national phosphate company of Morocco, is the world's largest producer and exporter of phosphate rock and upgraded phosphates as a company. The contract price for phosphate rock is based on phosphate rock costs incurred by certain domestic competitors of the Company and on the long-term financial performance of the Company's phosphate operations. Under this formula, the Company realizes favorable phosphate rock prices and is afforded significant protection during periods when market conditions are depressed and its DAP operations are not profitable. As a result, the Company has been able to sustain its operations since reopening the Pascagoula facility in December 1991, despite a sustained period of low prices for phosphate products during fiscal 1993 and 1992. Conversely, in favorable markets, when the Company's DAP operations are profitable, the contract price of phosphate rock will escalate based on the profitability of its DAP operations. Pursuant to this contract, the Company and OCP are required to negotiate further adjustments as needed to maintain the viability and economic competitiveness of the Pascagoula plant. The strategic alliance with OCP has functioned effectively since inception, and the Company considers its relations with OCP to be good.\nSulfur\nSulfur is used in the manufacture of sulfuric acid at the Pascagoula plant. Sulfur is in adequate supply and is available on the open market in quantities sufficient to satisfy the Company's current requirements of 290,000 tons per year. The location of the Company's plant at Pascagoula, Mississippi, near major oil and gas fields which supply substantial amounts of sulfur, provides the Company with a strategic advantage in the purchase of sulfur over its Florida competitors.\nAmmonia\nUntil recently, ammonia has been in adequate supply at depressed prices. In early 1994, intermittent shortages of ammonia, which caused a surge in ammonia prices, developed as a result of increased consumption in agricultural and industrial markets, several unplanned plant outages and reduced imports from the former Soviet Union (\"FSU\"). Heavy demand from industrial and agricultural markets continued into 1995. Ammonia prices have declined from the level reached during spring 1995 but remain at relatively high levels.\nCOMPETITION\nSince fertilizers are global commodities which are available from multiple sources, the primary competitive factor is price. Other competitive factors include product quality, customer service and availability of product. In each product category, the Company competes with a broad range of domestic producers, including farmer cooperatives, subsidiaries of larger companies, integrated energy companies and independent fertilizer companies. Many of the Company's domestic competitors have larger financial resources and sales than the Company. The Company also competes with foreign producers. Foreign competitors are often owned or subsidized by their governments and, as a result, may have cost advantages over domestic companies. Additionally, foreign competitors are frequently motivated by non-market factors such as the need for hard currency.\nThe Company produces and sells nitrogen fertilizer products primarily in the southern United States. Because competition is based largely on price, maintaining low production costs is critical to competitiveness. The Company believes it is one of the lowest-cost producers of nitrogen fertilizers in the United States. Natural gas comprises the majority of the raw materials cost of nitrogen fertilizers. Competitive natural gas purchasing is essential to maintaining the Company's low-cost position. Equally important is efficient use of this gas because of the energy-intensive nature of the nitrogen fertilizer business. Therefore, cost-competitive production facilities that allow flexible upgrading of ammonia to other finished products are critical to a low-cost competitive position. In the highly fragmented nitrogen fertilizer market, product quality and customer service can also be sources of product differentiation.\nThrough Atlantic, the Company sells approximately two-thirds of its DAP in international markets. The United States phosphate industry has become more concentrated as a result of recent consolidations and joint ventures, and the Company is significantly smaller than most of its competitors in terms of resources and sales. Most of the Company's principal competitors have captive sources of some or all of the raw materials, and this may provide them with cost advantages. The Company's long-term phosphate rock contract with its flexible pricing mechanism is a key element to the Company's ability to compete.\nMost potash consumed in the United States is provided by large Canadian producers who have economies of scale and lower variable costs than their U.S. counterparts. Over 80% of United States potash production capacity is located in the Carlsbad, New Mexico, area. While the Carlsbad producers have higher mining costs than the Canadian producers, this disadvantage is offset by logistical and freight advantages in certain markets in the southwestern United States and the lower United States corn belt. The Company competes in these markets primarily with three other Carlsbad potash producers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. OTHER PROPERTIES\nThe Company owns an administration building in Yazoo City which contains approximately 65,000 square feet of office space.\nThe Company's plants are complete with necessary support facilities, such as roads, railroad tracks, storage, offices, laboratories, warehouses, machine shops and loading facilities. Adequate supplies of water and electric power are available at all locations. In addition to the fertilizer storage facilities at Yazoo City and Pascagoula, Mississippi; Carlsbad, New Mexico; and Donaldsonville, Louisiana, the Company also owns or leases 19 major fertilizer storage and distribution facilities at other locations in Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, Tennessee and Texas, with a total system-wide storage capacity of approximately 256,000 tons.\nIn 1980, the Company completed the purchase of phosphate rock property in Hardee County, Florida. This property, containing approximately 12,000 acres, is estimated by the Company to contain approximately 62,000,000 recoverable tons of phosphate rock of commercial quality. During 1990, the Company entered into an agreement granting a third party the exclusive option, for a period of four years, to purchase this undeveloped phosphate rock property. The Company received an aggregate of $14 million in option payments during this four-year period. As of July 12, 1994, the Company and the option holder entered into new agreements with respect to this property whereby (i) the Company conveyed approximately 2,500 acres of this property to the third party; (ii) for aggregate additional option payments of $7 million to be paid during the option period, the Company granted to the third party the exclusive option, for a period of three and one-half years, to purchase the remaining 9,500 acres; (iii) the Company was granted a put option pursuant to which the Company has the right to sell the 9,500 acres to the third party if the third party does not exercise its prior option to purchase the property; and (iv) the Company was granted an exclusive option to repurchase the previously conveyed 2,500 acres in the event the third party does not exercise its option to purchase the 9,500 acres and the Company does not exercise its put option on the 9,500 acres.\nRESEARCH AND DEVELOPMENT\nThe Company has a research and development staff of 13 full-time professional employees whose activities relate primarily to the improvement of existing products. The expenditures on research activities sponsored by the Company during fiscal 1995, 1994 and 1993 were approximately $1.3 million, $1.4 million, and $1.4 million, respectively.\nEMPLOYEES\nAs of June 30, 1995, the Company employed approximately 1,000 persons at all locations. The Company considers its employee relations to be satisfactory.\nCOMPLIANCE WITH ENVIRONMENTAL REGULATIONS\nThe Company's operations are subject to federal, state and local laws and regulations pertaining to the environment, among which are the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Comprehensive Emergency Response Compensation and Liability Act, the Toxic Substances Control Act and the Mississippi State Pollution Prevention Act. The Company's facilities require operating permits that are subject to review by governmental agencies. The Company believes that its policies and procedures now in effect are generally in compliance with applicable laws and with the permits relating to the facilities.\nIn the past, significant capital and operating costs related to environmental laws have been incurred. The majority of the Company's environmental capital expenditures have been in response to the requirements of the Clean Air Act and the Clean Water Act. Since 1967, the Company has spent in excess of $50 million on its fertilizer production facilities in order to meet applicable federal and state pollution standards. The Company has been involved in certain litigation involving a Louisiana waste disposal site. See \"-Legal Proceedings-Combustion, Inc. Litigation.\"\nCapital expenditures related to environmental obligations for the past three fiscal years were approximately as follows: 1995-$7,750,000; 1994-$619,000; and 1993-$7,000,000. A portion of the expenditures for fiscal 1995 relate to the installation of a new scrubber system in two ammonium nitrate prill towers at the Yazoo City facility. These systems will allow operators to reduce the amount of particulate discharged from the facility. Also included in the 1995 expenditure is a portion of the cost of a project which relocates the discharge point of the Yazoo City facility's process waste water from an intermittent stream to the Yazoo River. Included in the foregoing expenditures for fiscal 1993 is a portion of the cost of a new nitric acid plant and related facilities in Yazoo City which was completed in early 1993. This facility increased capacity and also replaced existing production from other plants that were closed. Enhanced environmental protection under the Clean Air Act was a primary factor in the Company's decision to construct the plant.\nEnvironmental capital expenditures are expected to be approximately $11.2 million for fiscal 1996. A portion of these funds relate to the development of a new gypsum disposal facility at Pascagoula. The estimated cost of this facility is expected to be $16.3 million, which amount will be expended over an estimated 16 months. The Company is currently negotiating for the purchase of additional lands for this facility and is seeking the necessary permits for its development.\nDuring fiscal 1994, the Company charged to its earnings approximately $6.1 million relating to the estimated cost of the future closure of the existing gypsum disposal facility located at Pascagoula. In fiscal 1995, the Company charged an additional $562,000 toward this estimated cost of closure. The total accrual of approximately $6.7 million relates to the portion of the disposal facility utilized to date. In future years, the Company expects to record additional charges of approximately $2.4 million related to the anticipated closure costs of the gypsum disposal facility. These charges will be recorded over the estimated five-year remaining life of the facility.\nIn the normal course of its business, the Company is exposed to risks relating to possible releases of hazardous substances into the environment. Such releases could cause substantial damage or injuries. Environmental expenditures have been and will continue to be significant. It is impossible to predict or quantify the impact of future environmental laws and regulations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCombustion, Inc., Litigation. On July 15, 1986, the first of 17 lawsuits was filed in the Twenty-first Judicial District Court, Parish of Livingston, state of Louisiana, against Triad Chemical (a 50%-owned, joint venture) and approximately 90 other named defendants by numerous plaintiffs. The plaintiffs' claims are based on alleged personal injuries and property damages as a result of exposure to hazardous waste allegedly contributed by the defendants to the Combustion, Inc., site in Livingston Parish, Louisiana.\nTriad Chemical recently agreed with the Plaintiffs' Steering Committee in the case to settle the tort claims against it as part of a group settlement by certain defendant companies. Triad Chemical's share of the group settlement is $600,000. Preliminary settlement documents have been filed with the court and procedures are currently underway to obtain the necessary court approval of the settlement as required in class action suits.\nCleve Reber CERCLA Site. Triad has received and responded to letters issued by the United States Environmental Protection Agency (\"EPA\") under Section 104 of the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") relative to the possible disposition of Triad waste at the disposal site identified as the Cleve Reber site in Ascension Parish, Louisiana.\nIt is Triad's position that, based upon available information and records, Triad did not utilize the Cleve Reber site for the disposition of hazardous material, and it does not appear that Triad has any responsibility for investigation and clean-up on this site. It should be noted that the EPA is contemplating an action under the Resource Conservation and Recovery Act, Section 7003, as well as the CERCLA action mentioned above. The EPA has issued Section 106 orders against the major contributors at the site for clean-up. They are now engaged in negotiations for clean-up. In 1994, Triad received a supplemental 104(e) request for information from the EPA, indicating the EPA's renewed interest in pursuing Potential Responsible Persons at the site. Triad filed a Freedom of Information Act request to investigate allegations that some plant trash from Triad may have been disposed of at the Cleve Reber site. In the opinion of management, the likelihood of the CERCLA investigation resulting in a loss in a material amount is remote.\nPotash Antitrust Investigation. On November 24, 1993, the Antitrust Division of the Department of Justice served the Company with a grand jury subpoena in connection with its investigation of allegations of price fixing by United States and Canadian potash producers. The subpoena requests that the Company produce certain documents relating to its potash business in the United States and Canada. The Company has assembled these documents for production. In addition, a number of employees and former employees of the Company have testified before the grand jury regarding the Company's potash operations.\nTerra International, Inc. On August 31, 1995, the Company filed suit in federal court in Mississippi against Terra International, Inc. (\"Terra\") seeking a declaratory judgment and other relief establishing that certain technology relating to the design of an ammonium nitrate neutralizer which the Company licensed to Terra is not defective and was not the cause of an explosion which occurred in 1994 at Terra's Port Neal, Iowa, fertilizer facility. Also, on August 31, 1995, Terra filed suit in federal court in Iowa against the Company seeking damages on the basis of losses caused by the explosion. Terra alleges that the Company negligently designed the ammonium nitrate neutralizer technology licensed to Terra and that that design defect led to the Port Neal explosion. In addition, two lawsuits have been filed in Iowa against the Company on behalf of certain persons killed or injured in the explosion.\nRankin County, Mississippi, vs Jackson Oil Products Company, Inc., et. al. On September 21, 1995, the Company was served with a complaint in which it is named as an additional defendant in the referenced action filed in federal court in Mississippi. The plaintiff seeks to recover clean-up costs in connection with the remediation of a former waste oil processing facility located in Rankin County, Mississippi. The suit alleges that the Company contributed waste oil to the site. The Company is in the process of investigating the allegations.\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 by this item is set forth in the Company's 1995 Annual Report to Shareholders under the caption \"Quarterly Results,\" contained in \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" which 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 Company's 1995 Annual Report to Shareholders under the caption \"Financial Highlights\" 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 is set forth in the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" which information 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 Arthur Andersen LLP dated July 28, 1995, appearing in the Company's 1995 Annual Report to Shareholders are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) The information required by this item regarding directors is set forth in the Company's Proxy Statement for the 1995 annual meeting of shareholders under the captions \"Nominees for Election to Serve Until 1998,\" \"Directors Continuing to Serve Until 1997,\" and \"Directors Continuing to Serve Until 1996,\" which information is incorporated herein by reference.\n(b) Executive officers of the Registrant as of June 30, 1995, are as follows: Executive officers are elected for a one-year term by the Board of Directors.\nOFFICE AND EMPLOYMENT DURING THE NAME OF OFFICER AGE LAST FIVE FISCAL YEARS\nCharles O. Dunn 47 President and Chief Executive Officer since April 1 1993; Executive Vice President (1988- 1993)\nWilliam F. Hawkins 64 Senior Vice President-Finance and Administration since April 28, 1987\nDavid W. Arnold 58 Senior Vice President-Technical Group since July 1, 1991; Senior Vice President-Research and Engineering (1987-1991)\nC. E. McCraw 47 Senior Vice President-Operations since July 12, 1994; Senior Vice President-Fertilizer Group (1991-1994); Vice President-Fertilizer Group (1991); Vice President-Operations (1987-1991)\nRobert E. Jones 48 Vice President and General Counsel since October 24, 1989\nJohn J. Duffy 61 Vice President-Marketing since July 1, 1995; Vice President-Sales and Marketing (1994-1995); Director of Sales and Marketing (1991-1994); Director, Field Sales (1988-1991)\nRosalyn B. Glascoe 51 Corporate Secretary since June 24, 1986\n(c) The information called for with respect to the identification of certain significant employees is not applicable to the Registrant.\n(d) There are no family relationships between the directors and executive officers listed above. There are no arrangements nor understandings between any named officer and any other person pursuant to which such person was selected as an officer.\n(e) There are no legal proceedings involving directors, nominees for directors, or officers.\nThe information required by this item regarding compliance with Section 16(a) of the Exchange Act is set forth in the Company's Proxy Statement for the 1995 annual meeting of shareholders under the caption \"Compliance with Section 16(a) of the Exchange Act,\" which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is set forth in the Company's Proxy Statement for the 1995 annual meeting of shareholders under the captions \"Compensation of Executive Officers\" and \"Retirement Program,\" 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 is set forth in the Company's Proxy Statement for the 1995 annual meeting of shareholders under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Management Ownership of the Company's Stock,\" which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is set forth in the Company's Proxy Statement for the 1995 annual meeting of shareholders under the caption \"Compensation Committee Interlocks and Insider Participation,\" which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) FINANCIAL STATEMENTS AND SCHEDULES\nThe consolidated financial statements, together with the report thereon of Arthur Andersen LLP dated July 28, 1995, appearing in the 1995 Annual Report to Shareholders are incorporated by reference in this Form 10-K. With the exception of the aforementioned information and information incorporated by reference in Items 5, 6, 7 and 8, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this Form 10-K. The following financial statement schedule should also 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 have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. Separate financial statements of 50% or less owned persons accounted for by the equity method which are not shown herein have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary.\n(i)Financial Statements:\nReport of Independent Public Accountants\nConsolidated Balance Sheets, June 30, 1995 and 1994\nConsolidated Statements of Income Years Ended June 30, 1995, 1994 and\nConsolidated Statements of Shareholders' Equity, Years Ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows, Years Ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(ii)Report of Independent Public Accountants on Financial Statement Schedules\n(iii)Exhibits:\nExhibits filed as part of this report are listed below. Certain exhibits have been previously filed with the Commission and are incorporated herein by reference.\nSEC EXHIBIT REFERENCE NO. DESCRIPTION\n1 Shareholder Rights Plan; filed as Exhibit 1 to the Company's Report on Form 8-A dated August 15, 1994, SEC File No. 2-7803, and incorporated herein by reference.\n3.1 Articles of Incorporation of the Company; filed as Exhibit 3.1 to the Company's Amendment No. 1 to Form S-1 Registration Statement filed August 2, 1994, SEC File No. 33-53119, and incorporated herein by reference.\n3.2 Bylaws of the Company; filed as Exhibit 3.2 to the Company's Amendment No. 1 to Form S-1 Registration Statement filed August 2, 1994, SEC File No. 33-53119, and incorporated herein by reference.\n4.1 Revolving Credit\/Term Loan Agreement dated August , 1992, between the Company and NationsBank of Tennessee, purchaser of the Company's Series I Secured Note, Due June 30 1999, in the aggregate principal amount of $20,000,000; filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992, SEC File No. 2-7803, and incorporated herein by reference.\n4.2 Indenture of Mortgage, Deed of Trust, Assignment and Security Agreement dated as of September 1, 1976, among the Company, the New Orleans Bank for Cooperatives, John H. Farrelly, as trustee for the benefit of the New Orleans Bank for Cooperatives under certain deeds of trust, and Deposit Guaranty National Bank); filed as Exhibit B to Exhibit 2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1976, SEC File No. 2-7803, and incorporated herein by reference.\n4.3 Sixteenth Supplemental Indenture dated as of June 30, 1994, between the Company and Deposit Guaranty National Bank.\n4.4 Fifteenth Supplemental Indenture and Amendment to Series I Revolving Credit\/Term Loan Agreement dated as of June 17, 1994, between the Company and Deposit Guaranty National Bank.\n4.5 Fourteenth Supplemental Indenture dated as of June 17, 1994, between the Company and Deposit Guaranty National Bank.\n4.6 Thirteenth Supplemental Indenture dated as of July 16, 1993, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated April 26, 1994, SEC File No. 2-7803, and incorporated herein by reference.\n4.7 Twelfth Supplemental Indenture dated as of August 6, 1992, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992, SEC File No. 2-7803, and incorporated herein by reference.\n4.8 Eleventh Supplemental Indenture dated as of July 16, 1990, between the Company and Deposit Guaranty National Bank, together with Exhibit A thereto, being an Agreement for Real Estate Purchase Option dated July 16, 1990, for the sale of the Company's Hardee County, Florida, property and underlying phosphate reserves; filed as Exhibit 4.2 to Amendment No. 1 of the Company's Report on Form 8 dated November 7, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n4.9 Tenth Supplemental Indenture dated as of December 26, 1989, between the Company and Deposit Guaranty National Bank, together with Exhibit A thereto, being a Note Purchase Agreement dated as of December 26, 1989, between the Company and John Hancock Variable Life Insurance Company, purchaser of the Company's 9.97% Secured Notes, Series , Due 1999, in the aggregate principal amount of $6,000,000; filed as Exhibit 4.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n4.10 Ninth Supplemental Indenture dated as of February 23, 1988, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988, File No. 2-7803, and incorporated herein by reference.\n4.11 Eighth Supplemental Indenture dated as of May 15, 1983, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to Post-Effective Amendment No. 3 to Registration Statement No. 2-71827 and incorporated herein by reference.\n4.12 Seventh Supplemental Indenture dated as of October 1, 1979, between the Company and Deposit Guaranty National Bank; filed as Exhibit 2 to Post-Effective Amendment No. 3 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.13 Sixth Supplemental Indenture dated as of September 1, 1979, between the Company and Deposit Guaranty National Bank, filed as Exhibit 3 to Post-Effective Amendment No. 3 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.14 Fifth Supplemental Indenture dated as of June 1, 1978, between the Company and Deposit Guaranty National Bank; filed as Exhibit 7 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1979, SEC File No. 2-7803, and incorporated herein by reference.\n4.15 Fourth Supplemental Indenture dated as of May 1, 1978, between the Company and Deposit Guaranty National Bank; filed as Exhibit 9 to Post-Effective Amendment No. 2 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.16 Third Supplemental Indenture dated as of June 28, 1977, between the Company and Deposit Guaranty National Bank; filed as Exhibit 6 to Post-Effective Amendment No. 1 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.17 Second Supplemental Indenture dated as of September 30, 1976, among the Company, New Orleans Bank for Cooperatives, John H. Farrelly and Deposit Guaranty National Bank; filed as Exhibit 6 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.18 First Supplemental Indenture, dated as of September 7, 1976, among the Company, New Orleans Bank for Cooperatives, John H. Farrelly and Deposit Guaranty National Bank; filed as Exhibit 3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1976, SEC File No. 2-7803, and incorporated herein by reference.\n10.1 Mississippi Chemical Corporation 1994 Stock Incentive Plan; filed as Appendix A to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.2 Mississippi Chemical Corporation 1995 Stock Option Plan for Nonemployee Directors; filed as Appendix B to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.3 Mississippi Chemical Corporation 1995 Restricted Stock Purchase Plan for Nonemployee Directors; filed as Appendix C to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.4 Purchase Agreement entered into as of September 15, 1994, by and between the Company and Air Products and Chemicals, Inc., for the sale and purchase of ammonium nitrate prills.1\n10.5 Amendment No. 1 to Purchase Agreement entered into as of May 31, 1995, by and between the Company and Air Products and Chemicals, Inc.\n10.6 Agreement effective as of October 1, 1991, entered into by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation; filed as Exhibit 10.1 to Amendment No. 1 to the Company's Report on Form 8 dated January 7, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.7 Amendment of Agreement, effective as of August 1, 1994, to the Agreement entered into as of October 1, 1991, by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation.\n[FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from paragraph 1.5, paragraph 6.1, paragraph 11.1; Exhibit A and Exhibit F of the Purchase Agreement, and an application for confidential treatment has been filed separately with the Commission.\n10.8 Amendment of Agreement, effective as of July 1, 1993, to the Agreement entered into as of October 1, 1991, by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation; filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.9 Agreement made and entered into as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock; filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991, File No. 2-7803, and incorporated herein by reference.\n10.10 Amendment No. 3, effective as of January 1, 1995, to the Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.2\n10.11 Amendment No. 2, effective as of July 1, 1993, to the Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.3\n[FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from Schedule 1 to Amendment No. 3, Exhibit B, and an application for confidential treatment has been filed separately with the Commission.\nPursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from paragraphs numbered 5 and 8 of Amendment No. 2; from the first paragraph, paragra ph numbered 1, paragraph numbered 2, and paragraph numbered 3 of Schedule 1, Exhibit A; from Schedule 2, Exhibit B; from Schedule 3, Exhibit C, and from Schedule 4, Exhibit D; and an application for confidential treatment has been filed separately with the Commission.\n10.12 Amendment No. 1, effective as of July 1, 1992, to the Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.4\n10.13 Gas Sales Agreement entered into by the Company and Sonat Marketing Company as of July 13, 1995, for the sale and purchase of natural gas.5\n10.14 Triad Chemical Joint Venture Agreement; filed as Exhibit G1 to Post-Effective Amendment No. 6 to Registration Statement No. 2-25041 and incorporated herein by reference.\n10.15 Amendment to Joint Venture Agreement entered into by the Company and First Mississippi Corporation effective as of May 28, 1993; filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.16 Products Withdrawal Agreement dated June 3, 1968, between First Mississippi Corporation and MisCoa covering withdrawal of product from Triad Chemical; filed as Exhibit H to Post-Effective Amendment No. 7 to Registration Statement No. 2-25041 and incorporated herein by reference.\n10.17 Amendment to Products Withdrawal Agreement entered into by the Company and First Mississippi Corporation effective as of May 28, 1993; filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference. [FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from the first and second paragraphs of paragraph numbered 1 of Amendment No. 1 and an application for confidential treatment has been filed separately with the Commission.\nPursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from Article IV, Price, and an application for confidential treatment has been filed separately with the Commission.\n10.18 Agreement for Real Estate Purchase Option dated July 16, 1990, for the sale of the Company's Hardee County, Florida, property and underlying phosphate reserves; filed as an exhibit to Exhibit 4.2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n13 Excerpts from the Company's 1995 Annual Report to Shareholders.\n21 List of subsidiaries of the Company.\n23 Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.\n(b) REPORTS ON FORM 8-K:\nNo reports were filed on Form 8-K 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.\nMISSISSIPPI CHEMICAL CORPORATION\nBy: \/s\/ Charles O. Dunn President Principal Executive Officer\nBy: \/s\/ William F. Hawkins Senior Vice President-Finance and Administration Principal Financial Officer and Chief Accounting Officer\nDate: September 28, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE\n\/s\/ Charles O. Dunn Director, September 28, 1995 President and Chief Executive Officer (principal executive officer)\n\/s\/ Coley L. Bailey Director, Chairman of the September 28, 1995 Board\n\/s\/ John Sharp Howie Director, Vice Chairman of September 28, 1995 the Board\n\/s\/ John W. Anderson Director September 28, 1995\n\/s\/ Frank R. Burnside, Director September 28, 1995 Jr.\n\/s\/ Robert P. Dixon Director September 28, 1995\n\/s\/ W. R. Dyess Director September 28, 1995\n\/s\/ Woods E. Eastland Director September 28, 1995\n\/s\/ G. David Jobe Director September 28, 1995\n\/s\/ George D. Penick, Jr. Director September 28, 1995\n\/s\/ David M. Ratcliffe Director September 28, 1995\n\/s\/ Wayne Thames Director September 28, 1995\nMISSISSIPPI CHEMICAL CORPORATION\nEXHIBIT INDEX TO FORM 10-K\nEXHIBIT PAGE NUMBER DESCRIPTION NUMBER\n1 Shareholder Rights Plan; filed as Exhibit 1 to the Company's Report on Form 8-A dated August 15, 1994, SEC File No. 2-7803, and incorporated herein by reference.\n3.1 Articles of Incorporation of the Company; filed as Exhibit 3.1 to the Company's Amendment No. 1 to Form S-1 Registration Statement filed August 2, 1994, SEC File No. 33-53119, and incorporated herein by reference.\n3.2 Bylaws of the Company; filed as Exhibit 3.2 to the Company's Amendment No. 1 to Form S-1 Registration Statement filed August 2, 1994, SEC File No. 33-53119, and incorporated herein by reference.\n4.1 Revolving Credit\/Term Loan Agreement dated August 6, 1992, between the Company and NationsBank of Tennessee, purchaser of the Company's Series I Secured Note, Due June 30 1999, in the aggregate principal amount of $20,000,000; filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992, SEC File No. 2-7803, and incorporated herein by reference.\n4.2 Indenture of Mortgage, Deed of Trust, Assignment and Security Agreement dated as of September 1, 1976, among the Company, the New Orleans Bank for Cooperatives, John H. Farrelly, as trustee for the benefit of the New Orleans Bank for Cooperatives under certain deeds of trust, and Deposit Guaranty National Bank); filed as Exhibit B to Exhibit 2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1976, SEC File No. 2-7803, and incorporated herein by reference.\n4.3 Sixteenth Supplemental Indenture dated as of June 30, [ ] 1994, between the Company and Deposit Guaranty National Bank.\n4.4 Fifteenth Supplemental Indenture and Amendment to [ ] Series I Revolving Credit\/Term Loan Agreement dated as of June 17, 1994, between the Company and Deposit Guaranty National Bank.\n4.5 Fourteenth Supplemental Indenture dated as of June 17, [ ] 1994, between the Company and Deposit Guaranty National Bank.\n4.6 Thirteenth Supplemental Indenture dated as of July 16, 1993, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated April 26, 1994, SEC File No. 2-7803, and incorporated herein by reference.\n4.7 Twelfth Supplemental Indenture dated as of August 6, 1992, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992, SEC File No. 2-7803, and incorporated herein by reference.\n4.8 Eleventh Supplemental Indenture dated as of July 16, 1990, between the Company and Deposit Guaranty National Bank, together with Exhibit A thereto, being an Agreement for Real Estate Purchase Option dated July 16, 1990, for the sale of the Company's Hardee County, Florida, property and underlying phosphate reserves; filed as Exhibit 4.2 to Amendment No. 1 of the Company's Report on Form 8 dated November 7, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n4.9 Tenth Supplemental Indenture dated as of December 26, 1989, between the Company and Deposit Guaranty National Bank, together with Exhibit A thereto, being a Note Purchase Agreement dated as of December 26, 1989, between the Company and John Hancock Variable Life Insurance Company, purchaser of the Company's 9.97% Secured Notes, Series , Due 1999, in the aggregate principal amount of $6,000,000; filed as Exhibit 4.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n4.10 Ninth Supplemental Indenture dated as of February 23, 1988, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988, File No. 2-7803, and incorporated herein by reference.\n4.11 Eighth Supplemental Indenture dated as of May 15, 1983, between the Company and Deposit Guaranty National Bank; filed as Exhibit 4.1 to Post-Effective Amendment No. 3 to Registration Statement No. 2-71827 and incorporated herein by reference.\n4.12 Seventh Supplemental Indenture dated as of October 1, 1979, between the Company and Deposit Guaranty National Bank; filed as Exhibit 2 to Post-Effective Amendment No. 3 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.13 Sixth Supplemental Indenture dated as of September 1, 1979, between the Company and Deposit Guaranty National Bank, filed as Exhibit 3 to Post-Effective Amendment No. 3 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.14 Fifth Supplemental Indenture dated as of June 1, 1978, between the Company and Deposit Guaranty National Bank; filed as Exhibit 7 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1979, SEC File No. 2-7803, and incorporated herein by reference.\n4.15 Fourth Supplemental Indenture dated as of May 1, 1978, between the Company and Deposit Guaranty National Bank; filed as Exhibit 9 to Post-Effective Amendment No. 2 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.16 Third Supplemental Indenture dated as of June 28, 1977, between the Company and Deposit Guaranty National Bank; filed as Exhibit 6 to Post-Effective Amendment No. 1 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.17 Second Supplemental Indenture dated as of September 30, 1976, among the Company, New Orleans Bank for Cooperatives, John H. Farrelly and Deposit Guaranty National Bank; filed as Exhibit 6 to Registration Statement No. 2-57390 and incorporated herein by reference.\n4.18 First Supplemental Indenture, dated as of September 7, 1976, among the Company, New Orleans Bank for Cooperatives, John H. Farrelly and Deposit Guaranty National Bank; filed as Exhibit 3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1976, SEC File No. 2-7803, and incorporated herein by reference.\n10.1 Mississippi Chemical Corporation 1994 Stock Incentive Plan; filed as Appendix A to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.2 Mississippi Chemical Corporation 1995 Stock Option Plan for Nonemployee Directors; filed as Appendix B to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.3 Mississippi Chemical Corporation 1995 Restricted Stock Purchase Plan for Nonemployee Directors; filed as Appendix C to the Company's 1995 Proxy Statement and incorporated herein by reference.\n10.4 Purchase Agreement entered into as of September 15, 1994, [ ] by and between the Company and Air Products and Chemicals, Inc., for the sale and purchase of ammonium nitrate prills.6 [FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from paragraph 1.5, paragraph 6.1, paragraph 11.1; Exhibit A and Exhibit F of the Purchase Agreement, and a n application for confidential treatment has been filed separately with the Commission.\n10.5 Amendment No. 1 to Purchase Agreement entered into as of [ ] May 31, 1995, by and between the Company and Air Products and Chemicals, Inc.\n10.6 Agreement effective as of October 1, 1991, entered into by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation; filed as Exhibit 10.1 to Amendment No. 1 to the Company's Report on Form 8 dated January 7, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.7 Amendment of Agreement, effective as of August 1, 1994, [ ] to the Agreement entered into as of October 1, 1991, by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation.\n10.8 Amendment of Agreement, effective as of July 1, 1993, to the Agreement entered into as of October 1, 1991, by the Company's subsidiary Mississippi Phosphates Corporation for the exclusive distribution of diammonium phosphate produced by Mississippi Phosphates Corporation; filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.9 Agreement made and entered into as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock; filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991, File No. 2-7803, and incorporated herein by reference.\n10.10 Amendment No. 3, effective as of January 1, 1995, to the [ ] Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.7\n10.11 Amendment No. 2, effective as of July 1, 1993, to the [ ] Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.8\n[FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from Schedule 1 to Amendment No. 3, Exhibit B, and an application for confidential treatment has been filed separately with the Commission.\nPursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from paragraphs numbered 5 and 8 of Amendment No. 2; from the first paragraph, paragraph numbered 1, paragraph numbered 2, and paragraph numbered 3 of Schedule 1, Exhibit A; from Schedule 2, Exhibit B; from Schedule 3, Exhibit C, and from Schedule 4, Exhibit D; and an application for confidential treatment has been filed separately with the Commission.\n10.12 Amendment No. 1, effective as of July 1, 1992, to the [ ] Agreement effective as of September 15, 1991, between Office Cherifien des Phosphates and the Company's subsidiary Mississippi Phosphates Corporation for the sale and purchase of phosphate rock.9\n10.13 Gas Sales Agreement entered into by the Company and Sonat [ ] Marketing Company as of July 13, 1995, for the sale and purchase of natural gas.10\n10.14 Triad Chemical Joint Venture Agreement; filed as Exhibit G1 to Post-Effective Amendment No. 6 to Registration Statement No. 2-25041 and incorporated herein by reference.\n10.15 Amendment to Joint Venture Agreement entered into by the Company and First Mississippi Corporation effective as of May 28, 1993; filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n[FN] Pursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from the first and second paragraphs of paragraph numbered 1 of Amendment No. 1 and an application for confidential treatment has been filed separately with the Commission.\nPursuant to the Securities Exchange Act of 1934, Rule 24b-2, confidential business information has been deleted from Article IV, Price, and an application for confidential treatment has been filed separately with the Commission.\n10.16 Products Withdrawal Agreement dated June 3, 1968, between First Mississippi Corporation and MisCoa covering withdrawal of product from Triad Chemical; filed as Exhibit H to Post-Effective Amendment No. 7 to Registration Statement No. 2-25041 and incorporated herein by reference.\n10.17 Amendment to Products Withdrawal Agreement entered into by the Company and First Mississippi Corporation effective as of May 28, 1993; filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 2-7803, and incorporated herein by reference.\n10.18 Agreement for Real Estate Purchase Option dated July 16, 1990, for the sale of the Company's Hardee County, Florida, property and underlying phosphate reserves; filed as an exhibit to Exhibit 4.2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, SEC File No. 2-7803, and incorporated herein by reference.\n13 Excerpts from the Company's 1995 Annual Report to [ ] Shareholders.\n21 List of subsidiaries of the Company. [ ]\n23 Consent of Arthur Andersen LLP. [ ]\n27 Financial Data Schedule.","section_15":""}
{"filename":"833083_1995.txt","cik":"833083","year":"1995","section_1":"ITEM 1. BUSINESS\nThe company is in its developmental stages and has not yet become operational. At the present time the company is engaging in research and development, specializing in new energy technologies and related new product design and development.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nNone.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\na) Market Information.\n(1) (i) The principal United States market in which the registrant's common stock has been traded is the NASD Over the Counter (OTC) Bulletin Board. The registrant's common stock began trading in August, 1993. Through the third and fourth quarters of 1993 the high sales price was $4.00 and the low sales price was $1.00. The Company's Common stock was suspended from trading in the First Quarter of 1994 due to delinquencies in certain filings. Having become current with respect to its filings, the Company sought a market maker which would reapply to the NASD to trade to Company's stock. The Company secured the services of Public Securities, Inc., Spokane, Washington, in providing market making services for the stock. Through the direct efforts of Public Securities, the NASD approved ReDOX Technology Corporation Common stock for reinstatement and listing under the symbol \"RDOX\" as of May 10, 1995.\n(ii) Since reinstatement of trading status in May 1995, the Company's stock under the symbol \"RDOX\", has experienced sales of stock at a high of 3\/8 and a low of 1\/32 per share through December 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe Company filed pursuant to Rule 402(c) under Securities Act of 1993 a Form S-8 in October 1995 to register common stock of the Company to be issued pursuant to a compensation contract solely for a consultant of the Company who has provided bona fide services which were in connection with the offer or sale of securities in capital-raising transactions. The Form S-8 registration provided for the issuance of 300,000 fully paid, non-assessable common stock shares.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.\nAs previously reported, this corporation is in developmental stages and has not yet become operational or conducted any business so as to become an income producing entity. The corporation continues to utilize capital borrowed from its principal shareholder, said capital's recognition as debt or equity contribution being negotiated as provided. Any such debt is covered by an unsecured Promissory Note, bearing interest at the rate of six percent (6%) per annum. The principal and interest on the Note is due and payable upon vote of the Directors that payment will not jeopardize the working capital of the corporation, or five (5) years from date of the Note, or whichever occurs earlier. Through December 31, 1995 the corporation had utilized capital borrowed from its principal shareholder, Richard A. Szymanski. The amount borrowed by the corporation through December 31, 1994 was $186,023, which included principal and interest. Mr. Szymanski, as per an agreement with the corporation, provided for that entire amount to be contributed as Additional Paid-in Capital increasing the total Additional Paid-in Capital balance to $207,026, through December 31, 1994. Through December 31, 1995 an additional $33,212 was provided by Mr. Szymanski as operating capital and converted to Additional Paid-in Capital bringing the balance up to $308,238.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nRegistrants financial condition has not changed materially from December 31, 1994 to date herewith provided. To the extent that the Company has incurred continuing expenses without any revenues having been generated, shareholder's equity would have suffered proportionately had it not been for the continuing infusion of capital from the Company director Richard Szymanski. Because the absence of revenues and the inability thus far to raise the capital necessary to commence manufacturing operations, there are no assurances that the Company will be able to fully carry out its plans, and continue as a going concern.\nSee Exhibit 3.\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) (b) Directors and Officers: Identification of Directors and Officers.\nThe members of the Board of Directors of the company are elected by the shareholders at each annual meeting for a one year term. Officers are elected by the Directors at each annual meeting for a one year term, or until otherwise replaced by the Board of Directors. The following table sets forth certain information with respect to the Officers and Directors of the company.\nc) Identification of Certain Significant Employees. None.\nd) Family Relationships of All Officers and Directors. None.\ne) Business Experience of All Officers and Directors.\n1) Background during last 5 years.\nRichard A. Szymanski has served as Executive Vice president and Director of the corporation since April 1993. During the past five (5) years, Mr. Szymanski has been employed by Hybrid Energy Corporation which is engaged in research and development. Hybrid Energy Corporation is not a parent, subsidiary or an affiliate of registrant. Mr. Szymanski has over 27 years experience in pioneering the use of computers for printing, publishing, typesetting and layout; supervising the writing, illustration, publishing and photography of major world events; and more recently the development and improvement of high density power sources.\nBenjamin Botello has served as President, Treasurer and Director of the Corporation since April, 1993. During the past five (5) years Mr. Botello has been employed by San Jacinto Savings Association until 1990, and then by NGL Industries, Inc., to date. San Jacinto Savings Association is involved in commercial banking activities and NGL Industries, Inc., is involved in the development and financing of oil and gas properties; neither company is a parent, subsidiary or affiliate of the registrant. Additionally, Mr. Botello has been engaged in the development of energy related processing equipment and the development of a high energy battery cell. Mr. Botello served as an officer in the U.S. Army from 1971 to 1981. Mr. Botello has 9 years experience as a commercial banking officer. From 1981 through 1990 he served as an officer in a national banking institution with primary responsibility in establishing and maintaining loan portfolios.\nClifford A. Jones has served as Secretary and Director of the Corporation since April, 1993. Mr. Jones was the founder and Senior Partner of the firm of Jones, Close and Brown, Chartered Attorney-at-Law, in Las Vegas, Nevada, where he has been practicing law for the past 38 years. Mr. Jones served as Lieutenant Governor of the State of Nevada for two consecutive terms. He is listed in Who's Who in American Law and Who's Who in the World.\nThomas Poung Au has been a Director of the Corporation since April, 1993. During the past five (5) years Mr. Au has been employed by Poung Au Design. Poung Au Design serves as consultant to manufacturers in new product development. Poung Au Design is not a parent, subsidiary or affiliate of registrant. Mr. Au has over 25 years experience in interior and industrial design and marketing.\nPaul L. Parshall has been a Director of the Corporation since April, 1993. During the past five (5) years Mr. Parshall has been employed by The Worthington Company, which is in the business of private consulting in money management and investments, is registered, pursuant to Section 203 of the Investment Advisors Act of 1940, with the U.S. Securities and Exchange Commission, is not a parent, subsidiary or affiliate of registrant. Mr. Parshall has over 30 years experience in mortgage banking; manufacturing; news media, through several companies founded by him, and private consulting in the field of money management and investment. Mr. Parshall's wife, Theodora Parshall is the principal of Transamerica Securities Ltd., which is the Company's stock transfer agent.\n(2) Directorships.\n(a) Clifford A. Jones also serves as a Director of the following public corporation:\n(i) 18 Greenway Environmental Services, Inc.\n(b) Paul L. Parshall also serves as a Director of the following public corporations:\n(i) Edgewater Petroleum Ltd. (ii) IIS Ltd. (iii) National Sorbents (iv) Family Health Systems, Inc. (v) Dewey's Candy Company (vi) Romarco Resources, Inc. (vii) Life Choice, Inc. (vi) Romarco Resources, Inc. (viii) Bucaneer Casino & Hotels (ix) Norton-BSA, Inc. (x) Global Ecosystems, Inc. (xi) Industrial Ecosystems, Inc. (xii) Opti-Corp. (xiii) Prime Air Inc. (xiv) ITEK Corp.\n(f) Involvement in Certain Legal Proceedings. None.\n(g) Promoters and Control Persons. None.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNone\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Certain Beneficial Owners.\n(b) Security Ownership of Management.\nNote: As a group, the officers and directors beneficially own approximately 21,424,317 Shares.\nChanges in Control. None.\nPART IV\nITEM 14.","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 the report:\n(1) Articles of Incorporation and By-Laws\n(2) Financial Statements\n(b) Reports on Form 8-K.\nMay 10, 1995, Form 8-K filed with respect to approval by NASD for the listing of the Company stock on the Over the Counter (OTC) Electronic Bulletin Board service under the symbol \"RDOX\".\n(c) Exhibits:\n(3.i) Articles of Incorporation\n(3.ii) By-Laws\n(99) Recent Sales of Unregistered Securities\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nREDOX TECHNOLOGY CORPORATION\nBy: \/s\/ Richard A. Szymanski -------------------------------------------------- Richard A. Szymanski \/ President \/ Director\nDate: 5\/31\/96 ------------------\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 capacities and on the dates indicated.\nBy: \/s\/ Benjamin Bottello -------------------------------------------------- Benjamin Botello\/Director\nDate: 5\/31\/96 ------------------\nBy: \/s\/ Thomas Poung Au -------------------------------------------------- Thomas Poung Au\/Director\nDate: 5\/31\/96 ------------------\nFINANCIAL STATEMENTS, DECEMBER 1995\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Balance Sheet December 31, 1995 Unaudited\nASSETS\nSee accompanying notes to financial statements\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Balance Sheet December 31, 1995\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee accompanying notes to financial statements\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Statement of Income and Retained Earnings For the 12 Months Period Ended December 31, 1995\nSee accompanying notes to financial statements\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Statement of Stockholders' Equity December 31, 1995\nSee accompanying notes to financial statements\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Notes to Financial Statements December 31, 1994\nNOTE 1. NATURE OF BUSINESS\nREDOX TECHNOLOGY CORPORATION, was incorporated on April 25, 1988, under the laws of the State of Delaware. The original name of the corporation was DCUSA CORPORATION. DCUSA Management referred to the company as a 'blind pool' or 'blank check' company. Its primary business was to obtain an acquisition and\/or merger transaction whereby its stockholders' would benefit. On June 1, 1993 the name of the corporation was changed to REDOX TECHNOLOGY CORPORATION. During 1993, the Company acquired a pending patent and all rights thereto which REDOX management intends to develop for commercial purposes.\nNOTE 2. SIGNIFICANT ACCOUNTING POLICIES\nINCOME TAXES: The company is currently operating at a loss. It has therefore not provided for income taxes.\nORGANIZATION COSTS: The Company has capitalized the costs of organization and registration of its securities. Amortization is computed on a straight-line basis over sixty months commencing April 25, 1988. The company is no longer amortizing its organizational costs. These costs will be written off at such time that it may be determined that the company has been unsuccessful in its efforts to attract a suitable partner.\nNOTE 3. FIXED ASSETS\nIn January 1994, the Company received furniture and office equipment from Mr. Richard Szymanski as part of a Sale Contract and Bulk Transfer Agreement between Mr. Szymanski and the Company. The assets have been recorded in the books at their fair market value of $25,000.\nNOTE 4. PATENT ACQUISITION\nOn April 9, 1993 the Company acquired all interest in a U.S. Patent Pending application titled \"EMERGENCY RESERVE BATTERY.\" It involves high density energy technology to enhance battery cells. The rights to the patent pending were acquired in exchange for fifteen million (15,000,000) shares of par value .001 per share, with actual value of the intellectual property so acquired to be determined by an independent agency. For purpose of prior statements, the value is shown as $1,500, to be adjusted and recognized as Additional Paid-in Capital to the Company upon receipt of the independent agency's reported valuation. The fair market value of this property is computed at $5,200,000. This value has been determined by Battelle Memorial Institute which is an independent valuation agency. Management has decided to record this property on the books at its fair market value.\nREDOX TECHNOLOGY CORPORATION (Formerly Dcusa Corporation) Notes to Financial Statements (Continued) December 31, 1995\nNOTE 5. COMMON STOCK\nOn April 9, 1993, the number of outstanding shares of the Company's Common Stock was increased by fifteen million (15,000,000) shares. These fifteen million (15,000,000) shares were issued to Richard A. Szymanski in exchange for assignment of all rights to the pending patent application (see note 4 above). On June 16, 1993 and July 20,1993, the Board of Directors of the Company resolved that a three year common stock purchase stock option be granted to each of the following directors:\nClifford Jones 50,000 shares Thomas Poung Au 50,000 shares Benjamin Botello 100,000 shares Paul Parshall 50,000 shares Robert Vickers 50,000 shares\nThese options could be exercised by the individuals at their discretion, at any time within a period of three years by paying the corporation an amount equal to the par value of $.001 per share for each share purchased under the option. Each director listed above has exercised his option.\nOn June 25, 1993, the Board of Directors approved a one for ten (1:10) reverse stock split of its common stock.\nNOTE 6. ADDITIONAL PAID IN CAPITAL\nThe cost of Furniture and equipment acquired during the year was $0. (See note 3). The fair market value has been determined at $25,000. The corporation has decided to record the asset in the books at the fair market value. The difference between the acquisition cost and the fair market value has therefore been transferred to additional paid in capital.\nAs of March 31, 1994, the corporation was utilizing capital borrowed from its principal shareholder, Richard A. Szymanski. The principal and interest due on the note as of that date was $120,539. As per an agreement with Mr. Szymanski, the entire balance due to him was converted to Additional Paid-in Capital.\nNOTE 7. CHANGE OF FISCAL YEAR\nOn June 16, 1993, the Board of Directors approved the change of fiscal year of the corporation from beginning on June 1 and ending on May 31, to beginning on January 1 and ending December 31.\nEXHIBITS INDEX\nThe Exhibits referred to herein and attached hereto are more particularly described below. In addition, certain other Exhibits have been attached hereto, as supplementary information, which may assist in further understanding of the overall information presented.\nDESCRIPTION OF EXHIBITS (SUPPLEMENTAL OR OTHERWISE) SUBMITTED\nEXHIBIT NO. DESCRIPTION OF EXHIBIT ----------- ----------------------\n3.i Articles of Incorporation\n3.ii ByLaws.\n27 Financial Data Schedule\n99 Miscellaneous\/Recent sales of unregistered securities.","section_15":""}
{"filename":"92476_1995.txt","cik":"92476","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSouthwestern Bell Telephone Company (Telephone Company) was incorporated in 1882 under the laws of the State of Missouri, and has its principal executive offices at One Bell Center, St. Louis, Missouri 63101-3099 (telephone number 314-235-9800). The Telephone Company is a wholly-owned subsidiary of SBC Communications Inc. (SBC), which was incorporated under the laws of the State of Delaware in 1983 by AT&T Corp. (AT&T) as one of seven regional holding companies (RHCs) formed to hold AT&T's local telephone companies. AT&T divested SBC by means of a spin-off of stock to its shareowners on January 1, 1984 (divestiture). The divestiture was made pursuant to a consent decree, referred to as the Modification of Final Judgment (MFJ), issued by the United States District Court for the District of Columbia (District Court).\nFEDERAL LEGISLATION AND THE MFJ\nOn February 8, 1996, the Telecommunications Act of 1996 (the Act) was enacted into law. The Act is intended to address various aspects of competition within, and regulation of, the telecommunications industry. The Act provides that all post- enactment conduct or activities which were subject to the MFJ are now subject to the provisions of the Act. Among other things, the Act also defines conditions SBC must comply with before being permitted to offer interLATA long-distance service and establishes certain terms and conditions intended to promote competition for the Telephone Company's local exchange services.\nAdditional information relating to the Act is contained in Item 7, Management's Discussion and Analysis of Results of Operations under the heading \"Competition\" beginning on page 14 of this report.\nThe MFJ, as originally approved by the District Court in 1982, had placed restrictions, known as the \"line of business\" restrictions, on the types of businesses in which SBC could engage. SBC could obtain relief from these restrictions upon a showing that there was no substantial possibility that it could use its monopoly power to impede competition in the specific market it sought to enter (the Waiver Standard).\nAs a result of waiver proceedings before the District Court since divestiture, the MFJ's initial line of business restrictions against engaging in nontelecommunications businesses, providing intraLATA information services, and providing telecommunications products had all been removed. SBC was also authorized to engage in the restricted lines of business outside the United States, subject to certain conditions designed to prevent an impact on United States markets. However, SBC was prohibited from providing interexchange telecommunications services and manufacturing telecommunications products and customer premises equipment (CPE).\nInterexchange telecommunications refers to telecommunications between Local Access and Transport Areas (LATAs) which were created during the divestiture process, and are generally centered on a standard metropolitan statistical area or other identifiable community of interest. The District Court interpreted manufacturing to include design and development activities, as well as actual equipment fabrication.\nThrough 1995, SBC had submitted various requests to the District Court, seeking to remove or modify the remaining restrictions. The passage of the Act potentially supersedes many of these and other court actions filed by SBC or to which SBC was a party. Among these actions are a petition requesting the MFJ be vacated, a court order establishing conditions under which SBC could offer interLATA long-distance service over its wireless network and a suit challenging the Federal Communications Commission's (FCC) intention to require telephone companies to file applications with the FCC before they acquire or operate cable television systems in their telephone service areas.\nBUSINESS OPERATIONS\nThe Telephone Company's principal services include local, long- distance and network access services, which are provided in the states of Texas, Missouri, Oklahoma, Kansas and Arkansas (five- state area). Local services involve the transport of telecommunications traffic between telephones and other CPE located within the same local service calling area. Local services include: basic local exchange service, extended area service, dedicated private line services for voice and special services, directory assistance and various custom calling services. Long-distance services involve the transport of telecommunications traffic between local calling areas within the same LATA (intraLATA). Long-distance services also include other services such as Wide Area Telecommunications Service (WATS or 800 services) and other special services. Network access services connect a subscriber's telephone or other equipment to the transmission facilities of other carriers which provide long- distance (principally interLATA) and other communications services. Network access services are either switched, which use a switched communications path between the carrier and the customer, or special, which use a direct nonswitched path.\nThe following table sets forth for the Telephone Company the percentage of total operating revenues by any class of service which accounted for 10% or more of total operating revenues in any of the last three fiscal years.\nPercentage of Total Operating Revenues\n1995 1994 1993\nLocal service 48% 48% 48%\nNetwork access 34% 34% 33%\nLong-distance service 9% 11% 12%\nThe Telephone Company provides its services over approximately 9.5 million residential and 4.5 million business access lines in the five-state area. During 1995, nearly two-thirds of the Telephone Company's access line growth occurred in Texas.\nDuring 1995, the Telephone Company continued to expand its offering of optional services including: Caller ID, a feature which displays the telephone number of the person calling and the caller's name in certain markets; Call Return, a feature that redials the number of the last incoming call; and Call Blocker, a feature which allows customers to automatically reject calls from a designated list of telephone numbers.\nThe FCC has certain rules that impact the manner in which the Telephone Company may offer network services for enhanced service providers. Enhanced services are services other than basic transmission services. Under these rules, the Telephone Company is permitted to offer enhanced services either on its own or jointly with its affiliates, subject to nonstructural safeguards designed to permit the Telephone Company's competitors to acquire needed network services on an efficient, non-discriminatory basis and to reduce the risk of cross-subsidization. These safeguards include accounting and reporting procedures and Open Network Architecture (ONA) requirements, which represent the Telephone Company's plan to provide equal access to its network to all enhanced service providers. Enhanced services are deregulated at the federal level, and none of the state commissions to which the Telephone Company is subject has asserted jurisdiction over intrastate enhanced services. The nonstructural safeguards are currently being reviewed by the FCC as a result of an October 1994 judicial remand which ruled that the FCC had not adequately explained how ONA would prevent discrimination against competitors. While the outcome cannot be predicted, it is anticipated that the FCC will reaffirm the nonstructural safeguards.\nDuring 1996, Southwestern Bell Telecommunications Inc., a wholly- owned subsidiary of SBC which markets business and residential communications equipment, will be merged into the Telephone Company. The merger is not expected to have a significant impact on the Telephone Company's results of operations.\nGOVERNMENT REGULATION\nIn the five-state area, the Telephone Company is subject to regulation by state commissions which have the power to regulate, in varying degrees, intrastate rates and services, including local, long-distance and network access (both intraLATA and interLATA access within the state) services. The Telephone Company is also subject to the jurisdiction of the FCC with respect to foreign and interstate rates and services, including interstate access charges. Access charges are designed to compensate the Telephone Company for the use of its facilities for the origination or termination of long-distance and other communications by other carriers. There are currently no access charges for access to the Internet.\nAdditional information relating to federal and state regulation of the Telephone Company is contained in Item 7, Management's Discussion and Analysis of Results of Operations of this report under the heading \"Regulatory Environment\" beginning on page 12 of this report.\nMAJOR CUSTOMER\nApproximately 13% in 1995, 14% in 1994 and 15% in 1993 of the Telephone Company's revenues were from services provided to AT&T. No other customer accounted for more than 10% of total revenues.\nCOMPETITION\nInformation relating to competition in the telecommunications industry is contained in Item 7, Management's Discussion and Analysis of Results of Operations of this report under the heading \"Competition\" beginning on page 14 of this report.\nRESEARCH AND DEVELOPMENT\nThe majority of company-sponsored basic and applied research is conducted at Bell Communications Research, Inc. (Bellcore). The Telephone Company owns a one-seventh interest in Bellcore along with the other six RHCs. In April 1995, SBC and the other RHCs announced their intention to pursue the disposition of their interests in Bellcore. A disposition would be subject to obtaining satisfactory financial and other terms and all necessary approvals. If a disposition were to occur, the RHCs would retain the portion of Bellcore that coordinates the Federal government's telecommunications requirements for national security and emergency preparedness.\nBasic and applied research is also conducted at Southwestern Bell Technology Resources, Inc. (TRI), a subsidiary of SBC. TRI provides technology planning and evaluation services to SBC and its subsidiaries.\nEMPLOYEES\nAs of December 31, 1995, the Telephone Company employed 48,180 persons. Approximately 76% of the employees are represented by the Communications Workers of America (CWA). A three-year contract was negotiated between the CWA and the Telephone Company, which became effective in August 1995. This contract will be subject to renegotiation in mid-1998.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties of the Telephone Company do not lend themselves to description by character and location of principal units. At December 31, 1995, network access lines represented 45% of the Telephone Company's investment in telephone plant; central office equipment represented 37%; land and buildings represented 10%; other miscellaneous property, comprised principally of furniture and office equipment and vehicles and other work equipment, represented 6%; and information origination\/termination equipment represented 2%.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSeven class action lawsuits are now pending against the Telephone Company in state and federal courts in Texas, Missouri, Oklahoma and Kansas involving the provision by the Telephone Company of maintenance and trouble diagnosis services covering standard telephone inside wire located on the customer's premises. The actions allege that the Telephone Company's sales practices in connection with these services violated antitrust, fraud and\/or deceptive trade practices statutes and seek unspecified damages together with punitive damages and attorney's fees. The Telephone Company believes it has several meritorious defenses to these claims and is vigorously contesting the allegations. Although the outcomes of these cases are uncertain, management believes that this litigation will not have a material adverse impact on the Telephone Company's results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOmitted pursuant to General Instruction J(2).\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 AND OPERATING DATA\nAt December 31, or for the year ended 1995 1994\nReturn on Weighted Average 14.95% 13.02% Total Capital *\nDebt Ratio (debt, including 65.06% 47.65% current maturities, as a percentage of total capital)\nNetwork access lines in 14,223 13,612 service (000)\nAccess minutes of use (000,000) 53,681 48,430\nLong-distance messages billed 988 1,018 (000,000)\nNumber of employees 48,180 48,440\n* Calculated using income before extraordinary loss. The impact of this charge is included in shareowner's equity.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS Dollars in millions\nThis discussion should be read in conjunction with the financial statements and the accompanying notes.\nResults of Operations\nSummary\nFinancial results, including changes from the prior year, are summarized as follows:\nPercent 1995 1994 Change 1995 vs.\nOperating revenues $ 8,937.7 $ 8,447.7 5.8%\nOperating expenses $ 6,903.0 $ 6,500.9 6.2%\nIncome before extraordinary $ 1,120.7 $ 1,071.9 4.6% loss\nExtraordinary loss $ (2,819.3) - -\nNet income (loss) $ (1,698.6) $ 1,071.9 -\nThe Telephone Company reported income before extraordinary loss of $1,120.7 and $1,071.9 in 1995 and 1994, respectively. In 1995, the Telephone Company recognized an extraordinary loss of $2,819.3 from the discontinuance of regulatory accounting. As a result, net loss for 1995 was $1,698.6.\nThe primary factor contributing to the increase in income before extraordinary loss in 1995 was the growth in demand for services and products, partially offset by increases in operating expenses and an after-tax charge of $57.8 recorded in connection with SBC's strategic functional realignment.\nItems affecting the comparison of the operating results between 1995 and 1994 are discussed in the following sections.\nOperating Revenues\nTotal operating revenues increased $490.0, or 5.8%, in 1995. Components of total operating revenues, including changes from the prior year, are as follows:\nPercent 1995 1994 Change 1995 vs.\nLocal service $ 4,302.3 $ 4,022.0 7.0%\nNetwork access Interstate 2,034.4 1,912.5 6.4\nIntrastate 1,032.3 944.5 9.3\nLong-distance service 821.9 903.5 (9.0)\nOther 746.8 665.2 12.3\n$ 8,937.7 $ 8,447.7 5.8%\nLocal Service revenues increased in 1995 due to increases in demand, including growth in the number of access lines of 4.5%. Nearly two-thirds of the access line growth occurred in Texas. Approximately 25% of access line growth was due to the sales of additional residential lines. Increased demand for enhanced services, including Caller ID, also contributed to the increase in revenues.\nNetwork Access Interstate network access revenues increased in 1995 due largely to increases in demand for access services. Growth in revenues from end user charges attributable to an increasing access line base also contributed to the increase. The increase was partially offset by rate reductions of approximately $65 under the FCC's revised price cap plan which became effective August 1, 1995. Revenues in 1994 reflect a retroactive billing adjustment that decreased interstate network access revenues slightly while increasing intrastate network access revenues.\nIntrastate network access revenues increased in 1995 due primarily to increases in demand, including usage by alternative intraLATA toll carriers. Revenues in 1994 reflect the retroactive billing adjustment noted above.\nLong-Distance Service revenues decreased in 1995, reflecting the continuing trend of competition-related decreases in residential message volumes and the impact of optional calling plans and extended area service plans. Competition from interexchange carriers has continued to increase through advertising and usage of \"10XXX\" and \"1-800\" access numbers. The decrease in long-distance service revenue was partially mitigated by higher network access revenues, as noted above, and the impact of extended area service plans.\nOther operating revenues consist of the Telephone Company's non-regulated network services and products, billing and collection services performed for interexchange carriers and other miscellaneous revenues. The increase in 1995 was due primarily to increases in demand for the Telephone Company's nonregulated services and products, including Caller ID equipment, computer network services and videoconferencing services. Other operating revenues no longer include the provision for uncollectibles, which has been reclassified to selling, general and administrative expenses. During 1996, Southwestern Bell Telecommunications Inc., a wholly-owned subsidiary of SBC which markets business and residential communications equipment, will be merged into the Telephone Company. Other operating revenues in 1996 will reflect these equipment sales subsequent to the merger.\nOperating Expenses\nTotal operating expenses increased $402.1, or 6.2%, in 1995. Components of total operating expenses, including changes from the prior year, are as follows:\nPercent 1995 1994 Change 1995 vs.\nCost of services and products $ 2,844.7 $ 2,761.0 3.0%\nSelling, general and 2,304.2 2,047.7 12.5 administrative\nDepreciation and amortization 1,754.1 1,692.2 3.7\n$ 6,903.0 $ 6,500.9 6.2%\nCost of Services and Products increased in 1995 due to demand- related increases for enhanced services and annual compensation increases. The increase was partially offset by a decrease in switching system software license fees.\nSelling, General and Administrative expenses increased in 1995 primarily due to a $92.7 charge for costs associated with the strategic realignment discussed in Other Business Matters. Increased advertising, contracted services and operating taxes also contributed to the increase.\nDepreciation and Amortization increased in 1995 due to changes in plant level and composition and the effect of regulatory depreciation represcription.\nInterest Expense decreased $18.5, or 5.2%, in 1995 due to the change in accounting for capitalized interest related to the discontinuance of regulatory accounting (described in Note 2 to the financial statements) and the interest accrued in 1994 on potential rate reductions.\nFederal Income Tax expense increased $55.1, or 12.1%, in 1995 primarily due to higher income before income taxes and a reduction in the amortization of investment tax credits resulting from the discontinuance of regulatory accounting.\nExtraordinary Loss In 1995, the Telephone Company recorded an extraordinary loss of $2.8 billion from the discontinuance of regulatory accounting. The loss included a reduction in the net carrying value of telephone plant partially offset by the elimination of net regulatory liabilities. Management does not expect a significant increase in depreciation expense in the near future as a result of the discontinuance of regulatory accounting.\nOperating Environment and Trends of the Business\nRegulatory Environment\nThe Telephone Company's telecommunications operations are subject to regulation by each of the five states in which it operates for intrastate services and by the FCC for interstate services. Each of the states and the FCC have adopted incentive regulation, in the form of price caps, to regulate prices for various services provided by the Telephone Company. The Telephone Company is permitted to establish and modify prices, not to exceed the price caps, subject to approval by the governing jurisdiction. Prices for other services not specifically covered by price caps are also subject to regulatory approval.\nThe states set intrastate price caps for various periods, depending upon the state. Price caps set by the FCC are adjusted annually for inflation, a productivity offset and certain other changes in costs. The productivity offset is a fixed percentage used to reduce price caps and is designed to encourage increased productivity.\nUnder the original FCC plan adopted in 1991, the Telephone Company applied a productivity offset of 3.3%, with sharing at various rates of return on investment. The FCC adopted revised price cap rules which became effective August 1, 1995. These revised rules required an initial reduction of 2.8% in price caps for the Telephone Company, based on its previous productivity offset. In addition, the new rules allowed a choice of three new productivity offsets, two of which provide for a sharing of profits with consumers above certain earnings levels. The Telephone Company elected a 5.3% productivity offset with no sharing. Other changes adopted by the FCC include changes to the Telephone Company's costs that may be used to adjust price caps (referred to as Exogenous Treatment), which, among other things, exclude the effects of the Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The total effect of these changes in price cap regulation is expected to result in an annualized reduction in interstate access revenues of approximately $150. The Telephone Company has filed two separate judicial appeals of certain aspects of the FCC's price cap plan which are still pending.\nThe revised plan described above is an interim measure and should be revised again in 1996. The FCC is expected to conduct further proceedings to address various pricing and productivity issues, and to perform a broader review of price cap regulation in a competitive environment.\nFollowing is a summary of significant state regulatory developments.\nTexas In Texas, House Bill 2128 facilitating telecommunications reform was signed into law on May 26, 1995, effective September 1, 1995. Following are major provisions of the new legislation.\nThe law allows the Telephone Company and other Local Exchange Carriers (LECs) to elect to move from rate of return regulation to price regulation, with elimination of earnings sharing. On September 1, 1995, the Telephone Company notified the Texas Public Utility Commission (TPUC) that it elected incentive regulation under the new law. Basic network service rates will be capped at existing levels for four years. Pricing flexibility is provided for other services according to their classification as \"discretionary\" (e.g., Call Waiting, Call Return, Integrated Services Digital Network (ISDN), 1 plus intraLATA toll, etc.) or \"competitive\" (e.g., WATS, 800 services, private lines, special access, etc.). The TPUC is prohibited from reducing switched access rates charged to interexchange carriers for a four-year period.\nThe law requires LECs electing price regulation to commit to network and infrastructure improvement goals, including expansion of digital switching and advanced high speed services to qualifying public institutions such as schools, libraries and hospitals requesting the services. The law also establishes an infrastructure grant fund for use by public institutions in upgrading their communications and computer technology. The law provides for a fund that will assess a total of $150 annually on all telecommunications providers in Texas for a ten-year period, half of which would be paid by the cellular and wireless industry. The constitutionality of the law requiring the establishment of different assessment rates for the landline service providers and the cellular and wireless service providers was challenged in state district court by a number of paging and cellular phone companies. In January 1996, the court ruled that the law requiring two different rates was unconstitutional and ordered the lower rate be applied to both categories of service providers, which will result in less than a $150 annual assessment. Based on this order, the Telephone Company's annual payment is currently estimated to be approximately $35 to $40. It is not yet known whether the state will challenge the court's ruling. Depending upon the final resolution of any subsequent state actions, the Telephone Company's annual payment could change.\nThe law establishes local exchange competition by allowing other providers of local exchange services to apply for certification by the TPUC, subject to certain build-out requirements, resale restrictions and minimum service requirements. The Telephone Company will remain the default carrier of 1 plus intraLATA toll traffic until all LECs are allowed to carry interLATA long- distance.\nIn January 1996, MCI Communications Corporation (MCI) sued the state of Texas, alleging that the law violates the Texas state constitution. MCI claims the law establishes anticompetitive barriers designed to prevent MCI, AT&T Corp. (AT&T) and Sprint Corporation (Sprint) from providing local services within Texas. Management is unable to predict the outcome of this proceeding.\nMore than 20 applications for competitive local service certification have been filed with the TPUC, and several have been approved. As a result, the Telephone Company expects competition to continue to develop for its local services, but the specific financial impacts of this legislation cannot be reasonably estimated until all required tariff filings are approved by the TPUC for the Telephone Company and other companies intending to provide local service.\nPrior to September 1, 1995, the Telephone Company operated under an extension of a four-year incentive regulation agreement which ended in November 1994. Under its terms, the Telephone Company agreed to cap certain local rates, provide annual rate reductions and other benefits to customers in Texas, and upgrade the network at a cost of approximately $329. Rate reductions for 1994 and 1993 were $146 and $21, respectively. The agreement also provided an earnings-sharing mechanism designed to encourage efficiency and innovation by the Telephone Company. There was no sharing of 1993 revenues. Sharing amounts for the period ending November 1994 included earnings sharing credits of approximately $30 plus additional Lifeline Surplus credits for the four-year period of approximately $18. Sharing amounts for the period ending August 1995 have not been approved by the TPUC but are estimated to be approximately $20.\nMissouri On September 7, 1995, in response to a legal challenge brought by interexchange carriers and the Missouri Cable TV Association, the Cole County Circuit Court (Circuit Court) overturned the August 1994 settlement agreement reached among the Telephone Company, the Missouri Public Service Commission (MPSC) and the Office of Public Counsel (OPC).\nThe settlement agreement had ended a legal dispute with the MPSC over a December 1993 order which had required rate reductions of $84.6 annually, beginning in 1994. Under the agreement, which would have continued in effect through December 31, 1998, the Telephone Company implemented annual rate reductions of $69.6, issued one-time credits to customers totaling $64, and committed to an average annual capital investment of $275, including $35 in special projects, during the term of the agreement. It also provided that the Telephone Company would not file a general rate case or increase basic local exchange service rates. There would be no sharing of earnings under the agreement. The MPSC and OPC agreed not to initiate any complaints regarding the Telephone Company's earnings prior to January 1, 1999.\nThe practical effect of the Circuit Court's decision is to eliminate the prospective commitments under the settlement agreement including the rate review moratorium and capital investment requirements. The decision has no immediate impact on the Telephone Company's current rates because they were approved by the MPSC in separate proceedings, which were not appealed. The Telephone Company is continuing to fulfill the terms of the settlement agreement.\nThe MPSC and the Telephone Company appealed the Circuit Court's decision on October 12 and 13, 1995, respectively. These appeals are currently pending.\nOklahoma On October 30, 1995, the Oklahoma Corporation Commission (OCC) approved a settlement that resolved pending court appeals of a 1992 rate order. The settlement ended a dispute which began in 1989, when the OCC ordered an investigation into the reasonableness of the Telephone Company's intrastate rates. An order was issued in August 1992, requiring the Telephone Company to refund $148.4, representing revenues in excess of an 11.41% return on equity for the period April 1991 through the date of the final order. The order also called for prospective annual rate reductions of $100.6 effective September 1992, required an investment of $84 in network modernization over five years, and lowered the allowed return on equity from 14.25% to 12.20%.\nUnder the terms of the settlement, the Telephone Company paid a cash settlement of $170 to business and residential customers, and offered discounts with a retail value of $268 for certain Telephone Company services. Previously ordered rate reductions of $100.6 have been lowered to $84.4, of which $57.1 had already been implemented. The settlement allows the remaining $27.3 in rate reductions to be deferred, with approximately $8.9 becoming effective in 1996 and the remainder during 1997. The Telephone Company will continue a previously announced $84 network modernization plan for rural Oklahoma. The settlement also provides that no overearnings complaint can be filed against the Telephone Company until January 1, 1998. In addition, the OCC began exploring alternative forms of regulation.\nManagement anticipates that this settlement will not have a significant impact on earnings. The Telephone Company began accruing for the order in 1992, and the settlement and associated costs had been fully accrued as of the end of the third quarter of 1995.\nCompetition\nCompetition continues to expand in the telecommunications industry. Legislation and regulatory and court decisions have increased the number of alternative service providers offering telecommunications services. Technological advances have expanded the types and uses of services and products available. Accordingly, the Telephone Company faces increasing competition in significant portions of its business.\nRecent federal legislation will increase both competition and competitive opportunities for SBC. On February 8, 1996, the Telecommunications Act of 1996 (the Act) was enacted into law. The Act is intended to address various aspects of competition within, and regulation of, the telecommunications industry. The Act provides that all post-enactment conduct or activities which were subject to the consent decree issued at the time of AT&T's divestiture of the Regional Holding Companies (RHCs) are now subject to the provisions of the Act. Among other things, the Act also defines conditions SBC must comply with before being permitted to offer interLATA long-distance service and establishes certain terms and conditions intended to promote competition for the Telephone Company's local exchange services. SBC may immediately offer interLATA long-distance outside the five-state area and over its wireless network both inside and outside the five-state area. Before being permitted to offer landline interLATA long-distance service in the five-state area, the Telephone Company must obtain state and FCC approval of an interconnection agreement with a predominantly facilities-based competitor serving residential and business customers. The interconnection agreement must comply with the 14 point competitive checklist contained in the Act. If no competing provider within a state requests an interconnection agreement, the Telephone Company may receive interLATA authority from the FCC upon obtaining a state-approved statement of terms and conditions under which it will offer access and interconnection, which includes all items in the competitive checklist. The Act directs the FCC to establish rules and regulations to implement the Act, and to preempt specific state law provisions under certain circumstances. The Act also allows RHCs to provide cable services over their own networks, but sets limits on RHCs acquiring interests in cable television operations in their telephone service areas. It is anticipated that many of the new services and products that SBC is allowed to offer under the Act will be provided by subsidiaries of SBC other than the Telephone Company.\nThe passage of the Act potentially supersedes various court actions filed by SBC or to which SBC was a party. Among these court actions are a petition requesting the consent decree be vacated, a court order establishing conditions under which SBC could offer interLATA long-distance over its wireless network and a suit challenging the FCC's intention to require telephone companies to file applications with the FCC before they acquire or operate cable television systems in their telephone service areas.\nThe Telephone Company currently faces competition from various local service providers. Some of these providers have built fiber optic \"rings\" throughout large metropolitan areas to provide transport services (generally high-speed data) for large business customers and interexchange carriers. Also, an increasing number of high-usage customers, particularly large businesses, now bypass Telephone Company facilities by establishing alternative telecommunications links for voice and data, such as private network systems, shared tenant services or private branch exchange (PBX) systems (which are customer-owned and provide internal switching functions without use of Telephone Company central office facilities). The extent of the economic incentive to bypass the local exchange network depends upon local exchange prices, access charges, regulatory policy and other factors. End user charges ordered by the FCC are designed in part to mitigate the effect of system bypass.\nThe FCC adopted rules requiring large LECs, including the Telephone Company, to provide expanded interconnection to independent parties for provision of special access and switched access transport services. (Special access refers to a dedicated transmission path, used primarily by large business customers and long-distance carriers, which does not involve switching at the LEC central office. Switched access refers to the link between LECs' switching facilities and long-distance carriers' networks; switched access transport is one component of this service.) A July 1994 FCC order required that LECs provide equipment and establish a set of technical and pricing rules intended to position alternative providers as if their equipment were located in the central office (referred to as virtual collocation). Alternatively, the LEC could, at its discretion, allow alternative providers to physically collocate their equipment within its central office.\nThe current FCC collocation rules will be affected by the Act which requires incumbent LECs to provide physical collocation of equipment necessary for interconnection or access to unbundled network elements at the premises of the LEC. The Act allows the incumbent LEC to provide virtual collocation if the LEC demonstrates to state commissions that physical collocation is not practical for technical reasons or because of space limitations.\nCompetition exists and continues to intensify in the Telephone Company's intraLATA toll markets. Principal competitors are interexchange carriers, which are assigned an access code (e.g., \"10XXX\") used by their customers to route intraLATA calls through the interexchange carrier's network, and resellers, which sell toll services obtained at bulk rates.\nRecently enacted and pending state regulatory and legislative proceedings also allow increased competition for local exchange services in the future. In Texas, the TPUC has granted several companies authority to provide local exchange services in areas within the Telephone Company's service territory. Hearings continue on additional applications. In Missouri, legislation that embraced most of the recommendations of a commission appointed by the Governor was proposed but not adopted in 1995. The legislation would have opened the Telephone Company's local exchange market to competition and ended earnings regulation for the Telephone Company, but also would have provided only limited pricing flexibility for its services. Similar legislation has been filed for the 1996 legislative session, and other proposals to permit basic local exchange competition and authorize price cap and other forms of incentive regulation are also expected to be introduced, but it is not known whether such legislation will be passed during 1996. Additionally, the MPSC has established a docket to investigate local competition issues. In Kansas, the Kansas Corporation Commission (KCC) has approved direct local telephone service competition in Kansas City, Kansas and, pursuant to a 1994 KCC order, Wichita, Kansas has local private line competition. In Kansas and Oklahoma, there are generic competition dockets pending which address competitive issues related to the provision and regulation of intrastate telecommunications services.\nIn the future, it is likely that additional competitors will emerge in the telecommunications industry. Cable television companies and electric utilities have expressed an interest in, or already are, providing telecommunications services. As a result of recent and prospective mergers and acquisitions within the industry, SBC may face competition from entities offering both cable and telephone services in the Telephone Company's operating territory. Interexchange carriers have also expressed interest in providing local service, either directly or through alternative wireless networks, and a number of major carriers have publicly announced their intent to provide local service in certain markets, some of which are in the Telephone Company's five-state area.\nIn 1994, SBC filed a lawsuit in the United States District Court in Dallas (Court), seeking to overturn provisions of the Cable Communications Policy Act of 1984, in order to provide video service in the Telephone Company's five-state area. In March 1995, the Court ruled in favor of SBC. In December 1995, SBC began offering video services to 1,800 customers in a consumer trial in Richardson, Texas. The advanced broadband network in Richardson is capable of delivering a variety of video and communications services. Alternatives for offering these services in other markets within the five-state area are being evaluated in connection with the Richardson trial.\nSBC is aggressively representing its interests regarding competition before federal and state regulatory bodies, courts, Congress and state legislatures. SBC will continue to evaluate the increasingly competitive nature of its business and develop the appropriate regulatory, legislative and competitive solutions needed to respond effectively to competition.\nOther Business Matters\nStrategic Realignment In July 1995, SBC announced a strategic realignment which will position the company to be a single-source provider of telecommunications services. All of SBC's operations within the five-state area will report to one management group, while international operations and domestic operations outside the five-state area will report to a separate management group.\nIn connection with this realignment of functions, in 1995 the Telephone Company recognized $92.7 in selling, general and administrative expenses. These expenses include postemployment benefits for employees arising from the consolidation of operations within the five-state area, streamlining support and administrative functions and integrating financial systems over the next 18 to 24 months. The realignment is expected to eliminate approximately 2,400 positions throughout SBC. The charge reduced the Telephone Company's net income for 1995 by approximately $57.8.\nPending Litigation During 1995, the Telephone Company settled litigation with several Texas cities arising from the Telephone Company's alleged breach of certain ordinances relating to the Telephone Company's use of, and work activities in, streets and other public ways. The ordinances provide for the payment of a percentage of the gross receipts received by the Telephone Company from the provision of certain services within the cities. While the particular claims of the cities varied, they all alleged that the Telephone Company should have included revenues received from other services in calculating the compensation described in the ordinances. The settlement did not have a material impact on the Telephone Company's results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReport of Independent Auditors\nThe Board of Directors Southwestern Bell Telephone Company\nWe have audited the accompanying balance sheets of Southwestern Bell Telephone Company as of December 31, 1995 and 1994, and the related statements of income, shareowner'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 (a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Southwestern Bell Telephone 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 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 2 to the financial statements, the Company discontinued its application of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" in 1995. As discussed in Notes 6 and 7 to the financial statements, the Company changed its method of accounting for income taxes, postretirement benefits other than pensions, and postemployment benefits in 1993.\nERNST & YOUNG LLP\nSan Antonio, Texas February 9, 1996\nNotes to Financial Statements Dollars in millions\n1. Summary of Significant Accounting Policies\nSouthwestern Bell Telephone Company (Telephone Company) provides telecommunications services to customers in Texas, Missouri, Oklahoma, Kansas and Arkansas. The Telephone Company is a wholly- owned subsidiary of SBC Communications Inc. (SBC).\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.\nCertain amounts in prior period financial statements have been reclassified to conform to the current year's presentation.\nIncome Taxes - The Telephone Company is included in SBC's consolidated federal income tax return. Federal income taxes are provided for in accordance with the provisions of the Tax Allocation Agreement (Agreement) between the Telephone Company and SBC. In general, the Telephone Company's income tax provision under the Agreement reflects the financial consequences of income, deductions and credits which can be utilized on a separate return basis or in consolidation with SBC and which are assured of realization.\nDeferred income taxes are provided for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes.\nInvestment tax credits resulted from federal tax law provisions that allowed for a reduction in income tax liability based on certain construction and capital expenditures. Corresponding income tax expense reductions were deferred and are being amortized as reductions in income tax expense over the life of the property, plant and equipment that gave rise to the credits.\nCash Equivalents - Cash equivalents include all highly liquid investments with an original maturity of three months or less.\nMaterial and Supplies - New and reusable materials are carried principally at average original cost. Specific costs are used for large individual items. Nonreusable material is carried at estimated salvage value.\nProperty, Plant and Equipment - Property, plant and equipment is stated at cost. The cost of additions and substantial betterments of property, plant and equipment is capitalized. The cost of maintenance and repairs of property, plant and equipment is charged to operating expenses.\nProperty, plant and equipment is depreciated using straight-line methods over its estimated useful lives, generally ranging from 3 to 50 years. Prior to September 1995, the Telephone Company computed depreciation using certain straight-line methods and rates as prescribed by regulators. In accordance with composite group depreciation methodology, when a portion of the Telephone Company's depreciable property, plant and equipment is retired in the ordinary course of business, the gross book value is charged to accumulated depreciation.\n2. Discontinuance of Regulatory Accounting\nIn September 1995, the Telephone Company discontinued its application of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" (FAS 71). FAS 71 requires depreciation of telephone plant using lives set by regulators which are generally longer than those established by unregulated companies, and deferral of certain costs and obligations based on regulatory actions (regulatory assets and liabilities). As a result of the adoption of price-based regulation for most of the Telephone Company's revenues and the acceleration of competition in the telecommunications market, management determined that the Telephone Company no longer met the criteria for application of FAS 71.\nUpon discontinuance of FAS 71, the Telephone Company recorded a non- cash, extraordinary charge to net income of $2,819.3 (after a net deferred tax benefit of $1,764.0). This charge is comprised of an after-tax charge of $2,897.3 to reduce the net carrying value of telephone plant, partially offset by an after-tax benefit of $78.0 for the elimination of net regulatory liabilities. The components of the charge are as follows:\nPre-tax After-tax\nIncrease telephone plant accumulated $4,657.0 $ 2,897.3 depreciation\nAdjust unamortized investment tax (40.9) (25.4) credits\nEliminate tax-related regulatory (87.5) (87.5) assets and liabilities\nEliminate other regulatory assets 54.7 34.9\nTotal $4,583.3 $ 2,819.3\nThe increase in accumulated depreciation of $4,657.0 reflects the effects of adopting depreciable lives for many of the Telephone Company's plant categories which more closely reflect the economic and technological lives of the plant. The adjustment was supported by a discounted cash flow analysis which estimated amounts of telephone plant that may not be recoverable from future discounted cash flows. This analysis included consideration of the effects of anticipated competition and technological changes on plant lives and revenues. The adjustment also included elimination of accumulated depreciation deficiencies recognized by regulators and amortized as part of depreciation expense.\nFollowing is a comparison of new lives to those prescribed by regulators for selected plant categories:\nAverage Lives (in Years) Regulator- Estimated Prescribed Economic\nDigital switch 17 11 Digital circuit 12 7 Copper cable 24 18 Fiber cable 27 20 Conduit 57 50\nThe increase in accumulated depreciation also includes an adjustment of approximately $450 to fully depreciate analog switching equipment scheduled for replacement. Remaining analog switching equipment will be depreciated using an average remaining life of four years.\nInvestment tax credits have historically been deferred and amortized over the estimated lives of the related plant. The adjustment to unamortized investment tax credits reflects the shortening of those plant lives discussed above. Regulatory assets and liabilities are related primarily to accounting policies used by regulators in the ratemaking process which are different from those used by non-regulated companies, predominantly in the accounting for income taxes and deferred compensated absences. These items are required to be eliminated with the discontinuance of accounting under FAS 71.\nAdditionally, in September 1995, the Telephone Company began accounting for interest on funds borrowed to finance construction as an increase in property, plant and equipment and a reduction of interest expense. Under the provisions of FAS 71, the Telephone Company accounted for a capitalization of both interest and equity costs allowed by regulators during periods of construction as other income and as an addition to the cost of plant constructed.\n3. Property, Plant and Equipment\nProperty, plant and equipment, which is stated at cost, is summarized as follows at December 31: 1995 1994 Property, plant and equipment\nIn service $ 27,763.6 $ 26,731.6\nUnder construction 245.1 231.5\n28,008.7 26,963.1\nAccumulated depreciation and (16,881.3) (11,227.1) amortization\nProperty, plant and equipment--net $ 11,127.4 $ 15,736.0\nThe Telephone Company's depreciation expense as a percentage of average depreciable plant was 6.5% for 1995 and 1994 and 6.7% for 1993.\nCertain facilities and equipment used in operations are under operating or capital leases. Rental expenses under operating leases for 1995, 1994 and 1993 were $77.7, $76.8 and $68.3, respectively. At December 31, 1995, the future minimum rental payments under noncancelable operating leases for the years 1996 through 2000 were $27.7, $23.1, $13.6, $33.5 and $7.5, respectively, and $8.2 thereafter. Capital leases were not significant.\n4. Debt\nLong-term debt, including interest rates and maturities, is summarized as follows at December 31: 1995 1994 Debentures 4.50%-5.88% 1995-2006 $ 600.0 $ 700.0 6.12%-6.88% 2000-2024 1,200.0 1,050.0 7.00%-7.75% 2009-2026 1,500.0 1,200.0 8.25%-8.30% 1996-2017 200.0 650.0 3,500.0 3,600.0 Unamortized discount--net of premium (30.7) (31.2) Total debentures 3,469.3 3,568.8 Notes 5.04%-7.67% 1995-2010 950.5 815.9 Unamortized discount (5.4) (5.2) Total notes 945.1 810.7 Capitalized leases 3.8 5.8 Total long-term debt, including 4,418.2 4,385.3 current maturities Current maturities (201.1) (117.2) Total long-term debt $ 4,217.1 $ 4,268.1\nDuring 1995, the Telephone Company refinanced long-term debentures. Costs of $18.2 associated with refinancing are included in other income (expense) - net, with related income tax benefits of $6.8 included in income taxes, in the Telephone Company's Statements of Income.\nDuring 1993, the Telephone Company recorded an extraordinary loss on the refinancing of long-term debentures of $153.2, net of related income tax benefits of $92.2.\nAt December 31, 1995, the aggregate principal amounts of long-term debt scheduled for repayment for the years 1996 through 2000 were $201.1, $120.7, $172.1, $63.7 and $150.1, respectively. As of December 31, 1995, the Telephone Company was in compliance with all covenants and conditions of instruments governing its debt.\nDebt maturing within one year consists of the following at December 31: 1995 1994\nCommercial paper $ 549.3 $ 543.0 Current maturities of long-term debt 201.1 117.2 Total $ 750.4 $ 660.2\nThe weighted average interest rate on commercial paper debt at December 31, 1995 and 1994 was 5.7% and 6.0%, respectively. The Telephone Company has entered into agreements with several banks for lines of credit totaling $410.0, all of which may be used to support commercial paper borrowings. The majority of these lines are on an informal basis with interest rates determined at time of borrowing. There were no borrowings outstanding under these lines of credit at December 31, 1995.\n5. Financial Instruments\nThe carrying amounts and estimated fair values of the Telephone Company's long-term debt, including current maturities, are summarized as follows at December 31: 1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value\nDebentures $3,469.3 $3,553.4 $3,568.8 $3,169.3 Notes 945.1 964.8 810.7 730.2\nThe fair values of the debentures were estimated based on quoted market prices. The fair values of the notes were based on discounted cash flows using current interest rates. The carrying amounts of cash and cash equivalents and commercial paper debt approximate fair values.\nThe Telephone Company does not hold or issue any financial instruments for trading purposes.\n6. Income Taxes\nThe Telephone Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109) effective January 1, 1993. In adopting FAS 109, the Telephone Company adjusted its net deferred income tax liability for all temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, computed based on provisions of the enacted tax law. The cumulative effect of adopting FAS 109 as of January 1, 1993 was to decrease net income for 1993 by $8.6. The adoption of FAS 109 had no material effect on pre-tax income for 1993.\nAs a result of implementing FAS 109, the Telephone Company recorded a $431.4 net reduction in its deferred tax liability. This reduction was substantially offset by the establishment of a net regulatory liability, resulting in minimal effect on net income for 1993. The net regulatory liability was eliminated with the discontinued application of FAS 71 in September 1995 (see Note 2).\nSignificant components of deferred tax liabilities and assets are as follows at December 31: 1995 1994\nDepreciation $ 1,411.5 $ 2,947.0 Other 81.0 122.0 Gross deferred tax liabilities 1,492.5 3,069.0 Employee benefits 1,151.0 1,101.8 Unamortized investment tax credits 108.3 134.8 Other 202.2 288.6 Gross deferred tax assets 1,461.5 1,525.2 Net deferred tax liabilities $ 31.0 $ 1,543.8\nThe components of income tax expense are as follows:\n1995 1994 1993 Federal Current $ 447.5 $ 619.1 $ 568.9 Deferred--net 105.9 (102.5) (139.0) Amortization of (42.3) (60.6) (65.5) investment tax credits 511.1 456.0 364.4 State and local Current 37.4 67.7 69.6 Deferred--net 19.1 (9.7) (24.8) 56.5 58.0 44.8 Total $ 567.6 $ 514.0 $ 409.2\nA reconciliation of income tax expense and the amount computed by applying the statutory federal income tax rate (35%) to income before income taxes, extraordinary loss and cumulative effect of changes in accounting principles is as follows:\n1995 1994 1993\nTaxes computed at federal statutory $ 590.9 $ 555.1 $ 498.5 rate\nIncreases (decreases) in taxes resulting from:\nAmortization of investment tax credits over the life of the plant (38.8) (60.6) (65.5) that gave rise to the credits--1995 net of deferred tax\nExcess deferred taxes due to rate (24.2) (34.6) (43.2) change\nDepreciation of telephone plant construction costs previously 14.3 18.3 22.5 deducted for tax purposes--net\nState and local income 36.7 37.7 29.1 taxes--net of federal tax benefit\nOther--net (11.3) (1.9) (32.2)\nTotal $ 567.6 $ 514.0 $ 409.2\n7. Employee Benefits\nPensions - Substantially all employees of the Telephone Company are covered by noncontributory pension and death benefit plans sponsored by SBC. The pension benefit formula used in the determination of pension cost is based on a flat dollar amount per year of service according to job classification for nonmanagement employees and a stated percentage of adjusted career income for management employees.\nSBC's objective in funding the plans, in combination with the standards of the Employee Retirement Income Security Act of 1974 (as amended), is to accumulate funds sufficient to meet its benefit obligations to employees upon their retirement. Contributions to the plans are made to a trust for the benefit of plan participants. Plan assets consist primarily of stocks, U.S. government and domestic corporate bonds and real estate.\nSignificant assumptions used by SBC in developing pension information include: 1995 1994 1993\nDiscount rate for determining 7.25% 7.5% 7.25% projected benefit obligation\nLong-term rate of return on plan 8.0% 8.0% 8.0% assets\nComposite rate of compensation 4.6% 4.6% 4.6% increase\nStatement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" requires certain disclosures to be made of components of net periodic pension cost for the period and a reconciliation of the funded status of the plans with amounts reported in the balance sheets. Since the funded status of plan assets and obligations relates to the plans as a whole, which are sponsored by SBC, this information is not presented for the Telephone Company. The Telephone Company recognized pension cost for 1995, 1994 and 1993 of $104.2, $79.6 and $21.6, respectively. As of December 31, 1995, the amount of the Telephone Company's cumulative amount of pension cost recognized in excess of its cumulative contributions made to the trust was $52.8. As of December 31, 1994, the amount of the Telephone Company's cumulative contributions made to the pension trust in excess of its cumulative amount of pension cost recognized was $51.4.\nPostretirement Benefits - The Telephone Company provides certain medical, dental and life insurance benefits to substantially all retired employees. Effective January 1, 1993, the Telephone Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (FAS 106), which requires accrual of actuarially determined postretirement benefit costs as active employees earn these benefits. Prior to the adoption of FAS 106, the Telephone Company expensed retiree medical benefits when claims were incurred.\nIn implementing FAS 106, the Telephone Company immediately recognized an accumulated obligation for postretirement benefits (transition obligation) in the amount of $2,756.9 and a related deferred income tax benefit of $976.2. The resulting charge to net income of $1,780.7 is included in the cumulative effect of changes in accounting principles in the 1993 Statement of Income.\nSBC maintains collectively bargained Voluntary Employee Beneficiary Association (CBVEBA) trusts to fund postretirement benefits. During 1995 and 1994, the Telephone Company contributed $147.0 and $130.6, respectively, into the CBVEBA trusts to be ultimately used for the payment of postretirement benefits. The Telephone Company also funds postretirement life insurance benefits at an actuarially determined rate. Assets consist principally of stocks and U.S. government and corporate bonds.\nFAS 106 requires certain disclosures to be made of components of net periodic postretirement benefit cost and a reconciliation of the funded status of the plans to amounts reported in the balance sheets. Since the funded status of assets and obligations relates to the plans as a whole, this information is not presented for the Telephone Company. The Telephone Company recognized postretirement benefit cost for 1995, 1994 and 1993 of $209.3, $224.1 and $238.8 respectively. At December 31, 1995 and 1994, the amount included in the Balance Sheets for accrued postretirement benefit obligation was $2,632.8 and $2,692.7 respectively. Significant assumptions for the discount rate, long-term rate of return on plan assets and composite rate of compensation increase used by SBC in developing the accumulated postretirement benefit were the same as those used in developing the pension information.\nThe assumed medical cost trend rate in 1996 is 9.5%, decreasing gradually to 5.5% in 2004, prior to adjustment for cost-sharing provisions of the plan for active and certain recently retired employees. The assumed dental cost trend rate in 1996 is 6.5%, reducing to 5.0% in 2002. Raising the annual medical and dental cost trend rates by one percentage point increases the net periodic postretirement benefit cost for the year ended December 31, 1995 by approximately 7.3%.\nPostemployment Benefits - Under its benefit plans, the Telephone Company provides employees varying levels of severance pay, disability pay, workers' compensation and medical benefits under specified circumstances. Effective January 1, 1993, the Telephone Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (FAS 112), which requires accrual of these postemployment benefits at the occurrence of an event that renders an employee inactive or, if the benefits ratably vest, over the vesting period. These expenses were previously recognized as the claims were incurred. A charge to net income of $60.1, after a deferred tax benefit of $32.9, is included in the cumulative effect of changes in accounting principles in the 1993 Statement of Income. FAS 112 has not materially affected postemployment benefit expense.\nSavings Plans - Substantially all employees are eligible to participate in contributory savings plans sponsored by SBC. Under the savings plans, the Telephone Company matches a stated percentage of eligible employee contributions, subject to a specified ceiling.\nThe Telephone Company's match of employee contributions to the savings plans is fulfilled with SBC's shares of stock allocated from two Employee Stock Ownership Plans and with purchases of SBC's stock in the open market. The costs relating to these savings plans were $32.0, $37.1 and $43.5 in 1995, 1994 and 1993, respectively.\n8. Additional Financial Information\nDecember 31, Balance Sheets 1995 1994\nAccounts payable and accrued liabilities Accounts payable $ 829.2 $ 856.5 Accrued taxes 258.0 292.4 Advance billing and customer 249.4 237.3 deposits Compensated future absences 178.0 170.4 Accrued interest 80.6 85.2 Accrued payroll 88.3 91.7 Other 606.3 706.6 Total $ 2,289.8 $ 2,440.1\nStatements of Income 1995 1994 1993 Interest expense incurred $ 344.3 $ 357.9 $ 385.2 Capitalized interest (4.9) - - Total interest expense $ 339.4 $ 357.9 $ 385.2 Allowance for funds used during construction $ 10.6 $ 18.6 $ 20.7\nStatements of Cash Flows 1995 1994 1993 Cash paid during the year for: Interest $ 344.1 $ 359.5 $ 389.6 Income taxes $ 510.0 $ 740.8 $ 477.8\nApproximately 13% in 1995, 14% in 1994 and 15% in 1993 of the Telephone Company's revenues were from services provided to AT&T Corp. No other customer accounted for more than 10% of total revenues.\nApproximately 76% of the Telephone Company's employees are represented by the Communications Workers of America (CWA). A three-year contract was negotiated between the CWA and the Telephone Company, which became effective in August 1995. This contract will be subject to renegotiation in mid-1998.\n9. Quarterly Financial Information (Unaudited)\nCalendar Total Operating Quarter Revenues Operating Income Net Income (Loss)\n1995 1994 1995 1994 1995 1994\nFirst $2,163.2 $2,041.7 $ 539.3 $ 489.0 $ 300.3 $ 272.1\nSecond 2,226.4 2,093.6 544.9 513.2 307.0 282.5\nThird (1) 2,262.5 2,125.5 550.5 495.7 (2,513.8) 278.5\nFourth (2) 2,285.6 2,186.9 400.0 448.9 207.9 238.8\nAnnual (1) $8,937.7 $8,447.7 $2,034.7 $1,946.8 $(1,698.6) $1,071.9\n(1) 1995 Net Loss reflects an extraordinary loss of $2,819.3 from discontinuance of regulatory accounting.\n(2) 1995 Operating Income reflects $92.7 in selling, general and administrative expenses associated with a strategic realignment of functions. These expenses include postemployment benefits for employees arising from the consolidation of operations within the five-state area, streamlining support and administrative functions and integrating financial systems.\n1995 Net Income reflects after-tax charges of $57.8 for the strategic realignment of functions and $11.4 for refinancing of debt.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo changes in accountants or disagreements with accountants on any accounting or financial disclosure matters occurred during the period covered by this report.\nPART III\nITEMS 10 THROUGH 13.\nOmitted pursuant to General Instruction J(2).\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Documents filed as a part of the report: Page\n(1) Report of Independent Auditors Financial Statements Covered by Report of Independent Auditors: Statements of Income Balance Sheets Statements of Cash Flows Statements of Shareowner's Equity\n(2) Financial Statement Schedules Covered by Report of Independent Auditors: II - Valuation and Qualifying Accounts\nFinancial statement schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n(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 4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument which defines the rights of holders of long-term debt of the registrant is filed herewith. Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n12 Computation of Ratios of Earnings to Fixed Charges.\n23 Consent of Ernst & Young LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K:\nNo report on Form 8-K was filed by the Registrant during the last quarter of the year covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 12th day of March, 1996.\nSOUTHWESTERN BELL TELEPHONE COMPANY\nBy \/s\/ Richard G. Lindner (Richard G. Lindner 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 date indicated.\nPrincipal Executive Officer: Edward A. Mueller* President and Chief Executive Officer\nPrincipal Financial and Accounting Officer: Richard G. Lindner Vice President-Chief Financial Officer and Treasurer \/s\/ Richard G. Lindner Directors: (Richard G. Lindner, as attorney-in-fact and on his own behalf as Principal Royce S. Caldwell* Financial Officer and Principal Cassandra C. Carr* Accounting Officer) William E. Dreyer* James D. Ellis* March 12, 1996 Donald E. Kiernan* Edward A. Mueller*\n* by power of attorney\nEXHIBIT INDEX\nExhibit Number\n4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument which defines the rights of holders of long- term debt of the registrant is filed herewith. Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n12 Computation of Ratios of Earnings to Fixed Charges.\n23 Consent of Ernst & Young LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule.","section_15":""}
{"filename":"107687_1995.txt","cik":"107687","year":"1995","section_1":"ITEM 1. Business\nGENERAL\nWinnebago Industries, Inc. is a leading U.S. manufacturer of motor homes, self-contained recreation vehicles used primarily in leisure travel and outdoor recreation activities. Motor home sales by the Company represented more than 80 percent of its revenues in each of the past five fiscal years. The Company's motor homes are sold through dealer organizations primarily under the Winnebago, Itasca, Vectra, Rialta and Luxor brand names.\nOther products manufactured by the Company consist principally of extruded aluminum and a variety of component products for other manufacturers. Service revenues during fiscal 1995, 1994 and 1993 consisted principally of revenues from satellite courier and tape duplication services and revenues from floor plan and rental unit financing of dealer inventories of the Company's products. Additionally in fiscal years 1993, 1992 and 1991, service revenues included revenues from contract assembly of a variety of electronic products.\nThe Company was incorporated under the laws of the state of Iowa on February 12, 1958, and adopted its present name on February 28, 1961. The Company's executive offices are located at 605 West Crystal Lake Road in Forest City, Iowa. Unless the context indicates otherwise, the term \"Company\" refers to Winnebago Industries, Inc. and its subsidiaries.\nPRINCIPAL PRODUCTS\nThe Company determined it was appropriate to define its operations into three business segments for fiscal 1995 (See Note 17, \"Business Segment Information\" in the Company's Annual Report to Shareholders for the year ended August 26, 1995). However, during each of the last five fiscal years, at least 87% of the revenues of the Company were derived from recreational vehicle products.\nThe following table sets forth the respective contribution to the Company's net revenues by product class for each of the last five fiscal years (dollars in thousands):\n(1) The fiscal year ended August 31, 1991 contained 53 weeks; all other fiscal years in the table contained 52 weeks.\n(2) Primarily recreation vehicle related parts, service and van conversions.\n(3) Principally sales of extruded aluminum and component products for other manufacturers.\n(4) Principally Cycle-Sat, Inc. (Cycle-Sat) revenues from satellite courier and tape duplication services. Also includes in years prior to the year ended August 27, 1994, North Iowa Electronics, Inc. (NIE) revenues from contract assembly of a variety of electronic products; and in the last three fiscal years, Winnebago Acceptance Corporation (WAC) revenues from dealer financing.\nUnit sales of the Company's principal recreation vehicles for the last five fiscal years were as follows:\nFiscal Year Ended (1) August 26, August 27, August 28, August 29, August 31, 1995 1994 1993 1992 1991 Motor Homes Class A ....... 5,993 6,820 6,095 4,161 2,814 Class B ....... 1,014 376 --- --- --- Class C ....... 2,853 1,862 1,998 2,425 2,647 Total .... 9,860 9,058 8,093 6,586 5,461\nVan Conversions (2) 119 1,020 1,103 876 842\n(1) The fiscal year ended August 31, 1991 contained 53 weeks; all other fiscal years in the table contained 52 weeks.\n(2) During fiscal 1995, the Company discontinued its van conversion operations.\nThe primary use of recreation vehicles for leisure travel and outdoor recreation has historically led to a peak retail selling season concentrated in the spring and summer months. The Company's sales of recreation vehicles are generally influenced by this pattern in retail sales, but can also be affected by the level of dealer inventory. The Company has generally manufactured recreation vehicles during the entire year, both for immediate delivery and for inventory to satisfy the peak selling season. During fiscal years when interest rates are high and\/or market conditions are uncertain, the Company attempts to maintain a lower level of inventory of recreation vehicles. Order backlog information is not deemed significant to understand the Company's business.\nPresently, the Company meets its working capital and capital equipment requirements and cash requirements of subsidiaries with funds generated internally and funds from agreements with financial institutions. Since March 26, 1992, the Company has had a financing and security agreement with NationsCredit Corporation, formerly Chrysler First Commercial Corporation. Additionally, in February 1995, the Company and Cycle-Sat entered into a $4,500,000 line of credit with Firstar Bank Cedar Rapids. (See Note 8, Notes Payable, in the Company's Annual Report to Shareholders for the year ended August 26, 1995.)\nRECREATION VEHICLES\nMOTOR HOMES - A motor home is a self-propelled mobile dwelling used primarily as a temporary dwelling during vacation and camping trips.\nRecreation Vehicle Industry Association (RVIA) classifies motor homes into three types (Class A, Class B and Class C). Winnebago currently manufactures and sells all three types.\nClass A models are conventional motor homes constructed directly on medium-duty truck chassis which include the engine and drive components. The living area and driver's compartment are designed and produced by the recreation vehicle manufacturer.\nClass B models are a panel-type truck to which sleeping, kitchen and toilet facilities are added. These models also have a top extension added to them for more head room.\nClass C models are mini motor homes built on van-type chassis onto which the manufacturer constructs a living area with access to the driver's compartment. Certain models of the Company's Class C units include van-type driver's compartments built by the Company.\nThe Company currently manufactures and sells motor homes primarily under the Winnebago, Itasca, Vectra, Rialta and Luxor brand names. The Class A and Class C motor homes generally provide living accommodations for four to seven persons and include kitchen, dining, sleeping and bath areas, and in some models, a lounge. Optional equipment accessories include, among other items, air conditioning, electric power plant, stereo system and a wide selection of interior equipment.\nExcept for the Company's new Rialtas, the Company's motor homes are sold with a basic warranty against defects in workmanship or materials for a period of 12 months or 15,000 miles, whichever occurs first. The Company's new Rialtas are sold with a basic warranty package for a period of 24 months or 24,000 miles, whichever occurs first. At the expiration of the basic warranty period, the first owner receives a 36-month or 36,000-mile, whichever occurs first, limited warranty against delamination on the sidewalls and back walls.\nThe Company's motor homes are sold by dealers in the retail market at prices ranging from approximately $32,000 to more than $219,000, depending on size and model, plus optional equipment and delivery charges.\nThe Company currently manufactures Class A and Class C motor homes ranging in length from 23 to 37 feet and 21 to 29 feet, respectively. The Company's Class B motor homes are 17 feet in length.\nNON-RECREATION VEHICLE ACTIVITIES\nOEM - Original equipment manufacturer sales of component parts such as aluminum extrusions, metal stamping, rotational moldings, vacuum formed plastics and fiberglass to outside manufacturers.\nCYCLE-SAT, INC. - Through the use of the latest innovations in satellite, fiber optic and digital technologies, Cycle-Sat has grown to become a leading high-speed distributor of television and radio commercials. To this end, Cycle-Sat employs a satellite-assisted duplication center in Memphis, Tennessee and a satellite network in place at approximately 550 television stations in the U.S. and Canada. The Company's patented Cyclecypher equipment allows the direct and automatic distribution of television commercials and traffic instructions to specific television and radio stations. Ancillary services include audio and video post production services and the operation of two satellite news gathering vehicles, (sold subsequent to August 26, 1995 fiscal year end) which are leased to provide spot news coverage of sports events and for corporate videoconferences.\nDuring fiscal 1995, Cycle-Sat finalized the purchase of a majority of the assets of the TFI division of MPO Videotronics, a private company headquartered in Newbury Park, California.\nWINNEBAGO ACCEPTANCE CORPORATION - WAC engages in floor plan and rental unit financing for a limited number of the Company's dealers.\nDISCONTINUED ACTIVITIES - The Company discontinued its van conversion operations in fiscal 1995.\nThe Company sold a majority of the assets of North Iowa Electronics, Inc., a contract assembler of a variety of electronic products, on August 8, 1993. See Note 3, Sale of North Iowa Electronics, Inc. in the Company's Annual Report to Shareholders for the year ended August 26, 1995.\nPRODUCTION\nThe Company's Forest City facilities have been designed to provide vertically integrated production line manufacturing. The Company also operates a fiberglass manufacturing facility in Hampton, Iowa, and a sewing operation in Lorimor, Iowa. The Company manufactures the majority of the components utilized in its motor homes, with the exception of the chassis, engines, auxiliary power units and appliances.\nMost of the raw materials and components utilized by the Company are obtainable from numerous sources. The Company believes that substitutes for raw materials and components, with the exception of chassis, would be obtainable with no material impact on the Company's operations. The Company purchases Class A and C chassis and engines from General Motors Corporation - Chevrolet Division and Ford Motor Company; Class C chassis and engines from Volkswagen of America, Inc.; and Class A chassis and engines from Freightliner Custom Chassis Corporation and Spartan Motors, Inc. Class B chassis and engines from Volkswagen of America, Inc. are utilized in the Company's EuroVan Camper. Only two vendors accounted for as much as five percent of the Company's purchases in fiscal 1995, Ford Motor Company and General Motors Corporation (approximately 28 percent, in the aggregate).\nMotor home bodies are made principally of Thermo-Panel materials: the lamination of aluminum and\/or fiberglass, extruded polystyrene foam and plywood into lightweight rigid structural panels by a process developed by the Company. These panels are cut to form the floor, roof and sidewalls. Additional structural strength is provided by Thermo-Steel(R) construction, which combines Thermo-Panel materials and a framework of heavy gauge steel reinforcement at structural stress points. The body is designed to meet Winnebago safety standards, with most models subjected to computer stress analysis. Certain models of motor homes are made in part of other materials such as aluminum, fiberglass and plastic.\nThe Company manufactures picture windows, lavatories, and all of the doors, cabinets, shower pans, waste holding tanks, wheel wells and sun visors used in its recreation vehicles. In addition, the Company produces most of the bucket seats, upholstery items, lounge and dinette seats, seat covers, mattresses, decorator pillows, curtains and drapes.\nThe Company produces substantially all of the raw, anodized and powder-painted aluminum extrusions used for interior and exterior trim in its recreation vehicles. The Company also sells aluminum extrusions to over 130 customers.\nDISTRIBUTION AND FINANCING\nThe Company markets its recreation vehicles on a wholesale basis to a broadly diversified dealer organization located throughout the United States and, to a limited extent, in Canada and other foreign countries. Foreign sales, including Canada, were less than ten percent of net revenues in fiscal 1995. As of August 26, 1995, the motor home dealer organization included approximately 360 dealers, compared to approximately 325 dealers at August 27, 1994. During fiscal 1995, ten dealers accounted for approximately 25 percent of motor home unit sales, and only one dealer accounted for more than seven percent (7.2%) of motor home unit sales.\nWinnebago Industries Europe GmbH, a wholly-owned subsidiary, was formed in fiscal 1992 to expand the Company's presence in Europe. (See Note 17, Business Segment Information, in the Company's Annual Report to Shareholders for the year ended August 26, 1995.)\nThe Company has sales agreements with dealers which are renewed on an annual or bi-annual basis. Many of the dealers are also engaged in other areas of business, including the sale of automobiles, and many dealers carry one or more competitive lines. The Company continues to place high emphasis on the capability of its dealers to provide complete service for its recreation vehicles. Dealers are obligated to provide full service for owners of the Company's recreation vehicles, or in lieu thereof, to secure such service at their own expense from other authorized firms.\nAt August 26, 1995, the Company had a staff of 32 people engaged in field sales and service to the motor home dealer organization.\nThe Company advertises and promotes its products through national RV magazines and cable TV networks and on a local basis through trade shows, television, radio and newspapers, primarily in connection with area dealers.\nSubstantially all sales of recreation vehicles to dealers are made on cash terms. Most dealers are financed on a \"floor plan\" basis under which a bank or finance company lends the dealer all, or substantially all, of the purchase price, collateralized by a lien upon, or title to, the merchandise purchased. Upon request of a lending institution financing a dealer's purchases of the Company's products, and after completion of a credit investigation of the dealer involved, the Company will execute a repurchase agreement. These agreements provide that, in the event of default by the dealer on the dealer's agreement to pay the lending institution, the Company will repurchase the financed merchandise. The agreements provide that the Company's liability will not exceed 100 percent of the invoice price and provide for periodic liability reductions based on the time since the date of the invoice. The Company's contingent liability on all repurchase agreements was approximately $120,487,000 and $118,954,000 at August 26, 1995 and August 27, 1994, respectively. Included in these contingent liabilities are approximately $37,616,000 and $36,231,000, respectively, of certain dealer receivables subject to recourse, (See Note 11, Contingent Liabilities and Commitments in the Company's Annual Report to Shareholders for the year ended August 26, 1995). The Company's contingent liability under repurchase agreements varies significantly from time to time, depending upon seasonal shipments, competition, dealer organization, gasoline supply and availability of bank financing.\nCOMPETITION\nThe recreation vehicle market is highly competitive, both as to price and quality of the product. The Company believes its principal marketing advantages are the quality of its products, its dealer organization, its warranty and service capability and its marketing techniques. The Company also believes that its prices are competitive to competitions' units of comparable size and quality.\nThe Company is a leading manufacturer of motor homes. For the 12 months ended August 31, 1995, RVIA reported factory shipments of 34,300 Class A motor homes, 3,900 Class B motor homes and 17,000 Class C motor homes. Unit sales of such products by the Company for the last five fiscal years are shown elsewhere in this report. The Company is not a significant factor in the markets for its other recreation vehicle products and its non-recreation vehicle products and services, except for the markets serviced by Cycle-Sat, which is a major factor in the satellite courier and tape duplication business.\nREGULATION, TRADEMARKS AND PATENTS\nThe plumbing, heating and electrical systems manufactured and installed in all of the Company's motor homes are manufactured and installed to meet National Fire Protection Association 501C (American National Standards Institute 119.2) as well as Federal Motor Vehicle Safety Standards applicable to motor homes. A variety of other federal and state regulations pertaining to safety in recreation vehicles have been adopted or are proposed from time to time. The Company believes that it is in compliance with all such existing regulations and while it is not able to predict what effect the adoption of any such future regulations will have on its business, it is confident of its ability to equal or exceed any reasonable safety standards.\nThe Company has several registered trademarks, including Winnebago, Itasca, Chieftain, Minnie Winnie, Brave, Passage, Sunrise, Adventurer, Spirit, Suncruiser, Sundancer, Sunflyer, Warrior, Vectra, Thermo-Panel and Thermo-Steel.\nRESEARCH AND DEVELOPMENT\nDuring fiscal 1995, 1994 and 1993, the Company spent approximately $2,216,000, $1,704,000 and $1,077,000, respectively, on research and development activities. These activities involved the equivalent of 23, 30 and 17 full-time employees during fiscal 1995, 1994 and 1993, respectively.\nHUMAN RESOURCES\nAs of September 1, 1995, 1994 and 1993, the Company employed approximately 3,010, 3,150 and 2,770 persons, respectively. Of these, approximately 2,240, 2,300 and 2,090 persons, respectively, were engaged in manufacturing and shipping functions. None of the Company's employees are covered under a collective bargaining agreement.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Company's manufacturing, maintenance and service operations are conducted in multi-building complexes, containing an aggregate of approximately 1,452,000 square feet in Forest City, Iowa. The Company also owns 698,000 square feet of warehouse facilities located in Forest City. The Company leases approximately 235,000 square feet of its unoccupied manufacturing facilities in Forest City to others. The Company also owns a manufacturing facility (74,000 square feet) in Hampton, Iowa. The Company leases a storage facility (25,000 square feet) in Hampton, Iowa and a manufacturing facility (17,200 square feet) in Lorimor, Iowa. Leases on the above facilities expire at various dates, the earliest of which is March, 1996. In fiscal 1989, the Company purchased a 308,000 square foot shopping mall on 30 acres in Temple, Texas. At August 26, 1995, the Company had leased a majority of the mall to various retail stores. In fiscal 1993, Winnebago Industries Europe GmbH purchased a distribution and service facility in Kirkel, Germany. The facility has approximately 16,700 square feet and is located on approximately six acres of land. The Company also owns a 14,400 square foot facility in Forest City which is leased to Cycle-Sat. The Company's facilities in Forest City are located on approximately 784 acres of land, all owned by the Company.\nMost of the Company's buildings are of steel or steel and concrete construction and are fire resistant with high-pressure sprinkler systems, dust collector systems, automatic fire doors and alarm systems. The Company believes that its facilities and equipment are well maintained, in excellent condition, suitable for the purposes for which they are intended and adequate to meet the Company's needs for the foreseeable future.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Company is involved in various legal proceedings which are ordinary routine litigation incident to its business, many of which are covered in whole or in part by insurance. Counsel for the Company based on his present knowledge of pending legal proceedings and after consultation with trial counsel, has advised the Company that, while the outcome of such litigation is uncertain, he is of the opinion that it is unlikely that these proceedings will result in any recovery which will materially exceed the Company's reserve for estimated losses. On the basis of such advice, Management is of the opinion that the pending legal proceedings will not have any material adverse effect 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\nNot Applicable.\nExecutive Officers of the Registrant\n+ Director\nOfficers are elected annually by the Board of Directors. All of the foregoing officers have been employed by the Company as officers or in other responsible positions for at least the last five years.\nThe only executive officers of the Company who are related are John K. Hanson and Paul D. Hanson. Paul D. Hanson is the son of John K. Hanson.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nReference is made to information concerning the market for the Company's common stock, cash dividend and related stockholder matters on page 32 and the inside back cover of the Company's Annual Report to Shareholders for the year ended August 26, 1995, which information is incorporated by reference herein. On October 19, 1995, the Board of Directors declared a cash dividend of $.10 per common share payable December 4, 1995 to shareholders of record on November 3, 1995. The Company did not pay any dividends during fiscal years 1994 or 1993.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nReference is made to the information included under the caption \"Selected Financial Data\" on page 30 of the Company's Annual Report to Shareholders for the year ended August 26, 1995, which information is incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nReference is made to the information under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 27 through 29 of the Company's Annual Report to Shareholders for the year ended August 26, 1995, which information is incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe consolidated financial statements of the Company which appear on pages 10 through 26 and the report of the independent accountants which appears on page 31, and the supplementary data under \"Interim Financial Information (Unaudited)\" on page 30 of the Company's Annual Report to Shareholders for the year ended August 26, 1995, are incorporated by reference herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot Applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nReference is made to the information included under the caption \"Election of Directors\" in the Company's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held December 13, 1995, which information is incorporated by reference herein.\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors and persons who own more than 10 percent of the Company's common stock (collectively \"Reporting Persons\") to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the \"SEC\") and the New York Stock Exchange. Reporting Persons are required by the SEC regulations 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 or written representations from certain Reporting Persons that no Forms 5 were required for those persons, the Company believes that, during fiscal year 1995, all the Reporting Persons complied with all applicable filing requirements with the exception of the inadvertent late filing by Mr. Paul D. Hanson, Vice President-Strategic Planning, of one Form 4 reporting a single sale of Common Stock and the inadvertent late filing by Mr. Frederick M. Zimmerman, a director of the Company, of one Form 4 reporting a single purchase of Common Stock.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nReference is made to the information included under the caption \"Executive Compensation\" in the Company's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held December 13, 1995, which information is incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nReference is made to the share ownership information included under the caption \"Voting Securities and Principal Holders Thereof\" in the Company's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held December 13, 1995, which information is incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nReference is made to the information included under the caption \"Certain Transactions with Management\" in the Company's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held December 13, 1995, which information is incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Consolidated Financial Statement Schedules and Reports on Form 8-K\n(a) 1. The consolidated financial statements of the Company are incorporated by reference in ITEM 8 and an index to financial statements appears on page 13 of this report.\n2. Consolidated Financial Statement Schedules Winnebago Industries, Inc. and Subsidiaries\nPAGE Report of Independent Public Accountants on Supplemental Financial Schedule 14 II. Valuation and Qualifying Accounts 15\nAll schedules, other than those indicated above, are omitted because of the absence of the conditions under which they are required or because the information required is shown in the consolidated financial statements or the notes thereto.\n(a) 3. Exhibits\nSee Exhibit Index on page 16.\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.\nUNDERTAKING\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 2-40316 (which became effective on or about June 10, 1971), 2-73221 (which became effective on or about August 5, 1981), 2-82109 (which became effective on or about March 15, 1983), 33-21757 (which became effective on or about May 31, 1988), and 33-59930 (which became effective on or about March 24, 1993):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing 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 indemnifi-cation 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.\nWINNEBAGO INDUSTRIES, INC.\nBy \/s\/ John K. Hanson Chairman of the Board\nDate: November 17, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on November 17, 1995, by the following persons on behalf of the Registrant and in the capacities indicated.\nSIGNATURE CAPACITY\n\/s\/ John K. Hanson John K. Hanson Chairman of the Board and Director\n\/s\/ Fred G. Dohrmann Fred G. Dohrmann President, Chief Executive Officer and Director\n\/s\/ Edwin F. Barker Edwin F. Barker Vice President, Controller and Chief Financial Officer\n\/s\/ Gerald E. Boman Gerald E. Boman Director\n\/s\/ Keith D. Elwick Keith D. Elwick Director\n\/s\/ David G. Croonquist David G. Croonquist Director\n\/s\/ Joseph M. Shuster Joseph M. Shuster Director\n\/s\/ Frederick M. Zimmerman Frederick M. Zimmerman Director\n\/s\/ Francis L. Zrostlik Francis L. Zrostlik Director\n\/s\/ Donald W. Olson Donald W. Olson Director\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nWINNEBAGO INDUSTRIES, INC. AND SUBSIDIARIES *PAGE\nIndependent Auditors' Report 31 Consolidated Balance Sheets 10 - 11 Consolidated Statements of Operations 12 Consolidated Statements of Changes in Stockholders' Equity 14 Consolidated Statements of Cash Flows 13 Notes to Consolidated Financial Statements 15 - 26\n* Refers to respective pages in the Company's 1995 Annual Report to Shareholders, a copy of which is attached hereto, which pages are incorporated herein by reference.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholder Winnebago Industries, Inc. Forest City, Iowa\nWe have audited the consolidated financial statements of Winnebago Industries, Inc. and subsidiaries (the Company) as of August 26, 1995 and August 27, 1994 and for each of the three years in the period ended August 26, 1995 and have issued our report thereon dated October 19, 1995, which includes an explanatory paragraph regarding the Company' s change in its method of accounting for post-retirement health care and other benefits during the year ended August 27, 1994: Such consolidated financial statements and report are included in your fiscal 1995 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of Winnebago Industries, Inc. and subsidiaries, as listed in 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 audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ Deloitte & Touche LLP\nMinneapolis, Minnesota October 19, 1995\nWINNEBAGO INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\n* Includes transfers of reserves from doubtful dealer receivables to doubtful accounts and from doubtful accounts to long-term notes receivable.\nEXHIBIT INDEX\n3a. Articles of Incorporation previously filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended August 27, 1988 (Commission File Number 1-6403), and incorporated by reference herein.\n3b. Amended Bylaws of the Registrant previously filed with the Registrant's Annual Report Form 10-K for the fiscal year ended August 27, 1994 (Commission File Number 1-6403) and incorporated by reference herein.\n4a. Restated Inventory Floor Plan Financing Agreement between Winnebago Industries, Inc. and NationsCredit Corporation previously filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended August 27, 1994 (Commission File Number 1-6403), and incorporated by reference herein and the First Amendment dated October 31, 1995 thereto.\n4b. Restated Financing and Security Agreement dated July 6, 1995 between Winnebago Industries, Inc. and NationsCredit Commercial Corporation.\n4c. Line of Credit Agreement dated February 24, 1994, among Winnebago Industries, Inc., Cycle-Sat and Firstar Bank Cedar Rapids previously filed with the Registrant's quarterly report on Form 10-Q for the quarter ended February 26, 1994 (Commission File Number 1-6403) and an amendent thereto previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 25, 1995 (Commission File Number 1-6403), and both incorporated by reference herein.\n10a. Winnebago Industries, Inc. Stock Option Plan for Outside Directors previously filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended August 29, 1992 (Commission File Number 1-6403), and incorporated by reference herein.\n10b. Amendment to Winnebago Industries, Inc. Deferred Compensation Plan.\n10c. Amendment to Winnebago Industries, Inc. Profit Sharing and Deferred Savings and Investment Plan.\n10d. Winnebago Industries, Inc. Book Unit Rights Plan previously filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended August 29, 1987 (Commission File Number 1-6403), and incorporated by reference herein.\n10e. Winnebago Industries, Inc. 1987 Non-Qualified Stock Option Plan previously filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended August 29, 1987 (Commission File Number 1-6403), and incorporated by reference herein.\n10f. Winnebago Industries, Inc. RV Incentive Compensation Plan.\n13. Winnebago Industries, Inc. Annual Report to Shareholders for the year ended August 26, 1995.\n21. List of Subsidiaries.\n23. Consent of Independent Accountants.\n27. Financial Data Schedule.","section_15":""}
{"filename":"42228_1995.txt","cik":"42228","year":"1995","section_1":"ITEM 1. -- BUSINESS\nGolden Enterprises, Inc. (the \"Company\") is a holding company which owns all of the issued and outstanding capital stock of Golden Flake Snack Foods, Inc., a wholly-owned operating subsidiary company (\"Golden Flake\"). Golden Enterprises is paid a fee by Golden Flake for providing management services for it.\nThe Company was originally organized under the laws of the State of Alabama as Magic City Food Products, Inc. on June 11, 1946. On March 11, 1958, it adopted the name Golden Flake, Inc. On June 25, 1963, the Company purchased Don's Foods, Inc., a Tennessee corporation which was merged into the Company on December 10, 1966. The Company was reorganized December 31, 1967 as a Delaware corporation without changing any of its assets, liabilities or business. On January 1, 1977, the Company which had been engaged in the business of manufacturing and distributing potato chips, fried pork skins, cheese curls and other snack foods, spun off its operating division into a separate Delaware corporation known as Golden Flake Snack Foods, Inc. and adopted its present name of Golden Enterprises, Inc.\nThe Company owns all of the issued and outstanding capital stock of Golden Flake Snack Foods, Inc.\nGolden Flake Snack Foods, Inc.\nGeneral\nGolden Flake Snack Foods, Inc. (\"Golden Flake\") is a Delaware corporation with its principal place of business and home office located at 110 South Sixth Street, Birmingham, Alabama. Golden Flake manufactures and distributes a full line of salted snack items, such as potato chips, tortilla chips, corn chips, pretzels, fried pork skins, baked and fried cheese curls, peanut butter crackers, cheese crackers, onion rings and buttered and cheese popcorn. These products are all packaged in cellophane bags or other suitable wrapping material. Golden Flake also sells a line of cakes and cookie items, canned dips, dried meat products, and nuts packaged by other manufacturers using the Golden Flake label. No single product or product line accounts for more than 50% of Golden Flake's sales, which affords some protection against loss of volume due to a crop failure of major agricultural raw materials.\nRaw Materials\nGolden Flake purchases raw materials used in manufacturing and processing its snack food products on the open market and under contract through brokers and directly from growers. A large part of the raw materials used by Golden Flake consists of farm commodities which are subject to precipitous change in supply and price. Weather varies from season to season and directly affects both the quality and supply available. Golden Flake has no control of the agricultural aspects and its profits are affected accordingly.\nDistribution\nGolden Flake sells its products through its own sales organization to commercial establishments which sell food products in Alabama and in parts of Tennessee, Kentucky, Georgia, Florida, Mississippi, Louisiana, North Carolina, South Carolina, Arkansas, Missouri and Indiana. The products are distributed by approximately 580 route salesmen who are supplied with selling inventory by the Company's trucking fleet which operates out of Birmingham, Alabama, Nashville, Tennessee, and Ocala, Florida. All of the route salesmen are employees of Golden Flake and use the direct store door delivery method. Golden Flake is not dependent upon any 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 single customer accounts for more than 10% of its total sales. Golden Flake has a fleet of 912 company owned vehicles to support the route sales system, including 40 tractors and 73 trailers for long haul delivery to the various company warehouses located throughout its distribution areas, 719 store delivery vehicles and 80 cars and miscellaneous vehicles. Golden Flake also leases 20 trailers.\nCompetition\nThe snack foods business is highly competitive. In the area in which Golden Flake operates, many companies engage in the production and distribution of food products similar to those produced and sold by Golden Flake. Most, if not all, of Golden Flake's products are in direct competition with similar products of several local and regional companies and at least one national company, the Frito Lay Division of Pepsi Co., Inc., which is larger in terms of capital and sales volume than is Golden Flake. Golden Flake is unable to state its relative position in the industry. Golden Flake's marketing thrust is aimed at selling the highest quality product possible and giving good service to its customers, while being competitive with its prices. Golden Flake constantly tests the quality of its products for comparison with other similar products of competitors and maintains tight quality controls over its products.\nEmployees\nGolden Flake employs approximately 1,300 employees. Approximately 750 employees are involved in route sales and sales supervision, approximately 450 are in production and production supervision, and approximately 100 are management and administrative personnel.\nGolden Flake believes that the performance and loyalty of its employees are the most important factors in the growth and profitability of its business. Since labor costs represent a significant portion of Golden Flake's expenses, employee productivity is important to profitability. Golden Flake considers its relations with its employees to be excellent.\nGolden Flake has a Profit Sharing Plan and an Employee Stock Ownership Plan designed to reward the long term employee for his loyalty. In addition, the employees are provided medical insurance, life insurance, and an accident and sickness salary continuance plan. Golden Flake believes that its employee wage rates are competitive with those of its industry and with prevailing rates in its area of operations.\nEnvironmental Matters\nThere have been no material effects of compliance with government provisions regulating discharge of materials into the environment.\nRecent Developments\nSince the beginning of its last fiscal year, no significant change has occurred in the kinds of products manufactured or in the markets or methods of distribution, and no material changes or developments have occurred in the business done and intended to be done by Golden Flake.\nSteel City Bolt & Screw, Inc. and Nall & Associates, Inc.\nOn February 8, 1995, the Company sold all of the capital stock of Steel City Bolt & Screw, Inc. (\"Steel City\") and Nall & Associates, Inc. (\"Nall\"), which were wholly-owned subsidiaries of the Company, to Coosa Acquisitions, Inc., an Alabama corporation (\"Coosa\"), for a purchase price of $2,100,000. For accounting purposes, the sale was treated to have occurred as of the close of business on January 31, 1995. All of the purchase price was paid in cash at closing. Coosa is a non-affiliated company and was created for the specific purpose of purchasing the capital stock of Steel City and Nall. After the closing, Steel City and Nall became wholly-owned subsidiaries of Coosa and were then merged into Coosa, which changed its operating name to Steel City Bolt & Screw, Inc.\nExecutive Officers Of Registrant And Its Subsidiary\nName and Age Position and Offices with Management ------------ ------------------------------------ Sloan Y. Bashinsky, Sr., 75 Mr. Bashinsky is Chairman of the Board and Treasurer of the Company. He has been employed with the Company since 1946. Mr. Bashinsky has been Chairman of the Board, with a one year interruption, since 1972. Mr. Bashinsky served as Chief Executive Officer from 1976 to June 1, 1991. Prior to becoming Chairman of the Board in 1972, he was President from 1956 to 1972 and reassumed the position of President from 1984 to July 1985. Mr. Bashinsky served as Chairman of the Board, President and Chief Executive Officer under a written employment agreement until May 31, 1985 at which time the employment agreement terminated. Mr. Bashinsky is elected Chairman of the Board and Treasurer on an annual basis with his present term to expire May 31, 1996.\nJohn S. Stein, 58 Mr. Stein is President and Chief Executive Officer of the Company. He was elected Chief Executive Officer on June 1, 1991 and has served as President of the Company since 1985. Mr. Stein served as President of Golden Flake Snack Foods, Inc. from 1976 to September 20, 1991. Mr. Stein has been employed with the Company and its subsidiaries since 1961. Mr. Stein is elected President and Chief Executive Officer annually, and his present term will expire on May 31, 1996.\nF. Wayne Pate, 60 Mr. Pate is President of Golden Flake Snack Foods, Inc., a wholly-owned subsidiary of the Company. He was elected President on September 20, 1991, and has been employed by Golden Flake since 1968. During his employment, he has served as Vice President of Research and Development, Vice President of Manufacturing and Executive Vice President of Manufacturing and Sales. Mr. Pate is elected President annually, and his present term will expire on May 31, 1996.\nJohn H. Shannon, 58 Mr. Shannon has been employed with the Company since 1962. He was elected Controller in 1976, Secretary in 1978 and Vice-President in 1979, and has served in these capacities since then. Mr. Shannon is elected to his positions on an annual basis, and his present term of office will expire on May 31, 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. -- PROPERTIES\nThe office headquarters of the Company are located at Suite 212, 2101 Magnolia Avenue South, Birmingham, Alabama 35205. The Company occupies approximately 1300 square feet of office space under lease. The properties of the subsidiary are described below.\nGolden Flake\nManufacturing Plants and Office Headquarters\nThe main plant and office headquarters of Golden Flake are located at 110 South Sixth Street, Birmingham, Alabama, and are situated on approximately 23 acres of land which is serviced by a railroad spur track. This facility consists of 6 buildings which have a total of approximately 300,000 square feet of floor area. The plant manufactures a full line of Golden Flake products. Golden Flake maintains a garage and vehicle maintenance service center from which it services, maintains, repairs and rebuilds its fleet and delivery trucks. Golden Flake has adequate employee and fleet parking.\nGolden Flake owns approximately 17 acres of undeveloped real estate which is adjacent to its main plant and office headquarters in Birmingham. This property is zoned for industrial use and is readily available for future use. Plans for the utilization of this property have not been finalized.\nGolden Flake has a manufacturing plant in Nashville, Tennessee, which is located at 2930 Kraft Drive. The building is of masonry construction and has approximately 70,000 square feet of floor space. This facility is serviced by a railroad spur track. Golden Flake manufactures potato chips and pretzels at this plant. The Company also owns 2 acres of land across the street from its Nashville plant which is presently used for parking. This property is zoned for industrial use and is readily available for future use. Plans for the utilization of this property have not been finalized.\nGolden Flake also has a manufacturing plant in Ocala, Florida. This plant was placed in service in November 1984. The plant consists of approximately 100,000 square feet and is located on a 56-acre site on Silver Springs Boulevard. The Company manufactures corn chips, tortilla chips and potato chips from this facility. This manufacturing plant, with allowance for future expansion, will use approximately 27 acres of the 56-acre site. The remaining 29 acres are undeveloped and are readily available for future use for commercial and\/or light industrial development. Plans for the utilization of this property have not been finalized.\nThe manufacturing plants, office headquarters and additional lands are owned by Golden Flake free and clear of any debts.\nDistribution Warehouses\nGolden Flake owns branch warehouses in Montgomery, Demopolis, Fort Payne, Muscle Shoals, Huntsville, Phenix City, Tuscaloosa, Mobile, Dothan and Oxford, Alabama; Gulfport and Jackson, Mississippi; Chattanooga, Knoxville and Memphis, Tennessee; Decatur, Marietta, Forest Park and Macon, Georgia; Jacksonville, Panama City, Clearwater, Tampa, Orlando, Tallahassee and Pensacola, Florida; Baton Rouge and New Orleans, Louisiana; Louisville, Kentucky and Little Rock, Arkansas. The warehouses vary in size from 2,400 to 8,000 square feet. All distribution warehouses are owned free and clear of any debts.\nVehicles\nGolden Flake owns a fleet of 912 vehicles which includes 719 route trucks, 40 tractors, 73 trailers and 80 cars and miscellaneous vehicles. There are no liens or encumbrances on Golden Flake's vehicle fleet. Golden Flake also leases 20 trailers and owns a 1987 Cessna Citation II aircraft.\nITEM 3.","section_3":"ITEM 3. -- LEGAL PROCEEDINGS\nThere are no material pending legal proceedings against the Company or its subsidiary other than ordinary routine litigation incidental to the business of the Company and its subsidiary.\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\nGOLDEN ENTERPRISES, INC. AND SUBSIDIARIES\nMARKET AND DIVIDEND INFORMATION\nThe Company's common stock is traded in the over-the-counter market under the \"NASDAQ\" symbol, GLDC, and transactions are reported through the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System. The following tabulation sets forth the range of high and low bid quotations for the common stock during each quarter of the fiscal years ended May 31, 1995 and 1994 and the amount of dividends paid per share in each quarter. The Company currently expects that comparable regular cash dividends will be paid in the future.\nMarket Price Dividends Paid Quarter High Low Per share\nFiscal 1995\nFirst $8 $6 3\/4 $.11 1\/4 Second 7 1\/4 6 3\/4 .11 1\/2 Third 7 1\/4 6 3\/4 .11 1\/2 Fourth 7 1\/4 6 3\/4 .11 1\/2\nFiscal 1994\nFirst $8 3\/4 $7 3\/4 $.11 Second 8 3\/4 7 7\/8 .11 1\/4 Third 8 1\/4 7 3\/4 .11 1\/4 Fourth 8 1\/8 7 1\/8 .11 1\/4\nThese over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission.\nAs of August 1, 1995, there were approximately 1,800 record holders of common stock.\nITEM 6.","section_6":"ITEM 6. -- SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nGOLDEN ENTERPRISES, INC. AND SUBSIDIARIES\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nWorking capital was $25.8 million at May 31, 1995 compared to $26.2 million at May 31, 1994. Net cash provided by operations amounted to $6.6 million in fiscal year 1995, $5.0 million in 1994, and $9.7 million in 1993. An additional $0.3 million in cash was provided this year by a net decrease in investment securities compared to $2.0 million in 1994, and a usage of $0.9 million in 1993 to increase investment securities. $2.1 million in cash was received this year from the sale of the Company's fastener division, which consisted of two wholly-owned subsidiaries, Steel City Bolt & Screw, Inc. and Nall & Associates, Inc.\nAdditions to property, plant and equipment, net of disposals, were $1.4 million, $0.7 million, and $1.8 million in fiscal years 1995, 1994, and 1993, respectively, and are expected to be about $5.0 million in 1996.\nCash dividends of $5.7 million were paid during fiscal year 1995 compared to $5.6 million in 1994 and $5.5 million in 1993.\nCash in the amount of $1.9 million was used to purchase treasury shares during fiscal 1995 while $1.2 million and $0.7 million was used for this purpose in 1994 and 1993, respectively.\nLong-term liabilities as a percentage of total capitalization was 1.3% at May 31, 1995. The Company's current ratio at the year end was 5.26 to 1.00.\nManagement is not aware of any trends or events that will cause a material change in the Company's liquidity.\nOperating Results\nNet sales and other operating income increased by 1.8% in fiscal year 1995, decreased by 2.8% in 1994, and increased by 2.3% in 1993. Although the intense competition in the snack food industry continued in 1995, sales were up compared to 1994 because of a better general economy and improved effectiveness of the Company's advertising and promotions.\nThe Company's investment income as a percentage of income before taxes was 8.1% in 1995, 9.4% in 1994, and 5.8% in 1993. The decrease in this percentage in 1995 compared to 1994 was due to the increase in the Company's operating income, and the increase in 1994 compared to 1993 was due to the decrease in 1994's operating income.\nCost of sales was 43.9% in 1995, 43.8% in 1994, and 42.8% in 1993. This percentage stabilized for the past two years after increasing considerably in 1994 due to increased raw material costs primarily in cooking oil and potatoes.\nSelling, general and administrative expenses were 50.6% of sales in 1995, 53.4% in 1994, and 52.5% in 1993. The significant improvement in this percentage for 1995 was due to a decrease in advertising expense and the impact of route and job consolidations. Prior to 1995, the upward trend in this percentage was due to increases in advertising and promotional expense and employee health benefit costs.\nThe Company's fastener business was sold for cash as of January 31, 1995. Accordingly, the income from operations of the fastener business is reported as income from operations of discontinued business. The consolidated financial statements have been reclassified to report separately the assets, liabilities and operating results of the discontinued business. The Company's consolidated financial statements and notes to consolidated financial statements have been restated to reflect comparative information on the continuing business. The discontinuance of the fastener business will not significantly impact the Company's performance because fastener revenues were less than 4% of the Company's total revenues, and fastener income was below 3% of total income.\nInflation\nAlthough inflation has moderated in recent years, certain costs and expenses of the Company are affected adversely by inflation, and the Company's prices for its products for the last five years have remained relatively flat. The Company will continue to contend with the effect of further inflation through efficient purchasing, improved manufacturing methods, pricing, and by monitoring and controlling expenses.\nSFAS No. 107\nThe Financial Accounting Standards Board has issued Standard No. 107 which is required to be adopted by the Company in a future year. This standard is discussed in Note 1 to the Consolidated Financial Statements. The standard will be implemented when required. Management does not believe the implementation of the standard will have a material impact on the Company's financial statements.\nEnvironmental Matters\nThere have been no material effects of compliance with governmental provisions regulating discharge of materials into the environment.\nITEM 8.","section_7A":"","section_8":"ITEM 8. -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the registrant and its subsidiaries for the year ended May 31, 1995, consisting of the following, are contained herein:\nConsolidated Balance Sheets -- May 31, 1995 and 1994\nConsolidated Statements of Income -- Years ended May 31, 1995, 1994 and 1993\nConsolidated Statements of -- Years ended May 31, 1995, 1994 and 1993 Cash Flows\nConsolidated Statements of Changes -- Years ended May 31, 1995, 1994 and 1993 in Stockholders' Equity\nNotes to Consolidated Financial Statements -- Years ended May 31, 1995, 1994 and 1993\nQuarterly Results of Operations -- Years ended May 31, 1995 and 1994\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Golden Enterprises, Inc.\nWe have audited the accompanying consolidated balance sheets of Golden Enterprises, Inc. and subsidiaries as of May 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 May 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 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 Golden Enterprises, Inc. and subsidiaries as of May 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 May 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 item 14(a) 2 are presented for purposes of complying with the Securities Exchange Commission's rules and are not part of the basic financial statements. These schedules for the years ended May 31, 1995, 1994, and 1993, 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.\nBirmingham, Alabama July 12, 1995 DUDLEY, HOPTON-JONES, SIMS & FREEMAN PLLP\nGOLDEN ENTERPRISES, INC. AND SUBSIDIAIRES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMay 31, 1995, 1994 and 1993\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation\nThe consolidated financial statements include the accounts of Golden Enterprises, Inc. and its wholly-owned subsidiaries: Golden Flake Snack Food, Inc., Steel City Bolt & Screw, Inc. and Nall & Associates, Inc. (the \"Company\"). All significant intercompany transactions and balances have been eliminated.\nDiscontinued Operations\nOn January 31, 1995, the Company disposed of its investment in its wholly-owned subsidiaries, Steel City Bolt & Screw, Inc. and Nall & Associates, Inc. (the Steel City group) for cash. Accordingly, the Steel City group's income from operations, previously reported in the bolt and other fasteners segment of business, is reported as income from operations of discontinued business. The consolidated financial statements have been reclassified to report separately the assets, liabilities and operating results of the discontinued business. The Company's consolidated financial statements and notes to consolidated financial statements have been restated to reflect comparative information on the continuing business.\nRevenue Recognition\nThe Company recognizes sales and related costs upon delivery or shipment of products to its customers.\nCash and Cash Equivalents\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nInvestment Securities\nInvestment securities at May 31, 1995 are principally instruments of the U.S. Government and its agencies, of municipalities and of short-term mutual municipal and corporate bond funds. Effective June 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). This statement, among other things, requires investment securities (bonds, notes, common stock and preferred stock) to be divided into one of three categories: held-to-maturity, available-for-sale, and trading. The Company currently classifies all investment securities as available-for-sale. Under SFAS 115 securities accounted for as available-for-sale includes bonds, notes, common stock and non-redeemable preferred stock not classified as either held-to-maturity or trading. Securities available-for-sale are reported at fair value, adjusted for other-than-temporary declines in value. Unrealized holding gains and losses, net of tax, on securities available-for-sale are reported as a net amount in a separate component of stockholders' equity until realized. Realized gains and losses on the sale of securities available-for-sale are determined using the specific-identification method.\nPrior to adopting SFAS 115, all of the Company's marketable securities were reported at cost which approximated market value. Therefore, no adjustment was necessary for the initial effect of adopting SFAS 115 at June 1, 1994.\nInventories\nInventories are stated at the lower of cost or market. Cost is computed on the first-in, first-out method. The opening and closing inventories used in computing cost of sales are as follows:\nDate Amount\nMay 31, 1993 $4,489,871 May 31, 1994 4,251,253 May 31, 1995 4,554,846\nProperty, Plant and Equipment\nProperty, plant and equipment are stated at cost. For financial reporting purposes, depreciation and amortization have been provided principally on the straight-line method over the estimated useful lives of the respective assets. Accelerated methods are used for tax purposes.\nExpenditures for maintenance and repairs are charged to operations as incurred; expenditures for renewals and betterments are capitalized and written off by depreciation and amortization charges. Property retired or sold is removed from the asset and related accumulated depreciation accounts and any profit or loss resulting therefrom is reflected in the statements of income.\nEmployee Benefit and Stock Options Plans\nThe Company has trusteed \"Qualified Profit-Sharing Plans.\" The plans are \"Non-Formula\" plans and the annual contributions to the plans are determined by the applicable Board of Directors. The profit-sharing expenses for the years ended May 31, 1995, 1994 and 1993 were $518,663, $522,803, and $523,083, respectively.\nThe Company has an Employee Stock Ownership Plan. The annual contributions to the plan are amounts determined by the Boards of Directors of the Company. Annual contributions are made in cash or common stock of the Company. The Employee Stock Ownership Plan expenses for the years ended May 31, 1995, 1994 and 1993 were $103,823, $104,671 and $104,615, respectively.\nThe contributions to the Profit-Sharing Plans and the Employee Stock Ownership Plan may not exceed fifteen percent of the total compensation of all participating employees. The Company expects to continue these plans indefinitely; however, the rights to modify, amend or terminate the plans have been reserved.\nThe Company has a salary continuation plan with certain of its key officers whereby monthly benefits will be paid for a period of fifteen years following retirement. The Company is accruing the present value of such retirement benefits until the key officers reach normal retirement age.\nIn 1988, the Company's shareholders approved the \"1988 Stock Option and Stock Appreciation Rights Plan\" for certain employees of the Company. The plan provides that non-qualified stock options and stock appreciation rights may be granted to key employees for up to 400,000 shares of the Company's common stock. The options and stock appreciation rights are exercisable three years after date of grant. The option price may be less than, equal to or greater than the fair market value of the stock on the date of grant. Each stock appreciation right entitles the option holder, upon exercise of the related stock option, to receive from the Company the amount of the appreciation in the underlying common stock as determined by the excess of the fair market value of a share of common stock on the exercisedate of the related stock option over the option price. The options and stock appreciation rights granted, if not exercised, will expire three months from the date they are exercisable. As of May 31, 1995, options and stock appreciation rights had been granted for 145,000 shares (net of 13,000 shares forfeited) at an option price of $6 per share and for 79,500 shares (net of 6,000 shares forfeited) at an option price of $5 per share. 36,500 shares and 41,000 shares were exercised at $5 per share during the fiscal years ended May 31, 1995 and 1994, respectively. The plan expires July 6, 2002, except as to options and stock appreciation rights outstanding on that date; however, the rights to amend, suspend or terminate the plan have been reserved.\nIncome Taxes\nDeferred income taxes are recorded on the differences between the tax bases of assets and liabilities and the amounts at which they are reported in the consolidated financial statements. Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted.\nNet Income Per Share\nNet income per share computations are based on the weighted average number of shares outstanding of 12,376,769 in 1995; 12,540,809 in 1994 and 12,595,896 in 1993. Stock options were not included in these computations as their effect was not material.\nPostretirement Benefits Other than Pensions\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The standard requires employers to account for retiree benefit obligations (principally for health care) on an accrual basis (rather than on a \"pay-as-you-go\" basis) for fiscal years beginning after December 15, 1992, although recognition in an earlier year is permitted. The Company adopted the standard on June 1, 1993; however, the implementation of the standard did not have a material impact on the financial statements of the Company.\nFinancial Instruments\nIn December 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments,\" the adoption of which is required in fiscal 1996. The statement requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the statement of financial position, for which it is practicable to estimate fair value. The Company has elected not to adopt the provisions of SFAS 107 before the required date.\nPostemployment Benefits\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" The standard requires employers to accrue, for fiscal years beginning after December 15, 1993 with earlier adoption permitted, for benefits provided to former or inactive employees after employment but prior to retirement. The Company adopted the standard in fiscal 1995; however, the implementation of the standard did not have a material impact on the financial statements of the Company.\nNOTE 2 _ INVESTMENT SECURITIES\nThe amortized cost, gross unrealized gains and losses and fair value of the investment securities available-for-sale as of May 31, 1995, are as follows:\nMaturities of investment securities classified as available-for-sale at May 31, 1995 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to recall or prepay obligations with or without call or prepayment penalties.\nProceeds from sales of investment securities available-for-sale during fiscal 1995 were $85,497,783 and related net realized losses included in income were $44,399.\nAt May 31, 1994 marketable securities are as follows:\nU.S. Treasury Bills $11,308,214 Mutual Funds -- government and corporate bonds 2,107,754\nTotal $13,415,968\nNOTE 3 -- LONG-TERM LIABILITIES\nLong-term liabilities are summarized below:\n1995 1994\nStock appreciation rights $ -- $ 71,366 Salary continuation benefits 598,922 478,526 Less: Current installments -- 71,366\nTotal $598,922 $478,526\nAggregate annual maturities of long-term liabilities within each of the next five fiscal years following May 31, 1995 are as follows: 1996 through 2000, $-0-.\nNOTE 4 -- INCOME TAXES\nThe effective tax rate for continuing operations differs from the expected tax using statutory rates. A reconciliation between the expected tax and the actual income tax expense follows:\nThe tax effects of temporary differences that result in deferred tax liabilities are as follows:\nThe income tax effects of changes in temporary differences are as follows:\nNOTE 5 -- COMMITMENTS AND CONTINGENCIES\nRental expenses were $540,284 in 1995, $515,256 in 1994 and $477,488 in 1993. At May 31, 1995, the Company was obligated under certain leases (which have not been capitalized) for buildings, office space and equipment. The following amounts represent future payment commitments under these leases:\nYears Ending Buildings and May 31, Office Space Equipment Total\n1996 $14,000 $162,000 $176,000 1997 -- 117,000 117,000 1998 -- 35,000 35,000\nOne of the subsidiaries leases equipment from a company which is principally owned by the Chairman of the Board of Golden Enterprises, Inc. The terms of these leases are equal to or better than those available from unaffiliated third parties.\nThe Company had investment securities with a fair value of $2,105,901 pledged to its insurance carrier to support the Company's self-insurance program at May 31, 1995. The self-insurance program was supported by a letter of credit of approximately $1,266,000 at May 31, 1994 with a 1% commitment fee.\nNOTE 6 -- CONCENTRATIONS OF CREDIT RISK\nThe Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents and trade receivables.\nThe Company's cash equivalents are in high quality securities placed with a financial institution. The investment policy limits the Company's exposure to concentrations of credit risk.\nThe Company's trade receivables result primarily from its snack food operations and reflect a broad customer base, primarily large grocery chains located in the southeastern United States. The Company routinely assesses the financial strength of its customers. As a consequence, concentrations of credit risk are limited.\nNOTE 7 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a summary of the unaudited quarterly results of operations of the years ended May 31, 1995, 1994 and 1993:\nNOTE 8 -- SUPPLEMENTARY STATEMENT OF INCOME INFORMATION\nThe following tabulation gives certain supplementary statement of income information for continuing operations the years ended May 31, 1995, 1994 and 1993:\nAmounts for depreciation and amortization of intangible assets, royalties, other taxes, rents and research and development costs are not presented because each of such amounts is less than 1% of total revenues.\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\nWith the exception of a description of Executive Officers of The Registrant which appears on page 5 herein, Part III is omitted because prior to September 28, 1995, the Company will file a definitive Proxy Statement with the Securities and Exchange Commission pursuant to Regulation 14A which involves the election of directors.\nPART IV\nITEM 14.","section_14":"ITEM 14. -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. and 2. LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Golden Enterprises, Inc. and subsidiary required to be included in Item 8 are listed below:\nConsolidated Balance Sheets -- May 31, 1995 and 1994\nConsolidated Statements of Income -- Years ended May 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity -- Years ended May 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows -- Years ended May 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nThe following consolidated financial statements schedule is included in Item 14(d):\nSchedule II -- Valuation and Qualifying Accounts\nAll other schedules are omitted because the information required therein is not applicable, or the information is given in the financial statements and notes thereto.\n3. Exhibits:\n21.1 -- Subsidiary of the Registrant. 99.1 -- A copy of Agreement for Purchase and Sale of Stock of Steel City Bolt & Screw, Inc. and Nall & Associates, Inc. dated as of December 19, 1994 Between Golden Enterprises, Inc., Seller and Coosa Acquisitions, Inc., Purchaser.\n(b) Report on Form 8-K -- The Registrant did not file a Form 8-K report during the last quarter of the period covered by this report.\n(c) Exhibits. See (a)3. above.\n(d) Financial Statement Schedules. The response to this portion of Item 14, is submitted under Item 14.(a) 1. and 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.\nGOLDEN ENTERPRISES, INC.\nBy \/s\/ John H. Shannon August 25, 1995 ----------------------------------- --------------- John H. Shannon Date Vice President, Principal Financial Officer and Controller 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 --------------------------- --------------------- ---------- \/s\/ Sloan Y. Bashinsky, Sr. Chairman of the Board August 25, 1995 Sloan Y. Bashinsky, Sr.\n\/s\/ John S. Stein President, Chief Executive August 25, 1995 John S. Stein Officer and Director\n\/s\/ John H. Shannon Vice President, Secretary, August 25, 1995 John H. Shannon Principal Financial Officer and Controller\n\/s\/ F. Wayne Pate Director August 25, 1995 F. Wayne Pate\n\/s\/ Edward R. Pascoe Director August 25, 1995 Edward R. Pascoe\n\/s\/ John P. McKleroy, Jr. Director August 25, 1995 John P. McKleroy, Jr.\n\/s\/ James I. Rotenstreich Director August 25, 1995 James I. Rotenstreich\n\/s\/ John S. P. Samford Director August 25, 1995 John S. P. Samford\n\/s\/ D. Paul Jones, Jr. Director August 25, 1995 D. Paul Jones, Jr.\n\/s\/ J. Wallace Nall, Jr. Director August 25, 1995 J. Wallace Nall, Jr.\nINDEX TO EXHIBITS\nExhibit Number Page\n21.1 Subsidiary of the Registrant 32\n99.1 A copy of Agreement for Purchase and Sale of Stock of Steel City Bolt & Screw, Inc. and Nall & Associates, Inc. dated as of December 19, 1994 Between Golden Enterprises, Inc., Seller and Coosa Acquisitions, Inc., Purchaser 33\nEXHIBIT 21.1 SUBSIDIARY OF THE REGISTRANT\nThe Registrant owns all of the capital stock of Golden Flake Snack Foods, Inc., a wholly-owned subsidiary. Golden Flake Snack Foods, Inc. is a Delaware corporation.\nEXHIBIT NUMBER 99.1\nA copy of Agreement for Purchase and Sale of Stock of Steel City Bolt & Screw, Inc. and Nall & Associates, Inc. dated as of December 19, 1994 Between Golden Enterprises, Inc., Seller and Coosa Acquisitions, Inc., Purchaser.\nAgreement for Purchase and Sale of Stock of Steel City Bolt & Screw, Inc. and Nall and associates, Inc.\nDated as of December 19, 1994,\nbetween\nGolden Enterprises, Inc. Seller\nand\nCoosa Acquisitions, Inc., Purchaser\n1. SALE AND TRANSFER OF SHARES 1 1.1 Sale 1 1.2 Consideration From Purchaser At Closing 1 1.3 Adjustment To Purchase Price 2 1.4 Manner of Payment 2\n2. REPRESENTATIONS AND WARRANTIES OF SELLER 2 2.1 Good Standing and Qualification 2 2.2 Subsidiaries 2 2.3 Capital Structure 2 2.4 Title to Shares 3 2.5 Capacity of and Execution by Seller 3 2.6 Conflict with Other Instruments 3 2.7 Financial Statements 4 2.9 Absence of Undisclosed Liabilities 4 2.10 Tax Returns and Tax Liabilities 4 2.11 Real Property Assets 5 2.12 Tangible Personal Property 5 2.13 Title to Assets 5 2.14 Accounts Receivable 6 2.15 Employment Contracts 6 2.16 Insurance Policies 6 2.17 Absence of Certain Business Practices 7 2.18 Compliance with Laws 7 2.19 Litigation 8 2.20 Employee Benefit Plans 9 2.21 Material Information 12 2.22 Other Contracts 12 2.23 Licenses and Permits 12\n3. PURCHASER'S REPRESENTATIONS AND WARRANTIES 12 3.1 Purchaser's Standing and Qualification 12 3.2 Execution, Delivery and Performance of Agreement 12 3.3 Investment Representation 13\n4. SELLER'S OBLIGATIONS BEFORE CLOSING 13 4.1 Purchaser's Access to Premises and Information 13 4.2 Conduct of Business 13 4.3 Preservation of Business 13 4.4 Corporate Matters 14 4.5 Maintenance of Insurance 14 4.6 Employees and Compensation 14 4.7 New Transaction 14 4.8 Dividends, Distributions and Acquisition of Stock 14 4.9 Waiver of Claims 14 4.10 Existing Agreements 15\n5. CONDITIONS PRECEDENT TO PURCHASER'S PERFORMANCE 15 5.2 Performance by Seller 15 5.3 No Material Adverse Change 15 5.4 Certification by Seller 15 5.5 Opinion of Seller's Counsel 15 5.6 Absence of Litigation 17 5.7 Statutory Requirements 17 5.8 Resignations 17 5.9 Environmental Report 17 5.10 Survey; Title Insurance 18 5.11 Seller's Undertakings 18 5.12 Eminent Domain 18 6. CONDITIONS PRECEDENT TO SELLER'S PERFORMANCE 19 6.1 Accuracy of Purchaser's Representations and Warranties 19 6.2 Purchaser's Performance 19 6.3 Corporate Approval 20 6.4 Opinion of Purchaser's Counsel 20 6.5 Absence of Litigation 20 6.6 Statutory Requirements 20 6.7 Certification by Purchaser 21\n7. THE CLOSING 21 7.1 Time and Place 21 7.2 Seller's Obligations at the Closing 21 7.3 Purchaser's Obligations at the Closing 21\n8. NATURE AND SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATION, ETC. 22 8.1 Survival of Representations, Warranties, Etc. 22 8.2 Seller's Indemnity 22 8.3 Purchaser's Indemnity 23 8.4 Third Party Claims 23\n9. CERTAIN TAX MATTERS 24 9.1 Cooperation 24 9.2 Current Year's Tax Returns 24 9.3 Contest Provisions 24\n10. CONTINUED EMPLOYMENT OF OFFICERS, DIRECTORS AND EMPLOYEES 25\n11. PRESS RELEASE; DISCLOSURE 25\n12. CONFIDENTIALITY 25\n13. FEES AND EXPENSES 25\n14. TRANSFER TAXES 26\n15. NOTICES 26\n16. SUCCESSORS AND ASSIGNS 27\n17. COUNTERPARTS 27\n18. ENTIRE AGREEMENT 27\n19. TERMINATION AND ABANDONMENT 27\n20. OTHER INSTRUMENTS TO BE EXECUTED 27\n21. SCHEDULES 28\n22 APPLICABLE LAW 28\nTABLE OF SCHEDULES\nThe following Schedules will be provided to Purchaser by Seller on or before January 15, 1995 and will be attached hereto and made a part of this Agreement. Schedule 2.9 Liabilities Not Reflected on Acquisition Balance Sheet Schedule 2.11 Real Property Schedule 2.12 Description and Location of Tangible Personal Property Owned or Leased by the Corporation with a Depreciated Book Value in excess of $1,000 Schedule 2.15 Employment Contracts, Collective Bargaining Agreements, and Pension, Bonus, Profit Sharing and Stock Option Agreements Schedule 2.16 Insurance Policies Schedule 2.17 Shareholder, Officer, Director and Employee Interests in Other Entities Schedule 2.19 Litigation Schedule 2.20 Benefit Plans Schedule 2.22 Material Contracts Schedule 2.23 Licenses and Permits\nAGREEMENT FOR PURCHASE AND SALE OF STOCK OF STEEL CITY BOLT & SCREW, INC. AND NALL & ASSOCIATES, INC.\nTHIS AGREEMENT for purchase and sale of stock of STEEL CITY BOLT & SCREW, INC. and NALL & ASSOCIATES, INC. (the \"Agreement\") is entered into as of December 19, 1994, by and between GOLDEN ENTERPRISES, INC. (\"Seller\") and COOSA ACQUISITIONS, INC., an Alabama corporation (\"Purchaser\").\nR E C I T A L S\nSeller owns all of the issued and outstanding shares of stock of Steel City Bolt & Screw, Inc., an Alabama corporation (\"Steel City\") and all of the issued and outstanding shares of stock of Nall & Associates, Inc., an Alabama corporation (\"Nall\") (Steel City and Nall are collectively referred to as the \"Corporation\").\nPurchaser desires to purchase from Seller and Seller desires to sell to Purchaser all of the outstanding stock of Steel City and all of the outstanding stock of Nall (collectively, the \"Shares\").\nAGREEMENT\nIn consideration of the mutual covenants, agreements, representations and warranties contained in this Agreement, the parties agree as follows:\n1. SALE AND TRANSFER OF SHARES\n1.1 Sale. Subject to the terms and conditions set forth in this Agreement, on the Closing Date (as defined in Section 7), Seller shall sell, assign, transfer and convey the Shares to Purchaser, and Purchaser shall acquire the Shares from Seller.\n1.2 Consideration From Purchaser At Closing. Subject to adjustment pursuant to Paragraph 1.3 below, Purchaser agrees to pay Seller as consideration for the sale and transfer to Purchaser of the Shares, the aggregate amount of Two Million One Hundred Thousand and NO\/100 Dollars ($2,100,000.00) (the \"Purchase Price\"). Purchaser and Seller represent and warrant to each other that no broker's, finder's or any other commissions or other fees are owed or shall be owed in connection with this Agreement and the consumption of the transactions contemplated herein. Any commissions or fees owed to any party shall be the responsibility of the party incurring such liability. Purchaser and Seller agree to indemnify and hold the other harmless against any and all demands and claims for such fees and\/or commissions, together with all charges, costs and expenses incurred by the other including reasonable attorneys' fees, arising out of or in connection with the defense of any such demand or claim.\n1.3 Adjustment To Purchase Price. On the day that is 180 days after the Closing Date, the Seller shall purchase from the Purchaser all accounts receivable of the Corporation that remain uncollected at that time that were at least 60 days past due on the Closing Date. The Seller shall purchase said accounts receivable at the value at which they are carried on the books of the Corporation.\n1.4 Manner of Payment. At the Closing, as provided in Paragraph 7 herein, Purchaser shall pay to Seller by wire transfer of immediately available funds made payable to the account of the Seller in accordance with its written instructions received by Purchaser at least two business days prior to the Closing, the Purchase Price.\n2. REPRESENTATIONS AND WARRANTIES OF SELLER.\nExcept as otherwise specified below, Seller represents and warrants that the following facts are true and correct, all of which shall be deemed to have been made also at the Closing without further writing and to be true and correct thereupon, and all of which shall survive the Closing as hereinafter provided or any termination or cancellation of this Agreement, unless otherwise provided herein.\n2.1 Good Standing and Qualification. Each of Steel City and Nall, is a corporation duly organized, validly existing and in good standing under the laws of the State of Alabama; each of them has all requisite corporate power and authority to carry on its business as now being conducted and to own, lease or operate its properties in the places where such business is now conducted and such properties are now owned, leased or operated, and each is duly qualified to transact business in all other jurisdictions in which, by reason of the nature of its business or activities, such qualification is necessary. Seller shall deliver at the Closing to Purchaser true and complete copies of Steel City's and Nall's Articles of Incorporation and all amendments thereto certified by the Judge of Probate of Jefferson County, and the By-laws of Steel City and Nall then in effect, certified as true and correct by the Secretary of Steel City and Nall, respectively.\n2.2 Subsidiaries. Neither Steel City or Nall has any interest, direct or indirect, or any commitment to purchase any interest, direct or indirect, in any other corporation, or in any partnership, joint venture or other business enterprise or entity.\n2.3 Capital Structure. The authorized capital stock of Steel City consists of 2000 shares of common stock (the \"Steel City Stock\") having a par value of $10.00 per share, 1,850 of which shares are issued and outstanding. The authorized capital stock of Nall consists of 1000 shares of common stock (the \"Nall Stock\") having a par value of $10.00 per share, 450 of which shares are issued and outstanding. All of the outstanding shares of Steel City Stock and Nall Stock are duly authorized, validly issued and outstanding, fully paid and non-assessable. All of the outstanding shares of Steel City Stock and Nall Stock have been issued in full compliance with all federal and state securities laws. There are no outstanding subscriptions, options, rights, warrants, convertible securities or other agreements or commitments obligating Steel City or Nall or any shareholder of Steel City or Nall to issue or to transfer from treasury or otherwise any additional shares of capital stock of any class. The issued and outstanding equity securities of Steel City and Nall of all classes and kinds consist exclusively of said Steel City Stock and said Nall Stock, respectively, and at the Closing the issued and outstanding equity securities of Steel City and Nall of all classes and kinds will consist exclusively of said Steel City Stock and said Nall Stock, respectively.\n2.4 Title to Shares. Seller is the lawful owner of record and beneficially of the Shares free and clear of all liens, encumbrances, pledges, security agreements, equities, options, claims, charges and restrictions whatsoever except as created by this Agreement. Seller represents and warrants that Seller has full power to transfer the Shares to Purchaser without obtaining the consent or approval of any other person, entity or governmental authority.\n2.5 Capacity of and Execution by Seller. Seller has full and unrestricted power, authority and capacity to execute, deliver and perform this Agreement and to deliver certificates representing the Shares and now has, and at the Closing will have, full legal power to sell and transfer the Shares to Purchaser in accordance with this Agreement and to carry out all the transactions contemplated hereby. All proceedings required to be taken by Seller to authorize the execution, delivery and performance of this Agreement and the transactions contemplated hereby have been properly taken. This Agreement has been duly and validly executed and delivered by Seller and constitutes the valid and binding obligation of Seller enforceable in accordance with its terms; and delivery of the Shares at the Closing in accordance with this Agreement will vest good and marketable title to the Shares in Purchaser, free and clear of all security interests, pledges, liens, encumbrances, claims and equities of any kind whatsoever.\n2.6 Conflict with Other Instruments. Neither the execution, delivery nor performance of this Agreement by Seller, with or without the giving of notice or the passage of time, or both, will conflict with, results in a default, right to accelerate or lose any right under, or result in the creation of a lien, charge or encumbrance pursuant to any provision of the Seller's, Steel City's or Nall's Articles of Incorporation or By-laws, or any material franchise, mortgage, deed of trust, lease, license, agreement, understanding, law, ordinance, rule or regulation or any order, judgment, or decree to which Steel City, Nall or the Seller is a party or by which Steel City, Nall or the Seller may be bound or affected.\n2.7 Financial Statements. The consolidated Balance Sheet of Steel City and Nall, as of September 30, 1994 (the \"Acquisition Balance Sheet\") and the period then ended previously delivered by Seller to Purchaser have in all material respects been prepared in accordance with generally accepted accounting principles consistently applied and in all material respects fairly represent the financial position of the Corporation as of September 30, 1994, and the results of operations for the period then ended.\n2.8 Absence of Certain Changes. Since September 30, 1994, there has not occurred:\n(i) any material adverse change in the financial condition or properties, liabilities, capitalization or business of Steel City or Nall, except changes in the ordinary course of business, none of which is materially adverse, or\n(ii) any damage, destruction, loss or occurrence (whether or not covered by insurance) materially and adversely affecting the properties, business or prospects of Steel City or Nall.\n2.9 Absence of Undisclosed Liabilities. Except as set forth in Schedule 2.9, neither Steel City or Nall has any material debt, liability or obligation of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, that is not reflected in the Acquisition Balance Sheet other than current liabilities arising in the ordinary course of business subsequent to the date of the Acquisition Balance Sheet, none of which alone or in the aggregate is material to the property, business, prospects, or financial condition of the Corporation.\n2.10 Tax Returns and Tax Liabilities. Each of Steel City and Nall have (i) timely filed all tax returns required to be filed in any jurisdiction on which either is subject, (ii) either timely paid in full all taxes due on such returns or any assessment, deficiency notice, 30-day letter or similar notice received by it (except for any such taxes as are being contested in good faith by appropriate proceedings), and any interest, additions to tax and penalties with respect thereto, or provided adequate reserves for the payment thereof, and (iii) fully accrued on their respective books all taxes, and any interest, additions to tax and penalties with respect thereto, for any period through the date hereof which are not yet due, including such as are being contested. Seller has no information that would lead it to believe that any taxing authority or jurisdiction to which Steel City or Nall is or was subject has instituted or will institute an audit, review, examination, or other investigation of Steel City or Nall with respect to any tax applicable to Steel City or Nall prior to the date hereof. Seller has caused Steel City and Nall to make available for inspection by Purchaser or by Purchaser's authorized representative complete and correct copies of all material income tax, franchise or capital stock tax, sales, occupational, employment, personal property, real property or other tax returns related to Steel City and Nall for each of the three (3) fiscal years of Steel City and Nall which conclude with the fiscal year that ended May 31, 1994, together with complete and correct copies of any reports of tax authorities relating to examination of such returns and all prior returns for periods ending since May 31, 1989 that have been audited, together with any elections to adopt any particular method of treating an item for tax purposes and any closing agreement applicable to Steel City or Nall.\n2.11 Real Property Assets. Schedule 2.11 to this Agreement sets forth a complete and accurate legal description of each parcel of real property owned by the Corporation. Schedule 2.11 contains a description of all buildings, fixtures and other improvements located on real properties owned by the Corporation and a list of all policies of title insurance issued to the Corporation for these properties. The zoning of each parcel of real property described in Schedule 2.11 permits the currently existing improvements and the continuation of the business currently being conducted on such parcel. There is no pending or, to the best knowledge of the Seller, contemplated eminent domain or condemnation proceeding affecting any of the real property described in Schedule 2.11 or any part thereof, and Seller shall give prompt notice to Purchaser of any such proceeding which occurs or is threatened with respect to such property prior to the Closing. The real property described on Schedule 2.11 includes all of the real property occupied or used by the Corporation on the date hereof or in the last 12 months. No real property is leased to the Corporation.\n2.12 Tangible Personal Property. Schedule 2.12 to this Agreement is a complete and accurate schedule describing and specifying the location of all trucks, automobiles, machinery, equipment, furniture, supplies and all other tangible personal property owned or leased by Steel City or Nall in connection with their respective businesses having a current depreciated book value of $1,000 or more. Included on Schedule 2.12 are certain assets with a depreciated book value of less than $1,000. Except as specified in Schedule 2.12, no personal property used by Steel City or Nall in connection with its business is held under any lease, security agreement, conditional sales contract, or other title retention or security arrangement or is located other than in the possession of Steel City or Nall.\n2.13 Title to Assets. Each of Steel City and Nall has good and marketable title to all of its assets and interests in assets, whether real, personal, tangible or intangible, which constitute all of the assets and interests in assets that are used in the business of Steel City and Nall, respectively. All these assets are free and clear of all mortgages, liens, pledges, charges, encumbrances, equities, claims, easements, rights of way, covenants, conditions or restrictions whatsoever, except for (i) those disclosed in Schedule 2.12; (ii) those disclosed in the Acquisition Balance Sheet; (iii) the lien for current taxes not yet due and payable; and (iv) possible minor matters that in the aggregate are not substantial in amount and do not materially detract from or interfere with the present use of any of these assets or materially impair business operations of Steel City or Nall. To the best of Seller's knowledge, all real property and material tangible personal property of Steel City and Nall are in good operating condition and repair, except for ordinary wear and tear and any defects, the cost of repairing which would not be material. Neither Seller nor, to the best of Seller's knowledge, any officer, director or employee of Seller, Steel City or Nall owns or has any interest, directly or indirectly, in any of the real or material personal property owned by or leased to Steel City or Nall. Neither Steel City nor Nall occupies any real property in violation of any law, regulation or decree.\n2.14 Accounts Receivable. All customer accounts receivable of the Corporation shown on the Acquisition Balance Sheet arose from valid sales in the ordinary course of business and will at the Closing be valid, binding obligations in favor of the Corporation, and the Seller has no reason to believe that such accounts receivable (net of applicable revenues) are not collectible in the ordinary course of business without undue delay of expense.\n2.15 Employment Contracts. Schedule 2.15 to this Agreement is a list of all employment contracts and all pension, bonus, profit-sharing, stock option or other agreements or arrangements providing for employee remuneration or benefits to which Steel City or Nall is a party or by which either is bound; all these contracts and arrangements are in full force and effect, and neither Steel City nor Nall is in default under them. There have been no claims of default, and to the best knowledge of Seller, there are no facts or conditions which if continued or unnoticed will result in a default, under any such contract or arrangement. Neither Steel City nor Nall is a party to any collective bargaining agreements. There is no pending or, to Seller's knowledge, threatened labor dispute, strike, or work stoppage affecting Steel City or Nall.\n2.16 Insurance Policies. Schedule 2.16 to this Agreement is a description of all insurance policies held by Steel City or Nall concerning their respective businesses and properties (other than the title insurance policies heretofore listed in Schedule 2.11). All these policies are in the principal amounts set forth in Schedule 2.16. Steel City and Nall have maintained and now maintain (i) insurance on all their respective assets and businesses of a type customarily insured, covering property damage and loss by fire or other casualty; and (ii) adequate insurance protection against all liabilities, claims and risks against which it is customary to insure.\n2.17 Absence of Certain Business Practices. None of Steel City, Nall or any director, officer, or, to the best of Seller's knowledge, any employee or agent, of Steel City or Nall or any other person acting on their behalf has, directly or indirectly, within the past five (5) years given or agreed to give any gift or similar benefit to any customer, supplier, governmental employee or other person who is or may be in a position to help or hinder the business of Steel City or Nall which might reasonably subject Steel City or Nall to any damage or other liability in any private or governmental, civil or criminal litigation or proceeding. Except as set forth in Schedule 2.17, neither Seller nor, to the best of Seller's knowledge, any officer, director, or employee of Steel City or Nall, has any direct or indirect interest of material character in any competitor, supplier or customer of Steel City or Nall, or in any person from whom or to whom Steel City or Nall leases any real or material personal property, or in any other person with whom Steel City or Nall is doing any material business.\n2.18 Compliance with Laws. Neither Steel City nor Nall has received any notice of failure of compliance with or violation of applicable federal, state or local statutes, laws or regulations that would materially affect its properties or the operation of its business including without limitation, any applicable building, zoning or other law, ordinance or regulation materially affecting its properties or the operation of its business during the last five years. To Seller's best knowledge Steel City and Nall have properly discharged, transported, stored, disposed of and dealt with any Hazardous Material either has produced or accumulated in accordance with all federal, state and local laws and do not require, or are not otherwise subject to any material remedial, response, removal or corrective action under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") 42 USC SectionSection9601 et seq., as amended, the Resource Conservation and Recovery Act (\"RCRA\") 42 USC SectionSection 6901 et seq., applicable provisions of law of the State of Alabama, or any other federal, state, local or foreign statutes, regulations, policies or orders now existing with respect to Hazardous Materials or relating to pollution or protection of the environment. \"Hazardous Materials\" shall mean any chemical substance known to be hazardous wastes, hazardous substances, hazardous constituents, toxic substances or related materials, whether solid, liquid or gaseous, including but not limited to substances defined as \"hazardous wastes,\" \"hazardous substances,\" \"toxic substances,\" \"pollutants,\" \"contaminants,\" \"chemicals known in the State of Alabama to cause cancer or reproductive toxicity,\"-\"radioactive materials,\" or other similar designations in or otherwise subject to regulation under any environmental laws, or under the plans, rules, regulations or ordinances adopted, or other criteria and guidelines promulgated pursuant to any environmental laws, including without limitation asbestos, polychlorinated biphenyls (PCBs) or urea formaldehyde foam insulation. To the best of Seller's knowledge, Steel City and Nall have complied in all material respects with all laws and regulations of any applicable jurisdiction with which it is or was required to comply in connection with its ownership or use of its properties and operation of its business (including without limitation the Occupational Safety and Health Act of 1970, as amended (\"OSHA\"), the Equal Employment Opportunity Act, as amended (the \"EEOA\"), the Clear Water Act, the Clean Air Act, the Federal Water Pollution Control Act, the Solid Waste Disposal Act, RCRA and CERCLA, or any rules and regulations promulgated pursuant thereto or any similar or equivalent state or local legislation or rule or regulation), the enforcement of which would have a material and adverse effect on the business of Steel City or Nall. Steel City and Nall have all material governmental permits, permissions, and licenses necessary to own their respective properties or conduct their respective businesses in conformance with all applicable federal, state, and local legislation, rules and regulations, none of which require the permission, approval or consent of any person to remain fully effective with respect to such corporation and for said business after consummating the transactions contemplated by this Agreement.\nThere are no known conditions in any way relating to Steel City or Nall or their businesses, resulting from any action or inaction of the Seller or their agents or Steel City or Nall during the time Seller owned Steel City or Nall, involving or resulting from any past or present spill, discharge, leak, emission, injection, escape, dumping or release of any kind whatsoever of any substance or exposure of any type in any work place or to any medium, including, but not limited to, air, land, surface waters and ground waters or from any generation, transportation, treatment, storage, disposal of waste materials, toxic materials or Hazardous Materials of any kind, or from the storage, use or handling of any toxic substance or Hazardous Materials that have had or it is reasonable to expect will have a material adverse effect on said business or the properties of Steel City or Nall.\n2.19 Litigation. Except as set forth in Schedule 2.19 hereto, there are no actions, suits, investigations or proceedings pending in any court or before any governmental agency to which Steel City or Nall is a party or, to the best of Seller's knowledge, otherwise affecting its properties or its business and, to the best of Seller's knowledge, there is no litigation, proceeding, claim, grievance, proceeding or controversy threatened against Steel City or Nall with regard to or affecting its properties or its business. There is no action, suit, proceeding or investigation known to Seller that is pending or threatened that questions the validity or propriety of this Agreement or any action taken or to be taken by Seller or Steel City or Nall in connection with this Agreement. Neither Steel City nor Nall is subject to any judicial injunction or mandate or any quasi-judicial order or quasi-judicial restriction directed to or against it as a result of its ownership of its properties or its conduct of its business as currently conducted by it, and, except as set forth in Schedule 2.19 hereto, no governmental agency has at any time during the five years immediately preceding the date hereof challenged or questioned in writing the legal right of Steel City or Nall to conduct its business so as to materially and adversely affect the ownership and use of its properties.\n2.20 Employee Benefit Plans\n(a) Schedule 2.20 hereto sets forth a description of each compensation, employment, or collective bargaining agreement, and each stock option, stock purchase, life, health, accident or other insurance, bonus, deferred or incentive compensation, severance or separation, profit sharing, retirement, or other employee benefit plan, practice, policy or arrangement, covering employees or former employees of Steel City or Nall, which Steel City or Nall maintains, to which Steel City or Nall contributes, or under which Steel City's or Nall's employees or former employees are covered (collectively, the \"Benefit Plans\"). The term \"Benefit Plans\" as used herein refers to all plans included in Schedule 2.20, but the terms \"plan\" or \"plans\" are used in this Agreement for convenience only and do not constitute an acknowledgment that a particular arrangement, agreement, commitment, pleading, policy or understanding is an employee benefit plan within the meaning of Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\").\n(b) Seller shall, on or before January 15, 1995, deliver to Purchaser true and complete copies of each Benefit Plan maintained by Steel City or Nall listed on Schedule 2.20, including all amendments, if any, to each thereof and copies of all summary plan descriptions booklets and other communications and disclosures provided to or made to the Corporation's employees with respect to each such Benefit Plan.\n(c) As of the date of the Acquisition Balance Sheet, all contributions required to be made by Steel City or Nall under Steel City's and Nall's normal funding procedures to any Benefit Plan for or on behalf of its employees for periods prior to the date of the Acquisition Balance Sheet have been made or reserves adequate for such purposes as of the date of the Acquisition Balance Sheet have been set aside therefor and reflected in the Acquisition Balance Sheet, in accordance with the terms of each such plan. As of the date of the Acquisition Balance Sheet, there were no accrued salaries, wages or other employee benefits that are not reflected on the Acquisition Balance Sheet. All contributions made by employees of Steel City or Nall as of the date of the Acquisition Balance Sheet have been deposited by Steel City or Nall with the appropriate funding agency of each Benefit Plan in accordance with the terms of each such plan. There are no material outstanding liabilities of any such Benefit Plan maintained by Steel city or Nall other than liabilities for benefits to be paid to participants in such plan and their beneficiaries in accordance with the terms of such plan. As of Closing there shall have been no material change in the status of any Benefit Plan maintained by Steel City or Nall. As of the Closing Date, all contributions required to be made by Steel City or Nall under the Corporation's normal funding procedures to any Benefit Plan for or on behalf of its employees for periods prior to the Closing Date shall have been made or reserves adequate for such purposes shall have been set aside therefor as of the Closing Date; and any such plan shall be fully funded, as that phrase is commonly understood in the industry, in accordance with the terms thereof as of the Closing Date.\n(d) Each Benefit Plan maintained by Steel City or Nall is, and has been, administered in material compliance with the applicable provisions of ERISA and with other applicable federal or state law.\n(e) There are no actions, suits, or claims (other than routine claims for benefits) pending or, to the best of Seller's knowledge, threatened, against any Benefit Plan maintained by Steel City or Nall, or any administrator or fiduciary of any such plan except as set forth on Schedule 2.9.\n(f) Except as provided in subparagraph (g) below and except as may be required in order to comply with any requirements of the Internal Revenue Service (\"IRS\") or to bring any Benefit Plan into compliance with the Internal Revenue Code of 1986, as amended (the \"Code\") or any IRS guidelines, or to conform any Benefit Plan to current operational practices, neither Steel City nor Nall has any agreement, arrangement, commitment or understanding, whether legally binding or not, to create any additional Benefit Plan or to continue, modify, change, or terminate, in any material respect, any existing Benefit Plan.\n(g) Steel City and Nall are participating employers in the Golden Enterprises, Inc. Amended and Restated Employee Stock Ownership Plan and Trust (the \"Stock Ownership Plan\"). At or prior to the Closing, Steel City and Nall will terminate their participation in the Stock Ownership Plan. During the period that the Stock Ownership Plan has been maintained for the benefit of employes of Steel City and Nall, (i) the Stock Ownership Plan has been qualified and continues to be qualified in all material respects under Section 401(a) of the Code, (ii) the assets of the Stock Ownership Plan have been and continue to be held in a trust which is tax exempt under Section 501(a) of the Code, (iii) the Stock Ownership Plan has been and is the subject of a favorable determination letter from the Internal Revenue Service, (iv) the Stock Ownership Plan has been filed for a determination with respect to the compliance of the plan with the Tax Reform Act of 1986, and such application is pending, and (v) the Stock Ownership Plan has been administered and operated in accordance with its terms and in a manner to preserve its tax qualification.\n(h) Neither Steel City nor Nall has ever participated in any pension plan, as defined in Section 3(2) of ERISA, which would subject it or the plan to (i) any liability to the Pension Benefit Guaranty Corporation (\"PBGC\"), (ii) the provisions of Section 40441, 4042, or 4043 of ERISA, or (iii) the funding requirements of Section 302 of ERISA. Further, neither Steel City nor Nall has ever participated in any multiemployer plan, as defined in Section 3(37) of ERISA, which would subject it or the plan to (A) any withdrawal liability under Section 4201 of ERISA, or (B) any increased annual liability as a result of a plan reorganization as described in Section 4241 of ERISA.\n(i) Steel City and Nall are participating employers in Seller's Voluntary Employee Benefits Association (the \"VEBA\"). At or prior to the Closing, Steel City and Nall will terminate their participation in the VEBA. During the period that the VEBA has been maintained for the benefit of employees of Steel City and Nall, (i) the VEBA and the related trust established for the VEBA have been maintained and operated so as to preserve the tax exempt status of the trust under Section 501(c)(9) of the Code, to include compliance with the nondiscrimination requirements imposed by Section 505(b) of the Code and the notice requirements imposed by Section 505(c) of the Code, and (ii) the VEBA has been funded in compliance with the requirements of and subject to the limitations imposed by Section 419 of the Code.\n(j) To the best of Seller's knowledge, (i) none of the Benefit Plans is currently under investigation, audit, or review by the Department of Labor, the Internal Revenue Service, or any other federal or state agency or is liable for any federal, state, local, or foreign taxes, and (ii) there is no transaction in connection with which Steel City or Nall or any fiduciary of any Benefit Plan could be subject to either a civil penalty assessed pursuant to Section 502 of ERISA, a tax imposed by Section 4975 of the Code, or liability for a breach of fiduciary or other responsibility under ERISA.\n2.21 Material Information. Neither the Schedules nor Exhibits attached hereto nor any written material furnished by Seller to Purchaser hereunder or pursuant to this Agreement contained, as of their respective dates, nor does this Agreement contain, any untrue statement of a material fact or omit to state a material fact necessary to make statements contained therein or herein not false or misleading in light of the circumstances under which they are made.\n2.22 Other Contracts. Neither Steel City nor Nall is a party to, or in any way obligated under, any material understanding or agreement, written or oral, of any sort applicable to or affecting the business or properties of Steel City or Nall, other than (a) leases listed on Schedule 2.11, (b) the agreements listed in Schedule 2.15 hereto, and (c) contracts listed in Schedule 2.22 hereto. A true copy of each contract described in Schedule 2.22 shall be furnished to Purchaser on or before January 15, 1995, and each such Contract is in full force and effect, and none of the parties thereto are in default in any material respect thereunder.\n2.23 Licenses and Permits. Schedule 2.23 contains a true and accurate list of all material licenses and permits to which Steel City or Nall is a party. A copy of each license or permit listed on Schedule 2.23 shall be furnished to Purchaser on or before January 15, 1995, and each such license or permit is in full force and effect as of the date thereof.\n3. Purchaser's REPRESENTATIONS AND WARRANTIES. Purchaser represents and warrants that the following facts are true and correct, all of which shall be deemed to have been made also at the Closing without further writing, and all of which shall survive the Closing as hereinafter provided or any termination or cancellation of this Agreement unless otherwise contemplated hereby.\n3.1 Purchaser's Standing and Qualification. Purchaser is a Corporation duly organized, validly existing and in good standing under the laws of the State of Alabama; it has all requisite corporate power and authority to own its properties and to carry on its business as now being conducted and is duly qualified to transact business in all other jurisdictions in which, by reason of the nature of its business or activities, such qualification is necessary.\n3.2 Execution, Delivery and Performance of Agreement. Neither the execution, delivery n or performance of this Agreement by Purchaser, with or without the giving of notice, or the passage of time, or both, conflict with, result in a default, right to accelerate or loss of any right under, or result in the creation of any lien, charge or encumbrance pursuant to any provision of Purchaser's Certificate of Incorporation or By-laws, or any material franchise, mortgage, deed of trust, lease, license agreement, understanding, law, ordinance, rule or regulation or any order, judgment, or decree to which Purchaser is a party or by which Purchaser may be bound or affected. Purchaser has full power and authority to enter into this Agreement and to carry out the transactions contemplated hereby; all proceedings required to be taken by Purchaser to authorize the execution, delivery and performance of this Agreement and the agreements relating hereto have been properly taken; and this Agreement has been duly executed and delivered by Purchaser and constitutes a valid and binding obligation of Purchaser.\n3.3 Investment Representation. Purchaser understands that the Shares have not been registered under the Securities Act of 1933, as amended, or any applicable state securities law and that they must be held indefinitely unless they are subsequently registered thereunder or an exemption from registration is available. Purchaser represents and warrants to Seller that it is acquiring the Shares for investment, and not with a view to the distribution thereof, and agrees that it will not transfer any of the Shares in violation of the provisions of any applicable securities statute.\n4. SELLER'S OBLIGATIONS BEFORE CLOSING.\nFrom the date hereof through the Closing Date:\n4.1 Purchaser's Access to Premises and Information. Purchaser and its counsel, accountants, and other representatives shall have full access during normal business hours, upon reasonable notice, to all properties, books, accounts, records, contracts and documents relating to the Corporation. Seller shall furnish or cause to be furnished to Purchaser and its representatives all data and information concerning the business, finances and properties of the Corporation that may reasonably be requested.\n4.2 Conduct of Business. The Corporation shall carry on its business and activities in the ordinary course and in substantially the same manner as they previously have been carried on and shall not make or institute any unusual or novel methods of production, manufacture, purchase, sale, lease, management, accounting or operation that will vary materially from those methods used by the Corporation as of the date of this Agreement.\n4.3 Preservation of Business. The Corporation will use all reasonable efforts to preserve its business organization intact, to retain its current employees and preserve its current relationships with suppliers, customers and others having business relationships with it.\n4.4 Corporate Matters. Neither Steel City nor Nall will (i) amend its Articles of Incorporation or By-laws, (ii) issue any shares of its capital stock, (iii) issue or create any warrants, obligations, subscriptions, options, convertible securities or other commitments under which any additional shares of its stock of any class might be directly or indirectly authorized, issued or transferred from treasury, or (iv) agree to do any of the acts listed above.\n4.5 Maintenance of Insurance. The Corporation will continue to carry its existing insurance subject to variations in amounts required by the ordinary operations of its business. At the request of Purchaser, and at Purchaser's sole expense, the amount of insurance against fire and other casualties which at the date of this Agreement the Corporation carries on any of its properties or in respect of its operations shall be increased by such an amount as Purchaser shall specify.\n4.6 Employees and Compensation. The Corporation will not do, or agree to do, any of the following acts, without Purchaser's prior written consent: (i) grant any increase in salaries payable or to become payable to any director, officer or employee other than regularly scheduled salary increases for employees earning less than $25,000 per year; or (ii) increase benefits payable to any officer, director or employee under any bonus or pension plan or other contract or commitment other than scheduled increases that take effect pursuant to existing plans or arrangements described in Schedule 2.20 or as required by law, or (iii) enter into any collective bargaining agreement by which the Corporation may be bound.\n4.7 New Transaction. The Corporation will not, without Purchaser's written consent, enter into any contract, commitment or transaction not in the usual and ordinary course of business.\n4.8 Dividends, Distributions and Acquisition of Stock. Neither Steel City nor Nall will, without Purchaser's prior written consent, (i) declare, set aside or pay any dividend (cash or stock), or make any distribution in respect to its capital stock; (ii) directly or indirectly purchase, redeem or otherwise acquire any shares of its capital stock; or (iii) enter into any agreement obligating it to do any of the foregoing prohibited acts.\n4.9 Waiver of Claims. The Corporation will not do any of the following acts without Purchaser's prior written consent: (i) waive or compromise any right or claim of substantial value, or (ii) cancel without full payment any note, loan or other obligations owing to the Corporation; provided, however, that the Corporation may make adjustments in accounts receivable in the ordinary course of business.\n4.10 Existing Agreements. The Corporation will not, except in the ordinary course of business, modify, amend, cancel or terminate any of its existing material contracts or agreements or agree to do any of those acts without the prior written consent of Purchaser.\n5. CONDITIONS PRECEDENT TO PURCHASER'S PERFORMANCE.\nAll obligations of Purchaser under this Agreement to be performed on the Closing Date are specifically subject to the satisfaction of the following conditions precedent on or before the Closing Date or the waiver thereof by Purchaser all as indicated below:\n5.1 Accuracy of Seller's Representations and Warranties. Except as otherwise permitted by this Agreement, all representations and warranties by Seller contained in this Agreement or in any written statement that shall be delivered to Purchaser by Seller shall be true in all material respects as of the date hereof and on and as of the Closing Date.\n5.2 Performance by Seller. Seller shall have performed, satisfied and complied with in all material respects all covenants, agreements and conditions required by this Agreement to be performed or complied with by them, or any of them, on or before the Closing.\n5.3 No Material Adverse Change. Since September 30, 1994, to the Closing, there shall not have been any material adverse change in the financial condition or the results of operations of the Corporation, and the Corporation shall not have sustained any material loss or damage to its assets, whether or not insured, that materially affects its ability to conduct its business.\n5.4 Certification by Seller. Purchaser shall have received a certificate dated as of the Closing, signed by the Seller and in such detail as Purchaser and its counsel may reasonably request, certifying that all actions and transactions to be performed by Seller pursuant to the terms of this Agreement have been performed, and that all representations and warranties by Seller contained in this Agreement or in any written statement delivered to Purchaser by Seller are true in all material respects as of the Closing Date.\n5.5 Opinion of Seller's Counsel. Purchaser shall have received from Spain, Gillon, Grooms, Blan & Nettles, counsel for Seller, an opinion dated as of the Closing Date in form and substance reasonably satisfactory to Purchaser and its counsel that:\n(i) Each of Steel City and Nall is a corporation duly organized and validly existing and in good standing under the laws of the State of Alabama and has all necessary corporate power to own its properties as now owned and to operate its business as now operated.\n(ii) The authorized capital stock of Steel City consists of 2000 shares of common stock with par value of $10.00 per share, of which 1,850 shares and no more are issued and outstanding. All outstanding shares are validly issued, fully paid and non-assessable. To the best knowledge and belief of counsel, there are no outstanding subscriptions, options, rights, warrants, convertible securities or other agreements or commitments obligating Steel City to issue any additional shares of its capital stock of any class.\n(iii) The authorized capital stock of Nall consists of 1000 shares of common stock with par value of $10.00 per share, of which 450 shares and no more are issued and outstanding. All outstanding shares are validly issued, fully paid and non-assessable. To the best knowledge and belief of counsel, there are no outstanding subscriptions, options, rights, warrants, convertible securities or other agreements or commitments obligating Steel City to issue any additional shares of its capital stock of any class.\n(iv) Except as set forth in Schedules 2.9 and 2.19 to this Agreement, counsel does not know of any suit, action, arbitration, or legal or administrative or other proceeding, or governmental investigation pending or threatened against the Corporation or any of its business or properties or its financial or other condition.\n(v) To the best of such counsel's knowledge, neither the execution nor delivery of this Agreement nor the consummation of the transactions contemplated by this Agreement will constitute (a) a default, or an event that would with notice or lapse of time, or both, constitute a default under, or a violation or breach of, any material agreement or understanding to which the Corporation is a party, or (b) an event that would permit any party to any agreement or instrument to terminate it or to accelerate the maturity of any material indebtedness or material other obligations of the Corporation or (c) an event that would result in the creation or imposition of any lien, charge, or encumbrance on any material asset of the Corporation, under the Articles of Incorporation, By-Laws of Steel City or Nall or any material indenture, license, lease, franchise, mortgage, instrument or other material agreement to which either Steel City or Nall is a party or may be bound of which such counsel has knowledge after due inquiry;\n(v) To the best of such counsel's knowledge, Seller is the owner of record of all the issued and outstanding shares of each of Steel City and Nall as set forth in paragraph (ii) above, free and clear of all liens and encumbrances, Seller will at the Closing have full power to transfer such shares to Purchaser without obtaining the consent or approval of any other person or governmental authority (other than such consents or approvals as shall have been duly obtained) and upon payment for and delivery of the Shares in accordance with the terms of this Agreement and assuming Purchaser is acquiring the Shares in good faith without notice of any adverse claim, Purchaser will be the owner of the Shares, free and clear of any adverse claim (other than security interests, pledges, liens, encumbrances, claims or equities created by Purchaser).\n(vi) This Agreement has been duly executed and delivered by Seller and constitutes the valid and binding obligation of Seller enforceable against it in accordance with its terms, except as enforcement may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights or by general principles of equity.\n5.6 Absence of Litigation. No action, suit or proceeding before any court or any governmental body or authority pertaining to the transaction contemplated by this Agreement or to its consummation shall have been instituted on or before the Closing.\n5.7 Statutory Requirements. All statutory requirements and all material authorizations, consents and approvals by federal, state and local governmental agencies and authorities necessary or required to be obtained for the valid consummation of the transaction contemplated by this Agreement shall have been fulfilled or obtained.\n5.8 Resignations. Seller shall have delivered to Purchaser the written resignation of all the officers and directors of the Corporation in form and substance satisfactory to Purchaser and its counsel and will cause any other action to be taken with respect to these resignations that Purchaser may reasonably request.\n5.9 Environmental Report. Seller shall have delivered to Purchaser at Seller's expense, prior to Closing, a Phase I environmental\/hazardous substances report in form and substance satisfactory to Purchaser for the property owned and leased by the Corporation, which report shall be prepared by an environmental engineer or other environmental consultant satisfactory to Purchaser. The report will include, at a minimum: (i) the qualifications of the engineer\/consultant with respect to environmental testing, (ii) a site inspection, (iii) an inquiry into prior uses and ownership of the site and identification of the sources used in such inquiry, (iv) identification of the types of waste which should be generated by said use, (v) soil borings tests to determine if any hazardous substance or waste has contaminated the site or an explanation as to why the same was not necessary in their opinion, (vi) an inquiry with city, county, state and federal environmental agencies to determine if the site is on a list of problem sites or is located such that a problem site could affect the Corporation's site, or if special permits for the handling of hazardous substances or wastes have been issued to previous owners or operators of the site, (vii) a detailed statement of findings, and (viii) a statement that in the opinion of the engineer\/consultant its level of inquiry was sufficient to determine the existence of Hazardous Materials, hazardous or dangerous wastes or substances or petroleum products. Such environmental report shall not have revealed any material environmental remediation required on any such real property such that the indemnification provisions of this Agreement could reasonably be regarded as an inadequate remedy therefor.\n5.10 Survey; Title Insurance. Seller shall have delivered to Purchaser, at Seller's expense, (i) an accurate survey certified by the surveyor, reflecting that the real estate described in Schedule 2.11, describes all of the real estate occupied or used by the Corporation on the date hereof; and (ii) a commitment for owner's title insurance reflecting that the Corporation has good and merchantable title to the real property described in Schedule 2.11 as being owned by the Corporation, subject to no liens, encumbrances or restrictions, except (i) liens for state and county taxes for the current year which are a lien but which are not yet due and payable, (ii) easements, restrictions, convenants and rights of way which do not interfere with the use of the premises for the manufacture of bolts and special fasteners, (iii) liens which are reflected in the Acquisition Balance Sheet; and (iv) liens which are otherwise described herein.\n5.11 Seller's Undertakings. Seller shall have performed and satisfied in all material respects, to the satisfaction of the Purchaser, each of the transactions undertaken by Seller pursuant to this Agreement.\n5.12 Eminent Domain. There shall be no eminent domain or condemnation proceeding pending or contemplated affecting the real property described in Schedule 2.11 hereto or any part thereof.\n5.13 Employment Agreement. Purchaser shall have entered into an Employment Agreement with Edward R. Pascoe in form and substance satisfactory to Purchaser.\n5.14 Cash and Marketable Securities. At the Closing Date, the Corporation shall have cash and marketable securities on hand in an amount not less than Three Hundred Thousand and NO\/100 Dollars ($300,000.00).\n5.15 Financing Condition. The Purchaser shall have been successful in obtaining bank loans in order to finance the transaction, including a $900,000 Revolving Line of Credit and a term loan of at lease $525,000, such loans to be on terms and conditions satisfactory to Purchaser.\n5.16 Due Diligence Review. The Purchaser shall not have discovered in its due diligence review of the Corporation any information not disclosed to Purchaser prior to the execution of this Agreement that would have a material adverse impact on the business, property, prospects or financial condition of the Corporation.\n5.17 Stockholder's Equity. The Corporation shall have stockholder's equity, calculated in accordance with Generally Accepted Accounting Principles, on a consolidated basis, of not less than $2,050,000 as of the Closing Date.\n5.18 Closing Balance Sheet. Seller shall have delivered to Purchaser a consolidated balance sheet of the Corporation as of the date as close to the Closing Date as reasonably practicable audited by Dudly, Hopton-Jones, Sims & Freeman (the \"Closing Balance Sheet\"). Purchaser agrees that if the Closing Date is on or prior to February 28, 1995, a balance sheet dated as of December 31, 1994, shall satisfy this condition.\n5.19 Schedules. On or prior to January 15, 1995, Seller shall deliver to Purchaser any Schedules referred to herein that are not attached to this Agreement on the date hereof. When the Schedules are delivered to the Purchaser, they will be attached to this Agreement and will become a part hereof as if they had been attached at the time of the execution of this Agreement.\n6. CONDITIONS PRECEDENT TO SELLER'S PERFORMANCE. The obligations of Seller to sell and transfer the Shares under this Agreement are specifically subject to the satisfaction at or before the Closing of the following conditions or the waiver thereof by Seller:\n6.1 Accuracy of Purchaser's Representations and Warranties. All representations and warranties by Purchaser contained in this Agreement or in any written statement delivered by Purchaser under this Agreement shall be true in all material respects on and as of the Closing as though such representations and warranties were made on and as of that date.\n6.2 Purchaser's Performance. Purchaser shall have performed, satisfied and complied with in all material respects all covenants, agreements and conditions required by this Agreement to be performed, compiled with or satisfied by it on or before the Closing.\n6.3 Corporate Approval. Purchaser shall have duly authorized and approved the execution and delivery of this Agreement and all corporate action necessary or proper to fulfill the obligations of Purchaser to be performed under this Agreement on or before the Closing shall have been performed.\n6.4 Opinion of Purchaser's Counsel. Purchaser shall have furnished Seller with an opinion dated as of the Closing by Burr & Furman, counsel for Purchaser, in form and substance reasonably satisfactory to Seller and their counsel to the effect that:\n(i) Purchaser is a Corporation duly organized, validly existing and in good standing under the laws of the State of Alabama and has all requisite corporate power to perform its obligations under this Agreement.\n(ii) All corporate action required by law or by the provisions of this Agreement to be taken by Purchaser on or before the Closing in connection with the execution and delivery of this Agreement and the consummation of the transactions contemplated by this Agreement has been duly and validly taken; this Agreement has been duly executed and delivered of Purchaser and constitutes the valid and binding obligation of Purchaser enforceable against Purchaser in accordance with its terms, except as enforcement may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors's rights or by general principles of equity.\n(iii) The consummation of the transactions contemplated by this Agreement does not violate or contravene any of the provisions of Purchaser's Certificate of Incorporation, By-laws, or, to such counsel's knowledge, of any material indenture, agreement, judgment, or order to which Purchaser is a party or by which Purchaser is bound.\n6.5 Absence of Litigation. No action, suit or proceeding before any court or any governmental body or authority pertaining to the transaction contemplated by this Agreement or to its consummation shall have been instituted on or before the Closing.\n6.6 Statutory Requirements. All statutory requirements and all material authorizations, consents and approvals by federal, state and local governmental agencies and authorities necessary or required to be obtained for the valid consummation of the transaction contemplated by this Agreement shall have been fulfilled or obtained.\n6.7 Certification by Purchaser. Seller shall have received a certificate dated as of the Closing Date, signed by Purchaser and in such detail as Seller and its counsel may reasonably request, certifying that all actions and transactions to be performed by Purchaser pursuant to the terms of this Agreement have been performed.\n7. THE CLOSING.\n7.1 Time and Place. The payment of the Purchase Price by Purchaser and the transfer and conveyance of the Shares by Seller to Purchaser (the \"Closing\") shall take place in the offices of Burr & Forman at 420 North 20th Street, Suite 3100, Birmingham, Alabama at 10:00 a.m. local time on February 1, 1995 (the \"Closing Date\"), or at such other time and place as the parties may agree in writing.\n7.2 Seller's Obligations at the Closing. At the Closing, Seller shall deliver to Purchaser the following instruments:\n(a) Certificates representing the Shares registered in the name of Seller, duly endorsed by Seller for transfer or accompanied by assignments of the Shares duly executed by Seller;\n(b) The stock books, stock ledgers, minute books and corporate seals of each of Steel City and Nall;\n(c) The opinion of Seller's counsel as provided in Paragraph 5.5:\n(d) The written resignations of all the officers and directors of the Corporation;\n(e) A certificate executed by the Seller, dated as of the Closing Date, certifying that all of its respective representations and warranties in this Agreement are true and correct in all material respects at and as of the Closing as though each representation and warranty had been made on that date;\n(f) The certificate required by Paragraph 5.4.\n7.3 Purchaser's Obligations at the Closing. At the Closing, Purchaser shall deliver to Seller the following instruments and documents:\n(a) Wire transfer of immediately available funds in the amount of the Purchase Price, made payable to the account of the Seller in accordance with its written instructions received by Purchaser at least two business days prior to the Closing;\n(b) The opinion of Purchaser's counsel dated as of the Closing as provided for in Paragraph 6.4;\n(c) A certified resolution of Purchaser's Board of Directors in form satisfactory to counsel for Seller authorizing the execution and performance of this Agreement and all action to be taken by Purchaser under this Agreement and a certified copy of Purchaser's By-laws;\n(d) A certificate executed by an officer of Purchaser certifying that all Purchaser's representations and warranties under this Agreement are true in all material respects as of the Closing as though each of those representations and warranties had been made on that date;\n8. NATURE AND SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATION, ETC. All statements contained in any Schedule hereto or in any certificate or instrument of transfer or conveyance delivered by or on behalf of the parties pursuant to this Agreement or in connection with the transactions contemplated hereby shall be deemed representations and warranties by the parties hereunder.\n8.1 Survival of Representations, Warranties, Etc. All representations and warranties of the parties made in this Agreement or as provided herein shall survive the Closing Date for a period of thirty-six (36) months thereafter notwithstanding any investigation at any time made by or on behalf of the other party (the \"Survival Period\"); provided, however, that all representations and warranties related to any claim asserted in writing prior to the expiration of the Survival Period shall survive until such claim shall be resolved and payment in respect thereof, if any is owing, shall be made.\n8.2 Seller's Indemnity. Sell shall indemnify, defend and hold harmless Purchaser against and in respect of any and all claims, demands, lawsuits, costs, expenses, obligations, liabilities, damages, recoveries and deficiencies including interest, penalties and reasonable attorneys' fees (collectively, \"Losses\"), that it shall incur or suffer which shall result from or relate to (i) any breach of or failure by Seller to perform any of its representations, warranties, covenants or agreements in this Agreement or in any schedule, certificate, or any other instrument furnished or to be furnished by Seller under this Agreement, (ii) any tax liability of any kind whatsoever (including taxes, interest, additions to tax and penalties) of the Corporation for any period ending prior to the Closing Date in excess of the amount accrued therefor on the Closing Balance Sheet.\n8.3 Purchaser's Indemnity. Purchaser agrees to indemnify and hold Seller harmless against and in respect of any and all Losses it may incur or suffer which shall result from or relate to any breach of or failure by Purchaser to perform any of its representations, warranties, covenants or agreements in this Agreement or in a schedule, certificate, or any other instrument furnished or to be furnished by Purchaser under this Agreement or by reason of any act of omission by Purchaser after the Closing that constitutes a breach or default under or failure to perform any obligation, duty or liability of the Corporation under any loan agreement, lease, contract, order or any other agreement to which it is a party or for which they are bound at the Closing or otherwise arising out of the conduct of the business of the Corporation after the Closing.\n8.4 Third Party Claims. Promptly after the receipt by any party hereto of notice of any claim, action, suit or proceeding of any third party that is subject to indemnification hereunder, such party (the \"Indemnified Party\") shall give written notice of such claim to the party obligated to provide indemnification hereunder (the \"Indemnifying Party\") as promptly as practicable after receipt of notice thereof, stating the nature and basis of such claim and the amount thereof, to the extent known. The Indemnifying Party shall have the right to compromise or defend, at its own expense and by its own counsel, any such matter. Such notice, and the opportunity to compromise or defend as herein provided, shall be a condition precedent to any liability of the Indemnifying Party under the provisions of this Paragraph 8. If the Indemnifying Party shall undertake to compromise or defend, it shall promptly notify the Indemnified Party of its intention to do so, and the Indemnified Party shall cooperate with the Indemnifying Party and its counsel in the defense thereof and in any compromise thereof. Such cooperation shall include, but not be limited to, furnishing the Indemnifying Party with any books, records or information reasonably requested by the Indemnifying Party that are in the Indemnified Party's possession or control. After the Indemnifying Party has notified the Indemnified Party of its intention to undertake to defend any such asserted liability, the Indemnifying Party shall not be liable for any additional legal expenses incurred by the Indemnified Party in connection with any defense of such asserted liability, except as requested by the Indemnifying Party. If the Indemnifying Party shall desire to make a final and complete compromise of any such third party claim and then the Indemnifying Party's liability under this Paragraph 8 with respect to such third party claim shall be limited to the amount so offered in compromise with said third party. Under no circumstances shall the Indemnified Party compromise any third party claim without the written consent of the Indemnifying Party.\n9. CERTAIN TAX MATTERS.\n9.1 Cooperation. After the Closing Date, Purchaser will provide Seller, promptly upon their request, with access to all such records and other factual information relating to the business of the Corporation during periods prior to the Closing Date as Seller may reasonably require in connection with the preparation or audit of the Corporation's federal, state, and local income and other tax returns or with respect to any dispute, refund claim or litigation relating thereto, and Purchaser will give Seller such other assistance as it may reasonably request, including reasonable access to the Corporation's employees, in connection with any such audit, dispute, refund claim or litigation. In addition, Purchaser agrees that all records, information or documents relating to tax matters shall be preserved by Purchaser until the expiration of any applicable statutes of limitations (and, if notified thereof, extensions thereof).\n9.2 Current Year's Tax Returns. Any and all tax returns of the Corporation for the current taxable year not filed on or prior to the Closing Date shall be subject to review by Seller prior to being filed, and Purchaser and the Corporation shall lend such assistance to Seller for purposes of their review as Seller shall reasonably require.\n9.3 Contest Provisions. If any taxing authority shall at any time contact Purchaser or the Corporation with respect to any tax matter which, if paid by Purchaser would be the subject of indemnity by Seller hereunder, then promptly upon the occurrence thereof (and in all events within ten (10) business days after such occurrence) Purchaser shall notify Seller thereof in writing, shall furnish Seller with copies of any legal process or documents delivered to Purchaser or the Corporation with respect thereto, and shall cooperate with Seller to cause such taxing authority to deal directly with Seller or Seller's designee with respect to such matters. In all events Seller shall decide whether to contest, and shall have control over any contest relating to, any such matters and may direct Purchaser or the Corporation to resist payment of any deficiency asserted against such Corporation until there has been a Final Determination (as hereinafter defined).\nFor purposes hereof, \"Final Determination\" shall mean a closing agreement with the taxing authority, a notice of deficiency with respect to which there has been executed a waiver of restrictions on assessment or with respect to which the period for filing a petition with the United States Tax Court has expired or, if such a petition is filed, a decision of any court of competent jurisdiction which is not subject to appeal or the time for appeal of which has expired.\nIf Seller decides to contest any asserted deficiency by causing Purchaser to make payment thereof (in which case a Final Determination shall have occurred and indemnity hereunder paid) and to file a claim for refund, Purchaser will cooperate with Seller in connection therewith. Upon notice of disallowance of such claim for refund, if any, Seller, on behalf of the Corporation, may contest such disallowance by suing for a refund and shall have control over the conduct of such contest (including appeal of any adverse determination) with counsel reasonably satisfactory to Purchaser. Upon receipt by Purchaser of any refund or offset (including any refund or offset that would have been received but for a counterclaim not indemnified by Seller hereunder) from any taxing authority of any amounts paid by it based on the deficiency, within thirty (30) days of receipt thereof, Purchaser shall pay to Seller the amount of such refund together with any interest received thereon (or any interest that would have been received if no other matters had been involved in the judicial or administrative proceeding in question) together with any tax benefits Purchaser realizes as a result of making such payment.\n10. CONTINUED EMPLOYMENT OF OFFICERS, DIRECTORS AND EMPLOYEES. Subject to the requirements of any employment agreement to which the Corporation is a party, listed on Schedule 2.15 hereto, Purchaser shall have no responsibility of any kind to continue the employment of any of the officers, directors or employees of the Corporation.\n11. PRESS RELEASE; DISCLOSURE. Upon execution of this Agreement, Seller shall have the right to make the contents of this Agreement public.\n12. CONFIDENTIALITY. All information furnished by Seller and the Corporation or either of them to Purchaser pursuant hereto shall be treated as the sole property of Seller and shall be kept confidential by Purchaser until Closing. If this Agreement is terminated, as herein provided, Purchaser shall return to Seller all documents and other materials containing, reflecting or referring to such other information and shall keep confidential all such information. Purchaser's obligation to keep such information confidential shall continue for two years from the date of the termination of this Agreement and shall not apply to (i) any information which (a) was already in its possession prior to the disclosure thereof by Seller; (b) was then generally known to the public; (c) became known to the public through no fault of Purchaser or any of its agents or representatives; or (d) was disclosed to Purchaser by a third party unaffiliated with Purchaser who was not bound by any obligation of confidential to Seller or (ii) disclosures required to be made in accordance with any law, regulation or order of a court of competent jurisdiction.\n13. FEES AND EXPENSES. Each of the parties hereto shall be responsible for any and all fees, costs or expenses incurred by such party in connection with the negotiations, preparation and execution of this Agreement and the Closing including the fees and costs of attorneys, accountants, consultants of every kind and nature. Each party will hold the other party harmless and indemnify the other from any claim or liability in connection therewith. In the event that either Purchaser or Seller shall commence any legal action or proceeding against the other arising out of or in connection with this Agreement or any alleged breach thereof, the prevailing party shall be entitled to receive from the losing party such reasonable attorneys' fees as the court may determine.\n14. TRANSFER TAXES. Any transfer tax, use tax, sales tax or other tax imposed a result of the purchase and sale of the Shares shall be paid by Seller.\n15. NOTICES. Any notice required or permitted to be given hereunder shall be deemed to be effectively given not more than seventy-two (72) hours after having been deposited in the United States mail, certified or registered mail, postage prepaid and addressed as follows:\nTO SELLER:\nGolden Enterprises, Inc. 2101 Magnolia Avenue South Birmingham, Alabama 35205 Attn: Mr. John S. Stein\nwith a copy to:\nSpain, Gillon, Grooms, Blan & Nettles 2117 2nd Avenue North Birmingham, Alabama 35203 Attn: John P. McKleroy, Jr.\nTO PURCHASER:\nCoosa Acquisitions, Inc. 2530 Mountain Brook Circle Birmingham, Alabama 35233 Attn: Philip C. Jackson, III\nwith a copy to:\nBurr & Forman 3000 SouthTrust Tower 420 South 20th Street\nEither party may change such address by giving written notice of such change to the other party in the manner provided above. Any such notice shall be deemed to be delivered as of the date delivered if personally delivered to such party.\n16. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and shall inure to the benefit of the parties, and their respective heirs, legal representatives, successors and assigns; provided, however, that neither Seller, nor Purchaser may assign any of their rights under this Agreement except that Purchaser may assign its rights under this Agreement to an entity controlled by Purchaser. No such assignment by Purchaser shall relieve Purchaser of any of its obligations or duties under this Agreement.\n17. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.\n18. ENTIRE AGREEMENT. This Agreement and the other documents and agreements referred to herein or entered into in connection herewith constitute the entire agreement between the parties pertaining to the subject matter contained herein and therein and supersede all prior agreements, representations and understandings of the parties. No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by all of the parties. No waiver of any provision of this Agreement shall be deemed or shall constitute a waiver of any other provision, whether or not similar, nor shall any waiver constitute a continuing waiver. No waiver shall be binding unless executed in writing by the party making the waiver.\n19. TERMINATION AND ABANDONMENT. This Agreement may be terminated and the transactions contemplated hereby abandoned (i) by the mutual consent of Purchaser and Seller; (ii) by Purchaser or Seller at any time after February 28, 1994 (or such later date as shall have been agreed to in writing by them) if the conditions set forth in Paragraphs 5 or 6 of this Agreement have not been fulfilled (or waived by the party entitled to the benefit thereto) by February 28, 1995, without liability on the party of any party hereto; provided, however, that no party shall be released from liability hereunder if any such condition is not fulfilled by reason of the breach by such party of its obligations hereunder or under any other instrument or agreement contemplated hereby.\n20. OTHER INSTRUMENTS TO BE EXECUTED. From and after the Closing Date, Seller shall, from time to time, at the request of Purchaser and without further consideration (but at Purchaser's expense) do, execute, acknowledge and deliver, all such further acts, deeds, assignments, transfers, conveyances, powers of attorney and assurances as may be reasonably required more effectively to convey, assign, transfer or confirm the sale of the Shares and complete the transactions contemplated herein.\n21. SCHEDULES. The Schedules attached hereto are incorporated herein and made a part hereof for all purposes. As used herein, the expression \"this Agreement\" means the body of this Agreement and such Schedules, and the expressions \"hereof,\" \"herein,\" and \"hereunder\" and other words of similar import refer to this Agreement and such Schedules as a whole and not to any particular part or subdivision thereof.\n22. APPLICABLE LAW. This Agreement shall be governed and construed in accordance with the laws of the State of Alabama.\nIN WITNESS WHEREOF, the parties to this Agreement have duly executed it on the day and the year first above written.\n\"PURCHASER\"\nCOOSA ACQUISITIONS, INC.\nBy: \/s\/ Philip C. Jackson, III Philip C. Jackson, III President\n\"SELLER\"\nGOLDEN ENTERPRISES, INC.\nBy: \/s\/ John S. Stein John S. Stein President","section_15":""}
{"filename":"105006_1995.txt","cik":"105006","year":"1995","section_1":"ITEM 1. BUSINESS (A) General Development of Business\nIn 1995 Watkins-Johnson decided to divide its Electronics Group, recognizing the two major markets that it served, into the Wireless Communication segment and the Government Electronics segment for reporting purposes. Other than this split into two reporting segments, the company's structure during 1995 was unchanged from the previous year. Since the company realigned its business between 1991 and 1993, operations had been reported as three business segments: semiconductor equipment, electronics products and environmental services. At the end of 1994, the environmental services unit was divested.\nNo material reclassifications, mergers or consolidations of the company or its subsidiaries occurred during 1995. Other than in the ordinary course of business, there were no acquisitions or dispositions of material amounts of assets during the year.\n(b) Financial Information about Industry Segments\nThe company operates in three industry segments--semiconductor equipment, wireless communications, and government electronics. The previously reported environmental services segment was divested at the end of 1994. Financial information covering these industry segments is included in Note 8 to the consolidated financial statements contained in Part II, Item 8 of this annual report on form 10-K.\n(c) Narrative Description of Business\nWatkins-Johnson Company is a high-technology corporation specializing in semiconductor-manufacturing equipment, subassemblies and transceivers for wireless communications, and radio-frequency electronics for government applications.\nSemiconductor Equipment\nThe company's Semiconductor Equipment Group designs, develops and manufactures equipment to deposit thin dielectric films by chemical vapor deposition (CVD), using two fundamental CVD processes. The earlier process, atmospheric-pressure CVD (APCVD), accounted for all of the equipment sold in 1995. This equipment functions by injecting the gases needed for the reaction over the substrate material. The substrates are transported under the injectors on a continuously moving conveyor belt through a resistance heated muffle. This approach allows high deposition rates with a simpler reactor design yielding higher reliability operation and high wafer throughput.\nThe major market for the APCVD equipment is the semiconductor industry where the equipment is used to deposit thin films of doped and undoped silicon dioxide used in the making of integrated circuits. The company's APCVD process is highly productive and offers an attractive cost of ownership. The equipment is sold world-wide to most of the major semiconductor manufacturers, especially to those engaged in high volume integrated circuit manufacture. Customers include both firms that manufacture and sell their own products and semiconductor foundry firms that contract manufacturing services to \"fabless\" companies. As such the company's equipment is used in the manufacture of all types of integrated circuits from logic circuits to semiconductor memory chips.\nThe newer process, high density plasma CVD (HDP), was first introduced to the customers in July 1995 at the important SEMICON West exposition as the WJ-2000. High density plasma is a variant of plasma-enhanced CVD which uses an RF-induced glow discharge to transfer energy into the reactant gases. This allows the substrate to remain at a lower temperature than in the APCVD process. Improved generators allow higher density of plasmas which the semiconductor industry expects to use for future integrated circuits with smaller feature size transistors and conductors. These smaller (0.25 micron and below) features are needed to fabricate devices such\nas the 256 megabit dynamic random access memory (256 Meg DRAM) and the seventh generation of microprocessors. Using the philosophy developed with its APCVD equipment, WJ's HDP equipment is designed for high productivity. Following the July introduction, the company has concentrated on a series of tests in its Scotts Valley laboratory to verify the production capabilities of the equipment with wafers provided by WJ and customers. Additional tests for the equipment at selected customer facilities (beta test sites) will be performed in 1996 prior to accepting orders.\nThe company markets the APCVD systems as the WJ-999 and the WJ-1000. The WJ-999 and WJ-TEOS999 systems are for production lines using 150 mm (6-inch) semiconductor wafers; they are capable of simultaneous processing of two wafers in parallel. The WJ-1000 is also offered with either hydride or TEOS reactant processes and is specifically designed for high productivity processing on 200 mm (8-inch) semiconductor processing lines. The company's APCVD process is mostly used in depositing doped oxide films, boro-phosphoro-silicate glass (BPSG) and phosphoro-silicate-glass (PSG), for the initial dielectric layers deposited on the wafers. These initial layers, sometimes termed the interlevel dielectric (ILD), are deposited prior to the metal layers which are used to connect the transistors and provide the circuit action. BPSG is a useful dielectric layer since it self-planarizes, offering a smoother surface for the following metal and dielectric layers. The equipment market for the pre-metal dielectric depositions (PMD) for 1995 was estimated by Dataquest, a high technology market research firm, to be $475 million. The WJ APCVD equipment is well suited for these applications and the company believes it is the PMD equipment market leader. This market has grown more rapidly than the semiconductor equipment market in general since the increased chip complexity is leading semiconductor manufacturers to use more dielectric layers.\nAs chip complexity increases, more than one metal layer is required to provide the circuit connections. Another growing market for dielectric deposition equipment is inter-metal dielectric deposition (IMD). The development of the new WJ-2000 HDP equipment is aimed specifically at this market. Dataquest estimated the 1995 IMD equipment market to exceed $600 million. The IMD equipment market is forecast to grow more rapidly than the PMD equipment market; Dataquest forecast the total dielectric equipment market to approach $3 billion in the year 2000.\nThe APCVD process equipment is easily scaleable. It has thus been adapted for the manufacture of the active matrix liquid crystal displays used in personal communication, computing and entertainment products.\nSales in the Semiconductor Equipment segment were 57% of consolidated sales in 1995, 43% in 1994 and 29% in 1993. The company is changing its mode of selling semiconductor equipment. In place of a network of manufacturers' representatives and distributors, the company is establishing a direct sales and service force world-wide to better serve its customers and reduce international expenses. Currently, the company has direct offices in the United States, Korea, Taiwan, Singapore and Europe (added in 1995). The business plans for the direct office in Japan have been initiated with a phase-over agreement with the distributor, Marubeni Hytech, and the purchase of a site for the office and applications laboratory. Office and lab construction will be initiated in 1996.\nThe company sells capital equipment to a majority of the global semiconductor manufacturers. Most of the sales are to makers of semiconductor integrated circuits. Although there are many such customers, a majority of the integrated circuits world-wide are produced by approximately 20 companies, with roughly two-thirds of the business outside the United States. NEC (through Marubeni Hytech, the company's Japanese distributor), Hyundai Electronics Ind. Co. Ltd. and Samsung Pacific International Inc. are significant customers of the segment. There are several domestic and international competitors (some of whom are larger than the company) and competition is intense. In meeting the competition, emphasis is placed on selling quality products with good technical performance and reliability with a competitive cost of ownership. The company's growing global customer-support network is a possible competitive advantage.\nThe Semiconductor Equipment Group's business depends upon the planned and actual capital expenditures of the semiconductor manufacturers, who react to the current and anticipated market demand for integrated circuits. Although this demand has been growing over the past few years, it has a history of cyclical variations. It is recognized that the semiconductor equipment business can vary rapidly in response to customer demand. Following placement of orders, customers frequently seek either faster or delayed delivery, based on their changing needs. Uncertainty increases significantly when projecting product demand more than 6 months in the future.\nWireless Communications\nThis newly recognized segment serves original equipment manufacturers in the rapidly growing market for wireless communication equipment. The company's long time leadership as a microwave-electronics manufacturer and its historic strength in space communication components provide a competitive advantage in offering unique solutions to requirements for wireless network communications and satellite systems.\nThe company has entered two wireless communication business areas paralleling the skills it had developed as a defense-electronics supplier. In the Palo Alto facility the company is producing components and subassemblies for cellular, personal communication services (PCS) and space applications. At the Gaithersburg facility the company is successfully adapting its communications-intelligence equipment technology to the design and production of low-cost, sensitive receivers for cellular telephone fraud detection and wideband transceivers for base station applications.\nBoth of these operations take advantage of the processes, devices and monolithic microwave integrated circuits (MMIC) developed and manufactured in the company's gallium-arsenide (GaAs) foundry. These proprietary devices and circuits perform highly reliable signal-processing functions in the various equipment and have enabled the company to capture programs over its competition. Other strengths the company brings to this marketplace are derived from the skills and technology developed over many years of providing microwave components and communications receivers for defense-electronics applications. The company is mining this technology to take advantage of expected market growth in the wireless communications sector. Substantial research and development efforts are being expended in an attempt to take advantage of projected growth opportunities.\nSales by the Wireless Communications segment were 8% of consolidated sales in 1995, 7% in 1994 and 7% in 1993. Although the business is international in scope, present selling efforts are concentrated in the United States. Marketing and sales are performed by company direct sales personnel and distributors. Major accounts are handled by direct company sales and service. Components, subassemblies, receivers and transceivers are primarily sold to companies which manufacture base station equipment for various wireless communication carriers. Although the customer community represents a large business opportunity, the number of individual customer companies is not large.\nThe telecommunications bill recently enacted reorganizes the business opportunities for the telecommunications industry. Although the company believes the results of this reorganization will be positive for its wireless communication business, its full effects are not clear. Various regulatory agencies of federal, state and local governments can also affect the wireless communication market dynamics, causing unforeseen ebb and flow of orders and delivery requirements. Domestic and international competition from a number of companies, some of which are much larger than Watkins-Johnson, is intense. The company seeks to win competitions by excellent service and superior technical performance. It seeks to protect its intellectual property by an aggressive patent and trade secret program as indicated below.\nGovernment Electronics\nThe Government Electronics segment designs, develops and manufactures microwave components, subsystems, and receivers for a broad range of applications. The segment supplies sophisticated electronic products for defense-intelligence, missile-guidance, electronic-warfare and space-communications missions.\nWatkins-Johnson receivers and signal-analysis equipment are used by military and other governmental agencies to perform range-monitoring, frequency-measurement, signal localization and interference-analysis functions, often in complex, high-signal-density environments. The company continues to sustain its technological and marketing leadership in communications intelligence equipment. Company funded design and development efforts are producing advanced receivers and related equipment featuring the small-size, light-weight and low-power- consumption characteristics demanded by its customers at competitive prices. This design effort is also serving the demand by government customers for \"commercial-off-the-shelf\" (COTS) equipment.\nThe company is the largest merchant supplier of integrated microwave subsystems to guided missile prime contractors. The company's integrated capability provides a technological advantage, while its microwave hybrid assembly and test capabilities give it a manufacturing edge over competing suppliers (including the internal capabilities of customer companies). The company is a subcontractor for certain key missile programs, such as the Advanced Medium-Range Air-to-Air Missile (AMRAAM), the High-speed Anti-Radiation Missile (HARM) and the Standard Missile Block IV which continue to represent a substantial portion of the segment's core defense-electronics business.\nGovernment Electronics products are marketed through direct selling efforts and distributor networks domestically and overseas. A small portion of the sector's business is exported to customers similar to those in the U.S. Such sales are generally subject to U.S. Government export control procedures.\nSales by the Government Electronics segment were 35% of consolidated sales in 1995, 50% in 1994 and 64% in 1993. A majority of segment sales are to government agencies and government prime contractors, such as Hughes Aircraft Company, engaged in defense contracting. The principal end user for such sales is the U.S. Department of Defense. Sales contracts with the government are customarily subject to terms and conditions which provide for renegotiation of profits and termination of the contract at the election of the government. The right to terminate for convenience has not had any significant effect on the company's financial position or results of operations.\nThe Government Electronics segment has numerous competitors which include large, diversified corporations and smaller specialty firms. In addition to pressures from competing companies, the company's defense electronics business is influenced by U.S. and foreign political activity and national budgetary policies. In recent years, Department of Defense budget cutbacks have had direct and indirect impact on the company. The indirect impacts had come about as large diversified customers retained within their companies work which WJ had previously performed. The company has reduced its work force and restructured its organization to better address the changing business opportunities. Continued reductions in defense spending could limit the demand for the company's products.\nOther Business Items\nRaw materials for the production of semiconductor equipment, wireless communications and government electronic products are acquired from a broad range of suppliers. Because suppliers are numerous, dependence on any one supplier is kept to a minimum. On occasion, however, the failure of a supplier to deliver key parts can jeopardize the on-time shipment of WJ products.\nBusiness operations are not believed to be seasonal. Except for negotiated advance or progress payments from customers on long-term contracts in the defense-electronics business, there are no special working capital practices.\nThe company has been active in securing patents and licensing agreements to protect certain proprietary technologies and know-how resulting from its ongoing research and development. The financial impact of the company's efforts to protect its intellectual property are unknown. Management believes that the company's competitive strength derives primarily from its core competence in engineering, manufacturing and understanding its customers and markets; therefore, aggressive steps to protect that knowledge are considered justifiable.\nTotal company backlog at December 31, 1995 was $250,276,000 compared to $235,942,000 at December 31, 1994. The percentage of backlog attributable to the Semiconductor Equipment, Wireless Communications and Government Electronics segments were 49%, 11% and 40%, respectively, in 1995, compared to 39%, 6% and 55% in 1994. Approximately 97% of all backlog at year-end 1995 is shippable within 12 months, compared to 92% at year-end 1994.\nCompany-sponsored research and development expense was $47,629,000 in 1995, $34,436,000 in 1994, and $27,163,000 in 1993. Customer-sponsored research and development was estimated to be approximately $20,000,000 in 1995, $24,000,000 in 1994, and $18,000,000 in 1993, and was performed mostly by the Government Electronics segment.\nThe company's employment at December 31, 1995 was 2,180. None of the company's employees is covered by a collective-bargaining agreement. The company's relationship with its employees is generally good.\nEnvironmental issues are discussed in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales.\nCombined export sales and sales from foreign operations accounted for 47% of the company's sales in 1995, 45% in 1994, and 33% in 1993. Assets and sales from foreign operations are less than ten percent of consolidated totals. The inherent risks of foreign business are similar to domestic business, with the additional risks of foreign government instability and export license cancellation. A major portion of foreign product orders in the Government Electronics segment requires export licensing by the Department of State prior to shipment. For international shipments for all company business segments, the company purchases forward exchange contracts and\/or obtains customer letters of credit to reduce foreign currency fluctuation and credit risks. For further information on foreign sales, see Note 8 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWatkins-Johnson Company and subsidiaries conduct their main operations at plants in Palo Alto and Scotts Valley, California and Gaithersburg, Maryland. During 1995, the company divested its switch-matrix business operations conducted in Windsor, England, and the facility is offered for sale. The plant in San Jose, California, which had been closed at the end of 1994 and offered for sale, has been taken off the market. Space limitations at the Semiconductor Equipment Group's headquarters in Scotts Valley prompted the company to reopen the San Jose facility in order to accommodate the Group's rapid expansion. Adjacent undeveloped land at the San Jose site is still offered for sale. The company closed its 50,000 square foot facility in Columbia (Savage), Maryland, in the first quarter of 1995 and returned it to the lessor.\nAt December 31, 1995, there were approximately 725,000 square feet of plant space in California, and 175,000 square feet in Maryland. Approximately 75% of the company's plant space is occupied for the company's operations. The company is pursuing opportunities to realize the market value of its properties while ensuring efficient use of available space.\nThe Government Electronics and Wireless Communications segments utilize substantially all of the Palo Alto and Gaithersburg facilities. The Scotts Valley plant houses the Semiconductor Equipment Group, with the Group expanding into the San Jose facility.\nThe Palo Alto facility and sales office locations are leased. Information on long-term obligations is in Note 3 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation required under this item is contained in Note 6 to the consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe company submitted no matters to a vote of the shareowners 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 principally traded on the New York and Pacific stock exchanges. At December 31, 1995 there were approximately 4,900 shareowners, which included holders of record and beneficial owners. The company expects that comparable cash dividends will continue in the future.\nDIVIDENDS AND STOCK PRICES\n1995 QUARTERS 1ST 2ND 3RD 4TH - --------------------------------------- ------ ----- ----- ----- Dividends Declared Per Share (in cents) 12 12 12 12 Stock Price (NYSE-in dollars) ..........High 40-1\/4 48-3\/8 57 54-7\/8 Low 29-3\/4 38-5\/8 43-1\/2 40-1\/2\n1994 QUARTERS 1ST 2ND 3RD 4TH - ------------------------------------------- ----- ----- ----- ----- Dividends Declared Per Share (in cents) 12 12 12 12 Stock Price (NYSE-in dollars) ...........High 28-3\/4 35-5\/8 36-5\/8 36 Low 19-5\/8 24-7\/8 26-1\/8 28-1\/2\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFinancial Condition\nThe company's financial condition remains healthy. Net income has increased from $21 million in 1994 to $31.4 million in 1995. During the same periods, cash provided by operations increased from $11.8 million in 1994 to $14.2 million in 1995, reflecting the need to fund increases in working capital items to support the company's growth. In 1995, purchases of capital equipment grew to $25.5 million from $12.5 million in 1994, in order to support the company's growing semiconductor equipment and wireless communications operations. Cash provided by operations and stock option exercises were sufficient to fund these capital expenditures as well as the 1995 dividend payments. Cash and equivalents at December 31, 1995 were virtually unchanged from\nthe prior year. For 1996, growth expectations are anticipated to require the use of external financing. The company has established a $100 million unsecured credit facility with several banks. The company has not had any borrowings under its credit facility during 1995.\nCurrent Operations and Business Outlook\nSemiconductor Equipment Group orders for 1995 were 34% above last year, reaching a total of $252 million. Semiconductor Equipment Group sales accounted for 57% of total company revenue. The mainstay of the group's product line in 1995 was the WJ-1000 atmospheric-pressure chemical-vapor-deposition (APCVD) system which was produced specifically to process 200-mm (8-inch) wafers. The group is continuing to increase its international presence. A sales and service office was established in Europe and progress is currently underway for the construction of an applications laboratory in Japan. Space limitations at the group's headquarters in Scotts Valley, California, prompted the company to reopen its San Jose, California, facility to accommodate rapid expansion. Training, marketing, sales, and spares functions will relocate to San Jose in the first half of 1996, followed in 1997 by the group's engineering organization. The outlook for 1996 appears positive as the group enters the year with record backlog and strong orders prospects. The group expects 1996 profit margins to be at about the 1995 level.\nAlthough Wireless Communications is Watkins-Johnson's newest and smallest business segment today, representing nearly 10 percent of 1995 revenue, its growth rate is expected to be higher than the rest of the company's businesses. The segment enters 1996 with a strong backlog for wireless subassemblies which coupled with good orders prospects from a few key customers should allow wireless revenues to nearly double. Industry analysts forecast healthy expansion for the wireless industry at about 25% to 30% revenue growth per year through the end of the century. The company's longtime leadership as a microwave-electronics manufacturer and historic strength in space communication provide a competitive advantage in providing unique solutions to the increasing requirements placed on network communications and satellite systems. Although revenues for the wireless market is expected to grow strongly, such growth will require continued high research and development spending by the group in 1996 to capitalize on the opportunities. It is expected this business segment will continue to operate at a slight loss in 1996.\nWhile revenue from the Government Electronics segment declined in 1995, due in part to the divestiture of certain product lines, profitability increased 35% as a result of aggressive management action. The company maintained tight control of costs, consolidated its Savage and Gaithersburg, Maryland, operations into its Gaithersburg plant, divested its California-based microwave surveillance systems operation and sold its Windsor, England, switch-matrix business. These actions enable the segment to concentrate on its long-term technical strengths and focus on those opportunities in which it can be most competitive. For 1996, the segment expects flat sales with improved profitability.\nResults of Operations\n1995 Compared to 1994: Semiconductor Equipment Group sales and Wireless Communications sales increased 55% and 31%, respectively, while Government Electronics sales were down 19%, resulting in an overall company increase of 16%. The $31.5 million decrease in Government Electronics sales was due in part to the divestiture of certain product lines in the second quarter of 1995 which accounted for approximately $28 million of sales in 1994. Gross margins increased from 41% to 43% due mostly to the revenue mix shifting towards more profitable semiconductor equipment products and improved margins in the Government Electronics segment. Although selling and administrative expenses as a percentage of sales decreased slightly, expenses were up 5% due to the increased volume. Research and development expenses increased from 10% to 12% of sales due to the company's substantial efforts in developing next generation products, particularly for the Semiconductor Equipment Group and the development and commercialization of products for the Wireless Communications segment. The effective tax rate for federal and foreign income taxes decreased from 30% to 29% compared to the same period last year. The tax\nrate decrease resulted mostly from tax benefits related to higher export sales. Due to the combined effect of the above factors, net income increased 50% over 1994.\n1994 Compared to 1993: Sales by the Semiconductor Equipment Group and Wireless Communications segment increased 78% and 16%, respectively, more than offsetting the 9% decline in Government Electronics, resulting in an overall company increase of 18%. The favorable shift towards more profitable semiconductor-equipment products helped to improve the company's gross margin to above 40% despite consolidation costs incurred in the Government Electronics segment. Selling and administrative expenses grew faster than revenues because of commissions on higher international semiconductor-equipment sales. To improve customer service and better control international expenses, the company moved to establish certain foreign operations and phase out its international distributors. The offices will operate in parallel with the current distributors during a transition period. Research and development expenditures were expectedly higher than last year due to the company's efforts in advancing high-density plasma technology and the development of next generation products for all business segments. The effective tax rate declined from 31% to 30% primarily due to higher R&D credit. As a result of the above factors, net income from continuing operations rose 78%.\nFactors That May Affect Future Results\nStatements included in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" which are not historical facts are forward looking statements that involve risks and uncertainties that may affect future results, including but not limited to: product demand and market acceptance risks, the effect of economical conditions, the impact of competitive products and pricing, product development, commercialization and technological difficulties, capacity and supply constraints or difficulties, business cycles, the results of financing efforts, actual purchases under agreements, the effect of the company's accounting policies, U.S. Government export policies and other risks detailed in the company's Security and Exchange Commission filings.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation--The consolidated financial statements include those of the company and its subsidiaries after elimination of intercompany balances and transactions.\nCash Equivalents--Cash equivalents consist principally of municipal bond funds and commercial paper acquired with remaining maturity periods of 90 days or less and are stated at cost plus accrued interest which approximates market value. The company's investment guidelines limit holdings in commercial paper to $1,000,000 per issuer.\nInventories--Inventories are stated at the lower of cost, using first-in, first-out and average-cost basis, or market. Cost of inventory items is based on purchase and production cost. Long-term contract costs and selling and administrative expenses are excluded from inventory. Progress payments are not netted against inventory.\nProperty, Plant and Equipment--Property, plant and equipment are stated at cost. Leases which at inception assure the lessor full recovery of the fair market value of the property over the lease term are capitalized. Provision for depreciation and amortization is primarily based on the sum-of-the-years'-digits and straight-line methods.\nRevenue Recognition--Revenue on fixed-price contracts other than long-term contracts is recorded upon shipment or completion of tasks as specified in the contract. Estimated product warranty costs are accrued at the time of shipment. Sales and allowable fees under cost-reimbursement contracts are recorded as costs are incurred. Long-term contract sales and cost of goods sold are recognized using the percentage- of-completion method based on the actual physical completion of work performed and the ratio of costs incurred to total estimated costs to complete the contract. Any anticipated losses on contracts are charged to earnings when identified.\nForeign Currency Translation--The functional currency for all foreign operations is the U.S. dollar with the exception of the company's subsidiary located in Japan which uses the local functional currency. Gains or losses, which result from the process of remeasuring foreign currency financial statements and transactions into U.S. dollars, are generally included in net income. For Japan, the cumulative translation adjustments are recorded directly in shareowners' equity. Translation gains or losses are not material in any year presented.\nIncome Taxes--The consolidated statements of operations include provisions for deferred income taxes using the liability method for transactions that are reported in one period for financial accounting purposes and in another period for income tax purposes. State and local income taxes are included in selling and administrative expenses.\nPer Share Information--Net income per share is computed using the weighted average number of common and common equivalent shares (dilutive stock options) outstanding during the year. The difference between fully diluted earnings per share and primary earnings per share is not significant.\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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The December 31, 1995 consolidated balance sheet includes approximately $6.5 million of inventories for recently introduced products. Such inventory may be subject to a higher risk of technological obsolescence than the company's other inventory.\nRecently Issued Accounting Standard--Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" (SFAS 123) defines a fair value method of accounting for stock- based compensation whereby 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 SFAS\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\n123, companies are encouraged, but are not required, to adopt the fair value method no later than fiscal years beginning after December 15, 1995 for all employee awards granted after the beginning of such year. Companies are permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" (APB 25) but would be required to disclose in a note to the financial statements proforma net income and earnings per share as if the company had applied SFAS 123. The company has determined it will not adopt the fair value method and therefore will continue to account for stock-based compensation under APB 25, reporting the required footnote disclosures pursuant to SFAS 123 in 1996.\nReclassification--Certain amounts for 1994 and 1993 have been reclassified to conform to the 1995 presentation.\n2. RECEIVABLES\nReceivables consist of the following (in thousands):\n1995 1994 --------- --------- U.S. Government long-term contracts: Billed ..................................... $ 617 $ 2,613 Unbilled ................................... 213 9,516 Commercial long-term contracts: Billed ..................................... 258 9,663 Unbilled ................................... 919 723 --------- --------- Total long-term contract receivables ...... 2,007 22,515 Other trade receivables .................... 84,304 57,912 --------- --------- Total receivables, less allowance of $1,034 in 1995 and $1,015 in 1994 ................. $ 86,311 $ 80,427 ========= =========\nUnbilled receivables represent revenue recognized for long-term contracts not yet billable based on the terms of the contract. These amounts are billable upon shipment of the product, achievement of milestones, or completion of the contract. Unbilled receivables are expected to be billed and collected within one year. Receivables representing retainage not collectible within one year are not material. There are no significant billed or unbilled receivables subject to future negotiation.\nGovernment contracts have provisions for audit, price redetermination and other profit and cost limitations. Contracts may be terminated without prior notice at the Government's convenience. In the event of such termination, the company may be compensated for work performed, a reasonable allowance for profit, and commitments at the time of termination. The right to terminate for convenience has not had any significant effect on the company's financial position or results of operations.\n3. LONG-TERM OBLIGATIONS AND LINES OF CREDIT\nLong-term obligations, excluding amounts due within one year, consist of (in thousands):\n1995 1994 --------- -------- Deferred compensation ... $ 6,356 $ 6,330 Environmental remediation 7,613 8,430 Long-term leases ......... 7,700 7,823 --------- -------- Total ................ $21,669 $22,583 ========= ========\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe current portion of long-term obligations is included in current liabilities. The expected maturity amounts are as follows: 1996, $2,786,000; 1997, $1,798,000; 1998, $1,812,000; 1999, $1,827,000; 2000, $1,834,000.\nDeferred Compensation--The company has deferred compensation plans covering selected members of management and key technical employees. The purpose is to reward and encourage talented employees to remain with the company.\nEnvironmental Remediation--As discussed in Note 6, the company is obligated to remediate groundwater contamination at the Scotts Valley and Palo Alto facilities. The portion expected to be paid within one year is included in current liabilities.\nLeases--Certain long-term leases for plant facilities are treated as capital leases for financial statement purposes. The leases expire during the years 2014 to 2029, and renewal options do not provide for lease extensions beyond the year 2029. The company also has noncancellable operating leases for plant facilities and equipment expiring through the year 2000. The leases may be renewed for various periods after the initial term. Payment obligations under these capital and operating leases as of December 31, 1995 are as follows (in thousands):\nCAPITAL OPERATING LEASES LEASES --------- ---------- Lease payments: 1996 ........................ $ 848 $1,716 1997 ........................ 848 1,525 1998 ........................ 848 620 1999 ........................ 848 340 2000 ........................ 848 286 Remaining years ............. 14,872 ---------- --------- Total .......................... 19,112 $4,487 ========= Imputed interest ............... (11,289) ---------- Present value of lease payments (current portion, $123)...... $ 7,823 ==========\nRent expense included in continuing operations for property and equipment relating to operating leases is as follows (in thousands):\n1995 1994 1993 --------- --------- ------- Real property... $ 1,202 $ 774 $ 822 Equipment ...... 665 626 865 --------- -------- ------- Total ...... $ 1,867 $ 1,400 $1,687 ========= ======== =======\nLines of Credit--During 1995, the company terminated its unsecured revolving lines of credit totaling $23,500,000 and established a $100,000,000 unsecured credit facility with several banks. This facility expires on December 8, 1998. No material compensating balances are required or maintained. Borrowings under this facility generally bear interest at the lower of prime rate or London Interbank Offered Rates (LIBOR) plus .75%. Although the lines of credit and new credit facility were unused during the year, interest rates applicable to these facilities ranged from 5.7 to 6.9 percent in 1995. The amount of outstanding letters of credit and other guarantees was not material at December 31, 1995.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\n4. SHAREOWNERS' EQUITY\nStock Repurchase Program--The Board of Directors has authorized the company to repurchase a maximum of 2,500,000 shares of company stock. Through December 31, 1994, 1,500,000 shares have been repurchased. No repurchases were made during 1995. The program enables the company to acquire its common stock from time to time when appropriate.\nCommon Share Purchase Rights--For each share of company common stock outstanding, one Common Share Purchase Right is attached. If not renewed, the Rights expire October 20, 1996. The Rights may be redeemed by the company for $.01 per Right at any time prior to 15 days after an entity acquires 20% or more of the company's common stock. The Rights become exercisable if an entity acquires 20% or more of the company's outstanding common stock, or announces an offer which would result in such entity acquiring 30% or more of the company's common stock. When exercisable, the Rights trade separately from the common stock and entitle a holder to buy one share of the company's common stock for $160. If the company is subsequently involved in a merger or other business combination, each Right will entitle its holder to buy a number of shares of common stock of the surviving company having a market value of twice the $160 exercise price. The Rights also provide for protection against self-dealing transactions by a controlling shareowner.\nStock Option Plans--The Employee Stock Option Plan provides for grants of nonqualifying and incentive stock options to certain key employees and officers. The options are granted at the market price on date of grant and expire at the tenth anniversary date. One-third of the options granted are exercisable in each of the third, fourth and fifth succeeding years. The Plan allows those employees who are subject to the insider trading restrictions certain limited rights to receive cash in the event of a change in control. Shares issued are net of retirement of shares used in payment for options exercised. In addition, the Plan permits the award of restricted stock rights subject to a fixed vesting schedule. The holder of vested restricted stock has certain dividend, voting, and other shareowner rights. No restricted stock awards have been made through December 31, 1995.\nThe Nonemployee Directors Stock Option Plan provides for a fixed schedule of options to be granted through 1998. Options granted are exercisable similarly to the Employee Stock Option Plan. The total number of shares to be issued under this plan may not exceed 200,000 shares. Included in the tables below, 12,600 and 5,440 option shares were granted at $39.75 and $39.88, respectively, in 1995 and 16,320 option shares were granted at $29.00 in 1994.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nActivity related to stock option plans is as follows:\n1995 SHARES PRICE --------------------------- ----------- ---------------- Granted ...................... 680,290 $31.88 to $55.00 Exercised .................... 566,198 $ 9.63 to $36.75 Terminated ................... 83,184 At December 31: Outstanding ................ 1,875,157 $ 9.63 to $55.00 Exercisable ................ 668,457 $ 9.63 to $36.75 Reserved for future grants.. 511,446\n1994 SHARES PRICE ------------------------------ ----------- ---------------- Granted ...................... 577,320 $22.75 to $35.88 Exercised .................... 573,842 $ 9.63 to $28.25 Terminated ................... 28,641 At December 31: Outstanding ................ 1,844,249 $ 9.63 to $36.75 Exercisable ................ 865,146 $ 9.63 to $36.75 Reserved for future grants.. 1,108,551\nIncluded in the Consolidated Statements of Shareowners' Equity are tax benefits related to sales under stock option plans of $4,735,000, $2,327,000 and $123,000 for 1995, 1994 and 1993, respectively.\n5. INCOME TAXES\nThe provision for income taxes includes deferred taxes reflecting the net tax effects of temporary differences that are reported in one period for financial accounting purposes and in another period for income tax purposes. Deferred tax assets are recognized when management believes realization of future tax benefits of temporary differences is more likely than not. In estimating future tax consequences, generally all expected future events are considered other than enactments of changes in the tax law or rates. The provision for Federal and foreign income taxes on income from continuing operations consists of the following (in thousands):\n1995 1994 1993 --------- --------- -------- Current ....... $13,574 $ 9,895 $ 6,625 Deferred ...... (985) (695) (1,075) --------- --------- -------- Total ..... $12,589 $ 9,200 $ 5,550 ========= ========= ========\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nDeferred tax assets (liabilities) are comprised of the following at December 31 (in thousands):\n1995 1994 1993 -------- -------- -------- Deferred compensation .............. $ 3,259 $ 3,251 $ 3,357 Loss accruals ...................... 6,753 6,295 5,423 Environmental remediation ......... 3,298 3,490 4,034 Uniform capitalization ............. 1,456 1,273 1,055 Vacation accrual ................... 1,794 1,724 1,744 Other .............................. 2,426 1,307 1,129 -------- -------- -------- Gross deferred tax assets....... 18,986 17,340 16,742 -------- -------- -------- Depreciation ....................... (2,297) (1,562) (1,413) Other .............................. (84) (158) (404) -------- -------- ------- Gross deferred tax liabilities.. (2,381) (1,720) (1,817) -------- -------- ------- Net deferred tax asset ........... $16,605 $15,620 $14,925 ======== ======== =======\nThe differences between the effective income tax rate and the statutory Federal income tax rate are as follows:\n1995 1994 1993 ------- ------- ------- Statutory Federal tax rate ....... 35.0% 35.0% 35.0% Export sales benefit ........... (6.0) (5.5) (7.0) Research credit ................ (1.4) (2.3) Foreign subsidiary earnings and losses ....................... (.7) .2 1.7 Other .......................... 1.7 2.4 1.7 ------- ------- ------- Effective rate ................... 28.6% 29.8% 31.4% ======= ======= =======\nDomestic state and local income taxes included in selling and administrative expenses totaled $1,670,000 in 1995, $1,813,000 in 1994, and $1,257,000 in 1993. Foreign operation amounts represent less than 5% of totals.\n6. ENVIRONMENTAL REMEDIATION AND OTHER CONTINGENCIES\nThe company remains in compliance with the remedial action plans being monitored by various regulatory agencies at its Scotts Valley and Palo Alto sites. In 1991 the company recorded a $15 million charge for estimated remediation actions and cleanup costs. No additional provision has been recorded since 1991. In 1994 the company reached agreement with the other potentially responsible parties regarding allocations of the remediation costs at the Palo Alto site. Included in other income for 1995 are recoveries from insurers totaling $1,331,000. Expenditures of $778,000, $2,727,000 and $1,676,000 were incurred for the years 1995, 1994 and 1993, respectively. While the timing and ultimate amount of expenditures of restoring the sites cannot be predicted with certainty, management believes that the provision taken is adequate based on facts known at this time. The company will continue to vigorously pursue any potential recoveries from insurers or other responsible parties. Changes in environmental regulations, improvements in cleanup technology and discovery of additional information concerning these sites and other sites could affect the estimated costs in the future.\nIn addition to the above environmental matters, the company is involved in various legal actions which arose in the ordinary course of its business activities. Except for the environmental provision noted above, management believes the final resolution of these matters should not have a material impact on its results of operations, cash flows, and financial position.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\n7. EMPLOYEE BENEFIT PLANS\nEmployees' Investment Plan--The Watkins-Johnson Employees' Investment Plan conforms to the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code as a qualified defined contribution plan. The Plan covers substantially all employees and for 1995 provided that the company match employees' 401(k) salary deferrals up to 3% of eligible employee compensation. Prior to 1995, the plan provided for company contributions equal to 9% of the net pretax earnings and be funded each year. The amount charged to income was $2,577,000 in 1995, $3,190,000 in 1994, and $1,945,000 in 1993.\nEmployee Stock Ownership Plan (ESOP)--The ESOP was established to encourage employee participation and long-term ownership of company stock. The Board determines each year's contribution depending on the performance and financial condition of the company. The Board approved a contribution equal to 1% of eligible employee compensation for 1995, 1994, and 1993, which resulted in charges to income of $839,000, $894,000, and $887,000, respectively. The ESOP held 197,000 and 204,000 shares of common stock at December 31, 1995 and 1994, respectively. The ESOP is a qualified defined contribution plan under ERISA and the Internal Revenue Code.\n8. BUSINESS SEGMENT REPORTING\nThe company operates in three industry segments. Operations in the Semiconductor Equipment segment involve the development, production, sales and service of chemical-vapor-deposition equipment used in the manufacture of semiconductor products and flat-panel displays. In 1995, the company established its wireless communications business as a new reporting business segment, separate and apart from the Electronics Group. The Electronics Group was renamed \"Government Electronics\" for segment reporting purposes. Amounts reported for prior years have been restated to reflect the split of the former Electronics Group as two reporting segments. Operations in the Wireless Communications segment involve the design, development, manufacture and sale of advanced wireless telecommunication products for cellular service providers, personal communication systems, and other wireless product manufacturers. Operations in the Government Electronics segment include the design, development, manufacture and sale of advanced electronic systems and devices for guided-missile programs, communications intelligence, and other government agency applications. The environmental services business was divested at the end of 1994 and is reported as a discontinued business in the financial statements.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nCorporate assets consist primarily of cash and equivalents, and included in 1994 and 1993 balances are assets of discontinued operations which are not material for any year presented.\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe U.S. Government and Hughes Aircraft Company are significant customers for the Government Electronics segment. Marubeni Hytech (the company's Japanese distributor), Hyundai Electronics Ind. Co. Ltd., and Samsung Pacific Int'l Inc. are significant customers for the Semiconductor Equipment Group. Sales to significant customers are as follows (in thousands):\n1995 1994 1993 ------- ------- ------- United States Government ................... $42,000 $57,000 $60,000 Hughes Aircraft Company .................... 40,000 35,000 41,000 Marubeni Hytech ............................ 61,000 39,000 16,000 Hyundai Electronics Ind. Co. Ltd. .......... 28,000 11,000 4,000 Samsung Pacific Int'l Inc. ................. 22,000 17,000 10,000\nSales from continuing operations by geographic area are as follows (in thousands):\n1995 1994 1993 -------- -------- -------- United States ............................. $203,460 $183,963 $188,919 Export sales: Europe ..................................... 19,958 26,534 20,830 Japan ...................................... 60,674 43,544 19,447 Korea ...................................... 53,470 32,292 14,307 Other Asia-Pacific countries ............... 30,388 23,088 11,216 Other ...................................... 9,975 12,385 15,652 Foreign operations ........................... 9,106 10,800 11,763 -------- -------- -------- Total ................................... $387,031 $332,606 $282,134 ======== ======== ========\nForeign operations' sales and identifiable assets are less than ten percent of consolidated totals.\nSummarized below are operating results and assets of the discontinued Environmental Services business. Intersegment sales were transferred based on negotiated prices (in thousands).\nYEAR ENDED DECEMBER 31 ------------------------- 1994 1993 ------- ------- Sales ............................................ $ 4,911 $ 5,536 Intersegment sales ............................... (1,294) (1,380) ------- ------- Net sales ........................................ 3,617 4,156 ------- ------- Loss before income taxes ......................... (690) (869) Income tax benefit ............................... 200 300 Loss on disposition net of $100 income tax benefit .............................. (200) ------- ------- Net loss ......................................... $ (690) $ (569) ======= =======\nDECEMBER 31 -------------------- 1994 1993 ------- -------- ASSETS .......................................... $ 2,281 $ 3,923 ======= ========\nWATKINS-JOHNSON COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\n9. QUARTERLY FINANCIAL DATA--UNAUDITED\nUnaudited quarterly financial data are as follows (in thousands, except per share amounts):\n1995 QUARTERS 1ST 2ND 3RD 4TH - ------------------------------------ -------- -------- -------- -------- Sales .............................. $92,983 $102,004 $ 95,550 $ 96,494 Gross profit ....................... 39,877 41,649 40,572 43,141 Net income ......................... 5,353 7,776 8,910 9,389 Net income per share ............... $.63 $.88 $.98 $1.04\n1994 QUARTERS 1ST 2ND 3RD 4TH - ------------------------------------ -------- -------- -------- -------- Sales .............................. $80,526 $ 87,365 $ 83,174 $ 81,541 Gross profit ....................... 29,476 37,585 34,776 35,211 Net income ......................... 3,624 5,934 5,386 6,017 Net income per share ............... $.45 $.73 $.61 $.77\nThe total of quarterly amounts for net income per share will not necessarily equal the annual amount, since the computations are based on the average number of common and common equivalent shares outstanding during each period.\nIncluded in 1994 net income and net income per share are results from discontinued operations which do not have a material impact on any individual quarter.\nREPORT OF MANAGEMENT\nThe consolidated financial statements of Watkins-Johnson Company and subsidiaries were prepared by management, which is responsible for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and, as such, include amounts that are based on the best judgments of management.\nThe system of internal controls of the company is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorization and are reported properly. The most important safeguard for shareowners is the company's emphasis in the selection, training and development of professional accounting managers to implement and oversee the proper application of its internal controls and the reporting of management's stewardship of corporate assets and maintenance of accounts in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP, independent auditors, are retained to provide an objective, independent review as to management's discharge of its responsibilities insofar as they relate to the fairness of reported operating results and financial position. They obtain and maintain an understanding of the company's accounting and financial controls, and conduct such tests and related procedures as they deem necessary to arrive at an opinion on the fairness of the financial statements.\nThe Audit Committee of the Board of Directors, composed solely of Directors from outside the company, meets periodically, separately and jointly, with the independent auditors and representatives of management to review the work of each. The functions of the Audit Committee include recommending the engagement of the independent auditors, reviewing the scope and results of the audit and reviewing management's evaluation of the system of internal controls.\nW. Keith Kennedy, Jr. Scott G. Buchanan President and Vice President and Chief Executive Officer Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nThe Shareowners and Board of Directors of Watkins-Johnson Company:\nWe have audited the accompanying consolidated balance sheets of Watkins-Johnson Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, 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 Watkins-Johnson 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.\nDeloitte & Touche LLP San Francisco, California February 2, 1996\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\nThe information required by this item concerning the company's directors is shown under the caption \"Election of Directors\" in the company's definitive proxy statement filed with the Commission pursuant to Regulation 14A.\nThe information relating to the company's executive officers is presented in Part I of this Form 10-K under the caption \"Executive Officers of the Registrant\".\nITEM 11. EXECUTIVE COMPENSATION\nSee this caption in the definitive proxy statement which the company has filed with the Commission pursuant to Regulation 14A.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is shown under the captions \"Security Ownership of Certain Beneficial Owners & Management\" in the company's definitive proxy statement filed with the Commission pursuant to Regulation 14A.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning certain business relationships is shown under the caption \"Executive Compensation\" in the definitive proxy statement which the company has filed with the Commission pursuant to Regulation 14A. There were no transactions with management for which disclosure would be required by Item 404 of Regulation S-K.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPAGE -------\n(a)1. Consolidated Financial Statements\nConsolidated Statements of Operations For the Years Ended December 31, 1995, 1994 and 1993 10\nConsolidated Balance Sheets December 31, 1995 and 1994 11\nConsolidated Statements of Shareowners' Equity For the Years Ended December 31, 1995, 1994 and 1993 12\nConsolidated Statements of Cash Flows For the Years Ended December 31, 1995, 1994 and 1993 13\nNotes to Consolidated Financial Statements 14-23\nReport of Management 24\nIndependent Auditors' Report 25\nPAGE -------\n2. Financial Statement Schedules\nIndependent Auditors' Report 29\nII Valuation and Qualifying Accounts and Reserves For the Years Ended December 31, 1995, 1994 and 1993 30\nSchedules not listed above are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or in the notes thereto.\n3. Exhibits\nA list of the exhibits required to be filed as part of this report is set forth in the Exhibit Index, which immediately precedes such exhibits. The exhibits are numbered according to Item 601 of Regulation S-K. Exhibits incorporated by reference to a prior filing are designated by an asterisk.\n- ---------- (b) No reports on Form 8-K were required to be filed during the last quarter of the period covered by this report. (c) The exhibits required to be filed by Item 601 of Regulation S-K are the same as Item 14(a)3 above. (d) Financial statement schedules not included herein have been omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or in the notes thereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWATKINS-JOHNSON COMPANY ---------------------------------------------- (Registrant)\nDate: February 26, 1996 By \/s\/ DEAN A. WATKINS ---------------------------------------------- DEAN A. WATKINS 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.\nINDEPENDENT AUDITORS' REPORT\nWatkins-Johnson Company:\nWe have audited the consolidated financial statements of Watkins-Johnson Company 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 2, 1996; such consolidated financial statements and report are included in Item 8","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"808420_1995.txt","cik":"808420","year":"1995","section_1":"ITEM 1. BUSINESS\nAssociated Planners Realty Income Fund (the \"Partnership\"), was organized in December 1986, under the California Revised Limited Partnership Act. West Coast Realty Advisors, Inc. (\"WCRA\"), a California corporation, and W. Thomas Maudlin Jr., an individual, are general partners (collectively referred to herein as the \"General Partner\").\nThe Partnership was organized for the purpose of investing in, holding, and managing improved, unleveraged income-producing property, such as residential properties, office buildings, commercial buildings, industrial properties, mini- warehouse facilities, and shopping centers (\"Properties\"), which are believed to have potential for cash flow and capital appreciation. The Partnership intends to own and operate such Properties for investment over an anticipated holding period of approximately five to ten years. At December 31, 1995, the Partnership had no employees.\nThe Partnership's principal investment objectives are to invest the net proceeds in real properties which will:\n1. Preserve and protect the Partnership's invested capital; 2. Provide for cash distributions from operations; 3. Provide gains through potential appreciation; and 4. Generate federal income tax deductions so that a portion of cash distributions may be treated as a return of capital for tax purposes and, therefore, may not represent taxable income to the Limited Partners.\nOn October 25, 1988. the Partnership acquired a 100% interest in a shopping center located in Chino, California. On January 9, 1990, the Partnership, together with Associated Planners Realty Growth Fund (an affiliate), purchased a one-story building located in San Marcos, California. The acquisition was paid for entirely in cash totaling $3,118,783 of which $2,806,905 was provided by the Partnership and $311,878 by the affiliate. The Partnership owns a 90% undivided interest in the property.\nThe ownership and operation of any income-producing real estate is subject to those risks inherent in all real estate investments. These include national and local economic conditions, the supply of and demand for similar types of real property, competitive marketing conditions, zoning changes, possible casualty losses, and increases in real estate taxes, assessments, and operating expenses, as well as others. In addition, the real estate market at this date is in a general state of uncertainty, and there is no assurance as to how long it might continue or its possible effect on the Partnership.\nThis uncertainty is evidenced by the following conditions:\n1. Downtrends in the real estate market in various areas of the country as evidenced by high vacancy rates in the commercial sector, and a large unsold inventory of new homes, particularly in California.\n2. Economic recession, as evidenced by higher unemployment, slow consumer spending, and low increases in gross national product figures.\n3. The effect of current or proposed tax reform legislation which has slowed the level of sale and development of real estate and the formation of real estate partnerships, in many areas of the country. 4. Availability and cost of financing to allow for the purchase and sale of properties and to maintain overall real estate values.\nAlthough these factors have not materially affected the current financial results of the Partnership, there is a potential for them to have material effects on the Partnership's operations over the long-term.\nThe Partnership is subject to competitive conditions that exist in the local markets where it operates rental real estate. These conditions are discussed in ITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - - \"PROPERTIES\".\nThe Partnership is operated by the General Partner, subject to the terms of the Amended and Restated Agreement of Limited Partnership. The Partnership has no employees, and all administrative services are provided by West Coast Realty Advisors Inc.(\" WCRA\") the co-General Partner.\nOn February 26, 1988, the Partnership attained its minimum funding requirement with the initial release of escrow funds totaling $1,272,000 and terminated its offering on September 5, 1989. As of December 31, 1989, gross proceeds from sales of Partnership units totaled $5,106,000 and $4,594,101 net of syndication costs and sales commissions.\nITEM 2. PROPERTIES\nThe properties acquired by the Partnership are described below:\nYORBA CENTER\nOn October 25, 1988, the Partnership purchased Yorba Center, a retail shopping center located in Chino, California.\nThe Center, constructed in 1987, provides 12,697 rentable square feet located on a .91-acre parcel of land. As of December 31, 1995, the Center was 90% leased to eight tenants. The average monthly rent per occupied square foot was $1.20. All but two tenants are renting space on a \"triple net\" lease basis, i.e., each tenant being proportionately responsible for payment of all expenses including insurance, taxes, maintenance, and other operating expenses. The remaining two tenants are renting space on a \"gross\" basis, i.e. the landlord is responsible for payment of all expenses pertaining to these tenants.\nThe building and improvements are depreciated over 31.5 to 40 years using a straight-line method for both financial and income tax reporting purposes. The financial and income tax basis for the property are the same. In the opinion of the General Partner, the property is adequately insured. The property is managed by West Coast Realty Management, Inc. (\"WCRM\"), an affiliate of the corporate General Partner.\nThe Center is dependent upon the vitality of the consumer market in the general area. Since the City of Chino applies strict building regulations on developers, it is expected that new development will be limited, thereby preserving the Center's competitive edge during the Partnership's intended holding period. Although all areas of Southern California have been affected by the economic slowdown, layoffs, plant closings and military cutbacks, these economic factors are not expected to significantly impact the occupancy of the shopping center.\nTenants occupying 10% or more of rental square footage as of December 31, 1995:\nMels Liquor: 15.79% of rental square footage; $45,324 rent per year; lease expires on May 31, 2002; Renewal Options: Lessee has option to extend lease 5 years to May 31, 2007.\nVideo Club: 13.69% of rental square footage; $17,232 rent per year; lease expires on August 31, 1998; Renewal Options: No renewal options.\nSan Bernardino County Superintendent Schools: 17.11% of rental square footage; $28,188 rent per year; lease expires on June 30, 1996; Renewal Options: Lessee has 2 options to extend the lease for one additional year.\nSAN MARCOS INDUSTRIAL BUILDING\nOn January 9, 1990, the Partnership together with Associated Planners Growth Fund (a 90%\/10% interest, respectively) purchased the San Marcos Industrial Building located in San Marcos, California.\nThe industrial building, constructed in 1986, consists of 40,720 rentable square feet including 6,000 square feet of office area plus 1,300 square feet of mezzanine above the office area and is located on a 2.66 acre parcel of land. The building was 100% occupied by Professional Care Products, Inc. through January 8th, 1995, on a triple net lease. This lease required the tenant to pay insurance, taxes, maintenance, and all other operating costs.\nOn February 13, 1995, a new lease was executed with No Fear, Inc., which runs through June 30, 1998. This is also a triple net lease.\nThe building and improvements are depreciated over 31.5 to 40 years using a straight-line method for both financial and income tax reporting purposes. The financial and income tax basis for the property are the same. In the opinion of the General Partner, the property is adequately insured. The property is managed by WCRM.\nThe building is located in North San Diego County, in an area of increasing population and desirability for San Diego area professional and skilled workers and significant employers. It is expected the building will benefit from projected growth of the North San Diego County area.\nTenants occupying 10% or more of rental square footage as of December 31, 1995:\nNo Fear Inc.: 100% of rental square footage; $219,888 rent per year; lease expires on June 30, 1998; Renewal Options: Extend lease for 60 additional months at lessee's option.\nSUMMARY\nAs of December 31, 1995, the combined occupancy rate for all of the Partnership's properties was 97.6%. The properties were nearly fully leased and are generating a level of cash flow consistent with the market conditions in which the properties operate.\nThe total acquisition cost to the Partnership of each property and the date of acquisition are as follows:\nACQUISITION ACQUISITION DESCRIPTION COST DATE\nYORBA CENTER $1,851,147 10\/25\/88 SAN MARCOS INDUSTRIAL BUILDING $2,806,905 01\/09\/90\nThe schedule below indicates the average occupancy rate expressed as a percentage of square feet for the last five years:\nYEAR YORBA CENTER SAN MARCOS INDUSTRIAL BUILDING\n1995 90 % 88%\n1994 90% 100%\n1993 61% 100%\n1992 61% 100%\n1991 61% 100%\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt December 31, 1995, there were 5,096 limited partnership units outstanding and 424 unit holders of record. The units sold are not freely transferable and no public market for the sold units presently exists or is likely to develop.\nDistributions totaling $189,361, $222,950 and $242,060 were made in 1995, 1994, and 1993, to unit holders of record at the end of the calendar quarters indicated below. These distributions constituted a return of capital of $49,683, $425, and $49,745 in 1995, 1994, and 1993, respectively. In addition, $63,700 ($12.50\/partnership unit) in distributions were paid to unit holders subsequent to year-end in February 1996. The distribution amounts for 1995 and 1994 are summarized below:\nRECORD DATE PER UNITS TOTAL DATE PAID UNIT OUTSTANDING PAID\n12\/31\/93 02\/09\/94 12.50 5,096 63,700 03\/31\/94 05\/05\/94 12.50 5,096 63,700 06\/30\/94 08\/02\/94 12.50 5,096 63,700 09\/30\/94 11\/03\/94 6.25 5,096 31,850 12\/31\/94 02\/03\/95 6.25 5,096 31,850 3\/31\/95 05\/05\/95 8.4088 5,096 42,851 6\/30\/95 08\/04\/95 10.00 5,096 50,960 9\/30\/95 11\/06\/95 12.50 5,096 63,700\nDistributions are made out of the income from operations, before depreciation and amortization, available as a result of the previous quarter's operations.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data should be read in conjunction with the financial statements and related notes and ITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership began offering for sale limited partnership units on October 1987. On February 26, 1988, the Partnership reached its minimum offer level of $1,200,000. The Partnership sold units throughout the remainder of the year, and had raised $3,891,000 in gross proceeds or $3,483,788 net of syndication costs and sales commissions as of December 31, 1988. During 1989, the Partnership continued to raise funds through the sale of Units and had raised $5,106,000 in gross proceeds or $4,594,101 net of syndication costs and sales commissions as of September 5, 1989, the day the Partnership terminated its offering of limited partnership units.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nDuring the year ended December 31, 1995, the Partnership made distributions to the limited partners totaling $189,361, $49,683 of which constituted a return of capital. On February 6, 1996, the Partnership made distributions of $12.50 to unit holders of record at December 31, 1995. Distributions are determined by management based on cash flow and the liquidity position of the Partnership and anticipated occupancy of the properties. It is the intention of management to make quarterly distributions of cash, subject to maintenance of reasonable reserves.\nManagement uses cash as its primary measure of a partnership's liquidity. The amount of cash that represents adequate liquidity for a real estate limited partnership depends on several factors. Among them are:\n1. Relative risk of the partnership; 2. Condition of the partnership's properties; 3. Stage in the partnership's life cycle (e.g., money -raising, acquisition, operating or disposition phase); and 4. Distributions to partners.\nThe Partnership has adequate liquidity based upon the above four points. The first point refers to the approximately 1% property reserve requirement of capital funds raised that the Partnership currently has; this relatively low reserve level is appropriate since all Partnership properties are acquired without the use of debt financing. This is a minimum guideline that is disclosed in the Partnership's prospectus; the Partnership had more than enough funds to meet this requirement as of December 31, 1995. Related to the property reserve requirement is the second point, the condition of the Partnership's properties. Since the properties are in good condition, no unusual maintenance and repair expenditures are anticipated. The third point is relevant to the Partnership because after the January 1990 purchase of the San Marcos property, the Partnership had completed its acquisition phase, and entered the operating phase. The fourth point relates to partner distributions. The Partnership makes distributions from operations quarterly. Such distributions are subject to payment of Partnership expenses and reasonable reserves for expenses, maintenance, and replacements.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nDuring the year ended December 31, 1995 the Partnership paid the General Partner a partnership management fee of $21,092 and distributed $189,361 to the limited partners of which $49,683 constituted a return of capital. In February 1996, the Partnership paid the General Partner a partnership management fee of $7,078 and distributed $63,700 to the limited partners. Partnership management fees were calculated and paid in accordance with the Partnership Agreement.\nThe Tax Reform Acts of 1986 and 1987 and the Revenue Reconciliation Acts of 1990 and 1993 did not have a material impact on the Partnership's operations.\nThe effects of the slowdown in the economy, inflation and changing prices have not had a material impact on the Partnership's revenues and income from operations. During the years of the Partnership's existence, inflationary pressures in the U.S. economy have been minimal, and this has been consistent with the experience of the Partnership in operating rental real estate in California. The Partnership has several clauses in the leases with its properties' tenants that would help alleviate much of the negative impact of inflation.\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 new 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 Partnership has elected the early adoption of SFAS No. 121. This change had no effect on the statement of income for the year ended December 31, 1995.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nRESULTS OF OPERATIONS - 1995 VS. 1994\nOperations for the years ended December 31, 1995 and 1994 reflect full years of rental activities for the Partnership's properties. However, the San Marcos property was not leased from January 8 to February 12, 1995. This was due to vacancy at the property between the time that the Professional Care Products lease terminated and the No Fear lease began. In addition to the vacancy at the property, the lease rate that No Fear entered into was approximately 30% less than the rate that Professional Care Products was paying during its tenancy. Although the occupancy rate at the Yorba center Shopping Center remained relatively steady at 90% as of December 31, 1995 (as compared to 90% at December 31, 1994), the drop in rental rates at the San Marcos property was responsible for a 22% ($100,080) decrease in rental revenue for 1995, as compared to 1994. The drop in rental rates was due primarily to a decrease in demand for commercial space in the general area.\nPrimarily due to the partial vacancy at the San Marcos property, operating expenses increased 9% ($6,646) as the result of less costs that the Partnership was able to pass on to tenants. However, the Partnership also experienced a 22% decrease in general and administrative costs ($17,481) due to lower insurance costs and lower partnership management fees (due to a decrease in distributions to investors). The Partnership also experienced a 41% ($4,007) increase in interest income due to larger cash reserve balances maintained during 1995 as compared to 1994.\nOverall, the Partnership generated $239,359 in income from operations before depreciation expense of $98,076 and loss on government securities of $1,605. This compares unfavorably to 1994 when income from operations totaled $324,597 before depreciation of $97,933 and loss on government securities of $4,139. Net income per limited partnership unit fell from $37.57 in 1994 to $22.94 in 1995. The number of limited partnership units outstanding in each year was 5,096.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nIn 1994, the Partnership purposely started reducing the amount of distributions to investors in anticipation of lower rental revenues from the San Marcos property. Up until January 1995, it was not clear to the General Partner as to what rent, if any, could be realized on an ongoing basis from the San Marcos Property. Distributions to limited partners fell from a high of $47.50 per unit in 1993, to $43.75 in 1994, to $37.16 in 1995. With the placement of a tenant in the San Marcos Building (No Fear, Inc.) and the build-up of a track record of rent collections from the tenant, the general partner now feels it would be prudent to make cash distributions to limited partners so that a large portion of the large cash balance is gradually paid out (contingent upon the maintenance of reasonable reserve levels). Therefore, distributions are expected to total between $40.00 and $45.00 per unit for 1996.\nDuring the year, $375,284 in cash was provided by operating activities. This resulted from a net cash basis income of $237,754 from operations (net income plus depreciation expense) plus $163,272 in gross proceeds received in connection with the sale of government securities and $5,991 resulting from a decrease in accounts receivable (primarily from the collection of rents receivable). These amounts were offset by a $26,505 increase in other assets (primarily due to a prepaid leasing fee paid in connection with the re-leasing of the San Marcos property), and a $4,408 decrease in security deposits (primarily due to a decrease in the amount of security deposit required from the new tenant at San Marcos). Cash used in investing activities totaled $9,999 in connection with tenant improvements on the San Marcos property. Cash used in financing activities totaled $189,361 due to the distribution to the limited partners during the year.\nThe area in which the Yorba Center operates continues to experience a relatively high level of economic vitality, and the General Partner does not foresee significant challenges in keeping the center occupied by various small retailers and service businesses.\nThe Partnership anticipates continuing to operate properties during 1996 for the purpose of generating the maximum amount of cash available for distribution to the limited partners, while maintaining a reasonable level of cash reserves. There are currently no plans to dispose of either of the two properties.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nRESULTS OF OPERATIONS - 1994 VS. 1993\nOperations for the years ended December 31, 1994 and 1993 reflect full years of rental activities for the Partnership's properties. The occupancy of the Yorba Center improved in 1994 as compared to 1993, as the occupancy was 90% in 1994 as compared to 61% at the end of 1993. This accounted for the 8.6% ($36,678) increase in property revenues in 1994, as compared to 1993.\nThe Partnership generated $324,597 in income from operations before depreciation expense of $97,933 and $4,139 in unrealized loss on government securities for 1994 compared to $290,297 in income from operations for 1993 before depreciation of $97,982. Interest income increased $4,462 (86%) as the result of higher interest rates and higher investable cash balances. An unrealized loss of $4,139 was recognized in 1994 in connection with the Partnership's $163,272 investment in a pool of short-term government securities. Operating and General and Administrative costs increased from 1993 to 1994 by $6,840 (4.8%) primarily due to increased repairs and maintenance and management fee expenditures.\nThe statement of cash flows reflects proceeds from the sales (purchases) of government securities for 1994 and 1993. These amounts pertain to gross sales and (purchases) of government securities and are not being reflected as net sales or (purchases) for the periods being reported.\n5,096 limited partnership units were outstanding in 1994. The net income per limited partnership unit was $37.57 in 1994 vs.. $32.23 in 1993. Total distributions dropped from $242,060 in 1993 to $222,950 in 1994. Much of this decrease was the result of management's decision to hold back distribution of some earnings in anticipation of a vacancy at the San Marcos building beginning in January 1995. (The space was subsequently re-leased in February 1995).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE Report of Independent Certified Public Accountants.................. 15\nBalance Sheets -- December 31, 1995 and 1994 ..................... 16\nStatements of Income for the years ended December 31, 1995, 1994, and 1993 ............................... 17\nStatements of Partners' Equity for the years ended December 31, 1995, 1994, and 1993 ............................... 18\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 ............................... 19\nSummary of Accounting Policies ................................. 20-21\nNotes to Financial Statements .................................... 22-27\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nAssociated Planners Realty Income Fund (a California limited partnership) Los Angeles, California\nWe have audited the accompanying balance sheets of Associated Planners Realty Income Fund (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. We have also audited 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Associated Planners Realty Income Fund (a California 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.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\nAs discussed in the summary of accounting policies, the Partnership changed its method in accounting for investments in 1994 to conform with SFAS No. 115.\nBDO SEIDMAN, LLP\nLos Angeles, California February 12, 1996\n[FN] SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND NOTES TO FINANCIAL STATEMENTS\n[FN] SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND NOTES TO FINANCIAL STATEMENTS\n[FN] See accompanying summary of accounting policies and notes to financial statements.\n[FN] See accompanying summary of accounting policies and notes to financial statements.\nASSOCIATED PLANNERS REALTY INCOME FUND SUMMARY OF ACCOUNTING POLICIES\nBUSINESS Associated Planners Realty Income Fund (\"the Partnership\"), a California limited partnership, was formed on December 23, 1986 under the Revised Limited Partnership Act of the State of California for the purpose of developing or acquiring, managing and operating unleveraged income producing real estate. The Partnership met its minimum funding of $1,200,000 on February 26, 1988 and terminated its offering on September 5, 1989. The Partnership was formed to acquire income-producing real property throughout the United States with emphasis on properties located in California and southwestern states. The Partnership purchases such properties on an all cash basis and intends to own and operate such properties for investment over an anticipated holding period of approximately five to ten years.\nBASIS OF The financial statements do not give effect to any assets PRESENTATION that the partners may have outside of their interest in the partnership, nor to any personal obligations, including income taxes, of the partners.\nRENTAL REAL Assets are stated at cost. Depreciation is computed ESTATE AND using the straight-line method over estimated useful DEPRECIATION lives ranging from 31.5 to 40 years for financial and income tax reporting purposes.\nIn the event that facts and circumstances indicate that the cost of an asset may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the carrying amount to determine if a write-down to market value is required.\nLEASE Lease commissions which are paid to real estate brokers COMMISSIONS for locating tenants are capitalized and amortized over the life of the lease.\nRENTAL Rental revenue is recognized when the amount is due and REVENUE payable under the terms of a lease agreement.\nASSOCIATED PLANNERS REALTY INCOME FUND SUMMARY OF ACCOUNTING POLICIES\nINVESTMENTS During 1994, the Partnership changed its method of accounting for Investments. Investments which represent trading securities, are accounted for in accordance with SFAS No. 115. The difference between historical cost and market value are reported as unrealized gains or losses in the statement of income. The effect of this change in accounting policy is not material to the financial statements.\nSTATEMENTS OF For purposes of the statements of cash flows, the CASH FLOWS Partnership considers cash in the bank and all highly liquid investments purchased with original maturities of three months or less, to be cash and 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 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 For comparative purposes, certain prior year amounts have been reclassified to conform to the current year presentation.\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n1. NATURE OF The Partnership began accepting subscriptions in October PARTNERSHIP 1987 and closed the offering on September 5, 1989. The Partnership began operations in March 1988.\nUnder the terms of the partnership agreement, the General Partners (West Coast Realty Advisors, Inc., and W. Thomas Maudlin, Jr.) are entitled to cash distributions from 10% to 15%. The General Partners are also entitled to net income (loss) allocations varying from 1% to 15% and 1% of depreciation and amortization in accordance with the partnership agreement. Further, the General Partners receive acquisition fees for locating and negotiating the purchase of rental real estate, management fees for operating the Partnership and a commission on the sale of the partnership properties.\n2. RENTAL REAL The Partnership owns the following two rental real estate ESTATE properties, one is wholly-owned and the second, a 90% undivided interest:\nLocation Acquisition (Property Name) Date Purchased Cost\nChino, California (Yorba Center) October 25, 1988 $1,851,147 San Marcos, California January 9, 1990 2,806,905\nThe major categories of rental real estate are:\nDecember 31, 1995 1994\nLand $1,282,861 $1,282,861 Buildings and improvements 3,416,326 3,406,327\n4,699,187 4,689,188 Less accumulated depreciation 626,340 528,264\nRental real estate, net $4,072,847 $4,160,924\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n2. RENTAL REAL A significant portion of the Partnership's rental revenue ESTATE was earned from tenants whose individual rents (CONTINUED) represented more than 10% of total rental revenue. Specifically:\nTwo tenants accounted for 12% and 52% in 1995; Two tenants accounted for 10% and 62% in 1994; Two tenants accounted for 10% and 72% in 1993.\n3. FUTURE As of December 31, 1995, future minimum rental income MINIMUM under existing leases, excluding month to month rental RENTAL INCOME agreements, that have remaining noncancelable terms in excess of one year are as follows:\nYears ending December 31, Amount\n1996 $353,234 1997 329,136 1998 163,333 1999 37,903 2000 36,825\nTotal $920,431\nFuture minimum rental income does not include lease renewals or new leases that may result after a noncan- celable-lease expires.\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n4. RELATED PARTY (a) In accordance with the partnership agreement, TRANSACTIONS compensation earned by or services reimbursed to the corporate General Partner consisted of the following:\nYears ended December 31, 1995 1994 1993\nPartnership management fees $21,092 $24,773 $26,896 Administrative services: Data processing 4,709 4,877 4,770 Postage 2,582 2,247 2,460 Investor processing 1,884 1,951 1,908 Duplication 942 975 954 Investor communications 1,413 1,463 1,431 Miscellaneous 471 487 477\n$33,093 $36,773 $38,896\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n(b) The Partnership owns a 90% undivided interest in property located in San Marcos, California. The remaining 10% interest is owned by Associated Planners Realty Growth Fund, an affiliate.\n(c) Property management fees incurred in accordance with the partner ship agreement with West Coast Realty Management, Inc., an affiliate of the corporate General Partner, totaled $17,568, $24,760 and $22,886 for 1995, 1994 and 1993. Related party accounts payable to West Coast Realty Management, Inc. at December 31, 1995 and 1994 were $4,973 and $206. Related party accounts payable to West Coast Realty Advisors, Inc. at December 31, 1995 was $6,000. Related party accounts payable to Associated Financial Group, Inc. at December 31, 1995 was $11,507.\n(d) Related party accounts receivable from Associated Planners Realty Growth Fund, at December 31, 1994 was $2,173.\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n5. NET INCOME The Net Income per Limited Partnership Unit was computed AND CASH in accordance with the partnership agreement on the basis DISTRIBUTIONS of the weighted average number of outstanding Limited PER LIMITED Partnership Units of 5,096 for 1995, 1994 and 1993. PARTNERSHIP UNIT The Limited Partner cash distributions, computed in accordance with the Partnership Agreement, were as follows:\nOutstanding Amount Total Record Date Units Per Unit Distribution\nSeptember 30, 1995 5,096 $ 12.5000 $ 63,700 June 30, 1995 5,096 10.0000 50,960 March 31, 1995 5,096 8.4088 42,851 December 31, 1994 5,096 6.2500 31,850\nTotal $189,361\nSeptember 30, 1994 5,096 $ 6.2500 $ 31,850 June 30, 1994 5,096 12.5000 63,700 March 31, 1994 5,096 12.5000 63,700 December 31, 1993 5,096 12.5000 63,700\nTotal $222,950\nSeptember 30, 1993 5,096 $ 12.5000 $ 63,700 June 30, 1993 5,096 12.5000 63,700 March 31, 1993 5,096 12.5000 63,700 December 31, 1992 5,096 10.0000 50,960\nTotal $242,060\nDistributions are paid in the fiscal quarter following the record date.\nASSOCIATED PLANNERS REALTY INCOME FUND NOTES TO FINANCIAL STATEMENTS\n6. NEW Statement of Financial Accounting Standards No. 121, ACCOUNTING \"Accounting for the Impairment of Long-Lived Assets and PRONOUNCE- for Long-Lived Assets to Be Disposed of\" (SFAS No. 121) MENTS 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 new 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 Partnership has elected the early adoption of SFAS No. 121. This change had no effect on the statement of income 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\nThe Partnership is managed by the General Partners and the Limited Partners have no right to participate in the management of the Partnership or its business.\nResumes of the General Partners' principal officers and directors and a description of the General Partners are set forth in the following paragraphs. See description below.\nWEST COAST REALTY ADVISORS, INC.\nWest Coast Realty Advisors, Inc. (\"WCRA\") is a California corporation formed on May 10, 1983 for the purpose of structuring real estate programs and to act as general partner of such programs. It is a subsidiary of Associated Financial Group, Inc.\nPHILIP N. GAINSBOROUGH (Born 1938) is Chairman and a Director of West Coast Realty Advisors, Inc. He is also currently the President of Associated Financial Group, Inc., Associated Securities Corp., Associated Planners Insurance Services, Inc., and Associated Planners Investment Advisory, Inc. In addition, from January 1981 to the present, he has served as President of Gainsborough Financial Consultants, Inc., a financial planning firm located in Los Angeles, California. From January 1981 to December 1982, Mr. Gainsborough served as a Registered Principal of Private Ledger Financial Services, Inc. From January 1977 to December 1980, he was employed by E.F.Hutton & Co. as a Registered Representative.\nW. THOMAS MAUDLIN JR. (Born 1936) is a Director and President of West Coast Realty Advisors, Inc. (\"WCRA\"). He is also co-General Partner (with WCRA) of the Partnership. Mr. Maudlin has been active in the real estate area for over 30 years, serving as co-developer of high-rise office buildings and condominiums. He has structured transactions for syndicators in apartment housing, including sale leasebacks, all-inclusive trust deeds, buying and restructuring transactions to suit a particular buyer, and as a buyer acting as a principal. Mr. Maudlin was co-developer of the Gateway Los Angeles office building, a 165,000 square foot, fourteen-story office building located in West Los Angeles. Form 1980 to 1985, in partnership with the Muller Company, he developed eleven acres in San Bernardino which included a 42,000 square-foot office building, a six-plex movie theater and two restaurants. From 1980 to 1985, Mr. Maudlin was involved in building in San Bernardino, California, a 134- unit condominium development, a shopping center, and a restaurant in Ventura. He is a graduate of the University of Southern California.\nWILLIAM T. HAAS (Born 1946 ) is a Director and Executive Vice President\/Secretary of West Coast Realty Advisors, Inc., Associated Planners Insurance Services, Associated Securities Corp., and Associated Planners Investment Advisory, Inc. He is also Executive Vice President\/Secretary and a Director of Associated Financial Group, Inc. He has been affiliated with various Associated companies since 1982. From December 1977 to December 1982, Mr. Haas was employed by the National Association of Securities Dealers, Inc. in various capacities, including that of Supervisor of Examiners. From 1968 to 1977, he was associated with Merrill Lynch as a branch office operations manager, and in the home office Operations Liaison department.\nMICHAEL G. CLARK (Born 1956) is Senior Vice President\/Treasurer of West Coast Realty Advisors, Inc., Associated Financial Group, Inc., and Associated Securities Corp. Prior to joining AFG in 1986, he served as Controller for Quest Resources, a Los Angeles-based syndicator and operator of alternative energy projects, from October 1984 to March 1986, and Assistant Controller for Valley Cable T.V., from March 1982 through September 1984. In addition, Mr. Clark served as an auditor for Arthur Young & Co. in Los Angeles, from July 1978 to March 1982. He is a graduate of the University of California, Santa Barbara (BA) and California State University, Northridge (MS).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDuring its last calendar year, the Registrant paid no direct or indirect compensation to directors or officers.\nThe Registrant has no annuity, pension or retirement plans, or existing plan or arrangement pursuant to which compensatory payments are proposed to be made in the future to directors or officers.\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 Registrant has no outstanding securities possessing general voting rights.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Registrant was organized in December 1986 as a California Limited Partnership. Its General Partners (collectively referred to herein as the \"General Partner\") are West Coast Realty Advisors, Inc. and W. Thomas Maudlin Jr., an individual. The Registrant has no executive officers or directors. Philip N. Gainsborough, an officer of the General Partner, made an original limited partnership contribution to the Partnership in March 1987, which was subsequently paid back to him in March 1988 when the Partnership met its minimum funding requirement. The General Partner and its affiliates are entitled to compensation from the Partnership for the following services:\n1. For Partnership management services rendered to the Partnership, the General Partner is entitled to receive up to 10% of all distributions of cash from operations. For the year ended December 31, 1995, the amount paid the General Partner was $21,092. In addition, the General Partner is entitled to reimbursement for certain public offering expenses, the cost of certain personnel employed in the organization of the Partnership, and certain administrative services performed by the General Partner. For the year ended December 31, 1995, the Partnership reimbursed $12,000 to the General Partner for these expenditures.\n2. For property management services, the General Partner engaged West Coast Realty Management, Inc. (\"WCRM\") an affiliate of the General Partner. For the year ended December 31, 1995, the Partnership incurred property management fees of $17,568 with WCRM.\n3. The General Partner received a 10% allocation of net income before depreciation and amortization and 1% of depreciation and amortization. For the year ended December 31, 1995 this resulted in a $23,774 allocation of net income before depreciation and amortization and a $981 allocation of depreciation and amortization, or a net income allocation of $22,793.\n4. On December 31, 1995 the Partnership was indebted to WCRM for $4,973, which was paid subsequent to year-end.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS The following financial statements of Associated Planners Realty Income Fund, a California Limited Partnership, are included in PART II, ITEM 8:\nPAGE\nReport of Independent Certified Public Accountants................. 15\nBalance Sheets -- December 31, 1995 and 1994 ...................... 16\nStatements of Income for the years ended December 31, 1995, 1994, and 1993 ......................... 17\nStatements of Partners' Equity for the years ended December 31, 1995, 1994, and 1993 ......................... 18\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 ......................... 19\nSummary of Accounting Policies ................................ 20-21\nNotes to Financial Statements ................................... 22-27\n2. FINANCIAL STATEMENT SCHEDULES\nSchedule III --Real Estate and Accumulated Depreciation ...... 33\nAll other schedules have been omitted because they are either not required, not applicable or the information has been otherwise supplied.\n(b) REPORTS ON FORM 8-K\nNONE\n(c) EXHIBITS\nNONE\nSIGNATURES\nPursuant to the requirements of the 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nASSOCIATED PLANNERS REALTY INCOME FUND A California Limited Partnership (Registrant)\nW. THOMAS MAUDLIN JR. (A General Partner)\nBy: WEST COAST REALTY ADVISORS, INC. (A General Partner)\nWILLIAM T. HAAS (Director and Executive Vice President\/Secretary)\nMICHAEL G. CLARK (Vice President\/Treasurer)\nApril 1, 1996","section_15":""}
{"filename":"37946_1995.txt","cik":"37946","year":"1995","section_1":"ITEM 1. BUSINESS\nThe text appearing under the caption, \"Business\" on page 25 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. 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 THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe text and tabular presentation appearing under the caption, \"Market for the Registrant's Common Stock and Related Stockholder Matters\" on page 27 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe tabular presentation appearing under the caption, \"Selected Financial Data\" on page 28 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe text appearing under the caption, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" commencing on page 24 and ending on page 25 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements and related Notes to Consolidated Financial Statements and Independent Auditors' Report commencing on page 1 and ending on page 23 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 are incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - 13. PART III\nThe information required by these items will be included in a definitive proxy statement pursuant to Regulation 14A filed with the Commission not later than 120 days after the close of the fiscal year covered by this Report.\nPART IV\nITEM 14.","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements:\nConsolidated Balance Sheets 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 fiscal years in the period ended December 30, 1995, Notes to Consolidated Financial Statements and Independent Auditors' Report commencing on page 1 and ending on page 23 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 30, 1995 are incorporated herein by reference. With the exception of the pages referred to in the preceding sentence and other information specifically incorporated by reference in this Form 10-K, the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994 is not deemed filed as a part of this Report.\n(2) Financial Statement Schedules:\nIndependent Auditors' Report on Schedules II Valuation and Qualifying Accounts for the Fiscal Years Ended December 30, 1995, December 31, 1994 and December 25, 1993. Financial statements and schedules not listed above are omitted because of the absence of the conditions under which they are required or because the information, if material, is set forth in the consolidated financial statements or the notes thereto.\n(3) The following Exhibits are filed as part of this Report:\nForm 10-K Exhibit Number ------\n13 Annual Report to Shareholders for the Fiscal Year Ended December 30, 1995 (parts not incorporated by reference are furnished for information purposes only and are not filed herewith).\n22 Subsidiaries of the Registrant.\n27 Financial Data Schedule\n(b) No reports on Form 8-K were filed during the three months ended December 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.\nFOR BETTER LIVING, INC. (Registrant)\nDate: March 15, 1996 By: KARL M. STOCKBRIDGE ------------------- Karl M. Stockbridge Executive Vice President and Chief Financial Officer (Principal Financial Officer)\nINDEPENDENT AUDITORS' REPORT ON SCHEDULE\nTo the Stockholders and Board of Directors of For Better Living, Inc.:\nWe have audited the consolidated financial statements of For Better Living, Inc. and subsidiaries as of December 30, 1995 and December 31, 1994, and for each of the three fiscal years in the period ended December 30, 1995, and have issued our report thereon dated March 15, 1996; 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 consolidated financial statement schedule of For Better Living, 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 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 Costa Mesa, California March 15, 1996\nSchedule II FOR BETTER LIVING, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993 - -------------------------------------------------------------------------------- (In thousands)\n1995 1994 1993 ALLOWANCE FOR DOUBTFUL ACCOUNTS: Balance at beginning of fiscal year $ 841 $ 570 $ 838 Provision charged to income 230 424 159 Uncollectible receivables written off, net of recoveries (324) (153) (427) ----- ----- -----\nBalance at end of fiscal year $ 747 $ 841 $ 570 ----- ----- -----","section_15":""}
{"filename":"775345_1995.txt","cik":"775345","year":"1995","section_1":"ITEM 1 - BUSINESS United Bancorp, Inc. (the \"Company\") was incorporated on May 31, 1985 as a business corporation under the Michigan Business Corporation Act, pursuant to the authorization and direction of the Directors of United Bank & Trust (the \"Bank\").\nThe Company is a bank holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act, with the Bank as its only wholly-owned subsidiary. The Bank was acquired by the Company effective January 1, 1986. The Company has corporate power to engage in such activities as permitted to business corporations under the Michigan Business Corporation Act, subject to the limitations of the Bank Holding Company Act and regulations of the Federal Reserve System. In general, the Bank Holding Company Act and regulations restrict the Company with respect to its own activities and activities of any subsidiaries to the business of banking or such other activities which are closely related to the business of banking.\nThe Bank offers a full range of services to individuals, corporations, fiduciaries and other institutions. Banking services include checking, NOW accounts, savings, time deposit accounts, money market deposit accounts, safe deposit facilities and money transfers. Lending operations provide real estate loans, secured and unsecured business and personal loans, consumer installment loans, credit card and check-credit loans, home equity loans, accounts receivable and inventory financing, equipment lease financing and construction financing.\nThe Bank's Trust & Investment Group offers a wide variety of fiduciary services to individuals, corporations and governmental entities, including services as trustee for personal, corporate, pension, profit sharing and other employee benefit trusts. The Department provides securities custody services as an agent, acts as the personal representative for estates and as a fiscal, paying and escrow agent for corporate customers and governmental entities.\nIn 1995, the Bank renewed its efforts to offer nontraditional financial services to its market. Through an agreement with Security First Corporation, the Bank began offering the sale of mutual funds and annuities through representatives located in the Bank's offices.\nLate in 1995, the Bank formed an insurance agency. No activity was conducted by the Agency during 1995, but this subsidiary provides an additional vehicle to provide additional financial services to clients and nonclients in the future.\nBanking services are delivered through a system of thirteen banking offices plus nine automated teller machines, all in Lenawee County, Michigan. The business base of the County is primarily agricultural and light manufacturing, with its manufacturing sector exhibiting moderate dependence on the automotive and refrigeration and air conditioning industries. The Bank maintains correspondent bank relationships with several larger banks, which involve check clearing operations, transfer of funds, loan participation, and the purchase and sale of federal funds and other similar services.\nSupervision and Regulation As a bank holding company within the meaning of the Bank Holding Company Act, the Company is required by said Act to file annual reports of its operations and such additional information as the Board of Governors may require and is subject, along with its subsidiaries, to examination by the Board of Governors. The Federal Reserve is the primary regulator of the Company.\nThe Bank Holding Company Act requires every bank holding company to obtain prior approval of the Board of Governors before it may merge with or consolidate into another bank holding company, acquire substantially all the assets of any bank, or acquire 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 holding company or bank. The Board of Governors may not approve the acquisition by the Company of voting shares or substantially all the assets of any bank located in any state other than Michigan unless the laws of such other state specifically authorize such an acquisition. The Bank Holding Company Act also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. However, holding companies may engage in, and may own shares of companies engaged in, certain businesses found by the Board of Governors to be so closely related to banking or the management or control of banks as to be a proper incident thereto.\nUnder current regulations of the Board of Governors, a holding company and its nonbank subsidiaries are permitted, among other activities, to engage, subject to certain specified limitations, in such banking related business ventures as sales and consumer finance, equipment leasing, computer service bureau and software operations, data processing and services transmission, discount securities brokerage, mortgage banking and brokerage, sale and leaseback and other forms of real estate banking. The Bank Holding Company Act does not place territorial restrictions on the activities of nonbank subsidiaries of bank holding companies.\nIn addition, federal legislation prohibits acquisition of \"control\" of a bank or bank holding company without prior notice to certain federal bank regulators. \"Control\" in certain cases may include the acquisition of as little as 10% of the outstanding shares of capital stock.\nMichigan's banking laws restrict the payment of cash dividends by a state bank by providing, subject to certain exceptions, that dividends may be paid only out of net profits then on hand after deducting therefrom its losses and bad debts and no dividends may be paid unless the bank will have a surplus amounting to not less than twenty percent (20%) of its capital after the payment of the dividend.\nUnited Bank & Trust is a Michigan banking corporation, and as such is subject to the regulation of, and supervision and regular examination by, the Michigan Financial Institutions Bureau (\"FIB\") and also the Federal Deposit Insurance Corporation (\"FDIC\"). The FIB is the primary regulator of the Bank. Deposit accounts of the Bank are insured by the FDIC. Requirements and restrictions under the laws of the United States and the State of Michigan include the requirement that banks maintain reserves against deposits, restrictions on the nature and amount of loans which may be made by a bank and the interest that may be charged thereon, restrictions on the payment of interest on certain deposits and restrictions relating to investments and other activities of a bank.\nThe Federal Reserve Board has established guidelines for risk-based capital by bank holding companies. These guidelines establish a risk adjusted ratio relating capital to risk-weighted assets and off-balance-sheet exposures. These capital guidelines primarily define the components of capital, categorize assets into different risk classes, and include certain off-balance-sheet items in the calculation of capital requirements. Tier I capital consists of shareholders' equity less intangible assets and unrealized gain or loss on securities available for sale, and Tier 2 capital consists of Tier 1 capital plus qualifying loan loss reserves.\nThe capital ratios of the Company exceed the regulatory guidelines for well capitalized institutions. The following table shows the Company's regulatory capital and capital ratios at December 31, 1995 and 1994, as well as the regulatory requirements for adequately capitalized and well capitalized institutions established by the FDIC. Figures shown are in thousands of dollars, where appropriate.\nThe above ratios, in conjunction with regulatory ratings, have qualified the Bank for the lowest FDIC insurance rate available to insured financial institutions.\nDuring 1993, the Company adopted three accounting standards issued by the Financial Accounting Standards Board (\"FASB\"). In 1994 the Company modified and expanded certain disclosures to comply with Statement of Financial Accounting Standards No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments. For 1995 the Company adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" In 1995 the Company also adopted AICPA Statement of Position 94-6, \"Disclosure of Certain Significant Risks and Uncertainties.\" The adoption of these pronouncements is discussed in Note 1 of Item 8 on Pages 26 - 29 and is incorporated herein by reference.\nCompetition The banking business in the Bank's service area is highly competitive. In Lenawee County, the Bank competes with seven other banks, one savings & loan association, two credit unions, and various finance companies and loan production offices. Three of the banks and the savings & loan association are subsidiaries of large multi-state, multi-bank holding companies. The Bank expanded its penetration in various areas in the County through two acquisitions in 1992 and one acquisition in 1994. These acquisitions opened up markets in the County that were not previously served directly by the Company. During 1994, the Bank completed a significant addition to its existing Adrian office to house additional offices of the Bank's Trust & Investment Group, and\ncompleted construction of a 3,500 square foot office near the Adrian Mall, in the City of Adrian. In addition construction of an office in the Village of Blissfield was completed in May of 1995.\nThe Bank continued to make inroads into Lenawee County markets through its offices. The Company believes that the market perceives a competitive benefit to an independent, locally controlled commercial bank. Much of the Bank's competition comes from affiliates of organizations controlled from outside the area. Against these competitors, the Bank continues to expand its loan portfolio. Coupled with the fact that the Company offers the only locally-based trust department in the County, this local focus has provided a significant competitive advantage.\nEmployees On December 31, 1995, the Bank employed 134 full-time and 36 part-time employees. This compares to 129 full time and 28 part time employees as of December 31, 1994. The Company has no full time employees. Its operation and business are carried out by officers and employees of the Bank, who are not compensated by the Company.\nI SELECTED STATISTICAL INFORMATION\n(A) Distribution of Assets, Liabilities and Shareholders' Equity; (B) Interest Rates and Interest Differential:\nThe information called for by this item is presented in Item 7 on pages 18 - 20 and is incorporated herein by reference.\nII SECURITIES PORTFOLIO\nThe following table reflects the amortized costs and yields of the Company's securities portfolio for 1995. The average yield on tax exempt securities of states and political subdivisions is adjusted to a taxable equivalent basis, assuming a 34% marginal tax rate. In thousands of dollars where applicable:\nAmortized Costs and Yields of Investments\n(1) Reflects the scheduled amortization and an estimate of future prepayments based on past and current experience of amortizing U.S. agency securities. (2) Reflects the scheduled amortization and an estimate of future prepayments based on past and current experience of the issuer for various collateralized mortgage obligations.\nThe Company's securities portfolio contains no concentrations by issuer greater than 10% of shareholders' equity. Additional information concerning the Company's securities portfolio is included in Item 7 on Page 12 and in Note 4 on Page 30 of Item 8 and is incorporated herein by reference.\nIII LOAN PORTFOLIO (A) TYPES OF LOANS\nThe table below shows loans outstanding (net of unearned interest) at December 31. All loans are domestic and contain no concentrations by industry or customer. Balances are stated in thousands of dollars.\n(1) includes loans held for sale\n(B) MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES\nThe following table presents the maturity of total loans outstanding, other than residential mortgages and personal loans, as of December 31, 1995, according to scheduled repayments of principal. All figures are stated in thousands of dollars.\n(C) RISK ELEMENTS Non-Accrual, Past Due and Restructured Loans\nThe aggregate amount of non-performing loans is presented in the table below. Nonperforming loans comprise (1) loans accounted for on a nonaccrual basis; (2) loans contractually past due 90 days or more as to interest or principal payments (but not included in the nonaccrual loans in (1) above), and (3) other loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower (exclusive of loans in (1) or (2) above). All numbers other than the percent of total loans are stated in thousands of dollars.\nFor purposes of the above summary, loans renewed on market terms existing at the time of renewal are not considered troubled debt restructurings. The accrual of interest income is discontinued when a loan becomes 90 days past due unless it is both well secured and in the process of collection, or the borrower's capacity to repay the loan and the collateral value appear sufficient.\nThe following shows the effect on interest revenue of nonperforming loans for the year ended December 31, 1995, in thousands of dollars:\nAdditional information concerning nonperforming loans, the Bank's nonaccrual policy, and loan concentrations is provided in Note 1 on Page 26, Note 5 on Page 31 and Note 6 on Page 31 of Item 8 and is incorporated herein by reference.\nAt December 31, 1995, the Bank had no loans other than those disclosed above which cause management to have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans pursuant to Item III.C.1.\n(D) OTHER INTEREST BEARING ASSETS\nAs of December 31, 1995, there were no other interest bearing assets that would be required to be disclosed under Item III, Parts (C)(1) or (C)(2) of the Loan Portfolio listing if such assets were loans.\nIV SUMMARY OF LOAN LOSS EXPERIENCE (A) CHANGES IN ALLOWANCE FOR LOAN LOSSES\nThe Bank's allowance for loan losses was 1.01% of total loans at December 31, 1995 and 1994. The table below summarizes changes in the allowance for loan losses for the years 1991 through 1995, stated in thousands of dollars.\nCHANGES IN ALLOWANCE FOR LOAN LOSSES\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 economic conditions, volume, amount and composition of the loan portfolio, and other factors. The higher-than-historical loan losses experienced in 1992 were caused primarily by one business customer. Management increased the provision charged to earnings to $361,000 in 1995, compared to $249,000 in 1994 and $335,000 in 1993. The allowance is based on the analysis of the loan portfolio and a four year historical average of net charge offs to average loans of .13% of the portfolio.\n(B) ALLOCATION OF ALLOWANCE FOR LOAN LOSSES\nThe following table presents the portion of the allowance for loan losses applicable to each loan category in thousands of dollars, and the percent of loans in each category to total loans, as of December 31.\nALLOCATION OF ALLOWANCE FOR LOAN LOSSES\nThe allocation method used takes into account specific allocations for identified credits and a four year historical loss average in determining the allocation for the balance of the portfolio.\nV DEPOSITS\nThe information concerning average balances of deposits and the weighted-average rates paid thereon is included in Item 8, Pages 18 and 20 of this report, and is incorporated herein by reference. Maturities of negotiated rate time deposits of $100,000 or more outstanding at December 31, 1995 are summarized below, in thousands of dollars:\nVI RETURN ON EQUITY AND ASSETS\nVarious ratios required by this section and other ratios commonly used in analyzing bank holding company financial statements are included in the table below. Book value per share is based on outstanding shares at December 31, of 1,489,840 in 1995 and 1,488,375 in 1994 and 1993. Dividends per share is based on average shares outstanding of 1,488,379 in 1995 and 1,488,375 in 1994 and 1993.\nVII SHORT-TERM BORROWINGS\nThe information called for by this item is contained in Note 8, Page 32 of Item 8 and is incorporated herein by reference.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -PROPERTIES\nThe executive offices of the Company are located at the main office of United Bank & Trust, 205 East Chicago Boulevard, Tecumseh, Michigan. The Bank owns and occupies the entire two-story brick building, which was built in 1980. The Bank operates three other offices in the Tecumseh area, two in the city of Adrian, one each in the cities of Hudson and Morenci, one each in the villages of Britton and Blissfield, and one each in Clinton, Rollin and Raisin Townships, all in Lenawee County. The Bank owns all of the buildings and leases the land for one office in the city of Adrian. All branches offer drive-up facilities.\nITEM 3","section_3":"ITEM 3 -LEGAL PROCEEDINGS\nThe Company is not involved in any material legal proceedings. The Bank is involved in ordinary routine litigation incident to its business; however, no such proceedings are expected to result in any material adverse effect on the operations or earnings of the Bank. Neither the Bank nor the Company is involved in any proceedings to which any director, principal officer, affiliate thereof, or person who owns of record or beneficially more than five percent (5%) of the outstanding stock\nof either the Company or the Bank, or any associate of the foregoing, is a party or has a material interest adverse to 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 during the fourth quarter of 1995.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE FOR COMMON STOCK\nThe following table shows the high and low selling prices of common stock of the Company for each quarter of 1995 and 1994 as reported by First of Michigan Corporation. These prices do not reflect private trades not involving First of Michigan Corporation. The common stock of the Company is traded over the counter. The Company had 830 shareholders as of December 31, 1995. The prices and dividends per share have been adjusted to reflect the 1994 stock split.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe following table presents five years of financial data for the Company, for the years ended December 31. (In thousands, except per share data).\n(1) Per share data is based on average shares outstanding and has been adjusted to reflect a 3 for 1 stock split in 1994 and stock dividends paid in 1993 and 1991.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion provides information about the consolidated financial condition and results of operations of United Bancorp, Inc. and its subsidiary, United Bank & Trust.\nFINANCIAL CONDITION\nSECURITIES The securities portfolio of the Bank increased slightly during 1995, following declines in 1994. This increase reflects deposit growth which outpaced loan growth during the year.\nIn 1995, the Bank actively pursued high-balance money market deposit accounts from existing clients, and invested the funds in variable rate mortgage backed agency securities. Holdings in U.S. Treasury and agency securities declined during the year as a result of maturities in the portfolio. These investments were generally replaced with U.S. Government agency mortgage backed securities, which offered higher yields than U.S. Treasury bonds. In general, maturities of corporate asset backed and debt securities were not replaced during the year.\nHoldings in tax exempt obligations of states and political subdivisions increased during the year, as in prior years. The Company's current and projected tax position continues to make carrying these securities valuable to the Bank. In addition, the Company does not anticipate being subject to the alternative minimum tax in the near future. The investment in local municipal issues also reflects the Company's commitment to the development of the local area through support of its political subdivisions.\nInvestments in U.S. Treasury and agency securities are considered to possess low credit risk. Obligations of U.S. government agency mortgage-backed securities possess a somewhat higher interest rate risk due to certain prepayment risks. The Bank's portfolio contains no \"high risk\" mortgage securities or structured notes.\nThe Company experienced a significant shift in its unrealized gains and losses on securities available for sale during 1995 and 1994. At December 31, 1993, the gain was $196,000, net of tax. During 1994, market rates increased, resulting in declines in the market value of investments. At December 31, 1994, the unrealized net loss on securities available for sale was $854,000, net of tax. Following declines in rates during 1995, market values increased, and at December 31, 1995, the position had shifted to an unrealized net gain of $105,000.\nThese unrealized gains and losses are temporary, since they are a result of market changes, rather than a reflection of credit quality. Management has no specific intent to sell any securities classified as either held to maturity or available for sale.\nLOANS Total loans increased 3.4% in 1995, compared to 6.8% growth in 1994. Growth in the consumer loan area during 1995 continued to reflect significant growth in the Bank's home equity, credit card and consumer installment loan portfolios. Demand for business loans was flat during the year, following significant growth in 1994. The continued decline in tax exempt loans reflects normal amortization as well as a decline in demand for this type of financing.\nThe Bank continues to be the single largest provider of residential mortgage loans in Lenawee County. As a full service lender, the Bank offers a variety of home mortgage loan products in its market. During 1995, the preference of consumers was primarily for fixed rate residential real estate loans, rather than for variable rate loans. This resulted in a decline in the residential real estate portfolio, since the Bank generally retains ownership of adjustable rate and short term fixed rate loans, and originates and sells long term single family residential fixed rate mortgage loans in the secondary market. While the Bank anticipates that it will continue to sell loans in the secondary market, the actual amounts originated for sale will depend on several factors, including local economic conditions and demand in the real estate market.\nCREDIT QUALITY The Company continues to maintain a high level of asset quality as a result of actively monitoring delinquencies, nonperforming assets and potential problem loans. At December 31, 1995, the Bank had approximately $202,000 of loans past due 90 days or more or not accruing interest. This amount represents .07% of all loans outstanding, and is an unusually low percentage for the industry. This number is down from $517,000 at the end of 1994, when the increase from 1993 was due primarily to the delinquency of one large commercial customer, for which no loss was experienced.\nThe largest single category of loans is also generally the category with the least risk. Loans to finance residential mortgages are well-secured and have had historically low levels of net losses. Personal and business loans make up the balance of the portfolio in equal proportions.\nBusiness loans carry the largest balances per loan, and therefore, any single loss would be proportionally larger than losses in other portfolios. Because of this, in addition to the precautions taken with credit quality in the other portfolios, the Bank uses an independent loan review firm to assess the continued quality of its business loan portfolio. Business loans contain no significant concentrations other than geographic concentrations within Lenawee County.\nPersonal loan balances were $57.4 million at December 31, 1995. Of those loans, approximately 73% are direct and indirect installment loans. Home equity loans comprise another 20% of personal loans, and the balance consists of credit card loans and unsecured revolving line of credit loans, including overdraft protection. Installment loans consist primarily of loans for consumer durable goods, principally automobiles. Indirect personal loans consist of loans for automobiles and manufactured housing.\nDuring the past two years, the Bank has increased its involvement in indirect personal lending. This indirect lending is performed within the Bank's market area, and underwriting standards are strict. All loans are obtained through established dealers who are well-known to the Company. Indirect lending is traditionally somewhat riskier than direct lending, but the Company maintains a high level of asset quality on indirect loans as well as direct loans by actively monitoring delinquencies, nonperforming assets and potential problem loans.\nFurther information concerning credit quality is contained in Note 6 of the Notes to Consolidated Financial Statements.\nDEPOSITS AND REPURCHASE AGREEMENTS Deposits increased during 1995, following modest declines in 1994. The greatest percentage increases in deposits during 1995 were seen in demand deposits, money market deposit accounts, certificates of deposit over one year and interest bearing certificates greater than $100,000. The majority of the Bank's deposits are derived from core customer sources, relating to long term\nrelationships with local personal, business and public customers.\nA number of factors contributed to deposit growth in 1995. Personal demand deposit accounts increased due to the introduction of the very successful Freedom Checking product during 1995. This product features no monthly statement charges or minimum balances, with unlimited check writing. In addition, successful penetrations into the Adrian and Blissfield markets contributed to deposit growth. Increases in long term CDs more than offset declines in short term CDs, as clients continued their shifts to longer maturities during 1995.\nLate in 1994, the Bank began offering a repurchase agreement product to non-retail customers, and balances in this product were $5.2 million at December 31, 1994. Management considered this product to be a logical replacement for uninsured deposits for municipalities and large corporate customers. However, following the decrease in FDIC insurance rates in 1995, rates on repurchase agreements became less attractive to clients, and most of these balances returned to certificates of deposit over $100,000. This is responsible for a large portion of the increases in that category of deposits. Other interest bearing deposits remained virtually unchanged as a percent of total deposits.\nIn financial institutions, the presence of interest bearing certificates greater than $100,000 often indicates a reliance upon purchased funds. However, in the Bank's deposit portfolio, these balances represent core deposits of local clients. The Bank does not support its growth through purchased or brokered deposits.\nThe Bank's deposit rates are consistently competitive with other banks in its market, and in general, the Lenawee County market has traditionally paid higher interest rates on deposits than the nearby Detroit and Toledo metropolitan market areas.\nCASH EQUIVALENTS AND BORROWED FUNDS The Bank found it advantageous to borrow periodically through the federal funds market during 1994. However, early in 1995, the Bank shifted from being a user to a provider of funds in the federal funds market. This strategic move was in response to a flattening of the yield curve, which made short term rates relatively more attractive. Further information concerning this change is discussed in the \"Liquidity and Funds Management\" section below.\nIn addition to the federal funds market, the Bank continued to use advances from the Federal Home Loan Bank, renewing $3 million of advances which matured during 1995. Additional information concerning borrowings is detailed in Notes 8 and 9 of the Notes to Consolidated Financial Statements and in the \"Liquidity and Funds Management\" section following.\nLIQUIDITY AND FUNDS MANAGEMENT\nLIQUIDITY While 1994 presented challenges to provide funding for continued strong loan demand, expansion in the Adrian market and entry into the Blissfield market contributed additional sources of deposits in 1995.\nDuring 1995, the interest rate yield curve shifted dramatically, providing proportionally better returns for federal funds balances than for other types of investments. In order to take advantage of this unusual rate scenario, the reinvestment of some investment maturities was delayed in order to enhance investment income. This provided additional liquidity during the year.\nThe Bank monitors its liquidity position regularly, and is in compliance with regulatory guidelines for liquidity. The Company has a number of liquidity sources other than deposits, including federal funds and other lines of credit with correspondent banks, securities available for sale, and a line of credit with the Federal Home Loan Bank of Indianapolis. Information concerning available lines is contained in Note 8 of the Notes to Consolidated Financial Statements.\nFUNDS MANAGEMENT Bank policies place strong emphasis on stabilizing net interest margin, with the goal of providing a sustained level of satisfactory earnings. The Funds Management, Investment and Loan policies provide direction for the flow of funds necessary to supply the needs of depositors and borrowers. Management of interest sensitive assets and liabilities is also necessary to reduce interest rate risk during times of fluctuating interest rates.\nThe Funds Management Committee of the Bank is also responsible for evaluating and anticipating various risks other than interest rate risk. Those risks include prepayment risk, credit risk and liquidity risk. The Committee is made up of senior members of management, and continually monitors the makeup of interest sensitive assets and liabilities to assure appropriate liquidity, maintain interest margins and to protect earnings in the face of changing interest rates and other economic factors.\nThe Bank relies on traditional methods to balance the interest sensitivity of its asset and liability portfolios. Interest rate futures, caps, swaps and similar instruments are avoided, in preference for more familiar, traditional funds management techniques.\nThe Funds Management policy of the Bank provides for a level of interest sensitivity which, Management believes, allows the Bank to take advantage of opportunities within the market relating to liquidity and interest rate risk, allowing flexibility without subjecting the Bank to undue exposure to risk. In addition, other measures are used to evaluate and project the anticipated results of Management's decisions.\nThe Bank continued to maintain its interest sensitivity position near to a neutral position. As a result, continued emphasis on variable rate assets was combined with attempts to acquire short term fixed rate deposits.\nThe following table shows the rate sensitivity of earning assets and interest bearing liabilities as of December 31, 1995. Assets and liabilities are shown in the table according to their anticipated repricing dates. Loans and investments are categorized using their scheduled payment dates, where applicable. Savings, NOW and money market deposit accounts are considered to be immediately repriceable. All other liabilities are reported by their scheduled maturities.\nINTEREST SENSITIVITY SUMMARY\nCAPITAL RESOURCES It is the policy of the Company to pay 30% to 35% of net earnings as cash dividends to shareholders. These dividends have resulted in a dividend yield of approximately 3.3% and 3.5% in 1995 and 1994, respectively, with the decline due entirely to an increase in the market value of the stock. A three-for-one stock split was paid in 1994, and a 5% stock dividends was paid to shareholders in 1993. The stock of the Company is traded locally over the counter, and demand consistently exceeds supply. Additional information concerning capital ratios and shareholder return is included in \"Financial Highlights.\"\nThe capital ratios of the Bank and the Company continued to increase through the retention of earnings during 1995. Capital ratios continued to exceed the levels required by its regulators.\nThe Company maintains a five year 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 a return to shareholders.\nRESULTS OF OPERATIONS\nConsolidated net income for 1995 was $4,035,000, compared to $3,584,000 for 1994 and $3,820,000 for 1993. This resulted in a return on consolidated average assets for 1995 of 1.30%, compared to 1.20% for 1994 and 1.30% for 1993. Return on average shareholders' equity increased to 14.9%, up from 14.7% in 1994 and down from 17.3% in 1993. In addition, earnings per share for 1995 were $2.71, compared to $2.41 and $2.57 for 1994 and 1993, respectively. All per share figures have been restated to reflect the stock split in 1994 and the stock dividend distributed in 1993.\nNET INTEREST INCOME United Bancorp, Inc. derives its income primarily from net interest income, which is an important indicator of the Company's profitability. In general, the Bank has a lower net interest margin than its peers, due principally to its deposit mix. Interest income yields of the Bank are generally in line with peers, but relatively low levels of noninterest bearing deposits and a high amount of certificates of deposit contribute to a relatively high cost of funds.\nManagement's attempts to influence the deposit mix proved marginally successful during 1994, as the percent of noninterest bearing deposits to total deposits increased slightly. This trend continued in 1995, due in part to the introduction of the Freedom Checking product, as discussed under \"Deposits,\" above. Improvements in margin also resulted in part from continued attempts during 1995 to influence deposit mix through pricing and target marketing. The Yield Analysis table provides insight into the various components of net interest income, as well as the results of recent initiatives which have helped to improve the margin.\nYIELD ANALYSIS OF CONSOLIDATED AVERAGE ASSETS AND LIABILITIES DOLLARS IN THOUSANDS\nYIELD ANALYSIS OF CONSOLIDATED AVERAGE ASSETS AND LIABILITIES, CONTINUED\n(a) Non-accrual loans and overdrafts are included in the average balances of loans. (b) Fully tax-equivalent basis; 34% tax rate.\nWhile the spread improved from 3.81% in 1994 to 3.99% in 1995, the improvement in margin from 4.26% in 1994 to 4.54% in 1995 is perhaps more significant. However, the ratio of interest earning assets to interest bearing liabilities remained unchanged, at 1.14 for 1995 and 1994.\nTotal dollars of net interest income increased significantly during 1995, as a result of both volume and rate increases. As noted above under \"Securities,\" the move from U.S. Treasury securities to federal funds sold provided improvements in interest income. Continued growth in personal loans also contributed to the improvement in margin, as pricing on these products is generally higher than on other categories of loans.\nThe following table sets forth the effects of volume and rate changes on net interest income on a taxable equivalent basis. All figures are stated in thousands of dollars.\n(a) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.\nThe above tables further demonstrate the effect of volume and rate changes on net interest income on a taxable equivalent basis for the last two years. The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. Nonaccrual loans are included in total loans, and changes are treated as volume variances.\nPROVISION FOR LOAN LOSSES The purpose of the provision for loan losses is to maintain an adequate allowance to absorb potential loan losses. Management strives to maintain the allowance for loan losses at an appropriate level based upon their analysis of the loan portfolio, in order to provide for possible future losses and anticipated growth.\nThe Bank has consistently low levels of nonperforming loans, and loan loss history has been excellent compared to peers. The use of an independent loan review function for business loans, and careful monitoring of loans by management allows the Bank to maintain its high level of quality in the loan portfolio. All of these factors combine with the high level of residential real estate loans to support an allowance as a percent of total loans at a level which is somewhat below average for a commercial bank.\nThe amount of the 1995 provision for loan losses was $361,000, compared to $249,000 in 1994 and $335,000 in 1993. Actual charge offs were $361,000 in 1995, compared to $243,000 in 1994 and $201,000 during 1993, while recoveries for the same periods were $70,000, $48,000 and $68,000, respectively. The allowance for loan losses at year end 1995 reached $2,197,000, representing 1.01% of total loans. The adoption by the Company of Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" effective\nJanuary 1, 1995 was immaterial to the Company's consolidated financial statements.\nNONINTEREST INCOME Total noninterest income increased 29.8% during 1995, following a decrease of 13.2% from 1993 to 1994. A number of items contributed to these changes.\nGrowth in deposits, primarily in the banking offices opened in 1994 and 1995, contributed to a 23.0% increase in deposit service charges from 1994 to 1995. This followed modest declines from 1993 to 1994.\nAlso contributing to the overall profitability of the Company is the Trust & Investment Group of the Bank, as gross income generated from trust fees continued to rise. Trust & Investment fees provided 32.8% of the Company's noninterest income in 1995, compared to 34.7% in 1994 and 30.1% in 1993. Total Trust & Investment Group fee income increased 9.6% in 1995 over 1994. Future increases in Trust fee income are dependent on the growth of the Department and the market value of assets managed, but are expected to continue to increase in future periods. The Department will celebrate its 20th year of operation in 1996.\nOne area of income that showed some improvement in 1995 following significant decline for 1994 was income from the sales and servicing of loans. Gains on the sale of loans, combined with net provision for losses on loans held for sale was $237,000 in 1995. This compares to $65,000 for 1994 and $509,000 for 1993, and reflects a rebound from the slowing of the demand for residential real estate mortgages during 1994, as a decrease in long term rates in 1995 resulted in some increase in volume from 1994 levels. The unprecedented origination volume experienced throughout the country in 1993 and 1992 was a result of interest rates which were significantly lower than the rates on virtually all mortgages that were in place at that time. Almost all mortgage borrowers were able to benefit during that period by refinancing their existing mortgage loans. Management believes that the origination levels experienced in 1993 and 1992 are not likely to be repeated even as rates fall.\nThe Bank continues to build a significant portfolio of sold loans which it continues to service, and this servicing provides ongoing income for the life of the loans. The Bank generally markets its production of fixed rate long term mortgages in the secondary market, and retains adjustable rate mortgages for its portfolio. As loan rates declined during 1995, client preference shifted toward fixed rate loans, resulting in a greater proportion of those loans originated by the Bank being sold in the secondary market. The Bank currently services nearly $72 million of sold loans, compared to $53 million at the end of 1994. These loans will continue to generate fee income in future periods.\nThe other area providing significant increases from 1994 is income from the sale of nondeposit investment products. Enhancements to the Bank's program in late 1994 have provided substantial increases in sales, resulting in increased fee income. Total income provided from the sale of annuities and mutual funds these products in 1995 was $272,000, up 700% from 1994.\nIn 1995, the Michigan Banking Code was modified to permit state banks to sell insurance products of all kinds. United Bank & Trust subsequently formed an insurance agency, although the agency has not yet commenced operations and no income was generated during the year.\nManagement anticipates that noninterest income will continue to be emphasized in the future as a significant source of income to help augment net interest income in light of continued increased competition in the financial services markets.\nNONINTEREST EXPENSE Personnel expense continues to be the largest single area of expense. Expansion and growth requires adequate staffing, and personnel expense increased 18.7% over 1994. Total full-time equivalent staffing was 156.5 at December 31, 1995, compared to 144.5 in 1994. This expansion also contributed to increases in occupancy and equipment expenses, which increased 17.1% during 1995, compared to an increase of 5.8% in 1994 and 42.0% in 1993.\nOther noninterest expenses increased moderately due to the continued expansion of the Company. Several areas reflecting increases relate primarily to this expansion, and include costs of marketing, business development and staff education, as well as expenses relating to the operation of thirteen banking offices in 1995, compared to eleven for most of 1994 and 1993.\nA reduction of FDIC insurance premium rates resulted in a decrease of approximately $284,000 in the Company's FDIC insurance cost from 1994. Effective May 1, 1995, the FDIC reduced the Company's premium rate from 23 basis points per $100 of deposits to 4 basis points. This change was a result of the Bank Insurance Fund (\"BIF\"), which insures 95% of the Company's deposit accounts, reaching its statutorially required level in the spring of 1995.\nThis rate has further been reduced to zero for the first six months of 1996. However, because the Savings Association Insurance Fund (\"SAIF\") is not projected to reach its fully funded level for several more years, SAIF insured institutions will not benefit from these premium reductions. There has been active discussion in the United States Congress that a significant premium disparity between BIF and SAIF insured institutions might be inappropriate or undesirable. One option being actively considered is a one-time special assessment on SAIF insured deposits. Such special assessment or other charges, if implemented, may reduce the level of premium reduction currently announced. The Company has a small amount of SAIF insured deposits arising from the acquisition of branches from a thrift institution, and the net income affect of the one time charge currently proposed would be less than $55,000.\nFEDERAL INCOME TAX The Company's effective tax rate remained substantially unchanged from prior years.\nTax exempt income continues to be a significant factor in the tax calculation for the Company, due to the relatively large portion of the investment portfolio carried in tax exempt municipal securities. The Bank intends to continue to invest in these securities as long as liquidity, safety and tax equivalent yields make them an attractive alternative.\nPROSPECTIVE ACCOUNTING AND REGULATORY CHANGES Information concerning the adoption of prospective accounting changes is reviewed in Note 1 of the Notes to Consolidated Financial Statements. Management is not aware of any other trends, events or uncertainties that are likely to have a material effect on the Company's liquidity, capital\nresources, or operations. In addition, Management is not aware of any current recommendations by regulatory authorities, other than those previously discussed, which would have such an effect.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED BALANCE SHEET United Bancorp, Inc. and Subsidiary\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENT OF INCOME United Bancorp, Inc. and Subsidiary\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS United Bancorp, Inc. and Subsidiary\nNoncash Investing Activities Upon the adoption of SFAS No. 115 at December 31, 1993, the Company transferred $46,882,000 of securities at fair value to securities available for sale.\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY United Bancorp, Inc. and Subsidiary\nThe accompanying notes are an integral part of these consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Bancorp, Inc. and Subsidiary\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF OPERATIONS The consolidated financial statements include the accounts of United Bancorp, Inc. (\"Company\") and its wholly owned subsidiary, United Bank & Trust (\"Bank\"), after elimination of significant intercompany transactions and accounts. The Company is engaged 100% in the business of commercial and retail banking and trust and investment services, with operations conducted through its main office and twelve offices located in Lenawee County in southeastern Michigan. This County is the source of substantially all of the Company's deposit, loan and trust activities. The majority of the Company's income is derived from commercial and retail lending activities and investments. Primarily all installment and residential loans are secured by real and personal property, while approximately 97% of commercial loans are secured by business and personal assets.\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 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 as well as affecting the disclosures provided. Actual results could differ from those estimates.\nEstimates incorporated into the Company's consolidated financial statements which are more susceptible to change in the near term include the allowance for loan losses and fair values of certain financial securities.\nSECURITIES Securities available for sale consist of bonds and notes not classified as held to maturity. Such securities might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs, or other factors. At December 31, 1993, the Company adopted Statement of Financial Accounting\nStandards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). As required by SFAS No. 115, securities classified as available for sale are reported at their fair value and the related unrealized holding gain or loss is reported, net of related income tax effect, as a separate component of shareholders' equity until realized. Realized gains or losses are based upon the amortized cost of the specific securities sold.\nBonds and notes for which Management has the positive intent and the Bank has the ability to hold to maturity are reported at amortized cost. Premiums and discounts on securities are recognized in interest income using the interest method over the period to maturity.\nLOANS HELD FOR SALE Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or market in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income. Loan servicing fees are recognized when received and the related costs are recognized when incurred. The Bank sells mortgage loans into the secondary market at market prices which include consideration for normal servicing fees.\nLOANS Loans receivable that Management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of any deferred fees or costs.\nInterest on loans is credited to operations based on the principal amount outstanding. Management reviews loans delinquent 90 days or more to determine if the interest accrual should be discontinued. Loan fees, net of direct loan origination costs, are deferred and recognized over the life of the loan as a yield adjustment. Fees on loans sold are recognized at the time of the sale.\nThe carrying values of impaired loans are 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 increases or decreases in bad debt expense.\nALLOWANCE FOR LOAN LOSSES The 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 economic conditions, volume, amount and composition of the loan portfolio, and other factors. The allowance is increased by provisions for loan losses charged to income and reduced by net charge-offs.\nIn May of 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS No. 114\") and later amended by Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" The Company adopted SFAS No. 114 and 118 at January 1, 1995. Under this standard, the carrying value of loans considered to be impaired is reduced to the present value of expected future cash flows or, as a practical expedient, to the fair value of the 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 bad debt expense. There was no increase in the allowance for loan losses due to the adoption of SFAS No. 114 at January 1, 1995.\nSmaller-balance homogeneous loans are residential first mortgage loans secured by one-to-four family residences, residential construction loans, and automobile, home equity and second mortgage loans, and are collectively evaluated for impairment. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When credit analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower's business are not adequate to meet its debt service requirements, including the Bank's loans to the borrower, the loan is evaluated for impairment. Often this is associated with a delay or shortfall of payments of 30 days or more. Commercial loans are rated \"Class 1\", \"Class 2\" and \"All Other\". Class 2 are special mention loans and Class 1 are deemed substandard. Loans in these categories are individually evaluated for impairment. All other loans\nare considered to be satisfactory. Loans are generally moved to nonaccrual status when 90 days or more past due. These loans are often also considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. This typically occurs when the loan is 120 or more days past due. SFAS Nos. 114 and 118 disclosures for impaired loans are not expected to be materially different from nonaccrual and renegotiated loans disclosures or non-performing and past-due asset disclosures.\nPREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. The provisions for depreciation are computed principally by the straight line method, based on useful lives of 10 to 40 years for premises and 5 to 8 years for equipment.\nOTHER REAL ESTATE OWNED Other real estate, which is included with other assets, consists of properties acquired through foreclosure or acceptance of a deed in lieu of foreclosure and property acquired for possible future expansion. Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and 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 carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowances are included in loss on foreclosed real estate. The historical average holding period for such properties is less than 18 months.\nINTANGIBLE ASSETS AND GOODWILL The value of core deposits acquired in bank and branch acquisitions are amortized on an accelerated method over their expected lives. The excess of purchase price over the fair value of assets and liabilities acquired (goodwill) is amortized on a straight-line basis over 15 years.\nINCOME TAX Beginning January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). The Company records income tax expense based on the amount of taxes due on its tax 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 enacted tax rates, adjusted for allowances made for uncertainty regarding the realization of net tax assets. The cumulative effect of adopting SFAS No. 109, and the effect on 1993 net income, was immaterial.\nEARNINGS PER SHARE Earnings per share are based upon the weighted average number of shares outstanding during the year. On May 27, 1994 the Company's stock was split on a 3 for 1 basis. Earnings per share, dividends per share and weighted average shares have been restated to reflect the 1994 stock split. The weighted average number of shares outstanding was 1,488,379 for 1995 and 1,488,375 for 1994 and 1993.\nSTATEMENT OF CASH FLOWS For purposes of this statement, cash and cash equivalents include cash on hand, demand balances with banks, and federal funds sold. Federal funds are generally sold for one day periods. The Company reports net cash flows for customer loan and deposit transactions, deposits made with other financial institutions, and short term borrowings.\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 No. 121\"). 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, 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 Statement is effective for fiscal years beginning after December 15, 1995. Management does not expect the Statement to have a material impact on the financial condition or results of operations of the Company.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights\" (\"SFAS No. 122\"). This Statement changes the accounting for mortgage servicing rights retained by the loan originator. Under the Statement, if the originator sells or securitizes mortgage loans and retains the related servicing rights, the total cost of the mortgage loan is allocated between the loan (without the servicing rights) and the servicing rights, based on their relative fair values. Under current practice, all such costs are assigned to the loan. The costs allocated to mortgage servicing rights will be recorded as a separate asset and amortized in proportion to, and over the life of, the net servicing income. The carrying value of the mortgage servicing rights will be periodically evaluated for impairment. Impairment will be recognized using the fair value of individual stratum of servicing rights based on the underlying risk characteristics of the serviced loan portfolio, compared to an aggregate portfolio approach under existing accounting guidance.\nThe Company currently retains servicing on almost all loans originated and sold into the secondary market. Accordingly, the Statement will apply to most loan sales. The impact on the Company's results of operations and financial position will depend upon the volume of loans sold with servicing retained, the cost of loans originated, the relative fair values of loans and servicing rights at the point of sale, among other factors. In general, this Statement will increase the amount of income recognized when loans are sold and will reduce the amount of income recognized during the servicing period. The Statement is effective for the Company in 1996. Retroactive application for servicing rights created prior to adoption of the statement is prohibited. Based on its current volume of loan originations and sales, the Company anticipates that the adoption of SFAS No. 122 would have a positive effect on income of approximately $120,000 net of tax, for 1996.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation\" (\"SFAS No. 123\"). The 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 that 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 guidance in place prior to SFAS No. 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 No. 123 has been adopted. The accounting requirements of the Statement are required for transactions entered into in fiscal years that begin after December 15, 1995, although early adoption is permitted. The Company currently has no stock based compensation plans which would fall under the standards established by the Statement and currently has not taken any action to implement such a plan. Accordingly, the Statement will have no impact on the financial condition or results of operations of the Company.\nRECLASSIFICATIONS Certain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation.\nNOTE 2 - ACQUISITIONS On September 23, 1994, the Bank acquired one office and related deposits from Comerica Bank. Approximately $1.5 million of deposits were assumed. The transaction was accounted for using the purchase method of accounting.\nNOTE 3 - RESTRICTIONS ON CASH AND DEMAND BALANCES IN OTHER BANKS The Bank is required to maintain average reserve balances in the form of cash or balances due from the Federal Reserve Bank. These reserve balances vary depending on the level of customer deposits in the Bank. The amounts of reserve balances required at December 31, 1995 and 1994 were approximately $2,424,000 and $1,869,000, respectively.\nNOTE 4 - SECURITIES The amortized cost and fair value of securities, in thousands of dollars, as of December 31, 1995, 1994 and 1993 are as follows:\nState and municipal and other corporate securities represent securities which are actively traded in a liquid market, and fair values are determined from these markets. The Bank occasionally purchases local, nonrated municipal securities in small dollar amounts. The amount of these local municipal securities held is not significant. All other securities are rated investment grade by a national rating service.\nSales activities for securities for the years indicated are shown in the following table. All sales during 1994 and 1993 were of securities identified as available for sale. Proceeds for 1995 relate to the sale of one security from the held to maturity category, which was sold due to a significant deterioration in the credit quality of the issuing municipality, resulting from losses on certain derivatives.\nThe amortized cost and fair value of securities 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. Asset backed securities are included in periods based on their estimated average lives.\nSecurities carried at $12,104,000 as of December 31, 1995 were pledged to secure deposits of public funds, repurchase agreements, and for other purposes as required by law. In 1994, the Bank entered into an agreement with the Department of Labor to pledge $632,000 of securities as a contingency to cover any potential liability for the purchase of Presidential Life annuities when the Bank terminated its defined benefit pension plan in 1989. The potential future liability of the Bank depends on the ongoing financial viability of Presidential Life, but will continue to decrease as annuities pay down.\nNOTE 5 - LOANS The table below shows total loans outstanding, including loans held for sale, at December 31. All loans are domestic and contain no concentrations by industry or customer.\nMortgage loans originated for sale in the secondary market are generally sold with servicing rights retained. Mortgage loans serviced for others were $71,633,000 and $53,005,000 at December 31, 1995 and 1994, respectively. Future potential recourse obligations at December 31, 1995 consisted of 2 loans for a total of $84,000.\nNOTE 6 - ALLOWANCE FOR LOAN LOSSES An analysis of the allowance for loan losses for the years ended December 31 follows:\nInformation regarding impaired loans for the year ended December 31 follows:\nNOTE 7 - PREMISES AND EQUIPMENT Premises and equipment consisted of the following:\nAt December 31, 1995 future minimum lease payments under noncancelable leases are $36,000 in 1996, 1997 and 1998, $37,000 in 1999, $42,000 in 2000 and $434,000 thereafter.\nNOTE 8 - SHORT TERM BORROWINGS The Company has several credit facilities in place for short term borrowing which are used on occasion as a source of short term liquidity. These facilities consist of borrowing authority totaling $13.2 million from two major correspondent banks to purchase federal funds on a daily basis. There was no outstanding balance at December 31, 1995 and $1.6 million at December 31, 1994. In addition, at December 31, 1995 and 1994 the Company had an unused line of credit from the Federal Home Loan Bank of Indianapolis (\"FHLB\") of $9.0 million.\nThe Bank also enters into sales of securities under agreements to repurchase (repurchase agreements). These agreements generally mature within one to 120 days from the transaction date. U.S. Treasury and agency securities involved with the agreements are recorded as assets and are generally held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain large customers as an investment alternative to deposit products.\nInformation concerning securities sold under agreements to repurchase is summarized as follows:\nNOTE 9 - OTHER BORROWINGS The Bank carries fixed rate, noncallable advances from the FHLB totaling $6.0 million; $3.0 million at 4.80% due in 1996 and $3.0 million at 5.99% due in 1998. These advances are collateralized by loans under a blanket security agreement. The 5% commitment fee paid with these advances is being amortized using the interest method over the lives of the advances. Interest payments are made monthly with principal due at maturity.\nNOTE 10 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONTINGENCIES The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to make loans, unused lines of credit, and letters of credit. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans is represented by the contractual amount of those instruments. The Bank follows the same credit policy to make such commitments as is followed for those loans and investments recorded in the consolidated financial statements. The Bank's commitments to extend credit are agreements at predetermined terms, as long as the customer continues to meet specified criteria, with fixed expiration dates or termination clauses.\nThe following table shows the commitments to make loans and the unused lines of credit available to Bank customers at December 31:\nCommitments to make loans generally expire within thirty to ninety days while unused lines of credit expire at the maturity date of the individual loans. At December 31, 1995, the rates for amounts in the fixed rate category ranged from 7.3% to 10.0%.\nNoninterest bearing and interest bearing deposits and federal funds sold at two regional money center banks totaled $15.0 million and $3.8 million at December 31, 1995 and 1994, respectively.\nThe Company and its subsidiary are subject to certain claims and legal actions arising in the ordinary course of business. In the opinion of Management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.\nNOTE 11 - INCOME TAX Income tax expense consists of the following for the years ended December 31:\nThe components of deferred tax assets and liabilities are as follows:\nA valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. Management has determined that no such allowance was necessary at December 31, 1995 and 1994.\nA reconciliation between total federal income tax and the amount computed through the use of the federal statutory tax rate for the years ended is as follows:\nNOTE 12 - RELATED PARTY TRANSACTIONS Certain directors and executive officers of the Company and the Bank, including their immediate families and companies in which they are principal owners, are loan customers of the Bank. Such loans did not, in the opinion of Management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of these loans at December 31, 1994 was $2,822,000. During 1995, new loans to such related parties amounted to $1,123,000 and repayments amounted to $1,199,000, resulting in a balance at December 31, 1995 of $2,746,000.\nNOTE 13 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES Banking laws and regulations restrict the amount the Bank can transfer to the Company in the form of cash dividends and loans. At December 31, 1995, $16.6 million of retained earnings of the Bank was available for distribution to the Company as dividends without prior regulatory approval. It is not the intent of Management to pay dividends in amounts which would reduce the capital of the Bank to a level below that which is considered prudent by Management and in accordance with the guidelines of regulatory authorities.\nNOTE 14 - EMPLOYEE BENEFIT PLANS Employee Savings Plan The Bank maintains a 401(k) employee savings plan which is available to substantially all employees. Individual employees may make contributions to the plan up to 15% of their compensation. The Bank offers discretionary matching of funds for a percentage of the employee contribution, plus an amount based on Bank earnings. The Bank's contributions for 1995, 1994 and 1993 were $313,000, $246,000 and $242,000, respectively.\nFor 1995, the Company offered employees the option of purchasing Corporation stock with the match portion of their 401(k) contribution. On that basis, on December 31, 1995, 1,465 shares of United Bancorp, Inc. common stock were issued to the 401(k) plan for the benefit of plan participants who so elected Company stock for their 1995 match.\nINCENTIVE COMPENSATION PLAN Bonuses for officers and supervisory personnel are administered under an Incentive Compensation Plan which requires a minimum return on assets before any performance incentive award can be made. Bonuses for the six executive officers consist of both cash and deferred cash payments, while payments for other participants are not deferred. Incentive compensation expense is included in salaries and employee benefits.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\") as of January 1, 1993. This Statement requires the costs of retiree health care and life insurance benefits to be accrued over employee service periods. Retiree life and health insurance coverage provided by the Company was previously charged to expense as premiums were paid. The accumulated postretirement benefit obligation (\"APBO\") for both medical and death benefits was approximately $520,000 as of January 1, 1993 and $627,000 at December 31, 1995. As permitted under SFAS No. 106, the Company has elected to amortize the APBO at January 1, 1993 as an operating expense over 20 years. Postretirement benefit expense for 1995, 1994 and 1993 was approximately $77,000 in each year.\nNOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair value of principal financial assets and liabilities were as follows:\nEstimated fair values require subjective judgments and are approximate. The above estimates of fair value are not necessarily representative of amounts that could be realized in actual market transactions, nor of the underlying value of the Company. Changes in the following methodologies and assumptions could significantly affect the estimated fair value:\nCash and cash equivalents, accrued interest receivable and accrued interest payable - Due to the short periods to maturity, the carrying amounts are reasonable estimates of the fair values of these instruments at the respective balance sheet dates.\nSecurities - Fair values for securities are based on quoted market prices, and are disclosed in detail in Note 4.\nNet loans - The carrying amount is a reasonable estimate of fair value for personal loans for which rates adjust quarterly or more frequently, and for business and tax exempt loans which are prime related and for which rates adjust immediately or quarterly. The fair value for residential mortgage loans which are held for sale on the secondary market is the price offered by the secondary market purchaser. The fair value of all other loans is estimated by discounting future cash flows using current rates for loans with similar characteristics and maturities.\nDeposit liabilities - With the exception of certificates of deposit, the carrying value is deemed to be the fair value due to the demand nature of the deposits. The fair value of fixed maturity certificates of deposit is estimated by discounting future cash flows using the current rates paid on certificates of deposit with similar maturities.\nShort term borrowings - Carrying value is a reasonable approximation of fair value.\nOther borrowings - The fair value is estimated by discounting future cash flows using current rates on advances with similar maturities.\nOff-balance-sheet financial instruments - The Bank's commitments to extend credit, standby letters of credit, and undisbursed loans are deemed to have no material fair value as such commitments are generally fulfilled at current market rates.\nNOTE 16 - PARENT COMPANY ONLY FINANCIAL INFORMATION The condensed financial information for United Bancorp, Inc. is summarized below.\nREPORT OF INDEPENDENT AUDITORS United Bancorp, Inc. and Subsidiary\nShareholders and Board of Directors United Bancorp, Inc. Tecumseh, Michigan\nWe have audited the accompanying consolidated balance sheet of United Bancorp, Inc. and Subsidiary 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Bancorp, Inc. 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 and 14 to the Consolidated Financial Statements, the Company changed its method of accounting for loan impairment in 1995 and its methods of accounting for securities, income taxes and postretirement benefits other than pensions in 1993.\n\/S\/ Crowe Chizek and Company LLP ----------------------------------- Crowe, Chizek and Company LLP Grand Rapids, Michigan January 19, 1996\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information required by this item is inapplicable, and therefore has been omitted.\nPART III\nSome information called for by the items within this part is contained in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, and is incorporated herein by reference, as follows:\nInformation appearing in Note 12 on Page 34 of Item 8 and on Page 11 of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, is incorporated herein by reference in response to this item.\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:\n2. Not applicable.\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(b) No reports on Form 8-K were filed during the quarter ending December 31, 1995.\n(c) Listing of Exhibits (numbered as in Item 601 of Regulation S-K):\n(d) All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUnited Bancorp, Inc.\n\/S\/ David S. Hickman March 13, 1996 ---------------------------------- -------------- David S. Hickman, President and Date 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 and in the capacities indicated, on March 13, 1996.\nS\/ John J. Wanke \/S\/ Dale L. Chadderdon - ---------------------------------- ---------------------------------- John J. Wanke Dale L. Chadderdon,Senior Vice Executive Vice President, Director President, Secretary and Treasurer\n\/S\/ David N. Berlin \/S\/ L. Donald Bush - ---------------------------------- ---------------------------------- David N. Berlin, Director L. Donald Bush, Director\n\/S\/ Linda J. Herrick \/S\/ Patrick D. Farver - ---------------------------------- ---------------------------------- Linda J. Herrick, Director Patrick D. Farver, Director\n\/S\/ James C. Lawson \/S\/ Charles E. Gross - ---------------------------------- ---------------------------------- James C, Lawson, Director Charles E. Gross, Director\n\/S\/ David E. Maxwell \/S\/ Ann Hinsdale Knisel - ---------------------------------- ---------------------------------- David E. Maxwell, Director Ann Hinsdale Knisel, Director\n\/S\/ Richard Whelan \/S\/ Donald J. Martin - ---------------------------------- ---------------------------------- Richard Whelan, Director Donald J. Martin, Director\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION PAGE NO. - ----------- ----------- --------\nEX-21 Subsidiaries\nEX-27 Financial Data Schedule","section_15":""}
{"filename":"735961_1995.txt","cik":"735961","year":"1995","section_1":"Item 1 Business - --------------------------------------------------------------------------------\nGeneral Westport Bancorp, Inc. (\"Bancorp\") was organized in 1983 as a Delaware corporation for the purpose of becoming the holding company of The Westport Bank & Trust Company (the \"Bank\") (collectively, the \"Company\"), a Connecticut-chartered bank and trust company headquartered in Westport, Connecticut, the deposit accounts of which are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (\"FDIC\"). Bancorp is regulated and examined by the Federal Reserve Board. The Bank is regulated by the FDIC and the Banking Commissioner of the State of Connecticut (the \"Commissioner\").\nBancorp's principal asset is all of the capital stock of the Bank and Bancorp's principal business is the business of the Bank. Bancorp is a separate legal entity from the Bank; the principal sources of its revenues on an unconsolidated basis are interest and other income received from its investments, including dividends from the Bank.\nThe Bank was originally chartered in 1852. Bancorp acquired the Bank on October 9, 1984.\nThe principal business of the Bank is to provide a broad range of corporate and individual banking products and services, including commercial banking, residential mortgage origination, commercial lending, commercial real estate lending, retail banking and trust services to individuals, and small to medium size businesses. The Bank's operations are conducted from its home office in Westport, Connecticut and from branch offices located in the mid-Fairfield County, Connecticut communities of Weston, Fairfield, Redding\/Georgetown, Greens Farms and Saugatuck. In addition, the Bank's operations center is located in Shelton, Connecticut.\nPrincipal Market Area The Bank's branch office network currently consists of six banking offices, including its main office. The towns in the Bank's market area, which consists principally of Fairfield County, Connecticut, are primarily bedroom communities of New York City, although Stamford, Bridgeport and Norwalk are commercial centers. Two major highways (Interstate 95 and the Merritt Parkway) traverse the area and a number of regional airports are located within Fairfield County. Those towns bordering I-95 have had substantial commercial office development, particularly near the major highway intersections. This market is also accessible by railway.\nLending Activities The Bank's principal lending activities include the origination of conventional and construction mortgage loans on residential, one-to-four family real properties, as well as commercial and real estate loans to businesses. The Bank also provides consumer loans, which include home equity credit lines, installment loans (such as home improvement, automobile and personal loans) and checking account related loans. See Item 6 of this Form 10-K.\nResidential Mortgage Loans. While the Bank is authorized to make loans secured by real estate located either within or outside the State of Connecticut, its past and present policy is to concentrate on loans secured by properties located within Connecticut, particularly in Fairfield County. Less than 2% of the Bank's total residential real estate loan portfolio at December 31, 1995 represented loans on properties located outside the State of Connecticut.\nThe Bank currently offers adjustable and fixed rate mortgages, the majority of which are originated to conform with the existing criteria for sale in the secondary mortgage market. Points are generally charged on residential mortgage loans. Interest rate adjustments on adjustable rate loans are generally determined by reference to rates on one-year Treasury obligations published by the Federal Reserve Board.\nCommercial Mortgage Loans. The Bank's commercial mortgage investments consist of loans made on commercial property and multi-family homes (more than four units). In general, the Bank lends up to 75% of the appraised value of a commercial property. Status reports on all commercial mortgage loans are reviewed by the Bank's Management Loan Committee and Directors' Loan Committee on a regular basis. Given the general economic downturn and the dramatic decline since the late 1980's in real estate values in New England, and in Connecticut in particular, real estate development and construction within the Bank's market area has dramatically declined over the past several years. During 1995 and 1994, this trend showed signs of stabilizing and the Bank experienced some increased demand for commercial mortgage loans.\nCommercial Loans. The Bank has been engaged in commercial lending activity for more than fifty years. Term loans to finance machinery, equipment or vehicle purchases, short term loans for working capital needs, revolving credit supported by accounts receivable and\/or inventory, and lines of credit are representative of these types of loans in the Bank's portfolio. These loans are generally secured by collateral other than real property; less than 11% of the Bank's commercial loan portfolio at December 31, 1995 was unsecured.\nHome Equity Loans. Home equity loans consist of lines of credit, which are collateralized by first or second mortgages on residential one-to-four family real properties.\nConsumer Loans. Consumer loans consist primarily of installment loans, which include home improvement loans, automobile loans, personal loans and checking account overdraft protection related loans.\nFDIC Loans. In the fourth quarter of 1992, the Bank purchased $18.8 million in performing commercial business loans from the FDIC, of which $12.6 million consisted of loans to businesses located in the Bank's primary market area of Fairfield County, with $6.2 million in the area immediately surrounding Westport. The loans were acquired at par value; the purchase\nwas funded from existing liquidity. The purchase agreement contained a three year provision (the \"put\"), which ended on December 7, 1995, that required the FDIC to repurchase any loans that became nonperforming, at a previously negotiated price plus sixty days of accrued interest. Losses resulting from repurchases during the three year period have been minimal due to the loans' performing status. At December 7, 1995, the outstanding balance of these loans retained by the Bank was $4.3 million.\nInterest Rates. Interest rates charged on loans are primarily determined by the Bank's cost of funds, comparable investment alternatives available to the Bank and competitive conditions.\nLoan Commitments. Commitments to extend commercial lines of credit and to make mortgage loans on residential and commercial real property are made for periods of up to 60 days from the date of commitment. Commitments on residential transactions are generally made at the market interest rate prevailing at the time the commitment is made to the customer. Commitments on commercial transactions are generally made at the market interest rate in effect on or immediately prior to the date of closing.\nDeposits and Other Sources of Funds Deposits have traditionally been the Bank's major source of funds for investments and lending and are expected to continue to be in the foreseeable future. The Bank also derives funds from scheduled loan principal payments, the sale of residential mortgage loans in the secondary market, loan prepayments, the sale or maturity of investment securities, interest income and fee income. Other sources of funds include the sale of investment securities to securities firms and correspondent banks under repurchase agreements, unsecured lines of credit with correspondent banks and secured lines of credit with the Federal Home Loan Bank. See Item 6 of this Form 10-K.\nDeposits. The Bank offers a wide range of retail and commercial deposit accounts designed to attract both short and long-term funds. It has been the Bank's policy to offer a variety of rates and types of deposit accounts to meet its customers' requirements. Demand deposits, certificates of deposit, regular savings, money market deposits and NOW checking accounts have been the primary source of deposit funds. Certificates of deposit currently offered by the Bank have maturities which range from seven days to five years.\nThe Bank encounters competition for deposits from other community banks, the branch offices of larger commercial banks and thrift institutions. The Bank also competes for interest-bearing funds with securities firms, mutual funds and issuers of commercial paper and other securities. Bank management anticipates that competition for deposits in the Bank's market area will continue to increase in the foreseeable future due to competition from securities firms, mutual funds, and as other banks enter the Bank's market area as a result of changes in the interstate banking law.\nTrust Operations At December 31, 1995, the Bank's Trust department held, for the account of others, assets under trust management and in custodial accounts having a market value of $548.5 million. As allowed by state law, the Bank acts as executor and administrator of decedents' estates, as trustee of inter-vivos and testamentary trusts, as guardian and conservator of estates of minors and incapable persons, as custodian of funds, as investment advisor and as trustee of employee benefit plans. From its trust and related activities, the Bank generates substantial fee income. In the trust business, the Bank competes with commercial banks, located both in and out of state, and with individuals and entities appointed to act under testamentary and other instruments as fiduciaries, investment managers and financial advisors. See Item 6 of this Form 10-K.\nEmployees At December 31, 1995, the Bank had a total of 133 employees, 105 on a full-time basis and 28 on a part-time basis. Management considers the Bank's relations with its employees to be good. The Bank's employees are not represented by any collective bargaining group.\nCompetition Competition in the financial services industry in the Bank's market area is strong. Numerous commercial banks, savings banks and thrift institutions maintain home offices in the area and banks headquartered elsewhere maintain offices in the area. Commercial banks, savings banks, thrift institutions, mutual funds, mortgage brokers, finance companies, credit unions, insurance companies, securities firms and private lenders compete with the Bank for deposits, loans and employees. Many of these competitors have far greater resources than the Bank does and are able to conduct more intensive and broader based promotional efforts to reach both commercial and individual customers.\nChanges in the financial services industry resulting from fluctuating interest rates, technological changes and deregulation have resulted in increased competition, merger activity, failures among banking institutions and customer awareness of product and service differences among competitors.\nRegulation and Supervision As a Connecticut-chartered state bank whose deposits are insured by the FDIC, the Bank is subject to extensive regulation and supervision by both the Commissioner and the FDIC. The Bank is also subject to various Federal Reserve Board regulatory requirements applicable to FDIC insured financial institutions. As a bank holding company, Bancorp is regulated by the Federal Reserve Board. Such governmental regulation is intended to protect depositors, not stockholders.\nConnecticut Regulation. As a state-chartered capital stock bank, the Bank is subject to the applicable provisions of Connecticut law and the regulations adopted thereunder by the Commissioner. The Commissioner administers Connecticut banking laws, which contain comprehensive provisions for the regulation of banks. The Bank derives its lending and investment powers from these laws, and is subject to periodic examination by, and reporting to, the Commissioner.\nConnecticut bank and trust companies are empowered by statute, subject to limitations expressed therein, to accept savings and time deposits, to offer checking accounts, to pay interest on such deposits and accounts, to make loans on residential and other real estate, to make consumer and commercial loans, to invest, with certain limitations, in equity securities and debt obligations of banks and corporations, to issue credit cards, and to offer various other banking services to their customers. Connecticut banking laws grant banks broad lending authority. Such authority is limited, however, to the extent that a bank's loans to any one obligor may not exceed 25%, if fully secured, and 15%, if not fully secured, of the total of a bank's equity capital and loan loss reserves.\nThe Connecticut Interstate Banking Act permits Connecticut banks and bank holding companies, with the approval of the Commissioner, to engage in stock acquisitions of banks and bank holding companies in other states with reciprocal legislation. Many states have such legislation. Before the Interstate Banking Act was adopted in March 1990, Connecticut banks and bank holding companies were allowed to engage in stock acquisitions with banks and bank holding companies in other New England states with reciprocal legislation, all of which have such legislation. See \"Recent Developments\" for a discussion of recent changes to the regulations relating to interstate banking and branching.\nSeveral interstate mergers involving large Connecticut banks with offices in the Bank's service area and banks headquartered out-of-state have been completed during recent years, resulting in increased competition for the Bank. A New York based institution acquired two failed institutions from the FDIC in the Bank's market area in 1991 and a New Jersey based institution acquired another bank, headquartered in the Bank's principal market, in 1993. During 1995 and early 1996, two of the largest commercial banks in the Bank's market area completed their merger, while numerous smaller institutions were acquired by larger in-state and out-of-state financial institutions.\nThe Bank is prohibited by Connecticut banking law from paying dividends except from its net profits, which are defined as the remainder of all earnings from current operations. The total of all dividends declared by the Bank in any calendar year may not, unless specifically approved by the Commissioner, exceed the total of its net profits for that year combined with its retained net profits from the preceding two years. These dividend limitations can affect the amount of dividends payable to Bancorp as the sole stockholder of the Bank, and therefore affect Bancorp's payment of dividends to its stockholders. During 1995, Bancorp resumed the payment of dividends after all regulatory restrictions were removed.\nUnder Connecticut banking law, no person may acquire the beneficial ownership of more than 10% of any class of voting securities of a bank chartered by the State of Connecticut or having its principal office in Connecticut or a bank holding company thereof, unless the Commissioner approves such acquisition.\nAny state-chartered bank meeting statutory requirements may, with the approval of the Commissioner, establish and operate branches in any town or towns within the state.\nDuring January 1996, representatives of the Commissioner completed a routine examination of the Bank as of October 30, 1995. Other than minor suggestions for improvements, there were no significant examination findings which are believed to have potentially negative implications for the Bank.\nFDIC Regulation. The deposit accounts of the Bank are insured by the Bank Insurance Fund of the FDIC to a maximum of $100,000 for each insured depositor. As an insured bank, the Bank is subject to supervision and examination by the FDIC and to FDIC regulations regarding many aspects of its business, including types of deposit instruments offered, permissible methods for acquisition of funds, and activities of subsidiaries and affiliates. The FDIC periodically examines insured institutions.\nIn December 1991, the Federal Deposit Insurance Act (\"FDIA\") was amended with the enactment of the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"). Provisions of FDIA, as amended, which may have a material effect on the Bank and Bancorp include, among others, the following:\n1. FDIA classifies banks in one of five categories according to capital levels. With respect to banks not meeting prescribed minimum capital levels, and depending on the extent to which a bank is undercapitalized, federal bank regulators may be required, in certain cases, to take corrective actions against the bank, including requiring an acceptable capital restoration plan or placing a bank into conservatorship or receivership. In addition, undercapitalized banks may be subject to certain restrictions on their activities and operations, including restrictions on asset growth, rates of interest paid on deposits, transactions with affiliates, engaging in material transactions not in the ordinary course of business, and other activities. See \"Prompt Corrective Action\" below.\n2. FDIA makes it more difficult for undercapitalized banks to borrow funds from the Federal Reserve's \"discount window\", thus possibly limiting or eliminating a source of liquidity for a bank. The Bank is approved to borrow funds from the \"discount window\".\n3. FDIA can result in higher deposit insurance premiums for banks under a \"risk-based\" premium determination, with possible negative effects on a bank's operating results and financial condition.\n4. FDIA limits, with certain exceptions, the ability of banks to engage in activities or make equity investments that are not permissible for national banks.\nIn addition, the FDIC has issued regulations providing for capital guidelines based upon the ratio of a bank's capital to total assets adjusted for risk. Under such regulations, a bank's risk-based capital ratio is calculated by dividing its qualifying total capital base by its risk-weighted assets. Banks are expected to meet a minimum Tier 1 capital to risk-weighted asset ratio of 4.00% and a total capital to risk-weighted asset ratio of 8.00%. At December 31, 1995, Bancorp's Tier 1 capital to risk-weighted asset ratio was 12.77%, and its total capital to risk-weighted asset ratio was 14.02%, well above the minimum requirements. There are no significant differences between Bancorp's and the Bank's capital ratios at December 31, 1995.\nPrompt Corrective Action. Pursuant to the FDIA, the federal banking agencies established for each capital measure levels at which an insured institution is deemed to be well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Federal banking agencies are required to take prompt corrective action with respect to insured institutions that fall below minimum capital standards. The degree of required regulatory intervention for institutions that are not at least adequately capitalized is tied to an insured institution's capital category, with increasing scrutiny and more stringent restrictions, including the appointment of a receiver, being imposed as an institution's capital declines. An insured institution that falls below the minimum capital standards must submit a capital restoration plan and could be subject to operating restrictions.\nThe prompt corrective action regulations are generally based upon an institution's capital ratios. Under the prompt corrective action regulation adopted by the FDIC, a bank will be considered to be (i) \"well-capitalized\" if the institution has a total risk-based capital ratio of 10% or greater, a Tier 1 or core capital to risk-weighted assets ratio of 6% or greater, and a leverage ratio of 5% or greater (provided that the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure); (ii) \"adequately capitalized\" if the institution has a total risk-based capital ratio of 8% or greater, a Tier 1 or core capital to risk-weighted assets ratio of 4% or greater, and a leverage ratio of 4% or greater (3% or greater if the institution is rated composite 1 under the CAMEL rating system in its most recent report of examination); (iii) \"undercapitalized\" if the institution has a total risk-based capital ratio that is less than 8%, a Tier 1 or core capital to risk-weighted assets ratio of less than 4%, or a leverage ratio that is less than 4% (3% if the institution is rated composite 1 under the CAMEL rating system in its most recent report of examination); (iv) \"significantly undercapitalized\" if the institution has a total risk-based capital ratio that is less than 6%, a Tier 1 or core capital to risk-weighted assets ratio that is less than 3%, or a leverage ratio that is less than 3%; and (v) \"critically undercapitalized\" if the institution has a ratio of tangible equity to total assets that is less than or equal to 2%. The prompt corrective action regulations also permit the FDIC to determine that a bank institution should be classified in a lower category based on other information, such as the institution's examination report, after written notice. Under the FDIC's prompt corrective action regulations, at December 31, 1995, the Bank was classified as well-capitalized based on its capital ratios.\nAn institution that is not well-capitalized is prohibited from accepting deposits through a deposit broker. However, an adequately capitalized institution can apply for a waiver to accept brokered deposits. Institutions that receive a waiver are subject to limits on the rates of interest they may pay on brokered deposits. Undercapitalized institutions are prohibited from offering rates of interest on insured deposits that significantly exceed the prevailing rate in their normal market area or the area in which the deposits would otherwise be accepted. Institutions classified as undercapitalized are precluded from increasing their assets, acquiring other institutions, establishing additional branches, or engaging in new lines of business without an approved capital plan and an agency determination that such actions are consistent with the plan. Institutions that are significantly undercapitalized may be required to take one or more of the following actions: (i) raise additional capital so that the institution will be adequately capitalized; (ii) be acquired by, or combined with, another institution if grounds exist for appointing a receiver; (iii) refrain from affiliate transactions; (iv) limit the amount of interest paid on deposits to the prevailing rates of interest in the region where the institution is located; (v) further restrict asset growth; (vi) hold a new election for directors, dismiss any director or senior executive\nofficer who held office for more than 180 days immediately before the institution became undercapitalized, or employ qualified senior executive officers; (vii) stop accepting deposits from correspondent depository institutions; and (viii) divest or liquidate any subsidiary that the FDIC determines is a significant risk to the institution. Critically undercapitalized institutions are subject to additional restrictions.\nAny company that controls an \"undercapitalized\" institution, must guarantee that the institution will comply with the plan and provide appropriate assurances of performance in connection with the submission of a capital restoration plan by the depository institution. The aggregate liability of any such controlling company under such guaranty is limited to the lesser of (i) 5% of the institution's assets at the time it became undercapitalized; or (ii) the amount necessary to bring the institution into capital compliance at the time the institution fails to comply with the terms of its capital plan. If the Bank were to become \"undercapitalized\", Bancorp would be required to guarantee performance of any capital restoration plan submitted as a condition to FDIC approval of that plan pursuant to the FDIA.\nSafety and Soundness Guidelines. The federal banking agencies have prescribed safety and soundness guidelines relating to (i) internal controls, information systems, and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate exposure; (v) asset growth; and (vi) compensation and benefit standards for officers, directors, employees and principal shareholders. Such guidelines impose standards based upon an institution's asset quality and earnings. The guidelines are intended to set out standards that the agencies will use to identify and address problems at institutions before capital becomes impaired. Institutions are required to establish and maintain a system to identify problem assets and prevent deterioration of those assets in a manner commensurate with its size and the nature and scope of their operations. Furthermore, institutions must establish and maintain a system to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves in a manner commensurate with their size and the nature and scope of its operation.\nUnder the guidelines, an institution not meeting one or more of the safety and soundness guidelines is required to file a compliance plan with the appropriate federal banking agency. In the event that an institution, such as the Bank, were to fail to submit an acceptable compliance plan or fail in any material respect to implement an accepted compliance plan within the time allowed by the agency, the institution would be required to correct the deficiency and the appropriate federal agency would be authorized to: (1) restrict asset growth; (2) require the institution to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the institution may pay; or (4) take any other action that would better carry out the purpose of the corrective action. The Bank was in compliance with all such guidelines as of December 31, 1995.\nCommunity Reinvestment Act. Under the Community Reinvestment Act (the \"CRA\") and the implementing FDIC regulations, which were amended in 1995 to provide for a performance-based evaluation system, the Bank has a continuing and affirmative obligation to help meet the credit needs of its local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of the Bank. The CRA requires that the Board of Directors of the Bank adopt a CRA statement for each assessment area that, among other things, describes its efforts to help meet community credit needs and the specific types of credit that the institution is willing to extend. The FDIC and the Federal Reserve Board are required to take\ninto account the Bank's record of meeting the credit needs of its community in determining whether to grant approval for certain types of applications including mergers and acquisitions.\nUnder CRA, the federal banking agencies established the following ratings: (i) \"outstanding\" - an institution in this group has an outstanding record of, and is a leader in, ascertaining and helping to meet the credit needs of its entire delineated community, including low and moderate income neighborhoods, in a manner consistent with its resources and capabilities, (ii) \"satisfactory\" - an institution has a satisfactory record of ascertaining and helping to meet the credit needs of its entire delineated community including low and moderate income neighborhoods, in a manner consistent with its resources, (iii) \"needs to improve\" - an institution in this group needs to improve its overall record of ascertaining and helping to meet the credit needs of its entire delineated community, including low and moderate income neighborhoods, in a manner consistent with its resources, and (iv) \"substantial noncompliance\" - an institution in this group has a substantially deficient record of ascertaining and helping to meet the credit needs of its entire delineated community, including low and moderate income neighborhoods, in a manner consistent with its resources and capabilities. The Bank's current CRA rating is satisfactory.\nFederal Reserve System. Pursuant to the Depository Institutions Deregulation and Monetary Control Act of 1980 (the \"Deregulation Act\"), the Federal Reserve Board adopted regulations that require the Bank to maintain reserves against its transaction accounts and non-personal time deposits. At December 31, 1995, these regulations generally require that reserves of 3% be maintained for aggregate transaction accounts of up to $52.0 million and that reserves of 10% be maintained against the portion of transaction accounts in excess of that amount.\nThe Deregulation Act also gives the Bank authority to borrow from the Federal Reserve Bank's \"discount window\".\nThe Federal Reserve Board has established capital adequacy guidelines for bank holding companies that are similar to those required by the FDICIA. Bank holding companies are currently required to comply with the FDICIA's risk-based capital and minimum leverage capital requirements.\nBancorp is subject to regulation by the Federal Reserve Board as a registered bank holding company. The Bank Holding Company Act of 1956, as amended (the \"BHCA\"), under which Bancorp is registered, limits the types of companies which Bancorp may acquire or organize and the activities in which it or they may engage. In general, Bancorp and its subsidiaries are prohibited from engaging in, or acquiring direct control of any company engaged in, non-banking activities unless such activities are so closely related to banking or managing or controlling banks as to be a proper incident thereto. At this time, Bancorp has not determined which, if any, of these or other permissible non-banking activities it might seek to engage in.\nUnder BHCA, Bancorp is required to obtain the prior approval from the Federal Reserve Board to acquire, with certain exceptions, more than 5% of the outstanding voting stock of any bank or bank holding company, to acquire all or substantially all of the assets of a bank or to merge or consolidate with another bank holding company.\nUnder BHCA, Bancorp and the Bank and any other subsidiaries are prohibited from engaging in certain tying arrangements among Bancorp and its subsidiaries relating to any extension of\ncredit or provision of any property or services to third parties. The Federal Reserve Board relaxed some of these restrictions in 1994. The Bank is also subject to certain restrictions imposed by the Federal Reserve Board on extending credit to Bancorp or any of its subsidiaries, or on making investments in the stock or securities thereof, and on taking such stock or securities as collateral for loans to any borrower.\nBancorp is required under BHCA to file annually with the Federal Reserve Board a report on its operations. Bancorp and the Bank and any other subsidiaries are subject to examination by the Federal Reserve Board.\nPursuant to the Change in Bank Control Act of 1978, as amended, any person must give 60 days notice to the Federal Reserve Board prior to acquiring control of a bank holding company such as Bancorp. Control is defined as ownership of 25% of any class of voting stock of a bank holding company, or the power to direct the management or policies of the bank holding company. Control is presumed upon ownership of 10% or more of any class of voting stock if (i) the bank holding company's shares are registered pursuant to Section 12 of the Securities Exchange Act of 1934 as amended (as are Bancorp's shares of Common Stock), or (ii) the acquiring party would be the largest stockholder of the class of voting stock of the bank holding company. The statute and underlying regulations authorize the Federal Reserve Board to disapprove a proposed transaction on certain specified grounds.\nIn addition to the Change in Bank Control Act, prior approval by the Federal Reserve Board is required under the BHCA for any \"company\" to become a bank holding company and to become subject to regulation as such by the Federal Reserve Board. A company may become a bank holding company with Federal Reserve Board approval if the company controls a bank or a bank holding company. A \"company\" includes certain trusts, partnerships, corporations and other business entities, but does not include individuals. For purposes of BHCA, control is defined as (i) ownership, control or the power to vote 25% or more of any class of voting securities of a bank or a bank holding company; (ii) control in any manner of the election of a majority of the directors of a bank or a bank holding company; or (iii) direct or indirect exercise of a controlling influence over the management or policies of a bank or a bank holding company, as determined by the Federal Reserve Board. A company that is required to obtain prior approval under BHCA to become a bank holding company is exempt from the prior approval requirement of the Change in Bank Control Act.\nRecent Developments. In 1994, Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act, which will remove restrictions on interstate branching and interstate bank acquisitions. In connection with the Riegle-Neal Act, the State of Connecticut has enacted legislation that permits merger transactions between a Connecticut and an out-of-state bank beginning on September 25, 1995. Moreover, restrictions on interstate branching will be removed effective on January 1, 1997.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties - --------------------------------------------------------------------------------\nBancorp does not directly own or lease any real property. It uses the premises and equipment of the Bank, without payment of rental fees to the Bank. The table below sets forth certain information relating to the Bank's properties:\nItem 3","section_3":"Item 3 Legal Proceedings - --------------------------------------------------------------------------------\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to their business, to which Bancorp or the Bank is a party or to which any of their property is subject.\nItem 4","section_4":"Item 4 Submission of Matters to a Vote of Security Holders - --------------------------------------------------------------------------------\nNo matter was submitted to a vote of Bancorp's security holders during the fourth quarter of 1995.\nPART II Item 5","section_5":"Item 5 Market For Bancorp's Common Equity and Related Stockholder Matters - --------------------------------------------------------------------------------\nBancorp's Common Stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol \"WBAT\". The following table sets forth the high and low bid prices of the Common Stock as reported by NASDAQ for the periods indicated. At December 31, 1995, the Company had approximately 658 stockholders of record and 5,433,665 outstanding shares of Common Stock. The 658 estimated stockholders does not reflect the number of persons or entities who hold their stock in nominee or \"street\" name through various brokerage firms.\nPrice Range ---------------- Dividends Dividends Fiscal Year High Low Declared Paid (1) - -------------------------------------------------------------------------------\n1995 First Quarter $ 5 $ 2 7\/8 --- --- Second Quarter 6 4 $.02 $.02 Third Quarter 5 3\/4 4 1\/2 $.02 $.02 Fourth Quarter 7 4 3\/4 $.05 $.025\n1994 First Quarter $ 3 1\/2 $ 2 1\/2 --- --- Second Quarter 3 1\/4 2 1\/4 --- --- Third Quarter 3 1\/2 2 1\/4 --- --- Fourth Quarter 3 1\/2 2 3\/4 --- ---\n(1) See Item 1 \"Regulation and Supervision -- Connecticut Regulation\" and Item 7 \"Liquidity\" for discussion regarding restriction on payment of dividends.\nItem 6","section_6":"Item 6 Selected Consolidated Financial Data - --------------------------------------------------------------------------------\nThe selected consolidated financial information of the Company set forth below has been derived from the Company's audited consolidated financial statements for such periods. This selected financial information should be read in conjunction with the Company's consolidated financial statements and related notes included elsewhere herein. Certain prior year amounts have been reclassified to conform with the 1995 presentation.\nItem 7","section_7":"Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations - --------------------------------------------------------------------------------\nOverview The following is a discussion and analysis of the Company's financial condition at the end of 1995 and 1994 and of the results of its operations for the last three years. This section should be read in conjunction with the consolidated financial statements included in Item 8.","section_7A":"","section_8":"Item 8 Financial Statements and Supplementary Data - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nWESTPORT BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 Summary of Significant Accounting and Reporting Policies\nPrinciples of Consolidation The consolidated financial statements include the accounts of Westport Bancorp, Inc. (\"Bancorp\") and its subsidiary, The Westport Bank & Trust Company (the \"Bank\") (collectively, the \"Company\"). All significant intercompany accounts and transactions have been eliminated.\nBasis of Financial Statement Presentation The consolidated financial statements have been prepared in accordance with generally accepted accounting principles within the banking industry.\nIn preparing the financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statement of condition and the reported amounts of revenues and expenses during the reporting period. Actual future results could differ significantly from these estimates. Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired through foreclosures or in satisfaction of loans. In determining the allowance for loan losses and the valuation of other real estate owned, independent appraisals are obtained for significant properties collateralizing loans or other real estate owned. Future additions to the allowance for loan losses or write-downs of other real estate owned may be necessary based on changes in economic conditions, particularly in the Bank's service area, Fairfield County, Connecticut. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses and the carrying value of other real estate owned. Such agencies may recommend that the Bank recognize additions to the allowance for loan losses or the reserve for other real estate owned based on their judgments and information available to them at the time of their examinations.\nSecurities Effective January 1, 1994, the Bank adopted Financial Accounting Standards Board's (\"FASB\") Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities\". SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Adoption of SFAS 115 did not have a material effect on the financial statements.\nIn accordance with SFAS 115, at the time of purchase, investment securities are classified as available for sale if the securities are purchased for asset\/liability management and liquidity purposes, or as held to maturity if management has the intent and ability to hold the securities to maturity. However, in the fourth quarter of 1995, the FASB provided companies with a one time opportunity to reclassify securities between the available for sale portfolio and the held to\nmaturity portfolio. The Company took advantage of this opportunity and reclassified its entire $42,459,000 held to maturity portfolio to the available for sale portfolio. This reclassification resulted in the transfer of $146,000 to the unrealized depreciation on the securities available for sale component of stockholder's equity, before the related tax effect. This reclassification is not reflected in the consolidated statement of cash flows because no cash was involved.\nSecurities in the available for sale portfolio are carried at fair value, with unrealized gains and losses net of tax, adjusted for the amortization of premiums or accretion of purchase discounts, recorded in a separate component of stockholders' equity. Gains and losses on the sale of securities in the available for sale portfolio are determined by specific identification and are included in operations.\nSecurities which are classified as held to maturity are stated at cost, adjusted for amortization of premiums or accretion of discounts to the date of maturity or earlier call date or, in the case of mortgage-backed securities, over the estimated life of the security. The Company has the ability and intention to hold these investments until maturity.\nIf a security held in either the available for sale portfolio or held to maturity portfolio has experienced a decline that is other than temporary, it is written down to estimated fair value through a charge to operations.\nPrior to the adoption of SFAS 115 on January 1, 1994, securities available for sale were carried at the lower of aggregate cost or market while securities held to maturity were carried at cost. In both cases, cost was adjusted for the amortization of premiums or accretion of discount.\nLoans Effective January 1, 1995, the Bank adopted FASB's Statement of Financial Accounting Standards No. 114 (\"SFAS 114\"), \"Accounting by Creditors for Impairment of a Loan\", and Statement of Financial Accounting Standards No. 118 (\"SFAS 118\"), \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\". SFAS 114 and 118 address the accounting by creditors for impairment of certain loans and the recognition of interest income on these loans and requires that impairment of certain loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of collateral. The adoption did not materially affect the Company's consolidated financial statements or the amount of the allowance for loan losses.\nInterest income on loans is accrued based on rates applied to principal amounts outstanding and includes loan fees, net of direct origination costs, which are amortized over the term of the loan using the interest method. The accrual of interest is discontinued when: 1) it appears that future collection of interest or principal may be doubtful, or 2) when principal or interest is due and remains unpaid for ninety days or more, unless the loan is both well secured and in the process of collection. At the time a loan is placed on nonaccrual status, interest accrued but not collected is generally reversed. Nonaccrual loans that commence repayment are returned to accrual status only when, in management's opinion, there has been demonstrated performance for a reasonable period and continued timely repayment according to loan terms is reasonably\nassured. Restructured loans represent loans formally renegotiated as to maturity, or at interest rates lower than market rates at the time of restructure. To the extent these loans are currently performing and the interest rate remains below market, they are presented as impaired accruing loans and are included in the consolidated financial statements as nonperforming assets.\nAllowance for Loan Losses The provision for loan losses is the amount deemed appropriate by management to maintain the allowance for loan losses at a level adequate to absorb probable losses in the loan portfolios. The allowance for loan losses is based on estimates; actual losses may vary from the current estimates. In estimating losses, consideration is given to the performance of the loan, the financial condition of the borrower or guarantor, an analysis of the borrower's cash flow, estimates of the current value of the underlying collateral based on appraisals or recent sale prices (net of costs of disposal), the overall risk characteristics of the Company's portfolios, past credit experience, current economic and real estate market conditions, and other relevant factors. Management monitors these factors and adjustments are reported in earnings in the period in which they become known.\nWhen losses on specific loans are judged by management to be certain, the portion deemed uncollectible is charged to the allowance for loan losses. Subsequent recoveries, if any, are credited to the allowance.\nIn accordance with SFAS 114 and 118, effective January 1, 1995 the Company revised the method by which the allowance for loan losses is determined for impaired loans. The impact of this change was not material.\nMortgage Banking Activities The Bank originates residential mortgage loans, some of which are held in portfolio and others of which are sold to investors. Loans originated for sale but not yet sold are carried at the lower of cost or market. Origination and commitment fees, net of direct origination costs, relating to sold loans are recognized as a component of the gain on loan sales. The Bank serviced, on behalf of investors, approximately $50.7 million, $41.3 million and $45.9 million of residential mortgage loans at December 31, 1995, 1994 and 1993, respectively.\nIn May 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 122 (\"SFAS 122\"), \"Accounting for Mortgage Servicing Rights\". SFAS 122 addresses the accounting for mortgage servicing rights for purchased as well as originated mortgages by a servicer. Additionally, SFAS 122 requires the capitalization of the fair value of mortgage servicing rights and amortization of these rights in proportion to the net servicing income over the period during which servicing income is expected. The Company adopted SFAS 122 in the fourth quarter of 1995. The adoption of SFAS 122 resulted in the recognition of a servicing asset of $171,000, which amount is included in 1995 loan sale gains on the statement of income.\nOther Real Estate Owned Other real estate owned (\"OREO\") consists of properties acquired through foreclosure. OREO properties are recorded at the lower of cost or fair value, less estimated disposal costs, at the date transferred to OREO. Losses arising at the time of transfer to OREO are charged against the allowance for loan losses. Subsequent write-downs of the carrying value of these properties may be required to reflect the properties at the lower of cost (market value at the date of transfer to OREO) or market value and are charged to operations. Realized gains and losses from the sale of OREO are also included in operations. Transfers of loans to OREO of $450,000 and $524,000 in 1994 and 1993, respectively, are not reflected in the consolidated statement of cash flows because no cash was involved in these transfers. No loans were transferred to OREO during 1995. The 1994 transfer of an OREO property, valued at $1,349,000, to bank-owned premises is also not reflected in the consolidated statement of cash flows because no cash was involved in the transfer.\nPremises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on the straight-line method over the estimated useful life of each type of asset, ranging from 3 to 30 years, or the lease term, if shorter.\nIncome Taxes In January 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\". The adoption of SFAS 109 changed the Company's method of accounting for income taxes from the deferred method (APB Opinion No. 11) to an asset and liability approach. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities. Adoption of SFAS 109 had no effect on the Company's consolidated financial statements due to the tax position of the Company at that time.\nEarnings Per Share Primary and fully diluted earnings per share were computed by dividing earnings (adjusted, if applicable) by the weighted average number of common shares and common share equivalents outstanding. For primary earnings per share, common share equivalents are computed using the average closing price of the Company's common stock for the period. For fully diluted earnings per share, common share equivalents are computed using the closing price of the Company's common stock at the end of the period. Fully diluted earnings per share were not applicable in 1994 and 1993.\nFor the year ended December 31, 1995 and 1994, the computation includes 4,706,250 and 3,148,913 weighted average common shares outstanding and 1,483,337 and 2,787,921 weighted average common equivalent shares, (fully diluted for 1995), respectively, computed under the treasury stock method. The earnings per share computations also include 4,279,712 and 4,445,000 weighted average common shares in 1995 and 1994, respectively, issuable upon the adjusted conversion of preferred stock. Adjusted earnings consist of net income and the interest effect of the assumed reduction in short-term borrowings, computed under the treasury stock method.\nOther For purposes of presenting the consolidated statements of cash flows, cash equivalents include due from banks, interest-bearing deposits with banks and Federal funds sold, all of which have original maturities of three months or less.\nTrust income is recorded on an accrual basis. Assets held in a fiduciary or agency capacity for customers are not included in the consolidated statements of condition since such items are not assets of the Bank.\nCertain amounts from prior years have been reclassified to conform with the 1995 presentation.\nNote 2 Regulatory Matters\nThe Federal Reserve Board and the Federal Deposit Insurance Corporation (FDIC) require bank holding companies and banks, respectively, to comply with capital guidelines based upon the ratio of capital to total assets adjusted for risk.\nThe following summarizes the minimum capital requirements and Bancorp's capital position (there are no significant differences between the Bank's and Bancorp's capital ratios) at December 31, 1995.\nRegulatory Bancorp Minimum - -------------------------------------------------------------------------------- ($ in thousands)\nTier 1 leverage ratio 8.18% 3.00%(1) Tier 1 leverage capital $23,903 $8,766\nTier 1 risk-based ratio 12.77% 4.00% Tier 1 risk-based capital $23,903 $7,487\nTotal risk-based ratio 14.02% 8.00% Total risk-based capital $26,249 $14,973\nRisk-weighted assets $187,167 ---\n(1) An additional 1% to 2% and the corresponding additional capital is required for all but the most highly rated institutions.\nThe Federal Deposit Insurance Act (\"FDIA\"), as amended by the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), classifies banks in one of five categories according to capital levels. At December 31, 1995, the Company was \"well capitalized\" under FDIA, as amended, based upon the above capital ratios. Deterioration of economic conditions and real estate values could adversely affect future results, leading to increased levels of loan charge-offs, provision for loan losses and nonaccrual loans, affecting the ability of the Company to maintain the well capitalized classification, and resulting in reductions in income and total capital.\nNote 3 Investment Securities\nIn accordance with SFAS 115 and as discussed in Note 1, during the fourth quarter of 1995, the Company's held to maturity portfolio was reclassified as available for sale.\nSecurities Available for Sale The aggregate amortized cost and estimated market value of securities available for sale at December 31, 1995 and 1994 were as follows:\nSales of securities available for sale during 1995 consisted of $28.8 million of U.S. Government Agency securities. During 1994, sales of securities from the available for sale portfolio consisted of $4.2 million of U.S. Government Agency securities. Gains of $59,000 and $3,000 for 1995 and 1994, respectively, were realized on the sales of these securities. Losses of $288,000 were realized on the sale of securities during 1995. No losses were realized in 1994 from sales of securities.\nThe following represents the contractual maturities and weighted average yields of securities available for sale at December 31, 1995. Expected maturities may differ from contractual maturities due to prepayments.\nSecurities Held to Maturity The table below summarizes the aggregate financial statement carrying value and market value of securities held to maturity at December 31, 1994. The Company had no securities in the held to maturity portfolio at December 31, 1995.\nNote 4 Restricted Assets\nAt December 31, 1995, securities with a carrying value of $12,652,000 were pledged to secure treasury deposits, municipal deposits and repurchase agreements.\nCash and due from banks of $5,488,000 was subject to withdrawal and usage restrictions as of December 31, 1995, as a result of Federal Reserve requirements to maintain certain average balances.\nNote 5 Loans\nThe composition of the Bank's loan portfolio at December 31, 1995 and 1994 was as follows:\nChanges in the allowance for loan losses for the years ended December 31, 1995, 1994 and 1993 were as follows:\nNonperforming assets at December 31, 1995 and 1994 were as follows:\n1995 1994 - ------------------------------------------------------------------------------- ($ in thousands) Loans 90 days or more past due on accrual status: Mortgage: Secured by residential property $ 5 $ 78 Commercial and other --- --- Commercial --- 6 Home equity 149 102 Consumer and other 4 14 - ------------------------------------------------------------------------------- Total 158 200 - -------------------------------------------------------------------------------\nNonaccrual loans: Mortgage: Secured by residential property 85 2,659 Commercial and other 1,098 1,098 Commercial 813 500 Home equity --- 59 Consumer and other --- --- - ------------------------------------------------------------------------------- Total 1,996 4,316 - -------------------------------------------------------------------------------\nImpaired accruing loans 447 3,724 - -------------------------------------------------------------------------------\nTotal nonperforming loans 2,601 8,240\nOther real estate owned --- 352 - -------------------------------------------------------------------------------\nTotal nonperforming assets $ 2,601 $ 8,592 ===============================================================================\nAt December 31, 1995, the recorded investment in loans for which impairment has been recognized in accordance with SFAS 114 and 118 totaled $2,443,000, of which $1,996,000 were nonaccrual loans. At December 31, 1995, the valuation allowance related to all impaired loans totaled $634,000 and is included in the allowance for loan losses on the statement of condition. For the year ended December 31, 1995, the average recorded investment in impaired loans was approximately $5.2 million. During 1995, total interest of $95,000 was recognized on accruing impaired loans.\nThe Bank would have recorded an additional $214,000, $183,500 and $382,000 of interest income in the years ended December 31, 1995, 1994 and 1993, respectively, if loans on nonaccrual status at each year end had been current throughout the year. At December 31, 1995, the Bank has no commitments to lend additional funds to borrowers whose loans are classified as nonaccrual or impaired. The Bank would have recorded an additional $7,700, $27,000 and $113,000 of interest income during 1995, 1994 and 1993 if accruing restructured loans had made payments in accordance with the original repayment terms.\nCertain directors, executive officers and affiliates of the Bank had loans outstanding aggregating approximately $511,000 and $1,579,000, at December 31, 1995 and 1994,respectively. Such loans were made on substantially the same terms as comparable loans to others and were performing in 1995 and 1994. Changes in loans outstanding to such parties during 1995 and 1994 were as follows:\nDecember 31, 1995 1994 - ------------------------------------------------------------------------------- ($ in thousands)\nBalance, January 1, $ 1,579 $ 1,324 Additional loans 205 637 Loans repaid (1,273) (244) Other --- (138) - ------------------------------------------------------------------------------- Balance, December 31, $ 511 $ 1,579 ===============================================================================\nThe \"other\" amount primarily represents loans to directors and officers (including members of their immediate families or associates) who resigned, retired or changed qualifying employment status during the year ended December 31, 1994.\nNote 6 Premises and Equipment\nPremises and equipment and accumulated depreciation and amortization are summarized as follows:\nDecember 31, 1995 1994 - ------------------------------------------------------------------------------- ($ in thousands)\nLand $ 572 $ 572 Premises 3,817 3,847 Equipment 2,482 2,971 Leasehold improvements 1,018 1,027 - ------------------------------------------------------------------------------- Total 7,889 8,417 Less: Accumulated depreciation and amortization (2,956) (3,280) - ------------------------------------------------------------------------------- Premises and equipment - net $ 4,933 $ 5,137 ===============================================================================\nNote 7 Deposits and Short-term Borrowings\nDeposits by major classifications were as follows: December 31, 1995 1994 1993 - -------------------------------------------------------------------------------- ($ in thousands) Demand $ 78,421 $ 72,972 $ 57,479 NOW 47,816 51,861 55,047 Savings 45,455 56,854 61,944 Money market 22,141 27,541 28,393 Certificates of deposit and other 80,837 44,730 52,653 - -------------------------------------------------------------------------------- Total deposits $274,670 $253,958 $255,516 ================================================================================\nIncluded in the table above are certificates of deposit in denominations of $100,000 or more. These certificates and their remaining maturities were as follows:\nDecember 31, 1995 1994 - -------------------------------------------------------------------------------- ($ in thousands) Three months or less $34,733 $ 1,436 Three through twelve months 1,771 1,133 Over twelve months 1,150 1,568 - -------------------------------------------------------------------------------- Total $37,654 $ 4,137 ================================================================================\nInterest expense on certificates of deposit with denominations of $100,000 or more was $887,000, $138,000 and $125,000 in 1995, 1994, and 1993, respectively.\nShort-term borrowings aggregated $7,733,000 and $10,484,000 at December 31, 1995 and 1994, respectively. Such borrowings include securities sold under agreements to repurchase of $1,050,000 and $7,800,000 in 1995 and 1994, respectively, and U.S. Treasury note obligations related to treasury, tax and loan deposits in the amount of $1,683,000 in 1995 and $2,684,000 in 1994. The weighted average interest cost of short-term borrowings was 5.94% and 4.95% at December 31, 1995 and 1994, respectively, and the terms of the agreements ranged from one to seven days.\nIn addition to the securities sold under repurchase agreements and U.S. Treasury note obligations, the Bank entered into two unsecured Federal fund line of credit arrangements with correspondent banks totaling $5,000,000. At December 31, 1995, the outstanding balance of these lines was $5,000,000.\nDuring the second quarter of 1995, the Bank became a member of the Federal Home Loan Bank of Boston (\"FHLBB\"). Services offered by the FHLBB include an unsecured credit line of up to a maximum of 2% of the Bank's assets, and collateralized fixed and variable rate borrowings. At December 31, 1995 these available lines amounted to $17.1 million. The FHLBB also offers cash management services, investment services, as well as lower cost advances for affordable housing or community investment programs. During 1995, borrowings under these lines were immaterial. The Bank did not have any borrowings from the FHLBB at December 31, 1995.\nThe following table summarizes the average balances, weighted average interest rates and the maximum month end outstanding amounts of short-term borrowings for 1995, 1994 and 1993.\n1995 1994 1993 - -------------------------------------------------------------------------------- ($ in thousands) Federal funds purchased and securities sold under agreements to repurchase: Average balance $13,778 $ 6,172 $ 1,420 Weighted average interest rate 6.0% 4.5% 2.6% Maximum month end outstanding amount $28,230 $19,289 $ 3,648\nU.S. Treasury note obligation related to treasury, tax and loan deposits: Average balance $ 1,657 $ 668 --- Weighted average interest rate 5.6% 4.6% --- Maximum month end outstanding amount $ 3,613 $ 3,193 ---\nThe Bank paid approximately $5,670,000, $4,799,000 and $5,744,000 in interest on deposits and short-term borrowings during 1995, 1994 and 1993, respectively.\nNote 8 Commitments\nLong-term Leases All noncancellable leases are operating leases at December 31, 1995, 1994 and 1993. The Bank has leases for administrative and branch offices with terms (including renewal options) ranging from one to ten years. Under most lease arrangements, the Bank pays property taxes, insurance, maintenance and expenses related to the leased property. Total rental expense under operating leases was $779,000 in 1995, $761,000 in 1994 and $844,000 in 1993.\nMinimum future obligations on leases (including base rents and common area charges) in effect at December 31, 1995 were:\nOperating Leases - -------------------------------------------------------------------------------- ($ in thousands) 1996 $ 784 1997 753 1998 706 1999 710 2000 663 Thereafter 280 - -------------------------------------------------------------------------------- Total minimum obligations $3,896 ================================================================================\nEmployment Contracts At December 31, 1995, the Bank was committed under employment agreements with various key officers requiring aggregate annual salary payments of approximately $532,000 for the terms of the contracts which expire at various dates through 1998. These agreements provide that if the key officers are terminated following a change in control (as defined) of Bancorp, they are entitled to receive lump sum severance payments and to continue to participate in certain benefit plans for three years.\nNote 9 Stockholders' Equity\nPreferred Stock and Warrants In February 1992, Bancorp completed a private placement of 46,700 investment units (the \"Private Placement\"). Each unit consisted of 1 share of Series A Noncumulative Convertible Preferred Stock (each share being convertible into 100 shares of Common Stock) and 50 Warrants (each Warrant being exercisable commencing in 1994 for 1 share of Common Stock at an exercise price of $.75 per share). Holders of record of the Series A Preferred Stock are entitled to dividends, when and if declared by Bancorp's Board of Directors, at a rate to be determined by Bancorp's Board of Directors. Holders of shares of Series A Preferred Stock vote together as a class with holders of the Common Stock for the election of directors and all other matters as to which holders of the Common Stock are entitled to vote. Each share of Series A Preferred Stock is entitled to 100 votes. All warrants expire on December 31, 1996.\nDividends Connecticut banking law prohibits the Bank from paying dividends except from its net profits, which are defined as the remainder of all earnings from current operations. The total of all dividends declared by the Bank in any calendar year may not, unless specifically approved by the State of Connecticut Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. These dividend limitations can affect the amount of dividends payable to Bancorp as the sole stockholder of the Bank, and therefore affect Bancorp's payment of dividends to its stockholders.\nDividend Reinvestment and Stock Purchase Plan Bancorp introduced a Dividend Reinvestment and Stock Purchase Plan on January 1, 1989. Under the terms of the plan, participating stockholders were allowed to purchase additional shares of Common Stock by reinvesting their cash dividends. Such plan participants could also make optional cash payments, up to $3,000 per quarter, to purchase additional shares. Shares purchased through the plan directly from Bancorp were priced at 95% of the average market value at the time of purchase; shares purchased in the open market were priced at cost. Bancorp discontinued the Dividend Reinvestment and Stock Purchase Plan in 1996.\nStockholder Rights Offering In the fourth quarter of 1992, holders of Bancorp's Common Stock received rights to acquire additional shares of Common Stock. The rights entitled each shareholder to purchase one share of Common Stock for every two shares owned as of February 21, 1992. The purchase price was initially set at $1.50 per share and increased to $2.00 on December 1, 1992 and $3.00 on June 1, 1993. Prior to its expiration on May 31, 1994, the rights offering raised $1,117,000, net of expenses. Bancorp contributed a total of $1,000,000 of the net proceeds during 1993 and 1994 to the capital of the Bank.\nStock Option Agreements On December 17, 1992, Bancorp's Board of Directors conditionally granted certain executive officers options to purchase a total of up to 725,000 shares of Bancorp's Common Stock at an exercise price of $2.00 per share, which was the fair market value of the stock on that date. The grants became effective upon approval by the shareholders of Bancorp at the 1993 Annual Meeting of Bancorp's shareholders. These stock options become exercisable gradually over a five year period and expire within ten years following the date of the conditional grant. All unexpired options become immediately exercisable if a change in control (as defined) of Bancorp occurs.\nIncentive Stock Option Plans Under the 1995 Incentive Stock Option Plan (the \"1995 Plan\"), the Board of Directors may grant options to purchase a total of up to 200,000 shares of Bancorp's Common Stock to key employees of Bancorp and the Bank. Under the 1985 Incentive Stock Option Plan (the \"1985 Plan\"), for which the authority to grant options expired on December 31, 1995, the Board was authorized to grant options to purchase a total of up to 300,000 shares of Bancorp's Common Stock to key employees of Bancorp and the Bank. The exercise price of options granted under the Plans are set at the market price of Bancorp's Common Stock on the date of the grant. Each option may be exercised as to one-half of the total number of shares covered by such option after one year of continuous employment, and, as to the other one-half, after two years of continuous employment. Options, in both Plans, expire ten years after the date of their grant. No options have been granted under the 1995 Plan.\nActivity for the 1985 Plan for the years ended December 31, 1995, 1994 and 1993 was as follows:\n1995 1994 1993 - -------------------------------------------------------------------------------\nOptions outstanding, January 1, 276,550 274,310 129,310 Options granted 5,000 37,200 150,000 Options exercised (9,750) (17,500) --- Options canceled --- (9,960) (5,000) Options expired (4,850) (7,500) --- - ------------------------------------------------------------------------------- Options outstanding, December 31, 266,950 276,550 274,310 ===============================================================================\nOptions exercisable, December 31, 243,350 164,350 68,810 ===============================================================================\nPrice per share of options $2.00 $2.00 $2.00 outstanding, December 31, to to to $3.50 $19.75 $19.75 ===============================================================================\nAt the discretion of Bancorp's Board of Directors, all outstanding unexercisable options under the 1985 Plan may become exercisable if a change in control (as defined) of Bancorp occurs.\nNote 10 Income Taxes\nAt December 31, 1995, 1994 and 1993, the Company had recorded net deferred tax assets (included in Other Assets) of $2,772,000, $1,650,000 and $350,000, respectively, for anticipated future utilization of net operating loss carryforwards (\"NOL's\") and the tax effect of other temporary differences. At December 31, 1995, the Company has recognized substantially all of the financial statement benefit of its deferred tax assets.\nThe provision (benefit) for income taxes was comprised of the following:\nYears ended December 31, 1995 1994 1993 - --------------------------------------------------------------------------------\nFederal - current $ 103,000 $ 48,000 $ 23,000 State - current 14,000 16,000 75,000 Federal - deferred (benefit) (1,122,000) (1,300,000) (350,000) - -------------------------------------------------------------------------------- $(1,005,000) $(1,236,000) $(252,000) ================================================================================\nCash payments for income taxes were $111,000, $78,000 an $89,000 in 1995, 1994 and 1993, respectively.\nA reconciliation of the statutory federal income tax provision to the reported income tax benefit for the years ended December 31, 1995, 1994 and 1993 is as follows:\nIn addition, $470,000 and $256,000 of state taxes (net of the related federal tax benefit) were not provided in 1995 and 1994, respectively, because of the utilization of state NOL's.\nThe components of and changes in the deferred tax asset during 1995, 1994 and 1993, were as follows:\nAt December 31, 1995, the only temporary difference which gives rise to a significant portion of the tax effected temporary differences shown above was the loan loss allowance, which resulted in a deferred liability of approximately $340,000.\nAs of December 31, 1995, the Company has aggregate NOL's of approximately $5.9 million for federal purposes and $6.5 million for state purposes which are available to offset future income for tax return purposes. The NOL's are scheduled to expire as follows:\nFederal State - -------------------------------------------------------------------------------- 2006 - $5.8 million 1996 - $6.4 million 2007 - $0.1 million 1997 - $0.1 million\nNote 11 Employee Benefit Plans\nThe Bank has a qualified noncontributory defined benefit pension plan (the \"Pension Plan\") covering all employees over the age of 21 who have worked at least 1,000 hours per year. The Pension Plan was temporarily frozen, effective January 1, 1992, resulting in no additional benefits for future service since that date. The Bank also has a non-qualified supplemental executive retirement plan (the \"Supplemental Plan\") for certain senior officers. Under the terms of the Supplemental Plan, if participants are terminated on or after their early retirement date following a change in control (as defined) of Bancorp, they are entitled to receive benefits which amount to 70% of average annual compensation, reduced by a factor for age and any pension benefits. During 1995, several participants were discontinued from the Supplemental Plan, resulting in a curtailment gain.\nThe following table sets forth the funded status of the plans and the amounts shown in the accompanying consolidated statements of condition at December 31, 1995 and 1994:\nPension (benefit) expense for 1995, 1994 and 1993 included the following components:\nKey assumptions used in the above calculations at December 31, 1995, 1994 and 1993 were as follows:\nPension Plan assets are primarily invested in fixed income and equity securities. The net unrecognized loss from past experience different than assumed is being amortized on a straight line basis over 12 years. The Bank uses the straight-line method of amortization for prior service cost (over 10.8 years) and unrecognized gains and losses (over 12 years) which aggregate more than 10% of the value of plan assets.\nThe Bank also has a qualified Employee Stock Ownership Plan (\"ESOP\") and, commencing in 1992, a 401(k) Plan covering all eligible employees. Contributions to the ESOP are at the discretion of the Board of Directors of the Bank; no contributions were made in 1995, 1994 or 1993. Participants in the 401(k) Plan are entitled to contribute up to 20% of their compensation, subject to Internal Revenue Service annual limitations. The Bank contributed 25% in 1993 and 1994 and 50% of annual employee contributions in 1995, up to 6% of a participants' compensation. Employees are fully vested in the Bank's contributions after five years of service. The Bank contributed $91,000, $49,000 and $20,000 to the 401(k) Plan in 1995, 1994 and 1993, respectively.\nNote 12 Related Party Transactions\nThe Bank purchases insurance from an insurance brokerage firm owned by a director of the Bank and Bancorp. This director is the president of the insurance firm. During 1995, the Bank made insurance payments of $364,062 to this firm. Payments to this firm for insurance premiums were $326,791 and $475,462 during 1994 and 1993, respectively.\nThe Bank leases office space from a trust of which a director of the Bank and Bancorp serves as trustee. Rental payments of $54,584, $53,740 and $53,527 for this office space were paid during 1995, 1994 and 1993, respectively.\nThe Bank also leases office space from a trust which benefits a family member of a director of the Bank and Bancorp. The Bank made rental payments totaling $194,196, $195,000 and $184,141 during 1995, 1994 and 1993, respectively, relating to this office space.\nNote 13 New Accounting Standards Not Yet Adopted\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 for Long-Lived Assets to be Disposed Of\". SFAS 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. SFAS 121 applies to financial statements for fiscal years beginning after December 15, 1995. Bancorp does not anticipate that adoption of this pronouncement will have a material impact on its consolidated financial statements.\nIn October 1995, FASB issued Statement of Financial Accounting Standards No. 123 (\"SFAS 123\"), \"Accounting for Stock-Based Compensation\". SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. SFAS 123 is effective for fiscal years beginning after December 15, 1995. Bancorp does not anticipate that adoption of this pronouncement will have a material impact on its consolidated financial statements.\nNote 14 Westport Bancorp, Inc. (Parent Company Only) Condensed Financial Statements\nThere are various restrictions which limit the ability of a bank subsidiary to transfer funds in the form of cash dividends, loans or advances to its parent company. The Bank is prohibited by Connecticut banking law from paying dividends except from its net profits, which are defined as the remainder of all earnings from current operations. The total of all dividends declared by the Bank in any calendar year may not, unless specifically approved by the Commissioner, exceed the total of its net profits for that year combined with its retained net profits from the preceding two years. These dividend limitations can affect the amount of dividends payable to Bancorp as the sole stockholder of the Bank, and therefore affect Bancorp's payment of dividends to its stockholders.\nIn addition, the Bank is subject to restrictions under Section 23A of the Federal Reserve Act. These restrictions limit the transfer of funds to a parent company, in the form of loans or extensions of credit, investments and purchases of assets. Such transfers are limited to 10% of the Bank's capital and surplus. These transfers are also subject to various collateral requirements.\nNote 15 Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk\nThe Bank is a party to financial instruments with off-balance sheet risk entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit (unfunded loans and unused lines of 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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments and evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies, but may include real estate, accounts receivable, inventory, property and securities.\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 at the customer's request to support various personal and\/or business obligations. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The amount of credit is based on management's credit evaluation of the counterparty. Collateral held varies but may include real estate, accounts receivable, inventory, property, securities and certificates of deposit.\nThe Bank's maximum exposure to credit loss from outstanding loan commitments and standby letters of credit at December 31, 1995 was: ($ in thousands) Loan commitments: Residential mortgage $ 2,588 Commercial mortgage 260 Residential construction 1,276 - -------------------------------------------------------------------------------- Total 4,124 - --------------------------------------------------------------------------------\nLines of Credit commitments: Commercial 15,352 Home equity 16,865 Personal 2,333 - -------------------------------------------------------------------------------- Total 34,550 - --------------------------------------------------------------------------------\nStandby letters of credit 1,532 - --------------------------------------------------------------------------------\nTotal commitments and letters of credit $ 40,206 ================================================================================\nThe Bank grants residential, commercial and consumer loans to customers, principally in the town of Westport and the Fairfield County area of Connecticut. Although the loan portfolio is diversified, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in the area, especially in the real estate sector. There are no other concentrations of loans exceeding 10% of total loans.\nNote 16 Fair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires disclosure of the estimated fair value of financial instrument assets, liabilities, commitments and guarantees. Approximately 96% of the Company's assets and 99% of its liabilities are considered financial instruments as defined in SFAS 107. Many of the Company's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. In addition, the majority of the Company's financial instruments, such as loans and deposits, are held to maturity and are realized or paid according to the contractual agreement with the customer.\nSignificant estimations and present value calculations were used by the Company for the purposes of this disclosure. The estimation methodologies used, the estimated fair values, and financial statement balances at December 31, 1995 and 1994 ($ in thousands) are shown below.\nFinancial instrument assets actively traded in a secondary market have been valued at quoted available market prices. For short-term financial instruments, the financial statement balance equals fair market value.\nThe following financial instrument liabilities with no stated maturities have been valued at an estimated fair value equal to both the amount payable on demand and the financial statement balance:\nThe loan portfolio has been valued using a combination of quoted market prices and recent comparable sales data for both home equity credit lines and residential mortgages and discounted cash flow for commercial mortgages, consumer loans and business loans. The discount rate used in these calculations are current market rates for similar items.\nChanges in assumptions or estimation methodologies may have a material effect on these estimated fair values.\nManagement is concerned that reasonable comparability between financial institutions may not be possible due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.\nAll off-balance sheet items are believed to relate to quality assets. There are no off-balance sheet items that relate to adversely classified assets. The fees charged for off-balance sheet items are at fair values for similar transactions. See Note 15 for further information on off-balance sheet items.\nNote 17 Quarterly Data (Unaudited)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Westport Bancorp, Inc.:\nWe have audited the accompanying consolidated statements of condition of Westport Bancorp, Inc. (a Delaware corporation) and subsidiary 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 financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Westport Bancorp, 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.\nArthur Andersen LLP\nNew York, New York January 25, 1996\nItem 9","section_9":"Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure - --------------------------------------------------------------------------------\nNone.\nPART III Item 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors and Executive Officers of the Registrant - --------------------------------------------------------------------------------\nThe information required by this item is set forth under the captions \"Election of Directors -- Information about Nominees,\" \"Management -- Executive Officers\" and \"Management -- Section 16(a) Compliance\" in Bancorp's definitive Proxy Statement for Bancorp's 1996 Annual Meeting of Stockholders. Such information is hereby incorporated by reference herein and specifically made a part hereof by reference.\nItem 11","section_11":"Item 11 Executive Compensation - --------------------------------------------------------------------------------\nThe information required by this item is set forth under the captions \"Management -- Executive Compensation,\" \"Management -- Option Exercises and Holdings,\" \"Management -- Pension and Retirement Plans,\" \"Management -- Supplemental Executive Retirement Plan,\" \"Management -- Split Dollar Life Insurance,\" \"Management -- Compensation of Directors,\" \"Management -- Agreements With Certain Executive Officers,\" and \"Management -- Compensation Committee Interlocks and Insider Participation\" in Bancorp's definitive Proxy Statement for Bancorp's 1996 Annual Meeting of Stockholders. Such information is hereby incorporated by reference herein and specifically made a part hereof by reference.\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management - --------------------------------------------------------------------------------\nThe information required by this item is set forth under the caption \"Security Ownership of Management and Certain Beneficial Owners\" in Bancorp's definitive Proxy Statement for Bancorp's 1996 Annual Meeting of Stockholders. Such information is hereby incorporated by reference herein and specifically made a part hereof by reference.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions - --------------------------------------------------------------------------------\nThe information required by this item is set forth under the captions \"Management -- Compensation Committee Interlocks and Insider Participation\" and \"Management -- Certain Other Transactions\" in Bancorp's definitive Proxy Statement for Bancorp's 1996 Annual Meeting of Stockholders. Such information is hereby incorporated by reference herein and specifically made a part hereof by reference.\nPART IV Item 14","section_14":"Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K - --------------------------------------------------------------------------------\nFinancial Statements. The following financial statements are included in Item 8 of this Form 10-K:\n(a) Westport Bancorp, Inc. Consolidated Statements of Condition as at December 31, 1995 and 1994.\n(b) Westport Bancorp, Inc. Consolidated Statements of Income for years ended December 31, 1995, 1994 and 1993.\n(c) Westport Bancorp, Inc. Consolidated Statements of Changes In Stockholders' Equity as at December 31, 1995, 1994, and 1993 and January 1, 1993.\n(d) Westport Bancorp, Inc. Consolidated Statements of Cash Flows for years ended December 31, 1995, 1994, and 1993.\n(e) Westport Bancorp, Inc. Notes to Consolidated Financial Statements.\n(f) Report of Independent Public Accountants, on Westport Bancorp, Inc.'s Consolidated Financial Statements for 1995, 1994 and 1993.\nFinancial Statement Schedules. Schedules are omitted either because they are not applicable or because the information is included at Item 8 in this Form 10-K.\nExhibits. The exhibits which are filed with this Form 10-K or which are incorporated herein by reference are set forth below:\nExhibit No. Exhibit Description - --------------------------------------------------------------------------------\n3(a) Restated Certificate of Incorporation of Bancorp. (Filed as Exhibit 3(a) to Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-12936 (\"1991 Form 10-K\"), and incorporated herein by reference.)\n3(b) Certificate of Designation of Series A Convertible Preferred Stock of Bancorp. (Filed as Exhibit 3(b) to 1991 Form 10-K, and incorporated herein by reference.)\n3(c) Certificate of Amendment of Bancorp.\n3(d) By-Laws of Bancorp, as amended. (Filed as Exhibit 3(d) to Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-12936 (\"1992 Form 10-K\"), and incorporated herein by reference.)\n4(a) Specimen Common Stock Certificate. (Filed as Exhibit 4 to Registration Statement on Form S-1, File No. 2-93773, and incorporated herein by reference.)\n4(b) Specimen Series A Convertible Preferred Stock Certificate. (Filed as Exhibit 4(b) to 1991 Form 10-K, and incorporated herein by reference.)\n4(c) Specimen Warrant Certificate. (Filed as Exhibit 4(c) to 1991 Form 10-K, and incorporated herein by reference.)\n10(a) Weston lease dated June 5, 1979 between the Bank and Weston Shopping Center, Inc. (Filed as Exhibit 10(c) to Registration Statement on Form S-1, File No. 2- 93773, and incorporated herein by reference.)\n10(b) Weston lease dated August 23, 1979, between the Bank and Weston Shopping Center Associates, as amended by Modification dated July 1, 1993. (Filed as Exhibit 10(e) to Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-12936, and as Exhibit 10(c) to Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-12936 (\"1993 Form 10-K\"), respectively, and incorporated herein by reference.)\n10(c) Trust Department lease dated November 7, 1986 between the Bank and John Sherwood, Trustee. (Filed as Exhibit 10(e) to 1992 Form 10-K, and incorporated herein by reference.)\n10(d) Gault Building lease dated April 1, 1987 between the Bank and William L. Gault, Trustee. (Filed as Exhibit 10(f) to 1992 Form 10-K, and incorporated herein by reference.)\n10(e) Shelton Operations Center lease dated March 22, 1991 between the Bank and One Research Drive Associates Limited Partnership. (Filed as Exhibit 10(h) to 1991 Form 10-K, and incorporated herein by reference.)\n10(f) Fairfield branch lease dated March 20, 1995 between the Bank and C.A.T.F. Limited Partnership.\n10(g) Employment Agreement among Michael H. Flynn, Bancorp and the Bank dated August 31, 1989, as amended December 17, 1991 and November 13, 1995. (Agreement dated August 31, 1989 and Amendment dated December 17, 1991 filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(h) Employment Agreement among Thomas P. Bilbao, Bancorp and the Bank dated June 16, 1992 and as amended November 13, 1995. (Agreement dated June 16, 1992 filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(i) Employment Agreement among Richard T. Cummings, Jr., Bancorp and the Bank dated January 12, 1990, as amended December 17, 1991 and November 13, 1995. (Agreement dated January 12, 1990 and Amendment dated December 17, 1991 filed as Exhibit (10)(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(j) Employment Agreement among William B. Laudano, Jr., Bancorp and the Bank dated February 23, 1995 and as amended November 13, 1995. (Agreement dated February 23, 1995 filed as Exhibit 10(g)(6) to 1994 Form 10-K, and incorporated herein by reference.)\n10(k) Employment Agreement among Richard L. Card, Bancorp and the Bank dated November 15, 1993, and as amended November 13, 1995. (Agreement dated November 15, 1993 filed as Exhibit 10(i)(4) to 1993 Form 10-K, and incorporated herein by reference.)\n10(l) Executive Agreement between Arnold Levine and Bancorp dated October 16, 1989 and as amended December 17, 1991. (Filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(m) Stock Option Agreement between Michael H. Flynn and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(n) Stock Option Agreement between Thomas P. Bilbao and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(o) Stock Option Agreement between Richard T. Cummings, Jr. and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(p) Stock Option Agreement between William B. Laudano, Jr. and Bancorp dated September 2, 1993. (Filed as Exhibit 10(i)(5) to 1993 Form 10-K, and incorporated herein by reference.)\n10(q) Stock Option Agreement between Richard L. Card and Bancorp dated November 18, 1993. (Filed as Exhibit 10(i)(5) to 1993 Form 10-K, and incorporated herein by reference.)\n10(r) Split Dollar Insurance Agreement between William B. Laudano, Jr. and the Bank.\n10(s) Split Dollar Insurance Agreement between Richard T. Cummings, Jr. and the Bank.\n10(t) Split Dollar Insurance Agreement between Richard L. Card and the Bank.\n10(u) Supplemental Executive Retirement Plan of Bancorp dated November 13, 1995, as amended November 29, 1995 and January 18, 1996.\n10(v) Trust under Supplemental Executive Retirement Plan between the Bank and People's Bank, Trustee.\n10(w) Directors Retirement Plan of Bancorp. (Filed as Exhibit 10(m) to 1992 Form 10-K, and incorporated herein by reference.)\n10(x) 1985 Incentive Stock Option Plan of Bancorp, as restated. (Filed as Exhibit 10(n) to 1992 Form 10-K, and incorporated herein by reference.)\n10(y) 1995 Incentive Stock Option Plan of Bancorp.\n11 Statement Regarding Computation of Per Share Earnings.\n21 Subsidiary of Bancorp. (Filed as Exhibit 22 to 1991 Form 10-K, and incorporated herein by reference.)\n23 Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.\nReports on Form 8-K.\nBancorp did not file any 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.\nWESTPORT BANCORP, INC. ----------------------- (Registrant)\nDATE March 21, 1996 By: \/s\/ Michael H. Flynn ---------------- -------------------- Michael H. Flynn President and Chief Executive Officer (principal executive officer)\nDATE March 21, 1996 By: \/s\/ William B. Laudano, Jr. ---------------- --------------------------- William B. Laudano, Jr. Senior Vice President and Chief Financial Officer (principal financial officer and principal accounting officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignatures Title Date - --------------------------------------------------------------------------------\nDirector - ------------------- George H. Damman\n\/s\/Michael H. Flynn Director March 21, 1996 - ------------------- Michael H. Flynn\n\/s\/William L. Gault Director March 21, 1996 - ------------------- William L. Gault\n\/s\/Kurt B. Hersher Director March 21, 1996 - ------------------- Kurt B. Hersher\nSignatures Title Date - --------------------------------------------------------------------------------\n\/s\/William E. Mitchell Director March 21, 1996 - ------------------------- William E. Mitchell\n\/s\/David A. Rosow Chairman of the March 21, 1996 - ------------------------- Board of Directors David A. Rosow\nDirector - ------------------------- William D. Rueckert\n\/s\/Jay Sherwood Director March 21, 1996 - ------------------------- Jay Sherwood\nEXHIBIT INDEX\nExhibit No. Exhibit Description - --------------------------------------------------------------------------------\n3(a) Restated Certificate of Incorporation of Bancorp. (Filed as Exhibit 3(a) to Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-12936 (\"1991 Form 10-K\"), and incorporated herein by reference.)\n3(b) Certificate of Designation of Series A Convertible Preferred Stock of Bancorp. (Filed as Exhibit 3(b) to 1991 Form 10-K, and incorporated herein by reference.)\n3(c) Certificate of Amendment of Bancorp.\n3(d) By-Laws of Bancorp, as amended. (Filed as Exhibit 3(d) to Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-12936 (\"1992 Form 10-K\"), and incorporated herein by reference.)\n4(a) Specimen Common Stock Certificate. (Filed as Exhibit 4 to Registration Statement on Form S-1, File No. 2-93773, and incorporated herein by reference.)\n4(b) Specimen Series A Convertible Preferred Stock Certificate. (Filed as Exhibit 4(b) to 1991 Form 10-K, and incorporated herein by reference.)\n4(c) Specimen Warrant Certificate. (Filed as Exhibit 4(c) to 1991 Form 10-K, and incorporated herein by reference.)\n10(a) Weston lease dated June 5, 1979 between the Bank and Weston Shopping Center, Inc. (Filed as Exhibit 10(c) to Registration Statement on Form S-1, File No. 2- 93773, and incorporated herein by reference.)\n10(b) Weston lease dated August 23, 1979, between the Bank and Weston Shopping Center Associates, as amended by Modification dated July 1, 1993. (Filed as Exhibit 10(e) to Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-12936, and as Exhibit 10(c) to Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-12936 (\"1993 Form 10-K\"), respectively, and incorporated herein by reference.)\n10(c) Trust Department lease dated November 7, 1986 between the Bank and John Sherwood, Trustee. (Filed as Exhibit 10(e) to 1992 Form 10-K, and incorporated herein by reference.)\n10(d) Gault Building lease dated April 1, 1987 between the Bank and William L. Gault, Trustee. (Filed as Exhibit 10(f) to 1992 Form 10-K, and incorporated herein by reference.)\n10(e) Shelton Operations Center lease dated March 22, 1991 between the Bank and One Research Drive Associates Limited Partnership. (Filed as Exhibit 10(h) to 1991 Form 10-K, and incorporated herein by reference.)\n10(f) Fairfield branch lease dated March 20, 1995 between the Bank and C.A.T.F. Limited Partnership.\n10(g) Employment Agreement among Michael H. Flynn, Bancorp and the Bank dated August 31, 1989, as amended December 17, 1991 and November 13, 1995. (Agreement dated August 31, 1989 and Amendment dated December 17, 1991 filed as Exhibit (10)(i)(1) to 1992 Form 10-K, and incorporated by reference.)\nExhibit No. Exhibit Description - --------------------------------------------------------------------------------\n10(h) Employment Agreement among Thomas P. Bilbao, Bancorp and the Bank dated June 16, 1992 and as amended November 13, 1995. (Agreement dated June 16, 1992 filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(i) Employment Agreement among Richard T. Cummings, Jr., Bancorp and the Bank dated January 12, 1990, as amended December 17, 1991 and November 13, 1995. (Agreement dated January 12, 1990 and Amendment dated December 17, 1991 filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(j) Employment Agreement among William B. Laudano, Jr., Bancorp and the Bank dated February 23, 1995 and as amended November 13, 1995. (Agreement dated February 23, 1995 filed as Exhibit 10(g)(6) to 1994 from 10-K, and incorporated herein by reference.)\n10(k) Employment Agreement among Richard L. Card, Bancorp and the Bank dated November 15, 1993, as amended November 13, 1995. (Agreement dated November 15, 1993 filed as Exhibit 10(i)(4) to 1993 Form 10-K, and incorporated herein by reference.)\n10(l) Executive Agreement between Arnold Levine and Bancorp dated October 16, 1989 and as amended December 17, 1991. (Filed as Exhibit 10(i)(1) to 1992 Form 10-K, and incorporated herein by reference.)\n10(m) Stock Option Agreement between Michael H. Flynn and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(n) Stock Option Agreement between Thomas P. Bilbao and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(o) Stock Option Agreement between Richard T. Cummings, Jr. and Bancorp dated December 17, 1992. (Filed as Exhibit 10(i)(3) to 1992 Form 10-K, and incorporated herein by reference.)\n10(p) Stock Option Agreement between William B. Laudano, Jr. and Bancorp dated September 2, 1993. (Filed as Exhibit 10(i)(5) to 1993 Form 10-K, and incorporated herein by reference.)\n10(q) Stock Option Agreement between Richard L. Card and Bancorp dated November 18, 1993. (Filed as Exhibit 10(i)(5) to 1993 Form 10-K, and incorporated herein by reference.)\n10(r) Split Dollar Insurance Agreement between William B. Laudano, Jr. and the Bank.\n10(s) Split Dollar Insurance Agreement between Richard T. Cummings, Jr. and the Bank.\n10(t) Split Dollar Insurance Agreement between Richard L. Card and the Bank.\n10(u) Supplemental Executive Retirement Plan of Bancorp dated November 13, 1995, as amended November 29, 1995 and January 18, 1996.\n10(v) Trust under Supplemental Executive Retirement Plan between the Bank and People's Bank, Trustee.\n10(w) Directors Retirement Plan of Bancorp. (Filed as Exhibit 10(m) to 1992 Form 10-K, and incorporated herein by reference.)\n10(x) 1985 Incentive Stock Option Plan of Bancorp, as restated. (Filed as Exhibit 10(n) to 1992 Form 10-K, and incorporated herein by reference.)\nExhibit Description - --------------------------------------------------------------------------------\n10(y) 1995 Incentive Stock Option Plan of Bancorp.\n11 Statement Regarding Computation of Per Share Earnings.\n21 Subsidiary of Bancorp. (Filed as Exhibit 22 to 1991 Form 10-K, and incorporated herein by reference.)\n23 Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.","section_15":""}
{"filename":"312155_1995.txt","cik":"312155","year":"1995","section_1":"ITEM 1: BUSINESS - -----------------\nNooney Real Property Investors-Two, L.P. (the \"Registrant\") is a limited partnership formed under the Missouri Uniform Limited Partnership Law on September 26, 1979, to invest, on a leveraged basis, in income-producing real properties such as shopping centers, office buildings, apartment complexes, office\/warehouses and light industrial properties. The Registrant originally invested in six real property investments described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES - -------------------\nOn October 3, 1979, the Registrant purchased the Maple Tree Shopping Center (the \"Center\") located at the corner of Clayton and Clarkson Roads in West St. Louis County, Missouri. Constructed in 1974 of steel and masonry block, the Center contains approximately 72,000 net rentable square feet and is located on a 7.8 acre site which provides paved parking for 366 cars. The Center was 96% leased by 15 tenants at year end. The purchase price of the Center was $3,184,053.\nOn October 15, 1980, the Registrant purchased Park Plaza I & II, (\"Park Plaza\") an office\/warehouse center located at 5707-5797 Park Plaza Court in Indianapolis, Indiana. Park Plaza consists of two one-story, concrete block buildings. Park Plaza I was built in 1975 and Park Plaza II in 1979. Park Plaza is located on a 9 acre site which provides paved parking for 150 cars. The buildings contain a total of approximately 95,000 net rentable square feet and were 100% leased by 29 tenants at year end. The purchase price of Park Plaza was $2,411,163.\nOn March 27, 1981, the Registrant purchased Morenci Professional Park Buildings A, B, C, D & G (\"Morenci\"), an office\/warehouse complex located at 62nd Street and Guion Road in Indianapolis, Indiana. Morenci consisted of five one-story, masonry buildings located on a 13.35 acre site. Buildings A, B, C & D were built in 1975 and building G was built in 1979. On November 14, 1991, Building G was sold to a party unaffiliated with the Registrant. The remaining buildings contain a total of approximately 105,600 net rentable square feet and were 99% leased by 29 tenants at year end. The major tenant occupying 49% of the property vacated as of December 31, 1995. The total purchase price, excluding Building G, of Morenci was $3,009,924.\nOn March 27, 1981, the Registrant purchased the Jackson Industrial Building A (\"Jackson A\"), a warehouse building located at Post Road and 30th Street in Indianapolis, Indiana. Jackson A is a one-story, masonry building and is located on a 21.87 acre site. The building, originally constructed in 1976 and subsequently expanded in 1980, contains approximately 320,000 net rentable square feet. Jackson A was 100% leased by 2 tenants at year end. The purchase price of Jackson A was $6,089,929.\nReference is made to Note 3 to Notes to Financial Statements filed herewith as Exhibit 99.3 in response to Item 8 for a description of the mortgage indebtedness secured by the Registrant's real property investments. Reference is also made to Note 6 to Notes to Financial Statements for a discussion of revenues derived from major tenants.\nThe following table sets forth certain information as of November 30, 1995, relating to the properties owned by the Partnership.\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 security holders during the fourth quarter of fiscal 1995.\nPART II -------\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------\nAs of February 1, 1996, there were 1,081 record holders of Interests in the Registrant. There is no public market for the Interests and it is not anticipated that a public market will develop.\nThere were no cash distributions paid to the Limited Partners during fiscal 1994 or fiscal 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 - ----------------------------------------------------------\nLiquidity and Capital Resources - -------------------------------\nCash reserves as of November 30, 1995 are $628,358, an increase of $25,319 from year ended November 30, 1994. The increase in cash was provided by the operations of the Registrant's properties. The cash balances are being allowed to accumulate to establish adequate cash reserves to fund future capital expenditures, leasing, and tenant finish costs. These reserves are necessary based on the fact that a major tenant occupying 49% of the space at Morenci Professional Park vacated in December 1995, and partial roof replacement is needed at Jackson Industrial. The Registrant expects to fund anticipated capital expenditures throughout 1996 from cash flow provided by operations and the current level of cash reserves. The anticipated capital expenditures by property are as follows:\nThroughout 1996, approximately $502,791 of capital expenditures have been forecasted. Park Plaza I & II, Morenci Professional Park, and Maple Tree Shopping Center have leasing capital to fund tenant alterations to their respective suites along with lease commissions for new leases signed. At Park Plaza I & II, the Registrant has forecasted resurfacing of sections of the rear parking areas, concrete repair\/replacement, and interior sprinkler head adjustments. At Morenci Professional Park, the Registrant has forecasted other capital to clean up and renovate the space previously occupied by the major tenant in order for it to present well to potential tenants. At Maple Tree Shopping Center, the Registrant has scheduled the enclosure of its waste storage bins in an effort to comply with city ordinances. At Jackson Industrial, the Registrant has forecasted the re-roofing of approximately 68,000 square feet at the southern end of the building.\nAs of November 1, 1995, the Registrant negotiated an extension of the second mortgages secured by Park Plaza I & II, Morenci Professional Park, and Maple Tree. The term of the extension is for a period of one year at a rate of 1.5% over the then published prime rate. As of November 30, 1995, interest rate on the debt was 10.25%. The balance of the debt on Park Plaza I & II and Morenci as of November 30, 1995, is $259,925. The balance of the debt on Maple Tree as of November 30, 1995, is $290,060.\nThe first mortgage debt on Morenci Professional Park and Park Plaza I & II have maturity dates of October 1, 2005, and December 31, 2003, respectively.\nOn November 1, 1995, the Registrant refinanced the existing first deed of trust on Jackson Industrial for a period of five years at a rate of 9.31%, being amortized over 18 years.\nThe future liquidity of the Registrant is dependent on its ability to fund future capital expenditures and mortgage payments from operations and cash reserves, maintain occupancy, and negotiate with lenders the refinancing of mortgage debt as it matures. Until such time as the real estate market recovers and profitable sale of the properties is feasible, the Registrant will continue to manage the properties to achieve its investment objectives.\nResults of Operations - ---------------------\nThe results of operations for the Registrant's properties for the years ended November 30, 1995, 1994, and 1993 are detailed in the schedule below. Expenses of the Registrant are excluded.\nAt Jackson Industrial, the wide swings in revenues and expenses relate to the property's real estate taxes. In 1994 the county taxing authority discovered an error in the method in which the property had been assessed. The error was corrected, resulting in a significant increase in the real estate tax expense accrual in 1994. As the real estate tax accruals increased, they were passed through to the tenants in the form of a real estate tax reimbursement. From 1994 to 1995 real estate taxes paid leveled out with the expense accrual\nresulting in a decrease of $56,212 in the expense. Real estate tax reimbursement decreased $30,395 from 1994 to 1995 due to the renewal of a major tenant's lease, resulting in a change in their real estate tax base year.\nMaple Tree Shopping Center had increases in net income for the three years presented due primarily to decreasing expenses. Revenues have remained relatively stable over the three year period. The decrease in expenses from 1993 to 1994 relates to repairs and maintenance ($16,700), snow removal ($5,037), and real estate taxes ($18,662), offset by parking lot expenditures ($22,874). The expense decrease from 1994 to 1995 is attributable to depreciation expense ($32,582) and administrative costs ($6,877), offset by increases in repairs and maintenance ($15,317) and real estate taxes ($11,020).\nThe operating results at Park Plaza I & II for the years ended November 30, 1995 and 1994 are similar. However, net income from 1993 to 1994 increased $48,214 due to an increase in revenues of $26,458 and a decrease in expenses of $21,756. The increase in revenues can be attributed to increased occupancy resulting in increased rental revenues. The decrease in expenses relates to repairs and maintenance ($16,634).\nAt Morenci Professional Park, net income varied significantly from year to year. Revenues increased from year to year while expenses increased from 1993 to 1994 and then decreased from 1994 to 1995. The increase in revenues from 1993 to 1994 relate to escalation income which is a result of increases in reimbursable operating expenses. The operating expenses that increased from 1993 to 1994 are repairs and maintenance ($6,501), real estate taxes ($3,845), snow removal ($2,917), and vacancy expenses ($3,684). Revenues from 1994 to 1995 increased due to higher occupancy which resulted in increased rental income. Expenses trended downward from 1994 to 1995 due to decreases in vacancy expense ($6,889), repairs and maintenance ($9,546), snow removal ($4,133), and sewer charges ($3,456).\nThe occupancy at the Registrant's properties at year-end remain at a high level. However, as previously discussed, a major tenant that occupied approximately 49% of Morenci Professional Park vacated the premises in December 1995. The occupancy levels at November 30 are as follows:\nFor the quarter ended November 30, 1995, occupancy at Park Plaza I & II increased from 92% to 100% through the leasing of 9,720 square feet to three individual tenants, offset by a single tenant vacating 2,340 square feet. For the year, leasing at Park Plaza I & II consisted of the renewal of 19,800 square feet, the execution of six new leases with a total square feet of 30,360, and the vacating by 6 tenants who occupied 30,360 square feet. At Park\nPlaza I & II, no tenant occupies more than 10% of the total space. The occupancy at the years ended 1994 and 1995 was 100%.\nDuring the fourth quarter, the occupancy level at Morenci Professional Park remained the same as the previous quarter. Leasing activity during the fourth quarter is as follows: one new lease occupying 1,200 square feet, two lease renewals for 3,600 square feet, and one tenant vacated 1,200 square feet. During the year, occupancy increased 5% due to the execution of four new leases with 9,600 square feet, the renewal of 9,600 square feet, and the vacating of 4,800 square feet. As previously stated, a tenant which occupies approximately 49% of the available space vacated their space at the expiration of their lease in December 1995. The remainder of the space is leased in small sections by various tenants.\nAt Maple Tree Shopping Center during the fourth quarter, leasing activity netted a decrease in occupancy by 2% or 1,200 square feet. The Registrant renewed 18,560 square feet, signed one new lease for 2,640 square feet, and one tenant vacated 1,200 square feet. For the year, occupancy decreased 2% and had the following leasing activity: one new lease for 2,640 square feet, renewed three leases totaling 19,360 square feet, vacated two leases with 3,840 square feet. Maple Tree Shopping Center has two major tenants who occupy 18% and 42% of the available space. The tenants that occupy approximately 18% and 42% of the available space have lease expirations of April 30, 2000, and July 31, 1999, respectively.\nJackson Industrial currently has two tenants who lease 100% of the available space. The major tenant who occupies approximately 70% of the available space has renewed their lease for a period of five years. The renewal has a marginal increase in rate and expires July 31, 2001. The other tenant has a lease expiration of July 31, 1997.\n1995 Comparisons - ----------------\nAs of November 30, 1995, the Registrant's consolidated revenues are $2,341,704 compared to $2,357,368 for the year ended November 30, 1994. On a consolidated basis, revenues decreased $15,664 or less than 1%. Even though consolidated revenues remained relatively stable from 1994 to 1995, the individual properties had changes from year to year. These changes have been previously analyzed.\nThe Registrant's consolidated expenses for the year ended November 30, 1995 is $2,287,260. When compared to year ended November 30, 1994, consolidated expenses decreased $105,152 or 4.40%. The decrease is attributable to interest expense, real estate taxes, and other operating expenses. The decrease in interest expense is attributable to all the Registrant's properties. All the properties, except for Jackson Industrial, have long-term loans with original amortization periods ranging from 25 to 30 years. As these loans amortize, each payment is applied less to interest and more to principal resulting in a decrease in interest expense. As previously stated, the decrease in real estate taxes is attributable to Jackson Industrial. The decrease in other operating expenses is comprised of several categories and they are: vacancy expense ($16,134); administrative ($9,154); snow removal ($8,797); and insurance ($4,675). Offsetting the aforementioned expense decreases were increases in professional services ($12,830) and office expenses ($5,507).\nWith revenues remaining relatively flat and expenses decreasing, the Registrant had favorable operating results for the year ended November 30, 1995. Net income is $54,444 or $4.49 per limited partnership unit, an increase in net income of $89,488 or $7.38 per limited partnership unit when comparing November 30, 1995, to November 30, 1994. Cash flow provided by operations for the year ended November 30, 1995, is $493,356 which enabled the Registrant to fund capital expenditures of $135,205 and reduce loan balances by $332,832.\n1994 Comparisons - ----------------\nFor the year ended November 30, 1994, consolidated revenues were $2,357,368 which represents an increase of $91,455 when compared to November 30, 1993. The increase in revenues is attributable to an increased real estate tax reimbursement at Jackson Industrial, rental income and expense pass throughs at Maple Tree Shopping Center, and rental income at Park Plaza I & II. The increase in real estate tax reimbursement at Jackson Industrial was previously discussed. The increases in rental income at Maple Tree Shopping Center and Park Plaza I & II relate to the Registrant's ability to renew and execute new leases at rental rates that exceeded the previous tenants' rates. The increase in expense pass throughs at Maple Tree Shopping Center directly correlate with increases in expenses which can be passed through to the tenants of the property.\nAs of November 30,1994, consolidated expenses for the year-end are $2,392,412, an increase of $65,160 or 2.80% when compared to year-to-date consolidated expenses as of November 30, 1993. The increase in consolidated expenses is attributable to real estate tax expense at Jackson Industrial. Offsetting the significant increase in real estate taxes are decreases in interest and depreciation and amortization. The decrease in interest expense is attributable to all the Registrant's properties. All the properties, except for Jackson Industrial, have long-term loans with amortization periods ranging from 25 to 30 years. As these loans amortize, each payment is applied less to interest and more to principal resulting in a decrease in interest expense. The decrease in depreciation and amortization relates to tenant alterations and lease commissions at Jackson Industrial and the amortization of these items over the term of the appropriate leases.\nNet loss for the year ended November 30, 1994, was $35,044 or $2.89 per limited partnership unit. For the same period ended November 30, 1993, the net loss was $61,339 or $5.06 per limited partnership unit. Cash flow provided by operations for the year ended November 30, 1994, was $315,534. The operating cash flow along with reserve cash was applied by the Registrant to fund capital expenditures of $63,324 and to fund principal payments of $307,491.\nInflation - ---------\nThe effects of inflation did not have a material impact upon the Registrant's operation in fiscal 1995, and are not expected to materially affect the Registrant's operation in 1996.\nInterest Rates - --------------\nInterest rates on floating rate debt went up in 1995 which negatively affected the operations of the Registrant in 1995. Future increases in the prime interest rate can adversely affect the operations of the Registrant in 1996 and in the future.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nFinancial Statements of the Registrant are filed herewith as Exhibit 99.3 and are incorporated herein by reference (see Item 14(a)(1)). The supplementary financial information specified by Item 302 of Regulation S-K is provided in Item 7.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ----------------------------------------------------------\nNone\nPART III --------\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nThe General Partners of the Registrant responsible for all aspects of the Registrant's operations are Gregory J. Nooney, Jr., age 65, and Nooney Investors, Inc., a Missouri corporation. Gregory J. Nooney, Jr. is a senior officer of Nooney Company, the sponsor of the Registrant.\nThe background and experience of the General Partners are as follows:\nGregory J. Nooney, Jr. joined Nooney Company in 1954 and is currently Chairman of the Board and Chief Executive Officer.\nJohn J. Nooney is a Special General Partner of the Partnership and as such, does not exercise control of the affairs of the Partnership.\nJohn J. Nooney joined Nooney Company in 1958 and was President and Treasurer until he resigned in 1992. Mr. Nooney is currently Chairman of the Board of Dalton Investments, a real estate asset management firm.\nNooney Investors, Inc., a wholly-owned subsidiary of Nooney Company, was formed in June 1979 for the purpose of being a general and\/or limited partner in the Registrant and other limited partnerships. Gregory J. Nooney, Jr. is a director of Nooney Investors, Inc.\nGregory J. Nooney, Jr. and John J. Nooney are brothers. Gregory J. Nooney, Jr. and Faith L. Nooney (wife of John J. Nooney) are stockholders of Nooney Company, with Gregory J. Nooney, Jr. controlling all voting stock of Nooney Company.\nThe General Partners will continue to serve as General Partners until their withdrawal or their removal from office by the Limited Partners.\nCertain of the General Partners act as general partners of limited partnerships and hold directorships of companies with a class of securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934 or subject to the requirements of Section 15(d) of the Act. A list of such directorships, and the limited partnerships for which the General Partners serve as general partners, is filed herewith as Exhibit 99.1 and incorporated herein by reference.\nDuring 1993 Lindbergh Boulevard Partners, L.P. filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code. Gregory J. Nooney, Jr. 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.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION - --------------------------------\nThe General Partners are entitled to a share of distributions and a share of profits and losses as more fully described under the headings \"Compensation to General Partners and Affiliates\" on pages 8-11 and \"Profits and Losses for Tax Purposes; Distributions; and Expenses of General Partners\" on pages A-14 to A-17 of the Prospectus of the Registrant dated November 16, 1979, as supplemented and filed pursuant to Rule 424(c) of the Securities Act of 1933 (the \"Prospectus\"), which are incorporated herein by reference.\nDuring fiscal 1995, there were no cash distributions paid to the General Partners by the Registrant.\nSee Item 13 below for a discussion of transactions between the Registrant and certain 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.\nThe aggregate amount beneficially owned by the above listed reporting persons totals 856 Units, or 7.06% of the outstanding interests of the Registrant. The sole general partner of each of the above reporting persons is Liquidity Financial Group, L.P., a California limited partnership. Voting and dispositive power is exercised on behalf of each reporting person by its general partner.\n(b) Security Ownership of Management.\nNone of the General Partners is known to the Registrant to be the beneficial owner, either directly or indirectly, of any Interests in the Registrant.\n(c) Changes in Control.\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 - --------------------------------------------------------\n(a) Transactions with Management and Others.\nCertain affiliates of the General Partners are entitled to certain fees and other payments from the Registrant in connection with certain transactions of the Registrant as more fully described under the headings \"Compensation to General Partners and Affiliates\" on pages 8-11 and \"Management\" on pages 23-25 of the Prospectus, which are incorporated herein by reference.\nNooney Krombach Company, the manager of Registrant's properties, is a wholly- owned subsidiary of Nooney Company. Nooney Krombach Company is entitled to receive monthly compensation from the Registrant for property management and leasing services, plus administrative expenses. During fiscal 1995 the Registrant paid property management fees of $116,228 to Nooney Krombach Company.\nThe Registrant paid Nooney Krombach Company $30,000 during fiscal 1995 as reimbursement for indirect expenses incurred in connection with management of the Registrant.\nSee Item 11 above for a discussion of cash distributions paid to the General Partners during fiscal 1995.\n(b) Certain Business Relationships.\nThe relationship of certain of the General Partners to certain of their affiliates is set forth in Item 13(a) above. Also see Item 13(a) above for a discussion of amounts paid by the Registrant to the General Partners or their affiliates during fiscal 1995 in connection with various transactions.\n(c) Indebtedness of Management.\nNot Applicable.\n(d) Transactions with promoters.\nNot Applicable.\nPART IV -------\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------\n(a) The following documents are filed as a part of this report:\n(1) Financial Statements (filed herewith as Exhibit 99.3):\nIndependent auditors' report Balance sheets Statements of operations Statements of partners' equity (deficiency in assets) Statements of cash flows Notes to financial statements\n(2) Financial Statement Schedules (filed herewith as Exhibit 99.3):\nSchedule - Reconciliation of partners' equity (deficit) Schedule III - Real estate and accumulated depreciation\nAll other schedules are omitted because they are inapplicable or not required under the instructions.\n(3) Exhibits:\nSee Exhibit Index on Page 17.\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 17.\n(d) Not Applicable\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) under the 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 REAL PROPERTY INVESTORS-TWO, L.P.\nDate: February 21, 1996 \/s\/ Gregory J. Nooney, Jr. ----------------------------------------- Gregory J. Nooney, Jr. General Partner\nNooney Investors, Inc. General Partner\nDate: February 21, 1996 By: \/s\/ Gregory J. Nooney, Jr. ------------------------------------- Gregory J. Nooney, Jr. Chairman of the Board and Chief Executive Officer\nBy: \/s\/ Patricia A. Nooney ------------------------------------- Patricia A. Nooney Senior Vice President and Secretary\nEXHIBIT INDEX -------------\nExhibit Number Description - -------------- ---------------------------------------------------------------\n3.1 Amended and Restated Agreement and Certificate of Limited Partnership dated November 5, 1979, is incorporated by reference to the Prospectus contained in Amendment No. 1 to the Registration Statement on Form S-11 under the Securities Act of 1933 (File No. 2-65006).\n10 Management Contract between Nooney Real Property Investors-Two, L.P. and Nooney Company is incorporated by reference to Exhibit 10(a) to the Registration Statement on Form S-11 under the Securities Act of 1933 (File No. 2-65006). The Management Contract was assigned by Nooney Company to Nooney Management Company (now Nooney Krombach Company), a wholly-owned subsidiary of Nooney Company, on April 1, 1985, and is identical in all material respects.\n27 Financial Data Schedule (provided for the information of the U.S. Securities and Exchange Commission only)\n99.1 List of Directorships filed in response to Item 10.\n99.2 Pages 8-11, 23-25 and A-14 - A-17 of the Prospectus of the Registrant dated November 16, 1979, as supplemented and filed pursuant to Rule 424(c) of the Securities Act of 1933 are incorporated by reference.\n99.3 Financial Statements and Schedules.","section_15":""}
{"filename":"201944_1995.txt","cik":"201944","year":"1995","section_1":"ITEM 1. BUSINESS --------\n1. GENERAL DESCRIPTION OF BUSINESS -------------------------------\nGRC International, Inc. (the \"Company\") was organized in California in 1961. Since 1974, the Company has been a Delaware corporation. The Company, headquartered in Vienna, Virginia, is an internationally recognized provider of professional and technical services to military, civil and commercial clients. As a leader in knowledge-based services and high-quality technical solutions, the Company has gained prominence for innovation in complex information technology, studies and analysis, modeling and simulation, testing and evaluation, proprietary products and telecommunications.\n2. NARRATIVE DESCRIPTION OF BUSINESS ---------------------------------\nThe majority of the Company's revenues are generated from professional and technical services. The Company provides a wide variety of services under cost- plus-fee, fixed price and time and materials contracts, primarily in the field of defense and national security. In general, the contracts involve the investigation and application of advanced technology and innovative management techniques to help make critical decisions and increase productivity and efficiency, primarily for defense-related agencies of the United States Government. The Company's services capabilities involve systems research and analysis, information systems, operations analysis, testing and evaluation, systems engineering, economic modeling, cost estimating, applied physics, data processing, software development, military system effectiveness, and personnel management.\nThe Company has long been providing high-quality knowledge-based services and technical solutions in numerous areas of national importance. These are:\nInformation technology: The Company is involved in creating large-scale ---------------------- decision-support systems and software engineering environments; applying operations research and mathematical modeling to business and management systems; and implementing advanced database technology.\nThe Company has expertise at creating pure open system computing environments which employ diverse technology platforms and are accessible from different security levels. These seamless information systems let customers draw useful information from virtually any type of electronic data to help them make critical decisions.\nThe Company has capabilities in data collection, information management and presentation that support automated government acquisition, financial management and personnel functions. Our contract work has led to automating administrative functions to make certain documentation activities more efficient.\nThe Company's extensive involvement in technology transfer and related export control issues has led to the development of DecisionVue(R) - a collection of specialized decision-support tools. Through hyper-texting and other functions, DecisionVue(R) breaks down complex technologies, such as satellites, into individual components so that the details of suitable replacement parts can be determined. DecisionVue(R) has also been used in evaluating technology transfer issues, such as whether exporting satellite or radar technologies will compromise national security; summary and comparison of research and development facilities; and analysis of space qualified components.\nStudies and analysis: The Company provides studies and analysis -------------------- capabilities to help customers solve complex multidisciplinary problems involved in policy development and planning of state-of-the-art high-technology systems. The Company's technical staff has extensive experience in radar, optics, communication networks, electronics, navigation, guidance and control systems, and space and surveillance systems. In addition, we provide independent, unbiased evaluation verification, and solutions that support a cost-conscious military evaluating high technology policy development and system acquisition. As our cost and operational effectiveness analysis and micro\/macro simulations define a problem, the Company works to identify the tools which will best help customers quantify, assess and mitigate risks or highlight available options.\nModeling and simulation: The Company has expertise in developing ----------------------- responsive, cost-effective driver hardware and software used in real-time testing of sensor, weapon and battlefield management command, control and communication (BM\/C\/3\/) systems. In addition, our computer-based solutions are becoming valuable training tools. We have worked to build an interactive multimedia training module to teach pilots about different types of electronic warfare and radar systems and optical evasive tactics. Our additional high- performance, computer-aided training solutions include interactive video disk with touch screen, multiple language treatment, insitu training and workforce retraining.\nTesting and evaluation: Intertwined with the Company's modeling and ---------------------- simulation capabilities are its professionals' testing and evaluation skills. The Company has an established 20-year record of working with the United States Government in conducting laboratory and field tests and evaluations of nuclear and kinetic energy weapons, hypervelocity impact effects, advanced armor and anti-armor performance and effects of space debris on operational satellites.\nIn parallel with the governmental testing and evaluation support, the Company designs, manufactures and markets a line of electronically instrumented impact testing equipment for dynamic materials testing under the Dynatup(R) trademark and markets several software products. The materials testing product line, sold to industrial users for materials evaluation, includes instrumental drop tower systems and microprocessor-based automated test systems which are used to determine failure points in a wide variety of structures and materials. The Company also develops and markets hardware\/software systems which utilize adaptive learning networks to perform non-destructive materials testing.\nProprietary products: The Company's Flow Gemini(TM) software product is a -------------------- comprehensive and flexible data management system with applications for occupational health information, environmental information and personnel assurance. This system is designed to manage health, environmental and personnel related data to facilitate compliance with federal and state recordkeeping and to help organizations deal effectively with problems in these areas. In addition, the Company offers two software\/hardware library data systems using CD-ROM and personal computers. These are the LASERQUEST(R) system, which contains a bibliographic database and software that facilitates library cataloging, and the LASERGUIDE(R) system, which is a library patron access catalog system.\nThe Company markets an AASP(TM) security product (Automated Assessment Signal Processor), which is a neural network signal processor that can be integrated into existing perimeter security systems to enhance their real-time intrusion detection capabilities. The AASP(TM) can be \"trained to distinguish between perimeter sensor signals that are nuisances\", such as wildlife and other environmental factors, and actual intruders penetrating a security system. The product is particularly effective at large high security installations, such as military bases, nuclear power plants, petrochemical facilities and prisons, as well as commercial and smaller installations.\nTelecommunications: The Company has entered the fiber optics ------------------ telecommunications market with the introduction of its OSU(TM) Network Interface, which solves problems of network isolation, security and\ninteroperability in the emerging new world of wide-band communications. Once integrated into a fiber optic network, the OSU(TM) will help interexchange carriers (IECs) and Regional Bell Operating companies (RBOCs) detect performance anomolies in a network rapidly and allow networks to operate securely with reduced risk of disruptions.\nIn addition, a new application for the Company's technology was identifieid when an agreement was signed for the use of an OSU-derivative product in the video distribution market. This product will enable video, previously available only on cable networks, to be distributed through RBOCs. The Company believes that as fiber optic telecommunications mature, new network boundaries where the OSU(TM) can provide standard demarcation, security and interoperability features will emerge.\nAs part of the Company's strategy of exporting its government products to commercial markets, it has begun the development of NetworkVUE(TM), a telecommunications network configuration and optimization analysis management system. NetworkVUE(TM), an integration of several of the Company's leading-edge technology tools for modeling, simulation and visualization, artificial intelligence and database management is designed to serve a niche market of telecommunications and Fortune 500 network operations and outsourcing firms.\nCONTRACTS ---------\nContract revenues from professional and technical services, either as prime contractor or subcontractor, represented approximately 96%, 95% and 95% of the Company's total revenues from the fiscal years ended June 30, 1995, 1994 and 1993, respectively. The Company's government contracts can fall into one of three categories: (1) cost-plus-fee, (2) fixed price, or (3) time and materials. Under a cost-plus-fee contract, the government reimburses the Company for its allowable costs and expenses and pays a fee which is either negotiated and fixed or awarded based on performance. Under a fixed price contract, the government pays an agreed upon price for the Company's services or products and the Company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the Company incurs actual costs below anticipated costs on these contracts, the Company could realize greater profits. Under a time and materials contract, the government pays the Company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a certain profit margin. For fiscal years 1995 and 1994, approximately 53% and 56% of the Company's professional and technical services revenues were from cost-plus-fee contracts, while approximately 47% and 44% were fixed price or time and materials type contracts, respectively.\nDuring fiscal year 1995, the Company's contracts were performed for a number of program offices within various defense agencies, including each of the armed services. Customers outside the field of defense and national security include other agencies of the federal government, agencies of state and local governments and private industry. Any or all of the contracts with agencies of the United States Government may be subject to termination for the convenience of the government. If a contract were to be terminated, the Company would be reimbursed for its allowable costs up to the date of the termination, and would be paid a proportionate amount of the fees attributable to the work actually performed. In addition to the normal risks found in any business, companies conducting research and analysis services for the United States Government are subject to changes in the defense budget, changing national priorities, the potential of suspension or debarment from new government business, and significant changes in contract scheduling and funding.\nCOMPETITION -----------\nThe Company encounters substantial competition in the professional and technical services area from a large number of entities, some of which are significantly larger than it in size and financial resources.\nThe management of the Company believes that it has a relatively small percentage of the total market. Competition comes principally from other companies and certain non-profit organizations engaged in similar aspects of research and analysis.\nCompetition for the Company in the materials testing field is more limited due to a confined market and the high degree of specialization involved. Nevertheless, a number of other products used for materials testing are produced by other corporations. Sales of the Company's testing machines account for a relatively small percentage of all product sales associated with materials testing. The software market in general is highly competitive and rapidly changing, although the competition experienced by any one product or specialty application may be limited.\nRESEARCH AND DEVELOPMENT ------------------------\nThe Company concentrates its research and development efforts on projects intended to result in technological enhancements to present products and the development of new products compatible with existing product lines. This approach reflects management's commitment to research and development activities intended to produce additional revenues in the near term. Research and development expenditures were approximately $1.1 million, $.4 million and $.7 million for 1995, 1994 and 1993, respectively.\nPATENTS, TRADEMARKS, LICENSES, COPYRIGHTS -----------------------------------------\nWhile the Company and its subsidiaries hold a number of patents, trademarks, licenses and copyrights, in the opinion of management no individual patent, trademark, license or copyright is material to the present operations of the Company as a whole.\nEMPLOYEES ---------\nAs of June 30, 1995, the Company employed 1,290 full-time people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nAll of the Company's operations are conducted in leased facilities. The terms of Company leases range from monthly tenancies to fifteen years, and many of these leases may be renewed for additional periods at the option of the Company. Major leased facilities are at locations in California and Virginia.\nManagement believes that the Company's facilities and equipment are generally well maintained, in good operating condition, and adequate for its present operations. Management does not anticipate any material adverse effect on the Company's financial position or results of operations in connection with obtaining lease renewals or suitable alternative space for any of its facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nIn October 1993, the Company was served with a lawsuit filed in the Superior Court of Orange County, California by ICN Biomedicals, Inc. (\"ICN\") and its parent company, ICN Pharmaceuticals, Inc. (\"Pharmaceuticals\"). The suit alleged fraud, negligent misrepresentation, violations of state and federal securities laws and other claims against the Company in connection with the sale of its biomedical business to ICN in 1989, and sought to recover all monies paid and damages for expenses and interest in the approximate amount of $100 million. In December 1993, the court ordered ICN to arbitrate its claims, and\nICN filed for arbitration in March 1994. In December 1994, the arbitration panel dismissed ICN's claims and ordered ICN to pay the Company the remaining amounts due under the 1989 agreement, approximately $2.7 million. In March 1995, the court confirmed the arbitration award, and ICN paid the final amounts due to the Company in April 1995. In May 1995, the court dismissed the remaining claims of Pharmaceuticals, without prejudice to Pharmaceuticals filing an action in federal court in Delaware pursuant to the forum selection clause in the 1989 agreement. In June 1995, the court denied Pharmaceuticals' motion for reconsideration of the dismissal. In August 1995, Pharmaceuticals appealed the dismissal. In September 1995, the Court of Appeal dismissed Pharmaceuticals' appeal.\nAs a result of the various arbitration and court decisions, the Company was able to reverse reserves during fiscal 1995 of approximately $400,000 (credited to general, administrative, etc.) that were associated with the various ICN matters.\nIn addition, during the course of the lawsuit and arbitration, ICN informed the Company of three ongoing tax inquiries of the biomedical business involving proposed tax deficiencies exceeding $1 million (including interest and penalties), which includes periods of ownership by the Company.\nManagement believes that the proposed tax assessments are excessive and that ICN is responsible for a significant portion of any liabilities associated with these assessments. Management does not believe that the ultimate outcome of these actions will have a material adverse effect on the consolidated financial conditions or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNo matter was submitted to a vote of holders of the Company's stock in 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 --------------------------------------------------------------------\nInformation as to the markets in which the Company's common stock is traded, the high and low prices of such stock, stockholders of record and dividend policy appears on page 11 of the Company's Annual Report to Stockholders for 1995, and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nSelected financial data appears on page 6 of the Company's Annual Report to Stockholders for 1995, and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND ----------------------------------------------------------------- FINANCIAL CONDITION -------------------\nManagement's discussion and analysis of results of operations and financial condition appears on pages 7 through 11 of the Company's Annual Report to Stockholders for 1995, and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe Consolidated balance sheets as of June 30, 1995 and 1994 and the consolidated statements of income and cash flows for each of the three years in the period ended June 30, 1995, together with the report of independent public accountants contained on pages 12 through 27 of the Company's Annual Report to Stockholders for 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 --------------------------------------------------\nThe information required by this item is hereby incorporated by reference to the Proxy Statement (to be filed).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nThe information required by this item is hereby incorporated by reference to the Proxy Statement (to be filed).\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 to the Proxy Statement (to be filed).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nThe information required by this item is hereby incorporated by reference to the Proxy Statement (to be filed).\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ----------------------------------------------------------------\n(A) EXHIBITS\nSee \"Index to Exhibits\" hereinafter contained and incorporated herein by reference.\n(B) SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULES\nThe following financial information is filed herewith on the pages indicated:\nAll other schedules are omitted since they are not applicable, not required or the required information is included in the financial statements or notes thereto.\n(C) 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.\nGRC INTERNATIONAL INC.\nDate: September 21, 1995 By: \/s\/ JimRoth ------------------ ------------------------------- Jim Roth President and Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Philip R. Pietras his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPursuant to 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: September 21, 1995 By: \/s\/ Jim Roth ------------------ ------------------------------- Jim Roth President and Chief Executive Officer\nDate: September 21, 1995 By: \/s\/ Philip R. Pietras ------------------ ------------------------------- Philip R. Pietras Vice President, Treasurer and Chief Financial Officer\nDate: September 21, 1995 By: \/s\/ H. Furlong Baldwin ------------------ ------------------------------- H. Furlong Baldwin, Director\nDate: September 21, 1995 By: \/s\/ Leslie B. Disharoon ------------------ ------------------------------- Leslie B. Disharoon, Director\nDate: September 21, 1995 By: \/s\/ Charles H.P. Duell ------------------ ------------------------------- Charles H.P. Duell, Director\nDate: September 21, 1995 By: \/s\/ Edward C. Meyer ------------------ ------------------------------- Edward C. Meyer, Chairman of the Board\nDate: September 21, 1995 By: \/s\/ George R. Packard ------------------ ------------------------------- George R. Packard, Director\nDate: September 21, 1995 By: \/s\/ Herbert Rabin ------------------ ------------------------------- Herbert Rabin, Director\nDate: September 21, 1995 By: \/s\/ Harris W. Seed ------------------ ------------------------------- Harris W. Seed, Director and Assistant Secretary\nDate: September 21, 1995 By: \/s\/Joseph R. Wright, Jr. ------------------ ------------------------------- Joseph R. Wright, Jr., Director\nINDEPENDENT AUDITORS' REPORT ---------------------------- ON -- SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULE ------------------------------------------\nTo the Stockholders of GRC International, Inc.:\nWe have audited the consolidated financial statements of GRC International, Inc. and subsidiaries 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 August 11, 1995, except as to the fourth paragraph of Note 5, as to which the date is September 14, 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 consolidated financial statement schedule of GRC International, Inc. listed in Item 14. This consolidated 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, 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 McLean, Virginia August 11, 1995, except as to the fourth paragraph of Note 5, as to which the date is September 14, 1995\nINDEPENDENT AUDITORS' CONSENT -----------------------------\nWe consent to the incorporation by reference in Registration Statements No. 33-1046, 33-39512, 33-39513, 33-52536, 33-52538, 33-87981 and 33-87982 of GRC International, Inc. on Form S-8 of our reports dated August 11, 1995, except as to the fourth paragraph of Note 5, as to which the date is September 14, 1995, appearing in and incorporated by reference in this Annual Report on Form 10-K of GRC International, Inc. for the year ended June 30, 1995.\nDELOITTE & TOUCHE LLP McLean, Virginia September 21, 1995\nGRC INTERNATIONAL, INC. AND SUBSIDIARIES ---------------------------------------- SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ----------------------------------------------- (IN THOUSANDS)\n\/(A)\/ Reductions of revenue for potentially nonrecoverable costs. \/(B)\/ Write off of uncollectible accounts and cost against reserves, net of recoveries.\nINDEX TO EXHIBITS\n(EXHIBIT NUMBERS CORRESPOND TO EXHIBIT TABLE, REGULATION S-K, ITEM 601)\n* Indicates management contract or compensatory plan.","section_15":""}
{"filename":"702403_1995.txt","cik":"702403","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Dyco Oil and Gas Program 1981-2 Limited Partnership (the \"Program\") is a Minnesota limited partnership engaged in the production of oil and gas. The Program commenced operations on June 1, 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 17 -- Total 18\nNet productive wells(3): Oil .27 Gas 1.97 ---- Total 2.24\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 -------- -------- -------- Production: Oil (Bbls)(1) 1,042 1,389 897 Gas (Mcf)(2) 217,111 186,160 135,140\nOil and gas sales: Oil $ 16,155 $ 19,839 $ 14,537 Gas 293,175 282,540 236,655 ------- ------- ------- Total $309,330 $302,379 $251,192 ======= ======= ======= Total direct operating expenses $145,795 $126,433 $171,788 ======= ======= =======\nDirect operating expenses as a percentage of oil and gas sales 47.1% 41.8% 68.4%\nAverage sales price: Per barrel of oil $15.50 $14.28 $16.21 Per Mcf of gas 1.35 1.52 1.75\nDirect operating expenses per equivalent Mcf of gas(3) $ .65 $ .65 $ 1.22\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.\n(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\nreflect 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 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 Values From Proved Reserves\nAs of December 31, 1995\nEstimated proved reserves: Natural gas (Mcf) 1,222,493 Oil and liquids (Bbls) 4,029\nNet present value (discounted at 10% per annum) $ 857,169\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 18 gross (2.24 net) productive wells in which the Program owned a working interest. The Program owned a non-working interest in an additional 3 gross wells. Affiliates of the Program operate 11 (52%) of its total wells. As of December 31, 1995, the Program's net interests in its properties resulted in estimated total proved reserves of 1,222,493 Mcf of natural gas and 4,029 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 17 gross (1.97 net) wells in which the Program owned a working interest. The Program owned a non-working interest in an additional 3 gross wells. Affiliates of the Program operate 10 (50%) 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 1,069,838 Mcf of natural gas and approximately 2,288 barrels of crude oil, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $722,992.\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 $115 $ - Second Quarter 140 - Third Quarter 140 - Fourth Quarter 140 -\n1995: First Quarter $140 - Second Quarter 140 - Third Quarter 142 - Fourth Quarter 142 -\n1996: First Quarter $142 (1)\n- - ---------- (1) To be declared in March 1996.\nThe Program has 6,074 Units outstanding and approximately 1,996 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 increased 2.3% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase was primarily a result of an increase in the volumes of natural gas sold, partially offset by a decrease in the average price of natural gas sold and a decrease in the volumes of oil sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994. Volumes of oil sold decreased by 347 barrels, while volumes of natural gas sold increased by 30,951 Mcf for the year ended December 31, 1995 as compared to the year ended December 31, 1994. The increase in volumes of natural gas sold resulted primarily from (i) the shutting in of one well during the year ended December 31, 1994 which resulted in increased pressure on the well, thereby improving the well's production capabilities in 1995 and (ii) a recompletion on another well during the year ended December 31, 1995 which significantly improved the well's production capabilities during the remainder of the year, partially\noffset by a negative gas balancing adjustment on another well during the year ended December 31, 1995. Average natural gas prices decreased to $1.35 per Mcf for the year ended December 31, 1995 from $1.52 per Mcf for the year ended December 31, 1994, while the average price of oil sold increased to $15.50 per barrel for the year ended December 31, 1995 from $14.28 per barrel for the year ended December 31, 1994.\nOil and gas production expenses (including lease operating expenses and production taxes) increased 15.3% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase resulted primarily from the increase in volumes of natural gas sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994, partially offset by an accrual for certain legal contingencies during the year ended December 31, 1994. As a percentage of oil and gas sales, these expenses increased to 47.1% for the year ended December 31, 1995 from 41.8% for the year ended December 31, 1994. This percentage increase was primarily a result of the increase in oil and gas production expenses discussed above and 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.\nDepreciation, depletion, and amortization of oil and gas properties decreased $34,161 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily a result of a significant increase in the estimate of the Program's remaining natural gas reserves at December 31, 1995. As a percentage of oil and gas sales, this expense decreased to 10.2% for the year ended December 31, 1995 from 21.7% for the year ended December 31, 1994. This percentage decrease was primarily a result of the increase in the estimate of the Program's remaining natural gas reserves as discussed above.\nGeneral and administrative expenses increased $6,431 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase resulted 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 21.4% for the year ended December 31, 1995 from 19.8% for the year ended December 31, 1994. This percentage increase was primarily a result of the dollar increase in general and administrative expenses discussed above.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993 -------------------------------------\nTotal oil and gas sales increased 20.4% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This increase was due to increases in the volumes of oil and natural gas sold, partially offset by decreases in the average prices of oil and natural gas sold. Volumes of oil and natural gas sold increased by 492 barrels and 51,020 Mcf, respectively, for the year ended December 31, 1994 as compared to the year ended December 31, 1993. The increase in volumes of natural gas sold resulted primarily from the shutting in of one well during part of the year ended December 31, 1993 which resulted in increased pressure on the well which improved the well's production capabilities. Average oil and natural gas prices decreased to $14.28 per barrel and $1.52 per Mcf for the year ended December 31, 1994 from averages of $16.21 per barrel and $1.75 per Mcf for the year ended December 31, 1993.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased 26.4% 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 decreased to 41.8% for the year ended December 31, 1994 from 68.4% for the year ended December 31, 1993. These decreases reflected a return to expected levels of such expenses from the abnormally high levels of such expenses during the year ended December 31, 1993. However, these decreases were offset by an accrual for certain legal contingencies in the current period.\nDepreciation, depletion, and amortization of oil and gas properties increased $31,475 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This dollar increase was primarily due to the increase in volumes of oil and natural gas sold and reduced year-end prices associated with the Program's remaining natural gas reserves in 1994. As a percentage of oil and gas sales, this expense increased to 21.7% for the year ended December 31, 1994 from 13.6% for the year ended December 31, 1993. This percentage increase was primarily a result of the dollar increase discussed above and the decreases in the average prices of oil and natural gas sold.\nGeneral and administrative expenses decreased slightly by $1,048 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 decreased slightly to 19.8% for the year ended December 31, 1994 from 24.3% for the year ended December 31, 1993.\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 5.6 years for gas reserves and 3.9 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 1981-2 LIMITED PARTNERSHIP\nWe have audited the financial statements of the Dyco Oil and Gas Program 1981-2 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 1981-2 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 1981-2 LIMITED PARTNERSHIP Balance Sheets December 31, 1995 and 1994\nASSETS ------ 1995 1994 -------- -------- CURRENT ASSETS: Cash and cash equivalents $245,084 $163,279 Accrued oil and gas sales, including $58,366 and $49,800 due from related parties 62,818 51,195 ------- ------- Total current assets $307,902 $214,474\nNET OIL AND GAS PROPERTIES, utilizing the full cost method 164,698 173,279\nDEFERRED CHARGE 51,226 60,571 ------- ------- $523,826 $448,324 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL --------------------------------- CURRENT LIABILITIES: Accounts payable $ 29,391 $ 27,536 Gas imbalance payable - 9,730 ------- ------- Total current liabilities $ 29,391 $ 37,266\nACCRUED LIABILITY 128,288 120,306\nCONTINGENCY (Note 4)\nPARTNERS' CAPITAL: General Partner, issued and outstanding, 74 Units 3,661 2,907 Limited Partners, issued and outstanding, 6,000 Units 362,486 287,845 ------- ------- Total Partners' Capital $366,147 $290,752 ------- ------- $523,826 $448,324 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-2 LIMITED PARTNERSHIP Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------- -------- -------- REVENUES: Oil and gas sales, including $289,835, $273,334, and $236,655 of sales to related parties $309,330 $302,379 $251,192 Interest 9,712 3,471 3,689 Other - - 24,935 ------- ------- -------\n$319,042 $305,850 $279,816\nCOSTS AND EXPENSES: Lease operating $124,768 $101,276 $153,291 Production Taxes 21,027 25,157 18,497 Depreciation, depletion, and amortization of oil and gas properties 31,503 65,664 34,189 General and administrative 66,349 59,918 60,966 ------- ------- -------\n$243,647 $252,015 $266,943 ------- ------- -------\nNET INCOME $ 75,395 $ 53,835 $ 12,873 ======= ======= =======\nGENERAL PARTNER (1%) - NET INCOME $ 754 $ 538 $ 129 ======= ======= =======\nLIMITED PARTNERS (99%) - NET INCOME $ 74,641 $ 53,297 $ 12,744 ======= ======= =======\nNET INCOME per Unit $ 12 $ 9 $ 2 ======= ======= =======\nUNITS OUTSTANDING 6,074 6,074 6,074 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-2 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 $8,618 $853,196 $861,814 Cash distributions ( 6,378) ( 631,392) ( 637,770) Net income 129 12,744 12,873 ----- ------- -------\nBalances at December 31, 1993 $2,369 $234,548 $236,917 Net income 538 53,297 53,835 ----- ------- -------\nBalances at December 31, 1994 $2,907 $287,845 $290,752 Net income 754 74,641 75,395 ----- ------- -------\nBalances at December 31, 1995 $3,661 $362,486 $366,147 ===== ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-2 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 $ 75,395 $ 53,835 $ 12,873 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 31,503 65,664 34,189 (Increase) decrease in accrued oil and gas sales ( 11,623) ( 20,171) 68,861 Decrease in related party receivable - - 380,092 (Increase) decrease in deferred charge 9,345 ( 60,571) - Increase (decrease) in payable to General Partner - ( 11,000) 11,000 Increase (decrease) in accounts payable 1,855 20,253 ( 432) Increase (decrease) in gas imbalance payable ( 9,730) 207 9,523 Increase in accrued liability 7,982 48,736 71,570 ------- ------- ------- Net cash provided by operating activities $104,727 $ 96,953 $587,676 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties ($ 22,963) ($ 14,615) ($ 34,236) Retirements of oil and gas properties 41 2,899 235 ------- ------- ------- Net cash used by investing activities ($ 22,922) ($ 11,716) ($ 34,001) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions $ - $ - ($637,770) ------- ------- ------- Net cash used by financing activities $ - $ - ($637,770) ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 81,805 $ 85,237 ($ 84,095)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 163,279 78,042 162,137 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $245,084 $163,279 $ 78,042 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-2 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 1981-2 Limited Partnership (the \"Program\"), a Minnesota limited partnership, commenced operations on June 1, 1981. Dyco Petroleum Corporation (\"Dyco\") is the General Partner of the Program. Affiliates of Dyco owned 2,406.05 (39.6%) 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 $0.14, $0.34, and $0.24, 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 108,415 Mcf, resulting in prepaid lease operating expenses of $51,226. 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 125,250 Mcf, resulting in prepaid lease operating expenses of $60,571.\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 271,509 Mcf, resulting in accrued lease operating expenses of $128,288. 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 248,771 Mcf, resulting in accrued lease operating expenses of $120,306.\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, 1994, total sales exceeded the Program's share of estimated total gas reserves on three wells by $9,730 (6,852 Mcf). This amount was recorded as gas imbalance payable at December 31, 1994 in accordance with the sales method. At December 31, 1995, no such liability was recorded.\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 $66,349, $59,918, and $60,966, respectively, of which $47,952, $47,952, and $47,490, were paid to Dyco and its affiliates.\nThe Program had a payable to the General Partner of $11,000 at December 31, 1993. The Program repaid the General Partner in full in March, 1994.\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 has sold 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 $289,835, $273,334, and $236,655, respectively. At December 31, 1995 and 1994, accrued oil and gas sales included $58,366, and $49,800, 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 93.7% 90.4% 94.2%\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. The Program's share of such verdict is approximately $155,000 in actual damages and approximately $31,000 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 in the amount 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 ------------- ------------- Proved properties $39,719,805 $39,696,883\nUnproved properties, not subject to depreciation, depletion, and amortization - - ---------- ----------\n$39,719,805 $39,696,883\nLess accumulated depreciation, depletion, amortization, and valuation allowance ($39,555,107) ($39,523,604) ---------- ----------\nNet oil and gas properties $ 164,698 $ 173,279 ========== ==========\nCosts 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 22,963 14,615 34,236 ------ ------ ------\nTotal costs incurred $22,963 $14,615 $34,236 ====== ====== ======\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.\nPART 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) $47,952 $47,952 $47,490\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 majority 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 compensation 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 $289,835, $273,334, and $236,655, 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\naffiliated 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 2,406.05 (39.6%)\nAll directors, officers, and affiliates of Dyco as a group and Dyco (8 persons) 2,406.05 (39.6%)\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 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 the 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.\nThese provisions are similar to those contained in prospectuses and partnership agreements for other public oil and gas partnerships.\nFor a description of certain other 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 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 June 5, 1981 for Dyco Drilling Program 1981-2 by and between Dyco Oil and Gas Program 1981-2, 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 by reference.\n4.2 Program Agreement dated June 5, 1981 for Dyco Oil and Gas Program 1981-2 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 by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1981-2 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 by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1981-2 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 by reference.\n27.1 Financial Data Schedule containing summary finan- cial information extracted from the Dyco Oil and Gas Program 1981-2 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 1981-2 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 June 5, 1981 for Dyco Drilling Program 1981-2 by and between Dyco Oil and Gas Program 1981-2, 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 by reference.\n4.2 Program Agreement dated June 5, 1981 for Dyco Oil and Gas Program 1981-2 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 by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1981-2 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 by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1981-2 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 by reference.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1981-2 Limited Partnership's financial statements as of December 31, 1995 and for the year ended December 31, 1995.","section_15":""}
{"filename":"842785_1995.txt","cik":"842785","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF PARTNERSHIP\nSwift Energy Managed Pension Assets Partnership 1988-1, Ltd., a Texas limited partnership (the \"Partnership\" or the \"Registrant\"), is a partnership formed under a public serial limited partnership offering denominated Swift Energy Managed Pension Assets Fund II (Registration Statement No. 33-19721 on Form S-1, originally declared effective April 22, 1988 and amended effective May 3, 1988 [the \"Registration Statement\"]). The Partnership was formed effective September 14, 1988 under a Limited Partnership Agreement dated September 13, 1988. The initial 190 limited partners made capital contributions of $1,874,876.\nThe Partnership is principally engaged in the business of acquiring nonoperating interests (I.E., net profits interests, royalty interests and overriding royalty interests) in proven oil and gas properties within the continental United States. The Partnership does not acquire working interests in or operate oil and gas properties, and does not engage in drilling activities. At 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 organizational fees and expenses) in the acquisition and development of nonoperating interests in producing properties, which properties are described under Item 2, \"Properties,\" below. The Partnership's income is derived almost entirely from its nonoperating interests and the disposition thereof.\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 Partners, Ltd. (\"VJM\"), a Texas limited partnership, consults with and advises Swift as to certain financial matters.\nThe general manner in which the Partnership acquires nonoperating interests and otherwise conducts its business is described in detail in the Registration Statement under \"Proposed Activities,\" which is incorporated herein by reference. The following is intended only as a summary of the Partnership's manner of doing business and specific activities to date.\nMANNER OF ACQUIRING NONOPERATING INTERESTS IN PROPERTIES; NET PROFITS AND OVERRIDING ROYALTY INTEREST AGREEMENT\nThe nonoperating interests owned by the Registrant have typically been acquired pursuant to a Net Profits and Overriding Royalty Interest Agreement dated September 14, 1988 (the \"NP\/OR Agreement\") between the Registrant and Swift Energy Income Partners 1988-1, Ltd. (the \"Operating Partnership\"). The Operating Partnership is a Texas limited partnership that is also managed by Swift and VJM. The Operating Partnership was formed to acquire and develop producing oil and gas properties.\nUnder the NP\/OR Agreement, the Registrant and the Operating Partnership have, in effect, combined their funds to acquire producing properties. Using funds committed to the NP\/OR Agreement by both partnerships, the Operating Partnership acquires producing properties, then promptly conveys nonoperating interests therein to the Registrant. The Operating Partnership retains a working interest in each such property, and is responsible for the production of oil and gas therefrom. For the sake of legal and administrative convenience, producing properties are usually acquired from the third party sellers by Swift, which then conveys a working interest in each such property to the Operating Partnership. The Registrant initially committed $1,610,215 and the Operating Partnership initially committed $1,694,818 for acquisitions under the NP\/OR Agreement. The Operating Partnership is obligated under the NP\/OR Agreement to convey to the Registrant a 49% fixed net profits interest and a variable overriding royalty interest in specified depths of all producing properties acquired under the NP\/OR Agreement.\nUnder the NP\/OR Agreement, the Operating Partnership is required to convey to the Registrant, and the Registrant is required to purchase, nonoperating interests in all producing properties acquired by the Operating Partnership, except that:\nI-1\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD.\n1. properties anticipated to require significant development operations and nonoperating interests offered to the Operating Partnership by third parties may be purchased by the Operating Partnership outside the NP\/OR Agreement, without participation by the Registrant;\n2. during a specified one-year period, the Registrant is entitled to reduce the amount originally committed by it to purchases under the NP\/OR Agreement and to redirect such funds to the purchase of nonoperating interests from sources other than the Operating Partnership; and\n3. the Registrant's funds will be released from the NP\/OR Agreement if they are not completely spent by the Operating Partnership within a specified period, or if there is a prior withdrawal of funds by the Operating Partnership to purchase properties anticipated to require significant development.\nPurchases of nonoperating interests by the Registrant using withdrawn or released funds may be made from the Managing General Partner and its affiliates, other partnerships affiliated with the Operating Partnership (possibly through the Registrant's entry into a new NP\/OR Agreement), or from unaffiliated third parties. During 1988, the Registrant withdrew a portion of its funds originally committed to the NP\/OR Agreement in order to purchase certain nonoperating interests directly from Northwind Exploration Company.\nIn accordance with its obligations under the NP\/OR Agreement, as of December 31, 1995 the Operating Partnership had conveyed to the Registrant a 49% net profits interest burdening certain depths of all producing properties acquired by the Operating Partnership thereunder. Typically, a net profits interest in an oil and gas property entitles the owner to a specified percentage share of the gross proceeds generated by the burdened property, net of operating costs. The net profits interest conveyed to the Registrant under the NP\/OR Agreement differs from the typical net profits interest in that it is calculated over the entire group of producing properties conveyed under the NP\/OR Agreement; I.E., all operating costs attributable to the burdened depths of such properties are aggregated, and the total is then subtracted from the total of all gross proceeds attributable to such depths in order to calculate the net profits to which the Registrant is entitled. The net profits interest conveyed to the Registrant burdens only those depths of each subject property which were evaluated to contain proved reserves at the date of acquisition, to the extent such depths underlie specified surface acreage.\nThe Operating Partnership has also conveyed to the Registrant under the NP\/OR Agreement an overriding royalty interests in each property acquired thereunder. An overriding royalty interest is a fractional interest in the gross production (or the gross proceeds therefrom) of oil and gas from a property, free of any exploration, development, operation or maintenance expenses. Under the NP\/OR Agreement, the overriding royalty interest burdens the portions of each producing property that were evaluated at the date of acquisition not to contain proved reserves.\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-2\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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.\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-3\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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-4\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. NONOPERATING INTERESTS IN PROPERTIES\nAs of December 31, 1995, the Partnership has acquired nonoperating interests in producing oil and gas properties which are generally described below.\nPRINCIPAL OIL AND GAS PRODUCING PROPERTIES\nThe Partnership's fields are highly diversified in 7 states none of which equals or exceeds 15 percent of the total Partnership value.\nTITLE TO PROPERTIES\nTitle to substantially all significant producing properties in which the Partnership owns nonoperating interests has been examined. In addition to the nonoperating interests owned by the Partnership, 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 volumes of the Partnership's net nonoperating interests in oil and gas production expressed in MCFs. 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-5\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD.\nNET PROVED OIL AND GAS RESERVES\nPresented below are the estimates of the Partnership's nonoperating interests in proved reserves as of December 31, 1995, 1994 and 1993. All of the Partnership's nonoperating interests in 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-6\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD.\nThe following table summarizes by acquisition the Registrant's reserves and its nonoperating interests in gross and net 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.\nI-7\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 190 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 $53,500 and $26,200, 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. The 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 and development by acquiring nonoperating interests in 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 nonoperating 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.\nRESULTS OF OPERATIONS\nIncome from nonoperating interests decreased 43 percent in 1995 over 1994. Oil and gas sales decreased 31 percent in 1995 vs. 1994. Production volumes decreased 13 percent due to a 12 percent gas production decrease and a 17 percent oil production decline. Since the Partnership's reserves are 74 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 27 percent or $.54\/MCF further contributed to the Partnership's decreased revenues.\nAssociated amortization expense decreased 8 percent in 1995 when compared to 1994.\nIncome from nonoperating interests remained virtually unchanged in 1994 over 1993. Oil and gas sales decreased 13 percent in 1994 vs. 1993. Production volumes decreased 16 percent due to an 18 percent gas production decrease and a 7 percent oil production decline. Since the partnership's reserves are 74 percent gas, the decrease in gas production, due to accelerated production declines on mature wells and production curtailments due to declining prices, had a major impact on partnership performance. The Partnership experienced a decline in oil prices of 6 percent or $.88\/BBL further contributing to the decreased revenues. An increase in gas prices of 4 percent or $.07\/MCF compared to 1993 partially offset the production declines.\nAssociated amortization expense decreased 12 percent in 1994 when compared to 1993.\nThe Partnership recorded an additional provision in amortization in 1995 and 1994 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.\nII-2\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD.\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.\nII-3\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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.\nIII-1\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 are 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, on one hand, and Swift, VJM and their affiliates, on the other.\nCERTAIN TRANSACTIONS WITH GENERAL PARTNERS\n1. As described in Item 1, \"Business,\" above, during 1988 the Partnership entered into an NP\/OR Agreement with the Operating Partnership, which is also managed by Swift and VJM. Pursuant to such NP\/OR Agreement, the Operating Partnership acquired the oil and gas properties described under Item 2 above and conveyed nonoperating interests therein to the Partnership.\n2. Swift acts as operator for many of the wells in which the Partnership has nonoperating 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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, 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 -----------------------------\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 Limited Partnership Agreement of Swift Energy Managed Pension Assets Partnership 1988-1, Ltd., dated September 13, 1988. (Form 10-K for year ended December 31, 1988, Exhibit 3.1).\n3.2 Certificate of Limited Partnership of Swift Energy Managed Pension Assets Partnership 1988-1, Ltd., as filed September 14, 1988, with the Texas Secretary of State. (Form 10-K for year ended December 31, 1988, Exhibit 3.2).\n10.1 Net Profits and Overriding Royalty Interest Agreement between Swift Energy Managed Pension Assets Partnership 1988-1, Ltd. and Swift Energy Income Partners 1988-1, Ltd. dated September 14, 1988. (Form 10-K for year ended December 31, 1988, Exhibit 10.1).\n99.1 A copy of the following section of the Prospectus dated April 22, 1988, contained in Pre-Effective Amendment No. 1 to Registration Statement No. 33-19721 on Form S-1 for Swift Energy Managed Pension Assets Partnership II, as filed on April 21, 1988, which have been incorporated herein by reference: \"Proposed Activities\" (pp 38 - 48) and \"Conflicts of Interest\" (pp. 65 - 73). (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, 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 to security holders covering the Partnership's 1995 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 Managed Pension Assets Partnership 1988-1, Ltd.:\nWe have audited the accompanying balance sheets of Swift Energy Managed Pension Assets Partnership 1988-1, 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 Managed Pension Assets Partnership 1988-1, 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD. BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-3\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-4\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD. NOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND TERMS OF PARTNERSHIP AGREEMENT -\nSwift Energy Managed Pension Assets Partnership 1988-1, Ltd., a Texas limited partnership (the Partnership), was formed on September 14, 1988, for the purpose of purchasing net profits interests, overriding royalty interests and royalty interests (collectively, \"nonoperating interests\") in producing oil and gas properties within the continental United States. Swift Energy Company (\"Swift\"), a Texas corporation, and VJM Partners, Ltd. (\"VJM\"), a Texas limited partnership, serve as Managing General Partner and Special General Partner of the Partnership, respectively. The Managing General Partner is required to contribute up to 1\/99th of limited partner net contributions. The 190 limited partners made total capital contributions of $1,874,876.\nNonoperating interests acquisition costs and the management fee are borne 99 percent by the limited partners and one percent by the Managing General Partner. Organization and syndication costs were borne solely by the limited partners.\nInitially, all continuing costs (including 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, 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. During 1989, the cash distribution rate (as defined in the Partnership Agreement) exceeded 17.5 percent and thus, in 1990, the continuing costs and revenues were shared 85 percent by the limited partners, and 15 percent by the general partners. During 1990, the cash distribution rate fell below 17.5 percent and thus, beginning in 1991, the continuing costs and revenues were shared 90 percent by the limited partners and 10 percent by the general partners. 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.\nNONOPERATING INTERESTS IN OIL AND GAS PROPERTIES -\nFor financial reporting purposes, the Partnership follows the \"full-cost\" method of accounting for nonoperating interests in oil and gas properties. Under this method of accounting, all costs incurred in the acquisition of nonoperating interests in oil and gas properties are capitalized. The unamortized cost of nonoperating interests in 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 nonoperating interests in proved properties using current prices, discounted at ten percent. Proceeds from the sale or disposition of nonoperating interests in oil and gas properties are treated as a reduction of the cost of the nonoperating interests with no gains or losses recognized except in significant transactions.\nThe Partnership computes the provision for amortization of nonoperating interests in oil and gas properties on the units-of-production method. Under this method, the provision is calculated by multiplying the total unamortized cost of nonoperating interests in oil and gas properties by an overall rate 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 attributable to the Partnership's nonoperating interests at the beginning of the period.\nIV-7\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe calculation of the \"ceiling limitation\" and the provision for 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) ACQUISITION OF NONOPERATING INTERESTS IN OIL AND GAS PROPERTY COSTS -\nEffective September 14, 1988, the Partnership entered into a Net Profits and Overriding Royalty Interests Agreement (NP\/OR Agreement) with Swift Energy Income Partners 1988-1, Ltd. (Operating Partnership), managed by Swift, for the purpose of acquiring interests in producing oil and gas properties. Under terms of the NP\/OR Agreement, the Partnership has been conveyed a nonoperating interest in the aggregate net profits (i.e., oil and gas sales net of related operating costs) of the properties acquired equal to its proportionate share of the property acquisition costs as defined. Property acquisition costs are amounts actually paid by the Operating Partnership for the properties plus costs incurred by the Operating Partnership in acquiring the properties and costs related to screening and evaluation of properties not acquired. In 1995, 1994 and 1993, the Partnership acquired nonoperating interests in producing oil and gas properties for $8,626, $38,095 and $14,394, respectively.\nDuring 1995 and 1994, the Partnership's unamortized oil and gas property costs exceeded the quarterly calculations of the \"ceiling limitation\" resulting in an additional provision for amortization of $48,561 and $36,457, respectively. In addition, the limited partners' share of unamortized oil and gas property costs exceeded their \"ceiling limitation\" in 1995 and 1994 resulting in valuation allowances of $43,227 and $28,827, respectively. These amounts are included in the income (loss) attributable to the limited partners shown in the statements of partners' capital together with a \"combining adjustment\" for the differences between the limited partners' valuation allowances and the Partnership's valuation allowances. The \"combining adjustment\" changes quarterly as the Partnership's total amortization provision is more or less than the combined amortization provision attributable to general and limited partners.\n(4) RELATED-PARTY TRANSACTIONS -\nAn affiliate of the Special General Partner, as Dealer Manager, received $46,872 for managing and overseeing the offering of limited partnership units.\nA one-time management fee of $46,872 was paid Swift in 1988 for services performed for the Partnership. During 1995, 1994 and 1993 the Partnership paid Swift $4,911, $7,888 and $8,252, respectively, as general and administrative overhead allowances.\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 royalty income for federal income tax purposes is ultimately changed by the taxing authorities, the tax liability of the limited partners could be changed accordingly. Royalty income reported on the Partnership's federal return of income for the years ended December 31, 1995, 1994 and 1993 was $21,423, $36,113 and $56,166, respectively. The difference between royalty income for federal income tax purposes reported by the Partnership and income or loss from nonoperating interests reported herein primarily results from the exclusion of amortization (as described below) from ordinary income reported in the Partnership's federal return of income.\nIV-8\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nFor federal income tax purposes, amortization with respect to oil and gas is computed separately by the partners and not by the Partnership. Since the amount of amortization on nonoperating interests in oil and gas properties is not computed at the Partnership level, amortization 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 nonoperating interests in oil and gas properties, and thus is treated as a separate item on the partners' Schedule K-1. Amortization 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) 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(7) 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-9\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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 MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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-10\nSWIFT ENERGY MANAGED PENSION ASSETS PARTNERSHIP 1988-1, 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-11","section_15":""}
{"filename":"82329_1995.txt","cik":"82329","year":"1995","section_1":"Item 1.Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 2.","section_1A":"","section_1B":"","section_2":"Item 2.Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 3.","section_3":"Item 3. Legal Proceedings\nThe Company is one of the defendants in certain litigation brought in July 1984 by the Cheyenne-Arapaho Tribes of Oklahoma in the U.S. District Court for the Western District of Oklahoma, seeking to set aside two communitization agreements with respect to three leases involving tribal lands in which the Company previously owned interests and to have those leases declared expired. In June 1989, the U.S. District Court entered an interim order in favor of the plaintiffs. On appeal, the U.S. Court of Appeals for the Tenth Circuit upheld the decision of the trial court and petitions for rehearing of that decision were denied. Petitions for writs of certiorari filed by the parties with the U.S. Supreme Court have been denied, and the case has been remanded to the trial court for determination of damages.\nIn November 1988, a lawsuit was filed in the U.S. District Court for the Southern District of West Virginia against Reading & Bates Coal Co., a wholly owned subsidiary of the Company, by SCW Associates, Inc. claiming breach of an alleged agreement to purchase the stock of Belva Coal Company, a wholly owned subsidiary of Reading & Bates Coal Co. with coal properties in West Virginia. When those coal properties were sold in July 1989 as part of the disposition of the Company's coal operations, the purchasing joint venture indemnified Reading & Bates Coal Co. and the Company against any liability Reading & Bates Coal Co. might incur as the result of this litigation. A judgment for the plaintiff of $32,000 entered in February 1991 was satisfied and Reading & Bates Coal Co. was indemnified by the purchasing joint venture. On October 31, 1990, SCW Associates, Inc., the plaintiff in the above-referenced action, filed a separate ancillary action in the Circuit Court, Kanawha County, West Virginia against the Company and a wholly owned subsidiary of Reading & Bates Coal Co., Caymen Coal, Inc. (former owner of the Company's West Virginia coal properties), as well as the joint venture, Mr. William B. Sturgill personally (former President of Reading & Bates Coal Co.), three other companies in which the Company believes Mr. Sturgill holds an equity interest, two employees of the joint venture, First National Bank of Chicago and First Capital Corporation. The lawsuit seeks to recover compensatory damages of $50 million and punitive damages of $50 million for alleged tortious interference with the contractual rights of the plaintiff and to impose a constructive trust on the proceeds of the use and\/or sale of the assets of Caymen Coal, Inc. as they existed on October 15, 1988. Subsequently, the court entered an order dismissing the Company's indirect subsidiary. The Company intends to defend its interests vigorously and believes the damages alleged by the plaintiff in this action are highly exaggerated. In any event, the Company believes that it has valid defenses and that it will prevail in this litigation.\nOn March 17, 1995, an action was filed by Louis Silverman, individually and on behalf of all other shareholders of Reading & Bates Corporation similarly situated, against the Company and the individual members of its board of directors in the Court of Chancery of the State of Delaware, New Castle County. On April 7, 1995 three additional actions were filed on behalf of Congregation Beth Joseph, Harry Lewis and Mortimer Shulman against the Company and its directors in the Court of Chancery of the State of Delaware. In each of the four actions, the plaintiff alleges, inter alia, that the directors breached their fiduciary duties by rejecting the previously announced unsolicited merger proposal made by Sonat Offshore Drilling Inc. and by adopting the previously announced shareholder rights plan. Each of the named plaintiffs in the four actions purports to be an owner of the Company's Common Stock and seeks to represent a class of shareholders of the Company who are similarly situated. Each of the plaintiffs seeks injunctive relief, damages in unspecified amounts and certain other relief, including costs and expenses. The Company believes each of the plaintiff's claims in these four actions are groundless and that the defendants have meritorious defenses in each action. The Company intends to defend each action vigorously.\nThe Company is involved in these and various other legal actions arising in the normal course of business. After taking into consideration the evaluation of such actions by counsel for the Company, management is of the opinion that outcome of all known and potential claims and litigation will not have a material adverse effect on the Company's business or consolidated financial position or results of operations. See Note E of Notes to Consolidated Financial Statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted to a vote of security holders of the Company during the fourth quarter of fiscal year 1995.\nRegulation S-K Item 401(b)\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information concerning each executive officer of the Company. Unless otherwise indicated, each has served in the positions set forth for more than five years. Executive officers are elected for a term of one year. There are no family relationships between any of the persons named.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Company's Common Stock is traded on the New York and Pacific Stock Exchanges under the symbol \"RB\". The following table shows for the periods indicated the high and low sales prices of the Common Stock as reported on the New York Stock Exchange Composite Transactions Tape.\nThere were approximately 7,100 holders of record of the Company's Common Stock as of February 29, 1996.\nThe Company has not paid cash dividends on the Common Stock since the first quarter of 1986 and management does not expect any cash dividends will be declared or paid on the Common Stock in the reasonably foreseeable future.\nIn March 1995, the Company adopted a Preferred Share Rights Agreement. See \"FINANCIAL CONDITION\" under Item 7.\nItem 6.","section_6":"Item 6. Selected Financial Data\nREADING & BATES CORPORATION AND SUBSIDIARIES\n(in thousands except per share amounts)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFINANCIAL CONDITION\nMerger Proposal\nOn February 28, 1995, the Company announced that it had received an unsolicited merger proposal from Sonat Offshore Drilling Inc. (\"Sonat Offshore\") providing for the acquisition of 100% of the common stock of the Company for a combination of Sonat Offshore common stock and $100 million in cash. As proposed by Sonat Offshore, the Company's shareholders would have, at their election, received either (i) .357 shares of Sonat Offshore common stock or (ii) $7.50 of cash for each share of the Company. To the extent that the election resulted in an under- or oversubscription as to the $100 million of cash, a proration formula would have been utilized. The Company engaged Morgan Stanley & Co. Incorporated to act as its financial advisor with respect to evaluating the Sonat Offshore proposal. On March 16, 1995, the Company announced that its board of directors had rejected the Sonat Offshore proposal on the basis that it was not in the best interests of the Company and its shareholders. On April 18, 1995, Sonat Offshore announced that the merger discussions had broken off following the rejection by the Company of Sonat Offshore's proposal. The Company responded the same day announcing that discussions with Sonat Offshore had not to that date demonstrated a willingness on the part of Sonat Offshore to consider a transaction that would be reflective of the short-term or long-term business prospects and value of the Company. Subsequent to their announcing their intent to break off discussions in April 1995, Sonat Offshore initiated additional discussions in May 1995 with regard to potential merger transactions. However, these subsequent discussions similarly did not result in terms that recognized the Company's current or long-term value. The Company and Sonat Offshore discontinued discussions in June 1995. The Company remains willing to engage in discussions regarding possible business combinations that would potentially strengthen its competitive position in the offshore drilling industry, appropriately reflect the underlying value of the Company and maximize shareholder value.\nArcade Acquisition\nIn June 1994, the Company completed a transaction which increased its direct ownership in Arcade Drilling AS (\"Drilling\") and sold its entire ownership in Arcade Shipping AS (\"Shipping\"). The transaction consisted of the Company selling its entire 82.6% ownership in Shipping for approximately $27.8 million, purchasing from Shipping its entire 46.2% ownership in Drilling and equity securities in Dragon Oil for approximately $45.4 million and Shipping repaying a loan of approximately $12.9 million to the Company. This transaction resulted in a net cash outflow of $4.7 million. Also in September 1994, the Company purchased an additional 5.7% of Drilling's outstanding shares pursuant to a mandatory tender offer in Norway required by the Oslo Stock Exchange. In December 1995, the management agreement for one of Drilling's drilling units expired and a subsidiary of the Company now manages the drilling unit. See \"The Company's Fleet\" under Items 1 and 2. As of December 31, 1995, the Company's direct ownership in Drilling was 74.4%. See Note B of Notes to Consolidated Financial Statements.\nPurchase of Semisubmersibles\nIn September 1994, the Company purchased the second-generation semisubmersible \"RIG 41\" (ex \"BENVRACKIE\") with the intent to contribute the drilling unit to a new joint venture with DeepTech International Inc. The objective of the new joint venture company was to acquire and operate semisubmersible drilling units to be converted for use as floating production systems. However, it was subsequently agreed by the Company and DeepTech International Inc. not to establish the new joint venture and the rig is currently stacked and available for conversion to a floating production system or deployment, after completion of upgrades, as a conventional drilling unit.\nIn September 1995, the Company purchased the support vessel \"IOLAIR\" from BP Exploration Operating Company Limited (\"BP Exploration\"). The \"IOLAIR\" is a dynamically positioned third-generation deepwater semisubmersible support vessel built in 1982 for field support and living accommodations. The \"IOLAIR\" is currently contracted with BP Exploration and is expected to undergo a comprehensive upgrade in 1996 after which it would be used under a long-term contract with BP Exploration for its west of Shetland development program for up to 200 days per year. The vessel would be available for use by other North Sea area operators for the remaining period of each year. Also in September 1995, the Company purchased the second-generation semisubmersible drilling unit \"RIG 42\" from FPS II, Inc. \"RIG 42\" is a candidate for the extended well test market, deepwater and\/or harsh environment drilling or eventual conversion to a floating production system. In connection with the purchase of \"RIG 42\" the Company issued 1,232,057 shares of the Company's Common Stock, par value $.05 per share and filed a shelf registration statement in September 1995 registering such 1,232,057 shares (see \"Shelf Registration\" below).\nSale\/Lease-back of Drilling Units\nIn November 1995, the Company entered into a sale\/lease-back of the \"M. G. HULME, JR.\". As part of this transaction the Company could receive up to $60 million in cash, inclusive of a $10 million funding provision for upgrades, and agreed to lease the drilling unit for ten years. As of December 31, 1995, the Company had received $52.5 million. The lease-back is accounted for as an operating lease and a deferred gain of $7.4 million was recorded and is being amortized over the life of the lease. In addition, the lease contains a provision which allows the Company to repurchase the drilling unit at the end of the lease for a fair market price. See Note E of Notes to Consolidated Financial Statements.\nIn March 1992, the Company entered into a sale\/lease-back of the \"SONNY VOSS\". Proceeds received of $27.7 million resulted in a gain of $6.3 million which was deferred and was being amortized over the lease term. In December 1994, for a fee of $.5 million, the Company negotiated an early release from all of its remaining lease obligations with respect to the \"SONNY VOSS\". Such lease obligations were scheduled to have expired in September 1995 and the net effect of the early release on the Company's results of operations was a gain of $.5 million recognized as a reduction of operating expenses in the fourth quarter of 1994. See Note E of Notes to Consolidated Financial Statements.\nPurchase of Oil & Gas Interest\nIn October 1995, the Company purchased an approximately 20% working interest in the Green Canyon 254 Allegheny oil and gas development project in the U.S. Gulf of Mexico from the operator, Enserch Exploration, Inc. (\"Enserch\"). The third-generation semisubmersible \"M. G. HULME, JR.\" has been contracted for three years to drill the development wells upon completion of an upgrade of the unit for operations in up to 3,300 feet of water, and the Company is expected to convert either its second-generation semisubmersible \"RIG 41\", or an equivalent unit, to a floating production vessel capable of processing up to 70,000 barrels of oil per day. In addition, Mobil Exploration & Producing U.S. Inc., an affiliate of Mobil Corporation, has a 40% working interest in the project. Enserch is expected to retain the remaining 40% working interest. As of December 31, 1995, the Company had accumulated costs related to the project of approximately $23.3 million which are included in Property and Equipment, Other.\nPurchase of Lease Debt\nIn the third quarter of 1994, the Company purchased certain notes and interests relating to the lease debt outstanding associated with the operating leases of the drilling units \"GEORGE H. GALLOWAY\" and \"C.E. THORNTON\", and the secured contingent obligations associated with the capital lease of the \"F.G. McCLINTOCK\". Total consideration for the transaction was approximately $36.5 million which consisted of the Company paying cash of approximately $12.2 million and issuing 4,230,235 shares of the Company's Common Stock, par value $.05 per share, totalling approximately $24.3 million at then prevailing stock prices. In October 1994, the Company filed a shelf registration registering such shares (see \"Shelf Registration\" below). In the second quarter of 1995, the Company acquired title to the \"GEORGE H. GALLOWAY\". See Note E of Notes to Consolidated Financial Statements.\nPublic Offering\nIn July 1993, the Company effected a public offering (the \"1993 Offering\") of 2,990,000 shares of $1.625 Convertible Preferred Stock, par value $1.00 per share (the \"Preferred Stock\"), pursuant to which the Company raised gross proceeds of approximately $74.7 million in cash (net proceeds of approximately $71.2 million). The proceeds were utilized to repay indebtedness under two credit facilities, both under the ING Facility, totalling approximately $17.1 million. See \"LIQUIDITY AND CAPITAL RESOURCES - ING Facility\". The remaining proceeds were used by the Company for working capital and general corporate purposes. The Preferred Stock is convertible at the option of the holder at any time into shares of the Company's Common Stock at a conversion rate of 2.899 shares of Common Stock for each share of Preferred Stock (equivalent to a conversion price of $8.625 per share of Common Stock), subject to adjustment in certain events. Annual dividends are $1.625 per share and are cumulative and are payable quarterly commencing September 30, 1993. The Preferred Stock is redeemable at any time on and after September 30, 1996, at the option of the Company, in whole or in part, at a redemption price of $26.1375 per share, and thereafter at prices decreasing ratably annually to $25.00 per share on and after September 30, 2003, plus accrued and unpaid dividends. The holders of the Preferred Stock do not have any voting rights, except as required by applicable law, and except that, among other things, whenever accrued and unpaid dividends on the Preferred Stock are equal to or exceed the equivalent of six quarterly dividends payable on the Preferred Stock, the holders of the Preferred Stock will be entitled to elect two directors to the Board until the dividend arrearage has been paid in full. The term of office of all directors so elected will terminate immediately upon such payment. The Preferred Stock has a liquidation preference of $25.00 per share, plus accrued and unpaid dividends. The Company has declared and paid all cumulative dividends accrued on the Preferred Stock through December 31, 1995.\nShelf Registration\nIn October 1994, the Company filed a shelf registration registering the 4,230,235 shares of the Company's Common Stock issued for the purchase of the leased rigs as discussed above. In September 1995, the Company filed a shelf registration registering the 1,232,057 shares of the Company's Common Stock issued for the purchase of \"RIG 42\", as previously discussed, and the Company has been informed that all of such shares have been sold. Pursuant to the terms of the registration rights agreements among the Company and certain other holders of the Company's Common Stock, as currently in effect, the Company is required to maintain continuously effective shelf registration statements with respect to approximately 7.4 million shares of its Common Stock until the earlier to occur of (i) the sale of such shares by the holders thereof or (ii) August 1, 1996 (in the case of approximately 5.4 million shares) or September 14, 1996 (in the case of approximately 2 million shares).\nPreferred Share Rights Agreement\nOn March 15, 1995, 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 outstanding on March 31, 1995 (the \"Record Date\"). Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, par value $1.00 per share (the \"Preferred Shares\") of the Company at a price of $30.50, subject to adjustment. The Rights will not become exercisable until 10 days after a public announcement that a person or group has acquired 10% or more of the Company's Common Stock (thereby becoming an \"Acquiring Person\") or the commencement of a tender or exchange offer upon consummation of which such person or group would own 10% or more of the Company's Common Stock (the earlier of such dates being called the \"Distribution Date\"). Rights will be issued for all shares of the Company's Common Stock issued and outstanding on the Record Date. Until the Distribution Date, the Rights will be evidenced by the certificates representing the Company's Common Stock and will be transferrable only with the Company's Common Stock. In the event that any person or group becomes an Acquiring Person, each Right, other than Rights beneficially owned by the Acquiring Person (which will thereafter be void), will thereafter entitle its holder to purchase shares of the Company's Common Stock having a market value of two times the exercise price of the Right. After any person or group has become an Acquiring Person and prior to the acquisition by such person or group of 50% or more of the outstanding shares of Common Stock, the Company's board of directors may exchange each Right (other than Rights of the Acquiring Person), in whole or in part, at an exchange ratio of one Common Share or one one-hundredth of a Preferred Share per Right. If after a person or group has become an Acquiring Person, the Company is acquired in a merger or other business combination transaction or 50% or more of its assets or earning power are sold, each Right will entitle its holder to purchase, at the Right's then current exercise price, that number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right. The board of directors of the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right at any time prior to such time as any person or group becomes an Acquiring Person. The Rights expire on March 31, 2005. Preferred Shares purchasable upon exercise of the Rights will not be redeemable. Each Preferred Share will be entitled to a preferential quarterly dividend payment equal to the greater of $1 per share or 100 times the dividend declared per Common Share. Liquidation preference will be equal to the greater of $100 per share or 100 times the payment made per Common Share. Each Preferred Share will have one vote, voting together with the Common Stock. See \"LIQUIDITY AND CAPITAL RESOURCES\".\nReverse Stock Split\nOn October 2, 1992, the Company effected a one-for-five reverse stock split of the Common Stock. All share and per share amounts have been restated.\nMiscellaneous\nIn February 1992, Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") was issued and supersedes substantially all existing income tax pronouncements. The Company adopted SFAS 109 effective January 1, 1993. The cumulative effect of the accounting change at January 1, 1993 was not material to the Company's consolidated results of operations or financial position. See Note A of Notes to Consolidated Financial Statements.\nIn October 1993, the Company announced that Mr. J. T. Angel, President and Chief Operating Officer, as well as a member of the Board of Directors, resigned from those positions in order to pursue other business interests. In the fourth quarter of 1993, the Company recorded a charge of approximately $1.1 million against earnings related to a severance agreement with Mr. Angel.\nIn March 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 121\") was issued. SFAS 121, which becomes effective in 1996, requires that certain long-lived assets be reviewed for impairment whenever events indicate that the carrying amount of an asset may not be recoverable, and that an impairment loss be recognized under certain circumstances in the amount by which the carrying value exceeds the fair value of the asset. In 1995, the Company adopted SFAS 121 which had no effect on the Company's consolidated results of operations or consolidated financial position. See Note A of Notes to Consolidated Financial Statements.\nFor a discussion of certain legal proceedings see Part I, Item 3.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity\nAt December 31, 1995, the Company had working capital of $41.3 million compared to $6.7 million at December 31, 1994. The $34.6 million increase is primarily due to improved cash flow and new term financing in 1995 that was used to repay the ING Facility (as discussed below) and the Company's debentures that matured in 1995.\nCash provided by operating activities during 1995 amounted to $34.5 million, an increase of $3.7 million from 1994. Cash provided by operating activities during 1994 amounted to approximately $30.8 million, an increase of $4.3 million from 1993.\nCash used in investing activities was $3.5 million in 1995 compared to $48.8 million in 1994 compared to $29.4 million in 1993. During 1995, the Company entered into a sale\/lease-back transaction of the \"M.G. HULME, JR.\" drilling unit that provided approximately $50 million of cash and used $51.9 million to purchase property and equipment, such as the oil and gas interest in the Gulf of Mexico as previously discussed. During 1994, the Company used $10.7 million to purchase additional shares in Drilling and $38.4 million to purchase property and equipment, such as the purchase of certain notes and interests relating to the lease debt outstanding associated with the operating leases of the drilling units \"GEORGE H. GALLOWAY\" and \"C. E. THORNTON\" and the secured contingent obligations associated with the capital lease of the drilling unit \"F. G. McCLINTOCK\", and the purchase of the second-generation semisubmersible drilling unit \"RIG 41\". During 1993, the Company used $20.6 million to purchase additional shares in Drilling and Shipping. See \"FINANCIAL CONDITION\".\nCash used in financing activities was $37.1 million in 1995 compared to $20 million in 1994 compared to cash provided by financing activities of $30.1 million in 1993. During 1995, the Company made principal payments of $85.3 million which was primarily the repayment of the ING Facility and the 8% Convertible Subordinated Debentures which matured in 1995, paid Preferred Stock dividends of $4.9 million and received $50 million from two new financing sources and $3 million from the exercise of employee stock options. During 1994, the Company made principal payments of $24.6 million, paid Preferred Stock dividends of $4.9 million and received $9.5 million from the ING Facility. During 1993, the Company received $71.2 million of net proceeds from the 1993 Offering, received $11.6 million from the ING Facility and made principal payments of $50.6 million and paid dividends of $2.1 million on the Preferred Stock. See \"FINANCIAL CONDITION\".\nLiquidity of the Company should be considered in light of the fluctuations in demand experienced by drilling contractors as changes in oil and gas producers' expectations and budgets occur. These fluctuations can impact the Company's liquidity as supply and demand factors directly affect utilization and dayrates, which are the primary determinants of cash flow from the Company's operations. The Company's management currently expects that its cash flow from operations, in combination with cash on hand and other sources, including new debt, new equity, asset disposals and\/or by proper scheduling of its planned capital or other expenditures, will be sufficient to satisfy the Company's 1996 working capital needs, dividends on and the possible redemption of the Preferred Stock, planned investments, capital expenditures, debt and other payment obligations. The Company currently expects to call for redemption its Preferred Stock in accordance with its terms on or after September 30, 1996. The Company expects that most, if not all, holders of the Preferred Stock will convert their shares into Common Stock rather than allow the Company to redeem their shares. At present, the Company would expect to fund the Preferred Stock redemption, if any, out of working capital.\nAt December 31, 1995, approximately $17.1 million of total consolidated cash and cash equivalents of $36.2 million were restricted from the Company's use outside of Drilling's activities. See \"Drilling\" below regarding recent changes in such restrictions.\nCapital Expenditures and Deferred Charges\nPlanned capital expenditures and deferred charges (including mobilization, demobilization and contract preparation costs not recoverable from the Company's customers or claim proceeds from insurance underwriters) for 1996 are expected to aggregate in excess of $73 million principally for upgrades or replacement of equipment either to fulfill obligations under existing contracts or to improve the marketability of certain of the Company's drilling units and for mobilization of the Company's drilling units between drilling sites. Additionally, the Company has capital funding obligations for its participation in the previously discussed oil and gas development project estimated to be in excess of $17 million for 1996. The Company anticipates that such capital expenditures will be funded through cash provided by operations and\/or an increase of an existing credit facility and\/or new financing. Certain projects currently being considered by the Company would require, if they materialize, capital expenditures or other cash requirements not included in the above estimate. In addition to planned capital expenditures referred to above, the Company will also continue to review acquisitions of drilling units from time to time and will also consider further investments in floating production equipment. See \"Item 1. Business - Business Strategy\".\nING Facility\nThe Company's principal credit facility agreement (the \"ING Facility\") with ING Bank was fully repaid in November 1995 from funds provided by the sale\/lease-back of the \"M. G. HULME, JR.\" and the CBK Facility, as discussed below. The ING Facility consisted of four facilities, \"Facility A\", \"Facility C\", \"Facility D\" and \"Facility E\". A fifth credit facility (\"Facility F\") was both created and repaid during 1993. Facility A was in the form of a term loan with an original balance of $30 million. Facilities C, D & E consisted of $30 million of working capital financing. Facility C was in the form of an overdraft account up to a maximum of $15 million. Facility D was in the form of a $5 million long-term letter of credit which collateralized a $15 million note payable relating to the \"HARVEY H. WARD\" drilling unit. Facility E was in the form of short-term letters of credit aggregating $10 million, which supported bid, performance and other bonds needed by the Company in the ordinary course of its business. Facility F consisted of a revolving credit facility in an amount not to exceed $15.5 million, for the purchase of shares of Shipping and Drilling. In March 1993, the Company received approximately $11.6 million from Facility F and in July 1993 the Company repaid Facility F from proceeds from the 1993 Offering. In addition, a separate facility (\"Facility B\") provided by ING Bank was in the form of a term loan with an original balance of $45 million. Facility B was the result of ING Bank acquiring, in June 1991, certain interests in two promissory notes issued in connection with the previous sale and lease-back to the Company of the \"C.E. THORNTON\" and the \"GEORGE H. GALLOWAY\" drilling units. The present value of the Company's obligations under such operating leases at date of repayment amounted to approximately $23.2 million. Substantially all of the Company's assets (including its shares of Drilling) that did not serve as collateral for other obligations of the Company collateralized the ING Facility. See Notes C, D and E of Notes to Consolidated Financial Statements.\nCBK Facility\nIn November 1995, the Company entered into a five year $55 million credit facility agreement (the \"CBK Facility\") with Christiania Bank og Kreditkasse. The CBK Facility consists of a $45 million reducing revolving credit facility (\"CBK Facility A\") and a $10 million standby letter of credit facility (\"CBK Facility B\"). CBK Facility A allows the Company to make drawdowns, minimum of $1 million, as funds are needed, shall be reduced\/repaid by nine semi-annual installments of $3.4 million commencing in May 1996 and one final reduction\/repayment of $14.4 million in November 2000 and bears interest at the London Interbank Offered Rate (\"LIBOR\") (5.719% at December 31, 1995) plus 1.75%. In addition, a commitment fee of .75% per annum is paid on the unused portion of CBK Facility A. CBK Facility B is in the form of stand-by letters of credit aggregating $10 million, for use in the ordinary course of business. Any amounts available under CBK Facility A may be utilized under CBK Facility B. At December 31, 1995, $20 million was outstanding under CBK Facility A and $13.3 million was outstanding under CBK Facility B, leaving $21.7 million available under CBK Facility A. The CBK Facility contains covenants which require the Company to meet certain ratios and working capital conditions, and is collateralized by vessel mortgages on two of the drilling units owned by the Company and related assignments of insurance and earnings. See Notes C and E of Notes to Consolidated Financial Statements.\nCIT Financing\nIn May 1995, the Company entered into a $25 million loan agreement with The CIT Group\/Equipment Financing, Inc. In December 1995, the Company borrowed an additional $5 million under such loan agreement. The loan bears interest at the one month LIBOR (5.719 % at December 31, 1995) plus 2.5%, and interest is payable monthly. Principal repayments are $5,416,667 in November 1996, 34 monthly installments of $416,667 commencing in December 1996 and one payment of $10,416,655 in October 1999. The loan agreement contains covenants which require the Company to meet certain financial conditions, including, among others, a cash flow coverage ratio and a long-term debt to total assets ratio, and is collateralized by vessel mortgages on two of the drilling units owned by the Company and related assignments of insurance and earnings.\nDrilling\nAs of December 31, 1995, Drilling had a $42.5 million term loan payable to The Chase Manhattan Bank, N.A. as agent for a syndicate of banks (including itself). The adjusted payment terms of this bank obligation currently provide for repayment of principal in 17 semiannual installments which commenced in August 1991. The Company has not guaranteed repayment of such obligation. Drilling has also entered into an interest rate swap agreement, which is combined with the bank credit facility for payment purposes (as set forth below). The swap agreement terminates in August 1996 and the notional principal swapped amount will have been reduced on a semiannual basis to $30.6 million at that time. At December 31, 1995, the notional principal amount of $34.1 million bears interest at 10.69% and the remaining principal amount bears interest at the 6 month LIBOR (5.531% at December 31, 1995) plus 1.75%. Following the termination of the swap agreement, the remaining balance of the loan will bear interest at LIBOR plus 1.75%. The loan is collateralized by the drilling units \"HENRY GOODRICH\" and \"PAUL B. LOYD, JR.\" (ex \"SONAT ARCADE FRONTIER\"). The loan agreement was amended in November 1995 to change certain financial condition requirements and such changes are reflected below. The amended loan agreement requires Drilling to meet certain financial conditions, including maintaining current assets of at least twice the level of current liabilities and liquid assets of at least $2 million ($10 million if Drilling can not annually provide to the lenders satisfactory contractual commitments for the employment of both drilling units for the next twelve months), maintaining a ratio of operating cash flow (including actual and projected cash flows) to interest charges of at least 1.75 to 1 and maintaining a ratio of total liabilities to tangible net worth of no more than 1 to 1. Additionally, the amended loan agreement (i) restricts the payment of dividends by Drilling to not more than 50% of net earnings after tax per year, (ii) prohibits Drilling from making loans, granting credit, giving any guarantee or indemnity to or for the benefit of any other person or assuming any liability with respect to any obligation of any other person, (iii) prohibits Drilling from engaging in any merger or consolidation and (iv) prohibits the encumbrance of Drilling's assets or the sale of such assets other than at fair market value, in each case without the prior written consent of the banks party to the loan agreement holding a majority of the outstanding balance. The amended loan agreement allows Drilling to declare a distribution to stockholders in the first quarter of 1996 up to $15 million provided $2 million of liquid assets remain after payment of such distribution. The Company currently expects to receive approximately $11.2 million with respect to such distribution in the first quarter of 1996. It is also an event of default if there should occur a material adverse change in the financial or business condition of Drilling. Pursuant to a series of waivers, for the period from May 1, 1992 to May 1, 1993, the bank syndicate waived the requirement that Drilling comply with the actual operating cash flow ratio covenant. For the period from January 1, 1992, to April 30, 1993, the bank syndicate waived the requirement that Drilling comply with the projected operating cash flow ratio covenant. In connection with the most recent waiver, Drilling was required to pay on April 30, 1993 (i) a fee to the bank syndicate of approximately $.1 million and (ii) the last two semiannual installments (totalling $8 million). Since May 1, 1993, Drilling has not requested any additional waivers. Drilling expects to meet its repayment obligations under the facility through cash flow generated from operations and current working capital. At December 31, 1995, Drilling held $17.1 million in cash and cash equivalents available to satisfy such obligations, but otherwise subject to the restrictions on use of such cash and cash equivalents set out in such amended loan agreement. See Note C of Notes to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nThe Company reported net income for 1995 of $21.8 million ($.28 earnings per share after preferred stock dividends of $4.9 million), compared to a net loss of $17.1 million ($.39 loss per share after preferred stock dividends of $4.9 million) for 1994 and net income of $4.7 million ($.05 earnings per share after preferred stock dividends of $2.1 million) for 1993. Included in the 1995 results is an extraordinary gain of $3.4 million related to the extinguishment of a debt obligation.\nOperating revenues are primarily a function of dayrates and utilization. The $43.7 million increase in 1995 over 1994 is primarily due to the increased utilization of the fourth-generation semisubmersible and jack-up fleets. Also contributing to the increased operating revenues is the increase in average dayrates earned by the units, again particularly in the semisubmersible and jack-up fleets. The $14.7 million decrease in 1994 compared to 1993 is primarily due to the decreased utilization of these fleets between those two years.\nUnit utilization measured in terms of the number of days the units were earning revenues to the total days the units were owned or leased by the Company (the operating method) for the years ended December 31, 1995, 1994 and 1993 is shown below by class:\nThe utilization trends experienced by the Company are generally consistent with those experienced by the industry.\nAverage dayrates for the Company's units for the years ended December 31, 1995, 1994 and 1993 are shown below by class (in thousands):\nOperating expenses do not necessarily fluctuate in proportion to changes in operating revenues due to the continuation of personnel on board and equipment maintenance when the Company's units are stacked. It is only during prolonged stacked periods that the Company is significantly able to reduce labor costs and equipment maintenance expense. Additionally, labor costs fluctuate due to the geographic diversification of the Company's units and the mix of labor between expatriates and nationals as stipulated in the contracts. Labor costs have increased in the last three fiscal years primarily due to higher salary levels, inflation and the decline of the U.S. dollar relative to certain foreign currencies of countries where the Company operates. Equipment maintenance expenses fluctuate depending upon the type of activity the drilling unit is performing and the age and condition of the equipment. Scheduled maintenance of equipment and overhauls are performed on a basis of number of hours operated in accordance with the Company's preventive maintenance program.\nOperating expenses increased in 1995 as compared to 1994 due to higher operating costs for several rigs and the addition of the \"IOLAIR\" to the fleet. This increase was offset somewhat by lease expense which decreased between the two years due to the 1994 termination of the lease for the \"SONNY VOSS\" and the elimination of the \"GEORGE H. GALLOWAY\" and \"C. E. THORNTON\" leases due to a 1994 purchase of the lease obligations by the Company.\nDespite the increase in operating expenses in 1995, operating expenses as a percentage of revenues decreased by 13.0% in 1995 compared to 1994 due mainly to increased revenues in 1995. Also contributing to this decrease is the reduction of operating expenses in 1995 as compared to 1994 associated with reduced lease expense in the amount of $8.3 million. Currently, management expects operating expenses as a percentage of revenue to continue to decrease over the next two years. Although management currently expects operating expenses to rise during this period due to higher operating costs and the addition of two rigs to the fleet, operating revenues are currently expected to rise at a faster rate due to contracts with higher dayrates, some of which are already in place.\nIncluded in operating expenses for 1994 is a credit of approximately $3.1 million due to the recognition of the remaining deferred gain on the sale\/lease-back of the \"SONNY VOSS\" as the Company was prematurely released from its lease obligation.\nOperating expenses as a percentage of revenues increased by 8.7% in 1994 compared to 1993 due to decreased revenues as well as increased operating costs in Australia and overall equipment maintenance costs.\nIncluded in operating expenses for 1993 is a credit of approximately $1.8 million due to the recognition of the deferred gain on the sale\/lease-back of the \"SONNY VOSS\" and a credit of approximately $1.2 million due to the recognition of a gain on the \"JACK BATES\" casualty caused by Hurricane Andrew in 1992.\nDepreciation and amortization expense increased $1.5 million in 1995 compared to 1994 due to increased utilization of the fleet.\nDepreciation and amortization expense decreased $.8 million in 1994 compared to 1993.\nGeneral and administrative expenses decreased $.9 million in 1995 compared to 1994 primarily related to the reduction of expenses for Drilling's office located in Oslo.\nGeneral and administrative expenses increased $1 million in 1994 compared to 1993 after adjusting 1993 by $1.1 million of termination benefits that were accrued in 1993. The increase is primarily due to an increase in payroll and related expenses.\nDespite a decrease in the average principal debt balance outstanding during 1995 as compared to 1994 due to the refinancing of the Company's principal credit facility with ING Bank in the fourth quarter of 1995 as well as the repayment of scheduled principal payments on the Company's long-term obligations, interest expense increased by $1.6 million. This increase is primarily attributable to the purchase of certain notes and interest relating to the lease debt outstanding for the previously leased rigs, \"C.E. THORNTON\" and \"GEORGE H. GALLOWAY\" in the latter part of 1994. Noncash interest expense attributable to amortization of discount and deferrals associated with the 8% Senior Subordinated Convertible Debentures due 1998 and the 8% Convertible Subordinated Debentures which were repaid in the fourth quarter of 1995 for the year ended December 31, 1995 was $4 million.\nDespite a decrease in the average principal debt balance outstanding during 1994 compared to 1993 due to the repayment of scheduled principal payments on the Company's long-term obligations, interest expense remained constant in 1994 compared to 1993 due to higher interest rates in 1994. Noncash interest expense attributable to amortization of discount and deferrals associated with the 8% Senior Subordinated Convertible Debentures due 1998 and the 8% Convertible Subordinated Debentures which were repaid in the fourth quarter of 1995 for the year ended December 31, 1994 was $3.6 million.\nInterest income decreased $1.4 million in 1995 compared to 1994 due to interest earned on decreased average cash and cash equivalents balance. Conversely, interest income increased $1.2 million in 1994 compared to 1993 due to interest earned on the increased average outstanding cash and cash equivalents balance primarily due to proceeds received from the 1993 Offering.\nFor 1995, other, net included $1.2 million of expenses associated with the merger discussions with Sonat Offshore.\nFor 1994, other, net included the recognition of a $1.2 million loss associated with interests in the exploration and production of oil and gas, a $.8 million expense for the change in the estimate of the reserve for prior workers compensation claims and a $.7 million loss on the sale of a cash investment due to the decline in the market value.\nIncome tax expense for 1995 decreased as compared to 1994 despite increases in revenues and income before income taxes. Such decrease is primarily due to a change in the Company's foreign geographic areas of operations coupled with the resolution, in the third quarter of 1995, of a foreign tax assessment at less than expected cost.\nIncome tax expense was recognized for the year ended December 31, 1994 despite losses before income taxes of $13.9 million. This represents income tax expense incurred with respect to certain foreign operations.\nMinority interest relates primarily to the results of Drilling and the percentage attributable to stockholders other than the Company. Drilling reported income in 1995 of $5.6 million and losses of $3 million and $4.5 million in 1994 and 1993, respectively. The ownership percentages attributable to stockholders other than the Company were 25.7%, 26.1% and 46.8% for the years ending December 31, 1995, 1994 and 1993, respectively.\nThe impact of inflation on the Company's operations for the three years ended December 31, 1995 has not been material.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREADING & BATES CORPORATION AND SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders Reading & Bates Corporation\nWe have audited the accompanying consolidated balance sheets of Reading & Bates Corporation (a Delaware corporation) and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the period ended December 31, 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 Reading & Bates 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.\nArthur Andersen LLP\nHouston, Texas February 13, 1996\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET December 31, 1995 and 1994 (dollars in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET December 31, 1995 and 1994 (in thousands except share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (in thousands except per share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nFor the Three Years Ended December 31, 1995 (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nREADING & BATES CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ______________\n(A) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of Reading & Bates Corporation (\"Reading & Bates\") and its subsidiaries, including its majority-owned subsidiary Arcade Drilling AS (\"Drilling\") (collectively, the \"Company\"). As of December 31, 1995, Reading & Bates owned approximately 74.4% of the outstanding stock of Drilling (see Note B). Investments in unconsolidated investees are accounted for on the equity method. All significant intercompany accounts and transactions have been eliminated.\nCASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. At December 31, 1995, $17.1 million of the cash and cash equivalents balance related to Drilling. Such cash and cash equivalents balance is available to Drilling for all purposes subject to certain debt covenants under a credit facility provided by The Chase Manhattan Bank, N.A. (\"Chase Manhattan\") which require the maintenance of a minimum of $10 million in liquid assets and, under certain circumstances, prohibit Drilling from paying dividends or granting loans (including to the Company). In the fourth quarter of 1995, the credit facility was amended to i) lower the $10 million requirement of liquid assets to $2 million provided that Drilling could annually provide to the lenders satisfactory contractual commitments for employment of both of the drilling units for the next twelve months and ii) allow Drilling to declare a distribution to stockholders in the first quarter of 1996 up to $15 million provided $2 million of liquid assets remained after payment of such distribution.\nMATERIALS AND SUPPLIES INVENTORY - Materials and supplies are stated at the lower of average cost or market.\nPROPERTY AND EQUIPMENT - Property and equipment are recorded at historical cost as adjusted in the Company's quasi-reorganization in 1989. Reading & Bates' drilling units are depreciated under either the units-of-production method or the straight-line method. Drilling's drilling units are depreciated under the straight-line method. Estimated useful lives for drilling equipment range from three to twenty-five years. Gain (loss) on disposal of properties is credited (charged) to income. Effective January 1, 1993, the Company changed its estimate of the useful lives of its fourth-generation semisubmersible fleet from an average of 16 years to 25 years. This change was made to reflect the estimated period during which such assets will remain in service. For the year ended December 31, 1993, the change had the effect of reducing depreciation expense and increasing net income by approximately $6.8 million or $.12 per share. In 1995, the Company purchased an approximately 20% working interest in the Green Canyon 254 Allegheny oil and gas development project in the U.S. Gulf of Mexico from the operator, Enserch Exploration, Inc. As of December 31, 1995, the Company had accumulated costs related to the project of approximately $23.3 million which are included in Property and Equipment, Other (see Note D).\nSTOCKHOLDERS' EQUITY - The Company's accumulated deficit at March 31, 1991 was eliminated as a result of the Company's recapitalization in 1991.\nINCOME TAXES - Deferred income taxes are recognized for revenues and expenses reported in different years for financial statement purposes and income tax purposes. In February 1992, Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") was issued and supersedes substantially all existing income tax pronouncements. The Company adopted SFAS 109 effective January 1, 1993. The cumulative effect of the accounting change at January 1, 1993 was not material to the Company's consolidated results of operations or financial position.\nREVENUE RECOGNITION - Revenues from drilling contracts are recognized as they are earned. Proceeds associated with the early termination of a contract for a drilling unit are recorded as deferred income and recognized as drilling contract revenues over the remaining term of the contract or until such time as the drilling unit begins a new contract. There were no such amounts deferred at December 31, 1995 or 1994. In 1993, the Company secured a contract to convert a semisubmersible drilling unit into a floating production system. Under this contract the Company, for a fixed fee and certain incentives, functioned as an agent for its customer and accordingly, disbursements made on behalf of the customer were netted against receipts from the customer in the accompanying financial statements. The contract was completed in the third quarter of 1995 and the disbursements and receipts associated with the contract through that date amounted to approximately $123 million.\nFOREIGN CURRENCY TRANSACTIONS - The net gains and losses resulting from foreign currency transactions included in determining net income amounted to a net loss of $.8 million in 1995, a net loss of $.6 million in 1994 and a net gain of $.1 million in 1993. The Company may enter into forward exchange contracts to hedge specific commitments and anticipated transactions. During 1995 and 1994, the Company did not enter into any forward exchange contracts.\nEXTRAORDINARY GAIN - In December 1995, the Company recorded an extraordinary gain of $3,430,000 for the extinguishment of a debt obligation (see Note C).\nEARNINGS (LOSS) PER COMMON SHARE - Earnings (loss) per common share is computed by dividing income (loss), after deducting the preferred stock dividend, by the weighted average number of common shares outstanding during the year. The effects of common equivalent shares were antidilutive or immaterial for all periods presented and, accordingly, no adjustment was made for these common equivalent shares. The computation of fully diluted earnings per share is not presented as the results are antidilutive.\nCONCENTRATION OF CREDIT RISK - The Company maintains cash balances with commercial banks throughout the world. The Company's cash equivalents generally consist of commercial paper, money-market mutual funds and interest-bearing deposits with strong credit rated financial institutions and generally mature within three months, therefore, bearing minimal risk. However, in 1994 the Company incurred a $.7 million loss on the sale of a cash investment due to the decline in the market value. No losses were incurred during 1995.\nThe Company's revenues were generated primarily from its drilling units. Revenues can be generated from a small number of customers which are primarily major U.S. oil and gas companies or their subsidiaries and foreign government-owned oil and gas companies. The Company performs ongoing credit evaluations of its customers' financial conditions and generally requires no collateral from its customers. The Company's allowance for doubtful accounts at December 31, 1995 and 1994 was $1,123,000 and $373,000, respectively.\nINDUSTRY CONDITIONS - Results of operations and financial condition of the Company should be considered in light of the fluctuations in demand experienced by drilling contractors as changes in oil and gas producers' expectations and budgets occur. These fluctuations can impact the Company's results of operations and financial condition as supply and demand factors directly affect utilization and dayrates, which are the primary determinants of cash flow from the Company's operations.\nLIQUIDITY - As of December 31, 1995, the Company's total consolidated cash and cash equivalents were $36.2 million. Of this amount, approximately $17.1 million is restricted from the Company's use outside of Drilling (see CASH AND CASH EQUIVALENTS above). The Company's management currently expects that its cash flow from operations, in combination with cash on hand and other sources, including new debt, new equity, asset disposals and\/or by proper scheduling of its planned capital or other expenditures, will be sufficient to satisfy the Company's 1996 working capital needs, dividends on and possible redemption of the preferred stock, planned investments, capital expenditures, debt and other payment obligations. The Company currently expects to call for redemption its preferred stock in accordance with its terms on or after September 30, 1996. Also, the Company expects that most, if not all, holders of the preferred stock will convert their shares into common stock rather than allow the Company to redeem their shares. At present, the Company would expect to fund the preferred stock redemption, if any, out of working capital.\nNEWLY ISSUED ACCOUNTING STANDARD - In March 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 121\") was issued. SFAS 121, which becomes effective in 1996, requires that certain long-lived assets be reviewed for impairment whenever events indicate that the carrying amount of an asset may not be recoverable, and that an impairment loss be recognized under certain circumstances in the amount by which the carrying value exceeds the fair value of the asset. In 1995, the Company adopted SFAS 121 which had no effect on the Company's consolidated results of operations or financial position.\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 prior period amounts in the consolidated financial statements have been reclassified for comparative purposes. Such reclassifications had no effect on the net income (loss) or the overall financial condition of the Company.\n(B) INVESTMENT IN ARCADE\nARCADE ACQUISITION - In June 1991, as part of its strategy of emphasizing geographic diversification and \"fourth-generation\" semisubmersible drilling technology, the Company began acquiring the stock of Arcade Shipping AS (\"Shipping\") and Drilling, both of which are Norwegian companies (the \"Arcade Acquisition\"). Beginning with the first quarter of 1992, the Company began to consolidate the accounts of Drilling and Shipping into the consolidated financial statements of the Company. Drilling owns the \"HENRY GOODRICH\" and the \"PAUL B. LOYD, JR.\" (ex \"SONAT ARCADE FRONTIER\"), two fourth- generation semisubmersible drilling units. Shipping, which the Company sold its ownership interest in June 1994, had two principal lines of operations, the shipping operations which included owning and chartering vessels and the drilling operations which principally consisted of the ownership of approximately 46.2% of the outstanding stock of Drilling. The shipping operations of Shipping had been accounted for as discontinued operations until June 1994, when the Company completed a transaction which consisted of the Company selling its entire 82.6% ownership in Shipping for approximately $27.8 million, purchasing from Shipping its entire 46.2% ownership in Drilling and equity securities in Dragon Oil for approximately $45.4 million and Shipping repaying a loan of approximately $12.9 million to the Company. This transaction resulted in a net cash outflow of $4.7 million.\nThe Arcade Acquisition has been funded through short-term financing, a private placement of both preferred and common stocks and the Company's working capital. As of December 31, 1995, the Company had acquired approximately 74.4% of the outstanding stock of Drilling, at an accumulated cost of approximately $113.5 million.\nThe following unaudited pro forma selected financial data for the three years ended December 31, 1995 show the consolidated data as if the Arcade Acquisition (ownership percentage as of December 31, 1995) and related financing activities had occurred on January 1, 1993, (in thousands except per share amounts):\nDISCONTINUED OPERATIONS OF SHIPPING - On June 22, 1994, the Company sold its entire ownership in Shipping (see above). Shipping's operating revenues and net loss from January 1, 1994 to the date of sale were approximately $6.5 million and $2 million, respectively. Operating revenues and net loss of discontinued operations not included in the Consolidated Statement of Operations for the year ended December 31, 1993 were $14.8 million and $4.6 million, respectively.\n(C) LONG-TERM OBLIGATIONS\nLong-term obligations at December 31, 1995 and 1994 consisted of the following (in thousands):\n(D) SHORT-TERM OBLIGATIONS\nShort-term obligations at December 31, 1995 and 1994 consisted of the following (in thousands):\n(E) COMMITMENTS AND CONTINGENCIES\nCAPITAL EXPENDITURES - At December 31, 1995, the Company had purchase commitments of $3.4 million for equipment on drilling units.\nOPERATING LEASES - The Company has operating leases covering premises and equipment. Certain operating leases contain renewal options and have options to purchase the asset at fair market value at the end of the lease term. Net rent expense amounted to $2.3 million (1995), $11.2 million (1994) and $12.7 million (1993). As of December 31, 1995, future minimum rental payments relating to operating leases were as follows (in thousands):\nIn November 1995, the Company entered into a sale\/lease-back of the \"M. G. HULME, JR.\". As part of this transaction the Company could receive up to $60 million in cash, inclusive of a $10 million funding provision for upgrades, and agreed to lease the drilling unit for ten years. As of December 31, 1995, the Company had received $52.5 million. The lease-back is accounted for as an operating lease and a deferred gain of $7.4 million was recorded and is being amortized over the life of the lease (see Note F).\nIn the third quarter of 1994, the Company purchased certain notes and interests relating to the lease debt outstanding associated with the operating leases of the drilling units \"GEORGE H. GALLOWAY\" and \"C.E. THORNTON\", and the secured contingent obligations associated with the capital lease of the \"F.G. McCLINTOCK\". Total consideration for the transaction was approximately $36.5 million which consisted of cash of approximately $12.2 million and the Company issuing 4,230,235 shares of the Company's Common Stock, par value $.05 per share, totalling approximately $24.3 million at then prevailing stock prices. Since through such purchases, the Company now controls and has effective ownership of the three rigs, it recorded the purchase of the notes and interests as purchases of the rigs. The Company now has title to the \"GEORGE H. GALLOWAY\" and \"F. G. McCLINTOCK\". In the fourth quarter of 1994, the Company reclassed the remaining lease obligation (Facility B) from other liabilities to debt obligations (see Note C).\nIn March 1992, the Company entered into a sale\/lease-back of the \"SONNY VOSS\". Proceeds received of $27.7 million resulted in a gain of $6.3 million which was deferred and was being amortized over the lease term. In December 1994, for a fee of $.5 million, the Company negotiated an early release from all of its remaining lease obligations with respect to the \"SONNY VOSS\". Such lease obligations were scheduled to have expired in September 1995 and the net effect of the early release on the Company's statement of operations was a gain of $.5 million recognized as a reduction of operating expenses in the fourth quarter of 1994.\nLITIGATION - The Company is one of the defendants in certain litigation brought in July 1984 by the Cheyenne-Arapaho Tribes of Oklahoma in the U.S. District Court for the Western District of Oklahoma, seeking to set aside two communitization agreements with respect to three leases involving tribal lands in which the Company previously owned interests and to have those leases declared expired. In June 1989, the U.S. District Court entered an interim order in favor of the plaintiffs. On appeal, the U.S. Court of Appeals for the Tenth Circuit upheld the decision of the trial court and petitions for rehearing of that decision were denied. Petitions for writs of certiorari filed by the parties with the U.S. Supreme Court have been denied, and the case has been remanded to the trial court for determination of damages.\nIn November 1988, a lawsuit was filed in the U.S. District Court for the Southern District of West Virginia against Reading & Bates Coal Co., a wholly owned subsidiary of the Company, by SCW Associates, Inc. claiming breach of an alleged agreement to purchase the stock of Belva Coal Company, a wholly owned subsidiary of Reading & Bates Coal Co. with coal properties in West Virginia. When those coal properties were sold in July 1989 as part of the disposition of the Company's coal operations, the purchasing joint venture indemnified Reading & Bates Coal Co. and the Company against any liability Reading & Bates Coal Co. might incur as the result of this litigation. A judgment for the plaintiff of $32,000 entered in February 1991 was satisfied and Reading & Bates Coal Co. was indemnified by the purchasing joint venture. On October 31, 1990, SCW Associates, Inc., the plaintiff in the above-referenced action, filed a separate ancillary action in the Circuit Court, Kanawha County, West Virginia against the Company and a wholly owned subsidiary of Reading & Bates Coal Co., Caymen Coal, Inc. (former owner of the Company's West Virginia coal properties), as well as the joint venture, Mr. William B. Sturgill personally (former President of Reading & Bates Coal Co.), three other companies in which the Company believes Mr. Sturgill holds an equity interest, two employees of the joint venture, First National Bank of Chicago and First Capital Corporation. The lawsuit seeks to recover compensatory damages of $50 million and punitive damages of $50 million for alleged tortious interference with the contractual rights of the plaintiff and to impose a constructive trust on the proceeds of the use and\/or sale of the assets of Caymen Coal, Inc. as they existed on October 15, 1988. Subsequently, the court entered an order dismissing the Company's indirect subsidiary. The Company intends to defend its interests vigorously and believes the damages alleged by the plaintiff in this action are highly exaggerated. In any event, the Company believes that it has valid defenses and that it will prevail in this litigation.\nThe Company is involved in these and various other legal actions arising in the normal course of business. After taking into consideration the evaluation of such actions by counsel for the Company, management is of the opinion that the outcome of all known and potential claims and litigation will not have a material adverse effect on the Company's business or consolidated financial position or results of operations.\nEMPLOYMENT CONTRACTS - The Company has committed under employment contracts to provide two key executives with severance benefits totalling approximately $3.7 million which vest in September 2003 or earlier if the executive both reduces his ownership of the Company's common stock below a specified level and resigns. The Company amortizes the cost of the severance benefits over the ten year period from September 1993 to September 2003, unless the executive reduces his stock ownership and resigns prior to September 2003 in which case the unamortized severance cost would be expensed.\nLETTERS OF CREDIT - At December 31, 1995, the Company had letters of credit outstanding and unused totalling $13.3 million and $21.7 million, respectively (see Note C). At December 31, 1994, the Company had letters of credit outstanding and unused totalling $13.1 million and $11.9 million, respectively.\n(F) ACCRUED LIABILITIES AND OTHER NONCURRENT LIABILITIES\nThe components of \"Accrued liabilities\" at December 31, 1995 and 1994 were as follows (in thousands):\nThe components of \"OTHER NONCURRENT LIABILITIES\" at December 31, 1995 and 1994 were as follows (in thousands):\n(G) INCOME TAXES\nIncome tax expense for the years ended December 31, 1995, 1994 and 1993 consisted of the following (in thousands):\nThe domestic and foreign components of income (loss) before income taxes for the years ended December 31, 1995, 1994 and 1993 were as follows (in thousands):\nThe effective tax rate, as computed on income before income taxes, differs from the statutory U.S. income tax rate for the years ended December 31, 1995, 1994 and 1993 due to the following:\nIncome taxes of $4,093,000 were recognized in 1994 despite losses before income taxes. The expense resulted primarily from income tax expense incurred with respect to certain foreign operations. The Company was limited in utilization of tax benefits from investment tax credits prior to 1986 and operating losses in 1994.\nDeferred income taxes result from those transactions which affect financial and taxable income in different years. The nature of these transactions (all of which were long-term) and the income tax effect of each as of December 31, 1995 and 1994 was as follows (in thousands):\nValuation allowance is necessary to reflect the anticipated expiration of tax benefits (primarily net operating loss carryforwards) prior to their utilization. The estimated amount of net operating loss carry forward available increased in 1995 and the Company recognized corresponding additional valuation allowance.\nRecapitalizations of the Company in 1989 and 1991 resulted in ownership changes for federal income tax purposes. As a result of these ownership changes, the amount of tax benefit carryforwards generated prior to the ownership changes which may be utilized to offset federal taxable income is limited by the Internal Revenue Code to approximately $2.7 million annually plus certain built-in gains that existed as of the date of such changes. Net tax operating losses of $18,283,000 arising since the 1991 ownership change are not subject to this limitation. Any tax benefits due to the utilization of carryforwards which were generated prior to the recapitalization in 1991 will be reported as a credit to \"Capital in excess of par value\".\n(H) CAPITAL SHARES\nOn March 15, 1995, 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 outstanding on March 31, 1995 (the\"Record Date\"). Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, par value $1.00 per share (the \"Preferred Shares\") of the Company at a price of $30.50, subject to adjustment. The Rights will not become exercisable until 10 days after a public announcement that a person or group has acquired 10% or more of the Company's Common Stock (thereby becoming an \"Acquiring Person\") or the commencement of a tender or exchange offer upon consummation of which such person or group would own 10% or more of the Company's Common Stock (the earlier of such dates being called the \"Distribution Date\"). Rights will be issued for all shares of the Company's Common Stock issued and outstanding on the Record Date. Until the Distribution Date, the Rights will be evidenced by the certificates representing the Company's Common Stock and will be transferrable only with the Company's Common Stock. In the event that any person or group becomes an Acquiring Person, each Right, other than Rights beneficially owned by the Acquiring Person (which will thereafter be void), will thereafter entitle its holder to purchase shares of the Company's Common Stock having a market value of two times the exercise price of the Right. After any person or group has become an Acquiring Person and prior to the acquisition by such person or group of 50% or more of the outstanding shares of Common Stock, the Company's board of directors may exchange each Right (other than Rights of the Acquiring Person), in whole or in part, at an exchange ratio of one Common Share or one one-hundredth of a Preferred Share per Right. If after a person or group has become an Acquiring Person, the Company is acquired in a merger or other business combination transaction or 50% or more of its assets or earning power are sold, each Right will entitle its holder to purchase, at the Right's then current exercise price, that number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right. The board of directors of the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right at any time prior to such time as any person or group becomes an Acquiring Person. The Rights expire on March 31, 2005. Preferred Shares purchasable upon exercise of the Rights will not be redeemable. Each Preferred Share will be entitled to a preferential quarterly dividend payment equal to the greater of $1 per share or 100 times the dividend declared per Common Share. Liquidation preference will be equal to the greater of $100 per share or 100 times the payment made per Common Share. Each Preferred Share will have one vote, voting together with the Common Stock.\nCONVERTIBLE PREFERRED STOCK - In July 1993, the Company effected a public offering of 2,990,000 shares of $1.625 Convertible Preferred Stock, par value $1.00 per share (the \"Preferred Stock\"), pursuant to which the Company raised gross proceeds of approximately $74.7 million in cash (net proceeds of approximately $71.2 million). The proceeds were utilized to repay indebtedness under two credit facilities, both under the ING Facility, totalling approximately $17.1 million. The remaining proceeds were used by the Company for working capital and general corporate purposes. The Preferred Stock is convertible at the option of the holder at any time into shares of the Company's Common Stock at a conversion rate of 2.899 shares of Common Stock for each share of Preferred Stock (equivalent to a conversion price of $8.625 per share of Common Stock), subject to adjustment in certain events. Annual dividends are $1.625 per share and are cumulative and are payable quarterly commencing September 30, 1993. The Preferred Stock is redeemable at any time on and after September 30, 1996, at the option of the Company, in whole or in part, at a redemption price of $26.1375 per share, and thereafter at prices decreasing ratably annually to $25.00 per share on and after September 30, 2003, plus accrued and unpaid dividends. The holders of the Preferred Stock do not have any voting rights, except as required by applicable law and except that, among other things, whenever accrued and unpaid dividends on the Preferred Stock are equal to or exceed the equivalent of six quarterly dividends payable on the Preferred Stock, the holders of the Preferred Stock will be entitled to elect two directors to the Board until the dividend arrearage has been paid in full. The term of office of all directors so elected will terminate immediately upon such payment. The Preferred Stock has a liquidation preference of $25.00 per share, plus accrued and unpaid dividends. During 1995, 5,000 shares of the Preferred Stock were converted into 14,495 shares of the Company's Common Stock.\nCOMMON STOCK - In the third quarter of 1994, the Company issued 4,230,235 shares of the Company's Common Stock in association with the purchase of certain notes and interests relating to the lease debt outstanding on the drilling units \"GEORGE H. GALLOWAY\" and the \"C. E. THORNTON\", and the secured contingent obligations on the \"F. G. McCLINTOCK\" (see Note E).\nIn September 1995, the Company issued 1,232,057 shares of the Company's Common Stock in association with the purchase of \"RIG 42\" and filed a shelf registration statement in September 1995 registering such 1,232,057 shares. The Company has been informed that all of such shares have been sold. Pursuant to the terms of registration rights agreements among the Company and certain other holders of the Company's Common Stock, as currently in effect, the Company is required to maintain continuously effective shelf registration statements with respect to approximately 7.4 million shares of its Common Stock until the earlier to occur of (i) the sale of such shares by the holders thereof or (ii) August 1, 1996 (in the case of approximately 5.4 million shares) or September 14, 1996 (in the case of approximately 2 million shares).\nAs of December 31, 1995, authorized, unissued shares of Common Stock were reserved for issuance as follows:\nClass A (Cumulative Convertible) Capital Stock (the \"Class A Stock\") has been included with \"Capital in excess of par value\" due to the insignificance of the $880 outstanding at December 31, 1995 and 1994.\n(I) EMPLOYEE BENEFIT PLANS\nPENSION PLANS - The Company has three noncontributory pension plans. Substantially all of its employees are covered by one or more of these plans. Plan benefits are primarily based on years of service and average high thirty-six month compensation.\nThe Reading & Bates Pension Plan (the \"Domestic Plan\") is qualified under the Employee Retirement Income Security Act (ERISA). It is the Company's policy to fund this plan not less than the minimum required by ERISA. It is the Company's policy to contribute to the Reading & Bates Offshore Pension Plan (the \"Offshore Plan\") an amount equal to the normal cost plus amounts sufficient to amortize the initial unfunded actuarial liability and subsequent unfunded liability caused by plan or assumption changes over thirty years. The unfunded liability arising from actuarial gains and losses is funded over fifteen years. The Offshore Plan is a nonqualified plan and is not subject to ERISA funding requirements. The Domestic and Offshore Plans invest in cash equivalents, fixed income and equity securities.\nThe Reading & Bates Retirement Benefit Replacement Plan (the \"Replacement Plan\") is a self-administered unfunded excess benefit plan. All members of the Domestic Plan or the Reading & Bates Savings Plan are potential participants in the Replacement Plan.\nNet Pension costs for the years ended December 31, 1995, 1994 and 1993 included the following components (in thousands):\nThe funded status of the plans at December 31, 1995 was as follows (in thousands):\nThe additional minimum liability is shown as a reduction of stockholders' equity.\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations was 7.4% and 4.5%, respectively. The weighted average expected long-term rate of return on assets was 10%.\nPOSTRETIREMENT BENEFITS - In addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees. The Company's employees may become eligible for these benefits if they reach normal or early retirement age while working for the Company and if they have accumulated 15 years (25 years effective January 1, 1996) of service. Health care costs are paid as they are incurred. Life insurance benefits are provided through an insurance company whose premiums are based on benefits paid during the year.\nPostretirement benefit costs for the years ended December 31, 1995, 1994 and 1993 included the following (in thousands):\nThe health care cost trend rates used to measure the expected cost in 1996 for medical, dental and vision benefits were 8%, 5.5% and 5.5%, respectively, each graded down to an ultimate trend rate of 5%, 4.5% and 4.5%, respectively, to be achieved in the year 2021. The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 7.4% and 4.5%, respectively. The effect of a one-percentage-point increase in health care cost trend rates for future periods would increase the service cost and interest cost portion of net periodic postretirement benefit cost approximately 16%. The accumulated postretirement benefit obligation would increase by approximately 12.8%.\nThe amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1995 and 1994 was as follows (in thousands):\nSAVINGS PLANS - The Company has two savings plans, the Reading & Bates Savings Plan and the Reading & Bates Offshore Savings Plan. Under the plans, an employee may contribute up to 10% of base salary (subject to certain limitations) and the Company may make matching contributions at a rate of up to $1.00 for each dollar contributed by the employee up to 6% of the employee's base salary. Since January 1, 1992, the Company has made matching contributions at a rate of $.50 for each dollar contributed by the employee. Employees may direct the investment of their contributions and the contributions of the Company in various plan options.\nTwenty-five percent of the Company's contribution vests after two years of an employee's service with the Company, 50% after three years, 75% after four years and 100% after five years. Compensation costs under the plans amounted to $518,000 in 1995, $531,000 in 1994 and $502,000 in 1993.\nSTOCK OPTION PLAN - The Company's 1990 Stock Option Plan (the \"1990 Plan\") is intended to provide an incentive that will allow the Company to retain in its employ, persons of the training, experience and ability necessary for the development and financial success of the Company. The 1990 Plan authorized options with respect to 1,966,000 shares of Common Stock to be granted to certain employees of the Company at an adjusted option price of $7.375 per share. On September 25, 1991, options with respect to all 1,966,000 shares were granted. Total adjusted compensation under the 1990 Plan of approximately $1,550,000 represents the excess of market price at the measurement date over the option price multiplied by the number of options granted. This amount was recognized as expense over the four year vesting period which commenced in March 1991. Compensation recognized under the plan for the three years ending December 31, 1995, 1994 and 1993 totalled approximately $126,000, $507,000 and $507,000, respectively. The plan will terminate on March 29, 2001.\nSTOCK INCENTIVE PLANS - The Company has two stock incentive plans, the 1992 Long-Term Incentive Plan (the \"1992 Plan\") and the 1995 Long-Term Incentive Plan (the \"1995 Plan\"). Both plans provide for grants of stock options, stock appreciation rights, stock awards and cash awards, which may be granted singly, in combination or in tandem. An aggregate of 1,000,000 and 2,500,000 shares of Common Stock is available for awards granted wholly or partly in Common Stock under the 1992 Plan and 1995 Plan, respectively. In 1992, the Company granted Restricted Stock Awards under the 1992 Plan totalling 300,000 shares of Common Stock. Such shares awarded are restricted as to transfer until vested pursuant to a schedule whereby 1\/24th of the total number of shares is vested per calendar quarter from June 30, 1992 through March 31, 1998 (subject to certain conditions). The market value at the date of grant of the Common Stock granted was recorded as unearned compensation and is amortized to expense over the periods during which the restrictions lapse or shares vest. In 1995, the Company granted Stock Options under the 1992 Plan and 1995 Plan with respect to 700,000 and 600,000 shares of Common Stock, respectively, at option prices ranging from $9.00 to $13.875 per share (the market price on the date of grants). Such options become exercisable either over a three or four year period from the date of grant and no options are exercisable within six months or later than ten years from the date of grant. Also in 1995, the Company granted Restricted Stock Awards under the 1995 Plan totalling 544,200 shares of Common Stock. Such shares awarded are restricted as to transfer until fully vested three years from the date of grant. The market value at the date of grant of the Common Stock granted was recorded as unearned compensation and is amortized to expense over the period during which the shares vest. Unearned compensation is shown as a reduction of stockholders' equity.\nDIRECTOR STOCK OPTION PLAN - The Company's 1995 Director Stock Option Plan (the \"1995 Director Plan\") is intended to obtain and retain non-employee members of the board of directors by rewarding them for making major contributions to the success of the Company. The 1995 Director Plan authorized options with respect to 200,000 shares of Common Stock to be granted at an option price of $7.375 per share. In 1995, the Company granted 120,000 options. The market value of the Company's Common Stock at the date of grant was less than the option price, and no compensation expense was recorded.\nStock option transactions under the plans were as follows:\n(J) RELATED PARTY TRANSACTIONS\nIn 1994, as a part of the purchase of certain notes and interests relating to two of the leased drilling units \"C.E. THORNTON\" and \"F.G. McCLINTOCK\" (see Note E), the Company paid cash of $93,500 and issued 44,000 shares of Common Stock to BCL Investment Partners, L.P. (\"BCL\"), a major shareholder of the Company during 1994. Such cash and Common Stock represented payment for BCL's proportionate holdings of such notes and interests and was paid pro rata to all sellers of such notes and interests.\nDrilling has rig management agreements with Sonat Offshore Drilling Inc. (\"Sonat Offshore\"), a major shareholder of Drilling, for the operation and marketing of both of its drilling units. In December 1995, the management agreement for one of Drilling's drilling units expired and a subsidiary of the Company now manages the drilling unit. For each of the years ending December 31, 1995, 1994 and 1993, Drilling paid to Sonat Offshore approximately $2.6 million, $2.5 million and $2.5 million, respectively, for such management services. In addition, Drilling has a bareboat charter agreement with Sonat Offshore for the other drilling unit. For the years ended December 31, 1995, 1994 and 1993, Drilling received from Sonat Offshore approximately $11.8 million, $13.9 million, and $14.7 million, respectively, for such bareboat charter. At December 31, 1995 and 1994, Drilling had a net receivable from Sonat Offshore of $5.4 million and $4.9 million, respectively.\n(K) MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION\nThe Company, together with its 50% or less owned unconsolidated investees, operates principally in international offshore contract drilling of oil and gas wells. For the year ended December 31, 1995, revenues from two customers of $29.4 million and $28.9 million each accounted for 14% of the Company's total operating revenues. For the year ended December 31, 1994, revenues from one customer of $35.2 million accounted for 21% of the Company's total operating revenues. For the year ended December 31, 1993, revenues from three customers of $39.6 million, $37.7 million and $20.3 million accounted for 22%, 20% and 11%, respectively, of the Company's total operating revenues.\nGeographic information about the Company's operations for the three years ended December 31, 1995 is as follows (in thousands):\nREADING & BATES CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL CONSOLIDATED FINANCIAL INFORMATION\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for the two years ended December 31, 1995, are as follows (in thousands except for per share amounts):\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nThe information called for by Part III of Form 10-K is incorporated by reference from the Registrant's Proxy Statement relating to its annual meeting of Stockholders to be held May 14, 1996, which will be filed by the Registrant with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year. Also reference is made to the information contained under the captioned \"Executive Officers of Registrant\" contained in Part I hereof.\nPART IV\nItem 14. Exhibits, Financial Statements and Reports on Form 8-K\n(a) Financial Statements and Exhibits 1. Financial Statements:\nReport of Independent Public Accountants Consolidated Balance Sheet as of December 31, 1995 and 1994 Consolidated Statement of Operations for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements Supplemental Consolidated Financial Information (unaudited)\n2. Exhibits:\nExhibit 3.1- The Registrant's Restated Certificate of Incorporation. (Filed as Exhibit 3.1 to Post-Effective Amendment No. 2 to the Company's Registration Statement on Form 8-A\/A dated May 27, 1994 and incorporated herein by reference.)\nExhibit 3.2- Certificate of Designations of Series B Junior Participating Preferred Stock of the Registrant.\nExhibit 3.3- The Registrant's Bylaws, as amended and restated effective March 2, 1995. (Filed as Exhibit 3.1 to the Registrant's Form 8-K dated March 3, 1995 and incorporated herein by reference.)\nExhibit 4.1- Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10- K for 1989 and incorporated herein by reference.)\nExhibit 4.2- Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3- Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4- Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.5- Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.6- Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.7- Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.8- Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.9- Amendment No. 3, dated as of August 1, 1994, to the Registration Rights Agreement. (Filed as Exhibit 4.5 to the Registration No. 33-56029 and incorporated herein by reference.)\nExhibit 4.10- Common Stock Issuance Agreement dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 4.11- Common Stock Issuance Agreement dated August 31, 1995 between the Company and DeepFlex Production Partners L.P. (Filed as Exhibit 4.7 to Registration No. 33- 62727 and incorporated herein by reference.)\nExhibit 4.12- Rights Agreement dated as of March 15, 1995, including Exhibit A, \"Form of Certificate of Designations\"; Exhibit B, \"Form of Rights Certificate\"; Exhibit C, \"Summary of Rights to Purchase Preferred Shares\". (Filed as Exhibit 4 to the Company's Registration Statement on Form 8-A dated March 22, 1995 and incorporated herein by reference.)\nExhibit 10.1- Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2- Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3- Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4- Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5- Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Second Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.6- Amendment No. 1, dated July 31, 1995, to the Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.7- Amendment No. 2, dated November 29, 1995, to the Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.8- Amendment No. 3 to Trust Indenture dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.9- Amendment No. 7, dated November 29, 1995, to Preferred Fleet Mortgage dated March 29, 1991 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.10- Amendment No. 3 to Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.11- Amendment No. 3 to Assignment of Insurances dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.12- Galloway Assignment Agreement dated November 29, 1995 between Internationale Nederlanden Bank N.V. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.13- Thornton Assignment Agreement dated November 29, 1995 between Internationale Nederlanden Bank N.V. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.14- Termination of Charter Payments Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.15- Termination Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.16- Letter of Credit Wind-Down Agreement dated November 28, 1995 between the Registrant and Internationale Nederlanden Bank, N.V.\nExhibit 10.17- Termination of Pledge Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.18- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.19- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among Reading & Bates Borneo Drilling Co., Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.20- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among Reading & Bates (A) Pty. Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.21- Termination of Assignment of Insurances dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.22- Termination of Assignment of Insurances dated November 29, 1995 among Reading & Bates Borneo Drilling Co., Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.23- Termination of Assignment of Insurances dated November 29, 1995 among Reading & Bates (A) Pty. Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.24- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between the Registrant and Bank One, Texas, N.A., as trustee.\nExhibit 10.25- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.26- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.27- Termination of Indenture of Trust dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.28*- Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.29*- 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.30*- 1995 Long-Term Incentive Plan of Reading & Bates Corporation (Filed as Exhibit 99.A to the Company's Proxy Statement dated March 29, 1995 and incorporated herein by reference.)\nExhibit 10.31*- 1995 Director Stock Option Plan of Reading & Bates Corporation (Filed as Exhibit 99.B to the Company's Proxy Statement dated March 29, 1995 and incorporated herein by reference.)\nExhibit 10.32*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian. (Filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.33*- Surrender Letter dated as of February 7, 1995 by C. A. Donabedian.\nExhibit 10.34*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean. (Filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.35*- Surrender Letter dated as of February 7, 1995 by J. W. McLean.\nExhibit 10.36*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer. (Filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.37*- Surrender Letter dated as of February 7, 1995 by R. L. Sandmeyer.\nExhibit 10.38*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster. (Filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.39*- Surrender Letter dated as of February 7, 1995 by S. A. Webster.\nExhibit 10.40*- Stock Option Agreement dated as of February 7, 1995 between A.L. Chavkin and the Registrant.\nExhibit 10.41*- Stock Option Agreement dated as of February 7, 1995 between Willem Cordia and the Registrant.\nExhibit 10.42*- Stock Option Agreement dated as of February 7, 1995 between C.A. Donabedian and the Registrant.\nExhibit 10.43*- Stock Option Agreement dated as of February 7, 1995 between Ted Kalborg and the Registrant.\nExhibit 10.44*- Stock Option Agreement dated as of February 7, 1995 between J.W. McLean and the Registrant.\nExhibit 10.45*- Stock Option Agreement dated as of February 7, 1995 between R.L. Sandmeyer and the Registrant.\nExhibit 10.46*- Stock Option Agreement dated as of February 7, 1995 between S.A. Webster and the Registrant.\nExhibit 10.47*- Stock Option Agreement dated as of April 19, 1995 between M.A.E. Lacqueur and the Registrant.\nExhibit 10.48*- Stock Option Agreement with respect to the 1995 Long- Term Incentive Plan dated February 6, 1996 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.49*- Stock Option Agreement with respect to the 1992 Long- Term Incentive Plan dated February 6, 1996 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.50*- Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.51*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.22 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.52*- Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.53*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.54*- Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.55*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.56*- Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.57*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.58*- Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.59*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.60*- Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.61*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.62*- Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.63*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.64*- Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.65*- Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.66- Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.67- Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.68- Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.69- Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.70- Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.71- Amendment Agreement dated November 30, 1995 to Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A.\nExhibit 10.72- Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.73- HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.74- Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.75- Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.76- Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.77- ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between The Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.78- Assignment Agreement \"F. G. McClintock\" dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 10.55 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.79- Assignment Agreement \"F. G. McClintock\" dated as of September 27, 1994 between the Company and BT Advisors, Inc. (Filed as Exhibit 10.56 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.80- Assignment Agreement \"C. E. Thornton\" dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 10.57 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.81- Assignment Agreement \"C. E. Thornton\" dated as of September 27, 1994 between the Company and BT Advisors, Inc. (Filed as Exhibit 10.58 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.82- Assignment Agreement \"George H. Galloway\" dated as of August 24, 1994 between the Company and Elliott Associates L.P. (Filed as Exhibit 10.59 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.83- Loan Agreement dated as of May 25, 1995 among the Registrant and Reading & Bates Offshore, Limited, a subsidiary of the Registrant, and the CIT Group\/Equipment Financing, Inc. (Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the Second Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.84- Amendment No. 1 dated as of December 20, 1995 Loan Agreement dated as of May 25, 1995 among The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant and the Registrant.\nExhibit 10.85- Amendment No. 1 dated as of December 20, 1995 to the Guaranty dated as of May 25, 1995 made by the Registrant in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.86- First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.87- Supplement No. 1 dated July 13, 1995 to First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.88- Supplement No. 2 dated December 20, 1995 to First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.89- General Assignment of Earnings dated May 25, 1995 by Reading & Bates Offshore, Limited, a subsidiary of the Registrant, in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.90- Assignment of Insurance dated May 25, 1995 by Reading & Bates Offshore, Limited, a subsidiary of the Registrant, in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.91- Memorandum of Agreement dated August 31, 1995 between FPS II, Inc., as holder of legal title for the benefit of DeepFlex Production Partners, L.P. and Reading & Bates (U.K.) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.92- Agreement for the sale and purchase of Semi-Submersible Emergency Support Vessel Iolair dated September 8, 1995 between BP Exploration Operating Company Limited and Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.93- Mortgage of a Ship dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and BP Exploration Operating Company Limited. (Filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.94- Mortgage of a Ship dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and Britoil plc. (Filed as Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.95- Deed of Covenant dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and BP Exploration Operating Company Limited. (Filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.96- Deed of Covenant dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and Britoil Public Limited Company. (Filed as Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.97- Performance Guarantee dated September 8, 1995 by the Registrant in favour of BP Exploration Operating Company Limited. (Filed as Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.98- Performance Guarantee dated September 8, 1995 by the Registrant in favour of Britoil plc. (Filed as Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.99- Initial Services Agreement dated September 8, 1995 between Britoil Public Limited Company and Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.100- Heads of Agreement for the provision of Vessel Services dated September 8, 1995 between Britoil Public Limited Company, Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and the Registrant. (Filed as Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.101- Credit Facility Agreement dated November 16, 1995 among the Registrant, Reading & Bates Drilling Co. and Reading & Bates Exploration Co., subsidiaries of the Registrant, and Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.102- Guarantee dated November 28, 1995 by the Registrant in favor of Christiania Bank Og Kreditkasse.\nExhibit 10.103- First Preferred Mortgage on the \"Jack Bates\" dated November 28, 1995 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.104- First Preferred Mortgage on the \"D.R. Stewart\" dated November 28, 1995 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.105- Indenture of Trust dated November 16, 1995 among Reading & Bates Drilling Co. and Reading & Bates Exploration Co., subsidiaries of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.106- General Assignment with respect to the \"Jack Bates\" dated November 28, 1995 by Reading & Bates Drilling Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.107- General Assignment with respect to the \"D.R. Stewart\" dated November 28, 1995 by Reading & Bates Exploration Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.108- Assignment of Insurances with respect to the \"Jack Bates\" dated November 28, 1995 by Reading & Bates Drilling Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.109- Assignment of Insurances with respect to the \"D.R. Stewart\" dated November 28, 1995 by Reading & Bates Exploration Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.110- Memorandum of Agreement dated November 28, 1995 between Reading and Bates, Inc., a subsidiary of the Registrant, and Deep Sea Investors, L.L.C.\nExhibit 10.111- Bareboat Charter \"M.G. Hulme, Jr.\" dated November 28, 1995 between Deep Sea Investors, L.L.C. and Reading & Bates Drilling Co., a subsidiary of the Registrant.\nExhibit 10.112- Purchase and Sale Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.113- Assignment and Bill of Sale (OCS-G-8504) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.114- Assignment and Bill of Sale (OCS-G-8012 effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.115- Assignment and Bill of Sale (OCS-G- 7049) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.116- Assignment and Bill of Sale (OCS-G-8010) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.117- Assignment and Bill of Sale (OCS-G-13696) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.118- Assignment and Bill of Sale (OCS-G-13171) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.119- Assignment and Bill of Sale (OCS-G-8005) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.120- Assignment and Bill of Sale (OCS-G-8000) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.121- Assignment and Bill of Sale (OCS-G-8006) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.122- Assignment and Bill of Sale (OCS-G-8876) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.123- Payment Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.124- Mortgage and Security Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.125- Operating Agreement made effective as of May 1, 1995 among Enserch Exploration, Inc., Mobil Oil Corporation, Mobil Oil exploration & Producing Southeast Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.126- Option Agreement made effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 11 - Computation of Earnings Per Common Share\nExhibit 21 - Schedule of Subsidiaries of the Company\nExhibit 23 - Consent of Arthur Andersen LLP\nExhibit 27 - Financial Data Schedule. (Exhibit 27 is being submitted as an exhibit only in the electronic format of this Annual Report on Form 10-K being submitted to the Securities and Exchange Commission.)\nExhibit 99 - Annual Report on Form 11-K with respect to Reading & Bates Savings Plan.\nInstruments with respect to certain long-term obligations of the Company are not being filed as exhibits hereto as the securities authorized thereunder do not exceed 10% of the Company's total assets. The Company agrees to furnish a copy of each such instrument to the Securities and Exchange Commission upon its request.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K\nThere were four Current Reports on Form 8-K filed during the three months ended December 31, 1995. A Current Report on Form 8-K was filed on October 16, 1995 disclosing the Company's 3rd quarter 1995 earnings; filed October 25, 1995 disclosing the Company's purchase of a 20% working interest in the Green Canyon 254 Allegheny project from Enserch Exploration, Inc.; filed November 9, 1995 disclosing that ARCO China Inc. elected to exercise three option wells for the \"JACK BATES\"; and filed December 4, 1995 disclosing the closing of two separate financings aggregating approximately $115 million, which included the sale\/lease-back of the \"M.G. HULME, JR.\".\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned, thereunto duly authorized on March 11, 1996.\nREADING & BATES CORPORATION\nBy \/s\/ Paul B. Loyd, Jr. ------------------------- Paul B. Loyd, Jr. President, Chief Executive Officer, Chairman and Director\nPursuant to the requirements of the Securities Exchange Act of l934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on March 11, 1996.\nBy \/s\/ Paul B. Loyd Jr. By \/s\/Macko A. E. Laqueur --------------------------- --------------------------- Paul B. Loyd, Jr. Macko A. E. Laqueur President, Chief Director Executive Officer, Chairman and Director\nBy \/s\/ C. Kirk Rhein, Jr. By \/s\/ Charles A. Donabedian --------------------------- -------------------------- C. Kirk Rhein, Jr. Charles A. Donabedian Vice Chairman and Director Director\nBy \/s\/ Tim W. Nagle By \/s\/ J. W. McLean --------------------------- -------------------------- Tim W. Nagle J. W. McLean Executive Vice President, Director Finance and Administration Principal Accounting Officer\nBy \/s\/ Ted Kalborg By \/s\/ Arnold L. Chavkin --------------------------- --------------------------- Ted Kalborg Arnold L. Chavkin Director Director\nBy \/s\/ Steven A. Webster By \/s\/ Robert L. Sandmeyer --------------------------- --------------------------- Steven A. Webster Robert L. Sandmeyer Director Director","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 and Exhibits 1. Financial Statements:\nReport of Independent Public Accountants Consolidated Balance Sheet as of December 31, 1995 and 1994 Consolidated Statement of Operations for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements Supplemental Consolidated Financial Information (unaudited)\n2. Exhibits:\nExhibit 3.1- The Registrant's Restated Certificate of Incorporation. (Filed as Exhibit 3.1 to Post-Effective Amendment No. 2 to the Company's Registration Statement on Form 8-A\/A dated May 27, 1994 and incorporated herein by reference.)\nExhibit 3.2- Certificate of Designations of Series B Junior Participating Preferred Stock of the Registrant.\nExhibit 3.3- The Registrant's Bylaws, as amended and restated effective March 2, 1995. (Filed as Exhibit 3.1 to the Registrant's Form 8-K dated March 3, 1995 and incorporated herein by reference.)\nExhibit 4.1- Indenture relating to the Registrant's 8% Senior Subordinated Convertible Debentures due 1998 dated as of August 29, 1989, between the Registrant and IBJ Schroder Bank & Trust Company, as Trustee. (Filed as Exhibit 4.1 to the Company's Annual Report on Form 10- K for 1989 and incorporated herein by reference.)\nExhibit 4.2- Form of the Registrant's registered 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.2 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.3- Form of the Registrant's bearer 8% Senior Subordinated Convertible Debentures due 1998. (Filed as Exhibit 4.3 to Registration No. 33-28580 and incorporated herein by reference.)\nExhibit 4.4- Form of the Registrant's Common Stock Certificate. (Filed as Exhibit 4.6 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 4.5- Form of Preferred Stock Certificate for $1.625 Convertible Preferred Stock ($1.00 par value). (Filed as Exhibit 4.4 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.6- Registration Rights Agreement dated as of March 29, 1991 among the Registrant, Holders as referred therein and members of Offering Committee as referred therein. (Filed as Exhibit 4.22 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 4.7- Amendment No. 1, dated as of September 1, 1992, to the Registration Rights Agreement filed as Exhibit 4.7 hereto. (Filed as Exhibit 4.18 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 4.8- Amendment No. 2, dated as of June 1, 1993, to the Registration Rights Agreement. (Filed as Exhibit 4.8 to Registration No. 33-65476 and incorporated herein by reference.)\nExhibit 4.9- Amendment No. 3, dated as of August 1, 1994, to the Registration Rights Agreement. (Filed as Exhibit 4.5 to the Registration No. 33-56029 and incorporated herein by reference.)\nExhibit 4.10- Common Stock Issuance Agreement dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 4.24 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 4.11- Common Stock Issuance Agreement dated August 31, 1995 between the Company and DeepFlex Production Partners L.P. (Filed as Exhibit 4.7 to Registration No. 33- 62727 and incorporated herein by reference.)\nExhibit 4.12- Rights Agreement dated as of March 15, 1995, including Exhibit A, \"Form of Certificate of Designations\"; Exhibit B, \"Form of Rights Certificate\"; Exhibit C, \"Summary of Rights to Purchase Preferred Shares\". (Filed as Exhibit 4 to the Company's Registration Statement on Form 8-A dated March 22, 1995 and incorporated herein by reference.)\nExhibit 10.1- Amended and Restated Lease Restructuring Agreement dated as of March 29, 1991 among the Registrant, other obligors, the Lessors, the Lease Lenders, the Lease Trustees, the Lease Equity Participant and the Lease Agent, all as named therein. (Filed as Exhibit 4.26 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.2- Bareboat Charter Party Amendment No. 2 dated March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Drilling Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.27 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.3- Bareboat Charter Party Amendment No. 3 dated as of March 29, 1991 between The Connecticut National Bank, as Owner Trustee and Reading & Bates Exploration Co., a subsidiary of the Registrant, as Charterer. (Filed as Exhibit 4.28 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.4- Amendment No. 1 to Trust Indenture and First Preferred Ship Mortgage dated as of March 29, 1991 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee. (Filed as Exhibit 4.29 to the Company's Annual Report on Form 10-K for 1990 and incorporated herein by reference.)\nExhibit 10.5- Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Second Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.6- Amendment No. 1, dated July 31, 1995, to the Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V. (Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.7- Amendment No. 2, dated November 29, 1995, to the Amended and Restated Credit Facility Agreement dated as of April 27, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.8- Amendment No. 3 to Trust Indenture dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc., Reading and Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.9- Amendment No. 7, dated November 29, 1995, to Preferred Fleet Mortgage dated March 29, 1991 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.10- Amendment No. 3 to Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.11- Amendment No. 3 to Assignment of Insurances dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.12- Galloway Assignment Agreement dated November 29, 1995 between Internationale Nederlanden Bank N.V. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.13- Thornton Assignment Agreement dated November 29, 1995 between Internationale Nederlanden Bank N.V. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.14- Termination of Charter Payments Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.15- Termination Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.16- Letter of Credit Wind-Down Agreement dated November 28, 1995 between the Registrant and Internationale Nederlanden Bank, N.V.\nExhibit 10.17- Termination of Pledge Agreement dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Internationale Nederlanden Bank N.V.\nExhibit 10.18- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.19- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among Reading & Bates Borneo Drilling Co., Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.20- Termination of Assignment of Drilling Contract Revenues and Earnings dated November 29, 1995 among Reading & Bates (A) Pty. Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.21- Termination of Assignment of Insurances dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.22- Termination of Assignment of Insurances dated November 29, 1995 among Reading & Bates Borneo Drilling Co., Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.23- Termination of Assignment of Insurances dated November 29, 1995 among Reading & Bates (A) Pty. Ltd., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.24- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between the Registrant and Bank One, Texas, N.A., as trustee.\nExhibit 10.25- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.26- Termination of Pledge Agreement and Irrevocable Proxy dated November 29, 1995 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.27- Termination of Indenture of Trust dated November 29, 1995 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co. and Reading & Bates, Inc., Reading & Bates Borneo Drilling Co., Ltd. and Reading & Bates (A) Pty. Ltd., subsidiaries of the Registrant, and Bank One, Texas, N.A., as trustee.\nExhibit 10.28*- Reading & Bates 1990 Stock Option Plan. (Filed as Appendix A to the Company's Proxy Statement dated April 26, 1993 and incorporated herein by reference.)\nExhibit 10.29*- 1992 Long-Term Incentive Plan of Reading & Bates Corporation. (Filed as Exhibit B to the Registrant's Proxy Statement dated April 27, 1992 and incorporated herein by reference.)\nExhibit 10.30*- 1995 Long-Term Incentive Plan of Reading & Bates Corporation (Filed as Exhibit 99.A to the Company's Proxy Statement dated March 29, 1995 and incorporated herein by reference.)\nExhibit 10.31*- 1995 Director Stock Option Plan of Reading & Bates Corporation (Filed as Exhibit 99.B to the Company's Proxy Statement dated March 29, 1995 and incorporated herein by reference.)\nExhibit 10.32*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and C. A. Donabedian. (Filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.33*- Surrender Letter dated as of February 7, 1995 by C. A. Donabedian.\nExhibit 10.34*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and J. W. McLean. (Filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.35*- Surrender Letter dated as of February 7, 1995 by J. W. McLean.\nExhibit 10.36*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and R. L. Sandmeyer. (Filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.37*- Surrender Letter dated as of February 7, 1995 by R. L. Sandmeyer.\nExhibit 10.38*- Director Stock Option Agreement dated as of September 14, 1993 between the Registrant and S. A. Webster. (Filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.39*- Surrender Letter dated as of February 7, 1995 by S. A. Webster.\nExhibit 10.40*- Stock Option Agreement dated as of February 7, 1995 between A.L. Chavkin and the Registrant.\nExhibit 10.41*- Stock Option Agreement dated as of February 7, 1995 between Willem Cordia and the Registrant.\nExhibit 10.42*- Stock Option Agreement dated as of February 7, 1995 between C.A. Donabedian and the Registrant.\nExhibit 10.43*- Stock Option Agreement dated as of February 7, 1995 between Ted Kalborg and the Registrant.\nExhibit 10.44*- Stock Option Agreement dated as of February 7, 1995 between J.W. McLean and the Registrant.\nExhibit 10.45*- Stock Option Agreement dated as of February 7, 1995 between R.L. Sandmeyer and the Registrant.\nExhibit 10.46*- Stock Option Agreement dated as of February 7, 1995 between S.A. Webster and the Registrant.\nExhibit 10.47*- Stock Option Agreement dated as of April 19, 1995 between M.A.E. Lacqueur and the Registrant.\nExhibit 10.48*- Stock Option Agreement with respect to the 1995 Long- Term Incentive Plan dated February 6, 1996 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.49*- Stock Option Agreement with respect to the 1992 Long- Term Incentive Plan dated February 6, 1996 between the Registrant and Paul B. Loyd, Jr.\nExhibit 10.50*- Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.51*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and L. E. Voss, Jr. (Filed as Exhibit 10.22 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.52*- Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.53*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and T. W. Nagle. (Filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.54*- Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.55*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and C. R. Ofner. (Filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.56*- Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.57*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and D. L. McIntire. (Filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.58*- Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.59*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of November 1, 1991 between the Registrant and W. K. Hillin. (Filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.60*- Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.42 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.61*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and Paul B. Loyd, Jr. (Filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.62*- Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.43 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.63*- Amendment No. 1, dated as of October 1, 1993, to the Employment Agreement dated as of January 1, 1992 between the Registrant and C. Kirk Rhein, Jr. (Filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.64*- Employment Agreement dated as of January 1, 1992 between the Registrant and J. T. Angel. (Filed as Exhibit 10.44 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.65*- Agreement amending Employment Agreement dated October 7, 1993 between the Registrant and J. T. Angel. (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1993 and incorporated herein by reference.)\nExhibit 10.66- Agreement dated as of August 31, 1991 among Registrant, Arcade Shipping AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for 1991 and incorporated herein by reference.)\nExhibit 10.67- Thornton Waiver Agreement dated as of May 31, 1991 among the Noteholders, the Owner Trustee and the Indenture Trustee named therein. (Filed as Exhibit 10.46 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.68- Thornton Rescission Agreement dated as of June 28, 1991 among Reading & Bates Exploration Co., the Registrant, the Noteholders, the Owner Trustee, the Indenture Trustee and the Owner Participant named therein. (Filed as Exhibit 10.49 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.69- Thornton Assignment Agreement dated as of June 28, 1991 between the Holders named therein and NMB Postbank Groep N.V. (Filed as Exhibit 10.50 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.70- Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A. (Filed as Exhibit 10.51 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.71- Amendment Agreement dated November 30, 1995 to Facility Agreement dated February 21, 1991 between Arcade Drilling AS, Chase Investment Bank Limited and The Chase Manhattan Bank, N.A.\nExhibit 10.72- Hull 515 Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.52 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.73- HG Rig Management Agreement dated October 26, 1990 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.53 to Registration No. 33- 51120 and incorporated herein by reference.)\nExhibit 10.74- Modification Agreement dated as of May 27, 1992 between Arcade Drilling AS and Sonat Offshore Drilling Inc. (Filed as Exhibit 10.54 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.75- Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading & Bates Drilling Co., Reading & Bates Exploration Co., Reading and Bates, Inc. and NMB Postbank Groep, N.V. (Filed as Exhibit 10.57 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.76- Amendment No. 1, dated as of June 30, 1992, to Charter Payments Agreement dated as of September 30, 1991 among the Registrant, Reading and Bates Drilling Co., Reading and Bates Exploration Co., Reading and Bates, Inc. and Internationale Nederlanden Bank N.V. (formerly known as NMB Postbank Groep N.V.). (Filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for 1992 and incorporated herein by reference.)\nExhibit 10.77- ISDA Interest and Currency Exchange Agreement dated as of October 26, 1990 between The Chase Manhattan Bank, N.A. and K\/S Frontier Drilling, and Novation Agreement with respect thereto dated February 28, 1991. (Filed as Exhibit 10.62 to Registration No. 33-51120 and incorporated herein by reference.)\nExhibit 10.78- Assignment Agreement \"F. G. McClintock\" dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 10.55 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.79- Assignment Agreement \"F. G. McClintock\" dated as of September 27, 1994 between the Company and BT Advisors, Inc. (Filed as Exhibit 10.56 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.80- Assignment Agreement \"C. E. Thornton\" dated as of August 24, 1994 between the Company and BCL Investment Partners L.P. (Filed as Exhibit 10.57 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.81- Assignment Agreement \"C. E. Thornton\" dated as of September 27, 1994 between the Company and BT Advisors, Inc. (Filed as Exhibit 10.58 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.82- Assignment Agreement \"George H. Galloway\" dated as of August 24, 1994 between the Company and Elliott Associates L.P. (Filed as Exhibit 10.59 to the Company's Annual Report on Form 10-K for 1994 and incorporated herein by reference.)\nExhibit 10.83- Loan Agreement dated as of May 25, 1995 among the Registrant and Reading & Bates Offshore, Limited, a subsidiary of the Registrant, and the CIT Group\/Equipment Financing, Inc. (Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the Second Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.84- Amendment No. 1 dated as of December 20, 1995 Loan Agreement dated as of May 25, 1995 among The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant and the Registrant.\nExhibit 10.85- Amendment No. 1 dated as of December 20, 1995 to the Guaranty dated as of May 25, 1995 made by the Registrant in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.86- First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.87- Supplement No. 1 dated July 13, 1995 to First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.88- Supplement No. 2 dated December 20, 1995 to First Preferred Fleet Mortgage dated May 25, 1995 between The CIT Group\/Equipment Financing, Inc. and Reading & Bates Offshore, Limited, a subsidiary of the Registrant.\nExhibit 10.89- General Assignment of Earnings dated May 25, 1995 by Reading & Bates Offshore, Limited, a subsidiary of the Registrant, in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.90- Assignment of Insurance dated May 25, 1995 by Reading & Bates Offshore, Limited, a subsidiary of the Registrant, in favor of The CIT Group\/Equipment Financing, Inc.\nExhibit 10.91- Memorandum of Agreement dated August 31, 1995 between FPS II, Inc., as holder of legal title for the benefit of DeepFlex Production Partners, L.P. and Reading & Bates (U.K.) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.92- Agreement for the sale and purchase of Semi-Submersible Emergency Support Vessel Iolair dated September 8, 1995 between BP Exploration Operating Company Limited and Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.93- Mortgage of a Ship dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and BP Exploration Operating Company Limited. (Filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.94- Mortgage of a Ship dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and Britoil plc. (Filed as Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.95- Deed of Covenant dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and BP Exploration Operating Company Limited. (Filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.96- Deed of Covenant dated September 8, 1995 between Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and Britoil Public Limited Company. (Filed as Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.97- Performance Guarantee dated September 8, 1995 by the Registrant in favour of BP Exploration Operating Company Limited. (Filed as Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.98- Performance Guarantee dated September 8, 1995 by the Registrant in favour of Britoil plc. (Filed as Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.99- Initial Services Agreement dated September 8, 1995 between Britoil Public Limited Company and Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant. (Filed as Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.100- Heads of Agreement for the provision of Vessel Services dated September 8, 1995 between Britoil Public Limited Company, Reading & Bates (Caledonia) Limited, a subsidiary of the Registrant, and the Registrant. (Filed as Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q for the Third Quarter of 1995 and incorporated herein by reference.)\nExhibit 10.101- Credit Facility Agreement dated November 16, 1995 among the Registrant, Reading & Bates Drilling Co. and Reading & Bates Exploration Co., subsidiaries of the Registrant, and Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.102- Guarantee dated November 28, 1995 by the Registrant in favor of Christiania Bank Og Kreditkasse.\nExhibit 10.103- First Preferred Mortgage on the \"Jack Bates\" dated November 28, 1995 between Reading & Bates Drilling Co., a subsidiary of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.104- First Preferred Mortgage on the \"D.R. Stewart\" dated November 28, 1995 between Reading & Bates Exploration Co., a subsidiary of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.105- Indenture of Trust dated November 16, 1995 among Reading & Bates Drilling Co. and Reading & Bates Exploration Co., subsidiaries of the Registrant, and Wilmington Trust Company, as Indenture Trustee.\nExhibit 10.106- General Assignment with respect to the \"Jack Bates\" dated November 28, 1995 by Reading & Bates Drilling Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.107- General Assignment with respect to the \"D.R. Stewart\" dated November 28, 1995 by Reading & Bates Exploration Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.108- Assignment of Insurances with respect to the \"Jack Bates\" dated November 28, 1995 by Reading & Bates Drilling Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.109- Assignment of Insurances with respect to the \"D.R. Stewart\" dated November 28, 1995 by Reading & Bates Exploration Co., a subsidiary of the Registrant, in favor of Christiania Bank Og Kreditkasse, as agent.\nExhibit 10.110- Memorandum of Agreement dated November 28, 1995 between Reading and Bates, Inc., a subsidiary of the Registrant, and Deep Sea Investors, L.L.C.\nExhibit 10.111- Bareboat Charter \"M.G. Hulme, Jr.\" dated November 28, 1995 between Deep Sea Investors, L.L.C. and Reading & Bates Drilling Co., a subsidiary of the Registrant.\nExhibit 10.112- Purchase and Sale Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.113- Assignment and Bill of Sale (OCS-G-8504) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.114- Assignment and Bill of Sale (OCS-G-8012 effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.115- Assignment and Bill of Sale (OCS-G- 7049) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.116- Assignment and Bill of Sale (OCS-G-8010) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.117- Assignment and Bill of Sale (OCS-G-13696) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.118- Assignment and Bill of Sale (OCS-G-13171) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.119- Assignment and Bill of Sale (OCS-G-8005) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.120- Assignment and Bill of Sale (OCS-G-8000) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.121- Assignment and Bill of Sale (OCS-G-8006) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.122- Assignment and Bill of Sale (OCS-G-8876) effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.123- Payment Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.124- Mortgage and Security Agreement dated October 18, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.125- Operating Agreement made effective as of May 1, 1995 among Enserch Exploration, Inc., Mobil Oil Corporation, Mobil Oil exploration & Producing Southeast Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 10.126- Option Agreement made effective as of May 1, 1995 between Enserch Exploration, Inc. and Reading & Bates Development Co., a subsidiary of the Registrant.\nExhibit 11 - Computation of Earnings Per Common Share\nExhibit 21 - Schedule of Subsidiaries of the Company\nExhibit 23 - Consent of Arthur Andersen LLP\nExhibit 27 - Financial Data Schedule. (Exhibit 27 is being submitted as an exhibit only in the electronic format of this Annual Report on Form 10-K being submitted to the Securities and Exchange Commission.)\nExhibit 99 - Annual Report on Form 11-K with respect to Reading & Bates Savings Plan.\nInstruments with respect to certain long-term obligations of the Company are not being filed as exhibits hereto as the securities authorized thereunder do not exceed 10% of the Company's total assets. The Company agrees to furnish a copy of each such instrument to the Securities and Exchange Commission upon its request.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K\nThere were four Current Reports on Form 8-K filed during the three months ended December 31, 1995. A Current Report on Form 8-K was filed on October 16, 1995 disclosing the Company's 3rd quarter 1995 earnings; filed October 25, 1995 disclosing the Company's purchase of a 20% working interest in the Green Canyon 254 Allegheny project from Enserch Exploration, Inc.; filed November 9, 1995 disclosing that ARCO China Inc. elected to exercise three option wells for the \"JACK BATES\"; and filed December 4, 1995 disclosing the closing of two separate financings aggregating approximately $115 million, which included the sale\/lease-back of the \"M.G. HULME, JR.\".\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned, thereunto duly authorized on March 11, 1996.\nREADING & BATES CORPORATION\nBy \/s\/ Paul B. Loyd, Jr. ------------------------- Paul B. Loyd, Jr. President, Chief Executive Officer, Chairman and Director\nPursuant to the requirements of the Securities Exchange Act of l934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on March 11, 1996.\nBy \/s\/ Paul B. Loyd Jr. By \/s\/Macko A. E. Laqueur --------------------------- --------------------------- Paul B. Loyd, Jr. Macko A. E. Laqueur President, Chief Director Executive Officer, Chairman and Director\nBy \/s\/ C. Kirk Rhein, Jr. By \/s\/ Charles A. Donabedian --------------------------- -------------------------- C. Kirk Rhein, Jr. Charles A. Donabedian Vice Chairman and Director Director\nBy \/s\/ Tim W. Nagle By \/s\/ J. W. McLean --------------------------- -------------------------- Tim W. Nagle J. W. McLean Executive Vice President, Director Finance and Administration Principal Accounting Officer\nBy \/s\/ Ted Kalborg By \/s\/ Arnold L. Chavkin --------------------------- --------------------------- Ted Kalborg Arnold L. Chavkin Director Director\nBy \/s\/ Steven A. Webster By \/s\/ Robert L. Sandmeyer --------------------------- --------------------------- Steven A. Webster Robert L. Sandmeyer Director Director","section_15":""}
{"filename":"718943_1995.txt","cik":"718943","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Dyco Oil and Gas Program 1982-1 Limited Partnership (the \"1982-1 Program\") and Dyco Oil and Gas Program 1982-2 Limited Partnership (the \"1982-2 Program\") (collectively, the \"Programs\") are Minnesota limited partnerships engaged in the production of oil and gas. The 1982-1 Program and 1982-2 Program commenced operations on June 14, 1982 and March 1, 1983, respectively, with the primary financial objective of investing their limited partners' subscriptions in the drilling of oil and gas prospects and then distributing to their 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 Programs. 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 Programs as of December 31, 1995.\nWell Statistics(1) As of December 31, 1995\n1982-1 1982-2 Program Program ------- ------- Gross productive wells(2): Oil 2 - Gas 20 22 -- -- Total 22 22\nNet productive wells(3): Oil .79 - Gas 2.31 2.53 ---- ---- Total 3.10 2.53\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 Programs 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 Programs, revenues attributable to such production, and certain price and cost information.\nNet Production Data\nYear Ended December 31, ---------------------------- 1995 1994 1993 -------- -------- -------- 1982-1 Program: - - --------------\nProduction: Oil (Bbls)(1) 2,308 2,615 2,493 Gas (Mcf)(2) 170,795 168,203 216,923\nOil and gas sales: Oil $ 39,156 $ 40,017 $ 42,514 Gas 224,175 270,556 399,425 ------- ------- ------- Total $263,331 $310,573 $441,939 ======= ======= ======= Total direct operating expenses $134,081 $ 90,531 $115,318 ======= ======= =======\nDirect operating expenses as a percentage of oil and gas sales 50.9% 29.1% 26.1%\nAverage sales price: Per barrel of oil $16.97 $15.30 $17.05 Per Mcf of gas 1.31 1.61 1.84\nDirect operating expenses per equivalent Mcf of gas(3) $ .73 $ .49 $ .50\n1982-2 Program: - - --------------\nProduction: Oil (Bbls)(1) 704 1,938 563 Gas (Mcf)(2) 437,387 475,083 329,173\nOil and gas sales: Oil $ 9,554 $ 21,248 $ 8,535 Gas 573,087 742,072 622,849 ------- ------- ------- Total $582,641 $763,320 $631,384 ======= ======= ======= Total direct operating expenses $168,278 $178,821 $187,145 ======= ======= ======= Direct operating expenses as a percentage of oil and gas sales 28.9% 23.4% 29.6%\nAverage sales price: Per barrel of oil $13.57 $10.96 $15.16 Per Mcf of gas 1.31 1.56 1.89\nDirect operating expenses per equivalent Mcf of gas(3) $ .38 $ .37 $ .56\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 Programs' 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 Programs' 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 Programs' 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 Programs' 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 Programs' 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\n1982-1 Program: --------------\nEstimated proved reserves: Natural gas (Mcf) 633,507 Oil and liquids (Bbls) 9,674\nNet present value (discounted at 10% per annum) $581,851\n1982-2 Program: --------------\nEstimated proved reserves: Natural gas (Mcf) 973,504 Oil and liquids (Bbls) 707\nNet present value (discounted at 10% per annum) $922,832\nNo estimates of the proved reserves of the Programs comparable to those included herein have been included in reports to any federal agency other than the SEC. Additional information relating to the Programs' proved reserves is contained in Notes 4 and 5 to the Programs' financial statements, included in Item 8 of this Annual Report.\nSignificant Properties\n1982-1 Program --------------\nAs of December 31, 1995, the 1982-1 Program's properties consisted of 22 gross (3.10 net) productive wells in which the 1982-1 Program owned a working interest. The 1982-1 Program owned a non- working interest in an additional 9 gross wells. Affiliates of the 1982-1 Program operate 11 (35%) of its total wells. As of December 31, 1995, the 1982-1 Program's net interests in its properties resulted in estimated total proved reserves of 633,507 Mcf of natural gas and 9,674 barrels of oil. Substantially all of the 1982-1 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 1982-1 Program's properties are located onshore in the continental United States.\nAs of December 31, 1995, the 1982-1 Program's properties in the Anadarko Basin consisted of 21 gross (2.59 net) wells in which the 1982-1 Program own a working interest. The 1982-1 Program owned a non-working interest in an additional 8 gross wells. Affiliates of the 1982-1 Program operate 10 (34%) of its total wells in the Anadarko Basin. As of December 31, 1995, the 1982-1 Program's net interest in such wells resulted in estimated total proved reserves of approxi- mately 598,225 Mcf of natural gas and approximately 9,674 barrels of crude oil, with a present value (discounted at 10% per annum) of esti- mated future net cash flow of approximately $553,560.\n1982-2 Program --------------\nAs of December 31, 1995, the 1982-2 Program's properties consisted of 22 gross (2.53 net) productive wells in which the 1982-2 Program owned a working interest. The 1982-2 Program owned a non- working interest in an additional 6 gross wells. Affiliates of the 1982-2 Program operate 10 (36%) of its total wells. As of December 31, 1995, the 1982-2 Program's net interests in its properties resulted in estimated total proved reserves of 973,504 Mcf of natural gas and 707 barrels of oil. All of the 1982-2 Program's reserves are located in the Anadarko Basin.\nTitle to Oil and Gas Properties\nManagement believes that the Programs have satisfactory title to their oil and gas properties. Record title to substantially all of the Programs' properties is held by Dyco as nominee.\nTitle to the Programs' 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 Programs' interest therein or materially interfere with their use in the operation of the Programs' 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 1982-2 Program had an approximate 1.6% working 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 1982-2 Program's share of such verdict is approximately $43,000 in actual damages and approximately $8,800 in punitive damages. See Note 4 to the 1982-2 Program's financial statements included in Item 8 of this Annual Report. Dyco is presently appealing the matter.\nExcept for the foregoing litigation, to the knowledge of the management of Dyco and the Programs, neither Dyco, the Programs, nor the Programs' properties are subject to any litigation, the results of which would have a material effect on the Programs' 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 of either Program during 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S LIMITED PARTNERSHIP UNITS AND RELATED LIMITED PARTNER MATTERS\nThe Programs do not have an established trading market for their units of limited partnership interest (\"Units\"). Pursuant to the terms of the Programs' limited partnership agreements, Dyco, as General Partner, is obligated to annually offer a repurchase offer which is based on the estimated future net revenues from the Programs' 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 Programs' cash distributions per Unit for the same period. For purposes of this Annual Report, a Unit represents an initial subscription of $5,000 to a Program.\n1982-1 PROGRAM --------------\nRepurchase Cash Price Distributions ---------- ------------- 1994: First Quarter $60 $ - Second Quarter 56 20 Third Quarter 56 - Fourth Quarter 56 -\n1995: First Quarter $56 - Second Quarter 56 - Third Quarter 54 - Fourth Quarter 54 -\n1996: First Quarter $54 (1)\n- - ---------- (1) To be declared in March 1996.\n1982-2 PROGRAM --------------\nRepurchase Cash Price Distributions ---------- ------------- 1994: First Quarter $147 $20 Second Quarter 144 25 Third Quarter 144 - Fourth Quarter 114 30\n1995: First Quarter $114 - Second Quarter 114 - Third Quarter 129 30 Fourth Quarter 99 -\n1996: First Quarter $ 99 (1)\n- - ---------- (1) To be declared in March 1996.\nThe 1982-1 Program has 10,100 Units outstanding and approximately 3,425 limited partners of record. The 1982-2 Program has 8,080 Units outstanding and approximately 2,682 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 Programs' 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 Programs. 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 Programs 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 Programs 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 Programs' cash flow, however, is dependent on such future gas prices.\n1982-1 Program --------------\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994 -------------------------------------\nTotal oil and gas sales decreased 15.2% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was due to decreases in both the average price of natural gas sold and volumes of oil sold, partially offset by increases in both volumes of natural gas sold and the average price of oil sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994. Volumes of oil sold decreased 307 barrels, while volumes of natural gas sold increased 2,592 Mcf for the year ended December 31, 1995 as compared to the year ended December 31, 1994. Average natural gas prices decreased to $1.31 per Mcf for the year ended December 31, 1995 from $1.61 per Mcf for the year ended December 31, 1994, while average oil prices increased to $16.97 per barrel for the year ended December 31, 1995 from $15.30 per barrel for the year ended December 31, 1994.\nOil and gas production expenses (including lease operating expenses and production taxes) increased 48.1% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase was primarily due to workover charges on several wells during the year ended December 31, 1995. As a percentage of oil and gas sales, these expenses increased to 50.9% for the year ended December 31, 1995 from 29.1% for the year ended December 31, 1994. This increase was primarily a result of the workover charges incurred during the year ended December 31, 1995 and the decrease in oil and gas sales discussed above.\nDepreciation, depletion, and amortization of oil and gas properties decreased $26,059 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily a result of an increase in the estimate of the 1982-1 Program's remaining natural gas reserves at December 31, 1995. As a percentage of oil and gas sales, this expense decreased to 15.3% for the year ended December 31, 1995 from 21.4% for the year ended December 31, 1994. This percentage decrease was primarily a result of the dollar decrease in depreciation, depletion, and amortization as discussed above.\nGeneral and administrative expenses increased by $11,998 for the year ended December 31, 1995 as compared to the year ended December 31 1994. This increase resulted 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 39.5% for the year ended December 31, 1995 from 29.7% for the year ended December 31, 1994. This percentage increase was primarily a result of the dollar increase in general and administrative expenses 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 29.7% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease was primarily due to a decrease in volumes of natural gas sold and decreases in the average prices of oil and natural gas sold. Volumes of oil sold increased slightly by 122 barrels, while volumes of natural gas sold decreased 48,720 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 due to volume adjustments made by a third party operator on one well who used an incorrect ownership interest in distributing revenues after such well had reached payout. Average oil and natural gas prices decreased to $15.30 per barrel and $1.61 per Mcf for the year ended December 31, 1994 from averages of $17.05 per barrel and $1.84 per Mcf for the year ended December 31, 1993.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased 21.5% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease was primarily due to the decreases in the volumes of natural gas sold and decreases in the average prices of oil and natural gas sold during 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 29.1% for the year ended December 31, 1994 compared to 26.1% for the year ended December 31, 1993. This increase was primarily a result of the decreases in the average prices of oil and natural gas sold.\nDepreciation, depletion, and amortization of oil and gas properties decreased $27,173 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease was primarily a result of the decrease in volumes of natural gas sold and an increase in the estimate of remaining natural gas reserves during 1994. As a percentage of oil and gas sales, this expense remained relatively constant at 21.4% for the year ended December 31, 1994 compared to 21.2% for the year ended December 31, 1993.\nGeneral and administrative expenses increased slightly by $1,067 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 29.7% for the year ended December 31, 1994 from 20.6% for the year ended December 31, 1993. This percentage increase was primarily a result of the decreases in the average prices of oil and natural gas sold.\n1982-2 Program -------------\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 was due to a decrease in the average price of natural gas sold and decreases in the volumes of oil and natural gas sold, partially offset by an increase in the average price of oil sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994. Volumes of oil and natural gas sold decreased by 1,234 barrels and 37,696 Mcf, respectively, 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 positive prior period volume adjustments from a purchaser on one well during the year ended December 31, 1994 and negative prior period volume adjustments on another well during the year ended December 31, 1995. The decrease in volumes of natural gas sold resulted primarily from\n(i) higher production on one well during 1994 which was recompleted in early 1994 and (ii) positive prior period volume adjustments from purchasers on several wells during the year ended December 31, 1994, partially offset by positive prior period volume adjustments on several wells during the year ended December 31, 1995. Average natural gas prices decreased to $1.31 per Mcf for the year ended December 31, 1995 from $1.56 per Mcf for the year ended December 31, 1994, while the average price of oil sold increased to $13.57 per barrel for the year ended December 31, 1995 from $10.96 per barrel for the year ended December 31, 1994.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased 5.9% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease resulted primarily from (i) an accrual for certain litigation costs during the year ended December 31, 1994 and (ii) workover charges on several wells during the year ended December 31, 1994 which were incurred in order to improve the recovery of reserves, partially offset by workover charges on several wells during the year ended December 31, 1995. As a percentage of oil and gas sales, these expenses increased to 28.9% for the year ended December 31, 1995 from 23.4% 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 $93,773 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily a result of both (i) the decrease in the volumes of oil and natural gas sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994 and (ii) an upward revision in the estimate of the 1982-2 Program's remaining natural gas reserves at December 31, 1995. As a percentage of oil and gas sales, this expense decreased to 18.4% for the year ended December 31, 1995 from 26.3% for the year ended December 31, 1994. This percentage decrease was primarily due to the dollar decrease in depreciation, depletion, and amortization discussed above, partially offset by the decrease in oil and gas sales discussed above.\nAs a result of a decline in natural gas prices during the first part of 1995, the 1982-2 Program recognized a non-cash charge against earnings of $14,169 during the year ended December 31, 1995. The valuation allowance for oil and gas properties at December 31, 1995 was necessary due to the unamortized costs of oil and gas properties exceeding the present value of the estimated future net revenues from the oil and gas properties. No similar charge was necessary during the year ended December 31, 1994.\nGeneral and administrative expenses increased by $9,532 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase resulted 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 14.3% for the year ended December 31, 1995 from 9.7% for the year ended December 31, 1994. This increase was primarily a result of the dollar increase in general and administrative expenses discussed above and the decrease in oil and gas sales during the year ended Decem- ber 31, 1995 as compared to the year ended December 31, 1994.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993 -------------------------------------\nTotal oil and gas sales increased 20.9% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This increase was due to increases in the volumes of oil and natural gas sold, partially offset by decreases in the average prices of oil and natural gas sold. Volumes of oil and natural gas sold increased 1,375 barrels and 145,910 Mcf, respectively, for the year ended December 31, 1994 as compared to the year ended December 31, 1993. The increase in volumes of oil sold was primarily a result of an increase in production on one well which was recompleted in early 1994. The increase in volumes of natural gas sold was primarily a result of increased production from the recompleted well discussed above and positive prior period volume adjustments from purchasers on several wells during the year ended December 31, 1994. Average oil and natural gas prices decreased to $10.96 per barrel and $1.56 per Mcf for the year ended December 31, 1994 from averages of $15.16 per barrel and $1.89 per Mcf for the year ended December 31, 1993.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased 4.4% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease resulted primarily from the accrual of lease operating expenses in 1993 associated with revenues received for overproduced wells, which amount was partially offset by an accrual for certain litigation costs in 1994 and workover charges incurred on several of the 1982-2 Program's wells during 1994. As a percentage of oil and gas sales, these expenses decreased to 23.4% for the year ended December 31, 1994 from 29.6% for the year ended December 31, 1993. This percentage decrease was primarily a result of the increases in volumes of oil and natural gas sold, partially offset by the decreases in the average prices of oil and natural gas sold during the year ended December 31, 1994 as compared to the year ended December 31, 1993.\nDepreciation, depletion, and amortization of oil and gas properties increased $37,317 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This increase was consistent with the increase in volumes of oil and natural gas sold, which amount was partially offset by an upward revision in the estimate of the 1982-2 Program's remaining oil and natural gas reserves during 1994. As a percentage of oil and gas sales, this expense remained relatively constant at 26.3% for the year ended December 31, 1994 compared to 25.9% for the year ended December 31, 1993. This expense stated as a percentage of oil and gas sales remained relatively constant due to the offsetting effects of the dollar increase as discussed above and the decreases in the prices of oil and natural gas sold.\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 decreased to 9.7% for the year ended December 31, 1994 from 11.7% for the year ended December 31, 1993. This decrease was primarily a result of the increase in volumes of oil and natural gas sold, partially offset by the decreases in the average prices of oil and natural gas sold during the year ended December 31, 1994 as compared to the year ended December 31, 1993.\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 1982-1 Program's and 1982-2 Program's proved reserve quantities at December 31, 1995 would have a life of approximately 3.7 and 2.2 years, respectively, for gas reserves and 4.2 and 1.0 years, respectively, for oil reserves.\nThe Programs' 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 Programs 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 Programs' future cash distributions. The Programs' ability to make cash distributions depends primarily upon the level of available cash flow generated by the Programs' operating activities, which will be affected (either positively or negatively) by many factors beyond the control of the Programs, 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 Programs 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 Programs 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 1982-1 LIMITED PARTNERSHIP\nWe have audited the financial statements of the Dyco Oil and Gas Program 1982-1 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 1982-1 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. Tulsa, Oklahoma February 6, 1996\nDYCO OIL AND GAS PROGRAM 1982-1 LIMITED PARTNERSHIP Balance Sheets December 31, 1995 and 1994\nASSETS ------ 1995 1994 -------- -------- CURRENT ASSETS: Cash and cash equivalents $ 29,087 $ 16,790 Accrued oil and gas sales, including $33,654 due from related parties in 1995 46,151 14,871 ------- ------- Total current assets $ 75,238 $ 31,661\nNET OIL AND GAS PROPERTIES, utilizing the full cost method 216,077 256,428\nDEFERRED CHARGE 59,970 102,269 ------- -------\n$351,285 $390,358 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\nCURRENT LIABILITIES: Accounts payable $ 6,648 $ 7,137 ------- ------- Total current liabilities $ 6,648 $ 7,137\nACCRUED LIABILITY 55,380 78,902\nPARTNERS CAPITAL: General Partner, issued and outstanding, 100 Units 2,892 3,043 Limited Partners, issued and outstanding, 10,000 Units 286,365 301,276 ------- ------- Total Partners' Capital $289,257 $304,319 ------- -------\n$351,285 $390,358 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-1 LIMITED PARTNERSHIP Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ---------- -------- --------\nREVENUES: Oil and gas sales, including $195,118, $252,043, and $423,709 of sales to related parties $263,331 $310,573 $441,939 Interest 207 3,610 4,258 Other - - 30,641 ------- ------- -------\n$263,538 $314,183 $476,838\nCOSTS AND EXPENSES: Lease operating $115,436 $ 73,341 $ 81,958 Production taxes 18,645 17,190 33,360 Depreciation, depletion and amortization of oil and gas properties 40,413 66,472 93,645 General and administrative 104,106 92,108 91,041 ------- ------- -------\n$278,600 $249,111 $300,004 ------- ------- -------\nNET INCOME (LOSS) ($ 15,062) $ 65,072 $176,834 ======= ======= =======\nGENERAL PARTNER (1%) - NET INCOME (LOSS) ($ 151) $ 651 $ 1,768 ======= ======= =======\nLIMITED PARTNERS (99%) - NET INCOME (LOSS) ($ 14,911) $ 64,421 $175,066 ======= ======= =======\nNET INCOME (LOSS) per Unit ($ 1) $ 6 $ 18 ======= ======= =======\nUNITS OUTSTANDING 10,100 10,100 10,100 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-1 LIMITED PARTNERSHIP Statements of Partners' Capital For the Years Ended December 31, 1995, 1994, and 1993\nGeneral Limited Partner Partners Total --------- ------------ ------------\nBalances at Dec. 31, 1992 $10,724 $1,061,689 $1,072,413 Cash distributions ( 8,080) ( 799,920) ( 808,000) Net income 1,768 175,066 176,834 ------ --------- ---------\nBalances at Dec. 31, 1993 $ 4,412 $ 436,835 $ 441,247 Cash distributions ( 2,020) ( 199,980) ( 202,000) Net income 651 64,421 65,072 ------ --------- ---------\nBalances at Dec. 31, 1994 $ 3,043 $ 301,276 $ 304,319 Net income (loss) ( 151) ( 14,911) ( 15,062) ------ --------- ---------\nBalances at Dec. 31, 1995 $ 2,892 $ 286,365 $ 289,257 ====== ========= =========\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-1 LIMITED PARTNERSHIP 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) ($ 15,062) $ 65,072 $176,834 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 40,413 66,472 93,645 (Increase) decrease in accrued oil and gas sales ( 31,280) 57,721 17,165 Decrease in related party receivable - - 467,089 (Increase) decrease in deferred charge 42,299 ( 99,973) ( 2,296) Increase (decrease) in accounts payable ( 489) 790 ( 97) Increase (decrease) in gas imbalance payable - ( 74,559) 23,115 Decrease in gas prepayment - - ( 58,249) Increase (decrease) in related party payable - ( 58,249) 58,249 Increase (decrease) in accrued liability ( 23,522) 78,902 - ------- ------- ------- Net cash provided by operating activities $ 12,359 $ 36,176 $775,455 ------- ------- -------\nCASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties ($ 88) ($ 767) ($ 32,571) Retirements of oil and gas properties 26 10,290 1,138 ------- ------- ------- Net cash provided (used) by investing activities ($ 62) $ 9,523 ($ 31,433) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions - ($202,000) ($808,000) ------- ------- ------- Net cash used by financing activities - ($202,000) ($808,000) ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 12,297 ($156,301) ($ 63,978)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,790 173,091 237,069 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 29,087 $ 16,790 $173,091 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-1 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 1982-1 Limited Partnership (the \"Program\"), a Minnesota limited partnership, commenced operations on June 14, 1982. Dyco Petroleum Corporation (\"Dyco\") is the general partner of the Program. Affiliates of Dyco owned 3,857.66 (38.2%) 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 $0.22, $0.36, and $0.40, 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\nThe Deferred Charge at December 31, 1995 and 1994 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 123,727 Mcf, resulting in prepaid lease operating expenses of $59,970. 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 174,640 Mcf, resulting in prepaid lease operating expenses of $102,269.\nAccrued Liability\nAccrued Liability 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 114,257 Mcf, resulting in accrued lease operating expenses of $55,380. 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 134,738 Mcf, resulting in accrued lease operating expenses of $78,902.\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 and 1994 no such liability was recorded.\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. 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 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 $104,106, $92,108, and $91,041, respectively, of which $74,460, $74,460, and $73,743, 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 $195,118, $252,043, and $423,709, respectively. At December 31, 1995, accrued oil and gas sales included $33,654 due from Premier. There were no accrued oil and gas sales due from Premier at December 31, 1994.\n3. MAJOR CUSTOMERS\nThe following purchasers individually accounted for more than 10% of the combined oil and gas sales of the Program for the years ended December 31, 1995, 1994, and 1993:\nPurchaser 1995 1994 1993 --------- ----- ----- -----\nPremier 74.1% 81.2% 95.9% National Cooperative Refinery 20.4% - % - %\nIn the event of interruption of purchases by these significant customers 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. 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 $52,568,885 $52,568,823\nUnproved properties, not subject to depreciation, depletion, and amortization - - ---------- ----------\n$52,568,885 $52,568,823\nLess accumulated depreciation, depletion, amortization, and valuation allowance ( 52,352,808) ( 52,312,395) ---------- ----------\nNet oil and gas properties $ 216,077 $ 256,428 ========== ==========\nCosts 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 88 767 32,571 ------ ------ ------\nTotal costs incurred $ 88 $ 767 $32,571 ====== ====== ======\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.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nDYCO OIL AND GAS PROGRAM 1982-2 LIMITED PARTNERSHIP\nWe have audited the financial statements of the Dyco Oil and Gas Program 1982-2 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 1982-2 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. Tulsa, Oklahoma February 6, 1996\nDYCO OIL AND GAS PROGRAM 1982-2 LIMITED PARTNERSHIP Balance Sheets December 31, 1995 and 1994\nASSETS ------ 1995 1994 -------- -------- CURRENT ASSETS: Cash and cash equivalents $160,547 $ 59,881 Accrued oil and gas sales, including $78,204 and $93,816 due from related parties 90,919 109,603 ------- ------- Total current assets $251,466 $169,484\nNET OIL AND GAS PROPERTIES, utilizing the full cost method 340,653 461,002\nDEFERRED CHARGE 24,820 35,910 ------- -------\n$616,939 $666,396 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\nCURRENT LIABILITIES: Accounts payable $ 27,055 $ 27,296 Gas imbalance payable 8,822 40,855 ------- ------- Total current liabilities $ 35,877 $ 68,151\nACCRUED LIABILITY 67,850 60,316\nCONTINGENCY (Note 4)\nPARTNERS' CAPITAL: General Partner, issued and outstanding, 80 Units 5,132 5,379 Limited Partners, issued and outstanding, 8,000 Units 508,080 532,550 ------- ------- Total Partners' Capital $513,212 $537,929 ------- ------- $616,939 $666,396 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-2 LIMITED PARTNERSHIP Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------- -------- --------\nREVENUES: Oil and gas sales, including $471,392, $626,073, and $622,137 of sales to related parties $582,641 $763,320 $631,384 Interest 7,766 5,542 3,266 ------- ------- -------\n$590,407 $768,862 $634,650\nCOSTS AND EXPENSES: Lease operating $126,949 $123,535 $141,268 Production taxes 41,329 55,286 45,877 Depreciation, depletion and amortization of oil and gas properties 107,051 200,824 163,507 Valuation allowance for oil and gas properties 14,169 - - General and administrative 83,226 73,694 73,834 ------- ------- -------\n$372,724 $453,339 $424,486 ------- ------- ------- NET INCOME $217,683 $315,523 $210,164 ======= ======= =======\nGENERAL PARTNER (1%) - NET INCOME $ 2,177 $ 3,155 $ 2,102 ======= ======= =======\nLIMITED PARTNERS (99%) - NET INCOME $215,506 $312,368 $208,062 ======= ======= =======\nNET INCOME per Unit $ 27 $ 39 $ 26 ======= ======= =======\nUNITS OUTSTANDING 8,080 8,080 8,080 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-2 LIMITED PARTNERSHIP Statements of Partners' Capital For the Years Ended December 31, 1995, 1994, and 1993\nGeneral Limited Partner Partners Total --------- ------------ ------------\nBalances at Dec. 31, 1992 $10,626 $1,052,016 $1,062,642 Cash distributions ( 4,444) ( 439,956) ( 444,400) Net income 2,102 208,062 210,164 ------ --------- ---------\nBalances at Dec. 31, 1993 $ 8,284 $ 820,122 $ 828,406 Cash distributions ( 6,060) ( 599,940) ( 606,000) Net income 3,155 312,368 315,523 ------ --------- ---------\nBalances at Dec. 31, 1994 $ 5,379 $ 532,550 $ 537,929 Cash distributions ( 2,424) ( 239,976) ( 242,400) Net income 2,177 215,506 217,683 ------ --------- ---------\nBalances at Dec. 31, 1995 $ 5,132 $ 508,080 $ 513,212 ====== ========= =========\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-2 LIMITED PARTNERSHIP Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ---------- -------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $217,683 $315,523 $210,164 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amorti- zation of oil and gas properties 107,051 200,824 163,507 Valuation allowance for oil and gas properties 14,169 - - Increase (decrease) in accrued oil and gas sales 18,684 ( 5,756) 46,415 (Increase) decrease in deferred charge 11,090 ( 35,910) - Increase (decrease) in accounts payable ( 241) 18,742 1,879 Increase (decrease) in gas imbalance payable ( 32,033) ( 3,333) 44,188 Increase in accrued liability 7,534 27,995 32,321 ------- ------- ------- Net cash provided by operating activities $343,937 $518,085 $498,474 ------- ------- -------\nCASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties ($ 3,273) ($ 712)($ 99,679) Retirements of oil and gas properties 2,402 12,680 1,006 ------- ------- ------- Net cash provided (used) by investing activities ($ 871) $ 11,968 ($ 98,673) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($242,400) ($606,000)($444,400) ------- ------- ------- Net cash used by financing activities ($242,400) ($606,000)($444,400) ------- ------- -------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $100,666 ($ 75,947)($ 44,599)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 59,881 135,828 180,427 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $160,547 $ 59,881 $135,828 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1982-2 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 1982-2 Limited Partnership (the \"Program \"), a Minnesota limited partnership, commenced operations on March 1, 1983. Dyco Petroleum Corporation (\"Dyco\") is the general partner of the Program. Affiliates of Dyco owned 2,848.06 (35.2%) 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 the gross revenue method using estimates of proved reserves. The full cost amortization rates per equivalent Mcf of\ngas produced during the years ended December 31, 1995, 1994, and 1993 were $0.24, $0.41, and $0.49, 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. During the year ended December 31, 1995, the Program charged to expense a valuation allowance of $14,169 which represents the amount of unamortized oil and gas properties which exceeded the full cost ceiling. No such valuation allowance was incurred in 1994 or 1993. This valuation allowance should have been recognized during the first quarter of 1995 and reflected in the Program's Quarterly Report on Form 10-Q for the three months ended March 31, 1995. 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 99,718 Mcf, resulting in prepaid lease operating expenses of $24,820. 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 147,779 Mcf, resulting in prepaid lease operating expenses of $35,910.\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 272,600 Mcf, resulting in accrued lease operating expenses of $67,850. 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 248,214 Mcf, resulting in future lease operating expenses of $60,316.\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 $8,822 (4,478 Mcf). At December 31, 1994, total sales exceeded the Program's share of estimated total gas reserves on two wells by $40,855 (26,529 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 $83,226, $73,694, and $73,834, respectively, of which $58,440, $58,440, and $57,879, 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 $471,392, $626,073, and $622,137, respectively. At December 31, 1995 and 1994, accrued oil and gas sales included $78,204 and $93,816, 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 80.9% 82.0% 98.5%\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 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. The 1982-2 Program's share of such verdict is approximately $43,000 in actual damages and approximately $8,800 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 $38,332,779 $38,331,908\nUnproved properties, not subject to depreciation, depletion, and amortiza- tion - - ---------- ---------- $38,332,779 $38,331,908\nLess accumulated depreciation, depletion, amortization, and valuation allowance ( 37,992,126) ( 37,870,906) ---------- ----------\nNet oil and gas properties $ 340,653 $ 461,002 ========== ==========\nCosts 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 3,273 712 99,679 ------ ------ ------\nTotal costs incurred $ 3,273 $ 712 $99,679 ====== ====== ======\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.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Programs are limited partnerships and have no directors or executive officers. The following individuals are directors and executive officers of Dyco, 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 Programs are limited partnerships and, therefore, have no officers or directors. The following table summarizes the amounts paid by the Programs 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 ------- ------- ------- 1982-1 Program - - --------------\nCompensation: Operations $ (2) $ (2) $ (2) Gas Marketing $ (3) $ (3) $ (3)\nReimbursements: General and Administrative, Geological, and Engineering Expenses and Direct Expenses(4) $74,460 $74,460 $73,743\n1982-2 Program - - --------------\nCompensation: Operations $ (2) $ (2) $ (2) Gas Marketing $ (3) $ (3) $ (3)\nReimbursements: General and Administrative, Geological, and Engineering Expenses and Direct Expenses(4) $58,440 $58,440 $57,879\n- - ----------\n(1) The authority for all of such compensation and reimbursement is the limited partnership agreements of the Programs. 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 Programs serve as operator of a significant portion of the Programs' 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 Programs to such affiliates is impossible to quantify as of the date of this Annual Report.\n(3) Premier, an affiliate of the Programs until December 6, 1995, purchased a portion of the Programs' 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 1982-1 Program sold $195,118, $252,043, and $423,709, respectively, of gas to Premier. For the years ended December 31, 1995, 1994, and 1993, the 1982-2 Program sold $471,392, $626,073, and $622,137, respectively, of gas to Premier. (4) The Programs reimburse 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 Programs. The directors, officers, and employees of Dyco and its affiliates receive no direct remuneration from the Programs for their services to the Programs. See \"Salary Reimbursement Table\" below. The allocable general and administrative, geological, and engineering expenses are apportioned on a reasonable basis between the Programs' 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 Programs 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 Programs for their services. However, to the extent such services represent direct involvement with the Programs, as opposed to general corporate functions, such persons' salaries are allocated to and reimbursed by the Programs. Such allocation to the Programs' 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 Programs' 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 Programs 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 Programs for a portion of such costs based upon the Programs' 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 Programs' 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. Number of Units Beneficially Owned (Percent Beneficial Owner of Outstanding) --------------------------------- -----------------\n1982-1 Program: --------------\nSamson Properties Incorporated 3,857.66 (38.2%)\nAll directors, officers, and affiliates of Dyco as a group and Dyco (8 persons) 3,857.66 (38.2%)\n1982-2 Program: --------------\nSamson Properties Incorporated 2,848.06 (35.2%)\nAll directors, officers, and affiliates of Dyco as a group and Dyco (8 persons) 2,848.06 (35.2%)\nTo the best knowledge of the Programs 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 Programs 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 Programs and Dyco also create potential conflicts of interest. Dyco and its affiliates own a significant amount of the Programs' Units and therefore have an identity of interest with other limited partners with respect to the operations of the Programs.\nIn order to attempt to assure limited liability for limited partners as well as an orderly conduct of business, management of the Programs is exercised solely by Dyco. The partnership agreements of the Programs grant Dyco broad discretionary authority with respect to the Programs' 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 Programs involves circumstances where Dyco has conflicts of interest and where it must allocate costs and expenses, or opportunities, among the Programs and other competing interests.\nDyco does not devote all of its time, efforts, and personnel exclusively to the Programs. Furthermore, the Programs do not have any employees, but instead rely on the personnel of the Samson Companies. The Programs thus compete 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 Programs as are indicated by the circumstances and as are consistent with Dyco's fiduciary duties.\nAffiliates of the Programs are solely responsible for the negotiation, administration, and enforcement of oil and gas sales agreements covering the Programs' 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 Programs who provide services to the Programs 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 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 Programs' negotiating strength and contractual positions have been enhanced by virtue of its affiliation with the Samson Companies.\nFor a description of certain other 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 and Schedules. The following financial statements and schedules for the Programs 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: Reports 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 16, 1982 for Dyco Drilling Program 1982-1 by and between Dyco Oil and Gas Program 1982-1, 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 by reference.\n4.2 Program Agreement dated February 16, 1992 for Dyco Oil and Gas Program 1982-1 by and between Dyco Petroleum Corporation and 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 by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1982-1 dated February 9, 1991 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 by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1982-1 Limited Partnership 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 by reference.\n4.5 Drilling Agreement dated June 14, 1982 for Dyco Drilling Program 1982-2 by and between Dyco Oil and Gas Program 1982-2, Dyco Petroleum Corporation, and Jaye F. Dyer 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 by reference.\n4.6 Form of Program Agreement for Dyco Oil and Gas Program 1982-2 by and between Dyco Petroleum Corporation and the Participants filed as Exhibit 4.6 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n4.7 Amendment to Program Agreement for Dyco Oil and Gas Program 1982-2 dated February 9, 1989 filed as Exhibit 4.7 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n4.8 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1982-2 Limited Partnership filed as Exhibit 4.8 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n27.1 Financial Data Schedule containing summary finan- cial information extracted from the Dyco Oil and Gas Program 1982-1 Limited Partnership's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.2 Financial Data Schedule containing summary finan- cial information extracted from the Dyco Oil and Gas Program 1982-2 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 1982-1 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\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 1982-2 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 16, 1982 for Dyco Drilling Program 1982-1 by and between Dyco Oil and Gas Program 1982-1, 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 by reference.\n4.2 Program Agreement dated February 16, 1992 for Dyco Oil and Gas Program 1982-1 by and between Dyco Petroleum Corporation and 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 by reference.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1982-1 dated February 9, 1991 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 by reference.\n4.4 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1982-1 Limited Partnership 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 by reference.\n4.5 Drilling Agreement dated June 14, 1982 for Dyco Drilling Program 1982-2 by and between Dyco Oil and Gas Program 1982-2, Dyco Petroleum Corporation, and Jaye F. Dyer 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 by reference.\n4.6 Form of Program Agreement for Dyco Oil and Gas Program 1982-2 by and between Dyco Petroleum Corporation and the Participants filed as Exhibit 4.6 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n4.7 Amendment to Program Agreement for Dyco Oil and Gas Program 1982-2 dated February 9, 1989 filed as Exhibit 4.7 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n4.8 Certificate of Limited Partnership, as amended, for Dyco Oil and Gas Program 1982-2 Limited Partnership filed as Exhibit 4.8 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated by reference.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1982-1 Limited Partnership'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 Dyco Oil and Gas Program 1982-2 Limited Partnership's financial statements as of December 31, 1995 and for the year ended December 31, 1995.","section_15":""}
{"filename":"787648_1995.txt","cik":"787648","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nTexas Regional Bancshares, Inc. (\"Texas Regional\" or the \"Company\"), a Texas business corporation registered as a bank holding company under the Bank Holding Company Act of 1956, was incorporated in 1983. Texas Regional commenced operations as a bank holding company with the acquisition of Texas State Bank, McAllen, Texas, and Harlingen State Bank, Harlingen, Texas (\"Harlingen State Bank\") in May 1984. In March 1992, the Company acquired Mid Valley Bank, Weslaco, Texas (\"Mid Valley Bank\") and merged Harlingen State Bank and Mid Valley Bank into Texas State Bank (the \"Bank\"). In 1995, Texas State Bank acquired the Rio Grande City and Roma branches of First National Bank of South Texas (the \"RGC\/Roma Branch Acquisitions\"). Texas State Bank, which is the Company's sole subsidiary, operates nine banking locations in the Rio Grande Valley: four banking locations in McAllen (including its main office), two banking locations in Weslaco, and one banking location each in Harlingen, Rio Grande City and Roma. At December 31, 1995, Texas Regional had consolidated total assets of $646.8 million, loans outstanding (net of unearned discount) of $450.9 million, total deposits of $579.7 million, and shareholders' equity of $62.7 million.\nThe business strategy of Texas Regional is for the Bank to provide its customers with the financial sophistication and breadth of products of a regional bank, while retaining the local appeal and level of service of a community bank. The Board of Directors and senior management of the Company have maintained the Company's community orientation by tailoring products and services to meet community and customer needs. Management believes that the Company is well positioned in its market due to its responsive customer service, the strong community involvement of Texas State Bank management and employees, recent trends in the Texas banking environment in general and the economy of the Rio Grande Valley in particular. Management's strategy is to provide a business culture in which individual customers and small and medium sized businesses are accorded the highest priority in all aspects of the Company's operations. Management believes that individualized customer service will allow the Company to increase its market share in lending volume and deposits. As part of its operating and growth strategies, the Company is working to continue to attract business from, and provide service to, small and medium sized businesses, and expand operations in the Rio Grande Valley. Management believes that the Mergers are consistent with this strategy.\nBy maximizing personal knowledge of and contact with customers and endeavoring to understand the needs and preferences of its customers, the Company is working to maintain and further enhance its reputation of providing excellent customer service, allowing it to achieve its growth and earnings goals. The Company has developed an organizational structure that allows it to make credit and other banking decisions rapidly. Management believes that this structure, when compared to competing financial institutions, enables the Company to provide a higher degree of service and increased flexibility to creditworthy customers.\nThe Bank continues to focus on small and medium sized businesses and individual customers as its principal market, and seeks to provide services to its customers across all product lines. Many financial institutions in the Rio Grande Valley have become part of much larger state-wide or national organizations. Management believes that the acquiring institutions in many cases have shifted decision making and operations out of the Rio Grande Valley, and therefore have decreased the level of personal service that the Company seeks to provide to small and medium sized businesses that are the core of the Company's existing business and marketing efforts. The Company intends to continue to target its marketing efforts to those businesses and individuals who prefer the personalized customer service emphasized by the Company.\nBank management and other employees participate actively in a wide variety of civic and community activities and organizations, including local chambers of commerce, industrial foundations and charitable and civic activities such as educational institutions, health care organizations and the McAllen Affordable Housing Corporation. Management has also been actively involved in organizations to promote border trade and economic development. The Company believes that these activities assist the Bank through increased visibility and through development and maintenance of customer relationships.\nFor its business customers, Texas State Bank offers checking facilities, certificates of deposit, short term loans for working capital purposes, construction financing, mortgage loans, term loans for fixed asset and expansion needs, and other commercial loans. The services provided for individuals by Texas State Bank include checking accounts, savings accounts, certificates of deposit, individual retirement accounts and consumer loan programs, including installment loans for home repair and for purchases of consumer goods, including automobiles, trucks and boats, and mortgage loans. Texas State Bank also provides travelers checks, money orders and safe deposit facilities, and offers trust services.\nThe Bank has also expanded the services which it provides to third party correspondent banks. The Bank data processing center, for example, presently serves three banks in addition to providing data processing services for all Bank banking locations.\nThe Company has expanded its market area and increased its market share through both internal growth and through acquisitions. In August 1995, the Company completed the RGC\/Roma Branch Acquisitions. In that transaction, which was accounted for as a purchase, the Bank acquired substantially all of the fixed assets associated with the banking locations, certain loans coded to the banking locations, and certain other assets, in consideration of the assumption of certain deposit accounts coded to the banking locations. The RGC\/Roma Branch Acquisitions increased loans and deposits of the Company by $43.7 million and $79.7 million, respectively, at the time of the acquisition. In addition to the pending Mergers, management believes there may be additional opportunities to expand by acquiring financial institutions or by acquiring assets and deposits that will allow the Company to enter adjacent markets or further increase market share in existing markets. Management intends to pursue acquisition opportunities in strategic markets in circumstances in which management believes that its managerial, operational and capital resources will enhance the performance of acquired institutions. Except for the Merger Agreements, there are currently no agreements or understandings related to any acquisition.\nIn January 1996, the Company entered into definitive agreements to acquire through merger First State Bank & Trust Co., Mission, Texas (\"First State Bank\" and The Border Bank, Hidalgo, Texas (\"Border Bank\") (the \"Mergers\"). First State Bank and Border Bank had combined total assets of approximately $524.0 million at December 31, 1995. Assuming consummation of the Mergers, on a pro forma basis at December 31, 1995, Texas State Bank would have had total assets of $1.143 billion, which would have made Texas Regional the largest bank holding company headquartered in the Rio Grande Valley. At December 31, 1995, First State Bank had total assets of $404.5 million, loans outstanding (net of unearned discount) of $188.1 million and stockholders' equity of $59.4 million. At December 31, 1995, Border Bank had total assets of $119.5 million, loans outstanding (net of unearned discount) of $47.3 million and stockholders' equity of $17.1 million. Elliot B. Bottom is the Chairman of the Board of both First State Bank and Border Bank, and the banks have substantial common ownership. The purpose of the Mergers is to further strengthen Texas State Bank's branch network and banking business in the Rio Grande Valley by adding six new banking locations in Mission, Penhas, McAllen and Hidalgo, Texas. The purchase price for the Mergers is estimated to be $99.5 million, approximately $40.0 million of which will be paid from the proceeds of the offering made hereby. The Company intends to fund the balance of the purchase price principally from liquidation of cash equivalents and, to the extent necessary, selected investment securities on a consolidated basis.\nManagement of Texas State Bank believes that the Mergers will expand the Company's community banking network into contiguous markets, substantially increasing its market share and enabling the Bank to compete more effectively with other financial institutions in the Rio Grande Valley. Because of the proximity of Mission to McAllen, there is a substantial overlap in the markets served by Texas State Bank and First State Bank. For this reason and because the banks serve a similar customer base, First State Bank is considered by Texas State Bank management to be a direct competitor of Texas State Bank, particular as to loan customers. The new or expanded services to be offered to First State Bank and Border Bank customers include enhanced data processing services, additional automated teller facilities and other services now offered to Texas State Bank customers. Texas State Bank management believes that First State Bank, Border Bank and Texas State Bank customers will benefit from the expansion of Texas State Bank's branch network from nine to 15 banking locations. Texas State Bank expect to realize certain operating and administrative efficiencies as a result of the Mergers; however, because of the relatively low employee-to- asset ratio at First State Bank and Border Bank, costs savings is not a principal motivating factor for the Mergers. The operating efficiencies which are expected include the use by all banking locations of the existing Texas State Bank data processing facility, operation of a single human resources department, and economics of a combined advertising program.\nMARKET REGIONS Texas Regional's operations are located in the Rio Grande Valley, which consists of Cameron, Hidalgo, Willacy and Starr Counties. Cameron, Hidalgo and Starr Counties are each directly adjacent to the Rio Grande River, which forms part of the border between the United States and Mexico. Texas State Bank's banking locations are located in Hidalgo County (McAllen and Weslaco), Cameron County (Harlingen), and Starr County (Rio Grande City and Roma). The offices of First State Bank and Border Bank are all located in Hidalgo County.\nThe ability of Texas Regional to continue its rate of growth and profitability is closely linked to the economy of the Rio Grande Valley. The economy of the Rio Grande Valley is based principally on retailing (including trade with Mexico), government, agriculture, tourism, manufacturing, health care and education. A large number of retirees spend all or part of the year in the Rio Grande Valley. Many twin manufacturing plants, or \"maquiladoras\", are located in the Rio Grande Valley or in cities located across the border in Mexico, such as Reynosa and Matamoros.\nThe City of McAllen, which is the location of the Company's headquarters, serves as the center of a 150 mile retail market area. A large part of this trade area is composed of the Mexican states of Nuevo Leon and Tamaulipas, which had estimated populations of 3.1 million and 2.2 million, respectively, in 1990. The major industrial and commercial center of northern Mexico, the City of Monterrey in the Mexican state of Nuevo Leon, is located approximately 150 miles southwest of McAllen. Among the largest cities in the Mexican state of Tamaulipas are Reynosa, located ten miles south of McAllen and estimated to have a population in excess of 700,000 persons, and Ciudad Victoria, which is located 200 miles south of McAllen. The Rio Grande Valley market includes a U.S. population of approximately 800,000, a population which increased 128.0% (or 3.5% annually) between 1970 and 1994. The market area served by Texas State Bank has been recognized as among the fastest growing areas in the nation. The McAllen-Edinburg-Mission area has a projected population growth rate of 23.8% between 1994 and 2000, and the Brownsville-Harlingen area has a projected population growth rate of 16.0% during that same period.\nThe Rio Grande Valley has also experienced significant recent growth in the retail and construction industries. Retail sales in the Rio Grande Valley totaled approximately $5.9 billion in 1994, representing an annual compound growth rate of 7.9% since 1984. With respect to new construction activity, building permits in the Rio Grande Valley have grown 89.8% between 1989 and 1994, representing an annual compound growth rate of 13.7%.\nLENDING ACTIVITIES\nThe primary source of income generated by Texas State Bank is the interest earned from its loan and investment portfolios. Texas State Bank maintains diversification when considering investments and the granting of loan requests. Emphasis is placed on the borrower's ability to generate cash flow to support its debt obligations and other cash related expenses. Lending activities include commercial loans, agricultural loans, consumer loans and real estate loans. Commercial loans and agricultural loans are originated primarily for working capital funding. Consumer loans include those for the purchase of automobiles, mobile homes, home improvements and investments. Real estate loans include the origination of loans for commercial property acquisition or remodeling, and also include conventional mortgages for the purchase of single-family houses or lots. A substantial proportion of the properties collateralizing Texas State Bank's mortgage portfolio is located in the Company's primary market area.\nDuring 1995, Frank A. Kavanagh, President of Texas State Bank's Weslaco banking location, was appointed the Chief Lending Officer of Texas State Bank. During 1995, Texas State Bank also further standardized documentation requirements and centralized loan controls and supervision. Texas State Bank management continues to seek to preserve and enhance the quality of the Bank's loan portfolio.\nAt December 31, 1995, Texas Regional's total loan portfolio (net of unearned discount) was $450.9 million, representing 77.8% and 69.7% of its total deposits and total assets, respectively, at that date. Total loans increased $110.9 million, or 32.6%, during 1995 from December 31, 1994 levels of $339.9 million. A significant portion of this increase was attributable to the RGC\/Roma Branch Acquisitions. The Company's legal lending limit to any one borrower was $11.5 million at December 31, 1995. However, the legal lending limit does not include the portion of a loan collateralized by cash or cash equivalents and government guaranties. All current loans fall well below applicable legal lending limits. Texas Regional's lending policy generally limits loans to one borrower to $8.0 million, with exceptions allowed for selected customers. An example of an exception is a $34.0 million loan made during 1995 to fund a leveraged employee stock ownership trust, which was secured by, among other assets, cash and cash equivalents of $27.5 million.\nAssuming consummation of the Mergers, on a pro forma basis at December 31, 1995, Texas Regional's total loan portfolio (net of unearned discount) would have been $685.3 million and its legal lending limit would have been $21.5 million.\nAt December 31, 1995, First State Bank and Border Bank had $13.0 million of loans secured by non-U.S. collateral, primarily real estate and other assets in Mexico. Management currently intends to maintain the portfolio of such loans but does not intend to significantly expand the volume of such loans.\nThe following table summarizes the loan portfolio of the Company by loan category and amount at December 31, 1995 and on a pro forma basis at December 31, 1995, assuming that the Mergers had been consummated at December 31, 1995:\nCOMMERCIAL LENDING\nAt December 31, 1995, the Company had $146.5 million of commercial loans outstanding, representing 32.5% of its total loans. Commercial loan balances increased $44.6 million, or 43.8%, during 1995 from December 31, 1994 levels of $101.9 million. The increase in commercial loans for the year ended December 31, 1995 was primarily attributable to the funding of a $34.0 million leveraged employee stock ownership trust loan which is collateralized by stock and assets of the employer and approximately $27.5 million of cash and cash equivalent assets. Excluding this loan, commercial loans at December 31, 1995 represented an increase of $10.6 million, or 10.4%, compared to levels at December 31, 1994. On a pro forma basis at December 31, 1995, the Company would have had $215.3 million of commercial loans outstanding, representing 31.4% of total loans at December 31, 1995.\nTexas State Bank offers a variety of commercial loan services including term loans, lines of credit, and equipment financing. A broad range of short-to-medium term commercial loans, both collateralized and uncollateralized, is made available to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements), and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure.\nGenerally, Texas State Bank's commercial loans are underwritten in the Bank's primary market area on the basis of the borrower's ability to service such debt from income. As a general practice, Texas State Bank takes as collateral a lien on any available real estate, equipment, or other assets. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets.\nUnlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his employment and other income and which are collateralized by real property whose value tends to be more readily ascertainable, commercial loans typically are underwritten on the basis of the borrower's ability to make repayment from the cash flow of its business and generally are collateralized by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds or collateral value available to support the repayment of commercial loans may deteriorate over time, cannot be appraised with precision, and may fluctuate based on the success of the business.\nAGRICULTURAL LOANS\nAt December 31, 1995, the Company had $25.1 million of agricultural loans outstanding, representing 5.6% of its total loans. Agricultural loan balances increased $7.9 million, or 45.9%, during 1995 from December 31, 1994 levels of $17.2 million. On a pro forma basis at December 31, 1995, the Company would have had $34.0 million of agricultural loans outstanding, representing 5.0% of total loans.\nREAL ESTATE LOANS\nAt December 31, 1995, the Company had $236.0 million of real estate loans outstanding. Real estate loan balances increased $45.9 million, or 24.1% during 1995 from December 31, 1994 levels of $190.2 million. Real estate loans represented 52.3% and 55.9% of total loans outstanding at December 31, 1995 and 1994, respectively. On a pro forma basis at December 31, 1995, the Company would have had $371.3 million of real estate loans outstanding, or 54.2% of total loans.\nA substantial portion of the Bank's real estate mortgage loans are secured by non-farm, non-residential properties, which are loans to commercial customers for purposes of providing working capital. In addition, some of the Bank's real estate mortgage loans have been made to finance or refinance the acquisition and holding of commercial real estate. The Bank offers a variety of mortgage loan products which generally are (i) amortized over five to 15 years, (ii) payable in monthly installments of principal and interest, and (iii) due and payable in full within three to five years.\nFinally, a small portion of the Bank's lending activity has consisted of the origination of single-family residential mortgage loans collateralized by owner-occupied property located in the Bank's primary market area. The Bank intends to pursue increased originations of single-family residential mortgage loans with respect to its existing customer base. Loans collateralized by single family residential real estate generally have been originated in amounts of no more than 85% of appraised value. The Bank requires mortgage title insurance and hazard insurance in the amount of the loan. Although the contractual loan payment periods for single family residential real estate loans are generally amortized over five to 20 years, they are payable in monthly installments of principal and interest and are typically due and payable in full within three to five years. At December 31, 1995, approximately $13.0 million of the single family residential mortgage loans at First State Bank and Border Bank consisted of loans to low and moderate income borrowers. The characteristics of these loans may contribute to a higher level of delinquencies. Management believes that this component of the pro forma portfolio will not have an adverse impact on the financial performance of the Company.\nCONSUMER LOANS\nAt December 31, 1995, the Company had $43.3 million of consumer loans outstanding, representing 9.6% of its total loans. Aggregate consumer loan balances increased $12.6 million, or 40.9%, during 1995 from December 31, 1994 levels of $30.7 million. On a pro forma basis at December 31, 1995, the Company would have had $64.7 million of consumer loans outstanding, or 9.4% of its total loans.\nConsumer loans made by the Bank have included automobile loans, recreational vehicle loans, boat loans, second mortgage loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 60 months and vary based upon the nature of collateral and size of loan.\nConsumer loans are attractive to the Bank because they typically have a short term and carry higher interest rates than those charged on other types of loans. Installment loans, however, do pose additional risks of collectability when compared to traditional types of loans granted by commercial banks, such as residential mortgage loans. In many instances, the Bank is required to rely on the borrower's ability to repay since the collateral may be of reduced value at the time of collection. Accordingly, the initial determination of the borrower's ability to repay is of primary importance in the underwriting of consumer loans.\nINVESTMENTS\nAt December 31, 1995 the Company had federal funds sold of $3.6 million and investment securities of $131.6 million, including $63.1 million classified as Available for Sale and $68.5 million classified as Held to Maturity. Investments are managed to maintain adequate sources of liquidity and diversification and to generate acceptable levels of tax-equivalent yield.\nOn a pro forma basis at December 31, 1995, after giving effect to the Mergers and this offering at December 31, 1995, the Company would have had federal funds sold of $4.9 million and investment securities of $328.1 million, including $65.9 million classified as Available for Sale and $262.2 million classified as Held to Maturity. The pro forma adjustments include assumptions regarding the use of sources of liquidity including federal funds sold and sales of certain investment securities to fund a portion of the purchase price. Management believes that sources of liquidity will be adequate to fund the required portion of consideration in the Mergers but will decide on specific securities to be sold based on market conditions at the time of Closing.\nThe following table summarizes the investment portfolio of the Company by investment category and amount at December 31, 1995 and on a pro forma basis at December 31, 1995, assuming that the Mergers had been consummated at December 31, 1995:\nAs a part of the Company's purchase accounting adjustments, the Company will review investment securities acquired in the Mergers for reclassification as Available for Sale or Held to Maturity.\nDEPOSITS\nThe Company has a stable noninterest-bearing source of funds as reflected in the ratio of average demand deposits to average total deposits for years ended December 31, 1995 and 1994 of 20.2% and 20.9%, respectively. Deposits provide funding for the Company's investments in loans and securities, and the interest paid for deposits must be managed carefully to control the level of interest expense.\nTexas State Bank's deposits at December 31, 1995 were $579.7 million, an increase of $107.6 million, or 22.8% during 1995 from December 31, 1994 levels of $472.1 million. A portion of this increase was attributable to the RGC\/Roma Branch Acquisitions. Deposits currently consist primarily of core deposits from the Rio Grande Valley and surrounding areas. Texas State Bank does not have any \"brokered deposits\", defined as deposits which, to the knowledge of management of Texas Regional, have been placed with the Bank by a person who acts as a broker in placing such deposits on behalf of others. On a pro forma basis at December 31, 1995, the Bank's deposits would have been $1.024 billion.\nAt December 31, 1995, certificates of deposit held by Texas State Bank in excess of $100,000 were $126.4 million, or 21.8% of total deposits. On a pro forma basis at December 31, 1995, certificates of deposit held by the Bank in excess of $100,000 would have been $265.5 million, or 25.9% of total deposits.\nTexas State Bank acts as local depository for a number of local governmental entities in its market area, including the City of McAllen, the South Texas Community College District, the City of Weslaco, the Weslaco Independent School District, the City of Rio Grande City, the City of Roma and Starr County. Local government deposits are subject to competitive bid and in many cases must be secured by government securities. Total deposits by or on behalf of governmental entities at December 31, 1995, aggregated approximately $39.3 million, or 6.8% of total deposits. On a pro forma basis at December 31, 1995, the Bank's total deposits by or on behalf of government entities would have been $128.5 million, or 12.6% of total deposits.\nAs with loan transactions, Texas State Bank has developed deposit relations with depositors who are Mexican residents. At December 31, 1995, $56.5 million, or 9.8% of the Bank's total demand and time deposits were deposited primarily by or on behalf of residents of Mexico. On a pro forma basis at December 31, 1995, $146.9 million, or 14.4% of the Bank's total demand and time deposits, would have been deposited primarily by or on behalf of residents of Mexico. As with loan transactions, management believes that Texas State Bank's percentage of deposits by or on behalf of residents of Mexico, and the percentage of deposits on a pro forma basis at December 31, 1995, on behalf of residents of Mexico, are somewhat less than that of banks of comparable size located in the Rio Grande Valley.\nCOMPETITION\nThe banking industry in the market area served by Texas State Bank is highly competitive. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of banking facilities, and, in the case of loans to commercial borrowers, relative lending limits. A substantial number of the commercial banks in the Rio Grande Valley are branches of much larger organizations affiliated with national, regional or state-wide banking companies, and as a result of those affiliations have greater resources than Texas Regional or Texas State Bank. However, as an independent community bank headquartered in Texas State Bank's primary market area, management of the Company believes that Texas State Bank's community commitment and involvement in its primary market area, as well as its commitment to quality and personalized banking services, are factors that contribute to the Company's competitiveness.\nPERSONNEL\nAt December 31, 1995, Texas Regional employed 332 full-time equivalent employees, and on a pro forma basis at December 31, 1995, would have employed 467 full-time equivalent employees. Substantially all of the present First State Bank and Border Bank officers and employees are expected to be employed by Texas State Bank. The Company's employees are not unionized, and management believes employee relations to be favorable.\nREGULATION AND SUPERVISION\nIn addition to the generally applicable state and federal laws governing businesses and employers, the Company and Texas State Bank are further extensively regulated by special federal and state laws applicable only to financial institutions and their parent companies. Virtually all aspects of the Company's operations are subject to specific requirements or restrictions and general regulatory oversight, from laws regulating consumer finance transactions, such as the Truth In Lending Act, the Home Mortgage Disclosure Act and the Equal Credit Opportunity Act, to laws regulating collections and confidentiality, such as the Fair Debt Collections Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. With few exceptions, state and federal banking laws have as their principal objective either the maintenance of the safety and soundness of the federal deposit insurance system or the protection of consumers or classes of consumers, rather than the specific protection of shareholders of the Company. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation.\nREGULATION OF THE COMPANY\nTexas Regional is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (\"BHCA\"), as amended, and therefore is subject to regulation and supervision by the FRB. In addition, the Company is required to file reports with and to furnish such other information as the FRB may require pursuant to the BHCA, and to subject itself to examination by the FRB. The FRB has the authority to issue bank holding companies orders to cease and desist from unsound practices and violations of conditions imposed by, or violation of agreements with, the FRB. The FRB is also empowered to assess civil penalties against companies or individuals who violate the BHCA or orders or regulations thereunder in amounts up to $1.0 million per day, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Certain violations may also result in criminal penalties. The FRB and the FDIC, as appropriate, are authorized to exercise comparable authority, under the Federal Deposit Insurance Act (the \"FDI Act\") and other statutes, with respect to subsidiary banks.\nThe FRB takes the position that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB's position that, in serving as a source of strength to its\nsubsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. This doctrine has become known as the \"source of strength\" doctrine. Although the United States Court of Appeals for the Fifth Circuit found the FRB's source of strength doctrine invalid in 1990, stating that the FRB had no authority to assert the doctrine under the BHCA, the decision was reversed by the United States Supreme Court on procedural grounds. Changes in the FDI Act made by the FDICIA now require an undercapitalized institution to submit to the FRB a capital restoration plan with a guaranty by each company having control of the bank of the bank's compliance with the plan.\nThe BHCA and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or company acquiring \"control\" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption.\nAs a bank holding company, the Company is required to obtain approval prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company.\nThe Company is also prohibited from acquiring a direct or indirect interest in or control of more than 5% 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 furnishing services to its subsidiary bank, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse affects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. In considering any application for approval of an acquisition or merger, the FRB is also required to consider the financial and managerial resources of the companies and the banks concerned, as well as the applicant's record of compliance with the Community Reinvestment Act (the \"CRA\"). The CRA generally requires a financial institution to take affirmative action to ascertain and meet the credit needs of its entire community, including low and moderate income neighborhoods.\nThe BHCA generally imposes certain limitations on extensions of credit and other transactions by and between banks that are members of the Federal Reserve System and other banks and non-bank companies in the same holding company. Under the BHCA and the FRB'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, lease or sale of property or furnishing of services.\nThe Company, as an affiliate of the Bank, is subject to certain restrictions regarding transactions between a bank and companies with which it is affiliated. These provisions limit extensions of credit (including guarantees of loans) by the Bank to affiliates, investments in the stock or other securities of the Company by the Bank, and the nature and amount of collateral that the Bank may accept from any affiliate to secure loans extended to the affiliate.\nREGULATION OF THE BANK\nTexas State Bank is a Texas state-chartered bank subject to regulation by the Banking Department. Texas State Bank, the deposits of which are insured by the Bank Insurance Fund (the \"BIF\") of the FDIC, is also a member of the Federal Reserve System, and therefore the FRB is the primary federal regulator for Texas State Bank.\nThe requirements and restrictions applicable to Texas State Bank under laws of the United States and the State of Texas include (i) the requirement that reserves be maintained, (ii) restrictions on the nature and amount of loans which can be made, (iii) restrictions on the business activities in which the Bank may engage, (iv) restrictions on the payment of dividends to shareholders, and (v) the maintenance of minimum capital requirements.\nTexas Regional is dependent upon dividends received from Texas State Bank for discharge of Texas Regional's obligations and for payment of dividends to the Company's shareholders. However, the application of minimum capital requirements and other rules and regulations applicable to Texas State Bank restrict dividend payments by Texas State Bank. The Banking Department and the FRB can each further limit payment of dividends if the regulatory authority finds that the payment of dividends would constitute an unsafe or unsound practice. In addition, Texas law requires that, before declaring a dividend, not less than 10% of the net profits of a bank earned since the last dividend was declared be transferred to a \"certified surplus\" account. Except to absorb losses in excess of undivided profits and uncertified surplus, such certified surplus may not be reduced without the prior written consent of the Banking Commissioner. However, state banks are not required to transfer any amount that would increase the certified surplus account to more than the capital of the bank. See \"Texas Regional Bancshares, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nInterest rate limitations for Texas State Bank are primarily governed by the laws of the State of Texas. The maximum annual interest rate that may be charged on most loans made by Texas State Bank is based on doubling the average auction rate, to the nearest 0.25%, for United States Treasury Bills, as computed by the Office of Consumer Credit Commissioner of the State of Texas. However, the maximum rate does not decline below 18% or rise above 24% (except for loans in excess of $250,000 that are made for business, commercial, investment or other similar purposes (excluding agricultural loans), in which case the maximum annual rate may not rise above 28%, rather than 24%). On fixed rate closed-end loans, the maximum non-usurious rate is to be determined at the time the rate is contracted, while on floating rate and open-end loans (such as credit cards), the rate varies over the term of the indebtedness. State usury laws (but not late charge limitations) have been preempted by federal law for loans secured by a first lien on residential real property.\nBanks are affected by the credit policies of other monetary authorities, including the FRB, which regulate the national supply of bank credit. Such regulation influences overall growth of bank loans, investments, and deposits and may also affect interest rates charged on loans and paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.\nFDICIA\nFDICIA requires that federal bank regulatory authorities take \"prompt corrective action\" with respect to any depository institution which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels which require or permit the FRB and other regulatory authorities to take supervisory action. The relevant classifications range from \"well capitalized\" to\n\"critically undercapitalized\". Under these regulations, which became effective December 19, 1992, an institution is considered well capitalized if it has a total risk-based capital ratio of 10.0% or greater, a Tier I risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. An institution is considered adequately capitalized if it has a total risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio of 4.0% or greater and a leverage capital ratio of 3.0% or greater (if the institution is rated composite 1 in its most recent report of examina- tion, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of a well capitalized institution. An institution is considered undercapitalized if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0%, or a leverage ratio that is less than 4.0% (or a leverage ratio that is less than 3.0% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A significantly undercapitalized institution is one which has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%. A critically undercapitalized institution is one which has a ratio of tangible equity to total assets that is equal to or less than 2.0%.\nThe FRB is authorized by the legislation to take various enforcement actions against any significantly undercapitalized institution and any undercapitalized institution that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the appropriate agency. These powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers. These restrictions, either individually or in aggregate, could if imposed have a significantly adverse impact on the operations of the Bank.\nWith certain exceptions, an institution will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause the institution to become undercapitalized. Furthermore, undercapitalized institutions will be required to file capital restoration plans with the appropriate federal regulator. Pursuant to FDICIA, undercapitalized institutions also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The FRB also may, among other things, require an undercapitalized institution to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances to divest itself of any subsidiary.\nCritically undercapitalized institutions may be subject to more extensive control and supervision and the FRB may prohibit any critically undercapitalized institution from, among other things, entering into any material transaction not in the ordinary course of business, amending its charter or bylaws, or engaging in certain transactions with affiliates. In addition, critically undercapitalized institutions generally will be prohibited from making payments of principal or interest on outstanding subordinated debt. Within 90 days of an institution becoming critically undercapitalized, the FRB must appoint a receiver or conservator unless certain findings are made with respect to the prospect for the institution's continued operation.\nBased on Texas State Bank's capital ratios at December 31, 1995, Texas State Bank was classified as \"well capitalized\" under the applicable regulations. On a pro forma basis at December 31, 1995, Texas State Bank would also have been \"well capitalized\" under applicable regulations. As a result, the Company does not believe that FDICIA's prompt corrective action regulations will have any material effect on the activities or operations of Texas State Bank.\nFDICIA also requires the FDIC to establish a schedule to increase (over a period of not more than 15 years) the reserve ratio of the BIF, which insures deposits of Texas State Bank, to 1.25% of insured deposits, and impose higher deposit insurance premiums on BIF members, if necessary, to achieve that ratio. FDICIA also requires a risk-based assessment system for deposit insurance premiums commencing January 1, 1994. Since BIF reached its designated reserve ratio in mid-1995, the FDIC adjusted the BIF\nassessments, so that the assessment rate now in effect ranges from a minimum of zero to a maximum of $0.27 per $100 of deposits. Institutions whose assessment rate would be zero are required to pay a statutory minimum semiannual assessment of $1,000. Based on the risk category applicable to Texas State Bank, the premium paid by Texas State Bank is presently $2,000 per annum.\nFDICIA contains numerous other provisions, including accounting, auditing and reporting requirements, the termination (beginning in 1995) of the \"too big to fail\" doctrine except in special cases, regulatory standards in areas such as asset quality, earnings and compensation, and revised regulatory standards for the powers of state chartered banks, real estate lending, bank closures and capital adequacy.\nCOMMUNITY REINVESTMENT ACT\nUnder the CRA, a bank's applicable regulatory authority (the FDIC or the FRB) is required to assess the record of each financial institution which it regulates to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the institution, and to take that record into account in its evaluation of any application made by such institution for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition or shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. The Bank received a \"satisfactory\" rating in its most recent CRA review. Both the United States Congress and the banking regulatory authorities have proposed substantial changes to the CRA and fair lending rules and regulations which, if enacted, could have a material adverse effect on the Company.\nCAPITAL RESOURCES\nCapital management, which is a continuous process at Texas Regional and Texas State Bank, consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements of various banking regulators, such as the FRB, the Banking Department and the FDIC. At December 31, 1995, Texas Regional and its subsidiaries were in compliance with minimum capital requirements of the respective regulatory agencies and are expected to remain in compliance in the future.\nThe various federal bank regulatory agencies, including the FRB, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure as adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.\nThe risk-based capital standards as established by the FRB apply to Texas Regional and Texas State Bank. The minimum standard for the ratio of capital to risk-weighted assets (including certain off-balance sheet obligations, such as standby letters of credit) is 8.0%. At least half of the risk-based capital must consist of common equity, retained earnings, and qualifying perpetual preferred stock, less deductions for goodwill and various other intangibles (\"Tier I capital\"). The remainder (\"Tier II capital\") may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock, and a limited amount of the general valuation allowance for loan losses. The sum of Tier I capital and Tier II capital is \"total risk-based capital.\"\nThe FRB also has adopted guidelines which supplement the risk-based regulations to include a minimum leverage ratio of Tier I capital to average total consolidated assets (\"Leverage ratio\") of 3.0%. The FRB has emphasized that the foregoing standards are supervisory minimums and that a banking organization will be permitted to maintain such minimum levels of capital only if it has well diversified\nrisk, including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings; and is in general considered to be a strong banking organization, rated composite 1 under applicable federal guidelines, and the banking organization is not experiencing or anticipating significant growth. All other banking organizations are required to maintain a Leverage ratio of at least 4.0% to 5.0%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The FRB continues to consider a \"tangible Tier I leverage ratio\" in evaluation proposals for expansion or new activities. The tangible Tier I leverage ratio is the ratio of a banking organization's Tier I capital, less deductions for intangibles otherwise includable in Tier I capital, to total tangible assets.\nBank regulators continue to consider raising capital requirements applicable to banking organizations beyond current levels. However, the Company is unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules, and therefore cannot predict what effect such higher requirements may have on the Company and the Bank.\nThe following table presents an analysis of capital for Texas Regional and Texas State Bank at the end of each of the last three years:\nThe following table presents an analysis of capital for Texas Regional and Texas State Bank on a pro forma basis at December 31, 1995.\n- ---------\n(1) On a pro forma basis at December 31, 1995, and assuming completion of the Mergers and completion of the offering of Common Stock as described in this Prospectus at a price of $21.00 per share, net of estimated underwriting discounts, commissions and expenses of the offering of $3,247,000.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nTexas State Bank targets commercial customers by offering a broad range of commercial banking services through a total of nine full service banking locations in the Rio Grande Valley, as follows:\n- --------- (1) Represents the date the facility opened for business as a commercial bank.\n(2) Represents the date the facility was acquired by Texas State Bank from a third party.\nAll of Texas Regional's banking locations are owned by Texas Regional, except for the Company's Roma banking location. The banking locations include extensive drive-through facilities at the main bank location in McAllen, at the Harlingen location, and at the new south McAllen banking location. The Kerria Plaza banking location and the main office of Texas Regional are located within the Kerria Plaza Building. While the Texas Regional banking facilities are considered adequate for Texas State Bank's present operations, management believes that it will be desirable in the future to consider the establishment of additional banking locations in Edinburg, Harlingen and Brownsville, and to consider development or acquisition of a substantial facility in McAllen.\nUpon consummation of the Mergers, Texas State Bank will acquire the following additional banking locations:\n- ------------ (1) Represents the date the facility opened for business as a commercial bank.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTexas State Bank is involved in routine litigation in the normal course of its business, which in the opinion of management of Texas Regional will not have a material adverse effect on the financial condition or results of operations of Texas Regional.\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.\nSince the public offering of the Common Stock in March 1994, the Common Stock has traded in the Nasdaq National Market System under the symbol \"TRBS.\" The following table shows (i) high and low prices of the Common Stock as reported in the Summary of Activity provided to the Company by The Nasdaq Stock Market for transactions occurring on the Nasdaq National Market System during the past two years, and (ii) the total number of shares involved in such transactions. In addition, with respect to periods prior to March 16, 1994, the information is based upon transactions with respect to which the management of Texas Regional had knowledge of the transaction price, since during those periods transactions were reported on an informal basis, and no independent verification of the transaction prices was made. Therefore, during periods prior to March 16, 1994, the prices reported may not be indicative of the actual or market value of the Common Stock.\nDuring the two years ended December 31, 1995, an aggregate of 58,500 shares purchased by the KSOP are included in the foregoing table.\nThe Company paid no dividends on its Common Stock prior to June 1994. Beginning in June 1994, the Company paid a quarterly dividend of $0.08 per share of its Common Stock. During 1995, the Company increased its quarterly dividend to $0.10 per share, and currently intends to continue to pay such dividend in the foreseeable future. On March 12, 1996, the Company's Board of Directors declared a dividend of $0.10 per share of Common Stock payable to shareholders of record as of April 8, 1996.\nThe final determination of the timing, amount and payment of dividends on the Common Stock is at the discretion of the Company's Board of Directors and will depend on conditions then existing, including Texas Regional's profitability, liquidity, financial condition, capital requirements and other relevant factors, including regulatory restrictions applicable to the Company. The Company's principal source of the funds to pay dividends on the Common Stock is dividends from Texas State Bank. The payment of dividends by Texas State Bank is subject to certain restrictions imposed by federal and state banking laws, regulations and authorities. At December 31, 1995, an aggregate of $8.7 million was available for payment of dividends by the Bank to the Company under the applicable limitations and without regulatory approval.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial information under the captions \"Summary of Operations\" and \"Period-End Balance Sheet Data\" below for, and as of, each of the years in the five-year period ended December 31, 1995 has been derived from the consolidated financial statements of the Company, which financial statements have been audited by KPMG Peat Marwick LLP, independent auditors.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion provides additional information regarding the financial condition and the results of operations for the Company for each of the years ended December 31, 1995, 1994 and 1993. This discussion should be read in conjunction with the consolidated financial statements of the Company and the notes thereto appearing elsewhere herein.\nSELECTED CONSOLIDATED FINANCIAL INFORMATION\nNet income for the year ended December 31, 1995 was $8.7 million, reflecting a net increase of $1.5 million or a 21.4% increase compared to net income of $7.2 million for the year ended December 31, 1994. The earnings per share of $1.40 for the year ended December 31, 1995 increased $0.24 or 20.7% compared to the earnings per share of $1.16 for the year ended December 31, 1994. Earnings performance for the year ended December 31, 1995 reflected gains in net interest income and an increase in noninterest income. These positive factors were partially offset by an increase in provision for loan losses and noninterest expenses. A more detailed description of the results of operations is included in the material that follows.\nDuring August 1995, Texas State Bank completed the RGC\/Roma Branch Acquisitions which included the purchase of $43.7 million in loans and the assumption of approximately $79.7 million in deposit liabilities of these banking locations. This transaction was accounted for as a purchase; therefore, the results of operations of the two banking locations are included in the consolidated financial statements of the Company from the date of acquisition. Purchase accounting adjustments for the purchase of loans and the assumption of deposit liabilities of these banking locations were immaterial.\nOn March 31, 1992, the Company acquired, through merger, Mid Valley Bank, Weslaco, Texas. Simultaneously with the acquisition of Mid Valley Bank, both the surviving bank in that merger transaction and Harlingen State Bank, Harlingen, Texas, a subsidiary of the Company, merged with and into Texas State Bank and the former Weslaco and Harlingen banks became banking locations of Texas State Bank. The Mid Valley Bank merger was accounted for under the purchase method of accounting. Accordingly, certain income statement and balance sheet comparisons during calendar 1991 and 1992 and at year-end 1991 and 1992, respectively, may not be appropriate.\nANALYSIS OF RESULTS OF OPERATIONS\nNET INTEREST INCOME\nNet interest income is the difference between interest earned on assets and interest expense incurred for the funds supporting those assets. The largest category of earning assets consists of loans. The second largest category of earning assets is investment securities, followed by federal funds sold. For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets.\nEarning assets are financed by consumer and commercial deposits and short-term borrowings. In addition to these interest-bearing funds, assets also are supported by interest-free funds, primarily demand deposits and shareholders' equity. Variations in the volume and mix of assets and liabilities, and their relative sensitivity to interest rate movements, determine changes in net interest income.\nTaxable-equivalent net interest income was $27.8 million for the year ended December 31, 1995, an increase of $4.7 million or 20.3% compared to the year ended December 31, 1994, and taxable-equivalent net interest income of $23.1 million for the year ended December 31, 1994, increased $3.7 million or 19.3% compared to the year ended December 31, 1993. Both net interest income and the yield on earning assets were reduced by interest foregone on nonaccrual and renegotiated loans. If interest on\nthose loans had been accrued at the original contractual rates, additional interest income would have approximated $247,000, $476,000, and $149,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe net yield on total interest-earning assets, also referred to as interest rate margin, represents net interest income divided by average interest-earning assets. Since a significant portion of the Company's funding is derived from interest-free sources, primarily demand deposits and shareholders' equity, the effective rate paid for all funds is lower than the rate paid on interest-bearing liabilities alone. As the following table illustrates, the interest rate margin of 5.33% for the year ended December 31, 1995 increased 21 basis points compared to 5.12% for the year ended December 31, 1994 while the interest rate margin of 5.12% for the year ended December 31, 1994 increased 28 basis points compared to 4.84% for the year ended December 31, 1993.\nThe increase in the interest rate margin for the year ended December 31, 1995 is reflective of the shift in the mix of interest-earning assets to loans from lower yielding investment securities, including federal funds sold, which contributed to an increase in yield on interest-earning assets during the year. The mix of interest-earning assets was changed by total average loans of $370.3 million increasing $61.2 million or 19.8%, total average investment securities of $131.0 million increasing $967,000 or 0.7% and average federal funds sold of $19.8 million increasing $8.3 million or 72.4%. The increase in loan yield reflects the general increase in average interest rates in 1995 compared to 1994. The increase in investment securities yield resulted from lower yielding investment securities maturing and the reinvesting of the proceeds into higher yields. The increase in interest on deposits during the year ended December 31, 1995 resulted primarily from increased volume and the higher average rate paid compared to the previous year.\nThe following table presents for the last three calendar years the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the average interest-bearing liabilities, expressed both in dollars and rates. Average balances are derived from average daily balances and the yields and costs are established by dividing income or expense by the average balance of the asset or liability. Income and yield on interest-earning assets include amounts to convert tax-exempt income to a taxable-equivalent basis, assuming a 34% effective income tax rate.\nTHREE-YEAR FINANCIAL SUMMARY\n- ------------ (1) For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate).\nThe following table presents the effects of changes in volume, rate and rate\/volume on interest income and interest expense for major categories of interest-earning assets and interest-bearing liabilities. Nonaccrual loans are included in assets, thereby reducing yields (see \"Nonperforming Assets\"). The allocation of the rate\/volume variance has been made pro-rata on the percentage that volume and rate variances produce in each category.\n- --------- (1) For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate).\nNET YIELD ON EARNING ASSETS\nThe following table presents net interest income, average earning assets and the net yield by quarter for the past three years. Income and yield on earning assets include amounts to convert tax-exempt income to a taxable-equivalent basis, assuming a 34% effective federal income tax rate.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses for the year ended December 31, 1995 was $1.7 million, an increase of $600,000 or 55.3% from the $1.1 million for the year ended December 31, 1994. The provision for loan losses for the year ended December 31, 1994 of $1.1 million reflects an increase of $693,000 or 176.8% from the $392,000 provision for loan losses for the year ended December 31, 1993. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management based on such factors as historical experience, the volume and type of lending conducted by the Company, the amount of nonperforming assets, regulatory policies, generally accepted accounting principles, general economic conditions, particularly as they relate to the Company's lending area, and other factors related to the collectibility of the Company's loan portfolio. The increase in the provision for the year ended December 31, 1995, compared to the provision for the year ended December 31, 1994, was primarily attributable to loan growth of $110.9 million and net charge-offs of $1.1 million. See \"Allowance for Loan Losses.\"\nIn January 1995, the Company adopted Statement of Financial Accounting Standards No. 114 (\"Statement 114\"), \"Accounting by Creditors for Impairment of a Loan\", and the amendment thereof, Statement of Financial Accounting Standards No. 118 (\"Statement 118\"), \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". In management's opinion, the adoption of Statement 114 and Statement 118 did not have a material effect on the Company's financial position or results of operations.\nNONINTEREST INCOME\nNoninterest income of $6.5 million for the year ended December 31, 1995 increased $746,000 or 12.9% compared to $5.8 million for the year ended December 31, 1994, and noninterest income of $5.8 million for the year ended December 31, 1994 increased $740,000 or 14.7% compared to $5.0 million for the year ended December 31, 1993. All categories of noninterest income, except Other Service Charges and Net Investment Securities Gains (Losses), for the year ended December 31, 1995, increased when compared to the year ended December 31, 1994. Total Service Charges of $4.3 million for the year ended December 31, 1995 increased $392,000 or 10.0% compared to the year ended December 31, 1994, and Total Service Charges of $3.9 million for the year ended December 31, 1994, increased $646,000 or 19.6% compared to the year ended December 31, 1993. The increase in Total Service Charges for the years ended December 31, 1995, 1994 and 1993 is attributable to increased account transaction fees as a result\nof the deposit growth experienced by the Company. The decline in Other Service Charges for the year ended December 31, 1995 compared to the year ended December 31, 1994 was primarily attributable to a decrease in foreign currency exchange fees. The recent events in Mexico, primarily the peso devaluation, have resulted in a decrease in volume and spread on peso exchange fee activity.\nTrust Service Fees of $1.3 million for the year ended December 31, 1995 increased $95,000 or 8.2% compared to $1.2 million for the year ended December 31, 1994, and Trust Service Fees of $1.2 million for the year ended December 31, 1994 increased $74,000 or 6.8% compared to $1.1 million for the year ended December 31, 1993. The increase in Trust Service Fees in each of years 1995 and 1994 is attributable to increases in both the number of trust accounts and the book value of assets managed. The book value of assets managed at December 31, 1995 and 1994 was $237.4 million and $192.4 million, respectively. Assets held by the trust department of the Bank in fiduciary or agency capacities are not assets of the Company and are not included in the consolidated balance sheets.\nNet Investment Securities Gains (Losses) was ($111,000) for the year ended December 31, 1995, compared to an $8,000 gain for the year ended December 31, 1994. The decrease was primarily attributable to a $99,000 loss recorded on the sale of two bonds.\nOther operating income of $601,000 for the year ended December 31, 1995 increased $192,000 or 46.9% compared to $409,000 for the year ended December 31, 1994 and other operating income of $409,000 for the year ended December 31, 1994 increased $27,000 or 7.1% compared to year ended December 31, 1993.\nA detailed summary of noninterest income during the last three years is presented in the following table:\n- --------- *Not meaningful.\nNONINTEREST EXPENSE\nNoninterest expense of $19.0 million for the year ended December 31, 1995 increased $2.5 million or 15.0% compared to $16.5 million for the year ended December 31, 1994, and noninterest expense of $16.5 million for the year ended December 31, 1994 increased $2.0 million or 13.7% compared with $14.5 million for the year ended December 31, 1993. These increases for the years ended December 31, 1995 and 1994 were primarily attributable to the increased volume of business conducted by the Company.\nThe largest category of noninterest expense, Salaries and Employee Benefits (\"Personnel\"), of $9.6 million for the year ended December 31, 1995, increased $1.5 million or 19.3% compared to year ended December 31, 1994 levels of $8.0 million. Personnel expense of $8.0 million for the year ended December 31, 1994 increased $217,000 or 2.8% compared to year ended December 31, 1993 levels of $7.8\nmillion. Personnel expense increased for the year ended December 31, 1995 primarily due to staffing increases, including the additional staff acquired as a result of the RGC\/Roma Branch Acquisitions, and increases in payroll taxes, medical insurance premiums and pension expenses for all employees.\nNet occupancy expense of $1.1 million for the year ended December 31, 1995 increased $108,000 or 11.2% compared to $961,000 for the year ended December 31, 1994, and net occupancy expense of $961,000 for the year ended December 31, 1994 increased $141,000 or 17.2% when compared to a net occupancy expense of $820,000 for the year ended December 31, 1993. The increase for the year ended December 31, 1995 is primarily attributable to the occupancy expenses associated with the RGC\/Roma Branch Acquisitions.\nEquipment expense of $2.0 million for the year ended December 31, 1995 increased $380,000 or 23.1% compared to $1.6 million for the year ended December 31, 1994 and equipment expense of $1.6 million for the year ended December 31, 1994 increased $282,000 or 20.6% when compared with $1.4 million for the year ended December 31, 1993. The equipment expense increase noted during the year ended December 31, 1995 is primarily attributable to equipment obtained in the RGC\/Roma Branch Acquisitions and equipment acquired to service the Company's increasing customer base.\nOther Real Estate (Income) Expense, Net includes rent income from foreclosed properties, gain or loss on sale of other real estate properties and direct expenses of foreclosed real estate including property taxes, maintenance costs and write-downs. Write-downs of other real estate are required if the fair value of an asset acquired in a loan foreclosure subsequently declines below its carrying value. Other Real Estate (Income) Expense, Net of $107,000 for the year ended December 31, 1995 increased $32,000 or 42.7% when compared to $75,000 net expense for the year ended December 31, 1994. Other Real Estate (Income) Expense, Net of $75,000 net expense for the year ended December 31, 1994 decreased $403,000 or 122.9% compared to $328,000 net income for the year ended December 31, 1993. The increased expense during the year ended December 31, 1995 is primarily attributable to commissions paid on new lease agreements on rental property included in Other Real Estate. Management is actively seeking buyers for all Other Real Estate and is of the opinion that the carrying value of Other Real Estate approximates its estimated fair value less estimated closing costs.\nAdvertising and Public Relations expense of $772,000 for the year ended December 31, 1995 increased $79,000 or 11.4% compared to $693,000 for the year ended December 31, 1994. The increase in advertising and public relations expense is primarily attributable to a new marketing program and additional advertising in the service area acquired in the RGC\/Roma Branch Acquisitions.\nFDIC insurance of $540,000 for the year ended December 31, 1995, decreased $433,000 or 44.5% compared to $973,000 for the year ended December 31, 1994 due to a rebate and a premium rate reduction. On August 8, 1995, the FDIC Board of Directors voted to reduce the deposit insurance premiums paid by most members of the Bank Insurance Fund, effective as of June 1, 1995. As a result, the overpaid assessments for the period June 1 to September 30, 1995 and interest (totaling $297,000) were refunded on September 15, 1995. The Company continues to receive the most favorable risk classification for purposes of determining the annual deposit insurance assessment rate, although there can be no assurance that the Company will continue in the most favorable risk classification in the future.\nThe increase in Other Losses represents additional losses sustained on overdraft accounts and the costs of settlement during the period ending December 31, 1995 of certain litigation.\nA detailed summary of noninterest expense during the last three years is presented in the following table:\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn December 1990, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 106 (\"Statement 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which is effective for fiscal years beginning after December 15, 1992. Statement 106 requires companies that have postretirement benefit plans to accrue the estimated cost of providing those benefits to an employee and the employee's beneficiaries and covered dependents. The Company does not presently provide postretirement benefits other than the KSOP Plan, which is available to all eligible employees, and a nonqualified deferred compensation plan for the benefit of Glen E. Roney, Chairman of the Board, President and Chief Executive Officer.\nINCOME TAX\nThe Company recorded income tax expense of $4.7 million for the year ended December 31, 1995 compared to $3.9 million for the year ended December 31, 1994. The increase in income tax expense for the year ended December 31, 1995 is due primarily to an increased level of pretax income during the year ended December 31, 1995.\nThe Texas franchise tax is based in part on capital and in part on federal taxable income with certain modifications. A portion of the tax is accrued in the year in which the income to which it relates is earned, even though the tax constitutes a fee for the privilege of doing business in a succeeding period and is payable in that period. The Company recorded Texas franchise tax expense of $217,000, $207,000 and $149,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNET INCOME\nNet income was $8.7 million, $7.2 million and $6.0 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nANALYSIS OF FINANCIAL CONDITION\nBALANCE SHEET COMPOSITION\nThe Company continues to experience growth in total assets, deposits and loans attributable in the opinion of management, in part to the vitality of the Rio Grande Valley economy and in part to the RGC\/ Roma Branch Acquisitions. The recent devaluation of the Mexican peso relative to the U.S. dollar has reduced retail sales to Mexican nationals. However, the effects of NAFTA and the devaluation have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras) which benefit the Rio Grande Valley economy. Management does not believe that the recent Mexican financial problems will materially adversely affect the Company's growth and earnings prospects.\nAverage interest-earning assets of $521.1 million increased $70.5 million or 15.7% for the year ended December 31, 1995 compared to $450.6 million for the year ended December 31, 1994 and $51.3 million or 12.8% for the year ended December 31, 1994 compared to $399.3 million for the year ended December 31, 1993. Management's continued focus on lending has resulted in average loans increasing $61.2 million or 19.8% to $370.3 million for the year ended December 31, 1995 compared to December 31, 1994 levels of $309.0 million, while average investment securities of $131.0 million increased $967,000 or 0.7% for the year ended December 31, 1995 compared to December 31, 1994 levels of $130.0 million. Total average assets increased $73.7 million or 14.6% to $577.9 million for the year ended December 31, 1995 compared to December 31, 1994 levels and $56.1 million or 12.5% to $504.2 million for the year ended December 31, 1994 compared to December 31, 1993 levels of $448.1 million.\nAverage interest-bearing deposits increased $54.3 million or 15.3% to $409.5 million for the year ended December 31, 1995 compared to the year ended December 31, 1994 levels of $355.2 million. Demand deposits also increased $10.0 million or 10.7% for the year ended December 31, 1995 to $103.8 million compared to the year ended December 31, 1994 levels of $93.8 million partially as a result of the increase in public funds from several local municipalities and independent school districts. The Company has a stable noninterest-bearing source of funds as reflected in the ratio of average demand deposits to average total deposits for years ended December 31, 1995, 1994 and 1993 of 20.2%, 20.9%, and 20.6%, respectively.\nThe following table presents the Company's average balance sheets during the last three years:\nCASH AND DUE FROM BANKS\nTexas State Bank, through its nine banking locations, offers a broad range of commercial banking services to individuals and businesses in its service area. Texas State Bank also acts as a correspondent to a number of banks in its service area, providing check clearing, wire transfer, federal funds transactions, loan participations, data processing and other correspondent services. The amount of cash and due from banks held on any one day is significantly influenced by temporary changes in cash items in process of collection. At December 31, 1995, cash and due from banks was $30.9 million, $9.5 million less than at December 31, 1994.\nINVESTMENT SECURITIES\nIn May 1993, the FASB issued Statement of Financial Accounting Standards No. 115 (\"Statement 115\"), \"Accounting for Certain Investments in Debt and Equity Securities\". Statement 115 established\nstandards of financial accounting and reporting for investments in equity securities that have a readily determinable fair value and for all investments in debt securities. At acquisition, the Bank is required to classify debt and equity securities into one of three categories: Held to Maturity, Trading or Available for Sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities are classified as Held to Maturity and measured at amortized cost in the consolidated balance sheet only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as Trading and measured at fair value in the consolidated balance sheet with unrealized holding gains and losses included in earnings. Investments not classified as either Held to Maturity or Trading are classified as Available for Sale and measured at fair value in the consolidated balance sheet with unrealized holding gains and losses reported in a separate component of shareholders' equity until realized.\nEffective December 31, 1993, the Company adopted Statement 115, which caused various investment securities to be reclassified from Held to Maturity to Available for Sale. All treasury and agency bonds with a maturity of two years or less from December 31, 1993, all floating rate bonds and two small equity securities were reclassified to Available for Sale. During 1994, management continued classifying bonds purchased with a final maturity of two years or less as Available for Sale. During 1995, management has classified bonds purchased with a final maturity of three years or less as Available for Sale. All other bonds have been classified as Held to Maturity. Future purchases of investment securities will be classified as Available for Sale or Held to Maturity at time of purchase as determined by the investment committee.\nOn October 18, 1995, the FASB decided to grant to all entities a one-time opportunity during the period from approximately the middle of November to December 31, 1995, to reconsider their intent and ability to hold securities accounted for as Held to Maturity under Statement 115. This opportunity allowed entities to transfer securities from the Held to Maturity category to Available for Sale or Trading without calling into question their intent to hold other debt securities to maturity. On December 31, 1995, the Bank transferred approximately $1.5 million in Held to Maturity securities to the Available for Sale category resulting in no change to shareholders' equity per share. As a result of this transfer, all Other Securities are classified as Available for Sale.\nAt December 31, 1995, 1994 and 1993, no securities were classified as Trading.\nThe following table presents estimated market value of Securities Available for Sale at December 31, 1995, 1994 and 1993:\n- ------------------------------ * Not meaningful.\nThe following table presents the maturities, amortized cost, estimated market value and weighted average yields of the Securities Available for Sale at December 31, 1995:\n- --------- (1) Amortized cost for Securities Available for Sale is stated at par plus any remaining unamortized premium paid or less any remaining unamortized discount received.\nThe following table presents amortized cost of Securities Held to Maturity at December 31, 1995, 1994 and 1993:\nTotal investments in states and political subdivisions represent investments in entities within the State of Texas. No single issuer accounted for as much as 10.0% of total shareholders' equity at December 31, 1995. Of the obligations of states and political subdivisions held by the Company at December 31, 1995, 88.1% were rated A or better by Moody's Investor Services, Inc.\nThe following table presents the maturities, amortized cost, estimated market value and weighted average yields of Securities Held to Maturity at December 31, 1995:\n- --------- (1) Amortized cost for Securities Held to Maturity is stated at par plus any remaining unamortized premium paid or less any remaining unamortized discount received.\nLOANS\nThe Company manages its credit risk by establishing and implementing strategies and guidelines appropriate to the characteristics of borrowers, industries, geographic locations and products. Diversification of risk within each of these areas is a primary objective. Policies and procedures are developed to ensure that loan commitments conform to current strategies and guidelines. Management continues to refine the Company's credit policies and procedures to address the risks in the current and prospective environment and to reflect management's current strategic focus. The credit process is controlled with continuous credit review and analysis, and by review by internal and external auditors and regulatory authorities. The Company's loans are widely diversified by borrower and industry group.\nThe Company has collateral management policies in place so that collateral lending of all types is approached, to the extent possible, on a basis consistent with safe and sound standards. Valuation analysis is utilized to take into consideration the potentially adverse economic conditions under which liquidation could occur. Collateral accepted against the commercial loan portfolio includes accounts receivable and inventory, marketable securities, equipment and agricultural products. Autos, deeds of trust, life insurance and marketable securities are accepted as collateral for the installment loan portfolio.\nManagement of the Company believes that the Company has benefitted from increased loan demand due to passage of NAFTA and the strong population growth in the Rio Grande Valley. More recently, the devaluation of the Mexican peso relative to the U.S. dollar has reduced retail sales to residents of Mexico. However, the effects of NAFTA and the devaluation have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras) which benefit the Rio Grande Valley economy. Management believes the current Mexican financial problems will not have a material adverse effect on the Company's growth and earnings prospects.\nTotal loans of $450.9 million for the year ended December 31, 1995 increased $110.9 million or 32.6% compared to the year ended December 31, 1994 levels of $339.9 million and increased $49.4 million or 17.0% for the year ended December 31, 1994 compared to levels of $290.5 million at\nDecember 31, 1993. The increase in total loans for the year ended December 31, 1995 is primarily attributable to the RGC\/Roma Branch Acquisitions, funding a large leveraged employee stock ownership trust loan and management's efforts to improve the earnings mix of earning assets by increasing loan volume. The increase in Commercial loans in general, and Commercial-Tax Exempt loans in particular, for the year ended December 31, 1995 was primarily attributable to the funding of a $34.0 million employee stock ownership trust loan which is collateralized by stock and assets of the employer and approximately $27.5 million of cash and cash equivalent assets. Excluding this loan, Total Commercial Loans at December 31, 1995 represented an increase of $10.6 million, or 10.4%, compared to levels at December 31, 1994, and Total Loans at December 31, 1995 represented an increase of $76.9 million, or 22.6%, compared to levels at December 31, 1994. A substantial portion of the increase in loans classified as Real Estate-Commercial Mortgage loans consists of loans secured by real estate and other assets to commercial customers. The increase in total loans for the year ended December 31, 1992 is primarily due to the acquisition of Mid Valley Bank. The following table presents the composition of the loan portfolio at the end of each of the last five years:\nThe contractual maturity schedule of the loan portfolio at December 31, 1995 is presented in the following table:\nAs shown in the preceding table, loans maturing within one year totaled $176.5 million at year-end 1995. The Company's policy on maturity extensions and rollovers is based on management's assessment of individual loans. Approvals for the extension or renewal of loans without reduction of principal for more than one twelve-month period are generally avoided, unless the loans are fully secured or are revolving lines subject to annual analysis and renewal.\nNONPERFORMING ASSETS\nThe Bank has several procedures in place to assist in maintaining the overall quality of its loan portfolio. The Bank has established underwriting guidelines to be followed by its officers and monitors its delinquency levels for any negative or adverse trends, particularly with respect to credits which have total exposures of $10,000 or more.\nNonperforming assets consist of nonaccrual loans, loans for which the interest rate has been renegotiated below originally contracted rates and real estate or other assets that have been acquired in partial or full satisfaction of loan obligations. At December 31, 1995, five loan relationships in excess of $100,000 totaling $1.6 million accounted for 76.1% of the total nonaccrual loans. These five nonaccrual credits are secured primarily by real estate, and management believes that it is unlikely that any material loss will be incurred on disposition of the collateral. The remaining nonaccrual loans represent loans of less than $100,000 each.\nThe Company's policy generally is to place a loan on nonaccrual status when payment of principal or interest is contractually past due 90 days, or earlier when concern exists as to the ultimate collection of principal and interest. At the time a loan is placed on nonaccrual status, interest previously accrued but uncollected is reversed and charged against current income.\nLoans which are contractually 90 days or more past due, which are both well secured or guaranteed by financially responsible third parties and in the process of collection, generally are not placed on nonaccrual status. The amount of such accruing loans 90 days or more past due for the years ended December 31, 1995, 1994 and 1993 totaled $642,000, $226,000 and $439,000, respectively. The increase in accruing loans 90 days or more past due at December 31, 1995 as compared to December 31, 1994 is partly attributable to two credits over $100,000 included in the category, both of which are in the process of collection.\nNonperforming assets of $3.6 million at December 31, 1995 decreased $1.2 million or 25.5% compared to December 31, 1994 levels of $4.8 million and decreased $138,000 or 2.9% for the year ended December 31, 1994 compared to December 31, 1993 levels of $5.0 million. Management actively seeks buyers for all Other Real Estate. See \"Noninterest Expense\" above. The ratio of nonperforming assets plus accruing loans 90 days or more past due as a percent of total loans and other nonperforming assets at December 31, 1995 decreased to 0.94% from 1.47% at December 31, 1994 due primarily to the reduction in other nonperforming assets and the addition of $43.7 million of performing loans from the RGC\/Roma Branch Acquisitions.\nManagement is not aware of any borrower relationships that are not reported as nonperforming where management has serious doubts as to the ability of such borrowers to comply with the present loan repayment terms which would cause nonperforming assets to increase materially.\nEffective January 1, 1995, the Company adopted Statement 114 and the amendment thereof, Statement 118. Under Statement 114, a loan is considered impaired when, based upon 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. Statement 114 requires that an impaired loan be valued utilizing (i) the present value of expected future cash flows discounted at the effective interest rate of the loan, (ii) the fair value of the underlying collateral, or (iii) the observable market price of the loan. Statement 118 amended Statement 114 by expanding the related disclosure requirements and permitting use of existing methods for recognizing interest income on impaired loans.\nAt December 31, 1995, the Company had a $2.0 million recorded investment in impaired loans for which there was a related allowance for loan losses of $172,000. At December 31, 1995, there were no impaired loans for which there was no related allowance for loan losses. The average level of impaired loans during the year ended December 31, 1995 was $1.9 million. The Company recorded interest income of $91,000 on its impaired loans during the year ended December 31, 1995.\nAn analysis of the components of nonperforming assets for the last five years is presented in the following table:\nInterest income that would have been recorded for the year ended December 31, 1995 on nonaccrual and renegotiated loans had such loans performed in accordance with their original contractual terms and been outstanding throughout the year ended December 31, 1995, or since origination, if held for only part of that year, was approximately $247,000. For the year ended December 31, 1995, the amount of interest income actually recorded on nonaccrual and restructured loans was approximately $176,000.\nManagement regularly reviews and monitors the loan portfolio to identify borrowers experiencing financial difficulties. Management believes that, at December 31, 1995, all such loans had been identified and included in the nonaccrual, restructured or 90 days past due loan totals reflected in the table above. Management continues to emphasize maintaining a low level of nonperforming assets and returning nonperforming assets to an earning status.\nALLOWANCE FOR LOAN LOSSES\nManagement analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. In assessing the adequacy of the allowance, management reviews the size, quality and risks of loans in the portfolio and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets and economic conditions. A specific percentage is allocated to total loans in good standing and additional amounts are added for individual loans considered to have specific loss potential. Loans identified as losses are charged off. In addition, the loan review committee of the Bank reviews the assessments of management in determining the adequacy of the Bank's allowance for loan losses. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management. While management uses available information to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary. The allowance for loan losses at December 31, 1995 was $4.5 million, which represents an increase of $1.0 million or 29.3% as compared to the allowance for loan losses at December 31, 1994. Management believes that the allowance for loan losses at December 31, 1995 adequately reflects the risks in the loan portfolio. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.\nThe following table summarizes the activity in the allowance for loan losses for the last five years:\nThe allocation of the allowance for loan losses by loan category and the percentage of loans in each category to total loans at the end of each of the last five years is presented in the table below:\nPREMISES AND EQUIPMENT\nPremises and equipment of $18.4 million at December 31, 1995 increased $3.1 million or 20.3% compared to $15.3 million at December 31, 1994 in addition to a net increase of $480,000 or 3.2% for December 31, 1994 compared to $14.8 million at December 31, 1993. The net increase for the year\nended December 31, 1995 is primarily attributable to the $1.8 million in fixed assets acquired in the RGC\/ Roma Branch Acquisitions and $1.0 million for new equipment and software for the data processing center.\nINTANGIBLES\nIntangibles of $5.7 million at December 31, 1995 increased $3.7 million or 188.1% compared to $2.0 million at December 31, 1994 and decreased $224,000 or 10.1% for December 31, 1994 compared to $2.2 million at December 31, 1993. The net increase for the year ended December 31, 1995 is attributable to the goodwill recorded as a result of the RGC\/Roma Branch Acquisitions.\nDEPOSITS\nTotal deposits of $579.7 million at December 31, 1995 increased $107.6 million or 22.8% compared to December 31, 1994 levels of $472.1 million and total deposits of $472.1 million for the year ended December 31, 1994 increased $42.6 million or 9.9% compared to December 31, 1993 levels of $429.5 million. The increase in total deposits at December 31, 1995 compared to December 31, 1994 is primarily attributable to the RGC\/Roma Branch Acquisitions. Total noninterest-bearing deposits of $120.4 million for the year ended December 31, 1995 represented an increase of $20.8 million or 20.8% compared to the year ended December 31, 1994 and $10.2 million or 11.5% for the year ended December 31, 1994 compared to the year ended December 31, 1993. Total public funds deposits (consisting of Public Funds Demand Deposits, Public Funds Money Market Checking and Savings and Public Funds Time Deposits) of $39.3 million for the year ended December 31, 1995 decreased $16.3 million or 29.3% compared to December 31, 1994 levels of $55.6 million. The decline in public funds is primarily due to the loss of a large public fund to a competitor as a result of a competitive bid in September 1995. The Bank actively seeks consumer and commercial deposits, including deposits from correspondent banks and public funds deposits. The following table presents the composition of total deposits at the end of the last three years:\nTime deposits of $100,000 or more are solicited from markets served by the Bank and are not sought through brokered sources. Time deposits continue to be a significant source of funds. Texas State Bank does not solicit brokered deposits. The following table presents the maturities of time deposits of $100,000 or more at December 31, 1995 and 1994:\nMexico is a part of the trade territory of the Company and foreign deposits from Mexican sources have traditionally been a source of funding. In December 1994, the Mexican government announced a 15% devaluation of the Mexican peso relative to the United States dollar, and the Mexican peso has since continued to decline relative to the dollar. The Company does not anticipate any negative impact on foreign deposits due to these recent devaluations of the peso. The increase in foreign deposits is primarily attributable to Mexican deposits obtained with the RGC\/Roma Branch Acquisitions. The following table presents foreign deposits, primarily from Mexican sources, at December 31, 1995 and 1994:\nLIQUIDITY\nLiquidity management assures that adequate funds are available to meet deposit withdrawals, loan demand and maturing liabilities. Insufficient liquidity can result in higher costs of obtaining funds, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative investments. The ability to renew and acquire additional deposit liabilities is a major source of liquidity. The Company's principal sources of funds are primarily within the local markets of the Bank and consist of deposits, interest and principal payments on loans and investment securities, sales of loans and investment securities and borrowings. See previous discussion regarding the maturity dates for \"Loans,\" \"Investment Securities\" and \"Deposits.\"\nAsset liquidity is provided by cash and assets which are readily marketable, or which can be pledged, or which will mature in the near future. These include cash, federal funds sold and U.S. Government-backed securities. At December 31, 1995, the Company's liquidity ratio, defined as cash, U.S. Government-backed securities and federal funds sold as a percentage of deposits, was 27.5% compared to 34.2%\nat December 31, 1994 and compared to 36.0% at December 31, 1993. The Company's liquidity ratio has declined as a result of management's efforts to improve the Company's earnings mix by increasing loan volume.\nLiability liquidity is provided by access to core funding sources, principally various customers' interest-bearing and noninterest-bearing deposit accounts in the Company's trade area. The Company does not have or nor does it solicit brokered deposits. Federal funds purchased and short-term borrowings are additional sources of liquidity. These sources of liquidity are short-term in nature and are used, as necessary, to fund asset growth and meet short-term liquidity needs.\nDuring 1995, funds for $79.4 million of investment purchases and $69.5 million of net loan growth came from various sources, including a net increase in deposits of $27.9 million, $12.6 million in proceeds from sale of investment securities, $62.5 million in proceeds from maturing investment securities and $8.7 million of net income.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") requires that federal bank regulatory authorities take \"prompt corrective action\" with respect to any depository institution which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels which require or permit the FRB and other regulatory authorities to take supervisory action. The relevant classifications range from \"well capitalized\" to \"critically undercapitalized.\" The classifications are generally determined by applicable ratios of the institution, including Tier I capital to risk-weighted assets, total capital to risk-weighted assets and leverage ratios. Based on Texas State Bank's capital ratios at December 31, 1995, Texas State Bank was classified as \"well capitalized\" under the applicable regulations. As a result, the Company does not believe that the prompt corrective action regulations have any material effect on the activities or operations of the Company or Texas State Bank.\nThe principal sources of liquidity for the Company during 1995 were the proceeds from the 1994 sale of 1.0 million shares of Common Stock and interest income of $338,000 from the Bank. The funds received were used primarily to pay common stock dividends and other expenses.\nThe Company is dependent on dividend and interest income from the Bank and the sale of stock for its liquidity. Applicable FRB regulations provide that bank holding companies are permitted by regulatory authorities to pay cash dividends on their common or preferred stock if consolidated earnings and consolidated capital are within regulatory guidelines and the Bank is classified as \"well capitalized\" for purposes of FDICIA.\nThe funds management policy of the Company and the Bank is to maintain a reasonably balanced position of rate sensitive assets and liabilities to avoid adverse changes in net interest income. Changes in net interest income occur when interest rates on loans and investments change in a different time period from that of changes in interest rates on liabilities, or when the mix and volume of interest-earning assets and interest-bearing liabilities change. The interest rate sensitivity gap represents the dollar amount of difference between rate sensitive assets and rate sensitive liabilities within a given time period (\"GAP\"). A GAP ratio is determined by dividing rate sensitive assets by rate sensitive liabilities. A ratio of 1.0 indicates a perfectly matched position, in which case the effect on net interest income due to interest rate movements would be zero.\nRate sensitive assets maturing within one year exceeded rate sensitive liabilities with comparable maturities at December 31, 1995 by $22.3 million. Management monitors the rate sensitivity GAP on a regular basis and takes steps when appropriate to improve the sensitivity. The ratio of cumulative rate sensitivity GAP to Total Assets at a period of twelve months or less was 3.45% of interest-earning assets at December 31, 1995.\nThe following table summarizes interest rate sensitive assets and liabilities by maturity at December 31, 1995:\n- --------- (1) Rate sensitive interest-earning assets less rate sensitive interest-bearing liabilities.\nEFFECTS OF INFLATION\nFinancial institutions are impacted differently by inflation than are industrial companies. While industrial and manufacturing companies generally have significant investments in inventories and fixed assets, financial institutions ordinarily do not have such investments. As a result, financial institutions are generally in a better position than industrial companies to respond to inflationary trends by monitoring the spread between interest costs and interest income yields through adjustments of maturities and interest rates of assets and liabilities. In addition, inflation tends to increase demand for loans from financial institutions as industrial companies attempt to maintain a constant level of goods in inventory and assets. As consumers of goods and services, financial institutions are affected by inflation as prices increase, causing an increase in costs of salaries, employee benefits, occupancy expense and similar items.\nCAPITAL RESOURCES\nShareholders' equity of $62.7 million for the year ended December 31, 1995 reflects a net increase of approximately $7.0 million or 12.5% compared to shareholders' equity of $55.7 million for the year\nended December 31, 1994. This net increase was primarily attributable to earnings for 1995. The net increase in shareholders' equity reflects dividends paid on Common Stock of $2.5 million which included $620,000 declared December 12, 1995 and paid on January 16, 1996.\nOn March 21, 1994, the Board of Directors of the Company adopted a resolution calling for redemption on April 22, 1994 of all issued and outstanding preferred stock, including the Company's First Series Convertible Preferred Stock, Series 1990 Convertible Preferred Stock and Series 1991 Convertible Preferred Stock (herein collectively called the \"Preferred Stock\") at a redemption price of $104 per share plus all accrued and unpaid dividends through the date fixed for redemption. The Preferred Stock was convertible into 13.2 shares of Common Stock for each share of Preferred Stock held.\nEffective April 22, 1994, 356 shares of Preferred Stock were redeemed and 74,172 shares of Preferred Stock were converted into 979,009 shares of Common Stock.\nThe risk-based capital standards as established by the FRB apply to Texas Regional and Texas State Bank. The numerator of the risk-based capital ratio for bank holding companies includes Tier I capital, consisting of common shareholders' equity and qualifying cumulative and noncumulative perpetual preferred stock; and Tier II capital, consisting of other preferred stock, reserve for possible loan losses and certain subordinated and term-debt securities. Beginning on December 31, 1993, goodwill is deducted from Tier I capital. At no time is Tier II capital allowed to exceed Tier I capital in the calculation of total capital. The denominator or asset portion of the risk-based capital ratio aggregates generic classes of balance sheet and off-balance sheet exposures, each weighted by one of four factors, ranging from 0% to 100%, based on the relative risk of the exposure class.\nRatio targets are set for both Tier I and total capital (Tier I plus Tier II capital). The minimum level of Tier I capital to total assets is 4.0% and the minimum total capital ratio is 8.0%. The FRB has guidelines for a leverage ratio that is designed as an additional evaluation of capital adequacy of banks and bank holding companies. The leverage ratio is defined to be the company's Tier I capital divided by its risk-adjusted total assets. An insured depository institution is \"well capitalized\" for purposes of the FDICIA if its Total Risk-Based Capital Ratio is equal to or greater than 10.0%, and Tier I Risk-Based Capital Ratio is equal to or greater than 6.0%, and Tier I Leverage Capital Ratio is equal to or greater than 5.0%. The Company's Tier I Risk-Based Capital Ratio was approximately 11.70% and 14.71% at December 31, 1995 and 1994, respectively. The Company's Total Risk-Based Capital Ratio was approximately 12.64% and 15.67% at December 31, 1995 and 1994, respectively. The Company's Tier I Leverage Capital Ratio was 8.96% and 10.37%, at December 31, 1995 and 1994, respectively. Based on capital ratios, the Company is within the definition of \"well capitalized\" for FRB purposes at December 31, 1995.\nThe following table presents the Company's risk-based capital calculation:\nCURRENT ACCOUNTING ISSUES\nEffective January 1, 1995, the Company adopted Statement 114 and the amendment thereof, Statement 118. Under Statement 114, a loan is considered impaired when, based upon 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. Statement 114 requires that an impaired loan be valued utilizing (i) the present value of expected future cash flows discounted at the effective interest rate of the loan, (ii) the fair value of the underlying collateral, or (iii) the observable market price of the loan. Statement 118 amended Statement 114 by expanding the related disclosure requirements and permitting use of existing methods for recognizing interest income on impaired loans.\nLoans which were restructured prior to the adoption of Statement 114 and which are performing in accordance with the renegotiated terms are not required to be reported as impaired. Loans restructured subsequent to the adoption of Statement 114 are required to be reported as impaired in the year of restructuring. Thereafter, such loans can be removed from the impaired loan disclosure if the loans were paying a market rate of interest at the time of restructuring and are performing in accordance with their renegotiated terms.\nFor loans covered by Statement 114, the Company makes an assessment for impairment when and while such loans are on nonaccrual status or when the loan has been restructured. When a loan with unique risk characteristics has been identified as being impaired, the amount of impairment will be measured by the Company using discounted cash flows, except when it is determined that the sole (remaining) source of repayment for the loan is the operation or liquidation of the underlying collateral. In such case, the current fair value of the collateral, reduced by costs to sell, will be used in place of discounted cash flows. At the time a loan is placed on nonaccrual status, interest previously recognized but uncollected is reversed and charged against current income. Subsequent interest payments received on nonaccrual loans are either applied against principal or reported as income, depending upon management's assessment of the ultimate collectability of principal.\nIn management's opinion, the adoption of Statement 114 and Statement 118 did not have a material effect on the Company's results of operations.\nIn October 1995, FASB issued Statement of Financial Accounting Standards No. 123 (\"Statement 123\"), \"Accounting for Stock-Based Compensation\". Statement 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. Statement 123 encourages entities to adopt a \"fair value\" based method of accounting for stock-based compensation plans which requires an estimate of the fair value of stock options or other equity instruments to which employees become entitled when they have rendered requisite service or satisfied other conditions necessary to earn the right to benefit from the instruments. Compensation cost is then determined based on the fair value estimate and is recognized over the service period, which is usually the vesting period. Statement 123 also requires that an employer's financial statements include certain disclosures about stock-based employee compensation arrangements regardless of the method used to account for them.\nThe accounting requirements of Statement 123 are effective for transactions entered into in fiscal years that begin after December 15, 1995. In management's opinion, implementation of Statement 123 should have no material effect on the Company's consolidated financial statements.\nFOURTH QUARTER RESULTS\nThe fourth quarter net income for 1995 of $2.4 million or $0.39 per share reflected an increase of $139,000 or 6.1% compared to $2.3 million or $0.37 per share for the fourth quarter of 1994. Earnings\nperformance for the fourth quarter of 1995 as compared to the fourth quarter of 1994 reflects increases in net interest income, noninterest income and noninterest expense. The following table presents a summary of operations for the last five quarters:\nNet interest income of $7.6 million for the fourth quarter of 1995 increased $1.3 million or 21.4% compared to $6.3 million for the fourth quarter of 1994, reflecting the increased volume of earning assets and net increase in yield for the year ended December 31, 1995. Average earning assets of $574.0 million for the fourth quarter of 1995 increased $104.4 million or 22.2% compared to $469.6 million for the fourth quarter of 1994. The fourth quarter of 1995 interest margin was 5.28% compared to 5.31% for the fourth quarter of 1994 and 5.15% in the third quarter of 1995.\nThe provision for loan losses charged against earnings in the fourth quarter of 1995 was $625,000 compared to $455,000 for the fourth quarter of 1994, reflecting an increase of $170,000 or 37.4%. The provision for loan losses in the fourth quarter of 1995 was primarily attributable to loan growth.\nNoninterest income of $1.7 million for the fourth quarter of 1995 increased $215,000 or 14.2% compared to $1.5 million for the fourth quarter of 1994, primarily due to an increased volume of business and as a result of the RGC\/Roma Branch Acquisitions. All components of noninterest income reflect increases for fourth quarter of 1995 compared to fourth quarter of 1994 except Other Service Charges and Investment Securities Gains (Losses). The decline in Other Service Charges is primarily attributable to a decline in foreign currency exchange fees. Investment Securities Gains (Losses) of ($98,000) for the fourth quarter of 1995 compared to Investment Securities Gains (Losses) of $8,000 for the fourth quarter of 1994.\nNoninterest expense of $5.0 million for the fourth quarter of 1995 increased $1.2 million or 33.0% compared to $3.8 million for the fourth quarter of 1994. The increase in noninterest expense is primarily attributable to Other Losses of $239,000 for the fourth quarter of 1995 reflecting a net increase of $738,000 compared to a net gain of $499,000 for the fourth quarter of 1994. The net gain for the fourth quarter of 1994 was primarily attributable to a benefit of $553,000 from the reversal of a second quarter 1994 accrual. The reversal of the accrual resulted from the settlement of a lawsuit in the last quarter of 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nMANAGEMENT'S REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nTo Our Shareholders\nThe management of Texas Regional Bancshares, Inc. and its subsidiary has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles. The consolidated financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements.\nManagement maintains a comprehensive system of internal control to assure the proper authorization of transactions, the safeguarding of assets, and the reliability of the financial records. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. The Company maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. Management believes that as of December 31, 1995, the Company maintains an effective system of internal control.\nThe Audit Committee of the Board of Directors reviews the systems of internal control and financial reporting. The Committee meets and consults regularly with management, the internal auditors and the independent accountants to review the scope and results of their work.\nThe accounting firm of KPMG Peat Marwick LLP has performed an independent audit of the Company's consolidated financial statements. Management has made available to KPMG Peat Marwick LLP all of 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 KPMG Peat Marwick LLP during its audit were valid and appropriate. the firms's report appears below.\n\/s\/ G.E. RONEY - --------------------------- Glen E. Roney Chairman of the Board, President & Chief Executive Officer\n\/S\/ GEORGE R. CARRUTHERS - --------------------------- \/s\/ George R. Carruthers Executive Vice President & Chief Financial Officer\nJanuary 26, 1996\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors Texas Regional Bancshares, Inc.\nWe have audited the accompanying consolidated balance sheets of Texas Regional Bancshares, Inc. and subsidiary as of December 31, 1995 and 1994, 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 Texas Regional Bancshares, 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.\n\/s\/ KPMG PEAT MARWICK LLP\nHouston, Texas January 26, 1996\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of the consolidated financial statements.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Texas Regional Bancshares, Inc. (the \"Parent\" or \"Corporation\") and subsidiary (collectively, the \"Company\") conform to generally accepted accounting principles and to prevailing 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 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.\nA summary of the more significant accounting policies follows:\nFINANCIAL STATEMENT PRESENTATION\nThe consolidated financial statements include the accounts of Texas Regional Bancshares, Inc. (the \"Corporation\") and its wholly owned subsidiary, Texas State Bank (the \"Bank\"), collectively (the \"Company\"). All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in the subsidiary are accounted for on the equity method in the Parent's financial statements.\nTRUST ASSETS\nAssets held by the trust department of the subsidiary bank in fiduciary or agency capacities are not assets of Texas Regional Bancshares, Inc. or its subsidiary and are not included in the consolidated balance sheets.\nINVESTMENT SECURITIES\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 115 (\"Statement 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" Statement 115 establishes standards of financial accounting and reporting for investments in equity securities that have a readily determinable fair value and for all investments in debt securities. At acquisition, a bank is required to classify debt and equity securities into one of three categories: Held to Maturity, Trading or Available for Sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities are classified as Held to Maturity and measured at amortized cost in the balance sheet only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as Trading and measured at fair value in the balance sheet with unrealized holding gains and losses included in net income. Investments not classified as Held to Maturity nor Trading are classified as Available for Sale and measured at fair value in the balance sheet with unrealized holding gains and losses reported in a separate component of shareholders' equity until realized.\nEffective December 31, 1993, the Company adopted Statement 115, which caused various investment securities to be reclassified from Held to Maturity to Available for Sale. All treasury and agency bonds with a maturity of two years or less from December 31, 1993, all floating rate bonds and two small equity securities were reclassified to Available for Sale. As a result, at December 31, 1993 the Company recorded an increase in shareholders' equity of $179,000, as unrealized holding gains. Future purchases of investment securities will be classified as Available for Sale or Held to Maturity at time of purchase as determined by the investment committee. At December 31, 1995 and 1994 no securities were classified as Trading.\nOn October 18, 1995, the FASB decided to grant to all entities a one-time opportunity during the period from approximately mid November to December 31, 1995, to reconsider their intent and ability to hold securities accounted for as Held to Maturity under Statement 115. This allowed entities to transfer\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) securities from the Held to Maturity category to Available for Sale or trading without calling into question their intent to hold other debt securities to maturity. On December 31, 1995, the Bank transferred approximately $1.5 million in Held to Maturity securities to the Available for Sale category resulting in no change to stock equity per share. As a result of this transfer, all other securities are classified as Available for Sale.\nLOANS\nLoans are stated at the principal amount outstanding, net of unearned discount. Interest income on discounted loans is recognized on the sum-of-the-months-digits method which approximates the interest method, while interest income on other loans is calculated using applicable interest rates and the daily amount of outstanding principal.\nLOAN FEES\nLoan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the loan yields.\nNONPERFORMING ASSETS\nNonperforming assets are comprised of (a) loans for which the accrual of interest has been discontinued, (b) loans for which the interest rate has been reduced to less than originally contracted rates due to a serious weakening in the borrower's financial condition and (c) other assets which consist of real estate and other property which have been acquired in lieu of loan balances due and which are awaiting disposition.\nA loan is generally placed on nonaccrual status when principal or interest is past due 90 days or more, and the loan is not both well-secured and in the process of collection. A loan is also placed on nonaccrual status immediately if, in the opinion of management, full collection of principal or interest is unlikely. At the time a loan is placed on nonaccrual status, interest previously recognized but uncollected is reversed and charged against current income. Subsequent interest payments received on nonaccrual loans are either applied against principal or reported as income, depending upon management's assessment of the ultimate collectibility of principal.\nReal estate and other assets acquired in lieu of loan balances due are recorded at the lesser of cost basis or estimated fair value less estimated closing costs. Valuation losses are charged to the allowance for loan losses on foreclosure. Write-downs of real estate and other assets are charged to noninterest expense if the estimated fair value subsequently declines below its carrying value. Realized gains and losses on sales of other real estate are included in noninterest expense.\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 (\"Statement 114\"), \"Accounting by Creditors for Impairment of a Loan\" and the amendment thereof, Statement of Financial Accounting Standards No. 118 (\"Statement 118\"), \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". Under Statement 114, a loan is considered impaired when, based upon 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. Statement 114 requires that an impaired loan be valued utilizing (i) the present value of expected future cash flows discounted at the effective interest rate of the loan, (ii) the fair value of the underlying collateral, or (iii) the observable market price of the loan. Statement 118 amended Statement 114 by expanding the related disclosure requirements and permitting use of existing methods for recognizing interest income on impaired loans.\nLoans which were restructured prior to the adoption of Statement 114 and which are performing in accordance with the renegotiated terms are not required to be reported as impaired. Loans restructured\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) subsequent to the adoption of Statement 114 are required to be reported as impaired in the year of restructuring. Thereafter, such loans can be removed from the impaired loan disclosure if the loans were paying a market rate of interest at the time of restructuring and are performing in accordance with their renegotiated terms.\nFor loans covered by this statement, the Company makes an assessment for impairment when and while such loans are on nonaccrual or when the loan has been restructured. When a loan with unique risk characteristics has been identified as being impaired, the amount of impairment will be measured by the Company using discounted cash flows, except when it is determined that the sole (remaining) source of repayment for the loan is the operation or liquidation of the underlying collateral. In such case, the current fair value of the collateral, reduced by costs to sell, will be used in place of discounted cash flows. At the time a loan is placed on nonaccrual status, interest previously recognized but uncollected is reversed and charged against current income. Subsequent interest payments received on nonaccrual loans are either applied against principal or reported as income, depending upon management's assessment of the ultimate collectibility of principal.\nThe adoption of Statement 114 and Statement 118 did not have a material effect on the Company's financial position or results of operations.\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is established by a charge to operations (provision for loan losses). Actual loan losses or recoveries are charged or credited directly to this allowance. The provision for loan losses is based on management's estimate of the amount required to maintain an allowance adequate to absorb potential losses in the loan portfolio. While management uses available information to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary.\nPREMISES AND EQUIPMENT\nPremises and equipment are stated at cost, net of accumulated depreciation. Depreciable assets are depreciated over their estimated useful lives. For financial reporting, depreciation is computed using the straight-line method; in computing federal income tax, both the straight-line and accelerated methods are used. Maintenance and repairs which do not extend the life of premises and equipment are charged to noninterest expense.\nINCOME TAX\nThe Company files a consolidated federal income tax return. The Company establishes a deferred tax asset or liability for the recognition of future deductions or taxable amounts and operating loss and tax credit carry-forwards. Deferred tax expense or benefit is recognized as a result of the change in the asset or liability during the year.\nEARNINGS PER SHARE COMPUTATIONS\nPrimary earnings per share are computed by dividing net income less preferred stock dividends, if any, by the weighted average number of common stock and common stock equivalents outstanding during the period, retroactively adjusted for stock splits effected as a stock dividend. The convertible preferred stock did not satisfy the criteria for consideration as common stock equivalents.\nFully diluted earnings per share is computed as if all convertible preferred stock had been converted to common stock.\nCASH FLOWS\nFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) RESERVE REQUIREMENTS Cash of approximately $16.2 million and $14.6 million at December 31, 1995 and 1994, respectively, was maintained to satisfy regulatory reserve requirements.\n(3) INVESTMENT SECURITIES The amortized cost and estimated market value of investments in Securities Available for Sale at December 31, 1995 and December 31, 1994 follows:\nSECURITIES AVAILABLE FOR SALE\nSECURITIES AVAILABLE FOR SALE\nThe amortized cost and estimated market value of investments in Securities Held to Maturity at December 31, 1995 and December 31, 1994 follows:\nSECURITIES HELD TO MATURITY\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(3) INVESTMENT SECURITIES (CONTINUED) SECURITIES HELD TO MATURITY\nThe amortized cost and estimated market 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.\nProceeds from sales of Securities Available for Sale for the year ended December 31, 1995 were $12.6 million. Gross losses of $111,000 and no gross gains were realized on sales for the year ended December 31, 1995. Proceeds from sales of Securities Available for Sale for the year ended December 31, 1994 were $12.4 million. Cost was determined on a specific identification basis for determining realized gain or loss.\nNet unrealized holding gain of $117,000 and net unrealized holding loss of $587,000 at December 31, 1995 and 1994, respectively, on Securities Available for Sale are included as a separate component of shareholders' equity for each respective year.\nThere were no sales from the Held to Maturity category in 1995 and 1994.\nInvestment securities having a carrying value of $99.6 million at December 31, 1995 and $99.8 million at December 31, 1994 are pledged to secure public funds and trust assets on deposit and for other purposes required or permitted by law.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES An analysis of loans at December 31, 1995 and December 31, 1994 follows:\nIn the ordinary course of business, the Company's subsidiary bank made loans to its officers and directors, including entities related to those individuals. These loans are made on substantially the same terms and conditions as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectibility or present other unfavorable features. An analysis of these loans for the years ended December 31, 1995 and December 31, 1994 follows:\nA summary of the transactions in the allowance for loan losses for years ended December 31, 1995, 1994 and 1993 follows:\nNonaccrual loans and renegotiated loans were $2.1 million, $2.4 million and $2.4 million at December 31, 1995, 1994 and 1993, respectively. If interest on these nonaccrual and renegotiated loans had been accrued at the original contractual rates, interest income would have been increased by approximately $247,000, $476,000 and $149,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) At December 31, 1995, the Company had a $2.0 million recorded investment in impaired loans for which there was a related allowance for loan losses of $172,000. At December 31, 1995, there were no impaired loans for which there was no related allowance for loan losses. The average level of impaired loans during the year ended December 31, 1995 was $1.9 million. The Company recorded interest income of $91,000 on its impaired loans during the year ended December 31, 1995.\n(5) PREMISES AND EQUIPMENT A summary of premises and equipment and related accumulated depreciation and amortization as of December 31, 1995 and December 31, 1994 follows:\nDepreciation and amortization expense for the years ended December 31, 1995, 1994 and 1993 was approximately $1.6 million, $1.3 million and $1.1 million, respectively.\n(6) TIME DEPOSITS Time deposits of $100,000 or more totaled $126.4 million and $91.1 million at December 31, 1995 and 1994, respectively. Interest expense for the years ended December 31, 1995, 1994 and 1993 on time deposits of $100,000 or more was approximately $5.7 million, $3.5 million and $2.8 million, respectively.\n(7) FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS The following table summarizes selected information regarding federal funds purchased and securities sold under repurchase agreements as of and for the years ended December 31, 1995, 1994 and 1993:\nSecurities sold under agreements to repurchase are comprised of customer deposit agreements with maturities ranging from overnight to six months. These obligations are not federally insured but are collateralized by a security interest in various investment securities. These pledged securities are segregated and maintained by a third party bank.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(8) INCOME TAX The components of income tax expense for the years ended December 31, 1995, 1994 and 1993 consisted of the following:\nFollowing is a reconciliation between the amount of reported income tax expense for the years ended December 31, 1995, 1994 and 1993 and the amount computed by multiplying the income before tax by the federal statutory tax rate:\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (\"Statement 109\"), \"Accounting for Income Taxes\", which requires establishment of deferred tax liabilities and assets, as appropriate, for the recognition of future deductions or taxable amounts caused when the tax basis of an asset or liability differs from that reported in the financial statements. The cumulative effect of the accounting change on years prior to January 1, 1993, of $32,000 is included for the year ended December 31, 1993 as an increase to income.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(8) INCOME TAX (CONTINUED) The net deferred tax liability included with accounts payable and accrued expenses in the accompanying consolidated balance sheets is comprised of the following deferred tax assets and liabilities as of December 31, 1995 and December 31, 1994.\nFor the years ended December 31, 1995 and December 31, 1994, the deferred tax liability results primarily from the use of accelerated methods of depreciation of equipment for tax purposes and the write-off of core deposits for book purposes. The deferred tax asset results from differences in the bad debts written-off for financial purposes and the amount allowed under tax law, and a difference in other real estate basis due to write-downs for financial statement purposes for both years ended December 31, 1995 and 1994, respectively.\nThe valuation allowance was established to reduce the amount that will more likely than not be realized due to increased recoveries in allowance for loan losses.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(9) PREFERRED STOCK The Corporation has 10,000,000 authorized shares of $1 par value Preferred Stock. The Articles of Incorporation of the Corporation grant discretion to the Board of Directors to establish series of Preferred Stock with such rights, preferences and limitations as may be determined by resolution of the Board. Series of Preferred Stock outstanding at December 31, 1995, 1994 and 1993 were as follows:\nThe Corporation's First Series Convertible Preferred Stock and Series 1990 Convertible Preferred Stock were issued in 1989 and 1990, respectively, for cash equal to the stated value of $100.00 per share. The Series 1991 Convertible Preferred Stock was issued in 1991 in connection with the Company's acquisition of Mid Valley Bank of Weslaco, Texas. The shares of First Series, Series 1990 and Series 1991 Preferred Stock ranked on a parity with each other, and superior to the Class A Voting Common Stock of the Corporation, as to dividends and liquidation preference. Shares of each series of Preferred Stock were convertible into shares of Class A Voting Common Stock of the Corporation.\nOn March 21, 1994, the Board of Directors adopted a resolution calling for the redemption on April 22, 1994, of all issued and outstanding Preferred Stock at a redemption price of $104.00 per share plus all accrued and unpaid dividends through the date fixed for redemption. At that time, the Preferred Stock was convertible into 13.2 shares of Class A Voting Common Stock for each share of Preferred Stock held. Effective April 22, 1994, 356 shares of Preferred Stock were redeemed for cash and 74,172 shares of Preferred Stock were converted into 979,009 shares of Class A Voting Common Stock. As a result, as of December 31, 1994, there were no shares of Preferred Stock outstanding.\nPursuant to the Texas Business Corporation Act, the Board of Directors of the Corporation has the authority to eliminate any series of shares which the Board has authority to establish, if there are no shares outstanding or held as treasury shares. Upon adoption of a resolution eliminating the series and all references to the series, the shares resume status as authorized but unissued shares of Preferred Stock for which the Board has the authority to determine the designations, preferences, limitations and relative rights.\nOn February 14, 1995, the Board of Directors of the Corporation approved a resolution to eliminate the series of shares known as the First Series Convertible Preferred, the Series 1990 Convertible Preferred and the Series 1991 Convertible Preferred shares of the Corporation, and further provided for the elimination of all references thereto from the Articles of Incorporation. As a result of the elimination of the series of Preferred shares, the shares resume status as authorized but unissued shares of Preferred Stock for which the Board has the authority to determine the designations, preferences, limitations and relative rights.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\n(10) COMMON STOCK On March 16, 1994, the Corporation completed a public offering of 1.2 million shares of the Corporation's Class A Voting Common Stock at an offering price of $12.00 per share, and contemporaneously listed the Common Stock for trading in the NASDAQ Stock Market's National Market System under the trading symbol \"TRBS.\" In the offering, the Corporation sold one million newly issued shares and an aggregate of 200,000 shares were sold on behalf of certain selling shareholders of the Corporation. As a part of the offering, the Corporation granted the Underwriters an option, exercisable within 30 days following the date of the Underwriting Agreement, to purchase up to 180,000 additional shares of Corporation Class A Voting Common Stock solely to cover over-allotments. On April 15, 1994, the Underwriters exercised this option and purchased 28,291 additional shares of Class A Voting Common Stock.\nOn May 11, 1993, the Board of Directors approved a 20% stock split effected as a stock dividend to Class A Voting Common Stock shareholders of record on May 11, 1993, with any fractional shares resulting from such stock split to be paid in cash based on a value of $10.00 per share.\n(11) EMPLOYEE BENEFITS In 1984, the Company adopted a target benefit pension plan covering substantially all of their employees. In December, 1990, the Company restated its target benefit pension plan as an Employee Stock Ownership Plan (with section 401(k) provisions) (the \"KSOP\"). The Company received a favorable determination letter on July 29, 1993, in which the Internal Revenue Service stated that the plan, as designed, was in compliance with the applicable requirements of the Internal Revenue Code. Employer contributions to the KSOP are discretionary, and as such, determined at the sole discretion of the Board of Directors. The KSOP covers employees who have completed twelve consecutive months of credited service, as defined in the plan, and attained age 21. A participant's account balance will be fully vested after six years of credited service. The purpose of the restatement is to permit employees to acquire an equity interest in the Company through the KSOP's purchase of common stock. Pension expense, which includes Employer matching as discussed below, for the years ended December 31, 1995, 1994 and 1993 was $526,000, $462,000, and $570,000, respectively.\nA Participant of the KSOP may authorize the Company to contribute to the Trust on his behalf Salary Reduction Contributions. Such Salary Reduction Contributions shall be stated as a whole percentage and shall not be less than 1% or more than 15% of the Participant's compensation. The total amount of Salary Reduction Contributions for any Plan Year shall not exceed $7,000, multiplied by any cost of living adjustment factor prescribed by the Secretary of the Treasury under Section 415(d) of the Code. Such contributions are matched at the discretion of the Board of Directors up to a maximum of 100% of the Participant's Salary Reduction Contribution and shall be based on a Participant's Salary Reduction Contribution of up to 4% of such Participant's compensation. The Participant's and Employer matching contributions are vested immediately.\nIn March 1986, the shareholders of the Company approved three separate stock plans involving the Class A Voting Common Stock, providing for the issuance of up to 253,434 shares to certain key employees for their purchase and 10,000 shares as part of a bonus plan for employees of the Company. One option plan provides for sale of up to 126,717 shares to the chief executive officer at a price to be determined by a committee of directors on the date of grant; another provides for sale of up to 126,717 shares at fair market value at the date the options are granted to key employees of the Company, excluding the chief executive officer. The third plan provides for up to 10,000 shares to be distributed as employee bonuses without payment of consideration by the employees. The third plan was terminated effective January 9, 1996.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(11) EMPLOYEE BENEFITS (CONTINUED) On May 10, 1994, options to acquire up to 126,717 Class A Voting Common shares at $12.00 per share were granted to Glen E. Roney, Chief Executive Officer and a member of the Board of Directors of Texas Regional, pursuant to the Texas Regional Bancshares, Inc. 1985 Non-Statutory Stock Option Plan exercisable commencing May 10, 1995. In addition, options to acquire up to 49,433 Class A Voting Common shares at $12.00 per share were granted to certain key employees of the Company pursuant to the Texas Regional Bancshares, Inc. Incentive Stock Option Plan exercisable commencing May 10, 1995 including options to acquire 8,333 shares granted to Glen E. Roney. The Incentive Stock Option Plan expired in September 1995. Any options outstanding under this Plan, at the time of its termination, remain in effect until the options shall have been exercised or the expiration date of the option, whichever is earlier. Options to acquire 52,595 Class A Voting Common Stock were awarded May 10, 1994, and expire on May 10, 2000. During 1995, options to acquire 3,162 Class A Voting Common Stock were exercised at a price of $12.00 per share.\nEffective December 12, 1995, the Company adopted the 1995 Nonstatutory Stock Option Plan of Texas Regional Bancshares, Inc. (the \"Plan\"), which provides for granting to key employees of the Company options to acquire up to an aggregate maximum of 90,000 shares of the Class A Voting Common Stock of the Corporation, subject to adjustment for stock dividends, stock splits and upon the occurrence of other events as specified in the Plan. The Board of Directors has recommended the Plan to the shareholders of the Corporation and has authorized and directed the officers of the Corporation to submit the Plan to the shareholders for approval at the next regular or special meeting of the shareholders of the Corporation. In addition, options to acquire up to 90,000 Class A Voting Common shares at $17.25 per share were granted to certain key employees of the Company pursuant to the Plan including options to acquire 65,000 shares granted to Glen E. Roney. Options to purchase one-fourth of the shares as granted shall be exercisable commencing on the later of July 1, 1996, or the date of approval of the Plan by the shareholders of the Corporation, and (provided that the Plan has received the approval of the shareholders of the Corporation) options to purchase an additional one-fourth of the shares as granted pursuant to these resolutions shall be exercisable beginning July 1 of each year thereafter, and in each case options to purchase shares granted pursuant to these resolutions shall thereafter be exercisable at any time prior to July 1, 2002, subject to other provisions applicable to such options as specified in the Plan.\nThe following is a summary of option transactions for the years ended December 31, 1995, 1994 and 1993.\nEffective as of December 14, 1993, the Company adopted a Deferred Compensation Plan for the benefit of Glen E. Roney. The Deferred Compensation Plan provides for a retirement benefit payable to Mr. Roney (or his designated beneficiary or his estate if Mr. Roney dies prior to payment of the full amount of deferred compensation) of $100,000 per year commencing October 29, 2002, and continuing annually thereafter for fourteen years. If Mr. Roney dies prior to commencement of the retirement benefit, payments would commence immediately and be paid to his designated beneficiary or his estate. The Company also adopted the Trust Under Glen E. Roney Deferred Compensation Plan, in the form prescribed by applicable regulations adopted by the Internal Revenue Service for nonqualified deferred compensation plans. Among other things, the Plan and Trust provide for an initial deposit into the Trust by the Company and subsequent deposits in the discretion of the Board of Directors, and further provide for full funding of the amount necessary to discharge the retirement benefit in the event of a change of control, as that term is defined in the Trust. The Company has incurred Deferred Compensation expense and has funded into the Trust $87,000, $87,000 and $116,000 respectively, for the years ended December 31, 1995, 1994 and 1993, respectively.\n(12) COMMITMENTS AND CONTINGENCIES In the normal course of business, the Company enters into various transactions which, in accordance with generally accepted accounting principles, are not included on the consolidated balance\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(12) COMMITMENTS AND CONTINGENCIES (CONTINUED) sheets. These transactions are referred to as \"off-balance sheet commitments.\" The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and letters of credit which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The Company attempts to minimize its exposure to loss under these commitments by subjecting them to the same credit approval and monitoring procedures as its other credit facilities.\nThe Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Company's commitments to extend credit are contingent on customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for possible loan losses.\nLetters of credit are written for conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company's policies generally require that letters of credit arrangements contain security and debt covenants similar to those contained in loan agreements.\nAt December 31, 1995, the Company had outstanding commitments to extend credit of approximately $79.0 million which included standby letters of credit of approximately $2.6 million. Management does not anticipate any losses as a result of these commitments.\nFuture minimum lease payments on operating leases as of December 31, 1995 are as follows:\nThe Company is a defendant in various legal proceedings arising in connection with its ordinary course of business. In the opinion of management, the financial position of the Company will not be materially affected by the final outcome of these legal proceedings.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(13) OTHER NONINTEREST EXPENSE Other noninterest expense for the years ended December 31, 1995, 1994 and 1993 consisted of the following:\n(14) TEXAS REGIONAL BANCSHARES, INC. (PARENT ONLY) CONDENSED FINANCIAL STATEMENTS\nCONDENSED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(14) TEXAS REGIONAL BANCSHARES, INC. (PARENT ONLY) CONDENSED FINANCIAL STATEMENTS (CONTINUED) CONDENSED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(14) TEXAS REGIONAL BANCSHARES, INC. (PARENT ONLY) CONDENSED FINANCIAL STATEMENTS (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe amount of retained earnings in the Bank at December 31, 1995 was $12.0 million. On December 31, 1995, the aggregate amount of dividends which legally could be paid to the Corporation without prior approval of various regulatory agencies was approximately $8.7 million.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(15) FAIR VALUE OF FINANCIAL INSTRUMENTS\nDISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107 (\"Statement 107\"), \"Disclosures about Fair Value Instruments\", requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments.\nDEBT SECURITIES\nFor securities held as investments, fair market value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for a similar security.\nInvestments not classified as Held to Maturity or Trading are classified as Available for Sale and measured at fair value in the consolidated balance sheets with unrealized holding gains and losses reported as a separate component of shareholders' equity until realized.\nThe following table presents the amortized cost and estimated fair value of securities classified as Available for Sale at December 31, 1995:\nThe following table presents the carrying value and estimated fair value of securities classified as Held to Maturity at December 31, 1995:\nLOANS\nThe Company does not consider its loan portfolio to have the homogeneous categories of loans for which the fair value could be estimated by using quoted market prices for securities backed by similar loans. Therefore, the fair value of all loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(15) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The following table presents information for loans at or for the year ended December 31, 1995:\nDEPOSIT LIABILITIES\nThe 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 certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The following table presents the carrying value and estimated fair value of deposit liabilities at December 31, 1995:\nThe fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The Company has not attempted to determine the amount of increase in net assets that would result from the benefit of considering the low-cost funding provided by deposit liabilities.\nCOMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES WRITTEN\nThese financial instruments are not sold or traded, and estimated fair values are not readily available. The carrying amount of commitments to extend credit and standby letters of credit is the net unamortized deferred cost or income arising from these unrecognized financial instruments. The estimated fair value of these commitments is considered to be the carrying value. Financial guarantees written consist of obligations for credit cards issued to certain customers. Substantially all of the liability for financial guarantees written is collateralized by deposits pledged to the Company.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(15) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The following table presents the contract amount, carrying amount and estimated fair value for commitments to extend credit, standby letters of credit and financial guarantees written at December 31, 1995:\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 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. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nFair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has a substantial trust department that contributes net fee income annually. The trust department is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include the deferred tax liabilities, property, plant, equipment and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.\n(16) ACQUISITION ACTIVITY On January 10, 1996, the Company announced definitive agreements have been signed under which Texas State Bank, the principal operating subsidiary of the Corporation, will acquire through merger the First State Bank & Trust Co., Mission, Texas, and The Border Bank, Hidalgo, Texas (the \"Mergers\"). The definitive agreements have been approved by the appropriate Boards of Directors of the Corporation, Texas State Bank, First State Bank & Trust Co. and The Border Bank. Under the terms of the definitive agreements, Texas State Bank will acquire First State Bank & Trust Co. for a total cash consideration of $79.0 million and will acquire The Border Bank for a total cash consideration of $20.5 million.\nThe following pro forma combined condensed balance sheet was based on the assumption that the acquisition had been consummated on December 31, 1995. The Mergers will be accounted for using the purchase method of accounting.\nThe Mergers are subject to completion of satisfactory due diligence by the Corporation and must be approved by the shareholders of First State Bank & Trust Co. and The Border Bank. The Mergers must also be approved by the appropriate regulators. Closing is also contingent upon the Corporation having successfully raised $40.0 million of additional capital to partially fund these transactions on terms and conditions acceptable to the Corporation.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(16) ACQUISITION ACTIVITY (CONTINUED) During August 1995, the Bank acquired two branch bank locations, one in Rio Grande City, Texas, and the other in Roma, Texas (the \"RGC\/Roma Branch Acquisitions\"). The transaction included the purchase of $43.7 million in loans and the assumption of approximately $79.7 million in deposit liabilities of these branches. Investment securities were not acquired. Purchase accounting adjustments for the purchase of loans and the assumption of deposit liabilities of the RGC\/Roma Branch Acquisitions were immaterial. This transaction was accounted for as a purchase.\nThe Company's consolidated balance sheets at December 31, 1995 reflected the assets and liabilities of the RGC\/Roma Branch Acquisitions. The results of operations of the RGC\/Roma Branch Acquisitions were included in the Company's consolidated financial statements of income from the date of acquisition.\nThe following unaudited pro forma combined condensed statements of income for the years ended December 31, 1995 and 1994, assume the Mergers and the RGC\/Roma Branch Acquisitions occurred January 1, 1994. Intangibles arising from the Mergers and RGC\/Roma Branch Acquisitions are approximately $21.6 million and $4.1 million, respectively. The pro forma adjustments reflect the amortization of the core deposit premium over a 10-year period, the fixed maturity deposit premium over a 3-year period and the goodwill intangible over a 15-year period. The pro forma results do not necessarily represent the actual results that would have occurred and should not be considered indicative of future results of operations.\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(16) ACQUISITION ACTIVITY (CONTINUED) PRO FORMA COMBINED CONDENSED BALANCE SHEET\nDECEMBER 31, 1995 (UNAUDITED)\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(16) ACQUISITION ACTIVITY (CONTINUED) PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME\nFOR THE YEAR ENDED DECEMBER 31, 1995 (UNAUDITED)\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(16) ACQUISITION ACTIVITY (CONTINUED) PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME\nFOR THE YEAR ENDED DECEMBER 31, 1994 (UNAUDITED)\nTEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(16) ACQUISITION ACTIVITY (CONTINUED) The unaudited pro forma combined condensed balance sheet combines the three entities at December 31, 1995. In combining the entities, the following adjustments were made:\n(A) To record the estimated proceeds of the $42.5 million net capital raised through the offering based on an assumed sale by Texas Regional of 2,180,000 shares of Class A Voting Common Stock at a price of $21.00 per share, the closing price as of February 20, 1996 net of underwriting discounts, commissions and other estimated offering expenses.\n(B) To record the elimination of an intercompany demand deposit account.\n(C) To adjust securities purchased to fair value at December 31, 1995.\n(D) To record estimated $7.0 million increase in fair value of fixed assets.\n(E) To record estimated deferred federal income tax on the net fair value increases.\n(F) To record the payment of $99.5 million to the First State Bank and Border Bank shareholders or 100% of their outstanding stock, elimination of all the First State Bank and Border Bank equity accounts and the recording of goodwill.\n(G) To adjust loan carrying value to estimated fair value.\n(H) To record estimated fair value of core deposits.\n(I) To record estimated fair value of fixed maturity deposit premium.\n(J) To reclassify deferred federal income taxes.\nThe unaudited pro forma combined condensed statements of income combine the three entities for the years ended December 31, 1995 and 1994. In combining the entities, the following adjustments were made:\n(K) To record a reduction in interest income on the $57.0 million net purchase price ($99.5 million less $42.5 million) of the Mergers and $4.25 million purchase price of the RGC\/Roma Branch Acquisitions at the Company's average federal funds rate of 5.92% and 4.52% for the years ended December 31, 1995 and 1994, respectively and the tax effect of the prior two transactions using an effective tax rate of 34%.\n(L) To amortize the fixed maturity deposit premium.\n(M) To record depreciation on fair market value increases of depreciable fixed assets acquired in the Mergers.\n(N) To record amortization of the goodwill and core deposit premium recorded in connection with the Mergers and the RGC\/Roma Branch Acquisitions.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no disagreements with accountants on accounting or financial disclosure matters within the twenty-four months prior to December 31, 1995.\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 is set forth in Texas Regional's Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 1996 in the sections entitled \"Election of Directors\" and \"Executive Officers\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information concerning the compensation of the executive officers of the Company is set forth in Texas Regional's's Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 1996 in the section entitled \"Executive Compensation\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOwnership of the Company's common stock by certain beneficial owners and by management is set forth in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 1996 in the section entitled \"Stock Ownership of Management and Others\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information concerning transactions between management and others and the Company is set forth in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 1996 in the section entitled \"Transactions with Management and Others\".\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) The following consolidated financial statements of the registrant and its subsidiaries, are included herein: Independent Auditors' Report 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 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, 1994 and 1993\n(2) Financial Statement Schedules are omitted because the required information is not applicable.\n(3) Exhibits\n2.1 Agreement and Plan of Reorganization by and between Texas State Bank, McAllen, Texas, First State Bank & Trust Co., Mission, Texas (\"First State Bank\"), Texas Regional Bancshares, Inc., and certain shareholders of First State Bank, dated as of January 9, 1996 (incorporated by reference from Form 8-K, Commission File No. 0-14517).\n2.2 Agreement and Plan of Reorganization by and between Texas State Bank, McAllen, Texas, The Border Bank, Hidalgo, Texas (\"Border Bank\"), Texas Regional Bancshares, Inc., and certain shareholders of Border Bank, dated as of January 9, 1996 (incorporated by reference from Form 8-K, Commission File No. 0-14517).\n3.1 Articles of Incorporation of Texas Regional Bancshares, Inc. (incorporated by reference from Form 10, Commission File No. 0- 14517).\n3.2 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed December 28, 1983 (incorporated by reference from Form 10, Commission File No. 0-14517).\n3.3 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed June 25, 1986 (incorporated by reference from Form S-1, Commission File No. 33-28340).\n3.4 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed April 4, 1988 (incorporated by reference from Form S-1, Commission File No. 33-28340).\n3.5 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed April 12, 1991 (incorporated by reference from Form 10-K, Commission File No. 0-14517).\n3.6 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed March 2, 1992 (incorporated by reference from Form 10-K, Commission File No. 0-14517).\n3.7 Resolution Eliminating from the Articles of Incorporation certain preferred series of shares of Texas Regional Bancshares, Inc., filed February 21, 1995 (incorporated by reference from 1994 Form 10-K, Commission File No. 0-14517).\n3.8 Bylaws of Texas Regional Bancshares, Inc., as amended (incorporated by reference from Form S-1, Commission File No. 33-74992).\n4 Relevant portions of Texas Regional Bancshares, Inc. Articles of Incorporation and Bylaws (incorporated by reference as Exhibit 3.1 through 3.8).\n10.1 Incentive Stock Option Plan (incorporated by reference from Form 10, Commission File No. 0-14517).\n10.2 1985 Non-Statutory Stock Option Plan (incorporated by reference from Form 10, Commission File No. 0-14517).\n10.3 1995 Non-Statutory Stock Option Plan (incorporated by reference from Form S-1, Commission File No. 333-1467)\n10.4 Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions) (incorporated by reference from Form S-8, Commission File No. 33-39386).\n10.5 Amendment No. 1 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted July 9, 1991 (incorporated by reference from 1991 Form 10-K, Commission File No. 0-14517).\n10.6 Amendment No. 2 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted May 12, 1992 (incorporated by reference from 1992 Form 10-K, Commission File No. 0-14517).\n10.7 Amendment No. 3 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted September 8, 1992, effective January 1, 1992 (incorporated by reference from Form S-1, Commission File No. 33-74992).\n10.8 Amendment No. 4 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions), adopted August 10, 1993 (incorporated by reference from Form S-1, Commission File No. 33-74992).\n10.9 Amendment No. 5 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions), adopted August 10, 1993 (incorporated by reference from 1994 Form 10-K, Commission File No. 0-14517).\n10.10 Amendment No. 6 to Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provision), adopted as of August 8, 1995 (incorporated by reference from Form S-1, Commission File No. 333-1467).\n10.11 Glen E. Roney Amended and Restated Deferred Compensation Plan dated as of January 9, 1996 (incorporated by reference from Form S-1, Commission File No. 333-1467).\n21 Subsidiaries of the Registrant.\n27 Financial Data Schedule\n(b) Reports on Form 8-K\nA report on Form 8-K and on Amended Form 8-K report were filed by Texas Regional Bancshares, Inc. on January 23, 1996 and March 20, 1996 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.\nTEXAS REGIONAL BANCSHARES, INC. (Registrant)\nBy: \/s\/ G.E. Roney ---------------------------- Glen E. Roney Chairman of the Board, President and Chief Executive Officer\nDate: March 27, 1996\nPursuant to the requirement of the securities exchange Act of 1934, this report has 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\/Morris Atlas Director March 27, 1996 - ------------------------------ Morris Atlas\n\/s\/Frank N. Boggus Director March 27, 1996 - ------------------------------ Frank N. Boggus\n\/s\/George R. Carruthers Executive Vice President - ------------------------------ & Chief Financial Officer March 27, 1996 George R. Carruthers\n\/s\/Robert G. Farris Director March 27, 1996 - ------------------------------ Robert G. Farris\n\/s\/Joe M. Kilgore Director March 27, 1996 - ------------------------------ Joe M. Kilgore\n\/s\/C. Kenneth Landrum,M.D. Director March 27, 1996 - ------------------------------ C. Kenneth Landrum,M.D.\n\/s\/Glen E. Roney Chairman of the Board, - ------------------------------ President, Chief Executive March 27, 1996 Glen E. Roney Officer & Director\n\/s\/Nancy Schultz Senior Vice President & - ------------------------------ Secretary\/Treasurer March 27, 1996 Nancy Schultz\n\/s\/Ann Sefcik Controller & Assistant - ------------------------------ Secretary March 27, 1996 Ann Sefcik\n\/s\/Julie G. Uhlhorn Director March 27, 1996 - ------------------------------ Julie G. Uhlhorn\n\/s\/Paul G. Veale Director March 27, 1996 - ------------------------------ Paul G. Veale\n\/s\/Jack Whetsel Director March 27, 1996 - ------------------------------ Jack Whetsel\nINDEX TO EXHIBITS FILED HEREWITH\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT - ------- ------------\n21 Subsidiaries of the Registrant 27 Financial Data Schedule","section_15":""}
{"filename":"732026_1995.txt","cik":"732026","year":"1995","section_1":"ITEM 1 - BUSINESS - - ----------------- General - - ------- Trio-Tech International (the Company or the Registrant) was incorporated in California in 1958. The Company is a designer, producer and marketer of environmental testing equipment used to test the structural integrity of semiconductor devices that must meet high-reliability specifications and rate of turn test equipment for aerospace, geographical, laboratory and other applications. In addition, the Company owns and operates facilities where a broad range of structural and electronic tests are performed for manufacturers and end-users of merchant and high-reliability semiconductor devices. The Singapore subsidiary also acts as a distributor for certain test equipment made by other manufacturers.\nIn 1976, the Company formed Trio-Tech International Pte Ltd (TTIPte), a wholly owned subsidiary, and it in turn formed Trio-Tech Test Services Pte Ltd (TTTSPte), its wholly owned subsidiary. They autonomously operate in the Republic of Singapore, for the purpose of selling testing equipment and providing testing services to integrated circuit (IC) manufacturers located in Singapore and elsewhere in the Pacific basin. The Singapore facility benefits from moderate labor costs, the absence of currency and tariff restrictions, and the rapid growth of the semiconductor manufacturing industry in Asia and the Pacific basin, including the expansion of manufacturing activities by American industries in Singapore and the Pacific Rim.\nIn August 1984, the Company formed a wholly owned Cayman Islands subsidiary, European Electronic Test Centre (EETC). In July 1985, EETC commenced operating a semiconductor testing facility in Dublin, Ireland. The Company obtained a grant from the Industrial Development Authority (IDA) of the Republic of Ireland to provide 30% of actual expenditures for building modifications and fixed assets up to a maximum of $1,279,000. Grant monies received from the IDA of $120,000 may have to be repaid if certain events occur within one year from June 30, 1995.\nIn 1985, the Company's Singapore subsidiary entered into a joint-venture agreement with a group of Malaysian investors to operate a testing facility in Penang, Malaysia. Under this agreement, the Singapore subsidiary provides the equipment and management for the Penang facility. The operations of this entity are included in the consolidated financial statements. In July of l990, the joint venture opened another testing facility in Kuala Lumpur, Malaysia. This facility is primarily involved in the testing business. In March 1994, this facility started a new operation in Batang Kali, Malaysia. This new operation is set up primarily to handle sub-contract work on optoelectronic assemblies.\nOn September 1, 1988, the Company acquired the Rotating Test Equipment Product Line of Genisco Technology Corporation (Genisco). On November 1, 1990, Trio-Tech acquired Express Test Corporation then of Mountain View, California. The Company paid cash, notes and stock for Express Test. Express Test is a manufacturer of pressurized vessels (autoclaves) designed for humidity stress testing of integrated circuits. Whereas most of Trio-Tech's integrated circuit testing devices are for hermetically sealed ceramic devices, Express Test machines are designed to test plastic sealed devices.\nIn October 1992, the Company's Singapore subsidiary formed a wholly owned subsidiary to provide testing services in Bangkok, Thailand. The Singapore subsidiary provides the equipment and management for this new operation.\nIn October 1993, the Company's Singapore subsidiary entered into a joint-venture agreement with a Chinese Company to operate a crude oil chemical processing business in Wuhan, China. This new business diversification\ninvolves a value added production process in which crude oil is chemically processed, repackaged and distributed to industrial users. Production in the facility commenced in August, 1994.\nIn November 1993, the Company's Singapore subsidiary acquired a 73% equity interest in Prestal Enterprise Sdn Bhd, an investment holding Company which owned a 6% indirect share holding in Trio-Tech Malaysia (TTM). The purpose was to acquire an additional 5% shareholding in TTM.\nThe following table sets forth the percentage of revenues derived from product sales and testing services during the last three fiscal years and the breakdown of revenues derived from customers in the United States, Southeast Asia and Europe. The amounts represented in Product Sales and Service include revenues derived from the test equipment distribution business in Singapore. See Note 14, Business Segment, for a more detailed description.\nBackground Technology - - --------------------- Semiconductors are fundamental building blocks used in electronic equipment and systems. Integrated circuits (IC) consist of silicon \"chips\" of semiconductor material that perform electronic functions, encapsulated in packaging material, usually plastic or ceramic, having lead wires that connect to a printed circuit board. Integrated circuits have become increasingly complex, with greater capacity, versatility and smaller size. The protective packaging, whether ceramic, plastic or some other material, is intended to hold the device in place and protect it against corrosion, oxidization, shock, handling, temperature and other problems that can result in the failure of the device. A minute defect in the packaging can cause a semiconductor device to fail prematurely. The Registrant manufactures test equipment for reliability analysis of both ceramic and plastic encapsulated integrated devices.Hermetically sealed (normally ceramic) packaging is required by military,aerospace, telecommunications and other commercial users for semiconductor devices that must have high reliability and long life. It is also used for hybrid circuits and certain other specialized devices, and for semiconductor devices that are produced in smaller quantities. There have been significant advances in the plastics industry, thereby making plastic sealed devices as reliable as ceramic ones. Plastic is the material of choice in the commercial integrated circuit markets, because polymers are less expensive and easier to process than ceramic materials.\nMany manufacturers and purchasers of high-reliability integrated circuits follow government-defined reliability standards, including rigorous military standard specifications. Military specifications, which are detailed and precise, have brought about considerable standardization of quality assurance programs in the semiconductor industry.\nMilitary and commercial specifications include, among other things, environmental testing, which is aimed at both detecting defective devices and accelerating failure in potentially defective ones. An additional objective of environmental testing is to determine and to evaluate statistically the ultimate reliability and integrity of integrated circuits and to predict their performance and durability under ordinary or adverse conditions. The devices are tested before incorporating them into the finished product. The tests vary according to the use for which the device is intended but usually include visual inspection, stabilization bake, thermal shock temperature cycling, mechanical shock, centrifugal force testing, fine and gross leak testing, burn-in testing and electrical testing.\nProducts - - -------- The Registrant designs and manufactures environmental testing equipment for testing of ceramic and plastic packaged integrated circuits. The Registrant's products are sold both as separate products and as part of an integrated system for environmental testing.\nCentrifuges - - ----------- The Registrant manufactures a line of centrifuges that tests the mechanical integrity of hermetic encased electronic parts. The Registrant's centrifuges are used to identify mechanical weaknesses of devices by spinning them at a specified acceleration, creating a pressure of up to 30,000 g's (900,000 pounds per square inch). This pressure will crack or break packages having certain defects in the hermetic packages. The Registrant also designs the fixtures that are inserted into the centrifuge to hold the semiconductors while they are being tested.\nLeak Testers - - ------------ he Registrant also manufactures systems for leak detection in hermetically packaged semiconductor devices. Certain defects may appear in some tests but not in others, so that thorough testing requires three separate leak procedures using different equipment. The Registrant manufactures a range of equipment and systems designed to detect leaks in hermetic packaging by means of visual scanning for bubble trails emanating from defective devices and radioactive detection for ultra fine leaks.\nRate of Turn Tables - - ------------------- This product line includes centrifuges and rate of turn tables that are used in applications for aerospace, electronics, instrumentation, environmental laboratory, medical and geographical fields. Among the commercial applications of these centrifuges are gravity simulation testing of components, assemblies and systems for aerospace, military hardware (accelerometers, devices, fuses, etc.), biomedical research, geophysical testing, automotive components, fluid removal from sensitive components, gas removal from liquids and other large-scale separation requirements. One prominent example of the product line is the use of the 1100 Centrifuge at the Pittsburgh Eye and Ear Hospital in rotational testing of the vestibule of the inner-ear system that causes dizziness and unsteady eye and body movements when diseased. Typical rate of turn table application is gyroscope calibration and testing, angular accelerometers, turn and bank indicators, inertial platforms and direction sensing equipment.\nBurn-in Equipment and Fixtures - - ------------------------------ Trio-Tech International, Singapore is a leading burn-in system manufacturer in the Pacific Rim. Burn-in equipment is used to subject all types of integrated circuits to sustained heat while testing them electrically in order to identify early product failures (\"infant mortalities\") as well as to assure long-term reliability. Burn-in testing approximates, in a compressed time frame, the electrical and thermal conditions to which the device would be subjected during its normal life.\nThe Singapore operation also offers test fixtures for its Cobis burn-in systems and other brands of burn-in systems. Burn-in boards are used as fixture devices for the purpose of electrically exercising test devices during high temperature environmental stressing.\nPressurized Humidity Testing Equipment - - -------------------------------------- The Registrant manufactures a range of pressurized humidity test equipment and specialized test fixtures which the company continues to market under the name of Express Test Corporation. Pressurized humidity test equipment utilizes a pressurized vessel (autoclave) as the main test chamber in order to force moisture into the plastic encapsulate and thereby determine the moisture resistance of the test devices much more rapidly than non pressurized conventional humidity test systems. Highly accelerated temperature and humidity stress test systems offer reliability data for high reliability commercial IC manufacturers and end-users such as computer, automotive and other commercial customers.\nTemperature Test Equipment - - -------------------------- The Artic Temperature Test Systems are used to control the temperature of semiconductor wafers and components to allow testing and characterization at hot and cold temperatures. During the past year, the Registrant developed and released two new products in this product range. The systems utilize thermoelectric modules to achieve wide temperature ranges without the need for special refrigerants and cooling fluids.\nProduct Development - - ------------------- Development of the Rate of Turn Tables and large Centrifuges is targeted at new applications in the automotive industry. The latest centrifuges and rate tables combine two technologies which facilitates the acceleration test of devices at hot and cold temperatures. The Registrant has developed and released a new electrical test system for electronic components. This product is being developed into a product range which will include failure analysis testers and test systems for electronic modules.\nTesting Services - - ---------------- The Registrant owns and operates facilities that provide testing services for ceramic and plastic encased semiconductor devices and other electronic components to meet the requirements of military, aerospace, industrial and commercial applications. The Registrant uses its own proprietary equipment for certain burn-in, centrifugal and leak tests, and commercially available equipment for the various other environmental tests. The Registrant conducts its testing operations at its facilities located in San Fernando, California; the Republic of Singapore; Dublin, Ireland; Penang and Kuala Lumpur, Malaysia; and Bangkok, Thailand.\nThe testing services are used by manufacturers and purchasers of semiconductors and other components who either do not have any testing capabilities or whose in-house screening facilities are not sufficient to test devices to military or certain commercial specifications. In addition, the Registrant provides overflow testing and independent verification for companies that have their own in-house capabilities. The laboratories perform a variety of tests, including stabilization bake, thermal shock, temperature cycling, mechanical shock, constant acceleration, gross and fine leak tests, electrical testing, static and dynamic burn-in tests, and vibration testing. The laboratories also perform qualification testing, consisting of intense tests conducted on small samples of output from manufacturers who must obtain periodic qualification under the terms of their contracts. The Registrant delivers written certification to customers reporting on the test results.\nDistribution Activities - - ----------------------- The Company's Singapore subsidiary continues to develop its international distribution division. This is in addition to its manufacturing and testing business. This distribution business purchases products from European and Pacific Rim manufacturers for resale. Specifically, Heraeus-Votsch of West Germany has been utilizing Trio-Tech International Pte. Ltd. in Singapore as a distributor of its products for nearly seven years. The Singapore subsidiary also represents several Japanese and American manufacturers. This segment of Singapore's business\ncontinues to grow. It affords Trio-Tech additional sales penetration opportunities in the Pacific Rim for the remainder of the Trio-Tech product line.\nMarketing, Distribution and Service - - ----------------------------------- The Company markets its products and services worldwide, both directly and through independent sales representatives. There are approximately 13 of these representatives that operate within the United States and 10 in various foreign countries. The Company's marketing efforts in the United States and Europe are coordinated from its headquarters in San Fernando, and its Far East marketing efforts are assisted by its subsidiary in Singapore. Its European marketing is assigned to its subsidiary in Ireland. The Registrant advertises in trade journals and participates in trade shows.\nThe Company's products and services are purchased by independent testing laboratories and by users and manufacturers of high-reliability semiconductor devices, including Hyundai, TRW Teledyne, Allied Signal, AMD, Motorola, National Semiconductor, SGS Thomson and Texas Instruments. During the year ended June 30, 1995, the Company had sales of $3,000,000 and $2,431,000 to two different customers. One customer was responsible for more than 10% of the Company's consolidated sales for fiscal year 1994.\nBased upon past experience, the Company does not anticipate any significant cancellations. The purchase orders for equipment call for delivery within the next 12 months. The testing services backlog is scheduled to be performed within the next year. The Company does not anticipate any difficulties in meeting the above delivery schedule.\nManufacturing and Supply - - ------------------------ The Registrant's products are designed by its engineers and are assembled and tested at its facilities in San Fernando, California, the Republic of Singapore and the Republic of Ireland. All parts and certain components are purchased from outside sources for assembly by the Company. The Registrant uses Fluorinert, a special indicator fluid sold by the 3M Company, in its gross leak equipment, and Krypton 85, sold by Amersham, in its Tracer-Flo. The Registrant has not experienced any difficulty in obtaining Fluorinert or Krypton 85 to date. There can be no assurance that the Registrant will not experience difficulties or delays in obtaining Fluorinert or Krypton 85 in the future.\nCompetition - - ----------- Management believes that the Registrant is one of the leading manufacturers in the specific areas of fine leak and gross leak testers for ceramic and plastic packaged semiconductor devices and constant acceleration centrifuges used for structural testing of such devices. Because of the importance of testing as part of the manufacturing process for high-reliability semiconductor devices, management believes that the quality, accuracy and reputation of its products and services, and to a lesser extent price, are the bases of competition in the product and service areas\nserved by the Company. In order for the Company to remain competitive, it must have the ability to adapt to rapid technological change and to develop new and improved products.\nThere are numerous testing laboratories in the areas in which the Registrant operates that perform a range of testing services similar to those offered by the Registrant. Since the Registrant has sold and will continue to sell its leak testing systems and centrifuges to competing laboratories, the Registrant's competitors can offer the same capabilities in testing. The Registrant also sells its products and systems to semiconductor manufacturers and users who might otherwise have used outside testing laboratories, including the Registrant, to perform environmental testing. Reputation for dependable testing and prompt performance, to a greater extent than price, appear to be the primary bases of competition among testing laboratories. The existence of competing laboratories and the purchase of testing equipment by manufacturers and users are potential threats to the Company's future revenues and earnings from testing.\nPatents - - ------- The Registrant holds a U.S. Patent granted in 1987 in relation to its pressurization humidity testing equipment. The Registrant also holds a U.S. Patent granted in 1994 on certain aspects of its Artic Temperature Test Systems. In addition the Registrant has recently filed a new Patent application for certain aspects of its new Artic Temperature Test products.\nGovernment Regulation - - --------------------- The Tracer-Flo process uses Krypton 85, an inert radioactive gas, the supply and handling of which are subject to regulation by the United States Nuclear Regulatory Commission (NRC) and the California Department of Health Physics. The Company must, therefore, train the Tracer-Flo operators, which are licensed by the State of California, and must maintain records and control its supplies of Krypton 85. The California agency conducts periodic site inspections, and the NRC monitors interstate shipments and can inspect the Company's shipping records. No security clearance is required to handle the gas, which has a low level of radioactivity.\nEmployees - - --------- As of June 30, 1995, the Company had 33 employees in the United States, 179 in Singapore, 260 in Malaysia, 73 in Bangkok and 8 in Ireland. Of the employees in the United States, 8 were engaged primarily in engineering and services, 17 in manufacturing or testing, 3 in sales, and 5 in general and administrative positions. None of the Company's employees are represented by a labor union. However, in Dublin, Ireland, the Union Agreement is still in place without any members. Management considers its employee relations to be good.\n*1 Purchased for S$1 million, equivalent to approximately U.S.$ 447,000 based on the exchange rate as of June 28,1985. This amount was completely repaid in fiscal year 1991. However, under Singapore law, this land may not be purchased outright. Accordingly, the term for this land lease will expire in December 2030. The Company has acquired the fullest ownership rights possible under Singapore law which includes an option to renew the lease at that time.\n*2 Purchased for 270,000 Irish Pounds, equivalent to approximately U.S. $261,000 based on the exchange rate as of June 28, 1985, of which approximately 30% was recovered by the Company as part of the grant monies received from the Industrial Development Authority of the Republic of Ireland. However, these monies may have to be repaid if certain events occur within one year from June 30, 1995.\n*3 Purchased for Thai Baht 13,500,000, equivalent to approximately U.S.$533,000 based on the exchange rate as of June 25, 1993. The mortgage agreement commenced in October 1992 and will expire in September 1998.\n*4 Purchased for Malaysia Ringgit 1,000,000, equivalent to U.S.$387,000 based on the exchange rate as at June 24, 1994.\nITEM 3","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 - - ------ LEGAL PROCEEDINGS - - ----------------- On August 24, 1995, the Company was served in a civil action brought by HM Holdings, Inc. against 106 defendants, including the Company. HM has paid $3,750,000 to the Federal Environmental Protection Agency to settle a proceeding alleging that HM's predecessor company caused soil and groundwater contamination of the North Hollywood (California) Superfund Site and may have additional liabilities. HM alleges that the 106 defendants caused or contributed to the contamination. This suit may arise in part out of a related suit by Lockheed Martin Corporation against HM and other defendants, possibly including Trio-Tech (which has not been served in this related suit), involving the nearby Burbank Superfund Site, which HM is seeking to settle and to assign its claim against the 106 defendants to Lockheed Martin. Trio-Tech vacated its Burbank location in 1987. Trio-tech and its counsel have not yet had the opportunity to investigate the allegations. Management, based on its present information, believes that the outcome of this litigation will not materially affect the Company's consolidated financial position or results of operations.\nThere are no material proceedings to which any director, officer or affiliate of the Registrant, any beneficial owner of more than five percent of the\nRegistrant's common stock or any associate of such person is a party that is adverse to the Registrant or its properties.\nITEM 4","section_4":"ITEM 4 - - ------ SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - - --------------------------------------------------- The Company did not submit any matters 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 - - ------------------------------------ The Registrant's common stock is traded on the Over-the-Counter Market. The prices below have been adjusted to take account of a one-for-four reverse stock split of the common stock in October 1994. The range of bid information as quoted by the NASDAQ is as follows:\nThe Registrant's common stock is held by approximately 347 shareholders of record as of August 21, 1995. 174,500 shares are held by Cede and Co., a clearinghouse that holds stock certificates in \"street\" name for an unknown number of shareholders.\nThe Company has not declared any cash dividends on its common stock. It is anticipated that no dividends will be paid to holders of common stock in the foreseeable future. Any future determinations as to cash dividends will depend upon the earnings and financial position of the Company at that time and such other factors as the Board of Directors may deem appropriate.\nThe Company has not declared any cash or stock dividends on its common stock in any of the fiscal years reported above.\nYear Ended June 30, 1995 (\"1995\") Compared to Year Ended June 24, 1994 (\"1994\") - - ------------------------------------------------------------------------------- Sales increased $4,323,000 or 28.5% to $19,488,000 in 1995 from $15,165,000 in 1994 as a result of improved operations in each of the business segments. Sales for the Far East operations increased $3,249,000 (26.1%) due primarily to improved operations in Malaysia as the volume of testing services in that region increased. Additionally, there was an increase in manufacturing revenues in the Far East as a result of the sale of additional systems during 1995. The U.S. operations sales increased $710,000 (34.4%) due to increased sales volume in the manufacturing segment. Sales for Ireland improved $364,000 (55.6%) as a result of increases in the volume of testing services performed in the current year.\nCost of sales increased $2,783,000 or 27.9% from $9,961,000 in 1994 to $12,744,000 in 1995. However, cost of sales as a percentage of sales remained relatively stable and actually decreased from 65.7% in 1994 to 65.4% in 1995 as a result of continued cost cutting efforts.\nOperating expenses increased $1,197,000 (29.9%) to $5,197,000 in 1995. As percentage of sales, operating expenses were almost the same at 26.7% in 1995 as compared to 26.4% in 1994.\nInterest expense decreased $331,000 in 1995 as compared to 1994 due to the significant reduction in average outstanding debt balances during the current year. During 1994, the Company entered into an agreement with its previous lender which resulted in reduced bank borrowings.\nOther income increased $284,000 primarily due to currency exchange losses experienced in 1994 which did not reoccur in 1995.\nIncome taxes increased $207,000 as a direct result of the increase in operations experienced in the current year. The effective tax rate in 1995 was 26% which approximates the foreign income tax rate for the Far East operations. The U.S. operations have net operating losses which are used to offset any income taxes associated with their taxable income.\nYear Ended June 24, 1994 (\"1994\") Compared to Year Ended June 25, 1993 (\"1993\") - - ------------------------------------------------------------------------------- Net sales decreased by approximately $557,000 or 4% in fiscal 1994 compared to 1993. The decrease was primarily due to a $940,000 reduction in sales from the U.S. operations due to continued economic problems in the U.S. semiconductor industry. This was partially offset by a $392,000 increase in sales from the Far East operations. Ireland's sales remained relatively constant during fiscal year 1994.\nCost of sales as a percentage of net sales decreased to 65.7% in fiscal 1994 compared to 67.6% in fiscal 1993. This decrease was due to increased sales in the distribution segment which experiences higher margins than manufacturing or testing. Additionally, the Company continues its efforts to reduce manufacturing and overhead costs.\nOperating expenses decreased approximately $159,000 or 4% and remained relatively constant as a percentage of sales.\nIncome before income taxes and extraordinary item as a percentage of sales increased to 4.1% in fiscal 1994 compared to 3.6% in fiscal 1993. The increase resulted from improved gross margins in the current year which were partially offset by a $109,000 write-off of an investment.\nExtraordinary income of $1,751,000 was recognized by the Company in fiscal 1994 as a result of the extinguishment of a significant portion of its bank debt.\nLiquidity and Capital Resources - - ------------------------------- The Company's working capital improved significantly from $511,000 as of June 24, 1994 to $1,689,000 as of June 30, 1995. The improvement in working capital is attributable to the significant increase in sales and profitability during fiscal year 1995.\nThe Company has a secured credit agreement with Standard Charter Bank which provides for a total line of credit of approximately $655,000 which can be used to finance the company's Far East operations. Borrowings under the line were $219,000 as of June 30, 1995 and bear interest at the bank's prime rate (7% at June 30, 1995) plus 3%. In addition, the Company's subsidiary, TTM, has a line of credit which provides for borrowings of approximately $234,000. At June 30,\n1995, there were no borrowings outstanding. Interest on the line is at the bank's reference rate plus 2%. The company currently has no financing arrangements to fund operations outside of the Far East region.\nMost of the capital expenditures incurred during fiscal 1995 were used to update and expand the variety of testing services required by the customer base in the Far East.\nManagement believes that the Company's operations will be able to be funded over the next twelve months through operations, existing working capital and its available lines of credit.\nITEM 8","section_6":"","section_7":"","section_7A":"","section_8":"ITEM 8 - - ------ FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - ------------------------------------------- The information called for by this item is included in the Company's consolidated financial statements beginning on page 19 of this Annual Report on Form 10-K.\nITEM 9","section_9":"ITEM 9 - - ------ DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - - ---------------------------------------------------- No disagreements of a reportable nature have occurred between the Registrant and its accountants.\nPART III\nThe information required by Part III is hereby incorporated by reference from the Company's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 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 - - --------------------------------------------------------------- (a) (1) FINANCIAL STATEMENTS:\nThe following financial statements, including notes thereto and the independent auditors' report with respect thereto, are filed as part of this Annual Report on Form 10-K, starting on page 19 hereof:\n1. Independent Auditors' Report 2. Consolidated Balance Sheets 3. Consolidated Statements of Income 4. Consolidated Statements of Shareholders' Equity 5. Consolidated Statements of Cash Flows 6. Notes to Consolidated Financial Statements\n(a) (2) FINANCIAL STATEMENT SCHEDULES:\nThe following schedules are filed as part of this Annual Report on Form 10-K, starting on page 38 hereof:\n1. Schedule VIII - Valuation and Qualifying Accounts and Reserves\nNo other schedules have been included because they are not applicable, not required, or because information is included in the consolidated financial statements or notes thereto.\n(b) REPORTS ON FORM 8-K:\nThe Registrant has filed no reports on Form 8-K for the fiscal year ended June 30, 1995.\n(c) EXHIBITS:\nNumber Description Page Number - - ------ ----------- -----------\n3.1 Articles of Incorporation, as currently in effect. [Previously filed as Exhibit 3.1 to the Annual Report on Form 10-K for June 24, 1988.] -------\n3.2 Bylaws, as currently in effect. [Previously filed as Exhibit 3.2 to the Annual Report on Form 10-K for June 24, 1988.] -------\n10.1 Trio-Tech Stock Option Plan. [Previously filed as Exhibit 10.1 to the Registration Statement on Form S-8 (No. 2-87606).] -------\n10.2 Real Estate Lease, dated September 29, 1987, between Stierlin Industrial Center and Registrant. [Previously filed as Exhibit 10.5 to the Registration Statement on Form S-1 (No. 2-87606).] -------\n10.3 Tenancy of Flatted Factory Unit, dated December 2, 1982, between Jurong Town Corporation and Registrant. [Previously filed as Exhibit 10.8 to the Registration Statement on Form S-1 (No. 2-87606).] -------\n10.4 Tenancy of Flatted Factory Unit, dated September 10, 1982, between Jurong Town Corporation and Registrant. [Previously filed as Exhibit 10.9\nto the Registration Statement on Form S-1 (No. 2-8766).] -------\nNumber Description Page Number - - ------ ----------- -----------\n10.5 Real Estate Lease, dated December 15, 1986, between San Fernando Associates and Registrant. [Previously filed as Exhibit 10.17 to the Annual Report on Form 10-K for June 28, 1987.] -------\n10.6 Deferred Compensation Agreement, dated March 1, 1986, between the Company and A. Charles Wilson. [Previously filed as Exhibit 10.16 to the Annual Report on Form 10-K for June 24, 1988.] -------\n10.7 Deferred Compensation Agreement, dated March 1, 1986, between the Company and John C. Guy. [Previously filed as Exhibit 10.17 to the Annual Report on Form 10-K for June 24, 1988.] -------\n10.9 Credit Facility Letter dated November 2, 1993, between Trio-Tech International Pte. Ltd. and Standard Chartered Bank. --------\n11.1 Statement re: Computation of Per Share Earnings --------\n22.1 Subsidiaries of the Registrant (100% owned by the Registrant except as otherwise stated):\nTrio-Tech International Pte. Ltd., a Singapore Corporation Trio-Tech Test Services Pte. Ltd., a Singapore Corporation Trio-Tech Reliability Services, a California Corporation Express Test Corporation, A California Corporation European Electronic Test Center, Ltd., A Cayman Islands Corporation Trio-Tech Malaysia, a Malaysia Corporation (55% owned by the Registrant) Trio-Tech (KL), a Malaysia Corporation (50% owned by the Registrant) Trio-Tech Bangkok, a Thailand Corporation Prestal Enterprise Sdn Bhd, a Malaysia Corporation (73% owned by the Registrant)\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTRIO-TECH INTERNATIONAL\nBy: \/s\/ VICTOR H.M. TING -----------------------\nVICTOR H.M. TING\nVice President and Chief Financial Officer Date:\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.\n\/s\/A. CHARLES WILSON SEPTEMBER 26, 1995 --------------------------- A. Charles Wilson, Director Chairman of the Board\n\/s\/S.W. YONG SEPTEMBER 26, 1995 --------------------------- S. W. Yong, Director President and Chief Executive Officer\n\/s\/VICTOR H.M. TING SEPTEMBER 26, 1995 ---------------------------- Victor H.M. Ting Vice President, Chief Financial Officer and Principal Accounting Officer\n\/s\/JOHN C. GUY SEPTEMBER 26, 1995 ---------------------------- John C. Guy Director and Secretary\n\/s\/FRANK S. GAVIN SEPTEMBER 26, 1995 ----------------------------- Frank S. Gavin, Director\n\/s\/WILLIAM L. SLOVER SEPTEMBER 26, 1995 ----------------------------- William L. Slover, Director\n\/s\/RICHARD C. HOROWITZ SEPTEMBER 26, 1995 ----------------------------- Richard C. Horowitz, Director\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors Trio-Tech International San Fernando, California:\nWe have audited the accompanying consolidated balance sheets of Trio-Tech International and subsidiaries as of June 30, 1995 and June 24, 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1995. Our audits also\nincluded 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 these financial statements and financial statement 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 audits provide a reasonable basis for our opinion.\nIn our opinion, based on our audits, such consolidated financial statements present fairly, in all material respects, the financial position of Trio-Tech International and subsidiaries as of June 30, 1995 and June 24, 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, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\n\/s\/Deloitte & Touche LLP\nWoodland Hills, California August 25, 1995\nSUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS :\nIn October 1993, the Company acquired a 73% equity interest in Prestal Enterprise Sdn Bhd in exchange for 73,873 shares of common stock of the Company totaling $148,000.\nAssets acquired $ 61,000 Liabilities Assumed (1,000) Cost in excess of net assets acquired 88,000 ---------- $ 148,000 (Concluded)\n[FN] See notes to consolidated financial statements.\nTRIO-TECH INTERNATIONAL AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1995, JUNE 24, 1994 AND JUNE 25, 1993 - - --------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - Trio-Tech International (the \"Company\" or \"TTI\") is a designer and manufacturer of equipment used to test the structural integrity of semiconductor devices that must meet high-reliability specifications. The Company also owns and operates testing facilities that perform structural and electronic testing of semiconductor devices and acts as a distributor of electronic testing equipment in Singapore and other Southeast Asian countries. The consolidated financial statements include the accounts of the Company and its principal subsidiaries: Trio-Tech International Pte Ltd (TTI Pte), Trio-Tech Test Services Pte Ltd (TTTS Pte), Express Test, European Electronic Test Centre (EETC), Trio-Tech Bangkok (TTBkk), Trio-Tech Malaysia (TTM) (a 55%-owned joint venture of Trio-Tech International Pte. Ltd) and Prestal Enterprise Sdn Bhd (PESB) (a 73% owned subsidiary of Trio-Tech International Pte Ltd). In 1994, the Company entered into a joint venture in the Peoples Republic of China. The amount of this investment was minimal at June 30, 1995. All material intercompany transactions, profits and balances have been eliminated.\nAccounting Period - The Company's fiscal reporting period coincides with the 52-53 week period ending on the last Friday in June.\nInventories - Inventories are stated at the lower of cost, using the first-in, first-out (FIFO) method, or market.\nProperty, Equipment and Capitalized Leases - Property, equipment and capitalized leases are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided over the estimated useful lives of the assets or the terms of the leases, whichever is shorter, using the straight-line method. Estimated useful lives range from 3 to 45 years. Capital grants from the Industrial Development Authority in Ireland are accounted for when claimed by reducing the cost of the related assets. The grants are amortized over the depreciable lives of those assets.\nForeign Currency Translation - All assets and liabilities of operations outside the United States have been translated at the foreign exchange rates in effect at year-end. Revenues and expenses for the year are translated at average exchange rates in effect during the year. Unrealized translation gains and losses are not included in determining net income but are accumulated and reported as a separate component of shareholders' equity. Net realized gains and losses resulting from foreign currency transactions are credited or charged to income.\nOther Assets - The excess of cost over net assets acquired is included in other assets and is being amortized over 5-10 years. The Company reviews the carrying value of all intangible assets on a regular basis, and if future cash flows are believed insufficient to recover the remaining carrying value of an intangible asset, the carrying value is written down in the period the impairment is identified to its future recoverable value.\nTaxes on Income - The Company accounts for its income taxes in accordance with Statement of Financial Accounting Standards No. 109, \" Accounting for Income Taxes.\" This Statement requires an asset and liability approach to\nfinancial accounting and reporting for income taxes. Deferred taxes and liabilities are computed annually for differences between the financial statement basis and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which the differences are\nexpected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.\nResearch and Development Costs -The Company incurred research and development costs of $51,000 in 1995, $71,000 in 1994 and $9,000 in 1993, which were charged to cost of sales as incurred.\nIncome per Share - Income per share is based upon the weighted average number of shares outstanding and common stock equivalents (consisting of stock options), excluding those common stock equivalents which would be anti-dilutive.\nReclassification - Certain reclassifications have been made to the previous year's financial statements to conform to current year presentation.\n2. INVENTORIES\nInventories consist of the following:\nJune 30, June 24, 1995 1994 ------- -------- Raw materials $ 559,000 $ 541,000 Work in progress 403,000 402,000 Finished goods 230,000 122,000 ---------- ---------- $1,192,000 $1,065,000 ========== ==========\nIncluded in the inventory balance as of June 30, 1995 and June 24, 1994 are amounts totaling approximately $137,000 and $116,000, respectively, which are not expected to be sold within one year.\n3. PROPERTY, EQUIPMENT AND CAPITALIZED LEASES\nProperty, equipment and capitalized leases consist of the following:\nJune 30, June 24, 1995 1994 ------ -------- Building and improvements $ 2,329,000 $ 1,824,000 Leasehold improvements 982,000 797,000 Machinery and equipment 11,122,000 9,578,000 Furniture and fixtures 1,673,000 1,526,000 Equipment under capital leases 1,227,000 1,111,000 ------------ ----------- 17,333,000 14,836,000 Less: Accumulated depreciation and amortization 11,002,000 8,759,000 Accumulated amortization on equipment under capital leases 1,066,000 890,000 ------------ --------- $ 5,265,000 $ 5,187,000 =========== ===========\n4. OTHER ASSETS\nOther assets consist of the following: June 30, June 24, 1995 1994 ------- -------- Cost in excess of net assets acquired, net of accumulated amortization of $340,000 (1995) and $264,000 (1994) $301,000 $367,000 Other 232,000 219,000 --------- --------- Total $533,000 $586,000 ======== ========\n5. NOTES PAYABLE\nThe Company's subsidiary, TTI Pte, has a secured credit agreement with a bank which provides for a total line of credit of $655,000. The agreement contains certain debt covenants including maintaining a minimum net worth of $2,400,000 at TTI Pte. Borrowings under the line were $219,000 and $294,000 at the end of fiscal 1995 and 1994, respectively. The interest rate on borrowings is at the bank's prime rate (7% at June 30, 1995) plus 3%. Borrowings under this agreement are collateralized by substantially all of TTI Pte's assets.\nThe Company's subsidiary, TTM, has a secured credit agreement with a bank which provides for a total line of credit of $234,000. At June 30, 1995, there were no borrowings outstanding. The line of credit bears interest at the bank's reference rate plus 2%.\nIncluded in Notes Payable are past due shareholder notes owed to the former owners of Express Test of $36,000 at the end of fiscal 1994. The notes were fully repaid in fiscal 1995.\n6. ACCRUED EXPENSES\nAccrued expenses consist of the following: June 30, June 24, 1995 1994 -------- -------- Payroll and related $1,486,000 $1,113,000 Other 760,000 902,000 ---------- ---------- Total $2,246,000 $2,015,000 ========== ==========\n7. LONG-TERM DEBT AND CAPITALIZED LEASES\nLong-term debt and capitalized leases consist of the following: June 30, June 24, 1995 1994 ---- ---- Capitalized lease obligations, due in various installments through 1997, bearing interest at approximately 8.25%, collateralized by leased assets (see Note 9) $ 56,000 $ 105,000\nTerm notes payable, due in monthly installments through 2000, bearing interest at 3% above bank reference rate (7% at June 30, 1995), collateralized by substantially all of TTI Pte's assets 378,000 564,000\nTerm notes payable, due in monthly installments through 1996, bearing interest at 5.53%. 267,000 308,000\nTerm loan, due in quarterly installments through 1995, bearing interest at 11%. 143,000\nMortgage loan, due in monthly installments through 1997, bearing interest at 1.5% above bank reference rate (13% at June 30, 1995), collateralized by land and building in TTBkk. 315,000 381,000\nNote payable to officer and share- holder, bearing interest at 10%, due January 1, 1996, unsecured. 40,000 40,000 ------------- -------- 1,056,000 1,541,000 Less current portion 459,000 602,000 ------------ ---------- $ 597,000 $ 939,000 =========== ==========\nMaturities of long-term debt as of June 30, 1995 are as follows (exclusive of capital lease obligations):\nFiscal Year ---- 1996 $ 453,000 1997 325,000 1998 193,000 1999 29,000 ------ $1,000,000 ==========\n8. TAXES ON INCOME\nThe provision for income taxes consists of the following:\nYear Ended ----------------------------- June 30,June 24, June 25, 1995 1994 1993 ---- ---- ---- Current: Domestic $ 3,000 $ 3,000 $ - Foreign 457,000 245,000 293,000 ---------- --------- --------- 460,000 248,000 293,000 ---------- --------- --------- Deferred: Domestic Foreign (17,000) (12,000) 75,000 ----------- ---------- ----------\n$ 443,000 $236,000 $368,000 ========= ======== ======== The pre-tax income (before extraordinary item and minority interest) related to domestic and foreign operations is as follows:\nYear Ended ------------------------------------\nJune 30, June 24, June 25, 1995 1994 1993 ---- ---- ---- Domestic $ 320,000 $220,000 $(83,000) Foreign 1,364,000 397,000 652,000 ----------- ---------- --------- $1,684,000 $617,000 $569,000 ========== ======== ========\nThe reconciliation between the U.S. federal statutory tax rate and the effective income tax rate is as follows:\nYear Ended ---------------------------\nJune 30, June 24, June 25, 1995 1994 1993 ---- ---- ---- Statutory federal tax rate 35% 35% 34% Foreign income taxed at lower rates 27% 27% 27% Unbenefitted losses 4% Utilization of federal net operating loss carryforwards (35%) (24%) Other (1%) ---- --------- -------- Effective rate 26% 38% 65% === ==== ===\nThe Company files income tax returns in several countries. Income in one country is not offset by losses inanother country. Accordingly, no benefit is provided for losses in countries except where the loss can be carried back against income recognized in previous years. Income taxes are provided in those countries where income is earned. The effect of providing tax against profits while not providing benefit for losses results in an effective tax rate which differs from the federal statutory rate.\nDeferred income taxes arise from temporary differences in the recognition of certain revenues and expenses for tax and financial statement purposes. The components of deferred tax assets (liabilities) are as follows:\nJune 30, June 24, 1995 1994 -------- -------- Deferred tax assets: Net operating loss carry forward $1,109,000 $1,138,000 Accrued vacations 36,000 28,000 Reserve for obsolescence 131,000 141,000 Other 4,000 4,000 ---------- ----------- Total deferred tax assets 1,280,000 1,311,000 --------- --------- Deferred tax liabilities: Depreciation (774,000) (866,000) Other (123,000) (19,000) ------------ ------------ Total tax liabilities (897,000) (885,000) ------------- ------------ Subtotal 383,000 426,000 Valuation allowance (1,253,000) (1,279,000) ----------- ----------- Net deferred tax liability $(870,000) $(853,000) ========== =========\nAt June 30, 1995, the Company has net operating loss carryforwards of approximately $3,262,000 available to offset future U.S. federal taxes, which primarily expire between 2005 and 2008.\n9. COMMITMENTS AND CONTINGENCIES\nThe Company leases certain of its facilities and equipment under long-term agreements expiring at various dates through 2030. Certain of these leases require the Company to pay real estate taxes and insurance and provide for escalation of lease costs based on certain indices. Future minimum payments under capital leases and noncancellable operating leases as of June 30, 1995 are as follows:\nOperating Leases ---------------------- Capital Rental Sublease Net Rental Fiscal Year Leases Commitment Income Commitment ----------- ------ ---------- -------- ---------- 1996 $ 47,000 $ 540,000 $364,000 $ 176,000 1997 12,000 253,000 151,000 102,000 1998 86,000 86,000 1999 58,000 58,000 2000 58,000 58,000 Thereafter 1,774,000 1,774,000 -------- ---------- --------- ---------- Total minimum lease payments 59,000 $2,769,000 $515,000 $2,254,000 ========== ======== ==========\nLess amount representing interest (3,000) ---------- Capital lease obligations $56,000 =======\nTotal rental expense on all operating leases, both cancelable and noncancelable, amounted to $461,000 in 1995, $433,000 in 1994 and $369,000 in 1993. Total rental income under sublease was $124,000 in 1995, $121,000 in 1994 and $182,000 in 1993.\n10. SHAREHOLDERS' EQUITY\nThe Company has a qualified stock option plan (the Plan) under which officers, directors and employees are eligible to receive options to purchase shares of the Company's common stock at a price that is not less than 100 percent of the fair market value at the date of grant. There are 125,000 shares authorized for grant under the Plan. Additionally, the Board of Directors issues non-qualified options at their discretion at a price not less than fair market value at the date of grant. There are 125,000 shares authorized for grant under the non- qualified plan. The following table summarizes the stock option activity for the three years ended June 30, 1995:\nNumber of Shares Option Price ---------------- ------------ Non-qualified Qualified ------------- --------- Balance, June 26, 1992 55,000 123,488 $ 2.28 to $3.00\nOptions granted 15,750 $ 2.28 to $2.44 Options exercised (1,444) $ 2.28 Options expired (27,775) $ 2.28 ----------- ------- Balance, June 25, 1993 55,000 110,019 $ 2.28 to $3.00 Options granted 63,000 3,250 $ 2.28 to $2.40 Options exercised (13,250) $ 2.28 to $2.44 Options expired (3,856) $ 2.28 to $2.44 ------------ ------- Balance, June 24, 1994 118,000 96,163 $ 2.28 to $3.00 Options granted 16,000 $ 3.25 Options exercised (15,000) (12,375) $ 2.28 Options expired (750) (1,900) $ 2.28 ---------- ------- Balance, June 30, 1995 118,250 81,888 $ 2.28 to $3.25 ======= ======\nShares exercisable 81,315 77,498 ====== ====== 11. COMMON STOCK\nIn December 1993, the Board of Directors approved the private placement of up to 312,500 shares of restricted common stock. The common stock was offered to qualified investors (up to 187,500 shares) as well as certain employees and management of the Company (up to 125,000 shares) at a price of $2.40 per share. The price represents the fair market value of the stock on that date. The investors are restricted from selling their shares of common stock for two years from the date of purchase. In connection with the private placement, 254,845 shares of common stock were issued raising $612,000 in capital.\nIn October 1994, the Board of Directors approved a one-for-four reverse stock split (the \"Reverse Split\"). Common stock and stock options have been retroactively adjusted for the split.\n12.RELATED PARTY TRANSACTION\nIn October 1993, the Company purchased a 73% equity interest in Prestal Enterprise Sdn Bhd from an Officer and Director of the Company in exchange for 73,873 shares of common stock of the Company valued at $148,000.\n13.EXTRAORDINARY ITEM\nIn December 1993, the Company entered into a settlement arrangement with a bank whereby $3,612,000 of debt and accrued interest was satisfied in exchange for a cash payment of $1,800,000. This transaction resulted in a gain of $1,751,000 (net of applicable taxes of $61,000) on extinguishment of debt which is reflected as extraordinary income in fiscal 1994.\n14. BUSINESS SEGMENTS\nThe Company operates principally in three industry segments, the designing and manufacturing of equipment that tests the structural integrity of integrated circuits and other products which measure the rate of turn, the testing service industry that performs structural and electronic tests of semiconductor devices and the distribution of various products from other manufacturers in Singapore and Southeast Asia.\nThe allocation of the cost of equipment, the current year investment in new equipment and depreciation expense have been made on the basis of the primary purpose for which the equipment was acquired.\nThe Company's wholly owned subsidiary, TTI Pte. in Singapore (including TTI Pte.'s wholly owned subsidiaries TTTS Pte and TTBk, 55% owned joint venture of Trio-Tech Malaysia, another subsidiary wholly owned by Trio-Tech Malaysia and 73% owned PESB), operates in the manufacturing, the testing service and the distribution industry segments.\nAll intersegment sales are sales from the manufacturing segment to the testing and distribution segment. Corporate assets mainly consist of cash and prepaid expenses. Corporate expenses mainly consist of salaries, insurance, professional expenses and directors' fees.\nThe Company exports a portion of its equipment. Export sales by geographic area are as follows: Year Ended -----------------------------------\nJune 30, June 24, June 25, 1995 1994 1993 ---- ------- -------- Southeast Asia $ 976,000 $ 501,000 $ 991,000 Europe 595,000 227,000 60,000 All others 153,000 513,000 160,000 ------------ ------------ ------------ $1,724,000 $1,241,000 $1,211,000 ========== ========== ==========\nThe Company had two major customers which accounted for 15% and 12% of the Company's sales during fiscal year 1995. A single customer accounted for 16% of sales during fiscal year 1994. Two customers accounted for 15% and 13% of sales during fiscal 1993. The Company has no significant concentration of credit risks other than discussed above.\n15. SUBSEQUENT EVENTS\nOn August 24, 1995, the Company was named in a civil action brought against 106 defendants alleging that they may have caused or contributed to soil and groundwater contamination that required the plaintiff to pay $3,750,000 to the Federal Environmental Protection Agency to settle. The Company has not yet had the opportunity to investigate the allegations. In the opinion of management, based on its present information, this matter should not have a material impact on the Company's consolidated financial position or results of operations.\nTRIO-TECH INTERNATIONAL AND SUBSIDIARIES SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS AND RESERVES - - ----------------------------------------------------------------------- Allowance for Reserve Doubtful for Accounts Inventory\nBalance at June 26,1992 85,000 363,000\nAdditions charged to cost and expense 41,000 114,000 Write offs (60,000) (56,000) Balance at June 25, 1993 66,000 421,000\nAdditions charged to cost and expenses 6,000 121,000 Write offs (15,000) (97,000) Balance at June 24, 1994 57,000 445,000\nAdditions charged to cost and expenses 4,000 11,000 Recoveries (11,000) (22,000) Write-offs (40,000) (6,000) Balance at June 30, 1995 $ 10,000 $428,000\nTRIO-TECH INTERNATIONAL AND SUBSIDIARIES EXHIBIT 11.1 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS\nYEAR ENDED\nJUNE 30, JUNE 24, JUNE 25, 1995 1994 1993\nIncome (loss) before extraordinary item (2) $ 570,000 $ 289,000 $ 103,000 Extraordinary item 1,751,000 Net income (loss) (2) $ 570,000 $2,040,000 $ 103,000\nPrimary earnings per share: Weighted average number of common shares outstanding 1,162,000 1,009,000 809,000\nDilutive effect of stock options and warrants after application of treasury stock method 208,000 8,000 (1)\nNumber of shares used to compute primary earnings per share 1,370,000 1,017,000 809,000\nPrimary earnings per share: Income before extraordinary item $0.42 $0.28 $0.13 Extraordinary item 1.72 Net income per share $0.42 $2.00 $0.13\nFully diluted earnings per share: Weighted average number of common shares outstanding 1,162,000 1,009,000 809,000\nDilutive effect of stock options and warrants after application of treasury stock method 349,000 8,000 (1)\nNumber of shares used to compute fully diluted earnings per share 1,511,000 1,017,000 809,000\nFully diluted earnings per share: Income before extraordinary item $0.38 $0.28 $0.13 Extraordinary item 1.72 Net income per share $0.38 $2.00 $0.13\n(1) The earnings per share calculations were made without considering the effects of the exercise of outstanding stock options,as they are antidilutive. (2) Net of applicable minority interest.","section_15":""}
{"filename":"276283_1995.txt","cik":"276283","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nEvans & Sutherland Computer Corporation (E&S or the Company) was incorporated under the laws of the State of Utah on May 10, 1968. The Company has its principal executive and operations facilities in Salt Lake City, Utah. The Company also has software and hardware design facilities in Austin and Dallas, Texas, Horsham, United Kingdom, and Munich, Germany, and has sales and service offices at various locations around the world.\nEvans & Sutherland designs, develops, manufactures, and markets high- performance computer systems for various applications with demanding graphics requirements. The Company is a leading supplier of visual systems for flight training and simulation, is the supplier of high-performance graphics accelerators to major workstation manufacturers, and is a leading supplier of GL-based software development tools (a popular graphics language) used for advanced 3D (three-dimensional) graphics applications on the industry's leading workstation platforms. Evans & Sutherland's vision statement is to be a leader in profitably providing systems to generate high-quality real-time synthetic environments. These systems will include hardware, software, databases, and integration.\nSTRATEGIC ACTIVITIES\nE&S follows a three-point growth strategy, consisting of growing existing businesses, developing new businesses internally, and selectively acquiring businesses. During the past 12 months, Evans and Sutherland acquired two businesses (Xionix, Inc. and Terabit Computer Specialty Company), invested in another business (Strata, Inc.), and divested one product group (CDRS). The Company expects to continue with this growth strategy. A summary of these strategic activities are summarized below:\nE&S completed the sale of its Design Software group (CDRS) to Parametric Technology Corporation (PTC) on April 12, 1995 for a final net adjusted value of $31,500,000. The decision to sell the group was based on a desire to focus on the core businesses of the Company and to take advantage of an offer considered to be high relative to the earnings which could be realized inside the Company.\nThe Company announced a strategic agreement with Digital Equipment Corporation (DEC) on May 2, 1995 to develop high-end graphics accelerators for the newest members of DEC's workstation family, the AlphaStation line. Digital will sell and support the product worldwide. E&S now provides graphics hardware and software solutions that are sold and supported by DEC, Hewlett-Packard, IBM, and Sun Microsystems, as well as 3D graphics hardware and software products for the personal computer.\nE&S and Strata, Inc., a leading developer and marketer of quality software tools, announced the formation of a strategic alliance on August 10, 1995, which includes a non-consolidated equity investment in Strata by E&S plus a technology cooperation agreement. The new relationship with Strata will aid E&S in the delivery of high-performance software and hardware for modeling and rendering on both PC and Macintosh machines, which will benefit the Company's customers in simulation, game development, and multimedia applications.\nEvans & Sutherland, Hughes Training, Inc., and Thomson Training & Simulation Ltd. announced on September 14, 1995 the resolution of differences among them and their parent companies and the dismissal of any and all legal actions resulting from contractual disputes related to prior distribution agreements. The settlement allows each company to proceed to supply their products to the market, and it will make it possible for each party to work with one or more of the other parties in continuing to serve the market.\nOn October 9, 1995, E&S announced the purchase of Xionix Simulation Inc. of Dallas, Texas, a leading supplier of low-cost flight management system trainers used for training flight crews in the operation of the complex systems found in the computer-controlled cockpit. The acquisition further solidifies the Company's expansion into the civil airline training systems market. Xionix operates from its base near the Dallas\/Fort Worth International Airport as a separate business unit within E&S' existing commercial simulation market.\nE&S announced a working agreement on October 19, 1995 with United Artists Theatre Circuit Inc. to install the Company's Virtual Glider(TM) product in United Artists Theatres' Starport entertainment centers. The Company's alliance with United Artists Theatres complements both companies' strategies in terms of developing real-time, interactive high-tech entertainment products. E&S has installed Virtual Glider in the first two Starport Centres operated by United Artists Theatres, located in Dallas, Texas and Indianapolis, Indiana.\nThe Company and Mitsubishi Electronics America, Inc., a leading semiconductor supplier world-wide, announced on October 23, 1995 a technology development partnership to produce professional 3D graphics products for the personal computer market. The resulting products will be aimed at professionals requiring high-end, workstation-class graphics at a lower price point, for animation, entertainment, CAD, and visualization.\nOn March 20, 1996, E&S purchased Terabit Computer Specialty Company, Inc., based in Salt Lake City. Terabit supplies simulated cockpit instruments and other airborne electronics displays used in training simulators for military and commercial aircraft. Terabit will operate as a business unit within the Company.\nPRODUCTS AND MARKETS\nThe Company's current products are of four basic types:\n1. Visual systems which create and display computed images of stored digital models of various real-world environments that allow real-time interaction within databases that replicate specific geographic areas or imaginary worlds. Operators interact with the environment by means of an interface that has typically been integrated in flight training simulators, weapons training systems, simulators used for designing vehicles, digital planetarium systems, and virtual reality systems for entertainment applications. These include computer image generators, display systems, modeling tools, and other software products. Extensive use of custom VLSI design capability in-house improves performance, reliability, and maintainability of E&S products.\n2. Graphics accelerators which are used as a component in high-performance, interactive graphics display systems for workstations. These machines allow users to make line drawings of the edges and vertices of models of 3D objects and also to generate shaded images of such models stored in computer memory. They are useful tools for computer-aided design, analysis, research, and simulation. These products may be systems which run alongside workstations, boards which plug into workstations, or integrated circuits (chips). They allow users of DEC, HP, IBM, and Sun machines to achieve high-performance 3D graphics similar to that available on other systems in the market.\n3. Software Systems and development tools which are used with multi-platform interactive graphics systems to produce leading-edge 3D graphics software and hardware solutions to a broad customer base. Portable Graphics Inc. (PGI), a wholly-owned subsidiary, develops and markets GL-related libraries and toolkits for a variety of hardware platforms, which allow applications developed in the IRIS GL and Open GL programming interfaces to run on all the industry's leading workstation platforms.\n4. Training Systems for flight management which are used within the commercial aviation training market for pilot training. Xionix Simulation Inc., a wholly- owned subsidiary, develops and markets training devices which range from low-end desktop trainers to more sophisticated free standing flight management systems trainers.\nMARKETING\nEvans & Sutherland products are marketed worldwide by the Company or its agents, including Rikei in Japan, directly to end-users, subcontractors, and prime contractors. The Company continues to develop and form both domestic and international marketing alliances, which are proving to be an effective method of reaching specific markets. In addition, the Company has OEM agreements for its Visual System products with STN Atlas Elektronik GmbH in Germany, and Mitsubishi Precision Co., Ltd. in Japan, OEM agreements for its Graphics Accelerator products with Digital Equipment, Hewlett Packard, IBM, and Sun Microsystems, and a technology development partnership with Mitsubishi Electronics. Sales, marketing, and product support are offered by the OEM suppliers. Software Systems (Portable Graphics Inc.) products are sold through a direct sales force, through distributors, and through some of the same OEM customers as the Graphics Accelerator products. Training Systems (Xionix Simulation Inc.) products are marketed and supported by the Company's sales and marketing staff.\nSIGNIFICANT CUSTOMERS\nCustomers accounting for more than 10% of the Company's net sales in 1995 were the U.S. government and Loral Corporation. Sales to the U.S. government and prime contractors under government contracts were $54.7 million in 1995 (48% of total sales), $51.4 million in 1994 (45% of total sales), and $47.1 million in 1993 (33% of total sales). A portion of these sales are included in sales to Loral Corporation and Thomson Training Systems. Sales to Loral accounted for $34.3 million in 1995 (30% of total sales), $25.7 million in 1994 (23% of total sales), and $8.2 million in 1993 (6% of total sales). In prior years, Thomson accounted for more than 10% of the Company's sales. Sales through Thomson accounted for $10.7 million in 1995 (9% of total sales), $13.9 million in 1994 (12% of total sales), and $21.0 million in 1993 (15% of total sales).\nCOMPETITION\nPrimary competitive factors for the Company's products are performance and price. Because competitors are constantly striving to improve their products, E&S must assure that it continues to offer products with the best performance at a competitive price. The Company believes it is able to compete well in this environment and will continue to be able to do so. In 1995, the Company gained market share in the Government Simulation market. CAE Electronics, Ltd., Lockheed Martin, Silicon Graphics, Inc., and Thomson are the major competitors in this market. The Commercial Simulation business has been slow due to depressed market conditions in the civil airlines industry. However, conditions are improving and the Company was awarded several highly competitive orders in 1995. CAE and Flight Safety are the principal competitors in this market. Graphics Systems, for use with DEC, HP, IBM, and Sun workstations, sells into the competitive market for high-performance engineering workstations. Sale of these products depend on strong OEM partners. Stiff competition comes from Silicon Graphics, Inc. and products manufactured by the workstation manufacturers themselves. In the Education and Entertainment business, the Company's DIGISTAR II(R) digital planetarium product competes with traditional optical-mechanical products. Competitors include Minolta Planetarium Co. Ltd., Goto Optical Mfg. Co., Carl Zeiss Inc., and Spitz Inc. In entertainment systems, E&S is one of many companies in a highly competitive and fragmented market.\nBACKLOG\nThe Company's backlog was $76,822,000 on December 29, 1995, compared with $67,133,000 on December 30, 1994, and $68,685,000 on December 31, 1993. The predominant portion of the backlog as of December 29, 1995, is for visual simulation products. It is anticipated that most of the 1995 backlog will be filled in 1996.\nINTERNATIONAL SALES\nSales known to be ultimately installed outside the U.S. are considered international sales by the Company. Sales to foreign end-users were $44,503,000 or 39% of the Company's 1995 sales volume. To take full advantage of this sales pattern, the Company operated a wholly-owned Foreign Sales Corporation (FSC) subsidiary through fiscal year 1995, the use of which resulted in tax benefits in 1995 amounting to approximately $344,000. For additional information, see footnote 13 of \"Notes to Consolidated Financial Statements\" in Part II of this report.\nDEPENDENCE ON SUPPLIERS\nMost parts and assemblies used by E&S are readily available in the open market; however, a limited number are available only from a single vendor. In these instances the Company stocks a substantial inventory and attempts to develop alternative components or sources where appropriate.\nPATENTS\nEvans & Sutherland owns a number of patents and is a licensee under several others which were developed principally at the University of Utah. Several patent applications are presently pending in the United States, Japan, and several European countries. E&S is continuing the practice, begun in 1985, of copyrighting chip masks designed by the Company and has instituted copyright procedures for these masks in Japan. E&S does not rely on, and is not dependent on, patent ownership for its competitive position. Were any or all patents held to be invalid, management believes the Company would not suffer significant damage. However, E&S actively pursues patents on its new technology.\nRESEARCH & DEVELOPMENT\nIn 1995, company-funded research and development decreased 30% to $19,406,000 from $27,890,000. As a percentage of sales, R&D decreased to 17% in 1995 from 25% in 1994. The Company continues to fund almost all R&D efforts internally. It is anticipated that high levels of R&D will continue in support of essential product development and research efforts to ensure the Company maintains technical excellence, leadership, and market competitiveness.\nENVIRONMENTAL STANDARDS\nThe Company believes its facilities and operations are within standards fully acceptable to the Environmental Protection Agency and that all facilities and procedures are in accord with environmental rules and regulations, as well as federal, state, and local laws.\nEMPLOYEES\nAs of March 1, 1996, the Company and its subsidiaries employed 754 persons. The Company believes its relations with its employees are good.\nSEASONALITY\nThe Company believes there is no inherent seasonal pattern to its business. However, sales volume fluctuates month-to-month or quarter-to-quarter due to relatively large individual sales and the random nature of customer-established shipping dates. Although the Company's volume has been skewed toward the fourth quarter in the past few years, the Company is working diligently to smooth quarter-to-quarter revenues and expects further success in achieving this goal.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal operations are located in the University of Utah Research Park, in Salt Lake City, Utah, where it owns six buildings of approximately 440,000 square feet. E&S occupies four buildings and leases out the remaining two buildings. The buildings are located on land leased from the University of Utah on 40-year land leases. Two buildings have options to renew for an additional 40 years, and four have options to renew for 10 years. The Company also owns 46 acres of land in North Salt Lake. E&S has no encumbrance on any of the real property. The Company and its subsidiaries hold leases on several sales, service, and production facilities located throughout the U. S. and in Europe.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 14, 1995, Evans & Sutherland, Hughes Training, Inc., and Thomson Training & Simulation Ltd. announced the resolution of differences among them and their parent companies and the dismissal of any and all legal actions resulting from contractual disputes related to prior distribution agreements. E&S has had a long history of working with both Hughes and Thomson to jointly provide high quality equipment and services to the pilot training market. The settlement allows all three companies to proceed to supply their products to the market, and will make it possible for each party to work with one or more of the other parties in continuing to serve the market.\nExcept as noted above, neither the Company, nor any of its subsidiaries, is a party to any material legal proceeding 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 matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following sets forth certain information regarding the executive officers of the Company as of March 29, 1996:\n- -------- Mr. Carrell was elected Chairman of the Board of Directors of the Company on March 7, 1991. He has been a member of the Board for 12 years. He also serves as the Chairman of Seattle Silicon Corporation, and he is a director of Tripos, Inc. From mid-1984 until October 1993, Mr. Carrell was Chairman and Chief Executive Officer of Diasonics, Inc., a medical imaging company. From November 1983 until early 1987, Mr. Carrell was also a General Partner in Hambrecht & Quist, a west coast based investment banking and venture capital firm.\nMr. Oyler was appointed President and Chief Executive Officer of the Company and a member of the Board of Directors in December 1994. He is also a director of Ikos Systems, Inc. Previously, Mr. Oyler served as Senior Vice President of Harris Corporation from 1976 through 1990 and also served as consultant with Booz, Allen & Hamilton. He has 1 year of service with the Company.\nMr. Lemley joined the Company in November 1995 as Vice President and Chief Financial Officer. Prior to coming to the Company, he was Senior Vice President and Chief Financial Officer at Megahertz Corporation. Previously, Mr. Lemley was with Medtronic, Inc., where he held several positions including Corporate Controller and Acting Chief Financial Officer. Prior to Medtronic, Mr. Lemley spent 17 years in a variety of financial management positions with Hewlett Packard Company. He has less than 1 year of service with the Company.\nMr. Meredith has been Senior Vice President and Secretary since 1995. He is also a director of Blue Cross Blue Shield of Utah and Tripos, Inc. Previously, Mr. Meredith served as Vice President and Chief Financial Officer and Secretary and in other capacities with E&S. He has 18 years of service with the Company.\nMr. Anderson has been Vice President, General Manager of Commercial Simulation since 1994. Prior to joining the Company, he served as General Manager Business Development for Hughes Rediffusion Simulation Ltd. from 1992 to 1994, and numerous other positions with Rediffusion Simulation beginning in 1961. He has 1 year of service with the Company.\nMr. Chidester has been Vice President of Manufacturing since 1994. He previously served as Director of Graphics Workstation Manufacturing and has 7 years of service with the Company.\nMr. Doenges has been Director of Strategic Development since 1994. He previously served as Vice President, Strategic Technology, and Manager of New Business Development. He has 22 years of service with the Company.\nMr. Horwood has been Vice President, General Manager of Entertainment & Education since 1994. Prior to joining the Company, he was Manager of Marketing and Sales with Hughes Training, Inc. He has 2 years of service with the Company.\nMr. Hurley has been Vice President of Shared Technology since 1994. He previously served as Vice President of Engineering in the Simulation Division. Mr. Hurley has 15 years of service with the Company.\nMr. Maule joined the Company in February 1996 as the Vice President, General Manager of Graphics Systems. Prior to joining the Company, Mr. Maule was Vice President of Marketing and Strategy for Concurrent Computer Corporation. Previously he served as Director of Business Development for Lockheed Missiles & Space Company. Mr. Maule has less than 1 year of service with the Company.\nMr. Schultz has been Controller since 1979 and has 20 years of service with the Company.\nMr. Sutherland has been Vice President, General Manager of Government Simulation since 1994. He previously served as Executive Vice President of the Government Sector, and Vice President of Simulation Products. Mr. Sutherland has 14 years of service with the Company.\nMr. Tanner joined the Company in March 1996 as the Vice President, General Manager of Display Systems. Prior to joining the Company, Mr. Tanner was President of Terabit Computer Specialty Company between 1979 and 1996. Terabit was merged with E&S in March. Mr. Tanner has less than 1 year of service with the Company.\n[THIS SPACE INTENTIONALLY LEFT BLANK]\nFORM 10-K\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nPRICE RANGE OF COMMON STOCK\nThe Company's common stock trades on The Nasdaq Stock Market under the symbol \"ESCC\". The following table sets forth the range of the high and low sales prices per share of the Company's common stock for the calendar quarters indicated, as reported by Nasdaq. Quotations represent actual transactions in Nasdaq's quotation system but do not include retail markup, markdown, or commission.\nAPPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS\nOn March 22, 1995, there were 933 holders of record of the Company's common stock. Because many of such shares are held by brokers and other institutions on behalf of shareholders, the Company is unable to estimate the total number of shareholders represented by these record holders.\nTitle of Class --------------\nCommon Stock, $0.20 Par Value\nDIVIDENDS\nEvans & Sutherland has never paid a cash dividend on its common stock, retaining its earnings for the operation and expansion of its business. The Company intends for the foreseeable future to continue the policy of retaining its earnings to finance the development and growth of its business.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\n(Dollars in thousands except per share amounts)\nQUARTERLY FINANCIAL DATA (Unaudited)\n(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\nITEMS FROM THE CONSOLIDATED STATEMENTS OF OPERATION (AS A PERCENT OF SALES)\nNET SALES WORLDWIDE AND BY MAJOR MARKET SECTORS (IN THOUSANDS)\nRESULTS OF OPERATIONS\nOVERVIEW\nThe Company had a good year in 1995 in terms of revenue growth and profit growth from continuing operations. In 1995, E&S achieved net earnings of $20.8 million versus a net loss of $3.7 million in 1994, and sales from ongoing businesses were up nearly 14% (excluding CDRS and Tripos). Early in 1995, E&S completed its restructuring of operations that were begun the previous year, which included Company-wide reductions affecting every business group in the Company. As a result, expenses as a percent of sales have been significantly reduced (see table on the facing page, \"Items from the Consolidated Statements of Operations\"), and productivity increased 31% as measured by revenue per employee ($142 versus $108). In addition, several strategic transactions were completed during the year, including divesting CDRS, and acquiring Xionix, Inc. and Terabit Computer Specialty Company. The Company plans to continue these corporate development activities.\nNET SALES\nIn 1995, net sales increased less than 1% ($113.2 million versus $113.1 million in 1994). International sales increased 17% ($44.5 million versus $37.9 million in 1994), which offset a 9% decrease in U.S. sales ($68.7 million compared to $75.2 million in 1994). Strong growth in the international markets was led by sales that nearly doubled in the Pacific Rim region ($13.9 million compared to $7.0 million in 1994) and a 26% sales increase in Great Britain ($11.6 million compared to $9.2 million in 1994). Sales in other European and foreign locations showed a slight decrease (see table on the facing page, \"Net Sales Worldwide and by Major Market Sectors\").\nIn 1994, sales decreased 20% ($113.1 million versus $142.2 million in 1993). International sales decreased 46% ($37.9 million compared to $69.9 million in 1993), which more than offset a 4% increase in U.S. sales ($75.2 million compared to $72.3 million in 1993). Results were below expectations in the international markets with significant reductions in each region served, reflecting the unsettled political and business environment in 1994 fueled by the end of the cold war, the worldwide recession, and low oil prices. At the end of 1994, however, signs indicated that these international markets were strengthening, which proved correct as reflected in the 1995 results.\nSales in the Government Simulation market segment increased 5% in 1995 ($85.7 million versus $81.4 million in 1994), compared to a 6% decrease in 1994 ($81.4 million versus $86.2 million in 1993). The improvement was led by increased market share and strong international activity. With a solid backlog of orders and excellent forward visibility, this business is expected to remain strong and continue to show good performance.\nGraphics Systems sales increased 5% in 1995 ($11.6 million versus $11.1 million in 1994) compared to an 18% decrease in 1994 ($11.1 million versus $13.6 million in 1993). The business has been stabilized and it is expected to continue its rebuilding. Recent management changes are expected to have a positive impact in the coming year. The Company expects significant opportunities in the NT workstation market with graphics accelerator and simulation products.\nSales in the Commercial Simulation market (civil aviation) more than doubled from the prior year ($9.1 million versus $4.2 million in 1994), compared to a 73% decrease in 1994 ($4.2 million versus $15.5 million in 1993). Sales in 1995 included $3.7 million in the settlement with Thomson. The Company was awarded several highly competitive orders during the year, including a major order from Airbus Industrie for current and future simulators. In addition to the new relationship with Thomson, E&S continues to build a position as a supplier of complete visual systems, which include the acquisitions of Xionix and Terabit, further expanding both the Company's customer base and its range of products.\nEducation and Entertainment sales nearly tripled from the prior year ($6.0 million versus $2.2 million in 1994), compared to a 21% decrease in 1994 ($2.2 million versus $2.8 million in 1993). Strong performance by the Company's new DIGISTAR II planetarium system and other new entertainment orders both contributed to the growth. Virtual Hang Gliders, a virtual reality hang-glider ride, were installed in two Virtual Reality entertainment centers opened by United Artists Theatres. Growth of such centers is expected, and other E&S products are expected to be featured in these centers in the future.\nCDRS sales in 1995 represent only three months of operations due to the divestiture of CDRS that occurred on April 13, 1995. Tripos, Inc. sales for 1994 represent five months of operations due to the spin-off of Tripos that occurred on June 1, 1994. CDRS and Tripos were included in Graphics Systems prior to disposition, but are classified separately in the table on the facing page for comparative purposes.\nCOSTS AND EXPENSES\nCost of Sales, as a percent of sales, were 56%, 54%, and 46%, respectively, in 1995, 1994, and 1993. The increases in the cost of sales percentages were anticipated. Increased competition with respect to nearly all of the Company's products added pressure on prices and margins. Also, the Company-wide restructuring included the elimination of non-profitable product lines, which resulted in a $7.4 million write-down of inventory in 1995.\nTotal operating expenses were 26% lower in 1995 compared to 1994, and 14% lower in 1994 compared to 1993 due to cost reductions resulting from restructuring the Company. As a percent of sales, total operating expenses, excluding the write-off of in-process R&D in 1995 and the cost of restructuring in 1994 and 1993, were 44%, 54%, and 51%, respectively, for 1995, 1994, and 1993.\nMarketing, General, and Administrative expenses were 7% lower in 1995 compared to 1994, and also lower as a percent of sales (27% in 1995 versus 29% in 1994). In 1994, these expenses were 18% lower compared to 1993, but slightly higher as a percent of sales. The lower expenses in both 1995 and 1994 were expected due to the restructuring.\nResearch and Development expenses were 30% lower in 1995 compared to 1994, and 12% lower in 1994 compared to 1993 due to the restructuring. As a percent of sales, R&D was significantly lower than 1994 (17% in 1995 versus 25% in 1994). Management intends to reduce R&D, as a percent of sales, over the next few years. However, high levels of R&D will continue in support of essential product development to ensure that the Company maintains technical excellence and market competitiveness. The Company continues to fund nearly all R&D costs internally.\nGAIN FROM SALE OF CDRS\nThe Company realized a one-time net gain of $23,506,000 from the sale of CDRS to Parametric Technology Corporation on April 13, 1995. The final transaction value net of expenses was $31,500,000.\nOTHER INCOME, NET\nOther income, net, increased 104% in 1995 from 1994, compared to a decrease of 16% in 1994 from 1993. This resulted from an increase in interest income of 75% in 1995 over 1994, compared to a decrease of 1% in 1994 from 1993. In 1995, higher cash balances were primarily the result of the sale of CDRS. Interest expense declined 22% and 27% respectively in 1995 from 1994 and in 1994 from 1993 due to a lower balance of the Company's outstanding convertible debentures during both 1995 and 1994. Sales of appreciated assets in 1995, 1994, and 1993 resulted in net realized gains of $7,126,000, $4,009,000 and $6,238,000 respectively. The underlying marketable securities comprising these sales were 399,500 shares, 295,000 shares, and 510,000 shares of VLSI common stock sold in each of those years.\nEXTRAORDINARY GAIN\nThe Company realized extraordinary gains of $327,000 and $1,859,000 in 1995 and 1994, respectively. The gains resulted from repurchase by the Company of its 6% Subordinated Convertible Debentures at less than par. There were no repurchase of debentures by the Company in 1993. The current outstanding face amount of debentures outstanding is $18,015,000.\nINCOME TAXES\nProvision (benefit) for income taxes was 39%, (51%), and 36% of pre-tax earnings (loss) for 1995, 1994, and 1993 respectively. The rate increase in 1994's tax benefit results primarily from the closing of the Company's wholly- owned subsidiary in France. In 1993, the Company adopted FASB 109 Accounting for Income Taxes as described in footnote 1 of \"Notes to Consolidated Financial Statements\" in Part II of this report with the resulting tax effects shown as a separate line item in the Consolidated Financial Statements of Operations.\nLIQUIDITY AND CAPITAL RESOURCES\nFunds to support the Company's operations come from net cash provided by operating activities, sale of marketable securities held for investment, and proceeds from employee stock purchase and option plans. The Company also has cash equivalents and short-term marketable securities which can be used as needed.\nDuring 1995, proceeds from the sale of CDRS provided $31,488,000, the sale of VLSI marketable securities contributed $7,930,000, net cash from operating activities provided $7,610,000, and employee stock purchases contributed $2,295,000. The major use of cash in 1995 was for the purchase of capital equipment for $5,846,000, the investment in Strata Inc. of $3,000,000, and the repurchase of convertible debentures of $1,831,000. The net result was an increase in cash and marketable securities to $91,741,000 at the end of 1995 from $51,810,000 in 1994. At the end of 1995, there were no material capital commitments.\nThe Company believes that through internal cash generation, plus the cash investments and marketable securities identified above, it has sufficient resources to cover its cash needs during fiscal year 1996.\nEFFECTS OF INFLATION\nThe effects of inflation were not considered material during 1995.\nFACTORS THAT MAY AFFECT FUTURE RESULTS\nEvans & Sutherland's domestic and international businesses operate in highly competitive markets. The business of the Company is subject to national and worldwide economic and political influences such as recession, political instability, the economic strength of governments, and rapid changes in technology. The Company's operating results are dependent on its ability to rapidly develop, manufacture, and market innovative products that meet customers needs. Inherent in this process are a number of risks that the Company must manage in order to achieve favorable operating results. The process of developing new high technology products is complex and uncertain, requiring innovative designs and features that anticipate customer needs and technological trends. The products, once developed, must be manufactured and distributed in sufficient volumes at acceptable costs to meet demand. Furthermore, portions of the manufacturing operations are dependent on the ability of suppliers to deliver components and subassemblies in time to meet critical manufacturing and distribution schedules. Constraints in these supply lines may adversely affect E&S's operating results until alternate sourcing can be developed.\nThis report contains both historical facts and forward-looking statements. Any forward-looking statements involve 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 detailed in this filing. Although the Company believes it has the product offerings and resources for continuing success, future revenue and margin trends cannot be reliably predicted. Factors external to the Company can result in volatility of the Company's common stock price. Because of the foregoing factors, recent trends should not be considered reliable indicators of future stock prices or financial performance.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following constitutes a list of Financial Statements included in Part II of this report:\n* Report of Management\n* Independent Auditors' Report\n* Consolidated Balance Sheets - December 29, 1995 and December 30, 1994.\n* Consolidated Statements of Operations - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\n* Consolidated Statements of Stockholders' Equity - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\n* Consolidated Statements of Cash Flows - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\n* Notes to Consolidated Financial Statements - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\nThe following constitutes a list of Financial Statement Schedules included in Part IV of this report:\n* Schedule II - 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 presented in the Financial Statements or notes thereto.\nREPORT OF MANAGEMENT\nResponsibility for the integrity and objectivity of the financial information presented in this report rests with the management of Evans & Sutherland. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, where necessary, include estimates based on management judgment. Management also prepared other information in this report and is responsible for its accuracy and consistency with the financial statements.\nEvans & Sutherland has established and maintains an effective system of internal accounting controls. The Company believes this system provides reasonable assurance that transactions are executed in accordance with management authorization in order to permit the financial statements to be prepared with integrity and reliability and to safeguard, verify, and maintain accountability of assets. In addition, Evans & Sutherland's business ethics policy requires employees to maintain the highest level of ethical standards in the conduct of the Company's business.\nEvans & Sutherland's financial statements have been audited by KPMG Peat Marwick LLP, independent public accountants. Management has made available all the Company's financial records and related data to allow KPMG Peat Marwick LLP to express an informed professional opinion in their accompanying report.\nThe Audit Committee of the Board of Directors is composed of the Chairman of the Board and all outside directors and meets regularly with the independent accountants, as well as with Evans & Sutherland management and internal auditing, to review accounting, auditing, internal accounting control, and financial reporting matters.\nJames R. Oyler John T. Lemley President and Vice President and Chief Executive Officer Chief Financial Officer\nREPORT OF INDEPENDENT ACCOUNTANTS\nWe have audited the consolidated financial statements of Evans & Sutherland Computer Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the 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 Evans & Sutherland Computer 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 years in the three-year 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 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 to adopt the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities effective January 1, 1994 and the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of SFAS No. 109, Accounting for Income Taxes.\nKPMG Peat Marwick LLP\nFebruary 13, 1996 Salt Lake City, Utah\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDecember 29, 1995 and December 30, 1994\n(Dollars in Thousands Except Share Amounts)\nSee accompanying notes to consolidated financial statements.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYears ended December 29, 1995, December 30, 1994, and December 31, 1993\n(In thousands except per share amounts)\nSee accompanying notes to consolidated financial statements.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYears ended December 29, 1995, December 30, 1994, and December 31, 1993\n(Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 29, 1995, December 30, 1994, and December 31, 1993 (In thousands)\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nYears ended December 29, 1995, December 30, 1994, and December 31, 1993\n(In thousands)\nSee accompanying notes to consolidated financial statements.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 29, 1995, December 30, 1994, and December 31, 1993\n(Dollars in thousands except share and per share amounts)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\n(A) DESCRIPTION OF BUSINESS -----------------------\nEvans & Sutherland Computer Corporation (the Company) designs, develops, manufactures, and markets high-performance computer systems for various applications with demanding graphics requirements. The Company is a supplier of visual systems for flight training and simulation, high-performance graphics accelerators to major workstation manufacturers, and GL-based software development tools used for advanced three-dimensional (3D) graphics applications on the industry's leading workstation platforms. The Company's operations consist of a single line of business.\nThe Company's fiscal year ends the last Friday in December. The fiscal year ends for the years included in the accompanying consolidated financial statements are the periods ended December 29, 1995, December 30, 1994, and December 31, 1993. Unless otherwise specified, all references to a year are to the fiscal year ending in the year stated.\n(B) PRINCIPLES 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.\n(C) REVENUE RECOGNITION -------------------\nNet sales include revenue from system and software products, software license rights, and service contracts. Product revenues are generally recognized when the product is shipped and the Company has no additional performance obligations.\nRevenue from long-term contracts is recorded using the percentage-of- completion method, determined by the units-delivered method, or when there is significant nonrecurring engineering, the ratio of costs incurred to management's estimate of total anticipated costs. If estimated total costs on any contract indicate a loss, the Company provides currently for the total anticipated loss on the contract. Billings on uncompleted long-term contracts may be greater than or less than incurred costs and estimated earnings and are recorded as an asset or liability in the accompanying consolidated balance sheets.\nSoftware license fees are recognized when the product has been delivered, provided that the Company has no additional performance obligations. Revenues from service contracts are recognized ratably over the related contract period.\n(D) CASH AND CASH EQUIVALENTS -------------------------\nThe Company considers all highly liquid financial instruments purchased with an original maturity to the Company of three months or less to be cash equivalents. Cash equivalents consist of debt securities of $-0- and $21,997 at December 29, 1995 and December 31, 1994, respectively.\n(E) INVENTORIES -----------\nRaw materials and supplies inventories are stated at the lower of weighted average cost or market. Work-in-process and finished goods are stated on the basis of accumulated manufacturing costs, but not in excess of market (net realizable value).\n(F) PROPERTY, PLANT, AND EQUIPMENT ------------------------------\nProperty, plant, and equipment are stated at cost. Depreciation and amortization are computed using the straight-line and double-declining balance methods based on the estimated useful lives of the related assets.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(G) OTHER ASSETS ------------\nOther assets include deferred bond offering costs and goodwill, and are being amortized on the straight-line basis over the bond term, and five years, respectively.\n(H) SOFTWARE DEVELOPMENT COSTS --------------------------\nSoftware development costs are capitalized from the date technological feasibility is achieved, if material; capitalization is discontinued when the product is available for general release to customers. Such deferrable costs have not been material during the periods presented.\n(I) MARKETABLE SECURITIES ---------------------\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (Statement 115) at January 1, 1994. Under Statement 115, the Company classifies its debt and marketable equity securities as available-for-sale.\nAvailable-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of stockholders' equity until realized. A decline in the market value below cost that is deemed other than temporary is charged to results of operations resulting in the establishment of a new cost basis for the security. Dividend income is recognized when earned. Realized gains and losses are included in results of operations and are determined on the specific- identification basis.\n(J) WARRANTY RESERVE ----------------\nThe Company provides a warranty reserve for estimated future costs of servicing products under warranty agreements extending for periods from 90 days to one year. Anticipated costs for product warranty are based upon estimates derived from experience factors and are recorded at the time of sale or over the contract period for long-term contracts.\n(K) EARNINGS (LOSS) PER SHARE -------------------------\nEarnings (loss) per common share are computed based on the weighted average number of shares outstanding during the year totaling 8,638,665, 8,519,990, and 8,256,331 shares for 1995, 1994, and 1993, respectively. Fully diluted earnings per share reflect additional dilution related to stock options and warrants using the market price at the end of the period when higher than the average price for the period. Fully-diluted earnings per share are based on 9,000,710 shares outstanding for 1995.\n(L) INCOME TAXES ------------\nEffective December 26, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes and reported the cumulative effect of the change in the method of accounting for income taxes in the 1993 consolidated statement of operations. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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(M) FOREIGN CURRENCY TRANSLATION ----------------------------\nThe local foreign currency is the functional currency for the Company's foreign subsidiaries. Assets and liabilities of foreign operations are translated to U.S. dollars at the current exchange rates as of the applicable balance sheet date. Revenues and expenses are translated at the average exchange rates prevailing during the period. Adjustments resulting from translation are reported as a separate component of stockholders' equity.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(M) FOREIGN CURRENCY TRANSLATION (CONTINUED) ----------------------------\nCertain transactions of the foreign subsidiaries are denominated in currencies other than the functional currency, including transactions with the parent company. Transaction gains and losses are included in miscellaneous income (expense) for the period in which the transaction occurs and amounted to net gains (losses) of $(53) in 1995, $266 in 1994, and $(291) in 1993.\n(N) 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(O) RECLASSIFICATIONS -----------------\nCertain reclassifications have been made in the 1994 and 1993 consolidated financial statements to conform with classifications adopted in 1995.\n(2) MARKETABLE SECURITIES ---------------------\nThe amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value for securities by major security type and class of security at 1995 and 1994, were as follows:\nProceeds from sales of securities during 1995 and 1994 were $85,147 and $16,062, respectively. Gross realized gains for 1995 and 1994 were $154 and $3 and gross realized losses for the same periods were $291 and $8, respectively.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(2) MARKETABLE SECURITIES (CONTINUED) ---------------------\nLong-term investment securities are summarized as follows:\nProceeds from sales of long-term securities during 1995 and 1994 were $7,930 and $4,502, respectively. Gross realized gains for 1995 and 1994 were $7,263 and $4,014 and there were no gross realized losses for the same periods.\nOn August 10, 1995, the Company purchased 109,259 common shares of Strata, Inc. (Strata) which represents less than 10% of the outstanding common shares. The shares are not marketable and are stated at cost. Strata is a developer of software tools for multimedia producers.\n(3) INVENTORIES ----------- Inventories are summarized as follows:\nInventories totaling $10,767 were written off during 1995 of which $7,467 was charged to cost of sales and $3,300 to the CDRS sale (note 19).\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(4) LONG-TERM CONTRACTS ------------------- Comparative information with respect to uncompleted contracts follows:\n(5) PROPERTY, PLANT, AND EQUIPMENT ------------------------------\nThe cost and estimated useful lives of property, plant, and equipment are summarized as follows:\nAll buildings and improvements owned by the Company are constructed on land leased from an unrelated third party. Such leases extend for a term of 40 years from 1986, with options to extend two of the leases for an additional 40 years and the remaining four leases for an additional 10 years. At the end of the lease term, including any extension, the buildings and improvements revert to the lessor.\n(6) NOTES PAYABLE TO BANKS ----------------------\nThe following is a summary of notes payable to banks:\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(6) NOTES PAYABLE TO BANKS (CONTINUED) ----------------------\nThe average balance outstanding and weighted average interest rate are computed based on the outstanding balances and interest rates at month-end during each year.\nThe Company has unsecured revolving line of credit agreements with foreign banks totaling $7,466 at December 29, 1995, of which approximately $3,693 was unused and available. The Company also has a $5,000 unsecured line of credit with a U.S. bank for which $-0- and $350 were outstanding at December 31, 1995 and 1994, respectively.\n(7) ACCRUED EXPENSES ----------------\nAccrued expenses consist of the following:\n(8) LONG-TERM DEBT --------------\nLong-term debt is comprised of six percent convertible subordinated debentures due in 2012. The six percent convertible subordinated debentures are convertible at the bondholders option at any time prior to maturity, subject to adjustments in certain events. The debentures are redeemable at the Company's option, in whole or in part, at declining redemption premiums until March 1, 1997, and at par on and after such date. The Company is required to provide a sinking fund balance of five percent of the applicable principal amount of the debentures annually beginning March 1, 1998. The debentures are subordinated to all existing and future superior indebtedness.\nDuring 1995 and 1994, the Company repurchased $2,360 and $16,691, respectively, of convertible debentures on the open market. These purchases resulted in extraordinary gains of approximately $536 and $2,974, respectively. These extraordinary gains are shown net of income taxes in the accompanying consolidated statements of operations.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(9) INCOME TAXES ------------ Components of income tax expense (benefit) attributable to income (loss):\nThe actual tax expense differs from the tax expense (benefit) as computed by applying the U.S. federal statutory tax rate of 35 percent for 1995, and 34 percent for 1994 and 1993, to earnings before income taxes as follows:\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(9) INCOME TAXES (CONTINUED) ------------\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 29, 1995 and December 30, 1994, are presented below:\nManagement believes the existing net deductible temporary differences will reverse during the periods in which the Company generates net taxable income. The Company has a strong taxable earnings history. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset may not be realized. The Company has established a valuation allowance primarily for net operating loss and tax credit carryforwards from an acquired subsidiary and foreign subsidiaries as a result of the uncertainty of realization.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(10) STOCK OPTION, PURCHASE, AND BONUS PLANS ---------------------------------------\nStock Option Plans - The Company has granted options to officers, ------------------ directors, and employees to acquire shares of the Company's common stock. Substantially all options so granted provide for purchase prices equal to the fair market value on the date of grant. During 1995, shareholders authorized an additional 350,000 shares to be granted under the plans. In addition, 180,000 authorized shares from the stock bonus plan were transferred to the stock option plans and the stock bonus plan was eliminated. A summary of activity follows:\nUnder the terms of the stock option plans, 794,004 shares of common stock were authorized and reserved for issuance, but were not granted at December 29, 1995.\nStock Purchase Plan - The Company has an employee stock purchase plan ------------------- whereby qualified employees are allowed to purchase limited amounts of the Company's common stock at 85 percent of the market value of the stock at the time of the sale. A total of 500,000 shares are authorized under the plan.\n(11) LEASE COMMITMENTS -----------------\nThe Company occupies real property and uses certain equipment under lease arrangements, which are accounted for primarily as operating leases. A summary of lease expense under such arrangements follows:\nA summary of noncancelable long-term operating lease commitments follows:\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(12) INDUSTRY SEGMENT AND FOREIGN OPERATIONS ---------------------------------------\nA summary of operations by geographic area follows:\nTransfers between geographic areas are accounted for at market price, and intercompany profit is eliminated in consolidation. Operating earnings (loss) are total sales, less operating expenses. Identifiable assets are those assets of the Company that are identified with the operations in each geographic area. Corporate assets are principally cash, marketable securities, and long-term investments.\n(13) SALE TO FOREIGN AND MAJOR CUSTOMERS -----------------------------------\nA summary of sales to foreign and major customers follows:\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(14) EMPLOYEE BENEFIT PLANS ----------------------\nPension Plan (Plan) - The Company has a defined benefit pension plan ------------ covering substantially all employees who have attained age 21 with service in excess of one year. Benefits at normal retirement age (65) are based upon the employee's years of service and the employee's highest compensation for any consecutive five of the last ten years of employment. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes.\nSupplemental Executive Retirement Plan (SERP) - Effective July 1, 1995, --------------------------------------------- the Company introduced a non-qualified SERP which will be phased in over three years. The SERP, which is unfunded, provides eligible executives defined pension benefits, outside the Company's pension plan, based on average earnings, years of service, and age at retirement.\nNet annual Plan and SERP expense is summarized as follows:\nThe following assumptions were used in accounting for the pension plan at the end of each year:\nSince the SERP was established on July 1, 1995, the discount rate used in determining the 1995 expense was 7.0 percent.\nThe following summarizes the funded status and amounts recognized in the Company's consolidated financial statements:\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(14) EMPLOYEE BENEFIT PLANS (CONTINUED) ----------------------\nDeferred Savings Plan - The Company has a deferred savings plan which --------------------- qualifies under Section 401(k) of the Internal Revenue Code. The plan covers all employees of the Company who have at least one year of service and who are age 18 or older. The Company makes matching contributions of 50 percent of each employee's contribution not to exceed six percent of the employee's compensation. The Company's contributions to this plan for 1995, 1994, and 1993 were $836, $1,064, and $1,025, respectively.\nLife Insurance - In 1995, the Company purchased company-owned life -------------- insurance policies insuring the lives of certain active employees. The policies accumulate asset values to meet future liabilities including the payment of employee benefits such as supplemental retirement. At December 29, 1995, the investment in the policies included in other assets was $294 and net life insurance expense was $57.\n(15) PREFERRED STOCK ---------------\nThe Company has both Class A and Class B Preferred Stock with 5,000,000 shares authorized for each class. The Company has reserved 300,000 shares of the Class A Preferred Stock as Series A Junior Preferred Stock under a shareholder rights plan. This preferred stock entitles holders to 100 votes per share and to receive the greater of $2.00 per share or 100 times the common dividend declared. Upon voluntary or involuntary liquidation, dissolution, or winding up of the Company, holders of the preferred stock would be entitled to be paid, to the extent assets are available for distribution, an amount of $100 per share plus any accrued and unpaid dividends before payment is made to common stockholders.\nIn connection with this preferred stock, the Company issued one warrant to each common stockholder that would be exercisable contingent upon certain conditions and would allow the holder to purchase 1\/100th of a preferred share per warrant. The warrants attached to the shares outstanding on November 30, 1988 and to all new shares issued after that date; the warrants outstanding at December 29, 1995 and December 30, 1994 are equal to the shares outstanding of 8,715,320, and 8,552,106, respectively. At December 29, 1995 and December 30, 1994, the warrants were not exercisable, and no shares of preferred stock have been issued.\n(16) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS ---------------------------------------------------------\nThe carrying amount of cash and cash equivalents, receivables, notes payable to bank, accounts payable, and accrued expenses approximates fair value because of their short maturity.\nThe fair value of the Company's long-term debt instruments ($16,214 at December 29, 1995) is based on quoted market prices.\n(17) COMMITMENTS AND CONTINGENCIES -----------------------------\nIn the normal course of business, the Company has various legal claims and other contingent matters, including items raised by government contracting officers and auditors. Although the final outcome of such matters cannot be predicted, the Company believes the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial condition, liquidity, or results of operations.\nIn September 1995, the Company reached a settlement agreement with Thomson Training & Simulation (Thomson). Under the agreement, the Company received $3,750 from lost revenues for breach of a working agreement by Thomson. The settled agreement allows the Company and Thomson to pursue opportunities in the civil pilot market on a nonexclusive basis. The amount paid to the Company under this settlement is classified as sales in the Company's consolidated statements of operations.\n(18) RESTRUCTURING CHARGES ---------------------\nIn the fourth quarter of 1994, the Company incurred a restructuring charge of $8,212. The restructuring was undertaken to remove the Company's divisional structure, reengineer research and development, consolidate manufacturing, finance, administration and field service operations, and to modify product lines. This restructuring eliminated approximately 200 jobs worldwide in the areas noted above or about 20 percent of the work force. Amounts expended in 1995 approximated the December 30, 1994 accrual balance.\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(18) RESTRUCTURING CHARGES (CONTINUED) ---------------------\nIn the fourth quarter of 1993, the Company incurred a restructuring charge of $7,900. The restructuring was undertaken to better serve the Company's changing markets and to more appropriately focus its resources on profitable opportunities. This restructuring eliminated approximately 170 jobs worldwide or about 13 percent of the work force. Amounts expended in 1994 approximated the December 31, 1993 accrual balance.\n(19) BUSINESSES SOLD, ACQUIRED, AND SPIN-OFF ---------------------------------------\nOn April 12, 1995, the Company sold CDRS to Parametric Technology Corporation (PTC), a Massachusetts Corporation. The proceeds from the sale net of direct expenses of $1,591 was approximately $31,488 resulting in a gain of $23,506 summarized as follows:\nOn October 3, 1995 and on November 21, 1994, the Company acquired all of the outstanding common stock of Xionix Simulation, Inc. (Xionix) and Portable Graphics, Inc. (PGI) for $1,080 and $1,300, respectively. Xionix manufactures low-cost flight-system trainers and PGI is involved in software development. These business combinations were accounted for under the purchase method of accounting. Accordingly, the purchase price was allocated to assets and liabilities based on their estimated fair values as of the date of acquisition. Operations of Xionix and PGI are included in the accompanying consolidated financial statements from the date of acquisition, and are not material in relation to the Company's consolidated financial statements; pro forma financial information has therefore not been presented. The Company allocated $705 of the Xionix purchase price to in process research and development which has no alternative future use and this amount was written off during 1995.\nEffective June 1, 1994 the Company's stockholders received a special dividend in the form of a spin-off of Tripos, Inc. (Tripos), a wholly-owned subsidiary of the Company at the time. Stockholders received one share of Tripos common stock for every three shares of E&S common stock held on May 25, 1994, the record date of the spin-off.\n(20) ACCOUNTING STANDARDS ISSUED NOT YET ADOPTED -------------------------------------------\nIn October 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.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\n\"None\"\n[THIS SPACE INTENTIONALLY LEFT BLANK]\nFORM 10-K\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nInformation regarding directors of the Company is incorporated by reference from \"Election of Directors\" in the 1995 Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 16, 1996.\nInformation concerning current executive officers of the Company is incorporated by reference to the section in Part I hereof found under the caption \"Executive Officers of the Registrant\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding this item is incorporated by reference from \"Executive Compensation\" in the 1995 Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 16, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding this item is incorporated by reference from \"Security Ownership of Certain Beneficial Owners and Management\" in the 1995 Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 16, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding this item is incorporated by reference from \"Executive Compensation - Summary Compensation Table\", \"Report of the Compensation and Stock Options Committee of the Board of Directors\", and \"Termination of Employment and Change of Control Arrangements\", in the 1995 Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 16, 1996.\nFORM 10-K\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe following constitutes a list of Financial Statements, Financial Statement Schedules, and Exhibits required to be included in this report:\n1. FINANCIAL STATEMENTS - INCLUDED IN PART II, ITEM 8 OF THIS REPORT: --------------------\nReport of Management\nReport of Independent Auditors\nConsolidated Balance Sheets - December 29, 1995 and December 30, 1994.\nConsolidated Statements of Operations - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\nConsolidated Statements of Stockholders' Equity - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\nConsolidated Statements of Cash Flows - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\nNotes to Consolidated Financial Statements - Years ended December 29, 1995, December 30, 1994, and December 31, 1993.\n2. FINANCIAL STATEMENT SCHEDULES - INCLUDED IN PART IV OF THIS REPORT: -----------------------------\nSchedule II - 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 presented in the Financial Statements or notes thereto.\n3. EXHIBITS --------\n3.1 Articles of Incorporation, as amended, filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 25, 1987, and incorporated herein by this reference.\nAmendments to Articles of Incorporation filed as Exhibit 3.1.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 1988, and incorporated herein by this reference.\n3.2 By-laws, as amended, filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 25, 1987, and incorporated herein by this reference.\n10.1 1985 Stock Option Plan, filed as Exhibit 1 to the Company's Post- effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 2-76027, and incorporated herein by this reference.\n10.2 1989 Stock Option Plan for Non-employee Directors, filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1989, and incorporated herein by this reference.\n10.3 The Company's 1981 Executive Stock Bonus Plan, filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1982, and incorporated herein by this reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\n3. EXHIBITS (CONTINUED) --------\n10.4 The Company's 1991 Employee Stock Purchase Plan, filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8, SEC File No. 33-39632, and incorporated herein by this reference.\n10.5 Transition Employment and Separation Agreement dated January 19, 1994, between the Company and Mr. Richard F. Leahy, filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.6 Terms of Employment Agreement dated June 23, 1994, between the Company and Mr. Steven C. Eror, filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.7 Employment Agreement dated November 17, 1994, between the Company and Mr. Gary E. Meredith, filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.8 Employment Agreement dated November 29, 1994, between the Company and Mr. James R. Oyler, filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.9 Release and Separation Agreement dated January 6, 1995, between the Company and Mr. Robert A. Schumacker, filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.10 Mutual Release and Separation Agreement dated January 27, 1995, between the Company and Mr. Rodney S. Rougelot, filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1994, and incorporated herein by this reference.\n10.11 The Company's 1995 Long-Term Incentive Equity Plan.\n10.12 Asset Purchase Agreement dated March 1, 1995, between the Company and Parametric Technology Corporation as to E&S' divestiture of its Design Software group (CDRS).\n10.13 Settlement Agreement dated September 13, 1995, between the Company, Thomson Training and Simulation Limited, and Hughes Aircraft Company.\n10.14 The Company's Executive Savings Plan.\n10.15 The Company's Supplemental Executive Retirement Plan (SERP).\n23.1 Consent of Independent Accountants.\n24.1 Powers of Attorney for Messrs. Stewart Carrell, Henry N. Christiansen, Peter O. Crisp, John T. Lemley, Gary E. Meredith, James R. Oyler, Ivan E. Sutherland, and John E. Warnock.\nNo reports on Form 8-K were filed during the fourth quarter of the year ended December 29, 1995.\nTRADEMARKS USED IN THIS FORM 10-K\nDIGISTAR II and Virtual Glider are trademarks or registered trademarks of Evans & Sutherland Computer Corporation. CDRS is a registered trademark of Tripos, Inc. All other products or services mentioned in this Form 10-K are identified by the trademarks or service marks of their respective companies or organizations.\nSchedule II -----------\nEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nYears ended December 29, 1995, December 30, 1994, and December 31, 1993\n(In thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEVANS & SUTHERLAND COMPUTER CORPORATION\nMarch 28, 1996 By: \/s\/ JAMES R. OYLER ------------------------- JAMES R. OYLER, PRESIDENT\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ STEWARD CARRELL * Chairman of the March 28, 1996 ------------------------- STEWART CARRELL Board of Directors\n\/s\/ JAMES R. OYLER Director and President March 28, 1996 -------------------------- JAMES R. OYLER (Chief Executive Officer)\n\/s\/ JOHN T. LEMLEY Vice President and Chief March 28, 1996 -------------------------- JOHN T. LEMLEY Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ HENRY N. CHRISTIANSEN * Director March 28, 1996 -------------------------- HENRY N. CHRISTIANSEN\n\/s\/ PETER O. CRISP * Director March 28, 1996 -------------------------- PETER O. CRISP\n\/s\/ IVAN E. SUTHERLAND * Director March 28, 1996 -------------------------- IVAN E. SUTHERLAND\n\/s\/ JOHN E. WARNOCK * Director March 28, 1996 -------------------------- JOHN E. WARNOCK\nBy: \/s\/ GARY E. MEREDITH * March 28, 1996 -------------------------- GARY E. MEREDITH Attorney-in-Fact","section_15":""}
{"filename":"769689_1995.txt","cik":"769689","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nHealth Images, Inc. (the \"Company\") is a radiology management company which establishes and operates 52 freestanding diagnostic imaging centers (\"Imaging Centers\"). Management believes the Company is the largest operator of freestanding magnetic resonance imaging (\"MRI\") centers in the United States. The Company began its imaging center business in 1984 and recently began its second decade in the business of providing radiology services.\nTraditionally the Company's emphasis has been to provide MRI services exclusively. In recent years the Company has begun adding other imaging modalities in certain of its centers. The Company believes its expertise in radiology services and the economies of scale in the imaging business aid it in its expansion into other imaging modalities in its current markets. The Company evaluates each of its centers separately to determine whether to add other imaging modalities. In certain markets, the Company is beginning to experience a preference by certain third party payors for multi-modality diagnostic imaging centers. The Company is responding to these preferences in those markets where they are apparent.\nEffective March 31, 1995, the Company acquired fifteen (15) multi-modality diagnostic imaging centers from MedAlliance, Inc. These centers are located in Aurora, Colorado (2 centers) (a suburb of Denver); Denver, Colorado; Baton Rouge, Louisiana (2 centers); Beaumont, Texas; Birmingham, Alabama (2 centers); Carrollton, Georgia; Chattanooga, Tennessee; Greenville, South Carolina; Huntsville, Alabama; Knoxville, Tennessee; Nashville, Tennessee; and Port Arthur, Texas. The Company sold the Carrollton center effective June 6, 1995, and the Chattanooga center effective November 1, 1995. The Company retained its interest in an MRI joint venture in Chattanooga. The Company also consolidated its two centers in Birmingham into one center in September, 1995.\nThe MedAlliance acquisition of multi-modality centers complements the Company's addition of imaging modalities other than MRI at certain of its existing centers. Seventeen (17) of the Company's Imaging Centers offer computerized tomography (\"CT\"), in addition to MRI, seventeen (17) of the Company's Imaging Centers offer x-ray services, fifteen (15) Imaging Centers offer ultrasound (\"US\") services, and twelve (12) Imaging Centers offer mammography (\"MM\").\nIn 1996, Health Images of Jacksonville will expand into a multi-modality center offering CT, X-ray, MM, US, nuclear medicine and fluoroscopy services. Shamrock Imaging will add a second MRI system (1.5 Tesla) in 1996 as well as fluoroscopy and nuclear medicine. In addition, Shamrock Imaging will be the first center to expand into the area of pain management services. Health Images of Arlington will add a fixed site MRI System (instead of a mobile) and nuclear medicine in 1996.\nMRI uses magnetic fields and radio waves to produce diagnostic images of cross-sectional anatomy. Although other imaging modalities may be more cost efficient for certain purposes, MRI studies are generally better defined and more precise than those produced by other imaging modalities. The Company believes that MRI is the imaging modality of choice for diagnosing most central nervous system disorders and that physicians are increasingly requesting MRI for non-neurological applications. Licensed physicians provide diagnostic readings of the imaging scans pursuant to contractual arrangements with the Company.\nAs an outgrowth of its MRI business, the Company established an Engineering Services Division in September, 1986, to provide maintenance to MRI systems at certain of the Company's Imaging Centers as well as to provide MRI system maintenance to other operators. In 1988, the Engineering Services Division began to assemble the HI Standard(R) MRI system for use in the Company's Imaging Centers. The HI Standard MRI system is a mid-field .6 Tesla system which has received FDA approval. It is a derivative of systems manufactured by Technicare Corporation, a subsidiary of Johnson & Johnson, and is produced under licenses from Johnson & Johnson and the British Technology Group. See \"Business -- Engineering Services Division.\" In late 1991, the Engineering Services Division also began servicing the Company's Diasonics MRI Systems, which are located at seven (7) of the Company's Imaging Centers. In 1995, this Division began servicing the magnets on seven (7) GE MRI systems acquired from MedAlliance. The Engineering Services Division also services the Company's Picker CT Systems.\nThe Engineering Services Division reduces the Company's effective cost of equipment and maintenance by repairing, refurbishing and rebuilding certain of the Company's MRI systems and other imaging equipment and by assembling the HI Standard MRI system for use in the Company's Imaging Centers. Because the Company's MRI system costs the Company less than MRI systems purchased from other manufacturers, the operating break even point (before allocation of corporate overhead) is approximately 40% lower at the Imaging Centers that use the HI Standard MRI system. All of the Imaging Centers developed by the Company and opened since the beginning of 1989 use the HI Standard MRI system. The Engineering Services Division also sells MRI system upgrades such as surface coils to third parties, and is engaged in research and development relating to enhancing and upgrading MRI systems.\nIn June 1993, the Board of Directors authorized a major technology program to develop a new state-of- the-art MRI system. This system, the HI STAR(TM) will replace the HI Standard MRI system. The Company received 510(k) approval of the HI STAR MRI System in September 1995, and commenced beta testing of the HI STAR in summer 1995. The Company has begun manufacturing the HI STAR MRI System and plans to install the first system by summer 1996.\nThe Company was incorporated in 1982 as a Florida corporation providing cardiovascular perfusion services to hospitals. In February 1984, management expanded the business activities of the Company to establish the Atlanta Imaging Center in north Atlanta, Georgia. Effective March 31, 1985, the Company discontinued its cardiovascular perfusion business. On June 29, 1989, the Company changed its state of incorporation from Florida to Delaware.\nDEVELOPMENT AND ACQUISITION OF IMAGING CENTERS\nThe Company currently has one Imaging Center under development. It is located in York, England and is scheduled to open in mid-1996. It will be the Company's fifth center in the United Kingdom.\nThe Company regularly reviews acquisition opportunities on an individual basis. The Company plans to acquire an individual imaging center or group of centers in geographic areas in which it currently operates or a company in the diagnostic imaging business if management feels that the purchase price is attractive. The Company believes its size provides economies of scale that enhance any such prospective combination. The Company may also develop new Imaging Centers in the future in areas where the HI STAR MRI System and the Company's in-house construction capabilities allow the Company to establish a cost-effective center in an area which is currently underserved by MRI.\nThe Company currently views the expansion of certain of its existing centers into additional diagnostic imaging modalities as being the most immediate source for growth opportunities. The Company reviews each center on an individual basis to determine whether to add a modality. In certain markets, this decision is driven by managed care payors seeking multi-modality imaging centers to supply the radiology needs of their beneficiaries.\nOPERATION OF IMAGING CENTERS\nEach Imaging Center is staffed by administrative and technical personnel. In addition, a physician or a physician group provides professional services and interprets studies for each Imaging Center under a contract with the Company. Such physicians are independent contractors and are not employees of the Company or the affiliated partnerships; however, in certain isolated instan-\nces, some of these physicians have investment interests in the Company or in a particular affiliated partnership or both.\nThe Imaging Centers are open at such hours as are appropriate for the local medical community. Most are open from 7:30 a.m. to 9:00 p.m. each weekday, and approximately one-third of the Imaging Centers routinely maintain hours on Saturdays. Others will open on Saturdays as needed.\nThe diagnostic modalities at each Imaging Center are maintained by either the Company's Engineering Services Division or under an agreement with the manufacturer. The Company's Engineering Services Division services all of the Imaging Centers which utilize either the HI Standard or Diasonics MRI Systems. The Company and its affiliated partnerships purchase upgrades for the MRI systems and other diagnostic modalities from time to time as needed from either the Company's Engineering Services Division or from the manufacturer of the modality.\nEach Imaging Center generally charges patients a fee for providing diagnostic studies on a per procedure or per study basis. The physician or physician group that provides diagnostic readings of the studies generally receives a contractually specified percentage of such fee when and if collected by the Company or the limited partnership. At certain Imaging Centers, the entity which provides the diagnostic readings bills the patient or third- party payor directly for such services.\nPricing of medical services, including MRI scans, varies by region and locality. The Imaging Centers maintain a competitive billing strategy based upon evaluation of available pricing data with respect to each location. Each Imaging Center adopts standard pricing procedures which may be modified under certain circumstances. The current undiscounted average list patient charge per non-contrast MRI study for the Imaging Centers, including physician interpretation fees, is approximately $834.00. In most cases, however, charges are discounted and the average realizable charge per MRI is substantially less than list. Each Imaging Center maintains sufficient price flexibility to enable it to compete with other diagnostic imaging services provided in the local community.\nENGINEERING SERVICES DIVISION\nIn 1986, in response to the decision of Johnson & Johnson to discontinue the MRI system manufacturing business of its wholly-owned subsidiary, Technicare Corporation (\"Technicare\"), the Company's management decided to establish an Engineering Services Division to service Technicare MRI systems owned by the Company. The Company hired a number of MRI field service technicians experienced in servicing Technicare CT and MRI systems and purchased parts inventories in order to conduct its own engineering and service functions.\nAfter determining that a market to service Technicare equipment operated by others existed, the Company expanded the Engineering Services Division to service such MRI systems. As of March 15, 1995, the Engineering Services Division provided service for thirty-five (35) MRI systems operated by parties other than the Company or any of its affiliated partnerships.\nThe Engineering Services Division reduces the Company's effective cost of equipment and maintenance by repairing, refurbishing and rebuilding certain of the Company's MRI systems. As a result of expertise acquired in repairing and improving these Company MRI systems and pursuant to the licenses described below, the Company, through its Engineering Services Division, began in August 1988 to assemble the HI Standard MRI system for use in the Company's Imaging Centers.\nTo enable the Company to manufacture MRI systems arising from the Technicare technology, the Company entered into a Master Patent License Agreement (the \"Patent Agreement\") with The National Research Development Corporation, an English corporation d\/b\/a British Technology Group (\"BTG\") as of October 1, 1987, and a license agreement (the \"J&J Agreement\") with Johnson & Johnson as of April 1, 1988. Pursuant to the Patent Agreement, the Company obtained non-exclusive perpetual licenses under certain patents and patent applications of which BTG is the proprietor. The licenses allow the Company to develop, manufacture and market MRI systems and upgrade packages for MRI systems in the United States. The Patent Agreement was amended as of January 1, 1989 to allow the Company to develop, manufacture and market MRI systems and upgrade packages for MRI systems worldwide. Under the J&J Agreement, the Company obtained non-exclusive perpetual licenses to create, copy, use, license and sell certain Johnson & Johnson MRI software, hardware and derivative works relating to the Teslacon II MRI system anywhere in the world. Johnson & Johnson is the assignee of its wholly-owned subsidiary, Technicare.\nThe thirty-one (31) Imaging Centers opened since the beginning of 1989 use the HI Standard MRI system. Because the Company's MRI system costs the Company less than MRI systems purchased from other manufacturers, the operating break even point (before allocation of corporate overhead) is approximately 40% lower at the Imaging Centers which use the HI Standard MRI system. The Company contemplates a comparable break even difference between those imaging centers using the HI STAR MRI System and MRI Systems manufactured by third parties.\nIn June 1993, the Board of Directors approved a major technology program to develop a state-of-the-art MRI system. This system, the HI STAR, will replace the Company's HI Standard MRI systems. The HI STAR MRI system is not based on Technicare technology. The HI STAR will allow the Company to retain its edge of having a more cost-effective MRI system than its competitors.\nIn September 1995 the federal Food and Drug Administration issued the 510(k) approval of the HI STAR MRI system. The Company has commenced clinical beta testing of the HI STAR MRI system and plans to begin manufacturing and installing the HI STAR MRI system in certain centers in 1996.\nIMAGING CENTERS\nThe following table sets forth certain information concerning the Imaging Centers owned and operated by the Company as of March 15, 1996. The table also set forth the Imaging Centers which provide diagnostic modalities other than MRI.\nThe five (5) Imaging Centers that are not 100% owned by the Company are owned by limited partnerships in which the Company is sole general partner, except Lancaster and Health Images of Philadelphia where it is a co- general partner. The Company has offered to buy out the remaining interests, in each of these limited partnerships at fair market value but the remaining limited partners do not wish to sell. The percentage of ownership shown for limited partnerships represents the limited partnership interests owned by the Company.\n=========================================\n(1) Health Images of Jacksonville will expand into a new 11,000 square foot multi-modality facility in summer 1996 offering CT, ultrasound, mammography, nuclear medicine and fluoroscopy.\n(2) Shamrock is adding a 6,000 square foot expansion that will add a second, higher field strength (1.5T) MRI system, fluoroscopy, and nuclear medicine services in 1996. In addition, Shamrock will be the first of the Company's imaging centers to offer pain management services.\n(3) The Company acquired this center as of the date indicated from a party unaffiliated with Health Images.\n(4) Health Images of Arlington is relocating to a new 10,000 square foot facility in 1996 that will offer a fixed site MRI system (rather than a mobile) and will add nuclear medicine.\nONCOLOGY CENTER\nOn January 15, 1990, the Company opened a radiation oncology center in Williamsport, Pennsylvania, the Williamsport Regional Radiation Oncology Center (the \"Oncology Center\"). The Oncology Center provides radiation treatment therapy to cancer patients in the Williamsport area on an outpatient basis. Radiation therapy uses high energy x-rays produced by a machine called a linear accelerator designed to stop cancer cells from growing and multiplying. The Oncology Center's medical equipment (a Mevatron MD Class Dual Photon Medical Linear Accelerator and a Mevasim S for simulation and localization of radiation therapy) is used by the Oncology Center's board certified oncologists and professional staff to assess, plan and provide treatment to cancer patients. The Company has no current plans to operate additional oncology centers.\nGOVERNMENT REGULATION\nThe Imaging Centers and the Oncology Center are subject to federal law and various federal and state regulations. While the Company believes that its operations comply with applicable regulations, the Company has not sought or received interpretive rulings to that effect. Additionally, there can be no assurance that subsequent laws, subsequent changes in present laws or interpretations of laws will not adversely affect the Company's operations. Certain applicable laws and regulations are generally described below:\nFDA Regulation of MRI\nNo one may market a medical device without the approval of the U.S. Food and Drug Administration (the \"FDA\"). The Company has obtained the appropriate approval from the FDA to market its HI Standard MRI system for commercial use. On June 23, 1989, the FDA also reclassified the HI Standard MRI system from a Class III to a Class II Medical Device, which reduces the level of FDA regulation applicable to new technological developments. The Company filed with the FDA for 510(k) approval of the HI STAR MRI System on September 22, 1994, and received approval in September 1995.\nThe Company registered with the FDA as a Medical Device Establishment on October 3, 1987. The Company updates this registration annually.\nCertificates of Need\nMost states have Certificate of Need (\"CON\") programs which control and regulate the construction of health care facilities and the acquisition by health care facilities of major medical equipment. Although such programs vary, generally a CON is required before constructing a \"health care facility,\" and a health care facility must obtain a CON before acquiring major medical equipment or establishing new institutional services. A CON is granted on the basis of various criteria relating to need, giving consideration to the extent to which such facilities, equipment or services are available to a specified geographical area and the population of such area. The term \"health care facility,\" as defined by many states, does not include facilities that provide service only to outpatients. Accordingly, in those jurisdictions, an outpatient clinic need not obtain a CON.\nSome states, however, require that any person acquiring major medical equipment, such as an MRI system, first obtain a CON regardless of whether or not the MRI system is acquired by or placed in a health care facility. In those states, even if an Imaging Center may be constructed without a CON, the purchase of an MRI system at a cost comparable to that paid by the Imaging Centers will require a CON.\nThe Company has CONs for Stage Road Magnetic Imaging in Memphis and Nashville ODC in Nashville, Tennessee, the Philadelphia, Lancaster and Lebanon Centers in Pennsylvania, and the Greenville Center, the Charleston Center and the Hilton Head Center in South Carolina. Knoxville ODC's operations were grandfathered by the State of Tennessee when it adopted its current CON laws.\nProhibition Against Practice of Medicine\nThe establishment, marketing and operation of the Imaging Centers are subject to laws prohibiting the practice of medicine by non-physicians and the rebate or division of fees between physicians and non-physicians. They also limit the manner in which patients may be solicited. Management believes that its plan of operations complies with such laws. Under the Company's plan, the employees of each Imaging Center provide only technical services relating to the diagnostic scans. Professional medical services, such as the reading of the diagnostic studies and related diagnosis, are separately provided by licensed physicians. There can be no assurance, however, that state authorities or courts will not determine that these relationships constitute the unauthorized practice of medicine by the Company. Such determinations could have a materially adverse effect upon the Company and the partner-\nships and would prohibit the affected Imaging Centers from continuing their current procedures for conducting business.\nReimbursement\nBecause most patients at the Imaging Centers rely upon third-party or government reimbursement in payment for medical services, the amount and availability of third-party and government reimbursement for MRI scans directly impact the use and revenues of the Imaging Centers.\nPrivate third-party insurance carriers generally pay for medically necessary MRI scans. The Company's Imaging Centers accept Medicare patients and, for competitive reasons, enter from time to time into contractual reimbursement arrangements with various third parties, including HMOs, Blue Cross\/Blue Shield and other insurers. These arrangements generally result in net collected revenues lower than the Company's list prices for services.\nMedicare reimbursement rates vary from state to state and vary among regions within a state. During the year ended December 31, 1995, approximately 11.6% of the patients referred to the Imaging Centers were Medicare patients. The percentage of Medicare patients varies greatly among the Imaging Centers, with the lowest percentage being 4.8% and the highest percentage being 41.5% during the same period. The Company's average Medicare reimbursement for MRI was $527.00.\nAlso, beginning in January 1992, HCFA, at the direction of Congress, changed the way it paid for many health care services reimbursed under Medicare, including MRI services. At that time, it implemented a Resource-Based Relative Value Scale (\"RBRVS\") system for certain covered services. As a result of this change, the Company's per scan reimbursement from Medicare has been reduced in some instances.\nThe Company has been facing declining reimbursements in recent years due to a number of factors although the rate of decline has diminished recently. The reasons for this decline arise from cost containment efforts at federal and state levels and from efforts of insurers and businesses to rein in health care costs. The Company's average reimbursements per scan from Medicare, Medicaid and Blue Cross\/Blue Shield have all declined in recent years. In addition, an increasing percentage of the patients are covered under managed care agreements that stipulate a discount.\nIn addition, Pennsylvania, where five (5) of the Company's Imaging Centers are located, adopted legislation that limits reimbursement in cases of workmen's compensation and automobile injury. Effective August 31, 1993, it limits reimbur-\nsement to 113% of the Medicare reimbursement for the medical service. The Act also eliminates a physician's or other provider's ability to refer to clinics in which it has a financial interest.\nThe Company's emphasis on Managed Care (see \"Business-Managed Care Division\") has resulted in fewer patients paying list prices for MRI scans. The Company anticipates that this trend of discounting prices under managed care contracts with HMOs, PPOs, IPAs, TPAs and directly with businesses for their own employees will continue. The Company believes that its competitors are suffering comparable declining reimbursements.\nFraud and Abuse\nAll medical providers, which accept Medicare or Medicaid reimbursements, are currently subject to the fraud and abuse provisions of the Social Security Act (the \"Act\"), which prohibit bribes, kickbacks, and rebates and any direct or indirect remuneration for the referral of Medicare or Medicaid patients or for providing Medicare-covered or Medicaid-covered services, items or equipment. Violation of these provisions may result in civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs. Recently, the Department of Justice has given health care fraud a higher priority and made more personnel available to investigate instances of alleged health care fraud.\nAn important case in this area is The Inspector General v. The Hanlester Network, et.al. (the \"Hanlester Decision\"). In this case, the Inspector General of HHS had alleged that distributions offered or paid by medical laboratories operating as limited partnerships to their physician investors constituted remuneration, which was paid or offered to induce referrals, in violation of the Act. An Administrative Law Judge reviewing the case had previously held that, in order to prove a violation of the Act, the offer or payment of remuneration to the physician investors must have been conditioned on the physicians agreeing to refer Medicare or Medicaid program-related business to the laboratory. Because the partnership distributions were not made on the basis of agreed referrals, no violation of the Act was found. The Appeals Board overruled the Administrative Law Judge's decision in this regard, holding that an agreement to refer program-related business is not a necessary element of proof for violation of the Act. The Appeals Board stated that \"a violation occurs whenever an individual or entity knowingly and willfully offers or pays anything of value, in any manner or form, with the intent of exercising influence over a physician's reason or judgment in an effort to cause the referral of a [Medicare or Medicaid] program-related business.\"\nThe Appeals Board in the Hanlester Decision remanded the case to the Administrative Law Judge to reconsider his findings in light of the broad principles set forth in the Hanlester Decision. On March 10, 1992, the Administrative Law Judge issued his decision\non remand. In applying the standards established by the Departmental Appeals Board, the Administrative Law Judge found that all of the respondents knowingly and willfully offered remuneration to physicians to induce them to refer Medicare business in violation of federal law. As a result, he permanently excluded the three joint venture laboratories from the Medicare program and any other federally funded health care program because he found that it was impossible for them to exist, as then-structured, without violating the Act. In addition, he excluded the Hanlester Network which acted as the general partner in all three entities, for two years. None of the individual respondents were excluded by the Administrative Law Judge.\nOn July 24, 1992, the Appeals Board issued its final decision in the Hanlester case. The Appeals Board upheld the Administrative Law Judge's decision that the respondents had violated the anti-kickback law, but found he had erred in not excluding certain individuals affiliated with the laboratories from the Medicare program and other federal health care programs. As a result, the Appeals Board also ordered the exclusion of three of the individuals for two years, and two of the individuals for one year. A U.S. District Court for the Central District of California has affirmed this decision.\nIn April, 1995, the District Court's decision was overturned in part by the U.S. Court of Appeals for the Ninth Circuit. The Appeals Court found that the individual partners in the venture had not acted \"knowingly and willfully,\" as required by the statute, because there was no showing that they had directed or approved of any of the partnerships' unlawful activities. The Solicitor General, who represents HHS in court, has declined to ask the Supreme Court to review the Ninth Circuit's decision.\nAs the Ninth Circuit's decision is only controlling in the states of that Circuit, it is unclear what impact, if any, the Court of Appeals decision will have on future HHS actions in this area. The principles announced in the Appeals Board decision, and their application in the Administrative Law Judge's decision on remand, could be applied by HHS officials in future cases to find a violation of the Act in situations where physicians and other health care providers have made investments in medical care businesses, such as Imaging Centers. Although no express agreement regarding referrals exists, such investors could be deemed to receive proscribed remuneration under the Act.\nIn addition, in December 1992, National Health Laboratories (\"NHL\") entered into a settlement with the federal government by which it paid $111 million and agreed to certain other conditions, as a result of charges that it had submitted false claims to government health care programs. The president of the company, and the company itself, also pleaded guilty to two counts of submitting false claims. The government alleged that NHL had defrauded the\ngovernment by manipulating doctors into ordering medically unnecessary tests by charging them low prices on testing when it was billed to the physician. When NHL billed Medicare for this testing, however, it did so at substantially increased prices. The government alleged that physicians did not know that Medicare was being charged these higher prices for these tests. Subsequent cases have been brought against other laboratories based on the same theory.\nFurther, on July 29, 1991, the Office of the Inspector General at HHS (\"OIG\") issued regulations which provide specific \"safe harbors\" for certain practices that would not violate the provisions of the Act. These regulations specify limited circumstances under which a \"safe harbor\" will be available when physician investors refer Medicare patients to entities in which they maintain a passive investment interest (i.e., either as a shareholder or a limited partnership interest). Under the safe harbor rules, payments constituting a return on investment (e.g., dividends, interest) will not constitute proscribed remuneration under the Act in the following two circumstances:\n(A) Payments to investors will not violate the Act if the business making the payment possesses more than $50,000,000 in undepreciated net tangible assets, and\n(1) the investment interest, if equity, is registered with the U.S. Securities and Exchange Commission;\n(2) the investment interest of an investor \"in a position to make or influence referrals to, furnish items or services to, or otherwise generate business\" for the business (a \"Referral Source\") is acquired on terms equally available to the public on a U.S. national securities exchange or quotation system;\n(3) neither the business nor any investor markets or furnishes the business' items or services to passive investors differently than to non-investors;\n(4) the business does not loan funds to, or guarantee a loan for, a Referral Source to acquire an interest in the business; and\n(5) the payment by the business to the investor is directly proportional to the amount of capital invested.\n(B) Payments to investors will also not violate the Act if the business making the payment has active and\/or passive investors, and\n(1) no more than 40% of the value of the investment interests of each class of investments in the business is held by Referral Sources;\n(2) the terms on which the investment interest in the business is offered to a passive investor is the same regardless of whether he or she is a Referral Source;\n(3) the terms on which the investment interest in the business is offered to a Referral Source is not related to previous or expected volume of referrals, items or services furnished, or the amount of the business otherwise generated from such investor;\n(4) there is no requirement that a passive investor in the business be or remain a Referral Source to hold his or her investment interest;\n(5) neither the business nor any investor markets or furnishes the business' items or services to passive investors differently than to non-investors;\n(6) no more than 40% of the gross revenue of the business comes from referrals, items or services furnished, or business otherwise generated by investors;\n(7) the business does not loan funds to, or guarantee a loan for, a Referral Source to acquire an interest in the business; and\n(8) the payment by the business is directly proportional to the amount of capital invested.\nOn July 21, 1994, the OIG proposed a clarification of several of these provisions. That proposal was subject to public comment and has yet to be issued in final form.\nNone of Health Images' affiliated partnerships falls within any of the safe harbors set forth in the HHS Regulations. Any of them may therefore be deemed to violate the Act. This conclusion would be unchanged, even if the proposed clarification, discussed above, were adopted in final, in the same form as proposed. It is currently impossible to predict the risk of prosecution. Health Images has offered to purchase the interests of the limited partners in each of its affiliated partnerships in order to effect a termination of the Partnerships and avoid any risk that Health Images or the limited partners will be prosecuted under the Act. None of the remaining limited partners wishes to\nsell. None of the remaining limited partners has more than a nominal interest in the limited partnership.\nIn addition, on November 5, 1992, the OIG proposed a second set of safe harbors that would protect certain managed care activities from the reach of the federal anti-kickback laws. That proposal was issued in final form on November 25, 1995. In some instances, the safe harbor would cover price reductions offered by providers to health plans. On September 21, 1993, the OIG proposed another set of safe harbors which, among other things, modified the investment safe harbor discussed above for entities located in rural areas and serving residents of such areas. The Company is currently reviewing these regulations to determine what action, if any, is necessary as a result of these regulations.\nIn addition, the OIG periodically issues \"Fraud Alerts,\" which identify specific practices within the health care industry that the OIG believes could raise questions under the federal fraud and abuse laws. The following areas have been the subject of Fraud Alerts by the OIG: joint venture arrangements; routine waiver of Medicare Part B copayments and deductibles; hospital incentives to referring physicians; prescription drug marketing practices; arrangements for the provision of clinical laboratory services, arrangements for home health services; and arrangements involving nursing homes. The Company monitors these Fraud Alerts to determine what action, if any, is necessary to comply with their requirements.\nIn addition, many states also have their own anti-kickback laws. The Company monitors these laws to determine what action, if any, is necessary to comply with their requirements.\nIn August 1993, the Omnibus Budget Reconciliation Act of 1993 (\"OBRA '93\") enacted new restrictions on the practice of physician self-referral; i.e., the practice by which physicians refer to entities with which they have a financial relationship. Under the terms of OBRA '93, it will be unlawful for a physician, an immediate family member of a physician, or an entity in which either has an ownership interest to refer patients, for certain \"designated health services,\" to an entity with which any one of them has a \"financial relationship,\" if the services are reimbursed by either Medicare or Medicaid. Among the services included in the definition of \"designated health services\" are \"radiology services,\" such as MRI and CT services, and \"radiation therapy services.\" This provision became effective on January 1, 1995. However, no regulations implementing the OBRA '93 provisions have been proposed. In addition, the form on which providers would report their financial relationships has not been issued. The Company has endeavored to draft or amend its contracts with physicians to meet the personal services or the rental of office space exceptions to the statute's prohibitions.\nIn addition, OBRA '93 also modified several of the exceptions to the self-referral prohibition that were in existence prior to its enactment. With respect to MRI and radiation therapy, these exceptions also became effective in January 1995. The Company does not believe that the provisions of OBRA '93 will impact its business directly, but there may be an indirect effect over time if some competitors of the Company who rely on physician self- referral and have a high volume of Medicare or Medicaid business cease operations. The Company has not yet seen any material impact from the statutes.\nIn addition, a number of proposals to curtail fraud and abuse by health care providers were adopted by both houses of Congress during the 1995-96 legislative session. These proposals generally would have increased the federal government's role in the monitoring and punishment of fraudulent and abusive behavior by providers by, among other things, (i) significantly increasing the monetary penalties for violations of the fraud and abuse laws; (ii) establishing an anti-fraud and abuse trust funded through collection of penalties and fines for violations of such laws; and (iii) establishing a health care fraud and abuse task force. In addition, the bill also would have relaxed a number of the provisions applicable to physician self-referral, although physicians would still have been prohibited from referring Medicare and Medicaid patients to MRI facilities in which they had an ownership or investment interest. The President vetoed the conference bill that contained these measures, but it is possible that other attempts could be made in the future to reintroduce such legislation.\nState Regulation\nMany states are implementing their own health care reform plans, which may include provisions that could affect the structure of health care and the manner in which health care services are delivered in a particular state. The Company's management monitors such legislation to determine what action, if any, is necessary as a result of such provisions.\nAlso, certain of the states in which the Company has Imaging Centers have enacted provisions concerning physician self-referral. In 1991, the State of New Jersey enacted a law that prohibits physicians from referring any patient to a health care entity in which they have a financial interest. This law, however, exempted those entities that were in existence on the effective date of the law, August 1, 1991.\nThe State of Illinois has also enacted prohibitions on self-referral of diagnostic imaging. The Illinois law is effective January 1, 1993, or January 1, 1996, depending on when the interest was acquired. In addition, the States of Florida, Georgia, Maryland, South Carolina and Tennessee have all passed legislation\nthat would, in some form, prohibit physicians from referring patients to entities in which they have a financial interest. Other states may also be considering (or have enacted) similar legislation.\nThe Company is studying the proposed regulations and monitoring legislative activity with respect to limiting physician investments in MRI centers to determine what action, if any, may be necessary to comply with pending legislation or new interpretations of existing laws applicable to the Company's business.\nCOMPETITION\nThe health care industry, including the market for outpatient imaging diagnostic facilities, is competitive. The Company and its Imaging Centers compete with local hospitals, radiologists and other imaging diagnostic centers. Competitors may have existing relationships with the medical community which may be superior to those of the Company's Imaging Centers. In addition, some hospitals use their control over inpatient services to extract exclusive arrangements or advantageous pricing from third party payors for their outpatient services such as diagnostic imaging.\nMRI competes with less expensive imaging diagnostic devices and procedures which may provide similar information to the physician. Alternative imaging diagnostic technology includes CT scans, nuclear medicine, radiography\/fluoroscopy, ultrasound, x-ray mammography, and conventional x-ray. The cost of a particular study depends upon the complexity of the procedure, the length of time of equipment utilization and whether the procedure requires introduction of contrast agents into the body. Management believes that MRI's significant benefits justify the pricing differential between MRI and other modalities.\nAs a provider of maintenance services to facilities operating major medical diagnostic equipment, the Company's Engineering Services Division competes with other companies that have significantly more capital, parts inventory, personnel and office locations with which to provide such services.\nEMPLOYEES\nAt December 31, 1995, the Company had 955 employees (762 full-time and 193 part-time). At March 16, 1996, the Company had 953 employees. An MRI Imaging Center typically has a full-time staff of approximately ten (10) employees, generally consisting of three MRI technicians, one marketing representative, two billing clerks, one transcriptionist, two receptionists and one office manager. A multi-modality imaging center requires more personnel and typically has a staff of 30 employees. The Company attracts and maintains qualified personnel by paying competitive salaries and offering opportunities for rapid advancement.\nINSURANCE\nThe Company carries workers' compensation insurance and maintains comprehensive and general liability and fire insurance in amounts deemed adequate by management with respect to each Imaging Center. The Company is self- insured with respect to its health and dental insurance risk. The Company provides MRI technical services and has professional liability insurance. The Company is not engaged in the practice of medicine, and requires that physicians reading the diagnostic scans maintain medical malpractice insurance. In addition, the Company maintains liability insurance coverage. There can be no assurance that claims will not exceed the amounts of insurance coverage, that the cost for such coverage will not increase to such an extent that the Company will be forced to self-insure a substantial portion of this risk, or that such coverage will not be reduced or become unavailable. The Company does not maintain product liability insurance coverage with respect to system upgrades sold to third parties. The Company carries officers and directors liability insurance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters are located in Atlanta, Georgia and occupy approximately 52,600 square feet at this location under an 84-month lease that commenced January 1, 1993, and expires December 31, 1999. The annual rental rate for this lease is $473,791.\nThe Company or its affiliated partnerships lease the land or building at thirteen (13) of the fifty- three (53) existing Imaging Centers. The real property and improvements thereon may be collateralized under real estate mortgages or security deeds. The real property and improvements for the other existing Imaging Centers are subject to leases expiring between 1996 and 2010. The real property and the building for the Oncology Center is leased for a term of twenty (20) years, terminating December 31, 2008.\nThe existing single modality Imaging Centers occupy an average of 3,642 square feet. Multi-modality centers occupy an average of 10,500 square feet. The Company owns most of the diagnostic modalities utilized by the Company at the imaging centers existing prior to the MedAlliance acquisition. Most of the diagnostic modalities at the centers acquired from MedAlliance were leased and the Company assumed the leases. The Company's modalities are used from time to time as collateral for loans obtained by the Company.\nManagement believes that its corporate offices and the facilities in which each of the Imaging Centers is housed are suitable for the purposes for which they are used but plans to move its corporate offices to new space north of Atlanta. The move is\nplanned for late 1996. The Company does not anticipate any problems with either subleasing or relinquishing the current corporate headquarters space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn March 1, 1993, Pamela C. Smith, a former employee of the Company, filed a charge with the U.S. Equal Employment Opportunity Commission. In her charge, Ms. Smith asserted three claims against the Company. First, Ms. Smith asserted a claim for \"hostile working environment\" sexual harassment. Second, Ms. Smith asserted a claim for discriminatory denial of promotion, alleging that she was denied the position of Corporate Buyer because of her gender. Third, Ms. Smith asserted a claim for constructive discharge.\nThe Company has denied these allegations. On July 26, 1993, the EEOC terminated its investigation at Ms. Smith's request and issued a Right-To-Sue letter on the same day.\nOn August 13, 1993, Ms. Smith filed suit in Fulton County Superior Court in Georgia against the Company and Robert D. Carl, III, the Chairman of the Board of the Company. Upon the motion of counsel for the Company and Mr. Carl on August 27, 1993, this case was moved to the United States District Court for the Northern District of Georgia, Atlanta Division. In her complaint, Ms. Smith is seeking declaratory, injunctive, and equitable relief, general, compensatory, and punitive damages of $5,000,000.00, and costs and attorney fees. In addition to the legal claims described above as part of Ms. Smith's EEOC charge, the complaint originally accused the Company and Mr. Carl of slander and libel, intentional infliction of emotional distress and effecting illegal stock transactions. Ms. Smith has since voluntarily dismissed her claims for libel and slander as well as the claim of discriminatory denial of promotion.\nMs. Smith's stock allegations have been severed from the action by the Federal court and are now pending in a separate case in Fulton County Superior Court.\nIn the opinion of management for the Company, these lawsuits are without merit. Management has defended, and will continue to defend these lawsuits vigorously. Management further believes that resolution of this litigation will not materially affect the Company's financial condition.\nOn February 21, 1995, the Company filed a lawsuit in the Superior Court of the State of California, San Mateo County, against each of the selling shareholders of National Diagnostic Systems, Inc. (\"NDS\"). The Company acquired the remaining 51.5% of NDS from the selling shareholders in an August 4, 1994, acquisition. The Company's complaint is for rescission and res-\ntitution, breach of contract, intentional misrepresentation, negligent misrepresentation, suppression of act, and indemnification. The Company's complaint was instituted after the selling shareholders failed to respond adequately to a February 13, 1995, demand letter for rescission of the transaction.\nOn February 17, 1995, one of the selling shareholders, James J. Fitzsimmons, the former President and Chief Executive Officer of Interactive Diagnostic Services, Inc. (\"IDSI\") (the successor entity to NDS), filed a complaint against the Company and IDSI in the Superior Court of the State of California, San Mateo County. Mr. Fitzsimmons' complaint purports to allege breach of his employment agreement with IDSI and the Company, and a breach of Implied Covenant of Good Faith and Fair Dealing and Declaratory Relief. Mr. Fitzsimmons' employment with IDSI terminated as of January 20, 1995.\nOn March 21, 1995, Mr. Fitzsimmons amended his complaint to substitute attorneys, add the remaining selling shareholders as plaintiffs, and change the causes of action. The amended complaint purports to allege causes of action including a breach of fiduciary duty by the Company, fraud by the Company, and a breach of the implied covenant of good faith and fair dealing by the Company and IDSI, in addition to the previous causes of action asserted by Mr. Fitzsimmons.\nIn August 1995 the California Superior Court judge ruled that the Company's complaint and the selling shareholders' complaint be consolidated into a single binding arbitration proceeding to be heard by an arbitrator appointed through the American Arbitration Association (\"AAA\"). The AAA selected an arbitrator in February 1996. The initial meeting of the parties with the arbitrator is currently scheduled for April 3, 1996.\nThe Company intends to defend itself vigorously against this lawsuit by the selling shareholders, and will continue to pursue its claims against the selling shareholders. Management believes that its claims against the selling shareholders are meritorious. Management regards the claims asserted in the amended complaint as without merit.\nOn April 12, 1995, Paul W. Harris, who was involved in the acquisition of NDS and served as an Executive Vice President of IDSI, sued the Company alleging breach of his employment agreement because he received no severance following his December 9, 1994, termination. The Company is vigorously defending Mr. Harris' lawsuit.\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company is authorized by its Certificate of Incorporation to issue up to 42,000,000 shares of capital stock, of which 40,000,000 shares are designated Common Stock, par value $.01 per share, and 2,000,000 were designated Preferred Stock, par value $.01 per share.\nCOMMON STOCK\nThe Company's common stock (the \"Common Stock\") began trading in the over-the-counter market through the NASDAQ System under the symbol \"HIMG\" on July 30, 1985, the date on which the Common Stock was first publicly traded. From January 5, 1987 to January 26, 1993, the Company's Common Stock was included on the NASDAQ National Market System. Effective January 27, 1993, the Company's Common Stock became listed on the New York Stock Exchange under the symbol \"HII.\"\nThe following table presents quarterly information on the price range of the Company's Common Stock for 1994 and 1995. This information indicates the high and low sale prices reported by the New York Stock Exchange. These quotations and prices do not include retail markups, markdowns or commissions.\nAs of March 26, 1996, there were issued and outstanding 11,428,257 shares of the Company's Common Stock held of record by approximately 807 shareholders. At March 26, 1996 the Company's Common Stock closed at $7.375.\nIn 1995, the Company began paying the dividend quarterly at a rate of $0.02 per share. The Company paid a dividend of $0.02 per share on its Common Stock on March 1, 1995, on June 1, 1995 and on September 1, 1995. In September 1995, the Company's Board of Directors increased the quarterly dividend to $.025. The Company paid a dividend of $.025 on December 1, 1995. Actual dividends paid by the Company on its Common Stock in the future will depend, among other things, upon the earnings and financial condition of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED CONSOLIDATED FINANCIAL DATA FOR THE YEAR ENDED DECEMBER 31 (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following table sets forth the percentage of total net revenue represented by certain line items in the Consolidated Statements of Operations for the years indicated. The text following the table discusses year-to-year variances.\nComparison of the year ended December 31, 1995 to the year ended December 31,\nNet patient service revenue(1) increased $38,925,500 or 53.8% primarily due to $41,783,800 in patient revenue from the Company's acquisition of 15 imaging centers from MedAlliance, Inc. (\"the MedAlliance Acquisition\"), an increase in net revenue at imaging centers that were in operation for both the 1995 and 1994 periods (\"same center revenue\") of $825,200 or 1.3%, partially offset by the sale of certain clinic properties during 1995. Health Images signed a management agreement with the purchasers of one of the properties sold (Central Pennsylvania Magnetic Imaging) under which the Company provides management services under a fee arrangement based upon net collections of the facility. This management fee is included in miscellaneous income of the Company's financial statements and are contractually limited to a maximum of $750,000 per year.\nEngineering Revenue decreased $595,200 or 16.2% due to decreases in demand for the Company's third party upgrade and maintenance services. Other revenue and income increased $83,200 or 8.1%.\nOperating costs increased $23,370,500 primarily due to expenses associated with the MedAlliance Acquisition and increased patient volumes at the Company's same center facilities, partially offset by the elimination of costs at the sold centers and continued cost control efforts. Operating costs as a percentage of revenue were 60.0% in 1995, 59.6% in 1994, and 61.8% in 1993. The consistency of operating costs as a percentage of revenue reflects the Company's success in reducing expenses at its facilities and acquired properties while experiencing declining patient service reimbursements. Depreciation and amortization expenses increased $5,408,100 or 44.4% due to increased depreciation charges and additional goodwill amortization related to the MedAlliance Acquisition. The Company's provision for bad debts was $4,646,000 or 4.2% of patient revenue compared to $2,835,500 or 3.9% in 1994. Provision for bad debts results from required write-offs of accounts management deems to be uncollectible. Management expects future bad debt results to be comparable to these results. General and administrative expenses increased $2,345,600 or 38.1%, primarily due to increased expenses related to the Company's increased volume of business. General and administrative expense as a percentage of net revenue was 7.4% in the 1995 period compared\n- ---------------------------------\n(1)Net patient service represents imaging revenue reduced by contractual adjustments related to discount arrangements with third party payors. Such discount arrangements are customary in the health care industry and are, in the opinion of management, necessary for competitive reasons.\nto 8.0% in 1994. The reduction in general and administrative expenses as a percentage of revenue reflects the economies gained in the MedAlliance Acquisition and the Company's continued cost control efforts.\nInterest income decreased by $143,900 due primarily to lower cash balances. Interest expense increased by $2,475,700 or 197.8% due to higher amounts of debt outstanding resulting from the MedAlliance clinic acquisition. Minority interest in income of consolidated entities increased by $409,600 or 208.9%, primarily due to minority interest expense associated with the clinics acquired from MedAlliance. Income taxes increased $951,600 or 27.7% due to higher pretax income.\nNet income from continuing operations increased $1,498,000, or 27.8%, to $6,890,800 in the 1995 period from $5,392,800 in 1994. Primary and fully diluted earnings from continuing operations increased $0.13 per share, or 28.3%, to $0.59 in the 1995 period as compared to $0.46 in 1994. Earnings per share were calculated using 11,582,700 primary and 11,651,100 fully diluted weighted average common share equivalents for the 1995 period as compared to 11,725,600 primary and 11,727,900 fully diluted weighted average common share equivalents in the prior year period.\nDuring the quarter ended March 31, 1995, the Company discontinued the operations of Interactive Diagnostics Services (\"IDSI\") based in San Francisco, California, and the financial results are treated as discontinued operations. During 1995 the Company recognized $1,161,900 in after tax losses from this operation compared to $6,528,300 in after tax losses in 1994. Substantially all costs related to IDSI, including estimated future expenditures, have been accounted for in the 1995 loss from discontinued operations. After giving effect to these losses the Company reported net income of $5,728,900, or $0.49 per share in the 1995 period compared to a net loss of $1,135,500 or $0.10 per share in 1994.\nAs indicated in the preceding discussion, the MedAlliance Acquisition (effective as of April 1, 1995) was a significant event for Health Images. Net of interest costs, this acquisition was additive to earnings during the year ended December 31, 1995, and management expects the acquisition to continue to be additive to earnings in the future. The extent of the earnings increase, if any, will ultimately depend on the Company's ability to reduce certain overhead and operating costs as well as successfully maintain patient procedure volume levels. During 1995 the Company generated economies of scale and increased patient service revenues at its existing and acquired facilities, and management expects these trends will continue for the future. Long term, however, the diagnostic imaging industry remains intensely competitive. The continued growth of managed care plans has placed downward pressure on imaging reimbursements and has led to increased scrutiny of the appropriateness of referrals for major diagnostic imaging procedures such as the MRI and CT services which are the Company's\nprincipal sources of revenue. In addition, the Company may be at a competitive disadvantage to hospital systems which can offer a comprehensive range of health care services to managed care plans. Management believes, however, that the Company is better positioned than many of its competitors because of its lower cost structure and lack of reliance upon physician self-referral practices. The Company's vertical integration results in lower equipment costs and significantly reduced maintenance expenses. During 1996, Health Images plans to begin installation of its new proprietary HI STAR MRI system currently under development. If successful, this advance will significantly increase the competitiveness of the Company's technology at a relatively low marginal cost. Management also believes that internal growth opportunities and additional acquisitions may be available during 1996 as the industry continues to consolidate.\nComparison of the year ended December 31, 1994 to the year ended December 31,\nNet patient service revenue increased $3,910,000, or 5.7%, primarily due to increases of $3,891,000 in net revenue at imaging centers that were in operation for both 1994 and 1993 (\"same center revenue\"). The increase in same center revenue was due to an increase of 8.8% in same center MRI studies and an increase in revenue from other imaging modalities, principally CT and X-ray, partially offset by a 6.2% decline in average reimbursement per MRI study and a decrease in revenue from the Company's radiation oncology center.\nEngineering revenue decreased $1,041,400, or 22.1%, primarily due to decreases of $974,500, or 23.8%, in service revenue and $66,900, or 10.9%, in upgrade revenue.\nOther revenue and income decreased by $1,835,500, or 64.1%, primarily due to a decrease of $328,700, or 43.2%, in the Company's Mobile Leasing Program revenue, and a decrease of $1,539,400, or 97.9%, in the Company's Medical Construction Revenue, offsetting an increase of $31,200 in miscellaneous revenue and gains on sale of securities.\nOperating costs decreased by $1,039,100, or 2.2%, primarily due to decreases in expenses related to the decline in engineering revenue and the Company's efforts to reduce clinical operating costs. Operating costs as a percentage of net revenue decreased to 59.6% in 1994 from 61.8% in 1993 due primarily to clinic cost control and reduced revenue contribution from the Company's lower margin medical construction business. Depreciation and amortization expense increased $317,800 or 2.7%. The Company's provision for bad debts was $2,835,500, or 3.9% of net patient service revenue in 1994 as compared to $2,651,500, or 3.9%, in 1993. General and administrative expenses decreased $176,700, or 2.8% primarily due to decreased legal and professional fees, offset by slightly higher costs associated with the Company's increased\npatient volumes. General and administrative expenses decreased as a percentage of net revenue from 8.3% in 1993 to 8.0% in 1994.\nOn August 4, 1994, the Company purchased 100% of its former equity affiliate, National Diagnostic Systems, Inc. (\"NDS\"), a start-up enterprise that specialized in the development and operation of proprietary systems for imaging prospective review and outcomes analysis. Before the acquisition of NDS, the Company recognized its share of the net loss of NDS of $364,700 in 1994 as compared to $466,300 in 1993, a decrease of 21.8%.\nSubsequent to its purchase of the remaining NDS equity, the Company has determined that the financial statements of NDS did not fairly reflect NDS's financial position or business prospects. After consultation with independent legal counsel, the Company brought suit against the selling shareholders of NDS seeking rescission of the Company's purchase of NDS, and alleging, among other things, breach of contract, intentional misrepresentation, negligent misrepresentation, and suppression of fact. The Company cannot predict the outcome of this litigation. The Company has concluded that its investment in NDS (subsequently merged into a Company subsidiary, Interactive Diagnostic Services, Inc. (\"IDSI\") has become substantially impaired and the Company discontinued the operation of this division in March of 1995. The financial results are reported as discontinued operations on the Company's financial statements.\nInterest income decreased by $5,100, or 1.9%, due to lower cash balances and lower interest rates. Interest expense decreased by $432,000 due to lower amounts of debt outstanding. Minority interest in income of consolidated entities increased by $24,400, or 14.2%, primarily due to higher operating income at imaging centers with minority partners. The Company's tax rate on continuing operations for 1994 was 38.9% as compared to 36.8% in 1993.\nNet income from continuing operations increased $1,167,600, or 27.6%, to $5,392,800 in 1994 from $4,225,200 in 1993. Loss on discontinued operations related to IDSI totaled $6,528,300 in the 1994 period compared to $466,300 in 1993. After giving effect to these losses from discontinued operations, the net loss for 1994 was $1,135,500 compared to net income of $3,758,900 in 1993. The primary and fully diluted loss per share was $0.10 in 1994 as compared to net income per share of $0.32 in 1993. Earnings per share were calculated using 11,725,600 primary and 11,727,900 fully diluted weighted average common share equivalents as compared to 11,611,700 primary and fully diluted weighted average common share equivalents in 1993. The higher number of primary and fully diluted weighted average common share equivalents in 1994 as compared to 1993 reflects the Company's issuing 559,811 shares of its common stock in connection with the NDS acquisition, a higher common stock price which increases the dilutive effect of outstanding stock options, partially offset by the purchase of\n500,000 shares of treasury stock in 1994 for $3,433,100, and 239,900 shares of treasury stock for $1,540,800 in 1993.\nInflation\nThe impact of inflation and changing prices on the Company has, to date, been primarily limited to salary increases and has not been material to the Company's operation. In the event of increased inflation, management believes that the Company may not be able to raise the prices for its goods and services by an amount sufficient to offset cost inflation.\nGrowing health care costs are a national concern. Management believes that this concern will most likely lead to a continuation of reduced reimbursements for the Company's health care services even in an otherwise inflationary environment. The Company believes, however, that the rate of decline in reimbursements is decreasing. The Company has historically responded to any threat to its margins by lowering its capital costs and by increasing the volume of its business.\nLiquidity and Capital Resources\nNet cash provided by operating activities was $28,611,700 in 1995, an increase of $10,710,200 or 59.8% from $17,901,500 in 1994. Net trade receivables increased $6,883,500 primarily due to the MedAlliance Acquisition, partially offset by a decreased $274,000 in trade receivables related to existing operations. As of December 31, 1995 the Company's average age of patient receivables outstanding was 74, compared to 81 days at December 31, 1994, and 76 days as of December 31, 1993. The decrease in average age of patient accounts receivable during the 1995 period is primarily due to the collection patterns at the centers acquired from MedAlliance. These centers benefit from a centralized billing and collection system and perform fewer litigation cases than the existing Health Images clinics. These legal cases can remain outstanding for over one year, and while generally collectible, increase the average age of patient receivables. Management intends to improve collections for all centers by utilizing this central billing and collection methodology, potentially reducing days outstanding. Conversely, management may attempt to increase legal cases at certain centers where capacity and market conditions allow, which would increase average age. Overall the Company believes its average age of receivables will be comparable to the previous three years experience and feels these levels are within industry norms.\nThe Company's total debt outstanding increased by $36,304,800 from $25,048,200 at December 31, 1994 to $61,353,000 at December 31, 1995, primarily due to increased borrowings related to the MedAlliance Acquisition. The Company funded the $23,859,200 in cash paid in 1995 related to the MedAlliance Acquisition from a term loan issued by its primary bank. (See note #4 to the\nfinancial statements for detailed information on notes payable). As of December 31, 1995 the Company had available $4,459,900 in unused credit under an existing $5,000,000 bank line. This line, as well as the Company's primary term loan, bear interest on a leveraged adjustment to prime which varies from prime plus .25% to prime minus .50% dependant upon certain financial ratios. At December 31, 1995 the Company had met the requirements necessary to reduce the interest rate to prime minus .50%. At December 31, 1995 the Company was in technical violation of two covenants related to the term loan. These violation were subsequently in writing waived by the lender.\nCapital expenditures in 1995 were $11,694,700 as compared to $6,600,200 in 1994 primarily due to increased levels of expenditures related to the MedAlliance Acquisition, addition of equipment to expand services at certain of the Company's existing facilities, and costs incurred with the Company's HI STAR MRI upgrade project. Management expects 1996 clinical and equipment related capital expenditures will be comparable to the 1995 levels. In addition, the Company plans to relocate its corporate headquarters during 1996 to a constructed facility expected to cost approximately $4,700,000. This contemplated level of capital expenditures is subject to change in the event the Company decides to undertake significant expansions of its business or make additional acquisitions.\nHealth Images liquidity and working capital levels are substantially reduced due to the increase in debt levels related to the MedAlliance Acquisition. Such debt includes $16,352,500 in current maturities due in 1996. While management considers current cash and liquidity adequate to fund the Company's existing business, additional borrowings will be necessary to fund equipment purchases and the Company's proposed headquarters relocation. Management believes such additional funding is available to the Company from several sources.\nAt December 31, 1995, the Company had outstanding commitments on equipment contracts totaling $4,345,200 primarily related to the Company's HI STAR MRI upgrade project and the expansion of imaging services at the centers.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee pages through herein.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nNote #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Note #2 - PROPERTY AND EQUIPMENT Note #3 - INTANGIBLE ASSETS Note #4 - NOTES PAYABLE Note #5 - ACCRUED EXPENSES Note #6 - STOCK OPTION PLANS AND COMMON STOCK PURCHASE WARRANTS Note #7 - RELATED PARTY TRANSACTIONS Note #8 - LEASE COMMITMENTS Note #9 - COMMITMENTS Note #10 - PROVISION FOR INCOME TAXES Note #11 - EARNINGS PER SHARE Note #12 - BUSINESS SEGMENT INFORMATION Note #13 - STOCKHOLDERS' EQUITY AND RIGHTS PLAN Note #14 - EMPLOYEE BENEFIT PLAN Note #15 - ACQUISITIONS Note #16 - FAIR VALUE OF FINANCIAL INSTRUMENTS Note #17 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nF - 1 REPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors and Stockholders Health Images, Inc. Atlanta, Georgia\nWe have audited the accompanying consolidated balance sheets of Health Images, 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. The 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 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 Health Images, Inc., 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.\nJOSEPH DECOSIMO AND COMPANY\nAtlanta, Georgia February 23, 1996\nF - 2 HEALTH IMAGES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31,\nThe accompanying notes are an integral part of the financial statements.\nF - 3\nThe accompanying notes are an integral part of the financial statements. HEALTH IMAGES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying notes are an integral part of the financial statements.\nF - 4\nThe accompanying notes are an integral part of the financial statements. HEALTH IMAGES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEAR ENDED DECEMBER 31, 1995\nThe accompany notes are an integral part of the financial statements.\nF - 5 HEALTH IMAGES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying notes are an integral part of the financial statements.\nF - 6\nThe accompanying notes are an integral part of the financial statements. SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES\nThe accompanying notes are an integral part of the financial statements.\nNOTE #1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDESCRIPTION OF BUSINESS\nA majority of the Company's revenue is derived from out-patient medical diagnostic imaging services. The Company operates forty nine domestic imaging centers and four imaging centers in the United Kingdom, and one domestic radiation oncology center. Health Images also manufactures MRI scanners and provides MRI and CT equipment maintenance, medical construction services and mobile MRI leasing to third-party clients. The Company's services are not concentrated in any one geographical area of the United States or United Kingdom.\nThe significant accounting policies and practices followed by the Company and its subsidiaries are as follows:\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and investments in limited partnerships in which the Company or a corporate subsidiary acts as a general partner and owns a majority interest in the limited units of the partnership. Intercompany balances and transactions have been eliminated in consolidation. Investments in affiliated companies in which the Company owns less than fifty percent (50%) interest are accounted for on the equity method.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid debt instruments with maturity of three (3) months or less to be cash equivalents. At December 31, 1995, cash equivalents consisted primarily of short-term commercial paper and money market accounts. The Company, at times, maintains cash balances which exceed federally insured limits.\nINVENTORIES\nInventories, consisting principally of parts, are stated at the lower of cost or market value. Cost is determined on a weighted average basis.\nMARKETABLE EQUITY SECURITIES\nEffective January 1, 1994, the company adopted Statement of Financial Standards No. 115,\"Accounting for Certain Investments in Debt and Equity Securities\". As of December 31, 1995 and 1994, all marketable equity securities were considered held for trading purposes and recorded at fair value.\nF - 7\nPROPERTY AND EQUIPMENT\nProperty and equipment is stated at cost. Depreciation is calculated on a straight line basis over the estimated useful lives of the assets as follows:\nINTANGIBLE ASSETS\nThe cost of intangible assets are amortized on a straight line basis over the period expected to receive benefits therefrom as follows:\nOrganizational and start-up costs include the direct cost of organizing and initiating the operations of the Company's medical facilities.\nThe company reviews recoverability of the carrying value of goodwill using projections of future cash flows and future earnings. The company's basis for write-offs of the carrying value of goodwill is based on management's best estimates of future performance of the affected entity. It is reasonably possible that these estimates could change materially in the near term.\nREVENUE RECOGNITION\nRevenue is recognized from medical services when services are rendered. Medical services revenue is presented net of contractual adjustments related to discount arrangements with third party providers. These discounts amounted to 29.4% of medical services gross revenue for 1995, 25.5% for 1994, and 25.0% for 1993. Amounts paid in advance on engineering service contracts are recognized as revenue when earned. Revenue on medical construction building contracts are recognized using the percentage of comple-\nF - 8 tion method. The Company maintains a policy of providing charity care to indigent patients. These services amounted to 6.5% of conducted studies for 1995, 3.9% for 1994, and 1.7% for 1993.\nINCOME TAXES\nDeferred income taxes arise from temporary differences between the income tax and financial reporting basis of assets and liabilities. If it is more likely than not that some portion or all of a deferred tax asset will be not realized, a valuation allowance is recognized.\nDEVELOPMENT COSTS\nDevelopment costs related to enhancements of imaging equipment are expensed as incurred. Total expenditures on development totaled $146,000 for 1995, $896,200 for 1994, and $741,300 for 1993.\nFOREIGN CURRENCY TRANSLATIONS\nAssets and liabilities of foreign subsidiaries are translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rates of exchange prevailing during the year. The related translation adjustments are reflected in the accumulated translation adjustment section of the consolidated balance sheet. Foreign currency gains and losses resulting from transactions are included in results of operations.\nESTIMATES AND UNCERTAINTIES\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 financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Management's estimate of the allowance for doubtful accounts and contractual adjustments is based on historical experience and an evaluation of the balance of accounts receivable. It is reasonably possible that these estimates could change materially in the near term.\nRECLASSIFICATIONS\nCertain amounts in the presented financial statements have been reclassified to conform to the current year presentation.\nF - 9\nNOTE #2 - PROPERTY AND EQUIPMENT\nProperty and Equipment consist of the following major classifications:\nEquipment under capital leases is amortized on a straight line basis over the lease term and amortization is included in depreciation expense. Amortization of capital leases totaled $2,414,700 during 1995.\nF - 10 NOTE #3 - INTANGIBLE ASSETS\nIntangible Assets consist of the following:\nNet goodwill increased $33,058,000 primarily due to the acquisition of 15 imaging centers from MedAlliance. (See Note #15).\nF - 11\nNOTE #4 - NOTES PAYABLE\nLong-term debt consists of the following:\nSubstantially all notes, other than the 10% Senior Extendable notes, are collateralized by accounts receivable, inventory, property, plant and equipment.\nThe Company is required to maintain certain financial ratios related to liquidity, tangible capital, and debt service, and is limited to a yearly fixed amount of capital expenditures under the terms of its primary bank debt.\nF - 12\nThe Company obtained a waiver from its primary lender for violations of the tangible capital and capital expenditure covenants of its primary debt. The waiver is for 1995 only and does not extend to future periods.\nThe Company's primary bank debt interest is based on a leveraged adjustment to prime, ranging from prime plus .25% to prime minus .50% dependant upon certain funded debt and cash flow criteria.\nLong-term debt and capital lease obligations maturities during the years subsequent to December 31, 1995, are set forth below:\nInterest expense totaled $3,727,200 for 1995, $1,251,500 for 1994, and $1,683,500 for 1993. Interest costs totaled $4,651,300 for 1995, $1,726,700 for 1994, $2,047,600 for 1993, of which $924,100, $475,200, and $364,100, respectively, were capitalized as construction period interest.\nThe prime rate of interest paid by the Company as of December 31, 1995, was 8.75%.\nF - 13\nNOTE #5 - ACCRUED EXPENSES\nAccrued expenses consist of the following:\nF - 14\nNOTE #6 - STOCK OPTION PLANS AND COMMON STOCK PURCHASE WARRANTS\nThe Company has a qualified employee incentive stock option plan which provides for granting options to employees, including officers, to purchase up to 900,000 shares of Common Stock. Options must be granted within ten (10) years from the date of adoption of the plan, and options granted under the plan must be exercised within ten (10) years from the date of grant. The exercise price of the option must be at least 100% of the fair market value of the shares on the effective date of grant. The right to exercise options thus far granted under this plan vest over a three-year term of employment.\nIn addition, the Company grants non-qualified options from time to time to certain officers and directors of the Company at prices approximating the fair value of shares on the effective date of grant. Non-qualified options for a total of 463,700 shares are outstanding as of December 31, 1995.\nAt December 31, 1995, a Common Stock warrant for 250,000 shares at $4.50 per share held by the president of the Company was outstanding and fully exercisable.\nOn July 1, 1995, the Company implemented an Employee Stock Purchase Program. The Program allows an employee of the Company to receive Common Stock contributions from the Company in an amount equal to 50% of the participants net Common Stock purchases up to a maximum of 2,500 shares per participant, per program year. To receive the Stock Contribution, the employee must own the Common Stock for at least six (6) months.\nF - 15\nChanges in stock options for the three (3) years ended December 31, 1995, are as follows:\nSFAS Statement Number 123, \"Accounting for Stock Based Compensation\" issued in 1995, defines a fair value method of accounting for stock options and encourages companies to adopt that method. Management anticipates continuing to use the intrinsic method acceptable under APB 25 and will disclose the effect of not using the fair value method in its 1996 financial statements as required by SFAS 123.\nF - 16\nNOTE #7 - RELATED PARTY TRANSACTIONS\nTransactions and outstanding balances with related parties are summarized as follows:\nThe Company recognized equity losses in National Diagnostic Systems, Inc. (\"NDS\") of $466,300 in 1993 and $364,700 in 1994. On August 2, 1994 the Company purchased the remaining 51.5% ownership in NDS. (See Note #15).\nF - 17\nNOTE #8 - LEASE COMMITMENTS\nThe Company has certain equipment under capital leases and also leases certain land, buildings and equipment under operating leases. Minimum lease payments under existing non-cancelable capital and operating leases are as follows:\nCertain building leases include provisions for short-term rent deferral, additional rent payments equal to 5% of estimated collections in excess of $400,000 at particular locations, and rent adjustments based on a United States government index.\nRental expense is calculated on a straight line basis over the life of each lease after giving effect to scheduled rent increases and totaled $3,124,800 for 1995, $1,872,500 for 1994, and $1,626,300 for 1993.\nF - 18\nNOTE #9 - COMMITMENTS\nAs of December 31, 1995, the Company had no material commitments on construction contracts. As of December 31, 1995, the Company had outstanding commitments to purchase equipment totaling $4,345,200 primarily related to the Company's expansion of imaging services provided at the centers and the Company's upgrade program for its magnetic resonance imaging (\"MRI\") equipment.\nThe Company is subject to legal proceedings and claims which arise in the ordinary course of business. In management's opinion, the amount of ultimate liability will not materially affect the financial position or results of operations of the company.\nThe Company is a defendant in a lawsuit brought against the Company and its Chairman and CEO by a former employee, alleging sexual harassment and gender discrimination. Management believes the lawsuit to be without merit and intends to defend itself vigorously. Management further believes that resolution of this litigation will not materially affect the Company's financial condition. The Company is a plaintiff in a lawsuit against the former shareholders of National Diagnostic Systems, Inc. (NDS), and is a defendant in a countersuit filed by a former NDS shareholder. Further details are available in note # 15.\nF - 19\nNOTE #10 - PROVISION FOR INCOME TAXES\nProvisions for income taxes attributable to continuing operations consist of the following:\nReconciliation of the provisions for income taxes to statutory rates is as follows:\nF - 20\nTemporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give 2ise to significant portions of the net deferred income tax liability relate to the following:\nThe Company has net operating loss carryforwards for income tax purposes as of December 31, 1995 of approximately $1,201,400. The carryforwards expire in the year 2008 and are restricted for use against a subsidiary's future earnings.\nF - 21\nNOTE #11 - EARNINGS PER SHARE\nPrimary earnings per share is computed based on the weighted average number of shares actually outstanding plus common equivalents which would arise from the exercise of stock options and warrants. Fully diluted earnings per share are similarly computed but would include the dilutive effect of the Company's common equivalents. Earnings per share have been computed by dividing net income by the weighted average number of common stock and equivalent shares outstanding.\nF - 22\nNOTE #12 - BUSINESS SEGMENT INFORMATION\nSince March 31, 1985, the Company's principal operations have been devoted to the establishment and operation of imaging centers providing magnetic resonance imaging diagnostic services (\"Medical Imaging\"). Since January 1990, the Company has also operated a radiation oncology center, which provides radiation oncology services, and is included in Medical Imaging. In 1992, the Company expanded its Medical Imaging services at certain locations to include computed tomography, ultrasound, mammography and X-ray. During 1995, the Company acquired 15 diagnostic facilities from MedAlliance Inc. (See note #15). The newly acquired centers were primarily multi-modality. During September 1986, the Company established an engineering services division which is engaged in the service and maintenance of major medical diagnostic equipment primarily owned by outside parties (\"Engineering Services\"). During February 1987, the Company established a medical construction management division which provides medical facility development consulting services to the Company's affiliated imaging centers and to non-affiliated third parties (\"Medical Construction Services\"). For the three years presented, the operations of Medical Construction Services did not have a material impact upon the overall consolidated operations of the Company. Capital expenditures and assets of Medical Construction Services for the three years presented have, therefore, been combined with the Medical Imaging category in the accompanying table.\nOperations of all segments have been limited to the United States until November 1990 at which time the Company opened its first center providing magnetic resonance imaging diagnostic services in Guildford, England. The Company opened or acquired two additional imaging centers in the United Kingdom during 1992 and opened one additional imaging center in 1993. In 1994, the Company leased two mobile MRI units in Tiajuana and Celaya, Mexico. The company discontinued the operation of these mobile units during 1995. Results of operations for the Company's United Kingdom and Mexico operations were not significant to the overall consolidated results of the Company for the three years presented and are, therefore, not separately presented in the accompanying table.\nThe following table presents financial data for business segments:\nF - 23\nF - 24\nNOTE #13 - STOCKHOLDERS' EQUITY AND RIGHTS PLAN\nThe Board of Directors is authorized to issue shares of preferred stock in one or more series, and to determine the designations and the powers, preferences, and other special rights of each series.\nOn May 10, 1989, the Company adopted a Stockholder Rights Plan and, pursuant to the plan, declared a dividend on its Common Stock of one right (\"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 B Participating Preferred Stock at a price of $56. The Rights expire on May 21, 1999, and, prior to the occurrence of certain events, may be redeemed at a price of $.01 per Right. Of the Company's 2,000,000 authorized shares of preferred stock, the Board of Directors has designated 200,000 shares as Series B Participating Preferred Stock.\nF - 25\nNOTE #14 - EMPLOYEE BENEFIT PLAN\nDuring 1989, the Company adopted the Health Images, Inc., Profit Sharing and Savings Plan which qualified under Internal Revenue Code Section 401(k). Contributions by the Company are discretionary and made from profits to match a portion of the elective before-tax contributions of participating employees. In 1993, the Company made a cash contribution of $105,300 to the Plan to match 25% of the contributions made by participating employees in 1992. In 1994, the Company made a cash contribution of $125,100 to the plan to match 25% of the contributions made by participating employees in 1993. In 1995, the Company made a cash contribution of $121,200 to the plan to match 25% of the contributions made by participating employees in 1994.\nThe Company changed its employer contribution method in 1995 to match employees'contributions to the Plan on a dollar-for-dollar basis with a maximum match of three per cent (3%) of the contributing employee's salary. In 1996, the Company contributed $332,600 in Common Stock and cash to match 1995 contributions by participating employees.\nF - 26\nNOTE #15 - ACQUISITIONS\nDuring April 1993, the Company purchased the assets of Matlock Imaging Center in Arlington, Texas, for $1,410,000 with $1,350,000 cash and 10,000 shares of restricted common stock. The acquisition was accounted for as a purchase with the excess purchase price over the fair value of the assets attributed to goodwill.\nDuring August 1994, the Company acquired the remaining interest in its equity affiliate, National Diagnostic Systems, Inc. (\"NDS\") and merged NDS into a wholly-owned subsidiary of the Company, Accountable Radiology, Inc. The resulting subsidiary was renamed \"Interactive Diagnostic Services, Inc.\" (\"IDSI\"). The Company issued an aggregate of 559,811 shares of its common stock, market value of $2,939,000, to the selling shareholders of NDS to acquire their respective equity interests in NDS. As additional consideration, the Company paid off NDS indebtedness of $524,000 and paid $22,200 to a selling shareholder for his NDS stock options. The Company paid $315,000 in salary buydowns to selling shareholders who would remain employees of IDSI and $120,000 in a consulting agreement with the former Chairman and Chief Executive Officer of NDS. In addition, the Company cancelled indebtedness of $1,010,000 owed by NDS to Health Images. Goodwill of $4,271,900 was recorded and acquisition costs of $1,087,400 related to the salary buydowns, the consulting agreement, a write-off of abandoned software and other miscellaneous costs were expensed.\nOn December 31, 1994, the Company wrote off the $5,359,300 related to NDS investment items previously mentioned. In addition, the Company expensed $218,900 for estimated contract losses, and $538,700 in organization and start-up costs. The nonrecurring asset impairment charge totaled $6,116,900 and was expensed in 1994.\nThe Company filed a lawsuit on February 21, 1995 against the selling shareholders of NDS asking for rescission of the acquisition described above and restitution. The complaint alleges breach of contract, intentional misrepresentation, negligent misrepresentation, and suppression of fact.\nThe Company discontinued the operations of IDSI during the quarter ending March 31, 1995. Revenues attributable to discontinued operations were $401,800 for 1995. The loss from discontinued operations and loss on disposal of discontinued operations before taxes totaled $1,874,100. An income tax benefit of $712,200 was recognized in 1995 based on a 38% applicable rate, which differs from the Company's overall effective rate due to\nF - 27\ncertain permanent tax differences. The net loss attributable to discontinued operations was $1,161,900 for 1995.\nOn April 14, 1995, the Company acquired 15 imaging centers from MedAlliance, Inc. by paying $23,859,200 in cash (net of cash received), redemption of MedAlliance preferred stock and accumulated dividends of $11,569,300, assumption of liabilities totaling $28,991,800, and the issuance of a note payable to MedAlliance of $6,241,600. The acquisition was accounted for as a purchase with the excess purchase price over the fair value of the assets attributed to goodwill. The transaction was effective for accounting purposes as of April 1, 1995. The following table discloses unaudited pro forma operating statement information as if the acquisition occurred at the beginning of each period presented.\nF - 28\nNOTE #16 - FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments are as follows:\nThe fair value of long-term debt is based on current rates at which the Company could borrow funds with similar remaining maturities.\nF - 29\nNOTE #17 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for 1995 and 1994 is as follows:\n- ---------------------- * The sum of the 1995 and 1994 quarterly earnings per share may differ from the annual earnings per share because of the differences in the weighted average number of common shares outstanding and common shares used in the quarterly and annual computation as well as differences in rounding.\nF - 30\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company has neither changed its independent accountants nor had any disagreements on accounting and financial disclosure with such accountants.\nPART III\nThe Company's Proxy Statement to be filed in connection with its Annual Meeting of Shareholders on May 31, 1996, is hereby 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 STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(A)1. FINANCIAL STATEMENTS\nThe following consolidated financial statements of Registrant are filed with this report and included in Part II, Item 8:\n(A)2. FINANCIAL STATEMENT SCHEDULES\nThe following financial statement schedules of Registrant are filed with this report:\nAll other schedules not listed above have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto.\nBoard of Directors and Stockholders Health Images, Inc. Atlanta, Georgia\nWe have audited the consolidated financial statements of Health Images, Inc., 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 23, 1996, such financial statements and report are included elsewhere in this annual report. Our audits also included the financial statement schedules of Health Images, Inc., and subsidiaries, listed in Item 14(a)2. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 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.\nJOSEPH DECOSIMO AND COMPANY\nAtlanta, Georgia February 23, 1996\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nHEALTH IMAGES, INC., AND SUBSIDIARIES\n- ---------------\n(a) Accounts written off.\nEXHIBIT 11--COMPUTATION OF NET EARNINGS PER SHARE\n(A)3. EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nThe following Executive Compensation Plans and Arrangements are filed with this Form 10-K or have previously been filed as indicated below:\n1. Employment Agreement dated as of October 1, 1994, by and between the Company and Robert D. Carl, III (12) Exhibit 10(b)(i)).\n2. Employment Agreement dated as of October 1, 1994, by and between the Company and W.A. Wilson (12) (Exhibit 10(b)(ii)).\n3. Amended and Restated Employee Incentive Stock Option Plan of Registrant dated December 20, 1985 (1) (Exhibit 10(v)(i)).\n4. Amended and Restated Employee Incentive Stock Option Plan of Registrant dated May 19, 1987 (9) (Exhibit 4(d)).\n5. First Amendment to the Amended and Restated Employee Incentive Stock Option Plan dated June 29, 1989 (5) (Exhibit 10(p) (vii)).\n6. Second Amendment to the Amended and Restated Employee Incentive Stock Option Plan dated June 5, 1992 (10) (Exhibit 10(c)(iv)).\n7. Form of Incentive Stock Option Agreement (7) (Exhibit 10(p) (ix)).\n8. Form of Non-Qualified Option Agreement (5) (Exhibit 10(p) (xi)).\n9. Non-Qualified Stock Option Plan (8) (Exhibit 10(d)(i)).\n10. Form of Option Agreement under the Non-qualified Stock Option Plan (8) (Exhibit 10(d)(ii)).\n11. Form of Non-Employee Director Option Agreement (8) (Exhibit 10(d) (iii)).\n12. 1995 Formula Stock Option Plan for Outside Directors (Exhibit 10(d)(iv) below).\n13. Form of Formula Stock Option Agreement (Exhibit 10(d)(v) below).\n14. Key man life insurance policy on the life of Robert D. Carl, III (2) (Exhibit 10(p)).\n15. Exchange Agreement dated May 19, 1987 between Registrant and Robert D. Carl, III (3) (Exhibit 10(q)(vii)).\n16. Warrant Agreement and Certificate dated May 19, 1987, between Registrant and Robert D. Carl, III (3) (Exhibit 10(q) (viii)).\n(A)4. ADDITIONAL INFORMATION\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. 33-18747 (filed November 25, 1987), 33-32666 (filed December 28, 1989), 33-38369 (filed December 21, 1990), 33-39216 (filed February 28, 1991) and 33-50170 (filed July 29, 1992) related to the Company's compensation plans:\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.\nITEM 14(B) In the quarter ended December 31, 1995, there were no reports filed on Form 8-K:\nITEM 14(C) Table of Exhibits\nExhibits required to be filed by Item 601 of Regulation S-K are included as Exhibits to this report as follows:\n- ---------------------\n(1) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1985 (File No. 0-14746).\n(2) Incorporated herein by reference to exhibit of same number to Amendment No. 2 to Registrant's Registration Statement on Form S-1, filed July 14, 1986 (Reg. No. 33-5855).\n(3) Incorporated herein by reference to exhibit of same number to Registrant's Registration Statement on Form S-1, filed May 20, 1987 (Reg. No. 33-14437).\n(4) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1988. (File No. 0-14746).\n(5) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1989. (File No. 0-14746)\n(6) Incorporated herein by reference to exhibit of same number to Amendment No. 2 to Registrant's Registration Statement on Form S-2 filed June 14, 1990. (Reg. No. 33-34161)\n(7) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1990. (File No. 0-14746)\n(8) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1991. (File No. 0-14746)\n(9) Incorporated herein by reference to exhibit 4(d) to Registrant's Registration Statement for Form S-8, filed November 24, 1987 (Reg. No. 33-18747).\n(10) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1992 (File No. 0-14746).\n(11) Incorporated herein by reference to exhibit of same number to Registrant's Current Report on Form 8-K dated December 28, 1994 (File No. 0-14746).\n(12) Incorporated herein by reference to exhibit of same number to Registrant's Annual Report on Form 10-K for 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.\nHEALTH IMAGES, INC.\nDate: March 29, 1996 BY:\/s\/ ROBERT D. CARL, III ----------------------- Robert D. Carl, III 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:","section_15":""}
{"filename":"355472_1995.txt","cik":"355472","year":"1995","section_1":"ITEM 1. BUSINESS\nAll references to \"Notes\" are to Notes to Consolidated Financial Statements contained in this report.\nThe registrant, JMB Income Properties, Ltd.-IX (the \"Partnership\"), is a limited partnership formed in 1981 and currently governed by the Revised Uniform Limited Partnership Act of the State of Illinois to invest in improved income-producing commercial and residential real property. The Partnership sold $77,127,000 in Limited Partnership Interests (the \"Interests\") commencing on April 14, 1982, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-73991). A total of 77,127 Interests were sold to the public at $1,000 per Interest. The holders of 25,599 Interests were admitted to the Partnership in fiscal 1982; the holders of 51,528 Interests were admitted to the Partnership in fiscal 1983. The offering closed on May 10, 1983. Included in the 77,127 Limited Partnership Interests subscribed and issued are 382 Interests belonging to an affiliate of the lead underwriter in consideration of consulting services in connection with the organization of the Partnership. No Limited Partner has made any additional capital contribution after such date. The Limited Partners of the Partnership share in their portion of the benefits of ownership of the Partnership's real property investments according to the number of Interests held.\nThe Partnership is engaged solely in the business of the acquisition, operation and sale and disposition of equity real estate investments. Such equity investments are held by fee title, leasehold estates and\/or through joint venture partnership interests. The Partnership's sole remaining real estate investment is the Blanchard Plaza Building which is located in Seattle, Washington. A presentation of information about industry segments, geographic regions, raw materials or seasonality is not applicable and would not be material to an understanding of the Partnership's business taken as a whole. Pursuant to the Partnership Agreement, the Partnership is required to terminate no later than October 31, 2031. The Partnership is self-liquidating in nature. At sale of a particular property, the net proceeds, if any, are generally distributed or reinvested in existing properties rather than invested in acquiring additional properties. As discussed further in Item 7, the marketplace in which the portfolio operates and real estate markets in general are in a recovery mode. The Partnership currently expects to conduct an orderly liquidation of the remaining asset as quickly as possible and to wind up its affairs of the Partnership not later than December 31, 1999, barring any unforeseen economic developments. (Reference is also made to Note 1.)\nThe Partnership has made the real property investments set forth in the following table:\nThe Partnership's remaining real property investment is subject to competition from similar types of properties (including properties owned or advised by affiliates of the General Partners) in the vicinity in which it is located. Such competition is generally for the retention of existing tenants. Additionally, the Partnership is in competition for new tenants. Reference is made to Item 7 below for a discussion of competitive conditions and future renovation and capital improvement plans of the Partnership for its remaining investment property. Approximate occupancy levels for the properties are set forth in the table in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owns or owned directly or through joint venture partnerships the properties or interests in the properties referred to under Item 1 above to which reference is hereby made for a description of said properties.\nThe following is a listing of principal businesses or occupations carried on in and approximate occupancy levels by quarter during fiscal years 1995 and 1994 for the Partnership's investment properties owned during 1995:\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 fiscal years 1995 and 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nAs of December 31, 1995, there were 6,804 record holders of Interests of the Partnership. There is no public market for Interests and it is not anticipated that a public market for Interests will develop. Upon request, the Managing General Partner may provide information relating to a prospective transfer of Interests to an investor desiring to transfer his Interests. The price to be paid for the Interests, as well as any other economic aspects of the transaction, will be subject to negotiation by the investor. There are certain conditions and restrictions on the transfer of Interests, including, among other things, the requirement that the substitution of a transferee of Interests as a Limited Partner of the Partnership be subject to the written consent of the Managing General Partner. The rights of a transferee of Interests who does not become a substituted Limited Partner will be limited to the rights to receive his share of profits or losses and cash distributions from the Partnership, and such transferee will not be entitled to vote such Interests. No transfer will be effective until the first day of the next succeeding calendar quarter after the requisite transfer form satisfactory to the Managing General Partner has been received by the Managing General Partner. The transferee consequently will not be entitled to receive any cash distributions or any allocable share of profits or losses for tax purposes until such succeeding calendar quarter. Profits or losses from operations of the Partnership for a calendar year in which a transfer occurs will be allocated between the transferor and the transferee based upon the number of quarterly periods in which each was recognized as the holder of Interests, without regard to the results of Partnership's operations during particular quarterly periods and without regard to whether cash distributions were made to the transferor or transferee. Profits or losses arising from the sale or other disposition of Partnership properties will be allocated to the recognized holder of the Interests as of the last day of the quarter in which the Partnership recognized such profits or losses. Cash distributions to a holder of Interests arising from the sale or other disposition of Partnership properties will be distributed to the recognized holder of the Interests as of the last day of the quarterly period with respect to which distribution is made.\nReference is made to Item 6","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nOn April 14, 1982, the Partnership commenced an offering to the public of up to $80,000,000 pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. Through May 10, 1983 (the final admission date), the Partnership had received $70,605,480 (net of selling commissions of $6,139,520) of offering proceeds and issued 77,127 Interests (including 382 Interests issued to an affiliate of the lead underwriter in consideration of consulting services in connection with the organization of the Partnership).\nAfter deducting selling expenses and other offering costs, the Partnership had approximately $68,000,000 with which to make investments in income-producing commercial and residential real property, to pay legal fees and other costs (including acquisition fees) related to such investments and for working capital reserves. A portion of such proceeds was utilized to acquire the properties described in Item 1 above.\nAt December 31, 1995, the Partnership and its consolidated venture had cash and cash equivalents of approximately $4,180,000. Such funds are available for capital improvements, future distributions to partners, payment of certain deferrals to affiliates of the General Partners and for working capital requirements including operating deficits at the Blanchard Plaza office building. As a result of certain limitations provided for in the Partnership Agreement, an affiliate of the General Partners of the Partnership is deferring payment of certain management and leasing fees as more fully described in Note 6. The Partnership and its consolidated venture have currently budgeted approximately $633,800 for tenant improvements and other capital expenditures in 1996. The amounts and timing may vary depending on a number of factors including actual leasing activity, results of operations, liquidity considerations and other market conditions. Effective in 1993, the Partnership suspended its quarterly distribution so that future cash requirements may be met. The source of capital for such items and for long-term future liquidity and distributions is dependent on cash reserves held by the Partnership and through the sale of the investment. In such regard, reference is made to the discussions below and to Notes 3 and 4. The remaining property's operations are not expected to generate any short-term liquidity as described below. The Partnership's and its venture's remaining mortgage obligation is a separate non-recourse loan secured by the investment property and is not the obligation of the Partnership.\nThe Blanchard Plaza investment property currently operates at a small deficit. This deficit results from a modification of the property's mortgage note which provides for an annual cash flow payment to the lender which reduces the principal balance of the loan as described in Note 4. The Partnership expects to continue to utilize the remaining proceeds from the sale of the Lynnhaven Mall to cover these operating deficits. The mortgage note was scheduled to mature December 1, 1995 and has since been extended to December 1, 1996. There can be no assurance that the joint venture will be able to further extend, refinance or obtain alternative financing for all or substantially all of the mortgage loan when the debt matures. The joint venture is preparing to market the Blanchard Plaza office building for sale in 1996. There can be no assurance that a sale of the property will occur. Also, it is currently expected that any such sale would result in the return of only a modest portion of the Partnership's original cash invested in the property. The Seattle office market is showing significant improvement as vacancy rates continue to decline. The current vacancy rate for the sub-market in which the property operates is approximately 6%. Of the approximately 43,700 square feet of leases (18% of the building's leasable square footage) originally scheduled to expire in 1995 and 1996, the Partnership has been successful in signing new and renewing leases of approximately 24,600 square feet. In addition, the Partnership signed new leases for another approximately 4,650 square feet of space which had never been occupied and another lease representing approximately 5,000 square feet of space is currently being negotiated. The Partnership is actively pursuing the renewal or re-lease of the remaining space in the building. In addition, the joint venture amended the lease with the General Services Administration (\"GSA\") in 1994. In exchange for certain rent concessions, this amendment eliminated the GSA's option to terminate the lease at any time after October 1998. The GSA lease expires in October 2002 but has an option to extend its lease for an additional five years.\nThe joint venture received notification from the GSA that it was due approximately $423,000 in minimum rent credits. The joint venture has disputed this claim. The GSA began offsetting its monthly rent payments in January 1996 in an amount equal to 1\/12 of the amount in dispute. The joint venture has filed an appeal with the General Services Board of Contract Appeals and is awaiting a response. Though the joint venture believes that it is entitled to retain the amounts previously received and recover the amounts offset by the GSA, there can be no assurance that the joint venture will not ultimately have to settle for a lesser amount or suffer an adverse judgment respecting this dispute.\nDuring December 1995, the lender realized upon its security for its non-recourse loan, which included the land, buildings and related improvements of the Town and Country Center (\"the Property\"), as described below. The property was approximately 73% occupied (8% represents temporary tenants) on the disposition date. The property was acquired through a joint venture with an affiliated partnership (\"T & C\"), which was in turn a partner in a joint venture (\"Town & Country\") with the developer of the center.\nAs previously reported, the Property faced strong competition from, among others, the Town and Country Village, a multi-building retail project encompassing over sixty acres contiguous to the Property. Although not all tenants at this project will compete directly with the mall tenants at the Property, a number of tenants that in the past have occupied space in enclosed regional malls have recently signed leases for free-standing space in Town and Country Village, and these stores are now scheduled to open in 1996.\nOver the past year, Town and Country had prepared and evaluated a plan for an extensive renovation and re-merchandising of the Property for the long-term stability and enhancement of the Property's occupancy and revenue potential. In connection with the plan, Town and Country approached a number of national and regional tenants to lease space at the Property. In discussions with these tenants, a majority of them indicated that, in addition to significant tenant leasing incentives, a major renovation of the Property would be essential for them to lease space at the Property. Accordingly, The Partnership worked extensively with an architectural firm and marketing personnel to determine the most effective redevelopment plan to improve the Property. Focus group studies on the area residents further supported this concept. A condition to undertaking a redevelopment of the Property was to have been Town and Country's obtaining extensions of the agreements for the department stores to continue operating their stores at the Property. The Partnership believed that the renovation and re- merchandising of the Property was viable and that it would be the best strategy to enhance value. Accordingly, during this process, it remained the Partnership's intent to hold the Property as a long-term investment.\nTown and Country completed its evaluation of an extensive redevelopment of the center in early September 1995. The total cost for such a redevelopment, including obtaining tenant leases for the mall space and extensions of the department store operating agreements, was estimated to be in excess of $25 million. However, many of the retail tenants considered integral to a successful re-merchandising of the property upon completion of a renovation were now unwilling to take further space in the Houston market even if offered significant tenant leasing incentives. The continued sluggishness in the Houston economy in recovering from the previous recession, as well as the intense competition in the Property's trade area, appear to be among the factors dissuading prospective retail tenants from committing to lease space at the Property. In addition, the projected return on the estimated cost was not expected to be sufficient to warrant an investment of this magnitude.\nGiven Town and Country's level of debt, the strong competition that the Property faced, and the significant cost that would have been required to lease, renovate and re-merchandise the Property, Town and Country decided in September 1995 not to commit any additional capital to pay continued operating deficits of the property, including funding for debt service payments, unless it could obtain a modification to the existing non-recourse mortgage loan. Consequently, Town and Country remitted to the lender only the amount of cash flow from property operations after expenses rather than the full debt service payment required for the month of September 1995. Town and Country approached the lender to discuss the possibility of a modification to the existing loan to eliminate, or reduce significantly, future operating deficits. However, the lender was unwilling to modify the loan. On September 13, 1995, the lender notified Town and Country that it was in default, and that the lender intended to realize upon its security for the mortgage loan as soon as possible. Due to the uncertainty of the Partnership's ability to recover the net carrying value of the Town and Country Center, the Partnership made, as a matter of prudent accounting practice, a provision at September 30, 1995 for value impairment of the Town and Country Center of $30,114,810 (of which the Partnership's share is $1,686,425). Such provision reduced the net carrying value of the investment property to the then outstanding balance of the non-recourse loan.\nThrough December 5, 1995, (immediately prior to the disposition) the Partnership and its affiliated joint venture partner had made interest- bearing loans aggregating $4,740,437 to the T&C venture to fund operating deficits at the Property pursuant to a proposed amendment to the Town & Country joint venture agreement. However, such proposed amendment was not executed prior to termination. The Partnership's portion of these loans were $1,489,920 (including accrued interest) and has been reflected as contributions to unconsolidated venture in the consolidated financial statements and have been netted into the gain on disposition as of December 5, 1995.\nTown & Country also was obligated under a 12% promissory note payable ($991,686 outstanding at December 5, 1995 (immediately prior to the disposition) and at December 31, 1994) to an affiliate of the developer which matured June 30, 1993. The Partnership and JMB-VIII had reached an agreement in principle with the developer to extend the original due date of the promissory note. Although no interest payments were being made currently, the venture continued to accrue interest on the note at the original contract rate. As of the date of disposition of the Property, such promissory note was cancelled and the note (including accrued interest of $586,537 at December 5, 1995 (immediately prior to the disposition) was treated as a capital contribution by the unaffiliated venture partner).\nOn December 5, 1995, the lender completed the proceedings to realize upon its security and took title to the Property in full satisfaction of its loan. As a result of the disposition of the Property, the Partnership recognized a gain of approximately $908,413 for financial reporting purposes and approximately $3,501,670 for Federal income tax purposes. There were no proceeds from the disposition.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.\nAs a result of the real estate market conditions discussed above, the Partnership continues to conserve its working capital. All expenditures are carefully analyzed and certain capital projects are deferred when appropriate. As previously reported, the Partnership's remaining property is not currently generating operating cash flow. Due to these factors, the Partnership had, beginning the second quarter of 1993, indefinitely suspended quarterly distributions to the partners. By conserving working capital, the Partnership will be in a better position to meet future needs of its property since the availability of satisfactory outside sources of capital may be limited given the Partnership's current debt level. As has been reported previously, due to these factors, the Partnership held certain of its investment properties longer than originally anticipated in an effort to maximize the return to the Limited Partners. However, after reviewing Blanchard Plaza and the marketplace in which it operates, the General Partners of the Partnership expect to liquidate this asset as quickly as practicable. Therefore, the affairs of the Partnership are expected to be wound up no later than 1999 (sooner if the Blanchard Plaza property is sold or disposed of in the nearer term), barring unforeseen economic developments.\nRESULTS OF OPERATIONS\nThe increase in cash and cash equivalents and corresponding decrease in short-term investments at December 31, 1995 as compared to December 31, 1994 is primarily due to all of the Partnership's investments of U.S. Government obligations being classified as cash equivalents at December 31, 1995. Reference is made to Note 1. The aggregate decrease in cash and cash equivalents and short-term investments is primarily due to the Partnership's funding of deficits incurred at the Town & Country Center and the Blanchard Plaza office building during 1995. Reference is made to Note 3.\nThe decrease in interest, rents and other receivables, along with the aggregate decrease in investment in unconsolidated venture at equity at December 31, 1995 as compared to December 31, 1994 and the related increase in the Partnership's share of loss from operations of unconsolidated venture and the Partnership's share of gain from the disposition of unconsolidated venture property is due to the lender realizing upon its security for its non-recourse loan related to the Town & Country Center investment property in December 1995 (Notes 1 and 3(b)).\nThe decrease in accounts payable at December 31, 1995 as compared to December 31, 1994 is primarily due to the timing of payment of certain deferred expenses, including re-leasing costs, related to the Blanchard Plaza office building.\nThe decrease in tenant security deposits at December 31, 1995 as compared to December 31, 1994 is due to the refund of security deposits to certain tenants and the replacement of such tenants with tenants under leases which do not require security deposits at the Blanchard Plaza office building in 1995.\nThe increase in interest income for the year ended December 31, 1995 as compared to the year ended December 31, 1994 and December 31, 1994 as compared to December 31, 1993 is primarily due to the increase in average balances of U.S. Government obligations held by the Partnership during 1995 and 1994.\nThe increase in amortization of deferred expenses for the year ended December 31, 1995 as compared to the year ended December 31, 1994 is primarily due to the 1995 amortization of lease commissions previously deferred at the Blanchard Plaza office building in December 1994.\nThe increase in general and administrative expenses for the year ended December 31, 1995 as compared to the years ended December 31, 1994 and 1993 is attributable primarily to an increase in reimbursable costs to affiliates of the General Partners in 1995 and the recognition of certain additional prior year reimbursable costs to such affiliates. Reference is made to Note 6.\nThe increase in Partnership's share of loss from operations of unconsolidated venture for 1994 as compared to 1993 is primarily due to a decrease in rental income due to the writeoff of certain delinquent tenants receivables in 1994 at the Town and Country Center.\nINFLATION\nDue to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.\nInflation is not expected to significantly impact future operations due to the expected liquidation of the Partnership by 1999. However, to the extent that inflation in future periods would have an adverse impact on property operating expenses, the effect would generally be offset by amounts recovered from tenants as many of the long-term leases at the Partnership's remaining office building have escalation clauses covering increases in the cost of operating and maintaining the property as well as real estate taxes. Therefore, there should be little effect on operating earnings if the property remains substantially occupied.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nJMB INCOME PROPERTIES, LTD. - IX (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURE\nINDEX\nIndependent 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 Partners' Capital Accounts (Deficits), 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\nSchedule -------- Consolidated Real Estate and Accumulated Depreciation III\nSchedules not filed:\nAll schedules other than the one indicated in the index have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners JMB INCOME PROPERTIES, LTD. - IX:\nWe have audited the consolidated financial statements of JMB Income Properties, Ltd. - IX (a limited partnership) and Consolidated Venture as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partners of the Partnership, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JMB Income Properties, Ltd. - IX and Consolidated Venture 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.\nThe accompanying consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Notes 3(c) and 4 of the consolidated financial statements, the mortgage loan matures December 1, 1996. This circumstance raises substantial doubt about the Partnership's ability to retain its ownership in the property and continue as a going concern. The General Partner's plans in regard to this matter are described in Note 3(c). The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 25, 1996\nJMB INCOME PROPERTIES, LTD. - IX (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURE\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(1) OPERATIONS AND BASIS OF ACCOUNTING\nThe Partnership holds (through a joint venture) an equity investment in an office building in Seattle, Washington. Business activities consist of rentals to a governmental agency and a variety of commercial companies, and the ultimate sale or disposition of such real estate. The Partnership currently expects to conduct an orderly liquidation of its remaining investment, and wind up its affairs not later than December 31, 1999.\nThe accompanying consolidated financial statements include the accounts of the Partnership and its consolidated venture, Plaza\/Seattle Limited Partnership (\"Plaza\/Seattle\"). The effect of all transactions between the Partnership and the consolidated venture has been eliminated in the consolidated financial statements. The equity method of accounting has been applied in the accompanying consolidated financial statements with respect to the Partnership's venture interest in T&C-JMB Partners (\"T&C\"). Accordingly, the accompanying consolidated financial statements do not include the accounts of T&C and T&C's venture, H&M Associates, Ltd. - Houston (\"Town & Country\") (notes 3(b) and 8).\nThe Partnership's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying consolidated financial statements have been prepared from such records after making appropriate adjustments to reflect the Partnership's accounts in accordance with generally accepted accounting principles (\"GAAP\") and to consolidate the accounts of the venture as described above.\nSuch GAAP and consolidation adjustments are not recorded on the records of the Partnership. The net effect of these items for the years ended December 31, 1995 and 1994 is summarized as follows:\nThe net loss per limited partnership interest is based upon the number of limited partnership interests outstanding at the end of each period (77,132).\nThe preparation of financial statements in accordance with GAAP requires the Partnership to make estimates and assumptions that affect the reported or disclosed amount 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.\nStatement of Financial Accounting Standards No. 95 requires the Partnership to present a statement which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The required information has been segregated and accumulated according to the classifications specified in the pronouncement. Partnership distributions from its unconsolidated venture are considered cash flow from operating activities only to the extent of the Partnership's cumulative share of net earnings. The Partnership records amounts held in U.S. Government obligations at cost, which approximates market. For the purposes of these statements, the Partnership's policy is to consider all such amounts held with original maturities of three months or less ($3,719,182 and $2,350,000 at December 31, 1995 and 1994, respectively) as cash equivalents with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDeferred expenses consist primarily of loan fees and lease commissions which are amortized over the terms stipulated in the related agreements or over the terms of the related leases using the straight-line method.\nAlthough certain leases of the Partnership provide for tenant occupancy during periods for which no rent is due and\/or increases in minimum lease payments over the term of the lease, the Partnership accrues prorated rental income for the full period of occupancy on a straight-line basis.\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires entities to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its current assets and liabilities approximates SFAS 107 value due to the relatively short maturity of these instruments. The debt secured by the Blanchard Plaza office property matures in December 1996 and, accordingly, the Partnership believes the carrying value of such debt approximates the SFAS 107 value. There is no quoted market value available for any of the Partnership's other instruments. The debt secured by the Blanchard Plaza office property matures in December 1996 and, accordingly, the Partnership believes the carrying value of such debt approximates the SFAS 107 value. The Partnership has no other significant financial instruments.\nNo provision for State or Federal income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership. However, in certain instances, the Partnership has been required under applicable law to remit directly to the tax authorities amounts representing withholding from distributions paid to partners.\n(2) INVESTMENT PROPERTIES\nThe Partnership had acquired, through joint ventures (note 3), three shopping centers and one office building as investments. Three properties have been sold or disposed of by the Partnership. The remaining property owned at December 31, 1995 was operating. The cost of the investment property represents the total cost to the Partnership and its ventures plus miscellaneous acquisition costs.\nDepreciation on the properties has been provided over the estimated useful lives of the various components as follows:\nYEARS -----\nBuildings and improvements (new or used) -- straight-line. . . . . . . . . . . . . . 5-30 Personal property (new or used) -- straight-line . . . . . . . . . . . . . 5-10 ====\nMaintenance and repair expenses are charged to operations as incurred.\nSignificant betterments and improvements are capitalized and depreciated over their estimated useful lives.\nDuring March 1995, 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\" was issued. SFAS 121, when effective, will require that the Partnership record an impairment loss on its long- lived asset to be held and used whenever the carrying value cannot be fully recovered through estimated undiscounted future cash flows from operations and sale. The amount of the impairment loss to be recognized would be the difference between the long-lived asset's carrying value and the asset's estimated fair value. Any long-lived assets identified \"to be disposed of\" would no longer be depreciated. Adjustments for impairment loss would be made in each period as necessary to report these assets at the lower of carrying value and fair value less costs to sell. In certain situations, such estimated fair value could be less than the existing non-recourse debt which is secured by the property. There would be no assurance that any estimated fair value of these assets would ultimately be obtained by the Partnership in any future sale or disposition transaction.\nUnder the current impairment policy, provisions for value impairment are recorded with respect to investment properties whenever the estimated future cash flows from a property's operations and projected sale are less than the property's net carrying value. The amount of any such impairment loss recognized by the Partnership is limited to the excess, if any, of the property's carrying value over the outstanding balance of the property's non-recourse indebtedness. An impairment loss under SFAS 121 would be determined without regard to the nature or the balance of such non-recourse indebtedness. Upon the disposition of a property with the related extinguishment of the long-term debt for which an impairment loss has been recognized under SFAS 121, the Partnership would recognize, at a minimum, a net gain (comprised of gain on extinguishment of debt and gain or loss on sale or disposition of property) for financial reporting purposes to the extent of any excess of the then outstanding balance of the property's non- recourse indebtedness over the then carrying value of the property, including the effect of any reduction for impairment loss under SFAS 121.\nThe Partnership will adopt SFAS 121 as required in the first quarter of 1996. Based upon the Partnership's current assessment of the full impact of adopting SFAS 121, it is not anticipated that any significant provisions for value impairment would be required.\nIn addition, upon the disposition of an impaired property, the Partnership would generally recognize more net gain for financial reporting purposes under SFAS 121 than it would have under the Partnership's current impairment policy, without regard to the amount, if any, of cash proceeds received by the Partnership in connection with the disposition. Although implementation of this new accounting statement could significantly impact the Partnership's reported earnings, there would be no impact on cash flows. Further, any such impairment loss would not be recognized for Federal income tax purposes.\nThe investment property is pledged as security for the long-term debt, for which there is no recourse to the Partnership.\n(3) VENTURE AGREEMENTS\nThe terms of the venture agreements are summarized as follows:\n(a) General\nThe Partnership, at December 31, 1995, is a party to one operating joint venture agreement (the Partnership's interest in T&C was terminated in 1995, (see note 3(b)). Pursuant to such agreement, the Partnership made initial capital contributions of approximately $19,435,000 (before legal and other acquisition costs and its share of operating deficits as discussed below). Under certain circumstances, either pursuant to the remaining venture agreement or due to the Partnership's obligations as a general partner, the Partnership may be required to make additional cash contributions to the remaining venture.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.\n(b) Town and Country\nOn December 5, 1995, the lender realized upon its security for its non-recourse loan, which included the land, buildings and related improvements of the Town and Country Center as further described below.\nIn February 1983, the Partnership acquired, through an existing joint venture partnership with an investor and the developer of Town and Country, an interest in an enclosed shopping center in Houston, Texas. The Partnership acquired its interest through a joint venture partnership (\"T&C\") with JMB Income Properties, Ltd.- VIII (\"JMB-VIII\"), a partnership sponsored by the Managing General Partner of the Partnership.\nThe Partnership acquired an interest in T&C for a purchase price of $11,000,000 (31.43%) of a total of $35,000,000 invested in T&C by the Partnership and JMB - VIII. On December 30, 1992, the T&C venture and the developer each purchased 50% of the investor's interest in Town and Country for $150,000 each. The property was subject to a first mortgage note in the original amount of $33,390,000.\nThe terms of the T&C partnership agreement provided that all of T&C's share of the Town & Country's annual cash flow, net proceeds from sale or refinancing, profits and losses and tax items are allocated between the Partnership and JMB - VIII based upon the ratio of capital contributions made by each partner (31.43% by the Partnership and 68.57% by JMB - VIII). The T&C partnership was allocated 73.07% of Town and Country's operating profits and losses.\nTown & Country's net cash flow was distributable as follows: first, T&C was entitled to receive the cumulative deficiency in its preferred cash return through 1992; next, the developer was entitled to receive a cumulative amount equal to its unreimbursed capital contributions used to fund operating deficits incurred with respect to the property and T&C's preferential return in prior years; finally, any cash flow in excess of these preferred amounts was to be distributable 73.07% to T&C and 26.93% to the developer. The Partnership did not receive any distributions from T&C in 1995, 1994 or 1993. Any operating deficits were funded by contributions to the venture by the venture partners in the ratio of their respective residual ownership percentages.\nUpon sale of the shopping center, T&C was entitled to a preferential share of the net sale proceeds plus any deficit in T&C's cumulative annual preferred return. However, there were no distributable proceeds from the disposition of the property.\nTown and Country was also obligated under a 12% promissory note payable ($991,686 outstanding at December 5, 1995 (immediately prior to the disposition) and at December 31, 1994) to an affiliate of the developer which matured June 30, 1993. The Partnership and JMB-VIII had reached an agreement in principle with the developer to extend the original due date of the promissory note. Although no interest payments were being made currently, the venture continued to accrue interest on the note at the original contract rate. As of the date of disposition of the Property, such promissory note was cancelled and the note (including accrued interest of $586,537 at December 5, 1995 (immediately prior to the disposition) was treated as a capital contribution by the unaffiliated venture partner.\nThrough December 5, 1995, (immediately prior to the disposition) the Partnership and its affiliated joint venture partner had made interest- bearing loans aggregating $4,740,437 to the T&C venture to fund operating deficits at the property pursuant to a proposed amendment to the Town and Country joint venture agreement. However, such proposed amendment was not executed prior to termination. The Partnership's portion of these loans were $1,489,920 (including accrued interest) and has been reflected as contributions to unconsolidated venture in the consolidated financial statements and have been netted into the gain on disposition as of December 5, 1995.\nPursuant to the terms of the joint venture agreement, the Partnership and its joint venture partners also made advances aggregating $1,013,880. The Partnership's portion of these advances was $270,510 and has been reflected as contributions to the unconsolidated venture in the consolidated financial statements and have been netted into the gain on disposition as of December 5, 1995.\nTown and Country was approximately 73% occupied (8% represents temporary tenants) on the disposition date. Town and Country faced strong competition in its area. T&C Venture had prepared and evaluated a plan for an extensive renovation and re-merchandising of Town and Country. Given Town and Country's level of debt, the strong competition that the Town and Country faced and the significant cost that would have been required to lease, renovate and re-merchandise Town and Country, T&C Venture decided in September 1995 not to commit any additional capital to pay continued operating deficits of Town and Country, including funding for debt service payments, without obtaining a modification to the existing non-recourse mortgage loan. Consequently, Town and Country remitted to the lender only the amount of cash flow from property operations after expenses rather than the full debt service payment required for the month of September 1995. The lender was unwilling to modify the loan and realized upon its security as a result of the default in the payment of debt service.\nAs a result of the disposition of Town and Country to the lender and the liquidation of the joint ventures mentioned above, the Partnership has recognized a gain of approximately $908,413 net of the venture partners' shares, for financial reporting purposes and a gain of approximately $3,501,670 net of the venture partners' shares, for Federal income tax reporting purposes. The Partnership had previously recorded a provision for value impairment of approximately $30,115,000 (of which the Partnership's share is $1,686,425) for financial reporting purposes relating to the underlying real estate assets. There were no proceeds from the disposition. Under the terms of the applicable venture agreements, gain on disposition of Town and Country and liquidations of the joint ventures was to be allocated according to the respective ownership percentages of the venture partners as previously discussed.\nAn affiliate of the Managing General Partner of the Partnership had responsibility for management and leasing of the Town and Country Center under a management agreement which provides for a management fee based on a percentage of gross income (as defined) from the property's operations not to exceed 5% in aggregate.\n(c) Plaza\/Seattle\nIn July 1983, the Partnership acquired, through a joint venture partnership, an interest in a 15-story office building in Seattle, Washington.\nThe terms of the joint venture partnership agreement provide that the joint venture partners will not be obligated to make any cash contributions to the joint venture; however, the value of the joint venture partners' contribution of their interest in the land to the joint venture was taken into account in determining the terms of the joint venture partnership agreement. Distribution of annual cash flow (after debt service) is to be made first to the Partnership as reimbursement for its aggregate additional contributions; then the joint venture partners are entitled to receive the next $90,000 per annum of annual cash flow; the Partnership is entitled to receive the next $1,078,838, and any excess annual cash flow will be distributable 92.3% to the Partnership and 7.7% to the joint venture partners. Distributions of annual cash flow to the Partnership and to the joint venture partners ceased in prior years. The Partnership has funded 100% of all subsequent deficits at Blanchard Plaza office building. Consequently, operating profits and losses are allocated 100% to the Partnership.\nThe joint venture partnership agreement provides that the net proceeds, if any, from any sale or refinancing of the property will be allocated as follows: first to the Partnership as reimbursement for its aggregate additional capital contributions; then the Partnership shall be paid the outstanding balance of its $2,000,000 loan to the venture (such loan has been eliminated in consolidated financial statements, see note 1) plus any accrued interest thereon (monthly payments of interest only are due and have been made at a rate of 10.88%); the joint venture partners are entitled to receive the next $1,250,000 of such proceeds; the Partnership is entitled to receive the next $15,225,000 and any remaining proceeds will be distributed 92.3% to the Partnership and 7.7% to the joint venture partners. The joint venture partnership agreement provides for gain or loss on the disposition of the property to be allocated to the extent needed to equalize the capital accounts of the joint venture partners, to the extent of any net proceeds distributed to the joint venture partners, and any remaining gain or loss 92.3% to the Partnership and 7.7% to the joint venture partners.\nAn affiliate of the Managing General Partner had responsibility for management and leasing of the Blanchard Plaza office building under a management agreement which provides for a management fee equal to 4% of gross income (as defined) from the property's operations. In December 1994, such affiliate sold substantially all of its assets and assigned its interest in its management contracts including the agreement for the Blanchard Plaza office building, to an unaffiliated third party (note 6).\nThe joint venture received notification from the GSA that it was due approximately $423,000 in minimum rent credits. The joint venture has disputed this claim. The GSA began offsetting its monthly rent payments in January 1996 in an amount equal to 1\/12 of the amount in dispute. The joint venture has filed an appeal with the General Services Board of Contract Appeals and is awaiting a response. Though the joint venture believes that it is entitled to retain the amounts previously received and recover the amounts offset by the GSA, there can be no assurance that the joint venture will not ultimately have to settle for a lesser amount or suffer an adverse judgment respecting this dispute.\nThe long-term non-recourse mortgage note secured by the Blanchard Plaza office building located in Seattle, Washington has been extended to December 1, 1996 when all principal and accrued interest becomes due. There can be no assurance that the joint venture will be able to further extend, refinance or obtain alternative financing for all or substantially all of the mortgage loan when the debt matures (note 4). The joint venture is preparing to market the Blanchard Plaza office building for sale in 1996. There can be no assurance that a sale of the property will occur. Also, it is currently expected that any such sale would result in the return of only a modest portion of the Partnership's original cash invested in the property.\n(4) LONG-TERM DEBT\nThe long-term non-recourse mortgage note secured by the Blanchard Plaza office building located in Seattle, Washington was modified effective December 1, 1988. Such modification, among other things, provided for debt service to be paid at reduced rates through the May 1, 1991 payment with the interest rate differential being added monthly to the principal balance on the note. The mortgage note balance includes cumulative deferred interest of $2,565,705 and $2,784,297 at December 31, 1995 and 1994, respectively. The note has been classified as a current liability at December 31, 1995 and 1994, since an agreement was reached in 1995 to extend the maturity from December 1, 1995 to December 1, 1996 when all principal and accrued interest will become due (note 3(c)). The note accrues interest at a fixed rate of 10.5% and requires monthly payments of principal and interest of $148,693. The note provides for additional principal payments of annual net cash flow payable in April of the following year. As of December 31, 1995, an additional principal payment of $255,800 is payable in 1996.\n(5) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement, net profits or losses of the Partnership from operations are allocated 96% to the Limited Partners and 4% to the General Partners. Profits from the sale or refinancing of investment properties are to be allocated to the General Partners to the greater of 1% of such profits or the amount of cash distri- butable to the General Partners from any such sale or refinancing (as described below). Losses from the sale or refinancing of investment properties will be allocated 1% to the General Partners. The remaining sale or refinancing profits and losses will be allocated to the Limited Partners.\nThe Partnership Agreement, also generally provides that notwithstanding any allocation contained in the Agreement, if at any time profits are realized by the Partnership, any current or anticipated event that would cause the deficit balance in absolute amount in the Capital Account of the General Partners to be greater than their share of the Partnership's indebtedness (as defined) after such event, then the allocation of profits to the General Partners shall be increased to the extent necessary to cause the deficit balance in the Capital Account of the General Partners to be no less than their respective shares of the Partnership's indebtedness after such event. In general, the effect of this provision is to allow the deferral of the recognition of taxable gain to the Limited Partners.\nThe General Partners are not required to make any capital contributions except under certain limited circumstances upon termination of the Partnership. Distributions of \"cash flow\" of the Partnership is allocated 90% to the Limited Partners and 10% to the General Partners. However, a portion of such distributions to the General Partners is subordinated to the Limited Partners' receipt of a stipulated return on capital.\nThe Partnership Agreement provides that the General Partners shall receive as a distribution from the sale of real property by the Partnership 3% of the selling price, and that the remaining proceeds (net after expenses and retained working capital) be distributed 85% to the Limited Partners and 15% to the General Partners. However, the Limited Partners shall receive 100% of such net sale proceeds until the Limited Partners (i) have received cash distributions of sale or refinancing proceeds in an amount equal to the Limited Partners' aggregate initial capital investment in the Partnership and (ii) have received cumulative cash distributions from the Partnership's operations which, when combined with sale or refinancing proceeds previously distributed, equal a 6% annual return on the Limited Partners' average capital investment for each year (their initial capital investment as reduced by sale or refinancing proceeds previously distributed) commencing with the second fiscal quarter of 1983. Payment of the portion of sale and refinancing proceeds allocable to the General Partners pursuant to the above is deferred until such time as the Limited Partners have received cash distributions, of sale and refinancing proceeds and of Partnership operations, in an amount equal to the Limited Partners' initial capital investment in the Partnership plus a 10% annual return on the Limited Partners' average capital investment. Approximately $3,197,000 has been deferred by the General Partners pursuant to the distribution levels described above.\n(6) TRANSACTIONS WITH AFFILIATES\nThe Partnership, pursuant to the Partnership Agreement, is permitted to engage in various transactions involving the Managing General Partner and its affiliates including the reimbursement for salaries and salary- related expenses of its employees, certain of its officers, and other direct expenses relating to the administration of the Partnership and the operation of the Partnership's investments. Fees, commissions and other expenses required to be paid by the Partnership to the General Partners and their affiliates as of December 31, 1995, 1994 and 1993 are as follows:\nIn December 1994, one of the affiliated property managers sold substantially all of its assets and assigned its interest in its management contracts to an unaffiliated third party. In addition, certain of the management personnel of the property manager became management personnel of the purchaser and its affiliates. The successor to the affiliated property manager's assets is acting as the property manager of the Blanchard Plaza office building after the sale on the same terms that existed prior to the sale.\nEffective October 1, 1995, the Managing General Partner of the Partnership engaged independent third parties to perform certain administrative services for the Partnership which were previously performed by and partially reimbursed to, affiliates of the General Partners. Use of such third parties is not expected to have a material effect on the operations of the Partnership.\n(7) LEASES\nAs Property Lessor\nAt December 31, 1995, the Partnership and its consolidated venture's principal asset is one office building. The Partnership has determined that all leases relating to this property are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the property, excluding the cost of the land, is depreciated over the estimated useful life. Leases with tenants range in terms from one to fifteen years and provide for fixed minimum rent and partial reimbursement of operating costs.\nMinimum lease payments, including amounts representing executory costs (e.g. taxes, maintenance, insurance) and any related profit, to be received in the future under the operating leases are as follows:\n1996 . . . . . . . . . . . .$ 3,388,810 1997 . . . . . . . . . . . . 3,379,846 1998 . . . . . . . . . . . . 3,034,011 1999 . . . . . . . . . . . . 3,090,268 2000 . . . . . . . . . . . . 2,906,820 Thereafter . . . . . . . . . 6,007,629 ----------- Total. . . . . . . . . . $21,807,384 ===========\nThe Partnership leases approximately 63% of the available space of the property to one tenant under a seven year lease term. This tenant represented approximately 71% of total revenue for the year ended December 31, 1995, and all of the accrued rents receivable at December 31, 1995. The tenant's principal business is that of a governmental agency.\n(8) INVESTMENT IN UNCONSOLIDATED VENTURE\nSummary financial information for the Town and Country venture (for the period ending December 5, 1995 (the disposition date) note 3(b)) and as of and for the year ended December 31, 1994 are as follows:\n1995 1994 ----------- -----------\nCurrent assets. . . . . . . . . . $ -- 2,033,870 Current liabilities . . . . . . . -- 3,813,317 ----------- ----------- Working capital. . . . . . -- (1,779,447) ----------- ----------- Investment property, net. . . . . -- 59,054,204 Other assets. . . . . . . . . . . -- 1,523,836 Other liabilities . . . . . . . . -- (1,097,400) Long-term debt. . . . . . . . . . -- (29,651,372) Venture partners' subordinated equity. . . . . . . -- (26,726,921) ----------- ----------- Partners' capital. . . . . $ -- 1,322,900 =========== =========== Represented by: Invested capital. . . . . . . . $13,321,032 12,787,758 Cumulative distributions. . . . (6,460,225) (6,460,225) Cumulative losses . . . . . . . (6,860,807) (5,004,633) ----------- ----------- $ -- 1,322,900 =========== =========== Total income. . . . . . . . . . . $ 5,664,565 6,934,956 =========== =========== Expenses applicable to operating loss . . . . . . . . . $39,731,163 10,486,956 =========== =========== Operating loss. . . . . . . . . . $34,066,598 3,551,999 =========== =========== Gain on disposition . . . . . . . $ 2,589,331 -- =========== ===========\nAlso, for the year ended December 31, 1993, total income, expenses applicable to operating loss and operating loss were $8,471,063, $10,895,645 and $2,424,582, respectively, for the unconsolidated venture noted above.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes of or disagreements with accountants during fiscal years 1994 and 1995.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nThe Managing General Partner of the Partnership is JMB Realty Corporation (\"JMB\"), a Delaware corporation, substantially all of the outstanding stock of which is owned, directly or indirectly, by certain of its officers and directors and members of their families. JMB has responsibility for all aspects of the Partnership's operations, subject to the requirement that sales of real property must be approved by the Associate General Partner of the Partnership, ABPP Associates, L.P. Effective December 31, 1995, ABPP Associates, L.P. acquired the general partnership interest in the Partnership of the Associate General Partner, Income Associates-IX, L.P., (which constituted substantially all of the assets of Income Associates-IX, L.P.). ABPP Associates, L.P. an Illinois limited partnership with JMB as the sole general partner, continues as the Associate General Partner. The Associate General Partner shall be directed by a majority in interest of its limited partners (who are generally officers, directors and affiliates of JMB or its affiliates) as to whether to provide its approval of any sale of real property (or any interest therein) of the Partnership. The Partnership is subject to certain conflicts of interest arising out of its relationships with the General Partners and their affiliates as well as the fact that the General Partners and their affiliates are engaged in a range of real estate activities. Certain services have been and may in the future be provided to the Partnership or its investment properties by affiliates of the General Partners, including property management services and insurance brokerage services. In general, such services are to be provided on terms no less favorable to the Partnership than could be obtained from independent third parties and are otherwise subject to conditions and restrictions contained in the Partnership Agreement. The Partnership Agreement permits the General Partners and their affiliates to provide services to, and otherwise deal and do business with, persons who may be engaged in transactions with the Partnership, and permits the Partnership to borrow from, purchase goods and services from, and otherwise to do business with, persons doing business with the General Partners or their affiliates. The General Partners and their affiliates may be in competition with the Partnership under certain circumstances, including, in certain geographical markets, for tenants for properties and\/or for the sale of properties. Because the timing and amount of cash distributions and profits and losses of the Partnership may be affected by various determinations by the General Partners under the Partnership Agreement, including whether and when to sell or refinance a property, the establishment and maintenance of reasonable reserves, the timing of expenditures and the allocation of certain tax items under the Partnership Agreement, the General Partners may have a conflict of interest with respect to such determinations.\nThe names, positions held and length of service therein of each director and the executive and certain other officers of the Managing General Partner are as follows:\nSERVED IN NAME OFFICE OFFICE SINCE - ---- ------ ------------\nJudd D. Malkin Chairman 5\/03\/71 Director 5\/03\/71 Chief Financial Officer 2\/22\/96 Neil G. Bluhm President 5\/03\/71 Director 5\/03\/71 Burton E. Glazov Director 7\/01\/71 Stuart C. Nathan Executive Vice President 5\/08\/79 Director 3\/14\/73 A. Lee Sacks Director 5\/09\/88 John G. Schreiber Director 3\/14\/73 H. Rigel Barber Executive Vice President 1\/02\/87 Chief Executive Officer 8\/01\/93 Glenn E. Emig Executive Vice President 1\/01\/93 Chief Operating Officer 1\/01\/95 Gary Nickele Executive Vice President and 1\/01\/92 General Counsel 2\/27\/84 Gailen J. Hull Senior Vice President 6\/01\/88 Howard Kogen Senior Vice President 1\/02\/86 Treasurer 1\/01\/91\nThere is no family relationship among any of the foregoing directors or officers. The foregoing directors have been elected to serve a one-year term until the annual meeting of the Managing General Partner to be held on June 5, 1996. All of the foregoing officers have been elected to serve one-year terms until the first meeting of the Board of Directors held after the annual meeting of the Managing General Partner to be held on June 5, 1996. There are no arrangements or understandings between or among any of said directors or officers and any other person pursuant to which any director or officer was elected as such.\nJMB is the corporate general partner of Carlyle Real Estate Limited Partnership-VII (\"Carlyle-VII\"), Carlyle Real Estate Limited Partnership-IX (\"Carlyle-IX\"), Carlyle Real Estate Limited Partnership-X (\"Carlyle-X\"), Carlyle Real Estate Limited Partnership-XI (\"Carlyle-XI\"), Carlyle Real Estate Limited Partnership-XII (\"Carlyle-XII\"), Carlyle Real Estate Limited Partnership-XIII (\"Carlyle-XIII\"), Carlyle Real Estate Limited Partnership- XIV (\"Carlyle-XIV\"), Carlyle Real Estate Limited Partnership-XV (\"Carlyle-XV\"), Carlyle Real Estate Limited Partnership-XVI (\"Carlyle- XVI\"), Carlyle Real Estate Limited Partnership-XVII (\"Carlyle-XVII\"), JMB Mortgage Partners, Ltd. (\"Mortgage Partners\"), JMB Mortgage Partners, Ltd.-II (\"Mortgage Partners-II\"), JMB Mortgage Partners, Ltd.-III (\"Mortgage Partners-III\"), JMB Mortgage Partners, Ltd-IV (\"Mortgage Partners-IV\"), Carlyle Income Plus, Ltd. (\"Carlyle Income Plus\") and Carlyle Income Plus, Ltd.-II (\"Carlyle Income Plus-II\") and the managing general partner of JMB Income Properties, Ltd.-IV (\"JMB Income-IV\"), JMB Income Properties, Ltd.-V (\"JMB Income-V\"), JMB Income Properties, Ltd.-VI (\"JMB Income-VI\"), JMB Income Properties, Ltd.-VII (\"JMB Income-VII\"), JMB Income Properties, Ltd.-X (\"JMB Income-X\"), JMB Income Properties, Ltd.-XI (\"JMB Income-XI\"), JMB Income Properties, Ltd.-XII (\"JMB Income-XII\"), and JMB Income Properties, Ltd.-XIII (\"JMB Income-XIII\"). JMB is also the sole general partner of the associate general partner of most of the foregoing partnerships. Most of the foregoing directors and officers are also officers and\/or directors of the various affiliated companies of JMB including Arvida\/JMB Managers, Inc. (the general partner of Arvida\/JMB Partners, L.P. (\"Arvida\")), Arvida\/JMB Managers-II, Inc. (the general partner of Arvida\/JMB Partners, L.P.-II (\"Arvida-II\")), and Income Growth Managers, Inc. (the corporate general partner of IDS\/JMB Balanced Income Growth, Ltd. (\"IDS\/BIG\")). Most of such directors and officers are also partners of certain partnerships which are associate general partners in the following real estate limited partnerships: Carlyle-VII, Carlyle-IX, Carlyle-X, Carlyle-XI, Carlyle-XII, Carlyle-XIII, Carlyle-XIV, Carlyle-XV, Carlyle-XVI, Carlyle-XVII, JMB Income-VI, JMB Income-VII, Income-X, JMB Income-XI, JMB Income-XII, JMB Income-XIII, Mortgage Partners, Mortgage Partners-II, Mortgage Partners-III, Mortgage Partners-IV, Carlyle Income Plus, Carlyle Income Plus-II and IDS\/BIG.\nThe business experience during the past five years of each such director and officer of the Managing General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 58) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Malkin has been associated with JMB since October, 1969. Mr. Malkin is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a Certified Public Accountant.\nNeil G. Bluhm (age 58) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Bluhm has been associated with JMB since August, 1970. Mr. Bluhm is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nBurton E. Glazov (age 57) has been associated with JMB since June, 1971 and served as an Executive Vice President of JMB until December, 1990.\nHe is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nStuart C. Nathan (age 54) has been associated with JMB since July, 1972. Mr. Nathan is also a director of Sportmart, Inc., a retailer of sporting goods. He is a member of the Bar of the State of Illinois.\nA. Lee Sacks (age 62) (President and Director of JMB Insurance Agency, Inc.) has been associated with JMB since December, 1972.\nJohn G. Schreiber (age 49) has been associated with JMB since December, 1970 and served as an Executive Vice President of JMB until December, 1990. Mr. Schreiber is President of Schreiber Investments, Inc., a company which is engaged in the real estate investing business. He is also a senior advisor and partner of Blackstone Real Estate Partners, an affiliate of the Blackstone Group, L.P. Since 1994, Mr. Schreiber has also served as trustee of Amli Residential Property Trust, a publicly-traded real estate investment trust that invests in multi-family properties. Mr. Schreiber is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is also director of a number of investment companies advised by T. Rowe Price Associates and its affiliates. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business.\nH. Rigel Barber (age 46) has been associated with JMB since March, 1982. He holds a J.D. degree from the Northwestern Law School and is a member of the Bar of the State of Illinois.\nGlenn E. Emig (age 48) has been associated with JMB since December, 1979. Prior to becoming Executive Vice President of JMB in 1993, Mr. Emig was Executive Vice President and Treasurer of JMB Institutional Realty Corporation. He holds a Masters Degree in Business Administration from the Harvard University Graduate School of Business and is a Certified Public Accountant.\nGary Nickele (age 43) has been associated with JMB since February, 1984. He holds a J.D. degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nGailen J. Hull (age 47) has been associated with JMB since March, 1982. He holds a Masters degree in Business Administration from Northern Illinois University and is a Certified Public Accountant.\nHoward Kogen (age 60) has been associated with JMB since March, 1973. He is a Certified Public Accountant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no officers or directors. The General Partners of the Partnership are entitled to receive a share of cash distributions, when and as cash distributions are made to the Limited Partners, and a share of profits or losses. Reference is also made to Note 5 for a description of such transactions, distributions and allocations. No cash distributions were paid in 1995, 1994 and 1993 to the General Partners.\nAn affiliate of the Managing General Partner provided property management services to the Partnership in 1994 for the Blanchard Plaza office building in Seattle, Washington for a fee calculated at 4% of gross income from the property until December 1994 when the affiliate sold substantially all of its assets and assigned its interest in its management contracts to an unaffiliated third party (see Note 6). As of December 31, 1995, $467,897 of leasing fees to the affiliated management company were unpaid. As set forth in the Prospectus of the Partnership, the Managing General Partner must negotiate such agreements on terms no less favorable to the Partnership than those customarily charged for similar service in the relevant geographical area (but in no event at rates greater than 4% of gross income from a property), and such agreements must be terminable by either party thereto, without penalty upon 60 days' notice.\nThe General Partners of the Partnership may be reimbursed for their salaries, salary-related expenses and direct expenses relating to the administration of the Partnership and the operation of the Partnership's real property investments. During 1995, the Managing General Partner earned reimbursement for such expenses in the amount of $92,977, of which $12,970 was unpaid.\nEffective October 1, 1995, the Managing General Partner of the Partnership engaged independent third parties to perform certain administrative services for the Partnership which were previously performed by, and partially reimbursed to, affiliates of the General Partners.\nThe Partnership is permitted to engage in various transactions involving affiliates of the Managing General Partner of the Partnership or its affiliates. The relationship of the Managing General Partner (and its directors and officers) to its affiliates is set forth above in Item 10 above and Exhibit 21 hereto.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Managing General Partner, affiliates or their management other than those described in Note 6, Items 10 and 11 above.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated April 14, 1982, as supplemented September 23, 1982, January 11, 1983, February 22, 1983, and March 28, 1983, and filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 8-16, 118-120 and A-6 to A-9 are incorporated herein by reference to Exhibit 3 to the Partnership's report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which is hereby incorporated herein by reference to Exhibit 3 to the Partnership's report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n4-A. Modification documents relating to the long-term mortgage note secured by the Blanchard Plaza Building in Seattle, Washington are hereby incorporated by reference to Exhibit 4-A to the Partnership's Report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n4-B. Modification documents relating to the extension of the mortgage note secured by Blanchard Plaza Building in Seattle, Washington are filed herewith.\n10-A. Acquisition documents relating to the purchase by the Partnership of an interest in the Blanchard Plaza Building in Seattle, Washington are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-12432) dated July 29, 1983.\n10-B. Disposition documents relating to the Partnership transferring its interest in the Town and Country Center in Houston Texas are filed herewith.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\n99-A. Form 8K for December 5, 1995 describing the disposition of the Town and Country Center dated January 9, 1996 is filed herewith.\n(b) The following Report on Form 8-K was filed since the beginning of the last quarter of the period covered by the this report.\nThe Partnership's Report on Form 8-K for December 5, 1995 (File No. 0-12432) describing the disposition of the Town and Country Center was filed. No financial statements were required to be filed therewith.\n---------------- No annual report or proxy material for the fiscal year 1995 has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJMB INCOME PROPERTIES, LTD. - IX\nBy: JMB Realty Corporation Managing General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: 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.\nBy: JMB Realty Corporation Managing General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Chief Financial Officer Date: March 25, 1996\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 25, 1996\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 25, 1996\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 25, 1996\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 25, 1996\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 25, 1996\nBy: STUART C. NATHAN* Stuart C. Nathan, Executive Vice President and Director Date: March 25, 1996\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 25, 1996\nJMB INCOME PROPERTIES, LTD. - IX\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------- ----\n3-A. Pages 8-16, 118-120 and A-6 to A-9 of the Prospectus of the Partnership dated April 14, 1982 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Modification documents related to the Blanchard Plaza Building Yes\n4-B. Modification documents related to the extension of the mortgage note secured by the Blanchard Plaza Building No\n10-A. Acquisition documents related to the Blanchard Plaza Building Yes\n10-B. Disposition documents related to Town and Country Center No\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99-A. Form 8K for Town and Country Center dated January 9, 1996 Yes","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Managing General Partner, affiliates or their management other than those described in Note 6, Items 10 and 11 above.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated April 14, 1982, as supplemented September 23, 1982, January 11, 1983, February 22, 1983, and March 28, 1983, and filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 8-16, 118-120 and A-6 to A-9 are incorporated herein by reference to Exhibit 3 to the Partnership's report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which is hereby incorporated herein by reference to Exhibit 3 to the Partnership's report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n4-A. Modification documents relating to the long-term mortgage note secured by the Blanchard Plaza Building in Seattle, Washington are hereby incorporated by reference to Exhibit 4-A to the Partnership's Report on Form 10-K (File No. 0-12432) for December 31, 1992 dated March 19, 1993.\n4-B. Modification documents relating to the extension of the mortgage note secured by Blanchard Plaza Building in Seattle, Washington are filed herewith.\n10-A. Acquisition documents relating to the purchase by the Partnership of an interest in the Blanchard Plaza Building in Seattle, Washington are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-12432) dated July 29, 1983.\n10-B. Disposition documents relating to the Partnership transferring its interest in the Town and Country Center in Houston Texas are filed herewith.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\n99-A. Form 8K for December 5, 1995 describing the disposition of the Town and Country Center dated January 9, 1996 is filed herewith.\n(b) The following Report on Form 8-K was filed since the beginning of the last quarter of the period covered by the this report.\nThe Partnership's Report on Form 8-K for December 5, 1995 (File No. 0-12432) describing the disposition of the Town and Country Center was filed. No financial statements were required to be filed therewith.\n---------------- No annual report or proxy material for the fiscal year 1995 has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJMB INCOME PROPERTIES, LTD. - IX\nBy: JMB Realty Corporation Managing General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: 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.\nBy: JMB Realty Corporation Managing General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Chief Financial Officer Date: March 25, 1996\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 25, 1996\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 25, 1996\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 25, 1996\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 25, 1996\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 25, 1996\nBy: STUART C. NATHAN* Stuart C. Nathan, Executive Vice President and Director Date: March 25, 1996\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 25, 1996\nJMB INCOME PROPERTIES, LTD. - IX\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------- ----\n3-A. Pages 8-16, 118-120 and A-6 to A-9 of the Prospectus of the Partnership dated April 14, 1982 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Modification documents related to the Blanchard Plaza Building Yes\n4-B. Modification documents related to the extension of the mortgage note secured by the Blanchard Plaza Building No\n10-A. Acquisition documents related to the Blanchard Plaza Building Yes\n10-B. Disposition documents related to Town and Country Center No\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99-A. Form 8K for Town and Country Center dated January 9, 1996 Yes","section_15":""}
{"filename":"30625_1995.txt","cik":"30625","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Duriron Company, Inc. was incorporated under the laws of the State of New York on May 1, 1912. All references herein to the \"Company\" or \"Duriron\" refer collectively to The Duriron Company, Inc. and its subsidiaries, unless otherwise indicated by the context.\nOn November 30, 1995, the Company acquired Durametallic Corporation (\"Durametallic\") in a tax-free exchange of common stock valued at $150 million under the terms of the acquisition agreement. The Company issued approximately 5.4 million new shares of common stock to complete this exchange and thereby acquired this manufacturer of mechanical seals and sealing system products. The transaction was accounted for as a pooling of interests, and the Company's prior financial statements were restated to incorporate Durametallic's financial results. Accordingly, all subsequent references to the Company also include Durametallic, unless the context clearly requires otherwise.\nDuriron is principally engaged in the design, manufacture and marketing of fluid handling equipment, primarily pumps and valves and mechanical seals for industries that utilize difficult to handle and often corrosive fluids in manufacturing processes. The Company specializes in the development of precision-engineered equipment that is capable of withstanding the severely deteriorating effects associated with the flow of acids, chemical solutions, slurries and gases.\nBased upon its analysis of trade association data and other market information, the Company considers itself a leading supplier of corrosion resistant fluid movement and control equipment to the basic chemical industry. The Company's materials expertise, design, engineering capabilities and applications know-how have enabled it to develop product lines that are responsive to the chemical process industries' desire to achieve manufacturing efficiencies, avoid premature equipment failure and reduce maintenance cost.\nThe Company operates primarily in one business segment, fluid movement and control equipment (primarily pumps, valves, mechanical seals and related equipment). Included in Note 19 of the Financial Statements provided as part of Item 8 of this Report and incorporated herein by this reference, is information concerning the Company's revenues, operating profit and identifiable assets by geographic area for each year in the three-year period ended December 31, 1995. With respect to a majority of its products, the Company's domestic operations supply each other and the Company's foreign manufacturing subsidiaries with components and subassemblies.\nPRODUCTS\nThe Company's principal fluid movement and control equipment products are pumps, valves, mechanical seals and related equipment, marketed primarily under the trademarks \"Durco,\" \"Atomac,\" \"Valtek,\" \"Automax,\" \"Accord,\" \"Kammer,\" \"Mecair,\" \"Sereg,\" \"Durametallic,\" \"Dura Seal,\" \"Pac-Seal\" and \"Metal Fab.\" In many manufacturing processes, fluids must be moved by pumps, and flow must be controlled by valves. The Company's pumps,\nvalves and mechanical seals are designed to withstand the corrosive nature of the fluids and the varying temperatures and pressures under which manufacturing processes occur.\nThe Company manufactures, under the Durco trade name, several lines of centrifugal pumps, including metallic and non-metallic pumps, varying in size, capacity, material components and sealant specifications. Durco pumps are used primarily to move liquids during processing activities as well as in auxiliary services such as waste removal, water treatment and pollution control. Critical elements in pump selection include the nature and volume of the fluids to be handled, the height and distance the fluids are to be moved, the temperature and pressure at which they are to flow, the presence of stray elements or particles, and the toxicity of the fluids. The Company also manufactures several lines of metering pumps under the Durco trade name which are generally used to inject measured quantities of additives or catalysts into a process stream.\nThe Company's valves are used to control the flow of liquids and gases in industrial processing systems. The Company manufactures product lines of plug and butterfly valves under the Durco trademark which are made of various metals, alloys and plastics. The Company also produces a lined ball valve under the Atomac trade name. Actuators and other control accessories manufactured by the Company under the Automax and Accord trade names are either sold independently or mounted on these valves to move them from open to closed positions and to various specified positions in between.\nThe Company manufactures, under the Valtek, Kammer and Sereg trade names, automatic control valves, valve actuators and related components. Automatic control valves are important components in the automation of manufacturing and processing systems since they are capable of modulating (that is, automatically adjusting) the rate and amount of fluids moving in a manufacturing production system. The Valtek product line includes high-pressure valves, rotary valves, and anti-noise and anti-cavitation valves. Substantially all of the Valtek valves are sold with an actuator. The Company also developed and manufactures a Valtek automatic control valve (under the \"StarPac\" trade name) with \"on-board\" sensor and microprocessor capabilities. The Kammer automated control valves are primarily sold with actuators to chemical process applications requiring alloy steel control valves of a smaller size than most of the Valtek products. The Company sells control valves under the Valtek Sereg trade name primarily in France and other European countries.\nThe Company's mechanical seals and sealing systems are used to prevent the leakage of process fluids along the rotating shaft of industrial pumps, mixing equipment and miscellaneous other rotating equipment used in moving and otherwise handling process fluids during manufacturing operations. Certain types of these mechanical seals and sealing systems, which are marketed under the \"Durametallic\" and \"Dura Seal\" trade names, are used within the centrifugal pumps manufactured by the Company. Durametallic mechanical seals include a spring loaded design and a welded metal bellows design which both offer fluid sealing protection while rotating with the shaft of pumps, mixers and similar equipment in industrial operations. Mechanical seals sold under the \"Pac-Seal\" trademark are primarily used in water pumps and other non-corrosive applications.\nFinally, the Company also manufactures filtration products and related spare parts under the Durco trade name and specialty welded metal bellows products under the \"Metal Fab\" trade name.\nMARKETING AND DISTRIBUTION\nThe Company's Durco pump and Durco quarter-turn valve products are primarily marketed to end-users and engineering contractors through the Company's own sales forces, regional service centers, a national parts distribution center and independent distributors and representatives. The Company sales personnel are divided, for the Durco pump and Durco valve products, into separate organizations which specialize in the respective product lines. The specialization of these two sales forces helps enable them to maintain a high level of technical knowledge about their applicable products, customer applications, in-plant installation and maintenance services. Both the pump and quarter-turn valve sales organizations have field sales offices located in principal industrial markets and resident sales personnel at additional locations.\nThe Company also maintains regional service centers in the greater Houston, Salt Lake City and metropolitan Philadelphia areas. These centers stock a full array of critical pump parts and have machining and product modification capabilities. A national pump parts distribution and service center, located in Birmingham, Alabama, provides 24-hour assistance to customers and ships critical replacement parts on an immediate need basis. The Company also has licensed certain independent valve distributors located throughout the United States to service and remanufacture its quarter-turn valve products.\nAutomax and Atomac products are distributed with Durco manual valves by Company sales personnel and through a network of independent stocking distributors. The Company's sales force provides training and technical assistance to the Company's independent distributors, who also participate in periodic training programs relating to Company products and customer applications.\nDurametallic and Pac-Seal products are sold through a combination of direct sales personnel who specialize only in these products and by independent sales representatives or distributors. The Company maintains branch and service center facilities in the U.S. at the following locations which specialize in Durametallic and Pac-Seal products: Baton Rouge, Louisiana, Carson, California; Posen, Illinois; Bridgeport, New Jersey; Matthews, North Carolina; Cincinnati, Ohio; Houston, Texas; and Vancouver, Washington. Durametallic products are also marketed internationally through sales offices in almost sixty (60) countries. The Company also markets Durametallic products through foreign subsidiaries including operations established in Argentina, Canada, Belgium, Mexico, Brazil, Australia, New Zealand and Singapore. The Company maintains joint ventures in India, Korea, Saudi Arabia and Malaysia to manufacture and sell mechanical seals utilizing Durametallic product technology within those countries.\nValtek products are marketed through specialized sales offices with sales engineers and service centers in Springville (Utah), Houston, Philadelphia, Beaumont (Texas), Corpus Christi and Baton Rouge. In other territories, Valtek products are sold on a commission basis through independent manufacturers' representatives located in principal marketing centers in the\nUnited States. The Company provides extensive training in the sophisticated Valtek products and customer applications for its sales representatives.\nKammer products are primarily marketed through a direct sales force in Germany and through independent distribution in other countries. Kammer products are marketed with Valtek products in certain U.S. locations, with a Kammer product sales office located in Pittsburgh, Pennsylvania, supporting U.S. marketing. Valtek Sereg products are generally sold through employees in France and combined with other Valtek products for sale in the U.S. and elsewhere.\nThe Company maintains a subsidiary, Davco Equipment Inc., to market its Durco pumps, Durco quarter-turn valves, Automax actuators and Valtek control valves directly and on a consolidated basis through employees of this subsidiary to customers in the Freeport, Texas, area. Formerly, the Company had marketed these varying product lines through a variety of specialized independent distributors and employees.\nThe Company's international sales include domestic export sales and sales by the Company's foreign subsidiaries. Duriron Canada Inc., headquartered in Woodbridge, Ontario, manufactures and sells Durco pumps and valves throughout eastern Canada. S.A. Durco Europe N.V. is headquartered in Brussels, Belgium. This subsidiary manufactures pumps and valves in its Petit Rechain, Belgium, facility and maintains selling organizations in Europe and sales representatives in the Middle East. Atomac, of Ahaus, Germany, and a division of Durco GmbH, engages in the manufacture and sale of lined ball valves and associated equipment. The Company further maintains subsidiaries in the United Kingdom, Italy, Spain, The Netherlands and France to provide sales and service of Durco products in these countries.\nA Singapore subsidiary, Durco Valtek (Asia Pacific) Pte. Ltd., services and prepares pumps, quarter-turn valves and control valves for sale in the Asian market in a recently expanded facility.\nAn Italian subsidiary of the Company manufactures actuators sold in the U.S. under the Automax trade name and elsewhere under the \"Mecair\" trade name. The Company worked to standardize such worldwide marketing under the Automax trade name over 1995.\nThe Company has manufacturing and marketing operations for Valtek products in Australia and Canada. Valtek products are also manufactured and marketed by licensees in the United Kingdom and Brazil under long-term license arrangements. The Company has additionally entered into a joint venture with Yokogawa Electric Corporation and Kitz Corporation, both of which are Japanese companies, to manufacture and sell certain Valtek products within Japan.\nThe Company has entered into licenses with local manufacturers in Mexico, South Korea and India to permit them to manufacture and market pumps and valves under the Durco trade name and pursuant to Company specifications in those respective countries.\nThe Company maintains a strategic alliance agreement with A. Ahlstrom, a Finnish company with significant world-wide sales to the pulp and paper industry, to permit A. Ahlstrom to market and sell Durco pumps to this industry. The Company also maintains an alliance with\nElsag Bailey to market and sell Valtek control valves as part of the computer-based process control systems of Elsag Bailey.\nThe Company also owns Sereg Vannes, S.A., a French company which manufactures control valve product offerings for distribution in France and other locations.\nBACKLOG\nThe Company's backlog of orders was approximately $101.4 million, $78.2 million, and $69.7 million at December 31, 1995, 1994 and 1993, respectively. Nearly all current backlog is expected to be shipped within the next 12 months. Sales of the Company's products are not normally subject to material seasonal fluctuations. Almost all of the Company's customers are in the private sector, and the Company's backlog is thus not exposed to renegotiation in any significant way at the election of a government customer.\nCOMPETITION AND CUSTOMERS\nBased upon its analysis of trade association data and other marketing data, the Company considers itself a leading supplier of corrosion-resistant pumps, mechanical seals, valves, valve actuators and control valves to the basic U.S. chemical industry, with generally a lesser market share in other countries. No significant competitor of the Company manufactures pumps, valves and mechanical seals or has as its single primary market the basic chemical industry. However, the Company competes with companies which manufacture either pumps, valves or mechanical seals, portions of whose product lines are sold to the chemical process industries. The Company competes in general on the basis of product design and quality, materials expertise, delivery capability, price, application know-how, parts support and similar factors. The Company believes that it is, in the aggregate, strong in these areas. During 1995, no single customer or group of related customers accounted for more than 10% of sales.\nMANUFACTURING AND RAW MATERIALS\nThe Company is a vertically-integrated manufacturer. Certain of the corrosion-resistant castings for Company products are manufactured at its Dayton, Ohio, foundries, which include a highly automated precision foundry, plus resin shell, no bake and centrifugal foundries. Ductile iron, gray iron, steel and large alloy metal castings are purchased from outside sources. Other Company manufacturing locations machine castings to precise specifications and assemble Company products. The Company's commitment to Total Quality control procedures and cellular manufacturing technologies is key to the efficient and successful manufacture of its products.\nThe Company also produces most of its highly engineered corrosion resistant plastic parts for its pump and valve product lines. This includes rotomolding as well as injection and compression molding of a variety of fluorocarbon and other plastic materials.\nBasic manufacturing raw materials are purchased from various foreign and domestic vendors. These materials include Teflon, nickel, chrome, molybdenum, high silicon pig iron, ferro silicon, fused silica, epoxy resins and fluorocarbon resins, tungsten carbide, silicon\ncarbides and high grade tubing. In addition, bar stock, tubing, motors and other necessary equipment for inclusion in the Company's finished products are purchased from various suppliers. The supply of raw materials and components has been, in general, sufficient and available without significant delivery delays.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development laboratories in Dayton, Ohio, Cookeville, Tennessee, Ahaus, Germany, Springville, Utah, and Kalamazoo, Michigan support the Company's manufacturing efforts by providing hydraulic test facilities for the Company's fluid movement and control products as well as facilities for the development of corrosion-resistant alloys and plastics.\nThe Company spent approximately $8.0 million, $8.6 million, and $7.8 million on Company sponsored research and development activities in 1995, 1994 and 1993, respectively. The expenditures were primarily for new product development.\nPATENTS, TRADEMARKS AND LICENSES\nThe Company owns a number of trademarks, patents and patent applications relating to the name and design of its products. While the Company considers that, in the aggregate, its trademarks and patents are useful to its operations, the Company believes that the successful manufacture and sale of its products generally depend more upon its specialized materials, designs and manufacturing methods developed over a period of time. The Company, in general, is the owner of the rights to the products which it manufactures and sells, and the Company is not dependent in any material way upon any licenses or franchises in order to so operate.\nPERSONNEL\nAt December 31, 1995, the Company employed approximately 3,900 persons, of whom about 2,600 were employed in the United States. Approximately 375 of the Company's employees, who are primarily located in the Company's pump, foundry and filtration operations, are represented by either the United Steel Workers of America or the International Union of Electronic, Electrical, Technical Salaried & Machine Workers. The Company believes, in general, that it has good relations with these unions and its nonunion employees. The Company's three year collective bargaining agreement with the United Steel Workers representing production workers at its pump and foundry operations in Dayton, Ohio expires in October, 1996.\nInformation with regard to the directors and executive officers of the Company is incorporated herein by reference to Item 10 of this Report and the Proxy Statement.\nENVIRONMENTAL MATTERS\nThe Company completed projects in prior years relating to compliance with federal, state and local environmental protection regulations. At present, the Company has no plans for material capital expenditures for environmental control facilities. However, the\nCompany has experienced and continues to experience substantial operating costs relating to environmental matters, although certain costs have been offset in part by the Company's successful waste minimization programs.\nFOREIGN OPERATIONS\nThe Company's foreign operations are affected by various factors and subject to risks which may be different from or in addition to those present in domestic operations. These may include currency exchange rate fluctuations, restrictions on the Company's ability to repatriate funds to the United States, and potential political and economic instability. As the Company expands its international business, the factors and risks associated with international operations will likely have a more significant impact on the Company's results. However, the Company believes that, in general, the geographical diversification of its business operations is of benefit in expanding the size of its markets and in helping to partially offset the full impact of normal business cycles in the U.S. market.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters and executive offices are located in Dayton, Ohio, at a leased site in the Miami Valley Research Park. This site encompasses approximately 40,000 square feet.\nThe location, size and products manufactured of the Company's principal manufacturing facilities are as follows:\nAll manufacturing facilities are owned with the exception of the Cookeville, Tennessee, facility, the Cincinnati, Ohio, facility, the Springboro facility, the Burr Ridge, Illinois facility, the Melbourne, Australia, facility, the Italian facilities, the Gent facility and a portion of the Brazilian site and the Angola, New York, facility. The Company also leases space for district sales offices and service centers throughout the United States, Canada, Europe, and Asia.\nOn the average, the Company utilizes roughly 85% of its manufacturing capacity, although there is a variation in usage rate among the facilities. The Company could, in general, increase its capacity through the purchase of new or additional manufacturing equipment without obtaining additional facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAlthough the Company is involved in litigation arising from its business operations, there are no legal proceedings involving the Company which management believes are likely to have a material adverse impact on the Company. For further information about such litigation, please see Footnote #11, entitled \"Contingencies,\" in the Company's \"Financial Statements and Supplementary Data\" set forth in Item 8. Such footnote is incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOn November 30, 1995, a special meeting of shareholders of the Company was held. At this meeting, shareholders approved the Company's \"Agreement and Plan of Merger\" with Durametallic. The vote was 15,345,795 votes for, 53,403 votes against, and 956,954 abstentions or non votes. Shareholders also approved an amendment to the Company's Certificate of Incorporation which increases the authorized common stock from 30 to 60 million. The vote on this issue was 15,888,394 votes for, 430,250 votes against and 37,507 abstentions or non votes.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION\nThe common stock of the Company (DURI) is traded in the Over-the-Counter market and quotations are supplied by the National Association of Securities Dealers through NASDAQ's National Market System.\nIn January 1996, Transfer Agent records showed 2,380 shareholders of record. Based on these records plus requests from brokers and nominees listed as shareholders of record, the Company estimates there are approximately 7,000 shareholders of its common stock. During 1995, the Company paid a dividend of eleven and one-half cents per share each calendar quarter, and in 1994, a dividend of ten and one-half cents per share was paid each calendar quarter.\nOn February 9, 1996, a 13% dividend increase was declared which will raise the quarterly dividend to 13 cents per share.\nPrice Range of Duriron Common Stock (high\/low closing prices)\nPrices have been restated to reflect the March 25, 1994 stock dividend which had the effect of a three-for-two stock split.\nFIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA(a) (dollars in thousands except for per share data)\n(a) Historical financial information has been restated to reflect the merger with Durametallic under the pooling of interests method of accounting. See Note 3 to Consolidated Financial Statements.\n(b) Net earnings for the year ended December 31, 1995 were $35.1 million, or $1.42 per share, excluding transaction expenses of $4.4 million after tax, or $.18 per share. See Note 3 to Consolidated Financial Statements.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nIn November 1995, the Company merged with Durametallic Corporation, a global manufacturer of mechanical seals and sealing systems. Under the terms of the merger agreement, Duriron acquired Durametallic through the issuance of approximately 5.35 million shares in a tax-free exchange of common stock with Durametallic's shareholders. The acquisition, valued at $150 million under the merger agreement, was accounted for under the pooling of interests method of accounting which requires all financial data presented in this report to be restated for current and prior periods. See Note 3 to Consolidated Financial Statements for additional discussion on the acquisition.\nNet sales and earnings were at record levels in 1995 due to strong capital spending by the Company's process industries customers. Compared with 1994, restated net sales increased 15.7% to $532.7 million and restated net earnings increased 43.8% to $35.1 million, or $1.42 per share, excluding merger transaction expenses of $4.4 million. The merger with Durametallic was accretive to earnings by $.05 per share in 1995, excluding transaction expenses. The financial condition of the Company remained strong after the merger as reflected by a debt ratio of 16.9% and a cash balance of $19.4 million at December 31, 1995.\nRESULTS OF OPERATIONS\nNet sales for 1995 of $532.7 million were at a record level for the ninth consecutive year reflecting increases of 15.7% over $460.5 million in 1994 and 26.3% over $421.8 million in 1993. The increase in sales in 1995 reflects strong capital spending in the global markets served by the Company particularly in North America, Europe and Asia-Pacific. The Company's sales mix contains both major project activity and high levels of maintenance and replacement orders. In addition, strengthening of the European currencies against the U.S. dollar, moderate price increases and strategic acquisitions favorably impacted reported net sales growth in 1995. The acquisitions favorably impacting 1995 sales were Durametallic's acquisition of Pac-Seal, a manufacturer of mechanical seals located in Burr Ridge, Illinois, in August of 1995 and Duriron's acquisitions of Sereg Vannes, a manufacturer of automatic control valves located in Thiers, France, in May of 1994. The 1994 sales compared with 1993 reflected stronger capital spending in the North American and Asian markets and a recovering European economy. Sales in 1993 were unfavorably impacted by weakness in the international marketplace during that period. In addition, the 1994 acquisition of Mecair SpA, a manufacturer of valve actuators located in Milan, Italy, and Sereg Vannes contributed to the 1994 sales growth.\nIncoming business for 1995 of $555.2 million was at a record level, up 19.1% over the previous year's record of $466.4 million in 1994 and up 32.0% over $420.5 million in 1993. The 1995 incoming business volume reflected aggressive capital spending by the worldwide process industries, strengthening of the European currencies against the U.S. dollar, moderate price increases and the impact of the aforementioned acquisitions. Asia-Pacific incoming business which doubled and European incoming business which increased over 30% were particularly strong throughout 1995. Strong incoming business in 1995 resulted in an ending backlog of\n$101.4 million at December 31, 1995, an increase of $23.2 million over the 1994 ending backlog of $78.2 million.\nInternational subsidiary contributions to consolidated net sales were an historic high of 33.4% in 1995, compared to 30.5% and 25.4% in 1994 and 1993, respectively. The majority of international sales are distributed through the Company's international subsidiaries. Export sales from the United States were $27.1 million in 1995, compared to $27.1 million and $37.0 million in 1994 and 1993, respectively. Export sales were unusually high in 1993 due to shipment of the Malaysian liquified natural gas project from the Company's Valtek Incorporated subsidiary. Total net sales to international customers, as a percentage of net sales, were a record 38.5% in 1995, compared to 36.4% in 1994 and 34.1% in 1993. The improvement in international sales reflects the strength in the Asia-Pacific and European markets in 1995, strengthening of the European currencies and the acquisitions of Sereg Vannes and Mecair. The Company expects the percent of international sales contributions to consolidated net sales to increase in future years as management continues its strategic emphasis on international sales and market development in the Asia-Pacific region.\nGross profit margins were 40.4% in 1995, compared with 40.3% and 40.8% in 1994 and 1993, respectively. The 1995 gross profit margin was favorably impacted by moderate price increases, improvements in burden absorption related to higher levels of plant utilization and the continuing positive effects of cost reduction and productivity improvement programs throughout the Company. Partially offsetting these were one-time start-up problems related to transition and training issues with the installation of a new computer system at Valtek International in Springville, Utah which resulted in unfavorable variances of $1.5 million during the third quarter of 1995. Valtek's fourth quarter 1995 gross profit margin was at its historical average level and Valtek's Customer Oriented Reengineering Program which is supported by the new computer system should have a favorable future impact on the gross profit margin. The 1993 gross profit margin was unusually high due to the positive impact of a planned reduction in inventories which favorably impacted the LIFO inventory pool resulting in earnings of $.08 per share. Pricing throughout the three year periods has been competitive, especially within the sealing systems and automatic control valve businesses, and is expected to remain competitive. The Company believes its emphasis on becoming the low total cost producer and continued emphasis on improving customer service will have a favorable impact on the gross profit margin in the future.\nSelling and administrative expenses as a percent of net sales were 25.8% in 1995, compared to 27.2% and 27.2% in 1994 and 1993, respectively. The leveraging of selling and administrative expense as a percent of net sales in 1995 compared with 1994 was planned. Selling and administrative expense in dollars increased in 1995 from 1994 due to continued development and growth of international markets, especially in the Asia-Pacific, the strength of the European currencies against the U.S. dollar, the acquisitions of Pac-Seal and Sereg Vannes and the impact of general wage increases. Selling and administrative expense in dollars increased in 1994 from 1993 due predominately to consolidation of the Mecair and Sereg Vannes expense. Excluding the 1994 acquisitions, selling and administrative expenses in 1994 were relatively flat with 1993 without Durametallic, but up slightly with Durametallic. The Company continues to invest resources in the development and growth of international operations. While this has increased selling and service costs at the expense of short-term profits, these programs are consistent with the Company's longer-range goals. The Company expects to further leverage selling and\nadministrative expenses as a percent of net sales in 1996 through continued emphasis on cost containment.\nResearch, engineering and development expenses (including research and development expenses reported in Note 15 to Consolidated Financial Statements) were $15.0 million in 1995, compared to $14.9 million and $13.9 million in 1994 and 1993, respectively. The spending level during 1995 reflects the Company's continued investment in new products and production processes. Research, engineering and development as a percent of net sales declined over the three year period because of a planned reduction of expenses in manufacturing engineering as the majority of the Company's transition to focused factory (cellular) programs has been implemented. The Company believes that continued investment in research, engineering and development will provide important new products and processes that will benefit its customers and shareholders in future years.\nOther expense was $2.8 million in 1995 compared to $2.0 and $2.9 million in 1994 and 1993, respectively. The increase in expense in 1995 reflects higher levels of incentive compensation expense related to the Company's long and short term incentive plans since the Company achieved record financial results and exceeded goals. In addition, severance costs associated with personnel reductions in the Company's European operations were recognized in 1995. The 1994 expense included unusually high foreign currency losses offset in part by a gain on the sale of a Durametallic service center facility. The 1993 expense included a $1.4 million write-off of impaired goodwill at Durametallic.\nMerger transaction expenses of $5.0 million pretax were recognized in 1995 as a result of the merger with Durametallic. Approximately $3.3 million of the expense was non-tax deductible and related to financial advisory, legal, accounting, printing and other related services associated with the merger. The remaining expense of $1.7 million was tax deductible and included severance fees for certain Durametallic management who elected to retire under Executive Severance Agreements assumed by the Company which became effective after the change in control.\nThe Company discounts its postretirement health care and pension obligations using a 7.5% interest rate. The rate used to discount Durametallic's postretirement health care obligation was reduced in 1995 from 8.0% and the rates used to discount Duriron's postretirement health care and pension obligations were reduced from 8.0% in 1993. In addition, the Company in 1994 modified its postretirement health care benefit and pension plans. The net effect of the aforementioned plan changes increased the accumulated pension and postretirement health care obligations by less than 5% in aggregate.\nEffective January 1 1993, the Company adopted the principles of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Compliance with this standard resulted in a cumulative after tax loss of $.9 million, or $.04 per share, which represents the accumulated postemployment benefit obligation as of January 1, 1993. Compliance with SFAS No. 112 did not impact 1995 or 1994 earnings and is not expected to materially impact future earnings.\nThe effective tax rate was 38.8% in 1995, compared to 36.8% and 39.9% in 1994 and 1993, respectively. The 1995 tax rate reflects the unfavorable impact of the non-tax deductible merger transaction expenses which had the effect of increasing the tax rate by 2.3%. The 1995\nrate was favorably impacted by utilization of tax loss carryforwards generated within the Company's European and Asia-Pacific operations. The 1994 rate included the favorable impacts of the fourth quarter liquidation of a wholly owned foreign entity, utilization of tax loss carryforwards generated within the Company's European operations and resolution of a multi-year state tax issue. The 1993 tax rate reflects losses in the Company's foreign operations due to weak business conditions and non-tax deductible goodwill written-off by Durametallic.\nRecord net earnings in 1995 reflect the third consecutive year of earnings improvement. Excluding merger fees of $4.4 million after tax, net earnings in 1995 improved 43.8% to $35.1 million, or $1.42 per share. This compares with $24.4 million, or $.99 per share, and $17.8 million, or $.72 per share in 1994 and 1993, respectively. The merger with Durametallic was accretive to earnings by $.05 per share in 1995 (excluding transaction expenses) and $.09 per share in 1994. Including merger transaction fees, record net earnings were still achieved at $30.7 million, or $1.24 per share. The increase in earnings resulted from improved global business conditions which led to stronger North American and European profits and the generation of profits in the Asia-Pacific operations and the Company's focus on controlling costs. Excluding the impact of the merger with Durametallic, earnings increased 53.9% to $26.4 million from previously reported 1994 earnings of $17.2 million as operating costs were effectively leveraged against the sales growth of 15.5%. Durametallic's earnings increased 19.7% to $8.7 million from previously reported 1994 earnings of $7.2 million. The 1994 earnings growth reflected general economic improvements from 1993 earnings which were depressed due to weakness in the European economy.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's capital structure, consisting of long-term debt, deferred items and shareholders' equity, continues to enable the Company to finance short- and long-range business objectives. At December 31, 1995, long-term debt was 16.9% of the capital structure, compared to 15.8% and 14.2% at December 31, 1994 and 1993, respectively. The increase in long-term debt in 1995 from 1994, both as a percent of the capital structure and in absolute dollars, resulted from the acquisition of Pac-Seal which was partially funded through external borrowings, but it was partially offset by scheduled debt repayments.\nThe return on average net assets was 11.5% including merger transaction expenses (13.0% excluding the merger transaction expenses). This compares to 10.4% in 1994 and 8.1% in 1993. In 1995, return on average shareholders' equity was 16.6% (19.0% excluding merger transaction expenses), compared to 14.5% in 1994 and 11.3% in 1993. The change in the returns resulted from the improvements in profitability over the three year period resulting from strong business conditions and focus on cost management. Management continues to focus on improving its performance in these areas.\nCapital expenditures in 1995 were $13.3 million, compared to $14.4 million and $12.1 million in 1994 and 1993, respectively. The 1995 expenditures were invested in equipment and process technology to enable the Company to further progress toward its goal of being the highest quality and lowest total cost producer in its market. In addition to manufacturing equipment, the 1994 expenditures included improved information systems associated with Valtek's Customer Oriented Reengineering Program. The planned 1996 expenditures, expected to be approximately\n$17.5 million, will be invested in new and replacement products, international market development and general manufacturing equipment upgrades.\nCash and cash equivalents were $19.4 million, compared to $19.6 million and $26.3 million at December 31, 1994 and 1993, respectively. Cash flow from operations over the past three years enabled the Company to fully fund all capital expenditures, debt repayments and dividend payments and to partially fund the acquisitions of Pac-Seal, Sereg Vannes and Mecair. Cash in excess of current requirements was invested in high-grade, short-term securities. Cash and amounts available under borrowing arrangements will be adequate to fund operating needs and capital expenditures through the coming year.\nThe Company's liquidity position is reflected in a current ratio of 2.5 to 1 at December 31, 1995. This compares to 2.6 to 1 and 2.7 to 1 at December 31, 1994 and 1993, respectively. Working capital increased to $135.0 million in 1995, compared to $114.4 million and $108.8 million in 1994 and 1993, respectively. Working capital as a percent of net sales was 25.3%, compared to 24.8% and 25.8% for 1994 and 1993, respectively.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED STATEMENT OF INCOME (dollars in thousands except per share data)\n(See accompanying notes.) CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (dollars in thousands except share data)\n(See accompanying notes.) CONSOLIDATED BALANCE SHEET (dollars in thousands)\n(See accompanying notes.)\nCONSOLIDATED STATEMENT OF CASH FLOWS (dollars in thousands)\n(See accompanying notes.)\nUNAUDITED QUARTERLY FINANCIAL DATA (a) (dollars in thousands except per share data)\n(a) Historical financial information has been restated to reflect the merger with Durametallic under the pooling of interests method of accounting. See Note 3 to Consolidated Financial Statements. (b) Net earnings in the fourth quarter of 1995 include transaction expenses of $4.4 million after tax, or $.18 per share, related to the merger with Durametallic. Excluding transaction expenses, 1995 fourth quarter net earnings were $10.3 million, or $.42 per share, and net earnings for the year ended December 31, 1995 were $35.1 million, or $1.42 per share. See Note 3 to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(dollars presented in tables in thousands except per share data)\n1. ORGANIZATION\nThe Duriron Company, Inc. (the \"Company\") was incorporated under the laws of the State of New York on May 1, 1912. The Company, headquartered in Dayton, Ohio, is principally engaged in the design, manufacture and marketing of fluid handling equipment, primarily pumps, valves and mechanical seals, for industries that utilize difficult to handle and often corrosive fluids in manufacturing processes. Based upon its analysis of trade association data and other market information, the Company considers itself a leading supplier of corrosion resistant fluid movement and control equipment to the basic chemical industry. The Company markets its products on a global basis. With respect to a majority of its products, the Company's domestic operations supply each other and the company's foreign manufacturing subsidiaries with components and subassemblies.\n2. SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries. All significant intercompany transactions have been eliminated. Investments in unconsolidated affiliated companies, which represent all non-majority ownership interests, are carried on the equity basis, which approximates the Company's equity in their underlying net book value.\nBUSINESS COMBINATIONS - Business combinations which have been accounted for under the pooling of interests method of accounting combine the assets, liabilities, and stockholders' equity of the acquired entity with the Company's respective accounts at recorded values. Prior period financial statements have been restated to give effect to the merger.\nBusiness combinations which have been accounted for under the purchase method of accounting include the results of operations of the acquired business from the date of acquisition. Net assets of the companies acquired are recorded at their fair value to the Company at the date of acquisition.\nCASH EQUIVALENTS - Cash equivalents represent short-term investments with an original maturity of three months or less when purchased which are highly liquid with principal values that are not subject to significant risk of change due to interest rate fluctuations.\nACCOUNTS RECEIVABLE - Accounts receivable are stated net of the allowance for doubtful accounts of $1,408,000 and $1,470,000 at December 31, 1995 and 1994, respectively.\nINVENTORIES - Inventories are stated at the lower-of-cost or market. Cost is determined for all domestic inventories by the last-in, first-out (LIFO) method and for foreign inventories by the first-in, first-out (FIFO) method.\nFINANCIAL INSTRUMENTS - Gains and losses on hedges of existing assets or liabilities are included in the carrying amounts of those assets or liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to hedges of anticipated transactions are recognized in income as the transactions occur.\nThe carrying amounts of the Company's financial instruments approximate fair value as defined under SFAS No. 107. Fair value is estimated by reference to quoted prices by financial institutions, as well as through other valuation techniques.\nRETIREMENT BENEFIT COSTS - Defined benefit pension expense and postretirement benefit expense are based on independent actuarial valuations assuming current and prior service costs are recognized over employees' expected service periods.\nPROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION - Property, plant and equipment is stated on the basis of cost. Depreciation is computed by the straight-line method based on the estimated useful lives of the depreciable assets for cost and by accelerated methods for income tax purposes.\nINTANGIBLES AND OTHER ASSETS - Excess cost over the fair value of net assets acquired (or goodwill) generally is amortized on a straight-line basis over 15-40 years. The carrying value of goodwill will be reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the Company's carrying value of the goodwill will be reduced by the estimated shortfall of cash flows. The Company has not early 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.\nFOREIGN CURRENCY TRANSLATION - Assets and liabilities of the Company's foreign affiliates, other than those located in highly inflationary countries, are translated at current exchange rates, while income and expenses are translated at average rates for the period. For entities in highly inflationary countries, a combination of current and historical rates is used to determine currency gains and losses resulting from financial statement translation and those resulting from transactions. Translation gains and losses are reported as a component of stockholders' equity, except for those associated with highly inflationary countries which are reported directly in the consolidated statements of income.\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.\nDISCONTINUED OPERATIONS - In 1992, Durametallic negotiated the sale of its 80 percent interest in Leap Technologies, Inc., for a note receivable. Leap was engaged in the design, manufacture and sale of injection molds and parts for the plastics industry. As part of the sale agreement, Durametallic committed to contingently guaranty the bank debt of the acquiring Company. The sale resulted in a pretax gain in 1992, which was not recognized in the consolidated statement of income due to concern for the significant financial leverage of the acquiring company. During 1993, the acquiring company defaulted on its payment of the bank loan and the loan guaranty was enforced by the bank. Durametallic made full payment on the loan, and in addition, the note receivable on the sale of Leap and the deferred gain were written off. These transactions resulted in a loss in 1993 of $2.9 million, net of tax of $.4 million.\n3. MERGERS AND ACQUISITIONS POOLING TRANSACTION - On November 30, 1995, Durametallic Corporation was merged with and into a subsidiary of the Company. Durametallic, a privately held corporation headquartered in Kalamazoo, Michigan, is a leading manufacturer of mechanical seals and sealing systems. The Company exchanged 5,344,868 shares of common stock for all outstanding shares of Durametallic. Additionally, 125,283 shares of the Company's common stock were reserved for outstanding stock options issued by Durametallic and assumed by the Company. The merger was accounted for under the pooling of interests method of accounting, and accordingly, the accompanying consolidated financial statements have been restated for all periods prior to the acquisition to include the financial position, results of operations and cash flows of Durametallic. Net sales and net earnings for the individual entities are as follows:\nIn connection with the merger of the Company and Durametallic, merger transaction expenses of $4,399,000 after tax, or $.18 per share, were recognized in 1995.\nIn 1992, the Company early complied with SFAS No. 106, \"Employers Accounting for Postretirement Benefits\". Durametallic's financial results were restated to reflect compliance with the accounting policy in 1992, compared with compliance in 1993 as reported in financial statements issued prior to the acquisition with Duriron.\nDividends per share were $.31 per share and $.29 per share for the nine months ended September 30, 1995 and 1994, respectively.\nPURCHASE TRANSACTIONS - On August 31, 1995, Durametallic purchased Pac-Seal and two affiliated companies. Pac-Seal, located in Burr Ridge, Illinois, is a manufacturer of mechanical seals used primarily in water pump applications. The\nacquisition was funded through the combination of internal cash and long-term borrowings.\nOn April 28, 1994, the Company purchased Sereg Vannes S.A., an automatic control valve company headquartered in Thiers, France. The acquisition was funded with the combination of internal cash and long-term borrowings.\nOn January 5, 1994, the Company purchased the valve actuator business of Mecair SpA in Milan, Italy, and its associated companies in Limburg, Germany; Alton Hampshire, England; and Gennevilliers, France. The acquisition was funded through the utilization of internal cash.\nThe aforementioned 1995 and 1994 purchase transactions were not material, either individually or in the aggregate by year, therefore, no pro forma information is presented for these acquisitions.\n4. INVENTORIES\nInventories at December 31, 1995 and 1994 and the method of determining cost were as follows:\nLIFO inventories at current cost were $36,127,000 and $34,991,000 higher than reported at December 31, 1995 and 1994, respectively. During 1993 certain inventory quantities were reduced which resulted in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect of the 1993 liquidation was to increase net earnings by $2,792,000.\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31, 1995 and 1994 were as follows:\n6. INTANGIBLES AND OTHER ASSETS\nIntangibles and other assets at December 31, 1995 and 1994 were as follows:\n7. ACCRUED LIABILITIES Accrued liabilities at December 31, 1995 and 1994 were as follows:\n8. DEBT AND DIVIDEND RESTRICTIONS\nLong-term debt, including capital lease obligations, at December 31, 1995 and 1994 were as follows:\nInterest paid amounted to $4,957,000, $4,418,000 and $4,554,000 in 1995, 1994 and 1993, respectively.\nMaturities of long-term debt, including capital lease obligation for each of the four years subsequent to 1996, are as follows:\n1997 $9,747 1998 $10,355 1999 $11,892 2000 $6,428\nThe 8.94% loan is a U.S. dollar private placement which was effectively converted to a deutsche mark obligation through a currency swap agreement. The currency swap is a hedge of the net investment in a German subsidiary. Unrealized gains and losses on the hedge are not recognized in income, but are shown in the cumulative translation adjustment account included in shareholders' equity with the related amounts due to and from the counterparty included in long-term debt. The maturity and repayment terms of the swap match precisely the maturity and repayment term of the underlying debt.\nLong-term debt agreements require the company to maintain specified levels of tangible net worth and restrict the payment of cash dividends. Approximately, $28,543,000 and $24,828,000 of consolidated retained earnings were unrestricted for the payment of dividends at December 31, 1995 and 1994, respectively. Dividends are limited to $15,000,000 plus common stock issued and 50% of defined net earnings subsequent to January 1, 1992.\nAt December 31, 1995 and 1994, the Company had short term credit facilities available from banks under which it could borrow, at local market rates up to $32,830,000 and $33,096,000, respectively. Under these facilities, the Company had $3,723,000 and $5,905,000 in borrowings outstanding at December 31, 1995 and 1994, respectively . The weighted average interest rate on these borrowings at December 31, 1995 and 1994, was 5.3% and 7.7%, respectively. In both years, these borrowings were used primarily to support the operations of foreign subsidiaries. Additionally, at December 31, 1995, the Company had $18,035,000 available under revolving credit facilities.\n9. POSTRETIREMENT BENEFITS AND OTHER DEFERRED ITEMS\nDeferred postretirement benefits and other deferred items at December 31, 1995 and 1994 were as follows:\n10. LEASES AND RENTALS\nAssets subject to capitalized leases and included in property, plant and equipment at cost amounted to $7,320,000 in 1995 and $7,871,000 in 1994. Accumulated amortization for the capitalized leases amounted to $6,019,000 in 1995 and $6,313,000 in 1994.\nThe minimum rental commitments as of December 31, 1995 for all noncancelable leases were as follows:\nTotal rental expense amounted to $8,490,000, $8,065,000 and $7,449,000 in 1995, 1994 and 1993, respectively.\n11. CONTINGENCIES\nThe Company is involved as a \"potentially responsible party\"at five former public waste disposal sites which may be subject to remediation under pending government procedures. The sites are in various stages of evaluation by federal and state environmental authorities. The projected cost of remediating these sites, as well as the Company's alleged \"fair share\" allocation, is uncertain and speculative until all studies have been completed and the parties have either negotiated an amicable resolution or the matter has been judicially resolved. At each site, there are many other parties who have similarly been identified, and the identification and location of additional parties is continuing under applicable federal or state law. Many of the other parties identified are financially strong and solvent companies which appear able to pay their share of the remediation costs. Based on the Company's preliminary information about the waste disposal practices at these sites and the environmental regulatory process in general, the Company believes that it is likely that ultimate remediation liability costs for each site will be apportioned among all liable parties, including site owners and waste transporters, according to the volumes and\/or toxicity of the wastes shown to have been disposed of at the sites.\nIn 1995, the Company was successful in terminating the applicable consent decree and completing all its remedial activities at its former foundry landfill site at nominal additional expense. Additionally, the Company ended involvement at nominal cost at two other waste disposal sites under governmental remediation regulation.\nThe Company is a defendant in numerous pending lawsuits (which include, in many cases, multiple claimants) which seek to recover damages for alleged personal injury allegedly resulting from exposure to asbestos containing products formerly manufactured and distributed by the Company. A high percentage of these claims was assumed by the Company in 1995 as the result of the merger with Durametallic Corporation. All such products were used within self-contained process equipment, and management does not believe that there was any emission of ambient asbestos fiber during the use of this equipment. The Company has resolved numerous claims at an average of about $120 per claim, the cost of which was fully paid by insurance. The Company continues to have a substantial amount of available insurance from financially solvent carriers to cover the cost of both defending and resolving the claims.\nThe Company is also a defendant in several other products liability lawsuits which are insured, subject to the applicable deductibles, and certain other non-insured lawsuits received in the ordinary course of business. The Company has fully accrued the estimated loss reserve for each such lawsuit. No insurance recovery has been projected for any of the insured claims because management currently believes that all will be resolved within applicable deductibles.\nAlthough none of the aforementioned gives rise to any additional liability that can now be reasonably estimated, it is possible that the Company could incur additional costs in the range of $250,000 to $1,000,000 over the upcoming five years to fully resolve these matters. Although the Company has accrued the minimum end of this range as a precaution, management has no current reason to believe that any such increase is probable or quantifiable. The Company will continue to evaluate these contingent loss exposures and, if they develop, recognize expense as soon as such losses can be reasonably estimated.\n12. SHAREHOLDERS' EQUITY\nIn 1995, the Company increased its authorized $1.25 par value common stock from 30,000,000 to 60,000,000 shares. At both December 31, 1995 and 1994, 1,000,000 shares of $1.00 preferred stock was authorized. During March of 1994, the Company distributed a stock dividend which had the effect of a three-for-two stock split. All per share and share data, where appropriate, have been restated to reflect this stock split.\nEach share of the Company's common stock contains a preferred stock purchase right. These rights are not currently exercisable and trade in tandem with the common stock. The rights, in general, become exercisable and trade separately in the event of certain significant changes in common stock ownership or on the commencement of certain tender offers which in either case, may lead to a change of control of the Company. Upon becoming exercisable, the rights provide shareholders the opportunity to acquire a new series of Company preferred stock to be then automatically issued at a pre-established price. In the event of certain forms of acquisition of the Company, the rights also provide Company shareholders the opportunity to purchase shares of the acquiring company's common stock from the acquirer at a 50% discount from the current market value. The rights are redeemable for $.022 per right by the Company at any time prior to becoming exercisable and will expire in August, 1996.\nAt December 31, 1995, approximately 1,395,000 shares of common stock were reserved for exercise of stock options and for grants of restricted stock.\n13. STOCK PLANS\nThe Company maintains shareholder approved stock option plans which provide for the grant of options to purchase shares of the Company's common stock. Options have been granted to officers and employees to purchase shares of common stock at a price not less than the fair market value on the date of grant. Generally, these options become exercisable over staggered periods, but may not be exercised after 10 years from the date of the grant. The plan provides than any option may include a stock appreciation right, however, none have been granted since 1989. The impact of stock appreciation rights on earnings for the three years ending on December 31, 1995, was not material.\nDuring 1995, options for 212,537 shares became exercisable at an average price of $13.57 . At December 31, 1995, 1994 and 1993, the aggregate number of options exercisable were 570,601, 455,139 and 367,560, respectively.\nThe restricted stock plan was approved by shareholders in 1989. The plan authorized the grant of up to 337,500 shares of the Company's common stock as restricted shares to directors and employees of the Company. In general, the shares cannot be transferred for a period of not less than one nor more than ten years, and are subject to forfeiture during the restriction period. The market value of the shares awarded under the plan is amortized to compensation expense over the periods in which the restrictions lapse. Restricted stock grants of 4,100, 2,400 and 19,686 shares were made in 1995, 1994 and 1993, respectively, at an average market value of $16.07 per share.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation\" was issued in October 1995 and is effective for years beginning after December 15, 1995. The Statement establishes financial accounting and reporting standards for stock based compensation plans. Companies may elect to account for such plans under the fair value method or to continue previous accounting and disclose proforma net earnings and earnings per share as if the fair value method was applied. The Company has not reached any conclusion regarding the adoption of this Statement.\n14. INCOME TAXES\nEarnings before income taxes consist of the following components:\nSignificant components of the provision for income taxes attributable to continuing operations are as follows:\nIncome taxes paid amounted to $19,508,000, $13,476,000 and $19,167,000 during 1995, 1994 and 1993, respectively.\nThe reasons for the differences between the effective tax rate and the U.S. federal income tax rate were 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. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994 were as follows:\nThe Company has recorded valuation allowances to reflect the estimated amount of deferred tax assets which may not be realized due to the expiration of net operating loss, foreign tax credit and capital loss carryforwards. The change in the valuation allowances for the year ended December 31, 1995 were as follows:\nUndistributed earnings of the Company's foreign subsidiaries amounted to approximately $35,000,000 at December 31, 1995. These earnings are considered to be indefinitely reinvested and, accordingly, no additional United States income taxes or foreign withholding taxes have been provided.\n15. RESEARCH AND DEVELOPMENT\nResearch and development expense amounted to $7,965,000, $8,642,000 and $7,784,000 in 1995, 1994 and 1993, respectively.\n16. RETIREMENT BENEFITS\nThe Company sponsors several noncontributory defined benefit pension plans, covering approximately 40% of domestic employees, which provide benefits based on years of service and compensation. Retirement benefits for all other employees are provided through defined contribution pension plans and government sponsored retirement programs. All defined benefit pension plans are funded based on independent actuarial valuations to provide for current service and an amount sufficient to amortize unfunded prior service over periods not to exceed thirty years.\nNet defined benefit pension income for 1995, 1994 and 1993 included the following components:\nThe following table presents defined benefit pension plan funded status and amounts recognized in the Company's consolidated balance sheet at December 31, 1995 and 1994:\nThe average discount rate and the assumed rate of increase in future compensation levels used in determining the actuarial present value of benefit obligations were 7.5% and 5.0%, respectively. The expected long-term rate of return on plan assets was 8.0%. Plan assets include marketable equity securities, corporate and government debt securities, insurance company contracts and real estate.\nThe Company sponsors several defined contribution pension plans covering substantially all domestic and Canadian employees and certain other foreign employees. Employees may contribute to these plans and these contributions are matched in varying amounts by the Company. The Company may also make additional contributions to eligible employees. Defined contribution pension expense for the Company was $5,966,000, $4,236,000 and $4,972,000 for 1995, 1994 and 1993, respectively.\nThe Company also sponsors several defined benefit postretirement health care plans covering approximately 65% of future retirees and most current retirees in the United States. These medical and dental benefits are provided through insurance companies and health maintenance organizations, include participant contributions, deductibles, co-insurance provisions and other limitations, and are integrated with Medicare and other group plans. The plans are funded as insured benefits and health maintenance organization premiums are incurred.\nNet postretirement benefit expense for 1995, 1994 and 1993 included the following components:\nThe following table presents postretirement benefit amounts recognized in the Company's consolidated balance sheet at December 31, 1995 and 1994:\nThe average discount rate used in determining accumulated postretirement benefit obligations was 7.5%. The assumed annual rates of increase in per capita costs were, for periods prior to Medicare, 9.5% for 1995 and 9% for 1996 with a gradual decrease to 6% for 2002 and future years and, for periods after Medicare, 7.5% for 1995 and 7% for 1996 with a gradual decrease to 5% for 2000 and future years. Increasing the assumed rate of increase in postretirement benefit costs by 1% in each year would increase net postretirement benefit expense by approximately $362,000 and accumulated postretirement benefit obligations by $3,441,000.\n17. POSTEMPLOYMENT BENEFITS UNDER SFAS NO. 112\nEffective January 1, 1993, the Company early adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", in accounting for workers' compensation and health care continuation benefits. The cumulative effect as of January 1, 1993 of this change in accounting principle was to decrease net earnings by $945,000, or $.04 per share. Prior to January 1, 1993, the Company recognized the cost of providing these benefits on a cash basis. Under the new method of accounting, the Company accrues the benefits when it becomes probable that such benefits will be paid and when sufficient information exists to make reasonable estimates of the amounts to be paid. As required by the Statement, prior year financial statements have not been restated to reflect the change in accounting principle. The effect of the change on 1995, 1994 and 1993 income before the cumulative effect of the change was not material.\n18. FOREIGN CURRENCY TRANSLATION\nThe foreign currency translation equity adjustments consist of the following:\n19. OPERATIONS IDENTIFIED BY GEOGRAPHIC AREA\nThe Company operates in predominately one business segment, fluid movement and control equipment (pumps, valves, seals and related equipment).\nTransfers between geographic areas are accounted for primarily at cost plus a profit margin. Operating profit consists of revenues less certain costs and expenses. In determining operating profit none of the following items have been added or deducted: unallocated general corporate expense, interest expense and income taxes. Identifiable assets are those assets of the Company that are identifiable with the operations in each geographic area. Unallocated general corporate assets principally reflect future tax benefits.\nNo individual country within the below listed geographic segments represents 10% or more of the consolidated Company's revenues from sales to unafilliated customers or its identifiable assets. The Other geographic segment includes Canada, Latin and South America and the Asia Pacific.\nExport sales from the United States to foreign unaffiliated customers were $27,068,000, $27,143,000 and $37,014,000 in 1995, 1994 and 1993, respectively.\nFinancial information by geographic area follows:\nIn 1995, 1994 and 1993 foreign currency transaction gains\/(losses) of approximately $217,000 ($1,150,000) and $152,000, respectively, were included in earnings before income taxes.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders The Duriron Company, Inc.\nWe have audited the accompanying consolidated balance sheet of The Duriron Company, Inc. 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 listed in the Index at Item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Duriron Company, Inc. 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 17 to the consolidated financial statements, effective January 1, 1993 the Company changed its method of accounting for postemployment benefits.\nErnst & Young LLP\nDayton, Ohio January 30, 1996\nREPORT OF MANAGEMENT\nThe Company's management has prepared and is responsible for the consolidated financial statements and information included in this Annual Report. The financial statements were prepared in accordance with generally accepted accounting principles and present fairly the Company's financial position and results of operations. Such statements necessarily include amounts based on judgements and estimates by management.\nInternal accounting control systems have been designed and implemented over the years and transactions are executed in accordance with management's authorizations. These internal control systems provide reasonable assurance that the financial statements and information included in this report properly reflect transactions of the Company. The Company also maintains an internal auditing function which evaluates and formally reports on the adequacy and effectiveness of internal accounting controls, policies and procedures.\nThe Board of Directors has an Audit\/Finance Committee composed of five members who are non-employee Directors of the Company. The Audit\/Finance Committee met a total of three times during 1995. The Committee regularly meets (jointly and separately) with representatives of the independent auditors, the internal auditors and management.\nThe Company's consolidated financial statements have been audited by Ernst & Young LLP, who have expressed their opinion with respect to the fairness of these statements. Their audit included a review of internal controls and testing of transactions and records that they consider necessary in the circumstances.\nWilliam M. Jordan Bruce E. Hines President and Chief Senior Vice President and Executive Officer Chief Administrative Officer\nITEM 9.","section_9":"ITEM 9. NOT APPLICABLE\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOfficers are, in general, appointed annually to their respective positions at the April meeting of the Board of Directors. The executive officers and other officers of the Company at February 1, 1996 were as follows:\nWilliam M. Jordan, President and Chief Executive Officer, Director Bruce E. Hines, Senior Vice President and Chief Administrative Officer Curtis E. Daily, Group Vice President - Rotating Equipment Group Thomas E. Haan, Group Vice President - Fluid Sealing Group George A. Shedlarski, Group Vice President - Industrial Products Group Mark E. Vernon, Group Vice President - Flow Control Group Ronald F. Shuff, Vice President - Secretary and General Counsel Gregory L. Smith, Treasurer Kathleen A. Giddings, Controller\nWILLIAM M. JORDAN, 52, was elected President and Chief Executive Officer in 1993 and a Director in 1991. In February, 1996, he was additionally elected Chairman of the Board to become effective on April 25, 1996. Mr. Jordan became Executive Vice President in 1990 and President in 1991. He was Chief Operating Officer from 1990 to 1993. From 1984 until 1991, Mr. Jordan was the Group Vice President of International Operations, and he was the Assistant Group Vice President - International Operations in 1983. From 1979 to 1983, he was Vice President and General Manager of Duriron Canada Inc. Mr. Jordan joined the Company in 1972 as a sales engineer and held various sales positions prior to 1979.\nBRUCE E. HINES, 52, who rejoined the Company in 1989, was then elected Senior Vice President and added the position of Chief Administrative Officer in 1990. He previously had served as President of Vernay Labs, a manufacturer of precision rubber components. Prior to joining Vernay Labs, Mr. Hines had served in a variety of financial positions with the Company for nineteen years. He also functions as Chief Financial Officer.\nCURTIS E. DAILY, 52, was elected a Group Vice President in 1990. He is responsible for all the Company's worldwide pump operations and certain foreign operations. He previously was the corporate Director of International Operations in 1989 after serving as the resident President of the Company's Belgian subsidiary, S.A. Durco Europe N.V. He joined the Company in 1965.\nTHOMAS E. HAAN, 46, was elected a Group Vice President effective January 1, 1996. He is responsible for the global operations of the Company's mechanical seal and sealing system products which are marketed under the \"Durametallic\" trade name. In 1970, he joined Durametallic. He was elected to the following Durametallic offices: a Vice President in 1985, Senior Vice President in 1990 and Executive Vice President - Chief Operating Officer in 1993.\nGEORGE A. SHEDLARSKI, 52, was elected a Group Vice President in 1987 and is responsible for the Company's worldwide manual valve, actuator, foundry and filtration products\nand for certain foreign operations. From 1984 until becoming a Group Vice President, Mr. Shedlarski was President of the Filtration Systems Division. From 1983 to 1984, he served as President and General Manager of Duriron Canada Inc. Mr. Shedlarski joined the Company in 1972 as a filtration product specialist and held various sales and managerial positions prior to 1983.\nMARK E. VERNON, 43, was elected a Group Vice President in 1993. He is responsible for the worldwide operations of the Company's control valve products which are marketed under the Valtek, Kammer and Sereg trade names. He was President of the Company's Valtek Inc. subsidiary from 1991 to 1993 and Senior Vice President of Valtek from 1988 to 1990. Mr. Vernon joined Valtek Incorporated in 1978.\nRONALD F. SHUFF, 43, was elected Vice President - Secretary and General Counsel of the Company in 1990. He joined the Company in 1988 as General Counsel and Assistant Secretary and became General Counsel and Secretary in 1989. Previously, he served as General Counsel and Secretary of AccuRay Corporation (a manufacturer of process control equipment which subsequently became a subsidiary of Asea Brown Boveri).\nGREGORY L. SMITH, 42, was elected Treasurer in 1987. He joined the Company in 1975. From 1985 until assuming his present position, he was Assistant Treasurer and, prior to becoming Assistant Treasurer, he was Manager of Corporate Tax.\nKATHLEEN A. GIDDINGS, 33, was elected Controller in 1993. She joined the Company in 1985. She has served the Company in a number of financial management positions, including Director of Financial Reporting and Corporate Controller in 1993, Manager Financial Accounting from 1990 to 1992, Supervisor Financial Accounting in 1989 and Financial Accountant from 1985 to 1989.\nAdditional information required by this Item 10 is incorporated herein by this reference from the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is set forth in the Proxy Statement and is incorporated herein by this 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 in the Proxy Statement and is incorporated herein by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is set forth to the extent applicable in the Proxy Statement and is incorporated herein by this reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) FINANCIAL STATEMENTS\nThe following consolidated financial statements of the Company are incorporated herein by this reference as part of this Report at Item 8 hereof.\nReport of Independent Auditors\nConsolidated Statement of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Shareholders' Equity 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 Consolidated Financial Statements\n(a) (2) FINANCIAL STATEMENT SCHEDULE\nSchedule II - Valuation and Qualifying Accounts (at page 52 of this Report)\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) EXHIBITS\nSee INDEX to EXHIBITS\n(b) REPORTS ON FORM 8-K\nOn December 14, 1995, the Company filed, on Form 8-K, its announcement of the completion of its acquisition of Durametallic on November 30, 1995. As part of this filing, the Company also submitted certain financial statements covering Durametallic's financial results for the nine month period ended September 30, 1995 and certain pro forma consolidated statements covering the combined operations of Durametallic and the Company for the same period.\nTHE DURIRON COMPANY, INC. Schedule II - Valuation and Qualifying Accounts (dollars in thousands)\n(a) Deductions from reserve represent accounts written off, net of recoveries.\n(b) Deductions from reserve represent inventory written off.\n(c) Deductions from reserve represent fixed assets written off, and amounts reclassified to the general restructuring reserve.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, The Duriron Company, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 9th day of February, 1996.\nTHE DURIRON COMPANY, INC.\nBY \/S\/ WILLIAM M. JORDAN ------------------ WILLIAM M. JORDAN 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 Duriron Company, Inc. and in the capacities and on the dates indicated:\nINDEX TO EXHIBITS\n(3) ARTICLES OF INCORPORATION AND BY-LAWS:\n3.1* 1988 Restated Certificate of Incorporation of The Duriron Company, Inc. was filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.\n3.2* 1989 Amendment to Certificate of Incorporation was filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n3.3* By-Laws of The Duriron Company, Inc. (as restated) were filed with the Commission as Exhibit 3.2 to The Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n3.4 1996 Certificate of Amendment of Certificate of Incorporation.\n3.5 Amendment No. 1 to Restated Bylaws.\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES:\n4.1+ Lease agreement, indenture of mortgage and deed of trust, and guarantee agreement, all executed on June 1, 1978 in connection with 9-1\/8% Industrial Development Revenue Bonds, Series A, City of Cookeville, Tennessee.\n4.2+ Lease agreement, indenture of trust, and guaranty agreement, all executed on June 1, 1978 in connection with 7-3\/8% Industrial Development Revenue Bonds, Series B, City of Cookeville, Tennessee.\n4.3* Lease agreement, indenture of mortgage and agreement, lessee guaranty agreement, and letter of representation and indemnity agreement, all dated as of December 1, 1983 and executed in connection with the Industrial Development Revenue Bonds (1983 The Duriron Company, Inc. Project), Erie Company, New York Industrial Development Agency were filed with the Commission as Exhibit 4.4 to the Company's Report on Form 10-K for the year ended December 31, 1983.\n4.4* Form of Rights Agreement dated as of August 1, 1986 between The Duriron Company, Inc. and Bank One, Indianapolis, National Association, as Rights Agent was filed as an Exhibit to the Company's Form 8-A dated August 13, 1986.\n4.5* Loan Agreement, dated as of March 19, 1987, between The Duriron Company, Inc. and Metropolitan Life Insurance Company, including the form of Promissory Note delivered in connection therewith, was filed with the Commission as Exhibit 7 to the Company's Current Report on Form 8-K dated April 6, 1987.\n4.6+ The Credit Agreement between The Duriron Company, Inc. and Bank One, Dayton, N.A., dated as of November 30, 1989.\n4.7* Interest Rate and Currency Exchange Agreement between the Company and Barclays Bank dated November 17, 1992 PLC in the amount of $25,000,000 was filed as Exhibit 4.9 to Company's Report of Form 10-K for year ended December 31, 1992.\n4.8* Loan Agreement in the amount of $25,000,000 between the Company and Metropolitan Life Insurance Company dated November 12, 1992 was filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4.9+ Revolving Credit Agreement between the Company and Fifth Third Bank dated November 23, 1992 in the amount of $10,000,000.\n4.10+ Revolving Credit Agreement between the Company and First of America Bank - Michigan, N.A. in the amount of $20,000,000 and dated August 22, 1995.\n(10) MATERIAL CONTRACTS: (See Footnote \"a\")\n10.1* The Duriron Company, Inc. Incentive Compensation Plan (the \"Incentive Plan\") for Senior Executives, as amended and restated effective January 1, 1994, was filed as Exhibit 10.1 to Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.2 Amendment No. 1 to the Incentive Plan.\n10.3* The Duriron Company, Inc. Supplemental Pension Plan for Salaried Employees was filed with the Commission as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.4* The Duriron Company, Inc. amended and restated Director Deferral Plan was filed as Attachment A to the Company's definitive 1996 Proxy Statement filed with the Commission on March 10, 1996.\n10.5* Form of Employment Agreement (\"Employment Agreement\") between The Duriron Company, Inc. and each of the current officers was filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for year ended December 31, 1992.\n10.6 Form of Amendment No. 1 to Employment Agreement.\n10.7* The Duriron Company, Inc. First Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.8* Amendment #1 to the first Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.9* Amendment #2 to First Master Benefit Trust Agreement was filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.10* The Duriron Company, Inc. Second Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.11* First Amendment to Second Master Benefit Trust Agreement was filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.12* The Duriron Company, Inc. Long-Term Incentive Plan (the \"Long-Term Plan\"), as amended and restated effective November 1, 1993 was filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.13 Amendment No. 1 to the Long-Term Plan.\n10.14* The Duriron Company, Inc. 1989 Stock Option Plan as amended and restated April 23, 1991 was filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.15* The Duriron Company, Inc. 1989 Restricted Stock Plan (the \"Restricted Stock Plan\") as amended and restated effective April 23, 1991, was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.16* Amendment #1 to the Restricted Stock Plan was filed as Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.17* Amendment #2 to the Restricted Stock Plan was filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.18 Amendment #3 to the Restricted Stock Plan.\n10.19 Amendment #4 to the Restricted Stock Plan.\n10.20* The Duriron Company, Inc. Retirement Compensation Plan for Directors (\"Director Retirement Plan\") was filed as Exhibit 10.15 on the Company's Annual Report to Form 10-K for the year ended December 31, 1988.\n10.21 Amendment No. 1 to Director Retirement Plan.\n10.22* The Company's Employee Protection Plan (which provides severance benefits for certain employees after a change of control of the Company) was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10.23* The Company's Benefit Equalization Pension Plan (\"Equalization Plan\") was filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10.24* Amendment #1 dated December 15, 1992 to the Equalization Plan was filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.25 The Company's Equity Incentive Plan as amended and restated effective July 21, 1995.\n10.26* Supplemental Pension Agreement between the Company and William M. Jordan dated January 18, 1993 was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.27* 1979 Stock Option Plan, as amended and restated April 23, 1991, and Amendment #1 thereto dated December 15, 1992, was filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.28* Deferred Compensation Plan for Executives was filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.29 Executive Life Insurance Plan of The Duriron Company, Inc.\n10.30 Executive Long-Term Disability Plan of The Duriron Company, Inc.\n10.31 Consulting Agreement between James S. Ware and Durametallic Corporation dated April 21, 1991.\n10.32 Senior Executive Death Benefit Agreement between James S. Ware and Durametallic dated April 12, 1991\n10.33 Executive Severance Agreement between James S. Ware and Durametallic Corporation dated January 6, 1994\n10.34 Agreement between James S. Ware and the Company dated September 11, 1995\n10.35* Agreement and Plan of Merger Among The Duriron Company, Inc., Wolverine Acquisition Corporation and Durametallic Corporation, dated as of September 11, 1995 was filed as Annex A on the Form S-4 Registration Statement filed by the Company on September 11, 1995\n(22) SUBSIDIARIES:\nThe Duriron Company, Inc. has direct or indirect subsidiaries all of which (i) are beneficially owned or controlled; (ii) do business under the name under which they are organized and (iii) are included in the consolidated financial statements of the Company.\n22.1 Subsidiaries of the Company\n(23) CONSENTS OF EXPERTS AND COUNSEL\n23.1 Consent of Ernst & Young LLP\n(27) FINANCIAL DATA SCHEDULE\n27.1 Financial Data Schedule (submitted for the SEC's information)\n_______________\n\"*\" Indicates that the exhibit is incorporated by reference into this Annual Report on Form 10-K from a previous filing with the Commission. The Company's file number with the Commission is \"0-325\".\n\"+\" Indicates that the document relates to a class of indebtedness that does not exceed 10% of the total assets of the Company and subsidiaries and that the Company will furnish a copy of the document to the Commission upon request.\n\"a\" The documents identified under Item 10 include all management contracts and compensatory plans and arrangements required to be filed as exhibits.","section_15":""}
{"filename":"68589_1995.txt","cik":"68589","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are various legal and regulatory proceedings pending that involve the Company and its affiliates. While it is not feasible to predict or determine the outcome of these proceedings, the Company's management believes that the outcome will not have a material adverse effect on the Company's financial position.\nMountain Fuel, as a result of acquiring Questar Pipeline's gas purchase contracts, is responsible for any judgment rendered against Questar Pipeline in a lawsuit that was tried before a jury in 1994. The jury awarded an independent producer compensatory damages of approximately $6,100,000 and punitive damages of $200,000 on his claims involving take-or-pay, tax reimbursement, contract breach, and tortious interference with a contract. A judgment has not been entered because the presiding judge has still not issued a decision concerning the competing forms of judgment entered by the opposing parties. The producer's counterclaims originally exceeded $57,000,000, but were reduced to less than $10,000,000, when the presiding judge dismissed with prejudice some of the claims prior to the jury trial. Under existing PSCU rulings, any payments resulting from this judgment will be included in Mountain Fuel's gas balancing account and recovered in its rates for natural gas sales service.\nAs a result of its former ownership of Entrada and Wasatch Chemical Company, Mountain Fuel has been named as a \"potentially responsible party\" for contaminants located on property owned by Entrada in Salt Lake City, Utah. Questar and Entrada have also been named as potentially responsible parties. (Entrada and the Company are both direct, wholly owned subsidiaries of Questar; prior to October 2, 1984, Mountain Fuel was the parent of Entrada.) The property, known as the Wasatch Chemical property, was the location of chemical operations conducted by Entrada's Wasatch Chemical division, which ceased operation in 1978. A portion of the property is included on the national priorities list, commonly known as the \"Superfund\" list.\nIn September of 1992, a consent order governing clean-up activities was formally entered by the federal district court judge presiding over the underlying litigation involving the property. This consent order was agreed to by Questar, Entrada, the Company, the Utah Department of Health and the Environmental Protection Agency (the EPA).\nDuring 1995, Entrada completed soil remediation activities on the property, using an in situ vitrification procedure. It is continuing to conduct ground water remediation activities.\nEntrada has accounted for all costs spent on the environmental claims and has also accounted for all settlement proceeds, accruals and insurance claims. It has received cash settlements, which together with accruals and insurance receivables, should be sufficient for future clean-up costs. Mountain Fuel has consistently maintained that Entrada should be responsible for any liability imposed on the Questar group as a result of actions involving Wasatch Chemical. The Company has not paid any and does not expect to pay any costs associated with the clean-up activities for the property.\nMountain Fuel recently settled a lawsuit in which Utah Power claimed that the Company was responsible for contamination located on property that is next to Mountain Fuel's operations center in Salt Lake City. The operations center was the site of an abandoned coal gasification plant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1995, Mountain Fuel did not submit any matters to a vote of security holders.\nPart II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's outstanding shares of common stock, $2.50 par value, are owned by Questar. Information concerning the dividends paid on such stock and the ability to pay dividends is reported in the Statements of Common Shareholder's Equity and the Notes to Financial Statements included in Item 8.\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\nFollowing is a summary of revenues and operating information for the Company's operations:\nRevenues, net of gas costs, increased $4,410,000 in 1995 when compared with 1994 after decreasing $4,499,000 in 1994 when compared with 1993. The positive influences derived from a general rate case settlement, a 3.6% increase in the number of customers, an increase in transportation volumes for industrial customers and productivity improvement measures offset the effect of temperatures that were 5% warmer than were experienced in 1994.\nOn August 11, 1995, the Public Service Commission of Utah (PSCU) approved a settlement of Mountain Fuel's general rate case filed April 13, 1995. Mountain Fuel received a $3.7 million increase in revenues. The settlement allowed the Company to implement a weather normalization adjustment, provided about $2 million in additional revenues through a new-premises fee and added about $1.7 million from sharing capacity-release revenues. The settlement did not specify an authorized return on equity, but Mountain Fuel's allowed return on rate base increased from 10.08% to between 10.22% and 10.34%. A weather-normalization adjustment applied to about 40% of Mountain Fuel's weather sensitive volumes for the last quarter of 1995 and reduced the net income effect caused by warmer-than-normal temperatures by about $1.3 million. Mountain Fuel pays for firm-transportation capacity and sells unused firm-transportation capacity as capacity-release service. Under the rate settlement, Mountain Fuel is allowed to credit 20% of capacity-release revenues, which amounted to $676,000 in 1995, to earnings.\nNatural gas deliveries to residential and commercial customers were largely unchanged in 1995 when compared with 1994. Both years experienced warmer-than-normal temperatures and a near 4% increase in the number of customers. Sales volumes dropped 6% in 1994 after increasing 16% in 1993 due to 1994 being 13% warmer than 1993. The number of customers increased by 3.6% in 1995, 4.0% in 1994 and 3.4% in 1993.\nGas deliveries to industrial customers increased by 14% in 1995 and 1% in 1994. Mountain Fuel's service area has experienced strong economic growth for several successive years. The Company has benefitted from a higher gas demand for expanded operations and environmental reasons.\nMountain Fuel closed four regional offices and reduced functions at six other offices in an effort to consolidate and restructure operations. In addition, the Company's offer of early retirement was accepted by 109 employees effective April 30, 1995. The cost reductions associated with these changes averaged $400,000 per month or about $3.2 million for 1995. The early retirement program did not cause a material increase in pension expense. Mountain Fuel is depending on its investment in customer information system technology to provide increased efficiency in serving customers. Mountain Fuel's customers satisfaction rating continued to increase reaching a record 91.3% in 1995.\nStarting in 1993, Mountain Fuel began accruing gas-distribution revenues for gas delivered to residential and commercial customers but not billed at the end of the reporting period. The impact of these accruals on the income statement has been deferred and is being recognized at the rate of $2,011,000 per year over a five-year period beginning in 1994, in accordance with a PSCU rate order. This rate order also reduces customer rates by $2,011,000 per year over the same five-year period. In addition in 1994, Mountain Fuel recorded other income of $5,589,000 for a one-time reduction in gas costs associated with these unbilled revenues. This transaction added about $3.5 million to net income in 1994.\nNatural gas purchases decreased 4% in 1995 when compared with 1994 primarily due to lower prices for natural gas. Natural gas purchases decreased 9% in 1994 when compared with 1993 largely the result of a reduction in volumes sold.\nOperating and maintenance expenses decreased 1% in 1995 primarily because of productivity improvement measures implemented in 1995. Operating and maintenance expenses were 2% higher in 1994 when compared to 1993 because of the costs associated with more customers and an expanded service territory. Depreciation and amortization expense increased 3% in 1995 and 6% in 1994 as a result of capital expenditures.\nThe effective income tax rate was 24.6% in 1995, 25.3% in 1994 and 23.5% in 1993 primarily due to income tax credits received from production of gas from certain properties. These credits amounted to $4,376,000 in 1995, $4,670,000 in 1994 and $5,463,000 in 1993.\nMountain Fuel, as a result of acquiring Questar Pipeline's gas purchase contracts, is responsible for any judgment rendered against Questar Pipeline in a lawsuit that was tried before a jury in 1994. The jury awarded an independent producer compensatory damages of approximately $6.1 million and punitive damages of $200,000 on his claims. The producer's counterclaims originally exceeded $57 million, but were reduced to less than $10 million, when the presiding judge dismissed with prejudice some of the claims prior to the jury trial. Under existing PSCU rulings, any payments resulting from this judgment will be included in Mountain Fuel's gas balancing account an recovered in its rates for natural gas service.\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, that becomes effective for the Company January 1, 1996. Statement No. 121 requires the Company to review for impairment, assets that are held and used whenever events or changes in circumstances indicate that an asset's carrying value may not be recoverable. If impairment is indicated, the Company must reduce the carrying value of the asset in question. The Company will adopt Statement No. 121 in 1996 and does not expect a significant effect to either operating results or financial position.\nLIQUIDITY AND CAPITAL RESOURCES\nOperating Activities\nNet cash provided from operating activities increased 107% in 1995. Net cash provided from operating activities was $68,546,000 in 1995, $33,143,000 in 1994 and $37,139,000 in 1993. The increase in 1995 was largely due to the collection of accounts receivable and lower gas purchase costs.\nInvesting Activities\nFollowing is a summary of capital expenditures for 1995 and 1994, and a forecast of 1996 expenditures.\nMountain Fuel's capital spending is primarily in response to a rapid increase in the number of customers, amounting to 20,564 in 1995, 21,990 in 1994 and 18,075 in 1993 due to population growth and construction activity in its service area. Mountain Fuel extended its system by 559 miles of main, feeder and service lines in 1995.\nMountain Fuel transferred a building with a net book value of $8,915,000 to an affiliate in the third quarter of 1994.\nFinancing Activities\nThe Company funded 1995 capital expenditures and cash dividends with cash provided from operations and borrowings from Questar. Forecasted 1996 capital expenditures of $55 million are expected to be financed with cash provided from operations and borrowings from Questar.\nThe Company has a short-term line-of-credit arrangement with a bank under which it may borrow up to $500,000. The line has interest rates generally below the prime interest rate and is renewable on an annual basis. No amount was borrowed under this arrangement at either December 31, 1995 or 1994. Questar loans funds to the Company under a short-term borrowing arrangement. Outstanding short-term notes payable to Questar totaled $56,100,000 with an interest rate of 6.01% at December 31, 1995 and $53,500,000 with an interest rate of 6.11% at December 31, 1994.\nMountain Fuel has a capital structure of 45% long-term debt, 1% preferred stock and 54% common equity. Moody's and Standard and Poor's have rated Mountain Fuel's long-term debt A-1 and A+.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's financial statements are included in Part IV, Item 14, herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nMountain Fuel has not changed its independent auditors or had any disagreements with them concerning accounting matters and financial statement disclosures within the last 24 months.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the Company's directors and executive officers is located in the following chart:\nBusiness Experience and Positions Held Name Age With the Company and Affiliates\nM. E. Benefield 56 Vice President, Gas Supply, May 1992; Vice President, Planning and Corporate Development, Questar (March 1989 to May 1992.)\nR. D. Cash 53 Director, May 1977; Chairman of the Board, May 1985; Director, President and Chief Executive Officer, Questar, May 1984; Chairman of the Board, Questar, May 1985. Director, Zions First National Bank and Zions Bancorporation, Associated Electric and Gas Insurance Services Limited, and a member of the Board of Directors of the Federal Reserve Bank (Salt Lake branch) of San Francisco; Trustee, Southern Utah University.\nSusan Glasmann 48 Vice President, Marketing, February 1994; General Manager, Marketing, April 1991 to February 1994; Manager, Corporate Communications, Questar, October 1989 to April 1991.\nRobert E. Kadlec 62 Director, March 1987; Director, Questar, March 1987; President and Chief Executive Officer, BC Gas Inc. (Vancouver, British Columbia) to December 1995; founder of Kadlec Holdings (investment and consulting firm); Director, BC Gas Inc., Trans Mountain Pipe Line Company Ltd., British Pacific Properties Ltd., and International Forest Products Limited, and Advisory Director, Andersen Consulting.\nDixie L. Leavitt 66 Director, May 1987; Director, Questar, May 1987; founder and Chairman of the Board, Leavitt Group Agency Association (a group of approximately 54 separate insurance agencies); President and Chairman of entities engaged in dairy, cattle, agriculture, and real estate operations in Utah and southern Nevada; Director, Zions First National Bank.\nGary G. Michael 55 Director, February 1994; Director, Questar, February 1994; Chairman and Chief Executive Officer, Albertson's; Director, Albertson's and of the Federal Reserve Bank of San Francisco.\nS. E. Parks 44 Vice President, Treasurer and Chief Financial Officer, Mountain Fuel and Questar, February 1996; Treasurer, Questar and Mountain Fuel, May 1984.\nD. N. Rose 51 President and Chief Executive Officer, October 1984; Director, May 1984; Executive Vice President, Questar, February 1996; Director, Questar, May 1984; Director, Key Bank of Utah; Trustee, Westminster College.\nG. H. Robinson 45 Vice President and Controller, April 1991; Vice President, Marketing, March 1985 to April 1991.\nS. C. Yeager 48 Vice President, Customer Service, April 1991; Vice President, Retail Operations, March 1985 to April 1991.\nExcept as otherwise indicated, the executive officers and directors have held the principal occupations described above for more than the past five years. There are no family relationships among the directors and executive officers of the Company. Directors of the Company are elected to serve three-year terms. Executive officers of the Company serve at the pleasure of the Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following Summary Compensation Table lists annual and long-term compensation earned by Mr. D. N. Rose, the Company's President and Chief Executive Officer, and the other four most highly compensated officers during 1993, 1994, and 1995:\nSummary Compensation Table\n1\/ Base salary amounts listed for Messrs. Robinson and Yeager for 1995 include lump-sum merit payouts that were received in lieu of base salary increases.\n2\/ Amounts listed under this heading are cash payments earned and discretionary bonuses awarded under the Annual Management Incentive Plans (AMIP) for the Company and Questar (for Mr. Cash). The amounts listed for Mr. Cash are the amounts allocated to Mountain Fuel.\n3\/ Amounts under this heading include the value (as of the grant date) of any restricted shares of Questar's common stock used in 1994, 1995 and 1996, in lieu of cash, as partial payment of bonuses earned under the Company's AMIP and the Company's allocated portion of the value of restricted shares granted to Mr. Cash under Questar's AMIP. All shares of restricted stock vest in two equal, annual installments occurring on the first business day in February of the first and second years following the grant date. Dividends are paid on the restricted shares at the same rate dividends are paid on other shares of Questar's common stock. As of year-end 1995, Mr. Rose had 1,928 shares of restricted stock having a market value of $64,558; Mr. Cash had 4,683 shares worth $156,881; Mr. Benefield had 851 shares worth $28,509; Messrs. Robinson and Yeager each had 808 shares worth $27,608.\n4\/ Mountain Fuel's executive officers are granted stock options to purchase shares of Questar's common stock under Questar's Long-Term Stock Incentive Plan.\n5\/ Amounts listed under this heading include employer matching and nonmatching contributions, matching contributions to the Deferred Share Plan, and directors' fees paid by the Company, and, for 1995 only, vacation buy-back pay. The figure opposite Mr. Rose's name for 1995 include $8,795 in contributions to the Employee Investment Plan, $8,853 in matching contributions to the Deferred Share Plan, $6,800 in director's fees, and $4,616 for unused vacation. The 1995 figure for Mr. Cash includes the Company's allocated portion of contributions to the Employee Investment Plan of $3,882, $6,800 in directors' fees paid by the Company, and the Company's allocated portion of contributions to the Deferred Share Plan of $10,834. The 1995 figure listed for Mr. Benefield includes $8,795 in contributions to the Employee Investment Plan and $1,589 in matching contributions to the Deferred Share Plan. The 1995 figure for Mr. Robinson includes $8,795 in contributions to the Employee Investment Plan and $1,087 in matching contributions to the Deferred Share Plan. The 1995 figure for Mr. Yeager includes $8,795 in contributions to the Employee Investment Plan, $1,087 in matching contributions to the Deferred Share Plan and $2,577 for unused vacation.\n6\/ Mr. Cash also serves as an executive officer of Questar and other affiliated companies. The base salary shown for Mr. Cash is the combination of the amount directly paid by the Company and the amount allocated to the Company.\nThe following table lists information concerning the stock options to purchase shares of Questar's common stock that were granted to Mountain Fuel's five highest paid officers during 1995 under Questar's Long-Term Stock Incentive Plan. No stock appreciation rights were granted during 1995.\nOption Grants in Last Fiscal Year\n1\/ These stock options vest in four annual, equal installments, with the first installment exercisable as of August 14, 1995. Participants can use cash or previously-owned shares as consideration for option shares. Options expire when a participant terminates his employment, unless termination is caused by an approved retirement, death, or disability. Options can be exercised for three months following a participant's approved retirement and 12 months following a participant's death or disability.\n2\/ When calculating the present value of options as of the date granted (February 14, 1995), Questar used the Black-Scholes option pricing model. Questar assumed a volatility of 20.81 percent, a risk free interest rate of 7.7 percent, a dividend yield of 4.16 percent and a vesting discount of 5.7 percent. The real value of the listed options depends upon the actual performance of Questar stock. There can be no assurance that the values shown in this table will be achieved.\nThe following table lists information concerning the options to purchase shares of Questar's common stock that were exercised by the officers named above during 1995 and the total options and their value held by each at year-end 1995:\nAggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year-End Options\/SAR Values\n1\/ The \"value\" is calculated by subtracting the fair market value of the shares purchased on the date of exercise minus the option price. The value is equal to the amount of ordinary income recognized by each officer. The current value of the shares may be higher or lower than the aggregate value reported in the table.\n2\/ Stock appreciation rights (SARs) have not been granted since February of 1989. At year-end 1995, there were no SARs outstanding.\nRetirement Plan\nCompany employees (including executive officers) participate in the employee benefit plans of Questar. The Company has agreed to pay its share of the costs associated with the plans that are described below. Questar maintains a noncontributory Retirement Plan that is funded actuarially and does not involve specific contributions for any one individual. The following table lists the estimated annual benefits payable under the Retirement Plan as of December 31, 1995, and, if necessary, the Supplemental Executive Retirement Plan (the SERP). The benefits shown are based on earnings and years of service reaching normal retirement age of 65 in 1995 and do not include Social Security benefits. Benefits under the Retirement Plan are not reduced or offset by Social Security benefits.\nPENSION PLAN TABLE\nQuestar's Retirement Plan has a \"step rate\/excess\" benefit formula. The formula provides for a basic benefit that is calculated by multiplying the employee's final average earnings by a specified base benefit factor and by subsequently multiplying such sum by the employee's years of service (up to a maximum of 25). This basic benefit is increased for each year of service in excess of 25 and is reduced for retirement prior to age 62. Employees also receive a supplemental benefit calculated by multiplying the difference between the employee's final average earnings and his \"covered compensation\" by a supplemental factor that varies by age. (The term covered compensation refers to the 35-year average Social Security wage base tied to year of an employee's birth.) Employees who retire prior to age 62 also receive a temporary supplement that is tied to years of service until they are eligible to receive Social Security benefits at age 62.\nFederal tax laws impose limits on the amount of annual compensation that can be used when calculating benefits under qualified plans and on the amount of benefits that can be paid from such plans. The SERP, a nonqualified plan, was adopted in 1987 to compensate officers who are affected by these limits; it provides for retirement benefits equal to the difference between the benefits payable under the qualified Retirement Plan and the benefits that would be payable absent such limits. All of the officers listed in the table earn annual compensation in excess of the current cap of $150,000 and all of them have vested benefits under the SERP.\nThe \"final average earnings\" (average annual earnings for the last three years) for purposes of calculating retirement benefits for the executive officers named above in the table as of December 31, 1995, is as follows: $283,605 for Mr. Rose; $174,552 for Mr. Benefield; $162,750 for Mr. Robinson; and $162,250 for Mr. Yeager. (No figure is given for Mr. Cash because his final average earnings for purposes of the Retirement Plan and SERP would include compensation paid by the Company's affiliates.) (Mr. Benefield was eligible to participate in the early retirement program offered by the Company in the spring of 1995. As an eligible participant, he is eligible to receive the higher of his frozen benefit as of April 30, 1995, or his benefit earned under the Retirement Plan and SERP, when he does retire.) The officer's base salary, cash bonus payments, and value of restricted stock (paid in lieu of cash) reported in the Summary Compensation Table would be included in the calculation of the officer's final average earnings. The amounts reported in the Summary Compensation Table are somewhat different than the final average earnings because the latter figures include cash payments when made, not when earned, and the value of restricted stock when granted, not distributed. Dividends on the restricted shares are also included in the officer's final average earnings, but are not reported in the table. The years of credited service for the individuals listed in the compensation table are: 20 years for Mr. Cash; 27 years for Mr. Rose; 18 years for Mr. Benefield; 22 years for Mr. Robinson; and 20 years for Mr. Yeager.\nThe Company also participates in Questar's Executive Incentive Retirement Plan (the EIRP). Under the terms of this nonqualified plan, a participant will receive monthly payments upon retirement until death equal to 10 percent of the highest average monthly compensation (excluding incentive compensation) paid to the officer during any period of 36 consecutive months of employment. The plan also provides for a family benefit in the event of the death of an officer. Although not required to do so, Questar and its affiliates have purchased life insurance on the life of each participant, with Questar named as owner and beneficiary. The covered officers have no rights under or to such insurance policies. All of the Company's officers listed in the compensation table have been nominated to participate in the plan, have satisfied the 15 years of service requirement and have a vested right to receive benefits under the EIRP. The annual benefits payable to the named officers under this plan as of December 31, 1995, are as follows: Mr. Rose, $21,503; Mr. Benefield, $13,968 and Messrs. Robinson and Yeager, $13,154. (No figure is given for Mr. Cash because his compensation for purposes of calculating benefits under the EIRP would include compensation paid by the Company's affiliates.)\nAny benefits payable under the SERP are offset against payments from the EIRP. Consequently, an officer would not receive any benefits for the SERP unless his benefit under the EIRP was less than the difference between what he could be paid under Questar's Retirement Plan at the date of retirement and what he had earned under such plan absent federal tax limitations. Given this relationship between the two nonqualified plans, the amounts listed in the table above do not include benefits payable under the EIRP.\nExecutive Severance Compensation Plan\nQuestar has an Executive Severance Compensation Plan that covers the Company's executive officers. Under this plan, participants, following a change in control of Questar, are eligible to receive compensation equal to up to two years' salary and miscellaneous benefits upon a voluntary or involuntary termination of their employment, provided that they have continued working or agree to continue working for six months following a potential change in control of Questar. This plan was originally adopted in 1983 by Mountain Fuel and was assumed by Questar as of October 2, 1984. The plan also contains a provision that limits compensation and benefits payable under the plan to amounts that can be deducted under Section 280G of the Internal Revenue Code of 1986.\nThe dollar amounts payable to the Company's executive officers (based on current salaries paid by the Company) in the event of termination of employment following a change in control of Questar are as follows: $525,200 to Mr. Rose; $305,400 to Mr. Benefield; and $279,400 each to Messrs. Yeager and Robinson. (The amount payable to Mr. Cash is not given since such amount is based on each officer's total salary.) The Company's executive officers would also receive certain supplemental retirement benefits, welfare benefits, and cash bonuses.\nUnder the plan, a change in control is defined to include any change in control of Questar required to be reported under Item 6(e) of Schedule 14A of the Securities Exchange Act of 1934, as amended. A change in control is also deemed to occur once any person becomes the beneficial owner, directly or indirectly, of securities representing 15 percent or more of Questar's outstanding shares of common stock.\nDirectors' Fees\nAll directors receive an annual fee of $4,800 payable in 12 monthly installments and fees of $500 for each meeting of the Board of Directors that they attend.\nThe Company has a Deferred Compensation Plan for Directors under which directors can elect to defer all or any portion of the fees received for service as directors until their retirement from such service and can choose to have the deferred amounts earn interest as if invested in long-term certificates of deposit or be accounted for with \"phantom shares\" of Questar's common stock. Upon retirement, the phantom shares of stock are \"converted\" to their fair market cash equivalent. During 1995, several directors of the Company chose to defer receipt of all or a portion of the compensation earned by them for their service. (Any shares of phantom stock credited to directors are not included in the number of shares listed opposite their names below.)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company is a direct, wholly owned subsidiary of Questar. The following table sets forth information, as of December 31, 1995, with respect to each person known or believed by Questar to be the beneficial owner of 5 percent or more of its common stock:\nShares and Name and Nature of Address of Beneficial Percent Beneficial Owner Ownership of Class\nFirst Security Bank of Utah 4,072,485 10.0 N.A., 79 South Main Street Trustee for Salt Lake City, Utah 84111 Company Employee Benefit Plans and Bank1\n1\/ Of this total, First Security beneficially owns 3,971,820 shares in its role as trustee of employee benefit plans sponsored by Questar. Participating employees control the voting of such shares.\nThe following table sets forth information, as of March 1, 1996, concerning the shares of Questar's common stock beneficially owned by each of the Company's named executive officers and directors and by the Company's executive officers and directors as a group:\nShares Owned Percent of Name of Beneficial Owner Beneficially Outstanding Shares1\nDirectors Robert H. Bischoff 3,279 * R. D. Cash2,3,4,5,6 223,211 .55% W. Whitley Hawkins7 7,370 * Robert E. Kadlec7,8 14,750 * Dixie L. Leavitt6,7 18,863 * Gary G. Michael7 3,400 * D. N. Rose2,3,4 65,886 .16%\nNamed Executive Officers M. E. Benefield2,3,4 33,977 *1 G. H. Robinson2,3,4 30,339 *1 S. C. Yeager2,3,4 30,655 *1\nAll directors and executive503,645 1.2%1 officers (12 individuals)9\n1\/ Unless otherwise listed, the percentage of shares owned is less than .1 percent. The percentages of beneficial ownership have been calculated in accordance with Rule 13d-3(d)(1) under the Securities Exchange Act of 1934, as amended.\n2\/ The Company's executive officers own shares through their participation in Questar's Employee Investment Plan. The number of shares owned through this plan as of December 31, 1995, is as follows for the named officers: Mr. Benefield, 4,631; Mr. Cash, 29,550; Mr. Robinson, 7,747; Mr. Rose, 15,814; and Mr. Yeager, 8,551.\n3\/ The Company's executive officers have been granted nonqualified stock options under Questar's Stock Option Plan and Long-Term Stock Incentive Plan. The number of shares listed opposite the named officers attributable to vested options as of March 1, 1996, is as follows: Mr. Benefield, 15,500; Mr. Cash, 69,373; Mr. Robinson, 15,500; Mr. Rose, 28,500; and Mr. Yeager, 13,500.\n4\/ The Company's executive officers acquired restricted shares of Questar's common stock in partial payment of bonuses earned in the 1994 and 1995 bonus plans. The number of restricted shares beneficially owned by each of the named officers as of March 1, 1996, is as follows: Mr. Benefield, 632; Mr. Cash, 2,327; Mr. Robinson, 603; Mr. Rose, 1,485; and Mr. Yeager, 603.\n5\/ Mr. Cash is the Chairman of the Board of Trustees of the Questar Corporation Educational Foundation and the Questar Corporation Arts Foundation, two nonprofit corporations that own an aggregate of 42,596 shares of Questar's common stock. As the Chairman, Mr. Cash has voting control for such shares, but disclaims any beneficial ownership of them.\n6\/ Of the total shares reported for Mr. Cash, 3,270 shares are owned jointly with his wife and 4,899 are controlled by him as custodian for his son. Messrs. Leavitt and Yeager own their shares of record with their respective wives.\n7\/ Messrs. Hawkins, Kadlec, Leavitt, and Michael, as nonemployee voting directors of Questar, have been granted nonqualified stock options to purchase shares of Questar's common stock as follows: Mr. Hawkins, 7,150 shares; Mr. Kadlec, 11,150 shares; Mr. Leavitt, 7,000 shares, and Mr. Michael, 2,100 shares. These shares are included in the numbers listed opposite their respective names.\n8\/ Mr. Kadlec's wife owns 200 shares of common stock. Mr. Kadlec has voting control and investment control over such shares. Such shares are included in the shares listed opposite his name.\n9\/ The total number of shares reported for this group includes vested options to purchase 207,648 shares of Questar's common stock.\nCommittee Interlocks and Insider Participation\nThe Company itself has no formal \"Compensation Committee.\" Questar's Board of Directors has a Management Performance Committee that makes recommendations to the Company's Board of Directors concerning base salary and bonus payments. (Questar's Board approves all stock options.) Messrs. Cash and Rose, as directors and officers of the Company, are formally excused from all discussions by the Company's Board involving their compensation.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no relationships or transactions involving the Company's directors and executive officers.\nAs described above, there are significant business relationships between the Company and its affiliates, particularly Wexpro and Questar Pipeline. Questar, the Company's parent, also provides certain administrative services, e.g., personnel, legal, public relations, financial, tax, and audit to the Company and other members of the consolidated group. The costs of performing such services are allocated to the Company. Questar InfoComm, another affiliate, provides data processing and communication services for the Company; the charges for such services are based on cost of service plus a specified return on assets.\nSee Note H to the financial statements for additional information concerning transactions between the Company and its affiliates.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1)(2) Financial Statements and Financial Statement Schedules. The financial statements identified in the List of Financial Statements are filed as part of this report.\n(3) Exhibits. The following is a list of exhibits required to be filed as a part of this report in Item 14(c).\nExhibit No. Exhibit\n3.1.* Restated Consolidated Articles of Incorporation dated August 15, 1980. (Exhibit No. 4(a) to Registration Statement No. 2-70087, filed December 1, 1980.)\n3.2.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1982. (Exhibit No. 3(b) to Form 10-K Annual Report for 1982.)\n3.3.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 10, 1983. (Included in Exhibit No. 4.1. to Registration Statement No. 2-84713, filed June 23, 1983.)\n3.4.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated August 16, 1983. (Exhibit No. 3(a) to Form 8 Report amending the Company's Form 10-Q Report for Quarter Ended September 30, 1983.)\n3.5.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated October 26, 1984. (Exhibit No. 3.5. to Form 10-K Annual Report for 1984.)\n3.6.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1985. (Exhibit No. 3.1. to Form 10-Q Report for Quarter Ended June 30, 1985.)\n3.7.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated February 10, 1988. (Exhibit No. 3.7. to Form 10-K Annual Report for 1987.)\n3.8.* Bylaws (as amended effective August 11, 1992). (Exhibit No. 3.8. to Form 10-K Annual Report for 1992.)\n4.* Indenture dated as of May 1, 1992, between the Company and Citibank, as trustee, for the Company's Debt Securities. (Exhibit No. 4. to Form 10-Q Report for Quarter Ended June 30, 1992.)\n10.1.* Stipulations and Agreement, dated October 14, 1981, executed by Mountain Fuel Supply Company; Wexpro Company; the Utah Department of Business Regulations, Division of Public Utilities; the Utah Committee of Consumer Services; and the staff of the Public Service Commission of Wyoming. (Exhibit No. 10(a) to Form 10-K Annual Report for 1981.)\n10.7.* Data Processing Services Agreement effective July 1, 1985, between Questar Service Corporation and Mountain Fuel Supply Company. (Exhibit 10.7. to Form 10-K Annual Report for 1988.)\n10.8.1 Mountain Fuel Supply Company Annual Management Incentive Plan as amended and restated effective February 13, 1996.\n10.9.*1 Mountain Fuel Supply Company Window Period Supplemental Executive Retirement Plan effective January 24, 1991. (Exhibit No. 10.9. to Form 10-K Annual Report for 1990.)\n10.10.1 Mountain Fuel Supply Company Deferred Compensation Plan for Directors as amended and restated effective February 13, 1996.\n10.11.* Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Pipeline Company effective September 1, 1993.\n25. Power of Attorney.\n27. Financial Data Schedule. _______________________ *Exhibits so marked have been filed with the Securities and Exchange Commission as part of the referenced filing and are incorporated herein by reference.\n1 Exhibits so marked are management contracts or compensation plans or arrangements.\n(b) Mountain Fuel did not file any Current Reports on Form 8-K during the last quarter of 1995.\nANNUAL REPORT ON FORM 10-K\nITEM 8. ITEM 14 (a) (1) and (2), (c) and (d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nYEAR ENDED DECEMBER 31, 1995\nMOUNTAIN FUEL SUPPLY COMPANY\nSALT LAKE CITY, UTAH\nFORM 10-K--ITEM 14 (a) (1) and (2)\nMOUNTAIN FUEL SUPPLY COMPANY\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following financial statements of Mountain Fuel Supply Company are included in Item 8:\nStatements of income -- Years ended December 31, 1995, 1994 and\nBalance sheets -- December 31, 1995 and 1994\nStatements of common shareholder's equity -- Years ended December 31, 1995, 1994 and 1993\nStatements of cash flows -- Years ended December 31, 1995, 1994 and\nNotes to financial statements\nFinancial 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.\nReport of Independent Auditors\nBoard of Directors Mountain Fuel Supply Company\nWe have audited the balance sheets of Mountain Fuel Supply Company as of December 31, 1995 and 1994, and the related statements of income, common shareholder's 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 Mountain Fuel Supply 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.\nAs discussed in Note G to the financial statements, Mountain Fuel Supply Company changed its method of accounting for postemployment benefits in 1994.\nERNST & YOUNG LLP\nSalt Lake City, Utah February 9, 1996\nMOUNTAIN FUEL SUPPLY COMPANY STATEMENTS OF INCOME\nSee notes to financial statements.\nMOUNTAIN FUEL SUPPLY COMPANY BALANCE SHEETS\nASSETS\nLIABILITIES AND SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nMOUNTAIN FUEL SUPPLY COMPANY STATEMENTS OF COMMON SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nMOUNTAIN FUEL SUPPLY COMPANY STATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nMOUNTAIN FUEL SUPPLY COMPANY NOTES TO FINANCIAL STATEMENTS\nNote A - Summary of Accounting Policies\nMountain Fuel Supply Company (the Company or Mountain Fuel) is a wholly-owned subsidiary of Questar Corporation (Questar).\nBusiness and Regulation: The Company's business consists of natural gas distribution operations for residential, commercial and industrial customers. Mountain Fuel is regulated by the Public Service Commission of Utah (PSCU) and the Public Service Commission of Wyoming (PSCW). While Mountain Fuel also serves a small area of southeastern Idaho, the Idaho Public Service Commission has deferred to the PSCU for rate oversight of this area. These regulatory agencies establish rates for the sale and transportation of natural gas. The regulatory agencies also regulate, among other things, the extension and enlargement or abandonment of jurisdictional natural gas facilities. Regulation is intended to permit the recovery, through rates, of the cost of service including, a rate of return on investment.\nThe financial statements are presented in accordance with regulatory requirements. Methods of allocating costs to time periods, in order to match revenues and expenses, may differ from those of nonregulated businesses because of cost-allocation methods used in establishing rates.\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 of assets and liabilities and disclosure of contingent liabilities reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nRevenue Recognition: Revenues are recognized in the period that services are provided or products are delivered. Mountain Fuel accrues gas distribution revenues for gas delivered to residential and commercial customers but not billed at the end of the accounting period. Mountain Fuel periodically collects revenues subject to possible refund pending final orders from regulatory agencies. In these situations the Company establishes reserves for revenues collected subject to refund.\nPurchased-Gas Adjustments: Mountain Fuel accounts for purchased-gas costs in accordance with procedures authorized by the PSCU and PSCW whereby purchased-gas costs that are different from those provided for in the present rates are accumulated and recovered or credited through future rate changes.\nProperty, Plant and Equipment: Property, plant and equipment are stated at cost. The provision for depreciation and amortization is based upon rates which will amortize costs of assets over their estimated useful lives. The costs of natural gas distribution property, plant and equipment, excluding gas wells, are amortized using the straight-line method ranging from 3% to 33% per year and averaging 3.9% in 1995. The costs of gas wells were amortized using the units-of-production method at $.17 per Mcf of natural gas production during 1995. 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 Company will adopt Statement No. 121 in 1996 and does not expect a significant effect to either operating results or financial postion.\nCredit Risk: The Company's primary market area is the Rocky Mountain region of the United States. The Company's exposure to credit risk may be impacted by the concentration of customers in this region due to changes in economic or other conditions. The Company's customers include individuals and numerous industries that may be affected differently by changing conditions. Management believes that its credit-review procedures, loss reserves and customer deposits have adequately provided for usual and customary credit-related losses. The carrying amount of trade receivables approximates fair value.\nIncome Taxes: Mountain Fuel records cumulative increases in deferred taxes as income taxes recoverable from customers. The Company has adopted procedures with its regulatory commissions to include under-provided deferred taxes in customer rates on a systematic basis. Mountain Fuel uses the deferral method to account for investment tax credits as required by regulatory commissions. The Company's operations are consolidated with those of Questar and its subsidiaries for income tax purposes. The income tax arrangement between Mountain Fuel and Questar provides that amounts paid to or received from Questar are substantially the same as would be paid or received by the Company if it filed a separate return. Mountain Fuel also receives payment for tax benefits used in the consolidated tax return even if such benefits would not have been usable had the Company filed a separate return.\nReacquisition of Debt: Gains and losses on the reacquisition of debt are deferred and amortized as debt expense over the life of the replacement debt in order to match regulatory treatment.\nAllowance for Funds Used During Construction: The Company capitalizes the cost of capital during the construction period of plant and equipment using a method required by regulatory authorities. This amounted to $391,000 in 1995, $397,000 in 1994 and $528,000 in 1993.\nCash and Short-Term Investments: Short-term investments consist principally of Euro-time deposits and repurchase agreements with maturities of three months or less.\nNote B - Debt\nThe Company has a short-term line-of-credit arrangement with a bank under which it may borrow up to $500,000. The line has interest rates generally below the prime interest rate and is renewable on an annual basis. No amount was borrowed under this arrangement at either December 31, 1995 or 1994. Questar loans funds to the Company under a short-term borrowing arrangement. Outstanding short-term notes payable to Questar totaled $56,100,000 with an interest rate of 6.01% at December 31, 1995 and $53,500,000 with an interest rate of 6.11% at December 31, 1994.\nMountain Fuel's long-term debt consists of medium-term notes with interest rates ranging from 7.19% to 8.43%, due 2007 to 2024. There are no maturities of long-term debt for the five years following December 31, 1995 and no long-term debt provisions restricting the payment of dividends. Cash paid for interest was $16,458,000 in 1995, $15,290,000 in 1994 and $14,698,000 in 1993.\nNote C - Redeemable Cumulative Preferred Stock\nMountain Fuel has authorized 4,000,000 shares of nonvoting redeemable cumulative preferred stock with no par value, but a stated and redemption value of $100 per share. During 1995, the remaining shares of the $8.625 series were fully redeemed.\nRedemption requirements for the five years following December 31, 1995, are as follows: (In Thousands)\n1996 $97 1997 180 1998 180 1999 180 2000 180\nNote D - Financial Instruments\nThe carrying amounts and estimated fair values of the Company's financial instruments were as follows:\nThe Company used the following methods and assumptions in estimating fair values: (1) Cash and short-term investments - the carrying amount approximates fair value; (2) Short-term loans - the carrying amount approximates fair value; (3) Long-term debt - the fair value of the medium-term notes is based on the discounted present value of cash flows using the Company's current borrowing rates; (4) Redeemable cumulative preferred stock - the fair value is based on the discounted present value of cash flows using current preferred stock rates. Fair value is calculated at a point in time and does not represent what the Company would pay to retire the debt securities.\nNote E - Income Taxes\nThe components of income taxes were as follows:\nThe difference between income tax expense and the tax computed by applying the statutory federal income tax rate to income before income taxes is explained as follows:\nSignificant components of the Company's deferred tax liabilities and assets were as follows:\nCash paid for income taxes was $7,333,000 in 1995, $6,404,000 in 1994 and $8,631,000 in 1993.\nNote F - Rate Matters, Litigation and Commitments\nOn August 11, 1995, the PSCU approved a settlement of Mountain Fuel's general rate case filed April 13, 1995. Mountain Fuel received a $3.7 million increase in revenues. The settlement, which became effective September 1, allowed the Company to implement a weather normalization adjustment, provided about $2 million in additional revenues through a new-premises fee and added about $1.7 million from sharing capacity-release revenues. The settlement did not specify an authorized return on equity, but Mountain Fuel's allowed return on rate base increased from 10.08% to between 10.22% and 10.34%.\nIn December 1995, Mountain Fuel requested approval from the PSCU to make a lump sum refund of gas costs to Utah customers. The PSCU agreed with the procedure and the refund appeared as a credit on customers' February 1996 gas bills. A surplus of gas costs collected in 1995 led to the refund. The lump-sum refund was chosen as a mechanism to more quickly credit customers' accounts. Normally, amortization of either over-or under-collected gas costs requires about 12 months.\nMountain Fuel's Utah gas cost pass-through application was approved on an interim basis effective January 1, 1996. In connection with the application, the Utah Division of Public Utilities has raised issues about continuing to treat gathering costs as pass-through costs and about the reasonableness of such costs. The Company believes that its gathering costs are reasonable. The Committee of Consumer Services has requested additional information concerning a gas imbalance and may decide to raise the issue in the proceedings.\nIn 1993, Mountain Fuel began accruing revenues for gas delivered to residential and commercial customers but not billed at the end of the year. The impact of these accruals on the income statement has been deferred and is being recognized at the rate of $2,011,000 per year over a five-year period beginning in 1994 in accordance with a rate order received from the PSCU. This rate order also reduces customer rates by $2,011,000 per year over the same five-year period. In addition, Mountain Fuel recorded other income of $5,589,000 for a one-time reduction of gas costs associated with these unbilled revenues. This transaction resulted in additional net income of about $3.5 million in 1994.\nEach year, Mountain Fuel purchases significant quantities of natural gas under numerous gas- purchase contracts with varying terms and conditions. Purchases under these agreements totalled $44,892,000 in 1995, $73,682,000 in 1994 and $85,909,000 in 1993. Some of the agreements have terms that obligate Mountain Fuel to purchase specific quantities on a periodic basis into the future, while a few contracts have take-or-pay provisions that obligate Mountain Fuel to take delivery of a minimum amount of gas on an annual basis.\nProjected natural gas purchase commitments for the next five years are reported in the table below. These commitments are based upon current market conditions. Future changes will occur as a result of negotiations with suppliers and changes in market conditions.\n(In Millions)\n1996 $17.0 1997 2.0 1998 2.0 1999 2.1 2000 2.2\nThe Company has received notice that it may be partially liable in several environmental clean-up actions on sites that involve numerous other parties. Management believes that the Company's responsibility for remediation will be minor and that any potential liability will not be significant to its results of operations, financial position or liquidity.\nMountain Fuel, as a result of acquiring Questar Pipeline's gas purchase contracts, is responsible for any judgment rendered against Questar Pipeline in a lawsuit that was tried before a jury in 1994. The jury awarded an independent producer compensatory damages of approximately $6.1 million and punitive damages of $200,000 on his claims. The producer's counterclaims originally exceeded $57 million, but were reduced to less than $10 million, when the presiding judge dismissed with prejudice some of the claims prior to the jury trial. Under existing PSCU rulings, any payments resulting from this judgment will be included in Mountain Fuel's gas balancing account an recovered in its rates for natural gas service.\nThere are various legal proceedings against the Company. While it is not currently possible to predict or determine the outcome of these proceedings, it is the opinion of management that the outcome will not have a material adverse effect on the Company's results of operations, financial position or liquidity.\nNote G - Employee Benefits\nPension Plan: Substantially all Company employees are covered by Questar's defined benefit pension plan. Benefits are generally based on years of service and the employee's 36-month period of highest earnings during the ten years preceding retirement. It is Questar's policy to make contributions to the plan at least sufficient to meet the minimum funding requirements of applicable laws and regulations. Plan assets consist principally of equity securities and corporate and U.S. government debt obligations. Pension cost was $3,352,000 in 1995, $2,962,000 in 1994 and $3,251,000 in 1993.\nMountain Fuel's portion of plan assets and benefit obligations is not determinable because the plan assets are not segregated or restricted to meet the Company's pension obligations. If the Company were to withdraw from the pension plan, the pension obligation for the Company's employees would be retained by the pension plan. At December 31, 1995, Questar's fair value of plan assets exceeded the accumulated benefit obligation.\nPostretirement Benefits Other Than Pensions: The Company pays a portion of the health-care costs and all the life insurance costs for employees who retired prior to January 1, 1993. The plan was changed for employees retiring after January 1, 1993, to link the health-care benefit to years of service and to limit the Company's monthly health-care contribution per individual to 170% of the 1992 contribution. Employees hired after December 31, 1996, will not qualify for benefits under this plan. The Company's policy is to fund amounts allowable for tax deduction under the Internal Revenue Code. Plan assets consist of equity securities, corporate and U.S. government debt obligations, and insurance company general accounts. The Company is amortizing the transition obligation over a 20-year period. Total costs of postretirement benefits other than pensions were $3,183,000 in 1995, $3,584,000 in 1994 and $3,350,000 in 1993. Both the PSCU and the PSCW allowed Mountain Fuel to recover future costs if the amounts are funded in an external trust.\nThe Company's portion of plan assets and benefit obligations related to postretirement medical and life insurance benefits is not determinable because the plan assets are not segregated or restricted to meet the Company's obligations.\nPostemployment Benefits: The Company recognizes the net present value of the liability for postemployment benefits, such as long-term disability benefits and health care and life insurance costs, when employees become eligible for such benefits. Postemployment benefits are paid to former employees after employment has been terminated but before retirement benefits are paid. The Company accrues both current and future costs. The PSCU and the PSCW have allowed Mountain Fuel to recover postemployment costs through December 31, 1994 in future rates. At December 31, 1995, the Company had a $935,000 regulatory asset that it is amortizing over the next nine years.\nEmployee Investment Plan: The Company participates in Questar's Employee Investment Plan (ESOP), which allows eligible employees to purchase Questar Corporation common stock or other investments through payroll deduction. The Company makes contributions of Questar Corporation common stock to the ESOP of approximately 75% of the employees' purchases and contributes an additional $200 of common stock in the name of each eligible employee. The Company's expense and contribution to the plan was $1,622,000 in 1995, $1,542,000 in 1994 and $1,435,000 in 1993.\nNote H - Related Party Transactions\nWexpro, an affiliated company, operates certain properties owned by Mountain Fuel under the terms of the Wexpro Settlement Agreement. The Company receives a portion of Wexpro's income from oil operations after recovery of Wexpro's operating expenses and a return on investment. This amount, which is included in revenues, was $3,400,000 in 1995, $3,391,000 in 1994 and $1,028,000 in 1993. The Company paid Wexpro for the operation of Company-owned gas properties. These costs are included in natural gas purchases and amounted to $59,831,000 in 1995, $57,870,000 in 1994 and $49,595,000 in 1993.\nMountain Fuel purchased gas from Questar Pipeline amounting to $81,813,000 in 1993. The Company did not purchase gas from Questar Pipeline subsequent to September 1, 1993 when Questar Pipeline began operating in accordance with FERC Order No. 636. Also included in natural gas purchases are amounts paid to Questar Pipeline for the transportation, storage and gathering of Company-owned gas and purchased gas. These costs were $69,950,000 in 1995, $70,945,000 in 1994 and $38,862,000 in 1993.\nMountain Fuel has reserved transportation capacity on Questar Pipeline's system of approximately 800,000 decatherms per day and pays an annual demand charge of approximately $49.4 million for this reservation. Mountain Fuel releases excess capacity to its industrial transportation or other customers and receives a credit from Questar Pipeline for the released-capacity revenues and a portion of Questar Pipeline's interruptible-transportation revenues.\nQuestar InfoComm Inc. is an affiliated company that provides data processing and communication services to Mountain Fuel. The Company paid Questar InfoComm $15,781,000 in 1995, $15,996,000 in 1994 and $14,847,000 in 1993.\nQuestar charges Mountain Fuel for certain administrative functions amounting to $5,283,000 in 1995, $5,814,000 in 1994 and $5,609,000 in 1993. These costs are included in operating and maintenance expenses and are allocated based on each affiliated company's proportional share of revenues less gas costs; property, plant and equipment; and labor costs. Management believes that the allocation method is reasonable.\nThe Company received interest income from affiliated companies of $10,000 in 1995, $225,000 in 1994 and $327,000 in 1993. The Company had debt expense to affiliated companies of $1,273,000 in 1995, $134,000 in 1994, and $21,000 in 1993.\nNote I - Oil and Gas Producing Activities (Unaudited)\nThe following information discusses the Company's oil and gas producing activities. All of the properties are cost-of-service properties with the return on investment established by state regulatory agencies. Mountain Fuel has not incurred any costs for oil and gas producing activities for the three years ended December 31, 1995. Wexpro develops and produces gas reserves owned by the Company. See Note I for the amounts paid by Mountain Fuel to Wexpro.\nEstimated Quantities of Proved Oil and Gas Reserves: The following estimates were made by Questar's reservoir engineers. Reserve estimates are based on a complex and highly interpretive process which is subject to continuous revision as additional production and development drilling information becomes available. The quantities are based on existing economic and operating conditions using current prices and operating costs. All oil and gas reserves reported are located in the United States. Mountain Fuel does not have any long-term supply contracts with foreign governments or reserves of equity investees. No estimates are available for proved undeveloped reserves that may exist.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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.\nMOUNTAIN FUEL SUPPLY COMPANY (Registrant)\nBy \/s\/ D. N. Rose D. N. Rose 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\/ D. N. Rose President and Chief Executive D. N. Rose Officer; Director (Principal Executive Officer)\n\/s\/ S. E. Parks Vice President, Treasurer and Chief S. E. Parks Financial Officer (Principal Financial Officer)\n\/s\/ G. H. Robinson Vice President and Controller G. H. Robinson (Principal Accounting Officer)\n*Robert H. Bischoff Director *R. D. Cash Chairman of the Board *W. Whitley Hawkins Director *Robert E. Kadlec Director *Dixie L. Leavitt Director *Gary G. Michael Director *D. N. Rose Director\nMarch 27, 1996 *By \/s\/ D. N. Rose Date D. N. Rose, Attorney in Fact\nEXHIBIT INDEX\nExhibit Number Exhibit\n3.1.* Restated Consolidated Articles of Incorporation dated August 15, 1980. (Exhibit No. 4(a) to Registration Statement No. 2-70087, filed December 1, 1980.)\n3.2.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1982. (Exhibit No. 3(b) to Form 10-K Annual Report for 1982.)\n3.3.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 10, 1983. (Included in Exhibit No. 4.1. to Registration Statement No. 2-84713, filed June 23, 1983.)\n3.4.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated August 16, 1983. (Exhibit No. 3(a) to Form 8 Report amending the Company's Form 10-Q Report for Quarter Ended September 30, 1983.)\n3.5.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated October 26, 1984. (Exhibit No. 3.5. to Form 10-K Annual Report for 1984.)\n3.6.* Certificate of Amendment to Restated Consolidated Articles of Incorporation dated May 13, 1985. (Exhibit No. 3.1. to Form 10-Q Report for Quarter Ended June 30, 1985.)\n3.7.* Articles of Amendment to Restated Consolidated Articles of Incorporation dated February 10, 1988. (Exhibit No. 3.7. to Form 10-K Annual Report for 1987.)\n3.8.* Bylaws (as amended effective August 11, 1992). (Exhibit No. 3.8. to Form 10-K Annual Report for 1992.)\n4.* Indenture dated as of May 1, 1992, between the Company and Citibank, as trustee, for the Company's Debt Securities. (Exhibit No. 4. to Form 10-Q Report for Quarter Ended June 30, 1992.)\n10.1.* Stipulations and Agreement, dated October 14, 1981, executed by Mountain Fuel Supply Company; Wexpro Company; the Utah Department of Business Regulations, Division of Public Utilities; the Utah Committee of Consumer Services; and the staff of the Public Service Commission of Wyoming. (Exhibit No. 10(a) to Form 10-K Annual Report for 1981.)\n10.7.* Data Processing Services Agreement effective July 1, 1985, between Questar Service Corporation and Mountain Fuel Supply Company. (Exhibit 10.7. to Form 10-K Annual Report for 1988.)\n10.8.1 Mountain Fuel Supply Company Annual Management Incentive Plan as amended and restated effective February 13, 1996.\n10.9.*1 Mountain Fuel Supply Company Window Period Supplemental Executive Retirement Plan effective January 24, 1991. (Exhibit No. 10.9. to Form 10-K Annual Report for 1990.)\n10.10.1 Mountain Fuel Supply Company Deferred Compensation Plan for Directors as amended and restated effective February 13, 1996.\n10.11.* Gas Gathering Agreement between Mountain Fuel Supply Company and Questar Pipeline Company effective September 1, 1993.\n25. Power of Attorney.\n27. Financial Data Schedule. _______________________ *Exhibits so marked have been filed with the Securities and Exchange Commission as part of the referenced filing and are incorporated herein by reference.\n1 Exhibits so marked are management contracts or compensation plans or arrangements.","section_15":""}
{"filename":"318378_1995.txt","cik":"318378","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nBancTec Inc., a Delaware corporation, (\"BancTec\" or the \"Company\") is a leading provider of electronic and document-based financial transaction processing systems, application software and support services. The Company develops products for banking, financial services, insurance, government, utility, telecommunications, retail and other industries. In addition, BancTec designs and manufactures document processing hardware and scanners for value added resellers (\"VARs\") and original equipment manufacturer (\"OEM\") customers and provides network support services to users of local area networks (\"LANs\") and personal computers (\"PCs\"). Unless otherwise indicated, all further references to BancTec or the Company shall include its wholly owned subsidiaries and the ScanData and Servibanca joint ventures.\nBANCTEC PRODUCTS\nThe Company targets its products to specific market segments where it believes it has certain competitive advantages and can maintain or achieve a leadership position.\nSYSTEMS SOLUTIONS, SOFTWARE PRODUCTS AND EQUIPMENT. In fiscal year 1995, the Company derived approximately 56% of its revenues from sales of the following products:\nIMAGING SYSTEMS. BancTec offers image-based products which are used to process a variety of financial and full-page documents. The Company's ImageFIRST(R) product family provides solutions for financial document processing requirements. Remittance payment processors utilize ImageFIRST to capture, digitize and process check and other document images, including utility, telephone, retail and credit card bills, mortgage coupons and tax notices. ImageFIRST systems are also used worldwide to process sales drafts, European giro documents, coupons and many other types of financial documents.\nThe Company's imaging systems may also be used by banks for high volume check processing applications such as proof of deposit (\"POD\") and image statement preparation. Other BancTec products provide image-based solutions for rejected check repair, enabling financial institutions that handle large volumes of checks to more efficiently reprocess items which have been rejected in normal operating cycles.\nIn fiscal 1995, BancTec introduced ImageFIRST OpenArchive, an advanced product designed specifically for high speed archiving of financial document images and related transaction data. ImageFIRST OpenArchive contains a multi-tiered archival system that utilizes magnetic disks, optical disks and various tape cartridge technologies for high volume image storage. Images are routed over standard Ethernet connections using TCP\/IP protocol, and are displayed on industry standard PCs using the Microsoft Windows(R) operating system. The ImageFIRST Open Archive product is used by document processors to substantially increase productivity and improve customer service capabilities.\nThe Company's financial imaging products utilize an Open Systems Architecture (\"OSA\") platform which enables customers to easily add industry standard hardware and\/or software components to further improve processing capabilities. Development of OSA-based products has given BancTec an excellent competitive position with respect to financial document processing in the United States, Canadian, European and Australian markets.\nBancTec also offers products for a variety of full-page document imaging applications. The DocuScan(R) 2000 and 4000 series products utilize photo- optical technology, gray scale capture capabilities, image character recognition software and high-precision document transports to scan and digitize a variety of full-sized business documents. In addition, the Company provides systems solutions utilizing Computer Output to Laser Disk (\"COLD\") technology to electronically archive computer-generated documents such as invoices, statements and business forms on optical disks. In fiscal 1995, BancTec\nintroduced ImageFIRST Office, an Integrated Document Management Product that combines BancTec's advanced scanning systems, an open systems architecture, the Microsoft Windows operating system, and industry standard hardware, software and peripheral components. With ImageFIRST Office, companies and financial institutions have the ability to efficiently create, organize, annotate, route and store digitized images of all types of business documents.\nDOCUMENT PROCESSING SYSTEMS, CHECK SORTING SYSTEMS AND ELECTRONIC COMPONENTS. The 9400 Document Processing System is utilized for remittance and\/or sales draft applications by financial transaction processors that require automation but do not require high-speed image-based systems. By accelerating the processing of payments, customers are able to improve their cash flow and maximize funds availability. The system can operate as a stand-alone device or in a clustered environment with a LAN and data concentrator.\nThe 4300 Document Processing System is used by financial institutions to re-encode and re-introduce repaired documents into the check processing cycle. The 4300 can be configured as a PC-driven stand-alone device or a multi-application controller-based system. With the controller option, the 4300 can also process other types of documents, such as remittances and sales drafts.\nThe Company also offers low, medium and high-speed document reader\/sorters and related components that read magnetic ink character recognition (\"MICR\") and optical character recognition (\"OCR\") data from financial documents and sorts them according to patterns established by the user. BancTec markets these products directly to its customers and to various systems providers throughout the world.\nBancTec markets the Transaction Processing System (\"TPS\"), which utilizes reader\/sorters and application software to perform check clearing for large financial institutions in the United Kingdom, Ireland and India.\nComponents such as microfilm cameras, microfilm modules, image cameras, MICR encoders, ink jet printers and various peripheral equipment are also manufactured and marketed by the Company.\nINTEGRATED CORE PROCESSING AND BANK AUTOMATION SOFTWARE PRODUCTS. The Company provides Banker-II(R), ACCESS(TM) and PODExpress(R) products to community banks. Banker II and ACCESS are core processing software products which integrate check sorting, platform automation, loan processing, deposit management, ATM and teller processing and other bank operations activities. PODExpress combines PC and UNIX-based software products with the Company's reader\/sorters to provide solutions for proof-of-deposit and other check sorting applications. Community banks use BancTec's software products to improve operational efficiency and to compete effectively with larger institutions.\nELECTRONIC PAYMENT PROCESSING PRODUCTS. BancTec markets software products for electronic credit, debit and courtesy card processing, electronic check authorization, inventory management and other electronic funds transfer (\"EFT\") and point of sale (\"POS\") applications. The Company's products enable retailers to process consumers' electronic transactions in-lane, in- store, at the main office or at the electronic payment switch. BancTec also markets software products relating to electronic benefits transfer (\"EBT\") applications. EBT software products are currently being implemented by various U.S. and state governmental agencies to reduce fraud and increase efficiency in government-sponsored benefit payment programs.\nSUPPORT PRODUCTS AND CONSUMABLE SUPPLIES. The Company utilizes its telemarketing organization to distribute document processing supplies and related products that are a source of recurring revenue. BancTec's CheckMender(R), HeatStrip(R) and BancStrip(R) are used by banks to re- encode checks which cannot be read by traditional check sorting equipment. The Company's CheckMender automatically applies HeatStrip material to the bottom edge of checks which have been damaged, have missing or erroneous information or are otherwise unreadable. BancTec also provides encoding ribbons, microfilm, ink rollers and other consumable supplies that are used with the Company's document processing equipment. During fiscal 1995, BancTec introduced the CheckMender IV(R) product, which offers several operational improvements over previous CheckMender models.\nBancTec generally warrants its equipment and software products sold directly to end-users for 30 days from the date of installation and its OEM products sold to systems providers for 90 days from the date of shipment.\nNETWORK SERVICES AND EQUIPMENT MAINTENANCE. The Company derived approximately 44% of its revenue in fiscal 1995 from the following network services and equipment maintenance related products:\nNETWORK SERVICES AND PERSONAL COMPUTER SUPPORT. BancTec provides LAN and PC hardware support, systems integration services, asset management, help desk services and installation coordination to major companies. The Company's service engineers provide on-site or on-call support for file servers, personal computers, laptop computers, engineering document processing systems, printers and other peripheral equipment. BancTec also provides technical telephone support for Novell network operating systems software and is a U.S warranty service provider for Dell Computer Corp. and AST Research Inc.\nINSTALLATION AND MAINTENANCE OF BANCTEC PRODUCTS. A key aspect of BancTec's strategy of providing its customers with a total system solution is that the Company installs and maintains its own products. Standard maintenance contracts are available which specify type of service, hours of coverage and monthly rates. Contracts may also be tailored to meet the specific needs of individual customers. The Company's maintenance contracts typically include both parts and labor.\nTHIRD-PARTY SERVICE FOR OTHER DOCUMENT PROCESSING EQUIPMENT. BancTec provides hardware maintenance services for IBM 3890 and 3890 XP reader\/sorters, which are the primary transports for check sorting in many large banks. The Company also refurbishes and resells IBM 3890 and 3890 XP reader\/sorters to banks and bank service bureaus. The Company also provides hardware maintenance service for IBM 3800 printers.\nAt May 31, 1995, BancTec employed approximately 1,034 service engineers located in the United States, Canada, United Kingdom, Scandinavia, continental Europe and Australia.\nCHECK PROCESSING SERVICE BUREAU OPERATIONS. The Company also owns and operates three service bureau facilities that provide check and item processing services. The service bureaus utilize BancTec hardware, check processing software, operations personnel and maintenance services to process checks and related documents for financial institutions. The Company intends to continue to offer a variety of check-related services to U.S. community banks through its service bureau operations.\nSOFTWARE ENGINEERING\nThrough its staff of approximately 295 software engineers, the Company maintains standard system and application software products. In addition, the Company utilizes these software engineers to modify and enhance its standard application software products for customers in order to meet their particular operating requirements. Enhancements are generally paid by the customer under the terms of a sales contract. This software engineering activity is generally charged to cost of sales as incurred.\nPRODUCT DEVELOPMENT\nThe Company is engaged in ongoing development engineering activities in connection with new and existing products, employing as of May 31, 1995, approximately 83 persons for such activities.\nThe following table sets forth certain information regarding the Company's development engineering expenditures for the indicated fiscal years:\nThe Company also spent approximately $300,000, $994,000 and $851,000 in fiscal years 1995, 1994 and 1993, respectively, on engineering activities funded by customers relating to the development of new products and improvements of existing products.\nCurrent expenditures are concentrated on developing new applications for the Company's product lines and improving and expanding existing products, as described below:\nIMAGING SYSTEMS. The Company is currently developing methods of utilizing mathematical algorithms to enable document processing systems to automatically read and interpret the full handwritten \"legal amount\" found on standard checks. Other projects focus on the development of additional integrated image-based check processing software modules, the conversion of images between compression types in support of archiving and image interchange, various grayscale printing projects and the enhancement of current image-based document workflow software products.\nDOCUMENT PROCESSING SYSTEMS, CHECK SORTING SYSTEMS AND ELECTRONIC COMPONENTS. Development activity continues on low-cost, low-speed financial document transports for use at processing sites with modest volumes. Additional projects focus on the integration of Universal LAN Interchange technology (ULI) and standard PCs into the Company's non-image wholesale lockbox products. Other projects focus on integrating advanced laser printers into wholesale lockbox product configurations.\nINTEGRATED CORE PROCESSING AND BANK AUTOMATION SOFTWARE PRODUCTS. The Company continues to enhance its family of community bank-oriented integrated software products. Development activity continues on a \"next generation\" client\/server based core application processing product, which uses graphical user interfaces and the Microsoft Windows operating system to more efficiently process deposits and loans, generate management reports and coordinate community bank operations. Other products under development allow customers to transfer stored computer data into industry-standard relational data bases, facilitating the distribution of management information throughout an organization.\nELECTRONIC PAYMENT PROCESSING PRODUCTS. Several development projects are underway regarding the Company's EFT\/POS software products. These projects include an Open Systems switch product which allows electronic transaction information to flow across networks alongside other financial information. An additional project enhances the scalability of the Company's switch products, enabling them to be utilized by much larger retail customers. Other projects center around the generation of card production files and providing \"returns and refunds\" applications in Tandem environments.\nThere is no assurance that the Company's development efforts will result in successful commercial products. Many risks exist in developing new product concepts, adopting new technology and introducing new products to the market.\nSALES AND DISTRIBUTION\nThe Company's distribution strategy is to employ multiple sales channels to achieve the widest possible distribution of its products. The Company's products are sold to end-users, OEMs, VARs and systems integrators.\nDomestically, BancTec's U.S. Open Solutions Group focuses on the following areas:\n1. Financial document processing systems sold directly to high-volume document processors, such as large banks, financial service providers, telephone companies, gas and electric utilities, petroleum companies, service bureaus, insurance companies, retailers and other end-users.\n2. Systems solutions and integrated products for community banks and smaller regional banks.\n3. Software products for electronic funds transfer and point-of-sale applications for retailers, grocery chains and financial institutions.\nThe Company's North American Service and Manufacturing Group focuses on the following areas:\n1. PC\/LAN network support services, PC warranty services, third-party maintenance and other maintenance-related products and services for major North American companies and government institutions.\n2. Document processing equipment, imaging products and electronic components for OEMs, VARs and various other resellers.\nInternationally, BancTec also sells its products through a variety of channels. The Company has direct sales forces in the United Kingdom, Canada, Japan and Australia. Third-party maintenance and support services are also marketed in the United Kingdom via a separate direct sales force.\nIn fiscal 1992, BancTec, Inc. and Thomson-CSF established a joint venture company, ScanData N.V., which has exclusive rights to market and service various products provided by BancTec and Thomson in specified territories, consisting of continental Europe, Scandinavia and North Africa. In fiscal 1994, BancTec acquired a 33% equity interest in Servibanca, a document processing services provider located in Chile. Servibanca offers a variety of products and services to the South American document processing market. BancTec uses various other distributor and OEM relationships to market its products in Asia and various other locations.\nDuring fiscal year 1995, the Company began operations in Japan. BancTec Japan, Inc. has responsibility for the distribution of the Company's products and service programs to financial institutions and companies in Japan.\nThe Company's combined worldwide sales organization totals approximately 120 people. Major sales offices are located in several U.S. cities, Toronto, Montreal, London, Paris, Sydney, and Tokyo.\nSales of products to foreign entities, which accounted for approximately 18% of total revenues in fiscal 1995, are subject to various risks, including fluctuations in exchange rates, import controls and the need for export licenses. See Note K of Notes to Consolidated Financial Statements for financial information concerning the Company's international operations.\nSIGNIFICANT CUSTOMERS\nFor fiscal years 1995, 1994 and 1993, no single customer accounted for more than 10% of the total revenue of the Company.\nCOMPETITION\nThe Company believes that product performance, quality, service and price are important competitive factors in the markets in which it competes. Generally, the Company emphasizes unique product features, flexibility to configure unique systems from standard products, quality and service in its competitive efforts. In marketing its products, the Company competes directly or indirectly with a wide variety of companies, some of which have substantially greater financial and other resources than the Company.\nBACKLOG\nThe Company's firm order backlog for its products at March 26, 1995 and March 27, 1994 was approximately $44,125,000 and $48,379,000 respectively.\nThe Company's backlog does not include contracts for recurring service and maintenance-related products and support products. BancTec's backlog is subject to fluctuation due to various factors, including the size and timing of orders for the Company's products and exchange rate fluctuations, and is not necessarily indicative of the level of future revenue.\nMANUFACTURING\nThe Company's hardware and systems products are assembled using various standard purchased components such as PC monitors, minicomputers, encoders, communications equipment and other electronic devices. Certain engineered products are purchased from sole source suppliers. The Company generally has contracts with these suppliers that are renewed periodically and that require no minimum purchases. If the supply of certain components or subassemblies were interrupted without sufficient notice, the result could be an interruption of product deliveries. The Company has not experienced, nor does it foresee, any difficulty in obtaining the necessary parts.\nPATENTS\nThe Company has registered patents in the United States and Canada protecting the\nCompany's HeatStrip(R) product. In addition, BancTec holds U.S. patents relating to high-speed document handling, encoding, and optical and magnetic character recognition. BancTec also holds patents relating to image processing technology in the U.S. and several European countries.\nThe validity of any patents issued or which may be issued to the Company may be challenged by others and the Company could encounter legal difficulties in enforcing its patents rights against infringement. In addition, there can be no assurance that other technology cannot or will not be developed or that patents will not be obtained by others which would render the Company's patents obsolete. Management does not consider the Company's patents to be essential to the ongoing operations of the Company.\nThe Company has an exclusive, paid-up, worldwide right and license from Control Data Corporation to all issued and pending patents that pertain to certain OEM products and to the know-how and technology related to the manufacture of such products. This exclusive right and license expires in the year 2014.\nIn April 1986, the Company executed a non-exclusive license agreement with TRW Financial Systems, Inc. (formerly Teknekron Financial Systems, Inc.). The agreement permits the Company to manufacture and market digital image processing systems subject to a patent held by that company.\nBancTec has several registered trademarks, including \"BancTec\" and various product names.\nEMPLOYEES\nAt May 31, 1995, the Company employed approximately 2,274 full-time employees and considers its employee relations to be good. None of the Company's employees are represented by a labor union, and the Company has never experienced a work stoppage.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns or leases numerous facilities throughout the world to support its operations. The Company believes that these facilities are adequate to meet its ongoing needs. The loss of any one facility could have an adverse impact on operations in the short term.\nThe Company has the option to renew all leases on principal facilities at the end of the respective lease terms.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nNone\nEXECUTIVE OFFICERS OF BANCTEC\nExecutive officers are elected annually at the first meeting of the Board of Directors following the annual meeting of stockholders. No family relationships exist among the executive officers of BancTec.\nThe executive officers of BancTec are:\nName Age Position ---- --- -------- Grahame N. Clark, Jr....... 52 Chairman of the Board and Chief Executive Officer Norton A. Stuart, Jr....... 60 President William E. Bassett......... 53 Executive Vice President Tod V. Mongan.............. 44 Senior Vice President, Secretary and General Counsel James R. Wimberley......... 54 Senior Vice President George W. Christian........ 49 Vice President John G. Guthrie............ 58 Vice President Michael D. Kubic........... 40 Vice President, Controller, and Assistant Treasurer Kevin L. Roper............. 40 Vice President James E. Uren.............. 58 Vice President Michael N. Lavey........... 37 Treasurer\nMr. Clark has been Chairman of the Board and Chief Executive Officer since April 1987.\nMr. Stuart has been President since April 1987.\nMr. Bassett has been Executive Vice President since January 1993. Since October 1977, Mr. Bassett has been employed by BancTec in various management capacities.\nMr. Mongan has been Senior Vice President, Secretary and General Counsel since January 1993. Since November 1979, Mr. Mongan has been employed by BancTec in various management capacities.\nMr. Wimberley has been Senior Vice President since January 1993. Since January 1984, Mr. Wimberley has been employed by BancTec in various management capacities.\nMr. Christian has been Vice President since March 1995. Since April 1985, Mr. Christian has been employed by BancTec in various management capacities.\nMr. Guthrie has been Vice President since September 1993. Since February 1989, Mr. Guthrie has been employed by BancTec in various management capacities.\nMr. Kubic has been Vice President, Controller, and Assistant Treasurer since September 1993. Since August 1986, Mr. Kubic has been employed by BancTec in various management capacities.\nMr. Roper has been Vice President since March 1994. Since March 1985, Mr. Roper has been employed by BancTec in various management capacities.\nMr. Uren has been Vice President since September 1993. Since October 1988, Mr. Uren has been employed by BancTec in various management capacities.\nMr. Lavey has been Treasurer since March 1994. Since March 1990, Mr. Lavey has been employed by BancTec in various management capacities.\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 traded on the over-the-counter market and is quoted on The NASDAQ National Market system under the symbol BTEC. The following table sets forth the range of high and low sales prices per share of common stock, as reported by NASDAQ for the periods indicated.\nThe Company has not paid any cash dividends on its common stock since its organization and currently intends to continue a policy of retaining earnings for the Company's operations and planned expansion of its business or to repurchase its common stock. In addition, the Company's credit agreement places restrictions on the payment of dividends. The number of stockholders of record as of May 31, 1995, was approximately 1,470.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA\nThe foregoing summary reflects the acquisitions as discussed in Note B of Notes to Consolidated Financial Statements from their respective date of acquisition. Additionally, the per share amounts and the weighted average number of common shares have been restated to reflect the three-for-two common stock split on February 8, 1993 as discussed in Note A.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company continually attempts to seek out strategic acquisition opportunities in related businesses and technologies. The Company consummated no acquisitions during fiscal year 1995 but had made numerous acquisitions during the two years prior to fiscal year 1995. Fiscal year 1994 results reflected the acquisitions of LeRoux, Pitts, and Associates (\"LPA\"), a subsidiary of NYNEX, from August 23, 1993, Imagesolve International, Ltd. (\"Imagesolve\") from December 1, 1993, Advanced Computer Systems, Inc. (\"ACS\") from December 23, 1993 and Terminal Data Corporation, Inc. (\"TDC\") from February 28, 1994. Fiscal year 1993 results reflected the acquisitions of Computer Field Specialists, Inc. (\"CFS\") and Springfield Computer Consultants, Inc. (\"Access\") from June 29, 1992 and August 1, 1992, respectively. The combined revenues of the companies acquired in fiscal years 1994 and 1993 accounted for approximately 5% of consolidated revenues, in each of their respective years of acquisition. See Note B of Notes to Consolidated Financial Statements for a discussion of these acquisitions.\nFISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994\nConsolidated revenue for fiscal year 1995 of $297,539,000 increased by $50,001,000 or 20.2% from fiscal year 1994 due primarily to the full year effect of fiscal 1994 acquisitions, continued growth in the domestic network services business and increased shipment of image systems domestically. Partially offsetting these consolidated revenue increases were lower revenues for reader\/sorter and document processing systems hardware. For fiscal year 1995, revenue from equipment and software of $168,012,000 increased by $33,279,000 or 24.7% over fiscal year 1994. The increase in equipment and software revenue is attributed to inclusion for a full year of the TDC and ACS acquisitions. For fiscal year 1995, revenue from maintenance and other services of $129,527,000 increased $16,722,000 or 14.8% over fiscal year 1994. The increase in maintenance and other services revenue is due to the continued growth of the network services business domestically and a full year of maintenance from the TDC acquisition. Revenue from equipment and software represented 56.5% of total revenue in fiscal year 1995 compared to 54.4% in fiscal year 1994.\nConsolidated gross profit of $86,844,000 for fiscal year 1995 increased by $17,192,000 or 24.7% over the same period for last year and the gross margin percentage of 29.2% increased by 1.1 percentage points over the prior year's percentage. The improvement in gross profit and gross margin is due to higher returns in software as a result of the ACS acquisition and productivity improvements in delivering the Company's traditional software products. Partially offsetting these improvements were additional unfavorable manufacturing variances as a result of lower volume shipments of reader\/sorters and document processing systems. Gross profit from equipment and software increased by $12,811,000 while the associated gross margin percent also increased by 1.1 percentage points. The increases are primarily the result of the ACS acquisition offset in part by the unfavorable manufacturing variances. Gross profit for maintenance and other services increased by $4,381,000 while the gross margin percentage increased by 0.5 percentage points. The improvement in gross profit and gross margin is primarily the result of the increased network services revenue.\nOperating expenses increased by $17,110,000 from the prior year due to a combination of acquisition related goodwill amortization, additional staffing from the TDC and ACS acquisitions and a $4,250,000 charge taken in the fourth quarter to settle a litigation claim and for the reorganization of the Company's North American operations.\nNet interest expense increased by $4,003,000 from fiscal 1994 as a result of the increase in debt to fund the acquisitions and higher interest rates. Net sundry income increased by $838,000 primarily due to additional current year foreign currency transaction gains.\nThe provision for income taxes reflected an increase in the Company's effective tax rate to 42.9% in fiscal year 1995 from 40.0% in fiscal year 1994 due to increased nondeductible goodwill and the geographic mix of where profit is earned.\nMinority interest of $1,210,000 reflects the ScanData Joint Venture partner's (Thomson) 49.5% share of the losses incurred in the joint venture for fiscal year 1995, limited when the amount of net J.V. equity reached zero.\nFiscal year 1995 net income of $12,509,000 resulted in earnings per share of\n$1.12, compared to $16,343,000 and $1.45 in fiscal year 1994.\nFISCAL YEAR 1994 COMPARED TO FISCAL YEAR 1993\nConsolidated revenue for fiscal year 1994 of $247,538,000 increased by $13,653,000 or 5.8% from fiscal year 1993 due to increases in network service revenue and current year acquisitions offset in part by reductions in equipment revenue. Revenue from maintenance and other services of $112,805,000 increased $17,886,000 or 18.8% primarily due to growth in the domestic network services business. Revenue from equipment and software of $134,733,000 decreased by $4,233,000 or 3.0% from fiscal 1993 due to decreases in reader\/sorter and document processing systems hardware, offset in part by growth in software from current year acquisitions. Revenue from equipment and software represented 54.4% of total revenue in fiscal year 1994, compared to 59.4% in fiscal year 1993.\nConsolidated gross profit of $69,652,000 for fiscal year 1994 increased by $3,052,000 or 4.6% over the same period for the prior year. Gross margin of 28.1% decreased by 0.4 percentage points from the prior year due to a change in the mix of revenue to lower margin maintenance revenue and the reduction in equipment revenue from prior year levels. Gross profit from maintenance and other services increased by $5,556,000 due to the increase in network service revenue and an improvement in the gross margin to 22.4% compared to 20.8% in fiscal year 1993. Gross profit from equipment and software decreased by $2,504,000 due to the reduction in equipment revenue and a 1.0 percentage point decrease in the associated gross margin percent. Partially offsetting the reduction in equipment gross profit was an increase in software revenue primarily from current year acquisitions and an improvement in software margins.\nOperating expenses increased by $3,887,000 from the prior year due to the current year acquisitions. Operating expenses as a percentage of sales were 18.6% compared to 18.0% in the prior year.\nNet interest expense decreased by $494,000 from fiscal 1993 as a result of a lower average cost of borrowing and additional interest income on investments. Net sundry income increased by $2,103,000 due to the absence of exchange losses in the current year and gains on the sale of stock held for investment in fiscal 1994.\nThe provision for income taxes increased $720,000 over fiscal year 1993 due to the increase in taxable income. The overall effective tax rate of 40.0% remained constant with the prior year.\nMinority interest of $2,625,000 reflects the ScanData Joint Venture partner's (Thomson) 49.5% share of the losses incurred in the joint venture for fiscal year 1994.\nFiscal year 1994 income before cumulative effect of accounting change of $16,343,000 resulted in earnings per share of $1.45, compared to $14,351,000 and $1.32 in fiscal year 1993. The fiscal year 1993 net income after accounting change included $835,000 or an earnings per share effect of $0.08 for the cumulative effect of adoption of SFAS No. 109 - Accounting for Income Taxes.\nLIQUIDITY AND CAPITAL RESOURCES\nFunds to support the Company's operations, including capital expenditures, have been derived from a combination of funds provided by operations, long and short-term bank financing, capital leasing and, to a lesser extent, by sales of capital stock under employee stock option and purchase plans. The Company has three credit facilities currently in place under an agreement with several banks. Under the term loan facility, the Company borrowed $51,000,000 in fiscal year 1989 to fund the acquisition of Computer Entry Systems (CES), of which $5,895,000 is outstanding at March 26, 1995. The Company continues to make scheduled payments on the CES term loan of $1,821,000 per quarter until maturity in December 1995. Under the acquisition loan facility, the Company borrowed the maximum amount available of $55,000,000. The terms of the agreement have been revised and amended to allow borrowings in foreign currency which the Company utilizes as part of its foreign currency risk management program. The outstanding balance of $55,219,000 as of March 26, 1995 includes recognized but unrealized losses of $495,000 resulting from converting certain notes under the facility into foreign currencies. The amount outstanding has been converted to a term\nloan and is due and payable over 20 equal quarterly payments until maturity in December 1999 as required by the agreement. The Company also has available a $30,000,000 revolving credit facility which had an outstanding balance of $12,942,000 as of March 26, 1995. This balance included $642,000 in recognized but unrealized losses resulting from converting certain notes under this facility into foreign currencies. During fiscal year 1995, the Company borrowed a maximum amount of $15,000,000 against this revolving credit facility. See Note D of Notes to Consolidated Financial Statements for a further discussion of this agreement. The Company believes that it has sufficient financial resources available to support its anticipated requirements to fund operations in fiscal year 1996, and is not aware of any trends, demands or commitments which would have a material impact on the Company's long or short-term liquidity.\nCash and cash equivalents decreased during the year primarily as a result of the cash payments made to complete the fiscal year 1994 acquisitions and the repurchase of $6,994,000 of the Company's stock.\nAccounts receivable increased in fiscal 1995 due to a combination of a longer collection cycle on the larger end-user image installations and the growth in revenue over the prior fiscal year.\nNet inventory increased in the current year due to purchases of expendable field inventory to support the Company's maintenance business and for purchases in support of new products being developed by the Company.\nNet fixed assets increased primarily due to the purchase of spares in support of the Company's network services business, and the acquisition and refurbishment of a facility in Dallas.\nThe increase in Other Long-Term Assets resulted from recording the long- term portion of the deferred tax benefits associated with the acquisitions, the capitalization of Banker OSA software and the recording of a note receivable relating to the sale of the Frederick, Maryland facility.\nCurrent liabilities increased as a result of current maturities on the acquisition facility, borrowings against the revolving credit facility, growth in the ScanData Joint Venture deferred revenue, additional severance and legal accruals and the timing of payments for income taxes and accrued liabilities.\nLong-term debt decreased primarily due to payment of the TDC debenture, and reclassification of the CES Term Loan to current liabilities as scheduled payments are made.\nOther Long-Term Liabilities decreased primarily as a result of payments made on assumed acquisition liabilities.\nThe minority interest account was reduced to zero during the year as a result of losses incurred in the joint venture.\nInflation has not had a material effect on the operating results of the Company.\nSUBSEQUENT EVENT\nOn May 19, 1995, the Company entered an agreement with Recognition International, Inc. (\"Recognition\") to acquire 100% of the outstanding shares of Recognition in a stock for stock exchange. The transaction will be accounted for as a pooling of interests. See Note N of notes to consolidated financial statements for a further discussion of this agreement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Board of Directors and Stockholders BancTec, Inc.:\nWe have audited the accompanying consolidated balance sheets of BancTec, Inc. (a Delaware corporation) and subsidiaries as of March 26, 1995 and March 27, 1994, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended March 26, 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 BancTec, Inc. and subsidiaries as of March 26, 1995 and March 27, 1994, and the results of their operations and their cash flows for each of the three years in the period ended March 26, 1995 in conformity with generally accepted accounting principles.\nAs explained in Note G of Notes to Consolidated Financial Statements, effective March 30, 1992, the Company changed its method of accounting for income taxes.\nArthur Andersen LLP\nDallas, Texas May 19, 1995\nBANCTEC, INC.\nCONSOLIDATED BALANCE SHEETS\nA S S E T S\nSee notes to consolidated financial statements.\nBANCTEC, INC.\nCONSOLIDATED BALANCE SHEETS\nL I A B I L I T I E S A N D S T O C K H O L D E R S' E Q U I T Y\nSee notes to consolidated financial statements.\nBANCTEC, INC. CONSOLIDATED STATEMENTS OF INCOME\nSee notes to consolidated financial statements.\nBANCTEC, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nBANCTEC, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended March 26, 1995, March 27, 1994 and March 28, 1993 (In thousands)\nSee notes to consolidated financial statements.\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - SUMMARY OF ACCOUNTING POLICIES\nThe principal business of BancTec, Inc. and subsidiaries (\"the Company\") is the development, manufacture and sale of integrated financial transaction processing systems, application software and support services. The Company develops turn-key image processing systems, data capture systems and integrated software products for the banking, financial services, telecommunications, utility, petroleum, insurance, government, retail and other industries. The Company also designs, manufactures and markets document processing equipment for original equipment manufacturer (\"OEM\") customers and provides network support services for local area networks and personal computers.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and the ScanData Joint Venture which was established with Thomson-CSF in fiscal year 1992. All significant intercompany accounts and transactions have been eliminated. The Company's fiscal year is a 52\/53 week year which ends on or about March 31. Fiscal year 1995 ended on March 26, 1995, fiscal year 1994 ended on March 27, 1994 and fiscal year 1993 ended on March 28, 1993.\nThe Company uses a 13-week period for quarterly reporting.\nCASH EQUIVALENTS\nCash equivalents consist of investments with original maturities of three months or less. There were no investments with original maturities greater than three months at fiscal year-end 1995 and 1994.\nINVENTORIES\nInventories are valued at the lower of cost or market and include the cost of raw materials, labor, factory overhead and purchased subassemblies. Cost is determined using the first-in, first-out method.\nDEFERRED REVENUE\nCertain of the Company's contracts permit the Company to bill the customer in advance of the time revenue is recognized. Deferred revenue represents billings in excess of revenue recognized. Revenue is recognized ratably over the contract period as the services are performed, which usually occurs within one year of billing.\nDERIVATIVE FINANCIAL INSTRUMENTS\nPremiums paid for purchased interest rate cap agreements are amortized to interest expense over the period of the agreements. Unamortized premiums are included in other current assets or other assets on the balance sheet depending on the amortization period.\nAmounts receivable or payable in foreign currencies which have been hedged using forward exchange agreements are valued on the balance sheet at the rate of exchange under the forward exchange agreement.\nREVENUE RECOGNITION\nThe Company's revenue recognition policy for its principal sources of revenue are:\nEquipment and software sales - Revenue from sales of established products is recognized upon shipment in conformity with AICPA Statement of Position No. 91-1, Software Revenue Recognition. Revenue for new products, certain other equipment and software with lengthy development or installation periods is generally recognized at the time of acceptance by the customer. Contracts with lengthy software development periods are accounted for in conformity with Accounting Research Bulletin No. 45, Long-Term Construction Contracts. Under such contracts, the excess of engineering costs and other related miscellaneous equipment costs over advance billings on such contracts are recorded in other current assets. All contract costs, including equipment and software are charged to cost of sales at the time the related revenue is recognized. At March 26, 1995 and\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nMarch 27, 1994, there were $949,000 and $803,000, respectively, of costs in excess of advance billings recorded in other current assets.\nMaintenance - Revenue from maintenance contracts is recognized ratably over the term of the contract.\nThe Company generally warrants its equipment and software products sold directly to end-users for 30 days and OEM products sold to system providers for 90 days from the date of shipment. The Company provides for warranty costs at the time revenue is recorded.\nDEPRECIATION AND AMORTIZATION\nDepreciation is provided in amounts sufficient to charge the cost of depreciable assets to operations over their estimated service lives. Such amounts are charged to cost of sales or operating expenses in the consolidated statements of income, as appropriate. Straight-line or declining balance methods of depreciation are used for financial reporting purposes. Accelerated methods are used for tax purposes.\nLeasehold improvements and assets recorded under capital lease obligations are depreciated over the shorter of their estimated useful life or the remaining lease term. Field support spare parts, which are repairable replacement parts for products maintained under service contracts, are amortized over a useful life of three or five years. Depreciable lives for furniture, fixtures and machinery is generally seven years. Buildings utilize a forty-year life.\nIntangible assets are amortized on a straight-line basis over their estimated useful lives. The excess of cost over net assets of acquired business is amortized over 10 to 40 years. Other intangible assets are amortized over 3 to 5 years.\nPRODUCT DEVELOPMENT\nCompany-sponsored software product development costs are expensed as incurred until technological feasibiity has been established. At that time, the software product development costs are capitalized in conformity with Statement of Financial Accounting Standards (SFAS) No. 86 - Accounting for the costs of computer software to be sold, leased or otherwise marketed. At March 26, 1995, $857,000 of capitalized software costs were recorded in other long-term assets net of zero amortization. At March 27, 1994, there were no capitalized software costs recorded as the feasibility of the product was still being determined. Initial amortization of the amounts recorded during fiscal year 1995 will start when the product is available for general release. The annual amortization shall be the greater of the amount computed based on a ratio of units sold divided by an anticipated installation base of 300 units or the straight-line method over 3 years. Customer-sponsored product development costs are generally charged to costs of sales or the proceeds generated therefrom are credited to product development costs by the Company.\nINCOME TAXES\nDeferred income taxes recognize the effect of temporary differences between the reporting of transactions and the basis of assets and liabilities for financial accounting and income tax purposes.\nFOREIGN CURRENCY TRANSLATION\nThe assets and liabilities of the Company's foreign subsidiaries are translated into U.S. dollars at the year-end rates of exchange. Assets and Liabilities denominated in other than each entities non-functional currency, as defined in SFAS 52 - Foreign Currency Translation, are translated at the year- end rates of exchange. Revenue and expenses are translated monthly at the average exchange rates for the month. Translation gains and losses are reported as a separate component of stockholders' equity, and transaction gains and losses are included in results of operations.\nNET INCOME PER SHARE\nNet income per common and common equivalent share is based upon the weighted average number of outstanding shares during the year. The number of outstanding shares of common\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nstock has been adjusted to reflect the assumed exercise of all outstanding stock options which are dilutive, at the beginning of the period or date of issuance, and the use of the proceeds of such assumed exercise to repurchase, at market, common stock of the Company.\nCONCENTRATION OF CREDIT RISK\nThe Company sells its products to certain customers under specified credit terms in the normal course of business. These customers can generally be classified as banking, financial services, insurance, government, utility, telecommunications or retail entities. Due to the diversity of customers sold to, management does not consider there to be a concentration of risk within any single classification.\nAs of March 26, 1995, one customer's account balance amounted to 10 percent of the Company's accounts receivable.\nRECLASSIFICATION\nCertain prior year amounts have been reclassified to conform with current year presentation.\nOn February 8, 1993, the Company authorized a three-for-two stock split payable in the form of a 50% stock dividend to stockholders of record on February 18, 1993. All share and per share data has been adjusted to reflect the stock split.\nNOTE B - ACQUISITIONS AND EQUITY INVESTMENTS\nDuring the second quarter of fiscal year 1994, the Company acquired certain assets and assumed certain liabilities of LeRoux, Pitts and Associates (\"LPA\"), a subsidiary of NYNEX. The acquisition of LPA provides BancTec EFT-oriented software products for debit\/credit card processing and electronic check authorization requirements. The purchase price of the assets, including acquisition costs, was approximately $2,500,000, which was paid in cash, plus liabilities assumed of approximately $1,500,000. The business combination was accounted for as a purchase and, accordingly, LPA operations are included in the Company's consolidated results of operations from August 20, 1993, the effective date of the transaction. The assets and liabilities acquired are recorded in the Company's consolidated balance sheet at the assigned fair value.\nDuring the second quarter of fiscal year 1994, BancTec contributed approximately $500,000 in cash and certain other consideration in exchange for a 33% equity interest in Servibanca, S.A.(\"Servibanca\"), a Chilean company. Servibanca is a check processing service bureau as well as a distributor of BancTec image processing systems, document processing systems, and stand-alone reader\/sorters to banks, service bureaus, and other financial processors in Chile and other South American countries. BancTec's investment in and share of Servibanca's earnings have been included since September 14, 1993, and are recorded using the equity method of accounting.\nDuring the third quarter of fiscal year 1994, the Company acquired 100% of the stock of Imagesolve International, Ltd. (\"Imagesolve\"), a leading British provider of integrated systems solutions for electronic document imaging, specializing in solutions utilizing Computer Output to Laser Disk (COLD) technology, which electronically archives computer-generated documents onto optical disks. The purchase price for the stock, including acquisition costs, was approximately $2,800,000, which was paid in cash. The business combination was accounted for as a purchase and, accordingly, Imagesolve operations are included in the Company's consolidated results of operations from December 1, 1993, the effective date of the transaction. The assets and liabilities acquired are recorded in the Company's consolidated balance sheet at the assigned fair value.\nAlso during the third quarter of fiscal year 1994, the Company acquired 100% of the stock of Advanced Computer Systems, Inc. (\"ACS\"). ACS was a leading provider of software products which included integrating of check sorting, platform automation, loan processing, ATM and teller terminal processing and other bank operations activities, to banks with generally less than $300 million in assets. The purchase price for the stock, including acquisition costs, was approximately $25,300,000, which was paid in cash borrowed under the acquisition loan facility discussed in Note D. The business combination was accounted for as a purchase and, accordingly, ACS operations are included in the\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nCompany's consolidated results of operations from December 23, 1993, the effective date of the transaction. The assets and liabilities acquired are recorded in the Company's consolidated balance sheet at the assigned fair value.\nDuring the fourth quarter of fiscal year 1994, the Company acquired 100% of the stock of Terminal Data Corporation (\"TDC\"). TDC was a provider of document imaging systems, page scanning devices, and digital and microfilm cameras. The purchase price for the stock, including acquisition costs, was approximately $23,600,000, of which approximately $18,100,000 was paid in cash during fiscal year 1994. Such cash was borrowed under the acquisition loan facility. Non-cash consideration of approximately $5,500,000 consisted primarily of future payments to be made for stock and debt which were paid during fiscal year 1995 with cash borrowed under the acquisition loan facility and operating cash. The business combination was accounted for as a purchase and, accordingly, TDC operations are included in the Company's consolidated results of operations from February 28, 1994, the effective date of the transaction. The assets and liabilities acquired are recorded in the Company's consolidated balance sheet at the assigned fair value.\nThe following unaudited pro forma information combines the results of operations of the Company, ACS and TDC as if the purchase transactions had occurred at the beginning of fiscal year 1993. The pro forma information is based on the historical financial statements of BancTec, ACS and TDC giving effect to the transactions under the purchase method of accounting and including adjustments necessary to reflect the exclusion of certain ACS and TDC administration costs, additional interest on debt, amortization of the excess of cost over net assets of acquired business and the related tax impact thereof.\nManagement believes that these pro forma statements may not be indicative of the results that would have occurred if the combinations had been in effect on the dates indicated or which may be obtained in the future. Anticipated efficiencies from the consolidation of these entities are not fully determinable, and therefore, have been excluded from these pro forma results of operations. The Company has not considered the LPA and Imagesolve acquisitions in these unaudited pro forma results of operations because such acquisitions are not material to the consolidated financial statements.\nIn the second quarter of fiscal year 1993, the Company acquired Computer Field Specialists, Inc. and Computer Field Specialists of Texas, Inc. (collectively, \"CFS\") for 318,181 (477,272 as adjusted for stock split) shares of common stock. The acquisition was accounted for as a pooling of interests. The financial statements include the combined results of CFS and BancTec from June 29, 1992, the date of the acquisition. Prior periods have not been restated due to immateriality.\nAlso during the second quarter of fiscal year 1993, the Company acquired Springfield Computer Consultants, Inc., which marketed under the name of Access Banking Systems (\"Access\"). The purchase price, including acquisition costs, was approximately $3,400,000, of which $2,900,000 was paid in cash. Non-cash consideration of $500,000 consisted primarily of future payments to the former owners. The business combination was accounted for as a purchase and, accordingly, Access operations are included in the Company's consolidated results of operations from August 1, 1992, the effective date of the transaction. The assets and liabilities acquired are recorded in the Company's consolidated balance sheet at the assigned fair value.\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nThe Company has not disclosed unaudited pro forma results of operations of CFS and Access as if the acquisitions had been made as of the beginning of fiscal year 1993 because such acquisitions are not material to the consolidated financial statements.\nThe excess of the costs of these acquired businesses over the fair value assigned to the assets acquired less liabilities assumed are being amortized over their estimated useful lives using the straight-line method commencing with the respective dates of acquisition:\nAcquired Business Goodwill Amortization Period ----------------- ----------------------------\nLPA 15 years ImageSolve 20 years ACS 20 years TDC 25 years Access 15 years\nThe Company continually evaluates whether events and circumstances indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. No adjustments to recorded goodwill have resulted from these evaluations.\nFuture maturities of term loans payable to banks are as follows:\nDuring fiscal year 1995, the Company renegotiated the terms of its credit agreement with several banks. The amended and restated agreement provides for a $30,000,000 short-term revolving credit facility (\"revolving credit facility\"), a $51,000,000 term loan (\"term loan\") and a $55,000,000 acquisition loan facility (\"acquisition facility\") which are unsecured. The agreement contains restrictive covenants which, among other things, restrict payment of dividends, limit additional debt and require the Company to maintain a defined current ratio, minimum net worth and a minimum ratio of cash flow from operations to debt service. At March 26, 1995, the Company was in compliance with all of\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nthe covenants required under the agreement. The agreement was amended to permit borrowing in foreign currency which the Company utilizes as part of its foreign currency risk management program discussed in Note E. The revolving credit facility bears interest at the lender's prime commercial rate or, at the Company's option, the London Interbank Offered Rate (LIBOR) on Eurocurrency borrowings plus 1 point. A commitment fee of 1\/4% on the unused revolving credit facility is payable on a quarterly basis. The term loan and acquisition facility bear interest at the lender's prime commercial rate or, at the Company's option, LIBOR plus 1-1\/4 to 1-3\/4 points, depending on the Company's debt to capitalization ratio, as defined. At March 26, 1995, the Company's debt to capitalization ratio was .37 and the applicable interest rate was LIBOR plus 1-1\/2 points.\nAt March 26, 1995, the Company was party to one interest rate cap agreement. This agreement, which expires in May of 1997, entitles the Company to receive from a counterparty, on a quarterly basis, the amount, if any, by which interest payments calculated using LIBOR on the notional amount of $27,500,000 exceed 7.0%, with a ceiling of 9.5%, above which the Company would receive no additional amount. There were no interest rate cap agreements in place during fiscal years 1994 or 1993.\nAt March 26, 1995, the amount outstanding under the revolving credit facility was $12,942,000 at a weighted average interest rate of 6.65%. During fiscal year 1995, the Company borrowed a maximum amount of $15,000,000 against this facility.\nBorrowings under the term loan total $5,895,000 at March 26, 1995. Principal payments under the term loan are due in 28 equal quarterly installments, plus interest, which commenced on June 30, 1989 and matures in fiscal year 1996.\nUnder the acquisition facility, the Company was allowed to borrow up to $55,000,000 during the period from inception of the facility, October 6, 1993, through December 31, 1994 for the purpose of funding acquisitions. The Company borrowed the maximum amount available under this facility. At December 31, 1994, the balance of the acquisition facility was converted to a term loan and principal payments are due in 20 equal quarterly installments, plus interest, which commence on March 31, 1995 and end on December 31, 1999. At March 26, 1995, the balance of the acquisition facility was $55,219,000 which includes unrealized losses resulting from converting certain notes under the facility into foreign currencies. Such unrealized losses are offset by unrealized gains on intercompany borrowings.\nThe weighted average interest rate on borrowings under the term loan and acquisition facility was 7.63% at March 26, 1995.\nFuture minimum lease payments under capital lease obligations are as follows:\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nProperty, plant and equipment recorded under capital leases are as follows:\nThe Company paid cash totalling $4,853,000, $1,093,000, and $1,967,000, for interest during fiscal years 1995, 1994 and 1993, respectively.\nNOTE E - DERIVATIVE 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 foreign currency risks.\nInterest rate cap agreements are used to reduce the potential impact of increases in interest rates on floating-rate long-term debt. As discussed in Note D, the Company has one interest cap agreement in effect at March 26, 1995, which provides protection to the Company against increases in the LIBOR interest rate from 7.0% to 9.5% on approximately one-half of the Company's acquisition facility borrowings.\nThe Company utilizes foreign currency forward exchange agreements in conjunction with foreign currency borrowings discussed in Note D to hedge significant foreign currency receivables and payables. Under the terms of the forward exchange agreements, the Company and a counterparty agree to exchange foreign currency amounts on a specified date at an agreed upon exchange rate. At March 26, 1995, the Company had two forward exchange agreements in effect which required the Company to exchange 45,000,000 Swedish Krona (\"SEK\") and 21,000,000 SEK for German Deutschmarks (\"DM\") at the agreed upon SEK\/DM exchange rates of 4.8921 and 4.952, respectively. At March 26, 1995, the market exchange rate between SEK and DM was approximately 5.184.\nThe Company is exposed to credit losses in the event of nonperformance by the counterparties to its interest rate cap and foreign currency forward exchange agreements but has no off-balance sheet credit risk of accounting loss. The Company anticipates that its counterparties will be able to fully satisfy their obligations under their contracts. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of the counterparties.\nNOTE F - OTHER ACCRUED EXPENSES AND LIABILITIES\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nNOTE G - INCOME TAXES\nIn 1993, the Company adopted SFAS No. 109 - Accounting for Income Taxes. SFAS 109 is an asset and liability approach which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events which have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Previously, the Company used the SFAS 96 asset and liability approach that gave no recognition to future events other than the recovery of assets and settlement of liabilities at their recorded amounts.\nBancTec elected to reflect the cumulative effect of adopting this pronouncement as a change in accounting principle as of the beginning of fiscal year 1993 with a credit to earnings of $835,000. Prior year's financial statements were not restated. This credit consists primarily of the increase in net deferred tax assets to reflect the benefit of taxes previously provided for profit on inventory sold between BancTec entities within different taxing jurisdictions but still on the Company's consolidated books at the end of fiscal 1992. Such benefit could not be recorded under SFAS 96. The impact of adoption of SFAS 109 on fiscal 1993 results was not significant and previously reported quarters were not restated.\nThe domestic and foreign components of income before income taxes and cumulative effect of accounting change consisted of the following:\nThe income tax provision (benefit) consisted of the following:\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nThe difference between the income tax provision computed at the statutory federal income tax rate and the financial statement provision for taxes is summarized as follows:\nThe Company paid cash totalling $8,192,000, $9,414,000, and $5,006,000, for income taxes in fiscal years 1995, 1994 and 1993, respectively.\nDeferred income taxes reflect the tax consequences on future years of temporary differences between the tax basis of assets and liabilities and their financial reporting basis and are included in other current assets or other assets depending on the timing of the expected realization. The deferred tax benefit in fiscal years 1995, 1994 and 1993 represented the effect of changes in the amounts of temporary differences during those fiscal years.\nDeferred tax assets (liabilities), as determined under the provisions of SFAS 109, were comprised of the following:\nThe Company has net operating loss carryforwards which expire as follows: 1997 though 2000, $12,567,000; 2001 through 2008, $8,667,000; and indefinite, $12,660,000.\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nThe net change in the deferred tax asset valuation reserve in fiscal 1995, 1994 and 1993 was $1,978,000, $1,246,000, and $2,326,000, respectively, and is attributable to the increase in the net operating loss carryforwards of the Company's Canadian, Japanese and Australian subsidiaries and the German entity of the Scandata Joint Venture.\nAt March 26, 1995, the Company had approximately $188,000 in deductible temporary differences remaining for financial reporting purposes as a result of the acquisition of CES. An adjustment to the excess of cost over net assets of business acquired and a charge in lieu of taxes is recorded for any tax benefits resulting from realization of these carryforwards in years subsequent to the acquisition.\nUndistributed earnings of foreign subsidiaries were approximately $7,510,000, $7,264,000 and $6,831,000 at March 26, 1995, March 27, 1994, and March 28, 1993, respectively. No taxes have been provided on these undistributed earnings as they are considered to be permanently reinvested.\nNOTE H - STOCKHOLDERS' EQUITY\nOn February 8, 1993, the Company authorized a three-for-two stock split payable in the form of a 50% stock dividend to stockholders of record on February 18, 1993. A total of 3,457,553 shares of common stock were issued in connection with the split. Accordingly, $34,576 was transferred from additional paid-in capital to common stock. All share and per share data presented has been adjusted to reflect the stock split.\nEMPLOYEE STOCK AWARD PLANS\nAt March 26, 1995, a total of 2,622,644 shares of common stock were reserved for issuance under the Company's stock award plans. At March 26, 1995, 861,794 shares were available for future grant. In general, the plans provide for the granting of options or restricted shares to key employees. A summary of the key provisions of each type award is as follows:\nSTOCK OPTIONS\nIn general, the plans provide for the granting of options at not less than the fair market value of the stock at the date of grant. Options issued vest periodically as defined in the plans. At March 26, 1995, options to purchase 1,760,850 shares were outstanding, of which options to purchase 756,415 shares were vested and could be exercised.\nA summary of activity in the Company's stock option plans is as follows:\nRESTRICTED STOCK AWARDS\nThe Board of Directors of the Company periodically awards restricted stock to key employees as compensation. Vesting is pro rata and is subject to future service. Unearned compensation is charged for the market value of the shares on the date of grant and is amortized to expense over the vesting period. Such amount is shown as a reduction of stockholders' equity in the accompanying consolidated balance sheets. During fiscal year 1995, 6,203 shares were awarded and unearned compensation of $141,118 was recorded. During fiscal 1994, 27,981 restricted shares were awarded and\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nunearned compensation of $490,100 was recorded. Vesting on such shares ranges from 3 years to 21 years. In fiscal years 1995, 1994 and 1993, $227,037, $188,100 and $108,000, respectively, was amortized to expense.\nEMPLOYEE STOCK PURCHASE PLAN\nThe Company has an employees' stock purchase plan under which 194,512 shares of common stock were reserved at March 26, 1995. The shares are offered for sale to employees only, through payroll deductions, at prices equal to 85% of the lesser of the fair market value of the Company's common stock on the first day of the offering period or the last day of the exercise period. During fiscal years 1995 and 1994, the Company issued 47,630 and 49,186 shares, respectively, under the plan.\nSTOCKHOLDER RIGHTS\nOn June 16, 1988, the Company adopted a Stockholder Rights Plan in which common stock purchase rights were distributed as a dividend at the rate of one right for each common share held as of the close of business on June 27, 1988. Each share issued thereafter also received one right. As a result of the three- for-two stock split, the number of rights associated with each share of common stock has been adjusted from one right to two-thirds of a right. The Stockholder Rights Plan was 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 stockholders. The rights will expire on May 24, 1998.\nEach right will entitle stockholders to buy one and one-half shares of common stock of the Company at an exercise price of $35.50. The rights will be exercisable only if a person or group 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 30% or more of the common shares.\nIf any person becomes the beneficial owner of 35% or more of the Company's common stock, other than pursuant to certain tender or exchange offers described in the Plan, or if the Company is the surviving corporation in a merger with a 20%-or-more stockholder and its common shares are not changed or converted, or if a 20%-or-more stockholder engages in certain self-dealing transactions with the Company, then each right not owned by such person or related parties will entitle its holder to purchase, at the right's then current exercise price, shares of Company 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, after any person has become a 20%-or- more stockholder, (i) if the Company is involved in a merger or other business combination transaction in which it is not the continuing or surviving corporation (other than a merger described in the previous sentence or a merger that follows a certain tender or exchange offers described in the Plan), or (ii) if the Company sells 50% or more of its assets or earning power, 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 $.05 per right at any time until the fifteenth day (subject to certain limited extensions) following public announcement that a 20% position has been acquired.\nNOTE I - EMPLOYEE BENEFIT PLANS\nThe Company has an employee savings plan which allows substantially all full- time domestic employees to make contributions defined by Section 401(k) of the Internal Revenue Code. The Company elected to contribute 1.1%, 1.4%, and 1.5% of the qualifying participant's base salary in fiscal years 1995, 1994 and 1993, respectively. Amounts expensed under the plan for the years ended March 26, 1995, March 27, 1994, and March 28, 1993 were $600,000, $597,000, and $600,000, respectively. The Company provides no material postretirement benefits to its employees.\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nNOTE J - COMMITMENTS AND CONTINGENCIES\nThe Company leases most of its production facilities and certain equipment under non-cancelable operating leases expiring through fiscal year 2010. Total Company rent expense for the years ended March 26, 1995, March 27, 1994, and March 28, 1993 was $6,597,000, $4,263,000, and $4,701,000, respectively.\nFuture minimum payments under non-cancelable operating leases are approximately as follows:\nFiscal Year (In thousands) ----------- -------------- 1996............................. $ 5,476 1997............................. 4,232 1998............................. 3,624 1999............................. 2,134 2000............................. 1,022 Thereafter....................... 3,855 ------- $20,343 =======\nThe Company has the option to renew operating leases on its major facilities at the end of the current lease terms.\nThe Company and its subsidiaries are parties to various legal proceedings. Although the ultimate disposition of such proceedings is not presently determinable, in the opinion of the Company, any liability that might ensue would not be material in relation to the consolidated operations of the Company.\nNOTE K - GEOGRAPHIC OPERATIONS\nThe Company operates in the following geographic areas: the United States, including Puerto Rico, Europe, including the United Kingdom and Scandinavia, and other international areas consisting primarily of Australia, Japan, and Canada. Interarea sales to affiliates are accounted for at established transfer prices.\nSales and operating income for the years ended March 26, 1995, March 27, 1994, and March 28, 1993, and identifiable assets at the end of each of those years, classified by geographic area, are as follows:\nForeign currency transaction gains in fiscal year 1995 were $1,080,000, while foreign currency losses in fiscal years 1994 and 1993 were $374,000 and $1,122,000, respectively, and are included as part of sundry-net in the consolidated statements of income.\nBANCTEC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nNOTE L - RELATED PARTIES\nPrior to fiscal year 1994, ScanData S.A. subcontracted the performance of maintenance services for certain customers to Thomson, a partner in the ScanData Joint Venture. Under the terms of such agreement, ScanData S.A. received 12.5% of the amount billed for maintenance services in exchange for providing such customers to Thomson. This agreement expired at the end of fiscal year 1993. Included in fiscal year 1993 revenues is $461,000 related to this arrangement. Included in trade accounts payable at March 26, 1995 and March 27, 1994 are $6,713,000 and $6,635,000, respectively, payable to Thomson.\nNOTE M - SUMMARIZED QUARTERLY DATA (UNAUDITED)\nDue to the impact of stock prices on the computation of earnings per share, net income per share as presented does not equal the sum of the quarters.\nNOTE N - SUBSEQUENT EVENT\nOn May 19, 1995, the Company entered an agreement with Recognition International, Inc. (\"Recognition\") to acquire 100% of the outstanding shares of Recognition in a stock for stock exchange. This transaction, which will be accounted for as a pooling of interests, will result in the issuance of approximately 9,100,000 shares of BancTec common stock. The merger is subject to regulatory and shareholder approval and is expected to be completed in September, 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 is contained in the definitive proxy material of the Company to be filed in connection with its 1995 annual meeting of stockholders, except for the information regarding executive officers of the Company which is contained in Part I of this Annual Report on Form 10-K. The information required by this item contained in such definitive proxy material is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is contained in the definitive proxy material of the Company to be filed in connection with its 1995 annual meeting of stockholders, 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 is contained in the definitive proxy material of the Company to be filed in connection with its 1995 annual meeting of stockholders, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is contained in the definitive proxy material of the Company to be filed in connection with its 1995 annual meeting of stockholders, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) and (2) Financial Statements: See Index to Financial Statements and Schedules on page 35.\n(b) Reports on Form 8-K:\n(i) May 31, 1995, Execution of Agreement and Plan of Merger with Recognition International, Inc.\n(c) Exhibits\n3.1 - Certificate of Incorporation.(6)\n3.2 - By-Laws.(1)\n4.1 - Specimen of Common Stock Certificate.(1)\n10.1 - BancTec, Inc. 1989 Stock Plan.(8)\n10.2 - BancTec, Inc. Incentive Stock Option Plan, as amended.(3)\n10.3 - BancTec, Inc. 1982 Nonqualified Stock Option Plan, as amended.(3)\n10.4 - BancTec, Inc. 1994 Stock Plan.(11)\n10.5 - BancTec, Inc. 1990 Employee Stock Purchase Plan, as amended.(7)\n10.6 - BancTec, Inc. Deferred Compensation Plan.(9)\n10.7 - Employment Agreement with Grahame N. Clark, Jr. dated May 28, 1992.(10)\n10.8 - Employment Agreement with Norton A. Stuart dated May 28, 1992.(10)\n10.9 - Employment Agreement with Tod V. Mongan dated May 28, 1992.(10)\n10.10 - Rights Agreement dated June 16, 1988.(5)\n10.11 - Second Amended and Restated Credit Agreement dated December 28, 1994 among the Company, its Subsidiaries and Texas Commerce Bank National Association, as Agent.(12)\n10.12 - Form of Indemnification Agreement between the Company and each of its Directors and Officers.(4)\n10.13 - License Agreement dated April 1, 1986 between the Company and TRW Financial Systems, Inc. (formerly Teknekron Financial Systems, Inc.), a TRW company.(2)\n11.1 - Statement re: computation of net income per share.(12)\n21.1 - Subsidiaries.(12)\n23.1 - Consent of Independent Public Accountants.(12)\n27.0 - Selected Financial Data.(13) - ---------- (1) Filed as an Exhibit to the Company's Registration Statement on Form 8-B and incorporated herein by reference.\n(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 31, 1985 and incorporated herein by reference.\n(3) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 30, 1987 and incorporated herein by reference.\n(4) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 29, 1988 and incorporated herein by reference.\n(5) Incorporated by reference to the Company's current report on Form 8-A filed on July 6, 1988.\n(6) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended April 2, 1989 and incorporated herein by reference.\n(7) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 31, 1990 and incorporated herein by reference.\n(8) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 31, 1991 and incorporated herein by reference.\n(9) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 29, 1992 and incorporated herein by reference.\n(10) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 28, 1993 and incorporated herein by reference.\n(11) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended March 27, 1994 and incorporated herein by reference.\n(12) Filed herewith.\n(13) Filed electronically only.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBANCTEC, INC.\nBy \/s\/ Grahame N. Clark, Jr. ------------------------------- Grahame N. Clark, Jr. Chairman of the Board and Chief Executive Officer\nDated: June 16, 1995\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 Company and in the capacities and on the dates indicated:\nBANCTEC, INC.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nAll other schedules have been omitted as the required information is inapplicable, not required, or the information is included in the financial statements and notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Board of Directors and Stockholders BancTec, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in BancTec, Inc.'s Form 10-K, and have issued our report thereon dated May 19, 1995. Our report contained an explanatory paragraph calling attention to the Company's change in method of accounting for income taxes, effective March 30, 1992, as discussed in Note G to the consolidated financial statements. Our audits were made for the purpose of forming an opinion on those consolidated financial statements taken as a whole. The schedule listed in the index to financial statements and schedules is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic 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 May 19, 1995\nSCHEDULE II BANCTEC, INC.\nVALUATION AND QUALIFYING ACCOUNTS\nYears Ended March 26, 1995, March 27, 1994 and March 28, 1993 (In thousands)\n- ------------ (a) Write-off of uncollectible accounts. (b) Scrapping of obsolete inventory and book to physical inventory adjustments.","section_15":""}
{"filename":"800575_1995.txt","cik":"800575","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nPremark International, Inc. (the \"Registrant\") is a multinational consumer and commercial products company. The Registrant is a Delaware corporation which was organized on August 29, 1986 in connection with the corporate reorganization of Kraft, Inc. (\"Kraft\"). In the reorganization, the businesses of the Registrant and certain other assets and liabilities of Kraft and its subsidiaries were transferred to the Registrant. On October 31, 1986 the Registrant became a publicly held company through the pro-rata distribution by Kraft to its shareholders of all of the outstanding shares of common stock of the Registrant.\nThe Registrant's principal operating subsidiaries are Premark FEG Corporation, which owns the operating subsidiaries comprising the Registrant's Food Equipment Group; Wilsonart International, Inc. (\"Wilsonart\"); The West Bend Company (\"West Bend\"); Florida Tile Industries, Inc. (\"Florida Tile\"); Hartco Flooring Company (\"Hartco\"); Precor Incorporated (\"Precor\"); and Dart Industries Inc. (\"Dart\"), which owns the operating subsidiaries comprising the Registrant's Tupperware business. Dart was organized in Delaware in 1928 as a successor to a business originally established in 1902. In 1988, Wilsonart and West Bend were organized in Delaware as separate corporations owned directly by the Registrant, having previously been operating divisions of Dart acquired in 1966 and 1968, respectively. In 1995, Wilsonart changed its name from Ralph Wilson Plastics Company. Premark FEG Corporation was organized in Delaware in 1984, a successor to a business originally incorporated in 1897. Florida Tile, a Florida corporation organized in 1954, was acquired in 1990. Hartco, acquired in 1988, was organized in Tennessee in 1946. Precor, a Delaware corporation, was organized as a Washington corporation in 1981, and was acquired in 1984.\nOn November 1, 1995, the Registrant announced a plan for a pro-rata distribution to the Registrant's shareholders of all the stock of a Corporation owning the Registrant's Tupperware business. The new corporation, Tupperware Corporation (\"Tupperware\"), is a worldwide direct selling consumer products company engaged in the manufacture and sale of Tupperware brand products. Tupperware was organized under the laws of the State of Delaware on February 8, 1996 as part of the corporate reorganization of the Registrant in which Dart and its subsidiaries will be transferred to Tupperware. The distribution of Tupperware stock is expected to occur in June, 1996.\n(b) Financial Information About Industry Segments\nFor certain financial information concerning the Registrant's business segments, see Note 10 (\"Segments of the Business\") of the Notes to the Consolidated Financial Statements of Premark International, Inc., appearing on page 51 of the Annual Report to Shareholders for the year ended December 30, 1995, which is incorporated by reference into this Report by Item 8 hereof.\nFor certain financial information concerning the Registrant's Tupperware operation, see Note 2 (\"Distribution of Tupperware to Shareholders\") of the Notes to the Consolidated Financial Statements of Premark International, Inc., appearing on page 45 of the Annual Report to Shareholders for the year ended December 30, 1995, which is incorporated by reference into this Report by Item 8 hereof.\n(c) Narrative Description of Business\nThe Registrant conducts its business through its three continuing business segments: the Food Equipment Group, the Consumer Products Group, and the Decorative Products Group, as well as through its Tupperware operation. A discussion of the four business segments follows.\nFOOD EQUIPMENT GROUP\nPrincipal Products, Markets and Distribution\nThe Food Equipment Group, composed primarily of Premark FEG Corporation and its operating subsidiaries (the \"Group\"), is a leading manufacturer of commercial food preparation, cooking, storage, and cleaning equipment. For the fiscal years 1995, 1994, and 1993, sales by the Group contributed approximately 35 percent, 33 percent, and 33 percent, respectively, of the sales of the Registrant's businesses, including the Tupperware operation. Revenues from foreign operations constituted approximately 43 percent of the Group's 1995 sales.\nThe Group's core products include warewashing equipment; food preparation machines, such as mixers, slicers, cutters, meat saws and grinders; weighing and wrapping equipment and related systems; baking and cooking equipment, such as ovens, ranges, fryers, griddles and broilers; and refrigeration equipment. Products are marketed under the trademarks Hobart, Stero, Vulcan, Wolf, Tasselli, Adamatic, Still, Foster, and Ungermann. Ungermann, a German supplier of refrigerating equipment for the baking industry with 1995 sales of about $23 million, was acquired in 1995. The Hobart brand represents about 80% of the Group's sales.\nFood equipment products are sold to the retail food industry, including supermarket chains, independent grocers, delicatessens, bakeries, convenience and other food stores, and to the foodservice industry, including independent restaurants, fast-food chains, hospitals, correctional facilities, schools, hotels, resorts, and airlines.\nFood equipment products are distributed in more than 100 countries, either through company-owned operations or through distributors, dealers or licensing arrangements covering many areas of the world where a market for such products currently exists. The Group is the only major food equipment manufacturer in the United States with its own nationwide service network for the markets in which it sells, providing not only an important source of income but also an important source for developing new sales. The Group directly services its food machines, warewashers, weigh\/wrap equipment, and cooking equipment, while authorized independent agents service refrigeration units and some cooking equipment.\nMajor new products introduced by the Group in the United States in 1995 included a Hobart Quantum scale\/printer system, the Medalist by Hobart line of value-priced mixers and refrigeration equipment, a Hobart 1812 RS scale\/slicer, Vulcan- Hart thermal kettles, and Vulcan-Hart Euroline ranges. The Group has announced introduction of a new line of coffee brewers in the U.S. In Europe, the Group introduced in 1995 its Le Maillon product which keeps food cool while being transported, and an expanded Hobart utensil warewasher line.\nRaw Materials and Facilities\nThe Group uses stainless and carbon steel, aluminum, and plastics in the manufacture of its products. These materials are readily available from several sources, and no difficulties have been experienced with respect to their availability, although costs have increased somewhat. In addition to manufacturing certain component parts, the Group also purchases many component parts, such as electrical and electronic components, castings, hardware, fasteners, and bearings. Certain manufacturers utilize tooling provided by the Group for such components.\nThe Group owns its headquarters building and a major manufacturing complex consisting of four plants in Troy, Ohio. In addition, the Group operates nine manufacturing plants in California, Georgia, Kansas, Maryland, New Jersey, Ohio, and Virginia, and nine manufacturing plants in Canada, France, Italy, the United Kingdom, Germany, and Australia. Most of these plants are owned. The group is building a warewashing plant in China, with anticipated startup in 1997.\nCompetition\nThe Group competes in a growing worldwide market which is highly fragmented. No single manufacturer competes with respect to all of the Group's products, and the degree of competition varies among different customer segments and products. The commercial food equipment industry is mature, with growth primarily a function of new construction and replacement sales to existing locations, as well as menu and format changes. The extensiveness of the Group's brand acceptance across a broad range of products is deemed by the Registrant to be a significant competitive advantage. Another important competitive advantage is the group's extensive service network throughout North America and Europe, as well as in major markets in the Far East and Latin America. Competition is also based on numerous other factors, including product quality, performance, reliability, labor savings, price, and energy conservation.\nMiscellaneous\nThe Group had approximately $134 million and $132 million of backlog orders at the end of 1995 and 1994, respectively, after restatement of 1994 for exchange rate effects. The Group considers such orders to be firm, though changes or cancellations of insignificant amounts may occur, and expects that the 1995 backlog orders will be filled in 1996.\nDECORATIVE PRODUCTS GROUP\nPrincipal Products, Markets and Distribution\nWilsonart, Florida Tile and Hartco make up the Decorative Products Group. The Decorative Products Group contributed 19 percent, 20 percent, and 20 percent of the sales of the Registrant's businesses, including the Tupperware operation, for the fiscal years 1995, 1994, and 1993, respectively.\nWilsonart manufactures decorative plastic laminate products through a production process utilizing heated high pressure presses. These products, sold principally under the Wilsonart trademark in more than 700 colors, designs, and finishes, are used for numerous interior surfacing applications, including cabinetry, countertops, vanities, store fixtures, and furniture. Approximately 50 percent of the Wilsonart decorative laminate sold is used in residential applications, primarily for surfacing kitchen and bathroom countertops and cabinetry. Decorative laminate applications in the commercial market include office furniture, retail store fixtures, restaurant and hotel furniture, and doors. Wilsonart also manufactures specialty-grade laminates, including chemical-resistant, wear-resistant, and fire-retardant types. Among the specialized applications for Wilsonart laminate are those in laboratory work surfaces, jetways and naval vessels. In 1995, Wilsonart added 36 new designs to its standard laminate product line, and announced introduction of a high-pressure decorative laminate flooring line.\nIn addition to laminate products, Wilsonart sells a solid surfacing product which is marketed under the Gibraltar brand. The Company also produces and\/or sells contact adhesives under the Lokweld trademark, as well as Wilsonart decorative metallic surfacings, and Wilsonart decorative edge moldings for countertops and furniture. In 1995, the company began test marketing a solid surfacing veneer product.\nWilsonart decorative products are sold throughout the United States through wholesale building material distributors and directly to original equipment manufacturers. Export sales are now made to Japan, Ireland, Canada, Mexico, Central and South America, the Caribbean, Australia, New Zealand, Hong Kong, Taiwan, China, Korea, Indonesia, and Singapore. Wilsonart is seeking to expand its distribution network outside the U.S.\nFlorida Tile manufactures glazed ceramic wall and floor tile products in a wide variety of sizes, shapes, colors, and finishes, which are suitable for residential and commercial uses. Tile products are marketed under the Florida Tile trademark through company-owned and independent distributors. A small portion of Florida Tile's sales are exports. Florida Tile also imports foreign-produced tile products to supplement its line of manufactured products.\nHartco manufactures and distributes high-quality, prefinished and unfinished oak and prefinished maple flooring for residential and commercial applications. Its flooring products are pre-cut parquet panels, laminated three and five-ply maple plank lineal flooring products, laminated two, three and five-ply oak plank lineal flooring products, and 3\/4-inch solid strip prefinished and unfinished oak flooring, each of which is sold in a variety of colors and finishes. Hartco's solid strip oak flooring product was introduced in 1995. Hartco also manufactures wood moldings, installation adhesives, and a full line of proprietary floor care products to complement its line of flooring products. These products are marketed under the Hartco trademark to a nationwide network of independent wholesale floor covering distributors, home improvement store chains, and retail buying groups. A small portion of Hartco's sales are exports.\nRaw Materials and Facilities\nThe manufacture of decorative laminates requires various raw materials, including kraft and decorative paper, overlays, and melamine and phenolic resins. Each of these items is available from a limited number of manufacturers, but Wilsonart has not experienced difficulties in obtaining sufficient quantities. The principal raw materials used in Florida Tile products are clay, talc, stains, and frit (ground glass), all of which are available to Florida Tile in sufficient quantities. The principal raw materials used in Hartco's hardwood flooring products are Appalachian red and white oak, maple, steel wire, and various chemicals. All such raw materials are readily available from many sources in sufficient quantities.\nWilsonart owns and operates three manufacturing facilities in Texas and North Carolina, giving it the largest decorative laminate production capacity in North America. Adhesives are produced at two plants located in Louisiana and Texas. Solid surfacing products are manufactured in one facility in Texas, and are also purchased under a supply agreement. Wilsonart has 14 regional distribution centers which are geographically dispersed throughout the United States. Stock items can be delivered within 24 hours, and non-stock items can be produced and delivered within 10 working days. Florida Tile manufactures products in three owned manufacturing plants located in Florida, Georgia and Kentucky. It distributes its products through a network of company-owned and independent distribution outlets. Hartco manufactures its products in an owned manufacturing facility in Tennessee and a leased facility in Kentucky.\nCompetition\nWilsonart products are sold in highly competitive markets in the United States. Wilsonart has approximately 48 percent of the U.S. market for high pressure decorative laminates. Wilsonart successfully competes with other companies by providing fast product delivery, offering a broad choice of colors, designs, and finishes, and emphasizing quality and service. Florida Tile competes with a number of other domestic and foreign tile manufacturers in a fragmented market. The Registrant believes Florida Tile is the third largest U.S. tile manufacturer, with a market share substantially less than the largest U.S. manufacturer. Foreign-manufactured products account for approximately 55 percent of the U.S. tile market. Important competitive factors in the tile market include price, style, quality, breadth of product line, and service. Hartco competes with a number of other domestic and foreign suppliers of prefinished wood flooring products. Important competitive factors include price, fit, appearance, durability, the variety of finishes and colors, and the complementary molding, adhesive and floor care products. Wilsonart, Florida Tile, and Hartco products compete with other types of surfacing and flooring materials.\nMiscellaneous\nThe Decorative Products Group maintains a continuing program of product development. Its efforts emphasize product design, performance, durability, product enhancement, and new product applications, as well as manufacturing processes. Materials development for laminate products is generally performed by the companies providing those materials.\nThe group's products are sold for new construction and remodeling, in both the residential and commercial markets. As a consequence, the group's sales are affected by the seasonality of the construction and remodeling industry.\nPrices for paper and resin have increased substantially in the last year. Lumber supplies are also at a premium price compared with several years ago, although prices have moderated from the high levels of 1993.\nCONSUMER PRODUCTS GROUP\nPrincipal Products, Markets and Distribution\nThe Consumer Products Group consists of West Bend and Precor. It contributed 8 percent, 9 percent, and 8 percent of the sales of the Registrant's business, including the Tupperware operation, for the fiscal years 1995, 1994, and 1993, respectively.\nWest Bend manufactures and sells small electric appliances such as bread makers, electric skillets, slow cookers, woks, corn poppers, beverage makers, and electronic timers, primarily under the West Bend trademark. West Bend also manufactures and sells high-quality stainless steel cookware. During 1995, West Bend expanded its bread maker and drip coffeemaker lines. Precor manufactures physical fitness equipment such as treadmills, stationary bicycles, and low-impact climbers, all of which are marketed under the Precor trademark. In 1995, Precor introduced a new line of household treadmills, its Variable Aerobic Trainer walking machine for fitness club use, and its Smart Weights hand- held weights with treadmill remote control.\nWest Bend small appliances are sold primarily in the United States and Canada, directly to mass merchandisers, department stores, hardware stores, warehouse clubs, and catalog showrooms. West Bend's stainless steel cookware is sold to consumers by independent distributors through dinner parties and by other direct sales methods. Cookware is sold in 31 countries under 23 separate product lines. Precor equipment is sold primarily through specialty fitness equipment retail stores and high-end sporting goods and bicycle stores in the United States and Canada. In Asia, Europe, Latin America, and the Middle East, Precor products are sold primarily through select distributors. While Precor products have been primarily for home use, in recent years Precor has entered the fitness club market.\nRaw Materials and Facilities\nWest Bend uses aluminum, stainless steel, plastic resins, and other materials in the manufacture of its products. Precor uses steel, stainless steel, aluminum, and other materials in the manufacture of its products. Generally, neither West Bend nor Precor has experienced any significant difficulties in obtaining any of these raw materials or products, although the cost of these raw materials has risen. West Bend owns and operates two manufacturing plants in Wisconsin and Mexico. Precor maintains two leased plants in Washington state.\nCompetition\nProducts sold by West Bend and Precor compete with products sold by numerous other companies of varying sizes in highly competitive markets. Important competitive factors include price, development of new products, quality, name recognition, product performance, just-in-time delivery, warranties, and service.\nMiscellaneous\nWest Bend's sales in the fourth quarter typically are significantly higher due to the gift-giving season. Precor's business is significantly higher in the first and fourth quarters, when winter weather forces more people to exercise indoors. The Consumer Products Group is dependent on two customers for approximately one-third of its revenues.\nTUPPERWARE\nPrincipal Products, Markets and Distribution\nTupperware manufactures and markets a broad line of high quality consumer products for the home and for personal care. In fiscal years 1995, 1994, and 1993, Tupperware contributed approximately 38 percent, 38 percent, and 39 percent, respectively, of the sales of the Registrant's businesses.\nThe core of the product line continues to be food storage containers which preserve freshness of food through the well- known Tupperware seals. The line has expanded into kitchen, home storage and organizing uses with products such as Modular Mates and Fridge Stackables stackable storage containers, OneTouch canisters, and many specialized containers. In recent years, Tupperware has expanded its offerings in the food preparation and service areas through the addition of a number of products, including double colanders, tumblers and mugs, mixing and serving bowls, serving centers, microwaveable cooking and serving products, and kitchen utensils. It also has a line of children's educational toys, serving products, and gifts.\nProducts sold by Tupperware are produced primarily by Tupperware in its manufacturing facilities around the world. In some markets, Tupperware sources certain products from third parties and\/or contracts with local manufacturers to manufacture its products, utilizing high-quality molds which are supplied by Tupperware. Promotional items provided at product demonstrations include items obtained from outside sources.\nTupperware products are sold in the United States and in more than 100 foreign countries. For the past five years, sales in foreign countries represented on average 80 percent or more of total Tupperware revenues. Market penetration varies significantly throughout the world. \"Developing\" areas which have low penetration, such as Latin America, Asia, and Eastern Europe, provide significant growth potential. Tupperware's strategy continues to include aggressive expansion into new markets throughout the world during the balance of the decade. New markets entered by Tupperware in 1995 included Poland and several countries in southern Africa. Tupperware intends to establish operations in 1996 in China, additional Eastern European countries, and several Middle Eastern countries. Tupperware is seeking approval to do business in India.\nTupperware's products are distributed worldwide through the \"direct selling\" method of distribution, in which products are sold to consumers outside traditional retail store channels. Tupperware products are sold directly to distributors or dealers throughout the world. Distributors are granted the right to market Tupperware products using the demonstration method and utilizing the Tupperware trademark. The vast majority of Tupperware's distributorship system is composed of distributors, managers, and dealers who are independent contractors and not employees of Tupperware. In certain limited circumstances, in order to maintain market penetration, rather than utilizing an independent distributor, Tupperware owns the distributorship for a period of time until an independent distributor can be installed.\nKey aspects of Tupperware's strategy are expanding its business by enlarging the number of distributors, and increasing the business of existing distributors. Under the Tupperware system, distributors recruit, train and motivate a large sales force to cover the distributor's geographic area. Managers are developed and promoted by distributors to assist the distributor in recruiting, training, and motivating dealers. Managers also continue to hold their own demonstrations.\nAs of December 30, 1995, the Tupperware distribution system had over 1,670 distributors, 44,000 managers and 790,000 dealers worldwide. The dealer force continues to increase each year.\nTupperware primarily relies on the \"demonstration\" method of sales, which is designed to enable the purchaser to appreciate through demonstration the features and benefits of Tupperware products. Demonstrations are held in homes, offices, social clubs and other locations. In excess of 13 million demonstrations were held worldwide in 1995. Tupperware products are also promoted through monthly brochures mailed to persons invited to attend various types of demonstrations. Sales of Tupperware products are supported through a program of sales promotions, sales and training aids and motivational conferences for the independent sales force. Tupperware supports its sales force with catalogs, magazine advertising and toll-free telephone ordering, which helps increase its sales levels with hard-to- reach customers.\nThe distribution of products to consumers is the responsibility of distributors who are required to maintain their own inventory, warehouse facilities and delivery systems. In certain markets, Tupperware offers distributors the use of a delivery system of direct product shipment to dealers or consumers, which is intended to reduce the distributor's investment in inventory and enable distributors to be more cost- efficient.\nRaw Materials and Facilities\nProducts manufactured by Tupperware require plastic resins meeting its specifications. These resins are purchased from a number of large chemical companies, and Tupperware has experienced no difficulties in obtaining adequate supplies. Raw material costs increased significantly during the year, but began to decline in the fourth quarter. Research and development of resins used in Tupperware products are performed by both Tupperware and its suppliers.\nTupperware owns its principal executive office, located in Orlando, Florida. Tupperware owns manufacturing plants in twelve countries, including the United States, and leases an additional plant outside the United States. Tupperware conducts a continuing program of new product design and development at its facilities in Florida, Japan and Belgium. Most of the principal properties of Tupperware and its subsidiaries are owned, and none of the owned principal properties is subject to any material encumbrance.\nCompetition\nThere are two primary competitive factors which affect the Tupperware business: 1) competition with other \"direct sales\" companies for sales personnel and demonstration dates, and 2) competition in the markets for food storage and serving containers, toys, personal care items, and gifts in general. The Registrant believes Tupperware holds a significant market share in each of these markets in many countries. Tupperware's competitive strategies are to continue to expand its direct selling distribution system and to provide high quality, high value products throughout the world.\nOTHER INFORMATION RELATING TO THE BUSINESS\nTrademarks and Patents. The Registrant considers trademarks and patents to be of importance to its businesses. The Registrant's trademarks represent the leading brand names for most of its product lines. Its businesses have followed the practice of applying for patents with respect to most of the significant patentable developments, and now own a number of patents relating to their products. In certain cases the Registrant has elected common law trade secret protection in lieu of obtaining patent protection. In addition, exclusive and nonexclusive licenses under patents owned by others are utilized. No business is dependent to any material extent upon any single patent or trade secret or group of patents or trade secrets.\nResearch and Development. For fiscal years ended 1995, 1994 and 1993, the Registrant, including its Tupperware operation, spent approximately $44 million, $44 million, and $41 million, respectively, on research and development activities.\nEnvironmental Laws. Compliance by the Registrant's businesses with federal, state and local environmental protection laws has not in the past had, and is not expected to have in the future, a material effect upon its capital expenditures, liquidity, earnings or competitive position. The Registrant expects to expend approximately $0.2 million through 1997 on capital expenditures related to environmental facilities. In 1995, the Registrant had approximately $0.6 million of capital expenditures for environmental facilities, and approximately $3.3 million of remedial expenditures for environmental sites. See Item 3 for a further discussion of environmental matters.\nEmployees. The Registrant and its subsidiaries employ approximately 24,300 people, about 6,900 of whom are employed by the Registrant's Tupperware operation. Approximately 18 percent of the Registrant's employees are affiliated with one of the several unions with which the Registrant's subsidiaries have collective bargaining agreements. In recent years there has been no major effort to organize additional persons working for the Registrant's businesses, and there have been no significant work stoppages. The Registrant considers its relations with its employees to be good. The independent consultants, dealers, managers, distributors and franchisees engaged in the direct sale of Tupperware products are not employees of the Registrant.\nProperties. The principal executive offices of the Registrant are located in Illinois and are leased. Most of the principal properties of the Registrant and its subsidiaries are owned, and none of the owned principal properties is subject to any encumbrance material to the consolidated operations of the Registrant. The Registrant considers the condition and extent of utilization of the plants, warehouses and other properties in its respective businesses to be generally good, and the capacity of its plants and warehouses generally to be adequate for the needs of its businesses.\nMiscellaneous. Except as disclosed above in the narrative descriptions of the Registrant's business segments, none of the Registrant's businesses is seasonal, has working capital practices or backlog conditions material to an understanding of its businesses, is dependent on a small number of customers, or is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the federal government.\nFor information concerning foreign and domestic operations and export sales, see Note 7 (\"Income Taxes\") appearing on pages 46 and 47, and \"Segments of Business by Geographical Areas\" in Note 10 (\"Segments of the Business\") appearing on page 51 of the Annual Report to Shareholders for the year ended December 30, 1995, which are incorporated by reference into this Report by Item 8 hereof. For information concerning Registrant's discontinued Tupperware operation, see Note 2 (\"Distribution of Tupperware to Shareholders\") appearing on page 45 of the Annual Report to shareholders for the year ended December 30, 1995.\nExecutive Officers of the Registrant. Following is a list of the names and ages of all the Executive Officers of the Registrant, indicating all positions and offices with the Registrant held by each such person, and each such person's principal occupations or employment during the past five years. Each such person has been elected to serve until the next annual election of officers of the Registrant (expected to occur on May 1, 1996). The Registrant expects that upon the distribution of Tupperware stock Mr. Batts will resign his position as Chief Executive Officer and assume the position of Tupperware's Chairman of the Board and Chief Executive Officer, Mr. Ringler will become the Registrant's Chief Executive Officer and continue as President, and Messrs. Goings and Rose will resign their positions with the Registrant and continue as Tupperware's President and Chief Operating Officer and Tupperware's Vice President of Taxes and Government Affairs, respectively. The Registrant also expects that Ms. Richardson will resign her position with the Registrant in June, 1996. Name and Age Positions and Offices Held and Principal Occupations or Employment During Past Five Years\nWarren L. Batts (63) Chairman of the Board and Chief Executive Officer.\nJames M. Ringler (50) President and Chief Operating Officer since June 1992, after having served as Executive Vice President, Consumer and Commercial Products since January, 1990, and President, Food Equipment Group since August, 1990.\nE. V. Goings (50) Executive Vice President and President of Tupperware Worldwide since November 1992, after serving as a Senior Vice President of Sara Lee Corporation. Prior thereto, Mr. Goings served in various executive positions with Avon Products, Inc.\nJoseph W. Deering (55) Group Vice President of Premark and President of Premark's Food Equipment Group since June 1992, after serving as President of Leucadia National's Manufacturing group. Prior thereto, Mr. Deering served in various executive positions with Philips Industries, Inc.\nThomas W. Kieckhafer (57) Corporate Vice President and President of The West Bend Company.\nJames C. Coleman (56) Senior Vice President, Human Resources since July 1991. Prior thereto, Mr. Coleman served as Staff Vice President, Personnel Relations for General Dynamics Corporation.\nJohn M. Costigan (53) Senior Vice President, General Counsel and Secretary.\nLawrence B. Skatoff (56) Senior Vice President and Chief Financial Officer since September 1991. Prior thereto, Mr. Skatoff served as Vice President- Finance of Monsanto Company.\nL. John Fletcher (52) Vice President and Assistant General Counsel.\nIsabelle C. Goossen (44) Vice President, Financial Relations since January 1996, after serving as Vice President, Planning since June 1994, Director of Financial Relations since 1992, and prior thereto as Director in the Planning Department.\nRobert W. Hoaglund (57) Vice President and Controller since January 1996. Prior thereto Mr. Hoaglund was Vice President, Control & Information Systems.\nWendy R. Katz (38) Vice President, Internal Audit since May 1992. Prior thereto, Ms. Katz served in various financial positions at Tupperware.\nWilliam R. Reeb (48) Corporate Vice President since November 1994, and President and Chief Operating Officer of Wilsonart since August 1993. Prior thereto, Mr. Reeb served as Vice President, Marketing for the Decorative Products Group and Executive Vice President and Vice President of Marketing for Wilsonart.\nLisa Kearns Richardson (43) Vice President and Treasurer since April 1994, after serving as Vice President, Planning and Analysis since February 1991. Prior thereto, Ms. Richardson served as Assistant Controller.\nJames E. Rose, Jr. (53) Vice President, Taxes and Government Affairs.\nAnthony C. Scolaro (47) Vice President, Planning and Business Development since January 1996. Mr. Scolaro was Corporate Development Vice President at Ecolab, Inc. from 1994 to 1996, and was Assistant to the President at Rykoff-Sexton, Inc. from 1989 to 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nFor information concerning material properties of the Registrant and its subsidiaries, see the information under the sub-captions \"Narrative Description of Business\" in Section (c) of Item 1 above and \"Properties\" under the caption \"Other Information Relating To The Business\" in Section (c) of Item 1 above.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Registrant and its subsidiaries have pending against them a number of legal and administrative proceedings. Among such proceedings are those involving the discharge of materials into or otherwise relating to the protection of the environment. Certain of such proceedings involve federal environmental laws such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as well as state and local laws. The Registrant establishes reserves with respect to certain of such sites. Because of the involvement of other parties and the uncertainty of potential environmental impacts, the eventual outcomes of such actions and the cost and timing of expenditures cannot be estimated with certainty. It is not expected that the outcome of such proceedings, either individually or in the aggregate, will have a material adverse effect on the Registrant's consolidated financial position, results of operations, or any individual year's cash flow.\nKraft has assumed any liabilities arising out of any legal proceedings in connection with certain divested or discontinued former Dart businesses, including matters alleging product liability, environmental liability and infringement of patents.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe stock price information set forth in Note 12 (\"Quarterly Summary (unaudited)\") appearing on page 52 of the Annual Report to Shareholders for the year ended December 30, 1995 is incorporated by reference into this Report. The information set forth in Note 13 (\"Shareholders' Rights Plan\") on page 53 of the Annual Report to Shareholders for the year ended December 30, 1995 is incorporated by reference into this Report. As of March 4, 1996, the Registrant had 23,030 shareholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth under the caption \"Selected Financial Data\" on pages 38 and 39 of the Annual Report to Shareholders for the year ended December 30, 1995 is incorporated by reference into this Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information entitled \"Financial Review\" set forth on pages 33 through 37 of the Annual Report to Shareholders for the year ended December 30, 1995 constitutes \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and is incorporated by reference into this Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n(a) The following Consolidated Financial Statements of Premark International, Inc. and Report of Independent Accountants set forth on pages 40 through 53, and on page 54, respectively, of the Annual Report to Shareholders for the year ended December 30, 1995 are incorporated by reference into this Report:\nConsolidated Statements of Operations, Cash Flows and Shareholders' Equity--Years ended December 30, 1995, December 31, 1994 and December 25, 1993;\nConsolidated Balance Sheet--December 30, 1995 and December 31, 1994;\nNotes to the Consolidated Financial Statements; and\nReport of Independent Accountants dated February 23, 1996.\n(b) The supplementary data regarding quarterly results of operations contained in Note 12 (\"Quarterly Summary (Unaudited)\") of the Notes to the Consolidated Financial Statements of Premark International, Inc. on page 52 of the Annual Report to Shareholders for the year ended December 30, 1995 is incorporated by reference into this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information as to the Directors of the Registrant set forth under the sub-caption \"Board of Directors\" appearing under the caption \"Election of Directors\" on pages 2 through 4 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1996 is incorporated by reference into this Report. The information as to the Executive Officers of the Registrant is included in Part I hereof under the caption \"Executive Officers of the Registrant\" in reliance upon General Instruction G to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the caption \"Compensation of Directors\" on page 17 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1996, and the information on pages 11 through 16 of such Proxy Statement relating to executive officers' compensation is incorporated by reference into this Report.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information set forth under the captions \"Security Ownership of Certain Beneficial Owners\" on page 6 and \"Security Ownership of Management\" on page 5 of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 1996 is incorporated by reference into this Report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports On Form 8-K\n(a) (1) List of Financial Statements\nThe following Consolidated Financial Statements of Premark International, Inc. and Report of Independent Accountants set forth on pages 40 through 53, and on page 54, respectively, of the Annual Report to Shareholders for the year ended December 30, 1995 are incorporated by reference into this Report by Item 8 hereof:\nConsolidated Statements of Operations, Cash Flows and Shareholders' Equity--Years ended December 30, 1995, December 31, 1994 and December 25, 1993;\nConsolidated Balance Sheet--December 30, 1995 and December 31, 1994;\nNotes to the Consolidated Financial Statements; and\nReport of Independent Accountants dated February 23, 1996.\n(a) (2) List of Financial Statement Schedules\nThe following consolidated financial statement schedule (numbered in accordance with Regulation S-X) of Premark International, Inc. is included in this Report:\nReport of Independent Accountants on Financial Statement Schedule, page 33 of this Report; and\nSchedule II--Valuation and Qualifying Accounts for the three years ended December 30, 1995, page 34 of this Report.\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable, or the information called for therein is included elsewhere in the financial statements or related notes contained or incorporated by reference herein.\n(a) (3) List of Exhibits: (numbered in accordance with Item 601 of Regulation S-K)\nExhibit Number Description\n* 3.1 Restated Certificate of Incorporation (Exhibit 3A to the Registrant's Annual Report on Form 10-K for the year ended December 30, 1991)\n3.2 Amended By-Laws\n* 4.1 Form of Common Stock Certificate (Exhibit 3 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4.2 Rights Agreement dated March 7, 1989 (Exhibit 1 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4.3 Form of Right Certificate of Common Stock Purchase Right (Exhibit 1 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n* 4.4 Form of Indenture (Revised) in connection with the Registrant's Form S-3 Registration Statement No. 33-35137 (Exhibit (c)(3) to the Registrant's Current Report on Form 8-K dated September 17, 1990)\n*10.1 Reorganization and Distribution Agreement dated as of September 4, 1986 (Exhibit 2 to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10.2 Tax Sharing Agreement dated as of September 4, 1986 (Exhibit 10C to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10.3 Facilities and Guarantee Agreement, as amended, and Termination Agreement dated as of September 4, 1986 (Exhibit 10D to Registration of Securities on Form 10 dated September 8, 1986, File No. 1-9256)\n*10.4 $250,000,000 Credit Agreement dated as of June 15, 1994 (Exhibit (10) to the Registrant's Quarterly Report on Form 10-Q for the 27 weeks ended July 2, 1994)\n10.5 Form of Distribution Agreement by and among Premark International, Inc., Tupperware Corporation and Dart Industries Inc.\n10.6 Form of Tax Sharing Agreement by and between Premark International, Inc. and Tupperware Corporation.\nCOMPENSATORY PLANS OR ARRANGEMENTS [10G-10N]\n10.7 Form of Employee Benefits and Compensation Allocation Agreement by and between Premark International, Inc. and Tupperware Corporation.\n*10.8 Premark International, Inc. 1994 Incentive Plan (Exhibit 4.1 to the Registrant's Form S-8 Registration Statement No. 33-53561 dated May 4, 1994)\n*10.9 Premark International, Inc. Supplemental Benefits Plan (Exhibit 10L to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991)\n*10.10 Premark International, Inc. Change of Control Policy, as amended 1989 (Exhibit 4 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n*10.11 Form of Employment Agreement entered into on March 7, 1989 between the Registrant and certain executive officers (Exhibit 5 to the Registrant's Current Report on Form 8-K dated March 20, 1989)\n*10.12 Employment Agreement entered into on June 2, 1992 between the Registrant and Joseph W. Deering (Exhibit 10M to the Registrant's Annual Report on Form 10-K for the year ended December 26, 1992)\n*10.13 Employment Agreement dated November 9, 1992 between Registrant and E. V. Goings (Exhibit 10N to the Registrant's Annual Report on Form 10-K for the year ended December 25, 1993)\n*10.14 Premark International, Inc. Director Stock Plan, as amended 1993 (Exhibit 10O to the Registrant's Annual Report on Form 10-K for the year ended December 25, 1993)\n11 A statement of computation of 1995 per share earnings\n13 Pages 30 through 54 of the Annual Report to Shareholders of the Registrant for the year ended December 30, 1995\n21 Subsidiaries of the Registrant as of March 15,\n23 Manually signed Consent of Independent Accountants to the incorporation of their report by reference into the prospectuses contained in specified registration statements on Form S-8 and Form S-3\n24 Powers of Attorney\n27 Financial Data Schedule\n*Document has heretofore been filed with the Commission and is incorporated by reference and made a part hereof.\nThe Registrant agrees to furnish, upon request of the Commission, a copy of all constituent instruments defining the rights of holders of long-term debt of the Registrant and its consolidated subsidiaries.\n(b) Reports on Form 8-K\nDuring the quarter ended December 30, 1995 the Registrant filed a Current Report on Form 8-K dated November 2, 1995 reporting the Registrant's November 1, 1995 announcement of a plan providing for, among other things, a pro-rata distribution to Registrant's shareholders of all of the stock of a corporation owning Registrant's Tupperware business.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors and Shareholders of Premark International, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 23, 1996 appearing on page 54 of the 1995 Annual Report to Shareholders of Premark International, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement 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 Chicago, Illinois February 23, 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.\nPremark International, Inc. (Registrant)\nBy WARREN BATTS Warren L. Batts Chairman of the Board and Chief Executive Officer\nMarch 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 date indicated.\nSignature Title\nWARREN L. BATTS Chairman of the Board of Directors, Warren L. Batts Chief Executive Officer and Director (Principal Executive Officer)\nLAWRENCE B. SKATOFF Senior Vice President and Chief Lawrence B. Skatoff Financial Officer (Principal Financial Officer)\nROBERT W. HOAGLUND Vice President and Controller Robert W. Hoaglund (Principal Accounting Officer)\n* Director William O. Bourke\n* Director Dr. Ruth M. Davis\n* Director Lloyd C. Elam, M.D.\n* Director E.V. Goings\n* Director Clifford J. Grum\n* Director Joseph E. Luecke\n* Director Bob Marbut\n* Director John B. McKinnon\n* Director David R. Parker\n* Director Robert M. Price\nJAMES M. RINGLER President, Chief Operating Officer and James M. Ringler Director\n* Director Janice D. Stoney\n*By John M. Costigan John M. Costigan Attorney-in-fact March 25, 1996\nEXHIBIT INDEX\nExhibit No. Description Page\n11 A statement of computation of 27-28 1995 per share earnings\n13 Pages 30 through 54 of the 29-66 Annual Report to Shareholders of the Registrant for the year ended December 30, 1995\n22 Subsidiaries of the Registrant 67-69 as of March 10, 1995\n23 Manually signed Consent of 70 Independent Accountants to the incorporation of their report by reference into the prospec- tuses contained in specified registration statements on Form S-8 and Form S-3\n24 Powers of Attorney 71-72\n27 Financial Data Schedule 73","section_15":""}
{"filename":"765946_1995.txt","cik":"765946","year":"1995","section_1":"ITEM 1 - BUSINESS\nMay Drilling Partnership 1984-3 (the \"Drilling or General Partnership\") and May Limited Partnership 1984-3 (the \"Limited Partnership\") were organized by May Petroleum Inc. (\"May\") to explore for and develop oil and gas reserves primarily in Texas, Oklahoma and Louisiana. Funds received from the sale and production of oil and gas reserves are used to pay the obligations of the Limited Partnership. Funds not required by the Limited Partnership as working capital are distributed to the participants in the Drilling Partnership and the general partner.\nThe general partner of the Limited Partnership is EDP Operating, Ltd., which is one of the operating partnerships for Hallwood Energy Partners, L. P. (\"HEP\"). The Drilling Partnership is the sole limited partner of the Limited Partnership. The Limited Partnership does not have any subsidiaries, nor does it engage in any other kind of business. The Limited Partnership has no employees and is operated by Hallwood Petroleum, Inc. (\"HPI\"), a subsidiary of HEP. In February 1996, HPI employed 133 full-time employees.\nPursuant to the terms of the general partnership agreement and the limited partnership agreement, HEP is obligated, from time to time, to contribute certain amounts, in property, cash or unreimbursed services, to the Limited Partnership. As of December 31, 1995, all such required contributions had been accrued.\nPARTICIPATION IN EXPENSES AND REVENUES\nThe principal expenses and revenues of the Limited Partnership are shared by the general partner and the Drilling Partnership as shown in the following table. The charges and credits to participants in the Drilling Partnership are shared among the participants in proportion to their ownership of units of participation.\nIn 1996, the sharing ratio will be 66.4% to the limited partner and 33.6% to the general partner.\nTo the extent that the characterization of any expense of the Limited Partnership depends on its deductibility for federal income tax purposes, the proper characterization is determined by the general partner (according to its intended characterization on the Limited Partnership's federal income tax return) in good faith at the time the expense is to be charged or credited. Such characterization will control related charges and credits to the partners regardless of any subsequent determination by the Internal Revenue Service or a court of law that the reported expenses should be otherwise characterized for tax purposes.\nCOMPETITION\nOil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy. See also \"Marketing\" for a discussion of the market structure for oil and gas sales.\nREGULATION\nProduction and sale of oil and gas is subject to federal and state governmental regulations in a variety of ways including environmental regulations, labor law, interstate sales, excise taxes and federal, state and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases.\nThe production of oil and gas is subject to regulation by the state regulatory agencies in the states in which the Limited Partnership does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas.\nFEDERAL INCOME TAX CONSIDERATIONS\nThe Limited Partnership and the General Partnership are partnerships for federal income tax purposes. Consequently, they are not taxable entities; rather, all income, gains, losses, deductions and credits are passed through and taken into account by the partners on their individual federal income tax returns. In general, distributions are not subject to tax so long as such distributions do not exceed the partner's adjusted tax basis. Any distributions in excess of the partner's adjusted tax basis are taxed generally as capital gains.\nMARKETING\nThe oil and gas produced from the properties owned by the Limited Partnership has typically been marketed through normal channels for such products. Oil has generally been sold to purchasers at field prices posted by the principal purchasers of crude oil in the areas where the producing properties are located. The majority of the Limited Partnership's gas production is sold on the spot market and is transported in intrastate and interstate pipelines. Both oil and natural gas are purchased by refineries, major oil companies, public utilities and other users and processors of petroleum products.\nFactors which, if they were to occur, might adversely affect the Limited Partnership include decreases in oil and gas prices, the availability of a market for production, rising operational costs of producing oil and gas, compliance with and changes in environmental control statutes and increasing costs and difficulties of transportation.\nSIGNIFICANT CUSTOMERS\nFor the years ended December 31, 1995, 1994 and 1993, purchases by each of the following companies exceeded 10% of the total oil and gas revenues of the Limited Partnership.\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nENVIRONMENTAL CONSIDERATIONS\nThe exploration for, and development of, oil and gas involve the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the present general interest in environmental problems, the general partner cannot predict what effect possible future public or private action may have on the business of the Limited Partnership. The general partner is continually taking actions it believes necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations and does not presently anticipate that the compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, earnings or the competitive position of the Limited Partnership in the oil and gas industry.\nINSURANCE COVERAGE\nThe Limited Partnership is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. The Limited Partnership maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to the Limited Partnership's, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon the Limited Partnership's earnings and financial position.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Limited Partnership's oil and gas reserves are concentrated in one prospect in south Louisiana. Natural gas accounts for 57% of estimated future gross revenues in the Limited Partnership's reserve report as of December 31, 1995.\nSIGNIFICANT PROSPECT\nAt December 31, 1995, the following prospect accounted for all of the Limited Partnership's proved oil and gas reserves. Reserve quantities were obtained from the December 31, 1995 reserve report prepared by HPI's petroleum engineers.\nMONTET PROSPECT. The Montet prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect contains one productive well and has estimated remaining net proved reserves of 39,000 bbls of oil and 383,000 mcf of gas as of December 31, 1995. The Limited Partnership's working interest in this well is 15%. The prospect produces from one zone, the Bol Mex 3 formation at approximately 15,275 feet.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor a description of legal proceedings affecting The Limited Partnership, please refer to Item 8 - Note 3.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNo matter was submitted to a vote of participants 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\na) The registrant's securities consist of partnership interests which are not traded on any exchange and for which no established public trading market exists.\nb) As of December 31, 1995, there were approximately 531 holders of record of partnership interests in the Drilling Partnership.\nc) Distributions paid by the Limited Partnership were as follows (in thousands):\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\nMaterial changes in the Limited Partnership's cash position for the years ended December 31, 1995 and 1994 are summarized as follows:\nCash provided by operating activities in 1995 was used primarily for distributions to partners. Future distributions depend on, among other things, continuation of current or higher oil and gas prices and markets for production.\nThe Limited Partnership has net working capital of $654,000 at December 31, 1995. This working capital, together with cash flows generated from operations, may be used to fund future distributions.\nProved reserves and discounted future net revenues (discounted at 10% and before general and administrative expenses) attributable to proved reserves were estimated at 39,000 bbls and 383,000 mcf valued at $1,423,000 in 1995 and 36,000 bbls and 320,000 mcf valued at $1,084,000 in 1994. The Partnership's oil and gas reserves were revised upward during 1995 based upon the continued performance of the Freddie Aker.\nRESULTS OF OPERATIONS - ---------------------\n1995 COMPARED TO 1994 - ---------------------\nOIL REVENUE\nOil revenue decreased $37,000 during 1995 as compared with 1994. The decrease is comprised of a 14% decrease in production, partially offset by an increase in the average price from $16.18 per barrel in 1994 to $17.67 per barrel in 1995. The decrease in production from 40,675 barrels in 1994 to 35,169 barrels in 1995 is primarily due to decreased state allowable production limits combined with normal production declines.\nGAS REVENUE\nGas revenue decreased $286,000 during 1995 as compared with 1994. The decrease is due to a decrease in the average gas price from $2.27 per mcf during 1994 to $1.98 per mcf during 1995 combined with a 19% decrease in production. The decrease in production from 435,640 mcf in 1994 to 353,904 mcf in 1995 is due to decreased state allowable production limits as well as normal production declines.\nLEASE OPERATING\nLease operating expense increased $3,000 during 1995 as compared with 1994 primarily due to increased maintenance activity during 1995.\nPRODUCTION TAXES\nProduction taxes decreased $9,000 during 1995 as compared with 1994 as a result of decreased oil and gas revenue during 1995.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses increased $2,000 during 1995 as compared with 1994 primarily due to an increase in the allocation of overhead from the general partner.\nDEPLETION\nDepletion expense increased $3,000 during 1995 as compared with 1994 due to an increase in capitalized costs during 1995.\nLITIGATION SETTLEMENT\nLitigation settlement expense during 1995 represents the costs of a lawsuit settlement which is further discussed in Item 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE ----\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report 10\nBalance Sheets at December 31, 1995 and 1994 - May Drilling Partnership 1984-3 11\nBalance Sheets at December 31, 1995 and 1994 - May Limited Partnership 1984-3 12\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1984-3 13\nStatements of Changes in Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1984-3 14\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1984-3 15\nNotes to Financial Statements - May Drilling Partnership 1984-3 and May Limited Partnership 1984-3 16-18\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 19\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTO THE PARTNERS OF MAY DRILLING PARTNERSHIP 1984-3 AND MAY LIMITED PARTNERSHIP 1984-3:\nWe have audited the financial statements of May Drilling Partnership 1984-3 (\"General Partnership\") and May Limited Partnership 1984-3 (\"Limited Partnership\") as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, listed in the accompanying index at Item 8. 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 the General Partnership and the Limited Partnership at December 31, 1995 and 1994, and the results of operations and cash flows of the Limited Partnership for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDenver, Colorado February 27, 1996\nMAY DRILLING PARTNERSHIP 1984-3 BALANCE SHEETS (In thousands)\nNote: The statements of operations and cash flows for May Drilling Partnership 1984-3 are not presented because such information is equal to the Limited Partners' share of such activity as presented in the May Limited Partnership 1984-3 financial statements. The May Drilling Partnership carries its investment in May Limited Partnership 1984-3 on the equity method. The May Limited Partnership 1984-3 financial statements should be read in conjunction with this balance sheet.\nMAY LIMITED PARTNERSHIP 1984-3 BALANCE SHEETS (In thousands)\nMAY LIMITED PARTNERSHIP 1984-3 STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands, except for Units)\nMAY LIMITED PARTNERSHIP 1984-3 STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nMAY LIMITED PARTNERSHIP 1984-3 STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nThe accompanying notes are an integral part of the financial statements.\nMAY DRILLING PARTNERSHIP 1984-3 AND MAY LIMITED PARTNERSHIP 1984-3\nNOTES TO FINANCIAL STATEMENTS\n(1) ACCOUNTING POLICIES AND OTHER MATTERS\nGENERAL PARTNERSHIP\nMay Drilling Partnership 1984-3, a Texas general partnership (the \"General Partnership\"), was organized by May Petroleum Inc. (\"May\") for the purpose of oil and gas exploration through May Limited Partnership 1984-3 (the \"Limited Partnership\"). The General Partnership was formed on November 7, 1984, with investors (\"Participants\") subscribing an aggregate of $6,599,000 in assessable $1,000 units. After the expenditure of the initial contributions of the Participants, additional mandatory assessments from each Participant are provided for under the terms of the general partnership agreement in an amount up to 25% of the initial contribution of the Participant. During 1985, May assessed the Participants 5% of initial contributions. No additional assessments have been made since 1985.\nThe general partnership agreement requires that the manager, Hallwood Energy Partners, L. P. (\"HEP\"), offer to repurchase partnership interests from Participants for cash at amounts to be determined by appraisal of the Limited Partnership's net assets no later than December 31, 1988, and during the two succeeding years, if such net assets are positive. The manager has made repurchase offers in each year since 1989 and intends to make a repurchase offer in 1996.\nAs the General Partnership is the sole limited partner of the Limited Partnership, its results of operations, cash flows and changes in partners' capital are equal to the limited partner's share of the Limited Partnership's results of operations, cash flows and changes in partners' capital as set forth herein. Therefore, separate statements of operations, cash flows and changes in partners' capital are not presented for the General Partnership.\nLIMITED PARTNERSHIP\nThe Limited Partnership, a Texas limited partnership, was organized by May and the General Partnership, for the purpose of oil and gas exploration and production of crude oil, natural gas and petroleum products. The Limited Partnership's oil and gas reserves are concentrated in one prospect in south Louisiana. Among other things, the terms of the Limited Partnership agreement (the \"Agreement\") give the general partner the authority to borrow funds. The Agreement also requires that the general partner's total capital contributions to the Limited Partnership as of each year end, including unrecovered general partner acreage and equipment advances, must be compared to total Limited Partnership expenditures from inception to date, and if such contributions are less than 15% of such expenditures, an additional contribution in the amount of the deficiency is required. As of December 31, 1995, all such contributions had been accrued.\nOn June 30, 1987, May sold to HEP all of its economic interest in the Limited Partnership and account receivable balances due from the Limited Partnership. HEP became the general partner of the Limited Partnership in 1988.\nSHARING OF COSTS AND REVENUES\nCapital costs, as defined by the Agreement, for commercially productive wells and the costs related to the organization of the Limited Partnership are borne by the general partner. Noncapital costs and direct expenses, as defined by the Agreement, are charged 1% to the general partner and 99% to the limited partner. Oil and gas sales, operating expenses and general and administrative overhead are shared so that the general partner's allocation will equal the percentage that the amount of Limited Partnership expenses, as defined, allocated to the general partner bears to the aggregate amount of Limited Partnership expenses allocated to the general partner and the limited partner, plus 15 percentage points, but in no event will the general partner's allocation exceed 50%. The sharing ratio for each of the last three years was as follows:\nSIGNIFICANT CUSTOMERS\nFor the years ended December 31, 1995, 1994 and 1993, purchases by each of the following companies exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nINCOME TAXES\nNo provision for federal income taxes is included in the financial statements of the Limited Partnership or the General Partnership because, as partnerships, they are not subject to federal income tax and the tax effects of their activities accrue to the partners. The partnerships' tax returns, the qualification of the General and Limited Partnerships as partnerships for federal income tax purposes, and the amount of taxable income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes to the partnerships' taxable income or loss, the tax liability of the partners could change accordingly.\nOIL AND GAS PROPERTIES\nThe Limited Partnership follows the full cost method of accounting for oil and gas properties and, accordingly, capitalizes all costs associated with the exploration and development of oil and gas reserves.\nThe capitalized costs of evaluated properties, including the estimated future costs to develop proved reserves, are amortized on the units of production basis. Full cost amortization per dollar of gross oil and gas revenues was $.01 in 1995, $-0- in 1994 and $.03 in 1993.\nCapitalized costs are limited to an amount not to exceed the present value of estimated future net cash flows. No valuation adjustment was required in 1995, 1994 or 1993.\nGenerally no gains or losses are recognized on the sale or disposition of oil and gas properties. Maintenance and repairs are charged against income when incurred.\nGAS BALANCING\nThe Limited Partnership uses the sales method for accounting for gas balancing. Under this method, the Limited Partnership recognizes revenue on all of its sales of production, and any over production or under production is recovered at a future date.\nAs of December 31, 1995 the net imbalance to the Limited Partnership's interest is not considered material. Current imbalances can be made up with production from the existing well.\nUSE OF ESTIMATES\nThe preparation of the financial statements for the Limited Partnership and General Partnership 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.\nRELATED PARTY TRANSACTIONS\nHallwood Petroleum, Inc. (\"HPI\"), a subsidiary of the general partner, pays all costs and expenses of operations and receives all revenues associated with the Limited Partnership's properties. At month end, HPI distributes revenues in excess of costs to the Limited Partnership. The amounts due from HPI were $86,000 and $99,000 as of December 31, 1995 and 1994, respectively. These balances represent net revenues less operating costs and expenses.\nCASH FLOWS\nAll highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior years' amounts to conform to the classifications used in the current year.\n(2) GENERAL AND ADMINISTRATIVE OVERHEAD\nHPI conducts the day to day operations of the Limited Partnership and other affiliated partnerships of HEP. The costs of operating the entities are allocated to each partnership based upon the time spent on that partnership. General and administrative overhead allocated by HPI to the Limited Partnership totaled $44,000 in 1995, $43,000 in 1994 and $53,000 in 1993.\n(3) LEGAL PROCEEDING\nIn the fourth quarter of 1995, the parties settled the lawsuit styled Stutes v. Hallwood Petroleum, Inc. et al. The plaintiff alleged that as a result of exposure to benzene in the petroleum he was hauling from various wells owned and operated by the Limited Partnership and the approximately 80 other named defendants, he contracted myelogenous leukemia. The Limited Partnership's share of the settlement not covered by insurance was $8,000.\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited)\nThe following tables contain certain costs and reserve information related to the Limited Partnership's oil and gas activities. The Limited Partnership has no long-term supply agreements and all reserves are located within the United States.\nCOSTS INCURRED -\nOIL AND GAS RESERVES -\nCertain reserve value information is provided directly to partners pursuant to the Agreement. Accordingly, such information is not presented herein.\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\nThe Drilling Partnership and Limited Partnership are managed by affiliates of HEP and do not have directors or executive officers.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe partnerships pay no salaries or other direct remuneration to officers, directors or key employees of the general partner or HPI. The Limited Partnership reimburses the general partner for general and administrative costs incurred on behalf of the partnerships. See Note 2 to the Financial Statements.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo the knowledge of the general partner, no person owns of record or beneficially more than 5% of the Drilling Partnership's outstanding units, other than HEP, the address of which is 4582 S. Ulster Street Parkway, Denver, Colorado 80237, and which beneficially owns approximately 37.8% of the outstanding units. The general partner of HEP is Hallwood Energy Corporation.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information with respect to the Limited Partnership and its relationships and transactions with the general partner, see Part I, Item 1 and Part II, Item 7.\nPART IV -------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. Financial Statements and Schedules: See Index at Item 8.\nb. Reports on Form 8-K - None.\nc. Exhibits:\n3.1 The General Partnership Agreement and the Limited Partnership Agreement filed as an Exhibit to Registration Statement No. 2- 89194, are incorporated herein by reference.\nSIGNATURES - ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Partnerships have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.\nMAY DRILLING PARTNERSHIP 1984-3 MAY LIMITED PARTNERSHIP 1984-3 BY: EDP OPERATING, LTD., GENERAL PARTNER\nBY: HALLWOOD G.P., INC. GENERAL PARTNER\nBy: \/s\/William L. Guzzetti --------------------------- William L. Guzzetti 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.\nSignature Title Date --------- ----- -----\nVice President \/s\/Robert S. Pfeiffer (Principal February 29, 1996 --------------------------- Accounting ----------------- Robert S. Pfeiffer Officer)","section_15":""}
{"filename":"354604_1995.txt","cik":"354604","year":"1995","section_1":"ITEM 1. Business.\nGeneral\nManor Care, Inc. (\"Manor Care\"), a Delaware corporation organized in August 1981, is a holding company that conducts its business through the Manor Care Hotel Division (\"Hotel Division\") and three principal subsidiaries, Manor Healthcare Corp. (\"Healthcare\"), Vitalink Pharmacy Services, Inc. (\"Vitalink\") and Choice Hotels International, Inc. (\"Choice\"). Healthcare and its subsidiaries have been engaged since October 1968 in the business of developing, owning and managing nursing centers, which provide skilled nursing and convalescent care principally for residents over the age of 65. Healthcare owns approximately 82.3% of Vitalink, a public company that operates institutional pharmacies. Healthcare also owns and operates an acute care general hospital, rehabilitation centers, assisted living centers and nursing assistant training schools. Choice franchises the use of the \"Quality,\" \"Comfort,\" \"Clarion,\" \"Sleep,\" \"Rodeway,\" \"Econo Lodge\" and \"Friendship\" trademarks and other related trademarks and services. The Hotel Division is engaged in the business of owning and operating hotels in the United States under the Choice trademarks. Other subsidiaries of Manor Care are engaged in owning, operating and franchising hotels in foreign countries.\nIn fiscal year 1995, Manor Care derived approximately 32.6% of its total revenues through Medicare and Medicaid programs; aside from the foregoing, Manor Care has no few or single customers upon whom it is dependent.\nIndustry Segments\nThe Business Segment Information set forth on page 28 of the Company's 1995 Annual Report is hereby incorporated by reference.\nManor Healthcare Corp. - Healthcare Operations\nManor Care, through Healthcare and its subsidiaries, owns, operates or manages 179 nursing centers (including 18 medical and physical rehabilitation centers), which provide high acuity services, skilled nursing care, intermediate nursing care, custodial care and assisted living, principally for residents over the age of 65. Manor Care and its subsidiaries also own and operate an acute care hospital, 18 pharmacies, 5 nursing assistant training schools and 15 assisted living centers.\nNursing Center Operations\nHealthcare's nursing centers provide, in general, five types of services:\n-- High acuity services - for persons who require complex medical and physical rehabilitation services (patients who would otherwise be treated in an acute care hospital setting).\n-- Skilled nursing care - for persons who require 24-hour-a-day professional services of a registered nurse or a licensed practical nurse.\n-- Intermediate care - for persons needing less intensive nursing care than that provided to those requiring skilled care.\n-- Custodial care - for persons needing a minimum level of care.\n-- Assisted living - for persons needing some supervision and assistance with personal care.\nServices provided to all patients include the required type of nursing care, room and board, special diets, occupational, speech, physical and recreational therapy and other services that may be specified by the patient's physician, who directs the admission, treatment and discharge of that patient.\nEach high acuity, skilled and intermediate nursing center is under the direction of a state-licensed nursing center administrator supported by other professional personnel, such as a medical director, social worker, dietitian and recreation staff. Nursing departments in each such facility are under the supervision of a director of nurses who is state licensed.\nThe nursing staffs are composed of other registered nurses and licensed practical nurses, as well as nursing assistants. Staff size and composition vary depending on the size and location of each facility.\nManor Care has developed a Quality Assurance Program to ensure that high standards of care are maintained in each center. The Quality Assurance Department is composed of a director, registered nurses, dietitians, nutrition specialists, an environmental services specialist and a recreational therapist. These staff specialists set corporate standards for delivery of care, direct the Quality Improvement Program, and provide consulting and educational services to the centers.\nManor Care's nursing centers range in bed capacity from 52 to 240 beds, have an aggregate bed capacity of 23,830 beds, and achieved an occupancy rate of 90% during the 1995 fiscal year. Manor Care's nursing centers are located in 28 states: Arizona, California, Colorado, Delaware, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Maryland, Michigan, Missouri, Nevada, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Texas, Utah, Virginia, Washington and Wisconsin.\nThe nursing centers are modern structures generally of wall-bearing masonry with fire resistive or protective floor and roof suspension systems. Most have been designed to permit private and semi-private patient room accommodations, and rooms at some facilities may be converted to accommodate up to four beds. Most facilities have individually controlled heating and air-conditioning units. Each nursing center contains a fully equipped kitchen, an isolation room, day room areas, administrative offices and most contain a physical therapy room. Many of Manor Care's centers have specialized wings for assisted living, Alzheimer's patients, individuals with catastrophic injuries, and persons desiring extra amenities and activities. Manor Care believes all of the nursing centers and related equipment are in good condition and well maintained.\nManor Care has reorganized its healthcare operations into three new divisions. The Long-Term Care Division, in addition to operating general purpose skilled nursing centers, operates MedBridge facilities offering post- acute care for patients who no longer need hospital care. Ten MedBridge facilities and eight MedBridge units within skilled nursing centers currently operate in Colorado, Delaware, Illinois, Maryland, New Jersey, Ohio, Pennsylvania and Virginia. During 1995, the Company opened one new 100-bed nursing center in Ohio, and additions totaling 142 beds to 8 existing centers. The Company also acquired three nursing centers located in Illinois and Maryland for approximately $26,560,000. Manor Care currently has 2 new nursing centers with 120 beds each under construction in Florida and Illinois. Additions totaling 107 beds to 3 existing centers also are under construction.\nThe Assisted Living Division operates Springhouse Senior Residences (assisted living facilities designed for the frail elderly) and Arden Courts (assisted living facilities for persons with early to mid-stage\nAlzheimer's who do not yet need nursing care). There are 12 Springhouse facilities, located in California, Florida, Maryland, Michigan, North Carolina and Ohio, which include 2 facilities converted from hotels and opened during the year and 6 newly acquired facilities. Six facilities were acquired during the year for approximately $30,185,000. There are five Arden Courts in Illinois, Maryland and Pennsylvania, three that opened in fiscal 1995 and one each in June and July 1995.\nThe Alternate Site Services Division is exploring the entry into new businesses such as home healthcare and hospice programs.\nPatients seeking the services of the nursing centers come from a variety of sources, and are principally referred by hospitals and physicians. Most of Manor Care's nursing centers participate in state Medicaid and in the federal Medicare program (see \"Federal and State Assistance Programs\"). However, Manor Care attempts to locate and operate its nursing centers in a manner designed to attract patients who pay directly to the facilities for services without benefit of any government assistance program (\"private patients\").\nAs a general rule, the profit margin is higher with private patients than with patients to whom services are rendered with government assistance programs. The following table sets forth certain information concerning revenues from government assistance programs for all of Manor Care's health care operations during fiscal year 1995:\n*Represents the estimated difference between private patient billing rates and amounts recoverable under government programs.\nThe following table sets forth certain information concerning occupancy and revenues of Manor Care's nursing centers and hospital during fiscal year 1995:\nHospital Operations\nManor Care owns and operates Mesquite Community Hospital in Mesquite, Texas, a Dallas suburb. The 172 licensed bed facility, which opened in 1978, is a general medical\/surgical acute care hospital fully accredited by the Joint Commission for the Accreditation of Health Care Organizations. Services include obstetrics, emergency services, coronary\/intensive care, day surgery, skilled nursing, and geriatric psychiatry. Fully equipped, modern ancillary and diagnostic services include MRI, CT, nuclear medicine, cardiac catheterization and ultrasound with doppler. The medical staff, representing virtually every medical and surgical specialty, admit and refer patients into the hospital from their private office practices. Patient services are reimbursed from traditional insurance programs, managed care (HMO and PPO), Medicare and Medicaid. The hospital is in the midst of a 30,000 square foot, two-story addition, which will be completed in Spring 1996 and house a new emergency services department and a four operating suite day surgery center.\nPharmacy Operations\nHealthcare owns 82.3% of Vitalink Pharmacy Services, Inc. (\"Vitalink\"), a publicly traded company that owns and operates 18 pharmacies located in California, Colorado, Florida, Illinois, Indiana, Iowa, Maryland, New Jersey, Ohio, Oregon, Pennsylvania, Texas and Wisconsin.\nVitalink operates institutional pharmacies, which provide, in general, three types of services:\n-- Customized filling of prescription and non-prescription medications for individual patients pursuant to physician orders delivered to nursing facilities.\n-- Consultant pharmacist services to help ensure quality patient care through monitoring and reporting on prescription drug therapy.\n-- Infusion therapy services, consisting of a product (nutrient, antibiotic, chemotherapy or other drugs or fluids) and its administration by tube, catheter or intravenously. Vitalink prepares and delivers the product, which is administered by nursing center staff.\nPursuant to various master agreements, a portion of Vitalink's business is with Manor Care. As of May 31, 1995, Vitalink had contracts to serve 16,000 Manor Care beds and 26,400 beds not affiliated with Manor Care, resulting in revenues of $54,734,000 and $57,523,000, respectively, for fiscal 1995.\nIn April 1995, Vitalink purchased a pharmacy business in San Antonio, Texas, for $2,451,000, and in July 1995, Vitalink purchased a pharmacy business in Loveland, Colorado, for $2,400,000. In June 1994, Vitalink sold its last retail pharmacy, located in Appleton, Wisconsin, for $144,000.\nTraining School Operations\nMedical Aid Training Schools, Inc., a subsidiary of Healthcare, operates five nursing assistant training schools located in New York. The schools provide training for entry level nursing assistants for nursing facilities and home health care.\nRegulation\nManor Care's healthcare facilities are subject to certain federal statutes and regulations and to regulatory licensing requirements by state and local authorities. All of Manor Care's facilities are currently so licensed. In addition, the facilities are subject to various local building codes and other ordinances. It is anticipated that government regulation of the healthcare industry will become more comprehensive in the future. The extent of the impact of such increased regulation on Manor Care's operations and earnings cannot be predicted.\nState and local agencies survey all nursing centers on a regular basis to determine whether such centers are in compliance with governmental operating and health standards and conditions for participation in government medical assistance programs. Such surveys include reviews of patient utilization of healthcare facilities and standards for patient care. Manor Care endeavors to maintain and operate its facilities in compliance with all such standards and conditions. Manor Care believes that at this time, none of its facilities is in violation of any applicable regulation that would threaten the operation of its business or materially affect the standard of care provided.\nFederal and State Assistance Programs\nSubstantially all Manor Care's nursing centers and the Hospital are currently certified to receive benefits provided under the Federal Health Insurance for the Aged Act (commonly referred to as \"Medicare\"), and under programs administered by the various states to provide medical assistance to the medically indigent (\"Medicaid\"). Both initial and continuing qualification of a nursing center or hospital to participate in such programs depends upon many factors including accommodations, equipment, services, patient care, safety, personnel, physical environment, and adequate policies, procedures and controls.\nServices under Medicare consist of nursing care, room and board, social services, physical and occupational therapies, drugs, biologicals, supplies, and surgical, ancillary diagnostic and other necessary services of the type provided by extended care or acute care facilities. Under the Medicare program, the federal government pays the reasonable direct and indirect allowable costs (including depreciation and interest) of the services furnished.\nUnder the various Medicaid programs, the federal government supplements funds provided by the participating states for medical\nassistance to medically indigent persons. The programs are administered by the applicable state welfare or social service agencies. Although Medicaid programs vary from state to state, typically they provide for the payment of certain expenses, up to established limits, at rates based generally on cost reimbursement principles.\nFunds received by Manor Care under Medicare and Medicaid are subject to audit with respect to the proper application of various payment formulas. Such audits can result in retroactive adjustments of revenue from these programs, resulting in either amounts due to the government agency from Manor Care or amounts due Manor Care from the government agency. Manor Care believes that its payment formulas have been properly applied and that any future adjustments will not have a material adverse impact on its financial position or results of operations.\nBoth the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease the rate of program payments to healthcare facilities. Manor Care can give no assurance that payments under such programs will in the future remain at a level comparable to the present level or be sufficient to cover the operating and fixed costs allocable to such patients.\nCompetition\nManor Care's nursing centers compete on a local and regional basis with other long-term healthcare providers, some of which have greater financial resources or operate on a nonprofit basis. The degree of success with which Manor Care's nursing facilities compete varies from location to location and is dependent on a number of factors. Manor Care believes that the quality of care provided, reputation and physical appearance of facilities, and, in the case of private patients, charges for services, are significant competitive factors. Accordingly, it seeks to meet competition in each locality by establishing a reputation within the local medical communities for competent and competitive nursing center services. 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.\nManor Care's Hospital encounters competition in the Mesquite, Texas area where it competes for community and physician acceptance with other hospitals. Vitalink's pharmacies compete with other local distributors of pharmaceuticals.\nHotel Division - Domestic Lodging Operations\nThe Hotel Division operated 48 hotels containing a total of 7,971 rooms as of May 31, 1995. During 1995, the Hotel Division purchased 16 hotels containing 2,339 rooms in Arizona, Florida, Maryland, Massachusetts,\nMichigan, Ohio, Pennsylvania, South Carolina, Texas and Virginia for an aggregate purchase price of approximately $59,800,000.\nThe hotels operate under the \"Clarion,\" \"Comfort,\" \"Quality,\" \"Sleep,\" \"Econo Lodge\" and \"Rodeway\" trade names and are located in Alabama, Arizona, California, Florida, Georgia, Louisiana, Maryland, Massachusetts, Michigan, Missouri, North Carolina, Ohio, Pennsylvania, South Carolina, Texas, Utah and Virginia. All of the hotels are owned by Manor Care or its subsidiaries except two hotels located in California, which are leased.\nDuring 1995, lodging revenues and expenses included food and beverage sales of $8,121,000 and costs of sales of $6,866,000.\nQH Europe Partnership - Foreign Lodging Operations\nQuality Hotels Europe, Inc. and Choice Hotels International, Inc. (\"Choice\"), subsidiaries of Manor Care, formed QH Europe Partnership in 1994 to own, operate and franchise hotels in Europe. Partnership subsidiaries own three hotels in Germany and one in England containing 610 rooms, which operate under the \"Comfort\" or \"Quality\" trade names.\nDuring 1994, Partnership subsidiaries acquired certain assets of a French hotel chain, consisting primarily of franchise rights to approximately 100 hotels (now using the \"Comfort\" trade name) plus two owned and six leased hotels. During 1995, operations grew to 139 franchisees and eight leased hotels.\nChoice Hotels International, Inc. - Franchise Operations\nManor Care owns 100% of the Preferred Stock and approximately 94.5% of the Common Stock of Choice, which franchises the use of the \"Quality,\" \"Comfort,\" \"Clarion,\" \"Sleep,\" \"Econo Lodge,\" \"Friendship\" and \"Rodeway\" trademarks.\nServices provided to franchisees include national and regional meetings and periodic seminars to provide information on hotel operations and recent developments in the industry, training programs for franchisees and their employees, advertising and marketing, dissemination of directories of franchised locations, participation in a national reservations system and agreements with credit card companies.\nChoice also offers its franchisees interior design and decorating services and purchasing services for hotel furniture, fixtures and supplies. During 1995, the revenues and expenses of Choice included hotel supplies sales of $18,227,000 and costs of sales of $13,946,000.\nThe standard franchise agreement currently offered by Choice for Clarion Hotels (luxury), Quality Inns and Quality Suites (mid-priced), Comfort Inns and Comfort Suites (luxury-budget) and Sleep Inns (economy hotels with standardized design) provides for an initial fee of $300 per guest room with a $40,000 minimum ($35,000 for Quality). Choice sells Econo Lodge and Rodeway Inn franchises (economy brands) for an initial fee\nof $250 per guest room ($25,000 minimum). In addition, franchisees are required to pay a royalty fee of 3% to 5% of gross room revenues (depending on brand) and assessments for reservations and marketing services at rates that may be changed to reflect inflation and actual costs incurred. The agreement normally is for a 20-year term.\nChoice has discontinued selling new Friendship Inn franchises, and many existing Friendship Inns have been repositioned to the Rodeway brand.\nChoice supplies disclosure statements containing information for prospective franchisees in accordance with regulations of the Federal Trade Commission (\"FTC\"). In addition to the FTC regulations, certain states have requirements for registration of franchisors and disclosure requirements similar to the FTC regulations.\nChoice and an affiliate of Journey's End Corporation, a Canadian lodging management company, each own a 50% interest in a corporation that franchises Choice brands in Canada. Choice also has franchised hotels in more than 25 other foreign countries, including England, Ireland, Norway, France, Italy, Germany, India, New Zealand, Australia, Japan, Thailand and Mexico.\nAs of May 31, 1995, the seven hotel chains comprised 2,835 open and operating hotels with 245,669 rooms, as set forth below:\nCompetition\nThe above hotels compete with other hotels in nearby locations, some of which are affiliated with chains that are more widely known or offer different types of services. Demand for accommodations at both franchised and company-owned hotels is affected by such factors as the availability of accommodations in the local area and national and regional economic conditions. The operation of hotels may be seasonal, with a large percentage of revenues generated in the summer months.\nIn the sale of franchises, Choice competes with many other hotel franchisors, some of which have greater financial resources and offer different fee structures and franchise services. However, Choice believes that its continued growth, innovative hotel brands and successful reservations and marketing services enhance its competitive position.\nEmployees\nAs of May 31, 1995, Manor Care employed approximately 27,812 full and part-time employees, 23,135 of whom were employed in healthcare operations, 4,225 of whom were employed in lodging and franchise operations, and the remainder in Manor Care's headquarters.\nFrom time to time, some of Manor Care's nursing centers and the Hospital experience shortages of professional nursing help which may require Manor Care to seek temporary employees through employment agencies at an increased cost. Manor Care does not believe that use of these contract employees has had a material adverse effect on its financial position to date.\nA majority of the employees are covered by the federal minimum wage laws, and a few employees are represented by labor unions. Attempts have been made from time to time to unionize employees of certain other facilities. Manor Care believes that it enjoys a good relationship with its employees.\nInsurance\nManor Care maintains property insurance on its healthcare and lodging facilities. Manor Care insures some of its liability exposures and self insures, either directly or indirectly through insurance arrangements requiring it to reimburse insurance carriers, some of its liability risks other than catastrophic exposures. Physicians and dentists practicing at the Hospital are responsible for their own professional liability insurance coverage. Manor Care insures its workers' compensation risks in some states and self insures in others.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nAs of May 31, 1995, Manor Care owned, leased or managed 179 nursing and rehabilitation centers in 28 states and one acute care general hospital in Texas, as indicated below:\nAs of May 31, 1995, Vitalink leased 18 pharmacies in 13 states and its corporate offices in Naperville, Illinois. As of May 31, 1995, Manor Care owned or leased 62 hotels consisting of 48 domestic hotels containing 7,971 guest rooms and 14 hotels containing 1,160 rooms located in foreign countries. Manor Care also owned 15 assisted living centers.\nManor Care owns its three headquarters buildings in Silver Spring, Maryland; a fourth building in Silver Spring that is used by employees and leased to third parties; a building in Phoenix, Arizona, that serves as Western Regional Office of Choice; and several undeveloped parcels. Manor Care also leases office space as needed to accommodate regional employees.\nForty-eight (48) nursing centers and hotels have been pledged to secure related mortgage and capital lease obligations.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\n- On September 10, 1985, the U.S. Environmental Protection Agency sued Healthcare and other defendants in U.S. District Court, District of New Jersey, seeking clean-up costs at Lipari Landfill. A subsidiary that Healthcare acquired in its 1981 acquisition of Cenco Incorporated was alleged to have transported wastes to the landfill in the 1960's. The USEPA and the defendants have entered into a Consent Decree requiring the defendants to contribute approximately $52 million for certain clean-up costs. Healthcare's share of the settlement is approximately $2.6 million, most of which is covered by insurance. The USEPA is seeking additional funds from the defendants in connection with a future phase of the clean-up.\n- On October 30, 1989, the New Jersey Department of Environmental Protection sued Manor Care and other defendants in U.S. District Court, District of New Jersey, seeking clean-up costs at Kramer Landfill where the Cenco subsidiary allegedly transported wastes. On September 10, 1990, Transtech Industries, Inc. and other parties sued numerous defendants, including the Cenco subsidiary, in U.S. District Court, District of New Jersey, for contribution in connection with clean-up of Kin-Buc Landfill. The State of New Jersey also has issued administrative directives ordering numerous parties, including Manor Care as the alleged successor to the Cenco subsidiary, to contribute to the clean-up of various other landfills.\nManor Care also is subject to other regulatory and legal actions, investigations or claims for damages that arise from time to time in the ordinary course of business. Manor Care is defending the claims against it and believes that these proceedings will not have a material adverse effect on its financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended May 31, 1995.\nEXECUTIVE OFFICERS OF MANOR CARE, INC.\nThe name, age, title, present principal occupation, business address and other material occupations, positions, offices and employment of each of the executive officers of Manor Care, Inc. (\"Manor Care\") are set forth below. The business address of each executive officer is 10750 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise indicated.\nStewart Bainum, Jr. (49) Chairman of the Board of Manor Care and Manor Healthcare Corp. (\"Healthcare\") since March 1987; Chief Executive Officer of Manor Care since March 1987 and President since June 1989; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. (\"Vitalink\") since February 1995; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care since August 1981, of Vitalink since September 1991, of Healthcare since 1976 and of Choice Hotels International, Inc. and its predecessors (\"Choice\") since 1977; Chief Executive Officer of Healthcare since June 1989 and President from May 1990 to May 1991; Chairman of the Board and Chief Executive Officer of Vitalink from September 1991 to February 1995 and President and Chief Executive Officer from March 1987 to September 1991; Chairman of the Board of Choice from March 1987 to June 1990.\nStewart Bainum. (76) Vice Chairman of the Board of Manor Care and subsidiaries since March 1987; Chairman of the Board of Manor Care from August 1981 to March 1987, Chief Executive Officer from July 1985 to March 1987, President from May 1982 to July 1985; Chairman of the Board of Healthcare from 1968 to March 1987 and a Director since 1968; Director of Vitalink from September 1991 to September 1994; Chairman of the Board of Choice from 1972 to March 1987 and a Director since 1963; Chairman of the Board of Realty Investment Company, Inc. since 1965.\nDonald J. Landry. (46) President of Choice since January 1995; President of Manor Care Hotel Division since March 1992; various executive positions with Richfield Hotel Management, Inc. and its predecessors for more than 15 years, including President of MHM Corporation.\nWeldon Humphries. (58) Senior Vice President-Real Estate and Development of Manor Care since August 1981, of Choice since February 1981 and of Healthcare since December 1980.\nJames A. MacCutcheon. (43) Senior Vice President, Chief Financial Officer and Treasurer of Manor Care, Healthcare and Choice since September 1993; Senior Vice President-Finance and Treasurer from October 1987 to September 1993; Treasurer of Vitalink since September 1992 and a Director since September 1994; Senior Vice President-Finance and Treasurer and a Director of Vitalink from October 1987 to September 1991.\nJames H. Rempe. (65) Senior Vice President, General Counsel and Secretary of Manor Care since August 1981, of Choice since February 1981 and of Healthcare since December 1980; Secretary of Vitalink since January 1983 and a Director since September 1994; Senior Vice President and a Director of Vitalink from January 1983 to September 1991.\nCharles A. Shields. (51) Senior Vice President-Human Resources of Manor Care since September 1992; Vice President-Human Resources from October 1989 to September 1992.\nLeigh C. Comas. (29) Vice President-Finance of Manor Care since August 1995; Assistant Treasurer since September 1993; Manager of Corporate Finance from June 1992 to September 1993; previously a business student at Stanford University Graduate School of Business.\nDonald E. Feltman. (40) Vice President-Development of Manor Care since April 1993; previously employed for five years as Director of Development of Marriott Corporation's Senior Living Services Division.\nLarry R. Godla. (38) Vice President-Construction of Manor Care since March 1993; Director of Construction from January 1990 to March 1993.\nGary L. Henson. (41) Vice President-Information Resources since September 1993; Director of Information Resources from April 1993 to September 1993; Director of Data Processing Operations from April 1991 to April 1993; Director of Corporate Information Systems from December 1988 to April 1991; various other data processing positions from June 1982 to December 1988.\nAlan Marsh. (47) Vice President-Risk Management of Manor Care since September 1986; Vice President-Administration from November 1984 to September 1986.\nGregory D. Miller. (41) Vice President-Strategic Planning of Manor Care since May 1992; Vice President-Marketing and Strategic Planning of Healthcare since March 1995; various planning and marketing positions at Marriott Corporation for more than five years, including Vice President-Planning and Business Development for Courtyard by Marriott.\nJohn M. Sabin. (40) Vice President-Finance and Assistant Treasurer of Manor Care since December 1993; Vice President- Mergers and Acquisitions of Choice since May 1995; Vice President, Corporate Mergers and Acquisitions at Marriott Corporation for more than five years.\nMargarita Schoendorfer. (46) Vice President-Controller of Manor Care, Healthcare and Choice since November 1990; Corporate Controller from April 1986 to November 1990; Assistant Corporate Controller from August 1981 to April 1986.\nDonald C. Tomasso. (50) President, Long-Term Care Division, of Healthcare since February 1995 and a Director of Healthcare since June 1991; President and Chief Operating Officer of Healthcare from May 1991 to February 1995; Chairman and Chief Executive Officer of Vitalink since February 1995 and Vice Chairman from September 1991 to February 1995; previously employed by Marriott Corporation for more than five years, including as Executive Vice President\/General Manager of the Roy Rogers Division.\nJoseph Buckley. (47) President, Assisted Living Division, of Healthcare since February 1995; Senior Vice President- Information Resources and Development of Manor Care from June 1990 to February 1995; Vice President-Information Resources from July 1989 to June 1990; Vice President-Real Estate from September 1983 to July 1989.\nMark L. Gildea. (43) President, Alternate Site Services Division, of Healthcare since December 1994; Vice President, Managed Care Marketing, from December 1993 to December 1994; Executive Vice President of Option Care, Inc. from October 1992 to December 1993; previously employed by Caremark, Inc. for over 10 years, including as Area Vice President.\nDonna L. DeNardo. (43) President and Chief Operating Officer of Vitalink since September 1991; Vice President of Healthcare and Vice President and General Manager of Vitalink from December 1989 to September 1991; various management positions with Healthcare from 1977 to December 1989 including Senior Regional Director of Nursing Facility Operations. Business address: 1250 East Diehl Road, Naperville, Illinois 60563.\nRobert C. Hazard, Jr. (60) Co-Chairman of Choice since January 1995 and a Director since December 1980; Chairman from June 1990 to January 1995 and Chief Executive Officer from December 1980 to January 1995; President from December 1980 to June 1990.\nGerald W. Petitt. (49) Co-Chairman of Choice since January 1995 and a Director since December 1980; President from June 1990 to January 1995 and Chief Operating Officer from December 1980 to January 1995; Executive Vice President from December 1980 to June 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe shares of Manor Care's Common Stock are listed and traded on the New York Stock Exchange. Information on the high and low sales prices of Manor Care's Common Stock during the past two years is included on page 28 of the 1995 Annual Report and is incorporated herein by reference.\nAs of July 31, 1995, there were 3,131 record holders of Manor Care Common Stock.\nInformation required on the frequency and amount of any dividends declared during the past two years with respect to such Common Stock is included on page 28 of the 1995 Annual Report and is incorporated herein by reference.\nPART IV\n3. Exhibits\n(b) No report on Form 8-K was filed during the last quarter of the fiscal year ended 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.\nDated: August 28, 1995 MANOR CARE, INC.\nBy:\/s\/ James A. MacCutcheon ----------------------------- James A. MacCutcheon Senior Vice President- Finance and Treasurer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE SHAREHOLDERS OF MANOR CARE, INC.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Manor Care, Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated June 20, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index 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. 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\nWashington, D.C., June 20, 1995\nSchedule II\nMANOR CARE, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts\n(in thousands of dollars)\n(A) Represents reserves of acquired companies.\nEXHIBIT INDEX\nEXHIBIT INDEX Continued","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":"350387_1995.txt","cik":"350387","year":"1995","section_1":"ITEM 1. - HISTORY AND BUSINESS OF THE COMPANY\nThe Company was incorporated in Michigan in 1979 and commenced business in 1980. Originally, the Company was formed as a passive investor in oil and gas drilling ventures with Reef Petroleum Corporation (RPC) which was the operator of the wells drilled. However, in September of 1983, RPC filed a Chapter 11 Petition in the Bankruptcy Court of the Western District of Michigan and since then has liquidated all of its assets in a final bankruptcy action. In 1986, the Company's involvement with RPC was terminated.\nDuring 1987, the Company entered into a Management Agreement with Penteco Corporation to analyze the Company's financial position and provide management services to the Company. The Agreement called for an 18 month option to Penteco to purchase an additional 1,000,000 shares at $.31 per share and a 36 month option to purchase an additional 1,000,000 shares at $.50 per share. In 1990, the Management Agreement was extended for a three year period through September, 1993. Penteco has exercised part of their option for 1,000,000 shares at $.31 per share. Effective January 1993, the Management Agreement with Penteco Corporation was terminated, and those responsible for management duties became salaried employees or advisors to the Company.\nIn an exchange of shares in 1987, the Company purchased from Penteco a 12% interest in the general partners portion of the 1985-A Limited Partnership (Penteco East Central Pipeline) and from Penteco a 10% interest in Lincoln Gas and Oil Marketing Corporation for a total price of $290,000. Penteco East Central Pipeline is a gas gathering and transmission system located in the area of Southern Kansas and Northern Oklahoma. In 1991, Penteco East Central Pipeline was sold to Consolidated Capital of North America. Penteco received, and is holding for the benefit of the partnership, 450,000 shares of $1.00 preferred stock of Consolidated Capital. In addition, Penteco acquired for the partnership, a 10 percent working interest after debt service in the Tulare Lakes Field from Chevron. Lincoln Gas and Oil Marketing Corporation is located in Boston, Massachusetts and is involved in the development and supply of gas to co-generation facilities. In a restructuring of Lincoln Gas and Oil Marketing, Penteco provided an opportunity for General Energy to increase its holdings to 20 percent of Lincoln Gas and Oil Marketing and also to receive a 10 percent interest in Eastern Pacific Energy Corporation located in Los Angeles, California. During 1989 and 1992, the Company determined the value of these investments have suffered permanent declines of $185,000 and $103,950 respectively. Consequently, these investments are now carried at a value of $1,050.\nIt is the Company's intention to continue to drill or participate in the drilling of exploratory and development wells in the states of Michigan, Texas, Louisiana, Mississippi and Oklahoma in an effort to develop its oil and gas reserves. In order to facilitate this plan, the Company has purchased an interest in various oil and gas leases.\nDuring 1995, the Company participated in and operated a Niagaran horizontal well in Otsego County. The well tested both oil and gas and plans are to extend the well horizontally to further improve the production rates. The Company has interest in several gas wells that were hooked up in 1995 in South Texas and also acquired and operated a Niagaran gas discovery in Grand Traverse County which was drilled in early 1996.\nDESCRIPTION OF BUSINESS OF THE COMPANY\nIdentification of Prospects and Prospect Acquisition The Company will, as in the past, selectively maintain its lease inventory on the basis of its own information, the interpretation of the Company's seismic, geological and geophysical information and such additional information as may be acquired. The Company also is actively seeking and participating in exploration projects with other companies by purchasing working interest on a selective basis.\nThe following table provides information as to the expiration of the Company's leases (assuming extension by payment of delay rentals to the extent possible); and is intended to supply information required pursuant to industry Guide 2 Paragraph 5. All of the following leases are located in the state of Michigan.\nAcres Years of Expiration Gross Net ___________________ ____________________ 1995 560.000 160.000 1996 332.203 200.000 1997 160.000 40.000 1998 0.000 0.000\nGeology - Seismic Testing The Company prefers, where possible, to act on the basis of geophysical as well as geological information. A seismic survey of the areas covered by its inventory of leases is undertaken and evaluated. The Company's Geology Department seeks to utilize both seismic and geological data (primarily the results from nearby drilling) to locate geological traps which may contain hydrocarbons.\nDrilling, Completion and Operations of Producing Wells 1. During 1995, the Company participated in 1 wildcat prospect, which was successful. The Company also participated in the recompletion and workover of several wells in our 20 well Tulare Lakes Field in California. 2. The rights and obligations of the Company, as operator, are governed by a Lease Development Agreement (or, in the case of a participation commencing with the acquisition of the lease, a Lease Acquisition and Development Agreement) and a Standard Operating Agreement which provides for the allocation of costs, including specified amounts to defray the Company's nonspecifically identifiable costs based upon the depth of the well and other scheduled factors. 3. During 1995, the Company's Exploration Department supervised the drilling and completion of its wells; which included downhole completion as well as selecting the surface handling facilities to measure and separate out water and gas from oil, providing the connections to the gas pipelines and the storage tanks for oil and installing meters to measure production.\nMarketing Production from the Company's royalty and working interests is marketed by the operator of the well, generally to a major oil company or gas utility.\nIn the twelve month period ending December 31, 1995, the following purchasers accounted for more than 10 percent of the Company's oil and gas revenues:\nChevron 49% Shell Oil 14%\nOther purchasers of the Company's oil and gas production include Michigan Consolidated Gas, Total Petroleum, Delta Oil Company, Petrostar Energy and Peninsular Oil and Gas.\nSubstantially all gas sales are made under long term contracts with the above utilities. These contracts may relate either to the reserves from a specified well or wells or to those to be developed from specified acreage and generally obligate the utility to take or pay for specified annual quantities, typically in amounts sufficient to account for the bulk of the reserves within ten years or less. The contracts normally extend for a term substantially co-extensive with the life of the reserves and provide for periodic price adjustments, which usually involve annual or more frequent price increases on the basis of specified percentage or dollar increments and may also involve provision for increases or price limitations based on the prices paid to others for natural gas or alternative fuels or those permitted generally to be paid for natural gas pursuant to government price regulations. The Company has no reason to believe that any of the contracts for the sale of gas will be voided. Oil is sold under less structured arrangements and at posted prices more immediately responsive to market conditions.\nContracts, Accounting and Related Functions The Company handles the following procedures concerning the drilling of new wells: Contract negotiations, price determinations, government compliance, including, for example, NGPA-FERC gas well filings, maintenance of computerized records providing ownership and revenue distribution data on a well-by- well and owner-by-owner basis. The Company generates and distributes monthly reports containing information as to daily production and sales together with, in the case of working interest owners, operating statements detailing expenses.\nEmployees The Company began employing certain accounting and operations personnel in March, 1983. The Company presently has employees in the executive, geology and land, data processing, accounting and operations areas. The Company will also utilize third party contractors for needed services. None of the Company's employees are represented by a labor union or collective bargaining agent. Relations with the employees are good. There have been no work stoppages associated with labor disputes or grievances.\nAs of January 1, 1996, there are six employees of the Company.\nCompetition The Company competes with major oil companies, independent operators and others in acquiring drilling prospects, in contracting for oil and gas field services and equipment, in selling oil and gas production and in securing trained personnel.\nThe Company is not a significant factor in the oil and gas business even within the limited geographic area in which its operations are conducted.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. - PROPERTIES\nOil and Gas Reserves The Company has not filed estimates of its oil and gas reserves with any Federal Agency other than the Securities and Exchange Commission. The reserve information set forth in this section has been compiled from estimates made by the independent engineering firm of K&A Energy Consultants, Inc., Tulsa, Oklahoma in a report dated January 1, 1992 (and updated January 1, 1996 internally) on an unescalated basis for the Companies most productive 16 wells and from the independent engineering firm of Evan, Carey and Crozier, Bakersfield, California in a report dated July 24, 1989 and revised August 1, 1993 by Basim Ziara, Petroleum Engineering Consultants for the companies production purchase and operations in California. The remaining reserve figures are from a report dated January 1, 1988 and revised January 1, 1996 internally based on 1988 through 1995 production history changes, if any, and the acquisition and sale of production properties. The Company removed all reserve estimates from the Tulare Lakes Field in California and added reserves for the St. Dover & House #1-33A well in Otsego County, Michigan.\nReserve Category - Net to the Appraised Interest Interest Oil Gas Future Net Present Worth Cond. (Mcf) Cash Flow Discounted at (Bbls) 10 Percent _________________________________________________________________ Proved Developed Producing Totals n\/a n\/a n\/a n\/a\nOil and Gas Production The Company's net oil and gas production, constituting its share of production from its working and royalty interests for the years ended December 31, 1995, 1994 and 1993 are set forth in the table below: 1995 1994 1993 ____ ____ ____ Oil (Bbls) 11,920 16,634 22,736 Gas (Mcf) 63,342 65,034 65,839\n- --All of the Interests and Reserves of the Company are located within Michigan, with the exception of three fields.\nPrices and Costs The following tables set forth the average sales price per unit and average lifting cost with respect to the Company's production of oil and gas for the past three years.\nAverage sales Price per unit 1995 1994 1993 ____ ____ ____ Oil (Per Bbl) 16.73 14.40 16.76 Gas (Per Mcf) 1.97 2.37 2.78\nThe price per barrel of oil as of March 31, 1996, is $20.50 and the price per mcf of gas as of the same date ranges from $2.00 to $3.50 per mcf.\nAverage lifting cost (Oil & Gas Combined) 1995 1994 1993 ____ ____ ____ 12.24 9.06 9.44\nLifting costs include monthly operating charges and operating expenses but, do not include severance or windfall profit taxes.\nAverage lifting cost per sales dollar was $.82\nGross Net Exploratory Wells Net Development Wells _____ _____________________ _____________________ Year Wells Oil Gas Dry Oil Gas Dry ____ _____ ___ ___ ___ ___ ___ ___ 1991 9 .0400 ---- .0450 .00475 .0812 .0200 1992 10 .0400 ---- .3250 .08000 .0812 ---- 1993 5 ---- .0400 .0200 ---- ---- ---- 1994 10 ---- .0050 .0600 ---- ---- ---- 1995 1 .1500 ---- ---- ---- ---- ----\nFrom inception through January 1, 1996, the total gross wells (a well in which a working interest is owned) in which the Company has an interest is 27 and the total net productive wells (the fractional ownership working interests in gross wells equal to one) is 1.49.\nAs of January 1, 1996, the total gross developed acres (acres spaced or assignable to productive wells) is 7,720.\nAll working interests and acreage is located within the United States of America.\nThe Company's total working interest reserves developed during 1995 are as follows: Total Reserves Wells Drilled Developed ______________________ ______________________ Total Successful Dry Disposal Well Oil (Bbls) Gas (Mcf) _____ _________ ___ _____________ __________ _________ 1 1 0 0 24,000 0\nITEM 3.","section_3":"ITEM 3. - LEGAL PROCEEDINGS\nOn June 2, 1995, a lawsuit was filed in the Superior Court of the State of California for the County of Kings by Kings County Development Limited, a California Limited Partnership and J.G. Boswell Company, a California corporation as Plaintiffs. This lawsuit is due to a prior dispute between Chevron U.S.A., the previous owner of the field, and the royalty and land owners and was filed against numerous defendants including General Energy Resources and Technology Corporation and G.E.N.Y. Operations Inc., its subsidiary.\nThe cost of legal defense involving this lawsuit would have been greater than the Company could bear. In addition, General Energy does not have a working interest in the wells and was not a party to the contract with Chevron. The judge in California has left open the future option to consider a malicious prosecution action against the Plaintiffs with regard to the cause of action against General Energy.\nUpon recommendation of legal counsel, on March 25, 1996, General Energy and G.E.N.Y. Operations filed petitions for protection under Chapter 11 of the Bankruptcy Code.\nTo date, all attempts to negotiate a settlement with the California group have been unsuccessful. We hope that a settlement can be reached in the context of these Chapter 11s and are diligently working toward that conclusion.\nITEM 4.","section_4":"ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe registrant did not submit any matters for a vote of security holders during the fourth quarter of 1995 through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. - MARKET FOR THE REGISTRANTS COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS\nAs of March 1, 1996, there are 7,991,870 shares of the Company's Common Stock outstanding. The Company has registered the Common Stock under Section 15(d) of the Securities and Exchange Act of 1934. All warrants to purchase common shares expired on April 22, 1986 and there are no longer any warrants outstanding.\nThe stock is principally traded on the over-the-counter market. The high and low sales prices for the Company's Common Stock, for the following periods were:\nCommon Stock Common Stock 1995 Bid Asked 1994 Bid Asked ____ ____________ ____ ____________ December 31 1\/16 1\/4 December 31 1\/16 1\/4 September 30 1\/16 1\/4 September 30 1\/16 1\/4 June 30 1\/16 1\/4 June 30 1\/16 1\/4 March 31 1\/16 1\/4 March 31 1\/16 1\/4\nThe number of holders of record of the Common Stock as of March 1, 1996 totaled approximately 1,000. No dividends, either cash or stock, have been declared as of December 31, 1995, and there is no present intention on the part of the Company to declare dividends in the foreseeable future.\nITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity\/Capital Resources Net cash from operating activities for the Company as of the three most recent year-ends is as follows:\n1995 1994 1993 ____ ____ ____ Cash Flows 333,180 (89,695) (88,643)\nThe Company has generated cash flow from operations, bank borrowings and the funds derived from its initial public offering in 1981, which yielded $3.7 million. Private sales from stock and the exercise of options have provided additional working capital.\nIn June 1989, one of the Company's major trade creditors, Mosbacher Energy Company (MEC), filed an operator's lien against various properties in which the Company owns a working interest and for which the Company owed MEC operating expenses. The liens resulted in the curtailment of revenue from these properties. A repayment plan was negotiated and on June 1, 1990, the Company signed a $292,814 promissory note with MEC for the amount owed MEC by General Energy Corporation for well operations as of May 7, 1990. The note is secured by the Company's interest in eleven producing properties operated by MEC and bears interest at 7 1\/4 percent per annum. The terms of the agreement call for a monthly payment to Mosbacher Energy Company of the lesser of $20,000 or one months production of the secured properties.\nIn August of 1991, the Company borrowed $350,000 from Huntington Banks of Michigan. The note was secured by the personal guarantees of H. Terry Snowday and Edgar R. Puthuff, directors of the Company. Interest was payable monthly at one percent over the bank prime rate.\nProceeds from this note were loaned to American Barter Petroleum, Inc. to be used in a production property purchase in California. Interest is due at one percent over prime and principal is paid back out of production according to a predetermined schedule. In exchange for this loan, the Company received a 25 percent interest in net revenue.\nBoth notes were paid in full in October, 1992.\nIn 1991, the Company recorded approximately $875,500 of long-term debt on the Tulare Lakes Field. This represents a 25% share of the outstanding debt on the field. This is a non recourse debt. General Energy is not a party to the purchase contract between Chevron, Penteco and American Barter. The Company's 25% interest was to be paid from Penteco Corporation's working interest percentage, net of expenses. As of December 31, 1995, the total revenue from the field continued to be less than the total expenses with no expectation of improvement within the next twelve months. Management determined the asset and liability to be unrealistically presented on the financial statements and the outstanding debt balance of $908,410 which included accrued interest and the asset balance of $717,288, net of accumulated DD&A, were written off.\nThe Company has been able to satisfy its long-term debt commitments. The balance of accounts payable however, has increased to $692,031 at December 31, 1995 compared to $434,937 at December 31, 1994. A large portion of the accounts payable are for services provided by companies that have been very tolerant regarding timing of payment for these services.\nThe monthly operating cost for direct obligations for rent of the Company's office space will be $775.00. Management is aware that it has limited capital resources available with which to continue a lease acquisition\/exploration program. Evaluation of various investment alternatives will continue to be made on a case-by- case and\/or well-by-well basis, and commitments will be made as funds permit.\nManagement believes cash flow from the sale of its currently producing oil and gas properties as well as the two projects being completed in 1996, should be sufficient to pay current operating liabilities and to amortize the current portion of the long-term debt.\nManagement has developed contingency plans to obtain additional capital by the issuance of debt or sale of equities to the extent that these actions become necessary in the future.\nThe price that the Company received for oil during 1995 ranged from $15.26 to $18.75. The posted price for crude oil is at $20.50 per barrel as of March 31, 1996. There is uncertainty as to the price of oil over the next twelve months.\nWhile the sale of gas remains subject to NGPA regulated pricing policies, it is recognized that certain concessions must be made as to contractual pricing to insure that the Company's gas reserves remain a competitive alternative fuel.\nResults of Operations _____________________ Revenues Oil and gas sales Working interest $ 277,027 $ 333,805 $ 412,239 Royalty interest 57,007 71,268 91,108 Gain (loss) on sale of turnkey working interests and oil properties 29,456 31,970 22,808 Repromotional income 5,739 1,743 14,321 Consulting income 59,198 0 0 Administrative overhead 25,700 21,000 10,500 Gain on write-off 299,164 0 0 Other income 3 832 5,574 _________ _________ _________ Total Revenues 753,294 460,618 556,550 Net Earnings (loss) $ 191,588 $ (146,250) $ (467,877) ========= ========= =========\nThe Company's total revenues increased $292,676 from $460,618 at December 31, 1994 to $753,294 at December 31, 1995 and the Company's operating loss decreased $337,838 from $(146,250) at December 31, 1994 to $191,588 at December 31, 1995.\nA major factor contributing to the Company's year end earnings was a gain of $299,164 resulting from the write-off of a producing oil and gas property and its liability.\nThe cost incurred in oil and gas property acquisitions, exploration and development activities for the year ended December 31, 1995 totaled $29,117 and capitalized costs related to oil and gas producing activities as of December 31, 1995 totaled $338,551 as compared to $42,111 and $1,087,239 respectively in 1994.\nITEM 8. - FINANCIAL STATEMENTS\nConsolidated Balance Sheets. . . . . . . . . . . . . . 15 Consolidated Statements of Operations. . . . . . . . . . 17 Consolidated Statements of Cash Flows. . . . . . . . . . 19 Consolidated Statements of Stockholders' Equity. . . . . 21 Notes to Consolidated Financial Statements . . . . . . . 22 Supplemental Schedules . . . . . . . . . . . . . . . . . 31\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Balance Sheets, December 31, 1995 and 1994\nASSETS 1995 1994 ____ ____ CURRENT ASSETS Cash $ 136,108 $ 55,923 Accounts Receivable Trade 592,224 381,522 Less Allowance for Doubtful Accounts (8,698) (8,698) Prepaid Expenses 437 313 _________ _________ Total Current Assets 720,071 429,060\nPROPERTY AND EQUIPMENT, AT COST Proved Oil and Gas Properties, Successful Efforts Method of Accounting 2,891,901 3,724,331 Unproved Leasehold and Minerals 85,106 85,106 Drilling Contracts in Progress 12,213 11,253 _________ _________ 2,989,220 3,820,690 Less Accumulated Depreciation, Depletion, and Amortization 2,650,669 2,733,451 _________ _________ Net Property and Equipment 338,551 1,087,239\nOTHER ASSETS Investments (net of unrealized loss of $288,950) 1,050 1,050 _________ _________ $1,059,672 $1,517,349 ========= =========\nLIABILITIES AND STOCKHOLDER'S EQUITY\nCURRENT LIABILITIES Current Portion Long-Term Debt $ 3,000 $ 54,749 Account Payable Trade 692,031 434,937 Notes Payable 111,000 111,000 Joint Interest Prepayment 135,371 108,583 Salaries Payable 54,923 40,000 Stock Options Payable 25,603 25,603 _________ _________ Total Current Liabilities 1,021,928 774,872\nLONG-TERM DEBT 55,429 951,750\nSTOCKHOLDERS' EQUITY Common Stock ($.10 Par Value, 18,000,000 Shares Authorized, 7,991,870 Shares Issued and Outstanding) 799,187 799,187 Additional Paid-in Capital 7,435,012 7,435,012 Deficit (8,251,884) (8,443,472) _________ _________ Total Stockholders' Equity (17,685) (209,273) ========= ========= Total Liabilities and Stockholders' Equity $1,059,672 $1,517,349 ========= =========\nSee Accompanying Notes to Financial Statements\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Statements of Operations For the Years Ending December 31, 1995, 1994 and 1993\n1995 1994 1993 ____ ____ ____ REVENUES Oil and Gas Sales Working Interest $ 277,027 $ 333,805 $ 412,239 Royalty Interest 57,007 71,268 91,108 Gain(Loss) on Turnkey Working Interests and Oil Properties 29,456 31,970 22,808 Promotional Income 5,739 1,743 14,321 Consulting Income 59,198 0 0 Administrative Overhead 25,700 21,000 10,500 Gain on write-off 299,164 0 0 Other Income 3 832 5,574 _________ _________ _________ Total Revenues 753,294 460,618 556,550\nCOSTS AND EXPENSES Lease and Operating Expenses 275,189 248,987 318,290 Taxes Other Than Income 10,634 11,782 17,432 Dry Holes and Abandonments 929 24,312 326,372 Depreciation, Depletion And Amortization 41,175 45,515 60,853 General and Administrative 229,568 191,612 189,948 Interest Expense, Net of Capitalized Interest 4,211 84,660 111,532 _________ _________ _________ Total Costs and Expenses 561,706 606,868 1,024,427 _________ _________ _________ NET EARNINGS (LOSS) BEFORE TAXES 191,588 (146,250) (467,877)\nCURRENT INCOME TAXES 0 0 0 _________ _________ _________ NET EARNINGS (LOSS) $ 191,588 $ (146,250) $ (467,877) ========= ========= ========= Per Share of Common Stock, Weighted Average Method Income Before Extraordinary Items $ .02 $ (.018) $ (.059) ========= ========= ========= Net Income $ .02 $ (.018) $ (.059) ========= ========= ========= Weighted Average Number of Shares Outstanding 7,991,870 7,991,870 7,925,203 ========= ========= =========\nSee Accompanying Notes to Financial Statements\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Statements of Cash Flows For the Years Ending December 31, 1995, 1994 and 1993\n1995 1994 1993 ____ ____ ____ CASH FLOWS FROM OPERATING ACTIVITIES Net Income (Loss) $ 191,588 $ (146,250) $ (467,877) Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities Depreciation, Depletion and Amortization 41,175 45,515 60,853 Abandonments, Expired and Surrendered Leases 3,555 36,175 364,905 (Gain)Loss on Sale of Turnkey Working Interest and Oil and Gas Properties 8,883 0 (11,918) Permanent Decline in Valuation of Investment 0 0 0 (Increase)Decrease in Current Assets: Trade Accounts Receivable (210,702) (228,875) (109,873) Prepaid Expenses (124) 125 1,324 Increase(Decrease) in Current Liabilities: Trade Accounts Payable 257,094 163,615 73,943 Salaries Payable 14,923 40,000 0 Joint Interest Prepayments 26,788 0 0 _________ _________ _________ NET CASH FROM OPERATING ACTIVITIES 333,180 (89,695) (88,643)\nCASH FLOWS FROM INVESTING ACTIVITIES Acquisition of Property and Equipment (22,907) (15,714) (31,506) Proceeds from Sale of Property and Equipment 694 0 10,000 Write-off of Oil & Gas Property 717,288 0 0 _________ _________ _________ NET CASH FROM INVESTING ACTIVITIES 695,075 (15,714) (21,506)\nCASH FLOWS FROM FINANCING ACTIVITIES Acquisition of Short-Term Debt 0 100,000 11,000\nAcquisition of Long- Term Debt 0 78,091 181,293 Reduction of Long-Term Debt (39,660) (57,495) (92,749) Write-off of Long-Term debt (908,410) 0 0 Proceeds from Issuance of Stock 0 0 20,000 _________ _________ _________ NET CASH FROM FINANCING ACTIVITIES (948,070) 120,596 119,544 _________ _________ _________ NET INCREASE(DECREASE) IN CASH 80,185 15,187 9,395\nCASH AT BEGINNING OF PERIOD 55,923 40,736 31,341 _________ _________ _________ CASH AT END OF PERIOD $ 136,108 $ 55,923 $ 40,736 ========= ========= =========\nSee Accompanying Notes to Financial Statements\nStock Option Plan There is no current Stock Option Plan in effect.\nAmounts owed to officers and directors for excess payments under a previously existing Stock Option Plan amount to $25,603 and are included in current liabilities.\nIn 1986, one of the former officers returned his option stock to the Company. These 15,000 shares were held in treasury by the Company and recorded at par value. The Company reissued all treasury stock in 1992.\nStock Option Agreement The Company entered into a Stock Option Agreement with Penteco Corporation (Penteco). Penteco had an option to purchase 1,000,000 shares at a price of $.31 per share and an option to purchase another 1,000,000 shares at a price of $.50 per share at various times. That option was renewed by the Board to extend through September, 1993. Penteco exercised part of their option for the 1,000,000 shares at $.31. Effective January 1993, Penteco's Stock Option Agreement was terminated as a result of the termination of the Company's Management Agreement with Penteco Corporation. The Company had an outstanding Stock Option Agreement with an employee to purchase 100,000 shares of General Energy stock for $.25 per share. This Agreement expired on January 5, 1993.\nITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides information with respect to the shares of common stock of the Company beneficially owned by each beneficial owner of more than 5% of such shares, each director and officer of the Company, and all directors and officers as a group as of December 31, 1995.\nNumber of Shares Percent of Common Name Of Common Stock Stock Outstanding ____ _______________ _________________ H. Terry Snowday, Jr. 366,596 4.58% Robert M. Andrews 548,765 6.86% 12683 S. Marina Village Dr. Traverse City, MI 49684 Richard E. Calvert 449,935 5.62% P.O. Box 368 Perrinton, MI 48871-0368 Leslie L. Guernsey 6,700 (4) Armond Hansen 502,118 6.28% P.O. Box 6007 Mesa, AZ 85216-6007 Rosalie A. Newman 10,309 (4) Edgar R. Puthuff 941,998 (1) 11.78% John G. Ross 75,649 (2) (4) Charles W. Taylor 1,102,146 (3) 13.79% Edward A. Ward II 65,149 (4)\nall directors and officers as a group (7 in the group) 2,568,547 32.13%\n(1) Includes 10,000 shares owned by Edgar Puthuff & William Miller Trust of the Miller Puthuff Associates, Inc. Employees Pension Profit Sharing Plan, 17,649 shares owned by Edgar R. Puthuff Trust Miller Puthuff Associates Employees Pension Plan, 575,015 shares owned by Miller Puthuff Associates Pension Plan Profit Sharing Plan Profit Sharing Plan Trust and 100,000 shares owned by Edgar Puthuff Tr of the Miller Puthuff Associates Employees Pension Profit Sharing Plan.\n(2) Includes 35,649 shares held by Patricia E. Ross, his wife.\n(3) Includes 1,102,146 shares held by Penteco Corporation.\n(4) Less than 1%\nThe above list includes officers and directors who have a beneficial ownership in the securities of the Company. All officers and directors are voting FOR on all proposals. It is not known how the other 5% shareholders intend to vote their proxies.\nITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no family relationships between the officers and\/or directors of the Company other than Edward A. Ward II is a brother-in-law of H. Terry Snowday.\nDirector Charles W. Taylor is President, Chairman of the Board and Chief Executive Officer of Penteco Corporation and Chairman of the Board of Lincoln Gas and Oil Marketing Corporation.\nIn 1987, the Company entered into a Management Agreement with Penteco Corporation to analyze the Company's financial position and provide management services to the Company. Mr. Charles Taylor, a director of the Company, owns 25% of the outstanding shares of Penteco and is a director and officer of that Company. Director's Snowday, Puthuff and Ward are minority investors in Penteco Corporation. Mr. Taylor abstained from voting for the Management Agreement considering his position with Penteco. Effective January 1993, the Management Agreement with Penteco Corporation was terminated and those responsible for management duties became salaried employees or advisors to the Company.\nIn July of 1990, Penteco Corporation agreed to accept 1,891,182 shares of General Energy Resources and Technology Corporation stock as payment for management fees for the period November, 1987 to May, 1990 totaling $94,559.10. The Company had a two year buy-back option and in September 1992, the Company repurchased the 1,891,182 shares of General Energy Corporation stock at $.06 per share. The Company then issued 886,040 shares at $.20 to replace the shares purchased and as payment for additional management fees accrued through August, 1992.\nAs of December 31, 1995, the Company has a liability to Penteco of $13,262 for management fees and out-of-pocket costs.\nIn 1991, the Company loaned $350,000 to American Barter. American Barter agreed to repay this loan, with interest at the Company's borrowing rate and to assign a 25% working interest in the Tulare Lakes Field. The Tulare Lakes Field was purchased from Chevron by Penteco and American Barter in 1991. The agreement between Chevron and Penteco and American Barter states that the note owed to Chevron will be repaid from production from the Tulare Lakes Field. If production does not cover debt payments, General Energy is not liable to Chevron or other third parties. The Company booked 25% of the purchase price as proved oil and gas properties, approximately $875,900. The Company also recorded 25% of the liabilities for Penteco and American Barter's purchase of the field along with 25% of American Barter's $350,000 debt to General Energy, borrowed for costs of revitalizing the field. During 1992, and 1993, additional debt has been recorded for Society Bank loans used to pay off the original $350,000 and for operating expenses and accrued interest. In 1993, the Company sold a 1% interest to a company shareholder for $10,000. The Company's 25% interest was to be paid from Penteco Corporation's working interest percentage, net of expenses. As of December 31, 1995, the total revenue from the field continued to be less than the total expenses with no expectation of improvement within the next twelve months. Management determined the asset and liability to be unrealistically presented on the financial statements and the outstanding debt balance of $908,410 which included accrued interest and the asset balance of $717,288, net of accumulated DD&A, were written off.\nDuring 1991, the Company organized the sale of 306,410 shares of privately held General Energy stock. The Company did not purchase the stock, only brought together the buyers and sellers. The Company earned approximately $18,000 from this sale. These funds were applied to pay other obligations and settlements due the seller of the shares and costs related to the transaction.\nDuring 1992, the Company repurchased a 5% interest in the Fons- Jacob well from a Company director in exchange for 504,015 shares of restricted stock issued at $.20 per share.\nDuring 1993, the Company sold 200,000 shares of restricted stock to Company shareholders at $.10 per share. One of these shareholders also loaned $11,000 to the Company through its subsidiary, which is expected to be repaid in 1996.\nThe Company sold several turnkey working interests to major shareholders and directors during 1995. Accounts receivable from these related parties totaled $50,094 at December 31, 1995 while related party accounts payable amounted to $7,476. No interest has been accrued on any of the above amounts.\nPursuant to the requirements of Section 13, or 15(d) of the 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 12th day of April, 1996.\nGENERAL ENERGY RESOURCES AND TECHNOLOGY CORPORATION\nBy: H.TERRY SNOWDAY, JR. _____________________________ H. Terry Snowday, Jr. President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following person(s) on behalf of the registrant and in the capacities and on the date(s) indicated.\nSignature Title Date _________ _____ ____\nH. TERRY SNOWDAY, JR. President, Chairman of the 05\/07\/96 _____________________ Board, Chief Executive H. Terry Snowday, Jr. Officer and Director\nROSALIE A. NEWMAN Chief Financial Officer and 05\/07\/96 _____________________ Treasurer Rosalie A. Newman\nEDGAR R. PUTHUFF Director 05\/07\/96 _____________________ Edgar R. Puthuff\nJOHN G. ROSS Director 05\/07\/96 _____________________ John G. Ross\nCHARLES W. TAYLOR Director 05\/07\/96 _____________________ Charles W. Taylor\nEDWARD A. WARD Director 05\/07\/96 _____________________ Edward A. Ward","section_6":"","section_7":"ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity\/Capital Resources Net cash from operating activities for the Company as of the three most recent year-ends is as follows:\n1995 1994 1993 ____ ____ ____ Cash Flows 333,180 (89,695) (88,643)\nThe Company has generated cash flow from operations, bank borrowings and the funds derived from its initial public offering in 1981, which yielded $3.7 million. Private sales from stock and the exercise of options have provided additional working capital.\nIn June 1989, one of the Company's major trade creditors, Mosbacher Energy Company (MEC), filed an operator's lien against various properties in which the Company owns a working interest and for which the Company owed MEC operating expenses. The liens resulted in the curtailment of revenue from these properties. A repayment plan was negotiated and on June 1, 1990, the Company signed a $292,814 promissory note with MEC for the amount owed MEC by General Energy Corporation for well operations as of May 7, 1990. The note is secured by the Company's interest in eleven producing properties operated by MEC and bears interest at 7 1\/4 percent per annum. The terms of the agreement call for a monthly payment to Mosbacher Energy Company of the lesser of $20,000 or one months production of the secured properties.\nIn August of 1991, the Company borrowed $350,000 from Huntington Banks of Michigan. The note was secured by the personal guarantees of H. Terry Snowday and Edgar R. Puthuff, directors of the Company. Interest was payable monthly at one percent over the bank prime rate.\nProceeds from this note were loaned to American Barter Petroleum, Inc. to be used in a production property purchase in California. Interest is due at one percent over prime and principal is paid back out of production according to a predetermined schedule. In exchange for this loan, the Company received a 25 percent interest in net revenue.\nBoth notes were paid in full in October, 1992.\nIn 1991, the Company recorded approximately $875,500 of long-term debt on the Tulare Lakes Field. This represents a 25% share of the outstanding debt on the field. This is a non recourse debt. General Energy is not a party to the purchase contract between Chevron, Penteco and American Barter. The Company's 25% interest was to be paid from Penteco Corporation's working interest percentage, net of expenses. As of December 31, 1995, the total revenue from the field continued to be less than the total expenses with no expectation of improvement within the next twelve months. Management determined the asset and liability to be unrealistically presented on the financial statements and the outstanding debt balance of $908,410 which included accrued interest and the asset balance of $717,288, net of accumulated DD&A, were written off.\nThe Company has been able to satisfy its long-term debt commitments. The balance of accounts payable however, has increased to $692,031 at December 31, 1995 compared to $434,937 at December 31, 1994. A large portion of the accounts payable are for services provided by companies that have been very tolerant regarding timing of payment for these services.\nThe monthly operating cost for direct obligations for rent of the Company's office space will be $775.00. Management is aware that it has limited capital resources available with which to continue a lease acquisition\/exploration program. Evaluation of various investment alternatives will continue to be made on a case-by- case and\/or well-by-well basis, and commitments will be made as funds permit.\nManagement believes cash flow from the sale of its currently producing oil and gas properties as well as the two projects being completed in 1996, should be sufficient to pay current operating liabilities and to amortize the current portion of the long-term debt.\nManagement has developed contingency plans to obtain additional capital by the issuance of debt or sale of equities to the extent that these actions become necessary in the future.\nThe price that the Company received for oil during 1995 ranged from $15.26 to $18.75. The posted price for crude oil is at $20.50 per barrel as of March 31, 1996. There is uncertainty as to the price of oil over the next twelve months.\nWhile the sale of gas remains subject to NGPA regulated pricing policies, it is recognized that certain concessions must be made as to contractual pricing to insure that the Company's gas reserves remain a competitive alternative fuel.\nResults of Operations _____________________ Revenues Oil and gas sales Working interest $ 277,027 $ 333,805 $ 412,239 Royalty interest 57,007 71,268 91,108 Gain (loss) on sale of turnkey working interests and oil properties 29,456 31,970 22,808 Repromotional income 5,739 1,743 14,321 Consulting income 59,198 0 0 Administrative overhead 25,700 21,000 10,500 Gain on write-off 299,164 0 0 Other income 3 832 5,574 _________ _________ _________ Total Revenues 753,294 460,618 556,550 Net Earnings (loss) $ 191,588 $ (146,250) $ (467,877) ========= ========= =========\nThe Company's total revenues increased $292,676 from $460,618 at December 31, 1994 to $753,294 at December 31, 1995 and the Company's operating loss decreased $337,838 from $(146,250) at December 31, 1994 to $191,588 at December 31, 1995.\nA major factor contributing to the Company's year end earnings was a gain of $299,164 resulting from the write-off of a producing oil and gas property and its liability.\nThe cost incurred in oil and gas property acquisitions, exploration and development activities for the year ended December 31, 1995 totaled $29,117 and capitalized costs related to oil and gas producing activities as of December 31, 1995 totaled $338,551 as compared to $42,111 and $1,087,239 respectively in 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. - FINANCIAL STATEMENTS\nConsolidated Balance Sheets. . . . . . . . . . . . . . 15 Consolidated Statements of Operations. . . . . . . . . . 17 Consolidated Statements of Cash Flows. . . . . . . . . . 19 Consolidated Statements of Stockholders' Equity. . . . . 21 Notes to Consolidated Financial Statements . . . . . . . 22 Supplemental Schedules . . . . . . . . . . . . . . . . . 31\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Balance Sheets, December 31, 1995 and 1994\nASSETS 1995 1994 ____ ____ CURRENT ASSETS Cash $ 136,108 $ 55,923 Accounts Receivable Trade 592,224 381,522 Less Allowance for Doubtful Accounts (8,698) (8,698) Prepaid Expenses 437 313 _________ _________ Total Current Assets 720,071 429,060\nPROPERTY AND EQUIPMENT, AT COST Proved Oil and Gas Properties, Successful Efforts Method of Accounting 2,891,901 3,724,331 Unproved Leasehold and Minerals 85,106 85,106 Drilling Contracts in Progress 12,213 11,253 _________ _________ 2,989,220 3,820,690 Less Accumulated Depreciation, Depletion, and Amortization 2,650,669 2,733,451 _________ _________ Net Property and Equipment 338,551 1,087,239\nOTHER ASSETS Investments (net of unrealized loss of $288,950) 1,050 1,050 _________ _________ $1,059,672 $1,517,349 ========= =========\nLIABILITIES AND STOCKHOLDER'S EQUITY\nCURRENT LIABILITIES Current Portion Long-Term Debt $ 3,000 $ 54,749 Account Payable Trade 692,031 434,937 Notes Payable 111,000 111,000 Joint Interest Prepayment 135,371 108,583 Salaries Payable 54,923 40,000 Stock Options Payable 25,603 25,603 _________ _________ Total Current Liabilities 1,021,928 774,872\nLONG-TERM DEBT 55,429 951,750\nSTOCKHOLDERS' EQUITY Common Stock ($.10 Par Value, 18,000,000 Shares Authorized, 7,991,870 Shares Issued and Outstanding) 799,187 799,187 Additional Paid-in Capital 7,435,012 7,435,012 Deficit (8,251,884) (8,443,472) _________ _________ Total Stockholders' Equity (17,685) (209,273) ========= ========= Total Liabilities and Stockholders' Equity $1,059,672 $1,517,349 ========= =========\nSee Accompanying Notes to Financial Statements\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Statements of Operations For the Years Ending December 31, 1995, 1994 and 1993\n1995 1994 1993 ____ ____ ____ REVENUES Oil and Gas Sales Working Interest $ 277,027 $ 333,805 $ 412,239 Royalty Interest 57,007 71,268 91,108 Gain(Loss) on Turnkey Working Interests and Oil Properties 29,456 31,970 22,808 Promotional Income 5,739 1,743 14,321 Consulting Income 59,198 0 0 Administrative Overhead 25,700 21,000 10,500 Gain on write-off 299,164 0 0 Other Income 3 832 5,574 _________ _________ _________ Total Revenues 753,294 460,618 556,550\nCOSTS AND EXPENSES Lease and Operating Expenses 275,189 248,987 318,290 Taxes Other Than Income 10,634 11,782 17,432 Dry Holes and Abandonments 929 24,312 326,372 Depreciation, Depletion And Amortization 41,175 45,515 60,853 General and Administrative 229,568 191,612 189,948 Interest Expense, Net of Capitalized Interest 4,211 84,660 111,532 _________ _________ _________ Total Costs and Expenses 561,706 606,868 1,024,427 _________ _________ _________ NET EARNINGS (LOSS) BEFORE TAXES 191,588 (146,250) (467,877)\nCURRENT INCOME TAXES 0 0 0 _________ _________ _________ NET EARNINGS (LOSS) $ 191,588 $ (146,250) $ (467,877) ========= ========= ========= Per Share of Common Stock, Weighted Average Method Income Before Extraordinary Items $ .02 $ (.018) $ (.059) ========= ========= ========= Net Income $ .02 $ (.018) $ (.059) ========= ========= ========= Weighted Average Number of Shares Outstanding 7,991,870 7,991,870 7,925,203 ========= ========= =========\nSee Accompanying Notes to Financial Statements\nGeneral Energy Resources and Technology Corporation and Subsidiary Consolidated Statements of Cash Flows For the Years Ending December 31, 1995, 1994 and 1993\n1995 1994 1993 ____ ____ ____ CASH FLOWS FROM OPERATING ACTIVITIES Net Income (Loss) $ 191,588 $ (146,250) $ (467,877) Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities Depreciation, Depletion and Amortization 41,175 45,515 60,853 Abandonments, Expired and Surrendered Leases 3,555 36,175 364,905 (Gain)Loss on Sale of Turnkey Working Interest and Oil and Gas Properties 8,883 0 (11,918) Permanent Decline in Valuation of Investment 0 0 0 (Increase)Decrease in Current Assets: Trade Accounts Receivable (210,702) (228,875) (109,873) Prepaid Expenses (124) 125 1,324 Increase(Decrease) in Current Liabilities: Trade Accounts Payable 257,094 163,615 73,943 Salaries Payable 14,923 40,000 0 Joint Interest Prepayments 26,788 0 0 _________ _________ _________ NET CASH FROM OPERATING ACTIVITIES 333,180 (89,695) (88,643)\nCASH FLOWS FROM INVESTING ACTIVITIES Acquisition of Property and Equipment (22,907) (15,714) (31,506) Proceeds from Sale of Property and Equipment 694 0 10,000 Write-off of Oil & Gas Property 717,288 0 0 _________ _________ _________ NET CASH FROM INVESTING ACTIVITIES 695,075 (15,714) (21,506)\nCASH FLOWS FROM FINANCING ACTIVITIES Acquisition of Short-Term Debt 0 100,000 11,000\nAcquisition of Long- Term Debt 0 78,091 181,293 Reduction of Long-Term Debt (39,660) (57,495) (92,749) Write-off of Long-Term debt (908,410) 0 0 Proceeds from Issuance of Stock 0 0 20,000 _________ _________ _________ NET CASH FROM FINANCING ACTIVITIES (948,070) 120,596 119,544 _________ _________ _________ NET INCREASE(DECREASE) IN CASH 80,185 15,187 9,395\nCASH AT BEGINNING OF PERIOD 55,923 40,736 31,341 _________ _________ _________ CASH AT END OF PERIOD $ 136,108 $ 55,923 $ 40,736 ========= ========= =========\nSee Accompanying Notes to Financial Statements\nStock Option Plan There is no current Stock Option Plan in effect.\nAmounts owed to officers and directors for excess payments under a previously existing Stock Option Plan amount to $25,603 and are included in current liabilities.\nIn 1986, one of the former officers returned his option stock to the Company. These 15,000 shares were held in treasury by the Company and recorded at par value. The Company reissued all treasury stock in 1992.\nStock Option Agreement The Company entered into a Stock Option Agreement with Penteco Corporation (Penteco). Penteco had an option to purchase 1,000,000 shares at a price of $.31 per share and an option to purchase another 1,000,000 shares at a price of $.50 per share at various times. That option was renewed by the Board to extend through September, 1993. Penteco exercised part of their option for the 1,000,000 shares at $.31. Effective January 1993, Penteco's Stock Option Agreement was terminated as a result of the termination of the Company's Management Agreement with Penteco Corporation. The Company had an outstanding Stock Option Agreement with an employee to purchase 100,000 shares of General Energy stock for $.25 per share. This Agreement expired on January 5, 1993.\nITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides information with respect to the shares of common stock of the Company beneficially owned by each beneficial owner of more than 5% of such shares, each director and officer of the Company, and all directors and officers as a group as of December 31, 1995.\nNumber of Shares Percent of Common Name Of Common Stock Stock Outstanding ____ _______________ _________________ H. Terry Snowday, Jr. 366,596 4.58% Robert M. Andrews 548,765 6.86% 12683 S. Marina Village Dr. Traverse City, MI 49684 Richard E. Calvert 449,935 5.62% P.O. Box 368 Perrinton, MI 48871-0368 Leslie L. Guernsey 6,700 (4) Armond Hansen 502,118 6.28% P.O. Box 6007 Mesa, AZ 85216-6007 Rosalie A. Newman 10,309 (4) Edgar R. Puthuff 941,998 (1) 11.78% John G. Ross 75,649 (2) (4) Charles W. Taylor 1,102,146 (3) 13.79% Edward A. Ward II 65,149 (4)\nall directors and officers as a group (7 in the group) 2,568,547 32.13%\n(1) Includes 10,000 shares owned by Edgar Puthuff & William Miller Trust of the Miller Puthuff Associates, Inc. Employees Pension Profit Sharing Plan, 17,649 shares owned by Edgar R. Puthuff Trust Miller Puthuff Associates Employees Pension Plan, 575,015 shares owned by Miller Puthuff Associates Pension Plan Profit Sharing Plan Profit Sharing Plan Trust and 100,000 shares owned by Edgar Puthuff Tr of the Miller Puthuff Associates Employees Pension Profit Sharing Plan.\n(2) Includes 35,649 shares held by Patricia E. Ross, his wife.\n(3) Includes 1,102,146 shares held by Penteco Corporation.\n(4) Less than 1%\nThe above list includes officers and directors who have a beneficial ownership in the securities of the Company. All officers and directors are voting FOR on all proposals. It is not known how the other 5% shareholders intend to vote their proxies.\nITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no family relationships between the officers and\/or directors of the Company other than Edward A. Ward II is a brother-in-law of H. Terry Snowday.\nDirector Charles W. Taylor is President, Chairman of the Board and Chief Executive Officer of Penteco Corporation and Chairman of the Board of Lincoln Gas and Oil Marketing Corporation.\nIn 1987, the Company entered into a Management Agreement with Penteco Corporation to analyze the Company's financial position and provide management services to the Company. Mr. Charles Taylor, a director of the Company, owns 25% of the outstanding shares of Penteco and is a director and officer of that Company. Director's Snowday, Puthuff and Ward are minority investors in Penteco Corporation. Mr. Taylor abstained from voting for the Management Agreement considering his position with Penteco. Effective January 1993, the Management Agreement with Penteco Corporation was terminated and those responsible for management duties became salaried employees or advisors to the Company.\nIn July of 1990, Penteco Corporation agreed to accept 1,891,182 shares of General Energy Resources and Technology Corporation stock as payment for management fees for the period November, 1987 to May, 1990 totaling $94,559.10. The Company had a two year buy-back option and in September 1992, the Company repurchased the 1,891,182 shares of General Energy Corporation stock at $.06 per share. The Company then issued 886,040 shares at $.20 to replace the shares purchased and as payment for additional management fees accrued through August, 1992.\nAs of December 31, 1995, the Company has a liability to Penteco of $13,262 for management fees and out-of-pocket costs.\nIn 1991, the Company loaned $350,000 to American Barter. American Barter agreed to repay this loan, with interest at the Company's borrowing rate and to assign a 25% working interest in the Tulare Lakes Field. The Tulare Lakes Field was purchased from Chevron by Penteco and American Barter in 1991. The agreement between Chevron and Penteco and American Barter states that the note owed to Chevron will be repaid from production from the Tulare Lakes Field. If production does not cover debt payments, General Energy is not liable to Chevron or other third parties. The Company booked 25% of the purchase price as proved oil and gas properties, approximately $875,900. The Company also recorded 25% of the liabilities for Penteco and American Barter's purchase of the field along with 25% of American Barter's $350,000 debt to General Energy, borrowed for costs of revitalizing the field. During 1992, and 1993, additional debt has been recorded for Society Bank loans used to pay off the original $350,000 and for operating expenses and accrued interest. In 1993, the Company sold a 1% interest to a company shareholder for $10,000. The Company's 25% interest was to be paid from Penteco Corporation's working interest percentage, net of expenses. As of December 31, 1995, the total revenue from the field continued to be less than the total expenses with no expectation of improvement within the next twelve months. Management determined the asset and liability to be unrealistically presented on the financial statements and the outstanding debt balance of $908,410 which included accrued interest and the asset balance of $717,288, net of accumulated DD&A, were written off.\nDuring 1991, the Company organized the sale of 306,410 shares of privately held General Energy stock. The Company did not purchase the stock, only brought together the buyers and sellers. The Company earned approximately $18,000 from this sale. These funds were applied to pay other obligations and settlements due the seller of the shares and costs related to the transaction.\nDuring 1992, the Company repurchased a 5% interest in the Fons- Jacob well from a Company director in exchange for 504,015 shares of restricted stock issued at $.20 per share.\nDuring 1993, the Company sold 200,000 shares of restricted stock to Company shareholders at $.10 per share. One of these shareholders also loaned $11,000 to the Company through its subsidiary, which is expected to be repaid in 1996.\nThe Company sold several turnkey working interests to major shareholders and directors during 1995. Accounts receivable from these related parties totaled $50,094 at December 31, 1995 while related party accounts payable amounted to $7,476. No interest has been accrued on any of the above amounts.\nPursuant to the requirements of Section 13, or 15(d) of the 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 12th day of April, 1996.\nGENERAL ENERGY RESOURCES AND TECHNOLOGY CORPORATION\nBy: H.TERRY SNOWDAY, JR. _____________________________ H. Terry Snowday, Jr. President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following person(s) on behalf of the registrant and in the capacities and on the date(s) indicated.\nSignature Title Date _________ _____ ____\nH. TERRY SNOWDAY, JR. President, Chairman of the 05\/07\/96 _____________________ Board, Chief Executive H. Terry Snowday, Jr. Officer and Director\nROSALIE A. NEWMAN Chief Financial Officer and 05\/07\/96 _____________________ Treasurer Rosalie A. Newman\nEDGAR R. PUTHUFF Director 05\/07\/96 _____________________ Edgar R. Puthuff\nJOHN G. ROSS Director 05\/07\/96 _____________________ John G. Ross\nCHARLES W. TAYLOR Director 05\/07\/96 _____________________ Charles W. Taylor\nEDWARD A. WARD Director 05\/07\/96 _____________________ Edward A. Ward","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides information with respect to the shares of common stock of the Company beneficially owned by each beneficial owner of more than 5% of such shares, each director and officer of the Company, and all directors and officers as a group as of December 31, 1995.\nNumber of Shares Percent of Common Name Of Common Stock Stock Outstanding ____ _______________ _________________ H. Terry Snowday, Jr. 366,596 4.58% Robert M. Andrews 548,765 6.86% 12683 S. Marina Village Dr. Traverse City, MI 49684 Richard E. Calvert 449,935 5.62% P.O. Box 368 Perrinton, MI 48871-0368 Leslie L. Guernsey 6,700 (4) Armond Hansen 502,118 6.28% P.O. Box 6007 Mesa, AZ 85216-6007 Rosalie A. Newman 10,309 (4) Edgar R. Puthuff 941,998 (1) 11.78% John G. Ross 75,649 (2) (4) Charles W. Taylor 1,102,146 (3) 13.79% Edward A. Ward II 65,149 (4)\nall directors and officers as a group (7 in the group) 2,568,547 32.13%\n(1) Includes 10,000 shares owned by Edgar Puthuff & William Miller Trust of the Miller Puthuff Associates, Inc. Employees Pension Profit Sharing Plan, 17,649 shares owned by Edgar R. Puthuff Trust Miller Puthuff Associates Employees Pension Plan, 575,015 shares owned by Miller Puthuff Associates Pension Plan Profit Sharing Plan Profit Sharing Plan Trust and 100,000 shares owned by Edgar Puthuff Tr of the Miller Puthuff Associates Employees Pension Profit Sharing Plan.\n(2) Includes 35,649 shares held by Patricia E. Ross, his wife.\n(3) Includes 1,102,146 shares held by Penteco Corporation.\n(4) Less than 1%\nThe above list includes officers and directors who have a beneficial ownership in the securities of the Company. All officers and directors are voting FOR on all proposals. It is not known how the other 5% shareholders intend to vote their proxies.\nITEM 13.","section_13":"ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no family relationships between the officers and\/or directors of the Company other than Edward A. Ward II is a brother-in-law of H. Terry Snowday.\nDirector Charles W. Taylor is President, Chairman of the Board and Chief Executive Officer of Penteco Corporation and Chairman of the Board of Lincoln Gas and Oil Marketing Corporation.\nIn 1987, the Company entered into a Management Agreement with Penteco Corporation to analyze the Company's financial position and provide management services to the Company. Mr. Charles Taylor, a director of the Company, owns 25% of the outstanding shares of Penteco and is a director and officer of that Company. Director's Snowday, Puthuff and Ward are minority investors in Penteco Corporation. Mr. Taylor abstained from voting for the Management Agreement considering his position with Penteco. Effective January 1993, the Management Agreement with Penteco Corporation was terminated and those responsible for management duties became salaried employees or advisors to the Company.\nIn July of 1990, Penteco Corporation agreed to accept 1,891,182 shares of General Energy Resources and Technology Corporation stock as payment for management fees for the period November, 1987 to May, 1990 totaling $94,559.10. The Company had a two year buy-back option and in September 1992, the Company repurchased the 1,891,182 shares of General Energy Corporation stock at $.06 per share. The Company then issued 886,040 shares at $.20 to replace the shares purchased and as payment for additional management fees accrued through August, 1992.\nAs of December 31, 1995, the Company has a liability to Penteco of $13,262 for management fees and out-of-pocket costs.\nIn 1991, the Company loaned $350,000 to American Barter. American Barter agreed to repay this loan, with interest at the Company's borrowing rate and to assign a 25% working interest in the Tulare Lakes Field. The Tulare Lakes Field was purchased from Chevron by Penteco and American Barter in 1991. The agreement between Chevron and Penteco and American Barter states that the note owed to Chevron will be repaid from production from the Tulare Lakes Field. If production does not cover debt payments, General Energy is not liable to Chevron or other third parties. The Company booked 25% of the purchase price as proved oil and gas properties, approximately $875,900. The Company also recorded 25% of the liabilities for Penteco and American Barter's purchase of the field along with 25% of American Barter's $350,000 debt to General Energy, borrowed for costs of revitalizing the field. During 1992, and 1993, additional debt has been recorded for Society Bank loans used to pay off the original $350,000 and for operating expenses and accrued interest. In 1993, the Company sold a 1% interest to a company shareholder for $10,000. The Company's 25% interest was to be paid from Penteco Corporation's working interest percentage, net of expenses. As of December 31, 1995, the total revenue from the field continued to be less than the total expenses with no expectation of improvement within the next twelve months. Management determined the asset and liability to be unrealistically presented on the financial statements and the outstanding debt balance of $908,410 which included accrued interest and the asset balance of $717,288, net of accumulated DD&A, were written off.\nDuring 1991, the Company organized the sale of 306,410 shares of privately held General Energy stock. The Company did not purchase the stock, only brought together the buyers and sellers. The Company earned approximately $18,000 from this sale. These funds were applied to pay other obligations and settlements due the seller of the shares and costs related to the transaction.\nDuring 1992, the Company repurchased a 5% interest in the Fons- Jacob well from a Company director in exchange for 504,015 shares of restricted stock issued at $.20 per share.\nDuring 1993, the Company sold 200,000 shares of restricted stock to Company shareholders at $.10 per share. One of these shareholders also loaned $11,000 to the Company through its subsidiary, which is expected to be repaid in 1996.\nThe Company sold several turnkey working interests to major shareholders and directors during 1995. Accounts receivable from these related parties totaled $50,094 at December 31, 1995 while related party accounts payable amounted to $7,476. No interest has been accrued on any of the above amounts.\nPursuant to the requirements of Section 13, or 15(d) of the 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 12th day of April, 1996.\nGENERAL ENERGY RESOURCES AND TECHNOLOGY CORPORATION\nBy: H.TERRY SNOWDAY, JR. _____________________________ H. Terry Snowday, Jr. President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following person(s) on behalf of the registrant and in the capacities and on the date(s) indicated.\nSignature Title Date _________ _____ ____\nH. TERRY SNOWDAY, JR. President, Chairman of the 05\/07\/96 _____________________ Board, Chief Executive H. Terry Snowday, Jr. Officer and Director\nROSALIE A. NEWMAN Chief Financial Officer and 05\/07\/96 _____________________ Treasurer Rosalie A. Newman\nEDGAR R. PUTHUFF Director 05\/07\/96 _____________________ Edgar R. Puthuff\nJOHN G. ROSS Director 05\/07\/96 _____________________ John G. Ross\nCHARLES W. TAYLOR Director 05\/07\/96 _____________________ Charles W. Taylor\nEDWARD A. WARD Director 05\/07\/96 _____________________ Edward A. Ward","section_14":"","section_15":""}
{"filename":"805266_1995.txt","cik":"805266","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nOn November 9, 1995, after a long period of negotiation and discussion with the New York Insurance Department (NYID), Lawrence Insurance Group, Inc. (LIG or the Company) consented to United Community Insurance Company (UCIC) being liquidated. This action concludes the most difficult and challenging chapter in the history of the UCIC and LIG. While the Board deeply regretted this action, it believes that it was in the best interests of the public and its shareholders as it allows the Company to refocus its energies and resources on its remaining businesses. With the liquidation of UCIC, the Company is no longer required to carry the stockholders' deficit of UCIC as a liability. This had a positive impact on LIG's net income and stockholders' equity of $38,387,000 and $57,621,000, respectively. Primarily as a result of the problems at UCIC the Company had recorded a net loss of $7,091,000 for 1994 following a net loss of $77,104,000 for 1993. However, the Company and United Republic Insurance Company (URIC) could continue to be impacted by losses incurred by UCIC as a result of the pooling agreement between URIC and UCIC. Refer to Reinsurance Ceded for further detail.\nPartly as a consequence of UCIC's losses charged to URIC as a result of the pooling agreement between them and a disagreement with the Texas Department of Insurance (TDI) over the value of certain assets, URIC had been under a Confidential Order of Supervision from June 22, 1994 through August 25, 1995 when it was released. The release was conditioned upon URIC's meeting certain financial and other conditions. The failure to meet these conditions would allow URIC to be placed into conservatorship without the consent of URIC or LIG management. At December 31, 1995 URIC had not met all of those goals.\nUCIC, which the New York State Supreme Court of Schenectady County with the consent of the Company, ordered liquidated as of November 10, 1995, was a wholly owned subsidiary of the Company. UCIC was incorporated in 1967 and acquired by Albert W. Lawrence on December 30, 1981. UCIC was transferred by Mr. Lawrence to a subsidiary of Lawrence Group in 1982 and was transferred to the Company in 1986. UCIC wrote commercial and personal lines of Property and Casualty (P&C) insurance until mid-February 1994, when it ceased writing new or renewal business. Refer to Regulation for further detail.\nURIC is owned approximately 79% by the Company, and the remainder is owned by UCIC. URIC was incorporated in 1986 and was acquired by the Company on October 24, 1989. URIC assumed\nreinsurance and was also licensed to write business directly in some states. URIC voluntarily ceased writing business in 1994. Under the conditions of its confidential supervision and subsequent release, the approval of the TDI to accept any new or renewal business is required. Refer to Regulation for further detail.\nGlobal Insurance Company (Global) is a wholly owned subsidiary of URIC. Global was incorporated in 1969 and acquired by the Company effective January 1, 1992. Global wrote substandard automobile and excess and surplus lines of P&C insurance. Global voluntarily ceased writing new or renewal business in November 1993 although it continued to receive assignments from Georgia's automobile assigned risk pool. Refer to Regulation for further detail.\nSenate is a wholly owned subsidiary of URIC. Senate was incorporated in 1967, acquired by Albert W. Lawrence in 1978, transferred to a subsidiary of Lawrence Group in 1981 and transferred to the Company in 1986. Senate writes accident and health (A&H) insurance.\nSenate National Life Insurance Company (SNLIC), (formerly known as Commercial Resources Insurance Company), is a wholly owned subsidiary of Senate. SNLIC was incorporated in 1970 and acquired by Senate on January 13, 1983. SNLIC is licensed to write life insurance and assumes A&H and credit life insurance.\nSenate Syndicate, Inc. (Syndicate) was formed in 1985 and was a syndicate on the New York Insurance Exchange (Exchange) until its withdrawal in 1989. It is dormant.\nThe Company was formed in 1986 by Lawrence Group under the laws of Delaware, to function as an insurance holding company. Unless the context otherwise requires, URIC, Global, Senate, SNLIC and Syndicate each are sometimes referred to herein as the Company except for 1993 wherein the term Company also includes the accounts of UCIC.\nThe Company's executive offices are located at 500 Fifth Avenue, New York, New York 10110, and its telephone number is (212) 944-8242. The Company's principal administrative functions are located at 431 New Karner Road, Albany, New York 12212, and its telephone number is (518) 464-9200.\nRelationship with Lawrence Group, Inc.\nLawrence Group owns and operates subsidiaries principally engaged in insurance agency and brokerage operations, in addition to its ownership interest in the Company. Lawrence Group, headquartered in Schenectady, New York, was established on December\n30, 1983, as a holding company for the various insurance related enterprises controlled by Albert W. Lawrence.\nLawrence Group, through several of its subsidiaries provides marketing, underwriting and policy issuance services to Senate for its A&H insurance. Previously, it had provided marketing, policy issuance, loss control and risk management services for UCIC.\nLawrence Group owns approximately 93% of the common stock of the Company. Albert W. Lawrence, Chairman of the Board of the Company, is, along with Barbara C. Lawrence, his wife, the owner of 100% of the common stock of Lawrence Group.\nProducts\nThe Company's current product mix consists of A&H insurance. This class of insurance includes principally medical stop-loss insurance for self-insured medical plans, short-term disability coverage and group dental programs and student accident insurance. The Company's A&H coverage are marketed by A.W. Lawrence & Co., Inc. (AWL), a subsidiary of Lawrence Agency Corp.(LAC), which is a subsidiary of Lawrence Group, Inc. (Lawrence Group), the Company's principal stockholder. SNLIC is licensed to write life insurance and assumes credit A&H and credit life insurance. Due to the lengthy inactivity of URIC and Global in the market place it is uncertain what products, organization and relationships could be reestablished if these companies resume business.\nThe following table sets forth the Company's gross premiums written and earned by product line for the periods indicated:\nYear Ended December 31, 1995 1994 1993 1992 1991 ------------------------------------- (Dollars in thousands) Gross premiums written: Property\/casualty $ 137 $ 283 $111,838 $132,273 $128,169 Reinsurance assumed 1,281 (12,171) 7,815 29,183 30,288 Accident\/Health\/Life 5,237 8,974 11,513 11,673 10,156 ------ ------- ------- ------- ------- Totals $ 6,655 (2,914)$131,166 $173,129$168,613 ===== ===== ======= ======= ====== Gross premiums earned: Property\/casualty $ 222 $ 658 $119,615 $136,633 $131,179 Reinsurance assumed 2,091 451 14,480 26,349 27,799 Accident\/Health\/Life 5,222 8,857 11,547 11,686 9,952 ----- ------- ------- ------- ------- Totals $ 7,535 $ 9,966 $145,642 $174,668 $168,930 ===== ===== ======= ======= =======\nGross premiums written or premiums assumed are a measure of the Company's participation and acceptance in the market place. Premiums earned represent a pro rata portion of the business written or assumed in the current calendar year plus amounts carried over from the prior year that are taken into revenue in the current period. Audit premiums on workers' compensation policies are an exception to this rule as such premiums are treated as fully earned when written since the audits are performed after the expiration of the policy. The decline in premiums written and earned during 1995 and 1994 compared with 1993, was related primarily to the exclusion of UCIC and the halt of new and renewal business by URIC and Global.\nThe costs of reinsurance are deducted from gross premiums to arrive at net premiums written or earned. The Company, like the industry in general, utilizes reinsurance to minimize the concentration of exposure to losses in any one geographic area, type of coverage or any one insured or group of insureds. The following table shows the net premiums written and earned together with other key operating results, followed by a discussion of the individual products.\nKey operating results on a combined basis and for each product are summarized below: Year Ended December 31, 1995 1994 1993 ---- ---- ---- (Dollars in thousands) All products combined: Net premiums written $ 5,135 $(7,770) $117,861 Net premiums earned 5,533 $ 5,221 $121,015 Percentage of Company's total earned premium 100.0% 100.0% 100.0%\nLoss and LAE ratio 97.6% 77.0% 122.7% Losses - government pools ratio - % - % 0.7% Expense ratio 65.7% 65.6% 41.2% Dividend ratio - % - % 0.2% Combined ratio 163.3% 142.6% 164.8%\nProperty\/casualty: Net premiums written $ 137 $ 273 $100,541 Net premiums earned 222 $ 641 $ 96,874 Percentage of Company's total earned premium 4.0% 12.3% 80.0%\nLoss and LAE ratio 140.1% 130.9% 133.9% Losses - government pools ratio - % - % 0.9% Expense ratio 151.3% 69.0% 42.0% Dividend ratio - % - % 0.2% Combined ratio 291.4% 199.9% 177.0%\nYear Ended December 31, 1995 1994 1993 ---- ---- ---- (Dollars in thousands) Reinsurance assumed: Net premiums written $1,063 $(13,802) $ 7,093 Net premiums earned 1,490 (974) 13,862 Percentage of Company's total earned premium 26.9% (18.7)% 11.5%\nLoss and LAE ratio 208.6% - % 97.7% Expense ratio 89.9% - % 49.3% Combined ratio 298.5% - % 147.0%\nAccident\/health\/life: Net premiums written $3,935 $ 5,759 $10,227 Net premiums earned 3,821 $ 5,554 $10,279 Percentage of Company's total earned premium 69.1% 106.4% 8.5%\nLoss and LAE ratio 51.9% 37.9% 50.7% Expense ratio 51.0% 44.3% 23.6% Combined ratio 102.9% 82.2% 74.3%\nAll Products Combined: For 1995 net premiums written totaled $5,135,000 of which 69% were A&H premiums. Net premiums earned were $5,333,000. For 1994, net premiums written were $(7,770,000). The negative amount was attributable primarily to written premiums that were canceled as a result of the termination of the pooling agreement between URIC and UCIC on January 1, 1994 and retrospect- ive premium adjustments at URIC. Net premiums earned for 1994 totaled $5,221,000. The decrease excluding UCIC was attributable to the moratorium on new and renewal business at URIC and Global and a decline in Senate's net premium earned. The loss and loss adjustment expense (LAE) ratio was 122.7% in 1993, of which approx- imately 47 points of the total ratio represented adjustments to prior year loss reserves related primarily to the P&C business. The loss and LAE ratio was 97.6% and 77.0% for 1995 and 1994, respectively. The loss ratios for 1995 and 1994 were impacted largely by changes in premium and losses for the reinsurance assumed segment due to commutation and or adjustments to numerous reinsurance contracts. For 1995 this favorability was offset by adverse development related URIC's pooling agreement with UCIC.\nThe operating expense ratio for 1995 and 1994 was substantially higher than 1993 as changes in operating expenses have not kept pace with reductions in premiums.\nProperty\/Casualty: Property and casualty results essentially reflected the runoff of prior years' business as new business consisted only of personal automobile assigned risk assignments in\nGlobal. The Company's P&C premiums for 1993 comprised approximately 80% of the Company's net premiums earned. The Company's P&C combined ratio was 177.0% for 1993 and was due primarily to the adverse development and reserve strengthening within these lines of business.\nThe Company wrote very little products liability, professional malpractice and business containing environmental impact coverage. Consequently, the overall exposure to occupational diseases or similar long-time emerging disabilities is considered by Management to be minimal.\nReinsurance Assumed: Assumed reinsurance was underwritten for P&C coverage which emphasize short-tail exposures in the automobile and general liability lines of business where claims develop over a shorter period of time than do claims arising in such lines of business as medical malpractice and product liability. Reinsurance assumed business for 1995 and 1994 reflected the runoff of prior years business as new business was halted in 1994. Negative written premiums for 1994 were due largely to the termination of the pooling agreement between URIC and UCIC on January 1, 1994.\nAccident\/Health: Earned premiums from A&H insurance lines decreased by 31% in 1995 and 15% in 1994 excluding UCIC. The Company's premium volume in A&H has been largely from medical stop loss policies. The growth in this business has slowed as many of the customers who purchased these policies in the past are self insuring at higher retentions. In addition, the Company was impacted by the publicity related to the financial difficulties of UCIC. The Company's A&H loss and LAE ratio increased to 51.9% for 1995 after decreasing to 37.9% for 1994 from 50.7% in 1993. The expense ratio increased to 51.0% in 1995 from 44.3% for 1994 and from 23.6% in 1993.\nFurther discussion of operating results is provided in ITEM 7 - - Management's Discussion and Analysis of Financial Condition and Results of Operations.\nMarkets\nThe Company's markets for A&H insurance traditionally included school districts, municipalities, retail stores and other selected risks. Public school districts represented the Company's largest single market for its A&H coverage.\nA&H insurance is generally marketed by affiliates of LAC with a lesser percentage of such coverage marketed by agents not otherwise affiliated with Lawrence Group or the Company. A portion of this coverage is marketed to members of sponsoring organizations.\nThe Company is required by regulatory authorities to participate in a number of assigned risk pools (Pools) and joint underwriting associations (JUAs). Participation may take the form of either direct assignments of policies to be issued by the Company or payment of assessments to fund the operating deficits of the Pools and JUAs which utilize servicing carriers to provide coverage. For Pools and JUAs which utilize direct assignment of policies, the Company must insure risks that might not otherwise meet the Company's underwriting standards. In 1995, risks insured through direct assignment of policies by Pools and JUAs amounted to approximately $136,000 in net premiums written. Further discussion of the impact of assessments from Pools and JUAs on the Company's operations is provided in ITEM 7 in a section entitled Losses - Government Pools.\nClaims\nURIC's reinsurance assumed claims are administered by a claims manager and use of a claims consultant, when necessary. Individual claims originate from ceding companies and are sent by the reinsurance intermediaries to URIC. Claims are monitored and appropriate controls are established for each ceding company. Periodic claims audits are conducted by URIC at the claims offices of the ceding companies to determine the quality and timeliness of claims handling.\nGlobal's reinsurance assumed claims are administered by its Finance Department as the individual claims are sent by the ceding companies to Global.\nClaims on policies insured by Senate are handled by a related third party administrator. Senate is provided with monthly reports on claims activity.\nReserves\nInsurance companies are required to maintain reserves for losses and LAE for all lines of business. These reserves are intended to provide for the ultimate settlement and administration of claims for all losses incurred and unpaid, including those incurred but not yet reported (IBNR). As of December 31, 1993, net reserves for loss and LAE of UCIC were increased significantly in order to reflect the current estimate of settlement costs for all known and unknown claims.\nProperty\/Casualty and Accident\/Health:\nReserves for losses and LAE represent estimates of reported losses and LAE and estimates of IBNR based upon past and current experience and is net of salvage and subrogation to be received and is increased for reinsurance assumed. In developing reserve\nestimates, Global and Senate give consideration to the impact of changes in demographics and\/or line of business mix. The IBNR reserve is calculated by applying actuarial derived loss development factors to results recorded to date.\nReinsurance Assumed:\nReserves for losses on reinsurance assumed business are generally maintained by URIC at the amounts reported by the ceding companies.\nThe following table provides a reconciliation of the Company's beginning and ending property and casualty (P&C) loss and LAE liability balances for 1995, 1994 and 1993.\nYear Ended December 31,(1) (Dollars in thousands) 1995 1994 1993 -------- -------- -------- Reserves for losses and LAE at January 1, $45,560 $186,973 $145,308 Less reserves related to deconsolidating UCIC - 111,574 - Less reinsurance receivable 7,072 9,679 19,997 ------ ------- ------- Total 38,488 65,720 125,311 Provision for losses and LAE for claims occurring in the current year 368 4,614 86,129 Increase (decrease) in estimated losses and LAE for claims occurring in prior years 3,051 (2,699) 57,088 ----- ----- ------ Total incurred losses & LAE 3,419 1,915 143,217 Losses and LAE payments ----- ----- ------- for claims occurring during: Current year 141 2,758 24 261 Prior years 17,657 26,389 78,091 ------ ------ ------ Total losses and LAE payments 17,798 29,147 102,352 ------ ------ ------- Net reserves for losses and LAE at December 31, 24,109 38,488 166,176 Reinsurance receivables 4,600 7,072 20,797 ------ ------ ------- Gross reserves $28,709 $ 45,560 $186,973 ====== ====== =======\nNote 1: The above tables as presented exclude the reserves for losses and LAE on government pools recognized on the Company's P&C business and those of Senate and SNLIC. The reserves for\ngovernment pools are not under the control of the Company and reflect the operating results and reserving practices of servicing carriers and regulators who administer these assigned risk pools in which the Company is obligated to participate. Accordingly, these reserves have been excluded from the tables. As of December 31, 1993, the Company's loss and LAE reserves related to these government pools were approximately $11,246,000. The above table for 1995 and 1994 and the accompanying loss and LAE reserve summary, exclude UCIC and Senate and SNLIC. Net reserves for Senate and SNLIC were $1,102,000, $1,180,000 and $1,396,000 at December 31, 1995 , 1994 and 1993, respectively.\nLoss and LAE incurred for 1995 totaled $3,419,000 reflecting the unfavorable impact of the adverse development of the URIC's pooling agreement with UCIC partially offset by the favorable impact of commuting several reinsurance treaties. Loss and LAE for 1994 totaled $1,915,000 and included approximately $1,600,000 related to the Northbridge California earthquake. Reserves related to prior years were reduced by $3,699,000 reflecting more favorable results in the reinsurance assumed business. The favorable loss experience on the reinsurance assumed business was related primarily to contracts that have retrospective rating provisions. This resulted in a commensurate reduction in earned premiums.\nTotal net losses and LAE incurred for 1993 totaled approximate- ly $143,217,000. Implementation of Statement of Financial Account- ing Standards (SFAS) No. 113 increased losses by $12,902,000.\nIncluded in the total incurred losses and LAE for 1993 was approximately $57,088,000 of losses and LAE attributable to prior accident years and included significant reserve strengthening at year-end. This adverse development was approximately 46% of the Company's net reserves for losses and LAE as of the beginning of the year and is related primarily to the casualty and workers' compensation business written by UCIC.\nThe following table presents the development of the Company's GAAP balance sheet reserves for 1985 through 1995, excluding UCIC. The line \"Reserves for Losses and LAE\" reflects the reserves at the balance sheet date for each of the indicated years and represents the estimated amount of losses and LAE arising in all prior years that are unpaid at the balance sheet date. The \"Reserves Re- estimated\" lines of the table reflect the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The \"Cumulative Redundancy (Deficiency)\"\nrepresents the aggregate change in the estimates over all prior years. The \"Cumulative Paid\" lines of the table reflect the cumulative amounts paid as of successive years with respect to the aforementioned reserve liability.\nDecember 31, Year 1985 1986 1987 1988 1989 1990 Dollars in thousands - ----------------------------------------------------------------- Reserves for losses & LAE 1,049 1,873 506 742 15,053 30,342\nReserves - re-estimated:\nOne year later 1,291 678 175 120 15,051 29,898 Two years later 1,250 537 109 120 17,782 43,688 Three years later 1,224 505 109 120 25,016 45,953\nFour years later 1,214 505 109 120 24,722 36,419 Five years later 1,214 505 109 120 19,547 36,100 Six years later 1,214 505 109 120 19,875 Seven years later 1,214 505 109 120 Eight years later 1,214 505 109 Nine years later 1,214 505 Ten years later 1,214 Cumulative Redundancy (Deficiency) (165) 1,368 397 622 (4,822) (5,758)\nCumulative paid as of:\nOne year later 1,235 570 94 120 4,902 10,587 Two years later 1,221 514 109 120 8,351 26,284 Three years later 1,220 505 109 120 15,086 29,823 Four years later 1,214 505 109 120 15,264 27,491 Five years later 1,214 505 109 120 14,642 32,301 Six years later 1,214 505 109 120 17,804 Seven years later 1,214 505 109 120 Eight years later 1,214 505 109 Nine years later 1,214 505 Ten years later 1,214\nDecember 31, Year 1991 1992 1993 1994 1995 Dollars in thousands - ------------------------------------------------------------------- Reserves for losses & LAE 44,399 60,845 76,099 45,560 28,709\nReserves - re-estimated:\nOne year later 63,249 78,590 65,338 49,230 Two years later 69,794 69,444 68,383 Three years later 62,418 70,707 Four years later 61,264 Five years later Six years later Seven years later Eight years later Nine years later Ten years later\nCumulative Redundancy (Deficiency) (16,865) (9,862) 7,716 (3,670)\nCumulative paid as of: One year later 32,658 24,586 23,297 20,745 Two years later 41,747 40,771 42,158 Three years later 46,934 54,708 Four years later 54,220 Five years later Six years later Seven years later Eight years later Nine years later Ten years later\nThe Company does not discount its loss and LAE reserves to present value, except as required for tax purposes under the Tax Reform Act of 1986.\nReinsurance Ceded\nURIC, Global and Senate utilize reinsurance principally to reduce their net liability on individual risks and to protect against catastrophic losses. Reinsurance generally is written under contracts in which the coverage is either on a proportional basis (quota share), where the reinsurer shares proportionately in premiums and losses, or on an excess of loss basis, where only losses above a fixed point are reinsured.\nURIC utilized reinsurance to limit its exposure to catastrophic exposures that it assumed. Global used a combination of excess of loss reinsurance arrangements and quota share treaties to limit its liability on any one loss to $100,000. Senate also utilizes reinsurance to limit its maximum exposure to $500,000 on business written by it.\nThe ceding of reinsurance does not legally discharge the original insurer from its primary liability to the policyholder, and the ceding company is required to pay the loss even if the assuming company fails to meet its obligations under the reinsurance agreement. The practice of insurers, however, subject to certain statutory limitations and as permitted by regulatory authorities, is to account for reinsured risks to the extent of the reinsurance ceded as though they were not risks for which the original insurer is liable. Under SFAS No. 113, for balance sheet presentations, companies are required to show reserves before reinsurance ceded.\nFor 1993, UCIC had been a party to several different quota share reinsurance treaties which covered all lines of business written by it. For 1993, this reinsurance contract was considered a financing arrangement under SFAS No. 113. The following summarizes this contract and the related accounting treatment under SFAS No. 113.\nThe Company ceded $21,700,000 of premiums and $12,902,000 in losses and earned $8,380,000 in commissions. UCIC determined that the contract did not pass the risk transfer criteria of SFAS No. 113. Accordingly, the Company applied deposit accounting to this contract in 1993 and the premiums, losses and commissions are excluded from the income statements and reflected as a net deposit on the balance sheet.\nIn addition to the quota share agreements with unaffiliated reinsurers, UCIC had also entered into several quota share agreements with URIC. In order to spread the risk, URIC retroceded amounts to other reinsurers. All retrocession agreements were canceled prior to 1993.\nUCIC and URIC had a pooling agreement in effect during 1992 and 1993. Under the terms of the agreement, the premiums and losses incurred during 1992 and 1993 were to be combined between the carriers and then split: 65% going to UCIC and 35% to URIC. The contract was incorrectly administered for the 1992 and 1993 statutory statements. The correction had the effect of decreasing UCIC's statutory policyholder's surplus by $8,300,000 and\nincreasing URIC's by the same amount from the 1993 statutory statements filed June 7, 1994. The agreement was terminated effective January 1, 1994; however, each company is responsible for its share of all premium, losses and LAE incurred prior to that date. At December 31, 1995, URIC had a net liability to UCIC of approximately $6,187,000 under the quota share and pooling agreements.\nSenate also reinsured a portion of its A&H business with UCIC. Written premiums and claims expenses ceded to UCIC in 1994 totaled $1,462,000 and $1,299,000 respectively. This agreement was canceled on March 1, 1994. At December 31, 1995, Senate had a net recoverable from UCIC of approximately $53,000.\nCeded premiums earned under reinsurance treaties were approximately $2,002,000, $4,745,000 and $12,930,000 for 1995, 1994 and 1993, respectively. The decrease in 1995 is due primarily to the lower level of premiums written. The decrease in 1994 is due primarily to the deconsolidation of UCIC.\nFacultative reinsurance ceded as a percentage of gross premiums earned was 8% in 1993. The Company had no facultative reinsurance in 1995 and 1994. The Company obtained facultative reinsurance primarily for umbrella policies whose limits exceeded those provided under the Company's excess of loss treaties, as previously mentioned.\nInvestment Policy\nInsurance company investments must comply with the insurance law of the insurer's domiciliary state. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments within specified limits and subject to certain qualifications in federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, real estate mortgages, real estate and money market instruments. In its examination report, the NYID treated several of UCIC's investments as not being within Insurance Regulations. The NYID and TDI have taken issue with investments of UCIC and URIC in Alpha Trust. These investments, which total $13,000,000 and $14,000,000 respectively, were made in 1994. Refer to Regulation for additional comment.\nThe investment policy and investments of each of the Company's subsidiaries are determined by its Investment Committee, consisting of certain Directors, and all transactions are ratified by the Board of Directors. The current investment objective is to maintain adequate liquidity so that claims and other obligations can be paid. The Company's current investment policy is to maintain a portfolio comprised principally of fixed interest and short term securities.\nAt of December 31, 1995, the Company has classified its fixed investments as Fixed Maturities Available for Sale. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale.\nDuring 1993, the Company liquidated most of its long-term GNMA and FNMA fixed maturity portfolio and replaced it with short-term investments and an increased cash position. In January 1994, URIC used $14,000,000 of these cash and securities to invest in Alpha Trust as further described under Regulation.\nThe table set forth below reflects average investments and income earned thereon for the Company for each of the years in the three-year period ended December 31, 1995:\nYear Ended December 31, (Dollars in thousands) 1995 1994 1993 ---- ---- ---- Average investments $23,370 $48,338 $161,433 Net investment income 3,101 3,313 7,165 Average yield excluding income from Alpha Trust 6.8% 4.3% 4.4%\nNet investment income for 1995 and 1994 includes interest income from Alpha Trust whose principal is not included in average investments. Net investment income included $1,513,000 and $1,226,000 from Alpha Trust for 1995 and 1994, respectively. The increase in average yield for 1995 compared with 1994 was attributable primarily to the general improvement in interest rates. The reduction in invested assets excluding UCIC declined 12% during 1994. The reduction in invested assets for 1995 and 1994 was due to the increased demands on cash flow from operations as cash from invested assets and premium income declined more rapidly than claim costs and operating expenses of the Company.\nThe following table summarizes the combined cash, cash equivalents and investments of the Company as of December 31, 1995:\nPercent (Dollars in thousands) Amounts of Total\nCash and cash equivalents $ 5,688 25.1% Short-term investments 11,898 52.6 Common stocks 941 4.2 Fixed maturities available for sale 3,921 17.3 Mortgage loans on real estate 171 .8 Other invested assets 4 .0 ------ ----- Total $ 22,623 100.0% ====== =====\nThe table set forth below indicates the carrying amount of the fixed maturities portion of the investment portfolio by year of maturity as of December 31, 1995:\nPeriod from December 31, 1995 Percent of to Maturity Amounts Portfolio - ------------------------------ --------- ---------- (Dollars in thousands)\nOne year or less $ 2,301 58.7% More than one year to five years 155 3.9 More than five years to ten years 396 10.1 More than ten years 109 2.8 ----- ----- Sub-total 2,961 75.5 Mortgage backed securities 960 24.5 ----- ---- Total $ 3,921 100.0% ===== =====\nAll securities in the Company's fixed investment portfolio as of December 31, 1995 are rated A or better by Standard & Poor's Corporation or Moody's Investor Services.\nThe Company wrote down its investment in common stock of Mechanical Technology, Inc. (MTI) by $5,587,000 as of December 31, 1993 due to the bankruptcy filing of one of its principal subsidiaries and the reporting of a negative stockholders' equity.\nUCIC wrote down as of December 31, 1993, its investment in an unrelated finance company by $3,500,000 to $1,500,000 due to the substantial reduction during 1994 in the value of the collateral supporting UCIC's investment.\nOperations, Personnel and Management Agreements\nAt December 31, 1995, URIC, Senate and Global had 6, 4 and 1 employees, respectively.\nUCIC and AWL had been parties to an agency agreement (Agency Agreement), in which AWL provided sales, marketing, loss control and customer service functions and was authorized to quote and issue policies and to effect cancellations or terminations thereof. During 1993, UCIC incurred expenses of $21,903,000 pursuant to that agreement. AWL paid a substantial portion of those commissions to external brokers and subagents.\nUCIC and AWL were also parties to a management consultant agreement (Management Consultant Agreement), pursuant to which AWL\nprovided consulting services as to the expansion of UCIC's existing insurance business and as to the development and implementation of new insurance programs. Under the Management Consultant Agreement, AWL also provided UCIC with personnel and office space at certain offices of AWL. During 1993, UCIC incurred expenses totalling $915,000 pursuant to the Management Consultant Agreement.\nSenate and AWL are parties to a management agreement (Senate Management Agreement) pursuant to which AWL provides management services to Senate. During 1995, 1994 and 1993, Senate expended $264,000, $ 60,000 and $60,000, respectively, pursuant to the Senate Management Agreement. Senate also obtains a majority of its medical stop-loss insurance and group business through subsidiaries of LAC. During 1995, 1994, and 1993, Senate incurred commission expenses of $605,000, $963,000 and $942,000, respectively, on this business. LAC pays a portion of these commissions to external brokers and subagents.\nCompetition\nThe P&C and A&H industry is highly competitive and competitors have filled the vacuum caused by the moratorium on writings by URIC and the downgrading by Best of the ratings of URIC to \"D\" (very vulnerable). There can also be no assurance that customers can be recovered even if the moratorium were lifted and the ratings are improved. Competitors have also taken advantage of Senate's relationship with UCIC.\nIn the particular lines of coverage written by the Company, the primary competition was in price, service and products. The Company had responded to this competition within the industry by working aggressively to strengthen relationships with customers, sponsoring organizations and trade groups. There had been little evidence of meaningful price increases, except in some specialty segments of the market during the last several years.\nRegulation\nThe Company and its subsidiaries are subject to regulation in each state in which they conduct business, including licensing and supervision by state insurance departments. Current statutes and regulations govern such matters as the nature of and limitations on investments, the payment of dividends and capital and surplus requirements. In addition, in most states, approval of premium rates and policy forms is required. The Company and its subsidiaries are, and will continue to be subject to these regulations.\nThe Company and its subsidiaries also are subject to regulation under the holding company statutes of Texas,\nGeorgia and Arizona. These holding company statutes generally require insurers that are subsidiaries of holding companies to register and file reports containing information concerning their capital structure, ownership, management, financial condition and general business operations and to provide such information regarding the holding company as well. Such regulations also generally require prior regulatory agency notice or approval of intercompany transactions within the holding company structure. The regulatory agencies of each state have statutory authorization to enforce their laws and regulations through various administrative orders and enforcement proceedings.\nTexas Insurance Law provides that no person, as defined by the Texas Insurance Law, may acquire control of the Company, and thus indirect control of URIC, unless it has given notice to URIC and obtained prior written approval from the Commissioner of Insurance of Texas for such acquisition of control. Any purchaser of 10% or more of the Company would be presumed to have acquired control of the Company, unless such presumption is rebutted.\nGeorgia Insurance Law provides that no person, as defined by Georgia Insurance Law, may acquire control of the Company, and thus indirect control of Global, unless it has given notice to Global and obtained prior written approval from the Commissioner of Insurance of Georgia for such acquisition. Any purchaser of 10% or more of the Company would be presumed to have acquired control of the Company, unless such presumption is rebutted.\nArizona Insurance Law provides that no corporation or other person may acquire control of the Company, and thus indirect control of Senate and SNLIC, unless it has given notice to Senate and SNLIC and obtained prior written approval from the Director of Insurance of Arizona for such acquisition. Any purchaser of 25% or more of the Company would be presumed to have acquired control of the Company, unless such presumption is rebutted.\nTexas Insurance Law provides that the maximum amount of dividends that URIC may make without prior regulatory approval is the greater of adjusted net investment income or 10% of statutory surplus as of the preceding year-end subject to minimum earned surplus requirements. At December 31, 1995, URIC did not meet the earned surplus requirements for dividend purposes and cannot pay dividends to LIG and UCIC in 1996.\nGeorgia Insurance Law provides that Global may pay dividends only out of its earned surplus up to the lesser of net income, excluding realized capital gains, but including realized capital losses, or 10% of statutory surplus as of the preceding year-end without regulatory approval. Global may pay dividends to URIC only. Global cannot pay dividends in 1996.\nArizona Insurance Law provides that Senate and SNLIC may pay dividends only out of their earned surplus up to the lesser of net gain from operations or 10% of statutory surplus as of the preceding year-end without regulatory approval. Senate may pay dividends to URIC only. SNLIC may pay dividends to Senate only. Senate could pay $214,000 in dividends in 1996 and SNLIC could pay $14,000 in dividends in 1996.\nThe National Association of Insurance Commissioners (NAIC) annually calculates eleven financial ratios to assist state insurance regulators in monitoring the financial condition of P&C insurance companies. Many of these ratios are intended to express operating activity over a one or two year period as a factor of policyholders' statutory surplus. 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 commissioners as to certain aspects of a company's business.\nGlobal fell outside the normal range on two ratios. One was related to the winding down of Global's operations and one related to adverse loss development on a contract that was commuted in 1994.\nURIC fell outside the normal range on four ratios. Three of the ratios fell outside of the range as a result of the investment in Alpha Trust being treated as a non-admitted asset for 1995 and the fourth due to the negative premiums written in 1994.\nSenate fell outside the range on one ratio related to the decrease in premiums written during 1995.\nIn January, 1994, UCIC and URIC loaned $13,000,000 and $14,000,000, respectively, to the Alpha Trust, the trustee of which is The Bank of New York. These loans consisted of term notes with differing maturities and repayment schedules with the initial principal repayment commencing April 1, 1996 and ending on January 1, 2001. Interest is at the prime rate plus 2%. Interest is payable quarterly beginning April 1, 1994. The Alpha Trust loaned $27,000,000 to Lawrence Group, which owns approximately 93% of the Company. The NYID and TDI had taken the position that the loans from UCIC and URIC, respectively, did not qualify as admitted assets.\nThe NYID conducted its regular examination of UCIC. The Department concluded in its report dated May 4, 1994 that UCIC was insolvent in the amount of $33,224,941, its capital impaired in the amount of $36,224,941 and its required minimum surplus to policyholders is impaired in the amount of $37,624,941. Following lengthy discussions and negotiations between the NYID and Company Management, on November 10, 1995 UCIC with the consent of the\nCompany was placed into liquidation by order of the Court.\nThe TDI conducted its regular examination of URIC as of March 31, 1993. TDI issued their audit report on May 25, 1994. On June 22, 1994, the TDI issued a confidential order creating a state of supervision and appointing a supervisor of the operations of URIC. The order was based upon disagreements with valuations of several assets, chief among them Alpha Trust, in financial statements filed by URIC with the TDI and upon net operating losses reported during the first quarter of 1994. As part of the agreement between the Company and the TDI lifting the confidential order of supervision, the Company agreed to certain financial covenants. If it were not to meet them the TDI could place URIC into conservatorship without opposition from the Company. At December 31, 1995 URIC had not met all the requirements.\nGlobal, Senate and SNLIC also underwent their regular examinations as of December 31, 1993, by their respective state insurance departments. The results showed no material findings.\nAs a result of the financial difficulties, Best downgraded URIC's rating from B (adequate) to D (very vulnerable). Senate's B rating was placed under review due to the difficulties of its parent, but was subsequently reaffirmed as a B.\nThe NAIC, which is not itself a regulatory authority but makes recommendations to and takes other actions affecting state regulatory authorities, adopted a Risk-Based Capital (RBC) standard in the fourth quarter of 1993 for use by state insurance regulators. RBC is intended to be a \"tool\" for regulators to assess the capital adequacy of property and casualty insurers and to take action when capital under the standard is judged to be inadequate. This standard has four action levels based upon the relationship of actual capital to RBC. The mildest action occurs at a level of 2.5:1. Based upon the RBC standards developed by the NAIC, all consolidated subsidiaries capital except URIC exceeded the authorized control level RBC by a substantial margin. URIC's ratio was 2.0:1. At this level, the TDI could require that URIC submit a business plan, however they are currently under more stringent requirements than those imposed by the RBC standards.\nTax Legislation\nDuring 1995, the IRS did not issue any new regulations which would have any material impact on the Company's tax position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company occupies a variety of leased office space in Texas, Georgia and New York, with its corporate headquarters located in New York City, New York.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn addition to the proceedings with the NYID and TDI discussed under Regulation, the Company is a defendant in other legal proceedings which Management believes will not have a material impact on the Company's financial statements. Management is defending these cases.\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 security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMarket Information\nThe Company's common stock was traded on the American Stock Exchange under the symbol of LWR. Trading of the Company's common stock was suspended by the American Stock Exchange from May 16, 1994 to August 29, 1995 due to the lack of current financial information. On August 30, 1995 trading was resumed, however, at that time the Company did not meet the minimum financial requirements of the Exchange and delisting procedures could have been resumed in the future. As of December 31, 1995 the Company does not meet the minimum net worth requirements of the AMEX.\nThe high and low sales prices for each quarterly period are summarized in the following schedule:\n1995 1994 Quarter Ended High Low High Low - -------------- ---- --- ---- --- March 31 N\/A N\/A 4 3\/8 3 1\/4 June 30 N\/A N\/A N\/A N\/A September 30 1 3\/16 7\/8 N\/A N\/A December 31 15\/16 7\/8 N\/A N\/A\nAs of March 21, 1996, there were approximately 1,800 holders of the Company's common stock and there were 14,121,482 common shares issued and outstanding.\nThe Company has not declared or paid any dividends in 1995 or 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following GAAP basis tables should be read in conjunction with the consolidated financial statements of the Company and the notes thereto. Year Ended December 31, ($ in thousands) 1995 1994 1993 1992 1991 Operating Data: ----- ---- ---- ---- ---- Revenues: Net premiums earned $5,533 $5,221 $121,015 $131,799 $118,324 Net investment income 3,101 3,313 7,165 12,188 11,599 Realized gains (losses) on investments (743) (598) (5,471) 5,888 4,813 ----- ----- ------- ------ ------ Total revenues 7,891 7,936 122,709 149,875 134,736 Operating expenses: Losses and loss adjustment expenses 5,402 4,019 148,437 107,583 85,631 Losses-government pools - - 897 2,864 6,551 Policy acquisition expenses 1,863 2,068 35,378 24,799 19,033 Other operating expenses 1,769 1,360 14,771 14,706 13,574 ----- ----- ------ ------ ------ Total operating expenses 9,034 7,447 199,483 149,952 124,789 ----- ----- ------- ------- ------- Operating income (loss) (1,143) 489 (76,774) (77) 9,947 Equity in loss of non- consolidated subsidiary - (7,309) - - - Equity in earnings (loss) of investee - (103) 632 413 - ------ ----- ------ ------ ------ Income (loss) before income taxes, minority interest and extra- ordinary items (1,143) (6,923) (76,142) 336 9,947 Income tax expense (benefit) (282) 168 962 (919) 2,704 ---- ---- ----- ----- ----- Income (loss) before minority interest and other items (861) (7,091) (77,104) 1,255 7,243 Minority interest 219 - - - - Extraordinary gain 38,387 - - - - Change in accounting principle - - - (233) - ------ ------ ------ ----- ----- Net income (loss) $37,745 $(7,091) $(77,104)$ 1,022 $7,243 ====== ===== ====== ===== =====\nITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nYear Ended December 31, 1995 1994 1993 1992 1991 (Amounts in thousands, except per share data)\nBalance Sheet Data:\nTotal investments $16,935 $27,994 $121,036 $181,818 $188,280 Total assets 46,502 67,041 257,315 305,018 265,305 Reserves for losses and loss adjustment expenses (1) 30,974 47,165 200,845 160,857 131,159 Total stockholders' equity (deficiency) 145 (56,252) (19,251) 58,908 65,804\nPer Share Data: Net income before extraordinary items $ (.05) $ (.50) $ (5.46) $ .09 $ .51 Net income (loss) 2.67 (.50) (5.46) .07 .51 Dividends - - .27 .46 .46 Total stockholders' equity (deficiency) $ .01 $ (3.98) $ (1.36) $ 4.17 $ 4.66\nAverage shares outstanding 14,121 14,121 14,121 14,121 14,121\nCertain GAAP Financial Ratios:\nLoss and LAE ratio 97.6% 77.0% 122.7% 81.6% 72.4% Losses - government pools ratio - - .7 2.2 5.5 Acquisition expense ratio 33.7 39.6 29.2 18.8 16.1 Dividend ratio - - .2 .2 .3 Underwriting expense ratio 32.0 26.0 12.0 11.0 11.2 Combined ratio 163.3% 142.6% 164.8% 113.8% 105.5%\n(1) Reserves for loss and loss adjustment expenses have been restated for the years ended December 31, 1992 and 1991, to reflect the gross reporting provisions of Statement of Financial Accounting Standard No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\".\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview\nThe year 1995 represented a substantial turnaround compared with 1994 and 1993 which were the most difficult and challenging in the history of the Lawrence Insurance Group, Inc. (Company or LIG) although it was unfortunate that the Company was compelled by circumstances to agree to placing United Community Insurance Company (UCIC) into liquidation. This action was taken in order for the Company to devote its focus and resources to the healthy parts of the Company. The Company recorded a net loss before extraordinary gain of $642,000 for the year. This compares with a net loss of $7,091,000 in 1994, and a net loss of $77,104,000 for 1993. The Company also recorded an extraordinary gain of $38,387,000 in 1995 related to the liquidation of UCIC. The losses in 1994 and 1993 were essentially attributable to the operations of UCIC.\nThe consolidated financial statements for 1993 include the accounts of LIG and all of its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. Amounts in 1994 exclude UCIC except as follows. On July 7, 1994 UCIC, with the consent of UCIC management, was placed in Rehabilitation by court order. Consequently, LIG and UCIC management no longer exercised any decision making authority or control over UCIC. These functions were the responsibility of the New York Insurance Department (NYID). As a result of this loss of control, the Company has included the financial results of UCIC only through the date of the Order of Rehabilitation and then on an unconsolidated basis (ie. results of operations are reflected as \"Equity in loss of non-consolidated subsidiary\" and the Company's investment as \"Deficit of non-consolidated subsidiary\"). In 1995, as a result of the formal order of liquidation entered on November 10, 1995 the Company reversed these amounts resulting in the extraordinary gain described above.\nThe Texas Department of Insurance (TDI) conducted its regular examination of United Republic Insurance Company (URIC) as of March 31, 1993. TDI issued its audit report on May 25, 1994. As a result of that report URIC was placed under confidential supervision on June 22, 1994 by the TDI. This order was based upon disagreements with valuations of several assets, chief among them Alpha Trust, in financial statements filed by URIC with the TDI and upon net operating losses reported during the first quarter of 1994. On August 25, 1995 this Order was lifted. In exchange the Company agreed to certain minimum financial targets. URIC met the interim goals but has not met the December 31, 1995 policyholder\nsurplus target of $8.0 million. If URIC does not meet this target, the TDI can place URIC into conservatorship without the consent of the Company, although it has not evinced any inclination to do so.\nResults of Operations\nAs a result of the NYID taking control of UCIC on July 7, 1994, the results of UCIC for the 1994 year are included on a deconsolidated basis and only through the first six months of 1994. As a result of deconsolidation, the results of UCIC are included in LIG results as \"Equity in loss of non-consolidated subsidiary\" for 1994 operations and \"Deficit of non-consolidated subsidiary\" for UCIC's cumulative stockholder's deficiency. All other balances and amounts of individual balance sheet and operating accounts for 1994 exclude UCIC. Comparisons between 1993 and 1994 generally exclude UCIC from 1993 amounts. The reversal of the \"Equity in loss of non-consolidated subsidiary\" in 1995 is reflected as an extraordinary gain.\nFor 1995, the Company recorded net income of $37,745,000 including the extraordinary gain related to UCIC of $38,387,000. Net loss from ongoing operations was $642,000. The loss was attributable to the adverse development related to URIC's pooling agreement with UCIC partially offset by Company,s ability to commute several reinsurance agreements at favorable terms.\nFor 1994, the Company lost $7,091,000 as LIG recorded a loss related to UCIC of $7,307,000 for the first six months of 1994. In addition to the loss related to UCIC's own operations since UCIC owns 21.4% of URIC, LIG does not consolidate the full amount of income or loss earned by URIC. For 1994, this amounted to $2,000 in URIC earnings not consolidated by LIG. Excluding UCIC for 1994, the Company would have earned $216,000.\nNet Premiums Earned: Net premiums earned represent the pro rata portion of the business written in the calendar year plus amounts carried over from the prior year that are taken into revenue in the current period reduced by applicable reinsurance. Net earned premiums for 1995 totaled $5,533,000 compared with $5,221,000 for 1994. The increase from 1994 was attributable primarily to favorable adjustments to URIC assumed premiums partially offset by the decrease in Senate Insurance Company's (Senate) stop loss business. For 1994, net premiums earned decreased by $35,180,000 excluding UCIC vs. 1993. The decrease was attributable primarily to the termination of the pooling agreement between URIC and UCIC and the impact of the halt by URIC and Global Insurance Company (Global) on writing new and renewal business. Senate's premiums earned declined by $419,000 primarily due to adverse publicity surrounding UCIC and some customers self-insuring at higher retention levels.\nDuring 1993 and 1992, UCIC had been a party to several different quota share reinsurance treaties which covered all lines of business written by UCIC. The Company ceded $21,700,000 of premiums and $12,902,000 in losses and earned $8,380,000 in commissions in 1993. UCIC determined that the contract did not pass the risk transfer criteria of SFAS No. 113. Accordingly, the Company applied deposit accounting to this contract in 1993 and the premiums, losses and commissions are excluded from the income statements and reflected as a net deposit on the balance sheet at December 31, 1993.\nNet Investment Income: Net investment income was $3,101,000 for 1995. 1994 totaled $3,313,000 compared with $2,978,000 for 1993, excluding UCIC. The decrease for 1995 compared with 1994 was due to the lower level of invested assets as yields were higher. The increase in 1994 over 1993 was attributable to higher yields. The Company's net investment income for the year ended December 31, 1993 was approximately $7,165,000 including UCIC.\nAll securities in the Company's fixed investment portfolio at December 1995, are rated A or better by Standard & Poor's Corporation or Moody's Investor Services.\nRealized Gains (Losses) on Investments: Realized losses for 1995 totaled $946,000 and were related to the loss on the disposition of notes of Aquatic Development Corporation and losses on fixed investments. Realized gains totaled $203,000. Realized losses totaled $598,000 for the year 1994 with approximately $503,000 due to the write down of an equity investment in Aquatic Development Corporation. The Company realized net gains on the sale of investments of approximately $3,616,000 for 1993. The investment transactions for the year ended December 31, 1993 were made to take advantage of favorable market conditions and capital appreciation on selected securities. For 1993 the Company wrote down amounts on two investments that were deemed to be permanently impaired. These write downs totaled $9,087,000 and offset the net gain from the sale of investments above resulting in a net realized loss for 1993 of $5,471,000. These items are discussed below.\nDuring 1992, the Company purchased approximately 49% of the outstanding common stock of Mechanical Technology, Inc. (MTI) for $4,757,500. This investment in common stock, was presented in the Consolidated Balance Sheets as Equity in Common Stock of Investee, and accounted for under the equity method. Accordingly, the Company's pro rata share of MTI's undistributed earnings for 1993 which amounted to $632,000 has been included in the accompanying Consolidated Statements of Operations for the year ended December 31, 1993. After December 31, 1993, MTI reported a substantial loss. The Company as of December 31, 1993 wrote down its investment in MTI to $216,000, which represented the fair value of the Company's investment in MTI's stock. The fair value was\ndetermined by the average quoted market value of the stock on November 1, 1994. During 1994, the remaining investment balance was reduced to $0.\nDuring December 1993, UCIC made a loan to First Commercial Credit Corp. (FCCC), an unrelated finance company in the principal amount of $5,000,000. Because FCCC's unencumbered assets consisted largely of the claim participation receivable guaranteed by MTI, a commensurate portion of UCIC's term loan with FCCC was considered to be collateral dependent. As of December 31, 1993, UCIC wrote down its investment in connection with this loan by $3,500,000.\nLosses and Loss Adjustment Expenses: For the year 1995 losses and LAE totaled $5,402,000 compared with $4,019,000 for 1994 and $39,322,000 for the year 1993, excluding UCIC. The increase for 1995 vs 1994 was attributable to the adverse impact of URIC's pooling agreement with UCIC partially offset by favorable results related to the commutation of several reinsurance agreements and the reduced business volume at Senate. In addition, for 1994 the Company incurred losses of approximately $1,600,000 related to the Northbridge, California earthquake for which it had no counterpart in 1995. The decrease for 1994 compared with 1993 is related primarily to the termination of the pooling agreement between URIC and UCIC and the resultant decline in premium volume and related losses. In 1993, URIC was also significantly impacted by the adverse loss and LAE experienced by UCIC as a result of the pooling agreement. For the year ended December 31, 1993, losses and LAE totaled approximately $148,437,000 including UCIC. The change in reinsurance due to SFAS No.113 added $12.9 million to losses and LAE. During 1993, the projection of ultimate costs for business written by the Company prior to the current year was increased by approximately $57.1 million.\nThe reinsurance assumed business had negative loss and LAE in 1995 as the cost of commuting several reinsurance agreements were less than amounts provided in prior periods. Earned premium in 1994 was negative as a result of a moratorium on new business and adjustments to retrospectively rated treaties as some of these treaties showed favorable loss experience in 1994. The favorability was offset by losses incurred of approximately $1,600,000 related to the Northbridge California earthquake.\nThe accident and health (A&H) business, which constitutes the current majority of the Company's business, continues to enjoy favorable results. The loss and LAE ratio was 52%, 38% and 51% for 1995, 1994 and 1993, respectively. The decrease in the ratio for 1994 was attributable primarily to very favorable experience on its medical stop loss program.\nLoss and LAE are based on the ability to collect from\nreinsurers amounts due under reinsurance contracts. Management believes that the credit exposure is not significant. URIC's reinsurance is allocated to numerous companies. Senate reinsured through Lloyd's of London on a combined quota share\/excess of loss basis. Senate claims with insureds are settled quickly and reimbursed by Lloyd's of London promptly. This minimizes any significant credit risk associated with longer tail business where premiums are remitted to reinsurers long before claims are paid and reimbursed. Global has minimal reinsurance.\nLosses - Government Pools: Most states have established joint underwriting associations of insurance carriers which are commonly referred to as pools. The purpose of these pools is to provide individuals, businesses and other entities with a guaranteed means to obtain certain mandated insurance coverage when they would not otherwise be reasonably obtainable through the traditional insurance market from an individual insurance carrier. Participation in these pools by the individual insurance carriers is not voluntary.\nEach member carrier essentially guarantees its share of the solvency of the pool. The pool administrator collects the premium, pays the losses and administrative costs, and passes a proportionate share of the costs to each member. If the losses and expenses exceed the premiums, the members may be subject to an assessment by the pool to fund the pool's deficit.\nThe Company's expense for government pool losses, which represents the net assessments from various pools to fund their deficits, was approximately $897,000 in 1993. These amounts were related to UCIC.\nPolicy Acquisition Costs: Commissions and other acquisition expenses were approximately $1,863,000 in 1995, $2,068,000 in 1994, $35,378,000 in 1993. The changes in policy acquisition costs for these years are attributable to the change in the volume of business, changes in the mix of business from premium with a lower commission rate to premium with a higher commission rate and changes in reinsurance ceding commission income. The Company offsets reinsurance ceding commission income against commissions and other acquisition costs to arrive at the Company's net expense The Company's net expense is impacted by changes in reinsurance ceding commission, in addition to changes in direct commissions associated with the Company's direct and assumed premium.\nPolicy acquisition expenses for 1995 decreased by $205,000 compared with 1994 primarily as a result of lower premium volume at Senate. Policy acquisition expenses for 1994 were $2,068,000 compared with $7,821,000 for 1993, excluding UCIC. The decrease\nwas attributable primarily to the reduction in premium volume, partially offset by an increase in the average commission rate as a higher percentage of the total business was related to A&H, which has a higher commission rate, but a lower loss ratio than the other lines.\nOther Operating Expenses: The Company's other operating expenses were approximately $1,769,000, $1,360,000 and $14,771,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Other operating expenses for 1995 reflected increased costs of litigation relative to URIC and the TDI as well as costs associated with complying with other regulatory agencies as well as additional costs associated with positioning the company to be able to move forward in 1996. The Company's other operating expenses were $1,360,000 for the year 1994, compared with $5,962,000 for the year 1993, exclusive of UCIC. The decrease is attributable primarily to the termination of the pooling agreement between URIC and UCIC effective January 1, 1994 and cost reduction efforts related to reduced business activity. Under that agreement URIC was allocated a portion of UCIC's operating expenses as well as premiums and loss and LAE. Excluding the impact of pooling in 1993, operating expenses decreased by approximately $1,232,000.\nEquity in Earnings of Investee: During 1992, the Company acquired 49% of the outstanding common stock of MTI, a high-technology manufacturer primarily within the defense\/aerospace industry. The Company's pro rata share of MTI's undistributed earnings since the date of acquisition has been included in the Company's operating results in the amount of $(102,000) for 1994 and $632,000 for 1993. Based upon events subsequent to December 31, 1993, the investment was written down as of December 31, 1993 to reflect an impairment.\nIncome Taxes: For 1995 the company recorded a tax benefit of $282,000 representing an amount recoverable against prior expense by URIC partially offset by a provision for state income taxes of Senate. For 1994, the Company recorded a tax expense of approximately $168,000 which consisted of state income taxes due. For 1993, the Company recorded a tax expense of approximately $962,000 which consisted of a deferred tax expense of $6,568,000 principally related to the establishment of a tax valuation allowance partially offset by a tax benefit of $5,605,000 resulting from a tax loss carryback against prior years income. The statutory Federal rate was 34% for 1995, 1994 and 1993.\nLiquidity and Capital Resources\nInsurance premiums generally are collected prior to the disbursement of claims and related expenses resulting in a favorable cash flow from operations for the insurance subsidiaries. Funds are then used to purchase investments ranging in maturity\nfrom short-term to long-term, reflecting the varying duration of insurance liabilities for losses, as well as the investment market conditions.\nDuring 1994 the Company implemented SFAS No. 115 - \"Accounting for Certain Investment in Debt and Equity Securities.\" This requires that fixed investments be classified into categories for financial statement presentation: Fixed Maturities Held to Maturity and Fixed Maturities Available for Sale. Fixed Maturities Held to Maturity are carried at amortized cost. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale. Securities available for sale include securities that Management intends to use as part of its asset\/liability management strategy and that may be sold in response to changes in interest rates, prepayment risk and other similar economic factors, as well as to fund catastrophic losses and other unexpected cash needs. Fixed Maturities Available for Sale are carried at fair value after 1993. For 1995 the Company considered all fixed investments to be available for sale.\nDuring 1993, the Company liquidated most of its long-term GNMA and FNMA fixed maturity portfolio and replaced them with short-term investments and an increased cash position.\nOperating activities used cash and cash equivalents of approximately $8,233,000, $18,221,000 and $24,221,000 in 1995, 1994 and 1993, respectively. The decrease in operating cash flow for the three years reflects the reduction in premiums written and the change in income from underwriting operations, which was adversely impacted by the increase in losses and LAE, as well as the increase in policy acquisition costs in 1993. In addition, in January, 1994, UCIC and URIC loaned $13,000,000 and $14,000,000, respectively, to Alpha Trust. These loans consisted of term notes with differing maturities and repayment schedules with the initial principal repayment commencing April 1, 1996 and ending on January 1, 2001. Interest is at the prime rate plus 2%. Interest is payable quarterly beginning April 1, 1994. Alpha Trust loaned $27,000,000 to Lawrence Group, which owns approximately 93% of the Company. This represented a use of cash by URIC of $14,000,000.\nFor 1993, the positive cash flow from investing activities served to offset the negative cash flow from operations, to finance the payment of dividends to stockholders of approximately $3,813,000 and to purchase equipment of $617,000, net of disposals. The positive cash flow from investing activities resulted in a decrease in the Company's invested asset portfolio of approximately $57,670,000, net of disposals; and excluding realized gains, changes in net unrealized gains\/losses and equity in earnings of investee. The net effect of these activities in 1993 was to generate cash of approximately $29,019,000.\nA significant portion of the parent company's internal sources of funds historically consisted of dividends from its subsidiaries. Since the insurance subsidiaries are subject to regulatory restrictions on the amount of dividends that may be paid, their earnings are not necessarily available to the Company on a current basis. The restrictions are generally based on specific levels of statutory surplus and investment income, as determined under statutory insurance accounting practices. Based upon their restrictions as of December 31, 1995, the insurance subsidiaries will not be able to pay any dividends to the Company during 1996 without prior approval of regulatory authorities. Dividend payments from the Company's subsidiaries have been suspended since the fourth quarter of 1993 due to statutory limitations. Dividends from the Company to its shareholders have also been suspended pending future dividends from the subsidiaries. During 1993, the insurance subsidiaries paid $3,915,000 in dividends to the Company.\nIn the absence of dividends from its subsidiaries the Company has had to rely on tax refunds and other miscellaneous sources of cash to fund its own activities. While these requirements are not substantial it is uncertain to what degree they can be met in the future. The insurance subsidiaries are deemed to have ample cash and invested assets to meet their foreseeable cash requirements.\nEconomy\nPeriods of economic recession and inflation have varying effects on the Company's subsidiaries, as well as other companies in the insurance industry. Fluctuations in the economy will contribute to changing loss, LAE and operating costs. Investment income will be reflective of changes in available investment yields, as dictated by the general state of the economy. Premium rates, however, are not significantly affected by economic swings since competitive forces generally control such rates. The underwriting policy of each subsidiary is geared to obtaining an adequate return for the risk it is underwriting. For example, policies exclude environmental and pollution coverages, due to their uncertainty. Net premiums earned may therefore increase or decrease at a lower rate than increases in losses and expenses. Inflation, however, could adversely affect a subsidiary's results of operations if it occurs during a period of declining premium rates.\nNew Accounting Pronouncements\nThere were no new accounting pronouncements that would upon implementation have a significant impact on the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe consolidated financial statements required in response to this Item are submitted as part of ITEM 14 (a) 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\nThe Directors and Executive Officers of the Company at December 31, 1995 were as follows:\nName Age Position\nAlbert W. Lawrence 67 Chairman of the Board F. Herbert Brantlinger 56 Chief Executive Officer President, Director Albert F. Kilts 50 Vice President,Treasurer, Director R. Wayne Diesel (1) 50 Director Barbara C. Lawrence 67 Secretary, Director Lawrence A. Shore (1) 68 Director Nevin D. Harkness (2) 74 Director Milos R. Knorr (2) 77 Director William J. Mather 58 Director Rita E. Harfield 52 Director\n(1) Member of the Compensation Committee. (2) Member of the Audit Committee. All members of the Audit Committee serve only as Directors and have no management responsibilities with respect to the Company.\nAll Directors hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified. Officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. Mr. Lawrence and Mr. Shore have been Directors since June 30, 1986. Ms. Lawrence and Messrs. Harkness and Knorr became Directors on October 19, 1986. Mr. Mather became a Director on October 7, 1987. Mr. Brantlinger became a Director on December 14, 1989. Mr. Diesel became a Director on December 10, 1992, Mr. Kilts became a Director on December 8, 1994 and Ms. Harfield became a Director on March 30, 1995. On March 30 and April 2, 1996, Messrs Shore and Diesel resigned as Directors in order to avoid any potential conflict with their positions at MTI.\nAlbert W. Lawrence is the founder of Lawrence Group and its subsidiaries. He is the Chairman of the Board and Chief Executive Officer of Lawrence Group and has held various offices in the subsidiaries of Lawrence Group since prior to 1989. Mr. Lawrence serves as a Director of MTI.\nF. Herbert Brantlinger has been Chief Executive Officer and President of Lawrence Insurance Group, Inc. since July 1990 and Chief Executive Officer and President of URIC since September 1992. He also holds various offices in certain subsidiaries of Lawrence Group. He also served as First Executive Vice President of UCIC from September 1989 to July 1990 and as President of UCIC from July 1990 to July 1994.\nAlbert F. Kilts has been Vice President and Treasurer of Lawrence Insurance Group, Inc. since December 1994 and Chief Operating Officer of LIG since May 1994. From October 1993 to July 1994 he also held several positions within UCIC. He previously served as Corporate Auditor for Lawrence Management Group, Inc. from August, 1991 through September, 1993. From 1975 until joining the Lawrence Group in August, 1991, Mr. Kilts was affiliated with Key Corp where he most recently served as Senior Vice President of Banking Administration at the parent company.\nR. Wayne Diesel is President and Chief Executive Officer of Mechanical Technology Incorporated (MTI), and serves on its Board of Directors. Previously he served as President and Chief Financial Officer of Lawrence Management Group, Inc. He became a Director of the Company in 1992 and served as its Treasurer in 1993. Prior to his association with the Lawrence Group, he was Administrative Vice President of Key Corp, a bank holding company; and previously had held various executive positions with the State of New York. He served as a Director of several companies.\nBarbara C. Lawrence, the wife of Albert W. Lawrence, is the Secretary of Lawrence Insurance Group, Inc. and also holds offices in various subsidiaries of Lawrence Group, Inc. since prior to 1989. She has been active in financial, philanthropic, civic and church activities in New York and New England since 1950.\nLawrence A. Shore retired from the office of President of Lawrence Management Group, Inc. during 1993, a position he held since July, 1990. Mr. Shore also retired as Treasurer of the Company, a position he had held since his appointment in 1991. In his previous capacity with the Company, he served as Chief Executive Officer and President of Lawrence Insurance Group, Inc. and President of UCIC, offices which he had held since September 1986 and September 1985, respectively. Mr. Shore serves as Chairman of the Board of MTI.\nNevin D. Harkness had been a Director of UCIC since October 1983. During 1993, Mr. Harkness retired from the position of Chief Executive Officer and President of The Olympic Regional Development Authority, Lake Placid, New York. Mr. Harkness has been involved in the field of athletics as administrator and coach since prior to 1989 and is currently acting as a consultant to the Company and its affiliates in the marketing of sports related coverages.\nMilos R. Knorr is active as an independent consultant and advisor in insurance, reinsurance and related fields, and acts as an arbitrator. He also serves as a Director of several companies. Prior to 1982, he held various senior executive positions with the INA Group (now CIGNA), including head of European Reinsurance Operations, President of INA Insurance Company of Canada and Senior Vice President of INA Reinsurance Company.\nWilliam J. Mather is President of Global, Senate, SNLIC and holds various offices in various subsidiaries of Lawrence Group. He is currently the Chief Marketing Officer of Lawrence Group and President of the Lawrence Agency Corp. where he has been employed since prior to 1989.\nRita E. Harfield is currently Vice President for Lawrence Agency Corporation. She has held various positions within Lawrence Group since 1976.\nWith the exception of Barbara C. Lawrence, all of the officers of the Company spent substantially all of their time on the affairs of the Company during 1995.\nUnder the securities laws of the United States, the Company's Directors, its Executive Officers, and any persons holding more than ten percent of the Company's common stock are required to report their ownership of the Company's common stock and any changes in that ownership to the SEC. Specific due dates for these reports have been established and the Company is required to report in this Form 10-K any failure to file by these dates during 1995.\nIn making these statements, the Company has relied upon the written representations of its incumbent Directors and Officers and its ten percent holders and copies of the reports that they have filed with the SEC.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth all compensation that the Company and its subsidiaries paid or accrued for the year ended December 31, 1995 for F. Herbert Brantlinger as President and Chief Executive Officer of LIG. The Company did not have any other Executive Officer whose compensation exceeded $100,000 during 1995. All other Year Salary Bonus Compensation ----- ------ ------- ----------- 1995 $118,922 $ - $ - 1994 96,827 - - 1993 201,400 - 2,014\nThe Company does not have any long-term compensation plans based upon the issuance of restricted stock awards, stock options and\/or stock appreciation rights (SARs).\nDuring the period July 7, 1994 through December 1, 1995 a portion of Mr. Brantlinger's salary was paid by UCIC which was under the control of the NYID. These amounts have been excluded from the above table. On a annual basis Mr. Brantlinger's salary is $208,600.\nCompensation Committee Interlocks and Insider Participation\nMembers of the Compensation Committee consist of Lawrence A. Shore, Chairman and Vincent P. Brennan prior to his resignation in March, 1995 and R. Wayne Diesel. Mr. Shore was formerly President and CEO of the Company and of UCIC prior to his retirement in 1991.\nWhile Mr. Diesel was treasurer of LIG, he was also the Chief Financial Officer for LIG's parent company and his compensation was established at that level. There were no compensation interlocks.\nCompensation programs for the Company's executive officers are administered by the Compensation Committee of the Company's Board of Directors. The Committee is composed of non-employee directors who are not eligible to participate in any of the executive compensation programs.\nThe Company's executive compensation policies are designed to attract and retain qualified executives and ensure that their efforts are directed toward the long-term interests of the Company and the Company's shareholders. The executive compensation program is designed to provide value to the executive only if individual performance, Company performance versus budgeted earnings targets, longer term earnings per share growth and share price appreciation meet or exceed expectations while also taking into consideration challenges faced by the Company. The policies have been held in abeyance since the assumption of control of UCIC by the NYID. For 1995, there was no change in compensation levels for executive officers.\nFive Year Performance Graph\nComparison of Five-Year Cumulative Returns Among the Company, American Stock Exchange Composite (\"AMEX\") and the Insurance Industry Listed Companies:\nYear ended December ---------------------------------- 1990 1991 1992 1993 1994 1995 ---- ---- ---- ---- ---- ----\nLIG 100 167 138 61 41 26 AMEX Stock Market(US companies) 100 138 145 171 160 206 NYSE,AMEX,NASDAQ listed insurance carriers 100 136 174 189 177 255\nThe Stock Performance Graph, as presented above, reflects the cumulative return on the common stocks of the Company, AMEX and the Insurance Industry, respectively, assuming an original investment in each of $100 on December 31, 1990 (the \"base\") and reinvestment of quarterly dividends. Cumulative returns for each fiscal year subsequent to 1990 are measured as a change from this base.\nThe Company's return tracked the AMEX and Insurance indices for 1991. Since that time, the Company's return declined substant- ially, reflecting an earnings decline in 1992 and significant loss- es for 1993 and 1994. Trading in the Company's stock was suspended on May 13, 1994. The suspension was lifted on August 30, 1995. Trading has been in a narrow range since the suspension was lifted.\nRetirement Plans\nURIC, Global and Senate are participating employers in a profit sharing plan under Section 401(k) of the Internal Revenue Code, maintained by Lawrence Group (401(k) Plan). The 401(k) Plan covers all employees of URIC, Global and Senate who have completed one year of service and have attained age twenty and one-half. Each year, URIC, Global and Senate contribute to the 401(k) Plan such amounts as the Boards of Directors, in their discretion, may determine. In addition, participants may elect to reduce their salary and to have such amounts contributed by the Company to the 401(k) Plan. The participants' accounts are fully vested at all times. The 401(k) Plan was adopted effective as of January 1, 1986. The cost to the Company, including UCIC through July 7, 1994 of the 401(k) Plan was approximately $17,500, $23,000 and $66,000 for 1995, 1994 and 1993, respectively. These costs include $0 in 1995, $0 in 1994 and $4,000 in 1993 for executive officers.\nDirectors' Fees\nDirectors of the Company are paid $600 for each regular meeting of the Board of Directors which they attend.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the holdings of Common Stock by each of the Company's Directors and by all Officers and Directors as a group as of December 31, 1995. Except as otherwise indicated, to the Company's knowledge all shares are beneficially owned, and investment and voting power is held by the persons named as owners.\nName of Beneficial Owner Beneficial Ownership Outstanding Shares\nAlbert W. Lawrence (1) 6,585,571 46.6 F. Herbert Brantlinger (2) 2,872 * Barbara C. Lawrence (3) 6,575,348 46.6 R. Wayne Diesel - * Lawrence A. Shore 14,173 * Nevin D. Harkness 300 * Milos R. Knorr 3,000 * William J. Mather (4) 27,664 * Albert F. Kilts - * Rita E. Harfield 952 * All Officers and Directors as a group (1)(2)(3)(4) 13,209,880 93.5\n*Less than 1%\n(1) Includes 6,572,197.5 shares held by Lawrence Group. In addition, there are 8,374 shares in the account of Mr. Lawrence in the 401(k) Plan.\n(2) Includes 2,872 shares in the account of Mr. Brantlinger in the 401(k) Plan.\n(3) Includes 6,572,197.5 shares held by Lawrence Group.\n(4) Includes 26,839 shares in the account of Mr. Mather in the 401(k) Plan.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company paid $0, $0, and $3,548,000 in dividends to Lawrence Group in 1995, 1994 and 1993, respectively.\nThe Company and its subsidiaries supplemented the activities that were performed in-house by obtaining various services from A.W. Lawrence and Co., Inc. (AWL), a subsidiary of Lawrence Agency Corp. (LAC), which is a subsidiary of Lawrence Group, pursuant to agreements between the Company's subsidiaries and AWL. Under the terms of the Agency Agreement, AWL and its affiliates receive commissions when they are the agent for the transaction. UCIC received a substantial portion of its written premiums through AWL.\nIn 1993 UCIC incurred $21,903,000 in commissions. AWL pays a substantial portion of these commissions to external brokers and subagents.\nUnder a management consultant agreement with AWL in effect since 1982, UCIC received technical, accounting and management assistance in various administrative areas. These costs were $915,000 in 1993.\nUCIC subleased various office space from LAC. Rent expense totaled $493,000 for 1993.\nIn September 1992, Global entered into a sublease agreement with LAC to rent space located in Atlanta, Georgia. The sublease is for a term ending on September 1, 1995. Annual rent expense is $7,000 under this sublease.\nThe Company's subsidiaries held various notes receivable from other Lawrence Group affiliates at December 31, 1994. The notes are included in Other Invested Assets on the accompanying Consolidated Balance Sheets and amounted to $269,000 at December 31, 1994, All notes were repaid in 1995. Interest rates charged on these notes are Prime plus 1%. Interest income earned with respect to these loans totalled $11,000, $40,000 and $106,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company and its subsidiaries hold mortgage loans from employees of Lawrence Group as well as officers and directors of the Company and its subsidiaries. These loans totalled $34,000 and $186,000 December 31, 1995 and 1994, respectively. Interest rates on the mortgages include variable and fixed rates, with the fixed rates ranging from 7% to 8.5% and variable rates ranging from one-year Treasury Bill rate plus 3% to Prime plus 1%.\nSenate ceded a portion of its accident\/health business to UCIC. Written premiums ceded to UCIC under this arrangement amounted to $1,462,000 in 1994. Benefits and other underwriting expenses ceded to UCIC totalled $1,299,000. As a result of the reinsurance arrangement, Senate's accounts reflect a net recoverable from UCIC of $53,000 at December 31, 1995.\nSenate obtains a significant portion of its business from LAC to which it pays commissions. These commission expenses totalled $605,000, $963,000 and $942,000 in 1995, 1994 and 1993, respectively. LAC pays a portion of these to external brokers and subagents. Senate pays AWL for management services associated with Senate business. These payments were $264,000, $60,000 and $60,000 for 1995, 1994 and 1993, respectively.\nURIC loaned $14,000,000 Alpha Trust which in turn invested in notes issued by Lawrence Group, which owns approximately 93% of the Company during 1994.\nIn addition to the quota share treaty with UCIC, URIC and UCIC also had a pooling agreement in effect during 1992 and 1993. The agreement was terminated effective January 1, 1994; however, each company is responsible for its share of all premium, losses and LAE incurred prior to that date. At December 31, 1995, URIC had a net liability to UCIC under these reinsurance agreements of approximately $6,187,000.\nAt December 31, 1995 URIC carried a note payable due to LGI of $300,000. Interest is at 8%. LIG had received an advance of $185,000 from LGI the balance of which was outstanding at the end of 1995.\nAt December 31, 1995 the Company had income taxes payable to Lawrence Group of $113,000.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe 1995 financial statements listed on the accompanying Index to Financial Statements and Financial Statement Schedules Covered by Report of Independent Accountants are filed as part of this report.\n2. Schedules\nThe 1995 schedules listed on the accompanying Index to Financial Statements and Financial Statement Schedules Covered by Report of Independent Accountants are filed as part of this report.\n3. Exhibits\nThe exhibits listed on the accompanying Index to Exhibits are filed as part of this report.\n(b) Reports on Form 8-K\nOn August 29, 1995, the Company reported that the TDI had released URIC from confidential supervision which had been imposed on June 22, 1994. The release was conditioned upon URIC achieving certain capital surplus goals. In the event URIC failed to meet those requirements the TDI would have the authority to place URIC into conservatorship. In the same filing it was reported that the American Stock Exchange agreed to allow the resumption of trading of LIG stock as of August 30, 1995. It was noted, however, that since the Company did not meet its minimum financial guidelines, delisting procedures could be reinitiated in the future.\nOn November 17, 1995, the Company reported that by Order of Supreme Court of the State of New York entered on November 10, 1995, UCIC with the consent of the Company was ordered to be liquidated with the Superintendent of the NYID appointed as liquidator.\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.\nLAWRENCE INSURANCE GROUP, INC. (Registrant) Dated: April 12, 1996 By: \/s\/ F. HERBERT BRANTLINGER ------------------------------ F. Herbert Brantlinger 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.\nName Title Date\n\/s\/ ALBERT W. LAWRENCE Chairman of the Board April 12, 1996 Albert W. Lawrence\n\/s\/ F. HERBERT BRANTLINGER President and Director April 12, 1996 F. Herbert Brantlinger (Principal Executive Officer)\n\/s\/ ALBERT F. KILTS Treasurer and Director April 12, 1996 Albert F. Kilts ( Principal Accounting and Financial Officer)\n\/s\/ BARBARA C. LAWRENCE Secretary and Director April 12, 1996 Barbara C. Lawrence\n\/s\/ NEVIN D. HARKNESS Director April 12, 1996 Nevin D. Harkness\n\/s\/ MILOS R. KNORR Director April 12, 1996 Milos R. Knorr\n\/s\/ WILLIAM J. MATHER Director April 12, 1996 William J. Mather\n\/s\/ RITA E. HARFIELD Director April 12, 1996 Rita E. Harfield\nLAWRENCE INSURANCE GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nITEM 14 (a)\nForm 10-K\nPage\nReport 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 Stockholders' 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\nSchedules: I - Summary of Investments Other than Investments in Related Parties at December 31, 1995 S-2\nII - Condensed Financial Information of Registrant at December 31, 1995 and 1994 and for the Years Ended December 31, 1995, 1994 and 1993 S-3\nIII - Supplementary Insurance Information for the Years Ended December 31, 1995, 1994 and 1993 S-6\nIV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 S-10\nV - Valuation and Qualifying Accounts for the Years Ended December 31, 1995, 1994 and 1993 S-11\nVI - Supplementary Information Concerning Property and Casualty Insurance Operations for the Years Ended December 31, 1995, 1994 and 1993 S-12\nCOOPERS & LYBRAND L.L.P.\nREPORT OF INDEPENDENT ACCOUNTANTS\nWe have audited the consolidated financial statements and the financial statement schedules of Lawrence Insurance Group, Inc. and subsidiaries listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedules 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 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 Lawrence Insurance Group, 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 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.\nThe accompanying consolidated financial statements and financial statement schedules have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1, a subsidiary, United Republic Insurance Company (URIC), was under confidential supervision by the Texas Department of Insurance (TDI) under an order issued in June 1994. On August 25, 1995, the Commissioner of Insurance of the TDI issued a Release From Confidential Supervision Order and an Article 1.32 Order of Consent for URIC. The effect of these orders was to release URIC from confidential supervision contingent upon increasing its statutory policyholder surplus to $8 million and other administrative requirements. In addition, an Appointment of Conservator by Consent has been signed by URIC and could be executed by TDI should URIC fail to abide by the above mentioned financial and other administrative requirements. URIC has failed to meet several of these requirements, including the policyholder\nsurplus requirements. URIC could be placed in to conservatorship by the TDI at any time. The above actions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 1. The consolidated financial statements and financial statement schedules do not include any adjustments that might result from the outcome of these uncertainties.\nAs discussed in Note 1 to the consolidated financial statements, in 1994 the Company changed its method of accounting for United Community Insurance Company, a former wholly owned subsidiary.\n\/s\/ Coopers & Lybrand L.L.P.\nAlbany, New York April 8, 1996\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED BALANCE SHEETS ASSETS (SEE NOTES 1 & 2)\n($ in thousands) December 31, ------------------- 1995 1994 -------- ------- Investments: Fixed maturities held to maturity, at amortized cost (Fair value: 1994 - $7,684) $ - $ 7,698 Fixed maturities available for sale, at fair value (Cost: 1995 - $3,875, 1994 - $6,228) 3,921 5,784 Equity in common stock of investee at equity (Cost: 1995-$0, 1994-$103) - - Equity securities, at fair value (Cost: 1995 and 1994 - $997) 941 917 Short-term investments, at cost which approximates fair value 11,898 11,523 Collateral loan at cost which approximates fair value - 1,033 Mortgage loans on real estate, at aggregate outstanding principal balance 171 186 Other invested assets, at cost which approximates fair value Notes receivable from affiliates - 269 Other 4 584 ------- ------- Total investments 16,935 27,994 Cash and cash equivalents 5,688 2,500 Accrued investment income 475 668 Accounts receivable (Net of allowance for doubtful accounts of $0 in 1995 and 1994 10,777 12,467 Reinsurance recoverable 5,690 13,708 Reinsurance receivable 5,764 7,320 Prepaid reinsurance premiums 44 468 Deferred policy acquisition costs 68 289 Property and equipment, net 23 52 Income taxes recoverable 69 151 Other assets 969 1,424 ------- ------- Total assets $46,502 $67,041 ======= =======\nSee accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) (SEE NOTES 1 & 2)\n($ in thousands) December 31, _________________ 1995 1994 -------- -------- Liabilities: Reserves for losses and loss adjustment expenses $30,974 $ 47,165 Deficit of non-consolidated subsidiary - 56,879 Unearned premiums 505 1,384 Reinsurance balances payable 11,526 13,316 Accrued expenses and other liabilities 955 1,166 Payable to affiliate, net 441 407 Income taxes payable 113 468 Excess of fair value of acquired subsidiaries over purchase price 1,414 2,508 ------- ------- Total liabilities 45,928 123,293 ------- -------\nContingencies and commitments (Notes 8 & 9) - - Minority interest 429 - --- --- Stockholders' equity (deficiency): Preferred stock, $.01 par value; 2,000,000 shares authorized; no shares outstanding - - Common stock, $.01 par value; 20,000,000 shares authorized; 14,121,482 shares issued and outstanding 141 141 Additional paid-in-capital 39,739 39,739 Net unrealized losses on investments (Net of deferred income tax of $0 in 1995 and 1994) (8) (2,664) Receivable from Alpha Trust (Note 8) (11,004) (27,000) Accumulated deficit (28,723) (66,468) ------- -------- Total stockholders' equity (deficiency) 145 (56,252) ------- ------- Total liabilities and stockholders' equity (deficiency) $46,502 $67,041 ======= =======\nSee accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (SEE NOTES 1 & 2 ) (Amounts in thousands except Year Ended December 31, per share data) -------------------------- 1995 1994 1993 -------- -------- -------- Revenues: Net premiums earned $5,533 $5,221 $121,015 Net investment income 3,101 3,313 7,165 Realized losses on investments (743) (598) (5,471) ------ ------ -------- Total revenues 7,891 7,936 122,709 Operating expenses: Loss and loss adjustment expenses 5,402 4,019 148,437 Loss - government pools - - 897 Policy acquisition expenses 1,863 2,068 35,378 Other operating expenses 1,769 1,360 14,771 ------ ------ ------- Total operating expenses 9,034 7,447 199,483 ----- ----- ------- Operating income (loss) (1,143) 489 (76,774) Equity in loss of non-consolidated subsidiary - (7,309) - Equity in earnings (loss) of investee - (103) 632 ------ ------ ------- Loss before income taxes, minority interest and extraordinary gain (1,143) (6,923) (76,142) ------ ------ ------ Income tax expense (benefit) (282) 168 962 ------ ------ ------- Net loss before minority interest and extraordinary gain (861) (7,091) (77,104) Minority interest 219 - - ------ ------ ------- Net Loss before extraordinary gain (642) (7,091) (77,104) Extraordinary gain (net of $0 tax) 38,387 - - ------- ------- -------- Net income (loss) $37,745 $(7,091) $(77,104) ======= ======= ======== Per share data: Loss before extraordinary gain $ (.05) $ (.50) $ (5.46) Extraordinary gain 2.72 - - ------- ------- -------- Net income (loss) $ 2.67 $ (.50) $ (5.46) ===== ===== ===== Average shares outstanding 14,121 14,121 14,121 See accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n($ in thousands) Net unreal- ized gains Add'l (losses) on Preferred Common Paid-in investments Stock Stock Capital net of tax -------- ------ -------- ---------- Balance at January 1, 1993 $ - $141 $39,739 $ (817) Change in net unrealized losses 1,063 ------ ------ ------- ------- Balance at December 31, 1993 - 141 39,739 246 Change in net unrealized gains (2,910) ------ ------ ------- ------- Balance at December 31, 1994 - 141 39,739 (2,664) Change in net unrealized losses 2,656 ------ ------ ------- ------- Balance at December 31, 1995 $ - $141 $39,739 $ (8) ====== ==== ====== ===== Receivable Retained Stockholders' from earnings equity Alpha Trust (deficit) (deficiency) ----------- ---------- ----------- Balance at January 1, 1993 $ - $19,845 $58,908 Change in net unrealized losses 1,063 Net loss (77,104) (77,104) Cash dividends declared: Common stock $.15 per share (2,118) (2,118) -------- -------- -------- Balance at December 31, 1993 - (59,377) (19,251) Change in net unrealized gains (2,910) Net loss (7,091) (7,091) Receivable from Alpha Trust (27,000) (27,000) -------- -------- ------- Balance at December 31, 1994 (27,000) (66,468) (56,252) Change in net unrealized losses 2,656 Net income 37,745 37,745 Liquidation of subsidiary 15,996 15,996 ------- -------- -------- Balance at December 31, 1995 $(11,004) $(28,723) $ 145 ====== ====== =====\nSee accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\n($ in thousands) Year Ended December 31, ----------------------- 1995 1994 1993 ------- ------- -------- Operating activities: Net income (loss) $37,745 $(7,091) $(77,104) Adjustments to reconcile net income (loss) to net cash and cash equivalents used in operating activities: Realized losses on investments 743 598 5,471 Equity in loss of non-consolidated subsidiary - 7,309 - Equity in (earnings) loss of investee - 103 (632) Minority interest in subsidiary (219) - - Deferred income taxes - - 6,568 Extraordinary gain (38,387) - - Depreciation and amortization (1,061) (1,047) (85) Accrued investment income 194 (426) 445 Accounts receivable 1,690 3,959 13,951 Reinsurance recoverable 8,018 (3,289) 4,981 Reinsurance receivable 1,557 3,382 (3,982) Prepaid reinsurance premiums 424 (111) 11,322 Reinsurers deposits - - (16,543) Deferred policy acquisition costs 220 2,220 (79) Income taxes recoverable 81 2,503 (4,343) Other assets 454 3,876 2,565 Reserves for losses and loss adjustment expenses (16,191) (30,654) 39,988 Unearned premiums (880) (12,880) (14,476) Reinsurance balances payable (1,790) 14,287 7,132 Accrued expenses and other liabilities (831) (960) 600 -------- -------- -------- Net cash and cash equivalents used by operating activities (8,233) (18,221) (24,221) -------- -------- --------\nSee accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\n($ in thousands) Year Ended December 31, ----------------------- 1995 1994 1993 ------- ------- ------- Investing activities: Proceeds on sales of: Fixed maturities held to maturity $ 3,179 $ - $ - Fixed maturities available for sale 5,090 7,760 324,514 Other 682 - 9,946 Proceeds on redemptions of: Fixed maturities held to maturity 3,850 - 2,156 Fixed maturities available for sale 286 2,192 873 Other 520 - - Payments for purchases of: Fixed maturities held to maturity - - (1,997) Fixed maturities available for sale (2,111) (12,997) (245,859) Other - (2,259) (7,356) (Increase)decease short-term investments (375) 23,144 (24,607) Purchase of equipment-net - (1) (617) ------- ------- ------- Net cash & cash equivalents provided by investing activities 11,121 17,839 57,053 ------ ------ ------ Financing activities: Receivable from Alpha Trust - (14,000) - Dividends paid - - (3,813) Notes payable to affiliate 300 - - ------ ------ ------ Net cash and cash equivalents (used) provided by financing activities 300 (14,000) (3,813) ------ ------ ------ Increase (decrease) in cash and cash equivalents 3,188 (14,382) 29,019 Cash and cash equivalents - beginning of year 2,500 35,276 6,257 Cash & cash equivalents of non-consol- idated subsidiary at December 31, 1993 - (18,394) - ----- ------ ------ Cash and cash equivalents-end of year $5,688 $ 2,500 $ 35,276 ===== ===== ====== Supplemental disclosure of cash flow information: Cash paid (received) for income taxes $ 24 $(3,324) $(1,306) Non cash financing - elimination of Alpha Trust receivable due to liquidation of subsidiary $15,996 - -\nSee accompanying notes to consolidated financial statements.\nLAWRENCE INSURANCE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - GENERAL\nLawrence Insurance Group, Inc. (the Company or LIG) was incorporated in Delaware on June 30, 1986, as an insurance holding company, which is presently 93% owned by Lawrence Group, Inc. (Lawrence Group).\nSubsidiaries of the Company include United Republic Insurance Company (URIC), Global Insurance Company (Global), Senate Insurance Company (Senate), Senate National Life Insurance Company (SNLIC), and Senate Syndicate, Inc. (Syndicate). Senate and Global are wholly owned subsidiaries of URIC. SNLIC is a wholly owned subsidiary of Senate. United Community Insurance Company (UCIC) is no longer considered a subsidiary of the Company as a result of the Order of Rehabilitation issued on July 7, 1994 which transferred management and control to the New York Insurance Department (NYID) and the subsequent Order of Liquidation entered on November 10, 1995 by the New York Supreme Court, Schenectady County. URIC and Global, which are property and casualty insurance companies, have been in run-off since early 1994. Senate is an accident and health insurer doing business almost exclusively in New York. SNLIC and Syndicate are inactive.\n(a) BASIS OF PRESENTATION\nThe consolidated financial statements for 1993 include the accounts of LIG and all wholly owned subsidiaries (collectively, the Company) including UCIC. All significant intercompany transactions have been eliminated in consolidation. Amounts in 1995 and 1994 exclude UCIC except as noted below. On July 7, 1994, UCIC, with the consent of UCIC management, was placed in Rehabil- itation by court order. Consequently, LIG and UCIC management no longer exercised any decision making authority or control over UCIC These functions became the responsibility of the NYID. As a result of this loss of control, the Company included the financial results of UCIC only through the date of the Order of Rehabilitation and then on an unconsolidated basis, that is results of operations are reflected as \"Equity in loss of non-consolidated subsidiary\" and the Company's investment as \"Deficit of non-consolidated subsidiary\". Prior years financial statements have not been restated. The Company continued to reflect this liability until UCIC was entered into liquidation on November 10, 1995. See Note 2.\nThe accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company incurred substantial losses in 1993 and 1994 and even though UCIC's stockholder's deficiency has been eliminated, the Company's subsidiaries continue to be adversely impacted by UCIC's demise.\nLiquidity for the parent company has deteriorated significantly and is expected to remain in that condition as its principal source of cash was dividends from its subsidiaries. In addition, URIC had been under a confidential order of supervision by the Texas Department of Insurance (TDI) since June, 1994, until its release on August 25, 1995. As a condition to the release of the order the Company agreed to achieving certain financial goals. The financial goals include increasing statutory surplus to $8 million at December 31, 1995. The statutory surplus as filed with the TDI at December 31, 1995 was $6.6 million. This amount does not include the effect of the loss and LAE adjustment of approximately $4 million described under (f) of Note 1. The TDI could place URIC under conservatorship. Under conservation, the TDI assumes all control and decision making authority during the rehabilitation period. Under conservatorship, URIC would be accounted for as a non-consolidated subsidiary and any income or loss subsequent to the rehabilitation order would not be recorded in the financial statements of the Company until the rehabilitation order was lifted.\nThe accompanying consolidated financial statements are present- ed in accordance with generally accepted accounting principles, which differ in certain respects from those followed by subsidiar- ies of the Company in their reports to regulatory authorities. See Note 8. 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. Actual results could differ from those estimates.\nCertain amounts in the accompanying 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation. These reclassifications have no effect on consolidated net income (loss) or stockholders' equity (deficit).\n(b) INVESTMENTS\nFixed maturities, which consist of bonds and notes, are presented in two categories on the accompanying Consolidated Balance Sheets: Fixed Maturities Held to Maturity and Fixed Maturities Available for Sale. If Management has the intent and the Company has the ability to hold such securities until maturity, such securities are classified as being held to maturity. Securities classified as being held to maturity are carried at amortized cost. At December 31, 1994, securities classified as held to maturity included securities on deposit with various regulatory authorities in so far as they are usually not available to meet current liquidity needs of the Company. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as\navailable for sale and carried at fair value. In 1995, all securities were considered available for sale. Unrealized gain or losses on securities carried at fair value are recorded directly in stockholders' equity, net of applicable deferred income tax. The estimated fair value of financial instruments has been determined using available information and appropriate value methodologies. The estimated fair value of financial instruments are not necess- arily indicative of the amounts the company might pay or receive in actual market transactions. Potential taxes and other transaction costs have not been considered in estimating fair value.\nEquity in Common Stock of Investee at December 31, 1995 consists of a 23% interest in the common stock of a high technology manufacturing and research company. The accompanying Consolidated Balance Sheets reflect the Company's original investment plus its pro rata share of undistributed earnings (loss) since the date of acquisition of the common stock. See Note 3.\nEquity Securities, which consist of common stock and preferred stock, are carried at fair value. Negotiable certificates of deposit are carried at cost which approximates fair value. Mortgage Loans on Real Estate are recorded at their aggregate outstanding principal balance; and Short-Term Investments are stated at cost which approximates market. Short-Term Investments consist primarily of commercial paper, repurchase agreements with banks and other financial institutions and treasury bills. Collateral loans are carried at cost which approximates fair value. Other Invested Assets, are carried at fair value. See Note 3.\nRealized gains and losses on disposition of investments are reported in the Statement of Operations based upon the average cost method. Unrealized gains and losses on securities carried at fair value are recorded directly in stockholders' equity, net of applicable deferred income taxes. Provision for impairments of investments that are considered other than temporary is included in realized capital loss. See Note 3.\n(c) CASH AND CASH EQUIVALENTS\nThe Company considers cash to be funds held in checking and money market accounts. Non-negotiable certificates of deposit with original maturity less than thirty days are considered to be cash equivalents.\n(d) DEFERRED POLICY ACQUISITION COSTS\nThe costs of acquiring new business, principally commissions, premium taxes and certain underwriting expenses, are deferred and amortized as the related premiums are earned. Ceding commission income, which is realized on a written basis, is also deferred and amortized over the periods in which the underlying premiums are\nearned. The method used in computing deferred acquisition costs limits the amounts of such deferred costs to their net realizable value based upon the related unearned premiums and investment income less anticipated losses and loss adjustment expenses. The amortization of deferred acquisition costs results in a charge against current operations as follows: ($ in thousands) 1995 1994 1993 ----- ------- ------- Direct commission expense $1,803 $ 1,962 $32,346 Ceding commission (income) expense - - 508 Premium taxes 60 106 2,524 ------ ------- ------- 1,863 2,068 35,378 Underwriting expenses - - 2,620 ------ ------ ------- $1,863 $ 2,068 $37,998 ===== ====== ======\nOn the accompanying Consolidated Statements of Operations, commissions and premium taxes are presented as Policy Acquisition Expenses, and underwriting expenses are included in Other Operating Expenses.\n(e) REINSURANCE RECEIVABLE\/PREPAID REINSURANCE PREMIUMS\nEffective January 1, 1993, the Company adopted SFAS No. 113 \"Accounting for Reinsurance of Short-Duration and Long-Duration Contracts\". SFAS No. 113 eliminates the practice of reporting assets and liabilities relating to reinsured contracts net of the effects of reinsurance and provides guidance in assessing transfer of insurance risk in reinsurance, including gain and loss recognition. Two of the UCIC's reinsurance contracts did not meet the risk transfer criteria of SFAS No. 113 for 1993. See Note 4.\n(f) RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES\nReserves for losses and loss adjustment expenses (LAE) represent estimates of reported losses and estimates of incurred but not reported (IBNR) losses based on past and current experience. Such liability is net of salvage and subrogation to be received, and is increased for reinsurance assumed. To the extent claims settlement underlying the recent losses and LAE may differ perhaps significantly from those underlying the historical losses and LAE, this adds uncertainty to the estimated reserves for loss and LAE. Accordingly, the ultimate settlement of losses and LAE may vary perhaps significantly from the amounts included in the accompanying financial statements.\nAs discussed in Note 4, URIC has a reinsurance pooling arrangement with UCIC. UCIC has provided the Company with an estimate of URIC's share of its reserve for loss and LAE under the\npooling agreement of approximately $12 million as of December 31, 1995. The Company has included this amount in the accompanying balance sheet.\nThe Company filed URIC's 1995 statutory financial statements that includes a reserve for loss and LAE expenses under the above pooling arrangement of approximately $8 million. The Company's independent actuary certified URIC's loss and LAE reserves of which this was a part.\nThe recording of the UCIC estimates for loss and LAE had the effect of decreasing the Company's net income and stockholders' equity by approximately $3.2 million.\nThe following table provides a reconciliation of the Company's beginning and ending loss and LAE liability balances for 1995, 1994 and 1993. Year Ended December 31, ------------------------- ($ in thousands) 1995 1994 1993 ------- ------- ------- Reserves for losses and LAE at January 1, $47,165 $189,599 $149,076 Less reserves related to deconsolidating UCIC - 111,081 - Less reinsurance receivable 7,320 10,701 17,828 ------- ------- ------- Net balance at January 1 39,845 67,817 131,248 Provision for losses & LAE for claims occurring in the current year 2,926 7,332 91,349 Increase (decrease) in estimated losses and LAE for claims occurring in prior years 2,476 (3,313) 57,088 ------- ------- ------- Total incurred losses and LAE 5,402 4,019 148,437 ------- ------- ------- Losses and LAE payments for claims occurring during: Current year 1,772 4,555 33,805 Prior years 18,265 27,436 78,091 ------- ------- ------- Total losses and LAE payments 20,037 31,991 111,896 ------- ------- ------- Net reserves for losses and LAE at December 31, 25,210 39,845 167,789 Reinsurance receivables 5,764 7,320 21,810 ------- ------- ------- Gross reserves $30,974 $47,165 $189,599 ======= ======= =======\nThe previous table as presented exclude the reserves for losses\nand LAE on government pools recognized on the UCIC's P&C business in 1993. The reserves for government pools are not under the control of the Company and reflect the operating results and reserving practices of servicing carriers and regulators who administer these assigned risk pools in which the Company is obligated to participate. Accordingly, these reserves have been excluded from the tables. As of December 31, 1993 the Company's loss and LAE reserves related to these government pools were approximately $11,246,000. The above table for 1995 and 1994 excludes UCIC as a result of it being deconsolidated.\n(g) PREMIUM REVENUE\nPremium revenue, which is net of reinsurance ceded, is recognized as earned on a pro rata basis over the terms of the policies and includes audit premiums and estimates for retrospectively rated premiums. Unearned premiums for property\/casualty lines, excluding workers' compensation, are calculated on a daily basis. Accident\/health unearned premiums are calculated on a monthly basis. Unearned premiums on the remaining lines of business are calculated on a monthly pro rata basis.\n(h) LOSSES - GOVERNMENT POOLS\nMost states have established associations of insurance carriers which are commonly referred to as pools. The purpose of these pools is to provide a guaranteed means to obtain certain mandated insurance coverages which would not otherwise be reasonably obtainable through the traditional insurance market from an individual insurance carrier. Participation in these pools by the individual insurance carriers is not voluntary. The level of participation in the pool is often based upon the premium volume of selected lines written by the individual carriers in the state for which the pool has been established.\nEach member carrier essentially guarantees its share of the solvency of the pool. The pool administrator collects the premium, pays the losses and administrative costs, and passes a proportionate share of the costs to each member. If the losses and expenses exceed the premiums, the members may be subject to an assessment by the pool to fund the pool's deficit. On the accompanying 1993 Consolidated Statements of Operation, these assessments for pool deficits are reflected as Losses - Government Pools.\n(i) AMORTIZATION OF EXCESS OF FAIR VALUES OF ACQUIRED SUBSIDIARIES OVER PURCHASE PRICES\nThe excess of the fair value of the net assets of URIC and Global over the respective purchase prices at the dates of acquisition is being amortized on the straight-line basis over a\nperiod of seven years. Amortization in the amount of $1,094,000 is reflected in the accompanying Consolidated Statements of Operations as a reduction of Other Operating Expenses for 1995, 1994 and 1993.\n(j) INCOME TAXES\nThe Company and its subsidiaries are included in the consolidated Federal income tax return of Lawrence Group. The current income tax provision has been computed as if each company filed a separate return. See Note 6.\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.\n(k) EARNINGS PER SHARE\nNet income (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares outstanding during the period.\nNOTE 2 - NON-CONSOLIDATED SUBSIDIARY\nAs a result of the order of rehabilitation and assumption of management and control of UCIC on July 7, 1994 by the NYID, the Company has included the results of UCIC for 1994 on a decon- solidated basis up to the point of the court order. On November 10, 1995 UCIC with the Company's consent was ordered liquidated and as a consequence the Company has no further legal or financial interest in UCIC except for any contractual arrangements that arose in the ordinary course of business and any tax consequences that may result from UCIC's continued inclusion in the consolidated federal income tax return. The following table presents condensed financial information for UCIC through July 7, 1994. Amounts exclude the effect of eliminating UCIC's 21.4% ownership of URIC which is included in the \"Deficit of non-consolidated subsidiary\" and \"Equity in loss of non-consolidated subsidiary\" on the balance\nsheet and statement of operations, respectively for 1994 and as \"Minority interest\" for 1995.\n($ in thousands) As of and for the period: ------------------------ January 1, Year ended to July 7, December 31, 1994 1993 ----------- ----------- (Unaudited) (Unaudited) Cash and invested assets $ 50,872 $ 94,631 Amounts due from reinsurers 48,990 34,961 Premiums receivable 1,808 14,204 Deferred policy acquisition expenses 3,424 9,386 Other assets 5,626 11,775 ------ ------ Total assets $110,720 $164,957 ======= ======= Reserves for loss and LAE expenses $132,201 $129,508 Unearned premiums 18,249 40,106 Amounts due to reinsurers 17,221 25,213 Other liabilities 670 2,254 ------- ------- Total liabilities 168,341 197,081 Stockholder's deficiency (57,621) (32,124) ------- ------- Total liabilities and stockholder's (deficiency) $110,720 $164,957 ======= =======\nRevenues $ 43,959 $ 80,614 Operating loss (3,531) (64,671) Net loss (7,307) (67,023)\nIn the fourth quarter of 1995 the Company recorded the follow- ing to eliminate the stockholder's deficiency carried for UCIC and record minority interest:\nExtraordinary gain $ 38,387 Minority interest 429 Stockholders's equity- Receivable from Alpha Trust 15,996 Unrealized loss on investments 1,953 Deficit of non-consolidated subsidiary (56,765)\nIn January 1994, UCIC loaned $13,000,000 to the Alpha Trust, a business trust, which in turn invested in notes issued by Lawrence Group, which owns 93% of LIG. This loan and unrealized losses on investments for the period January 1, 1994 to July 7, 1994, is included in the Company's statement of stockholders' equity for the year ended December 31, 1994.\nNOTE 3 - INVESTMENTS\nNet investment income for the Company was as follows:\n($ in thousands) Year Ended December 31, ----------------------- 1995 1994 1993 ------ ------ ------ Investment income: Fixed maturities held to maturity $ 237 $ 531 $1,395 Fixed maturities available for sale 433 538 2,719 Equity securities 55 46 392 Short-term investments 778 786 2,832 Collateral loans 1,514 1,258 - Mortgage loans on real estate 15 19 76 Other 119 166 238 ----- ----- ----- Total investment income 3,151 3,344 7,652 Less: Investment expenses 50 31 487 ----- ----- ----- Net investment income $ 3,101 $3,313 $7,165 ===== ===== =====\nRealized gains (losses) on investments of the Company were as follows: ($ in thousands) Year Ended December 31, ---------------------- 1995 1994 1993 ----- ----- ----- Net realized gains (losses): Fixed maturities held to maturity $ 203 $ - $ 14 Fixed maturities available for sale (249) (95) 2,308 Equity in common stock of investee - - (5,587) Equity securities - (503) 1,337 Short-term investments (1) - (43) Collateral loans (683) - - Other invested assets (13) - (3,500) ------ ----- ----- Total net realized gains (losses) on investments $ (743) $(598) $(5,471) ===== ===== =====\nProceeds from the sale of fixed maturities held to maturity with an amortized cost of $2,976,000 were $3,179,000 in 1995. Gross gains were $203,000. There were no losses. These securities were sold to meet cash requirements. Based upon the circumstances leading to the sale of held to maturity securities in 1995, all remaining investments which were classified as held to maturity were transferred to available for sale. The amortized cost of the investments were $795,000 with unrealized gains of $14,000 at the date transferred. There were no sales of securities held to maturity in prior years.\nProceeds from sales of fixed maturities available for sale during 1995, 1994 and 1993 were $5,090,000, $7,760,000 and $324,514,000, respectively. Gross gains of $37,000, $0 and $2,424,000, for 1995, 1994 and 1993, respectively, were realized on those proceeds. Gross losses of $286,000, $95,000 and $116,000 for 1995, 1994 and 1993, respectively were realized.\nThe amortized cost and estimated fair values of the Company's investments as of December 31, 1995 are as follows:\n($ in thousands) ------- Gross ------ Esti- Amort- Unrealized mated ized ---------- Fair Cost Gains Losses Value ------ ------ ------ ------ Available for sale: Fixed maturities US Treasury securities and obligations of US government corporations and agencies $ 2,336 $ 22 $ - $ 2,358 Obligations of states and political subdivisions 590 13 - 603 Mortgage-backed securities 949 11 - 960 ------ ------ ----- ------ Total fixed maturities available for sale 3,875 46 - 3,921 Equity securities 997 - 56 941 Short term investments 11,898 - - 11,898 All other 175 - - 175 ------ ---- ---- ------ Total investments available for sale $16,945 $ 46 $ 56 $16,935 ====== ==== ==== ======\nThe amortized cost and estimated fair values of the Company's investments as of December 31, 1994 are as follows:\n($ in thousands) ------- Gross ------ Esti- Amort- Unrealized mated ized ------------ Fair Cost Gains Losses Value ------ ------ ------ ------ Fixed maturities held to maturity: US Treasury securities and obligations of US government corporations and agencies $5,931 $ 1 $ 20 $5,912 Obligations of states and political subdivisions 1,767 28 24 1,772 ----- ----- ----- ----- Total fixed maturities held to maturity $7,698 $ 29 $ 44 $7,684 ===== ===== ===== ===== Available for sale: Fixed maturities US Treasury securities and obligations of US government corporations and agencies $ 20 $ - $ - $ 20 Obligations of states and political subdivisions 355 6 - 361 Corporate securities 994 - 3 991 Mortgage-backed securities 4,859 - 447 4,412 ------ ----- ----- ------ Total fixed maturities available for sale 6,228 6 450 5,784 Equity securities 1,100 - 183 917 Short term investments 11,523 - - 11,523 All other 2,072 - - 2,072 ------ ----- ----- ------ Total investments available for sale $20,923 $ 6 $ 633 $20,296 ====== ==== ==== ======\nThe amortized cost and estimated market value of fixed maturities at December 31, 1995 and 1994 , by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities are stated separately as such securities produce a principal return on a monthly basis. Fixed maturities\nheld to maturity are carried at amortized cost, while fixed maturities available for sale are carried at fair value.\nDecember 31, 1995 ($ in thousands) Fixed maturities Available for sale ------------------ Amortized Estimated Cost Fair value\n------- -------- Due in one year or less $ 2,286 $ 2,301 Due after one year through five years 150 155 Due after five years through ten years 385 396 Due after ten years 105 109 ------ ------ Subtotal 2,926 2,961 Mortgage-backed securities 949 960 ----- ------ Total $3,875 $3,921 ====== ======\nDecember 31, 1994 ($ in thousands) Fixed maturities Fixed maturities Held to maturity Available for sale ---------------- ------------------ Amort- Esti- Amort- Esti- ized mated ized mated Fair Fair Cost Value Cost Value ------ ------ ------ ------ Due in one year or less $3,852 $3,840 $ 250 $ 253 Due after one year through five years 1,002 1,031 1,014 1,011 Due after five years through ten years 2,844 2,813 - - Due after ten years - - 105 108 ----- ------ ----- ----- Subtotal 7,698 7,684 1,369 1,372 Mortgage-backed securities - - 4,859 4,412 ----- ----- ----- ----- Total $7,698 $7,684 $6,228 $5,784 ===== ===== ===== =====\nAt December 31, 1995 and 1994, bonds and short-term investments with a carrying amount of $4,695,000 and $7,593,000, respectively, were on deposit with various regulatory authorities.\nThe Company at December 31, 1993 wrote down its investment in\ncommon stock of investee by $5,587,000 to $216,000 due to the bankruptcy filing of one of the investee's principal subsidiaries and the reporting of a negative stockholders' equity.\nUCIC, at December 31, 1993, wrote down its investment of $5,000,000 in an unrelated finance company, First Commercial Credit Corporation (FCCC) by $3,500,000 to $1,500,000 due to the substantial reduction in the value of the collateral supporting the investment.\nNOTE 4 - REINSURANCE\nReinsurance is ceded under both pro rata and excess of loss arrangements. The Company utilizes reinsurance principally to reduce the net liability of its subsidiaries on individual risks and to protect against catastrophic losses.\nDuring 1993 UCIC had been a party to a quota share reinsurance treaty which covered all lines of business written by UCIC. For 1993, this reinsurance contract was considered a financing arrangement under SFAS No. 113. UCIC ceded $21,700,000 of premiums and $12,902,000 in losses and earned $8,380,000 in commissions in 1993. UCIC determined that the contract did not pass the risk transfer criteria of SFAS No. 113. Accordingly, the Company applied deposit accounting to this contract in 1993 and the premiums, losses and commissions are excluded from the Statement of Operations and were reflected as a net deposit on the balance sheet at December 31, 1993.\nIn addition to the quota share agreements with unaffiliated reinsurers, UCIC had also entered into several quota share agreements with URIC. In order to spread the risk, URIC retroceded amounts to other reinsurers. All retrocession agreements were commuted prior to October 1, 1992.\nIn addition to the quota share treaty with UCIC, URIC and UCIC also had a pooling agreement in effect during 1992 and 1993. The agreement was terminated effective January 1, 1994; however, each company is responsible for its share of all premium, losses and LAE incurred prior to that date. At December 31, 1995, URIC had a net liability to UCIC under these reinsurance agreements of approximately $6,187,000.\nSenate ceded a portion of its accident\/health business to UCIC. Written premiums ceded to UCIC under this arrangement amounted to $1,462,000 in 1994. Benefits and other underwriting expenses ceded to UCIC totalled $1,299,000. As a result of the reinsurance arrangement, Senate's accounts reflect a net recoverable from UCIC of $53,000 at December 31, 1995. Senate\nreinsures a portion of its exposure on a quota share\/excess of loss basis principally through Lloyd's of London.\nPremiums written, premiums earned and losses and loss adjustment expenses information by direct, assumed and ceded for the years ended December 31 is as follows:\n($ in thousands) 1995 1994 1993 ------ ------ -------- Premiums written: Direct business $5,374 $ 9,257 $122,139 Reinsurance assumed 1,281 (12,172) 9,027 Reinsurance ceded (1,520) (4,855) (13,305) ----- ------ ------- Premiums written $5,135 $ 7,770 $117,861 ===== ====== ======= Premiums Earned: Direct business $5,444 $ 9,515 $129,813 Reinsurance assumed 2,091 451 15,829 Reinsurance ceded (2,002) (4,745) (24,627) ----- ----- ------ Premiums earned $5,533 $ 5,221 $121,015 ===== ===== ======= Losses and LAE Direct business $4,292 $ 3,646 $149,285 Reinsurance assumed 3,510) 4,054 15,327 Reinsurance ceded (2,400) (3,681) (16,175) ----- ----- ------ Losses and LAE $5,402 $ 4,019 $148,437 ===== ===== =======\nContingent liabilities exist with respect to reinsurance ceded, which would become liabilities of the Company in the event the assuming reinsurers were unable to meet their obligations under reinsurance agreements. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses and an allowance for uncollectible reinsurance is provided when collection is in doubt.\nNOTE 5 - EMPLOYEE BENEFIT PLAN\nURIC, Global and Senate are participating employers in a 401(k) Profit Sharing Plan (401(k) Plan) adopted by Lawrence Group on January 1, 1986. The 401(k) Plan covers all employees of URIC, Global and Senate who have completed one year of service and have attained age twenty and one-half. Each year, URIC, Global and Senate contribute to the 401(k) Plan such amounts as the Boards of Directors, in their discretion, may determine. Each eligible employee is vested immediately at 100%. The cost associated with the plan was approximately $18,000 in 1995 and $23,000 in 1994 and $66,000 in 1993.\nNOTE 6 - INCOME TAXES\nThe Company's current taxable income is included in the consolidated Federal tax return of Lawrence Group. The consolidated tax or benefit is allocated proportionately between the subsidiaries of Lawrence Group pursuant to a tax allocation agreement (Tax Agreement) based on the contribution of each company in the consolidated Federal tax return as if each company calculated its tax on a separate return basis. The Tax Agreement provides that if the Company's tax liability as calculated on a separate return basis exceeds the Company's portion of the consolidated tax liability, the Company is to pay the excess of the separate return liability over its allocated portion of the consolidated tax liability to Lawrence Group. If the Company should have a claim for refund of Federal income taxes, Lawrence Group will pay to the Company an amount equal to the refund that would have been received from the Internal Revenue Service if a separate return would have been filed. In 1994, approximately $2,900,000 of income tax recoveries was paid by Lawrence Group to the Company.\nAt December 31, 1995, the Company had income taxes payable of $113,000 which represented federal income taxes due to Lawrence Group pursuant to the tax sharing agreement and income taxes recoverable of $69,000 from various states.\nIncome tax benefit of $282,000 for the year ended December 31, 1995 represent a federal income tax benefit partially offset by state income tax expense. The expense for the year ended December 31, 1994, was attributable to various state income taxes. Income tax expense of $962,000 for the year ended December 31, 1993 was attributable primarily to the establishment of a valuation allowance for deferred tax assets as discussed below.\nIncome tax expense (benefit) attributable to income from operations consists of:\n($ in thousands) 1995 1994 1993 ------ ------ ------ Current U.S. Federal $ (307) $ - $(6,124) Current State 25 168 519 ----- ----- ----- Total current (282) 168 (5,605) ----- ----- ----- Deferred U.S. Federal - - 6,989 Deferred State - - (422) ----- ----- ----- Total deferred - - 6,567 ----- ----- ----- Total income taxes (benefit) $ (282) $ 168 $ 962 ===== ===== =====\nIncome tax expense (benefit) attributable to pretax operating income (excluding equity in loss of non-consolidated subsidiary) differed from the expected amounts computed by applying the U.S. Federal income tax rate of 34% as a result of the following: Year Ended December 31, ----------------------- ($ in thousands) 1995 1994 1993 ------ ----- -------- Computed expected Federal tax expense (benefit) $ (389) $ 131 $(25,888) State income taxes, net of Federal income tax benefit 17 109 (89) Change in valuation allowance 702 105 27,928 Amortization of negative goodwill (372) (372) (372) Tax exempt investment income (17) (44) (276) Dividends received deduction - - (68) Amortization of bonds - (11) (187) Other,net (223) 250 (86) ----- ---- ------ Total income tax expense (benefit) $ (282) $ 168 $ (962) ===== ==== =====\nThe tax effects of the Company's temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1995 and 1994 (excluding those assoc- iated with its non-consolidated subsidiary) are presented below: ($ in thousands) 1995 1994 ------ ------ Deferred tax assets: Reserves for losses, due to discounting for Federal tax purposes $ 1,563 $ 2,472 Tax loss carryforwards 5,394 3,710 Valuation allowances on investments 924 1,096 Other 87 62 ----- ------ Total gross deferred tax assets 7,968 7,340 ----- ----- Deferred tax liabilities: Deferred policy acquisition costs, principally due to deferral for financial reporting purposes (27) (101) Equity in undistributed earnings (losses) of investee (137) (137) ----- ----- Total gross deferred tax liabilities (164) (238) ------ ------ Net deferred tax asset before valuation allowance 7,804 7,102 Less valuation allowance (7,804) (7,102) ----- ----- Net deferred tax asset $ - $ - ===== =====\nA valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The Company's valuation allowance for deferred tax assets was $7,102,000 at December 31, 1994. The valuation allowance increased $702,000 from December 31, 1994 to a balance of $7,804,000 at December 31, 1995. The Company's conclusion is that more likely than not, it will not realize the benefit of all of its deductible temporary differences and net operating loss carryovers and as a result has maintained a full valuation allowance against its net deferred tax assets.\nThe Company has approximately $63 million in net operating loss carryforwards at December 31, 1995, of which approximately $46 million attributable to the non-consolidated subsidiary, UCIC, may be limited in their availability to offset future taxable income of the Company. The net operating loss carryforwards begin to expire in 2008.\nNOTE 7 - RELATED PARTY TRANSACTIONS\nThe Company paid $0, $0, and $3,548,000 in dividends to Lawrence Group in 1995, 1994 and 1993, respectively.\nThe Company and its subsidiaries supplemented the activities that were performed in-house by obtaining various services from AWL, a subsidiary of Lawrence Agency Corp. (LAC), which is a subsidiary of Lawrence Group, pursuant to agreements between the Company's subsidiaries and AWL. Under the terms of the Agency Agreement, AWL and its affiliates receive commissions when they are the agent for the transaction. UCIC received a substantial portion of its written premiums through AWL.\nIn 1993 UCIC incurred $21,903,000 in commissions. AWL paid a substantial portion of these commissions to external brokers and subagents.\nUnder a management consultant agreement with AWL in effect since 1982, UCIC received technical, accounting and management assistance in various administrative areas. These costs were $915,000 in 1993.\nUCIC subleased various office space from LAC. Rent expense totaled $493,000 for 1993.\nIn September 1992, Global entered into a sublease agreement with LAC to rent space located in Atlanta, Georgia. The sublease is for a term ending on September 1, 1995. Annual rent expense is $7,000 under this sublease.\nThe Company's subsidiaries held various notes receivable from other Lawrence Group affiliates at December 31, 1994. The notes\nare included in Other Invested Assets on the accompanying Consolidated Balance Sheets and amounted to $269,000 at December 31, 1994, All notes were repaid in 1995. Interest rates charged on these notes are Prime plus 1%. Interest income earned with respect to these loans totalled $11,000, $40,000 and $106,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company and its subsidiaries hold mortgage loans from employees of Lawrence Group as well as officers and directors of the Company and its subsidiaries. These loans totalled $34,000 and $186,000 December 31, 1995 and 1994, respectively. Interest rates on the mortgages include variable and fixed rates, with the fixed rates ranging from 7% to 8.5% and variable rates ranging from one-year Treasury Bill rate plus 3% to Prime plus 1%.\nSenate ceded a portion of its accident\/health business to UCIC. Written premiums ceded to UCIC under this arrangement amounted to $1,462,000 in 1994. Benefits and other underwriting expenses ceded to UCIC totalled $1,299,000. As a result of the reinsurance arrangement, Senate's accounts reflect a net recoverable from UCIC of $53,000 at December 31, 1995.\nSenate obtains a significant portion of its business from LAC to which it pays commissions. These commission expenses totalled $605,000, $963,000 and $942,000 in 1995, 1994 and 1993, respectively. LAC pays a portion of these to external brokers and subagents. Senate pays AWL for management services associated with Senate business. These payments were $264,000, $60,000 and $60,000 for 1995, 1994 and 1993, respectively.\nURIC loaned $14,000,000 Alpha Trust which in turn invested in notes issued by Lawrence Group, which owns approximately 93% of the Company during 1994.\nIn addition to the quota share treaty with UCIC, URIC and UCIC also had a pooling agreement in effect during 1992 and 1993. The agreement was terminated effective January 1, 1994; however, each company is responsible for its share of all premium, losses and LAE incurred prior to that date. At December 31, 1995, URIC had a net liability to UCIC under these reinsurance agreements of approximately $6,187,000.\nAt December 31, 1995, URIC carried a note payable due to LGI of $300,000. Interest is at 8%. LIG had received an advance of $185,000 from LGI the balance of which was outstanding at the end of 1995.\nAt December 31, 1995 the Company had income taxes payable to Lawrence Group of $113,000. See Note 6.\nNOTE 8 - STATE EXAMINATIONS, DIVIDEND RESTRICTIONS, INSURANCE DEPARTMENT REGULATIONS AND RELATED LEGAL PROCEEDINGS\nThe NAIC, which is not itself a regulatory authority but makes recommendations to and takes other actions affecting state regulatory authorities, adopted a Risk-Based Capital (RBC) standard in the fourth quarter of 1993 for use by state insurance regulators. RBC is intended to be a \"tool\" for regulators to assess the capital adequacy of property and casualty insurers and to take action when capital under the standard is judged to be inadequate. This standard has four action levels based upon the relationship of actual capital to RBC. The mildest action occurs at a level of 2.5:1. Based upon the RBC standards developed by the NAIC, all consolidated subsidiaries capital except URIC exceeded the authorized control level RBC by a substantial margin. URIC's ratio was 2.0:1. At this level, the TDI could require that URIC submit a business plan, however, they are currently under more stringent requirements than those imposed by the RBC standards.\nTexas Insurance Law provides that the maximum amount of dividends that URIC may make without prior regulatory approval is the greater of adjusted net investment income or 10% of statutory surplus as of the preceding year-end subject to minimum earned surplus requirements. At December 31, 1995, URIC did not meet the earned surplus requirements for dividend purposes and, therefore, cannot pay dividends to LIG and UCIC in 1996. The Company's principal source of cash flow had been dividends from UCIC and URIC.\nGeorgia Insurance Law provides that Global may pay dividends only out of its earned surplus up to the lesser of net income, excluding realized capital gains, but including realized capital losses, or 10% of statutory surplus as of the preceding year-end without regulatory approval. Global may pay dividends to URIC only. Global does not meet the requirement for the payment of dividends in 1996.\nArizona Insurance Law provides that Senate and SNLIC may pay dividends only out of their earned surplus up to the lesser of net gain from operations or 10% of statutory surplus as of the preceding year-end without regulatory approval. Senate may pay dividends to URIC only. SNLIC may pay dividends to Senate only. The maximum amount of dividends payable in 1996 by Senate without prior regulatory approval is $214,000. The maximum dividend payable by SNLIC in 1996 is $14,000.\nThe NYID completed an examination of UCIC for the years 1989 through 1993 in 1994 and found UCIC to be insolvent, its capital impaired and a shortfall of $37,624,941 in its required surplus to policyholders at December 31, 1993. As a result of that examination UCIC was placed in rehabilitation on July 7, 1994 and\nfollowing continued discussions and negotiations between the Company and the NYID, UCIC with the consent of the Company was placed into liquidation by court order on November 10, 1995. As part of the order, the Company, its directors, officers and employees were relieved of any liability for the deficit of UCIC except for obligations incurred in the ordinary course of business or due to fraudulent acts. URIC was also given the right of first refusal to purchase the shares of its stock owned by UCIC.\nThe Texas Department of Insurance (TDI) conducted its regular examination of URIC as of March 31, 1993. TDI issued their audit report on May 25, 1994. On June 22, 1994, the TDI issued a confidential order creating a state of supervision and appointing a supervisor of the operations of URIC. The order was based upon disagreements with valuations of several assets, chief among them Alpha Trust, in financial statements filed by URIC with the TDI and upon net operating losses reported during the first quarter of 1994. On August 25, 1995 URIC was released from this order conditioned upon it achieving certain minimum policyholders' surplus and other goals. If URIC did not achieve these goals the TDI could place URIC into conservatorship. Under conservatorship the TDI would assume all control and decision making authority during the period of conservatorship. As of December 31, 1995, URIC had not achieved all of these goals.\nGlobal, Senate and SNLIC underwent their regular examinations as of December 31, 1993, by the respective insurance departments. The reports showed no material findings.\nIn January, 1994, UCIC and URIC loaned $13,000,000 and $14,000,000, respectively, to Alpha Trust, the trustee of which is The Bank of New York. These loans consisted of term notes with differing maturities and repayment schedules with the initial principal repayment commencing April 1, 1996 and ending on January 1, 2001. Interest is at the prime rate plus 2%. Interest is payable quarterly beginning April 1, 1994. The Alpha Trust loaned $27,000,000 to Lawrence Group, which owns approximately 93% of the Company. The only assets of the Alpha Trust are these collateral loans to Lawrence Group. The NYID and TDI have taken the position that the loans from UCIC and URIC, respectively, did not qualify as admitted assets. For Statutory reporting purposes the investment in Alpha Trust was treated as a non-admitted asset at December 31, 1995.\nUCIC and URIC had a pooling agreement in effect during 1992 and 1993. Under the terms of the agreement, the premiums and losses incurred during 1992 and 1993 were to be combined between the carriers and then split: 65% going to UCIC and 35% to URIC. The contract was incorrectly administered for the 1992 and 1993 statutory statements. The correction had the effect of decreasing\nUCIC's statutory policyholder's surplus by $8,300,000 and increasing URIC's by the same amount from the 1993 statutory statements filed June 7, 1994. The NYID and TDI have agreed that the agreement covered only the years 1992 and 1993. The agreement was terminated effective January 1, 1994; however, each company is responsible for its share of all premium, losses and LAE incurred prior to that date.\nNet income (loss) and policyholders' surplus of UCIC, URIC, Global, Senate and SNLIC as filed with insurance regulatory authorities, are as follows:\nSTATUTORY NET INCOME (LOSS) ($ in thousands) (Unaudited) Year ended December 31, ------------------------ 1995 1994 1993 ------ ------ ------ United Community Insurance Company $ N\/A $ N\/A $(3,592) United Republic Insurance Company 631 75 (2,003) Global Insurance Company (290) (1,488) (726) Senate Insurance Company 134 731 922 Senate National Life Insurance Company 10 (11) 15\nPOLICYHOLDERS' SURPLUS ($ in thousands) (Unaudited) December 31 -------------------- 1995 1994 ------ ------ United Community Insurance Company $ N\/A $ N\/A United Republic Insurance Company 6,611(2) 17,063(1) Global Insurance Company 3,429 3,211 Senate Insurance Company 4,705 4,745 Senate National Life Insurance Company 654 644\n(1) Includes $14,000,000 receivable from Alpha Trust as an admitted asset. The TDI has taken the position that this loan did not quality as an admitted asset. For 1995 it was reflected as a non-admitted asset. (2) Does not include $4,000,000 in loss and LAE expense. See Note 1 Statutory accounting differs from GAAP primarily as follows: (1) the costs related to acquiring business are charged to income in the year incurred and thus are not amortized over the periods benefitted, whereas the related premiums are taken into income on a pro rata basis over the periods covered by the policies; (2) adjustments reflecting the equity in earnings of affiliated companies are carried to the surplus account as net unrealized capital gains or losses rather than income; (3) adjustments reflecting the revaluation of stocks and bonds are carried to the surplus account as unrealized investment gains or\nlosses, without provision for federal income taxes, or income tax reductions; (4) assets must be included in the statutory statements of admitted assets, liabilities, and surplus at \"admitted asset value\" and \"non-admitted assets\" are excluded through a charge against surplus; (5) deferred federal income taxes are not provided for temporary differences between book and tax income; (6) certain income and expense items are charged or credited to surplus; (7) majority owned subsidiaries are not consolidated; (8) no provision is made for the effect of Financial Accounting Standards Board Statement No. 115, whereby equity securities that have readily determinable fair values and all investments in debt securities are classified into three categories: held to maturity; trading; and available for sale; and would be reported in the financial statements at amortized cost; fair value, with unrealized gains and losses included in earnings; fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of surplus, respectively; and (9) insurance liabilities (reserves for policy and contract claims and loss and LAE and unearned premium) are presented net of reinsurance ceded.\nNOTE 9 - CONTINGENCIES AND COMMITMENTS\nThe Company leases office space and equipment under the terms of various operating leases. The future minimum lease payments with initial or remaining noncancelable lease terms in excess of one year at December 31, 1995 are as follows:\nYear Ending ($ in thousands) December 31, Amount ------------ ------ 1996 $ 19 Thereafter - ---- Total minimum lease payments $ 19 ====\nRent expense under all operating leases for office space was approximately $62,000, 56,000 and $684,000 for 1995, 1994 and 1993.\nThe Company is a defendant in other legal proceedings which Management believes will not have a material impact on the Company's financial statements. Management is defending these cases.\nThe Company had outstanding letters of credit in favor of insureds of approximately $1,300,000 and $2,151,000 at December 31, 1995 and 1994, respectively. These letters of credit were collateralized by investments of approximately $2,150,000 and $2,701,000 at December 31, 1995 and 1994, respectively.\nNOTE 10 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe quarterly unaudited financial information for the periods since LIG resumed trading on the AMEX are as follows:\n(Amounts in thousands except Quarter ended per share data) ------------------------ December 31 September 30, 1995 1995 -------- -------- Revenues: Net premiums earned $2,652 $1,342 Net investment income 718 807 Realized (losses) on investments (175) (568) ------ ------ Total revenues 3,195 1,581 Operating expenses 4,900 1,398 ----- ----- Operating income (1,705) 183 Equity in loss of non-consolidated subsidiary 83 (83) ----- ----- Income (loss) before income taxes, minority interest and extraordinary gain (1,622) 100 Income tax expense (benefit) 98 (364) ----- ----- Net income (loss) before minority interest and extraordinary gain (1,720) 464 Minority interest 219 - ------ ----- Net Income before extraordinary gain (1,501) 464 Extraordinary gain 38,387 - ------- ----- Net income (loss) $36,886 $ 464 ====== ===== Per share data: Income (loss) before extraordinary gain $ (.11) $ .03 Extraordinary gain 2.72 - ----- ---- Net income (loss) $ 2.61 $ .03 ==== === Average shares outstanding 14,121 14,121\nOperating results for the quarter ended December 31, 1995 should not be considered indicative of future results as the quarter included the favorable impact of the commutation of several reinsurance treaties.\nLAWRENCE INSURANCE GROUP, INC. INDEX TO FINANCIAL STATEMENT SCHEDULES\nPage\nI - Summary of Investments Other than Investments in Related Parties at December 31, 1995 S-2\nII - Condensed Financial Information of Registrant at December 31, 1995 and 1994 and for the Years Ended December 31, 1995, 1994 and 1993 S-3\nIII - Supplementary Insurance Information for the Years Ended December 31, 1995, 1994 and 1993 S-6\nIV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 S-10\nV - Valuation and Qualifying Accounts for the Years Ended December 31, 1995, 1994 and 1993 S-11\nVI - Supplementary Information Concerning Property and Casualty Insurance Operations for the Years Ended December 31, 1995, 1994 and 1993 S-12\nApril 14, 1996\nS-1\nSchedule I\nLAWRENCE INSURANCE GROUP, INC. SUMMARY OF INVESTMENTS DECEMBER 31, 1995\n($ in thousands) Amount at Which Shown Estimated on the Fair balance Cost Value sheet ------ -------- ---------- Fixed maturities available for sale: United States government and government agencies and political subdivisions 2,336 2,358 2,358 States, municipalities and political subdivisions 590 603 603 Mortgage backed securities 949 960 960 ------ ------ ------ Total fixed maturities available for sale 3,875 3,921 3,921 ------ ------ ------ Common Stock 997 941 941 Short-term investments 11,898 11,898 11,898 Mortgage loans on real estate 171 171 171 Other 4 4 4 ------ ------ ------ Total investments $16,945 $16,935 $16,935 ====== ====== ======\nS-2\nSchedule II\nLAWRENCE INSURANCE GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS\n($ in thousands) December 31, -------------- 1995 1994 ------ ------ ASSETS\nInvestment in subsidiaries $ 649 $ 905 Other invested assets, at fair value 4 24 Cash 2 3 Other assets 68 260 ----- ----- Total assets $ 723 $1,192 ===== =====\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) Liabilities: Accrued expenses and other liabilities $ 578 $ 565 Deficit of non-consolidated subsidiary - 56,879 ----- ------ Total liabilities 578 57,444 --- ------ Stockholders' equity: Preferred stock, $.01 par value; 2,000,000 shares authorized; no shares outstanding - - Common stock, $.01 par value; 20,000,000 shares authorized; 14,121,482 shares issued and outstanding 141 141 Additional paid-in capital 39,739 39,739 Net unrealized gains (losses) on investments (Net of deferred income taxes of $0 in 1995 and 1994) (8) (2,664) Receivable from Alpha Trust (11,004)(27,000) Accumulated deficit (28,723)(66,468) ------ ------ Total stockholders' equity (deficiency) 145 (56,252) ----- ------ Total liabilities and stockholders' equity (deficiency) $ 723 $ 1,192 ====== ======\nS-3\nSchedule II Continued\nLAWRENCE INSURANCE GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS\n($ in thousands) Year Ended December 31, ------------------------ 1995 1994 1993 ------ ------ ------ Net investment income $ 1 $ (7) $ 8 Equity in net income (loss) of subsidiaries (424) (6,625) (76,854) Other operating expenses (232) (688) (279) Income tax benefit 13 229 21 Extraordinary gain 38,387 - - ------ ------- ------ Net income (loss) $37,745 $(7,091) $(77,104) ====== ===== ======\nS-4\nSchedule II Continued LAWRENCE INSURANCE GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS\n($ in thousands) Year Ended December 31, ----------------------- 1995 1994 1993 ------ ------ ------ Operating activities: Net income (loss) $37,745 $ (7,091) $(77,104) Adjustments to reconcile net income to net cash provided (used) by operating activities: Equity in net (income) loss of subsidiaries 424 6,625 76,854 Extraordinary gain (38,387) - - Other assets 191 (153) (194) Accrued expenses and liabilities and all other 6 444 97 ------ ----- ------ Net cash used by operating activities (21) (175) (347) ------ ------ ------ Investing activities: (Increase) decrease in short-term investments - - 325 Repayment of long-term investments: Mortgage loans on real estate - 22 - Other invested assets 20 21 20 Dividends from subsidiaries - - 3,915 ------ ------ ------ Net cash provided by investing activities 20 43 4,260 ------ ------ ------ Financing activities: Dividends paid - - $(3,813) ---- ---- ----- Increase (decrease) in cash (1) (132) 100 Cash-beginning of year 3 135 35 ---- ---- ---- Cash-end of year $ 2 $ 3 $ 135 ==== ==== ==== Supplemental disclosure of cash flow information: Cash paid (received) during year for income taxes $ (13) $ 70 $ 67\nS-5\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INSURANCE INFORMATION YEAR ENDED DECEMBER 31, 1995 ($ in thousands) Schedule III\nColumn A Column B Column C Column D - --------------- ----------- ------------ ---------- 1995 Future Policy Deferred Benefits, Policy Losses, Acquisition Claims & Unearned Segment Costs Loss expense Premium - --------------- ----------- ----------- ---------- Property\/casualty $ 7 $ 849 $ 33 Reinsurance assumed 3 27,860 12 Accident & Health 58 2,265 459 --------- --------- -------- Total(3) $ 68 $ 30,974 $ 504 ========= ========= ======== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Benefits, Claims, Other policy Net Losses and Claims and Premium Investment Settlement Benefits payable Revenue Income(1) Expenses(2) - -------------- ----------- ----------- ---------- $ - $ 222 $ 278 $ 311 - 1,490 2,463 3,108 - 3,821 360 1,983 ---------- --------- --------- -------- - $ 5,533 $ 3,101 $ 5,402 ========= ========= ========= ======== Column I Column J Column K - --------------- ----------- ------------ Amortization of deferred Policy Other Acquisition Operating Premiums Costs Expenses(1) Written -------------- ----------- -------- $ 51 $ 285 $ 137 926 413 1,063 886 1,062 3,935 - ----------- --------- --------- $ 1,863 1,760 5,135 ========== ========= =========\nS-6\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INSURANCE INFORMATION YEAR ENDED DECEMBER 31, 1995\n($ in thousands) Schedule III (cont)\nColumn A Column B Column C Column D - --------------- ----------- ------------ ---------- 1994 Future Policy Deferred Benefits, Policy Losses, Acquisition Claims & Unearned Segment Costs Loss expense Premium - --------------- ----------- ----------- ---------- Property\/casualty $ 24 $ 2,369 $ 119 Reinsurance assumed 231 43,191 822 Accident & Health 34 1,605 443 --------- --------- -------- Total(3) $ 289 $ 47,165 $ 1,384 ========= ========= ======== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Benefits, Claims, Other policy Net Losses and Claims and Premium Investment Settlement Benefits payable Revenue Income(1) Expenses(2) - -------------- ----------- ----------- ---------- $ - $ 641 $ 378 $ 839 - (973) 2,678 1,076 - 5,553 257 2,104 ----------- --------- --------- -------- $ - $ 5,221 $ 3,313 $4,109 ========= ========= ========= ======== Column I Column J Column K - --------------- ----------- ------------ Amortization of deferred Policy Other Acquisition Operating Premiums Costs Expenses(1) Written -------------- ----------- ----------- $ (27) $ 297 $ 273 565 60 (13,802) 1,530 1,003 5,759 - ----------- --------- --------- $ 2,068 $ 1,360 $ (7,770) ========== ========= =========\nS-7\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INSURANCE INFORMATION YEAR ENDED DECEMBER 31, 1995\n($ in thousands) Schedule III (cont) Column A Column B Column C Column D - --------------- ----------- ------------ ---------- 1993 Future Policy Deferred Benefits, Policy Losses, Acquisition Claims & Unearned Segment Costs Loss expense Premium - --------------- ----------- ----------- ---------- Property\/casualty $ 10,709 $129,449 $ 49,590 Reinsurance assumed 1,120 68,470 3,956 Accident & Health 66 2,926 675 --------- --------- -------- Total $ 11,895 $200,845 $ 54,222 ======= ======== ====== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Benefits, Claims, Other policy Net Losses and Claims and Premium Investment Settlement Benefits payable Revenue Income(1) Expenses(2) - -------------- ----------- ----------- --------- $ - $ 96,875 $ 4,675 $107,491 - 13,862 2,316 35,726 - 10,278 174 5,220 ------------ --------- --------- -------- $ - $121,015 $ 7,165 $148,437 ========= ======= ======= ======= Column I Column J Column K - --------------- ----------- ------------ Amortization of deferred Policy Other Acquisition Operating Premiums Costs Expenses(1) Written -------------- ----------- ----------- $ 27,604 $ 13,071 $100,541 5,910 920 7,093 1,864 559 10,227 - ----------- --------- --------- 35,378 14,550 $117,861 ========== ========= =========\nS-8\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INSURANCE INFORMATION YEAR ENDED DECEMBER 31, 1995\n($ in thousands) Schedule III (cont)\n(1) The allocation among segments is based upon the actual income or expense of each underlying subsidiary of the parent. Each subsidiary generally represents only one segment. (2) Excludes amounts related to involuntary pools of $0, $0 and $897 for 1995, 1994 and 1993, respectively. (3) Excludes UCIC\nS-9\nSchedule IV\nLAWRENCE INSURANCE GROUP, INC. REINSURANCE\n($ in thousands)\nCeded Assumed Gross To From Net Assumed Amount Others Others Amount To Net ------ ------ ------ ------ ------\nFor year ended December 31, 1995 Premiums earned: Property\/casualty $ 222 $ - $ - $ 222 -% Accident\/health 5,222 1,401 - 3,821 -% Reinsurance assumed - 601 2,091 1,490 140.3% ----- ----- ----- ----- Total $5,444 $2,002 $2,091 $5,533 ===== ===== ===== ===== For year ended December 31, 1994 Premiums earned: Property\/casualty $ 658 $ 17 $ - $ 641 -% Accident\/health 8,857 3,303 - 5,554 -% Reinsurance assumed - 1,425 451 (974) -% ----- ----- ----- ----- Total $9,515 $4,745 $ 451 $5,221 ===== ===== === ===== For year ended December 31, 1993 (1) Premiums earned: Property\/casualty $118,266 $22,741 $ 1,349 $ 96,874 1.4% Accident\/health 11,547 1,268 - 10,279 - Reinsurance assumed - 618 14,480 13,862 104.4 ------- ------ ------ ------ Total $129,813 $24,627 $15,829 $121,015 ======= ====== ====== =======\n(1) Includes UCIC.\nS-10\nLAWRENCE INSURANCE GROUP, INC. Schedule V VALUATION ACCOUNTS\n($ in thousands) Additions ------------- Charged to Balance -------------- Balance Jan 1, Cost & Other Deduct- Dec 31, of year expenses Accounts ions of year ------ ------ ------ ------ ------\nDecember 31, 1995 Equity securities $ 502 $ - $ - $ (502) $ - Deferred Income Taxes - 7,102 702 - 7,804 Reinsurance Recoverable - 148 - - 148 ----- ---- ---- ----- -----\nTotal (1) $ 7,604 $ 148 $ 702 $ (502) $ 7,952 ===== ===== ===== ====== ======\nDecember 31, 1994 Equity in common stock of investee $ 2,651 $ - $ - $ (2,651) $ - Equity securities - 502 - - 502 Deferred Income Taxes - 6,997 - 105 - 7,102 ------ ---- ---- ------ ----- Total (1) $ 9,648 $ 502 $ 105 $ (2,651) $ 7,604 ===== ==== ==== ===== =====\nDecember 31, 1993 Equity in Common stock of investee $ - $ 5,587 $ - $ - $ 5,587 Other invested assets (Other) - 3,500 - - 3,500 Allowance for doubtful accounts 180 119 - 119 180 Deferred Income Taxes - - 27,928 - 27,928 ---- ----- ------ ---- ------ Total $ 180 $ 9,206 $27,928 $ 119 $ 37,195 ==== ===== ====== ==== ======\n(1) Excludes UCIC.\nS-11\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS DECEMBER 31, 1995 ($ in thousands) SCHEDULE VI Column A Column B Column C Column D - --------------- ----------- ------------ ---------- 1995 Future policy Deferred Benefits Policy Losses,claims Discount Acquisition and loss Deducted in Company Costs Expenses Column C - --------------- ----------- ----------- ---------- United Republic Insurance Company $ 3 $ 27,860 $ - Global Insurance Company 7 849 - --------- --------- -------- Total $ 10 $ 28,709 $ - ========= ========= ======== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Claim and Net Settlement Unearned Premium Investment Expense Premiums Revenue Income Current Yr - -------------- ----------- ----------- ----------\n$ 12 $ 1,490 $ 2,462 $ 288\n33 222 278 80 - ------------ --------- --------- -------- $ 45 $ 1,712 $ 2,740 $ 368 ======== ======== ======== ======= Column H Column I Column K Column K - --------------- ----------- ------------ --------- Claim and Amortization Paid claims, Settlement deferred policy and claim Expense Acquisition Adjustment Premium Prior Yrs Costs Expenses Written ----------- ----------- ----------- ---------\n$ 2,820 $ 926 $ 15,897 $ 1,063\n231 51 1,901 137 ---------- --------- --------- --------- $ 3,051 $ 977 $ 17,798 $ 1,200 ========== ========= ========= =========\nS-12\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS DECEMBER 31, 1995 ($ in thousands) SCHEDULE VI(cont) Column A Column B Column C Column D - --------------- ----------- ------------ ---------- 1994 Future policy Deferred Benefits Policy Losses,claims Discount Acquisition and loss Deducted in Company Costs Expenses Column C - --------------- ----------- ----------- ---------- United Republic Insurance Company $ 231 $ 43,191 $ - Global Insurance Company 24 2,369 - --------- --------- -------- Total $ 255 $ 45,560 $ - ========= ========= ======== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Claim and Net Settlement Unearned Premium Investment Expense Premiums Revenue Income Current Yr - -------------- ----------- ----------- ----------\n$ 822 $ (896) $ 2,684 $ 4,106\n119 565 378 508 - ------------ --------- --------- -------- $ 941 $ (331) $ 3,062 $ 4,614 ========= ========= ========= ======== Column H Column I Column K Column K - --------------- ----------- ------------ --------- Claim and Amortization Paid claims, Settlement Deferred Policy and claim Expense Acquisition Adjustment Premium Prior Yrs Costs Expenses Written ----------- ----------- ----------- ---------\n$ (3,030) $ 565 $ 24,315 $ (13,726)\n331 (28) 4,832 197 - ----------- --------- --------- --------- $ (2,699) $ 537 $ 29,147 $ (13,529) ========== ========= ========= =========\nS-13\nLAWRENCE INSURANCE GROUP INC. SUPPLEMENTARY INFORMATION PROPERTY & CASUALTY INSURANCE OPERATIONS DECEMBER 31, 1995 ($ in thousands) SCHEDULE VI(cont) Column A Column B Column C Column D - --------------- ----------- ------------ ---------- 1993 Deferred Future policy Policy Benefits Discount Acquisition Losses, claims Deducted in Company Costs Loss expense Column C - --------------- ----------- ----------- ---------- United Community Insurance Company $ 10,614 $122,520 $ - United Republic Insurance Company 1,120 68,470 - Global Insurance Company 94 6,929 - --------- --------- -------- Total $ 11,828 $197,919 $ - ========= ========= ======== Column E Column F Column G Column H - --------------- ----------- ------------ ---------- Net Clm & Settle- Unearned Premium Investment ment expense Premiums Revenue Income Current Yr - -------------- ----------- ----------- ----------\n$ 49,096 $ 95,976 $ 4,194 $ 68,863\n3,956 13,860 2,280 10,953\n494 898 481 967 - ------------ --------- --------- -------- $ 53,546 $110,734 $ 6,955 $ 80,783 ========= ========= ========= ======== Column H Column I Column K Column K - --------------- ----------- ------------ --------- Claim and Amortization Paid claims, Settlement of deferred and claim Expense Policy Acqui- Adjustment Premium Prior Yrs sition costs Expenses Written ----------- ----------- ----------- --------- $ 36,332 $ 27,153 $ 82,799 $ 99,426\n24,773 5,909 15,616 7,091\n1,329 451 3,937 1,115 - ----------- --------- --------- --------- $ 62,434 $ 33,513 $102,352 $107,632 ========== ========= ========= ========= S-14\nLAWRENCE INSURANCE GROUP INC INDEX TO EXHIBITS ITEM 601\nExhibit Number Description Reference\n1 Certification of Incorporation (1) 2-1 Bylaws (2) 4-1 Specimen Certificate of Common Stock (3) 10-1 Management Agreement between Senate Insurance Company and A.W.Lawrence and Company Inc. (2) 21-1 Subsidiaries of Registrant EX-21 27-1 Financial Data Schedule EX-27 28-1 Information from reports furnished to State insurance Regulatory Authorities EX-28\n(1) Previously filed on December 10,1986 in Amendment No. 3 to Form\nS-1 Registration Statement (Registration No. 33-9898)\n(2) Previously filed on October 31, 1986 in Form S-1 Registration Statement (Registration No. 33-9898)\n(3) Previously filed on December 29, 1986 in Amendment No. 5 to Form S-1 Registration Statement (Registration No. 33-9898)\nLAWRENCE INSURANCE GROUP INC EXHIBIT 21 SUBSIDIARIES OF REGISTRANT YEAR ENDED DECEMBER 31, 1995\nPercent Owned _____\nLawrence Insurance Group Inc. Del. United Republic Insurance Company Tx. 78.6% Global Insurance Company Ga. 100.0% Senate Insurance Company Az. 100.0% Senate National Life Insurance Company Az. 100.0% Senate Syndicate Inc. NY. 100.0%\nEX 21-1","section_15":""}
{"filename":"764586_1995.txt","cik":"764586","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nRegistrant owns a fee interest in five mini-storage facilities, as well as a 70% interest in a joint venture with an affiliated partnership (DSI Realty Income Fund VIII, a California Limited Partnership) which joint venture owns a mini-storage facility, none of which are subject to long-term indebtedness. 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\nAzusa, CA 2.94 acres 71,059 664 6\/11\/86\nElgin, IL 4.99 acres 48,363 441 9\/29\/86\nEverett, WA 2.71 acres 50,572 488 12\/01\/85\nMonterey Park, CA .95 acres 31,654 392 8\/23\/86\nRomeoville, IL 3.956 acres 65,941 690 11\/24\/86\nAurora, CO(1) 4.6 acres 86,676 887 9\/05\/85\n(1) The Partnership has a 70% fee interest in this facility. DSI Realty Income Fund VIII, a California Limited Partnership (an affiliated partnership) owns a 30% 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 30,693 limited partnership units during its offering and currently has 1,365 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 $9.06 per Limited Partnership Unit were declared and paid each quarter for the year ended December 31, 1995 and $8.75 per Limited Partnership Unit 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 $ 2,484,242 $ 2,312,201 $ 2,315,457 $ 2,144,647 $ 2,041,195\nCOSTS AND EXPENSES 1,563,848 1,520,382 1,552,502 1,532,136 1,494,797\nMINORITY INTEREST IN EARNINGS OF REAL ESTATE JOINT VENTURE (116,421) (93,634) (88,765) (59,417) (49,287) ----------- ----------- ----------- ------------ ------------\nNET INCOME $ 803,973 $ 698,185 $ 674,190 $ 553,094 $ 497,111 =========== =========== =========== ============ ============\nTOTAL ASSETS $ 8,677,898 $ 9,031,055 $ 9,525,832 $ 10,118,690 $ 10,706,384 =========== =========== =========== ============ ============\nNET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,488,619 $ 1,331,083 $ 1,213,385 $ 1,205,247 $ 1,179,966 =========== =========== =========== ============ ============\nNET INCOME PER LIMITED PARTNERSHIP UNIT $ 36.25 $ 35.00 $ 35.00 $ 35.00 $ 35.00 =========== =========== =========== ============ ============\nCASH DISTRIBUTION PER $500 LIMITED PARTNERSHIP UNIT $ 25.93 $ 22.52 $ 21.75 $ 17.84 $ 16.03 =========== =========== =========== ============ ============\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 $2,312,201 in 1994 to $2,484,242 in 1995, total expenses increased from $1,520,382 to $1,563,848 and minority interest in income of the real estate joint venture increased from $93,634 to $116,421. As a result of these fluctuations, net income increased from $698,185 in 1994 to $803,973 in 1995. The increase in rental revenues can be attributed to a combination of higher occupancy and unit rental rates. Average occupancy levels for the Partnership's six mini-storage facilities increased from 81.5% for the year ended December 31, 1994, to 85.2% for the year ended December 31, 1995. 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. The increase in operating expenses of approximately $22,000 (3.6%) was primarily due to increases in maintenance and repairs and salaries and wages partially offset by a decrease in yellow page advertising costs. General and administrative expenses increased by approximately $8,000 (3.5%) primarily as a result of higher property management fees. Property management fees, which are based on rental income, increased as a result of the increase in rental income. The amount of income from the Partnership's real estate joint venture allocated to the minority partner increased due to the increased profitability of the joint venture.\n1994 COMPARED TO 1993\nTotal revenues decreased slightly from $2,315,457 in 1993 to $2,312,201 in 1994, total expenses decreased from $1,552,502 to $1,520,382 and minority interest in income of the real estate joint venture increased from $88,765 to $93,634. As a result of these fluctuations, net income increased from $674,190 in 1993 to $698,185 in 1994. The slight decrease in rental revenues can be attributed to a combination of lower occupancy rates offset to some extent by higher unit rental rates. Average occupancy levels for the Partnership's six mini-storage facilities decreased from 84.2% for the year ended December 31, 1993, to 81.5% 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. The decrease in operating expenses of approximately $41,000 (6.3%) was primarily due to decreases in maintenance and repair, salaries and wages, workers' compensation insurance expenses and yellow page advertising costs offset to some extent by an increase in real estate tax expense. General and administrative expenses increased by approximately $9,000 (4.2%) primarily as a result of higher professional fees. The amount of income from the Partnership's real estate joint venture allocated to the minority partner increased due to the increased profitability of the joint venture.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities increased approximately $158,000 (11.9%) in 1995 compared to 1994 primarily as a result of the increase in net income and the reduction in the amount paid for deferred property management fees. Net cash provided by operating activities increased approximately $118,000 (9.7%) in 1994 compared to 1993 primarily as a result of the increase in net income and the reduction in the amount paid for deferred property management and General Partners' incentive management fees. Payment of a portion of the property management and General Partners' incentive management fees had been deferred in prior years in order to maximize cash available for distribution to Limited Partners.\nCash used in financing activities, as set forth in the statements of cash flows, has been used for distributions to partners and the minority interest in the Partnership's real estate joint venture. The General Partners determined that effective with the fourth quarter 1995 distribution, which was paid on January 15, 1996, 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 annual return of 7% paid in the prior year. Distributions paid to the minority interest in the Partnership's real estate joint venture have increased each year as a result of the increased profitability of the joint venture.\nCash used in investing activities, as set forth in the statements of cash flows, consists of acquisitions of equipment for the Partnership's mini-storage facilities in 1994 and 1995. 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 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, Robert J. Conway and Joseph W. Conway, brothers. 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. 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 IX 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 IX 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 IX\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 IX (A California Real Estate Limited Partnership)\nSELECTED FINANCIAL DATA FIVE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993 1992 1991\nREVENUES $2,484,242 $2,312,201 $2,315,457 $2,144,647 $2,041,195\nCOSTS AND EXPENSES $1,563,848 1,520,382 1,552,502 1,532,136 1,494,797\nMINORITY INTEREST IN EARNINGS OF REAL ESTATE JOINT VENTURE (116,421) (93,634) (88,765) (59,417) (49,287) ---------- ---------- ---------- ---------- ---------- NET INCOME $ 803,973 $ 698,185 $ 674,190 $ 553,094 $ 497,111 ========== ========== ========== ========== ========== TOTAL ASSETS $8,677,898 $9,031,055 $9,525,832 $10,118,690 $10,706,384 ========== ========== ========== ========== ========== NET CASH PROVIDED BY OPERATING ACTIVITIES $1,488,619 $1,331,083 $1,213,385 $1,205,247 $1,179,966 ========== ========== ========== ========== ========== CASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 36.25 $ 35.00 $ 35.00 $ 35.00 $ 35.00 ========== ========== ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 25.93 $ 22.52 $ 21.75 $ 17.84 $ 16.03 ========== ========== ========== ========== ==========\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.\nNet Partners' Income Equity\nPer financial statements $ 803,973 $ 7,530,440 Capitalization of property acquisition costs 466,135 Deferred rental revenues 56,022 Excess financial statement depreciation 19,840 116,855 Excess tax return income from real estate joint venture 31,405 373,652 Accrued incentive management fee 314,602 Accrued property taxes (75,000) Accrued distributions 310,030 ----------- ----------- Per Partnership income tax return $ 855,218 $ 9,092,736 =========== =========== Taxable income per $500 limited partnership unit $ 27 ===========\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE\nPage\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Income for the Three Years Ended December 31, 1995\nConsolidated Statements of Changes in Partners' 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\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 IX:\nWe have audited the accompanying balance sheets of DSI Realty Income Fund IX, 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 consolidated financial statements present fairly, in all material respects, the financial position of DSI Realty Income Fund IX 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 LLP LONG BEACH, CALIFORNIA\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 - --------------------------------------------------------------------------------\nASSETS 1995 1994\nCASH AND CASH EQUIVALENTS $ 617,951 $ 421,316\nPROPERTY, At cost (net of accumulated depreciation of $5,680,967 in 1995 and $5,083,294 in 1994) (Notes 1, 2 and 3) 8,018,490 8,574,285\nOTHER ASSETS 41,457 35,454 ----------- ----------- TOTAL $ 8,677,898 $ 9,031,055 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY\nLIABILITIES: Distribution due partners(Note 4) $ 310,030 $ 271,277 Incentive management fee payable to general partners (Note 4) 314,604 314,604 Property management fees payable (Note 1) 6,860 20,931 Customer deposits and other liabilities 96,103 105,478 ----------- ----------- Total liabilities 727,597 712,290 ----------- ----------- MINORITY INTERST IN REAL ESTATE JOINT VENTURE (Notes 1 and 2) 419,861 468,439\nPARTNERS' EQUITY (Notes 4): General partners (62,137) (58,938) Limited partners (30,693 limited partnership units outstanding at December 31, 1995 and 1994) 7,592,577 7,909,264 ------------ ----------- Total partners' equity 7,530,440 7,850,326 ------------ ----------- TOTAL $ 8,677,898 $ 9,031,055 ============ ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF INCOME THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nREVENUES: Rental revenues $2,470,543 $2,306,251 $2,310,902 Interest income 13,699 5,950 4,555 ---------- ---------- ---------- Total revenues 2,484,242 2,312,201 2,315,457 ---------- ---------- ---------- EXPENSES: Depreciation (Note 2) 597,673 587,750 587,750 Operating expenses (Note 1) 631,778 609,945 650,620 General and administrative 233,249 225,027 216,472 General partners' incentive management fee (Note 4) 101,148 97,660 97,660 ---------- ---------- ---------- Total expenses 1,563,848 1,520,382 1,552,502 ---------- ---------- ----------\nINCOME BEFORE MINORITY INTEREST IN INCOME OF REAL ESTATE JOINT VENTURE 920,394 791,819 762,955\nMINORITY INTEREST IN INCOME OF REAL ESTATE JOINT VENTURE (NOTES 1 and 2) (116,421) (93,634) (88,765)\nNET INCOME $ 803,973 $ 698,185 $ 674,190 ========== ========== ========== AGGREGATE NET INCOME ALLOCATED TO (Note 4): Limited partners $ 795,933 $ 691,203 $ 667,448 General partners 8,040 6,982 6,742 ---------- ---------- ---------- TOTAL $ 803,973 $ 698,185 $ 674,190 ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT (Notes 2 and 4) $ 25.93 $ 22.52 $ 21.75 ========== ========== ==========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nGeneral Limited Partners Partners Total\nBALANCE AT JANUARY 1, 1993 ($50,960) $ 8,699,124 $ 8,648,164\nNet income 6,742 667,448 674,190\nDistributions (Note 4) (10,851) (1,074,256) (1,085,107) ------- ---------- ---------- BALANCE AT DECEMBER 31, 1993 (55,069) 8,292,316 8,237,247\nNet income 6,982 691,203 698,185\nDistributions (Note 4) (10,851) (1,074,255) (1,085,106) ------- ---------- ----------- BALANCE AT DECEMBER 31, 1994 (58,938) 7,909,264 7,850,326\nNet income 8,040 795,933 803,973\nDistributions (Note 4) (11,239) (1,112,620) (1,123,859) ------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 ($62,137) $ 7,592,577 $ 7,530,440 ======= =========== ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: Cash received from customers $ 2,464,540 $ 2,318,004 $ 2,330,940 Cash paid to suppliers and employees (989,620) (992,871) (1,122,110) Interest received 13,699 5,950 4,555 ----------- ----------- ------------ Net cash provided by operating activities 1,488,619 1,331,083 1,213,385\nCASH FLOWS FROM FINANCING ACTIVITIES - Distributions paid to minority interest in real estate joint venture (165,000) (141,212) (139,760) Distributions to partners (1,085,106) (1,085,106) (1,085,107) ____________ ___________ __________ Net cash used in financing activities (1,250,106) (1,226,318) (1,224,867) ------------ ----------- ----------\nCASH FLOWS FROM INVESTING ACTIVITIES - Additions to property (41,878) (16,322) ----------- ----------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 196,635 88,443 (11,482)\nCASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 421,316 332,873 344,355 ----------- ----------- ------------ CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 617,951 $ 421,316 $ 332,873 =========== =========== ============ RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Net income $ 803,973 $ 698,185 $ 674,190 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 597,673 587,750 587,750 Minority interst in income of real estate joint venture 116,421 93,634 88,765 Changes in assets and liabilities: Other assets ( 6,002) 11,792 (6,374) Incentive management fee payable to general partners ( 62,560) Property management fees payable (14,071) (64,141) ( 97,089) Customer deposits and other liabilities ( 9,375) 3,863 28,703 ----------- ----------- ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,488,619 $ 1,331,083 $ 1,213,385\nSee accompanying notes to consolidated financial statements.\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\n1. GENERAL\nDSI Realty Income Fund IX, a California Real Estate Limited Partnership (the \"Partnership\"), has three general partners (DSI Properties, Inc., Robert J. Conway and Joseph W. Conway) and limited partners owning 30,693 limited partnership units which were purchased for $500 a unit. The general partners have made no 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 12, 1985 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 Monterey Park and Azusa, California; Everett, Washington; and Romeoville and Elgin, Illinois. The Partnership also entered into a joint venture with DSI Realty Income Fund VIII through which the Partnership has a 70% interest in a mini-storage facility in Aurora, Colorado. The 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., Robert J. Conway and Joseph W. Conway are the general partners. 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 5% of gross revenue from operations, as defined.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The consolidated financial statements include the accounts of DSI Realty Income Fund IX and its 70% owned real estate joint venture. All significant intercompany accounts and trans- actions have been eliminated in consolidation.\nCash and Cash Equivalents - The Partnership classifies its short-term investments purchased with an original maturity of three months or less as cash equivalents.\nNet Income per Limited Partnership Unit - Net income per limited partnership unit is computed by dividing the net income allocated to the limited partners by the weighted average number of limited partnership units outstanding during each year (30,693 in 1995, 1994 and 1993).\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 20 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.\nEstimates - The preparation of financial statements in conformity with generally accepted accounting principles 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 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 $ 2,729,790 $ 2,729,790 Buildings and improvements 10,969,667 10,927,789 ----------- -----------\nTotal 13,699,457 13,657,579 Less accumulated depreciation (5,680,967) (5,083,294) ----------- ----------\nProperty, net $ 8,018,490 $ 8,574,285 =========== ===========\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 the project.\nThe 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 Partnership distributions made from cash available for distribution from operations, as defined. Payment of incentive management fees earned by the general partners during the fiscal years 1986 through 1988 was subordinated to the limited partners' receiving a cumulative, noncompounded annual return of 8.1%. Incentive management fees payable to general partners is $314,604 at December 31, 1995 and 1994.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund IX:\nWe have audited the financial statements of DSI Realty Income Fund IX (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 IX, 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\nDELOITTE & TOUCHE LLP LONG BEACH, CALIFORNIA\nDSI REALTY INCOME FUND IX (A California Real Estate Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION - --------------------------------------------------------------------------------\nReal Estate Accumulated at Cost Depreciation\nBalance at January 1, 1993 $13,641,257 $3,907,794 Additions 587,750 ----------- ---------- Balance at December 31, 1993 13,641,257 4,495,544 Additions 16,322 587,750 ----------- ---------- Balance at December 31, 1994 13,657,579 5,083,294 Additions 41,878 597,673 ----------- ---------- Balance at December 31, 1995 $13,699,457 $5,680,967 =========== ==========\nThe total cost at the end of the period for Federal income tax purposes was approximately $10,975,000.\nEXHIBIT 2 March 28, 1996\nANNUAL REPORT TO LIMITED PARTNERS OF\nDSI REALTY INCOME FUND IX\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 and a 70% interest in a sixth mini-storage facility on a joint venture basis with an affiliated Partnership, DSI Realty Income Fund VIII. 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\nAzusa, CA 85% 75%\nElgin, IL 85% 81%\nEverett, WA 84% 81%\nMonterey Park, CA 86% 84%\nRomeoville, IL 82% 85%\nAurora, CO* 89% 83% - ---------- *The Partnership owns a 70% interest in this facility.\nWe will keep you informed of the activities of DSI Realty Income Fund IX 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 IX By: DSI Properties, Inc.\nBy___________________________ ROBERT J. CONWAY, President","section_15":""}
{"filename":"709197_1995.txt","cik":"709197","year":"1995","section_1":"Item 1. BUSINESS\nPeaches Entertainment Corporation (\"PEC\" or the \"Company\"), a Florida corporation, was incorporated in March, 1982. Its executive offices are located at 3451 Executive Way, Miramar, Florida 33025. Its telephone number is 305-432-4200. PEC is engaged in the operation of retail stores which sell prerecorded music, videos and related products (the \"Retail Business\") in the Southeastern part of the United States under the name \"PEACHES\".\nURT Industries, Inc. (\"URT\"), a Florida corporation, presently owns approximately 87% of PEC's issued and outstanding shares of common stock and all of its issued and outstanding shares of preferred stock and controls PEC. The remaining approximately 13% of PEC's issued and outstanding shares of common stock is owned by non-affiliated persons.\nURT entered into the retail business in November, 1981 and since April, 1982, such business has been operated by PEC.\nThe Peaches Stores\nThe following table sets forth the number of stores which were open at the beginning of the year, which opened during the year, which closed during the year and which were open at the end of the year, with respect to PEC's last five complete fiscal years ended April 1, 1995:\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Number of stores:\nAt beginning of period 20 21 22 21 20 Opened during period 1 0 0 2 2 Closed during period (2) (1) (1) (1) (1) -- -- -- -- -- At end of period 19 20 21 22 21\nBetween April 1, 1995 and the date of this filing, PEC closed two additional stores, leaving, at present, a total of 17 \"Peaches\" stores (the \"'Peaches' stores\") in operation in five states. Such states are Florida (10 stores), Virginia (3 stores), North Carolina (2 stores), South Carolina (1 store)\nand Alabama (1 store). PEC does not have any present plans to open any additional stores during the 1996 fiscal year.\nPEC leases all but one of its stores. It has options to renew most of its leases for various periods. The utilized space of the stores ranges from approximately 7,000 square feet to approximately 14,000 square feet. Each store either has its own parking area or is located in a shopping center which provides parking.\nTwo of the Florida stores, one in Fort Lauderdale and the other in Orlando, are currently leased from the Chairman of PEC and his brother, a former director of PEC. The store in North Miami Beach, Florida is leased from two directors and two children of such former director. See \"Certain Relationships and Related Transactions\".\nFor information concerning real property owned by PEC, see \"Properties\".\nTrademarks\nPEC is the registered owner of and owns nationwide rights to the tradename, service mark and trademark \"PEACHES\" (the \"Trademarks\") in connection with the operation of the Retail Business.\nOperation of the Peaches Stores\nThe \"Peaches\" stores are all similar in appearance. They have distinct, wood panelled interiors, are decorated in a manner which identifies them as \"Peaches\" stores and carry a wide selection of prerecorded music as well as recorded and blank video tapes, accessory items and specialty items such as T-shirts and crates. Some stores are free standing and others are contiguous to other stores in shopping centers. At present, each \"Peaches\" store is managed by an individual director who is responsible for ordering, pricing and displaying merchandise sold in the store, hiring and firing personnel and other matters relating to store administration. PEC has implemented a computerized inventory control system at each of its stores.\nAs of May 15, 1995, PEC purchased merchandise from approximately 54 suppliers, among whom the principal ones were BMG, CEMA, PGD, SONY, UNI and WEA. Approximately 77% of the merchandise purchased during the fiscal year ended April 1, 1995 (the \"1995 fiscal year\") came from such six principal suppliers. Purchases from given suppliers are, to a great extent, determined by which of them are manufacturing or distributing the most popular prerecorded music at a given time. PEC is not obligated to purchase merchandise from any supplier. It has numerous alternate sources of supply for inventory. The loss of any particular supplier would not have a materially negative effect on PEC's results of operations, although in some cases, the expenses would be greater if such alternate sources were utilized. Merchandise is generally delivered directly by suppliers to the stores.\nThe usual terms received from suppliers provide for payment to be made within 60 days from the end of the month in which a purchase is made. In addition, PEC normally receives an additional 30 to 120 days to pay for certain purchases during the course of the year. Such terms are usual in the industry.\nUnder current industry practice, PEC is able to return merchandise, without limitation, to all suppliers, who charge a slight penalty if returns exceed certain percentages of the dollar amounts of gross purchases. Up to the present time, the suppliers' return policies have not had any adverse effect on PEC's business.\nAdvertising in local newspapers and media is determined by consultation between each store director and PEC management. PEC also engages in cooperative advertising with suppliers who pay a portion of the cost. In addition to the director, each \"Peaches\" store is staffed with managers, cashiers and sales and stock room personnel. The stores are open seven days a week. Based on management's experience to date, retail business sales fluctuate during the year and are generally at their highest levels during the holiday season, i.e., between October and December. During the last three fiscal years, sales between January and March were approximately 24% of total sales for each year; sales between April and June were approximately 23% of total sales; sales between July and September were approximately 22% of total sales; and sales between October and December were approximately 31% of total sales.\nCompetition\nThe retail sale of prerecorded music and video products is highly competitive. There are hundreds of retail stores and department, discount and variety stores and supermarkets which offer such merchandise to the public. PEC's share of the retail market in the Southeastern United States is not significant. Recently, in addition to usual competition, there has been a proliferation of non-traditional music outlets, such as appliance and computer retailers and superbookstores, some of whom have used very aggressive price cutting tactics including selling some products below actual cost in order to attract customers and sell non-music and video products.\nEmployees\nAs of May 5, 1995, PEC employed 339 persons in all capacities. It is not a party to any collective bargaining agreements. Relations with employees have been satisfactory and there have been no work stoppages.\nManagement Agreement Between URT and PEC\nOn April 3, 1994, when the 1995 fiscal year began, a management agreement was in effect between URT and PEC (hereinafter, collectively, the \"URT Companies\"). Such agreement provided that it would remain in effect through March 30, 1996; that PEC would pay URT an annual fee of 3-1\/2% of its net sales, subject to a maximum amount of $1,400,000; that URT would provide PEC with the services of Allan Wolk as president and chairman of PEC; that URT would pay PEC for certain accounting and administrative services performed by PEC at the rate of $39,600 per annum (subject to periodic equitable adjustment depending upon the amount of such services); and that so long as URT and PEC filed consolidated income tax returns, their respective liabilities for such taxes would be equitably apportioned as provided in such agreement. Such agreement was amended as of October 2, 1994 to provide that for the above described services, instead of the compensation described above, PEC would be required to pay URT, in equal weekly installments, a fee of $500,000 during the period from October 2, 1994 through April 1, 1995 and a fee at the rate of $750,000 per annum for the period from April 2, 1995 until March 30, 1996. During both the 1994 and 1995 fiscal years, Mr. Wolk devoted approximately 75% of his working time to the business of PEC. As a result of the above-described arrangements, PEC paid URT a management fee of $1,024,386 for the 1995 fiscal year, as compared to $1,263,010 for the 1994 fiscal year, and URT paid expenses as described above of approximately $39,600 for each of such fiscal years.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nPEC's headquarters are located in Miramar, Florida in a building which is leased by PEC. Such building contains a total of approximately 26,000 square feet, approximately 11,000 square feet of which is office space and approximately 15,000 square feet of which is warehouse space.\nPEC owns real property in Mobile, Alabama on which it constructed and operates a \"Peaches\" store. Such property is subject to a first mortgage. All other \"Peaches\" stores are leased. For information concerning such other stores operated by PEC, see \"Business--The Peaches Stores\".\nDuring the 1995 fiscal year, PEC purchased land in Lafayette, Louisiana, with the intention of constructing a store. However, it subsequently decided not to construct a store and, after the end of such fiscal year, sold the land for an amount approximately equal to its original purchase price.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn April, 1991, Service Merchandise Company, Inc. (\"Service\") commenced an action against PEC in the North Carolina General Court of Justice, Superior Court Division, Mecklenburg County, based on PEC's closing of a store which it had leased in Charlotte, North Carolina and its refusal to pay rent with respect to such store from and after February, 1991. Before closing the store, PEC had attempted to sublease it to a subtenant, but Service refused to consent to the sublease. In such action, Service sought a judgment for rent arrears plus its reasonable attorneys' fees and expenses, and for an order requiring PEC to pay the rent required to be paid under the lease through July 31, 1997, less any amounts recovered from a current tenant or any subsequent occupant of such premises. PEC asserted various defenses including the failure of Service to mitigate damages by refusing to consent to the sublease of the premises by PEC to a financially responsible and reputable company. Following a trial in December, 1993, a judgment was issued in favor of Service in February, 1995, for rent due to such date and PEC remains liable under the lease through July 31, 1997. Under such judgment PEC was ordered to pay the sum of $405,460 to plaintiff, which amount was duly paid by PEC to Service in March, 1995.\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\nPrice Range of Common Stock\nPEC's Common Stock is quoted by market makers on the over-the-counter market. The following table sets forth the high and low, bid and asked quotations for PEC's common stock for the calendar periods indicated, based on information supplied by the National Quotation Bureau, Incorporated:\nBid Prices Asked Prices ----------- ------------ High Low High Low - ---- Quarter ended March 31, 1\/16 1\/16 1\/4 1\/4 Quarter ended June 30, 1\/16 1\/16 1\/4 1\/4 Quarter ended Sept. 30, 1\/16 1\/16 1\/4 1\/4 Quarter ended Dec. 31, 1\/16 1\/16 5\/16 1\/4\n- ---- Quarter ended March 31, 1\/16 1\/16 5\/16 1\/4 Quarter ended June 30th, 1\/16 1\/16 5\/16 1\/4 Quarter ended Sept. 30, 1\/16 .02 5\/16 1\/8 Quarter ended Dec. 31, 1\/32 .02 9\/32 .12\n- ---- Quarter ended March 31, 1\/32 1\/32 9\/32 7\/32 Quarter through May 30, 1\/32 1\/32 9\/32 7\/32\nThe above over-the-counter quotations represent prices between dealers, do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions.\nDividends\nThere has been no payment of dividends on PEC's Common Stock since its inception and payment of dividends on such stock in the future will depend on its earnings and needs. PEC is required to pay dividends on its outstanding shares of preferred stock.\nApproximate Number of Equity Security Holders\nThe following table indicates the approximate number of holders of record of each class of PEC's common equity securities as of May 30, 1995, based on information supplied by PEC's transfer agent:\nNumber of Record Title of Class Holders -------------- ----------------\nCommon Stock, $.01 par value 1,578\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data and other operating information of the Company. The 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.\"\nThere were no cash dividends declared for common stock in any of the periods presented. (1) Includes 53 weeks of operations.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFISCAL YEAR ENDED APRIL 1, 1995 (1995) COMPARED TO FISCAL YEAR ENDED APRIL 2, 1994 (1994)\nNet sales for 1995 decreased 12.0% compared to 1994. Such decrease is attributed to an 8.2% decrease in comparable store sales, and a 3.8% decrease in sales in those stores that opened or closed during 1995 versus 1994.\nDuring the last few years, non-traditional music retailers such as appliance and computer retailers and super bookstores have begun to sell prerecorded music and video products. They have adopted policies of selling music product at near or below wholesale cost as a means of attracting customers to sell other products. During the current fiscal year, the effect of this competition was encountered in some of our markets and will be expanded to some others in the future. The Company has reduced prices which has resulted in lower sales and lower gross profit. The Company believes that it will remain competitive due to its locations, selection of product and superior customer service.\nThe cost of sales for 1995 was lower than that for 1994 due to the decrease in net sales. Cost of sales as a percentage of net sales has increased from 62.7% in 1994 to 63.7% in 1995 due to a reduction in retail pricing in an effort to meet the increased competition.\nSelling, general, and administrative (SG&A) expenses in 1995 decreased 6.3% compared to 1994. Such decrease is attributable to a decrease in comparable store expenses (1.1%), a decrease in store operating expenses of stores that opened or closed during 1995 versus 1994 (2.9%), a decrease in corporate overhead (1.9%), and a decrease in the cost of store openings (0.4%). SG&A expenses, as a percentage of net sales increased from 33.7% in 1994 to 35.8% in 1995 due to the fixed nature of certain expenses and the decrease in net sales in addition to the aforementioned items.\nStore closing costs increased in 1995 over 1994 due to the fact that the cost of closing 1 store is included in 1994, and the cost of closing 4 stores is included in 1995.\nIn 1994, the Company adopted the provisions of Financial Standards No. 109 (SFAS 109) \"Accounting for Income Taxes,\" which established new financial accounting and reporting standards for income taxes. Such adoption resulted in a cumulative adjustment of approximately $74,000 of income which has been reflected in the statement of operations for 1994.\nThe Company incurred a net loss of approximately $1,995,000 in 1995 versus a net loss of approximately $108,000 in 1994 due to costs of closing 4 stores, the loss on litigation, and the reduction in net sales and gross profit as described above.\nFISCAL YEAR ENDED APRIL 2, 1994 (1994) COMPARED TO FISCAL YEAR ENDED APRIL 3, 1993 (1993)\nNet sales for 1994 decreased 4.1% compared to 1993. Such decrease is attributed to the fact that 1993 included 53 weeks of operations (1.7%), a decrease in comparable store sales (1.6%), store closings due to inclement weather (0.3%) and a decrease in sales in those stores that opened or closed during 1994 versus 1993 (0.5%).\nThe cost of sales for 1994 was lower than that for 1993 due to decreased net sales. Cost of sales as a percentage of net sales for both 1994 and 1993 was 62.7%.\nSelling, general, and administrative (SG&A) expenses in 1994 increased 1.8% compared to 1993. Such increase is attributable to an increase in comparable store expense (1.9%) an increase in corporate overhead (1.6%), an increase in the cost of store openings (0.8%), offset by a decrease in store expenses that opened or closed during 1994 versus 1993 (1.5%), and a decrease due to the fact that 1993 included 53 weeks of operations (1.0%). SG&A expenses, as a percentage of net sales increased from 31.8% in 1993 to 33.7% in 1994 due to the fixed nature of certain expenses and the decrease in net sales in addition to the aforementioned items.\nIn 1994, the Company adopted the provisions of Financial Standards No. 109 (SFAS 109) \"Accounting for Income Taxes,\" which established new financial accounting and reporting standards for income taxes. Such adoption resulted in a cumulative adjustment of approximately $74,000 of income which has been reflected in the statement of operations for 1994.\nThe Company incurred a net loss of approximately $108,000 in 1994 versus net income of approximately $296,000 in 1993 due to the decrease in net sales and an increase in certain SG&A expenses as discussed above, Approximately $55,000 of net income in 1993 is due to the fact that 1993 included 53 weeks of operations.\nFISCAL YEAR ENDED APRIL 1, 1993 (1993) COMPARED TO FISCAL YEAR ENDED MARCH 28, 1992 (1992)\nNet sales for 1993 increased 6.4% compared to 1992. Such increase is attributable to the fact that 1993 included 53 weeks of operations (1.8%), an increase in comparable store sales (3.8%), and an increase in sales in those stores that opened or closed during 1993 versus 1992 (0.8%).\nCost of sales for 1993 increased compared to 1992 due primarily to increased sales volume as described above. Cost of sales as a percentage of net sales for 1993 (62.7%) was lower than that for 1992 (63.7%) due to the amortization of $131,000 relating to the cost of video cassettes which were test marketed and discounted in 1992.\nSelling, general, and administrative (SG&A) expenses for 1993 decreased 0.7% compared to 1992. Such decrease is attributed to a decrease in expenses of comparable stores (3.4%), an increase in expenses of stores opened or closed in 1993 versus 1992 (1.0%), an increase attributable to the fact that 1993 included 53 weeks of operations (1.0%), an increase in corporate overhead (1.2%), and a decrease in expenses incurred in connection with the opening of stores (0.5%). SG&A expenses, as a percentage of net sales decreased from 34.1% in 1992 to 31.8% in 1993 due to the fixed nature of certain expenses and the increase in net sales.\nStore closing costs increased in 1993 over 1992 because the costs incurred with the closing of the store due to Hurricane Andrew in 1993 was higher than the negligible cost of closing the store in 1992.\nThe Company achieved net income of approximately $296,000 in 1993 versus a net loss of approximately $329,000 in 1992 due to the increase in net sales which was partially offset by the increases in certain SG&A expenses as discussed above. Approximately $55,000 of net income in 1993 is due to the fact that 1993 included 53 weeks of operations.\nLiquidity and Capital Resources\nThe Company had working capital of $2,058,184 at April 1, 1995 compared to working capital of $3,550,371 at April 2, 1994 and a current ratio (the ratio of total current assets to total current liabilities) of 1.35 to 1 at April 1, 1995 compared to a current ratio of 1.57 to 1 at April 2, 1994.\nThe Company has historically maintained a strong cash position and management believes that this will continue in the future.\nAt April 1, 1995, the Company had long-term obligations of $929,654. Management anticipates that its ability to repay its long-term obligations will be satisfied primarily through funds generated from its operations.\nManagement believes that the Company has excellent relationships with its banks and suppliers and does not anticipate any significant difficulties in financing operations at current levels.\nManagement anticipates that cash generated from operations and cash equivalents on hand will provide sufficient liquidity to maintain adequate working capital for operations and the opening of any new stores during the next few years.\nInflation trends have not had an impact upon revenues because increases in costs have been passed along to customers.\nThe Company's business is seasonal in nature, with the highest sales and earnings occurring in the third fiscal quarter, which includes the Christmas selling season.\nThe Company has 2,500 shares of $100 par, 11%, Series A Cumulative Preferred Stock and 2,500 shares of $100 par 13%, Series B Cumulative Preferred Stock, issued, and outstanding. On an annual basis, the Company pays dividends of $60,000 to its preferred shareholders based on its dividend requirements.\nIn July 1995, the Company will be selling its leasehold in a store to the landlord for $325,000.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nKPMG Peat Marwick LLP One Biscayne Tower Telephone 305 358 2300 Telefax 305 577 0544 Suite 2900 2 South Biscayne Boulevard Miami, FL 33131\nIndependent Auditors' Report\nDirectors and Shareholders Peaches Entertainment Corporation Miramar, Florida:\nWe have audited the accompanying balance sheets of Peaches Entertainment Corporation as of April 1, 1995 and April 2, 1994, and the related statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended April 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 financial statements referred to above present fairly, in all material respects, the financial position of Peaches Entertainment Corporation as of April 1, 1995 and April 2, 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended April 1, 1995, in conformity with generally accepted accounting principles.\n\/s\/ KPMG PEAT MARWICK LLP\nJune 9, 1995\nPEACHES ENTERTAINMENT CORPORATION\nBalance Sheets\nApril 1, 1995 and April 2, 1994\nAssets 1995 1994 ---- ---- Current assets: Cash and cash equivalents $ 1,537,293 3,610,205 Inventories 5,578,737 5,842,316 Prepaid expenses and other current assets 289,413 316,521 Land held for sale (note 9) 300,000 -- Refundable income taxes 257,229 36,000 ----------- ----------- Total current assets 7,962,672 9,805,042\nProperty and equipment, net (notes 2 and 3) 3,072,869 3,011,842 Deferred income taxes (note 8) -- 337,321 Other assets 189,348 236,328 ----------- -----------\n$11,224,889 13,390,533 =========== ===========\nLiabilities and Shareholders' Equity\nCurrent liabilities: Note payable (note 10) -- 75,000 Current portion of long-term obligations (note 3) 110,028 131,173 Accounts payable 4,130,530 4,614,580 Accrued liabilities (note 4) 1,663,930 1,433,918 ----------- ----------- Total current liabilities 5,904,488 6,254,671\nLong-term obligations (note 3) 929,654 705,109 Deferred rent 500,470 485,068 ----------- -----------\n7,334,612 7,444,848 ----------- -----------\nShareholders' equity (note 6): Preferred stock, $100 par value; 50,000 shares authorized; 5,000 shares issued and outstanding 500,000 500,000 Common stock, $.01 par value; 40,000,000 shares authorized; 20,107,850 shares issued; 19,781,270 shares outstanding 201,079 201,079 Additional paid-in capital 1,284,471 1,284,471 Retained earnings 1,964,622 4,020,030 ----------- ----------- 3,950,172 6,005,580\nTreasury stock, 326,580 common shares, at cost (59,895) (59,895) ----------- -----------\nTotal shareholders' equity 3,890,277 5,945,685\nCommitments and contingencies (note 5) ----------- ----------- $11,224,889 13,390,533 =========== ===========\nSee accompanying notes to financial statements.\nPEACHES ENTERTAINMENT CORPORATION\nStatements of Operations\nFor each of the years in the three-year period ended April 1, 1995\nSee accompanying notes to financial statements.\nPEACHES ENTERTAINMENT CORPORATION\nStatements of Shareholders' Equity\nFor each of the years in the three-year period ended April 1, 1995\nSee accompanying notes to financial statements.\nPEACHES ENTERTAINMENT CORPORATION\nStatements of Cash Flows\nFor each of the years in the three-year period ended April 1, 1995\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nStatements of Cash Flows, Continued\nSee accompanying notes to financial statements.\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nApril 1, 1995, April 2, 1994 and April 3, 1993\n(1) Business and Summary of Significant Accounting Policies\n(a) Business\nPeaches Entertainment Corporation (the \"Company\") is engaged in the business of retailing prerecorded music, video and accessory items, principally in the southeastern United States.\nThe Company is an 87%-owned subsidiary of URT Industries, Inc. (the \"Parent\").\n(b) Fiscal Year\nThe Company's fiscal year consists of the 52 or 53 weeks ending on the Saturday closest to the end of March. The fiscal years ended April 1, 1995, April 2, 1994 and April 3, 1993 consisted of 52 weeks, 52 weeks and 53 weeks, respectively.\n(c) Cash Equivalents\nThe Company considers highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Cash equivalents totaled approximately $89,000 and $1,819,000 at April 1, 1995 and April 2, 1994, respectively.\nThe Company has an agreement to purchase securities overnight under agreements to resell (\"repos\"). At April 1, 1995 and April 2, 1994, the outstanding repos, included above, approximated $37,000 and $990,000, respectively, which approximated market. The repos are collaterized by U.S. Government and agency securities.\n(d) Inventories\nInventories, comprised of compact discs, cassettes, videos and accessories, are stated at the lower of cost (principally average) including freight in, or market.\n(e) Property and Equipment\nProperty and equipment are stated at cost. The assets are depreciated over their estimated useful lives ranging from 5 to 31-1\/2 years using both straight-line and accelerated methods. The Company's policy is to retire assets from its accounts as they become fully depreciated.\n(f) Income Taxes\nThe Company files a consolidated income tax return with its Parent. Any applicable tax charges or credits are allocated to the Company on a separate return basis. Provision is made for deferred income taxes which result from certain items of income and expense being reported for tax purposes in periods different than those reported for financial reporting purposes. These items relate principally to the methods of accounting for store leases with future scheduled rent payment increases, inventory and the utilization of different methods of depreciation for financial statement and income tax purposes.\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nEffective April 4, 1993, the Company adopted the provisions of Financial Accounting Standards Board's SFAS No. 109, Accounting for Income Taxes and has reported the cumulative effect of that change in the method of accounting for income taxes in the statements of operations. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n(g) Income (Loss) Per Common Share\nIncome (loss) per common share was computed by dividing net income (loss) after deducting preferred dividend requirements by the weighted average number of common shares outstanding during the years. The weighted average number of common shares outstanding was 19,781,270 for the years ended April 1, 1995, April 2, 1994 and April 3, 1993.\n(h) Store Closing Costs\nStore closing costs are recorded in the period the Company decides to close the store. Such costs include the book value of abandoned leasehold improvements, provision for the present value of future lease obligations, less estimated sub-rental income as well as other costs incident to the store closing.\n(i) Reclassifications\nCertain amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.\n(2) Property and Equipment\nProperty and equipment consist of the following at April 1, 1995 and April 2, 1994:\n1995 1994 ---- ---- Land $ 395,570 395,570 Building 538,093 538,093 Leasehold improvements 3,356,279 3,063,957 Furniture and equipment 1,587,697 1,504,660 Building under capitalized lease (note 3) 206,964 206,964 ----------- ----------- 6,084,603 5,709,244 Less accumulated depreciation and amortization (3,011,734) (2,697,402) ----------- -----------\n$ 3,072,869 3,011,842 =========== ===========\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\n(3) Long-term Obligations\nLong-term obligations consists of the following at April 1, 1995 and April 2, 1994:\n1995 1994 ---- ---- Capital lease obligation, due in monthly installments of $3,382, including interest at 17.5%; final payment due March 2005 $ 191,096 197,605\nMortgage payable, due in equal installments of $2,981 per month, including interest at prime plus 0.5%; collateralized by the mortgaged property with depreciated cost of $836,297; final balloon payment of $427,500 due September 1997 514,013 549,788\nLease obligation on closed store, net of sublease rentals, including interest at 10%, payable in monthly installments until November 2004 334,573 --\nNote payable, with interest at 10%; repaid December 1994 -- 88,889 ----------- ----------- 1,039,682 836,282\nLess current portion (110,028) (131,173) ----------- ----------- $ 929,654 705,109 =========== ===========\nThe capital lease pertains to the building portion of property owned by one director and one former director. The rent expense on the land portion of this lease was $99,000 for each of the years in the three-year period ended April 1, 1995.\nThe following represents future minimum lease payments under the capital lease obligation:\nFiscal year Amount ----------- ------ 1996 $ 40,600 1997 40,600 1998 40,600 1999 40,600 2000 40,600 Thereafter 202,760 --------\nTotal minimum lease payments 405,760\nLess amount representing interest 214,664 --------\nPresent value of minimum lease payments $191,096 ========\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nMaturities of long-term obligations, excluding the capital lease obligation, to maturity, are as follows:\nFiscal year Amount ----------- ------ 1996 $102,284 1997 519,818 1998 37,639 1999 32,968 2000 35,021 Thereafter 120,856 -------- $848,586 ========\nIn addition, the Company has a standby letter of credit of $64,800 available to a landlord that was not drawn upon as of April 1, 1995. The letter of credit is fully collateralized by a certificate of deposit, which is included in other assets.\n(4) Accrued Liabilities\nAccrued liabilities consist of the following at April 1, 1995 and April 2, 1994:\n1995 1994 ---- ----\nGift certificate and credit slip liability $ 484,501 426,547 Other 1,179,429 1,007,371 ---------- --------- $1,663,930 1,433,918 ========== =========\n(5) Commitments and Contingencies\n(a) Leases\nThe Company is a lessee under various operating leases, several of which provide for percentage rent. An insignificant amount of percentage rent was incurred in each of the years in the three-year period ended April 1, 1995. Most of the leases contain renewal options.\nThe aggregate minimum rental commitments under all noncancelable operating leases are as follows:\nFiscal year Amount ----------- ------\n1996 $1,781,240 1997 1,664,207 1998 1,543,502 1999 1,340,440 2000 1,181,966 Thereafter 5,799,015 ----------- $13,310,370 ===========\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nRental expense under noncancelable operating leases, included in selling, general and administrative expenses in the accompanying statements of operations amounted to $2,367,765, $2,531,000 and $2,559,000, respectively, for each of the years in the three-year period ended April 1, 1995.\nRental expense on two stores owned by two directors and\/or their relatives was $234,000 for each of the years in the three-year period ended April 1, 1995.\n(b) Legal Matters\nThe Company has been party to a lawsuit involving the Company's closing of a store which it had leased in Charlotte, North Carolina and its refusal to pay rent with respect to such store from and after February, 1991. In February 1995, the court entered a judgment ordering the Company to pay the sum of $405,460 to plaintiff. The Company recorded a charge to operations for the year ended April 1, 1995 related to the loss on such litigation and paid such amount in March 1995.\n(c) Employment Agreement\nAs amended October 1, 1994, the Company entered into an amended and restated employment agreement (the agreement) with an officer which expires September 30, 1996 unless sooner terminated. The average annual base compensation under such agreement is approximately $242,000. The Company also agreed to engage the officer as a consultant during the period from the date immediately following the period of employment until September 3, 2005, with average annual base compensation of approximately $81,000. The employment agreement provides such officer with the use of an automobile, full medical coverage and reimbursement for life insurance policies.\n(d) Management Agreement\nFor the year ended April 3, 1993, the Company paid management fees to its Parent (\"URT\") for specified corporate services at the rate of 3.5% of net sales and certain expenditures of URT. The management fee agreement was in effect until March 28, 1993.\nOn March 29, 1993, the Company entered into a management and intercorporate agreement with URT whereby (i) the Company was required to pay URT an annual fee of 3.5 percent of its net sales, subject to a maximum amount of $1,400,000; (ii) URT was required to provide the Company with the services of the person who is the president and chairman; (iii) URT was required to pay the Company for certain accounting and administrative services performed by the Company at the rate of $39,600 per annum (subject to periodic equitable adjustment depending upon the amount of such services); and (iv) so long as URT and the Company filed consolidated income tax returns, their respective liabilities for such taxes would be equitably apportioned as provided in such agreement.\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nThe March 29, 1993 agreement was amended to provide that for the above described services, instead of the compensation described above, the Company would be required to pay URT $500,000 from October 1, 1994 through April 1, 1995 and $750,000 from April 2, 1995 until March 30, 1996.\n(6) Shareholders' Equity\nFor each of the years in the three-year period ended April 1, 1995, the Company had 2,500 shares of $100 par, 11%, Series A Cumulative Preferred Stock and 2,500 shares of $100 par, 13%, Series B Cumulative Preferred Stock authorized, issued and outstanding. The Company can issue up to 50,000 shares of preferred stock, and the directors have the authority to issue such shares in one or more additional series. Each share of Series A and Series B Cumulative Preferred Stock is entitled to one vote and has the same voting powers as the common stock, except that all matters on which the vote of shareholders is required must, in order to be approved, receive the requisite vote of either (i) both the Series A and Series B, voting as separate classes or (ii) the common stock and either the Series A or Series B, voting as separate classes. The shares of Series A stock may be convertible into shares of the Company's common stock upon the holders' compliance with certain surrender and notice provisions. The conversion price should be the higher of (a) the market value of a share of common stock or (b) the net worth per share of common stock of the Company as of the date of the most recent balance sheet filed with the Securities and Exchange Commission prior to the conversion date. In no event shall the conversion price be less than $.10 per share. The liquidating value for both the Series A and Series B shares is par value plus all accrued and unpaid dividends.\n(7) Pension Plan\nEffective September 15, 1994, the Company decided to curtail its noncontributory defined benefit plan which it had maintained with its Parent. As a result of this curtailment all future benefit accruals were eliminated and accrued benefits became fully vested.\nThe following table sets forth the plan's funded status at April 1, 1995 and April 2, 1994:\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nNet pension cost for each of the years in the three-year period ended April 1, 1995 included the following components:\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 5.75% and 8.0% and 0% and 4.5%, as of April 1, 1995 and April 2, 1994, respectively. The expected long-term rate of return on assets was 7.0%.\n(8) Income Taxes\nThe provision (benefit) for income taxes consists of:\n1995 1994 1993 ---- ---- ---- Current: Federal $(240,333) (36,000) 203,000 State -- -- 19,000 --------- --------- --------- (240,333) (36,000) 222,000 Deferred: Federal 291,834 (58,000) (40,000) State 45,487 -- 8,000 --------- --------- --------- 337,321 (58,000) (32,000) --------- --------- --------- $ 96,988 (94,000) 190,000 ========= ========= =========\nReasons for differences between income tax expense (benefit) and the amount computed by applying the statutory federal income tax rate of 34% to pretax income (loss) were:\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\nDeferred income tax benefit resulting from timing differences in the recognition of revenue and expense for tax and financial purposes for the year ended April 3, 1993 were as follows:\n---- Book over (under) tax depreciation on property and equipment $ (1,000) Capitalization of inventory costs (2,000) Excess of book over tax rent expense 53,000 State tax benefit (14,000) Other (4,000) -------- $ 32,000 ========\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets at April 1, 1995 and April 2, 1994 are presented below.\nAt April 1, 1995, the Company has a net operating loss carryfoward for federal income tax purposes of $126,026 which is available to offset future federal taxable income, if any, through 2010.\nA valuation allowance is provided to reduce deferred tax assets to a level which, more likely than not, will be realized. The net deferred assets reflect management's estimate of the amount which will be realized from future profitability which can be predicted with reasonable certainty.\n(9) Sale of Land\nOn May 17, 1995, the Company sold an unimproved parcel of land in Lafayette, Louisiana. As of April 1, 1995, the net book value of the land approximated the sales price.\n(Continued)\nPEACHES ENTERTAINMENT CORPORATION\nNotes to Financial Statements\n(10) Store Closings\nDuring 1993, the Company closed the Cutler Ridge, Florida store which was destroyed by Hurricane Andrew and entered into an agreement with the landlord to terminate the lease. The costs associated with the closing are included in store closing costs for the year ended April 3, 1993.\nDuring 1994, the Company closed the Aventura, Florida store and entered into an agreement to terminate the lease. The costs associated with the closing are included in store closing costs for the year ended April 2, 1994. As part of the agreement to terminate the lease, the Company executed a note to the former landlord in the amount of $75,000 payable in twelve monthly installments through March 1995.\nThe Company recorded a charge relating to four store closings of approximately $595,500 for the year ended April 1, 1995. The charge includes the write-off of leasehold improvements, loss incurred due to the present value of future lease obligations, less estimated sub-rental income and other costs incident to the store closings, offset by approximately $47,000 of deferred rent.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 PEC are:\nName Position Age ---- -------- ---\n*Allan Wolk Chairman of the Board, President, Chief Executive Officer and Director 57\n*David Jackowitz Executive Vice-President, Treasurer and Director 54\n*Ann Krouse Director 48\n*Brian Wolk Vice-President and Director 29\n*Jason Wolk Vice-President and Director 27\nAllan Wolk has been the Chief Executive Officer and a director of PEC since its formation in 1982. He has also been the Chief Executive Officer of URT since its formation. He has been engaged in the prerecorded music business for more than 35 years, principally in the rack merchandising and retail segments thereof.\nDavid Jackowitz has been the Executive Vice-President and a director of PEC since its formation. He was employed by URT from 1970 to 1991, when he became an employee of PEC. He has been the President of URT since 1978. Prior to his employment by URT, he was principally engaged as a certified public accountant.\n- ----------\n* Each of the indicated individuals is also a director of URT and, except for Ann Krouse, an executive officer of URT.\nBrian Wolk, an attorney, has been employed by the URT Companies in various capacities and at various times since 1982 and has been employed by them, full time, since 1992. He has been a director of URT and PEC since 1994 and a vice-president of both companies since June of 1995.\nJason Wolk, a certified public accountant, has been employed by the URT Companies in various capacities and at various times since 1983 and has been employed by them, full time, since 1994. Prior to his full time employment by the URT Companies, he had been employed as an accountant by KPMG Peat Marwick. He has been a director of URT and PEC since 1994 and a vice-president and the secretary of both companies since June of 1995.\nAnn Krouse has been a director of PEC since February, 1983. She has been Executive Vice-President of Educational Communications, Inc., an unaffiliated company, which is a biographical publisher in Illinois, for more than five years.\nAnn Krouse is Allan Wolk's sister. Brian Wolk and Jason Wolk are his sons.\nThe term of office of each director continues until the next meeting of the stockholders and until his or her successor is elected. Mr. Wolk and Mr. Jackowitz have employment agreements with URT and PEC, respectively (See \"Executive Compensation--Employment Contracts\"). Under the management agreement referred to above, PEC has the right to use the services of Mr. Wolk. (See \"Business--Management Agreement Between URT and PEC\").\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following table sets forth compensation paid or accrued by PEC for services rendered in all capacities to it during the 1995 fiscal year and the two prior fiscal years to (i) PEC's chief executive officer (\"CEO\") and (ii) each of the other most highly compensated executive officers of PEC whose cash compensation exceeded $100,000.\nSummary Compensation Table\n- ---------- (1) Mr. Wolk is employed and compensated under an employment agreement with URT which continues in effect until March 31, 2000. PEC receives the services of Mr. Wolk under the Management Agreement. (See \"Business--Management Agreement Between URT and PEC\").\n(2) Includes life insurance premiums ($23,494 in fiscal 1994) and amounts credited to Mr. Jackowitz under his employment agreement against monthly payments owed by him to URT under a promissory note and a stock purchase agreement, all as described below.\n(3) Pursuant to applicable rules, information is not included with respect to annual compensation which does not exceed the lesser of $50,000 or 10% of the salary and bonus reported for the named executive officer.\nEmployment Contracts\nWhen the 1995 fiscal year began, Mr. Jackowitz was employed by PEC under an employment agreement dated as of March 31, 1992. Effective October 1, 1994, PEC and Mr. Jackowitz entered into a new employment agreement which is presently in\neffect. Under his 1994 Agreement, Mr. Jackowitz' employment period will expire on September 30, 1996 instead of September 30, 2000, the expiration date of his 1992 Agreement (although PEC has the right under the 1994 Agreement to terminate his employment at any time after September 30, 1995). Thereafter, he is required to act as a consultant to the URT Companies until September 3, 2005 concerning company matters but is not required to spend more than ten hours per month in doing so. Mr. Jackowitz' 1994 Agreement reduced the annual rate of his base salary to $258,833 for the period from October 1, 1994 through March 31, 1995, and to $225,000 for the period from April 1, 1995 to September 30, 1996 (while his employment continues) as compared to a base salary at the annual rate of $309,490 together with cost of living increases based on increases in the consumer price index and proportional adjustments in compensation based on increases in U. S. individual income tax rates, which were provided for in the 1992 Agreement. The 1994 Agreement also provided that Mr. Jackowitz is entitled to a credit as additional compensation in the amount of $471 per month (as opposed to $846 per month under the 1992 Agreement) except (as had also been provided under the 1992 Agreement) that if he died or became disabled during the term of his employment agreement, all such credits (in such reduced amount) which he would have received if he had survived and not become disabled would be accellerated to the date of death or disability. Such credits are required to be paid both during his employment and consulting periods until the promissory notes against which they are to be applied have been paid in full. Such credits represent monthly amounts which are payable by him under certain promissory notes. The credits under the 1992 Agreement had also been applied against his obligations under a stock purchase agreement described below.\nMr. Jackowitz' 1994 Agreement retained provisions which were in his 1992 Agreement requiring PEC, during his period of employment, to furnish him with an automobile, reimburse him for business expenses including socially related business expenses incurred by him, and provide him with hospital and medical benefits while he is employed by PEC.\nMr. Jackowitz' 1994 Agreement also provides that during the first twelve months of the consulting period, Mr. Jackowitz will be compensated at the rate of $213,000 per annum and during each year of the balance of the consulting period at the rate of $65,000 per annum, provided, however, that if the consulting period should commence before October 1, 1996, other than as a result of death, voluntary resignation or conviction of a crime involving any act of dishonesty which was intended to harm the URT Companies, his compensation during the consulting period\nwould be at the rate of $225,000 per annum during the first year, $125,000 during the second year, and $65,000 per annum during the balance of the consulting period. If Mr. Jackowitz is unable to perform his consulting services as a result of sickness, accident or other cause outside of his control, PEC is still obligated under his 1994 Agreement to continue to pay him the compensation required to be paid during the consulting period.\nThe 1994 Agreement further provides that during the consulting period, PEC will use its best efforts to cause Mr. Jackowitz and his wife to be included in PEC's health insurance plan, as in effect at the time of the end of his employment period and, in such event, PEC will be required to pay for the cost thereof but not to exceed $485 per month; but that if they are unable to be included, PEC will be responsible for the cost incurred by Mr. Jackowitz for such purpose up to $485 per month; and that PEC will also pay him $500 per month to pay for the costs of any automobile which is used by him during the consulting period.\nIn his 1992 Agreement, PEC was required to pay or reimburse Mr. Jackowitz for the premiums on term or other life insurance coverage to be selected by PEC and payable to his designee in the amount of $1,000,000 if he died before age 70 and $750,000 if he died after age 70. The 1994 Agreement provides that from and after January 1, 1995, PEC is no longer required to do so but that on the first days of January during 1995 through 2000, it will pay to him as additional compensation, the amount of $10,000 per annum to enable him to obtain a policy of life insurance on his life from any insurance company which he selects.\nThe 1994 Agreement also provides that during the consulting period or any period during which he is disabled, as above described, Mr. Jackowitz will not own or operate or work for any company which owns or operates any retail stores which sell pre-recorded audio products or divulge any information relating to PEC's finances, leases, properties, personnel or manner in which it conducts business.\nCompensation Committee Interlocks and Insider Participation\nPEC does not have a compensation committee or other board committee performing equivalent functions. During the last completed fiscal year, all deliberations concerning executive officer compensation or any other arrangements between\nPEC and any executive officers were conducted by PEC's full board of directors, provided, however, that no director voted on compensation payable to him as an executive officer or any other arrangement between him and PEC, except for certain changes in the manner of funding life insurance coverage for Mr. Jackowitz which is required to be provided under his employment agreement, as above described.\nPension Plan\nThe URT Companies had adopted a defined benefit pension plan and trust (the \"Pension Plan\") effective April 1, 1985. Such Plan was amended during the 1995 fiscal year to provide that no present or future employee of the URT Companies who was not a participant in the Pension Plan on September 9, 1994 was eligible to become a participant in the Pension Plan, and that effective as of September 14, 1994, no further accrual of benefits would be made under the Plan except to the extent, if any, that such accruals were required by law. In March of 1995, the URT Companies decided to terminate the Pension Plan effective May 12, 1995 and will file documents with the Internal Revenue Service for such purpose. Upon receiving an appropriate determination letter from the Internal Revenue Service or the expiration of the period in which the Pension Benefit Guaranty Corporation can issue a notice of non-compliance, whichever is sooner, the assets of the Pension Plan will be distributed to Pension Plan participants. Interests in the Pension Plan have been computed on the basis of compensation and service.\nAs a result of the termination of the Pension Plan, the following officer will be entitled, at age 65, to receive a single life annuity, payable monthly, in the following annual amount:\nName of Individual Annual Amount ------------------ -------------\nDavid Jackowitz $48,921.60\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of May 30, 1995, URT owned 17,213,370 shares of PEC Common Stock, constituting approximately 87% of the issued and outstanding shares of such Common Stock, and all of PEC's issued and outstanding shares of Series A Preferred Stock and Series B Preferred Stock. All of such shares of PEC stock are owned directly with voting and investment power.\nAs set forth in the following table, Allan Wolk and members of his immediate family own approximately 29% of URT's Class A common stock and approximately 58% of URT's Class B common stock. The two classes of URT's common stock are identical except that each class votes separately so that all matters requiring the vote of stockholders require the approval of both classes of common stock voting as separate classes. By reason of such ownership and his position as Chairman of URT and Chairman and President of PEC, Mr. Wolk may be deemed to have effective control of PEC.\nThe following table contains information concerning the number of shares of each class of URT's common stock which was owned by each person who, on May 30, 1995, owned, beneficially, more than 5% thereof, and the number of shares of each class of such stock owned beneficially, directly or indirectly, by each executive officer and director and by all directors and executive officers as a group on such date:\nAmount & Nature of Beneficial Percent Title of Class Name Ownership of Class - -------------- ---- --------------- --------\nClass A Common Executive Officers Stock, par value and Directors $.01 per share ------------------ Allan Wolk 3,194,186(1)(5) 28.5%\nDavid Jackowitz 245,850 2.2%\nLawrence Strauss and Allan Wolk, as Trustees 33,072(2)(5) *\nAnn Krouse 12,096(4) *\nBrian Wolk 12,980(6) *\nJason Wolk 17,480(6) *\nAll officers and directors as a group (5 persons) 3,515,664 31.4%\nAmount & Nature of Beneficial Percent Title of Class Name Ownership of Class - -------------- ---- --------------- --------\nOther ----- Scorpio Music, Inc. P. O. Box A Trenton, N.J. 08691 1,195,800(7) 10.7%\nClass B Common Executive Officers and Directors Stock, par value -------------------------------- $.01 per share Allan Wolk 786,654(3)(5) 57.6%\nDavid Jackowitz 7,922 *\nAnn Krouse 3,024(4) *\nAll officers and directors as a group (3 persons) 797,600 58.4%\n- ---------- (1) Includes 3,150,786 shares owned by Allan Wolk, 25,920 shares owned by his wife and 17,480 shares held by him for his daughter. (2) Such shares are held by Lawrence Strauss and Allan Wolk as trustees for the benefit of children of Sheffield Wolk, Mr. Wolk's brother. (3) Includes 780,174 shares owned by Allan Wolk and 6,480 shares owned by his wife. (4) Includes 3,456 shares of Class A Stock and 864 shares of Class B Stock owned by Paul Krouse, husband of Ann Krouse. (5) Allan Wolk has renounced all voting and investment power with respect to those shares of URT which are held by him for his children and those which are held by a trust for the benefit of children of Allan Wolk's brother. All such powers as trustee are exercised exclusively by the co-trustee. Each director believes that his or her spouse will vote the shares owned by him or her in favor of proposals which he or she favors. However, each of such directors disclaims beneficial ownership of any shares owned by his or her spouse or held for the benefit of his children or others. (6) Such shares are held in the name of Allan Wolk, as custodian, but are not included under the shares listed as beneficially owned by Allan Wolk.\n(7) Based on information supplied by URT's transfer agent. Does not include 160,000 shares reported in a Schedule 13D, dated June 14, 1989, as owned by John T. Gervasoni, Scorpio's president and 100% shareholder, as to which no confirmation of ownership has been made by URT's transfer agent. (*) Less than one percent.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs a result of their purchase in 1983 from an unaffiliated third party seller, Allan Wolk and his brother, Sheffield Wolk, a former director of URT, are the owners of the land and building on which the PEC store in Fort Lauderdale, Florida, is located. Such property was and continues to be subject to a lease with PEC as tenant, which had been negotiated by the prior owner. During the 1995 fiscal year, PEC made and paid for certain renovations to the premises. Based on the provisions of the lease, the owners agreed to be responsible for $26,225 of such cost which, with interest, is being deducted by PEC over a period of 36 months.\nIn September, 1984, PEC entered into a long term lease with the mother of Allan Wolk, Sheffield Wolk and Ann Krouse, of premises owned by her in North Miami Beach, Florida (the \"North Miami Beach lease\"). It was approved by disinterested directors. As a result of her death, the premises are now owned by Allan Wolk (one-third interest), Ann Krouse (one-third interest), and two children of Sheffield Wolk, each of whom has a one-sixth interest. The lease term commenced on September 1, 1984 and is for a period of twenty years with two additional five year terms. The lease is a triple net lease. The rental consists of a net minimum rent plus 5% of net sales in excess of $1,400,000 up to $1,800,000 and 2-1\/2% of net sales in excess of $1,800,000. The net minimum rent during the first five years of the term was $95,000 per annum. There are annual increases in such minimum rent, before the adjustments described below, of $10,000 during each of the next three five year periods and annual increases of $7,500 during each of the last two five year periods.\nIn October, 1990, the North Miami Beach lease was amended for the purpose of including within the demised premises an adjoining parking area which is also owned by the owners of the store site. Such adjoining parking area was required by PEC for the purpose of complying with applicable zoning requirements. As a result of the inclusion of such adjoining\nparking area in the demised premises covered by the existing lease, PEC agreed to pay additional annual net minimum rent ranging from $9,000 in the first four years (commencing as of September 1, 1990) to $14,000 in the final five years covered by the amendment to such lease. The amendment was also approved by disinterested directors.\nIn December, 1984, PEC entered into a long-term lease with Allan Wolk and Sheffield Wolk for premises owned by them in Orlando, Florida. The lease term commenced in December, 1984, and is for a period of twenty years with two additional five year terms. The lease is a triple net lease. The lease provides for a net minimum rental rate of $125,000 per annum from the rental commencement date through March 31, 1985; a rate of $140,000 per annum during the following five year period; a rate of $145,000 per annum during the next five year period; a rate of $160,000 during the next five year period; and increases of $5,000 during every five year period thereafter. Notwithstanding the foregoing, commencing with the sixth rental year, if net sales at the store during any rental year are less than $1,800,000, the annual net minimum rental rate for such year will be the same as that which had been in effect during the preceding five year period. The lease was approved by disinterested directors.\nManagement believes that the terms of such North Miami Beach and Orlando leases are as reasonable as those which could have been obtained from unaffiliated third parties.\nIn April, 1989, PEC's board of directors authorized PEC to enter into agreements with its officers and directors under which directors and officers would be entitled to be indemnified by PEC and have their expenses advanced to them in the event of any claim against them in their capacities as officers and directors. On or about May 22, 1989, such agreements were entered into with all who were then officers and directors of PEC.\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.\nPage ---- 1. Consolidated Financial Statements 14\nIndependent Auditors' Report\nPeaches Entertainment Corporation Financial Statements:\nBalance sheets as of April 1, 1995 and April 2, 1994. 15\nStatements of operations for each of the years in the three year period ended April 1, 1995. 16\nStatements of shareholders' equity for each of the years in the three year period ended April 1, 1995. 17\nStatements of cash flows for each of the years in the three year period ended April 1, 1995. 18\nNotes to financial statements. 20\n2. Financial Statement Schedules\nSchedules have been omitted which are not applicable or where the required information is shown in the financial statements or the notes thereto.\n3. Exhibits.\nExhibit No. - -----------\n3.1 Articles of Incorporation of Peaches Entertainment Corporation (\"PEC\") dated March 3, 1982, incorporated by reference to Exhibit No. 3.3 to URT Industries', Inc. (\"URT\") and PEC's Registration Statement No. 2-81065.\n3.1-1 Amendment to PEC's Articles of Incorporation dated January 17, 1983, incorporated by reference to Exhibit No. 3.3-1 to URT's and PEC's Registration Statement No. 2-81065.\n3.2 By-Laws of PEC incorporated by reference to Exhibit No. 3.4 to URT's and PEC's Registration Statement No. 2-81065.\n3.3 Form of Amendment to PEC's Articles of Incorporation, incorporated by reference to Exhibit No. 3.5 to PEC's Registration Statement No. 2-81065.\n10.35 Lease dated July 1, 1984 between Shirley Wolk and PEC applicable to North Miami Beach, Florida premises, incorporated by reference to Exhibit No. 13.46 to URT's Registration Statement No. 2-63747.\n10.36 Lease dated December 13, 1984 between Allan Wolk and Sheffield Wolk and PEC applicable to Orlando, Florida premises, incorporated by reference to Exhibit No. 13.47 to URT's Registration Statement No. 2-63747.\n10.40 Amendment to Lease dated February 25, 1986 between Allan Wolk and Sheffield Wolk and PEC applicable to Orlando, Florida premises, incorporated by reference to Exhibit No. 10(ss) to URT's Form 10-K Annual Report for the year ended March 29, 1986.\n10.47 Indemnification Agreement dated May 22, 1989 between Allan Wolk and PEC, incorporated by reference to Exhibit 10.47 to PEC's Form 10-K Annual Report dated June 27, 1989.\n10.48 Indemnification Agreement dated May 22, 1989 between David Jackowitz and PEC, incorporated by reference to Exhibit 10.48 to PEC's Form 10-K Annual Report dated June 27, 1989.\n10.50 Indemnification Agreement dated May 22, 1989 between Ann Krouse and PEC, incorporated by reference to Exhibit 10.50 to PEC's Form 10-K Annual Report dated June 27, 1989.\n10.54 Lease dated December 22, 1989 between Sunbeam Properties, Inc. and PEC applicable to Miramar, Florida premises, incorporated by reference to Exhibit 10.54 to PEC's Form 10-K Annual Report dated June 27, 1991.\n10.57 Management and Intercorporate Agreement dated as of March 29, 1993 between URT and PEC, incorporated by reference to Exhibit 10(dddd) to URT's Form 10-K Annual Report dated June 25, 1993.\n10.58 Amended and Restated Employment Agreement, dated December 14, 1994, between David Jackowitz and PEC, incorporated by reference to Exhibit 10(ffff) to URT's Form 10-K Annual Report dated June 29, 1995.\n10.59 Agreement dated as of October 1, 1994 to Mangement and Intercorporate Agreement dated May 29, 1993 between URT and PEC, incorporated by reference to Exhibit 10(iiii) to URT's Form 10-K Annual Report dated June 29, 1995.\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.\nPEACHES ENTERTAINMENT CORPORATION\nBy: s\/Allan Wolk --------------------------- Allan Wolk, Chairman of the Board and President Dated: June 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.\nTitle Date ----- ----\nBy: s\/Allan Wolk June 29, 1995 ----------------------------- Allan Wolk, Chairman of the Board and President (Principal Executive Officer) and Director\nBy: s\/David Jackowitz June 29, 1995 ----------------------------- David Jackowitz, Treasurer (Principal Financial and Accounting Officer) and Director\nBy: s\/Brian Wolk June 29, 1995 ----------------------------- Brian Wolk, Director\nBy: s\/Jason Wolk June 29, 1995 ----------------------------- Jason Wolk, Director","section_15":""}
{"filename":"105016_1995.txt","cik":"105016","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nWatsco, Inc. (the \"Registrant\" or the \"Company\") is the largest distributor of residential central air conditioners and supplies in the United States, with leading positions in Florida, Texas and California, the three largest air conditioning markets in the country, as well as significant positions in Alabama, Arkansas, Arizona, Louisiana, Nevada, North Carolina, Latin America and South America. In 1989, the Company embarked on a strategy of establishing a network of distribution facilities across the sunbelt where U.S. population growth is greatest, weather patterns are predictably hot and air conditioning is seen as a necessity. Since initiating this strategy, the Company's revenues have increased from $25 million in 1988 to $331 million in 1995.\nThe Company estimates that the market for residential central air conditioners and related supplies in the sunbelt was over $7 billion in 1994 and has grown at an annual rate of 5.6% since 1990. The replacement market has increased substantially in size over the past ten years, surpassing the homebuilding market in significance as a result of the aging of the installed base of residential central air conditioners, the introduction of new energy efficient models and the upgrading of existing homes to central air conditioning. According to the Air Conditioning and Refrigeration Institute (ARI), over 61 million central air conditioner units have been installed in the United States since 1975. Many of the units installed from the mid-1970s to the mid-1980s are reaching the end of their useful lives, thus providing a growing replacement market.\nThe Company focuses on satisfying the needs of the higher margin replacement market, where customers demand immediate, convenient and reliable service. The Company believes that its size and financial resources allow it to provide superior customer service by offering a complete product line of equipment, parts and supplies, multiple warehouse locations and well-stocked inventories. The Company conducts its distribution business through its subsidiaries: Gemaire Distributors, Inc. (\"Gemaire\"); Heating & Cooling Supply, Inc. (\"Heating & Cooling\"); Comfort Supply, Inc. (\"Comfort Supply\"); and Central Air Conditioning Distributors, Inc. (\"Central Air Conditioning\") (collectively, the \"Distribution Operations\"). The primary supplier to the Distribution Operations is Rheem Manufacturing Company (\"Rheem\"), one of the largest manufacturers of residential central air conditioners in the United States, based on the number of units sold.\nThe Company also sells to the homebuilding market. The Company believes that its reputation for reliable, high quality service and its relationships with contractors, who generally serve both the replacement and new construction markets, allow it to compete effectively in this segment of the market. Homebuilding remains below the levels of the mid-1970s to mid-1980s in many of the markets the Company serves.\nThe Company has acquired eight air conditioning distributors since 1989 when the Company began its acquisition strategy to establish a network of distribution branches across the sunbelt. The following is a description of the Company's acquisitions completed in 1995:\nAirite, Inc. - In February 1995, the Company acquired Airite, Inc., a wholesale distributor of residential central air conditioners with branches in Shreveport and Monroe, Louisiana and Texarkana, Texas. Airite sells to nearly 400 licensed air conditioning and heating contractors and the Company believes that Airite had 1995 revenues of approximately $4 million.\nH.B. Adams, Inc. - In March 1995, the Company acquired certain assets of H.B. Adams, Inc. (now operating as H.B. Adams Distributors, Inc.). H.B. Adams is a wholesale distributor of air conditioning, heating and refrigeration products and operates seven branches in the Tampa, Florida market area, the second largest market for air conditioning equipment in Florida. H.B. Adams had 1995 revenues of approximately $20 million.\nEnvironmental Equipment & Supplies, Inc. - In May 1995, the Company acquired certain assets of Environmental Equipment & Supplies, Inc., a wholesale distributor of air conditioning and heating equipment which sells to nearly 300 licensed air conditioning and heating contractors. Environmental Equipment operates from branches in Fort Smith and Jonesboro, Arkansas and had 1995 revenues of approximately $6 million.\nCentral Air Conditioning Distributors, Inc. - In October 1995, the Company acquired certain assets of Central Air Conditioning Distributors, Inc., a wholesale distributor of residential central air conditioners and related products. Central Air Conditioning sells to approximately 1,200 licensed air conditioning and heating contractors from five branches in North Carolina and had 1995 revenues of approximately $21 million.\nIn addition to distributing air conditioning and heating equipment, the Company also produces over 4,000 electronic and mechanical components for air conditioning, heating and refrigeration equipment through its manufacturing subsidiaries: Watsco Components, Inc., Rho Sigma, Inc. and Cam-Stat, Inc. (the \"Manufacturing Operations\"). These components are sold to over 5,000 wholesale distributors and original equipment manufacturers (\"OEMs\").\nThe Company also owns Dunhill Personnel System, Inc. (\"Dunhill\"), a national provider of permanent and temporary personnel services to business, professional and service organizations, government agencies, health care providers and other employers.\nThe Company's principal executive offices are located at 2665 South Bayshore Drive, Suite 901, Coconut Grove, Florida 33133, and its telephone is (305) 858-0828.\nRECENT DEVELOPMENTS\nOn March 6, 1996, the Company completed a public offering in which it sold 1,570,000 shares of Common Stock resulting in net proceeds of approximately $32.6 million. The Company intends to use approximately $14 million of the proceeds to fund the pending acquisition of Three States Supply Company, Inc. discussed below.\nEffective March 19, 1996, the Company and Rheem completed a transaction pursuant to a Stock Exchange Agreement and Plan of Reorganization (the \"Exchange Agreement\") whereby the Company acquired Rheem's minority interests in three of the Company's distribution subsidiaries. See \"Relationship with Rheem Manufacturing Company\" for further discussion.\nThe Company has signed a letter of intent for the purchase of the net assets and business of Three States Supply Company, Inc., a Memphis, Tennessee-based distributor of building materials used primarily in the heating and air conditioning industry. The completion of the transaction is subject to certain conditions and is expected to occur during April 1996. The purchase price, estimated at $14 million, is subject to adjustment upon the completion of an audit of the net assets and will be funded from a portion of the proceeds from the sale of Watsco's Common Stock completed on March 6, 1996.\nAlso see \"Liquidity and Capital Resources\" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report to Shareholders for the year ended December 31, 1995 (the \"1995 Annual Report\").\nINDUSTRY SEGMENT INFORMATION\nThe Climate Control segment consists of the Distribution Operations and the Manufacturing Operations. The Distribution Operations distribute residential central air conditioners and related parts and supplies in Florida, California, Texas, Alabama, Arkansas, Arizona, Louisiana, Nevada, North Carolina and Latin America and South America. The Manufacturing Operations make components and equipment which are sold and distributed to the air conditioning, refrigeration and heating industry (see \"Climate Control Segment\").\nIn the Personnel Services segment, Dunhill and its subsidiaries provide temporary help and permanent placement services (see \"Personnel Services Segment\"). The Company also has certain employees and resources which provide services to each of these segments. Note 12 of Notes to Consolidated Financial Statements, included in the Company's 1995 Annual Report, incorporated herein by reference under Item 8, contains a table setting forth the revenues and operating income of the Company's two industry segments during the three years ended December 31, 1995, 1994 and 1993.\nDESCRIPTION OF BUSINESS\nDISTRIBUTION OPERATIONS\nPRODUCTS The Company markets a complete line of residential central air conditioners (primarily under the Rheem brand name) and related parts and supplies and maintains sufficient inventory to meet customers' immediate needs. The Company's strategy is to provide every product a contractor generally would require in order to install or repair a residential or light commercial central air conditioner. Such products include residential central air conditioners ranging from 1-1\/2 to 5 tons*, light commercial air conditioners ranging up to 20 tons, insulation, grills, sheet metal and other ductwork, copper tubing, concrete pads and tape. In addition, the Company also sells products such as electric and gas heating units, air-to-air heat pumps and rooftop equipment. Sales of air conditioning and heating equipment accounted for approximately 63% of the distribution operations' revenues for 1995. Sales of parts and supplies (currently numbering approximately 28,000 different inventory items) comprised the remaining portions of revenues. In 1995, purchases of Rheem products represented approximately 58% of the aggregate purchases of the distribution operations. Any significant interruption in the delivery of Rheem's products would inhibit the Company's ability to continue to maintain its current inventory levels and could adversely affect the Company's business. The Company's future results of operations are also materially dependent upon the continued market acceptance of Rheem's products and the ability of Rheem to continue to manufacture products that comply with laws relating to environmental and efficiency standards.\n* The cooling capacity of air conditioning units is measured in tons. One ton of cooling capacity is equivalent to 12,000 BTUs and is generally adequate to air condition approximately 500 square feet of residential space.\nDISTRIBUTION AND SALES The Company operates from 70 branch warehouses located in regions of the sunbelt which the Company believes have favorable demographic trends. The Company maintains well-stocked inventories at each warehouse location to meet the immediate need of its customers. This is accomplished by transporting inventory between warehouses daily and either directly delivering products to customers with the Company's fleet of 137 trucks or making the products available for pick-up at the branch nearest to the customer. The company has 111 commissioned salespeople who average 16 years of experience in the residential central air conditioning distribution industry.\nMARKETS The Company has been granted exclusive rights under distribution agreements for Rheem brand-name products in each of the most significant market areas and many of the major metropolitan areas in the United States sunbelt including: Florida; the eastern half of Texas (including the Dallas, Houston, San Antonio and Austin metropolitan areas), southern and central California; Arizona; Nevada; western North Carolina (including the Charlotte metropolitan area) and additional territories in Louisiana; Alabama and Arkansas. The Company also has distribution rights for the Rheem brand name or Weatherking brand name (manufactured by Rheem) in substantially all of Central America, South America and the Caribbean.\nCUSTOMERS AND CUSTOMER SERVICE The Company sells to contractors and dealers who service the new construction and replacement markets for residential and light commercial central air conditioners. In 1995, the Company served over 13,600 customers, with no single customer accounting for more than 2% of consolidated revenues. The Company focuses on providing products where and when the customer needs them, technical support by phone or on site as required, and quick and efficient service at the distribution branches. Management believes that the Company successfully competes with other distributors in the residential and light commercial central air conditioning market primarily on the basis of its experienced sales organization, strong service support, high quality reputation and broad product lines.\nRELATIONSHIP WITH RHEEM MANUFACTURING COMPANY The Company is Rheem's largest distributor and believes that it maintains a unique and mutually beneficial relationship with Rheem, one of the largest manufacturers of residential central air conditioning equipment in the United States. Rheem has a well-established reputation of producing high-quality, competitively priced products. The Company believes that Rheem's current product offerings, quality, serviceability and brand-name recognition allow the Company to operate favorably against its competitors. To maintain brand-name recognition, Rheem provides national advertising and participates with the Company in cooperative advertising programs and promotional incentives that are targeted to both contractors and homeowners. The Company estimates the replacement market currently accounts for approximately 65% of industry sales in the United States and expects this percentage to increase as units installed in the 1970s and 1980s wear out and get replaced or updated to more energy-efficient models. The Company believes Rheem's products have wide acceptance in the replacement market based on their high efficiency and low noise level -- two key homeowner considerations. Additionally, Rheem has demonstrated the flexibility to manufacture products to international specifications to meet export demands.\nRheem acquired minority ownership interests in Gemaire (20%), Comfort Supply (20%) and Heating & Cooling (50%) as a joint venture partner with the Company in the acquisition of each of these subsidiaries. In March 1996, the Company and Rheem restructured their relationship upon completing a transaction pursuant to a Stock Exchange Agreement and Plan of Reorganization (the \"Exchange Agreement\") whereby the Company acquired Rheem's minority ownership interests of these three subsidiaries in exchange for 964,361 shares of the Company's unregistered Common Stock. Following completion of this transaction, Gemaire, Comfort Supply and Heating & Cooling became wholly owned subsidiaries of the Company. Also, Rheem's Chief Executive Officer will become a member of the Company's Board of Directors.\nThe Exchange Agreement modified certain other agreements with respect to each of the distribution subsidiaries on terms that are favorable to the Company. Previous agreements between the Company and Rheem provided Rheem with the right to \"call\" from the Company and the Company with the right to \"put\" to Rheem the Company's ownership interests in Gemaire, Comfort Supply and Heating & Cooling during specified periods according to prescribed valuation formulas. Under the terms of the Exchange Agreement, the put\/call provisions are effectively eliminated because the rights to \"put\" or \"call\" become exercisable primarily upon the occurrence of certain insolvency events.\nThe Company also has distribution agreements with Rheem. The distribution agreements of Gemaire, Comfort Supply and Heating & Cooling extend through 2006 with annual renewals thereafter. These distribution agreements contain provisions limiting the sale of products that are directly competitive with Rheem products. Based on the acceptance of other complimentary, non-competitive equipment products and the Company's additional focus on the sale of parts and supplies, the Company does not believe that such limitations have a material effect on its operations. Except for the limitations set forth in the distribution agreements of Gemaire, Comfort Supply and Heating & Cooling, the Company may distribute other manufacturers' lines of air conditioning equipment.\nMANUFACTURING OPERATIONS\nThe Company's manufacturing operations are highly self-sufficient and include facilities for die-casting, stamping, screw machining, secondary metal working operations and a fully equipped tool room. The Company has not encountered significant problems in obtaining manufacturing materials, consisting primarily of metals and other raw materials, which are readily available from many suppliers.\nPRODUCTS The Company produces over 4,000 electronic and mechanical components for air conditioning, heating and refrigeration equipment. Products include: components, such as line tap and specialty valves, motor compressor protectors, liquid sight glasses and warm air controls; and equipment, such as vacuum pumps and refrigerant recovery systems. Many of the Company's products are patented and compete in the market place based on uniqueness as well as quality and price.\nCUSTOMERS The Company's OEM customers include most of the major residential air conditioning manufacturers such as Rheem, Carrier Air Conditioning, Inc., Inter-City Products Corporation and York International (through its Evcon subsidiary). Another significant OEM customer, RV Products, Inc., is the nation's largest manufacturer of air conditioning for recreational vehicles. The Company also sells to wholesale distributors who distribute the Company's products to the aftermarket. In 1995, the Company served over 5,000 domestic and international customers, with no single customer accounting for more than 1% of consolidated revenues.\nRESEARCH AND DEVELOPMENT The Company conducts research and development to improve the quality and performance of its manufactured products and to develop new products and product line improvements. The Company performs research and development both in-house and by extensive field testing of products. The Company's engineering staff, consisting of 11 employees, develops new customized products to end-user specification and continuously improves, supplements and enhances product lines with newly developed products.\nPERSONNEL SERVICES SEGMENT\nDunhill, founded in 1952, is one of the nation's best known personnel service networks. Through franchised, licensed, and company-owned offices in 38 states, Puerto Rico and Canada, Dunhill provides permanent placement and temporary help services to businesses, professional and service organizations, government agencies, health care providers, and other employers. Dunhill's operations consist of 114 franchised permanent placement offices and 19 franchised, 5 licensed and 14 company-owned temporary personnel service offices. Dunhill's franchisees operate their businesses autonomously within the framework of the Company's policies and standards, and recruit, employ, and pay their own employees, including temporary employees. Dunhill's permanent placement division recruits primarily middle-management, sales, technical, administrative and support personnel for permanent employment in a wide variety of industries and positions. The fees paid by employers to Dunhill for its permanent placement services are typically contingent upon the successful placement of an employee and are generally a percentage of the annual compensation to be paid to the new employee.\nDunhill receives an initial fee from all licensees and franchisees, and on-going revenues in the form of royalty fees and commissions from temporary help licensees and franchisees and permanent placement operations. Licenses and franchises are generally granted for 5 and 10 year terms, respectively, and are typically renewable at the option of the licensee or franchisee for additional terms of 5 and 10 years, respectively.\nOTHER INFORMATION\nCOMPETITION\nAll of the Company's businesses operate in highly competitive environments. The Company's distribution business competes with a number of distributors and also with air conditioner manufacturers who distribute a significant portion of their products through factory-owned distribution organizations. Many of the manufacturers which have distribution organizations are larger than the Company and have substantial financial resources. Competition within any given geographic market is based upon product availability, customer service, price and quality. The Company's manufacturing business has several major competitors, a few of which are larger and have substantial financial resources. Dunhill competes with numerous other large and small national, regional, and local personnel service providers. Competitive pressures or other factors could cause the Company's products or services to lose market acceptance or result in significant price erosion, all of which would have a material adverse effect on the Company's profitability.\nEMPLOYEES\nThe Climate Control segment employed 929 persons and the Personnel Services segment employed 91 persons as of March 21, 1996. The Company believes that its relations with these employees are good.\nSEASONALITY\nSales of residential central air conditioners, heating equipment and parts and supplies manufactured and distributed by the Company have historically been seasonal. Demand related to the residential replacement market generally peaks in the third quarter for air conditioners (the Company's principal distribution product) and in the fourth quarter for heating equipment. Demand related to the new construction market varies according to the season, with increased demand generally from March through October.\nOTHER\nOrder 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.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's significant facilities are currently in the following locations:\nThe Company believes that its facilities are well maintained and adequate to meet its needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is from time to time involved in routine litigation. Based on the advice of legal counsel, the Company believes that such actions presently pending will not have a material adverse impact on the Company's consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's security holders 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\nPage 28 of the 1995 Annual Report contains \"Information on Common Stock\", which identifies the market on which the Registrant's Common Stocks are being traded and contains the high and low sales prices and dividend information for the years ended December 31, 1995, 1994 and 1993 and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPage 8 of the Company's 1995 Annual Report contains \"Selected Consolidated 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\nPages 9 through 11 of the Company's 1995 Annual Report contain \"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\nPages 12 through 25 of the Company's 1995 Annual Report contain the Consolidated Financial Statements of the Company at December 31, 1995 and 1994 and for the years ended December 31, 1995, 1994 and 1993 and is incorporated herein by reference. The Company's unaudited quarterly financial data for the years ended December 31, 1995, 1994 and 1993 is included in the 1995 Annual Report on page 27. The Report of Independent Certified Public Accountants for the years ended December 31, 1995, 1994 and 1993 is included in the Company's 1995 Annual Report on page 26.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThis part of Form 10-K, which includes Items 10 through 13, is omitted because the Registrant will file definitive proxy material pursuant to Regulation 14A not more than 120 days after the close of the Registrant's year end, which proxy material will include the information required by Items 10 through 13 and is incorporated herein by reference.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFinancial Statements\n(a) (i) Data incorporated by reference from the attached 1995 Annual Report of Watsco, Inc.:\nReport of Independent Certified Public Accountants\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets as of 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(a) (iii) Exhibits:\n3.1 Company's Amended and Restated Articles of Incorporation (filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q dated June 30, 1995 and incorporated herein by reference).\n3.2 Company's Amended Bylaws (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1985 and incorporated herein by reference).\n4.1 Indenture dated as of September 12, 1986 between the Company and Southeast Bank, N.A. (filed as Exhibit 4 to the Company's Registration Statement on Form S-3 (No. 33-7758) and incorporated herein by reference).\n4.2 Specimen form of Class B Common Stock Certificate (filed as Exhibit 4.6 to the Company's Registration Statement on Form S-1 (No. 33-56646) and incorporated herein by reference).\n4.3 Specimen form of Common Stock Certificate (filed as Exhibit 4.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.1 Rheem Manufacturing Company Distributor Agreement by and between Rheem Manufacturing Company and Gemaire Distributors, Inc., dated December 30, 1988 (filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n10.2 Amendment dated January 4, 1991 to Distribution Agreement dated December 30, 1990 between Rheem Manufacturing Company and Gemaire Distributors, Inc. (filed as Exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33-56646) and incorporated herein by reference).\n10.3 Distributor Agreement between Heating & Cooling Supply, Inc. and Rheem Manufacturing, Inc. dated October 15, 1990 (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 and incorporated herein by reference).\n10.4 Rheem Manufacturing Company Distributor Agreement by and between Rheem Manufacturing Company and Comfort Supply, Inc. (filed as Exhibit 10.20 to the Company's Form 8-K dated May 26, 1993 and incorporated herein by reference).\n10.5 Preferred Stock Purchase Agreement between Heating & Cooling Supply, Inc. and Rheem Manufacturing Company dated June 10, 1993 (filed as Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q dated September 30, 1993 and incorporated herein by reference).\n10.6 Line of Credit Agreement by and between Comfort Supply, Inc. and NationsBank of Florida, N.A. dated September 23, 1993 (filed as Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q dated September 30, 1993 and incorporated herein by reference).\n10.7 Amended and Restated Revolving Credit and Term Loan Agreement by and between NationsBank of Florida, N.A. and Gemaire Distributors, Inc. dated March 10, 1995 (filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.8 Line of Credit Agreement between Heating & Cooling Supply, Inc. and Bank of America National Trust and Savings Association dated September 28, 1995 (filed as Exhibit 10.26 to the Company's Quarterly Report on Form 10-Q dated September 30, 1995 and incorporated herein by reference).\n10.9 Revolving Credit Agreement dated October 26, 1995 by and between CAC Acquisition, Inc. and NationsBank of Florida, N.A. (filed as Exhibit 10.27 to the Company's Registration Statement on Form S-3 (No. 333-00371) and incorporated herein by reference).\n10.10 Stock Exchange Agreement and Plan of Reorganization dated February 6, 1996 by and between Watsco, Inc. and Rheem Manufacturing Company (filed as Exhibit 10.29 to the Company's Registration Statement on Form S-3 (No. 333-00371) and incorporated herein by reference).\n10.16 Watsco, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q dated June 30, 1993 and incorporated herein by reference).\n10.17 Watsco, Inc. Amended and Restated Profit Sharing Retirement Plan and Trust Agreement dated October 21, 1994 (filed as Exhibit 10.25 to the Company's Annual 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.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES\nTo the Board of Directors and Shareholders of Watsco, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Watsco, Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated March 29, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The accompanying Schedules I and II are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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\nMiami, Florida, March 29, 1996.\nWATSCO, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In thousands of dollars)\n(Continued)\nWATSCO, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT For the Years Ended December 31,\n(In thousands of dollars)\n(Continued)\n(A) Income taxes are recorded at statutory rates receiving benefit for the dividends received deduction and tax free interest.\n(Continued)\nWATSCO, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT For the Years Ended December 31, (In thousands of dollars) (Continued)\nIn 1995, 1994 and 1993, $164,000, $192,000 and $2,607,000, respectively, of 10% Convertible Subordinated Debentures due 1996 were converted into Common Stock.\nIn May 1995, the Company effected a three-for-two stock split in the form of a 50% stock dividend for both classes of its common stock which had the effect of increasing the Company's common stock account by $1,024,000 and reducing paid-in capital and retained earnings by $371,000 and $653,000, respectively.\nWATSCO, INC. SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1995, 1994 and 1993 (In thousands of dollars)\nALLOWANCE FOR DOUBTFUL ACCOUNTS:\nBALANCE, December 31, 1992 $2,767 Allowances from acquisitions 583 Additions charged to costs and expenses 315 Recoveries 73 Write-offs (726) -------- BALANCE, December 31, 1993 3,012 Additions charged to costs and expenses 597 Recoveries 44 Write-offs (972) -------- BALANCE, December 31, 1994 2,681 Allowances from acquisitions 453 Additions charged to costs and expenses 1,197 Recoveries 89 Write-offs (1,319) -------- BALANCE, December 31, 1995 $3,101 ========\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWATSCO, INC.\nMarch 29, 1996 By: \/s\/ Albert H. Nahmad -------------------------------- Albert H. Nahmad, President\nMarch 29, 1996 By: \/s\/ Ronald P. Newman -------------------------------- Ronald P. Newman, 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.","section_15":""}
{"filename":"200243_1995.txt","cik":"200243","year":"1995","section_1":"Item 1. Business\nAt December 29, 1994 and, through September 1995, ARTRA Group Incorporated, a Pennsylvania corporation incorporated in 1933, and its majority-owned subsidiaries (hereinafter \"ARTRA\" or the \"Company\") principally operated in two industry segments as: 1) a manufacturer of packaging products principally serving the food industry; and 2) a designer and distributor of popular-priced fashion costume jewelry.\nDuring 1995, the Company's packaging products business was conducted by the wholly-owned Bagcraft Corporation of America (\"Bagcraft\") subsidiary and its then wholly-owned subsidiary Arcar Graphics, Inc. (\"Arcar\") acquired effective April 9, 1994. As discussed in Note 3 to the Company's consolidated financial statements, effective October 26, 1995, Bagcraft completed the sale of the business assets, subject to the buyer's assumption of certain liabilities, of Arcar.\nDuring 1995, the Company's fashion costume jewelry business was conducted by its then majority-owned subsidiary The Lori Corporation (\"Lori\") through its wholly-owned subsidiaries:\nRosecraft, Inc. (\"Rosecraft\") Lawrence Jewelry Corporation (\"Lawrence\")\nIn recent years, Lori's fashion costume jewelry operations had experienced a pattern of significantly lower sales levels and related operating losses primarily due to a shift in the buying patterns of its major customers (i.e. certain mass merchandisers) from participation in Lori's service program to purchases of costume jewelry and accessories directly from manufacturers and due to a continued unfavorable retail environment. Accordingly, in September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business as discussed in Note 3 to the Company's consolidated financial statements.\nAs discussed in Note 3 to the Company's consolidated financial statements, on October 17, 1995, Lori completed the acquisition of one hundred percent of the capital stock of COMFORCE Global, Inc. (\"Global\"), formerly Spectrum Global Services, Inc. d\/b\/a YIELD Global, a wholly owned subsidiary of Spectrum Information Technologies, Inc. for consideration of approximately $6.4 million, net of cash acquired, consisting of cash of approximately $5.6 million and 500,000 shares of Lori common stock issued as consideration for various fees and guarantees associated with the transaction. Global provides telecommunications and computer technical staffing services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. The acquisition of Global was completed on October 17, 1995. In connection with the re-focus of its business, Lori changed its name to COMFORCE Corporation (\"COMFORCE\"). Additionally, in conjunction with the Global acquisition, ARTRA has agreed to assume certain pre-existing Lori liabilities and indemnify COMFORCE in the event any future liabilities arise concerning pre-existing environmental matters and business related litigation.\nEffective July 4, 1995, Lori and ARTRA entered into employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. As additional compensation, the agreements provided for the issuance in aggregate of a 35% common stock interest in Lori. After the issuance of the Lori common shares, plus the effects of the issuance of Lori common shares sold by private placements and other Lori common shares issued in conjunction with the Global acquisition, ARTRA's common stock ownership interest in COMFORCE was reduced to approximately 25% at December 28, 1995.\nPackaging Products Segment\nEffective March 3, 1990, ARTRA entered into the packaging products business with its acquisition of Bagcraft. Bagcraft, established in 1947, is a leading manufacturer and supplier of flexible packaging products to the fast food, bakery, microwave popcorn and supermarket industries and is also a significant supplier to the theater industry. Several of Bagcraft's products are widely recognized and have become standard items within various segments of the food industry.\nBagcraft is a full-service supplier complete with its own laboratory and engineering departments. Bagcraft's sales and technical staff work in conjunction with Bagcraft's customers to determine the proper components of the package. Bagcraft's art department creates packaging designs, subject to customer approval, or duplicates customer-supplied designs. Thereafter, the packaging is produced in accordance with customer specifications using a variety of papers, film, foil and lamination. Bagcraft has developed a number of proprietary innovations in the manufacture of its packaging products. Such innovations include the Dubl-Wax(TM) bag, which introduced specialty waxed bags to the retail bakery industry. Bagcraft is also credited with being instrumental in developing and producing the first microwave popcorn bags.\nBagcraft currently produces over two billion bags and two billion sheets and wrappers annually for the packaging of more than 1,000 different products. Bagcraft purchases the paper, foil, films and chemicals it uses from a number of different unaffiliated suppliers. Since Bagcraft purchases each of the raw materials it requires from more than one supplier, it is not dependent upon a single supplier for any specific materials or supplies.\nSales orders are processed, and manufacturing and delivery schedules are determined primarily at Bagcraft's headquarters and principle production facility in Chicago. In September, 1994, Bagcraft completed the construction of a new 265,000 sq. ft. production facility in Baxter Springs, Kansas. The new Kansas facility, which has added production capacity in Bagcraft's growing food service products business, has replaced Bagcraft's production facility in Joplin, Missouri (which was conveyed to a contractor involved in constructing the Baxter Springs facility in partial consideration of such contractor's fees), its facility in Carteret, New Jersey (which was sold in 1994) and its facility in Forest Park, Georgia (which was converted into a distribution facility).\nBagcraft's products are sold throughout the United States by a sales force of approximately 20 full-time salespersons who sell to wholesale distributors and a number of independent brokers who sell Bagcraft product lines to large food processors and food chains. Bagcraft presently sells its products to more than 1,000 customers. Although some of these are the largest and most recognizable companies in the food industry, no single customer accounted for more than 10% of ARTRA's consolidated net sales in 1995.\nSales to customers are made pursuant to orders placed in advance for periods of up to one year. In certain instances Bagcraft and a customer can enter into an agreement to maintain a specified minimum inventory for the customer. The contracts entered into by Bagcraft with its customers vary in length depending on the customer's needs and Bagcraft's capacity to meet the customer's requirements. Generally, Bagcraft's contracts provide advance notice of from 30 days to one year to terminate a contract. The contracts typically provide for delivery of goods at an agreed-upon fixed price, subject to adjustment upon timely notice in advance. Bagcraft usually grants its customers rights of return, subject to penalty, except in the case of goods produced to specification. In addition, Bagcraft typically requires payment for goods 30 days after shipment, but gives its customers a 1% discount if payment is made within 10 days after shipment.\nBagcraft believes that it is the manufacturer of the most diversified line of flexible packaging products in the United States. However, there are a number of domestic and foreign companies which compete directly with Bagcraft in each of its major product lines, certain of which have a larger market share with respect to specific product lines. Bagcraft's competitors range from small companies to divisions of large corporations which have substantially greater financial resources than those available to Bagcraft. Bagcraft competes on the basis of quality, service and the price of its products.\nBagcraft believes that a modest level of continuing research and development and strict quality and process control will be necessary to maintain and improve its position in the flexible packaging industry. All product modifications and manufacturing innovations reflect input from its personnel in general management, sales, marketing design, R&D and engineering.\nBagcraft's products are sold by four marketing divisions as described below:\nPaper Division\nBagcraft believes it is the industry leader in specialty paper bags, which represented approximately 32% of Bagcraft's 1995 sales. Bakeries account for approximately 60% of the paper division's sales which also include supermarkets\nand various retail food chains. A number of the paper division's products, including Dubl-Wax(TM), Dubl-Panel(TM), Dubl-Clear(TM) and Sealing-Strip(TM) represent significant manufacturing innovations which have contributed to Bagcraft's position as the industry leader. Major customers include Walmart, Walgreen's, Albertson's, Dunkin' Donuts and Boston Market. Bagcraft believes the outlook for the future indicates stability and growth.\nBagcraft's Paper Division stocks approximately 150 generic products, which enables Bagcraft to lead the industry in providing the widest variety of immediately available unprinted and stock printed bags and sheets in the industry. Stock products are bought and inventoried by distributors who, in turn, sell them in varying quantities to end-users for a multitude of purposes. The stock line is sold mainly through Bagcraft field salespeople and telemarketing from Bagcraft's Chicago home office.\nFood Service Division\nThe Food Service Division, which represented approximately 47% of Bagcraft's 1995 sales, is a leader among its competitors. Bagcraft's products sold to the food service industry include foil and paper bags and sheets for sandwiches, french fries, chicken and other prepared foods. Major customers in this industry include Wendy's, Burger King, Taco Bell, Dairy Queen and McDonald's.\nThe development of the Honeycomb sheet helped propel Bagcraft to its industry leading position. The Honeycomb sheet incorporates a moisture absorbing layer which prevents buns from becoming soggy and tends to keep food warm for a longer period of time. Additionally, when used to replace rigid packaging, it represents significant source reduction to the solid waste system.\nSpecialty Bag Division\nThe Specialty Bag Division represented approximately 15% of Bagcraft's 1995 sales. Many of the division's products represent unique additions to Bagcraft's standard products. The Cue-Pon Bag(TM) has a \"tear out\" coupon affixed near the window on the bag which offers the shopper the immediate benefit of the coupon upon purchase. The Cue-Pon Pocket Bag(TM) has a pouch on the front of the bag which can be filled with novelty items by the retailer.\nThe division features products for the packaging of bakery goods, such as cookies and donuts, coffee, pre-popped popcorn and specialized promotional items such as premiums for kids meals sold by food service chains. This division provides bags with transparent windows, metal tin tie attachments and convenient self-opening bottoms.\nThis division also produces theater popcorn bags, which provide the theater chains with a more economical package that is easy to dispose of and substantially reduces the amount of space needed to inventory the product as well as providing a conveniently resealable bag by using Tac-Labels(TM) in lieu of Tin Ties. Bagcraft is the leading supplier of popcorn bags to theater chains such as General Cinema Corporation and Mann Theaters. The newest addition to this division is the \"To Go!\" Bags(TM). These double wall bags provide many of the properties of rigid containers such as tubs and cartons with the environmental and storage advantages of bags. Although in the early stages of production, \"To Go!\" Bags(TM) have been enthusiastically received and now are subject to a backlog. Other customers for the division include Bake-Line Products and Interstate Brands.\nMicrowave Popcorn Division\nThe Microwave Popcorn Division, which represented approximately 5% of Bagcraft's 1995 sales, represents an example of Bagcraft's high technology advancements. Bagcraft supplies microwave popcorn packaging to several industry leaders, including Hunt-Wesson (Orville Redenbacher) and U.S.A. Family Foods.\nBagcraft was instrumental in the development of the first microwave popcorn bag and played an important role in developing \"susceptor\" accelerator technology\nwhich it has incorporated into its products. The susceptor technology involves placing a metallized material into the popcorn bag which accelerates the heat transfer and results in a higher percentage of the popcorn kernels being popped.\nIn recent years, Bagcraft has experienced a decline in its domestic microwave popcorn business due to the acquisition of one of its major customers by a company with its own packaging ability. Accordingly, at December 31, 1995, Bagcraft incurred a charge to operations of approximately $1,500,000 to write-down the carrying value of idle machinery and equipment dedicated to the production of microwave popcorn products.\nAs discussed in Note 3 to the Company's consolidated financial statements, effective April 8, 1994, Bagcraft acquired the business assets, subject to buyer's assumption of certain liabilities of Arcar Graphics, Inc. (\"Arcar\"), a manufacturer and distributor of waterbase inks for the flexographic and rotogravure printing industries. Arcar is one of the larger waterbase ink suppliers in the United States and serves over 500 customers. The principal markets of Arcar's products included printers of tags and labels, flexible packaging manufacturers and polycoated cup manufacturers. As discussed in Note 3 to the Company's consolidated financial statements, effective October 26, 1995, Bagcraft completed the sale of the business assets, subject to the buyer's assumption of certain liabilities, of Arcar.\nEmployees\nAt December 28, 1995, the Company employed approximately 1,000 persons. The Company considers its relationships with its employees to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth a brief description of the properties of the Company and its subsidiaries. The Company and its subsidiaries believe that all of their facilities are adequate for their present and reasonably anticipated future business requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs discussed in Note 7 to the Company's consolidated financial statements in March, 1989, Envirodyne Industries, Inc. (\"Envirodyne\") and Emerald Acquisition Corporation (\"Emerald\") entered into a definitive agreement for a subsidiary of Emerald to acquire all of the issued and outstanding shares of Envirodyne common stock. Pursuant to the terms of certain letter agreements, ARTRA agreed to participate in the transaction and received Envirodyne's consent to sell its then 4,830,000 Envirodyne common shares (a 26.3% interest) to Emerald. On May 3, 1989 the transaction was consummated. ARTRA received consideration consisting of cash of $75,000,000, a 27.5% common stock interest in Emerald andEmerald junior debentures.\nOn January 6, 1993, a group of bondholders filed an involuntary petition for reorganization of Envirodyne under Chapter 11 of the U.S. Bankruptcy Code. On January 7, 1993, Envirodyne and certain of its subsidiaries (the \"Debtor\") filed petitions under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Illinois, Eastern Division. Subsequently, Emerald filed a voluntary petition under Chapter 11 of the Bankruptcy Code in the same court.\nEnvirodyne's plan of reorganization did not provide for any distribution or value to Emerald and Emerald, therefore, is without assets to provide value to ARTRA for ARTRA's investment in Emerald common stock and Emerald Junior Debentures. See discussion below and in Note 20 Litigation for remedies being pursued by ARTRA as damages for the lost value of its investment in Emerald common stock and Emerald Junior Debentures.\nOn July 18, 1995, ARTRA filed a Fourth Amended Counterclaim in the State Court Action for breach of fiduciary duty, fraudulent misrepresentation, negligent misrepresentation, breach of contract and promissory estopel. In the State Court Action, ARTRA seeks compensatory damages of $136.2 million, punitive damages of $408.6 million and approximately $33 million in fees paid to Salomon. The causes of action for breach of the fiduciary duty of due care were repleaded to reserve ARTRA's right to appeal the State Court's dismissal of the causes of action in the Third Amended Complaint. Defendant Kelly was dismissed with prejudice pursuant to a stipulation between ARTRA and the Kelly Defendants.\nOn or about March 1, 1996, DPK brought a motion for summary judgment as to ARTRA's claims for breach of contract and promissory estoppel. DPK's motion is currently pending.\nEffective December 31, 1989, ARTRA completed the disposal of its former scientific products segment with the sale of its Welch subsidiary, formerly Sargent-Welch Scientific Company, to a privately held corporation whose president and sole shareholder was a vice president of Welch prior to the sale. The consideration received by ARTRA consisted of $2,625,000 payable June 30, 1997, with interest at 10% beginning June 30, 1990, under terms of a noncompetition agreement and the buyer's subordinated note in the principal amount of $2,500,000. The receivable due June 30, 1997 under terms of the noncompetition agreement was reflected in ARTRA's condensed consolidated balance sheet at December 29, 1994 in other assets at $2,625,000. The subordinated security, due in 1997, was originally scheduled to be non-interest bearing for a period of three years, after which time interest will accrue at the rate of 10% per annum. The note was discounted at a rate of 10% during the non-interest bearing period and was reflected in ARTRA's consolidated balance sheet at December 29, 1994 in other assets at $1,375,000, net of a discount of $1,125,000.\nIn December, 1991 Welch filed a lawsuit against ARTRA alleging that certain representations, warranties and covenants made by ARTRA, which were contained in the parties' Stock Purchase Agreement, were false. Welch was seeking compensatory damages in the amount of $3,800,000. Subsequently, ARTRA had filed a counterclaim predicated upon Welch's breach of the payment terms of the parties' Non-Competition Agreement and the Subordinated Note executed by Welch. ARTRA was seeking damages in the amount of approximately $5,300,000 plus accrued interest. On November 23, 1994, the Circuit Court of Cook County Law Division in Chicago granted a judgment in favor of ARTRA affirming the validity of the amounts due under the Non-Competition Agreement and the Subordinated Note of $2,625,000 and $2,500,000, respectively.\nIn June 1995 ARTRA entered into an agreement to settle amounts due ARTRA by Welch under terms of the noncompetition agreement and the subordinated security. Per terms of the settlement agreement, ARTRA received cash of $3,000,000 and a subordinated note in the principal amount of $640,000 payable June 30, 2001.\nThe Company and its subsidiaries are the defendants in various business-related litigation and environmental matters. At December 28, 1995 and December 29, 1994, the Company had accrued $1,800,000 and $1,500,000, respectively, for potential business-related litigation and environmental liabilities. While these litigation and environmental matters involve wide ranges of potential liability, management does not believe the outcome of these matters will have a material adverse effect on the Company's financial statements. However, ARTRA may not have available funds to pay liabilities arising out of these business-related litigation and environmental matters or, in certain instances, to provide for its legal defense.\nIn January, 1985 the United States Environmental Protection Agency (\"EPA\") notified the Company's Bagcraft subsidiary that it was a potentially responsible party under the Comprehensive Environmental Responsibility Compensation and Liability Act (\"CERCLA\") for alleged release of hazardous substances at the Cross Brothers site near Kankakee, Illinois.\nAlthough Bagcraft has denied liability for the site, it has entered into a settlement agreement with the EPA, along with the other third party defendants, to resolve all claims associated with the site except for state claims. In May, 1994 Bagcraft paid $850,000 plus accrued interest of $29,000 to formally extinguish the EPA claim. Bagcraft filed suit in 1993 in the United States District Court for the Northern District of Illinois, against its insurers to recover its liability costs in connection with the Cross Brothers case. Bagcraft was subsequently reimbursed by its insurers for its liability costs incurred in connection with the EPA claim. With regard to the state action, Bagcraft is participating in settlement discussions with the State and thirteen other potential responsible parties to resolve all claims associated with the State. The maximum state claim is $1.1 million for all participants. Bagcraft has accrued $120,000 related to the State action in the Company's consolidated financial statements at December 28, 1995.\nBagcraft was listed as a de minimis contributor at the American Chemical Services, Inc. off-site disposal location in Griffith, Indiana and the Duane Marine off-site disposal location in Perth Amboy, New Jersey. These sites are included in the EPA's National Priorities List. Bagcraft is presently unable to determine its liability, if any, with respect to this site.\nBagcraft has been notified by the Federal Environment Protection Agency that it is a potentially responsible party for the disposal of hazardous substances at a site on Ninth Avenue in Gary, Indiana. Bagcraft has no records indicating that it deposited hazardous substances at this site and intends to vigorously defend itself in this matter.\nBagcraft is presently undertaking a soil remediation project for solvent-contaminated soil at its Chicago manufacturing facility. The environmental firm responsible for implementing the remediation has recommended that a soil vapor extraction process be used, at an estimated cost of $175,000. Although there can be no assurances that remediation costs will not exceed this estimate, in the opinion of management, no material additional costs are anticipated.\nIn April 1994, the EPA notified the Company that it was a potentially responsible party for the disposal of hazardous substances (principally waste oil) at a disposal site in Palmer, Massachusetts generated by a manufacturing facility formerly operated by the Clearshield Plastics Division (\"Clearshield\") of Harvel Industries, Inc. (\"Harvel\"), a majority owned subsidiary of ARTRA. In 1985, Harvel was merged into ARTRA's subsidiary Fill-Mor Holding, Inc. (\"Fill-Mor\"). This site has been included on the EPA's National Priorities List. In February 1983, Harvel sold the assets of Clearshield to Envirodyne. The alleged waste disposal occurred in 1977 and 1978, at which time Harvel was a majority-owned subsidiary of ARTRA. In May 1994, Envirodyne and its Clearshield National, Inc. subsidiary sued ARTRA for indemnification in connection with this proceeding. The cost of clean-up at the Palmer, Massachusetts site has been estimated to be approximately $7 million according to proofs of claim filed in the adversary proceeding. A committee formed by the named potentially responsible parties has estimated the liability respecting the activities of Clearshield to be $400,000. ARTRA has not made any independent investigation of the amount of its potential liability and no assurances can be given that it will not substantially exceed $400,000.\nIn a case titled Sherwin-Williams Company v. ARTRA GROUP Incorporated, filed in 1991 in the United States District Court for Maryland, Sherwin-Williams Company (\"Sherwin-Williams\") brought suit against ARTRA and other former owners of a paint manufacturing facility in Baltimore, Maryland for recovery of costs of investigation and clean-up of hazardous substances which were stored, disposed of or otherwise released at this manufacturing facility. This facility was owned by Baltimore Paint and Chemical Company, formerly a subsidiary of ARTRA from 1968 to 1980. Sherwin-William's current projection of the cost of clean-up is approximately $5 to $6 million. The Company has filed counterclaims against Sherwin-Williams and cross claims against other former owners of the property. The Company also is vigorously defending this action and has raised numerous defenses. Currently, the case is in its early stages of discovery and the Company cannot determine what, if any, its liability may be in this matter.\nARTRA was named as a defendant in United States v. Chevron Chemical Company brought in the United States District Court for the Central District of California respecting Operating Industries, Inc. site in Monterey Park, California. This site is included on the EPA's National Priorities List. ARTRA's involvement stemmed from the alleged disposal of hazardous substances by The Synkoloid Company (\"Synkoloid\") subsidiary of Baltimore Paint and Chemical Company, which was formerly owned by ARTRA. Synkoloid manufactured spackling paste, wall coatings and related products, certain of which generated hazardous substances as a by-product of the manufacturing process.\nARTRA entered into a consent decree with the EPA in which it agreed to pay $85,000 for one phase of the clean-up costs for this site; however, ARTRA defaulted on its payment obligation. ARTRA is presently unable to estimate the\ntotal potential liability for clean-up costs at this site, which clean-up is expected to continue for a number of years. The consent decree, even if it had been honored by ARTRA, was not intended to release ARTRA from liability for costs associated with other phases of the clean-up at this site. The Company is presently unable to determine what, if any, additional liability it may incur in this matter.\nIn a case titled City of Chicago v. NL Industries, Inc. and ARTRA GROUP Incorporated, filed in the Circuit Court of Cook County, Illinois, the City of Chicago alleged that ARTRA (and NL Industries, Inc.) had improperly stored, discarded and disposed of hazardous substances at the subject site, and that ARTRA had conveyed the site to Goodwill Industries to avoid clean-up costs. At the time the suit was filed, the City of Chicago claimed to have expended $1,000,000 in clean-up costs.\nARTRA and NL Industries, Inc. have counter sued each other and have filed third party actions against the subsequent owners of the property. The City of Chicago has made an offer to settle the matter for $350,000 for all parties. The parties are currently conducting discovery. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nIn a case titled Illinois Environmental Protection Agency v. NL Industries, Inc., ARTRA GROUP Incorporated, et al, the Illinois Environmental Protection Agency filed suit alleging all former owners contributed to the contamination of the site. The suit was dismissed, but subject to possible appeal. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nThe EPA has identified ARTRA GROUP Incorporated as a potentially responsible party in an action involving the former manufacturing facility. The EPA is currently investigating the site to determine the extent and type of contamination, if any. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market For the Registrant's Common Equity and Related Shareholder Matters.\nARTRA's common stock, without par value, is traded on the New York (\"NYSE\") and Pacific Stock Exchanges. The Company currently does not meet certain of the requirements for maintaining its listing on the NYSE and the NYSE is reviewing the status of the Company's listing on the exchange. As of March 31, 1996 and December 28, 1995, the approximate number of holders of its common stock was 2,500.\nThe high and low sales prices for ARTRA's common stock, as reported in the NYSE Quarterly Market Statistics reports, during the past two fiscal years were as follows:\n1995 1994 --------------------------- ------------------------- High Low High Low ------------ ------------ ------------ ----------\nFirst quarter 5 - 3\/4 3 - 1\/2 7 - 3\/4 5 - 1\/8 Second quarter 5 - 1\/2 3 - 1\/4 6 - 1\/4 4 - 3\/8 Third quarter 6 4 - 1\/8 7 - 1\/4 5 Fourth quarter 5 - 1\/8 3 - 5\/8 5 - 3\/8 3 - 3\/4\nNo dividends were paid in 1995 or 1994 nor are any anticipated in 1996. The Company was prohibited from paying dividends to its stockholders pursuant to the terms of its bank loan agreement that was discharged in February 1996. In addition, the Company's operating subsidiaries historically have been prohibited from or restricted in paying dividends or making distributions under their respective debt agreements (except for limited overhead allocations or payments in accordance with tax sharing agreements with the parent entity). Accordingly, current restrictions or limitations on the Company's Bagcraft subsidiary in upstreaming payments in 1996 and beyond would make the payment of dividends by ARTRA unlikely. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of the loan agreements of the Company and its Bagcraft subsidiary.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nFollowing is a consolidated summary of selected financial data of the Company for each of the five fiscal years in the period ended December 28, 1995. The information for the year ended December 29, 1994 has been reclassified to reflect the operations of Arcar Graphics, Inc. as discontinued operations. The sale of Arcar (acquired effective April 9, 1994) was completed on October 26, 1995. Certain selected financial data for each of the four fiscal years in the period ended December 29, 1994 has been reclassified to reflect the discontinuance of the Company's fashion costume jewelry business effective September 30, 1995 conducted by the former majority-owned subsidiary COMFORCE Corporation, formerly The Lori Corporation. In October 1995, due to additional issuances of COMFORCE common stock, the Company's interest in COMFORCE was reduced to approximately 25% and the investment in COMFORCE was accounted for under the equity method during the fourth quarter of 1995. See notes 3 and 6 to the Company's consolidated financial statements for a further discussion of the Company's investment in COMFORCE and its results of operations.\n(A) The loss from discontinued operations for the year ended December 28, 1995 includes a charge to operations of $6,430,000 to write-off the remaining goodwill of the Lori's fashion costume jewelry operations effective June 29, 1995, a provision of $1,000,000 for loss on disposal of the Lori's fashion costume jewelry operations and a gain on sale of Bagcraft's Arcar subsidiary of $8,483,000. The loss from discontinued operations for the year ended December 31, 1994 includes a charge to operations of $10,800,000 representing a write-off of New Dimensions goodwill. The loss from discontinued operations for the year ended December 31, 1992 includes charges to operations of $8,664,000 representing an impairment of goodwill at December 31, 1992 and $8,500,000 representing increased reserves for markdowns allowances and inventory valuation.\n(B) The 1995 and 1994 extraordinary credits represent gains from net discharge of indebtedness under terms of a debt settlement agreements with banks. The 1993 extraordinary credit represents a gain from a net discharge of indebtedness due to the reorganization of Lori's former New Dimensions subsidiary. See Note 8 to the Company's consolidated financial statements.\n(C) As partial consideration for a debt settlement agreement, in December, 1994 the Lori's bank lender received all of the assets of the New Dimensions subsidiary. See Note 8 to the Company's consolidated financial statements.\n(D) Effective in 1993, the Company adopted a 52\/53 week fiscal year ending the last Thursday of December .\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following discussion supplements the information found in the financial statements and related notes:\nChanges in Business\nArcar\nAs discussed in Note 3 to the Company's consolidated financial statements, effective April 8, 1994, Bagcraft purchased the business assets, subject to buyer's assumption of certain liabilities, of Arcar, a manufacturer and distributor of waterbase inks, for consideration of $10,264,000 consisting of cash of $2,264,000 and subordinated promissory notes totaling $8,000,000. The acquisition of Arcar was accounted for by the purchase method and, accordingly, the assets and liabilities of Arcar were included in ARTRA's financial statements at their estimated fair market value at the date of acquisition.\nEffective October 26, 1995, Bagcraft sold the business assets, subject to the buyer's assumption of certain liabilities, of Arcar for cash of approximately $20,300,000, resulting in a net gain of $8,483,000. The net proceeds, after extinguishment of certain Arcar debt obligations, of approximately $10,400,000, were used to reduce Bagcraft debt obligations.\nLori\/COMFORCE\nIn September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business and recorded a provision of $1,000,000 for the estimated costs to complete the disposal of the fashion costume jewelry business.\nEffective October 17, 1995, Lori acquired one hundred percent of the capital stock of COMFORCE Global, Inc. (\"Global\"), formerly Spectrum Global Services, Inc. d\/b\/a YIELD Global, a wholly owned subsidiary of Spectrum Information Technologies, Inc. for consideration of approximately $6.4 million, net of cash acquired, consisting of cash of approximately $5.6 million and 500,000 shares of Lori common stock issued as consideration for various fees and guarantees associated with the transaction. The cash consideration included net cash payments to the selling shareholders of approximately $5.2 million. The 500,000 shares of Lori common stock issued as consideration for the Global transaction included 150,000 shares issued to Peter R. Harvey, then a director of Lori and currently the president\/director of ARTRA and 100,000 shares issued to ARTRA for their guarantee to the selling shareholder of the payment of the Global purchase price at closing. The shares issued to Peter R. Harvey and ARTRA are subject to approval by the issuer's shareholders. Global provides telecommunications and computer technical staffing services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. The acquisition of Global was funded principally by private placements of approximately 1,950,000 shares of Lori common stock at $3.00 per share (total proceeds of approximately $5,800,000) plus detachable warrants to purchase approximately 970,000 shares of Lori common stock at $3.375 per share that expire five years from the date of issue. In connection with the re-focus of its business, Lori changed its name to COMFORCE Corporation. Additionally, in conjunction with the Global acquisition, ARTRA has agreed to assume certain pre-existing Lori liabilities and indemnify COMFORCE in the event any future liabilities arise concerning pre-existing environmental matters and business related litigation.\nEffective July 4, 1995, Lori and ARTRA entered into employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. As additional compensation, the agreements provided for the issuance in aggregate of a 35% common stock interest in Lori. After the issuance of the Lori common shares, plus the effects of the issuance of Lori common shares sold by private placements and other Lori common shares issued in conjunction with the Global acquisition, ARTRA's common stock ownership interest in COMFORCE common stock was reduced to approximately 25%. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the equity method through the end of fiscal 1995. See Note 6 to the Company's consolidated financial statements for a further discussion of and the accounting treatment of the Company's investment in COMFORCE at December 28, 1995.\nAs discussed below in the \"Liquidity and Capital Resources\" section, on August 18, 1994, as amended effective December 23, 1994, ARTRA, Lori's parent, Fill-Mor, Lori and Lori's operating subsidiaries entered into and agreement with Lori's bank lender to settle obligations due the bank under terms of the bank loan agreements of Lori and its discontinued fashion costume jewelry subsidiaries and Fill-Mor. Under terms of the amended settlement agreement, Lori's bank lender received all of the assets of New Dimensions and New Dimensions terminated operations effective December 27, 1994. In March, 1995, the remaining indebtedness of Lori and Fill-Mor was discharged, resulting in an additional extraordinary gain to Lori and Fill-Mor in 1995.\nLiquidity and Capital Resources\nCash and Cash Equivalents and Working Capital\nCash and cash equivalents increased $277,000 during the year ended December 28, 1995. Cash flows used by operating activities of $5,943,000 and cash flows used by financing activities of $14,419,000 exceeded cash flows from investing activities of $20,639,000. Cash flows used by operating activities were principally attributable to the Company's loss from operations, exclusive of the effect of a charge to operations of $6,430,000 representing an impairment of goodwill at COMFORCE's (formerly Lori) discontinued fashion costume jewelry operations and a compensation charge to continuing operations of $3,000,000 representing the issuance in aggregate of a 35% common stock interest in COMFORCE as additional consideration under employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. Cash flows used by financing activities were principally attributable to a net reduction of long-term debt with proceeds from the October 26, 1995 sale of Arcar. Cash flows from investing activities represent proceeds from the October 26, 1995 sale of Arcar.\nThe Company's consolidated working capital deficiency decreased $34,107,000 to $26,365,000 during the year ended December 28, 1995. The decrease in working capital deficiency is principally attributable to the classification of borrowings under Bagcraft's credit agreement as long-term liabilities at December 28, 1995 due to a February 1, 1996 amendment that extended the maturity date of the agreement until September 30, 1997 (see Note 10 to the Company's consolidated financial statements.. At December 29, 1994, borrowings under Bagcraft's credit agreement were classified in the Company's consolidated balance sheet as currently payable.\nStatus of Debt Agreements and Operating Plan\nAt December 28, 1995 the Company's corporate entity was in default of provisions of certain of its credit agreements. Under certain debt agreements ARTRA is limited in the amounts it can withdraw from its Bagcraft operating subsidiary. In February, 1996, a bank lender agreed to discharge amounts due under bank notes of the corporate entity ($12,063,000 plus accrued interest) and certain obligations of the Company's president, Peter R. Harvey. Effective February 1, 1996, Bagcraft's credit agreement was extended until September 30, 1997. See Notes 9 and 10 to the Company's consolidated financial statements and discussion below.\nEffective August 18, 1994, as amended effective December 23, 1994, ARTRA, Fill-Mor, Lori and Lori's operating subsidiaries entered into an agreement with Lori's bank lender to settle obligations due the bank under terms of the bank loan agreements of Lori and its operating subsidiaries and Fill-Mor. See Note 8 to the consolidated financial statements and discussion below.\nARTRA Corporate\nAt December 31, 1993, $17,063,000 in ARTRA notes, plus related loan fees and accrued interest were payable to a bank. The notes provided for interest at the prime rate. These bank notes were collateralized by, among other things, 100% of the common stock of ARTRA's BCA Holdings, Inc. (\"BCA\") subsidiary, the parent of Bagcraft, and a secondary position on the assets of BCA, payments due under a noncompetition agreement with the Company's former Welch subsidiary and by a\nsubordinated note in the principal amount of $2,500,000 received by ARTRA as part of the proceeds from the sale of Welch. See note 9 to the Company's consolidated financial statements for a further discussion of these bank notes.\nOn March 31, 1994, ARTRA entered into a series of agreements with its primary bank lender and with a private corporation that had guaranteed $2,500,000 of ARTRA's bank notes. Per terms of the agreements, the private corporation purchased $2,500,000 in ARTRA notes from ARTRA's bank thereby reducing the outstanding principal on ARTRA's bank notes to $12,063,000 at March 31, 1994 and the bank released the private corporation from its $2,500,000 loan guaranty. As consideration for purchasing $2,500,000 of ARTRA bank notes, the private corporation received a $2,500,000 note payable from ARTRA bearing interest at the prime rate. See Note 9 to the Company's consolidated financial statements for further discussion of this transaction and additional consideration received by the private corporation. A major shareholder and executive officer of the private corporation is an ARTRA director.\nAs additional consideration, the private corporation has received an option to put back to ARTRA the 49,980 shares of ARTRA common stock received as compensation for its former $2,500,000 ARTRA loan guaranty at a price of $15.00 per share. The put option is exercisable on the later of the day that the $2,500,000 note payable to the private corporation becomes due or the date the ARTRA bank notes have been paid in full. The option price increases by $2.25 per share annually ($18.938 per share at December 28, 1995). The $2,500,000 note payable to the private corporation is reflected in the Company's consolidated financial statements as amounts due to related parties. During the first quarter of 1996, the $2,500,000 note and related accrued interest was paid in full principally with proceeds from additional short-term borrowings.\nIn June 1995 ARTRA entered into an agreement to settle amounts due ARTRA by the former Welch subsidiary under terms of a noncompetition agreement and a subordinated note in the principal amount of $2,500,000 received by ARTRA as part of the proceeds from the 1989 sale of Welch. Per terms of the settlement agreement, ARTRA received cash of $3,000,000 and a subordinated note in the principal amount of $640,000 payable June 30, 2001. The cash proceeds were used for a $2,500,000 reduction of amounts due on certain ARTRA bank notes, with the remainder used for working capital. In conjunction with this transaction, ARTRA entered into a letter agreement with the bank whereby the bank agreed not to exercise any of its rights and remedies with respect to amounts due the bank under its ARTRA notes and certain obligations of ARTRA's president, Peter R. Harvey through at least September 28, 1995.\nIn February 1996, the bank agreed to discharge all amounts under its ARTRA notes ($12,063,000 plus accrued interest) and certain obligations of Mr. Harvey for consideration of $6,000,000, consisting of a cash payment of $5,150,000 and Mr. Harvey's $850,000 note payable to the bank. ARTRA will recognize a gain on the discharge of its bank indebtedness of approximately $10,000,000 in the first quarter of 1996 and will record a receivable for Mr. Harvey's prorata share of the debt discharge funded by the Company. As collateral for this advance and other previous advances (see note 21 to the Company's consolidated financial statements), Mr. Harvey provided ARTRA a $2,150,000 security interest in certain real estate.\nIn conjunction with the February 1996 discharge of indebtedness, the Company entered into a $1,900,000 short-term loan agreement with an unaffiliated company. The loan, due May 26, 1996, with interest at 12% is collateralized by, among other things, the common stock of ARTRA's BCA subsidiary. As additional compensation for the loan and for participating in the above discharge of indebtedness, the lender has received, to-date, 150,000 shares of ARTRA common stock and 37,500 shares of COMFORCE common stock held by ARTRA. Additionally, for a cash payment of $500,000 to ARTRA, the lender purchased an option to acquire up to 40% of the common stock of Bagcraft for nominal consideration. If the borrowings under the loan agreement are repaid by May 26, 1996, ARTRA can repurchase the option for a cash payment of $550,000. If the borrowings under the loan agreement are repaid subsequent to May 26, 1996, the percentage of the warrant ARTRA can repurchase declines on a sliding scale through July 25, 1996. The proceeds from this loan agreement along with proceeds received from the Bagcraft subsidiary as consideration for the issuance of BCA preferred stock were used to fund the cash payment to the bank for the above discharge of indebtedness.\nEffective May 14, 1991, ARTRA, through its wholly-owned Fill-Mor subsidiary, entered into a loan agreement with a bank providing for borrowings of up to $2,500,000 with interest at the prime rate plus 2%, of which $2,200,000 was outstanding at December 29, 1994. The loan was collateralized by ARTRA's interest in Lori common stock and preferred stock, by the proceeds of a tax sharing agreement between ARTRA and its Bagcraft subsidiary and by ARTRA's interest in Fill-Mor's common stock. At December 29, 1994, borrowings on this note were reclassified as amounts due under the debt restructuring agreement discussed in Note 8. In March, 1995, borrowings due under this loan agreement were discharged.\nAt December 29, 1994 an ARTRA bank note with outstanding borrowings of $3,600,000 had been past due since December 31, 1990. In October, 1995 the bank agreed to discharge the $3,600,000 note plus accrued interest of $1,467,000 for a cash payment of $150,000, resulting in an extraordinary gain of $4,917,000 in the fourth quarter of 1995.\nAn ARTRA bank note with outstanding borrowings of $345,000 at December 29, 1994 was guaranteed by a private company. Interest on the note was at the prime rate plus 2%. In October, 1995 all amounts due on this bank note were paid in full.\nIn December 1995, ARTRA completed a private placement of $2,500,000 of 12% convertible subordinated promissory notes due March 21, 1996. As additional consideration the noteholders received 15,000 ARTRA common shares per each $100,000 of notes issued, or an aggregate of 375,000 ARTRA common shares. The ARTRA common shares were valued at $1,266,000 ($3.375 per share) based upon the closing market value of ARTRA common stock on the date of issue, discounted for restricted marketability. In the event the notes and all accrued interest is not paid in full at maturity, the noteholders have the option to convert all or a portion of the amount due into shares of ARTRA common at a conversion price of $3.00 per share. The proceeds from the private placement, held in escrow at December 28, 19995, were used to pay down other debt obligations in January, 1996. The notes were repaid in April, 1995, substantially with proceeds from a new private placement of ARTRA notes.\nAs discussed in Note 21 to the Company's consolidated financial statements, ARTRA has total advances due from its president, Peter R. Harvey, of which $5,369,000 and $4,715,000, including accrued interest, remained outstanding at December 28, 1995 and December 29, 1994, respectively. The advances bear interest at the prime rate plus 2% (10.5% at December 28, 1995 and December 29, 1994). This receivable from Peter R. Harvey has been classified as a reduction of common shareholders' equity.\nIn May, 1991, ARTRA's wholly-owned Fill-Mor subsidiary made advances to Peter R. Harvey. The advances provided for interest at the prime rate plus 2%. At March 30, 1995 and December 29, 1994, advances of $1,540,000 and $1,510,000, respectively, including accrued interest, were outstanding. In April, 1995, these advances from ARTRA's Fill-Mor subsidiary to Peter R. Harvey were transferred to ARTRA as a dividend.\nCommencing January 1, 1993 to date, interest on all advances to Peter R. Harvey has been accrued and fully reserved.\nPeter R. Harvey has not received other than nominal compensation for his services as an officer or director of ARTRA or any of its subsidiaries since October of 1990. Additionally, Mr. Harvey has agreed not to accept any compensation for his services as an officer or director of ARTRA or any of its subsidiaries until his obligations to ARTRA, described above, are fully satisfied.\nUnder Pennsylvania Business Corporation Law of 1988, ARTRA (a Pennsylvania corporation) is permitted to make loans to officers and directors. Further, under the Delaware General Corporation Law, Fill-Mor (a Delaware corporation) is permitted to make loans to an officer (including any officer who is also a director, as in the case of Peter R. Harvey), whenever, in the judgment of the directors, the loan can reasonably be expected to benefit Fill-Mor.\nAt the September 19, 1991 meeting, ARTRA's Board of Directors discussed, but did not act on a proposal to ratify the advances made by ARTRA to Peter R. Harvey. The 1992 advances made by ARTRA to Mr. Harvey were ratified by ARTRA's Board of Directors. In the case of the loan made by Fill-Mor to Mr. Harvey, the Board of Directors of Fill-Mor approved the borrowing of funds from Fill-Mor's bank loan agreement, a condition of which was the application of a portion of the proceeds thereof to the payment of certain of Mr. Harvey's loan obligations to the bank. However, the resolutions did not acknowledge the use of such proceeds for this purpose and the formal loan documents with the bank did not set forth this condition (though in fact, the proceeds were so applied by the bank).\nAs partial collateral for amounts due from Peter R. Harvey, the Company has received the pledge of 1,523 shares of ARTRA redeemable preferred stock (with a liquidation value of $1,523,000, plus accrued dividends) which are owned by Mr. Harvey. In addition, Mr. Harvey has pledged a 25% interest in Industrial Communication Company (a private company). Such interest is valued by\nMr. Harvey at $800,000 to $1,000,000. During 1995, Peter R. Harvey entered into a pledge agreement with ARTRA whereby Mr. Harvey pledged additional collateral consisting of 42,067 shares of ARTRA common stock and 707,281 shares of Puretech International, Inc., a publicly traded corporation. As additional collateral for the above mentioned advances and a 1996 advance for Mr. Harvey's prorata of certain bank debt discharged, Mr. Harvey provided ARTRA a $2,150,000 security interest in certain real estate.\nARTRA has entered into various agreements under which it has sold its common shares along with options that require ARTRA to repurchase these shares at the option of the holder, principally one year after the date of each agreement. At December 28, 1995, options are outstanding that, if exercised, would require ARTRA to repurchase 283,965 shares of its common stock for an aggregate amount of approximately $4,774,000. ARTRA does not have available funds to satisfy its obligations if these options were exercised. However the holders of redeemable common stock have the option to sell their shares in the market subject to the limitations of Securities Act Rule 144. At its discretion and subject to its financial ability, ARTRA could reimburse the optionholders for any short-fall resulting from such sale.\nAs discussed in Note 12 to the consolidated financial statements, ARTRA, Bagcraft and Bagcraft's parent BCA have various redeemable preferred stock issues with an aggregate carrying value of $18,631,000 outstanding at December 28, 1995. These redeemable preferred stock issues have various maturity dates commencing in 1997.\nEffective February 1, 1996, BCA, Bagcraft and Ozite entered into an agreement to exchange certain preferred stock between the Companies. In connection with the agreement, BCA issued to Bagcraft 8,135 shares of BCA Series B preferred stock (with a liquidation preference equal to $1,000 per share) for cash of $4,135,000. Bagcraft in turn exchanged the BCA Series B preferred stock for Bagcraft redeemable preferred stock (82.7% of 50,000 shares, or 41,350 shares) held by Ozite. Funds for the transaction were obtained by Bagcraft through an advance under its revolving credit loan (see Note 10 to the Company's consolidated financial statements). BCA then upstreamed the proceeds to ARTRA for working capital purposes.\nAs a result of the preferred stock exchange agreement, 17.3% of the original Bagcraft redeemable preferred stock and the prorata share of dividends remain outstanding February 1, 1996. Dividends related to the Bagcraft redeemable preferred stock exchanged have been forgiven in accordance with the agreement. The dividend forgiveness will be reflected in the Company's consolidated financial statements in the first quarter of 1996.\nThe Company has suffered recurring losses from operations and has a net capital deficiency. As a result of these factors, the Company has experienced difficulty in obtaining adequate financing to replace certain current credit arrangements, certain of which are in default, to fund its debt service and liquidity requirements in 1995. Due to its limited ability to receive operating funds from its operating subsidiaries, ARTRA historically has met its operating expenditures with funds generated by such alternative sources as private placements of ARTRA common stock and notes, sales of ARTRA common stock with put options, loans from officers\/directors and private investors, as well as through sales of assets and\/or other equity infusions. ARTRA plans to continue to seek such alternative sources of funds to meet its future operating expenditures.\nARTRA does not currently have available funds to repay amounts due under various loan arrangements, principally with private investors, some of which are currently past due. ARTRA is currently negotiating with certain investors to issue a private placement of ARTRA notes, with the proceeds to be used to pay down outstanding debt obligations. ARTRA will continue to have significant levels of indebtedness in the future. The level of indebtedness may affect the rate at which or the ability of ARTRA to effectuate the refinancing or restructuring of debt. ARTRA intends to continue to negotiate with its creditors to extend due dates to allow ARTRA to maximize value from possible sale of assets and to explore various other sources of funding to meet its future operating expenditures. If ARTRA is unable to negotiate extensions with its creditors and complete the above mentioned transactions, ARTRA could suffer severe adverse consequences, and as a result, ARTRA may be forced to liquidate its assets or file for protection under the Bankruptcy Code.\nARTRA's corporate entity has no material commitments for capital expenditures.\nBagcraft\nEffective December 17, 1993, Bagcraft refinanced its bank debt by entering into a Credit Agreement that provides for a revolving credit loan and two separate term loans. The term loans were separate two-year facilities initially totaling $12,000,000 (Term Loan A) and $8,000,000 (Term Loan B), bearing interest at the lender's index rate plus 1.75% and 3%, respectively. The principal under\nTerm Loan A is payable at maturity, unless accelerated under terms of the Credit Agreement. The principal under Term Loan B ($4,600,000 and $5,000,000 outstanding at December 28, 1995 and December 29, 1994, respectively) was scheduled to be payable in twenty-four monthly installments of $250,000 from January 1, 1994 to December 1, 1995, with the remaining principal balance payable at maturity, unless accelerated under terms of the Credit Agreement. At December 28, 1995, interest rates on Term Loan A and Term Loan B were 10.25% and 11.5% respectively.\nThe amount available to Bagcraft under the revolving credit loan is subject to a borrowing base, as defined in the agreement, up to a maximum of $18,000,000. At December 28, 1995 and December 29, 1994, approximately $6,600,000 and $800,000, respectively, was available and unused by Bagcraft under the revolving credit loan. Borrowings under the revolving credit loan bear interest at the lender's index rate plus 1.5% and are payable upon maturity of the Credit Agreement, unless accelerated under terms of the Credit Agreement. At December 28, 1995 the interest rate on the revolving credit loan was 10%.\nBorrowings under the Credit Agreement are collateralized by substantially all of the assets of Bagcraft. The Credit Agreement, as amended, contains various restrictive covenants, that among other restrictions, require Bagcraft to maintain minimum levels of tangible net worth and liquidity levels, and limits capital expenditures and restricts additional loans, dividend payments and payments to related parties. In addition, the Credit Agreement prohibits changes in ownership of Bagcraft.\nIn October, 1995 the Credit Agreement was amended whereby, among other things, the maturity date of the Credit Agreement was extended until March 31, 1996, certain loan covenant violations were resolved and the principal payments under Term Loan B were modified to include five monthly installments of $200,000 from November 15, 1995 to March 31, 1996, with the remaining balance payable at maturity (March 31, 1996) .\nEffective February 1, 1996, the Credit Agreement was amended whereby, among other things, the maturity date of the Credit Agreement was extended until September 30, 1997, certain loan covenants were amended. The principal payments under Term Loan B were modified to include twenty-three monthly installments of $200,000 from November 15, 1995 to September 30, 1997, with the remaining balance payable at maturity (September 30, 1997) . Additionally, the lender consented to the use of $4,135,000 advance under the revolving credit loan to fund a preferred stock exchange agreement between BCA (the parent of Bagcraft), Bagcraft and the holder of Bagcraft's 13.5% cumulative, redeemable preferred stock (see Note 12).\nAs additional compensation for borrowings under the Credit Agreement, the lender received a detachable warrant, expiring in December 1998, with a put option to purchase up to 10% of the fully diluted common equity of Bagcraft at a nominal value. Under certain conditions Bagcraft is required to repurchase the warrant from the lender. The determination of the repurchase price of the warrant is to be based on the warrant's pro rata share of the highest of book value, appraised value or market value of Bagcraft.\nIn connection with the February 1, 1996 amendment to the Credit Agreement, the warrant agreement was amended to permit the holder to purchase 13% of the fully diluted common equity of Bagcraft at the original nominal purchase price.\nIn March, 1994 Bagcraft and the City of Baxter Springs, Kansas completed a $12,500,000 financing package associated with the construction of a new 265,000 sq. ft. production facility in Baxter Springs, Kansas. The financing package, funded by a combination of Federal, state and local funds, consists of the following loan agreements payable by Bagcraft directly to the City of Baxter Springs:\nA $7,000,000 promissory note payable in ten installments of $700,000 due annually on July 21 of each year beginning in 1995 through maturity on July 21, 2004. Interest, at varying rates from 4.6% to 6.6%, is payable semi-annually. At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $6,300,000 and $7,000,000, respectively, under this loan agreement.\nA $5,000,000 subordinated promissory note payable as follows: $150,000 due in 1996; $2,425,000 due in 1998; and $2,425,000 due in 1999. The subordinated promissory note is non-interest bearing, subject to certain repayment provisions as defined in the agreement (as amended). At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $5,000,000 and $4,810,000, respectively, under this loan agreement.\nTwo separate $250,000 subordinated promissory notes payable in varying installments through January 20, 2025. The subordinated promissory notes are non-interest bearing, subject to certain repayment provisions as defined in the agreement. At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $493,000 and $500,000, respectively, under this loan agreement.\nBorrowings under the above loan agreements are collateralized by a first lien on the land and building at the Baxter Springs, Kansas production facility and by a second lien on certain machinery and equipment. Under certain circumstances, repayment of the borrowings under the above loan agreements is subordinated to the repayment of obligations under Bagcraft's Credit Agreement. At December 28, 1995 $552,000 of borrowings from the above loan agreements is reflected in the consolidated balance sheet in current assets as restricted cash and equivalents. These funds, invested in interest bearing cash equivalents, are restricted for expenditures associated with the Baxter Springs, Kansas project.\nThe new Kansas facility replaced Bagcraft's production facility in Joplin, Missouri. Additionally, with the completion of the new Kansas facility, Bagcraft converted the manufacturing facility in Forest Park, Georgia into a distribution facility. The former Carteret, New Jersey facility was sold in December, 1994 and the proceeds of approximately $1,700,000 were used to reduce borrowings under Bagcraft's Credit Agreement.\nOn April 8, 1994, Bagcraft completed the acquisition of Arcar for consideration consisting of cash of $2,264,000 and subordinated promissory notes totaling $8,000,000 ($5,500,000 and $8,000,000 outstanding at September 28, 1995 and December 29, 1994, respectively). The subordinated promissory notes provided for interest payable quarterly at the prime rate (as defined in the agreement). At September 28, 1995, the remaining outstanding promissory notes were scheduled to mature as follows: $2,500,000 payable March 15, 1996; $2,500,000 payable March 15, 1997; $500,000 payable March 15, 1998. The seller also received a warrant to purchase 177,778 ARTRA common shares at a price of $5.625 per share, the market value at the date of grant. Exercise of the warrant was payable only through a reduction of the subordinated promissory notes and accrued interest due the seller under terms of the purchase agreement. The subordinated promissory notes were paid in full in October, 1995 with proceeds from the sale of Arcar (see Note 3 to the Company's consolidated financial statements).\nEffective April 8, 1994, Arcar entered into a Loan and Security Agreement (the \"Agreement\") with a bank that provided for a revolving credit loan and a term loan. The term loan, in the original principal amount of $2,750,000, provided for interest at the prime rate plus .75%. Borrowings under the Agreement were collateralized by substantially all of the assets of Arcar. The Agreement contained various restrictive covenants, that among other restrictions, require Arcar to maintain minimum levels of net worth and liquidity levels and limit additional loans, dividend payments, capital expenditures and payments to related parties. All borrowings under the Agreement were paid in full in October, 1995 with proceeds of the sale of Arcar (see Note 3 to the Company's consolidated financial statements).\nBagcraft has historically funded its capital requirements with cash flow from operations and funds available under its revolving credit loan. These sources should provide sufficient cash flow to fund Bagcraft's short-term capital requirements. As discussed above, it is anticipated that Bagcraft's recently amended Credit Agreement will provide Bagcraft with the ability to fund its long-term capital requirements.\nBagcraft anticipates that its 1996 capital expenditures, principally for manufacturing equipment, will be approximately $2,500,000 and will be funded principally from the above mentioned credit facilities and also from operations.\nCOMFORCE\/Lori\nIn September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business and recorded a provision of $1,000,000 for the estimated costs to complete the disposal of the fashion costume jewelry business.\nEffective October 17, 1995, September 11, 1995, Lori acquired one hundred percent of the capital stock of COMFORCE Global, Inc. (\"Global\"), formerly Spectrum Global Services, Inc. d\/b\/a YIELD Global, a wholly owned subsidiary of Spectrum Information Technologies, Inc. for consideration of approximately $6.4 million, net of cash acquired, consisting of cash of approximately $5.6 million and 500,000 shares of Lori common stock issued as consideration for various fees and guarantees associated with the transaction. The cash consideration included net cash payments to the selling shareholders of approximately $5.2 million. The 500,000 shares of Lori common stock issued as consideration for the Global transaction included 150,000 shares issued to Peter R. Harvey, then a director of Lori and currently the president\/director of ARTRA and 100,000 shares issued to ARTRA for their guarantee to the selling shareholder of the payment of the Global purchase price at closing. The shares issued to Peter R. Harvey and ARTRA are subject to approval by the COMFORCE's shareholders. Global provides telecommunications and computer technical staffing services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. The acquisition of Global was funded principally by private placements of approximately 1,950,000 shares of Lori common stock at $3.00 per share (total proceeds of approximately $5,800,000) plus detachable warrants to purchase approximately 970,000 shares of Lori common stock at $3.375 per share that expire five years from the date of issue. In connection with the re-focus of its business, Lori changed its name to COMFORCE Corporation.\nEffective July 4, 1995, Lori and ARTRA entered into employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. As additional compensation, the agreements provided for the issuance in aggregate of a 35% common stock interest in Lori. After the issuance of the Lori common shares, plus the effects of the issuance of Lori common shares sold by private placements and other common shares issued in conjunction with the Global acquisition, ARTRA's common stock ownership interest in COMFORCE common stock was reduced to approximately 25%. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from the ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the equity method through the end of fiscal 1995. See Note 6 to the Company's consolidated financial statements for a further discussion of and the accounting treatment of the Company's investment in COMFORCE at December 28, 1995.\nIn conjunction with the Global acquisition, ARTRA has agreed to assume certain pre-existing Lori liabilities and indemnify COMFORCE in the event any future liabilities arise concerning pre-existing environmental matters and business related litigation. Accordingly, ARTRA has accrued $4,500,000 of Lori liabilities classified in its consolidated balance at December 28, 1995 as current liabilities of discontinued operations.\nLori Debt Restructuring\nEffective August 18, 1994, as amended December 23, 1994, ARTRA, Fill-Mor, Lori and Lori's fashion costume jewelry subsidiaries, (including the New Dimensions Accessories, Ltd., (\"New Dimensions\") subsidiary, which terminated operations effective December 27, 1994) entered into an agreement with Lori's bank lender to settle obligations due the bank under terms of the bank loan agreements of Lori and its fashion costume jewelry subsidiaries and Fill-Mor. Borrowings due the bank (approximately $25,000,000 as of December 23, 1994), plus amounts due the bank for accrued interest and fees were reduced to $10,500,000 (of which $7,855,000 pertained to Lori's obligation to the bank and $2,645,000 pertained to Fill-Mor's obligation to the bank). Upon the satisfaction of certain conditions of the debt settlement agreement in 1995, as discussed below, the balance of this indebtedness was discharged.\nIn conjunction with the debt settlement agreement, ARTRA entered into a $1,850,000 short-term loan agreement with a non-affiliated corporation, the proceeds of which were used to fund amounts due the bank as discussed below. The loan, due June 30, 1995, with interest payable monthly at 10%, was collateralized by 100,000 shares of Lori common stock. These 100,000 Lori common shares were originally issued to the bank under terms of the August 18, 1994 Settlement Agreement. In August, 1995 the loan was extended until September 15, 1995 and the lender received the above mentioned 100,000 Lori common shares as consideration for the loan extension. The loan was repaid by ARTRA in February, 1996.\nThe Company recognized an extraordinary gain of $8,965,000 ($1.57 per share) in December 1994 as a result of the reduction of amounts due the bank under the loan agreements of the Borrowers and Fill-Mor to $10,500,000 (of which\n$7,855,000 pertained to Lori's obligation to the bank and $2,645,000 pertained to Fill-Mor's obligation to the bank) as of December 23, 1994.\nOn March 31, 1995 the bank was paid $750,000 and the remaining indebtedness of Lori and Fill-Mor was discharged, resulting in an additional extraordinary gain to the Company of $9,113,000 ($1.35 per share) in the first quarter of 1995. The $750,000 payment was funded with the proceeds of a $850,000 short-term loan from a former director of Lori. As consideration for assisting in the debt restructuring, the former director received 150,000 shares of the Lori common stock valued at $337,500 ($2.25 per share) based upon Lori's closing market value on March 30, 1995.\nThe common stock and virtually all the assets of the Company and its Bagcraft subsidiary have been pledged as collateral for borrowings under various loan agreements. Under certain debt agreements the Company is limited in the amounts it can withdraw from its operating subsidiaries. At December 28, 1995 substantially all cash and equivalents on the Company's consolidated balance sheet were restricted to use by and for the Company's operating subsidiaries.\nLitigation\nThe Company and its subsidiaries are the defendants in various business-related litigation and environmental matters. See Note 20 to the Company's consolidated financial statements. At December 28, 1995 and December 29, 1994, the Company had accrued $1,800,000 and $1,500,000 respectively, for potential business-related litigation and environmental liabilities. However, as discussed above ARTRA may not have available funds to pay liabilities arising out of these business-related litigation and environmental matters or, in certain instances, to provide for its legal defense. ARTRA could suffer severe adverse consequences in the event of an unfavorable judgment in any of these matters.\nNet Operating Loss Carryforwards\nAt December 28, 1995, ARTRA had Federal income tax loss carryforwards of approximately $33,000,000 expiring principally in 2003 - 2010. Additionally, ARTRA's discontinued Ultrasonix and Ratex subsidiaries had Federal income tax loss carryforwards of approximately $11,000,000 available to be applied against future taxable income, if any. In recent years, the Company has issued shares of its common stock to repay various debt obligations, as consideration for acquisitions, to fund working capital obligations and as consideration for various other transactions. Section 382 of the Internal Revenue Code of 1986 limits a corporation's utilization of its Federal income tax loss carryforwards when certain changes in the ownership of a corporation's common stock occurs. In the opinion of management, the Company is not currently subject to such limitations regarding the utilization of its Federal income tax loss carryforwards. Should the Company continue to issue a significant number of shares of its common stock, it could trigger a limitation that would prevent it from utilizing a substantial portion of its Federal income tax loss carryforwards.\nResults of Operations\nOn July 31, 1995, ARTRA and Bagcraft, entered into a letter of intent to sell the business assets, subject to the buyer's assumption of certain liabilities, of Arcar. On October 26, 1995, Bagcraft completed the sale of Arcar.\nIn September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business and recorded a provision of $1,000,000 for the estimated costs to complete the disposal of the fashion costume jewelry business.\nThe Company's consolidated financial statements have been reclassified to report separately the results of operations of Arcar and COMFORCE's (formerly Lori) discontinued fashion costume jewelry business prior to the deconsolidation of COMFORCE and its majority-owned subsidiaries effective October 1995. The following discussion of results of operations is presented for the Company's continuing operations at December 28, 1995, which were conducted by the Company's wholly-owned Bagcraft subsidiary.\nThe Company's Bagcraft subsidiary sells all of its products directly to its customers. On a very limited basis certain customers may be offered extended payment terms beyond 30 days depending upon prevailing trade practices and financial strength.\n1995 vs 1994\nNet sales from continuing operations of $121,879,000 for the year ended December 28, 1995 were $10,042,000, or 9.0%, higher than net sales from continuing operations for the year ended December 29, 1994. The 1995 sales increase is attributable to increased 1995 selling prices due to the significant increases in paper costs in the second half of 1994 and early 1995 and to an improved sales mix in 1995.\nThe Company's cost of sales from continuing operations of $102,508,000 for year ended December 28, 1995 increased $7,742,000 as compared to year ended December 29, 1994. Cost of sales from continuing operations in the year ended December 28, 1995 was 84.1% of net sales compared to a cost of sales percentage of 84.7% for the year ended December 29, 1994. The increase in cost of sales is primarily attributable to the significant increases in paper costs in the second half of 1994 and early 1995. The decrease in cost of sales percentage is primarily attributable to the Company's ability to pass along the significant increases in paper costs and to improved production efficiencies in 1995.\nSelling, general and administrative expenses from continuing operations were $19,131,000 in the year ended December 28, 1995 as compared to $16,760,000 in the year ended December 29, 1994. Selling, general and administrative expenses were 15.7% of net sales in the year ended December 28, 1995 as compared to 15.0% of net sales in the year ended December 29, 1994. The 1995 increase in selling, general and administrative expenses is primarily attributable to a compensation charge of $3,000,000 related to the issuance of a 35% common stock interest in COMFORCE\/Lori as additional compensation for certain individuals to enter into employment or consulting services agreements to manage its entry into and development of the telecommunications and computer technical staffing services business.\nIn recent years, Bagcraft has experienced a decline in its domestic microwave popcorn business due to the acquisition of one of its major customers by a company with its own packaging ability. Accordingly, at December 31, 1995, Bagcraft incurred a charge to operations of $1,503,000 to write-down the carrying value of idle machinery and equipment dedicated to the production of microwave popcorn products.\nOperating loss from continuing operations in the year ended December 28, 1995 was $5,593,000 as compared to operating loss of $4,026,000 in the year ended December 29, 1994. The increased operating loss is primarily attributable to a compensation charge of $3,000,000 related to the issuance of a 35% common stock interest in COMFORCE\/Lori as additional compensation for certain individuals to enter into employment or consulting services agreements to manage its entry into and development of the telecommunications and computer technical staffing services business and a charge to operations of $1,503,000 to write-down the carrying value of idle machinery and equipment dedicated to the production of microwave popcorn products, partially offset by improved operating margins of the Bagcraft subsidiary.\nInterest expense from continuing operations in the year ended December 28, 1995 increased $1,164,000 as compared to the year ended December 29, 1994. The 1995 increase is principally due to the cost of ARTRA common stock issued as additional compensation for the December 1995 private placement of ARTRA short-term notes.\nDue to the Company's tax loss carryforwards and the uncertainty of future taxable income, no income tax benefit was recognized in connection with the Company's 1995 and 1994 pre-tax losses. The 1995 extraordinary credit represents a net gain from discharge of bank indebtedness.\n1994 vs 1993\nNet sales from continuing operations of $111,837,000 for the year ended December 29, 1994 were $1,747,000, or 1.5%, lower than net sales from continuing operations for the year ended December 30, 1993. The 1994 net sales decrease is primarily attributable to the sale of Bagcraft's Roll Press division, which was completed in the second quarter of 1993.\nThe Company's cost of sales from continuing operations of $94,766,000 for year ended December 29, 1994 increased $1,305,000 as compared to year ended December 30, 1993. Cost of sales from continuing operations in the year ended December 28, 1995 was 84.7% of net sales compared to a cost of sales percentage of 82.3% for the year ended December 30, 1993. The increase in the packaging segment cost of sales and cost of sales percentage is primarily attributable to unforeseen delays in the completion of and higher than anticipated start-up costs of the Baxter Springs, Kansas production facility and higher raw material costs in the second half of 1994, partially offset by a more favorable product mix.\nSelling, general and administrative expenses from continuing operations were $16,760,000 in the year ended December 29, 1994 as compared to $15,537,000 in the year ended December 30, 1993. Selling, general and administrative expenses were 15.0% of net sales in the year ended December 29, 1994 as compared to 13.7% of net sales in the year ended December 30, 1993. The 1994 increase in selling, general and administrative expenses is primarily attributable to an increase in employee benefit costs and professional fees.\nIn December, 1993 the Bagcraft subsidiary recorded a charge to operations of $1,175,000 representing equipment and inventory relocation costs and employee severance and outplacement costs relating to the construction of a new manufacturing facility in Baxter Springs, Kansas.\nOperating loss from continuing operations in the year ended December 29, 1994 was $4,026,000 as compared to operating loss of $974,000 in the year ended December 30, 1993. The increased operating loss is primarily attributable to unforeseen delays in the completion of and higher than anticipated start-up costs of the Baxter Springs, Kansas production facility.\nInterest expense from continuing operations in the year ended December 29, 1994 increased $2,067,000 as compared to the year ended December 30, 1993. The 1994 increase is principally due to an overall increase in borrowings due to the December, 1993 refinancing of Bagcraft's bank debt, an increase in the prime rate and fees incurred for short-term borrowings at the Corporate entity.\nThe 1994 extraordinary credit represents a net gain from discharge of bank indebtedness under the loan agreements of Lori and its operating subsidiaries. The 1993 extraordinary credit represents a gain from a net discharge of indebtedness at Lori's New Dimensions subsidiary. No income tax expense is reflected in the Company's financial statements resulting from the extraordinary credit due to the utilization of tax loss carryforwards.\nImpact of Inflation and Changing Prices\nInflation has become a less significant factor in our economy; however, to the extent permitted by competition, the Company generally passes increased costs to its customers by increasing sales prices over time.\nRecently Issued Accounting Pronouncements\nImpairment of Long-Lived Assets\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. 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 26, 1996. The Company believes that adoption will not have a material impact on its financial statements.\nStock-Based Compensation\nSFAS 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 earnings per share under the new method. This new accounting principle is effective for the Company's fiscal year ending December 26, 1996. The Company believes that adoption will not have a material impact on its financial statements as the Company will not adopt the new fair value accounting, but instead comply with the disclosure requirements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial Statements and Schedules as listed on Page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\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 Part III will be filed as an amendment to Form 10-K.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1. Financial Statements as listed on Page. 2. Financial Statement Schedules as listed on Page. 3. Exhibits as listed on Page E-1.\n(b) Reports on Form 8-K.\nOn November 8, 1995 the Company filed Form 8-K to report:\n1) The October 26, 1995 sale of the business assets, subject to the buyers assumption of certain liabilities, of Bagcraft's Arcar Graphics subsidiary.\n2) The settlement of certain debt obligations due a bank lender of approximately $5,000,000 for a cash payment of $150,000.\nOn October 31, 1995 the Company filed Form 8-K to report:\n1) The October 17, 1995 acquisition of COMFORCE Global Inc. by The Lori Corporation and the discontinuance of Lori's fashion costume jewelry business.\n2) The reduction of the Company's common stock ownership interest in The Lori Corporation from 62.6% to approximately 25% due to the issuance Lori common shares principally to certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business and a private placement of Lori common shares to fund the acquisition of COMFORCE Global.\nOn October 11, 1995 the Company filed Form 8-K to report:\n1) On September 11, 1995, the Company's 62.6% owned subsidiary The Lori Corporation agreed to participate in the acquisition of COMFORCE Global Inc.\n2) On July 11, 1995 The Company and its 62.6% owned subsidiary The Lori Corporation entered into agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business.\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.\nARTRA GROUP INCORPORATED\nBy: JOHN HARVEY ----------------------- John Harvey Chairman and Director Dated: April 9, 1996 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.\nJOHN HARVEY Chairman and Director April 9, 1996 - ----------------------- John Harvey Chief Executive Officer\nPETER R. HARVEY President and Director April 9, 1996 - ----------------------- Peter R. Harvey Chief Operating Officer\nJAMES D. DOERING Vice President \/Treasurer April 9, 1996 - ----------------------- James D. Doering Chief Financial Officer\nGERARD M. KENNY Director April 9, 1996 - ----------------------- Gerard M. Kenny\nLAWRENCE D. LEVIN Controller April 9, 1996 - ----------------------- Lawrence D. Levin\nPage ---- ARTRA GROUP INCORPORATED AND SUBSIDIARIES\nReport of Independent Accountants\nConsolidated Balance Sheets as of December 28, 1995 and December 29, 1994\nConsolidated Statements of Operations for each of the three fiscal years in the period ended December 28, 1995\nConsolidated Statements of Changes in Shareholders' Equity (Deficit) for each of the three fiscal years in the period ended December 28, 1995\nConsolidated Statements of Cash Flows for each of the three fiscal years in the period ended December 28, 1995\nNotes to Consolidated Financial Statements\nSchedules:\nI. Condensed Financial Information of Registrant\nII. Valuation and Qualifying Accounts\nSchedules other than those listed are omitted as they are not applicable or required or equivalent information has been included in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors ARTRA GROUP Incorporated Northfield, Illinois\nWe have audited the consolidated financial statements and the financial statement schedules of ARTRA GROUP Incorporated and Subsidiaries as listed in the index on page of this Form 10-K. These financial statements and financial statement schedules are the responsibility of ARTRA GROUP Incorporated's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ARTRA GROUP Incorporated and Subsidiaries as of December 28, 1995 and December 29, 1994, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended December 28, 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.\nThe accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency. As a result of these factors, the Company has experienced difficulty in obtaining adequate financing to replace its current credit arrangements, certain of which are in default, to fund its debt service and to satisfy liquidity requirements for 1996. 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 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois April 9, 1996\nARTRA GROUP INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)\nDecember 28, December 29, 1995 1994 -------- --------\nASSETS Current assets: Cash and equivalents $2,347 $2,070 Restricted cash and equivalents 552 1,324 Receivables, less allowance for doubtful accounts and markdowns of $250 in 1995 and $1,654 in 1994 10,897 13,707 Inventories 16,634 20,268 Available -for-sale securities 1,427 - Other 324 1,148 -------- -------- Total current assets 32,181 38,517 -------- --------\nProperty, plant and equipment Land 930 930 Buildings 11,679 10,584 Improvements to land and leaseholds - 187 Machinery and equipment 30,547 33,756 Construction in in progress 1,117 2,693 -------- -------- 44,273 48,150 Less accumulated depreciation and amortization 17,335 17,110 -------- -------- 26,938 31,040 -------- --------\nOther assets: Available -for-sale securities 15,519 - Excess of cost over net assets acquired, net of accumulated amortization of $2,022 in1995 and $7,934 in 1994 3,258 19,076 Other 53 4,796 -------- -------- 18,830 23,872 -------- -------- $77,949 $93,429 ======== ========\nThe accompanying notes are an integral part of the consolidated financial statements.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)\nDecember 28, December 29, 1995 1994 -------- --------\nLIABILITIES Current liabilities: Notes payable, including amounts due to related parties of $5,675 in 1995 and $5,669 in 1994 $25,300 $28,053 Current maturities of long-term debt 3,512 37,521 Accounts payable, including amounts due to a related party of $399 in 1995 10,925 16,788 Accrued expenses 14,106 16,533 Income taxes 203 94 Liabilities of discontinued operations 4,500 - -------- ------- Total current liabilities 58,546 98,989 -------- -------\nLong-term debt 34,113 19,673 Debt subsequently discharged - 9,750 Other noncurrent liabilities 650 1,463 Commitments and contingencies\nRedeemable common stock, issued 283,965 shares in 1995 and 279,679 shares in 1994 4,774 4,144 ARTRA redeemable preferred stock payable to a related party, $1,000 par value; Series A, 6% cumulative payment-in-kind, including accumulated dividends, net of unamortized discount of $1,575 in 1995 and $1,842 in 1994; redeemable March 1, 2000 at $1,000 per share plus accrued dividends; authorized 2,000,000 shares all series; issued 3,750 shares 3,694 3,129 Bagcraft redeemable preferred stock payable to a related party, cumulative $.01 par value, 13.5%; including accumulated dividends; redeemable in 1997 with a liquidation preference equal to $100 per share; 50,000 shares authorized and issued 10,794 10,119 BCA Holdings preferred stock payable to a related party, $1.00 par value, Series A, 6% cumulative; including accumulated dividends; liquidation preference of $1,000 per share; 10,000 shares authorized; issued 3,675 shares 4,143 3,922\nSHAREHOLDERS' EQUITY (DEFICIT) Common stock, no par value; authorized 7,500,000 shares; issued 7,102,979 shares in 1995 and 6,455,602 shares in 1994 5,540 5,052 Additional paid-in capital 38,526 36,613 Unrealized appreciation of investments 21,047 - Receivable from related party, including accrued interest (4,318) (4,100) Accumulated deficit (98,755) (94,520) -------- -------- (37,960) (56,955) Less treasury stock (57,038 shares), at cost 805 805 -------- -------- (38,765) (57,760) -------- -------- $77,949 $93,429 ======== ========\nThe accompanying notes are an integral part of the consolidated financial statements.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\n_______________________________________________ * As reclassified for discontinued operations.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) (In thousands, except share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\nARTRA GROUP INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars)\nThe accompanying notes are an integral part of the consolidated financial statements.\nARTRA GROUP INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars)\nThe accompanying notes are an integral part of the consolidated financial statements.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Basis of Presentation and Financial Restructuring\nARTRA Group Incorporated's (\"ARTRA\" or the \"Company\") consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amount and classification of liabilities or other adjustments that might be necessary should ARTRA be unable to continue as a going concern.\nThe Company has suffered recurring losses from operations and has a net capital deficiency. As a result of these factors, the Company has experienced difficulty in obtaining adequate financing to replace certain current credit arrangements, certain of which are in default, and to fund its debt service and liquidity requirements in 1996. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. See Note 9, Notes Payable, and Note 10, Long Term Debt, for further discussion of the status of credit arrangements and restrictions on the ability of operating subsidiaries to fund ARTRA corporate obligations. Due to its limited ability to receive operating funds from its operating subsidiaries, ARTRA has historically met its operating expenditures with funds generated by alternative sources, such as private placements of ARTRA common stock and notes, sales of ARTRA common stock with put options, loans from officers\/directors and private investors, as well as through sales of assets and\/or other equity infusions. ARTRA plans to continue to seek such alternative sources of funds to meet its future operating expenditures.\nARTRA, through its wholly-owned subsidiary, Bagcraft Corporation of America (\"Bagcraft\"), currently operates in one industry segment as a manufacturer of packaging products principally serving the food industry. Prior to September 28, 1995, ARTRA's then 62.9% owned subsidiary, The Lori Corporation (\"Lori\"), operated as a designer and distributor of popular-priced fashion costume jewelry and accessories. In recent years, Lori's fashion costume jewelry operations had experienced a pattern of significantly lower sales levels and related operating losses primarily due to a shift in the buying patterns of its major customers (i.e. certain mass merchandisers) from participation in Lori's service program to purchases of costume jewelry and accessories directly from manufacturers and due to a continued unfavorable retail environment. Accordingly, in September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business as discussed in Note 3.\nAs discussed in Note 3, on September 11, 1995, Lori signed a stock purchase agreement to participate in the acquisition of one hundred percent of the capital stock of COMFORCE Global Inc. (\"Global\"), formerly Spectrum Global Services, Inc. d\/b\/a YIELD Global, a wholly owned subsidiary of Spectrum Information Technologies, Inc. Global provides telecommunications and computer technical staffing and consulting services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. On October 17, 1995, Lori completed the acquisition of one hundred percent of the capital stock of Global. In connection with the re-focus of its business Lori changed its name to COMFORCE Corporation (\"COMFORCE\").\nEffective July 4, 1995, Lori and ARTRA entered into employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. As additional compensation, the agreements provided for the issuance in aggregate of a 35% common stock interest in Lori. After the issuance of the Lori common shares, plus the effects of the issuance of Lori common shares sold by private placements and other Lori common shares issued in conjunction with the Global acquisition, ARTRA's common stock ownership interest in COMFORCE common stock was reduced to approximately 25% at December 28, 1995. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the equity method through the end of fiscal 1995. See Note 6 for a further discussion of ARTRA's investment in COMFORCE.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nEffective October 26, 1995, Bagcraft completed the sale of the business assets, subject to the buyer's assumption of certain liabilities, of its wholly-owned subsidiary, Arcar Graphics, Inc. (\"Arcar\"), for cash of approximately $20,300,000. The net proceeds, after extinguishment of certain Arcar debt obligations, of approximately $10,400,000, were used to reduce Bagcraft debt obligations.\nIn October, 1995 the Company recognized an extraordinary gain of $4,917,000 ($.71 per share) as a result of a settlement agreement with a bank whereby a $3,600,000 note payable due December 31, 1990 plus accrued interest of $1,467,000 were discharged for a cash payment of $150,000.\nAs discussed in Note 8, the Company recognized an extraordinary gain of $9,113,000 ($1.35 per share) in March 1995 as a result of the discharge of amounts due a bank under the loan agreements of Lori and its parent, Fill-Mor Holding, Inc. (\"Fill-Mor\").\nIn June 1995 ARTRA entered into an agreement to settle amounts due ARTRA by the former Welch Vacuum Technology (\"Welch\") subsidiary under terms of a noncompetition agreement and a subordinated note in the principal amount of $2,500,000 received by ARTRA as part of the proceeds from the 1989 sale of Welch. Per terms of the settlement agreement, ARTRA received cash of $3,000,000 and a subordinated note in the principal amount of $640,000 payable June 30, 2001. The cash proceeds were used for a $2,500,000 reduction of amounts due on certain ARTRA bank notes, with the remainder used for working capital. In conjunction with this transaction, ARTRA entered into a letter agreement with the bank whereby the bank agreed not to exercise any of its rights and remedies with respect to amounts due the bank under its ARTRA notes (see Note 9) and certain obligations of ARTRA's president, Peter R. Harvey.\nIn February 1996, the bank agreed to discharge all amounts under its ARTRA notes ($12,063,000 plus accrued interest) and certain obligations of Mr. Harvey for a cash payment of $5,150,000 and Mr. Harvey's $850,000 note payable to the bank. ARTRA will recognize a gain on the discharge of this indebtedness of approximately $10,000,000 in the first quarter of 1996. The cash payment due the bank was funded principally with proceeds received from a short-term loan agreement along with proceeds received from the Bagcraft subsidiary as consideration for the issuance of BCA Holdings, Inc. (\"BCA\", the parent of Bagcraft) preferred stock, see Note 12.\nARTRA intends to continue to negotiate with its creditors to extend due dates to allow ARTRA to maximize value from possible sale of assets and to explore various other sources of funding to meet its future operating expenditures. If ARTRA is unable to negotiate extensions with its creditors and complete the above mentioned transactions, ARTRA could suffer severe adverse consequences, and as a result, ARTRA may be forced to liquidate its assets or file for protection under the Bankruptcy Code.\nThe Company has adopted a 52\/53 week fiscal year ending the last Thursday of December.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Intercompany accounts and transactions are eliminated.\nB. Cash Equivalents\nShort-term investments with an initial maturity of less than ninety days are considered cash equivalents.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nC. Inventories\nInventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method.\nD. Property, Plant and Equipment\nProperty, plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operations as incurred and expenditures for major renovations are capitalized. Depreciation is computed on the basis of estimated useful lives principally by the straight line method for financial statement purposes and principally by accelerated methods for tax purposes. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the period covered by the lease.\nThe costs of property retired or otherwise disposed of are applied against the related accumulated depreciation to the extent thereof, and any profit or loss on the disposition is recognized in earnings.\nE. Investments in Equity Securities\nIn 1995, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" Under this statement, at December 28, 1995, the Company's investment in COMFORCE (see Note 6) is classified as available for sale and is stated at fair value. The adoption of SFAS No. 115 resulted in an increase to shareholders' equity in the fourth quarter of 1995 of $21,047,000. In prior years and, until October 1995, COMFORCE was a majority-owned subsidiary included in the consolidated financial statements of the Company.\nF. Intangible Assets\nThe net assets of a purchased business are recorded at their fair value at the date of acquisition. The excess of purchase price over the fair value of net assets acquired (goodwill) is reflected as intangible assets and amortized on a straight-line basis principally over 40 years.\nThe 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 forecasted future operations.\nG. Revenue Recognition\nSales to customers are recorded at the time of shipment net of estimated markdowns and merchandise credits.\nH. Income Taxes\nIncome taxes are accounted for as prescribed in Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes. Under the asset and liability method of Statement No. 109, the Company recognizes the amount of income taxes payable. 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 those temporary differences are expected to recovered or settled.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nI. Use of Estimates In Preparation of 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 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.\nJ. Recently Issued Accounting Pronouncements\nImpairment of Long-Lived Assets\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. 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 26, 1996. The Company believes that adoption will not have a material impact on its financial statements.\nStock-Based Compensation\nSFAS 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 earnings per share under the new method. This new accounting principle is effective for the Company's fiscal year ending December 26, 1996. The Company believes that adoption will not have a material impact on its financial statements as the Company will not adopt the new fair value accounting, but instead comply with the disclosure requirements.\n3. CHANGE OF BUSINESS\nArcar Graphics, Inc.\nEffective April 8, 1994, Bagcraft purchased the business assets, subject to buyer's assumption of certain liabilities, of Arcar, a manufacturer and distributor of waterbase inks, for consideration of $10,264,000 consisting of cash of $2,264,000 and subordinated promissory notes totaling $8,000,000. The acquisition of Arcar was accounted for by the purchase method and, accordingly, the assets and liabilities of Arcar were included in ARTRA's financial statements at their estimated fair market value at the date of acquisition.\nEffective October 26, 1995, Bagcraft sold the business assets, subject to the buyer's assumption of certain liabilities, of Arcar for cash of approximately $20,300,000, resulting in a net gain of $8,483,000. The net proceeds, after extinguishment of certain Arcar debt obligations, of approximately $10,400,000, were used to reduce Bagcraft debt obligations. At December 29, 1994, the total assets and liabilities of Arcar were approximately $13,157,000 and $11,914,000, respectively.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLori\/COMFORCE\nIn September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business and recorded a provision of $1,000,000 for the estimated costs to complete the disposal of the fashion costume jewelry business. At December 29, 1994, the total assets and liabilities of Lori's discontinued fashion costume jewelry business were approximately $17,460,000 and $11,914,000, respectively.\nEffective October 17, 1995, Lori acquired one hundred percent of the capital stock of COMFORCE Global, Inc. (\"Global\"), formerly Spectrum Global Services, Inc. d\/b\/a YIELD Global, a wholly owned subsidiary of Spectrum Information Technologies, Inc. for consideration of approximately $6.4 million, net of cash acquired, consisting of cash of approximately $5.6 million and 500,000 shares of Lori common stock issued as consideration for various fees and guarantees associated with the transaction. The cash consideration included net cash payments to the selling shareholders of approximately $5.2 million. The 500,000 shares of Lori common stock issued as consideration for the Global transaction included 150,000 shares issued to Peter R. Harvey, then a director of Lori and currently the president\/director of ARTRA and 100,000 shares issued to ARTRA for their guarantee to the selling shareholder of the payment of the Global purchase price at closing. The shares issued to Peter R. Harvey and ARTRA are subject to approval by the issuer's shareholders.\nGlobal provides telecommunications and computer technical staffing services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. The acquisition of Global was funded principally by private placements of approximately 1,950,000 shares of Lori common stock at $3.00 per share (total proceeds of approximately $5,800,000) plus detachable warrants to purchase approximately 970,000 shares of Lori common stock at $3.375 per share that expire five years from the date of issue. In connection with the re-focus of its business, Lori changed its name to COMFORCE Corporation. Additionally, in conjunction with the Global acquisition, ARTRA has agreed to assume certain pre-existing Lori liabilities and indemnify COMFORCE in the event any future liabilities arise concerning pre-existing environmental matters and business related litigation. Accordingly, ARTRA has accrued $4,500,000 of Lori liabilities classified in its consolidated balance at December 28, 1995 as current liabilities of discontinued operations.\nEffective July 4, 1995, Lori and ARTRA entered into employment or consulting services agreements with certain individuals to manage Lori's entry into and development of the telecommunications and computer technical staffing services business. As additional compensation, the agreements provided for the issuance in aggregate of a 35% common stock interest in Lori. After the issuance of the Lori common shares, plus the effects of the issuance of Lori common shares sold by private placements and other Lori common shares issued in conjunction with the Global acquisition, ARTRA's common stock ownership interest in COMFORCE common stock was reduced to approximately 25%. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the equity method through the end of fiscal 1995. See Note 6 for a further discussion of and the accounting treatment of the Company's investment in COMFORCE at December 28, 1995.\nOther\nDuring 1995 the Company was dismissed as party to certain litigation relating to the former Welch subsidiary. Accordingly, the Company reversed $700,000 of excess liability accruals originally provided in 1989 to complete the disposal of Welch.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe Company's consolidated financial statements have been reclassified to report separately the results of operations of Arcar and COMFORCE's discontinued fashion costume jewelry business prior to the deconsolidation of Lori and its majority-owned subsidiaries effective October 1995. The 1995, 1994 and 1993 operating results (in thousands) of Bagcraft's discontinued Arcar subsidiary and COMFORCE's discontinued fashion costume jewelry business and net gain on disposal of discontinued operations consist of:\n1995 1994 1993 -------- -------- ---------\nNet sales $ 16,932 $ 40,278 $ 46,054 ======== ======== =========\nLoss from operations before income taxes $ (8,156) $(15,832) $ (183 Provision for income taxes (17) (74) (33) -------- -------- --------- Loss from operations (8,173) (15,906) (216) -------- -------- ---------\nGain on sale of Arcar subsidiary 8,483 -- --\nProvision for disposal of business (300)\nProvision for income taxes -- -- -- -------- -------- --------- Gain on disposal of businesses 8,183 -- -- -------- -------- --------- Earnings (loss) from discontinued operations $ 10 $(15,906) $ (216) ======== ======== =========\n4. CONCENTRATION OF RISK\nThe accounts receivable of the Company's Bagcraft subsidiary at December 28, 1995 consist primarily of amounts due from companies in the food industry. As a result, the collectibility of these receivables is dependent, to an extent, upon the economic condition and financial stability of the food industry. Credit risk is minimized as a result of the large number and diverse nature of Bagcraft's customer base. Bagcraft's major customers include some of the largest companies in the food industry. At December 28, 1995, Bagcraft had 10 customers with accounts receivable balances that aggregated approximately 40% of the Company's total trade accounts receivable. No single customer accounted for 10% or more of Bagcraft's 1995 sales.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n5. INVENTORIES\nInventories consist of:\nDecember 28, December 29, 1995 1994 -------- -------- (in thousands)\nRaw materials and supplies $ 5,645 $ 7,041 Work in process 40 877 Finished goods 10,949 12,350 -------- -------- $ 16,634 $ 20,268 ======== ========\n6. INVESTMENT IN COMFORCE (formerly LORI) CORPORATION\nAs discussed in Note 3, due to the issuances of COMFORCE common shares in conjunction with the acquisition of Global, ARTRA's common stock ownership in COMFORCE was reduced to approximately 25%. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the requirements of APB Opinion No. 18 \"The Equity Method of Accounting for Investments in Common Stock\" through the end of fiscal 1995.\nEffective December 28, 1995, John Harvey and Peter R. Harvey, ARTRA's chairman and president, respectively, resigned as directors of COMFORCE. Due to such factors as a lack of board of directors representation and participation in policy formulation by ARTRA, as well as a lack of interchange of managerial personnel, ARTRA is not able to exercise significant influence over the operating and financial policies of COMFORCE. Additionally, assuming contemplated additional issuances of COMFORCE common shares, on a fully diluted basis ARTRA's ownership interest in COMFORCE will be reduced to less than 20%. In the opinion of the Company, effective December 28, 1995, the investment in COMFORCE ceased to conform to the requirements of APB Opinion No. 18. Accordingly, the Company adopted SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" Under this statement, at December 28, 1995, the Company's investment in COMFORCE is classified as available for sale and is stated at fair value. The adoption of SFAS No. 115 resulted in an increase to shareholders' equity in the fourth quarter of 1995 of $21,047,000. In prior years and, until October 1995, COMFORCE was a majority-owned subsidiary included in the consolidated financial statements of the Company.\nIn February 1996, ARTRA sold the 200,000 COMFORCE common shares it received in connection with Lori's acquisition of COMFORCE to certain officers, directors and key employees of ARTRA. As additional consideration for a February 1996 short-term loan (see Note 9) the lender has received to-date 37,500 COMFORCE common shares held by ARTRA. In March 1996, ARTRA sold 93,000 COMFORCE shares in the market, with the proceeds used for working capital. The above mentioned 330,500 COMFORCE shares were classified in the Company's consolidated balance sheet at December 28, 1995 in current assets as \"Available-for-sale securities.\" ARTRA's remaining investment in COMFORCE (1,970,536 shares) was classified in the Company's consolidated balance sheet at December 28, 1995 in noncurrent assets as \"Available-for-sale securities.\"\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n7. INVESTMENT IN EMERALD ACQUISITION CORPORATION \/ ENVIRODYNE INDUSTRIES, INC.\nIn March, 1989, Envirodyne Industries, Inc. (\"Envirodyne\") and Emerald Acquisition Corporation (\"Emerald\") entered into a definitive agreement for a subsidiary of Emerald to acquire all of the issued and outstanding shares of Envirodyne common stock. Pursuant to the terms of certain letter agreements, ARTRA agreed to participate in the transaction and received Envirodyne's consent to sell its then 4,830,000 Envirodyne common shares (a 26.3% interest) to Emerald. On May 3, 1989 the transaction was consummated. ARTRA received consideration consisting of cash of $75,000,000, a 27.5% common stock interest in Emerald and Emerald junior debentures.\nOn January 6, 1993, a group of bondholders filed an involuntary petition for reorganization of Envirodyne under Chapter 11 of the U.S. Bankruptcy Code. On January 7, 1993, Envirodyne and certain of its subsidiaries (the \"Debtor\") filed petitions under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Illinois, Eastern Division. Subsequently, Emerald filed a voluntary petition under Chapter 11 of the Bankruptcy Code in the same court.\nEnvirodyne's plan of reorganization did not provide for any distribution or value to Emerald and Emerald, therefore, is without assets to provide value to ARTRA for ARTRA's investment in Emerald common stock and Emerald Junior Debentures. See discussion below and in Note 20 Litigation for remedies being pursued by ARTRA as damages for the lost value of its investment in Emerald common stock and Emerald Junior Debentures.\nOn November 2, 1993, ARTRA filed suit in the Circuit Court of the Eighteenth Judicial Circuit for the state of Illinois (the \"State Court Action\") against Salomon Brothers, Inc., Salomon Brothers Holding Company, Inc., Charles K. Bobrinskoy, Michael J. Zimmerman (collectively, \"Salomon Defendants\"), D.P. Kelly & Associates, L.P. (\"DPK\"), Donald P. Kelly (\"Kelly Defendants\" along with DPK), James F. Massey and William Rifkind. On November 22, 1993, ARTRA filed a First Amended Complaint. The defendants removed the case to the Bankruptcy Court in which the Emerald Chapter 11 case is pending. On July 15, 1994 all but two of ARTRA's causes of action were remanded to the state court. The Bankruptcy Court retained jurisdiction of ARTRA's claims against the defendants for breaching their fiduciary duty as directors of Emerald to Emerald's creditors and interference with ARTRA's contractual relations with Emerald. On April 7, 1995, the Company's appeal of the Bankruptcy Court's order retaining jurisdiction over two claims was denied. On July 26, 1995, the Bankruptcy Court entered an order dismissing these claims. On August 4, 1995, ARTRA appealed from the Bankruptcy Court's dismissal order. That appeal is still pending.\nOn July 18, 1995, ARTRA filed a Fourth Amended Counterclaim in the State Court Action for breach of fiduciary duty, fraudulent misrepresentation, negligent misrepresentation, breach of contract and promissory estopel. In the State Court Action, ARTRA seeks compensatory damages of $136.2 million, punitive damages of $408.6 million and approximately $33 million in fees paid to Salomon. The causes of action for breach of the fiduciary duty of due care were repleaded to reserve ARTRA's right to appeal the State Court's dismissal of the causes of action in the Third Amended Complaint. Defendant Kelly was dismissed with prejudice pursuant to a stipulation between ARTRA and the Kelly Defendants.\nOn or about March 1, 1996, DPK brought a motion for summary judgment as to ARTRA's claims for breach of contract and promissory estoppel. DPK's motion is currently pending.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n8. EXTRAORDINARY GAINS\nARTRA Debt Restructuring\nIn October, 1995 the Company recognized an extraordinary gain of $4,917,000 ($.71 per share) as a result of a settlement agreement with a bank whereby a $3,600,000 note payable due December 31, 1990 plus accrued interest of $1,467,000 were discharged for a cash payment of $150,000.\nLori Debt Restructuring\nPer terms of a debt settlement agreement, borrowings due a bank under the loan agreements of Lori and its discontinued fashion costume jewelry subsidiaries (including the former New Dimensions (\"New Dimensions\") subsidiary, which ceased operations in December 1994) and Fill-Mor (approximately $25,000,000 as of December 23, 1994), plus amounts due the bank for accrued interest and fees were reduced to $10,500,000 (of which $7,855,000 pertained to Lori's obligation to the bank and $2,645,000 pertained to Fill-Mor's obligation to the bank). Upon the satisfaction of certain conditions of the debt settlement agreement in 1995, as discussed below, the balance of this indebtedness was discharged.\nIn conjunction with the debt settlement agreement, ARTRA entered into a $1,850,000 short-term loan agreement with a non-affiliated corporation, the proceeds of which were used to fund amounts due the bank as discussed below. The loan, due June 30, 1995, with interest payable monthly at 10%, was collateralized by 100,000 shares of Lori common stock. These 100,000 Lori common shares were originally issued to the bank under terms of the debt settlement agreement. In August, 1995 the loan was extended until September 15, 1995 and the lender received the above mentioned 100,000 Lori common shares as consideration for the loan extension. The loan was repaid by ARTRA in February, 1996.\nThe Company recognized an extraordinary gain of $8,965,000 ($1.57 per share) in December 1994 as a result of the reduction of amounts due the bank under the loan agreements of Lori and its discontinued fashion costume jewelry subsidiaries and Fill-Mor to $10,500,000 (of which $7,855,000 pertained to Lori's obligation to the bank and $2,645,000 pertained to Fill-Mor's obligation to the bank) as of December 23, 1994 calculated (in thousands) as follows:\nAmounts due the bank under loan agreements of Lori and its operating subsidiaries and Fill-Mor $ 25,394 Less amounts due the bank at December 29, 1994 (10,500) --------- Bank debt discharged 14,894 Accrued interest and fees discharged 3,635 Other liabilities discharged 1,985 Less consideration to the bank per terms of the amended settlement agreement Cash (1,900) ARTRA common stock (2,500) New Dimensions assets assigned to the bank at estimated fair market value (7,149) --------- Net extraordinary gain $ 8,965 =========\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nOn March 31, 1995, the bank was paid $750,000 and the remaining indebtedness of Lori and Fill-Mor was discharged, resulting in an additional extraordinary gain to the Company of $9,113,000 ($1.35 per share) in the first quarter of 1995. The $750,000 payment was funded with the proceeds of a $850,000 short-term loan from a former director of Lori. As consideration for assisting in the debt restructuring, the former director received 150,000 shares of Lori common stock valued at $337,500 ($2.25 per share) based upon Lori's closing market value on March 30, 1995. The first quarter 1995 extraordinary gain was calculated (in thousands) as follows:\nAmounts due the bank under loan agreements of Lori and its operating subsidiaries and Fill-mor $ 10,500 Less amounts due the bank (750) --------- Bank debt discharged 9,750 Less fair market value of Lori common stock issued as consideration for the debt restructuring (337) Other fees and expenses (300) --------- Net extraordinary gain $ 9,113 =========\nNew Dimensions 1993 Restructuring\nThe reorganization of New Dimensions resulted in a 1993 extraordinary gain of $22,057,000 ($4.49 per share) from a net discharge of indebtedness calculated (in thousands) as follows:\nAmount due on New Dimensions' 12.75% Senior Notes, including accrued interest $ 22,822 Trade liabilities and accrued expenses 3,231 --------- Total unsecured claims 26,053 Less present value of payments due to unsecured creditors (2,725) Less present value of bank restructuring loan fee (1,271) --------- Net extraordinary gain $ 22,057 =========\n9. NOTES PAYABLE\nNotes payable (in thousands) consist of: December 28, December 29, 1995 1994 -------- --------\nARTRA bank notes payable, at various interest rates $ 12,063 $ 18,507 Amounts due to related parties, interest from 8% to 12% 5,675 5,669 ARTRA 12% convertible subordinated promissory notes 2,500 - Other, interest from 8% to 20% 5,062 3,877 -------- -------- $ 25,300 $ 28,053 ======== ========\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nBank Notes Payable\nAt December 31, 1993, $17,063,000 in ARTRA notes, plus related loan fees and accrued interest were payable to a bank. The notes provided for interest at the prime rate. These bank notes were collateralized by, among other things, 100% of the common stock of ARTRA's BCA subsidiary, the parent of Bagcraft, and a secondary position on the assets of BCA, payments due under a noncompetition agreement with the Company's former Welch subsidiary and by a subordinated note in the principal amount of $2,500,000 received by ARTRA as part of the proceeds from the sale of Welch. Additionally, the bank notes are collateralized by a $5,500,000 personal guaranty of a private investor and, prior to March 31, 1994 as discussed below, the bank notes were collateralized by a $2,500,000 guaranty of a private corporation. A major shareholder and executive officer of the private corporation is an ARTRA director. As additional compensation, the private investor is receiving 1,833 shares of ARTRA common stock for each month the guaranty is outstanding and the private corporation received 833 shares of ARTRA common stock for each month the guaranty was outstanding. Among other things, the bank notes prohibit the payment of cash dividends by ARTRA.\nOn March 31, 1994, ARTRA entered into a series of agreements with its bank lender and with the private corporation noted above that had guaranteed $2,500,000 of ARTRA's bank notes. Per terms of the agreements, the private corporation purchased $2,500,000 of ARTRA notes from ARTRA's bank thereby reducing the outstanding principal on ARTRA's bank notes to $12,063,000 and the bank released the private corporation from its $2,500,000 loan guaranty. The ARTRA bank notes and related loan fees were payable on September 30, 1994. Interest on the bank notes continues to accrue at the prime rate (8.75% and 8.5% at September 28, 1995 and December 29, 1994, respectively) and is payable quarterly. Interest on the bank notes has been paid through June 14, 1994. Effective March 31, 1994, ARTRA pledged, as additional collateral for its bank notes, any and all net proceeds arising from its lawsuit against Salomon Brothers, Inc., Salomon Brothers Holding Company Inc. (collectively, \"Salomon\") D.P. Kelly & Associates, L.P. (\"Kelly\") and all of the directors of Emerald for breaches of fiduciary duty by the directors of Emerald, induced by Salomon and Kelly, in connection with the reorganization of Envirodyne as discussed in Note 7. As consideration for purchasing $2,500,000 of ARTRA bank notes, the private corporation received a $2,500,000 note payable from ARTRA bearing interest at the prime rate.\nAs additional consideration, the private corporation has received an option to put back to ARTRA the 49,980 shares of ARTRA common stock received as compensation for its former $2,500,000 ARTRA loan guaranty at a price of $15.00 per share. The put option is exercisable on the later of the day that the $2,500,000 note payable to the private corporation becomes due or the date the ARTRA bank notes have been paid in full. The option price increases by $2.25 per share annually ($18.938 per share at December 28, 1995). The $2,500,000 note payable to the private corporation is reflected in the above table as amounts due to related parties. During the first quarter of 1996, the $2,500,000 note and related accrued interest was paid in full principally with proceeds from additional short-term borrowings.\nIn June 1995 ARTRA entered into an agreement to settle amounts due ARTRA by the former Welch subsidiary under terms of a noncompetition agreement and a subordinated note in the principal amount of $2,500,000 received by ARTRA as part of the proceeds from the 1989 sale of Welch. Per terms of the settlement agreement, ARTRA received cash of $3,000,000 and a subordinated note in the principal amount of $640,000 payable June 30, 2001. The cash proceeds were used for a $2,500,000 reduction of amounts due on certain ARTRA bank notes, with the remainder used for working capital. In conjunction with this transaction, ARTRA entered into a letter agreement with the bank whereby the bank agreed not to exercise any of its rights and remedies with respect to amounts due the bank under its ARTRA notes and certain obligations of ARTRA's president, Peter R. Harvey through at least September 28, 1995.\nIn February 1996, the bank agreed to discharge all amounts under its ARTRA notes ($12,063,000 plus accrued interest) and certain obligations of Mr. Harvey for consideration of $6,000,000, consisting of a cash payment of $5,150,000 and Mr. Harvey's $850,000 note payable to the bank. ARTRA will recognize a gain on the discharge of its bank indebtedness of approximately $10,000,000 in the first quarter of 1996 and will record a receivable for Mr. Harvey's prorata share of the debt discharge funded by the Company. As collateral for this advance and other previous advances (see note 21), Mr. Harvey provided ARTRA a $2,150,000 security interest in certain real estate.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIn conjunction with the February 1996 discharge of indebtedness, the Company entered into a $1,900,000 short-term loan agreement with an unaffiliated company. The loan, due May 26, 1996, with interest at 12% is collateralized by, among other things, the common stock of ARTRA's BCA subsidiary. As additional compensation for the loan and for participating in the above discharge of indebtedness, the lender has received, to-date, 150,000 shares of ARTRA common stock and 37,500 shares of COMFORCE common stock held by ARTRA. Additionally, for a cash payment of $500,000 to ARTRA, the lender purchased an option to acquire up to 40% of the common stock of Bagcraft for nominal consideration. If the borrowings under the loan agreement are repaid by May 26, 1996, ARTRA can repurchase the option for a cash payment of $550,000. If the borrowings under the loan agreement are repaid subsequent to May 26, 1996, the percentage of the warrant ARTRA can repurchase declines on a sliding scale through July 25, 1996. The proceeds from this loan agreement along with proceeds received from the Bagcraft subsidiary as consideration for the issuance of BCA preferred stock (see Note 12) were used to fund the cash payment to the bank for the above discharge of indebtedness.\nEffective May 14, 1991, ARTRA, through its wholly-owned Fill-Mor subsidiary, entered into a loan agreement with a bank providing for borrowings of up to $2,500,000 with interest at the prime rate plus 2%, of which $2,200,000 was outstanding at December 29, 1994. The loan was collateralized by ARTRA's interest in Lori common stock and preferred stock, by the proceeds of a tax sharing agreement between ARTRA and its Bagcraft subsidiary and by ARTRA's interest in Fill-Mor's common stock. At December 29, 1994, borrowings on this note were reclassified as amounts due under the debt restructuring agreement discussed in Note 8. In March, 1995, borrowings due under this loan agreement were discharged.\nAt December 29, 1994 an ARTRA bank note with outstanding borrowings of $3,600,000 had been past due since December 31, 1990. Effective October 30, 1995, the Company settled this bank obligation totaling approximately $5,000,000, including accrued interest, for a cash payment of $150,000. The gain on this debt extinguishment was reflected in the Company's consolidated financial statements in the fourth quarter of 1995. In October, 1995 the bank agreed to discharge the $3,600,000 note plus accrued interest of $1,467,000 for a cash payment of $150,000, resulting in an extraordinary gain of $4,917,000 ($.71 per share) in the fourth quarter of 1995.\nAn ARTRA bank note with outstanding borrowings of $345,000 at December 29, 1994 was guaranteed by a private company. Interest on the note was at the prime rate plus 2%. In October, 1995 all amounts due on this bank note were paid in full.\nAmounts Due To Related Parties\nAt December 28, 1995 and December 29, 1994, the Company had outstanding borrowings from its Chairman, John Harvey, of $175,000 and $42,000, respectively. Since January, 1995, John Harvey's borrowings have been evidenced by unsecured short-term notes bearing interest at 8%. As additional compensation the loans provide for the issuance of warrants to purchase ARTRA common shares at prices equal to the market value of ARTRA's common stock at the date of issuance. The warrants expire five years from the date of issuance. Terms of the note provide for the issuance of additional warrants to purchase ARTRA common shares, as determined by the number of days the loans are outstanding. Through February 29, 1996, John Harvey has received warrants to purchase an aggregate of 58,007 shares of ARTRA common stock at prices ranging from $3.75 to $6.125 per share as additional compensation for his loans to ARTRA.\nAt March 30, 1995, amounts due to related parties included a $850,000 short-term loan from a then director of COMFORCE. The loan provided for interest at the prime rate plus 1%. As consideration for assisting with the debt restructuring, the former director received 150,000 Lori common shares valued at $337,500 ($2.25 per share) based upon COMFORCE closing market value on March 30, 1995. The principal amount of the loan was reduced to $750,000 at July 31, 1995. The remaining loan principal was not repaid on its scheduled to maturity date of July 31, 1995. Per terms of the loan agreement, the former director received an additional 50,000 COMFORCE common shares as compensation for the\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nnon-payment of the loan at its originally scheduled maturity. The maturity date of the loan was subsequently extended to September 30, 1995. The Company then entered into discussions with the director to extend the maturity date of the loan and, as additional consideration for the non-payment of the loan, the former director received an additional 25,000 shares of COMFORCE common stock in January 1996. In March 1996, the loan was repaid in full by ARTRA.\nAt December 29, 1994, amounts due to related parties also included borrowings of $127,000, respectively, from the above mentioned former director of COMFORCE. As additional compensation the former director has received warrants to purchase an aggregate of 236,315 ARTRA common shares at prices ranging from $3.75 to $6.375 per share based upon the market value of ARTRA's common stock at the date of issuance. The warrants expire five years from the date of issuance. Terms of the note provide for the issuance of additional warrants to purchase ARTRA common shares as determined by the number of days the loan is outstanding. In December 1995, amounts due pursuant to this loan were repaid by the issuance of 33,000 shares of ARTRA common stock.\nOn December 31, 1993, a religious organization, currently holding approximately 7% of ARTRA's outstanding common stock, loaned the Company $2,000,000 evidenced by a short-term note bearing interest at 10%. The proceeds of this loan were remitted to ARTRA's bank to pay principal and interest on ARTRA's bank notes as discussed above. In January, 1994 the religious organization made an additional $1,000,000 short-term loan to the Company also with interest at 10%. As additional compensation for the above loans, the lender received warrants to purchase an aggregate of 86,250 ARTRA common shares at prices ranging from $6.00 to $7.00 per share based upon the market of ARTRA's common stock at the date of issuance. The warrants expire in 1998, five years from the date of issuance. In July, 1994 ARTRA made a $2,000,000 payment against the amounts outstanding on the above loans and the religious organization subsequently loaned ARTRA an additional $2,000,000. At December 28, 1995 and December 29, 1994 borrowings due the religious organization totaled $3,000,000. In December, the religious organization received 126,222 shares of ARTRA common in payment of past due interest through October 31, 1995.\nConvertible Subordinated Promissory Notes\nIn December 1995, ARTRA completed a private placement of $2,500,000 of 12% convertible subordinated promissory notes due March 21, 1996. As additional consideration the noteholders received 15,000 ARTRA common shares per each $100,000 of notes issued, or an aggregate of 375,000 ARTRA common shares. The ARTRA common shares were valued at $1,266,000 ($3.375 per share) based upon the closing market value of ARTRA common stock on the date of issue, discounted for restricted marketability. In the event the notes and all accrued interest is not paid in full at maturity, the noteholders have the option to convert all or a portion of the amount due into shares of ARTRA common at a conversion price of $3.00 per share. The proceeds from the private placement, held in escrow at December 28, 1995, were used to pay down other debt obligations in January, 1996. The notes were repaid in April, 1996, substantially with proceeds from a new private placement of ARTRA notes.\nOther\nIn conjunction with the debt settlement agreement discussed in Note 8, ARTRA entered into a $1,850,000 short-term loan agreement with a non-affiliated corporation, the proceeds of which were used to fund amounts due the bank as discussed below. The loan, due June 30, 1995, with interest payable monthly at 10%, was collateralized by 100,000 shares of Lori common stock. These 100,000 COMFORCE common shares were originally issued to the bank under terms of the August 18, 1994 Settlement Agreement. In August, 1995 the loan was extended until September 15, 1995 and the lender received the above mentioned 100,000 COMFORCE common shares as consideration for the loan extension. The loan was repaid by ARTRA in February, 1996.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n10. LONG-TERM DEBT\nLong-term debt (in thousands) consists of: December 28, December 29, 1995 1994 -------- --------\nBagcraft Credit Agreement, Term loans, interest at the prime rate plus 1.75% to 3% $ 16,600 $ 17,000 Revolving credit loan, interest at the prime rate plus 1.5% 9,231 16,672 Unamortized discount - (315) Bagcraft, City of Baxter Springs, Kansas loan agreements, interest, at varying rates 11,794 12,310 Arcar subordinated promissory notes due to seller, interest at the prime rate - 8,000 Arcar bank term loan, interest at the prime rate plus .75% - 2,750 Amounts due a bank term under terms of a debt settlement agreement - 10,500 Other, at various interest rates, due in varying amounts through 1995 - 27 -------- --------\n37,625 66,944 Current scheduled maturities (3,512) (37,521) Debt subsequently discharged - (9,750) -------- -------- $ 34,113 $ 19,673 ======== ========\nBagcraft\nEffective December 17, 1993, Bagcraft refinanced its bank debt by entering into a Credit Agreement that provides for a revolving credit loan and two separate term loans. The term loans were separate two-year facilities initially totaling $12,000,000 (Term Loan A) and $8,000,000 (Term Loan B), bearing interest at the lender's index rate plus 1.75% and 3%, respectively. The principal under Term Loan A is payable at maturity, unless accelerated under terms of the Credit Agreement. The principal under Term Loan B ($4,600,000 and $5,000,000 outstanding at December 28, 1995 and December 29, 1994, respectively) was scheduled to be payable in twenty-four monthly installments of $250,000 from January 1, 1994 to December 1, 1995, with the remaining principal balance payable at maturity, unless accelerated under terms of the Credit Agreement. At December 28, 1995, interest rates on Term Loan A and Term Loan B were 10.25% and 11.5% respectively.\nThe amount available to Bagcraft under the revolving credit loan is subject to a borrowing base, as defined in the agreement, up to a maximum of $18,000,000. At December 28, 1995 and December 29, 1994, approximately $6,600,000 and\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\n$800,000, respectively, was available and unused by Bagcraft under the revolving credit loan. Borrowings under the revolving credit loan bear interest at the lender's index rate plus 1.5% and are payable upon maturity of the Credit Agreement, unless accelerated under terms of the Credit Agreement. At December 28, 1995 the interest rate on the revolving credit loan was 10%.\nBorrowings under the Credit Agreement are collateralized by substantially all of the assets of Bagcraft. The Credit Agreement, as amended, contains various restrictive covenants, that among other restrictions, require Bagcraft to maintain minimum levels of tangible net worth and liquidity levels, and limits capital expenditures and restricts additional loans, dividend payments and payments to related parties. In addition, the Credit Agreement prohibits changes in ownership of Bagcraft.\nIn October, 1995 the Credit Agreement was amended whereby, among other things, the maturity date of the Credit Agreement was extended until March 31, 1996, certain loan covenant violations were resolved and the principal payments under Term Loan B were modified to include five monthly installments of $200,000 from November 15, 1995 to March 31, 1996, with the remaining balance payable at maturity (March 31, 1996) .\nEffective February 1, 1996, the Credit Agreement was amended whereby, among other things, the maturity date of the Credit Agreement was extended until September 30, 1997, certain loan covenants were amended. The principal payments under Term Loan B were modified to include twenty-three monthly installments of $200,000 from November 15, 1995 to September 30, 1997, with the remaining balance payable at maturity (September 30, 1997) . Additionally, the lender consented to the use of $4,135,000 advanced under the revolving credit loan to fund a preferred stock exchange agreement between BCA (the parent of Bagcraft), Bagcraft and the holder of Bagcraft's 13.5% cumulative, redeemable preferred stock (see Note 12).\nAs additional compensation for borrowings under the Credit Agreement, the lender received a detachable warrant, expiring in December 1998, allowing the holder to purchase up to 10% of the fully diluted common equity of Bagcraft at a nominal value. Under certain conditions Bagcraft is required to repurchase the warrant from the lender. The determination of the repurchase price of the warrant is to be based on the warrant's pro rata share of the highest of book value, appraised value or market value of Bagcraft.\nIn connection with the February 1, 1996 amendment to the Credit Agreement, the warrant agreement was amended to permit the holder to purchase 13% of the fully diluted common equity of Bagcraft at the original nominal purchase price and to extend the expiration date to December 17, 1999.\nIn March, 1994 Bagcraft and the City of Baxter Springs, Kansas completed a $12,500,000 financing package associated with the construction of a new 265,000 sq. ft. production facility in Baxter Springs, Kansas. The financing package, funded by a combination of Federal, state and local funds, consists of the following loan agreements payable by Bagcraft directly to the City of Baxter Springs:\nA $7,000,000 promissory note payable in ten installments of $700,000 due annually on July 21 of each year beginning in 1995 through maturity on July 21, 2004. Interest, at varying rates from 4.6% to 6.6%, is payable semi-annually. At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $6,300,000 and $7,000,000, respectively, under this loan agreement.\nA $5,000,000 subordinated promissory note payable as follows: $150,000 due in 1996; $2,425,000 due in 1998; and $2,425,000 due in 1999. The subordinated promissory note is non-interest bearing, subject to certain repayment provisions as defined in the agreement (as amended). At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $5,000,000 and $4,810,000, respectively, under this loan agreement.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\nTwo separate $250,000 subordinated promissory notes payable in varying installments through January 20, 2025. The subordinated promissory notes are non-interest bearing, subject to certain repayment provisions as defined in the agreement. At December 28, 1995 and December 29, 1994, Bagcraft had outstanding borrowings of $493,000 and $500,000, respectively, under this loan agreement.\nBorrowings under the above loan agreements are collateralized by a first lien on the land and building at the Baxter Springs, Kansas production facility and by a second lien on certain machinery and equipment. Under certain circumstances, repayment of the borrowings under the above loan agreements is subordinated to the repayment of obligations under Bagcraft's Credit Agreement. At December 28, 1995 and December 29, 1994, $552,000 and $774,000, respectively, of borrowings from the above loan agreements is reflected in the consolidated balance sheet in current assets as restricted cash and equivalents. These funds, invested in interest bearing cash equivalents, are restricted for expenditures associated with the Baxter Springs, Kansas project.\nArcar\nOn April 8, 1994, Bagcraft completed the acquisition of Arcar for consideration consisting of cash of $2,264,000 and subordinated promissory notes totaling $8,000,000 ($5,500,000 and $8,000,000 outstanding at September 28, 1995 and December 29, 1994, respectively). The subordinated promissory notes provided for interest payable quarterly at the prime rate (as defined in the agreement). At September 28, 1995, the remaining outstanding promissory notes were scheduled to mature as follows: $2,500,000 payable March 15, 1996; $2,500,000 payable March 15, 1997; $500,000 payable March 15, 1998. The seller also received a warrant to purchase 177,778 ARTRA common shares at a price of $5.625 per share, the market value at the date of grant. Exercise of the warrant was payable only through a reduction of the subordinated promissory notes and accrued interest due the seller under terms of the purchase agreement. The subordinated promissory notes were paid in full in October, 1995 with proceeds from the sale of Arcar (see Note 3).\nEffective April 8, 1994, Arcar entered into a Loan and Security Agreement (the \"Agreement\") with a bank that provided for a revolving credit loan and a term loan. The term loan, in the original principal amount of $2,750,000, provided for interest at the prime rate plus .75%. Borrowings under the Agreement were collateralized by substantially all of the assets of Arcar. The Agreement contained various restrictive covenants, that among other restrictions, require Arcar to maintain minimum levels of net worth and liquidity levels and limit additional loans, dividend payments, capital expenditures and payments to related parties. All borrowings under the Agreement were paid in full in October, 1995 with proceeds from the sale of Arcar (see Note 3).\nLori\nAs discussed in Note 8, effective August 18, 1994, as amended effective December 23, 1994, ARTRA, Fill-Mor, Lori and Lori's fashion costume jewelry subsidiaries entered into an agreement with Lori's bank lender to settle obligations due the bank under terms of the bank loan agreements of Lori and its fashion costume jewelry subsidiaries and Fill-Mor. Borrowings due the bank under the loan agreements of Lori and its operating subsidiaries and Lori's parent, Fill-Mor, plus amounts due the bank for accrued interest and fees were reduced to $10,500,000 as of December 23, 1994 (of which $7,855,000 pertained to Lori's obligation to the bank and $2,645,000 pertained to Fill-Mor's obligation to the bank). As partial consideration for the Amended Settlement Agreement the bank received a $750,000 Lori note payable due March 31, 1995.\nIn March, 1995 the $750,000 note due the bank was paid and the remaining indebtedness of Lori and Fill-Mor was discharged, resulting in an additional extraordinary gain to Lori and Fill-Mor of $9,113,000 in 1995 (See Note 8).\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\nThe common stock and virtually all the assets of ARTRA's subsidiaries have been pledged as collateral for ARTRA's and its subsidiaries' borrowings. Under certain debt agreements the Company is limited in the amounts it can withdraw from its operating subsidiaries. At December 28, 1995 and December 29, 1994, substantially all cash and equivalents on the Company's consolidated balance sheet are restricted to use by and for the Company's operating subsidiaries.\nAt December 28, 1995 the aggregate amount of yearly maturities of long-term debt, exclusive of debt discharged, is: 1996, $3,512,000; 1997, $24,143,000; 1998, $3,137,000; 1999, $3,137,000; 2000, $712,000; thereafter, $2,983,000.\n11. REDEEMABLE COMMON STOCK\nARTRA has entered into various agreements under which it has sold its common shares along with options that require ARTRA to repurchase these shares at the option of the holder, principally one year after the date of each agreement. The difference between the option price and the net proceeds received is amortized over the life of the options by a charge to retained earnings. ARTRA agreed to register 100,000 ARTRA common shares issued to a bank as partial consideration for a 1994 debt settlement agreement on or before July 31, 1995, after which the bank has the right to put the 100,000 common shares back to ARTRA for an exercise price of $500,000. As of March 31, 1996 the ARTRA common shares have not been registered and the bank has not exercised the put option. At December 28, 1995 and December 29, 1994 options are outstanding that, if exercised, would require ARTRA to repurchase 283,965 and 279,679 shares of its common stock for an aggregate amount of $4,774,000 and $4,144,000, respectively.\n12. REDEEMABLE PREFERRED STOCK\nOn September 27, 1989, ARTRA received a proposal to purchase BCA, the parent of Bagcraft, from Sage Group, Inc. (\"Sage\"), a privately-owned corporation that owned 100% of the outstanding common stock of BCA. Sage was merged with and into Ozite Corporation (\"Ozite\") on August 24, 1990. Peter R. Harvey, ARTRA's President, and John Harvey, ARTRA's Chairman of the Board of Directors, were the principal shareholders of Sage and are the principal shareholders of Ozite. Effective March 3, 1990, a wholly-owned subsidiary of ARTRA acquired 100% of BCA's issued and outstanding common shares for consideration of $5,451,000, which included 772,000 shares of ARTRA common stock and 3,750 shares of $1,000 par value junior non-convertible payment-in-kind redeemable Series A Preferred Stock with an estimated fair value of $1,012,000, net of unamortized discount of $2,738,000. The Series A Preferred Stock accrues dividends at the rate of 6% per annum and is redeemable by ARTRA on March 1, 2000 at a price of $1,000 per share plus accrued dividends. Accumulated dividends of $1,519,000 and $1,221,000 were accrued at December 28, 1995 and December 29, 1994, respectively.\nIn 1987, Bagcraft issued to a subsidiary of Ozite $5,000,000 of preferred stock (50,000 shares of 13.5% cumulative, redeemable preferred stock with a liquidation preference equal to $100 per share) redeemable by Bagcraft in 1997 at a price of $100 per share plus accrued dividends. Dividends, which accrue and are payable semiannually on June 1 and December 1 of each year, are reflected in the Company's consolidated statement of operations as minority interest. The holder has agreed to forego dividend payments as long as such payments are prohibited by Bagcraft's lenders. Accumulated dividends of $5,794000 and $5,119,000 were accrued at December 28, 1995 and December 29, 1994, respectively.\nIn 1987, Bagcraft obtained financing from a subsidiary of Ozite through the issuance of a $5,000,000 unsecured subordinated note, due June 1, 1997. During 1992, per agreement with the noteholder, the interest payments were remitted to ARTRA and the noteholder received 675 shares of BCA Series A preferred stock ($1.00 par value, 6% cumulative with a liquidation preference equal to $1,000 per share) with a liquidation value of $675,000. In December, 1993, the unsecured subordinated note and accrued interest thereon were paid in full from proceeds of Bagcraft's Credit Agreement. Per agreement with the noteholder, the accrued interest outstanding on the note of $3,000,000 was remitted to ARTRA and the noteholder received an additional 3,000 shares BCA preferred stock having a liquidation value of $3,000,000.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)\nEffective February 1, 1996, BCA, Bagcraft and Ozite entered into an agreement to exchange certain preferred stock between the Companies. In connection with the agreement, BCA issued to Bagcraft 8,135 shares of BCA Series B preferred stock (with a liquidation preference equal to $1,000 per share) for cash of $4,135,000. Bagcraft in turn exchanged the BCA Series B preferred stock for Bagcraft redeemable preferred stock (82.7% of 50,000 shares, or 41,350 shares) held by Ozite. Funds for the transaction were obtained by Bagcraft through an advance under its revolving credit. BCA then upstreamed the proceeds to ARTRA for working capital purposes.\nAs a result of the preferred stock exchange agreement, 17.3% of the original Bagcraft redeemable preferred stock and the prorata share of dividends remain outstanding February 1, 1996. Dividends related to the Bagcraft redeemable preferred stock exchanged have been forgiven in accordance with the agreement. The dividend forgiveness will be reflected in the Company's consolidated financial statements in the first quarter of 1996.\n13. STOCK OPTIONS AND WARRANTS\nStock Option Plan\nIn July, 1985, ARTRA's shareholders approved a stock option plan (the \"Plan\") for certain officers and key employees of the Company and its subsidiaries. The Plan, as amended, reserved 1,000,000 shares of the Company's common stock and authorized the granting of options on or before February 1, 1995. The purchase price of such options was to be not less than the market value at the date of grant for incentive stock options (\"ISO\") and not less than 110% of the market value on the date of grant for an ISO granted to a shareholder possessing 10% more of the voting stock of the Company. Non-qualified options may be granted at such price and amount as the Company determines at the date of grant.\nDuring 1994, the Company issued a former officer of Bagcraft a non-qualified option to purchase 20,000 shares of ARTRA common stock at $5.75 per share as additional compensation for short-term loans to ARTRA.\nEffective January 8, 1993, the Company issued certain officers and key employees of ARTRA options to purchase 148,100 shares of ARTRA common stock at $3.75 per share. The options expire ten years from the date of grant.\nDuring 1993, the Company issued to a then officer of Bagcraft a non-qualified option to purchase 50,000 shares of ARTRA common stock at $3.75 per share as additional compensation for short-term loans to ARTRA. The options were exercised during 1993. The exercise of these options was principally paid through a reduction of the then Bagcraft officer's loans to ARTRA.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nA summary of stock option transactions for the three years in the period ended December 28, 1995 is as follows:\n1995 1994 1993 -------- -------- --------\nOutstanding at beginning of year:\nShares 445,460 450,760 340,360\n$ 3.75 $ 3.75 $ 5.25 Prices to to to $ 20.50 $ 20.50 $ 20.50\nOptions granted: Shares 20,000 198,100 Prices $ 5.75 $ 3.75\nOptions exercised: Shares (12,100) (25,300) (74,700)\n$ 3.75 Prices $ 4.00 $ 5.25 to $ 5.25 Options canceled: Shares (1,860) (13,000)\n$ 5.25 Prices $ 20.50 to $ 5.75 Outstanding at end of year: Shares 431,500 445,460 450,760 ======== ======== ========\n$ 3.65 $ 3.75 $ 3.75 Prices to to to $ 10.00 $ 20.50 $ 20.50\nOptions exercisable at end of year 431,500 445,460 450,760 ======== ======== ======== Options available for future grant at end of year - 390,814 410,814 ======== ======== ========\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nWarrants\nAt December 28, 1995, warrants were outstanding to purchase a total of 1,148,548 common shares at prices ranging from $3.50 per share to $10.50 per share. The warrants, exercisable from the date of issue, expire at various dates through 2003.\nDuring 1995, ARTRA issued warrants to purchase an aggregate of 140,507 shares of its common stock at prices ranging from $3.75 per share to $6.125 per share, principally to certain lenders as additional compensation for short-term loans. The warrants expire at various dates in 2000. Warrants to purchase 48,331 shares of ARTRA common stock at prices ranging from $6.75 per share to $11.375 per share expired unexercised during 1995. The warrants were issued as additional compensation for various short-terms loans.\nDuring 1994, ARTRA issued warrants to purchase an aggregate of 154,719 shares of its common stock at prices ranging from $4.50 per share to $6.625 per share, principally to certain lenders as additional compensation for short-term loans. The warrants expire at various dates from 1996 and 1999. Warrants to purchase 9,166 shares of ARTRA common stock at prices ranging from $10.00 per share to $11.25 per share expired unexercised during 1994. The warrants were issued as additional compensation for various short-terms loans.\nDuring 1993, ARTRA issued warrants to purchase an aggregate of 326,090 shares of its common stock at prices ranging from $3.50 per share to $7.00 per share, principally to certain lenders as additional compensation for short-term loans. The warrants expire at various dates from 1998 and 2003. Additionally, warrants to purchase 76,668 shares of ARTRA common stock at prices ranging from $18.00 per share to $27.00 per share expired unexercised during 1993. The warrants were issued as additional compensation for short-term loans in 1988.\n14. RESTRUCTURING COSTS\nIn December, 1993 the Bagcraft subsidiary recorded a charge to operations of $1,175,000 representing equipment and inventory relocation costs and employee severance and outplacement costs relating to the construction of a new manufacturing facility in Baxter Springs, Kansas. In September, 1994, Bagcraft completed construction of a new 265,000 sq. ft. production facility in Baxter Springs, Kansas. This facility replaced Bagcraft's production facilities in Joplin, Missouri, Carteret, New Jersey and Forest Park, Georgia.\n15. COMMITMENTS AND CONTINGENCIES\nThe Company and its subsidiaries lease certain buildings and equipment which are used in its manufacturing and distribution operations. At December 28, 1995, future minimum lease payments under operating leases that have an initial or remaining noncancellable term of more than one year (in thousands) are:\nYear ---- 1996 $ 944 1997 860 1998 737 1999 719 2000 449 After 2000 765 ------- $ 4,474 =======\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nRental expense was $861,000, $1,116,000 and $1,240,000 in fiscal years 1995, 1994 and 1993 respectively.\nIn conjunction with the sale of Arcar (see Note 3), Bagcraft entered into an ink products purchase agreement with the Arcar buyer for a period of five years. Under terms of the agreement, Bagcraft is required to purchase a minimum supply of ink based on market prices in effect at the time of each purchase. Minimum dollar amounts required for each of the contract years ending September 30 is $4,100,000 in 1996; $4,300,000 in 1997; $4,500,000 in 1998; $3,375,000 in 1999; and $2,250,000 in 2000. Bagcraft has issued a letter of credit of $1,000,000 in conjunction with this agreement.\nThe Company and its subsidiaries are the defendants in various business-related litigation and environmental matters. At December 28, 1995 and December 29, 1994, the Company had accrued $1,800,000 and $1,500,000, respectively, for potential business-related litigation and environmental liabilities. While these litigation and environmental matters involve wide ranges of potential liability, management does not believe the outcome of these matters will have a material adverse effect on the Company's financial statements. However, ARTRA may not have available funds to pay liabilities arising out of these business-related litigation and environmental matters or, in certain instances, to provide for its legal defense.\nIn January, 1985 the United States Environmental Protection Agency (\"EPA\") notified the Company's Bagcraft subsidiary that it was a potentially responsible party under the Comprehensive Environmental Responsibility Compensation and Liability Act (\"CERCLA\") for alleged release of hazardous substances at the Cross Brothers site near Kankakee, Illinois. Although Bagcraft has denied liability for the site, it has entered into a settlement agreement with the EPA, along with the other third party defendants, to resolve all claims associated with the site except for state claims. In May, 1994 Bagcraft paid $850,000 plus accrued interest of $29,000 to formally extinguish the EPA claim. Bagcraft filed suit in 1993 in the United States District Court for the Northern District of Illinois, against its insurers to recover its liability costs in connection with the Cross Brothers case. Bagcraft was subsequently reimbursed by its insurers for its liability costs incurred in connection with the EPA claim. With regard to the state action, Bagcraft is participating in settlement discussions with the State and thirteen other potential responsible parties to resolve all claims associated with the State. The maximum state claim is $1.1 million for all participants. Bagcraft has accrued $120,000 related to the State action in the Company's consolidated financial statements at December 28, 1995.\nBagcraft was listed as a de minimis contributor at the American Chemical Services, Inc. off-site disposal location in Griffith, Indiana and the Duane Marine off-site disposal location in Perth Amboy, New Jersey. These sites are included in the EPA's National Priorities List. Bagcraft is presently unable to determine its liability, if any, with respect to this site.\nBagcraft has been notified by the Federal Environment Protection Agency that it is a potentially responsible party for the disposal of hazardous substances at a site on Ninth Avenue in Gary, Indiana. The Company has no records indicating that it deposited hazardous substances at this site and intends to vigorously defend itself in this matter.\nBagcraft is presently undertaking a soil remediation project for solvent-contaminated soil at its Chicago manufacturing facility. The environmental firm responsible for implementing the remediation has recommended that a soil vapor extraction process be used, at an estimated cost of $175,000. Although there can be no assurances that remediation costs will not exceed this estimate, in the opinion of management, no material additional costs are anticipated.\nIn April 1994, the EPA notified the Company that it was a potentially responsible party for the disposal of hazardous substances (principally waste oil) at a disposal site in Palmer, Massachusetts generated by a manufacturing facility formerly operated by the Clearshield Plastics Division (\"Clearshield\") of Harvel Industries, Inc. (\"Harvel\"), a majority owned subsidiary of ARTRA. In 1985, Harvel was merged into ARTRA's Fill-Mor subsidiary. This site has been included on the EPA's National Priorities List. In February 1983, Harvel sold the assets of Clearshield to Envirodyne. The alleged waste disposal occurred in 1977 and 1978, at which time Harvel was a majority-owned subsidiary of ARTRA. In May 1994, Envirodyne and its Clearshield National, Inc. subsidiary sued ARTRA for indemnification in connection with this proceeding. The cost of clean-up at the Palmer, Massachusetts site has been estimated to be approximately $7 million according to proofs of claim filed in the adversary proceeding. A committee formed by the named potentially responsible parties has estimated the\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nliability respecting the activities of Clearshield to be $400,000. ARTRA has not made any independent investigation of the amount of its potential liability and no assurances can be given that it will not substantially exceed $400,000.\nIn a case titled Sherwin-Williams Company v. ARTRA GROUP Incorporated, filed in 1991 in the United States District Court for Maryland, Sherwin-Williams Company (\"Sherwin-Williams\") brought suit against ARTRA and other former owners of a paint manufacturing facility in Baltimore, Maryland for recovery of costs of investigation and clean-up of hazardous substances which were stored, disposed of or otherwise released at this manufacturing facility. This facility was owned by Baltimore Paint and Chemical Company, formerly a subsidiary of ARTRA from 1968 to 1980. Sherwin-William's current projection of the cost of clean-up is approximately $5 to $6 million. The Company has filed counterclaims against Sherwin-Williams and cross claims against other former owners of the property. The Company also is vigorously defending this action and has raised numerous defenses. Currently, the case is in its early stages of discovery and the Company cannot determine what, if any, its liability may be in this matter.\nARTRA was named as a defendant in United States v. Chevron Chemical Company brought in the United States District Court for the Central District of California respecting Operating Industries, Inc. site in Monterey Park, California. This site is included on the EPA's National Priorities List. ARTRA's involvement stemmed from the alleged disposal of hazardous substances by The Synkoloid Company (\"Synkoloid\") subsidiary of Baltimore Paint and Chemical Company, which was formerly owned by ARTRA. Synkoloid manufactured spackling paste, wall coatings and related products, certain of which generated hazardous substances as a by-product of the manufacturing process.\nARTRA entered into a consent decree with the EPA in which it agreed to pay $85,000 for one phase of the clean-up costs for this site; however, ARTRA defaulted on its payment obligation. ARTRA is presently unable to estimate the total potential liability for clean-up costs at this site, which clean-up is expected to continue for a number of years. The consent decree, even if it had been honored by ARTRA, was not intended to release ARTRA from liability for costs associated with other phases of the clean-up at this site. The Company is presently unable determine what, if any, additional liability it may incur in this matter.\nIn a case titled City of Chicago v. NL Industries, Inc. and ARTRA GROUP Incorporated, filed in the Circuit Court of Cook County, Illinois, the City of Chicago alleged that ARTRA (and NL Industries, Inc.) had improperly stored, discarded and disposed of hazardous substances at the subject site, and that ARTRA had conveyed the site to Goodwill Industries to avoid clean-up costs. At the time the suit was filed, the City of Chicago claimed to have expended $1,000,000 in clean-up costs.\nARTRA and NL Industries, Inc. have counter sued each other and have filed third party actions against the subsequent owners of the property. The City of Chicago has made an offer to settle the matter for $350,000 for all parties. The parties are currently conducting discovery. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nIn a case titled Illinois Environmental Protection Agency v. NL Industries, Inc., ARTRA GROUP Incorporated, et al, the Illinois Environmental Protection Agency filed suit alleging all former owners contributed to the contamination of the site. The suit was dismissed, but subject to possible appeal. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nThe EPA has identified ARTRA GROUP Incorporated as a potentially responsible party in an action involving the former manufacturing facility. The EPA is currently investigating the site to determine the extent and type of contamination, if any. The Company is presently unable to determine ARTRA's liability, if any, in connection with this case.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n16. INCOME TAXES\nThe provision (credit) for income taxes is included in the statements of operations as follows:\n1995 1994 1993 --------- --------- --------- (in thousands) Continuing operations $ 51 $ 9 $ 7 Discontinued operations 17 74 33 --------- --------- --------- $ 68 $ 83 $ 40 ========= ========= =========\nA summary of the provision (credit) for income taxes is as follows:\n1995 1994 1993 --------- --------- --------- (in thousands) Current: Federal $ - $ - $ - State 68 83 40 --------- --------- --------- $ 68 $ 83 $ 40 ========= ========= =========\nThe 1995, 1994 and 1993 extraordinary credits represent net gains from discharge of indebtedness. No income tax expense is reflected in the Company's financial statements resulting from the extraordinary credits due to the utilization of tax loss carryforwards.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n16. INCOME TAXES, continued\nIn 1995, 1994 and 1993, the effective tax rates from operations, including discontinued operations were (3.9)%, (.4)% and .3%, respectively, as compared to the statutory Federal rate, which are reconciled as follows:\n1995 1994 1993 --------- --------- ---------- (in thousands)\nProvision (credit) for income taxes using statutory rate $ (600) $ (6,629) $ 4,992 State and local taxes, net of Federal benefit 68 73 7 Current year tax loss not utilized - 3,151 1,938 Amortization of goodwill 155 206 212 Previously unrecognized benefit from utilizing tax loss carryforwards (2,136) - - Effect of not including all subsidiaries in the consolidated tax return 2,546 3,249 (7,113) Other 35 33 4 --------- --------- ---------- $ 68 $ 83 $ 40 ========= ========= ==========\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n16. INCOME TAXES, continued\nThe types of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to the deferred tax liabilities and deferred tax assets at December 28, 1995 and December 29, 1994 and their approximate tax effects (in thousands) are as follows:\nThe Company has recorded a valuation allowance with respect to the future tax benefits and the net operating loss reflected in deferred tax assets as a result of the uncertainty of their ultimate realization.\nAt December 28, 1995, the Company and its subsidiaries had Federal income tax loss carryforwards of approximately $44,000,000 available to be applied against future taxable income, if any. ARTRA's tax loss carryforwards of approximately $33,000,000 expire principally in 2003 - 2010. Additionally, ARTRA's discontinued Ultrasonix and Ratex subsidiaries had Federal income tax loss carryforwards of approximately $11,000,000 available to be applied against future taxable income, if any. In recent years, the Company has issued shares of its common stock to repay various debt obligations, as consideration for acquisitions, to fund working capital obligations and as consideration for various other transactions. Section 382 of the Internal Revenue Code of 1986 limits a corporation's utilization of its Federal income tax loss carryforwards when certain changes in the ownership of a corporation's common stock occurs. In the opinion of management, the Company is not currently subject to such\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nlimitations regarding the utilization of its Federal income tax loss carryforwards. Should the Company continue to issue a significant number of shares of its common stock, it could trigger a limitation that would prevent it from utilizing a substantial portion of its Federal income tax loss carryforwards.\n17. EMPLOYEE BENEFIT PLANS\nThe Company and its subsidiaries have certain contributory and noncontributory benefit plans covering eligible employees. Both employee and employer contributions are generally determined as a percentage of the covered employee's annual compensation. The total expense charged to continuing operations from all of these plans amounted to $477,000, $333,000 and $450,000 in 1995, 1994 and 1993, respectively.\nEffective June 1, 1990, the Company adopted an Employee Stock Ownership Plan (\"ESOP\") which covers eligible employees of ARTRA and certain of its subsidiaries. Employer contributions to the Plan are at the discretion of ARTRA's Board of Directors. Employee contributions are not permitted. Contributions are allocated in the same proportion that the percentage of a participant's compensation for the Plan year bears to the compensation of all participants for the Plan year. ARTRA contributed 8,750 common shares to the Plan with a fair market value of $42,000 ($4.75 per share) for the plan year ending December 28, 1995. ARTRA contributed 15,000 common shares to the Plan with a fair market value of $71,250 ($4.75 per share) for the plan year ending December 29, 1994. ARTRA contributed 65,000 common shares to the Plan with a fair market value of $423,000 ($6.50 per share) for the plan year ending December 30, 1993. At December 28, 1995, the ESOP held 271,775 shares of ARTRA common stock.\nEffective August 1, 1995, the Company terminated the ESOP and is currently is the process of distributing the related Employee accounts to participants.\nThe Company typically does not offer the types of benefit programs that fall under the guidelines of Statement of Financial Accounting Standards No. 106 - Employers Accounting for Post Retirement Benefits Other Than Pensions.\n18. EARNINGS PER SHARE\nEarnings (loss) per share is computed by dividing net earnings (loss), less redeemable preferred stock dividends and redeemable common stock accretion, by the weighted average number of shares of common stock and common stock equivalents (redeemable common stock, stock options and warrants), unless anti-dilutive, outstanding during each period. Fully diluted earnings per share is not presented since the result is equivalent to primary earnings per share.\n19. INDUSTRY SEGMENT INFORMATION\nAt December 28, 1995, the Company, through its Bagcraft subsidiary operates in one industry segment as a manufacturer of packaging products principally serving the food industry.\nPrior to September 28, 1995 and in prior years, ARTRA's then majority owned subsidiary, Lori, operated as a designer and distributor of popular-priced fashion costume jewelry and accessories. In recent years, Lori's fashion costume jewelry operations had experienced a pattern of significantly lower sales levels and related operating losses primarily due to a shift in the buying patterns of its major customers (i.e. certain mass merchandisers) from participation in Lori's service program to purchases of costume jewelry and accessories directly from manufacturers and due to a continued unfavorable retail environment. Accordingly, in September, 1995, Lori adopted a plan to discontinue its fashion costume jewelry business as discussed in Note 3.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nAs discussed in Note 3, on September 11, 1995, Lori signed a stock purchase agreement to participate in the acquisition of one hundred percent of the capital stock of Global. Global provides telecommunications and computer technical staffing and consulting services worldwide to Fortune 500 companies and maintains an extensive, global database of technical specialists, with an emphasis on wireless communications capability. On October 17, 1995, Lori completed the acquisition of one hundred percent of the capital stock of Global. In connection with the re-focus of its business, Lori changed its name to COMFORCE Corporation.\nDue to the issuances of COMFORCE common shares in conjunction with the acquisition of Global, ARTRA's common stock ownership in COMFORCE was reduced to approximately 25%. Accordingly, in October 1995, the accounts of COMFORCE and its majority-owned subsidiaries were deconsolidated from the ARTRA's consolidated financial statements and ARTRA's investment in COMFORCE was accounted for under the equity method through the end of fiscal 1995. As discussed in note 6, effective December 28, 1995, the Company adopted SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" Under this statement, at December 28, 1995, the Company's investment in COMFORCE is classified as available for sale and is stated at fair value.\nNo single customer accounted for more than 10% of consolidated net sales in 1995, 1994 and 1993.\n20. LITIGATION\nOn November 2, 1993, ARTRA filed suit in the Circuit Court of the Eighteenth Judicial Circuit for the state of Illinois (the \"State Court Action\") against Salomon Brothers, Inc., Salomon Brothers Holding Company, Inc., Charles K. Bobrinskoy, Michael J. Zimmerman (collectively, \"Salomon Defendants\"), D.P. Kelly & Associates, L.P. (\"DPK\"), Donald P. Kelly (\"Kelly Defendants\" along with DPK), James F. Massey and William Rifkind. On November 22, 1993, ARTRA filed a First Amended Complaint. The defendants removed the case to the Bankruptcy Court in which the Emerald Chapter 11 case is pending. On July 15, 1994 all but two of ARTRA's causes of action were remanded to the state court. The Bankruptcy Court retained jurisdiction of ARTRA's claims against the defendants for breaching their fiduciary duty as directors of Emerald to Emerald's creditors and interference with ARTRA's contractual relations with Emerald. On April 7, 1995, the Company's appeal of the Bankruptcy Court's order retaining jurisdiction over two claims was denied. On July 26, 1995, the Bankruptcy Court entered an order dismissing these claims. On August 4, 1995, ARTRA appealed from the Bankruptcy Court's dismissal order. That appeal is still pending.\nOn July 18, 1995, ARTRA filed a Fourth Amended Counterclaim in the State Court Action for breach of fiduciary duty, fraudulent misrepresentation, negligent misrepresentation, breach of contract and promissory estopel. In the State Court\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nAction, ARTRA seeks compensatory damages of $136.2 million, punitive damages of $408.6 million and approximately $33 million in fees paid to Salomon. The causes of action for breach of the fiduciary duty of due care were repleaded to reserve ARTRA's right to appeal the State Court's dismissal of the causes of action in the Third Amended Complaint. Defendant Kelly was dismissed with prejudice pursuant to a stipulation between ARTRA and the Kelly Defendants.\nOn or about March 1, 1996, DPK brought a motion for summary judgment as to ARTRA's claims for breach of contract and promissory estoppel. DPK's motion is currently pending.\nEffective December 31, 1989, ARTRA completed the disposal of its former scientific products segment with the sale of its Welch subsidiary, formerly Sargent-Welch Scientific Company, to a privately held corporation whose president and sole shareholder was a vice president of Welch prior to the sale. The consideration received by ARTRA consisted of $2,625,000 payable June 30, 1997, with interest at 10% beginning June 30, 1990, under terms of a noncompetition agreement and the buyer's subordinated note in the principal amount of $2,500,000. The receivable due June 30, 1997 under terms of the noncompetition agreement was reflected in ARTRA's condensed consolidated balance sheet at December 29, 1994 in other assets at $2,625,000. The subordinated security, due in 1997, was originally scheduled to be non-interest bearing for a period of three years, after which time interest will accrue at the rate of 10% per annum. The note was discounted at a rate of 10% during the non-interest bearing period and was reflected in ARTRA's consolidated balance sheet at December 29, 1994 in other assets at $1,375,000, net of a discount of $1,125,000.\nIn December, 1991 Welch filed a lawsuit against ARTRA alleging that certain representations, warranties and covenants made by ARTRA, which were contained in the parties' Stock Purchase Agreement, were false. Welch was seeking compensatory damages in the amount of $3,800,000. Subsequently, ARTRA had filed a counterclaim predicated upon Welch's breach of the payment terms of the parties' Non-Competition Agreement and the Subordinated Note executed by Welch. ARTRA was seeking damages in the amount of approximately $5,300,000 plus accrued interest. On November 23, 1994, the Circuit Court of Cook County Law Division in Chicago granted a judgment in favor of ARTRA affirming the validity of the amounts due under the Non-Competition Agreement and the Subordinated Note of $2,625,000 and $2,500,000, respectively.\nIn June 1995 ARTRA entered into an agreement to settle amounts due ARTRA by Welch under terms of the noncompetition agreement and the subordinated security. Per terms of the settlement agreement, ARTRA received cash of $3,000,000 and a subordinated note in the principal amount of $640,000 payable June 30, 2001.\nIn January, 1985 the United States Environmental Protection Agency (\"EPA\") notified the Company's Bagcraft subsidiary that it was a potentially responsible party under the Comprehensive Environmental Responsibility Compensation and Liability Act (\"CERCLA\") for alleged release of hazardous substances at the Cross Brothers site near Kankakee, Illinois. Although Bagcraft has denied liability for the site, it has entered into a settlement agreement with the EPA, along with the other third party defendants, to resolve all claims associated with the site except for state claims. In May, 1994 Bagcraft paid $850,000 plus accrued interest of $29,000 to formally extinguish the EPA claim. Bagcraft filed suit in 1993 in the United States District Court for the Northern District of Illinois, against its insurers to recover its liability costs in connection with the Cross Brothers case. Bagcraft was subsequently reimbursed by its insurers for its liability costs incurred in connection with the EPA claim. With regard to the state action, Bagcraft is participating in settlement discussions with the State and thirteen other potential responsible parties to resolve all claims associated with the State. The maximum state claim is $1.1 million for all participants. Bagcraft has accrued $120,000 related to the State action in the Company's consolidated financial statements at December 28, 1995.\nThe Company and its subsidiaries are the defendants in various other business-related litigation and environmental matters (see Note 15). Management does not believe the outcome of these matters will have a material adverse effect on the Company's financial statements.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n21. RELATED PARTY TRANSACTIONS\nAdvances to Peter R. Harvey, ARTRA's president, classified in the Consolidated Balance Sheet as a reduction of common shareholders' equity, consist of:\nDecember 28, December 29, 1995 1994 --------- --------- (in thousands)\nARTRA $ 5,369 $ 3,205 Fill-Mor - 1,510 --------- --------- 5,369 4,715 Less interest for the period January 1, 1993 to date, accrued and fully reserved (1,051) (615) --------- --------- $ 4,318 $ 4,100 ========= =========\nARTRA has total advances due from its president, Peter R. Harvey, of which $5,369,000 and $3,205,000, including accrued interest, remained outstanding at December 28, 1995 and December 29, 1994 The advances bear interest at the prime rate plus 2% (10.5% at December 28, 1995 and December 29, 1994). This receivable from Peter R. Harvey has been classified as a reduction of common shareholders' equity. See note 9 for an additional 1996 advance for Mr. Harvey's prorata share of debt discharged by a bank. The debt discharge was principally funded by ARTRA.\nIn May, 1991, ARTRA's wholly-owned Fill-Mor subsidiary made advances to Peter R. Harvey. The advances provided for interest at the prime rate plus 2%. At March 30, 1995 and December 29, 1994, advances of $1,540,000 and $1,510,000, respectively, including accrued interest, were outstanding. In April, 1995, these advances from ARTRA's Fill-Mor subsidiary to Peter R. Harvey were transferred to ARTRA as a dividend.\nCommencing January 1, 1993 to date, interest on all advances to Peter R. Harvey has been accrued and fully reserved. Interest accrued and fully reserved on the advances to Peter R. Harvey for the years ended December 28, 1995 and December 29, 1994 totaled $436,000 and $341,000, respectively.\nPeter R. Harvey has not received other than nominal compensation for his services as an officer or director of ARTRA or any of its subsidiaries since October of 1990. Additionally, Mr. Harvey has agreed not to accept any compensation for his services as an officer or director of ARTRA or any of its subsidiaries until his obligations to ARTRA, described above, are fully satisfied.\nUnder Pennsylvania Business Corporation Law of 1988, ARTRA (a Pennsylvania corporation) is permitted to make loans to officers and directors. Further, under the Delaware General Corporation Law, Fill-Mor (a Delaware corporation) is permitted to make loans to an officer (including any officer who is also a director, as in the case of Peter R. Harvey), whenever, in the judgment of the directors, the loan can reasonably be expected to benefit Fill-Mor.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nAt the September 19, 1991 meeting, ARTRA's Board of Directors discussed, but did not act on a proposal to ratify the advances made by ARTRA to Peter R. Harvey. The 1992 advances made by ARTRA to Mr. Harvey were ratified by ARTRA's Board of Directors. In the case of the loan made by Fill-Mor to Mr. Harvey, the Board of Directors of Fill-Mor approved the borrowing of funds from Fill-Mor's bank loan agreement, a condition of which was the application of a portion of the proceeds thereof to the payment of certain of Mr. Harvey's loan obligations to the bank. However, the resolutions did not acknowledge the use of such proceeds for this purpose and the formal loan documents with the bank did not set forth this condition (though in fact, the proceeds were so applied by the bank).\nAs partial collateral for amounts due from Peter R. Harvey, the Company has received the pledge of 1,523 shares of ARTRA redeemable preferred stock (with a liquidation value of $1,523,000, plus accrued dividends) which are owned by Mr. Harvey. In addition, Mr. Harvey has pledged a 25% interest in Industrial Communication Company (a private company). Such interest is valued by Mr. Harvey at $800,000 to $1,000,000. During 1995, Peter R. Harvey entered into a pledge agreement with ARTRA whereby Mr. Harvey pledged additional collateral consisting of 42,067 shares of ARTRA common stock and 707,281 shares of Puretech International, Inc., a publicly traded corporation.\nIn conjunction with Lori's October 1995 acquisition of Global (see Note 3), ARTRA has agreed to assume certain pre-existing Lori liabilities and indemnify COMFORCE in the event any future liabilities arise concerning pre-existing environmental matters and business related litigation. Accordingly, ARTRA has accrued $4,500,000 of Lori liabilities classified in its consolidated balance at December 28, 1995 as current liabilities of discontinued operations.\nFor a discussion of certain other related party debt obligations see Note 9.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES SCHEDULE I . CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nARTRA GROUP INCORPORATED BALANCE SHEETS (Registrant Only In Thousands)\nDecember 28, December 29, 1995 1994 --------- ---------\nASSETS Current assets: Cash $2,347 $91 Receivables 25 55 Other current assets 85 87 --------- --------- 2,457 233 --------- ---------\nProperty, plant and equipment 25 19 Less accumulated depreciation and amortization 14 6 --------- --------- 11 13 --------- ---------\nOther assets: Investments in and advances to affiliates 2,567 (15,264) Other - 4,000 --------- --------- 2,567 (11,264) --------- --------- $5,035 ($11,018) ========= =========\nLIABILITIES Current liabilities: Notes payable and current maturities of long-term debt $25,300 $28,053 Accounts payable 509 1,576 Accrued expenses 9,323 9,702 Income taxes 200 138 --------- --------- 35,332 39,469 --------- ---------\nRedeemable common stock 4,774 4,144 --------- ---------\nRedeemable preferred stock 3,694 3,129 --------- ---------\nSHAREHOLDERS' EQUITY (DEFICIT) Common stock 5,540 5,052 Additional paid-in capital 38,526 36,613 Unrealized appreciation of investments 21,047 - Receivable from related party, including accrued interest (4,318) (4,100) Accumulated deficit (98,755) (94,520) --------- --------- (37,960) (56,955) Less treasury stock, at cost 805 805 --------- --------- (38,765) (57,760) --------- --------- $5,035 ($11,018) ========= =========\nThe accompanying notes are an integral part of the condensed financial information.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES SCHEDULE I . CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nARTRA GROUP INCORPORATED STATEMENTS OF OPERATIONS (Registrant Only In Thousands)\nFiscal Year ----------------------------- 1995 1994* 1993* -------- --------- --------\nSelling, general and administrative expenses $1,760 $2,158 $1,907 Depreciation and amortization 27 4 2 Interest expense 4,953 3,139 2,641 Equity in loss of affiliates 7,817 6,129 3,423 Other expense, net 424 308 85 -------- --------- -------- Loss from continuing operations before income taxes (14,981) (11,738) (8,058) Charge equivalent to income taxes (1,962) (1,791) (269) -------- --------- --------\nLoss from continuing operations (16,943) (13,529) (8,327)\nEquity in earnings (loss) of discontinued affiliate 10 (15,906) (216) -------- --------- -------- Loss before extraordinary credit (16,933) (29,435) (8,543)\nExtraordinary credit, net discharge of indebtedness 14,030 8,965 22,057 -------- --------- --------\nNet earnings (loss) ($2,903) ($20,470) $13,514 ======== ========= ========\nThe accompanying notes are an integral part of the condensed financial information.\n______________________________________________ * As reclassified for discontinued operations.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES SCHEDULE I . CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nARTRA GROUP INCORPORATED STATEMENTS OF CASHFLOWS (Registrant Only In Thousands)\nThe accompanying notes are an integral part of the condensed financial information.\nARTRA GROUP INCORPORATED AND SUB AND SUBSIDIARIES SCHEDULE I. CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(Cont.)\nARTRA GROUP INCORPORATED NOTES TO FINANCIAL INFORMATION (Registrant Only)\n1. Presentation\nThe condensed financial information of the Registrant has been prepared in accordance with the instructions for Schedule I to Form 10-K. The Registrant's investments in subsidiaries and affiliates are presented on the equity method.\n2. Commitments and Contingencies\nSee Note 15 of the consolidated financial statements.\n3. Restricted Assets\nThe terms of several agreements place certain restrictions on the net assets of certain operating subsidiaries. See Notes 9 and 10 of the consolidated financial statements for additional information.\n4. Notes Payable and Long-Term Debt\nSee Notes 9 and 10 of the consolidated financial statements.\n5. Redeemable Common and Preferred Stock and Stock Options\nSee Notes 11, 12 and 13 of the consolidated financial statements.\n6. Income Taxes\nThe Registrant files a consolidated income tax return with its 80% or more owned subsidiaries. Separate returns are filed by the Company's majority-owned, but less than 80% owned subsidiaries. For financial reporting purposes, the Registrant's charge or benefit equivalent to income tax represents the difference between the aggregate of income taxes computed on a separate return basis for each of the subsidiaries and affiliates and the income taxes computed on a consolidated basis.\n7. Guarantees of Subsidiaries' Obligations\nSee Notes 3 and 21 of the consolidated financial statements for a discussion of guarantees of subsidiary obligations.\nARTRA GROUP INCORPORATED AND SUBSIDIARIES SCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS for each of the three fiscal years in the period ended December 28, 1995 (in thousands)\n(A) Principally amounts of discontinued operations. (B) Principally markdowns taken. (C) Principally uncollectible accounts written off, net of recoveries. (D) Principally inventory written off, net of recoveries.\nINDEX OF EXHIBITS\n(A) Exhibits included herein:\nEXHIBIT 3 Articles of Incorporation and By-laws\n3.1 Statement with Respect to Shares of Series A Preferred Stock of Registrant.\n3.2 Statement with Respect to Shares of Rights and Preferences of Series B Preferred Stock of Registrant.\nEXHIBIT 10 Material contracts\n10.1 Letter Agreement dated February 26, 1996 by and among ARTRA GROUP Incorporated, ARTRA Subsidiary, Inc., BCA Holdings, Inc., Peter and Jean Harvey, and Bank of America Illinois, re. certain Purchase and Sale Agreement and Assignment between the Bank and Arabella S.A., a Luxembourg holding company.\n10.2 PURCHASE AND SALE AGREEMENT AND ASSIGNMENT, dated as of February 26, 1996, by and between Bank of America Illinois (the \"Seller\") and Arabella S.A., a Luxembourg holding company (the \"Purchaser\").\n10.3 Letter Agreement dated February 26, 1996 by and among ARTRA GROUP Incorporated and Arabella S.A., a Luxembourg holding company, re. purchase of certain indebtedness by Arabella (the \"Purchaser\") from Bank of America Illinois (the \"Seller\").\n10.4 AMENDED AND RESTATED PROMISSORY NOTE, dated February 26, 1996 made by BCA HOLDINGS, INC. in favor of ARABELLA S.A.\n10.5 OPTION TO PURCHASE SHARES OF COMMON STOCK OF BAGCRAFT CORPORATION OF AMERICA sold by BCA HOLDINGS, INC. to ARABELLA S.A.\n10.6 PREFERRED STOCK AGREEMENT made by and between BCA HOLDINGS INC. AND BAGCRAFT CORPORATION OF AMERICA.\n10.7 PREFERRED STOCK EXCHANGE AGREEMENT, dated as of January 31, 1996 by and between Ozite Corporation, BCA Holdings Inc. and Bagcraft Corporation of America.\n10.8 LIMITED CONSENT AND SIXTH AMENDMENT TO CREDIT AGREEMENT, dated as of February 1, 1996 between BAGCRAFT CORPORATION OF AMERICA and GENERAL ELECTRIC CAPITAL CORPORATION.\nEXHIBIT 11 Computation of earnings per share and equivalent share of common stock for each of the three years in the period ended December 28, 1995.\nEXHIBIT 21 Subsidiaries.\nEXHIBIT 24 Consent of Independent Accountants.\n(B) Exhibits incorporated herein by reference:\nEXHIBIT 3 Articles of Incorporation and By-laws\n3.3 Amended and Restated Articles of Incorporation of the Registrant as filed in the Department of State of Pennsylvania on December 21, 1990.\n3.4 Bylaws of the Registrant, amended as of July 24, 1990, filed as an exhibit to Registrant's Form 10-K for the year ended December 31, 1990.\nEXHIBIT 10 Material contracts\n10.1 ASSET PURCHASE AGREEMENT made as of the 28th day of September, 1995, by and among Arcar Graphics, Inc., an Illinois corporation (\"Arcar\" or \"Seller\"), BCA Holdings, Inc., a Delaware corporation (\"BCA\"), Bagcraft Corporation of America, a Delaware corporation (\"BCA\" and, collectively with BCA, \"Bagcraft\"), ARTRA GROUP Incorporated, a Pennsylvania corporation (\"ARTRA\"), and Arcar Acquisition Corp., a Delaware corporation (\"Buyer\"), filed with Registrant's Form 8-K dated October 26, 1995.\n10.2 LIMITED RELEASE, dated October 30, 1995, between NatWest Bank N. A. (\"Releasor\"), and ARTRA GROUP Incorporated and Peter R. Harvey (\"Releasee\"), filed with Registrant's Form 8-K dated October 26, 1995.\n10.3 STOCK PURCHASE AGREEMENT, Dated September 11, 1995 by and Among Spectrum Technologies, Inc., The Lori Corporation, COMFORCE Corp.; ARTRA Group Incorporated, Peter R. Harvey, Marc L. Werner, James L. Paterek, Michael Ferrentino, and Christopher P. Franco, filed with Registrant's Form 8-K dated September 11, 1995.\n10.4 Letter Agreement dated June 29, 1995, regarding employment or consulting services between The Lori Corporation, ARTRA Group Incorporated, James L. Paterek, Michael Ferrentino, and Christopher P. Franco, filed with Registrant's Form 8-K dated September 11, 1995.\n10.5 ASSIGNMENT AGREEMENT, dated and effective March 31, 1995, by and among IBJ Schroder Bank & Trust Company, The Lori Corporation, Lawrence Jewelry Co., Lawrence Jewelry Corporation, New Dimensions Accessories Ltd., Rosecraft, Inc., Fill-Mor Holding, Inc., ARTRA GROUP Incorporated and Alexander Verde, filed as an exhibit to Registrant's Form 10-K, for the year ended December 29, 1994, dated April 12, 1995.\n10.6 REGISTRATION AND SETTLEMENT AGREEMENT dated as of March 31, 1995 by and between ARTRA GROUP Incorporated and IBJ Schroder Bank & Trust Company filed as an exhibit to Registrant's Form 10-K, for the year ended December 29, 1994, dated April 12, 1995.\n10.7 AMENDED SETTLEMENT AGREEMENT by and among THE LORI CORPORATION, LAWRENCE JEWELRY CO., LAWRENCE JEWELRY CORPORATION, NEW DIMENSIONS ACCESSORIES LTD. (formerly known as R.N. Koch, Inc.), ROSECRAFT, INC., FILL-MOR HOLDING, INC., ARTRA GROUP INCORPORATED AND IBJ SCHRODER BANK & TRUST COMPANY, dated as of December 23, 1994 filed as an exhibit to Registrant's Form 8-K, dated January 3, 1995.\n10.8 Loan Agreement, dated as of December 23, 1994, by and among ARTRA GROUP Incorporated and McGOODWIN JAMES & CO filed as an exhibit to Registrant's Form 8-K, dated January 3, 1995.\n10.9 Settlement Agreement dated August 18, 1994 by among The Lori Corporation, Lawrence Jewelry Co., Lawrence Jewelry Corporation, New Dimensions Accessories, Ltd., Rosecraft, Inc., Fill-Mor Holding, Inc., ARTRA GROUP Incorporated and IBJ Schroder Bank & Trust Company, dated as of August 18,1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.10 Pledge and Security Agreement between The Lori Corporation and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.10 Pledge and Security Agreement between Lawrence Jewelry Co. and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.11 Pledge and Security Agreement between Lawrence Jewelry Corporation and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.12 Pledge and Security Agreement between New Dimensions Accessories, Ltd and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.13 Pledge and Security Agreement between Rosecraft, Inc. and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.14 Pledge and Security Agreement between Fill-Mor Holding, Inc. and IBJ Schroder Bank & Trust Company dated as of August 18, 1994 filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 1994, dated August 19, 1994.\n10.15 Credit Agreement dated as of December 17, 1993 by and between Bagcraft Corporation of America as Borrower and General Electric Capital Corporation as agent and lender filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994. . 10.16 Loan Agreement dated December 27, 1993 in the amount of $5,000,000 between Bagcraft Corporation of America and the City of Baxter Springs, Kansas filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.19 Construction Loan Agreement dated as of February 15, 1994 in the amount of $7,000,000 between the City of Baxter Springs, Kansas and Bagcraft Corporation of America filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.20 Loan Agreement dated January 19, 1994 in the amount of $250,000 between Bagcraft Corporation of America and the City of Baxter Springs, Kansas filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.21 Loan Agreement dated January 20, 1994 in the amount of $250,000 between Bagcraft Corporation of America and the City of Baxter Springs, Kansas filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.22 Asset Purchase Agreement dated as March 1, 1994 by and between AGI Acq. Inc., a subsidiary of Bagcraft Corporation of America, and Arcar Graphics, Inc. filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.23 Loan and Security Agreement dated as of April 8, 1994 between AGI Acq. Inc. and American National Bank and Trust Company of Chicago filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.\n10.24 Revolving Note dated as of April 8, 1994 in the amount of $1,500,000 from AGI Acq. Inc. to American National Bank and Trust Company of Chicago filed as an exhibit to Registrant's Form 10-K for the year ended December 30, 1993, dated April 11, 1994.","section_15":""}
{"filename":"700997_1995.txt","cik":"700997","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nTCA Cable TV, Inc. (\"the Company\") is engaged in the development, operation and management of cable television systems.(1) At October 31, 1995, the Company owned and operated 56 cable television systems which had approximately 545,000 subscribers and managed 2 systems which are owned by affiliated corporations and had approximately 3,500 subscribers.(2) The Company is listed in industry trade publications as one of the 20 largest operators of cable television systems in the United States (including subscribers in managed systems). The Company's systems are located primarily in smaller markets in Texas, Louisiana, Arkansas, Mississippi and New Mexico where over-the-air television reception is unsatisfactory, and the Company intends to continue to concentrate its activities in these and similar areas.\nThe Company was organized as a Texas corporation in December, 1981, to consolidate the ownership of four corporations which had been developing and operating cable television systems since 1965, 1973, 1975 and 1976, respectively. Unless the context otherwise requires, all references to \"TCA Cable TV, Inc.\" and the \"Company\" in this report shall refer to TCA Cable TV, Inc. and its predecessors and subsidiaries.\nTHE CABLE TELEVISION INDUSTRY\nCable television is a service which delivers to the home varied entertainment and information programming, either as transmitted by licensed radio and television stations or programming designed specifically for cable distribution. Radio and television signals are received by \"off-air\" antennae, microwave relay systems and satellite earth stations and are modulated and amplified at an electronic control center, or \"headend\", for distribution through a network of aerial or underground coaxial cables or optical fiber to television sets owned by subscribers. Subscribers generally pay a monthly fee for the service. Cable systems generally operate under non-exclusive franchises granted by local or state governmental authorities. The growth of the cable television industry has been accompanied by a significant number of operator consolidations.\nThe cable television industry began in the early 1950's. The industry's birth and subsequent growth was the result of demand for more stations and improved reception in areas where over-the-air television reception was unsatisfactory because of topography or remoteness from broadcast towers. The use of cable as the means of providing additional television channels and improved over-the-air reception is now generally referred to as \"basic service\", and normally consists of programming available from nearby over-the-air television channels, public channels and a limited number of channels relayed from distant cities, and satellite programming. Additional satellite programming services are offered in a separate \"expanded basic\" service for an additional charge. For an additional monthly or individual event charge, cable operators also provide subscribers a choice of \"premium services\" (referred to as \"Pay TV\" or \"Pay-Per-View\"), generally consisting of feature films, sporting and other special entertainment events. The availability of cable specific channels and premium service has established cable television as an entertainment medium in addition to fulfilling its original purpose to provide better over-the-air television reception. This development has led to significant growth of cable television in larger metropolitan markets. Although the Company offers premium services and plans to increase its capacity to provide such services, it has no present plans to acquire or develop new systems in larger metropolitan markets.\n- ---------------\n(1) A system includes all areas served from a single administrative office. A system may include one or more \"headends\" and the cable properties related thereto, and one or more communities or franchise areas.\n(2) The Company reports its subscribers based on the number of separate accounts billed. The Company's practice differs from the \"subscriber equivalent\" method used by some other cable system operators. The Company estimates that the use of subscriber equivalents in its reporting would increase its number of subscribers by approximately 5%.\nThe Company believes the cable television industry may derive additional income in the foreseeable future from the sale of air time to advertisers who desire access to the television media to promote their products or services. This revenue source is commonly referred to as advertising income. Revenue from advertising was approximately 9%, 9% and 7% of total revenue during 1995, 1994 and 1993, respectively.\nThe Company is continually evaluating the technical and economic feasibility of providing enhanced or expanded subscriber services and may provide additional such services in the future. However, the Company cannot provide assurance that revenue from any of these sources will increase.\nDEVELOPMENT OF CABLE SYSTEMS\nThe following table provides data relative to the last five fiscal years and indicates the growth of the cable systems owned by the Company. Information with respect to systems managed by the Company but owned by others is not included in the table.\nSubscriber growth experienced by the Company in recent years has come from the acquisition of existing systems and the upgrading and development of systems already owned, rather than from the securing of new franchises or the construction of new systems. Prior to and upon its acquisition of a system, the Company conducts a review of the acquired system's cable plant and operating policies and procedures. On the basis of its review, the Company typically makes modifications, repairs, upgrades to the plant, and additionally institutes operating policies and procedures designed to expand the system and improve its profitability.\nThe Company intends to continue its emphasis on growth through acquisition of existing systems. There can be no assurances, however, that the Company will be able to acquire existing systems in the future on terms as favorable as it has been able to do in the past. The Company does not currently have any definitive agreements for the acquisition of any additional systems except for the partnership formed with Donrey Media Group on December 13, 1995 as discussed in Note 12 to the financial statements. However, the Company may in the future acquire additional systems on terms it deems favorable based on evaluations of a system's selling price relative to subscriber levels and projected cash flows, among other factors.\nIn addition to growth resulting from system acquisitions and improvements made to acquired systems, the Company expects to continue growth through increased subscriptions caused by population growth in its franchise areas, and by emphasizing the availability of increased services to its basic subscribers. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\". There can be no assurance, however, that the number of the Company's subscribers will continue to increase.\nTHE SYSTEMS\nThe following table sets forth information as of October 31, 1995, regarding the Company's cable systems, all of which are owned by the Company unless otherwise indicated:\n- ---------------\n* Equivalent Billing Units, presented here to allow comparison with cable TV companies which report by this method, are calculated by dividing the basic service revenue by the base rate on commercial accounts and adding the number of residential accounts. Multiple-outlet subscribers at rates higher than the base rate making up the difference.\nSYSTEM OPERATING OFFICES (AT OCTOBER 31, 1995)\n- ---------------\n(1) This does not include information relating to the Alexandria, Louisiana system acquired December 15, 1995, as described in Note 12 to the financial statements.\nSUBSCRIBER SERVICES\nThe Company offers services to its subscribers that are generally comparable to those offered by other cable television operators. The basic service offered by the Company typically includes signals of nearby over-the-air television stations carrying all four major commercial networks; independent, specialty and educational stations; sports and educational programming; and additional satellite programming such as signals of distant independent stations, news, sports and religious programming, and continuous time, news and weather information.\nThe Company offers an additional level of service known as \"expanded basic\" service. Under this level of service the Company makes available to subscribers a variety of packaged programming, including news,\nsports, educational and entertainment channels and programs purchased from independent suppliers and combined in different formats to appeal to different tastes. Expanded basic service is provided at an additional monthly charge. A new product tier, known as the \"premier package\", is now being introduced in systems where fiber optic rebuilds are either finished or in some stage of completion. The new product tier offers five to twelve channels most requested by customers.\nMost of the Company's systems normally offer at least four premium services while some systems offer additional premium service options. Premium services include channels such as: The Movie Channel, HBO, Showtime, Cinemax and The Disney Channel, which offer feature motion pictures, concerts and other special features without commercial interruption. The Company's services do not include X-rated motion pictures. The programming provided under premium service, and in some cases under basic service, is acquired by the Company from independent suppliers for a fee equal to a specified portion of the amount charged by the Company for the service. The fees paid by the Company to independent suppliers are believed by the Company to be comparable to those paid by similarly situated cable television companies.\nRates charged subscribers vary with the type of service selected. All of the Company's cable systems are subject to rate regulation. See \"Business-Regulation\". The monthly service fee for basic service generally ranges from $8 to $12. The monthly service fee for expanded basic service generally ranges from $6 to $13. The Company's average monthly revenue per subscriber during fiscal 1995 for basic and expanded basic services was $21.42. A one-time installation fee ranging from $24 to $42 is usually charged to new subscribers. Monthly charges for equipment furnished to the customer generally range from $1 to $3. Additionally, the Company generally charges $8.00 to $10.00 per month for each premium subscription service. Premium service charges are sometimes discounted for multiple services. Subscribers are free to terminate service at any time.\nThe Company also services commercial subscribers such as hotels, motels, hospitals, and apartments. These subscribers are charged a one-time connection fee, which is usually sufficient to cover the Company's cost of installation. Commercial subscribers are generally free to terminate service at any time.\nMANAGEMENT SERVICES\nIn addition to operating its own cable television systems, the Company provides general management services for two systems owned by corporations affiliated with the Company (\"the Affiliated Companies\"). The Company's management services include: accounting, auditing, billing, marketing, computer operations, purchasing, engineering, and other technical and administrative support services which the Company performs pursuant to management contracts. These services are charged to the systems on a fee basis equal to specified amounts per subscriber for each particular service performed or a specified percentage of revenue. The intention is to recover the Company's actual costs of providing the services, plus a profit. Total revenues received by the Company for management services for fiscal 1995, 1994 and 1993 were $60,388, $53,323 and $51,220, respectively.\nOne of the Company's management contracts provides the Company a right of first refusal with respect to any proposed sales of any of the Affiliated Company's cable systems or with respect to any cable system acquisition opportunities which come to the attention of the Affiliated Company subject to the management contract. The Company does not intend to exercise its rights of first refusal with respect to relatively small cable systems which are contiguous to, or in the vicinity of, the systems owned by the Affiliated Companies.\nThe Company believes that the terms of its management contracts with Affiliated Companies are at least as favorable to the Company as could be obtained with unaffiliated third parties in arm's-length transactions.\nFRANCHISES\nEach local government authority typically issues a non-exclusive permit or enacts a non-exclusive franchise ordinance for the construction and operation of a cable television system within its borders after considering presentations by competing cable television companies. The Company's franchises normally require that 2% to 5% of the gross revenues of the cable system be paid to the franchising authority.\nEffective January 1, 1987, rates charged to subscribers could no longer be regulated by local authorities in areas where the FCC determined that cable television systems were subject to \"effective competition\". Congress in the Cable Act of 1992 amended the effective competition standard in a manner that subjects virtually all of the Company's systems to rate regulation. See \"Business-Regulation\".\nFCC Rules and some franchises generally require approval by the franchising authority for the sale of a system. See \"Business-Regulation\". Most of the Company's franchises can be terminated prior to their stated expiration for breach of material provisions. The Company holds approximately 210 franchises with unexpired terms ranging generally from one to 40 years. No one franchise accounts for more than 10% of the Company's total revenue.\nFranchises have historically been renewed for companies that have provided adequate service and have complied generally with the franchise terms. Additionally, the Cable Communications Policy Act of 1984 established renewal procedures designed to protect incumbent franchisees against arbitrary denial of renewal. The Company believes that it has provided satisfactory levels of service and has maintained favorable relationships with local communities and anticipates that all or substantially all of its franchises will be renewed, although there can be no assurance of such renewals. In addition, other applicants have an opportunity to compete for the franchise upon its expiration. See \"Competition\" below. In connection with a renewal, the franchising authority may impose different and more stringent terms, the impact of which cannot be predicted. To date, however, all of the Company's franchises have been renewed or extended, generally at or prior to their stated expirations, and on modified, but not unduly burdensome, terms.\nIn City of Los Angeles v. Preferred Communications, Inc., the U.S. Supreme Court affirmed a decision that had allowed a challenge to the constitutionality of the cable television franchise process and which suggested that, where feasible, franchising authorities must grant access to others seeking to provide competitive cable television service in a community. If the rationale of the Preferred Communications case and other similar court decisions is applied generally to the cable television industry, many cable television operators, including the Company, may face increased competition from other cable television operators.\nCOMPETITION\nThe Company encounters competition for the acquisition of existing systems and may encounter similar competition at the time of franchise renewal. The cable television industry has undergone significant consolidation in recent years. At the same time, the number of United States communities that have not awarded cable television franchises has rapidly diminished and the competition for new franchises and for renewal of existing franchises has intensified. Furthermore, certain regulations restricting competition in the industry have recently been relaxed or rescinded, reflecting current and future policy objectives of the FCC and in Congress to increase competition to cable television. See \"Regulation.\" As a result of the foregoing, it may be expected that the Company will encounter increased competition from other entities having substantially greater resources than the Company.\nCompetition for the Company's cable services arises from numerous alternative entertainment and information sources such as movie theaters, broadcast television stations, direct broadcast satellites and home satellite receivers, wireless cable systems, video cassette recorders, and other sources of home entertainment. Advances in communications technology and changes in the market place are constantly occurring. Due to changes in technology and regulatory policies encouraging competition, the Company anticipates significantly increased competition, particularly from recently launched direct broadcast satellite systems, as well as telephone companies, providing video programming to subscribers.\nREGULATION\nGeneral. Cable television systems are regulated extensively by federal, local and sometimes state authorities. Local and state regulations generally relate to the awarding of franchises, rate regulation, customer service standards and other operational requirements.\nFCC REGULATION\nGeneral. Federal regulation of cable television systems is effected primarily through the Federal Communications Commission (FCC). Regulations promulgated by the FCC contain detailed provisions relating to virtually all aspects of the cable industry including rate regulation, must carry and retransmission consent for carriage of broadcast signals, technical standards, customer service standards, competition, programming, franchise issues, commercial leased access channels, ownership of cable television systems, non-duplication of network programming, syndicated program exclusivity, sports program blackouts, equal employment opportunities, comprehensive reporting requirements, signal leakage standards and other matters. The FCC is authorized to impose monetary fines on cable system operators for violations of FCC rules and may also issue cease and desist orders.\nCable Communications Policy Act of 1984 and the Cable Television Consumer Protection and Competition Act of 1992\nOn October 11, 1984, Congress passed the Cable Communications Policy Act of 1984 (\"Cable Act of 1984\"). A major objective of Congress in passing that law was to clarify the regulatory relationship between franchisers and cable operators. On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (\"Cable Act of 1992\"), which expands the scope of cable industry regulation beyond that imposed by the Cable Act of 1984. Provisions of these laws which the Company believes may have a significant impact on its operations are summarized below.\nRate Regulation\nAll of the Company's cable systems are or will be subject to rate regulation. Pursuant to the Cable Act of 1992 the FCC has established rate standards and procedures governing regulation of basic cable service rates. Franchising authorities may \"certify\" to the FCC that they will follow the FCC standards and procedures in regulating basic rates and, once such certification is made, the franchising authorities will assume rate regulation authority over basic rates. The Cable Act of 1992 also requires that the FCC, upon complaint from a franchising authority or a cable subscriber, review the \"reasonableness\" of rates for additional tiers of cable service. Only rates for premium pay channels and single event pay-per-view services are excluded entirely from rate regulation. Additionally, the Cable Act of 1992 imposes rate regulation pursuant to an FCC formula for the sale and lease of cable equipment such as converters, remote controls and additional outlets \"on the basis of actual cost.\" It is impossible to predict the exact impact of rate regulation upon existing and future rates of the Company, but such rate regulation could result in denial of requested rate increases and in reduction of existing rate levels.\nThe Cable Act of 1992 prohibits cable systems which have addressable technology and addressable converters in place from requiring cable subscribers to purchase service tiers above the basic level of service as a condition to purchasing premium movie channels. If cable systems do not have such addressable technology or addressable converters in place, they are given until December 2002 to comply.\nRetransmission Consent\nThe Cable Act of 1992 establishes a choice for broadcasters between \"must carry\" rights (as described below) or \"retransmission consent\" rights. As of October 1993, cable operators are required to secure permission from broadcasters that have selected retransmission consent before retransmitting the broadcaster's television signals. Local and distant broadcasters can require cable operators to make payments as a condition to granting such consent for carriage of the broadcast station on the cable system. This requirement has the potential of significantly increasing the cost of carriage of broadcast stations on the Company's cable systems.\nMust Carry Requirements\nThe Cable Act of 1992 imposes obligations to carry \"local\" broadcast stations should such stations choose a \"must carry\" right as opposed to the \"retransmission consent\" right described above. Generally, the\ncable operator must dedicate up to approximately one-third of its channel capacity for carriage of commercial television stations and additional channels for non-commercial television stations.\nProgramming Costs and Exclusivity\nPursuant to the Cable Act of 1992 the FCC has adopted regulations regarding the sale and acquisition of cable programming in which a cable operator has an attributable interest. The legislation and the subsequent FCC regulations preclude most exclusive programming contracts, limit to some degree \"volume discounts\" for programming that can be offered to affiliated cable operators, and require that such cable programmers make their programming services available to competing video technologies such as wireless cable systems and direct to the home broadcast satellite operators on terms and conditions that do not discriminate against such competing technologies.\nOwnership Restrictions\nThe Cable Act of 1984 codifies the FCC's regulatory cable cross-ownership restrictions which restrict common ownership of television broadcasting stations and cable television systems within the television broadcast station's broadcast area. Additionally, local telephone companies are prohibited from providing cable television services within their telephone service areas unless the area is deemed \"rural\" or unless a waiver is obtained from the FCC. The FCC has indicated its intention to expand the rural exemption and to relax the waiver standards to make it easier for telephone companies to obtain such waivers and has recommended to Congress elimination of the telephone\/cable cross-ownership restrictions in the Cable Act of 1984. In addition, a number of recent court decisions have held that the telephone\/cable cross-ownership restrictions are unconstitutional and unenforceable.\nThe FCC has authorized so-called \"video dialtone\" services, by which independent programmers may provide video services to the home over telephone-provided circuits, thereby by-passing the local cable system. The FCC has declared that such services would require no local franchise or payment to the local government authority, and that ruling has been upheld by the courts. The FCC decision allows telephone companies to acquire a limited financial interest in programming services, but currently limits their delivery role to that of a traditional \"common carrier.\" However, the FCC is considering proposals to reduce the limitations on telephone company involvement in programming. The FCC's actions, legislation which has passed both Houses of Congress, and recent court decisions are expected to result in greater involvement and competition from telephone companies in the cable industry.\nPursuant to the Cable Act of 1992 the FCC has adopted regulations establishing limits on the number of cable subscribers a person is authorized to reach through cable systems owned by such person, or in which such person has an attributable interest, and establishing limits on the number of channels on a cable system that can be occupied by a video programmer in which a cable operator has an attributable interest. Additionally, cable operators are prohibited from selling a cable system within three years of acquisition or construction of such cable system.\nCustomer Service\/Technical Standards\nPursuant to the Cable Act of 1992 the FCC has adopted regulations establishing comprehensive standards for customer service and technical system performance. Franchising authorities are allowed to enforce stricter customer service requirements than the FCC standards.\nOther Provisions\nThe Cable Act of 1992 contains a host of other regulatory provisions. Together with the Cable Act of 1984, a comprehensive regulatory framework for cable television systems has been created. Violation by a cable operator of the statutory provisions or the rules and regulations of the FCC can subject the operator to substantial monetary penalties and other significant sanctions.\nThe majority of the Cable Act of 1984 remains in place. The Cable Act of 1984 continues to: (a) affirm the right of franchising authorities to award one or more franchises for cable; (b) require cable television systems with 36 or more \"activated\" channels to reserve a percentage of such channels for commercial use by unaffiliated third parties; (c) permit franchise authorities to require the cable operator to provide channel capacity, equipment and facilities for public, educational and government access; (d) provide subscribers an opportunity to lock out offensive channels from personal reception; (e) establish a federal policy for use of subscriber lists and subscriber information; (f) establish civil and criminal liability for unauthorized reception or interception of programming offered over a cable television system or satellite delivered services; and (g) contain provisions governing cable operator's compliance with equal employment opportunity programs.\nMany of the specific obligations imposed on cable television systems under these laws and regulations are complex, burdensome and will continue to increase the Company's cost of doing business. Various provisions of the Cable Acts of 1984 and 1992 have been appealed in the courts. The outcome of some of those appeals and the potential impact on the legislation and the Company is uncertain. In addition, the constitutionality of various aspects of the cable television franchising process has been called into question by recent court decisions. See \"Business -- Franchises\".\nPENDING TELECOMMUNICATIONS LEGISLATION\nBoth the U.S. Senate and House of Representatives have recently passed the telecommunications bills and such legislation is likely to be enacted into law within the next several months. Although the final form of this legislation has has not yet been determined, it would, if adopted as anticipated, result in very significant changes in laws and regulations applicable to cable television companies, telephone companies and many other providers of communications services. Generally the legislation would eliminate the cross-ownership restrictions between telephone companies and cable operators subject to certain conditions. This would permit telephone companies to provide cable television services to subscribers within their telephone service area over telephone or other facilities, and cable operators would be permitted to provide telephone services under certain circumstances. In addition, the legislation would provide some eventual deregulation of cable television, but would also impose some additional obligations and expense on cable operators, including higher pole attachment fees. While the full impact of this legislation cannot be predicted at this time, the Company anticipates that it will face increased competition from telephone companies which generally have significantly greater financial resources than the Company.\nCOPYRIGHT ACT\nCable television systems are subject to the Copyright Act of 1976 (the \"Copyright Act\"). The Copyright Act requires the carrier of television signals to have a copyright license. The license for television broadcast signals is compulsory under the provisions of the Copyright Act and subjects the licensee to compliance with certain copyright and FCC regulations. Additionally, a semiannual royalty payment must be made to the U.S. Copyright Office and is generally calculated as a percentage of each system's gross receipts. The U.S. Copyright Office is empowered to review and increase copyright rates.\nCarriage of any television broadcast station by a cable system in a manner inconsistent with applicable FCC regulations, the Copyright Act, or copyright regulations can subject the cable system operator to full copyright liability, including a potential copyright infringement action for material damages and suspension of the operator's compulsory license. Cable systems do not receive a compulsory license and are subject to the general copyright laws, with respect to the transmission of nonbroadcast programming.\nVarious legislative proposals have been introduced and considered from time to time in Congress that, if adopted, would materially revise the Copyright Act. The proposals include, among other things, a significant increase in the rate structure for royalty fees, imposition of restrictions on carriage of television broadcast programming and elimination of the compulsory license for cable system carriage of television broadcast signals. The FCC has recommended to Congress the elimination of the cable compulsory license and similar recommendations have been made by other government agencies and interested parties. Although none of these bills have been enacted, it can be expected that similar proposals to change the Copyright Act and\nroyalty fee structure will be made in the future, and if enacted, could have an unfavorable impact on the Company.\nAVAILABILITY OF SUPPLIES\nThe Company experiences no difficulty in obtaining equipment or supplies.\nEMPLOYEES\nOn October 31, 1995, the Company had 1,141 full-time employees, none of whom was represented by a union. The Company has not experienced any work stoppages and considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal physical assets consist of operating plant and equipment, including signal receiving apparatus, headends and distribution plant and equipment for each of its cable television systems. The signal receiving apparatus typically includes a tower, antennae and ancillary electronic equipment for reception of over-the-air broadcast television signals, and earth stations and ancillary electronic equipment 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 systems consist of coaxial cables, optical fibers and related electronic equipment and customer connection devices (principally converters). The Company owns the receiving equipment, headends and distribution equipment and property, and owns or leases small parcels of property for the receiving sites and for business offices.\nThe Company's cables are generally attached to utility poles covered by rental agreements with local utility companies, although approximately 15% of the Company's cables are buried in trenches.\nAfter the expiration of an initial term of one to three years, pole rental agreements generally are terminable by the utility companies upon six months notice or less. The Company's activities are dependent upon its pole agreements, and substantially increased pole attachment fees or the termination of pole agreements would have a material adverse effect on the Company. Although the Company believes that any such termination is unlikely and knows of no situation in which such a termination of rights has been exercised, no assurance can be given that the utility companies will not attempt to exercise their termination rights.\nThe Company believes that its properties are in good condition and are suitable to and adequate for its business. The physical components of cable television systems require maintenance and also require upgrading to keep pace with technological advances.\nThe Company leases a building in Tyler, Texas, which houses its headquarters. The building is owned by a corporation controlled by the Chairman of the Board of Directors of the Company and the Company may cancel the lease at any time. The Company believes the terms of such lease are at least as favorable as would be obtainable from a third party lessor. The Company also owns and leases various offices, tower sites, microwave locations, test equipment and service vehicles, no one of which is considered material to the Company or its business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to certain legal proceedings arising in the ordinary course of business, none of which are believed to be material to the Company's business or 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\n(a) Price Range of Common Stock\nThe Company's common stock is traded in the over-the-counter market and is quoted on the NASDAQ National Market System under the symbol \"TCAT\". The following table shows the range of closing bids for the common stock of the Company in the over-the-counter market for each fiscal quarter beginning with the quarter ended January 31, 1994 as reported by NASDAQ. The quotations represent prices in the over-the-counter market between dealers in securities, do not include retail markup, markdown or commission and do not necessarily represent actual transactions.\n(b) Approximate Number of Equity Security Holders\n(c) Dividends\nDuring the fiscal year ended October 31, 1995, cash dividends were paid to shareholders in the amount of $11,787,622 ($.12 per share paid in January, April, July and October, 1995). During the prior fiscal year, $10,831,640 in cash dividends were paid to shareholders ($.11 per share paid in January, April, July and October, 1994). At the December 13, 1995 regularly scheduled Board of Directors meeting, a cash dividend of $.14 per share for the quarter ending January 31, 1996 was declared. This dividend was payable January 10, 1996 to shareholders of record as of December 27, 1995.\nThe Board of Directors of the Company intends to continue to declare comparable dividends and will determine dividend policy, including amounts and frequency thereof, taking into account, among other things, the amount of funds legally available, and the Company's earnings, financial condition and other cash requirements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated financial statements and the notes thereto set forth elsewhere in this Annual Report on Form 10-K.\n- ---------------\n(1) The Company adopted Statement on Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" during the first quarter of 1994 by recognizing a one-time cumulative effect adjustment which reduced net income by $1.9 million.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following historical table sets forth for the periods indicated certain items in the Selected Financial Data as a percentage of total revenues.\nRESULTS OF OPERATIONS\nGeneral. During the past three years, the Company has experienced increases in revenues, operating income and net income reflecting increased subscriptions due to internal growth, the acquisition and construction of additional systems and subscription rate increases. During the period from November 1, 1992 through October 31, 1995, revenues, operating income and net income increased at average annual growth rates of approximately 11%, 22% and 29%, respectively.\n1995 COMPARED TO 1994\nFiscal year 1995 revenue increased by 17% over 1994 revenue. Approximately 33% of the revenue increase was the result of increased revenue from existing customers, 10% from internal growth in the number of subscribers, 20% from additional advertising revenue and 37% from acquisitions. The Company's revenue from advertising increased 38%, revenue from basic and expanded basic services increased 14% and revenue from premium services increased 10%.\nOperating expenses increased 6% in 1995 compared to 1994. Programming costs increased 20%, salaries, wages and benefits 12%, other operating expenses 14%, selling, general and administrative 7% and depreciation and amortization decreased 16%.\nThe Company's other income decreased $1,309,000. Other income for 1994 includes a pre-tax gain of $1,459,000 from the sale of two cable television properties. Other income also includes losses of $543,000 for 1995 from the Company's investment in affiliates reported under the equity method.\nInterest expense increased 42% as a result of borrowings under the Company's bank lines of credit and a $100 million private placement, as described in Note 4 to the financial statements, made to finance the Company's acquisition of cable television properties.\n1994 COMPARED TO 1993\nFiscal year 1994 revenue increased by 7% over 1993 revenue. Approximately 14% of the revenue increase was the result of increased revenue from existing customers, 36% from internal growth in the number of subscribers, 40% from additional advertising revenue and 10% from acquisitions. The Company's revenue from advertising increased 40%, revenue from basic and expanded basic services increased 2% and revenue from premium services increased 6%.\nOperating expenses increased 8% in 1994 compared to 1993. Of the operating expense increase, 41% was from increases in programming costs, 39% from salaries, wages and benefits, 9% from other operating expenses, 7% from selling, general and administrative and 4% from depreciation and amortization. Programming costs increased 10%, salaries, wages and benefits 12%, other operating expenses 16%, selling, general and administrative 6% and depreciation and amortization 1%.\nThe Company's other income increased $1,342,000. Other income includes a pre-tax gain of $1,459,000 from the sale of two cable television properties. Other income also includes losses of $193,000 from the Company's investments in affiliates reported under the equity method.\nInterest expense decreased 11% as a result of the Company's repayment of term debt.\nThe Company has adopted Statement on Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" which has changed the Company's method of accounting for income taxes to an asset and liability method. The Company adopted FAS 109 during the first quarter of 1994 by recognizing a one-time cumulative effect adjustment which reduced net income by $1.9 million. Net income before the cumulative effect of FAS 109 was $23.0 million, a 12% increase over 1993. Net income after recognition of FAS 109 was $21.1 million, a 3% increase over 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's capital expenditures, other than for acquisitions, during fiscal 1995 were primarily directed at cable system construction, upgrading and rebuilding and purchases of converters to be furnished to subscribers. Approximately $39.8 million of internally generated funds was spent for system upgrading and expansion during fiscal 1995. The Company anticipates no increase in the amount of capital expenditures needed for system upgrading and expansion during 1996 compared to 1995. Approximately $150.7 million, $3.1 million and $6.9 million was spent on acquisitions in fiscal years 1995, 1994 and 1993, respectively. All of the funds were obtained from bank lines of credit and a $100 million private placement.\nThe Company anticipates paying approximately $21 million and $13.8 million in interest expense and dividends, respectively, during fiscal 1996. The Company does not anticipate a material negative affect on liquidity on account of the payment of such items.\nThe Company's net cash provided by operating activities during the most recent fiscal year increased to $68.2 million, up from $60.5 million in fiscal 1994 and $58.9 million in fiscal 1993. The increase is a result of additional subscribers in existing systems, increased revenue per subscriber and acquisitions, as more fully explained above with respect to the Company's results of operations.\nAt October 31, 1995, the Company had $109.7 million borrowed under its revolving credit agreements with eleven banks which provide for total credit of up to $228 million. The revolving credit agreements provide for interest at prime or LIBOR.\nDuring fiscal 1995, 1994 and 1993, the Company borrowed approximately $315.8 million, $73.7 million and $104.4 million, respectively, and repaid approximately $180.0 million, $90.5 million and $124.5 million, respectively. At October 31, 1995, the Company had total outstanding term debt of approximately $262.2 million, bearing interest at a weighted average rate of approximately 7.3%.\nUnder terms of the Company's current term debt, the Company will have scheduled debt maturities of approximately $42.0 million, $12.2 million, $12.0 million, $26.2 million and $18.2 million in fiscal 1996, 1997, 1998, 1999 and 2000, respectively. The Company believes that cash flow from operations and its ability to obtain financing will be adequate to fund these debt maturities.\nTwo measures of liquidity are debt to cash flow and interest coverage ratios. Debt to cash flow is the ratio of debt to operating income before depreciation and amortization. The Company's debt to cash flow ratio was 2.5 to 1, 1.6 to 1 and 1.8 to 1 at October 31, 1995, 1994 and 1993, respectively. Interest coverage is the ratio of operating income before depreciation and amortization to interest expense. The Company's interest coverage ratio was 773%, 816% and 708% for 1995, 1994 and 1993, respectively.\nExpenditures for rebuilding, upgrading and maintaining the Company's cable systems and for converter purchases have been financed principally with cash flow from operations and through bank borrowings and seller financing.\nThe Company believes that net cash provided by operating activities and the Company's ability to obtain additional financing will provide adequate sources of short-term and long-term liquidity in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe 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\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company are:\n- ---------------\n(1) Member of the Audit Committee\n(2) Member of the Stock Option and Compensation Committee\nEach of the foregoing persons has served in the above capacities since the inception of the Company in 1981 unless otherwise indicated. Each director serves until the next annual meeting of the Company's shareholders or until his successor is duly elected and qualified. The Company's executive officers serve at the discretion of the Board of Directors.\nRobert M. Rogers founded the Company and each of its subsidiaries and has served as Chairman of the Board of Directors and CEO of the Company and each of the Company's subsidiaries since their inception. Mr. Rogers was President of the Company from its inception in 1981 until September, 1990. Mr. Rogers has been actively involved in the ownership and operation of cable television systems since 1954. Mr. Rogers is an officer, director and shareholder of the Affiliated Companies. He is a member of the cable television Pioneers' Club.\nFred R. Nichols is President, Chief Operating Officer and a director of the Company. Prior to being named President in September, 1990, Mr. Nichols served as Executive Vice President and a director of the Company since its inception, Chief Operating Officer of the Company since December, 1983 and Secretary of the Company from September, 1984 until December, 1990. He had been Treasurer of the Company's subsidiaries from 1980 until 1985 when he was named President of TCA Management Company and all other wholly-owned subsidiaries of the Company, excluding VPI Communications, Inc. Mr. Nichols is currently Chairman of the Cable Telecommunications Association (CATA), a trade association of the cable industry. He is also on the Board of Directors of C-SPAN, a CATV network.\nJimmie F. Taylor is Vice President, Chief Financial Officer and Treasurer. Prior to being named Vice President in December, 1990, Mr. Taylor served as Chief Financial Officer and Treasurer of the Company since November 1, 1986. He had been Controller of the Company's wholly-owned subsidiary, TCA Management Company, since joining the Company in May, 1984. Immediately prior to joining the Company, he was employed for nine years in public accounting. Mr. Taylor is a Certified Public Accountant.\nJerry P. Yandell has served as a Vice President of the Company since March 25, 1987. He is Senior Vice President -- Operations of TCA Management Company, and has been Personnel Director since March, 1979. Immediately prior to joining the Company, he was employed as Personnel Director for General Electric in Tyler, Texas, where he had been for eighteen years.\nMelvin R. Jenschke has served as a Vice President of the Company since March 25, 1987. He has been with the Company since 1969 serving in several capacities prior to becoming Senior Vice President -- Engineering for TCA Management Company in 1983.\nWayne J. McKinney has been actively engaged in the cable television business since 1958 and was employed by the Company or its subsidiaries from 1958 until his retirement in January, 1986, serving as a Director and Senior Vice President -- Engineering of the Company from its inception and as Senior Vice President or Vice President, Chief Engineer and\/or Director of Engineering of the Company's subsidiaries. Mr. McKinney has been a member of the cable television Pioneers' Club since 1979, and is a Charter and Senior Member of the Society of Cable Telecommunications Engineers.\nBen R. Fisch, M.D., has been a director of the Company or its subsidiaries since 1967. Dr. Fisch has been retired from medical practice in Tyler, Texas since July, 1986.\nA. W. Riter, Jr. retired as Senior Chairman of the Board of Directors of NCNB Texas -- Tyler, Texas (successor to First RepublicBank Tyler), on September 30, 1988. He had served as Chairman and Chief Executive Officer until June 30, 1988 and held the same positions with First RepublicBank Tyler and its predecessor, InterFirst Bank Tyler, from August, 1979 to June, 1988 and served as President of Peoples National Bank (predecessor of InterFirst Bank Tyler) from 1964 until 1979. Mr. Riter served as a director and Vice President of most of the Company's subsidiaries from time to time from 1965 to 1974.\nJames F. Ackerman is President of Cardinal Ventures, LLC in Indianapolis, Indiana. Cardinal Ventures, LLC is an equity investor in small businesses. Mr. Ackerman had been President of Jim Ackerman and Associates, Inc., a financial consulting firm to the cable television industry from October, 1984 to December 31, 1994. From 1973 to December 1, 1984, he was Senior Vice President of A.G. Becker Paribas, Inc. Mr. Ackerman has been engaged in investment banking activities with respect to the cable television industry since 1959 and had served as a partner of Becker Communications Associates, a cable television investment partnership, from 1973 to 1989. He was also Chairman and Chief Executive Officer of Cardinal Communications, Inc., an Indiana cable television operator, a position he had held from 1971 until the company was sold in 1993. Mr. Ackerman is a former President and Director of the Indiana Cable Television Association, a past Director of the National Cable Television Association and a member of the cable television Pioneers' Club.\nKenneth S. Gunter is Chairman and CEO of MT Associates, Inc., San Angelo, Texas, a broadband communications design and construction contractor. Since 1958, he has served as a senior officer and director of several publicly-held cable television multiple system operators, including International Cablevision Corporation, Columbia Cable Systems, Inc., UA-Columbia Cablevision, Inc., Rogers-UA Cablesystems, Inc., and United Artists Communications, Inc. He is a past director of the National Cable Television Association, a Senior Member and past officer and director of the Society of Cable Telecommunications Engineers, and a member of the cable television Pioneers' Club.\nRandall K. Rogers has been with TCA since 1983, previously serving as general manager in Big Spring and Huntsville, Texas. Since 1989, Mr. Rogers has served as general manager of the Company's operations in Bryan\/College Station, Texas. Mr. Rogers is the son of Robert M. Rogers.\nFred W. Smith is Chairman of the Donald W. Reynolds Foundation, one of the thirty largest private charitable foundations in the United States. Mr. Smith's entire business career has been with the Donrey Media Group, which he joined in 1951. He served in various capacities until 1993 when he retired as the company's President and Chief Executive Officer.\nThe Board of Directors held four meetings during fiscal 1995. The Board of Directors has two standing committees -- the Audit Committee and the Compensation and Stock Option Committee.\nThe functions performed by the Audit Committee include: recommending to the Board of Directors selection of the Company's independent accountants for the ensuing year; reviewing with the independent accountants and management the scope and result of the audit; reviewing the independence of the independent accountants; reviewing actions by management and independent accountants' recommendations; and meeting with management and the independent auditors to review the effectiveness of the Company's system of internal control. The Audit Committee met two times during fiscal 1995.\nThe Compensation and Stock Option Committee met twice during 1995. The functions performed by this committee include: reviewing and recommending the Company's executive salary structure; reviewing the Company's Incentive Stock Option Plan (and granting options thereunder); recommending directors' fees; and approving salary and bonus awards to certain key employees.\nThe information called for by 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 herein by reference to the Registrant's definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held March 28, 1996, which shall be filed with the Securities and Exchange Commission within 120 days of the end of the Registrant's last fiscal year.\nPART IV\nITEM 14.","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe following consolidated financial statements of TCA Cable TV, Inc. and Subsidiaries, otherwise includable under Item 8, are included in this Item 14.\n14(A)(3) EXHIBITS\nEXHIBIT\n- ---------------\n*1 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1, File No. 2-75516, and incorporated by reference herein.\n*2 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 33-21901, and incorporated by reference herein.\n*3 Filed herewith.\n*4 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 2-88892, and incorporated by reference herein.\n*5 Previously filed as an exhibit to Registrant's Form 10-K for the fiscal year ended October 31, 1993, filed January 27, 1994 and incorporated by reference herein.\n*6 Previously filed as an exhibit to Registrant's Form 10-K for the fiscal year ended October 31, 1994, filed January 30, 1995 and incorporated by reference herein.\n*7 Previously filed as an exhibit to Registrant's Form 10-Q for the quarter ended April 30, 1995, filed June 14, 1995 and incorporated by reference herein.\n*8 Previously filed as an exhibit to Registrant's Form 10-Q for the quarter ended July 31, 1995, filed September 14, 1995 and incorporated by reference herein.\n*9 Previously filed as an exhibit to Registrant's Form 8-K , filed May 15, 1995 and incorporated by reference herein.\n*10 Previously filed as an exhibit to Registrant's Form 8-K , filed May 24, 1995 and incorporated by reference herein.\n*11 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 33-61041, and incorporated by reference herein.\n14(B) REPORTS ON FORM 8-K:\n1. Form 8-K\/A filed September 11, 1995, subsequent to the Fayetteville acquisition (Item 2).\n2. Form 8-K\/A filed September 13, 1995, subsequent to the San Angelo acquisition (Item 2).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(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.\nTCA CABLE TV, INC. (REGISTRANT)\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Shareholders TCA Cable TV, Inc.:\nWe have audited the consolidated financial statements of TCA Cable TV, Inc. and Subsidiaries 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 TCA Cable TV, Inc. and Subsidiaries 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.\nAs discussed in Note 2 to the consolidated financial statements, in 1994 the Company changed its method of accounting for income taxes.\nCOOPERS & LYBRAND L. L. P.\nDallas, Texas January 23, 1996\nTCA CABLE TV, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS OCTOBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of the consolidated financial statements.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED) FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. BASIS OF FINANCIAL STATEMENT PRESENTATION:\nTCA Cable TV, Inc. (the \"Company\" or \"TCA\") owns and operates cable television (\"CATV\") systems in nonurban areas. The consolidated financial statements include the accounts of TAL Financial Corporation (\"TAL\"), a wholly-owned subsidiary of the company, and TAL's wholly-owned subsidiaries: TCA Management Company; Teleservice Corporation of America; Texas Community Antennas, Inc.; Texas Telecable, Inc.; TCA Cable of Amarillo, Inc.; Telecable Associates, Inc.; Delta Cablevision, Inc., Sun Valley Cablevision, Inc., VPI Communications, Inc., AvComm Corporation, Tele-Communications of Arkansas L.P. and Tele-Communications of Northwest Arkansas L.P.\nAll significant intercompany transactions have been eliminated in consolidation.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is computed using the straight-line method over the estimated useful lives of the related assets as follows:\nMaintenance and repair costs are charged to expense as incurred. Major replacements and betterments are capitalized. Upon sale or retirement, the cost and accumulated depreciation applicable to the asset is removed from the accounts and the resulting profit or loss is reflected in income.\nIncome Taxes\nThe Company and its subsidiaries file a consolidated federal income tax return. During 1994, the Company adopted Statement on Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"FAS 109\"). This statement requires the use of an asset and liability approach for financial accounting and reporting for income taxes. Net income for 1994 was reduced $1,900,000 or $.07 per share by the recognition of a one-time cumulative effect adjustment from the adoption of FAS 109.\nIntangibles\nIntangible assets including franchises, noncompete agreements and goodwill are recorded at cost. Intangible assets are amortized on a straight-line basis over the expected useful lives of the assets which range from 5 to 40 years.\nGoodwill represents the excess of the cost of the acquisition over the fair value of the net assets acquired and is being amortized on a straight-line basis over 40 years. At each balance sheet date, management assesses whether there has been a permanent impairment in the value of goodwill by considering current operating results, trends and prospects.\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.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) Investments\nInvestments in affiliates in which the Company's voting interest is 20% to 50% are accounted for under the equity method. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company's share of the net earnings or losses of the affiliates as they occur rather than as dividends or other distributions are received. The Company's share of the results of operations of investees is not material.\n3. INTANGIBLE ASSETS:\nIntangible assets consists of the following at October 31:\n4. TERM DEBT:\nTerm debt consists of the following:\n- ---------------\n(a) The weighted average interest rate on the Company's revolving bank credit at October 31, 1995 was 6.64%.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n4. TERM DEBT -- (CONTINUED) The Company's revolving bank credit agreements and the term loan agreements contain restrictive covenants including minimum cash flow ratios. Under these covenants, the Company's dividends, capital expenditures and fixed principal payments could also be limited.\nScheduled maturities of term debt at October 31, 1995, are as follows:\n5. TRANSACTIONS WITH AFFILIATES:\nTCA Management Company performs all accounting and management services for two CATV systems owned by affiliated companies (the \"affiliated companies\"). Revenues received by TCA Management Company from the affiliated companies (which equal an expense reimbursement plus a profit) are included in CATV revenues and related expenses are included in operating expenses. These amounts are not material.\nThe Company leases its headquarters building from a company partially owned by an officer and director of TCA. The annual lease expense was $318,515, $324,784 and $393,744 for 1995, 1994 and 1993, respectively.\nThe Company purchased distribution system construction services from a partnership partially owned by a director of the Company. During 1995 and 1994, transactions with the partnership totaled $4,603,694 and $816,705, all of which were capitalized. The Company has also guaranteed a $198,000 loan from a bank for the same partnership.\nThe Company has a note receivable from TCA Communications, Inc., a 50% owned affiliate. The note is due in May 1996 with interest at 10%.\n6. CONTINGENCIES AND COMMITMENTS:\nAnnual rental expense for utility poles and tower sites for the years ended October 31, 1995, 1994 and 1993 was approximately $1,434,000, $1,482,000 and $1,490,000, respectively.\nRental expense for all rental agreements for the years ended October 31, 1995, 1994 and 1993 was approximately $2,316,000, $2,288,000 and $2,156,000, respectively.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n7. INCOME TAXES:\nThe following is a reconciliation of taxes computed at the statutory federal income tax rate with the provision for income taxes in the consolidated financial statements for the three years ended October 31:\nThe deferred income taxes liability balance of $48,180,000 and $40,000,000 at October 31, 1995 and 1994, respectively, is the tax effect of a temporary difference between allowable depreciation and amortization for tax purposes and depreciation and amortization provisions under generally accepted accounting principles. The Company does not have any other material temporary differences necessitating a provision for deferred income taxes.\n8. EARNINGS PER COMMON SHARE:\nEarnings per common share are computed using the weighted average number of shares outstanding during the period, including common stock equivalents: 24,582,447 shares for 1995, 24,638,135 shares for 1994, and 24,638,061 shares for 1993.\n9. SALES AND ACQUISITIONS:\nOn August 1, 1995, the Company, through a subsidiary, purchased the assets related to the operation of the cable television system serving approximately 10,000 subscribers in the city of El Dorado, Arkansas from Time Warner Cable Ventures, a division of Time Warner Entertainment, L.P. The purchase price was approximately $19 million, $15.4 million of which relates to acquired intangibles.\nOn July 1, 1995, the Company, through a subsidiary, acquired substantially all of the assets used by Marcus Cable of San Angelo, L.P. in the operation of the cable television systems serving approximately 28,000 subscribers in and around the following cities, counties, and areas in Texas: San Angelo, Andrews, Ballinger, Miles, Winters, Goodfellow Air Force Training Center, Andrews County, and Tom Green County. The cost of the acquisition was approximately $66 million, $57.8 million of which relates to acquired intangibles.\nIn May 1995, the Company, through its subsidiaries, acquired substantially all of the assets used by Time Warner Entertainment Company, L.P. in the operation of the cable television systems serving approximately 34,000 subscribers in and around the following cities in Arkansas: Fayetteville, Elkins, Farmington, Greenland, Russellvile, Clarksville, Booneville, Pottsville, Paris, and the unincorporated areas within the counties in which the foregoing cities are located. The cost of the acquisition was approximately $66 million, $56.4 million of which relates to acquired intangibles.\nThe 1995 acquisitions were paid in cash obtained from the Company's bank lines of credit and a $100 million private placement.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n9. SALES AND ACQUISITIONS -- (CONTINUED) On July 1, 1994, the Company acquired the assets of the cable television system serving 411 subscribers in Elm Springs, Arkansas and parts of Springdale, Arkansas. The cable television system is located adjacent to, and will be operated by, a currently owned system of the Company. The acquisition was funded by the payment of $540,465 in cash obtained from operations.\nOn June 1, 1994, the Company acquired 50% of the common stock of TCA Communications, Inc. (\"TCAC\"). TCAC is a new corporation whose initial purpose is to sell long distance telephone services in the cable television communities presently served by the Company and in other adjacent markets. The acquisition was funded by the payment of $2 million in cash obtained from operations. The remaining 50% of TCAC is owned by a privately held independent telephone company.\nIn April, 1994, the Company acquired 80% of the common stock of AvComm Corporation (\"AvComm\"), a new company formed to sell telecommunications services. The purchase price of $160,000 was obtained from operations. In September, 1994 the Company acquired the remaining 20% of the common stock of AvComm for $172,800 in cash from operations. The consolidated financial statements include the accounts of AvComm. All material intercompany transactions and balances have been eliminated.\nIn March, 1994, the Company acquired 40% of the stock of Intermedia Technologies, Inc. The Company also acquired a 40% interest in Intermedia Technologies, Ltd., a limited partnership engaged in telecommunications engineering and construction. The remaining 60% of both entities is owned by a director of the Company and his son. Intermedia Technologies, Inc. is the general partner of Intermedia Technologies, Ltd. The Company's initial investment in both entities was $122,333 paid in cash from operations. During 1994, the Company invested an additional $293,308 in Intermedia Technologies, Ltd.\nOn March 1, 1994, the Company sold the assets of the cable television systems serving 807 subscribers in two cities. The sales price was $1,008,750 resulting in a pre-tax gain of approximately $900,000 and an increase in net income of approximately $549,000 or $0.02 per share.\nOn December 1, 1993, the Company sold the assets of a cable television system serving 641 subscribers in one city. The sales price was $769,200 resulting in a pre-tax gain of approximately $559,000 and an increase in net income of approximately $341,000 or $0.01 per share.\nThese acquisitions were accounted for as purchases, and accordingly, results of operations of the acquired assets have been included in the consolidated financial statements from the dates of acquisition.\nThe pro forma operating results for the fiscal 1995 and 1994 acquisitions as though the acquisitions had been made at the beginning of the respective years are as follows:\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n10. INCENTIVE STOCK OPTION PLAN:\nIn January 1982, the company adopted an incentive stock option plan for the benefit of key employees. Under the terms of the plan, options to acquire up to 410,000 shares of common stock may be granted at no less than 100% of the fair market value on the date of grant.\nTransactions during 1995, 1994 and 1993 under this plan are summarized below:\n11. DEFERRED SAVINGS AND RETIREMENT PLAN:\nEffective September 1, 1983, the company and several of its affiliates adopted a deferred savings and retirement plan covering all employees with at least one year of service.\nEmployees may elect to contribute a portion of their compensation to the plan with the first one percent of their earnings being mandatory. The company may contribute up to an amount equal to the employee's contributions but not in excess of three percent of the employee's earnings. The company anticipates that all or substantially all of their discretionary and matching contributions will consist of registered shares of common stock of the company. The company's contributions for the years ended October 31, 1995, 1994 and 1993 were $553,401, $527,362 and $462,612, respectively.\n12. SUBSEQUENT EVENTS:\nAt the December 13, 1995 directors' meeting, a cash dividend of $0.14 was declared. This dividend is to holders of record on December 27, 1995 and payable on January 10, 1996.\nOn December 13, 1995, the Company and Donrey Media Group (\"Donrey\"), a division of Stephens Group, Inc. of Little Rock, AR, formed a partnership to combine certain cable television holdings owned by the Company with the systems owned by Donrey. The new partnership, TCA Cable Partners, will be comprised of all 22 of the Company's systems in Arkansas and Mississippi and Donrey's five systems in Arkansas, Oklahoma and California and will serve approximately 224,000 subscribers. The partnership is owned 75% by the Company and 25% by Donrey and is managed by the Company.\nOn December 15, 1995, the Company acquired the assets of a cable television system serving approximately 29,000 subscribers in Alexandria and Pineville, Louisiana (\"Alexandria\") through an exchange with Time Warner Entertainment -- Advance\/Newhouse Partnership (\"Time Warner\"). The transaction involved the acquisition by the Company of the assets of cable systems located in North and South Carolina from Star Cable Associates and the simultaneous exchange of these to Time Warner for Alexandria. The cost of the acquisition was approximately $63 million, all of which was paid from the Company's bank lines of credit.\nTCA CABLE TV, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):\nNet income for the first quarter of 1994 was reduced $1,900,000 or $.07 per share by the recognition of a one-time cumulative effect adjustment from the adoption of FAS 109. See note 2.\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe carrying amount of cash, accounts receivable subscribers, accounts payable and term debt approximates fair value.\n15. IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS\nAccounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of (FAS 121)\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\" (\"FAS 121\") effective for fiscal years beginning after December 15, 1995. 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 Company plans to adopt FAS 121 during the first quarter of the fiscal year ending October 31, 1997. Management does not expect the Statement to have a material impact on the financial statements of the Company.\nAccounting for Stock-Based Compensation (FAS 123)\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\") effective for fiscal years beginning after December 15, 1995. This Statement establishes a fair value based method of accounting for stock-based compensation plans. The Company plans to adopt the disclosure only requirements of FAS 123 during the first quarter of the fiscal year ending October 31, 1997.\nINDEX TO EXHIBITS\n- ---------------\n*1 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1, File No. 2-75516, and incorporated by reference herein.\n*2 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 33-21901, and incorporated by reference herein.\n*3 Filed herewith.\n*4 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 2-88892, and incorporated by reference herein.\n*5 Previously filed as an exhibit to Registrant's Form 10-K for the fiscal year ended October 31, 1993, filed January 27, 1994 and incorporated by reference herein.\n*6 Previously filed as an exhibit to Registrant's Form 10-K for the fiscal year ended October 31, 1994, filed January 30, 1995 and incorporated by reference herein.\n*7 Previously filed as an exhibit to Registrant's Form 10-Q for the quarter ended April 30, 1995, filed June 14, 1995 and incorporated by reference herein.\n*8 Previously filed as an exhibit to Registrant's Form 10-Q for the quarter ended July 31, 1995, filed September 14, 1995 and incorporated by reference herein.\n*9 Previously filed as an exhibit to Registrant's Form 8-K , filed May 15, 1995 and incorporated by reference herein.\n*10 Previously filed as an exhibit to Registrant's Form 8-K , filed May 24, 1995 and incorporated by reference herein.\n*11 Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-8, File No. 33-61041, and incorporated by reference herein.","section_15":""}
{"filename":"723188_1995.txt","cik":"723188","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCommunity Bank System, Inc. (\"Company\") was incorporated on April 15, 1983, under the Delaware General Corporation Law. Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is (315) 445-2282. The Company became a bank holding company in 1984 with the acquisition of The St. Lawrence National Bank (\"St. Lawrence Bank\") on February 3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A or \"Horizon Bank\") on March 2, 1984. Also in 1984 the Company obtained a national bank charter for its third wholly-owned subsidiary bank, The Exchange National Bank (\"Exchange Bank\"), and on July 1, 1984 Exchange Bank acquired the deposits and certain of the assets of three branches of the Bank of New York located in southwestern New York. On September 30, 1987, the Company acquired The Nichols National Bank (\"Nichols Bank\") located in Nichols, New York. On September 30, 1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located in Addison, New York, the parent company to Community National Bank (\"Community Bank\"). On March 26, 1990, Community Bank opened the Corning Market Street branch from the Company's acquisition of deposits and certain assets from Key Bank of Central New York. On January 1, 1992, the Company's five banking affiliates consolidated into a single, wholly-owned national banking subsidiary, known as Community Bank, N.A. (\"Bank\"). On March 31, 1993, the Bank's marketing representative office in Ottawa, Canada was closed. On June 3, 1994, the Company acquired three branch offices in Canandaigua, Corning and Wellsville, New York from the Resolution Trust Corporation. On October 28, 1994, the Company acquired the Cato, New York branch of The Chase Manhattan Bank, N.A. On July 14, 1995, the Company acquired 15 branch offices from The Chase Manhattan Bank, N.A. located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two), and Penn Yan, New York (\"Chase Branches\"). On December 15, 1995, the Company sold three of the Chase Branches, located in Norwich, New Hartford, and Utica, to NBT Bank, N.A.\nThe Company had a wholly-owned data processing subsidiary, Northeastern Computer Services, Inc. (\"Northeastern\"). Northeastern was acquired by the Company from the St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization. Northeastern had previously been a wholly-owned subsidiary of the St. Lawrence Bank and was the survivor of a merger with Lawban Computer Systems, Inc., another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the Company entered into a five year agreement with Mellon Bank, N.A. to provide data processing services. On June 30, 1992, Northeastern ceased operations and was dissolved.\nThe Company also had a wholly-owned mortgage banking subsidiary, Community Financial Services, Inc. (CFSI), which was established in June 1986; it commenced operation in January 1987. In July 1988, CFSI purchased Salt City Mortgage Corp., a Syracuse-based mortgage broker. CFSI was dissolved in 1990.\nThe Company, through its Community Bank, N.A. subsidiary, provides banking services through its two regional offices at 45-49 Court Street, Canton, New York and 201 North Union Street, Olean, New York, as well as through 47 banking offices in the counties of St. Lawrence, Jefferson, Lewis, Oneida, Cayuga, Seneca, Ontario, Oswego, Wayne, Yates, Allegheny, Cattaraugus, Tioga, Steuben, and Onondaga. The administrative office is located at 5790 Widewaters Parkway, DeWitt, New York, in Onondaga County.\nThe Bank is a member of the Federal Reserve System and the Federal Home Loan Bank of New York (\"FHLB\"), and its deposits are insured by the FDIC up to applicable limits.\nBANKING SERVICES\nThe Bank offers a range of commercial and retail banking services in each of its market areas to business, individual, agricultural and government customers.\nAccount Services. The Bank's account services include checking accounts, negotiable orders of withdrawal (\"NOW\"), savings accounts, time deposit accounts, and individual retirement accounts.\nLending Activities. The Bank's lending activities include residential and farm loans, business lines of credit, working capital facilities, inventory and dealer floor plans, as well as installment, commercial, term and student loans.\nThe Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. Nearly 70% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. In addition, the typical loan to the Company's commercial business borrowers is under $50,000, with less than one quarter of the commercial portfolio being in loans in excess of $500,000.\nOther Services. The Bank offers a range of trust services, including personal trust, employee benefit trust, investment management, financial planning and custodial services. In addition, through an affiliation with Prime Vest, Inc., the Bank offers non-bank financial products including fixed- and variable-rate annuities, mutual funds, and stock investments. The Bank also offers safe deposit boxes, travelers checks, money orders, wire transfers, collections, foreign exchange, drive-in facilities and twenty-four hour depositories. Through an accounts receivable management program, the Bank provides a service to qualifying businesses by purchasing accounts receivable on a discounted basis.\nCOMPETITION\nThe Company, through the Bank, competes in three distinct banking markets in the Northern (\"Northern Market\"), Finger Lakes (\"Finger Lakes Market\"), and Southern Tier (\"Southern Tier Market\") regions of New York State. The Bank considers its primary market areas in these regions to be the counties in which it has banking facilities. Major competitors in these markets include local branches of banks based in New York City, or Buffalo, New York, as well as local independent banking and thrift institutions and federal credit unions. Other competitors for deposits and loans within the Bank's market areas include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers. Lastly, personal and corporate trust and investment counseling services in competition with the Bank are offered by insurance companies, investment counseling firms and other financial service firms and individuals.\nThe Bank is a community retail bank committed to the philosophy of serving the financial needs of customers through its branch network, whose facilities are generally located in small cities and villages within its three distinct banking markets. The Company believes that the local character of business, the Bank's knowledge of the customer and customer needs, and its comprehensive retail and small business products, together with rapid decision-making at the branch and regional level, enable the Bank to compete effectively.\nNorthern Market. Branches in the Northern Market compete for loans and deposits in the four county primary market area of St. Lawrence, Jefferson, Lewis, and Oneida Counties in Northern New York State. Within this market area, the Bank maintains a market share(1) of 14.7%, including commercial banks, credit unions, savings and loan associations and savings banks. The Bank operates 21 customer facilities in this market and is ranked either first or second in market share in 14 of the 16 towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Franklin County.\nFinger Lakes Market. In the Finger Lakes Market, the Bank operates 14 customer facilities competing for loans and deposits in the five-county primary market area of Seneca, Oswego, Ontario, Wayne and Cayuga Counties. Within the Finger Lakes Market area, the Bank maintains a market share(1) of approximately 4.4%, including commercial banks, credit unions, savings and loan associations and savings banks. The Bank is ranked either first or second in market share in seven of the ten Finger Lakes Market area towns where its offices are located.\nSouthern Tier Market. The Bank's Southern Tier Market consists of two sub-markets, the Olean submarket and the Corning submarket.\nOlean Submarket. The Olean Submarket competes for loans and deposits in the primary market area of Cattaraugus and Allegany Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of approximately 14.0%, including commercial banks, credit unions, savings and loan associations and savings banks. The Olean Submarket operates five office locations, and the Bank is ranked either first or second in market share in three of the four towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chautauqua County.\nCorning Submarket. The Corning Submarket competes for loans and deposits in the primary market area of Steuben, Yates and Tioga Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of approximately 6.4%, including commercial banks, credit unions, savings and loan associations and savings banks. The Corning Submarket operates nine office locations, and the Bank is ranked either first or second in market share in six of the seven towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chemung and Schuyler Counties in New York State, and Tioga County in Pennsylvania.\n- -------------\n(1) Deposit market share data as of June 30, 1995, as calculated by Sheshunoff Information Services, Inc.\nEMPLOYEES\nAs of December 31, 1995, the Bank employed 563 full-time equivalent employees versus 440 at year-end 1994. The increase in full-time equivalent employees since year-end 1994 primarily reflects 116 full-time equivalent (FTEs) staff additions either formerly employed in the Chase branches or hired to provide operational support or develop business in new markets. The Bank provides a variety of employment benefits and considers its relationship with its employees to be good.\nCERTAIN REGULATORY CONSIDERATIONS\nBank holding companies and national banks are regulated by state and federal law. The following is a summary of certain laws and regulations that govern the Company and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the actual statutes and regulations thereunder.\nBANK HOLDING COMPANY SUPERVISION\nThe Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\") and as such is subject to regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). As a bank holding company, the Company's activities and those of its subsidiary are limited to the business of banking and activities closely related or incidental to banking. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital contributions to a troubled bank subsidiary. The Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the Company does not have the resources to provide it. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks.\nThe BHCA requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of, or substantially all of the assets of, any bank (unless it owns a majority of such bank's voting shares) or otherwise to control a bank or to merge or consolidate with any other bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank. The BHCA would prohibit the Federal Reserve Board from approving an application from the Company to acquire shares of a bank located outside of New York, unless such an acquisition is specifically authorized by statute of the state in which the bank whose shares are to be acquired is located.\nHowever, the Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on September 29, 1994) provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies will be eliminated effective September 29, 1995. The law will also permit interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. The Company anticipates that the effect of the new law may be to increase competition within the markets where the Company operates, although the Company cannot predict the effect to which competition will increase in such markets or the timing of such increase.\nOCC SUPERVISION\nThe Bank is supervised and regularly examined by the OCC. The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. There are no regulatory orders or outstanding issues resulting from regulatory examinations of the Bank.\nLIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES\nThe Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the OCC for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1995, the Bank had $20.4 million in undivided profits legally available for the payment of dividends.\nIn addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings.\nThere are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specified amounts.\nCAPITAL REQUIREMENTS\nThe Federal Reserve Board has established risk-based capital guidelines which are applicable to bank holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill (\"Tier I capital\"). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier I capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization's particular circumstances warrant. The remainder (\"Tier 2 capital\") may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves.\nThe sum of Tier I capital and Tier 2 capital is \"total risk-based capital.\" The Company's Tier I and total risk-based capital ratios as of December 31, 1995 were 10.62% and 11.76%, respectively.\nIn addition, the Federal Reserve Board has established a minimum leverage ratio of Tier I capital to quarterly average assets less goodwill (\"Tier I leverage ratio\") of 3.00% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other bank holding companies are required to maintain a Tier I leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Company's Tier I leverage ratio as of December 31, 1995 was 5.83%, which exceeded its regulatory requirement of 4.00%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Company is subject to the same OCC capital requirements as those that apply to the Bank.\nIn February 1994, the federal banking agencies proposed amendments to their respective risk-based capital requirements that would explicitly identify concentration of credit risk and certain risks arising from nontraditional activities, and the management of such risks, as important factors to consider in assessing an institution's overall capital adequacy. The proposed amendments do not, however, mandate any specific adjustments to the risk-based capital calculations as a result of such factors. On August 24, 1994, the Federal Reserve Board issued proposed amendments to its risk-based capital standards that would increase the amount of capital required under such standards for long-dated interest rate and exchange rate contracts and for derivative contracts based on equity securities and indexes, precious metals (other than gold) and other commodities. The proposed amendments would also permit banking institutions to recognize the effect of bilateral netting arrangements in calculating their exposure to derivative contracts for risk-based capital purposes. The Company and the Bank do not expect that these proposals, if adopted in their current form, would have a material effect on its financial condition or results of operations.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nIn December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund (\"BIF\") of the FDIC by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a \"prompt corrective action\" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the FDIC use the least-cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions including a Truth-in-Savings Act; (x) a requirement that the FDIC establish a risk-based deposit insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage.\nFDICIA also provides for increased funding of the FDIC insurance fund through a risk-related premium schedule for insured depository institutions. Under this schedule, premiums for deposits insured by the BIF Fund range from zero for the best-capitalized, healthiest institutions, to 0.27% for the weakest institutions; the corresponding premiums for deposits insured by the Savings Association Insurance Fund (\"SAIF\") are .23% and .31%, respectively. The Bank's premium for the semi-annual assessment period beginning January 1, 1996, will be zero for its BIF-insured deposits and .23% for its SAIF-insured deposits (approximately $49.9 million in deposits).\nFDICIA requires federal banking agencies to take \"prompt corrective action\" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized,\" and \"critically undercapitalized.\" The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered \"well capitalized\" or \"adequately capitalized\" under Federal Reserve Board regulations:\nAdequately Well Capitalized Capitalized ----------- -----------\nTotal Risk-Based Capital Ratio ........ 8% 10% Tier I Risk-Based Capital Ratio ....... 4% 6% Tier I Leverage Ratio ................. 4% 5%\nIf a bank does not meet all of the minimum capital ratios necessary to be considered \"adequately capitalized,\" it will be considered \"undercapitalized,\" \"significantly undercapitalized,\" or \"critically undercapitalized,\" depending upon the amount of the shortfall in its capital. As of December 31, 1995, the Bank's total risk-based capital ratio and Tier I risk-based capital ratio were 11.76% and 10.62%, respectively, and its Tier I leverage ratio as of such date was 5.83%.\nNotwithstanding the foregoing, if its principal federal regulator determines that an \"adequately capitalized\" institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan, restrict its asset growth and prohibit branching, new acquisitions and new lines of business. Among other things, an institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings or liquidity in its most recent examination.\nPossible sanctions for undercapitalized depository institutions include a prohibition on the payment of dividends and a requirement that an institution submit a capital restoration plan to its principal federal regulator. The capital restoration plan of an undercapitalized bank will not be approved unless the holding company that controls the bank guarantees the bank's performance. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lesser of five percent (5%) of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.\nIn addition, FDICIA requires regulators to impose new non-capital measures of bank safety, such as loan underwriting standards and minimum earnings levels. Regulators are also required to perform annual on-site bank examinations, place limits on real estate lending by banks and tighten auditing requirements.\nMany of the provisions of FDICIA will be implemented through the adoption of regulations by the various federal banking agencies. Although the precise effect of the legislation on the Company and the Bank therefore cannot be assessed at this time, the Company does not anticipate that such regulations will materially affect its operating results, financial condition or liquidity.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases its administrative offices at 5790 Widewaters Parkway, DeWitt, New York. The Bank owns its regional offices in Olean, New York and Canton, New York. Of the Bank's 49 customer facilities, 44 are owned by the Bank, and five are located on long-term leased premises.\nReal property and related banking facilities owned by the Company at December 31, 1995 had a net book value of $16.9 million and none of the properties was subject to any encumbrances. For the year ended December 31, 1995, rental fees of $537,371 were paid on facilities leased by the Bank for its operations.\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 following table sets forth certain information about the principal executive officers of the Company and the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors.\nNAME AND AGE POSITION ------------ -------- Sanford A. Belden President and Chief Executive Officer of Age 53 the Company and the Bank\nDavid G. Wallace Treasurer of the Company and Senior Vice Age 51 President and Chief Financial Officer of the Bank\nJames A. Wears Regional President, Northern Region Age 46 of the Bank\nMichael A. Patton Regional President, Southern Region Age 50 of the Bank\nSANFORD A. BELDEN (Director; President and Chief Executive Officer of the Company and the Bank). Mr. Belden has been President and Chief Executive Officer of the Company and the Bank since October 1, 1992. Mr. Belden was formerly Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to 1992 and prior thereto served as President, Community Banking for First Bank System, Minneapolis, Minnesota, a multi-state bank holding company.\nMICHAEL A. PATTON (Regional President, Southern Region of the Bank). Mr. Patton was the President and Chief Executive Officer of The Exchange National Bank, a former subsidiary of the Company, from 1984 until January 1992, when, in connection with the consolidation of the Company's five subsidiary banks into the Bank, he was named to his current position as Regional President for the Southern Region of the Bank.\nDAVID G. WALLACE (Treasurer of the Company; Senior Vice President and Chief Financial Officer of the Bank). Mr. Wallace became Vice President and Chief Financial Officer in November 1988, and has been Senior Vice President and Chief Financial Officer since August 1991.\nJAMES A. WEARS (Regional President, Northern Region of the Bank). Mr. Wears served as Senior Vice President of The St. Lawrence National Bank, a former subsidiary of the Company, from 1988 through January 1991, and as its President and Chief Executive Officer from January 1991 until January 1992. Following the January 1992 consolidation of the Company's five subsidiary banks into the Bank, Mr. Wears was named to his current position as Regional President for the Northern Region of the Bank.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Common Stock has been traded over-the-counter on the NASDAQ National Market under the symbol \"CBSI\" since September 16, 1986. The following table sets forth the high and low bid quotations for the Common Stock, and the cash dividends declared with respect thereto, for the periods indicated. The quotations represent bid prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. There were 3,682,315 shares of Common Stock outstanding on March 3, 1995 held by approximately 1,877 shareholders of record.\nPrice Range Cash Dividend ----------------- Declared Per High Low Share ------ ------ ------------- 1995:\nFirst Quarter ............. $27.75 $25.25 $0.30 Second Quarter ............ 29.00 24.25 0.30 Third Quarter ............. 36.75 25.25 0.30 Fourth Quarter ............ 34.25 31.00 0.33 ----- $1.23 =====\n1994:\nFirst Quarter ............. $30.75 $28.50 $0.27 Second Quarter ............ 30.50 28.50 0.27 Third Quarter ............. 31.75 29.00 0.30 Fourth Quarter ............ 31.75 25.75 0.30 ----- $1.14 =====\nThe Company has historically paid regular quarterly cash dividends on its Common Stock, and declared a cash dividend of $0.33 per share for the first quarter of 1996. The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the Common Stock, as well as to make payment of regularly scheduled dividends on the Preferred Stock as and when due, subject to the Company's need for those funds. However, because substantially all of the funds available for the payment of dividends by the Company are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations. See \"Supervision and Regulation -- Limits On Dividends and Other Payments.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five year period ended December 31, 1995. The historical \"Income Statement Data\" and historical \"Statement of Condition Data\" are derived from financial statements which have been audited by Coopers & Lybrand L.L.P., independent public accountants. The \"Per Share Data\", \"Selected Ratios\" and \"Other Data\" for all periods are unaudited. All financial information in this table should be read in conjunction with the information contained in \"Capitalization,\" \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Form.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion is intended to facilitate an understanding and assessment of significant changes in trends related to the financial condition of the Company and the results of its operations. The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Data and the Company's Consolidated Financial Statements and related notes thereto appearing elsewhere in this Form 10-K. All references in the discussion to financial condition and results of operations are to the consolidated position and results of the Company and its subsidiaries taken as a whole.\nRESULTS OF OPERATIONS\nNet income for 1995 rose 13.5% over last year to an all-time high of $11.5 million. Earnings per share were $3.41, down 5.0% primarily due to the Company's issuance of additional common and preferred stock in mid 1995. This issuance put sufficient capital in place to facilitate the purchase of 15 branches from The Chase Manhattan Bank, N.A. on July 14, 1995. Recurring or core earnings were up over 12% from last year to $11.9 million after removing the impact of certain nonoperating expenditures and net losses on the sale of investment securities and other assets. 1994's results climbed slightly over the prior year -- net income rose 5.6% to $10.1 million or $3.59 per share; core earnings rose at a 14% pace.\nThese results reflect the second consecutive year in which acquisitions had an important impact on the Company's results. Approximately $775,000 in one-time expenses was incurred this year associated with integrating the Chase purchase and consummating the subsequent sale of three of these branches, including related loans and deposits, to NBT Bank, N.A. on December 15, 1995; the facilities sold were the only properties in the purchase package from Chase not located in or adjacent to CBSI's existing market area. In 1994, when three branches from the Resolution Trust Company and one from Chase were acquired, nearly $425,000 in nonrecurring expenses was incurred to assimilate the purchases. One-time expenses in the earlier years largely related to the Company's operational and organizational consolidation of its five formerly independent commercial banks into today's Community Bank, N.A., a decision announced in the fall of 1990.\n1995's improvement in net income over the prior year is explained by the following major factors:\no Net interest income (full-tax equivalent basis) climbed 18.6%, reflecting earning asset growth of $218 million on average or 28.9%. As of the Chase branch acquisition date, earning assets rose approximately $157 million or 17% after repayment of short-term borrowings from the $383 million in deposits purchased. Earning asset growth more than offset the impact of a 42 basis point decline in the Company's net interest margin to 4.88%.\no Noninterest income (excluding net losses on the sale of investment securities and other assets) was up 19.3% owing to continued strength in fiduciary services income; higher fees from the sale of annuities and mutual funds; and greater overdraft fees, service charges, and commissions from an expanded customer base gained from acquisitions in 1994 as well as the Chase branch purchase. Net losses on the sale of investment securities and other assets were $12,000 this year versus $486,000 in 1994.\no Overhead expense increased by 24.6%; excluding one-time costs of the Chase acquisition, growth was $5.7 million or 21.7%. Approximately 60% of the latter increase reflected personnel costs, largely because of the Chase branches and required operations center support as well as selective additions in lending and financial product sales. A significant balance of the nonpersonnel expense increase was also related to the new branches and the cost of servicing their 25,000 customers (net of the branches sold to NBT Bank), in addition to amortization of intangible assets associated with the Chase transaction.\no Loan loss provision expense rose 3.7%, increasing the loan loss reserve to $7.0 million or 1.25% of loans outstanding, a 5 basis point decrease from one year earlier. Though loans rose a record 16.0%, asset quality remained strong, with the net charge-off\/average loans ratio improving to .21% and nonperforming loans falling by over one third to $2.0 million or .36% of loans outstanding. Consequently, coverage of reserves to nonperformers is ample in the opinion of management at 3.5 times.\nThe above combination of factors resulted in a level of profitability at or above that of CBSI's peer bank holding companies; this group is comprised of 108 companies nationwide having $1 billion to $3 billion in assets based on data through September 30, 1995 as provided by the Federal Reserve System. Net income per dollar employed, or return on average assets, was 1.09%; though off 16 basis points from the prior year's level, it nonetheless is in the peer normal 45th percentile. Shareholder return on equity, or net income as a percent of average equity, was reduced to 13.85%, or the 67th peer percentile.\nThese modestly lower levels of profitability reflect the half year impact of the Chase acquisition, which at the outset increased the Company's deposit base by 54%. By year end, approximately 116 full-time equivalent employees were added, either formerly employed by Chase or hired to provide operational support or develop business in the new markets. In addition, this early period of assimilation included relatively high one-time implementation expenses as well as the dampening impact on margins of the acquired branches' initially low 3.6% loan to deposit ratio. As of year-end 1995, loans in the markets served by the former Chase branches had more than doubled, increasing their loan to deposit ratio to 7.5%.\nRETURN ON AVERAGE ASSETS\nReturn on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows:\nNET INTEREST INCOME\nNet interest income is the Company's principal source of core operating income for payment of overhead and possible loan losses. It is the amount that interest and fees on earning assets exceeds the cost of funds, primarily interest paid to the Company's depositors. Net interest margin is the difference between the gross yield on earning assets and the cost of interest bearing funds as a percentage of earning assets.\nThe following table sets forth certain information concerning average interest earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and resultant yield information in the table is on a fully tax-equivalent basis for the three-year period ended December 31, 1995 using marginal federal income tax rates of 35%, 34%, and 34%, respectively. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Non-accrual loans have been included in interest-earnings for purposes of these computations.\nNet interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table sets forth for the periods indicated a summary of the changes in net interest income for each major category of interest-earning assets and interest-bearing liabilities resulting from volume changes and rate changes:\nNet interest income (with nontaxable income converted to a full tax-equivalent basis) totaled $47.6 million in 1995; this represents a $7.5 million or 18.6% increase from the prior year. Higher asset and liability volumes had a positive impact on net interest income of $10.9 million, while interest rate changes had a negative impact of $3.4 million. In 1994, net interest income totaled $40.1 million, an increase of $2.4 million or 6.3% over the prior year. Higher volumes accounted for $6.4 million of this increase while interest rate changes negatively impacted margins by $4.0 million.\nGreater average earning assets of $218 million helped contribute $21.6 million in additional gross interest income during 1995. Reflective of the Chase branch acquisition, earning asset volumes were up 28.9% over 1994's figures, a record for the Company since its formation in 1983. The 1995 increase surpasses the previous year's record growth of $117 million or 18.2%.\nIncreases in investment outstandings, due primarily to the strategic use of excess cash from the Chase branch deposit acquisition, accounted for $145 million or over 66% of 1995's average earning asset growth. Including the impact of selected pre-investment strategies prior to the acquisition's closing date, higher investment volumes produced an additional $12.4 million towards the increase in gross interest income. Average investment yields improved by 52 basis points from 6.93% in 1994 to 7.45% in 1995. Through September 30, 1995, the Company's investment yield was in the very favorable 94th peer bank percentile.\nThe remaining $74 million in average earning asset growth reflected increased lending activity from both existing markets and those from the newly acquired Chase branches. This growth in activity contributed an additional $9.2 million towards the increase in gross interest income. Because of the small initial amount of loans purchased from Chase, the ratio of loans to earning assets decreased this year. Average loan yields improved by 49 basis points from 9.12% in 1994 to 9.61% this year. Through September 30, 1995, the Company's loan yield was in the favorable 67th peer bank percentile.\nAverage deposit and other funding liabilities grew by $221 million in 1995, increasing total interest expense of the Company by an additional $14.2 million. Nearly one quarter of this additional expense is traceable to higher average rates paid on time deposits, whose costs closely track the movement of the treasury yield curve. During 1995, time deposit rates averaged 5.53%, or 119 basis points higher than their 1994 average of 4.34%. In addition, interest expense rose due to a growing mix of time deposits to total deposits, reflecting movement of funds from savings and money market accounts as well as the fact that the acquired Chase deposits contained a relatively higher portion of time accounts.\nManagement was quite successful in 1995 in controlling the rising cost of its interest bearing account base not directly priced relative to the treasury yield curve. The average rate on savings (including interest checking) and money market accounts increased by a combined total of only 10 basis points during 1995, rising from 2.55% in 1994 to 2.65% this year. This containment was able to be accomplished without materially affecting total average deposits outstanding, separate from the Chase branch acquisition. Largely because of the impact of the Chase deposits, the portion of interest bearing funds which supports earning assets rose slightly in 1995. Through September 30, 1995, the Company's average cost of funds rate was in the 51st peer bank percentile.\nOverall, CBSI's net interest margin declined from 5.30% in 1994 to 4.88% in 1995. This is attributable to a 79 basis point increase in the average cost of funds as compared to a rise in the yield on earning assets of less than half that amount. An increased mix of investment securities to earning assets largely contributed to the decline in earning asset yields, as marketable securities have historically had lower yields than most types of loans. Besides the impact of increased time deposits costs, the average rate on cost of funds was relatively higher during the first half of 1995, when more costly borrowings were used to support investment growth prior to being replaced by the lower priced Chase deposits. Despite the decline in the Company's net interest margin, it ranks in the 61st peer bank percentile through September 30, 1995.\nWhile the Company's net interest margin has historically been well above the norm, the primary objective in recent years has been to maximize shareholder returns through active utilization of tangible capital, which in the past has involved various borrowing and investment strategies. Thus, as management focuses on growing the earning asset base of the Company, a potential downward change in margin may be considered secondary to increasing the future stream of net interest income.\nThe two-year trend by quarter in net interest income, net interest margin and related components is set forth as follows:\nNONINTEREST INCOME\nThe primary sources of noninterest income are recurring fees from core banking operations and revenues from one-time events, defined as net gains\/losses from the sale of investments, loans, and miscellaneous assets. CBSI presently has no active nonbanking subsidiaries. Its former mortgage banking and data processing companies were closed in 1990 and 1992, respectively, as part of the Company's restructuring plan to reduce overhead and eliminate unprofitable functions.\nCore banking fees were up strongly for the second consecutive year to approximately $6.6 million in 1995, a 17.2% improvement following a 17.6% increase in 1994. This income source represented .62% of average assets, slightly lower than 1994's level of .69%. The decrease in this ratio is primarily because of nearly 30% more in average assets as a result of the Chase branch acquisition, expanded borrowings in anticipation of the planned Chase closing date in mid July, and the full year impact of the branch acquisitions in June and October of 1994. Approximately $575,000 of 1995's noninterest income resulted from fees generated by the 15 Chase branches; about 10% of that improvement pertained to the three branches sold to NBT Bank in mid December. Though progress has been steady in dollar terms over the last few years, strong asset growth has placed noninterest income in the relatively low 24th peer percentile compared to management's intermediate-term objective of becoming peer normal at approximately .90% of average assets.\nThe following table sets forth selected detailed information by category of non-interest income for the Company for the years indicated:\nIn light of management's objective, emphasis has been placed on a program of continuous improvement in recurring noninterest income. These efforts have resulted in new products, such as the Visa Debit card initiated this year (allows customer access to deposited funds at any merchant accepting VISA), secondary mortgage market sales\/servicing beginning in 1994, and the sale of mutual funds and annuities, a program also launched in 1994. The focus on growth continues to drive efforts to increase fiduciary income, control waived fees, and competitively price deposit service charges and commission-based services.\nAs a result of these efforts, in addition to the impact of the Chase acquisition and the full year effect of the smaller 1994 acquisitions, fees from core banking operations improved in several key areas in 1995:\no Fiduciary fees expanded to over $1.4 million, up 4.9% in 1995. This improvement represents growth in fees from employee benefit trust products of 24.3%, reflective of CBSI's attractive, creatively-designed plans for construction, nonprofit, and other specialty industries, both within and outside the Company's core banking areas. Fees from personal trust services, however, decreased 2.9% as a result of trust assets being transferred into the special investment products group, which is responsible for mutual funds and annuity sales. A more focused program of business development planned for 1996 is expected to strengthen future fiduciary income growth.\no Service charges on deposit accounts and overdraft fees increased to $3.3 million in 1995, an excellent 28.3% growth rate versus 9.0% in 1994. The full year impact of 1994's acquisitions and 1995's Chase acquisition explain most of this growth. The increase also reflects favorable movement in CBSI's core deposit volumes and the aforementioned emphasis on ensuring competitive pricing and reducing waived fees.\no Merchant fees earned through the Company's Visa affiliation fell approximately 60% in 1995 to $304,000, attributable to the loss of a large vendor early in 1995. However, because of the low margin on the lost vendor and continued improvement in the margins of the remaining vendors, the direct margin (net of processing expense) rose over 15.1 percentage points to an all-time high of 34.7%.\no 1995 is the second year in which CBSI has offered annuities, mutual funds, and other investment products through financial services representatives (FSRs) located in selected geographic markets within its branch network. Net commission income from this activity amounted to almost $475,000 on asset sales of $22 million, more than triple the 1994 level of approximately $150,000 on sales of $7.1 million. The number of FSR positions (staffed by registered representatives working through PrimeVest Financial Services, Inc. of Saint Cloud, Minnesota) increased by two during 1995 to seven as of year end. This line of special investment products is anticipated to continue strong growth in 1996, reflective of the full-year impact of an expanded sales staff as well as the additional 25,000 new customers contributed by the former Chase branches.\no General commissions and miscellaneous income at $1.0 million were up more than 43% in 1995. The majority of this year's increase is attributable to miscellaneous commissions on wire transfers, check orders, travelers checks, utility payment fees, and other recurring commissions that result from daily branch operations, as well as to safe box rent increases, all primarily a consequence of the acquisitions made over the past two years.\nNonrecurring other income reflected a loss of $12,000 in 1995 versus a loss of $486,000 in 1994. This year's results were caused by a $152,000 loss on the sale of $4.1 million in lower yielding investments being almost completely offset by gains on the sale of student loans and mortgages sold in the secondary market. The prior year's $502,000 investment loss resulted from the sale of $28 million in lower yielding securities. Benefits from incurring these investment losses include potential reinvestment of the proceeds into higher yielding assets (intended to increase net earnings over the average term to maturity of the investments sold), a possible lowering of future reinvestment risk, and reduction in market value exposure in the available for sale investment portfolio.\nThe two-year trend by quarter in noninterest income and its primary components is set forth in the following schedule:\nNON-INTEREST EXPENSE\nThe following table sets forth selected detailed information by category of non-interest expenses of the Company for the years indicated:\n--------------------------------- Year Ended December 31, --------------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Salary expense .................... $13,146 $10,564 $ 9,631 Payroll taxes and benefits ........ 3,611 2,534 2,321 Net occupancy expense ............. 2,608 2,043 1,814 Equipment expense ................. 1,992 1,697 1,642 Professional fees ................. 1,102 1,282 1,528 Data processing expense ........... 2,449 2,573 2,193 Amortization ...................... 1,686 355 166 Stationary and supplies ........... 1,231 739 696 Deposit insurance premiums ........ 925 1,390 1,317 Other ............................. 4,269 3,321 3,519 Total ..................... $33,019 $26,498 $24,827 Total operating expenses as a percentage of average assets .... 3.13% 3.28% 3.63% Efficiency ratio(1) ............... 60.82% 57.94% 58.45%\n- ---------- (1) Non-interest expense to recurring operating income\nNoninterest expense or overhead rose $6.5 million or 25% in 1995 to $33.0 million compared to a moderate 6.7% increase in the prior year. The primary reasons for this year's increase are the one-time and recurring additions to overhead associated with the acquisition of the Company's 13 new 1995 locations--12 former Chase branches (net of those sold to NBT Bank) plus one former Fleet Bank facility in Olean, New York. Overhead growth also reflects the full year impact of the 1994 branch acquisitions. As a percent of average assets, this year's overhead at 3.13% was in the favorable 38th peer percentile, an improvement from 3.28% or the 49th percentile in 1994.\nIn brief, approximately $5 million in additional expense was incurred in 1995 related to the new Chase branches, of which $775,000 was the nonrecurring cost of operationally consummating the transaction. Second, approximately $2 million in expense was associated with the direct operation of the Chase branches ($300,000 relate to branches sold to NBT Bank). Third, servicing the 25,000 former Chase customers required additional operational support in the Company's regional processing centers and some limited incremental administrative expense. And last, amortization of the intangible assets created by the Chase transaction added about $1.2 million.\nFor CBSI as a whole, higher personnel expense accounted for 56% of 1995's increase in overhead, with personnel costs being up 28% versus being 9.6% higher in 1994. Salary expense increased by 24%, primarily reflective of 116 new full-time equivalent (FTEs) staff additions either formerly employed by Chase or hired to provide operational support or develop business in the new markets. Additionally, the increase in salaries resulted from the full-year impact of the four branches acquired in 1994, modest annual merit awards, staffing of the new Olean branch facility, and continued strengthening of the lending and fiduciary services functions. Total FTEs at year end 1995 were 563 versus 440 at year-end 1994. Payroll taxes and benefits rose 43% largely due to the additions to staff, higher benefit costs per employee (including the impact of several large medical claims), and severance expense associated with the Chase transaction.\nNonpersonnel expense rose almost $2.9 million or 21.4% this year as opposed to a $525,000 or a 4.1% increase in 1994. Higher occupancy expense, supplies, telephone, postage, and computer services resulted from the 16 new locations (before the mid December sale of three locations) added in the last half of 1995 and the full-year impact of 1994's acquisitions. Amortization of intangible assets rose as a result of the 8.25% premium paid on the deposits acquired from Chase and the premiums paid on the prior year's acquisitions. Various other increases related to inflation, internal volume growth, and acquisitions were partially offset by lower credit card processing expense (caused by the loss of a large vendor) and a reduction in the FDIC deposit insurance premium rate from 23 basis points to zero during the year.\nThe efficiency ratio is defined as overhead expense divided by recurring operating income (full tax-equivalent net interest income plus noninterest income, excluding net securities gains and losses); the lower the ratio, the more efficient a bank is considered to be.\nThe sharp drop in the ratio from 77.4% in 1991 to 58.4% in 1993 resulted from the restructuring of the Company into a single bank holding company. 1994's flattening was caused by additional net overhead of the four branches acquired that year, which added $75 million in deposits and only a de minimus amount of related loans. The slight increase in the 1995 ratio to 60.8%, which represents the favorable 39th peer percentile, reflects increased costs resulting from the $383 million Chase deposit acquisition; as with the much smaller 1994 transactions, there has initially been a disproportionately smaller increase in net interest income since practically all of the acquired deposits are funding investments rather than higher yielding loans. Without the $775,000 in one-time Chase implementation expenses, the efficiency ratio would have been 59.5% in 1995. Management has set an objective to bring this ratio downward to 55% within the next three to five years.\nWhile the Company's expense ratios have generally been favorable, management maintains a heightened focus on controlling costs and eliminating inefficiencies. Areas for improvement have been identified through detailed peer comparisons, employee involvement, and targeted use of outside consultants. A task force has been initiated to coordinate technology improvements that may bring future expense savings (such as bringing automation to the branch customer service functions and capturing information on optical disk instead of microfiche). Further, line item expense monitoring on a regional basis has been assigned to individual managers as a supplement to regular surveillance by the corporate finance department. These efforts are intended to offset pressure from inflation and higher transaction volumes and allow the Company to more fully benefit from economies of scale as it continues to grow.\nEffective January 1, 1997, Financial Accounting Standards Board Statement No. 123, \"Accounting for Stock-Based Compensation\" will require a fair-value-based approach to accounting for stock-based compensation plans. Alternatively, the Statement allows for such plans to continue to be accounted for in accordance with APB Opinion 25, with disclosure of proforma amounts reflecting the difference between the costs charged to operations pursuant to Opinion 25 and the compensation cost that would have been charged had Statement No. 123 been applied. It is the Company's present intention to continue accounting for stock-based compensation plans in accordance with APB 25.\nEffective January 1, 1996, Financial Accounting Standards Board Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" establishes standards for measuring impairment of long-lived assets, including certain identifiable intangible assets. Adoption of this statement is not expected to have a significant effect on the Company's financial statements.\nThe two year trend by quarter in noninterest expense and its primary components is set forth as follows:\nINCOME AND INCOME TAXES\nIncome before tax in 1995 was nearly $18.9 million, up 15.2% over the prior year's amount, which was 6.7% higher than 1993's level. When pre-tax income is recast as if all tax-exempt revenues were fully taxable on a federal basis, 1995's results rose by $2.3 million or 13.6%.\nThe main reasons for improved pre-tax earnings were the favorable $7.5 million increase in net interest income (full tax-equivalent basis), which reflected the strong earning asset growth discussed previously, and a $1.4 million climb in noninterest income (including the change in net losses on the sale of securities and other assets). These factors were partially offset by $6.5 million more in overhead expense, including the aforementioned $5 million in one-time and other expenses associated with the Chase branches, and $63,000 more in loan loss provision expense.\nThe Company's combined effective federal and state tax rate rose 100 basis points this year to 39.2%. This rate has increased since 1993 largely as a result of a decreasing proportion of tax-exempt municipal investment holdings. More specifically, taxable earning assets have experienced a high rate of growth compared to tax-exempt holdings, whose level has been flat to falling primarily because of the less attractive nature of these investments.\nCAPITAL\nShareholders' equity ended 1995 at $100.1 million, up over 50% from one year earlier. Excluding the $2.9 million after-tax change in this year's market value adjustment on available for sale investment securities, capital rose 45%.\nIn addition to the contribution of strong earnings (partially offset by dividends paid to shareholders), the large increase in capital during 1995 can be attributed to shares of common and preferred stock issued to facilitate the Chase branch acquisition as indicated below. In total, $27.5 million in new capital was raised. The resulting profile of CBSI's common shareholder base as of September 30, 1995 reflects a net increase of 177 shareholders from year-end 1994, the bulk of which is associated with the mid-year common stock offering.\no On June 30, 1995, CBSI issued 710,000 shares of common stock ($24.25 per share) and 90,000 shares of 9% cumulative perpetual preferred stock ($100 per share).\no Pursuant to an overallotment option granted to the underwriter, 112,500 shares of common stock were issued on July 10, 1995 along with 40,000 shares reserved for directors and employees ($24.25 per share).\no On November 15, 1995, CBSI repurchased half ($4.5 million or 45,000 shares) of its preferred stock at par value without any prepayment penalty. The Company took this action in light of the success of its common stock issuance and the demonstrated earnings contribution of the Chase branch acquisition. The repurchase also eliminated a relatively high cost funding source.\nThe ratio of tier I capital to assets (or tier I leverage ratio), the basic measure for which regulators have established a 5% minimum to be considered \"well-capitalized,\" remains sound at 5.83%. This level compares to 6.80% a year ago. The change reflects growth in assets resulting from the Chase acquisition and the decision by management to limit the size of the Company's secondary capital offering to that required to remain \"well-capitalized.\" The total capital to risk-weighted assets ratio is 11.76% as of year-end 1995, well above the 6% minimum requirement for \"well-capitalized\" banks. The Company is confident that capital levels are being prudently balanced between regulatory and investor perspectives.\nCash dividends paid in 1995 of $3.9 million represented an increase of 26.2% over the prior year. This growth reflects the greater number of shares outstanding (due to both the secondary offerings and the exercise of stock options), payment of the preferred stock dividend, and a three cent per share increase in quarterly common stock dividend in the fourth quarter of 1995 from $.30 to $.33.\nRaising the Company's expected annualized dividend to $1.32 per common share represents management's confidence that earnings strength is sustainable and that capital can be maintained at a satisfactory level. The dividend payout ratio for the year was approximately 37%, or 35% excluding the preferred dividend, and represents an increase from the 1994 level of 31%. The Company's targeted payout range for dividends on common stock is 30-40%. Its payout ratio has historically been strong relative to peers, averaging in the 60th-68th percentile for 1992, 1993, and 1994. The 1995 peer payout ratio (including preferred dividend) places the Company in the 64th peer percentile.\nLOANS\nThe amounts of the Bank's loans outstanding (net of deferred loan fees or costs) at the dates indicated are shown in the following table according to type of loan:\nThe Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. Nearly 70% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. In addition, the typical size loan to the variety of commercial businesses in the Company's market areas is under $50,000, with less than one quarter of the commercial portfolio being in loans in excess of $500,000. The portfolio contains no credit card receivables. The overall yield on the portfolio is in the attractive 67th peer percentile.\nLoans outstanding, net of unearned discount, reached a record $560 million as of year-end 1995, up over $77 million or 16.0% compared to twelve months earlier. About one third of 1995's growth took place in the markets served by the branches purchased from Chase at mid year; outstandings at these branches have nearly doubled since the acquisition date to $24 million at year end. This marks the third consecutive year in which growth has exceeded 15%; loans in 1994 rose a strong $65 million or 15.6% while the prior year's increase was $56 million or 15.3%. Loans have been on the rise since March 1992, some nine months after the 1990 recession had statistically ended on the national level; net growth beyond the Company's previous record high began in the second quarter of 1993.\nThe primary reasons for the Company's success over the last three years vary by line of business, a construct which recombines the individual components of the preceding table into four major segments:\no Expanded residential real estate lending, which grew rapidly through year-end 1993, largely due to refinancing caused by the historically low mortgage rate environment; growth slowed thereafter as rates began to rise and the Company entered a program to sell certain originations in the secondary mortgage market;\no A relatively steady increase in the 1993-1994 period in lending to small and medium-sized businesses, with growth stepping up this year because of the Chase branch acquisition;\no An increase in indirect installment lending in the spring of 1993 after a three and one-half year decline, with accelerated growth beginning in the spring of 1994 as new car sales climbed nationwide; strength continued in 1995, though demand began to moderate in the fall of this year; and\no Relative flatness in general direct installment lending until the spring of 1994, with mild improvement thereafter.\nFor 1995 as a whole, about 42% of the $77 million in total loan growth took place in the consumer indirect area, slightly less than the 43% share achieved on 1994's $65 million increase in total loans. The increase in business lending was proportionately more significant in 1995 at 46% of total loan growth versus 28% in the prior year. The share of this year's increase from consumer mortgages dropped sharply to 4% from nearly 24% of total growth in 1994. And consumer direct loans accounted for 7% of 1995's rise, up from 5% in the prior year. The improved relative contribution of both business lending and consumer direct loans reflects the impact of the new Chase branch markets.\nDemand for installment debt indirectly originated through automobile, marine, and mobile home dealers continued to be strong in 1995 for the second consecutive year. Outstandings ended 1995 nearly 32% or $33 million higher compared to growth of 38% or $28 million in the prior year. Strength was evidenced in both CBSI's Northern Region, where this type of lending has been highly successful for a number of years, and in the Southern Region, where the commitment to indirect lending was re-energized during 1993 with continued good success since then. This portfolio segment, of which more than 93% relates to automobile lending, constitutes over 24% of total loans outstanding, up from its low of 18% at year-end 1993. Because the mix of automobiles is 42% new vehicles versus 58% used, the overall portfolio yield is additionally attractive, with an average maturity approximating 36 months.\nThe direct consumer lending activity has increased modestly over the last three years. Outstandings rose 5.6% or $5.5 million versus 3.4% or $3.3 million in 1994; about one third of this year's increase reflects the impact of the Chase branch purchase. This line of business is comprised of conventional installment loans (including some isolated installment lending to small businesses), personal loans, student loans (which are sold once principle amortization begins), and borrowing under variable rate home equity lines of credit. Growth in installment lending and in personal lines of credit explains this year's increase as opposed to in 1994, when home equity loans provided more than half the improvement. Despite its dollar growth in 1995, the consumer direct installment loan segment continued to trend downward, ending 1995 at 19% of total loans outstanding. Management expects that the 25,000 households served by the former Chase branches will have a positive impact on this line of business.\nThe segment of the Company's loan portfolio committed to consumer mortgages, which includes conventional residential lending as well as fixed rate home equity lines of credit, accounts for $147 million or 26% of total loans outstanding. The flattening of growth during the last two years reflects the increase in mortgage rates from their historic lows in late 1993, though demand began to improve in the summer of 1995 after rates started to soften. Growth has also been muted because of a program which began in mid 1994 to sell selected fixed rate originations in the secondary market. The purpose of this program, which resulted in sales of $1.2 million in its first year and $4.3 million in 1995, is to develop a meaningful source of servicing income as well as to provide an additional tool to manage interest rate risk. During 1995, the Financial Accounting Standards Board issued statement No. 122, \"Accounting for Mortgage Servicing Rights,\" which requires recognition of the value of servicing rights related to originated loans with servicing retained. Adoption of this pronouncement effective January 1, 1996, is not expected to have a significant effect of the Company's financial statements.\nThe combined total of general purpose business lending, dealer floor planning, mortgages on commercial property, and farm loans (the latter two categories totaling 5% of the Company's entire loan portfolio) is characterized as the Company's business lending activity. At $174 million, this segment represents 31% of loans outstanding at year end, having expanded its share by five percentage points from when the Company's loan portfolio began its second quarter 1992 upturn. This strength is largely attributable to borrowing by local commercial businesses and automobile dealers, plus a recent increase in agricultural lending. Outstandings climbed over $35 million or nearly 26% in 1995; excluding loans purchased from Chase and subsequent growth in these new markets, outstandings rose $13 million or 9%. Comparative growth rates were 15% for 1994 and an unusually high 26% in 1993, a year in which there were no acquisitions.\nAbout 90% of the Bank's commercial customers borrow less than $100,000, which as a group constitutes almost 40% of commercial loans outstanding. Borrowers needing up to $250,000 comprise about one quarter of loans outstanding. Borrowings in the size ranges of $250,000-$500,000 and over $500,000 constitute 13% and 23% of the portfolio, respectively.\nThe two year trend by quarter in loans by line of business is set forth as follows:\nNote: (a) Totals and change calculations may not foot due to rounding.\nMATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES\nThe following table shows the amount of loans outstanding as of December 31, 1994 which, based on remaining scheduled repayments of principal, are due in the periods indicated:\nThe following table sets forth the sensitivity of the loan amounts due after one year to changes in interest rates:\n------------------------------ At December 31, 1995 ------------------------------ Fixed Rate Variable Rate\nDue after one year but within five years ............................... $155,328 $52,982 Due after five years .................... 168,455 32,100 -------- ------- Total .......................... $323,784 $85,082 ======== =======\nNON-PERFORMING ASSETS\/RISK ELEMENTS\nThe following table presents information concerning the aggregate amount of non-performing assets:\nThe impact of interest not recognized on non-accrual loans, and interest income that would have been recorded if the restructured loans had been current in accordance with their original terms, was immaterial. The Company's policy is to place a loan on a non-accrual status and recognize income on a cash basis when it is more than ninety days past due, except when in the opinion of management it is well secured and in the process of collection.\nNonperforming loans, defined as nonaccruing loans plus accruing loans 90 days or more past due, ended 1995 at a very manageable $2.0 million. This level is nearly $1.3 million lower than one year earlier, largely due to resolution of a single public housing project where cost overruns delayed a take out by the Farmers' Home Administration. Today's level is also lower than the $2.4 million in nonperformers at year-end 1993, which was established following a critical view of certain commercial credits taken by the then new CEO and lending personnel added as a result of organizational turnover.\nConsistent with the reduction in nonperforming loans is a significant improvement in its ratio to total loans, which ended 1995 at .36%, down by almost half from the .67% level of one year earlier. As of September 30, 1995, when the nonperforming loan ratio stood at .33%, the Company's asset quality was in the very strong 11th percentile compared to peers. The ratio of nonperforming assets (which additionally include troubled debt restructurings and other real estate) to total loans plus OREO is also highly favorable at .47%.\nAs of December 31, 1995 and for years then ended, the Bank had no loans deemed to be impaired under FASB 114.\nTotal delinquencies, defined as loans 30 days or more past due and nonaccruing, followed a saucer-shaped trend during 1995, ending the year at 1.31%, virtually unchanged from twelve months earlier and down from 1.58% at year-end 1993. After a significant reduction in the second quarter as discussed above, commercial delinquencies remained relatively constant, concluding 1995 at a modest 1.32%. Past due installment loans dipped below 1.0% during spring of this year, reaching 1.65% by year end. Real estate delinquencies fluctuated in the .6-.8% range during most of the year, finishing at .91% in December.\nAs of September 30, 1995, when overall delinquencies were at 1.08%, the Company ranked in the very favorable lowest peer quartile, consistent with historically being better than the peer norm due to its reliable consumer borrower base. Other factors contributing to successful underwriting, collection, and credit monitoring include selective addition of experienced lenders over the last several years, clear delineation of authority along with newly adopted loan policies and procedures, regional loan servicing and collection departments focused on taking prompt corrective action, and a centralized loan review function which is given priority attention and has monthly Board of Director accountability.\nSUMMARY OF LOAN LOSS EXPERIENCE\nThe following table summarizes loan balances at the end of each period indicated and the daily average amount of loans. Also summarized are changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off and additions to the allowance which have been charged to expenses.\n(1) The additions to the allowance during 1991 through 1995 were determined using actual loan loss experience and future projected loan losses and other factors affecting the estimate of possible loan losses.\nBesides its favorable delinquency and nonperforming asset levels, another measure of the Company's strong asset quality is a low net charge-offs record, which for the third consecutive year was better than its historically acceptable norm. Gross charge-offs rose a relatively small 8.8% to $1.8 million, or .34% of average loans outstanding versus .36% in 1994. In addition, this year's recoveries were an all-time record both in dollar amount and in relation to prior year gross charge-offs. As a result, net charge-offs at $1.1 million represented a very acceptable .21% ratio to average loans. Since the banking industry in general has benefited from very favorable credit loss experience, the net charge-off ratio approximates the peer norm.\nA timely charge-off policy and relatively low nonperforming loans have enabled the Company to carry a reserve for loan losses well below peers, but sufficient in the event of an economic downturn. In addition, the Company's small business loan orientation reduces the likelihood of large, single borrower charge-offs.\nAs a percent of total loans, the loss reserve ratio was 1.25%, down slightly from the 1992-1994 levels when major building of the ratio took place. Though the reserve ratio is presently in the relatively low 27th peer percentile, coverage over nonperforming loans as of September 30, 1995 was well above the norm in the 83rd percentile; management considers the year-end level at 350% to be ample. Another measure of comfort to management is that after conservative allocation by specific customer and loan type, over 16% of loan loss reserves remains available for absorbing general, unforeseen loan losses, up from 13% at year-end 1994.\nThe annual loan loss provision has characteristically been well in excess of net charge-offs, being covered by over 1.3 times since 1990; this year's coverage exceeded 1.6 times. This practice has enabled a steady increase in the loan loss reserve level, which rose by almost $700,000 or 11% to an all-time high of $7.0 million at year-end 1995. Compared to average loans, the annual loan loss provision has been slightly above the peer norm.\nThe allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated:\nFUNDING SOURCES\nTypical of most commercial banking institutions today is the need to rely on a variety of funding sources to support its earning asset base as well as to achieve targeted growth objectives. There are three primary sources of funding that comprise CBSI's overall funding matrix, which considers maturity, stability, and price: deposits of individuals, partnerships, and corporations (IPC deposits); collateralized municipal deposits; and capital market borrowings.\nThe Company's key funding matrix was positively impacted by the Chase branch acquisition completed in July 1995. As a result of this purchase, IPC deposits on average for fourth quarter 1995 accounted for over 87% of all funding, up significantly from 72% for the comparable 1994 period. IPC deposits are generally considered the most attractive source of funding for a bank because of their general stability and relatively low cost, and because they provide management with a working customer base from which to cross-sell a variety of loan, deposit, and other financial services related products.\nAlthough IPC deposit outstandings averaged $921 million during the fourth quarter of 1995, $364 million of this average were deposits purchased from the Chase branch acquisition. Without this acquisition, fourth quarter average IPC outstandings would have been $557 million, or a 4.5% decrease from 1994 fourth quarter outstandings of $583 million. This level of performance met management's expectations, given the nonaggressive deposit pricing strategy for 1995; expected deposit inflows from the Chase branch acquisition heavily influenced this pricing objective.\nDeposits of local municipalities accounted for 12.1% of total CBSI funding during the fourth quarter of 1995, down slightly from its 12.4% position as of the fourth quarter of 1994. Under New York State Municipal Law, the Company is required to collateralize all local government deposits with marketable securities from its investment portfolio. Because of this stipulation, management considers this source of funding to be equivalent to capital market borrowings. As such, CBSI endeavors to price these deposits at or below alternative capital market borrowing rates.\nCapital market borrowings are defined as funding sources available on a national market basis, generally requiring some form of collateralization. Borrowing sources for the Company include the Federal Home Loan Bank of New York, as well as access to the national repurchase agreement market through established relationships with primary market security dealers. Capital market borrowings declined from 15.9% of total funding sources in 1994 to 5.0% as of fourth quarter 1995. This decline in outstandings was largely the result of management's decision to repay all short-term borrowings with deposit inflows from the Chase branch acquisition. On average, capital market borrowings in 1995 at $89 million were virtually unchanged from 1994's level.\nThe mix of CBSI's IPC deposits has changed over the last three years. The steady growth in time deposit mix reflects consumer movement away from immediately available, lower earning savings and money market accounts; in addition, the former Chase deposits contained a relatively higher proportion of time deposits.\nThe average daily amount of deposits and the average rate paid on each of the following deposit categories is summarized below for the years indicated:\nThe remaining maturities of time deposits in amounts of $100,000 or more outstanding at December 31, 1995 and 1994 are summarized below:\n------------------------- AT DECEMBER 31, (IN THOUSANDS) ------------------------- 1995 1994 ------- ------- Less than three months ................... $42,639 $29,963 Three months to six months ............... 13,574 9,983 Six months to one year ................... 9,169 4,248 Over one year ............................ 5,859 3,589 ------- ------- $71,241 $47,783\nBORROWING\nThe following table summarizes the outstanding balances of short-term borrowings of the Company for the years indicated:\n--------------------------------- AT DECEMBER 31, --------------------------------- 1995 1994 1993 -------- -------- ------- (Dollars in thousands)\nFederal funds purchased ................... $ 0 $57,300 $57,000 Term borrowing at banks (original term) 90 days or less ......................... 0 80,000 0 1 year .................................. 0 25,000 0 -------- -------- ------- Balance at end of period .............. $ 0 $162,300 $57,000 ======== ======== ======= Daily average during the year ............. $85,407 $86,777 $22,892 Maximum month-end balance ................. $188,200 $163,700 $57,000 Weighted-average rate during the year ..... 6.29% 4.48% 3.35% Year-end average rate ..................... 0.00% 5.44% 3.00%\nThe two year trend by quarter in funding sources and related cost is set forth as follows:\nINVESTMENTS AND ASSET\/LIABILITY MANAGEMENT\nThe primary objective of CBSI's investment portfolio is to prudently provide a degree of low-risk, quality assets to the balance sheet. This must be accomplished within the constraints of: (a) absorbing funds when loan demand is low and infusing funds when demand is high; (b) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (c) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (d) considering investment risk-weights as determined by regulatory risk-based capital guidelines; and (e) generating a favorable return without undue compromise of other requirements.\nGrowth in investments during 1995 was largely influenced by the need to strategically utilize excess cash from the Chase branch acquisition. Consequently, average portfolio outstandings grew by nearly 47% during 1995, compared to an increase of 21% in 1994. Primarily because of investments made as a result of the 1994 branch acquisitions and the strategy to pre-invest certain of the anticipated Chase branch deposits, growth in investments as measured by year-end outstandings was greater in 1994 than in 1995.\nConsistent with the Company's long-standing practice, all investment strategies implemented during 1995 were developed in conjunction with CBSI's asset\/liability position, with particular attention given to interest rate risk (IRR) of the entire balance sheet, not just that associated with incremental investment decisions. In order to effectively manage IRR, both a short-term tactical and longer-term strategic horizon are considered.\nAs a result of the Chase branch deposit acquisition, the asset\/liability profile underwent a dramatic, though fully anticipated, repositioning in 1995. The high level of 1994 year-end liability sensitivity was eliminated as all short-term borrowings were replaced by longer-term core deposits from the branch purchase. Beginning in mid 1995, the balance sheet reflected a structurally asset-sensitive position, as measured by CBSI's Gap Maturity Matrix. The year-end matrix and supporting data are displayed at the end of this section.\nThis new balance sheet profile afforded management the opportunity to extend the duration of certain investment purchases made in 1995, a move primarily aimed at reducing the Company's exposure to falling interest rates. This strategy was largely accomplished by the purchase of longer-dated, fixed rate callable U.S. government agency issues and discounted, fixed rate mortgage-backed securities. The timing of this strategy was largely limited to the first two quarters of 1995.\nAs the yield curve began to flatten in the second half of 1995, the appeal of longer-term, fixed-rate investments began to wane due to the potentially high degree of market value volatility such securities might experience over their expected lifetime. This concern prompted management to focus on a more defensive investment strategy for the remainder of 1995.\nThe majority of securities purchased by CBSI during the second half of 1995 were floating rate U.S. government agency collateralized mortgage-backed obligations or CMOs. These instruments featured discount margin spreads of between 110 and 115 basis points above the one-month LIBOR rate, adjusted monthly. As with most floating rate instruments, these bonds were subject to life-time yield caps, which ranged between 9.50% to 10.00%.\nThe composition of the portfolio continues to heavily favor U.S. governments and agency mortgage-backed obligations, resulting in effective use of regulatory risk-based capital. As of year-end 1995, these two security types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock) accounted for 96% of total portfolio investments, up from a level of 81% five years earlier.\nThe average life of the portfolio, including the exercise of embedded call options, extended to 4.5 years as of December 31, 1995. As of year-end 1994 and 1993, the average life of the portfolio stood at 3.5 years and 2.3 years, respectively. The investment strategies pursued during 1994 and 1995 were largely responsible for this extension.\nAverage investment yields for the year increased to 7.45% from 6.95% in 1994. The December 1995 portfolio yield averaged 7.55% compared to 7.30% for the same month one year prior. Through September 30, 1995, the Company's investment yield was in the very favorable 94th peer bank percentile.\nDuring the fourth quarter of 1995, management chose to reclassify approximately $40 million of held to maturity investments as available for sale, under a special one-time adjustment window granted by the Financial Accounting Standards Board on October 18, 1995. Securities which were moved as a result of this opportunity included $22 million in floating rate investments and $18 million in mortgage-backed securities with current face values of under $1 million. While these securities are now eligible for sale due to their change in accounting treatment, management has no immediate plan to exercise this option given the current interest rate environment.\nNet losses on the sale of securities were $152,000 in 1995, versus $502,000 in 1994 and $15,000 in 1993. Losses incurred resulted from normal investment management activity, which focuses on improving long-term portfolio earnings and profitability.\nThe following table sets forth the amortized cost and market value for the Company's held to maturity investment securities portfolio:\nThe following table sets forth as of December 31, 1995, the maturities of investment securities and the weighted-average yields of such securities, which have been calculated on the basis of the cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:\n- ---------- (1) Weighted-average yields on the tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a marginal federal tax rate of 35%. These yields are an arithmetic computation of accrued income divided by average balance; they may differ from the yield to maturity, which considers the time value of money.\nA tool known as a Gap Maturity Matrix is used to isolate interest rate sensitivity or repricing mismatches between assets and liabilities. The diagonal bank on the matrix indicates basic matching of asset\/liability repricing and maturity opportunities. Outstandings shown above the band are assets subject to repricing more quickly than their supporting liabilities (asset sensitivity). Outstandings shown below the band are liabilities subject to repricing more quickly than the assets which they support (liability sensitivity).\nThe following Gap Report and its representation in the Gap Maturity Matrix set forth information concerning interest rate sensitivity of the Company's consolidated assets and liabilities as of December 31, 1995:\nGAP REPORT\nAS OF DECEMBER 31, 1995 (COMMUNITY BANK SYSTEM, INC.)\nGAP MATURITY MATRIX AS OF DECEMBER 31, 1995 (COMMUNITY BANK SYSTEM, INC.)\nLIQUIDITY\nDue to the potential for unexpected fluctuations in deposits and loans, active management of the Company's liquidity is critical. In order to respond to these circumstances, adequate sources of both on-and off-balance sheet funding are in place.\nCBSI's primary approach to measuring liquidity is known as the Basic Surplus\/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short-term liabilities which are vulnerable to nonreplacement; and second, a projection of subsequent cash flow funding needs over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus\/Deficit approach is 7.5% of total assets for both the 30 and 90 day time horizons. As of year-end 1995, this ratio was a conservative 19.9% and 21.3%, respectively.\nEFFECTS OF INFLATION\nThe financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.\nVirtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rate changes have a more significant impact on the Company's performance than the effects of general levels of inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and auditor's reports of Community Bank System, Inc. and subsidiaries are contained on pages 51 through 76 of this item.\n-- Consolidated Statements of Condition-- December, 31, 1995 and 1994\n-- Consolidated Statements of Income-- Years ended December 31, 1995, 1994, and 1993\n-- Consolidated Statements of Changes in Stockholders' Equity-- Years ended December 31, 1995, 1994, and 1993\n-- Consolidated Statement of Cash Flows-- Years ended December 31, 1995, 1994, and 1993\n-- Notes to Consolidated Financial Statements-- December 31, 1995\n-- Auditors' report\nQuarterly Selected Data (Unaudited) are contained on page 77.\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nThe accompanying notes are an integral part of the consolidated financial statements.\nCOMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF OPERATIONS\nCommunity Bank System, Inc. (the Company) is a one bank holding company whose sole active operating subsidiary, Community Bank, N.A. (the Bank), operates 49 customer facilities throughout Northern New York, the Finger Lakes Region, the Southern Tier, and Southwestern New York. The Bank provides individual, business, agricultural and government customers with a complete range of banking services, including qualified retirement plan administration, investment management, and personal trust services; retail and commercial loan and deposit products; and non-deposit annuities and investment products.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, the Bank and a currently inactive nonbanking subsidiary. All intercompany accounts 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.\nCASH AND CASH EQUIVALENTS\nFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.\nThe carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.\nINVESTMENT SECURITIES\nThe Company has classified its investments in debt and equity securities as held to maturity or available for sale. Held to maturity securities are those for which the Company has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held to maturity are classified as available for sale and are reported at fair market value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes. None of the Company's investment securities have been classified as trading securities.\nThe average cost method is used in determining the realized gains and losses on sales of investment securities, which are reported under other income-investment security gains (losses).\nFair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\nLOANS\nLoans are stated at unpaid principal balances. Fair values for variable rate loans that reprice frequently, with no significant credit risk, are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flows and 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.\nDuring 1995, the Financial Accounting Standards Board issued Statement No. 122, \"Accounting for Mortgage Servicing Rights,\" which allows for recognition of the value of servicing rights related to originated loans sold with servicing rights retained. Adoption of this pronouncement, effective January 1, 1996, is not expected to have a significant effect on the Company's financial statements.\nINTEREST ON LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES\nInterest on commercial loans and mortgages is accrued and credited to operations based upon the principal amount outstanding. Unearned discount on installment loans is recognized as income over the term of the loan, principally by the actuarial method. Nonrefundable loan fees and related direct costs are deferred and amortized over the life of the loan as an adjustment to loan yield using the effective interest method.\nThe Bank places a loan on nonaccrual status and recognizes income on a cash basis when it is more than ninety days past due (or sooner, if management concludes collection of interest is doubtful), except, when in the opinion of management, it is well-collateralized and in the process of collection.\nThe reserve for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The reserve is increased by provisions charged to expense and reduced by net charge-offs. The level of the reserve is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions.\nEffective January 1, 1995, the Bank adopted Statement of Financial Accounting Standard No. 114, \"Accounting by Creditors for Impairment of a Loan.\" Under this standard, a loan is considered impaired, based current information and events, if it is probable that the Bank will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Adoption of this pronouncement had no effect on the Bank's financial statements for 1995.\nPREMISES AND EQUIPMENT\nPremises and equipment are stated at cost less accumulated depreciation. The annual provision for depreciation is computed using the straight-line method in amounts sufficient to recognize the cost of depreciable assets over their estimated useful lives. Maintenance and repairs are charged to expense as incurred.\nOTHER REAL ESTATE\nProperties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at the lower of the unpaid loan balance plus settlement costs, or fair value less estimated costs of disposal. At December 31, 1995 and 1994, other real estate, included in other assets, amounted to $614,478 and $222,855, respectively.\nINTANGIBLE ASSETS\nIntangible assets represent core deposit value and goodwill arising from acquisitions. The Company periodically reviews the carrying value of intangible assets using fair value methodologies. Core deposit intangibles are being amortized principally on an accelerated basis over ten years. Goodwill is being amortized on a straight-line basis over 15 to 25 years.\nDEPOSITS\nThe fair values disclosed for demand and savings deposits are equal to the carrying amounts at the reporting date. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using discounted cash flows and interest rates currently being offered on similar certificates. The carrying value of accrued interest approximates fair value.\nBORROWINGS\nThe carrying amounts of federal funds purchased and borrowings approximate their fair values.\nEARNINGS PER SHARE\nEarnings per share are computed on the basis of weighted average common and common equivalent shares outstanding throughout each year (3,261,205 in 1995; 2,814,710 in 1994; 2,722,093 in 1993).\nFAIR VALUES OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standard No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value of information on financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present values or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.\nThe fair values of investment securities, loans and deposits have been disclosed in footnotes C, D, and G, respectively.\nRECLASSIFICATION\nCertain amounts from 1994 and 1993 have been reclassified to conform to the current year's presentation.\nNOTE B: BRANCH ACQUISITIONS AND DIVESTITURES\nIn July 1995, the Company acquired certain assets and assumed certain liabilities relating to 15 branch offices of the Chase Manhattan Bank, N.A. located in the Northern, Central, and Finger Lakes regions of New York State. In December 1995, the Company sold the assets and liabilities of 3 of these branches to another banking entity. A summary of this acquisition and divestiture activity is as follows:\nAcquisition Divestiture ------------ ------------- Cash received (paid) .......................... $330,229,952 ($37,707,788)\nLoans acquired (divested) ..................... 13,954,164 (1,118,758)\nProperty and equipment acquired (divested) .... 5,133,354 (741,500)\nOther assets and liabilities acquired (divested), net ............................. 1,247,553 (124,406)\nPurchase (divestiture) price allocated to:\nCore deposit value .......................... 16,375,717 (1,941,210)\nGoodwill .................................... 15,635,610 (917,463) ------------ ------------\nDeposit liabilities assumed (divested) ........ $382,576,350 ($42,551,125) ============ ============\nNet core deposit value and goodwill arising from these transactions is being amortized over ten years on an accelerated basis, and over 25 years on a straight-line basis, respectively.\nIn 1994, the Company acquired three branches from the Resolution Trust Corporation (formerly owned by Columbia Savings FSA) and the Cato, New York branch from the Chase Manhattan Bank, N.A. In connection with these acquisitions, the Company assumed $75,000,000 in deposit liabilities and received cash and other assets of $69,000,000. The deposit premium of $6,000,000 is being amortized on a straight-line basis over 15 years.\nAll of the above transactions have been recorded under the purchase method of accounting, and accordingly, the operating results of the branches acquired have been included in the Company's consolidated financial statements from the date of acquisition. Results of operations on a pro-forma basis are not presented since historical financial information for the branches acquired is not available.\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.\nProceeds from sales of investments in debt securities during 1995, 1994, and 1993 were $3,950,000, $29,241,000 and $3,000,000, respectively. Gross gains of approximately $258,000 for 1994 and gross losses of $150,000, $761,000, and $15,000 were realized on those sales in 1995, 1994, and 1993 respectively.\nInvestment securities with a carrying value of $202,204,782 and $199,032,705 at December 31, 1995 and 1994, respectively, were pledged to collateralize deposits and securities sold under agreements to repurchase and for other purposes required by law.\nIn December 1995, the Company transferred investment securities having an amortized cost of $39,640,740 and net unrealized gains of $832,020 from held to maturity to available for sale. These transfers were made pursuant to the FASB's \"Implementation Guide to Statement 115\" and the Company's prevailing financial management objectives.\nNOTE D: LOANS\nMajor Classifications of Loans at December 31, are summarized as follows:\n1995 1994 ---- ---- Real estate mortgages: Residential ............................. $204,225,091 $196,547,718 Commercial .............................. 46,970,983 35,603,929 Farm .................................... 8,223,806 7,624,577 Agricultural loans ........................ 17,968,900 13,295,398 Commercial loans .......................... 81,562,024 67,975,882 Installment loans to individuals .......... 212,479,749 188,209,205 Other loans ............................... 2,190,134 1,482,066 ------------ ------------ 573,620,687 510,738,775 Less: Unearned discount .................. (13,469,032) (27,659,684) Reserve for possible loan losses ... (6,976,385) (6,281,109) ------------ ------------ Net loans ........................... $553,175,270 $476,797,982 ============ ============\nThe estimated fair value of loans receivable at December 31, 1995 and 1994 was $565,000,000 and $474,000,000, respectively.\nChanges in the reserve for possible loan losses for the years ended December 31 are summarized below:\n1995 1994 1993 ---- ---- ---- Balance at the beginning of year ..... $6,281,109 $5,706,609 $4,982,451 Provision charged to expense ......... 1,765,148 1,702,466 1,506,131 Loans charged off .................... (1,757,584) (1,615,712) (1,410,390) Recoveries ........................... 687,712 487,746 628,417 ---------- ---------- ---------- Balance at end of year ............... $6,976,385 $6,281,109 $5,706,609 ========== ========== ==========\nAs of December 31, 1995, the Bank had no impaired loans for which specific valuation allowances were recorded.\nNOTE E: PREMISES AND EQUIPMENT\nPremises and equipment consist of the following at December 31:\n1995 1994 ---- ---- Land and land improvements ................. $ 3,527,773 $ 2,253,625 Bank premises owned ........................ 15,761,996 11,998,034 Equipment .................................. 10,747,882 7,923,757 ----------- ----------- Premises and equipment gross ......... 30,037,651 22,175,416 Less: Allowance for depreciation .......... 13,101,795 11,583,906 ----------- ----------- Premises and equipment net ........... $16,935,856 $10,591,510 =========== =========== NOTE F: INTANGIBLE ASSETS\nIntangible assets consist of the following at December 31:\n1995 1994 ---- ---- Core deposit intangible .................... $15,007,907 $ 573,400 Goodwill and other intangibles ............. 21,591,942 6,593,203 ----------- ----------- Intangible assets, gross .............. 36,599,849 7,166,603 Less: Accumulated amortization ............ (2,629,474) (1,059,995) ----------- ----------- Intangible assets, net ................. $33,970,375 $ 6,106,608 =========== ===========\nNOTE G: DEPOSITS\nDeposits by type at December 31 are as follows:\n1995 1994 ---- ---- Demand ............................. $ 140,288,323 $103,006,969 Savings ............................ 414,279,708 306,023,336 Time ............................... 462,378,193 270,607,319 -------------- ------------ Total Deposits................... $1,016,946,224 $679,637,624 ============== ============\nThe estimated fair values of deposits at December 31, 1995 and 1994 were approximately $1,019,000,000 and $677,087,000, respectively.\nAt December 31, 1995 and 1994, time certificates of deposit in denominations of $100,000 and greater totaled $71,241,000 and $47,783,000.\nNOTE H: BORROWINGS\nAt December 31, 1995 and 1994, outstanding borrowings were as follows:\n1995 1994 ----- ----- Short-term borrowings: Federal funds purchased .............. $ 0 $ 57,300,000 Federal Home Loan Bank advances ...... 0 105,000,000 ----------- ------------ 0 162,300,000\nFederal Home Loan Bank Advances ...... 25,550,000 550,000 ----------- ------------ $25,550,000 $162,850,000 =========== ============\nFederal Home Loan Bank advances are secured by a blanket lien on the Company's residential real estate loan portfolio.\nAdvances at December 31, 1995 have maturity dates as follows:\nWeighted Average Rate ------------ September 10, 1996 ........................ 4.54% $ 550,000 December 14, 1998 ......................... 5.69% 10,000,000 December 10, 2000 ......................... 5.86% 15,000,000 ----- ----------- 5.76% $25,550,000\nNOTE I: INCOME TAXES\nEffective January 1, 1993 the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes,\" which requires an asset-liability approach to recognizing the tax effects of temporary differences between tax and financial reporting. In prior years, the Company accounted for the tax effects of timing differences between tax and financial reporting using Accounting Principle Board Opinion Number 11. This change had no significant affect on the 1993 consolidated financial statements.\nThe provision (benefit) for the income taxes for the years ended December 31 is as follows: consolidated financial statements.\n1995 1994 1993 ---------- ---------- --------- Current: Federal .............. $5,658,251 $4,993,505 $4,542,509 State ................ 1,825,335 1,717,768 1,631,979 Deferred: Federal .............. (76,248) (341,226) (305,383) State ................ (23,338) (113,742) (103,698) ---------- ---------- ---------- Total income taxes $7,384,000 $6,256,305 $5,765,407 ========== ========== ==========\nComponents of the net deferred tax asset, included in other assets, as of December 31 are as follows:\n1995 1994 ----------- ---------- Allowance for loan losses ...... $2,880,201 $2,555,480 Deferred net loan fees ......... 205,529 294,470 Post Retirement and other reserves ...................... 578,744 176,197 Pension ........................ 340,199 354,562 Investment securities .......... 0 388,683 ----------- ---------- Total deferred tax asset ....... $4,004,673 $3,769,392\nInvestment securities .......... 2,155,552 0 Depreciation ................... 65,853 66,238 ----------- ---------- Total deferred tax liability ... $2,221,405 $ 66,238 ----------- ---------- Net deferred tax asset ......... $1,783,268 $3,703,154 =========== ==========\nThe Company has determined that no valuation allowance is necessary as it is more likely than not that deferred tax assets will be realized through carryback to taxable income in prior years, future reversals of existing temporary differences, and through future taxable income.\nA reconciliation of the differences between the federal statutory income tax rate and the effective tax rate for the years ended December 31 is shown in the following table:\nNOTE J: LIMITS ON DIVIDENDS AND OTHER RESTRICTIONS\nThe Company's ability to pays dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the Office of the Comptroller of Currency (OCC ) for payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1995, the bank had approximately $20,432,000 in undivided profits legally available for the payment of dividends.\nIn addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings.\nThere are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specific amounts.\nNOTE K: PENSION PLAN\nThe Company has a noncontributory pension plan for all eligible employees; it is administered by the Trust Department of Community Bank, N.A. under the direction of an appointed retirement board. The policy of the Company is to fund the plan to the extent of its maximum tax deductibility.\nThe net periodic pension cost and actuarial assumptions for the years ended December 31 were as follows:\nThe entire amount of unrecognized gains and losses is amortized over the average remaining service lives of the participants on a straight-line basis.\nThe following table presents a reconciliation of the plan's funded status at December 31:\nThe decrease in the discount rate from 8% to 7% increased the projected benefit obligation at December 31, 1995 by $1,571,271.\nPlan assets consist primarily of listed stocks, governmental securities and cash equivalents. The plan is authorized to invest up to 10% of the fair value of its total assets in common stock of Community Bank System, Inc. At December 31, 1995 and 1994, the plan holds 23,064 and 1,160 shares, respectively, of the sponsor company common stock.\nThe Company also has an Employee Savings and Retirement Plan, which is administered by the Trust Department of Community Bank, N.A. The Employee Savings and Retirement Plan includes Section 401(k) and Thrift provisions as defined under the Internal Revenue Code. The provisions permit employees to contribute up to 15% of their total compensation on a pre-tax or post-tax basis. The Company matches amounts to 50% of the first 6% contributed. Company contributions to the trust amounted to $522,680, $460,459, and $361,827 in 1995, 1994, and 1993, respectively.\nThe Company has a deferred compensation agreement with its President and Chief Executive Officer whereby monthly payments will be provided upon retirement over a period of fifteen years. Expenses incurred during 1995 related to the agreement amounted to $55,000.\nNOTE L: POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides health and life insurance benefits for eligible retired employees and their dependents An employee becomes eligible for these benefits by satisfying plan provisions which include certain age and\/or service requirements. Medical benefits are based on years of service at retirement, with forty years of service being required in order to be fully eligible for benefits. The medical plans pay a stated percentage of medical expenses reduced by deductibles and other coverages. The Medicare supplement policy provides for a $100,000 maximum lifetime benefit. Generally, life insurance benefits are equal to $5,000.\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions.\" This statement requires that the cost of postretirement benefits be accrued for during the service lives of employees. The Company elected the prospective transition approach and is amortizing the transition obligation over a 20-year period.\nNet periodic postretirement benefit cost for the years ended December 31 include the following components:\n1995 1994 1993 --------- -------- -------- Service cost ..................... $ 80,600 $ 73,200 $ 89,900\nAmortization of transition obligation over 20.1 years ...... 61,200 61,200 102,000\nAmortization of prior service Cost ............................ 5,100 0 0\nAmortization of unrecognized net loss over 19.3 years ........ 13,400 21,800 0\nInterest on APBO less interest on expected benefit payments .... 163,800 156,300 180,500 --------- -------- -------- Net periodic postretirement benefit cost .................... $324,100 $312,500 $372,400 ========= ======== ========\nA 10.5 percent annual rate of increase in the per capita costs of covered health care benefits was assumed for 1995, gradually decreasing to 5.5 percent by the year 2051. Increasing the assumed health care cost trend rates by one percentage point each year would decrease the accumulated postretirement benefit obligation as of December 31, 1995 by $543,300 and decrease the aggregate service cost and interest components of net periodic postretirement benefit cost for 1995 by $28,400. Discount rates of 7% and 8% in 1995 and 1994, respectively, were used to determine the accumulated post-retirement benefit obligation. The following sets forth the funded status of the plan as of December 31:\n1995 1994 ----------- ----------- Accumulated Postretirement Benefit Obligation (APBO): Retirees .......................... $1,069,400 $1,047,500 Fully eligible active plan participants ................. 118,600 97,400 Other active plan participants .... 1,403,400 885,800 ----------- ---------- Total APBO ........................ 2,591,400 2,030,700\nPlan assets at fair value ............ 0 0 ----------- ---------- Accumulated postretirement benefits obligation in excess of plan assets ......................... (2,591,400) (2,030,700)\nUnrecognized prior service cost ...... 136,300 0\nUnrecognized portion of net obligation at transition ............ 1,046,900 1,108,100\nUnrecognized net loss ................ 760,100 458,500 --------- ----------- Accrued postretirement benefit cost .. ($648,100) ($464,100) ========= ===========\nA plan amendment effective January 1, 1994 limited the Company's expense to a maximum of $2,500 per person for medical coverage. This decreased the APBO at January 1, 1994 by approximately $779,000, reducing the remaining unrecognized transition obligation and decreasing the annual expense by approximately $41,000.\nNOTE M: INCENTIVE COMPENSATION\nThe Company has long-term incentive compensation programs for officers and key employees including incentive stock options (ISOs), restricted stock awards, nonqualified stock options (NQSOs) and warrants, and retroactive stock appreciation rights.\nIncentive stock options and warrants are granted at a price which is not less than market value at the time of the grant and are exerciseable within ten years, but no earlier than one year from the date of the grant, at dates specified by the Board of Directors of the Company. Retroactive stock appreciation rights may be granted with respect to both ISOs and NQSOs.\nInformation with respect to stock options and warrants under the above plans is as follows:\nThe program also provides for issuance of stock under a restricted stock award plan subject to forfeiture terms as designated by the Board of Directors of the Company. Stock issued under this plan is subject to restrictions as to continuous employment and\/or achievement of pre-established financial objectives during the forfeiture period. Restricted stockholders have dividend and voting rights during the forfeiture period.\nRestricted stock awarded in 1995, 1994, and 1993 amounted to 3,950, 0, and 200 shares, respectively. Total expense is determined based on the market value of the stock at the date of grant and is being accrued over the period the restrictions lapse. Expense in 1995, 1994, and 1993 was $77,618, $2,185 and $2,186, respectively.\nThere were 102,750, 130,000 and 46,909 shares available for future grants or awards under the various programs described above at December 31, 1995, 1994 and 1993, respectively.\nEffective January 1, 1996, the Board has approved a Stock-Based Compensation Plan and a Stock Option Plan for non-employee Directors of the Company who have completed at least six months of service as Director. The Stock-Based Compensation plan credits participants' accounts with an amount payable in the form of an annuity the first of the month following the later of a participant's dissociation from the Board or the participant's attainment of age 55. Participants become fully vested after 6 years of service. Amounts credited to participants' accounts are based on the performance of the Company's stock. The Stock Option Plan, pending stockholder approval, provides eligible non-employee directors with annual stock option grants at the December 31 market value of the stock.\nIn October of 1995, the Financial Accounting Standards Board issued Statement No.123, \"Accounting for Stock-Based Compensation,\" which establishes a fair-value-based method of accounting for stock compensation plans with employees and others. Alternatively, the statement allows that entities may continue to account for stock-based compensation plans in accordance with APB Opinion 25, with disclosure of pro forma amounts reflecting the difference between the cost charged to operations pursuant to Opinion 25 and compensation cost that would have been charged to operations had SFAS No. 123 been applied.\nIt is the Company's intention to continue accounting for stock-based compensation plans in accordance with APB 25.\nNOTE N: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS\nThe Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement of the Company in this particular class of financial instrument. 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 is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.\n1995 1994 --------- --------- Financial instruments whose contract amounts represent credit risk at December 31: Letters of Credit ................... $733,000 $507,000 Commitments to make or purchase loans or to extend credit on lines of credit .......................... 92,999,000 61,525,000 ----------- ----------- Total ............................ $93,732,000 $62,032,000 =========== ===========\nThe fair value of these financial instruments is not significant.\nCommitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include residential real estate, income-producing commercial properties, and personal property.\nThe Company had unused lines of credit totaling $110,164,000 and $62,031,000 at December 31, 1995 and 1994, respectively.\nThe Company is required to maintain a reserve balance, as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 1995 was $24,981,000 of which $12,254,000 was required to be on deposit with the Federal Reserve Bank of New York. The remainder, $12,727,000, was represented by cash on hand.\nThe Company is currently under examination by the Internal Revenue Service in connection with tax years 1990 to 1993, and has received certain notices of proposed adjustments. The Company intends to vigorously defend its position with respect to these proposed adjustments and believes the ultimate resolution will not have a material affect on the financial statements.\nNOTE O: LEASES\nRental expense included in operating expenses amounted to $630,459, $502,312, and $474,863 in 1995, 1994 and 1993, respectively.\nThe future minimum rental commitments as of December 31, 1995 for all noncancelable operating leases are as follows:\n----------------------------------------------------------------------------- YEARS ENDING DECEMBER 31: BUILDING EQUIPMENT TOTAL ----------------------------------------------------------------------------- 1996 .................... $533,166 $20,124 $553,290 1997 .................... 485,960 20,124 506,084 1998 .................... 437,659 18,447 456,106 1999 .................... 225,613 225,613 2000 .................... 177,673 177,673 Thereafter .............. 1,030,007 1,030,007\nNOTE P: PARENT COMPANY STATEMENTS\nThe following are the condensed balance sheets, statements of income and statements of cash flows for the Parent Company:\n- -------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS - -------------------------------------------------------------------------------- December 31 1995 1994 - --------------------------------------------------------------------------------\nAssets: Cash and cash equivalents ..................... $527,382 $ $723,024 Investment securities (approximate market value of $348,000 and $337,000) ............. 329,715 348,001 Investment in and advances to subsidiaries .... 100,441,826 66,058,804 Other assets .................................. 3,157 375 ------------ ----------- Total assets ................................. $101,302,080 $67,130,204 ================================================================================ Liabilities: Accrued liabilities ........................... $ 1,241,831 $ 840,689 Shareholders' equity .......................... 100,060,249 66,289,515 ------------ ----------- Total liabilities and shareholders' equity .. $101,302,080 $67,130,204 ================================================================================\nCONDENSED STATEMENTS OF INCOME - -------------------------------------------------------------------------------- 1995 1994 1993 - -------------------------------------------------------------------------------- Dividends from subsidiaries ...... $8,743,717 $3,160,414 $3,310,544 Interest on investments and deposits ........................ 6,376 6,465 6,220 ----------- ----------- ---------- Total revenues ................. 8,750,093 3,166,879 3,316,764 ----------- ----------- ---------- Expenses: Interest on short term borrowings .................... 0 2,243 0 Other expenses ................. 1,700 2,374 1,279 ----------- ----------- ---------- Total expenses ................. 1,700 4,617 1,279 ----------- ----------- ---------- Income before tax benefit and equity in undistributed net income of subsidiaries .......... 8,748,393 3,162,262 3,315,485 Income tax benefit (expense) ..... 0 (706) (1,857) ----------- ----------- ---------- Income before equity in undistributed net income of subsidiaries ................. 8,748,393 3,161,556 3,313,628\nEquity in undistributed net income: Subsidiary banks ............... 2,721,511 6,949,905 6,731,475 Bank-related subsidiaries ...... 0 (2,243) (470,329) ----------- ----------- ---------- Net income ..................... $11,469,904 $10,109,218 $9,574,774 ================================================================================\nNOTE P: PARENT COMPANY STATEMENTS (CONTINUED)\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTE P: PARENT COMPANY STATEMENTS (CONTINUED)\nIn conjunction with the 1995 branch acquisition (see Note B), the Company issued 862,500 shares of common stock during the period of June 30, 1995 to July 10, 1995 at $24.25 per share, raising net proceeds of approximately $18.5 million. Concurrent with the common stock offering, the Company also issued 90,000 shares of preferred stock at $100 per share.\nAt the Company's option, 45,000 shares of preferred stock were repurchased at the stated value of $100 per share plus accrued dividends on November 15, 1995. Total dividends paid on preferred stock in 1995 were $253,125.\nCash dividends on the preferred stock are cumulative from the date of issuance and are payable semi-annually in arrears at the rate of 9% per annum. The preferred stock has no preemptive rights and is not convertible. In certain events, holders will have the right to elect two members to the Board of Directors.\nOn or after January 1, 1996, the preferred stock is redeemable ratably at the option of the Company for cash, in whole or in part, at any time and from time to time, at declining redemption prices from $105 at 1996 to $100 after the year 2000, plus accrued and implied dividends without interest.\nIn the event of liquidation of the Company, the holders of the outstanding preferred stock will be entitled to receive $100 per share plus accrued dividends prior to the issuance of assets to common shareholders.\nOn February 21, 1995, the Company adopted a Stockholders Protection Rights Agreement and declared a dividend of one right for each outstanding share of common stock. The rights can only be exercised when an individual or group has acquired or attempts to acquire 15% or more of the Company's common stock, if such action the Board of Directors believes is not in the best interest of stockholders. Each right then entitles the holder to acquire common stock having a market value equivalent to two times the stated exercise price. The rights expire in February 2005 and may be redeemed by the Company in whole at a price of $.01 per right.\nCOOPERS & LYBRAND, L.L.P. CERTIFIED PUBLIC ACCOUNTANTS\nBOARD OF DIRECTORS AND SHAREHOLDERS COMMUNITY BANK SYSTEM, INC.\nWe have audited the accompanying consolidated statements of condition of Community Bank System, Inc. and Subsidiaries as of 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 condition of Community Bank System, 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 further discussed in the notes to the consolidated financial statements, the Company changed its method of accounting for post-retirement benefits other than pensions, income taxes, and investments in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P. - --------------------------------- Coopers & Lybrand L.L.P.\nSyracuse, New York January 26, 1996\nTWO-YEAR SELECTED QUARTERLY DATA\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------- ---------------------------------------------------- None\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- -------------------------------------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement. Information concerning executive officers is included in Part I after Item 4 of this Form 10-K Annual Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ---------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- -------------------------------------------------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ---------------------------------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ---------------------------------------------------------------- (a) Documents Filed\n1. The following consolidated financial statements of Community Bank System, Inc. and subsidiaries are included in Item 8:\n- Consolidated Statements of Condition -- December, 31, 1995 and 1994\n- Consolidated Statements of Income -- Years ended December 31, 1995, 1994, and 1993\n- Consolidated Statements of Changes in Stockholders' Equity -Years ended December 31, 1995, 1994, and 1993\n- Consolidated Statement of Cash Flows -- Years ended December 31, 1995, 1994, and 1993\n- Notes to Consolidated Financial Statements --\nDecember 31, 1995\n- Auditors' report\n- Quarterly selected data -- Years ended December 31, 1995 and 1994 (unaudited)\n2. Schedules are omitted since the required information is either not applicable or shown elsewhere in the financial statements.\n3. Listing of Exhibits (10) (a) Material Contracts: Employment agreement dated January 1, 1995 between the Company and Mr. Belden previously filed with the Commission on June 8, 1995 as exhibit 10 to the Company's quarterly report on Form 10-Q\/A and incorporated herein by reference.\n(11) Statement re: Computation of earnings per share\n(21) Subsidiaries of the registrant - Community Bank, National Association, State of New York - Northeastern Computer Services, Inc., State of New York - Community Financial Services, Inc., State of New York\n(b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of 1995.\n(c) See Exhibit 14(a)(3) above.\n(d) See Exhibit 14(a)(2) above\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nCOMMUNITY BANK SYSTEM, INC.\nBy: \/s\/ SANFORD A. BELDEN --------------------------------------------------- Sanford A. Belden President, Chief Executive Officer and Director March 20, 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 indicated on the 15th day of March 1995.\nNAME TITLE ---- ----- \/s\/ DR. EARL W. MACARTHUR Chairman of the Board of Directors - ------------------------------- and Director Dr. Earl W. MacArthur\n\/s\/ DAVID G. WALLACE Treasurer - ------------------------------- David G. Wallace\nDIRECTORS:\n\/s\/ JOHN M. BURGESS \/s\/ RICHARD C. CUMMINGS - ------------------------------- ------------------------------------ John M. Burgess, Director Richard C. Cummings, Director\n\/s\/ WILLIAM M. DEMPSEY \/s\/ NICHOLAS A. DICERBO - ------------------------------- ------------------------------------ William M. Dempsey, Director Nicholas A. DiCerbo, Director\n\/s\/ BENJAMIN FRANKLIN \/s\/ JAMES A. GABRIEL - ------------------------------- ------------------------------------ Benjamin Franklin, Director James A. Gabriel, Director\n\/s\/ LEE T. HIRSCHEY \/s\/ DAVID C. PATTERSON - ------------------------------- ------------------------------------ Lee T. Hirschey, Director David C. Patterson, Director\n\/s\/ WILLIAM N. SLOAN \/s\/ WILLIAM D. STALDER - ------------------------------- ------------------------------------ William N. Sloan, Director William D. Stalder, Director\n\/s\/ HUGH G. ZIMMER - ------------------------------- Hugh G. Zimmer, Director","section_15":""}
{"filename":"311048_1995.txt","cik":"311048","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nPage America Group, Inc. (the \"Company\" or \"Page America\") provides paging, messaging and information products and services through networks which it owns and operates as a radio common carrier (\"RCC\") under licenses from the Federal Communications Commission (\"FCC\"). As of December 31, 1995, the Company provided paging services through 11 offices in 14 states to approximately 221,000 pagers in geographic areas encompassing a total population of 34 million people.\nThe Company's strategy is to concentrate its operations in major metropolitan markets in which it can achieve both critical mass and a substantial market share position. The Company targets specific user segments and, through its broad distribution capabilities, markets and delivers its comprehensive package of paging and value-added messaging services to each particular segment. The Company has secured licenses for multiple channels in each of its markets and has developed, and continues to develop, networks which can support significant future growth in paging units as well as value-added messaging and information services. The Company emphasizes customer ownership of pagers, as compared to leasing of pagers, which significantly reduces the Company's capital costs. At March 1, 1996, approximately 74 percent of the Company's units in service were customer owned.\nThe accompanying financial statements have been prepared on a going concern basis. The Company, since its inception, has experienced a deficiency in working capital and recurring losses. In 1995, as a result of non-compliance by the Company with certain covenants of its credit facility, the terms were modified to accelerate the final maturity to December 29, 1995, and the subordinated notes were modified to provide for a final maturity of six months thereafter. The credit facility was not repaid at maturity causing the credit facility and the subordinated notes to be in default (see Note E of Notes to Consolidated Financial Statements). Such debt is classified as a current liability and the Company's current liabilities exceeded its current assets by $52.4 million at December 31, 1995. The Company intends to pay the balance due under the credit facility and the subordinated notes in 1996 from cash generated by the sale of its assets. Alternatively, the Company intends to complete a refinancing which repays the balance due under the credit facility and amends and extends the subordinated notes. The successful completion of one of these efforts is essential as the Company has no other immediate plans that will provide sufficient cash flows to satisfy its obligations. There can be no assurance that the Company will have sufficient funds to finance its operations, which continue to show losses, through the year ending December 31, 1996.\nAll of these matters raise substantial doubt about the Company'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 and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.\nSince October 1995, Daniels & Associates L.P. has been retained by the Company as its non-exclusive financial advisor to render financial advisory services to the Company in connection with the possible sale of one or more of the Company's paging operations.\nPage America was incorporated in 1976 under the laws of the State of New York. The Company's principal executive offices are located at 125 State Street, Hackensack, New Jersey 07601, and its telephone number is (201) 342-6676. Unless the context indicates otherwise, the terms \"Company\" and \"Page America\" as used herein refer to Page America Group, Inc. and its subsidiaries.\nSale of California and Florida Operations\nOn July 28, 1995, the Company sold to Paging Network of Florida, Inc. its California and Florida paging assets for a cash purchase price of $19.4 million. Approximately $1.0 million of the purchse price is held in escrow. Management expects that the escrow will be released to the Company in accordance with the time frame set forth in the agreement. The assets sold had a net book value of approximately $19.1 million and consisted of the assets which the Company acquired from Crico Communications Corporation (\"Crico\") on December 30, 1993 and the 900 Mhz channel which is licensed to provide state-wide coverage in California which the Company acquired in 1994 for a purchase price of $500,000. The purchase price paid by the Company for the Crico assets consisted of $12,650,000 in cash paid to Crico's lenders, the issuance of an aggregate of 1,435,903 shares of Common Stock to Crico's lenders and the issuance of 240,000 shares of Common Stock and warrants to purchase 130,000 shares of Common Stock at an exercise price of $5.00 per share to a company related to certain shareholders of Crico. After expenses, the sale resulted in a loss of approximately $718,000.\nRestructuring of Debt\nOn July 28, 1995, concurrent with the sale of the Company's Florida and California paging assets, the Company's senior secured credit facility with certain banks (\"Credit Facility\") was amended. Among other things, the amendment provided for an acceleration of the final maturity to December 29, 1995 and modified the financial covenants so that the Company would not be in default as of the amendment date. The Company used a portion of the net proceeds from the sale of its Florida and California operations to reduce the debt by $11.8 million and prepay interest at the LIBOR rate from August 1, 1995 through December 29, 1995. In its third fiscal quarter the Company recorded a charge of approximately $1.8 million related to the amended agreement which included the write-down of deferred financing costs of approximately $1.1 million. The Credit Facility was not repaid and the lenders have declared the Company in default. The Credit Facility is secured by substantially all the assets of the Company.\nOn July 28, 1995, the Company's 12 percent subordinated notes due 2003 were modified to provide for a final maturity of six months subsequent to the final maturity of the Credit Facility and to defer the cash payment of interest until maturity. As a result of the default under the Credit Facility, the Company is in default of the subordinated notes. Commencing January 1, 1995, interest is increased from 12 to 15 percent per annum, compounded semi-annually, and is satisfied by the issuance of additional promissory notes with terms substantially identical to the subordinated notes, as amended. In 1995 the Company recorded a charge of approximately $500,000 related to the modified agreement, which includes the write-down of deferred financing costs of approximately $479,000. If a change in control of the Company occurs, the note holders will have the right to require the Company to repurchase the notes at par plus accrued interest.\nBackground of the Paging Industry\nRadio paging began more than four decades ago as an adjunct to telephone answering services, delivering tone-only messages to subscribers. Beginning in the 1970's, cost-effective technological innovations and regulatory reforms helped to accelerate the use of paging services. Advances in microprocessor technology facilitated dramatic reductions in the size and weight of pagers. In 1982, the FCC increased the number of available channels for paging, further stimulating growth of the industry.\nDuring the 1980's, the paging industry expanded significantly. Factors contributing to the growth in the paging industry include: (i) a continuing shift towards a service-based economy and a resultant need to keep in contact; (ii) increasing mobility among workers; (iii) increasing awareness of the benefits of mobile communications; (iv) a reduction in the price of pagers; (v) product distribution at the retail level; and (vi) increasing availability of information service-based offerings.\nIn addition, the benefits of mobile and wireless communications have gained widespread acceptance as a result of the growth in cellular communications. The Company believes that paging will continue to grow with the wireless communications industry generally, because it believes paging is the most cost-effective form of mobile communication. Since paging is a form of one-way communication, it is less expensive than communicating by cellular telephones. Pagers and air time required to transmit an average message cost less than equipment and air time for cellular telephones. In fact, some users of cellular telephones use a pager in conjunction with their telephones to screen incoming calls and to minimize usage-based charges.\nThe availability of value-added paging products and services is creating demand within certain market segments which previously had not been attracted by the benefits of basic paging services alone. Demand for paging services is anticipated to increase further as a result of technological advances which permit messaging to be integrated into business tools (such as lap top and palm top computers) and into consumer products (such as wristwatches).\nBusiness Strategy\nThe Company's objective is to maximize revenues by focusing on a business strategy which emphasizes the following elements: (i) major metropolitan market focus; (ii) broad product distribution capabilities; (iii) network infrastructure and channel capacity; (iv) comprehensive service options; (v) targeted market segments; (vi) value-added services; and (vii) customer ownership of pagers.\nMajor Metropolitan Market Focus. The Company presently operates in the New York and Chicago metropolitan area markets serving an aggregate population of 34 million. Based upon its knowledge and experience in these markets, the Company believes that in each of its markets, the four largest competitors serve approximately 80 percent of pager users. Significant barriers to entry exist in the New York and Chicago metropolitan area markets, since there are no more FCC paging channels currently available for license and substantial capital would be required to construct and operate efficient and competitive paging systems.\nBroad Product Distribution Capabilities. The Company has developed and is continuing to expand multiple distribution channels which reach targeted market segments. Products are distributed through a number of different outlets, including 11 sales offices, four company-owned retail stores, a direct sales force and resellers.\nNetwork Infrastructure and Channel Capacity. The Company believes that controlling licenses to a large number of FCC-allocated paging channels is important to adequately service both current and future demand for paging and messaging services. The New York network utilizes 220 transmitters over 14 available paging channels to provide service to 140,000 pagers throughout most of Connecticut, New York State south of Albany (including Long Island), New Jersey and Eastern Pennsylvania. The Chicago network consists of 80 transmitters over 11 available paging channels. This network provides service to 81,000 pagers from the Wisconsin border, throughout Illinois, Northern Indiana and into Western Michigan. The Company has substantial capacity to expand in its New York and Chicago metropolitan area markets utilizing its existing network without the need for more licenses or significant additional capital expenditures for transmission and telephony infrastructure.\nComprehensive Service Options. Since the Company has multiple channels, it is able to offer customers the widest possible choice in services (tone, tone\/voice, numeric, alphanumeric), geographic coverage and pricing options. Customers select from a wide variety of pagers, which come with both silent and audible alerts. Convenience, as evidenced by the location of the sales offices, and flexible policies regarding service plan options are significant components of why customers select Page America.\nTargeted Market Segments. The Company has designed its product and service offerings to attract defined user groups. The Company's marketing efforts are focused on four principal market segments: mobile workers; medical and other on-call professionals; business professionals seeking a competitive advantage and the home market.\nValue-Added Services. The Company provides subscribers with value-added services, such as voice mail messaging and operator-assisted alphanumeric messaging, as well as equipment related services, including loss and damage protection and paging maintenance programs. Such offerings include: PageTalkSM, a voice mail system; PageGramSM, which involves delivery of messages from a personal computer; Group Calling, which allows notification of several pager users simultaneously with a common telephone number; and Nationwide Paging which enables a subscriber to be paged in over 200 cities across the United States. Provision of value-added services enables the Company to maximize revenues.\nCustomer Ownership of Pagers. The Company emphasizes customer ownership of pagers, as compared to leasing, since customer ownership significantly reduces the Company's capital costs and reduces potential exposure to changes in technology. Approximately 74 percent of the Company's units in service are customer owned (including resellers).\nPaging Services\nPaging operations consist of a process of signaling, through the use of a radio transmission network, a portable pocket size, battery-operated radio receiver carried by a subscriber, commonly called a \"pager\" or a \"beeper\". Each paging subscriber is assigned a distinct telephone number. When a telephone call for a subscriber is received at one of the Company's computerized paging terminals, the Company transmits a radio signal to the subscriber's pager, which causes the pager to emit a beep, vibrate or generate another signal and, in certain cases, provides the subscriber with additional information from the caller.\nThe Company currently provides the following four types of pagers:\nType of Pager Functions\nTone Only Alerts the user with a signal, so the user will know to call a pre-determined telephone number (such as the office).\nTone and Voice Alerts the user with a signal, followed by a brief voice message.\nNumeric (Digital) Display Visually displays numbers (such as a telephone number or a coded message) on a screen to communicate with the user.\nAlphanumeric Display Visually displays up to one-third of a page of text and\/or numbers on a screen so the user receives actual messages, instead of just a telephone number or coded message.\nThe table below sets forth the number of various types of pagers in service with subscribers of the Company at the dates indicated:\nTypes of Pagers in Service with Subscribers of the Company\nThe Company sells and leases a variety of paging models, including credit card-sized pagers, pen-like pagers, wristwatch pagers and conventional pagers, with a range of available options, such as silent vibrating alert and extended message memory. The Company provides its subscribers with local, wide-area and national coverage. While the Company continues to purchase most of its pagers from NEC America, Inc., it intends to purchase pagers from a number of sources.\nThe Company's value-added services include PageTalkSM, which combines the features of an answering machine and paging, enabling a caller to leave a voice message in the private mailbox of an end user on the Company's voice mail system, which in turn pages the end user to call the mailbox and retrieve the message; PageGramSM, which permits people originating messages to the end user to use either an operator or a personal computer to send a message to an end user who carries an alphanumeric pager; Group Calling, which allows the notification of several pager users simultaneously with a common telephone number; and Nationwide Paging, which allows a pager user to be paged in over 200 cities across the United States on a common frequency.\nThe Company provides paging services to pagers that are either (i) owned by the Company and leased to its subscribers, (ii) owned by its subscribers or (iii) owned by third party resellers which buy pagers from the Company, lease or sell such pagers to their own subscribers and resell the Company's paging services as resellers under agreements with the Company. Subscribers who own their own pagers pay a monthly paging service fee to the Company. Subscribers who lease pagers pay a monthly rental fee which is combined with a monthly paging service fee. Service fees, leasing rates and purchase prices for pagers vary widely by region served, service type and number of pagers purchased or leased by the subscriber.\nThe following table sets forth the respective numbers and percentages of pagers that are (i) serviced directly by the Company and owned by the Company, (ii) serviced directly by the Company and owned by subscribers and (iii) serviced by the Company through third party resellers, which may be owned by the third party resellers or by their subscribers.\nOwnership of Pagers in Service with Subscribers of the Company\nTechnical Facilities\nThe Company owns and operates RCC network facilities in each of its two markets. Page America presently provides service over six primary channels in New York and three primary channels in Chicago enabling the Company to provide a wide range of coverage, pricing and product offerings. One channel in New York, for example, is devoted exclusively to alphanumeric service. The Company's operations are highly automated and centralized, with all sales offices linked to a centralized billing, inventory and customer service computer system, and allowing direct interfacing from its resellers.\nThe Company completed construction of its own RCC system in New York in 1985. On July 13, 1990, the Company acquired the New York metropolitan area paging assets and business of NYNEX Mobile Communications Company and its affiliates (\"NYNEX\"). This acquisition increased the Company's number of units in service by approximately 74,000 pagers. The New York technical facilities currently consist of seven paging terminals. The New York network utilizes 220 transmitters over 14 available channels to provide service to 140,000 pagers throughout most of Connecticut, New York State south of Albany (including Long Island), New Jersey and Eastern Pennsylvania.\nThe Chicago RCC facilities, which were acquired by the Company in 1984, serve approximately 81,000 pagers in the Illinois and Northwestern Indiana areas. The Chicago technical facilities consist of three paging terminals, and the Chicago network consists of 80 transmitters over 11 available channels. This network provides service from the Wisconsin border, throughout Illinois, Northwestern Indiana and into Western Michigan.\nMarketing\nThe Company's customers include individuals, corporations and other organizations whose business or personal needs involve field operations or require substantial mobility, accessibility and the need to receive timely information. Potential users of pagers include people in every industry. The Company services four principal market segments: mobile workers; medical and other on-call professionals; business professionals seeking a competitive advantage and the home market.\nIn order to reach these markets, the Company has developed four channels of distribution: a direct sales force, resellers, independent retail dealers and retail stores. Each of the Company's distribution channels focuses on those market segments which it addresses most cost effectively. At December 31, 1995, the Company employed 86 persons in direct sales and marketing support positions.\nThe following table sets forth the respective revenues and percentages of revenues that are attributed to (i) the Company's direct sales force, including retail dealers, (ii) third party resellers and (iii) retail stores.\nChannels of Distribution\nThe Company's own direct sales force operates out of 11 sales offices. The direct sales effort is supported through a multimedia marketing campaign with advertising, promotion and subscriber enhancement campaigns. The Company also advertises in print media, including periodicals and yellow pages.\nThe Company also has a sales force which sells products and services in bulk to resellers and retail dealers. Resellers purchase service at wholesale rates from the Company, and in turn, provide service to their own customers. Resellers contribute to the Company's profits without the Company having to incur any significant selling or administrative overhead. Independent retail dealers, consisting of electronics and video stores, also market the Company's products.\nThe Company, in order to market its products directly to the consumers and reduce its cost of sales has opened three Company-owned stores in New York and one in Illinois. These stores sell cellular as well as paging products and maintain a high end, high tech appearance attracting consumers at all levels.\nThe Company's marketing strategies have been focused on small to medium-sized customer accounts, with the result that the Company is not dependent on any single customer or reseller. No single customer or reseller accounted for more than one percent of the Company's total revenues in the fiscal year ended December 31, 1995.\nRegulation\nThe construction and operation of RCCs are subject to both federal and state regulation, principally by the FCC under the Communications Act of 1934, as amended (the \"Communications Act\"). The Company believes it is in compliance with all applicable federal and state regulations.\nThe FCC's review and revision of rules affecting paging companies is ongoing and the regulatory requirements to which the Company is subject may be modified significantly. The FCC recently has proposed adopting a market area licensing scheme for all paging channels under which carriers would be licensed to operate on a particular channel throughout a broad geographic area, rather than being licensed on a site-by-site basis. Under the proposal, existing paging facilities would be entitled to protection as grandfathered systems. The ability of paging carriers to make major modifications to their current systems may be affected during the transition to the market area licensing process. On February 8, 1996, the FCC announced a temporary cessation in the acceptance of applications for new paging stations, and placed certain restrictions on the extent to which current licensees can expand into new territories on existing channels. The FCC has initiated an expedited comment period in which it will consider whether these interim processing procedures should be relaxed. The FCC also has proceedings underway that may have a significant impact on the manner in which telephone numbers are assigned and utilized by common carriers, including paging companies. Some of the alternatives under consideration by the FCC, if adopted, could adversely affect the Company.\nRCC operations may be conducted only on channels assigned by the FCC. The FCC grants a license for the use of such channels only upon compliance with FCC regulations. Upon receiving a grant, a licensee is authorized to construct and operate an RCC facility in the assigned area using the designated channel. In the Company's markets all available channels have been allocated.\nThe FCC licenses granted to the Company are for terms of 10 years, at the end of which time renewal applications must be approved by the FCC. The Company's current licenses all expire in 1999. In the past, FCC renewal applications routinely have been granted upon a demonstration of compliance with FCC regulations and adequate service to the public. The FCC has granted each renewal license the Company has filed. Although the Company is unaware of any circumstances which would prevent the grant of any renewal applications, no assurance can be given that any of the Company's licenses will be renewed by the FCC. In addition, the FCC has the authority to revoke or modify licenses. No licenses owned by the Company have ever been revoked.\nThe Communications Act requires licensees such as the Company to obtain prior approval from the FCC for the transfer of control of any construction permit or station license, or any rights thereunder. The Communications Act also requires prior approval by the FCC of acquisitions by the Company of other paging companies and transfers by the Company of a controlling interest in any of its licenses or construction permits. The FCC has approved each acquisition and transfer of control for which the Company has sought approval.\nThe Communications Act also limits foreign ownership of entities that hold licenses from the FCC. All the Company's FCC licenses are owned by wholly-owned subsidiaries of the Company. As a result, no more than 25 percent of the Company's stock may be owned or voted by aliens or their representatives, a foreign government or its representatives, or a foreign entity.\nIn addition to regulation by the FCC, certain states impose various regulations on certain paging operations of the Company. Such regulations may require the Company to obtain certificates of public convenience and necessity before constructing paging facilities or offering paging services and before modifying, expanding or abandoning such services. The Company may also be subject to regulations requiring the submission, for prior approval, of the rates, terms and conditions under which it plans to provide service, or any changes to those rates. Contracts for service and financial information regarding the Company may also be required to be filed. Those states which regulate paging services may also require the Company to obtain prior approval for the sale or acquisition of controlling interests in any other paging company certificates, licenses, construction permits or assets. The Company believes that to date all such required certificates and state approvals have been granted. Although no assurances can be given with respect to future approvals, the Company knows of no reason to believe such approvals will not be granted to the Company in connection with anticipated future requests.\nFrom time to time, legislation which could potentially affect the Company, either beneficially or adversely, is proposed by federal and state legislators. In 1993, federal legislation was enacted which permits auction of new radio spectrum allocated by the FCC to new or existing services which may have the effect of increasing competition for scarce spectrum and affecting costs of operation in markets in which the Company operates.\nCompetition\nThe Company experiences competition, from independent companies as well as Regional Bell Operating Companies, in its efforts to attract and retain customers for its services in the markets in which it operates. Competition for subscribers to the Company's paging services is based primarily on the quality, price and breadth of services offered (including geographic coverage in each market served). Since the transmitting and receiving equipment is virtually identical, companies differentiate themselves by marketing, channels of distribution, price competition, the variety of service options and breadth of service coverage (more transmitters covering a larger territory). The Company believes that based on the quality, price and breadth of services offered, it generally competes effectively with its competitors.\nMany RCCs in the United States are small companies serving limited market areas; however, some of the Company's competitors, including Regional Bell Operating Companies, are larger, have greater financial resources and are more established than the Company.\nIn addition, future technological advances in the telecommunications industry could create new services or products competitive with the paging services currently provided by the Company. There can be no assurance that the Company would not be adversely affected in the event of such technological change.\nEmployees\nAt February 29, 1996, Page America employed 162 persons, none of whom was represented by a labor union. Page America believes that its relations with its employees are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases approximately 15,200 square feet of office space at 125 State Street, Hackensack, New Jersey, under a lease expiring in 2000, at an annual base rent of $281,000, approximately 10,715 square feet of office space at 1919 South Highland Avenue, Lombard, Illinois, under a lease expiring in 2005, at an annual base rent of $151,000 and approximately 500 square feet of retail space at 41 East 42nd Street, New York, New York, under a lease expiring in 2004, at an annual base rent of $84,000. The Company has several other leases for office and retail space which are not material individually and which aggregate $472,000 per year expiring at various dates between 1996 and 2005. The Company does not own any material real property. The Company also leases sites for its transmitters on commercial broadcast towers, buildings and other fixed sites at various rentals for various terms. The Company believes its facilities are suitable and adequate for its purposes.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is involved in various lawsuits and proceedings arising in the normal course of business. In the opinion of management of the Company, the ultimate outcome of these lawsuits and proceedings will not have a material effect on the results of operations, financial position or cash flows of the Company.\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\nPrice Range of Common Stock\nThe Common Stock of the Company is listed on the American Stock Exchange (\"AMEX\") under the symbol PGG. The Company does not meet certain financial and other guidelines of the AMEX for continued listing of its Common Stock on the AMEX. As a result, the staff of the AMEX has determined to remove the Company's Common Stock from trading on the AMEX; however, the Company has appealed this determination. The appeal is presently pending and the Company believes that its Common Stock will continue to be traded on the AMEX pending the determination of its appeal. The following table sets forth for the calendar periods indicated the closing sales prices on the AMEX. High Low First Quarter $5.13 $4.13 Second Quarter 4.25 3.50 Third Quarter 5.13 3.00 Fourth Quarter 4.38 2.88\nFirst Quarter $3.75 $2.50 Second Quarter 3.38 0.50 Third Quarter 1.00 0.56 Fourth Quarter 0.75 0.13\nThere were approximately 2,043 shareholders of record of Common Stock as of February 29, 1996. This number does not include beneficial owners holding shares through nominee or \"street\" names.\nDividend Policy\nThe Company has never declared or paid cash dividends on its Common Stock and does not anticipate paying cash dividends to the holders of its Common Stock in the foreseeable future. The payment of dividends on Common Stock and Preferred Stock is also restricted pursuant to the provisions of the Company's Credit Agreement (the \"Credit Agreement\"). The Company's outstanding series of Series One Convertible Preferred Stock provides that the Company may not declare or pay dividends on its Common Stock unless all accrued dividends on the Series One Convertible Preferred Stock have been paid in full. Payment of dividends on the Series One Convertible Preferred Stock may be made in cash or in Common Stock of the Company registered under the Securities Act of 1933. At December 31, 1995, accrued and unpaid dividends on the Company's outstanding Series One Convertible Preferred Stock aggregated $1,432,000. It is anticipated that such dividends will be paid by the issuance of approximately 7,900,000 shares of the Company's Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected consolidated financial data for the nine-month period ended December 31, 1991 and each of the four years in the period ended December 31, 1995 are derived from the Consolidated Financial Statements of the Company. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto contained elsewhere in this report.\n(1) EBITDA for the nine-month period ended December 31, 1991 and for the years ended December 31, 1992, 1993, 1994 and 1995 was $8.0 million, $10.6 million, $9.1 million, $9.4 million, and $5.5 million respectively. EBITDA is a standard measure of financial performance in the paging industry but should not be construed as an alternative to operating income or cash flows from operating activities as determined in accordance with generally accepted accounting principles. EBITDA is also the operating measure by which the Company's financial covenants are calculated under its Credit Agreement. (2) In July 1995, the Company sold its California and Florida paging assets. Concurrently with the sale, the Company amended its Credit Facility providing, among other things, for an accelerated maturity date of December 29, 1995 and its subordinated notes were modified to provide for a final maturity of six months thereafter. Such debt, which was classified as long term at December 31, 1994, is in default and is classified as a current liability at December 31, 1995. (3) In August, 1994 and March, 1995, the Company issued shares of its Common Stock as full payment of fiscal year 1994 dividends on Series One Convertible Preferred Stock. On June 30, 1995, in exchange for the waiver of the dividend payment on Series One Convertible Preferred Stock, the accrued dividends were added to the liquidation value. See Note G of Notes to Consolidated Financial Statements. (4) On December 30, 1993, the Company acquired Crico and refinanced its senior and subordinated debt and redeemable Preferred Stocks. See Notes C and E of Notes to Consolidated Financial Statements. (5) In June of 1992, the Company repurchased its subordinated note payable. (6) The Company has never paid any cash dividends on its Common Stock.\n(7) Effective January 1, 1992, the Company changed its method of depreciation for pager equipment from the straight line method to the double declining balance method.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nThe following table presents certain items in the Consolidated Statement of Operations and as a percentage of total revenues for the periods indicated.\nYear Ended December 31, 1995 Compared with Year Ended December 31, 1994\nTotal revenues for fiscal 1995 were approximately $8.2 million (21.9 percent) lower than that of 1994. The sale of the operations in Florida and California accounted for a decrease of approximately $4.5 million while the Company's other operations experienced a $3.7 million decrease in total revenues as compared to 1994. Average revenue per subscriber declined as the result of the emphasis on the sale of pagers (for which the Company does not receive recurring equipment rental revenue) and rates obtained from new subscribers were lower than the rates associated with lost subscribers due to competitive pressure. Subscriber growth in 1994 and 1995 was limited as pager purchases were constrained by limited available capital. The Company's units in service at December 31, 1995 showed a decrease of 90,000 units from the 311,000 units in service at December 31, 1994. A substantial portion of this decrease (78,000 units) is attributable to the sale of the Florida and California operations.\nCost of service decreased $303,000 (10.3 percent) in 1995. This decrease was principally due to cost of service associated with the sold operations. Cost of sales decreased by approximately $1 million (37.7 percent) in 1995. As a percent of sales revenues, cost of sales increased from 61% of sales revenues in 1994 to 64% in 1995, primarily as a result of lower selling prices due to competitive pressure.\nSelling expense decreased by approximately $776,000 (11.3 percent) in 1995 as compared to 1994. $661,000 of the decrease was due to selling expenses associated with the sold operations.\nGeneral and administrative expenses decreased by $1.7 million (16.2 percent). A decrease of $1 million was due to expenses associated with the sold operations. The Company's remaining operations experienced a decrease of $700,000 primarily due to a reduction in bad debt expense and, to a lesser extent, reductions in personnel.\nTechnical expenses decreased by $423,000 (9.0 percent), principally as a result of the sale of the Florida and California operations, partially offset by an increase in personnel costs.\nDepreciation expense decreased by $1.1 million (17.8 percent), $462,000 of which was due to the sale of depreciable assets in Florida and California. The decrease experienced by the Company's existing operations resulted from the lower average price of pagers purchased in 1995 and the decrease in pagers on lease to customers, partially offset by a $465,000 valuation adjustment of pager assets in the fourth quarter of 1995.\nAmortization expense decreased by approximately $1.1 million (24.7 percent) in 1995 over 1994, principally due to the elimination of intangible assets related to the Florida and California operations and certain customer lists becoming fully amortized in the second quarter of 1994 and first quarter of 1995, partially offset by a write off of certain intangibles related to the Nynex acquisition.\nInterest expense increased by approximately $1.2 million (22.8 percent) in 1995 primarily due to higher interest rates, in the current period, on borrowings outstanding under the Company's senior credit facility and subordinated debt agreement.\nOther expenses increased approximately $3.3 million (682 percent) in 1995. The increase was primarily due to a write-down of deferred financing costs related to the senior debt and subordinated debt amounting to $1.6 million, loss realized on the sale of the Florida and California operations of approximately $718,000 and costs associated with the debt restructuring in the amount of $726,000.\nNet loss was $13.1 million (45.0 percent of total revenues) in the year ended December 31, 1995, as compared to $7.0 million (18.9 percent of total revenues) in the year ended December 31, 1994.\nEBITDA (earnings before interest, taxes, depreciation and amortization) in 1995 was $5.5 million as compared to $9.4 million in 1994.\nYear Ended December 31, 1994 Compared with Year Ended December 31, 1993\nTotal revenues for fiscal 1994 were approximately $7 million (23.1 percent) higher than that of 1993. The operations acquired in the Crico transaction accounted for increases of approximately $8.8 million while the Company's other operations experienced a $1.8 million decrease in total revenues as compared to 1993. Subscriber growth, primarily in the Company's New York operation, was not sufficient to offset the overall lower average revenue per subscriber. Average revenue per subscriber declined as the result of the emphasis on the sale of pagers (for which the Company does not receive recurring equipment rental revenue) and rates obtained from new subscribers were lower than the rates associated with lost subscribers due to lower monthly rates caused by competitive pressure. Subscriber growth in 1993 and 1994 was limited as pager purchases were limited, by management, to an amount necessary to maintain the subscriber base in order to conserve capital. The Company had 311,000 units in service at December 31, 1994, an increase of 6,000 units over the 305,000 units in service at December 31, 1993.\nCost of service increased $1.1 million (60 percent) in 1994. This increase was principally due to cost of service associated with the operations acquired from Crico. Cost of sales increased by approximately $353,800 (15 percent) in 1994. As a percent of sales revenues, cost of sales decreased from 66% of sales revenues in 1993 to 61% in 1994. This decrease in cost of sales as a percent of sales revenues is principally a result of lower current costs of pagers.\nSelling expense increased by approximately $1.9 million (40 percent) in 1994 as compared to 1993. The increase was due to selling expenses associated with the acquired operations.\nGeneral and administrative expenses increased by $1.9 million (23.0 percent). This increase was due to expenses associated with the acquired operations, partially offset as the Company's existing operations experienced a decrease of $449,600 primarily due to a reduction in salaries and related benefits.\nTechnical expenses increased by $1.3 million (40.1 percent) as a result of the operations acquired from Crico.\nDepreciation expense decreased by approximately $497,800 (7.3 percent). This resulted from the decrease in the renting of pagers to customers, in favor of the sale of pagers, the ensuing decrease in pager assets, and from the Company's $934,000 valuation adjustment of pager assets in the fourth quarter of 1993 which left a lower depreciable pager asset base. These offset the depreciation associated with the fixed assets acquired from Crico.\nAmortization expense increased by approximately $1.5 million (52.0 percent) in 1994 over 1993, due to intangibles acquired in the Crico transaction.\nInterest expense increased by approximately $1.1 million (26.6 percent) in 1994 as a result of higher interest bearing debt resulting from the December 30, 1993 acquisition financing and refinancing and higher interest rates in 1994.\nOther expenses decreased approximately $1.3 million (73.6 percent) in 1994. In 1993 approximately $677,400 was written off in deferred financing cost resulting from the debt refinancing. Fiscal year 1994 includes a second quarter gain of approximately $178,400 recognized on the sale of shares of stock in a cellular interest, owned by a subsidiary of the Company, and a gain of $175,000 recognized in the third quarter on the sale of a paging license in the State of Wisconsin.\nNet loss was $7.0 million (18.9 percent of total revenues) in the year ended December 31, 1994, as compared to $6.5 million (21.6 percent of total revenues) in the year ended December 31, 1993.\nEBITDA in 1994 was $9.4 million as compared to $9.1 million in 1993.\nLiquidity and Capital Resources\nThe Company had a working capital deficiency of approximately $52.4 million at December 31, 1995 as compared to a deficiency of $9.5 million at December 31, 1994. The increase in working capital deficiency was primarily due to an increase in current debt maturities of $47.6 million, which include $33.2 million and $14.7 million related to the senior credit facility and subordinated debt, respectively.\nTo reduce indebtedness and improve liquidity, the Company sold its California and Florida paging assets for a cash sale price of $19.4 million. One million dollars of the sale price is being held in escrow and is scheduled to be released to the Company over a two year period, as provided for in the agreement. In connection with this sale, the Company incurred expenses amounting to approximately $1.0 million. The Company used a portion of the net proceeds from this sale to reduce the balance due on its Credit Facility by $11.8 million and prepay interest at the LIBOR rate from August 1, 1995 through December 29, 1995.\nThe accompanying financial statements have been prepared on a going concern basis. The Company, since its inception, has experienced a deficiency in working capital and recurring losses. In 1995, as a result of non-compliance by the Company with certain covenants of its credit facility, the terms were modified to accelerate the final maturity to December 29, 1995, and the subordinated notes were modified to provide for a final maturity of six months thereafter. The credit facility was not repaid at maturity causing the credit facility and the subordinated notes to be in default (see Note E of Notes to Consolidated Financial Statements). Such debt is classified as a current liability and the Company's current liabilities exceeded its current assets by $52.4 million at December 31, 1995. The Company intends to pay the balance due under the credit facility and the subordinated notes in 1996 from cash generated by the sale of its assets. Alternatively, the Company intends to complete a refinancing which repays the balance due under the credit facility and amends and extends the subordinated notes. The successful completion of one of these efforts is essential as the Company has no other immediate plans that will provide sufficient cash flows to satisfy its obligations. There can be no assurance that the Company will have sufficient funds to finance its operations, which continue to show losses, through the year ending December 31, 1996.\nAll of these matters raise substantial doubt about the Company'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 and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.\nSustaining market share requires substantial capital expenditures, primarily for paging equipment. Management estimates that capital expenditures in 1996 will be approximately $4.8 million ($4.1 million for pagers and $700,000 for RCC equipment). The Company does not have any material capital expenditure commitments.\nAt December 31, 1995 the Company had net operating losses of approximately $71.5 million for federal income tax purposes which will expire at varying dates between 1998 and 2010. Certain stockholder transactions have resulted in an ownership change, as defined, which, under the Internal Revenue Code, limits the utilization of the net operating loss carryforwards.\nThe Company maintains a policy for delinquent customers of billing and attempting to collect the balance of the unexpired term of their contracts and the value of unreturned leased pagers. In 1995, the Company wrote off approximately $900,000 of accounts receivable against the allowance for doubtful accounts.\nInflation and Changing Prices\nInflation has not materially affected the sale of paging services by the Company. Paging systems equipment, leasing costs and transmission costs have not risen significantly, nor has the Company substantially increased its charges to customers. Pager costs have actually declined in recent years. This reduction in cost has generally been reflected in lower prices charged to subscribers. Overhead expenses are, however, subject to inflationary pressure.\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).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on 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 are as follows:\n(1) Member of the Audit Committee (2) Member of the Compensation Committee\nThe Directors are presently elected for one year terms which expire at the next annual meeting of shareholders. Executive officers are elected annually by the Board of Directors to hold office until the first meeting of the Board following the next annual meeting of shareholders and until their successors are chosen and qualified.\nMs. Parramore has been President and Chief Operating Officer of the Company since March 1995 and was Vice President from December 1990 until 1995. She has been employed by the Company since April 1990. From 1989 to 1990, she was general manager of Nationwide Cellular; from 1987 to 1989, she was Chief Financial Officer of American Mobile Communications; and from 1984 to 1987, she was Chief Financial Officer of AT&T Intelliserve.\nMr. Contrera has been Vice President--RCC Engineering of the Company since July 1985 and has been employed by the Company since November 1983. In 1983, Mr. Contrera was a Project Manager for 3M Corporation and from 1973 through 1982 held various positions with U.A. Columbia Cablevision, Inc., including Director of Operations.\nMr. Katz has been Vice President-Administration and Chief Financial Officer since April 1995. From 1987 through 1994, Mr. Katz was Chief Financial Officer and Vice President of Finance and Business Affairs at CEL Communications, Inc.\nMr. Neidell has been Secretary of the Company since 1983. For more than the past five years, Mr. Neidell has been a partner of Stroock & Stroock & Lavan, counsel to the Company.\nMr. Barry has been President of Bariston Associates, Inc. since April 1986. He has been acting as Chairman of the Board and Chief Executive Officer of the Company since August 1, 1995. Mr. Barry was Managing Director and Principal of Winthrop Financial Associates from September 1982 to April 1986. Prior thereto Mr. Barry was a Managing Director of Paine Webber Incorporated.\nThe Company's non-employee Directors are entitled to annual fees of $1,500 and $250 for each meeting attended, plus reimbursement for expenses in attending meetings.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth information concerning compensation paid to the Company's Chief Executive Officer and to each of the other most highly compensated executive officers of the Company whose salary and bonus for 1995 exceeded $100,000.\n(1) Consists of Company matching contributions under the Company's Stock Purchase Plan and $650 in premiums on an insurance policy on the life of Ms. Parramore under which she designates the beneficiaries.\nAgreements\nMs. Parramore is employed under an employment agreement with the Company which expires on February 28, 1997, and provides for an annual salary at the rate of $165,000 per year, plus a discretionary bonus. This agreement is automatically extended for successive one year periods unless terminated by the Company or Ms. Parramore at least three months prior to any expiration date. The Company may terminate the agreement at any time, with or without cause; provided, however, that if such termination is without cause, Ms. Parramore will be entitled to continue to receive her salary for one year.\nEffective August 1, 1995, Mr. Sinn resigned as Chairman of the Board and Chief Executive Officer of the Company. Mr. Sinn entered into a consulting and non-competition agreement with the Company pursuant to which Mr. Sinn agreed to serve as a consultant to the Company for one year at compensation of $250,000. Mr. Sinn also agreed pursuant to the agreement not to compete with the Company during his one year consulting term. During 1995, Mr. Sinn was paid $100,962 pursuant to the consulting agreement.\nStock Option Grants and Exercises\nThe table below shows information regarding the grant of stock options made to the Company's Chief Executive Officer and the other most highly compensated executive officers during the fiscal year ended December 31, 1995. The amounts shown for each officer as potential realizable values are based on arbitrarily assumed annualized rates of stock price appreciation over the term of the options. Actual gains, if any, on stock option exercises are dependent on the future performance of the Company's Common Stock. There is no assurance that such potential realizable values will be achieved.\nThe following table sets forth information with respect to the named executives concerning exercise of options during the fiscal year ended December 31, 1995 and unexercised options held at December 31, 1995. The value of unexercised, in-the-money options at December 31, 1995 is the difference between the exercise price of options and the fair market value of Page America's Common Stock on December 31, 1995, which was $.125 per share.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth certain information with respect to beneficial ownership of Common Stock at February 1, 1996 by (i) each person known by the Company to beneficially own more than five percent of outstanding Common Stock, (ii) each Director of the Company, (iii) each of the most highly compensated executive officers of the Company and (iv) all Directors and executive officers of the Company as a group. Except as noted below, each person or entity has sole voting and investment power with respect to all shares listed as owned by such person or entity.\n(1) Assumes exercise of options or warrants to purchase shares of Common Stock and conversion of shares of Series One Convertible Preferred Stock into shares of Common Stock.\n(2) David A. Barry is a director of the Company elected by the holders of the Company's Series One Convertible Preferred Stock. Mr. Barry and Jack Kadis are the general partners of BHI Associates VI, L.P., which is the sole general partner of Bariston Paging Partners, L.P. (\"Bariston Paging\"). Messrs. Barry and Kadis are the controlling shareholders of Bariston Holdings, Inc., which is the sole shareholder of Bariston Associates, Inc. (\"Bariston\") and Bariston Securities, Inc. The total number of shares listed above include 156,242 shares of Series One Convertible Preferred Stock owned by Bariston Paging; 2,254 shares of Series One Convertible Preferred Stock owned by Bariston Associates; 378 shares of Series One Convertible Preferred Stock owned by Mr. Barry, which are convertible into an aggregate of 3,530,180 shares of Common Stock; 125,778 shares of Common Stock issuable upon exercise of warrants owned by BHI Associates VI, L.P.; 41,672 shares of Common Stock issuable upon exercise of warrants owned by Bariston; 17 shares of Common Stock owned by Bariston Paging; 7,563 shares of Common Stock owned by Bariston; and 17,001 shares of Common Stock owned by Mr. Barry. Messrs. Barry and Kadis disclaim beneficial ownership of the portion of the foregoing shares in which they have no actual pecuniary interest.\n(3) Consists of 20,000 shares of Series One Convertible Preferred Stock convertible into an aggregate of 444,400 shares of Common Stock; warrants to purchase 711,111 shares of Common Stock at an exercise price of $3.50 per share; and 556,900 shares of Common Stock.\n(4) T. Rowe Price Strategic Partners Associates, Inc. is the general partner of T. Rowe Price Strategic Partners Fund, L.P. (the \"Fund\") and T. Rowe Price Strategic Partners Fund II, L.P. (\"Fund II\"). Consists of 5,642 shares of Series One Convertible Preferred Stock convertible into an aggregate of 125,365 shares of Common Stock and warrants to purchase 15,200 shares of Common Stock at an exercise price of $3.50 per share owned by the Fund and 12,918 shares of Series One Convertible Preferred Stock convertible into an aggregate of 287,037 shares of Common Stock and warrants to purchase an aggregate of 34,800 shares of Common Stock at an exercise price of $3.50 per share owned by Fund II.\n(5) Sandler Mezzanine General Partnership is the investment General Partner of each of Sandler Mezzanine T-E Partners, L.P. (\"TE\"), Sandler Mezzanine Partners, L.P. (\"SM\") and Sandler Mezzanine Foreign Partners, L.P. (\"FP\"). Consists of 5,390, 12,020, and 2,590 shares of Series One Convertible Preferred Stock owned by TE, SM, and FP, respectively, which are convertible into an aggregate of 444,400 shares of Common Stock; 15,333, 34,196 and 7,367 shares of Common Stock owned by TE, SM and FP, respectively; and warrants to purchase 119,823, 267,200 and 57,422 shares of Common Stock owned by TE, SM, and FP, respectively, at an exercise price of $3.50 per share.\n(6) Includes 20,000 shares of Series One Convertible Preferred Stock convertible into an aggregate of 444,400 shares of Common Stock.\n(7) Includes 10,000 shares of Common Stock issuable upon exercise of options and 15,757 shares of Common Stock vested under the Company's Stock Purchase Plan.\n(8) Includes 162,500 shares of Common Stock issuable upon exercise of options and 5,724 shares of Common Stock vested under the Company's Stock Purchase Plan.\n(9) Consists of 75,000 shares of Common Stock issuable upon exercise of options.\n(10) Includes 247,500 shares of Common Stock issuable upon exercise of options owned by all executive officers and Directors; 21,481 shares of Common Stock vested under the Company's Stock Purchase Plan; and 378 shares of Series One Convertible Preferred Stock which are convertible into 8,399 shares of Common Stock.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nBariston Associates, Inc. (\"Bariston\") has been engaged by the Company to provide investment banking functions for which it receives an annual fee of $105,000, subject to cost of living adjustments. This agreement will terminate upon the earlier to occur of Bariston and its affiliates ceasing to control a majority of the Series One Convertible Preferred Stock or Common Stock issued upon conversion thereof or Bariston and its affiliates owning less than 20 percent of the Company's full diluted shares of Common Stock.\nHolders of a majority of Series One Convertible Preferred Stock, as a class, have the right to elect two directors of the Company. In addition, if any dividend payments are not made to the holders of shares of Series One Convertible Preferred Stock, the dividend rate will increase to 15% per annum and the holders of a majority of Series One Convertible Preferred Stock will be entitled to elect an additional director of the Company. If a change in control of the Company occurs, the holders of Series One Convertible Preferred Stock have the right to cause the Company to repurchase such stock at its liquidation value, plus accrued dividends. Bariston Paging Partners, L.P. holds a majority of the Series One Convertible Preferred Stock. Mr. Barry is the director elected by the holders of Series One Convertible Preferred Stock. The holders of a majority of the Series One Convertible Preferred Stock have agreed that as long as they continue to own a majority of such stock they will vote for a nominee designated by the holders of a majority of such stock.\nDavid A. Barry, a director of the Company, is affiliated with Bariston Securities, Inc. and Bariston.\nAll of the terms and provisions of the foregoing transactions were determined on an arms length basis. The Company believes that the terms of these transactions were no less favorable to the Company than those which could have been obtained from unaffiliated third parties.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits and Financial Statement Schedules and Reports on Form 8-K.\n(a)(1). Financial Statements. The following consolidated financial statements of Page America Group, Inc. and Subsidiaries, required by Part II, Item 8, are included in Part IV of this report:\nReport of Independent Auditors\nConsolidated Balance Sheets at December 31, 1995 and December 31, 1994.\nConsolidated Statements of Operations for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nConsolidated Statement of Stockholders' Equity (Deficit) for the years ended December 31, 1995, December 31, 1994 and December 31, 1993.\nNotes to Consolidated Financial Statements.\n(a)(2). Financial Statement Schedule.\nSchedule II - Valuation and Qualifying Accounts\nAll other financial statement schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.\nExhibits\n(a)(3) Exhibits:\nExhibit No.\n3.1 Restated Certificate of Incorporation of the Registrant, as amended. Incorporated by reference to Exhibit 3.1 to Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (\"1993 10-K\"). 3.2 By-Laws of the Registrant. Incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-1 (File No. 33-46333). 10.1 Employment Agreement, dated as of March 1, 1995, between the Registrant and Kathleen Parramore. Incorporated by reference to Exhibit 10.1 Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (\"1994 10-K\"). 10.2 Asset Acquisition Agreement dated as of September 27, 1993, as amended, by and among Page America Group, Inc., Crico Communications Corporation and the stockholders thereof. Incorporated by reference to Exhibit 2(a) to Current Report on Form 8-K dated January 14, 1994. 10.3 Credit Agreement dated as of December 30, 1993 by and among Page America Group, Inc., its subsidiaries and NationsBank of Texas, N.A., Canadian Imperial Bank of Commerce, Fleet National Bank and State Street Bank and Trust Company. Incorporated by reference to Exhibit 10.3 to 1993 10-K. 10.4 Subordinated Promissory Note, Preferred Stock, Common Stock and Warrant Purchase Agreement dated as of December 30, 1993, by and among Page America Group, Inc., its subsidiaries and various purchasers parties thereto. Incorporated by reference to Exhibit 10.4 to 1993 10-K. 10.5 Second Amended and Restated Registration Rights Agreement dated as of December 30, 1993. Incorporated by reference to Exhibit 10.5 to 1993 10-K. 10.6 Subordinated Promissory Note Registration Rights Agreement dated as of December 30, 1993. Incorporated by reference to Exhibit 10.6 to 1993 10-K. 10.7 Series One Convertible Preferred Stock Voting Agreement dated as of December 30, 1993. Incorporated by reference to Exhibit 10.7 to 1993 10-K. 10.8 Investment Banking Agreement dated December 30, 1993 between Bariston Associates, Inc. and Page America Group, Inc. Incorporated by reference to Exhibit 10.8 to 1993 10-K. 10.9 Purchase and Sale Agreement dated August 10, 1993 between Page America Group, Inc. and Forsyth Company. Incorporated by reference to Exhibit 10.9 to 1994 10-K. 10.10 Asset Purchase Agreement dated as of February 24, 1995 by and among Paging Network of Florida, Inc., Page America Group, Inc. and various subsidiaries of Page America Group, Inc. Incorporated by reference to Exhibit 10.10 to 1994 10-K. 10.11 Consulting and Non-Competition Agreement dated August 1, 1995 between Registrant and Steven L. Sinn. 10.12 Third Amendment dated as of July 28, 1995 to Credit Agreement dated as of December 30, 1993 by and among Page America Group, Inc., its subsidiaries, and bank lenders. 10.13 Indenture dated as of June 30, 1994 among Page America Group, Inc., its subsidiaries, and American Stock Transfer and Trust Company, as Trustee. Incorporated by reference to Exhibit 4 to Registration Statement on Form S-4 (File No. 33-77832). 10.14 Amendment dated as of July 28, 1995 to Indenture dated as of June 30, 1994 by and among Page America Group, Inc., its subsidiaries, and American Stock Transfer and Trust Company, as Trustee. 21. Subsidiaries of the Registrant. Incorporated by reference to Exhibit 21 to 1994 10-K. 23. Consent of Ernst & Young LLP.\n(b) Reports on Form 8-K\nNone\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage\nReport of Independent Auditors\nConsolidated Balance Sheets at December 31, 1995 and December 31, 1994\nConsolidated Statements of Operations for the years ended December 31, 1995, December 31, 1994, and December 31, 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, December 31, 1994, and December 31, 1993\nConsolidated Statement of Shareholders' Equity (Deficit) for the years ended December 31, 1995, December 31, 1994, and December 31, 1993\nNotes to Consolidated Financial Statements\nREPORT OF INDEPENDENT AUDITORS\nShareholders and Board of Directors Page America Group, Inc.\nWe have audited the accompanying consolidated balance sheets of Page America Group, Inc. and subsidiaries as of December 31, 1995 and December 31, 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 audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Page America Group, Inc. and subsidiaries at December 31, 1995 and December 31, 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.\nThe accompanying consolidated financial statements have been prepared assuming that Page America Group, Inc. will continue as a going concern. As shown in the financial statements, the Company has incurred a loss of $13 million for the year ended December 31, 1995. Losses from operations in recent years have significantly weakened the Company's financial position and its ability to purchase paging equipment and meet current operating expenses. Further, as discussed in Note A, the Company is in default of its debt agreements under which it has outstanding borrowings of $48 million, including $33 million of borrowings under a credit facility with certain banks which is secured by substantially all of the assets of the Company. Such debt is classified as a current liability and the Company's current liabilities exceeded its assets by $52 million at December 31, 1995. Management's plans in regard to these matters are also described in Note A.\nThe matters referred to in the preceding paragraph raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.\nErnst & Young LLP\nHackensack, New Jersey March 15, 1996\nPage America Group, Inc. and Subsidiaries\nCONSOLIDATED BALANCE SHEETS ($ In Thousands)\nThe accompanying notes are an integral part of these statements.\nPage America Group, Inc. and Subsidiaries\nCONSOLIDATED BALANCE SHEETS (continued) ($ In Thousands, except share data)\nThe accompanying notes are an integral part of these statements.\nPage America Group, Inc. and Subsidiaries\nCONSOLIDATED STATEMENTS OF OPERATIONS ($ In Thousands, except per share 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 this statement.\nPage America Group, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDescription of Business--The Company is a radio paging company which markets and provides over-the-air messaging information, products and services in the New York and Chicago metropolitan area markets through facilities which it owns and operates as a radio common carrier (\"RCC\") under licenses from the Federal Communications Commission. The Company's diversified customer base provides for a lack of concentration of credit risk.\nBasis of Presentation--Certain amounts in the prior year financial statements have been reclassified to conform with the current year presentation.\nPrinciples of Consolidation--The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been 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 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 debt instruments purchased with a maturity of three months or less, at date of acquisition, to be cash equivalents.\nEquipment--Equipment is stated at cost less accumulated depreciation and amortization and includes pagers held for sale or lease. Depreciation is computed by the declining balance method for pager equipment and the straight-line method for all other equipment in amounts sufficient to allocate the cost of depreciable assets to operations over their estimated useful lives. Leasehold improvements are amortized over the shorter of the life of the respective lease or service life of the improvement. Cost of sales and service does not include depreciation expense, which is presented separately in the accompanying statements of operations.\nCertificates of Authority--The costs of certificates of authority related to the conduct of RCC operations are amortized on a straight-line basis principally over periods of 40 years.\nCustomer Lists--Customer lists generally consist of a portion of the cost of business acquisitions assigned to the value of customer accounts and are amortized on a straight-line basis over the estimated lives of those customers which range up to fourteen years.\nOther Intangibles--Other intangibles include the excess of the purchase price over the fair market value of the net assets acquired and are amortized on a straight-line basis principally over 40 year periods. The Company routinely evaluates the carrying value of all of its intangibles for impairment.\nInterest Rate Protection--On December 30, 1993, the Company entered into a new senior credit facility with certain banks. On February 15, 1994, the Company entered into an interest rate cap agreement which protects the Company against increases in interest rates on $25 million of this debt. The unamortized cost of this agreement is included in prepaid expenses in the consolidated balance sheet and is being amortized over the three year life of the agreement. The fair value of the instrument, as further described in Note E, was based upon a quote from an independent financial institution.\nLoss Per Share--Loss per share is computed based upon the weighted average number of common shares outstanding during the periods presented and is computed after giving effect to preferred stock dividend requirements. Stock options, warrants and the assumed conversion of the convertible preferred stock have not been included in the calculation, since their inclusion would not be dilutive for each of the periods presented.\nNet Losses and Management's Plans--The accompanying financial statements have been prepared on a going concern basis. The Company, since its inception, has experienced a deficiency in working capital and recurring losses. In 1995, as a result of non-compliance by the Company with certain covenants of its credit facility, the terms were modified to accelerate the final maturity to December 29, 1995, and the subordinated notes were modified to provide for a final maturity of six months thereafter. The credit facility was not repaid at maturity causing the credit facility and the subordinated notes to be in default (see Note E). Such debt is classified as a current liability and the Company's current liabilities exceeded its current assets by $52.4 million at December 31, 1995. The Company intends to pay the balance due under the credit facility and the subordinated notes in 1996 from cash generated by the sale of its assets. Alternatively, the Company intends to complete a refinancing which repays the balance due under the credit facility and amends and extends the subordinated notes. The successful completion of one of these efforts is essential as the Company has no other immediate plans that will provide sufficient cash flows to satisfy its obligations. There can be no assurance that the Company will have sufficient funds to finance its operations, which continue to show losses, through the year ending December 31, 1996.\nAll of these matters raise substantial doubt about the Company'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 and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.\nNOTE B--SALE OF FLORIDA AND CALIFORNIA OPERATIONS\nOn July 28, 1995, the Company sold its California and Florida paging assets for a cash sale price of $19.4 million. One million dollars of the sale price is being held in escrow and is scheduled to be released to the Company over a two year period, as provided for in the agreement. Part of the proceeds was used to reduce the Company's senior debt by $11.8 million and to prepay interest of $1.2 million through December 29, 1995. In connection with this sale, the Company incurred expenses amounting to approximately $1.0 million. This sale included approximately 78,000 pagers, two statewide and several regional frequencies. The assets sold had a net book value of approximately $19.1 million and consisted of the assets which the Company acquired from Crico Communications Corporation (\"Crico\") on December 30, 1993 and the 900 Mhz channel which is licensed to provide state-wide coverage in California which the Company acquired in 1994 for a purchase price of $500,000. The purchase price paid by the Company for the Crico assets consisted of $12,650,000 in cash paid to Crico's lenders, the issuance of an aggregate of 1,435,903 shares of Common Stock to Crico's lenders and the issuance of 240,000 shares of Common Stock and warrants to purchase 130,000 shares of Common Stock at an exercise price of $5.00 per share to a company related to certain shareholders of Crico. As a result of the sale, the Company incurred a loss of approximately $718,000.\nNOTE C--1993 REFINANCING AND ACQUISITION FINANCING\nOn December 30, 1993, contemporaneous with the Crico acquisition, the following occurred:\nCredit Facility\nThe Company entered into a new senior secured credit facility, replacing the Company's then existing credit facility. The new agreement provided for an $11.27 million reducing revolving credit and a $45 million term loan facility, each with a final maturity of March 31, 2000. In connection with this transaction, the Company wrote off $677,400 of deferred financing costs related to the retired credit facility. The terms of this credit facility were subsequently modified. See Note E.\nSubordinated Note Financing\nThe Company sold $13 million aggregate principal amount of 12 percent Subordinated Notes originally due 2003. Payments on the Subordinated Notes initially were to be interest only with mandatory principal payments of $1.3 million due semi-annually beginning on June 30, 1999. The terms of these notes were subsequently modified. See Note E.\nIn connection with the issuance of the notes, the Company also issued warrants to purchase an aggregate of 1,155,556 shares of Common Stock, at a purchase price of $3.50 per share. The warrants expire ten years from issuance. The Company may accelerate the expiration of the warrants at any time after December 31, 1996 if the average closing price of the Common Stock for both the 60 day and the five day periods preceding the notice date was equal to or greater than 150 percent of the warrant exercise price. The holders will be entitled to anti-dilution protection under certain circumstances. If a change of control of the Company occurs at less than a 25 percent premium over the exercise price, the warrant holders will have the right to cause the Company to pay to them the difference between the exercise price and 125 percent of the exercise price; provided, however, the warrants must be exercised.\nPreferred and Common Stock Issuance\nThe Company sold $8 million of a new series of Series One Convertible Preferred Stock (See Note G). As part of this transaction, the Company also sold 500,000 shares of Common Stock at a price of $4.00 per share. The Series One Convertible Preferred Stock has a 10 percent dividend, payable semi-annually in arrears and is convertible into Common Stock at $4.50 per share, subject to certain anti-dilution provisions. Payment of dividends may be made in cash or in Common Stock of the Company registered under the Securities Act of 1933. Any dividend payments not made when permitted under the Credit Facility and the Subordinated Note Financing will result in, among other things, an increase in the dividend rate to 15 percent per annum and entitle holders of the majority of the Series One Convertible Preferred Stock to elect an additional representative to the Board of Directors of the Company. Holders of the Series One Convertible Preferred Stock were originally entitled to a preference in liquidation of $100 per share plus any accrued but unpaid dividends. In 1995 the holders of the Series One Convertible Preferred Stock waived their rights to receive the dividend payment of $1,432,000 due on June 30, 1995. In exchange, this amount was added to the liquidation value of the shares thereby increasing the liquidation value to $105 per share. The Company may redeem the Series One Convertible Preferred Stock if the average closing price of the Common Stock for both the preceding 60 day and five day periods has equalled or exceeded 150 percent of the conversion price. After December 31, 2000, the Series One Convertible Preferred Stock may be redeemed at par, plus accrued dividends. If the Company calls the Series One Convertible Preferred Stock for redemption, the holders may convert to shares of Common Stock. Upon any redemption, accrued dividends must be paid by the Company in cash. Upon conversion of the Series One Convertible Preferred Stock, the Company will have the option to pay accrued dividends by issuing additional shares of its Common Stock. Holders of the Series One Convertible Preferred Stock will be entitled to vote as if their shares of Series One Convertible Preferred Stock were converted into shares of Common Stock. Holders of a majority of the Series One Convertible Preferred Stock, as a class, will be entitled to elect two representatives to the Board of Directors. If a change in control in the Company occurs, the holders of Series One Convertible Preferred Stock will have the right to cause the Company to repurchase such stock at the liquidation value, plus accrued dividends. The Company has registered for resale under the Securities Act of 1933 the Series One Convertible Preferred Stock, Common Stock issued in payment of dividends and the Common Stock issuable upon conversion of the Series One Convertible Preferred Stock. The Company also registered the warrants issued on December 30, 1993 and shares of Common Stock issuable upon exercise thereof.\nPreferred Stock Exchange\nThe Company also issued $23 million of Series One Preferred Stock in exchange for (i) all outstanding shares of Series A Preferred Stock, Series A-2 Preferred Stock and Series B Preferred Stock (which were reflected outside of shareholders' equity due to redemption provisions); (ii) warrants to purchase 1,276,289 shares of Common Stock having an exercise price of $6.761 per share and (iii) $8,065,960 of dividends accrued through December 31, 1993 on the exchanged preferred stock. As the result of the exchange, all the outstanding Series A, Series A-2 and Series B Preferred Stock were canceled and provisions relating to change in control and rights to terminate were terminated. The terms of the exchange were negotiated between independent members of the Board of Directors of the Company and the holders of the preferred stock.\nNOTE D--BALANCE SHEET CLASSIFICATIONS ($ In Thousands)\nPrepaid expenses and other current assets comprise the following:\nNOTE E--LONG-TERM DEBT\nLong-term debt is as follows:\nOn December 30, 1993, the Company entered into a senior secured credit facility with certain banks. The bank credit facility (\"Credit Facility\"), replacing the Company's then existing credit facility, provided for an $11.27 million reducing revolving credit line and a $45 million term loan facility, each with an original final maturity of March 31, 2000. The interest rate is based either on prime or LIBOR, at the option of the Company, with further adjustment depending on the Company's ratio of total debt to operating cash flow, as defined. Due to the existence of a default at December 31, 1995, the interest rate was based on prime plus the aforementioned adjustment. At December 31, 1995, the interest rate was prime of 8.5 percent plus 1.75 percent. At closing, the Company paid a fee to the Banks in the amount of $951,550. The Company was also required to pay the Banks a commitment fee of 0.5 percent on the unused balance of the revolving credit facility and annual fees of $55,000. The Company canceled its revolving credit facility effective November 29, 1994. Payments on the Credit Facility initially were to be interest only with mandatory principal payments due quarterly beginning on September 30, 1995.\nOn July 28,1995, concurrent with the sale of the Company's Florida and California paging assets, the Credit Facility was amended. Among other things, the amendment provided for an acceleration of the final maturity to December 29, 1995 and modified the financial covenants so that the Company would no longer be in default as of the amendment date. The Company used the net proceeds from the sale of its Florida and California operations to reduce the debt by $11.8 million and prepay interest at the LIBOR rate from August 1, 1995 through December 29, 1995. In its third fiscal quarter, the Company recorded a charge of approximately $1.8 million related to the amended agreement which includes the write-down of deferred financing costs of approximately $1.1 million. The Credit Facility has not been repaid and the lenders have declared the Company in default. The Credit Facility is secured by substantially all the assets of the Company.\nOn December 30, 1993 the Company sold $13 million aggregate principal amount of 12 percent Subordinated Notes originally due 2003, with warrants, pursuant to a Note Purchase Agreement. Payments on the Subordinated Notes initially were to be interest only with mandatory principal payments of $1.3 million due semi-annually beginning on June 30, 1999. All payments on the notes are subordinated to the prior payment in full of all amounts outstanding under the Credit Facility. The notes are governed by certain financial covenants. In July, 1994, the Company exchanged the notes for identical notes which were registered under the Securities Act of 1933.\nOn July 28, 1995, the subordinated notes were modified to provide for a final maturity of six months subsequent to the final maturity of the Credit Facility and to defer the cash payment of interest until maturity. As a result of the default under the Credit Facility, the Company is in default of the subordinated notes. Commencing January 1, 1995, interest is increased from 12 to 15 percent per annum, compounded semi-annually and is satisfied by the issuance of additional promissory notes with terms substantially identical to the subordinated notes, as amended. In 1995 the Company recorded a charge of approximately $500,000 related to the modified agreement, which includes the write-down of deferred financing costs of approximately $479,000. If a change in control of the Company occurs, the note holders will have the right to require the Company to repurchase the notes at par plus accrued interest.\nOn February 15, 1994, in accordance with the terms of the Credit Facility, the Company entered into an interest rate cap agreement for which the Company paid $65,000. This agreement protects the amount of $25 million against LIBOR rates in excess of 7.5 percent and expires in February of 1997. There was no impact on the weighted average borrowing rate or the reported interest expense during 1994 and 1995 as the LIBOR rate did not exceed 7.5 percent. The estimated fair value of this instrument at December 31, 1995 and March 31, 1995 was $0 and $137,000, respectively. The net carrying value of the instrument at December 31, 1995 was $24,000.\nNOTE F--CUMULATIVE SERIES C PREFERRED STOCK EXCHANGE\nOn March 7, 1994, the Company offered the holders of its Cumulative Series C Preferred Stock to exchange each share of such stock, and undeclared dividends thereon, for 2.725 shares of common stock. The holders of 112,509 shares of Series C elected to accept this offer. Accordingly, 306,581 shares of Common Stock of the Company were issued in exchange for those shares of Series C and the holders' right to $970,400 of associated undeclared dividends. In accordance with the original terms, on September 12, 1994, the remaining shares outstanding were mandatorily converted to shares of Common Stock of the Company and accrued dividends of $17,500 were paid.\nNOTE G--SHAREHOLDERS' EQUITY\nSeries One Convertible Preferred Stock--Series One Convertible Preferred Stock has a 10 percent dividend, payable semi-annually in arrears and is convertible into Common Stock at an initial price of $4.50 per share, subject to certain anti-dilution provisions. Payment of dividends may be made in cash or in Common Stock of the Company. On August 11, 1994 and March 8, 1995, the Company issued 406,220 shares and 437,629 shares of its Common Stock, respectively, to the holders of Series One Convertible Preferred Stock, as full payment of dividends for the year ended December 31, 1994. On June 30, 1995, the Preferred shareholders waived their rights to receive the dividend payment of $1,432,000 due on the same date. In exchange, this amount was added to the liquidation value of the shares. As of December 31, 1995, accrued dividends aggregated $1,432,000. It is anticipated that such dividends will be paid by the issuance of approximately 7,900,000 shares of the Company's Common Stock. See Note C.\nCommon Stock Reserved For Issuance--As of December 31, 1995, unissued Common Stock of the Company was reserved for issuance in accordance with the terms of outstanding warrants (1,511,238), stock options (251,700), convertible preferred stock (6,363,578) and preferred stock dividends (7,900,000).\nStock Options--The Company's 1983 Stock Option Plan, as amended, provides for the granting of options to purchase an aggregate of 235,000 shares of the Company's Common Stock to key employees. The option prices cannot be less than the fair market value of Common Stock at dates of grant. Options may not be exercised until specified time restrictions have lapsed and option periods cannot exceed five years. In August, 1995, 100,000 options held by the former President of the Company were canceled. No more options may be granted under this plan.\nThe Company's 1990 Stock Option Plan provides for the grant by the Company of options to purchase not more than 555,000 shares of Common Stock to key employees and directors. The exercise price per share is the fair market value of a share of Common Stock for options granted after December 29, 1992, and the greater of (i) the fair market value of a share of Common Stock or (ii) $7.00, for options granted on or before December 29, 1992. Options to be granted under the 1990 Stock Option Plan may not be exercised prior to one year from the date of grant and options may be exercised 20 percent per year thereafter. Exercise of such options will be accelerated if the Company is sold, a change in control occurs or as the Compensation Committee of the Board of Directors deems appropriate. In August, 1995, 252,508 options held by the former President of the Company were canceled. In October, 1995, 150,000 and 75,000 options were granted to the President and the Chief Financial Officer of the Company, respectively. These options have an exercise price of $.75 per share and will expire in October, 2002.\nThe following summarizes the changes in stock options:\nThe stock options outstanding at December 31, 1995 expire at various dates through October, 2002. As of December 31, 1995 and December 31, 1994, 308,300 and 266,292 options were available for grant, respectively.\nNOTE H--INCOME TAXES\nThe Tax Reform Act of 1986 enacted a complex set of rules limiting the utilization of net operating loss and tax credit carryforwards to offset future taxable income following a corporate \"ownership change\". In general, an ownership change occurs if the percentage of stock of a loss corporation owned (actually, constructively and, in some cases, deemed ownership) by one or more \"5 percent shareholders\" has increased by more than 50 percentage points over the lowest percentage of such stock owned by those persons during a three year testing period. If an ownership change occurs it would limit the utilization of the net operating loss carryforwards for federal income tax purposes. The Company has determined that there has been an ownership change as of December 31, 1993. As of December 31, 1995, the Company had net operating losses of approximately $71.5 million for federal income tax purposes which will expire at various dates between 1998 and 2010. $52.6 million of the total net operating losses of $71.5 million are subject to the aforementioned limitations. In addition, the Company has investment tax credit carryforwards of approximately $670,000 which expire principally in 1997 through 2000, which are also subject to limitation.\nThe effects of temporary differences that gave rise to deferred tax assets and liabilities are as follows:\nThe Company's valuation allowance increased by approximately $4,315 to $29,712 as of December 31, 1995 due principally to the increase in the net operating losses.\nThe reconciliation of income taxes computed at the U.S. federal statutory tax rate to income tax expense is:\nNOTE I--CONTINGENCIES\nThe Company is involved in various lawsuits and proceedings arising in the normal course of business. In the opinion of management of the Company, the ultimate outcome of these lawsuits and proceedings will not have a material effect on the results of operations, financial position or cash flows of the Company.\nNOTE J--RELATED PARTY TRANSACTIONS\nA company (the \"Related Company\") whose president is a Director of the Company acted as a placement agent in connection with the sale by the Company of shares of Series One Convertible Preferred Stock and subordinated notes and the entering into of the bank credit facility. As a result, the Related Company received a fee of $532,500 plus reimbursement of its out-of-pocket expenses which was paid in December, 1993.\nThe Related Company has been engaged to provide investment banking functions for which it receives an annual fee of $105,000, subject to cost of living adjustments. This agreement will terminate if the Related Company ceases to control a majority of the Series One Convertible Preferred Stock (or Common Stock issued upon conversion thereof) or owns less than 20% of the Company's fully diluted shares of Common Stock. At December 31, 1995, investment banking fees accrued but unpaid were $151,000.\nIn 1993 the Related Company repaid $421,000 of indebtedness owed to the Company by surrendering for cancellation 4,210 shares of Series One Convertible Preferred Stock which had a value of $100 per share.\nNOTE K--RENTALS\nRental expense for the fiscal years 1995, 1994 and 1993 was approximately $3,062,000, $3,236,000, and $2,353,000 respectively.\nFuture minimum annual payments under non-cancelable operating leases for office space and transmitter sites, as of December 31, 1995, are as follows:\nCertain leases are subject to increases in taxes, operating and other expenses.\nNOTE L--EMPLOYEE BENEFIT PLAN\nThe Company has a 401(K) plan covering substantially all of its employees. All employees who have completed ninety days of service are eligible to participate. Employees may contribute 1% to 4% of compensation to the plan on an after-tax basis and also defer additional amounts of compensation in 1% increments on a pre-tax basis, subject to limits established by the Internal Revenue Code. The Company matches 100% of after-tax and 25% of pre-tax contributions with shares of its common stock. The total cost of the plan amounted to $69,400, $124,800, and $140,700 in 1995, 1994 and 1993, respectively.\n(a) Accounts written off as 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.\nPAGE AMERICA GROUP, INC.\nMarch 28, 1996 By:\/s\/ Kathleen C. Parramore ------------------------ Kathleen C. Parramore President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nName Title Date\n\/s\/ David A. Barry Chairman of the Board David A. Barry and Chief Executive Officer March 28, 1996\n\/s\/ Martin Katz Chief Financial Officer March 28, 1996 Martin Katz","section_15":""}
{"filename":"717837_1995.txt","cik":"717837","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral - -------\nFirst Oak Brook Bancshares, Inc. (\"the Company\") was organized under Delaware law on March 3, 1983, as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company owns all of the outstanding capital stock of Oak Brook Bank (\"Bank\"), Oak Brook, Illinois, which is an Illinois state- chartered bank. The bank has seven locations in DuPage County and two locations in Cook County.\nThe Company has two classes of common stock, Class A Common stock and Common stock. The Common stock is convertible into Class A Common at any time on a one-for-one basis. The Company has authorized shares of Class A Common and Common stock of 4,000,000 and 3,000,000, respectively.\nAs of December 31, 1995, the Company had total assets of $678,102,000; loans of $362,728,000, deposits of $555,086,000, and shareholders' equity of $53,762,000.\nThe business of the Company consists primarily of the ownership, supervision and control of its subsidiary bank. The Company provides its subsidiary bank with advice, counsel and specialized services in various fields of financial, audit, legal and banking policy and operations. The Company also engages in negotiations designed to lead to the acquisition of other banks and closely related businesses.\nThe Bank is engaged in the general retail and commercial banking business. The services offered include demand, savings, and time deposits, corporate cash management services, commercial lending products such as commercial loans, mortgages and letters of credit, and personal lending products such as residential mortgages, home equity lines, auto loans and credit card products. In addition, related products and services are offered including discount brokerage, mutual funds and annuity sales, and foreign currency and precious metal sales. Oak Brook Bank has a full service trust and land trust department.\nThe Bank originates the following types of loans: commercial, real estate (land acquisition, development & construction, commercial mortgages, residential mortgages and home equity), credit card and consumer installment loans. The extension of credit inherently involves certain levels and types of risk (general economic, default, concentration, interest rate and credit) which the Company prudently manages through the establishment of lending, credit and asset\/liability management policies and procedures.\nLoans originated comply with the Bank's loan policies and governmental rules, regulations and laws. While the subsidiary bank's loan policy varies for different loan products, the policy generally covers such items as: percentages to be advanced against collateral, blanket or specific liens, insurance requirements, maximum terms, down payment requirements, debt-to-income ratio, credit history and other matters of credit concern.\nThe Bank's loan policy grants limited loan approval authority to designated loan officers. Where a credit request exceeds the loan officer's approval authority, approval by a more senior lending officer and\/or bank loan committee is required. The loan policy sets forth those credit requests that either because of the amount and\/or type, require the approval of the bank loan committee.\nThe chart that follows sets forth the credit risks, loan origination procedures, underwriting standards and lien position generally associated with the Bank's lending in each major loan category. The major loan categories are residential real estate, including purchase money, refinances and home equity; commercial real estate, including land acquisition, development and construction loans; commercial loans; auto loans (direct and indirect); credit cards and student loans. These loans, except for credit cards, are made generally in the Chicago Metropolitan area and are generally secured by collateral located in the Chicago Metropolitan area.\nThe chart sets forth the information generally considered in approving these loans and the collateral stated for each category is the collateral generally required for these loans. Each loan is reviewed on its own merits and the information set forth in the chart does not necessarily apply to each loan within those categories. The lien position (if any) and collateral documentation for commercial loans, commercial real estate and construction loans are structured specifically for each loan.\nCompetition - -----------\nThe Company and its subsidiary bank operate primarily in DuPage County, Illinois, with seven locations, and two locations in Cook County, Illinois, one of which is located in western Cook County and the other on Chicago's North Shore.\nAt June 30, 1995, the Company's seven DuPage County, Illinois, offices held $468 million in deposits for an approximate 5.2% market share in relation to the total deposits in DuPage County commercial banks. The Company's two offices in Cook County, Illinois contained $74 million in deposits for an approximate .1% market share of Cook County. The Company's offices are part of the Chicago banking market, as defined by the Federal Reserve Bank of Chicago, consisting of Cook, DuPage and Lake Counties, which at June 30, 1995 had $90.0 billion in deposits.\nThe Company's subsidiary bank is located in a highly competitive market facing competition for deposits, loans and other banking services from many financial intermediaries, including savings and loan associations, finance companies, credit unions, mortgage companies, retailers, stockbrokers, insurance companies and investment companies, many of which have greater assets and resources than the Company.\nRegulation and Supervision - --------------------------\nGeneral - -------\nThe Company is a bank holding company subject to the restrictions and regulations adopted under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"), and interpreted by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"), and the Company is also subject to Federal Securities Laws and Delaware Law. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before acquiring direct or indirect ownership or control of 5% or more of the voting shares of any bank or bank holding company. However, no acquisition may be approved if it is prohibited by applicable state law. The Company is examined by the Federal Reserve Bank of Chicago.\nThe subsidiary bank is subject to extensive governmental regulation and periodic regulatory reporting requirements. The regulations by various governmental entities, as well as Federal and State laws of general application affect the Company and the subsidiary bank in many ways including but not limited to: requirements to maintain reserves against deposits, payment of FDIC insurance, restrictions on investments, establishment of lending limits and payment of dividends. The subsidiary bank is primarily supervised and examined by the Illinois Commissioner of\nBanks and Trust Companies and the Federal Deposit Insurance Corporation.\nThe Federal Reserve Bank examines and supervises bank holding companies pursuant to risk-based capital adequacy guidelines. These guidelines establish a uniform capital framework that is sensitive to risk factors, including off-balance sheet exposures, for all federally supervised banking organizations. This can impact a bank holding company's ability to pay dividends and expand its business through the acquisition of subsidiaries if capital falls below the levels established by these guidelines. As of December 31, 1995 the Company's Tier 1, total risk-based capital and leveraged ratios were in excess of minimum regulatory guidelines and also exceed the FDIC criteria for \"well capitalized\" banks. See the Company's Annual Report at page 34 for a more detailed discussion of the Risk Based Assessment System and the impact upon the Company and its subsidiary bank.\nFederal Deposit Insurance Corporation's Reduction of Insurance Assessments - --------------------------------------------------------------------------\nUnder Federal law, the FDIC has authority to impose special assessments on insured depository institutions, to repay FDIC borrowings from the United States Treasury or other sources, and to establish semi-annual assessment rates for Bank Insurance Fund (\"BIF\") member banks to maintain the BIF at the designated reserve ratio required by law. Effective January 1, 1996, the FDIC reduced the assessment rate schedule for all BIF members as set forth below:\n*Subject to the statutory minimum of $2,000 per institution per year.\nThe assessment schedule requires a minimum annual fee of $2,000 per institution for the banks in the highest capital group and supervisory subgroup. Congress is still debating the merger of the BIF and the Savings Association Insurance Fund (\"SAIF\") funds which, if it occurs, may increase the BIF members assessment to pay for SAIF debt.\nThe Riegle\/Neal Interstate Banking and Branching Efficiency Act of 1994 \"The - ---------------------------------------------------------------------------- Interstate Banking Act\" - -----------------------\nThe Interstate Banking Act allowed \"adequately capitalized\" and \"adequately managed\" bank holding companies to acquire banks in any state as of September 29, 1995. The Act also allows interstate merger transactions after June 1, 1997.\nThe Interstate Banking Act amends Section (d) of the Bank Holding Company Act of 1956 authorizing the Federal Reserve to approve a bank holding company's application to acquire either control or substantial assets of a bank located outside of the bank holding company's home state regardless of whether the acquisition would be prohibited by state law. The Federal Reserve may approve these transactions only for \"adequately capitalized\" and \"adequately managed\" bank holding companies.\nThe Interstate Banking Act also amended the Federal Deposit Insurance Act and beginning June 1, 1997 responsible agencies may approve merger transactions between insured banks with different home states regardless of whether the transaction is prohibited under state law. Through interstate merger transactions, banks will be able to acquire branches of out of state banks by converting their offices into branches of the resulting bank. The Act provides that it will be the exclusive means for bank holding companies to obtain interstate branches. In these transactions, the resulting bank must remain \"adequately capitalized\" and \"adequately managed\" upon completion of the merger. The Act also states that a home state may enact a law preventing these transactions, Illinois will allow these transactions effective June 1, 1997. Each state has until June 1, 1997 to enact such legislation.\nFinancial Institutions Reform, Recovery and Enforcement Act of 1989 \"FIRREA\" - ----------------------------------------------------------------------------\nThe FIRREA has broadened the regulatory powers of federal bank regulatory agencies. One of the provisions of FIRREA contains a \"cross-guarantee\" provision which could impose liability on the Company for losses incurred by the FDIC in connection with assistance provided to or the failure of any of the Company's insured depository institutions. In addition, under Federal Reserve Board policy the Company is expected to act as a source of financial strength to its subsidiary bank and to commit resources to support the subsidiary bank. As a result of such policies, the Company could be required to commit resources to its subsidiary bank in circumstances where it might not do so absent such policies.\nComprehensive Environmental Response Compensation and Liability Act \"CERCLA\" - ----------------------------------------------------------------------------\nIn 1992 the U.S. Environmental Protection Agency (USEPA) adopted the CERCLA which provided lenders with an exemption from liability if the lender did not participate in the management of the contaminated property. The Secured Lender Exemption Rule protected secured lenders from CERCLA liability if they did not exercise significant control over the borrowers day-to-day operations and did not fail to foreclose and promptly dispose of the contaminated property. However, the Third Circuit Court of Appeals decision in Frank J. Kelley, Attorney General for the State of Michigan, v. Environmental Protection Agency, Chemical Manufactures Association v. Environmental Protection Agency, 15 F. 3d 1100 (D.C. Cir. 1994) (\"Kelley\") invalidated the secured lender exemption, and the U.S. Supreme Court denied the appeal.\nAt this time Congress has not altered the Kelley decision and secured lenders continue to be exposed to potential liability for clean-up of hazardous waste material on real property subject to their security interests. The Bank continues to require environmental assessments on commercial real property prior to approval and funding. This policy reduces the Bank's potential liability for hazardous waste clean-up by identifying the risks present on the property.\nThe state of Illinois amended its Innocent Landowner Law to protect lenders and purchasers from environmental clean up liabilities. The law provides \"innocent landowner\" protection for lenders and purchasers who perform Phase I and Phase II environmental assessments or audits meeting the statutory requirements. This law will protect the banks from prosecution by the Illinois Environmental Protection Agency; however, it does not protect them against CERCLA liability.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 \"FDICIA\" - --------------------------------------------------------------------------\nThe FDICIA significantly expanded the regulatory and enforcement powers of federal banking regulators. FDICIA gives federal banking regulators comprehensive directions to promptly direct or require the correction of problems of inadequately capitalized banks in a manner that is least costly to the Federal Deposit Insurance Fund. The degree of corrective regulatory involvement in the operations and management of banks and their holding companies will be largely determined by the actual or anticipated capital position of the institution. See the Company's Annual Report page 34 detailing the Company's capital position.\nFDICIA also directs federal banking regulatory agencies to issue new safety and soundness standards governing operational and managerial activities of banks and their holding companies\nparticularly in regard to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and executive compensation. The following regulations were passed to implement some of the above objectives:\n. The Bank is subject to and has complied with the Annual Independent Audits and Reporting Requirements' regulations. The regulations subject financial institutions with total assets of $500 million or greater to new stringent annual audit and reporting requirements including: (1) an audit committee comprised solely of outside directors; (2) submission of audited financial statements; and, (3) a report by management regarding compliance with designated laws and regulations and internal controls over financial reporting.\n. In August 1995, the Federal Banking Agencies jointly issued a final ruling which stated that the agencies will include in their evaluation of capital adequacy the exposure to declines in economic value of the bank's capital due to changes in interest rates. The implementation of the proposed process for measuring interest rate risk exposure has been delayed pending further review by the Federal Banking Agencies. If the regulators determine a bank is in a high risk position, additional capital may be required. The Company and its subsidiary bank, on a regular basis, monitor and establish policy limits on the sensitivity of net interest income to changes in interest rates.\nOther Laws and Regulations - --------------------------\nProposals that change the laws and regulations governing banks, bank holding companies and other financial institutions are discussed in congress, the state legislatures and before the various bank regulatory agencies. Banks are subject to a number of federal and state laws and regulations which have a material impact on their business. These include, among others, state usury laws, consumer protection laws and regulations, (e.g., the Truth in Lending Act, the Equal Credit Opportunity Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Truth in Savings Act), as well as the electronic funds transfer laws, Bank Secrecy Act, environmental laws and privacy laws.\nStatistical Disclosure by Bank Holding Companies - ------------------------------------------------\nSee \"Financial Review\" on pages 22 through 34, inclusive, of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by reference for the statistical disclosure by bank holding companies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's offices are located in Oak Brook, Illinois. The subsidiary bank and its branches conduct business in both owned and leased premises. The Company believes its facilities are suitable and adequate to operate its banking business. For information concerning lease obligations, see Note 6 of the Notes to Consolidated Financial Statements and lease exhibits previously filed and incorporated by reference.\nThe Company and Oak Brook Bank occupy space in a four-year old, three-story, 100,000 square foot, modern office building located at 1400 Sixteenth Street, Oak Brook, Illinois, which is owned and operated by Oak Brook Bank. The first and second floors and portions of the third floor and lower level are occupied by Oak Brook Bank. The Company leases a small portion (1,700 square feet) from Oak Brook Bank. The majority of the third floor is rented to third parties.\nIn addition, Oak Brook Bank operates the following branches:\nAddison - A 24 year old, 14,500 square foot, two-story brick, colonial building including a full basement and attached drive-up facility in Addison, Illinois. The second floor is rented to third parties. This facility and real estate are owned by Oak Brook Bank and was formerly the Heritage Bank of Addison, acquired September, 1974.\nBensenville - Approximately 2,000 square feet of leased space in a modern, two-story glass building in Bensenville, Illinois. Opened in May, 1986.\nBroadview - A 42 year old, 6,955 square foot, one-story brick building in Broadview, Illinois. This facility and real estate are owned by Oak Brook Bank. Formerly Liberty Bank acquired March, 1991.\nBroadview Drive-up - Oak Brook Bank also owns a detached one-story drive-up facility across the street from the Broadview location.\nBurr Ridge - Approximately 6,600 square feet of leased space in a one-story contemporary building located in Burr Ridge, Illinois. A portion of this space is used for record storage. Opened in October, 1988.\nGlenview - Approximately 1,800 square feet of leased space in a strip shopping center in Glenview, Illinois. Opened in March, 1990.\nLisle - Approximately 1,300 square feet of leased space in a neighborhood shopping center in a primarily residential\nsection of Lisle, Illinois. A detached drive-up automated teller machine is also operated at this location. Opened in October, 1985.\nNaperville - A 2,600 square foot, two-story contemporary Palladian-style building with a full basement and attached drive-up facility in Naperville, Illinois. This facility is owned by Oak Brook Bank. Opened in June, 1988.\nWarrenville - Approximately 4,400 square feet of leased space on the first floor of a two-story tudor-style building with a full basement and attached drive-up facility in Warrenville, Illinois. Formerly Warrenville Bank & Trust acquired April, 1983.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVarious actions and proceedings arising in the ordinary course of business are presently pending to which the Company or the subsidiary bank is a party. Management, after consulting with legal counsel, believes that the aggregate liabilities, if any, arising from such actions would not have a materially 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 a vote of shareholders during the fourth quarter of this year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSee page 48 and Notes 9 and 11 of the Notes to Consolidated Financial Statements on pages 45 and 46 of the Company's 1995 Annual Report to Shareholders which is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee \"Earnings Summary and Selected Consolidated Financial Data\" on page 22 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nSee \"Financial Review\" on pages 22 through 34, inclusive, of the Company'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 Consolidated Financial Statements and related notes are on pages 35 through 47, inclusive, of the Company's 1995 Annual Report to Shareholders, which 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\nSee \"Directors and Executive Officers\" on page 6 of the Company's Proxy Statement to be filed on or before April 5, 1996, which is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSee \"Summary Compensation Table\" and footnotes, \"Five Year Performance Comparison\" and \"Aggregated Option Exercises and Year-End Option Values Table\" and \"Option Grants Table\" on pages 10 through 14, inclusive, of the Company's Proxy Statement to be filed on or before April 5, 1996, which is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee \"Information Concerning Security Ownership of Certain Beneficial Owners and Management\" on pages 2 and 3 of the Company's Proxy Statement to be filed on or before April 5, 1996, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Certain Transactions\" on page 11 of the Company's Proxy Statement to be filed on or before April 5, 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\nANNUAL REPORT PAGE ---- (a) 1. The following financial statements are filed as part of this report:\nAnnual Report to Shareholders - Report of Independent Auditors 35 Consolidated Balance Sheets - December 31, 1995 and 1994 36 Consolidated Statements of Income for the Three Years Ended December 31, 1995 37 Consolidated Statements of Changes in Shareholders' Equity for The Three Years Ended December 31, 1995 38 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995 39 Notes to Consolidated Financial Statements 40-47\n2. Financial statement schedules: All schedules are omitted as they are not applicable or information is included in the consolidated financial statements or the notes thereto.\n(b) The following Reports on Form 8-K were filed during the last quarter of the period covered by this report: None\n(c) The following exhibits are included herein:\nExhibit (3) Articles of Incorporation including Amendments thereto and By Laws of First Oak Brook Bancshares, Inc. (Exhibit 3 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.1) Loan Agreement between First Oak Brook Bancshares, Inc. and LaSalle National Bank dated December 1, 1991 and amendments dated January 31, 1993 and March 31, 1994. (Exhibit 10.1 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.2) Lease Agreement between First Oak Brook Bancshares, Inc. and Oak Brook Bank dated November 8, 1991. (Exhibit 10.2 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.3) Data Processing Agreement between First Data Resources Inc. and Oak Brook Bank dated November 22, 1991. (Exhibit 10.3 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference.) Amendment thereto dated March 1, 1996 filed herewith.\nExhibit (10.4) First Oak Brook Bancshares, Inc. Employees' Stock Bonus Plan as amended and restated effective July 19, 1994. (Exhibit 10.4 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.5) First Oak Brook Bancshares, Inc. Amended and Restated 1987 Stock Option Plan effective September 21, 1987. (Exhibit 10.5 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.6) Lease Agreement between Oak Brook Bank, not personally, but solely as Trustee under Trust Agreement dated August 1, 1989 and known as Trust Number 2200 and Life Investors Insurance Co. of America, an Iowa Corporation, for Suite 300 of the Oak Brook Bank Building. (Exhibit 10.6 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.7) Lease Agreement between Oak Brook Bank, not personally, but solely as Trustee under Trust Agreement dated August 1, 1989 and known as Trust Number 2200 and CB Commercial Real Estate Group, Inc., a Delaware Corporation, for Suite 301 of the Oak Brook Bank Building. (Exhibit 10.7 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.8) License Agreement, between Jack Henry & Associates, Inc. and First Oak Brook Bancshares, Inc. dated March 10, 1993. (Exhibit 10.8 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.9) Form of Transitional Employment Agreement for Eugene P. Heytow, Richard M. Rieser, Jr. and Frank M. Paris. (Exhibit 10.9 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.10) Form of Transitional Employment Agreement for Senior Officers. (Exhibit 10.10 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.11) Form of Agreement Regarding Post-Employment Restrictive Covenants for Eugene P. Heytow, Richard M. Rieser, Jr. and Frank M. Paris. (Exhibit 10.11 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.12) Form of Supplemental Pension Benefit Agreement for Eugene P. Heytow. (Exhibit 10.12 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.13) Form of Supplemental Pension Benefit Agreement for Richard M. Rieser, Jr. (Exhibit 10.13 to the Company's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference).\nExhibit (10.14) Senior Executive Insurance Plan.\nExhibit (13) Annual Report to Shareholders.\nExhibit (21) Subsidiary of the Registrant.\nExhibit (23) Consent of Ernst & Young LLP.\nExhibit (27) Financial Data Schedule.\nExhibits 10.9 through 10.14 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) hereof.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 OAK BROOK BANCSHARES, INC. -------------------------------- (Registrant)\nBY: \/S\/EUGENE P. HEYTOW ------------------------------ (Eugene P. Heytow, Chairman of the Board and Chief Executive Officer)\nDATE: March 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 dates indicated.\nSignature Title Date - --------- ----- ----\n\/S\/EUGENE P. HEYTOW Chairman of the Board March 21, 1996 - --------------------------- and Chief Executive Eugene P. Heytow Officer\n\/S\/FRANK M. PARIS Vice Chairman of March 21, 1996 - --------------------------- the Board Frank M. Paris\n\/S\/RICHARD M. RIESER, JR. President, March 21, 1996 - --------------------------- Assistant Secretary, Richard M. Rieser, Jr. and Director\n\/S\/ALTON WITHERS Director March 21, 1996 - --------------------------- Alton Withers\n\/S\/MIRIAM LUTWAK FITZGERALD Director March 21, 1996 - --------------------------- Miriam Lutwak Fitzgerald\n\/S\/GEOFFREY R. STONE Director March 21, 1996 - --------------------------- Geoffrey R. Stone\n\/S\/ROBERT WROBEL Director March 21, 1996 - --------------------------- Robert Wrobel\n\/S\/ROSEMARIE BOUMAN Vice President, Chief March 21, 1996 - --------------------------- Financial Officer, Rosemarie Bouman Treasurer (Principal Accounting Officer)","section_15":""}
{"filename":"880416_1995.txt","cik":"880416","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE NORTHEAST UTILITIES SYSTEM\nNortheast Utilities (NU) is the parent company of the Northeast Utilities system (the System). NU is not an operating company. The System furnishes retail electric service in Connecticut, New Hampshire and western Massachusetts through four of NU's wholly owned subsidiaries (The Connecticut Light and Power Company [CL&P], Public Service Company of New Hampshire [PSNH], Western Massachusetts Electric Company [WMECO] and Holyoke Water Power Company [HWP]). In addition to their retail electric service, CL&P, PSNH, WMECO and HWP (including its wholly owned subsidiary, Holyoke Power and Electric Company [HPE]) (the System companies) together furnish firm wholesale electric service to five municipal electric systems and one investor-owned utility. The System companies also supply other wholesale electric services to various municipalities and other utilities. The System serves about 30 percent of New England's electric needs and is one of the 20 largest electric utility systems in the country as measured by revenues.\nNorth Atlantic Energy Corporation (NAEC) is a special-purpose subsidiary of NU that owns a 35.98 percent interest in the Seabrook nuclear generating facility (Seabrook) in Seabrook, New Hampshire and sells its share of the capacity and output from Seabrook to PSNH under two life-of-unit, full-cost recovery contracts.\nSeveral wholly owned subsidiaries of NU provide support services for the System companies and, in some cases, for other New England utilities. Northeast Utilities Service Company (NUSCO) provides centralized accounting, administrative, information resources, engineering, financial, legal, operational, planning, purchasing and other services to the System companies. North Atlantic Energy Service Corporation (NAESCO) has operational responsibility for Seabrook. Northeast Nuclear Energy Company (NNECO) acts as agent for the System companies and other New England utilities in operating the Millstone nuclear generating facilities in Connecticut. Three other subsidiaries construct, acquire or lease some of the property and facilities used by the System companies.\nNU has two other principal subsidiaries, Charter Oak Energy, Inc. (Charter Oak) and HEC Inc. (HEC), which have nonutility businesses. Directly and through subsidiaries, Charter Oak develops and invests in cogeneration, small- power production and other forms of nonutility generation and in exempt wholesale generators (EWGs)(collectively, NUGs) and foreign utility companies (FUCOs) as permitted under the Energy Policy Act of 1992 (Energy Policy Act). HEC provides energy management services for the System's commercial, industrial and institutional electric customers and others. See \"Nonutility Businesses.\"\nNU is functionally organized into two core business groups. The first group, the Energy Resources Group, is devoted to energy resource acquisition, nuclear, fossil and hydroelectric generation and wholesale marketing. The second group, the Retail Business Group, oversees all customer service, transmission and distribution operations and retail marketing in Connecticut, New Hampshire and Massachusetts. These two core business groups receive services from various support functions known collectively as the Corporate Center.\nPUBLIC UTILITY REGULATION\nThe System is regulated by various federal and state agencies.\nNU is regulated as a registered electric utility holding company under the Public Utility Holding Company Act of 1935 (1935 Act). Accordingly, the Securities and Exchange Commission (SEC) has jurisdiction over NU and its subsidiaries with respect to, among other things, securities issues, sales and acquisitions of securities and utility assets, intercompany loans, services performed by and for associated companies, certain accounts and records, involvement in nonutility operations and dividends. The 1935 Act limits the System, with certain exceptions, to the business of being an electric utility in the Northeastern region of the country. In 1995, the staff of the SEC recommended \"conditional repeal\" of the 1935 Act and substantial loosening of rules presently restricting NU's capital-raising and diversification activities. In 1995, a bill was introduced in the United States Senate to repeal the 1935 Act. To date these proposals have not been acted on.\nThe System companies are also subject to the Federal Power Act as administered by the Federal Energy Regulatory Commission (FERC). FERC regulates the wholesale power sales and interstate transmission service of the System. The Energy Policy Act amended the Federal Power Act to authorize FERC to order wholesale transmission wheeling services and under certain circumstances to require electric utilities to enlarge transmission capacity necessary to provide such services. FERC's authority to order wheeling does not extend to retail wheeling, and FERC may not issue a wheeling order that is inconsistent with state laws governing the retail marketing areas of electric utilities. For more information regarding retail wheeling, see \"Competition and Marketing-Retail Marketing\" and \"Rates.\"\nThe Nuclear Regulatory Commission (NRC) has broad jurisdiction over the System's nuclear units. Each of the System companies is subject to broad regulation by its respective state and\/or local regulatory authorities with jurisdiction over the service areas in which each company operates. For more information regarding recent NRC actions taken with respect to the System's nuclear units, including the recent designation of Millstone Station on the NRC's watch list, see \"Electric Operations-Nuclear Generation-Nuclear Plant Performance.\"\nThe System incurs substantial capital expenditures and operating expenses to identify and comply with environmental, energy, licensing and other regulatory requirements, including those described herein, and it expects to incur additional costs to satisfy further requirements in these and other areas of regulation. For more information regarding specific regulatory actions and proceedings, see generally \"Rates,\" \"Electric Operations\" and \"Regulatory and Environmental Matters.\"\nCOMPETITION AND MARKETING\nCOMPETITION AND COST RECOVERY\nCompetition in the energy industry continues to grow as a result of legislative and regulatory action, surplus generating capacity, technological advances, relatively high prices in certain regions of the country, including New England, and the increased availability of natural gas.\nA major risk of competition for many utilities, including the System, is \"strandable costs.\" These are costs that have been incurred by utilities in the past to meet their public service obligations, with the expectation that they would be recovered from customers in the future, and yet under certain circumstances might not be recoverable from customers in a fully competitive electric utility industry. The System's exposure to the risk of strandable costs is primarily based on: (i) the System's relatively high investment in nuclear generating capacity, which has a high initial cost to build; (ii) state-mandated purchased-power arrangements priced above market and (iii) significant regulatory assets, which are those costs (including purchased-power costs) that have been deferred by state regulators for future collection from customers.\nAs of December 31, 1995, the System's regulatory assets totaled approximately $2 billion. The System expects to recover substantially all of its regulatory assets from customers, and unless amortization is changed from currently scheduled rates, the System's regulatory assets are expected to be substantially decreased in the next five years. There are many contingencies, however, that may affect the System's ability to recover strandable costs, including the results of various electric utility restructuring initiatives in the System's service territory and the uncertainty of future rate schedules for CL&P, WMECO and PSNH.\nIn 1995, regulators in both Connecticut and Massachusetts concluded that electric utilities should be allowed a reasonable opportunity to recover strandable costs. There has been no such finding in New Hampshire; however, on February 22, 1996, PSNH and the staff of the New Hampshire Public Utilities Commission (NHPUC) reached an agreement, subject to further approvals, on a limited, retail wheeling program under which PSNH would recover all of its strandable costs allocable to this program.\nThe System believes that its assets would be worth more than their net depreciated value if all segments of the industry, not only generation, were to be deregulated and become competitive. These assets could include the transmission and distribution system and much of the System's coal-fired and hydroelectric generation.\nThe worst case scenario for the System would be for a rapid movement to an openly competitive market on terms such that all of its strandable costs cannot be recovered with little opportunity to realize the true value of below-market assets if such assets remain subject to traditional regulation. The System cannot predict at this time what will be the ultimate result of the various legislative and regulatory restructuring initiatives.\nCompetitive forces in the utility industry also create a risk that customers may choose alternative energy suppliers or relocate outside of the System's service territory. In response, the System has developed, and is continuing to develop, a number of marketing initiatives to retain and continue to serve its existing customers. In late 1994 the System began a reengineering process, which is ongoing, to become more competitive while improving customer service and maintaining a high level of operational performance.\nThe System's strandable cost risk and exposure to revenue loss from competitive forces are somewhat mitigated by a diverse customer retail base and lack of significant dependence on any one retail customer or industry.\nRETAIL MARKETING\nThe System companies continue to operate predominantly in state-approved franchise territories under traditional cost-of-service regulation. Retail wheeling, under which a retail customer would be permitted to select an electricity supplier other than its local electric utility and require the local electric utility to transmit the power to the customer's site, is not generally required in any of the System's jurisdictions. Emphasis on developing approaches to deregulation, however, is growing nationwide. For additional information regarding retail wheeling and electric industry restructuring initiatives in the System's service territory, see \"Rates.\"\nWhile retail wheeling is not yet generally required in the System's retail service territory, competitive forces nonetheless are influencing retail pricing. The System companies have been devoting increasing attention in recent years to negotiating long-term power supply arrangements with certain retail customers. Such arrangements are offered to customers who require an incentive to locate or expand their operations in the System's service territory, are considering leaving or reducing operations in the service territory, are facing short-term financial problems or are considering generating their own electricity.\nApproximately 6 percent of the System's retail revenues were under negotiated rate agreements at the end of 1995, up from 4 percent at the end of 1994. In 1995, those negotiated rate reductions amounted to approximately $35 million, up from $20 million in 1994. CL&P accounted for approximately $19 million of the 1995 rate reductions, PSNH for $7.5 million, WMECO for $7 million and HWP for $1.5 million. Management believes that the level of contractual rate reductions is likely to increase further in 1996, but that these agreements provide long-term benefits to the System by helping to stabilize retail revenues and attract additional retail load to its service territory. Currently, the costs of providing these discounts are borne by NU shareholders through reduced earnings prior to rate changes in the System's various jurisdictions. The System companies may request that such costs be shared by their customers during subsequent rate proceedings.\nRegulators in both Connecticut and New Hampshire took steps in 1995 that allowed electric utilities additional flexibility in negotiating special rate agreements with electric customers. In March 1995, the Connecticut Department of Public Utility Control (DPUC) approved new guidelines for CL&P's general rate riders that (i) allow CL&P to enter into special rate agreements of up to ten years with eligible customers, (ii) expand the eligibility for such rate agreements, (iii) authorize CL&P to provide additional services instead of rate concessions and (iv) lower the minimum pricing for such rate agreements. The Connecticut Consumer Counsel (CCC) appealed the DPUC's decision to the Connecticut Superior Court in May 1995, and the matter is pending. Previously, agreements with existing customers that were longer than five years had to be individually approved by the DPUC. CL&P's ten-year agreement with Pratt & Whitney, CL&P's largest industrial customer, was approved by the DPUC in June 1995 under the DPUC's previous rules.\nIn November 1995, the NHPUC issued guidelines permitting electric utilities to offer economic development and business retention rates. On February 23, 1996, the NHPUC issued an order accepting a package of rates submitted by PSNH that would result in rate reductions of up to 20 percent for existing manufacturers, who may close their business or move out of the state, and up to 30 percent for manufacturers creating new or expanded electric load. The order, however, includes a condition that prevents PSNH from recovering from other customers the difference between the economic development rates and full tariff rates, which would have the effect of PSNH losing money on each sale. As a result, PSNH will seek reconsideration by the NHPUC before deciding whether to offer an economic development rate. The order does not include the same restriction for business retention rates, and therefore, PSNH will proceed with the necessary tariff filings to offer these rates.\nIn 1994, the Massachusetts Department of Public Utilities (DPU) authorized WMECO to reduce rates by 5 percent for all customers whose demand exceeds one megawatt (MW) as long as those customers agree to give WMECO at least five years notice before generating their own power or purchasing it from an alternative supplier. The DPU also permits WMECO to offer specified discounts with a five- year term to attract new businesses and encourage business expansion in the state. The DPU must approve all other special rate agreements individually.\nDemand-side management (DSM) programs are also used by the System to make its customers more efficient and viable employers in its service territory. The System companies expect to spend approximately $50 million in 1996 on DSM programs. These programs help customers improve the efficiency of their electric lighting, manufacturing and heating, ventilating and air conditioning systems. DSM program costs are recovered from customers through various cost recovery mechanisms. For further information on the System's DSM programs, see \"Rates.\"\nThe System is continuing to expand its Retail Marketing organization to provide better customer service. Beginning in 1996, the System expects to devote significantly more resources to its retail marketing efforts. Much of the increased spending will be for developing new energy-related products and services and investing in technology that will be used to support new initiatives.\nWHOLESALE MARKETING\nThe System acts as both a buyer and a seller of electricity in the highly competitive wholesale electricity market in the Northeastern United States (Northeast). Because economic growth in this region has been modest since 1989 and because many new sources of power have become operational since that time, a significant surplus of generating capacity currently exists in New England and New York. As a result, wholesale electricity pricing is now significantly lower than it was in the late 1980s.\nAs a result of the continued expiration of some older, higher priced contracts, the System's wholesale revenues decreased to $303 million in 1995 from $331 million in 1994. Over the same period, sales of energy declined from 9.12 billion kilowatt-hours (KWh) in 1994 to 8.72 billion KWh in 1995. As a result of new contracts entered into in recent years, wholesale revenues in 1996 are expected to be comparable in amount to 1995.\nThe System's most important wholesale market at this time remains New England. Of the $303 million in total 1995 wholesale revenues, approximately $280 million came from sales to investor-owned, cooperative and municipal utilities in New England. Because most investor-owned utilities in New England have surplus generation, sales to those utilities have declined in recent years while sales to municipal utilities have increased. In 1995, revenues from sales to one new municipal customer, Madison Electric Works in Madison, Maine, were approximately $7 million. That load is expected to grow in the coming years as a paper company in Madison expands its operations.\nThe largest cooperative served by the System is the Connecticut Municipal Electric Energy Cooperative (CMEEC), which accounted for $71 million of wholesale revenues in 1995. Half of those sales resulted from a new ten-year agreement signed in January 1995 under which CMEEC buys power from CL&P on behalf of the Town of Wallingford, Connecticut. The contract price includes amortization of a lump sum payment to CL&P for early termination of a prior agreement with Wallingford directly for a comparable amount of System power sales.\nIn 1995, the System also had sales of $52 million to the New Hampshire Electric Cooperative (NHEC), approximately 90 percent of PSNH's wholesale revenues. NHEC is a party to a full-requirements power supply agreement with PSNH that cannot be terminated by its terms prior to November 1, 2006. In 1995, PSNH filed a complaint against NHEC with FERC challenging NHEC's decision to take bids on 20 megawatts (MW) of power, representing 14 percent of NHEC's total load, from qualifying facilities (QFs) to replace a comparable amount of capacity from PSNH supplied under the power supply agreement. PSNH believes that the solicitation of such bids violated the terms of its power supply agreement. That complaint is still pending at FERC and NHEC has not yet accepted any bids from new suppliers.\nThe System's second-largest wholesale market is New York State. In 1995, the System's sales to utilities in New York accounted for $14 million of revenues. Also in 1995, the Suffolk County Electric Agency announced that the System had won 200 MW of a 300-MW bid to provide base-load generation to customers in Suffolk County, Long Island. This contract, however, is subject to FERC approval and could be contested by other parties. Accordingly, it is unclear whether or when that contract will take effect.\nThe System also plans to expand its wholesale market through electric brokering activities and wholesale sales at market-based rates. On August 18, 1995, CL&P, PSNH, WMECO, NAEC and NUSCO received an order from the SEC under the 1935 Act allowing them to engage in electric brokering and marketing activities primarily throughout New England, New York, Pennsylvania, New Jersey and Maryland with both interconnected and remote parties. This order will allow the companies to arrange to both broker or buy and sell electricity from owned and contracted sources outside the System's retail service area. To date, the System has not received approval from FERC permitting it to sell power outside of New England at market-based rates.\nThe System's transmission system is an open-access wholesale transmission system: other parties, either utilities or independent power producers, can use NU's transmission system to move power from a seller to a wholesale buyer at FERC-approved rates, provided adequate capacity across those lines is available and service reliability is not endangered. See \"Electric Operations- Transmission Access\" for further information on pending FERC proceedings relating to the System's transmission tariffs.\nRATES CONNECTICUT RETAIL RATES\nGENERAL\nCL&P's retail rates are subject to the jurisdiction of the DPUC. Connecticut law provides that revised rates may not be put into effect without the prior approval of the DPUC. Connecticut law also authorizes the DPUC to order a rate reduction under certain circumstances before holding a full-scale rate proceeding. The DPUC is further required to review a utility's rates every four years if there has not been a rate proceeding during such period.\nThe DPUC issued a decision in CL&P's most recent rate case in June 1993 (1993 Decision) approving a multi-year rate plan that provided for annual retail rate increases of $46.0 million, or 2.01 percent, in July 1993, $47.1 million, or 2.04 percent, in July 1994 and $48.2 million, or 2.06 percent, in July 1995. These rate increases were implemented as scheduled. CL&P's rates in place as of July 1995 will remain in effect after July 1, 1996 unless a rate change is approved by the DPUC. For more information regarding the 1993 Decision, see \"Item 3. Legal Proceedings.\"\nELECTRIC INDUSTRY RESTRUCTURING IN CONNECTICUT\nThroughout the first half of 1995, the DPUC conducted a generic proceeding studying the restructuring of the electric industry and competition in order to develop findings and recommendations to be presented to legislative policymakers. In March 1995, as part of this proceeding, CL&P introduced its plan, entitled \"Path to a Competitive Future,\" for the future of the electric industry and related regulation in Connecticut. The plan calls for full recovery of all existing plant and regulatory assets and a fully competitive market for electricity by approximately 2003.\nOn July 14, 1995, the DPUC issued its final decision in this proceeding. The decision stressed the importance of retaining the benefits of the existing electric system, which it described as the \"least costly and most reliable in the world.\" One key conclusion was that retail access could result in benefits to customers under certain circumstances, but addressing the many transition issues must precede such access. In addition, the decision concluded that utilities are entitled to a reasonable opportunity to recover costs potentially strandable by the evolution toward competitive markets. The decision did not specify any particular time-frame for competition.\nIn February 1996, the Connecticut Legislative Task Force for restructuring the electric industry issued its interim report to the legislature. The report broadly establishes certain restructuring goals, including lowering electric prices (possibly through, among other things, a reduction in the gross earnings tax on electric revenues) and assuring reliable electric service to all customers. A final report to the legislature is due by January 1, 1997.\nCL&P ADJUSTMENT CLAUSES\nCL&P has a fossil fuel adjustment clause (FAC) which adjusts retail rates for changes in the price of fossil fuel reflected in base rates. If the price of fossil fuel increases above the level reflected in base rates, CL&P can recover the amount of the increase from retail customers on a current basis, subject to periodic review by the DPUC. Conversely, if the price of fossil fuel decreases below the level reflected in base rates, CL&P must credit the amount of the decrease on a current basis to its customers through the FAC. The FAC also adjusts retail rates for the costs of power purchased from third parties, including NUGs. On December 28, 1995, the DPUC approved, in significant part, CL&P's request to exclude from the calculation of the FAC rate both the fuel costs and the KWh sales of CL&P's firm and non-firm wholesale sales, thus neutralizing the effect of these sales on the fuel clause and eliminating a critical disincentive to making such sales.\nCL&P's current retail rates also assume that the nuclear units in which CL&P has entitlements will operate at a 72 percent composite capacity factor. A generation utilization adjustment clause (GUAC) levels the effect on rates of fuel costs incurred or avoided due to variations in nuclear generation above and below that performance level. Because nuclear fuel is less expensive than any other fuel utilized by the System, when actual nuclear performance is above the specified level, net fuel costs are lower than the costs reflected in base rates and when nuclear performance is below the specified level, net fuel costs are higher than the costs reflected in base rates. At the end of each 12-month period ending July 31, these net variations from the costs reflected in base rates are, with DPUC approval, generally refunded to or collected from customers over the subsequent 12-month period beginning September 1.\nFor the 1992-1993 and 1993-1994 GUAC periods, the DPUC issued decisions that disallowed $7.9 million and $7.8 million, respectively, of the GUAC deferrals accrued during these periods, finding that CL&P had overrecovered those amounts through base rate fuel recoveries. CL&P appealed both of these decisions and prevailed in the Connecticut Superior Court. The DPUC and other parties then appealed that court's decisions to the Connecticut Supreme Court. Oral argument before the Supreme Court will be held in the Spring of 1996.\nOn January 17, 1995, the DPUC issued a decision that allowed CL&P to continue to recover $80 million of the GUAC costs for the 1994-95 GUAC period (net of $19 million of asserted base fuel overrecoveries for the period) over an 18-month period (instead of the usual 12 months) beginning in September 1995. CL&P has appealed the $19 million that was set aside from its allowed recovery and will seek to join its appeal on this decision to the appeals currently pending before the Connecticut Supreme Court. The DPUC's decision on the 1994- 1995 GUAC period is also subject to the results of prudence reviews of the extended 1994-1995 outage at Millstone 2 and another 1994 Millstone 2 outage discussed below. For additional information regarding recent nuclear outages, see \"Electric Operations-Nuclear Generation-Nuclear Plant Performance.\"\nIn August 1995, the DPUC began investigating the adoption of a fuel clause designed to track and recover all costs of energy incurred to serve customers, which would supersede the current FAC and GUAC. A final decision is scheduled for April 1996.\nThe DPUC has conducted several reviews to examine the prudence of certain costs, including purchased-power costs, incurred in connection with outages at various nuclear units located in Connecticut, that occurred during the period July 1991 to February 1992. Three of these prudence reviews are still pending at the DPUC. Approximately $92 million of costs are at issue in these remaining cases. Management believes its actions with respect to these outages have been prudent and does not expect the outcome of the appeals to result in material disallowances.\nOn April 10, 1995, the DPUC initiated a proceeding to investigate the prudence of an extended outage at Millstone 2, which ended on June 18, 1994, involving the repair of damage to a reactor coolant pump. Approximately $13 million of replacement power costs related to the outage are at issue in this proceeding. Hearings in this proceeding are expected to begin in March 1996.\nDEMAND-SIDE MANAGEMENT\nCL&P participates in a collaborative process for the development and implementation of DSM programs for its residential, commercial and industrial customers. CL&P is allowed to recover DSM costs in excess of costs reflected in base rates over periods ranging from approximately four to ten years.\nOn April 12, 1995, the DPUC issued an order approving CL&P's budget of $36.7 million for 1995 DSM expenditures and an amortization period for new expenditures of approximately four years. On October 3, 1995, CL&P filed its 1996-1997 DSM programs and budgets with the DPUC. CL&P proposed a budget level of $37.1 million for 1996 DSM expenditures and an amortization period for new expenditures of approximately 2.4 years. CL&P's unrecovered DSM costs at December 31, 1995, excluding carrying costs, which are collected currently, were approximately $117 million.\nNEW HAMPSHIRE RETAIL RATES\nGENERAL\nPSNH's 1989 Rate Agreement (Rate Agreement) with the state of New Hampshire provides for seven base rate increases of 5.5 percent per year beginning in 1990 and a comprehensive fuel and purchased power adjustment clause (FPPAC). The first six base rate increases went into effect as scheduled and the remaining base rate increase is scheduled to be put into effect on June 1, 1996, concurrently with the semiannual adjustment for the FPPAC. Political and economic pressures, caused by PSNH's high retail electric rates, may force PSNH to accept less than an additional 5.5 percent rate increase scheduled for 1996, including an FPPAC increase; may lead to challenges to the Rate Agreement in the future; and may make recoveries of deferred costs after June 1, 1997 more difficult. The Rate Agreement provides that PSNH's rates will be subject to traditional rate regulation after the fixed rate period expires on June 1, 1997, but that the FFPAC will continue through June 1, 2000. The base rates effective as of June 1, 1996 will remain in effect after June 1, 1997 unless a rate change is approved by the NHPUC. For additional information regarding a recent lawsuit concerning the Rate Agreement, see \"Item 3. Legal Proceedings.\"\nELECTRIC INDUSTRY RESTRUCTURING IN NEW HAMPSHIRE\nOn February 22, 1996, PSNH and the staff of the NHPUC reached an agreement that, if approved by the NHPUC, would resolve the terms of PSNH's participation in an Electric Retail Competition Pilot Program (Program) in New Hampshire. Under this agreement, PSNH will provide access to approximately 3 percent of its retail customers (35.13 MW) to other electric suppliers. PSNH will charge participating customers for delivery services, comprised of distribution, transmission, acquisition premium and access charge components. PSNH would recover all strandable costs through these charges. Only the energy portion of its tariffs, which account for approximately 20 percent of PSNH's typical retail bill, would be exposed to alternative suppliers. Program participants will also receive a 10 percent \"incentive rebate\" off PSNH's traditional rates to encourage participation in the Program. The System estimates that, due to the 10 percent incentive feature, the Program, if implemented as proposed, could cost PSNH approximately $5 million over its two-year term.\nThe settlement terms are not binding on any future restructuring programs. The System companies also need FERC approval to allow Program participants access to the System's transmission system. Although the Program is scheduled to begin on May 28, 1996, this date is subject to both state and federal regulatory approvals.\nIf the above-settlement is not approved by the NHPUC, PSNH could be subject to the final guidelines for the Program issued by the NHPUC on February 28, 1996. The guidelines propose a two-year retail wheeling experiment under which a selected group of retail customers aggregating 50 MW of demand would be free to purchase power from suppliers other than their franchised local utility. Strandable costs resulting from the Program would be split equally between utility investors and participating customers, but, if requested, the NHPUC would allow for a review of these costs after the conclusion of a separate strandable cost proceeding.\nOn January 9, 1996, legislation was introduced in New Hampshire, requiring electric utilities to submit restructuring plans to the NHPUC by June 30, 1996, with final approval by June 30, 1997. The NHPUC would be further directed to implement full retail competition by June 30, 1998 or at the earliest date determined to be in the public interest by the NHPUC.\nUnder the New Hampshire's Limited Electrical Energy Producers Act (LEEPA), a qualifying generator of not greater than 5-MW capacity is permitted to sell its output to up to three retail customers. LEEPA also provides that the local franchised utility could be ordered to wheel the energy to these retail customers. On January 8, 1996, the NHPUC issued an order stating that the LEEPA retail wheeling provision was not pre-empted by federal law and that it had authority to order such retail wheeling service if it was found to be in the public good.\nIn 1994, Freedom Electric Power Company, now known as Freedom Energy Company, LLC (Freedom), filed a petition with the NHPUC for permission to operate as a retail electric utility selling to large industrial customers in New Hampshire, including customers of PSNH. On June 6, 1995, the NHPUC determined that electric utility franchises in New Hampshire are not exclusive as a matter of law. PSNH appealed this decision to the New Hampshire Supreme Court. Oral arguments on the appeal were heard on February 8, 1996. Pending this appeal and the related FERC proceeding referenced below, the NHPUC has delayed further activity in the underlying proceeding, including whether to allow Freedom to operate as a retail electric utility.\nOn July 14, 1995, Freedom filed a petition for declaratory ruling with FERC requesting a ruling that it is entitled to transmission access from PSNH. PSNH and numerous parties seeking intervenor status in this proceeding have filed comments with FERC opposing Freedom's petition as a sham transaction prohibited by the Energy Policy Act.\nFPPAC\nThe FPPAC provides for the recovery or refund by PSNH, for the ten-year period beginning on May 16, 1991, of the difference between its actual prudent energy and purchased power costs and the estimated amounts of such costs included in base rates established by the Rate Agreement. The FPPAC amount is calculated for a six-month period based on forecasted data and is reconciled to actual data in subsequent FPPAC billing periods.\nFor the period December 1, 1994 through November 30, 1995, the NHPUC approved a continuation of the FPPAC rate that had been in effect during the last half of 1994. This rate treatment allowed PSNH to limit overall rate increases in 1995 to a level that did not exceed an overall 5.5 percent increase, while maintaining an FPPAC rate level sufficient to collect 1994 Seabrook refueling costs. On November 27, 1995, the NHPUC approved a zero rate for the FPPAC period December 1, 1995 through May 31, 1996 that resulted in a 2.6 percent decrease in rates.\nOn April 4, 1995, the NHPUC opened a proceeding to consider whether under the Rate Agreement PSNH may recover its $28 million of expenditures-including approximately $22 million for pollution control additions at the Merrimack fossil generating station-and approximately $3.5 million of annual operating and maintenance expenses necessary for current compliance with the Clean Air Act Amendments of 1990 (CAAA) at PSNH's fossil generating stations. Also at issue is the prudence of PSNH's use of the selective catalytic reduction technology at Merrimack Station's Unit 2. Since June 1, 1995, the NHPUC has allowed PSNH to collect its CAAA costs through FPPAC until there is a final decision in this proceeding. For more information regarding the CAAA, see \"Regulatory and Environmental Matters-Environmental Regulation-Air Quality Requirements.\"\nNUGs\nThe costs associated with purchases by PSNH from certain NUGs at prices above the level assumed in rates are deferred and recovered through the FPPAC over ten years. As of December 31, 1995, NUG deferrals, including the remaining buy-out of two wood-fired NUGs discussed below, totaled approximately $192 million.\nUnder the Rate Agreement, PSNH and the State of New Hampshire have an obligation to use their best efforts to renegotiate burdensome purchased power arrangements with 13 specified NUGs that were selling their output to PSNH under long-term rate orders. If authorized, PSNH will exchange near-term cash payments for partial relief from high-cost purchased power obligations to the NUGs, with such payments and an associated return on the unamortized portion being recoverable from customers in a future amortization period.\nIn 1994, the NHPUC approved new purchased power agreements with five hydroelectric NUGs, which management anticipates will result in a decrease in payments to these NUGs during a year with normal waterflow of approximately 14 percent, or $1.4 million per year. The first of these new power purchase agreements will expire in 2022.\nIn addition, PSNH has been involved in negotiations with eight wood-fired NUGs. In September 1994, the NHPUC approved settlement agreements with two of these wood-fired NUGs covering approximately 20 MW of capacity. Pursuant to the settlement agreements, PSNH paid the owners approximately $40 million in exchange for the cancellation of the rate orders under which these NUGs sold their entire output at rates in excess of PSNH's replacement power costs. As of December 31, 1995, PSNH had not yet recovered the approximately $34.2 million of deferred costs remaining to be collected on these settlement agreements. These NUGs also agreed not to compete with PSNH or other System subsidiaries in New Hampshire.\nPSNH has reached agreements, subject to NHPUC approval, with the six remaining NUGs. The NHPUC will conduct hearings on four of the final settlement agreements during the first half of 1996, while the parties finalize the terms of the two remaining agreements. The six agreements could result in net savings of approximately $430 million to PSNH's customers over a period of 20 years following guaranteed payments of approximately $250 million. If the NHPUC fails to provide for full recovery of strandable costs, however, management would reevaluate whether to proceed with the NUG buydown agreements.\nUNAMORTIZED PSNH ACQUISITION COSTS\nThe Rate Agreement also provides for the recovery by PSNH through rates of unamortized PSNH acquisition costs, which is the aggregate value placed by PSNH's reorganization plan on PSNH's assets in excess of the net book value of its non-Seabrook assets and the value assigned to Seabrook. The unrecovered balance of the unamortized PSNH acquisition costs at December 31, 1995 was approximately $588.9 million. In accordance with the Rate Agreement, approximately $143 million of this amount is scheduled to be amortized and recovered through rates by 1998, and the remaining amount, approximately $446 million, is being amortized and will be recovered through rates by 2011. PSNH earns a return each year on the unamortized portion of the cost. For more information regarding PSNH's recovery of these costs after 1997, see \"Unamortized PSNH Acquisition Costs\" in the notes to NU's financial statements and \"Unamortized Acquisition Costs\" in the notes to PSNH's financial statements.\nDEMAND-SIDE MANAGEMENT\/LEAST COST PLANNING\nOn January 29, 1996, the NHPUC approved a settlement in PSNH's DSM proceeding authorizing a 1996 budget of approximately $4.3 million, including direct program costs plus the recovery of certain lost revenues attributable to the program of approximately $2.8 million.\nOn April 10, 1995, in connection with PSNH's 1994 integrated least-cost resource plan filing, the NHPUC ordered PSNH to conduct future least-cost planning by evaluating resource options available to PSNH based on the economics of only the PSNH system, rather than the combined NU system. This ruling could have an adverse effect on the System's future resource planning.\nSEABROOK POWER CONTRACTS\nPSNH and NAEC have entered into two power contracts that obligate PSNH to purchase NAEC's 35.98 percent ownership of the capacity and output of Seabrook for the term of Seabrook's NRC operating license and to pay NAEC's \"cost of service\" during this period, whether or not Seabrook continues to operate. NAEC's cost of service includes all of its prudently incurred Seabrook-related costs, including maintenance and operation expenses, cost of fuel, depreciation of NAEC's recoverable investment in Seabrook and a phased-in return on that investment. The payments by PSNH to NAEC under these contracts constitute purchased power costs for purposes of the FPPAC and are recovered from customers under the Rate Agreement. Decommissioning costs are separately collected by PSNH in its base rates. See \"Rates-New Hampshire Retail Rate-General\" and \"- FPPAC\" for information relating to the Rate Agreement. At December 31, 1995, NAEC's net utility plant investment in Seabrook was approximately $707.1 million.\nIf Seabrook were retired prior to the expiration of its NRC operating license term, NAEC would continue to be entitled under the contracts to recover its remaining Seabrook investment and a return on that investment and its other Seabrook-related costs over a 39-year period, less the period during which Seabrook has operated.\nThe contracts provide that NAEC's return on its \"allowed investment\" in Seabrook (its investment in working capital, fuel, capital additions after the date of commercial operation and a portion of the initial investment) is calculated based on NAEC's actual capitalization over the term of the contracts, its actual debt and preferred equity costs and a common equity cost of 12.53 percent for the first ten years of the contracts, and thereafter at an equity rate of return to be fixed in a filing with FERC. The portion of the initial investment, which is included in the allowed investment, has increased annually since May 1991 and will reach 100 percent by May 31, 1996. As of December 31, 1995, 85 percent of the initial investment was included in rates.\nNAEC is entitled to earn a deferred return on the portion of the initial investment not yet phased into rates. The deferred return on the excluded portion of the initial investment, together with a return on it, will be recovered between 1997 and 2001. At December 31, 1995, the amount of this deferred return was $162.4 million. For additional information regarding the contracts, see \"Seabrook Power Contracts\" in the notes to PSNH's financial statements.\nMASSACHUSETTS RETAIL RATES\nGENERAL\nWMECO's retail rates are subject to the jurisdiction of the DPU. The rates charged under HWP's contracts with industrial customers are not subject to the ratemaking jurisdiction of any state or federal regulatory agency.\nIn 1994, the DPU approved a settlement offer from WMECO and the Massachusetts Attorney General (AG) that, among other things, provided that WMECO's customers' overall bills would be reduced by approximately $13.3 million over a 20-month period from June 1, 1994 to January 31, 1996. Under the 1994 settlement agreement, base rates would revert to their pre-settlement level after February 1, 1996, resulting in a 2.4 percent rate increase. WMECO, however, did not increase its rates on February 1, 1996, pending settlement negotiations.\nOn February 27, 1996, WMECO and the AG submitted a proposed settlement to the DPU that would continue the rate reduction first instituted in June 1994. The settlement provides, among other things, that WMECO's rates remain about 2.4 percent lower than otherwise authorized (a reduction of approximately $8 million per year) through February 1998. In addition, the agreement accelerates WMECO's recovery of strandable costs by an additional $5.8 million in 1996 and $10 million in 1997. The terms of the settlement were put into effect as of March 1, 1996, but are subject to final DPU approval.\nELECTRIC INDUSTRY RESTRUCTURING IN MASSACHUSETTS\nIn February 1995, the DPU began an investigation into electric industry restructuring in Massachusetts. On March 31, 1995, WMECO submitted its plan for the future of the electric industry entitled \"Path To A Competitive Future\" to the DPU. WMECO's comments paralleled those submitted by CL&P to the DPUC in March 1995. See \"Rates-Connecticut Retail Rates-Electric Industry Restructuring in Connecticut.\" On August 16, 1995, the DPU found that it was in the public interest that electric utilities have an opportunity to recover net, nonmitigatable strandable costs during a transition to full competition, which period is to be no longer than ten years. Strandable costs are to be recovered by a mandatory charge. The DPU also ordered WMECO and two other Massachusetts utilities to submit, by February 16, 1996, plans for moving to a competitive generation market, retail choice of electric suppliers and incentive regulation for transmission and distribution.\nOn February 16, 1996, WMECO filed its restructuring plan with the DPU. WMECO's plan, if implemented, would institute a stable five-year rate path based on performance incentives; a universal service charge to recover \"net\" strandable costs; a comprehensive approach to pay off rapidly strandable costs; and rate design modifications that reflect more market influence. In addition, WMECO's plan would put into place the structural changes needed for a more competitive retail marketplace by proposing illustrative rates which unbundle charges for generation, distribution, transmission and ancillary services; building the information system necessary to provide customers the data to make informed choices within a competitive market; developing rules necessary to provide fair competition and adequate customer protection in a competitive retail market; and proposing pilot programs to test customer choice of alternate suppliers of energy.\nSeveral other utilities and the Massachusetts Division of Energy Resources (DOER) also filed restructuring plans with the DPU. The DOER plan requires, among other things, (i) total retail choice by January 1, 1998; (ii) the separation of presently regulated electric utility into unregulated generation and regulated distribution companies by January 1, 2001; and (iii) the use of a market-based valuation process (e.g., auction) for identifying and mitigating strandable costs. A final schedule for implementation of a Massachusetts restructuring plan has not yet been issued.\nWMECO FUEL ADJUSTMENT CLAUSE AND GENERATING UNIT OPERATING PERFORMANCE\nIn Massachusetts, all fuel costs are collected on a current basis by means of a forecasted semi-annual fuel clause, which is trued up periodically. The DPU must hold public hearings before permitting semi-annual adjustments in WMECO's retail fuel adjustment clause. In addition to energy costs, the fuel adjustment clause includes capacity and transmission charges and credits that result from short-term transactions with other utilities and from certain FERC- approved contracts among the System operating companies.\nMassachusetts law establishes an annual performance program related to fuel procurement and use and requires the DPU to review generating unit performance and related fuel costs. Fuel clause revenues collected in Massachusetts are subject to potential refund, pending the DPU's examination of the actual performance of WMECO's generating units. The DPU has found that possession of a minority ownership interest in a generating plant does not relieve a company of its responsibilities for the prudent operation of that plant. Accordingly, the DPU has established goals for the three Millstone units and for the three regional nuclear operating units (the Yankee plants) in which WMECO has ownership interests.\nThe DPU has initiated prudence reviews of WMECO's 1993-1994 and 1994-1995 generating unit performances. Pursuant to the terms of the February 27, 1996 settlement proposal discussed above and subject to DPU approval, these prudence reviews would be terminated. In addition the settlement precludes any prudence review concerning the extended 1994-1995 Millstone 2 outage.\nDEMAND-SIDE MANAGEMENT\nIn 1992, the DPU established a conservation charge (CC) to be included in WMECO's customers' bills. The CC includes incremental DSM program costs above or below base rate recovery levels, lost fixed-cost recovery adjustments and the provision for a DSM incentive mechanism.\nOn August 24, 1995 and November 27, 1995, the DPU issued decisions limiting WMECO's recovery of lost base revenues in calendar year 1996 to those revenues lost due to implementation of conservation-related costs in the most recent three-year period. The DPU decision did not affect 1995 revenues, but the three-year limit on recovery is expected to reduce 1996 revenues by approximately $5.5 million.\nOn January 17, 1996, the DPU approved a two-year settlement proposal that resolves WMECO's DSM-related proceedings before the DPU. The settlement resolves: (i) DSM budget levels for 1996 and 1997 (at $12.4 million and $11.9 million, respectively); (ii) the CC for each rate class for 1996 and 1997; and (iii) energy savings associated with past DSM activity. The DSM budget levels agreed upon for 1996 and 1997 are considerably lower than the $15.8 million in effect for 1995.\nThe February 27, 1996 settlement proposal of WMECO and the AG, however, modifies, in part, the above-referenced DSM decisions. If approved by the DPU, the settlement would shift $8 million now included in the CC as lost base revenues into base rates.\nRESOURCE PLANS\nCONSTRUCTION\nThe System's construction program in the period 1996 through 2000 is estimated as follows:\n1996 1997 1998 1999 2000 (Millions)\nCL&P $154.6 $172.9 $155.3 $146.0 $147.6\nPSNH 51.5 38.2 36.9 41.8 32.5\nWMECO 30.4 44.2 42.4 34.0 33.8\nNAEC 6.0 6.6 6.9 7.2 7.4\nOTHER 22.6 5.1 3.2 2.0 1.9\nTOTAL $265.1 $267.0 $244.7 $231.0 $223.2 ====== ====== ====== ====== ======\nThe construction program data shown above include all anticipated capital costs necessary for committed projects and for those reasonably expected to become committed, regardless of whether the need for the project arises from environmental compliance, nuclear safety, reliability requirements or other causes. The construction program's main focus is maintaining and upgrading the existing transmission and distribution system and nuclear and fossil-generating facilities.\nThe construction program data shown above generally include the anticipated capital costs necessary for fossil generating units to operate at least until their scheduled retirement dates. Whether a unit will be operated beyond its scheduled retirement date, be deactivated or be retired on or before its scheduled retirement date is regularly evaluated in light of the System's needs for resources at the time, the cost and availability of alternatives and the costs and benefits of operating the unit compared with the costs and benefits of retiring the unit. Retirement of certain of the units could, in turn, require substantial compensating expenditures for other parts of the System's bulk power supply system. Those compensating capital expenditures have not been fully identified or evaluated and are not included in the table.\nFUTURE NEEDS\nThe System periodically updates its long-range resource needs through its integrated demand and supply planning process. The System does not foresee the need for any new major generating facilities at least until 2011.\nThe System's long-term plans rely, in part, on certain DSM programs. These System company sponsored measures, including installations to date, are projected to lower the System summer peak load in 2011 by 752 MW and lower the winter peak load as of January 1, 2012 by 495 MW. See \"Rates\" for information about rate treatment of DSM costs.\nIn addition, System companies have long-term arrangements to purchase the output from certain NUGs under federal and state laws, regulations and orders mandating such purchases. NUGs supplied 649 MW of firm capacity in 1995. This is the maximum amount that the System companies expect to purchase from NUGs for the foreseeable future. See \"Rates-New Hampshire Retail Rates- NUGs\" for information concerning PSNH's efforts to renegotiate its agreements with 13 NUGs and \"CL&P Cogeneration Costs\" in the notes to NU's financial statements and \"Cogeneration Costs\" in the notes to CL&P's financial statements for information regarding CL&P's termination of one of its purchased-power agreements.\nThe System's long-term resource plan also considers the economic viability of continuing the operation of certain of the System's fossil fuel generating units beyond their current book retirement dates. Continued operation of existing fossil fuel units past their book retirement dates (and replacing certain critically located peaking units if they fail) is expected to provide approximately 2,300 MW of resources by 2011 that would otherwise have been retired.\nThe System's need for new resources may be affected by unscheduled retirements of its existing generating units, regulatory approval of the continued operation of fossil fuel units and nuclear units past scheduled retirement dates and deactivation of plants resulting from environmental compliance or licensing decisions.\nFINANCING PROGRAM\n1995 FINANCINGS\nOn January 23, 1995, CL&P Capital, L.P. (CL&P LP) issued $100 million of 9.3 percent Cumulative Monthly Income Preferred Securities (MIPS), Series A. CL&P is the sole general partner of CL&P LP and is the guarantor of the MIPS securities. The net proceeds from the issuance and sale of MIPS, along with the proceeds of short-term debt, were used to retire $67.5 million of CL&P's 1989 Series 9 percent preferred stock and $50 million of variable-rate 1989 Dutch Auction Rate Transferable Securities.\nIn December 1995, NAEC completed a $225 million variable rate note facility with a group of banks. NAEC retired $205 million principal amount of its 15.23 percent notes, due 2000, in early November 1995, with funding in early December 1995 from the proceeds of the variable rate note facility. Interest rate swap agreements were entered into to effectively convert the interest rate on the new notes from variable to fixed. Under the terms of the interest rate swap agreements, the effective interest rate on the new notes is 7.05 percent. The refinancing is expected to save approximately $4 million annually over the next five years.\nTotal System debt, including short-term and capitalized leased obligations, was $4.25 billion as of December 31, 1995, compared with $4.54 billion as of December 31, 1994 and $4.88 billion as of December 31, 1993. For more information regarding 1995 financings, see Notes to Consolidated Statements of Capitalization of NU's financial statements and \"Short-Term Debt\" in the notes to CL&P's, PSNH's, WMECO's and NAEC's financial statements.\n1996 FINANCING REQUIREMENTS\nThe System's aggregate capital requirements for 1996, exclusive of requirements under the Niantic Bay Fuel Trust (NBFT) and a one percent sinking and improvement fund for CL&P and WMECO, are as follows:\nTotal CL&P PSNH WMECO NAEC Other System\n(Millions) Construction........... $154.6 $51.5 $30.4 $6.0 $22.6 $265.1 Nuclear Fuel...... - 1.8 - 0.6 - 2.4 Maturities............. - 172.5 - - - 172.5 Cash Sinking-funds..... 9.4 - 1.5 20.0 16.3 47.2 ------ ------ ----- ----- ----- ------\nTotal............ $164.0 $225.8 $31.9 $26.6 $38.9 $487.2 ====== ====== ===== ===== ===== ======\nFor further information on NBFT and the System's financing of its nuclear fuel requirements, see \"Leases\" in the notes to NU's, CL&P's and WMECO's financial statements. For further information on the System's 1996 and five-year financing requirements, see \"Notes to Consolidated Statements of Capitalization\" in NU's financial statements and \"Long-Term Debt\" in the notes to CL&P's, PSNH's and WMECO's financial statements.\n1996 FINANCING PLANS\nThe System Companies propose to finance their 1996 requirements, through both internal cash flow and external funds, with internally generated funds expected to provide substantially all of the necessary funds for the System. This estimate excludes the nuclear fuel requirements financed through the NBFT and any additional financing needed in connection with the PSNH NUGs settlements, but includes assumed funding of liability for prior spent nuclear fuel in the amounts of $160.2 million for CL&P and $38.6 million for WMECO. For more information regarding the NUGs settlements, see \"Rates-New Hampshire Retail Rates-NUGs.\" In addition to financing their 1996 requirements, the System companies intend, if market conditions permit, to continue to refinance a portion of their outstanding long-term debt and preferred stock, if that can be done advantageously.\nIn April 1995, NU began issuing NU common stock to fund its Dividend Reinvestment Plan (DRP). The total amount financed through the DRP in 1995 was approximately $41 million. NU expects to raise approximately the same amount of capital through the DRP in 1996.\nCL&P intends to issue through the Connecticut Development Authority $62 million principal amount of Pollution Control Revenue Bonds in the first half of 1996. The net proceeds of these bonds will be used to reimburse CL&P for its share of the cost of pollution control and solid waste disposal facilities at Millstone 3. PSNH also intends to establish a new $225 million revolving credit agreement in the second quarter of 1996 to replace its existing $125 million revolving credit agreement, which expires in May 1996. This credit facility will be used by PSNH primarily for refunding of a $172.5 million principal amount issue of maturing first mortgage bonds and for working capital purposes.\nOn October 18, 1995, Moody's Investors Service lowered its ratings of PSNH and NAEC securities, bringing the rating for PSNH's First Mortgage Bonds below investment grade. Standard and Poor's had previously downgraded PSNH's first mortgage bonds below investment grade. NAEC's securities have never been rated investment grade by either agency. With both of the major nationally recognized securities rating organizations that rate PSNH and NAEC securities rating them below investment grade, PSNH's and NAEC's borrowing costs have increased and the future availability and cost of funds for those companies could be restricted.\nFINANCING LIMITATIONS\nThe amounts of short-term borrowings that may be incurred by NU, CL&P, PSNH, WMECO, HWP and NAEC are subject to periodic approval by the SEC under the 1935 Act. Effective June 28, 1995, the SEC no longer regulates the short-term borrowings of NU's non-utility subsidiary companies from nonaffiliates or through the Northeast Utilities System Money Pool (Money Pool).\nThe following table shows the amount of short-term borrowings authorized by the SEC for each company as of January 1, 1996 and the amounts of outstanding short-term debt of those companies at the end of 1995.\nMaximum Authorized Short-Term Debt Short-Term Debt Outstanding at 12\/31\/95* (Millions) NU.................. $ 150 $ 58 CL&P ............... 325 52 PSNH ............... 175 - WMECO............... 60 24 HWP................. 5 - NAEC................ 50 8 NNECO............... ** - RRR................. ** 17 Quinnehtuk.......... ** 5 HEC................. ** 2 ---\nTotal $ 166\n* This column includes borrowings of various System companies from NU and other System companies through the Money Pool. Total System short-term indebtedness to unaffiliated lenders was $99 million at December 31, 1995.\n** Effective June 28, 1995, the SEC no longer regulates the short-term debt issuances of these companies.\nThe supplemental indentures under which NU issued $175 million in principal amount of 8.58 percent amortizing notes in December 1991 and $75 million in principal amount of 8.38 percent amortizing notes in March 1992 contain restrictions on dispositions of certain System companies' stock, limitations of liens on NU assets and restrictions on distributions on and acquisitions of NU stock. Under these provisions, neither NU, CL&P, PSNH nor WMECO may dispose of voting stock of CL&P, PSNH or WMECO other than to NU or another System company, except that CL&P may sell voting stock for cash to third persons if so ordered by a regulatory agency so long as the amount sold is not more than 19 percent of CL&P's voting stock after the sale. The restrictions also generally prohibit NU from pledging voting stock of CL&P, PSNH or WMECO or granting liens on its other assets in amounts greater than 5 percent of the total common equity of NU. As of December 31, 1995, no NU debt was secured by liens on NU assets. Finally, NU may not declare or make distributions on its capital stock, acquire its capital stock (or rights thereto), or permit a System company to do the same, at times when there is an event of default under the supplemental indentures under which the amortizing notes were issued.\nThe charters of CL&P and WMECO contain preferred stock provisions restricting the amount of unsecured debt those companies may incur. As of December 31, 1995, CL&P's charter would permit CL&P to incur an additional $466 million of unsecured debt and WMECO's charter would permit it to incur an additional $112 million of unsecured debt.\nIn connection with NU's acquisition of PSNH, certain financial conditions intended to prevent NU from relying on CL&P resources if the PSNH acquisition strains NU's financial condition were imposed by the DPUC. The principal conditions provide for a DPUC review if CL&P's common equity falls to 36 percent or below, require NU to obtain DPUC approval to secure NU financings with CL&P stock or assets and obligate NU to use its best efforts to sell CL&P preferred or common stock to the public if NU cannot meet CL&P's need for equity capital. At December 31, 1995, CL&P's common equity ratio was 42.8 percent.\nWhile not directly restricting the amount of short-term debt that CL&P, WMECO, RRR, NNECO and NU may incur, credit agreements to which CL&P, WMECO, HWP, RRR, NNECO and NU are parties provide that the lenders are not required to make additional loans, or that the maturity of indebtedness can be accelerated, if NU (on a consolidated basis) does not meet a common equity ratio test that requires, in effect, that NU's consolidated common equity (as defined) be at least 30 percent for three consecutive quarters. At December 31, 1995, NU's common equity ratio was 35.7 percent.\nUnder a certain credit agreement, PSNH is prohibited from incurring additional debt unless it is able to demonstrate, on a pro forma basis for the prior quarter and going forward, that its equity ratio (as defined) will be at least 27 percent of total capitalization (as defined) through June 30, 1996 and 28.5 percent through June 30, 1997. In addition, PSNH must demonstrate that its ratio of operating income to interest expense will be at least 1.75 to 1 for the end of each fiscal quarter for the remaining term of the agreement. At December 31, 1995, PSNH's common equity ratio was 36.4 percent and its operating income to interest expense ratio for the 12-month period was 2.74 to 1.\nDuring 1995, NAEC entered into a credit agreement that prohibits the incurrence of additional debt unless NAEC demonstrates that at all times its common equity (as defined) will be at least 25 percent and its ratio of adjusted net income (as defined) to interest expense will be at least 1.35 to 1 through December 31, 1997 and 1.50 to 1 thereafter. At December 31, 1995, NAEC's common equity ratio was 28.3 percent and its adjusted net income to interest expense ratio for the 12-month period was 1.51 to 1.\nSee \"Short-Term Debt\" in the notes to NU's, CL&P's, PSNH's and WMECO's financial statements for information about credit lines available to System companies.\nThe indentures securing the outstanding first mortgage bonds of CL&P, PSNH, WMECO and NAEC provide that additional bonds may not be issued, except for certain refunding purposes, unless earnings (as defined in each indenture and before income taxes, and, in the case of PSNH, without deducting the amortization of PSNH's regulatory asset) are at least twice the pro forma annual interest charges on outstanding bonds and certain prior lien obligations and the bonds to be issued.\nThe preferred stock provisions of CL&P's, PSNH's and WMECO's charters also prohibit the issuance of additional preferred stock (except for refinancing purposes) unless income before interest charges (as defined and after income taxes and depreciation) is at least 1.5 times the pro forma annual interest charges on indebtedness and the annual dividend requirements on preferred stock that will be outstanding after the additional stock is issued.\nNU is dependent on the earnings of, and dividends received from, its subsidiaries to meet its own financial requirements, including the payment of dividends on NU common shares. At the current indicated annual dividend of $1.76 per share, NU's aggregate annual dividends on common shares outstanding at December 31, 1995, including unallocated shares held by the Employee Stock Option Plan, would be approximately $239 million. Dividends are payable on common shares only if, and in the amounts, declared by the NU Board of Trustees.\nSEC rules under the 1935 Act require that dividends on NU's shares be based on the amounts of dividends received from subsidiaries, not on the undistributed retained earnings of subsidiaries. The SEC's order approving NU's acquisition of PSNH under the 1935 Act approved NU's request for a waiver of this requirement through June 1997. PSNH and NAEC were effectively prohibited from paying dividends to NU through May 1993. Through the remainder of 1993 and 1994, PSNH did not pay dividends, to allow it to build up the common equity portion of its capitalization and to fund the buyout of certain NUGs operating in New Hampshire. See \"Rates-New Hampshire Retail Rates-FPPAC and NUGs.\" PSNH and NAEC paid dividends to NU of $52 million and $24 million, respectively, in 1995. If PSNH does not fund its pro rata share of NU's dividend requirements, NU expects to fund that portion of its dividend requirements with the proceeds of borrowings.\nThe supplemental indentures under which CL&P's and WMECO's first mortgage bonds and the indenture under which PSNH's first mortgage bonds have been issued limit the amount of cash dividends and other distributions these subsidiaries can make to NU out of their retained earnings. As of December 31, 1995, CL&P had $245.3 million, WMECO had $93.8 million and PSNH had $143.0 million of unrestricted retained earnings. PSNH's preferred stock provisions also limit the amount of cash dividends and other distributions PSNH can make to NU if after taking the dividend or other distribution into account, PSNH's common stock equity is less than 25 percent of total capitalization. The indenture under which NAEC's Series A Bonds have been issued also limits the amount of cash dividends or distributions NAEC can make to NU to retained earnings plus $10 million. At December 31, 1995, $69.6 million was available to be paid under this provision.\nPSNH's credit agreement prohibits it from declaring or paying any cash dividends or distributions on any of its capital stock, except for dividends on the preferred stock, unless minimum interest coverage and common equity ratio tests are satisfied. At December 31, 1995, $201 million was available to be paid under these provisions. NAEC's common equity covenant referred to above could also operate to restrict NAEC's ability to pay common dividends.\nCertain subsidiaries of NU established the Money Pool to provide a more effective use of the cash resources of the System and to reduce outside short- term borrowings. NUSCO administers the Money Pool as agent for the participating companies. Short-Term borrowing needs of the participating companies (except NU) are first met with available funds of other member companies, including funds borrowed by NU from third parties. NU may lend to, but not borrow from, the Money Pool. Investing and borrowing subsidiaries receive or pay interest based on the average daily Federal Funds rate, except that borrowings based on loans from NU bear interest at NU's cost. Funds may be withdrawn or repaid to the Money Pool at any time without prior notice.\nELECTRIC OPERATIONS\nDISTRIBUTION AND LOAD\nThe System companies own and operate a fully integrated electric utility business. The System operating companies' retail electric service territories cover approximately 11,335 square miles (4,400 in CL&P's service area, 5,445 in PSNH's service area and 1,490 in WMECO's service area) and have an estimated total population of approximately 4 million (2.5 million in Connecticut, 963,000 in New Hampshire and 582,000 in Massachusetts). The companies furnish retail electric service in 149, 198 and 59 cities and towns in Connecticut, New Hampshire and Massachusetts, respectively. In December 1995, CL&P furnished retail electric service to approximately 1.1 million customers in Connecticut, PSNH provided retail electric service to approximately 405,000 customers in New Hampshire and WMECO served approximately 194,000 retail electric customers in Massachusetts. HWP serves 38 retail customers in Holyoke, Massachusetts.\nThe following table shows the sources of 1995 electric revenues based on categories of customers:\nCL&P PSNH WMECO NAEC Total System\nResidential........ 41% 34% 37% - 37% Commercial.......... 35 29 32 - 31 Industrial .......... 13 18 20 - 15 Wholesale* .......... 8 17 7 100% 14 Other ................ 3 2 4 - 3 ---- ---- --- --- ---\nTotal ................ 100% 100% 100% 100% 100% * Includes capacity sales.\nNAEC's 1995 electric revenues were derived entirely from sales to PSNH under the Seabrook power contracts. See \"Rates-New Hampshire Retail Rates- Seabrook Power Contracts\" for a discussion of the contracts.\nThrough December 31, 1995, the all-time peak demand on the System was 6,358 MW, which occurred on August 2, 1995. The System was also selling approximately 1,217 MW of capacity to other utilities at that time. At the time of the peak, the System's generating capacity, including capacity purchases, was 8,035 MW.\nSystem energy requirements were met in 1995 and 1994 as set forth below:\nSource 1995 1994\nNuclear .................................... 52% 54% Oil ........................................ 4 7 Coal ....................................... 10 8 Hydroelectric .............................. 3 4 Natural gas ................................ 5 3 NUGs ....................................... 13 14 Purchased-power............................. 13 10 -- -- 100% 100%\nThe actual changes in retail KWh sales for the last two years and the forecasted sales growth estimates for the ten-year period 1995 through 2005, in each case exclusive of wholesale revenues, for the System, CL&P, PSNH and WMECO are set forth below:\n1995 over 1994 over Forecast 1995-2005 1994 1993 Compound Rate of Growth\nSystem......... (.1)% 2.9% 1.2% CL&P........... (.3)% 3.4% 1.1% PSNH........... .4 % 2.0% 1.6% WMECO.......... (.1)% 1.4% 0.6%\nThe actual changes in total KWh sales for the last two years, including wholesale KWh sales, for the System, CL&P, PSNH and WMECO are set forth below:\n1995 over (under) 1994 1994 over (under) 1993\nSystem ................... (1.24)% 2.53% CL&P ..................... (2.21)% 3.66% PSNH ..................... 1.08 % 1.70% WMECO .................... 0.33 % 1.49%\nFor a discussion of trends in wholesale sales, see \"Competition and Marketing- Wholesale Marketing.\"\nThe combination of much milder winter temperatures and slower economic growth caused retail electric sales to fall by 0.1 percent in 1995, compared with 1994. The most significant reduction was in residential electric sales, which are most affected by summer and winter temperature variations. Residential sales were down 1.8 percent in 1995. By comparison, commercial sales were up by .8 percent for the year and industrial sales rose 1.7 percent. Had weather patterns in 1995 been similar to those in 1994, the System estimates its total retail sales would have risen by 0.3 percent.\nThe reduced level of retail sales also resulted from a continued slowdown of economic growth in New England, particularly in Connecticut. Retail sales at CL&P fell by 0.3 percent in 1995. If weather effects were removed, CL&P's sales would have been flat when compared with 1994. The lack of growth is primarily attributable to the continued contraction of the manufacturing, defense, insurance and financial services sectors in Connecticut. PSNH's retail sales rose by 0.4 percent in 1995, largely because of a 4.4 percent increase in industrial sales. Higher industrial sales were due primarily to the continued growth of manufacturing activity in New Hampshire and a summer drought that reduced hydroelectric self-generation by some of PSNH's larger customers. WMECO retail sales were essentially flat in 1995 with 2.6 percent growth in commercial sales partially offsetting lower residential sales. For more information on the effect of competition on sales growth rates, see \"Competition and Marketing.\"\nIn spite of further defense and insurance curtailments moderate growth is forecasted to resume over the next ten years. The System forecasts a 1.0 percent growth rate of sales over this period. This growth rate is significantly below historic rates due to fewer young people entering the workforce and, in part, because of forecasted savings from System-sponsored DSM programs that are designed to minimize operating expenses for System customers and postpone the need for new capacity on the System. The forecasted ten-year growth rate of System sales would be approximately 1.5 percent if the System did not pursue DSM programs at the forecasted levels. See \"Rates\" for information about rate treatment of DSM costs.\nWith the System's generating capacity of 7,956 MW as of January 1, 1996 (including the net of capacity sales to and purchases from other utilities, and approximately 649 MW of capacity purchased from NUGs under existing contracts), the System expects to meet reliably its projected annual peak load growth of 1.0 percent until at least the year 2011.\nTaking into account projected load growth for the System and committed capacity sales, but not taking into account future potential capacity sales to other utilities or purchases from other utilities that are not subject to firm commitments, the System's installed reserve is expected to be approximately 1,614 MW in the summer of 1996.\nThe System companies operate and dispatch their generation as provided in the NEPOOL Agreement. In 1995, the peak demand on the NEPOOL system was 20,499 MW in July, which was 20 MW below the 1994 peak load of 20,519 MW in July of that year. NEPOOL has projected that there will be an increase in demand in 1996 and estimates that the summer 1996 peak load could reach 22,368 MW. NEPOOL projects that sufficient capacity will be available to meet this anticipated demand.\nREGIONAL AND SYSTEM COORDINATION\nThe System companies and most other New England utilities with electric generating facilities are parties to the NEPOOL Agreement, which coordinates the planning and operation of the region's generation and transmission facilities. System transmission lines form part of the New England transmission system linking System generating plants with one another and with the facilities of other utilities in the Northeastern United States and Canada. The generating facilities of all NEPOOL participants are dispatched as a single system through the New England Power Exchange, a central dispatch facility. The NEPOOL Agreement provides for a determination of the generating capacity responsibilities of participants and certain transmission rights and responsibilities. NEPOOL's objectives are to assure that the bulk power supply of New England and adjoining areas conforms to proper standards of reliability, to attain maximum practical economy in the bulk power supply system consistent with such reliability standards and to provide for equitable sharing of the resulting benefits and costs.\nSince 1994, NEPOOL has been studying its own restructuring. On January 5, 1996, NEPOOL adopted a vision statement for the future called \"NEPOOL Plus.\" NEPOOL Plus, if implemented, will maintain the pool's current strengths and adds key structural changes, including bid-based central energy dispatch, a changed and expanded basis for governance and increased independence of the operational function of NEPOOL staff as an independent system operator. The final NEPOOL restructuring plan will be subject to approval by FERC. Representatives of the System played an active role in the development of the plan. The System believes that NEPOOL Plus is an important component of electric industry restructuring in New England, providing the basis for a more efficient wholesale market for electricity and offering the potential for retail market efficiencies in the future.\nThere are two agreements that determine the manner in which costs and savings are allocated among the System companies. Under the NUG&T, CL&P, WMECO and HWP (Initial System Companies) pool their electric production costs and the costs of their principal transmission facilities. Pursuant to the merger agreement, the Initial System Companies and PSNH entered into a ten-year, sharing agreement, expiring in June 2002, that provides, among other things, for the allocation of the capability responsibility savings and energy expense savings resulting from a single-system dispatch through NEPOOL.\nTRANSMISSION ACCESS\nIn accordance with FERC's 1992 decision approving NU's acquisition of PSNH, NU made compliance filings with FERC, including transmission tariffs. FERC made all tariffs effective as of the merger date based on interim rates and terms of service established by FERC pursuant to summary determinations (without hearing). NU filed for rehearing of FERC's compliance tariff order in an effort to reinstate the originally proposed rates. FERC has not yet acted on NU's rehearing petition. In 1995, the System companies collected approximately $40 million in transmission revenues for transmission of power sales for the System companies and other electric utility generators. For information regarding the appeal of FERC's approval of NU's acquisition of PSNH, see \"Item 3. Legal Proceedings.\"\nOn March 29, 1995, FERC issued a Notice of Proposed Rulemaking (Mega-NOPR) on industry restructuring that would require, among other things, utilities to provide transmission access and certain ancillary services on the same terms as the utility provides those services to itself. The Mega-NOPR also supports full recovery of strandable costs as a result of retail wheeling with respect to those customers under FERC's jurisdiction. A final rule is not expected until June 1996.\nOn September 5, 1995, the System filed with FERC its four transmission tariffs to meet the comparability standards articulated in the Mega-NOPR. On October 31, 1995, FERC accepted for filing the System's revised transmission tariffs and made them effective November 1, 1995. In the order, however, FERC noted that certain terms and conditions for such tariffs were not fully consistent with the Mega-NOPR pro forma tariffs and made the tariffs subject to the final order in its Mega-NOPR proceeding. FERC also stated that the System may use levelized rates rather than previously used depreciated embedded cost rate methods. On February 29, 1996, NU filed a settlement with FERC in this proceeding. The settlement resolves all issues except two rate design issues, which will be resolved through expedited paper hearing procedures over the next several months. If NU's rate design is confirmed, the System could collect approximately $2 million of additional transmission revenues annually.\nFOSSIL FUELS\nThe System's residual oil-fired generation stations used approximately 5.6 million barrels of oil in 1995. The System obtained the majority of its oil requirements in 1995 through contracts with several large, independent oil companies. Those contracts allow for some spot purchases when market conditions warrant. Spot purchases represented approximately 10 percent of the System's fuel oil purchases in 1995. The contracts expire annually or biennially. The System currently does not anticipate any difficulties in obtaining necessary fuel oil supplies on economic terms.\nThe System has five generating stations, aggregating approximately 800 MW, which can fully or partially burn either residual oil or natural gas\/coals, as economics, environmental concerns or other factors dictate. CL&P is considering converting its oil-fired Middletown Station in Connecticut to a dual-fuel generating facility. Approximately 551 MW of capacity is capable of being converted at the Middletown Station. CL&P, PSNH and WMECO have contracts with the local gas distribution companies where the dual-fuel generating units are located, under which natural gas is made available by those companies on an interruptible basis. In addition, gas for CL&P'S Devon and Montville generating stations is being purchased directly from producers and brokers on an interruptible basis and transported through the interstate pipeline system and the local gas distribution company. The System expects that interruptible natural gas will continue to be available for its dual-fuel electric generating units on economic terms and will continue to supplement fuel oil requirements.\nSee \"Derivative Financial Instruments\" in the notes to NU's and CL&P's financial statements for information about CL&P's oil and natural gas swap agreements that hedge against fuel price risk on certain long-term, fixed-price energy contracts.\nThe System companies obtain their coal through long-term supply contracts and spot market purchases. The System companies currently have an adequate supply of coal. Because of changes in federal and state air quality requirements, the System may be required to use lower sulfur coal in its plants in the future. See \"Regulatory and Environmental Matters-Environmental Regulation-Air Quality Requirements.\"\nNUCLEAR GENERATION\nGENERAL\nCertain System companies have interests in seven operating nuclear units: Millstone 1, 2 and 3, Seabrook 1 and three other units, Connecticut Yankee (CY), Maine Yankee (MY) and Vermont Yankee (VY), owned by regional nuclear generating companies (the Yankee companies). System companies operate the three Millstone units and Seabrook 1 and have operational responsibility for CY. Certain System companies also have interests in Yankee Rowe owned by the Yankee Atomic Electric Company (YAEC), which was permanently removed from service in 1992.\nCL&P and WMECO own 100 percent of Millstone 1 and 2 as tenants in common. Their respective ownership interests are 81 percent and 19 percent.\nCL&P, PSNH and WMECO have agreements with other New England utilities covering their joint ownership as tenants in common of Millstone 3. CL&P's ownership interest in the unit is 52.93 percent, PSNH's ownership interest in the unit is 2.85 percent and WMECO's interest is 12.24 percent. NAEC and CL&P have 35.98 percent and 4.06 percent ownership interests, respectively, in Seabrook. The Millstone 3 and Seabrook joint ownership agreements provide for pro-rata sharing by the owners of each unit of the construction and operating costs, the electrical output and the associated transmission costs.\nCL&P, PSNH, WMECO and other New England electric utilities are the stockholders of the Yankee companies. Each Yankee company owns a single nuclear generating unit. The stockholder-sponsors of each Yankee company are responsible for proportional shares of the operating costs of the respective Yankee company and are entitled to proportional shares of the electrical output. The relative rights and obligations with respect to the Yankee companies are approximately proportional to the stockholders' percentage stock holdings, but vary slightly to reflect arrangements under which nonstockholder electric utilities have contractual rights to some of the output of particular units. The Yankee companies and CL&P's, PSNH's and WMECO's stock ownership percentages in the Yankee companies are set forth below:\nCL&P PSNH WMECO System Connecticut Yankee Atomic Power Company (CYAPC) ...... 34.5% 5.0% 9.5% 49.0% Maine Yankee Atomic Power Company (MYAPC) ............ 12.0% 5.0% 3.0% 20.0% Vermont Yankee Nuclear Power Corporation (VYNPC)... 9.5% 4.0% 2.5% 16.0% Yankee Atomic Electric Company (YAEC) ............ 24.5% 7.0% 7.0% 38.5%\nCL&P, PSNH and WMECO are obligated to provide their percentages of any additional equity capital necessary for the Yankee companies, but do not expect to need to contribute additional equity capital in the future. CL&P, PSNH and WMECO believe that the Yankee companies, excluding YAEC, could require additional external financing in the next several years to finance construction expenditures, nuclear fuel and for other purposes. Although the ways in which each Yankee company would attempt to finance these expenditures, if they are needed, have not been determined, CL&P, PSNH and WMECO could be asked to provide direct or indirect financial support for one or more Yankee companies. For information regarding additional capital requirements at MY, see \"Electric Operations-Nuclear Generation-Nuclear Plant Performance.\"\nOn February 1, 1996, the System instituted a reorganization of its nuclear organization that puts in place a six person team to lead the five nuclear units that the System operates. The new nuclear management team is in charge of overseeing safety, efficiency and community relations at all five nuclear units. The new structure pools the expertise and strengths from each unit to manage issues to be addressed at all the units.\nNUCLEAR PLANT LICENSING AND NRC REGULATION\nThe operators of Millstone 1, 2 and 3, CY, MY, VY, and Seabrook 1 hold full power operating licenses from the NRC. As holders of licenses to operate nuclear reactors, CL&P, WMECO, NAESCO, NNECO, and the Yankee companies are subject to the jurisdiction of the NRC. The NRC has broad jurisdiction over the design, construction and operation of nuclear generating stations, including matters of public health and safety, financial qualifications, antitrust considerations and environmental impact. The NRC issues 40-year initial operating licenses to nuclear units and NRC regulations permit renewal of licenses for an additional 20-year period.\nIn addition, activities related to nuclear plant operation are routinely inspected by the NRC for compliance with NRC regulations. The NRC has authority to enforce its regulations through various mechanisms which include the issuance of notices of violation (NOV) and civil monetary penalties. One regulatory enforcement action, with an associated penalty of $50,000, was taken by the NRC in 1995 for certain violations involving the operability of motor-operated valves at Millstone 2.\nThe NRC also regularly conducts generic reviews of technical and other issues, a number of which may affect the nuclear plants in which System companies have interests. The cost of complying with any new requirements that may result from these reviews cannot be estimated at this time, but such costs could be substantial. For more information regarding recent actions taken by the NRC with respect to the System's nuclear units, see \"Electric Operations- Nuclear Generation-Nuclear Plant Performance.\"\nNUCLEAR PLANT PERFORMANCE\nCapacity factor is a ratio that compares a unit's actual generating output for a period with the unit's maximum potential output. The average capacity factor for operating nuclear units in the United States was 77.6 percent in 1995 and 69.9 percent for the five nuclear units operated by the System in 1995, compared with 67.5 percent for 1994.\nThe System anticipates total expenditures in 1996 of approximately $425 million for operations and maintenance (O&M) and $55.5 million in capital improvements for the five nuclear plants that it operates.\nWhen the nuclear units in which they have interests are out of service, CL&P, PSNH and WMECO need to generate and\/or purchase replacement power. Recovery of replacement power costs is permitted, subject to prudence reviews, through the GUAC for CL&P, through FPPAC for PSNH and through a retail fuel adjustment clause for WMECO. For the status of regulatory and legal proceedings related to recovery of replacement power costs for the 1991-1995 period, see \"Rates.\"\nMILLSTONE UNITS\nFor the 12 months ended December 31, 1995, the three Millstone units' composite capacity factor was 64.5 percent, compared with a composite capacity factor of 66.4 percent for the 12 months ended December 31, 1994 and 79.3 percent for the same period in 1993.\nOn January 31, 1996, the NRC announced that the three Millstone nuclear units had been placed on its \"watch list\" because of long standing performance concerns that warranted \"increased NRC attention until the licensee demonstrates a period of improved performance.\" The NRC listed a number of problems which have arisen since 1990 at Millstone Station, including licensed reactor operator requalification failures, repetitive improper maintenance causing an unisolable valve failure, problems with a supplemental leak collection release system, inadequate erosion-corrosion monitoring, untimely corrective action involving a heater drain tank recirculation line rupture, poor testing control causing an inadvertent drain-down of a reactor vessel, a high number of safety system failures, safety relief valve setpoint drift problems, untimely corrective actions for identified design deficiencies, failures to implement procedures which precipitated significant plant events and in some cases endangered plant staff and failure to comply with safety-related aspects of Millstone's Final Safety Analysis Report and portions of other requirements. Also mentioned were two instances of escalated enforcement actions by the NRC for harassment, intimidation and discrimination against employees raising safety concerns and a continuing high volume of employee allegations of safety concerns not being resolved appropriately by the System.\nThe NRC recognized that at present there are significant current variations in the performance of the three units, but the foregoing events, combined with a failure to sustain performance improvements across all three units and to resolve employee concerns, required continued close NRC monitoring of programs and performance at Millstone Station to assure development and implementation of effective corrective action programs. While the NRC did not specifically restrict operations of the Millstone units, management expects that the increased NRC attention will inevitably have effects and costs that cannot be accurately estimated at this time.\nManagement also plans to continue its extensive efforts already underway to address the NRC's concerns that employees at the Millstone Station are unable to raise nuclear safety issues to company supervisors and managers without fear of retaliation. Among the NRC's recent actions has been the establishment of a senior-level group to conduct an evaluation of the handling of Millstone employee concerns. In February 1996, the NRC also requested information regarding the process followed by the System in connection with its recent nuclear workforce reduction. Management shares the NRC's concerns in this area and is continuing to take steps to ensure that the environment at Millstone Station is one in which workers feel free to raise issues without fear of retaliation. For more information regarding the workforce reduction, see \"Employees.\"\nOn March 7, 1996, NUSCO received two letters from the NRC: the first relates to Millstone 2 and the second concerns Millstone 3 and CY. The correspondence regarding Millstone 2 notes \"a number of operability and design concerns\" at the unit and requires NU to submit information to the NRC on what NU has done to ensure future operations at Millstone 2 will conform to NRC regulations and to the unit's operating license and Updated Final Safety Analysis Report (UFSAR). That information must be submitted at least seven days before Millstone 2 restarts subsequent to the outage described below. The second NRC letter requests reports by April 6, 1996 on actions taken to date and the System's plans and schedule to ensure that future operation of Millstone 3 and CY will conform to NRC regulations and the units' operating licenses and UFSARs. Management does not know at this time whether the NRC will request similar information and assurances regarding Seabrook.\nMillstone 1, a 660-MW boiling-water reactor, has a license expiration date of October 6, 2010. In 1995, Millstone 1 operated at a 77.2 percent capacity factor. The unit began a planned refueling and maintenance outage on November 4, 1995. The original outage duration of 49 days has been extended to the middle to late part of the second quarter to complete overlay repairs on the reactor recirculation system and to respond to a December 1995 letter from the NRC requesting information regarding actions to be taken to ensure that future operations of Millstone 1 will be conducted in accordance with the terms and conditions of its operating license and NRC regulations. Total replacement- power costs for CL&P and WMECO are expected to be approximately $6.5 million per month. It is also estimated that CL&P and WMECO will incur an additional $20 million of O&M costs as a result of the extended outage. The recovery of the replacement power and O&M costs could be subject to refund as a result of prudence reviews in Connecticut or Massachusetts.\nPetitions were filed with the NRC in August 1995 seeking enforcement and other sanctions against the System for its historic practice of off-loading the full reactor core at Millstone 1 during refueling outages, as well as certain refueling practices at the other Millstone units and Seabrook 1. The NRC initiated several investigations in response to the petitions. One of the investigations was completed by the NRC's Office of the Inspector General in December 1995, which issued four findings: two critical of the System and two critical of the NRC technical staff's oversight of the System.\nIn addition, several New England-based public interest groups have requested a hearing on a license amendment issued by the NRC for Millstone 1 which would explicitly authorize the full-core offload practice. The request for a hearing is pending before the NRC's Atomic Safety and Licensing Board, and hearings are expected to take place in 1996.\nMillstone 2, a 870-MW pressurized-water reactor, has a license expiration date of July 31, 2015. In 1995, Millstone 2 operated at a 35.9 percent capacity factor. In October 1994, Millstone 2 was shut down for a planned two month refueling and maintenance outage, which was extended by eight months. The outage encountered several unexpected difficulties that lengthened the duration of the outage. The outage extension was primarily caused by a significant scope increase in service water system repairs and an extremely deliberate approach to the conduct of work during the early portion of the outage. The unit returned to service on August 4, 1995. Replacement-power costs and O&M costs attributable to the extension of the outage for CL&P and WMECO were approximately $85 million and $24 million, respectively. The replacement power costs were recovered as incurred for WMECO and are currently being recovered by CL&P through the GUAC. O&M costs were deferred and are being amortized through rates by both CL&P and WMECO. The recovery of the replacement power and O&M costs could be subject to refund as a result of prudence reviews in Connecticut.\nMillstone 2 was shut down on February 21, 1996 as a result of an engineering evaluation that determined that some valves could be inoperable in certain emergency scenarios. With the unit already off-line, management has decided to move up a mid-cycle inspection outage that had previously been scheduled to begin in mid-April. Management does not know at this time whether the NRC's March 7, 1996 request for information discussed above will have a material impact on the restart schedule for Millstone 2 but does believe there will be an extension beyond the previously scheduled April 1995 restart date. For each month the unit is not in service, the System will incur approximately $8.5 million to $9 million for replacement power costs.\nMillstone 3, a 1154-MW pressurized-water reactor, has a license expiration date of November 25, 2025. In 1995, Millstone 3 operated at a 80.5 percent capacity factor. The unit began a planned refueling outage on April 14, 1995, which ended on June 7, 1995.\nSEABROOK\nSeabrook 1, a 1148-MW pressurized-water reactor, has a license expiration date of October 17, 2026. The Seabrook operating license expires 40 years from the date of issuance of authorization to load fuel, which was about three and one-half years before Seabrook's full-power operating license was issued. The System will determine at the appropriate time whether to seek recapture of some or all of this period from the NRC and thus add up to an additional three and one-half years to the operating term for Seabrook. In 1995, Seabrook operated at a capacity factor of 83.2 percent. The unit began a planned refueling and maintenance outage on November 3, 1995, which ended on December 11, 1995, the shortest planned outage in the unit's operating history.\nYANKEE UNITS\nCONNECTICUT YANKEE\nCY, a 582-MW pressurized-water reactor, has a license expiration date of June 29, 2007. In 1995, CY operated at a capacity factor of 72.6 percent. CY began a planned refueling and maintenance outage on January 28, 1995, which ended on April 19, 1995. The outage was extended by 31 days to inspect and replace service water piping and fan motor cables for the containment air recirculation fan cooler units.\nMAINE YANKEE\nMY, a 870-MW pressurized-water reactor, has a license expiration date of October 21, 2008. MY's operating license expires 40 years from the date of issuance of the construction permit, which was about four years before MY's full-power operating license was issued. At the appropriate time, MYAPC will determine whether to seek recapture of this construction period from the NRC and add it to the term of the MY operating license. In 1995, MY operated at a capacity factor of 2.6 percent.\nMY was out of service from early February 1995 through January 16, 1996 for a routine refueling outage combined with the sleeving of MY's three steam generators, at a cost of approximately $30 million. By order issued on January 3, 1996, the NRC suspended MY's authority to operate at full power and limited MY to operating at 90 percent power pending the NRC's review and approval of a computer code application used at MY. CL&P, WMECO and PSNH incurred additional costs for replacement power (estimated at $1 million, $200,000 and $400,000, respectively, per month) as result of the extended outage.\nVERMONT YANKEE\nVY, a 514-MW boiling water reactor, has a license expiration date of March 21, 2012. In 1995, VY operated at a capacity factor of 83.4 percent. VY had a 40-day planned refueling outage during 1995, which ended on May 3, 1995.\nYANKEE ROWE\nIn February 1992, YAEC's owners voted to shut down Yankee Rowe permanently based on an economic evaluation of the cost of a proposed safety review, the reduced demand for electricity in New England, the price of alternative energy sources and uncertainty about certain regulatory requirements. The power contracts between CL&P, PSNH, WMECO and YAEC permit YAEC to recover from each its proportional share of the Yankee Rowe shutdown and decommissioning costs. For more information regarding the decommissioning of Yankee Rowe, see \"Electric Operations-Nuclear Generation-Decommissioning.\"\nNUCLEAR INSURANCE\nThe NRC requires nuclear plant licensees to maintain a minimum of $1.06 billion in nuclear property and decontamination insurance coverage. The NRC requires that proceeds from the policy following an accident that exceed $100 million will first be applied to pay expenses. The insurance carried by the licensees of the Millstone units, Seabrook 1, CY, MY and VY meets the NRC's requirements. YAEC has obtained an exemption for the Yankee Rowe plant from the $1.06 billion requirement and currently carries $25 million of insurance that otherwise meets the requirements of the rule. For more information regarding nuclear insurance, see \"Nuclear Insurance Contingencies\" in the notes to NU's, CL&P's, PSNH's, WMECO's and NAEC's financial statements.\nNUCLEAR FUEL\nThe supply of nuclear fuel for the System's existing units requires the procurement of uranium concentrates, followed by the conversion, enrichment and fabrication of the uranium into fuel assemblies suitable for use in the System's units. The majority of the System companies' uranium enrichment services requirements is provided under a long-term contract with the United States Enrichment Corporation (USEC), a wholly owned United States government corporation. The majority of Seabrook's uranium enrichment services requirements is furnished through a Russian trading company. The System expects that uranium concentrates and related services for the units operated by the System and for the other units in which the System companies are participating, that are not covered by existing contracts, will be available for the foreseeable future on reasonable terms and prices.\nOn August 10, 1995, NAESCO filed a complaint in the United States Court of Federal Claims challenging the propriety of the prices charged by the USEC for uranium enrichment services procured for Seabrook Station in 1993. The complaint is an appeal of the final decision rendered by the USEC contracting officer denying NAESCO's claims, which range from $2.5 to $5.8 million, and will likely be considered along with similar complaints that are pending before the court on behalf of 13 other utilities.\nAs a result of the Energy Policy Act, the United States commercial nuclear power industry is required to pay to the United States Department of Energy (DOE), through a special assessment for the costs of the decontamination and decommissioning of uranium enrichment plants owned by the United States government, no more than $150 million for 15 years beginning in 1993. Each domestic nuclear utility's payment is based on its pro rata share of all enrichment services received by the United States commercial nuclear power industry from the United States government through October 1992. Each year, the DOE will adjust the annual assessment using the Consumer Price Index. The Energy Policy Act provides that the assessments are to be treated as reasonable and necessary current costs of fuel, which costs shall be fully recoverable in rates in all jurisdictions. The System's total share of the estimated assessment was approximately $62.4 million. Management believes that the DOE assessments against CL&P, WMECO, PSNH and NAEC will be recoverable in future rates. Accordingly, each of these companies has recognized these costs as a regulatory asset, with a corresponding obligation on its balance sheet.\nOn June 22, 1995, the United States Court of Federal Claims held that, as applied to YAEC, the Uranium Enrichment Decontamination and Decommissioning Fund is an unlawful add-on to the bargained-for contract price for enriched uranium. As a result, the federal government must refund the approximately $3.0 million that YAEC has paid into the fund since its inception. NU is evaluating the applicability of this decision to the $21 million that the System companies have already paid into the fund, and whether this alters the System companies' obligation to pay such special assessments in the future. The decision as to YAEC has been appealed by the federal government.\nNuclear fuel costs associated with nuclear plant operations include amounts for disposal of nuclear waste. The System companies include in their nuclear fuel expense spent fuel disposal costs accepted by the DPUC, NHPUC and DPU in rate case or fuel adjustment decisions. Spent fuel disposal costs are also reflected in FERC-approved wholesale charges. Such provisions include amortization and recovery in rates of previously unrecovered disposal costs of accumulated spent nuclear fuel.\nHIGH-LEVEL RADIOACTIVE WASTE\nThe Nuclear Waste Policy Act of 1982 (NWPA) provides that the federal government is responsible for the permanent disposal of spent nuclear reactor fuel and high-level waste. As required by the NWPA, electric utilities generating spent nuclear fuel and high-level waste are obligated to pay fees into a fund which would be used to cover the cost of siting, constructing, developing and operating a permanent disposal facility for this waste. The System companies have been paying for such services for fuel burned starting in April 1983 on a quarterly basis since July 1983. The DPUC, NHPUC and DPU permit the fee to be recovered through rates.\nIn return for payment of the fees prescribed by the NWPA, the federal government is to take title to and dispose of the utilities' high-level wastes and spent nuclear fuel. The NWPA provides that a disposal facility be operational and for the DOE to accept nuclear waste for permanent disposal in 1998. On April 28, 1995, DOE issued an interpretative release stating that it does not have an unconditional statutory or contractual obligation to accept spent fuel beginning January 1, 1998.\nOn June 23, 1995, the DPUC and the New Hampshire Office of Consumer Advocate joined the Connecticut, New Hampshire and Massachusetts Attorneys General and a number of states in a lawsuit filed in federal court against the DOE, seeking a declaratory judgment that the DOE has a statutory obligation to take high-level nuclear waste from utilities in 1998 and to establish judicially administered milestones to enforce that obligation. On October 4, 1995, NUSCO, NAESCO and CYAPC joined a companion lawsuit filed by a number of utilities seeking similar relief. The cases were consolidated by the federal court of appeals. Oral argument was held on January 17, 1996, and the matter is still pending. Nuclear utilities and state regulators are presently considering additional steps that they might take to ensure that the DOE is able to meet its obligations with regard to nuclear waste disposal as soon as possible.\nUntil the federal government begins accepting nuclear waste for disposal, operating nuclear generating plants will need to retain high-level waste and spent fuel on-site or make some other provisions for their storage. With the addition of new storage racks, storage facilities for Millstone 3 and CY are expected to be adequate for the projected life of the units. The storage facilities for Millstone 1 and 2 are expected to be adequate (maintaining the capacity to accommodate a full-core discharge from the reactor) until 2001. Fuel consolidation, which has been licensed for Millstone 2, could provide adequate storage capability for the projected lives of Millstone 1 and 2. In addition, other licensed technologies, such as dry storage casks or on-site transfers, are being considered to accommodate spent fuel storage requirements. With the current installation of new racks in its existing spent fuel pool, Seabrook is expected to have spent fuel storage capacity until at least 2010.\nIn 1995, MYAPC began replacing the fuel racks in the spent fuel pool at MY to provide for additional storage capacity. MYAPC believes that the replacement of the fuel racks will provide adequate storage capacity through MY's current licensed operating life. The storage capacity of the spent fuel pool at VY is expected to be reached in 2005, and the available capacity of the pool is expected to be able to accommodate full-core removal until 2001.\nBecause the Yankee Rowe plant was permanently shut down in February 1992, YAEC is considering the construction of a temporary facility to store the spent nuclear fuel produced by the Yankee Rowe plant over its operating lifetime until that fuel is removed by the DOE. See \"Electric Operations-Nuclear Generation-Decommissioning\" for further information on the closing and decommissioning of Yankee Rowe, including a recent order issued by the NRC halting decommissioning activities at Yankee Rowe.\nLOW-LEVEL RADIOACTIVE WASTE\nIn April 1995, the Northwest interstate compact passed a resolution and order broadening the types of low-level radioactive waste (LLRW) acceptable for disposal at the privately operated Envirocare facility in Utah. This policy change made a significant portion of utility LLRW acceptable for disposal at Envirocare. In July 1995, the state of South Carolina reopened the Barnwell LLRW disposal site to the nation (except for North Carolina).\nThese events enabled Seabrook to begin shipping its first LLRW ever and, for the first time since 1992, gave Millstone Station and CY a choice of disposal sites for certain categories of LLRW. By the end of November 1995, the System had contracts with both Barnwell and Envirocare for operational LLRW disposal. The vast majority of LLRW in storage from July 1994 through June 1995 at Millstone station and CY, and in storage since startup at the Seabrook plant, was shipped to either Barnwell or Envirocare by the end of 1995. The System incurred approximately $8 million in off-site LLRW disposal costs in 1995 for the five nuclear units it operates.\nBecause access to LLRW disposal may be lost at any time, the System has plans that will allow for on-site storage of LLRW for at least five years in the event that disposal is interrupted. Both Connecticut and New Hampshire are also pursuing other options for out-of-state disposal of LLRW.\nMY had stored all its LLRW on-site since January 1, 1993, when it lost access to off-site disposal facilities. Most of this stored waste has been shipped to Barnwell since Maine regained access to the site in mid-1995. The plant has the capability to store a volume of LLRW equivalent to at least five years generation, in the event that off-site disposal access is lost.\nVY has stored all its LLRW on-site since July 1994. The plant also has the capacity to store a volume of LLRW equivalent to at least five years generation, in the event that off-site disposal access is lost. With access to Barnwell in mid-1995, VY has elected to continue storing most of its LLRW on-site in anticipation of lower future disposal costs at the yet-to-be constructed Texas LLRW disposal site.\nBoth Maine and Vermont are in the process of implementing an agreement with Texas to provide access to a LLRW disposal facility that is to be developed in that state. All three states plan to form a LLRW compact that is currently awaiting approval by Congress.\nDECOMMISSIONING\nBased upon the System's most recent comprehensive site-specific updates of the decommissioning costs for each of the three Millstone units and for Seabrook, the recommended decommissioning method continues to be immediate and complete dismantlement of those units at their retirement. The table below sets forth the estimated Millstone and Seabrook decommissioning costs for the System companies. The estimates are based on the latest site studies, escalated to December 31, 1995 dollars.\nCL&P PSNH WMECO NAEC System (Millions) Millstone 1 $300.3 $ - $ 70.4 $ - $ 370.7 Millstone 2 265.8 - 62.3 - 328.1 Millstone 3 232.0 12.5 53.7 - 298.2 Seabrook 1 17.2 - - 152.5 169.7 ----- ----- ------ ------ ------- Total $815.3 $12.5 $186.4 $152.5 $1166.7 ====== ===== ====== ====== =======\nAs of December 31, 1995, the balances (at market) in certain external decommissioning trust funds, as discussed more fully below, were as follows:\nCL&P PSNH WMECO NAEC System (Millions) Millstone 1 $113.2 $ - $ 33.8 $ - $147.0 Millstone 2 73.2 - 22.8 - 96.0 Millstone 3 49.9 2.4 13.3 - 65.6 Seabrook 1 1.7 - - 15.3 17.0 ------ ------ ------ ----- ------ Total $238.0 $ 2.4 $ 69.9 $15.3 $325.6 ====== ====== ====== ===== ======\nPursuant to Connecticut law, CL&P has periodically filed plans with the DPUC for financing the decommissioning of the three Millstone units. In 1986, the DPUC approved the establishment of separate external trusts for the currently tax-deductible portions of decommissioning expense accruals for Millstone 1 and 2 and for all expense accruals for Millstone 3. In its 1993 CL&P multiyear rate case decision, the DPUC allowed CL&P's full decommissioning estimate for the three Millstone units to be collected from customers. This estimate includes an approximate 16 percent contingency factor for the decommissioning cost of each unit. The estimated aggregate cost of decommissioning the System's ownership share in the Millstone units is approximately $997 million in December 1995 dollars.\nWMECO has established independent trusts to hold all decommissioning expense collections from customers. In its 1990 WMECO multiyear rate case decision, the DPU allowed WMECO's decommissioning estimate for the three Millstone units ($840 million in December 1990 dollars) to be collected from customers. Due to the settlement in the 1992 WMECO rate case, the aggregate decommissioning estimate for the three Millstone units remains unchanged.\nNew Hampshire enacted a law in 1981 requiring the creation of a state- managed fund to finance decommissioning of any units in that state. The New Hampshire Decommissioning Fund Commission (NHDFC) approved a revised decommissioning estimate in June 1995. On the basis of this revised estimate, the total decommissioning cost for the System's ownership share of Seabrook is $169.7 million in December 1995 dollars. NAEC's costs for decommissioning are billed by it to PSNH and recovered by PSNH under the Rate Agreement. Under the Rate Agreement, PSNH is entitled to a base rate increase to recover increased decommissioning costs. See \"Rates-New Hampshire Retail Rates-General\" for further information on the Rate Agreement.\nThe decommissioning cost estimates for the System nuclear units are reviewed and updated regularly to reflect inflation and changes in decommissioning requirements and technology. Changes in requirements or technology, or adoption of a decommissioning method other than immediate dismantlement, could change these estimates. CL&P, PSNH and WMECO attempt to recover sufficient amounts through their allowed rates to cover their expected decommissioning costs. Only the portion of currently estimated total decommissioning costs that has been accepted by regulatory agencies is reflected in rates of the System companies. Based on present estimates, and assuming its nuclear units operate to the end of their respective license periods, the System expects that the decommissioning trusts funds will be substantially funded when those expenditures have to be made.\nCYAPC, YAEC, VYNPC and MYAPC are all collecting revenues for decommissioning from their power purchasers. The table below sets forth the estimated decommissioning costs of the Yankee units for the System companies. The estimates are based on the latest site studies, escalated to December 31, 1995 dollars. For information on the equity ownership of the System companies in each of the Yankee units, see \"Electric Operations-Nuclear Generation- General.\"\nCL&P PSNH WMECO System (Millions) VY $ 33.0 $ 13.9 $ 8.7 $ 55.6 Yankee Rowe* 65.9 18.8 18.8 103.5 CY 133.0 19.3 36.6 188.9 MY 42.4 17.7 10.6 70.7 ------ ------ ------ ------ Total $274.3 $ 69.7 $ 74.7 $418.7 ====== ====== ====== ======\n- --------------- * The costs shown include all remaining decommissioning costs and other closing costs associated with the early retirement of Yankee Rowe as of December 31, 1995.\nAs of December 31, 1995, the balances (at market) in the external decommissioning trust funds for the Yankee units were as follows:\nCL&P PSNH WMECO System (Millions) VY $ 13.4 $ 5.7 $ 3.5 $ 22.6 Yankee Rowe 29.0 8.3 8.3 45.6 CY 61.6 8.9 17.0 87.5 MY 17.1 7.1 4.2 28.4 ---- ---- ---- ---- Total $121.1 $30.0 $33.0 $184.1 ====== ===== ===== ======\nYAEC has begun decommissioning its nuclear facility. However, on October 12, 1995, the NRC issued an order halting major dismantlement or decommissioning activities at Yankee Rowe until after completion of an adjudicatory hearing process. The NRC's action was taken in response to a recent federal appeals court decision finding that the NRC should have offered a hearing opportunity prior to authorizing Yankee Rowe's component removal program in 1993. On January 16, 1996, the NRC issued a decision requiring that the proceeding, including hearings if necessary, be completed by mid-July 1996. Based on a pre-hearing conference held on February 21, 1996, YAEC expects that the NRC will reapprove the Yankee Rowe decommissioning plan.\nOn December 29, 1995, FERC approved a revised decommissioning estimate for Yankee Rowe, which assumed prompt resumption of major decommissioning activities. Based on the revised decommissioning estimate, the total remaining decommissioning cost for the System's ownership share of Yankee Rowe is approximately $103.5 million in December 1995 dollars.\nCYAPC accrues decommissioning costs on the basis of immediate dismantlement at retirement. In May 1993, FERC approved a settlement agreement in a CYAPC rate proceeding allowing a revised decommissioning estimate of $294.2 million (in July 1992 dollars) to be recovered in rates beginning on June 1, 1993. This amount will increase by a stated amount each year for inflation. The most current estimated decommissioning cost of the System's ownership share is approximately $188.9 million in year-end 1995 dollars.\nMYAPC estimates the cost of the System's ownership share of decommissioning MY at $70.7 million in December 31, 1995 dollars based on a study completed in July 1993. VYNPC estimates the cost of the System's ownership share of decommissioning VY at $55.6 million in December 31, 1995 dollars based on a study completed in March 1994.\nNONUTILITY BUSINESSES\nPRIVATE POWER DEVELOPMENT\nThe System participates as a developer and investor in domestic and international private power projects through its subsidiary, Charter Oak. Management currently does not permit Charter Oak to invest in facilities which are located within the System service territory or sell electric output to any of the System electric utility companies. Charter Oak is investing primarily in projects outside of the United States.\nCharter Oak owns, through wholly owned special-purpose subsidiaries, a 10 percent equity interest in a 220-MW natural gas-fired combined-cycle cogeneration QF in Texas, a 56 MW interest in a 1,875-MW natural gas-fired cogeneration facility in the United Kingdom and a 33 percent equity interest in a 114-MW natural gas-fired project in Argentina.\nCharter Oak is currently participating in the development of projects in Latin America and the Pacific Rim. Specifically, Charter Oak is engaged in constructing a 168-MW natural gas-fired project located in Argentina and a 20-MW wind-power project in Costa Rica.\nAlthough Charter Oak has no full-time employees, 14 NUSCO employees are dedicated to Charter Oak activities on a full-time basis. Other NUSCO employees provide services as required. NU's Board of Trustees has authorized investments up to $200 million in Charter Oak. NU's total investment in Charter Oak was approximately $64 million as of December 31, 1995. NU currently is committed to invest or guarantee up to an additional $75 million in Charter Oak to fund completion of the natural gas-fired project in Argentina and the wind-power project in Costa Rica. To date, Charter Oak's consolidated revenues and net income (loss) have not been material to the System.\nENERGY MANAGEMENT SERVICES\nIn 1990, NU organized a subsidiary corporation, HEC, to acquire substantially all of the assets and personnel of a nonaffiliated energy management services company. In general, HEC contracts to reduce its customers' energy costs and\/or conserve energy and other resources. HEC also provides DSM consulting services to utilities and others. HEC's energy management and consulting services previously had been directed primarily to the commercial, industrial and institutional markets and utilities in New England and New York, but, on July 19, 1995, HEC received expanded authority from the SEC to perform energy management services without geographical limitation. NU's aggregate equity investment in HEC was approximately $4 million through December 31, 1995.\nREGULATORY AND ENVIRONMENTAL MATTERS\nENVIRONMENTAL REGULATION\nGENERAL\nThe System and its subsidiaries are subject to federal, state and local regulations with respect to water quality, air quality, toxic substances, hazardous waste and other environmental matters. Similarly, the System's major generation and transmission facilities may not be constructed or significantly modified without a review by the applicable state agency of the environmental impact of the proposed construction or modification. Compliance with environmental laws and regulations, particularly air and water pollution control requirements, may limit operations or require substantial investments in new equipment at existing facilities. See \"Resource Plans\" for a discussion of the System's construction plans.\nSURFACE WATER QUALITY REQUIREMENTS\nThe federal Clean Water Act (CWA) requires every \"point source\" discharger of pollutants into navigable waters to obtain a National Pollutant Discharge Elimination System (NPDES) permit from the United States Environmental Protection Agency (EPA) or state environmental agency specifying the allowable quantity and characteristics of its effluent. System facilities have all required NPDES permits in effect. Compliance with NPDES and state water discharge permits has necessitated substantial expenditures and may require further expenditures because of additional requirements that could be imposed in the future.\nOn October 13, 1995, the Connecticut Department of Environmental Protection (CDEP) issued a consent order to CL&P and the Long Island Lighting Company (LILCO) requiring those companies to address leaks from the Long Island cable, which is jointly owned by CL&P and LILCO. The order requires CL&P and LILCO to study and propose alternatives for prevention, detection and mitigation of oil leaks and to evaluate the ecological effects of leaks on the environment. Alternatives to be studied include replacement of the cable and the dielectric fluid currently used in the cable. The System will incur additional costs to meet the requirements of the order and to meet any subsequent CDEP requirements resulting from the studies under the consent order, which costs cannot be estimated at this time. Management also cannot determine at this time whether long-term future operation of the cable will remain cost effective subsequent to any additional CDEP requirements.\nIn early February 1996, the CDEP notified CL&P and LILCO that it desired to amend the consent order to cover transformer oil that was inadvertently introduced into the cable by LILCO at its pumping station on Long Island. LILCO is in the process of removing the transformer oil from the cable and has instituted safeguards to prevent it from happening again. The System does not believe that any of the transformer oil reached the part of the cable in Connecticut.\nThe United States Attorney's Office in New Haven, Connecticut has commenced an investigation and has issued subpoenas to CL&P, NU, NUSCO, CONVEX and LILCO seeking documents relating to operation and maintenance of and recent leaks from the Long Island cable. Since the investigation is in its preliminary stages and the government has not revealed the scope of its investigation, management cannot evaluate the likelihood of a criminal proceeding being initiated at this time. However, management is aware of nothing that would suggest that any System company, officer or employee has engaged in conduct that would warrant such a proceeding.\nThe CWA requires EPA and state permitting authorities to approve the cooling water intake structure design and thermal discharge of steam-electric generating plants. All System steam-electric plants have received these approvals. In the renewed NPDES discharge permit for the three Millstone nuclear units, issued in 1992, CDEP included a condition requiring a feasibility study of various structural or operational modifications of the cooling water intake system to reduce the entrainment of winter flounder larvae. The report, submitted in 1993, concluded that the mitigation alternatives examined were not technically feasible or cost effective. The CDEP found that the current cooling water intake represents the \"best available technology\" for minimizing adverse impacts, but required NNECO to schedule refueling outages, when possible, to coincide with high larval winter flounder abundance at the intakes and to report the results of such efforts. The NPDES permit further states that additional evidence may result in the agency imposing more stringent requirements.\nMerrimack Station's NPDES permit requires site work to isolate adjacent wetlands from the station's waste water system. Plans have been approved by the New Hampshire Department of Environmental Services (NHDES), and PSNH is now preparing a permit application to begin construction.\nThe Merrimack permit also requires PSNH to perform further biological studies because significant numbers of migratory fish are being restored to lower reaches of the Merrimack River. These studies are in progress and initial results will be reported in 1996. Preliminary findings from these studies indicate that Merrimack Station's once-through cooling system does not interfere with the establishment of a balanced aquatic community. However, if NHDES determines there is interference, PSNH could be required to construct a partially enclosed cooling water system for Merrimack Station. The amount of capital expenditures relating to the foregoing cannot be determined at this time. However, if such expenditures were required, they would likely be substantial and a reduction of Merrimack Station's net generation capability could result.\nThe ultimate cost impact of the CWA and state water quality regulations on the System cannot be estimated because of uncertainties such as the impact of changes to the effluent guidelines or water quality standards. Additional modifications, in some cases extensive and involving substantial cost, may ultimately be required for some or all of the System's generating facilities.\nIn response to several major oil spills in recent years, Congress passed the Oil Pollution Act of 1990 (OPA 90). OPA 90 sets out the requirements for facility response plans and periodic inspections of spill response equipment at facilities that can cause substantial harm to the environment by discharging oil or hazardous substances into the navigable waters of the United States and onto adjoining shorelines. Pursuant to OPA 90, EPA has authority to regulate nontransportation-related fixed onshore facilities and the United States Coast Guard (Coast Guard) has the authority to regulate transportation-related onshore facilities. Response plans were filed for all System facilities believed to be subject to this requirement. The Coast Guard has completed its final review process and issued its approval of these plans. The EPA has issued its approval of all facility plans except PSNH's Schiller Station, where the EPA has authorized continued operation pending its final plan approval.\nOPA 90 includes limits on the liability that may be imposed on persons deemed responsible for release of oil. The limits do not apply to oil spills caused by negligence or violation of laws or regulations. OPA 90 also does not preempt state laws regarding liability for oil spills. In general, the laws of the states in which the System owns facilities and through which the System transports oil could be interpreted to impose strict liability for the cost of remediating releases of oil and for damages caused by releases. The System and its principal oil transporter currently carry a total of $900 million in insurance coverage for oil spills.\nAIR QUALITY REQUIREMENTS\nThe Clean Air Act Amendments of 1990 (CAAA) made extensive revisions and additions to the federal Clean Air Act and imposed many stringent new requirements on air emissions sources. The CAAA contains provisions that further regulate emissions of sulfur dioxide (SO2) and nitrogen oxide (NOX) for the purpose of controlling acid rain and ground level ozone. In addition, the CAAA addresses the control of toxic air pollutants. Installation of continuous emissions monitors (CEMs) and expanded permitting provisions are also included.\nExisting and future federal and state air quality regulations could hinder or possibly preclude the construction of new, or the modification of existing, fossil units in the System's service area and could raise the capital and operating cost of existing units. The ultimate cost impact of these requirements on the System cannot be estimated because of uncertainties about how EPA and the states will implement various requirements of the CAAA.\nNitrogen Oxide. Title I of the CAAA identifies NOX emissions as a precursor of ambient ozone. The Northeastern region of the United States, including Connecticut, Massachusetts and New Hampshire, currently exceeds the ambient air quality standard for ozone. Pursuant to the CAAA, states exceeding the ozone standard must implement plans to address ozone nonattainment. All three states have issued final regulations to implement Phase I reduction requirements, and the System has met these requirements. Compliance with Phase I requirements has cost the System a total of approximately $41 million: $10 million for CL&P, $27 million for PSNH, $1 million for WMECO and $3 million for HWP. Compliance has been achieved using a combination of currently available technology, combustion efficiency improvements and emissions trading. Compliance costs for Phase II, effective in 1999, are expected to result in an additional cost of $10 to $15 million.\nIn December 1993, PSNH reached a revised agreement regarding NOX emissions with various environmental groups and the New Hampshire Business and Industrial Association (NHBIA). The agreement provides for aggressive unit-specific NOX emission rate limits for PSNH's generating facilities, effective May 31, 1995. The agreement relieves PSNH of a prior commitment to retire or repower Merrimack Unit 2 by May 15, 1999. More stringent emission rate limits equivalent to the range of 0.1 to 0.4 pounds of NOX per million Btu, however, are required for the unit by that date. In May 1994, NHDES promulgated the New Hampshire NOX reduction rule in accordance with the terms of the NHBIA Agreement. PSNH has complied with the requirements of this rule by installing controls on the units. The additional requirements for Merrimack Unit 2 for 1999 may be attained through increased catalytic reduction of NOX at an additional estimated cost of $5 to $7 million.\nSulfur Dioxide. The CAAA mandates reductions in SO2 emissions to control acid rain. These reductions are to occur in two phases. First, certain high SO2 emitting plants were required to reduce their emissions beginning January 1, 1995. All Phase I units will be allocated SO2 allowances for the period 1995- 1999. These allowances are freely tradable. One allowance entitles a source to emit one ton of SO2 in a year. No unit may emit more SO2 in a particular year than the amount for which it has allowances. The only System units subject to the Phase I reduction requirements are PSNH's Merrimack Units 1 and 2. Additionally, Newington Station in New Hampshire and Mt. Tom Station in Massachusetts are conditional Phase I units. This means that the System can decide to include these plants as Phase I units during any year and obtain allowances for that year. The System has included these plants as Phase I units for 1995.\nOn January 1, 2000, the start of Phase II, a nationwide cap of 8.9 million tons per year of utility SO2 emissions will be imposed and existing units will be granted allowances to emit SO2. Most of the System companies' allocated allowances will substantially exceed its expected SO2 emissions for 2000 and subsequent years, except for PSNH, which expects to purchase additional SO2 allowances from either affiliated or nonaffilated companies.\nNew Hampshire and Massachusetts have each instituted acid rain control laws that limit SO2 emissions. The System is meeting the new SO2 limitations by using natural gas and lower sulfur coal in its plants. Under the existing fuel adjustment clauses in Connecticut, New Hampshire and Massachusetts, the System should be able to recover the additional fuel costs of compliance with the CAAA and state laws from its customers. For more information regarding a prudence hearing in New Hampshire on costs associated with PSNH's capital expenditures to comply with Phase I reduction requirements, see \"Rates-New Hampshire Retail Rates-FPPAC.\"\nManagement does not believe that the acid rain provisions of the CAAA will have a significant impact on the System's overall costs or rates due to the very strict limits on SO2 emissions already imposed by Connecticut, New Hampshire and Massachusetts. In addition, management believes that Title IV of the CAAA (acid rain) requirements for NOX limitations will not have a significant impact on System costs due to the more stringent NOX limitations resulting from Title I of the CAAA discussed above.\nEPA, Connecticut, New Hampshire and Massachusetts regulations also include other air quality standards, emission standards and monitoring and testing and reporting requirements that apply to the System's generating stations. They require that new or modified fossil fuel-fired electric generating units operate within stringent emission limits. The System could incur additional costs to meet these requirements, which costs cannot be estimated at this time.\nAir Toxics. Title III of the CAAA directed EPA to study air toxics and mercury emissions from fossil fired steam electric generation units to determine if they should be regulated. EPA exempted these plants from the hazardous air pollutant program pending completion of the studies, expected this year. Should EPA determine that such generating plants' emissions must be controlled to the same extent as emissions from other sources under Title III, the System could be required to make substantial capital expenditures to upgrade or replace pollution control equipment, but the amount of these expenditures cannot be readily estimated.\nTOXIC SUBSTANCES AND HAZARDOUS WASTE REGULATIONS\nPCBs. Under the federal Toxic Substances Control Act of 1976 (TSCA), EPA has issued regulations that control the use and disposal of polychlorinated biphenyls (PCBs). PCBs had been widely used as insulating fluids in many electric utility transformers and capacitors before TSCA prohibited any further manufacture of such PCB equipment. System companies have taken numerous steps to comply with these regulations and have incurred increased costs for disposal of used fluids and equipment that are subject to the regulations.\nIn general, the System sends fluids with concentrations of PCBs equal to or higher than 500 ppm but lower than 8,500 ppm to an unaffiliated company to dispose of using a chemical treatment process. Electrical capacitors that contain PCB fluid are sent off-site to dispose of through burning in high temperature incinerators approved by EPA. The System disposes of solid wastes containing PCBs in secure chemical waste landfills.\nAsbestos. Federal, Connecticut, New Hampshire and Massachusetts asbestos regulations have required the System to expend significant sums on removal of asbestos, including measures to protect the health of workers and the general public and to properly dispose of asbestos wastes. Asbestos costs for the System are expected to be approximately $2 million in 1996. These costs are generally included in capital budgets.\nRCRA. Under the federal Resource Conservation and Recovery Act of 1976, as amended (RCRA), the generation, transportation, treatment, storage and disposal of hazardous wastes are subject to EPA regulations. Connecticut, New Hampshire and Massachusetts have adopted state regulations that parallel RCRA regulations but in some cases are more stringent. The procedures by which System companies handle, store, treat and dispose of hazardous wastes are regularly revised, where necessary, to comply with these regulations.\nCL&P is expecting that EPA and CDEP will approve clean closure for CL&P's Montville and Middletown Stations' former surface impoundments. For the Norwalk Harbor and Devon sites, CL&P has applied for post-closure permits and is awaiting approval from EPA and CDEP. The System estimates that it will incur approximately $2.1 million in total costs for 30-year maintenance monitoring, and closure of the container storage areas and surface impoundments for these sites in the future, but the ultimate amount will depend on EPA's final disposition.\nHazardous Waste Liability. As many other industrial companies have done in the past, System companies have disposed of residues from operations by depositing or burying such materials on-site or disposing of them at off-site landfills or facilities. Typical materials disposed of include coal gasification waste, fuel oils, gasoline and other hazardous materials that might contain PCBs. It has since been determined that deposited or buried wastes, under certain circumstances, could cause groundwater contamination or create other environmental risks. The System has recorded a liability for what it believes is, based upon currently available information, its estimated environmental remediation costs for waste disposal sites for which the System companies expect to bear legal liability, and continues to evaluate the environmental impact of its former disposal practices. Under federal and state law, government agencies and private parties can attempt to impose liability on System companies for such past disposal. As of December 31, 1995, the liability recorded by the System for its estimated environmental remediation costs for known sites needing remediation including those sites described below, exclusive of recoveries from insurance or third parties, was approximately $15 million. This amount represents the minimum reserve required by the Financial Accounting Standards Board. These costs could be significantly higher if alternative remedies become necessary.\nUnder the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, commonly known as Superfund, EPA has the authority to clean up or order cleanup of hazardous waste sites and to impose the cleanup costs on parties deemed responsible for the hazardous waste activities on the sites. Responsible parties include the current owner of a site, past owners of a site at the time of waste disposal, waste transporters and waste generators. It is EPA's position that all responsible parties are jointly and severally liable, so that any single responsible party can be required to pay the entire costs of cleaning up the site. As a practical matter, however, the costs of cleanup are usually allocated by agreement of the parties, or by the courts on an equitable basis among the parties deemed responsible, and several federal appellate court decisions have rejected EPA's position on strict joint and several liability. Superfund also contains provisions that require System companies to report releases of specified quantities of hazardous materials and require notification of known hazardous waste disposal sites. System companies are in compliance with these reporting and notification requirements.\nThe System currently is involved in two Superfund sites in Connecticut, one in Kentucky and two in New Hampshire. The level of study of each site and the information about the waste contributed to the site by the System and other parties differs from site to site. Where reliable information is available that permits the System to make a reasonable estimate of the expected total costs of remedial action and\/or the System's likely share of remediation costs for a particular site, those cost estimates are provided below. All cost estimates were made in accordance with Financial Accounting Standards Board standards where remediation costs were probable and reasonably estimable. Any estimated costs disclosed for cleaning up the sites discussed below were determined without consideration of possible recoveries from third parties, including insurance recoveries. Where the System has not accrued a liability, the costs either were not material or there was insufficient information to accurately assess the System's exposure.\nA coalition of major parties had previously joined \"Northeast Utilities (Connecticut Light and Power)\" (NU (CL&P))as defendants in connection with the Beacon Heights and Laurel Park Superfund sites in Connecticut. In 1993, the United States District Court for the District of Connecticut dismissed the coalitions' claims against NU (CL&P) and a number of other defendants. The coalitions, however, have appealed the district court's decision, which is currently pending.\nEPA has issued a notice of potential liability to NNECO and CYAPC as potentially responsible parties (PRPs) at the Maxey Flats nuclear waste disposal site in Fleming County, Kentucky. The System had sent a substantial volume of LLRW from Millstone 1, Millstone 2 and CY to this site. PRPs that are members of the Maxey Flats PRP Steering Committee, including System companies, and several federal government agencies, including DOE and the Department of Defense as well as the Commonwealth of Kentucky have reached a tentative settlement with EPA embodied in a consent decree. On February 8, 1996, this consent decree was filed by the United States Department of Justice in a federal district court in Kentucky for approval. NUSCO, on behalf of NNECO and CYAPC, signed the consent decree in March 1995. The System has recorded a liability for future remediation costs for this site based on its best estimate of its share of ultimate remediation costs under the tentative agreement. The System's future liability at the site has been assessed at slightly over $1 million.\nPSNH has committed approximately $280,000 as its share to clean up one municipal landfill Superfund site in Dover, New Hampshire and has been assessed a de minimus share at another such site in North Hampton, New Hampshire. Some additional costs may be incurred at these sites, but they are not expected to be significant.\nAs discussed below, in addition to the remediation efforts for the above- mentioned Superfund sites, the System has been named as a PRP and is monitoring developments in connection with several state environmental actions.\nIn 1987, CDEP published a list of 567 hazardous waste disposal sites in Connecticut. The System owns two sites on this list, which are also listed on the EPA's list of hazardous waste sites. The System has spent approximately $700,000, as of December 31, 1995, completing investigations at these sites. Both sites were formerly used by CL&P predecessor companies for the manufacture of coal gas (also known as town gas sites) from the late 1800s to the 1950s. This process resulted in the production of coal tar and creosote residues and other byproducts, which, when not sold for other industrial or commercial uses, were frequently deposited on or near the production facilities. Site investigations are being carried out to gain an understanding of the environmental and health risks of these sites. Assessments of the need for site remediation is ongoing. The level of future cleanup will be established in cooperation with CDEP, which has recently issued cleanup standards for soil and groundwater.\nOne of the sites is a 25.8-acre site located in the south end of Stamford, Connecticut. Site investigations have located coal tar deposits covering approximately 5.5 acres and having a volume of approximately 45,000 cubic yards. A final risk assessment report for the site was completed in January 1994. Several remedial options have been evaluated to clean up the site, if necessary. The estimated costs of remediation and institutional controls range from $5 to $13 million.\nThe second site is a 3.5-acre former coal gasification facility that currently serves as an active substation in Rockville, Connecticut. Site investigations have located creosote and other polyaromatic hydrocarbon contaminants which may require remediation. Several options are being evaluated to remediate the site if necessary. To further evaluate the health risks at the site, additional studies are being planned in coordination with the CDEP during 1996.\nAs part of the 1989 divestiture of CL&P's gas business, site investigations were performed for properties that were transferred to Yankee Gas Services Company (Yankee Gas). CL&P agreed to accept liability for any required cleanup for the three sites it retained. These three sites include Stamford and Rockville (discussed above) and Torrington, Connecticut. At the Torrington site, investigations have been completed and the cost of any remediation, if necessary, is not expected to be material. CL&P and Yankee Gas also share a site in Winsted, Connecticut and any liability for required cleanup there. CL&P and Yankee Gas will share the costs of cleanup of sites formerly used in CL&P's gas business but not currently owned by either of them.\nPSNH contacted NHDES in December 1993 concerning possible coal tar contamination in Laconia, New Hampshire in Lake Opechee and the Winnipesaukee River near an area where PSNH and a second PRP formerly owned and operated a coal gasification plant from the late 1800's to the 1950's. PSNH completed a preliminary site investigation in December 1994. Results indicate that off-site coal tar\/creosote contamination is present in the adjacent water body. A comprehensive site investigation is planned for 1996. The cost of remediation, if necessary, at this site is estimated at $5 to 8 million. PSNH has entered into an interim cost sharing agreement with the other PRP wherein the other PRP will bear 25 percent of this cost. A second coal gasification facility formerly owned and operated by a predecessor company to PSNH is located in Keene, New Hampshire. The NHDES has been notified of the presence of coal tar contamination and further site investigations are planned in 1996. Additional New Hampshire sites include several former manufactured gasification facilities, an inactive ash landfill located at Dover Point and a municipal landfill in Peterborough. Historic reviews of these sites are ongoing. PSNH's liability at these sites cannot be estimated at this time.\nIn Massachusetts, System companies have been designated by the Massachusetts Department of Environmental Protection (MDEP) as PRPs for twelve sites under MDEP's hazardous waste and spill remediation program. At two sites, the System may incur remediation costs that may be material to HWP depending on the remediation requirements. At one site, HWP has been identified by MDEP as one of three PRPs in a coal tar site in Holyoke, Massachusetts. HWP owned and operated the Holyoke Gas Works from 1859 to 1902. The site is located on the east side of Holyoke, adjacent to the Connecticut River and immediately downstream of HWP's Hadley Falls Station. MDEP has designated both the land and river deposit areas as priority waste disposal sites. Due to the presence of tar patches in the vicinity of the spawning habitat of the shortnose sturgeon (SNS)-an endangered species-the National Oceanographic and Atmospheric Administration (NOAA) and National Marine Fisheries Service have taken an active role in overseeing site activities. Both MDEP and NOAA have indicated they may require the removal of tar deposits from the vicinity of the SNS spawning habitat. To date, HWP has spent approximately $405,000 for river studies and construction costs for an oil containment boom to prevent leaching hydrocarbons from entering the Hadley Falls tailrace and the Connecticut River. The total estimated costs for remediation of this site range from $2 to $3 million. The second site is a former manufactured gas plant facility in Easthampton, Massachusetts, owned by WMECO. The site is currently undergoing investigations both on-site and off-site to identify the extent of coal tar deposits.\nIn the past, the System has received other claims from government agencies and third parties for the cost of remediating sites not currently owned by the System but affected by past System disposal activities and may receive more such claims in the future. The System expects that the costs of resolving claims for remediating sites about which it has been notified will not be material, but cannot estimate the costs with respect to sites about which it has not been notified. If the System, regulatory agencies or courts determine that remedial actions must be taken in relation to past disposal practices on property owned or used for disposal by the System in the past, the System could incur substantial costs.\nELECTRIC AND MAGNETIC FIELDS\nIn recent years, published reports have discussed the possibility of adverse health effects from electric and magnetic fields (EMF) associated with electric transmission and distribution facilities and appliances and wiring in buildings and homes. Most researchers, as well as scientific review panels considering all significant EMF epidemiological and laboratory research to date, agree that current information remains inconclusive, inconsistent and insufficient for risk assessment of EMF exposures. Based on this information management does not believe that a causal relationship has been established or that significant capital expenditures are appropriate to minimize unsubstantiated risks. NU is closely monitoring research and government policy developments.\nThe System supports further research into the subject and is participating in the funding of the National EMF Research and Public Information Dissemination Program and other industry-sponsored studies. If further investigation were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems, the industry could be faced with the difficult problem of delivering reliable electric service in a cost- effective manner while managing EMF exposures. In addition, if the courts were to conclude that individuals have been harmed and that utilities are liable for damages, the potential monetary exposure for all utilities, including the System companies, could be enormous. Without definitive scientific evidence of a causal relationship between EMF and health effects, and without reliable information about the kinds of changes in utilities' transmission and distribution systems that might be needed to address the problem, if one is found, no estimates of the cost impacts of remedial actions and liability awards are available.\nThe Connecticut Interagency EMF Task Force (Task Force) provided a report to the state legislature in January 1995. The Task Force advocates a policy of \"voluntary exposure control,\" which involves providing people with information to enable them to make individual decisions about EMF exposure. Neither the Task Force, nor any Connecticut state agency, has recommended changes to the existing electrical supply system. The Connecticut Siting Council (Siting Council) previously adopted a set of EMF \"best management practices,\" which are now considered in the justification, siting and design of new transmission lines and substations. The Siting Council also opened a generic docket in 1994 to conduct a comparative life-cycle cost analysis of overhead and underground transmission lines, which was mandated by Connecticut PA-176. This act was adopted by the General Assembly in part due to public EMF concerns. The Siting Council hired consultants in 1995 to assist with this analysis. A decision is expected in 1996.\nEMF has become increasingly important as a factor in facility siting decisions in many states. Several bills involving EMF were introduced in Massachusetts in 1995, with no action taken. These bills were similar to ones introduced in previous years, on which no action was taken. WMECO supported one of the bills, which would have authorized a special commission to investigate health effects, if any, of EMF, and conduct EMF measurements in schools and daycare centers near transmission lines. The Connecticut General Assembly likewise took no action on a bill introduced in 1995 concerning electromagnetic sources near schools.\nCL&P has been the focus of media reports charging that EMF associated with a CL&P substation and related distribution lines in Guilford, Connecticut, are linked with various cancers and other illnesses in several nearby residents. See \"Item 3. Legal Proceedings,\" for information about two suits brought by plaintiffs who now live or formerly lived near that substation.\nFERC HYDRO PROJECT LICENSING\nFederal Power Act licenses may be issued for hydroelectric projects for terms of up to 50 years as determined by FERC. Upon the expiration of a license, any hydroelectric project so licensed is subject to reissuance by FERC to the existing licensee or to others upon payment to the licensee of the lesser of fair value or the net investment in the project plus severance damages less certain amounts earned by the licensee in excess of a reasonable rate of return.\nThe System companies hold FERC licenses for 19 hydroelectric projects aggregating approximately 1,142 MW of capacity, located in Connecticut, Massachusetts and New Hampshire. Four of the System licenses expired on December 31, 1993 (WMECO's Gardners Falls project and PSNH's Ayers Island, Smith and Gorham projects). On August 1, 1994, FERC issued new 30-year licenses to PSNH for the continued operation of the Smith and Gorham projects. Although rehearing requests on these new licenses are pending with FERC, it is anticipated that it will be economic for PSNH to continue operation of these projects. FERC has issued annual licenses allowing the Gardners Falls and Ayers Island projects to continue operations pending completion of the relicensing process. It is not known whether FERC will require any substantial changes in the operation or design of these two projects if and when it issues new licenses.\nThe license for HWP's Holyoke Project expires in late 1999. The relicensing process for this project began in 1994. On November 29, 1995, the Holyoke Gas and Electric Department initiated the process of applying to FERC for the license on the Holyoke Project. Absent significant differences in competing license applications, the Federal Power Act gives a preference to an existing licensee for the new license. Applications must be filed with FERC by August 1997.\nCL&P's FERC licenses for operation of the Falls Village and Housatonic Hydro Projects expire in 2001. The relicensing process for these projects will begin later in 1996.\nFERC has issued a notice indicating that it has authority to order project licensees to decommission projects that are no longer economic to operate. FERC has not required any such project decommissioning to date; the potential costs of decommissioning a project, however, could be substantial. It is likely that this FERC decision will be appealed at an appropriate time.\nEMPLOYEES\nAs of December 31, 1995, the System companies had 9,051 full and part-time employees on their payrolls, of which 2,285 were employed by CL&P, 1,339 by PSNH, 533 by WMECO, 101 by HWP, 1,333 by NNECO, 2,589 by NUSCO and 871 by NAESCO. NU, NAEC and Charter Oak have no employees.\nIn 1995 and early 1996, the System implemented a program to reduce the nuclear organization's total workforce by approximately 220 employees, which included both early retirements and involuntary terminations. The pretax cost of the program was approximately $8.7 million.\nApproximately 2,275 employees of CL&P, PSNH, WMECO, NAESCO and HWP are covered by nine union agreements, which expire between May 31, 1996 and October 1, 1998. Approximately 370 union employees of WMECO and HWP returned to work on September 1, 1995, ending a strike that began on May 25, 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe physical properties of the System are owned or leased by subsidiaries of NU. CL&P's principal plants and other properties are located either on land which is owned in fee or on land, as to which CL&P owns perpetual occupancy rights adequate to exclude all parties except possibly state and federal governments, which has been reclaimed and filled pursuant to permits issued by the United States Army Corps of Engineers. The principal properties of PSNH are held by it in fee. In addition, PSNH leases space in an office building under a 30-year lease expiring in 2002. WMECO's principal plants and a major portion of its other properties are owned in fee, although one hydroelectric plant is leased. NAEC owns a 35.98 percent interest in Seabrook 1 and approximately 719 acres of exclusion area land located around the unit. In addition, CL&P, PSNH, and WMECO have certain substation equipment, data processing equipment, nuclear fuel, nuclear control room simulators, vehicles, and office space that are leased. With few exceptions, the System companies' lines are located on or under streets or highways, or on properties either owned or leased, or in which the company has appropriate rights, easements, or permits from the owners.\nCL&P's properties are subject to the lien of its first mortgage indenture. PSNH's properties are subject to the lien of its first mortgage indenture. In addition, any PSNH outstanding revolving credit agreement borrowings are secured by a second lien, junior to the lien of the first mortgage indenture, on PSNH's property located in New Hampshire. WMECO's properties are subject to the lien of its first mortgage indenture. NAEC's First Mortgage Bonds are secured by a lien on the Seabrook 1 interest described above, and all rights of NAEC under the Seabrook Power Contract. In addition, CL&P's and WMECO's interests in Millstone 1 are subject to second liens for the benefit of lenders under agreements related to pollution control revenue bonds. Various of these properties are also subject to minor encumbrances which do not substantially impair the usefulness of the properties to the owning company.\nThe System companies' and NAEC's properties are well maintained and are in good operating condition.\nTransmission and Distribution System\nAt December 31, 1995, the System companies owned 103 transmission and 427 distribution substations that had an aggregate transformer capacity of 25,000,646 kilovoltamperes (kVa) and 9,134,229 kVa, respectively; 3,057 circuit miles of overhead transmission lines ranging from 69 kilovolt (kV) to 345 kV, and 192 cable miles of underground transmission lines ranging from 69 kV to 138 kV; 32,593 pole miles of overhead and 1,912 conduit bank miles of underground distribution lines; and 391,562 line transformers in service with an aggregate capacity of 16,422,713 kVa.\nElectric Generating Plants\nAs of December 31, 1995, the electric generating plants of the System companies and NAEC, and the System companies' entitlements in the generating plants of the three operating Yankee regional nuclear generating companies were as follows (See \"Item 1. Business - Electric Operations, Nuclear Generation\" for information on ownership and operating results for the year.):\nClaimed Year Capability* Owner Plant Name (Location) Type Installed (kilowatts) - ----- --------------------- ---- --------- -----------\nCL&P Millstone (Waterford, CT) Unit 1 Nuclear 1970 524,637 Unit 2 Nuclear 1975 708,345 Unit 3 Nuclear 1986 606,453 Seabrook (Seabrook, NH) Nuclear 1990 47,013 CT Yankee (Haddam, CT) Nuclear 1968 201,204 ME Yankee (Wiscasset, ME) Nuclear 1972 94,832 VT Yankee (Vernon, VT) Nuclear 1972 45,353 --------- Total Nuclear-Steam Plants (7 units) 2,227,837 Total Fossil-Steam Plants (9 units) 1954-73 1,776,400 Total Hydro-Conventional (25 units) 1903-55 98,930 Total Hydro-Pumped Storage (7 units) 1928-73 905,150 Total Internal Combustion (15 units) 1966-86 390,450 --------- Total CL&P Generating Plant (63 units) 5,398,767 =========\nPSNH Millstone (Waterford, CT) Unit 3 Nuclear 1986 32,624 CT Yankee (Haddam, CT) Nuclear 1968 29,160 ME Yankee (Wiscasset, ME) Nuclear 1972 39,514 VT Yankee (Vernon, VT) Nuclear 1972 19,068 --------- Total Nuclear-Steam Plants (4 units) 120,366 Total Fossil-Steam Plants (7 units) 1952-78 1,004,065 Total Hydro-Conventional (20 units) 1917-83 67,510 Total Internal Combustion (5 units) 1968-70 108,450 --------- Total PSNH Generating Plant (36 units) 1,300,391 =========\nWMECO Millstone (Waterford, CT) Unit 1 Nuclear 1970 123,063 Unit 2 Nuclear 1975 166,155 Unit 3 Nuclear 1986 140,216 CT Yankee (Haddam, CT) Nuclear 1968 55,404 ME Yankee (Wiscasset, ME) Nuclear 1972 23,708 VT Yankee (Vernon, VT) Nuclear 1972 11,948 --------- Total Nuclear-Steam Plants (6 units) 520,494 Total Fossil-Steam Plants (1 unit) 1957 107,000 Total Hydro-Conventional (27 units) 1904-34 110,910** Total Hydro-Pumped Storage (4 units) 1972-73 205,200 Total Internal Combustion (3 units) 1968-69 63,500 --------- Total WMECO Generating Plant(41 units) 1,007,104 =========\nClaimed Year Capability* Owner Plant Name (Location) Type Installed (kilowatts) - ----- --------------------- ---- --------- -----------\nNAEC Seabrook (Seabrook, NH) Nuclear 1990 416,672 =========\nHWP Mt. Tom (Holyoke, MA) Fossil-Steam 1960 147,000 Total Hydro-Conventional (15 units) 1905-83 43,560 --------- Total HWP Generating Plant (16 units) 190,560 =========\nNU System Millstone (Waterford, CT) Unit 1 Nuclear 1970 647,700 Unit 2 Nuclear 1975 874,500 Unit 3 Nuclear 1986 779,293 Seabrook (Seabrook, NH) Nuclear 1990 463,685 CT Yankee (Haddam, CT) Nuclear 1968 285,768 ME Yankee (Wiscasset, ME) Nuclear 1972 158,054 VT Yankee (Vernon, CT) Nuclear 1972 76,369 --------- Total Nuclear-Steam Plants (7 units) 3,285,369 Total Fossil-Steam Plants (18 units) 1952-78 3,034,465 Total Hydro-Conventional (87 units) 1903-83 320,910** Total Hydro-Pumped Storage (7 units) 1928-73 1,110,350 Total Internal Combustion (23 units) 1966-86 562,400 --------- Total NU System Generating Plant Including Regional Yankees (142 units) 8,313,494 ========= Excluding Regional Yankees (139 units) 7,793,303 =========\n*Claimed capability represents winter ratings as of December 31, 1995.\n**Total Hydro-Conventional capability includes the Cobble Mtn. plant's 33,960 kW which is leased from the City of Springfield, MA.\nFranchises\nNU's operating subsidiaries hold numerous franchises in the territories served by them. For more information regarding recent judicial, regulatory and legislative decisions and initiatives that may affect the terms under which the System companies provide electric service in their franchised territories, see \"Connecticut Retail Rates - Electric Industry Restructuring in Connecticut;\" \"New Hampshire Retail Rates - Electric Industry Restructuring in New Hampshire;\" and \"Massachusetts Retail Rates - Electric Industry Restructuring in Massachusetts,\" and \"Item 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n1. Litigation Relating to Electric and Magnetic Fields\nIn December 1991, NU and CL&P were sued in Connecticut Superior Court by Melissa Bullock, a nineteen-year old woman, and her mother, Suzanne Bullock, both residents of 28 Meadow Street in Guilford, Connecticut. The plaintiffs allege that they have lived in close proximity to CL&P's Meadow Street substation and distribution lines since 1979. The suit claims that Melissa Bullock suffers from a form of brain cancer and related physical and psychological injuries, which were \"brought on as a result of exposure in her home to electromagnetic radiation generated by the defendants.\" Suzanne Bullock claims various physical and psychological injuries, and a diminution in the value of her property. The various counts against NU and CL&P include allegations of negligence, product liability, nuisance, unfair trade practices and strict liability. The suit seeks monetary damages, both compensatory and punitive, in as-yet unspecified amounts, as well as an injunction to cease emission of \"dangerous levels\" of electric and magnetic fields (EMF) into the plaintiffs' home. The plaintiffs are represented in part by counsel with a nationwide emphasis on similar litigation, and management considers this lawsuit to be a test case. The case is presently in the pre-trial discovery process. Trial is not anticipated until 1997.\nIn January 1992, a related lawsuit by two other plaintiffs also alleging cancer from EMF emanating from CL&P's Meadow Street substation and distribution lines was served on CL&P and NU. The plaintiffs are represented by the same counsel as the Bullocks, and the claims are nearly identical to the Bullocks' suit. This case is also in the pretrial discovery process; a trial date is not yet known.\nManagement believes that the allegations that EMF caused or contributed to the plaintiffs' illnesses are not supported by current scientific studies. NU and CL&P intend to defend the lawsuits vigorously. For information on EMF studies and state and federal initiatives, see \"Item 1. Business - Regulatory and Environmental Matters - Electric and Magnetic Fields.\"\n2. Southeastern Connecticut Regional Resources Recovery Authority (SCRRRA) - Application of the Municipal Rate\nThis matter involves three separate disputes over the rates that apply to CL&P's purchases of the generation of the SCRRRA project in Preston, Connecticut.\nMunicipal Rate Litigation: In 1990, CL&P initiated a challenge in federal district court to the DPUC's approval of an electricity purchase contract for the SCRRRA project under Connecticut's so-called \"municipal rate law.\" Under this law, CL&P would be required to purchase a portion of the electricity from the resource recovery facility at a rate equal to the retail rate that CL&P charges municipalities for electricity (\"municipal rate\"), which is significantly higher than CL&P's avoided costs. The district court subsequently ordered the parties to seek FERC's resolution of this matter. On January 11, 1995, FERC ruled that a state cannot require an electric utility to enter into a contract paying a qualifying facility more than the utility's avoided costs. On April 12, 1995, FERC denied several petitions for rehearing and reaffirmed its ruling. SCRRRA and other participants in the FERC proceeding have appealed FERC's ruling to the United States Court of Appeals. FERC moved to dismiss the appeal on jurisdictional grounds, which motion is still pending. Should CL&P ultimately prevail, the benefits to CL&P customers would be approximately $14.5 million.\nNon-Participant Towns: CL&P also contested SCRRRA's claim that CL&P must pay the municipal rate for the portion of the project's electricity that is derived from the trash of towns that are not long-term participants in the project. On April 20, 1994, the DPUC granted SCRRRA's request that the municipal rate be made applicable to the non-participant's portion of electricity.\nOn June 9, 1994, CL&P filed an appeal of the DPUC's ruling in the Hartford Superior Court. A total of approximately $3.5 million is in dispute for the years 1992 through 1994. The rate CL&P would be required to pay would also be substantially higher in later years if the DPUC's ruling is upheld. On February 6, 1995, the Superior Court granted the SCRRRA's motion to stay this proceeding until FERC issues a final decision on the municipal rate law. This case could be moot once the FERC decision is final.\nExcess Capacity: CL&P also contested SCRRRA's claim that CL&P must purchase, at the applicable contract rates (each of which is higher than CL&P's current avoided costs), any excess of the project's generation above 13.85 MW per hour. On May 3, 1994, the Connecticut Appellate Court affirmed a Superior Court ruling that the DPUC should decide this issue. On September 20, 1995, the DPUC ruled that the project's electricity sales under the contract are limited to no more than an average of 13.85 MW in any month. If the current level of plant operations continues, CL&P's total savings would be in the range of $11.4 million (present worth basis) over the contract's entire term. In November 1995, CL&P and SCRRRA each filed appeals of the DPUC decision in Hartford Superior Court. CL&P maintains that its purchase obligation is limited to 13.85 MW applied on an hourly basis (instead of on a monthly basis), while SCRRRA maintains that CL&P's purchase obligation is not limited to 13.85 MW. These appeals are now in the briefing stage, after which the case will wait assignment to a judge for oral argument.\n3. CL&P's 1992-1993 Retail Rate Case\nIn June 1993, the DPUC issued a decision approving a multi-year rate plan for CL&P. Two appeals have been filed from the 1993 Decision, one by CL&P and the other by the Connecticut Office of Consumer Counsel (OCC) and the City of Hartford (City). The two appeals were consolidated, and in May 1994, the City's appeal was dismissed by the Hartford Superior Court on jurisdictional grounds. The City appealed that dismissal to the Connecticut Appellate Court. The Supreme Court of Connecticut transferred the jurisdictional issue to itself and, in August 1995, affirmed the lower court's dismissal of the City. The City filed several post-decision motions, which the Supreme Court subsequently denied on September 13, 1995. The OCC's appeal is now proceeding in Hartford Superior Court. The other appeal, CL&P's challenge to certain aspects of the rate decision, is also proceeding in Hartford Superior Court.\n4. Connecticut DPUC - CL&P's Petition for Declaratory Ruling Regarding Proposed Retail Sales of Electricity by Texas-Ohio Power, Inc. (TOP)\nOn August 3, 1995, CL&P filed a petition for declaratory rulings with the DPUC to determine whether TOP, which built a small congeneration plant in Manchester, Connecticut, can sell electricity from the facility to two CL&P retail customers in Manchester. The plant is located on property leased from one of the two customers. TOP expected to sell electricity to the other customer, a manufacturing facility located on adjacent property, via a 500 foot distribution line. TOP is a unit of Texas-Ohio Gas, a Houston-based gas pipeline operator and marketer. CL&P's petition pointed to the fact that CL&P has a franchised right to sell electricity in Manchester and TOP has not been authorized to compete by engaging in retail electricity sales within that territory. The petition also requested that the DPUC rule that, under Connecticut statutes, as well as judicial and DPUC decisions interpreting Connecticut law, TOP is prohibited from selling electricity at retail in Connecticut.\nOn December 4, 1995, CL&P informed the DPUC that it had entered into a flex rate contract with one of the two retail customers thereby retaining them as a customer and mooting the need for the DPUC to decide the issue of sales by a private power producer to an off-site customer. However, on December 6, 1995, the DPUC acted on CL&P's original petition and issued a final decision denying all of the specific declaratory rulings requested by CL&P. The DPUC concluded that, because TOP's project would not use the public streets, it did not require specific legislative authorization to make retail sales of electricity. Further, the DPUC found that specific statutory prohibitions against selling electricity at retail did not apply to TOP.\nOn January 17, 1996, CL&P appealed the DPUC's decision to the Hartford Superior Court. CL&P's appeal asks the Court to reverse the DPUC decision, insofar as it concludes that TOP is not prohibited from making retail electric sales in Connecticut, and to vacate the portions of the decision that deal with electricity sales to off-site customers. NU cannot predict the outcome of this proceeding or its ultimate effect on the System.\n5. FERC - PSNH Acquisition Case\nIn 1992, FERC's approval of NU's acquisition of PSNH was appealed to the United States Court of Appeals for the First Circuit (Court). The Court affirmed the decision approving the merger but ordered FERC to address whether, if FERC had applied a more stringent \"public interest standard\" to the Seabrook power contract, any modifications would have been necessary. Purporting to apply this standard, FERC reaffirmed certain modifications to the contract, interpreting the standard liberally to allow it to intervene in contracts on behalf of non-parties to the contract. NU requested rehearing, arguing that FERC had not applied the appropriate standard, which request was denied by FERC in July 1994. In September 1994, NU filed a Petition for Review with the First Circuit Court of Appeals concerning FERC's application of a \"public interest standard\" to the Seabrook Power Contract. On May 23, 1995, the Court affirmed FERC's order. The Court held that FERC had correctly applied the \"public interest standard\" to modify terms of the contract. The order affects only future changes to the Seabrook Power Contract, including changes to decommissioning charges and rate of return.\n6. New Hampshire Office of Consumer Advocate and the Campaign for Ratepayers Rights Case\nOn November 1, 1995, the New Hampshire Office of Consumer Advocate (OCA) and the Campaign for Ratepayers Rights filed suit in Superior Court against the NHPUC seeking a declaratory ruling that special contracts entered into by and between PSNH and certain retail customers are prohibited by the 1989 rate agreement between PSNH and the State of New Hampshire (Rate Agreement). The petition is based on an alleged inconsistency between the New Hampshire statute that allows special contracts agreed to by a utility and a customer when deemed appropriate by the NHPUC and the legislation accepting the Rate Agreement wherein PSNH received protection against NHPUC actions fixing rates other than in the manner agreed upon in the Rate Agreement. The petition alleges that the special contracts constitute a breach of the Rate Agreement by PSNH, thereby estopping PSNH from claiming benefits under the Rate Agreement. On December 11, 1995, the Superior Court denied a request for an emergency injunction which would have prevented the NHPUC from authorizing any further special contracts between PSNH and large industrial customers. The New Hampshire Attorney General is representing the NHPUC in this action. However, OCA disputes the New Hampshire Attorney General's authority to provide such representation. While NU believes this proceeding should be dismissed on procedural grounds, it cannot predict the outcome of this proceeding or its ultimate effect on the System.\n7. Tax Litigation\nIn 1991, per Connecticut statute, the Town of Haddam performed a town-wide revaluation of the Connecticut Yankee (CY) property in that town. Based on the report of the engineering firm hired by the town to perform the revaluation, Haddam determined that the full fair-market value of the property, as of October 1, 1991, was $840 million. At that time, CY's net-book value was $245 million.\nIn March 1992, CY appealed this excessive valuation to Haddam's Board of Tax Review, which subsequently rejected CY's appeal. CY then, in July 1992, appealed to the Middletown Superior Court. At issue is the fair market value of utility property. NU believes that the assessments should be based on a fair market value that approximates net book cost. This is the assessment level that taxing authorities are predominantly using throughout Connecticut. However, Haddam advocates a method that approximates reproduction costs.\nTwo expert appraisals of the property were prepared for CY's use in the appeal - 1) Stone & Webster's determination that the full fair-market value of CY's property, as of October 1, 1991, was $230 million and 2) AUS Consulting of Milwaukee's finding of a value of $219.4 million. Trial began in Middletown Superior Court in early December 1995, and a decision is expected during the first half of 1996. NU cannot predict the outcome of this proceeding or its ultimate effect on the System.\n8. Other Legal Proceedings\nThe following sections of Item 1 \"Business\" discuss additional legal proceedings: See \"Competition and Marketing\" for information regarding a DPUC proceeding on guidelines for CL&P's flexible rate agreements; \"Wholesale Marketing\" for information on a PSNH complaint filed against NHEC at the FERC; \"Rates\" for information about CL&P's rate and fuel clause adjustment clause proceedings, NHPUC proceedings involving Freedom Energy Company, New Hampshire's LEEPA statute and PSNH's franchise rights, and the Seabrook Power Contract; \"Electric Operations -- Generation and Transmission\" for information about proceedings relating to power and transmission issues; \"Electric Operations -- Nuclear Generation\" for information related to nuclear plant performance, nuclear fuel enrichment pricing, high-level and low-level radioactive waste disposal, decommissioning matters and NRC regulation; \"Regulatory and Environmental Matters\" for information about proceedings involving surface water and air quality, toxic substances and hazardous waste, electric and magnetic fields, licensing of hydroelectric projects, and other matters.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo Event that would be described in response to this item occurred with respect to NU, CL&P, WMECO, PSNH or NAEC.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrants' Common Equity and Related Shareholder Matters\nNU. The common shares of NU are listed on the New York Stock Exchange. The ticket symbol is \"NU,\" although it is frequently presented as \"Noeast Util\" and\/or \"NE Util\" in various financial publications. The high and low sales prices for the past two years, by quarters, are shown below.\nYear Quarter High Low ---- ------- ---- ---\n1995 First $24 1\/4 21 Second 23 7\/8 21 3\/8 Third 24 1\/2 22 Fourth 25 3\/8 23 1\/2\n1994 First $25 3\/4 23 Second 24 7\/8 21 1\/4 Third 24 5\/8 20 3\/8 Fourth 23 3\/8 21 1\/4\nAs of January 31, 1996, there were 129,943 common shareholders of record of NU. As of the same date, there were a total of 135,985,056 common shares issued, including approximately 8.5 million unallocated ESOP shares held in the ESOP trust.\nNU declared and paid quarterly dividends of $0.44 in 1995 and $0.44 in 1994. On January 23, 1996, the Board of Trustees declared a dividend of $0.44 per share, payable on March 31, 1996 to holders of record on March 1, 1996. The declaration of future dividends may vary depending on capital requirements and income as well as financial and other conditions existing at the time.\nInformation with respect to dividend restrictions for NU and its subsidiaries is contained in Item 1. Business under the caption \"Financing Program - Financing Limitations\" and in Note (b) to the \"Consolidated Statements of Common Shareholders' Equity\" on page 30 of NU's 1996 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P, PSNH, WMECO, and NAEC. The information required by this item is not applicable because the common stock of CL&P, PSNH, WMECO, and NAEC is held solely by NU.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNU. Reference is made to information under the heading \"Selected Consolidated Financial Data\" contained on page 45 of NU's 1995 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Selected Financial Data\" contained on page 35 of CL&P's 1995 Annual Report, which information is Incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Selected Financial Data\" contained on pages 32 and 33 of PSNH's 1995 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Selected Financial Data\" contained on page 33 of WMECO's 1995 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Selected Financial Data\" contained on page 21 of NAEC's 1995 Annual Report, which information is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nNU. Reference is made to information under the heading \"Management's Discussion and Analysis\" contained on pages 15 through 21 in NU's 1995 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 29 through 34 in CL&P's 1995 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 26 through 31 in PSNH's 1995 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 27 through 32 in WMECO's 1995 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 17 through 20 in NAEC's 1995 Annual Report, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nNU. Reference is made to information under the headings \"Company Report,\" \"Report of Independent Public Accountants,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Income Taxes,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Capitalization,\" \"Consolidated Statements of Common Shareholders' Equity,\" \"Notes to Consolidated Financial Statements,\" and \"Consolidated Statements of Quarterly Financial Data\" contained on pages 22 through 44 in NU's 1995. Annual Report to Shareholders, which information, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the headings \"Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Common Stockholder's Equity,\" \"Notes to Consolidated Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 2 through 28 and page 35 in CL&P's 1995 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" \"Statements of Common Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" \"Independent Auditors' Report,\" and \"Statements of Quarterly Financial Data\" contained on pages 2 through 25 and page 34 in PSNH's 1995 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" \"Statements of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 2 through 26 and page 33 in WMECO's 1995 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the headings \"Balance Sheet,\" \"Statement of Income,\" \"Statement of Cash Flows,\" \"Statement of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statement of Quarterly Financial Data\" contained on pages 2 through 16 and page 21 in NAEC's 1995 Annual Report which information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNo event that would be described in response to this item has occurred with respect to NU, CL&P, PSNH, WMECO, or NAEC.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nNU. In addition to the information provided below concerning the executive officers of NU, incorporated herein by reference is the information contained in the sections \"Proxy Statement,\" \"Committee Composition and Responsibility,\" \"Common Stock Ownership of Certain Beneficial Owners,\" \"Common Stock Ownership of Management,\" \"Compensation of Trustees,\" \"Summary Compensation Table,\" \"Pension Benefits,\" and \"Report on Executive Compensation\" of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1996 and filed with the Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 (the Act).\nFirst First Positions Elected Elected Name Held an Officer a Trustee - ----------------------- --------- ---------- ---------\nBernard M. Fox CHB, P, CEO, T 05\/01\/83 05\/20\/86\nCL&P. First First Positions Elected Elected Name Held an Officer a Director - ----------------------- --------- ---------- ----------\nRobert G. Abair D - 01\/01\/89 Robert E. Busch P, D 06\/01\/87 06\/01\/87 John H. Forsgren EVP, CFO 02\/01\/96 - Bernard M. Fox CH, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, CAO, D 06\/01\/91 01\/01\/94 Barry Ilberman VP 02\/01\/89 - John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John J. Roman VP, CONT 04\/01\/92 - Robert P. Wax VP, SEC, GC 08\/01\/92 -\nPSNH. First First Positions Elected Elected Name Held an Officer a Director - ----------------------- --------- ---------- ----------\nRobert E. Busch P 06\/05\/92 John C. Collins D - 10\/19\/92 John H. Forsgren EVP, CFO 02\/01\/96 - Bernard M. Fox CH, CEO, D 06\/05\/92 06\/05\/92 William T. Frain, Jr. P, COO, D 03\/18\/71 02\/01\/94 Cheryl W. Grise D 02\/06\/95 Barry Ilberman VP 07\/01\/94 - Gerald Letendre D - 10\/19\/92 Hugh C. MacKenzie D - 02\/01\/94 Jane E. Newman D - 10\/19\/92 John J. Roman VP, CONT 04\/01\/92 - Robert P. Wax VP,SEC,GC,D 08\/01\/92 02\/01\/93\nWMECO. First First Positions Elected Elected Name Held an Officer a Director - ----------------------- --------- ---------- ----------\nRobert G. Abair VP, CAO, D 09\/06\/88 01\/01\/89 Robert E. Busch P, D 06\/01\/87 06\/01\/87 John H. Forsgren EVP, CFO 02\/01\/96 - Bernard M. Fox C, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 06\/01\/91 01\/01\/94 Barry Ilberman VP 02\/01\/89 - John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John J. Roman VP, CONT 04\/01\/92 - Robert P. Wax VP, SEC, AC, GC 08\/01\/92 -\nNAEC. First First Positions Elected Elected Name Held an Officer a Director - ----------------------- --------- ---------- ----------\nRobert E. Busch P, D 10\/21\/91 10\/16\/91 Ted C. Feigenbaum EVP, CNO, D 10\/21\/91 10\/16\/91 John H. Forsgren EVP, CFO 02\/01\/96 - Bernard M. Fox C, CEO, D 10\/21\/91 10\/16\/91 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, CAO, D 10\/21\/91 01\/01\/94 Barry Ilberman VP 01\/29\/92 - Francis L. Kinney SVP 10\/21\/91 - John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Hugh C. MacKenzie D - 01\/01\/94 John J. Roman VP, CONT 04\/01\/92 - Robert P. Wax VP, SEC, GC 08\/01\/92 -\nKey: AC - Assistant Clerk CAO - Chief Administrative Office EVP - Executive Vice President CEO - Chief Executive Officer GC - General Counsel CFO - Chief Financial Officer P - President CH - Chairman SEC - Secretary CHB - Chairman of the Board SVP - Senior Vice President CNO - Chief Nuclear Officer T - Trustee COO - Chief Operating Officer TR - Treasurer CONT - Controller VP - Vice President D - Director\nName Age Business Experience During Past 5 Years - ------------------------ --- ---------------------------------------\nRobert G. Abair (1) 57 Elected Vice President and Chief Administrative Officer of WMECO in 1988.\nRobert E. Busch (2) 49 Elected President-Energy Resources Group of NU, CL&P, PSNH and WMECO February, 1996 and President of NAEC in 1994; previously Executive Vice President and Chief Financial Officer of NU, CL&P, PSNH, and WMECO since 1992; Executive Vice President and Chief Financial Officer of NAEC since 1992; Senior Vice President and Chief Financial Officer of NU, CL&P and WMECO since 1990.\nJohn C. Collins (3) 51 Executive Vice President, Lahey Clinic, since 1995. Previously Chief Executive Officer, The Hitchcock Clinic, Dartmouth - Hitchcock Medical Center from 1977 to 1995.\nTed C. Feigenbaum (4) 45 Elected Executive Vice President and Chief Nuclear Officer of NAEC February, 1996; previously Senior Vice President of NAEC since 1991; Senior Vice President and Chief Nuclear Officer of PSNH June, 1992 to August, 1992; President and Chief Executive Officer - New Hampshire Yankee Division of PSNH October, 1990 to June, 1992 and Chief Nuclear Production Officer of PSNH January, 1990 to June, 1992.\nJohn H. Forsgren 49 Elected Executive Vice President and Chief Financial Officer of NU, CL&P, PSNH, WMECO and NAEC February, 1996; previously Managing Director of Chase Manhattan Bank since 1995; Executive Vice President of Sun International Investments, LTD since 1994; and Senior Vice President-Chief Financial Officer of Euro Disney, The Walt Disney Company.\nBernard M. Fox (5) 53 Elected Chairman of the Board, President and Chief Executive Officer of NU, Chairman of CL&P, PSNH, WMECO and NAEC, and Chief Executive Officer of PSNH and NAEC in 1995; previously Vice Chairman of CL&P and WMECO, and Vice Chairman and Chief Executive Officer of NAEC since 1994; Chief Executive Officer of NU, CL&P, PSNH, WMECO and NAEC in 1993; President and Chief Operating Officer of NU, CL&P and WMECO in 1990 and NAEC since 1991; Vice Chairman of PSNH since 1992.\nWilliam T. Frain, Jr. (6)54 Elected President and Chief Operating Officer of PSNH in 1994; previously Senior Vice President of PSNH since 1992; previously Vice President and Treasurer of PSNH since 1991.\nCheryl W. Grise 43 Elected Senior Vice President and Chief Administrative Officer of CL&P, PSNH and NAEC, and Senior Vice President of WMECO in 1995; previously Senior Vice President-Human Resources and Administrative Services of CL&P, WMECO and NAEC since 1994; Vice President-Human Resources of NAEC since 1992 and of CL&P and WMECO since 1991.\nBarry Ilberman 46 Elected Vice President-Corporate and Environmental Affairs of CL&P, PSNH, WMECO and NAEC, in 1994; previously Vice President-Corporate Planning of CL&P, WMECO since 1992; Vice President-Corporate Business Practices of CL&P, WMECO since 1991; and Vice President-Human Resources of CLP, WMECO since 1989.\nJohn B. Keane (7) 49 Elected Vice President and Treasurer of NU, CL&P, PSNH, WMECO and NAEC in 1993; previously Vice President, Secretary and General Counsel-Corporate of NU, CL&P and WMECO since 1993; Vice President, Assistant Secretary and General Counsel-Corporate of PSNH and NAEC, Vice President, Secretary and General Counsel-Corporate of NU and CL&P, and Vice President, Secretary, Assistant Clerk and General Counsel-Corporate of WMECO since 1992; previously Associate General Counsel of NUSCO since 1985.\nFrancis L. Kinney (8) 63 Elected Senior Vice President-Governmental Affairs of CL&P, WMECO and NAEC in 1994; previously Vice President-Public Affairs of NAEC since 1992 and of CL&P and WMECO since 1978.\nGerald Letendre 54 President, Diamond Casting & Machine Co., Inc. since 1972.\nHugh C. MacKenzie (9) 53 Elected President-Retail Business Group of NU Feburary, 1996 and President of CL&P and WMECO in 1994; previously Senior Vice President-Customer Service Operations of CL&P and WMECO since 1990.\nJane E. Newman (10) 50 Executive Vice President, Exeter Trust Company since 1995. Previously President, Coastal Broadcasting Corporation since 1992; previously Assistant to the President of the United State for Management and Administration from 1989 to 1991.\nJohn J. Roman 42 Elected Vice President and Controller of NU, CL&P, PSNH, WMECO and NAEC in 1995; previously Assistant Controller of CL&P, PSNH, WMECO and NAEC since 1992.\nRobert P. Wax 47 Elected Vice President, Secretary and General Counsel of PSNH and NAEC in 1994; elected Vice President, Secretary and General Counsel of NU and CL&P and Vice President, Secretary, Assistant Clerk and General Counsel of WMECO in 1993; previously Vice President, Assistant Secretary and General Counsel of PSNH and NAEC since 1993; previously Vice President and General Counsel- Regulatory of NU, CL&P, PSNH, WMECO, and NAEC since 1992; previously Associate General Counsel of NUSCO since 1985.\n(1) Trustee of Easthampton Savings Bank. (2) Director of Connecticut Yankee Atomic Power Company. (3) Director of Fleet Bank - New Hampshire and Hamden Assurance Company Limited. (4) Director of Connecticut Yankee Atomic Power Company and Maine Yankee Atomic Power Company. (5) Director of The Institute of Living, The Institute of Nuclear Power Operations, The Connecticut Business and Industry Association, Mount Holyoke College, Fleet Financial Group, CIGNA Corporation, Connecticut Yankee Atomic Power Company and The Dexter Corporation. (6) Director of Connecticut Yankee Atomic Power Company, the Business and Industry Association of New Hampshire, the Greater Manchester Chamber of Commerce; Trustee of Optima Health, Inc., and Saint Anselm's College. (7) Director of Maine Yankee Atomic Power Company, Vermont Yankee Nuclear Power Corporation, Yankee Atomic Electric Company and Connecticut Yankee Atomic Power Company (8) Director of Mid-Conn Bank. (9) Director of Connecticut Yankee Atomic Power Company. (10) Director of Exeter Trust Company, Perini Corporation, NYNEX Telecommunications and Consumers Water Company.\nThere are no family relationships between any director or executive officer and any other director or executive officer of NU, CL&P, PSNH, WMECO or NAEC.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNU.\nIncorporated herein by reference is the information contained in the sections \"Summary Compensation Table,\" \"Pension Benefits,\" and \"Report on Executive Compensation\" of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1996 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nSUMMARY COMPENSATION TABLE\nThe following table presents the cash and non-cash compensation received by the CEO and the next four highest paid executive officers of the System, and by two retired executive officers who would have been among the five highest paid executive officers but for their retirement, in accordance with rules of the Securities and Exchange Commission (SEC):\nNotes:\n(1) Awards under the 1993 and 1994 short-term programs of the Northeast Utilities Executive Incentive Plan (EIP) were paid the next year in the form of cash. In accordance with the requirements of the SEC, these awards are included as \"bonus\" in the years earned.\n(2) \"All Other Compensation\" consists of employer matching contributions under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan, generally available to all eligible employees.\n(3) Awards under the short-term program of the EIP have typically been made by the Committee on Organization, Compensation and Board Affairs in April each year.\n(4) Mr. Fox is a Director and Executive Officer of CL&P, PSNH, WMECO and NAEC.\n(5) Mr. Busch is a Director of CL&P, WMECO and NAEC and an Executive Officer of CL&P, PSNH, WMECO and NAEC.\n(6) Mr. MacKenzie is a Director of CL&P, PSNH, WMECO and NAEC and an Executive Officer of CL&P and WMECO.\n(7) Mr. Kinney is an Executive Officer of CL&P, WMECO and NAEC.\n(8) Mrs. Grise is a Director of CL&P, PSNH, WMECO and NAEC and an Executive Officer of CL&P, WMECO and NAEC.\n(9) Mr. Ellis retired as Chairman of the Board and a Trustee of Northeast Utilities, and as Chairman and a Director of CL&P, PSNH, WMECO, and NAEC on August 1, 1995.\n(10) Mr. Opeka retired as Executive Vice President - Nuclear of NAEC and as a Director of NAEC, CL&P and WMECO on November 1, 1995.\nPENSION BENEFITS\nThe following table shows the estimated annual retirement benefits payable to an executive officer of Northeast Utilities upon retirement, assuming that retirement occurs at age 65 and that the officer is at that time not only eligible for a pension benefit under the Northeast Utilities Service Company Retirement Plan (the Retirement Plan) but also eligible for the \"make-whole benefit\" and the \"target benefit\" under the Supplemental Executive Retirement Plan for Officers of Northeast Utilities System Companies (the Supplemental Plan). The Supplemental Plan is a non-qualified pension plan providing supplemental retirement income to system officers. The \"make-whole benefit\" under the Supplemental Plan, available to all officers, makes up for benefits lost through application of certain tax code limitations on the benefits that may be provided under the Retirement Plan and includes as \"compensation\" awards under the Executive Incentive Compensation Program and Executive Incentive Plan and deferred compensation (as earned). The \"target benefit\" further supplements these benefits and is available to officers at the Senior Vice President level and higher who are selected by the Board of Trustees to participate in the target benefit and who remain in the employ of Northeast Utilities companies until at least age 60 (unless the Board of Trustees sets an earlier age). Each of the executive officers of Northeast Utilities named in the \"Summary Compensation Table\" is currently eligible for a target benefit.\nThe benefits presented are based on a straight life annuity beginning at age 65 and do not take into account any reduction for joint and survivorship annuity payments.\nANNUAL TARGET BENEFIT\nFINAL AVERAGE COMPENSATION YEARS OF CREDITED SERVICE 15 20 25 30 35 $200,000 $72,000 $96,000 $120,000 $120,000 $120,000 250,000 90,000 120,000 150,000 150,000 150,000 300,000 108,000 144,000 180,000 180,000 180,000 350,000 126,000 168,000 210,000 210,000 210,000 400,000 144,000 192,000 240,000 240,000 240,000 450,000 162,000 216,000 270,000 270,000 270,000 500,000 180,000 240,000 300,000 300,000 300,000 600,000 216,000 288,000 360,000 360,000 360,000 700,000 252,000 336,000 420,000 420,000 420,000 800,000 288,000 384,000 480,000 480,000 480,000 900,000 324,000 432,000 540,000 540,000 540,000 1,000,000 360,000 480,000 600,000 600,000 600,000 1,100,000 396,000 528,000 660,000 660,000 660,000 1,200,000 432,000 576,000 720,000 720,000 720,000\nFinal average compensation for purposes of calculating the \"target benefit\" is the highest average annual compensation of the participant during any 36 consecutive months compensation was earned. Compensation taken into account under the \"target benefit\" described above includes salary, bonus, restricted stock awards, and long-term incentive payouts shown in the Summary Compensation Table, but does not include employer matching contributions under the 401(k) Plan. In the event that an officer's employment terminates because of disability, the retirement benefits shown above would be offset by the amount of any disability benefits payable to the recipient that are attributable to contributions made by Northeast Utilities and its subsidiaries under long term disability plans and policies.\nAs of December 31, 1995, the five executive officers named in the Summary Compensation Table above had the following years of credited service for retirement compensation purposes: Mr. Fox - 31, Mr. Busch - 22, Mr. MacKenzie - - 30, Mr. Kinney - 34, and Mrs. Grise - 15. Assuming that retirement were to occur at age 65 for these officers, retirement would occur with 43, 38, 41, 36 and 36 years of credited service, respectively.\nIn 1992, Northeast Utilities entered into an agreement with Mr. Fox to provide for an orderly Chief Executive Officer succession. The agreement states that if Mr. Fox is terminated as Chief Executive Officer without cause, he will be entitled to specified severance pay and benefits. Those benefits consist primarily of (i) two years' base pay, medical, dental and life insurance benefits; (ii) a supplemental retirement benefit equal to the difference between the target benefit he would be entitled to receive if he had reached the age of 55 on the termination date and the actual target benefit to which he is entitled as of the termination date; and (iii) a target benefit under the Supplemental Plan, notwithstanding that he might not have reached age 60 on the termination date and notwithstanding other forfeiture provisions of that plan. The agreement also provides specified death and disability benefits. The agreement does not address Mr. Fox's normal compensation and benefits, which are to be determined by the Committee on Organization, Compensation and Board Affairs and the Board in accordance with their customary practices. The agreement terminates two years after Northeast Utilities gives Mr. Fox a notice of termination, but no earlier than the date he becomes 55.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNU.\nIncorporated herein by reference is the information contained in the sections \"Common Stock Ownership of Certain Beneficial Owners,\" \"Common Stock Ownership of Management,\" \"Compensation of Trustees,\" \"Summary Compensation Table,\" \"Pension Benefits,\" and \"Report on Executive Compensation\" of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1996 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO AND NAEC.\nNU owns 100% of the outstanding common stock of registrants CL&P, PSNH, WMECO and NAEC. As of February 27, 1996, the Directors of CL&P, PSNH, WMECO and NAEC, beneficially owned the number of shares of each class of equity securities of NU listed below. No equity securities of CL&P, PSNH, WMECO or NAEC are owned by the Directors and Executive Officers of their respective companies.\nCL&P, PSNH, WMECO, and NAEC DIRECTORS AND NAMED EXECUTIVE OFFICERS ------------------------------------------------------------------\nAmount and Nature of Title Of Name of Beneficial Percent of Class Beneficial Owner Ownership (1) Class (2) - ------- ---------------------- ----------- ----------\nNU Common Robert G. Abair(3) 6,489 (3,023) NU Common Robert E. Busch(4) 10,074 (5,492) NU Common John C. Collins(5) 25 NU Common Ted C. Feigenbaum(6) 474 (474) NU Common John H. Forsgren(7) 0 NU Common Bernard M. Fox(8) 25,092 (3,597) NU Common William T. Frain, Jr.(9) 1,793 (536) NU Common Cheryl W. Grise(10) 3,407 (1,116) NU Common Barry Ilberman(11) 6,822 (3,156) NU Common John B. Keane(12) 2,122 (1,475) NU Common Francis L. Kinney(13) 3,697 (2,189) NU Common Gerald Letendre(5) 0 NU Common Hugh C. MacKenzie(14) 8,047 (2,724) NU Common Jane E. Newman(5) 0 NU Common John J. Roman(15) 1,624 (1,624) NU Common Robert P. Wax(16) 2,791 (2,260)\nAmount beneficially owned by Directors and Executive Officers as a group - CL&P 71,958 (27,192) shares - PSNH 59,675 (20,505) shares - WMECO 71,958 (27,192) shares - NAEC 65,943 (24,642) shares\n(1) Unless otherwise noted, each Director and Executive Officer of CL&P, PSNH, WMECO and NAEC has sole voting and investment power with respect to the listed shares. The numbers in parentheses reflect the number of shares owned by each Director and Executive Officer under the Northeast Utilities Service Company Supplemental Retirement and Savings Plan (401(k) Plan), as to which the Officer has no investment power.\n(2) As of February 27, 1996 there were 136,023,358 common shares of NU outstanding. The percentage of such shares beneficially owned by any Director or Executive Officer, or by all Directors and Executive Officers of CL&P, PSNH, WMECO and NAEC as a group, does not exceed one percent.\n(3) Mr. Abair is a Director of CL&P and WMECO.\n(4) Mr. Busch is a Director of CL&P, WMECO and NAEC and an Executive Officer of CL&P, PSNH, WMECO and NAEC.\n(5) Messrs. Collins, Letendre and Ms. Newman are Directors of PSNH. Mr. Collins shares voting and investment power with his wife for 25 shares.\n(6) Mr. Feigenbaum is a Director and an Executive Officer of NAEC.\n(7) Mr. Forsgren is an Executive Officer of CL&P, PSNH, WMECO and NAEC.\n(8) Mr. Fox is a Director and Executive Officer of CL&P, PSNH, WMECO and NAEC. Mr. Fox shares voting and investment power with his wife for 3,031 of these shares. In addition, Mr. Fox's wife has sole voting and investment power for 140 shares as to which Mr. Fox disclaims beneficial ownership.\n(9) Mr Frain is a Director of CL&P, PSNH, WMECO and NAEC and an Executive Officer of PSNH.\n(10) Mrs. Grise is a Director of CL&P, PSNH, WMECO and NAEC and an Executive Officer of CL&P, WMECO and NAEC.\n(11) Mr. Ilberman is an Executive Officer of CL&P, PSNH, WMECO and NAEC. Mr. Ilberman shares voting and investment power with his wife for 290 of these shares and voting and investment power with his mother for 1,161 of these shares.\n(12) Mr. Keane is a Director of CL&P, WMECO and NAEC.\n(13) Mr. Kinney is an Executive Officer of CL&P, WMECO and NAEC. Mr. Kinney shares voting and investment power with his wife for 1,508 of these shares.\n(14) Mr. MacKenzie is a Director of CL&P, PSNH, WMECO and NAEC and an Executive Officer of CL&P and WMECO. Mr. MacKenzie shares voting and investment power with his wife for 1,467 shares.\n(15) Mr. Roman is an Executive Officer of CL&P, PSNH, WMECO and NAEC.\n(16) Mr. Wax is a Director of PSNH and an Executive Officer of CL&P, PSNH, WMECO and NAEC.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNU.\nIncorporated herein by reference is the information contained in the section \"Certain Relationships and Related Transactions\" of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 1, 1996 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO, AND NAEC.\nNo relationships or transactions that would be described in response to this item exist now or existed during 1995 with respect to CL&P, PSNH, WMECO, and NAEC.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements:\nThe Report of Independent Public Accountants and financial statements of NU, CL&P, PSNH, WMECO, and NAEC are hereby incorporated by reference and made a part of this report (see \"Item 8. Financial Statements and Supplementary Data\").\nReport of Independent Public Accountants on Schedules S-1\nConsent of Independent Public Accountants S-2\n2. Schedules:\nFinancial Statement Schedules for NU (Parent), NU and Subsidiaries, CL&P and Subsidiaries, PSNH and WMECO are listed in the Index to Financial Statement Schedules S-3\n3. Exhibits Index E-1\n(b) Reports on Form 8-K:\nNU, CL&P, PSNH, WMECO, and NAEC filed Form 8-Ks dated January 31, 1996 on January 31, 1996. This 8-K filing disclosed that the NRC had announced that the Millstone Nuclear Power Station had been placed on its \"watch list.\"\nNORTHEAST UTILITIES\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTHEAST UTILITIES -------------------\n(Registrant)\nDate: March 13, 1996 By \/s\/Bernard M. Fox -------------- ----------------- Bernard M. Fox 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.\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 A Trustee, Chairman \/s\/Bernard M. Fox - -------------- of the Board, ----------------- President and Bernard M. Fox Chief Executive Officer\nMarch 13, 1996 Executive Vice \/s\/ John H. Forsgren - -------------- President and Chief -------------------- Financial Officer John H. Forsgren\nMarch 13, 1996 Vice President and \/s\/John J. Roman - -------------- Controller ---------------- John J. Roman\nNORTHEAST UTILITIES SIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Trustee \/s\/Alfred F. Boschulte - -------------- ---------------------- Alfred F. Boschulte\nMarch 13, 1996 Trustee \/s\/Cotton Mather Cleveland - -------------- -------------------------- Cotton Mather Cleveland\nMarch 13, 1996 Trustee \/s\/George David - -------------- --------------- George David\nMarch 13, 1996 Trustee \/s\/E. Gail de Planque - -------------- --------------------- E. Gail de Planque\nMarch 13, 1996 Trustee \/s\/Gaynor N. Kelley - -------------- ------------------- Gaynor N. Kelley\nMarch 13, 1996 Trustee \/s\/Elizabeth T. Kennan - -------------- ---------------------- Elizabeth T. Kennan\nMarch 13, 1996 Trustee \/s\/Denham C. Lunt, Jr. - -------------- ---------------------- Denham C. Lunt, Jr.\nNORTHEAST UTILITIES SIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Trustee \/s\/William J. Pape II - -------------- --------------------- William J. Pape II\nMarch 13, 1996 Trustee \/s\/Robert E. Patricelli - -------------- ----------------------- Robert E. Patricelli\nMarch 13, 1996 Trustee \/s\/Norman C. Rasmussen - -------------- ---------------------- Norman C. Rasmussen\nMarch 13, 1996 Trustee \/s\/John F. Swope - -------------- ---------------- John F. Swope\nMarch 13, 1996 Trustee \/s\/John F. Turner - -------------- ----------------- John F. Turner\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE CONNECTICUT LIGHT AND POWER COMPANY ---------------------------------------\n(Registrant)\nDate: March 13, 1996 By \/s\/Bernard M. Fox -------------- -----------------\nBernard M. Fox Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Chairman and \/s\/Bernard M. Fox - -------------- a Director ----------------- Bernard M. Fox\nMarch 13, 1996 President and \/s\/Hugh C. MacKenzie - -------------- a Director -------------------- Hugh C. MacKenzie\nMarch 13, 1996 Executive Vice \/s\/ John H. Forsgren - -------------- President and Chief -------------------- Financial Officer John H. Forsgren\nMarch 13, 1996 Vice President and \/s\/John J. Roman - -------------- Controller ---------------- John J. Roman\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Director \/s\/Robert G. Abair - -------------- ------------------ Robert G. Abair\nMarch 13, 1996 Director \/s\/Robert E. Busch - -------------- ------------------ Robert E. Busch\nMarch 13, 1996 Director \/s\/William T. Frain, Jr. - -------------- ------------------------ William T. Frain, Jr.\nMarch 13, 1996 Director \/s\/Cheryl W. Grise - -------------- ------------------ Cheryl W. Grise\nMarch 13, 1996 Director \/s\/John B. Keane - -------------- ---------------- John B. Keane\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE ---------------------------------------\n(Registrant)\nDate: March 13, 1996 By \/s\/Bernard M. Fox -------------- ----------------- Bernard M. Fox 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.\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Chairman, Chief \/s\/Bernard M. Fox - -------------- Executive Officer ----------------- and a Director Bernard M. Fox\nMarch 13, 1996 President, Chief \/s\/William T. Frain, Jr. - -------------- Operating Officer ------------------------ and a Director William T. Frain, Jr.\nMarch 13, 1996 Executive Vice \/s\/ John H. Forsgren - -------------- President and Chief -------------------- Financial Officer John H. Forsgren\nMarch 13, 1996 Vice President and \/s\/John J. Roman - -------------- Controller ---------------- John J. Roman\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nDirector - -------------- ------------------ John C. Collins\nMarch 13, 1996 Director \/s\/Cheryl W. Grise - -------------- ------------------ Cheryl W. Grise\nDirector - -------------- ------------------ Gerald Letendre\nMarch 13, 1996 Director \/s\/Hugh C. MacKenzie - -------------- -------------------- Hugh C. MacKenzie\nMarch 13, 1996 Director \/s\/Jane E. Newman - -------------- ----------------- Jane E. Newman\nMarch 13, 1996 Director \/s\/Robert P. Wax - -------------- ---------------- Robert P. Wax\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWESTERN MASSACHUSETTS ELECTRIC COMPANY --------------------------------------\n(Registrant)\nDate: March 13, 1996 By \/s\/Bernard M. Fox -------------- ----------------- Bernard M. Fox Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Chairman and \/s\/Bernard M. Fox - -------------- a Director ----------------- Bernard M. Fox\nMarch 13, 1996 President and \/s\/Hugh C. MacKenzie - -------------- a Director -------------------- Hugh C. MacKenzie\nMarch 13, 1996 Executive Vice \/s\/ John H. Forsgren - -------------- President and Chief -------------------- Financial Officer John H. Forsgren\nMarch 13, 1996 Vice President and \/s\/John J. Roman - -------------- Controller ---------------- John J. Roman\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Director \/s\/Robert G. Abair - -------------- ------------------ Robert G. Abair\nMarch 13, 1996 Director \/s\/Robert E. Busch - -------------- ------------------ Robert E. Busch\nMarch 13, 1996 Director \/s\/William T. Frain, Jr. - -------------- ------------------------ William T. Frain, Jr.\nMarch 13, 1996 Director \/s\/Cheryl W. Grise - -------------- ------------------ Cheryl W. Grise\nMarch 13, 1996 Director \/s\/John B. Keane - -------------- ---------------- John B. Keane\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTH ATLANTIC ENERGY CORPORATION ---------------------------------\n(Registrant)\nDate: March 13, 1996 By \/s\/Bernard M. Fox -------------- ----------------- Bernard M. Fox 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.\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Chairman, Chief \/s\/Bernard M. Fox - -------------- Executive Officer ----------------- and a Director Bernard M. Fox\nMarch 13, 1996 President and \/s\/Robert E. Busch - -------------- a Director ------------------ Robert E. Busch\nMarch 13, 1996 Executive Vice \/s\/ John H. Forsgren - -------------- President and Chief -------------------- Financial Officer John H. Forsgren\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES (CONT'D)\nDate Title Signature - ---- ----- ---------\nMarch 13, 1996 Vice President and \/s\/John J. Roman - -------------- Controller ---------------- John J. Roman\nMarch 13, 1996 Director \/s\/Ted C. Feigenbaum - -------------- -------------------- Ted C. Feigenbaum\nMarch 13, 1996 Director \/s\/William T. Frain, Jr. - -------------- ------------------------ William T. Frain, Jr.\nMarch 13, 1996 Director \/s\/Cheryl W. Grise - -------------- ------------------ Cheryl W. Grise\nMarch 13, 1996 Director \/s\/John B. Keane - -------------- ---------------- John B. Keane\nMarch 13, 1996 Director \/s\/Hugh C. MacKenzie - -------------- -------------------- Hugh C. MacKenzie\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Northeast Utilities' annual report to shareholders and The Connecticut Light and Power Company's, Western Massachusetts Electric Company's, North Atlantic Energy Corporation's, and Public Service Company of New Hampshire's annual reports, incorporated by reference in this Form 10-K, and have issued our reports thereon dated February 16, 1996. Our reports on the financial statements include an explanatory paragraph with respect to the change in method of accounting for property taxes, if applicable to each company, as described in notes to the related company's financial statements. Our audits were made for the purpose of forming an opinion on each company's statements taken as a whole. The schedules listed in the accompanying index are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of each company's basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of each company's basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to each company's basic financial statements taken as a whole.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nHartford, Connecticut February 16, 1996\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference of our reports included or incorporated by reference in this Form 10-K, into previously filed Registration Statement No. 33-55279 of The Connecticut Light and Power Company, No. 33-56537 of CL&P Capital, LP, No. 33- 51185 of Western Massachusetts Electric Company, and No. 33-34622, No. 33-44814, and No. 33-40156 of Northeast Utilities.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nHartford, Connecticut March 13, 1996\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEETS\nAT DECEMBER 31, 1995 AND 1994\n(Thousands of Dollars)\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nSTATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n(Thousands of Dollars Except Share Information)\nSCHEDULE I NORTHEAST UTILITIES (PARENT) FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994, 1993 (Thousands of Dollars)\nEXHIBIT INDEX\nEach document described below is incorporated by reference to the files of the Securities and Exchange Commission, unless the reference to the document is marked as follows:\n* - Filed with the 1995 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1995 NU Form 10-K, File No. 1-5324 into the 1995 Annual Reports on Form 10-K for CL&P, PSNH, WMECO and NAEC.\n# - Filed with the 1995 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1995 NU Form 10-K, File No. 1-5324 into the 1995 Annual Report on Form 10-K for CL&P.\n@ - Filed with the 1995 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1995 NU Form 10-K, File No. 1-5324 into the 1995 Annual Report on Form 10-K for PSNH.\n** - Filed with the 1995 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1995 NU Form 10-K, File No. 1-5324 into the 1995 Annual Report on Form 10-K for WMECO.\n## - Filed with the 1995 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1995 Form 10-K, File No. 1-5324 into the 1995 Annual Report on Form 10-K for NAEC.\nExhibit Number Description\n3 Articles of Incorporation and By-Laws\n3.1 Northeast Utilities\n3.1.1 Declaration of Trust of NU, as amended through May 24, 1988. (Exhibit 3.1.1, 1988 NU Form 10-K, File No. 1-5324)\n3.2 The Connecticut Light and Power Company\n3.2.1 Certificate of Incorporation of CL&P,restated to March 2, 1994. (Exhibit 3.2.1, 1993 NU Form 10-K, File No. 1-5324)\n3.2.2 By-laws of CL&P, as amended to March 1, 1982. (Exhibit 3.2.2, 1993 NU Form 10-K, File No. 1-5324)\n3.3 Public Service Company of New Hampshire\n3.3.1 Articles of Incorporation, as amended to May 16, 1991. (Exhibit 3.3.1, 1993 NU Form 10-K, File No. 1-5324)\n3.3.2 By-laws of PSNH, as amended to November 1, 1993. (Exhibit 3.3.2, 1993 NU Form 10-K, File No. 1-5324)\n3.4 Western Massachusetts Electric Company\n3.4.1 Articles of Organization of WMECO, restated to February 23, 1995. (Exhibit 3.4.1, 1994 NU Form 10-K, File No. 1-5324)\n3.4.2 By-laws of WMECO, as amended to February 13, 1995. (Exhibit 3.4.2, 1994 NU Form 10-K, File No. 1-5324)\n3.5 North Atlantic Energy Corporation\n3.5.1 Articles of Incorporation of NAEC dated September 20, 1991. (Exhibit 3.5.1, 1993 NU Form 10-K, File No. 1-5324)\n3.5.2 Articles of Amendment dated October 16, 1991 and June 2, 1992 to Articles of Incorporation of NAEC. (Exhibit 3.5.2, 1993 NU Form 10-K, File No. 1-5324)\n3.5.3 By-laws of NAEC, as amended to November 8, 1993. (Exhibit 3.5.3, 1993 NU Form 10-K, File No. 1-5324)\n4 Instruments defining the rights of security holders, including indentures\n4.1 Northeast Utilities\n4.1.1 Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with\nrespect to the issuance of Debt Securities. (Exhibit 4.1.1, 1991 NU Form 10-K, File No. 1-5324)\n4.1.2 First Supplemental Indenture dated as of December 1, 1991 between Northeast Utilities and IBJ Schroder Bank & Trust Company, with respect to the issuance of Series A Notes. (Exhibit 4.1.2, 1991 NU Form 10-K, File No. 1-5324)\n4.1.3 Second Supplemental Indenture dated as of March 1, 1992 between Northeast Utilities and IBJ Schroder Bank & Trust Company with respect to the issuance of 8.38% Amortizing Notes. (Exhibit 4.1.3, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4 Warrant Agreement dated as of June 5, 1992 between Northeast Utilities and the Service Company. (Exhibit 4.1.4, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.1 Additional Warrant Agent Agreement dated as of June 5, 1992 between Northeast Utilities and State Street Bank and Trust Company. (Exhibit 4.1.4.1, 1992 NU Form 10-K, File No. 1-5324)\n4.1.4.2 Exchange and Disbursing Agent Agreement dated as of June 5, 1992 among Northeast Utilities, Public Service Company of New Hampshire and State Street Bank and Trust Company. Exhibit 4.1.4.2, 1992 NU Form 10-K, File No. 1-5324)\n4.1.5 Credit Agreements among CL&P, NU, WMECO, NUSCO (as Agent) and 15 Commercial Banks dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.38, 1992 NU Form U5S, File No. 30-246)\n4.1.6 Credit Agreements among CL&P, WMECO, NU, Holyoke Water Power Company, RRR, NNECO and NUSCO (as Agent) and 2 commercial banks dated December 3, 1992 (364 Day and Three-Year Facilities). (Exhibit C.2.39, 1992 NU Form U5S, File No. 30-246)\n4.2 The Connecticut Light and Power Company\n4.2.1 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, Trustee, dated as of May 1, 1921. (Composite including all twenty-four amendments to May 1, 1967.) (Exhibit 4.1.1, 1989 NU Form 10-K, File No. 1-5324)\nSupplemental Indentures to the Composite May 1, 1921 Indenture of Mortgage and Deed of Trust between CL&P and Bankers Trust Company, dated as of:\n4.2.2 April 1, 1967. (Exhibit 4.16, File No. 2-60806)\n4.2.3 January 1, 1968. (Exhibit 4.18, File No. 2-60806)\n4.2.4 December 1, 1969. (Exhibit 4.20, File No. 2-60806)\n4.2.5 June 30, 1982. (Exhibit 4.33, File No. 2-79235)\n4.2.6 December 1, 1989. (Exhibit 4.1.26, 1989 NU Form 10-K, File No. 1-5324)\n4.2.7 April 1, 1992. (Exhibit 4.30, File No. 33-59430)\n4.2.8 July 1, 1992. (Exhibit 4.31, File No. 33-59430)\n4.2.9 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.10 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.11 December 1, 1993. (Exhibit 4.2.14, 1993 NU Form 10-K, File No. 1-5324)\n4.2.12 February 1, 1994. (Exhibit 4.2.15, 1993 NU Form 10-K, File No. 1-5324)\n4.2.13 February 1, 1994. (Exhibit 4.2.16, 1993 NU Form 10-K, File No. 1-5324)\n4.2.14 June 1, 1994. (Exhibit 4.2.15, 1994 NU Form 10-K, File No. 1-5324)\n4.2.15 October 1, 1994. (Exhibit 4.2.16, 1994 NU Form 10-K, File No. 1-5324)\n4.2.16 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds, 1986 Series) dated as of December 1, 1986. (Exhibit C.1.47, 1986 NU Form U5S, File No. 30-246)\n4.2.16.1 Letter of Credit and Reimbursement Agreement (Pollution Control Bonds, 1986 Series) dated as of August 1, 1994. (Exhibit 1 (Execution Copy), File No. 70-7320)\n4.2.17 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds, 1988 Series) dated as of October 1, 1988. (Exhibit C.1.55, 1988 NU Form U5S, File No. 30-246)\n# 4.2.17.1 Letter of Credit (Pollution Control Bonds, 1988 Series) dated October 27, 1988.\n# 4.2.17.2 Reimbursement and Security Agreement (Pollution Control Bonds, 1988 Series) dated as of October 1, 1988.\n4.2.18 Financing Agreement between Industrial Development Authority of the State of New Hampshire and CL&P (Pollution Control Bonds) dated as of December 1, 1989. (Exhibit C.1.39, 1989 NU Form U5S, File No. 30-246)\n4.2.19 Loan and Trust Agreement among Business Finance Authority of the State of New Hampshire, CL&P and the Trustee (Pollution Control Bonds, 1992 Series A) dated as of December 1, 1992.(Exhibit C.2.33, 1992 NU Form U5S, File No. 30-246)\n# 4.2.19.1 Letter of Credit and Reimbursement Agreement (Pollution Control Bonds, 1992 Series A) dated as of December 1, 1992.\n4.2.20 Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds - Series A, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.2.21, 1993 NU Form 10-K, File No. 1-5324)\n4.2.20.1 Letter of Credit and Reimbursement Agreement (Pollution Control Bonds - Series A, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.2.23, 1993 NU Form 10-K, File No. 1- 5324)\n4.2.21 Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds - Series B, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.2.22, 1993 NU Form 10-K, File No. 1-5324)\n4.2.21.1 Letter of Credit and Reimbursement Agreement (Pollution Control Bonds - Series B, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.2.24, 1993 NU Form 10-K, File No. 1- 5324)\n4.2.22 Amended and Restated Limited Partnership Agreement (CL&P Capital, L.P.) among CL&P, NUSCO, and the persons who became limited partners of CL&P Capital, L.P. in accordance with the provisions thereof dated as of January 23, 1995 (MIPS). (Exhibit A.1 (Execution Copy), File No. 70-8451)\n4.2.23 Indenture between CL&P and Bankers Trust Company, Trustee (Series A Subordinated Debentures), dated as of January 1, 1995 (MIPS). (Exhibit B.1 (Execution Copy), File No. 70- 8451)\n4.2.24 Payment and Guaranty Agreement of CL&P dated as of January 23, 1995 (MIPS). (Exhibit B.3 (Execution Copy), File No. 70-8451)\n4.3 Public Service Company of New Hampshire\n4.3.1 First Mortgage Indenture dated as of August 15, 1978 between PSNH and First Fidelity Bank, National Association,New Jersey, Trustee, (Composite including all amendments to May 16, 1991). (Exhibit 4.4.1, 1992 NU Form 10-K, File No. 1-5324)\n4.3.1.1 Tenth Supplemental Indenture dated as of May 1, 1991 between PSNH and First Fidelity Bank, National Association. (Exhibit 4.1, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392).\n4.3.2 Revolving Credit Agreement dated as of May 1, 1991. (Exhibit 4.12, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.3 Series A (Tax Exempt New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.2, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.4 Series B (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.3, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.5 Series C (Tax Exempt Refunding) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.4, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.6 Series D (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.5, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.6.1 First Supplement to Series D (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1992. (Exhibit 4.4.5.1, 1992 NU Form 10-K, File No. 1-5324)\n4.3.6.2 Second Series D (May 1, 1991 Taxable New Issue and December 1, 1992 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of May 1, 1995 (Exhibit B.4, Execution Copy, File No. 70-8036)\n4.3.7 Series E (Taxable New Issue) PCRB Loan and Trust Agreement dated as of May 1, 1991. (Exhibit 4.6, PSNH Current Report on Form 8-K dated February 10, 1992, File No. 1-6392)\n4.3.7.1 First Supplement to Series E (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1993. (Exhibit 4.3.8.1, 1993 NU Form 10-K, File No. 1-5324)\n4.3.7.2 Second Series E (May 1, 1991 Taxable New Issue and December 1, 1993 Tax Exempt Refunding Issue) PCRB Letter of Credit and Reimbursement Agreement dated as of May 1, 1995. (Exhibit B.5, Execution Copy, File No. 70-8036)\n4.4 Western Massachusetts Electric Company\n4.4.1 First Mortgage Indenture and Deed of Trust between WMECO and Old Colony Trust Company, Trustee, dated as of August 1, 1954. (Exhibit 4.4.1, 1993 NU Form 10-K, File No. 1-5324)\nSupplemental Indentures thereto dated as of:\n4.4.2 March 1, 1967. (Exhibit 2.5, File No. 2-68808)\n4.4.3 September 1, 1990. (Exhibit 4.3.15, 1990 NU Form 10-K, File No. 1-5324.)\n4.4.4 December 1, 1992. (Exhibit 4.15, File No. 33-55772)\n4.4.5 January 1, 1993. (Exhibit 4.5.13, 1992 NU Form 10-K, File No. 1-5324)\n4.4.6 March 1, 1994. (Exhibit 4.4.11, 1993 NU Form 10-K, File No. 1-5324)\n4.4.7 March 1, 1994. (Exhibit 4.4.12, 1993 NU Form 10-K, File No. 1-5324)\n4.4.8 Loan Agreement between Connecticut Development Authority and WMECO, (Pollution Control Bonds - Series A, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.4.13, 1993 NU Form 10-K, File No. 1-5324)\n4.4.8.1 Letter of Credit and Reimbursement Agreement (Pollution Control Bonds - Series A, Tax Exempt Refunding) dated as of September 1, 1993. (Exhibit 4.4.14, 1993 NU Form 10-K, File No. 1- 5324)\n4.5 North Atlantic Energy Corporation\n4.5.1 First Mortgage Indenture and Deed of Trust between NAEC and United States Trust Company of New York, Trustee, dated as of June 1, 1992. (Exhibit 4.6.1, 1992 NU Form 10-K, File No. 1-5324)\n## 4.5.2 Term Credit Agreement dated as of November 9, 1995.\n10 Material Contracts\n10.1 Stockholder Agreement dated as of July 1, 1964 among the stockholders of Connecticut Yankee Atomic Power Company (CYAPC). (Exhibit 10.1, 1994 NU Form 10-K, File No. 1-5324)\n10.2 Form of Power Contract dated as of July 1, 1964 between CYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 10.2, 1994 NU Form 10-K, File No. 1-5324)\n10.2.1 Form of Additional Power Contract dated as of April 30, 1984, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.1, 1994 NU Form 10-K, File No. 1-5324)\n10.2.2 Form of 1987 Supplementary Power Contract dated as of April 1, 1987, between CYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.2.6, 1987 NU Form 10-K, File No. 1-5324)\n10.3 Capital Funds Agreement dated as of September 1, 1964 between CYAPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.3, 1994 NU Form 10-K, File No. 1-5324)\n10.4 Stockholder Agreement dated December 10, 1958 between Yankee Atomic Electric Company (YAEC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.4, 1993 NU Form 10-K, File No. 1-5324)\n10.5 Form of Amendment No. 3, dated as of April 1, 1985, to Power Contract between YAEC and each of CL&P, PSNH and WMECO, including a composite restatement of original Power Contract dated June 30, 1959 and Amendment No. 1 dated April 1, 1975 and Amendment No. 2 dated October 1, 1980. (Exhibit 10.5, 1988 NU Form 10-K, File No. 1-5324.)\n10.5.1 Form of Amendment No. 4 to Power Contract, dated May 6, 1988, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.1, 1989 NU Form 10-K, File No. 1-5324)\n10.5.2 Form of Amendment No. 5 to Power Contract, dated June 26, 1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.2, 1989 NU Form 10-K, File No. 1-5324)\n10.5.3 Form of Amendment No. 6 to Power Contract, dated July 1,1989, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.3, 1989 NU Form 10-K, File No. 1-5324)\n10.5.4 Form of Amendment No. 7 to Power Contract, dated February 1, 1992, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.4, 1993 NU Form 10-K, File No. 1-5324)\n10.6 Stockholder Agreement dated as of May 20, 1968 among stockholders of MYAPC. (Exhibit 4.15, File No. 2-30018)\n10.7 Form of Power Contract dated as of May 20, 1968 between MYAPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.14, File No. 2-30018)\n10.7.1 Form of Amendment No. 1 to Power Contract dated as of March 1, 1983 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.1, 1993 NU Form 10-K, File No. 1-5324)\n10.7.2 Form of Amendment No. 2 to Power Contract dated as of January 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.2, 1993 NU Form 10-K, File No. 1- 5324)\n10.7.3 Form of Amendment No. 3 to Power Contract dated as of October 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit No. 10.7.3, 1994 NU Form 10-K, File No. 1- 5324)\n10.7.4 Form of Additional Power Contract dated as of February 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.4, 1993 NU Form 10-K, File No. 1-5324)\n10.8 Capital Funds Agreement dated as of May 20, 1968 between Maine Yankee Atomic Power Company (MYAPC) and CL&P, PSNH, HELCO and WMECO. (Exhibit 4.13, File No. 2-30018)\n10.8.1 Amendment No. 1 to Capital Funds Agreement, dated as of August 1, 1985, between MYAPC, CL&P, PSNH and WMECO. (Exhibit No. 10.8.1, 1994 NU Form 10-K, File No. 1-5324)\n10.9 Sponsor Agreement dated as of August 1, 1968 among the sponsors of VYNPC. (Exhibit 4.16, File No. 2-30285)\n10.10 Form of Power Contract dated as of February 1, 1968 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 4.18, File No. 2- 30018)\n10.10.1 Form of Amendment to Power Contract dated as of June 1, 1972 between VYNPC and each of CL&P, HELCO, PSNH and WMECO. (Exhibit 5.22, File No. 2-47038)\n10.10.2 Form of Second Amendment to Power Contract dated as of April 15, 1983 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.2, 1993 NU Form 10-K, File No. 1- 5324)\n10.10.3 Form of Third Amendment to Power Contract dated as of April 24, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit No. 10.10.3, 1994 NU Form 10-K, File No. 1-5324)\n10.10.4 Form of Fourth Amendment to Power Contract dated as of June 1, 1985 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.4, 1986 NU Form 10-K, File No. 5324)\n10.10.5 Form of Fifth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.5, 1990 NU Form 10-K, File No. 1-5324)\n10.10.6 Form of Sixth Amendment to Power Contract dated as of May 6, 1988 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.6, 1990 NU Form 10-K, File No. 1-5324)\n10.10.7 Form of Seventh Amendment to Power Contract dated as of June 15, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.7, 1990 NU Form 10-K, File No. 1-5324)\n10.10.8 Form of Eighth Amendment to Power Contract dated as of December 1, 1989 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.8, 1990 NU Form 10-K, File No. 1- 5324)\n10.10.9 Form of Additional Power Contract dated as of February 1, 1984 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.9, 1993 NU Form 10-K, File No. 1-5324)\n10.11 Capital Funds Agreement dated as of February 1, 1968 between Vermont Yankee Nuclear Power Corporation (VYNPC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.16, File No. 2-30018)\n10.11.1 Form of First Amendment to Capital Funds Agreement dated as of March 12, 1968 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 4.17, File No. 2-30018)\n10.11.2 Form of Second Amendment to Capital Funds Agreement dated as of September 1, 1993 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.11.2, 1993 NU Form 10-K, File No. 1- 5324)\n10.12 Amended and Restated Millstone Plant Agreement dated as of December 1, 1984 by and among CL&P, WMECO and Northeast Nuclear Energy Company (NNECO). (Exhibit 10.12, 1994 NU Form 10-K, File No. 1-5324)\n10.13 Sharing Agreement dated as of September 1, 1973 with respect to 1979 Connecticut nuclear generating unit (Millstone 3). (Exhibit 6.43, File No. 2-50142)\n10.13.1 Amendment dated August 1, 1974 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 5.45, File No. 2-52392)\n10.13.2 Amendment dated December 15, 1975 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 7.47, File No. 2- 60806)\n10.13.3 Amendment dated April 1, 1986 to Sharing Agreement - 1979 Connecticut Nuclear Unit. (Exhibit 10.17.3, 1990 NU Form 10-K, File No. 1-5324)\n10.14 Agreement dated July 19, 1990, among NAESCO and Seabrook Joint owners with respect to operation of Seabrook. (Exhibit 10.53, 1990 NU Form 10-K, File No. 1-5324)\n10.15 Sharing Agreement between CL&P, WMECO, HP&E, HWP and PSNH dated as of June 1, 1992. (Exhibit 10.17, 1992 NU Form 10-K, File No. 1-5324)\n10.16 Rate Agreement by and between NUSCO, on behalf of NU, and the Governor of the State of New Hampshire and the New Hampshire Attorney General dated as of November 22, 1989. (Exhibit 10.44, 1989 NU Form 10-K, File No. 1-5324)\n* 10.16.1 First Amendment to Rate Agreement dated as of December 5, 1989.\n* 10.16.2 Second Amendment to Rate Agreement dated as of December 12, 1989.\n* 10.16.3 Third Amendment to Rate Agreement dated as of December 3, 1993.\n* 10.16.4 Fourth Amendment to Rate Agreement dated as of September 21, 1994.\n* 10.16.5 Fifth Amendment to Rate Agreement dated as of September 9, 1994.\n10.17 Form of Seabrook Power Contract between PSNH and NAEC, as amended and restated. (Exhibit 10.45, NU 1992 Form 10-K, File No. 1-5324)\n10.18 Agreement (composite) for joint ownership, construction and operation of New Hampshire nuclear unit, as amended through the November 1, 1990 twenty-third amendment. (Exhibit No. 10.17, 1994 NU Form 10-K, File No. 1-5324)\n10.18.1 Memorandum of Understanding dated November 7, 1988 between PSNH and Massachusetts Municipal Wholesale Electric Company (Exhibit 10.17, PSNH 1989 Form 10-K, File No. 1-6392)\n10.18.2 Agreement of Settlement among Joint Owners dated as of January 13, 1989. (Exhibit 10.13.21, 1988 NU Form 10-K, File No. 1-5324)\n10.18.2.1 Supplement to Settlement Agreement, dated as of February 7, 1989, between PSNH and Central Maine Power Company. (Exhibit 10.18.1, PSNH 1989 Form 10-K, File No. 1-6392)\n10.19 Amended and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1, 1990. (Exhibit 10.4.7, File No. 33-35312)\n10.19.1 Form of First Amendment to Exhibit 10.19. (Exhibit 10.4.8, File No. 33-35312)\n10.19.2 Form (Composite) of Second Amendment to Exhibit 10.19. (Exhibit 10.18.2, 1993 NU Form 10-K, File No. 1-5324)\n10.20 Agreement dated November 1, 1974 for Joint Ownership, Construction and Operation of William F. Wyman Unit No. 4 among PSNH, Central Maine Power Company and other utilities. (Exhibit 5.16 , File No. 2-52900)\n10.20.1 Amendment to Exhibit 10.20 dated June 30, 1975. (Exhibit 5.48, File No. 2-55458)\n10.20.2 Amendment to Exhibit 10.20 dated as of August 16, 1976. (Exhibit 5.19, File No. 2-58251)\n10.20.3 Amendment to Exhibit 10.20 dated as of December 31, 1978. (Exhibit 5.10.3, File No. 2-64294)\n10.21 Form of Service Contract dated as of July 1, 1966 between each of NU, CL&P and WMECO and the Service Company. (Exhibit 10.20, 1993 NU Form 10-K, File No. 1-5324)\n10.21.1 Service Contract dated as of June 5, 1992 between PSNH and the Service Company. (Exhibit 10.12.4, 1992 NU Form 10-K, File No. 1-5324)\n10.21.2 Service Contract dated as of June 5, 1992 between NAEC and the Service Company. (Exhibit 10.12.5, 1992 NU Form 10-K, File No. 1-5324)\n10.21.3 Form of Annual Renewal of Service Contract. (Exhibit 10.20.3, 1993 NU Form 10-K, File No. 1-5324)\n10.22 Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of June 1, 1970 with respect to pooling of generation and transmission. (Exhibit 13.32, File No. 2-38177)\n10.22.1 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of February 2, 1982 with respect to pooling of generation and transmission. (Exhibit 10.21.1, 1993 NU Form 10-K, File No. 1-5324)\n10.22.2 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of January 1, 1984 with respect to pooling of generation and transmission. (Exhibit 10.21.2, 1994 NU Form 10-K, File No. 1-5324)\n10.23 New England Power Pool Agreement effective as of November 1, 1971, as amended to November 1, 1988. (Exhibit 10.15, 1988 NU Form 10-K, File No. 1-5324.)\n10.23.1 Twenty-sixth Amendment to Exhibit 10.23 dated as of March 15, 1989. (Exhibit 10.15.1, 1990 NU Form 10-K, File No. 1- 5324)\n10.23.2 Twenty-seventh Amendment to Exhibit 10.23 dated as of October 1, 1990. (Exhibit 10.15.2, 1991 NU Form 10-K, File No. 1-5324)\n10.23.3 Twenty-eighth Amendment to Exhibit 10.23 dated as of September 15, 1992. (Exhibit 10.18.3, 1992 NU Form 10-K, File No. 1-5324)\n10.23.4 Twenty-ninth Amendment to Exhibit 10.23 dated as of May 1, 1993. (Exhibit 10.22.4, 1993 NU Form 10-K, File No. 1-5324)\n* 10.23.5 Thirty-second Amendment (Amendments 30 and 31 were withdrawn) to Exhibit 10.23 dated as of September 1, 1995.\n10.24 Agreements among New England Utilities with respect to the Hydro- Quebec interconnection projects. (See Exhibits 10(u) and 10(v); 10(w), 10(x), and 10(y), 1990 and 1988, respectively, Form 10-K of New England Electric System, File No. 1-3446.)\n10.25 Trust Agreement dated February 11, 1992, between State Street Bank and Trust Company of Connecticut, as Trustor, and Bankers Trust Company, as Trustee, and CL&P and WMECO, with respect to NBFT. (Exhibit 10.23, 1991 NU Form 10-K, File No. 1-5324)\n10.25.1 Nuclear Fuel Lease Agreement dated as of February 11, 1992, between Bankers Trust Company, Trustee, as Lessor, and CL&P and WMECO, as Lessees. (Exhibit 10.23.1, 1991 NU Form 10-K, File No. 1-5324)\n10.26 Simulator Financing Lease Agreement, dated as of February 1, 1985, by and between ComPlan and NNECO. (Exhibit 10.25, 1994 NU Form 10-K, File No. 1-5324)\n10.27 Simulator Financing Lease Agreement, dated as of May 2, 1985, by and between The Prudential Insurance Company of America and NNECO. (Exhibit No. 10.26, 1994 NU Form 10-K, File No. 1-5324)\n10.28 Lease dated as of April 14, 1992 between The Rocky River Realty Company (RRR) and Northeast Utilities Service Company (NUSCO) with respect to the Berlin, Connecticut headquarters (office lease). (Exhibit 10.29, 1992 NU Form 10-K, File No. 1-5324)\n10.28.1 Lease dated as of April 14, 1992 between RRR and NUSCO with respect to the Berlin, Connecticut headquarters (project lease). (Exhibit 10.29.1, 1992 NU Form 10-K, File No. 1- 5324)\n10.29 Millstone Technical Building Note Agreement dated as of December 21, 1993 between, by and between The Prudential Insurance Company of America and NNECO. (Exhibit 10.28, 1993 NU Form 10-K, File No. 1- 5324)\n10.30 Lease and Agreement, dated as of December 15, 1988, by and between WMECO and Bank of New England, N.A., with BNE Realty Leasing Corporation of North Carolina. (Exhibit 10.63, 1988 NU Form 10-K, File No. 1-5324.)\n10.31 Note Agreement dated April 14, 1992, by and between The Rocky River Realty Company (RRR) and Purchasers named therein (Connecticut General Life Insurance Company, Life Insurance Company of North America, INA Life Insurance Company of New York, Life Insurance Company of Georgia), with respect to RRR's sale of $15 million of guaranteed senior secured notes due 2007 and $28 million of guaranteed senior secured notes due 2017. (Exhibit 10.52, 1992 NU Form 10-K, File No. 1-5324)\n10.31.1 Note Guaranty dated April 14, 1992 by Northeast Utilities pursuant to Note Agreement dated April 14, 1992 between RRR and Note Purchasers, for the benefit of The Connecticut National Bank as Trustee, the Purchasers and the owners of the notes. (Exhibit 10.52.1, 1992 NU Form 10-K, File No. 1- 5324)\n10.31.2 Assignment of Leases, Rents and Profits, Security Agreement and Negative Pledge, dated as of April 14, 1992 among RRR, NUSCO and The Connecticut National Bank as Trustee, securing notes sold by RRR pursuant to April 14, 1992 Note Agreement. (Exhibit 10.52.2, 1992 NU Form 10-K, File No. 1-5324)\n10.32 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 1 decommissioning costs. (Exhibit 10.80, 1986 NU Form 10-K, File No. 1-5324)\n10.32.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.41.1, 1992 NU Form 10-K, File No. 1-5324)\n10.33 Master Trust Agreement dated as of September 2, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 2 decommissioning costs. (Exhibit 10.81, 1986 NU Form 10-K, File No. 1-5324)\n10.33.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.42.1, 1992 NU Form 10-K, File No. 1-5324)\n10.34 Master Trust Agreement dated as of April 23, 1986 between CL&P and WMECO and Colonial Bank as Trustee, with respect to reserve funds for Millstone 3 decommissioning costs. (Exhibit 10.82, 1986 NU Form 10-K, File No. 1-5324)\n10.34.1 Notice of Appointment of Mellon Bank, N.A. as Successor Trustee, dated November 20, 1990, and Acceptance of Appointment. (Exhibit 10.43.1, 1992 NU Form 10-K, File No. 1-5324)\n10.35 NU Executive Incentive Plan, effective as of January 1, 1991. (Exhibit 10.44, NU 1991 Form 10-K, File No. 1-5324)\n10.36 Supplemental Executive Retirement Plan for Officers of NU System Companies, Amended and Restated effective as of January 1, 1992. (Exhibit 10.45.1, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n10.36.1 Amendment 1 to Exhibit 10.36, effective as of August 1, 1993. (Exhibit 10.35.1, 1993 NU Form 10-K, File No. 1-5324)\n10.36.2 Amendment 2 to Exhibit 10.36, effective as of January 1, 1994. (Exhibit 10.35.2, 1993 NU Form 10-K, File No. 1-5324)\n* 10.36.3 Amendment 3 to Exhibit 10.36, effective as of January 1, 1996.\n10.37 Loan Agreement dated as of December 2, 1991, by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $175 million to an ESOP Trust. (Exhibit 10.46, NU 1991 Form 10-K, File No. 1-5324)\n10.37.1 First Amendment to Exhibit 10.37 dated February 7, 1992. (Exhibit 10.36.1, 1993 NU Form 10-K, File No. 1-5324)\n10.37.2 Loan Agreement dated as of March 19, 1992 by and between NU and Mellon Bank, N.A., as Trustee, with respect to NU's loan of $75 million to the ESOP Trust. (Exhibit 10.49.1, 1992 NU Form 10-K, File No. 1-5324)\n10.37.3 Second Amendment to Exhibit 10.37 dated April 9, 1992. (Exhibit 10.36.3, 1993 NU Form 10-K, File No. 1-5324)\n10.38 Employment Agreement. (Exhibit 10.48, NU Form 10-Q for the Quarter Ended June 30, 1992, File No. 1-5324)\n* 10.39 Northeast Utilities Deferred Compensation Plan for Trustees, Amended and Restated December 13, 1994.\n* 10.40 Deferred Compensation Plan for Officers of Northeast Utilities System Companies adopted September 23, 1986.\n* 10.41 Reciprocal Support Agreement Among NNECO, NAESCO, CYAPC, YAEC and NUSCO dated January 1, 1996.\n13 Annual Report to Security Holders (Each of the Annual Reports is filed only with the Form 10-K of that respective registrant.)\n* 13.1 Portions of the Annual Report to Shareholders of NU (pages 15-46) that have been incorporated by reference into this Form 10-K.\n13.2 Annual Report of CL&P.\n13.3 Annual Report of WMECO.\n13.4 Annual Report of PSNH.\n13.5 Annual Report of NAEC.\n*21 Subsidiaries of the Registrant.\n27 Financial Data Schedules (Each Financial Data Schedule is filed only with the Form 10-K of that respective registrant.)\n27.1 Financial Data Schedule of NU.\n27.2 Financial Data Schedule of CL&P.\n27.3 Financial Data Schedule of WMECO.\n27.4 Financial Data Schedule of PSNH.\n27.5 Financial Data Schedule of NAEC.","section_15":""}
{"filename":"230437_1995.txt","cik":"230437","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) Historical Development of Business:\nPacific Real Estate Investment Trust (the \"Trust\") was organized pursuant to a Declaration of Trust on April 17, 1963. The Trust is a California real estate investment trust and qualifies as a real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986, as amended (\"Code\").\nThe Trust invests in real estate interests and at December 31, 1995 owned (i) a 100% equity interest in two shopping centers, (ii) a 40% controlling interest in Kingsco, a general partnership that owns a shopping center and (iii) a 100% equity interest in a retail and professional office complex. In addition, the Trust holds various notes receivable, most of which are secured by deeds of trust, and were acquired in connection with sales or assignments of Trust properties or contractual rights to acquire properties.\nThe Trust's total assets were $63 million at December 31, 1995 and $95 million at December 31, 1994.\n(b) Financial Information About Industry Segments:\nThe Trust is currently involved in only one industry segment real estate. The Trust operates and holds for investment, income producing real property and promissory notes secured by real property. All of these activities are included in the real estate industry segment. Therefore, all of the revenues, operating profits and assets reported in the Consolidated Financial Statements contained herein relate to this industry segment.\n(c) Narrative Description of the Business:\nOVERVIEW\nThe Trust owns and manages a portfolio of neighborhood shopping centers, and a professional office and retail complex. Each of the Trust's properties is located in the metropolitan San Francisco Bay Area. Historically, the Trust has specialized in the acquisition and redevelopment of existing shopping centers, as well as the development of new centers. The Trust's existing property portfolio, described more fully below under \"Properties,\" consists primarily of properties situated in \"in-fill\" locations in suburban areas which are generally characterized by dense populations and restrictions on development.\nThe Trust's shopping centers attract local area customers and are typically anchored by a supermarket, superdrug, or other type of convenience store. Anchor retailers are critically important to the success of the shopping center because they attract consistent local traffic and repeat shoppers whose expenditures support a variety of other stores in the shopping center. Examples of anchor retailers in the Trust's shopping center properties are Lucky Stores and Walgreen. The overall tenant mix in each of the Trust's shopping centers typically caters to the retailing of day-to-day consumer necessities rather than high-priced luxury or specialty items.\nPOLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN ACTIVITIES\nThe following is a discussion of the Trust's objectives and policies with respect to investment, disposition, financing and certain other activities in light of current conditions. Current capital constraints affecting the Trust effectively preclude new acquisitions of significance. The investment policies and other policies of the Trust are reviewed herein in the context of the Trust's current financial condition. These policies are determined by the Trustees, and may be amended or revised from time to time at the discretion of the Trustees without a vote of the holders of beneficial interests of the Trust (\"shareholders\"). No assurance can be given that these investment objectives will be attained or that the value of the Trust will not decrease.\nINVESTMENT POLICY. The Trust's historic investment objective has been to invest in commercial real estate which would generate cash distributions and long-term capital appreciation. This policy was successful from 1964 until recent years. Since 1974 the Trust has sought to accomplish these objectives by acquisition, development and redevelopment of anchored neighborhood shopping centers and commercial property in Northern California. One reason we concentrated in retail was because the anchor retail stores tended to limit oversupply by building only to demand. But in recent years the emergence of an entirely new group of retailers have changed that completely resulting in increasing over-construction in retail. In addition, during the last four years, lack of access to equity capital and strongly adverse property market conditions have hampered and increasingly frustrated the Trust's achievement of its investment objectives. These circumstances have resulted in the suspension of cash distributions to shareholders, a reduction in the value of the Trust's assets and lack of liquidity for shareholders. The Trust has not acquired new investment property since 1992 and its development activities have been suspended.\nSince 1991 the Trust has been actively seeking to recapitalize to overcome these challenges. This activity has been conducted both under the direction of several investment bankers as well as independently with institutional investors. Recapitalization strategies that have been considered include joint venture, merger and listing on one of the national stock exchanges. During the early 1990's the impact of a nationwide economic recession and the volatility of public capital markets have prevented a successful outcome to these efforts. The Trust have conducted active discussions with potential merger or joint venture candidates and the Trustees plan to explore exhaustively every reasonable opportunity. However in the event that this strategy cannot be achieved in the best interest of the shareholders the Trustees are committed to pursuing an alternative approach involving the orderly sale of the Trust's assets. Such an approach is expected to enable the Trust to meet all of its debt obligations and to distribute remaining proceeds to its shareholders as liquidating dividends. There can be no assurance as to the amount of such liquidating dividends at this time because the Trust must determine the exact net value of its assets in the marketplace.\nThe value of the Trust's property portfolio has declined during the past three years. This decline is the result of several factors. Most prominent has been the collapse of commercial real estate values nationwide as a result of overbuilding and fallout from the savings and loan collapse and the consequent establishment of the Resolution Trust Corporation, which liquidated large numbers of commercial properties at prices significantly below replacement cost, severely depressing the nation's property markets. Another prominent factor has been the pronounced depth and protracted nature of the economic recession and defense industry cutbacks which severely affected California real estate values. Concurrent with these economic forces, the value of the Trust's shopping center portfolio has also been adversely affected by rapid and continuing changes in the retail industry. The proliferation of \"big-box\" discount retailers characterized by their predatory pricing and marketing practices is having a widespread impact, putting many traditional retailers at risk and some into bankruptcy. The corollary effect of this retailing revolution has been an aggressive overbuilding in the retail sector, increased vacancy, tenant business failures and the driving down of rents and property values. The combination of these economic and retail industry trends has adversely affected many retail REITs as well as the Trust.\nWhile the Trust's investment policy emphasizes equity real estate investments, it may invest in stock of other REITs, partnerships and other real estate interests. If the Trust were successful in locating a suitable merger or joint venture partner, it is possible that such a strategy could result in an exchange of stock or investment in stock of another REIT or real estate entity.\nIn considering dispositions, the Trust makes disposition decisions based on current market conditions and its objective of realizing maximum value for its shareholders.\nFINANCING. The Trust intends to continue to restructure its portfolio during 1996 in order to reduce indebtedness. This goal is to be achieved by either an infusion of equity capital or the sale of one or more of the Trust's properties, repayment of associated indebtedness and reduction of debt service costs.\nIn the event that the Trustees are successful in attracting additional capital, they have the full authority to issue additional interests in the Trust on such terms and for such consideration as they judge appropriate.\nDISTRIBUTIONS. Historically, the Trust's policy has been to pay dividends to its shareholders in an amount approximating 100% of its cash flows from operations (i.e., net operating income plus depreciation and amortization). Capital gains have been distributed on a case by case basis. That portion of a distribution which is sheltered by depreciation and amortization constitutes a nontaxable return of capital to the shareholders. Dividends were paid on a regular basis for twenty-nine years, however, on February 25, 1993, the Trustees unanimously decided to suspend the payment of regular dividends in order to conserve the Trust's cash flow, in an effort to meet its capital needs, to maintain the quality of the Trust's properties and to protect the Trust's credit, since the Trustees concluded that the Trust could no longer rely on its traditional sources of liquidity (i.e., secured bank financing and \"intrastate\" equity offerings) for these purposes. The suspension of regular dividends will continue until sufficient liquidity can be arranged from alternative sources. The suspension of dividends is not expected to affect the Trust's qualification as a REIT.\nWORKING CAPITAL RESERVES. The Trust seeks to maintain working capital reserves (and, when not sufficient, access to borrowings) in amounts that the Trustees determine to be adequate to meet normal capital demands in connection with the operation of the Trust's business and investments. As noted above, the Trust expects that it will either restructure or sell either all or a portion of its portfolio in order to generate adequate working capital reserves.\nCONFLICTS OF INTEREST POLICIES. The Trust has adopted certain policies designed to reduce potential conflicts of interest. Such policies do not apply where a Trustee, officer or affiliate has acquired property for the sole purpose of facilitating its acquisition by the Trust, and the total consideration paid by the Trust does not exceed the cost of the property to such person (which cost is increased by such person's holding costs and decreased by any income received by such person from the property) and no special benefit results to such person. The Trustees may engage in real estate transactions which may be of the type conducted by the Trust, but it is not anticipated that such transactions will have a material effect upon the Trust's operations.\nOTHER POLICIES. The Trust intends to operate in a manner that will not subject it to regulation under the Investment Company Act of 1940, as amended. The Trust does not intend (i) to invest in the securities of other issuers for the purpose of exercising control over such issuers, (ii) to underwrite securities of other issuers or (iii) to trade actively in loans or other investments.\nThe Trust may make investments other than as previously described, although it does not currently do so. The Trust has authority to repurchase or otherwise reacquire Trust Shares it has issued or may issue and it may engage in such activities in the future. The Trustees have no present intention of causing the Trust to repurchase any of the Trust Shares, and any such action would be taken only in conformity with applicable federal and state laws and the requirements for qualifying as a REIT under the Code and the Treasury Regulations. Although the Trust may do so in the future in connection with the purchase of additional properties or otherwise, the Trust has not issued securities in exchange for property, nor has it reacquired any of its securities. The Trust may make loans to third parties, including, without limitation, to officers and to joint ventures in which the Trust decides to participate.\nAt all times, the Trust intends to meet the requirements of the Code to qualify as a REIT unless, because of changes in future economic, market or legal conditions, or changes in the Code or in the Treasury Regulations, the Trustees elect to revoke the Trust's REIT election.\nMARKET CONDITIONS\nThe Company does not believe that the real estate market is an efficient market. Local conditions and the type of commercial operations conducted at each property directly affect property values in ways that may be unrelated to overall nationwide, regional or neighborhood market trends. The real estate market is also highly competitive, and maintaining property values is difficult. Access to economically available equity capital is critical to creating and maintaining real estate values. Other real estate investment trusts (many of which are much larger than the Trust), pension trusts, private investors, and real estate syndicates compete directly with the Trust for capital. In addition to these geographic and industry considerations, the market for real estate is heavily influenced by finance, bond and securities markets, as well as political, regulatory and Code factors.\nDuring the last several years, investors have become increasingly selective about real estate. This heightened selectivity has occurred against a complex marketplace backdrop characterized by declining values and reduced liquidity, lack of capital, adverse fallout resulting from reform of the tax code, property over-building, solvency crisis in the savings and loan industry and the related incidences of distress sales and dumping of swollen property inventories by the Resolution Trust Corporation. Most of this occurred within the context of a severe national economic recession. While 1994 began to witness the gradual recovery of the real estate market nationwide, the Trustees believe that the overall economic recovery in California during 1995 has continued by and large to lag the nationwide trend and continues to retard recovery of the California property markets. While the Trustees believe that the California real estate market will eventually recover, as the California economy emerges from recession, for the near term, they do not expect values to recover to the market levels achieved in the late 1980's and early 1990's, prior to the downturn. This is particularly true for retail property and there can be no assurance that this improvement will occur or that 1996 will see any improvement. Thus there remain significant impediments to the Trust's ability to resume cash distributions or establish liquidity for its shareholders without improvement in market values and either capital restructuring or asset sales.\nThe Trust is not involved in research and development activities other than market research.\nGOVERNMENT REGULATION\nENVIRONMENTAL MATTERS. Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous substances released on or in its property. Such laws impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of such substances, or the failure to properly remediate such substances, when released, usually reduces the value and adversely affects the ability to sell such real estate or to borrow using such real estate as collateral.\nThe Trust has notified a governmental authority of a spill from a former dry cleaning shop at King's Court Shopping Center and the Regional Water Quality Control Board of Santa Clara County has issued a clean-up order to the Trust. Currently, a plan of remediation has been prepared with a proposed plan of action for clean-up of the contamination. The remediation clean-up is now underway and is expected to last at least two years. This plan has been approved by the pertinent regulatory agencies on an interim basis, pending review of remediation and testing results. The cost to Kingsco for the clean-up is estimated to be $632,000, of which $503,000 has already been expended. The Trust was not a partner of Kingsco at the time the contamination occurred, and intends to look to the seller of the Trust's 40% interest in Kingsco, Kingsco's insurance carriers at the time of the contamination, the other partners of Kingsco and the entity that caused the contamination for payment of the clean-up costs. The Trust believes that the representations and warranties made by the seller in the agreement pursuant to which the Trust acquired its partnership interest give the Trust a cause of action against the seller for the clean-up costs.\nIn another, unrelated, environmental audit of the gasoline service station pad (\"Exxon Pad\") at King's Court Shopping Center, the Phase I and II work identified gasoline and possibly other service\nstation by-products in the soil underneath the station and its pumps. Exxon Corporation has assumed financial and legal responsibility of the hazardous materials and remediation of the Exxon Pad. The environmental firm responsible for maintaining and analyzing the data from various monitoring wells on the Pad continues to report to Menlo Management Company and governmental authorities on a quarterly basis. Remediation efforts are now underway and include both vapor extraction and \"pump and treat\" activities, depending upon the location of the materials in the soil and water.\nThe Trust has also become aware of a spill from a former dry cleaning establishment at El Portal Shopping Center. This spill probably occurred prior to the Trust's ownership of the property. The Contra Costa County Regional Water Quality Control Board is currently reviewing the situation and a clean-up remediation proposed by the Trust. The cost of clean-up and timetable have not yet been identified, however, based on current knowledge, the cost is not expected to have a material effect on the Trust's financial position. On March 21, 1996, the Trustees authorized the expenditures up to $100,000 for remediation.\nCompliance with federal, state and local laws and regulations relating to the protection of the environment could have a significant impact on the financial position of the Trust. However, other than disclosed herein, the Trustees are not currently aware of any conditions that would have a material adverse effect on the Trust.\nAMERICANS WITH DISABILITIES ACT. The Trust's properties are subject to the Americans with Disabilities Act of 1990, as amended (the \"ADA\"). The ADA has separate compliance requirements for \"public accommodations\" and \"commercial facilities\" and generally requires that public facilities such as retail shopping centers be made accessible to people with disabilities. These requirements became effective in 1992. Compliance with the ADA requirements will require removal of access barriers and other capital improvements at the Trust's properties. Noncompliance could result in imposition of fines by the United States government or an award of damages to private litigants. However, the Trust does not believe that the costs of compliance will be material. If required changes involve a greater expenditure than the Trust currently anticipates, or if the changes must be made on a more accelerated basis than it anticipates, the Trust could be adversely affected.\nMANAGEMENT\nThe search for suitable real estate capitalization and portfolio restructuring is pursued by the Trust's investment advisor, Collier Investments (the \"Advisor\"), a proprietorship owned by Charles R. Collier. Under the terms of an Investment Advisory Agreement between the Trust and the Advisor, the Advisor has agreed to use its best efforts to present to the Trust recapitalization and portfolio restructuring opportunities consistent with the investment policies and objectives of the Trust. After careful study and review, the Advisor may recommend to the Trustees those opportunities or strategies whose character is consistent with the investment program of the Trust. In addition to relying on the advice of the Advisor, the Trustees occasionally employ the services of independent professional consultants.\nThe Trust employs no full-time executives or administrative staff. The leasing and management of the Trust's properties and administration of the Trust itself is performed by an independent contractor, Menlo Management Company. Eighty-three percent of the outstanding capital stock of Menlo Management is owned by Robert C. Gould and the remainder is owned by Charles R. Collier, who is Mr. Gould's father-in-law. California Bavarian Company, a privately held California corporation, provides service to the Trust on a contractual basis for a monthly service fee.\nThe Trust has five trustees who meet once a month and who are compensated by the Trust. The Trustees include: Wilcox Patterson, who serves as President; Harry E. Kellogg, who serves as Treasurer; John H. Hoefer and Robert C. Gould, who serve as Vice Presidents and William S. Royce, who serves as Secretary. The Trustees, Officers and Advisor all invest in the Trust.\nCOMPETITION\nThe Trust's properties are all located in metropolitan communities in the San Francisco Bay Area. Each property is situated amidst fully developed commercial and retail areas. As such, there are other competing neighborhood and community shopping centers and professional office facilities located in near proximity to the Trust's properties. These factors will have a bearing on the Trust's ability to rent its properties to tenants on economic terms and to impose effective mechanisms to control operating costs and resultant net income. The Trust must compete for tenants and services with other property owners who may have greater resources or more attractive locations than those available to the Trust and its officers, directors and agents. Moreover, the extent and increasing rates of changes in community demographics, public policy, retail and office usage patterns, merchandising practices, consumer tastes and financial strength of tenants, amongst other considerations, can all affect adversely a property's competitive position in varying ways.\nINSURANCE\nThe Trust typically maintains comprehensive liability, fire, extended coverage and rental loss insurance with respect to its properties, and generally requires tenants to reimburse the Trust for their pro rata share of the Trust's insurance premiums and to maintain their own general liability insurance with respect to the properties with policy terms and insured limits customarily carried for similar properties. There are, however, certain types of losses (such as from wars, flood, riots or earthquakes) which may be uninsurable or insurable only at rates which, in the Trust's opinion, are prohibitive. Two of the Trust's properties (El Portal Shopping Center and King's Court Shopping Center) are insured against damage from earthquakes.\n(d) Foreign Operations\nThe Trust does not engage in any foreign operations or derive revenues from foreign sources.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDESCRIPTION OF THE TRUST'S PROPERTIES\nThe following table sets forth certain information relating to the Trust's properties as of December 31, 1995:\n- ------------------------------ (1) Lucky Stores owns its store at Monterey Plaza Shopping Center and, therefore, is not a tenant of the Trust. Even though the Trust does not benefit directly from the economic performance of this anchor store, the anchor is nonetheless critical to the success of the Trust's shopping center.\n(2) The aggregate gross leasable area does not include approximately 51,000 square feet at Monterey Plaza Shopping Center. This represents the store owned by Lucky Stores.\n(3) Total annual minimum rent for the year ended December 31, 1995, excluding (a) percentage rents, (b) additional rent payable by tenants such as common area maintenance, real estate taxes and other expense reimbursements, and (c) future contractual rent escalations or Consumer Price Index adjustments. Percentage rents are paid over and above base rents, and are calculated as a percentage of a tenant's gross sales above a predetermined threshold. The amount of percentage rents received to date by the Trust has not been material to the Trust's operations. Figures for total annual minimum rent in the above table have been calculated based on rental payments currently due, and have been adjusted for the effects of recognizing rent on a straight-line basis as reported in the Trust's financial statements.\n(4) Safeway, at El Portal, and HomeBase, at Monterey Plaza, ceased retail operations during 1994. Both tenants continue to be obligated under their lease agreements. Safeway is current with their lease payments and HomeBase is delinquent in payment of its rents and charges since January 1, 1996 as a consequence of a dispute with the Trust over certain lease provisions. The Trust expects that this dispute will be resolved satisfactorily. Under the terms of both leases, the tenants have the right to sublease their space without obtaining approval of the Trust. Both tenants are actively seeking sublessees. HomeBase at El Portal terminated its lease with the Trust on December 31, 1994 by agreement with the Trust and ceased retail operations in April 1995. See below for further discussion on each of these circumstances.\n(5) McCrory Corporation is operating its J.J. Newberry Store at El Portal under protection of Chapter 11 of the U.S. Bankruptcy Code. As part of the Settlement Agreement between the Trustee in Bankruptcy and the Trust, McCrory modified its lease to provide, in effect, for a year-to-year lease with mutual termination rights. Effective rent and triple net recoveries were reduced under the terms of the Settlement Agreement.\n(6) Long's Drug Store's lease at El Portal expired in February 1996 and Long's has vacated the center.\n(7) Menlo Center was sold in February 1996. See below (under Property Sales) for further discussion.\nEL PORTAL SHOPPING CENTER. El Portal Shopping Center is a community shopping center located in the community of San Pablo, California. The center was acquired by the Trust in 1976, and repositioned and expanded in 1978 and 1986, respectively. The center has a total of 271,426 square feet of gross leasable area. From 1976 to 1995 El Portal was an important source of cash flow to the Trust.\nToday, El Portal is again in need of substantial redevelopment to meet the rapidly changing methods of retailing and changing consumer shopping patterns in the Center's trade area.\nDuring 1994, the structure of the Center's anchor tenancy underwent a series of material changes. In February 1994 the parent of Newberry, McCrory Corporation, operating under the protection of Chapter 11 of the United States Bankruptcy Code (filed February 26, 1992), modified its lease, effectively reducing the terms of the lease to a one year maturity with a series of one year extensions and reducing the annual rental income stream by $62,000 and converting the triple net lease terms into gross lease terms. At the same time, the Newberry Store changed its merchandising format from that of a conventional variety store to a \"99 CENTS\" discount close-out store.\nDuring 1994, the Safeway Store suffered a sharp decline in gross sales volume as a result of newly established competing supermarkets in the trade area. In October 1994, Safeway abruptly terminated its operations. While Safeway is still liable for rent under the terms of its lease, the lease provides no mechanism affording the landlord the right to require continuing business operations. Safeway threatens to sub-lease its store to a local supermarket user whose usage and market draw would be inferior to that of a conventional Safeway Store. This store closing has had a substantial negative impact on the retail sales traffic in the Center and on the ability of the Center's remaining tenants to maintain viable retail sales volumes. The Trust is presently negotiating with a possible satisfactory replacement tenant for the Safeway Store and has received strong interest from a leading national warehouse supermarket chain. However, it has no assurance that these negotiations will be successful.\nAlso, late in 1994, Waban Inc, the parent of the HomeBase warehouse discount store chain, announced plans to close its stores in the Bay Area including its 100,000 square foot HomeBase store at El Portal. The Trust's lease with HomeBase contained sufficient provisions enabling the Trust to negotiate successfully for an economically acceptable lease termination. In exchange for a lease termination effective December 31, 1994 the Trust negotiated a $6,000,000 lease buy-out offer from HomeBase. The full amount of the buy-out was paid to the Trust on December 30, 1994. This sum was paid to the lender as required under the terms of the property financing. The HomeBase operations remained active at El Portal until April 8, 1995.\nThe combined effect of these three developments has prompted Long's Drug, the Center's fourth anchor tenant, to close its store at the termination of its lease in February 1996.\nThe result of these anchor lease events has been very serious. While the Center has successfully maintained acceptable overall occupancy levels in 1994 and 1995, it has been at the cost of reduced rental revenues and it is doubtful that many smaller retailers will be able to continue to sustain themselves as a result of the anchor store closures.\nThe Trust is vigorously exploring redevelopment possibilities with potential replacement retailers and the City of San Pablo in its effort to salvage as much equity as possible for shareholders. It is too soon to predict how successful these efforts will be.\nAt December 31, 1995, El Portal Shopping Center was 58% leased. The percentage of the center that is both leased and occupied at December 31, 1995 was 44%. Tenants leasing 10% or more of the rentable space as of December 31, 1995 are:\nIn 1995 the Trust discovered that there had been a toxic spill by a former dry cleaner tenant. This spill probably occurred prior to the Trust's acquisition of the Center. See above under Governmental Regulation -- Environmental Matters for a discussion of this spill.\nKING'S COURT SHOPPING CENTER. This neighborhood shopping center is located in the community of Los Gatos, California. The center is anchored by Lunardi's Supermarket, a local supermarket chain, and an array of retail and service tenants such as Hallmark Cards, Wells Fargo Bank and Bank of America. King's Court Shopping Center has 76,612 square feet of gross leasable space. The Trust presently owns a 40% interest in Kingsco, the general partnership which owns this shopping center. In addition, the Trust manages King's Court Shopping Center and has control over the shopping center's operations, including any leasing, renovation, sale and financing activities.\nKingsco owns a leasehold estate as to the land and fee title as to the improvements (excluding a gas station). The ground lease has a 65-year term expiring in 2024, and requires minimum annual payments of $40,000 plus 12% of the property's gross rental revenue in excess of $333,333 per annum. The Trust is presently attempting to negotiate with the ground lessors to extend the ground lease. There can be no assurance that these negotiations will succeed on economically acceptable terms. The carrying cost of the center, which includes the other partners' interest in the property, was $6,208,000 after depreciation at December 31, 1995. The property is security for a first mortgage loan with an interest rate of prime +1.75%. At December 31, 1995 the rate was 10.25% and the outstanding balance was $1,343,000.\nAt December 31, 1995, King's Court Shopping Center was 100% leased. Tenants occupying 10% or more of the rentable space as of December 31, 1995 are:\n- ------------------------ (1) Additional percentage rents paid by Lunardi's Supermarket were $140,000 in 1995, $99,000 in 1994, and $103,000 in 1993.\nThe Trust has discovered toxic pollution of the ground water under King's Court Shopping Center. See above under Governmental Regulation -- Environmental Matters for discussion of this circumstance.\nMENLO CENTER. Menlo Center is a prime quality mixed-use retail and professional office redevelopment project located near Stanford University in downtown Menlo Park, California. Menlo Center was completed in December 1989 and contains 54,903 square feet of gross leasable space (including storage space and common areas). The complex comprises a retail plaza of 15,375 square feet, anchored by Kepler's Books and Magazines, which draws its patrons from throughout the mid-San Francisco Peninsula. The professional office space contains 38,591 square feet, and is anchored by Dean Witter Reynolds Inc. Menlo Management Company, the entity which currently provides management services to the Trust, has a lease for 3,193 square feet of office space at Menlo Center, and the Trust's executive office is located within such space.\nThe Trust leases a 10,500 square foot portion of the land underlying Menlo Center. The ground lease has an effective term of 40 years, grants the Trust ten consecutive five-year renewal options and contains an option to purchase upon the death of the ground lessor.\nAt December 31, 1995, Menlo Center was 100% leased. Tenants occupying 10% or more of the rentable space as of December 31, 1995 are:\nAt December 31, 1995, the Trust's investment in Menlo Center was $17,376,000 before accumulated depreciation, and the total indebtedness on this property was $10,738,000. The Trust reduced the carrying value of Menlo Center to $15,000,000 after depreciation during 1994 in order to reflect its opinion of the then current market value. Menlo Center was sold on February 29, 1996.\nMONTEREY PLAZA SHOPPING CENTER. This community shopping center is located in San Jose, California. The Trust began the development of this shopping center in 1987, and completed development in 1990. The center has 233,000 square feet of retail space, of which the Trust owns 182,405 square feet, or all but the Lucky Store. In addition to the Lucky Stores anchor, other retailers include Walgreen, McDonald's, Lyon's Restaurant and Taco Bell.\nIn November 1994, HomeBase ceased its operations at Monterey Plaza as part of its overall strategy to close certain stores in Northern California. HomeBase remains liable for payment of rent and related occupancy charges. HomeBase is delinquent in payment of its rents and charges since January 1, 1996 as a consequence of a dispute with the Trust over certain lease provisions. The Trust expects that this dispute will be resolved satisfactorily. HomeBase does not have the obligation to maintain continuous business operations. HomeBase and the Trust are actively seeking an acceptable replacement tenant or sublessee at this time, though there is no assurance that one will be found. The HomeBase lease is an obligation of Waban, Inc., a New York Stock Exchange company. It is also a guaranteed by T.J.X. Corporation, also a New York Stock Exchange company. This anchor store closure has had a negative impact on retail sales in the rest of the shopping center. Replacement of this anchor continues to be a major goal of the Trust. The building (101,500 sq ft) will require substantial capital investment in order to prepare it for occupancy by a replacement retail tenant.\nAt December 31, 1995, Monterey Plaza Shopping Center was 95% leased. If the HomeBase vacancy is accounted for, the percentage of the Center both leased and occupied at December 31, 1995 was 39%. Tenants leasing 10% or more of the rentable space as of December 31, 1995 are:\nAt December 31, 1995, the Trust's investment in Monterey Plaza Shopping Center after accumulated depreciation was $25,673,000, and the total indebtedness on this property was $18,568,000.\nVESTING OF TITLE TO PROPERTIES\nWith the exceptions of the land under King's Court Shopping Center, a portion of the land under Menlo Center, and a parcel of land adjacent to El Portal Shopping Center fee title to all the properties is owned by the Trust. For King's Court Shopping Center, the Trust acquired a 40% controlling interest in the general partnership which owns a leasehold estate as to the land and fee title as to the improvements (excluding a gas station). The ground lease has a 65-year term expiring in 2024. In Menlo Park, the Trust leases a 10,500 square feet portion of the land underlying the Menlo Center project. The ground lease has an effective term of 40 years, grants the Trust 10 consecutive 5-year renewal options, and contains an option to purchase upon death of the ground lessor. At El Portal the Trust leases a 2.513-acre parcel of land adjacent to the El Portal Shopping Center and fronting onto San Pablo Avenue. The ground lease has an effective term of fifty years and contains an option to purchase upon the death of one of the ground lessors.\nPROPERTY CONDITION\nAll of the buildings are suitable and adequate for the purposes for which they were designed, are being used for those purposes, where leased and occupied, and are in a good state of repair. However, due to changes in retail industry practice, the Trust believes that several of its buildings at El Portal may be either functionally obsolete or require substantial physical upgrading in order to be capable of re-letting on economic terms in today's retailing environment. Moreover, in recent years it has become\nincreasingly evident that tenant improvements for new and replacement tenants have escalated in cost significantly in excess of the rate of inflation and have tended to increase capitalization in Trust properties to a material extent. This trend is partially a consequence of the growing competitiveness of the rental marketplace in which the Trust's properties operate. This is evident at Monterey Plaza Shopping Center where the building formerly occupied by HomeBase will require substantial physical renovation and upgrading in order to prepare it for occupancy by a replacement retail tenant.\nPROPERTY SALES\nThe Trust sold the Lakeshore Plaza Shopping Center on March 13, 1995 for a sales price of $31,292,000. The proceeds of this sale after provision for assumption of the existing First Deed of Trust financing, repayment of junior financing, closing costs, escrow holdbacks for supplemental property taxes, vacant spaces and pending tenant improvement allowances, legal fees, transfer taxes and miscellaneous selling expenses, were all used to pay down other short-term Trust debt, including debenture indebtedness maturing in July 1995.\nOn February 29, 1996, the Trust sold Menlo Center for a sales price of $16,200,000. The existing financing was assumed by the buyer. After provision for closing costs, transfer fees and real estate commissions, the proceeds of this sale were all used to pay down other short-term Trust indebtedness and to provide working capital for the Trust. The Trust remains liable to the buyer for an annual net income subsidy for the remaining term of the First Deed of Trust financing which matures in 2000.\nPRINCIPAL TENANTS\nHomeBase, Inc. (\"HomeBase\") is the Trust's largest tenant. HomeBase, a discount home improvement and hardware chain, is a subsidiary of Waban, Inc. (\"Waban\") which is traded on the New York Stock Exchange and, as of December 31, 1995, has credit ratings of BA3 and BB- as determined by Moody's and Standard and Poor's respectively. In November 1993, Waban announced plans to close or relocate approximately 24 of a total of 90 HomeBase Stores in locations where it perceived limited potential to achieve its corporate objectives. In the fall of 1994, HomeBase notified the Trust that it intended to shut down its operations at both El Portal Shopping Center and Monterey Plaza Shopping Center in pursuit of this policy. At that time, HomeBase's leases accounted for 29% of the Trust's gross leasable area and 17% of base rent revenues. The Monterey Plaza lease is guaranteed by T.J.X. Corporation and Waban, Inc., both of which are listed on the New York Stock Exchange.\nBecause of the terms of the HomeBase lease at El Portal, the Trust successfully negotiated an adequate financial compensation for HomeBase's closure of operations. On December 30, 1994, HomeBase paid a lease termination fee of $6,000,000 to the Trust. In exchange, HomeBase was granted the ability to terminate its lease effective December 31, 1994 with the obligation to surrender the premises to the Trust by April 1995. Under the terms of the First Deed of Trust to First Nationwide Life Insurance Company securing the loan on El Portal, the full proceeds of this lease buy out were applied towards principal reduction and prepayment penalty applicable to this loan. HomeBase closed its store on April 8, 1995.\nHomeBase closed its store at Monterey Plaza in November 1994. The HomeBase lease contains no continuous business operations provision; the lease only requires HomeBase to continue to pay rents and other occupancy charges as they become due. HomeBase is delinquent in payment of its rents and charges since January 1, 1996 as a consequence of a dispute with the Trust over certain lease provisions. The Trust expects that this dispute will be resolved satisfactorily. The closure has had a negative impact on the volume of retail sales business transacted at the Center. HomeBase and the Trust are cooperating to locate a suitable replacement anchor retailer for the 101,500 square foot premises. Replacing this anchor is a major goal for the Trust.\nSafeway, Inc. (\"Safeway\") is the Trust's second largest tenant, in terms of gross leasable area. Safeway is a major operator of retail supermarkets in the United States and Canada. Safeway is listed on the New York Stock Exchange and, as of December 31, 1995, has credit ratings of BA1\/BA2 and BBB- from Moody's and Standard and Poor's respectively. Safeway comprises 6% of the Trust's gross\nleasable area and 3% of its base rental revenue at December 31, 1995. As indicated above, Safeway closed operations at the El Portal store in October 1994. At the present time, Safeway remains liable for rent and occupancy costs during the remaining term of its lease and is current with all lease payments.\nOther significant tenants at the Trust's properties include McCrory Corporation (Newberry), Walgreen and Lunardi's Supermarkets, which lease properties representing approximately 11% of the Trust's gross leasable area and 7% of its base rental revenues. McCrory Corporation is operating under the jurisdiction of the Bankruptcy Court, having filed for relief under Chapter 11 of the Bankruptcy Code in 1992.\nInformation with respect to the Trust's five largest tenants as of December 31, 1995 is set forth in the following table:\nOCCUPANCY RATES FOR PAST FIVE YEARS\nThe following table shows year-end occupancy rates for rentable space both leased and occupied, expressed as a percentage of total rentable square footage for each of the Trust's properties for the past five fiscal years:\n- ------------------------ (1) The Safeway Store at El Portal Shopping Center and the HomeBase store at Monterey Plaza Shopping Center are leased but not currently occupied. Long's Drug has vacated its premises at El Portal upon the expiration of its lease in February 1996. This has had the impact of reducing the occupancy rate to 36%. See Description of Trust's Properties and Principal Tenants.\nAVERAGE EFFECTIVE ANNUAL BASE RENT PER SQUARE FOOT FOR PAST FIVE YEARS\nThe following table shows average effective annual rent per square foot for each of the Trust's properties for the past five years:\nLEASE EXPIRATIONS\nThe following table shows lease expirations for the next ten years for existing tenants at the Trust's properties as of December 31, 1995, assuming that none of the tenants exercise renewal options:\nLEASES\nThe majority of the anchor leases on the Trust's retail properties provide for initial lease terms of between ten and twenty years, and the leases on the Trust's smaller shop spaces typically provide for lease terms of between three and five years. The Trust typically seeks to structure the leases on its properties as \"triple net\" leases that impose on the tenant pro rata obligations for real property taxes and assessments, repairs and maintenance of common areas and insurance. Through the use of triple net leases, the Trust seeks to reduce its exposure to escalating operational costs and risks and the demands upon managerial time typically associated with investments in real estate. In this way, triple net leases provide opportunities for income growth from contractual rent increases without corresponding increases in operational costs. However, the Trust has agreed in certain instances to retain or limit the responsibility for some obligations that would otherwise be the responsibility of the tenant under a triple net lease. Tenants occupying the professional office space in Menlo Center are on gross leases, as is customary in professional office lease practice. Gross leases do not require tenants to bear their share of property taxes or costs of insurance and maintenance of common areas. At El Portal Shopping Center, several retail tenants are not responsible for full payment of property taxes, insurance or common area maintenance expenses. At Kings Court Shopping Center, one tenant is not responsible for its property taxes, insurance and common area maintenance expenses. Triple net expenses for vacant space are not recoverable and are thus net property expense to the Trust.\nOUTSTANDING INDEBTEDNESS\nAs of December 31, 1995, the combined total indebtedness of the Trust was approximately $48,008,000, consisting entirely of fixed rate debt except for $1,343,000 of floating rate debt. Aggregate indebtedness included $36,818,000 in long-term mortgage loans with maturity dates ranging from 1999 to 2000, $11,190,000 in short-term notes payable with maturity dates ranging from 1996 to 1997. The following table sets forth certain information with respect to the Trust's mortgage loans:\n- ------------------------ (1) Assumes no prepayments of principal prior to due dates thereof. The Trust's primary mortgage loan with respect to El Portal Shopping Center does not permit prepayment until after July 1995, and thereafter permits prepayment with a penalty. Mortgage loans with respect to Menlo Center and Monterey Plaza Shopping Center permit prepayment, but with substantial prepayment penalties.\n(2) This property is no longer owned by the Trust, but the Trust remains the primary obligor on the underlying mortgage. See \"Mortgage Notes Relating to Property Sales\" below.\n(3) This mortgage loan bears interest at prime +1.75%.\nThe following table shows the scheduled maturity of the Trust's long-term mortgage loans over the next five years:\nAs discussed above, the Trust is currently reviewing the feasibility of redeveloping El Portal Shopping Center. In addition, routine ongoing requirements of building upkeep and tenant replacements will necessitate capital expenditures during the future. The precise extent of such expenditures cannot yet be determined.\nMORTGAGE NOTES RELATING TO PROPERTY SALES\nAs part of its strategy to focus on metropolitan \"in-fill\" locations as opposed to more rural locations, the Trust sold two properties, one each in 1988 and 1990. In connection with such sales, the Trust accepted seller financing:\n(i) WESTWOOD VILLAGE SHOPPING CENTER. In December 1988, the Trust sold the Westwood Village Shopping Center for $6,475,000, payable in cash of $1,100,000 and a $5,375,000 seller-carryback note receivable due in seven years with interest only payments at a rate of 9%. In March 1990, the purchaser obtained a $4,100,000 loan secured by a first mortgage on this shopping center to pay down the Trust's note. The remaining amount owed to the Trust is subordinate to this new loan. The principal balance owed to the Trust on December 31, 1995 was $1,120,000 and payments are current. This loan was to mature in December 1995. The borrower requested an extension of the maturity date to December 1996 and the Trust granted this request. The shopping center income is sufficient to cover the payments on this note. However, there is considerable vacancy at Westwood Village due to overbuilding of retail facilities in the Redding area. This has put downward pressure on rents and property values. The Trust feels that this note will ultimately be collectible.\n(ii) MT. SHASTA SHOPPING CENTER. In August 1990, the Trust sold the Mt. Shasta Shopping Center for $5,100,000, payable in cash of $900,000 and a $4,200,000 all-inclusive promissory note and second deed of trust due January 1, 1999 (the \"Mt. Shasta Note\"). The Mt. Shasta Note bears interest 9.25%. Because the interest rate was less than the market rate during the initial period, the Mt. Shasta Note was discounted by $303,000 which is being recognized as additional interest income over the term of the Mt. Shasta Note. The Mt. Shasta Note requires interest only payments until it matures on January 1, 1999. The Trust continues to be the primary obligor on the underlying first mortgage note, the principal balance of which at December 31, 1995 was $1,631,000. Payments on the Mt. Shasta note are current. The current owner of Mt. Shasta Shopping Center expects to refinance the property and thereby repay the Trust's remaining loan balance. There is no assurance, however, that this refinance can be accomplished.\nOTHER DEVELOPMENTS\nOn December 10, 1993, the Trust entered into a purchase and sale agreement (the \"Plaza 580 Agreement\") with Plaza 580 Ltd., pursuant to which the Trust obtained an option to purchase a shopping center located in Livermore, California. On March 10, 1994, the Trust entered into three additional purchase option agreements: (i) with DSL\/Elk Grove, a California joint venture, with respect to a shopping center located in Elk Grove, California (the \"Elk Grove Agreement\"); (ii) with R\/ P Manteca Limited Partnership, a California limited partnership, with respect to Mission Ridge Shopping Center located in Manteca, California (the \"Manteca Agreement\"); and (iii) with DSL\/Fair Oaks, a California joint venture, with respect to Northridge Center located in Fair Oaks, California (the \"Northridge Agreement\").\nPursuant to an agreement dated May 9, 1994 (the \"Plaza 580 Assignment Agreement\"), the Trust assigned its rights under the Plaza 580 Agreement to Western Investment Real Estate Trust (\"WIRET\"), a California real estate investment trust, for the sum of $556,519, adjusted for certain closing costs and prorations. On May 27, 1994, WIRET closed its acquisition of the Trust's rights under the Plaza 580 Agreement and acquired the underlying property. Pursuant to the Plaza 580 Assignment Agreement, the Trust guaranteed the payment of certain rental rates with respect to two empty shop spaces located at Plaza 580 for a period of 24 months. The Trust also agreed to repay a portion of the purchase price with respect to any of such empty spaces that remain unleased at the end of the 24-month period. This space has since been leased.\nPursuant to an agreement dated May 11, 1994 (the \"Second Assignment Agreement\"), the Trust assigned its rights as purchaser under each of the Elk Grove Agreement, the Manteca Agreement and the Northridge Agreement to WIRET for $1,804,211, as adjusted for certain closing costs and prorations. On June 7, 1994, the transactions contemplated by the Second Assignment Agreement were consummated. Pursuant to the Second Assignment Agreement, the Trust guaranteed the payment of rent for 24 months for certain empty space at the Elk Grove and Northridge centers, and agreed to repay to WIRET, at the end of 24 months, a portion of the purchase price applicable to such empty space which remains unleased (or leased to tenants that do not meet certain guidelines) as of such 24-month period. At December 31, 1995 these spaces have all been leased. The Trust also agreed to pay pro forma rents for certain space at Northridge which space is subject to leases that expire within the first year after closing.\nDuring 1994, the Trust recorded a net gain of $994,000 and rent guarantee reserve accrual of $390,000, as the result of Plaza 580 Assignment Agreement and the Second Assignment Agreement. In 1995, the Trust increased the reserve by an additional $213,000, accordingly the remaining deferred gain of $203,000 is reflected in accounts payable and other liabilities.\nIn connection with the above transactions, on June 7, 1994, (i) Scotts Valley Plaza, a California limited partnership (\"Scotts\"), granted to the Trust a one-year option to acquire the shopping center commonly known as Scotts Village Plaza and (ii) Scotts Village Phase II, a California limited partnership (\"Scotts II\"), granted a one-year option to the Trust to purchase Scotts Valley Square, both of which are located in Scotts Valley, California. Concurrently with the grant of these options and in\nconnection with the transactions contemplated by the Second Assignment Agreement, the Trust made a loan to Malcolm R. Riley, one of the principals in Scotts and Scotts II, in the amount of $750,000. The loan bears interest at 9% per annum, payable monthly, and the principal is due and payable in 6 years. Simultaneously, the Trust made a loan to Russell R. Pratt, another of the principals in Scotts and Scotts II, in the amount of $500,000. That loan bears interest at 8% per annum, payable monthly, and the principal is due and payable in 6 years. Each of these loans is secured by the borrower's respective partnership interests in Scotts and Scotts II. The Trust also made a loan in the amount of $75,000 to Scotts, which bears interest at 8.6% per annum (payable monthly), is due in 6 years and is secured by a second deed of trust on Scotts Village Plaza. Payment on these notes are current.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Trust is not presently involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Trust or its properties, other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by the Trust's liability insurance and all of which collectively is not expected to have a material adverse effect on the business or financial condition of the Trust.\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 TRUST SHARES AND RELATED SHAREHOLDER MATTERS\nMARKET VALUE OF TRUST SHARES\nThere is no established public trading market for Trust Shares. Historically, the Trust maintained consecutive offerings of new Trust Shares to existing shareholders and to the investing public at prices representing the then current estimated market value for the Trust Shares. The Trust's policy has been to review the prices at which Trust Shares were offered at least annually, and at such other times as the Trustees believed the estimated value of the Trust's assets had changed to a degree sufficient to alter the prices of Trust Shares. In the past, Trust Shares have been offered solely to California residents pursuant to an exemption from the registration requirements of the federal securities laws, and have been qualified with the State of California for issuance pursuant to offering circulars prepared by the Trust. The Trust's most recent offering circular expired on December 15, 1992, and no new Trust Shares have been sold since such date.\nThe Trust also historically maintained a dividend reinvestment program through which existing shareholders were able to purchase Trust Shares at a discount from the then current offering price in lieu of receiving dividends in cash. The dividend reinvestment program has been suspended since the expiration of the Trust's last offering circular in December 1992.\nFrom time to time, to provide existing shareholders with a means of trading Trust Shares, Pacific Real Estate Securities Co., Inc. (\"Presco\") has acted as a crossing agent on behalf of the Trust so that persons interested in acquiring Trust Shares could purchase Trust Shares from persons interested in selling Trust Shares. Because there is no current offering circular in place, Presco is not presently effecting crossing transfers of Trust Shares, ceased operation as an N.A.S.D. broker\/dealer in November 1995, and has subsequently been wound up in 1996. Shareholders wishing to liquidate their interests in the Trust must locate buyers for their Trust Shares independently. As of December 31, 1995, there were 145,000 Trust Shares available for sale by existing shareholders. At this time, the Trust cannot predict when or at what price these Trust Shares will be liquidated.\nAs of December 31, 1995, there were 3,706,845 Trust Shares issued and outstanding which were held of record by approximately 3,500 shareholders.\nDISTRIBUTION POLICY\nThe following table sets forth on a quarterly basis historical distributions made by the Trust during its last three fiscal years. Distributions are based on operating results for the quarter prior to the quarter in which they are declared. Historical distributions are not intended to be indicative of future distributions.\nHistorically, the Trust's policy has been to pay dividends to its shareholders in an amount approximating 100% of its cash flows from operations (i.e., net operating income plus depreciation and amortization). From its inception in 1963, the Trust made 155 consecutive bi-monthly or quarterly regular distributions. With respect to distributions paid in 1991, 1992 and the first quarter of 1993, 100% of the amount paid was sheltered from current taxable liability as a result of book depreciation expense. On February 25, 1993, the payment of dividends was suspended in order to conserve the Trust's cash flow, to provide for its capital improvements program, to maintain the quality of the Trust's properties and to protect the Trust's credit, since the Trustees concluded that the Trust could no longer rely on its traditional sources of liquidity (i.e., secured bank financing and \"intrastate\" equity offerings). The Trust is applying the funds that would otherwise have been distributed to its shareholders (i) to fund capital expenditures necessary to maintain its properties, (ii) to make requisite principal payments on its mortgage indebtedness and (iii) to facilitate tenant improvements required upon developing and reletting of the Trust's properties. Because the Trust did not have taxable income for 1995, the suspension of dividends is not expected to affect the Trust's qualification as a REIT.\nIn December 1993, the Trust declared a special distribution of $0.05 per Trust share, payable on or prior to December 31, 1993 to all Trust shareholders of record on November 30, 1993. The timing of resumption of regular dividend payments is not known at this time.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following represents selected financial data for the Trust for the five years ended December 31, 1995. Acquisitions and dispositions which occurred during the periods presented below materially affect the comparability of the data. The data should be read in conjunction with the consolidated financial statements included elsewhere herein.\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 \"Selected Financial Data\" and the Consolidated Financial Statements and the Notes thereto appearing elsewhere herein.\nRESULTS OF OPERATIONS\nCOMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994\nDuring 1995 the Trust continued its efforts to recapitalize through a variety of ways, including joint venture or merger with a compatible real estate partner. The chief impediment has been rising yield expectations of potential institutional investor partners. In addition, the process has been hindered by the problems at El Portal Shopping Center and the unresolved HomeBase vacancy at Monterey Plaza, as well as the toxic pollution at King's Court Shopping Center. In order to meet its debt obligations and improve its earnings from operations, the Trust sold its Lakeshore Plaza Shopping Center in March 1995, Menlo Center in February 1996, and is considering the sale of further assets in 1996 in order to achieve these goals.\nNet loss for the year ended December 31, 1995 was $3,448,000 as compared to a net loss of $8,254,000 for the year ended December 31, 1994, a decrease in the loss of $4,806,000.\nRental revenues decreased from $12,417,000 to 9,183,000, a decrease of $3,234,000, or 26%, as a result of the sale of Lakeshore Plaza Shopping Center and the declining revenues at El Portal Shopping Center as a result of the HomeBase lease termination in 1994.\nOperating expenses decreased from $2,162,000 in 1994 to $2,145,000 in 1995, a decrease of $17,000, or 1% due to additional expense of El Portal ground lease and offset by a decrease in Lakeshore Plaza expense due to the sale of the Center.\nProperty taxes increased from $953,000 in 1994 to $1,194,000 in 1995, an increase of $241,000, or 25% due to supplemental bills at Monterey Plaza Shopping Center. Property management fees decreased from $456,000 in 1994 to $318,000 in 1995, a decrease of $138,000, or 30%. Depreciation and amortization decreased from $3,862,000 in 1994 to $2,886,000 in 1995, a decrease of $976,000 or 25%. Each of these decreases resulted from the sale of Lakeshore Plaza Shopping Center with the exception of property taxes.\nGeneral and administrative expenses decreased from $854,000 in 1994 to $609,000 in 1995, a decrease of $245,000 due to cost saving measures.\nInterest income decreased by $396,000, or 38%, from $1,033,000 to $637,000, as a result of the early repayment of two mortgage notes receivable during 1994.\nInterest expense decreased by $3,137,000, or 37%, from $8,501,000 to $5,364,000, due to a pay-down on the El Portal mortgage, a prepayment penalty in 1994 made in conjunction with the sale of Lakeshore Plaza Shopping Center and the pay-down of short-term debt.\nIn connection with a prospective offering of debt or equity securities, potential merger or joint venture activities, the potential acquisition of additional properties, and the proposed reincorporation as a Maryland Corporation, the Trust incurred expenses of $214,000 in 1995 as compared to $1,159,000 in 1994. These expenses were offset in part by a profit of $994,000 on the sale of property options accrued during this effort.\nThe aggregate lease-up rate for three of the Trust's four properties was approximately 97% at December 31, 1995 and December 31, 1994. At one property (El Portal) as a result of the termination of the HomeBase lease in 1994, the lease rate declined to 58%. At another property (Monterey Plaza) where the HomeBase lease remains in effect and the lease-up rate was 95%, the actual occupancy rate declined to 39%. Both of these declines relate primarily to vacancy arising from anchor tenant lease terminations or cessation of operations. The aggregate occupancy rate for the Trust's overall portfolio at December 31, 1995 was 55%.\nCOMPARISON OF YEAR ENDED DECEMBER 31, 1994 TO YEAR ENDED DECEMBER 31, 1993\nDuring 1994 the Trust endeavored to recapitalize and to reduce its ratio of debt to equity. It sought to achieve this through a variety of ways including a public equity offering, private offerings of debt and\/or equity and joint venture or merger with a compatible real estate enterprise. The Trust was advised throughout this process by its investment bankers. Due to market factors chiefly affecting yield and interest rates these goals could not be achieved and in the interests of preserving shareholder value the Trust decided to sell the Lakeshore Plaza to a pension fund. The sale was completed on March 13, 1995.\nIn the course of generating proposals that culminated in the sale of Lakeshore Plaza the Trust's property portfolio was formally exposed to the investment market. This exposure elicited several offers which were predicated on estimates of value for all the Trust's properties with the exception of the El Portal Shopping Center. El Portal was not a candidate for evaluation in this manner because of the losses in its tenant structure and its redevelopment needs. As a result of these estimates of value generated in competitive formal bids and subsequent informal negotiations, the Trustees were able to assess the probable current market value of most of its property portfolio. This had not previously been possible due to the dearth of comparable property transactions in the Bay Area since the decline of the real estate markets during the recent recession.\nThe estimated current market value information gathering in the process described above led the Trustees to the decision to adjust the Trust's book values to more closely reflect these current market values. The aggregate of these write-downs at December 31, 1994 was $8,000,000. The details of the amount of each adjustment are contained in the notes to the Trust's consolidated financial statements.\nNet loss for the year ended December 31, 1994 was $8,254,000 as compared to a net loss of $3,929,000 for the year ended December 31, 1993, an increase in the loss of $4,325,000. This increase was caused by an increase in interest expense of $2,663,000 and a loss on impairment of property value of $8,000,000 offset by the early termination of a lease which resulted in a net gain of $3,578,000 after giving effect to writing off the remaining book value of the building and associated tenant improvements leased by the former tenant, the sale of options on four shopping center properties which resulted in a net gain of $994,000, a one time loan commitment fee expensed in 1993 which did not recur in 1994 and $1,400,000 increase in operating income.\nRental revenues increased from $9,725,000 to $12,417,000, an increase of $2,692,000, or 28%, primarily as a result of income generated from a newly developed property, Lakeshore Plaza Shopping Center, which was fully operational beginning in October 1993.\nOperating expenses decreased from $2,254,000 in 1993 to $2,162,000 in 1994, a decrease of $92,000, or 4% due to reduced bad debt expense offset by increased operating expenses at Lakeshore Plaza Shopping Center.\nProperty taxes increased from $874,000 in 1993 to $953,000 in 1994, an increase of $79,000, or 9%. Property management fees increased from $320,000 in 1993 to $456,000 in 1994, an increase of $136,000, or 43%. Depreciation and amortization increased from $3,052,000 in 1993 to $3,862,000 in 1994, an increase of $810,000 or 27%. Each of these increases resulted from Lakeshore Plaza Shopping Center becoming fully operational beginning in October 1993.\nGeneral and administrative expenses increased from $495,000 in 1993 to $854,000 in 1994, an increase of $359,000 due to increased administrative expenses connected with the proposed reorganization.\nInterest income decreased by $133,000, or 11% from $1,166,000 to $1,033,000, as a result of the early repayment of two mortgage notes receivable originally scheduled to be repaid in future years.\nInterest expense increased by $2,935,000, or 53%, from $5,567,000 to $8,501,000, due to the assumption of new debt for Lakeshore Plaza Shopping Center, and the cessation of capitalized interest on this project as well as a prepayment penalty of $271,000 in connection with early repayment of a portion of the outstanding debt on El Portal Shopping Center.\nIn connection with a prospective offering of debt or equity securities and the potential acquisition of additional properties, the Trust proposed reincorporation as a Maryland corporation and incurred $1,159,000 in 1994 as compared to $989,000 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nCash flow used by operating activities was $1,759,000 in 1995, compared to cash flow provided by operating activities of $3,930,000 in 1994 and $33,000 used in 1993. The decrease in 1995 was primarily due to a one-time lease termination fee received in 1994 at one property. Additionally, cash flow from rental operations has declined in 1995.\nCash flow provided by investing activities was $29,623,000 in 1995, as compared to cash flow provided by investing activities in 1994 of $5,513,000 and $4,767,000 used in 1993. The increase in 1995 was due to proceeds received from the sale of Lakeshore Plaza Shopping Center. The increase in cash provided in 1994 was due to the early pay off of two notes receivable in 1994 and the decrease in 1993 was due to a property under construction in 1992 being substantially completed by early 1993.\nCash flow used by financing activities was $28,122,000 in 1995 as compared to $9,633,000 used in 1994 and $4,824,000 provided in 1993. The increase in 1995 is due to repayment of a mortgage note and the repayment of an unsecured note payable and short-term notes payable due to the sale of Lakeshore Plaza Shopping Center. The decrease in 1994 is primarily due to the early pay off of three mortgage notes payable paid early as a result of refinance by owner of a property formerly owned by the Trust, and also due to a mortgage loan pay-down due to HomeBase lease buy-out at El Portal Shopping Center. The increase in 1993 is primarily due to an increase in proceeds from short-term notes.\nThe Trust's financial structure at December 31, 1995 shows debt financing, including short-term and unsecured notes, representing approximately 68% of the book value of the Trust's properties, before depreciation. The decrease in leverage from the level of 75% in 1994 is primarily due to the Trust's use of the proceeds from the sale of Lakeshore Plaza Shopping Center to pay off the Lakeshore Plaza mortgage note, $8,045,000 of unsecured notes, and short term notes.\nThe Trust has a number of short-term notes due in 1996 and 1997. Menlo Management Company is the general partner of the partnership lenders which hold these short-term mortgage notes. The aggregate balance owed on these notes is $11,190,000 at December 31, 1995. The Trust has one $500,000 note due in May 1996. This note was paid off in March 1996.\nSources of liquidity for the Trust include five mortgage loans receivable, totaling approximately $6,565,000 at December 31, 1995. Two of these loans result from the sale of properties prior to 1991. Payments on these notes are due as follows: $1,120,000 in 1996 and $4,200,000 in January 1999. The balance of $1,325,000 of these notes matures in 2000.\nThe Trustees believe that the Trust has sufficient working capital and sources of liquidity to meet its current needs. The Trustees have considered the long-term liquidity needs of the Trust and have evaluated the following means of raising additional capital: (i) a merger or joint venture with a suitable existing REIT or real estate company, (ii) a public or private equity offering, (iii) or restructuring or sale of all or part of the Trust's portfolio.\nThe Trustees will consider the sale of one or more of the Trust's properties if an acceptable price and terms could be obtained. However, certain of the Trust's mortgage loans provide for substantial prepayment penalties. Also, in order for a purchaser to assume this debt, the applicable lender's consent would be required. The Trust has engaged in formal negotiations during 1994 and in 1995 regarding restructuring the Trust and the sale of certain Trust properties. The Trust is presently engaged in active discussions for the restructuring of the Trust through a joint venture or private equity offering. However, the discussions presently under way are not sufficiently advanced to generate any firm offer. The Trust expects to pursue such avenues actively during 1996. However, if these\nnegotiations are unsuccessful, the Trust will sell certain of its assets in order to generate liquidity sufficient to meet the Trust's needs. In pursuit of this strategy, on February 29, 1996, the Trust sold Menlo Center using the net proceeds to reduce the Trust's debt and to provide working capital.\nThere has been no public market for Trust Shares, nor have there been any known market-makers. From time to time, to provide shareholders with a means of trading Trust Shares, Presco has acted as a crossing agent on behalf of the Trust so that persons interested in acquiring Trust Shares could purchase Trust Shares from persons interested in selling Trust Shares. Presco has ceased to function in this capacity and the company has been wound up in 1996. The price of Trust Shares sold by the Trust and selling shareholders was determined by the Trustees, based on their estimate of the value of the Trust's properties and other assets net of estimated liabilities, with the properties being valued based on estimates of the long-term investment value of each property, rather than on current market value or liquidation value, assuming that the properties were held as long-term assets rather than being sold in mid-term or liquidated in currently depressed market conditions. This valuation approach assumed that the Trust would continue as a \"going concern\", and did not take into account then current market value or liquidation value and costs of liquidation. All existing shareholders who resided in California were given the opportunity to purchase shares in cross-selling transactions. Distributions of $760,000 were paid to shareholders in 1993.\nJOINT VENTURE INTEREST\nThe Trust presently owns a 40% interest in Kingsco, the general partnership which owns King's Court Shopping Center. In addition, the Trust has managing control over King's Court Shopping Center operations, including any leasing, renovation, sale or financing activities. The term of the partnership continues until September 30, 2039. Cash flows and expenses of the partnership are allocated in accordance with the partners' respective percentage interests, with the Trust's allocation being equal to its 40% interest. The shopping center is managed by Menlo Management on behalf of the Trust, and the Trust does not receive any portion of the management fee paid to Menlo Management for such management services.\nOTHER CAPITAL EXPENDITURES\nEach shopping center prepares an annual capital expenditure budget which is intended to provide for all necessary recurring capital improvements. At the present time, the Trust's existing shopping centers have been properly maintained on a current and regular basis and there are no material deferred capital maintenance obligations outstanding. However, the Trust expects that several of its buildings may require significant capital investment in 1996. This is particularly evident at El Portal Shopping Center where redevelopment and re-letting of obsolete or outmoded physical stores will require upgrading. This is also true at Monterey Plaza Shopping Center where the building formerly occupied by HomeBase and now vacant will require substantial capital investment in order to prepare it for occupancy by a replacement retail tenant. The Trust believes that in order to fund capital budgets for such physical improvements it may have to raise capital in a variety of ways including sale of assets, raising debt or entering into a joint venture or merger or other restructuring. These potential capital improvement needs have been discussed above in Item 2. Properties -- Description of Trust's Properties.\nECONOMIC CONDITIONS\nIn the last three years, inflation has not had a significant impact on the Trust because of the relatively low inflation rate. Nonetheless, the majority of the Trust's leases contain provisions designed to mitigate the adverse impact of inflation. Such provisions include clauses enabling the Trust to receive percentage rents which generally increase as prices rise, and\/or escalation clauses which are typically related to increases in the Consumer Price Index or similar inflation indices. Most of the Trust's leases require the tenant to pay its share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing the Trust's exposure to increases in\ncosts and operating expenses resulting from inflation. However, several tenants do not pay such expense reimbursements under the terms of their leases, as indicated in \"Item 2 Properties -- Leases\" section.\nThe United States generally, and the State of California in particular, has experienced a recent economic recession. The State of California continues to show the effect of economic recession, and further adverse changes in general or local economic conditions could result in the inability of some existing tenants of the Trust to meet their lease obligations and could otherwise adversely affect the Trust's ability to attract or retain tenants. The Trust's shopping centers are typically anchored by national or regionally recognized supermarket, super drug and other convenience stores which usually offer day-to-day necessities rather than high-priced luxury items. These types of retailers, in the experience of the Trust, generally continue to maintain their volume of sales despite a slowdown in economic conditions. However, economic conditions are not the only or even necessarily the major influences that can affect the success of tenants in achieving or maintaining sufficient sales volumes. Competitive factors and overall changes in retail merchandising practices can have an equal or even greater impact. The loss of an anchor retailer can lead to the diminution of retail sales and the loss of other retailers in the same shopping center. This can seriously affect the viability of a shopping center, as has become particularly evident at El Portal Shopping Center and, to a lesser extent, at Monterey Plaza Shopping Center.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPACIFIC REAL ESTATE INVESTMENT TRUST\nFinancial statements and supplemental financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in this report.\nINDEPENDENT AUDITORS' REPORT\nThe Trustees and Shareholders of Pacific Real Estate Investment Trust:\nWe have audited the accompanying consolidated financial statements of Pacific Real Estate Investment Trust (the \"Trust\") and its joint venture listed in the foregoing table of contents. Our audits also included the financial statement schedules listed in the foregoing table of contents. These financial statements and financial statement schedules are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Trust and its joint venture 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 shown therein.\nDELOITTE & TOUCHE San Francisco, California March 1, 1996\nPACIFIC REAL ESTATE INVESTMENT TRUST CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 ASSETS\nSee notes to consolidated financial statements.\nPACIFIC REAL ESTATE INVESTMENT TRUST CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nPACIFIC REAL ESTATE INVESTMENT TRUST\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nPACIFIC REAL ESTATE INVESTMENT TRUST\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION\nPacific Real Estate Investment Trust (the \"Trust\") is a trust organized under the laws of the State of California. The Trust is an investment vehicle whose purpose is to acquire, hold for investment, and ultimately sell, interests in neighborhood and community shopping centers and commercial property in selected Northern California metropolitan areas. The Trust has qualified and intends to continue to qualify as a real estate investment trust under provisions of the Internal Revenue Code.\nCONSOLIDATION\nThe consolidated financial statements include the Trust and a joint venture (\"Kingsco\") in which the Trust has a 40% controlling interest. The joint venture is included in the consolidated financial statements as the Trust has control over the joint venture's operations, including all leasing, renovation, sale or refinancing activities. All significant intercompany transactions and balances have been eliminated.\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 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.\nPROPERTIES\nProperties are stated at the lower of depreciated cost or realizable value from the operation and ultimate sale of such properties. Acquisition fees and interest incurred during construction periods are capitalized. Property and improvements acquired by the Trust in connection with its acquisition of a controlling interest in a joint venture are stated at amounts agreed upon among the partners at the date of acquisition which approximated market value at such date. Depreciation is computed by the straight-line method over estimated useful lives ranging from three to forty years. Properties and the related accumulated depreciation are removed from the accounts at the time of sale. The related gain or loss is included in the statement of operations. The determination of estimated realizable value involves subjective judgement because the actual market value of real estate can be determined only by negotiation between the parties in a sales transaction.\nDEFERRED LEASE COMMISSIONS\nDeferred lease commissions are amortized on a straight-line basis over the lives of the related leases, which range from two to forty years.\nDEFERRED FINANCING COSTS\nDeferred financing costs represent loan fees and points paid to obtain certain mortgage financing. These amounts are amortized on a straight-line basis over the lives of the related loans which range from six to ten years.\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOTHER ASSETS\nCertain lease agreements contain provisions for fixed rent increases for future periods and for periods of rent abatement during the earliest portion of such leases. Rental revenue from such leases is recognized on a straight-line basis over the lives of the related leases. Rental revenues in excess of amounts currently billed are reflected in other assets in the accompanying balance sheets.\nINCOME TAXES\nThe Internal Revenue Code provides that a trust qualifies as a real estate investment trust if, among other things, the trust distributes each year at least 95% of its taxable income to shareholders. If the Trust distributes at least 95% of its taxable income to shareholders, such distributions can be treated as deductions for income tax purposes. Because it is the policy of the Trust to distribute amounts approximately equal to its taxable income plus depreciation and amortization, no provision for income taxes has been made in the accompanying financial statements.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts of receivables and short-term notes payable are reasonable estimates of fair value due to the short period of time until their expected realization. The carrying amount of mortgage loans is a reasonable estimate of fair value based on the borrowing rates currently available to the Trust for loans with similar terms and average maturities.\nNET LOSS PER SHARE OF BENEFICIAL INTEREST\nNet loss per share of beneficial interest, is computed by dividing net loss by the weighted average number of shares outstanding of 3,706,845 in 1995 and 1994 and 3,707,072 in 1993.\nRECLASSIFICATIONS\nCertain 1994 amounts have been reclassified to conform with the 1995 presentation.\n2. INVESTMENT ADVISOR, PROPERTY MANAGEMENT AGREEMENTS AND SALES SUPPORT SERVICES AGREEMENT\nThe Trust has entered into certain transactions with Collier Investment (the \"Advisor\"), which is both the investment advisor to the Trust and its real estate broker, Menlo Management Company and Pacific Real Estate Securities Co. Inc. (\"Presco\"). Menlo Management Company manages the Trust's properties, is affiliated with the Advisor and is the owner of Presco. Until its dissolution in 1995, Presco provided support services and acted as a crossing agent for shareholders wishing to purchase existing shares of the Trust.\nIn April 1992, the Trust and the Advisor agreed that, during 1992 and 1993, the Advisor would be paid only real estate brokerage commissions at negotiated rates in connection with the purchase of the Trust's properties, in lieu of the base compensation otherwise payable under the investment advisory agreement. The investment advisory agreement was also amended to provide that, commencing January 1, 1994, the Trust pays to the Advisor, an annual base advisory fee equal to 0.2% of the average gross invested assets of the Trust (as defined in the advisory agreement). The Advisor also may receive real estate brokerage commissions at negotiated rates in connection with the purchase, sale or refinancing of the Trust's properties. In July 1994 the Advisor offered to reduce the annual base advisory fee by 50% retroactive to January 1, 1994. The Investment Advisor also voluntarily waived real estate brokerage commissions in connection with both the sale of Lakeshore Plaza Shopping Center, which was sold on March 13, 1995, and the sale of Menlo Center, which was sold on February 29, 1996.\nThe investment advisory agreement also provides for a yearly incentive compensation payment to the Advisor equal to the sum of: (1) 10% of net realized capital gains, excluding any depreciation, less accumulated realized capital losses, if any; plus (2) 7.5% of the amount, if any, by which net income,\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) before depreciation but excluding capital gains, exceeded a minimum base yield of 8.6% per annum on average net worth (as defined in the agreement) during the preceding calendar year. Net income for this purpose is after deduction of the regular fee, whether or not such fees were paid. No incentive compensation fees were paid to the Advisor in 1995, 1994 or 1993.\nThe Trust has a property management agreement with Menlo Management Company, which is related to the Advisor through common ownership, to manage the Trust's properties for a percentage of gross rentals ranging from 4% to 5% for each property. In addition, for each property, Menlo Management Company receives leasing commissions based on a percentage of the total lease rental revenues, with certain minimum commission charges. Menlo Management Company is the lessee of office space in one of the Trust's properties. The Trustees believe that the terms of the lease and property management agreements are comparable to terms the Trust would obtain from non-related parties.\nMenlo Management Company receives fees for administrative services provided to the Trust and development, planning and negotiating services in connection with development work at the Trust's properties.\nFees paid or payable to the Advisor, Menlo Management Company and Presco in 1995, 1994 and 1993 were as follows:\nReal estate brokerage commissions and fees for development, planning and lease negotiations have been capitalized and property and lease commissions have been deferred.\n3. NOTES RECEIVABLE\nNotes receivable consist of the following at December 31, 1995 and December 31, 1994:\nThe mortgage notes outstanding at December 31, 1995 result from sale of two shopping center properties located in Northern California bear interest from 9% to 9.25% and loans (see note 12). At the time of sale, the two shopping center notes were discounted to yield market interest rates ranging\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) from 9.5% to 13%. The discounts are recognized as interest income over the life of the note. The mortgage notes receivable have been pledged as security for various short-term notes payable, which were extended to various dates in 1996 and in 1997.\nNotes receivable are due as follows:\nThe debtor of a note scheduled to mature in December 1995 requested an extension to December 1996 and the Trust granted this extension in September 1995.\n4. SHORT-TERM NOTES\nAt December 31, 1995, notes outstanding totaled $11,190,000 with interest rates ranging from 10% to 10.20%. The notes are secured by mortgage notes receivable from property sales (see Note 3), additional deeds of trust on existing properties and the Trust's interest in a joint venture. All of these notes at December 31, 1995 are held by private limited partnerships independent of the Trust in which Menlo Management Company has a general partnership interest. Interest of $1,163,000 and $1,442,000 was paid on these notes in 1995 and 1994 respectively. The Notes are due in 1997 with the exception of one note for $500,000 which was paid off in March 1996. On March 13, 1995 the Trust paid off short-term notes of $5,045,000 with proceeds from the sale of Lakeshore Plaza Shopping Center.\n5. UNSECURED NOTE PAYABLE\nThe Trust obtained a $3 million unsecured note (loan and debenture) bearing interest at 10% on the first $1 million, 17% on the second $1 million and 18.1% on the final $1 million. The note terms called for interest payments of 10% on the first $1 million and 9% on the balance. The remaining interest was accrued, without compounding. This note was paid off on March 13, 1995 from the sale of Lakeshore Plaza Shopping Center.\n6. MORTGAGE LOANS\nOperating properties are pledged as collateral for mortgage loans which have interest rates varying from 9.375% to 10.25% at December 31, 1995. The loans are payable monthly over periods through July 2000. In connection with the sale of one property, the Trust remains the primary obligator on the underlying non-recourse note payable, totaling $1,631,000, which is secured by a first deed of trust on the property sold. The all-inclusive promissory note receivable from the buyer was received by the Trust at the date of sale.\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nMortgage loans mature in future years as follows (see Note 10 regarding repayments subsequent to December 31, 1995):\nTotal interest costs in 1995, 1994 and 1993 were $5,364,000, $8,230,000 and $8,247,000, of which $2,681,000 was capitalized in 1993. Interest paid was $5,364,000, $8,501,000 and $5,317,000, respectively, net of capitalized interest.\nIn 1993 loan commitment fees totaling $1,031,000 were charged to expense. The Trustees determined to forego these loan fees because the foregone commitment required a higher fixed rate of interest as compared with alternative financing available.\n7. COMMERCIAL PROPERTY OPERATING LEASES\nSpace in the Trust's operating properties is leased to tenants under long-term noncancelable operating leases. The lease agreements provide for fixed minimum rentals and generally include provisions for reimbursement of a portion of common area maintenance expenses, property taxes, insurance, and percentage rents. Minimum rentals under these leases at December 31, 1995 are as follows (excluding Menlo Center which was sold on February 29, 1996, see note 10):\nRental revenues in 1995, 1994 and 1993 included $153,000, $196,000 and $188,000 of contingent rentals based on individual tenants' sales volumes.\nFor the years ending December 31, 1995, 1994 and 1993 rental revenues representing 14% in 1995 and 17% in 1994 and 1993, of total revenues were earned from a single tenant at one of the Trust's properties in 1995 and at two of the Trust's properties in 1994 and 1993.\n8. GAIN ON LEASE TERMINATION\nIn December 1994, HomeBase, an anchor tenant at El Portal Shopping Center reached an agreement with the Trust whereby in exchange for a lease termination the Trust accepted a $6,000,000 lease buy-out payment.\nUnder the term of the mortgage loan secured by the property $5,729,000 of this lease buy out was applied towards the principal reduction and $271,000 was applied as a prepayment penalty. In connection with this transaction, the Trust determined that the HomeBase facility became functionally obsolete, therefore the remaining book value of $2,040,000 and associated accrued rents receivable resulting from the straightlining of HomeBase's rent of $383,000 were charged against the lease termination payment resulting in a net gain of $3,577,000.\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. SALE OF LAKESHORE PLAZA\nThe Trust sold the Lakeshore Plaza Shopping Center on March 13, 1995 for a sales price of $31,292,000. The proceeds of this sale after provision for assumption of the existing First Deed of Trust financing ($15,826,000 at March 13, 1995), repayment of second mortgage ($4,000,000), closing costs, escrow holdbacks for supplemental property taxes, vacant spaces and pending tenant improvement allowances, legal fees, transfer taxes and miscellaneous selling expenses, were all used to pay down other short-term notes ($5,045,000) and an unsecured note payable including interest payable ($3,467,000). The loss on sale was recognized in 1994 (see Note 11).\n10. SALE OF MENLO CENTER\nThe Trust sold Menlo Center on February 29, 1996. The sales price was $16,200,000. The buyer assumed the existing financing in the amount of $10,730,102. After payment of closing costs, transfer taxes, real estate commissions and miscellaneous selling expenses, all totalling approximately $550,000, the net proceeds of approximately $4,935,000 were used to repay short-term debt and to provide working capital. Under the terms of the sale contract, the Trust is obligated to subsidize the buyer's net operating income to the extent necessary to assure the buyer of an 8.5% investment yield from the operation of Menlo Center. The Trust's liability in this respect extends to the maturity date of the existing First Trust Deed financing which the buyer assumed in the purchase. This financing expires in 2000.\n11. LOSS OF IMPAIRMENT OF PROPERTY VALUE\nIn 1994, the Trustees decided to reduce the carrying value of two of the Trust's properties to reflect their estimated current market value more accurately. Accordingly, Menlo Center's carrying value was reduced by $3,600,000 to $15,000,000 after depreciation. Lakeshore Plaza Shopping Center's carrying value was reduced by $3,500,000 and an additional $900,000 related to deferred lease commissions and financing costs.\n12. PROPERTY PURCHASE OPTIONS\nOn December 10, 1993, the Trust entered into a purchase and sale agreement (the \"Plaza 580 Agreement\") with Plaza 580 Ltd., pursuant to which the Trust obtained an option to purchase a shopping center located in Livermore, California. On March 10, 1994, the Trust entered into three additional option purchase agreements: (i) with DSL\/Elk Grove, a California joint venture, with respect to a shopping center located in Elk Grove, California (the \"Elk Grove Agreement\"); (ii) with R\/ P Manteca Limited Partnership, a California limited partnership, with respect to Mission Ridge Shopping Center located in Manteca, California (the \"Manteca Agreement\"); and (iii) with DSL\/Fair Oaks, a California joint venture, with respect to Northridge Center located in Fair Oaks, California (the \"Northridge Agreement\").\nPursuant to an agreement dated May 9, 1994 (the \"Plaza 580 Assignment Agreement\"), the Trust assigned its rights under the Plaza 580 Agreement to Western Investment Real Estate Trust (\"WIRET\"), a California real estate investment trust, for the sum of $556,519, adjusted for certain closing costs and prorations. On May 27, 1994, WIRET closed its acquisition of the Trust's rights under the Plaza 580 Agreement and acquired the underlying property. Pursuant to the Plaza 580 Assignment Agreement, the Trust guaranteed the payment of certain rental rates with respect to one empty shop space located at Plaza 580 for a period of 24 months. The Trust also agreed to repay a portion of the purchase price with respect to any of such empty spaces that remain unleased at the end of the 24-month period. All vacant spaces have been leased and at December 31, 1995 there are no vacancies, although the Trust is obligated to pay some rents for spaces in which the tenant's rent start dates are later than their lease commencement dates.\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPursuant to an agreement dated May 11, 1994 (the \"Second Assignment Agreement\"), the Trust assigned its rights as purchaser under each of the Elk Grove Agreement, the Manteca Agreement and the Northridge Agreement to WIRET for $1,804,211, as adjusted for certain closing costs and prorations. On June 7, 1994, the transactions contemplated by the Second Assignment Agreement were consummated. Pursuant to the Second Assignment Agreement, the Trust guaranteed the payment of rent for 24 months for certain empty shop spaces at the Elk Grove and Northridge centers, and agreed to repay to WIRET, at the end of 24 months, a portion of the purchase price applicable to such empty spaces which remain unleased (or leased to tenants that do not meet certain guidelines) as of such 24-month period. The Trust also agreed to pay pro forma rents for certain space at Northridge which space is subject to leases that expire within the first year after closing. At December 31, 1995, all such spaces have been leased. The Trust has some residual rental obligations on newly leased space pending actual occupancy by the tenants.\nDuring 1994, the Trust recorded a net gain of $994,000 and rent guarantee reserve accrual of $390,000, as the result of Plaza 580 Assignment Agreement and the Second Assignment Agreement. In 1995, the Trust increased the reserve by an additional $213,000, accordingly the remaining deferred gain of $203,000 is reflected in accounts payable and other liabilities.\nIn connection with the above transactions, on June 7, 1994, (i) Scotts Valley Plaza, a California limited partnership (\"Scotts\"), granted to the Trust a one-year option to acquire the shopping center commonly known as Scotts Village Plaza and (ii) Scotts Village Phase II, a California limited partnership (\"Scotts II\"), granted a one-year option to the Trust to purchase Scotts Valley Square, both of which are located in Scotts Valley, California. Concurrently with the grant of these options and in connection with the transactions contemplated by the Second Assignment Agreement, the Trust made a loan to Malcolm R. Riley, one of the principals in Scotts and Scotts II, in the amount of $750,000. The loan bears interest at 9% per annum, payable monthly, and the principal is due and payable in 6 years. Simultaneously, the Trust made a loan to Russell R. Pratt, another of the principals in Scotts and Scotts II, in the amount of $500,000. That loan bears interest at 8% per annum, payable monthly, and the principal is due and payable in 6 years. Each of these loans is secured by the borrower's respective partnership interests in Scotts and Scotts II. The Trust also made a loan in the amount of $75,000 to Scotts, which bears interest at 8.6% per annum (payable monthly), is due in 6 years and is secured by a second deed of trust on Scotts Village Plaza.\n13. DISTRIBUTIONS TO SHAREHOLDERS\nDuring the second quarter of 1993, distributions were suspended. Except for a special distribution in December of 1993, distributions have remained suspended. Distributions during 1993 totaled $.205 per share and resulted in a nontaxable return of capital reportable by shareholders on their individual tax returns.\n14. REINCORPORATION TRANSACTIONS\nThe Trustees have formed Pacific Real Estate Investment Trust, Inc. (the \"Successor Company\") as a Maryland corporation for the purpose of effecting a reincorporation (the \"Reincorporation Transactions\"). The Successor Company has no material assets or liabilities. The Trust held a Special Meeting of the Shareholders on March 18, 1994, at which time the Reincorporation Transactions were approved by the Trust's shareholders. If completed, the Reincorporation Transactions would cause the Trust to transfer all of its assets and assign and delegate all of its enforceable liabilities and obligations to the Successor Company in exchange for 1,235,690 shares of Common Stock, $.01 par value (the \"Common Shares\"), of the Successor Company, and the Trust thereafter would liquidate, distributing the Common Shares to the shareholders of the Trust in cancellation of their shares of beneficial interest, in the ratio of one Common Share for each three shares of beneficial interest held of record by the shareholders on the record date for the liquidating distribution. The one-for-three\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) exchange ratio would in effect result in a reverse split of the currently outstanding shares of beneficial interest, in order to facilitate subsequent financing transactions by the Successor Company. As part of its assumption of the Trust's obligations, the Successor Company would commit to issue up to an additional 36,283 Common Shares in the event of exercise (during a two-year period beginning January 1, 1995) of warrants issued by the Trust in January 1992, covering an aggregate of 108,848.5 shares of beneficial interest.\nExpenses incurred in connection with the Reincorporation Transactions are reflected as reincorporation expenses in the accompanying consolidated statement of operations.\nAs a result of the present conditions of the capital markets, the Trust does not currently expect to effect the Reincorporation Transactions. This could change in the future if the reincorporation would facilitate the Trust's objectives.\n15. EXPENSES OF PROSPECTIVE OFFERING\nThe Trust was involved in discussions with underwriters regarding a potential offering of the Successor Company's Common Shares and\/or debt securities to public or private purchasers, should the Reincorporation Transactions be consummated. The expenses incurred in connection with such a prospective offering are reflected in the accompanying consolidated statements of operations as expenses of prospective offering as the ultimate timing and form of such transaction, if any, is not determinable.\n16. COMMITMENTS AND CONTINGENCIES\nThe Trust is obligated on four land leases. The first lease extends through 2012 and requires minimum annual payments of $26,000, plus 8% of the property's rental revenue in excess of $325,000. The second lease extends through 2024 and requires minimum annual payments of $40,000, plus 12% of the property's annual rental revenue in excess of $333,000. The third lease extends through 2028, has ten consecutive five-year renewal options, an option to purchase upon death of the ground lessor, and requires minimum annual payments of $60,000 prior to an adjustment for inflation. As discussed in Note 10, Menlo Center was sold on February 29, 1996 and the Trust is no longer obligated under this third land lease which is assumed by the buyer of Menlo Center. The fourth lease extends through 2045 and contains a dual option for the Trust to acquire fee title and for the ground lessor to \"put\" the property to the Trust. The option for the Trust to acquire commences upon the death of one of the ground lessors and lasts for five years from said date. The option for the ground lessors to \"put\" the property to the Trust incepts March 1, 1998 and survives through the term of the ground lease. The annual rent is $184,400 with annual increases of 4%. The purchase price under the options is the minimum ground rent capitalized at a 10% yield. Land lease expense totaled $400,000 in 1995, $236,000 in 1994 and $217,000 in 1993.\nIn connection with the refinancing efforts at the King's Court Shopping Center in 1994, the Kingsco partnership initiated an environmental audit of the property. The Phase I and II stages of the environmental audit identified certain dry cleaning solvents which had contaminated the ground water beneath the shopping center. Currently, a Phase III plan of remediation has been prepared with a proposed plan of action for clean-up of the contamination expected to be completed in approximately two years or longer. The cost to Kingsco for the clean-up is estimated to be $632,000 of which $503,000 has been expended in 1994 and 1995. The Trust was not a partner of Kingsco at the time the contamination occurred, and intends to look to the seller of the Trust's 40% interest in Kingsco, Kingsco's insurance carriers at the time of the contamination, the other partners of Kingsco and the entity that caused the contamination for payment of the clean-up costs. The Trust believes that the representations and warranties made by the seller in the agreement pursuant to which the Trust acquired its partnership interest give the Trust a cause of action against the seller for the clean-up costs. The interim plan of remediation has been approved by the Regional Water Quality Control\nPACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Board and remediation has commenced. Accordingly, $129,000 and $632,000 is reflected in the accompanying consolidated balance sheet at December 31, 1995 as Other Liabilities and Other Assets respectively.\nIn another, unrelated, environmental audit of the gasoline service station pad (\"Exxon Pad\") at King's Court Shopping Center, the Phase I and II work identified gasoline and possibly other service station by-products in the soil underneath the station and its pumps. Exxon Corporation has assumed financial and legal responsibility for the hazardous materials and remediation of the Exxon Pad. The environmental firm responsible for maintaining and analyzing the data from various monitoring wells on the Pad continues to report to Menlo Management Company and governmental authorities on a quarterly basis. Remediation efforts have commenced and include both vapor extraction and \"pump and treat\" activities, depending upon the location of the materials in the soil and water.\nIn connection with redevelopment efforts at El Portal Shopping Center, dry cleaning solvents have been discovered to have contaminated the ground water beneath the shopping center, arising from dry cleaning operations which probably preceded the Trust's ownership of the property. At the present time, the site characterization and negotiation with regulatory authorities are proceeding. The ultimate exposure to the Trust cannot yet be determined, however, based on current knowledge it is not expected to have a material adverse effect upon the Trust's financial position.\n17. SHAREHOLDERS' EQUITY\nIn January 1992, the Trust began a Rights Offering, which entitled each shareholder of record on December 31, 1991, to purchase an additional share in the Trust for each share owned. The rights were exercisable at $13.68 per share through March 20, 1992 when the offering expired. In addition, each right was accompanied by one warrant which entitles the owner to purchase an additional one-half share of beneficial interest for $7.00 during a two-year period beginning January 1, 1995. (This is equivalent to a purchase price of $14.00 for each whole share.) At December 31, 1995, 217,697 warrants, covering 108,848.5 shares of beneficial interest, were issued and outstanding.\nSCHEDULE XI\nPACIFIC REAL ESTATE INVESTMENT TRUST\nCOMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION\nDECEMBER 31, 1995\nSee notes on following page\nSCHEDULE XI\nPACIFIC REAL ESTATE INVESTMENT TRUST\nCOMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION\nDECEMBER 31, 1995\nNotes:\nSCHEDULE XII\nPACIFIC REAL ESTATE INVESTMENT TRUST MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1995\nSCHEDULE XII\nPACIFIC REAL ESTATE INVESTMENT TRUST MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1995\nNotes:\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\nMr. Wilcox Patterson, age 55, was elected a Trustee in 1980, and President of the Trust in May 1985. Mr. Patterson is a director of Grove Farm Company, Inc., a sugar plantation and real estate development corporation located on Kauai in the Hawaiian Islands. He is also an independent real estate manager and investor. Mr. Patterson served as Regional Vice President of Northern California Savings and Loan Association between April 1979 and September 1980. Prior to that appointment, he served as a Vice President and Manager of the Menlo Park branch of Northern California Savings and Loan Association. In these capacities, he has gained considerable experience in real estate financing.\nMr. John H. Hoefer, age 80, was elected a Trustee in 1982 and Vice President in June 1988. Mr. Hoefer is a Rear Admiral, United States Naval Reserve. He was founder of Hoefer, Dieterich and Brown, Inc., an advertising agency in San Francisco, and was its Chairman at the time of its merger with Chiat\/Day, Inc. in 1979. He was also a Chairman of Chiat\/Day, Inc. (San Francisco).\nMr. Harry E. Kellogg, age 72, has served as a Trustee and Treasurer of the Trust since the date of its inception and was an initial investor. Mr. Kellogg was elected Executive Vice President of the Trust on December 5, 1978 and was President from February 1980 to May 1985. Mr. Kellogg has served as Trustee of the Seattle Retail Clerks Union Pension Fund, the GEMCO Retail Clerks Union Pension Trust Fund and is the former Vice President Finance and Secretary of Leslie Salt Co., a salt production company, with extensive real estate holdings in the San Francisco Bay Area. At Leslie Salt Co., from which he retired in 1979, Mr. Kellogg was responsible for the financial, administrative and tax matters of the company.\nMr. William S. Royce, age 77, has been an investor in the Trust since 1964 and was elected a Trustee in 1980 and Secretary on June 15, 1988. Mr Royce is an independent management consultant specializing in business planning and regional economic development. He retired in 1984 from SRI International (Stanford Research Institute). Mr. Royce also is a director of Diablo Research Corporation and Treasurer of the Silicon Valley Economic Roundtable.\nMr. Robert C. Gould, age 51, was elected a Trustee and appointed Vice President in June 1989 and has previously served as a Vice President and Secretary of the Trust from 1985 through 1988. Mr. Gould is President and a director of Menlo Management. Mr. Gould is the son-in-law of Charles R. Collier and, together with his wife, owns 83% of Menlo Management. Prior to his employment with Menlo Management, he was a real estate analyst with Shell-Mex\/B.P. Ltd., a subsidiary of the Royal Dutch\/Shell Group of Companies. He is a registered NASD principal and securities representative, and a licensed California real estate broker.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDuring the fiscal year ended December 31, 1995, there were no officers and\/or Trustees whose aggregate direct remuneration exceeded $100,000. With respect to the President of the Trust, aggregate direct remuneration, consisting of fees for services performed as a Trustee, paid during the last three fiscal years was as follows:\nDuring fiscal 1995, aggregate direct remuneration paid to all Trustees and officers as a group (five persons) was $26,400, all of which consisted of fees for services performed as Trustees. Trustees are paid a monthly fee of $200 for their services and a fee of $200 per Trustee meeting attended. Committee members receive $100 per committee meeting attended. The Trust has an Audit Committee, which makes recommendations concerning the engagement of independent public accountants, reviews the plans and results of the audit engagement and reviews the adequacy of the Trust's internal accounting controls, and a Compensation Committee.\nNone of the Trustees or executive officers of the Trust has failed to file, on a timely basis, reports required to be filed pursuant to Section 16 of the Securities Exchange Act of 1934, as amended.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth as to each of the Trustees the number of Trust Shares owned, directly or indirectly, by him on December 31, 1995. No person is known by the Trust to be the beneficial owner of more than five percent of the Trust's outstanding Trust Shares. Each person identified in the table has sole voting and investment power with respect to all Trust Shares shown as beneficially owned by such person, except as otherwise set forth in the notes to the table. Unless otherwise indicated, the address of each person listed below is 1010 El Camino Real, Suite 210, Menlo Park, California 94025.\n- ------------------------ (1) Based on 3,706,845 Trust Shares outstanding as of December 31, 1995, and warrants to purchase 108,848.5 Trust Shares held by certain shareholders as of December 31, 1995.\n(2) Member of Audit Committee.\n(3) Member of Compensation Committee.\n(4) Voting and investment power are shared.\n(5) Includes 21,584 Trust Shares owned by members of Mr. Patterson's family as to which Mr. Patterson disclaims any beneficial ownership interest.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nINCENTIVE COMPENSATION PLAN\nFor 1990 and thereafter, the Trustees have approved an incentive compensation plan for Robert C. Gould, Trustee and Vice President of the Trust. The annual incentive bonus under the agreement will be determined as follows: 7.5% of the difference between \"operating income\" and 8.6% \"adjusted average equity.\" \"Operating income\" is defined as income from operations before depreciation, gain on property sales, and deductions for investment advisory fee, but after deduction for amortization of deferred costs. \"Adjusted average equity\" is defined as the average of the year's beginning and ending shareholders' equity plus accumulated depreciation. Incentive compensation will be paid in stock, valued per share at the time the compensation is paid at a price equal to the net proceeds per share received by the Trust in sales of shares to the public. The Trustees intend to review and modify if appropriate for each succeeding year, the percentage return on adjusted average equity used in the above calculation so that it is comparable to rates of return being earned by competing real estate entities. For 1995, 1994 and 1993, the incentive compensation program resulted in no bonus payment to Mr. Gould.\nINVESTMENT ADVISOR, PROPERTY MANAGEMENT AGREEMENTS AND SALES SUPPORT SERVICES AGREEMENT\nCollier Investment acts as both investment advisor and real estate broker for the Trust. Menlo Management manages the Trust's properties. Until its dissolution in 1995, Presco provided support and capital fund raising services and acted as a crossing agent for shareholders wishing to purchase existing Trust shares. Collier Investment is a proprietorship of Russell Collier. Menlo Management is 17% owned by Mr. Collier and 83% owned by Robert C. Gould, a Trustee and Vice President of the Trust. See Note 2 of Notes to Consolidated Financial Statements for a description of the compensation paid to Collier Investment and Menlo Management during the fiscal year ended December 31, 1995. Beginning on January 1, 1994, a revised investment advisory agreement became effective, which provides for a base advisory fee to Collier Investment of 1\/5 of 1% of gross Trust assets. In July 1994 at Mr. Collier's request this fee was reduced by 50% to 1\/10 of 1% of gross Trust assets retroactive to January 1, 1994. Mr. Collier also voluntarily waived his right to receive any real estate brokerage commissions as a result of the sales of Lakeshore Plaza Shopping Center, which was sold on March 13, 1995, and Menlo Center, which was sold on February 29, 1996.\nLOANS FROM AFFILIATES OF MENLO MANAGEMENT COMPANY\nDue to the shortage or unavailability of equity financing, the Trust obtained short-term financing at competitive rates to provide working capital and to complete the development of its Lakeshore Plaza Shopping Center through a group of private limited partnerships. Menlo Management Company serves as general partner in these partnerships and the Notes are secured by mortgages on the Trust's properties or pledge of Promissory Notes owned by the Trust.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K:\n(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. See Item 8 of this Annual Report or Form 10-K for Consolidated Financial Statements for the Trust, Notes thereto, and Consolidated Supplemental Schedules. A Table of Contents to Consolidated Financial Statements and Consolidated Supplemental Schedules is included in Item 8 and incorporated herein by reference.\n(b) REPORTS ON FORM 8-K. Report on Form 8-K was filed by the Trust on March 28, 1995. In 1996, Report on Form 8-K was filed by the Trust on March 14, 1996.\n(c) Exhibits:\nThe exhibits required by Item 601 of Regulation 5-K have been filed with previous reports by the registrant and are incorporated by reference 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.\nPACIFIC REAL ESTATE INVESTMENT TRUST\nRegistrant\nBy: \/s\/ WILCOX PATTERSON\n----------------------------------- Wilcox Patterson, PRESIDENT (PRINCIPAL EXECUTIVE OFFICER)\nBy: \/s\/ HARRY E. KELLOGG\n----------------------------------- Harry E. Kellogg, TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nDate: March 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 dates indicated.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPACIFIC REAL ESTATE INVESTMENT TRUST\nRegistrant\nBy:\n----------------------------------- Wilcox Patterson, PRESIDENT (PRINCIPAL EXECUTIVE OFFICER)\nBy:\n----------------------------------- Harry E. Kellogg, TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nDate: March 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 dates indicated.","section_15":""}
{"filename":"311173_1995.txt","cik":"311173","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nORGANIZATION - ------------\nUniversity Real Estate Partnership V (the \"Partnership\" or \"Registrant\") was organized on August 12, 1977, as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is University Advisory Company (\"UAC\" or the \"General Partner\"), a California general partnership. Southmark Commercial Management, Inc. (\"SCM\"), and Southmark Investors, Inc. (\"SII\"), both wholly-owned subsidiaries of Southmark Corporation (\"Southmark\"), are the two general partners of UAC. The principal place of business for the General Partner is 2711 LBJ Freeway, Suite 950, Dallas, Texas 75234.\nOn January 6, 1978, a Registration Statement on Form S-11 was declared effective by the Securities and Exchange Commission pursuant to which the Partnership offered for sale an aggregate of $25,000,000 Income and Growth\/Shelter Limited Partnership Units. The Limited Partnership 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 Limited Partnership Units closed on July 13, 1978, with 34,800 Limited Partnership Units sold at $500 each for gross proceeds of $17,400,000. Of the Limited Partnership Units sold, 347 have subsequently been repurchased by the Partnership. Of the 34,353 Limited Partnership Units currently outstanding, 17,733 are Income Units and 16,620 are Growth\/Shelter Units.\nOn March 9, 1993, Southmark and several of its affiliates (including the General Partner) entered into an Asset Purchase Agreement with SHL Acquisition Corp. III, a Texas corporation, and its permitted assigns (collectively \"SHL\") to sell various general and limited partnership interests owned by Southmark and its affiliates, including the general partnership interest of the Partnership. On December 16, 1993, Southmark and SHL executed the Second Amendment to Asset Purchase Agreement whereby SHL acquired an option to purchase the general partnership interest of the Partnership, rather than purchase the partnership interest itself. On the same date, SHL assigned its rights under the amended Asset Purchase Agreement to Hampton Realty Partners, L.P., a Texas limited partnership (\"Hampton\") and Hampton and Southmark affiliates also entered into an Option Agreement whereby Hampton acquired the right to purchase the option assets, including the general partnership interest of the Partnership, subject to the approval of the limited partners. On April 20, 1994, Insignia Financial Group, Inc., a Delaware corporation, and certain of its affiliates (collectively \"Insignia\") entered into an Option Purchase Agreement with Hampton to acquire Hampton's rights to solicit proxies from the Limited Partners seeking their consent to Hampton becoming the general partner of the Partnership. On August 8, 1994, the Insignia contract was terminated. On December 30, 1994, Hampton entered into an Assignment and Assumption of Option Agreement with JKD Financial Management, Inc. (\"JKD\"), a Texas corporation, whereby, among other things, JKD obtained the right to acquire Hampton's rights to proxy into the Partnership subject to approval of the Limited Partners. As of the date hereof, JKD has not exercised that right.\nEffective as of December 14, 1992, the Partnership entered into a Portfolio Services Agreement and a Property Management Agreement with Hampton UREF Management, Ltd. (\"Hampton UREF\"), Texas limited partnership, pursuant to which Hampton UREF began providing management for the Partnership's properties and certain other portfolio services. The operations of the Partnership's properties were managed by Hampton Management, Inc. (formerly SHL Management, Inc.) through a subcontract agreement with Hampton UREF. From April 20, 1994 to August 8, 1994, the Partnership and its properties were managed by Insignia pursuant to a Property Management Subcontract Agreement with Hampton UREF. As of August 8, 1994, the properties only were managed by an affiliate of Insignia under a Property Management Agreement directly with the Partnership.\nAs of December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Agreement with JKD pursuant to which JKD oversees the management of the Partnership.\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS Holdings, Inc. (\"OS\"), a Texas corporation, and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OS General Partner Company (\"OSGPC\"), a Texas corporation, for JKD and to\nextend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership's primary business is to own, operate and ultimately dispose of its portfolio of income-producing real properties for the benefit of its partners. The Partnership has liquidated many of its properties and is currently operating two income-producing properties, Glasshouse Square, and through its investment in Washington Towne Apartments, LLC, Washington Towne Apartments. In the course of liquidating certain of its properties, the Partnership has taken partial consideration in the form of notes receivable. Currently, a part of the Partnership's cash collections and revenue relates to one remaining note receivable.\nGlasshouse Square Environmental Issue:\nDuring 1993, it was determined in a Phase II Environmental Audit that the soils and groundwater in the Garcia's Tract and possibly part of the Glasshouse Square parking lot, located in the Northeastern most corner of Glasshouse Square property, contain elevated levels of certain petroleum products. During 1994 and 1995, the Partnership worked with counsel and environmental engineers in connection with further investigation of the alleged leaking of petroleum products from underground storage tanks and with San Diego County officials to determine the necessary level of clean-up. The Partnership also obtained a health risk assessment to ensure that the gasoline constituents beneath the Garcia's Tract are not emitting harmful vapors inside the building. The health assessment was returned \"non detect\" meaning no such harmful vapors were detected. In 1996, additional testing was conducted by the environmental engineers who determined there was no \"free product\" at the portions of the site that were tested and, also, no human health risk exists at this time. Management does not believe that the County of San Diego will take further action. Therefore, this situation should not have a material effect on the Partnership.\nBusiness Plan:\nThe business of the Partnership is not seasonal. The Partnership's anticipated plan of operation for 1996 is to preserve or increase gross revenue whenever possible and to maintain or decrease property operating expenditures whenever possible, while at the same time making whatever capital expenditures are reasonable under the circumstances in order to preserve and enhance the value of its properties. Whenever the General Partner deems it in the Partnership's best interest, the Partnership will sell its properties and will service any note receivable secured by the properties. In addition, if long-term financing for the Partnership properties becomes available under favorable terms, the Partnership may refinance its properties. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nFrom December 14, 1992 through April 20, 1994, Hampton UREF and its affiliates managed the day-to-day operations of the Partnership and its properties under terms of Property Management and Portfolio Services Agreements. From April 20, 1994 through December 31, 1994, the Partnership's properties were managed by Insignia or an affiliate, first pursuant to a Property Management Subcontract Agreement with Hampton UREF and then a Property Management Agreement with the Partnership itself. On December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Subcontract Agreement with JKD.\nCompetitive Conditions:\nSince the principal business of the Partnership is to own and operate real estate, the Partnership is subject to all of the risks incidental to ownership of real estate and interests therein, many of which relate to the illiquidity of this type of investment. These risks include changes in general or local economic conditions, changes in supply or demand for competing properties in an area, changes in interest rates and availability of permanent mortgage funds which may render the sale or refinancing of a property difficult or unattractive, changes in real estate and zoning laws, increases in real property tax rates and federal or local economic or rent controls. The illiquidity of real estate investments generally impairs the ability of the Partnership to respond promptly to changes in these circumstances. The Partnership competes with numerous established companies, private investors (including foreign investors), real estate investment trusts, limited partnerships and other entities (many of which have greater resources than the Partnership and broader experience than the General Partner) in connection with the acquisition, sale, financing and leasing of properties.\nIt appears that the Partnership's original schedule for meeting its objectives of, among other things, preservation of capital, current cash distributions and capital gains through potential appreciation of Partnership property is unlikely to be achieved. The Partnership has not been able to liquidate its property within the originally expected time frame of from five to ten years after its acquisition (i.e. between 1983 and 1988). The General Partner now expects to hold the Partnership's real estate investments until such time as the performance of the Partnership's investment improves and permits the Partnership to achieve its capital preservation and capital gains objectives. There can be no assurance, however, that the property's value will increase over an extended holding period.\nSOUTHMARK BANKRUPTCY - --------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership nor its 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 include Southmark's interests in the General Partner, are being sold or liquidated for the benefit of creditors.\nBecause neither the Partnership nor the General Partner were included in the Southmark bankruptcy proceedings, there has been no direct effect on the Partnership's operations during the bankruptcy period or resulting from confirmation of the plan. Ultimate decision-making authority with respect to the operations of the Partnership remains with the General Partner until such time as the Limited Partners approve a substitute general partner.\nSALE OF GENERAL PARTNER INTEREST - --------------------------------\nAs a result of Southmark's bankruptcy and its plan to liquidate all of its assets, the General Partner concluded that it was in the best interest of the Partnership to seek, as its qualified replacement as general partner, an entity which intends to remain involved in the management of real estate and real estate limited partnerships.\nOn March 9, 1993, Southmark and several of its affiliates (including the General Partner) entered into an Asset Purchase Agreement with SHL to sell various general and limited partnership interests owned by Southmark and its affiliates, including the general partnership interest of the Partnership. On December 16, 1993, Southmark and SHL executed the Second Amendment to Asset Purchase Agreement whereby SHL acquired an option to purchase the general partnership interest of the Partnership, rather than purchase the partnership interest itself. On the same date, SHL assigned its rights under the amended Asset Purchase Agreement to Hampton and Hampton and Southmark affiliates also entered into an Option Agreement whereby Hampton acquired the right to purchase the option assets, including the general partnership interest of the Partnership subject to the approval of the Limited Partners. On April 20, 1994, Insignia entered into an Option Purchase Agreement with Hampton to acquire Hampton's rights to solicit proxies from the Limited Partners seeking their consent to Hampton becoming the general partner of the Partnership. On August 8, 1994, the Insignia contract was terminated. On December 30, 1994, Hampton entered into an Assignment and Assumption of Option Agreement with JKD, whereby, among other things, JKD obtained the right to acquire Hampton's rights to proxy into the Partnership subject to the approval of the Limited Partners. As of the date hereof, JKD has not exercised that right.\nEffective as of December 14, 1992, the Partnership entered into a Portfolio Services Agreement and a Property Management Agreement with Hampton UREF pursuant to which Hampton UREF began providing management for the Partnership's properties and certain other portfolio services. The operations of the Partnership's properties were managed by Hampton Management, Inc. (formerly SHL Management, Inc.) through a subcontract agreement with Hampton UREF. From April 20, 1994 to August 8, 1994, the Partnership and its properties were managed by Insignia pursuant to a Property Management Subcontract Agreement with Hampton UREF. As of August 8, 1994, the properties were managed by an affiliate of Insignia under a Property Management Agreement directly with the Partnership.\nAs of December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Agreement with JKD pursuant to which JKD oversees the management of the Partnership.\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OSGPC for JKD and to extend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nDescription of Real Estate:\nThe following table sets forth the investment portfolio of the Partnership at December 31, 1995. It is the opinion of management that both properties are adequately covered by insurance. The property taxes for Washington Towne Apartments and Glasshouse Square Shopping Center totaled $39,240 and $93,897, respectively, in 1995. The mortgage notes payable totaled $10,674,931 at December 31, 1995 for Washington Towne Apartments and Glasshouse Square Shopping Center. A full detail of each mortgage is described in Item 8 - \"Note 7 - Mortgage Notes Payable\".\nGlasshouse Square - -----------------\nThe Glasshouse Square Shopping Center, along with the Garcia's Tract, are currently owned by the Partnership subject to a first and second lien deeds of trust as set forth more fully in Item 8 - \"Note 7 - Mortgage Notes Payable\". The section of land commonly referred to as the Garcia's Tract, located in the Northeastern most corner of the Glasshouse Square property, was leased to the Partnership through September 1993. The Partnership purchased a 50% undivided interest in the Garcia's Tract on April 14, 1989, and purchased the remaining 50% undivided interest from the Stallard Family Trust on September 16, 1993.\nAt December 31, 1995, the mortgages payable for Glasshouse Square had unpaid principal amounts of $7,435,834 and $1,492,431 both of which are due December 2000 (see Item 8 - \"Note 7 - Mortgage Notes Payable\").\nOn January 17, 1995, the lender filed a notice of default in San Diego County related to the Glasshouse Square mortgages payable. On March 27, 1995, the mortgages were modified and a forbearance agreement was executed\nwhereby the lender agreed to discontinue foreclosure proceedings. Additionally, on March 27, 1995, the Partnership obtained from this same lender a $400,000 line of credit due in December 2000 (see Item 8 - \"Note 7 - Mortgage Notes Payable\").\nDuring 1993, it was determined in a Phase II Environmental Audit that the soils and groundwater in the Garcia's Tract and possibly part of the Glasshouse Square parking lot, located in the Northeastern most corner of Glasshouse Square property, contain elevated levels of certain petroleum products. In 1994 and 1995, the Partnership worked with counsel and environmental engineers in connection with further investigation of the alleged leaking of petroleum products from underground storage tanks and with San Diego County officials to determine the necessary level of clean-up. The Partnership also obtained a health risk assessment to ensure that the gasoline constituents beneath the Garcia's Tract are not emitting harmful vapors inside the building. The health assessment was returned \"non detect\" meaning no such harmful vapors were detected. In 1996, additional testing was conducted by the environmental engineers who determined there was no \"free product\" at the portions of the site that were tested and, also, no human health risk exists at this time. Management does not believe that the County of San Diego will take further action. Therefore, this situation should not have a material effect on the Partnership.\nWashington Towne Apartments - ---------------------------\nThe mortgage payable for Washington Towne Apartments, LLC had unpaid principal amount of $1,746,666 at December 31, 1995. In September 1995, the Partnership obtained a mortgage loan payable in the amount of $1,750,000 from a new lender. In order to preserve the Partnership's ownership interest in the Washington Towne Apartments and in order to satisfy the new lender's structural requirements with respect to the refinancing of the mortgage note payable, the Partnership contributed the property on September 13, 1995 to an affiliated entity, Washington Towne Apartments, LLC, a Georgia limited liability company. The Partnership is the owner of all the capital stock of Washington Towne, Inc. The Partnership is the 99% member and Washington Towne, Inc. is the 1% managing member of Washington Towne Apartments, LLC. Therefore, the Partnership effectively retained a 100% interest in the property. In connection with the contribution of the property to Washington Towne Apartments, LLC, the lender provided sufficient funds to satisfy the matured loan obligation and to provide for certain property improvements. Property improvements have been completed prior to the end of the first quarter 1996 and have significantly enhanced the value of the property (see Item 8 - \"Note 7 - Mortgage Notes Payable\").\nOperating Data:\nOccupancy Rates for the Years 1991-1995\nThe following table shows tenants in Glasshouse Square occupying ten percent or more of the rentable square footage and their lease provisions:\nDuring 1995, Silo California, a major tenant at Glasshouse Square, ceased retail operations. Litigation has been filed by the Partnership. See Item 3","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nThe Partnership filed a lawsuit styled University Real Estate Partnership V v. --------------------------------------- Silo California, Inc. No. 692441 (Superior Court of the State of California) to - --------------------- recover possession of leased premises and damages related to breach of a lease at Glasshouse Square Shopping Center. The Partnership obtained an unlawful detainer judgment against the defendant on October 25, 1995, in the amount of $41,757.\nThe Partnership filed a claim against Silo California, Inc. on February 9, 1996, in a bankruptcy proceeding entitled In re: Silo California, Inc., a California ------------------------------------------- corporation, No. 95-1581 (U.S. Bankruptcy Court, District of Delaware), to - ----------- recover on the $41,757 unlawful detainer judgment. A second claim in the amount of $312,992 for additional damages related to breach of the lease was filed on February 20, 1996 against Silo California, Inc. and an identical $312,992 claim was filed against Silo Holdings, Inc. in In re: Silo Holdings, Inc., No. 95- -------------------------- 1578 (U.S. Bankruptcy Court, District of Delaware) on February 20, 1996. All three claims are still pending.\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(C) Cash distributions from the Partnership were suspended in 1992 and the Partnership is continuing to experience negative cash flows from operations as of December 31, 1995. Cash distributions from operations totaled $265,463 to the Income Unit Holders, $475,684 to the Growth\/Shelter Unit Holders and $64,447 to the General Partner in 1991. Cumulative distributions through December 31, 1995, were $15,812,536, $1,786,307, and $590,957 to the Income, Growth\/Shelter, and General Partners, respectively. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for discussion of distributions and likelihood of the reinstatement of 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 consolidated financial statements and notes thereto appearing in Item 8.\nNet income (loss) per Limited Partnership Unit is computed by dividing net income (loss) allocated to the Limited Partners by the weighted average number of Limited Partnership Units outstanding during the year. Per unit information has been computed based on 34,353 Limited Partnership Units outstanding in 1995 and 34,453 Limited Partnership Units outstanding in 1994, 1993, 1992, and 1991.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------- ----------------------------------------------------------------------- OF OPERATIONS -------------\nFINANCIAL CONDITION - -------------------\nThe Partnership was formed in 1977 to acquire, operate and ultimately dispose of a diversified portfolio of income-producing real property. Five of the Partnership's properties were sold and a sixth was deeded to the lender in cancellation of indebtedness in 1985, a seventh property was sold in 1986, and another in 1987. The Partnership received partial consideration from the sale of certain properties in the form of notes receivable. The Partnership held one note receivable (secured by the Bank of San Pedro Office Building) and operated two income-producing properties as of December 31, 1995.\nIn March 1994, the borrower on the Bank of San Pedro note receivable defaulted on the note and the Partnership began to contemplate foreclosure proceedings. In June 1994, the borrower signed over the deed in lieu of foreclosure on the property as a result of a Settlement Agreement. On July 20, 1995, the Partnership sold the Bank of San Pedro Office Building (see Item 8","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- --------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Partners of University Real Estate Partnership V:\nWe have audited the accompanying consolidated balance sheets of University Real Estate Partnership V as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' equity (deficit) and cash flows for the years then ended. 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 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.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of University Real Estate Partnership V 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.\n\/s\/ Wallace Sanders & Company WALLACE SANDERS & COMPANY\nDallas, Texas March 28, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Partners of University Real Estate Partnership V:\nIn our opinion, the accompanying statements of operations, of partners' equity and of cash flows for the year ended December 31, 1993 present fairly, in all material respects, the results of operations and cash flows of University Real Estate Partnership V for the year ended December 31, 1993, 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 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 financial statements of University Real Estate Partnership V for any period subsequent to December 31, 1993.\n\/s\/ Price Waterhouse, LLP PRICE WATERHOUSE, LLP\nDallas, Texas August 4, 1994\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENT OF PARTNERS' EQUITY (DEFICIT)\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nNet Increase (Decrease) in Cash and Cash Equivalents\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nReconciliation of Net Loss to Net Cash (Used in) Provided by Operating Activities\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:\nThe following noncash transactions occurred in 1995:\nOn March 31, 1995, the Partnership converted $250,000 of accrued liabilities into a note payable to Imperial Bank secured by Washington Towne Apartments second lien. On September 13, 1995, the Partnership paid all outstanding principal and accrued interest as a result of the refinancing of the Washington Towne Apartments.\nOn July 20, 1995 the Partnership sold the Bank of San Pedro Office Building for $1,350,000. The Partnership received, as partial consideration, a note receivable for $350,000. At year end a $100,000 provision for loss was recorded to reduce the carrying value of the Bank of San Pedro Office Building note receivable to $250,000 after the borrower defaulted on the note during the first quarter of 1996. Even though the default situation has been cured, the provision for loss was recorded in the event of any future complications with the borrower.\nThe mortgage payable on the Washington Towne Apartments matured in June 1995. In September 1995, Washington Towne, L.L.C., obtained a mortgage loan payable in the amount of $1,750,000 from a new lender. In connection with this refinancing, the lender included in the mortgage loan principal balance the payment of borrowing costs, required escrows, property taxes, interest, and the payoff of two mortgage notes payable secured by the Washington Towne Apartments. The following table represents the components of this refinancing:\nThe following noncash transactions occurred in 1994:\nOn June 20, 1994 the Partnership consummated a Settlement Agreement with the borrower on the Bank of San Pedro Office Building note receivable, whereby the Partnership received title to the Bank of San Pedro Office Building in lieu of foreclosure.\nThe note receivable from the borrower was retired and the property was placed on the Partnership books at the net note receivable balance, which approximated net realizable value, plus the value of certain other assets and liabilities acquired on the date of repossession. The following table represents the components of the cost of the repossessed real estate:\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES (CONTINUED):\nIn June 1994, Southmark paid off the first lien mortgage on the Bank of San Pedro Office Building. Consequently, the Partnership had a 90-day promissory note payable to Southmark bearing interest at 10%, secured by a first lien deed of trust, assignment of rents, and security agreement on the Bank of San Pedro Office Building, with all outstanding principal and accrued interest due on September 30, 1995, as a result of two maturity date extensions. The initial principal balance of this note was $877,000. At every maturity date extension, the Partnership incurred a fee in the amount of $78,075 in accordance with the note agreement. In 1994, the extension fees totaling $156,150 and all accrued interest were added to the principal balance in accordance with the note agreement. At December 31, 1994, the principal balance (which included both extension fees and accrued interest) was $1,086,554.\nThe Las Oficinas note receivable was reduced in 1994 to reflect the sale of the Las Oficinas note receivable in April 1995 for $750,000.\nNote receivable $ 1,100,000 Loss on write-down to net realizable value (350,000) -------------\nNet realizable value $ 750,000 =============\nPrior to that sale, certain letters of commitment were entered into in 1994 that essentially modified the Las Oficinas note receivable and related underlying mortgage payable. These transactions resulted in a loss on modification of note receivable in the amount of $530,695.\nSee accompanying notes to consolidated financial statements.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------\nOrganization - ------------\nUniversity Real Estate Partnership V (the \"Partnership\") was organized in 1977, as a limited partnership under the provisions of the California Uniform Limited Partnership Act as then in effect. The general partner of the Partnership is University Advisory Company (\"UAC\" or the \"General Partner\"), a California general partnership. Southmark Commercial Management, Inc. (\"SCM\"), and Southmark Investors, Inc. (\"SII\"), both wholly-owned subsidiaries of Southmark Corporation (\"Southmark\"), are the two general partners of UAC. The Partnership was formed to acquire, operate and ultimately dispose of a diversified portfolio of income-producing property.\nOn March 9, 1993, Southmark and several of its affiliates (including the General Partner) entered into an Asset Purchase Agreement with SHL Acquisition Corp. III, a Texas corporation, and its permitted assigns (collectively \"SHL\") to sell various general and limited partnership interests owned by Southmark and its affiliates, including the general partnership interest of the Partnership. On December 16, 1993, Southmark and SHL executed the Second Amendment to Asset Purchase Agreement whereby SHL acquired an option to purchase the general partnership interest of the Partnership, rather than purchase the Partnership interest itself. On the same date, SHL assigned its rights under the amended Asset Purchase Agreement to Hampton Realty Partners, L.P., a Texas limited partnership (\"Hampton\"). Hampton and Southmark affiliates also entered into an Option Agreement whereby Hampton acquired the right to purchase the option assets, including the general partnership interest of the Partnership, subject to the approval of the limited partners. On April 20, 1994, Insignia Financial Group, Inc., a Delaware corporation, and certain of its affiliates (collectively \"Insignia\") entered into an Option Purchase Agreement with Hampton to acquire Hampton's rights to solicit proxies from the Limited Partners seeking their consent to Hampton becoming the general partner of the Partnership. On August 8, 1994, the Insignia contract was terminated. On December 30, 1994, Hampton entered into an Assignment and Assumption of Option Agreement with JKD Financial Management, Inc. (\"JKD\"), a Texas corporation, whereby, among other things, JKD obtained the right to acquire Hampton's rights to proxy into the Partnership subject to approval of the Limited Partners. As of the date hereof, JKD has not exercised that right.\nEffective as of December 14, 1992, the Partnership entered into a Portfolio Services Agreement and a Property Management Agreement with Hampton UREF Management, Ltd. (\"Hampton UREF\"), Texas limited partnership, pursuant to which Hampton UREF began providing management for the Partnership's properties and certain other portfolio services. The operations of the Partnership's properties were managed by Hampton Management, Inc. (formerly SHL Management, Inc.) through a subcontract agreement with Hampton UREF. From April 20, 1994 to August 8, 1994, the Partnership and its properties were managed by Insignia pursuant to a Property Management Subcontract Agreement with Hampton UREF. As of August 8, 1994, the properties only were managed by an affiliate of Insignia under a Property Management Agreement directly with the Partnership.\nOn December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Agreement with JKD pursuant to which JKD oversees the management of the Partnership.\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS Holdings, Inc. (\"OS\"), a Texas corporation, and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OS General Partner Company (\"OSGPC\"), a Texas corporation, for JKD and to extend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - --------------------------------------------------------------------------------\nPrinciples of Consolidation - ---------------------------\nOn September 13, 1995, the Partnership contributed the Washington Towne Apartments to an affiliated entity, Washington Towne Apartments, LLC, a Georgia limited liability company. The Partnership is the 99% member and Washington Towne, Inc. is the 1% managing member of Washington Towne Apartments, LLC. The Partnership is the owner of all the capital stock of Washington Towne, Inc. Therefore, the Partnership effectively retained a 100% interest in the Washington Towne Apartments.\nThe consolidated financial statements include the accounts of the Partnership, Washington Towne Apartments, LLC, and Washington Towne, Inc.\nReal Estate Investments - -----------------------\nReal estate investments and improvements are generally stated at cost except in cases where it has been determined that the property has sustained an impairment in value. At such time, a provision for loss is recorded to reduce the basis of the property to its net realizable value. Improvements are capitalized and repairs and maintenance are charged to operations as incurred.\nReal estate accounted for as an in-substance foreclosure is recorded at the lower of the note balance or the fair value of the property at the date the in- substance foreclosure is deemed to have occurred. Effective December 1992, in- substance foreclosure assets are valued at the fair value of the property in accordance with Statement of Position 92-3.\nRepossessed Real Estate Held for Resale - ---------------------------------------\nRepossessed real estate held for resale is recorded at the lower of the net note receivable balance or the net realizable value of the property at the date of repossession.\nDepreciation - ------------\nBuildings and improvements are depreciated using the straight-line method over 5 to 30 years. Tenant improvements are amortized over the terms of the related tenant lease using the straight-line method.\nCash and Cash Equivalents - -------------------------\nCash and cash equivalents include cash on hand, demand deposits, money market funds and investments in certificates of deposit with original maturities of three months or less. Cash and cash equivalents also include cash held in segregated accounts for tenant security deposits.\nDeferred Borrowing Costs - ------------------------\nLoan fees for long-term financing of real property are capitalized and are amortized over the terms of the related mortgage note payable using the straight-line method. Amortization of deferred borrowing costs is included in interest expense on the Consolidated Statements of Operations.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - --------------------------------------------------------------------------------\nRental Revenues - ---------------\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. The Partnership leases its commercial property under noncancelable operating leases that expire over the next 10 years. Some leases provide concessions and periods of escalating or free rent. Rental income is recognized on a straight-line basis over the life of the lease. The excess of the rental income recognized over the contractual rental payments due is recorded as accrued rent receivable.\nNotes Receivable - ----------------\nNotes receivable 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.\nDiscounts on Mortgage Notes Payable - -----------------------------------\nDiscounts on mortgage notes payable are amortized over the remaining terms of the related notes using the interest method. Amortization of discounts is included in interest expense.\nIncome Taxes - ------------\nNo provision for Federal income taxes is necessary in the consolidated 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.\nUse 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFinancial Instruments - ---------------------\nThe Partnership's carrying values for financial instruments approximate their fair values.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - --------------------------------------------------------------------------------\nAllocation of Net Income and Net Loss - -------------------------------------\nThe Partnership Agreement provides for net income of the Partnership for both consolidated financial statements and income tax reporting purposes to be allocated 99% to the Limited Partners and 1% to the General Partners. Net income allocated to the Limited Partners shall be allocated first to the Limited Partners holding Growth\/Shelter Units in the same ratio and manner that losses were charged to these Limited Partners and up to amounts equal to such previously charged losses and then to all of the Limited Partners in the same ratio that distributions from all sources, other than proceeds from the sale of Limited Partnership units, have been allocated.\nThe Partnership Agreement provides for net losses of the Partnership for both financial statement and income tax reporting purposes to be allocated 1% to the General Partner and 99% to the Growth\/Shelter Unit holders.\nFederal income tax law provides that the allocation of loss to a partner will not be recognized unless the allocation has substantial economic effect. Internal Revenue Code Section 704(b) and Treasury Regulation Sections establish criteria for allocations of partnership deductions attributable to nonrecourse debt. The Partnership's allocations for the three years ended December 31, 1995 have been made in accordance with these provisions.\nNet Loss Per Limited Partnership Unit - -------------------------------------\nNet loss per Limited Partnership Unit is computed by dividing net loss allocated to the Limited Partners by the weighted average number of Limited Partnership Units outstanding during the year. Per unit information has been computed based on 34,353 Limited Partnership Units outstanding in 1995 and 34,453 Limited Partnership Units outstanding in 1994 and 1993.\nDistributions - -------------\nDistributions to the Partners are made at the discretion of the General Partner and are subject to payment of expenses of the Partnership, including debt service, and maintenance of reserves. Distributions to the Partners are paid from operations of the Partnership's properties, from sales or refinancing of properties, or from other sources, if any. Distributions to the Partners were suspended in the first quarter of 1992.\nReclassification - ----------------\nCertain prior year amounts have been reclassified to conform with the current year presentation.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - TRANSACTIONS WITH AFFILIATES - -------------------------------------\nOn March 9, 1993, Southmark and several of its affiliates (including the General Partner) entered into an Asset Purchase Agreement with SHL to sell various general and limited partnership interests owned by Southmark and its affiliates, including the general partnership interest of the Partnership. On December 16, 1993, Southmark and SHL executed the Second Amendment to Asset Purchase Agreement whereby SHL acquired an option to purchase the general partnership interest of the Partnership, rather than purchase the partnership interest itself. On the same date, SHL assigned its rights under the amended Asset Purchase Agreement to Hampton. Hampton and Southmark affiliates also entered into an Option Agreement whereby Hampton acquired the right to purchase the option assets, including the general partnership interest of the Partnership, subject to the approval of the limited partners. On April 20, 1994, Insignia entered into an Option Purchase Agreement with Hampton to acquire Hampton's rights to solicit proxies from the Limited Partners seeking their consent to Hampton becoming the general partner of the Partnership. On August 8, 1994, the Insignia contract was terminated. On December 30, 1994, Hampton entered into an Assignment and Assumption of Option Agreement with JKD, whereby, among other things, JKD obtained the right to acquire Hampton's rights to proxy into the Partnership subject to approval of the Limited Partners. As of the date hereof, JKD has not exercised that right.\nEffective as of December 14, 1992, the Partnership entered into a Portfolio Services Agreement and a Property Management Agreement with Hampton UREF, pursuant to which Hampton UREF began providing management for the Partnership's properties and certain other portfolio services. The operations of the Partnership's properties were managed by Hampton Management, Inc. (formerly SHL Management, Inc.) through a subcontract agreement with Hampton UREF. From April 20, 1994 to August 8, 1994, the Partnership and its properties were managed by Insignia pursuant to a Property Management Subcontract Agreement with Hampton UREF. As of August 8, 1994, the properties only were managed by an affiliate of Insignia under a Property Management Agreement directly with the Partnership.\nAs of December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Agreement with JKD pursuant to which JKD oversees the management of the Partnership.\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OSGPC for JKD and to extend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nThe Partnership pays property management fees based on 5% of gross rental revenues for supervising the maintenance and operations of the Partnership's properties.\nBeginning December 14, 1992, the Partnership began reimbursing SHL, and subsequently Hampton, for its costs, including overhead, of administering the Partnership's affairs. Reimbursements are \"Overhead Fees\" which include salaries, travel and other expenses properly allocated to the services provided for the benefit of the Partnership, and an Asset Management Fee is charged at 0.75% of the Partnership's Tangible Asset Value. The Partnership's Tangible Asset Value of the Partnership's real properties is determined by applying a capitalization rate of 10% to annualize the net operating income of each real property, plus the book value of all other tangible assets. At December 31, 1995, there were no accounts payable-affiliates. At December 31, 1994, accounts payable-affiliates for the Partnership's Asset Management Fees were $20,894.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 - TRANSACTIONS WITH AFFILIATES (CONTINUED) - -------------------------------------------------\nUnder the Partnership Agreement, the General Partner or an affiliate is entitled to a subordinated real estate commission upon the sale of Partnership properties. Payment of the commission is subordinated to distributions to the Limited Partners of original invested capital plus a 9% per annum cumulative return. Subordinated real estate commissions payable to a Southmark affiliate but assigned to Hampton pursuant to the Second Amendment to Asset Purchase Agreement totaled $549,218 at December 31, 1995 and 1994.\nCompensation and reimbursements paid to or accrued for the benefit of Hampton and affiliates subsequent to December 15, 1992 are as follows:\nIn June 1994, Southmark paid off the first lien mortgage on the Bank of San Pedro Office Building. Consequently, the Partnership had a 90-day promissory note payable to Southmark bearing interest at 10%, secured by a first lien deed of trust, assignment of rents, and security agreement on the Bank of San Pedro Office Building, with all outstanding principal and accrued interest due on September 30, 1995, as a result of two maturity date extensions. The initial principal balance of this note was $877,000. At every maturity date extension, the Partnership incurred a fee in the amount of $78,075 in accordance with the note agreement. In 1994, the extension fees totaling $156,150 and all accrued interest were added to the principal balance in accordance with the note agreement. At December 31, 1994, the principal balance (which included both extension fees and accrued interest) was $1,086,554. On April 11, 1995, the Partnership made a principal prepayment in the amount of $750,000 on the promissory note payable to Southmark. In consideration for this principal prepayment, Southmark reduced the remaining unpaid principal balance of the note payable by $75,000 and extended the maturity date for an additional 90 days. The $75,000 gain on debt forgiveness is included as an extraordinary item in the consolidated statements of operations at December 31, 1995. On July 20, 1995, the Partnership sold the Bank of San Pedro Office Building and paid all remaining principal and accrued interest, totaling $381,593, due on the promissory note payable to Southmark (see Note 5 - \"Repossessed Real Estate Held for Resale\").\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3 - TAXABLE INCOME (LOSS) - ------------------------------\nA reconciliation between consolidated financial statement net loss and loss for income tax purposes follows:\nThe Partnership reports certain transactions differently for tax and financial statement purposes. The aggregate cost of the Partnership's total assets for Federal income tax purposes was approximately $11,296,780 and $15,716,760 at December 31, 1995 and 1994, respectively.\nUniversity Real Estate Partnership V 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 consolidated 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.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3 - TAXABLE INCOME (LOSS) (CONTINUED) - ------------------------------------------\nThe tax attributes of the Partnership's net assets flow directly to each individual partner. Individual partners will have different investment bases depending upon the timing and prices of acquisition of Limited Partnership Units. Further, each partner's tax accounting, which is partially dependent upon their individual tax position, may differ from the accounting followed in the consolidated financial statements.\nAccordingly, there could be significant differences between each individual partner's tax basis and their proportionate share of the net assets reported in the consolidated financial statements. Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, requires disclosure by a --------------------------- publicly held partnership of the aggregate difference in the basis of its net assets for financial and tax reporting purposes. However, the Partnership does not have access to information about each individual partner's tax attributes in the Partnership, and the aggregate tax bases cannot be readily determined. In any event, the General Partner does not believe that, in the Partnership's circumstances, the aggregate difference would be meaningful information.\nNOTE 4 - REAL ESTATE INVESTMENTS - --------------------------------\nThe cost and accumulated depreciation and amortization of the Partnership's real estate investments held at December 31, 1995 and 1994, is set forth in the following tables:\nOn March 31, 1995, the Partnership executed a note payable secured by the Washington Towne Apartments for a principal amount of $250,000, bearing interest at 11.5% per annum with one payment of principal and interest in the amount of $2,476 due May 1, 1995, and all remaining outstanding principal and accrued interest originally due and payable June 1, 1995. The lender subsequently extended the maturity date and on September 13, 1995, the Partnership paid all outstanding principal and accrued interest as a result of the refinancing of the Washington Towne Apartments as described below.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 - REAL ESTATE INVESTMENTS (CONTINUED) - --------------------------------------------\nThe mortgage payable on the Washington Towne Apartments matured in June 1995. In September 1995, the Partnership obtained a mortgage loan payable in the amount of $1,750,000 from a new lender. In order to preserve the Partnership's ownership interest in the Washington Towne Apartments and in order to satisfy the new lender's structural requirements with respect to the refinancing of the mortgage note payable, the Partnership contributed the property on September 13, 1995 to an affiliated entity, Washington Towne Apartments, LLC, a Georgia limited liability company. The Partnership is the owner of all the capital stock of Washington Towne, Inc. The Partnership is the 99% member and Washington Towne, Inc. is the 1% managing member of Washington Towne Apartments, LLC. Therefore, the Partnership effectively retained a 100% interest in the property. In connection with the contribution of the property to Washington Towne Apartments, LLC, the lender provided sufficient funds to satisfy the matured loan obligation and to provide for certain property improvements. Property improvements have been completed prior to the end of the first quarter 1996 and have significantly enhanced the value of the property (see Note 7 - \"Mortgage Notes Payable\").\nThe Partnership leased under a noncancelable operating lease through September 1993 fifty percent of the Glasshouse Square Shopping Center land tract, known as the Garcia's Tract. Rent expense was $110,337 for the year ended December 31, 1993. On September 16, 1993, the Partnership purchased the remaining fifty percent undivided interest in the land for a cash purchase price of $1,716,005 including closing costs.\nDuring 1993 it was determined in a Phase II Environmental Audit that the soils and groundwater in the Garcia's Tract and possibly part of the Glasshouse Square parking lot, located in the Northeastern most corner of Glasshouse Square property, contain elevated levels of certain petroleum products. In 1994 and 1995, the Partnership worked with counsel and environmental engineers in connection with further investigation of the alleged leaking of petroleum products from underground storage tanks and with San Diego County officials to determine the necessary level of clean-up. The Partnership also obtained a health risk assessment to ensure that the gasoline constituents beneath the Garcia's Tract are not emitting harmful vapors inside the building. The health assessment was returned \"non detect\" meaning no such harmful vapors were detected. In 1996, additional testing was conducted by the environmental engineers who determined there was no \"free product\" at the portions of the site that were tested and, also, no human health risk exists at this time. Management does not believe that the County of San Diego will take further action. Therefore, this situation should not have a material effect on the Partnership.\nThe Partnership leases Glasshouse Square Shopping Center, its only commercial property, under noncancelable operating lease agreements that expire over the next 10 years. Future minimum rents over the next five years are as follows:\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 - REAL ESTATE INVESTMENTS (CONTINUED) - --------------------------------------------\nOn January 17, 1995, the lender filed a notice of default in San Diego County related to the Glasshouse Square mortgages payable. On March 27, 1995, the mortgages were modified and a forbearance agreement was executed whereby the lender agreed to discontinue foreclosure proceedings. The first lien mortgage is payable in varying monthly installments of principal and interest, bearing interest at 9.5% per annum and maturing in December 2000. The second lien mortgage payable requires monthly interest only payments in the amount of $6,595, bearing interest at 11% per annum and maturing in December 2000. Principal balances for the first and second lien mortgages as of December 31, 1995, were $7,435,834 and $1,492,431, respectively. In addition to the mortgage modifications and forbearance agreement, on March 27, 1995, the lender granted the Partnership a line of credit for the maximum amount of $400,000 bearing interest at 9.5% per annum payable in full on December 1, 2000. The line of credit is restricted to Glasshouse Square for the use of mortgage payment shortfalls, tenant improvements, leasing commissions, and a monument sign. The line of credit is secured by a deed of trust. As of December 31, 1995, the Partnership owed $186,206 against the line of credit. This draw on the line of credit increased the first lien mortgage principal balance to $7,435,834 as of December 31, 1995 (see Note 7 - \"Mortgage Notes Payable\").\nIn September 1995, Silo California, a major tenant that provided approximately 25% of the gross rental revenues to Glasshouse Square, defaulted on its lease and ceased retail operations. The Partnership filed a lawsuit styled University ---------- Real Estate Partnership V v. Silo California, Inc. No. 692441 (Superior Court of - ------------------------------------------------- the State of California) to recover possession of leased premises and damages related to breach of a lease at Glasshouse Square Shopping Center. The Partnership obtained an unlawful detainer judgment against the defendant on October 25, 1995, in the amount of $41,757.\nThe Partnership seeks to collect from Silo California all base rent and common area maintenance charges, $18,689 and $5,919, respectively, per month, for the periods that they are in default or until a new tenant has been secured to lease their location. At December 31, 1995, an allowance for doubtful accounts in the amount of $107,044 was recorded for the Silo California lease default (see Note 11 - \"Subsequent Events\"). However, the Partnership cannot predict what the final recovery amount will be.\nNOTE 5 - REPOSSESSED REAL ESTATE HELD FOR RESALE - ------------------------------------------------\nIn January 1994, the borrower ceased making regularly scheduled debt payments constituting an event of default on a note receivable held by the Partnership resulting from the sale of Bank of San Pedro Office Building in 1987. In March 1994, the Bank of San Pedro Office Building was placed in receivership due to the contemplation of a foreclosure proceeding by the Partnership against the borrower. The Partnership, instead of initiating foreclosure proceedings against the borrower, entered into a Settlement Agreement with the borrower.\nUnder the Settlement Agreement, the Bank of San Pedro Office Building was conveyed to the Partnership in lieu of the foreclosure of the wrap lien held by the Partnership on June 20, 1994. In return, the Partnership paid $30,000.\nAt December 31, 1994, the Bank of San Pedro Office Building was recorded on the consolidated financial statements as repossessed real estate held for resale with a value of $1,422,391. This amount was the net note receivable balance plus the book value of assets and liabilities acquired at the date of repossession, which approximated net realizable value. The Partnership did not plan to hold the Bank of San Pedro Office Building as an income-producing property. Thus, it was not considered a depreciable real estate investment.\nThe underlying mortgage note on the Bank of San Pedro Office Building matured in June 1992. Negotiations with the lender for an extension were completed in June 1993, and the maturity date was extended to April 1, 1994. After the note matured in April 1994, the Partnership was not able to negotiate another extension or renewal of the\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5 - REPOSSESSED REAL ESTATE HELD FOR RESALE (CONTINUED) - -----------------------------------------------------------\nfirst lien. In June 1994, Southmark paid off the first lien mortgage. Consequently, the Partnership had a promissory note payable to Southmark that matured September 30, 1995.\nOn July 20, 1995, the Partnership sold the Bank of San Pedro Office Building for $1,350,000. The Partnership received partial consideration from the sale in the form of a note receivable for $350,000, bearing interest at 9% per annum with interest only payments due monthly, secured by a second lien deed of trust on the Bank of San Pedro Office Building, maturing on July 20, 1998 and net cash of $291,562. On the date of sale, all remaining principal and accrued interest, totaling $381,593, due on the promissory note payable to Southmark was paid (see Note 2 - \"Transactions with Affiliates\" and Note 6 - \"Notes Receivable\").\nA loss on sale of repossessed real estate was recognized in 1995 relating to this transaction as follows:\nOn March 30, 1996, the borrower on the note receivable ceased making regularly scheduled debt payments constituting an event of default. The borrower has currently cured the default situation; however, a provision for loss in the amount of $100,000 was recorded in 1995 in the event of any future complications.\nNOTE 6 - NOTES RECEIVABLE - -------------------------\nThe following sets forth the notes receivable of the Partnership.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6 - NOTES RECEIVABLE (CONTINUED) - -------------------------------------\nOn July 20, 1995, the Partnership sold the Bank of San Pedro Office Building for $1,350,000. The Partnership received, as partial consideration from the sale, a note receivable for $350,000, bearing interest at 9% per annum with interest only payments due monthly, secured by a second lien deed of trust on the Bank of San Pedro Office Building, maturing on July 20, 1998 (see Note 2 - \"Transactions with Affiliates\" and Note 5 - \"Repossessed Real Estate Held for Resale\"). On March 30, 1996, the borrower on the note receivable ceased making regularly scheduled debt payments constituting an event of default. The borrower has currently cured the default situation; however, a provision for loss in the amount of $100,000 was recorded in the event of any future complications.\nIn September 1994, the Las Oficinas note receivable and the underlying mortgage payable matured. On October 1, 1994, a commitment letter was executed regarding the Las Oficinas mortgage payable in order to transfer all liability from the Partnership to the borrower on the Las Oficinas note receivable. On December 1, 1994, a commitment letter was executed between the borrower and the Partnership stating that the Partnership, among other things, would reduce the note receivable principal balance from $3,031,936 to $1,100,000. Both of these modifications took place simultaneously.\nOn February 27, 1995, the closing of the above transactions was executed. At this time, the Partnership was released from the mortgagor position on the Las Oficinas mortgage payable. Concurrently, the Las Oficinas note receivable was modified reducing the principal amount by $1,931,936 to $1,100,000, bearing interest at a rate of 8% per annum and maturing on September 1, 1999.\nThe modification of the Las Oficinas note receivable and underlying mortgage payable, as previously discussed, is reflected as of December 31, 1994 as a loss on modification of note receivable in the amount of $530,695.\nOn April 7, 1995, the modified Las Oficinas note receivable for $1,100,000 was sold to a third party for $750,000. This $350,000 valuation loss was recorded as of the modification date, December 1, 1994.\nThe following is a summary of the activity for the notes receivable.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - MORTGAGE NOTES PAYABLE - -------------------------------\nThe following is a summary of mortgage notes payable.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - MORTGAGE NOTES PAYABLE (CONTINUED) - ------------------------------------------\nOn September 16, 1993, the Partnership granted a second lien on Glasshouse Square in order to finance the purchase of the remaining 50% undivided interest in the land. Interest only payments are required for the first year, and beginning in the second year payments of principal and interest are required until maturity in September 2008.\nOn January 17, 1995, the lender filed a notice of default in San Diego County related to the Glasshouse Square mortgages payable. On March 27, 1995, the mortgages were modified and a forbearance agreement was executed whereby the lender agreed to discontinue foreclosure proceedings. The first lien mortgage is payable in varying monthly installments of principal and interest, bearing interest at 9.5% per annum and maturing in December 2000. The second lien mortgage payable requires monthly interest only payments in the amount of $6,595, bearing interest at 11% per annum and maturing in December 2000. In addition to the mortgage modifications and forbearance agreement, on March 27, 1995, the lender granted the Partnership a line of credit for the maximum amount of $400,000 bearing interest at 9.5% per annum payable in full on December 1, 2000. The line of credit is restricted to Glasshouse Square for the use of mortgage payment shortfalls, tenant improvements, leasing commissions, and a monument sign. The line of credit is secured by the same first lien deed of trust as the first lien mortgage. As of December 31, 1995, the Partnership owed $186,206 against the line of credit. This draw on the line of credit increased the first lien mortgage principal balance to $7,435,834 as of December 31, 1995.\nThe mortgage payable on the Bank of San Pedro Office Building matured in June 1992. Negotiations with the lender for an extension were completed in June 1993. The extension on the Bank of San Pedro Office Building mortgage matured April 1994. Southmark purchased the first lien in June 1994 (see Note 2 - \"Transactions with Affiliates\").\nOn March 31, 1995, the Partnership executed a note payable secured by the Washington Towne Apartments for a principal amount of $250,000, bearing interest at 11.5% per annum with one payment of principal and interest in the amount of $2,476 due May 1, 1995 and all remaining outstanding principal and accrued interest originally due and payable June 1, 1995. The lender subsequently extended the maturity date and on September 13, 1995, the Partnership paid all outstanding principal and accrued interest as a result of the refinancing of the Washington Towne Apartments as described below.\nThe mortgage payable on the Washington Towne Apartments matured in June 1995. In September 1995, the Partnership obtained a mortgage loan payable in the amount of $1,750,000 from a new lender. In order to preserve the Partnership's ownership interest in the Washington Towne Apartments and to satisfy the new lender's structural requirements with respect to the refinancing of the mortgage note payable, the Partnership contributed the property on September 13, 1995 to an affiliated entity, Washington Towne Apartments, LLC, a Georgia limited liability company. The Partnership is the owner of all the capital stock of Washington Towne, Inc. The Partnership is the 99% member and Washington Towne, Inc. is the 1% managing member of Washington Towne Apartments, LLC. Therefore, the Partnership effectively retained a 100% interest in the property. In connection with the contribution of the property to Washington Towne Apartments, LLC, the lender provided sufficient funds to satisfy the matured loan obligation and to provide for certain property improvements. Property improvements have been completed prior to the end of the first quarter of 1996 and have significantly enhanced the value of the property.\nIn September 1994, the mortgage payable on Las Oficinas matured. On October 1, 1994, a commitment letter was executed regarding the transfer of the mortgage from the Partnership to the borrower on the Las Oficinas note receivable.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 - MORTGAGE NOTES PAYABLE (CONTINUED) - -------------------------------------------\nOn February 27, 1995, the transaction, as discussed above, was executed. On this date, the Partnership was released from the mortgagor position on the mortgage payable on Las Oficinas. Concurrent with this transaction, the Las Oficinas note receivable modification was executed (see Note 6 - \"Notes Receivable\").\nNOTE 8 - DISTRIBUTIONS - ----------------------\nDistributions of cash from operations, to the extent deemed available by the General Partner for distribution, are allocated 92% to the Limited Partners and 8% to the General Partner, and are made in the following order:\n(a) First to the holders of Income Units until they receive a return of 9% per annum cumulative on their adjusted capital investment; then,\n(b) to the holders of Growth\/Shelter Units until they receive a non-cumulative return for the year of distribution equal to 5% per annum on their adjusted capital investment; then,\n(c) to all the Limited Partners based on number of Units held.\nDistributions of cash from other sources, including sales and refinancing and cash reserves, are made in the following order:\n(a) First, 99% to the Limited Partners and 1% to the General Partner until the Limited Partners have received a return of their aggregate capital investment plus a 9% per annum cumulative return on their adjusted capital investment. In this regard, distributions to the Limited Partners are allocated first to holders of Income Units until they have received their entire capital investment and their 9% return. Holders of Growth\/Shelter Units then receive return of their entire capital investment and their 9% return. Further distributions to the Limited Partners under this section are allocated generally 20% to holders of Income Units and 80% to holders of Growth\/Shelter Units. Distributions then continue;\n(b) to the General Partner until the General Partner has received 12% of all distributions from other sources; then,\n(c) 12% to the General Partner and 88% to all the Limited Partners.\nDuring 1995, 1994 and 1993, no distributions were made by the Partnership.\nNOTE 9 - SOUTHMARK BANKRUPTCY - ------------------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership nor its 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 include Southmark's interests in the General Partner, are being sold or liquidated for the benefit of creditors.\nBecause neither the Partnership nor the General Partner were included in the Southmark bankruptcy proceedings, there has been no direct effect on the Partnership's operations during the bankruptcy period or resulting from confirmation of the plan. Ultimate decision-making authority with respect to the operations of the Partnership remains with the General Partner until such time as the Limited Partners approve a substitute general partner (see Note 10 - \"Sale of General Partner Interest\").\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10 - SALE OF GENERAL PARTNER INTEREST - ------------------------------------------\nAs a result of Southmark's bankruptcy and its plan to liquidate all of its assets, the General Partner concluded that it was in the best interest of the Partnership to seek, as its qualified replacement as general partner, an entity which intends to remain involved in the management of real estate and real estate limited partnerships.\nOn March 9, 1993, Southmark and several of its affiliates (including the General Partner) entered into an Asset Purchase Agreement with SHL to sell various general and limited partnership interests owned by Southmark and its affiliates, including the general partnership interest of the Partnership. On April 22, 1993, Southmark and SHL executed the First Amendment to Asset Purchase Agreement whereby SHL acquired an option to purchase the general partnership interest of the Partnership, rather than purchase the Partnership interest itself. On December 16, 1993, SHL assigned its rights under the amended Asset Purchase Agreement to Hampton. Hampton and Southmark affiliates also entered into an Option Agreement whereby Hampton acquired the right to purchase the option assets, including the general partnership interest of the Partnership subject to the approval of the Limited Partners. On April 20, 1994, Insignia entered into an Option Purchase Agreement with Hampton to acquire Hampton's rights to solicit proxies from the Limited Partners seeking their consent to Hampton becoming the general partner of the Partnership. On August 8, 1994, the Insignia contract was terminated. On December 30, 1994, Hampton entered into an Assignment and Assumption of Option Agreement with JKD whereby, among other things, JKD obtained the right to acquire Hampton's rights to proxy into the Partnership subject to the approval of the Limited Partners. As of the date hereof, JKD has not exercised that right.\nEffective as of December 14, 1992, the Partnership entered into a Portfolio Services Agreement and a Property Management Agreement with Hampton UREF pursuant to which Hampton UREF began providing management for the Partnership's properties and certain other portfolio services. The operations of the Partnership's properties were managed by Hampton Management, Inc. (formerly SHL Management, Inc.) through a subcontract agreement with Hampton UREF. From April 20, 1994 to August 8, 1994, the Partnership and its properties were managed by Insignia pursuant to a Property Management Subcontract Agreement with Hampton UREF. As of August 8, 1994, the properties were managed by an affiliate of Insignia under a Property Management Agreement directly with the Partnership.\nAs of December 30, 1994, Hampton UREF entered into an Assignment and Assumption of Portfolio Services Agreement with JKD pursuant to which JKD oversees the management of the Partnership.\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OSGPC for JKD and to extend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nNOTE 11 - SUBSEQUENT EVENTS - ---------------------------\nOn January 29, 1996, SCM and SII entered into a purchase agreement to sell their partnership interests in UAC to OS and JKD, respectively. The transfer documents were executed January 31, 1996, and placed into escrow. The transfer would not be effective until certain conditions precedent were satisfied and, if the conditions precedent were not satisfied by April 29, 1996, the transfer documents would be returned to SCM and SII and the transfer would not occur. On April 29, 1996 the purchase agreement was amended to facilitate the substitution of OSGPC for JKD\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11 - SUBSEQUENT EVENTS (CONTINUED) - ---------------------------------------\nand to extend the escrow period through June 30, 1996. On June 25, 1996 a Second Amendment of Escrow Agreement was entered into to extend the escrow period through August 31, 1996.\nThe Partnership filed a claim against Silo California, Inc. on February 9, 1996, in a bankruptcy proceeding entitled In re: Silo California, Inc., a California ------------------------------------------ corporation, No. 95-1581 (U.S. Bankruptcy Court, District of Delaware), to - ----------- recover on the $41,757 unlawful detainer judgment. A second claim in the amount of $312,992 for additional damages related to breach of the lease was filed on February 20, 1996 against Silo California, Inc. and an identical $312,992 claim was filed against Silo Holdings, Inc. in In re: Silo Holdings, Inc., No. 95- -------------------------- 1578 (U.S. Bankruptcy Court, District of Delaware) on February 20, 1996. All three claims are still pending.\nAs of March 30, 1996, the borrower on the Bank of San Pedro Office Building note receivable ceased making regularly scheduled debt payments constituting an event of default. The borrower has currently cured the default situation; however, a provision for loss in the amount of $100,000 was recorded in 1995 in the event of any future complications.\nNOTE 12 - PRO FORMA INFORMATION - -------------------------------\nUnaudited pro forma balance sheet information as of December 31, 1994, has been prepared to reflect the financial condition of the Partnership as if the sales of the Bank of San Pedro Office Building and the Las Oficinas Note Receivable had occurred on December 31, 1994.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 - PRO FORMA INFORMATION (CONTINUED) - -------------------------------------------\nUnaudited pro forma information for the year ended December 31, 1994, has been prepared to reflect the results of operations as if the sales of the Bank of San Pedro Office Building and the Las Oficinas Note Receivable had occurred on January 1, 1994. The results are not necessarily indicative of the results which would have occurred had these transactions been consummated at the beginning of 1994 or of future results of operations of the Partnership.\nPro Forma Adjustments - ---------------------\n(A) To record the effect of the sale of Bank of San Pedro Office Building including (1) a reduction in repossessed real estate held for resale and retirement of underlying note payable to Southmark affiliate and (2) reductions in accounts receivable, other assets, accounts payable and other liabilities resulting from the disposition of the property. (B) To record the effect of the sale of the Las Oficinas Note Receivable. (C) To record the cash proceeds from the sales ($1,750,000), security deposit cash surrendered ($1,706), and cash payments of selling expenses, accounts payable, and repayment of debt ($1,458,438). (D) To record the note receivable received as proceeds and interest earned from the sale of the Bank of San Pedro Office Building. (E) To remove the revenues and expenses related to the Bank of San Pedro Office Building rental operations and record loss on the sale of the Bank of San Pedro Office Building. (F) To remove interest income, interest expense, and record loss on the sale of the Las Oficinas note receivable.\nSCHEDULE VIII\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nVALUATION AND QUALIFYING ACCOUNTS\nDecember 31, 1995\nSCHEDULE X\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nSUPPLEMENTARY STATEMENTS OF OPERATIONS INFORMATION\nFor the Years Ended December 31, 1995, 1994 and 1993\n1) Amortization of deferred borrowing costs was not set forth as such items do not exceed one percent of total sales as shown in the related statements of operations.\n2) Advertising costs was not set forth as such items do not exceed one percent of total sales as shown in the related statements of operations.\n3) Royalty expense is not applicable to these financial statements.\nSCHEDULE XI\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nREAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION\nDecember 31, 1995\n(a) The aggregate cost of real estate for Federal Income tax purposes was $19,295,359 at December 31, 1995.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nReal Estate Investments and Accumulated Depreciation and Amortization\nNote to Schedule XI\nChanges in real estate investments and accumulated depreciation and amortization are as follows:\nSCHEDULE XII\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nMORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1995\n(1) Monthly installments of principal and interest of $14,239. (2) Varying monthly installments of principal and interest. (3) Monthly installments of interest only of $6,595.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nPrice Waterhouse LLP served as the independent accountant previously engaged to audit the financial statements of University Real Estate Partnership V (the \"Partnership\") for the three years ended December 31, 1993. On May 10, 1995, the Partnership's Manager selected Wallace Sanders & Company to serve the Partnership as its independent accountant to audit the Partnership's finacial statements for the calendar year ended December 31, 1994. The failure of the Manager of the Partnership to select Price Waterhouse LLP as the Partnership's independent accountant to audit the financial statements for the year ended December 31, 1994, constituted Price Waterhouse LLP being \"dismissed\" (as such term is used in Item 304 of Regulation S-K).\nDuring the years Price Waterhouse LLP served as the independent accountants to audit the financial statements of the Partnership and thereafter through the date hereof, the Partnership has not had any disagreement with Price Waterhouse LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which disagreement, if not resolved to the satisfaction of Price Waterhouse LLP, would have caused Price Waterhouse LLP to make reference to the subject matter of the disagreement in connection with this report. The decision to change accountants was not recommended by an audit or similar committee (since the Manager has no such committee) and was made only by the Manager.\nThe Partnership has provided Price Waterhouse LLP with a copy of the foregoing disclosures at the same time as the filing of this report with the Commission and has requested such former accountant to furnish the Partnership with a letter addressed to the Securities and Exchange Commission (the \"Commission\") stating whether Price Waterhouse LLP agrees with the statements made by the Partnership herein and, if not, stating the respects in which it does not agree. Price Waterhouse LLP by letter dated July 18, 1995, addressed to the Office of the Chief Accountant of the Commission, advised that it agrees with the statements made by the Partnership. A copy of the Price Waterhouse LLP letter was attached to Form 8-K as filed with the Securities and Exchange Commission on July 24, 1995.\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. University Advisory Company is the General Partner of the Partnership. Southmark Commercial Management, Inc. and Southmark Investors, Inc., both wholly-owned subsidiaries of Southmark Corporation, are the two general partners of UAC. The executive officer and director of the General Partner who controls the affairs of the Partnership is as follows:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nNo individual principal or principals as a group received over $60,000 in direct remuneration from the Registrant.\nThe General Partner is not compensated directly for services rendered to the Partnership. Certain officers and directors of the General Partner and Hampton receive compensation from the General Partner or Hampton and\/or their affiliates (but not from the Registrant) for services performed for various affiliated entities which may include services performed for the Registrant. See \"Item 13 - - Certain Relationships and Related Transactions\" and Note 2 to the financial statements appearing in Item 8.\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 Registrant is the beneficial owner of more than 5 percent of the Registrant's securities.\n(B) Security ownership of management.\nNeither the General Partner nor any of its officers or directors owns any Limited Partnership Units.\nThe General Partner is entitled to distributions of cash from operations and from other sources (primarily from the sale or refinancing of Partnership properties and the reserve account) as set forth in Item 8 - \"Note 8 - Distributions.\"\n(C) Change in Control.\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nBeginning December 14, 1992, Property Management and Portfolio Services Agreements were entered into with Hampton UREF and the Partnership began paying property management fees, through a subcontract agreement with the Hampton UREF, to Hampton and began reimbursing Hampton for its costs of administering the Partnership's affairs. Beginning April 20, 1994, the Partnership began paying property management fees to Insignia, through a Property Management Subcontract Agreement with Hampton UREF and later the Partnership directly. On December 30, 1994 an Assignment and Assumption of Portfolio Services Agreement was entered into between Hampton UREF and JKD whereby the Partnership began reimbursing JKD for its costs of administering the Partnership's affairs.\nCompensation or reimbursements paid to or accrued for the benefit of Hampton and affiliates and Insignia during 1995 are as follows:\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINACIAL STATEMENTS, SCHEDULES AND REPORTS ON - -------- -------------------------------------------------------------------- FORM 8-K --------\n(a)(1) Consolidated Financial Statements\nConsolidated finacial statements for University Real Estate Partnership V, listed in the Index to the Consolidated Financial Statements and Supplementary Data on page 16, are filed as part of this Annual Report.\n(a)(2) Consolidated Financial Statement Schedules\nConsolidated Financial Statement Supplementary Data for University Real Estate Partnership V, listed in the Index to the Consolidated Financial Statements and Supplementary Data on page 16, are filed as part of this Annual Report.\nPage ----\n(a)(3) Index to Exhibits......................................... 17\n(b) Reports on Form 8-K....................................... 20 (a)(3) The following documents are filed as part of this report and is an index to the exhibits.\nExhibit Number Description ------ -----------\n3.1 Limited Partnership Agreement (Incorporated by reference to Registration Statement No. 2-74914 on Form S-11 filed by Registrant).\n3.2i Articles of Incorporation of Washington Towne, Inc. executed on August 9, 1995. (6)\n3.2ii Washington Towne, Inc. Bylaws. (6)\n3.3i Articles of Organization of Washington Towne Apartments, L.L.C. executed on August 9, 1995. (6)\n3.3ii Operating Agreement of Washington Towne Apartments, L.L.C. entered into and dffective August 9, 1995 by and between Washington Towne, Inc., a Georgia corporation and University Real Estate Partnership V, a California limited partnership. (6)\n4. Limited Partnership Agreement (Incorporated by reference to Registration Statement No. 2-74914 on Form S-11 filed by Registrant).\n4.1 Trust Indenture Agreement (Incorporated by reference to Exhibit 4.1 to Registration Statement 2-74914 on Form S- 11 filed by Registrant).\n10.1 Asset Purchase Agreement among Southmark Corporation and its affiliates and SHL Acquisition Corp. III dated March 9, 1993, (2)\nExhibit Number Description - ------ ----------- 10.2 Asset Purchase Agreement amoung Southmark Corporation and its affiliates and SHL Acquisition Corp. III dated March 9, 1993 as amended by the First Amendment to Asset Purchase Agreement dated April 22, 1993. Incorporated by reference to the Annual Report of the Registration on Form 10-K for the period ended December 31, 1992, as filed with the Securities and Exchange Commission on May 1, 1993.\n10.3 Asset Purchase Agreement amoung Southmark Corporation and its affiliates and SHL Corp. III dated March 9, 1993, as amended by the Second Amendment to Asset Purchase Agreement dated December 14, 1993. (2)\n10.4 University V Option Agreement entered into as of December 16, 1993, by and amoung University Advisory Company and Hampton Realty Partners, L.P. and\/or its Permitted Assigns. (3)\n10.5 Portfolio Services Agreement between the Partnership and Hampton UREF Management, Ltd. dated December 16, 1993 to be effective as of December 14, 1992. (3)\n10.6 Assignment of Rights of the Asset Purchase Agreement between SHL Acquisition Corp. III and Hampton HCW, Hampton Realty Partners, L.P., and Hampton UREF Management, Ltd. dated December 16, 1993. (3)\n10.7 Portfolio Service Subcontract between Hampton UREF Management, Ltd. and IFGP Corporation dated April 20, 1994. (3)\n10.8 Property Management Subcontract between Hampton UREF Management, Ltd. and Insignia Management Group, L.P. dated April 20, 1994. (3)\n10.9 Purchase Agreement between Hampton Realty Partners, L.P. and Insignia Financial Group, Inc. dated April 20, 1994. (3)\n10.10 Note dated June 10, 1994 by and between University Real Estate Partnership V, a California limited partnership, and Southmark Corporation, a Georgia corporation, in the amount of $877,000.00. (3)\n10.11 Settlement Agreement between PDP Venture V, a California limited partnership, and University Real Estate Partnership V, a California limited partnership, dated June 20, 1994. (3)\n10.12 Portfolio Services Subcontract Agreement between Hampton UREF Management, Ltd. and IFGP Corporation dated April 20, 1994 as amended July 31, 1994. (3)\n10.13 Termination of Purchase Agreement between Hampton Realty Partners, L.P. and Insignia Financial Group, Inc. dated August 8, 1994. (3)\n10.14 Property Management Subcontract Agreement between Hampton UREF Management, Ltd. and Insignia Management Group, L.P. dated April 20, 1994, as amended August 8, 1994. (3)\n10.15 Termination of Property Management Agreement between Hampton UREF Management, Ltd. and the Partnership dated August 8, 1994. (3)\nExhibit Number Description ------ -----------\n10.16 Property Management Agreement between the Partnership and Insignia Commercial Group, Inc., dated August 8, 1994. (3)\n10.17 Termination of Property Management Subcontract Agreement between Hampton UREF Management, Ltd. and Insignia Management Group, Ltd. dated September 1, 1994. (3)\n10.18 Assignment and Assumption of Portfolio Services Agreement between Hampton UREF Management, Ltd. and JKD Financial Management, Inc. dated December 30, 1994. (4)\n10.19 Assignment and Assumption of Option Agreement between Hampton Realty Partners, L.P. and JKD Financial Management, Inc. dated December 30, 1994. (4)\n10.20 Modification and\/or Extension Agreement dated March 27, 1995 by and between Imperial Bank, a California banking corporation, and University Real Estate Partnership V, a California limited partnership. (5)\n10.21 Disbursement Agreement and Deed of Trust dated March 27, 1995, between Imperial Bank, a California banking corporation, and University Real Estate Partnership V, a California limited partnership for the additional line of credit granted to the Partnership in the amount of $400,000. (5)\n10.22 Forbearance Agreement dated March 27, 1995 by and between University Real Estate Partnership V, a California limited partnership and Imperial Bank, a California banking corporation. (5)\n10.23 Note dated March 31, 1995 by and between University Real Estate Partnership V, a California limited partnership, and Imperial Bank, a California banking corporation in the amount of $250,000. (5)\n10.24 Amended and Restated Forbearance Agreement entered into on April 28, 1995 by and between University Real Estate Partnership V, a California limited partnership and Imperial Bank, a California banking corporation. (5)\n10.25 Promissory Note dated September 13, 1995 by and between Washington Towne Apartments, L.L.C. and First Union National Bank of North Carolina for the principal amount of $1,750,000. (6)\n10.26 Deed to Secure Debt and Security Agreement dated September 13, 1995 by and between Washington Towne Apartments, L.L.C. and First Union National Bank of North Carolina. (6)\n10.27 Assignment of Leases and Rents dated September 13, 1995, by and between Washington Apartments, L.L.C. and First Union Bank of North Carolina. (6)\n10.28 Indemnity and Guaranty Agreement dated September 13, 1995 by and between University Real Estate Partnership V and First Union National Bank. (6)\nExhibit Number Description ------ -----------\n11. Statement regarding computation of Net Loss per Limited Partnership Unit: Net Loss per Limited Partnership Unit is computed by dividing net loss allocated to the Limited Partners by the number of Limited Partnership Units outstanding. Per unit information has been computed based on 34,353 and 34,453 Limited Partnership Units outstanding in 1995 and 1994 respectively.\n16. Letter dated July 18, 1995 from Price Waterhouse LLP with respect to a change in certifying accountant. Incorporated by reference to Form 8-K - Current Report for the period ending September 30, 1995, as filed with the Securities and Exchange Commission on July 24, 1995.\n(2) Incorporation by reference to Annual Report of the Registrant on Form 10-K for the period ended December 31, 1993, as filed with the Securities and Exchange Commission on March 30, 1995.\n(3) Incorporated by reference to Quarterly Report of the Registrant on Form 10-Q for the period ended September 30, 1994, as filed with the Securities and Exchange Commission on October 6, 1995.\n(4) Incorporated by reference to Annual Report of the Registrant on Form 10-K for the period ended December 31, 1994, as filed with the Securities and Exchange Commission on October 10, 1995.\n(5) Incorporated by reference to Quarterly Report of the Registrant on Form 10-Q for the period ending March 31, 1995, as filed with the Securities and Exchange Commission on November 20, 1995.\n(6) Incorporated by reference to Quarterly Report of the Registrant on Form 10-Q for the period ending September 30, 1995, as filed with the Securities and Exchange Commission on May 23, 1996.\n(b) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended December 31, 1995.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\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.\nUNIVERSITY REAL ESTATE PARTNERSHIP V\nBy: UNIVERSITY ADVISORY COMPANY General Partner\nBy: SOUTHMARK INVESTORS, INC. a General Partner\nJuly 17, 1996 By: \/s\/ Glen Adams - -------------------------- --------------------------------- Date Glen Adams, 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.\nJuly 17, 1996 By: \/s\/ Glen Adams - -------------------------- --------------------------------- Date Glen Adams, President, Principal Executive Officer, and Director Southmark Investors, Inc.\nJuly 17, 1996 By: \/s\/ Charles B. Brewer - -------------------------- --------------------------------- Date Charles B. Brewer, Executive Vice President and Principal Financial and Accounting Officer Southmark Investors, Inc.","section_15":""}
{"filename":"793952_1995.txt","cik":"793952","year":"1995","section_1":"ITEM 1. BUSINESS - ------- -------- SUMMARY - -------\nHarley-Davidson, Inc. was incorporated in 1981, at which time it purchased the Harley-Davidson Motorcycle Business from AMF Incorporated (currently doing business as Minstar) in a management buyout. In 1986, Harley-Davidson, Inc. became publicly held. Unless the context otherwise requires, Harley-Davidson, Inc. (the \"Company\") includes all of its subsidiaries and other wholly owned affiliates. The Company operates in two segments (excluding discontinued operations): Motorcycles and Related Products, and Financial Services.\nThe Motorcycles and Related Products (\"Motorcycles\") segment consists primarily of its wholly-owned subsidiary Harley-Davidson Motor Company (the \"Motor Company\"). The Motorcycles segment designs, manufactures and sells primarily heavyweight (engine displacement of 751cc or above) touring and custom motorcycles and a broad range of related products which include motorcycle parts and accessories and riding apparel. The Company, which is the only major American motorcycle manufacturer, has held the largest share of the United States heavyweight motorcycle market since 1986. While definitive market share information (engine displacement of 751cc or above) is not available in many foreign countries, the Company believes it holds an approximate 11% market share in the European markets in which it competes and a 22% market share in the Pacific Rim (Japan and Australia).\nThe Financial Services segment consists of the Company's majority-owned subsidiary, Eaglemark Financial Services, Inc.(\"Eaglemark\"). Eaglemark provides motorcycle floor planning and parts and accessories financing to the Company's participating North American dealers. Eaglemark also offers retail financing opportunities to the Company's domestic motorcycle customers. In addition, Eaglemark has established a proprietary credit card for use in the Company's independent dealerships. Eaglemark also provides property and casualty insurance for motorcycles as well as extended warranty contracts. A smaller portion of its customers are in other leisure products businesses.\nIn January, 1996, the Company announced its strategic decision to discontinue the operations of its Transportation Vehicles segment in order to concentrate its financial and human resources on its core motorcycle business. On March 6, 1996, the Company completed the sale of substantially all of the assets of its Holiday Rambler Recreational Vehicle Division (the \"RV Division\") to Monaco Coach Corporation (\"Monaco\"). Monaco acquired the RV Division's manufacturing operations located in Wakarusa, Indiana and 10 of its 14 Holiday World Recreational Vehicle Dealerships. The sale of the remainder of the Transportation Vehicles segment is expected to be finalized during 1996. The Company does not anticipate a loss on the discontinuance of the Transportation Vehicles segment. The results of the Transportation Vehicles segment have been reported separately as discontinued operations. Prior year financial information has been restated to present the Transportation Vehicles segment as a discontinued operation. See Note 3 to the 1995 consolidated financial statements for further information.\nRevenue, operating income (loss) and identifiable assets attributable to each of the Company's segments are as follows (in thousands):\n(1) The Transportation Vehicles segment was reported as discontinued operations in 1995. Prior year results have been reclassified in order to conform to this presentation. See note 3 to the 1995 consolidated financial statements for further information.\n(2) The Financial Services segment's 1995 results of operations are included in operating income. During 1994 and 1993, the equity in earnings of the Financial Services subsidiary was included in other income. See note 4 to the 1995 consolidated financial statements for further information.\nThe domestic heavyweight motorcycle market continued to expand in 1995. Worldwide quarterly revenue and operating income (loss) (in thousands), by segment, and motorcycle shipment information, are as follows:\nMOTORCYCLES AND RELATED PRODUCTS\nThe primary business of the Motorcycles segment is to produce and sell premium heavyweight motorcycles. The Company's motorcycle products emphasize traditional styling, design simplicity, durability, ease of service and evolutionary change. Studies by the Company indicate that the typical U.S. Harley-Davidson(R) motorcycle owner is a male in his early forties, with a household income of approximately $66,000, who purchases a motorcycle for recreational purposes rather than to provide transportation and who is an experienced motorcycle rider. Over two-thirds of the Company's sales are to buyers with at least one year of higher education beyond high school, and 34% of the buyers have college degrees. Approximately 9% of the Company's U.S. retail sales are to female buyers.\nThe heavyweight class of motorcycles is comprised of four types: standard, which emphasizes simplicity and cost; performance, which emphasizes handling and speed; touring, which emphasizes comfort and amenities for long-distance travel; and custom, which emphasizes styling and individual owner customization. Touring and custom models are the primary classes of heavyweight motorcycles the Company manufactures. The Company presently manufactures and sells 23 models of touring and custom heavyweight motorcycles, with suggested retail prices ranging from approximately $5,100 to $18,200. The touring segment of the heavyweight market was pioneered by the Company and includes motorcycles equipped for long-distance touring with fairings, windshields, saddlebags and Tour Paks(R). The custom segment of the market includes motorcycles featuring the distinctive styling associated with certain classic Harley-Davidson motorcycles. These motorcycles are highly customized through the use of trim and accessories. The Company's motorcycles are based on variations of four basic chassis designs and are powered by one of three air cooled, twin cylinder engines of \"V\" configuration which have displacements of 883cc, 1200cc and 1340cc. The Company manufactures its own engines and frames.\nDuring 1993, the Company acquired a 49 percent interest in Buell Motorcycle Company (\"Buell\"), a manufacturer of performance motorcycles. This investment in Buell offers the Company the possibility of gradually gaining entry into select niches within the performance motorcycle market. Buell began distribution of a limited number of Buell motorcycles during 1994 to select domestic Harley- Davidson dealers.\nAlthough there are some accessory differences between the Company's top-of-the line touring motorcycles and those of its competitors', suggested retail prices are generally comparable. The top of the Company's custom product line is typically priced as much as 50% more than its competitors' custom motorcycles. The custom portion of the product line represents the Company's highest unit volumes and continues to command a premium price because of its features, styling and high resale value. The Company's smallest displacement custom motorcycle (the 883cc Sportster(R)) is directly price competitive with competitors' comparable motorcycles. The Company's surveys of retail purchasers indicate that, historically, over three-quarters of the purchasers of its Sportster model have come from competitive-brand motorcycles, are people completely new to the sport of motorcycling or have not participated in the sport for at least five years. Since 1988, the Company's research has consistently shown a repurchase intent in excess of 92% on the part of purchasers of its motorcycles, and the Company expects to see sales of its 883cc Sportster model partially translated into sales of its higher-priced products in the normal two to three year ownership cycle. Domestic motorcycle sales generated 49.3%, 50.3% and 51.4% of revenues in the Motorcycles segment during 1995, 1994 and 1993, respectively.\nThe major product categories for the Parts and Accessories business are replacement parts (Genuine Motor Parts(TM)), mechanical accessories (Genuine Motor Accessories(TM)), rider accessories\n(MotorClothes(R) clothing and collectibles) and specially formulated oil and other lubricants. Domestic motorcycle Parts and Accessories sales comprised 17.4%, 17.8% and 17.4% of net sales in the Motorcycles segment in 1995, 1994 and 1993, respectively. Net sales from domestic motorcycle Parts and Accessories have grown 86.6% over the last three years (since 1992).\nThe Company also provides a variety of services to its dealers and retail customers including service training schools, delivery of its motorcycles, motorcycling vacations, memberships in an owners club and customized software packages for dealers. The Company has had success under a program emphasizing modern store design and display techniques in the merchandising of parts and accessories by its dealers. Currently, 425 domestic and 130 international dealerships have completed store design renovation projects.\nLicensing. In recent years, the Company has endeavored to create an awareness of the brand among the non-riding public and provide a wide range of product for enthusiasts by licensing its trademark \"Harley-Davidson(R)\" and numerous related trademarks owned by the Company. The Company currently has licensed the production and sale of a broad range of consumer items, including t-shirts and other clothing, jewelry, small leather goods and numerous other products and is expanding its licensing activity in the toy category. In 1993, the licensed Harley-Davidson Cafe opened in Manhattan, New York. In 1995, the Company entered into an agreement for licensing three additional restaurants with the Cafe owners. Although the majority of licensing activity occurs in the U.S., the Company has expanded into international markets in coordination with international marketing efforts.\nThis licensing activity provides the Company with a valuable source of advertising and goodwill. Licensing also has proven to be an effective means for enhancing the Company's image with consumers and provides an important tool for policing the unauthorized use of the Company's trademarks, thereby protecting the brand and its use. Royalty revenues from licensing were approximately $24 million, $22 million and $14 million during 1995, 1994 and 1993, respectively. While royalty revenues from licensing activities are relatively small, the profitability of this business is relatively high.\nMarketing and Distribution. The Company's basic channel of United States distribution for its motorcycles and related products consists of approximately 600 independently owned full-service dealerships to whom the Company sells direct. With respect to sales of new motorcycles, approximately 75% of the dealerships sell Harley-Davidson motorcycles exclusively. All dealerships carry Genuine Harley-Davidson replacement parts and aftermarket accessories and perform servicing of Harley-Davidson motorcycle products.\nThe Company's marketing efforts are divided among dealer promotions, customer events, magazine and direct mail advertising, public relations, and cooperative programs with Harley-Davidson dealers. The Company also sponsors racing activities and special promotional events and participates in all major motorcycle consumer shows and rallies. In an effort to encourage Harley-Davidson owners to become more actively involved in the sport of motorcycling, the Company formed a riders club in 1983. The Harley Owners Group(R), or \"HOG(R)\", currently has approximately 292,000 members worldwide and is the industry's largest company-sponsored motorcycle enthusiast organization. The Company's expenditures on domestic marketing and advertising were approximately $71.5 million, $65.6 million and $53.8 million during 1995, 1994 and 1993, respectively.\nRetail Customer and Dealer Financing. Among the factors affecting the volume of the Motor Company's parts and accessory, and to a lesser extent motorcycle, sales are the availability and cost\nof credit to both retail purchasers and Harley-Davidson dealers. The Motor Company believes that Eaglemark and other financial services companies provide adequate retail and wholesale financing to the Motor Company's dealers and customers. In addition, to encourage its dealers to carry sufficient parts and accessories inventories and to counteract the seasonality of the parts and accessories business, the Motor Company from time to time offers its domestic dealers quarterly special discounts and\/or 120 day delayed billing terms through Eaglemark.\nInternational Sales. International sales were $395 million, $331 million and $263 million, accounting for approximately 29%, 29% and 28% of net sales of the Motorcycles segment, during 1995, 1994 and 1993, respectively. The Company believes the international heavyweight market is growing and is significantly larger than the U.S. heavyweight market. The Company estimates, using data reasonably available to the Company, that it holds an approximate 11% market share in the European markets in which it competes and an approximate 22% market share in the Pacific Rim (Japan and Australia).\nThe Company has three wholly owned foreign subsidiaries located in Germany, Japan and the United Kingdom. The German subsidiary also serves Austria, France, Denmark, Czech Republic, Hungary and Poland. The combined foreign subsidiaries have a network of 133 dealers of which approximately one-half sell the Company's motorcycles exclusively. Distribution through these subsidiaries allows the Company flexibility in responding to changing economic conditions in a variety of foreign markets. The Company is represented throughout the rest of the world by an independent network of distributors and direct sales dealers. At the end of 1995, this network included 15 distributors serving 17 country markets with approximately 275 dealers. The remainder of the network includes 19 direct sales dealers serving 17 country markets. Germany, Japan, Canada and Australia, in that order, represent the Company's largest export markets and account for approximately 60% of export sales. See Note 12 to the consolidated financial statements for additional information regarding foreign operations.\nDuring 1994, the Company established its European Distribution Centre in Rotterdam which consolidated the motorcycle and Parts and Accessories distribution. In 1995, the Company established the Harley-Davidson European headquarters in the United Kingdom which created an in-country management team dedicated to improving the relationships between the Company and its distributors, dealers and customers. The focus in 1996 will be on gradual expansion of the dealer network, improved management information systems, better product availability and development of new markets.\nIn the Asia\/Pacific region, the findings of an intensive market study that the Company conducted, the early stages of which were completed in 1995, show that short-term growth opportunities will come from existing markets, led by Japan and Australia, with long-term growth coming from developing new markets. The focus of 1996 is to ensure consistency among our dealer network with special emphasis on increasing technical service competencies.\nCompetition. The U.S. and international heavyweight motorcycle markets are highly competitive. The Company's major competitors generally have financial and marketing resources which are substantially greater than those of the Company. The Company's principal competitors have larger overall sales volumes and are more diversified than the Company. The Company believes that the heavyweight motorcycle market is the most profitable segment of the U.S. motorcycle market. During 1995, the heavyweight segment represented approximately 36% of the total U.S. motorcycle market in terms of new units registered.\nThe Company first began to experience significant competition in the domestic heavyweight motorcycle market from Japanese manufacturers in the early 1970's, and prior to 1984, the Company's U.S. market share declined almost continuously. Domestically, the Company competes in the touring and custom segments of the heavyweight motorcycle market, which together accounted for 78%, 76% and 75% of total heavyweight retail unit sales in the U.S. during 1995, 1994 and 1993, respectively. The custom and touring motorcycles are generally the most expensive and most profitable vehicles in the market.\nFor the last 10 years, the Company has led the industry in domestic sales of heavyweight motorcycles. The Company's share of the heavyweight market was 55.8% in 1995; down slightly from 56.1% in 1994. This is primarily a result of the Company's constrained production capacity in a growing market. The Company is currently reviewing alternative sites for the construction of a new manufacturing facility to enable it to achieve its long-term goal of nearly doubling motorcycle production capacity by 2003. The Company currently estimates it will have the capacity to produce at least 115,000 units in 1996, 125,000- 130,000 units in 1997 and 145,000-150,000 units in 1998.\n* Information in this report regarding motorcycle registrations and market shares has been derived from data published by R.L. Polk & Co.\n- ------------------------------------------------------------------------------\nOn a worldwide basis, the Company measures its market share using the heavyweight classification. Although definitive market share information does not exist for many of the smaller foreign markets, the Company estimates its worldwide competitive position, using data reasonably available to the Company, to be as follows:\n(1) Includes the United States and Canada (2) Includes Austria, Belgium, France, Germany, Italy, Netherlands, Spain, Switzerland and United Kingdom.\n- ----------------------------------------------------------------------\nCompetition in the heavyweight motorcycle market is based upon a number of factors, including price, quality, reliability, styling, product features and warranties. The Company emphasizes quality, reliability and styling in its products and offers warranties which are generally comparable to those of its competitors. In general, resale prices of Harley-Davidson motorcycles, as a percentage of price when new, are significantly higher than resale prices of motorcycles sold by the Company's competitors.\nDomestic heavyweight registrations increased 11% and 15% during 1995 and 1994, respectively. The Company believes its ability to maintain its current market share will depend primarily on its ability to increase its annual production capacity as discussed below.\nTo enhance international growth, the Company completed, in 1994, a study of Europe, the world's largest heavyweight motorcycle market, and began implementation of new strategies to improve the quality of its distribution systems, dealer network and customer support activities there. In addition, the Company has begun a similar study of its current and future potential in the Asia\/Pacific region, to determine the levels of commitment required to adequately serve the needs of motorcycle customers in this region.\nMotorcycle Manufacturing. In an effort to achieve cost and quality parity with its competitors, the Company has incorporated manufacturing techniques to continuously improve its operations. These techniques, which include employee involvement, just-in-time inventory principles and statistical process control, have significantly improved quality, productivity and asset utilization.\nThe Company's use of just-in-time inventory principles allows it to minimize its inventories of raw materials and work in process, as well as scrap and rework costs. This system also allows quicker reaction to engineering design changes, quality improvements and market demands. The Company has trained the majority of its manufacturing employees in problem solving and statistical methods.\nThe Company is in the process of completing a comprehensive motorcycle manufacturing strategy designed to, among other things, enable further increases in annual motorcycle production in order to nearly double its production capacity by 2003. \"Plan 2003\" calls for the enhancement of the Motorcycles segment's ability to increase capacity, adjust to changes in the market place and further improve quality while reducing costs. The strategy calls for the achievement of the increased capacity (up to 150,000 units) at the existing facilities (with some additions) and construction of a new assembly plant. The Company expects to begin implementing Plan 2003 in 1996 and estimates that it will reach the production goal of at least 115,000 units in 1996. In addition, the Company currently estimates it will have the capacity to produce 125,000- 130,000 units in 1997 and 145,000-150,000 units in 1998.\nRaw Material and Purchased Components. The Company has endeavored to establish with its suppliers long-term informal \"partnership\" relationships, directly assisting them in the implementation of the manufacturing techniques employed by the Company through training sessions and plant evaluations. In furtherance of the Company's \"partnership\" philosophy, the Company reduced the number of its manufacturing suppliers in recent years and is conducting more business with suppliers that have implemented these same manufacturing techniques in their manufacturing operations.\nThe Company purchases all of its raw material, principally steel and aluminum castings, forgings, sheets and bars, and certain motorcycle components, including carburetors, batteries, tires, seats, electrical components and instruments. Certain of these components are secured from one of a limited number of suppliers. Interruptions from certain of these suppliers could adversely affect the Company's production pending the establishment of substitute supply arrangements. The Company anticipates no significant difficulties in obtaining raw materials or components for which it relies upon a limited source of supply.\nResearch and Development. The Company believes that research and development are significant factors in the Company's ability to continuously improve its competitive position. As a result, the Company began construction of a new 200,000 square foot Product Development Center in 1995. The cost is estimated at approximately $25 million, and construction is scheduled to be completed in December, 1996. The Motorcycles segment incurred research and development expenses of approximately $27.2 million, $22.1 million and $19.2 million during 1995, 1994 and 1993, respectively.\nPatents and Trademarks. The Company owns certain patents which relate to its motorcycles and related products and processes for their production. The Company believes that the loss of any of its patents would not have a material effect upon its business.\nTrademarks are important to the Company's motorcycle business and licensing activities. The Company has a vigorous global program of trademark registration and enforcement to strengthen the value of its trademarks, prevent the unauthorized use of its trademarks and improve its image and\ncustomer goodwill. The Company believes that its \"Harley-Davidson(R)\" trademark is highly recognizable by the general public and one of its most valuable assets. The Company's Bar and Shield design trademark is also highly recognizable by the general public. Additionally, the Company has numerous trademarks, trade names and logos, registered both in the United States and abroad. The Company has continuously used the \"Harley-Davidson\" trademark since 1903 and the Bar and Shield trademark since 1910.\nSeasonality. The Company, in general, does not experience significant seasonal fluctuations in motorcycle production. This is primarily the result of a strong demand for the Company's motorcycles and related products, as well as the availability of floor plan financing arrangements for its North American independent dealers. Floor plan financing allows dealers to build their inventory levels in anticipation of the spring and summer selling seasons.\nRegulation. Both federal and state authorities have various environmental control requirements relating to air, water and noise pollution which affect the business and operations of the Company. The Company endeavors to ensure that its facilities and products comply with all applicable environmental regulations and standards.\nTo ensure compliance with lower European Union noise standards (80dba), which took effect in calendar year 1994, the Company began a product development program during late 1990. The design changes were implemented in July 1994 (1995 model year start-up) after European Union Certification procedures were completed. Near the end of the decade there may be a further reduction of European Union noise standards (to 77dba). Accordingly, the Company anticipates that it will continue to incur some level of research and development costs related to this matter over the next several years.\nThe Company's motorcycles are subject to certification by the U.S. Environmental Protection Agency (EPA) for compliance with applicable emissions and noise standards and by the State of California Air Resources Board (ARB) with respect to the ARB's more stringent emissions standards. The Company's motorcycles are subjected to the additional ARB tailpipe and evaporative emissions standards that require the Company to build unique vehicles for sale exclusively in California. The Company's motorcycle products have been certified to comply fully with all such applicable standards.\nThe Company, as a manufacturer of motorcycle products, is subject to the National Traffic and Motor Vehicle Safety Act (Safety Act), which is administered by the National Highway Traffic Safety Administration (NHTSA). The Company has acknowledged to NHTSA that its motorcycle products comply fully with all applicable federal motor vehicle safety standards and related regulations.\nIn accordance with NHTSA policies, the Company has from time to time initiated certain voluntary recalls. During the last three years, the Company has initiated 6 voluntary recalls at a total cost of approximately $3.1 million. The Company fully reserves for all estimated costs associated with recalls in the period that they are announced.\nFederal, state, and local authorities have adopted various control standards relating to air, water, and noise pollution which affect the business and operations of the Motorcycles segment. Management does not anticipate that any of these standards will have a materially adverse impact on its capital expenditures, earnings, or competitive position.\nEmployees. As of December 31, 1995, the Motorcycles segment had approximately 4,800 employees. Production workers at the motorcycle manufacturing facilities in Wauwatosa and Tomahawk, Wisconsin, are represented principally by the United Paperworkers International Union (UPIU) of the AFL-CIO, as well as the International Association of Machinist and Aerospace Workers (IAM). Production workers at the motorcycle manufacturing facility in York, Pennsylvania, are represented principally by the IAM. The collective bargaining agreement with the UPIU and the Wisconsin-IAM will expire on April 14, 2001, and the collective bargaining agreement with the Pennsylvania-IAM will expire on February 2, 1997.\nFINANCIAL SERVICES\nEaglemark Financial Services, Inc. provides private label financial services programs to leisure product manufacturers, their dealers and customers in the United States and Canada. The Company acquired a 49% interest in Eaglemark in 1993 and acquired substantially all of the remaining shares in 1995. Eaglemark commenced doing business in 1993 with the purchase of the Harley- Davidson wholesale financing portfolio from ITT Commercial Finance Corporation.\nHarley-Davidson. Eaglemark's largest division provides both wholesale and retail financial services to Harley-Davidson dealers and customers and operates under the trade names Harley-Davidson(R) Credit and Harley-Davidson(R) Insurance. Wholesale financial services include floorplan financing of motorcycles, trade acceptance financing of motorcycle parts and accessories, computer loans, showroom remodeling loans and the brokerage of a range of commercial insurance products, including property and casualty, general liability and special events insurance policies. Eaglemark's wholesale financial services are offered to all Harley-Davidson dealers in the United States and Canada and during 1995 were utilized one or more times by approximately 90% of such dealers. Eaglemark's wholesale finance operations are located in Plano, Texas.\nRetail financial services include installment lending for new and used Harley- Davidson motorcycles, the Harley Card(TM), an exclusive credit card for use only in Harley-Davidson dealerships, and the brokerage of a range of motorcycle insurance products, including liability, casualty, and credit life and disability insurance policies, and extended warranty agreements. Eaglemark's retail financial services are available through virtually all Harley-Davidson dealers in the United States and Canada. Eaglemark's retail finance operations are located in Carson City, Nevada.\nOther Manufacturers. Eaglemark also provides private label wholesale and retail financial services (other than extended warranty agreements) through manufacturer participation programs to Holiday Rambler(R), Boston Whaler(R), Skeeter(R), Mastercraft(TM) and WetJet(TM) dealers and customers. These programs are similar to the Harley-Davidson program described above.\nFunding. Eaglemark's growth has been funded through a combination of capital contributions from the Company, commercial paper borrowings, revolving credit facility borrowings and securitization of its retail installment loans. Future growth is expected to be financed by using similar sources as well as internally generated funds. Eaglemark acts only as an insurance agent and does not assume any underwriting risk with regard to the various insurance policies and extended warranty agreements that it sells.\nCompetition. Eaglemark believes that its ability to offer a package of wholesale and retail financial services utilizing the name of the manufacturer provides a significant competitive advantage over its competitors. Its competitors compete for business based largely on price and, to a lesser extent, service. Eaglemark competes based on convenience, service and, to a lesser extent, price.\nThe only significant national retail financing competitor for Harley-Davidson motorcycle installment loans is Greentree Financial. Greentree Financial does not offer insurance products, extended warranty, or the private-label credit card and focuses on high volume Harley-Davidson dealers. In contrast, competition to provide retail financial services to recreational vehicle and watercraft dealers is substantial, with many competitors being much larger than Eaglemark. These competitors include The CIT Group, Ganis Credit Corp, BankOne and Key Bank USA. Credit unions, banks, other financial institutions and insurance agencies also compete for retail financial services business in their local markets.\nEaglemark faces little national competition for the Harley-Davidson wholesale finance business. Competitors are primarily banks and other financial institutions who provide wholesale financing to Harley-Davidson dealers in their local markets. In contrast, competition to provide wholesale financial services to recreational vehicle and watercraft dealers is substantial, with many competitors being much larger than Eaglemark. These competitors include Deutsche Financial, NationsCredit, Bombardier and Transamerica. They typically offer manufacturer sponsored programs similar to Eaglemark's programs.\nPatents and Trademarks. Eaglemark has applied for federal trademark registrations for the name \"Eaglemark\" and the Eaglemark logo. All the other trademarks or trade names used by Eaglemark, such as Harley-Davidson Credit and MasterCraft Credit, are licensed from the manufacturer.\nSeasonality. The leisure products for which Eaglemark currently provides financial services are primarily used only during the warmer months of the year in the northern United States and Canada, generally March through August. As a result, the business experiences significant seasonal variations. From September until mid-March dealer inventories build and turn more slowly, increasing wholesale financing volume substantially. During this same time there is a corresponding decrease in the retail financing volume. Customers typically do not buy motorcycles, watercraft and recreational vehicles until they can use them. From about mid-March through August retail financing volume increases and wholesale financing volume decreases.\nEmployees. As of December 31, 1995, the Financial Services segment had approximately 180 employees. None of Eaglemark's personnel are represented by labor unions.\nTRANSPORTATION VEHICLES (DISCONTINUED OPERATIONS)\nAs previously discussed, on January 22, 1996, the Company announced its strategic decision to discontinue the operations of the Transportation Vehicles segment in order to concentrate its financial and human resources on its core motorcycle business. The Transportation Vehicles segment is comprised of the Commercial Vehicles division and B & B Molders, a manufacturer of custom or standard tooling and injection molded plastic pieces and formerly included the Recreational Vehicles division. The Company does not anticipate a loss on the discontinuance of the Transportation Vehicles segment, which is expected to be finalized during 1996. The results of the Transportation Vehicles segment have been reported separately as discontinued operations. Prior year financial information has been restated to present the Transportation Vehicles segment as a discontinued operation.\nCOMMERCIAL VEHICLES - -------------------\nThe Company, through its Utilimaster division, builds a variety of commercial body configurations for special uses. Sales of the Commercial Vehicles division accounted for 29.7%, 24.8% and 27.8% of the Transportation Vehicles segment's revenues in 1995, 1994 and 1993, respectively.\nUtilimaster currently installs its bodies on chassis of various sizes supplied by third parties. The Company's products are offered in aluminum or fiberglass reinforced plywood (FRP) construction and are available in lengths of 9 to 28 feet. The Company's products (excluding chassis) range in price from $2,800 to $16,000 although special service vehicles can sell as high as $80,000.\nThe principal types of commercial bodies are as follows:\nParcel Delivery Vans - Aluminum or FRP parcel delivery van bodies are installed on chopped van chassis supplied by the major Detroit truck manufacturers. These parcel delivery van bodies range in length from 10 to 16 feet and are primarily used for local delivery of parcels, freight and perishables.\nWalk-In Vans - Utilimaster manufactures its walk-in vans (step-vans) on a truck chassis supplied with engine and drive train components, but without a cab. The Company fabricates the driver's compartment and body using aluminum panels. Uses for these vans include the distribution of food products and small packages.\nTruck Bodies - Utilimaster's truck bodies are typically fabricated up to 28 feet in length with prepainted aluminum or FRP panels, aerodynamic front and side corners, hardwood floors, and various door configurations to accommodate end-user loading and unloading requirements. These products are used for diversified dry freight transportation. The Company installs its truck bodies on chassis supplied with a finished cab.\nMobile Rescue and Special Use Emergency Vehicles - Utilimaster builds a variety of high cube and walk-in specialty use vehicles for the fire and rescue industry. These vehicles range in lengths from 10 to 22 feet and usually require extensive customization to meet the needs of the local emergency agencies.\nRECREATIONAL VEHICLES - ---------------------\nOn March 6, 1996, the Company completed the sale of substantially all of the assets of its Holiday Rambler Recreational Vehicles Division to Monaco Coach Corporation (\"Monaco\"). Monaco acquired the Recreational Vehicles division's manufacturing operations located in Wakarusa, Indiana and 10 of its 14 Holiday World Recreational Vehicle Dealerships. The Company is in the process of disposing of the remaining 4 dealerships.\nPrincipal types of recreational vehicles produced by the Recreational Vehicles division included Class A or \"conventional\" motorhomes, fifth wheel travel trailers and conventional travel trailers. Recreational vehicle classifications are based upon standards established by the Recreation Vehicle Industry Association. The Recreational Vehicles division marketed its recreational vehicle products through a network of over 115 dealers located throughout the continental United States, including fourteen company-owned Holiday World dealerships.\nThe Recreational Vehicles division's sales (including retail, wholesale and other sales) were $304.1 million, $274.5 million and $192.7 million in 1995, 1994 and 1993, respectively. Sales of the Recreational Vehicles division accounted for 68.5%, 71.7% and 67.8% of the Transportation Vehicles segment's revenues for the years ended December 31, 1995, 1994 and 1993, respectively.\nOTHER PRODUCTS - --------------\nThe Transportation Vehicles segment's B & B Molders division designs and manufactures a diverse range of custom or standard tooling and injection molded plastic pieces. The Transportation Vehicles segment's Creative Dimensions division produced a broad line of contemporary office furniture. The Creative Dimensions division was sold in the second quarter of 1995.\nOther products accounted for 1.8%, 3.5% and 4.4% of the Transportation Vehicles segment revenues for the years ended December 31, 1995, 1994 and 1993, respectively.\nALL DIVISIONS - -------------\nProduction - Holiday Rambler's products are built utilizing an assembly line process. Holiday Rambler has designed and built its own fabricating and assembly equipment for the majority of its manufacturing processes. In addition to assembling its products and installing various options and accessories, Holiday Rambler manufactures a majority of its plastic components and other installed products, such as draperies, bathtubs, holding tanks, wheel covers, and wiring harnesses.\nProduction Materials. The principal raw materials and other components used in the production of commercial vehicles are purchased from third parties. With the exception of the chassis, these materials, including aluminum, plywood, lumber, plastic and fiberglass, are generally available from numerous sources. In general, Holiday Rambler has not experienced any substantial shortages of raw materials or components. However, the industry has occasionally experienced short-term chassis shortages.\nPatents and Trademarks. The Transportation Vehicles segment owns various patents and know-how which relate to its recreational vehicles and other products and the processes for their production. The Company believes that the loss of any of these patents would not have a material effect upon its business.\nTrademarks are important to the Transportation Vehicles segment's commercial vehicle business. The Transportation Vehicles segment has several valuable registered trademarks, trade names, and logos used in its business.\nRegulation. The manufacture, distribution, and sale of the Transportation Vehicles segment's vehicles are subject to governmental regulations in the United States at the federal, state, and local levels. The most extensive regulations are promulgated under the Safety Act which, among other things, enables the NHTSA to require a manufacturer to remedy vehicles containing \"defects related to motor vehicle safety\" or vehicles which fail to conform to all applicable federal motor vehicle safety standards. Pursuant to the Safety Act and related regulations, the Transportation Vehicles segment from time to time has initiated voluntary recalls of its recreational and commercial vehicles. Since the beginning of 1993, recalls by the Transportation Vehicles segment initiated under the Safety Act, all of which have been voluntary, have involved an aggregate cost to the Company of approximately $1.0 million.\nFederal, state, and local authorities have adopted various control standards relating to air, water, and noise pollution which affect the business and operations of the Transportation Vehicles segment. Management does not anticipate that any of these standards will have a materially adverse impact on its capital expenditures, earnings, or competitive position.\nEmployees. As of December 31, 1995, the Transportation Vehicles segment had approximately 2,400 employees. None of the segment's personnel are represented by labor unions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------- ----------\nThe following is a summary of the principal properties of the Company as of March 22, 1996.\nMotorcycles and Related Products Segment - ----------------------------------------\nThe Motorcycles segment has three facilities that perform manufacturing operations: Wauwatosa, Wisconsin, a suburb of Milwaukee (motorcycle power train production); Tomahawk, Wisconsin (fiberglass parts production and painting); and York, Pennsylvania (motorcycle parts fabrication, painting and assembly).\nThe Company estimates that generally the size of the existing facilities, with some additions, would be adequate to meet its current goal of being able to produce 145,000-150,000 motorcycles annually by 1998. The Company is currently reviewing alternative sites for the construction of a new manufacturing facility to enable it to achieve its long-term goal of nearly doubling motorcycle production capacity by 2003.\nFinancial Services Segment - ----------------------------\nThe Financial Services segment has three office facilities: Chicago, Illinois, (corporate headquarters); Carson City, Nevada, (retail and insurance operations); and Plano, Texas (wholesale operations).\nTransportation Vehicles Segment - -------------------------------\nThe above table does not reflect property sold to Monaco Coach Corporation on March 6, 1996. The Transportation Vehicles segment's units are manufactured in approximately 17 separate buildings. Additionally, the Segment owns 9 buildings used for administrative, storage, and other purposes. Substantially all of the facilities are located on three sites at or near the Transportation Vehicles segment's corporate headquarters in Wakarusa, Indiana. Because commercial vehicles are produced largely through a labor-intensive assembly process, the facilities do not house extensive capital equipment. The Transportation Vehicles segment's present facilities are generally adequate for their current intended use.\nItem 3.","section_3":"Item 3. Legal proceedings - ------- -----------------\nThe Company is involved with government agencies in various environmental matters, including a matter involving soil and groundwater contamination at its York, Pennsylvania facility (the Facility). The Facility was formerly used by the U.S. Navy and AMF (the predecessor corporation of Minstar). The Company purchased the facility from AMF in 1981. Although the Company is not certain as to the extent of the environmental contamination at the Facility, it is working with the Pennsylvania Department of Environmental Resources in undertaking certain investigation and remediation activities. In March 1995, the Company entered into a settlement agreement (the Agreement) with the Navy. The Agreement calls for the Navy and the Company to contribute amounts into a trust equal to 53% and 47%, respectively, of future costs associated with investigation and remediation activities at the Facility (response costs). The trust will administer the payment of the future response costs at the Facility as covered by the Agreement. In addition, in March 1991 the Company entered into a settlement agreement with Minstar related to certain indemnification obligations assumed by Minstar in connection with the Company's purchase of the Facility. Pursuant to this settlement,\nMinstar is obligated to reimburse the Company for a portion of its response costs at the Facility. Although substantial uncertainty exists concerning the nature and scope of the environmental remediation that will ultimately be required at the Facility, based on preliminary information currently available to the Company and taking into account the Company's settlement agreement with the Navy and the settlement agreement with Minstar, the Company estimates that it will incur approximately $5 million of net additional response costs at the Facility. The Company has established reserves for this amount. The Company has also put certain of its insurance carriers on notice that it intends to make claims relating to the environmental contamination at the Facility. However, the Company is currently unable to determine the probable amount of recovery available, if any, under insurance policies.\nIn the fourth quarter of 1995, the Company settled its trademark license dispute with Motorcycle Equities, Inc. (\"MEI\") by agreeing to extend MEI licenses for three additional restaurants. The lawsuit, including all counterclaims asserted by MEI, was dismissed. The settlement does not involve the payment of compensatory amounts.\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 the Company in the fourth quarter of 1995.\nExecutive officers of the registrant ------------------------------------\nThe following sets forth, as of March 22, 1996, the name, age and business experience for the last five years of each of the executive officers of Harley- Davidson.\nExecutive Officers ------------------\nAll of these individuals have been employed by the Company in an executive capacity for more than five years, except Martin R. Snoey. Mr. Snoey has been President and Chief Operating Officer of Holiday Rambler since joining the Company in January 1993. Prior to that time, he held, from January 1992 to December 1992, a general management consulting assignment with Precision Castparts Corporation, a specialty manufacturer supplying the transportation industry. From July 1989 to March 1991, he was the President and CEO of Geostar Corporation, an entrepreneurial, global satellite communications company, serving the transportation industry.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Harley-Davidson, Inc. common stock and related shareholder - ------- --------------------------------------------------------------------- matters -------\nHarley-Davidson, Inc. common stock is traded on the New York Stock Exchange. The high and low market prices for the common stock, reported as New York Stock Exchange Composite Transactions, were as follows:\nThe Company paid the following dividends:\nPrior to the declaration of its first quarterly dividends during 1993, the Company had not paid cash dividends on its common stock.\nThe Company has continuing authorization from its Board of Directors to repurchase up to 4 million shares of the Company's outstanding common stock. The repurchases are authorized to be made from time to time in the open market or in privately negotiated transactions. During 1995, the Company repurchased 1,650,000 shares of its common stock.\nAs of March 22, 1996, there were approximately 36,170 shareholders of record of Harley-Davidson, Inc. common stock.\nItem 6.","section_6":"Item 6. Selected financial data - -------------------------------\n*1993 includes a $57.0 million charge related primarily to the write-off of goodwill at Holiday Rambler. **During 1993, the Company adopted accounting standards related to postretirement health care benefits and income taxes.\nItem 7.","section_7":"Item 7. Management's discussion and analysis of financial condition and - ------- --------------------------------------------------------------- results of operations ---------------------\nRESULTS OF OPERATIONS 1995 COMPARED TO 1994\nOVERALL Net sales for 1995 of $1.4 billion were $191.6 million, or 16.5%, higher than net sales for 1994. Net income and earnings per share from continuing operations were $111.1 million and $1.48, respectively, for 1995 as compared with $96.2 million and $1.26, respectively, for 1994. Net income and earnings per share from discontinued operations were $1.4 million and $.02, respectively, for 1995 as compared with $8.0 million and $.11, respectively, for 1994, which included a $4.6 million, or $.06 per share, one-time tax benefit related to the legal reorganization of Holiday Rambler.\nOn January 22, 1996, the Company announced its strategic decision to discontinue the operations of the Transportation Vehicles segment in order to concentrate its financial and human resources on its core motorcycle business. The Company does not anticipate a loss on the discontinuance of the Transportation Vehicles segment. The results of the Transportation Vehicles segment have been reported separately as discontinued operations for each year presented.\nOn November 14, 1995, the Company acquired substantially all of the common stock and common stock equivalents of Eaglemark Financial Services, Inc. (Eaglemark) that it did not already own. The purchase price was approximately $45 million, which was paid from internally generated funds and short-term borrowings. The Company has included the results of operations of the Financial Services segment ($3.6 million) in its statement of operations for the year ended December 31, 1995 as though it had been acquired at the beginning of the year and deducted the preacquisition earnings as part of non- operating expense.\nThe Company increased its quarterly dividend in September from $.04 per share to $.05 per share which resulted in a total year payout of $.18 per share.\nMOTORCYCLE UNIT SHIPMENTS AND NET SALES\nThe Motorcycles and Related Products (Motorcycles) segment's net sales increased 16.5% over 1994 primarily due to a 9,293 unit (9.7%) increase in motorcycle shipments, as well as a 14.0% increase in its Parts and Accessories business. The increase in motorcycle shipments is the result of ongoing implementation of the Company's manufacturing strategy and efforts to satisfy demand. The manufacturing strategy is designed to increase capacity, adjust to changes in the market place and further improve product quality while reducing costs.\nSales of Buell motorcycles (which are distributed through select Harley- Davidson dealers) increased to $14 million in 1995 as compared to $6 million in 1994. (Included in \"Other\" in the above table.)\nThe Company began 1995 at a scheduled motorcycle production rate of 395 units per day. As the implementation of the manufacturing strategy continued, the rate increased to 470 units per day by the end of the year. The Company exceeded its production goal of 100,000 units in 1995 and anticipates 1996 production will reach at least 115,000 units. The Company is currently reviewing alternative sites for the construction of a new manufacturing facility to enable it to achieve its long-term goal of doubling motorcycle production by 2003.\nYear-end data indicates that the domestic (United States) motorcycle market continued to grow throughout 1995. Compared to 1994, industry registrations of domestic heavyweight (engine displacements in excess of 751cc) motorcycles were up 11.3% (data provided by R.L. Polk). The Company ended 1995 with a domestic market share of 55.8% compared to 56.1% in 1994. This decrease is a reflection of the Company's constrained production capacity in a growing heavyweight motorcycle market. Demand for the Company's motorcycles continues to exceed supply with nearly all of the Company's independent domestic dealers reporting retail orders on all of their remaining 1996 model year motorcycle allocations (production through June, 1996).\nExport revenues totaled $394.8 million during 1995, an increase of approximately $63.6 million (19.2%) over 1994. The Company has exported approximately 30% of its motorcycle unit shipments since 1990 and expects to maintain approximately the same percentage during 1996. The Company distributes approximately one-half of its exported units through its wholly owned subsidiaries in Germany, Japan and the United Kingdom, which allows the Company flexibility in responding to changing economic conditions in a variety of foreign markets. While definitive market share information (engine displacements in excess of 751cc) is not available in many foreign countries, the Company believes it holds an approximate 11% market share in the European markets in which it competes and a 22% market share in the Pacific Rim (Japan and Australia).\nDuring 1995, the Parts and Accessories business generated $292.3 million in revenues, an increase of 14.0% over 1994. The rate of increase is lower than experienced in recent years, however, management believes the 1995 increase is more indicative of the long-term growth potential of the Parts and Accessories business. The Motorclothes business, which accounted for approximately $100 million of Parts and Accessories sales in 1995, is expected to remain stable in 1996, while the Motor Parts and Motor Accessories businesses are expected to increase. The Parts and Accessories business is expected to grow at an annual rate similar to the annual growth rate in motorcycle shipments.\nThe Company is developing an improved system to better monitor domestic dealer inventories and retail traffic. In addition, the Company initiated several promotional programs in the fourth quarter of 1995 to increase dealer floor traffic and plans to continue this promotional strategy in 1996. To further strengthen its ability to process and fill orders for the Parts and Accessories business, the Company plans to construct a new distribution center (at an approximate cost of $17 million). Construction is scheduled to begin in the second quarter of 1996, and the facility should be fully operational by the first quarter of 1997.\nGROSS PROFIT\nGross profit increased $53.1 million, or 14.8%, in 1995 as compared with 1994 primarily due to an increase in volume. The gross profit margin was 30.5% in 1995 as compared with 30.9% in 1994. The gross profit margin was negatively affected by the overtime incurred to produce additional motorcycle units and make up for production time lost because production employees were involved in numerous strategic planning sessions during 1995.\nOPERATING EXPENSES (Dollars in Millions)\nOperating expenses for 1995 increased $29.4 million, or 14.4%, over 1994. The increase was primarily volume related. Engineering, information services and international operations were other principal areas of increased spending. The decrease in the Corporate charges is primarily due to a one-time charge in 1994 related to the legal reorganization of Harley-Davidson, Inc. and its Holiday Rambler subsidiaries.\nOPERATING INCOME FROM FINANCIAL SERVICES\nThe results of operations of the Financial Services segment for the year ended December 31, 1995 of $3.6 million have been included in operating profit and the preacquisition earnings have been deducted as part of non-operating expense. Prior to 1995, the Company accounted for its investment in Eaglemark using the equity method and included its share of earnings in other income.\nOTHER EXPENSE\nOther expense for 1995 of $4.9 million is primarily comprised of Eaglemark preacquisition earnings of $1.9 million, charitable donations of $1.9 million and loss on sale of machinery and equipment due to the ongoing manufacturing reorganization of $1.2 million.\nCONSOLIDATED INCOME TAXES\nThe Company's effective tax rate decreased in 1995 to 37.0% from 38.5% in 1994. The decrease is attributable primarily to the full year effect of a 1994 corporate restructuring.\nDISCONTINUED OPERATIONS\nThe operations for the Transportation Vehicles segment have been classified as discontinued operations. The results of operations, net of applicable income taxes, were net income of $1.4 million and $8.0 million in 1995 and 1994, respectively. 1994 included a one-time tax benefit of $4.6 million related to the legal reorganization of the Transportation Vehicles segment. The sale of the Recreational Vehicles division and ten of the fourteen Holiday World stores was completed in the first quarter of 1996 (the remaining four stores will be disposed of by the Company in due course). The disposition of the remaining businesses (Commercial Vehicles division and B&B Molders) is expected to be finalized during 1996.\nRESULTS OF OPERATIONS 1994 COMPARED TO 1993\nOVERALL Net sales for 1994 of $1.2 billion were $225.6 million, or 24.2%, higher than net sales for 1993. Net income and earnings per share from continuing operations were $96.2 million and $1.26, respectively, for 1994 as compared with $76.3 million and $1.00, respectively, for 1993, excluding the $30.3 million (after tax) one-time charge for accounting changes in 1993. Net income and earnings per share form discontinued operations were $8.0 million and $.11, respectively, for 1994 as compared with a net loss of $57.9 million and loss per share of $.76 for 1993 ($53.5 million, $.70 per share, of the 1993 loss was due to the write-off of goodwill).\nThe Company increased its quarterly dividend in September, 1994 from $.03 per share to $.04 per share which resulted in a total year payout of $.14 per share.\nMOTORCYCLE UNIT SHIPMENTS AND NET SALES\nThe Motorcycles and Related Products (Motorcycles) segment's net sales increased 24.2% over 1993 due to a 14,115 unit (17.3%) increase in motorcycle shipments, as well as a 28.8% increase in its Parts and Accessories business. The increase in motorcycle shipments was the result of ongoing implementation of the Company's manufacturing strategy to increase capacity, adjust to changes in the market place and further improve product quality while reducing costs.\nThe Company began 1994 at a scheduled motorcycle production rate of 365 units per day. As the implementation of the manufacturing strategy continued, the rate increased to 395 units per day by the end of the year.\nYear-end data indicates that the domestic (United States) motorcycle market continued to grow throughout 1994. Compared to 1993, industry registrations of domestic heavyweight motorcycles were up 14.5%. The Company ended 1994 with a domestic market share of 56.1% compared to 58.4% in 1993. This decrease is a reflection of the Company's constrained production capacity in a growing heavyweight motorcycle market.\nOverall, international demand remained strong. Export revenues totaled $331.2 million during 1994, an increase of approximately $68.4 million (26.0%) over 1993. The Company has exported approximately 30% of its motorcycle unit shipments since 1990. The Company distributed approximately one-half of its exported units through its wholly owned subsidiaries.\nDuring 1994, the Parts and Accessories business generated $256.3 million in revenues, an increase of 28.8% over 1993. The MotorClothes line increased 32.6% due in part to the introduction of the Biker Blues denim clothing line which contributed an incremental $3.7 million. Sales of Genuine Parts and Accessories, which outpaced aftermarket competitors, increased 26.8% over 1993.\nGROSS PROFIT\nGross profit increased $66.4 million, or 23% in 1994 as compared with 1993 primarily due to an increase in volume. The gross profit margin was 30.9% in 1994 as compared with 31.3% in 1993. The gross profit margin was negatively affected by the continued investment (approximately $10 million) in the manufacturing strategy designed to increase capacity, improve quality, and reduce costs. In addition, approximately 28% of 1994 unit shipments were lower- margin Sportster models compared to approximately 27% in 1993.\nOPERATING EXPENSES (Dollars in Millions)\nOperating expenses for 1994 increased $42.1 million, or 25.9%, over 1993. The increase was primarily volume related. MotorClothes advertising costs and product liability were other areas of increased spending. The increase in the Corporate charges is primarily due to a one-time charge related to the legal reorganization of Harley-Davidson, Inc. and its Holiday Rambler subsidiaries.\nOTHER EXPENSE\nOther expense for 1994 decreased $4.4 million as compared to 1993 due primarily to a $2.0 million contribution in 1993 for the initial funding of the Harley- Davidson Foundation which administers the Company's charitable contributions.\nCONSOLIDATED INCOME TAXES\nThe Company's effective tax rate decreased in 1994 to 38.5% from 39.5% in 1993.\nDISCONTINUED OPERATIONS\nThe operations for the Transportation Vehicles segment have been classified as discontinued operations to conform to the 1995 presentation. The results of operations, net of applicable income taxes, were a net income of $8.0 million and a net loss of $57.9 million in 1994 and 1993, respectively. 1994 included a one-time tax benefit of $4.6 million related to the legal reorganization of the Transportation Vehicles segment. 1993 included a $53.5 million charge to operations resulting from the write-off of the remaining goodwill associated with the Transportation Vehicles segment.\nOTHER MATTERS\nACCOUNTING CHANGES\nThe 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\" and SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which become effective January 1, 1996. Adopting SFAS No. 121 will have no effect. As is permitted under SFAS No. 123, the Company has decided to continue accounting for employee stock compensation under the APB 25 rules, but will disclose pro forma results using the new standard's alternative accounting treatment.\nOn January 1, 1993, the Company adopted the provisions of Statements of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" and No. 109 \"Accounting for Income Taxes.\" The adoption of SFAS No. 106 resulted in the recognition of a $32.1 million charge (net of tax) representing the cumulative effect of adopting the standard. The adoption of SFAS No. 109 resulted in the recognition of a cumulative effect adjustment of $1.8 million. The adoption of these standards had no impact on cash flows.\nNET DEFERRED TAX ASSET\nThe Company had a net deferred tax asset of approximately $42 million and $33 million at December 31, 1995 and 1994, respectively. In considering the necessity of establishing a valuation allowance on deferred tax assets, management considered: the levels of taxes paid in prior years that would be available for carryback; its ability to offset reversing deferred tax assets against reversing deferred tax liabilities; and, the Company's prospects for future earnings. Accordingly, it is the opinion of management that it is more likely than not that the gross deferred tax assets included in the consolidated balance sheet at December 31, 1995 will be realized in their entirety. Management evaluates the realizability of deferred tax assets on a quarterly basis.\nFOREIGN CURRENCY\nAs discussed in Note 11 of the notes to the consolidated financial statements, the Company attempts to limit its foreign currency exposure (primarily against German Deutsche Marks and Canadian Dollars) by entering into forward exchange contracts.\nENVIRONMENTAL MATTERS\nThe Company's policy is to comply with all applicable environmental laws and regulations and, the Company has a compliance program in place to monitor, and report on, environmental issues. The Company has reached settlement agreements with its former parent (Minstar, successor to AMF Incorporated) and the U.S. Navy regarding groundwater remediation at the Company's manufacturing facility in York, Pennsylvania and currently estimates that it will incur approximately $5 million of net additional costs related to the remediation effort. The Company has established reserves for this amount.\nRecurring costs associated with managing hazardous substances and pollution in ongoing operations are not material.\nThe Company regularly invests in equipment to support and improve its various manufacturing processes. While the Company considers environmental matters in capital expenditure decisions, and while some capital expenditures also act to improve environmental compliance, only a small portion of the Company's annual capital expenditures relate to equipment which has the sole purpose of meeting environmental compliance obligations. During 1995, the Company spent approximately $1 million on equipment used to limit hazardous substances\/pollutants and anticipates approximately the\nsame level of spending in 1996. The Company does not expect that these expenditures related to environmental matters will have a material effect on future operating results or cash flows.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company recorded cash flows from operating activities of $169.1 million in 1995 compared to $83.0 million during 1994. Working capital items increased cash by approximately $12.1 million in 1995 as compared to decreasing cash by approximately $37 million in 1994. A 15.4% increase in accounts receivable in 1995 when compared to 1994, was primarily the result of accelerated international shipments in the fourth quarter and the associated extended winter terms on international receivables. Depreciation and amortization also increased approximately $10 million from continued investment in the manufacturing strategy.\nCapital expenditures amounted to $113 million and $89 million during 1995 and 1994, respectively. The Company anticipates 1996 capital expenditures will approximate $150-$175 million. The Company currently estimates it will have the capacity to produce at least 115,000 units in 1996, 125,000-130,000 units in 1997 and 145,000-150,000 units in 1998. Although the Company does not know the exact range of capital it will incur to implement the program, it estimates the capital required in 1997 and 1998 will be in the range of $175-$225 million per year. The Company anticipates it will have the ability to fund all capital expenditures with internally generated funds and short-term financing.\nThe Company (excluding Eaglemark) currently has nominal levels of long-term debt and has available lines of credit of approximately $46 million, of which approximately $29 million remained available at year-end.\nOn November 14, 1995, the Company acquired substantially all of the common stock and common stock equivalents of Eaglemark Financial Services, Inc. that it did not already own. The purchase price was approximately $45 million, which was paid from internally generated funds and short-term borrowings.\nEaglemark finances its business, without guarantees from the Parent Company (Harley-Davidson, Inc.), through commercial paper, a revolving credit facility and by securitizing its retail installment loans. Eaglemark issues short-term commercial paper secured by wholesale finance receivables with maximum issuance available of $155 million of which $132 million was outstanding at year-end. Maturities of commercial paper issued range from 1 to 60 days. Eaglemark has in place a $60 million revolving credit facility provided by a syndicate of banks to fund primarily the United States and Canadian retail loan originations of which $32.5 million was outstanding at December 31, 1995. Borrowings under the facility are secured by and limited to a percentage of eligible receivables ranging from 75% to 95% of the outstanding loan balances. The amount of net eligible receivables at December 31, 1995 was approximately $80.5 million. During 1995, Eaglemark securitized and sold $154 million of its retail installment loans to investors with limited recourse, with servicing rights being retained by Eaglemark. The Company expects the future growth of Eaglemark will be financed from additional capital contributions from the Parent Company and a continuation of its programs of commercial paper and securitizations.\nThe Company has continuing authorization from its Board of Directors to repurchase up to 4 million shares of the Company's outstanding common stock. During 1995, the Company repurchased 1,650,000 shares of its common stock with cash on hand and short-term borrowings of $40 million.\nThe Company's Board of Directors declared quarterly cash dividends during 1995 and 1994 totaling $.18 and $.14 per share, respectively.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated financial statements and supplementary data - ------- --------------------------------------------------------\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Harley-Davidson, Inc.\nWe have audited the accompanying consolidated balance sheets of Harley-Davidson, 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. We did not audit the 1995 financial statements of Eaglemark Financial Services, Inc. (Eagle), a majority-owned subsidiary effective November 14, 1995, which statements reflect total assets of $227.3 million at December 31, 1995, and operating income of $3.6 million for the year then ended. 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 Eagle, 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, for 1995, the report of other auditors, provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and, for 1995, the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harley-Davidson, 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 notes 6 and 9 to the consolidated financial statements, effective January 1, 1993, the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nERNST & YOUNG LLP\nMilwaukee, Wisconsin January 20, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Eaglemark Financial Services, Inc.:\nWe have audited the accompanying consolidated balance sheet of EAGLEMARK FINANCIAL SERVICES, INC. (a Delaware 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 two 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 audit. The consolidated financial statements of Eaglemark Financial Services, Inc. and Subsidiaries as of December 31, 1993, were audited by other auditors whose report dated January 21, 1994, expresses 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 Eaglemark Financial Services, Inc. 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 in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nChicago, Illinois January 19, 1996\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 1995, 1994 and 1993 (In thousands, except per share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (In thousands, except share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994 and 1993 (In thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years ended December 31, 1995, 1994 and 1993 (In thousands, except share amounts)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHARLEY-DAVIDSON, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year ended December 31, 1995\n1. Summary of significant accounting policies ------------------------------------------\nPrinciples of consolidation and basis of presentation - The consolidated financial statements include the accounts of Harley-Davidson, Inc. and all of its wholly owned subsidiaries (the Company), including the accounts of Harley-Davidson Motor Company (HDMC), Holiday Rambler LLC (Holiday Rambler) and Eaglemark Financial Services, Inc. (Eagle). All significant intercompany accounts and transactions are eliminated. As disclosed in Note 3, the operations of Holiday Rambler are classified as discontinued operations. As such, certain prior-year balances have been reclassified in order to conform to current-year presentation.\nThe Company has an investment which is accounted for using the equity method. Accordingly, the Company's share of the net earnings (losses) of this entity is included in consolidated net income (loss).\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.\nCash and cash equivalents - The Company considers all highly liquid investments purchased with an original maturity of three months or less and restricted cash balances held in connection with commercial paper programs to be cash equivalents. At December 31, 1995, the Company had $1.1 million in restricted cash balances. No similar balances existed at December 31, 1994.\nFinance receivables income recognition - Interest income on finance receivables is recorded as earned and is based on the average outstanding daily balance for wholesale and retail receivables. Accrued interest is classified with finance receivables. Certain loan origination costs are deferred and amortized over the estimated life of the related receivable as a reduction in financing revenue.\nFinance receivables credit losses - The provision for credit losses on finance receivables is charged to income in amounts sufficient to maintain the allowance for uncollectible accounts at a level considered adequate to cover the losses of principal and interest in the existing portfolio. The Company's wholesale loan charge-off policy is based on a loan-by-loan review. Retail revolving charge receivables are charged off at the earlier of 180 days contractually past due or when otherwise deemed to be uncollectible. Retail installment receivables are generally charged off upon repossession and sale of the underlying collateral or at 120 days contractually past due.\nRetail installment loans sold with limited recourse; securitization and servicing income - During 1995, Eagle securitized and sold $154 million of its retail installment loans to investors with limited recourse, with servicing rights being retained by Eagle. These transactions were treated as sales. As such, the receivables are removed from the balance sheet upon sale and a gain is recognized for the difference between the carrying value of the receivables and the adjusted sales price. The adjusted sales price is determined based on a present value estimate of future cash flows on each loan pool sold.\nInventories - Inventories are valued at the lower of cost or market. Inventories located in the United States are valued using the last-in, first-out (LIFO) method. Other inventories, $16.9 million in 1995 and $19.4 million in 1994, are valued at the lower of cost or market using the first- in, first-out (FIFO) method.\nDepreciation - Depreciation of plant and equipment is determined on the straight-line basis over the estimated useful lives of the assets. Accelerated methods are used for income tax purposes.\n1. Summary of significant accounting policies (continued) ------------------------------------------------------ Product warranty - Product warranty costs are charged to operations based upon the estimated warranty cost per unit sold.\nResearch and development expenses - Research and development expenses from continuing operations were approximately $27.2 million, $22.1 million and $19.2 million for 1995, 1994 and 1993, respectively.\nEnvironmental - The Company accrues for environmental loss contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company does not use discounting in determining its environmental liabilities. See Note 7.\nEarnings (loss) per share - Earnings (loss) per common share assuming no dilution is calculated by dividing elements of net income (loss) by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding during 1995, 1994 and 1993 were 75.1 million, 76.2 million, and 75.9 million, respectively. Stock options were not materially dilutive during 1995, 1994 or 1993.\nStock compensation - The Company accounts for employee stock compensation (e.g., restricted stock and stock options) in accordance with APB Opinion No. 25 (APB 25), \"Accounting for Stock Issued to Employees.\" Under APB 25, the total compensation expense recognized is equal to the difference between the award's exercise price and the underlying stock's market price at the measurement date.\nStatement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation,\" is effective January 1, 1996. As is permitted under SFAS No. 123, the Company has decided to continue accounting for employee stock compensation under the APB 25 rules, but will disclose pro forma results using the new standard's alternative accounting treatment, which calculates the total compensation expense to be recognized as the fair value of the award at the date of grant for effectively all awards.\nImpairment - The Company is required to adopt SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" effective January 1, 1996. Adopting SFAS No. 121 will have no effect.\n2. Additional balance sheet and cash flows information ---------------------------------------------------\nAccounts receivable consist of the following:\nDomestic motorcycle sales are generally floor planned by the purchasing dealers. Foreign motorcycle sales are sold on open account except for sales to European distributors, which are typically backed by letters of credit.\nThe allowance for doubtful accounts deducted from accounts receivable was $1.5 million and $1.8 million at December 31, 1995 and 1994, respectively.\n3. Discontinued operations -----------------------\nOn January 22, 1996, the Company announced its strategic decision to discontinue the operations of the Transportation Vehicles segment in order to concentrate its financial and human resources on its core motorcycle business. The Transportation Vehicles segment is comprised of the Recreational Vehicles division, the Commercial Vehicles division and B & B Molders, a manufacturer of custom or standard tooling and injection molded plastic pieces. The Company also announced on January 22, 1996, the proposed sale of the manufacturing operations of the Recreational Vehicles division as well as the sale of ten of the division's fourteen Holiday World RV dealerships to Monaco Coach Corporation. The purchase price for the division will be approximately $50 million, consisting of cash, a new series of Monaco preferred stock and a note. Monaco will also assume certain liabilities. The sale is subject to antitrust clearance and Monaco's securing of financing. The transaction is expected to close by the end of March, 1996. The sale of the remaining operations comprising the Transportation Vehicles segment is expected to be completed by the end of June, 1996. The Company does not anticipate a loss on the discontinuance of the Transportation Vehicles segment. The results of the Transportation Vehicles segment have been reported separately as discontinued operations. Prior year consolidated financial statements have been restated to present the Transportation Vehicles segment as a discontinued operation.\nThe components of net assets of discontinued operations included in the balance sheets at December 31, are as follows:\nThe condensed statement of operations relating to the discontinued operations for the years ended December 31, are presented below:\nIn 1994, the Company's tax provision includes a one-time benefit of $4.6 million related to the legal reorganization of the Transportation Vehicles segment. In 1993, the Company recorded a $53.5 million charge to operations resulting from the write-off of the remaining goodwill associated with the Transportation Vehicles segment.\nIt is the Company's policy to allocate interest on debt (to be assumed by the buyer) to discontinued operations, which was approximately $2.5 million, $1.6 million, and $1.3 million for 1995, 1994 and 1993, respectively.\n4. Eaglemark Financial Services, Inc. ----------------------------------\nOn January 5, 1993, the Company invested $10.0 million for a 49% interest in Eaglemark Financial Services, Inc., formerly Eagle Credit Corporation, (Eagle). Eagle was formed to provide wholesale and retail financing to the Company's dealer networks and customers.\nOn November 14, 1995, the Company acquired substantially all of the common stock and common stock equivalents of Eagle that it did not already own. The transaction was accounted for as a step acquisition under the purchase method. The purchase price for the shares and equivalents was approximately $45 million, which was paid from internally generated funds and short-term borrowings. The excess of the acquisition cost over the fair value of the net assets purchased resulted in approximately $43 million of goodwill which is being amortized on a straight-line basis over twenty years.\nThe Company has included the results of operations of Eagle in its statement of operations for the year ended December 31, 1995 as though it had been acquired at the beginning of the year and deducted the preacquisition earnings as part of non-operating expense. Prior to 1995, the Company accounted for its investment in Eagle using the equity method. The carrying value of its investment in Eagle was approximately $9.5 million and is included in other assets at December 31, 1994. The results of operations for 1995 and 1994 on a pro forma basis, would not have been materially different from the reported amounts for 1995 or 1994 if the acquisition were assumed to have taken place at the beginning of 1994.\nFinance receivables originated or purchased by Eagle were as follows at December 31, 1995 (in thousands):\nEagle's finance receivables include wholesale loans to dealers for the purpose of inventory financing and retail loans to consumers in the form of installment sales contracts and revolving charge receivables. The Company holds titles to vehicles financed, and certain revolving charge receivables are cross-collateralized when the customer also has an installment contract. The Company generates finance receivables in the United States and Canada and has a geographically diversified loan portfolio.\nWholesale finance receivables are primarily motorcycles and related parts and accessories which are contractually due within one year. Retail finance receivables are primarily motorcycles and revolving credit card balances. On December 31, 1995, contractual maturities of finance receivables were as follows (in thousands):\n4. Eaglemark Financial Services, Inc. (continued) ----------------------------------------------\nThe allowance for credit losses is comprised of individual components relating to wholesale and retail finance receivables. Changes in the allowance for credit losses for the year ended December 31, 1995, is as follows (in thousands):\nEagle serviced with limited recourse $160.2 million of retail installment loans as of December 31, 1995.\nEagle's debt as of December 31, consisted of the following (in thousands):\nAs of December 31, 1995, Eagle has in place a $60 million revolving credit facility provided by a syndicate of banks to fund primarily the United States and Canadian retail loan originations. This facility expires on October 31, 1996. Borrowings under the facility are secured by and limited to a percentage of eligible receivables ranging from 75% to 95% of the outstanding loan balances. The amount of net eligible receivables at December 31, 1995 was approximately $80.5 million.\nEagle also issues short-term commercial paper secured by wholesale finance receivables with maximum issuance available of $155 million. Maturities of commercial paper issued range from 1 to 60 days, and the current commercial paper program expires in December, 1996. The weighted average interest rate on outstanding commercial paper balances was 5.81% at December 31, 1995.\n5. Notes payable -------------\nAs of December 31, 1995, the Company had unsecured lines of credit totaling approximately $49.9 million, of which approximately $26.9 million remained available after consideration of borrowings and outstanding letters of credit.\n6. Income taxes ------------\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". The Company adopted this standard on a prospective basis effective January 1, 1993. The adoption resulted in additional income of $1.8 million.\nDetails of income from continuing operations before provision for income taxes and accounting changes are as follows:\nProvision for income taxes consists of the following:\nThe provision for income taxes differs from the amount which would be provided by applying the statutory U.S. corporate income tax rate due to the following items:\n6. Income taxes (continued) ------------------------\nDeferred income taxes result from temporary differences between the recognition of revenues and expenses for financial statements and income tax returns. The principal components of the Company's deferred tax assets and liabilities as of December 31 include the following:\n7. Commitments and contingencies -----------------------------\nThe Company is involved with government agencies in various environmental matters, including a matter involving soil and groundwater contamination at its York, Pennsylvania facility (the Facility). The Facility was formerly used by the U.S. Navy and AMF (the predecessor corporation of Minstar). The Company purchased the Facility from AMF in 1981. Although the Company is not certain as to the extent of the environmental contamination at the Facility, it is working with the Pennsylvania Department of Environmental Resources in undertaking certain investigation and remediation activities. In March 1995, the Company entered into a settlement agreement (the Agreement) with the Navy. The Agreement calls for the Navy and the Company to contribute amounts into a trust equal to 53% and 47%, respectively, of future costs associated with investigation and remediation activities at the Facility (response costs). The trust will administer the payment of the future response costs at the Facility as covered by the Agreement. In addition, in March 1991 the Company entered into a settlement agreement with Minstar related to certain indemnification obligations assumed by Minstar in connection with the Company's purchase of the Facility. Pursuant to this settlement, Minstar is obligated to reimburse the Company for a portion of its response costs at the Facility. Although substantial uncertainty exists concerning the nature and scope of the environmental remediation that will ultimately be required at the Facility, based on preliminary information currently available to the Company and taking into account the Company's settlement agreement with the Navy and the settlement agreement with Minstar, the Company estimates that it will incur approximately $5 million of net additional response costs at the Facility. The Company has established reserves for this amount. The Company has also put certain of its insurance carriers on notice that it intends to make claims relating to the environmental contamination at the Facility. However, the Company is currently unable to determine the probable amount of recovery available, if any, under insurance policies.\nThe Company self-insures its product liability losses in the United States up to $3 million (catastrophic coverage is maintained for individual claims in excess of $3 million up to $25 million). Outside the United States, the Company is insured for product liability up to $25 million per individual claim and in the aggregate. The Company accrues for claim exposures which are probable of occurrence and can be reasonably estimated.\n7. Commitments and contingencies (continued) -----------------------------------------\nAt December 31, 1995, the Company was contingently liable for $23.0 million related to letters of credit. The letters of credit typically act as a guarantee of payment to certain third parties in accordance with specified terms and conditions.\n8. Employee benefit plans ----------------------\nThe Company has several noncontributory defined benefit pension plans covering substantially all employees of the Motorcycles segment. Benefits are based primarily on years of service and, for certain plans, levels of compensation. The Company's policy with respect to the pension plans is to fund pension benefits to the extent contributions are deductible for tax purposes.\nThe following data is provided for the pension plans for the years indicated (in thousands):\nReconciliation of funded status:\nIn 1993, the Company elected to change the measurement date for pension plan assets and liabilities from December 31 to September 30. The change in measurement date had no effect on 1993, or prior years', pension expense.\n8. Employee benefit plans (continued) ----------------------------------\nThe provisions of Financial Accounting Standards Board Statement No. 87, \"Employers' Accounting for Pensions,\" require the recognition of an additional minimum liability and related intangible asset to the extent that accumulated benefits exceed plan assets. At December 31, 1995, the adjustment required to reflect the Company's minimum pension liability was $5.9 million. The Company has recorded an intangible asset in the same amount.\nThe assumptions used in determining pension expense (for the following year) and funded status information shown above were as follows:\nCertain of the Company's plans relating to hourly employees have been amended to increase the scheduled benefits. The Company's plan relating to salaried employees was also amended to increase the scheduled benefits.\nThe Company has various defined contribution benefit plans which in total cover substantially all full-time employees. Employees can make voluntary contributions in accordance with the provisions of their respective plan, which includes a 401(k) tax deferral option. The Company accrued $1.5, $1.4 and $1.2 million for matching contributions during 1995, 1994 and 1993, respectively.\n9. Postretirement health care benefits -----------------------------------\nThe Company has several postretirement health care benefit plans covering substantially all employees of the Motorcycles segment. Employees are eligible to receive benefits upon attaining age 55 after rendering at least 10 years of service to the Company.\nOn January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires companies to accrue the cost of postretirement benefits during the employees' active service period. The Company elected to immediately recognize the accumulated postretirement benefit obligation upon adoption of SFAS 106. The Company recorded a cumulative effect adjustment of $32.1 million, net of tax, related to the transition obligation. In prior years, the Company accounted for postretirement benefits on a cash basis.\nThe Company uses September 30 as the measurement date for valuing its postretirement health care obligation.\n9. Postretirement health care benefits (continued) -----------------------------------------------\nThe Company's postretirement health care plans are currently funded as claims are submitted ($1.8 million in 1995 and $1.6 million in 1994). Some of the plans require employee contributions to offset benefit costs. The status of the plans was as follows:\nThe net periodic postretirement benefit cost includes the following:\nThe weighted average health care cost trend rate used in determining the accumulated postretirement benefit obligation of the health care plans was 10% in 1995. The per capita health care cost trend rate is assumed to decrease gradually to 6% for 1999 and remain at that level thereafter. This assumption can have a significant effect on the amounts reported. If the weighted average health care cost trend rate were to increase by 1%, the accumulated postretirement benefit obligation as of September 30, 1995 and the aggregate of service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1996 would increase by $3.7 million and $.5 million, respectively. The weighted average discount rate used to determine the accumulated postretirement benefit obligation of the health care plans as of September 30, 1995 and 1994 was 8.25%. The Company used a weighted average discount rate of 8.5% in establishing the transition obligation at January 1, 1993.\n10. Capital stock -------------\nThe Company has 200 million authorized shares of $.01 par value common stock.\nThe Company has continuing authorization from its Board of Directors to repurchase up to 4 million shares of the Company's outstanding common stock. During 1995, the Company repurchased 1,650,000 shares of its common stock with cash on hand and short-term borrowings.\nThe Company has designated .5 million of the authorized shares of preferred stock as Series A Junior Participating preferred stock (Preferred Stock). The Preferred Stock has a par value of $1 per share. Each share of Preferred Stock, none of which is outstanding, is entitled to 400 votes per share (subject to adjustment) and other rights such that the value of a one one-hundredth interest in a share of Preferred Stock should approximate the value of four shares of common stock.\n10. Capital stock (continued) -------------------------\nThe Preferred Stock is reserved for issuance in connection with the Company's outstanding Preferred Stock purchase rights (Rights). Each outstanding share of common stock entitles its holder to one-quarter Right. Under certain conditions, each Right entitles the holder to purchase one one-hundredth of a share of Preferred Stock at an exercise price of $300, subject to adjustment. The Rights are only exercisable if a person or group has acquired 15% or more of the outstanding common stock or has announced an intention to acquire 25% or more of the outstanding common stock. If there is a 15% acquiring party, each holder of a Right, other than the acquiring party, will be entitled to purchase, at the exercise price, common stock having a market value of two times the exercise price.\nThe Company has a restricted stock plan in which plan participants are entitled to cash dividends and voting rights on their respective shares. Restrictions generally limit the sale or transfer of shares during a restricted period, not exceeding ten years. Participants may vest in certain amounts of the restricted stock upon death, disability or retirement as described in the plan.\nUnearned compensation was charged for the market value of the restricted shares on the date of grant and is being amortized over the restricted period. The unamortized unearned compensation value is shown as a reduction of shareholders' equity in the accompanying consolidated balance sheets.\nInformation with respect to restricted stock outstanding is as follows:\nExpense in 1995, 1994 and 1993 associated with this restricted stock plan was $.3 million, $.7 million and $.4 million, respectively.\nThe Company has Stock Option Plans under which the Board of Directors may grant to employees nonqualified stock options with or without appreciation rights. The options may be exercised one year after the date of grant, not to exceed 25 percent of the shares in the first year with an additional 25 percent to be exercisable in each of the three following years. The options expire ten years from the date of grant. The maximum number of shares of common stock available for grants under such plans were 9.3 million and 6.0 million at December 31, 1995 and 1994, respectively, of which 3.8 million and 1.2 million shares remained available for future grants at those dates, respectively. The exercise price of outstanding options at December 31, 1995 ranged from $1.48 to $26.94. A summary of option activity is as follows:\n11. Fair value of financial instruments -----------------------------------\nThe Company's financial instruments consist primarily of cash and cash equivalents, trade receivables, finance receivables, receivables from retail installment loan sales, debt and foreign currency exchange contracts. The book values of cash and cash equivalents, trade receivables and finance receivables are considered to approximate their respective fair values.\nThe book value of receivables from retail installment loan sales is $12.4 million and is included with finance receivables on the balance sheet. The fair value of these receivables is estimated to be $13.5 million based on discounting future excess cash flows associated with these transactions. None of the Company's debt instruments have readily ascertainable market values; however, the carrying values are considered to approximate their respective fair values. See Note 4, for the terms and carrying values of the Company's various debt instruments.\nThe Company enters into forward exchange contracts to hedge against sales transactions denominated principally in European currencies. The purpose of the Company's foreign currency hedging activities is to protect the Company from the risk that the eventual dollar cash flows resulting from the sale of products to foreign subsidiaries will be adversely affected by changes in exchange rates. At December 31, 1995, the Company had forward exchange contracts that required it to convert these foreign currencies, at a variety of rates, into U.S. Dollars or German Deutsche Marks. These contracts represent a combined U.S. dollar equivalent commitment of approximately $29.4 million and $59.2 million at December 31, 1995 and 1994, respectively. Eagle has also entered into Canadian forward contracts to hedge the Canadian dollar in connection with their wholesale finance program. At December 31, 1995, Eagle had $17.4 million of Canadian forward contracts outstanding. The current contracts mature at various dates through May, 1996. Unrealized gains and losses on these forward exchange contracts, which were not material at December 31, 1995 or 1994, are deferred and recognized at the time the hedged transaction is settled. The fair value of these contracts at December 31, 1995 and 1994 is not significant, and is estimated as the net unrealized gain or loss.\nEagle has interest rate cap agreements to reduce the impact of fluctuations in interest rates on its floating rate debt. At December 31, 1995, Eagle had approximately $20 million in interest rate caps outstanding. At December 31, 1995, the amount Eagle would receive to terminate the interest rate cap agreements is approximately $.2 million.\n12. Business segments and foreign operations ----------------------------------------\n(a) BUSINESS SEGMENTS\nThe Company operates in two business segments (excluding discontinued operations): Motorcycles and Related Products and Financial Services.\nThe Motorcycles and Related Products (\"Motorcycles\") segment consists primarily of the Company's wholly-owned subsidiary H-D Michigan, Inc. and its wholly owned subsidiary Harley-Davidson Motor Company. The Motorcycles segment designs, manufactures and sells primarily heavyweight (engine displacement of 751cc or above) touring and custom motorcycles and a broad range of related products which include motorcycle parts and accessories and riding apparel. The Company, which is the only major American motorcycle manufacturer, has held the largest share of the United States heavyweight motorcycle market since 1986. The Company holds a smaller market share in the European market, which is a larger market than the United States.\n12. Business segments and foreign operations (continued) ----------------------------------------------------\nThe Financial Services (\"Eagle\") segment consists of the Company's majority-owned subsidiary, Eaglemark Financial Services, Inc. Eagle provides motorcycle floor planning and parts and accessories financing arrangements to the Company's U.S. Dealers. Eagle also offers retail financing opportunities to the Company's domestic motorcycle customers. In addition, Eagle has established a proprietary credit card for use in the Company's independent dealerships. Eagle also provides property and casualty insurance for motorcycles as well as extended warranty contracts. A smaller portion of their customers are in other leisure products businesses. Prior to 1995, Eagle carried on business only in the United States. In 1995, Eagle expanded its operations to include Canada.\nInformation by industry segment is set forth below (in thousands):\n(1) During 1995, the results of operations for the majority-owned financial services subsidiary are included in Income from operations in the statements of operations. During 1994 and 1993, the equity in earnings of the financial services subsidiary was included in other income. See Note 4.\n(2) The results of operations for the Transportation Vehicles segment are classified as discontinued operations in the statements of operations. Prior year results have been reclassified in order to conform to current year presentation. See Note 3.\nThere were no sales between business segments for the years ended December 31, 1995, 1994 or 1993.\n12. Business segments and foreign operations (continued) ----------------------------------------------------\n(b) FOREIGN OPERATIONS\nIncluded in the consolidated financial statements are the following amounts relating to foreign affiliates:\nExport sales of domestic subsidiaries to nonaffiliated customers were $172.9 million, $155.2 million and $117.6 million in 1995, 1994 and 1993, respectively.\nSUPPLEMENTARY DATA - ------------------\nQuarterly financial data (unaudited) - ------------------------------------ (In millions, except per share data)\nNote: Amounts previously reported have been restated to reflect the Transportation Vehicles segment as discontinued operations.\n(a) 1994 second quarter results include a one-time benefit of $4.6 million related to the legal reorganization of the Transportation Vehicles segment.\nItem 9.","section_9":"Item 9. Changes in and disagreements with accountants on accounting and - ------- --------------------------------------------------------------- financial disclosure --------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and executive officers of the registrant - ------- --------------------------------------------------\nInformation with respect to the Directors of the registrant will be included in the Company's definitive proxy statement for the 1996 annual meeting of shareholders (the \"Proxy Statement\"), which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1995, and is hereby incorporated by reference to such Proxy Statement.\nItem 11.","section_11":"Item 11. Executive compensation - ------- ----------------------\nThe information required by this section will be included in the Proxy Statement, which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1995, and is hereby incorporated by reference to such Proxy Statement.\nItem 12.","section_12":"Item 12. Security ownership of certain beneficial owners and management - ------- --------------------------------------------------------------\nThe information required by this section will be included in the Proxy Statement, which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1995, and is hereby incorporated by reference to such Proxy Statement.\nItem 13.","section_13":"Item 13. Certain relationships and related transactions - ------- ----------------------------------------------\nThe information required by this section will be included in the Proxy Statement, which will be filed within 120 days after the close of the Company's fiscal year ended December 31, 1995, and is hereby incorporated by reference to such Proxy Statement.\nItem 14.","section_14":"Item 14. Exhibits, financial statement schedules, and reports on Form 8-K - ------- ----------------------------------------------------------------\n(A) 1. Financial statements - The financial statements listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules are filed as part of this annual report and such Index to Consolidated Financial Statements and Financial Statement Schedules is incorporated herein by reference.\n2. Financial statement schedules - The financial statement schedule listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules is filed as part of this annual report and such Index to Consolidated Financial Statements and Financial Statement Schedules is incorporated herein by reference.\n3. Exhibits - The exhibits listed on the accompanying List of Exhibits are filed as part of this annual report and such List of Exhibits is incorporated herein by reference.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ AND FINANCIAL STATEMENT SCHEDULES ---------------------------------\n[Item 14(a) 1 and 2]\nAll other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules.\nLIST OF EXHIBITS ---------------- [Items 14(a)(3) and 14(c)]\nExhibit No. Description - ----------- -----------\n2.1 Asset Purchase Agreement, dated as of March 4, 1996, among Harley-Davidson, Inc., Holiday Holding Corp., Holiday World, Inc. (California), Holiday World, Inc. (Texas), Holiday World, Inc. (Florida), Holiday World, Inc. (Oregon), Holiday World, Inc. (Indiana), Holiday World, Inc. (Washington), Holiday World, Inc. (New Mexico), Monaco Coach Corporation, and MCC Acquisition Corporation.\n2.2 Asset Purchase Agreement, dated as of January 21, 1996, among Harley-Davidson, Inc., Holiday Rambler LLC, State Road Properties L.P., and Monaco Coach Corporation.\n2.3 Amendment No. 1 dated as of March 4, 1996 to Asset Purchase Agreement, dated as of January 21, 1996 among Harley-Davidson, Inc., Holiday Rambler LLC, State Road Properties L.P., and Monaco Coach Corporation.\n2.4 Subordinated Promissory Note, dated March 4, 1996 between MCC Acquisition Corporation and Holiday Holding Corp.\n3.1 Restated Articles of Incorporation\n3.2 By-Laws\n4.1 Form of Rights Agreement between the Registrant and Firstar Trust Company\n4.2 Amendment to Rights Agreement dated as of June 21,1991\n4.3 Amendment to Rights Agreement dated as of August 23, 1995\n10.1* Form of Employment Agreement between the Registrant and each of Messrs. Bleustein, Gelb, Hoelter and Teerlink\n10.2* 1986 Stock Option Plan\n10.3* 1988 Stock Option Plan\n10.4* 1990 Stock Option Plan\n10.5* 1995 Stock Option Plan\n10.6* Consulting Agreement between the Registrant and Mr. Beals\nLIST OF EXHIBITS ---------------- [Items 14(a)(3)and 14(c)]\nExhibit No. Description - ----------- -----------\n10.7* Restated Long-Term Incentive Plan II, as amended\n10.8* Form of Growth Unit Cancellation Agreement between the Registrant and Mr. Brostowitz\n10.9* Form of Transition Agreement between the Registrant and each of Messrs. Bleustein, Gelb, Hoelter, Snoey and Ziemer\n10.10* Transition Agreement between the Registrant and Mr. Teerlink\n10.11* Deferred Compensation Plan\n10.12* Description of supplemental executive retirement benefits\n10.13* Form of Life Insurance Agreement between the Registrant and each of Messrs. Bleustein, Brostowitz, Gelb, Gray, Hoelter, Teerlink and Ziemer\n10.14* Form of Restricted Stock Agreement between the Registrant and each of Messrs. Bleustein, Gelb and Gray\n10.15* Form of Severance Benefits Agreement between the Registrant and each of Messrs. Bleustein, Brostowitz, Gelb, Gray, Hoelter, Snoey, Teerlink and Ziemer\n10.16* Harley-Davidson, Inc. Corporate Short Term Incentive Plan\n11 Computation of Primary and Fully Diluted Earnings Per Share\n21 List of Subsidiaries\n23.1 Consent of Ernst & Young LLP, Independent Auditors\n23.2 Consent of Independent Accountants\n27 Financial Data Schedule for 1995\n27 Restated Financial Data Schedule for 1994\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nSchedule II -----------\nHARLEY-DAVIDSON, INC.\nCONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1995, 1994 and 1993 (In thousands)\n(1) Represents amounts written off to the reserve, net of recoveries.\n(2) Stated in last-in, first-out (LIFO) cost.\nSIGNATURES ----------\nPursuant to the requirements of Section 13, or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 28, 1996.\nHARLEY-DAVIDSON, INC.\nBy: \/S\/ Richard F. Teerlink ------------------------------ Richard F. Teerlink 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 28, 1996.\nName Title ---- -----\n\/S\/ Richard F. Teerlink President, Chief Executive Officer -------------------------------- Richard F. Teerlink (Principal executive officer) and Director\n\/S\/ James L. Ziemer Vice-President and Chief Financial Officer -------------------------------- James L. Ziemer (Principal financial officer)\n\/S\/ James M. Brostowitz Vice-President\/Controller (Principal -------------------------------- James M. Brostowitz accounting officer) and Treasurer\n\/S\/ Vaughn L. Beals Chairman and Director -------------------------------- Vaughn L. Beals, Jr.\n\/S\/ Barry K. Allen Director -------------------------------- Barry K. Allen\n\/S\/ William F. Andrews Director -------------------------------- William F. Andrews\n\/S\/ Richard J. Hermon-Taylor Director -------------------------------- Richard J. Hermon-Taylor\n\/S\/ Donald A. James Director -------------------------------- Donald A. James\n\/S\/ Richard G. LeFauve Director -------------------------------- Richard G. LeFauve\n\/S\/ Sara L. Levinson Director -------------------------------- Sara L. Levinson\n\/S\/ James A. Norling Director -------------------------------- James A. Norling\nINDEX TO EXHIBITS ----------------- [Items 14(a)(3) and 14(c)]\nExhibit No. Description - ----------- -----------\n2.1 Asset Purchase Agreement, dated as of March 4, 1996, among Harley-Davidson, Inc., Holiday Holding Corp., Holiday World, Inc. (California), Holiday World, Inc. (Texas), Holiday World, Inc. (Florida), Holiday World, Inc. (Oregon), Holiday World, Inc. (Indiana), Holiday World, Inc. (Washington), Holiday World, Inc. (New Mexico), Monaco Coach Corporation, and MCC Acquisition Corporation (incorporated herein by reference to Exhibit 2.1 to the Registrants's Current Report on Form 8-K dated March 6, 1996 (File No. 1-9183)).\n2.2 Asset Purchase Agreement, dated as of January 21, 1996, among Harley-Davidson, Inc., Holiday Rambler LLC, State Road Properties L.P., and Monaco Coach Corporation (incorporated herein by reference to Exhibit 2.2 to the Registrants's Current Report on Form 8-K dated March 6, 1996 (File No. 1-9183)).\n2.3 Amendment No. 1 dated as of March 4, 1996 to Asset Purchase Agreement, dated as of January 21, 1996 among Harley-Davidson, Inc., Holiday Rambler LLC, State Road Properties L.P., and Monaco Coach Corporation (incorporated herein by reference to Exhibit 2.3 to the Registrants's Current Report on Form 8-K dated March 6, 1996 (File No. 1-9183)).\n2.4 Subordinated Promissory Note, dated March 4, 1996 between MCC Acquisition Corporation and Holiday Holding Corp. (incorporated herein by reference to Exhibit 2.4 to the Registrants's Current Report on Form 8-K dated March 6, 1996 (File No. 1-9183)).\n3.1 Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-9183)).\n3.2 By-Laws (incorporated herein by reference to Exhibit 3.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-9183)).\n4.1 Form of Rights Agreement between the Registrant and Firstar Trust Company (incorporated herein by reference to Exhibit 4.6 to the Registrants' Quarterly Report on Form 10-Q for the period ended September 30, 1990 (File No. 1-9183)).\n4.2 Amendment to Rights Agreement dated as of June 21, 1991(incorporated herein by reference to Exhibit 4.8 to the Registrants's Registration Statement on Form 8-B dated June 24, 1991 (File No. 1-9183 (the \"Form 8-B\")).\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nINDEX TO EXHIBITS ----------------- [Items 14(a)(3) and 14(c)]\nExhibit No. Description - ----------- -----------\n4.3 Amendment to Rights Agreement dated as of August 23, 1995 (incorporated herein by reference to Exhibit 4 to the Registrants' Quarterly Report on Form 10-Q for the period ended September 24, 1995 (File No. 1-9183)).\n10.1* Form of Employment Agreement between the Registrant and each of Messrs. Bleustein, Gelb, Hoelter and Teerlink (incorporated by reference from Exhibit 10.1 to the Registrant's Registration Statement on Form S-1 (File No. 33-5871)).\n10.2* Harley-Davidson, Inc. 1986 Stock Option Plan (incorporated herein by reference to Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-9183)).\n10.3* Harley-Davidson, Inc. 1988 Stock Option Plan (incorporated herein by reference to Exhibit 10.3 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-9183)).\n10.4* Harley-Davidson, Inc. 1990 Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-9183)).\n10.5* Harley-Davidson, Inc. 1995 Stock Option Plan (incorporated herein by reference to Exhibit A of the Company's Proxy Statement dated March 31, 1995 (File No. 1-9183))\n10.6* Consulting Agreement between the Registrant and Mr. Beals (incorporated herein by reference from Exhibit 10.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.7* Restated Long-Term Incentive Plan II, as amended (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.8* Growth Unit Cancellation Agreement between the Registrant and Mr. Brostowitz (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.9* Form of Transition Agreement between the Registrant and each of Messrs. Bleustein, Gelb, Hoelter, Snoey and Ziemer (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.\nINDEX TO EXHIBITS ----------------- [Items 14(a)(3) and 14(c)]\nExhibit No. Description - ----------- -----------\n10.10* Transition Agreement between the Registrant and Mr. Teerlink (incorporated herein by reference from Exhibit 10.2 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-9183)).\n10.11* Deferred Compensation Plan (incorporated herein by reference from Exhibit 10.8 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-9183)).\n10.12* Description of supplemental executive retirement benefits (incorporated herein by reference from Exhibit 10.9 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-9183)).\n10.13* Form of Life Insurance Agreement between the Registrant and each of Messrs. Bleustein, Brostowitz, Gelb, Gray, Hoelter, Teerlink and Ziemer (incorporated herein by reference from Exhibit 10.10 to the Registrants' Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-9183)).\n10.14* Form of Restricted Stock Agreement between the Registrant and each of Messrs. Bleustein, Gelb and Gray.\n10.15* Form of Severance Benefits Agreement between the Registrant and each of Messrs. Bleustein, Brostowitz, Gelb, Gray, Hoelter, Snoey, Teerlink and Ziemer.\n10.16* Harley-Davidson, Inc. Corporate Short Term Incentive Plan (incorporated herein by reference from Exhibit A to the Registrants' 1993 Proxy Statement for the May 14, 1994 Annual Meeting of Shareholders)\n11 Computation of Primary and Fully Diluted Earnings Per Share.\n21 List of Subsidiaries.\n23.1 Consent of Ernst & Young LLP, Independent Auditors.\n23.2 Consent of Independent Public Accountants.\n27 Financial Data Schedule for 1995.\n27 Restated Financial Data Schedule for 1994.\n* Represents a management contract or compensatory plan, contract or arrangement in which a director or named executive officer of the Company participated.","section_15":""}
{"filename":"771142_1995.txt","cik":"771142","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nGENERAL\nRoTech Medical Corporation (\"RoTech\" or the \"Company\") provides comprehensive home health care and primary care physician services to patients in non-urban areas. RoTech operated 205 home health care locations and 20 primary care physician practices, employing 26 physicians as of July 31, 1995, and has subsequently acquired an additional 50 home health care locations. The Company's home health care business provides a diversified range of products and services, with emphasis on respiratory and home infusion therapies. RoTech has pursued an aggressive acquisition strategy since 1988 which included in fiscal 1995 acquisitions of 56 locations of smaller home health care companies and the opening of 15 new locations. Current industry estimates indicate that approximately half of the nation's home health care industry remains fragmented and is run by either single operators or small, local chains. These smaller providers are RoTech's main competition and main acquisition opportunities. The Company plans to continue to enter new home health care markets through acquisition or start-up as competitive and pricing pressures encourage consolidation and economies of scale. In January 1994, the Company expanded this strategy to include the acquisition of primary care physician practices in certain markets to enable the ultimate development of an integrated primary health care delivery system capable of providing a broad range of non- institutional care to patients in these markets. The Company believes this system will facilitate managed care concepts and pricing in these markets, where managed care currently has little penetration, and should prevent the outmigration of the non-urban population to urban health care facilities and service providers. The Company's revenues have grown from $18 million for the fiscal year ended July 31, 1990 to $134 million for the fiscal year ended July 31, 1995.\nRecent data suggests that there is a shortage of health care services in non- urban markets. According to the United States Census Bureau, in 1990 non-urban areas of the United States accounted for roughly 25% of the national population, or approximately 62 million people. However, according to the American Medical Association, just 11% of physicians, or approximately 75,000 physicians, practice in non-metropolitan markets. This data indicates that rural markets are underserved, and suggests that there may be opportunities for improvement in access to primary care physicians, as well as specialty services. The Company believes that these needs result in significant opportunities for companies such as RoTech, which can attract, retain and network physicians in non-urban settings while offering ancillary services such as home health care, to become a full-service, non-institutional based primary health care provider.\nOPERATING AND EXPANSION STRATEGY\nRoTech was founded in 1981 to provide home respiratory and home medical equipment products and services to patients in Florida. With its founders' roots in pharmacy and pharmaceutical sales, the Company's marketing directive has always been to consult with primary care physicians in utilizing home health care techniques, products and services for their patient base. Counseling these physicians as to disease management leads to earlier identification and treatment of patients, enhancing the patient's quality of life and longevity. The Company has not targeted specialists, as their patients are more acute and since specialists have historically been tied to the hospital systems which results in higher hospitalizations. RoTech's philosophy and practice is to assist in identifying patients of primary care physicians prior to hospitalization and prior to an acuity level that would require utilizing a specialist.\nThe Company's strategy is to develop integrated health care delivery systems through the acquisition of smaller local home health care companies and primary care physician practices in non-urban areas. The Company targets non-urban markets of smaller cities and rural areas, due to the dominance of primary care physicians in these markets, reduced competition and a tendency to care for patients in the home setting. The Company believes that acquisitions of home health care companies will continue to expand the base of relationships with primary care physicians in these markets. Primary care physicians in these markets typically have long-standing relationships with loyal patient bases. These physicians are usually solo practitioners and are the key decision makers in the treatment of their patients. The Company believes that making home health care products and services available to these physicians will result in better, less expensive health care that provides an improved quality of life for the patients and their caregivers in these communities.\nRoTech expanded its strategy in 1994 to acquire primary care physician practices in two specific markets, northern Mississippi and central Florida, where it has strong market presence in its home health care business. The Company believes that networking these acquired primary care physicians, who are predominantly solo practitioners, will allow economies of scale, justification for advanced equipment to be shared among physicians, and standardization of protocols. The Company believes that assertive patient management at the primary care level, which would include the use of home health care techniques, should result in patient retention and higher quality of care. Aggregation of patient lives under the treatment of these physicians who can comprehensively manage patients is currently attractive to managed care entities and could eventually enable the Company to provide a managed care product in non-urban America.\nSALES AND MARKETING\nRoTech believes that the sales and marketing skills of its employees have been instrumental in its growth to date and are critical to its future success. RoTech emphasizes to its employees the importance of patient base growth and retention by providing quality service to physicians and their patients. Approximately 28% of RoTech's employees are actively involved in sales and marketing. The sales representatives employed by the Company include registered or certified respiratory therapists, registered pharmacists and registered nurses who market all of the Company's services and products and are responsible for maintaining and expanding the Company's relationships with physicians, targeting primary care physicians in non-urban areas.\nRoTech provides formal marketing, training, product and service information to all of its technical and sales personnel so they can communicate effectively with physicians about the Company's services and products. These personnel are instructed on methods of serving the physicians by counseling them on new procedures and medical technologies. Each technical and sales person must attend periodic seminars conducted on a Company-wide basis. The Company emphasizes the cross-marketing of all its products to physicians with which its salespeople have already developed professional relationships. The Company believes its marketing approach allows the primary care physician to identify acute and chronic patients earlier in the disease process. Treatment is done at the primary care level and accordingly at less cost than the advanced treatment of the disease by specialists or in a hospital setting.\nREIMBURSEMENT FOR SERVICES\nA substantial percentage of RoTech's revenue is attributable to third-party payors, including private insurers, Medicare and, to a lesser extent, Medicaid. The Company has substantial expertise at processing claims and continues to create and improve systems to manage third-party reimbursements, to produce clean claims and obtain timely reimbursements by third-party payors. The Company has developed distinct billing and collection departments for Medicare and Medicaid reimbursements and for private insurance company claims which are supported by customized computer systems. These departments work closely with reimbursement officers at branch locations and third-party payors and are responsible for the review of patient coverage, the adequacy and timeliness of documentation and the follow-up with third-party payors to expedite reimbursement payments. Reimbursement from the Medicare program as a percentage of RoTech's total operating revenue approximated 36% for fiscal 1992, 39% for fiscal 1993, 35% for fiscal 1994 and 49% for fiscal 1995.\nRoTech has achieved increased operating revenue in home respiratory and other medical equipment operations despite increased regulation and certain reimbursement reductions. While the increased regulation tends to reduce the amount of reimbursement from government sources for individual cases, the Company believes the continued increased regulation also benefits the Company by reducing the competition from joint ventures and fee revenue sharing arrangements, which the Company has historically avoided.\nThe Company's levels of operating revenue and profitability, like of other health care companies, are affected by the continuing efforts of third- party payors to contain or reduce the health care costs by lowering reimbursement rates, increasing case management review of services and negotiating reduced contract pricing. Home health care, which is generally less costly to third-party payors than hospital-based care, has benefited from those cost containment objectives. However, as expenditures in the home health care market continue to grow, initiatives aimed at reducing the health care delivery costs at non-hospital sites are increasing. Changes in reimbursement policies by third-party payors, or the reduction in or elimination of such reimbursement programs, could have a material adverse impact on the Company's revenues. Various state and federal health reform initiatives may lead to additional changes in reimbursement programs.\nPRODUCTS AND SERVICES\nHOME HEALTH CARE PRODUCTS AND SERVICES\nHOME RESPIRATORY CARE AND OTHER HOME MEDICAL EQUIPMENT PRODUCTS AND SERVICES ----------------------------------------------------------------------------\nRoTech provides a variety of home respiratory therapy products and services on a monthly rental or sale basis. Home respiratory care and other home medical equipment represented 66% of the Company's revenues for fiscal 1995. RoTech focuses on serving patients of primary care physicians with chronic pulmonary diseases in their pre-acute stages. Early identification and retention of these patients at the primary care level reduces health care costs and should improve the patient's quality of life. RoTech also enjoys patient retention post-hospitalization at the patient's or physician's request and does not rely on referrals of patients by hospital discharge planners or case managers. Industry-wide home respiratory market revenues were approximately $1.6 billion in 1993.\nThe Company's home respiratory care product line includes oxygen concentrators, portable liquid oxygen systems, nebulizers, and ventilator care. Oxygen concentrators extract oxygen from room air and generally provide the least expensive supply of oxygen for patients who require a continuous supply of oxygen, are not ambulatory and who do not require excessive flow rates. Liquid oxygen systems store oxygen under pressure in a liquid form. The liquid oxygen is stored in a stationary unit that can be refilled at the patient's home and can be used to fill a portable device that permits greatly enhanced patient mobility. Nebulizers are devices which aerosolize medications, allowing them to be inhaled directly into the patient's lungs. Ventilator therapy is used for the individual that suffers from respiratory failure by mechanically assisting the individual to breathe. The Company provides technicians who deliver and\/or install the respiratory care equipment, instruct the patient in its use, refill the high pressure and liquid oxygen systems as necessary and provide continuing maintenance of the equipment.\nRoTech provides a full line of equipment and supplies of home medical equipment and supplies for convalescents, including custom pieces required for rehabilitation patients. Provision of home medical equipment enables the Company to provide a \"one-stop shopping\" presence in its non-urban markets, which is required for full patient service satisfaction. These products are provided on a monthly rental or sale basis and include wheelchairs, hospital beds, walkers, patient lifts, orthopedic supplies, catheters, syringes and bathroom aids.\nHOME INFUSION THERAPY ---------------------\nHome infusion therapy involves the administration of antibiotics, nutrients or other medications intravenously, intramuscularly, subcutaneously or through a feeding tube. The Company focuses on providing home infusion therapy to patients prior to or in lieu of hospitalization, which generally offers significant cost savings and preferable logistics for patients, their families and caregivers over hospital-based treatments. RoTech believes that its marketing methods of consulting with primary care physicians on home infusion therapies and the continuing evolution of related technological advances should enable further growth of this portion of the business. Focus on the referring primary care physician facilitates the identification of patients requiring sub-acute antibiotic treatments, which constitute 39% of the home infusion therapy market. Home infusion therapies accounted for 25% of RoTech's revenues for fiscal 1995, which includes the following types and approximate percentage mix of therapies for the same period:\nAntibiotic Therapy, 72% of home infusion therapy revenues. Antibiotic therapy ------------------ requires the infusion of antibiotic drugs into the patient's bloodstream to treat infections and diseases, such as osteomyelitis (bone infections), bacterial endocarditis (infection of the lining around the heart), wound infections, infections associated with HIV\/AIDS, and infections of the kidneys and urinary tract. Antibiotics are generally believed to be more effective when infused directly into the bloodstream than when taken orally. These treatments can be prescribed by primary care physicians, are short-term in nature and recur occasionally.\nEnteral Nutrition Therapy, 12% of home infusion therapy revenues. Enteral ------------------------- nutrition therapy is administered to patients who cannot eat as a result of an obstruction to the upper gastrointestinal tract or because they are otherwise unable to be fed orally. As with total parenteral nutrition therapy, enteral nutrition therapy is often administered over a long period.\nPain Management and Chemotherapy, 6% of home infusion therapy revenues. Pain -------------------------------- management therapy is the administration of pain controlling drugs to terminally or chronically ill patients and is often administered in conjunction with intravenous chemotherapy. Chemotherapy is the continuous or intermittent intravenous administration of anti-cancer drugs. Chemotherapy generally is administered periodically for several weeks or months.\nTotal Parenteral Nutrition Therapy, 5% of home infusion therapy revenues. ---------------------------------- Total parenteral nutrition (TPN) therapy involves the intravenous feeding of nutrients to patients with impaired digestive tracts due to gastrointestinal illnesses or conditions, due to underlying conditions including cancer or HIV\/AIDS. TPN is usually longer in duration than other forms of infusion therapy, and can be lifelong.\nOther Therapies. Other therapies and services include therapies such as --------------- congestive heart failure therapy, hydration therapy and related nursing services.\nThe Company's home infusion therapy business is dependent in large measure upon physicians continuing to prescribe the administration of drugs and nutrients through intravenous and other infusion methods. Orally administered drugs and alternative drug delivery systems may have an effect upon the demand for certain infusion therapies. The Company can predict neither the ultimate impact of these treatments on the Company's business nor the nature of future medical advances or their eventual impact on the Company's business.\nPRIMARY CARE PHYSICIANS PRACTICES\nRoTech believes that acquisitions of primary care physician practices in its service areas present substantial opportunities. The Company believes that it will be able to increase the profitability of the individual practices through economies of scale and greater efficiencies, and that its centralized billing and reimbursement functions will typically result in lower costs per claim and quicker reimbursement. Based upon its many years of marketing to primary care physicians, RoTech believes that the additional training and responsibility of certain key personnel in a practice, typically a nurse, result in more efficiency and allow physicians to spend more time practicing medicine. Not only does this increased efficiency boost profitability, it also usually results in greater physician satisfaction. In a medical practice owned by RoTech, RoTech has the opportunity to instill the philosophy of patient retention whereby primary care physicians can help patients maintain control over their health care expenditures. The Company believes this increases the profitability of the primary care physician practice and reduces the total amount of money spent to treat a patient with no reduction in the overall level of care. RoTech currently provides home health care products and services to the patients of more than 2,000 primary care physicians. The Company believes that many of these physicians could ultimately become part of RoTech through its acquisitions of such practices. Physician practices currently represent approximately 9% of the Company's revenues.\nRoTech has been a proponent of physician independence and autonomy through its long-standing marketing to primary care physicians. This position is counter to the role of the hospitals and managed care organizations who have historically served to limit access and reimbursement of these physicians. By partnering with RoTech, primary care physicians are able to obtain purchasing power, administrative services, management, information systems and capital for expanded staffing needed to service a larger patient base and improve the medical practice and quality of life of the physician. As RoTech creates networks of primary care physicians in these non-urban markets, additional services\ncan be justified and facilitated such as introduction of specialists (pulmonologist, cardiologist, oncologist, or obstetrician) or mobile diagnostic equipment. The Company expects that these specialists will serve to educate, support and consult with the primary care physician; will be salaried, contracted or possibly capitated; and will provide hands-on treatment of more complex cases. The expected economies of scale and information systems strength will result in a better, more cost effective system for disease management, including early detection and treatment, preventive care and wellness programs.\nGOVERNMENT REGULATION\nThe home care industry is subject to extensive government regulation at the federal level through the Medicare program and at the state level through the Medicaid program. Medicare is a federally funded health insurance program which provides health insurance coverage for persons age 65 and older and certain disabled persons, and generally provides reimbursement at specified rates for sales and rentals of specified medical equipment and supplies, provided such equipment and supplies are determined to be medically necessary by the treating physician. Medicaid is a health insurance program administered by state governments which provides reimbursements for health care for certain financially or medically needy persons regardless of age.\nThe Company is subject to government audits of its Medicare and Medicaid reimbursement claims and has not, to date, experienced any material loss as a result of any such government audits. Under existing federal law, the knowing and willful offer or payment of any remuneration (including any kickback, bribe or rebate) of any kind to another person to induce the referral of Medicare or Medicaid beneficiaries for whom medical supplies and services may be reimbursed by the Medicare or Medicaid programs is prohibited and could subject the parties to such an arrangement to substantial criminal and civil penalties, including exclusion from participation in these programs, for Medicare or Medicaid fraud. The Office of Inspector General of the Department of Health and Human Services (\"OIG\") has promulgated regulatory \"safe harbors\" that describe certain practices and business arrangements that comply with Medicare and Medicaid regulations. The OIG and law enforcement authorities have recently increased their investigatory efforts to determine whether various business practices constitute remuneration for, or to induce, referrals. Certain states have also passed statutes and regulations that prohibit payments for referral of patients. These laws vary significantly from state to state. The result of legislative and regulatory efforts is a challenging compliance situation. The Company has been made aware that the OIG has made certain informal inquiries related to payments received by the Company in the late 1980's. The OIG submitted its findings to the United States Attorney for the Middle District of Florida, which has elected to file a civil suit, Case No. 95-558-CIV-ORL-18, in which it is contended that Medicare made some unspecified amount of payments to the Company by mistake in part of 1987, 1988, and 1989. The civil suit seeks repayment of the monies allegedly paid by mistake. While the Company is confident that it was at all times in compliance with all material Medicare requirements, and believes that all payments it received were made correctly and not by mistake, the Company seeks an amicable resolution of the issues involved in the civil suit in order to save time and potential litigation expenses. However, if the matter is not amicably resolved, the Company intends to mount a vigorous defense. The potential financial exposure of the Company in the civil suit is unknown.\nThe types of services and products delivered by the Company, the required quality of such services and products and the manner in which such services and products are delivered and billed are each subject to significant and complex regulations promulgated, interpreted and administered by the appropriate federal or state governmental agency. Although the Company believes that its products,\nservices and procedures comply in all respects with such regulations applicable to reimbursement eligibility, the unavailability of advance formal administrative rulings in most regulated areas subjects the Company to possible subsequent adverse interpretations and rulings which may affect the eligibility of some or all of the Company's services and products for reimbursement. Such an adverse interpretation or ruling could have a substantial adverse impact on the Company's business.\nIn addition, the Company is required to obtain federal and state licenses and permits relating to the distribution of pharmaceutical products, including a federal Controlled Dangerous Substance Registration Certificate and Florida State Wholesaler License. The Company is required to obtain similar licenses from each state in which it does business.\nThe Company's acquisitions of primary care physician practices are structured to attempt to comply with federal and state law restrictions on business relationships between the Company and persons who may be in a position to refer patients to the Company for the provision of health care related items or services. Accordingly, the Company endeavors to undertake such acquisitions in a manner where the consideration offered and paid is consistent with fair market value in arms-length transactions and is not determined in a manner that takes into account the volume or value of any referrals or business that might otherwise be generated between the Company and the physician whose practice to be acquired and for which payment may be made under Medicare or Medicaid. While the Company believes that its acquisitions do not entail any form of unlawful remuneration, there can be no assurances that enforcement authorities will not attempt to construe the consideration exchanged in certain acquisition transactions as entailing unlawful remuneration and to challenge such transactions on such basis.\nIn many states, the \"corporate practice of medicine doctrine\" prohibits business corporations from providing, or holding themselves out as providers of, medical care through the employment of physicians. Although the two states in which the Company has acquired practices of primary care physicians, Florida and Mississippi, have not adopted this prohibition, there can be no assurance that either state will not adopt this doctrine in the future or that the Company will not acquire a primary care medical practice in a state that has enacted or adopted through case law the corporate practice of medicine doctrine. While the Company intends to structure future acquisitions to comply with the corporate practice of medicine doctrine where it exists, there can be no assurance that, given varying and uncertain interpretations of such laws, the Company would be found to be in compliance with restrictions on the corporate practice of medicine in all states. Enforcement of such doctrine could require divestiture of acquired practices or restructuring of physician relationships.\nHealth care is an area of extensive and dynamic regulatory change. Changes in the law or new interpretations of existing laws can have a dramatic effect on permissible activities, the relative costs associated with doing business, and the amount of reimbursement by government and third-party payors. The Omnibus Budget Reconciliation Act of 1987 (\"OBRA 1987\") created six categories of durable medical equipment for purposes of reimbursement under the Medicare Part B program. There is a separate fee schedule for each category. OBRA 1987 also controls whether durable medical equipment products will be paid for on a rental or sale basis and established fixed payment rates for oxygen service as well as a 15-month rental ceiling on certain medical equipment. An interim final rule implementing the payment methodology under the fee schedules was published in the Federal Register. Payment based on the fee schedules is effective with covered items furnished on or after January 1, 1989. Generally, Medicare pays 80% of the lower of the supplier's actual charge for the item or the fee schedule amount, after adjustment for the annual deductible amount. OBRA 1990 made changes to Medicare Part B reimbursement that were implemented in 1991. The substantive change\nwas the standardization of Medicare rates for certain equipment categories. Laws and regulations often are adopted to regulate new products, services and industries. There can be no assurances that either the states or the federal government will not impose additional regulations upon the Company's activities which might adversely affect the Company's business.\nPolitical, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. Although Congress has failed to pass comprehensive health care reform legislation thus far, the Company anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems and may in the future propose and adopt legislation effecting fundamental changes in the health care delivery system and in the amount and circumstance under which federally funded payments such as Medicare and Medicaid are made. 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 industry or business.\nPursuant to federal legislation commonly known as \"Stark II\" enacted as part of The Omnibus Budget Reconciliation Act of 1993, and effective January 1, 1995, physicians are prohibited from making referrals to entities in which they (or immediate family members) have an investment interest or compensation arrangement, where such referral is for any \"designated health service\" covered by Medicare\/Medicaid, including parenteral and enteral nutrients, equipment and supplies, and home health services. Ownership by a physician of investment securities in a publicly-held corporation with stockholders' equity exceeding $75 million at the end of the corporation's most recent fiscal year or on average during the previous three fiscal years is exempt from the investment prohibition if the securities are traded on the New York, American or a regional stock exchange, or The Nasdaq National Market. Exemptions from the compensation arrangement prohibition include (i) amounts paid by an employer to a physician pursuant to a bona fide employment relationship meeting specified requirements, including payments being unrelated to referrals and consistent with the fair market value of the services provided and (ii) other personal service arrangements if certain requirements are met, including that compensation be paid over the term of a written agreement with a term of one year or more, be set in advance, not exceed fair market value, and be unrelated to referrals. While RoTech intends to structure its acquisitions and operations to comply with Stark II, there can be no assurance that future interpretations of that law will not require structural and organizational modifications of the Company's existing relationships with physicians, nor can assurance be given that present or future relationships between the Company and physicians will be found to be in compliance with such law.\nINSURANCE\nIn recent years, participants in the health care market have become subject to an increasing number of malpractice and product liability lawsuits, many of which involve large claims and significant defense costs. As a result of the liability risks inherent in the Company's lines of business, including the risk of liability due to the negligence of physicians or other health care professionals employed by or otherwise under contract to the Company, the Company maintains liability insurance intended to cover such claims. There can be no assurance that the coverage limits of the Company's insurance policies will be adequate, or that the Company can obtain liability insurance in the future on acceptable terms or at all.\nThe Company currently has in force general liability and products liability insurance policies, with coverage limits of $2.0 million per occurrence and in the aggregate annually (with a deductible of\n$25,000 per occurrence, and a deductible aggregate of $125,000). The Company also has in force a professional liability insurance policy, with a coverage limit of $1.0 million per occurrence and $3.0 million in the aggregate annually. The Company has in force, with respect to physicians employed by the Company, individual professional liability insurance policies, with coverage limits ranging from $250,000 per occurrence to $1 million per occurrence, and ranges from $750,000 in the aggregate annually to $3 million in the aggregate annually. The Company's insurance policies are subject to annual renewal.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe Company leases all of its offices and facilities. The Company's corporate headquarters is currently located in a 25,300 square foot warehouse\/office building located at 4506 L.B. McLeod Road, Suite F, Orlando, Florida, 32811, leased by the Company for a 5 year period ending September 30, 2000 at a current rate of $3.40 per square foot with utilities, taxes and insurance being the financial responsibility of the Company.\nIn addition to its corporate headquarters, the Company leases office facilities in its 225 locations. These facilities are primarily used for general office work and the dispatching of registered respiratory therapists, registered nurses, registered pharmacists and delivery personnel. From the above locations, the Company operates 34 pharmacies. The Company will consider opening additional pharmacies as business in each area dictates.\nThe Company's office facilities vary in size from approximately 200 to 6,000 square feet. The total space leased for these offices is approximately 750,000 square feet at an average price of $6 per square foot. All of such office space is leased pursuant to cancelable operating leases.\nManagement believes that its office and warehouse facilities are suitable and adequate for its planned needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nNo material legal proceedings are pending to which the Company or any of its subsidiaries is a party, or of which any of their property is subject, nor to the Company's knowledge, are any such legal proceedings threatened, except as discussed under the heading \"Government Regulation\" contained 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 during the fourth quarter of the fiscal year covered by this Report.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - -------------------------------------------------------------------------- MATTERS - -------\nThe information required by this item is set forth under the heading \"Prices of Common Stock\" on page 29 of the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and is hereby incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nThe information required by this item is set forth under the heading \"Selected Consolidated Financial Data\" on page 24 of the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and is hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATION - ------------\nRESULTS OF OPERATIONS\nThe following table presents certain statement of income data as a percentage of certain items relative to total operating revenue:\nFOR THE FISCAL YEARS ENDED JULY 31, 1995 AND 1994 - -------------------------------------------------\nOperating revenue increased 87.6% to $134.1 million for the fiscal year ended July 31, 1995 (\"fiscal 1995\") from $71.5 million for the fiscal year ended July 31, 1994 (\"fiscal 1994\"). The increase in operating revenue is attributable to acquisitions and expanded product and service lines in existing areas of operation. The Company continues to employ a single sales force to maintain and develop both the home respiratory and other medical equipment and home infusion therapy and other pharmacy related lines of business.\nOperating revenue from home respiratory and other medical equipment increased 113.7% to $88.8 million for fiscal 1995 from $41.6 million for fiscal 1994. The increase was due mainly to increases in patient bases throughout the Company's locations and increased marketing efforts in certain locations acquired during fiscal year 1994 and 1995.\nOperating revenue from home infusion therapy and pharmacy related services increased 31.6% to $33.6 million for fiscal 1995 from $25.5 million for fiscal 1994. Growth in this line of business should continue as the Company expands both its service areas and available products and services.\nOperating revenue from physician practices represented 8.7% of total operating revenue for fiscal 1995, compared to less than 5% for fiscal 1994. The Company currently owns 20 physician practices and employs 26 primary care physicians. These practices are clustered in two rural marketplaces. Growth in this line of business should continue yet decline as a percentage of operating revenue as the Company continues to acquire mostly home health care operations.\nCost of revenue as a percentage of operating revenue increased to 27.1% for fiscal 1995 from 24.4% for fiscal 1994 due to changes in the product mix in the last year resulting from mid-year fiscal 1994 and fiscal 1995 acquisitions. Selling, general and administrative expenses as a percentage of operating revenue remained relatively stable at 49.6% for fiscal 1995, down from 50.2% for fiscal 1994 as the revenue base has grown faster than the Company's costs. Selling, general and administrative expenses included a net gain from the sale of an other asset. The gain resulted from years of operational expenses flowing through the income statements rather than being capitalized. The net gain was offset by increased bad debt expense, resulting in no net impact on selling, general and administrative expenses and no impact on earnings from the gain. Management took the opportunity provided by the gain to improve its overall long-term financial position. Changes in the Company's mix of business also affect these categories. For example, physician practices have no cost of revenue, and all expenses are of a selling, general and administrative nature.\nDepreciation and amortization expense increased 79.2% to $9.6 million for fiscal 1995 from $5.3 million for fiscal 1994. Depreciation and amortization expense as a percentage of operating revenue was 7.1% for fiscal 1995 and 7.5% for fiscal 1994. The dollar increase was attributable to the Company's purchase of fixed and intangible assets resulting from various acquisitions and the fixed assets needed for the increased rentals of equipment. All acquisitions in fiscal 1995 were accounted for by the purchase method of accounting for acquisitions.\nInterest expense, net of interest income, increased to $835,000 for fiscal 1995 from $67,000 for fiscal 1994. This increase resulted from the Company borrowing monies to fund certain acquisitions. The proceeds from the Company's May 1995 stock offering were utilized to repay all bank indebtedness, yet due to the acquisition pace, the company became a borrower again in early July 1995.\nIncome tax expense was provided at a 37.2% effective rate, compared to 36.5% the prior fiscal year. The increase was due to the increase in non-deductible amortization expense in fiscal 1995 and the entry into a higher tax bracket.\nNet income for fiscal 1995 was $13.1 million, a 62.0% increase over the $8.1 million for fiscal 1994. Net income per share increased 28.3% to $1.27 for fiscal 1995 compared to $0.99 for fiscal 1994. The weighted average number of shares increased 26.9% to 10.3 million at July 31, 1995 from 8.1 million at July 31, 1994, primarily as a result of the March 1994 and May 1995 public stock offerings and shares issued in conjunction with certain acquisitions.\nFOR THE FISCAL YEARS ENDED JULY 31, 1994 AND 1993 - -------------------------------------------------\nOperating revenue for fiscal 1994 increased to $71.5 million from $48.4 million for the fiscal year ended July 31, 1993 (\"fiscal 1993\"). The 48% increase in operating revenue is attributable primarily to the increase from 71 locations to 134 locations in fiscal 1994 with approximately one-third of the increase resulting from the acquired home respiratory and other medical equipment companies. The balance of the growth in operating revenue was from existing locations, inclusion of fiscal 1993 acquisitions for a full year and locations internally developed in fiscal 1994.\nOperating revenue from home respiratory and other medical equipment grew 74% to $41.6 million for fiscal 1994 from $23.9 million for fiscal 1993. This 74% increase was due mainly to a continued focus of the Company's sales force toward home respiratory products and services and acquisitions of companies predominantly in this line of business.\nOperating revenue from home infusion therapy increased 17% to $25.5 million for fiscal 1994 from $21.7 million for fiscal 1993. The slower growth is due to the fiscal 1994 direction of the Company's single sales force toward home respiratory products and services, and unit growth in home infusion therapy products and services in spite of some pricing pressures experienced during the year.\nCost of revenue as a percentage of operating revenue decreased to 24.4% for fiscal 1994 from 25.5% for fiscal 1993. The Company continued to obtain better volume pricing with the addition of new entities and refocused its acquisition efforts on the home respiratory and other medical equipment line of business, which has a lower cost of revenue as a percentage of operating revenue. Selling, general and administrative expenses as a percentage of operating revenue decreased to 50.2% from 51.8% for the same two periods.\nDepreciation and amortization expense increased 91% to $5.3 million for fiscal 1994 from $2.8 million for fiscal 1993, and increased as a percentage of operating revenue during the same periods. This dollar increase is attributable to the Company's purchases of fixed and intangible assets resulting from various acquisitions and the fixed assets needed for the increased rentals of equipment.\nNet interest expense decreased to $67,000 for fiscal 1994 from $76,000 for fiscal 1993. This decrease resulted from the payment of outstanding debt balances in March 1994 with proceeds from the public offering and lower interest rates charged on borrowings from banks prior to March 1994. The decrease was also due to the interest income earned on short-term investments.\nThe effective tax rate was 36.5% for fiscal 1994, compared to 36.6% for fiscal 1993.\nAs a result of the foregoing, net income increased 58% to $8.1 million from $5.1 million and net income as a percentage of operating revenue increased to 11.3% for fiscal 1994 from 10.6% for fiscal 1993.\nThe Company was required to adopt Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in the first quarter of fiscal 1994 as more fully described in Note 1 of the consolidated financial statements.\nLIQUIDITY AND CAPITAL RESOURCES -------------------------------\nAt July 31, 1995, total current assets were $56.7 million and total current liabilities were $18.8 million, resulting in working capital of $37.9 million. The Company's current ratio was 3.01 to 1 at July 31, 1995 compared to 3.68 to 1 at July 31, 1994. Net trade accounts receivable increased $12.7 million in fiscal 1995, or 42.8%. This increase is attributable to acquisitions of the net assets of many home health care companies during the year and the 87.6% increase in operating revenue over the prior year. As a result, the Company's days revenue outstanding on net accounts receivable decreased to 98 days at July 31, 1995 from 116 days at July 31, 1994. Acquired receivables remaining outstanding account for approximately 10 days revenue outstanding at July 31, 1995 and 21 days revenue outstanding at July 31, 1994.\nCurrent liabilities increased $8.5 million in fiscal 1995, or 81.8%, as $10.0 million was borrowed on the working capital line of credit. The balance of the change was due to the timing of payments to vendors.\nDuring fiscal 1995, the Company generated cash of $17.1 million from operating activities primarily as a result of net income of $13.1 million along with non- cash expenses of $11.7 million. Advances on the working capital line of credit were utilized to fund acquisitions and internal expansion. During fiscal 1995, the Company spent $55.6 million to acquire various home health care companies and $17.3 million to purchase property and equipment, primarily rental equipment, for operational needs. The Company has been financing its revenue growth and increased working capital requirements with positive net cash provided by operating activities and short-term borrowings.\nAs of July 31, 1995, the Company had a working capital line of credit of $75.0 million, with approximately $65.0 million available for future borrowing. The working capital and acquisition line of credit carries a negative pledge on all Company assets, is payable on demand and provides for interest rates, at the Company's election, of LIBOR plus .70% or prime rate minus 1% for the first $20.0 million advanced to the Company and LIBOR plus .825% or prime rate minus 1% for any advances in excess of the first $20.0 million. The line of credit requires compliance by the Company with certain financial and negative covenants, including a restriction on dividends. Management believes that its credit capacity and cash flow from operations, will be sufficient for the Company's projected growth in the near future.\nThe Company completed a public offering in May of 1995 in which it issued an additional 1.7 million shares for cash of $49.9 million, compared with its March 1994 public offering of 2.0 million shares which provided cash of $36.7 million.\nFor fiscal 1994, the Company's operating activities provided $4.8 million in cash, compared to $1.6 million in fiscal 1993. The primary component of this change was an increase in net income to $8.1 million for fiscal 1994, compared to $5.1 million for fiscal 1993, offset by increased accounts receivable and decreased amounts payable on operating liabilities. The Company has generated positive net cash flow from operating activities in each of its last six fiscal years despite increases in accounts receivable in each period resulting from the similar growth in operating revenue.\nDuring fiscal 1994, investing activities used $47.1 million in cash, compared to $6.4 million during fiscal 1993. During fiscal 1994, the Company spent $9.4 million to purchase property and equipment, primarily rental equipment, for operations and general equipment needs, compared to $4.0 million in fiscal 1993. Purchases of property and equipment typically represent the major component of the Company's investing activities. The Company paid $38.6 million to acquire various home health care companies in fiscal 1994. Aside from increased purchases of home respiratory and other medical equipment to support its sales growth in its home respiratory and other medical equipment operations, the Company does not require significant fixed capital investment.\nFinancing activities provided $40.0 million in cash during fiscal 1994, compared to $7.2 million during fiscal 1993. The Company's strategy has been to use net cash flow from operations and borrowings to finance expansion of its business. The Company was able to complete an equity offering and repay all borrowings with a portion of the proceeds to enable the same strategy to continue for fiscal 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nFinancial Statements - --------------------\nThe information required by this item is set forth on pages 4 through 22 in the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and is hereby incorporated by reference.\nSelected Quarterly Consolidated Financial Data - ----------------------------------------------\nThe supplementary financial information is set forth on page 29 of the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and is hereby incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ----------------------------------------------------------------------- FINANCIAL DISCLOSURE - --------------------\nOn June 7, 1994, the Company dismissed Ernst & Young LLP as its independent accountants and engaged Deloitte & Touche LLP as its new independent accountants. The change was reported in a Current Report on Form 8-K dated June 10, 1994.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nInformation concerning Directors and Executive Officers of the Registrant is incorporated herein by reference to the Company's definitive proxy statement dated November 8, 1995 for the annual meeting of shareholders to be held on December 8, 1995, pages 3 and 4, \"ELECTION OF DIRECTORS\". Such definitive proxy statement will be filed with the Securities and Exchange Commission no later than October 28, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nInformation concerning executive compensation is incorporated herein by reference to the Company's definitive proxy statement dated November 8, 1995 for the annual meeting of shareholders to be held on December 8, 1995, page 4, \"Executive Compensation,\" and page 5, \"Key Man Life Insurance.\" Such definitive proxy statement will be filed with the Securities and Exchange Commission no later than October 28, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nInformation concerning security ownership of certain beneficial owners and management is incorporated herein by reference to the Company's definitive proxy statement dated November 8, 1995 for the annual meeting of shareholders to be held on December 8, 1995, pages 1 and 2, \"PRINCIPAL HOLDERS OF VOTING SECURITIES\". Such definitive proxy statement will be filed with the Securities and Exchange Commission no later than October 28, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nInformation concerning certain relationships and related transactions is incorporated herein by reference to the Company's definitive proxy statement dated November 8, 1995 for the annual meeting of shareholders to be held on December 8, 1995, page 5, \"Certain Related Transactions\". Such definitive proxy statement will be filed with the Securities and Exchange Commission no later than October 28, 1995.\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 audited consolidated balance sheets of the -------------------- Registrant and subsidiaries as of July 31, 1995 and July 31, 1994, and the related consolidated statements of income, changes in stockholders' equity and cash flows of the Registrant and subsidiaries for the three fiscal years ended July 31, 1995, are set forth on pages 4 through 21 of the Registrant's Annual Report to Shareholders for the fiscal year ended July 31, 1995, which statements are incorporated in this report by reference.\n2. Financial Statement Schedules. The following Financial Statement ----------------------------- Scheule for years ended July 31, 1995, 1994 and 1993 is set forth under the heading \"Financial Statement Schedule\" on page 21 of the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995 and is hereby incorporated by reference.\nSchedule II Valuation and Qualifying Accounts for the fiscal years ended July 31, 1995, 1994 and 1993\nAll other schedules are omitted because they are not required, are not applicable, or the required information is included in the Consolidated Financial Statements or notes thereto.\n(a) 3. Exhibits. The exhibits filed as a part of this Report are listed in -------- the attached Index to Exhibits.\n(b) Reports on Form 8-K filed in the fourth quarter of fiscal 1995. --------------------------------------------------------------\nThe Company filed a Current Report on Form 8-K dated June 20, 1995. The Current Report discussed that the Registrant, through its wholly-owned subsidiary, Distinct Home Health Care, Inc., acquired substantially all of the assets of Marshall Bell, Ltd., a Texas-based partnership referred to as \"Marshall Bell, Ltd.,\" or \"Seller\") for $11.3 million cash and the issuance of 146,000 shares of restricted common stock valued at $2 million; that Marshall Bell, Ltd., provides home health care products and services through its locations in Texas, Louisiana, Mississippi and Arkansas; that the Registrant intends to continue the business as acquired; that the Sellers had no material relationship with the Registrant prior to the acquisition; that the purchase price was paid from available cash on hand resulting from the May 1995 secondary public offering in which the Registrant raised approximately $49.9 million; that the price was based on comparable purchases in the home health care industry, type and timing of consideration to be paid and arms-length negotiations between the two parties.\nIndex to Exhibits\nExcept as otherwise indicated, the following Exhibits are incorporated by reference as a part 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, RoTech Medical Corporation has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nROTECH MEDICAL CORPORATION, a Florida corporation\nBy: \/s\/ Stephen P. Griggs ----------------------- Stephen P. Griggs, President\nDate: October 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.","section_15":""}
{"filename":"319687_1995.txt","cik":"319687","year":"1995","section_1":"ITEM 1. BUSINESS.\nContinental Airlines, Inc. (the \"Company\", \"Continental\" or the \"Reorganized Company\") is a major United States air carrier engaged in the business of transporting passengers, cargo and mail. Continental is the fifth largest United States airline (as measured by 1995 revenue passenger miles) and, together with its wholly owned subsidiary, Continental Express, Inc. (\"Express\"), and its 91%-owned subsidiary, Continental Micronesia, Inc. (\"CMI\"), each a Delaware corporation, serves 175 airports worldwide. Internationally, Continental flies to 58 destinations and offers additional connecting service through alliances with foreign carriers. Continental is one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline. In addition, Continental flies to three cities in South America, and is scheduled to commence service between Newark and Lima, Peru in March 1996 and between Newark and Quito, Ecuador (via Bogota, Colombia) in June 1996. Through Guam and Saipan, CMI provides extensive service in the western Pacific, including service to more Japanese cities than any other Unites States carrier.\nAs used in this Form 10-K, the terms \"Continental\" and \"Company\" refer to Continental Airlines, Inc. (or, as required by the context, its predecessor) and, unless the context indicates otherwise, its subsidiaries. This Form 10-K may contain forward-looking statements. In connection therewith, please see the cautionary statements contained in Item 1. \"Business. Risk Factors\", which identify important factors that could cause actual results to differ materially from those in the forward-looking statements.\n1993 REORGANIZATION\nThe Company reorganized under Chapter 11 of the federal bankruptcy code in April 1993 (the \"Reorganization\"), having filed for protection in December 1990. Continental's filing for reorganization was necessitated primarily by declines in revenue resulting from a recessionary environment, extreme price competition and significantly increased fuel prices resulting from the Persian Gulf War.\nPursuant to the Reorganization, Continental Airlines Holdings, Inc. (together with its subsidiaries, \"Holdings\" or the \"Predecessor Company\"), which had been the Company's parent, merged into the Company. The previously outstanding publicly held equity interests in Holdings were canceled and new stock in the Company was issued. Also pursuant to the Reorganization, a majority of the Company's equity was issued to Air Partners, L.P., a Texas limited partnership (\"Air Partners\"), and Air Canada, a Canadian corporation, in exchange for their investments in the Company. Additional shares of common stock were issued to the Company's retirement plan, and a fixed number of shares of common stock was issued to or for the benefit of prepetition creditors. See Item 3. \"Legal Proceedings. Plan of Reorganization\".\nPursuant to the Reorganization, System One Information Management, Inc. (\"System One\"), which had been a subsidiary of Holdings, was restructured as a wholly owned subsidiary of Continental, two separate commuter airline subsidiaries were restructured as Express and Continental's western Pacific operations were restructured by establishing CMI.\n1994 ROUTE RESTRUCTURING\nDuring 1994, the Company significantly reduced operations in Denver, resulting in the conversion of Denver from a hub to a spoke city. In connection with the reduction in Denver operations, a number of aircraft were redeployed to other hubs and to non-hub flying. Also in 1994, Continental rapidly expanded its \"Continental Lite\" operations (a network of short-haul, no-frills, low-fare flights) from 173 daily flights and 19 aircraft serving 14 cities in November 1993 to 1,000 daily flights and 114 aircraft serving 43 cities in September 1994. The rapid growth of Continental Lite was supplied by redeploying a substantial portion of Continental's capacity, including aircraft made available by elimination of the Denver hub, and by deliveries of new aircraft under the Company's agreement with The Boeing Company (\"Boeing\"). Continental Lite experienced operational problems in connection with this rapid growth and was not profitable in 1994. At its peak, approximately 35% of Continental Lite flying consisted of point-to-point, linear service not integrated with the Company's hubs (\"linear flying\"). Linear flying proved to be significantly unprofitable and was responsible for an estimated 70% of all Continental Lite system losses in 1994.\n1995-1996 BUSINESS STRATEGY\nIn November 1994, Gordon Bethune was appointed Chief Executive Officer of Continental, and was joined shortly thereafter by Greg Brenneman as Chief Operating Officer. Continental has since been operated by a substantially new management team consisting of executives with successful track records in the areas of pricing, scheduling, distribution, human resources, operations, airport services, law, accounting and finance. This new management team developed a strategic program to enhance Continental's domestic hub operations, rationalize capacity, improve customer service and employee relations and strengthen Continental's balance sheet and liquidity. Continental has implemented substantial elements of the new strategic program to date, and management believes that these initiatives contributed significantly to the Company's dramatically improved operating performance and net income of $224 million in 1995 after recording $31 million in employee profit sharing. This program, referred to as the Go Forward Plan, has four key components: Fly to Win, Fund the Future, Make Reliability a Reality and Working Together. The principal initiatives undertaken to carry out these components are outlined below.\no Route realignment. Continental determined to build on the strength of its principal hub operations at Newark, Houston Intercontinental and Cleveland, while de-emphasizing linear service not integrated with the Company's hubs. Under the route realignment strategy, the Company significantly downsized and realigned its domestic route structure, withdrawing from unprofitable routes (principally linear Continental Lite flights) and refocusing on its hub operations. Continental also significantly reorganized its flight schedules to eliminate cash-negative flying and improve hub connections and efficiency, and has continued to enhance its hub scheduling. As a result of these initiatives and the capacity rationalization described below, domestic capacity (as measured by available seat miles, \"ASMs\") declined by 18.3% from 13.1 billion ASMs in the three months ended December 1994 to 10.7 billion ASMs in the three months ended December 1995.\nIn connection with its route realignment strategy, effective June 6, 1996, Continental will significantly reduce its operations in Greensboro, reducing daily departures from an average of 43 to 11. All employees affected by the service change will be eligible to transfer elsewhere within the Continental system as flying is reallocated to Continental's Houston, Newark and Cleveland hubs.\no Capacity rationalization. Reflecting the revised systemwide route needs, management reduced overall capacity by retiring 24 less-efficient widebody aircraft from the Company's jet fleet. Smaller, more efficient aircraft were substituted for the larger widebody aircraft, permitting closer alignment of aircraft size with market demand. The cascade effect of these changes throughout Continental's fleet permitted aircraft substitutions on a large portion of Continental's routes. Management believes that this initiative significantly contributed to Continental's passenger load factor improvement to 65.6% in 1995 from 63.1% in 1994. Since April 1995, Continental's monthly load factor has generally equaled or exceeded the industry average. Express has also benefitted from Continental's rationalization of capacity, as smaller markets formerly served by Continental's jets are now served by Express's turboprop aircraft, generally permitting operation with higher load factors and yields. Continental's rationalization of capacity was accompanied by appropriate cost reductions, including reduction of average full-time equivalent employee headcount by 17.9% from the three months ended December 31, 1994 to the three months ended December 31, 1995.\no Improved pricing and yield management. The Company has hired new executives experienced in pricing and revenue management and invested in state-of-the-art revenue management and pricing systems. Management believes these investments, together with Continental's route realignment and capacity rationalization, have facilitated implementation of a higher-yield pricing structure. The Company believes that further enhancements to its pricing and revenue management processes are possible.\no Reliability and customer service. Management has targeted improved customer service (as evidenced by standard measures such as on-time performance, mishandled bags and customer complaints) as a major priority. In February 1995, management implemented a variety of on-time performance initiatives, including a program of monthly bonuses of $65 per employee (up to the manager level) in each month that Continental's on-time performance finished in the top half of major United States carriers, as reported monthly by the Department of Transportation (\"DOT\"). Following implementation of the program, Continental ranked in the top half of major United States carriers for on-time performance in nine out of 11 months, scored first in this measure in three of these months, and ranked first among such carriers for the fourth quarter of 1995. Continental had not previously scored first in monthly on-time performance since the DOT began compiling and publishing these statistics in 1987. For 1996, bonuses of $65 will continue to be paid to such employees for each month that Continental ranks second or third among major United States carriers in on-time performance, and bonuses of $100 will be paid for each month that Continental ranks first. Continental also ranked in the top half of the industry for the lowest number of mishandled bags per 1,000 enplanements in 10 out of 11 months since the implementation of the program and recorded the lowest mishandled bag ratio of all major carriers in August, September, October and November 1995. As a result of these and other operational and customer service initiatives, DOT-reported customer complaints with respect to the Company have dropped\nsubstantially; for the months of November and December 1995, the DOT recorded 11 and 13 customer complaints, respectively, compared to 60 and 48 complaints, respectively, in 1994. Continental's goal for 1996 is to be ranked monthly in the top three in each of these DOT performance metrics.\no Improved employee relations. Management believes that Continental's employees are its greatest asset as well as the cornerstones of improved reliability and customer service. New management has introduced a variety of programs to increase employee participation and foster a sense of shared community. These initiatives include regularly scheduled visits to airports throughout the route system by the senior executives of the Company (each of whom is assigned an airport for this purpose) and monthly meetings open to all employees, as well as other periodic on-site visits by management designed to encourage employee participation and cooperation and provide accurate information. Decision making and accountability have been pushed down to operating levels. For example, early in 1995, the Company formed the Operational Performance Department, which gathers employee suggestions regarding operational inefficiencies and finds and implements solutions to operational issues. In 1995, the Company successfully negotiated a collective bargaining agreement covering its Continental and CMI pilots, which was ratified by 93.0% of the affected pilots, and a separate agreement covering the pilots of Express.\no Revenue enhancement. In addition to the on-time performance and other programs noted above, management has acted in a number of areas to enhance Continental's attractiveness to business travelers and the travel agent community, including restoring certain benefits to its award-winning frequent flyer program, reinstating first class seating and travel agency incentive programs and enhancing meal services. Efforts to improve the airline's image among business travelers also include significantly improved reliability, consistent exterior and interior plane designs, increased efforts to enhance the appearance of airline cabins and improvements to airport gate areas. In addition to increasing revenue associated with its hub operations, these actions are intended to improve Continental's ability to increase its share of flow traffic.\no Liquidity and financial initiatives. The Company took the following steps in 1995 that improved liquidity by approximately $250 million and strengthened its financial position for the near and medium term:\n- Continental renegotiated lease payments on 32 widebody aircraft to achieve a variety of cash concessions including reduced or deferred rental payments and lease terminations. In connection with these arrangements, in addition to other payments and agreements, the Company issued $158 million in aggregate original principal amount of convertible secured debentures to certain aircraft lessors. As of February 1, 1996, all such debentures had been repurchased or redeemed by the Company.\n- The Company amended its principal secured loan agreements, certain lease agreements and certain promissory notes with General Electric Capital Corporation, General Electric Company and certain affiliates (any one or more of such entities, \"GE\") to defer 1995 and 1996 principal payments and certain 1995 lease payments.\n- Delivery of substantially all aircraft previously scheduled for 1996 and 1997 was rescheduled to 1998 and beyond, and options to purchase additional aircraft were canceled. Five aircraft previously scheduled for delivery in 1995 were sold to a third party and replaced by aircraft to be delivered in 1998.\n- The Company reached an agreement to reduce its commitment for gates and related space at the new Denver International Airport (\"DIA\"), resulting in expected annual savings of $20 million.\nThese transactions reduced financing needs for 1996 and 1997 and are expected to improve the Company's 1996 liquidity by approximately $275 million.\nThe Company has also undertaken a variety of other activities intended to strengthen its longer-term financial position and enhance earnings:\n- The Company consummated an offering of 8-1\/2% convertible trust originated preferred securities (\"TOPrS\"), which are convertible into Class B common stock of Continental at a price of $48.36 per share. A portion of the $242 million net proceeds of that offering was used to repurchase or redeem all of the Company's convertible secured debentures issued in connection with the lease renegotiations discussed above (which would otherwise have become convertible into Class B common stock in August 1996 at a price of $26 per share). An additional portion of the net proceeds was used to repay obligations incurred to aircraft lessors and lenders in connection with those renegotiations.\n- In the third quarter of 1995, the Company purchased from Air Canada warrants to purchase approximately 6.2 million shares of Continental's common stock with exercise prices of $15 and $30 per share for $14 million in cash (including a $5 million fee paid to a lender) and a $42 million one-year note (which note was repaid with a portion of the net proceeds of the TOPrS offering).\n- The Company recorded a $30 million after-tax gain in the second quarter of 1995 in connection with a series of transactions involving System One (described below), which increased liquidity by an additional $82 million, consisting of $40 million of cash proceeds and $42 million of outstanding indebtedness extinguished.\n- On January 31, 1996, the Company consummated the offering of $489 million of enhanced pass-through certificates that refinanced the underlying debt associated with 18 leased aircraft and will reduce Continental's annual operating lease expense by more than $15 million for the affected aircraft.\nDOMESTIC OPERATIONS\nContinental operates its domestic route system primarily through its hubs at Newark, Houston Intercontinental and Cleveland. The Company's hub system allows it to transport passengers between a large number of destinations with substantially more frequent service than if each route were served directly. The hub system also allows Continental to add service to a new destination from a large number of cities using only one or a limited number of aircraft. Management has recently reconfigured Continental's hubs to improve passenger connections and operational efficiency.\nNewark. As of February 16, 1996, Continental operated 50% (191 departures) of the average daily jet departures and, together with Express, accounted for 58% (309 departures) of all average daily departures (jet and turboprop) from Newark. Considering the three major airports serving New York City (Newark, LaGuardia and John F. Kennedy), the Company and Express accounted for 23% of all daily departures, while the next largest carrier, USAir, Inc. (\"USAir\"), and its commuter affiliate accounted for 15% of all daily departures.\nHouston Intercontinental. As of February 16, 1996, Continental operated 78% (290 departures) of the average daily jet departures and, together with Express, accounted for 81% (383 departures) of all average daily departures from Houston's Intercontinental Airport. Southwest Airlines Co. (\"Southwest\") also has a significant share of the Houston market through Hobby Airport. Considering both Intercontinental and Hobby Airports, Continental operated 55% and Southwest operated 26% of the daily jet departures from Houston.\nCleveland. As of February 16, 1996, Continental operated 53% (98 departures) of the average daily jet departures and, together with Express, accounted for 58% (176 departures) of all average daily departures from Cleveland. The next largest carrier, USAir, and its commuter affiliate accounted for 9% of all daily departures.\nContinental Express. Continental's jet service at each of its domestic hub cities is coordinated with Express, which operates under the name \"Continental Express\". Express operates advanced, new-generation turboprop aircraft that average approximately six years of age and seat 64 passengers or less. As of February 16, 1996, Express served 23 destinations from Newark and 21 destinations from each of Houston Intercontinental and Cleveland. In addition, commuter feed traffic is currently provided by other code-sharing partners to 14 destinations from Los Angeles, 9 from Greensboro and two from Denver. In general, Express flights are less than 200 miles in length and less than 90 minutes in duration.\nManagement believes Express's turboprop operations complement Continental's jet operations by allowing more frequent service to small cities than could be provided economically with conventional jet aircraft and by carrying traffic that connects onto Continental's jets. In many cases, Express (and Continental) compete for such connecting traffic with commuter airlines owned by or affiliated with other major airlines operating out of the same or other cities. In May 1994, Express terminated substantially all of its unprofitable Denver operations, which were taken over by GP Express Airlines, Inc. (\"GP Express\"), an unaffiliated commuter airline operator. GP Express, which provides commuter feed in Greensboro and Denver, filed for reorganization under Chapter 11 of the federal bankruptcy code in January 1996. The loss of\nfeed from GP Express is not expected to materially adversely affect the Company's operations at Greensboro or Denver.\nAmerica West Airlines, Inc. (\"America West\"). Continental has entered into a series of agreements with America West, including agreements related to code-sharing and ground handling, which have created substantial benefits for both airlines. These code-sharing agreements cover 80 city-pairs and allow Continental to link additional destinations to its route network. The sharing of facilities and employees by Continental and America West in their respective key markets has resulted in significant expense savings.\nIn connection with America West's emergence from bankruptcy in August 1994, Continental paid $19 million for 4.1% of the equity interest and 17.1% of the voting power (exclusive of warrants to purchase an additional 802,860 shares of common stock) of the reorganized America West. On February 21, 1996, Continental sold 1.1 million shares of America West's common stock for net proceeds of approximately $20 million in an underwritten public offering. Continental has granted the underwriters of such offering the right to purchase approximately 258,030 shares of America West's common stock for a 30-day period to cover overallotments. Assuming the exercise of such overallotment in full, Continental will own approximately 1.0% of the equity interest and 7.9% of the voting power of America West.\nINTERNATIONAL OPERATIONS\nInternational Operations. Continental has extensive operations in the western Pacific conducted by CMI and serves destinations throughout Europe, Mexico and Central and South America. As measured by 1995 ASMs, approximately 26.4% of Continental's jet operations were dedicated to international traffic. As of February 16, 1996, the Company offered 49 weekly departures to five European cities and marketed service to three other cities through code-sharing agreements. Continental is one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline.\nThe Company's Newark hub is a significant international gateway. From Newark, the Company serves London, Manchester, Paris, Frankfurt, Madrid and Montreal, as well as Rome, Milan, Amsterdam and certain destinations in Canada through code-sharing with other foreign carriers. In addition, the Company has non-stop service to two Mexican cities and six Caribbean destinations from Newark. The Company expects to begin service between Newark and Lima, Peru in March 1996 and between Newark and Quito, Ecuador (via Bogota, Colombia) in June 1996.\nThe Company's hub at Houston Intercontinental is the focus of its operations in Mexico and Central America. Continental currently flies to 11 cities in Mexico, every country in Central America and three cities in South America. In addition, Continental flies from its Houston Intercontinental hub to London and Paris.\nContinental Micronesia. CMI is a United States-certificated international air carrier engaged in the business of transporting passengers, cargo and mail in the western Pacific, which is one of the fastest growing areas for air travel in the world. From its hub operations based in Guam and Saipan, CMI provides service to seven cities in Japan, more than any other United States\ncarrier, and to other Pacific rim destinations, including Taiwan, the Philippines, Hong Kong, South Korea and Indonesia. CMI is the principal air carrier in the Micronesian Islands, where it pioneered scheduled air service in 1968. CMI's route system is linked to the United States market through Honolulu, which CMI serves non-stop from both Tokyo and Guam. CMI and Continental also maintain a code-sharing agreement and coordinate schedules on certain flights from the west coast of the United States to Honolulu, and from Honolulu to Guam and Tokyo to facilitate travel from the United States into CMI's route system.\nThe 9.0% minority interest in CMI is owned by United Micronesia Development Association, Inc. (\"UMDA\"), a private company. Under agreements entered into in connection with the Reorganization, UMDA would have the right to increase its ownership in CMI to just over 20% in the event any participating employer in the Company's pension plans failed to make, or Continental failed to adequately provide for, certain pension plan payments. CMI also pays UMDA a fee of one percent of CMI's gross revenue, as defined, which will continue until January 1, 2012. Prior to the establishment of CMI as part of the Reorganization, Continental had conducted the western Pacific operations itself under the name Continental\/Air Micronesia and had paid UMDA the one percent fee.\nCMI borrowed $160 million from GE, which is secured by a first mortgage on substantially all the assets of CMI. Continental has guaranteed repayment of the loan, and its guarantee is secured by a pledge of its stock in the parent of CMI.\nForeign Carrier Alliances. Over the last decade, major United States airlines have developed and expanded alliances with foreign air carriers, generally involving adjacent terminal operations, coordinated flights, code-sharing and other joint marketing. Continental is the sole major United States carrier to operate a hub in the New York City area, by virtue of its Newark operation. Consequently, management believes the Company is uniquely situated to attract alliance partners from Europe, the Far East and South America and intends to aggressively pursue such alliances in order to benefit from the high-yield flow traffic that may be generated thereby. Continental currently has code-sharing agreements with Alitalia Airlines (\"Alitalia\"), Air Canada and Transavia Airlines (\"Transavia\"), and joint marketing agreements with other airlines not involving code-sharing, which management believes are important to Continental's ability to compete as an international airline. Alitalia and Continental code-share between points in the United States and Italy, with Alitalia placing its code on Continental flights to seven cities and Continental placing its code on Alitalia flights to Rome and Milan. Continental and Air Canada (and its subsidiaries) code-share on five cross-border routes, where Continental places its code on 24 Air Canada flights per day, and Air Canada places its code on four Continental flights per day. Both Continental and Air Canada provide ground handling and other services for each other in the United States, Canada and at other locations worldwide. The Company has recently entered into code-sharing agreements with CSA Czech Airlines, China Airlines, the TACA Group (serving Central America and the northern tier of South America) and World Airways (serving four cities in South Africa, Israel and Ireland), which agreements will be implemented during the first half of 1996. The Company anticipates entering into other code-sharing agreements during 1996.\nCONTINENTAL CRS INTERESTS, INC. (\"CONTINENTAL CRS\")\nContinental and its System One subsidiary entered into a series of transactions on April 27, 1995 whereby a substantial portion of System One's assets (including the travel agent subscriber base and travel-related information management products and services software), as well as certain liabilities of System One, were transferred to a newly formed limited liability company, System One Information Management, L.L.C. (\"LLC\"). LLC is owned equally by Continental CRS (formerly System One, which remains a wholly owned subsidiary of Continental), Electronic Data Systems Corporation (\"EDS\") and AMADEUS, a European computerized reservation system (\"CRS\"). Substantially all of System One's remaining assets (including the CRS software) and liabilities were transferred to AMADEUS. In addition to the one-third interest in LLC, Continental CRS received cash proceeds of $40 million and an equity interest in AMADEUS valued at $120 million, and outstanding indebtedness of $42 million of System One owed to EDS was extinguished. In connection with these transactions, the Company recorded a pretax gain of $108 million, which amount was included in Nonoperating Income (Expense) in the accompanying consolidated statement of operations for the year ended December 31, 1995. The related tax provision totaled $78 million (which differs from the federal statutory rate due to certain nondeductible expenses), for a net gain of $30 million. System One's revenue, included in Cargo, mail and other revenue, and related net earnings were not material to the consolidated financial statements of Continental.\nEMPLOYEES\nAs of December 31, 1995, Continental had approximately 32,300 full-time equivalent employees, including approximately 14,100 customer service agents, reservations agents, ramp and other airport personnel, 5,600 flight attendants, 5,100 management and clerical employees, 4,400 pilots, 3,000 mechanics and 100 dispatchers. Labor costs are a significant variable that can substantially impact airline results. In 1995, labor costs constituted 26.3% of the Company's total operating expenses. While there can be no assurance that Continental's generally good labor relations and high labor productivity will continue, Continental's management has established as a significant component of its business strategy the preservation of good relations with the Company's employees, approximately one-third of whom are represented by unions.\nDuring 1995, the Company and its pilots (excluding Express pilots) entered into a collective bargaining agreement with the Independent Association of Continental Pilots (\"IACP\") that was ratified by the pilots and becomes amendable in July 1997. The new agreement provides for a $20 million cash payment by the Company in 1995, a 2.5% longevity wage increase on July 1, 1995, a $10 million cash payment on April 1, 1996, a 13.5% wage increase on July 1, 1996 and a 5.0% wage increase on June 30, 1997. Under the agreement, the pilots agreed to forego their participation in employee profit sharing for 1995 and 1996.\nExpress and its pilots entered into a collective bargaining agreement during 1995 with the IACP that was ratified by Express pilots and becomes amendable on October 1, 1997. The new agreement provides for a $2 million cash payment by Express, 2.5% wage increases on July 1, 1996 and June 30, 1997, profitability bonuses and participation in Continental's on-time performance bonus plan.\nIn 1995, the board of directors of the IACP voted to affiliate with the Air Line Pilots Association (\"ALPA\"), reportedly based in part on then widespread news reports of possible industry consolidation and a desire to place Continental pilots in a stronger position to preserve seniority if Continental were to be acquired by another airline. Any such affiliation with ALPA (which would be subject to, among other things, ratification by the members of the IACP) is not expected to have a material adverse effect on the Company's relations with its pilots.\nContinental's collective bargaining agreement with its flight attendants, represented by the International Association of Machinists and Aerospace Workers (\"IAM\"), becomes amendable in June 1996. The Company anticipates commencing bargaining with the IAM in the near future regarding an amendment to the collective bargaining agreement. In November 1995, Continental and the IAM successfully reached a four-year agreement with respect to the Express flight attendants which becomes amendable in November 1999. Approximately 85% of CMI's flight attendants are also represented by the IAM (excluding all foreign nationals), but are covered under a separate four-year contract that becomes amendable in September 1996.\nThe Aircraft Mechanics Fraternal Association (\"AMFA\") has filed an application with the National Mediation Board (\"NMB\") under the Railway Labor Act seeking to represent the Company's mechanics and related employees for purposes of collective bargaining. The NMB has appointed a mediator to investigate the application, and the Company has provided the NMB with a list of employees who would be potential eligible voters if an election were held. The Company believes that the AMFA has failed to gather a sufficient number of representation cards to require an election. The NMB is currently investigating this representation dispute.\nCMI's mechanics and mechanic-related employees are represented by the International Brotherhood of Teamsters (\"IBT\") under a collective bargaining agreement signed in April 1994, which becomes amendable in March 1997. The IBT also represents CMI's agent classification employees located on Guam, whose collective bargaining agreement was also signed in April 1994 and becomes amendable in March 1997. The IBT has also sought representation rights for CMI's agent employees located on Saipan. The NMB's certification of the IBT as the bargaining representative for these employees was successfully challenged by CMI in a suit brought in Saipan federal court in 1995. The NMB has filed a request for reconsideration. Regardless of the final outcome of this representation dispute, the Company does not anticipate any significant adverse effect on its employee relations resulting from these events.\nContinental's dispatchers are represented by the Transport Workers Union of America, AFL-CIO (\"TWUA\") under a collective bargaining agreement signed in 1991. The Company is currently in negotiations with the TWUA to amend the existing agreement. Express's dispatchers are also represented by the TWUA, but are currently without a contract. CMI's dispatchers are not represented by a union.\nThe other employees of Continental, Express and CMI are not represented by unions and are not covered by collective bargaining agreements.\nMARKETING\nAs is the case with other carriers, most tickets for travel on Continental are sold by travel agents. Travel agents generally receive commissions measured by the price of tickets sold. Accordingly, airlines compete not only with respect to the price of tickets sold but also with respect to the amount of commissions paid. Airlines often pay additional commissions in connection with special revenue programs. In February 1995, Delta Air Lines, Inc. (\"Delta\") placed a $25 cap on travel agency commissions for one-way tickets priced over $250 and a $50 cap on travel agency commissions for round-trip tickets priced over $500. Other airlines, including Continental, have imposed similar commission caps. Certain travel agencies sued such carriers, including Continental. See Item 3. \"Legal Proceedings. Antitrust Proceedings\".\nIn September 1995, Continental announced the expansion of its electronic ticket (\"E-Ticket\") product, which is now available throughout the United States and, for the first time, through select travel agents serving a limited number of markets. Continental launched E-Ticket, in cooperation with EDS and AT&T Global Information Solutions, in April 1995. E-Ticket reservations may be made through Continental's reservation phone line, city ticket offices, airport ticket counters, E-Ticket machines and (in certain markets) travel agents, after which a one-page confirmation is automatically sent by facsimile or mail to the customer. Using an E-Ticket machine, E-Ticket customers arriving at the airport may check in, receive boarding passes, select or change seat assignments, input OnePass numbers, make simple flight changes and receive luggage tags. E-Ticket machines are similar to automatic teller machines and allow passengers to avoid lines at ticket counters, thus improving overall customer service at airports. Continental plans to expand the E-ticket program to select international destinations and to increase travel agency access by the end of 1996. The E-Ticket system is eventually expected to reduce distribution costs and improve the accuracy and timeliness of certain of Continental's reporting systems.\nFREQUENT FLYER PROGRAM\nEach major airline has established a frequent flyer program designed to encourage travel on that carrier. Continental sponsors a frequent flyer program (\"OnePass\"), which allows passengers to earn mileage credits by flying Continental and certain other carriers, including Air Canada, Transavia, Alitalia and America West (each a \"OnePass Partner\"), and by using the services of hotels, car rental firms and credit card companies participating in the OnePass program.\nContinental accrues the incremental cost associated with the earned flight awards based on expected redemptions. The incremental cost to transport a passenger on a free trip includes the cost of incremental fuel, meals, insurance and miscellaneous supplies and does not include any charge for potential displacement of revenue passengers or costs for aircraft ownership, maintenance, labor or overhead allocation.\nContinental estimates that as of December 31, 1995 and 1994, the total available awards under the OnePass program (based on accumulated mileage) were 2.4 million and 3.1 million roundtrips, respectively, after eliminating those accounts below the minimum level. Continental estimates that as of December 31, 1995 and 1994, 2.0 million and 2.2 million, respectively, of such awards could be expected to be redeemed and, accordingly, Continental has recorded a\nliability with respect to such awards. The liability for expected redeemed flight awards decreased from $42 million in 1994 to $35 million in 1995 primarily due to a change in the structure of the OnePass program that increased the number of miles required for awards. The difference between the awards expected to be redeemed and the total awards available is an estimate, based on historical data, of breakage for those customers who do not redeem all or part of their mileage for travel awards or use their awards with a OnePass Partner.\nThe number of awards used on Continental was approximately 525,000 and 590,000 roundtrips for the years 1995 and 1994, respectively. Such awards represented approximately 3.3% and 4.7% of Continental's total revenue passenger miles for such years. Due to the structure of the program and the low level of redemptions as a percentage of total travel, Continental believes that displacement of revenue passengers by passengers using flight awards has historically been minimal.\nINDUSTRY REGULATION AND AIRPORT ACCESS\nContinental and its subsidiaries operate under certificates of public convenience and necessity issued by the DOT. Such certificates may be altered, amended, modified or suspended by the DOT if the public convenience and necessity so require, or may be revoked for intentional failure to comply with the terms and conditions of a certificate. The airlines are also regulated by the Federal Aviation Administration (\"FAA\"), primarily in the areas of flight operations, maintenance, ground facilities and other technical matters. Pursuant to these regulations, Continental has established, and the FAA has approved, a maintenance program for each type of aircraft operated by the Company that provides for the ongoing maintenance of such aircraft, ranging from frequent routine inspections to major overhauls.\nCertain regulations require phase-out of certain aircraft and aging aircraft modifications. Such types of regulations can significantly increase costs and affect a carrier's ability to compete. In December 1995, the FAA promulgated final rules requiring commuter carriers to operate under the same safety rules and standards, and train their crew and dispatchers in accordance with the more stringent requirements, as are currently applicable to carriers operating larger aircraft. The new rules are not expected to have a significant impact on the operations of Express.\nThe DOT allows local airport authorities to implement procedures designed to abate special noise problems, provided such procedures do not unreasonably interfere with interstate or foreign commerce or the national transportation system. Certain airports, including the major airports at Boston, Washington, D.C., Chicago, Los Angeles, San Diego, Orange County and San Francisco, have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of such operations. In some instances, these restrictions have caused curtailments in services or increases in operating costs and such restrictions could limit the ability of Continental to expand its operations at the affected airports. Local authorities at other airports are considering adopting similar noise regulations.\nSeveral airports have recently sought to increase substantially the rates charged to airlines, and the ability of airlines to contest such increases has been restricted by federal legislation, DOT regulations and judicial decisions. In addition, legislation which became effective June 1, 1992 allows public airports to impose passenger facility charges of up to $3 per departing or connecting passenger at such airports. With certain exceptions, these charges are passed on to the customers.\nThe FAA has designated John F. Kennedy, LaGuardia, O'Hare and Washington National airports as \"high density traffic airports\" and has limited the number of departure and arrival slots at those airports. Currently, slots at the high density traffic airports may be voluntarily sold or transferred between the carriers. The DOT has in the past reallocated slots to other carriers and reserves the right to withdraw slots. Various amendments to the slot system, proposed from time to time by the FAA, members of Congress and others, could, if adopted, significantly affect operations at the high density traffic airports or expand slot controls to other airports. Certain of such proposals could restrict the number of flights, limit the ownership transferability of slots, increase the risk of slot withdrawals, result in defaults under the Company's secured note agreements with GE or require charges to the Company's financial statements. Continental cannot predict whether any of these proposals will be adopted.\nThe availability of international routes to United States carriers is regulated by treaties and related agreements between the United States and foreign governments. The United States has in the past generally followed the practice of encouraging foreign governments to accept multiple carrier designation on foreign routes, although certain countries have sought to limit the number of carriers. Foreign route authorities may become less valuable to the extent that the United States and other countries adopt \"open skies\" policies liberalizing entry on international routes. Continental cannot predict what laws and regulations will be adopted or their impact, but the impact may be significant.\nMany aspects of Continental's operations are subject to increasingly stringent federal, state and local laws protecting the environment. Future regulatory developments could affect operations and increase operating costs in the airline industry, including for the Company.\nRISK FACTORS\nContinental's History of Operating Losses. Although Continental recorded net income of $224 million for the year ended December 31, 1995, it had experienced significant operating losses in the previous eight years. In the long term, Continental's viability depends on its ability to sustain profitable results of operations.\nLeverage and Liquidity. Continental has successfully negotiated a variety of agreements to increase its liquidity during 1995 and 1996. Nevertheless, Continental remains more leveraged and has significantly less liquidity than certain of its competitors, several of whom have available lines of credit and\/or significant unencumbered assets. Accordingly, Continental may be less able than certain of its competitors to withstand a prolonged recession in the airline industry.\nAs of December 31, 1995, Continental and its consolidated subsidiaries had approximately $1.9 billion (including current maturities) of long-term indebtedness and capital lease obligations, and had approximately $615 million of minority interest, preferred securities of trust, redeemable preferred stock and common stockholders' equity. Common stockholders' equity reflects the adjustment of the Company's balance sheet and the recording of assets and liabilities at fair market value as of April 27, 1993 in accordance with fresh start reporting.\nDuring the first and second quarters of 1995, in connection with negotiations with various lenders and lessors, Continental ceased or reduced contractually required payments under various agreements, which produced a significant number of events of default under debt, capital lease and operating lease agreements. Through agreements reached with the various lenders and lessors, Continental has cured all of these events of default. The last such agreement was put in place during the fourth quarter of 1995. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Liquidity and Capital Commitments\".\nAs of December 31, 1995, Continental had approximately $747 million of cash and cash equivalents, including restricted cash and cash equivalents of $144 million. Continental does not have general lines of credit and has no significant unencumbered assets. Continental's ability to maintain and improve its liquidity and its long-term viability will depend upon its ability to sustain profitable results of operations.\nContinental has firm commitments to take delivery of three new 737 and two new 757 aircraft through early 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is $2.7 billion. In connection with the rescheduling of jet aircraft deliveries, $72 million of purchase deposits was returned to the Company in 1995. In December 1994, Express contracted with Beech Acceptance Corporation (\"Beech\") for the purchase and financing of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. As of December 31, 1995, 13 Beech 1900-D aircraft had been delivered, of which eight had entered service by that date and five will enter service in the first quarter of 1996. The remaining 12 aircraft are scheduled to be delivered in 1996. The Company currently anticipates that the firm financing commitments available to it with respect to its acquisition of new aircraft from Boeing and Beech will be sufficient to fund all deliveries scheduled during 1996. Furthermore, the Company currently anticipates that it will have remaining financing commitments from aircraft manufacturers of $575 million for jet aircraft deliveries beyond 1996. The Company believes that further financing will be needed to satisfy the remaining amount of such capital commitments. There can be no assurance that sufficient financing will be available for all aircraft and other capital expenditures not covered by firm financing commitments.\nFor 1996, Continental expects to incur cash expenditures under operating leases of approximately $586 million, compared with $521 million for 1995, relating to aircraft and approximately $235 million relating to facilities and other rentals. In addition, Continental has capital requirements relating to compliance with regulations that are discussed below.\nContinental and CMI have secured borrowings from GE which as of December 31, 1995 aggregated $634 million. CMI's secured loans contain significant financial covenants, including requirements to maintain a minimum cash balance and consolidated net worth, restrictions on\nunsecured borrowings and mandatory prepayments on the sale of most assets. These financial covenants limit the ability of CMI to pay dividends to Continental. In addition, Continental's secured loans require Continental to, among other things, maintain a minimum monthly operating cash flow and cumulative operating cash flow, a minimum monthly cash balance and a minimum ratio of operating cash flow to fixed charges. Continental also is prohibited generally from paying cash dividends on its capital stock, from purchasing or prepaying indebtedness and from incurring additional secured indebtedness. In addition, to the extent Continental's actual quarterly average cash balances exceed certain forecasts, a portion of such excess cash is required to be used to prepay certain loan obligations to GE.\nAircraft Fuel. Since fuel costs constitute a significant portion of Continental's operating costs (approximately 12.5% for the year ended December 31, 1995), significant changes in fuel costs would materially affect the Company's operating results. Fuel prices continue to be susceptible to international events, and the Company cannot predict near or longer- term fuel prices. In the event of a fuel supply shortage resulting from a disruption of oil imports or otherwise, higher fuel prices or curtailment of scheduled service could result.\nIn August 1993, the United States increased taxes on domestic fuel, including aircraft fuel, by 4.3 cents per gallon. Airlines were exempt from this tax increase until October 1, 1995, and proposed legislation in Congress would reinstate the exemption through September 30, 1997, subject to termination of the exemption on September 30, 1996 if certain aviation trust fund taxes are not extended. These aviation trust fund taxes expired on December 31, 1995 and have not, as of February 16, 1996, been extended. There can be no assurance that the continuation of this exemption will be enacted, or if enacted, the terms on which and the period for which the exemption will be effective. Continental has begun making its regular semi-monthly deposits based on the increased fuel tax. Non-extension of the fuel tax exemption would increase the annual operating expenses of Continental and Express by $36 million based on projected domestic fuel consumption levels during 1996.\nCertain Tax Matters. In connection with the Reorganization and the recording of assets and liabilities at fair market value under the American Institute of Certified Public Accountants' Statement of Position 90-7 - \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"), the Company recorded a deferred tax liability at April 27, 1993, net of the amount of the Company's estimated realizable net operating loss carryforwards as required by Statement of Financial Accounting Standards No. 109 - \"Accounting for Income Taxes\". Realization of a substantial portion of the Company's net operating loss carryforwards will require the completion during the five-year period following the Reorganization of transactions resulting in recognition of built-in gains for federal income tax purposes. The Company has consummated one such transaction (as described under Item 1. \"Business. Continental CRS Interests, Inc.\"), which had the effect of realizing approximately 40% of the built-in gains required to be realized over the five- year period, and currently intends to consummate one or more additional transactions. If the Company were to determine in the future that not all such transactions will be completed, an adjustment to the net deferred tax liability of up to $116 million would be charged to income in the period such determination was made.\nCMI. CMI's operating profit margins have consistently been greater than the Company's margins overall. In addition to its non-stop service between Honolulu and Tokyo, CMI's operations focus on the neighboring islands of Guam and Saipan, resort destinations that cater primarily to Japanese travelers. Because the majority of CMI's traffic originates in Japan, its results of operations are substantially affected by the Japanese economy and changes in the value of the yen as compared to the dollar. Appreciation of the yen against the dollar during 1993 and 1994 increased CMI's profitability and a decline of the yen against the dollar may be expected to decrease it. To reduce the potential negative impact on CMI's earnings, CMI, from time to time, purchases average rate options as a hedge against its net yen revenue position. Any significant and sustained decrease in traffic from Japan could materially adversely affect Continental's consolidated profitability.\nIndustry Conditions and Competition. The airline industry is highly competitive and susceptible to price discounting. The Company has in the past both responded to discounting actions taken by other carriers and initiated significant discounting actions (such as Continental Lite) itself. Continental's competitors include carriers with substantially greater financial resources, as well as smaller carriers with lower cost structures. Airline profit levels are highly sensitive to, and during recent years have been severely impacted by, changes in fuel costs, fare levels (or \"average yield\") and passenger demand. Passenger demand and yields have been adversely affected by, among other things, the general state of the economy, international events and actions taken by carriers with respect to fares. From 1990 to 1993, these factors contributed to the domestic airline industry incurring unprecedented losses. Although fare levels have increased recently, significant industry-wide discounts could be reimplemented at any time, and the introduction of broadly available, deeply discounted fares by a major United States airline would likely result in lower yields for the entire industry and could have a material adverse effect on the Company's operating results.\nThe airline industry has consolidated in past years as a result of mergers and liquidations and may further consolidate in the future. Among other effects, such consolidation has allowed certain of Continental's major competitors to expand (in particular) their international operations and increase their market strength. Furthermore, the emergence in recent years of several new carriers, typically with low cost structures, has further increased the competitive pressures on the major United States airlines. In many cases, the new entrants have initiated or triggered price discounting. Aircraft, skilled labor and gates at most airports continue to be readily available to start-up carriers. Although management believes that Continental is better able than some of its major competitors to compete with fares offered by start-up carriers because of its lower cost structure, competition with new carriers or other low cost competitors on Continental's routes could negatively impact Continental's operating results.\nRegulatory Matters. In the last several years, the FAA has issued a number of maintenance directives and other regulations relating to, among other things, retirement of older aircraft, collision avoidance systems, airborne windshear avoidance systems, noise abatement, commuter aircraft safety and increased inspections and maintenance procedures to be conducted on older aircraft. The Company expects to continue incurring expenses for the purpose of complying with the FAA's noise and aging aircraft regulations. In addition, several airports have recently sought to increase substantially the rates charged to airlines, and the ability of airlines to contest such increases has been restricted by federal legislation, DOT regulations and judicial decisions. See Item 1. \"Business. Industry Regulation and Airport Access\".\nAdditional laws and regulations have been proposed from time to time that could significantly increase the cost of airline operations by imposing additional requirements or restrictions on operations. Laws and regulations have also been considered that would prohibit or restrict the ownership and\/or transfer of airline routes or takeoff and landing slots. Also, the availability of international routes to United States carriers is regulated by treaties and related agreements between the United States and foreign governments that are amendable. Continental cannot predict what laws and regulations may be adopted or their impact, but there can be no assurance that laws or regulations currently enacted or enacted in the future will not adversely affect the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nFLIGHT EQUIPMENT\nAs shown in the following table, Continental's (including CMI's) jet aircraft fleet consisted of 309 jets at December 31, 1995.\n*Stage II (noise level) aircraft.\nAll of the aircraft and engines owned by Continental are subject to mortgages.\nAs part of the Company's capacity rationalization program, during 1995, Continental removed from service 21 A300 aircraft, three 747 aircraft and 19 727 aircraft. All such aircraft, other than five A300 aircraft and one 747 aircraft, have been returned to their respective lessors. The aircraft removed from service are not included in the above table. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations\".\nThe FAA has adopted rules pursuant to the Airport Noise and Capacity Act of 1990 that require a scheduled phase out of Stage II aircraft during the 1990's. As a result of Continental's acquisition of a number of new aircraft and the retirement of older Stage II aircraft in recent\nyears, 64.7% of Continental's current jet fleet was composed of Stage III aircraft at December 31, 1995. The Company plans to either retire or install hush kits on the remainder of its Stage II jet fleet (excluding those aircraft operated by CMI) prior to the year 2000 in order to comply with such rules.\nContinental has firm commitments to take delivery of three new 737 and two new 757 aircraft through early 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is $2.7 billion. The Company currently anticipates that it will have remaining financing commitments from aircraft manufacturers of $575 million for jet aircraft deliveries beyond 1996. In addition, the Company recently purchased one DC-10-30 aircraft and entered into an operating lease for another DC-10-30 aircraft that are expected to be placed into service by the end of the second quarter of 1996.\nAs of December 31, 1995, Express operated a fleet of 81 aircraft, as follows:\nIn December 1994, Express contracted with Beech for the purchase and financing of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. As of December 31, 1995, 13 Beech 1900-D aircraft had been delivered, of which eight had entered service by that date and five will enter service in the first quarter of 1996. The remaining 12 aircraft are scheduled to be delivered in 1996. In the fourth quarter of 1995, Express disposed of three ATR-42 aircraft and acquired one ATR-72 aircraft. In addition, one ATR-42 aircraft owned by the Company is currently leased to an unrelated third party and is not included in the table above. The Company is exploring the possibility of acquiring regional jets for operation by Express. As of February 16, 1996, no decision with respect to any such acquisition had been made. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Liquidity and Capital Commitments\" for information regarding capital commitments and financing relating to aircraft.\nFACILITIES\nThe Company's principal facilities are located at Newark, Houston Intercontinental, Cleveland and Guam\/Saipan. All these facilities, as well as substantially all of Continental's other facilities, are leased on a long-term, net rental basis, with the lessee responsible for maintenance, taxes, insurance and other facility-related expenses and services. In certain locations, Continental owns hangars and other facilities on land leased on a long-term basis, which facilities will become the property of the lessor on termination of the lease. At each of its three\ndomestic hub cities and most other locations, Continental's passenger and baggage handling space is leased directly from the airport authority on varying terms dependent on prevailing practice at each airport.\nDenver's Stapleton Airport closed on February 28, 1995 in connection with the opening of DIA. In 1992, the Company agreed to lease (i) 20 gates at DIA for a period of five years from the date DIA opened, (ii) four of such gates for an additional five years and (iii) a substantial amount of operational space in connection with the gates. On April 10, 1995, the Company reached an agreement with the City and certain other parties to amend its lease by reducing the Company's lease term to five years, reducing to 10 the number of gates (and reducing associated space) leased by the Company and making certain changes in the rates and charges under the lease. The agreement cured defaults under the lease, and also provided for the release of certain claims and the settlement of certain litigation filed by the City against the Company. See Item 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nPLAN OF REORGANIZATION\nThe Company's Plan of Reorganization, which became effective on April 27, 1993, provides for the full payment of all allowed administrative and priority claims. Pursuant to the Plan of Reorganization, holders of allowed general unsecured claims are entitled to participate in a distribution of 1,900,000 shares of Class A common stock, 5,042,368 shares of Class B common stock and $6,523,952 of cash and have no further claim against the Company. The Plan of Reorganization provided for this distribution to be issued initially in trust to a distribution agent and thereafter for distributions to be made from the trust from time to time as disputed claims are resolved. The distribution agent must reserve from each partial distribution of stock or cash to allow a complete pro rata distribution to be made to each holder of a disputed claim in the event such claim is eventually allowed, unless the United States Bankruptcy Court for the District of Delaware (the \"Bankruptcy Court\") establishes a lower reserve or estimates the claim at a lesser amount for purposes of distribution. As of December 31, 1995, there remained 306,743 shares of Class A common stock, 804,390 shares of Class B common stock, and $1 million of cash available for distribution. The stock and cash set aside for distribution to prepetition unsecured creditors was fixed in the Plan of Reorganization and will not change as claims are allowed. However, as set forth below, a limited number of proceedings are still pending in which prepetition creditors seek to impose additional obligations on the Company.\nBANKRUPTCY APPEALS\nSeveral parties appealed the Bankruptcy Court's April 16, 1993 order confirming the Plan of Reorganization.\nOn December 3, 1990, the Company owned 77 aircraft and 81 spare engines (in four collateral pools) securing debt evidenced by equipment trust certificates. The trustees for the four collateral pools moved in the Bankruptcy Court for \"adequate protection\" payments under Sections 361 and 363 of the federal bankruptcy code for the Company's retention and use of the aircraft and engines after December 3, 1990, including postpetition claims for the alleged decline in market value of the aircraft and engines after December 3, 1990 and claims for deterioration in the condition of the aircraft and engines in the same period. The Bankruptcy Court rejected the adequate protection claims that alleged market value decline. Prior to April 16, 1993, the Company settled all of the adequate protection claims of the trustees, except for a claim of $117 million for alleged market value decline of 29 aircraft and 81 spare engines in the fourth collateral pool. On April 16, 1993, the Bankruptcy Court rejected the market value decline claims of the trustees for the fourth collateral pool in their entirety and incorporated those findings into its order confirming the Plan of Reorganization. The trustees for the fourth collateral pool appealed from these orders, but failed to obtain a stay pending appeal. The Company opposed these appeals on the merits and sought dismissal of the appeals on the grounds they were made moot by the substantial consummation of the Plan of Reorganization. The United States District Court for the District of Delaware (the \"District Court\") dismissed the appeals as moot, and the trustees appealed to the Third Circuit Court of Appeals (the \"Third Circuit\") seeking review of the District Court's mootness determination and the Bankruptcy Court's finding on the merits. The Third Circuit affirmed the District Court's dismissal in\nFebruary 1996. Although the trustees have applied for a rehearing and may appeal the Third Circuit's decision, the Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nOn July 19, 1994, the Bankruptcy Court approved a comprehensive settlement resolving certain claims filed by ALPA and former pilots of Eastern Air Lines, Inc. (\"Eastern\"). A group of separately represented Eastern pilots (the \"LPP Claimants\") filed an appeal from an order disallowing the integration of the Eastern pilots seniority list with the Company pilots seniority list. The Company filed a motion to dismiss as moot the appeals brought by the LPP Claimants, on the grounds that only ALPA had standing with regard to this proceeding and ALPA had previously withdrawn a similar appeal. On November 29, 1995, the District Court issued an opinion denying the LPP Claimants' appeal, and stating that even if the LPP Claimants could establish the merits of their claims, they would be entitled only to recovery of prepetition unsecured bankruptcy claims. The District Court also held that the LPP Claimants may pursue an arbitration hearing to attempt to establish the validity of their claims and the amount, if any, of the bankruptcy claims generated thereby. Both the LPP Claimants and a group of approximately 200 ex-Eastern pilots referred to as the Eastern Pilots' Merger Committee have appealed the District Court's decision. The Company is opposing these appeals both procedurally and on their merits. In addition, the Third Circuit has, on its own, questioned the Committee's standing to appeal. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nANTITRUST PROCEEDINGS\nIn February 1995, Delta imposed dollar limits on the base commissions it would pay to travel agents on domestic airline tickets. Shortly thereafter, other airlines, including the Company, imposed similar dollar limits on their respective commissions. In February and March of 1995, the Company and six other major United States airlines were sued in a number of putative class actions, which have been consolidated as In re Airline Travel Agents Antitrust Litigation in the United States District Court for the District of Minnesota (the \"Court\"), in which various travel agents allege that the Company and the other defendants combined and conspired in unreasonable restraint of trade and commerce in violation of applicable antitrust laws. The plaintiffs also allege that the defendant airlines unlawfully fixed, lowered, maintained and stabilized the commissions paid to United States travel agents. Plaintiffs seek injunctive relief, treble damages, attorneys fees and related costs. On August 23, 1995, the Court denied plaintiffs' motion for a preliminary injunction and denied defendants' motion for summary judgment. On September 12, 1995, defendants filed a motion to certify an interlocutory appeal to the Eighth Circuit Court of Appeals regarding the standard of review for summary judgment to be applied by the Court in a conspiracy case under the antitrust laws. Such motion was denied on September 27, 1995. Discovery is ongoing. The Company and the other defendant airlines are vigorously defending this lawsuit. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nDENVER INTERNATIONAL AIRPORT\nIn 1992, the Company agreed to lease (i) 20 gates at DIA for a period of five years from the date DIA opened, (ii) four of such gates for an additional five years and (iii) a substantial amount of operational space in connection with the gates and for the terms set forth in the agreement. During 1994, the Company significantly reduced its Denver operations. The City filed a complaint on February 22, 1995 against the Company in the United States District Court for the District of Colorado seeking a determination that the Company materially breached and repudiated the lease and a March 1994 agreement to pay certain costs associated with the delays in opening DIA. In addition, the City sought a judgment declaring the City's rights and the Company's obligations and the award of an injunction that the Company perform such obligations. The City also sought attorneys fees and costs relating to its suit.\nThe Company, the City and certain other parties entered into an agreement (the \"DIA Settlement\") that was approved by the Denver City Council on April 10, 1995. The DIA Settlement provided for the release of certain claims and the settlement of certain litigation filed by the City against the Company and reduced (i) the full term of the lease to five years, subject to certain rights of renewal granted to the Company, (ii) the number of gates leased from 20 to 10, and (iii) the amount of leased operational and other space by approximately 70%. The reduced number of gates and operational space exceed the Company's current needs at the airport. The Company is finalizing the sublease of four gates and certain operational space to another carrier, and is negotiating a sublease of one additional gate and certain operational space with a different carrier. The Company will attempt to sublease additional facilities and operational space as well. To the extent the Company is able to sublease additional gates and operational space, its costs under the lease will be reduced.\nAnother air carrier filed a complaint with the DOT alleging that the DIA Settlement had increased its rates and charges at DIA and that such carrier had not approved the changes to its rates and charges. The DOT dismissed the air carrier's complaint. The DIA Settlement could still be challenged by certain parties, including other air carriers, and the Company cannot predict what the outcome of any such challenge would be. If the DIA Settlement were successfully challenged, the Company believes it has defenses against the City, as well as claims against the City that would justify rescission of the lease or, if rescission were not awarded by the court, a substantial reduction in the Company's obligations thereunder. Although the Company believes that such a challenge is unlikely at this time, a successful challenge to the DIA Settlement could reduce or eliminate the Company's estimated savings at DIA.\nENVIRONMENTAL PROCEEDINGS\nUnder the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (commonly known as \"Superfund\") and similar state environment cleanup laws, generators of waste disposed of at designated sites may under certain circumstances be subject to joint and several liability for investigation and remediation costs. The Company (including its predecessors) has been identified as a potentially responsible party at four federal and two state sites that are undergoing or have undergone investigation or remediation. The Company believes that, although applicable case law is evolving and some cases may be interpreted to the contrary, some or all of any liability claims associated with these sites were\ndischarged by confirmation of the Company's Plan of Reorganization, principally because the Company's exposure is based on alleged offsite disposal known as of the date of confirmation. Even if any such claims were not discharged, on the basis of currently available information, the Company believes that its potential liability for its allocable share of the cost to remedy each site (to the extent the Company is found to have liability) is not, in the aggregate, material; however, the Company has not been designated a \"de minimis\" contributor at any of such sites.\nThe Company is also involved in other environmental matters, including the investigation and\/or remediation of environmental conditions at properties used or previously used by the Company. Although the Company is not currently subject to any environmental cleanup orders imposed by regulatory authorities, it is undertaking voluntary investigation or remediation at certain properties in consultation with such authorities. The full nature and extent of any contamination at these properties and the parties responsible for such contamination have not been determined, but based on currently available information the Company does not believe that any environmental liability associated with such properties will have a material adverse effect on the Company.\nGENERAL\nVarious other claims and lawsuits against the Company are pending that are of the type generally consistent with the Company's business. The Company cannot at this time reasonably estimate the possible loss or range of loss that could be experienced if any of the claims were successful. Typically, such claims and lawsuits are covered in whole or in part by insurance. The Company does not believe that the foregoing matters will have a material adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nContinental's common stock trades on the New York Stock Exchange. The table below shows the high and low sales prices for the Company's Class A common stock and Class B common stock as reported on the New York Stock Exchange during 1994 and 1995.\nAs of February 16, 1996, there were approximately 4,232 and 6,205 holders of record of Continental's Class A and Class B common stock, respectively.\nCertain of the Company's credit agreements currently prohibit the Company from paying cash dividends to its common stockholders. The Company has not paid any cash dividends on its common stock. Because the Company believes that it is important to retain earnings to strengthen the Company's balance sheet and liquidity, the Company has no current intention of paying dividends on its common stock.\nThe Company's certificate of incorporation provides that no shares of capital stock may be voted by or at the direction of persons who are not United States citizens unless such shares are registered on a separate stock record. The Company's bylaws further provide that no shares will be registered on such separate stock record if the amount so registered would exceed United States foreign ownership restrictions. United States law currently requires that no more than 25.0% of the voting stock of the Company (or any other domestic airline) may be owned directly or indirectly by persons who are not citizens of the United States. Because Air Canada owns 23.6% of the voting power of the Company's common stock and shares of common stock owned by Air Canada have priority in registration on the foreign stock record over shares held by other foreign holders, the number of shares that may be voted by other foreign holders is very limited.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth certain consolidated financial data of (i) the Reorganized Company at December 31, 1995, 1994 and 1993 and for the years ended December 31, 1995 and 1994 and the period April 28, 1993 through December 31, 1993 and (ii) the Predecessor Company, for the period January 1, 1993 through April 27, 1993 and as of and for the two years ended December 31, 1992 (in millions, except per share data).\nBecause the Reorganized Company includes System One (see Item 1. \"Business. Continental CRS Interests, Inc.\") and other businesses that had been consolidated with Holdings prior to April 28, 1993 (but not with pre-reorganized Continental), the discussion herein generally refers to Holdings' consolidated financial statements for periods prior to April 28, 1993. As a result of the adoption of fresh start reporting in accordance with SOP 90-7, upon consummation of the Plan of Reorganization on April 27, 1993, the consolidated financial statements of the Predecessor Company and the Reorganized Company have not been prepared on a consistent basis of accounting and are separated by a vertical black line.\n(continued on next page)\n*Not meaningful.\n(1) See Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nContinental Airlines, Inc. (the \"Company\", \"Continental\" or the \"Reorganized Company\") is the successor to Continental Airlines Holdings, Inc. (together with its subsidiaries, \"Holdings\" or the \"Predecessor Company\") and the pre- reorganized Continental Airlines, Inc. On December 3, 1990, Continental and Holdings and all their wholly owned domestic subsidiaries filed voluntary petitions to reorganize under Chapter 11 of the federal bankruptcy code. The companies' consolidated Plan of Reorganization was confirmed on April 16, 1993 and became effective on April 27, 1993 (the \"Reorganization\"). On such date, Holdings merged with and into Continental. Because consolidated Continental (as reorganized) includes businesses that had been consolidated with Holdings for periods through April 27, 1993 (but not with pre-reorganized Continental), the discussion herein generally refers to Holdings' consolidated financial statements for periods through April 27, 1993.\nOn April 27, 1993, in connection with the Reorganization, the Company adopted fresh start reporting in accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7 - \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"). The fresh start reporting common equity value of the Company was determined by the Company, with the assistance of its financial advisors, to be approximately $615 million based, in part, on assumptions as to future results of operations. The carrying value of the Company's assets does not reflect historical cost but rather reflects current values determined by the Company as of April 27, 1993 (including values for intangible assets such as routes, gates and slots of approximately $1.7 billion). The difference between (i) the equity valuation of the Company plus the estimated fair market value of the Company's liabilities and (ii) the estimated fair market value of its identifiable assets was allocated to reorganization value in excess of amounts allocable to identifiable assets. Due to the significant adjustments relating to the Reorganization and the adoption of fresh start reporting, the pre-reorganized consolidated financial statements are not comparable to the post-reorganized consolidated financial statements of the Company. A vertical black line is shown in the consolidated financial statements presented herein to separate Continental's post-reorganized consolidated financial statements from the pre-reorganized consolidated financial statements of Holdings since they have not been prepared on a consistent basis of accounting. The fresh start reporting adjustments, primarily related to the adjustment of the Company's assets and liabilities to fair market values, have also affected the Company's statements of operations. The more significant adjustments related to increased amortization expense relating to routes, gates and slots and reorganization value in excess of amounts allocable to identifiable assets, reduced aircraft rent expense and increased interest expense.\nThe following discussion may contain forward-looking statements. In connection therewith, please see the cautionary statements contained in Item 1. \"Business. Risk Factors\", which identify important factors that could cause actual results to differ materially from those in the forward-looking statements.\nRESULTS OF OPERATIONS\nThe following discussion provides an analysis of the Company's results of operations and reasons for material changes therein for the three years ended December 31, 1995. The Company's results of operations for the periods subsequent to April 27, 1993 have not been prepared on a basis of accounting consistent with the Predecessor Company's results of operations for periods prior to April 28, 1993 due to the implementation of fresh start reporting upon the Company's emergence from bankruptcy. Financial information for 1993 is derived by combining the results of operations of the Company for the period April 28, 1993 through December 31, 1993 with those of Holdings for the period January 1, 1993 through April 27, 1993.\nComparison of 1995 to 1994. Continental's financial and operating performance improved dramatically in 1995, reflecting among other things implementation of the Company's new strategic program to enhance the fundamentals of its operations, rationalize capacity (including the elimination of \"Continental Lite\" operations - a network of short-haul, no-frills, low-fare flights), improve customer service and employee relations and strengthen Continental's balance sheet and liquidity. The Company recorded consolidated net income of $224 million for the year ended December 31, 1995, after recording $31 million in employee profit sharing, as compared to a consolidated net loss of $613 million for the year ended December 31, 1994. The Company's net income in 1995 included a $30 million net after tax gain on the System One Information Management, Inc. (\"System One\") transactions. During the fourth quarter of 1994, the Company recorded a provision of $447 million, which included $278 million associated primarily with the planned early retirement of certain aircraft and $169 million relating to closed or underutilized airport and maintenance facilities and other assets.\nDuring 1995, the Company implemented its route realignment and capacity rationalization initiatives, which reduced capacity by 7.4% from 1994, while traffic declined only 3.8%, producing a 2.5 percentage point increase in load factor to 65.6%. This higher load factor, combined with a 9.4% increase in the average yield per revenue passenger mile, contributed to a 5.3% increase in passenger revenue to $5.3 billion despite the decreased capacity.\nCargo, mail and other revenue decreased 17.5%, $111 million, from 1994 to 1995, principally as a result of the System One transactions, which were effective April 27, 1995.\nWages, salaries and related costs decreased 6.5%, $100 million, from 1994 to 1995, primarily due to a reduction in the average number of full-time equivalent employees from approximately 40,400 for the year ended December 31, 1994 to approximately 33,700 for the year ended December 31, 1995. Such decrease was partially offset by a $20 million cash payment to pilots upon ratification of a new collective bargaining agreement, employee profit sharing and other incentive programs, including the payment of bonuses for Continental's on-time performance. Wage rates were impacted by longevity pay increases for substantially all employee groups, effective July 1, 1995. In addition, wage restorations relating to an average 10.0% wage reduction implemented by the Company in July 1992 also increased wage rates. Wage reductions were restored in equal increments in December 1992, April 1993, April 1994 and July 1994.\nAircraft fuel expense decreased 8.1%, $60 million, from 1994 to 1995. The quantity of jet fuel used dropped 7.7% from 1.3 billion gallons in 1994 to 1.2 billion gallons in 1995, principally reflecting capacity reductions and increased stage lengths. Such decrease was partially offset by a 2.8% increase in the average price per gallon from 53.5 cents in 1994 to 55.0 cents in 1995.\nAircraft rentals increased 14.8%, $64 million, from 1994 to 1995, primarily as a result of the delivery of new 737 and 757 aircraft from The Boeing Company (\"Boeing\") during late 1994 and throughout 1995. Such increase was partially offset by retirements and groundings of certain leased aircraft.\nCommission expense increased 11.4%, $50 million, from 1994 to 1995, primarily due to increased passenger revenue and higher average effective commission rates associated with the Company's targeted travel initiatives and the elimination of noncommissionable Continental Lite fares.\nMaintenance, materials and repairs costs decreased 13.3%, $66 million, from 1994 to 1995, principally due to the replacement of older aircraft with new aircraft, a reduction in the fleet size and the volume and timing of overhauls as part of the Company's ongoing maintenance program. Such decreases were partially offset by the shift of scheduled maintenance work to outside suppliers, which results in the entire cost of maintenance work performed by outside suppliers being included in maintenance, materials and repairs costs, whereas when Continental performs its own maintenance work, a portion of such cost is classified as wages, salaries and related costs.\nOther rentals and landing fees decreased by 9.2%, $36 million, from 1994 to 1995, principally due to reduced facility rentals and landing fees resulting from downsizing operations.\nOther operating expense decreased 6.3%, $88 million, from 1994 to 1995, primarily as a result of the System One transactions, which were effective April 27, 1995, coupled with decreases in advertising expense, aircraft servicing expense and catering expense. Such decreases were partially offset by increases in reservations and sales expense and other miscellaneous expense.\nInterest expense decreased 11.6%, $28 million, from 1994 to 1995, primarily due to (i) the reduced accretion of deferred credits recorded in connection with the Company's adjustment of operating leases to fair market value as of April 27, 1993 and (ii) principal reductions of long-term debt and capital lease obligations. Such decrease was partially offset by accrued interest on the convertible secured debentures.\nInterest capitalized decreased 64.7%, $11 million, from 1994 to 1995, principally due to a decrease in the average balance of purchase deposits for flight equipment.\nInterest income increased 34.8%, $8 million, from 1994 to 1995, primarily due to an increase in the average interest rate earned on investments coupled with an increase in the average balance of cash and cash equivalents.\nThe Company recorded a pretax gain of $108 million related to the System One transactions in Nonoperating Income (Expense) in the accompanying consolidated statement of operations. The tax provision related to these transactions totaled $78 million (which differs from the federal statutory rate due to certain nondeductible expenses), for a net gain of $30 million.\nIn 1995, the bankruptcy court approved a settlement resolving certain claims filed by the Company for the return of certain aircraft purchase deposits. As a result of the settlement, the Company recorded a $12 million gain in 1995, which was classified in Other, net in the accompanying consolidated statement of operations. These gains were partially offset by an additional provision of $14 million for underutilized airport facilities and other assets (primarily associated with Denver International Airport, \"DIA\") and a $5 million pretax charge related to the purchase of warrants held by Air Canada. The Company's Other, net in 1994 included gains of $10 million relating primarily to a gain on the sale of 10 aircraft from Beech Acceptance Corporation (\"Beech\") and five spare engines, offset by foreign exchange losses of $5 million (primarily related to Japanese yen-denominated transactions). In addition, during the fourth quarter of 1994, the Company recorded a provision of $447 million, which included $278 million associated primarily with the planned early retirement of certain aircraft and $169 million relating to closed or underutilized airport and maintenance facilities and other assets.\nComparison of 1994 to 1993. The Company recorded a consolidated loss of $613 million for the year ended December 31, 1994 as compared to a consolidated loss before extraordinary gain of $1 billion for the year ended December 31, 1993. The Company's net loss in 1994 included a provision of $447 million associated with the planned early retirement of certain aircraft and closed or underutilized airport and maintenance facilities and other assets. The Company's net income in 1993 included an extraordinary gain of $3.6 billion primarily related to the discharge of prepetition debt obligations in connection with the Reorganization.\nPassenger revenue of $5 billion in 1994 decreased 1.5%, $79 million, from 1993 due primarily to a 1.7% decrease in Continental's jet revenue passenger miles resulting from a 1.7% decrease in available seat miles. Such decrease was partially offset by a 0.8% increase in jet yields. Fourth quarter results for Continental Express, Inc. (\"Express\"), a wholly owned subsidiary of the Company, in 1994 were adversely affected by an Airworthiness Directive issued by the Federal Aviation Administration (\"FAA\"), which prohibited all airlines, including Express, from flying ATR-42 and ATR-72 aircraft during certain atmospheric conditions.\nCargo, mail and other revenue decreased by 2.8%, $18 million, from 1993 to 1994, primarily as a result of Continental's termination of service to Australia and New Zealand in October 1993 and poor weather in the eastern United States in the first quarter of 1994.\nWages, salaries and related costs increased 2.0%, $30 million, from 1993 to 1994, due to higher wage rates, partially offset by a decrease in the average number of full-time equivalent employees. In July 1992, the Company implemented an average 10.0% wage reduction, which reduction was restored in equal increments in December 1992, April 1993 and April 1994, with the final restoration occurring in July 1994. The number of average full-time equivalent employees decreased from approximately 41,300 in 1993 to approximately 40,400 in 1994.\nAircraft fuel expense decreased 8.7%, $71 million, from 1993 to 1994, primarily due to a 9.8% reduction in the average price per gallon from 59.3 cents in 1993 to 53.5 cents in 1994. Such decrease was partially offset by a 7.7% increase in the quantity of jet fuel used from 1.3 billion gallons in 1993 to 1.4 billion gallons in 1994, principally due to an increase in the frequency of take-offs and landings associated with Continental Lite operations.\nAircraft rentals increased 4.3%, $18 million, from 1993 to 1994, primarily as a result of the delivery of new Boeing 737 and 757 aircraft during 1994. Such increase was partially offset by retirements of leased aircraft and the full year impact in 1994 of the amortization of deferred credits recorded in connection with the Company's adjustment of operating leases to fair market value as of April 27, 1993.\nCommission expense decreased 20.6%, $114 million, from 1993 to 1994, primarily due to a decrease in commissionable sales and a reduction in the aggregate average commission rate.\nMaintenance, materials and repairs costs decreased 9.5%, $52 million, from 1993 to 1994, primarily due to increased operational efficiencies and the retirement of older aircraft.\nOther rentals and landing fees increased 3.7%, $14 million, from 1993 to 1994. Such increase was primarily due to increased landing fees resulting from reduced segment lengths associated with Continental Lite operations.\nDepreciation and amortization expense increased 7.9%, $19 million, from 1993 to 1994, due primarily to (i) an increase in aircraft operated under capital leases during the fourth quarter of 1993, (ii) the amortization of incremental capitalized costs associated with aircraft, and (iii) the annualized impact of fresh start adjustments relating to aircraft, routes, gates and slots and reorganization value in excess of amounts allocable to identifiable assets.\nOther operating expense increased 3.8%, $51 million, from 1993 to 1994, primarily as a result of increases in reservations and sales expense, advertising expense and other miscellaneous expense, partially offset by a decrease in catering expense.\nThe Company's interest expense increased 11.1%, $24 million, from 1993 to 1994, due primarily to a net increase in debt on which the Company was required to accrue interest. As a result of its Chapter 11 filing, through April 1993, the Company was not obligated to pay, and accordingly ceased accruing, contractual interest on its unsecured and undersecured obligations.\nInterest capitalized increased 70.0%, $7 million, from 1993 to 1994, due primarily to an increase in 1994 in the average balance during the year of purchase deposits for flight equipment.\nInterest income increased 27.8%, $5 million, from 1993 to 1994, primarily due to an increase in the average balance of cash and cash equivalents coupled with an increase in the average interest rate. Interest income earned on the Company's investments during the period prior to April 28, 1993 was netted against reorganization items in accordance with SOP 90-7.\nReorganization items, net, in 1993 included professional fees of $59 million, accruals for rejected aircraft agreements of $153 million and other miscellaneous adjustments of $34 million. In addition, in the second quarter of 1993, fresh start adjustments totaling $719 million were recorded relating to the adjustment of assets and liabilities to fair market value as well as other miscellaneous fresh start adjustments of $77 million. These fresh start adjustments were partially offset by the write-off of deferred gains on sale\/leaseback transactions of $219 million and interest income of $4 million.\nThe Company's Other, net in 1994 included gains of $10 million relating primarily to a gain on the sale of 10 Beech aircraft and five spare engines, offset by foreign exchange losses of $5 million (primarily related to Japanese yen-denominated transactions). In addition, during the fourth quarter of 1994, the Company recorded a provision of $447 million, which included $278 million associated primarily with the planned early retirement of certain aircraft and $169 million relating to closed or underutilized airport and maintenance facilities and other assets. Other, net in 1993 included a gain of $35 million related to System One's sale to Electronic Data Systems Corporation (\"EDS\") of substantially all of the assets of its Airline Services Division of a subsidiary offset by foreign exchange losses (primarily related to Japanese yen, German mark and British pound denominated transactions), charges totaling $13 million related to the Company's termination of services to Australia and New Zealand and other expense primarily related to the abandonment of airport facilities.\nIn 1993, the Company recorded an extraordinary gain of $3.6 billion resulting from the extinguishment of prepetition obligations, including the write-off of a deferred credit related to Eastern Air Lines, Inc. of $1.1 billion.\nCERTAIN STATISTICAL INFORMATION\nAn analysis of statistical information for Continental's jet operations for each of the three years in the period ended December 31, 1995 is as follows:\n(1) The number of scheduled miles flown by revenue passengers.\n(2) The number of seats available for passengers multiplied by the number of scheduled miles those seats are flown. (3) The number of hours an aircraft is operated in revenue service from gate to gate. (4) Revenue passenger miles divided by available seat miles. (5) The percentage of seats that must be occupied by revenue passengers in order for the airline to break even on an income before income taxes basis, excluding nonrecurring charges, nonoperating items and other special items. (6) Passenger revenue divided by available seat miles. (7) Total revenue divided by available seat miles. (8) Operating expenses divided by available seat miles. Operating cost for the year ended December 31, 1993 included $37 million of nonrecurring items related to the Reorganization. (9) The average revenue received for each mile a revenue passenger is carried. (10) The average block hours flown per day in revenue service per aircraft. (11) Operating cost and breakeven passenger load factor data for periods prior to April 28, 1993 are not comparable with data after April 27, 1993.\nLIQUIDITY AND CAPITAL COMMITMENTS\nAs part of the Company's Go Forward Plan, in January 1995, the Company commenced a series of initiatives designed to improve liquidity in 1995 and 1996. The major liquidity elements of this plan included (i) rescheduling principal amortization under the Company's loan agreements with its primary secured lenders (representing $599 million of the Company's outstanding long-term debt at December 31, 1994), (ii) restructuring the Company's commitments to purchase new Boeing aircraft and related engines, (iii) deferring or reducing cash requirements associated with certain existing aircraft, (iv) reducing the Company's lease commitments at DIA and (v) evaluating the potential disposition of non-core assets. As discussed below, by implementing the liquidity elements of the Company's Go Forward Plan, Continental improved its 1995 liquidity by approximately $250 million and expects to improve its 1996 liquidity by approximately $275 million.\nAs of December 31, 1995, Continental and its consolidated subsidiaries had approximately $1.9 billion (including current maturities) of long-term indebtedness and capital lease obligations, and had approximately $615 million of minority interest, preferred securities of trust, redeemable preferred stock and common stockholders' equity. As of February 1, 1996, the Company had redeemed or repurchased the remaining outstanding convertible secured debentures issued in connection with its renegotiation of aircraft leases. If the convertible secured debentures had been redeemed or repurchased as of December 31, 1995, the ratio of long-term debt and capital lease obligations (including current maturities) to common stockholders' equity, redeemable preferred stock and preferred securities of trust would have been 3.0. As of December 31, 1994, the ratio of long-term debt and capital lease obligations (including current maturities and debt in default) to common stockholders' equity and redeemable preferred stock was 10.9. Common stockholders' equity reflects the adjustment of the Company's balance sheet and the recording of assets and liabilities at fair market value as of April 27, 1993 in accordance with SOP 90-7.\nOn March 31, 1995, the Company signed agreements with Boeing and certain engine manufacturers to defer substantially all aircraft deliveries that had been scheduled for 1996 and 1997. Five Boeing 767 aircraft that had been scheduled for delivery to Continental in 1995 were sold to a third party. They were replaced by five Boeing 767 aircraft to be delivered starting in 1998. Options to purchase additional aircraft were canceled. Furthermore, on March 30, 1995 Continental amended its principal secured loan agreements with General Electric Capital Corporation, General Electric Company and certain affiliates (any one or more of such entities, \"GE\") to defer 1995 and 1996 principal payments and amended certain of its operating lease agreements with GE to defer 1995 rental obligations. In connection with the GE loan and lease agreement amendments, Continental agreed, among other things, to obtain concessions from certain aircraft lessors, all of which were subsequently obtained.\nThe Company retired from service 24 less-efficient widebody aircraft during 1995. In February 1995, the Company began paying market rentals, which were significantly less than contractual rentals on these aircraft, and began ceasing all rental payments as the aircraft were removed from service. In addition, in the first quarter of 1995, Continental reduced its rental payments on an additional 11 widebody aircraft leased at significantly above-market rates. These actions caused a significant number of defaults and cross defaults in various long-term debt and capital lease and operating lease agreements. The Company began negotiations in February 1995 with the lessors of (or lenders with respect to) these 35 widebody aircraft to amend the payment schedules and provide alternative compensation, including, in certain cases, convertible secured debentures in lieu of current cash payments. The Company reached resolutions covering all 35 widebody aircraft, thereby curing defaults under the related agreements and the resulting cross defaults. The last such resolution was achieved during the fourth quarter of 1995. In connection with these resolutions, Continental issued convertible secured debentures in an aggregate original principal amount of $158 million, entered into certain agreements including restructured leases and made certain payments to lessors and lenders. As of February 1, 1996, all such debentures (including payment-in-kind interest) had been repurchased or redeemed by the Company.\nThe Company had been in default under its lease of facilities at DIA. On April 10, 1995, the Denver City Council approved an agreement among the City and County of Denver, the Company and certain signatory airlines amending the Company's lease by reducing the Company's lease term to five years, reducing to 10 the number of gates (and reducing associated space) leased by the Company and making certain changes in the rates and charges under the lease. The agreement cured the default, and also provided for the release of certain claims and the settlement of certain litigation filed by the City against the Company.\nThe Company had also been in default under the debt agreement relating to the financing of the Company's Los Angeles International Airport (\"LAX\") maintenance facility. On September 29, 1995, the Company consummated a restructuring of such indebtedness, which involved the issuance of $65 million in principal amount (including payment-in-kind interest of $2 million) of unsecured indebtedness payable in installments between 1997 and 2000, in exchange for all of the indebtedness and accrued but unpaid interest thereon formerly secured by the Company's LAX maintenance facility and related equipment. This restructuring cured the defaults under the indebtedness and related cross defaults.\nAs a result of an FAA Airworthiness Directive which forced the partial grounding of the Company's ATR commuter fleet in late 1994 and early 1995, the Company withheld lease payments totaling $8 million on those ATR aircraft leased from the manufacturer. In 1995, the Company settled its claims with ATR.\nContinental and its System One subsidiary entered into a series of transactions on April 27, 1995 whereby a substantial portion of System One's assets (including the travel agent subscriber base and travel-related information management products and services software), as well as certain liabilities of System One, were transferred to a newly formed limited liability company, System One Information Management, L.L.C. (\"LLC\"). LLC is owned equally by Continental CRS Interests, Inc. (\"Continental CRS\") (formerly System One, which remains a wholly owned subsidiary of Continental), EDS and AMADEUS, a European computerized reservation system (\"CRS\"). Substantially all of System One's remaining assets (including the CRS software) and liabilities were transferred to AMADEUS. In addition to the one-third interest in LLC, Continental CRS received cash proceeds of $40 million and an equity interest in AMADEUS valued at $120 million, and outstanding indebtedness of $42 million of System One owed to EDS was extinguished. In connection with these transactions, the Company recorded a pretax gain of $108 million, which amount was included in Nonoperating Income (Expense) in the accompanying consolidated statement of operations for the year ended December 31, 1995. The related tax provision totaled $78 million (which differs from the federal statutory rate due to certain nondeductible expenses), for a net gain of $30 million. System One's revenue, included in Cargo, mail and other revenue, and related net earnings were not material to the consolidated financial statements of Continental.\nOn September 29, 1995, Continental issued a secured promissory note (the \"Redemption Loan\") with a principal amount of $21 million to GE in exchange for its 202,784 shares of Series A 8% Cumulative Preferred Stock, together with accumulated dividends thereon (representing all of the outstanding Series A 8% Cumulative Preferred Stock). The Redemption Loan bears interest at 8.0% per annum from September 29, 1995 through March 31, 1996 and 9.86% per annum thereafter.\nThe Company has also undertaken a variety of other activities intended to strengthen its longer-term financing position and enhance earnings. First, the Company consummated an offering of 8-1\/2% convertible trust originated preferred securities (\"TOPrS\"), which are convertible into Class B common stock of Continental at a price of $48.36 per share. A portion of the $242 million net proceeds of that offering was used to repurchase or redeem all of the Company's convertible secured debentures issued in connection with the lease renegotiations discussed above (which would otherwise have become convertible into Class B common stock in August 1996 at a price of $26 per share). An additional portion of the net proceeds was used to repay obligations incurred to aircraft lessors and lenders in connection with those renegotiations. Second, in the third quarter of 1995, the Company purchased from Air Canada warrants to purchase approximately 6.2 million shares of Continental's common stock with exercise prices of $15 and $30 per share for $14 million in cash (including a $5 million fee paid to a lender) and a $42 million one-year note (which note was repaid with a portion of the net proceeds of the TOPrS offering). Third, the Company recorded a $30 million after-tax gain in the second quarter of 1995 in connection with the System One transactions, which increased liquidity by an additional $82 million, consisting of $40 million of cash proceeds and $42 million of outstanding indebtedness\nextinguished. Finally, on January 31, 1996, the Company consummated the offering of $489 million of enhanced pass- through certificates that refinanced the underlying debt associated with 18 leased aircraft and will reduce Continental's annual operating lease expense by more than $15 million for the affected aircraft.\nThe Company had, as of December 31, 1995, deferred tax assets aggregating $1.4 billion, including $860 million of net operating loss carryforwards (\"NOLs\"). The Company recorded a valuation allowance of $782 million against such assets as of December 31, 1995. Realization of a substantial portion of the Company's remaining NOLs will require the completion by April 27, 1998 of transactions resulting in recognition of built-in gains for federal income tax purposes. Although the Company has consummated one such transaction involving System One, as previously discussed, and currently intends to consummate one or more additional transactions, in the event the Company were to determine in the future that not all such transactions will be completed, an adjustment to the net deferred tax liability of up to $116 million would be charged to income in the period such determination was made.\nAs a result of NOLs, the Company does not currently expect to pay United States federal income taxes (other than alternative minimum tax) prior to 1998. Additionally, for financial reporting purposes in 1995, the Company has utilized NOLs for which a tax benefit had not previously been recorded to offset tax expense. As of December 31, 1995, the Company had approximately $200 million of such unbenefitted NOLs. To the extent the Company's aggregate taxable income after December 31, 1995 for financial statement purposes exceeds such amount, it will record tax expense for financial statement purposes. Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize NOLs if it experiences a more than 50% ownership change over a three-year period. No assurance can be given that future transactions, whether within or outside the control of the Company, would not cause such a change in ownership, thereby substantially restricting the use of NOLs in future periods for both federal income tax and financial reporting purposes.\nContinental has firm commitments to take delivery of three new 737 and two new 757 aircraft through early 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is $2.7 billion. In connection with the rescheduling of jet aircraft deliveries, $72 million of purchase deposits was returned to the Company in 1995. In December 1994, Express contracted with Beech for the purchase and financing of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. As of December 31, 1995, 13 Beech 1900-D aircraft had been delivered, of which eight had entered service by that date and five will enter service in the first quarter of 1996. The remaining 12 aircraft are scheduled to be delivered in 1996. The Company currently anticipates that the firm financing commitments available to it with respect to its acquisition of new aircraft from Boeing and Beech will be sufficient to fund all deliveries scheduled during 1996. Furthermore, the Company currently anticipates that it will have remaining financing commitments from aircraft manufacturers of $575 million for jet aircraft deliveries beyond 1996. The Company believes that further financing will be needed to satisfy the remaining amount of such capital commitments. There can be no assurance that sufficient financing will be available for all aircraft and other capital expenditures not covered by firm financing commitments.\nIn addition, the Company recently purchased one DC-10-30 aircraft and entered into an operating lease for another DC-10- 30 aircraft that are expected to be placed into service by the end of the second quarter of 1996.\nContinental expects its cash outlays for 1996 capital expenditures, exclusive of aircraft acquisitions, to aggregate $120 million primarily relating to mainframe, software application and automation infrastructure projects, aircraft modifications and mandatory maintenance projects, passenger terminal facility improvements and office, maintenance, telecommunications and ground equipment. Continental's capital expenditures during 1995 and 1994 aggregated $41 million and $208 million, respectively, exclusive of aircraft acquisitions.\nAs of December 31, 1995, the Company had $747 million in cash and cash equivalents, compared to $396 million as of December 31, 1994. As of February 1, 1996, the Company had redeemed or repurchased the remaining outstanding convertible secured debentures that had been issued in connection with its renegotiation of aircraft leases, using $125 million in cash. Net cash provided by operating activities increased $306 million during 1995 compared to 1994, principally due to earnings improvement. In addition, net cash provided by investing activities increased $196 million, primarily as a result of (i) cash proceeds received from the System One transactions in 1995, (ii) an increase in purchase deposits returned in 1995 due to canceled aircraft options, delivery deferrals or delivery of aircraft, (iii) higher capital expenditures during 1994 relating to purchase deposits on jet and turboprop aircraft and (iv) expenditures in 1994 relating to the Company's discontinued Continental Lite operations and Continental's investment in America West Airlines, Inc. Net cash used by financing activities in 1995 compared to 1994 decreased $174 million, primarily due to cash proceeds received from the TOPrS offering offset by an increase in payments on long-term debt and capital lease obligations.\nContinental does not have general lines of credit, and substantially all of its assets, including the stock of its subsidiaries, are encumbered.\nApproximately $144 million and $119 million of cash and cash equivalents at December 31, 1995 and 1994, respectively, were held in restricted arrangements relating primarily to payments for workers' compensation claims and in accordance with the terms of certain other agreements. Continental and Continental Micronesia, Inc. (\"CMI\"), a 91%-owned subsidiary of the Company, have secured borrowings from GE which as of December 31, 1995 aggregated $634 million. CMI's secured loans contain significant financial covenants, including requirements to maintain a minimum cash balance and consolidated net worth, restrictions on unsecured borrowings and mandatory prepayments on the sale of most assets. These financial covenants limit the ability of CMI to pay dividends to Continental. As of December 31, 1995, CMI had a minimum cash balance requirement of $29 million. In addition, certain of Continental's secured loans require the Company to, among other things, maintain a minimum monthly operating cash flow and cumulative operating cash flow, a minimum monthly cash balance and a minimum ratio of operating cash flow to fixed charges. Continental also is prohibited generally from paying cash dividends in respect of its capital stock, from purchasing or prepaying indebtedness and from incurring additional secured indebtedness. In addition, to the extent Continental's actual quarterly average cash balances exceed certain forecasts, a portion of such excess cash is required to be used to prepay certain loan obligations to GE.\nThe Company has entered into petroleum option contracts to protect against a sharp increase in jet fuel prices, and CMI has entered into average rate option contracts to hedge a portion of its Japanese yen-denominated ticket sales against a significant depreciation in the value of the yen versus the United States dollar. The petroleum option contracts generally cover the Company's forecasted jet fuel needs for the next three to six months, and the average rate option contracts cover a portion of CMI's yen-denominated ticket sales for the next six to 10 months. At December 31, 1995 and 1994, the Company had petroleum option contracts outstanding with an aggregate contract value of $175 million and $140 million, respectively, and at December 31, 1995, CMI had an average rate option contract outstanding with a contract value of $185 million. At December 31, 1995 and 1994, the fair value of the option contracts was immaterial. The Company and CMI are exposed to credit loss in the event of nonperformance by the counterparties on the option contracts; however, management does not anticipate nonperformance by these counterparties. The amount of such exposure is generally the unrealized gains, if any, on such option contracts.\nManagement believes that the Company's costs are likely to be affected in 1996 by, among other factors, (i) increased wages, salaries and benefits, (ii) higher aircraft rental expense as new aircraft are delivered, (iii) changes in the costs of materials and services (in particular, the cost of fuel, which can fluctuate significantly in response to global market conditions), (iv) changes in governmental regulations and taxes affecting air transportation and the costs charged for airport access, (v) changes in the Company's fleet and related capacity and (vi) the Company's continuing efforts to reduce costs throughout its operations.\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\" (\"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 related assets' carrying amount. The impairment loss is measured by comparing the fair value of the asset to its 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. Due to the significant number of operating assets the Company maintains and the extensive number of estimates that must be made to assess the impact of SFAS 121, the financial statement impact has not yet been determined.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 - \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"). Under the provisions of SFAS 123, companies can elect to account for stock-based compensation plans using a fair value based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 - - \"Accounting for Stock Issued to Employees\" (\"APB 25\"). SFAS 123 requires that companies electing to continue using the intrinsic value method must make proforma disclosures of net income and earnings per share as if the fair value based method had been applied. The Company's required adoption date for SFAS 123 is January 1, 1996. The Company anticipates that it will continue to account for stock-based compensation using APB 25; therefore, SFAS 123 is not expected to have an impact on the Company's results of operations or financial position.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Consolidated Financial Statements\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Continental Airlines, Inc.\nWe have audited the accompanying consolidated balance sheets of Continental Airlines, Inc. (the \"Company\") as of December 31, 1995 and 1994, and the related consolidated statements of operations, redeemable and non-redeemable preferred stock and common stockholders' equity and cash flows for each of the two years in the period ended December 31, 1995 and for the period April 28, 1993 through December 31, 1993. We have also audited the accompanying consolidated statements of operations, redeemable and nonredeemable preferred stock and common stockholders' equity and cash flows for the period from January 1, 1993 through April 27, 1993 of Continental Airlines Holdings, Inc. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs discussed in Note 2 to the consolidated financial statements, the Company's consolidated Plan of Reorganization was confirmed by the bankruptcy court on April 16, 1993 and became effective April 27, 1993. As a result, Continental Airlines Holdings, Inc. (the \"Predecessor Company\") merged with and into the Company (the \"Reorganized Company\") effective April 27, 1993. The Company also adopted fresh start reporting effective April 27, 1993 and, as a result, the consolidated financial information for the period after April 27, 1993 is presented on a different basis of accounting than for the period before April 28, 1993 and, therefore, is not comparable.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 1995 and 1994, the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 1995 and the period from April 28, 1993 to December 31, 1993 and the consolidated results of operations and cash flows of Continental Airlines Holdings, Inc., for the period from January 1, 1993 through April 27, 1993, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nHouston, Texas February 12, 1996\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In millions of dollars, except per share data)\n(continued on next page)\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In millions of dollars, except per share data)\n*N.M. - Not meaningful - Historical per share data for the Predecessor Company is not meaningful since the Company has been recapitalized and has adopted fresh start reporting as of April 27, 1993.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONTINENTAL AIRLINES, INC. CONSOLIDATED BALANCE SHEETS (In millions of dollars, except for share data)\n(continued on next page) CONTINENTAL AIRLINES, INC. CONSOLIDATED BALANCE SHEETS (In millions of dollars, except for share data)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions of dollars)\n(continued on next page)\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions of dollars)\n(continued on next page)\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions of dollars)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY (DEFICIT) (In millions of dollars)\n(continued on next page)\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY (DEFICIT) (In millions of dollars)\nCONTINENTAL AIRLINES, INC. CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY NUMBER OF SHARES\nCONTINENTAL AIRLINES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nContinental Airlines, Inc. (the \"Company\", \"Continental\" or the \"Reorganized Company\") is a major United States air carrier engaged in the business of transporting passengers, cargo and mail. Continental is the fifth largest United States airline (as measured by 1995 revenue passenger miles) and, together with its wholly owned subsidiary, Continental Express, Inc. (\"Express\"), and its 91%-owned subsidiary, Continental Micronesia, Inc. (\"CMI\"), each a Delaware corporation, serves 175 airports worldwide. Internationally, Continental flies to 58 destinations and offers additional connecting service through alliances with foreign carriers. Continental is one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline. In addition, Continental flies to three cities in South America, and is scheduled to commence service between Newark and Lima, Peru in March 1996 and between Newark and Quito, Ecuador (via Bogota, Colombia) in June 1996. Through Guam and Saipan, CMI provides extensive service in the western Pacific, including service to more Japanese cities than any other United States carrier.\nAs used in these Notes to Consolidated Financial Statements, the terms \"Continental\" and \"Company\" refer to Continental Airlines, Inc. (or, as required by the context, its predecessor) and, unless the context indicates otherwise, its subsidiaries.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Principles of Consolidation -\nThe consolidated financial statements of the Company include the accounts of Continental and its operating subsidiaries, Express, CMI and prior to April 27, 1995, System One Information Management, Inc. (\"System One\"). See Note 11. All significant intercompany transactions have been eliminated in consolidation.\nThe minority interest holder of CMI has rights to acquire the minimum number of additional shares of CMI necessary to cause Continental's equity interest to decline below 80.0% if certain events relating to the defined benefit plans of Continental occur. The consolidated financial statements of the Company's predecessor include the accounts of Continental Airlines Holdings, Inc. (together with its operating subsidiaries, \"Holdings\" or the \"Predecessor Company\") and the pre-reorganized Company.\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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\n(c) Cash and Cash Equivalents -\nCash and cash equivalents consist of cash and short-term, highly liquid investments which are readily convertible into cash and have original maturities of three months or less. Approximately $144 million and $119 million of cash and cash equivalents at December 31, 1995 and December 31, 1994, respectively, were held in restricted arrangements relating primarily to payments for workers' compensation claims and in accordance with the terms of certain other agreements.\n(d) Spare Parts and Supplies -\nFlight equipment expendable parts and supplies were recorded at fair market values (which approximated average cost) as of April 27, 1993; subsequent purchases are valued at average cost. An allowance for obsolescence for flight equipment expendable parts and supplies is accrued to allocate the costs of these assets, less an estimated residual value, over the estimated useful lives of the related aircraft and engines.\n(e) Property and Equipment -\nProperty and equipment were recorded at fair market values as of April 27, 1993; subsequent purchases are valued at cost and are depreciated to estimated residual values over their estimated useful lives using the straight-line method. Estimated useful lives for such assets are 25 years from the date of manufacture for all owned jet and commuter aircraft; nine to 21 years, depending on the lease period, for aircraft acquired under long-term capital leases; and two to 25 years for other property and equipment, including airport facility improvements.\n(f) Intangible Assets -\nRoutes are amortized on a straight-line basis over 40 years, gates over the stated term of the related lease and slots over 20 years. Routes, gates and slots are comprised of the following (in millions):\nReorganization value in excess of amounts allocable to identifiable assets is amortized on a straight-line basis over 20 years. The carrying values of intangible assets are reviewed if the facts and circumstances suggest they may be impaired. If this review indicates that the Company's intangible assets will not be recoverable, as determined based on the\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nundiscounted cash flows over the remaining amortization periods, the Company's carrying values of the intangible assets are reduced by the estimated shortfall of cash flows.\n(g) Air Traffic Liability -\nPassenger revenue is recognized when transportation is provided rather than when a ticket is sold. The amount of passenger ticket sales not yet recognized as revenue is reflected in the accompanying consolidated balance sheets as air traffic liability. The Company performs periodic evaluations of this estimated liability, and any adjustments resulting therefrom, which can be significant, are included in results of operations for the periods in which the evaluations are completed. In the third quarter of 1993, the Company recorded an adjustment to increase passenger revenue by $75 million as a result of the completion of a periodic evaluation.\nContinental sponsors a frequent flyer program (\"OnePass\") and records an estimated liability for the incremental cost associated with providing the related free transportation at the time a free travel award is earned. The liability is adjusted periodically based on awards earned, awards redeemed and changes in the OnePass program.\n(h) Passenger Traffic Commissions -\nPassenger traffic commissions are recognized as expense when the transportation is provided and the related revenue is recognized. The amount of passenger traffic commissions not yet recognized as expense is included in Prepayments and other in the accompanying consolidated balance sheets.\n(i) Deferred Income Taxes -\nDeferred income taxes are provided under the liability method and reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the income tax amounts.\n(j) Deferred Credit - Aircraft Operating Leases -\nAircraft operating leases were adjusted to fair market values at April 27, 1993. The net present value of the difference between the stated lease rates and the fair market rates has been recorded as a deferred credit in the accompanying consolidated balance sheets. The deferred credit is increased through charges to interest expense and decreased on a straight-line basis as a reduction in rent expense over the applicable lease periods, generally one to 15 years.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\n(k) Maintenance and Repair Costs -\nMaintenance and repair costs for owned and leased flight equipment, including the overhaul of aircraft components, are charged to operating expense as incurred.\n(l) Option Contracts -\nThe Company purchases foreign currency average rate option contracts that effectively enable it to sell Japanese yen expected to be received from yen-denominated sales at specified dollar amounts. The option contracts have only nominal intrinsic value at the time of purchase. These contracts are designated and effective as hedges of probable monthly yen-denominated sales transactions, which otherwise would expose the Company to foreign currency risk. These option contracts are marked to market with realized and unrealized gains, if any, deferred and recognized in earnings as an adjustment to sales when the future sales occur (the deferral method).\nSimilarly, the Company purchases petroleum call option contracts to protect against a sharp increase in jet fuel prices. These contracts are also designated and effective as hedges of probable fuel purchases. These contracts are marked to market with realized and unrealized gains, if any, deferred and recognized in earnings as an adjustment to fuel expense when the fuel is purchased (the deferral method).\n(m) Earnings (Loss) per Share -\nEarnings (loss) per common share computations are based upon earnings (loss) applicable to common shares and the average number of shares of common stock and common stock equivalents (stock options, warrants and restricted stock) and potentially dilutive securities (convertible secured debentures and convertible trust originated preferred securities) outstanding. The number of shares used in the primary and fully diluted earnings per share computations for the year ended December 31, 1995 was 32,043,427 and 35,569,149, respectively. The number of shares used in both the primary and fully diluted loss per share computations for the year ended December 31, 1994 was 26,056,897. The number of shares used in both the primary and fully diluted loss per share computations for the period April 28, 1993 through December 31, 1993 was 18,022,918. Preferred stock dividend requirements, including additional dividends on unpaid dividends, accretion to redemption value and the accelerated accretion on the redeemed Series A 8% Cumulative Preferred Stock (\"Series A 8% Preferred\") caused by the exchange thereof for debt of the Company on September 29, 1995 (see Note 7) decreased net income for this computation by $9 million for the year ended December 31, 1995 and increased net loss for this computation by $6 million for the year ended December 31, 1994 and $3 million for the period April 28, 1993 through December 31, 1993.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\n(n) New 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\"), 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 related assets' carrying amount. The impairment loss is measured by comparing the fair value of the asset to its 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. Due to the significant number of operating assets the Company maintains and the extensive number of estimates that must be made to assess the impact of SFAS 121, the financial statement impact has not yet been determined.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 - \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"). Under the provisions of SFAS 123, companies can elect to account for stock-based compensation plans using a fair value based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 - \"Accounting for Stock Issued to Employees\" (\"APB 25\"). SFAS 123 requires that companies electing to continue using the intrinsic value method must make proforma disclosures of net income and earnings per share as if the fair value based method had been applied. The Company's required adoption date for SFAS 123 is January 1, 1996. The Company anticipates that it will continue to account for stock-based compensation using APB 25; therefore, SFAS 123 is not expected to have an impact on the Company's results of operations or financial position.\n(o) Reclassifications -\nCertain reclassifications have been made in the prior years' financial statements to conform to the current year presentation.\nNOTE 2 - PREDECESSOR COMPANY CHAPTER 11 REORGANIZATION\nOn December 3, 1990, the Predecessor Company and all its wholly owned domestic subsidiaries filed voluntary petitions to reorganize under Chapter 11 of the federal bankruptcy code. The Company's consolidated Plan of Reorganization was confirmed on April 16, 1993 and became effective on April 27, 1993 (the \"Reorganization\"). Therefore, on April 27, 1993, the Company adopted fresh start reporting in accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7 - \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"), which resulted in adjustments to the Company's common stockholders' equity and the carrying value of assets and liabilities. For accounting purposes, the inception date for the Reorganized Company is deemed to be April 28, 1993.\nNOTE 2 - PREDECESSOR COMPANY CHAPTER 11 REORGANIZATION (CONTINUED)\nAccordingly, the Company's post-reorganization consolidated financial statements have not been prepared on a consistent basis of accounting with the pre-reorganization consolidated financial statements for the period January 1, 1993 through April 27, 1993. A vertical black line is shown in the consolidated financial statements to separate the Company from the Predecessor Company since they have not been prepared on a consistent basis of accounting.\nNonoperating reorganization items recorded by the Predecessor Company for the period January 1, 1993 through April 27, 1993 consisted of the following (in millions):\nIn 1993, the Company recorded an extraordinary gain of $3.6 billion resulting from the extinguishment of prepetition obligations, including the write-off of a deferred credit related to Eastern Air Lines, Inc. of $1.1 billion.\nNOTE 3 - LONG-TERM DEBT\nLong-term debt as of December 31 is summarized as follows (in millions of dollars):\nAs of December 31, 1995 and 1994, the prime, LIBOR and Eurodollar rates associated with Continental's indebtedness approximated 8.5% and 8.5%, 5.6% and 6.5%, and 5.8% and 6.3%, respectively.\nSubstantially all of Continental's assets are subject to agreements securing indebtedness of Continental.\nThe Company retired from service 24 less-efficient widebody aircraft during 1995. In February 1995, the Company began paying market rentals, which were significantly less than contractual rentals on these aircraft, and began ceasing all rental payments as the aircraft were removed from service. In addition, in the first quarter of 1995, Continental reduced its rental payments on an additional 11 widebody aircraft leased at significantly above-market rates. These actions caused a significant number of defaults and cross defaults in various long-term debt and capital lease and operating lease agreements. The Company began negotiations in February 1995 with the lessors of (or lenders with respect to) these 35 widebody aircraft to amend the payment\nNOTE 3 - LONG-TERM DEBT (CONTINUED)\nschedules and provide alternative compensation, including, in certain cases, convertible secured debentures in lieu of current cash payments. The Company reached resolutions covering all 35 widebody aircraft, thereby curing defaults under the related agreements and the resulting cross defaults.\nIn connection with these resolutions, Continental issued $133 million of its Series A 6% Convertible Secured Debentures (\"Series A Debentures\") and $25 million of its Series B 8% Convertible Secured Debentures (\"Series B Debentures\") (together, the \"Convertible Secured Debentures\"). The Company repurchased all of its Series B Debentures on December 29, 1995 for $31 million (including a redemption premium of $4 million and payment-in-kind interest of $2 million). The Series A Debentures may be called for redemption at any time by Continental at par. On December 22, 1995, Continental repurchased $16 million of the Series A Debentures (including payment-in-kind interest of $1 million). These debentures were repurchased with a portion of the proceeds from the issuance of 8-1\/2% convertible trust originated preferred securities. See Note 6. As of February 1, 1996, the Company had redeemed or repurchased the remaining Series A Debentures for $125 million (including payment-in-kind interest of $7 million).\nContinental and CMI have secured borrowings from General Electric Capital Corporation, General Electric Company and certain affiliates (any one or more of such entities, \"GE\") which as of December 31, 1995 aggregated $634 million. CMI's secured loans contain significant financial covenants, including requirements to maintain a minimum cash balance and consolidated net worth, restrictions on unsecured borrowings and mandatory prepayments on the sale of most assets. These financial covenants limit the ability of CMI to pay dividends to Continental. As of December 31, 1995, CMI had a minimum cash balance requirement of $29 million, net assets of $301 million and was restricted from paying dividends in excess of $79 million. In addition, Continental's secured loans require Continental to, among other things, maintain a minimum monthly operating cash flow and cumulative operating cash flow, a minimum monthly cash balance and a minimum ratio of operating cash flow to fixed charges. Continental also is prohibited generally from paying cash dividends on its capital stock, from purchasing or prepaying indebtedness and from incurring additional secured indebtedness. In addition, to the extent Continental's actual quarterly average cash balances exceed certain forecasts, a portion of such excess cash is required to be used to prepay certain loan obligations to GE.\nMaturities of long-term debt due over the next five years are as follows (in millions):\nNOTE 3 - LONG-TERM DEBT (CONTINUED)\nNot included in the above table are the Convertible Secured Debentures, with a principal balance at December 31, 1995 of $124 million, which had been redeemed or repurchased as of February 1, 1996.\nNOTE 4 - LEASES\nContinental leases certain aircraft and other assets under long-term lease arrangements. Other leased assets include real property, airport and terminal facilities, sales offices, maintenance facilities, training centers and general offices. Most leases also include renewal options and some aircraft leases include purchase options.\nAt December 31, 1995, the scheduled future minimum lease payments under capital leases and the scheduled future minimum lease rental payments required under aircraft and engine operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows (in millions):\nNot included in the above operating lease table is $229 million in annual minimum lease payments relating to non- aircraft leases, principally airport and terminal facilities and related equipment.\nAt December 31, 1994, various capital lease and operating lease agreements totaling $225 million and $1.4 billion, respectively, were in default and cross default. The Company reached resolutions curing defaults under the related agreements and the resulting cross defaults. See Note 3.\nThe Company's total rental expense for all operating leases, net of sublease rentals, was $720 million, $675 million and $666 million in 1995, 1994 and 1993, respectively.\nNOTE 5 - FINANCIAL INSTRUMENTS\n(a) Cash equivalents -\nCash equivalents consist primarily of commercial paper with maturities of three months or less and approximate fair value due to the short maturity of three months or less.\n(b) Investment in Equity Securities -\nContinental's investment in America West Airlines, Inc. (\"America West\") is classified as available-for-sale and carried at an aggregate market value of $37 million and $17 million at December 31, 1995 and 1994, respectively. Included in stockholders' equity at December 31, 1995 and 1994 is a net unrealized gain of $18 million and a net unrealized loss of $2 million, respectively.\nSince a readily determinable market value does not exist for the Company's investment in AMADEUS (see Note 11), the investment is carried at cost in the accompanying consolidated balance sheet.\n(c) Option Contracts -\nThe Company has entered into petroleum option contracts to protect against a sharp increase in jet fuel prices, and CMI has entered into average rate option contracts to hedge a portion of its Japanese yen-denominated ticket sales against a significant depreciation in the value of the yen versus the United States dollar. The petroleum option contracts generally cover the Company's forecasted jet fuel needs for the next three to six months, and the average rate option contracts cover a portion of CMI's yen-denominated ticket sales for the next six to 10 months. At December 31, 1995 and 1994, the Company had petroleum option contracts outstanding with an aggregate contract value of $175 million and $140 million, respectively, and at December 31, 1995, CMI had an average rate option contract outstanding with a contract value of $185 million. At December 31, 1995 and 1994, the fair value of the option contracts was immaterial. Option hedging activities did not have a material impact on the consolidated statement of operations.\nThe Company and CMI are exposed to credit loss in the event of nonperformance by the counterparties on the option contracts; however, management does not anticipate nonperformance by these counterparties. The amount of such exposure is generally the unrealized gains, if any, on such option contracts.\n(d) Debt and Preferred Securities -\nThe fair value of the Company's debt with a carrying value of $1.35 billion and $1.34 billion as of December 31, 1995 and 1994, respectively, estimated based on the discounted amount of future cash flows using the current incremental rate of borrowing for a similar liability or quoted market prices, approximates $1.38 billion and $1.29 billion, respectively. The fair value of the remaining debt (with a carrying value\nNOTE 5 - FINANCIAL INSTRUMENTS (Continued)\nof $171 million and $84 million, respectively, and primarily relating to aircraft modification notes and various loans with immaterial balances) was not practicable to estimate due to the large number and small dollar amounts of these notes.\nThe fair value of Continental's 8-1\/2% convertible trust originated preferred securities approximates its carrying value.\nNOTE 6 - PREFERRED SECURITIES OF TRUST\nIn the fourth quarter of 1995, Continental Airlines Finance Trust, a Delaware statutory business trust (the \"Trust\") with respect to which the Company owns all of the common trust securities, completed a private placement of 4,997,000 8- 1\/2% Convertible Trust Originated Preferred Securities (\"TOPrS\"). The TOPrS have a liquidation value of $50 per preferred security and are convertible at any time at the option of the holder into shares of Continental's Class B Common Stock (\"Class B\") at a conversion rate of 1.034 shares of Class B for each preferred security (equivalent to $48.36 per share of Class B), subject to adjustment in certain circumstances. Distributions on the preferred securities are payable by the Trust at the annual rate of 8-1\/2% of the liquidation value of $50 per preferred security and are included in Distributions on Preferred Securities of Trust in the accompanying consolidated statement of operations. The proceeds of the private placement, which totaled $242 million (net of $8 million of underwriting commissions and expense) are included in Continental-Obligated Mandatorily Redeemable Preferred Securities of Trust in the accompanying consolidated balance sheet. Continental Airlines, Inc. has fully and unconditionally guaranteed, on a subordinated basis (the \"Guarantee\"), payment of (i) the distributions on the TOPrS, (ii) the amount payable upon redemption of the TOPrS, and (iii) the liquidation amount of the TOPrS. The Guarantee will apply to payment of distributions, redemptions and liquidations if and only to the extent the Trust has funds sufficient to make such payments.\nThe Trust invested the proceeds of the offering in 8-1\/2% Convertible Subordinated Deferrable Interest Debentures (\"Convertible Subordinated Debentures\") due 2020 issued by the Company. The Convertible Subordinated Debentures are redeemable by Continental, in whole or in part, on or after December 1, 1998 at designated redemption prices. If Continental redeems the Convertible Subordinated Debentures, the Trust must redeem the TOPrS on a pro rata basis having an aggregate liquidation value equal to the aggregate principal amount of the Convertible Subordinated Debentures redeemed. Otherwise, the TOPrS will be redeemed upon maturity of the Convertible Subordinated Debentures, unless previously converted. The Convertible Subordinated Debentures represent substantially all the assets of the Trust. The Convertible Subordinated Debentures and related income statement effects are eliminated in the Company's consolidated financial statements.\nNOTE 7 - REDEEMABLE PREFERRED AND COMMON STOCK\nContinental's Restated Certificate of Incorporation (\"Certificate of Incorporation\") authorizes the issuance of 10 million shares of preferred stock, 50 million shares each of Class A Common Stock (\"Class A\"), Class C Common Stock (\"Class C\") and Class D Common Stock (\"Class D\") and 100 million shares of Class B.\nREDEEMABLE PREFERRED STOCK\nRedeemable preferred stock consists of the following (in millions, except for share amounts):\nEffective June 30, 1995 and in exchange for the 171,000 shares of 8% Cumulative Redeemable Preferred Stock outstanding as of June 30, 1995 and all of the accrued and unpaid dividends accumulated thereon as of such date, the Company issued 202,784 shares of its new Series A 8% Preferred. On September 29, 1995, Continental issued a secured promissory note (the \"Redemption Loan\") with a principal amount of $21 million to GE in exchange for its 202,784 shares of Series A 8% Preferred, together with accumulated dividends thereon (representing all of the outstanding Series A 8% Preferred). As a result of this transaction, the Company recorded a $3 million charge against additional paid-in capital related to the unamortized accretion of the difference between the Series A 8% Preferred redemption value and its fair market value at the date of issuance. The Redemption Loan bears interest at 8.0% per annum from September 29, 1995 through March 31, 1996 and 9.86% per annum thereafter.\nEffective June 30, 1995 and in exchange for the 300,000 shares of 12% Cumulative Redeemable Preferred Stock outstanding as of June 30, 1995 and all of the accrued and unpaid dividends accumulated thereon as of such date, the Company issued 386,358 shares of its new Series A 12% Cumulative Preferred Stock (\"Series A 12% Preferred\") to an affiliate of Air Canada. Holders of Series A 12% Preferred are entitled to receive, when and if declared by the Board of Directors, cumulative dividends payable quarterly in additional shares of such preferred stock for dividends accumulating through December 31, 1996, and thereafter in cash at an annual rate of $12 per share. To the extent net income, as defined, for any calendar quarter is less than the amount of dividends due on all outstanding shares of Series A 12% Preferred for such quarter, the Board may declare dividends payable in additional shares of Series A 12% Preferred in lieu\nNOTE 7 - REDEEMABLE PREFERRED AND COMMON STOCK (CONTINUED)\nof cash. At any time, the Company may redeem, in whole or in part, on a pro rata basis among the stockholders, any outstanding shares of Series A 12% Preferred, and all outstanding shares are mandatorily redeemable on April 27, 2003 out of legally available funds. The redemption price is $100 per share plus accrued unpaid dividends. The Series A 12% Preferred is not convertible into shares of common stock and has no voting rights, except under limited circumstances. During 1995, the Board of Directors declared and issued 11,590 additional shares of Series A 12% Preferred in lieu of cash dividends.\nCOMMON STOCK\nContinental has two classes of common stock outstanding, Class A and Class B. Holders of shares of Class A and Class B are entitled to receive dividends when and if declared by the Board. Each share of Class A is entitled to 10 votes per share and each share of Class B is entitled to one vote per share.\nIn connection with the Reorganization (see Note 2), a majority of the Company's equity was issued to Air Partners, L.P., a Texas limited partnership (\"Air Partners\"), and Air Canada, a Canadian corporation, in exchange for their investments in the Company.\nPursuant to a stockholders' agreement, Air Canada and Air Partners have agreed to vote their shares for the election of six directors nominated by Air Canada, six directors nominated by Air Partners and six directors not affiliated with Air Partners or Air Canada. Air Canada may at any time convert shares of Class A into an equal number of shares of Class B and, so long as such exchange would comply with foreign ownership restrictions, may exchange up to 1,078,944 of its shares of Class B for an equal number of shares of Class A. Except for these special conversion and exchange rights of Air Canada, Class B is not convertible into or exchangeable for Class A and Class A is not convertible into or exchangeable for Class B. Also, Air Canada has the limited right, in certain circumstances, to convert its Class A into Class C, and Air Partners has the limited right, in certain circumstances, to convert its Class A into Class D. No person may hold or own Class C or Class D stock, respectively, other than Air Canada and certain of its affiliates or Air Partners and certain of its affiliates. The Class C and Class D common stock, if issued, would preserve the rights of each of Air Canada and Air Partners, respectively, to elect six directors to the Company's Board of Directors in certain circumstances, including a sale by the other party of its stock.\nOn December 14, 1993, the Company sold 8,086,579 shares of Class B in an underwritten public offering realizing net proceeds of $153 million. In January 1994, Air Canada converted 287,840 shares of Class B into an equal number shares of Class A to preserve its percentage of total voting power. In July 1994, 1,007,000 shares of restricted Class B were granted and issued to substantially all employees at or below the manager or equivalent level and 182,000 shares of restricted Class B were granted and issued to key officers. See Note 8. As of December 31, 1995, Air Canada held 18.0% of the equity interest and 23.6% of the voting power and Air Partners held 19.8% of the equity interest and 35.7% of the voting power of the Company. Had Air Partners exercised all of its outstanding warrants, as of December 31, 1995, Air Canada would have held 15.3% of the equity interest and 19.4% of the voting power and\nNOTE 7 - REDEEMABLE PREFERRED AND COMMON STOCK (CONTINUED)\nAir Partners would have held 31.8% of the equity interest and 47.3% of the voting power of the Company.\nAir Partners and Air Canada have the right to purchase additional shares of the Company's Class B pursuant to antidilution rights granted to them under the Certificate of Incorporation. During 1995, Air Partners purchased from the Company an aggregate of 482,773 shares of Class B with respect to such antidilution rights. See Note 13.\nWARRANTS\nAs of December 31, 1995, the Company has outstanding 4,902,366 Class A Warrants and Class B Warrants (collectively, the \"Warrants\"), all of which are held by Air Partners. Each Warrant entitles the holder to purchase one share of Class A or Class B. The Warrants are exercisable as follows: (i) 3,706,667 Warrants (1,149,067 Class A Warrants and 2,557,600 Class B Warrants) have an initial exercise price of $15 per share, and (ii) 1,195,699 Warrants (370,667 Class A Warrants and 825,032 Class B Warrants) have an initial exercise price of $30 per share. The Warrants expire on April 27, 1998.\nOn September 29, 1995, Continental purchased 6,217,635 warrants held by Air Canada to purchase an aggregate of 1,367,880 shares of Continental's Class A and 4,849,755 shares of Class B for an aggregate purchase price of $56 million (including a waiver fee of $5 million paid to a major creditor of the Company). The 6,217,635 warrants purchased had exercise prices of $15.00 per share (as to 3,706,667 shares) and $30.00 per share (as to 2,510,968 shares).\nNOTE 8 - STOCK PLANS AND AWARDS\nUnder the Company's 1994 Employee Stock Purchase Plan (the \"Stock Purchase Plan\"), all full and part-time employees of the Company who are on the United States payroll may purchase shares of Class B at 85.0% of the lower of fair market value on the first or last business day of a calendar quarter. Subject to adjustment, a maximum of 4,000,000 shares of Class B are authorized for purchase under the Stock Purchase Plan. During 1995, 259,214 shares of Class B were issued at prices ranging from $8.61 to $21.25 in connection with the Stock Purchase Plan.\nUnder the Continental Airlines, Inc. 1994 Incentive Equity Plan, as amended (the \"Incentive Plan\"), key officers and employees of the Company and its subsidiaries may receive stock options and\/or restricted stock. The Incentive Plan also provides for each outside director to receive on the day following the annual stockholders' meeting options to purchase 1,500 shares of Class B. The number of shares of Class B that may be issued under the Incentive Plan will not in the aggregate exceed 3,000,000 in accordance with the Incentive Plan. In 1995, the Incentive Plan was amended to provide for the exchange and repricing of substantially all the outstanding stock options for new options bearing a shorter exercise term and generally exercisable at a price lower than that of the canceled options, subject to certain conditions. The exercise price for the repriced options equals the market value per share on the date of grant ($16.00). As a result of the repricing, stock options generally vest over a period of three years.\nNOTE 8 - STOCK PLANS AND AWARDS (CONTINUED)\nThe following table summarizes stock option transactions pursuant to the Company's Incentive Plan for the years ended December 31, 1995 and 1994:\n* The option price for all stock options is equal to 100% of the fair market value at the date of grant.\nAs shown in the above table, options granted during 1995 include the grant of repriced options; options canceled during 1995 include the cancelation of the higher priced options.\nIn addition, the Incentive Plan permits awards of restricted stock to participants, subject to one or more restrictions, including a restriction period and a purchase price, if any, to be paid by the participant. In connection with the plan, 400,000 shares have been authorized for issuance as restricted stock. As of December 31, 1995 and 1994, 277,500 shares and 152,000 shares, respectively, were outstanding at no cost to the participant. Additionally, on March 4, 1994, the Board approved a one-time grant of 1,007,000 shares of restricted stock to substantially all employees at or below the manager level. These shares were issued at no cost to the employees and vest over a four-year period. Unvested shares of restricted stock are subject to certain transfer restrictions and forfeiture under certain circumstances. The unvested portion of restricted stock, representing the fair market value of the stock on the date of award, is being amortized to wages, salaries and related costs over the vesting period.\nDuring 1995 and 1994, 27,500 and 30,000 shares, respectively, were forfeited and returned to treasury stock. All of the shares returned to treasury stock were reissued in 1995.\nNOTE 9 - EMPLOYEE BENEFIT PLANS\nThe Company has noncontributory defined benefit pension and defined contribution (including 401(k) savings) plans. Substantially all domestic employees of the Company are covered by one or more of these plans. The benefits under the active defined benefit pension plan are based on years of service and an employee's final average compensation. For the years ended December 31, 1995, 1994 and 1993, total pension expense for the defined benefit plans was $40 million, $51 million and $52 million, respectively. Total expense for the defined contribution plans was $6 million, $1 million and $300,000 for each of 1995, 1994 and 1993, respectively.\nNet periodic pension cost of the Company's defined benefit plans for 1995, 1994 and 1993 included the following components (in millions):\nNOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED)\nThe following table sets forth the defined benefit plans' funded status amounts as of December 31, 1995 and 1994 (in millions):\nIn accordance with Statement of Financial Accounting Standards No. 87 - \"Employers' Accounting for Pensions\", an additional minimum pension liability for certain plans, representing the excess of accumulated benefits over plan assets and accrued pension costs, was recognized at December 31, 1995 and 1994. A corresponding amount was recognized as a separate reduction to stockholders' equity.\nPlan assets consist primarily of equity securities (including 128,621 shares of Continental's Class B), long-term debt securities and short-term investments.\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.25%, 8.75% and 7.50% for 1995, 1994 and 1993, respectively. The expected long-term rate of return on assets (which is used to calculate the Company's return on pension assets for the current year) was 9.25% for each of 1995, 1994 and 1993. The weighted average rate of salary increases was 6.3%, 6.3% and 5.3% for 1995, 1994 and 1993, respectively. The unrecognized net gain (loss) is amortized on a straight-line basis over the average remaining service period of employees expected to receive a plan benefit.\nNOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED)\nContinental's policy is to fund the noncontributory defined benefit pension plans in accordance with Internal Revenue Service (\"IRS\") requirements as modified, to the extent applicable, by agreements with the IRS.\nThe Company also has a profit sharing program under which an award pool consisting of 15.0% of the Company's annual pre- tax earnings, subject to certain adjustments, is distributed each year to substantially all employees on a pro rata basis according to base salary. The award pool for the year ended December 31, 1995 was $31 million.\nNOTE 10 - INCOME TAXES\nThe reconciliations of income tax computed at the United States federal statutory tax rates to income tax benefit for the years ended December 31, 1995 and 1994 and the period April 28, 1993 through December 31, 1993 are as follows (in millions):\nThe significant component of the provision (benefit) for income taxes for the year ended December 31, 1995 and 1994 and the period April 28, 1993 through December 31, 1993 was a deferred tax provision (benefit) of $71 million, $(42) million and $(13) million, respectively. The provision for income taxes for the period ended December 31, 1995 also reflects a current tax provision in the amount of $7 million as the Company is in an alternative minimum tax position.\nNOTE 10 - INCOME TAXES (CONTINUED)\nThe provision for income taxes of the Predecessor Company for the period from January 1 through April 27, 1993 was $2 million. The provision for income taxes of the Predecessor Company represents only state income taxes. Due to losses generated, there is no provision for federal income taxes for the period from January 1, 1993 through April 27, 1993.\nThe provision for income taxes for the period from April 28, 1993 through December 31, 1993 reflects an increase of $2 million which is related to the increase in the corporate tax rate from 34.0% to 35.0% enacted by the Revenue Reconciliation Act of 1993.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994 are as follows (in millions):\nAt December 31, 1995, the Company has net operating loss carryforwards (\"NOLs\") of $2.5 billion for income tax purposes that will expire from 1995 through 2009 and investment tax credit carryforwards of $45 million that will expire through 2001. As a result of the change in ownership of the Company on April 27, 1993, the ultimate utilization of the Company's net operating losses and investment tax credits could be limited.\nNOTE 10 - INCOME TAXES (CONTINUED)\nFor financial reporting purposes, a valuation allowance of $782 million has been recognized to offset the deferred tax assets related to a portion of the NOLs. The Company has considered prudent and feasible tax planning strategies in assessing the need for the valuation allowance. The Company has assumed $116 million of benefit attributable to such tax planning strategies. The Company has consummated one such transaction, which had the effect of realizing approximately 40% of the built-in gains required to be realized, and currently intends to consummate one or more additional transactions. In the event the Company were to determine in the future that any such tax planning strategies would not be implemented, an adjustment to the net deferred tax liability of up to $116 million would be charged to income in the period such determination was made. In the event the Company recognizes additional tax benefits related to NOLs and investment tax credit carryforwards attributable to the Predecessor Company, those benefits would be applied to reduce Reorganization value in excess of amounts allocable to identifiable assets and other intangibles to zero, and thereafter as an addition to paid-in capital.\nThe deferred tax valuation allowance decreased from $844 million at December 31, 1994 to $782 million at December 31, 1995. This decrease is related to the realization of deferred tax assets associated with net operating losses that had not previously been benefitted.\nApproximately $545 million of the Company's net operating losses can only be used to offset the separate parent company taxable income of Continental Airlines, Inc. Approximately $18 million of the Company's investment tax credits can only be used to offset the separate parent company tax liability of Continental Airlines, Inc.\nNOTE 11 - NON-OPERATING INCOME (EXPENSE)\nDuring the fourth quarter of 1994, the Company recorded a provision of $447 million associated with (i) the planned early retirement of certain aircraft ($278 million) and (ii) closed or underutilized airport and maintenance facilities and other assets ($169 million). This provision was included in Other, net in the accompanying consolidated statement of operations. Approximately $123 million of the provision represented a non-cash charge associated with a write-down of certain assets (principally inventory and flight equipment) to expected net realizable value. The total provision represented a net charge after taking into consideration $119 million of credits primarily related to the write-off of operating lease deferred credits associated with the aircraft to be retired. At December 31, 1994, the Company had total remaining accruals for such aircraft retirements and excess facilities of approximately $443 million, of which approximately $51 million was included in Accrued other liabilities in the accompanying consolidated balance sheet. The following represents the activity within these accruals during the year ended December 31, 1995:\nThe remaining accruals relate primarily to anticipated cash outlays associated with (i) the closure of the Los Angeles maintenance facilities, (ii) underutilized airport facilities (primarily associated with Denver International Airport), and (iii) the remaining liability associated with the grounded aircraft. The Company has assumed certain sublease rental income for these closed and under- utilized facilities and grounded aircraft in determining the accrual at December 31, 1995. However, should actual sublease rental income be different from the Company's estimates, the actual charge could be different from the amount estimated.\nThe remaining accrual represents cash outlays to be incurred over the remaining lease terms (from one to 15 years). The Company expects to finance the cash outlays primarily with internally generated funds.\nDuring the year ended December 31, 1995, the Company increased the accrual for underutilized airport facilities by $14 million and recorded a $5 million fee in connection with the Air Canada warrant redemption, partially offset by a gain of $12 million relating to a bankruptcy court approved settlement for the return of certain aircraft purchase deposits. Such amounts were included in Other, net in the accompanying consolidated statement of operations.\nNOTE 11 - NONOPERATING INCOME (EXPENSE) (CONTINUED)\nContinental and its System One subsidiary entered into a series of transactions on April 27, 1995 whereby a substantial portion of System One's assets (including the travel agent subscriber base and travel-related information management products and services software), as well as certain liabilities of System One, were transferred to a newly formed limited liability company, System One Information Management, L.L.C. (\"LLC\"). LLC is owned equally by Continental CRS Interests, Inc. (\"Continental CRS\") (formerly System One, which remains a wholly owned subsidiary of Continental), Electronic Data Systems Corporation (\"EDS\") and AMADEUS, a European computerized reservation system (\"CRS\"). Substantially all of System One's remaining assets (including the CRS software) and liabilities were transferred to AMADEUS. In addition to the one-third interest in LLC, Continental CRS received cash proceeds of $40 million and an equity interest in AMADEUS valued at $120 million, and outstanding indebtedness of $42 million of System One owed to EDS was extinguished. In connection with these transactions, the Company recorded a pretax gain of $108 million, which amount was included in Nonoperating Income (Expense) in the accompanying consolidated statement of operations for the year ended December 31, 1995. The related tax provision totaled $78 million (which differs from the federal statutory rate due to certain nondeductible expenses), for a net gain of $30 million. System One's revenue, included in Cargo, mail and other revenue, and related net earnings were not material to the consolidated financial statements of Continental.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES\nCapital Commitments\nContinental has firm commitments to take delivery of three new 737 and two new 757 aircraft through early 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is $2.7 billion. In connection with the rescheduling of jet aircraft deliveries, $72 million of purchase deposits was returned to the Company in 1995. In December 1994, Express contracted with Beech Acceptance Corporation (\"Beech\") for the purchase and financing of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. As of December 31, 1995, 13 Beech 1900-D aircraft had been delivered, of which eight had entered service by that date and five will enter service in the first quarter of 1996. The remaining 12 aircraft are scheduled to be delivered in 1996. The Company currently anticipates that the firm financing commitments available to it with respect to its acquisition of new aircraft from The Boeing Company (\"Boeing\") and Beech will be sufficient to fund all deliveries scheduled during 1996. Furthermore, the Company currently anticipates that it will have remaining financing commitments from aircraft manufacturers of $575 million for jet aircraft deliveries beyond 1996. The Company believes that further financing will be needed to satisfy the remaining amount of such capital commitments. There can be no assurance that sufficient financing will be available for all aircraft and other capital expenditures not covered by firm financing commitments.\nIn addition, the Company recently purchased one DC-10-30 aircraft and entered into an operating lease for another DC-10-30 aircraft that are expected to be placed into service by the end of the second quarter of 1996.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)\nContinental expects its cash outlays for 1996 capital expenditures, exclusive of aircraft acquisitions, to aggregate $120 million primarily relating to mainframe, software application and automation infrastructure projects, aircraft modifications and mandatory maintenance projects, passenger terminal facility improvements and office, maintenance, telecommunications and ground equipment.\nAs of December 31, 1995, Continental remains contingently liable on $202 million of long-term lease obligations of USAir, Inc. (\"USAir\") related to the East End Terminal at LaGuardia. In the event USAir defaults on these obligations, Continental might be required to cure the default, at which time it would have the right to reoccupy the terminal.\nLegal Proceedings\nThe Company and certain of its subsidiaries are defendants in various lawsuits, including suits relating to certain environmental and anti-trust claims, the Reorganization and proceedings arising in the normal course of business. While the outcome of these lawsuits and proceedings cannot be predicted with certainty and could have a material adverse effect on the Company's financial position, results of operations and cash flows, it is the opinion of management, after consulting with counsel, that the ultimate disposition of such suits will not have a material adverse effect on the Company's financial position, results of operations or cash flows.\nNOTE 13 - RELATED PARTY TRANSACTIONS\nThe following is a summary of significant related party transactions which have occurred during 1995, 1994 and the period April 28, 1993 through December 31, 1993 other than those discussed elsewhere in the Notes to Consolidated Financial Statements.\nCMI and United Micronesia Development Association, Inc. (\"UMDA\"), the minority stockholder of CMI, have a services agreement whereby UMDA is paid a fee of 1.0% of CMI's gross revenue, as defined, which will continue until January 1, 2012. For the years ended December 31, 1995 and 1994 and the period April 28, 1993 through December 31, 1993, these fees totaled $6 million, $5 million and $4 million, respectively. As of December 31, 1995 and 1994, the Company had a payable of $7 million maturing in 2011 to UMDA. Annual payments aggregating $1 million per year are applied to reduce the 1.0% fee.\nIn connection with Air Canada's investment in the Company, Air Canada, Air Partners and the Company agreed to identify and pursue opportunities to achieve cost savings, revenue enhancement or other synergies from areas of joint operation between the Company and Air Canada. The Company and Air Canada have entered into a series of synergies agreements, primarily in the areas of aircraft maintenance and commercial and marketing alliances (including agreements regarding coordination of connecting flights). The Company believes that the synergies agreements allocate potential benefits to the Company and Air Canada in a manner that is equitable and commercially reasonable, and contain terms at least as favorable to the Company as could be obtained from unrelated parties. As a result of these agreements, Continental paid Air Canada $38 million, $29 million and $9 million for the years ended December 31, 1995,\nNOTE 13 - RELATED PARTY TRANSACTIONS (CONTINUED)\n1994 and from the period April 28, 1993 through December 31, 1993, respectively, and Air Canada paid Continental $16 million, $13 million and $5 million in 1995, 1994 and for the period April 28, 1993 through December 31, 1993, respectively, primarily relating to aircraft maintenance. Continental also reimbursed Air Canada and Air Partners in 1993 for fees incurred in connection with their investment in Continental of $7 million and $11 million, respectively.\nAs a limited partner in AmWest Partners, L.P. (\"AmWest\"), the Company participated in the acquisition by AmWest of a portion of the equity of reorganized America West in connection with America West's emergence from bankruptcy, effective August 25, 1994. Each investor participating in the acquisition did so on individual terms; the Company and certain other parties invested at the same per share price, but at a higher price (approximately $9.36 per share as compared to approximately $7.01 per share) than the price paid by Air Partners, II, L.P., TPG Partners, L.P. and TPG Parallel I, L.P. (collectively, the \"TPG entities\"), partnerships controlled by David Bonderman, Chairman of the Board of the Company. However, as between the Company and the TPG entities, the Company is entitled to receive a 10.0% per year return on its investment before the TPG entities receive any return and to recoup its invested capital before the TPG entities recoup their capital.\nThe Company and America West entered into a series of agreements during 1994 related to code-sharing and ground handling that have created substantial benefits for both airlines. The services provided are considered normal to the daily operations of both airlines. As a result of these agreements, Continental paid America West $11 million and $1 million in 1995 and 1994, respectively and America West paid Continental $14 million and $ 2 million in 1995 and 1994, respectively.\nOn July 27, 1995 and August 10, 1995, Air Partners purchased from the Company an aggregate of 154,113 and 328,660 shares of Class B common stock, respectively, at purchase prices of $15.86 per share (with respect to a total of 355,330 shares) and $13.40 per share (with respect to a total of 127,443 shares). Of the total, 158,320 shares were purchased pursuant to the exercise of antidilution rights granted to Air Partners under the Certificate of Incorporation and the remaining 324,453 shares were purchased pursuant to the exercise of antidilution rights granted to Air Canada under the Certificate of Incorporation (which rights were purchased by Air Partners immediately prior to their exercise on August 10, 1995).\nNOTE 14 - FOREIGN OPERATIONS\nContinental conducts operations to various foreign countries. Operating revenue from foreign operations are as follows (in millions):\nNOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nUnaudited summarized financial data by quarter for 1995 and 1994 is as follows (in millions, except per share data):\n(a) The sum of the four quarterly earnings (loss) per share amounts does not agree with the earnings (loss) per share as calculated for the full year due to the fact that the full year calculation uses a weighted average number of shares based on the sum of the four quarterly weighted average shares divided by four quarters.\nNOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)\nDuring the second quarter of 1995, the Company recorded a pretax gain of $108 million and an after-tax gain of $30 million in connection with a series of transactions with System One. See Note 11.\nDuring the third quarter of 1994, the Company recorded a favorable adjustment of $23 million as a result of the Company's estimate of awards expected to be redeemed for travel on Continental under its frequent flyer program.\nDuring the fourth quarter of 1994, a provision of $447 million associated with the planned early retirement of certain aircraft and closed or underutilized airport and maintenance facilities and other assets was recorded for costs associated with grounding aircraft, reducing operations at certain airport facilities and modifying certain airport facilities and modifying certain aircraft and facilities lease agreements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were no changes in or disagreements on any matters of accounting principles or financial statement disclosure between the Company and its independent public accountants during the registrant's two most recent fiscal years or any subsequent interim period.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on May 17, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on May 17, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on May 17, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on May 17, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following financial statements are included in Item 8. \"Financial Statements and Supplementary Data\":\nReport of Independent Auditors Consolidated Statements of Operations for each of the Three Years in the Period Ended December 31, 1995 Consolidated Balance Sheets as of December 31, 1995 and 1994 Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 1995 Consolidated Statements of Redeemable and Nonredeemable Preferred Stock and Common Stockholders' Equity (Deficit) for each of the Three Years in the Period Ended December 31, 1995 Notes to Consolidated Financial Statements\n(b) Financial Statement Schedules:\nReport of Independent Auditors Schedule I - Condensed Financial Information of Registrant (Parent Company Only) Schedule II - Valuation and Qualifying Accounts\nAll other schedules have been omitted because they are inapplicable, not required, or the information is included elsewhere in the consolidated financial statements or notes thereto.\n(c) Reports on Form 8-K.\n(i) Report dated November 28, 1995 reporting an Item 5. \"Other Event\". No financial statements were filed with the report, which announced the consummation of the private placement of $225 million of 8-1\/2% convertible trust originated preferred securities of a special purpose finance trust.\n(d) See accompanying Index to Exhibits.\nREPORT OF INDEPENDENT AUDITORS\nWe have audited the consolidated financial statements of Continental Airlines, Inc. (the \"Company\") as of December 31, 1995 and 1994, and for the years then ended and the period from April 28, 1993 through December 31, 1993, and the consolidated statements of operations, redeemable and nonredeemable preferred stock and common stockholders' equity and cash flows for the period from January 1, 1993 through April 27, 1993 for Continental Airlines Holdings, Inc., and have issued our report thereon dated February 12, 1996 (included elsewhere in this Form 10-K). Our audits also included the financial statement schedules for these related periods listed in Item 14(b) of this Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nHouston, Texas February 12, 1996\nCONTINENTAL AIRLINES, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF OPERATIONS (a)(b) (In millions of dollars)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nCONTINENTAL AIRLINES, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET (a)(b) (In millions of dollars, except for share data)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nCONTINENTAL AIRLINES, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET (a)(b) (In millions of dollars, except for share data)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nCONTINENTAL AIRLINES, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS (a)(b) (In millions of dollars)\n(continued on next page)\nCONTINENTAL AIRLINES, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS (a)(b) (In millions of dollars)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nNOTES TO SCHEDULE I\n(a) See Note 2 to Notes to Consolidated Financial Statements for a discussion of Continental Airlines, Inc. (the \"Company\" or \"Continental\") and Predecessor Company's emergence from bankruptcy.\n(b) The Condensed Financial Information of Registrant includes the accounts of Continental and its wholly owned subsidiaries, Rubicon Indemnity, Ltd., (\"Rubicon\") and Continental Airlines Finance Trust (the \"Trust\"). Rubicon was formed for workers' compensation purposes. The Trust was formed for the issuance of preferred securities. These subsidiaries have been included in Schedule I to properly reflect the parent company's workers' compensation liability and redeemable preferred securities.\n(c) Continental's long-term debt (parent company only) was recorded at fair market value at April 27, 1993. Long- term debt as of December 31, 1995 and 1994 is summarized as follows (in millions):\nNOTES TO SCHEDULE I (continued)\nLong-term debt maturities due over the next five years are as follows (in millions):\nNot included in the above table are the Convertible Secured Debentures, with a principal balance at December 31, 1995 of $124 million, which were redeemed or repurchased as of February 1, 1996.\n(d) See Note 12 of Notes to Consolidated Financial Statements.\n(e) See Note 6 of Notes to Consolidated Financial Statements.\n(f) See Note 7 of Notes to Consolidated Financial Statements.\n(g) The Company received $81 million in dividends from wholly owned subsidiaries in 1995.\n(h) The Company has not paid dividends on its common stock.\nOn April 27, 1993, Continental adopted fresh start reporting in accordance with SOP 90-7, which resulted in adjustments to the Company's common stockholders' equity and the carrying values of assets and liabilities. Accordingly, the Parent Company Only post-reorganization balance sheets and statements of operations have not been prepared on a consistent basis of accounting with the Parent Company Only pre-reorganization balance sheet and statements of operations. See Note 2 of Notes to Consolidated Financial Statements.\nNOTES TO SCHEDULE I (continued)\nCONTINENTAL AIRLINES HOLDINGS, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF OPERATIONS (a) (In millions of dollars)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nNOTES TO SCHEDULE I (continued)\nCONTINENTAL AIRLINES HOLDINGS, INC. (Parent Company Only) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (a) (In millions of dollars)\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nNOTES TO SCHEDULE I (continued)\n(a) The Condensed Financial Information of Registrant includes the accounts of Continental Airlines Holdings, Inc. (\"Holdings\") and certain special purpose subsidiaries, primarily formed to provide fuel purchasing services to Holdings' airline subsidiaries and to finance aircraft leased to Continental.\nCONTINENTAL AIRLINES, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the Years Ended December 31, 1995, 1994, and 1993 (In millions of dollars)\n(a) Primarily represents fresh start adjustments in accordance with SOP 90-7.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCONTINENTAL AIRLINES, INC.\nBy \/s\/ LAWRENCE W. KELLNER --------------------------------- Lawrence W. Kellner Senior Vice President and Chief Financial Officer (On behalf of Registrant)\nDate: February 23, 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.\n*By \/s\/ LAWRENCE W. KELLNER ----------------------------------- Lawrence W. Kellner Attorney-in-Fact February 23, 1996\nINDEX TO EXHIBITS OF CONTINENTAL AIRLINES, INC.\n2.1 Revised Third Amended Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code with Respect to Debtors' Revised Second Amended Joint Plan of Reorganization Under Chapter 11 of the United States Bankruptcy Code, as filed with the Bankruptcy Court on January 13, 1993 -- incorporated by reference from Exhibit 2.1 to Continental's Annual Report on Form 10-K for the year ended December 31, 1992 (File no. 0-09781) (the \"1992 10-K\").\n2.2 Modification of Debtors' Revised Second Amended Joint Plan of Reorganization dated March 12, 1993 -- incorporated by reference to Exhibit 2.2 to Continental's Current Report on Form 8-K, dated April 16, 1993 (the \"April 8-K\").\n2.3 Second Modification of Debtors' Revised Second Amended Joint Plan of Reorganization, dated April 8, 1993 -- incorporated by reference to Exhibit 2.3 to the April 8-K.\n2.4 Third Modification of Debtors' Revised Second Amended Joint Plan of Reorganization, dated April 15, 1993 -- incorporated by reference to Exhibit 2.4 to the April 8-K.\n2.5 Confirmation Order, dated April 16, 1993 -- incorporated by reference to Exhibit 2.5 to the April 8-K.\n3.1 Restated Certificate of Incorporation of Continental -- incorporated by reference to Exhibit 4.1 to the April 8-K.\n3.2 By-laws of Continental, as amended to date -- incorporated by reference to Exhibit 3.1 to Continental's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 (the \"1995 Third Quarter 10-Q\").\n4.1 Specimen Class A Common Stock Certificate of the Company. (3)\n4.1(a) Specimen Class B Common Stock Certificate of the Company -- incorporated by reference to Exhibit 4.1 to Continental's Form S-1 Registration Statement (No. 33-68870) (the \"1993 S-1\").\n4.2 Certificate of Designations of Series A 12% Cumulative Preferred Stock -- incorporated by reference to Exhibit 4.3 to Continental's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 (\"the 1995 Second Quarter 10-Q\").\n4.3 Subscription and Stockholders' Agreement -- incorporated by reference to Exhibit 4.5 to the April 8-K.\n4.4 Registration Rights Agreement dated as of April 27, 1993, among Continental, Air Partners and Air Canada -- incorporated by reference to Exhibit 4.6 to the April 8-K.\n4.5 Warrant Agreement dated as of April 27, 1993, between Continental and Continental as warrant agent -- incorporated by reference to Exhibit 4.7 to the April 8-K.\n4.6 Loan Agreement dated as of April 27, 1993, among Continental Micronesia, Air Micronesia, Inc. and GE Capital -- incorporated by reference to Exhibit 4.8 to the April 8-K.\n4.6(a) Waiver, Consent and Amendment to CMI Loan Agreement, dated as of March 30, 1995, among CMI, Air Micronesia, Inc. and GE Capital -- incorporated by reference to Exhibit 4.8(a) to Continental's Annual Report on Form 10-K for the year ended December 31, 1994 (File no. 0-09781) (the \"1994 10-K\"). (2)\n4.7 Loan Agreements dated as of April 27, 1993, between ASATT Corp. and Continental -- incorporated by reference to Exhibit 4.9 to the April 8-K.\n4.7(a) Waiver, Consent and Amendment to Series B-1 Loan Agreement, dated as of March 30, 1995, between Continental and Global Project and Structured Finance Corporation (successor by merger to ASATT Corp.) -- incorporated by reference to Exhibit 4.9(a) to the 1994 10-K. (2)\n4.7(b) Waiver, Consent and Amendment to Series B-2 Loan Agreement, dated as of March 30, 1995, between Continental and Global Project and Structured Finance Corporation (successor by merger to ASATT Corp.) -- incorporated by reference to Exhibit 4.9(b) to the 1994 10-K. (2)\n4.7(c) Amendment No. 2 to Series B-1 Loan Agreement, dated as of September 29, 1995, between Continental and Global Project and Structured Finance Corporation. (3)\n4.7(d) Amendment No. 2 to Series B-2 Loan Agreement, dated as of September 29, 1995, between Continental and Global Project and Structured Finance Corporation. (2)(3)\n4.7(e) Amendment No. 3 to Series B-1 Loan Agreement, dated as of December 22, 1995, between Continental and Global Project and Structured Finance Corporation. (2)(3)\n4.7(f) Amendment No. 3 to Series B-2 Loan Agreement, dated as of December 22, 1995, between Continental and Global Project and Structured Finance Corporation. (2)(3)\n4.8 Loan Agreement dated as of April 27, 1993, between Continental and General Electric Company, individually and as agent -- incorporated by reference to Exhibit 4.10 to the 1993 S-1.\n4.8(a) First Amendment to Loan Agreement, dated as of August 12, 1993, between Continental and General Electric Company, individually and as agent. (3)\n4.8(b) Waiver, Consent and Amendment to Consolidation Loan Agreement, dated as of March 30, 1995, between Continental and General Electric Company, individually and as agent -- incorporated by reference to Exhibit 4.10(a) to the 1994 10-K. (2)\n4.8(c) Amendment No. 2 to Consolidation Loan Agreement, dated as of December 22, 1995, between Continental and General Electric Company, individually and as agent. (3)\n4.9 Master Restructuring Agreement, dated as of March 30, 1995, between Continental and GE Capital -- incorporated by reference to Exhibit 4.11 to the 1994 10-K. (2)\n4.9(a) Waiver Consent and Amendment, dated as of September 29, 1995, between Continental and GE Capital. (3)\n4.9(b) Amendment to Master Restructuring Agreement, dated as of December 22, 1995, between Continental and GE Capital. (3)\n4.10 Continental hereby agrees to furnish to the Commission, upon request, copies of certain instruments defining the rights of holders of long-term debt of the kind described in Item 601(b)(4)(iii)(A) of Regulation S-K.\n10.1 Litigation Settlement Agreement, dated as of August 31, 1992, among the Pension Benefit Guaranty Corporation and, jointly and severally, each of the debtors (as defined) -- incorporated by reference to Exhibit 10.10 to the 1992 10-K.\n10.2 Agreement of Lease dated as of January 11, 1985, between the Port Authority of New York and New Jersey and People Express Airlines, Inc., regarding Terminal C (the \"Terminal C Lease\") -- incorporated by reference to Exhibit 10.61 to the Annual Report on Form 10-K (File No. 0-9781) of People Express Airlines, Inc. for the year ended December 31, 1984.\n10.2(a) Supplemental Agreements Nos. 1 through 6 to the Terminal C Lease -- incorporated by reference to Exhibit 10.3 to Continental's Annual Report on Form 10-K (File No. 1-8475) for the year ended December 31, 1987 (\"the 1987 10-K\").\n10.2(b) Supplemental Agreement No. 7 to the Terminal C Lease -- incorporated by reference to Exhibit 10.4 to Continental's Annual Report on Form 10-K (File No. 1-8475) for the year ended December 31, 1988.\n10.2(c) Supplemental Agreements No. 8 through 11 to the Terminal C Lease -- incorporated by reference to Exhibit 10.10 to the 1993 S-1.\n10.2(d) Supplemental agreements No. 12 through 15 to the Terminal C Lease. (3)\n10.3 Assignment of Lease with Assumption and Consent dated as of August 15, 1987, among the Port Authority of New York and New Jersey, People Express Airlines, Inc. and Continental -- incorporated by reference to Exhibit 10.2 to the 1987 10-K.\n10.4* Amended and restated employment agreement between the Company and Gordon M. Bethune. (3)\n10.5* Amended and restated employment agreement between the Company and Gregory D. Brenneman. (3)\n10.6* Amended and restated employment agreement between the Company and Lawrence W. Kellner. (3)\n10.7* Amended and restated employment agreement between the Company and Barry P. Simon. (3)\n10.8* Amended and restated employment agreement between the Company and C. D. McLean. (3)\n10.9* Continental Airlines, Inc. 1994 Incentive Equity Plan -- incorporated by reference to Exhibit 4.3 to the Company's Form S-8 Registration Statement (No. 33-81324).\n10.9(a)* First Amendment to Continental Airlines, Inc. 1994 Incentive Equity Plan -- incorporated by reference to Exhibit 10.1 to the 1995 Third Quarter 10-Q.\n10.10 Purchase Agreement No. 1782, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 737-524 aircraft -- incorporated by reference to Exhibit 10.1 to Continental's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (the \"1993 Second Quarter 10-Q\"). (1)\n10.10(a) Supplemental Agreement No. 6 to Purchase Agreement No. 1782 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 737-524 aircraft -- incorporated by reference to Exhibit 10.11(a) to the 1994 10-K. (1)\n10.11 Purchase Agreement No. 1783, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 757-224 aircraft -- incorporated by reference to Exhibit 10.2 to the 1993 Second Quarter 10-Q. (1)\n10.11(a) Supplemental Agreement No. 4 to Purchase Agreement No. 1783 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 757-224 aircraft -- incorporated by reference to Exhibit 10.12(a) to the 1994 10-K. (1)\n10.12 Purchase Agreement No. 1784, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 767-324ER aircraft -- incorporated by reference to Exhibit 10.3 to the 1993 Second Quarter 10-Q. (1)\n10.12(a) Supplemental Agreement No. 3 to Purchase Agreement No. 1784 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 767-324ER aircraft -- incorporated by reference to Exhibit 10.13(a) to the 1994 10-K. (1)\n10.13 Purchase Agreement No. 1785, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 777-224 aircraft -- incorporated by reference to Exhibit 10.4 to the 1993 Second Quarter 10-Q. (1)\n10.13(a) Supplemental Agreement No. 3 to Purchase Agreement No. 1785 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 777-224 aircraft -- incorporated by reference to Exhibit 10.14(a) to the 1994 10-K. (1)\n10.14 Lease Agreement dated as of May 1992 between the City and County of Denver, Colorado and Continental regarding Denver International Airport -- incorporated by reference to Exhibit 10.17 to the 1993 S-1.\n10.14(a) Supplemental Lease Agreement, including an exhibit thereto, dated as of April 3, 1995 between the City and County of Denver, Colorado and Continental and United Air Lines, Inc. regarding Denver International Airport -- incorporated by reference to Exhibit 10.15(a) to the 1994 10-K.\n10.15 Stock Subscription Warrant of Continental Micronesia granted to United Micronesia Development Association, Inc. -- incorporated by reference to Exhibit 10.18 to the 1993 S-1.\n10.16 Lease Agreement, as amended and supplemented, between the Company and the City of Houston, Texas regarding Terminal C of Houston Intercontinental Airport -- incorporated by reference to Exhibit 10.5 to Continental's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (the \"1993 Third Quarter 10-Q\").\n10.17 Agreement and Lease dated as of May 1987, as supplemented, between the City of Cleveland, Ohio and Continental regarding Cleveland Hopkins International Airport -- incorporated by reference to Exhibit 10.6 to the 1993 Third Quarter 10-Q.\n10.18 Third Revised Investment Agreement, dated April 21, 1994, between America West Airlines, Inc. and AmWest Partners, L.P. -- incorporated by reference to Exhibit 1 to Continental's Schedule 13D relating to America West Airlines, Inc. filed on August 25, 1994.\n10.19* Form of Letter Agreement relating to certain flight benefits between the Company and each of its nonemployee directors. (3)\n11.1 Statement Regarding Computation of Per Share Earnings. (3)\n21.1 List of Subsidiaries of Continental. (3)\n23.1 Consent of Ernst & Young LLP. (3)\n24.1 Powers of attorney executed by certain directors and officers of Continental. (3)\n27.1 Financial Data Schedule. (3)\n__________\n*These exhibits relate to management contracts or compensatory plans or arrangements.\n(1) The Commission has granted confidential treatment for a portion of this agreement. (2) The Company has applied to the Commission for confidential treatment of a portion of this exhibit. (3) Filed herewith.\nContinental Airlines, Inc.\nThe Corporation will furnish without charge to each stockholder who so requests, a statement of the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and\/or rights.\nThe rights of persons who are not \"Citizens of the United States\" (as defined in 49 U.S.C. 1301(16), as now in effect or as hereafter amended) to vote the securities represented by this certificate are subject to certain restrictions contained in the Restated Certificate of Incorporation and By- Laws of the Corporation, copies of which are on file at the principal executive offices of the Corporation.\nThe following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:\nTEN COM - as tenants in common UNIF GIFT MIN ACT - ______ TEN ENT - as tenants by the (Cust) entireties Custodian _______ JT TEN - as joint tenants with (Minor) right of survivorship under Uniform Gifts and now as tenants in to Minors Act common __________________ (State)\nAdditional abbreviations may also be used through not in the above list.\nFor value received, ____________________ hereby sell, assign and transfer unto _____________________________________________ (PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE)\n___________________________________________________________________________ PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS INCLUDING POSTAL ZIP CODE OF ASSIGNEE\n__________________________________ Shares of the stock represented by the within Certificate, and do hereby irrevocably constitute and appoint __________________________________ Attorney to transfer the said stock on the books of the within-named Corporation with full power of substitution in the premises.\nDated ____________________________\nNOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER.\nX ________________________________ (SIGNATURE) X ________________________________ (SIGNATURE)\nTHE SIGNATURE(S) SHOULD BE GUARANTEED BY AN \"ELIGIBLE GUARANTOR INSTITUTION\" AS DEFINED IN RULE 19Ad-15 UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SIGNATURE(S) GUARANTEED BY:\nExhibit 4.7(c)\nAMENDMENT NO. 2 TO SERIES B-1 LOAN AGREEMENT\nAMENDMENT NO. 2 TO SERIES B-1 LOAN AGREEMENT, dated as of September 29, 1995 (this \"Amendment\"), between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Borrower\"), and GLOBAL PROJECT & STRUCTURED FINANCE CORPORATION (successor by merger to ASATT Corp.) (\"Lender\").\nW I T N E S S E T H :\nWHEREAS, Borrower and Lender are parties to that certain Loan Agreement, dated as of April 27, 1993, as amended by that certain Waiver, Consent and Amendment to Series B-1 Loan Agreement, dated as of March 30, 1995 (such Loan Agreement, as amended and as it may be hereafter amended, supplemented or otherwise modified from time to time, being hereinafter referred to as the \"Loan Agreement\", and capitalized terms defined therein and not otherwise defined herein being used herein as therein defined);\nWHEREAS, Borrower, together with Continental Express, Inc., GE Capital, General Electric Company and Lender, are parties to that certain Waiver and Consent and that certain Waiver, Consent and Amendment, each dated as of the date hereof (collectively, the \"Waivers\");\nWHEREAS, Borrower has advised Lender that Borrower wishes to amend certain provisions of the Loan Agreement in connection with the transactions contemplated by the Waivers, and Borrower has requested that Lender agree to various amendments to certain provisions of the Loan Agreement in connection therewith; and\nWHEREAS, Lender has agreed to amend certain provisions of the Loan Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendments to Loan Agreement. Section 1 of the Loan Agreement is hereby amended by amending and restating the definition of B-1\/B-2 Termination Date as follows:\n\"B-1\/B-2 Termination Date\" shall mean the date on which the B-1 Loan, the B-2 Loan and the Redemption Loan (as defined in the Other Tranche Agreement) and all accrued interest thereon shall have been completely discharged and no other Obligations (as such term is defined herein) and no other Obligations (as such term is defined in the Other Tranche Agreement) shall then be due and payable.\nSECTION 2. Effective Date. This Amendment shall become effective upon the delivery of the fully executed Redemption Note by Borrower to Lender.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Loan Agreement to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Loan Agreement as amended hereby. Upon the effectiveness of this Amendment, on and after the date hereof, each reference in each of the Loan Documents to \"the B-1 Loan Agreement,\" \"thereunder,\" \"thereof,\" \"therein,\" or words of like import referring to the Loan Agreement, shall mean and be a reference to the Loan Agreement as amended hereby.\n(b) Except as specifically amended herein, the Loan Agreement and all of the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. Without limiting the generality of the foregoing, Borrower hereby confirms that all of its obligations under the Collateral Documents shall continue and shall remain in full force and effect.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of any Lender under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section Titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Loan Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Each Lender and Borrower agree to submit to personal jurisdiction and, to the extent permitted by applicable law, to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by applicable law, service of process on Borrower or any Lender in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 11.11 of the Loan Agreement. Nothing herein shall preclude any Lender or Borrower from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by applicable law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nBy: Jeffrey A. Smisek Senior Vice President\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nBy: Name: Eric M. Dull Title: Vice President\nCONSENTED TO, AGREED AND ACKNOWLEDGED:\nCONTINENTAL EXPRESS, INC. as Guarantor\nBy: Name: Jeffrey A. Smisek Title: Senior Vice President\nExhibit 4.7(d)\nEXPURGATED CONFIDENTIAL TREATMENT REQUESTED BY CONTINENTAL AIRLINES, INC.\nAMENDMENT NO. 2 TO SERIES B-2 LOAN AGREEMENT\nAMENDMENT NO. 2 TO SERIES B-2 LOAN AGREEMENT, dated as of September 29, 1995 (this \"Amendment\"), between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Borrower\"), and GLOBAL PROJECT & STRUCTURED FINANCE CORPORATION (successor by merger to ASATT Corp.) (\"Lender\").\nW I T N E S S E T H :\nWHEREAS, Borrower and Lender are parties to that certain Loan Agreement, dated as of April 27, 1993, as amended by that certain Waiver, Consent and Amendment to Series B-2 Loan Agreement, dated as of March 30, 1995 (such Loan Agreement, as amended and as it may be hereafter amended, supplemented or otherwise modified from time to time, being hereinafter referred to as the \"Loan Agreement\", and capitalized terms defined therein and not otherwise defined herein being used herein as therein defined);\nWHEREAS, Borrower, together with Continental Express, Inc., GE Capital, General Electric Company and Lender, are parties to that certain Waiver and Consent and that certain Waiver, Consent and Amendment, each dated as of the date hereof (the \"Waivers\");\nWHEREAS, Borrower, Lender and GE Capital have entered into that certain letter agreement, dated as of the date hereof (the \"Exchange Agreement\"), in connection with the redemption of certain preferred stock of Borrower held by GE Capital;\nWHEREAS, Borrower has advised Lender that Borrower wishes to amend certain provisions of the Loan Agreement in connection with the transactions contemplated by the Waivers, and Borrower has requested that Lender agree to various amendments to certain provisions of the Loan Agreement in connection therewith; and\nWHEREAS, Lender has agreed to amend certain provisions of the Loan Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendments to Loan Agreement. The Loan Agreement is hereby amended as follows:\n(a) Section 1 is hereby amended as follows:\ni) by amending and restating the definition of B-1\/B-2 Termination Date as follows:\n\"B-1\/B-2 Termination Date\" shall mean the date on which the B-1 Loan and the Loan and all accrued interest thereon shall have been completely discharged and no other Obligations (as such term is defined herein) and no other Obligations (as such term is defined in the Other Tranche Agreement) shall then be due and payable.\nii) by amending and restating the definition of B-2 Deferred Amount as follows:\n\"B-2 Deferred Amount\" shall mean the aggregate amount of all principal payments deferred in accordance with the terms of Section 1 of the Waiver, Consent and Amendment and all principal payments deferred in respect of the Redemption Note, as set forth in Schedule 2.1A hereto; such amount shall include the amounts deferred under both the B-2 Note and the Redemption Note.\niii) by amending and restating the definition of Lender as follows:\n\"Lender\" shall mean (i) prior to the initial issuance of the B-2 Note, ASATT Corp. and, thereafter, (ii) each holder, from time to time, of any of the Notes.\niv) by amending and restating the definition of Loan as follows:\n\"Loan\" shall mean the B-2 Loan and the Redemption Loan, collectively.\nv) by amending and restating the definition of Loan Documents as follows:\n\"Loan Documents\" shall mean this Agreement, the B-2 Note, the Redemption Note, the Collateral Documents, the Relevant Guaranties, the Relevant Collateral Agency Agreements, and all other agreements, instruments, documents and certificates, including, without limitation, pledges, powers of attorney, consents, assignments, contracts, notices and all other written matter, executed after the Closing Date by or on behalf of any Loan Party, or any employee of any Loan Party, and delivered to Lender, pursuant to the terms of this Agreement and any amendments, modifications or supplements hereto or waivers hereof.\nvi) by amending and restating the definition of Required Lenders as follows:\n\"Required Lenders\" shall mean, as of any date, the holders of interests in the Notes evidencing at least 66 2\/3% of the aggregate unpaid principal amount of the Obligations.\nvii) by inserting the following new definitions in proper alphabetical order:\n\"B-2 Note\" shall have the meaning assigned to it in Section 2.1(a) hereof.\n\"Exchange Agreement\" shall have the meaning assigned to it in the recitals to Amendment No. 2 to the Series B-2 Loan Agreement, dated as of September 29, 1995, between Borrower and Lender.\n\"Notes\" shall mean the B-2 Note and the Redemption Note and Note shall mean either the B-2 Note or the Redemption Note.\n\"Redemption Date\" shall mean September 29, 1995.\n\"Redemption Loan\" shall mean have the meaning assigned to it in Section 2.1(d) hereof.\n\"Redemption Note\" shall mean have the meaning assigned to it in Section 2.1(d) hereof.\n(viii) by deleting the definition of \"Note\" appearing therein.\n(b) Section 2.1 is hereby amended by deleting subsection (a) thereof in its entirety and substituting the following new subsection (a) in lieu therefor:\n(a) Upon and subject to the terms and conditions hereof, Lender agrees, on or before the Commitment Termination Date, to make the B-2 Loan to Borrower in a principal amount equal to $100,000,000. The B-2 Loan shall be evidenced by one or more promissory notes to be executed and delivered by Borrower on the Closing Date, in substantially the form attached hereto as Exhibit I (the \"B-2 Note\").\n(c) Section 2.1 is hereby amended by deleting subsection (c) thereof in its entirety and substituting the following new subsection (c) in lieu therefor:\n(c) [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(d) A new Section 2.1(d) is hereby added to Section 2.1 which shall read as follows:\n(d) [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(e) Section 2.2 is hereby amended by deleting subsection (e) thereof in its entirety and substituting the following new subsection (e) in lieu therefor:\n(e) Each prepayment made pursuant to subsection (a) hereof shall be applied first, ratably to the scheduled payments of the outstanding amounts set forth in the column titled Deferred Principal Payment on Schedules 2.1 and 2.1A hereto and then, to the scheduled payments of the outstanding amounts set forth in the column titled Principal Payment on Schedules 2.1 and 2.1A hereto in the inverse order of maturity (apportioned ratably between amounts due on the same date). Notwithstanding anything to the contrary contained herein, the B-2 Deferred Amount may be prepaid in whole or in part without any prepayment penalty.\n(f) Section 2.4 is hereby amended by deleting it in its entirety and substituting the following in lieu therefor:\n2.4 Use of Proceeds. Borrower shall apply the proceeds of the B-2 Loan as set forth in Recital A of this Agreement and shall apply the proceeds of the Redemption Loan as contemplated by the Exchange Agreement.\n(g) A new Section 2.6(e) is hereby added to Section 2.6 which shall read as follows:\n(e) Notwithstanding anything to the contrary set forth in this Section 2.6, with respect to the Redemption Note, during each Payment Period, interest shall accrue on each day during such Payment Period on the amounts set forth in the columns titled Principal Balance and Deferred Principal Balance on Schedule 2.1A hereof (as reduced by any prepayments made during such Payment Period) opposite the Interest Payment Date that is the first day of such Payment Period at a rate per annum equal to 8% in respect of the period from the Redemption Date through March 31, 1996, and thereafter at the Stated Rate.\n(h) Section 2.7 is hereby amended by adding the following sentence after the first sentence thereof:\n[CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(i) Section 2.7 is hereby amended by deleting the term \"Note\" therein in each place it is used therein and replacing it with the term \"B-2 Note\".\n(j) Sections 2.12, 9.1(p), 9.3 and 10.1(b) are hereby amended by deleting the term \"Note\" therein in each place it is used therein and replacing it with the term \"Notes\".\n(k) The definition of Closing Date and Sections 2.1(b) and 2.7 are hereby amended by deleting the term \"Loan\" therein in each place it is used therein and replacing it with the term \"B-2 Loan\".\n(l) Section 10.1 is hereby amended by deleting subsection (a) thereof in its entirety and substituting the following new subsection (a) in lieu therefor:\n(a) The Loan Documents constitute the complete agreement between the parties with respect to the subject matter hereof. The Loan Documents supersede any and all discussions, negotiations, understandings or agreements, written or oral, express or implied with respect thereto, which are merged herein and superseded hereby. Borrower may not sell, assign or transfer any of the Loan Documents or any portion thereof, including, without limitation, Borrower's rights, title, interests, remedies, powers and duties hereunder or thereunder. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(m) A new Exhibit I-2 is hereby added to the Loan Agreement in the form attached to this Amendment as Exhibit A.\n(n) A new Schedule 2.1A is hereby added to the Loan Agreement in the form attached to this Amendment as Exhibit B.\nSECTION 2. Effective Date. This Amendment shall become effective upon the delivery of the fully executed Redemption Note by Borrower to Lender.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Loan Agreement to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Loan Agreement as amended hereby. Upon the effectiveness of this Amendment, on and after the date hereof, each reference in each of the Loan Documents to \"the B-2 Loan Agreement,\" \"thereunder,\" \"thereof,\" \"therein,\" or words of like import referring to the Loan Agreement, shall mean and be a reference to the Loan Agreement as amended hereby.\n(b) Except as specifically amended herein, the Loan Agreement and all of the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. Without limiting the generality of the foregoing, Borrower hereby confirms that all of its obligations under the Collateral Documents shall continue and shall remain in full force and effect.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of Lender or Agent under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section Titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Loan Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Agent, each Lender and Borrower agree to submit to personal jurisdiction and, to the extent permitted by applicable law, to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by applicable law, service of process on Borrower, Agent or any Lender in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 11.11 of the Loan Agreement. Nothing herein shall preclude Agent, Lender or Borrower from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by applicable law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Title:\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nBy: Name: Eric M. Dull Title: Vice President\nCONSENTED TO, AGREED AND ACKNOWLEDGED:\nCONTINENTAL EXPRESS, INC. as Guarantor\nBy: Name: Title:\nEXHIBIT B\nSchedule 2.1A to the Loan Agreement\n[CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nExhibit 4.7(e)\nEXPURGATED CONFIDENTIAL TREATMENT REQUESTED BY CONTINENTAL AIRLINES, INC.\nAMENDMENT NO. 3 TO SERIES B-1 LOAN AGREEMENT\nAMENDMENT NO. 3 TO SERIES B-1 LOAN AGREEMENT, dated as of December 22, 1995 (this \"Amendment\"), between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Borrower\") and GLOBAL PROJECT & STRUCTURED FINANCE CORPORATION (successor by merger to ASATT Corp.) (\"Lender\").\nW I T N E S S E T H :\nWHEREAS, Borrower and Lender are parties to that certain Loan Agreement, dated as of April 27, 1993 (such agreement, as modified to date and as further amended, supplemented or otherwise modified hereby and from time to time hereafter, being hereinafter referred to as the \"Loan Agreement\", and capitalized terms used herein and not otherwise defined having the meaning assigned to them in the Loan Agreement as therein defined);\n[CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nWHEREAS, the execution and delivery of this Amendment is a condition precedent to certain of the transactions contemplated by the Purchase Agreements; and\nWHEREAS, Lender has agreed so to amend certain provisions of the Loan Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendments to Loan Agreement. (a) Section 2.3 of the Loan Agreement is hereby amended by deleting subsection (f) thereof in its entirety and substituting the following new subsection (f) in lieu thereof:\n(f) [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(b) Section 1 of the Loan Agreement is hereby amended by inserting the following new definition in the proper alphabetical order:\n\"Modification Notes\" means the notes issued to any GE Party (as defined in the Restructuring Agreement) evidencing the Modification Financing.\n(c) Section 8.2 of the Loan Agreement is hereby amended and restated in its entirety as follows:\n8.2 Repayment of Loan and Other Tranch Loan. [Intentionally Deleted.]\nSECTION 2. Effective Date. This Amendment shall become effective upon execution and delivery hereof.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Loan Agreement and the other Loan Documents to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Loan Agreement as amended hereby.\n(b) Except as specifically amended herein, the Loan Agreement and all of the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. Without limiting the generality of the foregoing, Borrower hereby confirms that all of its obligations under the Collateral Documents shall continue and shall remain in full force and effect.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of Lender or Agent under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section Titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Loan Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Agent, each Lender and Borrower agree to submit to personal jurisdiction and, to the extent permitted by applicable law, to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by applicable law, service of process on Borrower, Agent or any Lender in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 10.11 of the Loan Agreement. Nothing herein shall preclude Agent, Lender or Borrower from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by applicable law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nGerald Laderman Vice President\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nEric M. Dull Vice President\nExhibit 4.7(f)\nEXPURGATED CONFIDENTIAL TREATMENT REQUESTED BY CONTINENTAL AIRLINES, INC.\nAMENDMENT NO. 3 TO SERIES B-2 LOAN AGREEMENT\nAMENDMENT NO. 3 TO SERIES B-2 LOAN AGREEMENT, dated as of December 22, 1995 (this \"Amendment\"), between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Borrower\") and GLOBAL PROJECT & STRUCTURED FINANCE CORPORATION (successor by merger to ASATT Corp.) (\"Lender\").\nW I T N E S S E T H :\nWHEREAS, Borrower and Lender are parties to that certain Loan Agreement, dated as of April 27, 1993 (such agreement, as modified to date and as further amended, supplemented or otherwise modified hereby and from time to time hereafter, being hereinafter referred to as the \"Loan Agreement\", and capitalized terms used and not otherwise defined having the meanings assigned to them in the Loan Agreement);\n[CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nWHEREAS, the execution and delivery of this Amendment is a condition precedent to certain of the transactions contemplated by the Purchase Agreements; and\nWHEREAS, Lender has agreed so to amend certain provisions of the Loan Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendments to Loan Agreement. (a) Section 2.3 of the Loan Agreement is hereby amended by deleting subsection (f) thereof in its entirety and substituting the following new subsection (f) in lieu thereof:\n(f) [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(b) Section 1 of the Loan Agreement is hereby amended by inserting the following new definition in the proper alphabetical order:\n\"Modification Notes\" means the notes issued to any GE Party (as defined in the Restructuring Agreement) evidencing the Modification Financing.\n(c) Section 8.2 of the Loan Agreement is hereby amended and restated in its entirety as follows:\n8.2 Repayment of Loan and Other Tranch Loan. [Intentionally Deleted.]\nSECTION 2. Effective Date. This Amendment shall become effective upon execution and delivery hereof.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Loan Agreement and the other Loan Documents to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Loan Agreement as amended hereby.\n(b) Except as specifically amended herein, the Loan Agreement and all of the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. Without limiting the generality of the foregoing, Borrower hereby confirms that all of its obligations under the Collateral Documents shall continue and shall remain in full force and effect.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of Lender or Agent under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section Titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Loan Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Agent, each Lender and Borrower agree to submit to personal jurisdiction and, to the extent permitted by applicable law, to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by applicable law, service of process on Borrower, Agent or any Lender in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 10.11 of the Loan Agreement. Nothing herein shall preclude Agent, Lender or Borrower from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by applicable law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nGerald Laderman Vice President\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nEric M. Dull Vice President\nExhibit 4.8(a)\nFIRST AMENDMENT TO LOAN AGREEMENT\nFIRST AMENDMENT dated as of August 12, 1993 (this \"First Amendment\") among Continental Airlines, Inc., a Delaware corporation (\"Borrower\"), and General Electric Company, a New York corporation (in its individual capacity, \"GE\"), on its own behalf and as agent (in such capacity, the \"Agent\") for the Holders (as defined in the Loan Agreement (as defined below)), to the Loan Agreement dated as of April 27, 1993 among Borrower and GE, on its own behalf and as Agent (the \"Original Loan Agreement\" and, as amended, the \"Loan Agreement\"), and as Consolidation Collateral Agent, Collateral Agent and Mortgagee (as such terms are defined in the Loan Agreement). Capitalized terms used herein but not otherwise defined herein shall have the meaning ascribed thereto in the Loan Agreement.\nWHEREAS, the parties hereto have previously entered into the Original Loan Agreement; and\nWHEREAS, simultaneously with entering into this First Amendment, the Borrower, as grantor, and GE, as Collateral Agent, are entering into an amendment to the Consolidation Security Agreement in the form attached hereto as Exhibit A (the \"First Amendment to Consolidation Security Agreement\") pursuant to which, among other things, additional collateral shall be granted by Borrower to GE, as Collateral Agent, to secure the Secured Obligations (as defined in the Consolidation Security Agreement); and\nWHEREAS, simultaneously with entering into this First Amendment, the Borrower, as grantor, and GE, as Mortgagee, are entering into an amendment to the Mortgage in the form attached hereto as Exhibit B (the \"First Amendment to Mortgage\") pursuant to which additional collateral shall be granted by Borrower to GE, as Mortgagee, to secure the Secured Obligations (as defined in the Mortgage); and\nWHEREAS, pursuant to Section 6.16 of the Original Loan Agreement, Borrower has agreed that at any time either or both of the Simulator Liens are no longer in effect, Borrower shall, among other things, grant, as security for the Obligations, a Lien on the Simulator so released in favor of Consolidation Collateral Agent; and\nWHEREAS, a Simulator Lien is no longer in effect as to a certain Simulator; and\nWHEREAS, the Borrower has requested certain consents and waivers under the Loan Agreement and the Consolidation Security Agreement; and\nWHEREAS, in order to give effect to the foregoing, the parties hereto desire to amend certain provisions of the Loan Agreement and GE, individually and as Agent, Consolidation Collateral Agent, Collateral Agent and Mortgagee desires to grant the consents and waivers requested by the Borrower;\nNOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, the parties hereto agree as follows:\nSection 1. Definitions.\nSection 1 of the Loan Agreement is hereby amended as follows:\n(i) The definition of \"Collateral\" is amended by inserting after the word \"Documents\" in the last line thereof, the following: \", and shall include all Primary Collateral\".\n(ii) The definition of \"Mortgage\" is amended by inserting after the words \"Exhibit M\" in the third line thereof, the following: \", including all amendments, modifications and supplements thereto,\".\n(iii) Clause (f) of the definition of \"Primary Collateral\" is amended and restated in its entirety as follows:\n\"(f) The six flight simulators described below, together with all other properties and rights related thereto, as more fully specified in the Consolidation Security Agreement:\nAircraft Type Manufacturer (Date) Location\nMcDonnell Douglas DC-9-30 Link\/GMI (2\/1\/83) Houston Boeing B727-200 Link (1\/1\/88) Houston Boeing B727-200 Link (1\/1\/83) Houston Boeing B737-200 Conductron (1\/1\/85) Houston Boeing B737-200 Rediffusion (1\/1\/88) Santa Monica Airbus A300B4 Thomson-CSF (1\/12\/78) Miami;\"\n(iv) The definition of \"Security Agreement\" is amended by inserting after the word \"hereunder\" in the last line thereof, the following: \", including all amendments, modifications and supplements thereto\".\n(v) the definition of \"Simulator Liens\" is amended and restated in its entirety as follows:\n\" \"Simulator Liens\" shall mean the Lien currently existing in favor of American General Corporation on the Simulators.\".\n(vi) The definition of \"Simulators\" is amended and restated in its entirety as follows:\n\" \"Simulators\" shall mean the Link flight simulator for DC10- 10\/30 aircraft located in Los Angeles.\".\nSection 2. Release of Lien on Simulators.\nSection 6.16 of the Loan Agreement is hereby amended by deleting the words \"either or both of\" in the second line thereof.\nSection 3. Simulator Liens.\nSection 7.15 of the Loan Agreement is hereby amended by inserting before the word \"Borrower\" in the first line thereof, the following: \"Except as contemplated by Section 6.16 hereof, until the execution and delivery by the Borrower of the security agreement referred to in Section 6.16 hereof,\".\nSection 4. Miscellaneous Amendments.\n(a) Schedule 4.24 of the Loan Agreement is hereby amended and restated in its entirety by replacing such schedule with Section 4.24 attached hereto.\n(b) Section 6.10(c)(ii) of the Loan Agreement is hereby amended by deleting \"Schedule 4.23\" in the second and fourth lines thereof, and inserting, in lieu thereof, \"Schedule 4.24\".\nSection 5. Conditions Precedent; Effectiveness. This First Amendment shall become effective as of the date (the \"Commencement Date\") the following conditions have been satisfied (or waived by Agent):\n(a) Documents. Borrower shall have delivered, or shall have caused to be delivered, to Agent each of the following:\n(i) This First Amendment, duly executed by Borrower, the First Amendment to Consolidation Security Agreement, duly executed by Borrower, and the First Amendment to Mortgage, duly executed by Borrower, together with:\n(x) executed copies of proper financing statements (Form UCC- 1 or UCC-3) or equivalent documents, to be duly filed under the Uniform Commercial Code of each jurisdiction (other than in the States of Maryland and Tennessee) as may be necessary or, in the reasonable opinion of Agent, desirable to perfect in the United States the security interests created by the First Amendment to Consolidation Security Agreement and the First Amendment to Mortgage;\n(y) evidence of the completion of all recordings and filings of the First Amendment to Consolidation Security Agreement and the First Amendment to Mortgage as may be necessary or, in the reasonable opinion of Agent, desirable to perfect in the United States the Liens created by the First Amendment to Consolidation Security Agreement and the First Amendment to Mortgage; and\n(z) evidence that all other actions necessary or, in the reasonable opinion of Agent, desirable to perfect in the United States and protect the security interests created by the First Amendment to Consolidation Security Agreement and the First Amendment to Mortgage have been taken (other than the filing of UCC financing statements).\n(b) Representations and Warranties. After giving effect to this First Amendment and the transactions contemplated in this First Amendment, all the representations and warranties of Borrower in Article 4 of the Loan Agreement and in any other Loan Document (other than representations and warranties which expressly speak as of a different date) and in Section 6 hereof shall be true and correct in all material respects on and as of the Commencement Date.\n(c) Event of Default; Default. On the Commencement Date, after giving effect to this First Amendment, no Event of Default or Default shall have occurred and be continuing or would result from the transactions contemplated hereby.\nSection 6. Representations and Warranties.\nBorrower hereby represents and warrants the following:\n(a) This First Amendment constitutes a legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its terms.\n(b) Borrower is or, to the extent that this First Amendment states that the Collateral is to be acquired after the date hereof, will be, the owner of the Collateral having good and, except as marketability may be affected by Primary Collateral Permitted Encumbrances or the Borrower's lack of possession of any certificate of title for any Titled Ground Equipment, marketable title thereto. Borrower has no place of business, offices where its books of account and records are kept, or places where the Collateral is used, stored or located, except as set forth on Schedule 4.24 annexed to the Original Loan Agreement, as amended hereby, or as disclosed by Borrower in writing after the date hereof. The Liens which are being granted by the First Amendment to Consolidation Security Agreement and the First Amendment to Mortgage create, as of the date thereof, valid and, upon the completion of the filings and recordings described in Section 5(a)(i) hereof, perfected, first-priority Liens on the Collateral covered thereby, and subject to no other Lien except as provided for in the Consolidation Security Agreement, as amended by the First Amendment to Consolidation Security Agreement or the Mortgage, as amended by the First Amendment to Mortgage, and except for Primary Collateral Permitted Encumbrances.\nSection 7. Consent and Waiver. GE, individually and as Agent, Consolidation Collateral Agent, Collateral Agent and Mortgagee, hereby (a) acknowledges the changes to (i) Schedule 4.24 to the Loan Agreement pursuant hereto, (ii) the locations of certain of the Flight Simulators pursuant to (and as defined in) the First Amendment to Consolidation Security Agreement and (iii) Schedule I to the Consolidation Security Agreement pursuant to the First Amendment to Consolidation Security Agreement, (b) consents to the possession by First Air, Inc. (\"First Air\") of the B737-200 flight simulator pursuant to the terms and conditions of the 737-200 Simulator Use Agreement made in March, 1991 between the Borrower and First Air, as amended by Amendment Number 1 thereto and (c) waives any Default or Event of Default that may have occurred as a result of any of the foregoing changes or possession (including, but not limited to, the failure of the Borrower to provide notice of any thereof). This consent and waiver shall not be deemed to constitute a consent or waiver of any Default or Event of Default other than those specifically set forth herein, and is not a consent to or waiver of any other breach or noncompliance now or hereafter existing under the terms of the Loan Agreement (as amended hereby and from time to time), the Consolidation Security Agreement (as amended by the First Amendment to Consolidation Security Agreement and as amended from time to time) or the Mortgage Agreement (as amended by the First Amendment to Mortgage and as amended from time to time), which terms are hereby ratified and confirmed and shall continue in full force and effect. Execution of this First Amendment does not require GE, individually or as Agent, Consolidation Collateral Agent, Collateral Agent or Mortgagee to execute a similar consent or waiver for a similar circumstance or on a future occasion, and all rights and remedies in respect of any other or further breach or non-compliance are fully reserved.\nSection 8. Reference to and Effect on the Loan Agreement.\n(a) Upon the effectiveness of this First Amendment, each reference in the Loan Agreement to \"this Agreement\", \"hereunder\", \"hereof\", \"herein\" or words of like import shall mean and be a reference to the Loan Agreement, as amended hereby, and each reference to the Loan Agreement in any other document, instrument or agreement executed and\/or delivered in connection with the Loan Agreement shall mean and be a reference to the Loan Agreement, as amended hereby.\n(b) Except as specifically amended hereby, the Loan Agreement shall remain in full force and effect and is hereby ratified and confirmed.\n(c) Except as specifically provided herein or in the First Amendment to Consolidation Security Agreement, the execution, delivery and effectiveness of this First Amendment shall not operate as a waiver of any right, power or remedy of GE or Agent under the Loan Agreement or any of the other Loan Documents, nor constitute a waiver of any provision contained therein.\nSection 9. Execution in Counterparts. This First Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument.\nSection 10. Headings. Section headings in this First Amendment are included herein for convenience of reference only and shall not constitute a part of this First Amendment for any other purpose.\nSection 11. Severability. In case any provision in or obligation under this First Amendment shall be invalid, illegal or unenforceable in any jurisdiction, the validity, legality and enforceability of the remaining provisions or obligations, or of such provision or obligation in any other jurisdiction, shall not in any way be affected or impaired thereby.\nSection 12. GOVERNING LAW. EXCEPT AS OTHERWISE EXPRESSLY PROVIDED IN ANY OF THE LOAN DOCUMENTS, IN ALL RESPECTS, INCLUDING ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE, THIS FIRST AMENDMENT AND THE OBLIGATIONS ARISING HEREUNDER SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK APPLICABLE TO CONTRACTS MADE AND PERFORMED IN SUCH STATE, WITHOUT REGARD TO THE PRINCIPLES THEREOF REGARDING CONFLICTS OF LAW, AND ANY APPLICABLE LAWS OF THE U.S. AGENT, COLLATERAL AGENT AND BORROWER AGREE TO SUBMIT TO PERSONAL JURISDICTION AND TO WAIVE ANY OBJECTION AS TO VENUE IN THE COUNTY OF NEW YORK, STATE OF NEW YORK. SERVICE OF PROCESS ON BORROWER, AGENT OR COLLATERAL AGENT IN ANY ACTION ARISING OUT OF OR RELATING TO ANY OF THE LOAN DOCUMENTS SHALL BE EFFECTIVE IF MAILED TO SUCH PARTY AT THE ADDRESS LISTED IN SECTION 10.11 OF THE LOAN AGREEMENT. NOTHING HEREIN SHALL PRECLUDE AGENT, COLLATERAL AGENT OR BORROWER FROM BRINGING SUIT OR TAKING OTHER LEGAL ACTION IN ANY OTHER JURISDICTION.\nIN WITNESS WHEREOF, this First Amendment has been duly executed as of the date first written above.\nCONTINENTAL AIRLINES, INC.\nBy: ___________________________________ Name: Title:\nGENERAL ELECTRIC COMPANY Individually and in its capacity as Agent, Consolidation Collateral Agent, Collateral Agent and Mortgagee\nBy: ___________________________________ Name: Title:\nExhibit 4.8(c)\nAMENDMENT NO. 2 TO CONSOLIDATION LOAN AGREEMENT\nAMENDMENT NO. 2 TO CONSOLIDATION LOAN AGREEMENT, dated as of December 22, 1995 (this \"Amendment\"), between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Borrower\"), and GENERAL ELECTRIC COMPANY, a New York corporation (in its individual capacity, \"GE\") on its own behalf and as agent for the Holders (as defined in the Loan Agreement referred to below) (in such capacity, \"Agent\").\nW I T N E S S E T H :\nWHEREAS, Borrower, GE and Agent are parties to that certain Loan Agreement, dated as of April 27, 1993 (such Loan Agreement, as modified to date and as further amended, supplemented or otherwise modified hereby and from time to time hereafter, being hereinafter referred to as the \"Loan Agreement\", and capitalized terms used herein and not otherwise defined having the meanings assigned to them in the Loan Agreement);\nWHEREAS, Borrower, GE and Agent have agreed to amend certain provisions of the Loan Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendments to Loan Agreement. The Loan Agreement is hereby amended as follows:\n(a) Section 2.4(a) is hereby amended and restated in its entirety to provide as follows:\n(a) [Intentionally Deleted.]\n(b) Section 5.1(j) is hereby amended and restated in its entirety to provide as follows:\n(j) [Intentionally Deleted.]\n(c) Section 6.15 is hereby amended and restated in its entirety to provide as follows:\n6.15 Annual Appraisal. Borrower will provide to Agent an Appraisal of the Fair Market Value of the then-existing Collateral prepared, at Borrower's expense, by an Independent Appraiser not later than thirty days before each anniversary of the Collateral Reset Date.\n(d) Section 6.17 is hereby amended and restated in its entirety to provide as follows:\n6.17 Release of Collateral. [Intentionally Deleted.]\n(e) Section 9.1(p) is hereby amended and restated in its entirety to provide the following:\n(p) Borrower shall fail to provide Agent with the Appraisal required pursuant to Section 6.15 hereof and such failure shall remain unremedied for a period ending 90 days after the Borrower shall have received written notice of such failure from Agent. Notwithstanding anything to the contrary in this Agreement, Section 9.1(c) hereof does not apply to Borrower's obligation to provide an Appraisal pursuant to Section 6.15 hereof.\nSECTION 2. Effective Date. This Amendment shall become effective upon execution and delivery hereof.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Loan Agreement and the other Loan Documents to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Loan Agreement as amended hereby.\n(b) Except as specifically amended herein, the Loan Agreement and all of the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. Without limiting the generality of the foregoing, Borrower hereby confirms that all of its obligations under the Collateral Documents shall continue and shall remain in full force and effect.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of Holders or Agent under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Loan Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Agent and Borrower agree to submit to personal jurisdiction, to the extent permitted by law, and to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by law, service of process on Borrower or Agent in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 10.11 of the Loan Agreement. Nothing herein shall preclude Agent or Borrower from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nGerald Laderman Vice President\nGENERAL ELECTRIC COMPANY, Individually and as Agent\nBy: Name: Title:\nExhibit 4.9(a)\nEXPURGATED CONFIDENTIAL TREATMENT REQUESTED BY CONTINENTAL AIRLINES, INC.\nWAIVER, CONSENT AND AMENDMENT\nThis WAIVER, CONSENT AND AMENDMENT, dated as of September 29, 1995 (this \"Waiver\"), is among Continental Airlines, Inc., a Delaware corporation (\"Continental\"), Continental Express, Inc., a Delaware corporation, General Electric Capital Corporation, a New York corporation (\"GE Capital\"), General Electric Company, a New York corporation (\"GE\"), and Global Project & Structured Finance Corporation, a Delaware corporation and successor by merger to ASATT Corp. (\"GPSF\").\nWHEREAS, Continental and GPSF are parties to that certain Series B- 1 Loan Agreement, dated as of April 27, 1993, as amended (the \"B-1 Loan Agreement\"), and that certain Series B-2 Loan Agreement, dated as of April 27, 1993, as amended (the \"B-2 Loan Agreement\");\nWHEREAS, Continental and GE are parties to that certain Consolidation Loan Agreement, dated as of April 27, 1993, as amended (the \"Consolidation Loan Agreement\");\nWHEREAS, the parties hereto are parties to that certain Master Restructuring Agreement, dated as of March 30, 1995 (the \"Restructuring Agreement\"), pursuant to which Continental sought to restructure certain of its operations and obligations and requested that the GE Parties refrain from taking certain actions in connection with certain breached obligations;\nWHEREAS, capitalized terms used herein without definition shall have the meanings assigned to them in the Restructuring Agreement or the B-1 Loan Agreement, as applicable;\nWHEREAS, Continental intends to issue for cash consideration shares of a new series of convertible preferred stock (the \"New Preferred Stock\");\nWHEREAS, the B-1 Loan Agreement, the B-2 Loan Agreement, the Consolidation Loan Agreement and the Restructuring Agreement (collectively, the \"Loan Documents\") require that a portion of the proceeds of any equity offering by Continental be applied to the prepayment of the loans made thereunder (the \"GE Loans\");\nWHEREAS, the Loan Documents also prohibit the purchase, redemption or prepayment by Continental of any Indebtedness other than the GE Loans and other Indebtedness owing to a GE Party;\nWHEREAS, Continental desires to apply the net proceeds of the issuance of the New Preferred Stock to the prepayment of certain indebtedness of Continental other than the GE Loans and for other corporate purposes without prepaying the GE Loans, except as provided in paragraph 1 below;\nWHEREAS, the Loan Documents would prohibit the payment of cash dividends in respect of the New Preferred Stock;\nWHEREAS, Continental desires to declare and pay cash dividends in respect of the New Preferred Stock;\nWHEREAS, GE Capital desires to exchange the shares of Series A 8% Cumulative Preferred Stock of Continental (the \"8% Preferred Stock\") held by GE Capital for new debt securities of Continental (the \"New Debt Securities\"), on the terms and conditions set forth in the letter agreement (the \"Preferred Exchange Agreement\") attached hereto as Annex I (the \"Preferred Stock Exchange\"); and\nWHEREAS, Continental and the GE Parties wish to amend the Restructuring Agreement to make certain amendments thereto.\nNOW, THEREFORE, based upon the foregoing, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows:\n1. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n2. GE Capital, as the holder of all outstanding shares of the 8% Preferred Stock, hereby consents to the issuance by Continental of the New Preferred Stock.\n3. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n4. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n5. Continental and GE Capital shall consummate the transactions contemplated by the Preferred Stock Exchange in accordance with the terms and conditions of the Preferred Exchange Agreement.\n6. Each of the GE Parties hereby waives compliance by Continental with the covenants contained in Sections 7.3 and 7.11 of Schedule 7.01 to the Restructuring Agreement, Section 2.3 of each of the B-1 Loan Agreement and the B-2 Loan Agreement and Section 2.4 of the Consolidation Loan Agreement, in each case, to the extent necessary to permit the Preferred Stock Exchange.\n7. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n8. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n9. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n10. Schedule 7.01 to the Restructuring Agreement shall be further amended by amending and restating Section 2.3, Section 7.18 and Section 8.2 contained therein as follows:\nSection 2.3 Mandatory Prepayment. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nSection 7.18 Information. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nSection 8.2 Repayment of Loan and Other Tranche Loan. [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n11. Each of the definitions of each of the following terms contained in Article I of the Restructuring Agreement shall be amended by adding the following text before the period at the end of such definition: \"and any amendments, modifications or supplements thereto and shall refer to such agreement as the same may be in effect at the time such reference becomes operative\". The terms to be amended by this addition are: \"Aircraft Lease,\" \"Boeing Contract,\" \"B-1 Loan Agreement,\" \"B-2 Loan Agreement,\" \"CMI Loan Agreement,\" \"Consolidation Loan Agreement,\" \"Continental AMI Pledge Agreement\" and \"Continental Express Pledge Agreement.\"\n12. Except as specifically amended or waived herein, the B-1 Loan Agreement, the B-2 Loan Agreement, the Consolidation Loan Agreement, the Restructuring Agreement, the other Restructuring Documents and the other Loan Documents (as defined in each of the B-1 Loan Agreement, the B-2 Loan Agreement and the Consolidation Loan Agreement) shall remain in full force and effect and are hereby ratified and confirmed, as amended. Without limiting the generality of the foregoing, Continental hereby confirms that all of its obligations under the B-1 Loan Agreement, the B-2 Loan Agreement, the Consolidation Loan Agreement, the Restructuring Agreement, the other Restructuring Documents and the other Loan Documents (as defined in each of the B-1 Loan Agreement, the B-2 Loan Agreement and the Consolidation Loan Agreement) shall continue and shall remain in full force and effect, as amended.\n13. The execution, delivery and effectiveness of this Waiver shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of any GE Party under the Restructuring Agreement, any of the Restructuring Documents or any of the other Loan Documents (as defined in each of the B-1 Loan Agreement, the B-2 Loan Agreement and the Consolidation Loan Agreement).\n14. This Waiver shall become effective when executed by each of the parties hereto. This Waiver may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n15. Except as otherwise expressly provided in any of the Restructuring Documents, in all respects, including all matters of construction, validity and performance, this Waiver shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States.\n* * *\nIN WITNESS WHEREOF, the parties hereto have caused this Waiver to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nBy:______________________________ Name: Jeffery A. Smisek Title: Senior Vice President\nCONTINENTAL EXPRESS, INC.\nBy:______________________________ Name: Jeffery A. Smisek Title: Senior Vice President\nGENERAL ELECTRIC CAPITAL CORPORATION\nBy:______________________________ Name: Eric M. Dull Title: Attorney-in-Fact\nGENERAL ELECTRIC COMPANY\nBy:______________________________ Name: Mark D. Powers Title: Director, Marketing & Information Customer Sales Finance\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nBy:______________________________ Name: Eric M. Dull Title: Vice President\nExhibit 4.9(b)\nEXPURGATED CONFIDENTIAL TREATMENT REQUESTED BY CONTINENTAL AIRLINES, INC.\nAMENDMENT TO MASTER RESTRUCTURING AGREEMENT\nThis AMENDMENT TO MASTER RESTRUCTURING AGREEMENT, dated as of December 22, 1995 (this \"Amendment\"), is among CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Continental\"), CONTINENTAL EXPRESS, INC., a Delaware corporation (\"Express\"), GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation (\"GE Capital\"), GENERAL ELECTRIC COMPANY, a New York corporation (\"GE\"), and GLOBAL PROJECT & STRUCTURED FINANCE CORPORATION (formerly Transportation and Industrial Funding Corporation), a Delaware corporation (\"GPSF\").\nWHEREAS, the parties hereto are parties to that certain Master Restructuring Agreement, dated as of March 30, 1995 (such agreement as modified to date and as further amended, supplemented or otherwise modified hereby from time to time hereafter, being hereinafter referred to as the \"Restructuring Agreement\"), pursuant to which Continental sought to restructure certain actions in connection with certain breached obligations;\n[CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nWHEREAS, the execution and delivery of this Amendment is a condition precedent to certain of the transactions contemplated by the Purchase Agreements; and\nWHEREAS, the parties hereto have agreed so to amend certain provisions of the Restructuring Agreement upon the terms and subject to the conditions provided herein;\nNOW, THEREFORE, in consideration of the premises, covenants and agreements contained herein, the parties hereto hereby agree as follows:\nSECTION 1. Amendment to Restructuring Agreement. The Restructuring Agreement is hereby amended as follows:\n(a) Section 1.02 of the Restructuring Agreement is amended by inserting the following new definition in the proper alphabetical order:\n\"Liquidation Value\" shall have the meaning specified in the Consolidation Loan Agreement.\n(b) Section 8.2 of Schedule 7.01 to the Restructuring Agreement is hereby amended and restated as follows:\nSection 8.2 [Intentionally Deleted].\n(c) A new Section 7.03 to the Restructuring Agreement is inserted as follows:\n7.03 [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(d) A new Section 7.04 to the Restructuring Agreement is hereby inserted as follows:\n7.04 [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(e) A new Section 7.05 to the Restructuring Agreement is hereby inserted as follows:\n7.05 [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\n(f) A new Section 7.06 to the Restructuring Agreement is hereby inserted as follows:\n7.06 [CONFIDENTIAL MATERIAL OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT]\nSECTION 2. Effective Date. This Amendment shall become effective upon execution and delivery hereof.\nSECTION 3. Miscellaneous. (a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Restructuring Agreement and the other Restructuring Documents to \"this Agreement,\" \"hereunder,\" \"hereof,\" \"herein,\" or words of like import, shall mean and be a reference to the Restructuring Agreement as amended hereby.\n(b) Except as specifically amended herein, the Restructuring Agreement and all of the other Restructuring Documents shall remain in full force and effect and are hereby ratified and confirmed.\n(c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of any party under any of the Restructuring Documents, nor constitute a waiver of any provision of any of the Restructuring Documents.\n(d) This Amendment may be executed in any number of separate counterparts, each of which shall, collectively and separately, constitute one agreement.\n(e) The Section Titles contained in this Amendment are and shall be without substantive meaning or content of any kind whatsoever and are not part of the agreement among the parties hereto.\n(f) Except as otherwise expressly provided in any of the Restructuring Documents, in all respects, including all matters of construction, validity and performance, this Amendment shall be governed by, and construed and enforced in accordance with, the laws of the State of New York, without regard to the principles thereof regarding conflicts of law, and any applicable laws of the United States. Each party hereto agrees to submit to personal jurisdiction and, to the extent permitted by applicable law, to waive any objection as to venue in the County of New York, State of New York. To the extent permitted by applicable law, service of process on each party hereto in any action arising out of or relating to this Amendment shall be effective if mailed to such party at the address listed Section 11.11 of the Restructuring Agreement. Nothing herein shall preclude any party hereto from bringing suit or taking other legal action in any other jurisdiction.\n(g) To the extent permitted by applicable law, the parties hereto waive all right to trial by jury in any action or proceeding to enforce or defend any rights under this Amendment.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nCONTINENTAL AIRLINES, INC.\nBy: Gerald Laderman Vice President\nCONTINENTAL EXPRESS, INC.\nBy: Name: Title:\nGENERAL ELECTRIC CAPITAL CORPORATION\nBy: Name: Title:\nGENERAL ELECTRIC COMPANY\nBy: Name: Title:\nGLOBAL PROJECT & STRUCTURED FINANCE CORPORATION\nBy: Eric M. Dull Vice President\nEXHIBIT 10.2(d)\nTHIS SUPPLEMENTAL AGREEMENT SHALL NOT BE BINDING UPON THE PORT AUTHORITY UNTIL DULY EXECUTED BY AN EXECUTIVE OFFICER THEREOF AND DELIVERED TO THE LESSEE BY AN AUTHORIZED REPRESENTATIVE OF THE PORT AUTHORITY\nNewark International Airport Lease No. ANA-170 Supplement No. 12\nSUPPLEMENTAL AGREEMENT\nTHIS AGREEMENT dated June 21, 1993 by and between THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY (hereinafter called \"the Port Authority\") and CONTINENTAL AIRLINES, INC., a corporation of the State of Delaware, having an office and place of business at Suite 1401, P.O. Box 4607, Houston, Texas 77210-4067, (hereinafter called \"the Lessee\"),\nWITNESSETH, That:\nWHEREAS, the Port Authority and People Express Airlines, Inc. (hereinafter called \"People Express\") as of January 11, 1985 entered into an agreement of lease (which agreement of lease as heretofore supplemented and amended is hereinafter called the \"Lease\"), covering certain premises, rights and privileges at and in respect to Newark International Airport (hereinafter called \"the Airport\") as therein set forth; and\nWHEREAS, the Lease was thereafter assigned by said People Express to the Lessee pursuant to an Assignment of Lease with Assumption and Consent Agreement entered into among the Port Authority, the Lessee and People Express and dated August 15, 1987; and\nWHEREAS, the Lessee is the successor by merger to Continental Airlines, Inc., a Delaware Corporation; and\nWHEREAS, the Port Authority and the Lessee desire to extend the periodical tenancy of the Area C-3 portion of the premises under the Lease and to amend the Lease in certain other respects as hereinafter provided;\nWHEREAS, a certain Stipulation between the parties hereto has been submitted for approval to the United States Bankruptcy Court for the District of Delaware (\"the Bankruptcy Court\") covering the Lessee's, as part of the confirmation of its reorganization plan in its Chapter 11 bankruptcy proceedings and as debtor and debtor in possession, assumption of the Lease, pursuant to the applicable provisions of United States Bankruptcy Code as set forth in and subject to the terms and conditions of said Stipulation (said Stipulation being hereinafter referred to as the \"Stipulation\");\nNOW, THEREFORE, the Port Authority and the Lessee, for and in consideration of the covenants and mutual agreements hereinafter contained, hereby agree to amend the Lease, effective as of May 1, 1993, as follows:\n1. The term of the letting of Area C-3 under the Lease is hereby extended to July 31, 1993 and month-to-month thereafter as a periodical tenancy unless sooner terminated, subject to the terms and conditions of the Lease, as hereby amended, and at the rentals set forth in the Lease; but in no event shall such periodical tenancy continue beyond December 31, 1993.\n2. (a) The Lessee agrees, at its sole cost and expense, to perform all work necessary to design and construct the following:\n(i) design and construction of a two-level annex building consisting of approximately 28,000 square feet to be located in the northwest corner of the Area D portion of Area C-3, with said annex building to be connected to the Terminal C building by a fully enclosed pedestrian walkway;\n(ii) modifications and replacements to existing ticketing areas in the Terminal C building;\n(iii) removal of existing pedestrian passenger loading bridge described in Paragraph 4 hereof and installation, as replacement therefor, of the new apron drive loading bridge described in Paragraph 4 hereof; and\n(iv) all appropriate, necessary and required work for paving of unpaved portions of the aircraft maneuvering areas at Area C-3 to accommodate small commuter aircraft movement and parking and to allow for wide-body jet aircraft in the vicinity of the Area C-3 passenger loading bridges;\nAll of the foregoing shall be in accordance with a Construction Application or Construction Applications and plans and specifications to be submitted by the Lessee for approval by the Port Authority. All of the foregoing design and construction work is hereinafter referred to as the \"Area C-3 Work.\"\nAll of the Area C-3 Work shall be constructed by the Lessee on the premises (specifically, the Area C-3 portion of the premises) and off the premises where necessary and where construted on the premises shall be and become a part of the premises under the Lease.\n(b) Prior to the commencement of the Area C-3 Work, the Lessee shall submit to the Port Authority for the Port Authority's approval complete plans and specifications (including a conceptual plan) therefor. The Port Authority may refuse to grant approval with respect to the Area C-3 Work if, in its opinion, any of the proposed Area C-3 Work as set forth in said plans and specifications (all of which shall be in such detail as may reasonably permit the Port Authority to make a determination as to whether the requirements hereinafter referred to are met) shall:\n(i) Be unsafe, unsound, hazardous or improper for the use and occupancy for which it is designed, or\n(ii) Not comply with the Port Authority's requirements for harmony of external architecture of similar existing or future improvements at the Airport, or\n(iii) Not comply with the Port Authority's requirements with respect to external and interior building materials and finishes of similar existing or future improvements at the Airport, or\n(iv) Not provide for sufficient clearances for taxiways, runways and apron areas, or\n(v) Be designed for use for purposes other than those authorized under the Lease, or\n(vi) Set forth ground elevations or heights other than those prescribed by the Port authority, or\n(vii) Not provide adequate and proper circulation areas, or\n(viii) Not be at locations or not be oriented in accordance with the Lessee's approved conceptual plan, or\n(ix) Not comply with the provisions of the Basic Lease, including without limiting the generality thereof, those provisions of the Basic Lease providing that the Port Authority will conform to the enactments, ordinances, resolutions and regulations of the City of Newark and its various departments, boards and bureaus in regard to the construction and maintenance of buildings and structures and in regard to health and fire protection which would be applicable if the Port Authority were a private corporation to the extent that the Port Authority finds it practicable so to do, or\n(x) Permit aircraft to overhang the boundary of the premises, except when entering or leaving the premises, or\n(xi) Be in violation or contravention of any other provisions and terms of this Lease, or\n(xii) Not comply with all applicable governmental laws, ordinances, enactments, resolutions, rules and orders, or\n(xiii) Not comply with all applicable requirements of the National Board of Fire Underwriters and the Fire Insurance Rating Organization of New Jersey, or\n(xiv) Not comply with the Port Authority's requirements with respect to landscaping, or,\n(xv) Not comply with the Port Authority's requirements and standards with respect to noise, air pollution, water pollution or other types of pollution.\n(c) All of the Area C-3 Work shall be done in accordance with the following terms and conditions:\n(i) The Lessee hereby assumes the risk of loss or damage to all of the Area C-3 Work prior to the completion thereof and the risk of loss or damage to all property of the Port Authority arising out of or in connection with the performance of the Area C-3 Work. In the event of such loss or damage, the Lessee shall forthwith repair, replace and make good the Area C-3 Work and the property of the Port Authority without cost or expense to the Port Authority. The Lessee shall itself and shall also require its contractors to indemnify and hold harmless the Port Authority, its Commissioners, officers, agents and employees from and against all claims and demands, just or unjust, of third persons (including employees, officers, and agents of the Port Authority) arising or alleged to arise out of the performance of the Area C-3 Work and for all expenses incurred by it and by them in the defense, settlement or satisfaction thereof, including without limitation thereto, claims and demands for death, for personal injury or for property damage, direct or consequential, whether they arise from the acts or omission of the Lessee, of any contractors of the Lessee, of the Port Authority, or of third persons, or from acts of God or of the public enemy, or otherwise, (including claims of the City of Newark against the Port Authority pursuant to the provisions of the Basic Lease whereby the Port Authority has agreed to indemnify the City against claims), excepting only claims and demands which result solely from affirmative willful acts done by the Port Authority, its commissioners, officers, agents and employees with respect to the Area C-3 Work.\nIf so directed, the Lessee shall at its own expense defend any suit based upon any such claim or demand (even if such suit, claim or demand is groundless, false or fraudulent), and in handling such it shall not, without obtaining express advance written permission from the General Counsel of the Port Authority, raise any defense involving in any way the jurisdiction of the tribunal, the immunity of the Port Authority, its Commissioners, officers, agents or employees, the governmental nature of the Port Authority, or the provisions of any statutes respecting suits against the Port Authority.\n(ii) Prior to engaging or retaining an architect or architects for the Area C-3 Work, the name or names of said architect or architects shall be submitted to the Port Authority for its approval. The Port Authority shall have the right to disapprove any substitute or other architect who may be unacceptable to it. All Area C-3 Work shall be done in accordance with plans and specifications to be submitted to and approved by the Port Authority prior to the commencement of the Area C-3 Work, and until such approval has been obtained the Lessee shall continue to resubmit plans and specifications as required. Upon approval of such plans and specifications by the Port Authority, the Lessee shall proceed diligently at its sole cost and expense, to perform the Area C-3 Work. All Area C-3 Work, including workmanship and materials, shall be of first class quality. The Lessee shall re-do, replace or construct at its own cost and expense, any Area C-3 Work not done in accordance with the approved plans and specifications, the provisions of this Paragraph 2 or any further requirements of the Port Authority under the Lease as hereby amended. The Lessee shall complete the Area C-3 Work no later than September 30, 1993.\n(iii) The Lessee shall submit to the Port Authority for its approval the names of the contractors to whom the Lessee proposes to award the Area C-3 Work contracts. The Port Authority shall have the right to disapprove any contractor who may be unacceptable to it. The Lessee shall include in all such contracts such provisions and conditions as may be reasonably required by the Port Authority. Without limiting the generality of the foregoing all of the Lessee's construction contracts shall provide as follows: \"If (i) the Contractor fails to perform any of his obligations under the Contract, including his obligation to the Lessee to pay any claims lawfully made against him by any materialman, subcontractor or workman or other third person which arises out of or in connection with the performance of the Contract or (ii) any claim (just or unjust) which arises out of or in connection with the Contract is made against the Lessee or (iii) any subcontractor under the Contract fails to pay any claims, lawfully made against him by any materialman, subcontractor, workman or other third persons which arises out of or in connection with the Contract or if in the Lessee's opinion any of the aforesaid contingencies is likely to arise, then the Lessee shall have the right, in its discretion, to withhold out of any payment (final or otherwise and even though such payments have already been certified as due) such sums as the Lessee may deem ample to protect it against delay or loss or to assume the payment of just claims of third persons, and to apply such sums in such manner as the Lessee may deem proper to secure such protection or satisfy such claims. All sums so applied shall be deducted from the Contractor's compensation. Omission by the Lessee to withhold out of any payment, final or otherwise a sum for any of the above contingencies, even though such contingency has occurred at the time of such payment, shall not be deemed to indicate that the Lessee does not intend to exercise its right with respect to such contingency. Neither the above provisions for rights of the Lessee to withhold and apply monies nor any exercise, or attempted exercise of, or omission to exercise such rights by the Lessee shall create any obligation of any kind to such materialmen, subcontractors, workmen or other third persons. Until actual payment is made to the Contractor, his right to any amount to be paid under the Contract (even though such amount has already been certified as due) shall be subordinate to the rights of the Lessee under this provision.\"\n(iv) The lessee shall file with the Port Authority a copy of its construction contracts with its contractors prior to the start of the construction work.\n(v) The Lessee shall furnish or require its architect to furnish a full time resident engineer during the construction period. The Lessee shall require certification by a licensed engineer of all pile driving data and of all controlled concrete work and such other certifications as may be requested by the Port Authority from time to time.\n(vi) The Lessee agrees to be solely responsible for any plans and specifications used by it and for any loss or damages resulting from the use thereof, notwithstanding that the same have been approved by the Port Authority and notwithstanding the incorporation therein of Port Authority recommendations or requirements. Notwithstanding the requirement for approval by the Port Authority of the contracts to be entered into by the Lessee or the incorporation therein of Port Authority requirements or recommendations and notwithstanding any rights the Port Authority may have reserved to itself hereunder, the Port Authority shall have no liabilities or obligations of any kind to any contractors engaged by the Lessee or for any other matter in connection therewith and the Lessee hereby releases and discharges the Port Authority, its Commissioners, officers, representatives and employees of and from any and all liability, claim for damages or losses of any kind, whether legal or equitable, or from any action or cause of action arising or alleged to arise out of the performance of any construction work pursuant to the contracts between the Lessee and its contractors. Any warranties contained in any construction contract entered into by the Lessee for the performance of the Area C-3 Work hereunder shall be for the benefit of the Port Authority as well as the Lessee, and the contract shall so provide.\n(vii) The Port Authority shall have the right, through its duly designated representatives, to inspect the Area C-3 Work and the plans and specifications thereof, at any and all reasonable times during the progress thereof and from time to time, in its discretion, to take samples and perform testing on any part of the Area C-3 Work.\n(viii) The Lessee agrees that it shall deliver to the Port Authority two (2) sets of \"as built\" microfilm drawings of the Area C-3 Work mounted on aperture cards, all of which shall conform to the specifications of the Port Authority (the receipt of a copy of said specifications prior to the execution hereof being hereby acknowledged by the Lessee), and the Lessee shall during the term of this Lease keep said drawings current showing thereon any changes or modification which may be made. No changes or modifications shall be made without prior Port Authority consent.\n(ix) The Lessee shall, if requested by the Port Authority, take all reasonable measures to prevent erosion of the soil and the blowing of sand during the performance of the Area C-3 Work, including but not limited to the fencing of the premises or portions thereof or other areas and the covering of open areas with asphaltic emulsion or similar materials as the Port Authority may direct.\n(x) Title to any soil, dirt, sand or other matter (hereinafter in this item (x) collectively called \"the matter\") excavated by the Lessee during the course of the Area C-3 Work shall vest in the Port Authority and the matter shall be delivered by the Lessee at its expense to any location on the Airport as may be designated by the Port Authority. The entire proceeds, if any, of the sale or other disposition of the matter shall belong to the Port Authority. Notwithstanding the foregoing the Port Authority may elect by prior written notice to the Lessee to waive title to all or portions of the matter in which event the Lessee at its expense shall dispose of the same without further instruction from the Port Authority.\n(xi) The Lessee shall pay or cause to be paid all claims lawfully made against it by its contractors, subcontractors, materialmen and workmen, and all claims lawfully made against it by other third persons arising out of or in connection with or because of the performance of the construction work, and shall cause its contractors and subcontractors to pay all such claims lawfully made against them, provided, however that nothing herein contained shall be construed to limit the right of the Lessee to contest any claim of a contractor, subcontractor, materialman, workman and\/or other person and no such claim shall be considered to be an obligation of the Lessee within the meaning of this Section unless and until the same shall have been finally adjudicated. The Lessee shall use its best efforts to resolve any such claims and shall keep the Port Authority fully informed of its actions with respect thereto. Nothing herein contained shall be deemed to constitute consent to the creation of any liens or claims against the premises or to create any rights in said third persons against the Port Authority.\n(xii) Effective as of the date of delivery to the Port Authority by the Lessee of a copy of Supplement No. 12 to the Lease fully executed on behalf of the Lessee, the Lessee in its own name as insured and including the Port Authority as an additional insured shall procure and maintain Comprehensive General Liability insurance, including but not limited to premises-operations, products-completed operations, explosion, collapse and underground property damages, personal injury and independent contractors, with a broad form property damage endorsement and with a contractual liability endorsement covering the obligations assumed by the Lessee pursuant to subparagraphs (c) (i) and (vi) of this Paragraph 2, and Comprehensive Automobile Liability insurance covering owned, non-owned and hired vehicles.\nThe said Comprehensive General Liability insurance shall have a limit of not less than $25,000,000 combined single limit per occurrence for bodily injury and property damage liability, and said Comprehensive Automobile Liability insurance shall have a limit of not less than $25,000,000 combined single limit per bodily injury and property damage liability.\nThe foregoing policies shall be in addition to all policies of insurance otherwise required by the Lease or the Lessee may provide such insurance by requiring each contractor engaged by it for the Area C-3 Work to procure and maintain such insurance including such contractual liability endorsement, said insurance, whether procured by the Lessee or by a contractor engaged by it as aforesaid, not to contain any care, custody or control exclusions, and not to contain any exclusion for bodily injury to or sickness, disease or death of any employee of the Lessee or of any of its contractors which would conflict with or in any way impair coverage under the contractual liability endorsement. The said policy or policies of insurance shall also provide or contain an endorsement providing that the protection afforded the Lessee thereunder with respect to any claim or action against the Lessee by a third person shall pertain and apply with like effect with respect to any claim or action against the Lessee by the Port Authority, but such endorsement shall not limit, vary or affect the protections afforded the Port Authority thereunder as an additional insured.\nThe Lessee shall also procure and maintain in effect, or cause to be procured and maintained in effect, Worker's Compensation Insurance and Employers' Liability Insurance in accordance with and as required by law. The insurance required hereunder shall be maintained in effect during the performance of the Area C-3 Work and shall be in compliance with and subject to the provisions of paragraph (c) of Section 18 of the Lease.\nThe lessee shall also procure and maintain Builder's Risk (All Risk) Completed Value Insurance covering the Area C-3 Work during the performance thereof including material delivered to the site but not attached to the realty. Such insurance shall be in compliance with and subject to the applicable provisions set forth herein and shall name the Port Authority, the City of Newark, the Lessee and its contractors and subcontractors as additional insureds and such policy shall provide that the loss shall be adjusted with and payable to the Lessee. Such proceeds shall be used by the Lessee for the repair, replacement or rebuilding of the Area C-3 Work and any excess shall be paid over to the Port Authority.\nThe policies or certificates representing insurance covered by this subparagraph (xii) shall be delivered by the Lessee to the Port Authority at least thirty (30) days prior to the commencement of the Area C-3 Work, and each policy or certificate delivered shall bear the endorsement of or be accompanied by evidence of payment of the premium thereof and, also, a valid provision obligating the insurance company to furnish the Port Authority and the City of Newark thirty (30) days' advance notice of the cancellation, termination, change or modification of the insurance evidenced by said policy or certificate. Renewal policies or certificates shall be delivered to the Port Authority at least thirty (30) days before the expiration of the insurance which such policies are to renew.\nThe insurance covered by this subparagraph (xii) shall be written by companies approved by the Port Authority, the Port Authority covenanting and agreeing not to withhold its approval unreasonably. If at any time any of the insurance policies shall be or become unsatisfactory to the Port Authority as to the form or substance or if any of the carriers issuing such policies shall be or become unsatisfactory to the Port Authority, the Lessee shall promptly obtain a new and satisfactory policy in replacement, the Port Authority covenanting and agreeing not to act unreasonably hereunder. If at any time the Port Authority so requests, a certified copy of each of the said policies shall be delivered to the Port Authority.\n(xiii) The Lessee shall be under no obligation to reimburse the Port Authority for expenses incurred by the Port Authority in connection with its normal review and approval of the original plans and specifications submitted by the Lessee pursuant to this Paragraph 2. The Lessee however agrees to pay to the Port Authority upon its demand the expenses incurred by the Port Authority in connection with any additional review for approval of any changes, modifications or revisions of the original plans and specifications which may be proposed by the Lessee for the Port Authority's approval. The expenses of the Port Authority for any such additional review and approval shall be computed on the basis of direct payroll time expended in connection therewith plus 100%. Wherever in this Lease reference is made to \"direct payroll time\", costs computed thereunder shall include a prorata share of the cost to the Port Authority of providing employee benefits, including, but not limited to, pensions, hospitalization, medical and life insurance, vacations and holidays. Such computations shall be in accordance with the Port Authority's accounting principles as consistently applied prior to the execution of this Lease.\n(xiv) The Lessee shall prior to the commencement of construction and at all times during construction submit to the Port Authority all engineering studies with respect to construction and samples of construction materials as may be reasonably required at any time and from time to time by the Port Authority.\n(xv) The Lessee shall at the time of submitting the conceptual plan to the Port Authority as provided in subparagraph (b) of this Paragraph 2 of the Lease submit to the Port Authority its forecasts of the number of people who will be working at various times during the term of the Lease at the premises, the expected utility demands of Area C-3, noise profiles and such other information as the Port Authority may require. The Lessee shall continue to submit its latest forecasts and such other information as may be required as aforesaid as the Port Authority shall from time to time and at any time request.\n(xvi) The Lessee shall execute and submit for the Port Authority's approval a Construction Application or Applications in the form prescribed by the Port Authority covering the Area C-3 Work or portions thereof. The Lessee shall comply with all the terms and provisions of the approved Construction Applications. In the event of any inconsistency between the terms of any Construction Application and the terms of the Lease, the terms of the Lease shall prevail and control.\n(xvii) Nothing contained in the Lease (as hereby amended) shall grant or be deemed to grant to any contractor, architect, supplier, subcontractor or any other person engaged by the Lessee or any of its contractors in the performance of any part of the Area C-3 Work any right of action or claim against the Port Authority, its Commissioners, officers, agents and employees with respect to any work any of them may do in connection with the Area C-3 Work. Nothing contained herein shall create or be deemed to create any relationship between the Port Authority and any such contractor, architect, supplier, subcontractor or any other person engaged by the Lessee or any of its contractors in the performance of any part of the Area C-3 Work and the Port Authority shall not be responsible to any of the foregoing for any payments due or alleged to be due thereto for any work performed or materials purchased in connection with the Area C-3 Work.\n(xiii) Without limiting any of the terms and conditions of this Lease, the Lessee understands and agrees that it shall put into effect prior to the commencement of any Area C-3 Work an affirmative action program and Minority Business Enterprise (MBE) program and Women-owned Business Enterprise (WBE) program in accordance with the provisions of Schedule E-1, attached hereto and hereby made a part of the Lease. The provisions of said Schedule E-1 of the Lease shall be applicable to the Lessee's contractor or contractors and subcontractors at any tier of construction as well as to the Lessee and the Lessee shall include the provisions of said Schedule E-1 within all of its construction contracts so as to make said provisions and undertakings the direct obligation of the construction contractor or contractors and subcontractors at any tier of construction. The Lessee shall and shall require its said contractor, contractors and subcontractors to furnish to the Port Authority such data, including but not limited to compliance reports relating to the operation and implementation of the affirmative action, MBE and WBE programs called for hereunder as the Port Authority may request at any time and from time to time regarding the affirmative action, minority business enterprises and women-owned business enterprises programs of the Lessee and its contractor, contractors, and subcontractors at any tier of construction, and the Lessee shall and shall also require that its contractor, contractors and subcontractors at any tier of construction make an put into effect such modifications and additions thereto as may be directed by the Port Authority pursuant to the provisions hereof and said Schedule E-1 to effectuate the goals of affirmative action and minority business enterprise and women-owned business enterprise programs.\nIn addition to and without limiting any terms and provisions of this Lease, the Lessee shall provide in its contracts and all subcontracts covering the Area C-3 Work, or any portion thereof, that:\n(aa) The contractor shall not discriminate against employees or applicants for employment because of race, creed, color, national origin, sex, age, disability or marital status, and shall undertake or continue existing programs of affirmative action to ensure that minority group persons are afforded equal employment opportunity without discrimination. Such programs shall include, but not be limited to, recruitment, employment, job assignment, promotion, upgrading, demotion, transfer, layoff, termination, rates of pay or other forms of compensation, and selections for training or retraining, including apprenticeships and on-the-job training;\n(bb) At the request of either the Port Authority or the Lessee, the contractor shall request such employment agency, labor union, or authorized representative of workers with which it has a collective bargaining or other lease or understanding and which is involved in the performance of the contract with the Lessee to furnish a written statement that such employment agency, labor union or representative shall not discriminate because of race, creed, color, national origin, sex age, disability or marital status and that such union or representative will cooperate in the implementation of the contractor's obligations hereunder;\n(cc) The contractor will state, in all solicitations or advertisements for employees placed by or on behalf of the contractor in the performance of the contract, that all qualified applicants will be afforded equal employment opportunity without discrimination because of race, creed, color, national origin, sex, age, disability or marital status;\n(dd) The contractor will include the provisions of subparagraphs (aa) through (cc) of this paragraph in every subcontract or purchase order in such a manner that such provisions will be binding upon each subcontractor or vendor as to its work in connection with the contract;\n(ee) \"Contractor\" as used herein shall include each contractor and subcontractor at any tier of construction.\n(b) The Lessee may wish to commence construction of portions of the Area C-3 Work prior to the approval by the Port Authority of its plans and specifications pursuant to paragraph (b) hereof, and if it does it shall submit a written request to the Port Authority setting forth the work it proposes then to do. The Port Authority shall have full and complete discretion as to whether or not to permit the Lessee to proceed with said work. If the Port Authority has no objection to the Lessee's proceeding with the work, it shall do so by writing a letter to the Lessee to such effect. If the Lessee performs the work covered by said letter, it agrees all such work shall be performed subject to and in accordance with all of the provisions of the approval letter and subject to and in accordance with the following terms and conditions:\n(i) The performance by the Lessee of the work covered by any request as aforesaid will be at its sole risk and if for any reason the plans and specifications for the Area C-3 Work are not approved by the Port Authority or if the approval thereof calls for modifications or changes in the work undertaken by the Lessee under any approval granted by the Port Authority pursuant to this subparagraph (d), the Lessee will, as directed by the Port Authority, at its sole cost and expense, either restore the area affected to the condition existing prior to the commencement of any such work or make such modifications and changes in any such work as may be required by the Port Authority.\n(ii) Nothing contained in any approval hereunder shall constitute a determination or indication by the Port Authority that the Lessee has complied with the applicable governmental laws, ordinances, enactments, resolutions, rules and orders, including but not limited to those of the City of Newark, which may pertain to the work to be performed.\n(iii) The approved work will be performed in accordance with and subject to the terms, indemnities and provisions hereof covering the Area C-3 Work and with the terms and conditions of any Construction Application which the Port Authority may request the Lessee to submit even though such Construction Application may not have, at the time of the approval under this subparagraph (d), been approved by the Port Authority.\n(iv) No work under any such approval shall affect or limit the obligations of the Lessee under all prior approvals with respect to its construction of the Area C-3 Work.\n(v) The Lessee shall comply with all requirements, stipulations and provisions as may be set forth in the letter of approval.\n(vi) In the event that the Lessee shall at any time during the construction of any portion of the Area C-3 Work under the approval granted by the Port Authority pursuant to this paragraph (d) fail in the opinion of the General Manager of New Jersey Airports of the Port Authority, to comply with all of the provisions of this Lease with respect to the Area C-3 Work, the Construction Application or the approval letter covering the same or be, in the opinion of the said General Manager of New Jersey Airports in breach of any of the provisions of this Lease, the Construction Application or the approval letter covering the same, the Port Authority shall have the right, acting through said General Manager of New Jersey Airports to cause the Lessee to cease all or such part of the Area C-3 Work as is being performed in violation of this Lease, the Construction Application or the approval letter. Upon such written direction from the General Manager of New Jersey Airports the Lessee shall promptly cease construction of the portion of the Area C-3 Work specified. The Lessee shall thereupon submit to the Port Authority for its written approval the Lessee's proposal for making modifications, corrections or changes in or to the Area C-3 Work that has been or is to be performed so that the same will comply with the provisions of this Lease, the Construction Application and the approval letter covering the Area C-3 Work. The Lessee shall not commence construction of the portion of the Area C-3 Expansion Work that has been halted until such written approval has been received.\n(vii) It is hereby expressly understood and agreed that, in the event the Port Authority assigns a field engineer to the Area C-3 Work, such field engineer has no authority to approve any plans and specifications of the Lessee with respect to the Area C-3 Work, to approve the construction by the Lessee of any portion of the Area C-3 Work or to agree to any variation by the Lessee from compliance with the terms of this Lease, or the Construction Application or the approval letter with respect to the Area C-3 Work. Notwithstanding the foregoing, should the field engineer or the General Manager of New Jersey Airports give any directions or approvals with respect to the Lessee's performance of any portion of the Area C-3 Work which are contrary to the provisions of this Lease, the Construction Application or the approval letter, said directions or approvals shall not affect the obligations of the Lessee as set forth herein nor release or relieve the Lessee from the strict compliance therewith. It is hereby further understood and agreed that the Port Authority has no duty or obligation of any kind whatsoever to inspect or police the performance of the Area C-3 Work by the Lessee and the rights granted to the Port Authority hereunder shall not create or be deemed to create such a duty or obligation. Accordingly, the fact that the General Manager of New Jersey Airports has not exercised the Port Authority's right to require the Lessee to cease its construction of all or any part of the Area C-3 Work shall not be or be deemed to be a Lease or acknowledgment on the part of the Port Authority that the Lessee has in fact performed such portion of the Area C-3 Work in accordance with the terms of the Lease, the Construction Application or the approval letter nor shall such fact be or be deemed to be a waiver by the Port Authority from the requirement of strict compliance by the Lessee with the provisions of the Lease, the Construction Application and the approval letter with respect to the Area C-3 Work.\n(viii) Without limiting the discretion of the Port Authority hereunder, the Port Authority hereby specifically advises the Lessee that even if the Port Authority hereafter in the exercise of its discretion wishes to grant approvals under this subparagraph (d), it may be unable to do so, so as to permit the Lessee to continue work without interruption following its completion of the work covered by any prior approval hereunder. The Lessee hereby acknowledges that if it commences work pursuant to this paragraph (d) it shall do so with full knowledge that there may not be continuity by it in the performance of its Area C- 3 Work under the procedures of this paragraph (d).\n(ix) No prior approval of any work in connection with the Area C-3 Work shall create or be deemed to create any obligation on the part of the Port Authority to permit subsequent work to be performed in connection with the Area C-3 Work prior to the approval by the Port Authority of the Lessee's complete plans and specifications thereof. It is understood that no such prior approval shall release or relieve the Lessee from its obligation to submit complete plans and specifications for the Area C-3 Work and to obtain the Port Authority's approval of the same as set forth in paragraph (b) hereof. It is further understood that in the event the Lessee elects not to continue to seek further approval letters pursuant to this paragraph (c), the obligations of the Lessee to restore the area and to make modifications and changes as set forth above in this subparagraph (d) shall be suspended until the Lesssee's submission of its complete plans and specifications in accordance with paragraph (b) hereof.\n(e) The Lessee will give the Port Authority fifteen (15) days' notice prior to the commencement of construction. The Port Authority will assign to the Area C-3 Work a full time field engineer or engineers. The Lessee shall pay to the Port Authority for the services of said engineer or engineers, the sum of Four Hundred Forty Dollars and No Cents ($440.00) for each day the engineer or engineers are so assigned. Nothing contained herein shall affect any of the provisions of paragraph (h) hereof or the rights of the Port Authority hereunder. This agreement for the services of said field engineer may be revoked at any time by either party on thirty (30) days' written notice to the other, but if revoked by the Lessee it shall continue during the period construction under any partial approvals pursuant to paragraph (d) hereof is performed.\n(f) (i) The Area C-3 Work shall be constructed in such a manner that there will be at all times a minimum of air pollution, water pollution or any other type of pollution and a minimum of noise emanating from, arising out of or resulting from the operation, use or maintenance of any portion thereof by the Lessee and from the operations of the Lessee under this Paragraph 2. Accordingly, and in addition to all other obligations imposed on the Lessee under this Lease, and without diminishing, limiting, modifying or affecting any of the same, the Lessee shall be obligated to construct as part of the Area C-3 Work hereunder such structures, fences, equipment, devises and other facilities as may be necessary or appropriate to accomplish the foregoing and each of the foregoing shall be and become a part of the premises it affects and all of the foregoing shall be covered under the plans and specifications of the Lessee submitted under subparagraph (b) of this Paragraph 2 and shall be part of the Area C-3 Work hereunder.\n(ii) Notwithstanding the provision of subparagraph (i) above and in addition thereto, the Port Authority hereby reserves the right from time to time and at any time during the term of the Lease to require the Lessee, subsequent to the completion of the Area C-3 Work, to design and construct at its sole cost and expense such further reasonable structures, fences, equipment, devices and other facilities as may be necessary or appropriate to accomplish the objectives as set forth in the first sentence of said subparagraph (i). All locations, the manner, type and method of construction and the size of any of the foregoing shall be determined by the Port Authority. The Lessee shall submit for Port Authority approval its plans and specifications covering the required work and upon receiving such approval shall proceed diligently to construct the same. All other provisions of this Paragraph 2 with respect to the Area C-3 Work shall apply and pertain with like effect to any work which the Lessee is obligated to perform pursuant to this subparagraph (ii) and upon completion of each portion of such work it shall be and become a part of the premises. The obligations assumed by the Lessee under this paragraph (f) are a special inducement and consideration to the Port Authority in granting the extension hereunder of the letting with respect to Area C-3 to the Lessee.\n(g) Title to all the Area C-3 Work which is located within the territorial limits of the City of Newark shall vest in the city of Newark as the same or any part thereof is erected, constructed or installed, and shall be or become a part of the premises if located within the premises. Title to each part of the Area C-3 Work, if any, which is located within the territorial limits of the City of Elizabeth shall vest in the Port Authority as the same or any part thereof is erected, constructed or installed, and shall be and become part of the premises if located within the premises.\n(h) (i) When the Area C-3 Work is substantially completed and ready for use the Lessee shall advise the Port Authority to such effect and shall deliver to the Port Authority a certificate signed by an authorized officer of the Lessee and also by the Lessee's architect or engineer certifying that the Area C-3 Work has been constructed strictly in accordance with the approved plans and specifications and the provisions of this Lease and in compliance with all applicable laws, ordinances and governmental rules, regulations and orders. Thereafter, the Area C-3 Work will be inspected by the Port Authority and if the same has been completed as certified by the Lessee, a certificate to such effect shall be delivered to the Lessee, subject to the condition that all risks thereafter with respect to the construction and installation of the same and any liability therefor for negligence or other reason shall be borne by the Lessee. The Lessee shall not use or permit the use of the Area C-3 Work or any portion thereof for the purposes set forth in the Lease until such certificate is received from the Port Authority.\n(ii) The term \"the Area C-3 Work Completion Date\" for the purposes of this Lease shall mean the date appearing on the certificate issued by the Port Authority pursuant to subparagraph (i) of this paragraph (h).\n(iii) In addition and without affecting the obligations of the Lessee under the preceding subparagraph, when an integral and material portion of the Area C-3 Work is substantially completed or is properly usable the Lessee may advise the Port Authority to such effect and may deliver to the Port Authority a certificate signed by an authorized officer of the Lessee and signed by the Lessee's architect or engineer certifying that such portion of the Area C-3 Work has been constructed strictly in accordance with the approved plans and specifications and the provisions of this Lease and in compliance with all applicable laws, ordinances and governmental rules, regulations and orders, and specifying that such portion of the Area C-3 Work can be properly used even though the Area C-3 Work has not been completed and that the Lessee desires such use. The Port Authority may in its sole discretion deliver a certificate to the Lessee with respect to each such portion of the Area C-3 Work permitting the Lessee to use such portion thereof for the purposes set forth in the Lease. In such event the Lessee may use such portion subject to the condition that all risks thereafter with respect to the construction and installation of the same and any liability therefor for negligence or other reason shall be borne by the Lessee, and subject to the risks as set forth in subparagraph (d) hereof in the event that the Port Authority shall not have then approved the complete plans and specifications for the Area C-3 Work. Moreover, at any time prior to the issuance of the certificate required in subparagraph (i) above for the Area C-3 Work, the Lessee shall promptly upon receipt of a written notice from the Port Authority cease its use of such portion of the Area C-3 Work which it had been using pursuant to permission granted in this subparagraph (iii).\n(i) The Lessee understands that there may be communications and utility lines and conduits presently located on or under the premises which do not, and may not in the future, serve the premises. The Lessee agrees at its sole cost and expense, if directed by the Port Authority so to do, to relocate and reinstall such communications and utility lines and conduits on the premises or off the premises as directed by the Port Authority and to restore all affected areas (such work being hereinafter collectively called \"the relocation work\"). The Lessee shall perform the relocation work subject to and in accordance with all the terms and provisions of this Paragraph 2 and the relocation work shall be and become a part of the Area C-3 Work; it being understood, however, that the relocation work shall not be or become a part of the premises hereunder.\n(j) The Lessee acknowledges that it intends to continue to use and occupy all of the premises during the period of time it is performing the Area C-3 Work hereunder. The Lessee further acknowledges that this would involve among other things inconvenience, noise, dust, interference and disturbance to the Lessee in its use and occupancy of the premises as well as to its patrons, invitees and employees and possibly other risks as well. The Lessee hereby expressly assumes all of the foregoing risks and agrees that there will be no reduction or abatement of any the rentals, fees or charges payable by the Lessee under the Lease on account of its performance of the Area C-3 Work and that the performance of the Area C-3 Work shall not constitute an eviction or constructive eviction of the Lessee nor be grounds for any abatement of rents, fees or charges payable by the Lessee under the Lease nor give rise to or be the basis of any claim or demand by the Lessee against the Port Authority, its Commissioners, officers, employees or agents for damages, consequential or otherwise, under the Lease.\n3. In addition to and without limiting any of the terms or provisions of the Lease, as hereby amended, the Lessee shall, at its sole cost and expense, if requested by the Port Authority (which request the Port Authority may make at its sole option and discretion), remove all of the Area C-3 Work (or the portions thereof specified by the Port Authority in its request) and shall restore the premises to the condition existing prior to the commencement of the Area C-3 Work.\n4. (a) With respect to the passenger loading bridges for which Port Authority construction advances were made pursuant to Sections 2 and 6 of the Lease (hereinafter sometimes referred to as the \"Section 2 loading bridges\"), it is hereby recognized that the Lessee has advised the Port Authority that, based on a change in the operating plan for the premises including greater utilization of wide-bodied aircraft, certain additional modifications and removal work, as part of the Area C-3 Work defined in Paragraph 2 hereof, are required consisting of (i) the removal from the premises of one (1) of the Section 2 passenger loading bridges and the transfer of the title thereof to the Lessee; said loading bridge being described as a fixed pedestal loading bridge for narrow body aircraft and being identified as a loading bridge in Schedule 1 attached to Supplement No. 4 of the Lease and also identified by serial number WS500R-32; and (ii) the installation in the premises of a new passenger loading bridge (as hereinafter described) and the transfer of the title thereof to the Port Authority. The new loading bridge to be installed by the Lessee, as part of the Area C-3 Work defined in Paragraph 2 hereof, is identified by description as a new jet apron drive loading bridge for a wide-bodied aircraft gate position newly manufactured and installed under a contract between the Lessee and Pneumo Abex Corporation by its Jetway Systems Division 1805 West 2550 South Ogden, Utah with an estimated value of Two Hundred Thousand Dollars and No Cents ($200,000.00) exclusive of delivery and installation costs, and is identified by number as Loading Bridge model number A3-58\/100-125R and by original serial number OG37489 and is herein referred to as the \"Jetway loading bridge A3-58\/100- 125R\". It is specifically understood and agreed that the Lessee shall at its sole cost and expense perform, as part of the Area C-3 Work defined in Paragraph 2 hereof, all work necessary, required or appropriate in connection with all of the foregoing removal and installation work subject to the terms and conditions of the Lease, including without limitation Paragraph 2 hereof, provided, however, that none of the foregoing shall be or become part of the cost of the construction work (as defined in Section 6 of the Lease) or part of the Construction Advance Amount (as defined in Section 6 of the Lease). It is further expressly understood and agreed that the parties intend, based on the Lessee's representation and warranty set forth in subparagraph (c) below, that the said Jetway Loading Bridge A3-58\/100-125R shall be deemed a replacement and substitution for the above said loading bridge No. WS500R-32 and that such replacement and substitution shall not result in any recomputation, adjustment or reduction of any construction advance, or the Construction Advance Amount or the Base Annual Rental.\n(b) It is expressly understood and agreed that, from and after the effective date of this Supplement No. 12 to the Lease, all references to the 42 passenger loading bridges in the Lease shall be deemed to mean the 42 passenger loading bridges as reduced in number and modified pursuant to the provisions of Paragraph 4 of the Supplement No. 7 to the Lease, Paragraph No. 9 of Supplement No. 8 to the Lease and as modified by the provisions of this Paragraph 4 hereof. Without limiting the generality of the foregoing, it is further expressly understood and agreed that the terms, provisions, covenants, conditions, representations and warranties set forth in and called for under paragraph (o) of Section 6 of the Lease (as set forth in Supplement No. 4 of the Lease) shall apply, and the Lessee hereby makes the same covenants, representations and warranties to the Port Authority, with like force and effect to Jetway Loading Bridge A3-58\/100-125R; and it is further hereby understood and agreed that with respect to Jetway Loading Bridge A3- 58\/100-125R the words \"the Lessee's contractor\", as used in Section 6 of the Lease shall mean Pneumo Abex Corporation by its Jetway Systems Division 1805 West 2550 South Ogden, Utah provided, however, that the provisions of subparagraph (1) (a) (ii) of said paragraph (o) shall not be applicable.\n(c) The Lessee, further, hereby expressly warrants and represents to the Port Authority that Jetway Loading Bridge A3-58\/100-125R is of equal or greater fair market value to that of the said loading bridge No. WS500R- 32.\n5. The Lessee expressly understands and agrees that the Area C-3 Work (as defined in Paragraph 2 above) shall be performed at the Lessee's sole risk, cost and expense and that neither the Supplement nor anything contained herein nor the performance by the Lessee of the Area C-3 Work or any portions thereof, nor any action taken by the Port Authority hereunder shall grant or be deemed to grant to the Lessee any right or claim to an extension of the term of the Lease and the letting thereunder, including without limitation the term of the letting of Area C-3, or to constitute any approval of or commitment by or agreement of the Port Authority to any such extension.\n6. (a) Paragraph 4 (b) of Supplement No. 8 of the Lease if hereby amended as follows:\nThe words \"(as set forth in Paragraph 2 hereof)\" appearing in the second and third lines thereof shall be deemed amended to read: \"(as set forth in Paragraph 1 of Supplement No. 12 of the Lease)\".\n(b) References in Paragraphs 6 (a) and 6 (b) of Supplement No. 8 of the Lease to \"the expiration date of the letting of Area C-3\" shall be deemed to mean the expiration date of the letting of the periodical tenancy of Area C-3 as set forth in Paragraph 1 of this Supplement No. 12 of the Lease.\n7. In addition to and without limiting any term or provision of Section 66 of the Lease or any other term or provision of the Lease, it is hereby understood and agreed that the Lessee shall no later than sixty (60) days after its execution of this Supplemental Agreement submit to the Port Authority for its review and approval in accordance with Sections 66 and 73 of the Lease, a revised updated comprehensive consumer services plan covering the consumer services to be provided in Area C-3 after the completion of the Area C-3 Work (as defined in Paragraph 2 hereof).\n8. It is expressly recognized that while the Stipulation (as hereinbefore defined) has been submitted to the United States Bankruptcy Court, the Stipulation may not have been fully approved by the Bankruptcy Court as of the date of the execution of this Supplemental Agreement by the parties hereto, and, accordingly, it is expressly understood and agreed that neither this Supplemental Agreement nor anything contained herein nor the execution hereof by either party hereto shall or shall be deemed to waive, alter or prejudice any of the rights or remedies of either party hereto under the Lease or at law or equity or otherwise, or with respect to or under the Stipulation, if as and when the same may be approved by the Bankruptcy Court.\n9. The Lessee represents and warrants that no broker has been concerned in the negotiation of this Supplemental Agreement and that there is no broker who is or may be entitled to be paid a commission in connection therewith. The Lessee shall indemnify and save harmless the Port Authority of and from any and all claims for commission or brokerage made by any and all persons, firms or corporations whatsoever for services in connection with the negotiation and execution of this Supplemental Agreement.\n10. Except as hereinbefore provided, all the terms covenants and conditions of the Lease shall be and remain in full force and effect.\n11. No Commissioner, director, officer, agent or employee of either party shall be charged personally or held contractually liable by or to the other party under any term or condition of this Agreement, or because of its execution or attempted execution or because of any breach or attempted or alleged breach thereof. The Lessee agrees that no representations or warranties with respect to this Agreement shall be binding upon the Port Authority unless expressed in writing herein.\n12. This Supplemental Agreement and the Lease which it amends constitute the entire agreement between the Lessee and the Port Authority on the subject matter, and may not be modified, discharged or extended except by instrument in writing duly executed on behalf of both the Port Authority and the Lessee.\nIN WITNESS WHEREOF, the Port Authority and the Lessee have executed these presents as of the date first above written.\nATTEST: THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY\n\/s\/ By \/s\/ Gerald P. FitzGerald Assistant Secretary (Title) Deputy Director of Aviation (Seal)\nATTEST: CONTINENTAL AIRLINES, INC.\n\/s\/ E. A. Hessler By \/s\/ Sam E. Ashmore Vice President & Corporate Secretary (Title) Sr. Vice President (Corporate Seal) SCHEDULE E-1\nPART I\nAffirmative Action Guidelines - Equal Employment Opportunity\nI. As a matter of policy the Port Authority hereby requires the Lessee and the Lessee shall require the Contractor, as hereinafter defined, to comply with the provisions set forth hereinafter. The provisions set forth in this Part I are similar to the conditions for bidding on federal government contracts adopted by the Office of Federal Contract Compliance and effective May 8, 1978.\nThe Lessee as well as each bidder, contractor subcontractor of the Lessee and each subcontractor of a contractor at any tier of construction (herein collectively referred to as \"the Contractor\" must fully comply with the following conditions set forth in this Schedule as to each construction trade to be used on the construction work or any portion thereof (said conditions being herein called \"Bid Conditions\"). The Lessee hereby commits itself to the goals for minority and female utilization set forth below and all other requirements, terms and conditions of the Bid Conditions. The Lessee shall likewise require the Contractor to commit itself to the said goals for minority and female utilization set forth below and all other requirements, terms and conditions of the Bid Conditions by submitting a properly signed bid.\nII. The Lessee and the Contractor shall each appoint an executive of its company to assume the responsibility for the implementation of the requirements, terms and conditions of the following Bid Conditions:\n(a) The goals for minority and female participation, expressed in percentage terms for the Contractor's aggregate workforce in each trade on all construction work are as follows:\n(1) Minority participation: Minority, except laborers 30% Minority, laborers 40% (2) Female participation: Female, except laborers 6.9% Female, laborers 6.9%\nThese goals are applicable to all the Contractor's construction work performed in and for the premises.\nThe Contractor's specific affirmative action obligations required herein of minority and female employment and training must be substantially uniform throughout the length of the contract, and in each trade, and the Contractor shall make good faith efforts to employ minorities and women evenly on each of its projects. The transfer of minority or female employees or trainees from contractor to contractor or from project to project for the sole purpose of meeting the Contractor's goals shall be a violation of the contract. Compliance with the goals will be measured against the total work hours performed.\n(b) The Contractor shall provide written notification to the Lessee and the Lessee shall provide written notification to the Manager of the Office of Business and Job Opportunity of the Port Authority within 10 working days of award of any construction subcontract in excess of $10,000 at any tier for construction work. The notification shall list the name, address and telephone number of the subcontractor; employer identification number; estimated starting and completion dates of the subcontract; and the geographical area in which the subcontract is to be performed.\n(c) As used in these specifications:\n(1) \"Employer identification number\" means the Federal Social Security number used on the Employer's Quarterly Federal Tax Return, U.S. Treasury Department Form 941:\n(2) \"Minority\" includes:\n(i) Black (all persons having origins in any of the Black African racial groups not of Hispanic origin);\n(ii) Hispanic (all persons of Mexican, Puerto Rican, Dominican, Cuban, Central or South American culture or origin, regardless of race);\n(iii) Asian and Pacific Islander (all persons having origins in any of the original peoples of the Far East, Southeast Asia, the Indian Subcontinent, or the Pacific Islands); and\n(iv) American Indian or Alaskan Native (all persons having origins in any of the original peoples of North America and maintaining identifiable tribal affiliations through membership and participation or county identification).\n(d) Whenever the Contractor, or any subcontractor at any tier, subcontracts a portion of the construction work involving any construction trade, it shall physically include in each subcontract in excess of $10,000 those provisions which include the applicable goals for minority and female participation.\n(e) The Contractor shall implement the specific affirmative action standards provided in subparagraphs (1) through (16) of Paragraph (h) hereof. The goals set forth above are expressed as percentages of the total hours of employment and training of minority and female utilization the Contractor should reasonably be able to achieve in each construction trade in which it has employees in the premises. The Contractor is expected to make substantially uniform progress toward its goals in each craft during the period specified.\n(f) Neither the provisions of any collective bargaining agreement, nor the failure by a union with whom the Contractor has a collective bargaining agreement, to refer either minorities or women shall excuse the Contractor's obligations hereunder.\n(g) In order for the nonworking training hours of apprentices and trainees to be counted in meeting the goals, such apprentices and trainees must be employed by the Contractor during the training period, and the Contractor must have made a commitment to employ the apprentices and trainees at the completion of their training subject to the availability of employment opportunities. Trainees must be trained pursuant to training programs approved by the U.S. Department of Labor.\n(h) The Contractor shall take specific affirmative actions to ensure equal employment opportunity (\"EEO\"). The evaluation of the Contractor's compliance with these provisions shall be based upon its good faith efforts to achieve maximum results from its actions. The Contractor shall document these efforts fully, and shall implement affirmative action steps at least as extensive as the following:\n(1) Ensure and maintain a working environment free of harassment, intimidation, and coercion at all sites, and in all facilities at which the Contractor's employees are assigned to work. The Contractor, where possible, will assign two or more women to each phase of the construction project. The Contractor, shall specifically ensure that all foremen, superintendents, and other supervisory personnel at the premises are aware of and carry out the Contractor's obligation to maintain such a working environment, with specific attention to minority or female individuals working at the premises.\n(2) Establish and maintain a current list of minority and female recruitment sources, provide written notification to minority and female recruitment sources and to county organizations when the Contractor or its unions have employment opportunities available, and maintain a record of the organizations' responses.\n(3) Maintain a current file of the names, addresses and telephone numbers of each minority and female off-the-street applicant and minority or female referral from a union, a recruitment source or community organization and of what action was taken with respect to each such individual. If such individual was sent to the union hiring hall for referral and was not referred back to the Contractor by the union or, if referred, not employed by the Contractor, this shall be documented in the file with the reason therefor, along with whatever additional actions the Contractor may have taken.\n(4) Provide immediate written notification to the Lessee when the union or unions with which the Contractor has a collective bargaining agreement has not referred to the Contractor a minority person or woman sent by the Contractor, or when the Contractor has other information that the union referral process has impeded the Contractor's efforts to meet its obligations.\n(5) Develop on-the-job training opportunities and\/or participate in training programs for the area which expressly include upgrading programs and apprenticeship and training programs relevant to the Contractor's employment needs, especially those programs funded or approved by the Department of Labor. The Contractor shall Provide notice of these programs to the sources compiled under subparagraph (2) above.\n(6) Disseminate the Contractor's EEO policy by providing notice of the policy to unions and training programs and requesting their cooperation in assisting the Contractor in meeting its EEO obligations; by including it in any policy manual and collective bargaining agreement; by publicizing it in the Contractor's newspaper, annual report, etc.; by specific review of the policy with all management Personnel and with all minority and female employees at least once a year; and by posting the Contractor's EEO policy on bulletin boards accessible to all employees at each location where construction work is performed.\n(7) Review, at least every six months the Contractor's EEO policy and affirmative action obligations hereunder with all employees having any responsibility for hiring, assignment, layoff, termination or other employment decisions including specific review of these items with on-premises supervisory personnel such as Superintendents General Foremen, etc., prior to the initiation of construction work at the premises. A written record shall be made and maintained identifying the time and place of these meetings, persons attending, subject matter discussed, and disposition of the subject matter.\n(8) Disseminate the Contractor's EEO policy externally by including it in any advertising in the news media, specifically including minority and female news media, and providing written notification to and discussing the Contractors EEO policy with other contractors and subcontractors with whom the Contractor does or anticipates doing business.\n(9) Direct its recruitment efforts, both oral and written, to minority, female and community organizations, to schools with minority and female students and to minority and female recruitment and training organizations and to State-certified minority referral agencies serving the Contractor's recruitment area and employment needs. Not later than one month prior to the date for the acceptance of applications for apprenticeship or other training by any recruitment source, the Contractor shall send written notification to organizations such as the above, describing the openings, screening procedures, and tests to be used in the selection process.\n(10) Encourage present minority and female employees to recruit other minority persons and women and, where reasonable, provide after school, summer and vacation employment to minority and female youth both on the premises and in other areas of a Contractor's workforce.\n(11) Tests and other selection requirements shall comply with 41 CFR Part 60 - 3.\n(12) Conduct, at least every six months, an inventory and evaluation at least of all minority and female personnel for promotional opportunities and encourage these employees to seek or to prepare for, through appropriate training, etc., such opportunities.\n(13) Ensure that seniority practices, job classifications, work assignments and other personnel practices, do not have a discriminatory effect by continually monitoring all personnel and employment related activities to ensure that the EEO policy and the Contractor's obligations hereunder are being carried out.\n(14) Ensure that all facilities and company activities are nonsegregated except that separate or single-user toilet and necessary changing facilities shall be provided to assure privacy between the sexes.\n(15) Document and maintain a record of all solicitations of offers for subcontracts from minority and female construction contractors and suppliers, including circulation of solicitations to minority and female contractor associations and other business associations.\n(16) Conduct a review, at least every six months, of all supervisor's adherence to and performance under the Contractor's EEO policies and affirmative action obligations.\n(i) Contractors are encouraged to participate in voluntary associations which assist in fulfilling one or more of their affirmative action obligations (subparagraphs (1)-(16) of Paragraph (h) above). The efforts of a contractor association, joint contractor-union, contractor- community, or other similar group of which the Contractor is a member and participant, may be asserted as fulfilling any one or more of its obligations under Paragraph (h) hereof provided that: the Contractor actively participates in the group, makes good faith efforts to assure that the group has a positive impact on the employment of minorities and women in the industry, ensures that the concrete benefits of the program are reflected in the Contractor's minority and female workforce participation, makes good faith efforts to meet its individual goals and timetables, and can provide access to documentation which demonstrates the effectiveness of actions taken on behalf of the Contractor. The obligation to comply, however, is the Contractor's and failure of such a group to fulfill an obligation shall not be a defense for the Contractor's non-compliance.\n(j) A single goal for minorities and a separate single goal for women have been established. The contractor, however, is required to provide equal employment opportunity and to take affirmative action for all minority groups, both male and female, and all women, both minority and nonminority. Consequently, the Contractor may be in violation hereof if a particular group is employed in a substantially disparate manner (for example, even though the Contractor has achieved its goals for women generally, the Contractor may be in violation hereof if a specific minority group of women is under-utilized).\n(k) The Contractor shall not use the goals and timetables or affirmative action standards to discriminate against any person because of race, color, religion, sex or national origin.\n(l) The Contractor shall not enter into any subcontract with any person or firm debarred from Government contracts pursuant to Executive Order 11246.\n(m) The Contractor shall carry out such sanctions and penalties for violation of this clause including suspension, termination and cancellation of existing subcontracts as may be imposed or ordered by the Lessee. Any Contractor who fails to carry out such sanctions and penalties shall be in violation hereof.\n(n) The Contractor, in fulfilling its obligations hereunder shall implement specific affirmative action steps, at least as extensive as those standards prescribed in paragraph (h) hereof so as to achieve maximum results from its efforts to ensure equal employment opportunity. If the Contractor fails to comply with the requirements of these provisions, the Lessee shall proceed accordingly.\n(o) The Contractor shall designate a responsible official to monitor all employment related activity to ensure that the company EEO policy is being carried out, to submit reports relating to the provisions hereof as may be required and to keep records. Records shall at least include for each employee the name, address, telephone numbers, construction trade, union affiliation if any, employee identification number when assigned, social security number, race, sex, status (e.g. mechanic, apprentice, trainee, helper, or laborer), dates of changes in status, hours worked per week in the indicated trade, rate of pay, and location at which the work was performed. Records shall be maintained in an easily understandable and retrievable form; however, to the degree that existing records satisfy this requirement, contractors shall not be required to maintain separate records.\n(p) Nothing herein provided shall be construed as a limitation upon the application of any laws which establish different standards of compliance or upon the application of requirements for the hiring of local or other area residents (e.g., those under the Public Works Employment Act of 1977 and the Community Development Block Grant Program).\n(q) Without limiting any other or provision under the Lease, the Contractor shall cooperate with all federal, state or local agencies established for the purpose of implementing affirmative action compliance programs and shall comply with all procedures and guidelines established or which may be established by the Port Authority.\nPART II\nMinority Business Enterprises\/Women-Owned Business Enterprises\nAs a matter of policy the Port Authority requires the Lessee and the Lessee shall itself and shall require the general contractor of other construction supervisor and each of the Lessee's contractors to use every good faith effort to provide for meaningful participation by Minority Business Enterprises (MBEs) and Women-owned Business Enterprises (WBEs) in the construction work, pursuant to the provisions hereof and in accordance with the Lease. For purposes hereof, Minority Business Enterprise (MBE) shall mean any business enterprise which is at least fifty-one percentum owned by or in the case of a publicly owned business, at least fifty-one percentum of the stock of which is owned by citizens or permanent resident aliens who are minorities and such ownership is real, substantial and continuing. For the purposes hereof, Women-owned Business Enterprise (WBE) shall mean any business enterprise which is at least fifty-one percentum owned by, or in the case of a publicly owned business, at least fifty-one percentum of the stock of which is owned by women and such ownership is real, substantial and continuing. A minority shall be as defined in paragraph II(c) of Part I of this Schedule E-1. \"Meaningful participation\" shall mean that at least seventeen percent (17%) of the total dollar value of the construction contracts (including subcontracts) covering the construction work are for the participation of Minority Business Enterprises and Women-owned Business Enterprises, of which at lease twelve percent (12%) of the total dollar value of the construction contracts (including subcontracts) are for the participation of Minority Business Enterprises. Good faith efforts to include meaningful participation by MBEs and WBEs shall include at least the following:\n(a) Dividing the Work to be subcontracted into smaller portions where feasible.\n(b) Actively and affirmatively soliciting bids for subcontracts from MBEs and WBEs, including circulation of solicitations to minority and female contractor associations. The Contractor shall maintain records detailing the efforts made to provide for meaningful MBE and WBE participation in the Work, including the names and addresses of all MBEs and WBEs contacted and, if any such MBE or WBE is not selected as a joint venturer or subcontractor, the reason for such decision.\n(c) Making plans and specifications for prospective construction work available to MBEs and WBEs in sufficient time for review.\n(d) Utilizing the list of eligible MBEs and WBE maintained by the Port Authority or seeking minorities and women from other sources for the purpose of soliciting bids for subcontractors.\n(e) Encouraging the formation of joint ventures, partnerships or other similar arrangements among subcontractors, where appropriate, to insure that the Lessee and Contractor will meet their obligations hereunder.\n(f) Insuring that provision is made to provide progress payments to MBEs and WBEs in a timely basis.\n(g) Not requiring bonds from and\/or providing bonds and insurance for MBEs and WBEs, where appropriate.\n\/s\/ For the Port Authority\nInitialled:\n\/s\/ SEA For the Lessee\nFORM XLD - Ack., N.J. 51380\nSTATE OF NEW YORK ) COUNTY OF NEW YORK ) ss. ) On this 21 day of September, 1993, before me, the subscriber, a notary public of New York, personally appeared Gerald P. Fitzgerald the Deputy of Aviation of The Port Authority of New Yorka dn New Jersey, who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Commissioners.\n\/s\/ Jacqueline White (notarial seal and stamp)\nSTATE OF TEXAS ) COUNTY OF HARRIS ) ss. ) On this 21st day of June, 1993, before me, the subscriber, a notary public of Texas personally appeared Sam E. Ashmore, the Senior Vice-President of CONTINENTAL AIRLINES, INC., who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\nKathryn K. Gutterman (notarial seal and stamp)\nSTATE OF ) COUNTY OF ) ss. )\nOn this day of , 1993, before me, the subscriber, a President of , who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed and delivered the same as his voluntary act and deed for the uses and purposes therein expressed.\n(notarial seal and stamp)\nTHIS SUPPLEMENTAL AGREEMENT SHALL NOT BE BINDING UPON THE PORT AUTHORITY UNTIL DULY EXECUTED BY AN EXECUTIVE OFFICER THEREOF AND DELIVERED TO THE LESSEE BY AN AUTHORIZED REPRESENTATIVE OF THE PORT AUTHORITY\nNewark International Airport Lease No. ANA-170 Supplement No. 13\nSUPPLEMENTAL AGREEMENT\nTHIS AGREEMENT dated February 1, 1994 by and between THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY (hereinafter called \"the Port Authority\") and CONTINENTAL AIRLINES, INC., a corporation of the State of Delaware, having an office and place of business at Suite 1401, P.O. Box 4607, Houston, Texas 77210-4067, (hereinafter called \"the Lessee\"),\nWITNESSETH, That:\nWHEREAS, the Port Authority and People Express Airlines, Inc. (hereinafter called \"People Express\") as of January 11, 1985 entered into an agreement of lease (which agreement of lease as heretofore supplemented and amended is hereinafter called the \"Lease\"), covering certain premises, rights and privileges at and in respect to Newark International Airport (hereinafter called \"the Airport\") as therein set forth; and\nWHEREAS, the Lease was thereafter assigned by said People Express to the Lessee pursuant to an Assignment of Lease with Assumption and Consent Agreement entered into among the Port Authority, the Lessee and People Express and dated August 15, 1987; and\nWHEREAS, the Port Authority and the Lessee desire to extend the letting of the Area C-3 portion of the premises under the Lease and to amend the Lease in certain other respects as hereinafter provided;\nWHEREAS, a certain Stipulation between the parties hereto has been submitted for approval of the United States Bankruptcy Court for the District of Delaware (\"the Bankruptcy Court\") covering the Lessee's assumption of the Lease as part of the confirmation of its reorganization plan in its Chapter 11 bankruptcy proceedings and as debtor and debtor in possession pursuant to the applicable provisions of United States Bankruptcy Code as set forth in and subject to the terms and conditions of said Stipulation (said Stipulation being hereinafter referred to as the \"Stipulation\");\nWHEREAS, the Stipulation and the Lessee's assumption of the Lease has been approved by the Bankruptcy Court by an Order thereof dated the 1st day of October, 1993;\nNOW, THEREFORE, the Port Authority and the Lessee, for and in consideration of the covenants and mutual agreements hereinafter contained, hereby agree to amend the Lease, effective as of October 2, 1993 (except as otherwise provided with respect to Paragraphs 1 and 2 below) as follows:\n1. Effective as of June 2, 1989, subparagraph (b) of Paragraph 2 of Supplement No. 9 of the Lease shall be deemed corrected and amended to read as follows:\n\"(b) Paragraph III of Schedule A to the Lease, as amended by Paragraph 3 (b) (v) of Supplement No. 8 to the Lease, is hereby further amended by deleting the figure stated as '1.799%' in the last line thereof (as set forth in said paragraph 3 (b) (v) of Supplement No. 8) and by substituting in lieu thereof the figure '2.033%'.\"\n2. Effective as of June 1, 1992: (a) Subparagraph (a) (ii) of Paragraph 3 of Supplement No. 8 of the Lease, as previously amended and set forth in Supplement No. 11 of the Lease, shall be deemed corrected and amended to read as follows:\n\"(ii) For the portion of the term of the letting of Area C-3 commencing on June 1, 1992 and continuing to and including the expiration date of the letting of Area C-3 an Area C-3 Annual Rental for Area C-3 at the annual rate of Five Million Seven Hundred Thirty-seven Thousand Eighty Dollars and No Cents ($5,737,080.00) subject to adjustment as provided in subparagraph (b) hereof. The aforesaid Area C-3 Annual Rental of Five Million Seven Hundred Thirty-Seven Thousand Eighty Dollars and No Cents ($5,737,080.00) is made up of two factors, one a constant factor in the amount of Four Million Six Hundred Thirty-four Thousand Seven Hundred Five Dollars and No Cents ($4,634,705.00) and the other a variable factor in the amount of One Million One Hundred Two Thousand Three Hundred Seventy-five Dollars and No Cents ($1,102,375.00). The variable factor aforesaid represents the Airport Services portion of the Area C-3 Annual Rental and such variable factor of the Area C-3 Annual Rental is herein referred to as the Airport Services Factor and is subject to adjustment as provided in subparagraph (b) hereof.\"\n(b) The sixteenth through the eighteenth lines of the last sentence of Paragraph III of Schedule A of the Lease as set forth in Paragraph 2 (c) (ii) of Supplement No. 11 of the Lease shall be deemed corrected and amended to read as follows:\n\"is being made; for the calendar year 1992 adjustment, it is hereby agreed said denominator shall be 1.999%.\"\n(c) The first sentence of the first paragraph of subparagraph (e) (2) of Paragraph 3 of Supplement No. 8 of the Lease, as previously amended and set forth in Paragraph 2 (d) (i) of Supplement No. 11 of the Lease, shall be deemed corrected and amended to read as follows:\n\"In addition, the Airport Services Factor of the Area C-3 Annual Rental shall be reduced for each calendar day or major fraction thereof the abatement remains in effect, for each square foot of land the use of which is denied the Lessee at the daily rate of $0.0021585 subject to adjustment as provided herein.\"\n(d) The second paragraph of said subparagraph (e) (2) of Paragraph 3 of Supplement No. 8 of the Lease as previously amended and as set forth in Paragraph 2 (d) (ii) of Supplement No. 11 of the Lease shall be deemed corrected and amended to read as follows:\n\"The aforesaid abatement rate of $0.0021585 per diem (hereinafter called 'the variable rate') is based upon the variable factor in the amount of One Million One Hundred Two Thousand Three Hundred Seventy-Five Dollars and No Cents ($1,102,375.00) per annum which is the tentative Airport Services Factor for 1992 (also subject to the adjustment under paragraph b (hereof). After the close of the calendar year 1992 and after the close of each calendar year thereafter, the Port Authority will adjust the variable rate, upwards or downwards, as provided in Schedule A. The resultant variable rate shall constitute the final variable rate for the calendar year for which the adjustment is being made. It shall also constitute the tentative variable rate for the calendar year in which such rate is calculated and for the following year until the next succeeding final variable rate is calculated.\"\n(e) Subparagraph (a) of Paragraph 5 of Supplement No. 11 of the Lease shall be deemed corrected and amended to read as follows:\n\"(a) The Lessee agrees to pay the Port Authority a rental for Area C-3 (the 'Area C-3 Monthly Rental') at the rate of Four Hundred Seventy-Eight Thousand Ninety Dollars and No Cents ($478,090.00) per month, subject to adjustment of the Airport Services Factor as provided in subparagraph (b) below, payable by the Lessee in advance on January 1, 1993 and on the first day of each and every month thereafter during the periodical tenancy until the expiration or earlier termination of the periodical tenancy hereunder. The aforesaid Area C-3 Monthly Rental of Four Hundred Seventy-Eight Thousand Ninety Dollars and No Cents ($478,090.00) is made up of two factors, one a constant factor in the amount of Three Hundred Eighty-six Thousand Two Hundred Twenty-Five Dollars and Forty-two Cents ($386,225.42) and the other a variable factor in the amount of Ninety-one Thousand and Eight Hundred Sixty-four Dollars and Fifty-eight cents ($91,864.58). The variable factor aforesaid represents the Airport Services Factor of the Area C-3 Monthly Rental and is subject to adjustment in accordance with Schedule A of the Lease, as amended.\"\n3. The term of the letting of Area C-3 under the Lease is hereby extended to December 31, 1998 unless sooner terminated, subject to the terms and conditions of the Lease, as hereby amended, and the Lessee shall pay to the Port Authority as the annual rental for Area C-3, during the said extension of the term of the letting thereof, the Area C-3 Annual Rental in accordance with, and as set forth in, Paragraph 3 of Supplement No. 8 of the Lease, as said Paragraph 3 has been amended by Paragraph 2 of Supplement No. 10 of the Lease and further amended by Paragraph 2 of Supplement No. 11 of the Lease, and as the same is herein further amended by this Supplemental Agreement.\n4. (a) Paragraph 4 (b) of Supplement No. 8 of the Lease is hereby amended as follows:\nThe words \"the expiration date of the letting of Area C-3 (as set forth in Paragraph 2 hereof)\" appearing in the second and third lines thereof shall be deemed amended to read: \"the expiration date of the letting of Area C-3 (as set forth in Paragraph 3 of Supplement No. 13 of the Lease)\".\n(b) References in Paragraphs 6 (a) and 6 (b) of Supplement No. 8 of the Lease and in subparagraph (a) (ii) of Paragraph 3 of Supplement No. 8 of the Lease, as set forth in Supplement No. 10 of the Lease and as amended by Paragraph 2 of Supplement No. 11 of the Lease and by Paragraph 2 above, to the \"expiration date of the letting of Area C-3\" shall be deemed to read and mean the expiration date of the letting of Area C-3 as set forth in Paragraph 3 of this Supplement No. 13 of the Lease.\n5. Paragraph 5 of Supplement No. 8 of the Lease, as previously amended, is hereby further amended to read as follows:\n\"5. (a) Without limiting any other rights of termination of the Port Authority under the Lease, it is hereby understood and agreed between the Lessee and the Port Authority that the Port Authority shall have the right at any time and from time to time, without cause, upon thirty (30) days' prior written notice to the Lessee, to terminate the Lease and the letting thereunder with respect to all or a portion or portions of that part of Area C-3 as shown in cross-hatch and in diagonal hatch on the sketch attached hereto, hereby made a part hereof and marked 'Exhibit DY'. The said portions of the premises are herein in this Paragraph collectively called 'the Terminated Portion'. It is understood that the Port Authority shall exercise its right to terminate hereunder only in the event that the Terminated Portion is needed for any of the following reasons: (i) in connection with the facilitation of aeronautical requirements of the Airport or (ii) because of the need to accommodate the operational characteristics of new aircraft or new versions of existing aircraft, or (iii) the requirements of the Federal Aviation Administration or any other governmental agency or governmental body having jurisdiction, or (iv) changes with respect to the Public Aircraft Facilities made in accordance with Section 51 of the Lease; or (v) in connection with the plans of the Port Authority for the redevelopment of the Airport.\n(b) Effective as of the date and time (hereinafter in this Paragraph called 'the Effective Date') stated in the notice aforesaid from the Port Authority to the Lessee specified in paragraph (a) hereof, the Lessee has terminated and does by these presents terminate its rights in the Terminated Portion and the term of years with respect thereto under the Lease, and all the rights, rights of renewal, licenses, privileges and options of the Lessee granted by the Lease all to the intent that the same may be wholly merged, extinguished and determined on the Effective Date with the same force and effect as if said term were fixed to expire on the Effective Date.\nTO HAVE AND TO HOLD the same to the Port Authority its successors and assigns forever.\n(c) The Lessee hereby covenants on behalf of itself, its successors and assigns that it has not done anything whereby the Terminated Portion or the Lessee's leasehold therein has been or shall be encumbered as of the Effective Date in any way and that the Lessee is and will remain until the Effective Date the sole and absolute owner of the leasehold estate in the Terminated Portion. All promises, covenants, agreements and obligations of the Lessee with respect to the Terminated Portion, which under the provisions of the Lease would have matured upon the date originally fixed in the Lease for the expiration of the term thereof, or upon the termination of the Lease prior to the said date, or within a stated period after expiration or termination shall, notwithstanding such provisions, mature upon the Effective Date. The Lessee has released and discharged and does by these presents release and discharge the Port Authority from any and all obligations on the part of the Port Authority to be performed under the lease with respect to the Terminated Portion. The Port Authority does by these presents release and discharge the Lessee from any and all obligations on the part of the Lessee to be performed under the Lease with respect to the Terminated Portion for that portion of the term subsequent to the Effective Date it being understood that nothing herein contained shall release, relieve or discharge the Lessee from any liability for rentals or for other charges that may be due or become due to the Port Authority for any period prior to the Effective Date or for breach of any obligation on the Lessee's part to be performed under the Lease for or during such period or periods or maturing pursuant to this paragraph.\n(d) The Lessee hereby agrees to terminate its occupancy of the Terminated Portion and to deliver actual, physical possession of the Terminated Portion to the Port Authority, on or before the Effective Date, in the condition required by the Lease upon surrender. The Lessee further agrees that it shall remove from the Terminated Portion, prior to the Effective Date, all equipment, inventories, removable fixtures and other personal property of the Lessee, for which the Lessee is responsible. With respect to any such property not so removed, the Port Authority may at its option, as agent for the Lessee and at the risk and expense of the Lessee remove such property to a public warehouse or may retain the same in its own possession and in either event, after the expiration of thirty (30) days, may sell or consent to the sale of the same at a public auction; the proceeds of any such sale shall be applied first to the expense of removal, sale and storage, and second to any sums owed by the Lessee to the Port Authority; any balance remaining shall be paid to the Lessee. The Lessee shall pay to the Port Authority any excess of the total cost of removal, storage and sale over the proceeds of sale.\nThe Lessee hereby acknowledges that each and every term, provision and condition of the Lease shall continue to apply to the premises remaining after the termination of the Terminated Portion.\n(e) From and after the Effective Date as defined the Lessee shall be entitled to an abatement of the Area C-3 Annual Rental in accordance with and pursuant to the Lease, as amended.\"\n6. (a) The Port Authority and the Lessee have heretofore entered into a letter agreement dated March 26, 1992 and bearing Port Authority identification number ANA-635 which letter agreement, as amended by a supplemental letter agreement dated February 2, 1993, (hereinafter referred to as the \"Letter Agreement\") covered the performance of certain work by the Lessee in the premises hereunder, therein described as the \"Lessee Work\" and also the performance by the Port Authority in the premises hereunder of certain work therein described as \"Port Authority Work\". A portion of the said Port Authority Work consisted of certain \"office relocation work\" as more fully described and set forth in Paragraph 25 (a) of the Letter Agreement. The Port Authority and the Lessee hereby recognize and agree that the Lessee subsequently to the date of the Letter Agreement agreed to perform the Office Relocation Work as herein-below defined, and the Port Authority and the Lessee hereby agree that the Port Authority shall reimburse to the Lessee the \"Cost of the Office Relocation Work\" (as hereinafter defined) in accordance with the following subparagraphs of this Paragraph 6.\n(b) (1) \"Office Relocation Work\" shall mean that portion of the work originally set forth as part of the Port Authority Work under, and as described in, Paragraph 25 (a) (ii) of the Letter Agreement, and for which the Lessee submitted Alteration Application No. NC-75, as and to the extent such Application, including its plans and specifications, were approved by the Port Authority, and subject to any and all conditions set forth therein.\n(2) The term \"Cost of the Office Relocation Work\" shall mean the sum of the following actually paid by the Lessee to the extent that the inclusion of the same is permitted by generally accepted accounting principles consistently applied:\n(i) the amount actually paid or incurred by the Lessee to its independent contractor(s) for work actually performed and labor and materials actually furnished in connection with the Office Relocation Work.\n(ii) amounts actually paid by the Lessee in connection with the Office Relocation Work for engineering, architectural, professional and consulting services and supervision of construction and all related expenses for the Office Relocation Work; provided, however, that payments under this item (ii) shall not exceed ten percent (10%) of the amounts paid under item (i) above.\n(c) (i) The Lessee, knowing that the Port Authority is relying on the truth and validity of the Lessee's representations and warranties and to induce the Port Authority to make the reimbursement payment to the Lessee as called for under this Paragraph, hereby expressly covenants, represents and warrants to the Port Authority that the Lessee has, prior to the execution of this Agreement, paid the Cost of the Office Relocation Work and has submitted to the Port Authority, subject to Port Authority review and audit, reproduction copies or duplicate originals of invoices of the Lessee's contractor(s) (including all entities mentioned in (i) and (ii) of subparagraph (b) (2) above) covering the Office Relocation Work, which the Lessee has submitted to the Port Authority for reimbursement under this Paragraph 6, that the Lessee has heretofore paid in full the amount of such invoices, and for each and all such invoices that the Lessee has also submitted to the Port Authority for its review and audit an acknowledgement by the Lessee's contractor(s) (including all entities mentioned in (i) and (ii) of subparagraph (b) (2) above) of the receipt by it or them of the amounts of such invoices, and all certifications by the Lessee that all such invoices are for amounts, payments and expenses for the Cost of the Office Relocation Work, which the Lessee has submitted to the Port Authority for reimbursement under this Paragraph 6; and the Lessee also hereby further covenants, represents and warrants to the Port Authority that the Lessee has performed the Office Relocation Work in accordance with and in full compliance with the terms and provisions of the aforesaid Alteration Application and the plans and specifications forming a part thereof and all obligations thereunder and all requirements of the Port Authority given in connection therewith including without limitation all requirements of applicable laws, ordinances and governmental rules, regulations and orders.\n(ii) The Lessee hereby certifies that it has completed the Office Relocation Work and that it has paid the entire and complete Cost of the Office Relocation Work and that there are no outstanding liens, mortgages, conditional bills of sale or claims of any kind whatsoever with respect to the Office Relocation Work in accordance with the aforesaid Alteration Application covering the same, and with all requirements of the Port Authority. The Lessee acknowledges that title to all of the Office Relocation Work has vested in the City of Newark with respect to all or such parts thereof located within the territorial limits of the City of Newark, and in the Port Authority with respect to all or each part thereof located within the territorial limits of the City of Elizabeth; and all such Work shall at the completion thereof be deemed to have become part of the premises under the Lease.\n(iii) The Lessee shall indemnify and hold harmless the Port Authority, its Commissioners, officers, agents and employees from and against all claims and demands, just or unjust of third persons (including employees, agents and officers of the Port Authority) arising or alleged to arise out of or in connection with the Office Relocation Work and the performance thereof and for all expenses incurred by it and by them in the defense, settlement or satisfaction thereof, including without limitation thereto, claims and demands for death, for personal injury or for property damage, direct or consequential, whether they arise from the acts or omissions of the Lessee, of any contractors of the Lessee, of the Port Authority, or of third persons, or from acts of God or of the public enemy, or otherwise, excepting only claims and demands which result solely from affirmative, wilful acts done by the Port Authority, its Commissioners, officers, agents and employees subsequent to the commencement of the Office Relocation work.\nIf so directed, the Lessee shall at its own expense defend any suit based upon any such claim or demand (even if such suit, claim or demand is groundless, false or fraudulent), and in handling such it shall not, without obtaining express advance written permission from the General Counsel of the Port Authority, raise any defense involving in any way the jurisdiction of the tribunal over the person of the Port Authority, the immunity of the Port Authority, its Commissioners, officers, agents, representatives employees, the governmental nature of the Port Authority, or the provisions of any statutes respecting suits against the Port Authority.\n(iv) Nothing contained herein shall grant or be deemed to grant to any contractor, engineer, architect, supplier, subcontractor or any other person engaged by the Lessee or any of its contractors in the performance of any part of the Office Relocation Work, any right or action or claim against the Port Authority, its Commissioners, officers, agents and employees with respect to work any of them may have done in connection the Office Relocation Work. Nothing contained herein shall create or be deemed to create any relationship between the Port Authority and such contractors, engineers, architects, subcontractors or any other persons engaged by the Lessee or any of its contractors in the performance of any part of the Office Relocation Work and the Port Authority shall not be responsible to any of the foregoing for any payments due or alleged to be due thereto for any work performed or materials furnished in connection the Office Relocation Work.\n(d) (1) Subject to the limitation set forth in paragraph (e) below, the Port Authority, based upon and in reliance on the covenants, certifications, representations, warranties, indemnities and inducement of the Lessee, as set forth above, agrees to reimburse to the Lessee, but not earlier than thirty (30) days after the Port Authority's execution of this Agreement, in a single rental credit applied against the rentals due under this Lease the amounts of the paid invoices of the Lessee heretofore paid by the Lessee and submitted by the Lessee as set forth in subparagraph (c) above as and for the Cost of the Office Relocation Work that the Lessee has submitted to the Port Authority for reimbursement under this Paragraph 6, but only to the extent that the same meet the criteria specified in subparagraph (b) (2) above.\n(2) It is understood and agreed that at the election of the Port Authority the rental credit shall not extend or include any one or more items of the cost of the Office Relocation Work with respect to which the Port Authority's inspection, review or audit does not substantiate the contents of any such item or items submitted by the Lessee to establish the Cost of the Office Relocation Work as called for under subparagraph (c) above, but the Port Authority shall have no obligation to conduct any such inspection, review or audit at the time set forth for the Port Authority's payment under subparagraph (1) above.\n(e) (1) The entire obligation of the Port Authority under this Agreement to reimburse the Lessee for the Cost of the Office Relocation Work shall be limited in amount to a total of Two Hundred Forty Thousand Dollars and No Cents ($240,000.00) to be paid to the Lessee in the form of a single rental credit against the Lessee's rental obligations under the Lease as set forth in subparagraph (d) above, pursuant and subject to all the terms, provisions, covenants and conditions hereof.\n(2) Without limiting any right or remedy of the Port Authority under this Agreement, the Lease or otherwise, whether in law or in equity, the Port Authority shall have the right by its agents, employees and representatives to audit and inspect during regular business hours the books and records and other data of the Lessee relating to the Office Relocation Work and the Cost of the Office Relocation Work; it being especially understood and agreed that the Port Authority shall not be bound by any prior audit, review or inspection conducted by it. The Lessee agrees to keep said books, records and other data within the Port of New York District. The Lessee shall not be required to maintain such books, records and other data for more than five (5) years after the date of the rental credit under subparagraph (d) hereof.\n7. The Lessee represents and warrants that no broker has been concerned in the negotiation of this Supplemental Agreement and that there is no broker who is or may be entitled to be paid a commission in connection therewith. The Lessee shall indemnify and save harmless the Port Authority of and from any and all claims for commission or brokerage made by any and all persons, firms or corporations whatsoever for services in connection with the negotiation and execution of this Supplemental Agreement.\n8. Except as hereinbefore provided, all the terms covenants and conditions of the Lease shall be and remain in full force and effect.\n9. No Commissioner, director, officer, agent or employee of either party shall be charged personally or held contractually liable by or to the other party under any term or condition of this Agreement, or because of its execution or attempted execution or because of any breach or attempted or alleged breach thereof. The Lessee agrees that no representations or warranties with respect to this Agreement shall be binding upon the Port Authority unless expressed in writing herein.\n10. This Supplemental Agreement and the Lease which it amends constitute the entire agreement between the Lessee and the Port Authority on the subject matter, and may not be modified, discharged or extended except by instrument in writing duly executed on behalf of both the Port Authority and the Lessee.\nIN WITNESS WHEREOF, the parties hereto have executed these presents as of the day and year first above written.\nATTEST: THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY\n\/s\/ By \/s\/ Gerald P. FitzGerald Secretary (Title) Deputy Director of Aviation (Seal)\nATTEST: CONTINENTAL AIRLINES, INC.\n\/s\/ E. A. Hessler By Sam E. Ashmore Secretary (Title) Sr. Vice President (Corporate Seal)\nCSL-61273; - Ack. N.J.; Corp. & Corp.\nSTATE OF NEW YORK ) COUNTY OF NEW YORK ) SS. ) On this 3 day of June, 1994, before me, the subscriber, a notary public of New York, personally appeared Gerald P. FitzGerald the Deputy Director of Avaition of The Port Authority of New Yorka dn New Jersey, who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Commissioners.\n\/s\/ Jacqueline White (notarial seal and stamp)\nSTATE OF TEXAS ) COUNTY OF HARRIS ) SS. ) On this 11th day of April, 1994, before me, the subscriber, a notary public of Texas personally appeared Sam E. Ashmore, the Sr. Vice-President of CONTINENTAL AIRLINES, INC., who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n\/s\/ Kathleen M. Plumley (notarial seal and stamp)\nSTATE OF TEXAS ) COUNTY OF HARRIS ) SS. )\nOn this 12th day of April, 1994, before me, the subscriber, a Notary Public and Corporate Secretary personally appeared E. A. Hessler the Vice President of CONTINENTAL AIRLINES who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n\/s\/ Mae Belle Zycha (notarial seal and stamp)\nTHIS SUPPLEMENT SHALL NOT BE BINDING UPON THE PORT AUTHORITY UNTIL DULY EXECUTED BY AN EXECUTIVE OFFICER THEREOF AND DELIVERED TO THE LESSEE BY AN AUTHORIZED REPRESENTATIVE OF THE PORT AUTHORITY\nPort Authority Lease No. ANA-170 Supplement No. 14 Port Authority Facility - Newark International Airport\nSUPPLEMENTAL AGREEMENT\nTHIS SUPPLEMENTAL AGREEMENT made as of February 1, 1994 by and between THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY (hereinafter called \"the Port Authority\") and CONTINENTAL AIRLINES, INC., (hereinafter called \"the Lessee\"),\nWITNESSETH, That:\nWHEREAS, the Port Authority and the Lessee are parties to entered into an agreement of lease dated January 11, 1985 (which agreement of lease, as the same has been heretofore supplemented and amended, is hereinafter called \"the Lease\"), covering certain premises, rights and privileges at and in respect to Newark International Airport (hereinafter called \"the Airport\") as therein set forth; and\nWHEREAS, the parties desire to amend the Lease in certain respects:\nNOW, THEREFORE, for and in consideration of the mutual covenants and agreements hereinafter set forth, it is hereby agreed effective as of February 1, 1994, as follows:\n1. (a) Exhibit Z attached to the Lease is hereby amended as follows: Paragraph 9 thereof (as set forth on pages 3 and 4 of said Exhibit Z) shall be deemed amended to read as set forth in the exhibit attached hereto, hereby made a part thereof and marked \"Exhibit Z-Paragraph 9,\" which shall be and form a part of Exhibit Z of the Lease as if therein set forth in full.\n(b) It is expressly recognized that the aforesaid amendment to Exhibit Z of the Lease is based on the specific request of the Lessee as reflected by the amendment of the fuel service agreement between the Lessee and the Port Authority's independent contractor (sometimes called the \"Operator\"), which amendment is attached hereto and marked as \"Exhibit A\", and, further, without limiting any other term or provision of the Lease or of Exhibit Z, that the contents of Exhibit Z, as hereby amended, form a part of the said fuel service agreement between the Port Authority's independent contractor and the Lessee, and, further, that neither Exhibit Z as hereby amended nor anything contained therein shall limit, modify or alter any rights and remedies or obligations of the Port Authority or the Lessee under the Lease or constitute the Port Authority as a party to the said agreement between the Operator and the Lessee. It is further specifically understood and agreed that neither said Exhibit Z, as hereby amended, nor anything contained therein shall be deemed to impose any liability or responsibility of any type whatsoever on the part of the Port Authority for any failure of the Operator to perform or for any improper performance by the Operator of any of its obligations under the said agreement between the Operator and the Lessee.\n2. (a) It is specifically recognized that, pursuant to the terms of the Lease, Exhibit Z may be changed, modified or amended (including the amendment herein provided) upon agreement of the Port Authority and a majority of the \"Airline Lessees\" as defined in the Lease, and that accordingly, this Supplemental Agreement shall be deemed effective upon (i) the execution hereof by the Lessee and the Port Authority and (ii) upon the execution of an agreement substantially similar to this Agreement by each of the airlines constituting said majority of \"Airline Lessees\".\n(b) It is also hereby specifically recognized and agreed that the said amendment to Exhibit Z of the Lease will be incorporated into the fuel storage permit of each fuel storage permittee at the Airport by an appropriate supplement or endorsement thereto, and that neither the failure or refusal of any such fuel storage permittee to execute said supplement or endorsement shall affect the effectiveness of the amendment to Exhibit Z hereunder.\n3. Except as hereinbefore provided, all the terms, covenants and conditions of the Lease shall be and remain in full force and effect.\n4. No Commissioner, director, officer, agent or employee of either party shall be charged personally or held contractually liable by or to the other party under any term or provision of this Agreement or because of its or their execution or attempted execution or because of any breach or attempted or alleged breach thereof. The Lessee agrees that no representations or warranties with respect to this Agreement shall be binding upon the Port Authority unless expressed in writing herein.\n5. This Supplemental Agreement, together with the Lease (to which it is supplementary) constitutes the entire agreement between the Port Authority and the Lessee on the subject matter, and may not be changed, modified, discharged or extended except by instrument in writing duly executed on behalf of the Port Authority and the Lessee. The Lessee agrees that no representations or warranties shall be binding upon the Port Authority unless in writing in the Lease or in this Supplemental Agreement.\nIN WITNESS WHEREOF, the parties hereto have executed these presents as of the day and year first above written.\nATTEST: THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY\n\/s\/ By \/s\/ Gerald P. Fitzgerald Secretary (Title) Deputy Director of Aviation (Seal)\nATTEST: CONTINENTAL AIRLINES, INC.\n\/s\/ E. A. Hessler By \/s\/ Sam E. Ashmore Vice President & Corporate Secretary (Title) Senior Vice President (Corporate Seal)\n\"Exhibit Z - Paragraph 9\"\nEXHIBIT 1\n8-Point Test\nThe \"8-Point Test\" shall consist of the following:\nTest Specification\n1. Color, Saybolt, min. Report\n2. API Gravity at 60 degrees F 37 degrees - 51 degrees\n3. Flash Point, TCC, min. 100 degrees - 150 degrees F\n4. Copper Strip Corrosion, max. No. 1 (2h at 212 degrees F)\n5. Freeze Point, ASTM D2386 max. Jet A - 40 degrees C Jet A-1 - 47 degrees C\n6. Water Tolerance: Separatin Rating, max. 2 Interface rating, max. 1(b) ML, change Report\n7. Distillation: 10% Evaporated, max. Temp. 400 degree F 50% Evaporated, max. Temp. Report 90% Evaporated, max. Temp. Report Final Boiling Point, max. Temp. 572 degrees F Residue, max. % 1.5% Loss, max. % 1.5%\n8. Water Separometer Index, 85 Modified Min.\n\/s\/ J.B. For the Port Authority\nInitialled:\n\/s\/ S.E.A. For the Lessee\nCONTINENTAL AIRLINES 3115 Allen Parkway, Suite 250 Houston, Texas 77019 (713) 620-7350\nJanuary 25, 1994\nMr. Bruce R. Pashley Ogden Aviation Service Company of New Jersey Marine Air Terminal Building 7 South LaGuardia Airport Flushing, New York 11371\nRE: Revised 8-Point Test\nDear Sirs,\nThis is to confirm the following agreement among the undersigned (the \"Airline\"), Ogden Aviation Service Company of New Jersey,Inc. (\"Ogden\") and the other airline members of the EWR Airline Fuel Committee:\n1. From and after the effective date of this agreement, the 8-point test set forth in the Exhibit attached hereto shall be the \"8-point test\" applied by Ogden's independent testing laboratory as required under the fueling standards, specifications and delivery procedures set forth in Article 2 and Exhibit 1 of each of the fuel service agreements between Ogden and each EWR Fuel Storage Permittee.\n2. This agreement shall become effective as of the day on which:\n(A) Each of the other airline members of the EWR Airline Fuel Committee shall have delivered to Ogden an executed agreement to the same effect as this agreement and Ogden shall have executed each such agreement and this agreement, and (B) The Port Authority of New York and New Jersey shall have provided to Ogden evidence of its approval for the use herein contemplated of the 8-point test set forth in the attached Exhibit which approval may be in the form of a notice from the Port Authority to Ogden indicating that the Port Authority and the required number of Master Airline Leases as specified in the Newark Master Airline Leases have agreed to the changes in the 8-Point Test. January 25, 1994\n3. Promptly after the effective date of this agreement, Ogden shall notify each Fuel Storage Permittee and provide to each a copy of the 8-point test set forth in the attached Exhibit, and the 8-point test referred in each Ogden service agreement shall thereupon be deemed amended to conform to the 8-point test set forth in the attached Exhibit without further amendment to any such documents.\nIf Ogden agrees to the foregoing, please so indicate in the place provided below and on the enclosed duplicate copy hereof, and return the executed duplicate to the undersigned.\nAgreed: Continental Airlines, Inc.\nBy: \/s\/ V. Gregory Hartford\nIts: Vice-President\nAgreed this 27th day of January, 1994 Ogden Aviation Service Company of New Jersey, Inc.\nBy: \/s\/ John W. Bauknecht\nIts: Vice-President Exhibit 1\n8-Point Test\nThe \"8-Point Test\" shall consist of the following:\nTest Specification\n1. Color, Saybolt, min. Report\n2. API Gravity at 60 degrees F 37 degrees - 51 degrees\n3. Flash Point, TCC, min. 100 degrees - 150 degrees F\n4. Copper Strip Corrosion, max. No. 1 (2h at 212 degrees F)\n5. Freeze Point, ASTM D2386 max. Jet A - 40 degrees C Jet A-1 - 47 degrees C\n6. Water Tolerance: Separatin Rating, max. 2 Interface rating, max. 1(b) ML, change Report\n7. Distillation: 10% Evaporated, max. Temp. 400 degrees 50% Evaporated, max. Temp. Report 90% Evaporated, max. Temp. Report Final Boiling Point, max. Temp. 572 degrees F Residue, max. % 1.5 Loss, max. % 1.5\n8. Water Separometer Index, 85 Modified Min.\nCSL-61273; - Ack. N.J.; Corp. & Corp.\nSTATE OF NEW JERSEY ) COUNTY OF ) SS. ) On this 20 day of September, 1994, before me, the subscriber, a notary public of New York, personally appeared Gerald P. Fitzgerald the Deputy Director of Aviation of The Port Authority of New York and New Jersey, who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Commissioners.\n\/s\/ Jacqueline White (notarial seal and stamp)\nSTATE OF TEXAS ) COUNTY OF HARRIS ) SS. ) On this 12th day of April, 1994, before me, the subscriber, a Notary Public of Texas personally appeared Sam E. Ashmore, the Sr. Vice-President of CONTINENTAL AIRLINES, INC., who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n\/s\/ Kathleen M. Plumley (notarial seal and stamp)\nSTATE OF ) COUNTY OF ) SS. )\nOn this day of , 1994, before me, the subscriber, a personally appeared the President of who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n(notarial seal and stamp)\nTHIS SUPPLEMENT SHALL NOT BE BINDING UPON THE PORT AUTHORITY UNTIL DULY EXECUTED BY AN EXECUTIVE OFFICER THEREOF AND DELIVERED TO THE LESSEE BY AN AUTHORIZED REPRESENTATIVE OF THE PORT AUTHORITY\nPort Authority Lease No. ANA-170 Supplement No. 15 Facility: Newark International Airport\nSUPPLEMENTAL AGREEMENT\nTHIS SUPPLEMENTAL AGREEMENT, dated as of March 20, 1995, by and between THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY (hereinafter called \"the Port Authority\"), and CONTINENTAL AIRLINES, INC. (hereinafter called \"the Lessee\");\nWITNESSETH, That\nWHEREAS, the Port Authority and People Express Airlines, Inc. (hereinafter called \"People Express\") as of January 11, 1985 entered into an agreement of lease (which agreement of lease as heretofore supplemented and amended is hereinafter called the \"Lease\"), covering certain premises, rights and privileges at and in respect to Newark International Airport (hereinafter called \"the Airport\") as therein set forth; and\nWHEREAS, the Lease was thereafter assigned by said People Express to the Lessee pursuant to an Assignment of Lease with Assumption and Consent Agreement entered into among the Port Authority, the Lessee and People Express and dated August 15, 1987; and\nWHEREAS, a certain Stipulation between the parties hereto was submitted for approval of the United States Bankruptcy Court for the District of Delaware (\"the Bankruptcy Court\") covering the Lessee's assumption of the Lease as part of the confirmation of its reorganization plan in its Chapter 11 bankruptcy proceedings and as debtor and debtor in possession pursuant to the applicable provisions of United States Bankruptcy Code as set forth in and subject to the terms and conditions of said Stipulation (said Stipulation being hereinafter referred to as the \"Stipulation\"); and\nWHEREAS, the Stipulation and the Lessee's assumption of the Lease was approved by the Bankruptcy Court by an Order thereof dated the lst day of October, 1993; and\nWHEREAS, the parties desire to extend the term of the letting of Area C-3 under the Lease, and to amend the Lease in certain other respects as hereinafter set forth;\nNOW, THEREFORE, the Port Authority and the Lessee hereby agree, effective as of January 1, 1995 unless otherwise stated, as follows:\n1. (a) The parties hereby acknowledge that the Port Authority is performing a certain construction project (hereinafter collectively called the \"Monorail Construction Work\") at the Airport consisting generally of the construction of a monorail system, including monorail stations, guideways and supports, maintenance control facilities, monorail vehicles, and all other associated construction work, facilities and equipment necessary for the installation or operation of such monorail system for the transportation of airline passengers and their baggage, and others; all of the foregoing being hereinafter sometimes collectively called the \"Monorail System.\"\n(b) (1) For purposes of this Supplemental Agreement, the term \"Monorail Construction Costs\" shall mean the total costs in connection with the Monorail Construction Work, as determined under subparagraph (a) (1) of Section II of Schedule M attached to the Lease by Paragraph 2 hereof.\n(2) For purposes of the calculations under this Paragraph 1, \"PFC Funds\" shall mean revenues derived from fees (hereinafter called \"Passenger Facility Charges\") charged air passengers at the Airport, a portion of which revenues shall be applied to the Monorail Construction Costs in accordance with Port Authority applications therefor as approved by the Federal Aviation Administration and the provisions of Section II of Schedule M as added to the Lease by Paragraph 2 of this Supplemental Agreement, the amount of which PFC Funds to be so applied being limited in amount to a total of One Hundred Million Dollars and No Cents ($100,000,000.00).\n(3) \"Monorail Fee Commencement Date\" shall mean the date which the Port Authority shall have certified to be the date as of which the Monorail Construction Work has been substantially completed and the Monorail System is operational.\n(4) (i) \"The Monorail Factor\" shall mean the sum of (1) the quotient obtained by dividing (x) the sum of the products derived by multiplying the average of the annual capital investment recovery rates calculated for six-month periods, commencing on January 1, 1991, of the \"25- Bond Revenue Index\" appearing in each of the issues of \"The Bond Buyer\" published during the period from January 1, 1991 to June 30, 1991 and each six-month period thereafter up to the last six-month period immediately prior to the Monorail Fee Commencement Date by the respective incremental costs as set forth in items A, B and C of subparagraph (a) (1) of Section II of Schedule M of the Lease paid or incurred during each of the six-month periods by (y) the total of the incremental costs as set forth in items A, B and C of subparagraph (a) (1) of Section II of Schedule M of the Lease paid or incurred during the period from January 1, 1991 up to the Monorail Fee Commencement Date, plus (2) one hundred fifty (150) basis points.\n(ii) The \"Additional Monorail Factor\" shall mean the annual average capital investment recovery rates of the \"25-Bond Revenue Index\" appearing in the last issue of \"The Bond Buyer\" published during the calendar year for which the said average will be applied, plus one hundred fifty (150) basis points.\n(iii) In the event that \"The Bond Buyer\" or its \"25-Bond Revenue Index\" shall be discontinued prior to the date on which the Port Authority determines the Monorail Factor or the Additional Monorail Factor, then the Port Authority shall by notice to the Lessee present a comparable substitute for such Index for all subsequent six-month and annual periods, as aforesaid. The determination of the Port Authority as to such substitute shall be final.\n(5) The \"Initial Monorail Construction Costs Payment Period\" shall mean the period commencing on the Monorail Fee Commencement Date and ending on the day immediately preceding the twenty-fifth (25th) anniversary of the Monorail Fee Commencement Date.\n(6) The \"Additional Monorail Construction Costs Payment Period\" shall mean any period commencing on the date on which the Port Authority shall have certified that the construction of any future capital improvement or replacement for the Monorail System has been substantially completed and is operational and ending on the final day of the useful life of such future capital improvement or replacement in accordance with Port Authority accounting practice.\n(7) \"Maximum Weight for Take-off\" when used with reference to aircraft shall mean the maximum gross weight which such aircraft may lawfully have at the time of leaving the ground at any airport in the United States (under the most favorable conditions which may exist at such airport and without regard to special limiting factors arising out of the particular time, place or circumstances of the particular take-off, such as runway length, air temperature, or the like). The foregoing represents the uniform practice applied to all Aircraft Operators having agreements with the Port Authority with respect to the payment of the Monorail Fee under the provisions in any particular agreement. If such maximum gross weight is not fixed by or pursuant to law, then said phrase shall mean the actual gross weight at take-off.\n(8) The term \"Passenger Aircraft,\" as used herein, shall mean all aircraft operated at the Airport except aircraft, configured to carry only cargo and air crew, government aircraft, and general aviation aircraft.\n(c) Effective as of the Monorail Commencement Date, the Lessee shall pay to the Port Authority the Monorail Fee established by the Port Authority from time to time in accordance with the Provisions of Schedule M, set forth in Paragraph 2 hereof, for each and every take-off of each and every Passenger Aircraft, as defined in subparagraph (b) of this Paragraph 1, operated by the Lessee. The said Monorail Fee shall be a fee per thousand pounds of total Maximum Weight for Take-off, as defined in said subparagraph (b).\n(d) Commencing no later than the 20th day of the month following the month during which the Monorail Fee Commencement Date occurs and no later than the 20th day of each and every month thereafter, including the month following the expiration or earlier termination of the Lease, when the Lessee furnishes to the Port Authority a statement duly certified by an authorized officer of the Lessee certifying the number of take-offs by type of aircraft operated by the Lessee during the preceding calendar month, it shall also separately state take-offs by Passenger Aircraft. The Lessee shall pay to the Port Authority at the time it is obligated to furnish to the Port Authority the foregoing statement the Monorail Fee determined in accordance with Schedule M and payable by the Lessee for its Passenger Aircraft operations during the preceding calendar month computed on the basis of said operations. The Monorail Fee payable by the Lessee hereunder shall be in addition to any and all other rents, charges and fees imposed upon and payable by the Lessee under the Lease. The Monorail Fee shall be payable by the Lessee whether or not the Lessee uses the Monorail System or any or all of the Public Aircraft Facilities in addition to the runways.\n(e) Without limiting any of the foregoing provisions of this Paragraph or any of the provisions of Schedule M, commencing on the effective date hereof and from time to time thereafter and during each calendar year, but no more frequently than quarterly, the Port Authority may notify the Lessee whether and to what extent the payments due to the Port Authority resulting from the tentative Monorail Fee established pursuant to Schedule M will be likely to exceed or be less than the payments which would result from the estimated finalized Monorail Fee as described in Paragraph II of Schedule M for such year for the period during such year as designated by the Port Authority's notice. If such notice is given the Lessee shall pay a new tentative Monorail Fee established by the Port Authority and set forth in said notice until the same is further adjusted in accordance with this subparagraph or Schedule M.\n2. There shall be added the the Lease, as \"Schedule M,\" the following:\n\"SCHEDULE M\"\nI. Commencing upon the date (hereinafter called the 'Monorail Fee Commencement Date') which the Port Authority shall have certified to be the date as of which the construction of the Monorail System at Newark International Airport (hereinafter called the 'Airport') has been substantially completed and is operational and continuing thereafter for the balance of the term of the Lease, the Lessee shall pay to the Port Authority a Monorail Fee for each and every take-off of each and every Passenger Aircraft, as defined in Paragraph 1 of Supplement No. 15 of the Lease, operated by the Lessee. For the period from the Monorail Fee Commencement Date through the 31st day of December of the year in which the said Monorail Fee Commencement Date occurs (which period is hereinafter referred to as 'the Initial Schedule M Period'), the Lessee shall pay for each and every such take-off, a tentative Monorail Fee at the rate of $0.94 per thousand pounds of Maximum Weight for Take-off, as defined in Paragraph 1 of Supplement No. 15 of the Lease. It is understood that the Monorail Fee for the Initial Schedule M Period set forth above is tentative only and is subject to final determination as hereinafter provided.\nII. Initial Construction Factor:\n(a) (1) On or after the Monorail Fee Commencement Date the Port Authority shall determine the portion of the total construction costs (the 'Monorail Construction Costs') paid or incurred by the Port Authority in connection with the Monorail Construction Work, which shall be the total of the following:\nA. Construction Costs:\n(1) payments to independent contractors, vendors and suppliers; (2) premiums or charges for Performance Bonds; (3) insurance premiums or charges; (4) direct payroll and expenses of Port Authority employees and agents engaged in performance or supervision of the work, charged in accordance with Port Authority accounting practice.\nB. Engineering Services:\n(1) payments to independent consultants and engineering firms; (2) direct payroll and expenses of Port Authority staff arising in connection with the work, charged in accordance with Port Authority accounting practice.\nC. Other direct costs charged in accordance with Port Authority accounting practice.\nD. Liquidated overhead in lieu of the Port Authority's administration and overhead costs in the amount of ten percent (10%) of the sum of all other elements of cost included in the Port Authority's net total cost (including Financial Expenses in 'E' below).\nE. Financial Expenses on the foregoing computed in accordance with Port Authority accounting practice.\n(2) The Port Authority shall deduct from the Monorail Construction Costs determined in subparagraph (1) above the amount of PFC Funds available to be applied to the Monorail System project, the remainder being hereinafter referred to as the 'Initial Net Capital Investment.'\n(b) The Port Authority shall determine an amount (the said amount being hereinafter referred to as the \"Initial Construction Factor') equal to even monthly payments derived by multiplying the Initial Net Capital Investment by a monthly multiplier derived in accordance herewith from time to time by the application of the following formula:\n= Monthly Multiplier\n1 - 1\ni i (1 + i)t =\nWhere i equals the Monorail Factor divided by twelve.\nWhere t (a power) equals 300.\nIII. Annual Operating Cost Factor\n(a) The Port Authority shall determine the total of the actual cost of direct labor, materials, insurance, payments to contractors and suppliers, utility purchases and other costs for operation, maintenance, repairs and replacements charged on an expensed basis directly to the Monorail System actually incurred or accrued, including any such costs incurred or accrued prior to the Monorail Fee Commencement Date, during the Initial Schedule M Period (hereinafter collectively called the 'Operating Costs'). Whether an item hereunder is expensed or capitalized will be governed by Port Authority accounting practices.\n(b) The Port Authority shall determine the total amount of rental or fees actually received by the Port Authority from rental car permittees specifically for and in connection with the portion of the Monorail Construction Costs and Operating Costs said permittees are obligated under their respective permits to pay the Port Authority (hereinafter called the 'Rental Car Credit'). The term 'Bus Service Credit' shall mean the amount of Five Hundred Thousand Dollars and No Cents ($500,000.00) and, together with the Rental Car Credit, shall be hereinafter collectively called 'the Credits'). The Port Authority shall subtract the Credits from the Operating Costs and multiply the remainder by one hundred and fifteen percent (115%), the product thereof being hereinafter called the \"Annual Operating Cost Factor.\" The sum of the Initial Construction Factor and the Annual Operating Cost Factor constitutes the 'Total Capital and Operating Costs' as of the last day of the Initial Schedule M period.\nIV. Additional Construction Factor\n(a) The Port Authority may in its discretion purchase an item or perform a project involving capital improvements and replacements other than the Monorail Construction Work in connection with the Monorail System and, in the event it does so, the Port Authority shall determine the portion of the Monorail Construction Costs paid or incurred by the Port Authority in connection therewith from and after the Monorail Fee Commencement Date up to and including December 31st of the calendar year during which the Monorail Fee Commencement Date occurs, or such subsequent calendar year during which such capital item or project is purchased or performed in connection with the Monorail System, which shall be the total of the elements of costs set forth in subparagraph (a) (1) of Section II hereof, said portion being hereinafter called the 'Additional Capital Investment.'\n(b) The Port Authority shall determine an amount (the said amount being hereinafter referred to as the 'Additional Construction Component' and, together with all other Additional Construction Components determined during the said calendar year, being hereinafter collectively called the 'Additional Construction Factor') equal to even monthly payments, payable over the useful life of the capital item or project for which it was made in accordance with Port authority accounting practice commencing on the date on which the Port Authority shall have certified that the purchase or construction of such capital item or project has been substantially completed and is operational and ending on the final date of the useful life of such capital item or project, derived by multiplying the Additional Capital Investment made during such calendar year by a monthly multiplier derived in accordance herewith from time to time by the application of the following formula:\n= Monthly Multiplier\n1 - 1\ni i (1 + i)t =\nWhere i equals the Additional Monorail Factor divided by twelve.\nWhere t (a power) equals the useful life of such capital item or project in accordance with Port Authority accounting practice expressed in number of months.\nV. Annual Monorail Cost\nThe sum of the Initial Construction Factor, the Annual Operating Cost Factor, and the Additional Construction Factor, as the case may be, for the Initial Schedule M period or each subsequent calendar year is hereinafter called the 'Annual Monorail Cost.'\nVI. Total Maximum Weight for Take-off\nThe Port Authority shall determine the Total Maximum Weight for Take-off of all Passenger Aircraft using the Airport during the Initial Schedule M period and close of each calendar year.\nVII. Monorail Fee Determination\nAfter the close of the Initial Schedule M Period and after the close of each calendar year thereafter, the Port Authority shall determine the Monorail Fee for the Initial Schedule M Period, or other calendar year, as the case may be, as follows:\n(a) The Port Authority shall determine the final Monorail Fee for the Initial Schedule M Period, or other calendar year for which the determination is being made, by dividing the Annual Monorail Cost by the Total Maximum Weight for Take-off (in thousands of pounds) determined in Section VI above. The result shall constitute the Monorail Fee for the Initial Schedule M Period or other calendar year for which the determination is being made. It shall also constitute the tentative Monorail Fee for the calendar year following the year for which the determination is being made, and such Monorail Fee shall be expressed in cents per thousand pounds of Total Maximum Weight for Take-off to the nearest ten thousands of a cent. The Monorail Fee shall be multiplied by the Total Maximum Weight for Take-off (in thousands of pounds) of all Passenger Aircraft operated by the Lessee which took off from the Airport during the Initial Schedule M Period or other calendar year for which the determination is being made and during the calendar months which have elapsed since the close of the Initial Schedule M Period or other calendar year. The resultant product shall constitute the Monorail Fee due and payable by the Lessee to the Port Authority for the Initial Schedule M Period, or for the calendar year for which the determination was made, and for the months which have elapsed since the close of the Initial Period or such other calendar year. The Lessee shall continue to make payments based on the new tentative Monorail Fee until the succeeding Monorail Fee is determined.\n(b) Any deficiency due to the Port Authority from the Lessee for the Initial Schedule M Period or for any calendar year thereafter resulting from the determination of any Monorail Fee as aforesaid shall be paid to the Port Authority by the Lessee within thirty (30) days after demand therefor and any excess payments made by the Lessee determined on the basis of a determination of any Monorail Fee shall be credited against future Monorail Fees, such credit to be made within thirty (30) days following the determination of the Monorail Fee. The determination of the Monorail Fee shall be made for the Initial Schedule M Period, and for such calendar year thereafter, by no later than April 30th of the following calendar year.\"\n3. (a) (1) In addition to the premises heretofore let to the Lessee under the Lease, the letting as to which shall continue in full force and effect, the Port Authority hereby lets to the Lessee and the Lessee hereby hires and takes from the Port Authority the following:\nThe portions of the Monorail Station, including the platform (up to but not including the platform doors to the monorail cars), stairway, escalators, and elevators providing access to the Monorail Station, serving Passenger Terminal Building C, which portions are shown in diagonal hatching and stipple on the drawings attached hereto, hereby made a part hereof and marked \"Exhibit M (Sheet 1 of 2)\" and \"Exhibit M (Sheet 2 of 2)\", respectively, together with the fixtures, improvements and other property, if any, of the Port Authority located or to be located therein or thereon, to be and become part of the premises under the Lease, as hereby amended, and are designated herein as and herein collectively called \"Area M\", let to the Lessee, subject to and in accordance with all the terms, provisions and covenants of the Lease as hereby amended for and during all the residue and remainder the term of the letting under the Lease as set forth in Section 4 (b) of the Lease. The parties acknowledge and agree that the ares added to the premises pursuant to this paragraph constitute non-residential real property.\n(2) Area M shall be used as a station of the Monorail System for the accommodation of employees, patrons, passengers, business visitors and guests of the Port Authority and the Lessee. Area M may also be used by other persons and the public generally.\n(3) There shall be no additional rental payable by the Lessee in connection with the use of Area M nor shall there be any abatement of rental in the event the Lessee shall lose the use of all or a portion of Area M.\n(b) If the Port Authority shall not give possession of Area M described in subparagraph (a) above on the effective date hereof by reason or failure or refusal of any occupant thereof to deliver possession thereof to the Port Authority or by reason of any cause or condition beyond the control of the Port Authority, the Port Authority shall not be subject to any liability for the failure to give possession on said date. No such failure to give possession on the date hereinabove specified shall in any wise affect the validity of this Agreement or the obligations of the Lessee hereunder, nor shall the same be construed in any wise to extend the term beyond the date stated in Section 4 (b) of the Lease. Tender shall be made by notice given at least (5) days prior to the effective date of the tender.\n(c) The Lessee acknowledges that it has not relied upon any representation or statement of the Port Authority or its Commissioners, officers, employees and agents as to the suitability of the areas added to the premises pursuant to this Paragraph for the operations permitted thereon by the Lease and agrees to take the said areas and to use the same in their \"as is\" condition at the time of the commencement of the letting hereunder subject to the Port Authority's right to perform and complete the Monorail Construction Work as defined in Paragraph 1 of Supplement No. 15 of the Lease. Without limiting any of the obligations of the Lessee under the Lease, the Lessee agrees that no portion of the premises under the Lease will be used initially or at any time during the letting thereof which is in a condition unsafe or improper for the conduct of the Lessee's operations under the Lease, as hereby amended, so that there is a possibility of injury or damage to life or property.\n4. There shall be added at the end of subparagraph (3) of paragraph (b) of Section 15 of the Lease the following sentence:\n\"As to Area M of the premises, the foregoing obligations shall not apply to the roof and exterior structure of Area M.\"\n5. (a) The parties hereby acknowledge that the Port Authority is performing a certain landside access construction project at the Airport consisting generally of the following portions: a) the construction of certain roadway improvements at the Airport's principal roadway entrance; b) the construction of an inbound ramp connecting the I-78 Connector to Brewster Road and a corresponding ramp to facilitate outbound movements of traffic; c) the construction of roads to connect Monorail Stations \"D2\" and \"E\" to adjacent Airport roads, and drop-off\/pick-up facilities at said Stations; d) an expansion of the Central Terminal Area Complex recirculation road; and e) other roadway improvements related thereto; all of the foregoing portions being hereinafter collectively called the \"Phase 1A Roadway Work.\"\n(b) (1) For purposes of this Supplemental Agreement, the term \"Phase 1A Costs\" shall mean the total costs in connection with all portions of the Phase 1A Roadway Work, as determined under subparagraph (a) (1) of Section II of Schedule M attached to the Lease by Paragraph 2 hereof as such costs are incurred in the performance of each portion of the Phase 1A Roadway Work.\n(2) \"Phase 1A Charge Commencement Date\" shall mean the date on which the Port Authority shall have certified that the construction of any portion of the Phase 1A Roadways has been substantially completed, provided, however, if any such date shall occur on other than the first day of a calendar month, the Phase 1A Charge Commencement Date shall mean the first (1st) day of the first (1st) full calendar month immediately following the month during which the said date occurs.\n(3) (i) \"The Phase 1A Factor\" shall mean the sum of (1) the respective averages of the annual capital investment recovery rates of the \"25-Bond Revenue Index\" appearing in the respective last issues of \"The Bond Buyer\" published during each of the respective calendar years commencing on January 1, 1992 for which each such average will be applied, plus (2) one hundred fifty (150) basis points.\n(ii) In the event that \"The Bond Buyer\" or its \"25-Bond Revenue Index\" shall be discontinued prior to the date on which the Port Authority determines the Phase 1A Factor, then the Port Authority shall by notice to the Lessee propose a comparable substitute for such Index for all subsequent periods as aforesaid. The determination of the Port Authority as to such substitute shall be final.\n(4) The \"Phase 1A Charge Period\" or \"Phase 1A Charge Periods\" shall mean the period or periods, as the case may be, commencing on the applicable Phase 1A Charge Commencement Date and ending on the day immediately preceding the twenty-fifth (25th) anniversary of said Phase 1A Charge Commencement Date.\n(5) For purposes of the calculations under this Paragraph 5, \"PFC Funds\" shall mean revenues derived from fees (herein called \"Passenger Facility Charges\") charged air passengers at the Airport, a portion of which revenues shall be applied to the Phase 1A Costs in accordance with Port Authority applications therefor as approved by the Federal Aviation Administration and the provisions of Section II of Schedule M as added to the Lease by Paragraph 2 of this Supplemental Agreement, the amount of which PFC Funds to be so applied being limited in amount to a total of Fifty Million Dollars and No Cents ($50,000,000.00).\n(c) (1) For any period from the applicable Phase 1A Commencement Date through the 31st day of December of the year in which the said date occurs (all such periods, for purposes of this Paragraph 5, being hereinafter referred to individually as a \"Phase 1A Period\"), the Port Authority shall establish and the Lessee shall pay a Phase 1A Charge, as follows:\n(i) The Port Authority shall determine the portion of the total Phase 1A Costs paid or incurred by the Port Authority up to and including the day immediately preceding the said Phase 1A Commencement Date, each such portion being hereinafter referred to as the \"Phase 1A Investment\".\n(ii) The Port Authority shall deduct from the first and each subsequent Phase 1A Investment determined in subparagraph (i) above the amount of PFC Funds available to be applied to the Phase 1A Costs until the amount of available PFC Funds is exhausted, the remainder and each such portion thereafter being hereinafter referred to as the \"Net Phase 1A Investment\".\n(iii) The Port Authority shall estimate an amount (each such amount being hereinafter referred to as the \"Annual Phase 1A Capital Cost\") equal to even monthly payments derived by multiplying the applicable Net Phase 1A Investment by a monthly multiplier derived in accordance herewith from time to time by the application of the following formula:\n= Monthly Multiplier\n1 - 1\ni i (1 + i)t =\nWhere i equals the Phase 1A Factor (as estimated by the Port Authority) divided by twelve.\nWhere t (a power) equals 300.\n(iv) The Port Authority shall determine the Total Developed Land Square Feet on the Airport, as defined in Section 72 of the Lease, for the calendar year immediately preceding the applicable Phase 1A Commencement Date and shall divide the applicable Annual Phase 1A Capital Cost by said Total, the quotient thereof being hereinafter referred to as the \"Phase 1A Charge Per Acre\".\n(v) The Port Authority shall determine the total developed land area at the Airport occupied by (i) all of the Lessee's premises hereunder (excluding Area C-3 thereof) and (ii) the portion of the Lessee's premises hereunder constituting Area C-3, all as determined in making the calculations under Paragraph II of Schedule A attached to the Lease, as of the last day of the applicable Phase 1A Period; the portions of said total under the foregoing clause (i) being hereinafter referred to as the \"Lessee's C-1 and C-2 Terminal Acreage\" and the portion of said total under the foregoing clause (ii) being hereinafter referred to as the \"Lessee's C-3 Terminal Acreage\".\n(vi) The Port Authority shall multiply the applicable Lessee's C-1 and C-2 Terminal Acreage by the applicable Phase 1A Charge Per Acre, and the Port Authority shall also multiply the applicable Lessee's C-3 Terminal Acreage by the applicable Phase 1A Charge Per Acre, the sum of the two resulting products thereof being herein referred to as the \"Phase 1A Charge\".\n(2) At the time the Port Authority advises the Lessee of the final Airport Services Factor for the calendar year during which any respective Phase 1A Period occurs, the Port Authority shall also advise the Lessee of the applicable Phase 1A Charge, which shall be the amount due and payable by the Lessee to the Port Authority for each calendar month during the applicable Phase 1A Period and for each and every month in the calendar year during which the Phase 1A Charge is calculated. The Lessee shall pay the accumulated total thereof for each month of the applicable Phase 1A Period and for the months that have elapsed since the end of the applicable Phase 1A Period at the time it pays the tentative Airport Services Factor for the calendar month following the month during which the applicable Phase 1A charge is calculated. The Lessee shall continue to make payments based on the said Phase 1A Charge until the same is further adjusted based upon actual costs incurred in the performance of the Phase 1A Roadway Work, as provided in subparagraph (3) hereof.\n(3) After the close of calendar year 1995 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is completed (it being understood that, in the event the Phase 1A Roadway Work is not completed by December 31, 1998, the Lessee shall have no right, nor shall the Port Authority have any obligation to extend or to offer, to extend the term of the letting hereunder beyond March 31, 2013), the Port Authority will adjust, if necessary, the applicable Phase 1A Charge, as follows:\n(i) The Port Authority shall determine the portion of the total Phase 1A Costs paid or incurred by the Port Authority during the calendar year for which the adjustment is being made for any portion of the Phase 1A Roadway Work certified as complete and operational, each such portion being hereinafter referred to as the \"Final Phase 1A Investment\".\n(ii) The Port Authority shall determine an amount (each such amount being hereinafter referred to as the \"Final Annual Capital Cost\") equal to even monthly payments derived by multiplying the applicable Final Phase 1A Investment by a monthly multiplier derived in accordance herewith from time to time by the application of the following formula:\n= Monthly Multiplier\n1 - 1\ni i (1 + i)t =\nWhere i equals the Phase 1A Factor (as determined by the Port Authority) divided by twelve.\nWhere t (a power) equals 300.\n(iii) The Port Authority shall determine the final Phase 1A Charge Per Acre in the manner set forth in item (iv) of subparagraph (c) (1) hereof.\n(iv) The Port Authority shall determine the final Lessee's C-1 and C-2 Terminal Acreage and the final Lessee's Terminal C-3 Acreage in the manner set forth in item (v) of subparagraph (c) (1) hereof.\n(v) The Port Authority shall determine the final Phase 1A Charge in the manner set forth in item (vi) of subparagraph (c) (1) hereof.\n(4) At the time the Port Authority advises the Lessee of the final Airport Services Factor for the calendar year for which the said determination is being made, the Port Authority shall also advise the Lessee of the final Phase 1A Charge, which shall be the amount due and payable by the Lessee to the Port Authority for each calendar month during the calendar year for which the said determination is being made and for each and every month thereafter during the remainder of the Phase 1A Charge Period. The Lessee shall pay the said Phase 1A Charge at the time it pays the tentative Airport Services Factor for the calendar month following the month during which the said Phase 1A Charge is calculated and shall continue to make payments based on the said Phase 1A Charge at the time it pays each Airport Services Factor during the remainder of the Phase 1A Charge Period.\n(5) In the event that the Port Authority shall determine that it expended in the cost of any portion of the Phase 1A Roadway Work amounts as set forth in subparagraph (b) (1) hereof which total more or which total less than the applicable Phase 1A Costs in effect on the day immediately preceding the applicable Phase 1A Charge Commencement Date up to the time of such determination or at any time after the determination of any final Phase 1A Charge then, (x) if more was expended, upon demand of the Port Authority, the Lessee shall pay to the Port Authority an amount equal to the difference between the amounts expended by the Port Authority as so determined by the Port Authority and, (y) if less was expended, the Port Authority shall credit to the Lessee an amount equal to the difference between the amounts expended by the Port Authority as so determined by the Port Authority and, in each case, the aforesaid Phase 1A Costs or such final Phase 1A Charge, as the case may be, in effect on the day immediately preceding the applicable Phase 1A Charge Commencement Date or the day immediately preceding the end of the calendar year for which such final Phase 1A Charge is calculated, and, effective from and after such date of such payment or credit, the applicable Phase 1A Costs for purposes of subparagraph (c) hereof shall be increased or decreased, as the case may be, by the amount of such payment or credit and the applicable Phase 1A Charge payable by the Lessee adjusted appropriately hereunder.\n(6) Any deficiency in the amounts due to the Port Authority from the Lessee for any calendar year resulting from the adjustment of any Phase 1A Charge shall be paid to the Port Authority by the Lessee within thirty (30) days after demand therefor and any excess payments made by the Lessee determined on the basis of an adjusted Phase 1A Charge shall be credited against future rentals, such credit to be made within thirty (30) days following the adjustment of the applicable Phase 1A Charge, as the case may be.\n6. There shall be added immediately after Paragraph VIII of Schedule A attached to the Lease a new Paragraph IX reading as follows:\n\"IX. The Port Authority and the Lessee hereby agree that the Monorail Construction Costs, as defined in Paragraph 1 of Supplement No. 15 of the Lease, and the Phase 1A Costs, as defined in Paragraph 5 of Supplement No. 15 of the Lease, shall not be included in any calculation under this Schedule A. All costs for construction, repair, maintenance, modification and operation of the Monorail System and the Phase 1A Roadways not included in the Monorail Construction Costs or the Phase 1A Costs, respectively, shall be included hereunder.\"\n7. Schedule B attached to the Lease, as heretofore amended, shall be deemed further amended further amended as follows:\n(a) The seventh (7th) line of Paragraph I thereof shall be amended to read as follows:\n\"Non-exclusive Areas for heating, domestic use and air conditioning, and, from and after January 1, 1995, in connection with the Phase 1A Roadway Work, as defined in Supplement No. 15 of the Lease.\"\n(b) There shall be added immediately after subparagraph 4 of Paragraph I thereof, as subparagraph 5, the following:\n\"5. Phase 1A CH&RP Charge:\n(a) In connection with the Phase 1A roadway Work, as defined in Supplement No. 15 of the Lease, and in addition to the charges above, the Lessee shall pay a Phase 1A CH&RP Charge determined as follows: after the close of calendar year 1994, the Port Authority shall establish an Initial Phase 1A CH&RP Charge by multiplying the Initial Fee Per Acre, as determined in Paragraph 5 of Supplement No. 15 of the Lease, by the total developed land area at the Airport occupied by the Central Heating and Refrigeration Plant during the calendar year for which the adjustment is being made and the resulting product shall be divided by three (3) which result thereof shall be divided by twelve (12) and the result thereof being herein referred to as the 'Initial Phase 1A CR&RP Charge.'\n(b) At the time the Port Authority advises the Lessee of the final Charges hereunder for the calendar year during which the Initial Period occurs, the Port Authority shall also advise the Lessee of the Initial Phase 1A CH&RP Charge, which shall be the amount due and payable by the Lessee to the Port Authority for each calendar month during the Initial Period and for each and every month in the calendar year during which the Initial Phase 1A CH&RP Charge is calculated. The Lessee shall pay the accumulated total thereof for each month of the Initial Period and for the months that have elapsed since the end of the Initial Period at the time it pays the tentative Charges hereunder for the calendar month following the month during which the Initial Phase 1A CH&RP Charge is calculated. The Lessee shall continue to make payments based on the said Initial Phase 1A CH&RP Charge until the same is further adjusted.\"\n(c) There shall be added immediately after Paragraph IV thereof, as Paragraph IVa, the following:\n\"IVa. (a) After the close of calendar year 1994 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is completed (it being understood that, in the event the Phase 1A Roadway Work is not completed by December 31, 1998, the Lessee shall have no right nor shall the Port Authority have any obligation to extend or to offer to extend the term of the letting hereunder beyond March 31, 2013), the Port authority will adjust the Initial Phase 1A CH&RP Charge specified above, upwards or downwards, as follows: after the close of calendar year 1995 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is completed, the Port Authority shall establish a New Phase 1A CH&RP Charge by multiplying the New Fee Per Acre, as determined in Paragraph 5 of Supplement No. 15 of the Lease, by the total developed land area at the Airport occupied by the Central Heating and Refrigeration Plant during the calendar year for which the adjustment is being made and the resulting product shall be divided by three (3) which result thereof shall be divided by twelve (12), and the product thereof being herein referred to as the 'New Phase 1A CH&RP Charge'.\n(b) At the time the Port Authority advises the Lessee of the final Charges hereunder for calendar year 1994 or such other calendar for which the adjustment is being made, the Port Authority shall also advise the Lessee of the New Phase 1A CH&RP Charge, which shall be the amount due and payable by the Lessee to the Port Authority for each calendar month during calendar year 1995 or such other calendar year and for each and every month thereafter during the remainder of the Phase 1A Charge Period. The Lessee shall pay the New Phase 1A CH&RP Charge at the time it pays the tentative Charges for the calendar month following the month during which the New Phase 1A CH&RP Charge is calculated and shall continue to make payments based on the said New Phase 1A CH&RP charge at the time it pays each Charge hereunder during the remainder of the Phase 1A Charge Period.\n(c) Any deficiency in the amounts due to the Port Authority from the Lessee for any calendar year resulting from the adjustment of the Initial or New Phase 1A CH&RP Charge shall be paid to the Port Authority by the Lessee within thirty (30) days after demand therefor and any excess payments made by the Lessee determined on the basis of an adjusted Initial or New Phase 1A CH&RP Charge shall be credited against future Charges hereunder, such credit to be made within thirty (30) days following the adjustment of the Initial or New Phase 1A CH&RP Charge, as the case may be.\"\n8. Schedule C attached to the Lease, as heretofore amended, shall be deemed further amended as follows:\n(a) The fifth (5th), sixth (6th) and seventh (7th) lines of Paragraph I thereof shall be amended to read as follows:\n\"(hereinafter called the 'Airport') and continuing thereafter throughout the term of the letting under the Agreement, the Lessee shall pay to the Port Authority a flight fee for each and every take- off made by any aircraft operated by the Lessee. In connection with the Phase 1A Roadway Work as defined in Supplement No. 15 of the Lease, there shall be included in the aforesaid flight fee an Initial Phase 1A Charge Factor subject to adjustment as hereinafter provided. For. . .\"\n(b) There shall be added immediately after subparagraph B of Paragraph II thereof, as subparagraph BB, the following:\n\"BB. Initial Phase 1A Charge Factor:\nIn connection with the Phase 1A Roadway Work and in addition to the P.A.F. Charge Factor and the Airport Services Charge Factor above, the Lessee shall pay an Initial Phase 1A Charge Factor determined as follows: after the close of calendar year 1994, the Port Authority shall establish an Initial Phase 1A Charge Factor by multiplying the Initial Fee Per Acre, as determined in Paragraph 5 of Supplement No. 15 of the Lease, by the total developed land area at the Airport occupied by the Public Aircraft Facilities during the calendar year for which the adjustment is being made and the resulting product shall be divided by the total Maximum Weight for Take-off of all aircraft, as determined under subparagraph A (2) of Section II hereof, at the Airport during the calendar year for which the adjustment is being made, and the quotient thereof shall be multiplied by one thousand (1000), the resulting product thereof being herein referred to as the 'Initial Phase 1A Charge Factor'.\"\n(c) There shall be added immediately after subparagraph BB thereof, as subparagraph BBB, the following:\n\"BBB. New Phase 1A Charge Factor\nAfter the close of calendar year 1994 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is substantially completed (it being understood that, in the event the Phase 1A Roadway Work is not completed by December 31, 1998, the Lessee shall have no right nor shall the Port Authority have any obligation to extend or to offer to extend the term of the letting hereunder beyond March 31, 2013), the Port Authority will adjust the Initial Phase 1A Charge Factor specified above and any New Phase 1A Charge Factor, as hereinafter defined, as the case may be, upwards or downwards, as follows: after the close of calendar year 1994 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is completed, the Port Authority shall establish a New Phase 1A Charge Factor by multiplying the New Fee Per Acre, as determined in Paragraph 5 of Supplement No. 15 of the Lease, by the total developed land area at the Airport occupied by the Public Aircraft Facilities during the calendar year for which the adjustment is being made and the resulting product shall be divided by the total Maximum Weight for Take-Off of all aircraft, as determined under subparagraph A(2) of Section I hereof, operated at the Airport during the calendar year for which the adjustment is being made, and the quotient thereof shall be multiplied by one thousand (1000), the resulting product thereof being, in each case, herein referred to as the 'New Phase 1A Charge Factor'.\"\n(d) The first (1st) line of subparagraph (C) thereof shall be amended to read as follows:\n\"The final P.A.F. Charge Factor, the final airport Services Charge Factor and the Initial or New Phase 1A Charge Factor, as the case may be, as determined above...\"\n9. Schedule D attached to the Lease, as heretofore amended shall be deemed further amended as follows:\n(a) The sixth (6th), seventh (7th) and eight (8th) lines of Paragraph I thereof shall be amended to read as follows:\n\"and continuing thereafter throughout the term of the letting under the Agreement the Lessee shall pay to the Port Authority a gallonage fee for each gallon of fuel delivered to aircraft operated by the Lessee. The Lessee, as an additional component of said gallonage fee and in connection with the Phase 1A Roadway Work, as defined in Supplement No. 15 to the Lease shall pay an initial Phase 1A Charge Component and a New Phase 1A Charge Component as hereinafter determined. The Lessee either itself, if it is a fuel storage....\"\n(b) There shall be added immediately after subparagraph B of Paragraph II thereof, as subparagraph BB, the following:\n\"BB. Initial Phase 1A Charge Component:\nIn connection with the Phase 1A Roadway Work and in addition to the System Charge Component and the Airport Services Charge Component above, the Lessee shall pay an Initial Phase 1A Charge Component determined as follows: after the close of calendar year 1994, the Port Authority shall establish an Initial Phase 1A Charge Component by multiplying the Initial Fee Per Acre, as determined in Paragraph 5 of Supplement No. 15 of the Lease, by the total developed land area at the Airport occupied by the Fuel System during the calendar year for which the adjustment is being made and the resulting product shall be divided by the actual number of gallons of fuel delivered through the Fuel System to all aircraft, as determined under subparagraph A (2) of Section II hereof, operated at the Airport during the calendar year for which the adjustment is being made, the quotient thereof being herein referred to as the 'Initial Phase 1A Charge Component'.\"\n(c) There shall be added immediately after subparagraph BB of Paragraph II thereof, as subparagraph BBB, the following:\n\"BBB. New Phase 1A Charge Component:\nAfter the close of calendar year 1994 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is substantially completed (it being understood that, in the event the Phase 1A Roadway Work is not completed by December 31, 1998, the Lessee shall have no right nor shall the Port Authority have any obligation to extend or to offer to extend the term of the letting hereunder beyond March 31, 2013), the Port Authority will adjust the Initial Phase 1A Charge Component specified above and any New Phase 1A Charge Component, as hereinafter defined, as the case may be, upwards or downwards, as follows: after the close of calendar year 1994 and after the close of each calendar year thereafter up to and including the calendar year during which the Phase 1A Roadway Work is completed, the Port Authority shall establish a New Phase 1A Charge Component by multiplying the New Fee Per Acre, as determined in Paragraph 5 of Supplement 15 of the Lease, by the total developed land area at the Airport occupied by the Fuel system during the calendar year for which the adjustment is being made and the resulting product shall be divided by the actual number of gallons of fuel delivered through the Fuel System to all aircraft, as determined under subparagraph A (2) of Section II hereof, operated at the Airport during the calendar year for which the adjustment is being made, the quotient thereof being herein referred to as the 'New Phase 1A Charge Component'.\"\n(d) The first (1st) line of subparagraph (C) thereof shall be amended to read as follows:\n\"The final System Charge Component, the final Airport Services Charge Component and the Initial or New Phase 1A Charge Component, as the case may be, as determined above shall be....\"\n10. There shall be added to the Lease immediately after Section 92 thereof the following \"Section 92A\":\n\"Section 92A. Airline Service Standards\nSubject to and without limiting or affecting any other term or provision of this Lease, the Lessee agrees to provide service at the premises for the benefit of the traveling public in a manner consistent with generally accepted airline industry standards for airport terminals and will cooperate with the Port Authority and other airlines serving the traveling public at the Airport in maintaining these standards through organized airport service improvement groups. The foregoing provision shall be binding as well on sublessees and others using the premises.\"\n11. Effective as of December 31, 1998, the term of the letting of the Area C-3 portion of the premises under the Lease is hereby extended for the period ending on March 31, 2013, unless sooner terminated, at the rentals in accordance with Paragraphs 12 and 13 below and upon all the terms, covenants, provisions and conditions of the Lease, as hereby amended.\n12. Area C-3 Annual Rentals: For the period commencing on January 1, 1999 to and including December 31, 2003, in addition to all other rentals, fees and charges under the Lease, the Lessee shall pay to the Port Authority rental for Area C-3 during the extension set forth in Paragraph 11 hereof as follows:\nFor Area C-3 rental at an annual rate consisting of a Facility Factor, as hereinafter defined, in the amount of Seven Million Seven Hundred Nine Thousand Eight Hundred Forty-Five Dollars and No Cents ($7,709.845.00) plus the Airport Services Factor, as the same shall then have been adjusted in accordance with Schedule A attached to the Lease, as herein amended, based upon a 1993 final Airport Services Factor in the amount of One Million Two Hundred Sixty-seven Thousand Four Hundred Twenty-eight Dollars and No Cents ($1,267,428.00), which annual rate is subject to adjustment from time to time as provided in Paragraph 13 hereof and Schedule A of the Lease, as herein amended, (\"Area C-3 Annual Rental\"). The Lessee shall pay the rental for Area C-3, as the same shall then have been determined based upon the aforesaid adjustments, monthly in advance on January 1, 1999 and on the first day of each and every succeeding month in equal installments until such time as the aforesaid annual rate has been further adjusted in accordance with Paragraph 13 hereof and Schedule A of the Lease, as herein amended, which adjusted annual rate shall remain in effect until the next adjustment and the monthly installments payable after each such adjustment shall be equal to one-twelfth (1\/12th) of said annual rate as so adjusted.\n13. (a) For the aforesaid period from January 1, 1999 to and including December 31, 2003, the Area C-3 annual rentals payable under Paragraph 12 hereof is made up of two factors, one, a variable factor herein called the \"Facility Factor\", presently represents Seven Million Seven Hundred Nine Thousand Eight Hundred Forty-five Dollars and No Cents ($7,709,845.00) of the aforesaid annual rentals and the other, a variable factor herein called the \"Airport Services Factor\", represents the Airport Services Factor under the Lease, as the same shall have then been adjusted in accordance with Schedule A, as herein amended, based upon a total 1993 final Airport Services Factor in the amount of One Million Two Hundred Sixty-seven Thousand Four Hundred Twenty-Eight Dollars and No Cents ($1,267,428.00), of the total aforesaid annual rentals.\n(b) On January 1, 2004 and on each succeeding fifth (5th) anniversary of said date, the Facility Factor of the Area C-3 annual rentals payable by the Lessee under Paragraph 12 hereof shall be increased to the product resulting from multiplying the Facility Factor in effect on December 31, 2003 and on each succeeding fifth (5th) anniversary of said date, as the case may be, by a percentage equal to 121.6653%. Accordingly,\n(i) for the period from January 1, 2004 to and including December 31, 2008, the Facility Factor of the Area C-3 annual rentals payable under Paragraph 12 hereof, shall represent Nine Million Three Hundred Eighty Thousand Two Hundred Six Dollars and Five Cents ($9,380,206.05); and\n(ii) for the period from January 1, 2009 to and including March 31, 2013, the Facility Factor of the Area C-3 annual rentals payable under Paragraph 12 hereof shall represent Eleven Million Four Hundred Twelve Thousand Four Hundred Fifty-five Dollars and Eighty-three Cents ($11,412,455.83).\n(c) After December 31, 1998 and after the close of each calendar year thereafter, the Port Authority will continue to adjust the Airport Services Factor of the Area C-3 annual rentals payable by the Lessee under Paragraph 12 hereof, such adjustment to be made as provided in Schedule A, as herein amended.\n(d) The Lessee shall pay the total Area C-3 annual rentals payable by the Lessee under Paragraph 12 hereof, as the same have been adjusted in accordance with subparagraphs (b) and (c) of this Paragraph 13, monthly in advance on January 1, 2004 and on the first day of each and every succeeding month in equal installments until such time as the said total Area C-3 annual rentals have been further adjusted in accordance with this Paragraph 13 and Schedule A, as herein amended, which adjusted total annual rentals shall remain in effect until the next adjustment and the monthly installments payable after each such adjustment shall be equal to one-twelfth (1\/12th) of said total annual rentals as so adjusted.\n(e) In the event the term of the letting of Area C-3 shall expire on a day other than the last day of a month, the monthly installment of rentals for Area C-3 for said month shall be the monthly installment prorated on a daily basis using the actual number of days in the said month.\n(f) The Lessee understands and agrees that, while the term of Area C-3 of the premises under the Lease as extended hereunder shall expire on March 31, 2013 the final Airport Services Factor for the year 2013 will not be determined for some months after such expiration and that the Lessee's obligation to pay any deficiency in the Area C-3 rental for the year 2014 or the Port Authority's obligation to pay a refund in said rentals resulting from the determination of the final Airport Services Factor for the year 2013 shall survive such expiration of the Lease and shall remain in full force and effect until such deficiency or refund, if any, is paid. The Lessee hereby specifically acknowledges that neither the survival of the obligation with respect to any such deficiency or refund nor any other provision of this Supplemental Agreement shall grant or shall be deemed to grant any rights whatsoever to the Lessee to have the term of the letting under the Lease, or any portion of the Premises thereunder, extended for the period beyond March 31, 2013 or affect in any way the Port Authority's right to terminate the Lease, or any portion of the premises thereunder, as provided therein.\n14. Effective as of January 1, 1999, Schedule A attached to the Lease, as the same has been heretofore amended, shall be deemed further amended as follows:\n(a) The second sentence of the first (1st) paragraph thereof (as set forth in Paragraph 3 (b) (2) (i) of Supplement No. 8 of the Lease) shall be deemed amended to read as follows:\n\"The Lessee shall pay the rentals for Area C-3 at the rates and times stated in Paragraphs 12 and 13 of Supplement No. 15 of the Lease until the said rates are adjusted as hereinafter provided\".\n(b) The last six lines of said first paragraph of Schedule A as the same are set forth in Paragraph 3 (b) (2) (ii) of Supplement No. 8 of the Lease shall be deemed amended to read as follows:\n\"further, after the close of calendar year 1998 and after the close of each calendar year thereafter, the Port Authority will adjust the Airport Services Factor of the Area C-3 Annual Rental presently set forth in subparagraph 13 (a) of Supplement No. 15 of the Lease, upwards or downwards, as follows:\"\n15. Effective January 1, 1999, subparagraph (e) (1) of Paragraph 3 of Supplement No. 8 of the Lease shall be deemed amended to read as follows:\n\"(e) (1) Effective from and after January 1, 1999, in the event the Lessee shall at any time by the provisions of this Agreement become entitled to an abatement of the Area C-3 Annual Rental, the Facility Factor of the Area C-3 Annual Rental for each square foot of floor space of Area C-3 shall be reduced for each calendar day or major fraction thereof the abatement remains in effect, the use of which is denied the Lessee, by the following amounts: (it being understood that there shall be no abatement of Area C-3 Annual Rental under the Lease for any portion of Area C-3 or for any portion of the term except as specifically provided in this Agreement):\n(i) for each square foot of floor space of Area C-3 at the following daily rate:\n(aa) for the portion of the term of the letting of Area C-3 set forth in Paragraph 13 (a) of Supplement No. 15 of the Lease (January 1, 1999 to and including December 31, 2003) at the daily rate of .....$0.1095890.\n(bb) for the portion of the term of the letting of Area C-3 set forth in Paragraph 13 (b) (i) of Supplement No. 15 of the Lease (January 1, 2004 to and including December 31, 2008) at the daily rate of ..........$0.1333318.\n(cc) for the portion of the term of the letting of Area C-3 set forth in Paragraph 13 (b) (ii) of Supplement No. 15 of the Lease (January 1, 2009 to March 31, 2013) at the daily rate of ......$0.1622186.\n(ii) with respect to the Area D portion of Area C-3 (as described in Paragraph 1 (a) (vi) of Supplement No. 8 of the Lease): Any such abatement shall be made on an equitable basis giving effect to the amount and character of the said Area D portion of Area C-3 the use of which is denied to the Lessee as compared with the entire Area C-3.\nFor the purpose of this Agreement, the measurement of interior building space in Area C-3 shall be computed (i) from the inside surface of outer walls of the structure of which Area C-3 forms a part; (ii) from the center of partitions separating Area C-3 from areas occupied from or used by others.\"\n16. Section 53 of the Lease entitled \"Payment of Flight Fees\" shall be deemed amended as follows:\n(a) The date appearing on the third (3rd) line of paragraph (a) (1) thereof as \"December 31, 1998\" shall be deemed amended to read \"March 31, 2013\".\n(b) Subparagraph (2) of paragraph (a) thereof shall be deemed amended to read as follows:\n\"(2) It is recognized that the flight fee provisions contained in Schedule C are effective through the expiration date of the lettering hereunder (March 31, 2013).\"\n17. Section 56 of the Lease entitled \"Fuel Gallonage Fees\" shall be deemed amended as follows:\n(a) The date appearing as \"December 31, 1998\" on the second (2nd) line of paragraph (a) thereof shall be deemed amended to read \"March 13, 2013\".\n(b) The second subparagraph of paragraph (a) thereof shall be deemed amended to read as follows:\n\"It is recognized that the fuel gallonage fee provisions contained in Schedule D are effective through the expiration of the letting hereunder (March 31, 2013).\"\n18. It is understood, acknowledged and agreed that the right of the Port Authority to terminate the Lease and the letting thereunder with respect to all or portions of Area C-3 as specified in, provided under, and as stated in Paragraph 5 of Supplement No. 11 of the Lease shall continue to apply with full force and effect in accordance with the terms thereof throughout the term of Area C-3 as such term is extended by Paragraph 11 hereof.\n19. The Lessee represents and warrants that no broker has been concerned in the negotiation of this Supplemental Agreement and that there is no broker who is or may be entitled to be paid a commission in connection therewith. The Lessee shall indemnify and save harmless the Port Authority of and from any and all claims for commission or brokerage made by any and all persons, firms or corporations whatsoever for services in connection with the negotiation and execution of this Supplemental Agreement.\n20. Neither the Commissioners of the Port Authority nor any of them, nor any officer, agent or employee thereof, shall be charged personally by the Lessee with any liability, or held liable to it under any term or provision of this Supplemental Agreement, or because of its execution or attempted execution or because of any breach thereof.\n21. As hereby amended, all of the terms, covenants, provisions, conditions and agreements of the Lease shall be and remain in full force and effect.\n22. This Supplemental Agreement and the Lease which it amends constitute the entire agreement between the Port Authority and the Lessee on the subject matter, and may not be changed, modified, discharged or extended except by instrument in writing duly executed on behalf of both the Port Authority and the Lessee. The Lessee agrees that no representations or warranties shall be binding upon the Port Authority unless expressed in writing in the Lease or this Supplemental Agreement.\nIN WITNESS WHEREOF, the Port Authority and the Lessee have executed these presents as of the date first above written.\nATTEST: THE PORT AUTHORITY OF NEW YORK AND NEW JERSEY\n\/s\/ Lysa C. Med By \/s\/ Gerald P. Fitzgerald Secretary (Title) Director of Aviation (Seal)\nATTEST: CONTINENTAL AIRLINES, INC.\n\/s\/ By \/s\/ Holden Shannon\n(Title) Staff Vice President (Corporate Seal)\nCSL-61273; - Ack. N.J.; Corp. & Corp.\nSTATE OF NEW YORK ) COUNTY OF NEW YORK ) SS. ) On this day of , 1995, before me, the subscriber, a notary public of New York, personally appeared the of The Port Authority of New York and New Jersey, who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Commissioners.\n(notarial seal and stamp)\nSTATE OF TEXAS ) COUNTY OF HARRIS ) SS. ) On this 13th day of September, 1995, before me, the subscriber, a notary public of Texas personally appeared Holden Shannon, the Staff Vice-President of CONTINENTAL AIRLINES, INC., who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n\/s\/ Sandra Y. Massalo (notarial seal and stamp)\nSTATE OF ) COUNTY OF ) SS. )\nOn this day of , 1995, before me, the subscriber, a President of , who I am satisfied is the person who has signed the within instrument; and, I having first made known to him the contents thereof, he did acknowledge that he signed, sealed with the corporate seal and delivered the same as such officer aforesaid and the within instrument is the voluntary act and deed of such corporation made by virtue of the authority of its Board of Directors.\n(notarial seal and stamp)\nExhibit 10.4\nAMENDED AND RESTATED EMPLOYMENT AGREEMENT\nTHIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (\"Agreement\") is made by and between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Company\"), and GORDON M. BETHUNE (\"Executive\").\nW I T N E S S E T H:\nWHEREAS, Company and Executive are parties to that certain Employment Agreement dated as of June 5, 1995 (the \"Current Agreement\"); and\nWHEREAS, the Human Resources Committee of the Board of Directors, at its November 2, 1995 meeting, authorized the amendment of the employment agreement of Executive with respect to certain matters; and\nWHEREAS, in connection therewith, the parties desire to amend the Current Agreement and restate it, as so amended, in its entirety as this Agreement;\nNOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, Company and Executive agree as follows:\nARTICLE I.: EMPLOYMENT AND DUTIES\n1A. Employment; Effective Date. Company agrees to employ Executive and Executive agrees to be employed by Company, beginning as of the Effective Date (as hereinafter defined) and continuing for the period of time set forth in Article 2 of this Agreement, subject to the terms and conditions of this Agreement. For purposes of this Agreement, the \"Effective Date\" shall be June 6, 1995.\n1B. Positions. From and after the Effective Date, Company shall employ Executive in the positions of President and Chief Executive Officer of Company, or in such other positions as the parties mutually may agree, and shall, for the full term of Executive's employment hereunder, cause Executive to be nominated for election as a director of Company and use its best efforts to secure such election.\n1C. Duties and Services. Executive agrees to serve in the positions referred to in paragraph 1.2 and, if elected, as a director of Company and to perform diligently and to the best of his abilities the duties and services appertaining to such offices as set forth in the Bylaws of Company in effect on the Effective Date, as well as such additional duties and services appropriate to such offices which the parties mutually may agree upon from time to time.\nARTICLE II.: TERM AND TERMINATION OF EMPLOYMENT\n2A. Term. Unless sooner terminated pursuant to other provisions hereof, Company agrees to employ Executive for a three-year period beginning on the Effective Date. Said term of employment shall be extended automatically for an additional successive three-year period as of the third anniversary of the Effective Date and as of the last day of each successive three-year period of time thereafter that this Agreement is in effect; provided, however, that if, prior to the date which is six months before the last day of any such three-year term of employment, either party shall give written notice to the other that no such automatic extension shall occur, then Executive's employment shall terminate on the last day of the three-year term of employment during which such notice is given.\n2B. Company's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Company, acting pursuant to an express resolution of the Board of Directors of Company (the \"Board of Directors\"), shall have the right to terminate Executive's employment under this Agreement at any time for any of the following reasons:\n1. upon Executive's death;\n2. upon Executive's becoming incapacitated for a period of at least 180 days by accident, sickness or other circumstance which renders him mentally or physically incapable of performing the material duties and services required of him hereunder on a full-time basis during such period;\n3. for cause, which for purposes of this Agreement shall mean Executive's gross negligence or willful misconduct in the performance of the material duties and services required of him pursuant to this Agreement;\n4. for Executive's material breach of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice to Executive by Company of such breach; or\n5. for any other reason whatsoever, in the sole discretion of the Board of Directors.\n2C. Executive's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Executive shall have the right to terminate his employment under this Agreement at any time for any of the following reasons:\n1. the assignment to Executive by the Board of Directors or other officers or representatives of Company of duties materially inconsistent with the duties associated with the positions described in paragraph 1.2 as such duties are constituted as of the Effective Date;\n2. a material diminution in the nature or scope of Executive's authority, responsibilities, or titles from those applicable to him as of the Effective Date;\n3. the occurrence of material acts or conduct on the part of Company or its officers or representatives which prevent Executive from performing his duties and responsibilities pursuant to this Agreement;\n4. Company requiring Executive to be permanently based anywhere outside a major urban center in Texas;\n5. the taking of any action by Company that would materially adversely affect the corporate amenities enjoyed by Executive on the Effective Date;\n6. a material breach by Company of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice of such breach by Executive to Company; or\n7. for any other reason whatsoever, in the sole discretion of Executive.\n2D. Notice of Termination. If Company or Executive desires to terminate Executive's employment hereunder at any time prior to expiration of the term of employment as provided in paragraph 2.1, it or he shall do so by giving written notice to the other party that it or he has elected to terminate Executive's employment hereunder and stating the effective date and reason for such termination, provided that no such action shall alter or amend any other provisions hereof or rights arising hereunder.\nARTICLE III.: COMPENSATION AND BENEFITS\n3A. Base Salary. During the period of this Agreement, Executive shall receive a minimum annual base salary equal to the greater of (i) $550,000.00 or (ii) such amount as the parties mutually may agree upon from time to time. Executive's annual base salary shall be paid in equal installments in accordance with Company's standard policy regarding payment of compensation to executives but no less frequently than semimonthly.\n3B. Bonus Programs. Executive shall participate in each cash bonus program maintained by Company on and after the Effective Date (including, without limitation, any such program maintained for the year during which the Effective Date occurs) at a level which is not less than the maximum participation level made available to any Company executive (determined without regard to period of service or other criteria that might otherwise be necessary to entitle Executive to such level of participation).\n3C. Life Insurance. During the period of this Agreement, Company shall maintain one or more policies of life insurance on the life of Executive providing an aggregate death benefit in an amount not less than the Termination Payment (as such term is defined in paragraph 4.7). Executive shall have the right to designate the beneficiary or beneficiaries of the death benefit payable pursuant to such policy or policies up to an aggregate death benefit in an amount equal to the Termination Payment. To the extent that Company's purchase of, or payment of premiums with respect to, such policy or policies results in compensation income to Executive, Company shall pay to Executive an additional payment (the \"Policy Payment\") in an amount such that after payment by Executive of all taxes imposed on Executive with respect to the Policy Payment, Executive retains an amount of the Policy Payment equal to the taxes imposed upon Executive with respect to such purchase or the payment of such premiums. If for any reason Company fails to maintain the full amount of life insurance coverage required pursuant to the preceding provisions of this paragraph 3.3, Company shall, in the event of the death of Executive while employed by Company, pay Executive's designated beneficiary or beneficiaries an amount equal to the sum of (1) the difference between the Termination Payment and any death benefit payable to Executive's designated beneficiary or beneficiaries under the policy or policies maintained by Company and (2) such additional amount as shall be required to hold Executive's estate, heirs, and such beneficiary or beneficiaries harmless from any additional tax liability resulting from the failure by Company to maintain the full amount of such required coverage.\n3D. Vacation and Sick Leave. During each year of his employment, Executive shall be entitled to vacation and sick leave benefits equal to the maximum available to any Company executive, determined without regard to the period of service that might otherwise be necessary to entitle Executive to such vacation or sick leave under standard Company policy.\n3E. Supplemental Executive Retirement Plan.\n1. Company agrees to pay Executive the deferred compensation benefits set forth in this paragraph 3.5 as a supplemental retirement plan (the \"Plan\"). The base retirement benefit under the Plan (the \"Base Benefit\") shall be in the form of an annual straight life annuity in an amount equal to the product of (a) 1.6% times (b) the number of Executive's credited years of service (as defined below) under the Plan times (c) the Executive's final average compensation (as defined below). For purposes hereof, Executive's credited years of service under the Plan shall be equal to the number of Executive's years of benefit service with Company, calculated as set forth in the Continental Airlines Retirement Plan beginning at January 1, 1995; provided, however, that if Executive is paid the Termination Payment under this Agreement, Executive shall be further credited with three (3) additional years of service under the Plan. For purposes hereof, Executive's final average compensation shall be equal to the greater of (1) $550,000 or (2) the average of the five highest annual cash compensation amounts paid to Executive by Company during the consecutive ten calendar years immediately preceding his termination of employment at retirement or otherwise. For purposes hereof, cash compensation shall include base salary plus cash bonuses other than any cash bonus paid on or prior to March 31, 1995. All benefits under the Plan shall be payable in equal monthly installments beginning on the first day of the month following the Retirement Date. For purposes hereof, \"Retirement Date\" is defined as the later of (A) the date on which Executive attains (or in the event of his earlier death, would have attained) age 65 or (B) the date of his retirement from employment with Company. If Executive is not married on the Retirement Date, benefits under the Plan will be paid to Executive during his lifetime in the form of the Base Benefit. If Executive is married on the Retirement Date, benefits under the Plan will be paid in the form of a joint and survivor annuity that is actuarially equivalent (as defined below) to the Base Benefit, with Executive's spouse as of the Retirement Date being entitled during her lifetime after Executive's death to a benefit (the \"Survivor's Benefit\") equal to 50% of the benefit payable to Executive during their joint lifetimes. In the event of Executive's death prior to the Retirement Date, his surviving spouse, if he is married on the date of his death, will receive beginning on the Retirement Date an amount equal to the Survivor's Benefit calculated as if Executive had retired with a joint and survivor annuity on the date before his date of death. The amount of any benefits payable to Executive and\/or his spouse under the Continental Airlines Retirement Plan shall be offset against benefits due under the Plan. Executive shall be vested immediately with respect to benefits due under the Plan. If Executive's employment with Company terminates for any reason prior to February 14, 1999, Company shall provide further benefits under the Plan to ensure that Executive is treated for all purposes as if he were fully vested under the Continental Airlines Retirement Plan.\n2. Executive understands that he must rely upon the general credit of Company for payment of benefits under the Plan. Company has not and will not in the future set aside assets for security or enter into any other arrangement which will cause the obligation created to be other than a general corporate obligation of Company or will cause Executive to be more than a general creditor of Company.\n3. For purposes of the Plan, the terms \"actuarial equivalent,\" or \"actuarially equivalent\" when used with respect to a specified benefit shall mean the amount of benefit of a different type or payable at a different age that can be provided at the same cost as such specified benefit, as computed by the Actuary. The actuarial assumptions used to determine equivalencies between different forms of annuities under the Plan shall be the 1984 Unisex Pensioners Mortality 50% male, 50% female calculation (with males set back one year and females set back five years), with interest at an annual rate of 7%. The term \"Actuary\" shall mean the individual actuary or actuarial firm selected by Company to service its pension plans generally or if no such individual or firm has been selected, an individual actuary or actuarial firm appointed by Company and reasonably satisfactory to Executive and\/or his spouse.\n4. Company shall indemnify Executive on a fully grossed-up, after-tax basis for any Medicare payroll taxes (plus any income taxes on such indemnity payments) incurred by Executive in connection with the accrual and\/or payment of benefits under the Plan.\n3F. Additional Disability Benefit. If Executive shall begin to receive long-term disability insurance benefits pursuant to a plan maintained by Company and if such benefits cease prior to Executive's attainment of age 65 and while Executive remains disabled, then Company shall immediately pay Executive upon the cessation of such benefits a lump-sum, cash payment in an amount equal to the Termination Payment. If Executive receives payment of a Termination Payment pursuant to the provisions of Article 4, then the provisions of this paragraph 3.6 shall terminate. If Executive shall be disabled at the time his employment with Company terminates and if Executive shall not be entitled to the payment of a Termination Payment pursuant to the provisions of Article 4 upon such termination, then Executive's right to receive the payment upon the occurrence of the circumstances described in this paragraph 3.6 shall be deemed to have accrued as of the date of such termination and shall survive the termination of this Agreement.\n3G. Other Perquisites. During his employment hereunder, Executive shall be afforded the following benefits as incidences of his employment:\n1. Automobile - Company has leased an automobile for Executive's use pursuant to a lease agreement dated July 11, 1994 with Chase Auto Leasing Corp., and Company will continue its performance thereof and its current practices with respect thereto during the term of this Agreement. Company agrees to take such actions as may be necessary to permit Executive, at his option, to acquire title to the automobile at the completion of the lease term by Executive paying the residual payment then owing under the lease.\n2. Business and Entertainment Expenses - Subject to Company's standard policies and procedures with respect to expense reimbursement as applied to its executive employees generally, Company shall reimburse Executive for, or pay on behalf of Executive, reasonable and appropriate expenses incurred by Executive for business related purposes, including dues and fees to industry and professional organizations, costs of entertainment and business development, and costs reasonably incurred as a result of Executive's spouse accompanying Executive on business travel.\n3. Parking - Company shall provide at no expense to Executive a parking place convenient to Executive's office and a parking place at Intercontinental Airport in Houston, Texas.\n4. Other Company Benefits - Executive and, to the extent applicable, Executive's family, dependents and beneficiaries, shall be allowed to participate in all benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, available to similarly-situated Company employees. Such benefits, plans and programs may include, without limitation, profit sharing plan, thrift plan, annual physical examinations, health insurance or health care plan, life insurance, disability insurance, pension plan, pass privileges on Continental Airlines, Flight Benefits and the like. Company shall not, however, by reason of this paragraph be obligated to institute, maintain, or refrain from changing, amending or discontinuing, any such benefit plan or program, so long as such changes are similarly applicable to executive employees generally.\nARTICLE IV.: EFFECT OF TERMINATION ON COMPENSATION\n4A. By Expiration. If Executive's employment hereunder shall terminate upon expiration of the term provided in paragraph 2.1 hereof, then all compensation and all benefits to Executive hereunder shall terminate contemporaneously with termination of his employment, except that the benefits described in paragraph 3.5 shall continue to be payable, Executive shall be provided Flight Benefits (as such term is defined in paragraph 4.7) for the remainder of Executive's lifetime, and, if such termination shall result from Company's delivery of the written notice described in paragraph 2.1, then Company shall (i) cause all options and shares of restricted stock awarded to Executive, including, without limitation, any such awards under Company's 1994 Incentive Equity Plan, as amended (the \"Incentive Plan\"), and other Awards (as defined in the Incentive Plan) made to Executive under the Incentive Plan, to vest immediately upon such termination, (ii) pay Executive on or before the effective date of such termination a lump-sum, cash payment in an amount equal to the Termination Payment, (iii) provide Executive with Outplacement Services (as such term is defined in paragraph 4.7), and (iv) provide Executive and his eligible dependents with Continuation Coverage (as such term is defined in paragraph 4.7) for a period of three years beginning on the effective date of such termination.\n4B. By Company. If Executive's employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and all benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except that the benefits described in paragraph 3.5 shall continue to be payable, Executive shall be provided Flight Benefits for the remainder of Executive's lifetime, and:\n1. if such termination shall be for any reason other than those encompassed by paragraphs 2.2(i), (ii), (iii) or (iv), then Company shall provide Executive with the payments and benefits described in clauses (i) through (iv) of paragraph 4.1; and\n2. if such termination shall be for a reason encompassed by paragraphs 2.2(i) or (ii), then Company shall (1) cause all options and shares of restricted stock awarded to Executive, including, without limitation, any such awards under the Incentive Plan, and other Awards (as defined in the Incentive Plan) made to Executive under the Incentive Plan, to vest immediately upon such termination, and (2) provide Executive (or his designated beneficiary or beneficiaries) with the benefits contemplated under paragraph 3.3 or paragraph 3.6, as applicable.\n4C. By Executive. If Executive's employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except that the benefits described in paragraph 3.5 shall continue to be payable, Executive shall be provided Flight Benefits for the remainder of Executive's lifetime and, if such termination shall be pursuant to paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi) or for any reason whatsoever following the occurrence of a Change in Control (as such term is defined in the Incentive Plan (as amended by the First Amendment thereto) in effect as of the date of this Agreement), then Company shall provide Executive with the payments and benefits described in clauses (i) through (iv) of paragraph 4.1. If Executive's employment hereunder shall be terminated by Executive prior to January 12, 1996 for any reason (other than those encompassed by paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi)) and if a Change in Control has not occurred prior to such termination, then Executive shall promptly refund to Company $750,000 (which amount represents 50% of the cash bonus paid to Executive by Company on July 12, 1994).\n4D. Certain Additional Payments by Company. Notwithstanding anything to the contrary in this Agreement, if any payment, distribution or provision of a benefit by Company to or for the benefit of Executive, whether paid or payable, distributed or distributable or provided or to be provided pursuant to the terms of this Agreement or otherwise (a \"Payment\"), would be subject to an excise or other special additional tax that would not have been imposed absent such Payment (including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended), or any interest or penalties with respect to such excise or other additional tax (such excise or other additional tax, together with any such interest or penalties, are hereinafter collectively referred to as the \"Excise Tax\"), Company shall pay to Executive an additional payment (a \"Gross-up Payment\") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any income taxes and Excise Taxes imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment (taking into account any similar gross-up payments to Executive under the Incentive Plan) equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company in writing of any claim by the Internal Revenue Service which, if successful, would require Company to make a Gross-up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within ten business days after the receipt of such claim. Company shall notify Executive in writing at least ten business days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive.\n4E. Payment Obligations Absolute. Company's obligation to pay Executive the amounts and to make the arrangements provided in this Article 4 shall be absolute and unconditional and shall not be affected by any cir- cumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which Company (including its subsidiaries and affiliates) may have against him or anyone else. All amounts payable by Company shall be paid without notice or demand. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Article 4, and, except as provided in paragraph 4.7 with respect to Continuation Coverage, the obtain- ing of any such other employment (or the engagement in any endeavor as an independent contractor, sole proprietor, partner, or joint venturer) shall in no event effect any reduction of Company's obligations to make (or cause to be made) the payments and arrangements required to be made under this Article 4.\n4F. Liquidated Damages. In light of the difficulties in estimating the damages upon termination of this Agreement, Company and Executive hereby agree that the payments and benefits, if any, to be received by Executive pursuant to this Article 4 shall be received by Executive as liquidated damages. Payment of the Termination Payment pursuant to paragraphs 4.1, 4.2, or 4.3 shall be in lieu of any severance benefit Executive may be entitled to under any severance plan or policy maintained by Company.\n4G. Certain Definitions and Additional Terms. As used herein, the following capitalized terms shall have the meanings assigned below:\n1. \"Continuation Coverage\" shall mean the continued coverage of Executive and his eligible dependents under Company's welfare benefit plans available to executives of Company who have not terminated employment (or the provision of equivalent benefits), including, without limitation, medical, health, dental, life insurance, disability, vision care, accidental death and dismemberment, and prescription drug, at no greater cost to Executive than that applicable to a similarly situated Company executive who has not terminated employment; provided, however, that (1) subject to clause (2) below, the coverage under a particular welfare benefit plan (or the receipt of equivalent benefits) shall terminate upon Executive's receipt of comparable benefits from a subsequent employer and (2) if Executive (and\/or his eligible dependents) would have been entitled to retiree coverage under a particular welfare benefit plan had he voluntarily retired on the date of his termination of employment, then such coverage shall be continued as provided in such plan upon the expiration of the period Continuation Coverage is to be provided pursuant to this Article 4. Notwithstanding any provision in this Article 4 to the contrary, Executive's entitlement to any benefit continuation pursuant to Section 601 et. seq. of the Employee Retirement Income Security Act of 1974, as amended, shall commence at the end of the period of, and shall not be reduced by the provision of, any applicable Continuation Coverage;\n(ii) \"Flight Benefits\" shall mean flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for Executive and his eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in Executive's name for charging flights (in any fare class) on the CO system for Executive, Executive's spouse, Executive's family and significant others as determined by Executive, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in Executive's name for use on the CO system, a membership for Executive and Executive's spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while an officer of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law);\n(iii) \"Outplacement Services\" shall mean outplacement services, at Company's cost and for a period of twelve months beginning on the date of Executive's termination of employment, to be rendered by an agency selected by Executive and approved by the Board of Directors (with such approval not to be unreasonably withheld); and\n(iv) \"Termination Payment\" shall mean an amount equal to three times the sum of (1) Executive's annual base salary pursuant to paragraph 3.1 in effect immediately prior to Executive's termination of employment and (2) a deemed annual bonus which shall be equal to 25% of the amount described in clause (1) of this paragraph 4.7(iv).\nExecutive agrees that, after receipt of an invoice or other accounting statement therefor, he will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on Executive's UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to Executive under the provisions of paragraph 3.7(ii) hereof. Executive agrees that the credit availability under Executive's UATP card (or Similar Card) may be suspended if Executive does not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of Executive's reimbursement in full, the credit availability under Executive's UATP card (or Similar Card) will be restored. The sole cost to Executive of flights on the CO system pursuant to use of Executive's Flight Benefits will be the imputed income with respect to flights on the CO system charged on Executive's UATP card (or Similar Card), calculated throughout the term of Executive's Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to Executive as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described in paragraph 4.7(ii) above, Executive will provide to the Company, upon request, a calculation or other evidence of Executive's marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to Executive, and Executive understands that the Company will not make any gross-up payment to Executive with respect to the income attributable to such reimbursement. Executive agrees that he will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. Executive shall be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for Executive and Executive's spouse, an appropriate flight pass identification card and an Employee Travel Card, each valid at all times during the term of Executive's Flight Benefits.\nARTICLE V.: MISCELLANEOUS\n5A. Interest and Indemnification. If any payment to Executive provided for in this Agreement is not made by Company when due, Company shall pay to Executive interest on the amount payable from the date that such payment should have been made until such payment is made, which interest shall be calculated at 3% plus the prime or base rate of interest announced by Texas Commerce Bank N.A. (or any successor thereto) at its principal office in Houston, Texas (but not in excess of the highest lawful rate), and such interest rate shall change when and as any such change in such prime or base rate shall be announced by such bank. If Executive shall obtain any money judgment or otherwise prevail with respect to any litigation brought by Executive or Company to enforce or interpret any provision contained herein, Company, to the fullest extent permitted by applicable law, hereby indemnifies Executive for his reasonable attorneys' fees and disbursements incurred in such litigation and hereby agrees (i) to pay in full all such fees and disbursements and (ii) to pay prejudgment interest on any money judgment obtained by Executive from the earliest date that payment to him should have been made under this Agreement until such judgment shall have been paid in full, which interest shall be calculated at the rate set forth in the preceding sentence.\n5B. Notices. For purposes of this Agreement, notices and all other communications provided for herein shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to Company to : Continental Airlines, Inc. 2929 Allen Parkway, Suite 2010 Houston, Texas 77019 Attention: General Counsel\nIf to Executive to : Mr. Gordon M. Bethune\nor to such other address as either party may furnish to the other in writing in accordance herewith, except that notices of changes of address shall be effective only upon receipt.\n5C. Applicable Law. This contract is entered into under, and shall be governed for all purposes by, the laws of the State of Texas.\n5D. No Waiver. No failure by either party hereto at any time to give notice of any breach by the other party of, or to require compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.\n5E. Severability. If a court of competent jurisdiction determines that any provision of this Agreement is invalid or unenforceable, then the invalidity or unenforceability of that provision shall not affect the validity or enforceability of any other provision of this Agreement, and all other provisions shall remain in full force and effect.\n5F. 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 together will constitute one and the same Agreement.\n5G. Withholding of Taxes and Other Employee Deductions. Company may withhold from any benefits and payments made pursuant to this Agreement all federal, state, city and other taxes as may be required pursuant to any law or governmental regulation or ruling and all other normal employee deductions made with respect to Company's employees generally.\n5H. Headings. The paragraph headings have been inserted for purposes of convenience and shall not be used for interpretive purposes.\n5I. Gender and Plurals. Wherever the context so requires, the masculine gender includes the feminine or neuter, and the singular number includes the plural and conversely.\n5J. Successors. This Agreement shall be binding upon and inure to the benefit of Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. Except as provided in the preceding sentence, this Agreement, and the rights and obligations of the parties hereunder, are personal and neither this Agreement, nor any right, benefit or obligation of either party hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the other party.\n5K. Term. This Agreement has a term co-extensive with the term of employment as set forth in paragraph 2.1. Termination shall not affect any right or obligation of any party which is accrued or vested prior to or upon such termination.\n5L. Entire Agreement. Except as provided in (i) the benefits, plans, and programs referenced in paragraph 3.7(iv), (ii) any signed written agreement heretofore or contemporaneously executed by Company and Executive with respect to Awards (as defined in the Incentive Plan) under the Incentive Plan, or (iii) any signed written agreement hereafter executed by Company and Executive, this Agreement constitutes the entire agreement of the parties with regard to the subject matter hereof, and contains all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by Company. Without limiting the scope of the preceding sentence, all prior understandings and agreements among the parties hereto relating to the subject matter hereof (including, without limitation, that certain Second Amended and Restated Employment Compensation Agreement by and between Company and Executive dated as of January 10, 1995) are hereby null and void and of no further force and effect. Any modification of this Agreement shall be effective only if it is in writing and signed by the party to be charged.\n5.13 Deemed Resignations. Any termination of Executive's employment shall constitute an automatic resignation of Executive as an officer of Company and each affiliate of Company, and an automatic resignation of Executive from the Board of Directors and from the board of directors of any affiliate of Company.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th day of November, 1995.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Jeffery A. Smisek Title: Senior Vice President\n\"EXECUTIVE\"\nGORDON M. BETHUNE\nExhibit 10.5\nAMENDED AND RESTATED EMPLOYMENT AGREEMENT\nTHIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (\"Agreement\") is made by and between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Company\"), and GREGORY D. BRENNEMAN (\"Executive\").\nW I T N E S S E T H:\nWHEREAS, Company and Executive are parties to that certain Employment Agreement dated as of June 5, 1995 (the \"Current Agreement\"); and\nWHEREAS, the Human Resources Committee of the Board of Directors, at its November 2, 1995 meeting, authorized the amendment of the employment agreements of officers of the Company, selected on a performance basis by the Chief Executive Officer of the Company, with respect to certain matters; and\nWHEREAS, Executive has been so selected by the Chief Executive Officer; and\nWHEREAS, in connection therewith, the parties desire to amend the Current Agreement and restate it, as so amended, in its entirety as this Agreement;\nNOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, Company and Executive agree as follows:\nARTICLE I.: EMPLOYMENT AND DUTIES\n1A. Employment; Effective Date. Company agrees to employ Executive and Executive agrees to be employed by Company, beginning as of the Effective Date (as hereinafter defined) and continuing for the period of time set forth in Article 2 of this Agreement, subject to the terms and conditions of this Agreement. For purposes of this Agreement, the \"Effective Date\" shall be June 6, 1995.\n1B. Position. From and after the Effective Date, Company shall employ Executive in the position of Chief Operating Officer of Company (and Executive shall be a member of the Office of the Chairman), or in such other position or positions as the parties mutually may agree. At the first regularly scheduled meeting of Company's stockholders that occurs after the Effective Date and for the remaining term of Executive's employment hereunder, Company shall cause Executive to be nominated for election as a director of Company and use its best efforts to secure such election.\n1C. Duties and Services. Executive agrees to serve in the position referred to in paragraph 1.2 and, if elected, as a director of Company and to perform diligently and to the best of his abilities the duties and services appertaining to such office as set forth in the Bylaws of Company in effect on the Effective Date, as well as such additional duties and services appropriate to such office which the parties mutually may agree upon from time to time.\nARTICLE II.: TERM AND TERMINATION OF EMPLOYMENT\n2A. Term. Unless sooner terminated pursuant to other provisions hereof, Company agrees to employ Executive for a three-year period beginning on the Effective Date. Said term of employment shall be extended automatically for an additional successive three-year period as of the third anniversary of the Effective Date and as of the last day of each successive three-year period of time thereafter that this Agreement is in effect; provided, however, that if, prior to the date which is six months before the last day of any such three-year term of employment, either party shall give written notice to the other that no such automatic extension shall occur, then Executive's employment shall terminate on the last day of the three-year term of employment during which such notice is given.\n2B. Company's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Company, acting pursuant to an express resolution of the Board of Directors of Company (the \"Board of Directors\"), shall have the right to terminate Executive's employment under this Agreement at any time for any of the following reasons:\n1. upon Executive's death;\n2. upon Executive's becoming incapacitated for a period of at least 180 days by accident, sickness or other circumstance which renders him mentally or physically incapable of performing the material duties and services required of him hereunder on a full-time basis during such period;\n3. for cause, which for purposes of this Agreement shall mean Executive's gross negligence or willful misconduct in the performance of the material duties and services required of him pursuant to this Agreement;\n4. for Executive's material breach of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice to Executive by Company of such breach; or\n5. for any other reason whatsoever, in the sole discretion of the Board of Directors.\n2C. Executive's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Executive shall have the right to terminate his employment under this Agreement at any time for any of the following reasons:\n1. the assignment to Executive by the Board of Directors or other officers or representatives of Company of duties materially inconsistent with the duties associated with the position described in paragraph 1.2 as such duties are constituted as of the Effective Date;\n2. a material diminution in the nature or scope of Executive's authority, responsibilities, or title from those applicable to him as of the Effective Date;\n3. the occurrence of material acts or conduct on the part of Company or its officers or representatives which prevent Executive from performing his duties and responsibilities pursuant to this Agreement;\n4. Company requiring Executive to be permanently based anywhere outside a major urban center in Texas;\n5. the taking of any action by Company that would materially adversely affect the corporate amenities enjoyed by Executive on the Effective Date;\n6. a material breach by Company of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice of such breach by Executive to Company; or\n7. for any other reason whatsoever, in the sole discretion of Executive.\n2D. Notice of Termination. If Company or Executive desires to terminate Executive's employment hereunder at any time prior to expiration of the term of employment as provided in paragraph 2.1, it or he shall do so by giving written notice to the other party that it or he has elected to terminate Executive's employment hereunder and stating the effective date and reason for such termination, provided that no such action shall alter or amend any other provisions hereof or rights arising hereunder.\nARTICLE III.: COMPENSATION AND BENEFITS\n3A. Base Salary. During the period of this Agreement, Executive shall receive a minimum annual base salary equal to the greater of (i) $525,000.00 or (ii) such amount as the parties mutually may agree upon from time to time. Executive's annual base salary shall be paid in equal installments in accordance with Company's standard policy regarding payment of compensation to executives but no less frequently than semimonthly.\n3B. Bonus Programs. Executive shall participate in each cash bonus program maintained by Company on and after the Effective Date (including, without limitation, participation effective as of April 27, 1995 in any such program maintained for the year during which such date occurs) at a level which is not less than the maximum participation level made available to any Company executive (determined without regard to period of service or other criteria that might otherwise be necessary to entitle Executive to such level of participation).\n3C. Life Insurance. During the period of this Agreement, Company shall maintain one or more policies of life insurance on the life of Executive providing an aggregate death benefit in an amount not less than the Termination Payment (as such term is defined in paragraph 4.7). Executive shall have the right to designate the beneficiary or beneficiaries of the death benefit payable pursuant to such policy or policies up to an aggregate death benefit in an amount equal to the Termination Payment. To the extent that Company's purchase of, or payment of premiums with respect to, such policy or policies results in compensation income to Executive, Company shall pay to Executive an additional payment (the \"Policy Payment\") in an amount such that after payment by Executive of all taxes imposed on Executive with respect to the Policy Payment, Executive retains an amount of the Policy Payment equal to the taxes imposed upon Executive with respect to such purchase or the payment of such premiums. If for any reason Company fails to maintain the full amount of life insurance coverage required pursuant to the preceding provisions of this paragraph 3.3, Company shall, in the event of the death of Executive while employed by Company, pay Executive's designated beneficiary or beneficiaries an amount equal to the sum of (1) the difference between the Termination Payment and any death benefit payable to Executive's designated beneficiary or beneficiaries under the policy or policies maintained by Company and (2) such additional amount as shall be required to hold Executive's estate, heirs, and such beneficiary or beneficiaries harmless from any additional tax liability resulting from the failure by Company to maintain the full amount of such required coverage.\n3D. Vacation and Sick Leave. During each year of his employment, Executive shall be entitled to vacation and sick leave benefits equal to the maximum available to any Company executive, determined without regard to the period of service that might otherwise be necessary to entitle Executive to such vacation or sick leave under standard Company policy.\n3E. Additional Disability Benefit. If Executive shall begin to receive long-term disability insurance benefits pursuant to a plan maintained by Company and if such benefits cease prior to Executive's attainment of age 65 and while Executive remains disabled, then Company shall immediately pay Executive upon the cessation of such benefits a lump-sum, cash payment in an amount equal to the Termination Payment. If Executive receives payment of a Termination Payment pursuant to the provisions of Article 4, then the provisions of this paragraph 3.5 shall terminate. If Executive shall be disabled at the time his employment with Company terminates and if Executive shall not be entitled to the payment of a Termination Payment pursuant to the provisions of Article 4 upon such termination, then Executive's right to receive the payment upon the occurrence of the circumstances described in this paragraph 3.5 shall be deemed to have accrued as of the date of such termination and shall survive the termination of this Agreement.\n3F. Stock Options and Restricted Stock.\n1. Executive and Company have entered into an agreement evidencing Company's award to Executive of an option to acquire 275,000 shares of Company's Class B Common Stock under Company's 1994 Incentive Equity Plan, as amended (the \"Incentive Plan\").\n2. Executive and Company have entered into an agreement evidencing Company's award to Executive of restricted stock under the Incentive Plan with respect to 75,000 shares of Company's Class B Common Stock.\n3G. Other Perquisites. During his employment hereunder, Executive shall be afforded the following benefits as incidences of his employment:\n1. Allowance for Automobile or Club Memberships - Company shall provide Executive with an automobile on substantially the same terms and conditions as Company currently provides an automobile for its Chief Executive Officer.\n2. Business and Entertainment Expenses - Subject to Company's standard policies and procedures with respect to expense reimbursement as applied to its executive employees generally, Company shall reimburse Executive for, or pay on behalf of Executive, reasonable and appropriate expenses incurred by Executive for business related purposes, including dues and fees to industry and professional organizations, costs of entertainment and business development, and costs reasonably incurred as a result of Executive's spouse accompanying Executive on business travel.\n3. Parking - Company shall provide at no expense to Executive a parking place convenient to Executive's office and a parking place at Intercontinental Airport in Houston, Texas.\n4. Other Company Benefits - Executive and, to the extent applicable, Executive's family, dependents and beneficiaries, shall be allowed to participate in all benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, available to similarly-situated Company employees. Such benefits, plans and programs may include, without limitation, profit sharing plan, thrift plan, annual physical examinations, health insurance or health care plan, life insurance, disability insurance, pension plan, pass privileges on Continental Airlines, Flight Benefits and the like. Company shall not, however, by reason of this paragraph be obligated to institute, maintain, or refrain from changing, amending or discontinuing, any such benefit plan or program, so long as such changes are similarly applicable to executive employees generally.\nARTICLE IV.: EFFECT OF TERMINATION ON COMPENSATION\n4A. By Expiration. If Executive's employment hereunder shall terminate upon expiration of the term provided in paragraph 2.1 hereof, then all compensation and all benefits to Executive hereunder shall terminate contemporaneously with termination of his employment, except that Executive shall be provided Flight Benefits (as such term is defined in paragraph 4.7) for the remainder of Executive's lifetime and, if such termination shall result from Company's delivery of the written notice described in paragraph 2.1, then Company shall (i) cause all options and shares of restricted stock awarded to Executive, including, without limitation, any such awards under the Incentive Plan, and other Awards (as defined in the Incentive Plan) made to Executive under the Incentive Plan, to vest immediately upon such termination, (ii) pay Executive on or before the effective date of such termination a lump-sum, cash payment in an amount equal to the Termination Payment, (iii) provide Executive with Outplacement Services (as such term is defined in paragraph 4.7), and (iv) provide Executive and his eligible dependents with Continuation Coverage (as such term is defined in paragraph 4.7) for a period of three years beginning on the effective date of such termination.\n4B. By Company. If Executive's employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and all benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except that Executive shall be provided Flight Benefits for the remainder of Executive's lifetime, and:\n1. if such termination shall be for any reason other than those encompassed by paragraphs 2.2(i), (ii), (iii) or (iv), then Company shall provide Executive with the payments and benefits described in clauses (i) through (iv) of paragraph 4.1; and\n2. if such termination shall be for a reason encompassed by para- graphs 2.2(i) or (ii), then Company shall (1) cause all options and shares of restricted stock awarded to Executive, including, without limitation, any such awards under the Incentive Plan, and other Awards (as defined in the Incentive Plan) made to Executive under the Incentive Plan, to vest immediately upon such termination, and (2) provide Executive (or his designated beneficiary or beneficiaries) with the benefits contemplated under paragraph 3.3 or paragraph 3.5, as applicable.\n4C. By Executive. If Executive's employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except that Executive shall be provided Flight Benefits for the remainder of Executive's lifetime and, if such termination shall be pursuant to paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi) or for any reason whatsoever following the occurrence of a Change in Control (as such term is defined in the Incentive Plan (as amended by the First Amendment thereto) in effect as of the date of this Agreement), then Company shall provide Executive with the payments and benefits described in clauses (i) through (iv) of paragraph 4.1.\n4D. Certain Additional Payments by Company. Notwithstanding anything to the contrary in this Agreement, if any payment, distribution or provision of a benefit by Company to or for the benefit of Executive, whether paid or payable, distributed or distributable or provided or to be provided pursuant to the terms of this Agreement or otherwise (a \"Payment\"), would be subject to an excise or other special additional tax that would not have been imposed absent such Payment (including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended), or any interest or penalties with respect to such excise or other additional tax (such excise or other additional tax, together with any such interest or penalties, are hereinafter collectively referred to as the \"Excise Tax\"), Company shall pay to Executive an additional payment (a \"Gross-up Payment\") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any income taxes and Excise Taxes imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment (taking into account any similar gross-up payments to Executive under the Incentive Plan) equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company in writing of any claim by the Internal Revenue Service which, if successful, would require Company to make a Gross-up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within ten business days after the receipt of such claim. Company shall notify Executive in writing at least ten business days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive.\n4E. Payment Obligations Absolute. Company's obligation to pay Executive the amounts and to make the arrangements provided in this Article 4 shall be absolute and unconditional and shall not be affected by any cir- cumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which Company (including its subsidiaries and affiliates) may have against him or anyone else. All amounts payable by Company shall be paid without notice or demand. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Article 4, and, except as provided in paragraph 4.7 with respect to Continuation Coverage, the obtain- ing of any such other employment (or the engagement in any endeavor as an independent contractor, sole proprietor, partner, or joint venturer) shall in no event effect any reduction of Company's obligations to make (or cause to be made) the payments and arrangements required to be made under this Article 4.\n4F. Liquidated Damages. In light of the difficulties in estimating the damages upon termination of this Agreement, Company and Executive hereby agree that the payments and benefits, if any, to be received by Executive pursuant to this Article 4 shall be received by Executive as liquidated damages. Payment of the Termination Payment pursuant to paragraphs 4.1, 4.2, or 4.3 shall be in lieu of any severance benefit Executive may be entitled to under any severance plan or policy maintained by Company.\n4G. Certain Definitions and Additional Terms. As used herein, the following capitalized terms shall have the meanings assigned below:\n1. \"Continuation Coverage\" shall mean the continued coverage of Executive and his eligible dependents under Company's welfare benefit plans available to executives of Company who have not terminated employment (or the provision of equivalent benefits), including, without limitation, medical, health, dental, life insurance, disability, vision care, accidental death and dismemberment, and prescription drug, at no greater cost to Executive than that applicable to a similarly situated Company executive who has not terminated employment; provided, however, that (1) subject to clause (2) below, the coverage under a particular welfare benefit plan (or the receipt of equivalent benefits) shall terminate upon Executive's receipt of comparable benefits from a subsequent employer and (2) if Executive (and\/or his eligible dependents) would have been entitled to retiree coverage under a particular welfare benefit plan had he voluntarily retired on the date of his termination of employment, then such coverage shall be continued as provided in such plan upon the expiration of the period Continuation Coverage is to be provided pursuant to this Article 4. Notwithstanding any provision in this Article 4 to the contrary, Executive's entitlement to any benefit continuation pursuant to Section 601 et. seq. of the Employee Retirement Income Security Act of 1974, as amended, shall commence at the end of the period of, and shall not be reduced by the provision of, any applicable Continuation Coverage;\n(ii) \"Flight Benefits\" shall mean flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for Executive and his eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in Executive's name for charging flights (in any fare class) on the CO system for Executive, Executive's spouse, Executive's family and significant others as determined by Executive, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in Executive's name for use on the CO system, a membership for Executive and Executive's spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while an officer of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law);\n(iii) \"Outplacement Services\" shall mean outplacement services, at Company's cost and for a period of twelve months beginning on the date of Executive's termination of employment, to be rendered by an agency selected by Executive and approved by the Board of Directors (with such approval not to be unreasonably withheld); and\n(iv) \"Termination Payment\" shall mean an amount equal to three times the sum of (1) Executive's annual base salary pursuant to paragraph 3.1 in effect immediately prior to Executive's termination of employment and (2) a deemed annual bonus which shall be equal to 25% of the amount described in clause (1) of this paragraph 4.7(iv).\nExecutive agrees that, after receipt of an invoice or other accounting statement therefor, he will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on Executive's UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to Executive under the provisions of paragraph 3.7(ii) hereof. Executive agrees that the credit availability under Executive's UATP card (or Similar Card) may be suspended if Executive does not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of Executive's reimbursement in full, the credit availability under Executive's UATP card (or Similar Card) will be restored. The sole cost to Executive of flights on the CO system pursuant to use of Executive's Flight Benefits will be the imputed income with respect to flights on the CO system charged on Executive's UATP card (or Similar Card), calculated throughout the term of Executive's Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to Executive as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described in paragraph 4.7(ii) above, Executive will provide to the Company, upon request, a calculation or other evidence of Executive's marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to Executive, and Executive understands that the Company will not make any gross-up payment to Executive with respect to the income attributable to such reimbursement. Executive agrees that he will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. Executive shall be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for Executive and Executive's spouse, an appropriate flight pass identification card and an Employee Travel Card, each valid at all times during the term of Executive's Flight Benefits.\nARTICLE V.: MISCELLANEOUS\n5A. Interest and Indemnification. If any payment to Executive provided for in this Agreement is not made by Company when due, Company shall pay to Executive interest on the amount payable from the date that such payment should have been made until such payment is made, which interest shall be calculated at 3% plus the prime or base rate of interest announced by Texas Commerce Bank National Association (or any successor thereto) at its principal office in Houston, Texas (but not in excess of the highest lawful rate), and such interest rate shall change when and as any such change in such prime or base rate shall be announced by such bank. If Executive shall obtain any money judgment or otherwise prevail with respect to any litigation brought by Executive or Company to enforce or interpret any provision contained herein, Company, to the fullest extent permitted by applicable law, hereby indemnifies Executive for his reasonable attorneys' fees and disbursements incurred in such litigation and hereby agrees (i) to pay in full all such fees and disbursements and (ii) to pay prejudgment interest on any money judgment obtained by Executive from the earliest date that payment to him should have been made under this Agreement until such judgment shall have been paid in full, which interest shall be calculated at the rate set forth in the preceding sentence.\n5B. Notices. For purposes of this Agreement, notices and all other communications provided for herein shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to Company to : Continental Airlines, Inc. 2929 Allen Parkway, Suite 2010 Houston, Texas 77019 Attention: General Counsel\nIf to Executive to : Mr. Gregory D. Brenneman\nor to such other address as either party may furnish to the other in writing in accordance herewith, except that notices of changes of address shall be effective only upon receipt.\n5C. Applicable Law. This contract is entered into under, and shall be governed for all purposes by, the laws of the State of Texas.\n5D. No Waiver. No failure by either party hereto at any time to give notice of any breach by the other party of, or to require compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.\n5E. Severability. If a court of competent jurisdiction determines that any provision of this Agreement is invalid or unenforceable, then the invalidity or unenforceability of that provision shall not affect the validity or enforceability of any other provision of this Agreement, and all other provisions shall remain in full force and effect.\n5F. 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 together will constitute one and the same Agreement.\n5G. Withholding of Taxes and Other Employee Deductions. Company may withhold from any benefits and payments made pursuant to this Agreement all federal, state, city and other taxes as may be required pursuant to any law or governmental regulation or ruling and all other normal employee deductions made with respect to Company's employees generally.\n5H. Headings. The paragraph headings have been inserted for purposes of convenience and shall not be used for interpretive purposes.\n5I. Gender and Plurals. Wherever the context so requires, the masculine gender includes the feminine or neuter, and the singular number includes the plural and conversely.\n5J. Successors. This Agreement shall be binding upon and inure to the benefit of Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. Except as provided in the preceding sentence, this Agreement, and the rights and obligations of the parties hereunder, are personal and neither this Agreement, nor any right, benefit or obligation of either party hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the other party.\n5K. Term. This Agreement has a term co-extensive with the term of employment as set forth in paragraph 2.1. Termination shall not affect any right or obligation of any party which is accrued or vested prior to or upon such termination.\n5L. Entire Agreement. Except as provided in (i) the benefits, plans, and programs referenced in paragraph 3.7(iv), (ii) any signed written agreement heretofore or contemporaneously executed by Company and Executive with respect to Awards (as defined in the Incentive Plan) under the Incentive Plan, or (iii) any signed written agreement hereafter executed by Company and Executive, this Agreement constitutes the entire agreement of the parties with regard to the subject matter hereof, and contains all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by Company. Without limiting the scope of the preceding sentence, all prior understandings and agreements among the parties hereto relating to the subject matter hereof (including, without limitation, that certain Memorandum of Understanding by and among Company, Executive, and Turnworks, Inc. dated as of April 27, 1995, but excluding the Termination Agreement between Company and Turnworks, Inc. referred to therein) are hereby null and void and of no further force and effect. Any modification of this Agreement shall be effective only if it is in writing and signed by the party to be charged.\n5.13 Deemed Resignations. Any termination of Executive's employment shall constitute an automatic resignation of Executive as an officer of Company and each affiliate of Company, and an automatic resignation of Executive from the Board of Directors and from the board of directors of any affiliate of Company.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th day of November, 1995.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Jeffery A. Smisek Title: Senior Vice President\n\"EXECUTIVE\"\nGREGORY D. BRENNEMAN\nExhibit 10.6\nAMENDED AND RESTATED EMPLOYMENT AGREEMENT\nTHIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (\"Agreement\") is made by and between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Company\"), and Lawrence W. Kellner (\"Executive\").\nW I T N E S S E T H:\nWHEREAS, Company and Executive are parties to that certain Employment Agreement dated as of June 5, 1995 (the \"Current Agreement\"); and\nWHEREAS, the Human Resources Committee of the Board of Directors, at its November 2, 1995 meeting, authorized the amendment of the employment agreements of officers of the Company, selected on a performance basis by the Chief Executive Officer of the Company, with respect to certain matters; and\nWHEREAS, Executive has been so selected by the Chief Executive Officer; and\nWHEREAS, in connection therewith, the parties desire to amend the Current Agreement and restate it, as so amended, in its entirety as this Agreement;\nNOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, Company and Executive agree as follows:\nARTICLE I.: EMPLOYMENT AND DUTIES\n1A. Employment; Effective Date. Company agrees to employ Executive and Executive agrees to be employed by Company, beginning as of the Effective Date (as hereinafter defined) and continuing for the period of time set forth in Article 2 of this Agreement, subject to the terms and conditions of this Agreement. For purposes of this Agreement, the \"Effective Date\" shall be June 6, 1995.\n1B. Position. From and after the Effective Date, Company shall employ Executive in the position of Senior Vice President and Chief Financial Officer of Company, or in such other position or positions as the parties mutually may agree.\n1C. Duties and Services. Executive agrees to serve in the position referred to in paragraph 1.2 and to perform diligently and to the best of his abilities the duties and services appertaining to such office as set forth in the Bylaws of Company in effect on the Effective Date, as well as such additional duties and services appropriate to such office which the parties mutually may agree upon from time to time.\nARTICLE II.: TERM AND TERMINATION OF EMPLOYMENT\n2A. Term. Unless sooner terminated pursuant to other provisions hereof, Company agrees to employ Executive for a three-year period beginning on the Effective Date.\n2B. Company's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Company, acting pursuant to an express resolution of the Board of Directors of Company (the \"Board of Directors\") or the Human Resources Committee of the Board of Directors (the \"HR Committee\"), shall have the right to terminate Executive's employment under this Agreement at any time for any of the following reasons:\n1. upon Executive's death;\n2. upon Executive's becoming incapacitated for a period of at least 180 days by accident, sickness or other circumstance which renders him mentally or physically incapable of performing the material duties and services required of him hereunder on a full-time basis during such period;\n3. for cause, which for purposes of this Agreement shall mean Executive's gross negligence or willful misconduct in the performance of, or Executive's abuse of alcohol or drugs rendering him unable to perform, the material duties and services required of him pursuant to this Agreement;\n4. for Executive's material breach of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice to Executive by Company of such breach; or\n5. for any other reason whatsoever, in the sole discretion of the Board of Directors or the Human Resources Committee.\n2C. Executive's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Executive shall have the right to terminate his employment under this Agreement at any time for any of the following reasons:\n1. the assignment to Executive by the Board of Directors or HR Committee or other officers or representatives of Company of duties materially inconsistent with the duties associated with the position described in paragraph 1.2 as such duties are constituted as of the Effective Date;\n2. a material diminution in the nature or scope of Executive's authority, responsibilities, or title from those applicable to him as of the Effective Date;\n3. the occurrence of material acts or conduct on the part of Company or its officers or representatives which prevent Executive from performing his duties and responsibilities pursuant to this Agreement;\n4. Company requiring Executive to be permanently based anywhere outside a major urban center in Texas;\n5. the taking of any action by Company that would materially adversely affect the corporate amenities enjoyed by Executive on the Effective Date;\n6. a material breach by Company of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice of such breach by Executive to Company; or\n7. for any other reason whatsoever, in the sole discretion of Executive.\n2D. Notice of Termination. If Company or Executive desires to terminate Executive's employment hereunder at any time prior to expiration of the term of employment as provided in paragraph 2.1, it or he shall do so by giving written notice to the other party that it or he has elected to terminate Executive's employment hereunder and stating the effective date and reason for such termination, provided that no such action shall alter or amend any other provisions hereof or rights arising hereunder.\nARTICLE III.: COMPENSATION AND BENEFITS\n3A. Base Salary. During the period of this Agreement, Executive shall receive a minimum annual base salary equal to the greater of (i) $350,000.00 or (ii) such amount as the parties mutually may agree upon from time to time. Executive's annual base salary shall be paid in equal installments in accordance with Company's standard policy regarding payment of compensation to executives but no less frequently than semimonthly.\n3B. Bonus Programs. Executive shall participate in each cash bonus program maintained by Company on and after the Effective Date (including, without limitation, participation effective as of April 1, 1995 in any such program maintained for the year during which such date occurs) at a level which is not less than the maximum participation level made available to any other executive of Company at substantially the same title or level of Executive (determined without regard to period of service or other criteria that might otherwise be necessary to entitle Executive to such level of participation).\n3C. Vacation and Sick Leave. During each year of his employment, Executive shall be entitled to vacation and sick leave benefits equal to the maximum available to any Company executive, determined without regard to the period of service that might otherwise be necessary to entitle Executive to such vacation or sick leave under standard Company policy.\n3D. Other Perquisites. During his employment hereunder, Executive shall be afforded the following benefits as incidences of his employment:\n1. Business and Entertainment Expenses - Subject to Company's standard policies and procedures with respect to expense reimbursement as applied to its executive employees generally, Company shall reimburse Executive for, or pay on behalf of Executive, reasonable and appropriate expenses incurred by Executive for business related purposes, including dues and fees to industry and professional organizations, costs of entertainment and business development, and costs reasonably incurred as a result of Executive's spouse accompanying Executive on business travel.\n2. Parking - Company shall provide at no expense to Executive a parking place convenient to Executive's office and a parking place at Intercontinental Airport in Houston, Texas.\n3. Other Company Benefits - Executive and, to the extent applicable, Executive's family, dependents and beneficiaries, shall be allowed to participate in all benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, available to similarly-situated Company employees. Such benefits, plans and programs may include, without limitation, profit sharing plan, thrift plan, annual physical examinations, health insurance or health care plan, life insurance, disability insurance, pension plan, pass privileges on Continental Airlines, Flight Benefits and the like. Company shall not, however, by reason of this paragraph be obligated to institute, maintain, or refrain from changing, amending or discontinuing, any such benefit plan or program, so long as such changes are similarly applicable to executive employees generally.\nARTICLE IV.: EFFECT OF TERMINATION ON COMPENSATION\n4A. By Expiration. If Executive's employment hereunder shall terminate upon expiration of the term provided in paragraph 2.1 hereof, then all compensation and all benefits to Executive hereunder shall terminate contemporaneously with termination of his employment; provided, however, that Executive shall be provided with Flight Benefits for the remainder of Executive's lifetime.\n4B. By Company. If Executive's employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and all benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be for any reason other than those encompassed by paragraphs 2.2(i), (ii), (iii) or (iv), then Company shall (a) pay Executive on or before the effective date of such termination a lump-sum, cash payment in an amount equal to the Termination Payment (as such term is defined in paragraph 4.7), (b) provide Executive with Flight Benefits (as such term is defined in paragraph 4.7) for the remainder of Executive's lifetime, (c) provide Executive with Outplacement Services (as such term is defined in paragraph 4.7), and (d) provide Executive and his eligible dependents with Continuation Coverage (as such term is defined in paragraph 4.7) for the Severance Period.\n4C. By Executive. If Executive's employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be pursuant to paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi), then Company shall provide Executive with the payments and benefits described in clauses (a) through (d) of paragraph 4.2.\n4D. Certain Additional Payments by Company. Notwithstanding anything to the contrary in this Agreement, if any payment, distribution or provision of a benefit by Company to or for the benefit of Executive, whether paid or payable, distributed or distributable or provided or to be provided pursuant to the terms of this Agreement or otherwise (a \"Payment\"), would be subject to an excise or other special additional tax that would not have been imposed absent such Payment (including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended), or any interest or penalties with respect to such excise or other additional tax (such excise or other additional tax, together with any such interest or penalties, are hereinafter collectively referred to as the \"Excise Tax\"), Company shall pay to Executive an additional payment (a \"Gross-up Payment\") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any income taxes and Excise Taxes imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment (taking into account any similar gross-up payments to Executive under the Incentive Plan (as such term is defined in paragraph 4.7)) equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company in writing of any claim by the Internal Revenue Service which, if successful, would require Company to make a Gross- up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within ten business days after the receipt of such claim. Company shall notify Executive in writing at least ten business days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive.\n4E. Payment Obligations Absolute. Company's obligation to pay Executive the amounts and to make the arrangements provided in this Article 4 shall be absolute and unconditional and shall not be affected by any cir- cumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which Company (including its subsidiaries and affiliates) may have against him or anyone else. All amounts payable by Company shall be paid without notice or demand. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Article 4, and, except as provided in paragraph 4.7 with respect to Continuation Coverage, the obtain- ing of any such other employment (or the engagement in any endeavor as an independent contractor, sole proprietor, partner, or joint venturer) shall in no event effect any reduction of Company's obligations to make (or cause to be made) the payments and arrangements required to be made under this Article 4.\n4F. Liquidated Damages. In light of the difficulties in estimating the damages upon termination of this Agreement, Company and Executive hereby agree that the payments and benefits, if any, to be received by Executive pursuant to this Article 4 shall be received by Executive as liquidated damages. Payment of the Termination Payment pursuant to paragraphs 4.2 or 4.3 shall be in lieu of any severance benefit Executive may be entitled to under any severance plan or policy maintained by Company.\n4G. Certain Definitions and Additional Terms. As used herein, the following capitalized terms shall have the meanings assigned below:\n1. \"Annualized Compensation\" shall mean an amount equal to the sum of (1) Executive's annual base salary pursuant to paragraph 3.1 in effect immediately prior to Executive's termination of employment hereunder and (2) a deemed annual bonus which shall be equal to 25% of the amount described in clause (1) of this paragraph 4.7(i);\n2. \"Change in Control\" shall have the meaning assigned to such term in the Incentive Plan (as amended by the First Amendment thereto) in effect as of the date of execution of this Agreement;\n3. \"Continuation Coverage\" shall mean the continued coverage of Executive and his eligible dependents under Company's welfare benefit plans available to executives of Company who have not terminated employment (or the provision of equivalent benefits), including, without limitation, medical, health, dental, life insurance, disability, vision care, accidental death and dismemberment, and prescription drug, at no greater cost to Executive than that applicable to a similarly situated Company executive who has not terminated employment; provided, however, that (1) subject to clause (2) below, the coverage under a particular welfare benefit plan (or the receipt of equivalent benefits) shall terminate upon Executive's receipt of comparable benefits from a subsequent employer and (2) if Executive (and\/or his eligible dependents) would have been entitled to retiree coverage under a particular welfare benefit plan had he voluntarily retired on the date of his termination of employment, then such coverage shall be continued as provided in such plan upon the expiration of the period Continuation Coverage is to be provided pursuant to this Article 4. Notwithstanding any provision in this Article 4 to the contrary, Executive's entitlement to any benefit continuation pursuant to Section 601 et. seq. of the Employee Retirement Income Security Act of 1974, as amended, shall commence at the end of the period of, and shall not be reduced by the provision of, any applicable Continuation Coverage;\n(iv) \"Flight Benefits\" shall mean flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for Executive and his eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in Executive's name for charging flights (in any fare class) on the CO system for Executive, Executive's spouse, Executive's family and significant others as determined by Executive, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in Executive's name for use on the CO system, a membership for Executive and Executive's spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while an officer of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law);\n(v) \"Incentive Plan\" shall mean Company's 1994 Incentive Equity Plan, as amended;\n(vi) \"Outplacement Services\" shall mean outplacement services, at Company's cost and for a period of twelve months beginning on the date of Executive's termination of employment, to be rendered by an agency selected by Executive and approved by the Board of Directors or HR Committee (with such approval not to be unreasonably withheld);\n(vii) \"Severance Period\" shall mean:\na. in the case of a termination of Executive's employment with Company that occurs within two years after the date upon which a Change in Control occurs, a period commencing on the date of such termination and continuing for thirty-six months; or\nb. in the case of a termination of Executive's employment with Company that occurs prior to a Change in Control or after the date which is two years after a Change in Control occurs, a period commencing on the date of such termination and continuing for twenty-four months; and\n(viii) \"Termination Payment\" shall mean an amount equal to Executive's Annualized Compensation multiplied by a fraction, the numerator of which is the number of months in the Severance Period and the denominator of which is twelve.\nExecutive agrees that, after receipt of an invoice or other accounting statement therefor, he will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on Executive's UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to Executive under the provisions of paragraph 3.4(i) hereof. Executive agrees that the credit availability under Executive's UATP card (or Similar Card) may be suspended if Executive does not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of Executive's reimbursement in full, the credit availability under Executive's UATP card (or Similar Card) will be restored. The sole cost to Executive of flights on the CO system pursuant to use of Executive's Flight Benefits will be the imputed income with respect to flights on the CO system charged on Executive's UATP card (or Similar Card), calculated throughout the term of Executive's Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to Executive as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described in paragraph 4.7 (iv) above, Executive will provide to the Company, upon request, a calculation or other evidence of Executive's marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to Executive, and Executive understands that the Company will not make any gross-up payment to Executive with respect to the income attributable to such reimbursement. Executive agrees that he will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. Executive shall be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for Executive and Executive's spouse, an appropriate flight pass identification card and an Employee Travel Card, each valid at all times during the term of Executive's Flight Benefits.\nARTICLE V.: MISCELLANEOUS\n5A. Interest and Indemnification. If any payment to Executive provided for in this Agreement is not made by Company when due, Company shall pay to Executive interest on the amount payable from the date that such payment should have been made until such payment is made, which interest shall be calculated at 3% plus the prime or base rate of interest announced by Texas Commerce Bank National Association (or any successor thereto) at its principal office in Houston, Texas (but not in excess of the highest lawful rate), and such interest rate shall change when and as any such change in such prime or base rate shall be announced by such bank. If Executive shall obtain any money judgment or otherwise prevail with respect to any litigation brought by Executive or Company to enforce or interpret any provision contained herein, Company, to the fullest extent permitted by applicable law, hereby indemnifies Executive for his reasonable attorneys' fees and disbursements incurred in such litigation and hereby agrees (i) to pay in full all such fees and disbursements and (ii) to pay prejudgment interest on any money judgment obtained by Executive from the earliest date that payment to him should have been made under this Agreement until such judgment shall have been paid in full, which interest shall be calculated at the rate set forth in the preceding sentence.\n5B. Notices. For purposes of this Agreement, notices and all other communications provided for herein shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to Company to : Continental Airlines, Inc. 2929 Allen Parkway, Suite 2010 Houston, Texas 77019 Attention: General Counsel\nIf to Executive to : Lawrence W. Kellner\nor to such other address as either party may furnish to the other in writing in accordance herewith, except that notices of changes of address shall be effective only upon receipt.\n5C. Applicable Law. This contract is entered into under, and shall be governed for all purposes by, the laws of the State of Texas.\n5D. No Waiver. No failure by either party hereto at any time to give notice of any breach by the other party of, or to require compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.\n5E. Severability. If a court of competent jurisdiction determines that any provision of this Agreement is invalid or unenforceable, then the invalidity or unenforceability of that provision shall not affect the validity or enforceability of any other provision of this Agreement, and all other provisions shall remain in full force and effect.\n5F. 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 together will constitute one and the same Agreement.\n5G. Withholding of Taxes and Other Employee Deductions. Company may withhold from any benefits and payments made pursuant to this Agreement all federal, state, city and other taxes as may be required pursuant to any law or governmental regulation or ruling and all other normal employee deductions made with respect to Company's employees generally.\n5H. Headings. The paragraph headings have been inserted for purposes of convenience and shall not be used for interpretive purposes.\n5I. Gender and Plurals. Wherever the context so requires, the masculine gender includes the feminine or neuter, and the singular number includes the plural and conversely.\n5J. Successors. This Agreement shall be binding upon and inure to the benefit of Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. Except as provided in the preceding sentence, this Agreement, and the rights and obligations of the parties hereunder, are personal and neither this Agreement, nor any right, benefit or obligation of either party hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the other party.\n5K. Term. This Agreement has a term co-extensive with the term of employment as set forth in paragraph 2.1. Termination shall not affect any right or obligation of any party which is accrued or vested prior to or upon such termination.\n5L. Entire Agreement. Except as provided in (i) the benefits, plans, and programs referenced in paragraph 3.4(iii), (ii) any signed written agreement heretofore or contemporaneously executed by Company and Executive with respect to Awards (as defined in the Incentive Plan) under the Incentive Plan, or (iii) any signed written agreement hereafter executed by Company and Executive, this Agreement constitutes the entire agreement of the parties with regard to the subject matter hereof, and contains all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by Company. Without limiting the scope of the preceding sentence, all prior understandings and agreements among the parties hereto relating to the subject matter hereof are hereby null and void and of no further force and effect. Any modification of this Agreement shall be effective only if it is in writing and signed by the party to be charged.\n5.13 Deemed Resignations. Any termination of Executive's employment shall constitute an automatic resignation of Executive as an officer of Company and each affiliate of Company, and an automatic resignation of Executive from the Board of Directors (if applicable) and from the board of directors of any affiliate of Company.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th day of November, 1995.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Jeffery A. Smisek Title: Senior Vice President\n\"EXECUTIVE\"\n______________________________________ Lawrence W. Kellner\nExhibit 10.7\nAMENDED AND RESTATED EMPLOYMENT AGREEMENT\nTHIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (\"Agreement\") is made by and between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Company\"), and Barry P. Simon (\"Executive\").\nW I T N E S S E T H:\nWHEREAS, Company and Executive are parties to that certain Employment Agreement dated as of June 5, 1995 (the \"Current Agreement\"); and\nWHEREAS, the Human Resources Committee of the Board of Directors, at its November 2, 1995 meeting, authorized the amendment of the employment agreements of officers of the Company, selected on a performance basis by the Chief Executive Officer of the Company, with respect to certain matters; and\nWHEREAS, Executive has been so selected by the Chief Executive Officer; and\nWHEREAS, in connection therewith, the parties desire to amend the Current Agreement and restate it, as so amended, in its entirety as this Agreement;\nNOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, Company and Executive agree as follows:\nARTICLE I.: EMPLOYMENT AND DUTIES\n1A. Employment; Effective Date. Company agrees to employ Executive and Executive agrees to be employed by Company, beginning as of the Effective Date (as hereinafter defined) and continuing for the period of time set forth in Article 2 of this Agreement, subject to the terms and conditions of this Agreement. For purposes of this Agreement, the \"Effective Date\" shall be June 14, 1995.\n1B. Position. From and after the Effective Date, Company shall employ Executive in the position of Senior Vice President - Europe of Company, or in such other position or positions as the parties mutually may agree.\n1C. Duties and Services. Executive agrees to serve in the position referred to in paragraph 1.2 and to perform diligently and to the best of his abilities the duties and services appertaining to such office as set forth in the Bylaws of Company in effect on the Effective Date, as well as such additional duties and services appropriate to such office which the parties mutually may agree upon from time to time.\nARTICLE II.: TERM AND TERMINATION OF EMPLOYMENT\n2A. Term. Unless sooner terminated pursuant to other provisions hereof, Company agrees to employ Executive for a three-year period beginning on the Effective Date.\n2B. Company's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Company, acting pursuant to an express resolution of the Board of Directors of Company (the \"Board of Directors\") or the Human Resources Committee of the Board of Directors (the \"HR Committee\"), shall have the right to terminate Executive's employment under this Agreement at any time for any of the following reasons:\n1. upon Executive's death;\n2. upon Executive's becoming incapacitated for a period of at least 180 days by accident, sickness or other circumstance which renders him mentally or physically incapable of performing the material duties and services required of him hereunder on a full-time basis during such period;\n3. for cause, which for purposes of this Agreement shall mean Executive's gross negligence or willful misconduct in the performance of, or Executive's abuse of alcohol or drugs rendering him unable to perform, the material duties and services required of him pursuant to this Agreement;\n4. for Executive's material breach of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice to Executive by Company of such breach; or\n5. for any other reason whatsoever, in the sole discretion of the Board of Directors or the Human Resources Committee.\n2C. Executive's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Executive shall have the right to terminate his employment under this Agreement at any time for any of the following reasons:\n1. the assignment to Executive by the Board of Directors or HR Committee or other officers or representatives of Company of duties materially inconsistent with the duties associated with the position described in paragraph 1.2 as such duties are constituted as of the Effective Date;\n2. a material diminution in the nature or scope of Executive's authority, responsibilities, or title from those applicable to him as of the Effective Date;\n3. the occurrence of material acts or conduct on the part of Company or its officers or representatives which prevent Executive from performing his duties and responsibilities pursuant to this Agreement;\n4. Company requiring Executive to be permanently based anywhere outside a major urban center in Texas;\n5. the taking of any action by Company that would materially adversely affect the corporate amenities enjoyed by Executive on the Effective Date;\n6. a material breach by Company of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice of such breach by Executive to Company; or\n7. for any other reason whatsoever, in the sole discretion of Executive.\n2D. Notice of Termination. If Company or Executive desires to terminate Executive's employment hereunder at any time prior to expiration of the term of employment as provided in paragraph 2.1, it or he shall do so by giving written notice to the other party that it or he has elected to terminate Executive's employment hereunder and stating the effective date and reason for such termination, provided that no such action shall alter or amend any other provisions hereof or rights arising hereunder.\nARTICLE III.: COMPENSATION AND BENEFITS\n3A. Base Salary. During the period of this Agreement, Executive shall receive a minimum annual base salary equal to the greater of (i) $300,000.00 or (ii) such amount as the parties mutually may agree upon from time to time. Executive's annual base salary shall be paid in equal installments in accordance with Company's standard policy regarding payment of compensation to executives but no less frequently than semimonthly.\n3B. Bonus Programs. Executive shall participate in each cash bonus program maintained by Company on and after the Effective Date (including, without limitation, participation effective as of January 1, 1995 in any such program maintained for the year during which such date occurs) at a level which is not less than the maximum participation level made available to any other executive of Company at substantially the same title or level of Executive (determined without regard to period of service or other criteria that might otherwise be necessary to entitle Executive to such level of participation).\n3C. Vacation and Sick Leave. During each year of his employment, Executive shall be entitled to vacation and sick leave benefits equal to the maximum available to any Company executive, determined without regard to the period of service that might otherwise be necessary to entitle Executive to such vacation or sick leave under standard Company policy.\n3D. Other Perquisites. During his employment hereunder, Executive shall be afforded the following benefits as incidences of his employment:\n1. Business and Entertainment Expenses - Subject to Company's standard policies and procedures with respect to expense reimbursement as applied to its executive employees generally, Company shall reimburse Executive for, or pay on behalf of Executive, reasonable and appropriate expenses incurred by Executive for business related purposes, including dues and fees to industry and professional organizations, costs of entertainment and business development, and costs reasonably incurred as a result of Executive's spouse accompanying Executive on business travel.\n2. Parking - Company shall provide at no expense to Executive a parking place convenient to Executive's office and a parking place at Intercontinental Airport in Houston, Texas.\n3. Other Company Benefits - Executive and, to the extent applicable, Executive's family, dependents and beneficiaries, shall be allowed to participate in all benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, available to similarly-situated Company employees. Such benefits, plans and programs may include, without limitation, profit sharing plan, thrift plan, annual physical examinations, health insurance or health care plan, life insurance, disability insurance, pension plan, pass privileges on Continental Airlines, Flight Benefits and the like. Company shall not, however, by reason of this paragraph be obligated to institute, maintain, or refrain from changing, amending or discontinuing, any such benefit plan or program, so long as such changes are similarly applicable to executive employees generally.\nARTICLE IV.: EFFECT OF TERMINATION ON COMPENSATION\n4A. By Expiration. If Executive's employment hereunder shall terminate upon expiration of the term provided in paragraph 2.1 hereof, then all compensation and all benefits to Executive hereunder shall terminate contemporaneously with termination of his employment; provided, however, that Executive shall be provided with Flight Benefits for the remainder of Executive's lifetime.\n4B. By Company. If Executive's employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and all benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be for any reason other than those encompassed by paragraphs 2.2(i), (ii), (iii) or (iv), then Company shall (a) pay Executive on or before the effective date of such termination a lump-sum, cash payment in an amount equal to the Termination Payment (as such term is defined in paragraph 4.7), (b) provide Executive with Flight Benefits (as such term is defined in paragraph 4.7) for the remainder of Executive's lifetime, (c) provide Executive with Outplacement Services (as such term is defined in paragraph 4.7), and (d) provide Executive and his eligible dependents with Continuation Coverage (as such term is defined in paragraph 4.7) for the Severance Period.\n4C. By Executive. If Executive's employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be pursuant to paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi), then Company shall provide Executive with the payments and benefits described in clauses (a) through (d) of paragraph 4.2.\n4D. Certain Additional Payments by Company. Notwithstanding anything to the contrary in this Agreement, if any payment, distribution or provision of a benefit by Company to or for the benefit of Executive, whether paid or payable, distributed or distributable or provided or to be provided pursuant to the terms of this Agreement or otherwise (a \"Payment\"), would be subject to an excise or other special additional tax that would not have been imposed absent such Payment (including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended), or any interest or penalties with respect to such excise or other additional tax (such excise or other additional tax, together with any such interest or penalties, are hereinafter collectively referred to as the \"Excise Tax\"), Company shall pay to Executive an additional payment (a \"Gross-up Payment\") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any income taxes and Excise Taxes imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment (taking into account any similar gross-up payments to Executive under the Incentive Plan (as such term is defined in paragraph 4.7)) equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company in writing of any claim by the Internal Revenue Service which, if successful, would require Company to make a Gross- up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within ten business days after the receipt of such claim. Company shall notify Executive in writing at least ten business days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive.\n4E. Payment Obligations Absolute. Company's obligation to pay Executive the amounts and to make the arrangements provided in this Article 4 shall be absolute and unconditional and shall not be affected by any cir- cumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which Company (including its subsidiaries and affiliates) may have against him or anyone else. All amounts payable by Company shall be paid without notice or demand. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Article 4, and, except as provided in paragraph 4.7 with respect to Continuation Coverage, the obtain- ing of any such other employment (or the engagement in any endeavor as an independent contractor, sole proprietor, partner, or joint venturer) shall in no event effect any reduction of Company's obligations to make (or cause to be made) the payments and arrangements required to be made under this Article 4.\n4F. Liquidated Damages. In light of the difficulties in estimating the damages upon termination of this Agreement, Company and Executive hereby agree that the payments and benefits, if any, to be received by Executive pursuant to this Article 4 shall be received by Executive as liquidated damages. Payment of the Termination Payment pursuant to paragraphs 4.2 or 4.3 shall be in lieu of any severance benefit Executive may be entitled to under any severance plan or policy maintained by Company.\n4G. Certain Definitions and Additional Terms. As used herein, the following capitalized terms shall have the meanings assigned below:\n1. \"Annualized Compensation\" shall mean an amount equal to the sum of (1) Executive's annual base salary pursuant to paragraph 3.1 in effect immediately prior to Executive's termination of employment hereunder and (2) a deemed annual bonus which shall be equal to 25% of the amount described in clause (1) of this paragraph 4.7(i);\n2. \"Change in Control\" shall have the meaning assigned to such term in the Incentive Plan (as amended by the First Amendment thereto) in effect as of the date of execution of this Agreement;\n3. \"Continuation Coverage\" shall mean the continued coverage of Executive and his eligible dependents under Company's welfare benefit plans available to executives of Company who have not terminated employment (or the provision of equivalent benefits), including, without limitation, medical, health, dental, life insurance, disability, vision care, accidental death and dismemberment, and prescription drug, at no greater cost to Executive than that applicable to a similarly situated Company executive who has not terminated employment; provided, however, that (1) subject to clause (2) below, the coverage under a particular welfare benefit plan (or the receipt of equivalent benefits) shall terminate upon Executive's receipt of comparable benefits from a subsequent employer and (2) if Executive (and\/or his eligible dependents) would have been entitled to retiree coverage under a particular welfare benefit plan had he voluntarily retired on the date of his termination of employment, then such coverage shall be continued as provided in such plan upon the expiration of the period Continuation Coverage is to be provided pursuant to this Article 4. Notwithstanding any provision in this Article 4 to the contrary, Executive's entitlement to any benefit continuation pursuant to Section 601 et. seq. of the Employee Retirement Income Security Act of 1974, as amended, shall commence at the end of the period of, and shall not be reduced by the provision of, any applicable Continuation Coverage;\n(iv) \"Flight Benefits\" shall mean flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for Executive and his eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in Executive's name for charging flights (in any fare class) on the CO system for Executive, Executive's spouse, Executive's family and significant others as determined by Executive, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in Executive's name for use on the CO system, a membership for Executive and Executive's spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while an officer of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law);\n(v) \"Incentive Plan\" shall mean Company's 1994 Incentive Equity Plan, as amended;\n(vi) \"Outplacement Services\" shall mean outplacement services, at Company's cost and for a period of twelve months beginning on the date of Executive's termination of employment, to be rendered by an agency selected by Executive and approved by the Board of Directors or HR Committee (with such approval not to be unreasonably withheld);\n(vii) \"Severance Period\" shall mean:\na. in the case of a termination of Executive's employment with Company that occurs within two years after the date upon which a Change in Control occurs, a period commencing on the date of such termination and continuing for thirty-six months; or\nb. in the case of a termination of Executive's employment with Company that occurs prior to a Change in Control or after the date which is two years after a Change in Control occurs, a period commencing on the date of such termination and continuing for twenty-four months; and\n(viii) \"Termination Payment\" shall mean an amount equal to Executive's Annualized Compensation multiplied by a fraction, the numerator of which is the number of months in the Severance Period and the denominator of which is twelve.\nExecutive agrees that, after receipt of an invoice or other accounting statement therefor, he will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on Executive's UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to Executive under the provisions of paragraph 3.4(i) hereof. Executive agrees that the credit availability under Executive's UATP card (or Similar Card) may be suspended if Executive does not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of Executive's reimbursement in full, the credit availability under Executive's UATP card (or Similar Card) will be restored. The sole cost to Executive of flights on the CO system pursuant to use of Executive's Flight Benefits will be the imputed income with respect to flights on the CO system charged on Executive's UATP card (or Similar Card), calculated throughout the term of Executive's Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to Executive as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described in paragraph 4.7 (iv) above, Executive will provide to the Company, upon request, a calculation or other evidence of Executive's marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to Executive, and Executive understands that the Company will not make any gross-up payment to Executive with respect to the income attributable to such reimbursement. Executive agrees that he will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. Executive shall be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for Executive and Executive's spouse, an appropriate flight pass identification card and an Employee Travel Card, each valid at all times during the term of Executive's Flight Benefits.\nARTICLE V.: MISCELLANEOUS\n5A. Interest and Indemnification. If any payment to Executive provided for in this Agreement is not made by Company when due, Company shall pay to Executive interest on the amount payable from the date that such payment should have been made until such payment is made, which interest shall be calculated at 3% plus the prime or base rate of interest announced by Texas Commerce Bank National Association (or any successor thereto) at its principal office in Houston, Texas (but not in excess of the highest lawful rate), and such interest rate shall change when and as any such change in such prime or base rate shall be announced by such bank. If Executive shall obtain any money judgment or otherwise prevail with respect to any litigation brought by Executive or Company to enforce or interpret any provision contained herein, Company, to the fullest extent permitted by applicable law, hereby indemnifies Executive for his reasonable attorneys' fees and disbursements incurred in such litigation and hereby agrees (i) to pay in full all such fees and disbursements and (ii) to pay prejudgment interest on any money judgment obtained by Executive from the earliest date that payment to him should have been made under this Agreement until such judgment shall have been paid in full, which interest shall be calculated at the rate set forth in the preceding sentence.\n5B. Notices. For purposes of this Agreement, notices and all other communications provided for herein shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to Company to : Continental Airlines, Inc. 2929 Allen Parkway, Suite 2010 Houston, Texas 77019 Attention: General Counsel\nIf to Executive to : Barry P. Simon\nor to such other address as either party may furnish to the other in writing in accordance herewith, except that notices of changes of address shall be effective only upon receipt.\n5C. Applicable Law. This contract is entered into under, and shall be governed for all purposes by, the laws of the State of Texas.\n5D. No Waiver. No failure by either party hereto at any time to give notice of any breach by the other party of, or to require compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.\n5E. Severability. If a court of competent jurisdiction determines that any provision of this Agreement is invalid or unenforceable, then the invalidity or unenforceability of that provision shall not affect the validity or enforceability of any other provision of this Agreement, and all other provisions shall remain in full force and effect.\n5F. 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 together will constitute one and the same Agreement.\n5G. Withholding of Taxes and Other Employee Deductions. Company may withhold from any benefits and payments made pursuant to this Agreement all federal, state, city and other taxes as may be required pursuant to any law or governmental regulation or ruling and all other normal employee deductions made with respect to Company's employees generally.\n5H. Headings. The paragraph headings have been inserted for purposes of convenience and shall not be used for interpretive purposes.\n5I. Gender and Plurals. Wherever the context so requires, the masculine gender includes the feminine or neuter, and the singular number includes the plural and conversely.\n5J. Successors. This Agreement shall be binding upon and inure to the benefit of Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. Except as provided in the preceding sentence, this Agreement, and the rights and obligations of the parties hereunder, are personal and neither this Agreement, nor any right, benefit or obligation of either party hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the other party.\n5K. Term. This Agreement has a term co-extensive with the term of employment as set forth in paragraph 2.1. Termination shall not affect any right or obligation of any party which is accrued or vested prior to or upon such termination.\n5L. Entire Agreement. Except as provided in (i) the benefits, plans, and programs referenced in paragraph 3.4(iii), (ii) any signed written agreement heretofore or contemporaneously executed by Company and Executive with respect to Awards (as defined in the Incentive Plan) under the Incentive Plan, or (iii) any signed written agreement hereafter executed by Company and Executive, this Agreement constitutes the entire agreement of the parties with regard to the subject matter hereof, and contains all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by Company. Without limiting the scope of the preceding sentence, all prior understandings and agreements among the parties hereto relating to the subject matter hereof are hereby null and void and of no further force and effect. Any modification of this Agreement shall be effective only if it is in writing and signed by the party to be charged.\n5.13 Deemed Resignations. Any termination of Executive's employment shall constitute an automatic resignation of Executive as an officer of Company and each affiliate of Company, and an automatic resignation of Executive from the Board of Directors (if applicable) and from the board of directors of any affiliate of Company.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th day of November, 1995.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Jeffery A. Smisek Title: Senior Vice President\n\"EXECUTIVE\"\n______________________________________ Barry P. Simon\nExhibit 10.8\nAMENDED AND RESTATED EMPLOYMENT AGREEMENT\nTHIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (\"Agreement\") is made by and between CONTINENTAL AIRLINES, INC., a Delaware corporation (\"Company\"), and C.D. McLean (\"Executive\").\nW I T N E S S E T H:\nWHEREAS, Company and Executive are parties to that certain Employment Agreement dated as of June 5, 1995 (the \"Current Agreement\"); and\nWHEREAS, the Human Resources Committee of the Board of Directors, at its November 2, 1995 meeting, authorized the amendment of the employment agreements of officers of the Company, selected on a performance basis by the Chief Executive Officer of the Company, with respect to certain matters; and\nWHEREAS, Executive has been so selected by the Chief Executive Officer; and\nWHEREAS, in connection therewith, the parties desire to amend the Current Agreement and restate it, as so amended, in its entirety as this Agreement;\nNOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, Company and Executive agree as follows:\nARTICLE I.: EMPLOYMENT AND DUTIES\n1A. Employment; Effective Date. Company agrees to employ Executive and Executive agrees to be employed by Company, beginning as of the Effective Date (as hereinafter defined) and continuing for the period of time set forth in Article 2 of this Agreement, subject to the terms and conditions of this Agreement. For purposes of this Agreement, the \"Effective Date\" shall be June 6, 1995.\n1B. Position. From and after the Effective Date, Company shall employ Executive in the position of Senior Vice President - Operations of Company, or in such other position or positions as the parties mutually may agree.\n1C. Duties and Services. Executive agrees to serve in the position referred to in paragraph 1.2 and to perform diligently and to the best of his abilities the duties and services appertaining to such office as set forth in the Bylaws of Company in effect on the Effective Date, as well as such additional duties and services appropriate to such office which the parties mutually may agree upon from time to time.\nARTICLE II.: TERM AND TERMINATION OF EMPLOYMENT\n2A. Term. Unless sooner terminated pursuant to other provisions hereof, Company agrees to employ Executive for a three-year period beginning on the Effective Date.\n2B. Company's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Company, acting pursuant to an express resolution of the Board of Directors of Company (the \"Board of Directors\") or the Human Resources Committee of the Board of Directors (the \"HR Committee\"), shall have the right to terminate Executive's employment under this Agreement at any time for any of the following reasons:\n1. upon Executive's death;\n2. upon Executive's becoming incapacitated for a period of at least 180 days by accident, sickness or other circumstance which renders him mentally or physically incapable of performing the material duties and services required of him hereunder on a full-time basis during such period;\n3. for cause, which for purposes of this Agreement shall mean Executive's gross negligence or willful misconduct in the performance of, or Executive's abuse of alcohol or drugs rendering him unable to perform, the material duties and services required of him pursuant to this Agreement;\n4. for Executive's material breach of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice to Executive by Company of such breach; or\n5. for any other reason whatsoever, in the sole discretion of the Board of Directors or the Human Resources Committee.\n2C. Executive's Right to Terminate. Notwithstanding the provisions of paragraph 2.1, Executive shall have the right to terminate his employment under this Agreement at any time for any of the following reasons:\n1. the assignment to Executive by the Board of Directors or HR Committee or other officers or representatives of Company of duties materially inconsistent with the duties associated with the position described in paragraph 1.2 as such duties are constituted as of the Effective Date;\n2. a material diminution in the nature or scope of Executive's authority, responsibilities, or title from those applicable to him as of the Effective Date;\n3. the occurrence of material acts or conduct on the part of Company or its officers or representatives which prevent Executive from performing his duties and responsibilities pursuant to this Agreement;\n4. Company requiring Executive to be permanently based anywhere outside a major urban center in Texas;\n5. the taking of any action by Company that would materially adversely affect the corporate amenities enjoyed by Executive on the Effective Date;\n6. a material breach by Company of any provision of this Agreement which, if correctable, remains uncorrected for 30 days following written notice of such breach by Executive to Company; or\n7. for any other reason whatsoever, in the sole discretion of Executive.\n2D. Notice of Termination. If Company or Executive desires to terminate Executive's employment hereunder at any time prior to expiration of the term of employment as provided in paragraph 2.1, it or he shall do so by giving written notice to the other party that it or he has elected to terminate Executive's employment hereunder and stating the effective date and reason for such termination, provided that no such action shall alter or amend any other provisions hereof or rights arising hereunder.\nARTICLE III.: COMPENSATION AND BENEFITS\n3A. Base Salary. During the period of this Agreement, Executive shall receive a minimum annual base salary equal to the greater of (i) $300,000.00 or (ii) such amount as the parties mutually may agree upon from time to time. Executive's annual base salary shall be paid in equal installments in accordance with Company's standard policy regarding payment of compensation to executives but no less frequently than semimonthly.\n3B. Bonus Programs. Executive shall participate in each cash bonus program maintained by Company on and after the Effective Date (including, without limitation, participation effective as of January 1, 1995 in any such program maintained for the year during which such date occurs) at a level which is not less than the maximum participation level made available to any other executive of Company at substantially the same title or level of Executive (determined without regard to period of service or other criteria that might otherwise be necessary to entitle Executive to such level of participation).\n3C. Vacation and Sick Leave. During each year of his employment, Executive shall be entitled to vacation and sick leave benefits equal to the maximum available to any Company executive, determined without regard to the period of service that might otherwise be necessary to entitle Executive to such vacation or sick leave under standard Company policy.\n3D. Other Perquisites. During his employment hereunder, Executive shall be afforded the following benefits as incidences of his employment:\n1. Business and Entertainment Expenses - Subject to Company's standard policies and procedures with respect to expense reimbursement as applied to its executive employees generally, Company shall reimburse Executive for, or pay on behalf of Executive, reasonable and appropriate expenses incurred by Executive for business related purposes, including dues and fees to industry and professional organizations, costs of entertainment and business development, and costs reasonably incurred as a result of Executive's spouse accompanying Executive on business travel.\n2. Parking - Company shall provide at no expense to Executive a parking place convenient to Executive's office and a parking place at Intercontinental Airport in Houston, Texas.\n3. Other Company Benefits - Executive and, to the extent applicable, Executive's family, dependents and beneficiaries, shall be allowed to participate in all benefits, plans and programs, including improvements or modifications of the same, which are now, or may hereafter be, available to similarly-situated Company employees. Such benefits, plans and programs may include, without limitation, profit sharing plan, thrift plan, annual physical examinations, health insurance or health care plan, life insurance, disability insurance, pension plan, pass privileges on Continental Airlines, Flight Benefits and the like. Company shall not, however, by reason of this paragraph be obligated to institute, maintain, or refrain from changing, amending or discontinuing, any such benefit plan or program, so long as such changes are similarly applicable to executive employees generally.\nARTICLE IV.: EFFECT OF TERMINATION ON COMPENSATION\n4A. By Expiration. If Executive's employment hereunder shall terminate upon expiration of the term provided in paragraph 2.1 hereof, then all compensation and all benefits to Executive hereunder shall terminate contemporaneously with termination of his employment; provided, however, that Executive shall be provided with Flight Benefits for the remainder of Executive's lifetime.\n4B. By Company. If Executive's employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and all benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be for any reason other than those encompassed by paragraphs 2.2(i), (ii), (iii) or (iv), then Company shall (a) pay Executive on or before the effective date of such termination a lump-sum, cash payment in an amount equal to the Termination Payment (as such term is defined in paragraph 4.7), (b) provide Executive with Flight Benefits (as such term is defined in paragraph 4.7) for the remainder of Executive's lifetime, (c) provide Executive with Outplacement Services (as such term is defined in paragraph 4.7), and (d) provide Executive and his eligible dependents with Continuation Coverage (as such term is defined in paragraph 4.7) for the Severance Period.\n4C. By Executive. If Executive's employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1 hereof then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment, except if such termination shall be pursuant to paragraphs 2.3(i), (ii), (iii), (iv), (v), or (vi), then Company shall provide Executive with the payments and benefits described in clauses (a) through (d) of paragraph 4.2.\n4D. Certain Additional Payments by Company. Notwithstanding anything to the contrary in this Agreement, if any payment, distribution or provision of a benefit by Company to or for the benefit of Executive, whether paid or payable, distributed or distributable or provided or to be provided pursuant to the terms of this Agreement or otherwise (a \"Payment\"), would be subject to an excise or other special additional tax that would not have been imposed absent such Payment (including, without limitation, any excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended), or any interest or penalties with respect to such excise or other additional tax (such excise or other additional tax, together with any such interest or penalties, are hereinafter collectively referred to as the \"Excise Tax\"), Company shall pay to Executive an additional payment (a \"Gross-up Payment\") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any income taxes and Excise Taxes imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment (taking into account any similar gross-up payments to Executive under the Incentive Plan (as such term is defined in paragraph 4.7)) equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company in writing of any claim by the Internal Revenue Service which, if successful, would require Company to make a Gross- up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within ten business days after the receipt of such claim. Company shall notify Executive in writing at least ten business days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive.\n4E. Payment Obligations Absolute. Company's obligation to pay Executive the amounts and to make the arrangements provided in this Article 4 shall be absolute and unconditional and shall not be affected by any cir- cumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which Company (including its subsidiaries and affiliates) may have against him or anyone else. All amounts payable by Company shall be paid without notice or demand. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Article 4, and, except as provided in paragraph 4.7 with respect to Continuation Coverage, the obtain- ing of any such other employment (or the engagement in any endeavor as an independent contractor, sole proprietor, partner, or joint venturer) shall in no event effect any reduction of Company's obligations to make (or cause to be made) the payments and arrangements required to be made under this Article 4.\n4F. Liquidated Damages. In light of the difficulties in estimating the damages upon termination of this Agreement, Company and Executive hereby agree that the payments and benefits, if any, to be received by Executive pursuant to this Article 4 shall be received by Executive as liquidated damages. Payment of the Termination Payment pursuant to paragraphs 4.2 or 4.3 shall be in lieu of any severance benefit Executive may be entitled to under any severance plan or policy maintained by Company.\n4G. Certain Definitions and Additional Terms. As used herein, the following capitalized terms shall have the meanings assigned below:\n1. \"Annualized Compensation\" shall mean an amount equal to the sum of (1) Executive's annual base salary pursuant to paragraph 3.1 in effect immediately prior to Executive's termination of employment hereunder and (2) a deemed annual bonus which shall be equal to 25% of the amount described in clause (1) of this paragraph 4.7(i);\n2. \"Change in Control\" shall have the meaning assigned to such term in the Incentive Plan (as amended by the First Amendment thereto) in effect as of the date of execution of this Agreement;\n3. \"Continuation Coverage\" shall mean the continued coverage of Executive and his eligible dependents under Company's welfare benefit plans available to executives of Company who have not terminated employment (or the provision of equivalent benefits), including, without limitation, medical, health, dental, life insurance, disability, vision care, accidental death and dismemberment, and prescription drug, at no greater cost to Executive than that applicable to a similarly situated Company executive who has not terminated employment; provided, however, that (1) subject to clause (2) below, the coverage under a particular welfare benefit plan (or the receipt of equivalent benefits) shall terminate upon Executive's receipt of comparable benefits from a subsequent employer and (2) if Executive (and\/or his eligible dependents) would have been entitled to retiree coverage under a particular welfare benefit plan had he voluntarily retired on the date of his termination of employment, then such coverage shall be continued as provided in such plan upon the expiration of the period Continuation Coverage is to be provided pursuant to this Article 4. Notwithstanding any provision in this Article 4 to the contrary, Executive's entitlement to any benefit continuation pursuant to Section 601 et. seq. of the Employee Retirement Income Security Act of 1974, as amended, shall commence at the end of the period of, and shall not be reduced by the provision of, any applicable Continuation Coverage;\n(iv) \"Flight Benefits\" shall mean flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for Executive and his eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in Executive's name for charging flights (in any fare class) on the CO system for Executive, Executive's spouse, Executive's family and significant others as determined by Executive, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in Executive's name for use on the CO system, a membership for Executive and Executive's spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while an officer of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law);\n(v) \"Incentive Plan\" shall mean Company's 1994 Incentive Equity Plan, as amended;\n(vi) \"Outplacement Services\" shall mean outplacement services, at Company's cost and for a period of twelve months beginning on the date of Executive's termination of employment, to be rendered by an agency selected by Executive and approved by the Board of Directors or HR Committee (with such approval not to be unreasonably withheld);\n(vii) \"Severance Period\" shall mean:\na. in the case of a termination of Executive's employment with Company that occurs within two years after the date upon which a Change in Control occurs, a period commencing on the date of such termination and continuing for thirty-six months; or\nb. in the case of a termination of Executive's employment with Company that occurs prior to a Change in Control or after the date which is two years after a Change in Control occurs, a period commencing on the date of such termination and continuing for twenty-four months; and\n(viii) \"Termination Payment\" shall mean an amount equal to Executive's Annualized Compensation multiplied by a fraction, the numerator of which is the number of months in the Severance Period and the denominator of which is twelve.\nExecutive agrees that, after receipt of an invoice or other accounting statement therefor, he will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on Executive's UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to Executive under the provisions of paragraph 3.4(i) hereof. Executive agrees that the credit availability under Executive's UATP card (or Similar Card) may be suspended if Executive does not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of Executive's reimbursement in full, the credit availability under Executive's UATP card (or Similar Card) will be restored. The sole cost to Executive of flights on the CO system pursuant to use of Executive's Flight Benefits will be the imputed income with respect to flights on the CO system charged on Executive's UATP card (or Similar Card), calculated throughout the term of Executive's Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to Executive as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described in paragraph 4.7 (iv) above, Executive will provide to the Company, upon request, a calculation or other evidence of Executive's marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to Executive, and Executive understands that the Company will not make any gross-up payment to Executive with respect to the income attributable to such reimbursement. Executive agrees that he will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. Executive shall be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for Executive and Executive's spouse, an appropriate flight pass identification card and an Employee Travel Card, each valid at all times during the term of Executive's Flight Benefits.\nARTICLE V.: MISCELLANEOUS\n5A. Interest and Indemnification. If any payment to Executive provided for in this Agreement is not made by Company when due, Company shall pay to Executive interest on the amount payable from the date that such payment should have been made until such payment is made, which interest shall be calculated at 3% plus the prime or base rate of interest announced by Texas Commerce Bank National Association (or any successor thereto) at its principal office in Houston, Texas (but not in excess of the highest lawful rate), and such interest rate shall change when and as any such change in such prime or base rate shall be announced by such bank. If Executive shall obtain any money judgment or otherwise prevail with respect to any litigation brought by Executive or Company to enforce or interpret any provision contained herein, Company, to the fullest extent permitted by applicable law, hereby indemnifies Executive for his reasonable attorneys' fees and disbursements incurred in such litigation and hereby agrees (i) to pay in full all such fees and disbursements and (ii) to pay prejudgment interest on any money judgment obtained by Executive from the earliest date that payment to him should have been made under this Agreement until such judgment shall have been paid in full, which interest shall be calculated at the rate set forth in the preceding sentence.\n5B. Notices. For purposes of this Agreement, notices and all other communications provided for herein shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to Company to : Continental Airlines, Inc. 2929 Allen Parkway, Suite 2010 Houston, Texas 77019 Attention: General Counsel\nIf to Executive to : C. D. McLean\nor to such other address as either party may furnish to the other in writing in accordance herewith, except that notices of changes of address shall be effective only upon receipt.\n5C. Applicable Law. This contract is entered into under, and shall be governed for all purposes by, the laws of the State of Texas.\n5D. No Waiver. No failure by either party hereto at any time to give notice of any breach by the other party of, or to require compliance with, any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.\n5E. Severability. If a court of competent jurisdiction determines that any provision of this Agreement is invalid or unenforceable, then the invalidity or unenforceability of that provision shall not affect the validity or enforceability of any other provision of this Agreement, and all other provisions shall remain in full force and effect.\n5F. 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 together will constitute one and the same Agreement.\n5G. Withholding of Taxes and Other Employee Deductions. Company may withhold from any benefits and payments made pursuant to this Agreement all federal, state, city and other taxes as may be required pursuant to any law or governmental regulation or ruling and all other normal employee deductions made with respect to Company's employees generally.\n5H. Headings. The paragraph headings have been inserted for purposes of convenience and shall not be used for interpretive purposes.\n5I. Gender and Plurals. Wherever the context so requires, the masculine gender includes the feminine or neuter, and the singular number includes the plural and conversely.\n5J. Successors. This Agreement shall be binding upon and inure to the benefit of Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. Except as provided in the preceding sentence, this Agreement, and the rights and obligations of the parties hereunder, are personal and neither this Agreement, nor any right, benefit or obligation of either party hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the other party.\n5K. Term. This Agreement has a term co-extensive with the term of employment as set forth in paragraph 2.1. Termination shall not affect any right or obligation of any party which is accrued or vested prior to or upon such termination.\n5L. Entire Agreement. Except as provided in (i) the benefits, plans, and programs referenced in paragraph 3.4(iii), (ii) any signed written agreement heretofore or contemporaneously executed by Company and Executive with respect to Awards (as defined in the Incentive Plan) under the Incentive Plan, or (iii) any signed written agreement hereafter executed by Company and Executive, this Agreement constitutes the entire agreement of the parties with regard to the subject matter hereof, and contains all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by Company. Without limiting the scope of the preceding sentence, all prior understandings and agreements among the parties hereto relating to the subject matter hereof are hereby null and void and of no further force and effect. Any modification of this Agreement shall be effective only if it is in writing and signed by the party to be charged.\n5.13 Deemed Resignations. Any termination of Executive's employment shall constitute an automatic resignation of Executive as an officer of Company and each affiliate of Company, and an automatic resignation of Executive from the Board of Directors (if applicable) and from the board of directors of any affiliate of Company.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th day of November, 1995.\nCONTINENTAL AIRLINES, INC.\nBy: Name: Jeffery A. Smisek Title: Senior Vice President\n\"EXECUTIVE\"\n______________________________________ C. D. McLean\nExhibit 10.19\nNovember 13, 1995\n[Name and address of director]\nDear ___________________:\nAt its November 2, 1995 meeting, the Board of Directors of Continental Airlines, Inc. (the \"Company\"), pursuant to the recommendation of the Human Resources Committee of the Board of Directors and resolutions duly adopted by the Board, granted certain lifetime flight benefits to the non-employee members of the Board of Directors of the Company. The purpose of this letter agreement, as contemplated and authorized by such resolutions, is to set forth the contractual obligations of the parties with respect to such flight benefits.\nPursuant to such resolutions, you are hereby granted Flight Benefits for your lifetime. As used herein, \"Flight Benefits\" means flight benefits on each airline operated by the Company or any of its affiliates or any successor or successors thereto (the \"CO system\"), consisting of the highest priority space available flight passes for you and your eligible family members (as such eligibility is in effect on the date hereof), a UATP card (or, in the event of discontinuance of the UATP program, a similar charge card permitting the purchase of air travel through direct billing to the Company or any of its affiliates or any successor or successors thereto (a \"Similar Card\")) in your name for charging flights (in any fare class) on the CO system for you, your spouse, your family and significant others as determined by you, a Gold Elite OnePass Card (or similar highest category successor frequent flyer card) in your name for use on the CO system, a membership for you and your spouse in the Company's President's Club (or any successor program maintained in the CO system) and reimbursement (while a member of the Board of Directors of the Company) of up to $10,000 annually for U.S. federal, state or local income taxes (or, if you are not subject to U.S. income tax, the national, provincial, local or other income taxes to which you are subject) on imputed income resulting from such flights (such imputed income to be calculated during the term of such Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law).\nYou agree that, after receipt of an invoice or other accounting statement therefor, you will promptly (and in any event within 45 days after receipt of such invoice or other accounting statement) reimburse the Company for all charges on your UATP card (or Similar Card) which are not for flights on the CO system and which are not otherwise reimbursable to you under the existing policies of the Company for reimbursement of business expenses of members of the Board of Directors. You agree that the credit availability under your UATP card (or Similar Card) may be suspended if you do not timely reimburse the Company as described in the foregoing sentence; provided, that, immediately upon the Company's receipt of your reimbursement in full, the credit availability under your UATP card (or Similar Card) will be restored.\nThe sole cost to you of flights on the CO system pursuant to use of your Flight Benefits will be the imputed income with respect to flights on the CO system charged on your UATP card (or Similar Card), calculated throughout the term of your Flight Benefits at the lowest published fare (i.e., 21 day advance purchase coach fare or other lowest available fare) for the applicable flight on the date of such flight, regardless of the actual fare class booked or flown, or as otherwise required by law, and reported to you as required by applicable law. With respect to any period with respect to which the Company is obligated to provide up to $10,000 of reimbursement for income taxes as described above, you will provide to the Company, upon request, a calculation or other evidence of your marginal tax rate sufficient to permit the Company to calculate accurately the amount to be so reimbursed to you, and you understand that the Company will not make any gross-up payment to you with respect to the income attributable to such reimbursement.\nYou agree that you will not resell or permit to be resold any tickets issued on the CO system in connection with the Flight Benefits. You will be issued a UATP card (or Similar Card), a Gold Elite OnePass Card (or similar highest category successor frequent flyer card), a membership card in the Company's Presidents Club (or any successor program maintained in the CO system) for you and your spouse, and an appropriate flight pass identification card, each valid at all times during the term of your Flight Benefits.\nThis letter agreement shall be binding upon and inure to the benefit of the Company and any successor of the Company, including without limitation any person, association, or entity which may hereafter acquire or succeed to all or substantially all of the business or assets of Company by any means whether direct or indirect, by purchase, merger, consolidation, or otherwise. This letter agreement supersedes and replaces any flight benefits (including observational passes) which you otherwise currently have on the CO system. This letter agreement and the benefits or obligations hereunder may not be assigned by you.\nIf you are in agreement with the terms of this letter agreement, please execute the enclosed copy hereof and return it to the Company at the above address, whereupon this letter agreement will become a binding obligation of the parties hereto.\nSincerely,\nCONTINENTAL AIRLINES, INC.\nBy:_________________________________ Jeffery A. Smisek Senior Vice President\nACCEPTED AND AGREED as of the date first above written:\n____________________________________\nExhibit 21.1\nSUBSIDIARIES OF CONTINENTAL AIRLINES, INC.\nSUBSIDIARY STATE OF INCORPORATION\nAir Micronesia, Inc. Delaware\nContinental Express, Inc. Delaware\nContinental Micronesia, Inc. Delaware\nExhibit 23.1\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in: (i) the Registration Statement (Form S-3 No. 33-79688) of Continental Airlines, Inc. and in the related Prospectus, and (ii) the Registration Statements (Form S-8 No. 33- 81324 and Form S-8 No. 33-60009) pertaining to the Continental Airlines, Inc. 1994 Incentive Equity Plan, (Form S-8 No. 33-81326 and Form S-8 No. 33-59995) pertaining to the Continental Airlines, Inc. 1994 Restricted Stock Grant, and (Form S-8 No. 33-81328) pertaining to the Continental Airlines, Inc. 1994 Employee Stock Purchase Plan, of our report dated February 12, 1996, with respect to the consolidated financial statements and schedules of Continental Airlines, Inc. included in this Form 10-K for the year ended December 31, 1995.\nERNST & YOUNG LLP\nHouston, Texas February 12, 1996\nExhibit 24.1\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Thomas J. Barrack, Jr.\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ David Bonderman\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Joel H. Cowan\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 18, 1996 By: \/s\/ Patrick Foley\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Rowland C. Frazee\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Hollis L. Harris\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 22, 1996 By: \/s\/ Dean C. Kehler\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 14, 1996 By: \/s\/ Robert L. Lumpkins\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 14, 1996 By: \/s\/ Douglas McCorkindale\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: March 1, 1996 By: \/s\/ David E. Mitchell\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Richard W. Pogue\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 7, 1996 By: \/s\/ William S. Price III\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Donald L. Sturm\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Clause I. Taylor, O.C.\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Karen Hastie Williams\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director and\/or officer of Continental Airlines, Inc. (the \"Company\"), does hereby constitute and appoint Lawrence W. Kellner and Jeffery A. Smisek or either of them, the undersigned's true and lawful attorney or attorneys, to execute the name, place and stead of the undersigned, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (and any amendments thereto), to be filed by the Company under the Securities Exchange Act of 1934, as amended, as fully and effectively in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has signed this Power of Attorney on and as of the date set forth below:\nDate: February 1, 1996 By: \/s\/ Charles A. Yamarone","section_15":""}
{"filename":"716714_1995.txt","cik":"716714","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nSterling Software, Inc. (\"Sterling,\" \"Sterling Software,\" or the \"Company\") was founded in 198l and became a publicly owned corporation in l983. Sterling is a recognized worldwide supplier of software products and services within the electronic commerce, systems management and applications management software markets and also provides technical professional services to certain sectors of the federal government. Consistent with Sterling's decentralized operating style, each major market is served by independently operated business groups which consist of divisions that focus on specific business niches within those markets. Sterling has steadily expanded its operations through internal growth and by business and product acquisitions.\nIn November 1994, Sterling completed the acquisition of KnowledgeWare, Inc. (\"KnowledgeWare\"), a leading provider of applications development software and services, based in Atlanta, Georgia, for approximately $106 million in a stock-for-stock acquisition plus cash costs accounted for as a purchase. Following the completion of the KnowledgeWare acquisition, Sterling reorganized into five groups which currently consist of twenty divisions. See Notes 5 and 6 of Notes to Consolidated Financial Statements--Segment Information and Operations by Geographic Area.\nAs of September 30, 1995, the Company was organized into the following five business groups:\n. The Electronic Commerce Group, headquartered in Columbus, Ohio, provides software and services to facilitate electronic commerce, defined by Sterling as the worldwide electronic interchange of business information. Product offerings include electronic data interchange (\"EDI\") software and network services, data communications software and electronic payments software for financial institutions. Since 1975, Sterling has been a major provider of EDI network services, the cornerstone of electronic commerce, and Sterling is the leading EDI translation software vendor worldwide.\n. The Systems Management Group, headquartered in Washington, D.C., provides systems management software products for computing environments across the enterprise. The group provides software products that specialize in storage management, VM systems management and operations management. Sterling addresses the needs of corporations as they move to client\/server computing environments, offering products that operate on a variety of computer platforms and operating systems.\n. The Applications Management Group, headquartered in Atlanta, Georgia, provides products for developing new applications and revitalizing existing applications and services to ensure that customers are successful using the applications management products. These software tools allow customers to quickly develop and implement new software applications and to integrate and improve existing applications at the desktop.\n. The Federal Systems Group, headquartered in Washington, D.C., provides technical professional services to the federal government under several multi-year contracts primarily in support of secure communications systems for the U.S. Department of Defense (\"DoD\") and National Aeronautics and Space Administration (\"NASA\") aerospace research projects. The group also markets the products and services of the Electronic Commerce Group to federal departments and agencies, and the group's personnel serve as a source of technical expertise for commercial customers and other divisions of Sterling.\n. The International Group, headquartered in Paris, France, is the exclusive channel to international markets for all of Sterling's products. The group operates through six regional divisions representing four regions of Europe, Asia\/Pacific and other countries throughout the world. The products are sold and supported through 30 offices in 17 countries and through trained agents and distributors in 36 additional countries.\nA large percentage of Sterling's business is recurring business through annual and multi-year product support agreements, generally having terms ranging from one to three years, fixed term product lease and rental agreements, generally having terms ranging from month-to-month to year-to- year, short-term electronic commerce services agreements cancelable upon 30 days notice and multi-year federal contracts. Recurring revenue represented 58% and 63% of the Company's total revenue in 1995 and 1994, respectively. Sterling's customer base includes 96 of the 100 largest U.S. industrial corporations, as ranked by 1994 sales reported in Fortune Magazine, and 99 of the top l00 U.S. commercial banks, as ranked by deposits as of December 31, 1994, in the American Banker magazine. At September 30, 1995, the Company employed approximately 3,700 people.\nThe product names used herein are registered or unregistered trademarks owned by the Company.\nELECTRONIC COMMERCE GROUP\nThe Electronic Commerce Group is comprised of four divisions and provides software and services offerings to facilitate electronic commerce. Sterling is one of the leading providers of business-to-business EDI network services, the cornerstone of electronic commerce, and is the leading EDI translation software provider worldwide. As of September 30, 1995, the group employed approximately 1,000 people.\nSterling's Network Services Division, a value-added electronic service provider, offers over a dozen services and software solutions under the COMMERCE family name. COMMERCE:Network combines the power of EDI, E-mail, library services and file transfer into a full-service network offering. The network supports all major communications, messaging and data standards including BSC, SNA, X.25, X.400, ANSI X.12 and EDIFACT. In addition, the network is accessible through a full range of connectivity options, including toll-free dial-up, internationally available packet-switched networks and the Internet. COMMERCE:Network can connect to over 20 other networks, facilitating even broader relationships. Value-added services include trading partner and vendor implementation programs, extended customer support, product training, education, consulting and other professional services. Other network services include COMMERCE:Catalog, an electronic database of product information that permits manufacturers to list products and related universal product code information in a central repository in order to place current product and ordering information quickly and easily in the hands of buyers. COMMERCE: Interactive, another network service, accelerates the speed of transmission for time-critical business documents. Software products include COMMERCE:Connection, a Windows-based suite of products that provides integrated access to a full range of electronic commerce services including EDI, E-mail, file transfer and electronic libraries. During the year, Sterling released COMMERCE:Forms, a PC-based software product that converts electronic forms into an EDI format and is targeted to the growing small- to medium-sized enterprise market. Sterling's electronic commerce training and education are provided through COMMERCE:Institute and supplemented with on-line information offered through COMMERCE:Resource. Sterling's network services are marketed into targeted vertical industry groups. Sterling is the electronic commerce market share leader within North America in the pharmaceutical and hardlines industries. Sterling's other primary vertical industry markets include grocery, healthcare, insurance, retail, train-truck-ship transportation, automotive, chemical and petroleum, paper and packaging, banking and government. During the year, Sterling launched its network services in Europe.\nSterling's Interchange Software Division markets the group's EDI management products under the GENTRAN family name. GENTRAN:Basic, the base EDI translation product for the mainframe, AS\/400 and HP 3000 platforms, translates data from internal formats into standard formats for EDI transmission and interprets incoming EDI communications back into internal formats for processing. GENTRAN:Plus adds Sterling's communications products to the GENTRAN:Basic offering for MVS or VSE mainframes. GENTRAN:Realtime for MVS mainframes provides a full set of powerful on-line translation and EDI management capabilities for critical documents requiring immediate response. GENTRAN:Director provides Windows-based EDI processing and GENTRAN:Integrator is a software developer's toolkit for GENTRAN:Director, providing tools to implement and EDI-enable PC applications for mass distribution or to build templates and forms for distribution with multiple copies of GENTRAN:Director's user interface. GENTRAN:Mentor, the first system to use expert systems technology and graphical navigation to fully automate EDI mapping, is available for PC and UNIX platforms. GENTRAN:Excel provides high performance EDI processing in PC-DOS and leading UNIX environments. GENTRAN:Server is a sophisticated electronic commerce gateway that recognizes, manages and routes all types of business messages, providing seamless integration of all the components required to support electronic commerce at the enterprise level. Other GENTRAN products provide additional EDI management functions: GENTRAN:Dataguard provides data security through encryption\/decryption; GENTRAN:Viewpoint enhances document tracking and exception handling; GENTRAN:Examiner provides user-defined tracking of healthcare claims documents; GENTRAN:Client permits trading partner and map development independent of connection to the hosts and GENTRAN:Structure allows the definition and support of fixed-format standards.\nSterling's Communications Software Division provides a range of data communications products under the CONNECT family name. The CONNECT family is a complete suite of integrated file transfer and communications management solutions that support a wide variety of protocols, including BSC, SNA, X.25 and TCP\/IP, on a variety of operating systems and hardware platforms, including MVS, VSE, VM, TANDEM, VMS, AS\/400, UNIX, MS-DOS, OS\/2, NetWare, Windows and Windows NT. The CONNECT products provide full-function automated file transfer for clients of all industry classifications. CONNECT:Direct is primarily used to move large volumes of data with a focus on high performance that addresses intracompany and intercompany requirements. CONNECT:Direct addresses the rapidly growing local area network market with releases for NetWare and Windows NT. CONNECT:Mailbox is used primarily to move information between corporations with a focus on wide connectivity.\nThe software works independently of applications, platforms and protocols, and provides open connections throughout the network to any host, midrange or remote workstation or value-added network. During the year, Sterling released CONNECT:Firewall, an application-layer security software and enterprise gateway management system that secures networks from intrusions via the Internet and provides E-mail and nameserver administration. CONNECT:Queue is a scheduling and workload balancing system for heterogeneous UNIX networks.\nSterling's Banking Systems Division provides the VECTOR family of products that automate several key functions in banks. The Banking Systems Division has been a leading provider of banking software and services since 1976. VECTOR products are used by major banks for item processing applications such as statement sorting, research and adjustments, check fraud control, electronic check presentment, return item processing, and signature verification. The products also enable banks to provide integrated corporate trade payment processing services for both paper-based check payments and electronic payments. The Banking Systems Division is the market leader in Financial EDI software for banks. VECTOR:Connexion provides Financial EDI payment services for banks' key corporate customers and is used by 41 of the top 100 largest U.S. bank holding companies as ranked by assets as of June 30, 1995 in the American Banker magazine. In 1995, the division acquired MAXXUS, Inc., a leading provider of PC-based cash management software, expanding the division's traditional market of serving large banks by adding over 200 new banking clients to the existing customer base and by providing complimentary electronic payment products to the division's Financial EDI offerings. Approximately 2,000 VECTOR systems have been installed by approximately 750 financial institutions worldwide, including 99 of the top 100 largest U.S. banks as ranked by deposits as of December 31, 1994 in the American Banker magazine.\nWorldwide revenue from the Company's Electronic Commerce market represented 37%, 35% and 29% of the Company's revenue during 1995, 1994 and 1993, respectively.\nSYSTEMS MANAGEMENT GROUP\nThe Systems Management Group is comprised of three divisions that provide systems management software for computing environments across the enterprise. These divisions specialize in storage management, VM systems management and operations management software. As of September 30, 1995, the group employed approximately 400 people.\nUnder the SAMS family name, the Storage Management Division provides software that manages, monitors, and automates data storage in both distributed and centralized environments. These products provide enterprise- wide storage management capabilities and include solutions for a variety of platforms. The division's enterprise products, SAMS:Vantage, SAMS:Expert, SAMS:Protect and SAMS:Control, automate the management of enterprise data storage. SAMS:Vantage delivers automation, interactive reporting, analysis and predictive modeling capabilities and centralized allocation control for MVS environments. SAMS:Expert provides policy-based automation, interactive viewing and fault-tolerant data protection for NetWare networks. SAMS:Protect provides high-performance data protection for OS\/2 LAN Server and workstations. SAMS:Control integrates these three products to provide high- performance LAN-to-mainframe backup, restore and remote vaulting. SAMS:Allocate is a centralized allocation control system to make volume pooling easier and SAMS:Disk is a complete DASD\/tape management solution. SAMS:Select is a high-performance backup accelerator for MVS data and SAMS:Compress is a data compression tool available for MVS, IMS and DB2 data. SAMS:Defrag is a defragmentation tool that reorganizes data on-line and in- place.\nSterling's VM Software Division provides comprehensive integrated systems management software for the VM operating system. VM:Manager, the division's flagship product, allows VM sites to control costs, improve performance and increase user productivity. VM:Manager provides solutions for automated operations, storage management, service-level management, security and recovery. In 1995, the VM Software Division introduced VM:Migrate, a storage management package that enables sites to better exploit the advantages and cost-savings potential of IBM's Shared File System (\"SFS\"). VM:Migrate automatically migrates unused and infrequently used SFS files from expensive primary storage to less expensive media.\nThe Company's remaining systems management products are marketed by the Operations Management Division under the SOLVE family name. The division is a pioneer in service-driven operations, providing software for managing systems and network operations from a service perspective. SOLVE:Netmaster automates SNA and other network management operations across a variety of enterprise platforms. SOLVE:Attach integrates network management across a number of environments including IBM, Tandem, TCP\/IP and NetWare. SOLVE:Monitor provides a graphical user interface to SOLVE:Netmaster. SOLVE:Central is a suite of products for managing\nenterprise-wide service desk operations and is comprised of: SOLVE:Problem for problem tracking and resolution; SOLVE:Change for managing the systems change process; SOLVE:Configuration for tracking software and hardware configuration changes; and SOLVE:Asset for business management of computer assets and the services they deliver. During the year, Sterling released the following products: SOLVE:Viewpoint, a Windows-based interface to the SOLVE:Central suite that brings complete administrative control to the desktop; SOLVE:Commander, a UNIX-based product that provides users with single-console visibility of both MVS\/SNA and UNIX\/SNMP environments from a service perspective; and SOLVE:Operations, a package that automates systems and network operations driven by enterprise policies, service-level agreements and business priorities.\nWorldwide revenue from the Company's Systems Management market represented 26%, 30% and 33% of the Company's revenue during 1995, 1994 and 1993 respectively.\nAPPLICATIONS MANAGEMENT GROUP\nEffective November 1, 1995, Sterling reorganized the Applications Management Group, establishing four divisions focused on the specific target markets the group serves, offering both products and services. As of September 30, 1995, the group employed approximately 500 people. As a part of the November 1, 1995 reorganization, approximately 150 positions were eliminated from the group's workforce.\nThe Applications Development Division markets scaleable PC-based products and services under the KEY family name for predictably developing new applications systems. The products combine business and applications modeling with state-of-the-art rapid prototyping and visual client\/server development to produce applications for Windows, UNIX, OS\/2, OS\/400 and MVS environments. A systematic approach to modeling, delivering and managing applications throughout the development process is provided. KEY:Enterprise is an OS\/2- based suite of second generation client\/server development and support products for the enterprise class business application. The toolset facilitates the development of multi-tier, client\/server applications, assisting users in all development phases: planning, analysis, prototyping, design, code generation, system documentation and maintenance. The KEY:Enterprise components are: KEY:Advise, KEY:Analyze, KEY:Client, KEY:Coordinate, KEY:Construct, KEY:Design, KEY:Document, KEY:Guide, KEY:Insight, KEY:Plan, KEY:Rapid, KEY:Rochade and KEY:Team. In September 1995, Sterling released KEY:Workgroup, a Windows-based application development environment based on an underlying object oriented architecture that combines the strengths of business modeling with the capabilities of visual development. The toolset is a complete environment consisting of integrated components based on the Object Linking and Embedding 2.0 interoperability framework. The Key:Workgroup components are: KEY:Advise, KEY:Model, KEY:Assemble and KEY:Empower.\nThe Information Management Division markets products and services under the VISION family name that enable customers to extract value from their existing corporate data and maximize the return on their information technology investment by extending the life and usefulness of their legacy applications. By improving existing applications, customers can reconcile their legacy and new development strategies, ensuring they have the resources to implement required new systems. VISION:Results is a comprehensive information management and report generation system for IBM mainframes and a dynamic complement to COBOL. VISION:Builder and VISION:Transact are applications development tools for batch and on-line environments, respectively, that operate on major IBM mainframe platforms. The VISION:Legacy suite of tools addresses the functions required to assess the quality and maintainability of applications, restructure old COBOL programs, redocument the flow of control through legacy systems and graphically represent the architecture and flow of existing systems. VISION:Inform facilitates data extraction from the mainframe database to the PC.\nThe Data Access Division markets products and services under the CLEAR family name that enable business users to access corporate data in an organized, efficient manner. CLEAR:Access and CLEAR:Manage are the cornerstones of the product line and run on Windows, Windows NT, Windows 95 and Macintosh platforms. CLEAR:Access facilitates end-user access as a query and reporting tool. CLEAR:Manage allows database managers to monitor and control database access in a client\/server environment.\nThe Frontware Division provides software products and services under the STAR family name that assist organizations in their delivery of client\/server applications which integrate desktop systems with an operational host. The division's flagship product, STAR:Flashpoint, is a Windows-based tool that, using visual development techniques, allows users to incorporate and integrate information at the desktop as well as to create graphical user interfaces for legacy applications.\nWorldwide revenue from the Company's Applications Management market represented 18% of the Company's revenue during 1995 and 11% of the Company's revenue during both 1994 and 1993.\nFEDERAL SYSTEMS GROUP\nThe Federal Systems Group formed a new division during the year and combined two formerly independent divisions. The group is now composed of two divisions that provide highly specialized technical professional services to sectors of the federal government, generally under multi-year contracts, and a third division that markets the products and services of the Electronic Commerce Group to federal departments and agencies.\nThe group's major customers are NASA and the DoD. In 1995, Sterling began its 29th year of service to both NASA and the DoD. Altogether, in 1995 the Federal Systems Group was working under 106 contracts, many of which are for multi-year terms.\nAs of September 30, 1995, the group employed approximately 1,100 people.\nSterling's Information Technology Division provides highly technical professional services, generally requiring Top Secret security clearances, to military command and control, intelligence and weather agencies. The division specializes in data handling, secure communications, networking, systems integration and application development in support of varied technical projects ranging from satellite data collection to counter-terrorism. Division computing resources include data processing facilities approved for classified operations, and substantial hardware and software configurations to support software life cycle activities in a distributed processing environment.\nEffective September 30, 1995, Sterling combined the Scientific Systems Division and NASA Ames Division, both located in Redwood City, California and suppliers to NASA, into the new Scientific Systems Division. Sterling's Scientific Systems Division is a provider of scientific software support and highly technical professional services to civil sectors of the federal government, particularly in scientific and engineering areas and specialty software products in advanced graphics, visualization and virtual reality. The division's contracts include projects such as spacecraft imagery and scientific data systems and applications such as aero-dynamics, aviation research and transportation safety. Under contract to NASA, the division's engineers designed and now operate the NASA Science Internet and designed and installed the Worldwide Web server home page for the White House. Customers include the Jet Propulsion Laboratory, the NASA Ames Research Center, the NASA Lewis Research Center and the MIT Lincoln Laboratory. In 1995, the division received \"excellent\" award fee scores on its three most significant NASA contracts.\nIn July 1995, Sterling formed the new Federal Electronic Commerce Division, combining the expertise of doing business with the government with proven electronic commerce solutions to address the growing federal government needs for cost-effective electronic commerce solutions. The Federal Electronic Commerce Division markets Sterling's electronic commerce and EDI software products, network services and professional services to federal departments and agencies. The Presidential Memorandum of October 1993 and the Federal Acquisition Streamlining Act of 1994 made electronic commerce the preferred way of doing business with the federal government and set milestone dates by which all federal departments and agencies must transact business electronically.\nRevenue from the Federal Systems Group represented 17%, 23% and 24% of the Company's revenue during 1995, 1994 and 1993, respectively.\nINTERNATIONAL GROUP\nThe International Group is the exclusive channel to international markets for all Sterling products. The group operates through six regional divisions representing four regions of Europe, Asia\/Pacific and a division representing the smaller, emerging growth markets located throughout the world.\nEach division is responsible for sales, marketing and first level support of all Sterling products and services in their respective regions. The Northern Europe Division, headquartered in London, England has responsibility for direct sales in the United Kingdom, Belgium, The Netherlands, Norway and Sweden and has offices in eight European cities. The Central Europe Division, headquartered in Dusseldorf, Germany, has responsibility for direct sales in Germany, Switzerland and Austria and has offices in five European cities. The Southern Europe Division, headquartered in Rome, Italy, has responsibility for direct sales in Italy, Spain and Portugal, has responsibility for indirect sales in Italy and has offices in four European cities. The France Division, with an office in Paris, France, has responsibility for direct sales in France. The Pacific Division, headquartered in Tokyo, Japan with an office in Sydney, has responsibility for direct sales in Japan, Australia and New Zealand and indirect sales in Japan. Sterling's Distributor Division, headquartered in London, England was renamed the Emerging Markets Division effective\nOctober 1, 1995. The division continues to manage approximately 74 agents and distributors and also has responsibility for direct sales in Singapore. Agents and distributors are responsible for territories that include: Asia (except Japan), the Middle East, South Africa, Eastern Europe, Mexico, and Central and South America.\nAs of September 30, 1995, the group employed approximately 500 people. In 1995, 1994 and 1993, approximately 27%, 22% and 23%, respectively, of Sterling's revenue came from the International Group.\nPRODUCT LICENSES\nSterling's software products are generally licensed for perpetual use or for a fixed term. Sterling typically does not sell or otherwise transfer title to its software products. The license agreements generally restrict the use of the product to designated sites or central processing units and prohibit reproduction, transfer or disclosure of the product. However, some license agreements may cover multiple sites or multiple central processing units at one site.\nPRODUCT SUPPORT\nProduct support is available to Sterling customers, typically in the form of annual contracts generally priced from 13% to 21% of the then current license fee. Sterling's product support contracts allow customers to receive updated or enhanced versions of Sterling's software products as they become available, as well as telephone access to Sterling's technical personnel.\nSERVICES\nSterling's services primarily include technical professional services in support of federal government contracts provided through Sterling's federal systems business and EDI network services provided through Sterling's electronic commerce business. Sterling provides training and education in support of its products generally in the form of customer training seminars, videos and instruction materials. Sterling also offers product-specific consulting and education services within the Applications Management Group to ensure customers are successful using the group's products.\nPRODUCT DEVELOPMENT\nSterling's product development programs in each of its businesses include the enhancement of existing products and introduction of new products based upon current and anticipated customer needs. Each division within Sterling's Electronic Commerce Group, Systems Management Group and Applications Management Group has its own development function. Each development lab operates as a profit center with revenues derived from intercompany royalties earned on products sold in the domestic and international markets. This management organization facilitates development cost control and focuses the development function on the customer's needs. Approximately 500 Sterling employees were engaged in product development at September 30, 1995. Gross product development costs in 1995, 1994 and 1993 were $64,217,000, $52,392,000 and $51,127,000, respectively, of which the Company capitalized $21,708,000, $19,390,000 and $23,730,000, respectively, as the cost of developing and testing new or significantly enhanced software products.\nSALES AND MARKETING\nConsistent with its decentralized operating style, Sterling conducts its sales and marketing activities in multiple software divisions focused on specific product markets. Sterling sells its products and services through a combination of direct sales and telesales organizations, and in certain countries, independent agents and distributors. The use of telesales has proven effective in reaching customers at a minimal cost. Each division within the Electronic Commerce Group, Systems Management Group and Applications Management Group has its own U.S. sales and marketing organizations and the Federal Systems Group's Federal Electronic Commerce Division has its own sales and marketing organization. In addition, the Company's International Group has its own sales function to focus specifically on the international marketplace for each of Sterling's product lines. At September 30, 1995, Sterling employed approximately 600 sales representatives.\nCUSTOMERS\nSterling's customers include 96 of the 100 largest U.S. industrial corporations, as ranked by 1994 sales in Fortune magazine and 99 of the top 100 U.S. commercial banks, as ranked by deposits as of December 31, 1994, in the American Banker magazine. In the year ended September 30, 1995, agencies, branches and departments of the federal government accounted for approximately 19% of the Company's consolidated revenue.\nCOMPETITION\nThe computer software and services industry is highly competitive. Sterling competes with both large companies with substantially greater resources and small specialized companies that compete in a particular geographic region or market niche. Sterling also competes with internal programming staffs of corporations and, increasingly, with hardware manufacturers. Some internal programming staffs of corporations are capable of developing products similar to those offered by the Company. In general, however, the Company believes that the time and costs associated with custom software development significantly exceed the time and costs required to license and install the comparable product from Sterling. Also, competition within the Company's federal business is increasing because of continued federal budget constraints and cutbacks.\nSterling believes that its products will continue to be chosen by customers due to superior product functionality, reliability and technical support, ease of product installation and use, close integration between the products and customer business applications and, finally, the Company's history of success and reputation for providing quality products.\nEMPLOYEES\nSterling's business is dependent upon its ability to attract and retain qualified personnel who are in limited supply. The Company's operations could be adversely affected if it were to lose the services of a significant number of qualified employees or if it were unable to obtain additional qualified employees when needed. To attract and retain qualified personnel, the Company strives to maintain excellent employee relations, attractive office facilities and challenging working environments, and offers competitive compensation and benefits packages.\nAt September 30, 1995, the Company employed approximately 3,700 people.\nTRADEMARKS AND COPYRIGHTS\nThe Company has certain trademarks that are registered in the United States and various foreign countries and certain copyrights that are registered with the United States Copyright Office. In general, however, management believes that the competitive position of the Company depends primarily on the skill, knowledge and experience of Sterling's personnel and their ability to develop, market and support software products, and that its business is not materially dependent on copyright protection or trademarks. The Company believes that all of its products are of a proprietary nature and its licensing agreements generally prohibit program disclosure. It is possible, however, for product users or competitors to copy portions of the Company's products without its consent.\nLicenses for a number of software products have been granted to the Company for its own use or for remarketing to its customers. In the aggregate, these licenses are material to the business of the Company, but the loss of any one of these licenses would not materially affect the Company's results of operations or financial position.\nBACKLOG\nSterling's backlog relates principally to the uncompleted portion of multi- year professional services contracts with the federal government, including renewal options with government agencies, a portion of which is restricted by law to a term ending on the last day of the government agencies' then current fiscal year.\nDetermination of the Company's backlog involves estimation, particularly with respect to customer requirements contracts and multi-year contracts of a cost-reimbursement or incentive nature. A large portion of the Company's federal government contracts is funded for one year or less and is subject to contract award, extension or expiration at different times during the year, and all of the Company's federal government contracts are subject to termination by the government. Based upon past practices, the Company believes that the contract renewal options included in existing contracts will be exercised for the full period designated in such contracts, but no assurances can be given that such contracts will be renewed.\nTotal backlog, including federal government contract renewal options not yet exercised and multi-year product support contracts at September 30, 1995 and 1994, was $224,611,000 and $228,345,000, respectively, 97% and 99% of which related to federal government sources, primarily in the Company's Federal Systems Group. Federal government renewal options not yet exercised or funded included in backlog at September 30, 1995 and 1994, were $57,846,000 and $52,163,000, respectively. Approximately $85,581,000 of the 1995 backlog is expected to be realized in the year ending September 30, 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases offices and facilities in or near approximately 64 cities in the United States, Canada and worldwide. Major U.S. facilities are located in the following metropolitan areas: Los Angeles, Palo Alto, San Francisco, Sacramento and San Bernardino, California; Atlanta, Georgia; Chicago, Illinois; Cleveland and Columbus, Ohio; Omaha, Nebraska; New York City and Rome, New York; Washington, D.C.; Detroit, Michigan; and Dallas, Texas. The Company's major international facilities are located in London and Reading, England; Paris, France; Montreal, Toronto and Ottawa, Canada; Duesseldorf, Stuttgart and Frankfurt, Germany; Zurich, Switzerland; Brussels, Belgium; Nieuwegein, The Netherlands; Stavanger and Oslo, Norway; Kista, Sweden; Tokyo, Japan; Sydney and Melbourne, Australia; Rome, Milan and Turin, Italy; and Tefen, Israel. The Company believes that its facilities are adequate for its immediate needs and that additional or substitute space is available if needed to accommodate expansion.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is subject to certain legal proceedings and claims that arise in the ordinary conduct of its business. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions, net of applicable reserves, will not materially affect the financial condition or results of operations of the Company.\nIn addition, KnowledgeWare is subject to certain legal proceedings and claims, as described in the last twelve paragraphs under \"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations-- Merger with KnowledgeWare, Inc.,\" which paragraphs are incorporated by reference in this Item 3.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThe Company did not submit any matters to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS\nSam Wyly co-founded Sterling Software in 1981 and has served as Chairman of the Board and a director since its formation. In 1963, Mr. Wyly founded University Computing Company, a computer software and services company, and served as President or Chairman from 1963 until 1979. Mr. Wyly co-founded Earth Resources Company, an oil refining and silver mining company, and served as its Executive Committee Chairman from 1968 to 1980. Mr. Wyly and his brother, Charles J. Wyly, Jr., bought the 20 restaurant Bonanza Steakhouse chain in 1967. It grew to approximately 600 restaurants by 1989, during which time he served as Chairman. Mr. Wyly currently serves as Chairman of Michaels Stores, Inc., a specialty retail chain (which has grown from 70 to 450 stores in 10 years of Wyly control), and as President of Maverick Capital, Ltd., an investment fund management company. Sam Wyly is the father of Evan A. Wyly, a director of Sterling Software.\nCharles J. Wyly, Jr. co-founded Sterling Software in 1981 and has served as a director since its formation and Vice Chairman since 1984. Mr. Wyly served as an officer and director of University Computing Company from 1964\nto 1975, including President from 1969 to 1973. Mr. Wyly and his brother, Sam Wyly, founded Earth Resources Company and Charles Wyly served as Chairman from 1968 to 1980. Mr. Wyly served as Vice Chairman of the Bonanza Steakhouse chain from 1967 to 1989. Mr. Wyly currently serves as Vice Chairman of Michaels Stores, Inc. and as Chairman of Maverick Capital, Ltd. Charles J. Wyly, Jr. is the father-in-law of Donald R. Miller, Jr., a director of Sterling Software.\nSterling L. Williams co-founded Sterling Software in 1981 and has served as President, Chief Executive Officer and a director of Sterling Software since its formation. Mr. Williams also currently serves as a director of INPUT, an information technology market research company.\nWarner C. Blow has served as Executive Vice President of Sterling Software since October 1989, prior to which he served as Senior Vice President since November 1986. Since July 1993, Mr. Blow has served as President of the Electronic Commerce Group. From October 1990 until July 1993, Mr. Blow served as President of Sterling Software's former EDI Group and prior to October 1990 he served as President of Sterling Software's former Applications Software Group.\nGeorge H. Ellis has served as Executive Vice President of Sterling Software since July 1993, Chief Financial Officer since February 1986 and Treasurer since December 1, 1994. Prior to July 1993, Mr. Ellis also served as Senior Vice President of Sterling Software.\nWerner L. Frank has served as Executive Vice President, Business Development of Sterling Software since December 1, 1994. From October 1984 until December 1, 1994, Mr. Frank served as Executive Vice President of Sterling Software. From July 1993 until December 1, 1994, Mr. Frank served as President of Sterling Software's former Enterprise Software Group. From 1985 until July 1993, Mr. Frank served as President of Sterling Software's former Systems Software Group.\nM. Gene Konopik has served as Executive Vice President of Sterling Software and President of Sterling Software's Federal Systems Group since December 1994. From July 1993 until December 1994, Mr. Konopik served as the President of Sterling Software's Information Technology Division and prior to July 1993 he served as the President of the former Intelligence and Military Division of Sterling Software.\nJeannette P. Meier has served as Executive Vice President of Sterling Software since July 1993 and has served as General Counsel and Secretary since 1985. Prior to July 1993, Ms. Meier also served as Senior Vice President of Sterling Software.\nPhillip A. Moore co-founded Sterling Software in 1981 and has served as a director since such time, as Executive Vice President, Technology from July 1993 until December 1994 and as Executive Vice President, Chief Technology Officer since December 1994. Prior to July 1993, Mr. Moore served as Senior Vice President, Technology of Sterling Software.\nA. Maria Smith has served as Executive Vice President of Sterling Software and President of Sterling Software's new Applications Management Group since December 1994. From July 1993 until December 1994, Ms. Smith served as President of Sterling Software's former Systems Management Division and prior to July 1993 she served as President of the former Systems Software Marketing Division of Sterling Software.\nClive A. Smith has served as Executive Vice President of Sterling Software since December 1994 and President of Sterling Software's International Group since October 1994. From July 1993 until October 1994, Mr. Smith served as the President of Sterling Software's former Europe Division and from September 1990 until July 1993 he served as the President of the former International Division of Sterling Software.\nGeno P. Tolari has served as Executive Vice President of Sterling Software since March 1990, prior to which he served as Senior Vice President since November 1986. Mr. Tolari has also served as President of Sterling Software's Systems Management Group since December 1, 1994 and he served as the President of the Federal Systems Group of Sterling Software from October 1985 until December 1994.\nEvan A. Wyly has served as a director of Sterling Software since July 1992 and as a Vice President of Sterling Software since December 1994. Mr. Wyly is a Managing Director of Maverick Capital, Ltd. Prior to joining Maverick Capital, Ltd., Mr. Wyly served as a Vice President of Michaels Stores, Inc. from December 1991 to October 1993. In June 1988, Mr. Wyly founded Premier Partners Incorporated, a private investment firm, and served as President prior to joining Michaels Stores, Inc. Mr. Wyly also serves as a director of Michaels Stores, Inc. and Xscribe Corp., a high-technology information management company.\nRichard Connelly has served as Vice President, Controller of Sterling Software since July 1993. From October 1992 until July 1993 Mr. Connelly served as Corporate Controller and from June 1987 until October 1992 he served as Director of Accounting of Sterling Software.\nAlbert K. Hoover has served as Vice President of Sterling Software since May 1994 and Assistant General Counsel of Sterling Software since June 1990.\nJames E. Jenkins, Jr. has served as Vice President, Tax of Sterling Software since May 1994. From May 1986 until May 1994 he served as Director of Tax.\nAnne Vahala has served as Vice President, Acquisitions of Sterling Software since October 1995 and served as Vice President, Investor Relations of Sterling Software from July 1993 until October 1995. From August 1992 until July 1993, Ms. Vahala served as Director, Investor Relations and prior to August 1992 she served as Senior Financial Analyst of Sterling Software.\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 (the \"Common Stock\") has been traded on the New York Stock Exchange since March 28, 1990, under the symbol SSW. Prior to that time, the Common Stock was traded on the American Stock Exchange since May 4, 1983. The high and low closing prices for the Common Stock for the periods indicated are set forth below.\nAt October 31, 1995, the Company had approximately 1,300 common stockholders of record.\nThe Company did not pay dividends on its Common Stock during the three years ended September 30, 1995. Under the terms of the Company's Second Amended and Restated Revolving Credit and Term Loan Agreement, the Company is prohibited from making distributions in the form of dividends on its Common Stock and is limited to $500,000 of dividends with respect to any outstanding shares of the Company's Series B Junior Preferred Stock (\"Junior Preferred Stock\"). At September 30, 1995 there were no shares outstanding of the Junior Preferred Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data should be read in conjunction with the consolidated financial statements of the Company included elsewhere herein.\n- ------------------- (1) On November 30, 1994, Sterling Software, Inc. (\"Sterling\" or the \"Company\") acquired KnowledgeWare, Inc. (\"KnowledgeWare\") in a stock-for- stock acquisition accounted for as a purchase. Accordingly, the operating results of KnowledgeWare are included in the Company's results of operations from the date of the acquisition. The results of operations include $62,000,000 of purchased research and development costs, which is the portion of the purchase price attributable to in-process research and development and which was charged to expense in accordance with purchase accounting guidelines. The 1995 results of operations also include a charge for restructure costs of $19,512,000 to integrate KnowledgeWare's business into the Company's operations. The restructure charge includes employee termination costs, costs related to the elimination of duplicate facilities, the write-off of costs related to certain software products which were not actively marketed and other out of pocket costs related to the reorganization. Cash costs and expenses directly related to the acquisition of\nKnowledgeWare and unrelated to the restructuring of the Company are accounted for as a cost of the acquisition. See Note 2 of Notes to Consolidated Financial Statements. (2) In August 1994, Sterling acquired American Business Computer Company (\"ABC\") in a stock-for-stock acquisition accounted for as a pooling of interests. In July 1993, the Company acquired Systems Center, Inc. (\"Systems Center\") in a stock-for-stock acquisition accounted for as a pooling of interests. Sterling's consolidated financial statements have been retroactively adjusted to include the results of ABC and Systems Center for all periods presented. See Note 2 of Notes to Consolidated Financial Statements. (3) The 1993 restructuring charges reflect the cost of combination of Sterling and Systems Center including transaction costs and charges relating to the elimination of duplicate facilities and equipment, severance costs and the write-off of costs related to certain software products not actively marketed by the Company. The 1992 restructuring charges include severance and other costs related to System Center's reduction in workforce, elimination of duplicate facilities and the sale of certain AS\/400 and UNIX utility products. The 1991 restructuring charges reflect a write-down by Systems Center of certain purchased computer software costs based on a revaluation of the products in light of changes in market conditions and increased competition, as well as severance costs and costs associated with elimination of certain management positions and duplicate functions resulting from previous business acquisitions. See Note 3 of Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nMERGER WITH KNOWLEDGEWARE, INC.\nOn November 30, 1994, Sterling Software, Inc. (together with its wholly owned subsidiaries, \"Sterling\" or the \"Company\") acquired KnowledgeWare, Inc. (\"KnowledgeWare\"), a Georgia corporation based in Atlanta, Georgia which was a leading provider of applications development software and services, for approximately $106 million, in a stock-for-stock acquisition (the \"Merger\"). In connection with the Merger, the Company issued approximately 2,421,000 shares of the Company's $0.10 par value Common Stock (the \"Common Stock\") valued at approximately $74,443,000 and reserved approximately 340,000 shares of Common Stock for issuance upon exercise of KnowledgeWare's options and warrants. In addition, the Company incurred cash costs directly related to the Merger of approximately $31,672,000. The Merger, which was accounted for as a purchase, was completed pursuant to the terms of an Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, as amended (the \"Merger Agreement\"), among the Company, SSI Corporation, a Georgia corporation and a recently organized wholly owned subsidiary of the Company (\"Merger Sub\"), and KnowledgeWare. Of the 2,421,000 shares of Common Stock issued, approximately 484,800 shares were placed in escrow (the \"Escrowed Shares\") to cover certain losses that may result in connection with any pending or threatened litigation, action, claim, proceeding, dispute or investigation (\"Actions\") (including amounts paid in settlement) to which the Company is entitled to indemnification pursuant to the terms of the Merger Agreement. Approximately 207,000 of the Escrowed Shares remain to cover potential losses associated with remaining Actions at October 31, 1995. (See Note 2 of Notes to Consolidated Financial Statements.)\nThe cash costs directly related to the Merger of approximately $31,672,000 are included in the aggregate cost of the Merger and consist of employee termination costs, transaction costs, costs associated with the elimination of duplicate facilities and other direct costs of the acquisition. Approximately $20,768,000 was paid in 1995.\nThe Company's restructuring charge related to the combining of KnowledgeWare and the Company (\"KnowledgeWare restructuring\") is $19,512,000, which is included in the results of operations for 1995. Approximately $7,000,000 of the KnowledgeWare restructuring charge has not been tax benefited. The components of the restructuring charge are the following:\nAs a result of the KnowledgeWare restructuring charge, future operating results are expected to benefit from the reduction in workforce and elimination of duplicate facilities. Estimated annual cost reductions of approximately $12,000,000 in salaries and benefits from the reduction in workforce and estimated total future cost reductions of approximately $8,200,000 in depreciation, amortization and rent expense are anticipated from the write-offs of software products which will not be actively marketed by the Company and the elimination of duplicate facilities and equipment. Of the total restructuring charge of $19,512,000, approximately $8,377,000 is a non- cash charge and the remaining $11,135,000 requires cash outlays, of which approximately $10,941,000 was expended prior to September 30, 1995. Future cash expenditures related to the KnowledgeWare restructuring are anticipated to be made from cash generated from operations. The Company does not expect to incur significant costs related to the KnowledgeWare restructuring in excess of the amount charged to operations in 1995.\nPursuant to purchase accounting guidelines, the deferred revenue balance associated with product support contracts and consulting services contracts acquired in a business combination may not be recognized as revenue ratably over the remaining terms of such contracts. However, the net present value of the costs associated with the Company's obligation to provide product support services under those contracts may be accrued at the date of acquisition. Accordingly, deferred revenue of approximately $14,208,000 related to product support contracts acquired in the acquisition of KnowledgeWare will not be recognized as revenue in periods subsequent to November 30, 1994 and costs of approximately $13,679,000 have been accrued representing the net present value of the Company's obligation to provide product support services under these contracts. As the product support services are performed the costs of performing such services will be offset against this accrued liability. Approximately $13,493,000 of costs incurred through September 30, 1995 have been offset against this accrued liability.\nSince August 30, 1994, a number of lawsuits have been filed against KnowledgeWare and certain of its former officers and directors alleging violations of securities laws. On December 18, 1991, a complaint (the \"1991 Class Action\") was filed in the United States District Court for the Northern District Of Georgia, Atlanta Division which consolidated and amended several class action lawsuits previously filed against KnowledgeWare and certain of its former officers and directors in October 1991. The 1991 Class Action was a class action lawsuit alleging violations of Sections 20 and 10 (b) of the Securities Exchange Act of 1934 (the \"Exchange Act\") and Rule 10b-5 under the Exchange Act. The complaint alleged KnowledgeWare misrepresented or failed to disclose material facts which would have a material adverse impact on KnowledgeWare or approved such misrepresentations and omissions. The complaint sought compensatory damages and reimbursements for the plaintiffs' fees and expenses. In April 1994, the District Court approved a settlement of the 1991 Class Action. On August 30, 1994, the plaintiffs in the 1991 Class Action filed motions alleging that the proposed business combination between KnowledgeWare and Sterling and an announcement by KnowledgeWare that it modified its accounting policy for revenue recognition and restated financial results for the first three quarters of fiscal year 1994 had substantially reduced the value of warrants available to the plaintiffs under the settlement agreement in the 1991 Class Action. On April 27, 1995, the District Court issued an order denying most of plaintiffs' motions.\nIn August and September, 1994, eight lawsuits were filed against KnowledgeWare and certain of its former directors and officers in the United States District Court for the Northern District of Georgia, Atlanta Division. Subsequently, these lawsuits were consolidated (the \"1994 Class Action\"). The 1994 Class Action is a class action on behalf of KnowledgeWare stockholders alleging violations of Sections 20 and 10 (b) of the Exchange Act, and Rule 10b-5 under the Exchange Act. The alleged factual basis underlying the 1994 Class Action is the plaintiffs' allegation that KnowledgeWare and the individual defendants actively misrepresented or failed to disclose the actual financial condition of KnowledgeWare throughout fiscal year 1994 and that the value of KnowledgeWare Common Stock was artificially inflated as a result of such misrepresentations or failures to disclose. The plaintiffs in the 1994 Class Action sought compensatory damages and reimbursement for the plaintiffs' fees and expenses.\nOn October 25, 1995, Sterling and the defendants in the 1991 and 1994 Class Actions entered into settlement agreements, subject to certain conditions and court approval, to resolve the 1991 and 1994 Class Actions for an aggregate of approximately $3.75 million in cash plus approximately 278,000 shares of Sterling Common Stock. The cash portion of the settlement is being paid by KnowledgeWare's insurance carrier. The stock portion will come out of the Escrowed Shares. Pursuant to the terms of the settlement agreements, the plaintiffs in the 1991 Class Action will receive $2.0 million of proceeds from the sale of Escrowed Shares in lieu of the Warrants. The plaintiffs in the 1994 Class Action will receive the remainder of the proceeds from the sales of Escrowed Shares included in the settlement and $3.75 million in cash, net of plaintiffs' attorneys fees and certain costs. Consummation of the settlements is contingent upon the fulfillment of customary conditions, including approval of the Court. In the event those settlements are not approved by the Court or do not become final for any reason, the 1991 and 1994 Class Actions may continue to be litigated.\nAfter giving effect to the class action settlements, there will remain approximately 207,000 shares of Sterling Common Stock in the Escrowed Shares, with a market value at October 31, 1995, of approximately $9.5 million.\nOn September 9, 1994, a lawsuit was filed against KnowledgeWare and certain of its former officers and directors in the Southern District of Iowa, Central Division (the \"Ecta Suit\"). The Ecta Suit alleges violations of Section 10 (b) of the Exchange Act, Rule 10b-5 under the Exchange Act, Section 12 (2) of the Securities Act of 1933, violation of the Iowa Blue Sky Laws, fraud and breach of contract. The alleged factual basis underlying the Ecta Suit raised in connection with the purchase by KnowledgeWare of substantially all of the assets of ClearAccess Corporation (now known as Ecta Corporation) and Fairfield Software, Inc. (now known as Fairfield Development, Inc.) pursuant to an Asset Purchase Agreement dated May 26, 1994 (the \"Acquisition Agreement\"). The plaintiffs allege that KnowledgeWare and the individual defendants misrepresented or failed to disclose the actual financial condition of KnowledgeWare, that the value of KnowledgeWare Common Stock was artificially inflated as a result of such misrepresentations or failures to disclose and that KnowledgeWare has breached certain warranties, representations and covenants made in the Acquisition Agreement. The Ecta Suit seeks unspecified compensatory damages, rescission of the Acquisition Agreement and\/or the sale of KnowledgeWare's securities issued pursuant thereto, punitive damages, prejudgment interest, and reimbursement of attorneys' fees and costs. This suit is currently in discovery.\nThere are also presently pending three lawsuits against KnowledgeWare and certain of its former officers and directors in the United States District Court, District of Minnesota, Fourth Division. The first such suit, filed on January 19, 1995, was brought against KnowledgeWare by seven named plaintiffs, including Irwin L. Jacobs, who purchased 666,700 shares of KnowledgeWare's common stock in a private placement (the \"Jacobs Suit\"). The second suit, filed on January 20, 1995, was brought against KnowledgeWare and its former directors and certain of its former officers by over twenty named plaintiffs who purchased shares of KnowledgeWare Common Stock from and after November 1993 (the \"Second Jacobs Suit\"). The third suit, filed on June 27, 1995, was brought by certain investment clients of Mitchell Hutchins Asset Management, Inc., who had purchased 177,000 shares of KnowledgeWare common stock in a private placement in January of 1994, against KnowledgeWare and certain of its former directors and officers (the \"Compass Investors Suit\"). These three suits were consolidated by court order on September 11, 1995. Discovery is ongoing in all three cases.\nIn the Jacobs Suit, the plaintiffs allege that representations and warranties in the private placement agreement relating to the financial condition of KnowledgeWare were false and misleading in that they contained untrue statements or omitted to state material facts necessary to make the statements not misleading. The claims include breach of contract, violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, controlling person liability of the individual defendants under Section 20 of the Exchange Act and the Georgia and Minnesota Securities Acts, claims for violation of Section 18 of the Exchange Act, violations of the Minnesota Consumer Fraud Act, breaches of fiduciary duty by the individual defendants, common law fraud and claims for treble and punitive damages and attorneys' fees under Federal and Georgia RICO statutes. Actual damages claimed are in the approximate amount of $8.1 million, plus interest.\nIn the Second Jacobs Suit, the plaintiffs allege they purchased shares of KnowledgeWare common stock based on defendants' representations which allegedly contained untrue statements of material fact or omitted to state material facts necessary to make the statements not misleading. The claims in the Second Jacobs Suit for violation of law are substantially the same as those in the Jacobs Suit, except in the Second Jacobs Suit there is no claim for breach of contract, and include claims for treble and punitive damages and attorneys' fees under Federal and Georgia RICO Statutes. Plaintiffs seek to rescind the stock purchases, in the case of stock still held, or to recover rescissory damages in the aggregate amount of $5.8 million, plus interest and other relief.\nThe plaintiffs in the Compass Investors Suit allege claims substantially identical to those alleged in the Jacobs Suit, except in the Compass Investors suit there is no claim for breach of fiduciary duty. Plaintiffs in the Compass Investors Suit seek compensatory damages of more than $2.0 million, treble and punitive damages, interest, attorneys' fees and expenses.\nOn April 27, 1995, Gerald Caussade, a former employee of KnowledgeWare and a principal of Ecta Corporation and Fairfield Development, Inc. (plaintiffs in the Ecta Suit referred to above), filed suit in the United States District Court, Southern District of Iowa, Central Division, against KnowledgeWare, Donald Addington, Francis Tarkenton, Sterling Software, Inc., Werner Frank and Sterling Williams. The plaintiff is claiming (a) breach of contract as a third party beneficiary under the Asset Purchase Agreement dated May 26, 1994 among KnowledgeWare, Ecta Corporation and Fairfield Development Inc., (b) as to the individual defendants, tortious interference with plaintiff's business relations with KnowledgeWare, (c) fraudulent misrepresentation and negligent misrepresentation in\nconnection with his accepting employment with KnowledgeWare, (d) wrongful termination in violation of public policy in connection with his termination from employment and (e) breach of contract under his employment contract. Plaintiff is seeking unspecified compensatory damages, damages for emotional distress, punitive damages and interest and other costs. Discovery is ongoing in this suit.\nOn March 14, 1995, the Securities and Exchange Commission entered an Order Directing Private Investigation and Designating Officers to take Testimony titled \"In the Matter of KnowledgeWare, Inc. (NY-6231).\" The investigation generally relates to trading in KnowledgeWare securities from July 1, 1992 through the time of the stock-for-stock transaction by which Sterling acquired KnowledgeWare, KnowledgeWare's compliance with SEC filing and reporting obligations and the adequacy and\/or accuracy of its public disclosures, recordkeeping and accounting controls.\nThere can be no assurance of the final resolution of any of the lawsuits, claims or inquires described above as to the amount of losses that will result in connection with such actions, nor as to the resulting impact on the Company. As of October 31, 1995, the Company estimates that approximately $1,340,000 of costs and expenses have been incurred with respect to such actions. The Company believes the above claims are subject to the indemnification arrangements described above related to the Company's acquisition of KnowledgeWare. Assuming the consummation of the settlements of the 1991 and 1994 Class Actions on the terms described above, however, Sterling's management believes that after giving effect to the value of the remaining Escrowed Shares and applicable reserves, the ultimate resolution of such actions will not materially affect the financial condition or results of operations of the Company.\nMERGER WITH AMERICAN BUSINESS COMPUTER COMPANY\nOn August 1, 1994, Sterling acquired all the outstanding common stock of American Business Computer Company (\"ABC\"), a Michigan corporation based near Detroit, Michigan, which developed, marketed and supported UNIX-based electronic data interchange products, including products that provide sophisticated electronic commerce gateway functionality. The stock-for-stock acquisition has been accounted for as a pooling of interests and, accordingly, Sterling's financial statements have been retroactively adjusted to include the results of ABC for all periods presented, including adjustments for the conforming of accounting policies.\nMERGER WITH SYSTEMS CENTER, INC.\nIn July 1993, Sterling acquired all of the outstanding common stock and preferred stock of Systems Center, a recognized leader in data communications and systems management software which developed, marketed and supported systems software products, for approximately $156 million in a stock-for-stock acquisition (the \"SCI Merger\") accounted for as a pooling of interests and, accordingly, Sterling's financial statements were retroactively adjusted to include the results of Systems Center for all periods presented, including adjustments for the conforming of accounting policies.\nIn connection with the SCI Merger, on July 1, 1993, approximately $2,177,000 of preferred dividends and $699,000 of interest was paid on the Systems Center Series A 9% Convertible Redeemable Preferred Stock (\"Systems Center Preferred Stock\"), which dividends were in arrears. Additionally, subsequent to the closing of the SCI Merger, Systems Center repaid the amounts outstanding under its revolving line of credit of approximately $30,337,000. The Company incurred a non-recurring charge to operations in the fourth quarter of 1993 of $91,260,000 to reflect the combination of Sterling and Systems Center, including charges related to the elimination of duplicate facilities, severance costs, the write-off of certain intangibles, property and equipment and certain transaction costs. Since September 30, 1993, there has been no significant increase in operating expenses as a result of the SCI Merger. Of the total restructuring charge of $91,260,000, approximately $21,348,000 was non-cash and the remaining $69,912,000 required cash outlays. Of the amount requiring cash outlays, approximately $63,047,000 has been expended through September 30, 1995. Future cash expenditures related to the restructuring, the majority of which relate to the elimination of duplicate facilities, are accrued and are anticipated to be made from cash generated from operations.\nRESULTS OF OPERATIONS\nThe results of the International Group are included in the Systems Management Group (\"SMG\"), Applications Management Group (\"AMG\") and Electronic Commerce Group (\"ECG\") for management's discussion and analysis of financial condition and results of operations.\n1995 Compared to 1994\nTotal revenue increased $114,774,000, or 24%, in 1995 over 1994. Revenue from the International Group (\"IG\") was $158,374,000 in 1995 and $103,824,000 in 1994, representing a $54,550,000, or 53% increase over\n1994. Revenue from IG represents 27% and 22% of total revenue in 1995 and 1994, respectively and the Company expects revenue from IG to continue to constitute a significant percentage of its revenue. The net impact of changes in foreign currency on revenue from a weaker U.S. dollar was approximately $11,000,000.\nThe Company's recurring revenue includes revenue recurring through annual and multi-year product support agreements generally having terms ranging from one to three years, fixed term product lease and rental agreements generally having terms ranging from month-to-month to year-to-year, short-term electronic commerce service agreements cancelable upon 30 days notice and multi-year federal contracts generally having terms ranging from one to five years, but, like most federal contracts, with provisions for termination by the government for convenience or for failure to obtain funding. Recurring revenue increased $40,182,000, or 13%, in 1995 over 1994 and represented 58% of total revenue in 1995 compared to 63% of total revenue in 1994. This decrease in the percentage of recurring revenue to total revenue is primarily due to a lower relative percentage of revenue from annual product support contracts acquired in the acquisition of KnowledgeWare and the impact of purchase accounting guidelines on the revenue recognized from such contracts acquired. See \"Merger with KnowledgeWare, Inc.\" For the year ended September 30, 1995, 37% of the Company's product revenue was for products that run on hardware platforms other than mainframe hardware. This compares to 18% for the previous year.\nECG revenue increased 31% over 1994 contributing $51,597,000 to the Company's total revenue growth in 1995. Service revenue primarily from network processing of EDI documents, increased 39% over 1994 primarily due to the growth in existing network customer volume and the addition of new customers to the network primarily in the healthcare, grocery, retail and hardlines vertical markets. The number of network customers grew by approximately 3,000, placing the total network customers at approximately 12,000 at September 30, 1995. Product revenue increased 30% and product support revenue increased 24% over 1994. The three ECG product lines, communications software, banking systems and interchange software each had revenue growth in product and product support revenue due to sales of new products from businesses acquired in 1994, new product releases, the addition of new customers, some product price increases and a continuing expansion of the installed customer base for product support revenue. Approximately 12% of ECG's 1995 revenue is derived from the International Group as compared to 11% in 1994.\nSMG revenue in 1995 increased $13,004,000, or 9%, over 1994 primarily due to an increase of 18% in product revenue. Revenue from software products and product support contracts increased in storage management and operations management product lines and was partially offset by a decrease in VM software product support revenue. The VM software product support revenue decrease is primarily due to a consolidation and downsizing by customers using the VM operating system. Approximately 54% of SMG's 1995 revenue is derived from the International Group. This compares to 53% in 1994.\nAMG revenue increased $57,275,000, or 115%, in 1995 over 1994 primarily due to the businesses acquired from KnowledgeWare in November 1994. As a direct result of this acquisition all the components of revenue increased in 1995 over 1994. Product revenue increased 117%, product support revenue increased 73%, and services revenue, primarily consulting services, increased significantly. Product support revenue in 1995 was negatively impacted by approximately $13,655,000 due to the application of purchase price accounting guidelines which prohibit the post acquisition recognition of the deferred revenue acquired in an acquisition. Consulting and training services revenue, previously an immaterial component of AMG's product revenue, represented 12% of total AMG revenue. Approximately 39% of AMG's revenue is derived from the International Group. This compares to 22% in 1994. The increase is attributed to the KnowledgeWare acquisition.\nFederal Systems Group (\"FSG\") revenue decreased $5,271,000, or 5% in 1995 versus 1994 primarily due to lower contract billings at NASA Ames resulting from lower billable costs and fewer federal contracts than in 1994. In 1995 a division was formed to sell electronic commerce software and services to the federal government. Revenue from this division is included in the ECG business segment revenue.\nTotal costs and expenses increased $159,470,000, or 42%, in 1995 over 1994. In 1995, total costs and expenses included restructuring expenses of $19,512,000 for Sterling's restructuring resulting from the acquisition of KnowledgeWare and the write-off of $62,000,000 of purchased research and development costs resulting from the application of purchase accounting guidelines in recording the Merger. The components of the 1995 restructuring charges were as follows:\nTotal cost of sales increased $18,818,000, or 11%, primarily due to increased consulting services and product support costs of businesses acquired in the stock-for-stock transaction and higher network services costs to support the increase in network services volume partially offset by lower contract costs associated with lower billings in FSG. In addition, approximately $13,493,000 of product support costs related to customer support contracts acquired in the stock-for-stock transaction were offset against a liability for product support costs accrued at the Merger date in accordance with purchase accounting guidelines. Cost of sales includes $33,572,000 and $25,914,000 of depreciation and amortization in 1995 and 1994, respectively.\nProduct development expense for 1995 of $42,509,000, net of $21,708,000 of amounts capitalized pursuant to Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed\" (\"FAS No. 86\") increased $9,507,000, or 29%, compared to 1994 product development expense of $33,002,000, net of $19,390,000 of amounts capitalized pursuant to FAS No. 86. The increase is primarily due to the increased gross product development expense relating to products acquired in the Merger as well as the decrease in the capitalization of software development costs. Total capitalized costs represented 34% and 37% of total development expense for 1995 and 1994, respectively. Product development expense and the capitalization rate may fluctuate from period to period depending in part upon the number and status of software development projects which are in process.\nSelling, general and administrative expense increased $49,633,000, or 29%, primarily due to increased sales, marketing and administrative support personnel in AMG and IG due to businesses acquired in the Merger and increased sales personnel in ECG and IG to support the continuing revenue growth.\nInterest expense increased due to higher average borrowings in IG to manage foreign currency risk and to maintain increased working capital requirements after the Merger. Investment income was also higher due to the higher average cash balances available for investment, as well as higher interest rates in 1995 versus 1994. The impact on operating profit from the foreign currency effect of the weaker U.S. Dollar was approximately $4,000,000. Income before income taxes was $52,894,000 in 1995 as compared to income before income taxes of $92,601,000 in 1994. The decrease in income before income taxes in 1995 can be attributed to the Merger restructure costs of $19,512,000 and the write-off of $62,000,000 of purchased research and development costs pursuant to the application of purchase accounting guidelines in recording the Merger. Excluding the restructure charges and write-off of purchased research and development costs, income before income taxes was $134,406,000, an increase of $41,805,000, or 45%, over 1994, primarily due to higher profits in ECG, up 45%, SMG, up 13% and in AMG, up 88%.\n1994 Compared to 1993\nTotal revenue increased $57,279,000, or 14%, in 1994 over 1993 due to sales increases in all four of the Company's markets. Recurring revenue increased $36,521,000, or 14%, in 1994 over 1993 and represented 63% of total revenue in both 1994 and 1993. Revenue from IG, primarily Europe, was $103,824,000 in 1994, representing an increase of $7,532,000, or 8%, over 1993. Revenue from IG represented 22% and 23% of total Company revenue in 1994 and 1993, respectively. The net impact of changes in foreign currency rates on revenue from outside of the United States was not significant.\nECG revenue increased $43,639,000, or 36%, on the strength of a 40% increase in network services revenue, a 43% increase in product revenue and a 20% increase in product support revenue. The increase in network services revenue was primarily due to an increase in the customer base primarily in the hardlines, grocery, retail, manufacturing and healthcare industries and increases in the network processing volume for existing customers. The number of network customers grew by approximately 2,000, placing the total network customers at September 30, 1994, at approximately 9,000. The three ECG product lines, communications software, banking systems and interchange software, each had revenue growth in product and product support revenue due to new customers, certain product price increases and a continuing expansion of the installed customer base for product support revenue. SMG revenue increased $5,403,000, or 4%, on a 4% increase in product revenue and a 4% increase in product support revenue. All three SMG product lines, storage management, operations management and VM software, increased revenue in 1994 over 1993. The introduction of a new storage management product, price increases for certain products and an increase in the installed customer base were the primary reasons for the SMG revenue growth. AMG revenue increased $2,093,000, or 4%, in 1994 over 1993, due to a 2% increase in product revenue and a 9% increase in product support revenue. Price increases for certain products and an increase in the installed customer base were the primary reasons for the AMG revenue growth. Federal Systems Group (\"FSG\") revenue increased $6,177,000, or 6%, in 1994 over 1993, due to higher contract billings in the NASA Ames, Information Technology and Scientific Systems divisions.\nTotal costs and expenses decreased $83,083,000, or 18%, in 1994 over 1993. In 1993, total costs and expenses included restructuring charges of $91,260,000 for Sterling's restructuring resulting from the acquisition of Systems Center. The components of the 1993 restructuring charges were the following:\nTotal cost of sales decreased $360,000; cost of sales services increased commensurate with the increase in services revenue, but the increase was offset primarily by decreased cost of sales products and product support as a percentage of the related revenue. The decrease relates to lower costs associated with technical support personnel as a result of the 1993 restructuring and, to a lesser extent, to decreased depreciation and amortization in cost of sales products and product support. Cost of sales includes $25,914,000 and $26,626,000 of depreciation and amortization in 1994 and 1993, respectively. Amortization of capitalized software development costs increased $5,138,000, or 42%, and amortization of intangible assets and depreciation of property and equipment increased $46,000, or 1%. These increases were offset by a decline of $5,561,000, or 68%, in the amortization of purchased software due to the full amortization of purchased software and the write-off of certain software in the fourth quarter of 1993 as a result of the SCI Merger, coupled with a decline of $313,000, or 11%, in the amortization of the excess costs over net assets of businesses acquired. Product development expense for 1994 of $33,002,000, net of $19,390,000 of amounts capitalized pursuant to Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed\" (\"FAS No. 86\") increased $5,605,000, or 20%, compared to 1993 product development expense of $27,397,000, net of $23,730,000 of amounts capitalized pursuant to FAS No. 86. The increase is primarily due to the decrease in the capitalization of software development costs and, to a lesser extent, to increased gross product development expense. Product development expense and the capitalization rate may fluctuate from period to period depending in part upon the number and status of software development projects which are in process. Selling, general and administrative expenses increased $2,932,000, or 2%, which is significantly less than the 14% increase in revenue, primarily due to decreased headcount as a result of the reduction in workforce in the fourth quarter of 1993.\nIncome before income taxes, extraordinary item and cumulative effect of a change in an accounting principle was $92,601,000 in 1994 as compared to a loss of $47,830,000 in 1993. Excluding the restructuring charges of $91,260,000 in 1993, income before income taxes, extraordinary item and cumulative effect of a change in an accounting principle increased $49,171,000 primarily due to higher operating profits in SMG, up 74%%, ECG, up 98%, AMG, up 13% and FSG, up 15%, in 1994 over 1993, respectively. Also contributing to this increase was a decrease of $1,091,000, or 14%, in interest expense primarily for interest accrued in 1993 on the unpaid dividends on previously outstanding Systems Center Preferred Stock.\nPursuant to the SCI Merger, Systems Center Preferred Stock was converted into the right to receive Common Stock. As a result, preferred stock dividends declined $808,000 in 1994 over 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company maintained a strong liquidity and financial position with $222,405,000 of working capital at September 30, 1995, which includes $179,305,000 of cash and equivalents and $61,341,000 of marketable securities. Net cash flows from operations was $97,425,000. The increase in accounts and notes receivable is due to 1995 fourth quarter sales of $172,594,000 versus $131,352,000 for the fourth quarter of 1994. Days sales outstanding at September 30, 1995, measured on a quarterly basis was 96 days versus 91 days, an increase of 5%, on a 31% increase in revenue in the fourth quarter of 1995 versus the fourth quarter of 1994. The increase in current and long-term deferred revenue is due to increased sales volume and higher levels of fixed term licenses sold with product support terms of one to five years. Cash flows from operations and the proceeds from the exercise of stock options and warrants during 1995 were used to fund capital expenditures and software additions.\nSoftware expenditures were $22,531,000, the majority of which were costs capitalized pursuant to FAS No. 86, were made during 1995, compared to $21,392,000 during 1994. ECG expended $10,331,000 for software during\n1995, primarily for enhancements of communications software products and interchange software products. SMG expended $7,848,000 of the total software expenditures during 1995, primarily for the development of systems management and storage management products and enhancements. Software expenditures in AMG were $4,352,000 for software enhancements of applications management and development products. Property and equipment purchases of $38,100,000 include purchases made for equipment upgrades for network processing systems, costs to add new network service features and computer and other equipment purchases to support the continuing growth of the Company.\nOn October 2, 1995, the Company renewed a share repurchase program pursuant to which it may repurchase shares of its common stock from time to time through open market transactions. The primary purpose of the program is to provide shares to fund the Company's 401(k) and stock option plans. As of November 10, 1995 699,500 shares of common stock were repurchased at an aggregate amount of approximately $30,931,000. Although no finite number of shares will be repurchased, depending on stock market conditions and plan needs the Company could repurchase up to one million shares and perhaps more. The 200,000 shares of the Company's Junior Preferred Stock outstanding at September 30, 1994 were exchanged on June 27, 1995 for warrants to purchase 269,380 shares of the Company's Common Stock. The warrants became fully exercisable on September 25, 1995 at an exercise price of $36.50 per share and expire on June 26, 1997, pursuant to their terms.\nProceeds from the exercise of the Company's stock options and warrants were $63,597,000 in 1995 and $21,906,000 in 1994. The tax benefit of $25,251,000 associated with the exercise of stock options and warrants was credited to paid in capital. Subsequent to September 30, 1995 and through November 10, 1995, proceeds from the exercise of stock options and warrants were approximately $16,865,000.\nIn February 1993, the Company issued $115,000,000 principal amount of 5 3\/4% Debentures. The 5 3\/4% Debentures are convertible into Common Stock at any time prior to maturity at a conversion price of $28.35. This transaction resulted in $111,450,000 of net proceeds after transaction costs.\nOn August 24, 1995, the Company entered into a Second Amended and Restated Revolving Credit and Term Loan Agreement (\"Loan Agreement\") with a borrowing capacity of $35,000,000. The Loan Agreement is unsecured and contains various restrictions on the Company, including limitations on additional borrowings, repurchase of subordinated debt, payment of dividends, acquisitions and capital expenditures. The Loan Agreement also requires that certain financial ratios be maintained. Borrowings under the Loan Agreement bear interest at the higher of the bank's prime rate or the Federal Funds Effective Rate plus one- half percent ( 1\/2%). Borrowings, if any, outstanding on August 24, 1998 will convert to four payments in equal installments due at the end of each subsequent quarter. There were no amounts borrowed during 1995 and 1994 or outstanding under the Company's loan facilities at September 30, 1995. At September 30, 1995, after the utilization of approximately $3,524,000 for standby letters of credit, approximately $31,476,000 was available for borrowing on the Loan Agreement. Certain of the Company's foreign subsidiaries have separate lines of credit totaling $24,328,000 available for foreign exchange exposure management and working capital requirements. These lines of credit are guaranteed by the U.S. parent company. At September 30, 1995, $4,170,000 was outstanding pursuant to foreign lines of credit.\nAt September 30, 1995, the Company's capital resource commitments consisted of commitments under lease arrangements for office space and equipment. The Company intends to meet such obligations primarily from internally generated funds. No significant commitments exist for future capital expenditures. Based on the Company's current tax attributes, future cash tax payments are expected to be substantially greater than cash tax payments made in 1995. See Note 12 of Notes to Consolidated Financial Statements--Income Taxes. The Company believes available balances of cash, cash equivalents and short-term investments combined with cash flows from operations and amounts available under credit and term loan agreements are sufficient to meet the Company's cash requirements for the foreseeable future.\nOTHER MATTERS\nDemand for many of the Company's products tends to improve with increased inflation as customers strive to increase employee productivity and reduce costs. However, the effect of inflation on the Company's relatively labor intensive cost structure could adversely affect its results of operations to the extent the Company might not be able to recover increased operating costs through increased product licensing and prices.\nThe assets and liabilities of non-U.S. operations are translated into U.S. dollars at exchange rates in effect as of the respective balance sheet dates, and revenue and expense accounts of these operations are translated at average\nexchange rates during the month the transactions occur. Unrealized translation gains and losses are included as an adjustment to retained earnings. The Company has mitigated a portion of its currency exposure through decentralized sales, marketing and support operations and through remote development facilities, in which all costs are local currency based. When necessary, the Company may also hedge to prevent material exposure.\nThe Company maintains a strategy of acquiring businesses and products that fill strategic market niches within the business groups. This acquisition strategy contributes in part to the Company's growth in revenue and operating profit before restructuring charges. The impact of future acquisitions on continued growth in revenue and operating profit cannot presently be determined.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSTERLING SOFTWARE, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Sterling Software, Inc.\nWe have audited the accompanying consolidated balance sheets of Sterling Software, Inc. (the \"Company\") as of September 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 September 30, 1995. 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 audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sterling Software, 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, presents fairly in all material respects the information set forth therein.\nErnst & Young LLP\nDallas, Texas November 16, 1995\nSTERLING SOFTWARE, INC.\nCONSOLIDATED BALANCE SHEETS\nSEPTEMBER 30, 1995 AND 1994 (IN THOUSANDS, EXCEPT SHARE INFORMATION)\nSee accompanying notes.\nSTERLING SOFTWARE, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes.\nSTERLING SOFTWARE, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes.\nSTERLING SOFTWARE, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSEPTEMBER 30, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe consolidated financial statements include the accounts of Sterling Software, Inc. and its wholly owned subsidiaries (\"Sterling\" or the \"Company\") (See Note 2) after elimination of all significant intercompany balances and transactions. Certain amounts for periods ended prior to September 30, 1995, have been reclassified to conform to the current year presentation. The financial statements have been prepared in conformity with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingencies at September 30, 1995 and 1994 and the results of operations for the years ended September 30, 1995, 1994 and 1993. While management has based their assumptions and estimates on the facts and circumstances known at September 30, 1995, final amounts may differ from such estimates.\nRevenue\nRevenue from license fees, including leasing transactions, for standard software products is recognized when the software is delivered, provided no significant future vendor obligations exist and collection is probable. Service revenue and revenue from products involving installation or other services are recognized as the services are performed.\nProduct support contracts entitle the customer to telephone support, bug fixing and the right to receive software updates as they are released. Revenue from product support contracts, including product support included in initial license fees, is recognized ratably over the contract period. All significant costs and expenses associated with product support contracts are expensed ratably over the contract period.\nIf software product transactions include the right to receive future products, a portion of the software product revenue is deferred and recognized as products are delivered. Contract accounting is applied for sales of software products requiring significant modification or customization, such that revenue is recognized only when the modification or customization is complete.\nWhen products, product support and services are billed prior to the time the related revenue is recognized, deferred revenue is recorded and related costs paid in advance are deferred.\nRevenue from professional services provided to the federal government under multi-year contracts is recognized as the services are performed. Revenue for services under long-term contracts is recognized using the percentage-of- completion method of accounting. Losses on long-term contracts are recognized when the current estimate of total contract costs indicates a loss on a contract is probable.\nSoftware Development Costs\nThe Company capitalizes the costs of developing and testing new or significantly enhanced software products in accordance with the provisions of Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.\" Unamortized software development costs of $56,117,000 and $56,713,000 are included in \"Computer software, net\" at September 30, 1995 and 1994, respectively.\nDepreciation and Amortization\nProperty and equipment are recorded at cost and depreciated using the straight-line method over average useful lives of three to twenty years. Computer software costs are amortized on a product-by-product basis using the greater of the amount computed by taking the ratio of current year net revenue to estimated future net revenue or the amount computed by the straight-line method over periods ranging from three to seven years. Excess costs over the net assets of businesses acquired are amortized on a straight-line basis over periods of seven to forty years. Other intangible assets are amortized on a straight-line basis over periods of three to ten years.\nDepreciation and amortization consists of the following for the years ended September 30, 1995, 1994 and 1993 (in thousands):\nIncome Taxes\nIn the fourth quarter of 1993, the Company adopted Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes\" (\"FAS No. 109\"), which requires the use of the asset and liability method of accounting for income taxes, and restated prior years' financial statements. Under the asset and liability method, a deferred tax asset or liability is recognized for estimated future tax effects attributable to temporary differences and carryforwards. The measurement of deferred income tax assets is adjusted by a valuation allowance, if necessary, to recognize future tax benefit only to the extent, based on available evidence, it is more likely than not it will be realized. The effect on deferred taxes of a change in income tax rates is recognized in the period that includes the enactment date.\nEarnings Per Common Share\nPrimary earnings per common share data is computed using the weighted average number of common shares and common share equivalents represented by stock options and warrants, if such stock options and warrants have a dilutive effect in the aggregate. For purposes of this computation, income applicable to common stockholders is adjusted to reflect use of net cash proceeds on the assumed exercise of stock options and warrants to purchase outstanding long-term debt or government securities, if such stock options and warrants have a dilutive effect.\nFully diluted earnings per common share computations assume, in addition, the conversion of the Company's 5 3\/4% Convertible Subordinated Debentures (\"5 3\/4% Debentures\") in 1995 and 1994 computations, the Company's 8% Convertible Senior Subordinated Debentures (\"8% Debentures\") and 5 3\/4% Debentures in 1993 computations, if such conversions have a dilutive effect. Upon assumed conversion of the convertible debentures, income applicable to common stockholders is adjusted to reflect the elimination of after tax interest expense related to such debentures. For purposes of this computation, income applicable to common stockholders is also adjusted to reflect use of net cash proceeds on the assumed exercise of stock options and warrants to purchase outstanding long-term debt or government securities, if such stock options and warrants have a dilutive effect.\nFor the year ended September 30, 1995 and 1993, neither the common share equivalents nor the assumed conversion of the debentures had a dilutive effect on the loss per share calculations. Accordingly, the net income (loss) per common share calculations for such periods is based on the weighted average number of common shares outstanding during the year. The number of shares used in the computations of net income (loss) per common share for the year ended September 30, 1995 was 23,649,000 and 1993 was 17,507,000. The number of shares used in the computations of primary and fully diluted income per common share for the year ended September 30, 1994, were 22,923,000 and 26,979,000, respectively.\nForeign Currency Translation\nThe assets and liabilities of consolidated wholly owned non-U.S. operations are translated into U.S. dollars at exchange rates in effect as of the respective balance sheet dates. Revenue and expense accounts of these operations are translated at average exchange rates prevailing during the period the transactions occur. Unrealized translation gains and losses are included as an adjustment to retained earnings.\nCash and Equivalents\nCash equivalents consist primarily of highly liquid investments in repurchase agreements backed by U.S. Treasury securities and investment-grade commercial paper of various issuers, with maturities of three months or less when purchased. The carrying amount reported in the consolidated balance sheet for cash and cash equivalents approximates its fair value.\nMarketable Securities and Other Investments\nThe Company invests excess cash in a diversified portfolio consisting of a variety of securities including commercial paper, medium term notes, U.S. government obligations, investment fund partnerships and certificates of deposit, which may include both investment grade and non-investment grade securities. The fair values for marketable securities are based on quoted market prices. Effective September 30, 1993, the Company adopted Statement of Financial Accounting Standard No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"FAS No. 115\").\nAll marketable securities and long-term investments are classified as available-for-sale securities. Unrealized holding gains and losses on securities available-for-sale are recorded as a component of stockholders' equity, net of any related tax effect. 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 values judged to be other-than- temporary on available-for-sale securities are included in investment income.\nOther Assets\nIncluded in \"other assets\" in the consolidated balance sheet are noncurrent marketable securities (see Note 7) debt issuance costs related to the issuance of the 5 3\/4% debentures (see Note 10), long-term deposits, certain intangibles and other noncurrent assets.\n2. BUSINESS COMBINATIONS\nOn November 30, 1994, Sterling Software, Inc. acquired KnowledgeWare, Inc. (\"KnowledgeWare\"), a Georgia corporation based in Atlanta, Georgia which was a leading provider of applications development software and services, for approximately $106 million, in a stock-for-stock acquisition (the \"Merger\"). In connection with the Merger, the Company issued approximately 2,421,000 shares of the Company's $0.10 par value Common Stock (the \"Common Stock\") valued at approximately $74,443,000 and reserved approximately 340,000 shares of Common Stock for issuance upon exercise of KnowledgeWare's options and warrants. In addition, the Company incurred cash costs directly related to the Merger of approximately $31,672,000. The Merger, which was accounted for as a purchase, was completed pursuant to the terms of an Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, as amended (the \"Merger Agreement\"), among the Company, SSI Corporation, a Georgia corporation and a wholly owned subsidiary of the Company (\"Merger Sub\"), and KnowledgeWare. Of the 2,421,000 shares of Common Stock issued, approximately 484,800 shares were placed in escrow (the \"Escrowed Shares\") to cover certain losses that may result in connection with any pending or threatened litigation, action, claim, proceeding, dispute or investigation (\"Actions\") (including amounts paid in settlement) to which the Company is entitled to indemnification pursuant to the terms of the Merger Agreement. Approximately 207,000 of the Escrowed Shares remain to cover potential losses associated with remaining Actions. See Note 4.\nIn a separate agreement, effective August 31, 1994, the Company acquired all of the interest of IBM Credit Corporation (\"IBM Credit\") under the Revolving Loan and Security Agreement with KnowledgeWare (the \"KWI Loan Agreement\") by paying to IBM Credit $15.1 million, which was equal to all amounts owed thereunder by KnowledgeWare. Concurrently, the Company and KnowledgeWare modified the terms of the KWI Loan Agreement and an additional $3 million was advanced to KnowledgeWare, resulting in total borrowings pursuant to the KWI Loan Agreement of $18,266,000 at September 30, 1994, including accrued interest.\nThe operating results of KnowledgeWare are included in the Company's results of operations from the date of the Merger. In addition, the results of operations for the first quarter of 1995 include $62,000,000 of purchased research and development costs, which is the portion of the purchase price attributed to in-process research and development, and which is charged to expense in accordance with purchase accounting guidelines. The $62,000,000 charge has no related tax benefit. The results of operations also include a charge for restructure costs of $19,512,000 to integrate KnowledgeWare's business into the Company's operations. See Note 3.\nThe following unaudited supplemental information presents the results of operations as if the Merger had occurred at October 1, 1993. This summary does not purport to be indicative of what would have occurred had the Merger occurred as of that date or of results which may occur in the future. This method of combining the companies is for the presentation of unaudited pro forma summary results of operations. The actual statements of operations of Sterling Software, Inc. and of KnowledgeWare have been combined from November 30, 1994 forward, with no retroactive restatement.\nThe unaudited supplemental information presented above does not include a $62,000,000 charge for purchased research and development costs and a $19,512,000 restructuring charge directly related to the acquisition.\nIn August 1994, the Company acquired all of the outstanding common stock of American Business Computer Company (\"ABC\"), a Michigan corporation based near Detroit, Michigan, which developed, marketed and supported UNIX-based electronic data interchange products, including products that provide sophisticated electronic commerce gateway functionality, in a stock-for-stock acquisition (the \"ABC Merger\") accounted for as a pooling of interests. The Company issued approximately 306,500 shares of the Company's $0.10 par value Common Stock (the \"Common Stock\") as a result of the transaction. The Company's financial statements for periods prior to the ABC Merger represent the combined financial statements of the previously separate entities adjusted to conform ABC's fiscal years and accounting policies to those used by the Company.\nIn July 1993, the Company acquired all of the outstanding common stock and preferred stock of Systems Center, Inc. (\"Systems Center\"), a recognized leader in data communications and systems management software for approximately $156 million in a stock-for-stock acquisition (the \"SCI Merger\") accounted for as a pooling of interests and, accordingly, the combination of the equity interests was given retroactive effect. The Company's financial statements for periods prior to the SCI Merger represent the combined financial statements of the previously separate entities adjusted to conform Systems Center's fiscal years and accounting policies to those used by the Company.\n3. RESTRUCTURING CHARGES\nThe Company recorded restructuring charges of approximately $19,512,000 and $91,260,000 during 1995 and 1993, respectively.\nThe components of the Company's restructuring charge related to the combining of KnowledgeWare and the Company (\"KnowledgeWare restructuring\") are the following:\nAs a result of the KnowledgeWare restructuring, future operating results are expected to benefit from the reduction in workforce and elimination of duplicate facilities. Estimated annual cost reductions of approximately $12,000,000 in salaries and benefits from the reduction in workforce and estimated total future cost reductions of approximately $8,200,000 in depreciation, amortization and rent expense are anticipated from the write- offs of software products which will not be actively marketed by the Company and the elimination of duplicate facilities and equipment. Of the total restructuring charge of $19,512,000, approximately $8,377,000 is a non-cash charge and the\nremaining $11,135,000 requires cash outlays, of which approximately $10,941,000 was expended in 1995. Future cash expenditures related to the KnowledgeWare restructuring are anticipated to be made from cash generated from operations. The Company does not expect to incur significant costs related to the KnowledgeWare restructuring in excess of the amount charged to operations in 1995. Approximately $7,000,000 of the restructuring charge has not been tax benefited.\nThe 1993 restructuring charges reflect the cost of combination of the Company and Systems Center, including transaction costs and charges relating to the elimination of duplicate facilities and equipment, severance costs and the write-off of costs related to certain software products not actively marketed by the Company. Of the total restructuring charge of $91,260,000, approximately $21,348,000 was non-cash and the remaining $69,912,000 required cash outlays. Cash of approximately $30,700,000 was expended prior to September 30, 1993, approximately $26,600,000 was expended in 1994 and $5,747,000 was expended in 1995. Future cash expenditures related to the restructuring, the majority of which relate to the elimination of duplicate facilities, are accrued and are anticipated to be made from cash generated from operations. See Note 11.\n4. LEGAL PROCEEDINGS AND CLAIMS\nThe Company is subject to certain legal proceedings and claims that arise in the ordinary conduct of its business. In the opinion of management, the amount of ultimate liability with respect to these actions, net of applicable reserves will not materially affect the financial condition or results of operations of the Company.\nIn addition, KnowledgeWare, which was acquired on November 30, 1994, is subject to certain legal proceedings and claims, involving, among other claims, allegations of federal and state securities fraud, breach of contract, breach of fiduciary duty by former officers and directors of KnowledgeWare, common law fraud, RICO violations under Federal and State law and, in certain cases, trebled and punitive damages. The Company believes those claims are subject to the indemnification arrangements described in Note 2, above. Two of the proceedings have been settled, subject to court approval and other customary conditions, for cash to be paid by KnowledgeWare's insurance carrier and for the proceeds from the sale of approximately 278,000 of the 484,800 shares held in the escrow described in Note 2, above. In addition, the Securities and Exchange Commission has entered an Order directing Private Investigation and Directing Officers to take Testimony related to trading in KnowledgeWare securities from July 1, 1992 through the time of the stock-for- stock acquisition by which the Company acquired KnowledgeWare, KnowledgeWare's compliance with filing and reporting procedures and\/or accuracy of its public disclosures, and KnowledgeWare's recordkeeping and accounting controls.\nAssuming the consummation of the pending settlements referred to above on the terms described, the Company's management believes that, after giving effect to the value of the remaining Escrowed Shares and applicable reserves, the ultimate resolution of such actions will not materially affect the financial condition or results of operations of the Company.\n5. SEGMENT INFORMATION\nThe Company acquires, develops, markets and supports a broad range of computer software products and services in four major markets classified as Systems Management, Electronic Commerce, Applications Management and Federal Systems. Each major market is represented through independently operated business groups. The Systems Management Group provides enterprise-wide systems management software for large computing environments. The Electronic Commerce Group provides software and services to facilitate electronic commerce, defined by the Company as the worldwide electronic interchange of business information, including electronic data interchange software and services, data communications software and electronic payments software for financial institutions. The Applications Management Group focuses exclusively on the applications management market. The group provides products for developing new applications and revitalizing existing applications and consulting services to ensure that customers are successful using the applications management products. The Federal Systems Group provides highly technical services to the federal government under several multi-year contracts primarily in support of National Aeronautics and Space Administration aerospace research projects and secure communications systems for the Department of Defense. In addition, the Federal Systems Group sells the Company's electronic commerce products to the federal government under a newly formed Federal Electronic Commerce Division. The fifth business group, International, is responsible for sales and first level support of the Company's products outside of the United States and Canada. International Group operating results are included, as applicable, in the Company's Systems Management, Electronic Commerce and Applications Management segments in the business segment tables contained herein. International Group revenue of $158,374,000, $103,824,000 and $96,292,000 and operating profit (loss) of $26,355,000, $14,325,000 and $(1,203,000) for 1995, 1994 and 1993, respectively, have been allocated to the business segments.\nFinancial information concerning the Company's operations, by business segment, for the years ended September 30, 1995, 1994 and 1993, restated to conform to the current year presentation, is summarized as follows (in thousands):\nThe amounts presented for \"Corporate and other\" include corporate expense, intersegment eliminations, cash balances, marketable securities, long-term investments, deferred income tax benefits, other assets and the results of operations and assets of the Company's retail software division.\n6. OPERATIONS BY GEOGRAPHIC AREA\nThe Company's operations in the United States and international markets at September 30, 1995, 1994 and 1993 and for the years then ended are summarized as follows (in thousands):\n7. MARKETABLE SECURITIES AND OTHER LONG-TERM INVESTMENTS\nAt September 30, 1995 and 1994, all of the Company's marketable securities and other long-term investments are classified as available-for-sale and consist of the following (in thousands):\nAt September 30, 1995, scheduled maturities of investments in debt securities are: $21,717,000 within one year and $22,737,000 between one and five years.\n8. ACCOUNTS AND NOTES RECEIVABLE\nAccounts and notes receivable consist of the following at September 30 (in thousands):\nAt September 30, 1995 and 1994, accounts receivable include $34,310,000 and $30,728,000, respectively, due under contracts with the federal government and related agencies. The remainder of the Company's receivables are due principally from corporations in diverse industries located in North America and Europe.\n9. PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following at September 30 (in thousands):\n10. LONG-TERM DEBT\nLong-term debt consists of the following at September 30 (in thousands):\nThe 5 3\/4% Debentures are unsecured general obligations of the Company and mature on February 1, 2003. Interest is payable semi-annually. The 5 3\/4% Debentures are convertible into Common Stock at a conversion price of $28.35. The 5 3\/4% Debentures are redeemable at a premium after February 12, 1996, at the option of the Company, in whole or in part. Upon a Change of Control (as defined), holders of the 5 3\/4% Debentures will have the right, subject to certain restrictions and conditions, to require the Company to purchase all or in part any of the 5 3\/4% Debentures at the principal amount, plus accrued interest. The 5 3\/4% Debentures are subordinated to all existing and future Senior Indebtedness (as defined) of the Company. Based on quoted market prices, the aggregate fair value of the 5 3\/4% Debentures was approximately $181,679,000 at September 30, 1995.\nIn February 1993, the Company called for redemption of its 8% Debentures at a price equal to 103.2% of the principal amount. At that time, holders of the 8% Debentures had the option to convert their holdings into shares of Common Stock or redeem the debentures for cash. Holders of $13,739,000 principal amount of 8% Debentures elected to convert their 8% Debentures into 636,054 shares of Common Stock. The remaining $38,894,000 principal amount of 8% Debentures was redeemed on March 4, 1993, for $40,165,000, including interest of $26,000. The redemption of the 8% Debentures resulted in an extraordinary loss of $1,481,000, net of applicable income tax benefit of $987,000.\nOn August 24, 1995, the Company entered into a Second Amended and Restated Revolving Credit and Term Loan Agreement (\"Loan Agreement\") with a borrowing capacity of $35,000,000. The Loan Agreement is unsecured and contains various restrictions on the Company, including limitations on additional borrowings, repurchase of subordinated debt, payment of dividends, acquisitions and capital expenditures. The Loan Agreement also requires that certain financial ratios be maintained. Borrowings under the Loan Agreement bear interest at the higher of the bank's prime rate or the Federal Funds Effective Rate plus one-half percent ( 1\/2%). Borrowings, if any, outstanding on August 24, 1998 will convert to four payments in equal installments due at the end of each subsequent quarter. There were no amounts borrowed during 1995 and 1994 or outstanding under the Loan Agreement at September 30, 1995. At September 30, 1995, after the utilization of approximately $3,524,000 for standby letters of credit, approximately $31,476,000 was available for borrowing on the Loan Agreement.\nCertain of the Company's foreign subsidiaries have $24,328,000 available under separate lines of credit for foreign exchange exposure management and working capital requirements. These lines of credit are guaranteed by the U.S. parent company. At September 30, 1995, $4,170,000 was outstanding pursuant to foreign lines of credit.\n11. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nAccounts payable and accrued liabilities consist of the following at September 30 (in thousands):\nAccrued restructuring and acquisition costs included in accounts payable and accrued liabilities are due to the Company's restructurings as a result of the acquisitions of Systems Center and KnowledgeWare (see Notes 2 and 3) and are primarily for the remaining commitments pursuant to operating leases of duplicate facilities.\n12. INCOME TAXES\nThe provision (benefit) for income taxes on income (loss) before extraordinary item and cumulative effect of a change in accounting principle is composed of the following (in thousands):\nThe effective income tax (benefit) rate on income (loss) before extraordinary item and cumulative effect of a change in accounting principle differed from the federal income tax statutory rate for the following reasons (in thousands):\nIncome (loss) before extraordinary item and cumulative effect of a change in accounting principle includes foreign pretax earnings (losses) of $(4,300,000), $12,104,000 and $(17,780,000) for the years ended September 30, 1995, 1994 and 1993, respectively.\nThe Company's income tax payments have been reduced by approximately $25,251,000 due to income tax deductions associated with the exercise of stock options and warrants. This reduction in tax payments has been credited to paid in capital 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 the Company's net deferred tax asset as of September 30 are as follows (in thousands):\nThe valuation allowance relates principally to certain net operating loss and credit carryforwards. Although realization is not assured, management believes that future taxable income based on expected future earnings of the Company will more likely than not utilize a portion of the net operating loss carryforwards, tax credit carryforwards and other future tax deductions in existence at September 30, 1995, equivalent to the net deferred income tax asset. As there can be no assurances on amounts in excess of the net deferred income tax asset, the aforementioned valuation allowance has been recorded and may change as estimates during the carryforward periods change.\nAt September 30, 1995, the Company had net operating loss and tax credit carryforwards for federal income tax purposes of approximately $125,000,000 and $15,491,000, respectively. These carryforwards will expire at various times between 1996 and 2009, with approximately $120,000,000 of the carryforwards expiring between 2006 and 2009. The usage of substantially all of these carryforwards is restricted to future taxable income of certain of the Company's wholly owned subsidiaries and limited by Section 382 of the Internal Revenue Code which cannot be assured.\n13. COMMITMENTS\nThe Company leases certain facilities and equipment under operating leases. Total rent expense for the years ended September 30, 1995, 1994 and 1993 was $33,896,000, $27,306,000 and $27,827,000, respectively. At September 30, 1995, minimum future rental payments due under all operating leases, net of future sublease income, are as follows (in thousands):\n14. PREFERRED STOCK\nThe Company is authorized to issue 10,000,000 shares of preferred stock, par value $0.10 per share (\"Preferred Stock\"), of which 200,000 shares designated as Series B Junior Preferred Stock (\"Junior Preferred Stock\") were issued and outstanding at September 30, 1994. The 200,000 shares of the Company's Junior Preferred Stock outstanding at September 30, 1994 were exchanged on June 27, 1995 for warrants to purchase 269,380 shares of the Company's Common Stock. The warrants became fully exercisable on September 25, 1995 at an exercise price of $36.50 per share and expire on June 26, 1997, pursuant to their terms. The Board of Directors of the Company is authorized, without action by the stockholders, to issue Preferred Stock and fix for each series the number of shares, designation, dividend rights, voting rights, redemption rights and other rights.\n15. STOCK OPTIONS AND WARRANTS\nThe Company has thirteen stock option plans that provide for the granting of options to officers, directors, key employees and advisors, including two stock plans assumed by the Company in the KnowledgeWare Merger (the \"KnowledgeWare Plans\") and six stock plans assumed by the Company in the SCI Merger (the \"Systems Center Plans\"), under which no further options or other rights may be granted. All options have been granted at or above the fair market value of the stock at the time of the grant.\nOptions granted pursuant to the plans (other than options pursuant to the Systems Center and KnowledgeWare Plans) become exercisable generally at a rate of 25% per year and expire within five years from the date of grant. All of the outstanding stock options granted under the Systems Center and KnowledgeWare Plans were fully vested as of September 30, 1995.\nStock option transactions are summarized below for the three years ended September 30, 1995:\nAt September 30, 1995 and 1994, a maximum of 1,293,704 and 3,096,711 shares, respectively, were reserved for future grants of options under the plans. Subsequent to September 30, 1995, 967,775 additional shares were granted under the Company's stock option plans. The tax benefit associated with the exercise of options and warrants is credited to paid in capital. This tax benefit recognized in 1995 was $25,251,000.\nThe following table summarizes the number of warrants exercised during 1995 and information with respect to warrants outstanding at September 30, 1995:\nDuring 1993, 158,465 warrants with an aggregate exercise price of $1,027,903 were exercised for shares of Common Stock.\nAll of the outstanding stock options and warrants are subject to anti- dilution adjustments.\n16. POSTRETIREMENT BENEFITS\nThe Company has a plan to provide retirement benefits under the provisions of Section 401(k) of the Internal Revenue Code for all domestic employees who have completed a specified term of service. Pursuant to this plan, eligible participants may elect to contribute a percentage of their annual gross compensation and the Company will contribute additional amounts, as provided by the plan. Benefits under the plan are limited to the assets of the plan. Company contributions charged to expense during 1995, 1994 and 1993 were $3,404,000, $2,895,000 and $2,517,000, respectively. A portion of the Company contributions are invested in Common Stock of the Company. During 1995, 1994 and 1993, the investment of the Company's contributions included 28,597, 40,700 and 43,600 shares of Common Stock, respectively. Of the 1995 contribution 10,215 shares of Common Stock were transferred to the plan in October 1995.\nCertain of the Company's subsidiaries also provide healthcare benefits to eligible retired employees. These benefits are subject to deductibles, copayment provisions and other limitations including retiree premium contributions. The Company's policy is to fund the cost of the postretirement healthcare coverage in amounts determined at the discretion of management. The Company and its subsidiaries may amend or change the plan periodically, or may terminate the plan.\nA plan amendment was adopted in October 1994 that reduced the number of employees eligible for participation in the postretirement benefit plan and reduced the Company's future costs for certain eligible participants. The impact of the amendment in 1995 is a curtailment gain of approximately $1,400,000.\nIn 1993, the Company adopted Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits other than Pensions\" (\"FAS No. 106\"). This new standard requires that the expected costs of retiree healthcare benefits be charged to expense during the years the employee renders service. The effect of adopting the new standard as of October 1, 1992, was a charge of $2,774,000, representing the accumulated benefit obligation existing at that date, net of related income tax benefit of $1,813,000. In addition, postretirement benefit costs for the year ended September 30, 1993, increased by $1,211,000 as a result of the adoption of the new standard.\nThe following table sets forth the computation of accrued postretirement healthcare benefit costs at September 30 (in thousands):\nThe following table presents net periodic postretirement healthcare benefit costs for the years ended September 30, 1995, 1994 and 1993 (in thousands):\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% at September 30, 1995. The weighted-average annual assumed rate of increase in the per capita cost of covered benefits (healthcare cost trend rate) is 10% for 1995 and is assumed to decrease gradually to 5% after 10 years and remain at that level thereafter. At September 30, 1994, the weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8%. The weighted average healthcare cost trend rate was 11 1\/2% for 1994 and is assumed to decrease gradually to 5% after 13 years and remain at that level thereafter.\nThe healthcare cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed healthcare cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of September 30, 1995 by $233,700 and the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1995 by $18,900.\nThe Company does not provide other significant postemployment benefits.\n17. CHANGE-IN-CONTROL AND EMPLOYMENT AGREEMENTS\nThe Company has change-in-control agreements with seventeen officers that grant the right to receive payments based on the individual's respective salary, bonus and benefits if there has been a change in control (as defined) in the Company and termination of employment has occurred. At September 30, 1995, the maximum liability for salary, bonus and benefits under these agreements would be approximately $35,000,000.\nThe Company has entered into employment agreements with fifteen officers of the Company. Five of the agreements provide for severance payments based on the individual officer's salary and bonus and continuation of benefits for a period of one year if the Company terminates the officer's employment. Nine of the agreements provide for severance payments based on the individual officer's salary and bonus and continuation of certain benefits for a period of three years if the Company terminates the officer's employment. The other employment agreement provides for an annual base salary plus agreed-upon bonuses or benefits and converts to a five year consulting agreement upon the occurrence of certain events. The aggregate commitment for future salaries, excluding bonuses, under these employment agreements would be approximately $13,400,000.\n18. QUARTERLY FINANCIAL RESULTS (UNAUDITED)\nThe Company's consolidated operating results for each quarter of 1995 and 1994 are summarized as follows (in thousands, except per share data):\n- -------- (1) On November 30, 1994, Sterling acquired KnowledgeWare in a stock-for-stock acquisition accounted for as a purchase. Accordingly, the operating results of KnowledgeWare are included in the Company's results of operations from the date of the acquisition. The results of operations include $62,000,000 of purchased research and development costs, which is the portion of the purchase price attributable to in-process research and development and which was charged to expense in accordance with purchase accounting guidelines. The 1995 results of operations also include a charge for restructure costs of $19,512,000 to integrate KnowledgeWare's business into the Company's operations. The restructure charge includes employee termination costs, costs related to the elimination of duplicate facilities, the write-off of costs related to certain software products which were not actively marketed and other out of pocket costs related to the reorganization. Legal costs and expenses directly related to the acquisition of KnowledgeWare and unrelated to the restructuring of the Company are accounted for as a cost of the acquisition. (2) In August 1994, Sterling acquired ABC in a stock-for-stock acquisition accounted for as a pooling of interests. Sterling's consolidated financial statements have been retroactively adjusted to include the results of ABC for all periods presented. See Note 2.\nInformation concerning the Company's operations by business segment for each quarter of 1995, 1994 and 1993 is summarized as follows (in thousands):\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information concerning the directors of the Company is set forth in the Proxy Statement to be delivered to stockholders in connection with the Company's 1996 Annual Meeting of Stockholders under the heading \"Election of Directors,\" which information is incorporated herein by reference. The name, age and position of each executive officer of the Company is set forth under the heading \"Executive Officers\" in Part I of this report, which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information concerning executive compensation is set forth in the Proxy Statement under the heading \"Management Compensation,\" which information is incorporated herein by reference. Information contained in the Proxy Statement under the caption \"Management Compensation--Report of the Executive and Stock Option Committees of the Board of Directors on Executive Compensation and-- Stock Performance Chart\" is not incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information concerning security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading \"Principal Stockholders and Management Ownership,\" which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information concerning certain relationships and related transactions is set forth in the Proxy Statement under the headings \"Management Compensation-- Executive and Stock Option Committee Interlocks and Insider Participation\" and \"Certain Transactions,\" which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as a part of this Annual Report on Form 10-K.\n1. Consolidated Financial Statements:\nSee Index to Consolidated Financial Statements at Item 8.\n2. Consolidated Financial Statement Schedules:\nSchedule II--Valuation and Qualifying Accounts for the Years Ended September 30, 1995, 1994 and 1993\n3. Exhibits:\n(b) Reports on Form 8-K.\nThe Company filed no reports on Form 8-K during the last quarter of its fiscal year. - -------- (1) Previously filed as an exhibit to the Company's Registration Statement No. 33-62028 on Form S-4 and incorporated herein by reference. (2) Previously filed as an exhibit to the Company's Registration Statement No. 33-56185 on Form S-4 and incorporated herein by reference. (3) Previously filed as an exhibit to the Company's Registration Statement No. 33-54961 and incorporated herein by reference. (4) Previously filed as an exhibit to the Company's Registration Statement No. 2-82506 on Form S-1 and incorporated herein by reference. (5) Previously filed as an exhibit to the Company's Registration Statement No. 33-69926 on Form S-8 and incorporated herein by reference. (6) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference. (7) Previously filed as an exhibit to the Company's Registration Statement No. 33-47131 on Form S-8 and incorporated herein by reference. (8) Previously filed as an exhibit to the Company's Registration Statement No. 2-86825 on Form S-1 and incorporated herein by reference. (9) Previously filed as an exhibit to the Quarterly Report on Form 10-Q of Systems Center, Inc. for the quarter ended June 30, 1991 and incorporated herein by reference. (10) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993 and incorporated herein by reference. (11) Previously filed as an exhibit to the Company's Registration Statement No. 33-65402 on Form S-8 and incorporated herein by reference. (12) Previously filed as an exhibit to the Company's Registration Statement No. 33-62401 and incorporated herein by reference. (13) Previously filed as an exhibit to the Company's Registration Statement No. 33-56679 on Form S-3 and incorporated herein by reference.\n(14) Previously filed as an exhibit to the Company's Registration Statement No. 33-71706 on Form S-3 and incorporated herein by reference. (15) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference. (16) Previously filed as an exhibit to the Company's Registration Statement No. 33-64073 on Form S-3 and incorporated herein by reference. (17) Previously filed as an exhibit to the Company's Registration Statement No. 33-53837 on Form S-3 and incorporated herein by reference. (18) Previously filed as an exhibit to the Company's Registration Statement No. 33-56681 on Form S-8 and incorporated herein by reference. (19) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1994 and incorporated herein by reference. (20) Management Contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of the form. (21) 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.\nSterling Software, Inc.\n\/s\/ Sterling L. Williams Date: November 16, 1995 By ____________________________________ Sterling L. Williams President, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ George H. Ellis Date: November 16, 1995 By ____________________________________ George H. Ellis Executive Vice President, Finance and 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 DATES INDICATED.\n\/s\/ Robert J. Donachie Date: November 16, 1995 By ____________________________________ Robert J. Donachie Chairman of the Audit Committee and Director\n\/s\/ Michael C. French Date: November 16, 1995 By ____________________________________ Michael C. French Director\n\/s\/ Phillip A. Moore Date: November 16, 1995 By ____________________________________ Phillip A. Moore Executive Vice President, Technology and Director\n\/s\/ Charles J. Wyly, Jr. Date: November 16, 1995 By ____________________________________ Charles J. Wyly, Jr. Vice Chairman of the Board and Director\n\/s\/ Evan A. Wyly Date: November 16, 1995 By ____________________________________ Evan A. Wyly Director\n\/s\/ Robert E. Cook Date: November 16, 1995 By ____________________________________ Robert E. Cook Director\n\/s\/ Donald R. Miller, Jr. Date: November 16, 1995 By ____________________________________ Donald R. Miller, Jr. Director\n\/s\/ Francis A. Tarkenton Date: November 16, 1995 By ____________________________________ Francis A. Tarkenton Director\n\/s\/ Sterling L. Williams Date: November 16, 1995 By ____________________________________ Sterling L. Williams President, Chief Executive Officer and Director\n\/s\/ Sam Wyly Date: November 16, 1995 By ____________________________________ Sam Wyly Chairman of the Board and Director\nSCHEDULE II\nSTERLING SOFTWARE, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n(1) Offsets to deferred revenue. (2) Accounts written off.\nINDEX TO EXHIBITS ------------------\n2(a) - Agreement and Plan of Merger dated as of March 31, 1993 among the Company, Systems Center, Inc. and SSI Acquisition Corporation (\"SCI Agreement and Plan of Merger\") (1) 2(b) - First Amendment to SCI Agreement and Plan of Merger (10) 2(c) - Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, among the Company, KnowledgeWare, Inc. and SSI Corporation (\"KWI Agreement and Plan of Merger\") (2) 2(d) - Agreement dated October 11, 1994 among the Company, KnowledgeWare, Inc. and SSI Corporation (2) 2(e) - First Amendment to KWI Agreement and Plan of Merger (2) 2(f) - Agreement of Merger dated as of August 1, 1994, among the Registrant, Sterling Acquisition, Inc., American Business Computer Company (\"ABCC\") and the Shareholders of ABCC (3) 3(a) - Certificate of Incorporation of the Company (4) 3(b) - Certificate of Amendment of Certificate of Incorporation of the Company (10) 3(c) - Certificate of Amendment of Certificate of Incorporation of the Company (5) 3(d) - Certificate of Amendment of Certificate of Incorporation of the Company (6) 3(e) - Restated Bylaws of the Company (7) 4(a) - Form of Common Stock Certificate (8) 4(b) - Indenture dated as of February 2, 1993 between the Company and Bank of America Texas, National Association, as Trustee, including the form of 5 3\/4% Convertible Subordinated Debenture attached as Exhibit A thereto (21) 4(c) - Preferred Stock and Warrant Purchase Agreement dated June 25, 1991 among Systems Center, Inc. and the Investors named therein (9) 4(d) - Warrant Agreement dated June 9, 1994 between KnowledgeWare, Inc. and Trust Company Bank (13) 4(e) - Supplemental Warrant Agreement dated as of November 30, 1994 between KnowledgeWare, Inc. and Trust Company Bank (13) 4(f) - Form of Common Stock Purchase Warrant dated June 27, 1995 (15) 10(a) - Amended and Restated Stock Option Agreement dated as of August 31, 1994 between the Company and KnowledgeWare, Inc. (2) 10(b) - Amended and Restated Stockholder Agreement dated as of August 31, 1994 between the Company and certain stockholders of KnowledgeWare, Inc. (21) 10(c) - Registration Rights Agreement dated as of November 30, 1994 among the Company and the Selling Stockholders named therein (21) 10(d) - Escrow Agreement dated as of November 30, 1994 among the Company, KnowledgeWare, Inc., The First National Bank of Boston, N.A. and Stuart Finestone (21) 10(e) - Incentive Stock Option Plan of the Company as amended through April 26, 1995 (6), (20) 10(f) - Non-Statutory Stock Option Plan of the Company as amended through June 15, 1995 (15), (20) 10(g) - Supplemental Executive Retirement Plan II of Informatics General Corporation (10) 10(h) - Form of Supplemental Executive Retirement Plan II Agreement (the \"SERP II Agreement\") (10) 10(i) - Amendment to SERP II Agreement (10) 10(j) - Form of Employment Agreement dated as of October 1, 1986 with Jeannette P. Meier, George H. Ellis and Phillip A. Moore (10), (20) 10(k) - Form of Amendment No. 1 to Employment Agreement dated February 14, 1989 with Jeannette P. Meier, George H. Ellis and Phillip A. Moore (10), (20)\n10(l) - Employment Agreement dated July 7, 1987 with Sam Wyly (10), (20) 10(m) - Employment Agreement dated July 7, 1987 with Charles J. Wyly, Jr. (10), (20) 10(n) - Employment Agreement dated July 7, 1987 with Sterling L. Williams (10), (20) 10(o) - Form of Amendment No. 1 to Employment Agreement dated February 14, 1989 with Charles J. Wyly, Jr. and Sterling L. Williams (10), (20) 10(p) - Amendment No. 1 to Employment Agreement dated February 14, 1989 with Sam Wyly (10), (20) 10(q) - Amendment No. 2 to Employment Agreement dated March 15, 1989 with Sam Wyly (10), (20) 10(r) - Consultation Agreement dated July 2, 1994 with REC Enterprises, Inc. (20), (21) 10(s) - Form of Employment Agreement dated October 1, 1989 with Warner C. Blow, Werner L. Frank and Geno P. Tolari (10), (20) 10(t) - Employment Agreement with Sterling L. Williams (1), (20) 10(u) - Form of Employment Agreement dated January 1, 1993 with Jeannette P. Meier, George H. Ellis, Phillip A. Moore, Warner C. Blow and Geno P. Tolari (1), (20) 10(v) - Employment Agreement with Werner L. Frank (17), (20) 10(w) - Second Amended and Restated Revolving Credit and Term Loan Agreement dated August 24, 1995 by and among the Company and The First National Bank of Boston as Agent and the Banks listed on Schedule 1.1 thereto (12) 10(x) - 1995 Executive Compensation Plan for Group Presidents (19), (20) 10(y) - 1996 Executive Compensation Plan for Group Presidents (20), (21) 10(z) - 1992 Non-Statutory Stock Option Plan as amended through September 11, 1995 (16), (20) 10(aa) - 1994 Non-Statutory Stock Option Plan (17), (20) 10(bb) - Form of Indemnity Agreement between the Company and each of its directors and officers (10), (20) 10(cc) - Systems Center, Inc. Restated and Amended Restricted Stock Plan (11) 10(dd) - Systems Center, Inc. Amended and Restated Nondiscretionary Restricted Stock Plan (11) 10(ee) - Systems Center, Inc. 1982 Stock Option Plan (11) 10(ff) - Systems Center, Inc. 1992 Stock Incentive Plan (11) 10(gg) - Systems Center, Inc. 1983 Stock Plan (11) 10(hh) - Systems Center, Inc. Share Option Scheme (11) 10(ii) - Registration Rights Agreement dated as of July 1, 1993 among the Company and the Selling Stockholders named therein (14) 10(jj) - KnowledgeWare, Inc. Incentive Stock Option Plan of 1984 (18) 10(kk) - KnowledgeWare, Inc. Second Incentive Stock Option Plan of 1984 (18) 10(ll) - KnowledgeWare, Inc. 1988 Stock Incentive Plan (18) 10(mm) - Consultation Agreement dated December 1, 1994 between the Company and Francis A. Tarkenton (19), (20) 10(nn) - Form of Employment Agreement with Richard Connelly, Albert Hoover, James Jenkins, Anne Vahala and Evan Wyly (15), (20) 10(oo) - Form of Employment Agreement with Richard Connelly, Albert Hoover, James Jenkins, Anne Vahala and Evan Wyly (15), (20) 10(pp) - Form of Employment Agreement dated as of July 7, 1995 with Warner C. Blow, George H. Ellis, Werner L. Frank, M. Gene Konopik, Jeannette P. Meier, Phillip A. Moore, Clive A. Smith, A. Maria Smith, Geno P. Tolari, Sterling L. Williams, Charles J. Wyly, Jr. and Sam Wyly (15), (20) 10(qq) - Exchange Agreement among the Company and the Preferred Stockholders named therein (15) 11 - Computation of Earnings Per Share, Year Ended September 30, 1994 (21) 21 - Subsidiaries (21) 23.1 - Consent of Ernst & Young LLP, Independent Auditors (21) 27 - Financial Data Schedule (21)\n- ------------ (1) Previously filed as an exhibit to the Company's Registration Statement No. 33-62028 on Form S-4 and incorporated herein by reference. (2) Previously filed as an exhibit to the Company's Registration Statement No. 33-56185 on Form S-4 and incorporated herein by reference. (3) Previously filed as an exhibit to the Company's Registration Statement No. 33-54961 and incorporated herein by reference. (4) Previously filed as an exhibit to the Company's Registration Statement No. 2-82506 on Form S-1 and incorporated herein by reference. (5) Previously filed as an exhibit to the Company's Registration Statement No. 33-69926 on Form S-8 and incorporated herein by reference. (6) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference. (7) Previously filed as an exhibit to the Company's Registration Statement No. 33-47131 on Form S-8 and incorporated herein by reference. (8) Previously filed as an exhibit to the Company's Registration Statement No. 2-86825 on Form S-1 and incorporated herein by reference. (9) Previously filed as an exhibit to the Quarterly Report on Form 10-Q of Systems Center, Inc. for the quarter ended June 30, 1991 and incorporated herein by reference. (10) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993 and incorporated herein by reference. (11) Previously filed as an exhibit to the Company's Registration Statement No. 33-65402 on Form S-8 and incorporated herein by reference. (12) Previously filed as an exhibit to the Company's Registration Statement No. 33-62401 and incorporated herein by reference. (13) Previously filed as an exhibit to the Company's Registration Statement No. 33-56679 on Form S-3 and incorporated herein by reference. (14) Previously filed as an exhibit to the Company's Registration Statement No. 33-71706 on Form S-3 and incorporated herein by reference. (15) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference. (16) Previously filed as an exhibit to the Company's Registration Statement No. 33-64073 on Form S-3 and incorporated herein by reference. (17) Previously filed as an exhibit to the Company's Registration Statement No. 33-53837 on Form S-3 and incorporated herein by reference. (18) Previously filed as an exhibit to the Company's Registration Statement No. 33-56681 on Form S-8 and incorporated herein by reference. (19) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1994 and incorporated herein by reference. (20) Management Contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of the form. (21) Filed herewith.","section_15":""}
{"filename":"832310_1995.txt","cik":"832310","year":"1995","section_1":"Item 1. BUSINESS\nRAL INCOME + EQUITY GROWTH V LIMITED PARTNERSHIP (the \"Registrant\" or \"Partnership\") is a Wisconsin Limited Partnership formed on April 1, 1988, under the Wisconsin Revised Uniform Limited Partnership Act. The Registrant was originally organized to acquire, for cash (no debt), real estate projects, including real estate for restaurants, mobile home communities, apartment complexes and other commercial properties. The Partnership raised $9,866,000 in Limited Partnership Interests (9,866 Interests at $1,000 per unit) pursuant to a registration statement on Form S-11 under the Securities Act of 1933. The Partnership has utilized the net offering proceeds to acquire the real property investments described under \"Properties\" (Item 2).\nThe officers and employees of RAL Asset Management Group, a Wisconsin general partnership, and its affiliates performed services for the Registrant until June 1, 1993. RAL Asset Management Group is controlled by the General Partners of the Partnership. Effective June 1, 1993 the Partnership made separate property and partnership management agreements.\nThe partnership management agreement is with an unrelated management company. The property management agreement is with a related entity with the same general partners as the Partnership. The related property management firm simultaneously subcontracted with the same unrelated management company handling the partnership management. The terms and conditions of these agreements are similar to the above related party agreements, which they replace.\nThe Registrant itself employs individual onsite managers and maintenance personnel in the mobile home parks and apartment complexes. The Registrant employed five at March 30, 1996.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAs of March 30, 1996, the Registrant owned the following properties:\nDate of Property Name Purchase Approximate Size - ------------------- --------- -----------------------------\nEvergreen Estates 07\/29\/88 161 mobile home sites on Mobile Home Park approximately 32 acres of land Faribault, MN*\nCedar Crossing 12\/23\/88 Minority ownership (12.291%) in Apartments a 109 unit garden apartment Frederick, MD complex (RAL Yield + Equities IV Limited Partnership, an affiliated limited partnership owns the remaining interest)\nChampion Auto Center 02\/28\/89 A 7,176 square foot building Ashwaubenon, WI 28,800 sq. ft. of land\nCamelot Homes 10\/17\/89 73 mobile home sites on 39 acres Mobile Home Park of land Pulaski, WI*\nMuir Heights 01\/12\/90 66 unit apartment complex Apartments Madison, WI*\nForest Downs 01\/03\/91 35 unit apartment complex Apartments Hales Corners, WI*\n*Denotes a material property, having gross revenues greater than 10% of total revenues.\nThe real estate business is highly competitive and the Partnership competes with other real estate investment entities many of which have greater financial resources. No one firm or group of firms, in the opinion of the General Partners, is dominate in the industry. The Partnership, therefore, faces substantial competition from a variety of sources for attractive real estate investment opportunities and attracting and retaining tenants for its existing properties.\nAny commercial, residential or mobile home community properties acquired by the Partnership have competition for tenants from similar properties in the vicinity. To the extent that the Partnership owns or acquires commercial properties, such as restaurants or shopping centers, which have leases entitling the Partnership to participate in gross receipts of tenants above fixed minimum amounts, the success of the Partnership will depend in part on the success of its tenants in competing with similar businesses in the vicinity.\nLeases on Investment Properties:\nThe mobile home parks and apartments lease rental spaces (apartments) and receive income on a monthly basis from tenant leases which normally have lease terms of one year or less.\nIn the opinion of management of the Partnership, all properties are adequately covered by insurance.\nMATERIAL PROPERTIES - -------------------\nFollowing is information with respect to each property whose revenues are greater than 10% of total revenues as denoted above.\nThe Federal tax basis for each of the material properties is identical to the book basis as listed in Schedule III on page of this report. Depreciation information for tax purposes on the properties is as follows:\nType of Asset Rate Method Depreciable Life ------------- ---- ------ ---------------- Land Improvements SL MACRS 15-40 Year Building SL MACRS 31.5-40 Year Equipment DDB MACRS 7-12 Year\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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a)&(b) As of March 30, 1996, there were approximately 1,150 record holders of Interests of the Partnership. There is no public market for Interests and it is not anticipated that a public market for Interests will develop. The General Partners will not redeem or repurchase Interests.\n(c) All cash available for distribution other than sale or refinancing proceeds is distributed 95% to the Limited Partners and 5% to the General Partners, at least semi -annually. See attached financial statements and footnotes for a detailed discussion of amounts and timing of distributions to Limited Partners.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\n(A) The Net Income per Interest is computed on the basis of the net income allocated to the Limited Partners divided by the outstanding Interests at the end of the period.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRAL INCOME + EQUITY GROWTH V LIMITED PARTNERSHIP is a Wisconsin Limited Partnership formed on April 1, 1988, under the Wisconsin Revised Uniform Limited Partnership Act. The Registrant was organized to acquire new and existing income producing properties for cash. Also, the Partnership may acquire undeveloped property on which improvements are to be constructed. The Partnership will not purchase or lease any property from, or sell or lease property to, the General Partners or their Affiliates, other than a purchase of property which such persons have temporarily purchased and held title to on behalf of the Partnership, and then only at their cost.\nThe Partnership has purchased six income-producing properties to- date (see Item (2)).\nLiquidity and Capital Resources:\nProperties acquired by the Partnership are intended to be held for approximately seven to ten years. During the properties' holding periods, the investment strategy is to maintain (on the \"triple net lease\" properties) and improve (on the residential properties) occupancy rates through the application of professional property management (including selective capital improvements). Cash flow generated from property operations is distributed to the partners on a quarterly or semi-annual basis. The Partnership also accumulates working capital reserves for normal repairs, replacements, working capital, and contingencies.\nNet cash flow provided from operating activities was $501,000 in 1995, $521,000 in 1994, and $567,000 in 1993. As of December 31, 1995, the Partnership had cash of approximately $255,000 representing undistributed cash flow, working capital reserves, and tenant security deposits. Total short term liabilities were approximately $278,000.\nThe Partnership has not experienced, and is not currently experiencing any liquidity problems. It is not expected that the Partnership will experience liquidity problems due to the nature of the current liabilities. Approximately $94,000 of the current liabilities represent tenant security deposits. The majority of the remaining current liabilities are accrued and escrowed real estate taxes payable in installments in 1996. The Partnership expects to meet all of its obligations as they come due.\nTotal distributions to Limited Partners in 1995 were approximately $416,000.\nDuring 1995, the Partnership financed a 17 pad expansion of the Camelot mobile home park in Pulaski, Wisconsin, with a $125,000 bank loan. The note has a 5 year term with a 9.95% interest rate and is secured by a real estate mortgage on the improved lots and a general business security agreement. The pads were completed and ready for occupancy June 1, 1995.\nResults of Operations:\nInflation:\nThe effect of inflation on the Partnership has not been material to date. Should the rate of inflation increase substantially over the life of the Partnership, it is likely to influence ongoing operations, in particular, the operating expenses of the Partnership. All of the Partnership's commercial leases contain clauses permitting pass-through of certain increased operating costs. Residential leases are typically of one year or less in duration; this allows the Partnership to react quickly (through increases in rent) to changes in the level of inflation. These factors should serve to reduce, to a certain degree, any impact of rising costs on the Partnership.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index to Financial Statements and Financial Statement Schedule on page, incorporated herein by reference.\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\na. Effective November 11, 1994, RAL Income & Equity Growth V Limited Partnership (RAL V) dismissed its prior certifying accountants, Ernst & Young LLP (E & Y), and retained Kolb Lauwasser & Company, S.C. as its new certifying accountants. E & Y's report on RAL V's financial statements for the fiscal year ended December 31, 1993 contained no adverse opinion or a disclaimer of opinion, and was not qualified as to uncertainty, audit scope or accounting principles. The decision to change accountants was approved by RAL V's general partners.\nDuring the fiscal year ended December 31, 1993 there were no disagreements between RAL V and E & Y 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 E & Y, 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)(ii) occurred with respect to RAL V within the fiscal year ended December 31, 1993.\nb. Effective November 11, 1994, RAL V engaged Kolb Lauwasser & Company, S.C. as its principal accountants. During the two fiscal years ended December 31, 1993 and the subsequent interim period to the date hereof, RAL V did not consult Kolb Lauwasser & Company, S.C. 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 PARTNERSHIP\nThe General Partners of RAL Income + Equity Growth V Limited Partnership are Robert A. Long, John A. Hanson, Thomas R. Brophy, and Bart Starr. The General Partners manage and control the Partnership's affairs and have the 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 certain other organizations affiliated with the General Partners, including RAL Asset Management Group. The relationship of the General Partners to their affiliates is described under the caption \"Conflicts of Interest\" on pages 10 through 12 of the Prospectus, a copy of which is filed with Form S- 11 for this Partnership and is incorporated herein by reference.\nThe general partners and significant employees of First Financial Realty Management are as follows: Position with RAL Asset Name Management Group - ---- -----------------------\nRobert A. Long General Partner John A. Hanson General Partner Thomas R. Brophy General Partner Bart Starr General Partner Douglas C. Heston President (FFRM) Christine D. Kennedy Controller (FFRM)\nThere is no family relationship among any of the foregoing officers. The business experience of the General Partners and significant employees includes the following:\nRobert A. Long, age 54, has, since January 1982, been a partner in RAL Asset Management Group. He is co-founder of RAL Asset Management Group. Since 1966 Mr. Long has been involved in real estate consulting, development and syndication. Mr. Long is a licensed securities agent. Since 1981 Mr. Long has been involved as an individual, general partner, or affiliate in ownership and management of twenty-six (26) mobile home parks totaling over 2,600 pads in the states of Wisconsin and Minnesota. Prior to 1981, Mr. Long developed or purchased over 200 commercial properties in six states and currently owns individually or through partnerships over 50 restaurants (land and building) leased to restaurant operators, including Pizza Hut, Hardee's, Taco Bell, and Rocky Rococo (or their franchisees). Mr. Long also played professional football for the Green Bay Packers, Atlanta Falcons, and Washington Redskins. Mr. Long received a Bachelor of Science Degree in Business from Wichita State University in 1965 and is currently Executive Director of the Vince Lombardi Scholarship Fund for Wichita State University. Mr. Long is also on the Board of Directors of Roundy's Inc., a major Midwest food distributor and originator of the Pick 'N Save stores. John A. Hanson, age 54, has, since March 1982, been a partner in RAL Asset Management Group. Mr. Hanson is involved individually, as a general partner, or as an affiliate, in the ownership and management of twenty-six (26) mobile home parks in the states of Wisconsin and Minnesota. Mr. Hanson has been involved in pension and profit-sharing and tax consulting for 25 years. In 1975 he founded, and since that time has been president of Pension Designers, Inc., of Appleton, Wisconsin, a firm that specializes in structuring and consulting with respect to qualified retirement plans, estate planning, investment sales and sales of life, health and disability insurance products to individuals, groups or corporations. From 1966 to 1971 Mr. Hanson was engaged in tax consulting, having management and tax accounting responsibilities for a farm management firm with approximately 200 clients. Mr. Hanson is past president of the Fox River Valley Association of Life Underwriters, and the General Agents and Managers Association, an associate member of the American Society of Pension Actuaries, a member of the International Association of Financial Planners, a qualifying and life member of the Million Dollar Round Table, and a registered principal with the National Association of Securities Dealers. Mr. Hanson received his Bachelor of Science Degree in Agri-Business from the University of Wisconsin - River Falls in 1966. Mr. Hanson is a licensed securities agent.\nThomas R. Brophy, CLU, ChFC., age 50, has, since March 1982, been a partner of RAL Asset Management Group. Mr. Brophy is involved individually, as a general partner, or as an affiliate in the ownership and management of twenty-six (26) mobile home parks in the states of Wisconsin and Minnesota which total approximately 2,600 pads. Mr. Brophy has been a NASD registered securities representative since 1969, active in the marketing and sales of mutual funds, unit investment trusts, stocks, bonds, limited partnerships and private ventures. Since 1967 Mr. Brophy has also been active in the marketing, selling, training, supervising and managing of personnel, with respect to qualified retirement plans and personal or business life, health and disability insurance plans. He is active in the financial planning field, having been conferred the degree of Chartered Financial Consultant, by the American College, Bryn Mawr, PA, in 1984. He is associated with the Principal Financial Group. Mr. Brophy is an active member of the National and Wisconsin Association of Life Underwriters, Million Dollar Round Table, Fox Valley Estate Planning Council and International Association of Financial Planners. He is recipient of the Fox River Valley Association of Life Underwriters' 1983 \"Agent of the Year\" award. A 1967 Bachelor of Science graduate from Marquette University, Mr. Brophy went on for advanced studies in insurance, receiving his Chartered Life Underwriter (CLU) degree from the American College, Bryn Mawr, PA, in 1975. Mr. Brophy is a licensed securities agent.\nBart Starr, age 63, has, since January 1984, been a partner in RAL Asset Management Group. He is a University of Alabama graduate with a B.S. Degree in Education. Since 1970, he has been a partner in the Bart Starr Motor Company, Birmingham, Alabama, and since January 1984. Since 1979 he has been a member of the Board of Directors of the Sentry Insurance Company, Stevens Point, Wisconsin. He was a Green Bay Packer football player from 1956- 1972, the Green Bay Packer Head Coach from 1975-1983, the NFL Most Valuable Player in 1966, and the Most Valuable Player in Super Bowls I and II. Mr. Starr was a CBS Game Analyst in 1973 and 1974 and the first winner of the Byron White Award in 1967. Mr. Starr has been the recipient of numerous civic and sports awards and is actively engaged in many charitable and public service organizations.\nThe following individuals are the employees of the General Partners who make significant contributions to the business of the Partnership:\nDouglas C. Heston, age 42, is President of First Financial Realty Management (FFRM). FFRM and affiliates own and\/or manage over 50 investment properties. Mr. Heston received a B.A. degree from Duke University (North Carolina) with a double major in Economics and Public Policy Analysis (Statistics) in 1975. He received an M.S. degree in Real Estate Investment Analysis from the University of Wisconsin in 1979. Previously he worked for real estate appraisal firms in Atlanta and Milwaukee. He co-founded RAL Asset Management Group in 1981 and left at the end of 1984 to found his current firm.\nChristine D. Kennedy, age 30, joined RAL Asset Management Group in December, 1990, as Assistant Controller. In November, 1991 she was promoted to Controller. She is now Controller for First Financial Realty Management. Prior to that she worked in the audit department of Arthur Young & Company in Milwaukee, Wisconsin for approximately three years. She received her B.B.A. in Accounting from the University of Wisconsin-Whitewater in 1987. She is a Certified Public Accountant.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\n(a,b,c, and d) The Registrant has not paid and does not propose to pay any executive compensation to the General Partners or any of their affiliates (other than described in Item 13 below).\n(e) 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\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the outstanding Interests of the Registrant as of March 30, 1996.\nAs of March 31, 1996, the General Partners own 3 Limited Partnership Interests in the Registrant.\n(c) None\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a and b) Certain General Partners own or control businesses which have agreed to perform a variety of services for the Partnership.\nThe Partnership also has various agreements with businesses owned by, controlled by, or affiliated with certain General Partners which entitle such businesses to receive fees for services rendered on terms established by the General Partners as summarized below:\n- Reimbursement of certain expenses at the lower of cost or the prevailing rates for comparable services;\n- Property management fees at 5% of gross revenues for residential properties, 6% for commercial properties if an Affiliate provides leasing related services, or 3% if such services are not provided, and 1.6% for net leased properties with a lease term of ten years or more for the first five years of the lease term and 1% thereafter;\n- Real estate commissions of up to 3% of the contract price subject to certain limitations.\n- Costs and fees paid or payable to affiliates of the General Partners for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe General Partners receive 5% of all Cash Available for Distribution. Distributions paid to the General Partners were $22,000 in 1995, $28,000 in 1994 and $32,000 in 1993.\n(c) No management person is indebted to the Registrant. (d) Not applicable.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1 and 2) See Index to Financial Statements and Financial Statement Schedule on Page\n(b) Reports on Form 8-K\nNone\n(c) Exhibits See Exhibit 27.\n(d) Financial Statement Schedule See Index to Financial Statements and Financial Statement Schedule on Page.\nRAL INCOME + EQUITY GROWTH V LIMITED PARTNERSHIP (A Wisconsin Limited Partnership)\nTABLE OF CONTENTS TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nCOVERED BY REPORTS OF INDEPENDENT AUDITORS\nReports of Independent Auditors\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the years ended December 31, 1995, 1994 and 1993 Statements of 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\nFinancial statement schedule: III - Real estate and accumulated depreciation Schedules, other than those listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nINDEPENDENT AUDITOR'S REPORT\nJanuary 23, 1996\nTo the Partners of RAL Income + Equity Growth V Limited Partnership\nWe have audited the accompanying Balance Sheets of RAL Income + Equity Growth V Limited Partnership as of December 31, 1995 and 1994, and the related Statements of Income, Partners' Equity and Cash Flows for the years then ended. Our audits also included the financial statement schedule listed in the Table of Contents at Item 14. 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 1995 and 1994 financial statements referred to above present fairly, in all material respects, the financial position of RAL Income + Equity Growth V Limited Partnership as of December 31, 1995 and 1994, and the results of their operations and cash flows for the years then ended 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.\nRespectfully submitted,\nKolb Lauwasser & Co., S.C.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTo the Partners of RAL Income + Equity Growth V Limited Partnership\nWe have audited the accompanying balance sheet of RAL Income + Equity Growth V Limited Partnership, a Wisconsin Limited Partnership (the Partnership), as of December 31, 1993, and the related statements of income, Partners' equity and cash flows for each of the two years in the period ended December 31, 1993. Our audits also included the financial statement schedule listed in the Table of Contents at Item 14. 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 the Partnership as of December 31, 1993, and the results of its operations and its cash flows for the two years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nMilwaukee, Wisconsin January 24, 1994 ERNST & YOUNG LLP\nRAL INCOME + EQUITY GROWTH V LIMITED PARTNERSHIP Notes to Financial Statement ----------------------------- For the years ended December 31, 1995, 1994 and 1993\nNote #1 Summary of Significant Accounting Policies - ------- ------------------------------------------ A. Organization and Nature of the Business ---------------------------------------\nRAL Income + Equity Growth V Limited Partnership (the Partnership) is a Wisconsin limited partnership formed on April 1, 1988, under the provisions of the Wisconsin Revised Uniform Limited Partnership Act, to acquire for cash, operate, lease, develop and eventually sell real estate properties. The Partnership owns and operates two mobile home parks and an apartment complex located in the upper midwest. It holds a minority interest in another apartment complex located in Maryland. The Partnership also leases a commercial property to a retail\/service business in the upper midwest. The Partnership will terminate December 31, 2018, except in the event of prior sale of the Partnership's properties, action by a majority interest of the limited partners, or certain other events.\nEffective June 9, 1990, the Partnership completed its offering of limited partnership interests. A total of 9,866 interests were sold for an aggregate contribution of $9,866,000. In connection with the sale of limited partnership interests, the Partnership incurred approximately $1,085,000 of costs to raise capital, which were charged against partners' equity.\nB. Method of Accounting -------------------- Assets, liabilities, revenue and expenses are recognized on the accrual basis method of accounting.\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.\nC. Income-Producing Properties --------------------------- Income-producing properties are carried at the lower of cost less accumulated depreciation or fair value. Cost includes acquisition fees paid to RAL Asset Management Group. Management periodically evaluates a property's fair value based upon occupancy rate and comparison to similar properties in the same geographic area.\nFor financial statement purposes, depreciation is determined using the straight-line method. For income tax reporting purposes, building and land improvements are depreciated using the straight-line method while equipment is depreciated using accelerated methods. Depreciable lives for financial statement and income tax purposes are set forth below:\nD. Allowance for Doubtful Accounts ------------------------------- Receivables are reviewed periodically by management to determine the adequacy of the allowance for doubtful accounts. Based upon managements' evaluation, no allowance for doubtful accounts was necessary as of December 31, 1995 and 1994.\nE. Deferred Charges - ---------------- Costs incurred with respect to organizing the Partnership were deferred and have been fully amortized. Prepaid management fees incurred in the initial public offering were amortized to expense on the straight-line method over the term (ten years) of the management agreement and have been fully amortized. Commission fees incurred to lease the properties are deferred and amortized over the respective lease term. The noncompete agreement is being amortized on a straight-line basis over a five-year period.\nCosts incurred in obtaining financing have been capitalized and are amortized over the term of the agreement (five years).\n====== ====== F. Leases ------ The Partnership has determined that all leases relating to the income-producing properties are properly classified as operating leases; therefore, rental income is reported when earned and the cost of each of the properties, excluding cost of land, is depreciated over its estimated useful life.\nG. Income Taxes ------------ No income taxes will be payable or provided by the Partnership since net income or loss is includable in the respective tax returns of the partners. In the initial year of ownership of partnership interests, each partner's share of taxable income or loss, tax credits and distributions is allocated to them on a pro rata basis that considers the number of days in the year during which their respective interests were held.\nH. Cash and Cash Equivalents ------------------------- For purposes of the Statements of Cash Flows, the Partnership considers all short-term investments in interest-bearing bank accounts and certificates of deposits with a maturity of three months or less, to be equivalent to cash. Several demand deposit accounts are at one financial institution. Such funds on deposit exceeded the federally insured limit by $173,381 and $66,000 for the years ended December 31, 1995 and 1994, respectively.\nI. Reclassifications ----------------- Certain information contained in the 1993 financial statements has been reclassified to conform with the 1995 and 1994 presentation.\nNote #2 Investment in Joint Venture - ------- --------------------------- On December 23, 1988, the Partnership entered into a joint venture agreement with an affiliated partnership to acquire and operate the Cedar Crossing Apartments. All assets, liabilities, revenue and expenses of the joint venture are included in the financial statements of the affiliate with the appropriate adjustment of income for the Partnership's participation in the joint venture. Profits, losses and distributions are allocated 12.291% to the Partnership and 87.709% to the affiliate.\nNote #3 Income-Producing Properties - ------- ---------------------------\nNote #4 Leases of Income-Producing Properties - ------- -------------------------------------\nNote #5 Note Payable - ------- ------------ The Company is indebted to Mitchell Bank on a five year note dated February 16, 1995. The note requires monthly payments of $1,658 including interest at 9.95% plus a balloon payment due February 16, 2000. The note is secured by a real estate mortgage on the improved lots at a mobile home park located in Pulaski, Wisconsin and a general business security agreement. 118,718 =======\nNote #6 General Provisions of the Limited Partnership Agreement - ------- ------------------------------------------------------- Pursuant to the terms of the partnership agreement, net profits or losses of the Partnership from operations are generally allocated 95% to the limited partners and 5% to the general partners. Notwithstanding the foregoing, all depreciation from tax-exempt use properties is allocated to tax-exempt limited partners.\nIn general, subject to certain limitations, all income from the sale of property will be allocated first to the limited partners with deficit capital accounts, then to the limited partners to the extent of any depreciation deductions not included in their deficit capital accounts, then to the general partners in an amount equal to the general partners' share of the amount distributable to the general partners as sale or refinancing proceeds and the remainder to the limited partners in proportion to the number of interests held by each of them on the date of such sale or other disposition provided that the general partners shall be allocated at least 1% of such income. Losses on the sale of property will be allocated 95% to the limited partners and 5% to the general partners.\nAt least semiannually, Cash Available for Distribution (as defined in the partnership agreement) from operations is distributed 95% to the limited partners and 5% to the general partners.\nSale or refinancing proceeds shall be distributed first to the limited partners until they have received an amount equal to their capital contribution and then to the limited partners until such amount, when added to Distributions of Cash Available for Distribution, equals their investment preference of 10% simple interest per annum and then 85% to the limited partners and 15% to the general partners.\nThe partnership agreement provides that, among other things, the general partners are responsible for managing all aspects of the operations of the Partnership and may ultimately be held responsible for any unpaid general obligations of the Partnership, except for those, if any, which are on a nonrecourse basis.\nNote #7 Related Party Transactions - ------- -------------------------- Certain general partners own or control businesses which have agreed to perform a variety of services for the Partnership. In addition, certain general partners were securities agents for the managing dealer which originally offered the limited partnership interests.\nIn consideration for these services, the general partners and their affiliates have received or will in the future receive certain compensation at amounts which are provided by the partnership agreement. The following table sets forth the types, amounts and recipients of compensation paid annually by the Partnership to the general partners and their affiliates:\nAffiliate and Service Amount of Compensation --------------------- ---------------------- General partners' and affiliates At lower of cost or prevailing reimburable expenses. rates at which comparable services could have been obtained in the same geographic area for similar services. The\namount of expenses reimbursed was $1,767 in 1993.\nProperty management fee payable Residential property: to RAL Asset Management Group for property management and rental At rates prevailing for services. comparable services where the properties are located, but not to exceed 5% of gross revenues.\nOther than residential properties:\nAt rates prevailing for comparable services where properties are located, but not to exceed 6% of gross revenues where leasing and related services are provided, or 3% if such services are not provided. Property under a net lease with a term of ten years or more is subject to an annual\nfee of 1.6% of gross revenues per year for the first five years plus an annual fee of 1% of gross revenues per year thereafter.\nTotal property management fees incurred were $16,800 in 1993.\nEffective June 1, 1993, the Partnership entered into new property and partnership management agreements. The partnership management agreement is with an unrelated management company. The property management agreement is with a related entity owned by the same general partners. The related property management firm simultaneously subcontracted with the same unrelated management company handling the partnership management. The terms and conditions of these agreements are similar to the above related party agreements, which they replace.\nRAL-YIELD EQUITIES V LIMITED PARTNERSHIP (A Wisconsin Limited Partnership)\nNOTES TO SCHEDULE III\n(a) All properties are unencumbered at December 31, 1995, except for Camelot Mobile Home Park's most recent expansion as discussed previously.\n(b) Includes personal property.\n(c) The aggregate cost of land, buildings and improvements for federal income tax purposes includes the Partnership's share of the Cedar Crossing Apartments fixed assets. For book purpose the amount invested is treated as an investment on the balance sheet and is not included in fixed assets.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.\nRAL INCOME + EQUITY GROWTH V LIMITED PARTNERSHIP\nBY: Robert A. Long -------------------------------------- Robert A. Long, General Partner\nDATE: 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.\nSignature Title Date - -----------------------------------------------------------------\nRobert A. Long Managing Partner 3\/30\/96 - -------------------- RAL Asset Management ---------- Robert A. Long Group and General Partner of RAL Income + Equity Growth V Limited Partnership\nJohn A. Hanson Partner - RAL Asset 3\/30\/96 - -------------------- Management Group and ---------- John A. Hanson General Partner of RAL Income + Equity Growth V Limited Partnership\nChristine D. Kennedy Controller, First Financial 3\/30\/96 - -------------------- Realty Management ---------- Christine D. Kennedy","section_15":""}
{"filename":"821139_1995.txt","cik":"821139","year":"1995","section_1":"ITEM 1. BUSINESS*\nRegistrant was incorporated in the State of Delaware in April 1987 as SMG Holdings Corporation. Subsequently, registrant's name was changed to Supermarkets General Holdings Corporation (the \"Company\"). The Company acquired Supermarkets General Corporation (\"Old Supermarkets\"), in October 1987 (the \"Acquisition\"). References to the Company in this Report refer to the Company and its subsidiaries on a consolidated basis, except where the context requires otherwise.\nIn October 1989, Old Supermarkets adopted an amended and restated Plan of Liquidation pursuant to which it was liquidated into three wholly owned subsidiaries of the Company. In November 1989, pursuant to such Plan, Old Supermarkets transferred substantially all of the assets of its Purity Supreme division to two of the three above mentioned wholly owned subsidiaries of the Company, Purity Supreme, Inc. (\"Purity\") and Li'l Peach Corp. (\"Li'l Peach\", and together with Purity, the \"Purity Operations\"), and said subsidiaries assumed substantially all of the liabilities of Old Supermarkets related to such division. Old Supermarkets completed the liquidation just prior to the year ended February 3, 1990 by merging with the third of the above mentioned wholly owned subsidiaries of the Company, which retained the name Supermarkets General Corporation. In connection with the Recapitalization referred to below, Supermarkets General Corporation changed its name to Pathmark Stores, Inc. (\"Pathmark\").\nOn December 17, 1991, the Company completed the sale of the Purity Operations for approximately $257.0 million (as adjusted), including the assumption of certain indebtedness of Purity and Li'l Peach. The Company recognized a loss of $228.0 million on the sale of the Purity Operations. Included in the loss was a write-off of approximately $214.0 million of goodwill related to the Purity Operations. The Company retains a 10% common equity interest in Purity Supreme and a new issue of Purity Supreme exchangeable preferred stock with an aggregate stated value of approximately $18.0 million. Such preferred stock has a redemption price, including unpaid dividends, of $14.5 million at January 28, 1995. These retained investments in Purity Supreme are carried on the Company's books at zero value. Pathmark is contingently liable for certain obligations of the Purity Operations under certain instruments, primarily 60 leases for real property, in the event of default thereunder by the Purity Operations. Prior to the sale of the Purity Operations, three properties of Purity Supreme were transferred to Pathmark. See \"Properties\".\nOn November 4, 1994, the Company completed the sale of its home centers segment for approximately $88.7 million, plus the assumption of certain indebtedness of Rickel. The Company used approximately $66.6 million before January 28, 1995 and $4.7 million after January 28, 1995 of its net proceeds to pay down the PTK Exchangeable Guaranteed Debentures due 2003 (the \"PTK DIB's\"), including accrued interest and debt premium.\nThe Company consummated a recapitalization plan (the \"Recapitalization\") on October 26, 1993. In connection with the Recapitalization, the Company, transferred all of the capital stock of Pathmark to PTK Holdings, Inc. (\"PTK\"), a newly formed, wholly owned subsidiary of the Company. The Recapitalization reduced Pathmark's interest expense and has allowed Pathmark to devote its capital to growing its core supermarket and drug store business.\nPTK was incorporated in the State of Delaware in Fiscal 1993 and owns 100% of the capital stock of Pathmark and also owns 100% of the capital stock of Plainbridge, Inc., a newly formed Delaware corporation (\"Plainbridge\"). Pathmark distributed the capital stock of Plainbridge to PTK in the Plainbridge Spin-Off (as defined below).\nIn connection with the Recapitalization, Pathmark contributed its Rickel home centers segment, the warehouse, distribution and transportation operations and the inventory therein that service the\n- ------------\n* Except as otherwise indicated, information contained in this Item is given as of January 28, 1995.\nPathmark supermarkets and drug stores and certain other assets to Plainbridge and distributed the shares of Plainbridge to PTK (the \"Plainbridge Spin-Off\"). In addition, Pathmark contributed to Chefmark, Inc., a newly formed Delaware corporation (\"Chefmark\"), the Chefmark deli food preparation operations and a related warehouse and a leased banana ripening warehouse and distributed the shares of Chefmark to Holdings (the \"Chefmark Spin-Off\", and, together with the Plainbridge Spin-Off, the \"Spin-Offs\"). In connection with the Plainbridge Spin-Off, Pathmark entered into a logistical services agreement with Plainbridge (the \"Logistical Services Agreement\") that provides for the continuing supply of merchandise to the Pathmark supermarkets and drug stores and for the provision of warehousing, distribution and logistical services relating to the supply of such merchandise. Pursuant to such agreement, Pathmark directs the purchase of such merchandise and negotiates the terms and conditions of its sale directly with the applicable vendors. For a further description of the terms of the Logistical Services Agreement see \"--Logistical Services Agreement\".\nCurrent Borrowings. (a) In 1993 Pathmark borrowed $400.0 million from banks under a term loan facility (the \"Term Loan\") and $50 million under a $175.0 million working capital facility (the \"Working Capital Facility\", and, together with the Term Loan, the \"Bank Credit Agreement\"). Borrowings under the Working Capital Facility were $33.5 million at April 24, 1995.\n(b) In 1993 Pathmark issued $440.0 million aggregate principal amount of 9 5\/8% Senior Subordinated Notes due 2003 (the \"Senior Subordinated Notes\").\n(c) Pathmark issued $198.5 million of its 11 5\/8% Subordinated Notes due 2002 (the \"Subordinated Notes\") for up to the $200.0 million aggregate principal amount outstanding of Holdings' 11 5\/8% Subordinated Notes due 2002 (the \"Holdings Subordinated Notes\"), in connection with an exchange offer (the \"11 5\/8% Exchange Offer\") in October 1993. During 1994, Pathmark issued an additional $0.5 million of Subordinated Notes in exchange for $0.5 million of Holdings Subordinated Notes. Approximately $1.0 million aggregate principal amount of Holdings Subordinated Notes remain outstanding at January 28, 1995. An equivalent amount of subordinated Intercompany Notes with terms corresponding to the terms of the Holdings Subordinated Notes also remain outstanding.\n(d) In 1993, Pathmark also issued $95.8 million aggregate principal amount of its 12 5\/8% Subordinated Debentures due 2002 (the \"Subordinated Debentures\") in connection with an exchange (the \"12 5\/8% Exchange Offer\") for $95.8 million aggregate principal amount of the $415.0 million aggregate principal amount outstanding of Holdings' 12 5\/8% Subordinated Debentures due 2002 (the \"Holdings Subordinated Debentures\") held by persons other than certain affiliates of The Equitable Life Assurance Society of the United States (the \"Equitable Affiliates\"). Holdings also purchased $4.2 million aggregate principal amount of such Debentures for cash at a price of 112.125% of the aggregate principal amount thereof, together with accrued interest to the date of purchase (the \"Tender Offer\", and, together with the 12 5\/8% Exchange Offer, the \"Tender and Exchange Offer\"). Holdings solicited consents from all holders of the Holdings Subordinated Debentures to certain proposed amendments to delete certain restrictions in the indenture under which the Holdings Subordinated Debentures were issued (the \"Holdings Subordinated Debenture Indenture\") and paid related consent fees. Holders of Holdings Subordinated Debentures (other than the Equitable Affiliates) tendered $95.8 million aggregate principal amount of Holdings Subordinated Debentures for Subordinated Debentures pursuant to the Tender and Exchange Offer, and holders representing over 99% of the aggregate outstanding principle amount of the Holdings Subordinated Debentures consented to the proposed amendments. In addition, as part of the Recapitalization, Holdings also purchased for cash $185.0 million aggregate principal amount of the Holdings Subordinated Debentures from the Equitable Affiliates at the same price offered in the Tender Offer and sold PTK's DIBs with an issue price of $130.0 million to the Equitable Affiliates in exchange for the remaining $130.0 million of Holdings Subordinated Debentures held by the Equitable Affiliates as described below.\n(e) In 1993, Pathmark issued in (the \"Deferred Coupon Notes Offering\", and, together with the Senior Subordinated Notes Offering, the \"Debt Offerings\") $225.25 million aggregate principal amount at maturity of its Junior Subordinated Deferred Coupon Notes due 2003 (the \"Deferred Coupon Notes\") at an issue price of $532.74 per $1,000 principal amount at maturity.\n(f) In 1993, PTK issued $130.0 million aggregate principal amount of PTK DIBs to Holdings that Holdings subsequently sold to the Equitable Affiliates in a private placement (the \"Private Placement\") in exchange for $130.0 million aggregate principal amount of the Holdings Subordinated Debentures held by the Equitable Affiliates. Such Holdings Subordinated Debentures were cancelled and the related intercompany indebtedness of Pathmark to Holdings (the \"Intercompany Notes\") was forgiven by Holdings resulting in a $130.0 million capital contribution to Pathmark.\nBUSINESS OF THE COMPANY\nThe Company's primary business activity is the management of its interests in Pathmark, Plainbridge and Chefmark. The Company holds all of the capital stock of PTK and all of the capital stock of Chefmark. Through PTK, the Company owns all of the capital stock of Pathmark and Plainbridge.\nThe primary business activity of Plainbridge is to operate the warehouse, distribution and transportation operations that service the Pathmark supermarkets and drug stores. Chefmark's primary business is to supply Pathmark with deli food preparation services and merchandise from the banana ripening facility.\nBUSINESS OF PATHMARK\nPathmark is the leading supermarket retailer, based on sales volume, operating under a single trade name in the northeast United States and the thirteenth largest in the United States. At January 28, 1995, Pathmark operated 143 supermarkets, primarily in the New York-New Jersey and Philadelphia metropolitan areas. These metropolitan areas contain over 10% of the population and grocery sales in the United States. At January 28, 1995, Pathmark also operated 30 freestanding conventional drug stores, primarily in the New York City metropolitan area, six \"deep discount\" drug stores in Connecticut and 136 pharmacies in its supermarkets, making it one of the leading drug store retailers, based on sales volume, in the northeast United States.\nThe following table presents the market area, number of stores and selling and total square footage for Pathmark's supermarkets and drug stores as of January 28, 1995.\nBUSINESS STRATEGY\nPathmark's business strategy is to increase profitability and market penetration in its existing markets (i) by providing superior value to its customers through its marketing and merchandising programs, (ii) through store openings, enlargements and renovations and (iii) through increased operating efficiencies. In implementing this strategy, Pathmark has used and will continue to use a large-store format to increase operating efficiencies and to expand its offering of higher margin merchandise and services, most notably, perishable products.\nMarketing and Merchandising\n. Super Center Format. The average Pathmark Super Center is approximately 50% larger than the average size supermarket in the United States and offers greater convenience by providing one-stop shopping and a wider assortment of foods and general merchandise than is offered by conventional supermarkets. Pathmark expects that its new stores opened during the current and next two fiscal years will average approximately 62,000 square feet.\n. Pathmark 2000. Pathmark 2000 is a new, larger Super Center format designed to provide Pathmark customers with a substantially greater selection of perishable products, particularly produce. Pathmark 2000 stores are also designed to be more \"customer friendly\", with wider aisles, more accessible customer service and information departments, improved signs and graphics, and increased availability of Pathmark associates. Implementation of elements of this format in certain stores has significantly enhanced sales and operating margins in these stores. A majority of Pathmark's new supermarkets and supermarket enlargements completed in Fiscal 1994 employed the Pathmark 2000 concept, and Pathmark expects that virtually all new stores and enlargements thereafter will employ the same concept. At January 28, 1995, 29 of Pathmark's supermarkets were Pathmark 2000s.\n. Flexible Merchandising. Pathmark believes that its large-store format gives it considerable flexibility to respond to changing consumer demands and competition by varying and enhancing its merchandise selection. Pathmark's \"Big Deals\" program, currently consisting of over 500 merchandise items offers large-sized merchandise at prices which Pathmark believes are competitive with those available in \"warehouse\" and \"club\" stores. Pathmark emphasizes competitive pricing plus weekly sales and promotions supported by extensive advertising, primarily in print media. Merchandising flexibility and effectiveness is enhanced through the increased utilization of a category management approach.\n. Pathmark Label. Pathmark believes that it is one of the leading supermarket retailers of private label merchandise in the United States offering for sale over 3,300 items through its private label program. Pathmark's private label brands are called Pathmark, No Frills and its newest brand, Pathmark Preferred.\n. Pharmacy. Pathmark, which is the leading filler of prescriptions in the New York metropolitan area, provides full pharmacy services in virtually all of its Super Center stores and in all of its drug stores. Pathmark's broad market coverage within its marketing area has enabled it to become a leading filler of third-party prescriptions in this area. Pathmark believes that its well-established pharmacy operations provide a competitive advantage in attracting and retaining customers.\nStore Expansion and Renovation Program\n. New Stores, Enlargements and Renovations. During Fiscal 1994, Pathmark opened four new Pathmark 2000s, closed three smaller stores, converted four supermarkets to \"deep discount\" drug stores and completed 25 major renovations and enlargments. During Fiscal 1995, Pathmark plans to open an aggregate of up to six new Pathmark 2000s, five of which will replace smaller Pathmark stores, and to complete up to an aggregate of 32 major renovations and enlargements.\nPathmark recognizes the importance of keeping its stores looking fresh and up-to-date; thus, each store typically receives a major renovation or enlargement every five years. At the end of Fiscal 1994, Pathmark derived approximately 80% of its supermarket sales from stores that were opened or enlarged or underwent major renovations during the last five years.\n. Core Market Focus. Pathmark has identified approximately 85 potential locations for new supermarkets within its current marketing areas and expects that all new stores opened during the current and next two fiscal years will be located in these areas. Pathmark believes that, by opening stores in its current marketing areas, it can achieve additional operating economies and other benefits from its store expansion program without the risks and costs associated with opening stores in new marketing areas.\nOperating Efficiencies\n. Technology. Pathmark has made a significant and continuing investment in information technology and believes it is a leader in the supermarket industry in this area. All Pathmark supermarket checkout terminals have third-generation \"state of the art\" IBM 4680 scanner systems supported by a RISC 6000 application processor in each store. These systems allow consumer credit and electronic fund transfer (\"EFT\") transactions, greatly facilitate system-wide promotion and merchandising programs, and improve the speed and control of customer transactions.\n. \"Outsourcing\" Agreement. In Fiscal 1991, Pathmark entered into a long-term facilities management and systems integration agreement with a subsidiary of IBM. This contract offers significant advantages to Pathmark in controlling computer hardware and software costs and providing ongoing access to \"state of the art\" information technology.\n. Geographic Concentration. All but one of the Pathmark supermarkets and drug stores are located within 100 miles of the Pathmark headquarters and principal warehousing facilities that service them. This allows for more efficient management supervision, increased speed of delivery and reduced transportation costs. All of the stores which Pathmark expects to open in the current fiscal year will be within this 100 mile radius.\nPATHMARK SUPERMARKETS\nPathmark operated 143 supermarkets at January 28, 1995. Supermarkets accounted for approximately 96% of Pathmark's sales for Fiscal 1994. The following table presents selected data respecting supermarket sales and stores for the last five fiscal years.\n- ------------\n(a) Major renovations involve an investment of $350,000 or more and average nearly $1.8 million per store.\n(b) Enlargements involve the addition of selling space and average an investment in excess of $2.5 million.\n(c) Reflects the Company's decision in the fourth quarter of Fiscal 1994 to reconsider its Fiscal 1993 decision to close or dispose of two stores.\n(d) Includes three supermarkets converted to \"deep discount\" drug stores during Fiscal 1994.\n(e) Includes two stores not wholly owned, one of which opened in Fiscal 1990. The sales figures for these stores are not included above.\nBy industry standards, Pathmark stores are large and productive, averaging approximately 50,400 square feet in size and generating high average sales volume of approximately $28.7 million per store ($781 per selling square foot) for stores open for all of Fiscal 1994. Pathmark's 143 supermarkets at January 28, 1995 ranged from 26,000 to 66,000 square feet in size and included 130 supermarkets that are 40,000 square feet or larger in size. All Pathmark stores carry a broad variety of food and drug store products, including an extensive variety of the Pathmark, No Frills and Pathmark Preferred brands.\nPathmark pioneered the development of the large \"superstore\" in the northeast United States, opening the first \"Pathmark Super Center\" in 1977, and currently operates 137 such stores, including 29 \"Pathmark 2000\" stores. Super Centers represented 96% of Pathmark supermarket sales for Fiscal 1994. The majority of Super Centers were created through the enlargement or renovation of existing stores. Super Centers average approximately 50,000 square feet in size. In addition to the broad variety of food and non-food items carried in conventional Pathmark stores, a typical Super Center includes a customer service center, pharmacy, additional food selections (including expanded perishables departments, cheese shops, bakeries, fresh fish-on-ice and service delicatessen departments), videotape rentals, book departments and expanded health and beauty care departments. All Super Centers have EFT and credit transaction capability at their checkout terminals and 128 supermarkets and drugstores also featured in-store automated teller machines.\nPathmark has developed a new, larger Super Center format called \"Pathmark 2000\" designed to provide Pathmark customers with a substantially greater selection of perishable products, particularly produce. Pathmark 2000 stores are also designed to be more \"customer friendly\", with wider aisles, more accessible customer service and information departments, improved signs and graphics, and increased availability of Pathmark associates. Implementation of elements of this format in certain stores has significantly enhanced sales and operating margins in these stores. A majority of Pathmark's new supermarkets and supermarket enlargements completed in Fiscal 1994 employed the Pathmark 2000 concept and Pathmark expects that virtually all new stores and enlargements will employ the same concept.\nPathmark was the leader in its market areas in extending the operation of supermarkets to 24 hours a day. Currently, almost all Pathmark supermarkets are open seven days a week, 24 hours a day. Pathmark believes that these hours of operation increase both customer convenience and operating efficiency.\nPATHMARK DRUG STORES\nPathmark also operated 30 freestanding conventional drug stores primarily in the New York City metropolitan area and six \"deep-discount\" drug stores in Connecticut at January 28, 1995. These stores, which accounted for approximately 4% of Pathmark's sales for Fiscal 1994, average 13,600 square feet in size and offer the full variety of products customarily offered by drug stores. In Fiscal 1994, Pathmark pharmacies, in both supermarkets and drug stores, filled approximately ten million prescriptions, making Pathmark one of the leading drugstore retailers, based on sales volume, in the northeast United States and the leading filler of prescriptions in the New York metropolitan area. In Fiscal 1994, Pathmark renovated a total of five drug stores, four of which were conventional drug stores. Pathmark's free-standing drug stores are generally open seven days a week during conventional hours.\nPathmark's supermarket and drug store business is generally not seasonal, although sales in the second and fourth quarters tend to be slightly higher than those in the first and third quarters.\nSTORE EXPANSION AND RENOVATION PROGRAM\nA key feature of Pathmark's business strategy has been and will continue to be the expansion of the total selling square footage of its operations. Pathmark believes that by adding new stores and increasing the selling area of existing stores, it can improve its competitive position and widen operating margins by achieving economies of scale in merchandising, advertising, distribution and supervision.\nDuring the five years ending with Fiscal 1994, Pathmark completed 104 major renovations and enlargements and opened 16 new supermarkets. At the close of Fiscal 1994, sales in these stores accounted for approximately 80% of its total supermarket sales.\nOver the past five years, Pathmark has spent approximately $371.0 million on store openings, enlargements and major renovations including properties acquired under capital leases. In Fiscal 1994, Pathmark opened four new Pathmark 2000 super centers and completed 14 major renovations and 11 enlargements of its existing supermarkets. Pathmark currently expects to open up to six new Pathmark \"2000\" Super Centers during Fiscal 1995, five of which will replace smaller stores, and to complete up to 32 major renovations and enlargements.\nADVERTISING AND PROMOTION\nAs part of its marketing strategy, Pathmark emphasizes its competitive pricing through weekly sales and promotions supported by extensive advertising. Additional savings are offered each week through Pathmark \"super coupons\" in newspapers and circulars. Pathmark's advertising expenditures are concentrated on print advertising, including advertisements and circulars in local and area newspapers and advertising flyers distributed by shopping malls. Most of the remaining advertising expenses are for radio and television advertisements. During Fiscal 1994, Pathmark introduced \"Smart Coupons\" in its advertisements. With \"Smart Coupons\", customers no longer are required to actually cut out Pathmark coupons from its advertisement and physically present them at the cash registers. Rather, when a coupon item is scanned during the check-out process, the coupon savings is automatically deducted from the price. Pathmark believes that its \"Smart Coupons\" greatly convenience its customers and improve customer service at the checkout.\nCONSUMER RESEARCH\nPathmark conducts numerous ongoing and special consumer research projects. These typically involve customer surveys (both in-store and by telephone) as well as focus groups. The information derived from these projects is used to evaluate consumers' attitudes and purchasing patterns and helps shape Pathmark's marketing programs. Pathmark conducts approximately 300,000 customer interviews per year.\nTECHNOLOGY\nPathmark has made a significant and continuing investment in information technology and believes it is a leader in the supermarket industry in this area. All Pathmark supermarket checkout terminals have third-generation \"state of the art\" IBM 4680 scanner systems supported by a RlSC 6000 application processor in each store. These systems allow consumer credit and EFT transactions, greatly facilitate system-wide promotion and merchandising programs, and improve the speed and control of customer transactions. This technology and the data generated by scanning not only have led to lower labor costs, improved price control and shelf allocation and quicker customer check-out, but also have assisted in the analysis of product movement, profit contribution and demographic merchandising. Pathmark also has a computer-assisted ordering system which enables it to replenish inventory to avoid \"out of stocks\" at store level while maintaining optimum overall inventory levels.\nAll of the pharmacies are equipped with pharmacy computers. In addition to improving customer service, these computers aid pharmacists in detecting drug interaction, improve the collection of third-party receivables and help to attract third-party businesses such as health maintenance organizations and union welfare plans.\nIn August 1991, Pathmark entered into a long-term facilities management and systems integration agreement with Integrated Systems Solutions Corporation (\"ISSC\"), a subsidiary of IBM. Under the agreement, ISSC has taken over Pathmark's data center operations and mainframe processing and information system functions (formerly performed by approximately 150 employees) and is providing\nbusiness applications and \"state of the art\" systems designed to enhance Pathmark's customer service and efficiency. ISSC developed Pathmark's recently installed scanner and checkout terminals. Additionally, over the next several years, ISSC has contracted to develop an integrated purchasing application, a new financial system, and electronic data interchange capabilities that will streamline communications between Pathmark and its primary suppliers.\nSUPPLY AND DISTRIBUTION\nPursuant to the Logistical Services Agreement and subject to Pathmark's direction, Plainbridge supplies Pathmark with most of the merchandise sold in Pathmark's supermarkets and drug stores through Plainbridge distribution facilities located in New Jersey, together with warehousing, distribution and logistical services relating to the supply of such merchandise. See \"--Logistical Services Agreement\". During Fiscal 1994, the Plainbridge distribution facilities supplied approximately 81% of the merchandise sold in Pathmark's supermarkets and drug stores. In addition, pursuant to a supply agreement between Chefmark and Pathmark (the \"Chefmark Supply Agreement\"), Chefmark supplies Pathmark with merchandise from its banana ripening and deli food preparation operations. The Chefmark Supply Agreement provides that, for a period of seven years, such services are to be performed by Chefmark in substantially the same manner as they have been performed by Pathmark's banana ripening and deli food preparation operations prior to the Chefmark Spin-Off.\nAll but one of Pathmark's stores are located within 100 miles of the principal Plainbridge and Chefmark distribution centers. The following table presents information concerning the distribution and processing facilities through which Plainbridge and Chefmark will supply Pathmark, and the product lines relevant to each as of January 28, 1995:\nDISTRIBUTION FACILITIES (1)\nSQUARE YEAR LOCATION PRODUCT LINE FOOTAGE OPENED - ----------------------------- --------------------------- ------- ------ Woodbridge, NJ(2)............ Dry Grocery 475,000 1968 Edison, NJ(3)................ General Merchandise, Health 266,000 1980 and Beauty Care Products, Pharmaceuticals, Tobacco Woodbridge, NJ(2)............ Meat, Dairy, Deli, Produce 255,000 1970 Dayton, NJ(3)................ Frozen Food Distribution 112,000 1994 Center\nPROCESSING FACILITIES\nSQUARE YEAR LOCATION PRODUCTS PROCESSED FOOTAGE OPENED - ----------------------------- --------------------------- ------- ------ Somerset, NJ(4).............. Delicatessen Products 16,000 1976 Avenel, NJ(5)................ Banana Ripening 30,000 1984\n- ------------\n(1) Pathmark also stores and ships certain products from independent warehouses, including a dry grocery storage facility in North Brunswick, New Jersey.\n(2) Owned by Plainbridge.\n(3) Leased by Plainbridge.\n(4) Owned by Chefmark.\n(5) Leased by Chefmark.\nLOGISTICAL SERVICES AGREEMENT\nIn connection with the Plainbridge Spin-Off, Pathmark and Plainbridge entered into the Logistical Services Agreement to provide for the supply by Plainbridge to Pathmark of most of the merchandise sold in Pathmark's retail stores and for the provision of warehousing, distribution and other logistical services relating to the supply of such merchandise. Pursuant to the Logistical Services Agreement, Pathmark directs the purchase of the merchandise to be provided to it by Plainbridge. Pathmark negotiates directly with vendors regarding the types of merchandise required, the quantities needed, delivery schedules, pricing, and all other terms and conditions of sale. All merchandise is ordered by Pathmark for the account of Plainbridge, which pays for, and retains title to, such merchandise until it has been delivered to Pathmark. If requested by a vendor, Pathmark, in its sole discretion, may guarantee payment of such orders by Plainbridge. In general, the Logistical Services Agreement also requires Plainbridge to perform the same services, in substantially the same manner, that were performed by Pathmark's warehouse and distribution group prior to the Plainbridge Spin-Off.\nThe Logistical Services Agreement requires, with certain exceptions and subject to certain termination rights, Plainbridge to sell to Pathmark, for a period of ten years, to the extent requested by Pathmark, all of Pathmark's merchandise requirements for both its existing and future stores. In addition, Pathmark has five one-year renewal options following the expiration of the original ten-year term. The Logistical Services Agreement does not limit Pathmark's ability to purchase goods from other suppliers, and merchandise that Pathmark customarily obtains directly from vendors is excluded from the Logistical Services Agreement.\nThe Logistical Services Agreement requires Plainbridge to store and deliver to Pathmark all merchandise purchased at Pathmark's direction. Pathmark is required in good faith to designate Plainbridge as its carrier with respect to merchandise customarily shipped directly from vendors to the Pathmark stores. Plainbridge may be required to maintain inventory with a book value of at least $130.0 million for the exclusive use of Pathmark, and to the extent that the inventory value falls below such level, Plainbridge may be asked by Pathmark to purchase sufficient merchandise to maintain such level to the extent such merchandise is ordered by Pathmark. Plainbridge is also required to accommodate physical annual increases of up to five percent in the volume of the Pathmark-directed purchases of merchandise to be handled by Plainbridge. Pathmark reimburses Plainbridge for all reasonable incremental out-of-pocket costs (but not capital costs) incurred by Plainbridge for the storage and handling of merchandise that is in excess of the five percent annual capacity increase, provided that such out-of-pocket costs do not exceed the costs of storage and handling at local independent warehouses.\nUpon the delivery of merchandise to the Pathmark stores by Plainbridge, Pathmark will owe Plainbridge for the cost of the merchandise plus a specified variable payment. This payment will vary according to the type and value of the merchandise. A minimum guaranteed payment is payable by Pathmark to the extent that the aggregate of the variable payments described above payable in any year does not exceed the minimum guaranteed payment. The minimum guaranteed payment for Fiscal 1995 is $136.1 million and such payment is adjusted upward (but not downward) each fiscal year by the rate of inflation. Pathmark is obligated to pay the minimum guaranteed payment to Plainbridge irrespective of whether Pathmark purchases merchandise from other suppliers, except in cases of force majeure or when Plainbridge shall have materially breached the Logistical Services Agreement or shall have failed to obtain or maintain the licenses and permits needed to operate its business. The minimum guaranteed payment will be reduced to the extent that the volume of merchandise purchases decreases as a result of any store dispositions by Pathmark and will also be reduced if the volume of Pathmark-directed merchandise falls below 90% of the actual volume achieved in Fiscal 1992, to the extent that Plainbridge is, as a result, able to realize reductions in its operating costs. Plainbridge will grant Pathmark an allowance, based on the amount of merchandise purchased by Plainbridge at Pathmark's direction, which will be credited against the variable fees and minimum guaranteed payment obligation. In addition, certain cost benefits derived from increases in the volume of merchandise purchased from\nPlainbridge by Pathmark or third parties will be shared equally between Pathmark and Plainbridge. Estimated payments are payable in weekly installments with an annual reconciliation for the amount of payments that are actually payable for such year. Pathmark will pay to Plainbridge the costs of the merchandise at the time a vendor requires payment from Plainbridge.\nThe Logistical Services Agreement allows Plainbridge to sell merchandise and provide logistical services to third parties, although it is not permitted to sell merchandise to supermarkets, drug stores and other retail stores stocking merchandise carried by Pathmark in Pathmark's current market areas, except for retail stores that do not in the ordinary course of business engage to a significant degree in the sale of food or pharmacy-related products, without Pathmark's prior written consent, which consent may not be unreasonably withheld. Plainbridge is also permitted to \"piggyback\" such third parties' orders onto Pathmark's orders from vendors, so long as they do not interfere with Pathmark's delivery schedules, quantity needs or other requirements.\nPlainbridge and the Company are allowed to terminate the Logistical Services Agreement if the other (i) materially breaches its terms and fails to cure such breach for 60 days after written notice has been provided by the other party or (ii) experiences certain insolvency events. Additionally, following the fourth anniversary of the date of the Logistical Services Agreement, the Company has the option of terminating it at will on six months notice. If the Company terminates the Logistical Services Agreement because of a material breach by, or insolvency of, Plainbridge, the Company has the right to purchase, within 30 days of the termination, that portion of the assets of Plainbridge which is essential to the support of Plainbridge's obligations to the Company under the Logistical Services Agreement (the \"Pathmark Distribution Assets\") at the lower of (i) their net book value or (ii) their fair market value. If the Company exercises its at will option to terminate the Logistical Services Agreement, the Company is required to offer to purchase the Pathmark Distribution Assets at their fair market value. If Plainbridge terminates the Logistical Services Agreement because of a material breach by, or insolvency of the Company, Plainbridge has the right to sell to the Company (and the Company will have the obligation to buy) the Pathmark Distribution Assets at their fair market value within 30 days of such termination.\nOther than in the ordinary course of business, Plainbridge is not permitted to sell any of the Pathmark Distribution Assets without Pathmark's prior written consent. Additionally, in the event of a change in the ultimate beneficial ownership of Plainbridge voting stock such that a person, other than Merrill Lynch and Co., Inc. (\"ML&Co.\") or an affiliate of ML&Co., holds a majority of such stock, Pathmark has, for a period of two years, the irrevocable and exclusive right to purchase any or all of the Pathmark Distribution Assets at their fair market value.\nOther provisions of the Logistical Services Agreement include (i) that Plainbridge will pass on to Pathmark all discounts and allowances made available to it by vendors in respect of merchandise purchased for Pathmark, unless such discounts or allowances were made available solely as a result of actions taken or not taken by Plainbridge, (ii) that Plainbridge must ensure that merchandise quality meets or exceeds the standards established by Pathmark for such merchandise, and that Pathmark may place its representatives at the Distribution Facilities to ensure that such quality is maintained, (iii) that Plainbridge will deliver merchandise to Pathmark at a 98% or better level of service measured in accordance with Pathmark's practices prior to the Plainbridge Spin-Off, (iv) that Pathmark will pay Plainbridge for any use of trailers for storage and (v) that each of Pathmark and Plainbridge will cooperate to reduce costs and improve service levels.\nDisputes between Pathmark and Plainbridge under the Logistical Services Agreement will be submitted to an arbitration panel made up of representatives of both parties. The President of Pathmark shall act as chairman of the dispute panel and each party shall appoint two other members to the dispute panel, the decision of which will be subject to the approval of the boards of directors of each party. If the decision of the dispute panel is not approved by each board of directors, the dispute will be required to be submitted to independent arbitration.\nThe Logistical Services Agreement is a result of a related party negotiation between Pathmark and Plainbridge. Pathmark believes that the payments provided for under the terms of the Logistical Services Agreement represent a reasonable allocation of the costs and benefits for both companies. In addition, Pathmark believes that the terms of the Logistical Services Agreement are no less favorable to Pathmark than those which could be obtained from unaffiliated parties and enable Pathmark to obtain substantially the same level of supply and other logistical services as was available from the Distribution Facilities prior to the Spin-Offs at substantially the same or a lower cost.\nCOMPETITION\nThe supermarket and drug store businesses are highly competitive and are characterized by high asset turnover and narrow profit margins. Pathmark's earnings are primarily dependent on the maintenance of relatively high sales volume per supermarket, efficient product purchasing and distribution and cost-effective store operating techniques. Pathmark's main competitors are national and regional supermarkets, drug stores, convenience stores, discount merchandisers, \"warehouse\" and \"club\" stores and other local retailers in the areas served. Principal competitive factors include price, store location, advertising and promotion, product mix, quality and service.\nTRADE NAMES, SERVICE MARKS AND TRADEMARKS\nPathmark has registered a variety of trade names, service marks and trademarks with the United States Patent and Trademark Office, each for an initial period of 20 years, renewable for as long as the use thereof continues. Pathmark considers its Pathmark service marks to be of material importance to its business and actively defends and enforces such service marks.\nREGULATION\nPathmark's food and drug business requires it to hold various licenses and to register certain of its facilities with state and federal health, drug and alcoholic beverage regulatory agencies. By virtue of these licenses and registration requirements, Pathmark is obligated to observe certain rules and regulations, and a violation of such rules and regulations could result in a suspension or revocation of the licenses or registrations. In addition, most of Pathmark's licenses require periodic renewals. Pathmark has experienced no material difficulties with respect to obtaining, effecting or retaining its licenses and registrations.\nEMPLOYEES\nAt January 28, 1995, the Company employed approximately 30,500 people, of whom approximately 20,400 were employed on a part-time basis.\nApproximately 86% of the Company's employees are covered by 31 collective bargaining agreements (typically having three or four year terms) negotiated with approximately 18 different local unions. During Fiscal 1995, six contracts covering approximately 2,100 Pathmark and Chefmark associates will expire. The Company does not anticipate any difficulty in renegotiating these contracts.\nThe Company believes that its relationship with its employees is generally satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES**\nReference is made to the answer to Item 1, \"Business\" of this report for information concerning the states in which the Company's supermarkets and drug stores and its distribution facilities are located.\nTHE COMPANY\nThe Company's primary subsidiary, Pathmark, leases and owns a large group of properties, as described below. In addition, Chefmark owns a 16,000 square foot delicatessen products processing and distribution facility in Somerset, New Jersey and leases a 30,000 foot banana ripening facility in Avenel, New Jersey. These facilities supply Pathmark's supermarkets with delicatessen and produce products.\nPATHMARK\nPathmark's 143 supermarkets have an aggregate selling area of approximately 5.2 million square feet. The ownership interest in the buildings and real property of ten supermarket locations (one of which is a closed store location) and the headquarters in Woodbridge, New Jersey were contributed to Plainbridge in the Spin-Offs and, except for the closed store location, were leased to Pathmark. Thirteen of the supermarkets are owned by Pathmark (or its subsidiaries) and the remaining 130 are leased. These supermarkets either are freestanding stores or are located in shopping centers. Thirty-four leases expire during the current and next four calendar years and Pathmark has options to renew 33 of them.\nPathmark's 36 freestanding drug stores (those not located in supermarkets) have an aggregate selling area of approximately 398,000 square feet. Two of the drug stores are owned by Pathmark and the remaining 34 are leased. Nineteen leases expire during the current and next four calendar years and Pathmark has options to renew 14 of them.\nCertain distribution facilities that supply Pathmark supermarkets and drug stores were transferred to Plainbridge in connection with the Plainbridge Spin-Off. Certain of these facilities are leased and some are owned. See \"Business of Pathmark--Supply and Distribution\" in Item 1 of this report.\nPathmark maintains administrative and accounting offices in Carteret, New Jersey in leased premises totalling approximately 150,000 square feet in size. Pathmark also currently leases or owns additional office space totaling approximately 128,000 square feet in various locations that are used as the Pathmark headquarters and regional offices for its operating divisions.\nMost of the facilities owned by Pathmark are owned subject to mortgages. Pathmark plans to acquire leasehold or fee interests in any property on which new stores or other facilities are opened and will consider entering into sale\/leaseback or mortgage transactions with respect to owned properties if Pathmark believes such transactions are financially advantageous.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn December 7, 1990, a lawsuit (the \"Complaint\") was commenced by a holder of the Exchangeable Preferred Stock, Stanley D. Bernstein, as custodian for Michelle Bernstein, against the Company, SMG-II Holdings Corp. (\"SMG-II\"), Merrill Lynch Capital Partners, Inc. (\"MLCP\"), Merrill Lynch & Co. (\"ML&Co.\") and the directors of the Company in the Chancery Court, New Castle County, Delaware. The Complaint purported to be a class action and alleged that the original terms of the Exchangeable Preferred Stock Offer, at $5 per share, constituted a coercive tender offer and a breach of fiduciary duties owed to holders of Exchangeable Preferred Stock. The Complaint sought declaratory and injunctive relief, as well as monetary damages, with respect to the Exchangeable Preferred Stock Offer, but no motions seeking any such relief on a provisional or permanent basis were filed either prior or subsequent to the completion of the Exchangeable Preferred Stock Offer on February 4, 1991. The Delaware Chancery Court dismissed the case with prejudice on July 7, 1994, and approved a total payment of $200,000 as attorneys' fees.\n- ------------\n** Except as otherwise indicated, information contained in this Item is given as of January 28, 1995.\nOn March 1, 1993 Pathmark was served with a summons and complaint filed by Hygrade Milk & Cream Co., Inc., Terminal Dairies, Inc., Sunbeam Farms, Inc., Hytest Milk Corp., Gold Metal Farms, Inc., Queens Farms Dairy, Inc., Babylon Dairy Co., Inc. and Meadowbrook Farms, Inc., in an action being heard in the United States District Court for the Southern District of New York. In the complaint the plaintiffs allege, among other things, that Pathmark induced processors of Tropicana orange juice to provide it with favorable price and other terms that discriminated against other sellers of orange juice in violation of the price discrimination provisions of the Robinson-Patman Act. On February 2, 1995, the Court entered an order approving plaintiffs' dismissal of Pathmark from the action with prejudice and without costs or fees. Pathmark is thus no longer a defendant in this action.\nIn addition to the litigation referred to above, the Company is a party to a number of legal proceedings in the ordinary course of business. Management believes that the ultimate resolution of these proceedings will not, in the aggregate, have a material adverse impact on the financial condition, results of operations or the business of the Company.\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 (AS OF APRIL 1, 1995)\nNeither the Company's Class A Common Stock nor its Class B Common Stock, each $0.01 par value, is publicly traded on any market. All of registrant's outstanding Common Stock is held by SMG-II.\nThe authorized preferred stock of the Company consists of 9,000,000 shares of Exchangeable Preferred Stock (the \"Holdings Preferred Stock\"), of which 4,890,671 shares were issued and outstanding at January 28, 1995. The Exchangeable Preferred Stock has a liquidation preference of $25 per share and its terms provide for cumulative quarterly dividends at an annual rate of $3.52 per share, when, as, and if declared by the Board of Directors of the Company. No active public trading market currently exists for the Company's Exchangeable Preferred Stock.\nThe Exchangeable Preferred Stock is non-voting, except that if an amount equal to six quarterly dividends is in arrears in whole or in part, the holders thereof, voting as a class are entitled to elect an additional two members of the board of directors of the Company. The Company is currently in arrears on payment of more than six quarterly dividends on the Exchangeable Preferred Stock and does not expect to receive cash flow sufficient to permit payments of dividends on the Exchangeable Preferred Stock in the forseeable future. The holders of the Exchangeable Preferred Stock will vote to elect two persons to the Holdings' board of directors at Holdings 1995 annual meeting once two persons have been nominated. See Note 24 to the Company's Consolidated Financial Statements in Item 8 of this report for additional information.\nThe payment of dividends to holders of the Company's Common Stock is subject to restrictions by the Certificate of Designation of Rights, Preferences and Privileges under which its Exchangeable Preferred Stock was issued. The Company has not paid any dividends on its Common Stock and does not anticipate paying cash dividends on its Common Stock during Fiscal 1995.\nThe authorized capital stock of SMG-II consists of 3,000,000 shares of SMG-II Class A Common Stock, 3,000,000 shares of SMG-II Class B Common Stock, of which 650,675 and 320,000 shares, respectively, were issued and outstanding at April 1, 1995, and 4,000,000 shares of SMG-II Preferred Stock, of which 1,500,000 shares are SMG-II Series A Preferred Stock and 1,500,000 shares are SMG-II Series B Preferred Stock and of which 236,731 and 180,769 shares, respectively, were issued and outstanding at April 1, 1995.\nSMG-II's capital stock is held beneficially as follows: (i) SMG-II Class A Common Stock by approximately 65 holders, including six affiliates of ML&Co. (The \"ML Common Investors\"), CBC Capital Partners, Inc. (\"CBC\"), an affiliate of Chemical Bank, and 58 current and former members of\nthe Company's management (the \"Management Investors\"); (ii) SMG-II Series A Preferred Stock by five holders, all affiliates of ML&Co., (the \"Merrill Lynch Investors\"); (iii) SMG-II Class B Common Stock held by four holders, including CBC, The Equitable Life Assurance Society of the United States (\"Equitable\") and the Equitable Affiliates (collectively, the \"Equitable Investors\"); and (iv) SMG-II Series B Preferred Stock held by four holders, including CBC and the Equitable Investors. Holders of shares of SMG-II Class A Common Stock are entitled to one vote per share on all matters to be voted on by stockholders. Holders of shares of SMG-II Class B Common Stock are not entitled to any voting rights, except as required by law or as otherwise provided in the Restated Certificate of Incorporation of SMG-II. Subject to compliance with certain procedures, holders of shares of SMG-II Class B Common Stock may exchange their shares for shares of SMG-II Class A Common Stock and holders of shares of SMG-II Class A Common Stock may exchange their shares for shares of SMG-II Class B Common Stock, in each case on a share-for-shares basis.\nSMG-II Preferred Stock has a stated value and liquidation preference of $200 per share and bears dividends at the rate of 10% of the stated value per annum, payable annually. At the option of SMG-II dividends are payable in cash or may accumulate (and the amount thereof shall compound annually at a rate of 10% of the stated value per annum, payable annually. At the option of SMG-II, dividends are payable in cash or may accumulate (and the amount thereof shall compound annually at a rate of 10% per annum).\nHolders of shares of SMG-II Series A Preferred Stock are entitled to one vote per share of SMG-II Class A Common Stock into which such SMG-II Series A Preferred Stock is convertible on all matters to be voted on by SMG-II stockholders, subject to increase to 1.11 votes per share upon the occurrence of certain events. Holders of shares of SMG-II Series B Preferred Stock are entitled to one vote per share of SMG-II Class B Common Stock into which such SMG-II Series B Preferred Stock is convertible for the purpose of voting on any consolidation or merger, any sale, lease or exchange of substantially all of the assets or any liquidation, dissolution or winding up, of SMG-II. Additionally, holders of SMG-II Preferred Stock have separate voting rights with respect to alteration in the voting powers, rights and preferences and certain other terms affecting the SMG-II Preferred Stock. Subject to compliance with certain procedures, holders of SMG-II Series B Preferred Stock may exchange their shares for shares of SMG-II Series A Preferred Stock and holders of SMG-II Series A Preferred Stock may exchange their shares for shares of SMG-II Series B Preferred Stock, on a share-for-share basis.\nAt the option of the holder, SMG-II Preferred Stock is convertible into SMG-II Common Stock at any time on or prior to the occurrence of certain events, including an initial public offering of in excess of 25% of the number of outstanding shares of common stock of SMG-II, at a conversion ratio of one share of the corresponding class of SMG-II Common Stock for each share of SMG-II Preferred Stock, subject to adjustment upon the occurrence of certain events.\nHolders of SMG-II Preferred Stock are party with the holders of SMG-II Common Stock to the SMG-II Stockholders Agreement which, among other things, restricts the transferability of SMG-II capital stock and relates to the corporate governance of SMG-II. None of SMG-II's capital stock is publicly traded on any market. See Item 12. \"Security Ownership of Certain Beneficial Owners and Management\" and Note 25 to the Company's Consolidated Financial Statements in Item 8 for additional information.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table represents selected financial data for the last five fiscal years and should be read in conjunction with the Company's Consolidated Financial Statements in Item 8 of this report.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION SUMMARY OF OPERATIONS AND FINANCIAL HIGHLIGHTS (IN MILLIONS)\n(footnotes on following page)\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO SUMMARY OF OPERATIONS AND FINANCIAL HIGHLIGHTS\n(footnotes continued on following page)\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO SUMMARY OF OPERATIONS AND FINANCIAL HIGHLIGHTS\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following is a discussion and analysis of the Company's financial condition and results from continuing operations. The results from discontinued operations for all periods presented represent the operations of the Company's home centers segment which was sold during Fiscal 1994. At the time of Recapitalization, Holdings intended to further spin off Plainbridge to Holdings' common stockholder. Such further spin-off would have required the satisfaction of dividend restrictions with respect to Holdings' Exchangeable Preferred Stock, as well as, obtaining consents from various lenders to Plainbridge and PTK. During the fourth quarter of Fiscal 1994, as a result of the aforementioned dividend restrictions, Holdings has concluded that a further spin-off of Plainbridge to Holdings' common stockholder is not likely to occur. Accordingly, prior year financial statements which had included the results of Plainbridge's warehouse, transportation and real estate operations as discontinued operations have been reclassified to include such results in continuing operations. Although the discontinued operations have generated positive operating cash flows, the Company believes that the impact on the Company's liquidity is not material.\nRESULTS OF OPERATIONS\nFiscal 1994 v. Fiscal 1993\nSales. Sales for Fiscal 1994 were $4.21 billion compared to $4.24 billion in Fiscal 1993. Sales for stores opened in both years, including replacement stores, decreased 0.4%. During Fiscal 1994, the Company opened four supermarkets, enlarged 11 supermarkets and completed major renovations in 14 supermarkets. At Fiscal 1994 year end, the Company operated 143 supermarkets, including 135 Pathmark Super Centers compared with the end of Fiscal 1993 when the Company operated 143 supermarkets, including 136 Pathmark Super Centers. The Company also operated 30 freestanding Pathmark drug stores and six \"deep discount\" drug stores at Fiscal 1994 year end compared with the end of Fiscal 1993 when the Company operated 31 freestanding Pathmark drug stores and two \"deep discount\" drug stores. In order to improve sales while continuing to improve profitability, the Company is continuing its focus on its store enlargement and renovation program.\nGross Profit. Gross profit for Fiscal 1994 was $1.19 billion or 28.2% of sales compared with $1.16 billion or 27.3% of sales in Fiscal 1993. This improvement in gross profit as a percentage of sales for Fiscal 1994 is attributable primarily to the Company's increased focus on merchandising programs as well as continuing emphasis on large super stores allowing expanded variety in all departments, particularly higher margin perishables. The cost of goods comparisons were affected by a pretax LIFO credit in Fiscal 1994 of $0.7 million compared to a $2.4 million credit in Fiscal 1993.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses for Fiscal 1994 increased $9.3 million or 1.0% compared to Fiscal 1993. As a percentage of sales, selling, general and administrative expenses were 22.2% for Fiscal 1994, up from 21.8% for Fiscal 1993. The increase as a percentage of sales during Fiscal 1994 was due to higher computer development costs, labor and labor related expenses and occupancy expenses, partially offset by lower promotional costs this year compared to the additional promotional programs implemented last year to regain sales level subsequent to the strike and lockouts and lower claims expense related to customer accidents, medical and workers compensation.\nDepreciation and Amortization. Depreciation and amortization expense of $75.6 million for Fiscal 1994 was $5.5 million more than the prior year's $70.1 million. The increase in depreciation and amortization expense is primarily due to the impact of increased capital spending levels. Depreciation and amortization excludes video tape amortization of $2.6 million in both Fiscal 1994 and Fiscal 1993 recorded in cost of goods sold (see Note 2).\nOperating Earnings. Operating earnings for Fiscal 1994 were $175.9 million compared to $140.2 million in Fiscal 1993. The increase in operating earnings was primarily due to the impact of the strike and lockouts in Fiscal 1993, the recapitalization expenses of $16.6 million in Fiscal 1993 and the\nprovision for store closings of $6.0 million in Fiscal 1993. Operating earnings were also affected by a pretax LIFO credit of $0.7 million in Fiscal 1994, compared to a $2.4 million credit in Fiscal 1993.\nInterest Expense. Interest expense for Fiscal 1994 was $170.8 million, a decrease of $19.3 million from the $190.1 million in Fiscal 1993. Interest charged to discontinued operations in Fiscal 1994 was $11.0 million compared to $13.1 million in Fiscal 1993. The lower interest expense, net of interest charged to discontinued operations, was primarily due to the benefit of lower interest rates on the debt incurred in connection with the Recapitalization.\nIncome Taxes. The income tax provision was $4.1 million in Fiscal 1994 compared to an income tax benefit of $20.8 million in Fiscal 1993. At January 28, 1995, the Company has a net deferred tax asset of approximately $32.8. Although the Company has generated pretax earnings in Fiscal 1994, the Company was unable to conclude that realization of such deferred tax assets was more likely than not due to pretax losses experienced in prior years. Accordingly, the Company has provided a valuation allowance of $26.8 million at January 28, 1995 to fully reserve its net deferred tax assets, except for its alternative minimum tax credit carryforwards which do not expire. Management will continue to assess the likelihood of realizing its deferred tax assets and will adjust the valuation allowance when and if, in the opinion of management, significant positive evidence exists which indicates that it is more likely than not that the Company will be able to realize such deferred tax assets. Such reductions in the valuation allowance, if any, will be reflected as a component of income tax expense. Refer to Note 19 to the Company's Consolidated Financial Statements for a further discussion of income taxes.\nSummary of Continuing Operations. Earnings from continuing operations before gain on disposal of home centers segment, extraordinary items and cumulative effect of accounting changes were $12.0 million in Fiscal 1994 compared to a $16.1 million loss in Fiscal 1993. The increase in earnings was primarily due to the impact of the strike and lockouts in Fiscal 1993, the recapitalization expenses of $16.6 million in Fiscal 1993, and the provision for store closings of $6.0 million in Fiscal 1993, as well as the lower interest expense during Fiscal 1994 as a result of the Recapitalization.\nNet Earnings (Loss). Net earnings were $23.2 in Fiscal 1994 compared to a net loss of $163.2 million in Fiscal 1993. During Fiscal 1994, the Company completed the sale of its home centers segment , recognizing a gain of $17.0 million, net of an income tax provision of $2.3 million. Fiscal 1994 and Fiscal 1993 included extraordinary items related to the net loss on early extinguishment of debt of $3.7 million and $106.2 million, respectively, and Fiscal 1993 included the cumulative effect of accounting changes of $40.4 million. Refer to Notes 4, 5 and 23 to the Company's Consolidated Financial Statements for a discussion of the home centers segment sale, the extraordinary items and the cumulative effect of accounting changes.\nFiscal 1993 v. Fiscal 1992\nSales. Sales for Fiscal 1993 were $4.24 billion compared to $4.34 billion in Fiscal 1992. The sales decrease for the year is primarily due to the impact of the strike and lockouts in the second quarter of Fiscal 1993 and the exclusion from reported results of the sales since the beginning of the second quarter of Fiscal 1993 of the three stores anticipated to be closed or sold as part of the provision for store closings. During Fiscal 1993, the Company opened four supermarkets, enlarged five supermarkets, and completed major renovations in twelve supermarkets. Five supermarkets were closed during Fiscal 1993. Sales for stores opened in both periods decreased by 2.4%. At Fiscal 1993 year end, the Company operated 143 supermarkets, including 136 Pathmark Super Centers, and 33 Pathmark freestanding drug stores. This compares with the end of Fiscal 1992 when the Company operated 146 supermarkets, including 139 Pathmark Super Centers, and 33 Pathmark freestanding drug stores.\nGross Profit. Gross profit for Fiscal 1993 was $1.16 billion or 27.3% of sales compared with $1.16 billion or 26.6% of sales in Fiscal 1992. This improvement in gross profit as a percentage of sales for Fiscal 1993 is attributable primarily to the Company's increased focus on merchandising programs as well as a continuing emphasis on large super stores allowing expanded variety in all departments, particularly higher margin perishables and service departments. The gross profit comparisons were\naffected by a pretax LIFO credit in Fiscal 1993 of $2.4 million compared with a pretax LIFO provision of $2.2 million in Fiscal 1992.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses for Fiscal 1993 increased $31.9 million or 3.6% compared to Fiscal 1992. As a percentage of sales, selling, general and administrative expenses were 21.8% for Fiscal 1993, up from 20.6% in Fiscal 1992. The increase as a percentage of sales during Fiscal 1993 was primarily attributable to higher promotional expenses and the lower sales volume and increased costs resulting from the strike and lockouts.\nRecapitalization Expenses. In connection with the Plainbridge Spin-Off and Recapitalization, the Company recorded a pretax charge of approximately $23.7 million in the third quarter of Fiscal 1993 to record estimated reorganization and restructuring costs, including an early retirement program offered to certain Company associates. During the fourth quarter of Fiscal 1993, the Company determined that the estimated costs related to the reorganization and restructuring were less than originally estimated and recorded a pretax credit of approximately $7.1 million. Of the total net pretax charge of $16.6 million for Fiscal 1993, $6.4 million related to the early retirement program and severance costs incurred to reduce the Company's workforce, $8.1 million related to additional technical information systems costs incurred in order to accomplish the Plainbridge Spin-Off and $2.1 million related to warehouse and consulting costs associated therewith. Through January 29, 1994, the Company had expended $11.9 million related to these reorganization and restructuring costs. The remaining $4.7 million was paid during Fiscal 1994.\nProvision for Store Closings. Effective with the beginning of the second quarter of Fiscal 1993, the Company originally made a decision to close or to dispose of five stores which the Company believed would continue to be unprofitable. As a result, the Company recorded a pretax charge in the second quarter of Fiscal 1993 of approximately $6.0 million. Operating results for the five stores had previously been excluded from the consolidated statements of operations since the beginning of the second quarter of Fiscal 1993. However, the Company decided on December 31, 1994 that two of the five stores would continue to be operated and, therefore, the operating results for these two stores have been included in the Fiscal 1994 and Fiscal 1993 statements of operations. The inclusion of these two stores had no effect on the Fiscal 1994 or 1993 reported results. The remaining three stores were closed during the fourth quarter of Fiscal 1994 and the related leases have been assigned or sublet subsequent to January 28, 1995.\nDepreciation and Amortization. Depreciation and amortization expense of $70.1 million for Fiscal 1993 was $0.9 million more than the prior year's $69.2 million. The increase in depreciation and amortization expense is primarily due to the impact of the assets transferred to Plainbridge as part of the Plainbridge Spin-Off.\nGoodwill Write-Off. During Fiscal 1992, the Company wrote off its remaining goodwill balance of $600.7 million. As a result of the write-off, there was no amortization of goodwill for Fiscal 1993 compared with $17.5 million for Fiscal 1992.\nOperating Earnings. Operating earnings for Fiscal 1993 were $140.2 million compared to an operating loss of $425.8 million in Fiscal 1992. The increase in operating earnings is due to the goodwill write-off of $600.7 million and the amortization of goodwill in Fiscal 1992, partially offset in Fiscal 1993 by the impact of the strike and lockouts and the subsequent promotional programs implemented in order to regain sales levels, the recapitalization expenses of $16.6 million and the provision for store closings of $6.0 million. Operating earnings were also affected by a pretax LIFO credit of $2.4 million in Fiscal 1993 compared to a pretax LIFO provision of $2.2 million in Fiscal 1992.\nInterest Expense. Interest expense for Fiscal 1993 was $190.1 million, a decrease of $7.7 million from the $197.8 million in Fiscal 1992. Interest charged to discontinued operations for Fiscal 1993 was $13.1 million compared to $13.0 million in Fiscal 1992. The lower interest expense, net of interest charged to discontinued operations, was primarily due to the benefit of lower interest rates on the debt\nincurred in connection with the Recapitalization partially offset by additional interest on the accreted principal of Holdings 13.125% Discount Debentures.\nIncome Taxes. As a result of the Company's net operating tax loss, the Company recorded income taxes receivable of approximately $22.4 million resulting from the carryback of such losses. The carryforward of those losses not carried back resulted in a net deferred tax asset of approximately $41.3 million at January 29, 1994. Since the Company has experienced pretax losses in each of Fiscal 1993, Fiscal 1992 and Fiscal 1991, the Company was unable to conclude that realization of such deferred tax assets was more likely than not. Accordingly, the Company has provided a valuation allowance of $38.4 million to fully reserve its net deferred tax assets, except for its alternative minimum tax credit carryforwards which do not expire (see Note 19 to the Company's Consolidated Financial Statements).\nThe Omnibus Budget Reconciliation Act of 1993 was signed into law on August 10, 1993, which, among other things, increased the federal income tax rates for corporations to 35% from 34%, effective January 1, 1993. Deferred tax liabilities and assets have been adjusted to reflect the 1% increase in federal income tax rates.\nSummary of Continuing Operations. The loss from continuing operations before gain on disposal of home centers segment, extraordinary items and cumulative effect of accounting changes was $16.1 million in Fiscal 1993 compared to $17.1 million (excluding the write-off of the remaining goodwill balance of $600.7 million and the Purity Operations gain of $2.0 million) in Fiscal 1992. The decrease in the loss is primarily due to lower interest expense as a result of the Recapitalization, increased operating earnings as discussed above and the elimination of goodwill amortization, partially offset by the impact of the strike and lockouts and the subsequent promotional programs implemented in order to regain sales levels, the recapitalization expenses, and the provision for store closings.\nNet Loss. Net loss was $163.2 million in Fiscal 1993 compared to $621.7 million in Fiscal 1992. Fiscal 1993 included extraordinary items related to the net loss on early extinguishment of debt of $106.2 million and the cumulative effect of accounting changes of $40.4 million. Refer to Notes 5 and 23 to the Company's Consolidated Financial Statements for a discussion of the extraordinary items and the cumulative effect of accounting changes. Fiscal 1992 included the goodwill write-off of $600.7 million.\nFINANCIAL CONDITION\nDebt Service. During Fiscal 1994, total debt decreased $49.6 million from the prior year end primarily due to the paydown of the PTK DIBs as a result of the home centers segment sale and the scheduled Term Loan repayments, partially offset by an increase in borrowings under the Pathmark Working Capital Facility and by debt accretion on Pathmark Deferred Coupon Notes and PTK DIBs. Borrowings under the Pathmark Working Capital Facility were $63.0 million at January 28, 1995 and have decreased to $33.5 million at April 24, 1995. There were no borrowings under the Plainbridge Working Capital Facility at January 28, 1995 and April 24, 1995.\nUnder the Pathmark Working Capital Facility, which expires in Fiscal 1998, Pathmark can borrow or obtain letters of credit in an aggregate amount not to exceed $175.0 million (of which the maximum of $100.0 million can be in letters of credit) subject to an annual cleandown provision. Under the terms of the Pathmark cleandown provision, in each fiscal year loans cannot exceed $50.0 million under the Pathmark Working Capital Facility for a period of 30 consecutive days. The Company has satisfied the terms of the Pathmark cleandown provision for Fiscal 1994 and Fiscal 1995. Under the Plainbridge Working Capital Facility, which expires in Fiscal 1997, Plainbridge can borrow or obtain letters of credit in an aggregate amount not to exceed $40.0 million subject to an annual cleanup provision, commencing in Fiscal 1994. Under the terms of the Plainbridge cleanup provision, in each fiscal year, loans cannot be made for a period of 30 consecutive days. The Company has satisfied the terms of the Plainbridge cleanup provisions for Fiscal 1994 and Fiscal 1995.\nPathmark is required to repay a portion of its borrowings under the Pathmark Term Loan each year, so as to retire such indebtedness in its entirety by Fiscal 1999.\nThe indebtedness under the Pathmark and Plainbridge Working Capital Facilities and the Pathmark Term Loan bear interest at floating rates and cash interest payments on such indebtedness may vary in future years. The Company does not currently maintain any interest rate hedging arrangements due to the reasonable risk that near term interest rates will not rise significantly. The Company is continuously evaluating this risk and will implement interest rate hedging arrangements when deemed appropriate.\nAs a result of the Recapitalization, the majority of the cash interest payments are scheduled in the second and fourth quarters.\nThe amounts of principal payments required each year on outstanding long-term debt (excluding the original issue discount with respect to the Pathmark Deferred Coupon Notes and the PTK DIBs) are as follows (dollars in thousands):\nPRINCIPAL FISCAL YEARS PAYMENTS - ---------------------------------------------------------- ------------------ 1995.................................................... $ 46,310 1996.................................................... 48,081 1997.................................................... 58,147 1998.................................................... 169,522 1999.................................................... 138,726 2000.................................................... 50,644 2001.................................................... 50,000 2002.................................................... 195,750 2003.................................................... 654,701\nLiquidity: The consolidated financial statements of the Company indicates that at January 28, 1995, current liabilities exceeded its current assets by $98.0 million and the Company's stockholder's deficit was $1.3 billion. Management believes that cash flows generated from operations, supplemented by the unused borrowing capacity under the Pathmark and Plainbridge Working Capital Facilities (see Note 12 of the Company's Consolidated Financial Statements) and the availability of capital lease financing will be sufficient to pay the Company's debts as they come due, provide for its capital expenditure program and meet its seasonal cash requirements. Further, the Company believes it will be in compliance throughout the upcoming fiscal year with its various debt covenants, which includes certain levels of operating cash flow (as defined), minimum interest coverage and a maximum leverage ratio.\nHoldings believes that it will be able to make the scheduled payments or refinance its obligations with respect to its indebtedness through a combination of operating funds and the Company's borrowing facilities. Future refinancing may be necessary if cash flow from operations is not sufficient to meet its debt service requirements related to the maturity of the Plainbridge Working Capital Facility in Fiscal 1997, the maturity of the Pathmark Working Capital Facility and certain mortgages in Fiscal 1998, the amortization and subsequent maturity of the Pathmark Term Loan in Fiscal 1999 and the maturity of the Pathmark Subordinated Notes and Pathmark Subordinated Debentures in Fiscal 2002. The Company expects that it will be necessary to refinance all or a portion of the Pathmark Senior Subordinated Notes, the Pathmark Deferred Coupon Notes due in Fiscal 2003 and the PTK DIBs due in Fiscal 2003. The Company may undertake a refinancing of some or all of such indebtedness sometime prior to its maturity. The Company's ability to make scheduled payments or to refinance its obligations with respect to its indebtedness depends on its financial and operating performance, which, in turn, is subject to prevailing economic conditions and to financial, business and other factors beyond its control. Although the Company's cash flow from its operations and borrowings has been sufficient to meet its debt service obligations, there can be no assurance that the Company's operating results will\ncontinue to be sufficient or that future borrowing facilities will be available for payment or refinancing of Pathmark's and PTK's indebtedness. While it is the Company's intention to enter into refinancings that it considers advantageous, there can be no assurances that the prevailing market conditions will be favorable to the Company. In the event the Company obtains any future refinancing on less than favorable terms, the holders of outstanding indebtedness could experience increased credit risk and could experience a decrease in the market value of their investment, because the Company might be forced to operate under terms that would restrict its operations and might find its cash flow reduced.\nPreferred Stock Dividends. The terms of the Exchangeable Preferred Stock provide for cumulative quarterly dividends at an annual rate of $3.52 per share when, and if declared by the Board of Directors of Holdings. Dividends for the first 20 quarterly dividend periods (through October 15, 1992) were paid at the Company's option in additional shares of Exchangeable Preferred Stock. Prior to the Recapitalization, the Old Working Capital Facility and the terms of the indentures governing the Company's public debt restricted the payment of cash dividends on the Exchangeable Preferred Stock unless certain conditions were met, including tests relating to earnings and cash flow ratios of Holdings. Prior to the Recapitalization, Holdings had not met the conditions permitting cash dividend payments on the Exchangeable Preferred Stock. Subsequent to the Recapitalization, the Company does not expect to receive cash flow sufficient to permit further payments of dividends on the Exchangeable Preferred Stock in the foreseeable future. All dividends not paid in cash will cumulate at the rate of $3.52 per share per annum, without interest, until declared and paid. As of January 28, 1995, unpaid dividends of $38.7 million were accrued.\nCapital Expenditures. Capital expenditures related to Pathmark supermarkets and drug stores for Fiscal 1994, including property acquired under capital leases, were approximately $90.5 million compared to approximately $74.0 million for Fiscal 1993 and $74.3 million for Fiscal 1992. In Fiscal 1994, Pathmark opened four new Super Centers, three of which replaced smaller stores, and completed 14 major renovations and 11 enlargements.\nCash Flows. Net cash provided by operating activities amounted to $116.6 million in Fiscal 1994 compared to $66.9 million in Fiscal 1993. The increase in net cash provided by operating activities in Fiscal 1994 compared to Fiscal 1993 is primarily due to the increased earnings in Fiscal 1994. Cash used for investing activities in Fiscal 1994 was $1.6 million, primarily due to expenditures of property and equipment of $84.0 million, partially offset by the disposal of the home centers segment of $81.1 million, compared to $69.4 million in Fiscal 1993, primarily reflecting the expenditures for property and equipment. Cash used for financing activities in Fiscal 1994 was $97.9 million, primarily due to the repayment of the PTK DIBs, the scheduled reductions in the Pathmark Term Loan and reductions in capital lease obligations, partially offset by the increase in Working Capital Facilities borrowings, compared to $4.8 million cash provided by financing activities in Fiscal 1993 primarily due to the net impact of the Recapitalization.\nNet cash provided by operating activities amounted to $66.9 million in Fiscal 1993, compared to $132.2 million in Fiscal 1992. Cash used for investing activities in Fiscal 1993 was $69.4 million, compared to $63.1 million in Fiscal 1992, primarily reflecting the expenditures for property and equipment in each year. Cash provided by financing activities in Fiscal 1993 was $4.8 million compared to cash used for financing activities of $69.4 million in Fiscal 1992. The increase in cash provided by financing activities in Fiscal 1993 was primarily due to the net impact of the Recapitalization. The cash used for financing activities in Fiscal 1992 primarily reflected the sale of the Holdings Subordinated Notes, partially offset by greater use of cash to repay the Old Working Capital Facility.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDER'S DEFICIT (IN THOUSANDS EXCEPT SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--ORGANIZATION AND BASIS OF PRESENTATION\nSupermarkets General Holdings Corporation (\"Holdings\") and its wholly owned subsidiary SMG Acquisition Corporation (\"SMG\") were formed by Merrill Lynch Capital Partners, Inc., a wholly owned subsidiary of Merrill Lynch & Co., Inc., (\"ML & Co.\"), to effect the acquisition (the \"Acquisition\") of Supermarkets General Corporation (\"Old Supermarkets\"). On June 15, 1987, Holdings completed the first step in the Acquisition when it acquired 32,800,000 shares (approximately 85%) of Old Supermarkets' common stock through a tender offer (the \"Tender Offer\") by SMG. The remaining outstanding common stock of Old Supermarkets was acquired by Holdings on October 5, 1987 when SMG was merged with and into Old Supermarkets pursuant to a Merger Agreement dated April 22, 1987, as amended.\nThe Acquisition was accounted for as a purchase, and accordingly, Holdings recorded the assets and liabilities of Old Supermarkets at their fair values at the date of the Acquisition. The tax basis for the assets and liabilities acquired was retained.\nIn October 1989, Old Supermarkets adopted an amended and restated Plan of Liquidation pursuant to which it was liquidated into three wholly owned subsidiaries of Supermarkets General Holdings Corporation. In November 1989, pursuant to such Plan, Old Supermarkets transferred substantially all of the assets of its Purity Supreme division to two of the three above-mentioned wholly owned subsidiaries, Purity Supreme, Inc. and Li'l Peach Corp., and said subsidiaries assumed substantially all of the liabilities of Old Supermarkets related to such division. Old Supermarkets completed the liquidation just prior to the year ended February 3, 1990, by merging with the third of the above- mentioned wholly owned subsidiaries which retained the name Supermarkets General Corporation (\"Supermarkets\"). On December 17, 1991, Purity Supreme, Inc. and Li'l Peach Corp. were sold (see Note 27). Supermarkets General Holdings Corporation and its respective subsidiaries are hereafter collectively referred to as \"Holdings\" or the \"Company\".\nOn November 15, 1990, SMG-II Holdings Corporation, (see Note 16), a newly incorporated Delaware corporation (\"SMG-II\"), commenced offers to purchase for cash up to $155.5 million principal amount of the Company's Junior Subordinated Discount Debentures (the \"Discount Debenture Offer\") and up to 1.7 million shares of the Company's Cumulative Exchangeable Redeemable Preferred Stock (the \"Exchangeable Preferred Stock Offer\"). Concurrently with the Discount Debenture Offer and the Exchangeable Preferred Stock Offer, SMG-II commenced an exchange offer (the \"Exchange Offer\", together with the Discount Debenture Offer and the Exchangeable Preferred Stock Offer, the \"Offers\") pursuant to which the then existing common stockholders of the Company could exchange, on a one-for-one basis, shares of the Company's common stock for shares of SMG-II's common stock. The Offers were subsequently amended to provide for offers to purchase up to $110.0 million principal amount of the Company's Junior Subordinated Discount Debentures (the \"Discount Debentures\") and up to 3.4 million shares of the Company's Cumulative Exchangeable Redeemable Preferred Stock (the \"Exchangeable Preferred Stock\").\nIn February 1991, SMG-II purchased approximately $74.1 million principal amount of the Discount Debentures at 33% of their principal amount and 2.7 million shares of Exchangeable Preferred Stock at $7.00 net per share, pursuant to the Discount Debenture Offer and the Exchangeable Preferred Stock Offer, respectively. In addition, all outstanding shares of the Company's common stock were exchanged pursuant to the Exchange Offer. As a result of the Exchange Offer, SMG-II owns all of the Company's common stock and is effectively a holding company for the operations of the Company. SMG-II financed the Purchases by selling 417,500 shares of its Cumulative Convertible Preferred Stock (the \"SMG-II Preferred Stock\") for an aggregate purchase price of $83.5 million to various institutional investors. The holders of SMG-II's voting and non-voting common stock and SMG-II\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--ORGANIZATION AND BASIS OF PRESENTATION--(CONTINUED) Preferred Stock include certain limited partnerships controlled directly or indirectly by Merrill Lynch Capital Partners, Inc. and certain indirectly wholly owned subsidiaries of ML & Co. ML & Co. beneficially owns approximately 88.6% of the outstanding stock of SMG-II, and accordingly, controls SMG-II and, indirectly, the Company.\nSubsequent to the completion of the Offers in Fiscal 1991, SMG-II acquired through open market transactions approximately $21.3 million principal amount of Discount Debentures, $9.8 million principal amount of the Company's 14.5% Senior Subordinated Notes due 1997 (the \"Senior Subordinated Notes\") and 94,900 shares of Exchangeable Preferred Stock and made a capital contribution to the Company of such securities together with the amounts of the Discount Debentures and the Exchangeable Preferred Stock purchased pursuant to the Discount Debenture Offer and the Exchangeable Preferred Stock Offer, respectively, as well as cash sufficient to pay associated taxes. The Company has retired the Senior Subordinated Notes, the Discount Debentures and the Exchangeable Preferred Stock contributed by SMG-II (see Note 24).\nDuring Fiscal 1993, the Board of Directors of Holdings authorized management of Holdings to proceed with the Recapitalization, which included a refinancing of Holdings' debt. In conjunction with the Recapitalization, the assets, liabilities and related operations of the home centers segment as well as certain assets and liabilities of the warehouse, distribution and processing facilities which service the Pathmark supermarkets and drug stores and certain inventories and real property, were contributed to Plainbridge, Inc. (\"Plainbridge\"), a newly formed indirect wholly owned subsidiary of Holdings and the shares of Plainbridge were then distributed to PTK Holdings, Inc. (\"PTK\"), a newly formed wholly owned subsidiary of Holdings (the \"Plainbridge Spin-Off\"). As a result of the Plainbridge Spin-Off, PTK holds 100% of the capital stock of both Plainbridge and Pathmark. At the time of Recapitalization, Holdings intended to further spin off Plainbridge to Holdings' common stockholder. Such further spin-off would have required the satisfaction of dividend restrictions with respect to Holdings' Exchangeable Preferred Stock, as well as, obtaining consents from various lenders to Plainbridge and PTK. Holdings has concluded that this further spin-off of Plainbridge is not likely to occur (see Note 2).\nOn November 4, 1994, the Company completed the sale of its home centers segment for approximately $88.7 million in cash, plus the assumption of certain indebtedness. The Company used the net proceeds to pay down PTK debt, including accrued interest and debt premium (see Note 4).\nThe accompanying consolidated financial statements of the Company indicate that, at January 28, 1995, current liabilities exceeded current assets by $98.0 million and stockholder's deficit was $1.3 billion. Management believes that cash flows generated from operations, supplemented by the unused borrowing capacity under the Pathmark and the Plainbridge Working Capital Facilities (see Note 12) and the availability of capital lease financing will be sufficient to pay the Company's debts as they come due, provide for its capital expenditure program and meet its seasonal cash requirements. Further, the Company believes it will be in compliance throughout the upcoming fiscal year with its various debt covenants (see Note 12).\nNOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation:\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of whom are wholly owned. All intercompany transactions have been eliminated in consolidation.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) During the fourth quarter of Fiscal 1994, as a result of the aforementioned dividend restrictions, Holdings has concluded that a further spin off of Plainbridge to Holdings' common stockholder is not likely to occur. Accordingly, prior year financial statements, which had included the results of Plainbridge's warehouse, transportation and real estate operations as discontinued operations, have been reclassified to include such results in continuing operations.\nThe results from discontinued operations for all periods presented represent the operations of the Company's home centers segment which was sold during Fiscal 1994 (see Note 4).\nFiscal Year:\nThe Company's fiscal year ends on the Saturday nearest to January 31 of the following calendar year. Normally each fiscal year consists of 52 weeks, but every five or six years the fiscal year consists of 53 weeks.\nStatements of Cash Flows:\nAll investments and marketable securities with a maturity of three months or less are considered to be cash equivalents. The Company had $14.8 million of cash equivalent investments as of January 28, 1995 and no such investments as of January 29, 1994.\nMerchandise Inventories:\nMerchandise inventories are valued at the lower of cost or market. Cost for substantially all merchandise inventories is determined on a last-in, first-out (\"LIFO\") basis.\nRental Video Tapes:\nVideo tapes purchased for rental purposes are capitalized and amortized over their estimated useful life as part of cost of goods sold. The amortization of video tapes included in cost of goods sold approximate $2.6 million, $2.6 million and $2.7 million in Fiscal 1994, Fiscal 1993 and Fiscal 1992, respectively.\nProperty and Equipment:\nProperty and equipment are stated at cost. Depreciation and amortization expense on owned property and equipment is computed on the straight-line method over their estimated useful lives. Capital leases are recorded at the present value of minimum lease payments or fair market value of the related property, whichever is less. Amortization of property under capital leases is computed on the straight-line method over the term of the lease or the leased property's estimated useful life, whichever is shorter.\nDepreciable lives of owned property and equipment are as follows:\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Income Taxes:\nThe Company's income tax expense is computed based on a tax sharing agreement with its ultimate parent, SMG-II, in which the Company computes a hypothetical tax return as if the Company was not joined in a consolidated or combined return with SMG-II. The Company must pay SMG-II the positive amount of any such hypothetical tax. If the hypothetical tax return shows entitlement to a refund, including any refund attributable to a carryback, then SMG-II will pay to the Company the amount of such refund.\nDeferred Financing Costs:\nDeferred financing costs are amortized on the straight-line method over the life of the related indebtedness.\nNet Earnings (Loss) Per Common Share:\nSince the Company is a wholly owned subsidiary, earnings (loss) per share information is not presented.\nStore Preopening and Closing Costs:\nStore preopening costs are expensed as incurred. Store closing costs, such as future rent and real estate taxes subsequent to the actual store closing, net of expected sublease recovery, are recorded at present value utilizing a risk free discount rate when management makes such decision to close a store.\nSelf-Insured Liabilities:\nSelf-insured liabilities represent an estimate of incurred but unpaid claims relating to customer, employee and vehicle accidents and covered employee medical benefits as of the balance sheet date. The liabilities for customer and employee accident claims are recorded at present value, utilizing a risk free discount rate, due to the long-term payout of these claims (see Note 11).\nReclassifications:\nCertain reclassifications have been made to the prior years' consolidated financial statements to conform to the Fiscal 1994 presentation.\nNOTE 3--FISCAL 1993 RECAPITALIZATION\nOn October 26, 1993, the Recapitalization was consummated. Pathmark Stores, Inc. (formerly Supermarkets General Corporation, hereinafter referred to as \"Pathmark\") borrowed $450.0 million under a bank credit agreement (the \"Bank Credit Agreement\"), consisting of $400.0 million under a term loan facility (\"the Pathmark Term Loan\") and $50.0 million under a $175.0 million working capital facility (the \"Pathmark Working Capital Facility\"), borrowed $436.6 million through the issuance of its 9.625% Senior Subordinated Notes due 2003 (the \"Pathmark Senior Subordinated Notes\"), issued $120.0 million initial principal amount of its 10.75% Junior Subordinated Deferred Coupon Notes due 2003 (the \"Pathmark Deferred Coupon Notes\"), exchanged $95.8 million principal amount of its 12.625% Subordinated Debentures due 2002 (the \"Pathmark Subordinated Debentures\") for $95.8 million principal amount outstanding of Holdings Subordinated Debentures and exchanged $198.5 million principal amount of its 11.625% Subordinated Notes due 2002 (the \"Pathmark Subordinated Notes\") for $198.5 million principal amount outstanding of the Holdings Subordinated Notes. As part of the Recapitalization, PTK borrowed $126.1 million through the issuance of its $130.0 million aggregate\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 3--FISCAL 1993 RECAPITALIZATION--(CONTINUED) principal amount 10.25% Exchangeable Guaranteed Debentures due 2003 (the \"PTK DIBs\") in a private placement, which bonds the Company has guaranteed. The proceeds from the aforementioned borrowings were used to redeem the Old Working Capital Facility, Holdings 14.5% Senior Subordinated Notes due 1997 (the \"Holdings Senior Subordinate Notes\") and Holdings 13.125% Junior Subordinated Discount Debentures due 2003 (the \"Holdings Discount Debentures\") and to purchase $185.0 million aggregate principal amount of the Holdings 12.625% Subordinated Debentures due 2002 (the \"Holdings Subordinated Debentures\") from the Equitable Affiliates. On October 26, 1993, Plainbridge, Inc. (\"Plainbridge\"), a newly formed indirectly wholly owned subsidiary of the Company, borrowed $3.5 million under a $50.0 million bank revolving credit agreement (the \"Plainbridge Working Capital Facility\"). On April 30, 1993, the Company repaid $5.7 million of indebtedness, which was secured by a mortgage on the distribution center of the home centers segment transferred to Plainbridge and on May 14, 1993, the Company repaid $2.5 million of indebtedness, which was secured by mortgages on two Pathmark retail properties transferred to Plainbridge.\nIn conjunction with the Plainbridge Spin-Off, Pathmark entered into a 10-year logistical services agreement (the \"Logistical Services Agreement\") with Plainbridge. The terms of the Logistical Services Agreement were designed to require Plainbridge to continue to provide Pathmark with substantially the same level of supply and other logistical services as was available from the warehouse, distribution and processing facilities prior to the Plainbridge Spin-Off at substantially the same or a lower cost (see Note 16).\nIn connection with the Plainbridge Spin-Off and the Recapitalization, the Company recorded a pretax charge of approximately $23.7 million in the third quarter of Fiscal 1993 to record estimated reorganization and restructuring costs, including an early retirement program offered to certain Company associates. During the fourth quarter of Fiscal 1993, the Company determined that the estimated costs related to the reorganization and restructuring were less than originally estimated and recorded a pretax credit of approximately $7.1 million. Of the total net pretax charge of $16.6 million for Fiscal 1993, $6.4 million related to the early retirement program and to the severance costs incurred to reduce the Company's workforce, $8.1 million related to the additional technical information systems costs incurred in order to accomplish the Plainbridge Spin-Off (see Note 20) and $2.1 million related to the warehouse and consulting costs associated therewith.\nNOTE 4--GAIN ON DISPOSAL OF HOME CENTERS SEGMENT\nOn November 4, 1994, the Company's Plainbridge subsidiary completed the sale of its home centers segment for approximately $88.7 million in cash, plus the assumption of certain indebtedness. During Fiscal 1994, the Company recognized a gain of $17.0 million on the sale of the home centers segment, net of an income tax provision of $2.3 million. Such gain included a pension plan curtailment gain of $6.2 million and the reduction in the deferred tax valuation allowance of $5.1 million, resulting from the utilization of the capital tax loss carryforward which had previously been reserved for (see Note 19). The Company used net cash proceeds of $66.6 million before January 28, 1995 and $4.7 million after January 28, 1995 to pay down the PTK DIBs, including accrued interest and debt premium.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--GAIN ON DISPOSAL OF HOME CENTERS SEGMENT--(CONTINUED) As of the date of sale, the net assets of the home centers segment were as follows (dollars in thousands):\nThrough the date of the sale, the Company reported the home centers segment as discontinued operations. Operating results of such discontinued operations were as follows (dollars in thousands):\n- ------------\nNOTE 5--CUMULATIVE EFFECT OF FISCAL 1993 ACCOUNTING CHANGES\nThe Company made the following accounting changes in Fiscal 1993:\nInventory:\nEffective January 31, 1993, the Company changed its method utilized to calculate LIFO inventories. Prior to Fiscal 1993, the Company utilized a retail approach to determine current cost and a general warehouse purchase index to measure inflation in the cost of its merchandise inventories in its stores. The Company's change arose from the development and utilization in Fiscal 1993 of internal cost indices based on the specific identification of merchandise in its stores to measure inflation in the prices, thereby eliminating the averaging and estimation inherent in the retail and general warehouse purchase index methods. The Company believes the use of such specific costs and internal indices results in a more accurate measurement of the impact of inflation in the costs of its store merchandise. The effect of this change resulted in a charge to income of $10.7 million, net of an income tax benefit of $7.8 million, and has been presented as a cumulative effect of a change in accounting method in the accompanying Fiscal 1993 consolidated statement of operations.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5--CUMULATIVE EFFECT OF FISCAL 1993 ACCOUNTING CHANGES--(CONTINUED) Postretirement Benefits other than Pensions:\nEffective January 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits other than Pensions\" which resulted in a charge to income of $15.6 million, net of an income tax benefit of $11.3 million, immediately upon adoption.\nPostemployment Benefits:\nEffective January 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" which resulted in a charge to income of $2.5 million, net of an income tax benefit of $1.8 million, immediately upon adoption.\nIncome Taxes:\nEffective January 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", which had no effect on the consolidated statements of operations, but resulted in a reclassification of the current and noncurrent deferred taxes.\nPresent Value Discount Rate Determination:\nEffective January 31, 1993, the Company made a change in the determination of the discount rate utilized to record the present value of certain noncurrent liabilities (self-insured liabilities and closed store liabilities) and reduced such rate from 12%, representing the Company's effective interest rate, to a risk free rate, estimated at 4%. The cumulative effect of this accounting change as of January 31, 1993 totalled $11.6 million, net of an income tax benefit of $8.4 million.\nNOTE 6--ACCOUNTS RECEIVABLE\nAccounts receivable are comprised of the following (dollars in thousands):\n- ------------\n(a) The allowance for doubtful accounts reflects a provision of $2.2 million and $3.2 million, as well as a write off of $3.1 million and $3.2 million in Fiscal 1994 and Fiscal 1993, respectively.\nNOTE 7--MERCHANDISE INVENTORIES\nMerchandise inventories are comprised of the following (dollars in thousands):\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7--MERCHANDISE INVENTORIES--(CONTINUED) Liquidation of LIFO layers in the periods reported did not have a significant effect on the results of continuing operations. The LIFO reserve decreased to $43.2 million at January 28, 1995 from $48.6 million at January 29, 1994 primarily due to the disposal of the home centers segment.\nNOTE 8--OTHER ASSETS\nPrepaid expenses increased to $26.6 million at January 28, 1995 from $21.8 million at January 29, 1994 due to the timing of rent and real estate tax payments. Other current assets increased to $29.5 million at January 28, 1995 from $12.4 million at January 29, 1994 principally due to an increase in assets held for sale. Other assets decreased to $24.0 million at January 28, 1995 from $27.7 million at January 29, 1994 primarily due to the utilization of the asset related to the Company's corporate owned life insurance policy of $7.5 million and the collection of certain notes receivable of $4.0 million, partially offset by an increase in the prepaid pension asset (see Note 17).\nNOTE 9--PROPERTY AND EQUIPMENT\nProperty and equipment are comprised of the following (dollars in thousands):\nNOTE 10--DEFERRED FINANCING COSTS\nDeferred financing costs, primarily related to the Recapitalization, are comprised of the following (dollars in thousands):\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--OTHER NONCURRENT LIABILITIES\nOther noncurrent liabilities are comprised of the following (dollars in thousands):\nCertain noncurrent liabilities, such as self-insured liabilities for incurred but unpaid claims relating to customer, employee and vehicle accidents and closed store liabilities, are recorded at present value, utilizing a 4% discount rate in Fiscal 1994 and Fiscal 1993, based on the projected payout of these claims.\nNOTE 12--LONG-TERM DEBT\nLong-term debt is comprised of the following (dollars in thousands):\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--LONG-TERM DEBT--(CONTINUED) Scheduled Maturities of Debt:\nLong-term debt principal payments are as follows (dollars in thousands):\nPRINCIPAL FISCAL YEARS PAYMENTS - ------------------------------------------------------ ---------- 1995................................................ $ 46,310 1996................................................ 48,081 1997................................................ 58,147 1998................................................ 169,522 1999................................................ 138,726 Thereafter.......................................... 951,095 ---------- $1,411,881 ---------- ----------\nBank Credit Agreements:\nUnder the Bank Credit Agreements, the Pathmark and the Plainbridge Working Capital Facilities and the Pathmark Term Loan bear interest at floating rates. At January 28, 1995, the interest rates for the Pathmark Term Loan and Pathmark Working Capital Facility were 8.9% and 9.5%, respectively. At January 29, 1994, the interest rates for the Pathmark Term Loan and Pathmark Working Capital Facility were 5.9% and 7.4%, respectively. At January 28, 1995, Plainbridge had no borrowings under its Working Capital Facility. At January 29, 1994, the interest rate for the Plainbridge Working Capital Facility was 7.4%. Pathmark is required to repay a portion of its borrowings under the Pathmark Term Loan each year, so as to retire such indebtedness in its entirety by October 31, 1999. Under the Pathmark Working Capital Facility, which expires on July 31, 1998, Pathmark can borrow or obtain letters of credit in an aggregate amount not to exceed $175.0 million (of which the maximum of $100.0 million can be in letters of credit) subject to an annual cleandown provision. Under the terms of the Pathmark cleandown provision, in each fiscal year, loans cannot exceed $50.0 million under the Pathmark Working Capital Facility for a period of 30 consecutive days. Pathmark has satisfied its cleandown provision for Fiscal 1994 and Fiscal 1995. Under the Plainbridge Working Capital Facility, which expires in Fiscal 1997, Plainbridge can borrow or obtain letters of credit in an aggregate amount not to exceed $40.0 million subject to an annual cleanup provision. Under the terms of the Plainbridge cleanup provision, in each fiscal year, loans cannot be made for a period of 30 consecutive days. Plainbridge satisfied its cleanup provision for Fiscal 1994 and Fiscal 1995. Holdings believes that Pathmark and Plainbridge each have sufficient unused borrowing capacity under their respective working capital facilities, which can be utilized for unforeseen or for seasonal cash requirements. At January 28, 1995, Pathmark and Plainbridge, in the aggregate, had approximately $76.6 million in unused borrowing capacity under their working capital facilities.\nAt January 28, 1995, the Company was in compliance with all of its debt financial covenants, as amended. Based upon projected results for the upcoming fiscal year, the Company believes it will be in compliance with its various debt financial covenants, which includes certain levels of operating cash flow (as defined), minimum interest coverage and a maximum leverage ratio, throughout the upcoming fiscal year. The Pathmark Term Loan, the Pathmark and Plainbridge Working Capital Facilities and the indentures for certain debt also contain covenants, including, but not limited to, covenants with respect to the following matters: (i) limitation on indebtedness; (ii) limitation on restricted payments; (iii) limitation on transactions with affiliates; (iv) limitation on liens; (v) limitation on the issuance of\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--LONG-TERM DEBT--(CONTINUED) preferred stock by subsidiaries; (vi) limitation on issuances of guarantees of indebtedness by subsidiaries; (vii) limitation on transfer of assets to subsidiaries; (viii) limitation on dividends and other payment restrictions affecting subsidiaries; and (ix) restriction on mergers and transfers of assets.\nPTK Exchangeable Guaranteed Debentures:\nThe PTK DIBs were originally formulated to accrete to a maturity value of $218.3 million in Fiscal 2003. The Company used the net cash proceeds of $66.6 million before January 28, 1995 and $4.7 million after January 28, 1995 to paydown PTK DIBs, including accrued interest and debt premium. The PTK DIBs begin paying cash interest on a semiannual basis on June 30, 1999 and have no sinking fund requirements. At January 28, 1995 the maturity value of the outstanding debentures is $120.5 million.\nPathmark Senior Subordinated Notes:\nThe Pathmark Senior Subordinated Notes accrete to a maturity value of $440.0 million in Fiscal 2003. These notes began paying cash interest on a semiannual basis on May 1, 1994 and have no sinking fund requirements.\nPathmark Deferred Coupon Notes:\nThe Pathmark Deferred Coupon Notes accrete to a maturity value of $225.3 million in Fiscal 2003. These notes begin paying cash interest on a semiannual basis on May 1, 2000 and have no sinking fund requirements.\nPathmark Subordinated Debentures:\nThe Pathmark Subordinated Debentures mature in Fiscal 2002 and began paying cash interest on a semiannual basis on December 15, 1993. These debentures have no sinking fund requirements.\nPathmark Subordinated Notes:\nThe Pathmark Subordinated Notes mature in Fiscal 2002 and contain a sinking fund provision that requires Pathmark to deposit $49.4 million (25% of the original aggregate principal amount) with the trustee of the Pathmark Subordinated Notes on June 15 in each of Fiscal 2000 and Fiscal 2001 for the redemption of the Pathmark Subordinated Notes, at a redemption price equal to 100% of the principal amount thereof, plus accrued interest to the redemption date and providing for the redemption of 50% of the original aggregate principal amount of such notes prior to maturity.\n11.625% Holdings Subordinated Notes due 2002:\nOn October 26, 1993, as part of the Recapitalization, $198.5 million principal amount of the Holdings Subordinated Notes were exchanged for $198.5 million principal amount of Pathmark Subordinated Notes. Approximately $1.0 million principal amount of the Subordinated Notes remain outstanding. Interest on the Holdings Subordinated Notes is payable semi-annually.\nIndustrial Revenue Bonds:\nInterest rates for the industrial revenue bonds range from 10.5%-10.9%. The industrial revenue bonds are payable in installments ending in Fiscal 2003. The industrial revenue bonds outstanding at January 28, 1995 and January 29, 1994 are unsecured.\nOther Debt:\nOther debt includes mortgage notes which are secured by property and equipment having a net book value of $71.2 million at January 28, 1995 and $72.9 million at January 29, 1994. These borrowings, whose interest rates averaged 10.5%, are payable in installments ending in Fiscal 2000.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount and fair values of the Company's financial instruments are as follows (dollars in thousands):\nThe Company believes the fair value of its cash and marketable securities due to their short term maturities approximates their carrying value. There is no quoted market prices for the securities representing the Company's investment in Purity and it is not practicable considering the materiality of this investment to the Company to obtain an estimate of its fair value (see Notes 27 and 29).\nThe fair value of the Pathmark Term Loan and the Pathmark and Plainbridge Working Capital Facilities approximated their carrying value due to their floating interest rates. The fair value of the notes, debentures and Exchangeable Preferred Stock are based on the quoted market prices at January 28, 1995 and January 29, 1994, since such instruments are publicly traded. The Company has evaluated its 10.25% PTK Exchangeable Guaranteed Debentures, other debt (primarily mortgages), industrial revenue bonds and believes based on interest rates, related terms and maturities that the fair value of such instruments approximates their respective carrying amounts.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 14--INTEREST EXPENSE\nInterest expense is comprised of the following (dollars in thousands):\nThe Company made cash interest payments of $129.6 million in Fiscal 1994, $196.5 million in Fiscal 1993 and $132.8 million in Fiscal 1992.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--LEASES\nAt January 28, 1995, the Company was liable under terms of noncancellable leases for the following minimum lease commitments (dollars in thousands):\n- ------------\n(a) Net of sublease income of $12,037 and $186,962 for capital and operating leases, respectively.\nDuring Fiscal 1994, Fiscal 1993 and Fiscal 1992, the Company incurred capital lease obligations of $21.3 million, $25.7 million and $8.7 million, respectively, in connection with lease agreements to acquire property and equipment.\nRent expense included in continuing operations under all operating leases having noncancellable terms of more than one year is summarized as follows (dollars in thousands):\n- ------------\n(b) Primarily based on sales.\nNOTE 16--RELATED PARTY TRANSACTIONS\nThe following is a summary of related party agreements and transactions between Pathmark and Plainbridge, the effects of which have been eliminated in consolidation.\n1) Spin-off:\nA) Services Agreements:\nPathmark, Plainbridge and the Company are parties to agreements pursuant to which Pathmark will continue to provide certain administrative services relating to the warehouse, distribution and home\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--RELATED PARTY TRANSACTIONS--(CONTINUED) centers operations of Plainbridge and certain administrative services to Chefmark. Such services include, among other things, legal, human resources, data processing, insurance, accounting, tax, treasury and property management services. Each of the agreements have an initial term of five years, with renewal options at the end of such term. The cost of the services charged to Plainbridge and Chefmark under these agreements in the aggregate was approximately $13.7 million and $4.2 million for the fiscal year ended January 28, 1995 and for the period from the date of the Plainbridge Spin-Off through January 29, 1994, respectively.\nB) The Logistical Services Agreement:\nIn connection with the Plainbridge Spin-Off, Pathmark and Plainbridge entered into the Logistical Services Agreement to provide for the supply by Plainbridge to Pathmark of most of the merchandise sold in Pathmark's retail stores and for the provision of warehousing, distribution and other logistical services relating to the supply of such merchandise. Pursuant to the Logistical Services Agreement, Pathmark directs the purchase of the merchandise to be provided to it by Plainbridge. Pathmark negotiates directly with vendors regarding the types of merchandise required, the quantities needed, the delivery schedules, the pricing, and all the other terms and conditions of sale. All merchandise is ordered by Pathmark for the account of Plainbridge, which will pay for and will retain title to such merchandise until it has been delivered to Pathmark. If requested by a vendor, Pathmark, in its sole discretion, may guarantee payment of such orders by Plainbridge. Pathmark guaranteed approximately $37.3 million and $42.8 million of such orders at January 28, 1995 and January 29, 1994, respectively. In general, the Logistical Services Agreement also requires Plainbridge to perform the same services in substantially the same manner as they were performed by Pathmark's warehouse and distribution group prior to the Plainbridge Spin-Off.\nThe Logistical Services Agreement requires that, with certain exceptions and subject to certain termination rights, Plainbridge is to sell to Pathmark, for a period of ten years, to the extent requested by Pathmark, all of Pathmark's merchandise requirements for both its existing and future stores. In addition, Pathmark has five one-year renewal options following the expiration of the original ten-year term. The Logistical Services Agreement does not limit Pathmark's ability to purchase goods from other suppliers. For the fiscal year ended January 28, 1995 and for the period from the date of the Plainbridge Spin-Off through January 29, 1994, the Company purchased 81% and 83%, respectively, of its total merchandise purchases from Plainbridge. Merchandise that Pathmark customarily obtains directly from vendors is excluded from the Logistical Services Agreement.\nThe Logistical Services Agreement requires Plainbridge to store and deliver to Pathmark all merchandise purchased at Pathmark's direction. Pathmark is required in good faith to designate Plainbridge as its carrier with respect to merchandise customarily shipped directly from vendors to Pathmark's stores. Plainbridge may be required to maintain inventory with a book value of at least $130.0 million for the exclusive use of Pathmark, and to the extent that the inventory value falls below such level, Plainbridge may be asked by Pathmark to purchase sufficient merchandise to maintain such level to the extent such merchandise is ordered by Pathmark. Plainbridge is also required to accommodate physical annual increases of up to five percent in the volume of Pathmark directed purchases of merchandise to be handled by Plainbridge. Pathmark is to reimburse Plainbridge for all reasonable incremental out-of-pocket costs (but not capital costs) incurred by Plainbridge for the storage and the handling of merchandise that is in excess of the five percent annual capacity increase, provided that such out-of-pocket costs do not exceed the costs of storage and of handling at local independent warehouses.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--RELATED PARTY TRANSACTIONS--(CONTINUED) Upon the delivery of merchandise to Pathmark's stores by Plainbridge, Pathmark will owe Plainbridge for the cost of the merchandise plus a specified variable payment. This payment will vary according to the type and to the value of the merchandise. A minimum annual fee will be payable by Pathmark to the extent that the aggregate of the variable fees described above payable in any year does not exceed the minimum annual fee. The minimum annual payment for Fiscal 1995 is $134.9 million and such fee is adjusted upward (but not downward) each fiscal year by the rate of inflation. This minimum payment was based upon the historical cost to Pathmark of operating the warehouse, distribution and transportation facilities. Pathmark is obligated to pay the minimum annual fee to Plainbridge irrespective of whether Pathmark purchases merchandise from other suppliers, except in cases of force majeure or when Plainbridge shall have materially breached the Logistical Services Agreement or shall have failed to obtain or to maintain the licenses and the permits needed to operate its business. The minimum annual fee will be reduced to the extent that the volume of merchandise purchases decreases as a result of any store dispositions by Pathmark and will also be reduced if the volume of Pathmark-directed merchandise falls below 90% of the actual volume achieved in Fiscal 1992, to the extent that Plainbridge is, as a result, able to realize reductions in its operating costs. Under this agreement, Pathmark paid Plainbridge approximately $139.4 million during Fiscal 1994 and $36.1 million during the period from the date of the Plainbridge Spin-Off to January 29, 1994. Plainbridge grants Pathmark an allowance, which is based on the amount of merchandise purchased by Plainbridge at Pathmark's direction. The allowance is credited against the variable fees and the minimum annual fee obligation. In Fiscal 1994 and for the period from the date of the Plainbridge Spin-Off through January 29, 1994, an allowance of approximately $25.5 and $6.6 million, respectively, was received by Pathmark. In addition, certain cost benefits, which were derived from increases in the volume or value of merchandise purchased from Plainbridge by Pathmark or by third parties, are to be shared equally between Pathmark and Plainbridge. Estimated fees are payable in weekly installments, and an annual reconciliation is performed for the amount of fees that are actually payable for such year. Pathmark will pay to Plainbridge the costs of the merchandise at the time a vendor requires payment from Plainbridge.\nThe Logistical Services Agreement allows Plainbridge to sell merchandise and to provide logistical services to third parties, although it is not permitted to sell merchandise to supermarkets, drug stores and to other retail stores stocking merchandise carried by Pathmark in Pathmark's current market areas. An exception is made for retail stores that do not, in the ordinary course of business, engage to a significant degree in the sale of food or of pharmacy related products, without Pathmark's prior written consent which consent may not be unreasonably withheld. Plainbridge is also permitted to \"piggyback\" such third parties' orders onto Pathmark's orders from vendors, so long as they do not interfere with Pathmark's delivery schedules, quantity needs or other requirements.\nPlainbridge and Pathmark are allowed to terminate the Logistical Services Agreement if the other (i) materially breaches its terms and fails to cure such breach for 60 days after written notice has been provided by the other party or (ii) experiences certain insolvency events. Additionally, following the fourth anniversary of the date of the Logistical Services Agreement, the Company has the option of terminating it at will on six months notice. If Pathmark terminates the Logistical Services Agreement because of a material breach by, or insolvency of, Plainbridge, Pathmark has the right to purchase, within 30 days of the termination, that portion of the assets of Plainbridge which is essential to the support of Plainbridge's obligations to Pathmark under the Logistical Services Agreement (the \"Pathmark Distribution Assets\") at the lower of (i) their net book value or (ii) their fair market value. If the Company exercises its at will option to terminate the Logistical Services Agreement, the\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--RELATED PARTY TRANSACTIONS--(CONTINUED) Company is required to offer to purchase the Pathmark Distribution Assets at their fair market value. If Plainbridge terminates the Logistical Services Agreement because of a material breach by, or insolvency of Pathmark, Plainbridge has the right to sell to Pathmark (and Pathmark will have the obligation to buy) the Pathmark Distribution Assets at their fair market value within 30 days of such termination.\nOther than in the ordinary course of business, Plainbridge is not permitted to sell any of the Pathmark Distribution Assets without Pathmark's prior written consent. Additionally, in the event of a change in the ultimate beneficial ownership of Plainbridge's voting stock such that a person, other than ML & Co. or an affiliate of ML & Co. (the majority shareholder of Holdings), holds a majority of such stock, the Company has for a period of two years, the irrevocable and exclusive right to purchase any or all of the Pathmark Distribution Assets at their fair market value.\nOther provisions of the Logistical Services Agreement include (i) that Plainbridge passes on to Pathmark all discounts and all allowances made available to it by vendors in respect of merchandise purchased for Pathmark, unless such discounts or allowances were made available solely as a result of actions taken or not taken by Plainbridge, (ii) that Plainbridge must ensure that merchandise quality meets or exceeds the standards established by Pathmark for such merchandise, and that Pathmark may place its representatives at the Distribution Facilities to ensure that such quality is maintained, (iii) that Plainbridge deliver merchandise to Pathmark at a 98% or better level of service, as measured in accordance with Pathmark's practices prior to the Plainbridge Spin-Off, (iv) that Pathmark pay Plainbridge for any use of trailers for storage and (v) that each of Pathmark and Plainbridge cooperate to reduce costs and to improve service levels.\nIn addition, pursuant to a supply agreement between Chefmark and Pathmark (the \"Chefmark Supply Agreement\"), Chefmark supplies Pathmark with merchandise from its banana ripening and deli food preparation operations. The Chefmark Supply Agreement provides that, for a period of seven years, such services are to be performed by Chefmark in substantially the same manner as they have been performed by Pathmark's banana ripening and deli food preparation operations prior to the Chefmark Spin-Off.\n2) Other:\nIn conjunction with the Plainbridge Spin-Off, certain real property was transferred to Plainbridge and is being leased to Pathmark at rentals which the Company believes approximate fair value. During Fiscal 1994 and for the period from the date of the Plainbridge Spin-Off through January 29, 1994, such rentals amounted to $4.4 million and $1.1 million, respectively.\nIn addition, Pathmark is leasing six store properties to Plainbridge, with a net book value of $9.0 million at January 28, 1995. The Company believes that the rentals received from Plainbridge approximate fair value. During Fiscal 1994 and for the period from the date of the Plainbridge Spin-Off through January 29, 1994, such rentals amounted to $3.8 million and $1.0 million, respectively.\nAs discussed in Note 25, certain Management Investors issued Recourse Notes to the Company related to the purchase of the Company's Class A common stock. These Management Investors have pledged shares of SMG-II Class A common stock to secure the repayment of the Recourse Notes. Recourse Notes in the amount of $1.7 million were outstanding at January 28, 1995 and January 29, 1994.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--RELATED PARTY TRANSACTIONS--(CONTINUED) During Fiscal 1994, the Company paid ML & Co. fees of approximately $1.0 million related to the disposal of the home centers segment. During Fiscal 1993, in conjunction with the Recapitalization, the Company paid ML & Co. fees of $12.8 million.\nNOTE 17--RETIREMENT AND BENEFIT PLANS\nThe Company has several noncontributory defined benefit pension plans, the most significant of which is the SGC Pension Plan, which covers substantially all nonunion and certain union associates of Pathmark and Plainbridge. Pension benefits to retired and to terminated vested associates are primarily based upon their length of service and upon a percentage of qualifying compensation. The Company's funding policy, which is consistent with federal funding requirements, is intended to provide not only for benefits attributed to service to date but also for those benefits expected to be earned in the future. Due to the overfunding status of the SGC Pension Plan, no contributions were required during the last three fiscal years.\nThe following table sets forth the funded status of the pension plans and the amounts recognized in the Company's financial statements (dollars in thousands):\nAssets of the Company's pension plans are invested in marketable securities, comprised, primarily of equities of domestic corporations, U.S. Government instruments and money market investments.\nThe increase in the prepaid pension cost at January 28, 1995 is primarily due to the pension plan curtailment gain related to the sale of the home centers segment (see Notes 4 and 8).\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--RETIREMENT AND BENEFIT PLANS--(CONTINUED) The following table provides the assumptions used in determining the actuarial present value of the projected benefit obligation:\nThe change in the weighted average discount rate, which is used in determining the actuarial present value of the projected benefit obligation, will not have a material impact on the Company's net pension cost for Fiscal 1995.\nThe net periodic pension cost included in continuing operations is comprised of the following components (dollars in thousands):\nThe Company also contributes to many multi-employer plans which provide defined benefits to certain union associates. The Company's contributions to these multi-employer plans were $18.0 million in Fiscal 1994, $17.9 million in Fiscal 1993 and $17.7 million in Fiscal 1992.\nThe Company sponsors a savings plan for eligible nonunion associates. Contributions under the plan are based on specified percentages of associate contributions. The Company's contributions to the savings plan were $3.5 million in Fiscal 1994, $4.0 million in Fiscal 1993 and $3.0 million in Fiscal 1992.\nThe Company maintains a Voluntary Employee Benefit Association (\"VEBA\") to provide for certain employee health benefits. The Company's tax-deductible contributions to the VEBA were $19.9 million in Fiscal 1994, $25.8 million in Fiscal 1993 and $21.3 million in Fiscal 1992.\nNOTE 18--OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nThe Company provides to its associates postretirement benefits, principally health care and life insurance benefits. The accumulated postretirement benefit obligation was determined utilizing an assumed discount rate of 8.5% at January 28, 1995 and 7.75% at January 29, 1994 and by applying the provisions of the Company's medical plans, the established maximums and sharing of costs, the relevant actuarial assumptions and the health-care cost trend rates which are projected at 10.0% and which grade down to 5.75% in Fiscal 1999. The effect of a 1% change in the assumed cost trend rate would change the accumulated postretirement benefit obligation by approximately $2.3 million as of January 28, 1995 and would change the net periodic postretirement benefit cost by $0.2 million for Fiscal 1994.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 18--OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS--(CONTINUED) The net postretirement benefit costs related to continuing operations consisted of the following components (dollars in thousands):\nThe annual charges recorded by the Company on a pay-as-you-go (cash basis) amounted to $1.2 million in Fiscal 1992.\nThe following table provides information on the status of the plans (dollars in thousands):\nThe Company also provides to its associates postemployment benefits, primarily long-term disability and salary continuation. The obligation for these benefits was determined by application of the provisions of the Company's long-term disability plan and includes the age of active claimants at disability and at valuation, the length of time on disability and the probability of claimant remaining on disability to maximum duration. These liabilities are recorded at their present value utilizing a discount rate of 4%.\nThe accumulated postemployment benefit obligation as of January 28, 1995 and January 29, 1994 was $8.3 million and $8.4 million, respectively. The net postemployment benefit cost for continuing operations consisted of the following components (dollars in thousands):\nThe annual charges recorded by the Company on a pay-as-you-go (cash basis) amounted to $1.4 million in Fiscal 1992.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 19--INCOME TAXES\nThe income tax provision (benefit) from continuing operations is comprised of the following (dollars in thousands):\nThe effective tax rate applicable to continuing operations differs from the federal statutory tax rate as follows:\nDeferred tax assets and liabilities consist of the following (dollars in thousands):\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 19--INCOME TAXES--(CONTINUED) The Company has a net deferred tax asset of approximately $32.8 and $41.3 million at January 28, 1995 and January 29, 1994, respectively. Although the Company generated pretax earnings in Fiscal 1994, the Company was unable to conclude that realization of such deferred tax assets was more likely than not, due to pretax losses experienced in prior years. Accordingly, the Company has provided a valuation allowance of $26.8 million and $38.4 million at January 28, 1995 and January 29, 1994, respectively, to fully reserve its net deferred tax assets, except for the alternative minimum tax credit carryforwards which do not expire. Management will continue to assess the likelihood of realizing its deferred tax assets and will adjust the valuation allowance when and if, in the opinion of management, significant positive evidence exists which indicates that it is more likely than not that the Company will be able to realize such deferred tax assets. Such reductions in the valuation allowance, if any, will be reflected as a component of income tax expense.\nThe capital loss carryforward at January 29, 1994 was utilized during Fiscal 1994 offsetting the capital gain generated by the sale of the home centers segment. The net operating loss carryforwards, including state net operating loss carryforwards, expire from Fiscal 1998 to Fiscal 2008.\nThe Company's state income tax provision, net of the change in the valuation allowance in Fiscal 1994, includes the recording of state taxes for certain issues related to prior years and the inability to utilize loss carryforwards in certain states. The Fiscal 1993 and Fiscal 1992 state income tax provisions resulted primarily from taxable income generated in New Jersey due to the nondeductibility of a significant portion of intercompany interest expense.\nThe income tax receivable of $7.8 million at January 28, 1995 includes a carryback refund claim related to the Fiscal 1993 net operating tax loss. The refund was received during the first quarter of Fiscal 1995.\nIn Fiscal 1994, Fiscal 1993, and Fiscal 1992, the Company made income tax payments of $6.5 million, $3.1 million and $21.0 million, respectively, and received income tax refunds of $25.9 million, $10.1 million and $5.9 million, respectively.\nThe Internal Revenue Service has completed its audits through Fiscal 1989 and is currently auditing Fiscal 1990 through Fiscal 1993.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 20--COMMITMENTS AND CONTINGENCIES\nIn August 1991, the Company entered into a long-term agreement with Integrated Systems Solutions Corporation (\"ISSC\"), a subsidiary of IBM, to provide a wide range of information systems services. Under the agreement, ISSC has taken over the Company's data center operations and mainframe processing and information system functions and is providing business applications and systems designed to enhance the Company's customer service and efficiency. The charges under this agreement are based upon the services requested at predetermined rates. The Company may terminate the agreement upon 90 days notice with payment of a specified termination charge. The amounts expensed under this agreement, and which are included in selling, general and administrative expenses in the accompanying consolidated statements of operations, were $16.0 million, $12.6 million and $12.9 million during Fiscal 1994, Fiscal 1993 and Fiscal 1992, respectively. Further, in Fiscal 1993, the Company expensed an additional $8.1 million of technical information costs in connection with the Plainbridge Spin-Off (see Note 3).\nThe Company is contingently liable for certain obligations of the Purity Operations primarily consisting of approximately 60 leases for real property, in the event of default thereunder by the purchaser of the Purity Operations. As of January 28, 1995, the estimated present value of such lease obligations approximated $109.5 million. The Company is also contingently liable for certain obligations of the recently sold home centers segment primarily consisting of 19 leases for real property, in the event of default thereunder by the purchaser of the recently sold home centers segment. As of January 28, 1995, the estimated present value of such lease obligations approximated $27.6 million.\nIn addition to the litigation referred to above, the Company is a party to a number of legal proceedings in the ordinary course of business. Management believes that the ultimate resolution of these proceedings will not, in the aggregate, have a material adverse impact on the financial condition, the results of operations or the business of the Company.\nNOTE 21--PROVISION FOR STORE CLOSINGS\nEffective with the beginning of the second quarter of Fiscal 1993, the Company originally made a decision to close or to dispose of five stores which the Company believed would continue to be unprofitable. As a result, the Company recorded a pretax charge in the second quarter of Fiscal 1993 of approximately $6.0 million. Operating results for the five stores had previously been excluded from the consolidated statements of operations since the beginning of the second quarter of Fiscal 1993. However, the Company decided on December 31, 1994 that two of the five stores would continue to be operated and, therefore, the operating results for these two stores have been included in the Fiscal 1994 and Fiscal 1993 consolidated statements of operations. The inclusion of these two stores had no significant effect on the Fiscal 1994 or 1993 reported results. The remaining three stores were closed during the fourth quarter of Fiscal 1994 and the related leases have been assigned or sublet subsequent to January 28, 1995.\nNOTE 22--LABOR DISPUTE\nThe Company's pretax earnings in the second quarter of Fiscal 1993 were adversely impacted by a labor dispute and by the related promotional programs implemented subsequent to such labor dispute. The related promotional programs were implemented in order to regain sales levels. The Company, with three other major supermarket companies (ShopRite, Foodtown and Grand Union), conducted separate but simultaneous negotiations with respect to an expired labor contract. The major issues of the contract concerned health care and related benefits. On May 7, 1993, the union began selective strikes\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 22--LABOR DISPUTE--(CONTINUED) against one of the Company's competitors. Over the course of the next three weeks, the labor dispute expanded until, on May 28, 1993, union members at over 250 supermarkets, including 53 Pathmark supermarkets, were either on strike or locked out. On May 29, 1993, the labor dispute was settled and, in June, the union membership ratified a new four-year contract, and the membership returned to work.\nNOTE 23--EXTRAORDINARY ITEMS\nThe extraordinary items reflected in the consolidated statements of operations are comprised of (dollars in thousands):\nDuring Fiscal 1994, in connection with the disposal of the home centers segment, the Company was required to pay down $62.9 million of PTK DIBs. The premium paid, including original issue discount, resulted in a net loss on early extinguishment of indebtedness of $3.7 million.\nDuring Fiscal 1993, in connection with the Recapitalization, the Company repaid or exchanged $1.3 billion of indebtedness through the issuance of new Pathmark and PTK indebtedness. This repayment of outstanding indebtedness and this origination of new indebtedness included premiums and other expenses and included the write off of existing deferred financing fees associated with indebtedness which was extinguished. This resulted in a net loss on early extinguishment of indebtedness which totalled $106.0 million. The Company also repaid $2.5 million principal amount of indebtedness, which was secured by mortgages on two retail properties which were transferred to Plainbridge. This repayment resulted in a net loss on early extinguishment of indebtedness of $0.06 million. In addition, the Company repaid $5.7 million aggregate principal amount of indebtedness, which was secured by a mortgage on the distribution center of the home centers segment transferred to Plainbridge. This repayment resulted in a net loss on early extinguishment of indebtedness of $0.1 million.\nDuring Fiscal 1992, the Company paid the remaining $132.0 million principal outstanding of the Old Term Loan by utilizing a portion of the proceeds from the sale of the Holdings Subordinated Notes resulting in the accelerated amortization of the deferred financing costs related to the Old Term Loan of $1.1 million, before applicable income tax benefit of $0.5 million.\nDuring Fiscal 1992, utilizing a portion of the proceeds from the sale of the Holdings Subordinated Notes, as well as utilizing additional Old Working Capital Facility borrowings, the Company, through open market purchases, purchased $71.0 million principal amount of Holdings Senior Subordinated Notes at a cost of $76.0 million. The premium paid of $5.0 million, as well as the accelerated amortization of deferred financing costs and of transaction expenses of $1.5 million related to the\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 23--EXTRAORDINARY ITEMS--(CONTINUED) repurchased Holdings Senior Subordinated Notes, resulted in a loss of $6.5 million, before an applicable income tax benefit of $2.6 million.\nDuring Fiscal 1992, SMG-II purchased, and subsequently contributed to the Company, $4.8 million principal amount of Holdings Senior Subordinated Notes. The Company, through open market purchases, purchased an additional $1.2 million principal amount of Holdings Senior Subordinated Notes. The premium paid on the contributed and on the purchased Holdings Senior Subordinated Notes of $0.3 million, as well as the amount paid for the accelerated amortization of deferred financing costs and for the transaction expenses of $0.1 million related to the repurchased Holdings Senior Subordinated Notes, resulted in a loss of $0.4 million, before an applicable income tax benefit of $0.2 million.\nNOTE 24--CUMULATIVE EXCHANGEABLE REDEEMABLE PREFERRED STOCK\nThe Company's Exchangeable Preferred Stock, which has a maturity date of December 31, 2007, consists of 9,000,000 authorized shares of which 4,890,671 shares are issued and outstanding at January 28, 1995. The fair market value of the Exchangeable Preferred Stock at date of original issuance of October 5, 1987 was $20 per share and the liquidation preference is $25 per share. Due to its mandatory redemption requirements, the Exchangeable Preferred Stock has been stated on the balance sheet as redeemable securities. The difference between fair market value at date of issue and liquidation preference is being accreted quarterly.\nIn the event of any liquidation, dissolution or winding up of the Company, holders of the Exchangeable Preferred Stock will be entitled to receive their full liquidation preference per share, together with accrued and unpaid dividends, before the distribution of any assets of the Company to the holders of shares of the Company's common stock or other shares which would rank junior to the Exchangeable Preferred Stock.\nThe Exchangeable Preferred Stock may be redeemed, at the option of the Company, in whole or in part, at liquidation preference, together with all accrued and unpaid dividends to the redemption date. Optional redemption of the Exchangeable Preferred Stock will be subject to restricted payments and other similar provisions of the Company's debt instruments.\nCommencing December 31, 2004, the Company is required to redeem in each year 20% of the highest amount at any time outstanding of the Exchangeable Preferred Stock. The redemption process is calculated to retire 60% of the issue prior to final maturity with the remaining amount of the issue to be redeemed at maturity.\nIf an amount equal to six quarterly dividends is in arrears in whole or in part, the holders of the Exchangeable Preferred Stock, voting as a class, may elect two members of the Board of Directors of the Company at a special meeting called by the Company until such time as all accrued dividends on the Exchangeable Preferred Stock shall have been paid for all dividend periods.\nThe Company has the option to require holders to exchange the Exchangeable Preferred Stock on any dividend payment date, in whole or in part, for exchange debentures (the \"Exchange Debentures\") of the Company. Such option is available at any time if (a) no event of default exists under any of the Company's loan agreements and (b) the exchange is allowed under the provisions of the limitation on the Company's indebtedness and other applicable provisions of the Company's loan agreements. Any such exchange will result in the issuance of Exchange Debentures in an amount equal to the aggregate\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 24--CUMULATIVE EXCHANGEABLE REDEEMABLE PREFERRED STOCK--(CONTINUED) liquidation preference of all shares of Exchangeable Preferred Stock being exchanged into Exchange Debentures and in an amount equal to all accrued but unpaid dividends.\nDuring Fiscal 1991, SMG-II made a capital contribution to the Company of 2.8 million shares of Exchangeable Preferred Stock, which were purchased pursuant to the Exchangeable Preferred Stock Offer and to the open market transactions. The Company has retired these shares (see Note 1).\nExchangeable Preferred Stock activity for the three years ended January 28, 1995 was as follows (dollars in thousands):\nThe terms of the Exchangeable Preferred Stock provide for cumulative quarterly dividends at an annual rate of $3.52 per share when, as, and if declared by the Board of Directors of the Company. Dividends for the first 20 quarterly dividend periods (through October 15, 1992) were paid at the Company's option in additional shares of Exchangeable Preferred Stock. Prior to the Recapitalization, the Old Bank Credit Agreement and the terms of the indentures governing the Company's public debt restricted the payment of cash dividends on the Exchangeable Preferred Stock unless certain conditions were met, including tests relating to earnings and to cash flow ratios of the Company. Prior to the Recapitalization, the Company had not met the conditions permitting cash dividend payments on the Exchangeable Preferred Stock. Subsequent to the Recapitalization, Holdings does not expect to receive cash flow sufficient to permit payments of dividends on the Exchangeable Preferred Stock in the foreseeable future. All dividends not paid in cash will cumulate at the rate of $3.52 per share per annum, without interest, until declared and paid. As such, at January 28, 1995, the unpaid dividends of $38.7 million were accrued and included in other noncurrent liabilities.\nDividends on the Exchangeable Preferred Stock must be paid in full for all prior periods as of the most recent dividend payment date before any dividends, other than dividends payable in shares of the Company's common stock or in any other class of the Company's capital stock ranking junior to the Exchangeable Preferred Stock, can be paid or can be set apart for payment to holders of common stock or to holders of any other shares which would rank junior to the Exchangeable Preferred Stock. In addition, dividends on the Exchangeable Preferred Stock must be paid in full for all prior periods before the redemption or purchase by the Company of shares of common stock or any other shares which would rank junior to the Exchangeable Preferred Stock.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 25--COMMON STOCK\nThe Company's authorized common stock, par value $.01 per share, consists of 1,075,000 shares of Class A common stock and 1,000,000 shares of Class B common stock, of which 650,675 shares and 320,000 shares, respectively, were issued and outstanding at January 28, 1995 and at January 29, 1994.\nHolders of shares of Class A common stock are entitled to one vote per share on all matters to be voted on by stockholders. Holders of shares of Class B common stock are not entitled to any voting rights, except as required by law or as otherwise provided in the Restated Certificate of Incorporation of the Company. Subject to compliance with certain procedures, holders of Class B common stock may exchange their shares for shares of Class A common stock and holders of Class A common stock may exchange their shares for shares of Class B common stock on a share-for-share basis. Upon liquidation or dissolution of the Company, holders of the Company's common stock are entitled to share ratably in all assets available for distribution to stockholders. Payment of all prior claims, including liquidation rights of any Exchangeable Preferred Stock outstanding, must be made before the holders of the Company's common stock are entitled to any distribution. Holders of the Company's common stock have no preemptive or subscription rights.\nOn February 4, 1991, as a result of the consummation of the Exchange Offer, all shares of the Company's Class A common stock and Class B common stock were owned directly by SMG-II. SMG-II is effectively a holding company for the operations of the Company (see Note 1).\nThe Company and certain executives of Supermarkets (collectively, \"Management Investors\") entered into a management subscription agreement under which, on October 5, 1987, the Management Investors purchased an aggregate of 100,000 shares of Class A common stock for consideration of $100 per share. In connection with the Exchange Offer, the Management Investors entered into an agreement (the \"Management Investors Exchange Agreement\") with respect to the SMG-II common stock which was received in exchange for the Company's Class A common stock. Under the terms of the Bank Credit Agreement, there are limitations in the amount of repurchases from Management Investors: $2 million during any fiscal year and $5 million in the aggregate. Prior to the Exchange Offer, all of the Class A common stock held by Management Investors was classified as Redeemable Securities. In Fiscal 1991, prior to the Exchange Offer, the Company repurchased 3,490 shares from Management Investors at an aggregate cost of $0.4 million.\nCertain Management Investors, who purchased shares of Class A common stock, borrowed a portion of the purchase price from the Company and were required to deliver a note to the Company (\"Recourse Note\") in the principal amount of the loan (see Note 16). Interest on the Recourse Note is to be paid annually and the principal is to be paid on the tenth anniversary of the date of issue. Each Management Investor who issued a Recourse Note was required to enter into a stock pledge agreement (\"Stock Pledge Agreement\") with the Company, pursuant to which the Management Investor pledged shares of Class A common stock to secure the repayment of the Recourse Note. In connection with the Exchange Offer, each Management Investor who issued a Recourse Note was required to execute an amendment to the Stock Pledge Agreement which provided for the substitution of the SMG-II common stock received in the Exchange Offer for the Company Class A common stock, in order, to secure the repayment of the Recourse Note. In connection with the repurchases of common stock from Management Investors, no payments of Recourse Notes were made during Fiscal 1994, Fiscal 1993 and Fiscal 1992. Recourse Notes in the amount of approximately $1.7 million were outstanding at January 28, 1995 and January 29, 1994. The Recourse Notes were included in other assets at January 28, 1995 and January 29, 1994.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 26--STOCK OPTION PLANS\nThe Management Investors 1987 Stock Option Plan (the \"Management Plan\") and the 1987 Employee Stock Option Plan (the \"Employee Plan\") were approved by the Board of Directors of the Company on November 24, 1987 and by the Stockholders on December 21, 1987. Under the terms of the Management and the Employee Plans, associates receive either incentive stock options or nonqualified stock options, the duration of which may not exceed ten years from the date of grant, to purchase shares of the Company's Class A common stock. In connection with the Exchange Offer, adjustments to outstanding options under the Management and the Employee Plans were made. As a result of these adjustments, each option under the Management and the Employee Plans, which were outstanding on February 4, 1991, became an option for the purchase of an equal number of shares of SMG-II Class A common stock.\nNOTE 27--DISPOSAL OF PURITY OPERATIONS AND INVESTMENT IN PURITY SUPREME\nOn December 17, 1991, the Company completed the sale of two subsidiaries, Purity Supreme, Inc. (\"Purity Supreme\") and Li'l Peach Corp. (\"Li'l Peach\", and together with Purity Supreme, the \"Purity Operations\"), for approximately $257.0 million (as adjusted), including the assumption of certain indebtedness of the Purity Operations, to a Company organized by Freeman Spogli & Co. In connection with the disposal of the Purity Operations, the Company retained a 10% common equity interest in Purity Supreme with a net book value of $8.9 million (as of sale date), a new issue of Purity Supreme exchangeable preferred stock (the \"Purity Preferred Stock\") with an aggregate stated value of $18.0 million and a convertible subordinated note of Purity Supreme (the \"Purity Note\") in the principal amount of $2.0 million. During Fiscal 1992, the Company collected the principal amount of the Purity Note and recorded a gain of $2.0 million, which reflected the reversal of the valuation reserve recorded upon the disposal of the Purity Operations.\nThe Purity Preferred Stock matures December 17, 2003 and accrues dividends at $1.3 million per annum on a semiannual basis each June 17 and December 17. The Purity Preferred Stock is subordinate to Purity Supreme's Series B Preferred Stock, redeemable at the option of Purity Supreme at stated discount rates and convertible into Purity Supreme debentures at the option of Purity Supreme. The Purity Preferred Stock has a redemption price, including unpaid dividends, of $15.2 million at January 28, 1995.\nDue to the Company's inability to readily convert these securities into cash, as there exists no current trading market, and as there is uncertainty of future cash flows from these securities, a valuation allowance for the redemption value of these securities has been recorded at January 28, 1995 and January 29, 1994.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 28--GOODWILL\nSince the Acquisition in Fiscal 1987, the Company, as constituted prior to the Recapitalization, did not achieve the sales and earnings projections prepared at the time of the Acquisition due to the economic recession in the Company's geographic trading area, the increased competitive pressures (from new and enlarged supermarkets, discount stores and warehouse club stores), the related weak retail environment and the lower than were projected food inflation rates. These conditions resulted in higher than expected losses and in a significant deficiency in equity and negatively impacted the real estate and financial markets so that the Company was not able to achieve the new store growth, enlargements and remodeling anticipated in the projections. The Company determined, based on the trend of operating results for Fiscal 1988 through Fiscal 1992, and without anticipating the effects of the Recapitalization and Spin-Offs on future projections, that its projected results, as of January 30, 1993, would not support the future amortization of the Company's remaining goodwill balance of $600.7 million.\nThe methodology that management used to assess the recoverability of goodwill was to project results of operations forward 35 years, which represented the remaining life of the goodwill as of January 30, 1993. The methodology was based on a five year historical trend line of actual results. Management believed that the projected future results, based on this historical trend, were the most likely scenario assuming a recapitalization was not consummated. Management evaluated the recoverability of goodwill based on this forecast of future operations and income. Management also evaluated recoverability based on the discounted value of this same forecast using a discount rate that reflected the Company's average cost of funds. Accordingly, in the fourth quarter of Fiscal 1992, the Company wrote off its remaining goodwill balance of $600.7 million.\nNOTE 29--SUBSEQUENT EVENT (UNAUDITED)\nOn April 24, 1995, a strategic buyer announced its plans to purchase Purity, subject to completion of regulatory approval and compliance with terms and conditions of the purchase agreement. The sale is expected to close later in 1995, with the Company expecting to receive approximately $16 million based upon the announced price. Until the proposed transaction is consummated, no adjustment will be made to the valuation allowance related to the securities representing the Company's investment in Purity. Further, based on the announced price, if the proposed transaction is consummated, a capital tax loss carryforward of approximately $70 million will be generated. The benefit of such capital tax loss carryforward will only be realized to the extent the Company generates capital gains.\nSUPERMARKETS GENERAL HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 30--QUARTERLY FINANCIAL DATA (UNAUDITED)\nFinancial data for the interim periods of Fiscal 1994 and Fiscal 1993 is as follows (dollars in thousands):\n- ------------ (a) The pretax LIFO inventory credit for the 52 weeks ended January 28, 1995 was estimated to be a $0.825 million provision in each of the first three fiscal quarters. The annual credit was $3.2 million, and resulted in a $0.7 million credit in the fourth quarter. (b) The pretax LIFO inventory credit for the 52 weeks ended January 29, 1994 was estimated to be a $0.65 million provision in each of the first three fiscal quarters. The annual credit was $2.4 million, and resulted in a $0.45 million credit in the fourth quarter.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholder SUPERMARKETS GENERAL HOLDINGS CORPORATION Woodbridge, New Jersey\nWe have audited the accompanying consolidated balance sheets of Supermarkets General Holdings Corporation and its subsidiaries (the \"Company\") as of January 28, 1995 and January 29, 1994, and the related consolidated statements of operations, stockholder's deficit and cash flows for each of the three years in the period ended January 28, 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 Supermarkets General Holdings Corporation and its subsidiaries as of January 28, 1995 and January 29, 1994, and the results of their operations and their cash flows for each of the three years in the period ended January 28, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, the Company changed its method of accounting for postretirement benefits other than pensions, postemployment benefits, income taxes, LIFO inventories and the determination of the discount rate utilized to record certain noncurrent liabilities as of January 31, 1993.\nDeloitte & Touche LLP Parsippany, New Jersey April 17, 1995 (April 24, 1995 as to Note 29)\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 (AS OF APRIL 15, 1995) (A) DIRECTORS OF THE COMPANY\nThe following table sets forth the name, principal occupation or employment at the present time and during the last five years, and the name and principal business of any corporation or other organization in which such occupation or employment is or was conducted, of the directors of the Company, all of whom are citizens of the United States. Each individual named below is a director of both the Company and Pathmark, except for Mr. Rubenstein, who is a director of the Company only.\n- ------------\n(1) Includes service with Pathmark's predecessor.\n(2) Prior positions are reflected under \"--Executive Officers\".\nPursuant to the SMG-II Stockholders Agreement, the Merrill Lynch Investors are entitled to designate seven directors, the Management Investors are entitled to designate three directors and the Equitable Investors are entitled to designate one director to Holdings' Board of Directors. By having the ability to designate a majority of Holdings' Board of Directors, the Merrill Lynch Investors have the ability to control the Company. Currently, five of the persons serving as directors were designated by the Merrill Lynch Investors (Messrs. Burke, Michas, Khanna, McLean and Rubenstein), two were designated by the Management Investors (Messrs. Futterman and Cuti) and one was designated by the Equitable Investors (Ms. Penny). Under the terms of the SMG-II Stockholders Agreement, SMG-II is obligated to re-elect the current directors to the Board. No family relationship exists between any director or nominee and any other director or nominee or executive officer of the Company.\n(B) EXECUTIVE OFFICERS\nThe following table sets forth the name, principal occupation or employment at the present time and during the last five years, and the name of any corporation or other organization in which such occupation or employment is or was conducted, of the executive officers of the Company, all of whom are citizens of the United States unless otherwise indicated and serve at the discretion of the Board of Directors of the Company. The executive officers of the Company listed below were elected to office for an indefinite period of time. No family relationship exists between any executive officer and any other executive officer or director of the Company. All current executive officers now hold identical positions with the Company and Pathmark, except for Messrs. Crowley and Rallo, who are executive officers of Pathmark only.\n- ------------\n(1) Includes service with Pathmark's predecessor.\n(2) Member of the Company's Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSUMMARY COMPENSATION TABLE\n- ------------ (1) Represents payments as reimbursement for interest paid to Holdings for a loan of less than $60,000 from Holdings in connection with the purchase of SMG-II Class A Common Stock and includes an amount sufficient to pay any income taxes resulting therefrom after taking into account the value of any deduction available as a result of the payment of such interest and taxes. (2) Stock options shown were granted pursuant to the Management Investors 1987 Stock Option Plan of SMG-II (the \"Plan\") and relate to shares of Class A Common Stock of SMG-II. (3) Represents Pathmark's matching contribution to the SGC Savings Plan (the \"Savings Plan\"). (4) Mr. Rallo became an executive officer of Pathmark in October 1993. (5) Mr. Borshadel left the Company's employ on November 4, 1994 in connection with the sale of the Rickel Home Centers segment. Pursuant to an agreement with Mr. Borshadel, the Company paid him a bonus of $1,400,000 upon the completion of said sale.\nNone of the executive officers named in the above Compensation table were granted stock options in the fiscal year ended January 28, 1995.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES(1)\n- ------------ (1) Options shown were granted pursuant to the Plan and relate to shares of Class A Common Stock of SMG-II. No options were exercised in Fiscal 1994.\nPENSION PLAN TABLE(1)\n- ------------ (1) The table above illustrates the aggregate annual pension benefits payable under the SGC Pension Plan and Excess Benefit Plan (collectively, the \"Pension Plans\"). The retirement benefit for individuals with 30 years of credited service is 40% of the individual's average compensation during his or her highest five compensation years in the last ten years before retirement, less one-half of the social security benefit received. The retirement benefit is reduced by 3.33% for every year of credited service less than 30. Covered compensation under the Pension Plans includes all cash compensation subject to withholding plus amounts deferred under the Savings Plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended, and as to individuals identified in the Summary Compensation Table, would be the amount set forth in that table under the headings \"Salary\" and \"Bonus\". The table shows the estimated annual benefits an individual would be entitled to receive if normal retirement at age 65 occurred in January 1995 after the indicated number of years of covered employment and if the average of the participant's covered compensation for the five years out of the last ten years of such employment yielding the highest such average equalled the amounts indicated. The estimated annual benefits are based on the assumption that the individual will receive retirement benefits in the form of a single life annuity (married participants may elect a joint survivorship option) and are before applicable deductions for social security benefits in effect as of January 1995. As of December 31, 1994, the following individuals had the number of years of credited service indicated after their names: Mr. Futterman, 21.6; Mr. Cuti, 3.0; Mr. Joyce, 30; Mr. Rallo, 30 and Mr. Gutman, 18.8. All of Mr. Borshadel's credited service was transferred to his new employer which is responsible for Mr. Borshadel's pension. As described below in \"Compensation Plans and Arrangements--Supplemental Retirement Agreements\", each of the named executives is party to a Supplemental Retirement Agreement with Pathmark except for Mr. Borshadel whose Supplemental Retirement Agreement has been fully assumed by the purchaser of the Rickel business.\nCOMPENSATION PLANS AND ARRANGEMENTS\nSupplemental Retirement Agreements. The Company has entered into supplemental retirement agreements with certain key executives, including the current executive officers named in the Summary Compensation Table, which provide that the executive will be paid upon termination of employment after attainment of age 60 a supplemental pension benefit in such an amount as to assure him or her an annual amount of pension benefits payable under the supplemental retirement agreement, the Company's qualified pension plans and certain other plans of the Company, including Savings Plan balances as of March 31, 1983, (a) in the case of Mr. Futterman, equal to (i) $475,000 or (ii) his base salary on the date of his retirement, death or disability, whichever is greater, (b) in the case of Mr. Cuti equal to 30% of his final average Compensation (as hereinafter defined) based on ten years of service with the Company and increasing 1% per year for each year of service thereafter to a maximum of 40% of his final average Compensation based on 20 years of service and (c) in the cases of Messrs. Rallo, Joyce and Gutman, equal to (i) 30% of his final average Compensation (as hereinafter defined) based on ten years of service with the Company and increasing 1% per year for each year of service thereafter, to a maximum of 40% of his final average Compensation based on 20 years of service, or (ii) $150,000, whichever is less. \"Compensation\" includes base salary and payments under the Executive Incentive Plan, but excludes Company matching contributions under the Savings Plan and cash awards under Old\nSupermarkets' former Long-Term Incentive Plan. If the executive leaves the Company prior to completing 20 years of service (other than for disability), the supplemental benefit would be reduced proportionately. Should the executive die, the surviving spouse then receiving or, if he or she was not then receiving a supplemental pension benefit, the spouse would be entitled to a benefit equal to two-thirds of the benefit to which the executive would have been entitled, provided the executive has attained at least ten years of service with the Company. Mr. Cuti's agreement credits him with ten years of service over and above his actual service.\nEmployment Agreements. As of August 1, 1993, the Company and Pathmark entered into an employment agreement with Mr. Futterman (the \"1993 Employment Agreement\"). The 1993 Employment Agreement is for an initial term of three years, which term is automatically extended for an additional year on the second anniversary of the commencement of the term and on each successive anniversary thereafter. Under the 1993 Employment Agreement, Mr. Futterman is entitled to a minimum annual base salary of $500,000. The 1993 Employment Agreement also provides that Mr. Futterman shall be eligible to receive an annual bonus of up to 75% of his annual base salary and shall be provided the opportunity to participate in pension and welfare plans, programs and arrangements that are generally made available to executives of Pathmark, or as may be deemed appropriate by the Compensation Committee of the Board of Directors of SMG-II.\nAs of August 1, 1993, the Company entered into an employment agreement (the \"August Agreement\", together with the 1993 Employment Agreement, the \"Employment Agreements\") with Mr. Cuti. The August Agreement is for an initial term of three years, which term is automatically extended for an additional year on the second anniversary of the commencement of the term and on each successive anniversary thereafter. Under the August Agreement, Mr. Cuti is entitled to a minimum annual base salary of $313,500. The August Agreement also provides that he shall be eligible to receive an annual bonus of up to 75% of his annual base salary and shall be provided the opportunity to participate in pension and welfare plans, programs and arrangements that are generally made available to executives of Pathmark or as may be deemed appropriate by the Compensation Committee of the Board of Directors of SMG-II.\nIn the event one of the above named executives' employment is terminated by the Company without Cause (as defined in the Employment Agreements), or by the executive for Good Reason (as defined in the Employment Agreements) prior to the termination of the applicable Employment Agreement, such executive will be entitled to continue to receive his base salary, plus bonus (if earned) and continued coverage under health and insurance plans for the two year period commencing on the date of such termination or resignation, reduced by any compensation or benefits which the executive is entitled to receive in connection with his employment by another employer during said period. In addition, if Mr. Futterman's employment is terminated by the Company without Cause or by him for Good Reason on or after a Change in Control, he will then be entitled to receive such benefits for a three year period, and his base salary shall be the greater of his base salary at the annual rate in effect immediately prior to such termination of resignation of $500,000.\nUnder the 1993 Employment Agreement, a Change in Control means (a) the acquisition by a Third Party (as hereinafter defined) of beneficial ownership of more than 30% of the issued and outstanding voting common stock of SMG-II, Holdings or the Company or (b) the acquisition of all or substantially all of the assets of the Company by a Third Party; provided, however, that no Change in Control will be deemed to occur as long as (i) the ML Investors, (ii) the management employees of the Company, or (iii) the ML Investors, in combination with the management employees of the Company, beneficially own, directly or indirectly, more than 50% of the voting common stock of the Company. \"Third Party\" shall mean any person other than the Company, Holdings or SMG-II, each of the ML Investors, or The Equitable Life Assurance Society of the United States and its affiliates. For purposes of the 1993 Employment Agreement, \"person\" and \"beneficial ownership\" shall have the meanings assigned to such terms under Section 13(d) of the Exchange Act, as amended, and \"affiliate\" of any first person shall mean a second person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such first person.\nThe Employment Agreements contain agreements by the executives not to compete with the Company as long as they are receiving payments under an Employment Agreement and an agreement by the executives not to disclose confidential information.\nMr. Borshadel had an employment contract identical in all material respects to Mr. Cuti's. As part of the sale, the purchaser of the Rickel business has fully assumed all obligations under Mr. Borshadel's contract.\nDIRECTOR'S FEES\nDirectors of the Company are not currently compensated for their services as such. However, Mr. Rubenstein receives an annual fee of $20,000 from Plainbridge for sitting on its Board.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nMessrs. Burke, Khanna and McLean comprise the compensation committee of the Board of Directors of SMG-II, and were responsible for decisions concerning compensation of the executive officers of the Company. Messrs. Burke and McLean are directors of MLCP and they, along with Mr. Khanna, have been retained by MLCP as consultants. MLCP is an indirect wholly-owned subsidiary of ML & Co. See \"Security Ownership of Certain Beneficial Ownership and Management.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSince February 4, 1991, all shares of the Holdings Common Stock are held by SMG-II. As of April 1, 1995, the number of shares of (a) SMG-II (i) Class A Common Stock, (ii) Class B Common Stock, (iii) Series A Preferred Stock, and (iv) Series B Preferred Stock and (b) Holdings Preferred Stock beneficially owned by the persons known by management of the Company to be the beneficial owners of more than 5% of the outstanding shares of any class as \"beneficial ownership\" has been defined under Rule 13d-3, as amended, under the Securities Exchange Act of 1934, are set forth in the following table:\n- ------------\n(1) Includes presently exercisable options granted under the Plan for 71,772 shares of SMG-II Class A Common Stock held by Management Investors and 500 shares of SMG-II Class A Common Stock that SMG-II has agreed to sell to two of the Company's employees, including 250 shares to Mr. Cuti. Does not include 39,120 options to purchase shares of SMG-II Class A Common Stock granted to non-management employees of the Company, which options are not exercisable until a public offering of SMG-II Common Stock occurs.\n(2) MLCP and its affiliates are the direct or indirect managing partners of ML Offshore LBO Partnership No. IX, Merrill Lynch Capital Appreciation Partnership No. IX, L.P., ML Employees LBO Partnership No. 1, L.P., Merrill Lynch Capital Appreciation Partnership No. B-X, L.P., ML Offshore LBO Partnership No. B-X and MLCP Associates, L.P. No. II. Such entities and those disclosed in footnote (3) below, are referred to herein as the \"Merrill Lynch Investors\" or ML Investors. The address of such entities is c\/o Merrill Lynch Capital Partners, Inc., in care of Stonington Partners, Inc., 767 Fifth Avenue, New York, New York 10153. MLCP is an indirect wholly owned subsidiary of ML&Co. The partners and principals of SPI (including Messrs. Burke, Michas, McLean and Khanna) are consultants to MLCP.\n(3) Merchant Banking L.P. No. 1, Merchant Banking L.P. No. IV, Merrill Lynch KECALP L.P. 1987, Merrill Lynch KECALP L.P. 1989, Merrill Lynch KECALP L.P. 1991 and ML IBK Positions, Inc. are indirectly controlled by ML&Co. The address of such entities is c\/o James Caruso, Merrill Lynch & Co., Inc., World Financial Center, South Tower, New York, New York 10080-6123.\n(4) CBC Capital Partners, Inc. is a wholly owned subsidiary of Chemical Banking Corp.\n(5) The Equitable Investors are separate purchasers who are affiliates of each other.\n(6) SMG-II Preferred stock may be converted into an equivalent number of shares of common stock of SMG-II in accordance with its terms.\n(7) Voting rights are limited to the election of two directors to the Board of Holdings.\nNo officer or director claims beneficial ownership of any share of Holdings Common Stock or of SMG-II stock other than SMG-II Class A Common Stock. The number of shares of SMG-II Class A Common Stock and Holdings Preferred Stock beneficially owned by each director, by each nominee for director, by each of the five highest compensated executive officers and by all directors and all current and executive officers as a group is as follows:\n- ------------\n* Less than 1%\n(1) Does not include 550,000 shares of SMG-II Class A Common Stock or 236,731.5 shares of SMG-II Series A Preferred Stock owned beneficially by a group of which MLCP is a part. Messrs. Burke, McLean and Michas, directors of MLCP, disclaim beneficial ownership in all such shares.\n(2) Includes 250 shares of SMG-II Class A Common Stock that SMG-II has agreed to sell to Mr. Cuti and presently exercisable options granted under the Plan to purchase shares of SMG-II Class A Common Stock, as follows: Mr. Cuti, 5,383; Mr. Futterman, 13,000; Mr. Gutman, 2,350; Mr. Joyce, 2,000; Mr. Rallo, 2,600 and Mr. Rubenstein, 1,000, and all directors and officers as a group, 31,466.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn March 1990, Jerry G. Rubenstein, a Director, borrowed from the Company $100,000 in order to help finance his purchase of Company Class A Common Stock. Subsequently, such shares of Company Class A Common Stock were exchanged for shares of SMG-II Class A Common Stock. The foregoing indebtedness to the Company is evidenced by a full recourse promissory note (the \"Recourse Note\"). The Recourse Note is for a term of ten years and bears interest at the rate of 8.02% per annum, payable annually. Except as otherwise provided in the Recourse Note, no principal on such recourse loan shall be due and payable until the tenth anniversary of the date of issue of such Recourse Note. Under the terms of the agreement pursuant to which the shares of Company Class A Common Stock were exchanged for shares of SMG-II Class A Common Stock, the Company is obligated to pay to each Management Investor who pays interest on his Recourse Note (except under certain circumstances) an amount equal to such interest, plus an amount sufficient to pay any income taxes resulting from the above described payment after taking into account the value of any deduction available to him as a\nresult of the payment of such interest or taxes (the \"Reimbursement Amount\"). As of April 1, 1995, Mr. Rubenstein remained indebted to the Company in the amount of $100,000.\nDuring Fiscal 1994, the Company retained ML & Co. to advise it in connection with its sale of its Rickel Home Center business. Also, in the current fiscal year, the Company has engaged ML & Co. to act as financial adviser in certain matters. The Company believes that the terms of the transactions referred to under this paragraph were no less favorable than those obtainable in transactions with unrelated persons. See Item 12 \"Security Ownership of Certain Owners and Management\".\nIn connection with the sale of its Rickel Home Center business, one of the Company's subsidiaries used approximately $71.3 million of the sale proceeds to partially prepay certain indebtedness, including accrued interest and debt premium, held by the Equitable Investors. Ms. Penny, a director of the Company, is an executive officer of a subsidiary of the Equitable Life Assurance Society of the United States. See Item 12 \"Security Ownership of Certain Beneficial Owners and Management\".\nThe holders of SMG-II Preferred Stock are a party with the holders of SMG-II Common Stock to a stockholders agreement (the \"SMG-II Stockholders Agreement\"), which, among other things, restricts the transferability of SMG-II capital stock and relates to the corporate governance of SMG-II and Holdings. Among other provisions, the SMG-II Stockholders Agreement requires a vote of at least 80% of the members of the Board of Directors to cause the Company to conduct any business other than that engaged in by the Company in February of 1991 and the approval of stockholders representing 66 2\/3% of the number of shares of SMG-II voting capital stock voting together as a single class for SMG-II to enter into any Significant Transaction (as defined), including certain mergers, sales of assets, acquisitions, sales or redemptions of stock, the amendment of the certificate of incorporation or by-laws or the liquidation of SMG-II. The SMG-II Stockholders Agreement also provides that SMG-II must obtain the prior written consent of the Equitable Investors with respect to certain of these transactions and that the Equitable Investors have certain preemptive rights with respect to the sale of capital stock of Holdings or the Company.\nThe SMG-II Stockholders Agreement also contains an agreement of the stockholders of SMG-II with respect to the composition of SMG-II's and Holdings' Boards of Directors. Under this agreement, the Merrill Lynch Investors will be entitled to designate up to seven directors, the Management Investors will be entitled to designate up to three directors and the Equitable Investors will be entitled to designate one director to both of SMG-II's and Holdings' Boards of Directors. Such agreement furthermore entitles the Merrill Lynch Investors to designate a majority of Holdings' Board of Directors at all times. Since Holdings owns all of the outstanding shares of Common Stock, by having the ability to designate a majority of Holdings' Board of Directors, the Merrill Lynch Investors will have the ability to control the Company. The Merrill Lynch Investors are controlled by ML & Co.\nIn addition to the foregoing, the SMG-II Stockholders Agreement contains terms restricting the transfer of SMG-II Common Stock and SMG-II Preferred Stock (collectively, the \"SMG-II Stock\") by the stockholders of SMG-II, and providing to the stockholders of SMG-II rights of first offer with respect to resales of SMG-II Stock, rights of first refusal with respect to certain issuances of shares of SMG-II Stock, certain rights to demand or participate in registrations of shares of SMG-II Stock under the Securities Act and certain \"tag-along\" rights.\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(b) Reports on Form 8-K.\n(c) Exhibits required by Item 601 of Regulation S-K.\nSee item 14(a) 3 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.\nDated: April 27, 1995 SUPERMARKETS GENERAL HOLDINGS CORPORATION\nBy: \/s\/ RON MARSHALL ..................................\nRon Marshall Executive Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX\n- ------------\n*Filed herewith.","section_15":""}
{"filename":"770618_1995.txt","cik":"770618","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENTS OF BUSINESS\nTrump's Castle Funding, Inc. (\"Funding\") was incorporated under the laws of the State of New Jersey in May 1985 and is wholly-owned by Trump's Castle Associates, a New Jersey general partnership (the \"Partnership\"). Funding was formed to serve as a financing corporation to raise funds for the benefit of the Partnership. Since Funding has no business operations, its ability to service its indebtedness is completely dependent upon funds it receives from the Partnership. Accordingly, the discussion in this Report relates primarily to the Partnership and its operations.\nThe Partnership is owner and operator of Trump's Castle Casino Resort (\"Trump's Castle\"), a luxury casino hotel located in the Marina District of Atlantic City, New Jersey. The partners in the Partnership are TC\/GP, Inc. (\"TC\/GP\"), which has a 37.5% interest in the Partnership, Donald J. Trump (\"Trump\"), who has a 61.5% interest in the Partnership, and Trump's Castle Hotel & Casino, Inc. (\"TCHI\"), which has a 1% interest in the Partnership. Trump, by virtue of his ownership of TC\/GP and TCHI, is the beneficial owner of 100% of the common equity interest in the Partnership, subject to the right of holders of warrants for 50% of the common stock of TCHI (the \"TCHI Warrants\") to acquire an indirect beneficial interest in 0.5% of the common equity interest in the Partnership.\nIn December 1993, the Partnership, Funding, and certain affiliated entities completed a recapitalization of their debt and equity capitalization (the \"Recapitalization\"). The purpose of the Recapitalization was (i) to improve the debt capitalization of the Partnership and, initially, to decrease its cash charges, (ii) to provide the holders of the Units, each Unit comprised of $1,000 principal amount of Funding's 9.5% Mortgage Bonds due 1998 (the \"Bonds\") and one share of TC\/GP common stock, who participated in the Exchange Offer (as defined below) with a cash payment of $6.19 and securities having a combined principal amount of $905 for each Unit, and (iii) to provide Trump with beneficial ownership of 100% of the common equity interests in the Partnership (subject to the TCHI Warrants).\nThe Recapitalization was also designed to take advantage of certain provisions of the Units which were designed to provide Trump with incentives to cause the Units to be repaid or redeemed prior to maturity. The Units were issued in connection with a restructuring (the \"Restructuring\") of the indebtedness of Funding, the Partnership and TCHI through a prepackaged plan of reorganization (the \"Plan\") under chapter 11 of title 11 of the United States Code, as amended (the \"Bankruptcy Code\"), which was consummated on May 29, 1992. The Plan was designed to alleviate a liquidity problem which the Partnership began to experience in 1990.\nIn June of 1995, the Partnership acquired an option to acquire at least 92% of Funding's Increasing Rate Subordinate Pay-in-Kind Notes due 2005 (the \"PIK Notes\"). The option which was initially scheduled to expire on December 12, 1995 has been extended to March 19, 1996 and may be extended until June 21, 1996. The option is exercisable at a price equal to 60% of the aggregate principal amount and accrued interest of the PIK Notes delivered upon exercise of the option.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Partnership operates in only one industry segment (See \"SELECTED CONSOLIDATED FINANCIAL DATA\" below).\n(c) NARRATIVE DESCRIPTION OF THE BUSINESS\nCASINO HOTEL OPERATIONS. The Partnership owns and operates Trump's Castle, a luxury casino hotel located in the Marina District of Atlantic City, New Jersey. Trump's Castle's 73,000 square foot casino, includes 90 table games (including six poker tables), 2,275 slot machines and simulcast racetrack wagering. See Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES OF THE PARTNERSHIP\nTHE CASINO PARCEL. Trump's Castle is located in the Marina District of Atlantic City on an approximately 14.7 acre triangular-shaped parcel of land, which is owned by the Partnership in fee, located at the intersection of Huron Avenue and Brigantine Boulevard, directly across from the Marina (see discussion below), approximately two miles from the Boardwalk.\nTrump's Castle has a total of 73,000 square feet of casino space, which accommodates 90 table games (including 6 poker tables), 2,275 slot machines, and simulcasting facilities. In addition to the casino, Trump's Castle consists of a 27 story hotel with 728 guest rooms, including 185 suites, of which 99 are \"Crystal Tower\" luxury suites. The facility also offers eight restaurants, a 460-seat cabaret theater, one cocktail lounge, 58,000 square feet of convention, ballroom and meeting space, a swimming pool, tennis courts, and a sports and health club facility. Trump's Castle has been designed so that it can be enlarged in phases into a facility containing 2,000 rooms, a 1,600-seat cabaret theater, and additional recreational amenities. Trump's Castle also has a nine-story garage providing on-site parking for approximately 3,000 vehicles, and a helipad which is located atop the parking garage, making Trump's Castle the only Atlantic City casino with access by land, air, and sea.\nDuring 1995, Trump's Castle replaced over 25% of the slot machines on its casino floor with new, more popular models, upgraded its computerized slot tracking and slot marketing system, and began the construction of two private clubs for preferred gaming patrons. In 1994, Trump's Castle added 153 slot machines, completed a 3,000 square foot expansion to its casino which enabled Trump's Castle to accommodate the addition of simulcast race track wagering, and expended in excess of $2 million on renovations to its hotel facility. The casino expansion also increased casino access and casino visibility for hotel patrons. In 1993, Trump's Castle completed the construction of a Las Vegas style marquee and reader board, the largest of its kind on the East Coast.\nTHE MARINA. Pursuant to an agreement (the \"Marina Agreement\") with the New Jersey Division of Parks and Forestry, the Partnership in 1987 began operating and renovating the Marina, including docks containing approximately 600 slips. An elevated pedestrian walkway connecting Trump's Castle to a two-story building at the Marina was completed in 1989. The Partnership has reconstructed the two-story building, which contains a 240-seat restaurant and offices, as well as a snack bar and a large nautically-themed retail store. Any improvements made to the Marina (which is owned by the State of New Jersey), excluding the elevated pedestrian walkway, automatically become the property of the State of New Jersey upon their completion. Pursuant to the Marina Agreement and pursuant to a certain lease between the State of New Jersey, as landlord, and the Partnership, as tenant, dated as of September 1, 1990, the Partnership commenced leasing the Marina and the improvements thereon for an initial term of twenty- five years. The lease is a net lease pursuant to which the Partnership, in addition to the payment of annual rent equal to the greater of (i) a certain percentage of gross revenues, and (ii) minimum base rent of $300,000 annually (increasing every five years to $500,000 in 2011), is responsible for all costs and expenses related to the premises, including but not limited to, all maintenance and repair costs, insurance premiums, real estate taxes, assessments, and utility charges.\nPARKING PARCEL. The Partnership also owns an employee parking lot located on Route 30, approximately two miles from Trump's Castle, which can accommodate approximately 1,000 cars.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership, its partners, certain members of the former Executive Committee, Funding, and certain of their employees are involved in various legal proceedings. The Partnership and Funding have 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.\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 majority of such claims are covered by liability insurance and the Partnership believes that the resolution of these claims, will not, individually or in the aggregate, have a material adverse effect on the financial condition or results of operations of 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 COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) There is no established public trading market for Funding's outstanding common stock or for the Partnership's partnership interests.\n(b) As of December 31, 1995, there was one holder of record of the outstanding common stock of Funding and three partners in the Partnership.\n(c) Funding has paid no cash dividends on its common stock, and except as set forth under \"Business -- The Recapitalization\" (Item 1), the Partnership has made no general distributions with respect to its equity interests.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe financial information presented below reflects the financial condition and results of operations of the Partnership. Funding is a wholly-owned subsidiary of the Partnership and conducts no business other than collecting amounts due under certain intercompany notes from the Partnership for the purpose of paying principal of, premium, if any, and interest on its indebtedness, which Funding issued as a nominee for the Partnership.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994. The Partnership's net revenues (gross revenues less promotional allowances) for the years ended December 31, 1995 and 1994 were approximately $305.5 million and $283.8 million, respectively. The Partnership believes that the $21.7 million (7.6%) increase is the result of aggressive marketing programs and special events introduced by Management during the current year as well as a continuing emphasis on providing superior customer service.\nGaming revenues provide the majority of the Partnership's revenues and primarily consist of slot machine and table games win.\nSlot machine win was approximately $197.4 million and $177.4 million (an increase of approximately $20.0 million or 11.3%) for the years ended December 31, 1995 and 1994, respectively. The total dollar amount wagered by customers on slot machines increased by approximately $322.9 million (16.4%) to $2,288.2 million for the year ended December 31, 1995 from $1,965.3 million for the year ended December 31, 1994. This increase in slot volume was partially offset by a decrease in the slot win percentage (slot win as a percentage of dollars wagered on slot machines) to 8.6% for the year ended December 31, 1995 from 9.0% for the year ended December 31, 1994. This win percentage decrease was primarily due to an increased volume of customer play on lower denomination slot machines which, traditionally, payout at a lower win percentage.\nTable game win was approximately $82.7 million and $81.0 million (an increase of $1.7 million or 2.1%) for the years ended December 31, 1995 and 1994, respectively. The total dollar amount wagered by customers on table games increased by approximately $10.2 million (2.1%) to $487.7 million for the year ended December 31, 1995 from $477.5 for the year ended December 31, 1994. The table game win percentage (table game win as a percentage of dollars wagered on table games) remained at 17% for the year ended December 31, 1995 compared to the year ended December 31, 1994. The table game win percentage is outside the control of the Partnership, and although it is fairly constant over the long- term, it can vary significantly from period to period, due in part to the play of certain premium patrons who tend to wager substantial dollar amounts on table games.\nFor the years ended December 31, 1995 and 1994, credit extended to the table games customers was approximately 30.0% and 31.4% of overall table play, respectively. This relatively high level of credit play continues a trend which started in the last fiscal year and is the result of an increased level of play by individuals who wager relatively large sums. These premium patrons tend to use a higher percentage of credit when they wager.\nNongaming revenues, in the aggregate, increased by approximately $3.1 million (5.2%) to $60.0 million for the year ended December 31, 1995 from $56.9 million for the year ended December 31, 1994, primarily as the result of rooms revenue (an approximate $538,000 increase) and food and beverage revenue (an approximate $2.4 million increase) activity. During the current year, marketing programs designed to increase gaming revenues caused an increase in complimentary rooms and food and beverage revenues (an approximate $2.7 million increase) as compared to the prior year.\nPromotional Allowances increased by approximately $2.9 million (9.2%) to $34.5 million for the year ended December 31, 1995 from $31.6 million for the year ended December 31, 1994. As discussed above, marketing programs instituted during the current year designed to increase gaming revenues caused an increase in complimentary rooms and food and beverage activity as compared to the prior year.\nGaming costs and expenses increased by approximately $14.7 million (9.7%) to $165.7 million for the year ended December 31, 1995 from $151.0 million for the year ended December 31, 1994. This increase is primarily the result of an increase in promotional cash back coupon costs associated with the new marketing programs and special events introduced during the current year to stimulate gaming revenues.\nFood and beverage costs and expenses for the years ended December 31, 1995 and 1994 increased approximately $1.1 million (9.0%). This increase corresponds to the increased food and beverage and gaming revenue activity for the year.\nOther costs and expenses increased approximately $790,000 (6.3%) to $13.4 million for the year ended December 31, 1995 from $12.6 million for the year ended December 31, 1994. This increase is principally the result of increased real estate taxes on the casino property.\nInterest expense increased approximately $1.8 million (4.1%) to $46.0 million for the year ended December 31, 1995 from $44.2 million for the year ended December 31, 1994. This increase is the result of an increase in both the outstanding principal and the interest rate related to the PIK Notes as well as an increase in the interest rate related to the Amended Term Loan.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993. The Partnership's net revenues (gross revenues less promotional allowances) for the years ended December 31, 1994 and\n1993 totaled approximately $283.8 million and $273.2 million, respectively, representing a $10.6 million (3.9%) increase. Gaming revenues were approximately $258.5 million for the year ended December 31, 1994 and $246.4 million for the comparable period in 1993. Management believes the $12.1 million (4.9%) increase in gaming revenues was attributable primarily to a continuing emphasis on customer service and a repositioning by Trump's Castle to expand profitable market segments.\nSlot machine win was approximately $177.5 million and $173.0 million (an increase of approximately $4.5 million or 2.6%) for the years ended December 31, 1994 and 1993, respectively. The total dollar amount wagered by customers on slot machines increased by approximately $113.9 million (6.2%) to $1,965.3 million for the year ended December 31, 1994 from $1,851.4 million for the year ended December 31, 1993. This increase in slot volume was partially offset by a decrease in the slot win percentage (slot win as a percentage of dollars wagered on slot machines) to 9.0% for the year ended December 31, 1994 from 9.3% for the year ended December 31, 1993. The lower slot win percentage was largely intentional and designed by Trump's Castle in order to remain competitive and stimulate patron play.\nTable game win was approximately $81.0 million and $73.4 million (an increase of $7.6 million or 10.4%) for the years ended December 31, 1994 and 1993, respectively. The total dollar amount wagered by customers on table games decreased by approximately $14.6 million (3.0%) to $477.5 million for the year ended December 31, 1994 from $492.1 million for the year ended December 31, 1993. This decrease in gaming volume was offset by an increase in the table game win percentage (table game win as a percentage of dollars wagered on table games) to 17.0% for the year ended December 31, 1994 from 14.9% for the year ended December 31, 1993. The table game win percentage is outside the control of the Partnership, and although it is fairly constant over the long- term, it can vary significantly from period to period, due in part to the play of certain premium patrons who tend to wager substantial dollar amounts on table games.\nFor the years ended December 31, 1994 and 1993, gaming credit extended to customers was approximately 31.4% and 28.9% of overall table play, respectively. This increase in credit play reflected, in part, a shift in the gaming patron mix as a result of increased play by individuals who wager relatively large sums. These patrons tend to use a higher percentage of credit when they wager.\nNongaming revenues, in the aggregate, decreased approximately $1.6 million (2.6%) to $56.9 million for the year ended December 31, 1994, from $58.5 million for the year ended December 31, 1993. This decline was primarily attributable to a decrease in food and beverage revenues of $2.2 million (7.1%), to $28.4 million for the year ended December 31, 1994, of which approximately $15.9 million consisted of complimentary food and beverage. This decline was due to the discontinuance of certain unprofitable marketing programs which resulted in fewer customers served. Such measures were implemented to improve overall operating efficiencies.\nOffsetting the nongaming revenues decrease was an increase in entertainment revenue of $100,000 (1.4%) and an increase in other income of $600,000 (8%).\nGaming costs and expenses increased by approximately $5.3 million (3.7%) to $151.0 million for the year ended December 31, 1994 from $145.7 for the year ended December 31, 1993. This increase corresponds to the increase in gaming revenues on a year- to-year basis.\nThe $2.6 million (15.1%) decrease in rooms and food and beverage operating expenses is primarily attributable to a variety of cost reduction measures and improvements in operational efficiency during 1994 compared to 1993.\nGeneral and administrative expenses increased approximately $7.4 million (13.6%) for the year ended December 31, 1994 as compared to the prior year. This increase was primarily attributable to:\n(1) The contribution of $2.5 million to a joint project with Harrah's for the beautification of the marina district of Atlantic City in which both casinos operate. (2) The contributions of approximately $3.3 million in Casino Reinvestment Development Authority deposits to certain public improvement projects. (3) Increased spending in connection with new business development and facilities maintenance.\nFor the year ended December 31, 1994, depreciation and amortization decreased $2.0 million (12.1%) over the comparable period in 1993, primarily as a result of the impact of fully depreciated assets.\nOther costs and expenses increased by $1.5 million (13.8%) due to significantly lower real estate tax expense incurred in the first quarter of 1993 because of a $1.8 million real estate tax credit.\nInterest expense decreased for the year ended December 31, 1994 over the comparable period in 1993 by approximately $12.8 million as a result of the Recapitalization on December 28, 1993.\nINFLATION. There was no significant impact on the Partnership's operations as a result of inflation during 1995, 1994, or 1993.\nLIQUIDITY AND CAPITAL RESOURCES.\nCash flow from operating activities is the Partnership's principal source of liquidity. For the year ended December 31, 1995, the Partnership's net cash flow provided by operating activities before cash debt service obligations was $49.8 million and cash debt service was $36.7 million, resulting in net cash provided by operating activities of $13.1 million.\nIn addition to cash needs to fund the day-to-day operations of Trump's Castle, the Partnership's principal uses of cash are capital expenditures and debt service.\nCapital expenditures for the year ended December 31, 1995 were $8.6 million and consisted of casino floor improvements, renovation of hotel rooms, and the purchase of slot machines. For 1996 total capital expenditures are anticipated to be $9.0 million and principally consist of (i) the purchase of slot machines, (ii) renovations to guest rooms and the hotel tower, and (iii) the construction of two new player clubs. Management believes that these levels of capital expenditures are sufficient to maintain the attractiveness of Trump's Castle and the aesthetics of its hotel rooms and other public areas.\nThe Partnership's debt consists primarily of (i) a loan with Midlantic National Bank (the \"Term Loan\"), (ii) the 11-1\/2% Senior Notes due 2000 (the \"Senior Notes\"), (iii) the 11-3\/4% Mortgage Notes due 2003 (the \"Mortgage Notes\"), and (iv) the Increasing Rate Subordinated Pay-in-Kind Notes due 2005 (the \"PIK Notes\").\nOn May 28, 1995, the Partnership exercised its option to extend the Term Loan for an additional five year term. The Term Loan bears interest at the prime rate plus 3%, currently 11-1\/2%, and requires amortized monthly principal payments of approximately $158,000 which commenced May 31, 1995. The Term Loan matures on May 28, 2000.\nThe Senior Notes have an outstanding principal amount of $27 million, and bear interest at the rate of 11-1\/2% per annum (which may be reduced to 11-1\/4% upon the occurrence of certain events). The Senior Notes mature on November 15, 2000, and are subject to a sinking fund which requires the retirement of 15% of the Senior Notes on each November 15, 1998 and 1999.\nThe Mortgage Notes have an outstanding principal amount of approximately $242 million, bear interest at the rate of 11-3\/4% per annum (which may be reduced to 11-1\/2% upon the occurrence of certain events), and mature on November 15, 2003.\nThe PIK Notes have an outstanding principal amount of approximately $61.9 million and mature on November 15, 2005. Interest is currently payable semi-annually at the rate of 13-7\/8%. On or prior to November 15, 2003, interest on the PIK Notes may be paid in cash or through the issuance of additional PIK Notes. During 1995, the Partnership and Funding issued an additional $7.8 million principal amount of PIK Notes in payment of interest on the PIK Notes. The Partnership anticipates that during 1996 interest on the PIK Notes will be paid through the issuance of additional PIK Notes.\nOn June 23, 1995, the Partnership entered into an Option Agreement with Hamilton Partners, L.P. (\"Hamilton\") which grants the Partnership an option (the \"Option\") to acquire the PIK Notes owned by Hamilton. Hamilton has represented to the Partnership\nthat it is the owner of at least 92% of the outstanding principal amount of the PIK Notes. The Option was granted to the Partnership in consideration of a $1.1 million payment to Hamilton. The Option is exercisable at a price equal to 60% of the aggregate principal amount and accrued interest of the PIK Notes delivered by Hamilton. Pursuant to the terms of the Option Agreement, upon the occurrence of certain events within 18 months of the time the Option is exercised, the Partnership is required to make an additional payment to Hamilton of up to 40% of the principal amount of the PIK Notes. The option expires on March 19, 1996 and may be extended to June 21, 1996.\nThe Partnership's cash debt service requirement was approximately $36.7 million in 1995 and the Partnership anticipates that approximately $37.8 million in cash will be required during 1996 to meet its debt service obligations.\nFor the years ended December 31, 1995 and 1994, the Partnership had a working capital surplus of $600,000 and a working capital deficit of $1.0 million, respectively. The Partnership believes that this level of working capital is adequate to sustain existing operations in the foreseeable future.\nManagement believes, based upon its current level of operations, that although the Partnership is highly leveraged, it will continue to have the ability to pay interest on its indebtedness and to pay other liabilities with funds from operations for the foreseeable future. However, there can be no assurance to that effect, as the Partnership's operating results are subject to numerous factors outside its control, including, without limitation, competition from within the Atlantic City market, from other gaming jurisdictions, and from the Other Trump Casinos; general economic conditions; weather and its effect on the ability of patrons to travel to Atlantic City; and, the slot machine and table game win percentages, which can vary significantly over a short-term time period. In the event that circumstances change, the Partnership may seek to obtain a working capital facility of up to $10 million, although there can be no assurance that such financing will be available on terms acceptable to the Partnership.\nThe ability of Funding and the Partnership to pay their indebtedness when due, will depend on their ability to either generate cash from operations sufficient for such purposes or to refinance such indebtedness on or before the date on which it becomes due. The Partnership does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amounts of the Mortgage Notes and the PIK Notes. Thus, the repayment of the principal amount of this indebtedness will likely depend primarily upon the ability of Funding and the Partnership to refinance this debt when due. The future operating performance of the Partnership and the ability to refinance this debt will be subject to the then prevailing economic conditions, industry conditions, and numerous other financial, business, and other factors, many of which are beyond the control of Funding or the Partnership. There can be no\nassurance that the future operating performance of the Partnership will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally, or the receptiveness of the capital markets to the gaming industry will be conducive to refinancing this debt or other attempts to raise capital.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAn index to financial statements and required financial statement schedules is set forth at Item 14.\nITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nAll decisions affecting the business and affairs of the Partnership, including the operation of Trump's Castle, are decided by the general partners acting by and through a Board of Partner Representatives, which includes a minority of Representatives elected indirectly by the holders of the Mortgage Notes and PIK Notes (the \"Board of Partner Representatives\"). As currently constituted, the Board of Partner Representatives consists of Donald J. Trump, Chairman, Nicholas L. Ribis, Roger P. Wagner, Robert M. Pickus, Asher O. Pacholder, Thomas F. Leahy, and Arthur S. Bahr. Messrs. Trump, Ribis, and Pickus also serve on the governing boards of Trump Taj Mahal Associates (\"TTMA\"), and Trump Plaza Associates (\"TPA\"). Messrs. Trump and Ribis also serve as directors and officers of Trump Hotels & Casino Resorts, Inc. (\"THCR\"), and Mr. Pickus serves as an officer of THCR.\nThe Partnership also has an Audit Committee on which Mr. Ribis serves with Mr. Leahy and Mr. Bahr, who have been appointed thereto in accordance with the requirements of the CCC. The Audit Committee reviews matters of policy, purpose, responsibilities and authority and makes recommendations with respect thereto on the basis of reports made directly to the Audit Committee. The Surveillance Department is responsible for the surveillance, detection, and video-taping of unusual and illegal activities in the casino hotel. The Internal Audit Department is responsible for the review of, reporting instances of noncompliance with, and recommending procedures to eliminate weakness in internal controls.\nThe sole director of Funding is Trump. Trump also serves as its Chairman of the Board, President, and Treasurer. Patricia M. Wild serves as its Secretary, and Robert E. Schaffhauser serves as its Assistant Treasurer.\nSet forth below are the names, ages, positions, and offices held with Funding and the Partnership, and a brief account of the business experience during the past five years of each member of the Board of Partner Representatives, the executive officers of Funding and the Partnership, and the director of Funding.\nDONALD J. TRUMP - Trump, 49 years old, has been the managing general partner of the Partnership and Chairman of the Board of Partner Representatives since May 1992 and Chairman of the Board, President and sole director of Funding since June 1985. Trump has been the President and sole director of TC\/GP since December 1993. Trump served as Chairman of the Executive Committee of the Partnership from June 1985 to May 1992 and as President and sole director of TC\/GP from November 1991 to May 1992. Trump has been a director and Treasurer of TCHI since April 17, 1985. Trump has been Chairman of the Board of THCR and its related funding company since their formation in 1995. Trump is the sole shareholder, Chairman of the Board of Directors, President, and Treasurer of TPFI, and the managing general partner of TPA. Trump was\nPresident and Chairman of the Board of Directors and a 50% shareholder of TP\/GP Corp. (\"TP\/GP\"), the former managing general partner of TPA, from May 1992 through June 1993; and Chairman of the Executive Committee and President of TPA from May 1986 to May 1992. Trump has been a director and President of TPHI and a partner in Trump Plaza Holding Associates (\"TPHA\") since February 1993. Trump was Chairman of the Executive Committee of 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; 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, 51 years old, has been a partner representative on the Board of Partner Representatives since May 1992 and Chief Executive Officer of Partnership since March 1991. Mr. Ribis has served as Vice President and Assistant Secretary of TCHI since December 1993 and January 1991, respectively. Mr. Ribis served as a member of the Executive Committee of the Partnership from April 1991 to May 1992 and as Secretary of TC\/GP from November 1991 to May 1992. Mr. Ribis has been President, Chief Executive Officer, Chief Financial Officer, and a director of THCR and its related funding company since their formation in 1995. Mr. Ribis has served as a director of TPHI since June 1993 and of TPFI since July 1993; as a director and Vice President of TP\/GP from May 1992 to June 1993; Chief Executive Officer of TPA since February 1991; and a member of the Executive Committee of TTMA since March to October 1991; and a 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 from February 1991 to December 1995 was 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. Mr. Ribis has been a member of the Board of Trustees of the CRDA since October 1993.\nROGER P. WAGNER - Mr. Wagner, 48 years old, has been a partner representative on the Board of Partner Representatives since May 1992 and President and Chief Operating Officer of the Partnership since January 1991. Mr. Wagner served as a member of the Executive Committee of the Partnership from January 1991 to May 1992. Mr. Wagner has been a director and president of TCHI since January 1991. Prior to joining the Partnership, Mr. Wagner served as President of the Claridge Hotel Casino from June 1985 to January 1991 and is presently the Chairman of the Casino Association of New Jersey.\nROBERT M. PICKUS - Mr. Pickus, 41 years old, has been a partner representative on the Board of Partner Representatives since October 1995, Executive Vice President of Corporate and Legal Affairs since February 1995, and Corporate Secretary since February 1996. He has also been the Executive Vice President of Corporate and Legal Affairs of Plaza Associates since February 16,\n1995. From December 1993 to February 1995, Mr. Pickus was the Senior Vice President and General Counsel of Plaza Associates and, since April 1994, he has been the Vice President and Assistant Secretary of Plaza Funding and Assistant Secretary of Plaza Holding, Inc. Mr. Pickus has been the Executive Vice President of Corporate and Legal Affairs of Taj Associates since February 1995, and a Class C Director of Taj Holding and TM\/GP since November, 1995. He was the Senior Vice President and Secretary of Trump's Castle Funding, Inc. from June 1988 until December 1993 and General Counsel of Trump's Castle Associates from June 1985 to June 1988. Mr. Pickus was also Secretary of Trump's Castle Associates from October 1991 until December 1993. Mr. Pickus has been Executive Vice President of Corporate and Legal Affairs of THCR since June of 1995.\nASHER O. PACHOLDER - Dr. Pacholder, 58 years old, has been a partner representative of the Board of Partner Representative since May 1992. Dr. Pacholder served as a director and the President of TC\/GP from May 1992 to December 1993. Dr. Pacholder has served as Chairman of the Board and Managing Director of Pacholder Associates, Inc., an investment advisory firm, since 1987. In addition, Dr. Pacholder serves on the Board of Directors of The Southland Corporation, United Gas Holding Corp., ICO, Incorporated, an oil field services company, UF&G Pacholder Fund, Inc., a publicly traded closed end mutual fund, U.S. Trails, Inc. a recreational facility company, and Forum Group, Inc., a retirement community managerial company.\nTHOMAS F. LEAHY - Mr. Leahy, 58 years old, has been a partner representative on the Board of Partner Representatives since June 1993. Mr. Leahy served as a director and Treasurer of TC\/GP from May 1992 to December 1993. From 1991 to July 1992, Mr. Leahy served as Executive Vice President of CBS Broadcast Group, a unit of CBS, Inc. Since November 1992, Mr. Leahy has served as President of The Theater Development Fund, a service organization for the performing arts. From July 1992 through November 1992, Mr. Leahy served as chairman of VT Properties, Inc., a privately- held corporation which invests in literary, state, and film properties.\nARTHUR S. BAHR - Mr. Bahr, 64 years old, has been a partner representative on the Board of Partner Representatives since June of 1995 and previously served as a director of TC\/GP from August 1993 to January of 1994. Mr. Bahr retired in February of 1994 after serving in various senior investment positions for General Electric Investment Corporation since 1970. Mr. Bahr serves on the Board of Directors of Renaissance Reinsurance and the Korean International Investment Fund.\nROBERT E. SCHAFFHAUSER - Mr. Schaffhauser, 49 years old, joined the Partnership as Senior Vice President of Finance in January 1994 and became Executive Vice President of Finance in January of 1995. He also became Assistant Treasurer, Chief Financial Officer, and Chief Accounting Officer of Funding, and Assistant Treasurer of TCHI and TC\/GP in January 1994. He served as a consultant to Trump during 1993. Mr. Schaffhauser previously\nserved as Senior Vice President of Finance and Administration for the Sands Hotel & Casino in Atlantic City for four years. For a period of 13 years prior thereto, he served as the Chief Financial Officer and Secretary for Metex Corporation, a publicly held manufacturer of engineered products. Mr. Schaffhauser also served as a member of Metex Corporation's Board of Directors.\nMARK A. BROWN - Mr. Brown, 35 years old, joined the Partnership as Executive Vice President of Operations in July of 1995. Previously, Mr. Brown served as Senior Vice President of Eastern Operations for Caesars World Marketing Corporation, National and International Divisions from 1993 until 1995. Prior to that, Mr. Brown served as Vice President of Casino Operations at Trump Taj Mahal from 1989 until 1993. From 1979 until 1989, Mr. Brown worked for Resorts International Hotel Casino departing as Casino Shift Manager in December 1989.\nPATRICIA M. WILD - Ms. Wild, 43 years old, has been Secretary of Funding and Senior Vice President and General Counsel of the Partnership and Secretary of TCHI since December 1993. Ms. Wild served as Assistant Secretary of TPFI and Vice President, General Counsel of TPA from February 1991 to December 1993; Vice President and General Counsel of TPFI from July 1992 through December 1993; and Associate General Counsel of TPA from May 1989 through January 1991. From December 1986 to April 1989, Ms. Wild served as Deputy Attorney General on the Environmental Prosecutions Task Force of the New Jersey Department of Law and Public Safety, Division of Criminal Justice. From April 1983 to December 1986, Ms. Wild served as Deputy Attorney General with the New Jersey Division of Gaming Enforcement.\nJOHN P. BURKE - Mr. Burke, 48 years old, has been the Corporate Treasurer of the Partnership and TPA since October 1991. Mr. Burke has been Chief Accounting Officer of TC\/GP since May 1992. Mr. Burke has been a Vice President of TCHI, TC\/GP, Funding and the Partnership since December 1993. Mr. Burke has been Vice President of the Trump Organization since September 1990. Since June 1995, Mr. Burke has been the Corporate Treasurer of THCR. He has also been Corporate Treasurer of Plaza Associates and Taj Associates since October 1991. Mr. Burke has been a Class C Director of TM\/GP and Taj Holding, and Vice President of TM\/GP 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.\nEach member of the Board of Partner Representatives, of the Audit Committee and all of the other persons listed above have been licensed or found qualified by the CCC.\nThe employees of the Partnership serve at the pleasure of the Board of Partner Representatives subject to any contractual rights contained in any employment agreement. The officers of Funding serve at the pleasure of Donald J. Trump, the sole director of Funding.\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, and John P. Burke served as directors of TPA and its affiliated entitled, 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 April 30, 1992, and declared effective on May 29, 1992. Donald J. Trump, Nicholas L. Ribis, Roger P. Wagner, 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 May 5, 1992, and was declared effective on May 29, 1992. Donald J. 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 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, 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. EXECUTIVE COMPENSATION\nExecutive officers of Funding do not receive any additional compensation for serving in such capacity. In addition, Funding 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, 1995, 1994, and 1993 to the Chief Executive Officer, and 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, 1995. 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.\nEMPLOYMENT AGREEMENTS. In September 1993, the Partnership entered into 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 also acts as Chief Executive Officer of TTMA and TPA, the Partnerships that own the Other Trump Casinos, and THCR which owns TPA and certain other gaming interests, and receives additional compensation from such entities. Mr. Ribis devotes approximately one-quarter of his professional time to the affairs of the Partnership. All other executive officers of the Partnership, except Messrs. Burke and Pickus, devote substantially all of their time to the business of the Partnership.\nThe Partnership, on January 17, 1991, entered into an employment agreement with Roger P. Wagner, with an amendment thereto dated January 17, 1991, and a second amendment thereto dated July 18, 1992, pursuant to which Mr. Wagner serves as the Partnership's and TCHI's President and Chief Operating Officer. Mr. Wagner's employment agreement, which terminates on January 16, 1997, provides for an annual salary beginning at a minimum of $400,000 until January 16, 1994, thereafter $500,000 per year until January 16, 1995, thereafter $600,000 per year until January 16, 1996, and thereafter $750,000 per year from January 17, 1996 until January 16, 1997 and, subject to CCC approval, 1% of the Partnership's Income from Operations (as defined in such agreement) in excess of $40.0 million.\nThe Partnership, on June 16, 1995, entered into a severance agreement with Robert E. Schaffhauser. Pursuant to the terms of this agreement Mr. Schaffhauser is to receive from the Partnership, if terminated by the Partnership for any reason other than cause as defined, an amount equal to twelve months of Mr. Schaffhauser's then current salary.\nThe Partnership, on July 10, 1995, entered into an employment agreement with Mark A. Brown pursuant to which Mr. Brown serves as the Partnership's Executive Vice President of Operations. The term of the agreement is three years. This employment agreement provides for an annual base salary of $350,000, a $75,000 bonus paid at the commencement of employment, and an annual bonus of no less than $75,000 per year over the three year term of the agreement.\nThe Partnership entered into an employment agreement with Patricia M. Wild pursuant to which, effective December 6, 1993, Ms. Wild serves as the Partnership's Senior Vice President\/General Counsel. The term of the agreement is one year and, in accordance\nwith the terms of the agreement, is automatically extended on a weekly basis so that at all times the term of the agreement shall be an unexpired period of twelve months. This employment agreement provides for an annual base salary of $115,000 reviewed on an annual basis.\nCOMPENSATION OF DIRECTORS. Each Partner Representative of the Partnership (other than Messrs. Trump, Ribis, Wagner, and Pickus) receives an annual fee of $50,000. In addition, each Partner Representative of the Partnership (other than Messrs. Trump, Ribis, Pickus, and Wagner) receives $2,500 per meeting attended, plus reasonable out-of-pocket expenses incurred in attending any meeting of the Board.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. In general, the compensation of executive officers of the Partnership is determined by the Board of Partner Representatives, which is composed of Donald J. Trump, Nicholas L. Ribis, Roger P. Wagner, Asher O. Pacholder, Thomas F. Leahy, Arthur S. Bahr, and Robert M. Pickus. The compensation of Nicholas L. Ribis and Roger P. Wagner is set forth in their employment agreements with the Partnership. The Partnership has delegated the responsibility over certain matters, such as the bonus of Mr. Ribis, to Mr. Trump. Executive officers of Funding do not receive any additional compensation for serving in such capacity.\nThe SEC requires issuers 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, Wagner, Pickus, and Burke, executive officers of the Partnership, serve on the Board of Directors of other entities in which members of the Board of Partner Representatives (namely, Messrs. Trump, Ribis, Wagner, and Pickus) serve as executive officers. The Partnership believes that such relationships have not affected the compensation decisions made by the Board of Partner Representatives in the last fiscal year.\nMessrs. Trump and Wagner serve as directors of TCHI, of which Messrs. Trump, Ribis, and Wagner serve as executive officers.\nMessrs. Trump, Ribis, Pickus, 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, Ribis, and Pickus 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, Ribis, and Pickus 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 Mr. Trump is an executive officer. Mr.\nTrump, however, does not receive any compensation for serving as an executive officer of Taj Realty Corp.\nMessrs. Trump and Ribis serve on the Board of Directors of TPFI, the managing general partner of TPA, of which Messrs. Trump, Ribis, and Pickus are executive officers. Messrs. Trump and Ribis also serve on the Board of Directors of TPHI, of which such persons are also executive officers. Mr. Ribis is compensated by TPA for his services as chief executive officer.\nMessrs. Trump and Ribis serve on the Board of Directors of THCR, of which Mr. Trump is Chairman of the Board. Messrs. Ribis, Pickus and Burke are executive officers of THCR and are compensated for their services by THCR.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information with respect to the amount of Funding's Common Stock owned by beneficial owners of more than 5% of Funding's Common Stock. Funding has no other class of equity securities outstanding.\nAmount and Nature Name and Address of of Beneficial Percent Title or Class Beneficial Owners Ownership of Class ______________ ___________________ _________________ ________\nCommon Stock Trump's Castle 200 shares 100% Associates Huron Avenue and Brigantine Blvd. Atlantic City, New Jersey 08401\nCurrently, Trump, TC\/GP and TCHI hold 61.5%, 37.5%, and 1.0% interests, respectively, in the Partnership and therefore are the beneficial owners of all of the outstanding shares of Common Stock of Funding.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOTHER TRUMP CASINOS. The following table sets forth the amounts due to the Partnership from Trump and his other affiliated casino entities as of December 31, 1995. For a more detailed description of these transactions, see \"Other Transactions with Affiliates\" below.\nAmount Due and Outstanding to the Partnership as of December 31, 1995 __________________________\nTrump Plaza Associates. . . . . . . . . . . .$ 720,000 Trump Taj Mahal Associates. . . . . . . . . . 164,000 The Trump Organization. . . . . . . . . . . . 262,000 _________ Total Due from Affiliates as of December 31, 1995. . . . . . . . .$1,146,000 ==========\nOTHER TRANSACTIONS WITH AFFILIATES. The Partnership has engaged in transactions with TPA, TTMA, and the Trump Organization (\"TO\") which are affiliates of Trump. These transactions include certain shared payroll costs, fleet maintenance and limousine services, as well as complimentary services offered to customers, for which the Partnership makes the initial payment and is then reimbursed by the appropriate affiliated entity. During 1995, the Partnership incurred expenses of approximately $1,673,000 in corporate salaries, and $1,109,000 of other transactions on behalf of these related entities. In addition, the Partnership received payments totalling $1,401,000 for services rendered and had $580,000 of deductions for similar services incurred by these related entities on behalf of the Partnership.\nSERVICES AGREEMENT. On December 28, 1993, the Partnership terminated the existing management agreement with a corporation wholly-owned by Trump and entered into a Services Agreement with TC\/GP (the \"Services Agreement\"). In general, the Services Agreement obligates TC\/GP 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 related services (the \"Services\") with respect to the business and operations of the Partnership, in exchange for certain fees to be paid only in those years in which EBITDA (EBITDA represents income from operations before depreciation, amortization, restructuring costs and the non-cash write-down of CRDA investments) exceeds prescribed amounts.\nIn consideration for the Services to be rendered by TC\/GP, the Partnership will pay an annual fee (which is identical to the fee which was payable under the previously existing management agreement) to TC\/GP in the amount of $1,500,000 for each year in which EBITDA exceeds the following amounts for the years indicated: 1993 - $40,500,000; 1994 - $45,000,000; 1995 and\nthereafter - $50,000,000. If EBITDA in any fiscal year does not exceed the applicable amount, no annual fee is due. In addition, TC\/GP will be entitled to an incentive fee beginning with the fiscal year ending December 31, 1994 in an amount equal to 10% of EBITDA in excess of $45,000,000 for such fiscal year. The Partnership will also be required to advance to TC\/GP $125,000 a month which will be applied toward the annual fee, provided, however, that no advances will be made during any year if and for so long as the Managing Partner (defined in the Services Agreement as Trump) determines, in his good faith reasonable judgment, that the Partnership's budget and year-to-date performance indicate that the minimum EBITDA levels (as specified above) for such year will not be met. If for any year during which annual fee advances have been made it is determined that the annual fee was not earned, TC\/GP will be obligated to promptly repay any amounts previously advanced. For purposes of calculating EBITDA under the Services Agreement, any incentive fees paid in respect of 1994 or thereafter shall not be deducted in determining net income.\nDuring the year ended 1995, the Partnership recorded fees of approximately $2,087,000 under the Services Agreement.\nUnless sooner terminated pursuant to its terms, the Services Agreement will expire on December 31, 2005.\nOTHER PAYMENTS TO TRUMP. During 1994, the Board of Partners Representatives approved a $1,000,000 bonus to be paid to Trump based upon 1994 operating results. The amount was paid in two equal installments in June and August 1995. No such bonus was approved for 1995.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) Financial Statements. See the Index immediately following the signature page.\n(B) Reports on Form 8-K. Funding did not file any reports on Form 8-K during the last quarter of the year ended December 31, 1995.\n(C) Exhibits. All exhibits listed below are filed with this Annual Report on Form 10-K unless specifically stated to be incorporated by reference to other documents previously filed with the Securities and Exchange Commission.\nEXHIBIT\n3(1) -Amended and Restated Certificate of Incorporation of Funding.\n3.1(1) -Bylaws of Funding.\n3.2-3.6 -Intentionally omitted.\n3.7(2) -Second Amended and Restated Partnership Agreement of the Partnership.\n4.1-4.10 -Intentionally omitted.\n4.11(2) -Indenture, among Funding, as issuer, the Partnership, as guarantor, and the Mortgage Note Trustee, as trustee.\n4.12(2) -Indenture of Mortgage between the Partnership, as Mortgagor, and Funding, as Mortgagee.\n4.13(2) -Assignment Agreement between Funding and the Mortgage Note Trustee.\n4.14(2) -Partnership Note.\n4.15 -Form of Mortgage Note (included in Exhibit 4.11).\n4.16 -Form of Partnership Guarantee (included in Exhibit 4.11).\n4.17(2) -Indenture between Funding, as issuer, the Partnership, as guarantor, and the PIK Note Trustee, as trustee.\n4.18(2) -Pledge Agreement between Funding and the PIK Note Trustee.\n4.19(2) -Subordinated Partnership Note.\n4.20 -Form of PIK Note (included in Exhibit 4.17).\n4.21 -Form of Subordinated Partnership Guarantee (included in exhibit 4.17).\n4.22(1) -Letter Agreement between the Partnership and the Proposed Senior Secured Note Purchasers regarding the Senior Secured Notes.\n4.23(2) -Note Purchase Agreement for 11-1\/2% Series A Senior Secured Notes of the Partnership due 1999.\n4.24(2) -Indenture, among Funding, as issuer, the Partnership, as guarantor, and the Senior Secured Note Trustee, as trustee.\n4.25(2) -Indenture of Mortgage and Security Agreement between the Partnership, as mortgagor\/debtor, and Funding as mortgagee\/secured party. (Senior Note Mortgage).\n4.26(2) -Registration Rights Agreement by and among the Partnership and certain purchasers.\n4.27 -Intentionally omitted.\n4.28(2) -Guarantee Mortgage.\n4.29(2) -Senior Partnership Note.\n4.30(2) -Indenture of Mortgage and Security Agreement between the Partnership as mortgagor\/debtor and the Senior Note Trustee as mortgagee\/secured party. (Senior Guarantee Mortgage).\n4.31(2) -Assignment Agreement between Funding, as assignor, and the Senior Note Trustee, as assignee. (Senior Assignment Agreement).\n4.32(2) -Amended and Restated Nominee Agreement.\n10.1-10.2 -Intentionally omitted.\n10.3(3) -Employment Agreement dated January 17, 1991, between the Partnership and Roger P. Wagner.\n10.4(4) -Second Amendment to Employment Agreement dated January 17, 1991 between the Partnership, TCHI, and Roger P. Wagner.\n10.5(5) -Form of License Agreement between the Partnership and Donald J. Trump.\n10.6-10.10 -Intentionally omitted.\n10.11(2) -Employment Agreement, between the Partnership and Nicholas Ribis.\n10.12(6) -Trump's Castle Hotel & Casino Retirement Savings Plan, effective as of September 1, 1986.\n10.13-10.18 -Intentionally omitted.\n10.19(3) -Lease Agreement by and between State of New Jersey acting through its Department of Environmental Protection, Division of Parks and Forests, as Landlord, and the Partnership, as tenant, dated September 1, 1990.\n10.20-10.26 -Intentionally omitted.\n10.27(1) -Services Agreement.\n10.28-10.31 -Intentionally omitted.\n10.32(7) -Employment Agreement dated December 20, 1993, between Patricia M. Wild and the Partnership\n10.33 -Intentionally Omitted.\n10.34(7) -Amended and Restated Credit Agreement, dated as of December 28, 1993, among Midlantic, the Partnership and Funding.\n10.35(7) -Amendment No. 1 to Amended and Restated Indenture of Mortgage, between the Partnership, as Mortgagor and Midlantic, as Mortgagee.\n10.36(7) -Amended and Restated Indenture of Mortgage, between the Partnership, as Mortgagor and Midlantic, as Mortgagee, dated as of May 29, 1992.\n10.37(7) -Amendment No. 1 to Amended and Restated Assignment of Leases and Rents, between the Partnership, as assignor, and Midlantic, as assignee.\n10.38(7) -Amended and Restated Assignment of Leases and Rents, between the Partnership, as assignor, and Midlantic, as assignee, dated as of May 29, 1992.\n10.39(7) -Amendment No. 1 to Amended and Restated Assignment of Operating Assets, between the Partnership, as assignor and Midlantic, as assignee.\n10.40(7) -Amended and Restated Assignment of Operating Assets, between the Partnership, as assignor, and Midlantic, as assignee, dated as of May 29, 1992.\n10.41(7) -Intercreditor Agreement, by and among Midlantic, the Senior Note Trustee, the Mortgage Note Trustee, the PIK Note Trustee, Funding and the Partnership.\n10.42(8) -Option Agreement, dated as of June 23, 1995, between Hamilton Partners, L.P. and the Partnership.\n10.43(9) -Form of Amended and Restated Term Note, dated as of May 28, 1995, between Midlantic Bank, N.A. and the Partnership.\n10.44 -Severance Agreement dated June 16, 1995, between Robert E. Schaffhauser and the Partnership.\n10.45 -Employment Agreement dated July 10, 1995, between Mark A. Brown and the Partnership. _________________\n(1) Incorporated herein by reference to the Exhibit to Funding's and the Partnership's Registration Statement on Form S-4, Registration No. 33-68038.\n(2) Incorporated herein by reference to the Exhibit to Amendment No. 5 to the Schedule 13E-3 of TC\/GP and the Partnership, File No. 5-36825, filed with the SEC on January 11, 1994.\n(3) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1990.\n(4) Incorporated herein by reference to the Exhibit to Funding's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n(5) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1991.\n(6) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1986.\n(7) Incorporated herein by reference to the identically numbered Exhibit to Funding's Registration Statement on Form S-4, Registration Number 33-52309 filed with the SEC on February 17, 1994.\n(8) Incorporated herein by reference to the identically numbered Exhibit to Funding's and the Partnership's Current Report on Form 8-K dated as of June 23, 1995.\n(9) Incorporated herein by reference to the identically numbered Exhibit to Funding's and the Partnership's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.\nReport of Independent Public Accountants\nConsolidated Balance Sheets of Trump's Castle Associates and Subsidiary as of December 31, 1995 and 1994\nConsolidated Statements of Operations of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Partners' Capital of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements of Trump's Castle Associates and Subsidiary\nSchedule\nII Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994, and 1993\nOther Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the combined financial statements or notes thereto.\nArthur Andersen LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Trump's Castle Associates and Subsidiary:\nWe have audited the accompanying consolidated balance sheets of Trump's Castle Associates (a New Jersey general partnership) and Subsidiary 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 schedule referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and 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 Trump's Castle Associates 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 ending 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 the financial statements 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 our audits of the basic financial statements, and in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN, LLP\nRoseland, New Jersey February 16, 1996\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nA\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nB\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nTRUMP'S CASTLE ASSOCIATES AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ORGANIZATION AND OPERATIONS:\nThe accompanying consolidated financial statements include those of Trump's Castle Associates, a New Jersey general partnership (the \"Partnership\") and its wholly-owned subsidiary, Trump's Castle Funding, Inc., a New Jersey corporation (\"Funding\"). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.\nThe Partnership was formed as a limited partnership in 1985 for the sole purpose of acquiring and operating Trump's Castle Casino Resort (\"Trump's Castle\"). The Partnership converted to a general partnership in February 1992. Trump's Castle is a luxury casino hotel located in the Marina District of Atlantic City, New Jersey. A substantial portion of Trump's Castle's revenues are derived from its gaming operations. Competition in the Atlantic City gaming market is intense and the Partnership believes that the competition will continue as new entrants to the gaming industry become operational.\nThe partners in the Partnership are TC\/GP, Inc. (\"TC\/GP\"), which has a 37.5% interest in the Partnership, Donald J. Trump (\"Trump\"), who has a 61.5% interest in the Partnership, and Trump's Castle Hotel & Casino, Inc. (\"TCHI\"), which has a 1% interest in the Partnership. Trump, by virtue of his ownership of TC\/GP and TCHI, is the beneficial owner of 100% of the common equity interest in the Partnership, subject to the right of holders of warrants for 50% of the common stock of TCHI (the \"TCHI Warrants\") to acquire an indirect beneficial interest in 0.5% of the common equity interest in the Partnership. Trump has pledged his direct and indirect ownership interest in the Partnership as collateral under various personal debt agreements.\nFunding was incorporated on May 28, 1985 solely to serve as a financing company to raise funds through the issuance of bonds to the public (Note 4). Since Funding has no business operations, its ability to repay the principal and interest on the 11-1\/2% Senior Secured Notes due 2000 (the \"Senior Notes\"), the 11-3\/4% Mortgage Notes due 2003 (the \"Mortgage Notes\"), and its Increasing Rate Subordinated Pay-in-Kind Notes due 2005 (the \"PIK Notes\") is completely dependent upon the operations of the Partnership.\n(2) PLAN OF RECAPITALIZATION:\nOn December 28, 1993, the Partnership, Funding, and TC\/GP consummated a recapitalization plan (the \"Recapitalization Plan\") whereby each $1,000 of principal of the 9.5% Mortgage Bonds issued as part of an earlier plan of reorganization was exchanged for\n$750 principal amount of Funding's Mortgage Notes, $120 principal amount of Funding's PIK Notes, and a cash payment of $6.19 plus all accrued and unpaid interest. Those bondholders who did not elect to exchange their Mortgage Bonds received a cash payment in redemption of their Mortgage Bonds of $750 for each $1,000 of principal amount of bonds plus accrued and unpaid interest. In addition, each share of TC\/GP common stock was exchanged for $35 principal amount of PIK Notes.\nAs a result of the Recapitalization Plan, approximately 96% of the principal amount of the previously issued Mortgage Bonds were exchanged for Mortgage Notes and PIK Notes and the TC\/GP common stock was redeemed. Those Bonds that were redeemed for cash were purchased at an amount which approximated their net book value at the date of purchase. The net book value of the exchanged Bonds has been carried forward and allocated to the Mortgage Notes and PIK Notes in proportion to the principal amount of Mortgage Notes and PIK Notes issued. The difference between the principal amount and net book value of these Mortgage Notes and PIK Notes is being accreted as a charge to interest expense over the life of the Mortgage Notes and PIK Notes using the effective interest method.\nIn addition to the Mortgage Notes and PIK Notes, Funding issued $27,000,000 of the Senior Notes. A portion of the proceeds from the Senior Notes were used to repay $7,000,000 of outstanding indebtedness.\nTransaction costs related to the Recapitalization Plan of approximately $9,000,000 were included in interest expense. Included in these costs was a $1,500,000 bonus to Trump for the services he provided in connection with the Recapitalization Plan.\n(3) ACCOUNTING POLICIES:\nPERVASIVENESS OF ESTIMATES\nThe preparation of these financial statements in conformity with generally accepted accounting principals 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 reporting period. Actual results may differ from these estimates.\nREVENUE RECOGNITION\nCasino revenues consist of the net win from gaming activities, which is the difference between gaming wins and losses. Revenues from hotel and other services are recognized at the time the related services are performed.\nThe Partnership provides an allowance for doubtful accounts arising from casino, hotel, and other services, which is based\nupon a specific review of certain outstanding receivables and historical collection performance. In determining the amount of the allowance, the Partnership is required to make certain estimates and assumptions and actual results may differ from these estimates and assumptions.\nPROMOTIONAL ALLOWANCES\nGross revenues include the retail value of the complimentary food, beverage, and hotel services provided to patrons. The retail value of these promotional allowances is deducted from gross revenues to arrive at net revenues. The cost of such complimentaries have been included in gaming costs and expenses in the accompanying consolidated statements of operations. The estimated departmental costs of providing such promotional allowances are included in gaming costs and expenses and are as follows:\n1995 1994 1993 ___________ ___________ ___________ Rooms $ 6,261,000 $ 6,554,000 $ 5,834,000 Food and Beverage 18,240,000 17,342,000 17,332,000 Other 2,483,000 2,693,000 2,073,000 ___________ ___________ ___________ $26,984,000 $26,589,000 $25,239,000 =========== =========== ===========\nINCOME TAXES\nThe accompanying consolidated financial statements do not include a provision for Federal income taxes of the Partnership, since any income or losses allocated to the partners are reportable for Federal income tax purposes by the Partners.\nUnder the Casino Control Act (the \"Act\") and the regulations promulgated thereunder, the Partnership and Funding are required to file a consolidated New Jersey corporation business tax return.\nAs of December 31, 1995, the Partnership had New Jersey State net operating losses of approximately $162,000,000, which are available to offset taxable income through the year 2002. The net operating loss carryforwards result in a deferred tax asset of $15,200,000, which has been offset by a valuation allowance of $15,200,000, as utilization of such carryforwards is not considered to be more likely than not.\nINVENTORIES\nInventories of provisions and supplies are carried at the lower of cost (first-in, first-out basis) or market.\nPROPERTY AND EQUIPMENT\nProperty and equipment is recorded at cost and is depreciated\non the straight-line method over the estimated useful lives of the assets. Estimated useful lives for furniture, fixtures, and equipment and buildings are from three to eight years and forty years, respectively.\nLONG LIVED ASSETS\nDuring 1995, the Partnership 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, the Partnership does not believe that any impairment exists in the recoverability of its long lived assets.\nSTATEMENTS OF CASH FLOWS\nFor purposes of the statements of cash flows, Funding and the Partnership consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nThe following supplemental disclosures are made to the statements of cash flows:\n1995 1994 1993 Cash paid during the ___________ ___________ ___________ year for interest (net of amounts capitalized) $35,338,000 $31,255,000 $44,857,000 =========== =========== ===========\nIssuance of debt in exchange for accrued $ 7,766,000 $ 3,559,000 $ -- interest =========== =========== ===========\nRECLASSIFICATION\nCertain reclassifications have been made to the 1994 and 1993 financial statements in order to conform to the classifications used in 1995.\n(4) MORTGAGE NOTES AND PIK NOTES:\nAs discussed in Note 2, On December 28, 1993 all of the outstanding Mortgage Bonds and TC\/GP common stock were either redeemed or exchanged for Mortgage Notes and PIK Notes by Funding. The Mortgage Notes bear interest, payable in cash, semi-annually, at 11-3\/4% and mature on November 15, 2003. As discussed in Note 2, the net book value of the exchanged bonds has been carried forward and allocated to the Mortgage Notes and PIK Notes in proportion to the principal amount of Mortgage Notes and PIK Notes\nissued. In the event the PIK Notes are redeemed prior to November 15, 1998, the interest rate on the Mortgage Notes will be reduced to 11-1\/2%. The Mortgage Notes may be redeemed at Funding's option at a specified percentage of the principal amount commencing in 1998.\nThe PIK Notes bear interest payable, at Funding's option in whole or in part in cash and through the issuance of additional PIK Notes, semi-annually at the rate of 7% through September 30, 1994 and 13-7\/8% through November 15, 2003. After November 15, 2003, interest on the Notes is payable in cash at the rate of 13-7\/8%. The PIK Notes mature on November 15, 2005. The PIK Notes may be redeemed at Funding's option at 100% of the principal amount under certain conditions, as defined in the PIK Note Indenture, and are required to be redeemed from a specified percentage of any equity offering which includes the Partnership. Interest has been accrued using the effective interest method. On May 15, 1995 and November 15, 1995, the semi-annual interest payments of $3,753,000 and $4,013,000, respectively, were paid by the issuance of additional PIK Notes.\nOn June 23, 1995, the Partnership entered into an Option Agreement with Hamilton Partners, L.P. (\"Hamilton\") which grants the Partnership an option (the \"Option\") to acquire the PIK Notes owned by Hamilton. Hamilton has represented to the Partnership that it is the owner of at least 92% of the outstanding principal amount of the PIK Notes. The Option was granted to the Partnership in consideration of a $1,100,000 payment to Hamilton, which is included in prepaid expenses and other current assets.\nThe Option is exercisable at a price equal to 60% of the aggregate principal amount and accrued interest of the PIK Notes delivered by Hamilton. Pursuant to the terms of the Option Agreement, upon the occurrence of certain events within 18 months of the time the Option is exercised, the Partnership is required to make an additional payment to Hamilton of up to 40% of the principal amount of the PIK Notes. The option expires on March 19, 1996 and may be extended to June 21, 1996.\nThe terms of both the Mortgage Notes and PIK Notes include limitations on the amount of additional indebtedness the Partnership may incur, distributions of Partnership capital, investments, and other business activities.\nThe Mortgage Notes are secured by a promissory note of the Partnership to Funding (the \"Partnership Note\") in an amount and with payment terms necessary to service the Mortgage Notes. The Partnership Note is secured by a mortgage on Trump's Castle and substantially all of the other assets of the Partnership. The Partnership Note has been assigned by Funding to the Trustee to secure the repayment of the Mortgage Notes. In addition, the Partnership has guaranteed (the \"Guaranty\") the payment of the Mortgage Notes, which Guaranty is secured by a mortgage on Trump's Castle. The Partnership Note and the Guaranty are expressly subordinated to the indebtedness described in Note 5 (the \"Senior Indebtedness\") and the liens of the mortgages securing the\nPartnership Note and the Guaranty are subordinate to the liens securing the Senior Indebtedness.\nThe PIK Notes are secured by a subordinated promissory note of the Partnership to Funding (the \"Subordinated Partnership Note\"), which has been assigned to the Trustee for the PIK Notes, and the Partnership has issued a subordinated guaranty (the \"Subordinated Guaranty\") of the PIK Notes. The Subordinated Partnership Note and the Subordinated Guaranty are expressly subordinated to the Senior Indebtedness, the Partnership Note, and the Guaranty.\nThe ability of Funding and the Partnership to pay their indebtedness when due, will depend on their ability to either generate cash from operations sufficient for such purposes or to refinance such indebtedness on or before the date on which it becomes due. The Partnership does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amounts of the Mortgage Notes and the PIK Notes when due. Thus, the repayment of the principal amount of this indebtedness will likely depend primarily upon the ability of Funding and the Partnership to refinance this debt when due. The future operating performance of the Partnership and the ability to refinance this debt will be subject to the then prevailing economic conditions, industry conditions, and numerous other financial, business, and other factors, many of which are beyond the control of Funding or the Partnership. There can be no assurance that the future operating performance of the Partnership will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally, or the receptiveness of the capital markets to the gaming industry will be conducive to refinancing this debt or other attempts to raise capital.\n(5) OTHER BORROWINGS:\nBANK BORROWINGS\nThe Partnership has a term loan with Midlantic National Bank (the \"Term Loan\") in the amount of $38,000,000. The Term Loan had an initial maturity date of May 29, 1995 and under its terms, the Partnership had the option, subject to certain conditions, to extend the Term Loan an additional five years. The Partnership exercised its option to extend the Term Loan on May 28, 1995. The interest rate was revised to be a fluctuating rate of 3% above the bank's prime rate, which was 8.5% at December 31, 1995, but in no event less than 9% per annum. In addition, the outstanding principal amount of the Term Loan will be amortized over the five- year extension period on a twenty year amortization schedule requiring principal payments of approximately $158,000 per month over the period. At December 31, 1995, $36,892,000 was outstanding on this Term Loan.\nThe Term Loan is secured by a mortgage lien on Trump's Castle that is prior to the lien securing the Mortgage Notes (Note 4) and the Senior Notes described below.\nSENIOR NOTES\nOn December 28, 1993, Funding issued the Senior Notes. Similar to the Mortgage Notes, the Senior Notes are secured by an assignment of a promissory note of the Partnership (the \"Senior Partnership Note\") which is in turn secured by a mortgage on Trump's Castle and substantially all of the other assets of the Partnership. In addition, the Partnership has guaranteed (the \"Senior Guaranty\") the payment of the Senior Notes, which Senior Guaranty is secured by a mortgage on Trump's Castle. The Senior Partnership Note and the Senior Guaranty are subordinated to the Term Loan described above.\nInterest on the Senior Notes is payable semiannually at the rate of 11-1\/2%; however in the event that the PIK Notes are redeemed prior to November 15, 1998, the interest rate will be reduced to 11-1\/4%. The Senior Notes are subject to a required partial redemption, as defined, commencing on June 1, 1998 at 100% of the principal amount of the amount redeemed.\n(6) RELATED PARTY TRANSACTIONS:\nTRUMP MANAGEMENT FEE\nThe Partnership had a management agreement (the \"Management Agreement\") with Trump's Castle Management Corp. (\"TCMC\"), a corporation wholly-owned by Trump. The Management Agreement provided that the day-to-day operation of Trump's Castle and all ancillary properties and businesses of the Partnership was to be under the exclusive management and supervision of TCMC.\nPursuant to the Management Agreement, the Partnership was required to pay an annual fee in the amount of $1,500,000 to TCMC for each year in which Earnings Before Interest, Taxes, Depreciation, and Amortization (\"EBITDA\"), as defined, exceeds certain levels. In addition, TCMC, beginning with the fiscal year ended December 31, 1994, was to receive an incentive fee equal to 10% of the excess EBITDA over $45,000,000 for such fiscal year. During the year ended December 31, 1993, the Partnership incurred fees and expenses of $1,647,000 under the Management Agreement.\nAs a result of the Recapitalization Plan described in Note 2, on December 28, 1993, the Partnership terminated the Management Agreement with TCMC and entered into a services agreement (the \"Services Agreement\") with TC\/GP. Pursuant to the terms of the Services Agreement, TC\/GP is obligated to provide 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 with respect to the business and operations of the Partnership, including such other services as the Managing Partner may reasonably request.\nIn consideration for the services to be rendered, the Partnership will pay TC\/GP an annual fee on the same basis as that of the previous Management Agreement, discussed above. During the\nyears ended December 31, 1995 and 1994, the Partnership incurred fees and expenses of $2,087,000 and $2,111,000, respectively, under the Services Agreement. The Services Agreement expires on December 31, 2005.\nOTHER PAYMENTS TO TRUMP\nDuring 1994, the Board of Partner Representatives approved a $1,000,000 bonus to be paid to Trump, based upon 1994 operating results. The amount was paid in two equal installments in June and August 1995. No such bonus was approved for 1995.\nDUE FROM AFFILIATES\nAmounts due from affiliates were $1,146,000 and $434,000 as of December 31, 1995 and 1994, respectively. The Partnership has engaged in limited intercompany transactions with Trump Plaza Associates, Trump Taj Mahal Associates, and the Trump Organization, which are affiliates of Trump. These transactions include certain shared payroll costs as well as complimentary services offered to customers, for which the Partnership makes initial payments and is then reimbursed by the affiliates.\nDuring 1995, 1994, and 1993, the Partnership incurred expenses of approximately $1,673,000, $1,631,000, and $1,332,000, respectively, in corporate salaries and $1,109,000, $1,047,000, and $952,000, respectively, of other transactions on behalf of these related entities. In addition, the Partnership received payments totaling $1,401,000, $2,438,000, and $2,004,000, respectively, for services rendered and had $580,000, $441,000, and $407,000, respectively, of charges for similar costs incurred by these related entities on behalf of the Partnership.\nPARTNERSHIP AGREEMENT\nUnder the terms of the Partnership Agreement, the Partnership was required to pay all costs incurred by TC\/GP. For the years ended December 31, 1995, 1994, and 1993, the Partnership paid $1,248,000, $1,188,000, and $736,000, respectively, of expenses on behalf of TC\/GP. For the years ended December 31, 1995 and 1994 these costs were charged to general and administrative expense in the accompanying consolidated financial statements. For the year ended December 31, 1993 these costs were expenses of TC\/GP and recorded as a capital contribution.\n(7) COMMITMENTS AND CONTINGENCIES:\nCASINO LICENSE RENEWAL\nThe Partnership is subject to regulation and licensing by the CCC. The Partnership's casino license must be renewed periodically, is not transferable, is dependent upon the financial stability of the Partnership, and can be revoked at any time. Due to the uncertainty of any license renewal application, there can be no assurance that the license will be renewed. Upon\nrevocation, suspension for more than 120 days, or failure to renew the casino license due to the Partnership's financial condition or for any other reason, the Casino Control Act (the \"Act\") provides that the CCC may appoint a conservator to take possession of and title to the hotel and casino's business and property, subject to all valid liens, claims, and encumbrances.\nOn June 22, 1995, the CCC renewed the casino license of the Partnership through 1999 subject to certain continuing reporting and compliance conditions.\nSELF INSURANCE RESERVES\nSelf insurance reserves represent the estimated amounts of uninsured claims settlements related to employee health medical costs, workers compensation, and other legal proceedings in the normal course of business. These reserves are established by the Partnership based upon a specific review of open claims as of the balance sheet date as well as historical claims settlement experience. Actual results may differ from these reserve amounts.\nEMPLOYMENT AGREEMENTS\nThe Partnership has entered into employment agreements with certain key employees which expire at various dates through July 30, 1998. Total minimum commitments on these agreements at December 31, 1995 were approximately $4,061,000.\nLEGAL PROCEEDINGS\nThe Partnership is involved in legal proceedings incurred in the normal course of business. In the opinion of management and its counsel, if adversely decided, none of these proceedings would have a material effect on the consolidated financial position of the Partnership.\nCASINO REINVESTMENT DEVELOPMENT AUTHORITY OBLIGATIONS\nPursuant to the provisions of the Act, the Partnership, must either obtain investment tax credits, as defined in the Act, in an amount equivalent to 1.25% of its gross casino revenues, as defined in the Act, or pay an alternative tax of 2.5% of its gross casino revenues. Investment tax credits may be obtained by making qualified investments, as defined, or by depositing funds which may be converted to bonds by the Casino Reinvestment Development Authority (the \"CRDA\"), both of which bear interest at below market interest rates. The Partnership is required to make quarterly deposits with the CRDA to satisfy its investment obligations.\nFrom time-to-time the Partnership has elected to donate funds that it has on deposit with the CRDA in return for tax credits to satisfy substantial portions of the Partnership's future investment alternative tax obligations. Donations in the amount of $375,000, $6,440,000, and $568,000 were made in 1995, 1994, and 1993, respectively. These donations, net of the tax credits\nreceived, were charged against operations in the year in which they were made and resulted in CRDA tax credits of $191,000, $1,474,000, and $290,000 to be applied to the years ending December 31, 1995, 1994, and 1993, respectively. For the years ended December 31, 1995, 1994, and 1993 the Partnership charged to operations $720,000, $955,000, and $115,000, respectively, which represents amortization of a portion of the tax credits discussed above.\nIn addition, for the years ended December 31, 1995, 1994, and 1993, the Partnership charged to operations $936,000, $735,000, and $953,000, respectively, to give effect to the below market interest rates associated with purchased CRDA bonds.\n(8) EMPLOYEE BENEFIT PLANS:\nThe Partnership has a retirement savings 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 up to the maximum amount permitted by law, and the Partnership will match 50% of an eligible employee's contributions up to a maximum of 5% of the employee's earnings. The Partnership recorded charges of approximately $1,013,000, $899,000, and $864,000 for matching contributions for the years ended December 31, 1995, 1994, and 1993, respectively.\nThe Partnership makes payments to various trusteed pension plans under industry-wide union agreements. The payments are based on the hours worked by or gross wages paid to covered employees. It is not practical to determine the amount of payments ultimately used to fund pension benefit plans or the current financial condition of the plans. Under the Employee Retirement Income Security Act, the Partnership may be liable for its share of the plans' unfunded liabilities, if any, if the plans are terminated. Pension expense for the years ended December 31, 1995, 1994, and 1993 were $497,000, $455,000, and $407,000, respectively.\nThe Partnership provides no other material post employment benefits.\n(9) FINANCIAL INFORMATION OF FUNDING:\nFinancial information relating to Funding as of and for the years ended December 31, 1995 and 1994 is as follows:\n1995 1994\nTotal Assets (including Mortgage $287,679,000 $277,541,000 Notes Receivable of $242,141,000, ============ ============ net of unamortized discount of $35,572,000 and $37,729,000 at December 31, 1995 and 1994; PIK Notes Receivable of $61,860,000, net of unamortized discount of $7,750,000 at December 31, 1995 and $54,094,000, net of unamortized discount of $7,965,000 at December 31, 1994, and Senior Notes Receivable of $27,000,000 at December 31, 1995 and 1994.)\nTotal Liabilities and Capital $287,679,000 $277,541,000 (including Mortgage Notes Payable ============ ============ of $242,141,000, net of unamortized discount of $35,572,000 and $37,729,000 at December 31, 1995 and 1994, PIK Notes Payable of $61,860,000, net of unamortized discount of $7,750,000 at December 31, 1995 and $54,094,000, net of unamortized discount of $7,965,000, at December 31, 1994 and Senior Notes Payable of $27,000,000 at December 31, 1995 and 1994.)\nInterest Income $ 41,768,000 $ 40,600,000\nInterest Expense $ 41,768,000 $ 40,600,000 ____________ ____________\nNET INCOME $ - $ - ============ ============\n(10) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount of the following financial instruments of the Partnership and Funding approximate fair value, as follows: (a) cash and cash equivalents and accrued interest receivables and payables based on the short-term nature of the financial instruments, (b) CRDA bonds and deposits based on the allowances to give effect to the below market interest rates.\nThe fair values of the Mortgage Notes and PIK Notes are based on quoted market prices. The fair value of the Mortgage Bonds was based on quoted market prices obtained by the Partnership from its investment advisor as follows:\nDecember 31, 1995 ______________________________ Carrying Amount Fair Value _______________ _____________ 11-3\/4% Mortgage Notes............ $ 206,569,000 $ 212,479,000 PIK Notes......................... $ 54,110,000 $ 48,096,000\nDecember 31, 1994 ______________________________ Carrying Amount Fair Value ______________ _____________ 11-3\/4% Mortgage Notes............ $ 204,412,000 $ 131,967,000 PIK Notes......................... $ 46,129,000 $ 43,546,000\nThere are no quoted market prices for the Partnership Term Loan and Senior Notes. A reasonable estimate of their value could not be made without incurring excessive costs.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrants have duly caused this Annual Report to be signed on their behalf by the undersigned, thereunto duly authorized, on the 22nd day of March, 1996.\nTRUMP'S CASTLE FUNDING, INC.\nBy: \/s\/Donald J. Trump _____________________ By: Donald J. Trump Title: President\nTRUMP'S CASTLE ASSOCIATES\nBy: \/s\/Donald J. Trump _____________________ By: Donald J. Trump Title: Managing General Partner\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report has been signed below by the following persons on behalf of the Registrants and in the capacities and on the date indicated.\nSignature Title Date\nTRUMP'S CASTLE FUNDING, INC.\nBy:\/s\/Donald J. Trump Chairman of the Board, March 22, 1996 ___________________ President, Chief Executive Donald J. Trump Officer (Principal Executive Officer), Treasurer (Principal Financial Officer), and sole Director of the Registrant.\nBy:\/s\/Robert E. Schaffhauser Assistant Treasurer March 22, 1996 _________________________ of the Registrant Robert E. Schaffhauser (Principal Accounting Officer)\nSignature Title Date\nTRUMP'S CASTLE ASSOCIATES\nBy:\/s\/Nicholas L. Ribis Board of Partner March 22, 1996 ____________________ Representatives Nicholas L. Ribis\nBy:\/s\/Roger P. Wagner Board of Partner March 22, 1996 __________________ Representatives Roger P. Wagner\nBy:\/s\/Asher O. Pacholder Board of Partner March 22, 1996 _____________________ Representatives Asher O. Pacholder\nBy:\/s\/Arthur S. Bahr Board of Partner March 22, 1996 ____________________ Representatives Arthur S. Bahr\nBy:\/s\/Thomas F. Leahy Board of Partner March 22, 1996 __________________ Representatives Thomas F. Leahy\nBy:\/s\/Robert M. Pickus Board of Partner March 22, 1996 ___________________ Representatives Robert M. Pickus\nBy:\/s\/Robert E. Schaffhauser Chief Financial Officer March 22, 1996 _________________________ and Chief Accounting Robert E. Schaffhauser Officer of the Partnership","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe financial information presented below reflects the financial condition and results of operations of the Partnership. Funding is a wholly-owned subsidiary of the Partnership and conducts no business other than collecting amounts due under certain intercompany notes from the Partnership for the purpose of paying principal of, premium, if any, and interest on its indebtedness, which Funding issued as a nominee for the Partnership.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994. The Partnership's net revenues (gross revenues less promotional allowances) for the years ended December 31, 1995 and 1994 were approximately $305.5 million and $283.8 million, respectively. The Partnership believes that the $21.7 million (7.6%) increase is the result of aggressive marketing programs and special events introduced by Management during the current year as well as a continuing emphasis on providing superior customer service.\nGaming revenues provide the majority of the Partnership's revenues and primarily consist of slot machine and table games win.\nSlot machine win was approximately $197.4 million and $177.4 million (an increase of approximately $20.0 million or 11.3%) for the years ended December 31, 1995 and 1994, respectively. The total dollar amount wagered by customers on slot machines increased by approximately $322.9 million (16.4%) to $2,288.2 million for the year ended December 31, 1995 from $1,965.3 million for the year ended December 31, 1994. This increase in slot volume was partially offset by a decrease in the slot win percentage (slot win as a percentage of dollars wagered on slot machines) to 8.6% for the year ended December 31, 1995 from 9.0% for the year ended December 31, 1994. This win percentage decrease was primarily due to an increased volume of customer play on lower denomination slot machines which, traditionally, payout at a lower win percentage.\nTable game win was approximately $82.7 million and $81.0 million (an increase of $1.7 million or 2.1%) for the years ended December 31, 1995 and 1994, respectively. The total dollar amount wagered by customers on table games increased by approximately $10.2 million (2.1%) to $487.7 million for the year ended December 31, 1995 from $477.5 for the year ended December 31, 1994. The table game win percentage (table game win as a percentage of dollars wagered on table games) remained at 17% for the year ended December 31, 1995 compared to the year ended December 31, 1994. The table game win percentage is outside the control of the Partnership, and although it is fairly constant over the long- term, it can vary significantly from period to period, due in part to the play of certain premium patrons who tend to wager substantial dollar amounts on table games.\nFor the years ended December 31, 1995 and 1994, credit extended to the table games customers was approximately 30.0% and 31.4% of overall table play, respectively. This relatively high level of credit play continues a trend which started in the last fiscal year and is the result of an increased level of play by individuals who wager relatively large sums. These premium patrons tend to use a higher percentage of credit when they wager.\nNongaming revenues, in the aggregate, increased by approximately $3.1 million (5.2%) to $60.0 million for the year ended December 31, 1995 from $56.9 million for the year ended December 31, 1994, primarily as the result of rooms revenue (an approximate $538,000 increase) and food and beverage revenue (an approximate $2.4 million increase) activity. During the current year, marketing programs designed to increase gaming revenues caused an increase in complimentary rooms and food and beverage revenues (an approximate $2.7 million increase) as compared to the prior year.\nPromotional Allowances increased by approximately $2.9 million (9.2%) to $34.5 million for the year ended December 31, 1995 from $31.6 million for the year ended December 31, 1994. As discussed above, marketing programs instituted during the current year designed to increase gaming revenues caused an increase in complimentary rooms and food and beverage activity as compared to the prior year.\nGaming costs and expenses increased by approximately $14.7 million (9.7%) to $165.7 million for the year ended December 31, 1995 from $151.0 million for the year ended December 31, 1994. This increase is primarily the result of an increase in promotional cash back coupon costs associated with the new marketing programs and special events introduced during the current year to stimulate gaming revenues.\nFood and beverage costs and expenses for the years ended December 31, 1995 and 1994 increased approximately $1.1 million (9.0%). This increase corresponds to the increased food and beverage and gaming revenue activity for the year.\nOther costs and expenses increased approximately $790,000 (6.3%) to $13.4 million for the year ended December 31, 1995 from $12.6 million for the year ended December 31, 1994. This increase is principally the result of increased real estate taxes on the casino property.\nInterest expense increased approximately $1.8 million (4.1%) to $46.0 million for the year ended December 31, 1995 from $44.2 million for the year ended December 31, 1994. This increase is the result of an increase in both the outstanding principal and the interest rate related to the PIK Notes as well as an increase in the interest rate related to the Amended Term Loan.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993. The Partnership's net revenues (gross revenues less promotional allowances) for the years ended December 31, 1994 and\n1993 totaled approximately $283.8 million and $273.2 million, respectively, representing a $10.6 million (3.9%) increase. Gaming revenues were approximately $258.5 million for the year ended December 31, 1994 and $246.4 million for the comparable period in 1993. Management believes the $12.1 million (4.9%) increase in gaming revenues was attributable primarily to a continuing emphasis on customer service and a repositioning by Trump's Castle to expand profitable market segments.\nSlot machine win was approximately $177.5 million and $173.0 million (an increase of approximately $4.5 million or 2.6%) for the years ended December 31, 1994 and 1993, respectively. The total dollar amount wagered by customers on slot machines increased by approximately $113.9 million (6.2%) to $1,965.3 million for the year ended December 31, 1994 from $1,851.4 million for the year ended December 31, 1993. This increase in slot volume was partially offset by a decrease in the slot win percentage (slot win as a percentage of dollars wagered on slot machines) to 9.0% for the year ended December 31, 1994 from 9.3% for the year ended December 31, 1993. The lower slot win percentage was largely intentional and designed by Trump's Castle in order to remain competitive and stimulate patron play.\nTable game win was approximately $81.0 million and $73.4 million (an increase of $7.6 million or 10.4%) for the years ended December 31, 1994 and 1993, respectively. The total dollar amount wagered by customers on table games decreased by approximately $14.6 million (3.0%) to $477.5 million for the year ended December 31, 1994 from $492.1 million for the year ended December 31, 1993. This decrease in gaming volume was offset by an increase in the table game win percentage (table game win as a percentage of dollars wagered on table games) to 17.0% for the year ended December 31, 1994 from 14.9% for the year ended December 31, 1993. The table game win percentage is outside the control of the Partnership, and although it is fairly constant over the long- term, it can vary significantly from period to period, due in part to the play of certain premium patrons who tend to wager substantial dollar amounts on table games.\nFor the years ended December 31, 1994 and 1993, gaming credit extended to customers was approximately 31.4% and 28.9% of overall table play, respectively. This increase in credit play reflected, in part, a shift in the gaming patron mix as a result of increased play by individuals who wager relatively large sums. These patrons tend to use a higher percentage of credit when they wager.\nNongaming revenues, in the aggregate, decreased approximately $1.6 million (2.6%) to $56.9 million for the year ended December 31, 1994, from $58.5 million for the year ended December 31, 1993. This decline was primarily attributable to a decrease in food and beverage revenues of $2.2 million (7.1%), to $28.4 million for the year ended December 31, 1994, of which approximately $15.9 million consisted of complimentary food and beverage. This decline was due to the discontinuance of certain unprofitable marketing programs which resulted in fewer customers served. Such measures were implemented to improve overall operating efficiencies.\nOffsetting the nongaming revenues decrease was an increase in entertainment revenue of $100,000 (1.4%) and an increase in other income of $600,000 (8%).\nGaming costs and expenses increased by approximately $5.3 million (3.7%) to $151.0 million for the year ended December 31, 1994 from $145.7 for the year ended December 31, 1993. This increase corresponds to the increase in gaming revenues on a year- to-year basis.\nThe $2.6 million (15.1%) decrease in rooms and food and beverage operating expenses is primarily attributable to a variety of cost reduction measures and improvements in operational efficiency during 1994 compared to 1993.\nGeneral and administrative expenses increased approximately $7.4 million (13.6%) for the year ended December 31, 1994 as compared to the prior year. This increase was primarily attributable to:\n(1) The contribution of $2.5 million to a joint project with Harrah's for the beautification of the marina district of Atlantic City in which both casinos operate. (2) The contributions of approximately $3.3 million in Casino Reinvestment Development Authority deposits to certain public improvement projects. (3) Increased spending in connection with new business development and facilities maintenance.\nFor the year ended December 31, 1994, depreciation and amortization decreased $2.0 million (12.1%) over the comparable period in 1993, primarily as a result of the impact of fully depreciated assets.\nOther costs and expenses increased by $1.5 million (13.8%) due to significantly lower real estate tax expense incurred in the first quarter of 1993 because of a $1.8 million real estate tax credit.\nInterest expense decreased for the year ended December 31, 1994 over the comparable period in 1993 by approximately $12.8 million as a result of the Recapitalization on December 28, 1993.\nINFLATION. There was no significant impact on the Partnership's operations as a result of inflation during 1995, 1994, or 1993.\nLIQUIDITY AND CAPITAL RESOURCES.\nCash flow from operating activities is the Partnership's principal source of liquidity. For the year ended December 31, 1995, the Partnership's net cash flow provided by operating activities before cash debt service obligations was $49.8 million and cash debt service was $36.7 million, resulting in net cash provided by operating activities of $13.1 million.\nIn addition to cash needs to fund the day-to-day operations of Trump's Castle, the Partnership's principal uses of cash are capital expenditures and debt service.\nCapital expenditures for the year ended December 31, 1995 were $8.6 million and consisted of casino floor improvements, renovation of hotel rooms, and the purchase of slot machines. For 1996 total capital expenditures are anticipated to be $9.0 million and principally consist of (i) the purchase of slot machines, (ii) renovations to guest rooms and the hotel tower, and (iii) the construction of two new player clubs. Management believes that these levels of capital expenditures are sufficient to maintain the attractiveness of Trump's Castle and the aesthetics of its hotel rooms and other public areas.\nThe Partnership's debt consists primarily of (i) a loan with Midlantic National Bank (the \"Term Loan\"), (ii) the 11-1\/2% Senior Notes due 2000 (the \"Senior Notes\"), (iii) the 11-3\/4% Mortgage Notes due 2003 (the \"Mortgage Notes\"), and (iv) the Increasing Rate Subordinated Pay-in-Kind Notes due 2005 (the \"PIK Notes\").\nOn May 28, 1995, the Partnership exercised its option to extend the Term Loan for an additional five year term. The Term Loan bears interest at the prime rate plus 3%, currently 11-1\/2%, and requires amortized monthly principal payments of approximately $158,000 which commenced May 31, 1995. The Term Loan matures on May 28, 2000.\nThe Senior Notes have an outstanding principal amount of $27 million, and bear interest at the rate of 11-1\/2% per annum (which may be reduced to 11-1\/4% upon the occurrence of certain events). The Senior Notes mature on November 15, 2000, and are subject to a sinking fund which requires the retirement of 15% of the Senior Notes on each November 15, 1998 and 1999.\nThe Mortgage Notes have an outstanding principal amount of approximately $242 million, bear interest at the rate of 11-3\/4% per annum (which may be reduced to 11-1\/2% upon the occurrence of certain events), and mature on November 15, 2003.\nThe PIK Notes have an outstanding principal amount of approximately $61.9 million and mature on November 15, 2005. Interest is currently payable semi-annually at the rate of 13-7\/8%. On or prior to November 15, 2003, interest on the PIK Notes may be paid in cash or through the issuance of additional PIK Notes. During 1995, the Partnership and Funding issued an additional $7.8 million principal amount of PIK Notes in payment of interest on the PIK Notes. The Partnership anticipates that during 1996 interest on the PIK Notes will be paid through the issuance of additional PIK Notes.\nOn June 23, 1995, the Partnership entered into an Option Agreement with Hamilton Partners, L.P. (\"Hamilton\") which grants the Partnership an option (the \"Option\") to acquire the PIK Notes owned by Hamilton. Hamilton has represented to the Partnership\nthat it is the owner of at least 92% of the outstanding principal amount of the PIK Notes. The Option was granted to the Partnership in consideration of a $1.1 million payment to Hamilton. The Option is exercisable at a price equal to 60% of the aggregate principal amount and accrued interest of the PIK Notes delivered by Hamilton. Pursuant to the terms of the Option Agreement, upon the occurrence of certain events within 18 months of the time the Option is exercised, the Partnership is required to make an additional payment to Hamilton of up to 40% of the principal amount of the PIK Notes. The option expires on March 19, 1996 and may be extended to June 21, 1996.\nThe Partnership's cash debt service requirement was approximately $36.7 million in 1995 and the Partnership anticipates that approximately $37.8 million in cash will be required during 1996 to meet its debt service obligations.\nFor the years ended December 31, 1995 and 1994, the Partnership had a working capital surplus of $600,000 and a working capital deficit of $1.0 million, respectively. The Partnership believes that this level of working capital is adequate to sustain existing operations in the foreseeable future.\nManagement believes, based upon its current level of operations, that although the Partnership is highly leveraged, it will continue to have the ability to pay interest on its indebtedness and to pay other liabilities with funds from operations for the foreseeable future. However, there can be no assurance to that effect, as the Partnership's operating results are subject to numerous factors outside its control, including, without limitation, competition from within the Atlantic City market, from other gaming jurisdictions, and from the Other Trump Casinos; general economic conditions; weather and its effect on the ability of patrons to travel to Atlantic City; and, the slot machine and table game win percentages, which can vary significantly over a short-term time period. In the event that circumstances change, the Partnership may seek to obtain a working capital facility of up to $10 million, although there can be no assurance that such financing will be available on terms acceptable to the Partnership.\nThe ability of Funding and the Partnership to pay their indebtedness when due, will depend on their ability to either generate cash from operations sufficient for such purposes or to refinance such indebtedness on or before the date on which it becomes due. The Partnership does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amounts of the Mortgage Notes and the PIK Notes. Thus, the repayment of the principal amount of this indebtedness will likely depend primarily upon the ability of Funding and the Partnership to refinance this debt when due. The future operating performance of the Partnership and the ability to refinance this debt will be subject to the then prevailing economic conditions, industry conditions, and numerous other financial, business, and other factors, many of which are beyond the control of Funding or the Partnership. There can be no\nassurance that the future operating performance of the Partnership will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally, or the receptiveness of the capital markets to the gaming industry will be conducive to refinancing this debt or other attempts to raise capital.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAn index to financial statements and required financial statement schedules is set forth at Item 14.\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\nAll decisions affecting the business and affairs of the Partnership, including the operation of Trump's Castle, are decided by the general partners acting by and through a Board of Partner Representatives, which includes a minority of Representatives elected indirectly by the holders of the Mortgage Notes and PIK Notes (the \"Board of Partner Representatives\"). As currently constituted, the Board of Partner Representatives consists of Donald J. Trump, Chairman, Nicholas L. Ribis, Roger P. Wagner, Robert M. Pickus, Asher O. Pacholder, Thomas F. Leahy, and Arthur S. Bahr. Messrs. Trump, Ribis, and Pickus also serve on the governing boards of Trump Taj Mahal Associates (\"TTMA\"), and Trump Plaza Associates (\"TPA\"). Messrs. Trump and Ribis also serve as directors and officers of Trump Hotels & Casino Resorts, Inc. (\"THCR\"), and Mr. Pickus serves as an officer of THCR.\nThe Partnership also has an Audit Committee on which Mr. Ribis serves with Mr. Leahy and Mr. Bahr, who have been appointed thereto in accordance with the requirements of the CCC. The Audit Committee reviews matters of policy, purpose, responsibilities and authority and makes recommendations with respect thereto on the basis of reports made directly to the Audit Committee. The Surveillance Department is responsible for the surveillance, detection, and video-taping of unusual and illegal activities in the casino hotel. The Internal Audit Department is responsible for the review of, reporting instances of noncompliance with, and recommending procedures to eliminate weakness in internal controls.\nThe sole director of Funding is Trump. Trump also serves as its Chairman of the Board, President, and Treasurer. Patricia M. Wild serves as its Secretary, and Robert E. Schaffhauser serves as its Assistant Treasurer.\nSet forth below are the names, ages, positions, and offices held with Funding and the Partnership, and a brief account of the business experience during the past five years of each member of the Board of Partner Representatives, the executive officers of Funding and the Partnership, and the director of Funding.\nDONALD J. TRUMP - Trump, 49 years old, has been the managing general partner of the Partnership and Chairman of the Board of Partner Representatives since May 1992 and Chairman of the Board, President and sole director of Funding since June 1985. Trump has been the President and sole director of TC\/GP since December 1993. Trump served as Chairman of the Executive Committee of the Partnership from June 1985 to May 1992 and as President and sole director of TC\/GP from November 1991 to May 1992. Trump has been a director and Treasurer of TCHI since April 17, 1985. Trump has been Chairman of the Board of THCR and its related funding company since their formation in 1995. Trump is the sole shareholder, Chairman of the Board of Directors, President, and Treasurer of TPFI, and the managing general partner of TPA. Trump was\nPresident and Chairman of the Board of Directors and a 50% shareholder of TP\/GP Corp. (\"TP\/GP\"), the former managing general partner of TPA, from May 1992 through June 1993; and Chairman of the Executive Committee and President of TPA from May 1986 to May 1992. Trump has been a director and President of TPHI and a partner in Trump Plaza Holding Associates (\"TPHA\") since February 1993. Trump was Chairman of the Executive Committee of 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; 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, 51 years old, has been a partner representative on the Board of Partner Representatives since May 1992 and Chief Executive Officer of Partnership since March 1991. Mr. Ribis has served as Vice President and Assistant Secretary of TCHI since December 1993 and January 1991, respectively. Mr. Ribis served as a member of the Executive Committee of the Partnership from April 1991 to May 1992 and as Secretary of TC\/GP from November 1991 to May 1992. Mr. Ribis has been President, Chief Executive Officer, Chief Financial Officer, and a director of THCR and its related funding company since their formation in 1995. Mr. Ribis has served as a director of TPHI since June 1993 and of TPFI since July 1993; as a director and Vice President of TP\/GP from May 1992 to June 1993; Chief Executive Officer of TPA since February 1991; and a member of the Executive Committee of TTMA since March to October 1991; and a 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 from February 1991 to December 1995 was 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. Mr. Ribis has been a member of the Board of Trustees of the CRDA since October 1993.\nROGER P. WAGNER - Mr. Wagner, 48 years old, has been a partner representative on the Board of Partner Representatives since May 1992 and President and Chief Operating Officer of the Partnership since January 1991. Mr. Wagner served as a member of the Executive Committee of the Partnership from January 1991 to May 1992. Mr. Wagner has been a director and president of TCHI since January 1991. Prior to joining the Partnership, Mr. Wagner served as President of the Claridge Hotel Casino from June 1985 to January 1991 and is presently the Chairman of the Casino Association of New Jersey.\nROBERT M. PICKUS - Mr. Pickus, 41 years old, has been a partner representative on the Board of Partner Representatives since October 1995, Executive Vice President of Corporate and Legal Affairs since February 1995, and Corporate Secretary since February 1996. He has also been the Executive Vice President of Corporate and Legal Affairs of Plaza Associates since February 16,\n1995. From December 1993 to February 1995, Mr. Pickus was the Senior Vice President and General Counsel of Plaza Associates and, since April 1994, he has been the Vice President and Assistant Secretary of Plaza Funding and Assistant Secretary of Plaza Holding, Inc. Mr. Pickus has been the Executive Vice President of Corporate and Legal Affairs of Taj Associates since February 1995, and a Class C Director of Taj Holding and TM\/GP since November, 1995. He was the Senior Vice President and Secretary of Trump's Castle Funding, Inc. from June 1988 until December 1993 and General Counsel of Trump's Castle Associates from June 1985 to June 1988. Mr. Pickus was also Secretary of Trump's Castle Associates from October 1991 until December 1993. Mr. Pickus has been Executive Vice President of Corporate and Legal Affairs of THCR since June of 1995.\nASHER O. PACHOLDER - Dr. Pacholder, 58 years old, has been a partner representative of the Board of Partner Representative since May 1992. Dr. Pacholder served as a director and the President of TC\/GP from May 1992 to December 1993. Dr. Pacholder has served as Chairman of the Board and Managing Director of Pacholder Associates, Inc., an investment advisory firm, since 1987. In addition, Dr. Pacholder serves on the Board of Directors of The Southland Corporation, United Gas Holding Corp., ICO, Incorporated, an oil field services company, UF&G Pacholder Fund, Inc., a publicly traded closed end mutual fund, U.S. Trails, Inc. a recreational facility company, and Forum Group, Inc., a retirement community managerial company.\nTHOMAS F. LEAHY - Mr. Leahy, 58 years old, has been a partner representative on the Board of Partner Representatives since June 1993. Mr. Leahy served as a director and Treasurer of TC\/GP from May 1992 to December 1993. From 1991 to July 1992, Mr. Leahy served as Executive Vice President of CBS Broadcast Group, a unit of CBS, Inc. Since November 1992, Mr. Leahy has served as President of The Theater Development Fund, a service organization for the performing arts. From July 1992 through November 1992, Mr. Leahy served as chairman of VT Properties, Inc., a privately- held corporation which invests in literary, state, and film properties.\nARTHUR S. BAHR - Mr. Bahr, 64 years old, has been a partner representative on the Board of Partner Representatives since June of 1995 and previously served as a director of TC\/GP from August 1993 to January of 1994. Mr. Bahr retired in February of 1994 after serving in various senior investment positions for General Electric Investment Corporation since 1970. Mr. Bahr serves on the Board of Directors of Renaissance Reinsurance and the Korean International Investment Fund.\nROBERT E. SCHAFFHAUSER - Mr. Schaffhauser, 49 years old, joined the Partnership as Senior Vice President of Finance in January 1994 and became Executive Vice President of Finance in January of 1995. He also became Assistant Treasurer, Chief Financial Officer, and Chief Accounting Officer of Funding, and Assistant Treasurer of TCHI and TC\/GP in January 1994. He served as a consultant to Trump during 1993. Mr. Schaffhauser previously\nserved as Senior Vice President of Finance and Administration for the Sands Hotel & Casino in Atlantic City for four years. For a period of 13 years prior thereto, he served as the Chief Financial Officer and Secretary for Metex Corporation, a publicly held manufacturer of engineered products. Mr. Schaffhauser also served as a member of Metex Corporation's Board of Directors.\nMARK A. BROWN - Mr. Brown, 35 years old, joined the Partnership as Executive Vice President of Operations in July of 1995. Previously, Mr. Brown served as Senior Vice President of Eastern Operations for Caesars World Marketing Corporation, National and International Divisions from 1993 until 1995. Prior to that, Mr. Brown served as Vice President of Casino Operations at Trump Taj Mahal from 1989 until 1993. From 1979 until 1989, Mr. Brown worked for Resorts International Hotel Casino departing as Casino Shift Manager in December 1989.\nPATRICIA M. WILD - Ms. Wild, 43 years old, has been Secretary of Funding and Senior Vice President and General Counsel of the Partnership and Secretary of TCHI since December 1993. Ms. Wild served as Assistant Secretary of TPFI and Vice President, General Counsel of TPA from February 1991 to December 1993; Vice President and General Counsel of TPFI from July 1992 through December 1993; and Associate General Counsel of TPA from May 1989 through January 1991. From December 1986 to April 1989, Ms. Wild served as Deputy Attorney General on the Environmental Prosecutions Task Force of the New Jersey Department of Law and Public Safety, Division of Criminal Justice. From April 1983 to December 1986, Ms. Wild served as Deputy Attorney General with the New Jersey Division of Gaming Enforcement.\nJOHN P. BURKE - Mr. Burke, 48 years old, has been the Corporate Treasurer of the Partnership and TPA since October 1991. Mr. Burke has been Chief Accounting Officer of TC\/GP since May 1992. Mr. Burke has been a Vice President of TCHI, TC\/GP, Funding and the Partnership since December 1993. Mr. Burke has been Vice President of the Trump Organization since September 1990. Since June 1995, Mr. Burke has been the Corporate Treasurer of THCR. He has also been Corporate Treasurer of Plaza Associates and Taj Associates since October 1991. Mr. Burke has been a Class C Director of TM\/GP and Taj Holding, and Vice President of TM\/GP 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.\nEach member of the Board of Partner Representatives, of the Audit Committee and all of the other persons listed above have been licensed or found qualified by the CCC.\nThe employees of the Partnership serve at the pleasure of the Board of Partner Representatives subject to any contractual rights contained in any employment agreement. The officers of Funding serve at the pleasure of Donald J. Trump, the sole director of Funding.\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, and John P. Burke served as directors of TPA and its affiliated entitled, 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 April 30, 1992, and declared effective on May 29, 1992. Donald J. Trump, Nicholas L. Ribis, Roger P. Wagner, 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 May 5, 1992, and was declared effective on May 29, 1992. Donald J. 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 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, 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\nExecutive officers of Funding do not receive any additional compensation for serving in such capacity. In addition, Funding 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, 1995, 1994, and 1993 to the Chief Executive Officer, and 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, 1995. 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.\nEMPLOYMENT AGREEMENTS. In September 1993, the Partnership entered into 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 also acts as Chief Executive Officer of TTMA and TPA, the Partnerships that own the Other Trump Casinos, and THCR which owns TPA and certain other gaming interests, and receives additional compensation from such entities. Mr. Ribis devotes approximately one-quarter of his professional time to the affairs of the Partnership. All other executive officers of the Partnership, except Messrs. Burke and Pickus, devote substantially all of their time to the business of the Partnership.\nThe Partnership, on January 17, 1991, entered into an employment agreement with Roger P. Wagner, with an amendment thereto dated January 17, 1991, and a second amendment thereto dated July 18, 1992, pursuant to which Mr. Wagner serves as the Partnership's and TCHI's President and Chief Operating Officer. Mr. Wagner's employment agreement, which terminates on January 16, 1997, provides for an annual salary beginning at a minimum of $400,000 until January 16, 1994, thereafter $500,000 per year until January 16, 1995, thereafter $600,000 per year until January 16, 1996, and thereafter $750,000 per year from January 17, 1996 until January 16, 1997 and, subject to CCC approval, 1% of the Partnership's Income from Operations (as defined in such agreement) in excess of $40.0 million.\nThe Partnership, on June 16, 1995, entered into a severance agreement with Robert E. Schaffhauser. Pursuant to the terms of this agreement Mr. Schaffhauser is to receive from the Partnership, if terminated by the Partnership for any reason other than cause as defined, an amount equal to twelve months of Mr. Schaffhauser's then current salary.\nThe Partnership, on July 10, 1995, entered into an employment agreement with Mark A. Brown pursuant to which Mr. Brown serves as the Partnership's Executive Vice President of Operations. The term of the agreement is three years. This employment agreement provides for an annual base salary of $350,000, a $75,000 bonus paid at the commencement of employment, and an annual bonus of no less than $75,000 per year over the three year term of the agreement.\nThe Partnership entered into an employment agreement with Patricia M. Wild pursuant to which, effective December 6, 1993, Ms. Wild serves as the Partnership's Senior Vice President\/General Counsel. The term of the agreement is one year and, in accordance\nwith the terms of the agreement, is automatically extended on a weekly basis so that at all times the term of the agreement shall be an unexpired period of twelve months. This employment agreement provides for an annual base salary of $115,000 reviewed on an annual basis.\nCOMPENSATION OF DIRECTORS. Each Partner Representative of the Partnership (other than Messrs. Trump, Ribis, Wagner, and Pickus) receives an annual fee of $50,000. In addition, each Partner Representative of the Partnership (other than Messrs. Trump, Ribis, Pickus, and Wagner) receives $2,500 per meeting attended, plus reasonable out-of-pocket expenses incurred in attending any meeting of the Board.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. In general, the compensation of executive officers of the Partnership is determined by the Board of Partner Representatives, which is composed of Donald J. Trump, Nicholas L. Ribis, Roger P. Wagner, Asher O. Pacholder, Thomas F. Leahy, Arthur S. Bahr, and Robert M. Pickus. The compensation of Nicholas L. Ribis and Roger P. Wagner is set forth in their employment agreements with the Partnership. The Partnership has delegated the responsibility over certain matters, such as the bonus of Mr. Ribis, to Mr. Trump. Executive officers of Funding do not receive any additional compensation for serving in such capacity.\nThe SEC requires issuers 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, Wagner, Pickus, and Burke, executive officers of the Partnership, serve on the Board of Directors of other entities in which members of the Board of Partner Representatives (namely, Messrs. Trump, Ribis, Wagner, and Pickus) serve as executive officers. The Partnership believes that such relationships have not affected the compensation decisions made by the Board of Partner Representatives in the last fiscal year.\nMessrs. Trump and Wagner serve as directors of TCHI, of which Messrs. Trump, Ribis, and Wagner serve as executive officers.\nMessrs. Trump, Ribis, Pickus, 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, Ribis, and Pickus 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, Ribis, and Pickus 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 Mr. Trump is an executive officer. Mr.\nTrump, however, does not receive any compensation for serving as an executive officer of Taj Realty Corp.\nMessrs. Trump and Ribis serve on the Board of Directors of TPFI, the managing general partner of TPA, of which Messrs. Trump, Ribis, and Pickus are executive officers. Messrs. Trump and Ribis also serve on the Board of Directors of TPHI, of which such persons are also executive officers. Mr. Ribis is compensated by TPA for his services as chief executive officer.\nMessrs. Trump and Ribis serve on the Board of Directors of THCR, of which Mr. Trump is Chairman of the Board. Messrs. Ribis, Pickus and Burke are executive officers of THCR and are compensated for their services by THCR.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information with respect to the amount of Funding's Common Stock owned by beneficial owners of more than 5% of Funding's Common Stock. Funding has no other class of equity securities outstanding.\nAmount and Nature Name and Address of of Beneficial Percent Title or Class Beneficial Owners Ownership of Class ______________ ___________________ _________________ ________\nCommon Stock Trump's Castle 200 shares 100% Associates Huron Avenue and Brigantine Blvd. Atlantic City, New Jersey 08401\nCurrently, Trump, TC\/GP and TCHI hold 61.5%, 37.5%, and 1.0% interests, respectively, in the Partnership and therefore are the beneficial owners of all of the outstanding shares of Common Stock of Funding.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOTHER TRUMP CASINOS. The following table sets forth the amounts due to the Partnership from Trump and his other affiliated casino entities as of December 31, 1995. For a more detailed description of these transactions, see \"Other Transactions with Affiliates\" below.\nAmount Due and Outstanding to the Partnership as of December 31, 1995 __________________________\nTrump Plaza Associates. . . . . . . . . . . .$ 720,000 Trump Taj Mahal Associates. . . . . . . . . . 164,000 The Trump Organization. . . . . . . . . . . . 262,000 _________ Total Due from Affiliates as of December 31, 1995. . . . . . . . .$1,146,000 ==========\nOTHER TRANSACTIONS WITH AFFILIATES. The Partnership has engaged in transactions with TPA, TTMA, and the Trump Organization (\"TO\") which are affiliates of Trump. These transactions include certain shared payroll costs, fleet maintenance and limousine services, as well as complimentary services offered to customers, for which the Partnership makes the initial payment and is then reimbursed by the appropriate affiliated entity. During 1995, the Partnership incurred expenses of approximately $1,673,000 in corporate salaries, and $1,109,000 of other transactions on behalf of these related entities. In addition, the Partnership received payments totalling $1,401,000 for services rendered and had $580,000 of deductions for similar services incurred by these related entities on behalf of the Partnership.\nSERVICES AGREEMENT. On December 28, 1993, the Partnership terminated the existing management agreement with a corporation wholly-owned by Trump and entered into a Services Agreement with TC\/GP (the \"Services Agreement\"). In general, the Services Agreement obligates TC\/GP 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 related services (the \"Services\") with respect to the business and operations of the Partnership, in exchange for certain fees to be paid only in those years in which EBITDA (EBITDA represents income from operations before depreciation, amortization, restructuring costs and the non-cash write-down of CRDA investments) exceeds prescribed amounts.\nIn consideration for the Services to be rendered by TC\/GP, the Partnership will pay an annual fee (which is identical to the fee which was payable under the previously existing management agreement) to TC\/GP in the amount of $1,500,000 for each year in which EBITDA exceeds the following amounts for the years indicated: 1993 - $40,500,000; 1994 - $45,000,000; 1995 and\nthereafter - $50,000,000. If EBITDA in any fiscal year does not exceed the applicable amount, no annual fee is due. In addition, TC\/GP will be entitled to an incentive fee beginning with the fiscal year ending December 31, 1994 in an amount equal to 10% of EBITDA in excess of $45,000,000 for such fiscal year. The Partnership will also be required to advance to TC\/GP $125,000 a month which will be applied toward the annual fee, provided, however, that no advances will be made during any year if and for so long as the Managing Partner (defined in the Services Agreement as Trump) determines, in his good faith reasonable judgment, that the Partnership's budget and year-to-date performance indicate that the minimum EBITDA levels (as specified above) for such year will not be met. If for any year during which annual fee advances have been made it is determined that the annual fee was not earned, TC\/GP will be obligated to promptly repay any amounts previously advanced. For purposes of calculating EBITDA under the Services Agreement, any incentive fees paid in respect of 1994 or thereafter shall not be deducted in determining net income.\nDuring the year ended 1995, the Partnership recorded fees of approximately $2,087,000 under the Services Agreement.\nUnless sooner terminated pursuant to its terms, the Services Agreement will expire on December 31, 2005.\nOTHER PAYMENTS TO TRUMP. During 1994, the Board of Partners Representatives approved a $1,000,000 bonus to be paid to Trump based upon 1994 operating results. The amount was paid in two equal installments in June and August 1995. No such bonus was approved for 1995.\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 immediately following the signature page.\n(B) Reports on Form 8-K. Funding did not file any reports on Form 8-K during the last quarter of the year ended December 31, 1995.\n(C) Exhibits. All exhibits listed below are filed with this Annual Report on Form 10-K unless specifically stated to be incorporated by reference to other documents previously filed with the Securities and Exchange Commission.\nEXHIBIT\n3(1) -Amended and Restated Certificate of Incorporation of Funding.\n3.1(1) -Bylaws of Funding.\n3.2-3.6 -Intentionally omitted.\n3.7(2) -Second Amended and Restated Partnership Agreement of the Partnership.\n4.1-4.10 -Intentionally omitted.\n4.11(2) -Indenture, among Funding, as issuer, the Partnership, as guarantor, and the Mortgage Note Trustee, as trustee.\n4.12(2) -Indenture of Mortgage between the Partnership, as Mortgagor, and Funding, as Mortgagee.\n4.13(2) -Assignment Agreement between Funding and the Mortgage Note Trustee.\n4.14(2) -Partnership Note.\n4.15 -Form of Mortgage Note (included in Exhibit 4.11).\n4.16 -Form of Partnership Guarantee (included in Exhibit 4.11).\n4.17(2) -Indenture between Funding, as issuer, the Partnership, as guarantor, and the PIK Note Trustee, as trustee.\n4.18(2) -Pledge Agreement between Funding and the PIK Note Trustee.\n4.19(2) -Subordinated Partnership Note.\n4.20 -Form of PIK Note (included in Exhibit 4.17).\n4.21 -Form of Subordinated Partnership Guarantee (included in exhibit 4.17).\n4.22(1) -Letter Agreement between the Partnership and the Proposed Senior Secured Note Purchasers regarding the Senior Secured Notes.\n4.23(2) -Note Purchase Agreement for 11-1\/2% Series A Senior Secured Notes of the Partnership due 1999.\n4.24(2) -Indenture, among Funding, as issuer, the Partnership, as guarantor, and the Senior Secured Note Trustee, as trustee.\n4.25(2) -Indenture of Mortgage and Security Agreement between the Partnership, as mortgagor\/debtor, and Funding as mortgagee\/secured party. (Senior Note Mortgage).\n4.26(2) -Registration Rights Agreement by and among the Partnership and certain purchasers.\n4.27 -Intentionally omitted.\n4.28(2) -Guarantee Mortgage.\n4.29(2) -Senior Partnership Note.\n4.30(2) -Indenture of Mortgage and Security Agreement between the Partnership as mortgagor\/debtor and the Senior Note Trustee as mortgagee\/secured party. (Senior Guarantee Mortgage).\n4.31(2) -Assignment Agreement between Funding, as assignor, and the Senior Note Trustee, as assignee. (Senior Assignment Agreement).\n4.32(2) -Amended and Restated Nominee Agreement.\n10.1-10.2 -Intentionally omitted.\n10.3(3) -Employment Agreement dated January 17, 1991, between the Partnership and Roger P. Wagner.\n10.4(4) -Second Amendment to Employment Agreement dated January 17, 1991 between the Partnership, TCHI, and Roger P. Wagner.\n10.5(5) -Form of License Agreement between the Partnership and Donald J. Trump.\n10.6-10.10 -Intentionally omitted.\n10.11(2) -Employment Agreement, between the Partnership and Nicholas Ribis.\n10.12(6) -Trump's Castle Hotel & Casino Retirement Savings Plan, effective as of September 1, 1986.\n10.13-10.18 -Intentionally omitted.\n10.19(3) -Lease Agreement by and between State of New Jersey acting through its Department of Environmental Protection, Division of Parks and Forests, as Landlord, and the Partnership, as tenant, dated September 1, 1990.\n10.20-10.26 -Intentionally omitted.\n10.27(1) -Services Agreement.\n10.28-10.31 -Intentionally omitted.\n10.32(7) -Employment Agreement dated December 20, 1993, between Patricia M. Wild and the Partnership\n10.33 -Intentionally Omitted.\n10.34(7) -Amended and Restated Credit Agreement, dated as of December 28, 1993, among Midlantic, the Partnership and Funding.\n10.35(7) -Amendment No. 1 to Amended and Restated Indenture of Mortgage, between the Partnership, as Mortgagor and Midlantic, as Mortgagee.\n10.36(7) -Amended and Restated Indenture of Mortgage, between the Partnership, as Mortgagor and Midlantic, as Mortgagee, dated as of May 29, 1992.\n10.37(7) -Amendment No. 1 to Amended and Restated Assignment of Leases and Rents, between the Partnership, as assignor, and Midlantic, as assignee.\n10.38(7) -Amended and Restated Assignment of Leases and Rents, between the Partnership, as assignor, and Midlantic, as assignee, dated as of May 29, 1992.\n10.39(7) -Amendment No. 1 to Amended and Restated Assignment of Operating Assets, between the Partnership, as assignor and Midlantic, as assignee.\n10.40(7) -Amended and Restated Assignment of Operating Assets, between the Partnership, as assignor, and Midlantic, as assignee, dated as of May 29, 1992.\n10.41(7) -Intercreditor Agreement, by and among Midlantic, the Senior Note Trustee, the Mortgage Note Trustee, the PIK Note Trustee, Funding and the Partnership.\n10.42(8) -Option Agreement, dated as of June 23, 1995, between Hamilton Partners, L.P. and the Partnership.\n10.43(9) -Form of Amended and Restated Term Note, dated as of May 28, 1995, between Midlantic Bank, N.A. and the Partnership.\n10.44 -Severance Agreement dated June 16, 1995, between Robert E. Schaffhauser and the Partnership.\n10.45 -Employment Agreement dated July 10, 1995, between Mark A. Brown and the Partnership. _________________\n(1) Incorporated herein by reference to the Exhibit to Funding's and the Partnership's Registration Statement on Form S-4, Registration No. 33-68038.\n(2) Incorporated herein by reference to the Exhibit to Amendment No. 5 to the Schedule 13E-3 of TC\/GP and the Partnership, File No. 5-36825, filed with the SEC on January 11, 1994.\n(3) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1990.\n(4) Incorporated herein by reference to the Exhibit to Funding's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n(5) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1991.\n(6) Incorporated herein by reference to the Exhibit to Funding's Annual Report on Form 10-K for the year ended December 31, 1986.\n(7) Incorporated herein by reference to the identically numbered Exhibit to Funding's Registration Statement on Form S-4, Registration Number 33-52309 filed with the SEC on February 17, 1994.\n(8) Incorporated herein by reference to the identically numbered Exhibit to Funding's and the Partnership's Current Report on Form 8-K dated as of June 23, 1995.\n(9) Incorporated herein by reference to the identically numbered Exhibit to Funding's and the Partnership's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.\nReport of Independent Public Accountants\nConsolidated Balance Sheets of Trump's Castle Associates and Subsidiary as of December 31, 1995 and 1994\nConsolidated Statements of Operations of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Partners' Capital of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows of Trump's Castle Associates and Subsidiary for the years ended December 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements of Trump's Castle Associates and Subsidiary\nSchedule\nII Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994, and 1993\nOther Schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the combined financial statements or notes thereto.\nArthur Andersen LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Trump's Castle Associates and Subsidiary:\nWe have audited the accompanying consolidated balance sheets of Trump's Castle Associates (a New Jersey general partnership) and Subsidiary 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 schedule referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and 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 Trump's Castle Associates 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 ending 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 the financial statements 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 our audits of the basic financial statements, and in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN, LLP\nRoseland, New Jersey February 16, 1996\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nA\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nB\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nTRUMP'S CASTLE ASSOCIATES AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ORGANIZATION AND OPERATIONS:\nThe accompanying consolidated financial statements include those of Trump's Castle Associates, a New Jersey general partnership (the \"Partnership\") and its wholly-owned subsidiary, Trump's Castle Funding, Inc., a New Jersey corporation (\"Funding\"). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.\nThe Partnership was formed as a limited partnership in 1985 for the sole purpose of acquiring and operating Trump's Castle Casino Resort (\"Trump's Castle\"). The Partnership converted to a general partnership in February 1992. Trump's Castle is a luxury casino hotel located in the Marina District of Atlantic City, New Jersey. A substantial portion of Trump's Castle's revenues are derived from its gaming operations. Competition in the Atlantic City gaming market is intense and the Partnership believes that the competition will continue as new entrants to the gaming industry become operational.\nThe partners in the Partnership are TC\/GP, Inc. (\"TC\/GP\"), which has a 37.5% interest in the Partnership, Donald J. Trump (\"Trump\"), who has a 61.5% interest in the Partnership, and Trump's Castle Hotel & Casino, Inc. (\"TCHI\"), which has a 1% interest in the Partnership. Trump, by virtue of his ownership of TC\/GP and TCHI, is the beneficial owner of 100% of the common equity interest in the Partnership, subject to the right of holders of warrants for 50% of the common stock of TCHI (the \"TCHI Warrants\") to acquire an indirect beneficial interest in 0.5% of the common equity interest in the Partnership. Trump has pledged his direct and indirect ownership interest in the Partnership as collateral under various personal debt agreements.\nFunding was incorporated on May 28, 1985 solely to serve as a financing company to raise funds through the issuance of bonds to the public (Note 4). Since Funding has no business operations, its ability to repay the principal and interest on the 11-1\/2% Senior Secured Notes due 2000 (the \"Senior Notes\"), the 11-3\/4% Mortgage Notes due 2003 (the \"Mortgage Notes\"), and its Increasing Rate Subordinated Pay-in-Kind Notes due 2005 (the \"PIK Notes\") is completely dependent upon the operations of the Partnership.\n(2) PLAN OF RECAPITALIZATION:\nOn December 28, 1993, the Partnership, Funding, and TC\/GP consummated a recapitalization plan (the \"Recapitalization Plan\") whereby each $1,000 of principal of the 9.5% Mortgage Bonds issued as part of an earlier plan of reorganization was exchanged for\n$750 principal amount of Funding's Mortgage Notes, $120 principal amount of Funding's PIK Notes, and a cash payment of $6.19 plus all accrued and unpaid interest. Those bondholders who did not elect to exchange their Mortgage Bonds received a cash payment in redemption of their Mortgage Bonds of $750 for each $1,000 of principal amount of bonds plus accrued and unpaid interest. In addition, each share of TC\/GP common stock was exchanged for $35 principal amount of PIK Notes.\nAs a result of the Recapitalization Plan, approximately 96% of the principal amount of the previously issued Mortgage Bonds were exchanged for Mortgage Notes and PIK Notes and the TC\/GP common stock was redeemed. Those Bonds that were redeemed for cash were purchased at an amount which approximated their net book value at the date of purchase. The net book value of the exchanged Bonds has been carried forward and allocated to the Mortgage Notes and PIK Notes in proportion to the principal amount of Mortgage Notes and PIK Notes issued. The difference between the principal amount and net book value of these Mortgage Notes and PIK Notes is being accreted as a charge to interest expense over the life of the Mortgage Notes and PIK Notes using the effective interest method.\nIn addition to the Mortgage Notes and PIK Notes, Funding issued $27,000,000 of the Senior Notes. A portion of the proceeds from the Senior Notes were used to repay $7,000,000 of outstanding indebtedness.\nTransaction costs related to the Recapitalization Plan of approximately $9,000,000 were included in interest expense. Included in these costs was a $1,500,000 bonus to Trump for the services he provided in connection with the Recapitalization Plan.\n(3) ACCOUNTING POLICIES:\nPERVASIVENESS OF ESTIMATES\nThe preparation of these financial statements in conformity with generally accepted accounting principals 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 reporting period. Actual results may differ from these estimates.\nREVENUE RECOGNITION\nCasino revenues consist of the net win from gaming activities, which is the difference between gaming wins and losses. Revenues from hotel and other services are recognized at the time the related services are performed.\nThe Partnership provides an allowance for doubtful accounts arising from casino, hotel, and other services, which is based\nupon a specific review of certain outstanding receivables and historical collection performance. In determining the amount of the allowance, the Partnership is required to make certain estimates and assumptions and actual results may differ from these estimates and assumptions.\nPROMOTIONAL ALLOWANCES\nGross revenues include the retail value of the complimentary food, beverage, and hotel services provided to patrons. The retail value of these promotional allowances is deducted from gross revenues to arrive at net revenues. The cost of such complimentaries have been included in gaming costs and expenses in the accompanying consolidated statements of operations. The estimated departmental costs of providing such promotional allowances are included in gaming costs and expenses and are as follows:\n1995 1994 1993 ___________ ___________ ___________ Rooms $ 6,261,000 $ 6,554,000 $ 5,834,000 Food and Beverage 18,240,000 17,342,000 17,332,000 Other 2,483,000 2,693,000 2,073,000 ___________ ___________ ___________ $26,984,000 $26,589,000 $25,239,000 =========== =========== ===========\nINCOME TAXES\nThe accompanying consolidated financial statements do not include a provision for Federal income taxes of the Partnership, since any income or losses allocated to the partners are reportable for Federal income tax purposes by the Partners.\nUnder the Casino Control Act (the \"Act\") and the regulations promulgated thereunder, the Partnership and Funding are required to file a consolidated New Jersey corporation business tax return.\nAs of December 31, 1995, the Partnership had New Jersey State net operating losses of approximately $162,000,000, which are available to offset taxable income through the year 2002. The net operating loss carryforwards result in a deferred tax asset of $15,200,000, which has been offset by a valuation allowance of $15,200,000, as utilization of such carryforwards is not considered to be more likely than not.\nINVENTORIES\nInventories of provisions and supplies are carried at the lower of cost (first-in, first-out basis) or market.\nPROPERTY AND EQUIPMENT\nProperty and equipment is recorded at cost and is depreciated\non the straight-line method over the estimated useful lives of the assets. Estimated useful lives for furniture, fixtures, and equipment and buildings are from three to eight years and forty years, respectively.\nLONG LIVED ASSETS\nDuring 1995, the Partnership 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, the Partnership does not believe that any impairment exists in the recoverability of its long lived assets.\nSTATEMENTS OF CASH FLOWS\nFor purposes of the statements of cash flows, Funding and the Partnership consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nThe following supplemental disclosures are made to the statements of cash flows:\n1995 1994 1993 Cash paid during the ___________ ___________ ___________ year for interest (net of amounts capitalized) $35,338,000 $31,255,000 $44,857,000 =========== =========== ===========\nIssuance of debt in exchange for accrued $ 7,766,000 $ 3,559,000 $ -- interest =========== =========== ===========\nRECLASSIFICATION\nCertain reclassifications have been made to the 1994 and 1993 financial statements in order to conform to the classifications used in 1995.\n(4) MORTGAGE NOTES AND PIK NOTES:\nAs discussed in Note 2, On December 28, 1993 all of the outstanding Mortgage Bonds and TC\/GP common stock were either redeemed or exchanged for Mortgage Notes and PIK Notes by Funding. The Mortgage Notes bear interest, payable in cash, semi-annually, at 11-3\/4% and mature on November 15, 2003. As discussed in Note 2, the net book value of the exchanged bonds has been carried forward and allocated to the Mortgage Notes and PIK Notes in proportion to the principal amount of Mortgage Notes and PIK Notes\nissued. In the event the PIK Notes are redeemed prior to November 15, 1998, the interest rate on the Mortgage Notes will be reduced to 11-1\/2%. The Mortgage Notes may be redeemed at Funding's option at a specified percentage of the principal amount commencing in 1998.\nThe PIK Notes bear interest payable, at Funding's option in whole or in part in cash and through the issuance of additional PIK Notes, semi-annually at the rate of 7% through September 30, 1994 and 13-7\/8% through November 15, 2003. After November 15, 2003, interest on the Notes is payable in cash at the rate of 13-7\/8%. The PIK Notes mature on November 15, 2005. The PIK Notes may be redeemed at Funding's option at 100% of the principal amount under certain conditions, as defined in the PIK Note Indenture, and are required to be redeemed from a specified percentage of any equity offering which includes the Partnership. Interest has been accrued using the effective interest method. On May 15, 1995 and November 15, 1995, the semi-annual interest payments of $3,753,000 and $4,013,000, respectively, were paid by the issuance of additional PIK Notes.\nOn June 23, 1995, the Partnership entered into an Option Agreement with Hamilton Partners, L.P. (\"Hamilton\") which grants the Partnership an option (the \"Option\") to acquire the PIK Notes owned by Hamilton. Hamilton has represented to the Partnership that it is the owner of at least 92% of the outstanding principal amount of the PIK Notes. The Option was granted to the Partnership in consideration of a $1,100,000 payment to Hamilton, which is included in prepaid expenses and other current assets.\nThe Option is exercisable at a price equal to 60% of the aggregate principal amount and accrued interest of the PIK Notes delivered by Hamilton. Pursuant to the terms of the Option Agreement, upon the occurrence of certain events within 18 months of the time the Option is exercised, the Partnership is required to make an additional payment to Hamilton of up to 40% of the principal amount of the PIK Notes. The option expires on March 19, 1996 and may be extended to June 21, 1996.\nThe terms of both the Mortgage Notes and PIK Notes include limitations on the amount of additional indebtedness the Partnership may incur, distributions of Partnership capital, investments, and other business activities.\nThe Mortgage Notes are secured by a promissory note of the Partnership to Funding (the \"Partnership Note\") in an amount and with payment terms necessary to service the Mortgage Notes. The Partnership Note is secured by a mortgage on Trump's Castle and substantially all of the other assets of the Partnership. The Partnership Note has been assigned by Funding to the Trustee to secure the repayment of the Mortgage Notes. In addition, the Partnership has guaranteed (the \"Guaranty\") the payment of the Mortgage Notes, which Guaranty is secured by a mortgage on Trump's Castle. The Partnership Note and the Guaranty are expressly subordinated to the indebtedness described in Note 5 (the \"Senior Indebtedness\") and the liens of the mortgages securing the\nPartnership Note and the Guaranty are subordinate to the liens securing the Senior Indebtedness.\nThe PIK Notes are secured by a subordinated promissory note of the Partnership to Funding (the \"Subordinated Partnership Note\"), which has been assigned to the Trustee for the PIK Notes, and the Partnership has issued a subordinated guaranty (the \"Subordinated Guaranty\") of the PIK Notes. The Subordinated Partnership Note and the Subordinated Guaranty are expressly subordinated to the Senior Indebtedness, the Partnership Note, and the Guaranty.\nThe ability of Funding and the Partnership to pay their indebtedness when due, will depend on their ability to either generate cash from operations sufficient for such purposes or to refinance such indebtedness on or before the date on which it becomes due. The Partnership does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amounts of the Mortgage Notes and the PIK Notes when due. Thus, the repayment of the principal amount of this indebtedness will likely depend primarily upon the ability of Funding and the Partnership to refinance this debt when due. The future operating performance of the Partnership and the ability to refinance this debt will be subject to the then prevailing economic conditions, industry conditions, and numerous other financial, business, and other factors, many of which are beyond the control of Funding or the Partnership. There can be no assurance that the future operating performance of the Partnership will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally, or the receptiveness of the capital markets to the gaming industry will be conducive to refinancing this debt or other attempts to raise capital.\n(5) OTHER BORROWINGS:\nBANK BORROWINGS\nThe Partnership has a term loan with Midlantic National Bank (the \"Term Loan\") in the amount of $38,000,000. The Term Loan had an initial maturity date of May 29, 1995 and under its terms, the Partnership had the option, subject to certain conditions, to extend the Term Loan an additional five years. The Partnership exercised its option to extend the Term Loan on May 28, 1995. The interest rate was revised to be a fluctuating rate of 3% above the bank's prime rate, which was 8.5% at December 31, 1995, but in no event less than 9% per annum. In addition, the outstanding principal amount of the Term Loan will be amortized over the five- year extension period on a twenty year amortization schedule requiring principal payments of approximately $158,000 per month over the period. At December 31, 1995, $36,892,000 was outstanding on this Term Loan.\nThe Term Loan is secured by a mortgage lien on Trump's Castle that is prior to the lien securing the Mortgage Notes (Note 4) and the Senior Notes described below.\nSENIOR NOTES\nOn December 28, 1993, Funding issued the Senior Notes. Similar to the Mortgage Notes, the Senior Notes are secured by an assignment of a promissory note of the Partnership (the \"Senior Partnership Note\") which is in turn secured by a mortgage on Trump's Castle and substantially all of the other assets of the Partnership. In addition, the Partnership has guaranteed (the \"Senior Guaranty\") the payment of the Senior Notes, which Senior Guaranty is secured by a mortgage on Trump's Castle. The Senior Partnership Note and the Senior Guaranty are subordinated to the Term Loan described above.\nInterest on the Senior Notes is payable semiannually at the rate of 11-1\/2%; however in the event that the PIK Notes are redeemed prior to November 15, 1998, the interest rate will be reduced to 11-1\/4%. The Senior Notes are subject to a required partial redemption, as defined, commencing on June 1, 1998 at 100% of the principal amount of the amount redeemed.\n(6) RELATED PARTY TRANSACTIONS:\nTRUMP MANAGEMENT FEE\nThe Partnership had a management agreement (the \"Management Agreement\") with Trump's Castle Management Corp. (\"TCMC\"), a corporation wholly-owned by Trump. The Management Agreement provided that the day-to-day operation of Trump's Castle and all ancillary properties and businesses of the Partnership was to be under the exclusive management and supervision of TCMC.\nPursuant to the Management Agreement, the Partnership was required to pay an annual fee in the amount of $1,500,000 to TCMC for each year in which Earnings Before Interest, Taxes, Depreciation, and Amortization (\"EBITDA\"), as defined, exceeds certain levels. In addition, TCMC, beginning with the fiscal year ended December 31, 1994, was to receive an incentive fee equal to 10% of the excess EBITDA over $45,000,000 for such fiscal year. During the year ended December 31, 1993, the Partnership incurred fees and expenses of $1,647,000 under the Management Agreement.\nAs a result of the Recapitalization Plan described in Note 2, on December 28, 1993, the Partnership terminated the Management Agreement with TCMC and entered into a services agreement (the \"Services Agreement\") with TC\/GP. Pursuant to the terms of the Services Agreement, TC\/GP is obligated to provide 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 with respect to the business and operations of the Partnership, including such other services as the Managing Partner may reasonably request.\nIn consideration for the services to be rendered, the Partnership will pay TC\/GP an annual fee on the same basis as that of the previous Management Agreement, discussed above. During the\nyears ended December 31, 1995 and 1994, the Partnership incurred fees and expenses of $2,087,000 and $2,111,000, respectively, under the Services Agreement. The Services Agreement expires on December 31, 2005.\nOTHER PAYMENTS TO TRUMP\nDuring 1994, the Board of Partner Representatives approved a $1,000,000 bonus to be paid to Trump, based upon 1994 operating results. The amount was paid in two equal installments in June and August 1995. No such bonus was approved for 1995.\nDUE FROM AFFILIATES\nAmounts due from affiliates were $1,146,000 and $434,000 as of December 31, 1995 and 1994, respectively. The Partnership has engaged in limited intercompany transactions with Trump Plaza Associates, Trump Taj Mahal Associates, and the Trump Organization, which are affiliates of Trump. These transactions include certain shared payroll costs as well as complimentary services offered to customers, for which the Partnership makes initial payments and is then reimbursed by the affiliates.\nDuring 1995, 1994, and 1993, the Partnership incurred expenses of approximately $1,673,000, $1,631,000, and $1,332,000, respectively, in corporate salaries and $1,109,000, $1,047,000, and $952,000, respectively, of other transactions on behalf of these related entities. In addition, the Partnership received payments totaling $1,401,000, $2,438,000, and $2,004,000, respectively, for services rendered and had $580,000, $441,000, and $407,000, respectively, of charges for similar costs incurred by these related entities on behalf of the Partnership.\nPARTNERSHIP AGREEMENT\nUnder the terms of the Partnership Agreement, the Partnership was required to pay all costs incurred by TC\/GP. For the years ended December 31, 1995, 1994, and 1993, the Partnership paid $1,248,000, $1,188,000, and $736,000, respectively, of expenses on behalf of TC\/GP. For the years ended December 31, 1995 and 1994 these costs were charged to general and administrative expense in the accompanying consolidated financial statements. For the year ended December 31, 1993 these costs were expenses of TC\/GP and recorded as a capital contribution.\n(7) COMMITMENTS AND CONTINGENCIES:\nCASINO LICENSE RENEWAL\nThe Partnership is subject to regulation and licensing by the CCC. The Partnership's casino license must be renewed periodically, is not transferable, is dependent upon the financial stability of the Partnership, and can be revoked at any time. Due to the uncertainty of any license renewal application, there can be no assurance that the license will be renewed. Upon\nrevocation, suspension for more than 120 days, or failure to renew the casino license due to the Partnership's financial condition or for any other reason, the Casino Control Act (the \"Act\") provides that the CCC may appoint a conservator to take possession of and title to the hotel and casino's business and property, subject to all valid liens, claims, and encumbrances.\nOn June 22, 1995, the CCC renewed the casino license of the Partnership through 1999 subject to certain continuing reporting and compliance conditions.\nSELF INSURANCE RESERVES\nSelf insurance reserves represent the estimated amounts of uninsured claims settlements related to employee health medical costs, workers compensation, and other legal proceedings in the normal course of business. These reserves are established by the Partnership based upon a specific review of open claims as of the balance sheet date as well as historical claims settlement experience. Actual results may differ from these reserve amounts.\nEMPLOYMENT AGREEMENTS\nThe Partnership has entered into employment agreements with certain key employees which expire at various dates through July 30, 1998. Total minimum commitments on these agreements at December 31, 1995 were approximately $4,061,000.\nLEGAL PROCEEDINGS\nThe Partnership is involved in legal proceedings incurred in the normal course of business. In the opinion of management and its counsel, if adversely decided, none of these proceedings would have a material effect on the consolidated financial position of the Partnership.\nCASINO REINVESTMENT DEVELOPMENT AUTHORITY OBLIGATIONS\nPursuant to the provisions of the Act, the Partnership, must either obtain investment tax credits, as defined in the Act, in an amount equivalent to 1.25% of its gross casino revenues, as defined in the Act, or pay an alternative tax of 2.5% of its gross casino revenues. Investment tax credits may be obtained by making qualified investments, as defined, or by depositing funds which may be converted to bonds by the Casino Reinvestment Development Authority (the \"CRDA\"), both of which bear interest at below market interest rates. The Partnership is required to make quarterly deposits with the CRDA to satisfy its investment obligations.\nFrom time-to-time the Partnership has elected to donate funds that it has on deposit with the CRDA in return for tax credits to satisfy substantial portions of the Partnership's future investment alternative tax obligations. Donations in the amount of $375,000, $6,440,000, and $568,000 were made in 1995, 1994, and 1993, respectively. These donations, net of the tax credits\nreceived, were charged against operations in the year in which they were made and resulted in CRDA tax credits of $191,000, $1,474,000, and $290,000 to be applied to the years ending December 31, 1995, 1994, and 1993, respectively. For the years ended December 31, 1995, 1994, and 1993 the Partnership charged to operations $720,000, $955,000, and $115,000, respectively, which represents amortization of a portion of the tax credits discussed above.\nIn addition, for the years ended December 31, 1995, 1994, and 1993, the Partnership charged to operations $936,000, $735,000, and $953,000, respectively, to give effect to the below market interest rates associated with purchased CRDA bonds.\n(8) EMPLOYEE BENEFIT PLANS:\nThe Partnership has a retirement savings 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 up to the maximum amount permitted by law, and the Partnership will match 50% of an eligible employee's contributions up to a maximum of 5% of the employee's earnings. The Partnership recorded charges of approximately $1,013,000, $899,000, and $864,000 for matching contributions for the years ended December 31, 1995, 1994, and 1993, respectively.\nThe Partnership makes payments to various trusteed pension plans under industry-wide union agreements. The payments are based on the hours worked by or gross wages paid to covered employees. It is not practical to determine the amount of payments ultimately used to fund pension benefit plans or the current financial condition of the plans. Under the Employee Retirement Income Security Act, the Partnership may be liable for its share of the plans' unfunded liabilities, if any, if the plans are terminated. Pension expense for the years ended December 31, 1995, 1994, and 1993 were $497,000, $455,000, and $407,000, respectively.\nThe Partnership provides no other material post employment benefits.\n(9) FINANCIAL INFORMATION OF FUNDING:\nFinancial information relating to Funding as of and for the years ended December 31, 1995 and 1994 is as follows:\n1995 1994\nTotal Assets (including Mortgage $287,679,000 $277,541,000 Notes Receivable of $242,141,000, ============ ============ net of unamortized discount of $35,572,000 and $37,729,000 at December 31, 1995 and 1994; PIK Notes Receivable of $61,860,000, net of unamortized discount of $7,750,000 at December 31, 1995 and $54,094,000, net of unamortized discount of $7,965,000 at December 31, 1994, and Senior Notes Receivable of $27,000,000 at December 31, 1995 and 1994.)\nTotal Liabilities and Capital $287,679,000 $277,541,000 (including Mortgage Notes Payable ============ ============ of $242,141,000, net of unamortized discount of $35,572,000 and $37,729,000 at December 31, 1995 and 1994, PIK Notes Payable of $61,860,000, net of unamortized discount of $7,750,000 at December 31, 1995 and $54,094,000, net of unamortized discount of $7,965,000, at December 31, 1994 and Senior Notes Payable of $27,000,000 at December 31, 1995 and 1994.)\nInterest Income $ 41,768,000 $ 40,600,000\nInterest Expense $ 41,768,000 $ 40,600,000 ____________ ____________\nNET INCOME $ - $ - ============ ============\n(10) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount of the following financial instruments of the Partnership and Funding approximate fair value, as follows: (a) cash and cash equivalents and accrued interest receivables and payables based on the short-term nature of the financial instruments, (b) CRDA bonds and deposits based on the allowances to give effect to the below market interest rates.\nThe fair values of the Mortgage Notes and PIK Notes are based on quoted market prices. The fair value of the Mortgage Bonds was based on quoted market prices obtained by the Partnership from its investment advisor as follows:\nDecember 31, 1995 ______________________________ Carrying Amount Fair Value _______________ _____________ 11-3\/4% Mortgage Notes............ $ 206,569,000 $ 212,479,000 PIK Notes......................... $ 54,110,000 $ 48,096,000\nDecember 31, 1994 ______________________________ Carrying Amount Fair Value ______________ _____________ 11-3\/4% Mortgage Notes............ $ 204,412,000 $ 131,967,000 PIK Notes......................... $ 46,129,000 $ 43,546,000\nThere are no quoted market prices for the Partnership Term Loan and Senior Notes. A reasonable estimate of their value could not be made without incurring excessive costs.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrants have duly caused this Annual Report to be signed on their behalf by the undersigned, thereunto duly authorized, on the 22nd day of March, 1996.\nTRUMP'S CASTLE FUNDING, INC.\nBy: \/s\/Donald J. Trump _____________________ By: Donald J. Trump Title: President\nTRUMP'S CASTLE ASSOCIATES\nBy: \/s\/Donald J. Trump _____________________ By: Donald J. Trump Title: Managing General Partner\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report has been signed below by the following persons on behalf of the Registrants and in the capacities and on the date indicated.\nSignature Title Date\nTRUMP'S CASTLE FUNDING, INC.\nBy:\/s\/Donald J. Trump Chairman of the Board, March 22, 1996 ___________________ President, Chief Executive Donald J. Trump Officer (Principal Executive Officer), Treasurer (Principal Financial Officer), and sole Director of the Registrant.\nBy:\/s\/Robert E. Schaffhauser Assistant Treasurer March 22, 1996 _________________________ of the Registrant Robert E. Schaffhauser (Principal Accounting Officer)\nSignature Title Date\nTRUMP'S CASTLE ASSOCIATES\nBy:\/s\/Nicholas L. Ribis Board of Partner March 22, 1996 ____________________ Representatives Nicholas L. Ribis\nBy:\/s\/Roger P. Wagner Board of Partner March 22, 1996 __________________ Representatives Roger P. Wagner\nBy:\/s\/Asher O. Pacholder Board of Partner March 22, 1996 _____________________ Representatives Asher O. Pacholder\nBy:\/s\/Arthur S. Bahr Board of Partner March 22, 1996 ____________________ Representatives Arthur S. Bahr\nBy:\/s\/Thomas F. Leahy Board of Partner March 22, 1996 __________________ Representatives Thomas F. Leahy\nBy:\/s\/Robert M. Pickus Board of Partner March 22, 1996 ___________________ Representatives Robert M. Pickus\nBy:\/s\/Robert E. Schaffhauser Chief Financial Officer March 22, 1996 _________________________ and Chief Accounting Robert E. Schaffhauser Officer of the Partnership","section_15":""}
{"filename":"54441_1995.txt","cik":"54441","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nKaneb Services, Inc. (\"KSI\" or the \"Company\") conducts its principal businesses in two industry segments: i) specialized industrial field services; and, ii) pipeline transportation and storage of refined petroleum products. The Company operates its specialized industrial field services business through its Furmanite group of wholly-owned subsidiaries (collectively, \"Furmanite\"), which provide underpressure leak sealing, on-site machining, valve testing and repair and other engineering products and services, primarily to electric power generating plants, petroleum refineries and other process industries in Western Europe, North America and the Pacific Rim (See: \"Industrial Field Services\"). The Company's wholly-owned subsidiary, Kaneb Pipe Line Company (\"KPL\"), operates and manages refined petroleum products pipeline transportation systems and petroleum products and specialty liquids terminal storage and pipeline facilities for the benefit of Kaneb Pipe Line Partners, L.P. (\"KPP\" or the \"Partnership\"), which owns such systems and facilities, through its subsidiaries (See: \"Pipeline and Terminaling Services\"). The Company is also engaged in the information management services industry through its wholly-owned subsidiary, Fields Financial Services, Inc. (\"Fields\"), which offers products and services that enable financial institutions to monitor the continual insurance coverage of their loan collateral and provides other information management services to financial institutions and other customers.\nKaneb Services, Inc. was incorporated in Delaware on January 23, 1953. The Company is a holding company that conducts its business through the subsidiaries identified above, among others. The Company's principal operating office is located at 2435 North Central Expressway, Richardson, Texas 75080 and its telephone number is (214) 699-4000.\nINDUSTRY SEGMENTS\nFinancial information regarding the Company's industry segments and foreign operations is presented under the caption \"Business Segment Data\" in Note 10 to Company's consolidated financial statements. Such information is hereby incorporated by reference into this Item 1.\nINDUSTRIAL FIELD SERVICES\nThe Company, through Furmanite, offers a variety of specialized industrial field services to an international base of process industry clients. Founded in Virginia Beach, Virginia in the 1920's as a manufacturer of leak sealing kits, Furmanite has evolved into an international service company. In the 1960's, Furmanite expanded within the United Kingdom, primarily through its leak sealing products and services; and, during the 1970's and 1980's, grew through geographic expansion and the addition of new techniques, processes and services to become the largest leak sealing company, and one of the largest on-site machining companies, in the world. In 1991, the Company acquired Furmanite to diversify the Company's operations and take advantage of anticipated international growth opportunities. For the year ended December 31, 1995, Furmanite's sales and operating income were approximately $104,500,000 and $3,900,000, respectively (See: \"Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nPRODUCTS AND SERVICES\nFurmanite is an industry leader in providing on-line repairs of leaks in valves, pipes and other components of piping systems and related equipment (\"leak sealing\") typically used in process industries (See: \"Customers and Markets\"). Other services provided by Furmanite include on-site machining, bolting and valve testing and repair on such systems and equipment, which tend to compliment Furmanite's leak sealing service, since these \"turnaround services\" are usually performed while a plant or piping system is off-line. In addition, Furmanite provides a variety of services, such as hot tapping, fugitive emissions monitoring, passive fire protection, concrete repair, heat exchanger repair and pipeline engineering, on a regional basis in response to the needs of a particular regional customer base. In performing these services, Furmanite technicians generally work at the customer's location, frequently responding on an emergency basis. Over its history, Furmanite has\nestablished a reputation for delivering quality service and helping its customers avoid or delay costly plant or equipment shutdowns. For each of the years ended December 31, 1995, 1994, and 1993, on-line, underpressure leak sealing services represented approximately 31%, 26% and 26%, respectively, of Furmanite's revenues, while on-site machining accounted for approximately 23%, 16% and 13%, respectively, and valve repair represented approximately 13%, 9% and 10%, respectively, of Furmanite's revenues for each of such years.\nFurmanite's on-line, underpressure leak sealing services are performed on a variety of process industry machinery, often in difficult situations. Many of Furmanite's techniques and materials are proprietary and, the Company believes, provide Furmanite with a competitive advantage over other organizations that provide similar services. The Company's skilled technicians work with equipment in a manner designed to enhance safety and efficiency in temperature environments ranging from cryogenic to 1,400 degrees Fahrenheit and pressure environments ranging from vacuum to 5,000 pounds per square inch. In many circumstances, Furmanite personnel are called upon to custom-design tools, equipment or other materials in order to effect the necessary repairs. These efforts are supported by an internal quality control group that works together with the on-site technicians in crafting these materials.\nCUSTOMERS AND MARKETS\nFurmanite's customer base spans a broad industry spectrum, which includes petroleum refineries, chemical plants, offshore energy production platforms, steel mills, power generation and other process industries in more than 20 countries. Over 80% of Furmanite's revenues are derived from fossil and nuclear fuel power generation companies, petroleum refiners and chemical producers; while other significant markets include offshore oil producers and steel manufacturers. As the worldwide industrial infrastructure continues to age, additional repair and maintenance expenditures are expected to be required for the specialized services provided by Furmanite and similarly situated organizations. Other factors that may influence the markets served by Furmanite include regulations governing construction of industrial plants; safety and environmental compliance requirements; and fulfillment of specialized services through the increased use of outsourcing, rather than an organization's in-house staff.\nFurmanite serves its customers from its Richardson, Texas worldwide headquarters and continues to maintain a strong presence in England and continental Europe. Furmanite currently operates North American offices in the United States in Baton Rouge, Beaumont, Charlotte, Chicago, Houston, Los Angeles, Philadelphia, Salt Lake City and San Francisco; and in Edmonton, Alberta and Sarnia, Ontario, Canada. Furmanite's worldwide strength is further supported by offices currently located in Austria, Belgium, France, Germany, Holland, Hong Kong, Norway, Singapore and the United Kingdom (10 locations) and by licensee and minority ownership interest arrangements in Argentina, Australia, China, the Czech Republic, Finland, India, Indonesia, Italy, Japan, Kuwait, Malaysia, Mexico, Portugal, Puerto Rico, Saudi Arabia, Slovenia, South Africa, South Korea, Sweden, Taiwan, Thailand, Trinidad and the United Arab Emirates. Sales by geographic region for 1995 were 31% for North America, 36% for the U.K. and 29% for continental Europe (See: \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 10 to the Company's consolidated financial statements).\nFurmanite's underpressure leak sealing and other specialty field services are marketed primarily through direct sales calls on customers by salesmen based at Furmanite's various operating locations, which are situated to facilitate timely customer response, 24 hours a day, seven days a week. Customers are usually billed on a time and materials basis for services typically performed pursuant to either job quotation sheets or purchase orders issued under written customer agreements. Customer agreements are generally short-term in duration and specify the range of and rates for the services to be performed. Furmanite typically provides various limited warranties, depending upon the services furnished, and, to date, has had no significant warranty claims. Furmanite competes on the basis of service, product performance and price, generally on a localized basis with smaller companies and the in-house maintenance departments of its customers. In addition to staff reductions and the trend toward outsourcing, Furmanite believes it presently has an advantage over in-house maintenance departments because of the ability of its multi-disciplined technicians to use Furmanite's proprietary techniques to perform quality repairs on a timely basis while customer equipment remains in service.\nSAFETY, ENVIRONMENTAL AND OTHER REGULATORY MATTERS\nMany aspects of Furmanite's operations are subject to governmental regulation. National, state and local authorities of the U.S. and various foreign countries have each adopted safety, environmental and other regulations relating to the use of certain methods, practices and materials in connection with the performance of Furmanite's services and which otherwise affect its operations. Additionally, Furmanite participates, from time to time, with various regulatory authorities in certain studies, reviews and inquiries of its projects and\/or operations. Further, because of its international presence, Furmanite is subject to a number of political and economic uncertainties, including expropriation of equipment, taxation policies, labor practices, import and export limitations, foreign exchange restrictions, currency exchange rate fluctuations and local political conditions. Except in certain developing countries, where payment in a specified currency is required by contract, Furmanite's services are paid, and its operations are typically funded, in the currency of the particular country in which its business activities are conducted.\nUnderpressure leak sealing and other Furmanite services are often performed in emergency situations under dangerous circumstances, involving exposure to high temperatures and pressures, potential contact with caustic or toxic materials, fire and explosion hazards and environmental contamination, any of which can cause serious personal injury or property damage. Furmanite manages its operating risks by providing its technicians with extensive classroom and field training and supervision, maintaining a system of technical support through its staff of professionally qualified specialists, establishing and enforcing strict safety and competency requirements, standardizing procedures and evaluating new materials and techniques for use in connection with its lines of service. Furmanite also maintains insurance coverage for certain risks, although there is no assurance that insurance coverage will continue to be available at rates considered reasonable or that the insurance will be adequate to protect the Company against liability and loss of revenues resulting from the consequences of a significant accident.\nRECENT DEVELOPMENTS\nOn December 28, 1995, the Company notified the holders of its 12% Convertible Class A Preferred Stock, Series D, which was originally issued in connection with the Company's acquisition of Furmanite, that it would redeem all outstanding shares of such Series on January 26, 1996. The Company effected such redemption as noticed, utilizing a portion of the proceeds that it received from a public offering of 3,500,000 Preference Units in Kaneb Pipe Line Partners, L.P. by Kaneb Pipe Line Company, a wholly-owned subsidiary of the Company and the General Partner of the Partnership (See: \"Pipeline and Terminaling Services - Recent Developments\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nIn February 1995, the Company completed the sale of certain unprofitable general maintenance projects in eastern Germany. These projects were acquired in 1991, 1992 and 1993, during the privatization of the former East Germany by the German government. As economic conditions in eastern Germany worsened considerably in 1994, the Company elected to close one project and sell the remaining projects (See: \"Item 3. Legal Proceedings\").\nPIPELINE AND TERMINALING SERVICES\nThrough its KPL subsidiary, the Company manages and operates refined petroleum products pipeline transportation system and petroleum products and specialty liquids terminal storage businesses, and their associated properties, for the benefit of KPP, which owns such systems and facilities through its subsidiaries. The pipeline business consists primarily of the transportation, as a common carrier, of refined petroleum products in Colorado, Iowa, Kansas, Nebraska, North Dakota, South Dakota and Wyoming, as well as related terminaling activities; while, through its Support Terminal Services, Inc. subsidiary, among others (collectively, \"ST\"), the Company operates 31 terminal storage facilities in 16 states and the District of Columbia, with a total storage capacity of approximately 16,800,000 barrels. Including those situated along its refined petroleum products pipeline systems, the Company's terminal storage operations comprise the third largest independent petroleum products and specialty liquids terminaling companies in the United States. For a more detailed discussion of the business, activities and results of operations of the Partnership than that which is contained herein, reference is made to the Annual Report on Form 10-K and the other publicly filed documents of Kaneb Pipe Line Partners, L.P. (NYSE: KPP, KPU).\nPIPELINE TRANSPORTATION SYSTEMS\nMARKETS SERVED\nInitially built in 1953, the KPP pipeline transportation operations currently consist of two pipeline systems: the East and West Pipelines (the \"Pipelines\"), with its operational headquarters located in Wichita, Kansas. The East Pipeline is a 2,075 mile integrated pipeline, ranging between six and sixteen inches in diameter, that transports refined petroleum products received from refineries in southeast Kansas or other interconnecting pipelines to terminals in Iowa, Kansas, Nebraska, North Dakota and South Dakota and to receiving pipeline connections in Kansas. The East Pipeline has direct connections to three Kansas refineries; has direct access by third-party pipelines to four other refineries in Kansas, Oklahoma and Texas; provides access to Gulf (of Mexico) Coast suppliers of refined petroleum products through a connecting pipeline which receives products from a pipeline originating on the Gulf Coast; and, through five connecting pipelines, receives propane from gas processing plants in Kansas, New Mexico, Oklahoma and Texas for shipment through the East Pipeline. The East Pipeline's operation also includes 16 public truck loading terminals located in five states, comprised of a total of 240 tanks having storage capacity of approximately 3,500,000 barrels of product. In addition, the East Pipeline has intermediate storage facilities in McPherson and El Dorado, Kansas, consisting of 23 tanks having an aggregate storage capacity of approximately 922,000 barrels.\nThe West Pipeline was acquired by the Partnership in February 1995 from Wyco Pipe Line Company (See: \"Recent Developments\") and consists of approximately 550 miles of pipeline, ranging from six to eight inches in diameter, that transports refined petroleum products received by direct terminals and other interconnecting pipelines from refineries located in Colorado, Montana, South Dakota and Wyoming to terminals in Colorado, South Dakota and Wyoming. Additionally, the West Pipeline's operations include four public truck loading terminals, also located in Colorado, South Dakota and Wyoming, having storage capacity of approximately 1,801,000 barrels of product. Through these facilities and operations, the West Pipeline serves the growing Denver and northeastern Colorado markets and supplies the jet fuel for Ellsworth Air Force Base, Rapid City, South Dakota.\nThe West Pipeline is the nearest pipeline system paralleling the East Pipeline to the west. Consequently, there is a high level of commonality of shippers on the Pipelines. Due to the proximity of the East and West Pipelines to one another, they often face similar competitive issues. The Pipelines' more significant competitors include common carrier pipelines, proprietary pipelines owned and operated by major integrated and large independent oil companies and other companies in the areas where the Company's pipeline systems and operations deliver products. In particular, the Pipelines' major competitor is an independent regulated common carrier pipeline system that operates approximately 100 miles east of and parallel with the East Pipeline. Competition between common carrier pipelines is based primarily on transportation charges, quality of customer service and proximity to end users. The Company believes that high capital costs, tariff regulation, environmental considerations and problems in acquiring rights-of-way make it unlikely that other competing pipeline systems comparable in size and scope to the Pipelines will be built in the near future, provided that the Pipeline has available capacity to satisfy demand and its tariffs remain at reasonable levels. Further, while pipeline transportation systems are generally the lowest cost method for intermediate and long-haul overland movement of refined petroleum products, trucks may also competitively deliver products in some of the areas served by the Pipelines. Trucking costs, however, render that mode of transportation uncompetitive for longer hauls or larger volumes. The Company does not believe that over the long term, trucks are effective competition to the Pipelines' long-haul volumes.\nPRODUCTS DELIVERED\nThe mix of refined petroleum products delivered varies seasonally, with gasoline demand peaking in early summer, diesel fuel demand peaking in late summer and propane demand higher in the fall. In addition, weather conditions in the geographic areas served by the Pipelines affect the demand for and the mix of the refined petroleum products delivered through the Pipelines, although any such impact on the volumes shipped has historically been short-term. Most of the refined petroleum products delivered through the East Pipeline are ultimately used in agricultural operations, including fuel for farm equipment, irrigation systems, crop drying facilities and trucks used to transport crops to a variety of destinations; while the West Pipeline's products are generally delivered to a more urban and commercial marketplace, including Ellsworth Air Force Base. The\nagricultural sector served by the East Pipeline is also affected by governmental policy and crop prices. Further, the Pipelines are dependent upon adequate levels of production of refined petroleum products by refineries that are connected to the Pipeline, which refineries are, in turn, dependent upon adequate supplies of suitable grades of crude oil. KPL, in its capacity as General Partner of the Partnership, believes that, in the event that operations at any one refinery were discontinued (and assuming unchanged demand in the markets served by the Pipelines), the effects thereof would be short-term in nature, and the Company's business would not be materially adversely affected over the long term. However, a substantial reduction of output by several refineries as a group could affect the Pipelines' operations to the extent that a greater percentage of the supply would have to come from refineries outside the Pipelines' connecting access pipelines.\nTARIFFS\nSubstantially all of the Pipelines' operations constitute common carrier activities that are subject to federal or state tariff regulation. Such common carrier activities are those under which transportation services through the Pipeline are available at published tariffs, as filed with the Federal Energy Regulatory Commission (\"FERC\") or the applicable state regulatory authority, to any shipper of refined petroleum products who requests such services, provided that each refined petroleum product for which transportation is requested satisfies the conditions, requirements and specifications for transportation.\nTERMINAL STORAGE OPERATIONS\nFACILITIES\nAcquired by the Partnership in 1993 (See: \"Recent Developments\"), ST and its predecessors have a proven track record of more than 30 years of quality service and experience in the operation of specialty liquids terminal storage facilities. ST's terminal facilities provide throughput and storage on a fee basis for a wide variety of products from petroleum products to specialty chemicals and edible and other liquids. ST's 31 facilities offer storage capacity ranging from 40,000 to 5,511,000 barrels, comprised of two to 124 tanks per facility. Following the acquisition of certain assets and facilities from Steuart Petroleum Company and certain of its affiliates (collectively, \"Steuart\") (See: \"Recent Developments\") and as of December 31, 1995, ST's five largest facilities were located at Piney Point, Maryland (5,511,000 Bbls capacity; 30 tanks); Jacksonville, Florida (2,061,000 Bbls capacity; 28 tanks); Texas City, Texas (2,002,000 Bbls capacity; 124 tanks); Westwego, Louisiana (858,000 Bbls capacity; 54 tanks); and, Baltimore, Maryland (826,000 Bbls capacity; 50 tanks). In addition to the foregoing, the other ST facilities are situated in Alabama (2), Arizona, California (2), the District of Columbia (2), Florida, Georgia (6), Illinois (2), Indiana, Kansas, Maryland, Minnesota, New Mexico, Oklahoma, Texas, Virginia (2) and Wisconsin, 27 of which are inland facilities that receive, store and deliver primarily petroleum products for a variety of customers, providing ST with a geographically diverse base of customers and revenue. ST's operational headquarters is located in Dallas, Texas.\nThe independent liquids terminaling industry is fragmented and includes both large, well financed publicly-traded companies that own and\/or operate many terminal locations and small private companies that may own and\/or operate only a single terminal location. In addition to the terminals owned by independent terminal operators, many major energy and chemical companies also own extensive terminal facilities. Although such terminals often have the same capabilities as those owned by independent operators, they generally do not provide terminaling services to third parties. In many instances, major energy and chemical companies that own storage facilities are also significant customers of independent terminal operators, when independent terminals have more cost effective locations near key transportation links such as deep water ports. Major energy and chemical companies also require independent terminal storage when their captive storage facilities are inadequate, either because of size constraints, the nature of the stored material or specialized handling requirements. Independent terminal owners, such as ST, compete on the basis of location, versatility of terminals, service and price. For example, a favorably located terminal will have access to various means of cost-effective transportation both to and from the terminal. Terminal versatility is a function of the operator's ability to offer safe handling for a diverse group of products having complex handling requirements. The service function typically provided by the terminal includes, among other things, the safe storage of the product at specified temperature, moisture and other conditions, as well as loading and unloading of product at the terminal. An increasingly important aspect of the versatility and service capabilities of an operator is that operator's ability to offer product handling and storage that\ncomplies with applicable environmental, safety and health regulations, among others, especially since customers may retain the liability for certain acts of non-compliance with such regulations.\nPRODUCTS\nThe variety of products that can be stored at ST's terminal storage facilities is a significant part of, what the Company believes is, its competitive advantage among similarly-situated organizations. ST's terminals provide storage capacity for such products as petroleum products, specialty chemicals, asphalt, fertilizer, latex and caustic solutions, and edible liquids, including animal and vegetable fats and oils. Further, the terminaling and pipeline transportation of jet fuel for the U.S. Department of Defense is an important part of ST's business. Nine of ST's 27 inland terminal sites are involved in the terminaling or transport (via pipeline) of jet fuel for the Defense Department. Six of the nine locations are utilized solely by the Defense Department and five of these locations include pipelines that deliver jet fuel directly to nearby military bases. Additionally, as part of the Steuart transaction, the Partnership acquired the pipeline that serves Andrews Air Force Base in Maryland (See: \"Recent Developments\"). Revenue attributable to Department of Defense activities is derived from a combination of terminal contracts and tenders for the handling and movement of jet fuel. The terminal contracts provide a fixed monthly revenue for a period of one to four years per contract, with additional revenues generated if specific throughput levels are exceeded. The tenders provide for charges per barrel of throughput and have no minimum guarantees. From time to time, military base closings or other events have impacted the operation of certain of ST's facilities. However, KPL, in its capacity as General Partner of the Partnership, does not believe that, in the aggregate, the inland terminals serving the U.S. Department of Defense will experience a significant decrease in cash flows for the foreseeable future as a result of Department of Defense changes in activity. KPL, in its capacity as General Partner of the Partnership, does not believe that ST's business is dependent upon any one customer or any small group of customers.\nSAFETY, ENVIRONMENTAL AND OTHER REGULATORY MATTERS\nIn addition to tariff regulation of the Partnership's Pipeline activities, certain operations of the Partnership are subject to federal, state and local laws and regulations relating to the construction, maintenance and management of its facilities, the safety of its personnel and the protection of the environment. Although KPL, in its capacity as General Partner of the Partnership, believes that the operations of the Partnership are in general compliance with applicable laws and regulations, risks of substantial costs and liabilities are inherent in both pipeline and terminaling operations, and there can be no assurance that significant costs and liabilities will not be incurred by the Partnership. For example, contamination resulting from spills or releases of refined petroleum products within the petroleum pipeline industry, or refined petroleum or other products within the terminaling industry, are not unusual in such industries. From time to time, the Partnership has experienced limited groundwater contamination at certain of its Pipeline-related terminal sites, resulting from spills of refined petroleum products. In each instance, the appropriate regulatory authorities have been notified of these events and appropriate remediation activities have either been completed or are ongoing. In connection with the formation of the Partnership, the Company agreed to bear the costs associated with identified environmental contamination relating to the operations of the East Pipeline arising prior to October 3, 1989; however, such costs have not been, and are not in the future anticipated to be, material.\nAdditionally, from time to time, the Partnership has experienced limited groundwater contamination at certain of its current and former terminal storage facilities, as a result of operations at or around these locations. Again, in each instance, the appropriate regulatory authorities have been notified of these events and appropriate remediation activities have either been completed, are ongoing, at times using extraction wells and air strippers, or are under investigation. In certain instances where other unrelated companies may also have responsibility for the contamination of a particular facility or area, the Partnership, through the appropriate operating subsidiary, has entered into agreements (or is in the process of negotiating such agreements) with such company or companies providing for the allocation of the costs and\/or responsibilities of remediation of such facilities or areas. Further, ST has been named as a \"potentially responsible party\" for a federally-designated and EPA-supervised \"Superfund\" site where a small amount of material handled by the former operator was attributed to the facility owned by ST.\nWhile the Company believes that the Partnership's obligations in connection with the remediation process at this location will be de minimis, until a final settlement agreement is signed with the EPA, there is a possibility that the EPA could bring additional claims against ST (See: \"Legal Proceedings\").\nRECENT DEVELOPMENTS\nOn December 19, 1995, the Partnership acquired the liquid terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, \"Steuart\") for $68,000,000 plus transaction costs and the assumption of certain environmental liabilities. Among the assets acquired by the Partnership were eight terminal storage facilities located in the District of Columbia, Florida, Georgia, Maryland and Virginia, consisting of 88 storage tanks having an aggregate capacity of approximately 9,000,000 barrels of product. The Maryland facility also includes the pipeline servicing operations for Andrews Air Force Base. The transaction was initially funded by a bank bridge loan, which is anticipated to be replaced during the 1996 calendar year by the private placement of $68,000,000 of first mortgage notes. The Partnership is currently in the process of finalizing the terms of such a private placement and has engaged an investment banking organization to assist with the proposed transaction. While the Company expects that the Partnership will be successful in completing the private placement, there can be no assurance that such will occur or, if so, it will contain the terms and conditions currently contemplated by the Partnership. On a pro-forma basis, giving effect to the Steuart acquisition, revenues generated by the Steuart assets would have accounted for approximately 8.3% of the Company's revenues for the year ended December 31, 1995.\nIn September 1995, the Partnership completed a public offering of 3,500,000 Preference Units (NYSE: KPU) at a price of $22.50 per unit. The Preference Units, which had been owned by KPL since 1989, represent a separate class of units from, and are junior to, the Partnership's Senior Preference Units (NYSE: KPP) (\"SPUs\"), which SPUs have been the subject of two previous public offerings in 1989 and 1993. The Company, through a dividend from its KPL subsidiary, realized net proceeds of approximately $74,000,000 from the offering of Preference Units; following which, the Company continued to retain control of the Partnership through a 2% General Partner interest and an aggregate 31.0% limited partner interest in the Partnership. A substantial portion of the proceeds from the offering were used by the Company in 1995 to retire two outstanding debt issues: $5,011,000 of Moran Energy Inc. 11.5% Subordinated Debentures, which were redeemed by the Company on October 23, 1995, and $43,200,000 of Moran Energy International, N.V. 8% Convertible Subordinated Debentures, which matured on November 1, 1995 and to repay a $10,000,000 bank term loan. Additionally, on February 1, 1996, the Company used a portion of the offering proceeds to retire a $6,000,000 bank loan and, on January 26, 1996, the Company used approximately $8,000,000 of the offering proceeds to redeem all of the outstanding shares of its 12% Convertible Class A Preferred Stock, Series D, which were originally issued in connection with the Company's acquisition of Furmanite (See: \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Industrial Field Services - Recent Developments\"). As stated, the Partnership has previously completed two public offerings of Partnership SPUs: the original offering of 5,000,000 units for $22 per unit in September 1989, following the formation of KPP and generating net proceeds to the Company of approximately $98,000,000 and a gain of approximately $60,000,000; and, an offering of an additional 2,250,000 SPUs for $25.25 per unit in April 1993, which resulted in net proceeds to KPP of approximately $53,200,000 and recognition by the Company in 1993 of a non-cash gain of approximately $15,100,000.\nOn February 24, 1995, the Partnership completed a transaction with Wyco Pipe Line Company (\"Wyco\"), an entity jointly owned by GATX Terminals Corporation and Amoco Pipe Line Company, pursuant to which KPP acquired certain refined petroleum pipeline assets from Wyco for $27,100,000 plus transaction costs and the assumption of certain environmental liabilities. The assets, which the Company refers to as \"the West Pipeline\", consist of approximately 550 miles of underground pipe in Wyoming, Colorado and South Dakota, four truck loading terminals, numerous pump stations and other related assets. KPP financed the acquisition of the former Wyco assets by the issuance of $27,000,000 of 8.37% first mortgage notes, due in 2002, to three insurance companies.\nENVIRONMENTAL CONTROLS\nThe Company believes that it is in substantial compliance with applicable state, federal and local legislation and regulations relating to environmental controls, and the existence of such laws and regulations has not had, nor at this time is expected to have, any materially restrictive effect on the Company. To date, the Company has not accounted for costs or capital expenditures incurred for environmental control facilities separately from other costs incurred in the operation of its businesses. The Company does not, however, believe that any such costs or expenditures have been material, and the Company does not expect that under present conditions such costs or expenditures will become material in the foreseeable future.\nEMPLOYEES\nAt December 31, 1995, the Company and its subsidiaries employed 1,657 persons, of which an aggregate total of 1,154 persons were employed by the Company's Furmanite subsidiaries, collectively, and an aggregate total of 347 persons were employed by KPL, collectively with its subsidiaries. The Partnership has no employees, as the business and operations of the Partnership are conducted by KPL, the General Partner of the Partnership and a wholly-owned subsidiary of the Company. As of December 31, 1995, approximately 550 of the persons employed by Furmanite were subject to representation by unions or other similar associations for collective bargaining or other similar purposes; however, there were no significant collective bargaining or other similar contracts covering the Furmanite employees in effect at that date. Additionally, as of December 31, 1995, approximately 139 of the persons employed by KPL (or its subsidiaries) were subject to representation by unions for collective bargaining purposes; however, except for approximately 30 persons employed by ST who were subject to representation by the Oil, Chemical and Atomic Workers International Union AFL-CIO (\"OCAW\"), there were no collective bargaining or other similar contracts covering employees of KPL (or its subsidiaries) in effect at that date. ST has an agreement with the OCAW regarding conditions of employment for such persons, which agreement is in effect through June 28, 1996 and is subject to automatic renewal for successive one-year periods unless ST or OCAW serves written notice to terminate or modify such agreement in a timely manner.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of the Company are located in Richardson, Texas, in a modern, sixteen story building pursuant to a five year lease agreement. In addition to properties owned or leased by its industrial field services and pipeline transportation and liquids terminaling businesses, the Company, through its wholly-owned subsidiary, Fields Financial Services, Inc., also leases office space in Bryan, Texas.\nDescriptions of other properties owned or utilized by the Company (or its subsidiaries) are contained in Item 1 of this report and such descriptions are hereby incorporated by reference into this Item 2. Under the caption \"Commitments and Contingencies\" in Note 9 to the Company's consolidated financial statements, additional information is presented concerning obligations of the Company (or its subsidiaries) for lease and rental commitments. Such additional information is also incorporated by reference into this Item 2.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn February 2, 1996 a lawsuit was filed in Germany on behalf of Gesellschaft fur Industrieanlagen und Maschineninstandhaltung GmbH or G.I.M. Engineering (\"GIM\") against one of the Company's German subsidiaries, Furmanite Technische Dienstleistungen GmbH (\"FTD\"), concerning the consideration received in a December 30, 1994 German contract that was part of a series of transactions relating to the sale of one of the Company's domestic subsidiaries. On February 5, 1996, the Court ruled in the Furmanite German subsidiary's favor in a separate but related injunctive proceeding involving the same consideration issue in the same contract. The December 30, 1994 contract was an integral part of the ultimate sale of the Company's domestic subsidiary and was consummated after a thorough review by, and based upon the advice of, the Company's German legal counsel and tax advisors. The Company intends to vigorously defend this action, which has not yet been set for hearing.\nIn March 1995, the Company completed a settlement agreement and release of claims among all parties relating to a lawsuit filed in September 1987 in Mobile County, Alabama, against the Company and certain of its affiliates and other unrelated parties by Stephen R. Herbel and others doing business as Pinnacle Petroleum Company (\"Pinnacle\"). The Company's portion of the settlement agreement was adequately reserved in its financial statements.\nTwo of the Company's subsidiaries, which subsidiaries are no longer actively conducting any operations, have been notified that they are \"potentially responsible parties\" in connection with two separate governmental investigations relating to two separate waste disposal facilities which may each be subject to remedial action as locations listed on the Environmental Protection Agency's (\"EPA\") Superfund National Priority List (\"Superfund\"). Such proceedings arising under Superfund typically involve numerous waste generators and other waste transportation and disposal companies for each identified facility and seek to allocate or recover costs associated with site investigation and cleanup, which costs could be substantial. These particular proceedings are based upon allegations that the Company's former operating subsidiaries disposed of hazardous substances at the facilities in question. One proceeding involves actions allegedly taken by the Company's former operating subsidiary at a time prior to the acquisition of such subsidiary by the Company. The Company's subsidiaries have been included within a de minimis group of waste generators that are involved in this proceeding, who have been negotiating a collective settlement of their liabilities with the EPA. However, the Company has joined with others within this de minimis group who are each contesting their respective liability. Proceedings in this matter have been ongoing since 1989 and there was no significant activity relating to this matter that occurred during 1995. The second proceeding involves alleged activity by a corporation in which a former operating subsidiary of the Company held a 50% interest, which interest is no longer owned by the Company's subsidiary or any affiliate of the Company. Accordingly, the Company believes that its liability in this proceeding is governed by the provisions of the agreement pursuant to which the Company's interest in such corporation was disposed. The Company has reviewed its potential exposure, if any, in connection with each location, giving consideration to the nature, accuracy and strength of evidence relating to the Company's alleged relationship to the location, the amount and nature of waste taken to the location, and the number, relationship and financial ability of other named and unnamed \"potentially responsible parties\" at the location. While the Company does not anticipate that the amount of expenditures from its involvement in the above matters will have a material adverse effect on the Company's operations or financial condition, the possibility remains that technological, regulatory, enforcement or legal developments, the results of environmental studies or other factors could materially alter this expectation at any time.\nIn addition, from time to time, the Company and certain of its subsidiaries are involved in various litigation and other legal proceedings in the ordinary course of business. However, the Company believes that a resolution of these matters will not have a material adverse affect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not hold a meeting of stockholders or otherwise submit any matter to a vote of stockholders in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nShares of the Company's Common Stock are listed and traded principally on the New York Stock Exchange. At March 15, 1996, there were approximately 4,870 holders of Common Stock of record. The following table sets forth, for the fiscal periods indicated, the quoted high and low sales prices of the shares on the New York Stock Exchange.\nRegular dividends on the Company's Adjustable Rate Cumulative Class A Preferred Stock have been regularly paid since the third quarter of 1990, in accordance with the provisions of the Certificates of Designation filed with the Delaware Secretary of State for such Preferred Stock. In connection with its 1991 acquisition of Furmanite, the Company issued a total of 1,098,373 shares of 12% Convertible Class A Preferred Stock, Series D, stated value of 5.34 Pounds Sterling. On December 28, 1995, the Company notified the holders of the Series D shares that it would redeem all outstanding shares of such Series on January 26, 1996. The Company used approximately $8,000,000 of the proceeds from the public offering of 3,500,000 Preference Units of KPP to effect the redemption as noticed. Also, the Company has issued 600 restricted shares of its Adjustable Rate Cumulative Class A Preferred Stock, Series C, to three senior officers of the Company, in connection with an executive compensation program established by the Company. In 1994, the holders of these shares were paid an aggregate dividend of $28,422, which had been previously accrued in 1991. Among other restrictions on payment of dividends on this Series of Preferred Stock, dividends on the Series C Preferred Stock that are otherwise payable for a year in which the Company has a net loss are not paid until completion of a year in which the Company has a net profit. Additionally, the credit facilities used to acquire Furmanite and for the working capital of each of Furmanite and KPL each contain restrictions on the respective subsidiary's ability to pay dividends or distributions to the Company, if an event of default exists.\nTEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA\nThe following selected financial data (in thousands, except per share amounts) is derived from the consolidated financial statements of Kaneb Services, Inc. and should be read in conjunction with the consolidated financial statements and related notes included herein. The Company has not declared a dividend on its common stock for any of the periods presented.\n(a) Represents the cumulative effect of accounting changes from the adoption of new financial accounting standards relating to taxes.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion should be read in conjunction with the consolidated financial statements of Kaneb Services, Inc. (the \"Company\") and notes thereto included elsewhere in this report.\nRESULTS OF OPERATIONS\nConsolidated revenues increased $3.4 million in 1995. Pipeline and terminaling services revenues increased $18.2 million, primarily as a result of the acquisition of the West Pipeline by the pipeline partnership in February 1995. Near the end of 1994, unprofitable operations in eastern Germany, which generated approximately $18.9 million in revenues in 1994, were sold. Revenues from the remaining core business in industrial field services increased $5.2 million in 1995. Consolidated operating income increased $11.5 million in 1995. Improvements in industrial field services totaled $2.3 million while pipeline and terminaling services were up $9.5 million, primarily as a result of the acquisition of the West Pipeline. Consolidated capital expenditures, excluding acquisitions, increased $3.2 million from 1994 to 1995, principally as a result of increased industrial field services equipment purchases and increased pipeline and terminaling capital maintenance projects.\nConsolidated revenues increased $10.2 million in 1994, primarily as a result of the inclusion for the entire year of a petroleum products and specialty liquids terminaling company that was acquired by the pipeline partnership in March 1993. Consolidated operating income increased $2.5 million from 1993 to 1994 as increases in pipeline and terminaling services profits of $3.7 million, largely due to improvements at the terminaling company acquired by the pipeline partnership in 1993, were partially offset by declines in industrial field services profits attributable to the unprofitable operations in eastern Germany that were not sold until near the end of 1994.\nIndustrial Field Services\nThe Company's industrial field services segment is comprised of the operations of Furmanite, which was acquired in March 1991. Furmanite provides specialized industrial field services to plants in the process and power industries and to refineries and chemical plants.\nFurmanite's revenues increased $5.2 million or 5% in 1995 and $8.9 million or 10% in 1994, excluding unprofitable general maintenance projects in eastern Germany that had revenues of approximately $18.9 million in 1994 and $26.0 million in 1993 and were sold near the end of 1994. Revenues from traditional underpressure services steadily improved in both years, especially in the United Kingdom and other western European countries where economic conditions have been sluggish over the last several years.\nOperating income increased $2.3 million or 144% in 1995 as a result of improvements in Furmanite's operations around the world, particularly in the United Kingdom and in Germany. Declines in the Rest of World in 1995 primarily resulted from non-recurring product sales with high margins in the Far East in 1994. The overall decline in Furmanite's operating income in 1994 was the result of the losses from the general maintenance projects in eastern Germany that were sold in late 1994 that were only partially offset by the improvements in the rest of Furmanite's operations.\nCapital expenditures are primarily related to field services equipment and the implementation of new services. Capital expenditures for 1996 are currently estimated to be $2 million to $4 million, depending on the economic environment and the needs of the business.\nPipeline and Terminaling Services\nThe Company's pipeline and terminaling services segment includes the operations of Kaneb Pipe Line Partners, L.P. (\"KPP\") which owns refined petroleum products pipeline assets and, since 1993, petroleum products and specialty liquids storage and terminaling assets. The Company operates, manages, and controls the pipeline and terminaling operations of KPP through its 2% general partner interest and a 31% limited partner interest in the partnership.\nRevenues increased $18.2 million or 23%, while operating income increased $9.5 million or 29% in 1995. The increase in revenues and operating income is primarily attributable to the acquisition of the West Pipeline by the pipeline partnership in 1995. Revenues increased $9.5 million or 14%, while operating income increased $3.7 million or 13% in 1994, primarily as a result of the inclusion of the operations of ST for the full year in 1994 versus a 10-month period in 1993 as well as an approximate 5.5% pipeline tariff increase implemented in April 1994, which was partially offset by an increase in property taxes and unusually high repair and maintenance expenditures.\nThe interest of outside non-controlling partners in the KPP's net income was $18.0 million, $12.6 million and $11.0 million in 1995, 1994 and 1993, respectively. Distributions paid to the outside non-controlling unitholders of KPP aggregated approximately $16.3 million, $16.2 million and $13.7 million in 1995, 1994 and 1993, respectively. The increase in the interest of outside non-controlling partners in KPP's net income in 1995 is attributable to the sale by the Company in 1995 of 3.5 million of the preference units that it had owned since 1989. The 1994 increase in both the interest of outside non-controlling partners in KPP's net income and in the distributions paid to the outside non-controlling unitholders is a result of the issuance of 2.25 million Senior Preference Units in 1993 by KPP.\nCapital expenditures relate to the maintenance of existing operations. Routine capital expenditures for 1996 are currently estimated to be $7.5 million.\nEffective March 1, 1993, KPP acquired Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company, for approximately $65 million. In April 1993 KPP completed a secondary public offering of 2.25 million Senior Preference Units at $25.25 per unit and used $50.8 million of the proceeds from the offering to repay a portion of the ST acquisition bank debt. The Company recognized a non-cash accounting basis gain in the amount of $22.4 million resulting from the change in its ownership interest of KPP as a result of this public offering. Consistent with the treatment in 1989 of the initial offering of Senior Preference Units, the Company deferred $7.3 million of this gain and recorded $15.1 million in the statement of income as a gain on the issuance of units by the Partnership.\nIn February 1995 KPP, through a wholly-owned subsidiary, acquired the pipeline assets of WYCO Pipe Line Company (the \"West Pipeline\"), a company jointly owned by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition was financed by the sale of first mortgage notes due February 24, 2002, which bear interest at the rate of 8.37% per annum. In December 1995 KPP, through a wholly-owned subsidiary, acquired the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively \"Steuart\") for $68 million plus transaction costs and the assumption of certain environmental liabilities, which was financed with a bridge loan from a bank.\nOther Operations\nThe Company had revenues of $10.6 million, $11.8 million, and $12.9 million in 1995, 1994 and 1993, respectively, and operating income of $1.7 million, $1.5 million and $.6 million for the same periods related to subsidiaries that provide payment, collection and information services to retail merchants and financial institutions.\nNew Accounting Pronouncement\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 (SFAS 121). SFAS 121 is effective for financial statements for fiscal years beginning after December 15, 1995 and requires the write-down to market of certain long-lived assets. The Company will adopt SFAS 121 in the first quarter of 1996 and such adoption will not have a material effect on the Company's financial position or results of operations.\nLIQUIDITY AND CAPITAL RESOURCES\nCash provided by consolidated operating activities was $40.0 million, $25.9 million and $30.9 million during the years 1995, 1994 and 1993, respectively. Almost two-thirds of the increase in 1995 related to pipeline and terminaling services, primarily as a result of the acquisition of the West Pipeline by the pipeline partnership in February 1995.\nAt December 31, 1995, $24.8 million was outstanding under a credit facility, as amended, that was obtained by a wholly-owned subsidiary in conjunction with the acquisition of Furmanite. The credit facility, which is without recourse to the Parent Company, is due 2001, bears interest at the option of the borrower at variable rates based on either the LIBOR rate or the prime rate plus a differential of up to 150 basis points, and contains certain financial and operational covenants with respect to the specialized industrial field services group of companies.\nIn 1994 KPP, through a wholly-owned subsidiary, issued $33 million of first mortgage notes (\"Notes\") to a group of insurance companies. The Notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, another wholly-owned subsidiary of KPP entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable interest rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1995 or 1994. In 1995 KPP financed the acquisition of the West Pipeline with the issuance of $27 million of Notes due February 24, 2002, which bear interest at the rate of 8.37% per annum. The Notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of KPP and contain certain financial and operational covenants. The acquisition of the Steuart terminaling assets in December 1995 was initially financed by a $68 million bridge loan from a bank. The bridge loan maturity has been extended until March 17, 1997, and bears interest at variable rates based on the LIBOR rate plus 50 to 100 basis points. KPP expects to refinance this obligation under terms similar to the Notes discussed above.\nIn September 1995 the Company, through a wholly-owned subsidiary, sold in a public offering 3.5 million Preference Units it held in KPP. The Company received net cash proceeds of approximately $74 million related to the sale and recorded a gain of $54.2 million. The Company used the proceeds from the sale to retire its 8% convertible subordinated debentures totaling $43.2 million, retire its 11.5% subordinated debentures totaling $5.0 million, repay its $10 million term loan, redeem, in 1996, its Series D Preferred Stock for approximately $8.0 million and retire, in 1996, its $6.0 million 8.85% senior note. The Company continues to control the pipeline and terminaling operations of KPP through its 2% general partner interest and a 31% limited partner interest.\nIn December 1995 the Company entered into an agreement with an international bank that provides for a $15 million revolving credit facility through December 1, 2000, that bears interest at variable rates at the Company's option based on the LIBOR rate plus 100 basis points or at the prime rate in effect from time to time with a commitment fee of .5% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1995.\nConsolidated capital expenditures for 1996 have been budgeted at $9.5 million to $11.5 million, depending on the economic environment and the needs of the business. Consolidated debt maturities are $4.1 million, $4.5 million, $8.7 million, $1.8 million and $1.5 million for each of the five years ending December 31, 2000. Capital expenditures in 1996 are expected to be funded from existing cash and anticipated cash flows from operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data of the Company begins on page of this report. Such information is hereby incorporated by reference into this Item 8.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated by reference from portions of the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year covered by this Report.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS PAGE ---- Set forth below are financial statements appearing in this report.\nReport of Independent Accountants ............................\nFinancial Statements of Kaneb Services, Inc, and Subsidiaries:\nConsolidated Statements of Income - Years Ended December 31, 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 Changes in Stockholders' Equity - Years Ended December 31, 1995, 1994 and 1993 ..\nNotes to Consolidated Financial Statements ...................\n(a)(2) FINANCIAL STATEMENT SCHEDULES\nSet forth are the financial statement schedules appearing in this report.\nSchedule I - Kaneb Services, Inc. (Parent Company) Condensed Financial Statements:\nStatements of Income - Years Ended December 31, 1995, 1994 and 1993 ............................................\nBalance Sheets - December 31, 1995 and 1994 ....................\nStatements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993 .........................\nSchedule II - Kaneb Services, Inc. Valuation and Qualifying Accounts - Years Ended December 31, 1995, 1994 and 1993 .............\nSchedules, other than those listed above, have been omitted because of the absence of the conditions under which they are required or because the required information is included in the consolidated financial statements or related notes thereto presented in the Annual Report to Stockholders.\n(A) (3) LIST OF EXHIBITS\n3.1 Restated Certificate of Incorporation of the Registrant, dated September 26, 1979, filed as Exhibit 3.1 of the exhibits to the Registrant's Registration Statement on Form S-16, which exhibit is hereby incorporated by reference.\n3.2 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, dated April 30, 1981, filed as Exhibit 3.2 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1981 (\"1981 Form 10-K\"), which exhibit is hereby incorporated by reference.\n3.3 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, dated May 28, 1985, filed as Exhibit 4.1 of the exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1985, which exhibit is hereby incorporated by reference.\n3.4 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, dated September 17, 1985, filed as Exhibit 4.1 of the exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1985, which exhibit is hereby incorporated by reference.\n3.5 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, dated July 10, 1990, filed as Exhibit 3.5 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (\"1990 Form 10-K\"), which exhibit is hereby incorporated by reference.\n3.6 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, dated September 21, 1990, filed as Exhibit 3.5 of the exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990, which exhibit is hereby incorporated by reference.\n3.7 By-laws of the Registrant, filed as Exhibit 3.5 of the exhibits to the Registrant's Annual Report on Form 10-K for year ended December 31, 1985, which exhibit is hereby incorporated by reference.\n4.1 Certificate of Designation related to the Registrant's Adjustable Rate Cumulative Class A Preferred Stock, filed as Exhibit 4 of the exhibits to the Registrant's Quarterly Report of Form 10-Q for the quarter ended September 30, 1983, which exhibit is hereby incorporated by reference.\n4.2 Certificate of Designation, Preferences and Rights related to the Registrant's Series B Junior Participating Preferred Stock, filed as Exhibit 1 of the exhibits to the Registrant's Current Report on Form 8-K and Registration Statement on Form 8-A, dated April 5, 1988, which exhibit is hereby incorporated by reference.\n4.3 Certificate of Designation related to the Registrant's Adjustable Rate Cumulative Class A Preferred Stock, Series D, dated February 11, 1991, filed as Exhibit 4.3 of the exhibits to the Registrant's 1990 Form 10-K, which exhibit is hereby incorporated by reference.\n4.4 Certificate of Designation related to the Registrant's Adjustable Rate Cumulative Class A Preferred Stock, Series C, dated April 23, 1991, filed as Exhibit 4.4 of the exhibits to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, which exhibit is hereby incorporated by reference.\n4.5 Certificate of Designation related to the Registrant's Adjustable Rate Cumulative Class A Preferred Stock, Series E, filed as Exhibit 10.2 of the exhibits to the Registrant's Current Report on Form 8-K, dated January 23, 1993, which exhibit is hereby incorporated by reference.\n4.6 Indenture between Moran Energy Inc. (\"Moran\") and First City National Bank of Houston (\"First City\"), dated as of January 1, 1978, under which Moran issued the 11 1\/2% Subordinated Debentures due 1998, filed as Exhibit 2(g) to Moran's Registration Statement on Form S-7 (SEC File No. 2-61216), which exhibit is hereby incorporated by reference.\n4.7 First Supplemental Indenture between the Registrant and First City, dated as of March 20, 1984, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.5 above, filed as Exhibit 4.4 to the exhibits of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1983 (\"1983 Form 10-K\"), which exhibit is hereby incorporated by reference.\n4.8 Indenture between Moran Energy International N.V. (\"Moran International\"), Moran and First City, dated as of November 1, 1980, under which Moran International issued the 8% Convertible Subordinated Debentures due 1995, guaranteed on a subordinated basis by Moran, filed as Exhibit 4(b) to Moran's Annual Report on Form 10-K for the year ended December 1, 1980, which exhibit is hereby incorporated by reference.\n4.9 First Supplemental Indenture between Moran International, the Registrant and First City, dated as of March 20, 1984, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.8 above, filed as Exhibit 4.7 of the 1983 Form 10-K, which exhibit is hereby incorporated by reference.\n4.10 Indenture between Moran and First City, dated January 15, 1984, under which Moran issued the 8 3\/4% Convertible Subordinated Debentures due 2008, filed as Exhibit 4.1 to Moran's Registration Statement on Form S-3 (SEC File No. 2-81227), which exhibit is hereby incorporated by reference.\n4.11 First Supplemental Indenture between the Registrant and First City, dated as of March 20, 1984, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.10 above, filed as Exhibit 4.7 of the 1983 Form 10-K, which exhibit is hereby incorporated by reference.\n10.1 Kaneb Services, Inc. 1984 Nonqualified Stock Option Plan, filed as Exhibit 10.26 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1984, which exhibit is hereby incorporated by reference.\n10.2 Kaneb Services, Inc. 1994 Stock Incentive Plan, filed as Exhibit 4.12 to the exhibits of the Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-54027), which exhibit is hereby incorporated by reference.\n10.3 Kaneb Services, Inc. Savings Investment Plan, filed as Exhibit 4.10 of the exhibits to the Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-41295), which exhibit is hereby incorporated by reference.\n10.4 Amended and Restated Loan Agreement between Furmanite PLC, Bank of Scotland and certain other Lenders, dated May 1, 1991, filed as Exhibit 10.8 of the exhibits to the Registrant's Annual Report on Form 10-K (\"1994 Form 10-K\"), which exhibit is hereby incorporated by reference.\n10.5 Amended and Restated Senior Secured Increasing Rate Promissory Note between the Registrant and the Bank of Scotland, dated July 2, 1993, filed as Exhibit 10.9 of the exhibits to the Registrant's 1994 Form 10-K, which exhibit is hereby incorporated by reference.\n10.6 Pledge and Proxy Agreement between the Registrant and Texas Commerce Bank, National Association, (\"TCB\"), dated October 11, 1993, filed as Exhibit 10.9 of the exhibits to the Registrant's 1993 Form 10-K, which exhibit is hereby incorporated by reference.\n10.7 Pledge and Security Agreement between Kaneb Pipe Line Company (\"KPL\") and TCB, dated October 11, 1993, filed as Exhibit 10.10 of the exhibits to the Registrant's 1993 Form 10-K, which exhibit is hereby incorporated by reference.\n10.8 Restated Credit Agreement between KPOP, TCB, and certain other Lenders, dated December 22, 1994, filed as Exhibit 10.13 of the exhibits to the Registrant's 1994 Form 10-K, which exhibit is hereby incorporated by reference.\n10.9 Note Purchase Agreement, dated December 22, 1994, filed as Exhibit 10.2 of the exhibits to Registrant's Current Report on Form 8-K, dated March 13, 1995, which exhibit is hereby incorporated by reference.\n10.10 Loan Agreement between the Registrant, KPL and Bank of Scotland, dated as of December 1, 1995, filed herewith.\n10.11 Bridge Financing Agreement between KPOP and TCB, dated December 18, 1995, filed herewith.\n10.12 Agreement for Sale and Purchase of Assets between Wyco Pipe Line Company and KPOP, dated February 19, 1995, filed as Exhibit 10.1 of the exhibits to the Registrant's Current Report on Form 8-K, dated March 13, 1995, which exhibit is hereby incorporated by reference\n10.13 Asset Purchase Agreements between and among Steuart Petroleum Company, SPC Terminals, Inc., Piney Point Industries, Inc., Steuart Investment Company, Support Terminals Operating Partnership, L.P. and KPOP, as amended, dated August 27, 1995, filed as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to Registrant's Current Report on Form 8-K\/A, dated January 3, 1996, which exhibits are hereby incorporated by reference.\n21 List of subsidiaries of the Registrant, filed herewith. 23 Consent of independent accountants: Price Waterhouse LLP, filed herewith. 24 Powers of Attorney, filed herewith. 27 Financial Data Schedule, filed herewith.\nCertain instruments respecting long-term debt of the Registrant have been omitted pursuant to instructions as to Exhibits. The Registrant agrees to furnish copies of any of such instruments to the Commission upon request.\n(B) REPORTS ON FORM 8-K - NONE.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Kaneb Services, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 18 present fairly, in all material respects, the financial position of Kaneb Services, Inc. and its subsidiaries (the \"Company\") at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years 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\nDallas, Texas March 5, 1996\nF - 1\nCONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nF - 2\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nASSETS\nSee notes to consolidated financial statements.\nF - 3\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following significant accounting policies are followed by Kaneb Services, Inc. (the \"Company\") and its subsidiaries in the preparation of financial statements.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries and Kaneb Pipe Line Partners, L.P. (\"KPP\"). The Company controls the pipeline operations of KPP through its two percent general partner interest and a 31% limited partner interest as of December 31, 1995. All significant intercompany transactions and balances are eliminated in consolidation.\nSegment Information\nThe Company provides specialized industrial field services to an international client base that includes oil refineries, chemical plants, pipelines, offshore drilling and production platforms, steel mills, food and drink processing facilities, power generation, and other process industries. The Company, as general partner, also manages and operates the pipeline and terminaling business of KPP.\nCash, Cash Equivalents and Short-term Investments\nThe Company's policy is to invest cash in highly liquid investments with maturities of three months or less, upon acquisition. Accordingly, uninvested cash balances are kept at minimum levels. Such investments are valued at cost, which approximates market, and are classified as cash equivalents. Similar investments with original maturities beyond three months are considered short-term investments and are carried at cost, which approximates market value.\nInventories\nInventories consist primarily of finished goods of the industrial services segment and are valued at the lower of average cost or market. Cost is determined using the weighted average cost method.\nProperty and Equipment\nProperty and equipment are carried at original cost. Certain leases have been capitalized and the leased assets have been included in property and equipment. Additions of new equipment and major renewals and replacements of existing equipment are capitalized. Repairs and minor replacements that do not materially increase values or extend useful lives are expensed.\nDepreciation of property and equipment is provided on the straight-line basis at rates based upon expected useful lives of the various classes of assets. The rates used for pipeline and certain storage facilities, which are subject to regulation, are the same as those promulgated by the Federal Energy Regulatory Commission.\nRevenue Recognition\nSubstantially all revenues are recognized when services to unaffiliated customers have been rendered. Pipeline transportation revenues are recognized upon receipt of the products into the pipeline system.\nEarnings Per Share\nEarnings per common share data have been computed by dividing income applicable to common stock by the weighted average number of shares outstanding during each period. The effect of common stock equivalents and other potentially dilutive securities on such computation was anti-dilutive for each period presented.\nForeign Currency Translation\nThe Company translates the balance sheets of its foreign subsidiaries using year-end exchange rates and translates income statement amounts using the average exchange rates in effect during the year. The gains and losses resulting from the change in exchange rates from year to year have been reported separately as a component of stockholders' equity. Gains and losses resulting from foreign currency transactions are included in the statements of income.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nExcess of Cost Over Fair Value of Net Assets of Acquired Business\nThe excess of the purchase price of an industrial field service company over the fair value of the net assets acquired is being amortized on a straight-line basis over a period of 40 years. Accumulated amortization was $8.4 million and $6.6 million at December 31, 1995 and 1994, respectively.\nEstimates\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 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.\nChange in Presentation\nCertain financial statement items for 1994 and 1993 have been reclassified to conform with the 1995 presentation.\n2. ACQUISITIONS\nIn February 1995, KPP acquired the refined petroleum product pipeline assets (the \"West Pipeline\") of Wyco Pipe Line Company for $27.1 million, plus transaction costs and the assumption of certain environmental liabilities. The West Pipeline was owned 60% by a subsidiary of GATX Terminals Corporation and 40% by a subsidiary of Amoco Pipe Line Company. The acquisition was financed by the issuance of $27 million of first mortgage notes. The assets acquired from Wyco Pipe Line Company did not include certain assets that were leased to Amoco Pipe Line Company and the purchase agreement did not provide for either (i) the continuation of an arrangement with Amoco Pipe Line Company for the monitoring and control of pipeline flows or (ii) the extension or assumption of certain credit agreements that Wyco Pipe Line company had with its shareholders.\nIn December 1995, KPP acquired, the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, \"Steuart\") for $68 million, plus transaction costs and the assumption of certain environmental liabilities. The acquisition price was financed by bank borrowings. The asset purchase agreement includes a provision for an earn-out payment based upon revenues of one of the terminals exceeding a specified amount for a seven-year period beginning in January 1996. The contracts also include a provision for the continuation of all terminaling contracts in place at the time of the acquisition, including those contracts with Steuart.\nThe acquisitions have been accounted for using the purchase method of accounting. The total purchase price of each acquisition has been allocated to the assets and liabilities based on their respective fair values based on valuations and other studies. The allocation of the purchase price of the Steuart acquisition presented in the consolidated financial statements is preliminary and subject to adjustment.\nThe following summarized unaudited pro forma consolidated results of operations for the years ended December 31, 1995 and 1994, assume the acquisitions occurred as of the beginning of each period presented. The unaudited pro forma financial results have been prepared for comparative purposes only and may not be indicative of the results that would have occurred if KPP had acquired the pipeline assets of the West Pipeline and the liquids terminaling assets of Steuart on the dates indicated or which will be obtained in the future.\n3. SALE OF PARTNERSHIP INTEREST\nIn September 1995, the Company through a wholly-owned subsidiary, sold in a public offering, 3.5 million Preference Units it held in KPP. The Company received net cash proceeds of $73.6 million related to the sale and recorded a gain of\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n$54.2 million, net of expenses. The Company used the proceeds to retire its 8% convertible subordinated debentures totaling $43.2 million, retire its 11.5% subordinated debentures totaling $5.0 million and repay its $10 million term loan in 1995 and, in 1996, redeem $8 million of its Series D Preferred Stock and repay $6 million of its long-term debt. The Company continues to control the pipeline and terminaling operations of KPP through its 2% general partner interest and a 31% limited partner interest.\n4. INCOME TAXES\nIncome (loss) before income tax expense is comprised of the following components:\nIncome tax expense is comprised of the following components:\nDeferred income tax provisions or benefits result from temporary differences between the tax basis of assets (principally fixed assets) and liabilities of foreign subsidiaries and certain domestic subsidiaries not included in the Company's consolidated federal tax return, and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years.\nThe Company has recorded deferred tax assets of approximately $86 million and $108 million as of December 31, 1995 and 1994, respectively, primarily relating to the Company's domestic net operating loss carryforwards and investment tax credit carryforwards, offset by a valuation reserve of $84 million and $108 million, respectively. In 1995 and 1994, the Company reduced its valuation allowance by $24 million and $5 million, respectively, primarily due to the utilization of domestic net operating loss carryforwards and the expiration of investment tax credit carryforwards. The Company has recorded a deferred tax liability of $1.7 million and $1.1 million as of December 31, 1995 and 1994, which is associated with certain domestic subsidiaries not included in the Company's consolidated federal tax return.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe reasons for the differences between the amount of tax expense provided and the amount of tax expense computed by applying the statutory Federal income tax rate to income from continuing operations before income taxes for the years 1995, 1994 and 1993 were as follows:\nAt December 31, 1995, the Company had the following domestic tax attribute carryforwards expiring in the years indicated:\nThe amounts shown above that expire in the years 1996 through 1999 represent the operating losses and investment tax credits acquired in the acquisition of Moran Energy, Inc. and its subsidiaries and it is unlikely that the Company will be able to utilize these tax carryforwards in the future. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of the tax carryforwards which could be utilized.\n5. RETIREMENT PLANS\nThe Company has a defined contribution benefit plan which covers substantially all domestic employees and provides for varying levels of employer matching. Company contributions to this plan were $.9 million, $.9 million and $.6 million for 1995, 1994 and 1993, respectively.\nOne of the Company's foreign subsidiaries has a defined benefit pension plan covering substantially all of its United Kingdom employees (the \"U.K. Plan\"). The benefit is based on the average of the employee's salary for the last three years of employment. Generally, the employee contributes 5% and the employer contributes up to 12% of pay. Plan assets are primarily invested in unitized pension funds managed by United Kingdom registered funds managers. The valuation of the U.K. Plan was performed as of November 1, 1995. Net pension cost for the U.K. Plan included the following components:\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nActuarial assumptions used in the accounting for the U.K. Plan were a weighted average discount rate of 9% for 1995 and 1994 and 7.5% for 1993, an expected long-term rate of return on assets of 9% for 1995, 1994 and 1993 and a rate of increase in compensation levels of 6% for 1995 and 1994 and 5.5% for 1993.\nThe funded status of the U.K. Plan is as follows:\n6. PROPERTY AND EQUIPMENT\nThe cost of property and equipment is as follows:\nEquipment acquired under capital leases and included in the cost of property and equipment is as follows:\n- --------------\n(a) The capital lease is secured by certain pipeline equipment and the pipeline partnership has recorded its option to purchase this equipment for approximately $4.1 million at the termination of the lease.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. DEBT\nDebt is summarized as follows:\nIndustrial Field Services\nAt December 31, 1995, $24.8 million was outstanding under a credit facility, as amended, that was obtained by a wholly-owned subsidiary in conjunction with the acquisition of Furmanite. The credit facility, which is without recourse to the Parent Company, is due 2001, bears interest at the option of the borrower at variable rates based on either the LIBOR rate or the prime rate plus a differential of up to 150 basis points, has a commitment fee equal to one-half of one-percent per annum on unutilized amounts, contains certain financial and operational covenants with respect to the specialized industrial field services group of companies and restricts the subsidiary from paying dividends to the parent company under certain circumstances. The credit facility is secured by all of the tangible assets of the industrial field services group (except those assets in Germany).\nPipeline and Terminaling Services\nIn 1994, KPP, through a wholly-owned subsidiary issued $33 million of first mortgage notes (\"Notes\") to a group of insurance companies. The Notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, a wholly-owned subsidiary entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable interest rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nfacility at December 31, 1995 or 1994. In 1995, KPP financed the acquisition of the West Pipeline with the issuance of $27 million of Notes due February 24, 2002 which bear interest at the rate of 8.37% per annum. The Notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of KPP and contains certain financial and operational covenants. The acquisition of Steuart was initially financed by a $68 million bridge loan from a bank. The loan bears interest at a variable rate based on the LIBOR rate plus 50 to 100 basis points and its maturity was extended until March 1997. KPP expects to refinance this obligation under terms similar to the Notes discussed above. The loan will be secured, pari passu with the existing Notes and credit facility, by a mortgage on the East Pipeline.\nParent Company\nOn February 1, 1996, the Company retired the 8.85% senior note. The 8.85% senior note was convertible into shares of the Company's common stock at a conversion price of $6.00 per share.\nThe 8.75% subordinated debentures are convertible into shares of the Company's Common Stock at a conversion price of $17.54 per share. The Company has satisfied the sinking fund requirements on its 8.75% subordinated debentures through 2000.\nIn December 1995 the Company entered into an agreement with an international bank that provides for a $15 million revolving credit facility through December 1, 2000, that bears interest at variable rates at the Company's option based on the LIBOR rate plus 100 basis points or at the prime rate in effect from time to time with a commitment fee of .5% per annum of the unused credit facility. The credit facility is secured by 1.0 million of the Company's limited partnership units in the pipeline partnership. No amounts were drawn under the credit facility at December 31, 1995.\nAnnual sinking fund requirements and debt maturities, including capital leases, are $4.1 million, $4.5 million, $8.7 million, $1.8 million and $1.5 million for each of the five years ending December 31, 2000.\n8. CAPITAL STOCK\nThe changes in the number of issued and outstanding shares of the Company's preferred and common stock are summarized as follows:\nThe Company has stock option plans and agreements for officers, directors and key employees. The options granted under these plans and agreements generally expire ten years from date of grant. All options were granted at prices greater than or equal to the market price at the date of grant. At December 31, 1995, options on 1,423,936 shares at prices ranging from $1.50 to $8.50 were outstanding, of which 1,110,936 were exercisable at prices ranging from $1.50 to $8.50.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSeries A Preferred Stock\nThe Company has 567,950 shares of its Cumulative Class A Adjustable Rate Preferred Stock, Series A (\"Series A Preferred\") with a stated value of $10 per share outstanding at December 31, 1995. Dividends accrue quarterly at the applicable U.S. Treasury rate plus 2.00 percentage points (200 basis points) (\"Applicable Rate\"), but will in no event be less than 7.5% per annum or greater than 14% per annum. If dividends are in arrears for two or more quarters, additional dividends accrue on all dividends in arrears at a rate equal to the Applicable Rate plus 25 basis points for each quarter dividends are in arrears (but not more than the lesser of 14% per annum or 300 basis points more than the Applicable Rate). If unpaid accrued dividends exist with respect to eight or more quarters, the holders of the Series A Preferred may elect individually to require the Company to redeem their shares at a price of $12 per share plus dividends in arrears. No such arrearages existed as of December 31, 1995, 1994 and 1993. The Company, at its option, may redeem shares at any time at a price of $12 per share (reduced ratably to $10 over 15 years unless unpaid accrued dividends exist with respect to eight or more quarters) plus accrued and unpaid dividends thereon.\nSeries B Preferred Stock\nOn March 26, 1988, the Board of Directors of the Company declared a dividend distribution of one stock purchase right (\"Right\") for each outstanding share of Common Stock to stockholders of record on April 19, 1988. Each Right entitles the holder, upon the occurrence of certain events, to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, no par value, at a price of $10, subject to adjustment. The Rights will not separate from the Common Stock or become exercisable until a person or group either acquires beneficial ownership of 20% or more of the Company's Common Stock or commences a tender or exchange offer that would result in ownership of 30% or more, whichever occurs earlier. The Rights, which expire on April 19, 1998, are redeemable in whole, but not in part, at the Company's option at any time for a price of $0.05 per Right. At December 31, 1995, 1994 and 1993 there were no Series B Preferred shares outstanding.\nSeries C Preferred Stock\nIn April 1991, the Company authorized 1,000 shares of Adjustable Rate Cumulative Class A Preferred Stock, Series C (\"Series C Preferred\") which has a preference value of $1.00 per share and which is only entitled to a dividend if the value of the Company's Common Stock increases. The Series C Preferred, as an entire class, is entitled to an annual dividend commencing January 1, 1992, equal to 1\/2 of 1% (proportionately reduced for authorized but unissued shares in the class) of the increase in the average per share market value of the Company's Common Stock during the year preceding payment of the dividend, over $4.79 (the average per share market value of the Company's Common Stock during 1990) multiplied by the average number of shares of Common Stock outstanding. The Series C Preferred has mandatory redemption requirements in the event of certain types of corporate reorganizations and may be redeemed at the option of the Company during the first 60 days of each year commencing 1994. The redemption price is the sum of (i) one divided by the average annual yield of all issues of preferred stock listed on the New York Stock Exchange during the calendar year preceding the date of the redemption period times the average dividend for the two most recent years plus (ii) a pro rata portion of the prior year's dividend based upon the number of elapsed days in the year of redemption plus (iii) any accrued and unpaid dividends. The Company may also repurchase the shares of a holder at such redemption price during the first 60 days following the year in which the holder first ceases to be an employee of the Company. A holder of the Series C Preferred may, at his option, require the Company to redeem his shares at 120% of such redemption price if the Company elects, within 10 days after the most recent dividend payment date, not to pay the accrued dividend. Upon liquidation, holders of the Series C Preferred are entitled to receive $1.00 per share plus accrued and unpaid dividends. The Company granted 600 shares of Series C Preferred to certain officers in April 1991.\nSeries D Preferred Stock\nIn conjunction with the acquisition of Furmanite, the Company issued 1,098,373 shares of its 12% Convertible Class A Preferred Stock, Series D (\"Series D Preferred\") with a stated value of 5.34 ($8.36) per share. The Series D Preferred is not redeemable by the holder; however, each share was convertible at the option of the holder into 1.691 shares of the Company's Common Stock. During 1994 and 1993, 10,880 shares and 26,268 shares were converted into 18,398 shares and 44,413 shares, respectively, of the Company's Common Stock. On December 28, 1995, the Company notified the Series D Preferred stockholders that it would redeem the Series D Preferred Stock and it was fully redeemed on January 26, 1996. Accordingly, the Company has reclassified its obligation to current liabilities on the December 31, 1995 balance sheet.\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. COMMITMENTS AND CONTINGENCIES\nThe Company leases vehicles, office space, data processing equipment, office equipment and other items of personal property under leases expiring at various dates. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Total rent expense under operating leases was $3.5 million for 1995, 1994 and 1993.\nAt December 31, 1995, minimum rental commitments under all capital leases and operating leases for future years are as follows:\nIn October 1994, the Company settled two lawsuits filed in the 1980's by Kanland Associates and Panance Property Corporation that related to the Company's former office building in Sugar Land, Texas. One of these suits had alleged damages at more than $38 million plus prejudgment interest, legal fees, court costs and punitive damages. The settlement of these lawsuits was adequately reserved.\nIn March 1995, the Company settled another lawsuit filed in the late 1980's by Stephen R. Herbel and other named individuals doing business as Pinnacle Petroleum Company (\"Pinnacle\") that related to coalbed gas produced from a property that a subsidiary of the Company previously owned an interest in. The settlement of this lawsuit was also adequately reserved.\nOn February 2, 1996 a lawsuit was filed in Germany on behalf of Gesellschaft fur Industrieanlagen und Maschineninstandhaltung GmbH or G.I.M. Engineering against one of the Company's German subsidiaries, Furmanite Technische Dienstleistungen GmbH, concerning the consideration received in a December 30, 1994 German contract that was part of a series of transactions relating to the sale of one of the Company's domestic subsidiaries. On February 5, 1996, the Court ruled in the Furmanite German subsidiary's favor in a separate but related injunctive proceeding involving the same consideration issue in the same contract. The December 30, 1994 contract was an integral part of the ultimate sale of the Company's domestic subsidiary and was consummated after a thorough review by, and based upon the advice of, the Company's German legal counsel and tax advisors. The Company intends to vigorously defend this action, which has not yet been set for hearing.\nKPP makes quarterly distributions of 100% of its Available Cash (as defined in the Partnership Agreement) to holders of limited partnership units and KPL. Available Cash consists generally of all the cash receipts of the Partnership less all of its cash disbursements and reserves. KPP believes it will make distributions of Available Cash for each quarter of not less than $.55 per Unit (\"Minimum Quarterly Distribution\"), or $2.20 per Unit on an annualized basis for the foreseeable future. The Minimum Quarterly Distribution on the Senior Preference Units is cumulative and preferential to the partnership units held by the Company. The assets, other than Available Cash, cannot be distributed without a majority vote of the non-affiliated unitholders.\nThe operations of KPP are subject to federal, state and local laws and regulations relating to protection of the environment. Although KPP believes that its operations are in general compliance with applicable environmental regulation, risks of additional costs and liabilities are inherent in its operations, and there can be no assurance that significant costs and liabilities will not be incurred by KPP. Moreover, it is possible that other developments, such as increasingly stringent environmental laws, regulations, enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of KPP, could result in substantial costs and liabilities to KPP. KPP has\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nrecorded a reserve in other liabilities for environmental claims of $5.2 million (including $4.4 million relating to the acquisitions of the West Pipeline and Steuart) as of December 31, 1995.\nThe Company has other contingent liabilities resulting from litigation, claims and commitments incident to the ordinary course of business. Management believes, based on the advice of counsel, that the ultimate resolution of such contingencies will not have a materially adverse effect on the financial position or results of operations of the Company.\n10. BUSINESS SEGMENT DATA\nSelected financial data pertaining to the operations of the Company's business segments is as follows:\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSelected financial data pertaining to the operations in geographical areas is as follows:\n11. DISCONTINUED OPERATIONS\nSince 1981, the Company has discontinued business segments to reduce debt, increase cash and concentrate its activities towards ongoing operations. The operations of the offshore and onshore drilling, exploration and production, coal, general contracting, underground storage tank (UST) testing operations and engineering services segments are classified as discontinued operations in the Company's consolidated financial statements and related footnotes. The remaining net liabilities of the discontinued operations have been reclassified in the balance sheet from their traditional classifications to \"Net liabilities of discontinued operations.\"\n12. ACCRUED EXPENSES\nAccrued expenses is comprised of the following components at December 31, 1995 and 1994:\nKANEB SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n13. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly operating results for 1995 and 1994 are summarized as follows:\n14. SUPPLEMENTAL CASH FLOW INFORMATION\nThe Company issued 18,398 and 44,413 shares of its common stock upon conversion of 10,880 and 26,268 shares of its Series D Preferred Stock in 1994 and 1993, respectively. The Company contributed 394,739, 349,942 and 197,433 shares of its common stock to its 401(k) Savings Plan in 1995, 1994 and 1993, respectively. The Company contributed 160,000, 410,000 and 220,000 shares of its common stock to its subsidiary's defined benefit pension plan in 1995, 1994 and 1993, respectively.\nSupplemental information on cash paid during the period for:\n15. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK\nThe estimated fair value of cash, cash equivalents, short-term investments and accounts receivables approximate their carrying amount due to the relatively short period to maturity of these instruments. The estimated fair value of all long-term debt (excluding capital leases) as of December 31, 1995 was approximately $180 million as compared to the carrying value of $183 million. These fair values were estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements, when quoted market prices were not available. The Company has not determined the fair value of its capital leases as it is not practicable. The estimates presented above are not necessarily indicative of the amounts that would be realized in a current market exchange.\nThe Company does not believe that it has a significant concentration of credit risk at December 31, 1995, as approximately 61% of the Company's accounts receivable are generated from its industrial field services customers located throughout the United States, the United Kingdom and Continental Europe.\nSCHEDULE I\nKANEB SERVICES, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF INCOME\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\n(CONTINUED) SCHEDULE I KANEB SERVICES, INC. (PARENT COMPANY) CONDENSED BALANCE SHEETS\nASSETS\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\n(CONTINUED) SCHEDULE I KANEB SERVICES, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\nSCHEDULE II KANEB SERVICES, INC. VALUATION AND QUALIFYING ACCOUNTS\n- --------------------- Notes: (A) Currency translation adjustment. (B) Receivable write-offs and reclassifications, net of recoveries.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Kaneb Services, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKANEB SERVICES, INC.\nBy: JOHN R. BARNES --------------------------------------- *John R. Barnes\nPresident and Chief Executive Officer 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 Kaneb Services, Inc. and in the capacities and on the date indicated.\nSIGNATURE TITLE DATE - --------------------------- ----- ----\nPrincipal Executive Officer\nJOHN R. BARNES - --------------------------- (John R. Barnes) President, Chief Executive March 28, 1996 Officer and Director\nPrincipal Accounting Officer\nTONY M. REGAN - ---------------------------- (Tony M. Regan) Controller March 28, 1996\nDirectors\nSANGWOO AHN - ---------------------------- (Sangwoo Ahn) Director March 28, 1996\nJOHN R. BARNES - ---------------------------- (John R. Barnes) Director March 28, 1996\nCHARLES R. COX - ---------------------------- (Charles R. Cox) Director March 28, 1996\nPRESTON A. PEAK - ---------------------------- (Preston A. Peak) Director March 28, 1996\nRALPH A. REHM - ---------------------------- (Ralph A. Rehm) Director March 28, 1996\nJAMES R. WHATLEY - ---------------------------- (James R. Whatley) Director March 28, 1996\nEXHIBIT INDEX","section_15":""}
{"filename":"742070_1995.txt","cik":"742070","year":"1995","section_1":"ITEM 1 - BUSINESS\nReference is made to Page 4 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1995, wherein this subject is covered.\nSTATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES\nThe following statistical tables and accompanying text provide required financial data about the Corporation and should be read in conjunction with the Consolidated financial statements and related notes, appearing in the 1995 Annual Report to Stockholders and is incorporated herein by reference thereto:\nPage of Annual Report\nI. Distribution of Assets, Liabilities and Stockholders' Equity: Interest Rates and Interest Differential 9\nRate\/Volume Analysis of Interest Margin on Earning Assets 10\nII. Investment Portfolio 11, 26-28 and 33\nIII. Loan Portfolio 12, 28, 29 and 33\na. Types of Loans 12\nb. Maturities and Sensitivities to Changes in Interest Rates 8 and 12\nc. Risk Elements 14 and 15\nIV. Summary of Loan Loss Experience 13 and 14\nV. Deposits 15, 29, 30 and 33\nVI. Return on Equity and Assets 16\nVII. Short Term Borrowing 16, 30 and 33\nI - 1\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Corporation's principal banking subsidiary, Park West Bank and Trust Company (\"Park West\") operates ten banking offices located as follows:\nLOCATION OWNED LEASED TOTAL\nAgawam (Feeding Hills) 1 1 Chicopee 1 1 Chicopee - Supermarket 1 1 East Longmeadow 1 1 Holyoke 1 1 West Springfield 2 1 3 Westfield 1 1 Westfield Supermarket 1 1\nTOTAL 5 5 10\nAll general banking offices except the one in Holyoke have drive-in facilities. Twenty-four hour automated teller machines are located in the three West Springfield branches, one each in Agawam, Chicopee, East Longmeadow, Westfield and the Banks two supermarket branches.\nTitle to the properties described as owned in the foregoing table is held by the Bank with warranty deed with no material encumbrances. Park West owns, with no material encumbrances, land adjacent to the main office which is available for parking, and also through a subsidiary, owns one other property consisting of land, also used as a parking lot adjacent to the main office. The Bank also owns the property on which its former Operations Center was located and is presently leased. In addition, the Bank holds other real estate as a result of foreclosure proceedings.\nAll of the property described as leased in the foregoing table is leased directly from independent parties. Management considers the terms and conditions of each of the existing leases to be in the aggregate favorable to the Bank.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nCertain litigation is pending against the Corporation and the Bank. Management, after consultation with legal counsel, does not anticipate that any liability arising out of such litigation will have a material effect on the Corporation's Financial Statements.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNONE\nI - 2\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR CORPORATION'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nReference is made to the inside back cover of the Corporation's Annual Report to Stockholders for the year ended December 31, 1995, wherein this subject is covered.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nReference is made to page 5 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1995, wherein this subject is covered.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to pages 6 through 18 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1995, wherein this subject is covered.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to pages 20 through 35 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1995, wherein this subject is covered.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE\nII - 1\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nReference is made to pages 3 through 6, of the Corporation's Proxy Statement to Stockholders for the 1996 Annual Meeting scheduled for April 17, 1996, wherein this subject is covered.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nReferences is made to pages 8 through 11, of the Corporation's Proxy Statement to Stockholders for the 1996 Annual Meeting scheduled for April 17, 1996, wherein this subject is covered.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to pages 6 and 7, of the Corporation's Proxy Statement to Stockholders for the 1996 Annual Meeting scheduled for April 17, 1996, wherein this subject is covered.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to pages 6 through 12, of the Corporation's Proxy Statement to Stockholders for the 1996 Annual Meeting scheduled for April 17, 1996, wherein this subject is covered under the caption \"Beneficial Ownership of Stock and Executive Compensation - Miscellaneous\".\nIII - 1\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 financial statements are incorporated in this Annual Report on Form 10-K by reference to the Corporation's Annual Report to Stockholders for the year ended December 31, 1995:\nWESTBANK CORPORATION Page of Annual Report\t Independent Auditors' Reports 19 Consolidated Balance Sheets at December 31, 1995 and 1994 20 Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993 21 Consolidated Statement of Stockholders' Equity from January 1, 1993, to December 31, 1995 22 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 23 Notes to Consolidated Financial Statements 24 - 35\nA current report on Form 8-K Reporting other Events was filed by the Registrant on:\nNONE\n2. Financial Statement Schedules\nFinancial Statement Schedules are omitted because they are inapplicable or not required.\n3. Exhibits\nSee accompanying Exhibit Index.\nIV - 1\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.\nWESTBANK CORPORATION\nBy: Donald R. Chase, 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.\nSignature Title Date\nDonald R. Chase President and Chief Executive Officer and Director March 20, 1996 Alfred C. Whitaker Chairman of the Board and Director March 20, 1996 John M. Lilly Treasurer and Chief Financial Officer March 20, 1996 Roland O. Archambault Director March 20, 1996 Mark A. Beauregard Director March 20, 1996 David R. Chamberland Director March 20, 1996 John E. Fitzgerald Director March 20, 1996 Leroy F. Jarrett Vice Chairman of the Board and Director March 20, 1996 Ernest N. Laflamme, Jr.\t Director March 20, 1996 Russell Mawdsley Director March 20, 1996 Paul J. McKenna Director March 20, 1996 Robert J. Perlak Corporate Clerk and Director March 20, 1996 James E. Tremble Director March 20, 1996\nIV - 2\nEXHIBIT INDEX\nPage No.\n3. Articles of Organization, as amended **\n(a) Articles of Organization, as amended *\n(b) By-Laws, as amended *\n10.1 Employment Contract dated October 1, 1986, between William A. Franks, Jr. and Westbank Corporation ***\n10.12 Termination Agreement dated February 20, 1987, between Donald R. Chase and Park West Bank and Trust Company ***\n10.14 Termination Agreement dated February 20, 1987, between Stanley F. Osowski and CCB, Inc. ***\n10.15 1985 Incentive Stock Option Plan for Key Employees *\n13. 1995 Annual Report to Stockholders ARS (IFC 1-36 IBC)\n21. Subsidiaries of Registrant \t\t\t\t\t\t TO BE INCLUDED\n27. Financial Data Schedule\t\t\t\t\t\t\t TO BE INCLUDED\n* Incorporated by reference to identically numbered exhibits contained in Registrant's Annual Report on Form 10-K for the year ended December 31, 1988\n** Incorporated by reference to identically numbered exhibits contained in Registrant's Annual Report on Form 10-K for the year ended December 31, 1987\n*** Incorporated by reference to identically numbered exhibits contained in Registrant's Annual Report on Form 10-K for the year ended December 31, 1986\nIV - 3","section_15":""}
{"filename":"764543_1995.txt","cik":"764543","year":"1995","section_1":"Item 1. Business.\nCentury Pension Income Fund XXIII, (the \"Registrant\") was organized in June 1984, as a California limited partnership under the Uniform Limited Partnership Act of the California Corporations Code. Fox Partners V, a California general partnership, is the general partner of the Registrant. Fox Capital Management Corporation (the \"Managing General Partner\") and Fox Realty Investors (\"FRI\") are the general partners of Fox Partners V.\nThe Registrant's Registration Statement, filed pursuant to the Securities Act of 1933 (No. 2-96389), was declared effective by the Securities and Exchange Commission on July 1, 1985. The Registrant marketed its securities pursuant to its Prospectus dated July 1, 1985, which was thereafter supplemented (hereinafter the \"Prospectus\"). This 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 to acquire, manage and ultimately sell income-producing properties, and invest in, service and ultimately collect or dispose of mortgage loans on income-producing properties. The Registrant is a \"closed\" limited partnership real estate syndicate of the unspecified asset type. For a further description of the business of the Registrant, see the sections entitled \"Risk Factors\" and \"Investment Objectives and Policies\" of the Prospectus.\nBeginning in July 1985 through December 1986, the Registrant offered $50,000,000 in Individual Investor Units and $65,000,000 in Pension Investor Notes (\"Nonrecourse Promissory Notes\" or \"Promissory Notes\"). The Registrant sold Individual Investor Units and Pension Investor Notes of $47,894,500 and $41,939,000, respectively. The net proceeds of this offering were originally used to acquire interests in five business parks and two shopping centers and to fund eight mortgage loans. The Registrant's original property portfolio was geographically diversified, with properties acquired and properties on which loans were funded located in nine states. One property is owned by a joint venture with an affiliated partnership in which the Registrant has a 66 2\/3 percent interest. Three properties are owned by another joint venture with an affiliated partnership in which the Registrant has a 68 percent interest. In the period from 1988 through 1991 four properties securing mortgage loans were acquired through foreclosure or deed in lieu of foreclosure and in 1992 one mortgage loan was reclassified as an in-substance foreclosure property. In 1995, the Registrant acquired through a deed in lieu of foreclosure a property on which the Registrant held a mortgage and the in-substance foreclosure property was foreclosed upon by the first mortgagee. See \"Property Matters\". See \"Item 2, Properties\" for a description of the Registrant's properties, and \"Item 8, Consolidated Financial Statements and Supplementary Data -Financial Statement Schedule IV, Mortgage Loans on Real Estate,\" for a description of the properties underlying the mortgage loans and the mortgage loan terms.\nBoth the income and expenses of operating the properties owned by the\nRegistrant are subject to factors beyond the Registrant's control, such as oversupply of similar rental facilities as a result of 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 rental 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 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 legislation and 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 owned by the Registrant.\nMortgage loans are subject to certain risks. In the event of default, the Registrant would have the added responsibility of foreclosing and protecting its investments. The Registrant may thereby be forced to operate an underlying property to protect the value of its investment and may also be required to invest additional sums to maintain and manage the property. In the event that a defaulting borrower becomes bankrupt, enforcement of the Registrant's rights under the deed of trust, including foreclosure on the underlying property, may be delayed. Bankruptcy proceedings may result in a modification of the terms of the obligation owed to the Registrant or a reinstatement of the original terms notwithstanding an acceleration by the Registrant and the expiration of the time for reinstatement under non-bankruptcy law. The Registrant had entered into wrap-around loans and junior mortgage loans with borrowers, which were subject to greater risks than first mortgage loans because such investments are subordinate to the liens of senior mortgages. All of the Registrant's remaining loans will require the borrower to make a \"balloon payment\" of principal at maturity. Certain of the Registrant's mortgage loans are loans in which the interest accrual rate exceeds the interest payment rate with deferred interest payable at specified intervals upon sale of the underlying property or at maturity of the loan. To the extent that a borrower has an obligation to pay a mortgage loan balance or deferred interest in a lump sum payment, its ability to satisfy this obligation may be dependent upon its ability to obtain suitable refinancing or otherwise to raise a substantial cash amount.\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 its\nproperties and believes such coverage to be adequate.\nWith respect to Limited Partners, at this time it appears that the original investment objective of capital growth from 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 herein as well as upon significant improvement in the performance of the Registrant's properties and the markets in which such properties are located and on the sales price of the properties. It is anticipated at this time that some of the properties will be held longer than originally expected. The ability to hold and operate these properties is dependent upon the Registrant's ability to obtain additional financing, refinancing, or debt restructuring as required.\nAs to the Promissory Note holders and assuming the Notes are held to maturity, at this time it appears that all or a significant portion of the remaining principal and possibly a portion of deferred interest will be returned. However, the ability of the Registrant to make such payments of principal and interest is dependent upon the ultimate sales prices, timing of sales of the properties, net proceeds received by the Registrant from sales and refinancings and overall operations. The Promissory Note holders will not receive any payment of residual interest.\nProperty Matters\nMedtronics\/Honeywell - In April 1995, the Registrant entered into various agreements with the borrowers on two of the Registrant's second mortgage loans receivable, which were cross collateralized and in default. The properties are located in Irvine (\"Irvine\") and Costa Mesa, California (\"Costa Mesa\"). The borrower on the Irvine property had terminated payments on the mortgage loan receivable in October 1994 and, in January 1995, a court appointed reviewer was placed on the Irvine property. On April 20, 1995, the Registrant acquired the Irvine property through deed in lieu of foreclosure and satisfied the existing first mortgage encumbering the property in the principal amount (including expenses) of approximately $1,114,000. On May 31, 1995, the receiver on the Irvine property was dismissed. The Registrant commenced operating the property on June 1, 1995. The mortgage loan receivable, net of the previously recorded provisions for impairment of value of $1,250,000, has been reclassified as real estate at September 30, 1995. The mortgagor of the Costa Mesa property assumed $400,000 of the principal amount of the debt encumbering the Irvine property resulting in an aggregate outstanding principal balance of $1,137,000. The Registrant extended the maturity date of the loan on the Costa Mesa property to March 31, 2000. Monthly payments to the Registrant remain the same. Upon the sale of the Costa Mesa property, the Registrant will be entitled to contingent interest of 50% of the amount received in excess of the current debt.\n1726 M Street - On June 20, 1995, the Registrant received a notice from the first mortgagee on 1726 M Street, indicating that they expect to foreclose on this property. On July 31, 1995, the Registrant lost its second mortgage interest in this property. In 1992, the Registrant fully reserved for this contingency.\nCoral Palm Plaza - The Registrant received a lease buy-out of $800,000 in January 1995 from a significant tenant that had occupied 27,000 square feet\nat Coral Palm Plaza (in which the Registrant has a 66 2\/3% interest). During June 1995, management re-leased 20,000 square feet of the unoccupied space, on similar terms, and recognized a portion of the lease buy-out in the amount of $517,000. During September 1995, management re-leased the remaining 7,000 square feet of the unoccupied space, on similar terms, and recognized the remaining portion of the lease buy-out fee as rental income in 1995, which represents the amortization of the fee prior to the new tenants' lease commencement dates.\nIn addition, in October 1995 the Coral Palm Plaza Joint Venture accepted a lease buy-out from a tenant that occupied 11,300 square feet of space for $300,000. The Management is currently attempting to release the vacated space. Sunnymead Towne Center - A tenant occupying 98,000 square feet vacated its space during 1995 in connection with its national downsizing. The Registrant continues to receive rent payments from this tenant.\nEffective March 1, 1996, the Registrant determined to cease making debt service payments and does not intend to make any future payments. Consequently, the Registrant expects that the property will be foreclosed upon.\nNote Receivable - On April 28, 1995, the Registrant received $1,007,000 in full satisfaction of its mortgage loan receivable on the Warren, Michigan property. The property has been classified as an insubstance foreclosure property. The Registrant accepted the discounted settlement because it determined that, based upon projected future operational cash flow of the property, and the cost of litigation, it appeared likely that a substantial portion of contractual obligations would not be collected. The Registrant recorded a $978,000 loss on satisfaction of a mortgage loan receivable. A $1,850,000 provision for doubtful mortgage loan and interest receivable had previously been recorded in 1992.\nEmployees\nServices are performed for the Registrant at Valley Apartments 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 Valley Apartments. 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%\nof 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 an affiliate of Insignia caused new officers and directors of each of those entities to be elected. See \"Item 10, Directors and Executive Officers of the Registrant.\"\nCompetition\nThe Registrant is affected by and subject to the general competitive conditions of the residential, commercial, retail and office real estate industries. In addition, each of the Registrant's properties competes in an area which normally contains numerous other real properties which may be considered competitive.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nA description of the income-producing properties in which the Registrant has an ownership interest is as follows. All of the Registrant's\nproperties are owned in fee unless otherwise indicated.\nDate of Name and Location Purchase Type Size\nPARTNERSHIP\nCommerce Plaza 03\/86 Business 83,000 5404 West Hillsborough Ave. Park sq.ft. Tampa, Florida\nRegency Centre 05\/86 Shopping 124,000 2301 Nicholasville Road Center sq.ft. Lexington, Kentucky\nHighland Park Commerce Center 09\/86 Business 67,000 Phase II Park sq.ft. 818-834 Tyvola Road Charlotte, North Carolina\nInterrich Plaza(1) 04\/88 Business 53,000 525 International Parkway Park sq.ft. Richardson, Texas\nCentre Stage Shopping Center(2) 01\/90 Shopping 96,000 6050 Peachtree Parkway Center sq.ft. Norcross, Georgia\nThe Enclaves(3) 04\/91 Apartment 268 7100 Roswell Road Complex units Atlanta, Georgia\nSunnymead Towne Center(4) 03\/91 Shopping 173,000 24899 Allesandro Blvd. Center sq.ft. Moreno Valley, California\nMedtronics(5) 04\/95 Industrial 35,000 18011 South Mitchell Building sq.ft Irvine, California\nCORAL PALM PLAZA JOINT VENTURE\nCoral Palm Plaza(6) 01\/87 Shopping 135,000 University Drive at N.W. 20th Center sq.ft. Coral Springs, Florida\nDate of Name and Location Purchase Type Size\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nAlpha Business Center(7) 05\/87 Business 172,000 8100 - 26th Avenue Park sq.ft. Bloomington, Minnesota\nPlymouth Service Center(7) 05\/87 Business 74,000 Water Tower Circle and Park sq.ft. Xenium Lane Plymouth, Minnesota\nWestpoint Business Center(7) 05\/87 Business 161,000 13800 Industrial Park Boulevard Park sq.ft. Plymouth, Minnesota\n(1) Property was acquired through foreclosure of a mortgage loan receivable on April 5, 1988. (2) Property was acquired through deed in lieu of foreclosure of a mortgage loan receivable on January 2, 1990. (3) Property was acquired through foreclosure of a mortgage loan receivable on April 2, 1991. Formerly known as Valley Apartments. (4) Property was acquired through foreclosure of a mortgage loan receivable on March 28, 1991. (5) Property was acquired through deed in lieu if foreclosure of a mortgage loan receivable on April 20, 1995. (6) Coral Palm Plaza is owned by a joint venture between the Registrant, which has a 66 2\/3 percent interest, and an affiliated partnership. (7) Alpha Business Center, Plymouth Service Center and Westpoint Business Center are owned by a joint venture between the Registrant, which has a 68 percent interest, and an affiliated partnership.\nThe Registrant also maintains a portfolio of mortgage loans on real properties. See \"Item 8, Consolidated Financial Statements and Supplementary Data - Financial Statement Schedule IV, Mortgage Loans on Real Estate,\" for information regarding these mortgage loans. See \"Item 8, Consolidated 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 average occupancy at the Registrant's remaining properties for the years ended December 31, 1995, 1994, 1993, 1992 and 1991:\nOCCUPANCY SUMMARY\nAverage Occupancy Rate(%) for the Year Ended December 31, 1995 1994 1993 1992 1991\nCommerce Plaza 94 99 99 98 99 Regency Centre 99 99 78 89 94 Highland Park Commerce Center - Phase II 93 92 74 70 72 Interrich Plaza 73 96 97 91 100 Centre Stage Shopping Center 97 94 93 86 82 The Enclaves(1) 96 95 96 92 91 Sunnymead Towne Center 91 91 92 90 87 Medtronics(2) 100 - - - -\nCORAL PALM PLAZA JOINT VENTURE: Coral Palm Plaza 74 83 76 71 78\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE: Alpha Business Center 92 89 79 82 73 Plymouth Service Center 93 98 75 91 90 Westpoint Business Center 93 80 83 87 85\n(1) Formerly known as Valley Apartments. (2) Property was acquired through deed in lieu of foreclosure of a mortgage loan receivable on April 20, 1995.\nSIGNIFICANT TENANTS (1) December 31, 1995\nAnnualized Square Nature of Expiration Base Rent Renewal Footage Business of Lease Per Year(2) Options(3)\nCommerce Plaza F.A.A. 9,523 Government 1996 $111,419 2-1 Yr Office Suntrust Service 64,186 Bank 2000 $488,269 2-5 Yr\nCentre Stage Shopping Center The Kroger Co. 58,890 Grocer 2011 $450,000 5-5 Yr\nInterrich Plaza General Diagnostics 17,050 Electronic 1998 $96,625 - Manufacturer\nRegency Center Michael's Stores 18,121 Craft Store 2003 (4) 1-5 Yr The TJX Operating Co. 32,154 Fashion 2004 $239,225 2-5 Yr Discount Highland Park Commercial Center - Phase II First Natl. Bank 13,154 Bank 1999 $115,098 - Applegate\/Potter 6,788 Marketing (5) $44,122 -\nSunnymead Towne Center K-Mart 98,471 Discount 2007 $440,160 - Retail Medtronics Medtronics Heart 35,000 Medical 1997 $285,600 2-3 Yr Valve(6) Products\nCORAL PALM PLAZA JOINT VENTURE: Luria & Sons 21,891 Catalog 2006 (4) 3-5 Yr Retailer Linen Supermarket 14,071 Household 1998 $168,852 1-5 Yr Item Store Michaels Stores 20,000 Craft Store 2005 $150,000 3-5 Yr\nAnnualized Square Nature of Expiration Base Rent Renewal Footage Business of Lease Per Year(2) Options(3)\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE: Plymouth Service Center Paul Robey & Assoc. 14,332 Sales - Tool 1999 $67,790 - Parts Sola Optical 13,966 Eye Doctor 1996 $78,768 - Guyer's Builder 35,768 Building 2003 $201,495 2-5 Yr Supplies\nWestpoint Business Center ETS Energy Tech System 18,637 Parts 1999 $65,820 - Manufacturer Kloster Corporation 21,850 Parts 1999 $138,737 1-2 Yr Manufacturer Tile by Design 21,815 Tile 1999 $161,018 -\n(1) Tenant occupying 10% or more of total rentable square footage of the property. (2) Represents annualized base rent excluding additional rent due as operating expense reimbursements, percentage rents and future contractual escalations. (3) The first amount represents the number of renewal options. The second amount represents the length of each option. (4) Lease expired February 28, 1996. Tenant continues to occupy space and is negotiating a new lease which would reduce space to 3,600 square feet. (5) Tenant pays percentage rent based on retail stores occupied. (6) Tenant occupies 100% of rentable space at property.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Partnership is unaware is of any pending or outstanding litigation that is not of a routine nature. The General Partner of the\nRegistrant believes that all such pending or outstanding litigation will be resolved without a material adverse effect upon the business, financial condition, or operations of the Registrant.\nItem 4.","section_4":"Item 4. Submission of Matter 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 Individual Investor Unit holders are entitled to certain distributions as provided in the Partnership Agreement. Distributions from operations to date for each Individual Investor Unit holder have been $122 to $172 for each $500 of original investment. Interest payments to date for each Pension Investor Note have been approximately $228 for each $500 of original investment. The Registrant continues to make the required semi-annual payments on the Pension Investor Notes of 5% of the principal amount of the note. No payments of the principal have occurred. No market for Individual Investor Units or Pension Investor Notes exists nor is 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 Individual Investor Units and Pension Investor Notes was as 3,045 and 5,125, respectively.\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 consolidated 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\n(Amounts in thousands except per unit data)\nTotal revenues $ 12,680 $11,473 $10,730 $11,102 $ 10,829 ======== ======= ======= ======= ======== Loss before minority interest in joint ventures' operation $ (6,651) $(9,762) $(4,466) $(7,330) $ (8,323)\nMinority interest in joint\nventures' operations (507) 1,245 (107) (258) 651 --------- ------- ------- ------- ------\nNet loss $ (7,158) $(8,517) $(4,573) $(7,588) $ (7,672) ========= ======== ======= ======= ========\nNet loss per individual investor unit(1) $ (73.23) $(87.14) $(46.79) $(77.63) $ (78.50) ========= ======== ======= ======= ========\nTotal assets $ 78,154 $83,300 $89,645 $91,370 $ 96,659 ======== ======= ======= ======= ========\nLong-term obligations: Nonrecourse promissory notes: Principal $ 41,939 $41,939 $41,939 $41,939 $ 41,939 Deferred interest payable 30,092 27,326 24,560 21,794 19,028\nNotes payable 16,956 16,947 16,902 15,674 15,573 ------- ------- ------- ------- -------\nTotal $ 88,987 $86,212 $83,401 $79,407 $76,540 ======== ======= ======= ======= =======\nCash distributions per individual investor unit $ - $ - $ - $ 10.00 $ 15.00 ======== ======= ======= ======= =======\n(1) $500 original contribution per unit, based on units outstanding during the year after giving effect to the allocation of net 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\nAs of March 31, 1996, the Registrant's real estate properties consist of one apartment complex located in Georgia, four business parks located in Florida, North Carolina, California and Texas and three shopping centers located in Kentucky, Georgia and California. The Registrant also holds majority joint venture interests in three business parks located in Minnesota and a shopping center located in Florida. The properties are leased to tenants subject to leases with original lease terms ranging from six months to one year for the residential property and remaining lease terms of up to sixteen years for commercial properties. The Registrant receives rental income from its properties and is responsible for operating expenses, administrative expenses, capital improvements and debt service payments. The Registrant also holds a second mortgage loan receivable on a property located in Costa Mesa, California. As described in \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 4\", in April 1995, the Registrant acquired the Irvine property by deed in lieu of foreclosure and satisfied the first mortgage encumbering this property, in the amount of approximately $1,114,000, including expenses. The mortgagor of\nthe Costa Mesa property assumed $400,000 of the debt encumbering the Irvine property and the Registrant extended the maturity date of the loan to March 31, 2000. In April 1995, the loan encumbering the Registrant's in-substance foreclosure property was satisfied at a discount. In July 1995, the Partnership lost its second mortgage interest on 1726 M Street when the first mortgagee foreclosed on this property. In 1992, the Partnership fully reserved for this contingency. All of the Registrant's properties, except the Registrant's The Enclaves Apartments (formerly Valley Apartments), generated positive cash flow during the year ended December 31, 1995. The Registrant's The Enclaves Apartments generated negative cash due to capital improvements (discussed below).\nThe Registrant uses working capital reserves from any undistributed cash flow from operations and proceeds from collection of a loan receivable as its primary sources of liquidity. For the long term, it is anticipated that cash from operations will remain the Registrant's primary source of liquidity. Cash distributions to limited partners will remain suspended as cash flow and existing working capital reserves are utilized for the repayment of Promissory Notes. Promissory Note Holders continue to receive the required minimum interest payments. The Registrant accepted a lease buy-out of $800,000 in December 1994 from a significant tenant that had occupied 27,000 square feet at Coral Palm Plaza (and was received in 1995). During 1995, management re-leased the unoccupied space, on similar terms, and recognized the remaining unamortized portion ($699,000) of the lease buy-out. In October 1995, the Registrant accepted a lease buy-out agreement with a tenant that occupied 11,300 square feet of space at Coral Palm Plaza for $300,000. The $300,000 payment is being amortized into income on a straight-line basis over the remaining three years of the tenant's lease. The Registrant is attempting to re-lease the space. In May 1995, a significant tenant at the Registrant's Interrich Plaza that occupied 19,000 square feet vacated. The Registrant is currently attempting to re-lease the unoccupied space. A significant tenant at the Registrant's Sunnymead Towne Center, that occupied 98,000 square feet, vacated during 1995 as part of the retail chain's national downsizing. The Registrant continues to receive monthly rent payments from the tenant. The Registrant has recorded a $2,900,000 provision for impairment of value on Sunnymead Towne Center. Effective March 1, 1996 the Registrant has ceased making debt service payments and does not intend to make any future payments on Sunnymead Towne Center. Consequently, the Registrant expects that the property will be foreclosed. If the property is lost through foreclosure, the Registrant would recognize an extraordinary gain for financial reporting purposes. During 1995 a construction project to replace the breezeways at the Registrant's The Enclaves Apartments was started and completed at a cost of approximately $260,000. Except for required tenant improvements, the Registrant has no other plans for material capital expenditures.\nThe level of liquidity based on cash and cash equivalents experienced a $1,176,000 increase at December 31, 1995, as compared to 1994. The Registrant's $3,005,000 of net cash provided by operating activities was partially offset by $981,000 of net cash used in investing activities, $805,000 of cash distributed to the joint venture partner (financing activities) and $43,000 of cash distributed to the general partner (financing activities). Cash used in investing activities consisted of $1,114,000 of cash paid to satisfy the first mortgage encumbering the Medtronics property, which the Registrant acquired through deed in lieu of foreclosure, $864,000 of cash used for improvements to real estate, primarily at the Registrant's The Enclaves Apartments and a $10,000\nincrease in restricted cash. The cash used in investing activities was partially offset by $1,007,000 of cash received by the Registrant in satisfaction, at a discount, of the mortgage loan encumbering the Registrant's in-substance foreclosure property. 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 currently being invested in a money market account or in 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, regular debt service payments and minimum interest payments on the Promissory Notes for the next twelve months and until February 1999 when the principal and deferred interest on the Promissory Notes become due. At that time, Registrant will be required to sell properties and\/or extend the maturity date or replace the Notes.\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. IFGP Corporation caused new officers and directors of NPI Equity II and the Managing General Partner to be elected. 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\".\nWith respect to limited partners, at this time it appears that the original investment objective of capital growth from inception of the Registrant will not be attained and that investors will not receive a return of all their invested capital and any portions that are returned will come from cash flow. 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 properties. In this regard, it is anticipated at this time that some of the properties will continue to be held longer than originally expected. The ability to hold and operate these properties is dependent on the Registrant's ability to obtain additional financing, refinancing or debt restructuring, as required. As to the Promissory Note Holders and assuming the notes are held to maturity, the ability of the Registrant to make it's payments of principal and interest is dependent upon the ultimate sales prices, timing of sales of the remaining properties, net proceeds received by the Registrant from sales and refinancing and overall Partnership operations. Based on current projections, the Promissory Note Holders will not receive any payment of residual interest.\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\ninstitutions) 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, before minority interest in joint ventures' operations, improved by $3,111,000 for the year ended December 31, 1995 as compared to 1994, due to an increase in revenues of $1,207,000 and a decrease in expenses of $1,904,000. Operating results improved due to increased rental revenues in excess of related operating expenses, the recognition of the lease buy-out fee, the lower provision for impairment of value and no provision for doubtful mortgage loans receivable in 1995.\nOperating results, before minority interest in joint ventures' operations and excluding the Medtronics property (which was acquired through deed in lieu of foreclosure in April 1995), improved by $2,869,000 due to an increase in revenues of $906,000 and a decrease in expenses of $1,963,000.\nRental revenues, before minority interest in joint ventures' operations and excluding the Medtronics property, increased by $437,000 primarily due to increased rental rates at the Registrant's The Enclaves Apartments and Regency Centre and increased occupancy at the Registrant's Centre Stage, Alpha Business Center and Westpoint Business Center joint venture properties. These increases were partially offset by a decline in occupancy at the Registrant's Interrich Plaza, Commerce Plaza and the Registrant's Coral Palm Plaza joint venture property. Occupancy and rental rates remained relatively constant at the Registrant's remaining properties. Interest and other income increased by $632,000 due to the recognition of $699,000 of lease termination income at the Registrant's Coral Palm Plaza joint venture property and an increase in interest income due to an increase in average working capital reserves available for investment and increased interest rates. The increases in interest and other income were partially offset by $185,000 of proceeds from a legal settlement at the Registrant's Regency Centre received during 1994. Interest income on mortgage loans declined by $163,000 due to the termination of payment by the borrower on the Medtronics mortgage loan in October 1994. The Registrant acquired the Medtronics property through deed in lieu of foreclosure in April 1995.\nExpenses, before minority interest in joint ventures' operations and excluding the Medtronics property, decreased for the year ended December 31, 1995, as compared to 1994, due to having a lesser amount of non-recurring type expenses. In 1995, the Registrant incurred a loss on satisfaction of the mortgage loan receivable of $978,000 and the provision for impairment of value on the Registrant's Sunnymead Towne Center property of $2,900,000. In 1994, the Registrant incurred a provision for impairment of value on the Registrant's Coral Palm Plaza joint venture property of $4,500,000 and a $1,250,000 provision for doubtful mortgage loans receivable on the Registrant's Medtronics mortgage loan receivable. The Registrant experienced decreases in depreciation expense of $151,000, general and administrative expenses of $81,000 and interest expense of $13,000, which were only slightly offset by an increase in operating expenses of $154,000. Depreciation expense declined due to the provision for impairment of value recorded on the Registrant's Coral Palm Plaza joint venture property.\nGeneral and administrative expenses decreased due to a reduction in asset management costs. Interest expense decreased due to a decrease in the amortization of deferred loan costs, which were fully amortized in 1994. All other expenses remained relatively constant.\n1994 Compared to 1993\nOperating results, before minority interest in joint ventures' operations, declined $5,296,000 for the year ended December 31, 1994, as compared to 1993, as the $743,000 increase in revenues was more than offset by the $6,039,000 increase in expenses which was due to the $4,500,000 provision for impairment of value recorded on the Registrant's Coral Palm Plaza Joint Venture property and a $1,250,000 provision for impairment of value on the Registrant's Medtronics mortgage loan receivable.\nRevenues increased by $743,000 for the year ended December 31, 1994, as compared to 1993, due to increases in rental revenue of $749,000 and interest and other income of $199,000, which were partially offset by a $205,000 decrease in interest income on mortgage loans. The Registrant experienced increased occupancy at its Highland Park Commerce Center, Regency Centre, Alpha Business Center and Plymouth Business Center properties. Occupancy remained relatively constant at the Registrant's remaining properties. The Registrant experienced an increase in rental rates at its Valley Apartments, Sunnymead Towne Center and Westpoint Business Center properties, which were partially offset by a decrease in rental rates at the Registrant's Commerce Plaza and Highland Park Commerce Center properties. Interest and other income increased due to an increase in average working capital reserves available for investment and proceeds received from a legal settlement for tenant rent at the Registrant's Regency Center property. Interest income on mortgage loans declined due to the termination of payments by the borrower on the 1726 M Street Office Building in September 1993, and on the Medtronics mortgage loan in October 1994. The accrual and deferral of interest on the Medtronics mortgage loan receivable ceased in 1994 due to the provision for impairment.\nExpenses increased $6,039,000 for the year ended December 31, 1994, as compared to 1993, due to a $4,500,000 provision for impairment of value on the Registrant's Coral Palm Plaza joint venture property and a $1,250,000 provision for impairment of value on the Registrant's Medtronics mortgage loan receivable. In addition the Registrant experienced increases in operating expenses of $443,000 and depreciation of $114,000, which were partially offset by decreases in interest expense of $171,000 and general and administrative expenses of $97,000. Operating expenses increased primarily due to increased rent-up and general repairs and maintenance expenses at the Registrant's The Enclaves Apartments property. Depreciation expense increased due to the effect of fixed asset additions, primarily at the Registrant's The Enclaves Apartments and at the Registrant's Alpha Business Center and Westpoint Business Center joint venture properties. General and administrative expenses decreased due to a reduction in asset management costs. Interest expense declined as a result of the modification of the interest rate on the mortgage encumbering the Registrant's Sunnymead Towne Center property, pursuant to the prior years reorganization plan effective November 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nCONSOLIDATED FINANCIAL STATEMENTS\nYEAR ENDED DECEMBER 31, 1995\nINDEX Page\nIndependent Auditors' Reports...........................................F - 2 Consolidated Financial Statements: Balance Sheets at December 31, 1995 and 1994.......................F - 4 Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993....................................................F - 5 Statements of Partners' Equity (Deficit) for the Years Ended December 31, 1995, 1994 and 1993................................F - 6 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993....................................................F - 7 Notes to Consolidated Financial Statements.........................F - 8 Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 1995, 1994 and 1993........... .......................F - 19 Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995.......................F - 20 Schedule IV - Mortgage Loans on Real Estate at December 31, 1995..........................F - 23\nCORAL PALM PLAZA JOINT VENTURE\nIndependent Auditors' Reports...........................................F - 25 Financial Statements: Balance Sheets at December 31, 1995 and 1994.......................F - 27 Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993....................................................F - 28 Statements of Partners' Equity for the Years Ended December 31, 1995, 1994 and 1993.................................F - 29 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993....................................................F - 30 Notes to Financial Statements......................................F - 31 Financial Statement Schedule: Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995.......................F - 35\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nIndependent Auditors' Reports...........................................F - 37 Financial Statements: Balance Sheets at December 31, 1995 and 1994.......................F - 39\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993....................................................F - 40 Statements of Partners' Equity for the Years Ended December 31, 1995, 1994 and 1993................................F - 41 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993...................................................F - 42 Notes to Financial Statements......................................F - 43 Financial Statement Schedule: Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995.......................F - 46\nFinancial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in financial statements.\nTo the Partners Century Pension Income Fund XXIII, A California Limited Partnership Greenville, South Carolina\nIndependent Auditors' Report\nWe have audited the accompanying consolidated balance sheets of Century Pension Income Fund XXIII, A California Limited Partnership (the \"Partnership\") and its joint ventures and subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' equity (deficit) and cash flows for the years then ended. Our audits also included the consolidated financial statement schedules supplied pursuant to Item 14(a)(2). 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 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.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Century Pension Income Fund XXIII, A California Limited Partnership, and its joint ventures and subsidiary 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. 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.\nImowitz Koeniz & Co., LLP\nCertified Public Accountants\nNew York, N.Y. March 1, 1996\nINDEPENDENT AUDITORS' REPORT\nCentury Pension Income Fund XXIII:\nWe have audited the accompanying consolidated statements of operations, partners' equity (deficit) and cash flows of Century Pension Income Fund XXIII (a California limited partnership) (the \"Partnership\") and its joint ventures and subsidiary 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.\nWe believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Partnership and its joint ventures and subsidiary for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nCONSOLIDATED STATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nUnit Total General holders' partners' partner's equity equity (deficit) (deficit) (deficit) ------------ ------------ ------------ Balance - January 1, 1993 $ (1,556,000) $ 2,265,000 $ 709,000\nNet loss (91,000) (4,482,000) (4,573,000)\nCash distributions (43,000) - (43,000) ------------ ------------ ------------\nBalance - December 31, 1993 (1,690,000) (2,217,000) (3,907,000)\nNet loss (170,000) (8,347,000) (8,517,000)\nCash distributions (43,000) - (43,000) ------------ ------------ ------------\nBalance - December 31, 1994 $ (1,903,000) (10,564,000) (12,467,000)\nNet loss (143,000) (7,015,000) (7,158,000)\nCash distributions (43,000) - (43,000) ------------ ------------ ------------\nBalance - December 31, 1995 $ (2,089,000) $(17,579,000) $(19,668,000) ============ ============ ============\nSee notes to consolidated financial statements.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nCentury Pension Income Fund XXIII (the \"Partnership\"), is a limited partnership organized in 1984 under the laws of the State of California to acquire, hold for investment and ultimately sell income-producing real properties, and invest in, service and ultimately collect or dispose of mortgage loans on income-producing real properties. The Partnership currently owns one apartment complex located in Georgia, four business parks located in Florida, North Carolina, California and Texas, and three shopping centers located in Kentucky, Georgia and California. The Partnership also holds a sixty-eight percent joint venture interest in three business parks located in Minnesota and a 66 and two thirds percent joint venture interest in a shopping center located in Florida. The general partner is Fox Partners V, a California general partnership whose general partners are Fox Capital Management Corporation (\"FCMC\"), a California corporation, and Fox Realty Investors (\"FRI\"), a California general partnership. The capital contributions of $47,894,500 ($500 per unit) were made by individual investor unit holders.\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.\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 Financial Group, Inc. (\"Insignia\") (see Note 13).\nConsolidation\nThe consolidated financial statements include the Partnership, its wholly owned subsidiary formed in 1991 which owns the Sunnymead Towne Center property and two joint ventures in which the Partnership has a controlling interest. An affiliated Partnership owns the minority\ninterest in these joint ventures which were formed in 1987. All significant intercompany transactions and balances 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 and mortgage receivable) approximates fair value due to the short term maturity of these instruments. The estimated fair value of the Partnership's mortgage receivable and long term debt, after discounting the scheduled payments to maturity, is as follows:\nCarrying Fair Value Value ----------- ----------- Mortgage Receivable $ 1,137,000 $ 1,042,000\nLong Term Debt (including deferred interest):\nNotes payable 17,670,000 19,215,000 Non-Recourse Promissory Notes 72,031,000 68,902,000\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.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 a money market account and repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year.\nDepreciation\nDepreciation is computed by the straight-line method over estimated useful lives ranging from 27.5 to 39 years for buildings and improvements and six years for furnishings.\nDeferred Sales Commissions and Organization Expenses\nSales commissions and organization expenses related to the Pension Investor Notes (\"Non-Recourse Promissory Notes\", \"Promissory Notes\" or \"Notes\") are deferred and amortized by the straight-line method over the life of the notes. In addition, as principal payments are made, a proportionate amount of deferred costs are expensed. Sales commissions and organization expenses related to the individual investor units were charged to partners' equity. At December 31, 1995 and 1994, accumulated\namortization of deferred sales commissions and organization expenses totaled $4,254,000 and $3,835,000, respectively.\nDeferred Leasing Commissions\nLeasing commissions are deferred and amortized over the lives of the related leases, which range from one to sixteen years. Such amortization is charged to operating expenses. At December 31, 1995 and 1994, accumulated amortization of deferred leasing commission totaled $656,000 and $511,000, respectively.\nNet Loss Per Individual Investor Unit\nThe net loss per individual investor unit is computed by dividing the net loss allocated to the individual investor unit holders by 95,789 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.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. RELATED PARTY TRANSACTIONS\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 rights 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 partner, 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 partner and affiliates in 1993. Subsequent to December 31, 1992, reimbursements were made to MMI. On December 16, 1993,\nthe services agreement with MMI was modified and, as a result thereof, the Managing General Partner 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. Related party expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 ---- ---- ----\nProperty management fees $104,000 $ 81,000 $ - Partnership management fees 111,000 111,000 111,000 Real estate tax reduction fees 88,000 10,000 - Reimbursement of operational expenses: Partnership accounting and investor services 96,000 88,000 - Professional services - 7,000 - -------- -------- -------- Total $399,000 $297,000 $111,000 ======== ======== ========\nProperty management fees and real estate tax reduction fees are included in operating expenses. Partnership management fees and reimbursed expenses are primarily included in general and administrative expenses. In addition, approximately $74,000 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.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. RELATED PARTY TRANSACTIONS (Continued)\nIn accordance with the partnership agreement, the general partner was allocated its two percent continuing interest in the Partnership's net loss and taxable loss. The partnership management fee and partnership management incentive are limited by the partnership agreement to ten percent of cash available for distribution before interest payments to the Promissory Note holders and the partnership management fee. In each of the years ended December 31, 1995, 1994 and 1993, the general partner received $43,000 of cash distributions, which were equal to 2 percent of cash distributions to Promissory Note holders.\n3. RESTRICTED CASH\nRestricted cash at December 31, 1995 and 1994 represents cash partially securing the Sunnymead Towne Center note payable, which is restricted as to its use pursuant to a court approved reorganization plan and the modified note agreements (see Note 11).\n4. MORTGAGE LOANS RECEIVABLE\nThe Partnership entered into various agreements with the borrowers on two of the Partnership's second mortgage loans receivable, which were cross collateralized and in default. The properties are located in Irvine (\"Irvine\") and Costa Mesa, California (\"Costa Mesa\"). The borrower on the Irvine property had terminated payments on the mortgage loan receivable in October 1994, and in January 1995, a court appointed receiver was placed on the Irvine property. As a result, on April 20, 1995, the Partnership acquired the Irvine property through deed in lieu of foreclosure and satisfied the existing first mortgage encumbering the property in the principal amount (including expenses) of approximately $1,114,000. On May 31, 1995, the receiver on the Irvine property was dismissed. The Partnership commenced operating the property on June 1, 1995. The mortgage loan receivable, net of the previously recorded provision for impairment of value of $1,250,000, has been reclassified as real estate in 1995. The mortgagor of the Costa Mesa property assumed $400,000 of the principal amount of the debt encumbering the Irvine property resulting in an aggregate outstanding principal balance of $1,137,000. The Partnership extended the maturity date of the loan on the Costa Mesa property to March 31, 2000. Monthly payments to the Partnership remain the same. Upon the sale of the Costa Mesa property, the Partnership will be entitled to contingent interest of 50% of the amount received in excess of the current debt.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. MORTGAGE LOANS RECEIVABLE (Continued)\nIn July 1995, the Partnership lost its second mortgage interest on 1726 M Street when the first mortgagee foreclosed on this property. In 1992, the Partnership fully reserved for this contingency.\nIn April 1995, the Partnership received $1,007,000 in full satisfaction of its mortgage loan receivable on the Warren, Michigan property. The property had been classified as an in-substance foreclosure property. The Partnership accepted the discounted settlement because it determined\nthat, based upon projected future operational cash flow of the property, and the cost of litigation, it appeared likely that a substantial portion of contractual obligations would not be collected. The Partnership recorded a $978,000 loss on satisfaction of a mortgage loan receivable. In 1992 a $1,850,000 provision for uncollectable mortgage and interest receivable had been recorded.\n5. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\nResidential Commercial 1995: Property Properties Total - ----- ------------ ------------ ------------ Land $ 1,901,000 $ 19,478,000 $ 21,379,000 Buildings and improvements 8,307,000 66,592,000 74,899,000 Furnishings 201,000 24,000 225,000 ------------ ------------ ------------\nTotal 10,409,000 86,094,000 96,503,000\nAccumulated depreciation (1,335,000) (17,759,000) (19,094,000) Allowance for impairment of value - (9,991,000) (9,991,000) ------------ ------------ ------------\nReal estate, net $ 9,074,000 $ 58,344,000 $ 67,418,000 ============ ============ ============\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. REAL ESTATE (Continued)\nResidential Commercial 1994: Property Properties Total - ----- ----------- ----------- ----------- Land $1,901,000 $19,133,000 $21,034,000 Buildings and improvements 7,879,000 64,793,000 72,672,000 Furnishings 187,000 20,000 207,000 In-Substance foreclosure - 1,985,000 1,985,000 ---------- ----------- -----------\nTotal 9,967,000 85,931,000 95,898,000\nAccumulated depreciation (1,032,000) (15,497,000) (16,529,000) Allowance for impairment of value - (7,091,000) (7,091,000) ---------- ----------- -----------\nReal estate, net $8,935,000 $63,343,000 $72,278,000 ========== =========== ===========\n6. PROVISION FOR IMPAIRMENT OF VALUE\nIn 1995 and 1994, a $2,900,000 provision for impairment of value and a $4,500,000 provision for impairment of value was recorded on the Partnership's Sunnymead Towne Center and Coral Palm Plaza Joint Venture properties, respectively. The Partnership determined that, based upon current economic conditions and projected future operational cash flows, the decline in values were other than temporary and that recovery of their carrying value was not likely. Accordingly, the properties carrying values were reduced to an amount equal to their estimated fair value. Due to the current real estate market it is reasonably possible that the Partnership's estimate of fair value will change within the next year.\n7. TERMINATION AGREEMENTS WITH FORMER TENANTS\nIn December 1994, the Partnership accepted a lease buy-out of $800,000 from a significant tenant at the Partnership's 66.67% owned joint venture property, which was received in 1995. During 1995, management re-leased all of the unoccupied space, on similar terms, and recognized the remaining portion of the lease buy-out in the amount of $699,000 as other income.\nIn October 1995, the Partnership accepted a lease buy-out and termination\nagreement with a former tenant at the Partnership's Coral Palm Plaza property. The $300,000 termination payment, has been deferred and is being amortized into income on a straight-line basis over the remaining three years of the former tenant's lease.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n8. NON-RECOURSE PROMISSORY NOTES\nThe Non-Recourse Promissory Notes are secured by a deed of trust on all properties owned in fee by the Partnership and its wholly owned subsidiary, by a secured interest in the joint venture interests held by the Partnership, and by a pledge of the note and of the deed of trust on the real properties underlying the mortgage loans made by the Partnership. The Notes were issued in two series. The \"1985 Series Notes,\" in the amount of $33,454,000, bear interest at 12 percent per annum, and the \"1986 Series Notes,\" in the amount of $8,485,000, bear interest at ten percent per annum, except that portions of the interest may be deferred, provided the Partnership makes minimum interest payments of 5% on the unpaid principal balance. The deferred interest does not accrue additional interest. The Notes are due February 15, 1999. In accordance with the Partnership Agreement and the Trust Indenture, upon the sale, repayment or other disposition of any Partnership property or Partnership mortgage loan, 98 percent of the resulting distributable cash proceeds is first allocated to the payment of Promissory Notes until such Notes and related accumulated deferred interest payable are repaid and thereafter the cash proceeds are distributed to the Partnership's general partner, Individual Unit holders, and Note holders. Note holders are also entitled to the payment of residual interest after specified payments to the general partner and Individual Unit holders as set forth in the Trust Indenture but it appears no residual interest will be paid.\n9. NOTES PAYABLE\nThe Sunnymead Towne Shopping Center (\"Sunnymead\") located in Moreno Valley, California and The Enclaves Apartments complex located in Atlanta, Georgia were the only properties pledged as collateral for notes payable at December 31, 1995. One note bore interest at 9.0 percent until November 1995 and 9.5 percent thereafter, and the other note at 12.0625 percent. The notes require balloon payments of $9,510,000 and $6,856,000 in 2000 and 2001, respectively, exclusive of deferred interest. Principal payments at December 31, 1995 are required as follows:\n1996 $97,000 1997 106,000 1998 117,000 1999 129,000 2000 9,651,000 2001 6,856,000 -----------\nTotal $16,956,000 ===========\nEffective March 1, 1996, the Partnership ceased making debt service payments on the Sunnymead property and will not make such payments in the future. Consequently, the Partnership expects that the property will be foreclosed upon and has recorded a $2,900,000 provision for impairment of value in 1995 (see Note 6). Upon foreclosure the Partnership would recognize an extraordinary gain on the extinguishment of debt for financial reporting purposes.\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n10. MINIMUM FUTURE RENTAL REVENUES\nMinimum future rental revenues from operating leases having non-cancelable lease terms in excess of one year at December 31, 1995, are as follows:\n1996 $ 7,215,000 1997 6,276,000 1998 5,396,000 1999 4,105,000 2000 3,002,000 Thereafter 11,403,000 -----------\nTotal $37,397,000 ===========\nAmortization of deferred leasing commissions totaled $254,000, $224,000 and $252,000 for 1995, 1994 and 1993, respectively, and are included in operating expenses.\n11. PETITION FOR RELIEF UNDER CHAPTER 11 BY A SUBSIDIARY\nIn March 1991 a wholly owned subsidiary of the Partnership acquired Sunnymead Towne Center Shopping Center through foreclosure. On June 24, 1992 a petition for relief was filed under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Central District of California in order to reorganize the debt relating to the property which the Partnership believed would facilitate continued ownership of the property for investment purposes.\nAn amended plan of reorganization became effective on November 15, 1993 at which time the carrying amount of unpaid principal and interest was $10,528,000. The plan limited the lenders claim to $10,100,000. In\naddition, a short fall account of $100,000 was established. Effective March 1, 1996, the Partnership ceased making debt service payments. The Partnership anticipates that the property will be lost through foreclosure (see Note 9).\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n12. 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 consolidated financial statements are as follows:\n1995 1994 1993 ---- ---- ----\nNet loss - financial statements $(7,158,000) $(8,517,000) $(4,573,000) Differences resulted from: Provision for impairment of value 2,900,000 4,500,000 - Provision for doubtful mortgage loans and interest receivable - 1,250,000 - Loss on satisfaction of mortgage receivable 978,000 - - Original issue discount (641,000) 740,000 418,000 Deferred income (425,000) 791,000 8,000 Depreciation (295,000) (122,000) (195,000) Long-term capital loss (7,980,000) - - Bad debt expense - (62,000) 69,000 Interest expense capitalized 52,000 21,000 59,000 Minority interest in joint ventures' operations 181,000 (1,815,000) (101,000) Interest accrual (118,000) (105,000) 260,000 Property tax accrual - - (45,000) ------------ ----------- ----------- Net loss - income tax method $(12,506,000) $(3,319,000) $(4,100,000) ============ =========== =========== Taxable loss per Individual Investor Unit after giving effect to the allocation to the general partner $ (128) $ (34) $ (42) ============ =========== ===========\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n12. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING (Continued)\n1995 1994 1993 ---- ---- ---- Partners' (deficit) - financial statements $(19,668,000) $(12,467,000) $(3,907,000) Differences resulted from: Sales commissions and organization expenses 6,558,000 6,558,000 6,558,000 Original issue discount 5,037,000 5,786,000 5,046,000 Provision for doubtful mortgage loans interest receivable - 4,999,000 3,749,000 Provision for impairment of value 9,991,000 7,091,000 2,591,000 Deferred income 400,000 825,000 34,000 Acquisition costs expensed (21,000) (21,000) (21,000) Depreciation (2,654,000) (2,359,000) (2,237,000) Payments credited to rental properties 2,111,000 2,111,000 2,111,000 Foreclosure of mortgage loan receivable - 1,895,000 1,895,000 Minority interest in joint ventures' operations (3,533,000) (3,714,000) (1,899,000) Capitalized expense 486,000 486,000 486,000 Interest expense capitalized 198,000 146,000 125,000 Bad debt expense 54,000 54,000 116,000 Interest accrual 788,000 906,000 1,011,000 Other 485,000 485,000 485,000 ----------- ----------- ----------- Partners' equity - income tax method $ 232,000 $12,781,000 $16,143,000 =========== =========== ===========\n13. 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. As a result of the transaction, the Managing General Partner of the Partnership is controlled by Insignia. Insignia affiliates now provide property management services to the Partnership's residential property, asset management services to the Partnership, maintain its books and records and oversee its operations.\nSCHEDULE II\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nVALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1995, 1994 and 1993\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- -------- -------- -------- -------- Additions -------------------- Charged Charged Balance Balance at to Costs to Other at Beginning and Accounts - Deductions - End of Description of Period Expenses Describe Describe Period - ----------- --------- -------- -------- -------- ------ Allowance for doubtful accounts receivable:\n1995 $ 55,000 $ 27,000 $ - $ 27,000(1) $ 55,000\n1994 $ 116,000 $ 45,000 $ - $ 106,000(1) $ 55,000\n1993 $ 47,000 $ 126,000 $ - $ 57,000(1) $ 116,000\nAllowance for loss on mortgage loans receivable:\n1995 $3,149,000 $ - $ - $1,250,000(2) $ -\n1994 $1,899,000 $1,250,000 $ - $ - $3,149,000\n1993 $1,899,000 $ - $ - $ - $1,899,000\n(1) Uncollected receivables written off.\n(2) Property acquired by Partnership through deed in lieu of foreclosure, (see Note 4 to the consolidated financial statements).\n(3) Partnership lost its second mortgage interest on property when the first mortgagee foreclosed on the property (see Note 4 to the consolidated statements).\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nREAL ESTATE AND ACCUMULATED DEPRECIATION SCHEDULE III DECEMBER 31, 1995\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 SCHEDULE III (Continued)\nSee accompanying notes.\nSCHEDULE III\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $100,693,000.\n(2) Balance, January 1, 1993 $ 93,303,000 Improvements capitalized subsequent to acquisition 1,578,000 ------------ Balance, December 31, 1993 94,881,000 Improvements capitalized subsequent to acquisition 1,017,000 ------------ Balance, December 31, 1994 95,898,000\nSatisfaction of mortgage receivable on property classified as an in-substance foreclosure property (1,985,000) Improvements capitalized subsequent to acquisition 864,000 Property acquired through deed in lieu of foreclosure of mortgage loan receivable 1,726,000 ------------ Balance, December 31, 1995 $ 96,503,000 ============ (3) Balance January 1, 1993 $ 13,870,000 Additions charged to expense 2,568,000 ------------ Balance, December 31, 1993 16,438,000 Additions charged to expense 2,682,000 Allowance for impairment of value 4,500,000 ------------ Balance, December 31, 1994 23,620,000\nAdditions charged to expense 2,565,000 Allowance for impairment of value 2,900,000 ------------ Balance, December 31, 1995 $ 29,085,000 ============ (4) The Non-Recourse Promissory Notes are secured by a deed of trust on all properties owned in fee by the Partnership and by a security interest in the joint venture interests held by the Partnership.\n(5) Property acquired through foreclosure of a mortgage loan receivable in 1988.\n(6) Property acquired through foreclosure of mortgage loan receivable in 1991.\n(7) Property acquired through deed in lieu of foreclosure of a mortgage loan receivable in 1990.\n(8) Property acquired through deed in lieu of foreclosure of a mortgage loan receivable in 1995. (see Note 4 to the consolidated financial statements).\nSCHEDULE IV\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nMORTGAGE LOANS ON REAL ESTATE December 31, 1995\nPART 1. MORTGAGE REAL ESTATE AT CLOSE OF PERIOD\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - -------- -------- -------- -------- -------- Carrying Amount of Amount of Prior Amount of principal unpaid mortgage Liens Mortgage at close being Description (3)(4) (1)(2) of period foreclosed - ----------- ------ -------- --------- ---------- (Amounts in thousands)\nSECOND MORTGAGE:\nHoneywell Costa Mesa, California $ 480 $1,137(5) $1 ,137 $ - ======= ====== ======= =======\nPART 2. INTEREST EARNED ON MORTGAGES\nCOLUMN F COLUMN G -------- -------- Interest due Interest income and accrued at earned applicable end of period to period ------------- --------- (Amounts in thousands) SECOND MORTGAGE:\nHoneywell Costa Mesa, California $ - $ 81 ----- ------ TOTAL $ $ 81 ===== ======\nSee accompanying notes.\nSCHEDULE IV\nCENTURY PENSION INCOME FUND XXIII, A California Limited Partnership\nMORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $920,000.\n(2) Balance, January 1, 1993 $ 2,936,000 Additions during period: Deferred interest added to principal 63,000 ----------- Balance, December 31, 1993 2,999,000 Deductions during period: Allowance for doubtful mortgage loan (1,250,000) ----------- Balance, December 31, 1994 1,749,000\nDeductions during period: Mortgage loan reclassified to real estate through acquisition of property through deed in lieu of foreclosure (612,000) ----------- $ 1,137,000 ===========\n(3) Prior lien balance at the date of second mortgage funding by the Partnership.\n(4) The Non-Recourse Promissory Notes are secured by a pledge of the notes and deeds of trust on the real properties underlying the mortgage loans made by the Partnership.\n(5) Maturity date has been extended to March 31, 2000 (see Note 4 to the consolidated financial statements).\nTo the Partners Coral Palm Plaza Joint Venture Greenville, South Carolina\nIndependent Auditors' Report\nWe have audited the accompanying balance sheets of Coral Palm Plaza Joint Venture (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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Coral Palm Plaza Joint Venture 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. 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\nNew York, N.Y. February 20, 1996\nINDEPENDENT AUDITORS' REPORT\nCoral Palm Plaza Joint Venture:\nWe have audited the accompanying statements of operations, partners' equity and cash flows of Coral Palm Plaza Joint Venture (the \"Partnership\") 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 financial statements present fairly, in all material respects, the results of operations and cash flows of the Partnership for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nCORAL PALM PLAZA JOINT VENTURE\nBALANCE SHEETS\nDECEMBER 31, ---------------------------- 1995 1994 ------------ ------------ ASSETS\nCash and cash equivalents $ 263,000 $ 239,000 Receivables and other assets 270,000 881,000\nReal Estate:\nReal estate 16,140,000 16,065,000 Accumulated depreciation (3,046,000) (2,829,000) Allowance for impairment of value (7,091,000) (7,091,000) ------------ ------------ Real estate, net 6,003,000 6,145,000\nDeferred leasing commissions, net 154,000 87,000 ------------ ------------ Total assets $ 6,690,000 $ 7,352,000 ============ ============\nLIABILITIES AND PARTNERS' EQUITY\nUnearned revenue and other liabilities $ 345,000 $ 844,000 ------------ ------------ Total liabilities 345,000 844,000 ------------ ------------ Contingencies\nPartners' equity:\nCentury Pension Income Fund XXIII 4,231,000 4,339,000 Century Pension Income Fund XXIV 2,114,000 2,169,000 ------------ ------------ Total partners' equity 6,345,000 6,508,000 ------------ ------------ Total liabilities and partners' equity $ 6,690,000 $ 7,352,000 ============ ============\nSee notes to financial statements.\nCORAL PALM PLAZA JOINT VENTURE\nSTATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, --------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Revenues: Rental $ 939,000 $ 1,084,000 $ 1,003,000 Interest and other income 717,000 6,000 5,000 ----------- ----------- ----------- Total revenues 1,656,000 1,090,000 1,008,000 ----------- ----------- ----------- Expenses: Provision for impairment of value - 4,500,000 - Operating 625,000 573,000 619,000 Depreciation 217,000 351,000 333,000 General and administrative 11,000 15,000 10,000 ----------- ----------- ----------- Total expenses 853,000 5,439,000 962,000 ----------- ----------- ----------- Net income (loss) $ 803,000 $(4,349,000) $ 46,000 =========== =========== ===========\nSee notes to financial statements.\nCORAL PALM PLAZA JOINT VENTURE\nSTATEMENTS OF PARTNERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nCentury Century Pension Pension Income Income Fund XXIII Fund XXIV Total ----------- ----------- ----------- Balance - January 1, 1993 $ 7,623,000 $ 3,812,000 $11,435,000\nNet income 31,000 15,000 46,000\nCash distributions (116,000) (58,000) (174,000) ----------- ----------- -----------\nBalance - December 31, 1993 $ 7,538,000 3,769,000 11,307,000\nNet (loss) (2,899,000) (1,450,000) (4,349,000)\nCash distributions (300,000) (150,000) (450,000) ----------- ----------- -----------\nBalance - December 31, 1994 4,339,000 2,169,000 6,508,000\nNet income 535,000 268,000 803,000\nCash distributions (643,000) (323,000) (966,000) ----------- ----------- -----------\nBalance - December 31, 1995 $ 4,231,000 $ 2,114,000 $ 6,345,000 =========== =========== ===========\nSee notes to financial statements.\nCORAL PALM PLAZA JOINT VENTURE\nSTATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nCORAL PALM PLAZA JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nCoral Palm Plaza Joint Venture (the \"Partnership\") is a general partnership organized in 1987 under the laws of the state of California to acquire Coral Palm Plaza, a shopping center located in Coral Springs, Florida. The general partners are Century Pension Income Fund XXIII (\"XXIII\") and Century Pension Income Fund XXIV (\"XXIV\"), California limited partnerships affiliated through their general partners.\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.\nCash and Cash Equivalents\nThe Partnership considers all highly liquid investments with an original maturity date 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 repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year.\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.\nDepreciation\nDepreciation is computed by the straight-line method over estimated useful lives ranging from 30 to 39 years for buildings and improvements.\nCORAL PALM PLAZA JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nDeferred Leasing Commissions\nLeasing commissions are deferred and amortized over the lives of the related leases, which range from one to eleven years. At December 31, 1995 and 1994, accumulated amortization of deferred leasing commissions totaled $90,000 and $68,000, respectively,\nNet Income (Loss) Allocation\nNet income (loss) is allocated based on the ratio of each partner's capital contribution to the joint venture.\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.\n2. RELATED PARTY TRANSACTIONS\nDuring 1995 and 1994, the Partnership paid an affiliate of the general partner a $16,000 and $10,000 fee, respectively, relating to a successful real estate tax appeal for the joint venture. These fees were allocated 66.67% to XXIII and 33.33% to XXIV, in accordance with the partnership agreement.\n3. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\n1995 1994 ---- ---- Land $ 4,876,000 $ 4,876,000 Buildings and improvements 11,264,000 11,189,000 ------------ -----------\nTotal 16,140,000 16,065,000\nAccumulated depreciation (3,046,000) (2,829,000) Allowance for impairment of value (7,091,000) (7,091,000)\n------------ -----------\nReal estate, net $ 6,003,000 $ 6,145,000 ============ ===========\nCORAL PALM PLAZA JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. ALLOWANCE FOR IMPAIRMENT OF VALUE\nDuring 1994, based upon current economic conditions and projected future operational cash flows, the Partnership determined that the decline in value of the Coral Palm Plaza Shopping Center was other than temporary and that recovery of its carrying value was not likely. Accordingly, the property's carrying value was reduced by $4,500,000 to an amount equal to its estimated fair value. Due to the current real estate markets it is reasonably possible that the Partnership's estimate of fair value will change within the next year.\n5. TERMINATION AGREEMENT WITH FORMER TENANT\nIn December 1994, the Partnership accepted a lease buy-out of $800,000 from a significant tenant that had occupied 27,000 square feet. The payment was received in 1995. During 1995, management re-leased all of the unoccupied space, on similar terms, and recognized the remaining portion of the lease buy-out in the amount of $699,000 as other income.\nIn October 1995, the Partnership accepted a lease buy-out and termination agreement with a former tenant at the Partnership's property. The $300,000 termination payment, has been deferred and is being amortized into income on a straight-line basis over the remaining three years of the former tenant's lease.\n6. MINIMUM FUTURE RENTAL REVENUES\nMinimum future rental revenues from operating leases having non-cancelable lease terms in excess of one year at December 31, 1995 are as follows:\n1996 $ 744,000 1997 782,000 1998 697,000 1999 576,000 2000 482,000 Thereafter 1,018,000 ---------- Total $4,299,000 ==========\nRental revenue from one tenant was 20 percent, 22 percent and 20 percent of total rental revenues in 1995, 1994 and 1993, respectively. Rental revenue from another tenant was 19 percent, 13 percent and 10 percent of total rental revenues in 1995, 1994 and 1993, respectively.\nCORAL PALM PLAZA JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n6. MINIMUM FUTURE RENTAL REVENUES (Continued)\nRental revenues included percentage and other contingent rentals of $59,000, $40,000 and $52,000 in 1995, 1994 and 1993, respectively.\nAmortization of deferred leasing commissions totaled $32,000, $29,000 and $25,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nSCHEDULE III\nCORAL PALM PLAZA JOINT VENTURE\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSee accompanying notes.\nSCHEDULE III\nCORAL PALM PLAZA JOINT VENTURE\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $16,568,000.\n(2) Balance, January 1, 1993 $ 15,967,000 Improvements capitalized subsequent to acquisition 72,000 ------------ Balance, December 31, 1993 16,039,000 Improvements capitalized subsequent to acquisition 26,000 ------------ Balance, December 31, 1994 16,065,000 Improvements capitalized subsequent to acquisition 75,000 ------------ Balance, December 31, 1995 $ 16,140,000 ============\n(3) Balance, January 1, 1993 $ 4,736,000 Additions charged to expense 333,000 ------------ Balance, December 31, 1993 5,069,000 Additions charged to expense 351,000 Provision for impairment of value 4,500,000 ------------ Balance, December 31, 1994 9,920,000 Additions charged to expense 217,000 ------------ Balance, December 31, 1995 $ 10,137,000 ============\nTo the Partners Minneapolis Business Parks Joint Venture Greenville, South Carolina\nIndependent Auditors' Report\nWe have audited the accompanying balance sheets of Minneapolis Business Parks Joint Venture (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 Minneapolis Business Parks Joint Venture 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. 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\nNew York, N.Y. February 20, 1996\nINDEPENDENT AUDITORS' REPORT\nMinneapolis Business Parks Joint Venture:\nWe have audited the accompanying statements of operations, partners' equity and cash flows of Minneapolis Business Parks Joint Venture (the \"Partnership\") 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 financial statements present fairly, in all material respects, the results of operations and cash flows of the Partnership for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nBALANCE SHEETS\nDECEMBER 31, ------------------------------- 1995 1994 ------------ ------------ ASSETS\nCash and cash equivalents $ 159,000 $ 648,000 Other assets 193,000 134,000\nReal Estate:\nReal estate 20,467,000 20,214,000 Accumulated depreciation (4,603,000) (3,999,000) ------------ ------------ Real estate, net 15,864,000 16,215,000\nDeferred leasing commissions, net 243,000 214,000 ------------ ------------ Total assets $ 16,459,000 $ 17,211,000 ============ ============\nLIABILITIES AND PARTNERS' EQUITY\nAccrued expenses and other liabilities $ 157,000 $ 151,000 ------------ ------------ Total liabilities 157,000 151,000 ------------ ------------ Contingencies\nPartners' equity:\nCentury Pension Income Fund XXIII 11,033,000 11,548,000 Century Pension Income Fund XXIV 5,269,000 5,512,000 ------------ ------------ Total partners' equity 16,302,000 17,060,000 ------------ ------------ Total liabilities and partners' equity $ 16,459,000 $ 17,211,000 ============ ============\nSee notes to financial statements.\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nSTATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, ----------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Revenues: Rental $ 2,833,000 $ 2,648,000 $ 2,361,000 Interest and other income 48,000 18,000 8,000 ----------- ----------- ----------- Total revenues 2,881,000 2,666,000 2,369,000 ----------- ----------- ----------- Expenses Operating 1,521,000 1,402,000 1,470,000 Depreciation 604,000 613,000 592,000 General and administrative 8,000 11,000 21,000 ----------- ----------- ----------- Total expenses 2,133,000 2,026,000 2,083,000 ----------- ----------- ----------- Net income $ 748,000 $ 640,000 $ 286,000 =========== =========== ===========\nSee notes to financial statements.\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nSTATEMENTS OF PARTNERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nCentury Century Pension Pension Income Income Fund XXIII Fund XXIV Total ----------- ----------- ----------- Balance - January 1, 1993 $11,223,000 $ 5,358,000 $16,581,000\nNet income 194,000 92,000 286,000\nCash distributions (304,000) (143,000) (447,000) ----------- ----------- -----------\nBalance - December 31, 1993 11,113,000 5,307,000 16,420,000\nNet income 435,000 205,000 640,000 ----------- ----------- -----------\nBalance - December 31, 1994 11,548,000 5,512,000 17,060,000\nNet income 509,000 239,000 748,000\nCash distributions (1,024,000) (482,000) (1,506,000) ----------- ----------- -----------\nBalance - December 31, 1995 $11,033,000 $ 5,269,000 $16,302,000 =========== =========== ===========\nSee notes to financial statements.\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nSTATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nMinneapolis Business Parks Joint Venture (the \"Partnership\") is a general partnership organized in 1987 under the laws of the state of California to acquire three business parks in Minnesota. The general partners are Century Pension Income Fund XXIII (\"XXIII\") and Century Pension Income Fund XXIV (\"XXIV\"), both are California limited partnerships which are affiliated through their general partners.\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.\nCash and Cash Equivalents\nThe Partnership considers all highly liquid investments with an original maturity date 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 repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year. At December 31, 1995, the Partnership had $116,000 invested in overnight repurchase agreements, secured by United States Treasury obligations, which are included in cash and cash equivalents.\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.\nDepreciation\nDepreciation is computed by the straight-line method over estimated useful lives ranging from 30 to 39 years for buildings and improvements.\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nDeferred Leasing Commissions\nLeasing commissions are deferred and amortized over the lives of the related leases, which range from one to eight years. At December 31, 1995 and 1994, accumulated amortization of deferred costs totaled $205,000 and $158,000, respectively.\nNet Income Allocation\nNet income is allocated based on the ratio of each partner's capital contribution to the joint venture.\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.\n2. RELATED PARTY TRANSACTIONS\nDuring 1995, the Partnership paid an affiliate of the managing general partner of XXIII and XXIV, a $33,000 fee relating to successful real estate tax appeals on Alpha and Westpoint Business Center joint venture properties. These fees were allocated 68 percent to XXIII and 32 percent to XXIV, in accordance with the partnership agreement.\n3. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\n1995 1994 ---- ----\nLand $ 4,523,000 $ 4,523,000 Buildings and improvements 15,944,000 15,691,000 ----------- -----------\nTotal 20,467,000 20,214,000\nAccumulated depreciation (4,603,000) (3,999,000) ------------ -----------\nReal estate, net $ 15,864,000 $16,215,000 ============ ===========\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. MINIMUM FUTURE RENTAL REVENUES\nMinimum future rental revenues from operating leases having non-cancelable lease terms in excess of one year at December 31, 1995 are as follows:\n1996 $2,350,000 1997 1,869,000 1998 1,565,000 1999 997,000 2000 659,000 Thereafter 1,037,000 ----------\nTotal $8,477,000 ==========\nAmortization of deferred leasing commissions totaled $79,000, $72,000 and $89,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nSCHEDULE III\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSee accompanying notes.\nSCHEDULE III\nMINNEAPOLIS BUSINESS PARKS JOINT VENTURE\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $21,800,000.\n(2) Balance, January 1, 1993 $ 19,345,000 Improvements capitalized subsequent to acquisition 309,000 ------------- Balance, December 31, 1993 19,654,000 Improvements capitalized subsequent to acquisition 560,000 ------------- Balance, December 31, 1994 20,214,000 Improvements capitalized subsequent to acquisition 253,000 ------------- Balance, December 31, 1995 $ 20,467,000 =============\n(3) Balance, January 1, 1993 $ 2,794,000 Additions charged to expense 592,000 ------------- Balance, December 31, 1993 3,386,000 Additions charged to expense 613,000 ------------- Balance, December 31, 1994 3,999,000 Additions charged to expense 604,000 ------------- Balance, December 31, 1995 $ 4,603,000 =============\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 uncertainty, audit scope or accounting principles. The decision to change Independent Auditors was approved by the Managing General Partner's Directors. During the 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 V (\"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 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 Officer of the Managing\nName Positions Held General Partner since\nWilliam 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 August 1994, 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 the 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\nofficers 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, as managing general partner of Fox, has discretionary control over most of the decisions made by or for the Registrant in accordance with the terms of the Partnership Agreement. The directors and officers of the Managing General Partner and its affiliates, as a group do not own any of the Registrant's voting securities.\nThere is no person known to the Registrant who owns beneficially or of record more than five percent of the voting securities of the Registrant.\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 Registrant's partnership agreement, the Registrant may be charged by the general partner and affiliates for services provided to the Partnership. On January 1, 1993, Metric Management, Inc. (\"MMI\"), a company which is not affiliated with the general partner, 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 partner and affiliates in 1993. 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, the Managing General Partner 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 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 $ 104,000 $ 81,000 $ - Partnership management fees 111,000 111,000 111,000 Real estate tax reduction fees 88,000 10,000 - Reimbursement of operational expenses: Partnership accounting and investor services 96,000 88,000 - Professional services - 7,000 - -------------------------------- Total $ 399,000 $ 297,000 $111,000 =================================\nProperty management fees and real estate tax reduction fees are included in operating expenses. Partnership management fees and reimbursed\nexpenses are primarily included in general and administrative expenses. In addition, approximately $74,000 of insurance premiums, which were paid to an affiliate of NPI 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 Registrant's partnership agreement, the general partner was allocated its two percent continuing interest in the Registrant's net loss and taxable loss. The partnership management fee and partnership management incentive are limited by the partnership agreement to ten percent of cash available for distribution before interest payments to the Promissory Note holders and the partnership management fee. In each of the years ended December 31, 1995, 1994 and 1993, the general partners received $43,000 of cash distributions, which were equal to 2 percent of cash distributions to Promissory Note holders.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K.\n(a)(1)(2) Consolidated Financial Statements and Consolidated Financial Statement Schedules:\nSee Item 8 of this Form 10-K for Consolidated Financial Statements of the Registrant, Notes thereto, and Consolidated Financial Statement Schedules. (A Table of Contents to Consolidated Financial Statements and Consolidated Financial Statement Schedules is included in Item 8 and incorporated herein by reference.)\n(a) (3) Exhibits:\n2. 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.\n3.4. Agreement of Limited Partnership incorporated by reference to Exhibit A to the Prospectus of the Registrant dated July 1, 1985 and thereafter supplemented contained in the Registrant's Registration Statement on Form S-11 (Reg. No. 2-96389)\n16. Letter from the Registrant's former Independent Auditor dated April 27, 1994, incorporated by reference to exhibit 10 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 28th day of March, 1996.\nCENTURY PENSION INCOME FUND XXIII\nBy: Fox Partners V Its General Partner\nBy: Fox Capital Management Corporation A 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.\n\/s\/ William H. Jarrard, Jr. President and March 28, 1996 - --------------------------- Director William H. Jarrard, Jr.\n\/s\/ Ronald Uretta Principal Financial March 28, 1996 - ----------------- Officer and Principal Ronald Uretta Accounting Officer\n\/s\/ John K. Lines Director March 28, 1996 - ----------------- John K. Lines\nExhibit Index\nExhibit Page\n2. NPI, Inc. Stock Purchase Agreement, dated as of (1) August 17, 1995,\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 A to the Prospectus of the Registrant dated July 1, 1985 and thereafter supplemented contained in the Registrant's Registration Statement on Form S-11 (Reg. No. 2-96389).\n(3) Incorporated by reference to Exhibit 10 to the Registrant's Current Report on Form 8-K dated April 22, 1994.","section_15":""}
{"filename":"743367_1995.txt","cik":"743367","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"ITEM 6. AVERAGE BALANCE SHEETS [CAPTION]\nNOTES TO AVERAGE BALANCE SHEET\n1. Tax-exempt income is calculated at coupon rate, no adjusted on a tax equivalent basis.\n2. At December 31, 1995, loans on non-accrual status totaled $3,359,857. These loans are included in the loan category on the preceding Average Balance Sheet. If interest had been accrued on such loans, interest income on loans would have been $416,342 higher in 1995.\n3. Interest on loans includes loan fees pursuant to FASB91 in the following amounts:\n4. The Bank s net interest margin remains above the national average, but has remained at higher than average levels for a number of years. The Bank is a community bank which focuses its efforts on customer relationships and good service while remaining competitive in the demand for loans both in the commercial and consumer sectors. The spread and margin for the Bank have been decreasing gradually over the past three years, as competition for the same customers within the Bank s market area continues to grow. The average rate on earning assets increased by 63 basis points in 1995 when compared to 1994; however, the average rate on interest bearing liabilities increased by 85 basis points. The Bank continues to seek quality loans, broadening its customer base as the spread tightens. The effect of rates and volumes is exemplified further in the Rate Volume Analysis found on page 12 of this report.\nRATE VOLUME ANALYSIS\nThe following table represents a summary of the changes in interest earned and interest paid as a result of changes in rates and changes in volumes. For each category of earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to change in rate (change in rate multiplied by old volume) and change in volume (change in volume multiplied by old rate). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.\nINTEREST RATE SENSITIVITY ANALYSIS AS OF DECEMBER 31, 1995 Amounts in Thousands\nThe following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1995 which are anticipated by the Bank, based upon certain assumptions, to reprice or mature in each of the future time periods shown.\nExcept as stated below, the amounts of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual terms of the asset or liability. The Bank has assumed that 3% of its savings is more rate sensitive and will react to rate changes, and has therefore categorized it in the one-year time horizon. The remainder is stable and is listed in the greater than five year category. NOW accounts, other than seasonal fluctuations approximating $4,000,000, are stable and are listed in the greater than five year category. Money market accounts are assumed to reprice in three months or less. Certificates of deposit are assumed to reprice at the date of contractual maturity. Fixed rate mortgages, totaling $35,000,000 are amortized using a 6% rate, which approximates the Bank s prior experience.\nSUMMARY OF INVESTMENT PORTFOLIO\nThe information presented below is to facilitate the analysis and comparison of sources of income and exposure to risks.\nMATURITY SCHEDULE FOR INVESTMENTS HELD TO MATURITY AT DECEMBER, 1995\nMATURITY SCHEDULE FOR INVESTMENTS AVAILABLE FOR SALE AT DECEMBER 31, 1995\nThe maturity schedule for securities available for sale excludes marketable equity securities totaling $5,421,086 and other investments of $240,483.\nYield on tax exempt bonds were not computed on a tax equivalent basis\nThe bank does not hold any securities for a single issuer where the aggregate book value of the securities exceed 10% of the Bank s stockholders equity.\nThe maturities for the mortgage-backed securities are shown at the stated maturity. If the Bank presented mortgage-backed securities by average expected life, the breakdown would be:\nIn 1987, the Bank purchased adjustable rate preferred (ARPS) securities totaling $1,319,000. As the economy entered into its recessionary cycle in the late 1980s, these ARPS, which were issued by other banks, were impacted by concerns of investors in the banking industry. The Bank elected to recognize a permanent write down on the ARPS totaling $387,000 beginning in 1990.\nThe ARPS portfolio began increasing in market value during 1991 as banks showed stronger earnings. Since this upward market trend continued in 1992, the Bank elected to sell its holdings of ARPS and by year end had a remaining balance of $463,000 in ARPS with minimum loss to the Bank. The remaining ARPS were sold in early 1993.\nChanges in the market value of the investment portfolio follow national interest rate fluctuations. As national interest rates dropped, the value of the portfolio has increased. The Bank does not hold any IOs or POs, nor does it hold any securities whose market value could change to a greater degree than traditional debt. The Bank does hold one 10-year government agency backed step up which has a fixed rate of interest for the first three years and which then increases incrementally each year until maturity. This debenture is callable one year from issuance date.\nSUMMARY OF LOAN PORTFOLIO\nPAST DUE LOANS (Amounts in Thousands)\nThe figures below represent loans past due 30 days or more (% is percentage of loans outstanding for a specific category of loans).\nLoans which were non-performing as of December 31, 1994 and for which the real estate was acquired by the Bank in 1995 totaled $181,000.\nMATURITY SCHEDULE - LOAN PORTFOLIO As of December 31,\nThe Bank makes construction loans on the basis of: a) permanent financing from another financial institution, or b)approval at the time of origination for permanent financing by our own Bank. In addition, a number of large commercial real estate loans are written and priced on the basis of fixed rates with a three to five year balloon payment. It is generally the intent of the Bank to renegotiate the rate and term of the loan at the balloon maturity. Lines of credit are renewed annually. There are consumer construction loans that will either be sold to the secondary market upon completion of construction or rolled into permanent portfolio residential mortgage loans on the Bank s books.\nThe total amount of commercial, financial and agricultural, construction, and land development loans with adjustable interest rates and maturities of greater than one year is $10,676,789 and with fixed interest rates and maturities of greater than one year is $7,730,755.\nRISK ELEMENTS\nIt is the policy of management to review past due loans on a monthly basis. Those loans 90 days or more past due which are not well secured or in the process of collection are designated as non-accruing. This includes government guaranteed loans unless the guaranteed portion has been sold. If interest had been accruing on such loans, interest income on loans would have been $416,342 higher in 1995. Interest collected on these loans totaled $184,983 in 1995 and was included in net income. Non-accrual loans represent 1.7% of average loans for 1995 and 1994.\nManagement is not aware of any potential problems loans which are not included in the above table.\nThe Bank makes single-family residential loans, commercial real estate loans, commercial loans, and a variety of consumer loans. The Bank s lending activities are conducted in north coastal Maine. Because of the Bank s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31, 1995, approximately $25,500,000 of loans were mde to companies in the hospitality industry. Of this total indebtedness, 1.8% were 30 days or more delinquent as of December 31, 1995. Loans to real estate investors and developers totaled $14,100,000 in 1995. In the fishing industry, loans decreased from $10,000,000 in 1994 to $7,500,000 in 1995. This decrease was attributable to the paydown of several aquaculture loans and a lesser need at year end for Bank support for the lobster pounding industry.\nFrom the standpoint of large loans to single borrowers, loans of $700,000 or more to one borrower decreased as a percentage of capital from 95% in 1994 to 90% in 1995. As most loans granted by the Bank are collateralized by real estate, the ability of the Bank s borrowers to repay is dependent on the level of economic activity and the level of real estate values in the Bank s market area. Because of the increasing health of the tourist industry and other industries in its market area, the Bank has benefited from the economic well-being of its customers.\nSUMMARY OF LOAN LOSSES\nDelinquencies are reviewed on a monthly and quarterly basis by senior management as well as the Board of Directors. Information reviewed is used in determining if and when loans represent potential losses to the Bank. A determination of a potential loss could result in a charge to the provision for loan losses, with an increase to the reserve for possible loans so that risks in the portfolio can be identified on a timely basis and an appropriate reserve can be maintained.\nHistorically, the amount allocated for the allowance for possible loan losses has been based on management s evaluation of the loan portfolio. Considerations used in this evaluation included past and anticipated loan loss experience, the character and size of the loan portfolio, the value of collateral, general economic conditions, and maintenance of the allowance at a level adequate to absorb anticipated losses. With net charge offs remaining under one-half of one percent of average loans outstanding for 1990, the above method and review was adequate.\nSince 1991, the Bank has utilized the methodology for the review of the allowance for loan losses to be in accordance with the approach suggested by bank regulators through FDIC Fil-34-91, dated June 28, 1992. The reserve includes specific reserves based on the review of specific credits, pool reserves based on historical charge offs by loan types and supplementary reserves reflecting concerns and loan concentrations by industry, by customer and by general economic conditions. The allocation has changed based on concentration of loans in the fishing and tourist related industries.\nIn 1992, the Bank continued to concentrate on resolving loan problems, focusing on the reduction of non-earning assets and resolution of troubled debt situations. With continued softness in the economy, the Bank aggressively charged off problem loans, and, at the same time provided more reserves for possible loan losses in the future. Building on the prior year s program of measuring adequacy, the Bank continued to build reserves to ensure that future earnings were not hurt by unforseen problems in the loan area.\nThe Bank experienced its greatest percentage of charge offs when compared to average loans outstanding in 1991 when the ratio was .74%. This ratio reached a low point in 1994 with charge offs representing only .25% of average loans. The percentage of charge offs to average loans in 1995 totals .41%. During the past five years, the majority of charge offs have been commercial loans secured by real estate. In 1992, increases in charge offs were attributable to an account where faulty documentation resulted in loss of collateral. The Bank real estate charge offs in 1994 represent charge down of loan balances on troubled loans based on updated fair value appraisals, or highest third party bids at auction.\nIn 1994 there were two writedowns of REO charged directly to earnings. A property in Northeast Harbor was sold at a loss of $74,000 after paying all expenses, and property on Main Street in Ellsworth was written down by $100,000 to more closely reflect a liquidation. In 1994, the same property\nin Ellsworth was written down by additional $23,500. This property was sold in 1995 for $120,000. Additionally in 1994, three residential properties owned by the Bank were written down by a total of $58,000 to more closely reflect their market values.\nApproximately 28% of the chargeoffs in 1995 represented loans secured by real estate, and 39% represented commercial credits. The increase in commercial loan chargeoffs in 1995 included a chargedown of a large commercial loan. Recoveries offset losses totaling $97,000, $141,000 and $264,900 for the years ended 1995, 1994 and 1993, respectively.\nSoftness in the economy in the early 1990s, reduction of collateral value, and, in some cases, poor management by the owners of the business have caused the major losses in the commercial area.\nBased on past experience and management s assessment of the present loan portfolio, it is expected that loan charge offs for 1996 will not exceed $840,000.\nA breakdown of the allowance for possible loan losses is as follows:\nSUMMARY OF LOAN LOSS EXPERIENCE (In thousands)\n% = Percentage of Loans Outstanding for a Specific Category of Loans\nSUMMARY OF DEPOSIT PORTFOLIO\nMATURITY SCHEDULE FOR TIME DEPOSITS $100,000 OR MORE\nRETURN ON EQUITY AND ASSETS\nAs of January 1, 1996, there were approximately 974 holders of record of Bar Harbor Bankshares common stock.\nDividends have been paid semi-annually during 1994 and 1995, as follows:\nIn 1996 the Company will pay dividends on a quarterly basis.\nSHORT TERM BORROWINGS\nThe terms for short-term FHLB advances taken in 1995 ranged from 5 days to 200 days and averaged 49 days. The terms for wholesale repurchase agreements taken in 1995 ranged from 4 days to 90 days and averaged 24 days.\nThe terms for short-term FHLB advances taken in 1994 ranged from 14 days to 257 days and averaged 82 days. The terms for wholesale repurchase agreements taken in 1994 ranged from four days to 90 days and averaged 25 days.\nThe terms for short-term FHLB advances taken in 1993 ranged from 17 days to 260 days and averaged 82 days. The terms for wholesale repurchase agreements taken in 1993 ranged from 6 days to 140 days and averaged 31 days.\nThe following data represents selected year end financial information for the past five years. All information is unaudited. (In thousands, except per share data)\nSUPPLEMENTARY FINANCIAL DATA BY QUARTERS (In thousands except per share data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information contained in the section captioned Management s Discussion and Analysis of Financial Condition and Results of Operations in the Company s Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements required are contained on pages 10 through 25 of the Company s Annual Report for the year ended December 31, 1995 and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe following statements pertain to all individuals listed below:\n1. There are no arrangements or understandings between any director or officer listed below and any other person pursuant to which such director or officer was selected as an officer or director.\n2. There is no family relationship among any of the directors and officers listed below.\n3. None of the directors and officers listed below have been involved in any bankruptcy, criminal, or other proceeding set forth or described in sub-section (f) of Item 401 of Regulation S-K as promulgated by the Securities and Exchange Commission.\n4. Each of the directors listed below has been elected to a three year term, except where the mandatory retirement age of 75 years precluded an election of a shorter term, with one third of the Board of Directors, as nearly as may be, standing for election each year. Each director of the Company also serves as a director of the Bank, and references below to the year in which an individual was first elected refer to the year in which s\/he was first elected a director of the Bank.\n[1] Robert H. Avery. Director, Age 67. Mr. Avery is retired. He first was elected as a Director on November 2, 1965. He was elected as President and Chief Executive Officer of the Bank in 1971 and retired as of June 30, 1986. He currently serves as Director and Treasurer of the Bar Harbor Water Company.\n[2] Frederick F. Brown, Director, Age 69. Mr. Brown s principal occupation during the past five years has been as proprietor and owner of F. T. Brown Company, which owns and operates a hardware store in Northeast Harbor and as one-third owner of Island Plumbing & Heating in Northeast Harbor. He also serves as President of Northeast Harbor Water Company. Mr. Brown first was elected as a director on October 2, 1979.\n[3] Thomas A. Colwell, Director. Age 51. Mr. Colwell s principal occupation during the past five years has been as owner of Colwell Brothers, Inc. He also serves as a member of the Board of Directors of the Maine Lobster Pound Association. Mr. Colwell was first elected as a director on October 1, 1991.\n[4] Bernard K. Cough, Director, Age 68. Mr. Cough s principal occupation during the past five years has been owner\/operator of several motels, including the Atlantic Oakes Motel, Atlantic Eyrie Lodge, Inc., Brookside Motel, Bay View, Inc., and Ocean Gate, Inc. Mr. Cough is also Treasurer of Cough Bros., Inc. And President of Downeast Inns, Inc. Mr. Cough was first elected as a director on October 1, 1985.\n[5] Peter Dodge, Director, Age 52. Mr. Dodge is President of the Peter Dodge Agency (a Maine corporation) d\/b\/a the Merle B. Grindle Insurance Agency in Blue Hill, Maine. He is also Director and Treasurer of Coastal Holdings, Inc., Trustee of George Stevens Academy, and Director, Bagaduce Music Lending Library. He was first elected as a director on October 6, 1987.\n[6] Lawrence L. Dorr, Director, Age 74. Mr Dorr is retired. Prior to his retirement, Mr. Dorr was the principal stockholder and administrator of Oceanview Nursing Home, Inc. Of Lubec. Mr. Dorr first was elected as a director on October 2, 1973.\n[7] Dwight L. Eaton, Senior Vice President and Trust Officer, Age 60. Mr. Eaton s principal occupation during the past five years has been as Senior Vice President and Trust Officer of Bar Harbor Banking and Trust Company. He serves as Chairman and Director of the Acadia Corporation. Mr. Eaton first was elected as a Director on October 4, 1988.\n[8] Ruth S. Foster, Director, Age 66. Mrs. Foster s principal occupation is the President and principal stockholder of Ruth Foster s, a children s clothing store in Ellsworth, Maine. Mrs. Foster first was elected as a director on October 7, 1986.\n[9] Robert L. Gilfillan, Chairman of the Board of Directors, Age 68. Mr. Gilfillan s principal occupation during the past five years has been as the owner and President of the West End Drug Company in Bar Harbor. Mr. Gilfillan first was elected as a director on November 5, 1957.\n[10] Sheldon F. Goldthwait, Jr., President and Chief Executive Officer, Age 57. He was appointed President and Chief Executive Officer of Bar Harbor Banking and Trust Company January 1, 1995. Prior to that he served as Executive Vice President of Bar Harbor Banking and Trust Company. He serves as Treasurer and Director of the Acadia Corporation. Mr. Goldthwait first was elected as a director on October 4, 1988.\n[11] James C. MacLeod, Director, Age 71. Mr. MacLeod is retired. Mr. MacLeod served as Vice President of the Bank until his retirement in December of 1987. He was appointed as a Vice president of the Bank in 1972 and was first elected as a director of the Bank on November 7, 1961.\n[12] John P. McCurdy, Director, Age 64. Prior to his retirement in 1991. Mr. McCurdy s principal occupation was the owner and operator of McCurdy Fish Company of Lubec, a processor of smoked herring. Mr. McCurdy first was elected as a director on October 2, 1979.\n[13] Jarvis W. Newman, Director, Age 60. Mr. Newman is the owner of Newman Marine, a boat brokerage in Southwest Harbor. Mr. Newman first was elected as a Director on October 5, 1971.\n[14] Robert M. Phillips, Director, Age 54. Mr. Phillips is Vice President and Chief Operating Officer of Jasper Wyman and Son (blueberry processors), Milbridge, Maine. He was first elected as a director on October 5, 1993.\n[15] John P. Reeves. Director, Age 61. Mr. Reeves is retired. He was elected as President and Chief Executive Officer of Bar Harbor Banking and Trust Company in 1986 and retired in 1994. He first was elected as a director on October 6, 1970.\n[16] Abner L. Sargent, Director, Age 71. Mr. Sargent is former owner and designated broker of High Street Real Estate and Vice President and Treasurer of Sargent s Mobile Homes, Inc., of Ellsworth. He first was elected as a director on October 6, 1981.\n[17] Lynda Z. Tyson, Director, Age 40. Mrs. Tyson is Chief Operating Officer and Marketing Director of Tyson & Partners, Inc., a marketing communications consulting firm in Bar Harbor. Mrs. Tyson was first elected as a director on October 5, 1993.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nOfficers of the Company do not, as such, receive compensation. The following table sets forth cash compensation received during the Bank s last fiscal year by the executive officers for whom such compensation exceeded $100,000.\nThe Bank has an incentive plan in which all employees who were on the payroll as of January 1st of a calendar year and who worked through December 31st are eligible. The computation is based on earnings per share growing by 10% each year with 1992 being the base year. Once the 10% growth is attained, a pool is created in which all eligible employees receive the same percentage of their salary in the form of an incentive payment.\nCOMPENSATION OF DIRECTORS\nEach of the directors of the Company is a director of the Bank and as such receives a fee of $250.00 for each meeting attended. The fee paid for the Annual Meeting is $500.00 per member of the Board of Directors. Meetings of the Board of Directors of the Bank are held monthly. No directors fees are paid to the directors of the Company as such. Those directors of the Bank who are also officers do not receive directors fees.\nEMPLOYEE BENEFIT PLANS\nEffective August 31, 1993, the Board of Directors ratified the termination of the Company s noncontributory defined benefit pension plan, which covered all eligible employees.\nAt December 31, 1994, the plan s projected benefit obligation was essentially equivalent to the plan s net assets available for benefits of approximately $2,150,000, and such assets were invested in U.S. Government obligations and cash equivalents. The settlement of the vested benefit obligation by the purchase of nonparticipating annuity contracts for, or the lump sum payments to, each covered employee was completed in 1994, upon receipt of certain regulatory approvals. The Company recognized no curtailment gain or loss in 1993 as a result of the plan termination and no gain or loss was recognized when the plan s benefit obligation was settled in 1994.\nPrior to the plan termination, pension benefits were based on years of service, and the Company s policy was to fund, at a minimum, the amount required under the Employee Retirement Income Security Act of 1974. Net pension income of $51,000 in 1993 has been included in operating results. The weighted average discount rate and increase in salary levels used in determining the projected benefit obligation were 8% in 1993. The expected long-term rate of return on assets was 9%.\nThe Bank offers a 401(k) plan to all employees who have completed one year of service and who have attained the age of 21. Employees may elect to defer from 1% to 15% of their salaries subject to a maximum amount determined by a formula annually, which amount was $9,240 in 1994 and 1995. In 1995, the bank matched employee contributions to the 401(k) plan to the extend of 25% of the first 6% of salary for a total of contribution by the bank of $46,637. The bank match for 1994 and 1993 was $42,590 and $37,195, respectively. On December 31, 1995, the Company contributed to each participating employee an additional 3% of the employee s salary, which represented a non-contributory plan replacing the Bank s contribution to the former defined benefit plan. The total contribution made for the non-contributory plan was $122,486. This non-contributory\nplan was established in 1994 with a contribution made by the Bank totalling $113,432. Any future contributions by the bank will be determined annually by the vote of the Board of Directors.\nIn 1995 and 1994, the Bank provided a restricted stock purchase plan through which each employee having one year of service may purchase up to 100 shares of Bar Harbor Bankshares stock at the current fair market price as of a date determined by the Board of Directors. These shares may be purchased through a direct purchase or through the employees 401(k) accounts.\nAt December 31, 1995, employees exercised their right to purchase 4,632 shares at $28.00 per share, with the actual purchase transpiring in January of 1996. At December 31, 1994, employees exercised their right to purchase 3,770 shares at $16.40 per share, with the actual purchase transpiring in January of 1995.\nThe Bank provides certain of its officers with individual memberships in local civic organizations and clubs. The aggregate value of these benefits with respect to any individual officer did not exceed $5,000 during the Bank s last fiscal year.\nThe Bank has entered into agreements with Messrs: Avery, Reeves, Goldthwait, and Eaton whereby those individuals or their beneficiaries will receive upon death or retirement an annual supplemental pension benefit over a period of 10 years in the amount of $15,000 (in the case of Messrs. Avery and Reeves) and in the amount of $10,000 (in the case of Messrs. Goldthwait and Eaton). This plan is unfunded and benefits will be paid out of Bank earnings. As of January 1, 1987, Mr. Avery began drawing his annual installment of $15,000 pursuant to this deferred compensation arrangement. Mr. Reeves began drawing his annual installment of $5,300.04 (reduced for early retirement) as of January 1, 1995.\nIn 1993, the Company established a non-qualified supplemental retirement plan for Messrs. Reeves, Eaton, Goldthwait and MacDonald. The agreements provide supplemental retirement benefits payable in installments over twenty years upon retirement or death. The Company recognizes the costs associated with the agreements over the service lives of the participating officers. The cost relative to the supplemental plan was $98,273, $368,898, and $181,415 for 1995, 1994, and 1993 respectively. The agreements with Messrs. Reeves, Eaton, Goldthwait and MacDonald are in the amounts of $49,020, $22,600, $37,400 and $7,700 respectively. Mr Reeves began drawing his annual installment of $49,020 as of January 1, 1995.\nOfficers of the Bank are entitled to participate in certain group insurance benefits. In accordance with Bank policy, all such benefits are available generally to employees of the Bank.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of December 31, 1995, to the knowledge of the Company, there are not any beneficial owners of more than five percent of the Company s common stock.\nThe following table lists, as of December 31, 1995, the number of shares of Common Stock and the percentage of the Common Stock represented thereby, beneficially owned by each director and nominee for director, and by all principal officers and directors of the Company as a group.\nFor purposes of this table, beneficial ownership has been determined in accordance with the provisions of Rule 13-d-3 promulgated under the Securities Exchange Act of 1934 as amended. Direct beneficial ownership includes shares held outright or jointly with others. Indirect beneficial ownership includes shares held in the same name of a director s spouse or minor children or in trust for the benefit of a director or member of his or her family. Indirect beneficial ownership does not include, in the case of each director, one seventeenth (2,864 shares) of the 48,680 shares (2.84%) of the Common Stock held by two trusts which shares, for purposes of voting, are allocated equally among the directors of the bank under the terms of the respective trust instruments. No director has any other\nbeneficial interest in such shares. Ownership figures for directors and nominees include directors qualifying shares owned by each person named.\nManagement is not aware of any arrangement which could, at a subsequent date, result in a change in control of the company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Bank retains the firm of Tyson & Partners, Inc. to assist with its marketing program. Lynda Z. Tyson, who was elected to the Board of the Company and the Bank on October 4, 1993, serves as that firm s Chief Operating Officer as well as Director of Marketing. Management believes that the fees charged by Tyson & Partners, Inc. are at least as favorable as any which could have been obtained from persons not affiliated with the Bank.\nThe Bank has had, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal stockholders and their associates upon substantially the same terms, including interest rates and collateral on the loans, as those prevailing at the same time for comparable transactions with others. Such loans have not and will not involve more than normal risk of collectibility or present other unfavorable features.\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 by reference from Item 8 hereof: [Annual Report to Stockholders included herein as Exhibit 13].","section_15":""}
{"filename":"311505_1995.txt","cik":"311505","year":"1995","section_1":"ITEM 1. BUSINESS\nCertain geographic information for Item 1 is contained in the Company's 1995 Annual Report to Stockholders on page 16, which information is incorporated herein by reference (and except for that page, the Company's Annual Report to Stockholders for the fiscal year ended March 31, 1995 is not deemed filed as part of this report).\nGENERAL\nPrintronix, Inc. designs, manufactures, and markets medium and high speed printers which support a wide range of computer systems and software platforms. Printronix printers produce \"hard copy\" through the application of impact printing and non-impact printing technologies. The Company's product line is designed primarily for business and industrial applications, quickly and reliably producing every type of printed computer output, from reports and graphics to bar code labels. The Company also produces and markets the Intelligent Graphics Printing which resides in the printer, enabling it to produce bar codes, forms, and logos.\nPrintronix, Inc. was incorporated in California in 1974 and was reincorporated in Delaware in December 1986. Unless the context otherwise requires, the terms \"Company\" and \"Printronix\" refer to Printronix, Inc. and its consolidated subsidiaries.\nCOMPUTER PRINTERS\nComputer printers are output devices that use electromechanical techniques to convert digitized information sent from a host computer to printed form. The printed output produced can then be read by humans and\/or machines, depending upon the format of the output. Such devices can print on paper and other substances, such as card stock or mylar, by means of impact or non-impact technologies.\nImpact printers are generally classified as being either text or graphics printers and as either serial or line printers. Text printers generally print a predetermined set of fully formed characters. Graphics printers, also referred to as All Points Addressable (APA), can place dots anywhere on the paper and are used for text and graphics applications. Serial printers print one character at a time and line printers print one line at a time. Most serial printers produced today are serial matrix printers, which use serial graphics technology to print text one character at a time. Higher speed line printers, that also print fully formed characters, use high speed mechanical devices, such as metal bands, upon which alphanumeric characters are embossed. With these devices, a hammer presses the paper and ribbon against the proper character when the band moves past the appropriate print location. Band printers and line matrix printers are examples of line printers.\nMatrix printers form characters by printing dots in combinations of patterns. Most manufacturers who use the matrix technique produce serial matrix printers, which create characters one at a time in horizontal sweeps across the page. Printronix manufactures line matrix printers. The Company's line matrix printers print a complete line of dots at a time, thus combining the flexibility of the matrix technique with the reliability and durability of a line printer.\nNon-impact printers print on paper by means of thermal, electrostatic, inkjet, laser, LED, and other techniques that deliver high resolution printed output for letter quality and graphics applications.\nTECHNOLOGY\nThe current Printronix product line encompasses impact line matrix printers, and three non-impact printer technologies: laser printers, LED printers, and thermal printers. The Company's line matrix printers are designed for heavy duty cycle, medium and high speed printing and plotting; Printronix laser, LED and thermal printers offer medium speed, high quality text and graphics printing.\nPrintronix line matrix printers electromechanically create an image on paper in a manner similar to the \"raster scan\" method by which a television creates a picture on its screen. The printers utilize small leaf-spring ham-\nmers and electromagnetic coils combined in a row or \"bank\" of hammers. When at rest, the hammers are held retracted by a permanent magnet; this \"stored energy\" is selectively released by electrical pulses passing through the coils.\nPrintronix line matrix printer models operate between 200 and 1200 lines per minute as summarized below. Printing is accomplished as the hammer bank shuttles a small distance back and forth, enabling the hammers to place dots anywhere along a row across the paper. Successive dot rows are produced by the paper advancing while the hammer bank reverses for printing the next dot row. Dots overlap horizontally and vertically to produce graphics as well as alphanumeric characters.\nThe dot placement of Printronix line matrix printers is very precise, permitting accurate character alignment. The combination of precise dot placement anywhere on the page and the use of overlapping dots rather than fully formed characters enables Printronix printers, under computer control, to produce graphic output. Another key feature of the line matrix technology is that hammer energy is optimized to print dots only, resulting in improved print quality on multi-part forms.\nThe Company's non-impact page printers create images on paper electrographically. Laser printers direct a laser beam onto a drum by means of a rotating mirror; LED array printers use fixed, light emitting diodes (LEDs) to image each dot position onto a belt. Both processes are facilitated by an electronic controller which provides intelligence to the printer by converting data sent from the host computer system into a raster image. The image is subsequently fixed to the paper with toner in the same manner as copiers. The intelligent controllers that are designed by the Company are integrated with print engines purchased from outside suppliers.\nThe Company's thermal printer creates an image on paper by heating thermal sensitive media. The image is created either by heating an ink based ribbon which transfers its ink to the paper label material or by heating paper label material in which the thermally sensitive ink is already impregnated. This type of printer is especially useful in \"on-demand\" label applications. As in the case of the Company's other non-impact printers, this process is facilitated by an electronic controller which provides intelligence to the printer by converting data sent from the host computer system into a raster image. The same intelligent controllers, designed by the Company and also used on its page printers, are integrated with a print engine purchased from an outside supplier.\nPRODUCTS\nLine matrix printer models include the P4000 Series with speeds up to 800 lines per minute; the P9000 Series with speeds up to 1200 lines per minute; the P6000L Series with speeds up to 800 lines per minute; the P3000 Series with speeds up to 400 lines per minute; and the MVP Series with speeds up to 200 lines per minute. Applications for line matrix printers include reports, multi-part forms, electronic forms generation, bar code labels and program listings.\nThe L5031 Multifunction Page Printer is an LED Printer that prints continuous forms at 31 pages per minute, A-Size, and cut sheet applications at 25 pages per minute. The L5031 has a unique Xenon flash fusing process which produces output of exceptionally high quality. It can handle continuous forms up to 12\" x 16\" and cut sheet stock up to 11\" x 17\" and has a duty cycle of 200,000 pages per month. The LED array imaging of the L5031 provides precise 300x300 dot-per-inch resolution. Both 400x400 or 240x240 dot-per-inch resolutions are available as options.\nThe L1016 Continuous Form Laser Printer combines 300 x 300 dot-per-inch resolution with the convenience and data integrity of continuous form operation. Printing at 16 pages per minute, the L1016 supports a variety of emulations, including bar code label, text and forms applications. A built-in disk drive makes it easy to load emulations, fonts, and upgrades. The L1024 is a 24 page per minute version.\nThe T1006 Thermal Printer operates at a speed of 6 inches per second, has a resolution of 203 dots-per-inch, and has a wide throat design to accommodate media up to 6.7 inches wide. Supporting both direct thermal and thermal transfer printing, the T1006 can print in either batch or on-demand mode. The T1006 serves a wide variety of label printing needs. A built-in disk drive makes it easy to load emulations, fonts, and upgrades.\nAll of the Company's printers are supported by the Intelligent Graphics Printing (IGP trademark) Series. This graphics productivity tool enables users to generate on-line forms, bar codes, logos, expanded\/compressed text, and reversed and rotated print. IGPs are available with either Printronix Graphics Language or QMS Code V trademark protocols.\nMARKETING AND CUSTOMERS\nThe market for the Company's products is related to the market for computer systems. Printronix printers are marketed worldwide directly to original equipment manufacturers (OEMs) and to end users through a network of full-service distributors and resellers.\nThe Company's 10 largest customers accounted for an aggregate of approximately 66, 57, and 51 percent of net sales during the fiscal years ended March 1995, 1994, and 1993, respectively. During fiscal 1995, the Company sold its products to OEMs and full-service distributors\/resellers, which accounted for approximately 47 percent and 48 percent of net sales, respectively. In addition, the Company sold consumables to end users, accounting for approximately 5 percent of fiscal 1995 net sales.\nIn fiscal 1995, the Company had two customers which individually represented greater than 10 percent of consolidated net sales. Sales to the largest customer, IBM, represented 28.8 percent and 10.7 percent of net sales for fiscal years 1995 and 1994, respectively. No sales were made to the largest customer in fiscal 1993. On a geographic basis, fiscal 1995 sales to the largest customer represented 30.2 percent of domestic net sales and 26.6 percent of international net sales. A significant decline in sales to our largest customer could have an adverse effect on the Company's operations. Sales to the second largest customer represented 10.5 percent, 14.6 percent and 13.7 percent of consolidated net sales for fiscal years 1995, 1994, and 1993, respectively.\nCOMPETITION\nThe Company has a wide range of printers that compete in the overall market for medium and high speed computer printers. The overall market includes serial, line matrix, band and non-impact printers. This overall market includes a large captive market which consists of computer systems manufacturers that produce their own printers and in the past have not bought from independent printer manufacturers. Due to the increasing competitive nature and the level of investment now required for ongoing printer development, more of these OEMs are now either buying or considering buying from independent manufacturers. The Company competes on a direct basis with several companies of varying sizes, including some of the largest businesses in the United States and Japan, in the non-captive market. Competing products include high end serial printers, medium and high speed line printers, laser printers, thermal printers, and other non-impact technologies.\nCompetitive factors in the Company's markets include reliability, durability, price, print quality, versatility of special performance features, and after sales support. The Company believes that its printers are highly competitive with regard to price\/performance and cost of ownership, and that the Company rates highly in after sales support.\nThe Company has periodically evaluated other printing technologies and intends to continue to do so. Introduction of products with superior performance or substantially lower prices could adversely affect the Company's business.\nORDER BACKLOG\nThe Company's order backlog at March 31, 1995 was approximately $17,559,000, compared with approximately $18,533,000 at March 25, 1994 and $11,258,000 at March 24, 1993. During fiscal 1995, the Company's improved product availability, achieved through reductions in the required time to build printers and faster response time on customer orders, resulted in a decline in the customers' lead time on product orders. The order backlog represents orders for which a delivery date within six months has been specified by the customer and the Company expects to ship within six months.\nRAW MATERIALS\nThe Company purchases basic mechanical and standard electronic components from numerous outside vendors. Most of those components used in the Company's impact printers are immediately available from alternate sources. The Company also purchases certain components from sole sources and has no reason to believe that it will be unable to obtain those components. However, if the Company were to lose any sole source for a component there could be a delay in shipment of printers using those components until an alternate source begins production. The Company's non-impact printer products are designed to use specific print engines manufactured by outside vendors. The Company has entered into written purchase agreements for each of the printer engines and has no reason to believe that it will be unable to obtain the engines it requires.\nENGINEERING AND DEVELOPMENT\nThe Company operates in an industry which is subject to rapid technological change, and its ability to compete successfully depends upon, among other things, its ability to react to change. Accordingly, the Company is committed to the development of new products. During fiscal 1995, 1994, and 1993, its engineering and development expenditures incurred were approximately $12,666,000, $10,201,000, and $10,186,000, respectively. Substantially all expenditures were Company sponsored. A substantial portion of engineering and development expenditures were associated with the continued development of lower cost line matrix printers, software and hardware development of the Printronix System Architecture for both non-impact printers and line matrix printers.\nNew products under development in fiscal 1995 included the following: (1) higher performance and lower cost fourth generation (P4200) line matrix printers with twinax, coax, and IPDS emulation capabilities; (2) customized versions of standard model printers for major OEM customers; and (3) non-impact printers including the L1024 and the L5031 with IBM, IPDS, IGP, and HP PCL 5 emulation capabilities.\nPATENTS AND LICENSES\nThe Company has been issued 40 United States patents, and related foreign patents (primarily in Canada, the United Kingdom, France and Germany) associated with various aspects of its printers. None of these patents will expire before 1996. The Company believes that its patented line dot matrix printing technology has competitive value and intends to continue its practice of enforcing its patent rights against potential infringers where it deems appropriate. Although there can be no assurance that the Company will be successful in defending its rights to any of its patents, the Company believes that its patents are valid.\nThe Company has no material licenses from others pertaining to the manufacture of its products, including those under development, and believes that none are currently required. The Company believes that, based on industry practice, any such licenses as might be required in the future could be obtained on terms which would not have a material effect on it. However, the Company does have licenses for the use of IPDS, POSTSCRIPT and PCL5 graphic languages.\nThe Company previously entered into a limited number of agreements granting others certain rights to manufacture printers using one or more of the Company's patents. The final agreement expired in March 1993 and the Company did not earn any royalty income in fiscal 1995 or 1994.\nIGP is a trademark of Printronix, Inc. PCL 5 is a trademark of Hewlett-Packard Corporation. IPDS is a registered trademark of International Business Machines Corporation. Code V is a trademark of QMS, Inc.\nEMPLOYEES\nThe Company had approximately 880 employees as of March 31, 1995 including 486 in the United States, 342 in Singapore and 52 in Europe.\nNone of the Company's employees in North America or Singapore is subject to a collective bargaining agreement. Printronix Nederland BV is a member of the Employers Union F.M.E., and some of its 41 employees have elected to become members of an employee union. This employee union is not government sponsored and is supported by contributions from its members. The Company believes that its relationship with its employees is good.\nFOREIGN OPERATIONS\nThe Company has manufacturing facilities in Singapore, wherein line matrix printer products and some printed circuit board assemblies are produced. In The Netherlands, the Company has a facility that provides assembly of selected models of impact and non-impact printers, product support and customer service, and product distribution. Foreign sales, including exports from the United States, represented approximately 38 percent, 38 percent, and 35 percent of the Company's total sales in fiscal years 1995, 1994, and 1993, respectively. The Company has sales offices within Germany, France, the United Kingdom and Singapore. The Company is not aware of any significant risks with respect to its foreign business other than those inherent in the competitive nature of the business and fluctuations in foreign currency exchange rates. Selected financial information regarding foreign and export sales by geographic area is set forth in Note 4 of Notes to Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive, manufacturing, engineering, administrative and marketing offices are located in a total of approximately 169,000 square feet of leased facilities in Irvine, California.\nThe Company's foreign operations are located in The Netherlands and Singapore in leased facilities of 41,000 and 79,000 square feet, respectively. The Company also leases several small offices, generally on short-term leases, throughout the United States and Europe for sales or service. The Company has certain idle facilities of approximately 7,500 square feet in The Netherlands. See Note 2 of Notes to Consolidated Financial Statements for a summary of the expiration dates and lease or rental commitments.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nENVIRONMENTAL ASSESSMENT\nIn January 1994, the Company was notified by the California Regional Water Quality Control Board - Santa Ana Region (the \"Board\") that groundwater monitoring reports indicate that the groundwater under one of the Company's former production plants is contaminated with various chlorinated volatile organic compounds (VOCs).\nEvidence adduced from site studies undertaken to date indicate that compounds containing the VOCs were not used by the Company during its tenancy, but were used by the prior tenant during its long-term occupancy of the site. The tests also indicate that the composition of the soil is such that off-site migration of contamination is very slow and contamination is most likely confined to the site. Accordingly, the Board is presently devoting its attention to the predecessor occupant of the site. Investigation indicates that the prior occupant is a well established business enterprise which has substantial assets and is affiliated with a publicly traded company.\nBecause of the focus of the Board's investigation, there are no further orders outstanding against the Company. Therefore, there are no recurring costs, capital expenditures or other mandated expenditures. As of March 31, 1995, the Company has reserved $214,000 which is expected to be more than adequate to cover further legal fees or any additional expenses related to environmental tests, which could be requested by the Board, at the site. To date, the Company has incurred only minimal expense in its initial response to the Board's request for information and for environmental testing. However, the Company could be subject to charges related to remediation of the site. These charges on a preliminary (and very general) basis, could be estimated as follows:\nRemediation involves a two-step procedure. The first step would include the installation of a soil vapor extraction system. The cost of installation could range from $50,000 to $100,000. There would also be annual operating costs of up to $50,000 for a period of several years. The second step would be the installation of a pump and water treatment system to cleanse the groundwater. The cost of installation would range from $100,000 to $200,000. The annual operating costs would range up to $100,000 for a period which cannot now be ascertained.\nThe Company is convinced that it bears no responsibility for any contamination at the site and intends to vigorously defend any action which might be brought against it in respect thereto. Furthermore, the Company believes it has adequately accrued for any future expenditures in connection with further legal fees or additional environmental tests that could be requested by the Board at the site, and that such expenditures will not have a materially adverse effect on its financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not submit any matter during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company and their ages as of May 12, 1995 are as follows:\nOfficers are appointed by and hold office at the pleasure of the Board of Directors.\nMr. Kleist is one of the founders of the Company and has served as a director and its President and Chief Executive Officer since its formation in 1974. In addition, Mr. Kleist served as Chief Financial Officer from February 1987 to October 1988, a position he also held from August 1985 until January 1986. Mr. Kleist is a director of Seagate Technology, a manufacturer of computer memory disk drives.\nDr. Belt joined the Company in December 1985 as Vice President, Engineering, Line Matrix Division. In February 1987, he was appointed Senior Vice President, Engineering and Chief Technical Officer. Dr. Belt was appointed to the additional position of Assistant Corporate Secretary in August 1989. From October 1984 to December 1985, Dr. Belt was Manager of Engineering, Large Communication Systems Division of Rolm Corp. From December 1979 to October 1984, he was Manager of Engineering, Schlumberger Sentry. In prior years, Dr. Belt has held engineering management positions at General Electric Co. and Pertec Computer Corp. He was also a founder and Engineering Vice President of Courier Terminal Systems in 1969.\nMr. Harwood joined the Company in October 1988 as Senior Vice President, Finance and Chief Financial Officer. Mr. Harwood was appointed to the additional office of Corporate Secretary in January 1989. In October 1994, Mr. Harwood assumed responsibility for the Company's Management Information Systems. From December 1984 to October 1988, Mr. Harwood was Chief Financial Officer and Vice President, Finance at Qume Corporation. From December 1982 to December 1984, Mr. Harwood was Group Controller of ITT Automotive Products, Worldwide. In prior years, Mr. Harwood has held various senior financial positions at ITT in Brussels, London and Zambia. Mr. Harwood is a Fellow of the Institute of Chartered Accountants in England and has had seven years of public accounting experience, primarily at Price Waterhouse.\nMr. Fitzsimmons joined the Company in September 1985 as Director of Management Information Systems. In December 1988, he was appointed Vice President, Management Information Systems. In May 1990, Mr. Fitzsimmons assumed responsibility for Printronix B.V., the Company's Netherlands subsidiary. Mr. Fitzsimmons was appointed to the additional office of Vice President, Irvine Manufacturing in October 1990. In July 1991, he assumed responsibility for Printronix A.G., the Company's Singapore subsidiary. From May 1992 to October 1994 Mr. Fitzsimmons was Senior Vice President, Manufacturing and Management Information Systems. In October 1994, he was appointed Senior Vice President, Worldwide Manufacturing. From September 1979 to September 1985, Mr. Fitzsimmons held various senior MIS positions at Magnavox Government and Industrial Electronics Company.\nMr. Steele joined the Company in July 1991 as Senior Vice President, Sales and Marketing. From May 1990 to June 1991, Mr. Steele was Senior Vice President, Sales and Marketing at DataWare. From May 1989 to May 1990, Mr. Steele was Vice President, Sales and Marketing at Talaris. From April 1972 to January 1987, Mr. Steele held various positions including District Sales Manager, National Sales Manager and Vice President, Sales and Marketing\nat Datagraphix. In January 1987, Datagraphix became Anacomp, Inc. and Mr. Steele was appointed Senior Vice President, Sales and Marketing, a position he held until October 1988. In prior years, Mr. Steele held various positions in sales management and systems engineering at IBM.\nPART II\nInformation for Items 5, 6, 7 and 8 is contained in the Company's 1995 Annual Report to Stockholders on the following pages, which information is incorporated herein by reference (and except for these pages, the Company's Annual Report to Stockholders for the fiscal year ended March 31, 1995 is not deemed filed as part of this report):\nITEM 9.","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE\nPART III\nInformation required under Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12 \"Security Ownership of Certain Beneficial Owners and Management,\" and Item 13","section_13":"Item 13 \"Certain Relationships and Related Transactions\" has been omitted from this report. Such information is hereby incorporated by reference from Printronix' Proxy Statement for its Annual Meeting of Stockholders to be held on August 15, 1995, which the Company intends to file with the Securities and Exchange Commission not later than July 11 , 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Index to Financial Statements\nAll schedules except Schedule II have been omitted for the reason that the required information is shown in financial statements or notes thereto, the amounts involved are not significant or the schedules are not applicable.\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\nReference is made to the Index of Exhibits beginning at page 14 of this report, which index is incorporated herein by reference.\n(d) Other Financial Statements There are no financial statements required to be filed by Regulation S-X which are excluded from the annual report to stockholders by Rule 14a-3(b)(1).\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Printronix, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Printronix, Inc.'s annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated April 26, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index is presented for purposes of complying with the Securities and Exchange Commission 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\nOrange County, California April 26, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: June 28, 1995\nPRINTRONIX, INC. BY ROBERT A. KLEIST ------------------------ Robert A. Kleist, 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.\nPRINTRONIX, INC. AND SUBSIDIARIES\n--------------\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED MARCH 31, 1995\nDESCRIPTIONS OF OTHER ADDITIONS AND DEDUCTIONS:\nA - Expenses incurred in providing warranty services\nB - Write-off of bad debt\nINDEX OF EXHIBITS\nEXHIBIT NUMBER DESCRIPTION - -------------- ----------- 3.1 Certificate of Incorporation of Printronix, Inc. (incorporated by reference to Exhibit 3.1 to the Company's Report on Form 10-K for the fiscal year ended March 27, 1987).\n3.2 By-laws of Printronix, Inc. currently in effect (incorporated by reference to Exhibit 3.2 to the Company's Report on Form 10-K for fiscal year ended March 31, 1989).\n4.1 Copies of certain instruments, which in accordance with paragraph (b)(4)(iii) of Item 601 of Regulation S-K are not required to be filed as exhibits to Form 10-K, have not been filed by Printronix. Printronix agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.\n4.2 Common Shares Rights Agreement dated as of March 17, 1989 between Printronix, Inc. and Chemical Trust Company of California, including the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A and B, respectively (incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A filed on or about March 17, 1989).\n4.3 Corporate Guarantee for Tat Lee Bank Limited dated April 12, 1995.\n10.1 Printronix, Inc. 1980 Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibits 4.1 and 4.2 to Post-Effective Amendment No. 5 to Registration Statement No. 2-70035 on Form S-8).\n10.2 Printronix, Inc. 1984 Stock Incentive Plan, as amended (incorporated by reference to Exhibits 4.3 and 4.4 to Registration Statement No. 33-14288 on Form S-8).\n10.3 Form of Indemnification Agreement between Printronix, Inc. and its directors (incorporated by reference to Exhibit 10.4 to the Company's Report on Form 10-K for the fiscal year ended March 27, 1987).\n10.4 Printronix, Inc. Executive Health Insurance Plan (incorporated by reference to Exhibit 10.5 to the Company's Report on Form 10-K for the fiscal year ended March 29, 1985).\n10.5 Restricted Stock Purchase Agreement dated July 6, 1990 between the Company and Robert A. Kleist (incorporated by reference to Exhibit 10.7 to the Company's Report on Form 10-K for the fiscal year ended March 29, 1991).\n10.6 Restricted Stock Purchase Agreement dated July 6, 1990 between the Company and J. Edward Belt (incorporated by reference to Exhibit 10.8 to the Company's Report on Form 10-K for the fiscal year ended March 29, 1991).\n10.7 Restricted Stock Purchase Agreement dated July 6, 1990 between the Company and George L. Harwood (incorporated by reference to Exhibit 10.9 to the Company's Report on Form 10-K for the fiscal year ended March 29, 1991).\n10.8 Restricted Stock Purchase Agreement dated May 7, 1992 between the Company and C. Victor Fitzsimmons (incorporated by reference to Exhibit 10.10 to the Company's Report on Form 10-K for the fiscal year ended March 27, 1992).\nINDEX OF EXHIBITS (continued)\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n10.9 Restricted Stock Purchase Agreement dated May 7, 1992 between the Company and Richard A. Steele (incorporated by reference to Exhibit 10.11 to the Company's Report on Form 10-K for the fiscal year ended March 27, 1992).\n10.10 Printronix, Inc. 1994 Stock Incentive Plan (incorporated by reference to Exhibit 10.10 to the Company's Report on Form 10-K for the fiscal year ended March 25, 1994).\n13 The Company's Annual Report to Stockholders for the fiscal year ended March 25, 1994, (with the exception of the information incorporated by reference into Items 5, 6, 7 and 8 of this report, the Annual Report to Stockholders is not deemed to be filed as part of this report).\n21 List of Printronix' subsidiaries.\n23 Consent of Independent Public Accountants, Arthur Andersen LLP, to the incorporation of their reports herein to Registration Statement Nos. 2-70035, 33-14288 and 33-83156.\n27 Financial Data Schedule (\"This schedule contains summary financial information extracted from the Company's Annual Report for the fiscal year ended March 31, 1995 and is qualified in its entirety by reference to such financial statements.\")","section_15":""}
{"filename":"77543_1995.txt","cik":"77543","year":"1995","section_1":"ITEM 1. BUSINESS - ------------------\nGeneral - -------\nPerini Corporation and its subsidiaries (the \"Company\" unless the context indicates otherwise) is engaged in two principal businesses: construction and real estate development. The Company was incorporated in 1918 as a successor to businesses which had been engaged in providing construction services since 1894.\nThe Company provides general contracting, construction management and design-build services to private clients and public agencies throughout the United States and selected overseas locations. Historically, the Company's construction business involved four types of operations: civil and environmental (\"heavy\"), building, international and pipeline. However, the Company sold its pipeline construction business in January, 1993.\nThe Company's real estate development operations are conducted by Perini Land & Development Company, a wholly-owned subsidiary with extensive development interests concentrated in historically attractive markets in the United States - Arizona, California, Florida, Georgia and Massachusetts, but has not commenced the development of any new real estate projects since 1990.\nBecause the Company's results consist in part of a limited number of large transactions in both construction and real estate, results in any given fiscal quarter can vary depending on the timing of transactions and the profitability of the projects being reported. As a consequence, quarterly results may reflect such variations.\nIn 1988, the Company, in conjunction with two other companies, formed a new entity called Perland Environmental Technologies, Inc. (\"Perland\"). Perland provides consulting, engineering and construction services primarily on a turn-key basis for hazardous material management and clean-up to both private clients and public agencies nationwide. The Company's investment in Perland was increased from 47 1\/2% to 100% in recent years as a result of Perland repurchasing its stock owned by the outside investors. During 1995, Perland's name was changed to Perini Environmental Services, Inc.\nIn January 1993, the Company sold its 74%-ownership in Majestic, its Canadian pipeline construction subsidiary, for $31.7 million which resulted in an after tax gain of approximately $1.0 million.\nAlthough Majestic was profitable in both 1992 and 1991, it participated in a sector of the construction business that was not directly related to the Company's core construction operations. The sale of Majestic served to generate liquid assets which improved the Company's financial condition without affecting its core construction business.\nEffective July 1, 1993, the Company acquired Gust K. Newberg Construction Co.'s (\"Newberg\") interest in certain construction projects and related equipment. The purchase price for the acquisition was (i) approximately $3 million in cash for the equipment paid by a third party leasing company which, in turn, simultaneously entered into an operating lease agreement with the Company for the use of said equipment, (ii) $1 million in cash paid by the Company and (iii) 50% of the aggregate net profits earned from each project from April 1, 1993 through December 31, 1994 and, with regard to one project, through December 31, 1995. This acquisition has been accounted for as a purchase.\n- 2 -\nInformation on lines of business and foreign business is included under the following captions of this Annual Report on Form 10-K for the year ended December 31, 1995.\nAnnual Report On Form 10-K Caption Page Number ------- ----------- Selected Consolidated Financial Information Page 15 Management's Discussion and Analysis Page 16 Footnote 13 to the Consolidated Financial Statements, entitled Business Segments and Foreign Operations Page 40\nWhile the \"Selected Consolidated Financial Information\" presents certain lines of business information for purposes of consistency of presentation for the five years ended December 31, 1995, additional information (business segment and foreign operations) required by Statement of Financial Accounting Standards No. 14 for the three years ended December 31, 1995 is included in Note 13 to the Consolidated Financial Statements.\nA summary of revenues by product line for the three years ended December 31, 1995 is as follows:\nRevenues (in thousands) Year Ended December 31, ------------------------------------------------ 1995 1994 1993 ---- ---- ---- Construction: Building $ 770,427 $ 640,721 $ 762,451 Heavy 286,246 310,163 267,890 ---------- ---------- ---------- Total Construction Revenues $1,056,673 $ 950,884 $1,030,341 ---------- ---------- ----------\nReal Estate: Sales of Real Estate $ 10,738 $ 33,188 $ 40,053 Building Rentals 16,799 16,388 19,313 Interest Income 12,396 7,031 6,110 All Other 4,462 4,554 4,299 ---------- ---------- ---------- Total Real Estate Revenues $ 44,395 $ 61,161 $ 69,775 ---------- ---------- ----------\nTotal Revenues $1,101,068 $1,012,045 $1,100,116 ========== ========== ==========\nConstruction - ------------\nThe general contracting and construction management services provided by the Company consist of planning and scheduling the manpower, equipment, materials and subcontractors required for the timely completion of a project in accordance with the terms and specifications contained in a construction contract. The Company was engaged in over 160 construction projects in the United States and overseas during 1995. The Company has three principal construction operations: heavy, building, and international, having sold its Canadian pipeline construction business in January 1993. The Company also has a subsidiary engaged in hazardous waste remediation.\nThe heavy operation undertakes large civil construction projects throughout the United States, with current emphasis on major metropolitan areas such as Boston, New York City, Chicago and Los Angeles. The heavy operation performs construction and rehabilitation of highways, subways, tunnels, dams, bridges, airports, marine projects, piers and waste water treatment facilities. The Company has been active in heavy operations since 1894, and believes that it has particular expertise in large and complex projects. The Company believes that infrastructure\n- 3 -\nrehabilitation is and will continue to be a significant market in the 1990's.\nThe building operation provides its services through regional offices located in several metropolitan areas: Boston and Philadelphia, serving New England and the Mid-Atlantic area; Detroit and Chicago, operating in Michigan and the Midwest region; and Phoenix, Las Vegas, Los Angeles and San Francisco, serving Arizona, Nevada and California. In 1992, the Company combined its building operations into a new wholly-owned subsidiary, Perini Building Company, Inc. This new company combines substantial resources and expertise to better serve clients within the building construction market, and enhances Perini's name recognition in this market. The Company undertakes a broad range of building construction projects including health care, correctional facilities, sports complexes, hotels, casinos, residential, commercial, civic, cultural and educational facilities.\nThe international operation engages in both heavy and building construction services overseas, funded primarily in U.S. dollars by agencies of the United States government. In selected situations, it pursues private work internationally.\nConstruction Strategy ---------------------\nThe Company plans to continue to increase the amount of heavy construction work it performs because of the relatively higher margin opportunities available from such work. The Company believes the best opportunities for growth in the coming years are in the urban infrastructure market, particularly in Boston, metropolitan New York, Chicago, Los Angeles and other major cities where it has a significant presence, and in other large, complex projects. The Company's acquisition during 1993 of Chicago-based Newberg referred to above is consistent with this strategy. The Company's strategy in building construction is to maximize profit margins; to take advantage of certain market niches; and to expand into new markets compatible with its expertise. Internally, the Company plans to continue both to strengthen its management through management development and job rotation programs, and to improve efficiency through strict attention to the control of overhead expenses and implementation of improved project management systems. Finally, the Company continues to expand its expertise to assist public owners to develop necessary facilities through creative public\/private ventures.\nBacklog -------\nAs of December 31, 1995, the Company's construction backlog was $1.53 billion compared to backlogs of $1.54 billion and $1.24 billion as of December 31, 1994 and 1993, respectively.\nBacklog (in thousands) as of December 31, ------------------------------------------------------- 1995 1994 1993 ----------------- ----------------- ----------------- Northeast $ 749,017 49% $ 803,967 52% $ 552,035 45% Mid-Atlantic 179,324 12 26,408 2 34,695 3 Southeast 33,223 2 783 - 34,980 3 Midwest 325,055 21 293,168 19 143,961 12 Southwest 94,725 6 174,984 11 314,058 25 West 134,259 9 193,996 13 143,251 11 Other Foreign 18,919 1 45,473 3 15,161 1 ---------- ---- ---------- ---- ---------- --- Total $1,534,522 100% $1,538,779 100% $1,238,141 100% ========== ==== ========== ==== ========== ====\nThe Company includes a construction project in its backlog at such time as a contract is awarded or a firm letter of commitment is obtained. As a result, the backlog figures are firm, subject only to the cancellation provisions contained in the various contracts. The Company estimates that approximately $657 million of its backlog will not be completed in 1996.\nThe Company's backlog in the Northeast region of the United States remains strong because of its ability to meet the needs of the growing infrastructure construction and rehabilitation market in this region, particularly in the metropolitan Boston and New York City areas. The increase in the Midwest region primarily reflects an increase in building work in that area. Other fluctuations in backlog are viewed by management as transitory.\n- 4 -\nTypes of Contracts ------------------\nThe four general types of contracts in current use in the construction industry are:\no Fixed price contracts (\"FP\"), which include unit price contracts, usually transfer more risk to the contractor but offer the opportunity, under favorable circumstances, for greater profits. With the Company's increasing move into heavy and publicly bid building construction in response to current opportunities, the percentage of fixed price contracts continue to represent the major portion of the backlog.\no Cost-plus-fixed-fee contracts (\"CPFF\") which provide greater safety for the contractor from a financial standpoint but limit profits.\no Guaranteed maximum price contracts (\"GMP\") which provide for a cost-plus-fee arrangement up to a maximum agreed price. These contracts place risks on the contractor but may permit an opportunity for greater profits than cost-plus-fixed-fee contracts through sharing agreements with the client on any cost savings.\no Construction management contracts (\"CM\") under which a contractor agrees to manage a project for the owner for an agreed-upon fee which may be fixed or may vary based upon negotiated factors. The contractor generally provides services to supervise and coordinate the construction work on a project, but does not directly purchase contract materials, provide construction labor and equipment or enter into subcontracts.\nHistorically, a high percentage of company contracts have been of the fixed price type. Construction management contracts remain a relatively small percentage of company contracts. A summary of revenues and backlog by type of contract for the most recent three years follows:\nRevenues - Year Ended Backlog As Of December 31, December 31, - --------------------- -------------------- 1995 1994 1993 1995 1994 1993 - ---- ---- ---- ---- ---- ---- 67% 54% 56% Fixed Price 74% 68% 65% 33 46 44 CPFF, GMP or CM 26 32 35 - ---- ---- ---- ---- ---- --- 100% 100% 100% 100% 100% 100% ==== ==== ==== ==== ==== ====\nClients -------\nDuring 1995, the Company was active in the building, heavy and international construction markets. The Company performed work for over 100 federal, state and local governmental agencies or authorities and private customers during 1995. No material part of the Company's business is dependent upon a single or limited number of private customers; the loss of any one of which would not have a materially adverse effect on the Company. As illustrated in the following table, the Company continues to serve a significant number of private owners. During the period 1993-1995, the portion of construction revenues derived from contracts with various governmental agencies remains relatively constant at 56% in 1995 and 1994, and 54% in 1993.\nRevenues by Client Source -------------------------\nYear Ended December 31, ----------------------- 1995 1994 1993 ---- ---- ---- Private Owners 44% 44% 46% Federal Governmental Agencies 8 11 12 State, Local and Foreign Governments 48 45 42 ---- ---- --- 100% 100% 100% ==== ==== ====\nAll Federal government contracts are subject to termination provisions, but as shown in the table above, the Company does not have a material amount of such contracts.\n- 5 -\nGeneral -------\nThe construction business is highly competitive. Competition is based primarily on price, reputation for quality, reliability and financial strength of the contractor. While the Company experiences a great deal of competition from other large general contractors, some of which may be larger with greater financial resources than the Company, as well as from a number of smaller local contractors, it believes it has sufficient technical, managerial and financial resources to be competitive in each of its major market areas.\nThe Company will endeavor to spread the financial and\/or operational risk, as it has from time to time in the past, by participating in construction joint ventures, both in a majority and in a minority position, for the purpose of bidding on projects. These joint ventures are generally based on a standard joint venture agreement whereby each of the joint venture participants is usually committed to supply a predetermined percentage of capital, as required, and to share in the same predetermined percentage of income or loss of the project. Although joint ventures tend to spread the risk of loss, the Company's initial obligations to the venture may increase if one of the other participants is financially unable to bear its portion of cost and expenses. For a possible example of this situation, see \"Legal Proceedings\" on page 13. For further information regarding certain joint ventures, see Note 2 to Notes to Consolidated Financial Statements.\nWhile the Company's construction business may experience some adverse consequences if shortages develop or if prices for materials, labor or equipment increase excessively, provisions in certain types of contracts often shift all or a major portion of any adverse impact to the customer. On fixed price type contracts, the Company attempts to insulate itself from the unfavorable effects of inflation by incorporating escalating wage and price assumptions, where appropriate, into its construction bids. Gasoline, diesel fuel and other materials used in the Company's construction activities are generally available locally from multiple sources and have been in adequate supply during recent years. Construction work in selected overseas areas primarily employs expatriate and local labor which can usually be obtained as required. The Company does not anticipate any significant impact in 1996 from material and\/or labor shortages or price increases.\nEconomic and demographic trends tend not to have a material impact on the Company's heavy construction operation. Instead, the Company's heavy construction markets are dependent on the amount of heavy civil infrastructure work funded by various governmental agencies which, in turn, may depend on the condition of the existing infrastructure or the need for new expanded infrastructure. The building markets in which the Company participates are dependent on economic and demographic trends, as well as governmental policy decisions as they impact the specific geographic markets.\nThe Company has minimal exposure to environmental liability as a result of the activities of Perini Environmental Services, Inc. (\"Perini Environmental\"), a wholly-owned subsidiary of the Company. Perini Environmental provides hazardous waste engineering and construction services to both private clients and public agencies nationwide. Perini Environmental is responsible for compliance with applicable law in connection with its clean up activities and bears the risk associated with handling such materials.\nIn addition to strict procedural guidelines for conduct of this work, the Company and Perini Environmental generally carry insurance or receive satisfactory indemnification from customers to cover the risks associated with this business.\nThe Company also owns real estate nationwide, most of which is residential, and as an owner, is subject to laws governing environmental responsibility and liability based on ownership. The Company is not aware of any environmental liability associated with its ownership of real estate property.\nThe Company has been subjected to a number of claims from former employees of subcontractors regarding exposure to asbestos on the Company's projects. None of the claims have been material. The Company also operates construction machinery in its business and will, depending on the project or the ease of access to fuel for such machinery, install fuel tanks for use on-site. Such tanks run the risk of leaking hazardous fluids into the environment. The Company, however, is not aware of any emissions associated with such tanks or of any other environmental liability associated with its construction operations or any of its corporate activities.\nProgress on projects in certain areas may be delayed by weather\n- 6 -\nconditions depending on the type of project, stage of completion and severity of the weather. Such delays, if they occur, may result in more volatile quarterly operating results.\nIn the normal course of business, the Company periodically evaluates its existing construction markets and seeks to identify any growing markets where it feels it has the expertise and management capability to successfully compete or withdraw from markets which are no longer economically attractive.\nReal Estate - -----------\nThe Company's real estate development operations are conducted by Perini Land & Development Company (\"PL&D\"), a wholly-owned subsidiary, which has been involved in real estate development since the early 1950's. PL&D engages in real estate development in Arizona, California, Florida, Georgia and Massachusetts. However, in 1993, PL&D significantly reduced its staff in California and has suspended any new land acquisition in that area. PL&D's development operations generally involve identifying attractive parcels, planning and development, arranging financing, obtaining needed zoning changes and permits, site preparation, installation of roads and utilities and selling the land. Originally, PL&D concentrated on land development. In appropriate situations, PL&D has also constructed buildings on the developed land for rental or sale.\nFor the past five years PL&D has been affected by the reduced liquidity in real estate markets brought on by the cutbacks in real estate funding by commercial banks, insurance companies and other institutional lenders. Many traditional buyers of PL&D properties are other developers or investors who depend on third party sources for funding. As a result, some potential PL&D transactions have been cancelled, altered or postponed because of financing problems. Over this period, PL&D looked to foreign buyers not affected by U.S. banking policies or in some cases, provided seller financing to complete transactions. Based on a weakening in property values which has come with the industry credit crunch and the national real estate recession, PL&D took a $31 million pre-tax net realizable value writedown against earnings in 1992. The charge affected those properties which PL&D had decided to sell in the near term. Currently it is management's belief that its remaining real estate properties are not carried at amounts in excess of their net realizable values. PL&D periodically reviews its portfolio to assess the desirability of accelerating its sales through price concessions or sale at an earlier stage of development. In circumstances in which asset strategies are changed and properties brought to market on an accelerated basis, those assets, if necessary, are adjusted to reflect the lower of cost or market value. To achieve full value for some of its real estate holdings, in particular its investments in Rincon Center and the Resort at Squaw Creek, the Company may have to hold those properties several years and currently intends to do so.\nReal Estate Strategy --------------------\nSince 1990, PL&D has taken a number of steps to minimize the adverse financial impact of current market conditions. In early 1990, all new real estate investment was suspended pending market improvement, all but critical capital expenditures were curtailed on on-going projects and PL&D's workforce was cut by over 60%. Certain project loans were extended, with such extension usually requiring paydowns and increased annual amortization of the remaining loan balance. Going forward, PL&D will operate with a reduced staff and adjust its activity to meet the demands of the market.\nPL&D's real estate development project mix includes planned community, industrial park, commercial office, multi-unit residential, urban mixed use, resort and single family home developments. Given the current real estate environment, PL&D's emphasis is on the sale of completed product and also developing the projects in its inventory with the highest near term sales potential. It may also selectively seek new development opportunities in which it serves as development manager with limited equity exposure, if any.\nReal Estate Properties ----------------------\nThe following is a description of the Company's major development projects and properties by geographic area:\nFlorida -------\nWest Palm Beach and Palm Beach County - In 1994, PL&D completed the sale\n- 7 -\nof all of the original 1,428 acres located in West Palm Beach at the development known as \"The Villages of Palm Beach Lakes\". PL&D's only continuing interest in the project is its ownership in the Bear Lakes Country Club which under agreement with the membership can be turned over to the members when membership reaches 650. Current membership is 438. The club includes two championship golf courses designed by Jack Nicklaus.\nAt Metrocentre, a 51-acre commercial\/office park at the intersection of Interstate 95 and 45th Street in West Palm Beach, one site totaling 2.78 acres was sold in 1995. That site was sold to a national motel chain. The park consists of 17 parcels, of which 2 1\/4 (7.3 acres) currently remain unsold. The park provides for 570,500 square feet of mixed commercial uses.\nMassachusetts -------------\nPerini Land and Development or Paramount Development Associates, Inc. (\"Paramount\"), a wholly-owned subsidiary of PL&D, owns the following projects:\nRaynham Woods Commerce Center, Raynham - In 1987, Paramount acquired a 409-acre site located in Raynham, Massachusetts, on which it had done preliminary investigatory and zoning work under an earlier purchase option period. During 1988, Paramount secured construction financing and completed infrastructure work on a major portion of the site (330 acres) which is being developed as a mixed use corporate campus style park known as \"Raynham Woods Commerce Center\". During 1989, Paramount completed the sale of a 24-acre site to be used as a headquarters facility for a division of a major U.S. company. During 1990, construction was completed on this facility. In 1990 construction was also completed on two new commercial buildings by Paramount. During 1992, a 17-acre site was sold to a developer who was working with a major national retailer. The site has since been developed into the first retail project in the park. No new land sales were made in 1993, but in 1994, an 11-acre site was sold to the same major U.S. company which had acquired land in 1989, and in 1995 a 4-acre site was sold to a major insurance company. Although the two Paramount commercial buildings owned within the park experienced some tenant turnover in late 1994 and into 1995, they remain 90% occupied. The park is planned to eventually contain 2.5 million square feet of office, R&D, light industrial and mixed commercial space.\nEaston Business Center, Easton - In 1989, Paramount acquired a 40-acre site in Easton, Massachusetts, which had already been partially developed. Paramount completed the work in 1990 and is currently marketing the site to commercial\/industrial users. No sales were closed in 1995.\nWareham - In early 1990, Paramount acquired an 18.9-acre parcel of land at the junction of Routes 495 and 58 in Wareham, Massachusetts. The property is being marketed to both retail and commercial\/industrial users. No sales were closed in 1995.\nGeorgia -------\nThe Villages at Lake Ridge, Clayton County - During 1987, PL&D (49%) entered into a joint venture with 138 Joint Venture partners to develop a 348-acre planned commercial and residential community in Clayton County to be called \"The Villages at Lake Ridge\", six miles south of Atlanta's Hartsfield International Airport. By year end 1990, the first phase infrastructure and recreational amenities were in place. In 1991, the joint venture completed the infrastructure on 48 lots for phased sales of improved lots to single family home builders and sold nine. During 1992, the joint venture sold an additional 60 lots and also sold a 16-acre parcel for use as an elementary school. During 1993, unusually wet weather in the spring delayed construction on improvements required to deliver lots as scheduled. As a result, the sale of an additional 58 lots in 1993 were below expectation. Although 1994 started off strong, rising interest rates created a slowdown in activity later in the year. For the year, 52 lots were sold. In 1995, the pace picked up again and a record 72 lots were sold. Because most of the homes built within the development are to first time buyers, demand is highly sensitive to mortgage rates and other costs of ownership. Financing restrictions generally require the joint venture to allow developers to take down finished lots only as homes built on previously acquired lots are sold. As a result, any slowdown in home sales will influence joint venture sales quickly thereafter. The development plan calls for mixed residential densities of apartments and moderate priced single-family homes totaling 1,158 dwelling units in the residential tracts plus 220,000 square feet of retail and 220,000 square feet of office space in the commercial tracts.\n- 8 -\nThe Oaks at Buckhead, Atlanta - Sales commenced on this 217-unit residential condominium project at a site in the Buckhead section of Atlanta near the Lenox Square Mall in 1992. The project consists of 201 residences in a 30-story tower plus 16 adjacent three-story townhome residences. At year end 207 units were either sold or under contract. Sixty-nine of these units were closed in 1995, up from 53 for 1994. PL&D (50%) is developing this project in joint venture with a subsidiary of a major Taiwanese company.\nCalifornia ----------\nRincon Center, San Francisco - Major construction on this mixed-use project in downtown San Francisco was completed in 1989. The project, constructed in two phases, consists of 320 residential rental units, approximately 423,000 square feet of office space, 63,000 square feet of retail space, and a 700-space parking garage. Following its completion in 1988, the first phase of the project was sold and leased back by the developing partnership. The first phase consists of about 223,000 square feet of office space and 42,000 square feet of retail space. The Phase I office space continues to be close to 100% leased with the regional telephone directory company as the major tenant on leases which run into early 1998. The retail space is currently 90% leased. Phase II of the project, which began operations in late 1989, consists of approximately 200,000 square feet of office space, 21,000 square feet of retail space, a 14,000 square foot U.S. postal facility, and 320 apartment units. Currently, close to 100% of the office space, 94% of the retail space and virtually all of the 320 residential units are leased. The major tenant in the office space in Phase II is the Ninth Circuit Federal Court of Appeals which is leasing approximately 176,000 square feet. That lease expires at the end of 1996. Currently, the space is being shown to potential tenants for possible 1997 occupancy. PL&D currently holds a 46% interest in and is managing general partner of the partnership which is developing the project. The land related to this project is being leased from the U.S. Postal Service under a ground lease which expires in 2050.\nIn addition to the project financing and guarantees disclosed in the first, second and third paragraphs of Note 11 to Notes to Consolidated Financial Statements, the Company has advanced approximately $78 million to the partnership through December 31, 1995, of which approximately $5 million was advanced during 1995, primarily to paydown some of the principal portion of project debt which was renegotiated during 1993. In 1995, operations before principal repayment of debt created a positive cash flow on an annual basis.\nTwo major loans on this property in aggregate totaling over $75 million were scheduled to mature in 1993. During 1993 both loans were extended for five additional years. To extend these loans, PL&D provided approximately $6 million in new funds which were used to reduce the principal balances of the loans. In 1995 and over the next three years, additional amortization will be required, some of which may not be covered by operating cash flow and, therefore, at least 80% of those funds not covered by operations will be provided by PL&D as managing general partner. Lease payments and loan amortization obligations at Rincon Center through 1997 are as follows: $7.5 million in 1996 and $7.3 million in 1997. Based on Company forecasts, it could be required to contribute as much as $9.4 million to cover these and possible tenant improvement requirements not covered by project cash flow through 1997. While the budgeted shortfall includes an estimate for tenant improvements, they may or may not be required. Although management believes operating expenses will be covered by operating cash flow at least through 1997, the interest rates on much of the debt financing covering Rincon Center are variable based on various rate indices. With the exception of approximately $20 million of the financing, none of the debt has been hedged or capped and is subject to market fluctuations. From time to time, the Company reviews the costs and anticipated benefits from hedging Rincon Center's interest rate commitments. Based on current costs to further hedge rate increases and market conditions, the Company has elected not to provide any additional hedges at this time.\nAs part of the Rincon One sale and operating lease-back transaction, the joint venture agreed to obtain an additional financial commitment on behalf of the lessor to replace at least $33 million of long-term financing by January 1, 1998. If the joint venture has not secured a further extension or new commitment for financing on the property for at least $33 million, the lessor will have the right under the lease to require the joint venture to purchase the property for a stipulated amount of approximately $18.8 million in excess of the then outstanding debt. Management currently believes it will be able to extend the financing or refinance the building such that this sale back to the Company will not occur.\nDuring 1993 PL&D agreed, if necessary, to lend Pacific Gateway\n- 9 -\nProperties (PGP), the other General Partner in the project, funds to meet its 20% share of cash calls. In return PL&D receives a priority return from the partnership on those funds and penalty fees in the form of rights to certain distributions due PGP by the partnership controlling Rincon. During 1993, 1994 and 1995, PL&D advanced $1.7 million, $.3 million and $.9 million, respectively, under this agreement, primarily to meet the principal payment obligations of the loan extensions described above.\nThe Resort at Squaw Creek - During 1990, construction was completed on the 405-unit first phase of the hotel complex of this major resort-conference facility. In mid-December of that year, the resort was opened. In 1991, final work was completed on landscaping the golf course, as well as the remaining facilities to complete the first phase of the project. The first phase of the project includes a 405-unit hotel, 36,000 square feet of conference facilities, a Robert Trent Jones, Jr. golf course, 48 single-family lots, all but three of which had been sold or put under contract by early 1993, three restaurants, an ice skating rink, pool complex, fitness center and 11,500 square feet of various retail support facilities. The second phase of the project is planned to include an additional 409-unit hotel facility, 36 townhouses, 27,000 square feet of conference space, 5,000 square feet of retail space and a parking structure. No activity on the second phase will begin until stabilization is attained on phase one and market conditions warrant additional investment.\nWhile PL&D has an effective 18% ownership interest in this joint venture, it has additional financial commitments as described below.\nIn addition to the project financing and guarantees disclosed in paragraphs four and five of Note 11 to Notes to Consolidated Financial Statements, the Company has advanced approximately $76 million to the joint venture through December 31, 1995, of which approximately $3.3 million was advanced during 1995, for the cost of operating expenses, debt amortization and interest payments. Further, it is anticipated the project may require additional funding by PL&D before it reaches stabilization which may take several years. During 1992, the majority partner in the joint venture sold its interest to a group put together by an existing limited partner. As a part of that transaction, PL&D relinquished its managing general partnership position to the buying group, but retained a wide range of approval rights. The result of the transaction was to strengthen the financial support for the project and led to an extension of the bank financing on the project to mid-1995. The $48 million of bank financing on the project was extended again in 1995 and currently matures in May, 1997, with an option by the borrower to extend an additional year.\nAs part of Squaw Creek Associates partnership agreement, either partner may initiate a buy\/sell agreement on or after January 1, 1997. Such buy\/sell agreement, which is similar to those often found in real estate development partnerships, provides for the recipient of the offer to have the option of selling its share or purchasing its partners share at the proportionate amount applicable based on the offer price and the specific priority of payout as called for under the partnership agreement based on a sale and termination of the partnership. The Company does not anticipate such a circumstance, because until the end of the year 2001, the partner would lose the certainty of a $2 million annual preferred return currently guaranteed by the Company. However, an exercise of the buy\/sell agreement by its partner could force the Company to sell its ownership at a price possibly significantly less than its full value should the Company be unable to buy out its partner and forced to sell at the price initiated by its partner.\nThe operating results of this project are weather sensitive. For example, a large snowfall in late 1994 helped improve results during the 1994-5 ski season. As a result, through October of 1995, the resort showed marked improvement over the previous year. Snowfall in late 1995, however, did not match the previous year which adversely affected results in late 1995 and in early 1996.\nCorte Madera, Marin County - After many years of intensive planning, PL&D obtained approval for a 151 single-family home residential development on its 85-acre site in Corte Madera and, in 1991, was successful in gaining water rights for the property. In 1992, PL&D initiated development on the site which was continued into 1993. This development is one of the last remaining in-fill areas in southern Marin County. In 1993, when PL&D decided to scale back its operations in California, it also decided to sell this development in a transaction which closed in early 1994. The transaction calls for PL&D to get the majority of its funds from the sale of residential units or upon the sixth anniversary of the sale whichever takes place first and, although indemnified, to leave in place certain bonds and other assurances previously given to the town of Corte Madera guaranteeing performance in compliance with approvals previously obtained. Sale of the units began in August of 1995 and by year end, 10 units were under contract or closed. - 10 -\nArizona -------\nI-10 West, Phoenix - In 1979, I-10 Industrial Park Developers (\"I-10\"), an Arizona partnership between Paramount Development Associates, Inc. (80%) and Mardian Development Company (20%), purchased approximately 160 acres of industrially zoned land located immediately south of the Interstate 10 Freeway, between 51st and 59th Avenues in the City of Phoenix. The project experienced strong demand through 1988. With the downturn in the Arizona real estate markets, subsequent to 1988, sales slowed. However, in 1995 the remaining 13.3 acres were sold and this project is sold out.\nAirport Commerce Center, Tucson - In 1982, the I-10 partnership purchased 112 acres of industrially zoned property near the Tucson International Airport. During 1983, the partnership added 54 acres to that project, bringing its total size to 166 acres. This project has experienced a low level of sales activity due to an excess supply of industrial property in the marketplace. However, the partnership built and fully leased a 14,600 square foot office\/warehouse building in 1987 on a building lot in the park, which was sold during 1991. In 1990, the partnership sold 14 acres to a major airline for development as a processing center and, in 1992, sold a one acre parcel adjacent to the existing property. After experiencing no new sales in 1993, approximately 12 acres were sold in 1994 and an additional 24 acres were sold in 1995. Currently, 87 acres remain to be sold.\nPerini Central Limited Partnership, Phoenix - In 1985, PL&D (75%) entered into a joint venture with the Central United Methodist Church to master plan and develop approximately 4.4 acres of the church's property in midtown Phoenix. Located adjacent to the Phoenix Art Museum and near the Heard Museum, the project is positioned to become the mixed use core of the newly formed Phoenix Arts District. In 1990, the project was successfully rezoned to permit development of 580,000 square feet of office, 37,000 square feet of retail and 162 luxury apartments. Plans for the first phase of this project, known as \"The Coronado\" have been put on hold pending improved market conditions. In 1993, PL&D obtained a three-year extension of the construction start date required under the original zoning and for the present is continuing to hold the project in abeyance.\nGrove at Black Canyon, Phoenix - The project consists of an office park complex on a 30-acre site located off of Black Canyon Freeway, a major Phoenix artery, approximately 20 minutes from downtown Phoenix. When complete, the project will include approximately 650,000 square feet of office, hotel, restaurant and\/or retail space. Development, which began in 1986, is scheduled to proceed in phases as market conditions dictate. In 1987, a 150,000 square foot office building was completed within the park and now is 97% leased with approximately half of the building leased to a major area utility company. During 1993, PL&D (50%) successfully restructured the financing on the project by obtaining a seven year extension with some amortization and a lower fixed interest rate. The annual amortization commitment is not currently covered by operating cash flow, which caused PL&D to have to provide approximately $1.2 million in 1994 and $.7 million in 1995 to cover the shortfall. In the near term it appears approximately $700,000 per year of support to cover loan amortization will continue to be required. No new development within the park was begun in 1994 nor were any land sales consummated. However, the lease covering space occupied by the major office tenant was extended an additional seven years to the year 2004 on competitive terms. In 1995, a day care center was completed on an 8-acre site along the north entrance of the park.\nSabino Springs Country Club, Tucson - During 1990, the Tucson Board of Supervisors unanimously approved a plan for this 410-acre residential golf course community close to the foothills on the east side of Tucson. In 1991, that approval, which had been challenged, was affirmed by the Arizona Supreme Court. When developed, the project will consist of 496 single-family homes. An 18-hole Robert Trent Jones, Jr. designed championship golf course and clubhouse were completed within the project in 1995. In 1993, PL&D recorded the master plat on the project and sold a major portion of the property to an international real estate company. Although it will require some infrastructure development before sale, PL&D still retains 33 estate lots for sale in future years.\nCapitol Plaza, Phoenix - In 1988, PL&D acquired a 1.75-acre parcel of land located in the Governmental Mall area of Phoenix. Original plans were to either develop a 200,000 square foot office building on the site to be available to government and government related tenants or to sell the site. The project has currently been placed on hold pending a change in market conditions.\n- 11 -\nGeneral -------\nThe Company's real estate business is influenced by both economic conditions and demographic trends. A depressed economy may result in lower real estate values and longer absorption periods. Higher inflation rates may increase the values of current properties, but often are accompanied by higher interest rates which may result in a slowdown in property sales because of higher carrying costs. Important demographic trends are population and employment growth. A significant reduction in either of these may result in lower real estate prices and longer absorption periods.\nThe well publicized real estate problems experienced by the commercial bank and savings and loan industries in the early 90's have resulted in sharply curtailed credit available to acquire and develop real estate; further, the continuing national weakness in commercial office markets has significantly slowed the pace at which PL&D has been able to proceed on certain of its development projects and its ability to sell developed product. In some or all cases, it has also reduced the sales proceeds realized on such sales and\/or required extended payment terms.\nGenerally, there has been no material impact on PL&D's real estate development operations over the past 10 years due to interest rate increases. However, an extreme and prolonged rise in interest rates could create market resistance for all real estate operations in general, and is always a potential market obstacle. PL&D, in some cases, employs hedges or caps to protect itself against increases in interest rates on any of its variable rate debt and, therefore, is insulated from extreme interest rate risk on borrowed funds, although specific projects may be impacted if the decision has been made not to hedge or to hedge at higher than current rates.\nThe Company has been replacing relatively low cost debt-free land in Florida acquired in the late 1950's with land purchased at current market prices. In 1995 and into the future, as the mix of land sold contains proportionately less low cost land, the gross margin on real estate revenues will decrease.\nInsurance and Bonding - ---------------------\nAll of the Company's properties and equipment, both directly owned or owned through partnerships or joint ventures with others, are covered by insurance and management believes that such insurance is adequate. However, due to conditions in the insurance market, the Company's California properties, both directly owned and owned in partnership with others, are not fully covered by earthquake insurance.\nIn conjunction with its construction business, the Company is often required to provide various types of surety bonds. The Company has dealt with the same surety for over 75 years and it has never been refused a bond. Although from time-to-time the surety industry encounters limitations affecting the bondability of very large projects and the Company occasionally has encountered limits imposed by its surety, these limits have not had an adverse impact on its operations.\nEmployees - ---------\nThe total number of personnel employed by the Company is subject to seasonal fluctuations, the volume of construction in progress and the relative amount of work performed by subcontractors. During 1995, the maximum number of employees employed was approximately 3,000 and the minimum was approximately 2,100.\nThe Company operates as a union contractor. As such, it is a signatory to numerous local and regional collective bargaining agreements, both directly and through trade associations, throughout the country. These agreements cover all necessary union crafts and are subject to various renewal dates. Estimated amounts for wage escalation related to the expiration of union contracts are included in the Company's bids on various projects and, as a result, the expiration of any union contract in the current fiscal year is not expected to have any material impact on the Company.\n- 12 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nProperties applicable to the Company's real estate development activities are described in detail by geographic area in Item 1. Business on pages 7 through 12. All other properties used in operations are summarized below:\nOwned or Leased Approximate Approximate Square Principal Offices by Perini Acres Feet of Office Space - ----------------- --------------- ----------- -------------------- Framingham, MA Owned 9 110,000 Phoenix, AZ Leased - 22,000 Southfield, MI Leased - 13,900 San Francisco, CA Leased - 3,500 Hawthorne, NY Leased - 12,500 West Palm Beach, FL Leased - 5,000 Los Angeles, CA Leased - 2,000 Las Vegas, NV Leased - 3,000 Atlanta, GA Leased - 1,700 Chicago, IL Leased - 14,700 Philadelphia, PA Leased - 2,100 -- ------- 9 190,400 == ======= Principal Permanent Storage Yards - --------------------------------- Bow, NH Owned 70 Framingham, MA Owned 6 E. Boston, MA Owned 3 Las Vegas, NV Leased 2 Novi, MI Leased 3 -- ==\nThe Company's properties are generally well maintained, in good condition, adequate and suitable for the Company's purpose and fully utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nAs previously reported, the Company is a party to an action entitled Mergentime Corporation et. al. v. Washington Metropolitan Transit Authority v. Insurance Company of North America (Civil Action No. 89-1055) in the U.S. District Court for the District of Columbia. The action involves WMATA's termination of the general contractor, a joint venture in which the Company was a minority partner, on two contracts to construct a portion of the Washington, D.C. subway system, and certain claims by the joint venture against WMATA for claimed delays and extra work.\nOn July 30, 1993, the Court upheld the termination for default, and found both joint venturers and their surety jointly and severally liable to WMATA for damages in the amount of $16.5 million, consisting primarily of WMATA's excess reprocurement costs, but specifically deferred ruling on the amount of the joint venture's claims against WMATA. Since the other joint venture partner may be unable to meet its financial obligations under the award, the Company could be liable for the entire amount.\nAt the direction of the judge now presiding over the action, during the third quarter of 1995, the parties submitted briefs on the issue of WMATA's liability on the joint venture's claims for delays and for extra work. As a result of that process, the company established a reserve with respect to the litigation. Management believes the reserve should be adequate to cover the potential ultimate liability in this matter.\n- 13 -\nIn the ordinary course of its construction business, the Company is engaged in other lawsuits. The Company believes that such lawsuits are usually unavoidable in major construction operations and that their resolution will not materially affect its results of future operations and financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNone.\n- 14 -\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------\nThe Company's common stock is traded on the American Stock Exchange under the symbol \"PCR\". The quarterly market price ranges (high-low) for 1995 and 1994 are summarized below:\n1995 1994 -------------- -------------- Market Price Range per Common Share: High Low High Low - ----------------------------------- ------ ----- ------ ----- Quarter Ended March 31 11 7\/8 - 9 3\/8 13 7\/8 - 11 1\/4 June 30 11 1\/2 - 9 1\/2 13 3\/8 - 10 7\/8 September 30 13 3\/8 - 10 1\/8 11 1\/2 - 9 1\/8 December 31 12 1\/4 - 7 7\/8 11 1\/8 - 9 1\/8\nFor information on dividend payments, see Selected Financial Data in Item 6","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\n- 15 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------\nRESULTS OF OPERATIONS - 1995 COMPARED TO 1994\nThe Company's 1995 operations resulted in a net loss of $27.6 million or $6.38 per common share on revenues of $1.1 billion compared to net income of $.3 million or a loss of $.42 per common share (after giving effect to the dividend payments required on its preferred stock) on revenues of $1.0 billion in 1994. The primary reasons for this decrease in earnings were a pretax charge of $25.6 million in connection with previously disclosed litigation in Washington, D.C. and downward revisions in estimated probable recoveries on certain outstanding contract claims, and lower than normal profit margins on certain heavy construction contracts, including a significant reduction in the profit level on a tunnel project in the Midwest.\nRevenues reached a record level of $1.101 billion in 1995, an increase of $89 million (or 9%) compared to the 1994 revenues of $1.012 billion. This increase resulted primarily from an increase in construction revenues of $106 million (or 11%) from $.951 billion in 1994 to $1.057 billion in 1995. This increase in construction revenues resulted primarily from an increase in building construction revenues of $122 million (or 19%), from $626 million in 1994 to $748 million in 1995, primarily due to substantially increased volume in the Midwest region resulting from a substantially higher backlog in that area entering 1995 combined with several hotel\/casino projects acquired during 1995. This increase was partially offset by a decrease in building construction revenues in the Eastern and Western regions, as well as in the overall heavy construction operations, due primarily to the timing in the start-up of several significant new projects and the completion early in 1995 of several other major projects. Revenues from real estate operations also decreased by $16.8 million (or 27%) from $61.2 million in 1994 to $44.4 million in 1995 due to the non-recurring sale in 1994 of two investment properties ($8.3 million) and fewer land sales in Massachusetts and California during 1995.\nIn spite of the 9% increase in revenues, the gross profit in 1995 decreased by $36.9 million, from $51.8 million in 1994 to $14.9 million in 1995, due primarily to an overall decrease in gross profit from construction operations of $32.1 million (or 67%), from $48.0 million in 1994 to $15.9 million in 1995. The primary reasons for this decrease were a pretax charge of $25.6 million in connection with previously disclosed litigation in Washington, D.C. (as more fully discussed in Note 11 to Notes to Consolidated Financial Statements) and downward revisions in estimated probable recoveries on certain outstanding contract claims, and lower than normal profit margins on certain heavy construction contracts, including a significant reduction in the profit level on a tunnel project in the Midwest. In addition, the overall gross profit from real estate operations decreased by $4.8 million, from a profit of $3.8 million in 1994 to a loss of $1.0 million in 1995 due to the sale in 1994 of the last parcels of high margin land in Florida and in a project in Massachusetts which was partially offset by improved operating results in 1995 from its two major on-going operating properties in California.\nTotal general, administrative and selling expenses decreased by $5.7 million (or 13%) from $43.0 million in 1994 to $37.3 million in 1995. This decrease primarily reflects reduced bonuses, an increased allocation of various insurance costs to projects in 1995, and a continuation during 1995 of the Company's re-engineering efforts commenced in prior years.\nThe increase in other income (expense), net, of $1.7 million, from a net expense of $.9 million in 1994 to a net income of $.8 million in 1995, is primarily due to an increase in interest income and, to a lesser extent, a gain realized on the sale of certain underutilized operating facilities, including a quarry, in 1995.\nThe increase in interest expense of $1.1 million (or 15%), from $7.5 million in 1994 to $8.6 million in 1995, primarily results from a higher average level of borrowings during 1995.\nThe Company recognized a tax benefit in 1995 equal to $2.6 million or 9% of the pretax loss. A portion of the tax benefit related to the 1995 loss was not recognized because of certain accounting limitations. However, an amount estimated to be approximately $20 million of future pretax earnings should benefit from minimal, if any, tax charges.\n----------------------------------------------------------\nLooking ahead, we must consider the Company's construction backlog and - 16 -\nremaining inventory of real estate projects. The overall construction backlog at the end of 1995 was $1.535 billion which approximates the 1994 record year-end backlog of $1.539 billion. This backlog has a better balance between building and heavy work and a higher overall estimated profit margin.\nWith the sale of the final 21 acres during 1994, the Company's Villages of Palm Beach Lakes, Florida land inventory was completely sold out. Because of its low book value, sales of this acreage have provided a major portion of the Company's real estate profit in recent years. With the sale of this property complete, the Company's ability to generate profit from real estate sales and the related gross margin will be reduced as was the case in 1995. Between 1989 and 1995, property prices in general have fallen substantially due to the reduced liquidity in real estate markets and reduced demand. Recently, the Company has noted improvement in some property areas. This trend has had some effect on residential property sales which were closed in 1995. However, this trend is still neither widespread nor proven to be sustainable.\nRESULTS OF OPERATIONS - 1994 COMPARED TO 1993\nThe Company's 1994 operations resulted in net income of $.3 million on revenues of $1.0 billion and a loss of 42 cents per common share (after giving effect to the dividend payments required on its preferred stock) compared to net income of $3.2 million or 24 cents per common share on revenues of $1.1 billion in 1993. In spite of the overall decrease in revenues during 1994, income from operations increased slightly compared to 1993 results. An increase in interest expense in 1994 and the non-recurring $1 million net gain after tax in 1993 from the sale by the Company of its 74%-ownership interest in Majestic Contractors Limited (\"Majestic\"), its Canadian pipeline subsidiary, contributed to the overall decrease in net income.\nRevenues amounted to $1.012 billion in 1994 compared to $1.100 billion in 1993, a decrease of $88 million (or 8%). This decrease resulted primarily from a net decrease in construction revenues of $79 million (or 8%) from $1.030 billion in 1993 to $.951 billion in 1994 due to a decrease in volume from building operations of $126 million (or 17%), from $752 million in 1993 to $626 million in 1994. The decrease in revenue from building operations was primarily due to the prolonged start-up phases on certain projects. This decrease was partially offset by an increase in revenues from civil and environmental construction operations of $47 million (or 17%), from $278 million in 1993 to $325 million in 1994, due to an increased heavy construction backlog going into 1994. In addition to the overall decrease in construction revenues, revenues from real estate operations decreased $8.6 million (or 12%), from $69.8 million in 1993 to $61.2 million in 1994, due primarily to the non-recurring sale ($23.2 million) in 1993 of a partnership interest in certain commercial rental properties in San Francisco and a $5.2 million decrease in land sales in Arizona. The decrease in real estate revenues was partially offset from the sale of two investment properties in 1994 ($8.3 million) and increased land sales in Massachusetts ($5.4 million) and California ($4.9 million).\nIn spite of the 8% decrease in total revenues, the gross profit in 1994 decreased only $1.0 million (or 2%), from $52.8 million in 1993 to $51.8 million in 1994. The gross profit from construction operations decreased $1.1 million (or 2.3%), from $49.1 million in 1993 to $48.0 million in 1994, due to the negative profit impact from the reduction in building construction revenues referred to above and a loss from international operations resulting from unstable economic and political conditions in a certain overseas location where the Company is working. These decreases were partially offset by slightly higher margins on the construction work performed in 1994 (5.0% in 1994 compared with 4.8% in 1993) and a slight overall increase ($.1 million) in the gross profit from real estate operations, from $3.7 million in 1993 compared to $3.8 million in 1994.\nTotal general, administrative and selling expenses decreased by $1.2 million (or 3%) in 1994, from $44.2 million in 1993 to $43.0 million in 1994 due to several factors, the more significant ones being a $2.1 million expense for severance incurred in 1993 in connection with re-engineering some of the business units, which was partially offset by the full year impact of expenses related to the acquisition referred to in Note 1 to Notes to Consolidated Financial Statements.\nThe decrease in other income (expense), net of $6.1 million, from income of $5.2 million in 1993 to a net loss of $.9 million in 1994 is primarily due to the pretax gain in 1993 of $4.6 million on the sale of Majestic and, to a lesser degree, an increase in other expenses in 1994, primarily bank fees.\nThe increase in interest expense of $1.8 million (or 32%), from $5.7 million in 1993 to $7.5 million in 1994 primarily results from higher interest rates during 1994 and higher average level of borrowings.\n- 17 -\nFINANCIAL CONDITION\nCASH AND WORKING CAPITAL\nDuring 1995, the Company provided $24.6 million in cash from operating activities, primarily due to an overall increase in accounts payable and advances from joint ventures; $9.0 million from financing activities due to an increase in borrowings under its revolving credit facility; and $23.9 million from cash distributions from certain joint ventures. These increases in cash were used to increase cash on hand by $21.2 million, with the balance used for various investment activities, primarily to fund construction and real estate joint ventures. In addition, the Company has future financial commitments to certain real estate joint ventures as described in Note 11 to Notes to Consolidated Financial Statements.\nDuring 1994, the Company used $15.6 million in cash for investment activities, primarily to fund construction and real estate joint ventures; $7.4 million for financing activities, primarily to pay down company debt; and $5.0 million to fund operating activities, primarily changes in working capital.\nDuring 1993, the Company used $39.1 million of cash for investment activities, primarily to fund construction and real estate joint ventures; $3 million for financing activities, primarily to pay down Company debt; and $1.6 million to fund operating activities, primarily changes in working capital.\nSince 1990, the Company has paid down $44.3 million of real estate debt on wholly-owned real estate projects (from $50.9 million to $6.6 million), utilizing proceeds from sales of property and general corporate funds. Similarly, real estate joint venture debt has been reduced by $158 million over the same period. As a result, the Company has reached a point at which revenues from further real estate sales that, in the past, have been largely used to retire real estate debt will be increasingly available to improve general corporate liquidity. With the exception of the major properties referred to in Note 11 to Notes to Consolidated Financial Statements, this trend should continue over the next several years with debt on projects often being fully repaid prior to full project sell-out. On the other hand, the softening of the national real estate market coupled with problems in the commercial banking industry have significantly reduced credit availability for both new real estate development projects and the sale of completed product, sources historically relied upon by the Company and its customers to meet liquidity needs for its real estate development business. The Company has addressed this problem by relying on corporate borrowings, extending certain maturing real estate loans (with such extensions usually requiring pay downs and increased annual amortization of the remaining loan balance), suspending the acquisition of new real estate inventory, significantly reducing development expenses on certain projects, utilizing treasury stock in partial payment of amounts due under certain of its incentive compensation plans, utilizing cash internally generated from operations and, during the first quarter of 1992, selling its interest in Monenco. In addition, in January 1993, the Company sold its majority interest in Majestic for approximately $31.7 million in cash. Since Majestic had been fully consolidated, the net result to the Company was to increase working capital by $8 million and cash by $4 million. In addition, the Company implemented a company-wide cost reduction program in 1990, and again in 1991 and 1993 to improve long-term financial results and suspended the dividend on its common stock during the fourth quarter of 1990. Also, the Company increased the aggregate amount available under its revolving credit agreement during the period from $70 million to $114.5 million at December 31, 1995. Effective February 26, 1996, the Company entered into a Bridge Loan Agreement for an additional $15 million through July 31, 1996 (see Note 4 to Notes to Consolidated Financial Statements). Management believes that cash generated from operations, existing credit lines and additional borrowings should probably be adequate to meet the Company's funding requirements for at least the next twelve months. However, the withdrawal of many commercial lending sources from both the real estate and construction markets and\/or restrictions on new borrowings and extensions on maturing loans by these very same sources cause uncertainties in predicting liquidity. In addition to internally generated funds, the Company has access to additional funds under its long-term revolving credit facility and Bridge Loan Agreement. At December 31, 1995, the Company has $24.5 million available under its revolving credit facility and, effective February 26, 1996, an additional $15 million became available under the Bridge Loan Agreement. The financial covenants to which the Company is subject include minimum levels of working capital, debt\/net worth ratio, net worth level and interest coverage, all as defined in the loan documents. Although the Company was in violation of certain of the covenants during the latter part of 1995, it obtained waivers of such violations and, effective February 26, 1996, received modifications to the Credit Agreement which eliminated any non-compliance.\n- 18 -\nThe working capital current ratio stood at 1.12:1 at the end of 1995, compared to 1.13:1 at the end of 1994 and to 1.17:1 at the end of 1993. Of the total working capital of $36.5 million at the end of 1995, approximately $6 million may not be converted to cash within the next 12 to 18 months.\nLONG-TERM DEBT\nLong-term debt was $84.2 million at the end of 1995, which represented an increase of $7.2 million compared with $77 million at the end of 1994, which was a decrease of $5.4 million compared with $82.4 million at the end of 1993. The ratio of long-term debt to equity increased from .58:1 at the end of 1994 to .80:1 at the end of 1995 due to the increase in long-term debt coupled with the negative impact on equity as a result of the net loss experienced by the Company in 1995. The ratio of long-term debt to equity improved from .63:1 at the end of 1993 to .58:1 at the end of 1994 due to the decrease in long-term debt achieved in 1994.\nSTOCKHOLDERS' EQUITY\nThe Company's book value per common share stood at $17.06 at December 31, 1995, compared to $23.79 per common share and $24.49 per common share at the end of 1994 and 1993, respectively. The major factor impacting stockholders' equity during the three-year period under review was the net loss recorded in 1995 and, to a lesser extent, preferred dividends paid or accrued, and treasury stock issued in partial payment of incentive compensation.\nAt December 31, 1995, there were 1,346 common stockholders of record based on the stockholders list maintained by the Company's transfer agent.\nDIVIDENDS\nDuring 1993 and 1994, the Company paid the regular quarterly cash dividends of $5.3125 per share on the Company's convertible exchangeable preferred shares for an annual total of $21.25 per share (equivalent to quarterly dividends of $.53125 per depositary share for an annual total of $2.125 per depositary share). During 1995, the Board of Directors continued to declare and pay the regular quarterly cash dividend on the Company's preferred stock through December 15, 1995. In conjunction with the covenants of the new Amended Revolving Credit Agreement (see Note 4 to Notes to Consolidated Financial Statements), the Company is required to suspend the payment of quarterly dividends on its preferred stock until the Bridge Loan commitment is no longer outstanding, if a default exists under the terms of the Amended Revolving Credit Agreement, or if the ratio of long-term debt to equity exceeds 50%. Therefore, the dividend that normally would have been declared during December of 1995 and payable on March 15, 1996 has not been declared (although it has been fully accrued due to the \"cumulative\" feature of the preferred stock). The Board of Directors intends to resume payment of the cumulative dividend on the Company's preferred stock as the Company satisfies the terms of the new credit agreement and the Board deems it prudent to do so. There were no cash dividends declared during the three-year period ended December 31, 1995 on the Company's outstanding common stock. It is Management's intent to recommend reinstating dividends on common stock once it is prudent to do so.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe Reports of Independent Public Accountants, Consolidated Financial Statements, and Supplementary Schedules, are set forth on the pages that follow in this Report and are hereby incorporated herein.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\n- 19 -\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the definitive proxy statement involving election of directors in connection with the Annual Meeting of Stockholders to be held on May 16, 1996 (the \"Proxy Statement\"), which section is incorporated herein by reference. The Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1995 pursuant to Regulation 14A of the Securities and Exchange Act of 1934, as amended.\nListed below are the names, offices held, ages and business experience of all executive officers of the Company.\nNAME, OFFICES HELD YEAR FIRST ELECTED TO PRESENT OFFICE AND AGE AND BUSINESS EXPERIENCE\nDavid B. Perini, He has served as a Director, President, Chief Executive Director, Chairman, Officer and Acting Chairman since 1972. He became Chairman President and on March 17, 1978 and has worked for the Company since 1962 Chief Executive in various capacities. Prior to being elected President, he Officer - 58 served as Vice President and General Counsel.\nRichard J. Rizzo, He has served in this capacity since January, 1994, which Executive Vice entails overall responsibility for the Company's building President, Building construction operations. Prior thereto, he served as Construction - 52 President of Perini Building Company (formerly known as Mardian Construction Co.) since 1985, and in various other operating capacities since 1977.\nJohn H. Schwarz, He has served as Executive Vice President, Finance and Executive Vice Administration since August, 1994, and as Chief Executive President, Finance Officer of Perini Land and Development Company, which and Administration entails overall responsibility for the Company's real estate of the Company and operations since April, 1992. Prior to that, he served as Chief Executive Vice President, Finance and Controls of Perini Land and Officer of Perini Development Company. Previously, he served as Treasurer from Land and August, 1984, and Director of Corporate Planning since May, Development 1982. He joined the Company in 1979 as Manager of Corporate Company - 57 Development.\nDonald E. Unbekant, He has served in this capacity since January, 1994, which Executive Vice entails overall responsibility for the Company's civil and President, Civil environmental construction operations. Prior thereto, he and Environmental served in the Metropolitan New York Division of the Company Construction - 64 as President since 1992, Vice President and General Manager since 1990 and Division Manager since 1984.\nThe Company's officers are elected on an annual basis at the Board of Directors Meeting immediately following the Shareholders Meeting in May, to hold such offices until the Board of Directors Meeting following the next Annual Meeting of Shareholders and until their respective successors have been duly appointed or until their tenure has been terminated by the Board of Directors, or otherwise.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nIn response to Items 11-13, reference is made to the information to be set forth in the section entitled \"Election of Directors\" in the Proxy Statement, which is incorporated herein by reference.\n- 20 -\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------\nPERINI CORPORATION AND SUBSIDIARIES -----------------------------------\n(a)1. The following financial statements and supplementary financial information are filed as part of this report:\nPages ----- Financial Statements of the Registrant --------------------------------------\nConsolidated Balance Sheets as of December 31, 1995 and 1994 23 - 24\nConsolidated Statements of Operations for the three years ended December 31, 1995, 1994 and 1993 25\nConsolidated Statements of Stockholders' Equity for the three years ended December 31, 1995, 1994 and 1993 26\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995, 1994 and 1993 27 - 28\nNotes to Consolidated Financial Statements 29 - 41\nReport of Independent Public Accountants 42\n(a)2. The following financial statement schedules are filed as part of this report: Pages -----\nReport of Independent Public Accountants on Schedule 43\nSchedule II -- Valuation and Qualifying Accounts and Reserves 44\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or in the Notes thereto. Separate condensed financial information of the Company has been omitted since restricted net assets of subsidiaries included in the consolidated financial statements and its equity in the undistributed earnings of 50% or less owned persons accounted for by the equity method do not, in the aggregate, exceed 25% of consolidated net assets.\n(a)3. Exhibits\nThe exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index which appears on pages 45 and 46. The Company will furnish a copy of any exhibit not included herewith to any holder of the Company's common and preferred stock upon request.\n(b) During the quarter ended December 31, 1995, the Registrant made no filings on Form 8-K.\n- 21 -\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.\nPERINI CORPORATION (Registrant)\nDated: March 27, 1996 s\/David B. Perini ----------------- David B. Perini Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n(i) Principal Executive Officer David B. Perini Chairman, President and Chief Executive Officer s\/David B. Perini March 27, 1996 - ------------------ David B. Perini\n(ii) Principal Financial Officer John H. Schwarz Executive Vice President, Finance & Administration s\/John H. Schwarz March 27, 1996 - ------------------ John H. Schwarz\n(iii) Principal Accounting Officer Barry R. Blake Vice President and Controller s\/Barry R. Blake March 27, 1996 - ------------------ Barry R. Blake\n(iv) Directors\nDavid B. Perini ) Joseph R. Perini ) By Richard J. Boushka ) Marshall M. Criser ) s\/David B. Perini ----------------- Thomas E. Dailey ) David B. Perini Albert A. Dorman ) Arthur J. Fox, Jr. ) Attorney in Fact John J. McHale ) Dated: March 27, 1996 Jane E. Newman ) Bart W. Perini )\n- 22 -\nThe accompanying notes are an integral part of these financial statements.\n- 23 -\n- 24 -\nThe accompanying notes are an integral part of these financial statements.\n- 25 -\n*Equivalent to $2.125 per depositary share (see Note 7).\nThe accompanying notes are an integral part of these financial statements.\n- 26 -\nThe accompanying notes are an integral part of these financial statements.\n- 28 -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1995 1994 & 1993\n[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n[a] Principles of Consolidation - ------------------------------- The consolidated financial statements include the accounts of Perini Corporation, its subsidiaries and certain majority-owned real estate joint ventures (the \"Company\"). All subsidiaries are currently wholly-owned. All significant intercompany transactions and balances have been eliminated in consolidation. Non-consolidated joint venture interests are accounted for on the equity method with the Company's share of revenues and costs in these interests included in \"Revenues\" and \"Cost of Operations,\" respectively, in the accompanying consolidated statements of operations. All significant intercompany profits between the Company and its joint ventures have been eliminated in consolidation. Taxes are provided on joint venture results in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\".\nEffective July 1, 1993, the Company acquired Gust K. Newberg Construction Co.'s (\"Newberg\") interest in certain construction projects and related equipment. The purchase price for the acquisition was (i) approximately $3 million in cash for the equipment paid by a third party leasing company, which in turn simultaneously entered into an operating lease agreement with the Company for the use of said equipment, (ii) $1 million in cash paid by the Company, and (iii) 50% of the aggregate of net profits earned from each project from April 1, 1993 through December 31, 1994 and, with regard to one project, through December 31, 1995. This acquisition has been accounted for as a purchase. If this acquisition had been consummated as of January 1, 1993, the 1993 pro forma results would have been. Revenues of $1,134,264,000 and Net Income of $3,724,000 ($.37 per common share).\n[b] Use 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 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. The most significant estimates with regard to these financial statements relate to the estimating of final construction contract profits in accordance with accounting for long term contracts (see Note 1(c) below), estimating of net realizable value of real estate development projects (see Note 1(d) below) and estimating potential liability in conjunction with certain contingencies and commitments, as discussed in Note 11. Actual results could differ from these estimates.\n[c] Method of Accounting for Contracts - -------------------------------------- Profits from construction contracts and construction joint ventures are generally recognized by applying percentages of completion for each year to the total estimated profits for the respective contracts. The percentages of completion are determined by relating the actual cost of the work performed to date to the current estimated total cost of the respective contracts. When the estimate on a contract indicates a loss, the Company's policy is to record the entire loss. The cumulative effect of revisions in estimates of total cost or revenue during the course of the work is reflected in the accounting period in which the facts that caused the revision became known. An amount equal to the costs attributable to unapproved change orders and claims is included in the total estimated revenue when realization is probable. Profit from claims is recorded in the year such claims are resolved.\nIn accordance with normal practice in the construction industry, the Company includes in current assets and current liabilities amounts related to construction contracts realizable and payable over a period in excess of one year. Unbilled work represents the excess of contract costs and profits recognized to date on the percentage of completion accounting method over billings to date on certain contracts. Deferred contract revenue represents the excess of billings to date over the amount of contract costs and profits recognized to date on the percentage of completion accounting method on the remaining contracts.\n[d] Methods of Accounting for Real Estate Operations - ---------------------------------------------------- All real estate sales are recorded in accordance with SFAS No. 66. Gross profit is not recognized in full unless the collection of the sale price is reasonably assured and the Company is not obliged to perform significant activities after the sale. Unless both conditions exist, recognition of all or a part of gross profit is deferred.\n- 29 -\nThe gross profit recognized on sales of real estate is determined by relating the estimated total land, land development and construction costs of each development area to the estimated total sales value of the property in the development. Real estate investments are stated at the lower of cost, which includes applicable interest and real estate taxes during the development and construction phases, or market. The market or net realizable value of a development is determined by estimating the sales value of the development in the ordinary course of business less the estimated costs of completion (to the stage of completion assumed in determining the selling price), holding and disposal. Estimated sales values are forecast based on comparable local sales (where applicable), trends as foreseen by knowledgeable local commercial real estate brokers or others active in the business and\/or project specific experience such as offers made directly to the Company relating to the property. If the net realizable value of a development is less than the cost of a development, a provision is made to reduce the carrying value of the development to net realizable value. At present, the Company believes its real estate properties are carried at amounts at or below their net realizable values considering the expected timing of their disposal.\n[e] Depreciable Property and Equipment - -------------------------------------- Land, buildings and improvements, construction and computer-related equipment and other equipment are recorded at cost. Depreciation is provided primarily using accelerated methods for construction and computer-related equipment and the straight-line method for the remaining depreciable property.\n[f] Goodwill - ------------ Goodwill represents the excess of the costs of subsidiaries acquired over the fair value of their net assets as of the dates of acquisition. These amounts are being amortized on a straight-line basis over 40 years.\n[g] Income Taxes - ---------------- The Company follows Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" (see Note 5).\n[h] Earnings (Loss) Per Common Share - ------------------------------------ Computations of earnings (loss) per common share amounts are based on the weighted average number of common shares outstanding during the respective periods. During the three-year period ended December 31, 1995, earnings (loss) per common share reflect the effect of preferred dividends accrued during the year. Common stock equivalents related to additional shares of common stock issuable upon exercise of stock options (see Note 9) have not been included since their effect would be immaterial or antidilutive. Earnings (loss) per common share on a fully diluted basis are not presented because the effect of conversion of the Company's depositary convertible exchangeable preferred shares into common stock is antidilutive.\n[i] Cash and Cash Equivalents - ----------------------------- Cash equivalents include short-term, highly liquid investments with original maturities of three months or less.\n[j] Reclassifications - --------------------- Certain prior year amounts have been reclassified to be consistent with the current year classifications.\n- 30 -\n[2] JOINT VENTURES\nThe Company, in the normal conduct of its business, has entered into partnership arrangements, referred to as \"joint ventures,\" for certain construction and real estate development projects. Each of the joint venture participants is usually committed to supply a predetermined percentage of capital, as required, and to share in a predetermined percentage of the income or loss of the project. Summary financial information (in thousands) for construction and real estate joint ventures accounted for on the equity method for the three years ended December 31, 1995 follows:\nCONSTRUCTION JOINT VENTURES Financial position at December 31, 1995 1994 1993 --------- --------- ---------\nCurrent assets $227,578 $232,025 $241,905 Property and equipment, net 22,491 19,386 17,228 Current liabilities (151,311) (132,326) (151,181) --------- --------- --------- Net assets $ 98,758 $119,085 $107,952 ========= ========= =========\nOperations for the year ended December 31, 1995 1994 1993 --------- --------- ---------\nRevenue $348,730 $544,546 $626,327 Cost of operations 329,414 505,347 574,383 --------- --------- --------- Pretax income $ 19,316 $ 39,199 $ 51,944 ========= ========= =========\nCompany's share of joint ventures Revenue $182,799 $241,784 $293,547 Cost of operations 177,990 224,039 272,137 --------- --------- --------- Pretax income $ 4,809 $ 17,745 $ 21,410 ========= ========= =========\nEquity $ 61,846 $ 66,346 $ 61,156 ========= ========= =========\nThe Company has a centralized cash management arrangement with most construction joint ventures in which it is the sponsor. Under this arrangement, excess cash is controlled by the Company; cash is made available to meet the individual joint venture requirements, as needed; and interest income is credited to the ventures at competitive market rates. In addition, certain joint ventures sponsored by other contractors, in which the Company participates, distribute cash at the end of each quarter to the participants who will then return these funds at the beginning of the next quarter. Of the total cash advanced at the end of 1995 ($34.8 million) and 1994 ($8.8 million), approximately $12.1 million in 1995 and $5.5 million in 1994 was deemed to be temporary.\nREAL ESTATE JOINT VENTURES\nFinancial position at December 31, 1995 1994 1993 --------- --------- ---------\nProperty held for sale or development $ 18,350 $ 28,885 $ 35,855 Investment properties, net 173,468 177,258 191,606 Other assets 61,700 62,101 61,060 Long-term debt (72,603) (77,968) (103,090) Other liabilities* (305,755) (277,184) (256,999) ---------- --------- --------- Net assets (liabilities) $(124,840) $(86,908) $(71,568) ========== ========= =========\nOperations for the year ended December 31, 1995 1994 1993 --------- --------- ---------\nRevenue $ 49,560 $ 58,326 $ 83,710 ---------- --------- --------- Cost of operations - Depreciation $ 7,304 $ 7,245 $ 8,660 Other 73,829 71,211 92,963 ---------- --------- --------- $ 81,133 $ 78,456 $101,623 ---------- --------- --------- Pretax income (loss) $ (31,573) $(20,130) $(17,913) ========== ========= =========\nCompany's share of joint ventures Revenue $ 23,424 $ 27,059 $ 43,590 ---------- --------- --------- Cost of operations - Depreciation $ 3,275 $ 3,323 $ 4,033 Other ** 20,888 26,682 40,716 ---------- --------- --------- $ 24,163 $ 30,005 $ 44,749 ---------- --------- --------- Pretax income (loss) $ (739) $ (2,946) $ (1,159) ========== ========= =========\nEquity *** $ (49,580) $(33,091) $(27,768) ========== ========= =========\n- 31 -\n* Included in \"Other liabilities\" are advances from joint venture partners in the amount of $236.8 million in 1993, $259.3 million in 1994, and $287.6 million in 1995. Of the total advances from joint venture partners, $165.9 million in 1993, $181.9 million in 1994, and $198.7 million in 1995 represented advances from the Company.\n** Other costs are reduced by the amount of interest income recorded by the Company on its advances to the respective joint ventures.\n*** When the Company's equity in a real estate joint venture is combined with advances by the Company to that joint venture, each joint venture has a positive investment balance at December 31, 1995.\n[3] NOTES PAYABLE TO BANKS\nDuring 1994, the Company maintained unsecured short-term lines of credit totaling $18 million. In support of these credit lines, the Company paid fees approximating 1\/4 of 1% of the amount of the lines. These lines were canceled as of December 12, 1994 upon the effective date of the expanded credit agreement referred to in Note 4 below. Information relative to the Company's short-term debt activity under such lines in 1994 follows (in thousands):\nBorrowings during the year: Average $10,992 Maximum $18,000 At year-end $ -\nWeighted average interest rates: During the year 7.4% At year-end -\n[4] LONG-TERM DEBT\nPayments required under these obligations amount to approximately $5,697 in 1996, $74,877 in 1997, $3,128 in 1998, $2,150 in 1999, $ - in 2000 and $4,000 for the years 2001 and beyond.\nEffective December 12, 1994, the Company entered into a new revolving credit agreement with a group of major banks which provided, among other things, for the Company to borrow up to an aggregate of $125 million (aggregate limit under previous agreements was $85 million), with a $25 million maximum of such amount also being available for letters of credit, of which $17 million was outstanding at December 31, 1995. The Company may choose from three interest rate alternatives including a prime-based rate, as well as other interest rate options based on LIBOR (London inter- bank offered rate) or participating bank certificate of deposit rates. Borrowings and repayments may be made at any time through December 6, 1997, at which time all outstanding loans under the agreement must be paid or otherwise refinanced. The Company must pay a commitment fee of 1\/2\n- 32 -\nof 1% annually on the unused portion of the commitment.\nThe aggregate $125 million commitment is subject to permanent partial reductions based on certain events, as defined, such as proceeds from real estate sales over a defined annual minimum, certain claims and future equity offerings and was reduced accordingly during 1995 by $10.5 million.\nThe revolving credit agreement, as well as certain other loan agreements, provides for, among other things, maintaining specified working capital and tangible net worth levels and, additionally, imposes limitations on indebtedness and future investment in real estate development projects. As a result of the loss in the third quarter of 1995, the Company was in violation of certain of these financial covenants; however, the Company obtained waivers of any such violations and effective February 26, 1996, received modifications to the Credit Agreement which eliminated any non-compliance.\nOther modifications included, among other things, a requirement to reduce the amount of this loan commitment by $2 million per month for four months commencing the later of September 1, 1996 or the date of repayment and cancellation of the Bridge Loan referred to below; additional collateral which consists of all available assets not included as collateral in other agreements; and suspension of payment of the 53 1\/8 cent per share quarterly dividend on the Company's Depositary Convertible Exchangeable Preferred Shares (see Note 7) until certain financial criteria are met.\nAlso, effective February 26, 1996, the Company entered into a Bridge Loan Agreement with its revolver banks to borrow up to an additional $15 million through July 31, 1996 at an interest rate of prime plus 2%. The Bridge Loan Agreement provides for, among other things, interim mandatory reductions in the amount of the commitment equal to the net proceeds from sale of collateral not included in the Company's 1996 budget and 50% of the net proceeds from any new equity.\n[5] INCOME TAXES\nThe Company accounts for income taxes in accordance with SFAS No. 109. This standard determines deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities, given the provisions of enacted tax laws.\nThe (provision) credit for income taxes is comprised of the following (in thousands):\nFederal State Total ------- ----- ----- Current $ - $ (11) $ (11) Deferred 2,726 (104) 2,622 -------- -------- -------- $ 2,726 $ (115) $ 2,611 ======== ======== ========\nCurrent $ - $ (21) $ (21) Deferred (108) (51) (159) -------- -------- -------- $ (108) $ (72) $ (180) ======== ======== ========\nCurrent $(2,824) $ (430) $(3,254) Deferred (1,808) 101 (1,707) -------- -------- -------- $(4,632) $ (329) $(4,961) ======== ======== ========\nThe table below reconciles the difference between the statutory federal income tax rate and the effective rate provided in the statements of operations.\n1995 1994 1993 ---- ---- ----\nStatutory federal income tax rate (34)% 34 % 34 % State income taxes, net of federal tax benefit - 4 2 Change in valuation allowance 25 - - Sale of Canadian subsidiary - - 24 Goodwill and other - (1) 1 ----- ----- -----\nEffective tax rate (9)% 37 % 61 % ===== ===== ===== - 33 -\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994 (in thousands):\nThe net of the above is deferred taxes in the amount of $1,141 in 1995 and $3,722 in 1994 which is classified in the respective Consolidated Balance Sheets as follows:\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 reflect management's estimate of the amount which will be realized from future taxable income which can be predicted with reasonable certainty.\nAt December 31, 1995, the Company has unused tax credits and net operating loss carryforwards for income tax reporting purposes which expire as follows (in thousands):\nUnused Investment Foreign Net Operating Loss Tax Credits Tax Credits Carryforwards ----------- ----------- -------------\n1996-2000 $ - $ 978 $ - 2001-2004 3,532 - 968 2005-2010 - - 39,251 ------ ------ ------- $3,532 $ 978 $40,219 ====== ====== =======\nApproximately $2.8 million of the net operating loss carryforwards can only be used against the taxable income of the corporation in which the loss was recorded for tax and financial reporting purposes. - 34 -\n[6] DEFERRED INCOME TAXES AND OTHER LIABILITIES AND OTHER INCOME (EXPENSE), NET\nDEFERRED INCOME TAXES AND OTHER LIABILITIES Deferred income taxes and other liabilities at December 31, 1995 and 1994 consist of the following (in thousands):\n1995 1994 ------- ------\nDeferred Income Taxes $14,180 $ 9,788 Insurance related liabilities 20,484 18,000 Employee benefit-related liabilities 5,110 4,700 Other 12,889 1,000 ------- ------- $52,663 $33,488 ======= =======\nOTHER INCOME (EXPENSE), NET Other income (expense) items for the three years ended December 31, 1995 are as follows (in thousands):\n1995 1994 1993 ------- ------- -------\nInterest and dividend income $ 1,369 $ 205 $ 624 Minority interest (Note 1) 10 24 167 Gain on sale of Majestic - - 4,631 Bank fees (1,099) (1,100) (584) Miscellaneous income (expense), net 534 15 369 -------- -------- ------- $ 814 $ (856) $5,207 ======== ======== =======\n[7] CAPITALIZATION\nIn July 1989, the Company sold 262,774 shares of its $1 par value common stock, previously held in treasury, to its Employee Stock Ownership Trust (\"ESOT\") for $9,000,000. The ESOT borrowed the funds via a placement of 8.24% Senior Unsecured Notes (\"Notes\") guaranteed by the Company. The Notes are payable in 20 equal semi-annual installments of principal and interest commencing in January 1990. The Company's annual contribution to the ESOT, plus any dividends accumulated on the Company's common stock held by the ESOT, will be used to repay the Notes. Since the Notes are guaranteed by the Company, they are included in \"Long-Term Debt\" with an offsetting reduction in \"Stockholders' Equity\" in the accompanying Consolidated Balance Sheets. The amount included in \"Long-Term Debt\" will be reduced and \"Stockholders' Equity\" reinstated as the Notes are paid by the ESOT.\nIn June 1987, net proceeds of approximately $23,631,000 were received from the sale of 1,000,000 depositary convertible exchangeable preferred shares (each depositary share representing ownership of 1\/10 of a share of $21.25 convertible exchangeable preferred stock, $1 par value) at a price of $25 per depositary share. Annual dividends are $2.125 per depositary share and are cumulative. Generally, the liquidation preference value is $25 per depositary share plus any accumulated and unpaid dividends. The preferred stock of the Company, as evidenced by ownership of depositary shares, is convertible at the option of the holder, at any time, into common stock of the Company at a conversion price of $37.75 per share of common stock. The preferred stock is redeemable at the option of the Company at any time, in whole or in part, at declining premiums until June 1997 and thereafter at $25 per share plus any unpaid dividends. The preferred stock is also exchangeable at the option of the Company, in whole but not in part, on any dividend payment date into 8 1\/2% convertible subordinated debentures due in 2012 at a rate equivalent to $25 principal amount of debentures for each depositary share.\n[8] SERIES A JUNIOR PARTICIPATING PREFERRED STOCK\nUnder the terms of the Company's Shareholder Rights Plan, as amended, the Board of Directors of the Company declared a distribution on September 23, 1988 of one preferred stock purchase right (a \"Right\") for each outstanding share of common stock. Under certain circumstances, each Right will entitle the holder thereof to purchase from the Company one one-hundredth of a share (a \"Unit\") of Series A Junior Participating Cumulative Preferred Stock, $1 par value (the \"Preferred Stock\"), at an exercise price of $100 per Unit, subject to adjustment. The Rights will not be exercisable or transferable apart from the common stock until the occurrence of certain events viewed to be an attempt by a person or group to gain control of the Company (a \"triggering\n- 35 -\nevent\"). The Rights will not have any voting rights or be entitled to dividends.\nUpon the occurrence of a triggering event, each Right will be entitled to that number of Units of Preferred Stock of the Company having a market value of two times the exercise price of the Right. If the Company is acquired in a merger or 50% or more of its assets or earning power is sold, each Right will be entitled to receive common stock of the acquiring company having a market value of two times the exercise price of the Right. Rights held by such a person or group causing a triggering event may be null and void.\nThe Rights are redeemable at $.02 per Right by the Board of Directors at any time prior to the occurrence of a triggering event and will expire on September 23, 1998.\n[9] STOCK OPTIONS\nAt December 31, 1995 and 1994, 481,610 shares of the Company's authorized but unissued common stock were reserved for issuance to employees under its 1982 Stock Option Plan. Options are granted at fair market value on the date of grant and generally become exercisable in two equal annual installments on the second and third anniversary of the date of grant and expire eight years from the date of grant. Options for 240,000 shares common stock granted in 1992 become exercisable on March 31, 2001 if the Company achieves a certain profit target in the year 2000; may become exercisable earlier if certain interim profit targets are achieved; and to the extent not exercised, expire 10 years from the date of grant. A summary of stock option activity related to the Company's stock option plan is as follows: Number of Number of Option Price Shares Shares Per Share Exercisable ------ --------- -----------\nOutstanding at December 31, 1993 434,425 $11.06-$33.06 143,000 Granted 20,000 $13.00 Canceled (32,900) $11.06-$33.06 Outstanding at December 31, 1994 421,525 $11.06-$33.06 251,525 Granted 10,000 $10.44 Canceled (52,875) $11.06-$33.06 Outstanding at December 31, 1995 378,650 $10.44-$33.06 198,650\nWhen options are exercised, the proceeds are credited to stockholders' equity. In addition, the income tax savings attributable to nonqualified options exercised are credited to paid-in surplus.\n[10] EMPLOYEE BENEFIT PLANS\nThe Company and its U.S. subsidiaries have a defined benefit plan which covers its executive, professional, administrative and clerical employees, subject to certain specified service requirements. The plan is noncontributory and benefits are based on an employee's years of service and \"final average earnings\", as defined. The plan provides reduced benefits for early retirement and takes into account offsets for social security benefits. All employees are vested after 5 years of service. Net pension cost for 1995, 1994 and 1993 follows (in thousands): 1995 1994 1993 ------ ------ ------\nService cost - benefits earned during the period $ 988 $ 1,178 $ 1,000 Interest cost on projected benefit obligation 2,956 2,936 2,862 Return on plan assets: Actual (6,971) 1,229 (4,002) Deferred 4,217 (3,839) 1,309 Other - - 19 -------- -------- -------- Net pension cost $ 1,190 $ 1,504 $ 1,188 ======== ======== ========\nActuarial assumptions used: Discount rate 7 %* 8 3\/4%** 7 1\/2% Rate of increase in compensation 4 %* 5 1\/2% 5 1\/2% Long-term rate of return on assets 8 % 8 % 8 %\n* Rates were changed effective December 31, 1995 and resulted in a net increase of $6.8 million in the projected benefit obligation referred to below.\n** Rate was changed effective December 31, 1994 and resulted in a net decrease of $5.6 million in the projected benefit obligation referred to below. - 36 -\nThe Company's plan has assets in excess of accumulated benefit obligation. Plan assets generally include equity and fixed income funds. The status of the Company's employee pension benefit plan is summarized below (in thousands):\nThe Company also has a contributory Section 401(k) plan and a noncontributory employee stock ownership plan (ESOP) which cover its executive, professional, administrative and clerical employees, subject to certain specified service requirements. Under the terms of the Section 401(k) plan, the provision is based on a specified percentage of profits, subject to certain limitations. Contributions to the related employee stock ownership trust (ESOT) are determined by the Board of Directors and may be paid in cash or shares of Company common stock.\nThe Company's policy is generally to fund currently the costs accrued under the pension plan and the Section 401(k) plan.\nThe Company also has an unfunded supplemental retirement plan for certain employees whose benefits under principal salaried retirement plans are reduced because of compensation limitations under federal tax laws. Pension expense for this plan was $.2 million in 1995 and 1994 and $.1 million in 1993. At December 31, 1995 the projected benefit obligation was $1.3 million. A corresponding accumulated benefit obligation of $.8 million has been recognized as a liability in the consolidated balance sheet and is equal to the amount of the vested benefits.\nIn addition, the Company has an incentive compensation plan for key employees which is generally based on achieving certain levels of profit within their respective business units.\nThe aggregate amounts provided under these employee benefit plans were $7.6 million in 1995, $9.2 million in 1994 and $8.5 million in 1993.\nThe Company also contributes to various multiemployer union retirement plans under collective bargaining agreements, which provide retirement benefits for substantially all of its union employees. The aggregate amounts provided in accordance with the requirements of these plans were $12.6 million in 1995, $12.4 million in 1994, and $5.2 million in 1993. The Multiemployer Pension Plan Amendments Act of 1980 defines certain employer obligations under multiemployer plans. Information regarding union retirement plans is not available from plan administrators to enable the Company to determine its share of unfunded vested liabilities.\n[11] Contingencies and Commitments\nIn connection with the Rincon Center real estate development joint venture, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on both mortgage and bond financing covering a project with loans totaling $59 million; has issued a secured letter of credit to collateralize $3.7 million of these borrowings; has guaranteed amortization payments on these borrowings which the Company estimates to be a maximum of $7.2 million; and has guaranteed a master lease under a sale operating lease-back transaction. In calculating the potential obligation under the master lease guarantee, the Company has an agreement with its lenders which employs a 10% discount rate and no increases in future rental rates beyond current lease terms. Based on these assumptions, management believes its additional future obligation will not\n- 37 -\nexceed $2.3 million. The Company has also guaranteed the $3.7 million letter of credit, $5.0 million of the subsidiary's $7.2 million amortization guaranty and any obligation under the master lease during the next three years. As part of the sale operating lease-back transaction, the joint venture, in which the Company's real estate subsidiary is a 46% general partner, agreed to obtain a financial commitment on behalf of the lessor to replace at least $43 million of long-term financing by July 1, 1993. To satisfy this obligation, the partnership successfully extended existing financing to July 1, 1998. To complete the extension, the partnership had to advance funds to the lessor sufficient to reduce the financing from $46.5 million to $40.5 million. Subsequent payments through 1995 have further reduced the loan to $38.2 million. In addition, as part of the obligations of the extension, the partnership will have to further amortize the debt from its current level to $33 million through additional lease payments over the next three years. If by January 1, 1998, the joint venture has not received a further extension or new commitment for financing on the property for at least $33 million, the lessor will have the right under the lease to require the joint venture to purchase the property for approximately $18.8 million in excess of the then outstanding debt.\nIn 1993, the joint venture also extended $29 million of the $61 million financing then outstanding through October 1, 1998. This extension required a $.6 million up front paydown. Subsequent payments through 1995 further reduced the loan by $2.7 million. The joint venture may be required to amortize up to $9.1 million more of the principal, however, under certain conditions, that amortization could be as low as $6.8 million. Total lease payments and loan amortization obligations at Rincon Center through 1997 are as follows: $7.5 million in 1996 and $7.3 million in 1997. It is expected that some but not all of these requirements will be generated by the project's operations. The Company's real estate subsidiary and, to a more limited extent, the Company, is obligated to fund any of the loan amortization and\/or lease payments at Rincon in the event sufficient funds are not generated by the property or contributed to it by its partners. Based on current Company forecasts, it is expected the maximum exposure to service these commitments in each of the years through 1997 is as follows: $5.4 million in 1996 and $4.0 million in 1997. Both years include an estimate for tenant improvements which may or may not be required.\nIn a separate agreement related to this same property, the 20% co-general partner has indicated it does not currently have nor does it expect to have the financial resources to fund its share of capital calls. Therefore, the Company's wholly-owned real estate subsidiary agreed to lend this 20% co-general partner on an as-needed basis, its share of any capital calls which the partner cannot meet. In return, the Company's subsidiary receives a priority return from the partnership on those funds it advances for its partner and penalty fees in the form of rights to certain other distributions due the borrowing partner from the partnership. The severity of the penalty fees increases in each succeeding year for the next several years. The subsidiary has advanced approximately $3 million to date under this agreement.\nIn connection with a second real estate development joint venture known as the Resort at Squaw Creek, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on mortgage financing with a total bank loan value currently estimated at $46 million; has guaranteed $10 million of loan principal; has posted a letter of credit for $2.0 million as its part of credit support required to extend the maturity of the loan to May 1997; and has guaranteed leases which aggregate $1.1 million on a present value basis as discounted at 10%. Effective May 1, 1995, the loan was renewed for an additional two years with an option to renew for a third year. Required principal payments are $250,000 per quarter for the first year and $500,000 per quarter for the second year.\nThe subsidiary also has an obligation through the year 2001 to cover approximately a $2 million per year preferred return to its joint venture partner at the Resort if the funds are not generated from hotel operations. Although results have shown improvement since the Resort opened in late 1990, it is not expected that hotel operations will contribute to the obligation during 1996. Under the terms of the loan extension, payment of the preferred return out of operating profits requires lender approval.\nIncluded in the loan agreements related to the above joint ventures, among other things, are provisions that, under certain circumstances, could limit the subsidiary's ability to dividend funds to the Company. In the opinion of management, these provisions should not affect the operations of the Company or the subsidiary.\nOn July 30, 1993, the U.S. District Court (D.C.), in a preliminary opinion, upheld terminations for default on two adjacent contracts for subway construction between Mergentime-Perini, under two joint ventures, and the Washington Metropolitan Area Transit Authority (\"WMATA\") and found the\n- 38 -\nMergentime Corporation, Perini Corporation and the Insurance Company of North America, the surety, jointly and severally liable to WMATA for damages in the amount of $16.5 million, consisting primarily of excess reprocurement costs to complete the projects. Many issues were left partially or completely unresolved by the opinion, including substantial joint venture claims against WMATA. As a result of developments in the case during the third quarter of 1995, the Company established a reserve with respect to the litigation. Management believes the reserve should be adequate to cover the potential ultimate liability in this matter.\nContingent liabilities also include liability of contractors for performance and completion of both company and joint venture construction contracts. In addition, the Company is a defendant in various lawsuits (some of which are for significant amounts). In the opinion of management, the resolution of these matters will not have a material effect on the accompanying financial statements.\n- 39 -\n[12] UNAUDITED QUARTERLY FINANCIAL DATA\nThe following table sets forth unaudited quarterly financial data for the years ended December 31, 1995 and 1994 (in thousands, except per share amounts):\n[13] BUSINESS SEGMENTS AND FOREIGN OPERATIONS\nThe Company is currently engaged in the construction and real estate development businesses. The Company provides general contracting, construction management and design-build services to private clients and public agencies throughout the United States and selected overseas locations. The Company's construction business involves three types of operations: civil and environmental (\"heavy\"), building and international. The Company's real estate development operations are concentrated in Arizona, California, Florida, Georgia and Massachusetts; however, the Company has not commenced the development of any new real estate projects since 1990. The following tables set forth certain business and geographic segment information relating to the Company's operations for the three years ended December 31, 1995 (in thousands):\nBusiness Segments Revenues\n1995 1994 1993 ------------ ----------- ----------\nConstruction $1,056,673 $ 950,884 $1,030,341 Real Estate 44,395 61,161 69,775 ------------ ----------- ---------- $1,101,068 $1,012,045 $1,100,116 ============ =========== ==========\nIncome (Loss) From Operations\n1995 1994 1993 ------------ ----------- ----------\nConstruction $ (15,322) $ 13,989 $ 15,164 Real Estate (2,921) 732 240 Corporate (4,185) (5,909) (6,830) ------------ ----------- ----------- $ (22,428) $ 8,812 $ 8,574 ============ =========== ===========\nAssets\n1995 1994 1993 ------------ ------------ ----------\nConstruction $ 298,564 $ 262,850 $ 219,604 Real Estate 209,789 209,635 218,715 Corporate* 30,898 10,015 38,059 ------------ ------------ ---------- $ 539,251 $ 482,500 $ 476,378 ============ ============ ==========\nCapital Expenditures\n1995 1994 1993 ----------- ----------- ----------\nConstruction $ 1,960 $ 2,491 $ 4,387 Real Estate 9,555 10,274 23,590 ----------- ----------- ---------- $ 11,515 $ 12,765 $ 27,977 =========== =========== ==========\n- 40 -\nDepreciation\n1995 1994 1993 ----------- ----------- -----------\nConstruction $ 2,369 $ 2,551 $ 2,552 Real Estate** 400 328 963 ----------- ----------- ----------- $ 2,769 $ 2,879 $ 3,515 =========== =========== =========== Geographic Segments Revenues 1995 1994 1993 ------------ ----------- -----------\nUnited States $1,084,390 $ 996,832 $1,064,380 Foreign 16,678 15,213 35,736 ----------- ----------- ----------- $1,101,068 $1,012,045 $1,100,116 =========== =========== ===========\nIncome (Loss) From Operations\n1995 1994 1993 ----------- ----------- -----------\nUnited States $ (15,405) $ 17,275 $ 17,249 Foreign (2,838) (2,554) (1,845) Corporate (4,185) (5,909) (6,830) ----------- ----------- ----------- $ (22,428) $ 8,812 $ 8,574 =========== =========== ===========\nAssets\n1995 1994 1993 ----------- ----------- -----------\nUnited States $503,114 $ 467,298 $ 433,488 Foreign 5,239 5,187 4,831 Corporate* 30,898 10,015 38,059 ----------- ----------- ----------- $539,251 $ 482,500 $ 476,378 =========== =========== ===========\n* In all years, corporate assets consist principally of cash, cash equivalents, marketable securities and other investments available for general corporate purposes.\n** Does not include approximately $3 to $4 million of depreciation that represents its share from real estate joint ventures. (See Note 2 to Notes to the Consolidated Financial Statements.)\nContracts with various federal, state, local and foreign governmental agencies represented approximately 56% of construction revenues in 1995 and 1994, and 54% in 1993.\n- 41 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Perini Corporation:\nWe have audited the accompanying consolidated balance sheets of PERINI CORPORATION (a Massachusetts corporation) and subsidiaries as of December 31, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Perini 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 February 26, 1996\n- 42 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE ----------------------------------------------------\nTo the Stockholders of Perini Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in this Form 10-K, and have issued our report thereon dated February 26, 1996. Our audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The supplemental schedule listed in the accompanying index is the responsibility of the Company's management and is presented for 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 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 February 26, 1996\n- 43 -\nSCHEDULE II PERINI CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS OF DOLLARS)\n(1) Represents reserve reclassed with related asset to \"Real estate inventory\".\n(2) Represents sales of real estate properties.\n- 44 -\nEXHIBIT INDEX\nThe following designated exhibits are, as indicated below, either filed herewith or have heretofore been filed with the Securities and Exchange Commission under the Securities Act of 1933 or the Securities Act of 1934 and are referred to and incorporated herein by reference to such filings.\nExhibit 3. Articles of Incorporation and By-laws\nIncorporated herein by reference:\n3.1 Restated Articles of Organization - As amended through July 7, 1994 - Exhibit 3.1 to 1994 Form 10-K, as filed.\n3.2 By-laws - As amended through September 14, 1990 - Exhibit 3.2 to 1991 Form 10-K, as filed.\nExhibit 4. Instruments Defining the Rights of Security Holders, Including Indentures\nIncorporated herein by reference:\n4.1 Certificate of Vote of Directors Establishing a Series of a Class of Stock determining the relative rights and preferences of the $21.25 Convertible Exchangeable Preferred Stock - Exhibit 4(a) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.2 Form of Deposit Agreement, including form of Depositary Receipt - Exhibit 4(b) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.3 Form of Indenture with respect to the 8 1\/2% Convertible Subordinated Debentures Due June 15, 2012, including form of Debenture - Exhibit 4(c) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.4 Shareholder Rights Agreement and Certificate of Vote of Directors adopting a Shareholders Rights Plan providing for the issuance of a Series A Junior Participating Cumulative Preferred Stock purchase rights as a dividend to all shareholders of record on October 6, 1988, as amended and restated as of May 17, 1990 - filed herewith.\nExhibit 10. Material Contracts\nIncorporated herein by reference:\n10.1 1982 Stock Option and Long Term Performance Incentive Plan - Exhibit A to Registrant's Proxy Statement for Annual Meeting of Stockholders dated April 15, 1992.\n10.2 Perini Corporation Amended and Restated General Incentive Compensation Plan - Exhibit 10.2 to 1991 Form 10-K, as filed.\n10.3 Perini Corporation Amended and Restated Construction Business Unit Incentive Compensation Plan - Exhibit 10.3 to 1991 Form 10-K, as filed.\n10.4 $125 million Credit Agreement dated as of December 6, 1994 among Perini Corporation, the Banks listed herein, Morgan Guaranty Trust Company of New York, as Agent, and Shawmut Bank, N.A., Co-Agent Exhibit 10.4 to 1994 Form 10-K, as filed. - 45 -\nEXHIBIT INDEX (Continued)\n10.5 Amendment No. 1 as of February 26, 1996 to the Credit Agreement dated as of December 6, 1994 among Perini Corporation, the Banks listed herein, Morgan Guaranty Trust Company of New York, as Agent, and Fleet National Bank of Massachusetts (f\/k\/a Shawmut Bank, N.A.), as Co- Agent - filed herewith.\n10.6 Bridge Credit Agreement dated as of February 26, 1996 among Perini Corporation, the Bridge Banks listed herein, Morgan Guaranty Trust Company of New York, as Agent, and Fleet National Bank of Massachusetts (f\/k\/a Shawmut Bank, N.A.) as Co-Agent - filed herewith.\nExhibit 22. Subsidiaries of Perini Corporation - filed herewith.\nExhibit 23. Consent of Independent Public Accountants - filed herewith.\nExhibit 24. Power of Attorney - filed herewith.\nExhibit 27. Financial Data Schedule - filed herewith.\n- 46 -\nEXHIBIT 22\nPERINI CORPORATION SUBSIDIARIES OF THE REGISTRANT\n- 47 -\nEXHIBIT 23\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the use of our reports, dated February 26, 1996, included in Perini Corporation's Annual Report on this Form 10-K for the year ended December 31, 1995, and into the Company's previously filed Registration Statements Nos. 2-82117, 33-24646, 33-46961, 33-53190, 33-53192, 33-60654, 33- 70206, 33-52967 and 33-58519.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts March 26, 1996\n- 48 -\nEXHIBIT 24 POWER OF ATTORNEY\nWe, the undersigned, Directors of Perini Corporation, hereby severally constitute David B. Perini, John H. Schwarz and Richard E. Burnham, and each of them singly, our true and lawful attorneys, with full power to them and to each of them to sign for us, and in our names in the capacities indicated below, any Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 to be filed with the Securities and Exchange Commission and any and all amendments to said Annual Report on Form 10-K, hereby ratifying and confirming our signatures as they may be signed by our said Attorneys to said Annual Report on Form 10-K and to any and all amendments thereto and generally to do all such things in our names and behalf and in our said capacities as will enable Perini Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission.\nWITNESS our hands and common seal on the date set forth below.\ns\/David B. Perini Director March 13, 1996 - ----------------- -------- -------------- David B. Perini Date\ns\/Joseph R. Perini Director March 13, 1996 - ------------------ -------- -------------- Joseph R. Perini Date\ns\/Richard J. Boushka Director March 13, 1996 - -------------------- -------- -------------- Richard J. Boushka Date\ns\/Marshall M. Criser Director March 13, 1996 - -------------------- -------- -------------- Marshall M. Criser Date\ns\/Thomas E. Dailey Director March 13, 1996 - ------------------ -------- -------------- Thomas E. Dailey Date\ns\/Albert A. Dorman Director March 13, 1996 - ------------------ -------- -------------- Albert A. Dorman Date\ns\/Arthur J. Fox, Jr. Director March 13, 1996 - -------------------- -------- -------------- Arthur J. Fox, Jr. Date\nDirector March 13, 1996 - -------------------- -------- -------------- Nancy Hawthorne Date\ns\/John J. McHale Director March 13, 1996 - ---------------- -------- -------------- John J. McHale Date\ns\/Jane E. Newman Director March 13, 1996 - ---------------- -------- -------------- Jane E. Newman Date\ns\/Bart W. Perini Director March 13, 1996 - ---------------- -------- -------------- Bart W. Perini Date\n- 49 -","section_15":""}
{"filename":"811863_1995.txt","cik":"811863","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral Background\nFFP Partners, L.P. (\"FFPLP,\" the \"Partnership\" or the \"Company\"), through its subsidiaries, owns and operates convenience stores, truck stops, and self-service motor fuel outlets over an eleven state area. It also operates check cashing outlets and sells motor fuel on a wholesale basis, both primarily in Texas. FFPLP, a Delaware limited partnership, was formed in December 1986, pursuant to the Agreement of Limited Partnership of FFP Partners, L.P. (the \"Partnership Agreement\"). FFP Partners Management Company, Inc. (\"FFPMC\" or the \"General Partner\") serves as the general partner of the Partnership. FFPMC or a subsidiary also serves as the general partner of the Partnership's subsidiary partnerships. References herein to the \"Company\" include FFPLP and its subsidiaries.\nThe Company commenced operations in May 1987 upon the purchase of its initial base of retail outlets from affiliates of the General Partner. The purchase of these outlets was completed in conjunction with the Company's initial public offering of 2,065,000 Class A Units of limited partnership interest, representing a 56% interest in the Company. In connection with this transaction, 1,585,000 Class B Units of limited partnership interest, representing a 43% interest in the Company, were issued to affiliates of the General Partner and the General Partner received its 1% interest in the Company. (As permitted in the Partnership Agreement, certain of these Class B Units were converted to Class A Units in January 1996.) The senior executives of the Company had owned and managed these operations prior to their acquisition by the Company. Although the companies from which the Company acquired these retail outlets engage in other businesses which they conducted in the past, they agreed not to engage in the convenience store, retail motor fuel, or other businesses which compete with the Company without prior approval by a majority of the General Partner's disinterested directors. The affiliates of the General Partner that received Class B Units upon the Partnership's commencement of operations were: Economy Oil Company; Gas-Go, Inc.; Gas-N-Sav, Inc.; Hi-Lo Corporation; Hi-Lo Distributors, Inc.; Nu-Way Distributing Company; Nu-Way Oil Company; Swifty Distributors, Inc.; Thrift-Way, Inc.; Thrift Distributors, Inc.; and Thrift Wholesale Company.\nThe Company maintains its principal executive offices at 2801 Glenda Avenue, Fort Worth, Texas 76117-4391; its telephone number is 817\/838-4700.\nOperations\nDescription of Operations. The Company conducts its operations principally through its 99%-owned subsidiary, FFP Operating Partners, L.P. (\"FFPOP\"), a Delaware limited partnership. FFPMC holds a 1% general partner's interest in FFPOP. The Company has other direct or indirect subsidiaries: Direct Fuels, L.P; FFP Financial Services, L.P.; FFP Illinois Money Orders, Inc.; Practical Tank Management, Inc., and FFP Transportation, L.L.C. These companies are engaged in the same businesses as FFPOP or in businesses that are complimentary to its activities.\nConvenience Stores. At December 31, 1995, the Company operated 127 convenience stores, the same number as at the previous year end. Although the Company sold the the merchandise operations of ten outlets to independent operators in 1995, it opened or converted from self-service gasoline outlets a like number of stores. {See Store Development.} The Company's stores are open seven days a week, offer extended hours (14 of the stores are open 24 hours a day, the remainder generally are open from 6:00 am to midnight), and emphasize convenience to the customer through location, merchandise selection, and service. The convenience stores sell groceries, tobacco products, take-out foods and beverages (including alcoholic beverages where local laws permit), dairy products, and non-food merchandise such as health and beauty aids and magazines and, at all except two of the stores, motor fuel. Five of the stores also offer check cashing and related money transfer services. Food service in the convenience stores varies from pre-packaged sandwiches and fountain drinks to full food-service delicatessens (at 41 stores) with limited in-store seating. During late 1993, the Company began installing small \"express\" franchises of Kentucky Fried Chicken(R) and Subway Sandwiches(R) in selected convenience stores and at the end of 1995 three of its convenience stores had such outlets in them. {See Store Development; Products, Store Design and Operation.} The convenience stores operate under several different trade names, all of which were used by the predecessor companies. The principal trade names are \"Kwik Pantry,\" \"Nu-Way,\" and \"Economy Drive-Ins.\"\nFor fiscal year 1995, the convenience stores accounted for 39% (44% in 1994) of the Company's consolidated revenues. They had average weekly per store merchandise sales of $9,560 and motor fuel sales of 12,093 gallons. In fiscal 1994, average weekly sales were $9,901 of merchandise and 12,013 gallons of fuel.\nTruck Stops. At December 31, 1995, the Company operated ten truck stops, the same number as at the previous year end. The truck stops, which principally operate under the trade name of \"Drivers,\" are located on interstate and other highways and are similar in their operations to the convenience stores, although the merchandise mix is directed towards truck drivers and the traveling public. Five of the truck stops have full service restaurants; the Company operates two of the restaurants and leases the other three to independent operators. The other five outlets offer prepared-to-order food service, including two outlets which have a combination Kentucky Fried Chicken\/Taco Bell \"express\" franchise and one which has a Pizza Hut franchise within the store. In 1995, the truck stops (including their associated restaurants and food service facilities) accounted for 13% (15% in 1994) of the Company's consolidated revenues, with average weekly per outlet merchandise and food sales (including food service sales) of $17,506 ($18,160 in 1994) and fuel sales of 68,274 gallons (79,348 gallons in 1994).\nSelf-Service Gasoline Outlets. The Company operated 194 self-service gasoline outlets at December 31, 1995, a net increase of 9 outlets since the prior year end. This increase resulted principally from the sale of the merchandise operations of certain convenience stores, referred to above. Although these convenience store operations were sold, the Company retained the motor fuel concession at these locations. In addition, the Company acquired some outlets through the execution of new contracts with convenience store operators and the re-opening of previously closed locations and closed or disposed of other locations. The Company's self-service gasoline outlets consist of fuel pumps and related storage equipment located at independently operated convenience stores. These outlets are operated pursuant to contracts that generally obligate the Company to provide motor fuel inventory, fuel storage and dispensing equipment, and maintenance of the fuel equipment while the store operator agrees to collection and remittance procedures. The convenience store operators are compensated by commissions based on profits and\/or the volume of fuel sold. In addition, the contracts generally grant the Company the right of first refusal to purchase the operator's convenience store should it be offered for sale. Many of the contracts have renewal options and, based on past experience, the General Partner believes that a significant number of those contracts which do not have renewal options will be renegotiated and renewed upon expiration. In addition to the contractual arrangement between the store operator and the Company, 99 of these operators also lease or sublease the store building and land from the Company or affiliates of the General Partner.\nDuring fiscal 1995, the self-service gasoline outlets had average weekly per outlet fuel sales of 7,794 gallons as compared to 7,579 gallons in fiscal 1994. In 1995, the Company's self-service gasoline outlets accounted for 23% (20% in 1994) of the Company's consolidated revenues.\nWholesale Fuel Sales. The Company has sold motor fuel on a wholesale basis to smaller independent and regional chains of fuel retailers since it commenced operations. The wholesale fuel operation was expanded in later years to include sales to commercial end-users of motor fuels, such as local governmental units, operators of vehicle fleets, and public utilities. In 1995, the Company's wholesale operations contributed 24% of consolidated revenues (20% in 1994). During 1995, the Company did not have facilities for the bulk storage of motor fuel. Accordingly, purchases were made to fill specific customer orders.\nIn March 1996, the Company completed the purchase of a non-operating fuel processing facility and bulk storage terminal located in Euless, Texas. The facility will require renovation to make it operational and the Company does not anticipate its becoming operational until late 1996 or early 1997.\nThe Company has been designated a \"jobber\" for Citgo, Chevron, Fina, Conoco, Texaco, Coastal, Diamond Shamrock, Sinclair, and Phillips 66. This designation enables the Company to work with independent fuel retailers to qualify the retailers to operate as a branded outlet for the large oil company. The Company then supplies motor fuel to such retailers on a wholesale basis under contracts ranging from five to ten years.\nManagement believes the Company's fuel wholesale activities enhance its relationships with its fuel vendors by increasing the volume of purchases from such vendors. In addition, the wholesale activities permit the Company to develop relationships with smaller fuel retailers that may, at some future time, be interested in entering into a self-service gasoline marketing arrangement with the Company. {See Self-Service Gasoline Outlets.}\nMarket Strategy. The Company's market strategy emphasizes the operation and development of existing stores and retail outlets in small communities rather than metropolitan markets. In general, the Company believes stores in communities with populations of 50,000 or less experience a more favorable operating environment, primarily due to less competition from larger national or regional chains and access to a higher quality and more stable labor force. In addition, costs of land, reflected in both new store development costs and acquisition prices for existing stores and retail outlets, are generally lower in small communities. As a result of these factors, the Company believes this market strategy enables it to achieve a higher average return on investment than would be achieved by operating primarily in metropolitan markets.\nStore Development. From 1989 through 1993 the Company increased the number of its convenience stores from 129 to 145, primarily by the acquisition of existing stores, including five stores in Illinois that were acquired, at no cost, by assuming the operation of stores previously operated by a company owned by the Company's Executive Vice President - Convenience Stores who was hired in the fourth quarter 1992, and five stores that were formerly self-service gasoline outlets. In 1994, the Company reduced the number of its convenience stores to 127. This decline resulted from the closing of the five Illinois stores acquired in 1992 and the sale of the merchandise operations at 15 convenience stores. The Company also converted certain of its self-service gasoline outlets to Company operated convenience stores and closed some other outlets.\nIn early 1994 in its continuing endeavor to increase the productivity and operating efficiency of its existing store base, the Company identified outlets that it believed would contribute more to the earnings of the Company if operated by independent operators rather than by the Company. The Company undertook a program to sell the merchandise operations of these outlets to independent operators. In 1995 and 1994 the Company sold the merchandise operations at 10 and 15 of these outlets, respectively. Because of their different overhead structure, independent operators are often able to operate the stores less expensively than can the Company. These sales were structured such that the Company retained the real estate or leasehold interest and leased or subleased the land and building to the operator for a five year period with a five year renewal option. The Company also entered into a self-service gasoline agreement covering the fuel sales at these locations. Management believes that the sales of these stores and the resulting combination of rents, fuel profits, and other income enhance the profitability of these outlets to the Company. The Company is continuing to negotiate the sales of the merchandise operation of additional stores.\nIn addition to the sales of the merchandise operations at certain convenience stores, discussed above, management is seeking other ways to increase the productivity of the Company's present base of convenience store and truck stop outlets. A part of this effort involves the installation of limited-menu \"express\" outlets of national food franchises in Company outlets. In March 1994, the Company commenced operating combination Kentucky Fried Chicken\/Taco Bell outlets in two truck stops, Kentucky Fried Chicken outlets in two convenience stores, and a Subway Sandwich franchise in one convenience store. In 1995 a Pizza Hut outlet was added in one of the Company's truck stops. The Company's experience with this type of food service operation indicates that it increases store traffic as it offers the advantage of national name-brand recognition and advertising. In addition, the training and operational programs of these franchisors provide a consistent and high-quality product to the Company's customers. Management is evaluating the existing operations to determine if it would be appropriate to install additional outlets of this type in other locations. It is also evaluating the relative merits of the various types of franchises.\nOpportunities to expand self-service gasoline outlets are limited by competitive factors, including the existence of established facilities at most independent convenience stores. However, the Company continues to pursue the acquisition of this type of outlet principally through the development of relationships through its fuel wholesaling operations.\nProducts, Store Design and Operation. The number and type of merchandise items stocked in the convenience stores vary from one store to another depending upon the size and location of the store and the type of products desired by the customer base served by the store. However, the stores generally carry national or regional brand name merchandise of the type customarily carried by competing convenience stores. Substantially all the convenience stores and truck stops offer fast foods such as hot dogs, pre-packaged sandwiches and other foods, and fountain drinks. Forty- one of the convenience stores have facilities for daily preparation of fresh food catering to local tastes, including fried chicken and catfish, tacos, french fries, and made-to-order sandwiches. Also, as discussed above three convenience stores and three truck stops have small \"express\" outlets of national fast-food franchises.\nAlthough the stores vary in layout and design, schematic diagrams for each store are used to direct the store manager in the placement of products to maximize exposure of high turnover and high margin items to the flow of customer traffic.\nDuring 1992 and 1993, the Company aggressively priced certain merchandise in its stores, especially cigarettes, in order to increase sales and customer traffic. Having built its store traffic, during 1994 and 1995 the Company became less aggressive in pricing certain items and focused on improving its merchandise gross profit margin. As a result, average weekly merchandise sales increased in 1992 and 1993 over the respective prior years and declined in 1994 and 1995. However, despite the sales declines in 1994 and 1995, managment believes that its overall profitability has been enhanced.\nThe Company utilizes a team approach to its marketing function rather than having a specific person who is responsible for that activity. Senior operations executives and other management personnel continually review and evaluate products and services for possible inclusion in the Company's retail outlets. Special emphasis is given to those goods or services which carry a higher than usual gross profit margin, will increase customer traffic within the stores, or complement other items already carried by the stores. The marketing teams, which include the Regional Managers, in conjunction with the Company's vendors, develop and implement promotional programs and incentives on selected items, such as fountain drinks and fast food items. In addition, new products and services are reviewed on a periodic basis to ensure a competitive product selection. Due to the geographic distribution of the Company's stores and the variety of trade names under which they are operated, the use of advertising is limited to location signage, point-of-sale promotional materials, advertisements in local newspapers, and locally distributed flyers.\nOver the last several years, the Company has increased the number of its \"branded\" outlets, those which are affiliated with a large oil company. In March 1996, the Company had 209 retail outlets which were branded, as compared to 65 such outlets in 1990. The Company has outlets that are branded Citgo, Chevron, Fina, Conoco, Texaco, Coastal, and Diamond Shamrock. Branded locations generally have higher fuel sales volumes (in gallons) than non-branded outlets due to the advertising and promotional activities of the respective major oil company and the acceptance of such oil company's proprietary credit cards. The increased customer traffic associated with higher fuel sales tends to increase merchandise sales volumes, as well. The Company continues to evaluate the desirability of branding additional outlets. In addition to the Company operated convenience stores and self-service fuel outlets that are branded, the Company also serves as a wholesale distributor to 160 branded retail outlets.\nMerchandise Supply. Based on competitive bids, the Company has selected a single company as the primary grocery and merchandise supplier to its convenience stores and truck stops. Certain merchandise items, however, such as bakery goods, dairy products, soft drinks, beer, and other perishable products, are generally purchased from local vendors and\/or wholesale route salespeople. The Company believes it could replace any of its merchandise suppliers, including its primary merchandise supplier, with no significant adverse effect on its operations.\nMotor Fuel Supply. The Company purchases fuel for its branded retail outlets and branded wholesale customers from the respective oil company which branded the outlet and for its unbranded outlets from large integrated oil companies and independent refineries. In order to maintain flexibility in the purchase of motor fuel, the Company does not have long-term contracts with any suppliers of petroleum products covering more than 10% of its motor fuel supply.\nDuring recent years, the Company has not experienced any difficulties in obtaining sufficient quantities of motor fuel to satisfy retail sales requirements. However, unanticipated national or international events could result in a curtailment of motor fuel supplies to the Company, thereby adversely affecting motor fuel sales. In addition, management believes a significant portion of its merchandise sales are to customers who also purchase motor fuel. Accordingly, reduced availability of motor fuel could negatively impact other facets of the Company's operations, as well.\nCompetition\nThe convenience store industry is highly competitive. Most convenience stores in the Company's market areas sell motor fuel; in addition, merchandise similar or identical to that sold by the Company's stores is generally available to competitors. The Company competes with local and national chains of supermarkets, drug stores, fast-food operations, and motor fuel retailers. It also competes with independently operated convenience stores and national chains of convenience stores such as \"7-Eleven\" and \"Circle K.\" Some of the Company's competitors have large sales volumes, benefit from national or regional advertising, and have greater financial resources than the Company. Major oil companies are also becoming a significant factor in the convenience store industry as they convert outlets that previously sold only motor fuel to convenience stores; however, major oil company stores generally carry a more limited selection of merchandise than that carried by the Company's outlets and operate principally in metropolitan areas, where the Company has few outlets.\nThe Company believes each of its retail outlets competes with other retailers in its immediately surrounding area, generally within a radius of one to two miles. Management believes the Company's outlets compete based on location, accessibility, the variety of products and services offered, extended hours of operation, price, and prompt check-out service.\nThe Company's wholesale fuel operation is also very competitive. Management believes this business is highly price sensitive, although the ability to compete is also dependent upon providing quality products and reliable delivery schedules. The Company's wholesale fuel operation competes for customers with large integrated oil companies and smaller, independent refiners and fuel jobbers, some of which have greater financial resources than the Company. Management believes it can compete effectively in this business because of the Company's purchasing economies, numerous supply sources, and the reluctance of many larger suppliers to sell to smaller customers.\nEmployees\nAt March 24, 1996, the Company employed 1,143 people (including part-time employees). In addition to employees of the Company, the General Partner employs five executive officers who perform services for the Company; the Company reimburses the General Partner for the direct and indirect costs of these personnel.\nThere are no collective bargaining agreements between the Company and any of its employees. Management believes the relationship with employees of the Company is good.\nTrademarks and Trade Names\nThe Company's convenience stores and truck stops are operated under a variety of trade names, including \"Kwik Pantry,\" \"Nu-Way,\" \"Economy,\" \"Dynamic Minute Mart,\" \"Drivers,\" and \"Drivers Diner.\" New outlets generally use the trade name of the Company's stores predominant in the geographic area where the new store is located. The Company sells money orders in its outlets, and through agents, under the service mark \"Financial Express Money Order Company.\" The money orders are produced using a computer controlled laser printing system developed by the Company. This system is also marketed to third parties under the name of \"Lazer Wizard.\"\nEight of the Company's truck stops operate under the trade name of \"Drivers;\" the two other truck stops use the same trade name as the Company's convenience stores in the area in which they are located.\nThe Company has registered the names \"FFP Partners,\" \"Kwik Pantry,\" \"Drivers,\" \"Drivers Diner,\" \"Financial Express Money Order Company,\" and \"Lazer Wizard\" as service marks or trademarks under federal law.\nInsurance\nThe Company does not carry workers' compensation insurance in the State of Texas. However, it has insurance policies, which limit the Company's exposure to losses related to claims of failure to provide a safe work environment. Management believes the limits, and related deductibles of this coverage, are prudent in light of the Company's exposure to loss. The Company maintains workers' compensation coverages in the other states in which it conducts business.\nThe Company maintains liability coverages for its vehicles which meet or exceed state requirements but it does not carry automobile physical damage insurance. Insurance covering physical damage of properties owned by the Company is generally carried only for selected properties. The Company maintains property damage coverage on leased properties as required by the terms of the leases thereon.\nThe Company maintains general liability insurance with limits and deductibles management believes prudent in light of the exposure of the Company to loss and the cost of the insurance. The Company does not maintain any insurance covering losses due to environmental contamination. {See Government Regulation - Environmental Regulation.}\nThe Company monitors the insurance markets and will obtain such additional insurance coverages as it believes appropriate at such time as they might become available at costs management believes reasonable.\nGovernment Regulation\nAlcoholic Beverage Licenses. The Company's retail outlets sell alcoholic beverages in areas where such sales are legally permitted. The sale of alcoholic beverages is generally regulated by state and local laws which grant to various agencies the authority to approve, revoke, or suspend permits and licenses relating to the sale of such beverages. In most states, such agencies have wide-ranging discretion to determine if a licensee or applicant is qualified to be licensed. The State of Texas requires that licenses for the sale of alcoholic beverages be held, directly or indirectly, only by individual residents of Texas or by companies controlled by such persons. Therefore, the Company has an agreement with a corporation controlled by John Harvison, the Chairman and a director of the General Partner, which permits that corporation to sell alcoholic beverages in the Company's Texas outlets where such sales are legal.\nIn many states, sellers of alcoholic beverages have been held responsible for damages caused by persons who purchased alcoholic beverages from them and who were at the time of the purchase, or subsequently became, intoxicated. Although the Company's retail operations have adopted procedures which are designed to minimize such liability, the potential exposure to the Company as a seller of alcoholic beverages is substantial. The Company's present liability insurance provides coverage, within its limits and subject to its deductibles, for this type of liability.\nEnvironmental Regulation. The Company is subject to various federal, state, and local environmental, health, and safety laws and regulations. In particular, federal regulations issued in late 1988 regarding underground storage tanks established requirements for, among other things, underground storage tank leak detection systems, upgrading of underground tanks with respect to corrosion resistance, corrective actions in the event of leaks, and the demonstration of financial responsibility to undertake corrective actions and compensate third parties for damages in the event of leaks. Certain of these requirements were effective immediately and others are being phased in over a ten year period. However, all underground storage tanks must comply with all requirements by December 1998. The Company has implemented a plan to bring all of its existing underground storage tanks and related equipment into compliance with these laws and regulations and currently estimates the costs to do so will range from $2,800,000 to $3,425,000 over the next three years. Such costs are included in the Company's anticipated capital expenditures.\nAll states in which the Company has underground storage tanks have established trust funds for the sharing, recovering, and reimbursing of certain cleanup costs and liabilities incurred as a result of leaks in such tanks. These trust funds, which essentially provide insurance coverage for the cleanup of environmental damages caused by an underground storage tank leak, are funded by a tax on underground storage tanks or the levy of a \"loading fee\" or other tax on the wholesale purchase of motor fuels within each respective state. The coverages afforded by each state vary but generally provide up to $1,000,000 for the cleanup of environmental contamination and most provide coverage for third-party liability, as well. Some of the funds require the Company to pay deductibles up to $25,000 per occurrence.\nAlthough the benefits afforded the Company as a result of the trust funds are substantial, the Company may not be able to recover through higher retail prices the costs associated with the fees and taxes which fund the trusts.\nManagement believes the Company complies in all material respects with existing environmental laws and regulations and is not currently aware of any material capital expenditures, other than as discussed above, that will be required to further comply with such existing laws and regulations. However, new laws and regulations could be adopted which could require the Company to incur significant additional costs.\nFederal Income Tax Law\nUnder the Internal Revenue Code of 1986, as amended (the \"Code\"), certain publicly-traded partnerships are treated as corporations for tax purposes. However, due to a transitional rule, the Company will continue to be treated as a partnership for federal income tax purposes until the earlier of (i) its first tax year beginning after 1997 or (ii) its addition of a \"substantial new line of business\" as defined by the Code. In addition, (i) the passive loss rules under the Code are applied separately with respect to items attributable to each publicly-traded partnership that is not treated as a corporation for tax purposes and (ii) net income from publicly-traded partnerships is not treated as passive income.\nLegislation has been introduced into Congress which would extend for a period of two years the \"grandfather\" provision which permits the Company to continue to be treated as a partnership for tax purposes. However, the likelihood of the passage of this legislation is not determinable at this point. The Company is continuing to evaluate its alternatives with respect to its tax status.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nThe following table summarizes the ownership status of the Company's retail outlets as of February 29, 1996:\nOwned Leased from Leased from by the Affiliates of the Unrelated Company General Partner Parties Total\nNumber of Locations\nConvenience Stores Land 37 61 26 124 Buildings 93 8 23 124\nTruck Stops Land 2 6 2 10 Buildings 6 2 2 10\nSelf-service gasoline outlets Land 10 89 92 191 Buildings 52 47 92 191\nOther\/Not Active Land 10 13 14 37 Buildings 15 8 14 37\nTotal Land 59 169 134 362 Buildings 166 65 131 362\nThe leases covering land and buildings leased from affiliates of the General Partner generally expire on May 31, 1997, and have one or two five-year renewal periods with renewal at the sole option of the Company. The monthly rent upon renewal will be adjusted by the increase in the consumer price index since the leases were entered into. Management believes the terms and conditions of the leases with affiliates are more favorable to the Company than could have been obtained from unrelated third parties.\nThe executive offices of the Company are located at 2801 Glenda Avenue, Fort Worth, Texas, where it occupies approximately 15,000 square feet of office space leased from three companies affiliated with the General Partner.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nThe Company was a defendant in Billy R. Delp, et al., v. John H. Harvison, FFP Partners Management Company, Inc., et al., Cause No. 141-127674-90, in the 141st Judicial District Court of Tarrant County, Texas, filed on May 7, 1990. In this case, plaintiffs claimed unspecified damages arising out of unspecified breaches of fiduciary duty by certain directors of the General Partner. In late 1993, a company owned by John H. Harvison and members of his immediate family acquired this cause of action in connection with the liquidation of the bankruptcy estate of Mr. Delp. This lawsuit was dismissed for lack of prosecution on May 19, 1995.\nThe Company is periodically involved in routine litigation arising in the ordinary course of its businesses, particularly personal injury and employment related claims. Management presently believes none of the pending or threatened litigation of this nature is material to the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of Unitholders during 1995.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS.\nThe Company's Class A Units are listed for trading on the American Stock Exchange (symbol \"FFP\"). At March 29, 1996, there were 232 unitholders of record of the Class A Units.\nAs of March 29, 1996, there were two record holders of the Company's Class B Units; the Class B Units are not listed for trading on any securities exchange. {See Item 12. Security Ownership of Certain Beneficial Owners and Management.}\nIn August 1989, the Company entered into a Rights Agreement and distributed to its Unitholders Rights to purchase Units under certain circumstances. Initially the Rights were attached to all Unit Certificates representing Units then outstanding and no separate Rights Certificates were distributed. Under the Rights Agreement, the Rights were to separate from the Units and be distributed to Unitholders following a public announcement that a person or group of affiliated or associated persons (an \"Acquiring Person\") had acquired, or obtained a right to acquire, beneficial ownership of 20% or more of the Partnership's Class A Units or all classes of outstanding Units. On August 8, 1994, a group of Unitholders announced that they had an informal understanding that they would vote their Units together as a block. The agreement related to units that constituted approximately 25% of the Class A Units then outstanding. Therefore, the Rights became exercisable on October 7, 1994, the record date for the issuance of the Rights Certificates (the \"Distribution Date\").\nThe Rights currently represent the right to purchase a Rights Unit (which is substantially equivalent to a Class A Unit) of the Company at a price of $20.00 per Unit. However, the Rights Agreement provides, among other things, that if any person acquires 30% or more of the Class A Units or of all classes of outstanding Units then each holder of a Right, other than an Acquiring Person, will have the right to receive, upon exercise, Rights Units (or in certain circumstances, other property) having a value of $40.00 per Unit. The Rights will expire on August 13, 1999, and do not have any voting rights or rights to cash distributions.\nThe following table sets forth the range of high and low sales prices for the Partnership's Class A Units as\nHigh Low Dollars\nFirst Quarter 5 5\/8 3 7\/8 Second Quarter 4 1\/2 3 1\/2 Third Quarter 4 3\/4 3 3\/4 Fourth Quarter 6 3\/4 3 1\/4\nFirst Quarter 8 5\/8 5 5\/8 Second Quarter 7 5\/8 5 3\/8 Third Quarter 8 6 Fourth Quarter 7 15\/16 6 3\/4\nThe following table sets forth the distributions declared and paid by the Company in 1994 and 1995:\nAmount per Class A and Record Date Date Paid Class B Unit\nApril 26, 1994 May 12, 1994 $0.08\nNovember 21, 1994 November 30, 1994 0.29\nMarch 31, 1995 April 12, 1995 0.12\nApril 24, 1995 May 9, 1995 0.27\nAugust 16, 1995 August 31, 1995 0.18\nNovember 28, 1995 December 12, 1995 0.30\nPrior to December 31, 1989, the Class B Units, which were held by affiliates of the General Partner, were subordinated to the Class A Units with respect to their right to cash distributions. However, with the payment on March 15, 1990, of a cash distribution on the Class A Units, this subordination terminated. Accordingly, any future cash distributions will be made pro rata on both the Class A and Class B Units.\nThe Class A and Class B Units have identical rights with respect to voting on matters brought before the partners and to cash distributions.\nDistributions are dependent upon the actual level of earnings and cash flow of the Company, capital expenditures required to maintain the productive capacity of the Company's asset base, and requirements for servicing the Company's debt. Management is evaluating re-instituting a regular quarterly cash distribution to unitholders. However, a determination has not yet been made with respect to whether or not to make distributions in such a manner, the amount of any such distributions, or the date on which such distributions might begin. Any future distributions will be dependent upon the continued profitability of the Company, its debt service requirements, needs for capital expenditures, and compliance with the restrictions in its Credit Agreement. {See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources.}\nThe Company has entered into a Credit Agreement with a bank which contains various restrictive covenants, including restrictions on the payment of cash distributions to unitholders. The Credit Agreement limits the payment of cash distributions by requiring that the Company maintain certain financial ratios which are predicated on, among other things, the level of cash distributions. {See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion of the Credit Agreement.}\nItem 6.","section_6":"Item 6. Selected Financial and Opertating Data.\n1995 1994 1993 1992 1991 Financial Data (in thousands, except per unit data):\nRevenues and Margins -\nMotor fuel sales $296,887 $275,278 $246,023 $217,248 $211,203\nMotor fuel margin 22,813 22,332 21,650 16,963 15,741\nMerchandise sales 65,512 72,827 74,921 56,946 55,899\nMerchandise margin 19,187 20,169 20,320 19,88 19,907\nMiscellaneous revenues 7,646 7,408 5,706 5,086 3,277\nTotal revenues 370,045 355,513 326,650 279,280 270,379\nTotal margin 49,646 49,909 47,676 41,933 38,925\nDirect store expenses 28,496 29,553 28,794 24,771 22,246\nGeneral and administrative 11,795 11,056 10,527 9,415 9,585\nDepreciation and amortization 3,769 4,352 5,681 5,435 5,330\nTotal operating expenses 44,060 44,961 45,002 39,621 37,161\nOperating incom 5,586 4,948 2,674 2,312 1,764\nInterest expense (1,176) (1,173) (1,565) (1,724) (2,458)\nIncome before income taxes\/other items 4,410 3,775 1,109 588 (694)\nDeferred income taxes (500) (244) (94) 0 0\nGain on extinguishment of debt 0 200 0 0 0\nChange in accounting for income taxes 0 0 (297) 0 0\nNet income\/(loss) $3,910 $3,731 $718 $588 $(694)\nIncome\/(loss) per unit -\nFrom continuing operations and before accounting change $1.07 $0.97 $0.28 $0.16 $(0.19)\nNet income\/(loss 1.07 1.03 0.20 0.16 (0.19)\nCash distributions declared per Class A and Class B Unit $0.87 $0.37 $0.00 $0.00 $0.00\nTotal assets $69,332 $67,978 $70,277 $68,116 $61,525\nLong-term obligations 7,100 9,527 10,755 17,164 20,196\nOperating Data:\nGallons of motor fuel sold 193,233 196,246 187,267 170,410 163,461 (retail, in thousands)\nRetail margin per gallon (cents) 10.9 10.1 10.0 9.2 8.9\nAverage weekly merchandise sales -\nConvenience stores $9,560 $9,901 $10,289 $8,370 $7,747\nTruck stops 17,506 18,160 17,798 15,709 15,423\nMerchandise margin 29.3% 27.7% 27.1% 34.9 35.6%\nNumber of locations at year end -\nConvenience stores 127 127 145 137 130\nTruck stops 10 10 10 9 9\nSelf-service fuel outlets 194 185 169 171 176\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGeneral\nThis discussion should be read in conjunction with the selected financial and operating data, the description of the Company's business operations and the financial statements and related notes and schedules included elsewhere in this Annual Report on Form 10-K.\nThe Company reports its results of operations using a fiscal year which ends on the last Sunday in December. Most fiscal years have 52 weeks but some consist of 53 weeks. Fiscal 1995 was a 53-week year, while fiscal 1994, 1993, 1992, and 1991 were 52-week years. This variation in time periods most affects revenues (and related costs of sales) and salary costs as other expenses (such as rent and utilities) are usually recorded on a \"monthly\" basis. However, differences in the number of weeks in a fiscal year should be considered in reviewing financial data.\n1995 Compared with 1994\nThe Company's motor fuel revenues for 1995 increased over the 1994 period by $21,609,000 (7.8%) due to increased wholesale fuel sales. Wholesale fuel sales increased 14,184,000 gallons (17.4%) over 1994. This increase was due to the presence for a full year of sales resulting from a marketing arrangement begun in mid-1994 that emphasizes sales to contractors and other commercial users of fuel as well as from growth in these sales. However, the increase in wholesale fuel sales was offset by a decline in retail fuel sales. Motor fuel sales at the Company's retail outlets declined by 3,013,000 gallons (1.5%) as a result of lower sales volumes at the Company's truck stops due to increased competition from new outlets in several of the Company's markets. The margin on fuel sales increased $481,000 (2.2%) in 1995 over 1994. This increase resulted from improved retail fuel margins (10.9 cents in 1995 vs 10.1 in 1994) and the additional margin from the increased wholesale activity.\nMerchandise sales in 1995 declined by $7,315,000 (10.0%) from the previous year due principally to the sale of the merchandise operations at ten convenience stores. The sales of these operations are the continuation of a program begun by the Company in mid-1994 to sell the merchandise operations of outlets that it believed would contribute more to the earnings of the Company if operated by independent operators rather than by the Company. The Company seeks to sell the merchandise operations of these outlets to independent operators who, because of their different overhead structure, are able to operate the stores less expensively than can the Company. These sales are structured such that the Company retains the real estate or leasehold interest and leases or subleases the land, building, and equipment to the operator. The Company also retains the motor fuel concession at these outlets, which become self-service fuel outlets for the Company. The merchandise sales decline was also affected by the absence of a full year's sales at the 15 outlets whose merchandise operations were sold in the third and fourth quarters of 1994.\nThe Company also experienced a decline in its average weekly per store sales for convenience stores of $341 (3.4%) in 1995 as compared to 1994 and a decline of 3.6% in sales at the truck stops (combined with their associated restaurants). These declines are attributable to the Company's efforts to increase the margin on merchandise sales at all of its outlets. Total merchandise margin declined by $982,000 due to the reduced merchandise sales but the gross profit percentage on merchandise sales increased to 29.3% from 27.7% reflecting the Company's program of selectively increasing prices on less price sensitive items.\nMiscellaneous revenues were up $238,000 (3.2%) in 1995 over 1994. This increase resulted primarily from increases in excise tax handling fees (due to increased fuel volumes) and money order fees (due to increased numbers of items sold and an increase in the per item fee) and a gain recognized from the sale of the Company's fleet fuel franchise offset by declines in food stamp commissions (due to the adoption in Texas of a \"debit\" card for this activity) and in commissions on the wholesale sale of cigarettes (due to a more competitive market).\nDirect store expenses consist of those costs directly attributable to the operation of the Company's retail outlets, such as salaries and other personnel costs, supplies, utilities, repairs and maintenance, and commissions paid to the operators of the self-service motor fuel outlets. In 1995 these costs declined $1,057,000 (3.6%) from the prior year. This reduction was due to the elimination of payroll (and related costs), utilities, and other operating expenses at the convenience stores whose merchandise operations were sold to independent operators offset by increases in the fuel commissions paid to the operators of those stores, and increases in wage and other personnel costs at the stores operated by the Company.\nGeneral and administrative expenses increased $739,000 (6.7%) in 1995 over 1994. This increase was caused by increased professional fees, principally attributable to the cost of consultants assisting in reorganizing certain of the Company's back office processes, increased rental expense, associated with the Company's increased use of leases to provide vehicles and to finance certain equipment, increased insurance costs, and increases in bank charges, associated with the trial use of a deposit pick up service at the Company's convenience stores and truck stops. These increases were offset by a reduction in bad debt expense due to better monitoring of receivables.\nThe $583,000 (13.4%) decline in depreciation and amortization expense is due to the continued full depreciation of assets acquired upon the Company's formation in 1987 and the somewhat limited additions to property and equipment over the past few years.\nEven though the Company's long-term bank debt declined by $3,580,000 from 1994 to 1995, interest expense was flat between the two years due to increased use of capital leases, which carry a somewhat higher but fixed interest rate, to fund capital expenditures.\nThe Company adopted Financial Accounting Standards Board Statement No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\") at the beginning of fiscal 1993. As a result of adopting this accounting principle, the Company is required to record deferred income tax expense attributable to changes arising in the current period in the temporary differences between financial and tax reporting which are expected to reverse after 1997, when the Company will become taxable as a corporation. These differences are due primarily to temporary differences between the financial reporting amounts and tax bases of the Company's property and equipment and the increase in the deferred tax expense in 1995 as compared to 1994 is principally due to additions to fixed assets which are depreciated differently for financial reporting and tax purposes. The deferred tax expense is expected to grow in 1996 and 1997 as the date at which the Company will become taxable as a corporation grows closer since fewer of the differences between tax and financial reporting will reverse prior to such date.\nThe $263,000 (0.5%) decline in the Company's total margin in 1995 as compared to 1994 was offset by significant reductions in operating expenses and depreciation and amortization such that income before income taxes and other items increased $635,000 (16.8%). However, due to the increase in deferred income taxes, discussed above, and the occurrence in 1994 of a $200,000 gain from the early extinguishment of debt in connection with the refinancing of the Company's bank debt in early 1994, net income increased by $179,000 (4.8%) between the two years.\n1994 Compared with 1993\nMotor fuel revenues in 1994 increased $29,255,000 (11.9%) from 1993 principally due to increases in the gallons of motor fuel sold at both wholesale and retail. Retail fuel gallons sold increased 4.8% due to an increase in the average number of outlets selling fuel, primarily self-service fuel outlets; same-store fuel sales (in gallons) were up 0.2% from 1993 to 1994. Wholesale fuel volumes were up 40.8% because of the marketing arrangement begun in mid-1994 which emphasizes sales to contractors and other commercial users. Fuel margin increased $682,000 (3.2%) between the two years. Retail fuel margin per gallon increased to 10.1 cents per gallon in 1994 from 10.0 cents in 1993 and wholesale fuel margin per gallon increased to 1.8 cents in 1994 from 1.7 cents in 1993.\nThe Company's merchandise sales declined $2,094,000 (2.8%) from 1993 to 1994 due to sales decreases at convenience stores offset by increases at truck stops. The sales decline at the convenience stores resulted from the closing in late 1994 of the Company's five convenience stores in Illinois, the reduction in sales caused by the sale of the merchandise operations of 15 outlets (under the program discussed above), and a same-store sales decline of 2.0% from the prior year. The Illinois stores had not been performing well and the Company elected to terminate its lease on those locations in August 1994, while most of the sales of convenience store merchandise operations occurred in the third and fourth quarters of 1994.\nThe increased sales at the truck stops resulted from the addition of one outlet in May 1993 and from a same- store sales increase of 9.2%. The strong growth in same-store sales is attributable to re-merchandising the truck stops and the impact of additional traffic generated by the Kentucky Fried Chicken and Taco Bell express outlets at two of the truck stops. Because of the success the Company has enjoyed with the branded fast food outlets, it is expanding this concept to additional truck stops.\nMerchandise margin decreased $151,000 (0.7%) in 1994 from 1993 due to the decreased merchandise sales. However, the gross profit percentage on merchandise sales increased to 27.7% (from 27.1% in 1993) due principally to higher margins realized at the truck stops as a result of the re-merchandising of those outlets and the branded fast food outlets.\nThe $1,702,000 (29.8%) increase in miscellaneous revenues in 1994 over 1993 was principally due to the $829,000 gain recognized on the sales of certain convenience store merchandise operations (discussed above) and increases in lottery commissions at the Company's convenience stores and fuel excise tax collection fees related to the increased volume of motor fuel sold.\nDirect store expenses increased $759,000 (2.6%) in 1994 over 1993 principally due to increased personnel costs at the convenience stores and truck stops related to routine wage increases and higher fuel commissions at the self-service motor fuel outlets due to the increased volumes of fuel sold by these outlets.\nGeneral and administrative expenses increased $529,000 (5.0%) from 1993 to 1994. These increases resulted from increases in bad debt expense related to the increase in self-service fuel outlets and increased wholesale fuel business, increased professional fees related to the Company's underground storage tank monitoring activity and increased efforts in marketing it's laser money order printing system, increased commissions related to its wholesale fuel sales to contractors and commercial users, and increased rent expense related to the use of lease financing for vehicles and equipment. These increases were offset by declines in uninsured claims and bank charges.\nThe $1,329,000 (23.4%) reduction in depreciation and amortization expense for 1994 over 1993 was caused by the full amortization in September 1993 of the value of self-service gasoline contracts and the complete depreciation in late 1993 and early 1994 of certain other assets, all of which were acquired upon the Company's initial formation in May 1987.\nInterest expense decreased $392,000 (25.0%) for 1994 from the prior year due to the refinancing of the Company's debt in February 1994. This refinancing, which was with a different financial institution, resulted in a reduced interest rate on the debt and also established a revolving line of credit thereby enabling the Company to reduce the debt outstanding from time to time by paying down on the credit line which also reduced interest expense. Interest expense was further reduced because of reductions in the balances outstanding due to scheduled payments on the Company's term debt. In addition, in connection with this transaction, the company received a $200,000 discount on the early payoff of the previous debt. This $200,000 gain on extinguishment of debt is reflected as an extraordinary item in the 1994 consolidated income statement.\nThe adoption of SFAS 109 at the beginning of fiscal 1993 was accounted for as a cumulative effect of a change in accounting principle and resulted in a noncash charge of $297,000 in the 1993 consolidated statement of operations\nThe substantial increases in the Company's total margin (total revenues less costs of fuel and merchandise) combined with the modest increases in operating expenses and the substantial reduction in depreciation and amortization, resulted in 1994 earnings of $3,731,000, an improvement of $3,013,000 over the prior year.\nLiquidity and Capital Resources\nThe Company has a Credit Agreement with a major bank under which it has a $10,000,000 revolving credit line (with sublimits of $8,000,000 for cash advances and $3,000,000 for letters of credit) to be used for working capital purposes and a term loan which had a balance at year end 1995 of $6,563,000. The revolving credit line matures on April 30, 1997, but the agreement requires that it be repaid for seven consecutive days during each calendar quarter. The term loan is due in quarterly installments of $312,500 through March 31, 2001. Both the term loan and the revolving credit line bear interest at the bank's prime rate. Although the interest rates on both loans are variable rates, the Credit Agreement provides the Company with the ability to fix the rates on all or a portion of the term loan for varying periods of time up to its maturity.\nIn March 1996, the Company amended its Credit Agreement principally to provide an additional term loan of $1,000,000 to be used by the Company to acquire and renovate a non-operating fuel terminal which the Company acquired in March 1996. This term loan is to be repaid in quarterly installments of $50,000 through March 31, 2001. The interest rate and related options on this loan are the same as on the other term debt under the Credit Agreement.\nThe Credit Agreement contains various requirements and restrictive covenants, including, a pledge of the Company's accounts receivable and inventories, a negative pledge of the Company's fixed assets, and the requirement to maintain certain financial ratios which have the effect of limiting the Company's capital expenditures and distributions to unitholders. At year end 1995, the Company was not in compliance with certain of the financial ratios but in connection with the March 1996 amendment of the Credit Agreement, mentioned above, the bank has waived compliance with these ratios.\nDuring 1995, the Company has made cash distributions to its unitholders. However, the distributions have not been made at regular, periodic intervals nor at fixed amounts. The Company anticipates that it will continue to make cash distributions to unitholders and is evaluating making such distributions on a regular quarterly basis. However, a determination has not yet been made with respect to whether or not to make distributions in that manner, the amount of any such distributions, or the date on which such distributions might begin. Further, any future distributions will be dependent upon the continued profitability of the Company, its debt service requirements, needs for capital expenditures, and compliance with the restrictions in its Credit Agreement.\nThe Company's cash flows from operating activities were $5,051,000 less in 1995 than in 1994. This decline was due principally to a $2,429,000 decrease in accrued expenses which is related to the timing of fuel excise tax payments relative to the Company's year end. Cash used for the purchase of property and equipment and other investing activities increased $1,970,000 in 1995 primarily due to increased purchases of property and equipment, some which is related to compliance with environmental regulations, and to other investments. The Company expects its level of capital expenditure to increase modestly over the next three years as it completes the upgrades of its underground storage tanks that are required to meet state and federal environmental requirements. The Company has contracted with a firm to install the necessary equipment and\/or to modify existing installations to meet current environmental requirements by the December 1998 deadline. The cost of this upgrading is expected to be between $2,800,000 and $3,425,000 and is expected to be incurred ratably over 1996, 1997, and 1998.\nThe Company will pay for some of these expenditures from its operating cash flow. However, it has a $2,500,000 lease financing facility with an affiliate of its primary bank lender which may be used to fund a portion of these expenditures as well as to acquire other machinery and equipment (other than underground storage tanks). Although this commitment expires in December 1996, the Company expects that it will be renewed for an additional amount at that time. The Company believes that this lease financing along with its operating cash flow and other financing alternatives that are available to it will be adequate to fund necessary capital expenditures, including the expenditures that are necessary to comply with environmental regulations.\nThe Company's cash used in financing activities decreased by $5,518,000 in 1995 as compared to 1994. This significant decrease resulted primarily from reduced payments on bank debt in 1995 as compared to 1994, when the Company's debt was refinanced.\nThe Company is party to commodity futures contracts and forward contracts to buy and sell fuel, both of which are used principally to satisfy balances owed on exchange agreements and both of which have off-balance sheet risk. Changes in the market value of open futures contracts are recognized as gains or losses in the period of change. These investments involve the risk of dealing with others and their ability to meet the terms of the contracts and the risk associated with unmatched positions and market fluctuations. {See Note 11 to the Consolidated Financial Statements.}\nThe Company had negative working capital at year end 1995 of $4,147,000 as compared to a negative $100,000 at the prior year end. The decline was largely due to the prepayment of $2,000,000 on the Company's term debt in mid-1995. Although this prepayment negatively affected working capital it helped the Company to minimize interest expense. The Company believes that the availability of funds under its revolving line of credit and its traditional use of trade credit will permit operations to be conducted in a customary manner.\nInflation and Seasonality\nThe Company believes inflation has not had a material effect on operating results in recent years except for the upward pressure placed on wages, primarily store wages, by the federal minimum wage increases which took effect in 1990 and 1991. Some federal political officials have proposed increasing the federal minimum wage again but it is uncertain at this time whether such an increase will become law. Should there be an increase in the federal minimum wage, the Company expects that it's operating margins would be adversely affected in the short run as it would take some time to increase prices in order to pass along this increased cost to customers but it does not expect that it would be at a competitive disadvantage as the Company believes its wage structure is in line with that of other convenience store operators. Apart from the impact of the possible minimum wage increase, operations for the foreseeable future are also not expected to be significantly impacted by inflation. Generally, increased costs of in-store merchandise can be quickly reflected in higher prices to customers. The price of motor fuel, adjusted for inflation, has declined over recent years. However, significant increases in the retail price of motor fuels could reduce fuel demand and the Company's gross profit on fuel sales.\nThe Company's businesses are subject to seasonal influences, with higher sales being experienced in the second and third quarters of the year as customers tend to purchase more motor fuel and convenience items, such as soft drinks, other beverages, and ice, during the warmer months.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary data filed herewith begin on page.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were no changes in, nor disagreements with, accountants during 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nGeneral Partner\nFFP Partners Management Company, Inc., a Delaware corporation formed in December 1986, is the General Partner of and manages the Company. The Unitholders have no power, as limited partners, to direct or participate in the control of the business of the Company.\nManagement of the General Partner\nSet forth below are the names, ages, positions, and business experience of the executive officers and directors of the General Partner:\nName Age Position\nJohn H. Harvison [1 62 Chairman of the Board and Chief Executive Officer\nRobert J. Byrnes [1] 55 President, Chief Operating Officer, and Director\nAvry Davidovich 42 Executive Vice President - Convenience Stores and Director\nSteven B. Hawkins 48 Vice President - Finance and Administration, Secretary, Treasurer, and Chief Financial Officer\nJ. D. St.Clair 61 Vice President - Fuel Supply and Distribution and Director\nRobert E. Garrison, II [1,2] 54 Director\nJohn W. Hughes [1,2] 54 Director\nGarland R. McDonald 58 Director\nJohn D. Harvison 39 Director\nE. Michael Gregory 44 Director - ---------------------------------------------------- [1] Member of Compensation Committee [2] Member of Audit Committee\nJohn H. Harvison has been Chairman of the Board of the General Partner since the commencement of the Company's operations in May 1987. Mr. Harvison is a founder and an executive officer of each of the companies from which the Company acquired its initial base of retail outlets, and has been active in the retail gasoline business since 1958 and in the convenience store business since 1973. In addition, he has been involved in oil and gas exploration and production, the ownership and management of an oil refinery and other personal investments. Until April 1992, Mr. Harvison served on the Board of Directors of Total Assets Protection, Inc. In March 1992, Total Assets Protection, Inc., filed a voluntary petition under Chapter 7 of the United States Bankruptcy Code. Mr. Harvison was an officer and director of Tech-Management, Inc., a privately held corporation, against which an involuntary petition in bankruptcy was filed in August 1991. In January 1995, Mr. Harvison consented to the entry of a cease and desist order by the United States Office of Thrift Supervision that, among other things, prohibits him from participating in any manner in the conduct of the affairs of federally insured depository institutions. This Order was issued in connection with Mr. Harvison's ownership in a federal savings bank and transactions between him (and companies in which he had an ownership interest) and that institution. In consenting to the issuance of the Order, Mr. Harvison did not admit any of the allegations against him and consented to the issuance of the Order solely to avoid the cost and distraction that would be caused by prolonged litigation to contest the positions taken by the Office of Thrift Supervision. Mr. Harvison is the father of John D. Harvison, who is also a director of the General Partner.\nRobert J. Byrnes has been the President of the General Partner since April 1989 and has been a Director since May 1987. From May 1987 to April 1989, Mr. Byrnes served as Vice President - Truck Stop Operations for the Company. Mr. Byrnes has been, since 1985, the President of Swifty Distributors, Inc., one of the companies from which the Company acquired its initial retail outlets. From 1975 through 1984, Mr. Byrnes was President of Independent Enterprises, Inc., which owned and operated convenience stores and a truck stop. During that period, he was also President of Enterprise Distributing, Inc., a wholesaler of motor fuels. Prior to 1975, Mr. Byrnes was President of Foremost Petroleum Corporation (which is now a subsidiary of Citgo Petroleum Corporation) and was a distribution manager for ARCO Oil & Gas Company. He is currently a director of Plaid Pantries, Inc., an operator of convenience stores headquartered in Beaverton, Oregon.\nAvry Davidovich has been Executive Vice President - Convenience Stores and a Director of the General Partner since October 1992 when the Company acquired the convenience stores operated by Mr. Davidovich. He had operated these convenience stores since February 1992. From June 1989 through February 1992, Mr. Davidovich was the General Manager of Lincoln Land Oil Company. From 1977 through May 1989, Mr. Davidovich was employed in a number of management positions by Emro Marketing, a convenience store chain owned by Marathon Oil Company that operated 1,600 outlets.\nSteven B. Hawkins has been Vice President - Finance and Administration, Secretary, and Treasurer of the General Partner since May 1987. From April 1980 through December 1987, Mr. Hawkins was employed as Secretary\/Treasurer, Controller and Chief Financial Officer by various companies affiliated with the General Partner. Prior to joining such affiliates, Mr. Hawkins was employed for nine years by Arthur Andersen & Co., an international public accounting firm. He is a member of both the American Institute of Certified Public Accountants and the Texas Society of CPAs.\nJ. D. St.Clair has been Vice President - Fuel Supply and Distribution and a Director of the General Partner since May 1987. Mr. St.Clair is a founder and an executive officer of several of the companies from which the Company acquired its initial retail outlets. He has been involved in the retail gasoline marketing and convenience store business since 1971. Prior to 1971, Mr. St.Clair performed operations research and system analysis for Bell Helicopter, Inc., from 1967 to 1971; for the National Aeronautics and Space Administration from 1962 to 1967; and Western Electric Company from 1957 to 1962.\nRobert E. Garrison, II, has been a Director of the General Partner since May 1987. Mr. Garrison is a managing partner of Harris, Webb & Garrison, a regional merchant and investment bank, and is also Chairman and Chief Executive Officer of Pinnacle Management & Trust Co., a state chartered independent trust company. From October 1992 through February 1994, Mr. Garrison was Chairman of Healthcare Capital Group, Inc., a regional investment bank focusing on the health care industry. From April 1991 through October 1992, Mr. Garrison was Chairman and Chief Executive Officer of Med Center Bank & Trust, one of the leading independent banks in Houston, Texas. Mr. Garrison served as President of Iroquois Brands, Ltd. (\"IBL\"), a manufacturer of material handling and construction equipment, pharmaceutical and personal care products, and operator of convenience stores and retail fuel outlets in the United Kingdom from 1989 until his resignation in September 1990. In June 1991, an involuntary petition under Chapter 11 of the United States Bankruptcy Code was filed against IBL and in November 1991, the Chapter 11 petition was converted to a Chapter 7 petition. From 1982 through March 1989, Mr. Garrison served as Executive Vice President and director of Lovett Mitchell Webb & Garrison, Inc. (\"LMW&G\"), one of the representatives of the underwriters in the initial public offering of the Company in May 1987, where he managed the Investment Research and Investment Banking Division, and Boettcher & Company, Inc., which acquired LMW&G in September 1987. From 1971 to 1982, Mr. Garrison was First Vice President and Director of Institutional Research at Underwood Neuhaus & Co. From 1969 to 1971, Mr. Garrison was Vice President of BDSI, a venture capital subsidiary of General Electric.\nJohn W. Hughes has been a Director of the General Partner since May 1987. Mr. Hughes is an attorney with the law firm of Garrison & Hughes, L.L.P., in Fort Worth, Texas. From 1991 to 1995 he was an attorney with the firm of Simon, Anisman, Doby & Wilson, P.C., in Fort Worth, Texas. Since 1963, Mr. Hughes has been a partner of Hughes Enterprises, which invests in venture capital opportunities, real estate, and oil and gas.\nGarland R. McDonald, is employed by the Company to oversee and direct a variety of special projects. He was elected to the Board in January 1990. He had previously served as a Director of the General Partner from May 1987 through May 1989 and served as a Vice President of the General Partner from May 1987 to October 1987. Mr. McDonald is a founder and the Chief Executive Officer of Hi-Lo Distributors, Inc., and Gas-Go, Inc., two of companies from which the Company initially acquired its retail outlets. He has been actively involved in the convenience store and retail gasoline businesses since 1967.\nJohn D. Harvison was elected a Director of the General Partner in April 1995. Mr Harvison has been Vice President of Dynamic Production, Inc., an independent oil and gas exploration and production company since 1977. He previously served as Operations Manager for Dynamic from 1977 to 1987. He also serves as an office of various other companies that are affiliated with Dynamic that are involved in real estate management and various other investment activities. Mr. Harvison is the son of John H. Harvison, the Chairman of the Board of the General Partner.\nE. Michael Gregory was elected to the Board of the General Partner in September 1995. Mr. Gregory is the founder and President of Gregory Consulting, Inc., an engineering and consulting firm that is involved in the development of products related to the distribution and storage of petroleum products and computer software for a variety of purposes including work on such products and software for the Company. Prior to founding Gregory Consulting in 1988, Mr. Gregory was the Chief Electronic Engineer for Tidel Systems (a division of The Southland Corporation) where he was responsible for new product concept development and was involved in projects involving the monitoring of fuel levels in underground storage tanks. He is a Registered Professional Engineer in Texas.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nRegulations issued under the Securities Exchange Act of 1934 require certain persons to report their holdings of the Company's Class A and Class B Units to the Securities and Exchange Commission (\"SEC\") and to the Company. To the best of the Company's knowledge, based upon copies of reports and other representations provided to the Company, all 1995 reports required under Section 16 of the Securities Exchange Act of 1934 were filed in a timely manner except that the following reports were filed late: (i) reports for the month of January 1995 for John H. Harvison, John D. Harvison, Randall W. Harvison, 7HBF, Ltd., and HBF Financial, Ltd., covering units indirectly acquired by them due to the acquisition by 7HBF, Ltd., of the 50% interest not previously held by 7HBF, Ltd., of a record owner of Class B Units; (ii) a report for the month of December 1995 for Robert E. Garrison, II, covering units he donated to a charitable institution; (iii) a report for the month of August 1995 for Garland R. McDonald covering units purchased by his individual retirement account; (iv) a report for the month of April 1995 for John D. Harvison covering options granted to him upon his election to the Board; and, (v) reports for the months of March 1995 and April 1995 for Avry Davidovich covering the exercise of options and the related sale of the units so acquired.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nThe Company reimburses the General Partner for all of its direct and indirect costs (principally officers' compensation and other general and administrative costs) allocable to the Company. Cash bonuses to executive officers of the General Partner are not chargeable to the Company as a reimbursable expense.\nEach director who is not an officer or employee of the General Partner or the Company receives an annual retainer of $4,000 plus $1,000 for each Board meeting, or committee meeting not held in conjunction with a Board meeting, which he attends and $500 for each telephone meeting in which he participates. Each director is also reimbursed for expenses related to attendance at board meetings.\nIn addition, non-employee directors are generally granted options to acquire 25,000 Class A Units at the fair market value of the underlying units on the date of grant. The options become exercisable with respect to one-third of the Units covered thereby on each of the anniversary dates following the grant and expire ten years after grant. In the event of a change in control of the Company, any unexercisable portion of the options will become immediately exercisable. Upon exercise, the option price may be paid, in whole or in part, in Class A Units owned by the director.\nMessrs. Garrison and Hughes were each granted options, in November 1992, to purchase 25,000 Class A Units at $3.75 per Unit; Mr. John D. Harvison was granted options to purchase 25,000 Class A Units at $6.00 per Unit in April 1995; and Mr. Gregory was granted options to purchase 25,000 Class A Units at $7.00 in September 1995. Mr. Garrison exercised all of his options in November 1995.\nDirectors who are officers or employees of the General Partner or the Company receive no additional compensation for attendance at Board or committee meetings.\nThe General Partner has employment agreements with Messrs. Harvison, Byrnes, Hawkins, and St.Clair which provide that if the employment of any such officer is terminated for any reason other than the commission of an act of fraud or dishonesty with respect to the Company or for the intentional neglect or nonperformance of his duties, such officer is to receive an amount equal to twice his then current annual salary plus a continuation of certain benefits provided by the Company for a period of two years. Any cost incurred under these agreements is to be borne by the Company. The Company has an employment agreement with Mr. Davidovich which provides that he is to receive an annual salary of $125,000. The agreement with Mr. Davidovich also provides that if his employment with the Company is terminated he will be paid his then current salary for up to four months.\nSummary Compensation Table\nThe following table provides information regarding compensation paid during each of the Company's last three fiscal years to the Company's Chief Executive Officer and to each of the Company's executive officers who earned salary and bonus of more than $100,000 in the latest fiscal year:\nAnnual Compensation ---------------------------------- Other Annual Name Compen- and Salary sation Principal Position Year ($) ($)\nJohn H. Harvison 1995 135,000 - Chairman and Chief Executive Officer 1994 135,000 - 1993 135,000 -\nRobert J. Byrnes 1995 135,000 - President, Chief Operating Officer 1994 135,000 - and Director 1993 135,000 -\nAvry Davidovich 1995 125,000 - Executive Vice President - 1994 125,000 - Convenience Stores and Director 1993 125,000 20,359 [1] - -------------------------------------------------------------------------------\n[1] Relocation costs paid to or on behalf of Mr. Davidovich in connection with his employment by the Company in October 1992.\nThere were no long-term compensation awards or payouts during any of the last three years.\nGeneral Partner's Incentive Bonus. On an annual, non-cumulative basis, the General Partner may earn incentive compensation (the \"Incentive Bonus\"), pursuant to the FFPOP Partnership Agreement, with respect to each fiscal year, only if (a) the net income of the Company for such year, as determined in accordance with generally accepted accounting principles and calculated prior to the payment of the incentive compensation, equals or exceeds $1.08 per Unit, and (b) the total of the quarterly cash distributions for such year to the holders of Units equals or exceeds $1.50 per Unit (such distributions being those made for such year, even though the distribution for the fourth quarter will actually be paid subsequent to year end). In the event these tests are met, incentive compensation will be paid in cash, by the Company, in an amount equal to 10% of net income before such incentive compensation. Although there is no requirement to do so, management believes that any such incentive compensation received by the General Partner would be used to pay bonuses to its executive officers. The General Partner did not earn any incentive compensation during 1995.\nClass A Unit Options Exercised during Fiscal 1995 and Fiscal Year End Option Values. The following table provides information about options exercised during the last fiscal year and the value of unexercised options held at the end of the fiscal year by the named executive officers:\nAggregated Option\/SAR Exercises in Last Fiscal Year and FY-End Option\/SAR Values Value Value of Units Number of Unexercised Acquired Unexercised In-the-Money on Value Options\/SAR's Option\/SAR's Exercise Realized at Fiscal at Fiscal (#) ($) [1] Year End Year End (#) ($) [2]\nName and Exercisable\/ Exercisable\/ Principal Position Unexercisable Unexercisable\nJohn H. Harvison - 0 - - 0 - 40,000\/0 $130,000\/$0 Chairman and Chief Executive Officer\nRobert J. Byrnes - 0 - - 0 - 35,000\/0 $113,750\/$0 President, Chief Operating Officer, and Director\nAvry Davidovich 28,000 $135,041 0\/0 $0\/$0 Executive Vice President - Convenience Stores and Director - -------------------------------------------------------------------------------\n[1] The value shown is determined by multiplying the difference between the closing price of the Company's Class A Units on the date the options were exercised, as reported by the American Stock Exchange, and the option exercise price times the number of units underlying the options exercised.\n[2] The closing price for the Company's Class A Units as reported by the American Stock Exchange on December 31, 1995, was $7.00. The value shown is calculated by multiplying the difference between this closing price and the option exercise price times the number of units underlying the option.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nClass A and Class B Units\nThe following table sets forth as of March 29, 1996, information regarding the only persons known by the Company to own, directly or indirectly, more than 5% of each class of its Class A and Class B Units:\nTitle Name and Address Amount and Nature of Percent of Classs of Beneficial Owner Beneficial Ownership of Class\nClass A 7HBF, Ltd. 524,333 [1] 15.2% 2801 Glenda Avenue Fort Worth, Texas 76117\nClass A HBF Financial, Ltd. 738,297 [2] 21.4% 2801 Glenda Avenue Fort Worth, Texas 76117\nClass A Garland R. McDonald 194,167 [3] 5.6% 2801 Glenda Avenue Fort Worth, Texas 76117\nClass A The Murray Foundation for Eye 166,500 [4] 4.8% Research, Inc. 280 Ridgeview Road Princeton, New Jersey 08540\nClass A Mark T. Boyer 134,200 [4] 3.9% Mitchell J. Soboleski 353 Sacramento Street, 16th Floor San Francisco, California 94111 and Henry Garehime and Barbara Garehime 4570 Opal Cliff Santa Cruz, California 94068\nClass A Edmund & Mary Shea Real 126,700 [4] 3.7% Property Trust Edmund H. Shea, Jr., Trustee 655 Brea Canyon Road P. O. Box 489 Walnut, California 91789-0489\nClass B 7HBF, Ltd 175,000 [5] 74.5% 2801 Glenda Avenue Fort Worth, Texas 76117\nClass B Summit National Bank 60,000 25.5% 1300 Summit Avenue Fort Worth, Texas 76102 - -------------------------------------------------------------------------------\n[1] Consists of 524,333 Class A Units owned by eight companies which are owned or controlled by 7HBF, Ltd., a limited partnership owned by John H. Harvison and members of his immediate family. 7HBF, Ltd., may be deemed to share beneficial ownership of 144,417 Units with Garland R. McDonald, 49,750 Units with Garland R. McDonald and Barbara J. Smith (John H. Harvison's sister), 83,417 Units with J. D. St.Clair, and 16,833 Units with Robert J. Byrnes.\n[2] Consists of 738,297 Class A Units owned by a company which is owned by HBF Financial, Ltd., a limited liability company owned by trusts for the benefit of members of John H. Harvison's immediate family. In addition HBF Financial, Ltd., owns 31% of the general partner of 7HBF, Ltd.\n[3] Consists of 194,617 Class A Units owned by two companies of which Mr. McDonald is deemed to be the beneficial owner. Mr. McDonald may be deemed to share beneficial ownership of 144,417 of these Units with 7HBF, Ltd., and 49,750 Units with Barbara J. Smith and 7HBF, Ltd.\n[4] According to Schedule 13Ds filed in August 1994 with the Securities and Exchange Commission by The Murray Foundation for Eye Research, Inc., and the Edmund and Mary Shea Real Property Trust, those two entities have an informal understanding with Mark T. Boyer, Mitchell J. Soboleski, Robert J. Bransten, and the John M. Bransten Trust that this group will vote the 524,600 Class A Units they hold, together as a block with regard to matters that require approval of the limited partners of the Company.\n[5] Consists of 175,000 Class B Units owned of record by a company owned by 7HBF, Ltd. The beneficial ownership of these Units is in dispute.\nThe following table sets forth as of March 29, 1996, information with respect to the Class A Units and Class\nTitle Amount and Nature of Percent of of Class Beneficial Ownership [1] Class [1] Name of Beneficial Owner\nJohn H. Harvison, Chairman Class A 0 [2,3] 0.0%\nRobert J. Byrnes, President Class A 16,833 [4] 0.5% and Director\nSteven B. Hawkins, Vice President Class A 2,000 [5] 0.1% J. D. St.Clair Class A 88,417 [6] 2.6% Vice President and Director\nAvry Davidovich, Executive Class A 12,566 [7] 0.4% Vice President and Director\nRobert E. Garrison, II, Director Class A 86,805 [7] 2.5%\nJohn W. Hughes, Director Class A 0 0.0%\nGarland R. McDonald, Director Class A 194,167 [8] 5.6%\nJohn D. Harvison, Director Class A 0 [9,10] 0.0%\nE. Michael Gregory, Director Class A 0 0.0%\nAll directors and executive Class A 400,788 [11,12] 11.6% officers as a group (10 persons)\n- -------------------------------------------------------------------------------\n[1] Excludes Class A Units covered by the options discussed in Item 11. Executive Compensation.\n[2] Excludes 524,333 Class A Units beneficially owned by 7HBF, Ltd. (a Texas limited partnership of which John H. Harvison and members of his family are partners), and 738,297 Class A Units beneficially owned by HBF Financial, Ltd. (a Texas limited liability company which is 98%-owned by trusts for the benefit of the children of John H. Harvison). 7HBF, Ltd., may be deemed to share beneficial ownership of 144,417 Units with Garland R. McDonald, 49,750 Units with Garland R. McDonald and Barbara J. Smith (John H. Harvison's sister), 83,417 Units with J. D. St.Clair, and 16,833 Units with Robert J. Byrnes.\n[3] Excludes 175,000 Class B Units owned of record by a company owned by 7HBF, Ltd. The benefical ownership of these Units is in dispute.\n[4] Shares are held by a company of which Mr. Byrnes is a director and executive officer. Mr. Byrnes may be deemed to share beneficial ownership of these units with 7HBF Financial, Ltd.\n[5] Includes 1,300 Units held by an Individual Retirement Account for the benefit of Mr. Hawkins and 700 Units held by a general partnership in which Mr. Hawkins holds a 50% ownership interest. Mr. Hawkins disclaims beneficial ownership of 50% of the 700 units held by the general partnership.\n[6] Includes 5,000 Units held directly and 83,417 Units held by a company of which Mr. St.Clair is a director and executive officer. Mr. St.Clair may be deemed to share beneficial ownership of the 83,417 Units with 7HBF Financial, Ltd.\n[7] Units are held directly.\n[8] Units are held by two companies of which Mr. McDonald is a director and executive officer. Mr. McDonald may be deemed to share beneficial ownership of 144,417 Units with 7HBF, Ltd., and of 49,750 Units with 7BHF, Ltd., and Barbara J. Smith.\n[9] Excludes 524,333 Class A Units beneficially owned by 7HBF, Ltd. (a Texas limited partnership of which John D. Harvison and members of his family are partners), and 738,297 Class A Units beneficially owned by HBF Financial, Ltd. (a Texas limited liability company which is 98%-owned by trusts for the benefit of the siblings of John D. Harvison). 7HBF, Ltd., may be deemed to share beneficial ownership of 144,417 Units with Garland R. McDonald, 49,750 Units with Garland R. McDonald and Barbara J. Smith (John H. Harvison's sister), 83,417 Units with J. D. St.Clair, and 16,833 Units with Robert J. Byrnes.\n[10] Excludes 175,000 Class B Units owned of record by a company owned by 7HBF, Ltd. Mr. Harvison is a manager of 7HBF, Ltd. The benefical ownership of these Units is in dispute.\n[11] Excludes the 524,333 and 738,297 Class A Units discussed in notes 2 and 9 and the 32,167 Class A Units discussed in note 9.\n[12] Excludes the 175,000 Class B Units discussed in notes 3 and 10.\nGeneral Partner\nThe General Partner makes all decisions relating to the management of the Company. Companies owned, directly or indirectly, by certain officers and directors (principally John H. Harvison and members of his immediate family) of the General Partner are the sole shareholders of the General Partner. Certain of these companies have executed proxies which assign the right to vote their respective stock in the General Partner to their respective stockholders on a basis pro rata to each stockholder's ownership of the respective company. By virtue of this action and through ownership of the equity interests in certain of these companies or their affiliates, John H. Harvison and members of his immediate family, have the right to vote 92.2% of the stock of the General Partner. Messrs. Byrnes, St.Clair, and McDonald collectively have the right to vote 6.1% of the stock of the General Partner.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nRelated Transactions\nThe Company leases land or land and buildings for some of its retail outlets and some administrative and executive office facilities from various entities directly or indirectly owned by Messrs. John H. Harvison, and members of his immediate family, Byrnes, St.Clair, and McDonald. During fiscal 1995, the Company paid $849,000 to such entities with respect to these leases. The General Partner believes the leases with its affiliates are on terms that are more favorable to the Company than terms that could have been obtained from unaffiliated third parties for similar properties.\nJohn H. Harvison, Chairman of the General Partner, owns 50% of Product Supply Services, Inc. (\"Product Supply\"), which provides consulting services and acts as an agent for the Company in connection with the procurement of motor fuel for sale by the Company. Product Supply provides such services to the Company pursuant to an agreement providing that the Company will pay Product Supply $5,000 per month, supply it with office space and support services, such as telephone and clerical assistance, and pay its reasonable out-of-pocket costs in providing such services. The agreement may be canceled either by the Company or Product Supply upon sixty days' written notice. During fiscal year 1995, the Company paid $67,000 to Product Supply for its services.\nJohn H. Harvison, Chairman of the General Partner, together with members of his immediate family, owned 50% of Southwest Office Systems, Inc. (\"Southwest\") until September 15, 1995. During all of 1995, the Company paid Southwest, and its subsidiary, $65,000 for the purchase of office supplies and equipment. The Company believes that the prices paid to Southwest for such supplies and equipment were comparable to those available from unrelated parties\nE. Michael Gregory, a Director of the General Partner since September 1995, is the owner and president of Gregory Consulting, Inc. (\"Gregory Consulting\"), which provides engineering, consulting, and other similar services to the Company. During the entire year of 1995, the Company paid Gregory Consulting $235,000 for such services.\nUnder Texas law, the Company is not permitted to hold licenses to sell alcoholic beverages in Texas. Consequently, the Company has entered into agreements with Nu-Way Beverage Company (\"Nu-Way Beverage\"), a company wholly owned by John H. Harvison, under which Nu-Way Beverage sells alcoholic beverages at the Company's Texas outlets. Under this agreement, the Company receives rent and a management fee relative to the sale of alcoholic beverages and it loans funds to Nu-Way Beverage to pay for alcoholic beverage purchases. The Company receives interest on such funds at 1\/2% above the prime rate charged by a major commercial bank and the loan is secured by the alcoholic beverage inventory located in the Company's Texas outlets. During 1995, the highest balance due under this loan was $485,000 and the balance at the end of the year was $433,000. During 1995, Nu-Way Beverage sold $9,116,000 of alcoholic beverages at the Company's Texas outlets. After deducting cost of sales and other expenses related to these sales, including $1,217,000 of rent, management fees, and interest paid to the Company, Nu-Way Beverage had earnings of $91,000 as a result of holding these alcoholic beverage permits.\nIn June 1994, the Company concluded the settlement of a lawsuit which it had filed against Nu-Way Oil Company and Nu-Way Distributing Company (the \"Nu-Way Companies\"), both of which are controlled by John Harvison and members of his immediate family, and a related suit which the Nu-Way Companies had filed against the Company. Under the settlement, all claims in both of the lawsuits were dismissed and the Company received cash, a promissory note from an affiliated company (secured by first and second liens on real estate), and title to a convenience store which was being leased by the Company from an affiliate. The Company estimated the assets it received had an aggregate value of $485,000. The affiliated companies received approximately $65,000 in cash (held in the Registry of the Court) and 30,000 Class B Units owned by an affiliate that were being held by an escrow agent. This agreement was approved by the disinterested directors of the General Partner. The note which the Company received in connection with this settlement is to be repaid over five years, with interest at 9.5%; the highest balance outstanding during 1995 under the note was $110,000, and the balance outstanding at year end 1995 was $92,000.\nIn 1980 and 1982, certain of the Affiliated Companies granted to E-Z Serve, Inc. (\"E-Z Serve\"), the right to sell motor fuel at retail for a period of ten years at self-serve gasoline stations owned or leased by the Affiliated Companies or their affiliates. All rights to commissions under these agreements and the right to sell motor fuel at wholesale to E-Z Serve at such locations were assigned to the Company on May 21, 1987, in connection with the acquisition of its initial base of retail operations. In December 1990, in connection with the expiration or termination of the agreements with E-Z Serve, the Company entered into agreements with Thrift Financial Co. (\"Thrift Financial\"), a company owned and controlled by members of John H. Harvison's immediate family, which grant to the Company the exclusive right to sell motor fuel at certain retail locations. The terms of these agreements are comparable to agreements that the Company has with other unrelated parties. During fiscal 1995, the Company paid Thrift Financial $261,000 under these agreements.\nIn 1995, the Company purchased four parcels of land, including buildings and petroleum storage tanks and related dispensing equipment, from H Investments, LLC (\"H Investments\"), a company indirectly owned by John H. Harvison and members of his immediate family. The Company paid a total of $144,000 for the real estate and related improvements. The Company is operating one of these locations as a convenience store and one as a self-service motor fuel outlet and intends to operate the other two as either convenience stores or self-service motor fuel outlets. Robert J. Byrnes, President of the General Partner, determined the puchase price by reference to similar properties acquired by the Company from unrelated parties. These properties had been acquired by H Investments in 1993 in connection with the acquisition of a package of notes receivable one of which was secured by the real estate discussed above as well as other assets. H Investments ascribed a value of $70,000 to this note.\nCost Allocations. Determinations are made by the General Partner with respect to costs incurred by the General Partner (whether directly or indirectly through its affiliates) that will be reimbursed by the Company. The Company reimburses the General Partner and any of its affiliates for direct and indirect general and administrative costs, principally officers' compensation and associated expenses, related to the business of the Company. The reimbursement is based on the time devoted by employees to the Company's business or upon such other reasonable basis as may be determined by the General Partner. In fiscal 1995, the Company reimbursed the General Partner and its affiliates $727,000 for such expenses.\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(1) Financial Statements.\nSee Index to Financial Statements and Financial Statement Schedules on page hereof.\n(2) Financial Statement Schedules.\nSee Index to Financial Statements and Financial Statement Schedules on page hereof.\nSchedules other than those listed on the accompanying Index to Financial Statements and Financial Statement Schedules are omitted because they are either not required, not applicable, or the required information is included in the consolidated financial statements or notes thereto.\n(3) Exhibits.\n3.1 Amended and Restated Certificate of Limited Partnership of FFP Partners, L.P. [3.7] {1}\n3.2 Amended and Restated Certificate of Limited Partnership of FFP Operating Partners, L.P. [3.8] {1}\n4.1 Amended and Restated Agreement of Limited Partnership of FFP Partners, L.P., dated May 21, 1987, as amended by the First Amendment to Amended and Restated Agreement of Limited Partnership dated August 14, 1989, and by the Second Amendment to Amended and Restated Agre dated July 12, 1991. {5}\n4.2 Amended and Restated Agreement of Limited Partnership of FFP Operating Partners, L.P. dated May 21, 1987. {2}\n4.3 Rights Agreement dated as of August 14, 1989, between the Company and NCNB Texas National Bank, as Rights Agent. [1] {3}\n10.1 Nonqualified Unit Option Plan of FFP Partners, L.P. [10.2] {1}\n10.2 Form of Ground Lease with Affiliated Companies. [10.3] {1}\n10.3 Form of Building Lease with Affiliated Companies. [10.4] {1}\n10.4 Form of Agreement with Product Supply Services, Inc. [10.5] {1}\n10.5 Agreement of Limited Partnership of Direct Fuels, L.P. [10.6] {4}\n10.6 Form of Employment Agreement between FFP Partners Management Company, Inc., and certain executive officers dated April 23, 1989, as amended July 22, 1992. [10.9] [{5}\n10.7 Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated February 25, 1994. [10.9] {6}\n10.8 First Amendment, dated March 30, 1994, to Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated February 25, 1994. {7}\n10.9 Second Amendment, dated August 31, 1994, to Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated February 25, 1994. {7}\n10.10 Third Amendment, dated May 1, 1995, to Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated Februrary 25, 1995 [10.12] {8}\n10.11 Fourth Amendment, dated December 20, 1995, to Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated Februrary 25, 1995 {9}\n10.12 Fifth Amendment, dated March 29, 1996, to Credit Agreement between Bank of America Texas, N.A., and FFP Operating Partners, L.P., dated Februrary 25, 1995 {9}\n10.13 Employment Agreements between FFP Operating Partners, L.P., and Avry Davidovich dated August 24, 1992, and September 30, 1992. [10.11] {5}\n10.14 Amendment dated May 17, 1994, to Employment Agreements between FFP Operating Partners, L.P., and Avry Davidovich {7}\n21.1 Subsidiaries of the Registrant. {9}\n23.1 Consent of KPMG Peat Marwick LLP. {9}\n27 Financial data schedule {9}\n99.1 Financial statements of FFP Operating Partners, L.P., a 99%-owned subsidiary of the Registrant. {These financial statements are being filed as an exhibit to facilitate compliance with certain state regulatory requirements.} {9}\n- --------------------------------\n{1} Included as the indicated exhibit in the Partnership's Registration Statement on Form S-1 (Registration No. 33-12882) dated May 14, 1987, and incorporated herein by reference.\n{2} Included as the indicated exhibit in the Partnership's Annual Report on Form 10-K for the fiscal year ended December 27, 1987, and incorporated herein by reference.\n{3} Included as the indicated exhibit in the Partnership's registration statement on Form 8-A dated as of August 29, 1989, and incorporated herein by reference.\n{4} Included as the indicated exhibit in the Partnership's Current Report on Form 8-K, dated February 10, 1989, and incorporated herein by reference)\n{5} Included as the indicated exhibit in the Partnership's Annual Report on Form 10-K for the fiscal year ended December 27, 1992, and incorporated herein by reference.\n{6} Included as the indicated exhibit in the Partnership's Annual Report on Form 10-K for the fiscal year ended December 26, 1993, and incorporated herein by reference.\n{7} Included as the indicated exhibit in the Partnership's Annual Report on Form 10-K for the fiscal year ended December 25, 1994, and incorporated herein by reference.\n{8} Included as the indicated exhibit in the Partnership's Quarterly Report on Form 10-Q for the first fiscal quarter ended March 26, 1995, and incorporated herein by reference.\n{9} Included herewith.\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this Annual Report on Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: April 12, 1996 FFP PARTNERS, L.P. (Registrant)\nBy: FFP Partners Management Company, Inc., General Partner\nBy: \/s\/ John H. Harvison John H. Harvison Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant in the capacities indicated as of April 16, 1996.\n\/s\/ John H. Harvison Chairman of the Board of Directors John H. Harvison and Chief Executive Officer of FFP Partners Management Company, Inc. (Principal executive officer)\n\/s\/ Robert J. Byrnes President, Chief Operating Officer, Rober J. Byrnes and Director of FFP Partners Management Company, Inc. (Principal operating officer)\n\/s\/ Steven B. Hawkins Vice President - Finance and Administration, Steven B. Hawkins and Chief Financial Officer of FFP Partners Management Company, Inc. (Principal financial and accounting officer)\n\/s\/ J. D. St.Clair Director of FFP Partners Management Company, Inc. J. D. St.Clair\n\/s\/ Avry Davidovich Director of FFP Partners Management Company, Inc. Avry Davidovich\n\/s\/ Robert E. Garrison, II Director of FFP Partners Management Company, Inc. Robert E. Garrison, II\n\/s\/ John W. Hughes Director of FFP Partners Management Company, Inc. John W. Hughes\n\/s\/ Garland R. McDonald Director of FFP Partners Management Company, Inc. Garland R. McDonald\n\/s\/ John D. Harvison Director of FFP Partners Management Company, Inc. John D. Harvison\n\/s\/ E. Michael Gregory Director of FFP Partners Management Company, Inc. E. Michael Gregory\nItem 8. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE.\nPage Number\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1995, and December 25, 1994\nConsolidated Income Statements for the Years Ended December 31, 1995, December 25, 1994, and December 26, 1993\nConsolidated Statements of Partners' Capital for the Years Ended December 31, 1995, December 25, 1994, and December 26, 1993\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, December 25, 1994, and December 26, 1993\nNotes to Consolidated Financial Statements\nSchedule II - Valuation and Qualifying Accounts\nF - 1\nINDEPENDENT AUDITORS' REPORT\nThe Partners FFP Partners, L.P.:\nWe have audited the consolidated financial statements of FFP Partners, L.P. (a Delaware Limited Partnership) 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 FFP Partners, L.P. and subsidiaries as of December 31, 1995 and December 25, 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 Notes 2(l) and 10 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick LLP\nFort Worth, Texas March 5, 1996, except for the third and fourth paragraphs of Note 5, which are as of March 29, 1996\nF - 2\nFFP PARTNERS, L.P., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995, AND DECEMBER 25, 1994 (In thousands)\n1995 1994\nASSETS\nCurrent Assets\nCash and cash equivalents $8,106 $11,400\nTrade receivables, less allowance for doubtful accounts of $1,045 and $917 in 1995 and 1994, respectively 9,440 8,092\nNotes receivable 453 452\nReceivables from affiliated company 436 451\nInventories 11,260 11,346\nPrepaid expenses and other current assets 615 607\nTotal current assets 30,310 32,348\nProperty and equipment, net 31,872 29,959\nNoncurrent notes receivable, excluding current portion 1,156 1,099\nClaims for reimbursement of environmental remediation costs 1,255 1,490\nOther assets, net 4,739 3,082\nTotal Assets $69,332 $67,978\nLIABILITIES AND PARTNERS' CAPITAL\nCurrent Liabilities\nAmount due under revolving credit line $4,003 $0\nCurrent installments of long-term debt 1,028 2,131\nCurrent installments of obligations under capital leases 884 552\nAccounts payable 13,030 13,180\nMoney orders payable 5,918 4,262\nAccrued expenses 9,894 12,323\nTotal current liabilities 34,757 32,448\nLong-term debt, excluding current installments 6,157 8,634\nObligations under capital leases, excluding current installments 943 893\nOther liabilities 1,774 1,153\nTotal Liabilities 43,631 43,128\nCommitments and contingencies\nPartners' Capital\nLimited partners' equity 25,713 24,870\nGeneral partner's equity 257 249\nTreasury units (269) (269)\nTotal Partners' Capital 25,701 24,850\nTotal Liabilities and Partners' Capital $69,332 $67,978\nSee accompanying notes to consolidated financial statements.\nF - 3\nFFP PARTNERS, L.P., AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS YEARS ENDED DECEMBER 31, 1995, DECEMBER 25, 1994, AND DECEMBER 26, 1993 (In thousands, except unit information)\n1995 1994 1993\nRevenues\nMotor fuel $296,887 $275,278 $246,023\nMerchandise 65,512 72,827 74,921\nMiscellaneous 7,646 7,408 5,706\nTotal Revenues 370,045 355,513 326,650\nCosts and Expenses\nCost of motor fuel 274,074 252,946 224,373\nCost of merchandise 46,325 52,658 54,601\nDirect store expenses 28,496 29,553 28,794\nGeneral and administrative expenses 11,795 11,056 10,527\nDepreciation and amortization 3,769 4,352 5,681\nTotal Costs and Expenses 364,459 350,565 323,976\nOperating Income 5,586 4,948 2,674\nInterest Expense 1,176 1,173 1,565\nIncome before income taxes, extraordinary item, and accounting change 4,410 3,775 1,109\nDeferred income tax expense 500 244 94\nIncome before extraordinary item and accounting change 3,910 3,531 1,015\nExtraordinary item - gain on extinguishment of debt 0 200 0\nCumulative effect of change in accounting for income taxes 0 0 (297)\nNet Income $3,910 $3,731 $718\nNet income allocated to\nLimited partners $3,871 $3,694 $711\nGeneral partner 39 37 7\nIncome\/(loss) per limited partner unit\nBefore extraordinary item and accounting change $1.07 $0.97 $0.28\nGain on extinguishment of debt 0.00 0.06 0.00\nChange in accounting for income taxes 0.00 0.00 (0.08)\nNet income $1.07 $1.03 $0.20\nDistributions declared per unit $0.87 $0.37 $0.00\nWeighted average number of Class\nA and Class B Units outstanding 3,632,221 3,589,337 3,585,233\nSee accompanying notes to consolidated financial statements.\nF - 4\nFFP PARTNERS, L.P., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL YEARS ENDED DECEMBER 31, 1995, DECEMBER 25, 1994, AND DECEMBER 26, 1993 (In thousands, except unit information)\nLimited Partners -------------------- Gemeral Treasury Class A Class B Partner Units Total\nBalance, December 27, 1992 $15,391 $6,330 $218 $(269) $21,670\nExercise of Class A Unit options by employees 15 0 0 0 15\nNet income 407 304 7 0 718\nBalance, December 26, 1993 15,813 6,634 225 (269) 22,403\nExercise of Class A Unit options by employees 53 0 0 0 53\nDistributions to partners ($0.37 per Class A and Class B Unit) (761) (563) (13) 0 (1,337)\nNet income 2,124 1,570 37 0 3,731\nBalance, December 25, 1994 17,229 7,641 249 (269) 24,850\nExercise of Class A Unit options by employees and directors 238 0 1 0 239\nRetirement of Class A Units (94) 0 0 0 (94)\nDistributions to partners ($0.87 per Class A and Class B Unit) (1,838) (1,334) (32) 0 (3,204)\nNet income 2,254 1,617 39 0 3,910\nBalance, December 31, 1995 $17,789 $7,924 $257 $(269) $25,701\nSee accompanying notes to consolidated financial statements.\nF - 5\nFFP PARTNERS, L.P., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, AND DECEMBER 25, 1994, DECEMBER 26, 1993 (In thousands, except supplemental information)\n1995 1994 1993\nCash Flows from Operating Activities\nNet income $3,910 $3,731 $718\nAdjustments to reconcile net income to net cash provided by operating activities\nDepreciation and amortization 3,769 4,352 5,681\nProvision for doubtful accounts 459 804 460\nProvision for deferred income taxes, including $297 for cumulative effect of change in acounting for income taxes in 1993 500 244 391\n(Gain)\/loss on sales of property and equipment (256) (16) 220\n(Gain) on extinguishment of debt 0 (200) 0\n(Gain) on sales of convenience store operations (791) (829) 0\nMinority interest in net income of subsidiaries 42 41 11\nChanges in operating assets and liabilities\n(Increase) in trade receivables (1,807) (2,018) (2,330)\n(Increase)\/decrease in notes receivable 733 80 (195)\n(Increase)\/decrease in receivables from affiliated companies 15 24 (147)\n(Increase)\/decrease in inventories 86 2,211 (876)\n(Increase)\/decrease in prepaid expenses and other current assets (8) 156 159\n(Increase)\/decrease in claims for reimbursement of environmental remediation costs 314 192 (52)\nDecrease in other assets 0 0 516\nIncrease\/(decrease)in accounts payable (150) 1,137 713\nIncrease in money orders payable 1,656 832 521\nIncrease\/(decrease)in accrued expenses (2,429) 353 2,222\nNet cash provided by operating activities 6,043 11,094 8,012\nCash Flows from Investing Activities\nPurchases of property and equipment (4,762) (3,772) (3,374)\nProceeds from sales of property and equipment 314 44 280\nInvestments in joint ventures and other entities (1,350) 0 0\n(Increase) in other assets (687) (787) (312)\nNet cash (used in) investing activities (6,485) (4,515) (3,406)\nCash Flows from Financing Activities\nBorrowings\/(payments) on revolving credit line, net 4,003 (7,116) 0\nProceeds from long-term debt 0 12,161 826\nPayments on long-term debt (4,178) (13,576) (3,494)\nBorrowings under capital lease obligations 1,076 1,560 0\nPayments on capital lease obligations (694) (115) 0\nProceeds from exercise of unit options 145 53 15\nDistributions to unitholders (3,204) (1,337) 0\n(Repayments to) General Partner, net 0 0 (332)\nNet cash (used in) financing activities (2,852 (8,370) (2,985)\nNet increase\/(decrease) in cash and cash equivalents (3,294) (1,791) 1,621\nCash and cash equivalents at beginning of year 11,400 13,191 11,570\nCash and cash equivalents at end of year $8,106 $11,400 $13,191\nSupplemental Disclosure of Cash Flow Information\nCash paid for interest during 1995, 1994, and 1993 was $1,394,000, $1,283,000, and $1,603,000, respectively.\nSupplemental Schedule of Noncash Investing and Financing Activities\nDuring 1995, the Company (i) acquired fixed assets of $598,000 in exchange for notes payable and (ii) retired $94,000 in Class A Units in connection with the surrender of 12,295 Class A Units in payment for the exercise of options to acquire 25,000 Class A Units by a director of the General Partner.\nDuring 1994, the Company acquired property valued at $215,000 and a note receivable of $120,000 through settlement of a lawsuit.\nSee accompanying notes to consolidated financial statements.\nFFP PARTNERS, L.P., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, DECEMBER 25, 1994, AND DECEMBER 26, 1993\n1. Basis of Presentation\n(a) Organization of Company\nFFP Partners, L.P. (\"FFPLP\"), through its subsidiaries, owns and operates retail convenience stores, truck stops, and self-service motor fuel outlets over an eleven state area. It also operates check cashing booths and conducts a wholesale motor fuel business, both primarily in Texas. FFPLP, a Delaware limited partnership, was formed in December 1986. FFP Partners Management Company, Inc. (\"FFPMC\" or the \"General Partner\"), serves as the general partner of FFPLP. FFPMC, or a subsidiary, also serves as the general partner of FFPLP's subsidiary partnerships. References in these notes to the \"Company\" include FFPLP and its subsidiaries.\nThe Company commenced operations in May 1987 upon the purchase of its initial base of retail outlets from affiliates of the General Partner. The purchase of these outlets was completed in conjunction with the Company's initial public offering of 2,065,000 Class A Units of limited partnership interest, the issuance of 1,585,000 Class B Units of limited partnership interest to the affiliates of the General Partner from which the retail outlets were acquired, and the issuance of a 1% interest in the Company to the General Partner.\nThe Company owns and conducts its operations through the following subsidiaries (entity, date formed, percentage owned, and principal activity):\nFFP Operating Partners, L.P. a Delaware limited partnership Formed December 1986 - 99% owned Operation of convenience stores and other retail outlets\nDirect Fuels, L.P. a Texas limited partnership Formed December 1988 - 99% owned Wholesale motor fuel sales\nFFP Financial Services, L.P. a Delaware limited partnership Formed Septmeber 1990 - 99% owned Operation of check cashing booths\nFFP Illinois Money Orders, Inc. an Illinois corporation Formed January 1993 - 100% owned Issuance of money orders in Illinois (inactive)\nPractical Tank Management, Inc. a Texas corporation Formed September 1993 - 100% owned Underground storage tank monitoring\nFFP Transportation, L.L.C. a Texas limited liability company Formed September 1994 - 100% owned Ownership of tank trailers leased to independent trucking company\nThe Company's Class A Units are traded on the American Stock Exchange. The Class B Units, which are not registered and are not traded on the American Stock Exchange, are held by entities affiliated with the General Partner. The Class B Units may be converted into Class A Units on a one-for-one basis at the option of the Class B unitholders. The Class A Units and Class B Units have identical rights with respect to cash distributions and to voting on matters brought before the partners.\n(b) Consolidation\nAll significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. The minority interest in the net income or loss of subsidiaries which are not wholly-owned by FFPLP is included in general and administrative expenses.\n(c) Reclassifications\nCertain amounts previously reported in the 1994 and 1993 consolidated financial statements have been reclassified to conform to the 1995 presentation.\n2. Significant Accounting Policies\n(a) Fiscal Years\nThe Company prepares its financial statements and reports its results of operations on the basis of a fiscal year which ends on the last Sunday of December. Accordingly, the fiscal year ended December 31, 1995, consisted of 53 weeks and the fiscal years ended December 25, 1994, and December 26, 1993, consisted of 52 weeks; certain other previous fiscal years consisted of 53 weeks. Year end data in these notes is as of the respective dates above.\n(b) Cash Equivalents\nThe Company considers all highly liquid investments with maturities at date of purchase of three months or less to be cash equivalents.\n(c) Notes Receivable\nNotes receivable are recorded at the amount owed, less a related allowance for impairment. The provisions of the Financial Accounting Standard Board's (\"FASB\") Statement of Financial Accounting Standard (\"SFAS\") No. 114, \"Accounting by Creditors for Impairment of a Loan,\" have been applied in the evaluation of the collectibility of notes receivable. At year end 1995 and 1994, no notes receivable were determined to be impaired.\n(d) Inventories\nInventories consist of retail convenience store merchandise and motor fuel products. Merchandise inventories are stated at the lower of cost or market as determined by the retail method. Motor fuel inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) inventory method.\nThe Company has selected a single company as the primary grocery and merchandise supplier to its convenience stores and truck stops although certain items, such as bakery goods, dairy products, soft drinks, beer, and other perishable products, are generally purchased from local vendors and\/or wholesale route salespeople. The Company believes it could replace any of its merchandise suppliers, including its primary grocery and merchandise supplier, with no significant adverse effect on its operations.\nThe Company does not have long-term contracts with any suppliers of petroleum products covering more than 10% of its motor fuel supply. Unanticipated national or international events could result in a curtailment of motor fuel supplies to the Company, thereby adversely affecting motor fuel sales. In addition, management believes a significant portion of its merchandise sales are to customers who also purchase motor fuel. Accordingly, reduced availability of motor fuel could negatively impact other facets of the Company's operations.\n(e) Property and Equipment\nProperty and equipment are stated at cost. Equipment acquired under capital leases is stated at the present value of the initial minimum lease payments, which is not in excess of the fair value of the equipment. Depreciation and amortization of property and equipment are provided on the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized on the straight-line method over the shorter of the lease term or the estimated useful lives of the respective assets.\n(f) Investments\nInvestments in joint ventures and other entities that are 50% or less owned are accounted for by the equity method and are included in other assets, net, in the accompanying consolidated balance sheets.\n(g) Intangible Assets\nIn connection with the allocation of the purchase price of the assets acquired in 1987 upon the commencement of the Company's operations, $6,192,000 was allocated to contracts under which the Company supplies motor fuel to various retail outlets and $1,093,000 was allocated as the future benefit of real estate leased from affiliates of the General Partner. The fuel contracts were amortized using the straight-line method over 6.3 years, the average life of such contracts at the time they were acquired. The value assigned to these contracts became fully amortized during 1993. The future benefit of the leases is being amortized using the straight-line method over 20 years, the initial term and option periods, of such leases.\nGoodwill of $2,020,000 is being amortized using the straight-line method over 20 years. The Company assesses the recoverability of goodwill by determining whether the amortization of the balance over the remaining amortization period 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 would be impacted if anticipated future operating cash flows are not achieved.\n(h) Sales of Convenience Store Operations\nThe Company sold the merchandise operations and related inventories of 10 and 15 convenience store locations to various third parties for approximately $900,000 and $1,834,000 in 1995 and 1994, respectively. Under these sales, the Company retained the real estate or leasehold interests, and leases or subleases the store facilities (including the store equipment) to the purchaser under five-year renewable operating lease agreements. The Company retains ownership of the motor fuel operations and pays the purchaser of the store commissions based on motor fuel sales. In addition, the new store operators may purchase merchandise under the Company's established buying arrangements for which the Company receives a commission.\nThe proceeds from the sales in 1995 consisted of cash of $357,000 and notes receivable of $543,000 and in 1994 consisted of cash of $778,000 and notes receivable of $1,056,000. The notes receivable generally are for terms of five years, require monthly payments of principal and interest, and bear interest at rates ranging from 8% to 10%. Gains on sales which meet specified criteria, including receipt of a significant cash down payment and projected cash flow from store operations sufficient to adequately service the debt, are recognized upon closing of the sale. Gains on sales which do not meet the specified criteria are recognized under the installment method as cash payments are received. Gains being recognized under the installment method are evaluated periodically to determine if full recognition of the gain is appropriate. During 1995 and 1994, the Company recognized gains of $791,000 and $829,000, respectively (included in miscellaneous revenues in the accompanying consolidated income statements), and deferred gains of $200,000 and $400,000, respectively (included in accrued expenses in the accompanying consolidated balance sheets).\n(i) Environmental Costs\nEnvironmental remediation costs are expensed; related environmental expenditures that extend the life, increase the capacity, or improve the safety or efficiency of existing assets are capitalized. Liabilities for environmental remediation costs are recorded when environmental assessment and\/or remediation is probable and the amounts can be reasonably estimated. Environmental liabilities are evaluated independently from potential claims for recovery. Accordingly, the gross estimated liabilities and estimated claims for reimbursement have been presented separately in the accompanying consolidated balance sheets (see Note 13b).\n(j) Motor Fuel Taxes\nMotor fuel revenues and related cost of motor fuel include federal and state excise taxes of $103,478,000, $103,117,000, and $82,890,000, for 1995, 1994, and 1993, respectively.\n(k) Exchanges\nThe exchange method of accounting is utilized for motor fuel exchange transactions. Under this method, such transactions are considered as exchanges of assets with deliveries being offset against receipts, or vice versa. Exchange balances due from others are valued at current replacement costs. Exchange balances due to others are valued at the cost of forward contracts (Note 11) to the extent they have been entered into, with any remaining balance valued at current replacement cost. Exchange balances due to others at year end 1995 and 1994 totaled $-0- and $123,000, respectively.\n(l) Income Taxes\nTaxable income or loss of the Company is includable in the income tax returns of the individual partners; therefore, no provision for income taxes has been made in the accompanying consolidated financial statements, except for applying the provisions of SFAS No. 109 \"Accounting for Income Taxes,\" which was adopted at the beginning of the Company's 1993 fiscal year.\nUnder the Revenue Act of 1987 (\"Revenue Act\"), certain publicly traded partnerships are to be treated as corporations for tax purposes. Due to a transitional rule, this provision of the Revenue Act will not be applied to the Company until the earlier of (i) its tax years beginning after 1997 or (ii) its addition of a \"substantial new line of business\" as defined by the Revenue Act. Legislation has been introduced into Congress which would extend for a two year period the Company's partnership tax status. However, no action has yet been taken on this legislation. The General Partner continues to evaluate the Company's alternatives with respect to its tax status.\nIncome taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to existing differences between\nfinancial statement carrying amounts of assets and liabilities and their respective tax bases that are expected to reverse after 1997. Deferred tax liabilities and assets are measured using enacted tax rates expected to be in effect when such amounts are realized or settled. The effect of a change in tax rates is recognized in income in the period that includes the enactment date.\n(m) Fair Value of Financial Instruments\nThe carrying amounts of cash, receivables, amounts due under revolving credit line, and money orders payable approximate fair value because of the short maturity of those instruments. The carrying amount of notes receivable approximates fair value which is determined by discounting expected future cash flows at current rates.\nThe carrying amount of long-term debt approximates fair value due to the variable interest rate on substantially all such obligations.\n(n) Units Issued and Outstanding\nUnits outstanding at year end 1995 and 1994 were as follows:\n1995 1994\nClass A Units 2,137,076 2,073,104\nClass B Units 1,533,522 1,533,522\nDuring 1990, the Company acquired 13,300 Class A Units and 51,478 Class B Units which are being held in the treasury at cost.\nIn January 1996, 1,298,522 Class B Units held by affiliates of the General Partner were converted to Class A Units, in accordance with the Partnership Agreement.\n(o) Income\/(Loss) per Unit\nThe Partnership Agreement provides that net income or loss is to be allocated (i) 99% to the limited partners and 1% to the General Partner and (ii) among the limited partners based on the number of units held. Accordingly, income\/(loss) per unit is calculated by dividing 99% of the appropriate income statement caption by the weighted average number of Class A and Class B Units outstanding for the year. No effect has been given to the unit purchase rights and options outstanding under the unit option plans (Note 9) since the effect is immaterial or anti-dilutive.\n(p) Cash Distributions to Partners\nDistributions to partners represent a return of capital and are allocated pro rata to the General Partner and holders of both the Class A and Class B Units.\n(q) Employee Benefit Plan\nEffective January 1, 1994, the Company adopted a 401(k) profit sharing plan covering all employees who meet age and tenure requirements. Participants may contribute to the plan a portion, within specified limits, of their compensation under a salary reduction arrangement. The Company may make discretionary matching or additional contributions to the plan. The Company did not make any contributions to the plan in 1995 or 1994.\n(r) Use of Estimates\nThe use of estimates is required to prepare the Company's consolidated financial statements in conformity with generally accepted accounting principles. Although management believes that such estimates are reasonable, actual results could differ from the estimates.\n(s) 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.\" SFAS 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 an asset may not be recoverable. Management is currently unable to reasonably estimate whether the adoption of SFAS 121 in 1996 will have a material effect on the Company's consolidated financial position or results of operations.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" SFAS 123 permits companies to retain the current approach set forth in Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" for recognizing stock-based compensation. Management believes that adopting the provisions of SFAS 123 in 1996 will not have a material effect on the Company's consolidated financial position or results of operations.\n3. Property and Equipment\nProperty and equipment consists of the following:\n1995 1994 (In thousands)\nLand $4,319 $3,853\nLand improvement 2,627 2,582\nBuildings and improvement 24,515 22,701\nMachinery and equipment 31,302 28,773\n62,763 57,909\nAccumulated depreciation and amortization (30,891) (27,950)\n$31,872 $29,959\nIn September 1995, the Company entered into an agreement to acquire a fuel terminal, including the land and equipment. This purchase was completed after year end.\n4. Other Assets\nOther assets consist of the following:\n1995 1994 (In thousands)\nIntangible Assets (Note 2g)\nGround leases $1,093 $1,093\nGoodwill 2,020 1,932\nOther 1,984 1,406\n5,097 4,431\nAccumulated amortization (2,056) (1,676)\n3,041 2,755\nInvestments in joint ventures and other entities 1,350 0\nOther 348 327\n$4,739 $3,082\nIn December 1995, the Company invested $1,200,000 for a 50% interest in a joint venture formed to acquire certain loans that are secured by convenience stores located in areas where the Company currently has operations. These loans will be liquidated through collection or through acquisition of the stores by the Company through foreclosure.\n5. Notes Payable and Long-Term Debt\nThe Company has a Credit Agreement with a bank that provides a $10,000,000 revolving credit line for working capital purposes with sublimits of $8,000,000 for cash advances and $3,000,000 for letters of credit. The revolving credit line bears interest at the bank's prime rate (8.5% at year end 1995) and matures on April 30, 1997. The Credit Agreement requires that the cash balance outstanding under the revolving credit line be repaid for seven consecutive calendar days in each quarter beginning July 1, 1996. At year end 1995, there was $4,003,000 due on the revolving credit line and there were outstanding letters of credit totaling $625,000\nThe Credit Agreement also provides a term loan, which had a balance at year end 1995 of $6,563,000. This loan bears interest at the bank's prime rate, requires quarterly payments of $312,500, plus interest, and matures on March 31, 2001.\nOn March 29, 1996, the bank and Company amended the Credit Agreement principally to provide an additional term loan of $1,000,000 to be used by the Company to finance the acquisition and renovation of a fuel terminal and processing plant. This loan bears interest at the bank's prime rate, is due in quarterly installments of $50,000 beginning June 30, 1996, and matures on March 31, 2001.\nAll loans are secured by the Company's accounts receivable and inventory. In addition the Company has provided a negative pledge of all its fixed assets and real property and the bank has the right to require a positive pledge of such assets at any time. The loans are guaranteed by the General Partner and its subsidiary. The Credit Agreement also contains various restrictive covenants including restrictions on borrowing from persons other than the bank, making investments in, advances to, or guaranteeing the obligations of other persons, maintaining specified levels of equity, and the maintenance of certain financial ratios which have the effect of limiting cash distributions and capital expenditures. At year end 1995, the Company was not in compliance with certain financial ratios. In connection with the March 29, 1996, amendment of the Credit Agreement, discussed above, the bank has waived compliance, to a limited extent, with these ratios until the Company's second 1996 fiscal quarter at which time the Company believes it will be in compliance with these ratios.\nThe Company has other notes payable which bear interest at 6% to 10% and are due in monthly or annual installments through 2012. Such notes are unsecured or secured by receivables or land and had aggregate balances of $622,000 and $265,000 at year end 1995 and 1994, respectively.\nThe aggregate fixed maturities of long-term debt for each of the five years subsequent to 1995 are as follows:\n(In thousands)\n1996 $1,028\n1997 1,346\n1998 1,296\n1999 1,410\n2000 1,289\nThereafter 816\n$7,185\nIn February 1994, the Company refinanced its then existing bank debt. In connection with this refinancing, the Company received a discount of $200,000 for the early retirement of the existing debt. This discount is reflected as an extraordinary item in the accompanying 1994 consolidated income statement.\n6. Capital Leases\nThe Company is obligated under noncancelable capital leases beginning to expire in 1997. The gross amount of the assets covered by these capital leases that are included in property and equipment in the accompanying consolidated balance sheets is as follows:\n1995 1994\n(In thousands)\nMachinery and equipment $2,636 $1,560\nAccumulated amortization (425) (19)\n$2,211 $1,541\nThe amortization of assets held under capital leases is included in depreciation and amortization expense in the accompanying consolidated income statements. Future minimum lease payments under the noncancelable capital leases for years subsequent to 1995 are:\n(In thousands)\n1996 $1,079\n1997 891\n1998 121\nTotal minimum lease payments 2,091\nAmount representing interest (264)\nPresent value of future minimum lease payments 1,827\nCurrent installments (884)\nObligations under capital leases, excluding current installment $943\n7. Operating Leases\nThe Company has noncancelable, long-term operating leases on certain locations, a significant portion of which are with related parties. Certain of the leases have contingent rentals based on sales levels of the locations and\/or have escalation clauses tied to the consumer price index. Minimum future rental payments (including bargain renewal periods) and sublease receipts for years after 1995 are as follows:\nFuture Rental Payments ------------------------------------------------------ Future Related Sublease Parties Others Total Receipts (In thousands)\n1996 $831 $668 $1,499 $623\n1997 762 532 1,294 533\n1998 712 476 1,188 495\n1999 712 426 1,138 396\n2000 677 383 1,060 113\nThereafter 2,700 1,624 4,324 0\n$6,394 $4,109 $10,503 $2,160\nTotal rental expense and sublease income were as follows:\nRent Expense ------------------------------------------------------ Related Sublease Parties Others Total Income (In thousands)\n1995 $849 $735 $1,584 $843\n1994 842 912 1,754 592\n1993 840 1,162 2,002 467\n8. Accrued Expenses\nAccrued expenses consist of the following:\n1995 1994 (In thousands)\nMotor fuel taxes payable $6,599 $8,232\nAccrued payroll and related expenses 1,349 1,199\nAccrued environmental remediation costs (Note 13b) 322 260\nOther 1,624 2,632\n$9,894 $12,323\n9. Nonqualifying Unit Option Plan and Unit Purchase Rights\nThe Company has a Nonqualifying Unit Option Plan and a Nonqualifying Unit Option Plan for Nonexecutive Employees that authorize the grant of options to purchase up to 450,000 and 100,000 Class A Units of the Company, respectively.\nFollowing is a summary of activity under the stock option plans:\nClass A Units Price\nOptions outstanding, December 27, 1992 377,000 $2.00 - $12.00\nOptions granted during year 7,000 $3.75\nOptions expired or terminated during year (70,000) $3.75 - $12.00\nOptions exercised during year (4,068) $3.75\nOptions outstanding, December 26, 1993 309,932 $2.00 - $3.75\nOptions granted during year 10,000 $3.88\nOptions expired or terminated during year (8,666) $3.75\nOptions exercised during year (17,336) $2.00 - $3.75\nOptions outstanding, December 25, 1994 293,930 $2.00 - $3.88\nOptions granted during year 50,000 $6.00 - $7.00\nOptions expired or terminated during year (6,999) $3.75\nOptions exercised during year (76,267) $2.00 - $3.88\nOptions outstanding, December 31, 1995 260,664 $3.75 - $7.00\nOptions exercisable, December 31, 1995 203,998 $3.75 - $3.88\nThe exercise price of each option granted under the plans is determined by the Board of Directors, but may not be less than the fair market value of the underlying units on the date of grant. The exercise prices of the options outstanding at year end 1995 are:\nExercise Options Price Outstanding\n$3.750 203,998\n$3.875 6,666\n$6.000 25,000\n$7.000 25,000\n260,664\nAll options outstanding at year end 1995 are exercisable with respect to one-third of the units covered thereby on each of the anniversary dates of their grants. In the event of a change in control of the Company, any unexercisable portion of the options will become immediately exercisable.\nIn August 1989, the Company entered into a Rights Agreement and distributed to its Unitholders Rights to purchase Units under certain circumstances. Initially the Rights were attached to all Unit Certificates representing Units then outstanding and no separate Rights Certificates were distributed. Under the Rights Agreement, the Rights were to separate from the Units and be distributed to Unitholders following a public announcement that a person or group of affiliated or associated persons (an \"Acquiring Person\") had acquired, or obtained a right to acquire, beneficial ownership of 20% or more of the Partnership's Class A Units or all classes of outstanding Units. On August 8, 1994, a group of Unitholders announced that they had an informal understanding that they would vote their Units together as a block. The agreement related to units constituting approximately 25% of the Class A Units then outstanding. Therefore, the Rights became exercisable on October 7, 1994, the record date for the issuance of the Rights Certificates (the \"Distribution Date\").\nThe Rights currently represent the right to purchase a Rights Unit (which is substantially equivalent to a Class A Unit) of the Company at a price of $20.00 per Unit. However, the Rights Agreement provides, among other things, that if any person acquires 30% or more of the Class A Units or of all classes of outstanding Units then each holder of a Right, other than an Acquiring Person, will have the right to receive, upon exercise, Rights Units (or in certain circumstances, other property) having a value of $40.00 per Unit. The Rights will expire on August 13, 1999, and do not have any voting rights or rights to cash distributions.\n10. Income Taxes\nAs discussed in Note 2(l), the Company adopted the provisions of SFAS No. 109 as of the beginning of its 1993 fiscal year. In the 1993 consolidated income statement, the Company recorded a $297,000 noncash charge which represented the cumulative effect of the change in accounting for income taxes. Noncash charges of $500,000, $244,000 and $94,000 were recorded in 1995, 1994, and 1993, respectively, to record deferred income tax expense.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities at year end 1995 and 1994, are presented below. Those temporary differences which are expected to reverse prior to the Company's being treated as a corporation for tax purposes (fiscal year 1998) have been excluded.\n1995 1994 (In thousands) Deferred tax liabilities: Property and equipment, principally due to basis differences and differences in depreciation (845) (583)\nOther (290) (52)\n$(1,135) $(635)\n11. Futures and Forward Contracts\nThe Company is party to commodity futures contracts with off-balance sheet risk. Changes in the market value of open futures contracts are recognized as gains or losses in the period of change. These investments involve the risk of dealing with others and their ability to meet the terms of the contracts and the risk associated with unmatched positions and market fluctuations. Contract amounts are often used to express the volume of these transactions, but the amounts potentially subject to risk are much smaller.\nFrom time-to-time the Company enters into forward contracts to buy and sell fuel, principally to satisfy balances owed on exchange agreements (Note 2k). These transactions, which together with futures contracts are classified as operating activities for purposes of the consolidated statements of cash flows, are included in motor fuel sales and related cost of sales and resulted in net gains as follows:\n(In thousands)\n1995 $87\n1994 1,069\n1993 730\nOpen positions under futures and forward contracts were not significant at year end 1995 and 1994.\n12. Related Party Transactions\nThe Company reimburses the General Partner and its affiliates for salaries and related costs of executive officers and others and for expenses incurred by them in connection with the management of the Company. These expenses were $727,000, $733,000, and $737,000 for 1995, 1994, and 1993, respectively.\nIn July 1991, the Company entered into an agreement with an affiliated company whereby the affiliated company sells alcoholic beverages at the Company's stores in Texas. Under Texas law, the Company is not permitted to hold licenses to sell alcoholic beverages in Texas. The agreement provides that the Company will receive rent and a management fee based on the gross receipts from sales of alcoholic beverages at its stores. In July 1992, the agreement was amended to be for a term of five years commencing on the date of amendment. The sales recorded by the affiliated company under this agreement were $9,116,000, $9,180,000, and $8,608,000 in 1995, 1994, and 1993, respectively. The Company received $1,217,000, $1,226,000, and $1,281,000 in 1995, 1994, and 1993, respectively, in rent, management fees, and interest, which are included in miscellaneous revenues in the consolidated income statements. After deducting cost of sales and other expenses related to these sales, including the amounts paid to the Company, the affiliated company had earnings of $91,000, $119,000, and $64,000 in 1995, 1994, and 1993, respectively, as a result of holding these alcoholic beverage permits. Under a revolving note executed in connection with this agreement, the Company advances funds to the affiliated company to pay for the purchases of alcoholic beverages. Receipts from the sales of such beverages are credited against the note balance. The revolving note provides for interest at 1\/2% above the prime rate charged by a major financial institution.\nFrom time to time, the General Partner advances funds to the Company. Under the Partnership Agreement, the General Partner is permitted to charge interest on such advances provided the interest rate does not exceed rates which would be charged by unrelated third parties. Interest expense of $19,000 is included in the results of operations for 1993. There were no advances owing to the General Partner during or at the year ends of 1995 and 1994.\nThe General Partner is entitled to noncumulative, incentive compensation each year in an amount equal to 10% of the net income of the Company for such year (prior to the calculation of the incentive compensation), but only if net income (prior to the calculation of the incentive compensation) equals or exceeds $1.08 per unit and only if the total of the quarterly cash distributions for such year are at least $1.50 per unit. The incentive compensation requirements were not met in 1995, 1994, or 1993.\nThe Company purchases certain goods and services (including office supplies, computer software and consulting services, and fuel supply consulting and procurement services) from related entities. Amounts incurred for these products and services were $421,000, $147,000, and $169,000 for 1995, 1994, and 1993, respectively.\nAs a part of its merchandise sales activities, the Company supplies its private label cigarettes on a wholesale basis to other retailers who do not operate outlets in its trade areas and pays them rebates based on the volume of cigarettes purchased. In 1995, the Company paid $51,000 of such rebates to a company on whose Board one of the Company's executive officers serves. The amount of rebates paid to this company was calculated in the same manner as the rebates paid to non-related companies.\nIn 1980 and 1982, certain companies from which the Company acquired its initial base of retail outlets granted to a third party the right to sell motor fuel at retail for a period of 10 years at self-serve gasoline stations owned or leased by the affiliated companies or their affiliates. All rights to commissions under these agreements and the right to sell motor fuel at wholesale to the third party at such locations were assigned to the Company in May 1987 in connection with the acquisition of its initial base of retail operations. In December 1990, in connection with the expiration or termination of the agreements with the third party, the Company entered into agreements with a company owned and controlled by the Chairman of the General Partner and members of his immediate family, which grant to the Company the exclusive right to sell motor fuel at retail at these locations. The terms of these agreements are comparable to agreements that the Company has with other unrelated parties. The Company paid this affiliated company commissions related to the sale of motor fuel at these locations of $261,000, $222,000, and $186,000 in 1995, 1994, and 1993, respectively.\nDuring 1995, the Company purchased four parcels of land, including building and petroleum storage tanks and related dispensing equipment, from a company controlled by the Chairman of the General Partner and members of his immediate family. The Company paid a total of $116,000 for the real estate and related improvements. The Company is operating one of these locations as a convenience store and one as a self-service motor fuel outlet and intends to operate the other two as either convenience stores or self-service motor fuel outlets. The purchase price was determined by reference to similar properties acquired by the Company from unrelated parties.\n13. Commitments and Contingencies\n(a) Uninsured Liabilities\nThe Company maintains general liability insurance with limits and deductibles management believes prudent in light of the exposure of the Company to loss and the cost of the insurance.\nThe Company self-insures claims up to $45,000 per year for each individual covered by its employee medical benefit plan for supervisory and administrative employees; claims above $45,000 are covered by a stop-loss insurance policy. The Company also self-insures medical claims for its eligible store employees. However, claims under the plan for store employees are subject to a $1,000,000 lifetime limit per employee and the Company does not maintain stop-loss coverage for these claims. The Company and its covered employees contribute to pay the self-insured claims and stop-loss insurance premiums. Accrued liabilities include amounts management believes adequate to cover the estimated claims arising prior to a year-end, including claims incurred but not yet reported. The Company recorded expense related to these plans of $353,000, $288,000, and $303,000, in 1995, 1994, and 1993, respectively.\nThe Company has elected to discontinue carrying workers' compensation insurance in the State of Texas. However, it has insurance policies, including an annual limit stop-loss policy, which limits the Company's exposure to losses related to claims to provide a safe work environment. Claims under these policies are limited to $250,000 per occurrence and $750,000 annual aggregate payments under the stop-loss policy. In other states, the Company is covered for worker's compensation through incurred loss retrospective policies. Accruals for estimated claims (including claims incurred but not reported) have been recorded at year end 1995 and 1994, including the effects of any retroactive premium adjustments.\n(b) Environmental Matters\nThe operations of the Company are subject to a number of federal, state, and local environmental laws and regulations, which govern the storage and sale of motor fuels, including those regulating underground storage tanks. In September 1988, the Environmental Protection Agency (\"EPA\") issued regulations that require all newly installed underground storage tanks be protected from corrosion, be equipped with devices to prevent spills and overfills, and have a leak detection method that meets certain minimum requirements. The effective commencement date for newly installed tanks was December 22, 1988. Underground storage tanks in place prior to December 22, 1988, must conform to the new standards by December 1998. The Company has implemented a plan to bring all of its existing underground storage tanks and related equipment into compliance with these laws and regulations and currently estimates the costs to do so will range from $2,800,000 to $3,425,000 over the next three years. The Company anticipates that substantially all these expenditures will be capitalized as additions to property and equipment. Such estimates are based upon current regulations, prior experience, assumptions as to the number of underground storage tanks to be upgraded, and certain other matters. At year end 1995 and 1994, the Company recorded liabilities for future estimated environmental remediation costs related to known leaking underground storage tanks of $643,000 and $503,000, respectively. Of such amounts, $322,000 and $260,000, respectively, were recorded in accrued expenses and the remainder was recorded in other liabilities. Corresponding claims for reimbursement of environmental remediation costs of $643,000 and $503,000 were recorded in 1995 and 1994, respectively, as the Company expects that such costs will be reimbursed by various environmental agencies. In 1995, the Company contracted with a third party to perform site assessments and remediation activities on 35 sites located in Texas that are known or thought to have leaking underground storage tanks. Under the contract, the third party will coordinate with the state regulatory authority the work to be performed and bill the state directly for such work. The Company is liable for the $5,000 per occurrence deductible and for any costs in excess of the $1,000,000 limit provided for by the state environmental trust fund. The Company does not expect that the costs of remediation of any of these 35 sites will exceed the $1,000,000 limit. The assumptions on which the foregoing estimates are based may change and unanticipated events and circumstances may occur which may cause the actual cost of complying with the above requirements to vary significantly from these estimates.\nDuring 1995, 1994, and 1993, environmental expenditures were $1,003,000, $934,000, and $340,000, respectively (including capital expenditures of $644,000, $820,000, and $118,000), in complying with environmental laws and regulations.\nThe Company does not maintain insurance covering losses associated with environmental contamination. However, all the states in which the Company owns or operates underground storage tanks have state operated funds which reimburse the Company for certain cleanup costs and liabilities incurred as a result of leaks in underground storage tanks. These funds, which essentially provide insurance coverage for certain environmental liabilities, are funded by taxes on underground storage tanks or on motor fuels purchased within each respective state. The coverages afforded by each state vary but generally provide up to $1,000,000 for the cleanup of environmental contamination and most provide coverage for third-party liability as well. The funds require the Company to pay deductibles ranging from $5,000 to $25,000 per occurrence. The majority of the Company's environmental contamination cleanup activities relate to underground storage tanks located in Texas. Due to an increase in claims throughout the state, the Texas state environmental trust fund has significantly delayed reimbursement payments for certain cleanup costs after September 30, 1992. In 1993, the Texas state fund issued guidelines that, among other things, prioritize the timing of future reimbursements based upon the total number of tanks operated by and the financial net worth of each applicant. The Company has been classified in the category with the lowest priority. Because the state and federal governments have the right, by law, to levy additional fees on fuel purchases, the Company believes these clean up costs will ultimately be reimbursed. However, due to the uncertainty of the timing of the receipt of the reimbursements, the claims for reimbursement of environmental remediation costs, totaling $1,255,000 and $1,490,000 at year end 1995 and 1994, respectively, have been classified as long-term receivables in the accompanying consolidated balance sheets,\n(c) Other\nThe Company is subject to various claims and litigation arising in the ordinary course of business, particularly personal injury and employment related claims. In the opinion of management, the outcome of such matters will not have a material effect on the consolidated financial position or results of operations of the Company.\n14. Quarterly Operating Results (Unaudited)\nQuarterly results of operations for 1995, 1994, and 1993, were as follows:\nFirst Second Third Fourth Full Quarter Quarter Quarter Quarter Year (In thousands, except per unit data)\nTotal revenues $84,413 $97,623 $93,716 $94,293 $370,045 Total margin 10,970 12,521 13,963 12,192 49,646 Net income 154 1,172 2,071 513 3,910 Net income per unit $0.04 $0.32 $0.56 $0.15 $1.07\nTotal revenues $83,825 $87,760 $96,771 $87,157 $355,513 Total margin 10,998 11,987 13,899 13,025 49,909 Income\/(loss) - Before extraordinary item (486) 517 2,473 1,027 3,531 Gain on extinguishment of debt 200 0 0 0 200 Net income\/(loss) (286) 517 2,473 1,027 3,731 Income\/(loss) per unit - Before extraordinary item $(0.13) $0.14 $0.68 $0.28 $0.97 Net income\/(loss) (0.08) 0.14 0.68 0.28 1.03\nTotal revenues $71,900 $80,217 $85,497 $89,036 $326,650 Total margin 10,554 11,959 13,471 11,692 47,676 Income\/(loss) - Before change in accounting principle 22 407 937 (351) 1,015 From change in accounting for income taxes (297) 0 0 0 (297) Net income\/(loss) (275) 407 937 (351) 718 Income\/(loss) per unit - Before change in accounting principle $0.01 $0.11 $0.26 $(0.10) $0.28 Net income\/(loss) (0.07) 0.11 0.26 (0.10) 0.20\nSchedule II\nFFP PARTNERS, L.P., AND SUBSIDIARIES Valuation and Qualifying Accounts (In thousands)\nYear Ended December 31, 1995 -----------------------------------------------------\nBalance Additions Balance at Charged to at Beginning Costs and Deductions End Description of Period Expenses (describe) of Period\nAllowances for doubtful accounts Trade receivables $917 $459 $331 (a) $1,045\nYear Ended December 25, 1994 ------------------------------------------------------------\nBalance Additions Balance at Charged to at Beginning Costs and Deductions End Description of Period Expenses (describe) of Period\nAllowances for doubtful accounts Trade receivables $531 $804 $418 (a) $917 Noncurrent receivable from affiliated companies 447 0 447 (a) 0\nYear Ended December 26, 1993 --------------------------------------------------------------\nBalance Additions Balance at Charged to at Beginning Costs and Deductions End Description of Period Expenses (describe) of Period\nAllowances for doubtful accounts Trade receivables $600 $460 $529 (a) $531 Noncurrent receivable from affiliated companies 447 0 0 447\n(a) Accounts charged-off, net of recoveries.","section_15":""}
{"filename":"276478_1995.txt","cik":"276478","year":"1995","section_1":"Item 1. Business\nGeneral American Transportation Corporation (GATC) is a wholly-owned subsidiary of GATX Corporation (GATX) and is engaged in the leasing and management of railroad tank cars and specialized freight cars and owns and operates tank storage terminals, pipelines and related facilities.\nINDUSTRY SEGMENTS\nRAILCAR LEASING AND MANAGEMENT\nThe Railcar Leasing and Management segment (Transportation), headquartered in Chicago, Illinois, is principally engaged in leasing specialized railcars, primarily tank cars, under full service leases. As of December 31, 1995, its domestic fleet consisted of approximately 64,900 railcars, including 53,900 tank cars and 11,000 specialized freight cars, primarily Airslide covered hopper cars and plastic pellet cars. In addition, Transportation has approximately 1,500 railcars in its Mexican fleet. Transportation has upgraded its fleet over time by adding new larger capacity cars and retiring older smaller capacity cars. Transportation's railcars have a useful life of approximately 30 to 33 years. The average age of the railcars in Transportation's fleet is approximately 15 years.\nThe following table sets forth the approximate tank car fleet capacity of Transportation as of the end of each of the years indicated and the number of cars of all types added to Transportation's fleet during such years:\nTransportation's customers use its railcars to ship over 700 different commodities, primarily chemicals, petroleum, food products and minerals. For 1995, approximately 54% of railcar leasing revenue was attributable to shipments of chemical products, 21% to petroleum products, 18% to food products and 7% to other products. Many of these products require cars with special features; Transportation offers a wide variety of sizes and types of cars to meet these needs. Transportation leases railcars to over 700 customers, including major chemical, oil, food and agricultural companies. No single customer accounts for more than 4% of total railcar leasing revenue.\nTransportation typically leases new railcars to its customers for a term of five years or longer, whereas renewals or leases of used cars are typically for periods ranging from less than a year to seven years with an average lease term of about three years. The utilization rate of Transportation's domestic railcars as of December 31, 1995 was approximately 95%.\nUnder its full service leases, Transportation maintains and services its railcars, pays ad valorem taxes, and provides many ancillary services. Through its Car Status Service System, for example, the company provides customers with timely information about the location and readiness of their leased cars to enhance and maximize the utilization of this equipment. Transportation also maintains a network of major service centers consisting of four domestic and one foreign service center, and 25 mobile trucks in 17 locations. Transportation also utilizes independent third-party repair shops.\nTransportation purchases most of its new railcars from Trinity Industries, Inc. (Trinity), a Dallas-based metal products manufacturer, under a contract entered into in 1984 and extended from time to time thereafter, most recently in 1992. Transportation anticipates that through this contract it will continue to be able to satisfy its customers' new car lease requirements. Transportation's engineering staff provides Trinity with design criteria and equipment specifications, and works with Trinity's engineers to develop new technology where needed in order to upgrade or improve car performance or in response to regulatory requirements.\nThe full-service railcar leasing industry is comprised of Transportation, Union Tank Car Company, General Electric Railcar Services Corporation, Shippers Car Line division of ACF Industries, Incorporated, and many smaller companies. Of the approximately 207,000 tank cars owned and leased in the United States at December 31, 1995, Transportation had approximately 53,900. Principal competitive factors include price, service and availability.\nTERMINALS AND PIPELINES\nGATX Terminals Corporation (Terminals) is engaged in the storage, handling and intermodal transfer of petroleum and chemical commodities at key points in the bulk liquid distribution chain. All of its terminals are located near major distribution and transportation points and most are capable of receiving and shipping bulk liquids by ship, rail, barge and truck. Many of the terminals are also linked with major interstate pipelines. In addition to storing, handling and transferring bulk liquids, Terminals provides blending and testing services at most of its facilities. Terminals, headquartered in Chicago, Illinois, owns and operates 28 terminals in 11 states, and eight terminals in the United Kingdom. Terminals also has joint venture interests in 14 international facilities. Additionally, Terminals owns or holds interests in four refined product pipeline systems.\nAs of December 31, 1995, Terminals had a total storage capacity of 75 million barrels. This includes 55 million barrels of bulk liquid storage capacity in the United States, 7 million barrels in the United Kingdom, and an equity interest in another 13 million barrels of storage capacity in Europe and the Far East. Terminals' smallest bulk liquid facility has a storage capacity of 95,000 barrels while its largest facility, located in Pasadena, Texas, has a capacity of over 12 million barrels. Capacity utilization at Terminals' wholly owned facilities was 85% at the end of 1995; throughput for the year was 655 million barrels.\nFor 1995, 75% of Terminals' revenue was derived from petroleum products, 23% from a variety of chemical products, and 2% from other products. Demand for Terminals' facilities is dependent in part upon demand for petroleum and chemical products and is also affected by refinery output, foreign imports, availability of other storage facilities, and the expansion of its customers into new geographical markets.\nTerminals serves approximately 300 customers, including major oil and chemical companies as well as trading firms and larger independent refiners. No single customer accounts for more than 5% of Terminals' revenue. Customer service contracts are both short term and long term. Terminals along with two Dutch companies, Paktank N.V. and Van Ommeren N.V., are the three major international public terminalling companies. The domestic public terminalling industry consists of Terminals, Paktank Corporation, International-Matex Tank Terminals, and many smaller independent terminalling companies. In addition to public terminalling companies, oil and chemical companies also have significant storage capacity in their own private facilities. Terminals' pipelines compete with rail, trucks and other pipelines for movement of liquid petroleum products. Principal competitive factors include price, location relative to distribution facilities, and service.\nTrademarks, Patents and Research Activities - ------------------------------------------- Patents, trademarks, licenses, and research and development activities are not material to these businesses taken as a whole.\nCustomer Base - ------------- GATC and its subsidiaries are not dependent upon a single customer or a few customers. The loss of any one customer would not have a material adverse effect on any segment or GATC as a whole.\nEmployees - --------- GATC and its subsidiaries have approximately 2,000 active employees, of whom 36% are hourly employees covered by union contracts.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------- Information regarding the location and general character of certain properties of GATC is included in Item 1, Business, of this document. The major portion of Terminals' land is owned; the balance is leased.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------- A railcar owned by Transportation was involved in a derailment near Dunsmuir, California, in July 1991 that resulted in a spill of metam sodium into the Sacramento River. Various lawsuits seeking damages in unspecified amounts have been filed against General American Transportation Corporation (GATC), or an affiliated company, most of which have been consolidated in the Superior Court of the State of California for the City and County of San Francisco (Nos. 2617 and 2620). GATC has now been dismissed by the class plaintiffs in those cases, and has resolved the claims of the plaintiffs who opted out of the class. There was one other case seeking recovery for response costs and natural resource damages: State of California, et al, vs. Southern Pacific, et al, filed in the Eastern District of California (CIV-S-92 1117). All other actions were consolidated with these two cases. GATC was also named as a potentially responsible party by the State of California with respect to the assessment and remediation of possible damages to natural resources which claim was also consolidated in the suit in the Eastern District of California. GATC has now entered into settlement agreements with the United States of America, the State of California, Southern Pacific and certain other defendants settling all material claims arising out of the above incident in an amount not material to GATC.\nOn July 14, 1995, a judgment in the amount of $9.7 million was entered against GATC by the U.S. District Court for the Northern District of Illinois in the matter of General American Transportation Corporation v. Cryo-Trans, Incorporated (Case No. 91 C 1305), a case involving an alleged patent infringement by GATC in the construction and use of its ArcticarTM cryogenically cooled railcar. That judgment has been reduced to approximately $9 million. GATC was also permanently enjoined from any further infringement of the patent as of August 1, 1995, subsequently extended to September 1, 1995. Of GATC's 65,000 railcar fleet, the injunction affected only 180 railcars, 80 of which were on lease and 100 on order. GATC has filed an appeal of the decision with the Federal Circuit Court of Appeals. Even in the event of an adverse decision on appeal, GATC does not believe the costs associated with the disposition of the affected cars will have a material adverse effect on GATC.\nVarious lawsuits have been filed in the Superior Court for the State of California and served upon Terminals, Calnev Pipe Line Company, or another GATX subsidiary seeking an unspecified amount of damages arising out of the May 1989 explosion in San Bernardino, California. Those suits, all of which were filed in the County of San Bernardino unless otherwise indicated, are: Aguilar, et al, v. Calnev Pipe Line Company, et al, filed February 1990 in the County of Los Angeles (No. 0751026); Alba, et al, v. Southern Pacific Railroad Co., et al, filed November 1989 (No. 252842); Terry, et al, v. Southern Pacific, et al, filed December 1989 (No. 253604); Charles, et al, v. Calnev Pipe Line, Inc., et al, filed May 1990 (No. 256269); Abrego, et al, v. Southern Pacific Transportation Corporation, et al, filed May 1990 in the County of Los Angeles (No. BC 000947) and settled November, 1995; Glaspie, et al, v. Southern Pacific Transportation, et al, filed May 1990 in the County of Los Angeles (No. BC002047) and settled November 1995; Burney, et al, v. Southern Pacific, et al, filed May 1990 in the County of Los Angeles (BC000876) and settled May, 95; Ledbetter, et al, v. City of San Bernardino, et al, filed May 1990 (No. 256173) and settled April,1995; Mary Washington v. Southern Pacific, et al, filed May 1990 (No. 256346); Stewart, et al, v. Southern Pacific Railroad Co., et al, filed May 1990 (No. 256464); Pearson v. Calnev Pipe Line Company, et al, filed May 1990 in the County of San Bernardino (No. 256206); Pollack v. Southern Pacific Transportation, et al, filed May 1992 (No. 271247); Davis v. Calnev Pipe Line Company, et al, filed May 1990 (No. 256207); J. Roberts, et al, v. Southern Pacific Transportation, et al, filed November 1992 (No. 275936); Brooks, et al, v. Southern Pacific, et al, filed May 1990 (No. 256176) and settled February 1994; Goldie, et al, v. Southern Pacific, et al, filed May 1990 and dismissed July 1993, appeal pending; Irby, et al, v. Southern Pacific, et al, (No. 255715) filed April 1990; Esparza, et al, v. Southern Pacific, et al, (No. 256433) filed May 1990 and settled February 1994; Reese, et al, v. Southern Pacific, et al (No. 256434) filed May 1990; Nancy Washington, et al, v. Southern Pacific, et al, (No. 256435) filed May 1990. As Terminals' insurance carriers have assumed the defense of these lawsuits without a reservation of rights and have paid all of the settlements entered to date, GATC believes that the likelihood of a material adverse effect on GATC's consolidated financial position or operations is remote.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot required.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nGATX Corporation owns all of the outstanding common stock of GATC.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNot required.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGATC reported record net income of $94 million for 1995 compared to $87 million in 1994 and $74 million in 1993. The increase was due to record earnings at Transportation reflecting significant growth in the number of railcars on lease and higher income on invested funds. Terminals' net income decreased slightly from 1994's record level as capacity utilization declined at certain terminals. This resulted from lower worldwide petroleum storage demand, significantly lower utilization of tanks in the Northeast due to reduced buildup of heating oil inventories, and lower demand and price competition in Los Angeles. Chemical markets, pipelines and income from European terminal joint ventures remained strong.\nOperating results at Transportation improved in 1994 due to significantly more railcars on lease. Terminals reported record earnings in 1994 as the result of increased utilization and throughput. Net income for 1993 was negatively impacted by a charge of $7 million for the cumulative increase in deferred income taxes as a result of the federal income tax rate increase from 34% to 35%. The impact of the tax rate change by segment is shown on page 36.\nGROSS INCOME\nConsolidated gross income for 1995 of $709 million exceeded 1994 revenue of $643 million and 1993 revenue of $602 million.\nTransportation's gross income of $361 million increased $39 million from 1994. Rental revenues increased 12% due to the increase in the number of railcars on lease, higher average rental rates and new operations in Mexico. At the end of 1995, Transportation had 61,400 railcars on lease in the United States versus 56,500 a year ago. Domestic fleet utilization of 95% at the end of the year was slightly higher than the prior year due to the continued high demand for tank cars. Over 6,200 new and used railcars were added to the domestic fleet in 1995, which is 1,400 more than were added in 1994. In addition, 1,200 cars were leased in from the Mexican National Railroad. Fleet additions in 1996 are expected to be at lower levels than the exceptionally high level of railcars added in 1995.\nTerminals' gross income of $313 million increased 3% over 1994 reflecting incremental revenues from newly-acquired terminals and strong petroleum activity in the first half of 1995, especially in the Los Angeles market. However, revenues in the latter part of the year were less than in 1994 as a result of lower worldwide petroleum storage demand, significantly lower utilization of tanks in the Northeast due to reduced buildup of heating oil inventories, and lower demand and price competition in Los Angeles. Revenues from chemical markets remained strong. Revenues at the two pipelines serving the Las Vegas and Orlando markets continue to increase as demand for clean products remains strong. The non-strategic Wyco pipeline was sold early in 1995. Capacity utilization at Terminals' wholly-owned facilities was 85% at the end of 1995 compared to 94% a year earlier, reflecting the effects of lower industry-wide petroleum inventory levels and tanks out of service for repairs and upgrades. Throughput was 655 million barrels compared to 671 million barrels the year before. Incremental throughput from newly-acquired terminals was offset by the absence of throughput at Wyco. Lower overall throughput reflected mild weather in early 1995, lower blending activity, refinery turnarounds, tanks out of service, and a contract termination with a large customer.\nTransportation's 1994 gross income of $322 million increased $20 million from 1993. Rental revenues increased 7% attributable to an average of 3,000 additional railcars on lease and slightly higher average fleet rental rates. The level of fleet additions increased in response to improved demand for new tank cars, which was expected to continue in 1995. At the end of 1994, Transportation had 56,500 railcars on lease compared to 51,900 at the end of 1993 and fleet utilization was 95% compared to 93%.\nTerminals' record gross income of $303 million in 1994 was the result of strong performance at a number of individual terminal and pipeline operations. The increase of $22 million or 8% over 1993 was due to high petroleum demand and improved chemical activity which resulted in both increased throughput and higher utilization. Capacity utilization at Terminals' wholly-owned facilities was 94% at the end of 1994 compared to 92% a year earlier. Throughput was 671 million barrels, up 6% from 1993, reflecting the overall improvement in the U.S. economy.\nCOSTS AND EXPENSES\nOperating expenses in 1995 increased $19 million or 7% over 1994. Transportation's operating expenses of $148 million increased $19 million over 1994 as a result of increased operating lease expense and increased fleet repair costs due to the expanded fleet size. Transportation continues to utilize sale leasebacks to finance its railcar additions. The leaseback is recorded as an operating lease which removes the asset and related liability from the balance sheet; the payments under the operating leases are recorded as operating lease expense. Fleet repair costs increased 11% over 1994 as a result of the increased fleet size and number of cars repaired, primarily at Transportation's service centers. Transportation's commitment to provide its customers with well maintained railcars, coupled with stricter maintenance standards in the industry and mandated inspection programs, will continue to increase repair costs. During the year, Transportation completed the major upgrade program for its four domestic service centers. This three year project was designed to control costs by improving the efficiency and productivity of the repair process and reducing the time a car is out of service. The number of cars repaired at GATC service centers increased 15% from last year. Average throughput days for a railcar in the repair shop has been reduced by almost 30% as a result of this project to approximately 32 days at year end. Terminals' 1995 operating costs of $164 million approximated 1994 levels.\nOperating expenses in 1994 increased $21 million or 8% over 1993. Transportation's operating expenses of $129 million increased $10 million from 1993 as a result of the increased level of operating lease assets and increased fleet repair costs, partially offset by lower environmental expense. Fleet repair costs increased 10% over 1993 reflecting the increased number of cars repaired. Operating margins were in line with 1993. Terminals' 1994 operating costs of $164 million increased $11 million over the prior year. Operating expenses increased mainly due to higher repair and maintenance spending, higher environmental costs and other costs as a result of expanded operations. Operating margins increased 1% through revenue improvement while controlling costs.\nInterest expense increased $21 million in 1995 to $99 million as the result of higher average debt balances to fund the growth of the business and higher interest rates. Interest expense at Transportation increased primarily due to the increased fleet size, investments in GATC service centers, and the new operations in Mexico. Interest expense grew at Terminals as additional debt was incurred to finance acquisitions as well as maintenance, regulatory and environmental expenditures. Environmental and maintenance spending continue to grow in keeping with GATC's commitment to improve terminalling assets and to operate its facilities in an environmentally responsible manner. The increase in interest rates had a minimal effect on results as assets are either match funded or offer repricing opportunities as lease contracts are renewed.\nInterest expense decreased slightly in 1994 to $78 million primarily as a result of slightly lower average interest rates, partially offset by a higher average debt balance. A portion of the decrease in interest expense was offset by an increase in the operating lease rent component of operating expenses as a result of the sale leasebacks at Transportation.\nThe company continues to utilize interest rate swaps to better match the duration of the debt portfolio to the terms of the railcar leases and floating rate assets. The effect of the swaps was to reduce interest expense in 1995, 1994 and 1993.\nThe provision for depreciation and amortization increased $10 million from 1994 which in turn increased $7 million over 1993. Depreciation expense increased as result of the continued growth in assets and updated service centers.\nSelling, general and administrative expenses of $55 million increased $8 million from 1994 due to increased employee costs, information systems costs, and consulting expenses. In addition, expenses increased related to new railcar operations in Mexico. SG&A increased $5 million in 1994 primarily due to expanded operations and higher training and information systems costs at Terminals.\nIncome tax expense of $47 million increased $4 million from 1994. The effective tax rate for 1995 and 1994 was 39% and 38%, respectively. The 1993 effective tax rate of 43% exceeded the statutory rate primarily as the result of the increase in deferred taxes due to the increase in the federal income tax rate from 34% to 35%. The effective tax rate for all years was higher than the statutory rate because of state taxes, minority interest, and nondeductible items.\nEQUITY IN NET EARNINGS OF AFFILIATED COMPANIES\nEquity in net earnings of affiliated companies of $20 million increased $3 million from 1994 which in turn increased $2 million from 1993. The increase in 1995 was due to strong chemical demand at Terminals' European and Singapore terminals and Transportation's Canadian railcar joint venture. Terminals' newly-acquired 25% interest in the Olympic Pipeline Company also contributed to the increase. The increase in 1994 was primarily due to higher equity earnings from certain European terminals as a result of improved results and favorable foreign exchange rates.\nNET INCOME\nConsolidated net income of $94 million in 1995 increased $7 million from 1994. Transportation's 1995 net income increased $8 million over 1994 reflecting the higher revenues, the increase in income generated from invested funds due to higher interest rates, and higher equity earnings from Transportation's Canadian affiliate. Operating margins improved slightly as the growth in revenues exceeded the increase in fleet repair costs and SG&A expense. Pressure on operating margins is expected to continue as higher standards of repair without compensating revenue increases characterize the industry today. Ownership costs, consisting of rental expense, depreciation and interest, increased 21% due to the increased fleet size, investments in GATC service centers, and the new operations in Mexico.\nTerminals' 1995 net income decreased $1 million from 1994. Higher revenues, slightly improved operating margins and increased earnings from foreign affiliates were offset by higher SG&A and interest expenses. Overall, the continuing long-term focus on improving physical assets, information systems and people may constrain near-term earnings. Terminals' business environment at year end was characterized by continuing low distillate storage demand, historically low petroleum industry inventory levels, lower pricing due to increased competition and low refinery margins. This environment is expected to continue into 1996. Terminals plans to selectively acquire and construct facilities both domestically and overseas.\nConsolidated net income of $87 million in 1994 increased $13 million from 1993 as a result of improved operating performance. In addition, net income for 1993 was reduced by a charge of $7 million for the cumulative increase in deferred income taxes. Transportation's 1994 income from operations increased 6% over 1993 due to significantly more railcars on lease. Increased rental income and lower environmental expense were partially offset by increased fleet repair costs, higher ownership costs and lower investment earnings. Ownership costs increased 9% primarily due to the high level of railcar additions. Terminals' 1994 income from operations increased 11% from 1993 reflecting higher revenues, slightly improved margins and increased earnings by its foreign affiliates which were partially offset by higher SG&A expenses.\nASSETS\nTotal assets at year end of $2.6 billion were $164 million higher than in 1994 as the high level of capital additions and investments in affiliates more than offset the depreciation of capitalized assets. GATC also utilizes additional railcars which are obtained through off-balance-sheet operating leases and therefore are not included on the balance sheet.\nNet property, plant and equipment increased $100 million to $1.9 billion. Transportation invested $350 million in new and used railcars, $17 million in new operations in Mexico and $15 million in facility improvements, which were partially offset by $250 million of railcar sale leasebacks. As these leasebacks qualified as operating leases, the assets were removed from the balance sheet. Terminals invested $129 million for tank construction, facility improvements and expansion, and the acquisition of terminal facilities.\nInvestments in affiliated companies increased $39 million. New investments of $30 million included an additional investment in a European rail joint venture and the purchase of a 25% equity interest in the Olympic Pipeline Company. Equity income of $20 million was partially offset by $7 million of cash distributions and $4 million of unrealized translation losses and other charges.\nLIABILITIES AND EQUITY\nTotal debt increased $118 million to fund a portion of the significant volume of capital additions made during the year.\nConsolidated equity increased $37 million attributable to 1995 earnings of $94 million partially reduced by dividends paid to GATX Corporation of $48 million. The balance of the change is attributable to foreign currency translation adjustments.\nLIQUIDITY AND CAPITAL RESOURCES\nGATC generates significant cash from its operating activities. Most of its capital requirements represent additions to the railcar fleet, terminal and pipeline facilities, and joint ventures, and are considered discretionary capital expenditures. However, the non-discretionary level of Terminals' capital program has grown due to the increasing regulatory and environmental requirements of the terminalling business. The level of discretionary capital spending can be adjusted as conditions in the economy or GATC's businesses warrant.\nCash provided by operating activities in 1995 of $211 million increased $10 million compared to 1994. Net income adjusted for non-cash items generated $233 million of cash, up $24 million from 1994. Other generated $14 million less cash than in 1994 primarily as a result of a decrease in working capital.\nCash provided by operating activities in 1994 of $201 million decreased $5 million compared to 1993. Net income adjusted for non-cash items generated $209 million of cash, up $16 million from 1993. Other generated $22 million less cash in 1993 primarily as the result of a decrease in working capital.\nCash used in investing activities in 1995 decreased $32 million from 1994. Capital additions of $541 million increased $101 million from 1994. Transportation invested $365 million in its domestic railcar fleet; $28 million also was invested in international operations in Mexico and Europe in 1995. During the year, Transportation completed a major upgrade program for its four strategically located domestic service centers. Terminals' capital spending of $149 million was $6 million lower than in 1994. Spending in 1995 included the expansion or upgrading of several existing terminal facilities, including the expansion of an existing pipeline in Central Florida, and the acquisition of an interest in a pipeline in the Northwest. Proceeds from asset dispositions of $271 million in 1995, including $250 million of sale leasebacks of certain railcars at Transportation, increased $133 million from 1994. GATC has used sale leasebacks as a cost effective method of financing assets given GATX's alternative minimum tax position.\nCash used in investing activities in 1994 increased $181 million from 1993. Capital additions of $440 million were up $167 million from 1993. Transportation invested $264 million in the railcar fleet versus $171 million in the prior year; $18 million also was invested in a multi-year program to significantly upgrade its repair facilities versus $24 million in 1993. Terminals' capital spending of $154 million increased $77 million from 1993 and included the acquisition of six additional terminal facilities plus the expansion or upgrading of several existing terminal facilities. Proceeds from asset dispositions of $137 million in 1994 included a $130 million sale leaseback of certain railcars at Transportation.\nCash provided by financing activities was $58 million in 1995 compared to $104 million in 1994. GATC finances its capital additions through cash generated from operating activities, debt financings, and the sale leasebacks of railcars. During the year $200 million of long-term debt was issued and $92 million of long-term obligations were repaid. Short-term debt increased $15 million to a balance of $145 million.\nCash provided by financing activities was $104 million in 1994 compared to $79 million of cash used in financing activities in 1993. During 1994 $182 million of long-term debt was issued and $56 million of long-term obligations were repaid. Short-term debt increased by $25 million to a balance of $129 million.\nGATC and GATX Terminals have revolving credit facilities. GATC also has a commercial paper program and uncommitted money market lines which are used to fund operating needs. In 1995, GATC amended its credit facility to extend until 2000. Under the covenants of the commercial paper programs and rating agency guidelines, GATC must keep unused revolver capacity at least equal to the amount of commercial paper and money market lines outstanding. At December 31, 1995, GATC and its subsidiaries had available unused committed lines of credit amounting to $212 million.\nIn December 1995, a $650 million GATC shelf registration for pass through trust certificates and debt securities became effective; none had been issued at year end. At year end, GATC had $171 million of commitments to acquire assets, all of which are scheduled to fund in 1996.\nEnvironmental Matters\nCertain operations of GATC and its subsidiaries (collectively GATC) present potential environmental risks principally through the transportation or storage of various commodities. Recognizing that some risk to the environment is intrinsic to its operations, GATC is committed to protecting the environment, as well as complying with applicable environmental protection laws and regulations. GATC, as well as its competitors, is subject to extensive regulation under federal, state and local environmental laws which have the effect of increasing the costs and liabilities associated with the conduct of its operations. In addition, GATC's foreign operations are subject to environmental regulations in effect in each respective jurisdiction.\nGATC's policy is to monitor and actively address environmental concerns in a responsible manner. GATC has received notices from the U.S. Environmental Protection Agency (EPA) that it is a potentially responsible party (PRP) for study and clean-up costs at 11 sites under the requirements of the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (Superfund). Under Superfund and comparable state laws, GATC may be required to share in the cost to clean-up various contaminated sites identified by the EPA and other agencies. In all but one instance, GATC is one of a number of financially responsible PRPs and has been identified as contributing only a small percentage of the contamination at each of the sites. Due to various factors such as the required level of remediation and participation in clean-up efforts by others, GATC's total clean-up costs at these sites cannot be predicted with certainty; however, GATC's best estimates for remediation and restoration of these sites have been determined and are included in its environmental reserves.\nFuture costs of environmental compliance are indeterminable due to unknowns such as the magnitude of possible contamination, the timing and extent of the corrective actions that may be required, the determination of the company's liability in proportion to other responsible parties, and the extent to which such costs are recoverable from third parties including insurers. Also, GATC may incur additional costs relating to facilities and sites where past operations followed practices and procedures that were considered acceptable at the time but in the future may require investigation and\/or remedial work to ensure adequate protection to the environment under current or future standards. If future laws and regulations contain more stringent requirements than presently anticipated, expenditures may be higher than the estimates, forecasts, and assessments of potential environmental costs provided below. However, these costs are expected to be at least equal to the current level of expenditures. In addition, GATC has provided indemnities for environmental issues to the buyers of two divested companies for which GATC believes it has adequate reserves.\nGATC's environmental reserve at the end of 1995 was $78 million and reflects GATC's best estimate of the cost to remediate its environmental conditions. Additions to the reserve were $14 million in 1995 and $27 million in 1994; 1994 included $13 million recorded in conjunction with terminal acquisitions. Expenditures charged to the reserve amounted to $16 million and $12 million in 1995 and 1994, respectively.\nIn 1995, GATC made capital expenditures of $18 million for environmental and regulatory compliance compared to $15 million in 1994. These projects included marine vapor recovery, discharge prevention compliance, waste water systems, impervious dikes, tank modifications for emissions control, and tank car cleaning systems. Environmental projects authorized or currently under consideration would require capital expenditures of approximately $28 million in 1996. GATC anticipates it will make annual expenditures at a similar level over the next five years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe response to this item is submitted under Item 14 (a)(1) of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nNot required.\nItem 11.","section_11":"Item 11. Executive Compensation\nNot required.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNot required.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot required.\nPART IV\nItem 14.","section_14":"Item 14. Financial Statement Schedules, Reports on Form 8-K and Exhibits Page\n(a) (1) Financial Statements\nThe consolidated financial statements of General American Transportation Corporation and its subsidiaries which are required in Item 8 are listed below:\nStatements of Consolidated Income and Reinvested Earnings-- years ended December 31, 1995, 1994 and 1993................... 17 Consolidated Balance Sheets--December 31, 1995 and 1994.......... 18 Statements of Consolidated Cash Flows-- years ended December 31, 1995, 1994 and 1993................... 20 Notes to Consolidated Financial Statements....................... 21\n(2) Financial Statement Schedules\nSchedule II Valuation and Qualifying Accounts............... 37\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.\nPART IV\nItem 14.Financial Statement Schedules, Reports on Form 8-K and Exhibits (Cont'd) Page\n(b)(1) GATC filed a Current Report on Form 8-K dated January 26, 1996, with respect to the Medium Term Notes, Series F. Copies of the forms of the underlying documents entered into by GATC as part of this transaction were filed as part of the Form 8-K Report.\n(2) GATC filed a Current Report on Form 8-K dated March 4, 1996 with respect to the offering of $100 million principal amount of 6-3\/4% Notes due March 1, 2006. A copy of the Note entered into by GATC as part of this transaction was filed as part of the Form 8-K Report.\n(c) Exhibit Index\nExhibit Number Exhibit Description Page\n3A. Certificate of Incorporation of General American Transportation Corporation, incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 2-54754.\n3B. By-Laws of General American Transportation Corporation, as amended and restated as of June 15, 1994, incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1994, file number 2-54754.\nIndenture dated October 1, 1987, incorporated by reference to 4A. Exhibit 4.1 to the GATC Registration Statement on Form S-3 filed October 8, 1987, file number 33-17692; Indenture Supplement dated May 15, 1988, incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, file number 2-54754. Second Supplemental Indenture dated as of March 15, 1990, incorporated by reference to GATC Quarterly Report on Form 10-Q for the quarter ended March 30, 1990, file number 2-54754. Third Supplemental Indenture dated as of June 15, 1990, incorporated by reference to GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, file number 2-54754. Fourth Supplemental Indenture dated as of January 15, 1996 filed with the SEC on Current Report on Form 8-K on January 26, 1996, file number 2-54754.\n4B. General American Transportation Corporation Notices 1 through 6 dated from November 6, 1987 through April 12, 1988 defining the rights of holders of GATC's Medium-Term Notes Series A issued during that period, incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, file number 2-54754.\nExhibit Number Exhibit Description Page\n4C. General American Transportation Corporation Notices 1 through 3 dated from October 17, 1988 through October 24, 1988 and 4 through 6 dated from November 7, 1988 through March 3, 1989 defining the rights of holders of GATC's Medium-Term Notes Series B issued during those periods, Notices 1 through 3 incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended September 30, 1988, and Notices 4 through 6 incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1988, file number 2-54754.\n4D. General American Transportation Corporation Notices 1 and 2 dated from March 30, 1989 through March 31, 1989, Notices 3 through 8 dated from April 4, 1989 through June 29, 1989, Notices 9 through 16 dated from July 19, 1989 through September 29, 1989, and Notices 17 through 21 dated from October 2, 1989 through October 9, 1989 defining the rights of the holders of GATC's Medium-Term Notes Series C issued during those periods. Notices 1 and 2, Notices 3 through 8 and Notices 9 through 16 are incorporated by reference to the GATC Quarterly Reports on Form 10-Q for the quarters ended March 31, 1989, June 30, 1989 and September 30, 1989, respectively, and Notices 17 through 21 incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 2-54754.\n4E. General American Transportation Corporation Notices 1 and 2 dated February 27, 1992, Notices 3 through 5 dated from December 7, 1992 through December 14, 1992 and notices 6 through 10 dated from May 18, 1993 through May 25, 1993 defining the rights of the holders of GATC's Medium-Term Notes Series D issued during those periods. Notices 1 and 2 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended March 31, 1992, Notices 3 through 5 are incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and Notices 6 through 10 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ending June 30, 1993, file number 2-54754.\n4F. General American Transportation Corporation Notices 1 and 2 dated June 8, 1994 and Notices 3 through 6 dated June 17, 1994, and Notices 7 through 11 dated July 18, 1994, defining the rights of the holders of GATC's Medium-Term Notes Series E issued during those periods. Notices 1 through 6 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, and Notices 7 through 11 are incorporated herein by reference to the Form 424(b)(5) dated July 18, 1994, file number 2-54754.\nExhibit Number Exhibit Description Page\n4G. General American Transportation Corporation Notices 12 through 14 dated February 24, 1995, Notices 15 through 20 dated May 11, 1995, amended May 24, 1995, and Notices 21 through 30 dated from November 8, 1995 through November 13, 1995 defining the rights of the holders of GATC's Medium-Term Notes Series E issued during those periods. Notices 12 through 14 are incorporated by reference to the Form 424(b)(5) dated February 24, 1995, Notices 15 through 20 are incorporated by reference to the Form 424(b)(5) dated May 11, 1995, and Notices 21 through 30 are incorporated by reference to the Form 424(b)(5) dated from November 8, 1995 through November 13, 1995, file number 2-54754.\n4H. Form of 8-5\/8% Note due December 1, 2004 filed with the SEC on Current Report on Form 8-K on December 7, 1994, file number 2-54754.\n4I. Form of 6-3\/4% Note due March 1, 2006 filed with the SEC on Current Report on Form 8-K on March 4, 1996, file number 2-54754.\n10A. Third Amended and Restated Revolving Credit Agreement for GATC dated as of March 31, 1994, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended March 31, 1994, file number 2-54754. Amendment Number 1 thereto dated as of April 21, 1995; submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n10B. Revolving Credit Facility Agreement for GATX Terminals Limited as borrower and GATC as guarantor dated as of July 13, 1993, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended September 30, 1993, file number 2-54754. Amendment effective June 30, 1994 and amendment dated June 19, 1995; submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n12. Statement regarding computation of ratios of earnings to fixed charges. 38\n23. Consent of Independent Auditors 39\n27. Financial Data Schedule for GATC for the fiscal year ended December 31, 1995, file number 2-54754. Submitted to the SEC along with the electronic submission of this report on Form 10-K.\nAny instrument defining the rights of security holders with respect to nonregistered long-term debt not being filed on the basis that the amount of securities authorized does not exceed 10 percent of the total assets of the company and subsidiaries on a consolidated basis will be furnished to the Commission upon request.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGENERAL AMERICAN TRANSPORTATION CORPORATION (Registrant)\n\/s\/D. Ward Fuller --------------------------------- D. Ward Fuller President, Chief Executive Officer and Director March 22, 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.\n\/s\/D. Ward Fuller \/s\/David M. Edwards - ----------------------------------- ----------------------------- D. Ward Fuller David M. Edwards President, Chief Executive Officer Director and Director March 22, 1996 March 22, 1996\n\/s\/Donald J. Schaffer \/s\/David B. Anderson - ---------------------------------- ----------------------------- Donald J. Schaffer David B. Anderson Vice President, Finance and Chief Director Financial Officer March 22, 1996 March 22, 1996\n\/s\/Ronald H. Zech - ------------------------------- Ronald H. Zech Director March 22, 1996\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors General American Transportation Corporation\nWe have audited the consolidated financial statements and related schedule of General American Transportation Corporation (a wholly-owned subsidiary of GATX Corporation) and subsidiaries listed in Item 14(a)(1) and (2) of the Annual Report on Form 10-K of General American Transportation Corporation for the year ended December 31, 1995. These financial statements and related schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and related schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and related schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of General American Transportation Corporation and subsidiaries at December 31, 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, it is our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.\nERNST & YOUNG LLP\nChicago, Illinois January 23, 1996\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A--SIGNIFICANT ACCOUNTING POLICIES\nSignificant accounting policies of General American Transportation Corporation (GATC) and its consolidated subsidiaries are discussed below.\nConsolidation: The consolidated financial statements include the accounts of GATC and its majority-owned subsidiaries. Investments in 20 to 50 percent-owned companies and joint ventures are accounted for under the equity method and are shown as investments in affiliated companies. Less than 20 percent-owned affiliated companies are recorded using the cost method.\nCash Equivalents: GATC considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair value of those assets.\nProperty, Plant and Equipment: Property, plant and equipment are stated principally at cost. Assets acquired under capital leases are included in property, plant and equipment and the related obligations are recorded as liabilities. Provisions for depreciation include the amortization of the cost of capital leases and are computed by the straight-line method which results in equal annual depreciation charges over the estimated useful lives of the assets. The estimated useful lives of depreciable assets are as follows:\nRailcars 20-33 years Buildings, leasehold improvements, storage tanks, and pipelines 5-40 years Machinery and related equipment 3-25 years\nGoodwill: GATC has classified as goodwill the cost in excess of the fair value of net assets acquired. Goodwill, which is included in other assets, is being amortized on a straight-line basis over 40 years. GATC continually evaluates the existence of goodwill impairment on the basis of whether the goodwill is recoverable from projected undiscounted net cash flows of the related business. Goodwill, net of accumulated amortization of $2.7 million and $2.2 million, was $18.3 million and $19.5 million as of December 31, 1995 and 1994, respectively. Amortization expense was $.5 million for each of 1995, 1994, and 1993.\nIncome Taxes: United States income taxes have not been provided on the undistributed earnings of foreign subsidiaries and affiliates which GATC intends to permanently reinvest in these foreign operations. The cumulative amount of such earnings was $141.3 million at December 31, 1995.\nOther Deferred Items: Other deferred items include the accrual for postretirement benefits other than pensions; environmental, general liability and workers' compensation reserves; and other deferred credits.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE A--SIGNIFICANT ACCOUNTING POLICIES (CONT'D)\nOff-Balance-Sheet-Financial Instruments: GATC uses interest rate and currency swaps, forwards and similar contracts to set interest and exchange rates on existing or anticipated transactions. These instruments qualify for hedge accounting. Fair values of GATC's off-balance-sheet financial instruments (futures, swaps, forwards, options and purchase commitments) are based on current market prices, settlement values or fees currently charged to enter into similar agreements. The fair values of the hedge contracts are not recognized in the financial statements. Net amounts paid or received on such contracts are recognized over the term of the contract as an adjustment to interest expense or the basis of the hedged financial instrument.\nEnvironmental Liabilities: Expenditures that relate to current or future operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are charged to environmental reserves. Reserves are recorded in accordance with accounting guidelines to cover work at identified sites when GATC's liability for environmental clean-up is both probable and a minimum estimate of associated costs can be made; adjustments to initial estimates are recorded as necessary.\nRevenue Recognition: The majority of GATC's gross income is derived from the rentals of railcars and terminals and other services.\nForeign Currency Translation: The assets and liabilities of GATC operations located outside the United States are translated at exchange rates in effect at year end, and income statements are translated at the average exchange rates for the year. Gains or losses resulting from the translation of foreign currency financial statements are deferred and recorded as a separate component of consolidated shareholder's equity. Incremental unrealized translation gains (losses) recorded in the cumulative foreign currency translation adjustment account were $(8.4) million, $19.1million and $(5.8) million during 1995, 1994, and 1993, respectively.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles necessarily 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 revenues and expenses during the reporting period. Actual amounts when ultimately realized could differ from those estimates.\nReclassifications: Certain amounts in the 1994 and 1993 financial statements have been reclassified to conform to the 1995 presentation.\nNOTE B--ACCOUNTING FOR LEASES\nThe following information pertains to GATC as a lessor:\nOperating leases: Railcar and tankage assets included in property, plant and equipment are classified as operating leases.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE B--ACCOUNTING FOR LEASES (CONT'D)\nMinimum future receipts: Minimum future rental receipts from noncancelable operating leases by year at December 31, 1995 were (in millions):\n1996 $ 457.2 1997 332.0 1998 242.6 1999 171.9 2000 105.4 Years thereafter 363.2 -------- $1,672.3 ========\nThe following information pertains to GATC as a lessee:\nCapital leases: Certain railcars are leased by GATC under capital lease agreements. Property, plant and equipment includes cost and related allowances for depreciation of $152.8 million and $76.5 million, respectively, at December 31, 1995 and $153.1 million and $70.0 million, respectively, at December 31, 1994 for these railcars. The cost of these assets is amortized on the straight-line basis with the charge included in depreciation expense.\nOperating leases: GATC has financed railcars through sale leasebacks which are accounted for as operating leases. In addition, GATC leases certain other assets and office facilities. Total rental expense for the years ended December 31, 1995, 1994, and 1993 was $65.1 million, $50.3 million, and $39.8 million, respectively.\nMinimum future rental payments: Future minimum rental payments due under noncancellable leases at December 31, 1995 were (in millions):\nCapital Operating Leases Leases --------- --------- 1996 $ 17.0 $ 53.3 1997 17.5 61.5 1998 17.3 63.0 1999 17.3 58.4 2000 17.2 59.2 Years thereafter 98.7 1,033.1 --------- --------- 185.0 $ 1,328.5 ========= Less - Amount representing interest (69.9) --------- Present value of future minimum capital lease payments $ 115.1 ========= The above capital lease amounts do not include the cost of licenses, taxes, insurance and maintenance which GATC is required to pay. Interest expense on the above capital lease obligations was $10.6 million in 1995, $11.3 million in 1994, and $11.8 million in 1993.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE C--ADVANCES TO\/FROM PARENT\nInterest income on advances to GATX, which is included in gross income on the income statement, was $34.8 million in 1995, $17.4 million in 1994, and $18.4 million in 1993. Interest expense on advances from GATX to GATC was $6.2 million in 1995, $1.8 million in 1994, and $2.2 million in 1993. These advances have no fixed maturity date. Interest income\/expense on advances to\/from GATX were based on an interest rate which is adjusted annually in accordance with an estimate of short-term borrowing rates and averaged 7.45% in 1995, 4.09% in 1994, and 4.30% in 1993.\nNOTE D--INVESTMENTS IN AFFILIATED COMPANIES\nGATC has investments in 20 to 50 percent-owned companies and joint ventures which are accounted for using the equity method. These investments are in businesses similar to GATC's operations. They include Canadian and European railcar leasing and foreign and domestic tank storage terminals and pipelines. Distributions received from such jointly-owned companies were $7.3 million, $2.6 million, and $3.1 million in 1995, 1994, and 1993, respectively.\nSummarized operating results for all affiliated companies in their entirety were (in millions):\nFor the Year ---------------------------------- 1995 1994 1993 ------ ------ ------ Revenues $233.8 $206.8 $176.8 Net income 44.0 35.7 32.4\nSummarized balance sheet data for all affiliated companies in their entirety were (in millions):\nDecember 31 ---------------------- 1995 1994 ------- ------- Total assets $868.0 $773.2 Long-term liabilities 347.6 339.0 Other liabilities 151.5 97.8 ------- ------- Shareholder's equity $368.9 $336.4 ======= =======\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE E--FOREIGN OPERATIONS\nGATC has a number of investments in subsidiaries and affiliated companies which are located in or derive income from foreign countries. Foreign entities contribute significantly to equity in net earnings of affiliated companies. The foreign identifiable assets are primarily investments in affiliated companies; and a United Kingdom terminalling operation and a Mexican railcar operation, which are fully consolidated.\nGROSS INCOME (IN MILLIONS) 1995 1994 1993 - -------------------------- -------- ------- ------- Foreign $ 35.5 $ 30.6 $ 26.5 United States 673.7 612.0 575.2 -------- ------- ------- $ 709.2 $ 642.6 $ 601.7 ======== ======= =======\nINCOME BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF AFFILIATED COMPANIES (IN MILLIONS) 1995 1994 1993 - --------------------------------- -------- -------- ------- Foreign $ .7 $ 2.8 $ 2.7 United States 120.3 110.0 101.9 -------- -------- ------- $ 121.0 $ 112.8 $ 104.6 ======== ======== =======\nEQUITY IN NET EARNINGS OF AFFILIATED COMPANIES (IN MILLIONS) 1995 1994 1993 - --------------------------------- ------- ------- ------- Foreign $ 19.6 $ 16.9 $ 14.6 United States .5 - - ------- ------- ------- $ 20.1 $ 16.9 $ 14.6 ======= ======= =======\nIDENTIFIABLE ASSETS (IN MILLIONS) 1995 1994 1993 - -------------------------------- -------- -------- --------\nForeign $ 318.2 $ 273.1 $ 212.6 United States 2,312.8 2,193.5 2,003.0 -------- -------- -------- $2,631.0 $2,466.6 $2,215.6 ======== ======== ========\nForeign cash flows generated are used to meet local operating needs and for reinvestment. The translation of the foreign balance sheets into U.S. dollars results in an increase or decrease to the unrealized foreign currency translation account.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE F--SHORT-TERM DEBT AND LINES OF CREDIT\nShort-term debt and its weighted average interest rate as of year end were (in millions):\nDecember 31 -------------------------------------- 1995 1994 Amount Rate Amount Rate ------- ------- ------ ------- Commercial paper $ 44.6 6.02% $ 60.0 6.15% Other short-term borrowings 100.2 6.41 69.4 5.99 ------- ------ $ 144.8 $129.4 ======= ======\nUnder a revolving credit agreement with a group of banks, GATC may borrow up to $250.0 million. The revolving credit agreement contains various restrictive covenants which include, among other things, minimum net worth, restrictions on additional indebtedness, and requirements to maintain certain financial ratios for GATC. Under the agreement GATC met its requirement to maintain a minimum net worth of $573.4 million at December 31, 1995. While at year end no borrowings were outstanding under the agreement, the available line of credit was reduced by $44.6 million of commercial paper outstanding. GATC had borrowings of $62.9 million under unsecured money market lines. Also, GATX Terminals has a revolving credit agreement of (pound)28.0 million of which (pound)4.0 million was available at year end.\nInterest expense on short-term debt was $8.5 million in 1995, $6.2 million in 1994, and $4.2 million in 1993.\nNOTE G--LONG-TERM DEBT\nLong-term debt consisted of (in millions):\nDecember 31 Interest Final ---------------- Rates Maturity 1995 1994 Fixed Rate: ---------- --------- ------ ------ Term notes 5.16%-10.8% 1996-2007 $885.0 $776.2 Industrial revenue bonds 6.625-7.3 2019-2024 87.9 87.9 ------ ------ $972.9 $864.1 ====== ======\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE G--LONG-TERM DEBT (CONT'D)\nMaturities of GATC's long-term debt as of December 31, 1995 for each of the years 1996 through 2000 were (in millions):\nYear Amount\n1996 $ 66.0 1997 65.0 1998 81.0 1999 84.0 2000 103.1\nInterest cost incurred on long-term debt, net of capitalized interest, was $74.1 million in 1995, $59.0 million in 1994, and $60.5 million in 1993. Interest cost capitalized as part of the cost of acquisition or construction of major assets was $4.6 million in 1995, $2.7 million in 1994, and $2.4 million in 1993. A loss of $.3 million was recorded on the early retirement of debt in 1994.\nNOTE H--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS\nIn the ordinary course of business, GATC enters into various types of transactions that involve financial instruments with off-balance-sheet risk which are used to manage financial market risk, including interest rate and foreign exchange risk.\nAt December 31, 1995 GATC had the following off-balance sheet financial instruments (in millions): Pay Recieve Interest Rate Swaps Amount Rate\/Index Rate\/Index Maturity - --------------------- ------- ---------- ------------- --------- GATC pays fixed, receives floating $765.5 4.7%-7.585% LIBOR 1996-2000 GATC pays floating, receives fixed 850.0 LIBOR 6.205%-7.646% 2003-2006\nCurrency Forwards Deliver Purchase Maturity - ----------------- -------- -------------- ---------\nSingapore dollar forwards $ 7.1 10.0 Singapore 1996\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE H--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS (CONT'D)\nGATC had the following interest rate hedge activity (in millions):\nPay Pay Interest Rate Swaps Fixed Floating - -------------------- ------- --------- Balance at January 1, 1994 $400.0 $500.0\nAdditions 200.0 100.0 Maturities (100.0) - ------- ------- Balance at December 31, 1994 500.0 600.0\nAdditions 365.5 250.0 Maturities (100.0) - ------- ------- Balance at December 31, 1995 $765.5 $850.0 ======= ======\nGATC manages its assets and liabilities using interest rate swaps and on occasion uses interest rate forwards for anticipated transactions. Interest rate swaps are utilized to better match the duration of GATC's debt portfolio to the duration of its railcar leases. Railcar assets are financed with long-term fixed rate debt or through sale leasebacks. However, the railcar assets are placed on lease with average new lease terms of 5 years; the average renewal term is 3 years. Rents are fixed over these lease terms. Interest rate swaps effectively convert GATC's long-term fixed rate debt to fixed rate debt with maturities of 3 months to 3 years. Through the swap program, railcar lease rates are expected to better reflect GATC's interest costs. At GATX Terminals Limited, an interest rate swap is used to fix the interest rate on a portion of its floating rate debt.\nIn its swaps, GATC agrees to exchange, at specific intervals the difference between fixed and floating rate interest amounts calculated on an agreed upon notional principal amount. The swaps have in effect converted $84.5 million of long-term fixed rate debt into floating rate debt and $765.5 million of long-term fixed rate debt into 1-3 year fixed rate debt.\nThe net amount payable or receivable from the interest rate swap agreements is accrued as an adjustment to interest expense. The fair value of its interest rate swap agreements is an estimate of the amount the company would receive or pay to terminate the swap agreement; at December 31, 1995, GATC would receive $27.1 million if the swaps were terminated. At December 31, 1994, GATC would have paid $45.2 million if the swaps were terminated at that time.\nIn conjunction with the financing of the purchase of an interest in a joint venture, GATX Terminals has a forward contract to deliver 10.0 million Singapore dollars in exchange for $7.1 million. The gain or loss from the final settlement will be used to offset any gain or loss from the underlying transaction.\nIn the event that a counterparty fails to meet the terms of the interest rate swap agreement or a foreign exchange contract, GATC's exposure is limited to the interest rate or currency differential. GATC manages the credit risk of counterparties by dealing only with institutions that the company considers financially sound and by avoiding concentrations of risk with a single counterparty. GATC considers the risk of nonperformance to be remote.\nNOTE I--FAIR VALUE OF OTHER FINANCIAL INSTRUMENTS\nSFAS No. 107, Disclosures about Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The following table presents the carrying amounts and estimated fair values of GATC's financial instruments that were recorded on the balance sheet at year end (in millions):\nDecember 31 ---------------------------------------------- 1995 1994 ---------------------- --------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- --------- -------- -------- Assets: Cash and cash equivalents $ 13.4 $ 13.4 $ 14.5 $ 14.5 Trade receivables-net 64.8 64.8 52.3 52.3 Due from GATX Corporation 373.9 373.9 362.4 362.4\nLiabilities: Accounts payable 89.9 89.9 106.4 106.4 Short-term debt 144.8 144.8 129.4 129.4 Long-term debt - fixed 972.9 1,085.2 864.1 883.3\nThe carrying amounts shown in the table are included in the balance sheet under the indicated captions.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash and cash equivalents, trade receivables, accounts payables and short-term debt are carried at cost which approximates fair value because of the short maturity of those instruments.\nThe carrying amounts reported in the balance sheet for the Due from GATX Corporation approximate fair value.\nThe fair value of fixed rate long-term debt was estimated by performing a discounted cash flow calculation using the note term and market interest rate based on GATC's current incremental borrowing rates for similar borrowing arrangements.\nNOTE J--PENSION BENEFITS\nGATC and its subsidiaries contributed to several pension plans sponsored by GATX which cover substantially all employees. Benefits under the plans are based on years of service and\/or final average salary. The funding policy for all plans is based on an actuarially determined cost method allowable under Internal Revenue Service regulations. Contributions to these plans were $3.5 million in 1995, $6.6 million in 1994, and $6.7 million in 1993.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE J-- PENSION BENEFITS (CONT'D)\nCosts pertaining to the GATX plans are allocated to GATC on the basis of payroll costs with respect to normal cost and on the basis of actuarial determinations for prior service cost. Net periodic pension cost for 1995, 1994, and 1993 was $3.1 million, $2.6 million, and $3.4 million, respectively. Plan benefit obligations, plan assets, and the components of net periodic cost for individual subsidiaries of GATX have not been determined.\nNOTE K--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nGATC provides health care, life insurance and other benefits for certain retired employees who meet established criteria. Most domestic employees are eligible for health care and life insurance benefits if they retire from GATC with immediate pension benefits under the GATX pension plan. The plans are either contributory or non-contributory, depending on various factors.\nNet periodic postretirement cost includes the following components (in millions):\n1995 1994 1993 -------- -------- --------\nCurrent service cost $ .4 $ .4 $ .3 Interest cost on accumulated postretirement benefit obligation 4.2 4.7 5.9 ------- ------ ------- Net periodic postretirement benefit cost $ 4.6 $ 5.1 $ 6.2 ======= ====== ======= Discount rate 7.75% 7.75% 8.5% ======= ====== =======\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE K--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONT'D)\nThe following table sets forth the amounts recognized in GATC's consolidated balance sheet (in millions):\nDecember 31 1995 1994 ------- -------\nAccumulated postretirement benefit obligation Retirees $48.2 $55.3 Fully eligible active plan participants 2.5 2.6 Other active plan participants 4.8 4.5 ------- ------- Total accumulated postretirement benefit obligation 55.5 62.4\nUnrecognized gain 9.1 1.2 ------- ------- Accrued postretirement benefit liability $64.6 $63.6 ====== ======\nThe accrued postretirement benefit liability was determined using an assumed discount rate of 7.75% for 1995 and 1994.\nFor measurement purposes, blended rates ranging from 9% decreasing to 5% over the next two years and remaining at that level thereafter were used for the increase in the per capita cost of covered health care benefits. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rates by 1% would increase the accumulated postretirement benefit obligation by $3.7 million and would increase aggregate service and interest cost components of net periodic postretirement benefit cost by $.3 million per year.\nNOTE L--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.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE L--INCOME TAXES (CONT'D)\nSignificant components of GATC's deferred tax liabilities and assets were (in millions):\nDecember 31 ------------------ 1995 1994 ------ ------ Deferred tax liabilities: Book\/tax basis differences due to depreciation $329.4 $323.6 Other 30.1 31.0 ------ ------ Total deferred tax liabilities 359.5 354.6\nDeferred tax assets: Accruals not currently deductible for tax purposes 34.4 34.7 Postretirement benefits other than pensions 22.8 22.4 Lease accounting 19.4 14.4 Other 1.8 11.8 ------ ------ Total deferred tax assets 78.4 83.3 ------ ------ Net deferred tax liabilities $281.1 $271.3 ====== ======\nThe results of operations of GATC and its United States subsidiaries are included in the consolidated federal income tax return of GATX. Current provisions for federal income taxes represent amounts payable to GATX resulting from inclusion of GATC's operations in the consolidated federal income tax return. Amounts shown as currently payable for federal income taxes represent taxes payable due to the alternative minimum tax.\nIncome taxes consisted of (in millions): For the Year 1995 1994 1993 ------- ------- ------- Current- Domestic: Federal $ 26.7 $ 30.1 $ 29.6 State and local 2.2 1.7 .7 ------- ------- ------- 28.9 31.8 30.3 Foreign .1 .2 .3 ------- ------- ------- 29.0 32.0 30.6 Deferred- Domestic: Federal 16.7 8.4 12.1 State and local 1.0 1.5 2.4 ------- ------- ------- 17.7 9.9 14.5 Foreign .5 .8 - ------- ------- ------- 18.2 10.7 14.5\nIncome tax expense $ 47.2 $ 42.7 $ 45.1 ======= ======= =======\nIncome taxes paid $ 26.9 $ 31.9 $ 28.0 ======= ======= =======\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE L--INCOME TAXES (CONT'D)\nThe reasons for the differences between the effective income tax rate and the federal statutory income tax rate were: For the Year ---------------------------- 1995 1994 1993 ----- ----- ----- Federal statutory income tax rate 35.0% 35.0% 35.0% Add (deduct) effect of: Minority interest 2.0 .9 .8 State income taxes 1.7 1.9 1.9 Purchase accounting adjustments - .3 2.1 Tax rate increase on deferred taxes - - 6.4 Other .3 (.3) (3.1) ----- ----- ----- 39.0% 37.8% 43.1% ===== ===== =====\nNOTE M--COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK\nGATC's revenues are derived from a wide range of industries and companies. However, approximately 80% of total consolidated revenues are generated from the transportation or storage of products for the chemical and petroleum industries.\nUnder its lease agreements, GATC retains legal ownership of the asset except when such assets have been financed by sale leasebacks. GATC performs credit evaluations prior to approval of a lease contract. Subsequently, the creditworthiness of the customer is monitored on an ongoing basis. GATC maintains an allowance for possible losses to provide for potential losses should customers become unable to discharge their obligations to GATC.\nAt December 31, 1995 GATC had firm commitments to acquire railcars and to upgrade facilities totaling $171 million.\nGATC and its subsidiaries are engaged in various matters of litigation and have a number of unresolved claims pending, including proceedings under governmental laws and regulations related to environmental matters. While the amounts claimed are substantial and the ultimate liability with respect to such litigation and claims cannot be determined at this time, it is the opinion of management that such liability to be paid by GATC is not likely to be material to GATC's consolidated financial position or results of operations.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS\nGATC is engaged in the following businesses:\nRailcar Leasing and Management represents General American Transportation Corporation and its foreign subsidiaries and affiliates (Transportation), which lease and manage tank cars and other specialized railcars.\nTerminals and Pipelines represents GATX Terminals Corporation and its domestic and foreign subsidiaries and affiliates (Terminals), which own and operate tank storage terminals, pipelines and related facilities.\nIntersegment sales are not significant in amount or meaningful to an understanding of GATC's business segments.\nThe following presentation of segment profitability includes the direct costs incurred at the segment's operating level plus expenses allocated by GATX. These allocated expenses represent costs for services provided by GATX which these operations would have incurred otherwise and are determined on a usage basis; management believes that this method is reasonable. Such costs do not include general corporate expense nor interest on debt of GATX.\nInterest costs associated with segment indebtedness are included in the determination of profitability of each segment since interest expense directly influences any investment decision and the evaluation of subsequent operational performance. Interest costs by segment have been shown separately so the reader can ascertain segment profitability before deducting interest expense.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS (CONT'D)\n(In millions) 1995 1994 1993 --------- --------- -------\nGross Income: - ------------- Railcar Leasing and Management $ 360.9 $ 322.1 $ 302.2 Terminals and Pipelines 313.4 303.1 281.1 --------- --------- ------- Subtotal 674.3 625.2 583.3\nIntersegment amounts with other GATX segments 34.9 17.4 18.4 --------- --------- ------- CONSOLIDATED $ 709.2 $ 642.6 $ 601.7 ========= ========= =======\nIncome Before Income Taxes and Equity in Net Earnings of Affiliated Companies: - ------------------------------------------ Railcar Leasing and Management $ 90.7 $ 79.6 $ 74.4 Terminals and Pipelines 30.3 33.2 30.2 --------- --------- ------- CONSOLIDATED $ 121.0 $ 112.8 $ 104.6 ========= ========= =======\nEquity in Net Earnings of Affiliated Companies: - --------------------------- Railcar Leasing and Management $ 5.4 $ 4.7 $ 4.5 Terminals and Pipelines 14.7 12.2 10.1 --------- --------- ------- CONSOLIDATED $ 20.1 $ 16.9 $ 14.6 ========= ========= =======\nNet Income: - ----------- Railcar Leasing and Management $ 62.9 $ 55.1 $ 47.6 Terminals and Pipelines 31.0 31.9 26.5 --------- --------- ------- CONSOLIDATED $ 93.9 $ 87.0 $ 74.1(A) ========= ========= =======\n(A) Income includes a $6.6 million charge for the cumulative increase in deferred income taxes as a result of the 1993 federal tax rate change (see following table for a breakdown by segment).\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS (CONT'D)\nFEDERAL TAX RATE CHANGE IN 1993\nThe following table shows the effect of the federal tax legislation enacted in 1993 which increased the federal income tax rate from 34% to 35% retroactively to January 1, 1993.\nIncome Net Before Tax Tax Rate Net Income Rate Change Change(A) Income --------- ------------- ---------- ------ In Millions 1994 1993 - ------------ --------- ---------------------------------- Railcar Leasing and Management $ 55.1 $ 51.9 $ (4.3) $ 47.6 Terminals and Pipelines 31.9 28.8 (2.3) 26.5\nCONSOLIDATED $ 87.0 $ 80.7 $ (6.6) $ 74.1\n(A) Effect of tax rate change on pre-1993 deferred taxes.\n(In Millions) 1995 1994 1993 -------- -------- -------- Identifiable Assets: Railcar Leasing and Management $2,041.9 $1,882.8 $1,701.0 Terminals and Pipelines 1,101.5 1,022.5 872.5 Other 1.0 .6 1.0 -------- -------- -------- 3,144.4 2,905.9 2,574.5 Intersegment amounts (513.4) (439.3) (358.9) -------- -------- -------- CONSOLIDATED $2,631.0 $2,466.6 $2,215.6\nCapital Additions: Railcar Leasing and Management $ 392.6 $ 285.4 $ 195.3 Terminals and Pipelines 148.6 154.4 77.8 -------- -------- -------- CONSOLIDATED $ 541.2 $ 439.8 $ 273.1\nProvision for Depreciation and Amortization: Railcar Leasing and Management $ 76.1 $ 68.3 $ 63.9 Terminals and Pipelines 45.3 43.5 41.0 -------- -------- -------- CONSOLIDATED $ 121.4 $ 111.8 $ 104.9\nInterest Expense: Railcar Leasing and Management $ 92.2 $ 70.0 $ 69.6 Terminals and Pipelines 46.4 39.7 39.0 -------- -------- -------- 138.6 109.7 108.6 Intersegment amounts (39.2) (31.4) (29.8) -------- -------- -------- CONSOLIDATED $ 99.4 $ 78.3 $ 78.8\nEXHIBIT 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in Registration Statement No. 33-48475 on Form S-3 filed July 30, 1992, Registration Statement No. 33-52301 on Form S-3 filed February 16, 1994 and Registration Statement No. 33-64697 on Form S-3 filed December 1, 1995 of General American Transportation Corporation of our report dated January 23, 1996 with respect to the consolidated financial statements and schedule of General American Transportation Corporation included in this Annual Report on Form 10-K for the year ended December 31, 1995.\nERNST & YOUNG LLP\nChicago, Illinois March 20, 1996\nEXHIBITS FILED WITH DOCUMENT\n10A. Third Amended and Restated Revolving Credit Agreement for GATC dated as of March 31, 1994, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended March 31, 1994, file number 2-54754. Amendment Number 1 thereto dated as of April 21, 1995; submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n10B. Revolving Credit Facility Agreement for GATX Terminals Limited as borrower and GATC as guarantor dated as of July 13, 1993, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended September 30, 1993, file number 2-54754. Amendment effective June 30, 1994 and amendment dated June 19, 1995; submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n12. Statement regarding computation of ratios of earnings to fixed charges.\n23. Consent of Independent Auditors\n27. Financial Data Schedule for GATC for the fiscal year ended December 31, 1995, file number 2-54754. Submitted to the SEC along with the electronic submission of this report on Form 10-K.","section_15":""}
{"filename":"93736_1995.txt","cik":"93736","year":"1995","section_1":"ITEM 1. BUSINESS\nNautica Enterprises, Inc., a Delaware corporation (the \"Company\") designs, sources and markets men's apparel through two wholly owned subsidiaries, Nautica International, Inc. (\"Nautica\") and State-O-Maine, Inc. (\"State-O-Maine\"). Nautica offers a lifestyle collection of men's sportswear, outerwear and activewear with a distinctive active outdoor image. The collection, sold under the Nautica brand, features innovative designs, classic styling, bold primary colors and quality fabric. State-O-Maine offers: Nautica brand men's dress shirts, robes and loungewear; sportswear and swimwear under the Bayou Sport label; apparel designed and sourced for private label programs; and, robes and loungewear under the Charles Goodnight and NFL (National Football League Properties) labels.\nNautica's in-store shop program is a primary component of the Company's growth strategy. Through this program, Nautica and a department store customer create a specific area within the store dedicated to the exclusive merchandising and sale of the Nautica collection. Each of these shops (referred to herein as a \"Nautica Shop\") is outfitted with signature Nautica fixtures and presents the Nautica collection in a visually attractive environment consistent with the Nautica image.\nIn addition to Nautica's wholesale business, the Company operates 28 Nautica factory outlet stores, one Company factory store and two flagship stores in New York City and Newport Beach, California through its wholly owned subsidiary Nautica Retail USA, Inc. (\"Nautica Retail\"). The factory outlet stores provide an additional sales channel for Nautica products and allow for organized distribution of excess and out-of-season merchandise.\nThe Company, through its wholly owned subsidiary Nautica Apparel, Inc., strategically extends the Nautica product lines and broadens the international distribution of the Nautica apparel collection through license agreements. The Nautica name is currently licensed for a range of products consistent with Nautica's design concepts and image, including men's cologne and skin care products, watches, eyewear and footwear.\nPRODUCTS\nNautica\nNautica offers a lifestyle collection of men's sportswear, outerwear and activewear with a distinctive active outdoor image. The collection, sold under the Nautica brand, features innovative designs, classic styling, bold primary colors and quality fabrics. The Nautica name and trademarks are prominently displayed on Nautica products to promote brand awareness and maintain consumer loyalty. Although Nautica products are targeted to the 25-54 year old age group, the Company believes that its products appeal to both younger and older consumers who identify with the Nautica lifestyle and image.\nThe Nautica collection is offered in three principal groups: Anchor, Crew and Fashion. Products in each of these groups are designed by Nautica's in-house staff and include sportswear, outerwear and activewear. Sportswear includes sweaters, cardigans, woven shirts, knit shirts, rugbys, pants and shorts. Outerwear includes parkas, anoraks, bomber jackets and foul weather gear. Activewear includes fleece and french terry tops, french terry pants and shorts, tee shirts and swimwear.\nThe Anchor group serves as the foundation for the Nautica collection and consists of basic items, including cotton twill shirts, cotton pique knit shirts, cotton twill pants, lightweight jackets and swimwear. These seasonless products feature Nautica's signature color schemes and styles and are available to retail customers throughout the year. The Company maintains inventory of Anchor products in order to continuously\nreplenish the stock of its retail customers. Since 1992, retail customers have been able to re-order Anchor products through electronic data interchange (EDI).\nThe Crew and Fashion groups are usually presented in nine deliveries during Nautica's four merchandising seasons. Crew is typically the first collection delivery of the Spring, Transitional, Fall and Holiday seasons. The Crew collections reinterpret Anchor basics by introducing seasonal colors and offer additional items and styles. Fashion follows with two or three deliveries in each of the Spring and Fall seasons and one delivery in each of the Summer and Holiday seasons. The Fashion collections are based on seasonal themes developed by Nautica's design and merchandising staffs. These themes, which have recently included \"Great Lakes Adventure\" and \"Windward Sailing\" reinforce the Nautica image. The Fashion group is distinguished by its distinctive use of color, novelty prints and fabrics and unique design elements. The Anchor, Crew and Fashion groups are developed to be merchandised together as a cohesive Nautica collection.\nThe Company also licenses the Nautica name and trademarks for a range of products consistent with Nautica's design concepts and image, including men's cologne and skin care products, watches, eyewear and footwear. See \"Licensing.\"\nState-O-Maine\nState-O-Maine offers: Nautica brand men's dress shirts, robes and loungewear; sportswear and swimwear under the Bayou Sport label; apparel designed and sourced for private label programs; and, robes and loungewear under the Charles Goodnight and NFL labels. The Nautica brand men's dress shirt line targets the same consumer base as the Nautica collection, but is typically sold and displayed in the men's furnishings department of leading department and specialty stores. For its other lines, State-O-Maine employs more competitive pricing and broader distribution strategies than those of Nautica.\nIn 1989, State-O-Maine commenced the development, sale and distribution of distinctive men's dress shirts, robes and loungewear bearing the Nautica label. This line features quality fabrics, classic styling and design concepts inspired by the Nautica collections.\nIn 1992, State-O-Maine introduced a spirited line of men's apparel under the Bayou Sport label. The Bayou Sport line of woven and knit shirts and swimwear features vibrant prints and bold colors and patterns, and is offered at competitive price points.\nState-O-Maine continues to actively develop its private label business for department store customers such as Belk and Dillard's and for national chain store operators such as J.C. Penney, Target and Sears, Roebuck and Co. Products designed and sourced for private label programs include sportswear, swimwear, robes and loungewear. The Company uses its design and sourcing expertise to offer quality products at competitive prices.\nIn 1994, State-O-Maine introduced robes and loungewear under the NFL label and in 1995 is introducing robes and loungewear under the Charles Goodnight label. The new license agreements will enable State-O-Maine to explore new business opportunities through the sale and distribution of its core robe and loungewear products.\nMARKETING\nNautica's in-store shop program is a primary component of the Company's growth strategy. Through this program, Nautica and a department store customer create a specific area within the store dedicated to the exclusive merchandising and sale of the Nautica collection. These Nautica Shops, strategically located in the men's collections departments of leading department stores, provide a distinctive selling environment tailored\nto Nautica's specifications and generally include cherry and ash wood flooring, custom designed ash fixtures, brass hardware and nautical props. As a result of their configuration, Nautica Shops stock a greater volume of Nautica inventory per square foot than would typically be carried in a standard department store setting. They also allow for enhanced customer service and monitoring of sales performance. Accordingly, management believes that the Nautica Shops achieve sales productivity significantly exceeding that of sales of Nautica products in a standard department store setting.\nNautica plans to continue to install and expand Nautica Shops in department stores which currently sell the Nautica collection and to install Nautica Shops in additional retail locations. The continued development of the Nautica Shop program is dependent on general apparel industry conditions, continued participation by retail customers and continued demand by consumers for the Nautica collection.\nIn order to maximize the effectiveness of the Nautica Shop program, Nautica established a merchandise coordinator program in 1990. Each of Nautica's merchandise coordinators services a group of retail customers within a common geographic region. They communicate with and visit each of their customers on a regular basis to ensure proper visual display of Nautica merchandise, analyze inventory requirements, and provide selling and merchandising support to the sales staff. Merchandise coordinators also train certain department store employees with regard to Nautica's product features, sales methods and shop management. They also provide sales information to the Company's retail analysts who monitor retail customer performance and develop plans to assist these retail customers with future purchases of Nautica products. Management believes that the performance of Nautica Shops is enhanced by the close interaction of its merchandise coordinators with its retail customers.\nNautica concentrates its marketing efforts on national and regional print advertising. The advertising captures the Nautica image in environments that reflect the Nautica lifestyle collection. The Nautica advertising campaign is featured throughout the year in national magazines including Conde Nast Traveler, Details, Esquire, GQ, Men's Journal, The New York Times Magazine, The New Yorker, Sports Illustrated, Vanity Fair; \"W\", and L'Uomo Vogue; and in regional magazines. In addition, Nautica participates with its retail customers in a cooperative advertising program.\nThe print advertising is supplemented by a series of special events and sponsorships. Nautica was the official sports clothing of Pact '95\/Young America, the sailing team that competed in defense of the America's Cup. In addition, Nautica continues its sponsorship of the U.S. Sailing Team, and its title sponsorship of the World Youth Sailing Championship and presentation of the Nautica Cup. The Company is the official apparel sponsor of the Northville (L.I.) Classic and the Transamerica Senior Golf Championship, two events on the Senior PGA tour. In 1995, Nautica also will sponsor the Nestle Invitational, a PGA sanctioned tournament and the PaineWebber Invitational, another Senior PGA event.\nNautica products are also sold through 29 Company-owned factory outlet stores located throughout the United States and two Company-owned retail stores located in New York City and Newport Beach, California. See \"Retail.\"\nNautica sells its products primarily to leading department and specialty stores. Its principal customers include Dillard's, May Company Department Stores (including Kaufmann's, Foley's, Filene's, Lord & Taylor and Famous Barr), Dayton's-Hudson-Field's, Federated Department Stores (including Macy's, Bloomingdale's, Lazarus\/Rich's) and Nordstrom. Nautica maintains showrooms in New York City and Dallas, Texas.\nState-O-Maine sells its products primarily to department stores including Dillard's and May Company Department Stores (including Lord & Taylor, Kaufmann's, Foley's, Famous Barr and Filene's), Dayton's-Hudson-Field's, and Federated Department Stores. In addition, State-O-Maine sells its products to\nnational chain store operators such as J.C. Penney Co., Inc. and Sears, Roebuck and Co. State-O-Maine's Bayou Sport line and its private label program employ more competitive pricing and broader distribution strategies than the Nautica brand. State-O-Maine products are generally sold in individual product categories through mainfloor classification departments. Its products are marketed by its regional sales managers and sales representatives through its showrooms in New York City, Dallas, Texas, and New Orleans, Louisiana. In fiscal 1995, Dillard's and May Company Department Stores each accounted for approximately 17% of the Company's total gross sales. No other customer of the Company accounted for 10% or more of the Company's sales during that period.\nPRODUCT DESIGN AND SOURCING\nThe Company manages the development of its apparel from initial product concept through color and pattern design, fabric identification and testing and garment manufacturing. Products are designed by the in-house staffs of Nautica and State-O-Maine. The design teams work in conjunction with the sales and production teams to determine the apparel styles for a particular season based upon an evaluation of current style trends, prior year's sales and consultations with retail customers. In conjunction with agents located in foreign countries, Nautica and State-O-Maine arrange fabric sourcing and garment production to ensure that final products satisfy detailed specifications and quality standards.\nThe Company contracts for the manufacture of its products and does not own or operate any manufacturing facilities. The Company's manufacturers are located primarily in Hong Kong, the People's Republic of China, the Philippines, Malaysia, Singapore, Saipan, Thailand, India and Turkey. The Company's agents, based in Hong Kong, Taiwan, Turkey and India monitor production to ensure compliance with design specifications, quality standards and timely delivery of finished garments. They are assisted by Company employees based in New York who regularly visit with the manufacturers to monitor production. To date, the Company has not experienced significant difficulty in obtaining manufacturing services. Management believes that many alternate manufacturing sources exist. However, the inability of current sources to satisfy the Company's manufacturing requirements, the loss of certain manufacturers, the loss of an agent of the Company or a delay in locating manufacturing capacity following termination of a manufacturing relationship, could have a material adverse effect on the Company's business and operating results. While the Company has long standing relationships with many of its manufacturers and believes its relations to be good, it does not have long-term commitments with manufacturers.\nThe Company sources for many of its manufacturers a broad range of natural and synthetic fabrics primarily from foreign textile mills and converters. The Company separately negotiates with fabric suppliers for the sale of required fabric which is then purchased by its manufacturers in accordance with the Company's specifications. To date, the Company has not experienced significant difficulty in sourcing fabrics for its manufacturers. Management believes that many alternate sources of supplies exist. However, the inability of current sources to satisfy the Company's fabric requirements, the loss of certain fabric vendors, or a delay in manufacturers obtaining fabric from certain vendors, could have a material adverse effect on the Company's business and operating results. The Company does not have any long-term commitments with fabric suppliers.\nThe Company contracts to purchase its goods in United States dollars and has not experienced material difficulties as a result of foreign political, economic or social instability. However, the Company's business remains subject to the usual risks associated with foreign suppliers.\nLICENSING\nThe Company strategically extends the Nautica product line and broadens the international distribution of the Nautica apparel collection through license agreements. These license agreements allow the Company to enter new businesses and countries with minimal capital commitments and to benefit from the experience of the licensee with the licensed product or the local market. The Nautica name and related\ntrademarks are licensed through the Company's wholly owned subsidiary, Nautica Apparel, Inc. (\"Nautica Licensing\"). Net royalty income to the Company was approximately $848,000, $942,000 and $1,285,000 in fiscal 1993, fiscal 1994 and fiscal 1995, respectively.\nNautica Licensing currently licenses products for wholesale distribution in the following product categories: men's cologne and skin care products, neckwear, tailored clothing, rainwear, boys' apparel, footwear, luggage, watches, caps, men's hosiery, eyewear, belts and small leather goods, umbrellas and a Lincoln-Mercury Villager minivan.\nInternationally, Nautica apparel is licensed for sale in Australia, Belgium, Brazil, Canada, the Caribbean, Chile, Colombia, Greece, Hong Kong, Italy, Japan, Korea, Mexico, New Zealand, Panama, Peru, Taiwan, Thailand, the United Kingdom and Venezuela. In addition to wholesale distribution of Nautica apparel, international licensees operate a total of approximately 53 Nautica retail stores in certain of these markets.\nAs a provision of the agreement by which the Company acquired the Nautica brand in 1984, David Chu, Executive Vice President of the Company and President of Nautica Licensing and Nautica, is entitled to receive 50% of the net royalty income from licensing the Nautica name and trademarks. The Company is entitled to receive the remaining 50% of such net royalty income.\nRETAIL\nFactory Outlet Stores\nThe Company operates 28 Nautica factory outlet stores generally located in manufacturers' outlet centers throughout the United States and one Company factory outlet store located in one of its Rockland, Maine facilities. The Company's retail operations are conducted through its wholly owned subsidiary, Nautica Retail USA, Inc. (\"Nautica Retail\"). These factory outlet stores have enabled the Company to increase sales in certain geographic markets where Nautica products were not previously available and to consumers who favor value-oriented retailers. They also provide opportunities for Nautica to sell excess and out-of-season merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices. Nautica factory outlet stores are geographically positioned to minimize potential conflict with the Company's retail customers.\nFlagship Stores\nThe Company operates two Nautica flagship stores, one in New York City and one in Newport Beach, California. With their signature Nautica cherry and ash wood flooring, ash fixtures, brass hardware and nautical props, these stores are designed to convey the complete Nautica image. The stores carry a wide range of Nautica brand products, including Nautica furnishings, watches and footwear. These stores serve as a showcase for Nautica's retail customers and build brand recognition among consumers.\nSEASONALITY\nHistorically, the Company has experienced its highest level of sales in the third quarter and its lowest level in the first quarter. This pattern has resulted primarily from the timing of shipments to retail customers for Spring and Fall seasons. In the future, the timing of seasonal shipments may vary by quarter.\nTRADEMARKS\nNautica and its related trademarks (the \"Nautica Marks\"), including the Nautica Spinnaker, are registered trademarks of Nautica Apparel, Inc. in the United States for apparel and other products, including cologne, eyewear, watches, small leather goods, umbrellas, luggage and jewelry. Applications to register the Nautica Marks in other product categories have been filed by the Company in the United States. In addition, the Company has registered or is in the process of registering the Nautica Marks in over 70 countries throughout the world for apparel and in other complementary product categories.\nState-O-Maine is a registered trademark, and Bayou Sport is a trademark, of State-O-Maine in the United States for certain apparel items. State-O-Maine has filed trademark applications in the United States for Bayou Sport.\nThe Company regards its trademarks and other proprietary rights as valuable assets.\nCOMPETITION\nThe apparel industry is highly competitive. The Company encounters substantial competition from brands such as Polo\/Ralph Lauren, Tommy Hilfiger and Claiborne, as well as from certain non-designer lines. In addition, department stores, including some of the Company's major retail customers, have increased in recent years the amount of goods manufactured specifically for them and sold under their own labels. Some of the Company's competitors are significantly larger and more diversified than the Company and have substantially greater resources available for marketing their products. The Company believes that its ability to compete effectively depends upon the continuing appeal of Nautica apparel and the Company's other products to its retail customers and consumers as well as the Company's ability to continue to offer high quality apparel at appropriate price points.\nEMPLOYEES\nAt February 28, 1995, the Company had approximately 760 employees. Approximately 160 employees are located at the Company's Rockland, Maine facilities; approximately 120 of such employees are members of the Amalgamated Clothing and Textile Workers Union, AFL-CIO, CLC. The Company considers its relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company operates three warehouse and distribution facilities in Rockland, Maine. A 165,000 square foot facility, owned by the Company, is used for receiving, shipping and warehousing the Nautica apparel and private label lines. The Company expects to complete an expansion of the facility in 1995, which will add approximately 165,000 square feet of usable area on three levels. A 100,000 square foot facility, also owned by the Company, is used primarily for receiving, shipping and warehousing the Nautica furnishings, Bayou Sport and Nautica Retail inventories. A leased facility of approximately 33,000 square feet is used for warehousing a range of the Company's products. All merchandise is shipped directly from the Company's manufacturers to its facilities in Rockland, Maine where it is processed and shipped to customers.\nThe Company has administrative and sales offices at 40 West 57th Street, New York, New York, where it occupies under lease approximately 42,000 square feet. It also leases a design studio of approximately 22,000 square feet located at 11 West 19th Street, New York, New York. The Company or its subsidiaries also lease retail stores in New York, New York and Newport Beach, California, sales offices in Dallas, Texas and New Orleans, Louisiana, and Nautica factory outlet stores in Kittery, Maine; Chattanooga,\nTennessee; Niagara Falls, New York; Reading, Pennsylvania; Martinsburg, West Virginia; Lake George, New York; Foley, Alabama; Freeport, Maine; Tannersville, Pennsylvania; Central Valley, New York; Sevierville, Tennessee; Destin, Florida; Osage Beach, Missouri; St. George, Utah; Lancaster, Pennsylvania; Barstow, California; St. Augustine, Florida; Oshkosh, Wisconsin; Lincoln City, Oregon; Dillon, Colorado; Manchester, Vermont; Castle Rock, Colorado; Rehoboth Beach, Delaware; Branson, Missouri; Tuscola, Illinois; Solvang, California; Napa, California; Vero Beach, Florida; and, Fremont, Indiana. All of the Company's facilities are deemed by it to be adequate for the purposes utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is publicly quoted on the National Market System of the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the trading symbol \"NAUT.\"\nThe following table sets forth for the periods indicated the high and low reported sales prices per share for the Common Stock as quoted by the NASDAQ National Market System. All prices have been adjusted to reflect a three-for-two stock split effected in the form of a stock dividend to holders of record of Common Stock on November 1, 1993. They have also been adjusted to reflect a three-for-two stock split to be effected in the form of a stock dividend to holders of record of Common Stock on May 5, 1995, subject to stockholder approval of an amendment to the Company's Certificate of Incorporation increasing the number of authorized shares of common stock.\nAs of May 19, 1995, there were approximately 4,200 stockholders of the Company's Common Stock.\nThe policy of the Company is to retain earnings to provide funds for the operation and expansion of its business and, accordingly, the Company has paid no cash dividends on its Common Stock. Any payment of future cash 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.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nAll share data has been adjusted to reflect a three-for-two stock split to be effected in the form of a stock dividend, payable to stockholders of record on May 5, 1995, subject to stockholder approval of an amendment to the Company's Certificate of Incorporation increasing the number of authorized shares of Common Stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFiscal year ended February 28, 1995 compared to February 28, 1994:\nConsolidated net sales increased 28.4% to $247.6 million in the fiscal year ended February 28, 1995 compared to $192.9 million in the prior fiscal year. This increase is primarily a result of increased sales of Nautica products through its wholesale and retail operations. Nautica's wholesale sales increased due to the expansion of Nautica's in-store shop program, sales to new retail customers and to additional locations of existing customers, and the continued growth of a basic stock replenishment program for the Anchor group of Nautica products. The increase in Nautica's wholesale sales is due to increased unit volume rather than price increases. Nautica retail sales increased as a result of opening eight additional Nautica factory outlet stores during the current year, the full year effect of four stores opened in the prior year and to an increase in comparable store sales of 18.9%.\nConsolidated gross profit during the fiscal year ended February 28, 1995 increased to 44.3% of net sales, as compared to 43.5% of net sales in the prior fiscal year. The net increase resulted primarily from a shift in sales mix to higher margin products.\nDesigning, selling, shipping and general and administrative expenses as a percentage of net sales increased to 29.7% during the fiscal year ended February 28, 1995 as compared to 29.5% in the prior fiscal year. The net increase resulted from additional expenses incurred due to the expiration of a license agreement in the Company's State-O-Maine, Inc. subsidiary in the current year.\nOperating profit increased 34.2% to $36.2 million (14.6% of net sales) in the fiscal year ended February 28, 1995 as compared to $27.0 million (14.0% of net sales) in the prior fiscal year as a result of the factors discussed above.\nNet royalty income increased by $343,000 to $1,285,000 in the fiscal year ended February 28, 1995 as compared to $942,000 in the prior fiscal year. This net increase resulted from increased royalty revenue associated with increased sales by licensees partially offset by increased expenses associated with a bankruptcy filing by one licensee.\nOther income consists of interest income of $1,997,000. Other expense of $881,000 relates primarily to costs associated with the Company's evaluation of its warehouse and distribution facilities resulting in the decision to remain in the state of Maine.\nThe effective tax rate decreased to 37.9% for the fiscal year ended February 28, 1995 as compared to 41.2% in the prior fiscal year. The decrease is primarily due to certain state tax relief provided to the Company and to tax exempt interest income.\nNet earnings increased 42.7% to $24.0 million in the fiscal year ended February 28, 1995 from $16.8 million in the prior fiscal year as a result of the factors discussed above.\nFiscal year ended February 28, 1994 compared to February 28, 1993:\nConsolidated net sales increased 27.8% to $192.9 million in the fiscal year ended February 28, 1994 compared to $151.0 million in the prior fiscal year. This increase is primarily a result of increased sales of Nautica products through its wholesale and retail operations. Nautica's wholesale sales increased due to the expansion of Nautica's in-store shop program, sales to new retail customers and to additional locations of existing customers, and the continued growth of a basic stock replenishment program for the Anchor group of Nautica products. The increase in Nautica's wholesale sales is due to increased unit volume rather than price increases. Nautica retail sales increased as a result of opening four additional Nautica factory outlet stores in the current year, to the full year effect of six stores opened in the prior fiscal year and to an increase in comparable store sales of 11%.\nConsolidated gross profit during the fiscal year ended February 28, 1994 increased to 43.5% of net sales, as compared to 42.0% of net sales in the prior fiscal year. The net increase resulted primarily from a shift in sales mix to higher margin products and a decrease in sales of close-out merchandise primarily due to the opening of additional Nautica factory outlet stores.\nDesigning, selling, shipping and general and administrative expenses as a percentage of net sales decreased to 29.5% during the fiscal year ended February 28, 1994 as compared to 30.3% in the prior fiscal year. The net decrease resulted from decreases in production, design, shipping, and general and administrative expenses as a percentage of net sales, partially offset by increases in selling and marketing expenses as a percentage of net sales. Production, design, shipping and general and administrative expenses decreased as a percentage of net sales due to economies of scale achieved with sales growth. The increase in selling and marketing expenses as a percentage of net sales was primarily due to the growth in sales of Nautica products, the expansion of Nautica's in-store shop program and the opening of additional Nautica factory outlet stores.\nInterest expense remained relatively constant at approximately $267,000 in the fiscal year ended February 28, 1994 as compared to the prior fiscal year.\nOperating profit increased 52.5% to $27.0 million (14.0% of net sales) in the fiscal year ended February 28, 1994 as compared to $17.7 million (11.7% of net sales) in the prior fiscal year as a result of the factors discussed above.\nNet royalty income increased by $94,000 to $942,000 in the fiscal year ended February 28, 1994 as compared to $848,000 in the prior fiscal year. This net increase resulted from increased royalty revenue associated with new license agreements entered into during the fiscal year, offset by increased expenses, primarily associated with the Company's trademark registration program for the Nautica marks, trademark amortization and salaries.\nOther income consists of interest income of $268,000 earned primarily on cash generated from the Company's public offering of common stock completed in December 1993. Other expense of $164,000 relates to the write-off of fixed assets associated with the relocation of the Nautica design studio.\nPre-tax income in the current fiscal year benefited from an $826,000 ($0.04 per share as adjusted) gain from non-taxable life insurance proceeds due to the death of the Company's Chairman of the Board on August 18, 1993.\nThe effective tax rate decreased to 41.2% for the fiscal year ended February 28, 1994 as compared to 42.8% in the prior fiscal year, due to non-taxable life insurance proceeds partially offset by an increase in income tax rates.\nNet earnings increased 60.2% to $16.8 million in the fiscal year ended February 28, 1994 from $10.5 million in the prior fiscal year as a result of the factors discussed above.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the year ended February 28, 1995 the Company generated cash from operating activities of $13.1 million. Such cash was principally from net earnings and increases in accounts payable and accrued expenses offset by inventory increases of $18.6 million. The increase in inventory is primarily the result of stocking more basic inventory to fill EDI orders resulting from increased demand for the Anchor group of Nautica products and to fill orders for shipments to be made in the future. During the year ended February 28, 1994 the Company generated cash from operating activities of $17.5 million. Such cash was principally from net earnings.\nDuring the year ended February 28, 1995 the Company's principal investing activities related to the continued expansion of Nautica's in-store shop program. The Company expects to continue to incur capital expenditures to promote the expansion of the Nautica in-store shop program. In addition, the Company is expanding its warehouse and distribution facilities in Rockland, Maine at an expected cost of approximately $15.0 million. The Company will utilize its existing cash and lines of credit during construction and will finance the project at its completion.\nThe Company has $60.0 million in lines of credit with two commercial banks available for short-term borrowings and letters of credit. These lines are collateralized by wholesale inventory and accounts receivable. At February 28, 1995 letters of credit outstanding under the lines were $28.3 million and there were no short-term borrowings outstanding.\nThe Company anticipates that internally generated funds from operations, existing cash balances and the Company's existing credit lines will be sufficient to satisfy its cash requirements.\nCURRENCY FLUCTUATIONS AND INFLATION\nThe Company purchases its products from manufacturers located primarily in the Far East. These purchases are denominated in United States dollars. The Company believes that, to date, the effect of fluctuations of the dollar against foreign currencies has not had a material effect on the cost of imports or the Company's results of operations. However, there can be no assurance that purchase prices for the Company's products will not be affected by future fluctuations in the exchange rate between the United States dollar and the local currencies of these manufacturers. Due to the number of currencies involved, the Company cannot quantify the potential effect of such future fluctuations on future income. The Company does not engage in hedging activities with respect to such exchange rate risk.\nThe Company believes that inflation has not had a material effect on the cost of imports or the Company's results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements required by Part II, Item 8 are included in Part IV, 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 is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on June 29, 1995.\nIn addition, for the fiscal year ended February 28, 1995, Charles H. Scherer, a Director of the Company, filed one late report under Section 16(a) of the Securities and Exchange Act of 1934, reflecting one transaction.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on June 29, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on June 29, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on June 29, 1995 and by reference to Footnotes H, I and L of the Financial Statement included in this report and referred to at Part IV, Item 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 Nautica Enterprises, Inc. and Subsidiaries required by Part II, Item 8, are included in Part IV of this report:\n(a) 3. Exhibits\n3(a) Registrant's By-Laws as currently in effect is incorporated by reference herein to the Registrant's Registration Statement on Form S-1 (Registration Number 33-21998).\n3(b) Registrant's Certificate of Incorporation is incorporated by reference herein to the Registrant's Registration Statement on Form S-3 (Registration Number 33-71926).\n10(iii)(a) Registrant's Executive Incentive Stock Option Plan is incorporated by reference herein from the Registrant's Registration Statements on Form S-8 (Registration Number 33-1488), as amended by the Company's Registration Statement on Form S-8 (Registration Number 33-45823).\n10(iii)(b) Registrant's 1989 Employee Incentive Stock Plan is incorporated by reference herein from the Registrant's Registration Statement on Form S-8 (Registration Number 33-36040).\n10(iii)(c) Registrant's 1994 Incentive Compensation Plan\n21 Subsidiaries of Registrant\n23.1 Consent of Independent Certified Public Accountants\n27 Financial Data Schedule\n(b) Reports on Form 8-K. None\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Stockholders NAUTICA ENTERPRISES, INC.\nWe have audited the accompanying consolidated balance sheets of Nautica Enterprises, Inc. and Subsidiaries as of February 28, 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 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 consolidated financial position of Nautica Enterprises, Inc. and Subsidiaries as of February 28, 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 February 28, 1995, in conformity with generally accepted accounting principles.\nWe have also audited the schedule listed in the accompanying index at Item 14(a)2. for each of the three years in the period ended February 28, 1995. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nNew York, New York April 20, 1995\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED BALANCE SHEETS\nFebruary 28,\nThe accompanying notes are an integral part of these statements.\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nFebruary 28,\nThe accompanying notes are an integral part of these statements.\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENTS OF EARNINGS\nYear ended February 28,\nThe accompanying notes are an integral part of these statements.\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nYears ended February 28, 1995, 1994 and 1993\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (CONTINUED)\nYears ended February 28, 1995, 1994 and 1993\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (CONTINUED)\nYears ended February 28, 1995, 1994 and 1993\nThe accompanying notes are an integral part of this statement.\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYear ended February 28,\nNautica Enterprises, Inc. and Subsidiaries\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nYear ended February 28,\nThe accompanying notes are an integral part of these statements.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFebruary 28, 1995, 1994 and 1993\nNOTE A - SUMMARY OF ACCOUNTING POLICIES\nNautica Enterprises, Inc. (the \"Company\") and Subsidiaries are principally engaged in the design, manufacture and sale of men's apparel.\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:\n1. Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.\n2. Cash and Cash Equivalents\nFor purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. The carrying amount approximates fair value because of the short maturity of those instruments.\n3. Revenue Recognition\nRevenue within wholesale operations is recognized at the time merchandise is shipped to customers. Retail store revenues are recognized at the time of sale.\n4. Inventories\nInventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (\"LIFO\") method for wholesale inventories and by the first-in, first-out (\"FIFO\") method for retail inventories.\n5. Property, Plant and Equipment\nProperty, plant and equipment are carried at cost. Depreciation for financial statement purposes is provided principally by the straight-line method over the estimated useful lives of the assets. Improvements to leased premises are amortized over the shorter of the useful lives of the improvements or the life of the related lease.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE A (CONTINUED)\n6. Excess of Cost Over Net Assets Acquired\nThe excess of cost over net assets acquired is being amortized on a straight-line basis over a forty-year period. Accumulated amortization at February 28, 1995 and February 28, 1994 was $364,430 and $314,710, respectively.\n7. Other Assets\nIncluded in other assets are long-term investments of $2,500,000. The investments are carried at cost which approximates market value at February 28, 1995.\n8. Deferred Design Charges\nThe Company defers certain design charges that relate to goods to be sold in future selling seasons. Such charges are charged to expense in the season the goods relate to.\n9. Income Taxes\nThe Company and its wholly-owned subsidiaries file a consolidated Federal income tax return. Deferred income taxes payable arise as a result of differences between financial statement and income tax reporting.\n10. Earnings Per Share\nEarnings per share are based on the weighted average number of shares of common stock outstanding during the year giving retroactive effect to the stock splits as described in Note H. Stock options are included in the calculation, when they are dilutive.\n11. Reclassifications\nCertain amounts in prior years have been reclassified to conform with classifications used in 1995.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE B - INVENTORIES\nInventories valued using the LIFO method comprised 85% and 75% of consolidated inventories before LIFO adjustment at February 28, 1995 and February 28, 1994, respectively. The FIFO earnings are presented in order to provide a basis for comparison to the operating results of those companies within the industry which do not use the LIFO method. Had the Company utilized the FIFO method of accounting for inventory, inventories would have been higher by $3,268,309, $4,101,208 and $3,592,057 at February 28, 1995, 1994 and 1993, respectively. Earnings before provision for income taxes would have been lower by $832,899 at February 28, 1995, higher by $509,151 at February 28, 1994 and higher by $418,855 at February 28, 1993. Net earnings would have been lower by $517,230 ($.02 per share) at February 28, 1995, higher by $299,381 ($.02 per share) at February 28, 1994 and higher by $239,585 ($.01 per share) at February 28, 1993. During the year ended February 28, 1995, reductions in certain LIFO pools had the effect of increasing earnings before income taxes by approximately $1,700,000 and net earnings by $1,056,000 ($.05 per share).\nInventories consist of the following:\nNOTE C - PREPAID EXPENSES AND OTHER CURRENT ASSETS\nPrepaid expenses and other current assets consist of the following:\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE D - PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are summarized as follows:\nDepreciation expense for the years ended February 28, 1995, 1994 and 1993 was $2,756,381, $2,407,071 and $1,659,815, respectively.\nNOTE E - SHORT-TERM BORROWINGS\nAs of February 28, 1995, the Company had $60,000,000 in lines of credit, with two commercial banks, available for short-term borrowings and letters of credit collateralized by wholesale inventory and accounts receivable. At February 28, 1995, letters of credit outstanding under the lines were $28,299,180 and there were no short-term borrowings outstanding. Interest is payable at the prime rate.\nData as to the Company's short-term borrowings are summarized as follows:\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE F - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES\nAccrued expenses and other current liabilities consist of the following:\nNOTE G - LONG-TERM DEBT\nThe following is a summary of the long-term debt:\n(a) Industrial revenue bond payable in annual installments of $50,000 through 2001, collateralized by land, building, and machinery (plant). The bond bears interest at a defined percentage of the prime rate (7.27% at February 28, 1995).\nThe aggregate maturities of the Company's long-term debt are as follows:\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE H - STOCKHOLDERS' EQUITY\nOn April 18, 1995, the Board of Directors declared a three-for-two stock split of the Company's common stock to be effected in the form of a stock dividend payable on July 6, 1995 to stockholders of record on May 5, 1995. The stock split is subject to stockholder approval of the Certificate of Incorporation amendment authorizing an increase in the number of shares of common stock from 20,000,000 shares to 50,000,000 shares. An amount equal to par value of the shares of common stock to be issued was transferred from additional paid-in capital to the common stock account. All prior year stock options and per share disclosures have been restated to reflect the stock split.\nOn December 23, 1993, the Company and certain selling stockholders sold an aggregate of 3,084,300 shares of common stock of the Company (including a portion of the underwriters' overallotment option). The Company did not receive any of the proceeds of the 695,422 shares sold by the selling stockholders. The net proceeds of the offering to the Company were approximately $32,600,000 after deducting underwriting commissions and direct offering costs. The offering costs were borne entirely by the Company.\nOn October 21, 1993, the Board of Directors declared a three-for-two split of the Company's common stock effected in the form of a stock dividend.\nThe Certificate of Incorporation, as amended, authorizes the Board of Directors to issue Preferred Stock, from time to time, in one or more series, with such voting powers, designations, preferences, and relative, participating, optional, conversion or other special rights, and such qualifications, limitations and restrictions, as the Board of Directors may, in their sole discretion, determine.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE I - COMMITMENTS AND CONTINGENCIES\n1. Leases\nThe Company leases real property and equipment, under operating leases expiring at various dates through 2009. Rent expense amounted to approximately $3,991,000 in 1995, $3,110,000 in 1994 and $2,528,000 in 1993. At February 28, 1995, minimum rental commitments under noncancellable leases are as follows:\n2. Royalties\nThe Company was a party to a licensing agreement, which expired during the 1995 fiscal year, which granted the Company an exclusive right to utilize certain designs and trade names in the manufacture of specific items of robes and activewear. Royalty expense, which is calculated on the basis of related sales, amounted to approximately $1,101,000 in 1995, $1,179,000 in 1994 and $1,397,000 in 1993.\n3. Stock Purchase Agreement and Life Insurance Proceeds\nThe Company is a party to an agreement with the president and current Chairman of the Board of the Company and the president of Nautica, and was a party to a similar agreement with the former chairman of the board (now deceased) of the Company (the principal stockholders), which provides, upon the death of any of the aforementioned stockholders, and at the request of their respective estates, that the Company will purchase a part of the common shares of the deceased stockholder. The Company has obtained policies of life insurance on the lives of the stockholders for the purpose of utilizing the proceeds from such insurance for the purchase of the shares of the Company's common stock. The agreement provides for the Company to purchase the deceased stockholder's shares of common stock at a defined market value on the date of death. The Company's obligation to purchase the common shares of the deceased stockholder is limited to the life insurance proceeds\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE I (CONTINUED)\nreceived by the Company on the death of such stockholder. The agreement also provides, as soon after the death of the stockholder as is practicable and upon the request of the estate of the deceased stockholder, for the filing of a registration statement with the Securities and Exchange Commission for an offering of the shares of common stock, if any, not purchased by the Company.\nDue to the death of the former chairman of the board of the Company in August 1993, the Company realized nontaxable income from life insurance proceeds in the amount of $825,556 ($.04 per share). The repurchase obligation relating to shares owned by the former chairman of the board of the Company expired on December 18, 1993.\n4. Executive Compensation\nIn the event of a change in control of the Company as defined in the agreement, senior management has the right to receive a lump-sum payment upon termination of employment other than for cause or permanent disability or resignation for good reason within three years. Such payments are to be equal to the excess of (A) the product of 2.90 multiplied by the \"base amount\" as determined within the meaning of Section 280G of the Internal Revenue Code over (B) the value on the date of the Change of Control Event of non-cash benefits as defined in the agreement. At February 28, 1995, the maximum amount payable, applicable to three individuals, would be approximately $8,777,000.\n5. Other\nThe Company is subject to claims and suits in the ordinary course of business. Management believes that the ultimate resolution of all such proceedings will not have a material adverse effect on the Company.\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. Dillard Department Stores, Inc. and May Department Stores Company accounted for approximately 17% and 17%, respectively, of gross wholesale sales in 1995, approximately 19% and 17%, respectively, of gross wholesale sales in 1994, and approximately 18% and 18%, respectively, of gross wholesale sales in 1993. In recent years, a number of corporate groups, which include certain of the Company's department store customers, excluding the above, have been involved in highly\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE I (CONTINUED)\nleveraged financial transactions and certain of these customers have filed for protection under Chapter 11 of the Federal Bankruptcy Code. The Company does not believe that this concentration of sales and credit risks represents a material risk of loss with respect to its financial position as of February 28, 1995.\nNOTE J - OTHER INCOME - NET\nOther income - net is comprised of the following:\nNOTE K - INCOME TAXES\nEffective as of March 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" The adoption of SFAS No. 109 did not have a material effect on the consolidated financial statements. Therefore, the effect of adopting SFAS No. 109 is included in income tax expense rather than as the cumulative effect of an accounting change.\nUnder the provisions of SFAS No. 109, deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Deferred tax assets and liabilities are measured using\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE K (CONTINUED)\nenacted tax law. Significant components of the Company's deferred taxes at February 28, 1995 and 1994 are as follows:\nThe provision for income taxes is comprised of the following:\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE K (CONTINUED)\nThe following is a reconciliation of the normal expected statutory Federal income tax rate to the effective rate reported in the financial statements:\nState income taxes in 1995 decreased due to certain tax relief provided to the Company and the inclusion of a one-time refund of taxes previously paid of $1,429,000.\nDeferred income taxes in fiscal 1993 reflect the impact of differences between financial statement and income tax reporting. The components of the deferred tax (benefit) are as follows:\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE L - TRANSACTIONS WITH RELATED PARTIES\nThe former Chairman of the Board, who was a principal stockholder of the Company, received a management fee for services rendered to the Company of $50,000 in 1994 and $180,000 in 1993.\nNautica has the exclusive right to use, exploit and license others to so use and exploit the Nautica name and trademarks. The President of Nautica receives 50% of the net royalties received by the Company with respect to the use of the Nautica name and trademarks. The President of Nautica received royalties of approximately $1,285,000, $942,000 and $848,000 in 1995, 1994 and 1993, respectively. At February 28, 1995 and 1994, the amount due to the President of Nautica included in accrued expenses and other current liabilities was approximately $627,000 and $398,000, respectively. The President of Nautica has the right of first refusal to purchase the Company's right and interests in the name \"Nautica\" in the event the Company abandons, sells or disposes its interest in the name.\nNOTE M - MULTIEMPLOYER PENSION PLAN\nThe Company contributed approximately $350,000 in 1995, $230,000 in 1994 and $172,000 in 1993 to a multiemployer pension and insurance plan for employees covered under a collective bargaining agreement. The plan is not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. The Multiemployer Pension Plan Amendments Act of 1980 (the \"Act\") significantly increased the pension responsibilities of participating employers. Under the provisions of the Act, if the plan terminates or the Company withdraws, the Company could be subject to a substantial \"withdrawal liability.\" As of February 28, 1995, the Company's share of unfunded vested benefits, if any, was not available from the plan's administrators.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE N - PROFIT-SHARING RETIREMENT AND SAVINGS PLAN\nThe Company has a contributory retirement savings plan (Section 401(k) of the Internal Revenue Code) for all full-time employees. Under the provisions of the plan, eligible employees are permitted to contribute up to 15% of their salary subject to specified limits. The plan provides for discretionary employer matching contributions not to exceed the lesser of 100% of the employee's contribution or 6% of the employee's compensation. The amount of Company contributions to the plan charged to expense during the years ended February 28, 1995, 1994 and 1993 were approximately $148,000, $109,000 and $64,000, respectively.\nNOTE O - STOCK OPTION PLAN AND OPTION AGREEMENT\nOn June 28, 1984, the Company adopted an Executive Incentive Stock Option Plan (the \"Plan\"). The Plan provides that the Board of Directors may grant options to officers and key employees of the Company and its subsidiaries to purchase up to 1,603,125 shares of the Company's common stock. The Plan expires in 2001, and options shall not be granted after that date. Under the Plan, each optionee must remain in the continuous employment of the Company for at least one year from the date of grant before he can exercise any part of the options. The exercise price covered by each option is 100% of the fair market value of the common stock at the time of granting the option. In the event, at the time the option is granted, the employee shall own (either in his own name or by attribution) shares constituting in excess of 10 percent of the outstanding shares of the Company, then the exercise price shall be 110% of the fair market value at the time of granting the option. The options are exercisable on a cumulative basis at the annual rate of 20% of the total number of shares covered by the option for a period not exceeding ten years.\nOn June 29, 1989, the Company adopted the Nautica Enterprises, Inc. 1989 Employee Incentive Stock Plan (the \"1989 Plan\"; the 1989 Plan and the Plan are referred to as the \"Plans\"). The 1989 Plan authorizes the Compensation Committee (consisting of at least two disinterested directors) to grant to eligible participants stock options, restricted stock and\/or stock bonus awards and expires in 1999. The 1989 Plan provides for the reservation and availability of 4,218,750 shares of common stock of the Company, subject to adjustment for future stock splits, stock dividends, reorganizations and similar events. The 1989 Plan's eligibility criteria encompass executives and other key employees of the Company and its subsidiaries.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE O (CONTINUED)\nNo accounting recognition is given to stock options issued under the Plans until they are exercised, at which time the proceeds are credited to the capital accounts.\nThe table below summarizes the activity in the Plans, as adjusted for the stock splits referred to in Note H:\nOn July 1, 1987, the Company entered into an Option Agreement (the \"Agreement\") with the president of Nautica. The Agreement granted the president the option to purchase up to an aggregate of 1,131,043 shares of the Company's common stock at a purchase price of $1.74 per share. The Agreement expires July 1, 1997; provided, however, in the event that the President of Nautica is employed by the Company on July 1, 1997, the options shall expire 60 days after the earlier of (i) July 1, 2007, or (ii) 10 months following the date that the President of Nautica ceases to be employed by the Company. Compensation expense (the difference between the quoted value of the common stock and the exercise price) under the Agreement is determined on the date the total options to be granted and the exercise price are known. The total compensation expense under the agreement aggregated approximately $1,500,000, of which approximately $67,000 has been recognized as compensation expense for the period ended February 28, 1993. The total compensation expense was amortized over the five-year term of the employment agreement of the president of Nautica.\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE O (CONTINUED)\nThe Company filed a Registration Statement which became effective on August 10, 1993 relating to the proposed sale by the president of Nautica of approximately 675,000 shares of the Company's common stock during the three-month period following the effective date of the Registration Statement. The shares registered are part of the 1,131,043 shares of restricted stock which the president of Nautica could acquire through the exercise of the stock options granted under the Agreement. During the year ended February 28, 1994, the president of Nautica exercised 790,062 options at an aggregate purchase price of $1,372,997. At February 28, 1995, 340,981 options exercisable at $1.74 per share remain outstanding.\nFor financial reporting purposes, the tax benefit resulting from compensation expense allowable for income tax purposes in excess of the expense recorded in the financial statements, amounting to $665,000 and $3,956,000 during the years ended February 28, 1995 and 1994, respectively, has been credited to additional paid-in capital.\nNOTE P - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nNautica Enterprises, Inc. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFebruary 28, 1995, 1994 and 1993\nNOTE P (CONTINUED)\nDuring the fourth quarter of the fiscal year ended February 28, 1995 and 1994, the Company recorded inventory-related adjustments which increased earnings before income taxes by approximately $1,700,000 and $1,300,000, respectively.\nNautica Enterprises, Inc. and Subsidiaries\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(a) Accounts written off as 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.\nNAUTICA ENTERPRISES, INC. (Registrant)\nBy: \/s\/ Harvey Sanders ------------------ Harvey Sanders Chairman (May 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 dates indicated.\nEXHIBIT INDEX -------------\nExhibit No. Description ------- -----------\n3(a) Registrant's By-Laws as currently in effect is incorporated by reference herein to the Registrant's Registration Statement on Form S-1 (Registration Number 33-21998).\n3(b) Registrant's Certificate of Incorporation is incorporated by reference herein to the Registrant's Registration Statement on Form S-3 (Registration Number 33-71926).\n10(iii)(a) Registrant's Executive Incentive Stock Option Plan is incorporated by reference herein from the Registrant's Registration Statements on Form S-8 (Registration Number 33-1488), as amended by the Company's Registration Statement on Form S-8 (Registration Number 33-45823).\n10(iii)(b) Registrant's 1989 Employee Incentive Stock Plan is incorporated by reference herein from the Registrant's Registration Statement on Form S-8 (Registration Number 33-36040).\n10(iii)(c) Registrant's 1994 Incentive Compensation Plan\n21 Subsidiaries of Registrant\n23.1 Consent of Independent Certified Public Accountants\n27 Financial Data Schedule","section_15":""}
{"filename":"820414_1995.txt","cik":"820414","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS - -----------------------\nCENTURY FINANCIAL CORPORATION (CORPORATION) IS A PENNSYLVANIA BUSINESS CORPORATION WHICH WAS ORGANIZED JULY 27, 1987, AT THE DIRECTION OF THE CENTURY NATIONAL BANK AND TRUST COMPANY (CENTURY) FOR THE PURPOSE OF ENGAGING IN THE BUSINESS OF A BANK HOLDING COMPANY AND OF OWNING ALL OF THE COMMON STOCK OF CENTURY. THE CORPORATION IS ENGAGED PRINCIPALLY IN COMMERCIAL BANKING ACTIVITIES THROUGH ITS BANKING SUBSIDIARY. CENTURY BECAME A WHOLLY-OWNED SUBSIDIARY OF THE CORPORATION ON JUNE 1, 1988. THE CORPORATION OWNS ALL OF THE ISSUED AND OUTSTANDING COMMON STOCK OF CENTURY. ON MARCH 1, 1989, CENTURY BECAME THE SOLE STOCKHOLDER OF THE INDEPENDENT BANKERS COMPUTER SERVICE, INC. (IBCS), A DATA PROCESSING CENTER. ON JUNE 1, 1989, THE CORPORATION ACQUIRED ALL OF THE STOCK OF IBCS FROM CENTURY AND WAS OPERATING THE CENTER AS A NON-BANK SUBSIDIARY. EFFECTIVE APRIL 1, 1995, INDEPENDENT BANKERS COMPUTER SERVICE, INCORPORATED WAS DISSOLVED AND ITS OPERATIONS INTEGRATED WITH CENTURY NATIONAL BANK AND TRUST COMPANY.\nGENERAL - -------\nCENTURY WAS FORMED IN 1973 AS A RESULT OF THE CONSOLIDATION OF THE UNION NATIONAL BANK OF NEW BRIGHTON, NEW BRIGHTON, PENNSYLVANIA, AND THE FREEDOM NATIONAL BANK, FREEDOM, PENNSYLVANIA. IN 1985, THE NATIONAL BANK OF BEAVER COUNTY, MONACA, PENNSYLVANIA, AND THE FIRST NATIONAL BANK OF MIDLAND, PENNSYLVANIA, WERE MERGED INTO CENTURY. EACH OF THESE BUSINESS COMBINATIONS WAS ACCOUNTED FOR AS A POOLING OF INTERESTS.\nCENTURY ENGAGES IN FULL SERVICE COMMERCIAL AND CONSUMER BANKING AND TRUST BUSINESS. CENTURY PROVIDES SERVICES TO ITS CUSTOMERS THROUGH ITS NETWORK OF TWELVE FULL SERVICE OFFICES WHICH INCLUDES DRIVE-IN FACILITIES. CENTURY'S SERVICES INCLUDE ACCEPTING TIME, DEMAND AND SAVINGS DEPOSITS INCLUDING NOW ACCOUNTS, REGULAR SAVINGS ACCOUNTS, MONEY MARKET ACCOUNTS, INVESTMENT CERTIFICATES, FIXED RATE CERTIFICATES OF DEPOSIT, AND CLUB ACCOUNTS. ITS SERVICES ALSO INCLUDE COMMERCIAL TRANSACTIONS EITHER DIRECTLY OR THROUGH REGIONAL INDUSTRIAL DEVELOPMENT CORPORATIONS, MAKING CONSTRUCTION AND MORTGAGE LOANS, AND THE RENTING OF SAFE DEPOSIT FACILITIES. ADDITIONAL SERVICES INCLUDE MAKING RESIDENTIAL MORTGAGE LOANS, REVOLVING CREDIT LOANS WITH\nITEM 1. DESCRIPTION OF BUSINESS (CONTINUED) - -----------------------\nOVERDRAFT CHECKING PROTECTION, SMALL BUSINESS LOANS, ETC. CENTURY'S BUSINESS LOANS INCLUDE SEASONAL CREDIT COLLATERAL LOANS, AND TERM LOANS. DURING THE FIVE YEAR PERIOD BEGINNING IN 1991 AND ENDING IN 1995, THE CORPORATION'S COMBINED TOTAL ASSETS HAVE GROWN FROM APPROXIMATELY $279 MILLION IN 1991 TO APPROXIMATELY $377 MILLION IN 1995. NET INCOME FOR EACH OF THE YEARS IN THIS PERIOD HAS INCREASED.\nPROPERTIES - ----------\nTHE CORPORATION'S EXECUTIVE OFFICES ARE LOCATED AT ONE CENTURY PLACE, ROCHESTER, PENNSYLVANIA, IN A BUILDING OWNED BY CENTURY AND WHICH ALSO CONTAINS CENTURY'S MAIN OFFICE. IN ADDITION, CENTURY OWNS NINE OTHER PROPERTIES LOCATED AT 2552 DARLINGTON ROAD, BEAVER FALLS, PENNSYLVANIA; FREEDOM AND HAINES SCHOOL ROAD, MARS, PENNSYLVANIA; THIRD AVENUE, FREEDOM, PENNSYLVANIA; SEVENTH STREET AND MIDLAND AVENUE, MIDLAND, PENNSYLVANIA; 1001 PENNSYLVANIA AVENUE, MONACA, PENNSYLVANIA; THIRD AVENUE, NEW BRIGHTON, PENNSYLVANIA; 800 BRODHEAD ROAD, ALIQUIPPA, PENNSYLVANIA; 700 MERCHANT STREET, AMBRIDGE, PENNSYLVANIA AND 716 FOURTEENTH STREET, BEAVER FALLS, PENNSYLVANIA. CENTURY LEASES THREE ADDITIONAL PROPERTIES LOCATED AT 613 BEAVER VALLEY MALL, MONACA, PENNSYLVANIA; NORTHERN LIGHTS SHOPPERS CITY, BADEN, PENNSYLVANIA AND THIRD AVENUE AND BUFFALO STREET, BEAVER, PENNSYLVANIA.\nALL FACILITIES AND EQUIPMENT ARE PERIODICALLY APPRAISED FOR INSURANCE PURPOSES AND ARE ADEQUATELY INSURED.\nSUPERVISION AND REGULATION - --------------------------\nTHE CORPORATION IS SUBJECT TO REGULATION UNDER THE BANK HOLDING COMPANY ACT OF 1956, AS AMENDED (THE \"ACT\"), AND THE SECURITIES AND EXCHANGE COMMISSION.\nCENTURY IS SUBJECT TO REGULATION AND PERIODIC EXAMINATION BY THE OFFICE OF THE COMPTROLLER OF THE CURRENCY. IT IS ALSO SUBJECT TO THE RULES AND REGULATIONS OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM AND THE FEDERAL DEPOSIT INSURANCE CORPORATION.\nTHE FINANCIAL INSTITUTIONS REFORM, RECOVERY, AND ENFORCEMENT ACT OF 1989 (\"FIRREA\") WAS ENACTED ON AUGUST 9, 1989.\nITEM 1. DESCRIPTION OF BUSINESS (CONTINUED) - -----------------------\nFIRREA HAS SIGNIFICANTLY AFFECTED THE FINANCIAL INDUSTRY IN SEVERAL WAYS, INCLUDING HIGHER DEPOSIT INSURANCE PREMIUMS, MORE STRINGENT CAPITAL REQUIREMENTS AND NEW INVESTMENT LIMITATIONS AND RESTRICTIONS. THE FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 (\"THE FDIC IMPROVEMENT ACT\") COVERS A WIDE EXPANSE OF BANKING REGULATORY ISSUES. THE FDIC IMPROVEMENT ACT DEALS WITH THE RECAPITALIZATION OF THE BANK INSURANCE FUND, WITH DEPOSIT INSURANCE REFORM, INCLUDING REQUIRING THE FDIC TO ESTABLISH A RISK-BASED PREMIUM ASSESSMENT SYSTEM, AND WITH A NUMBER OF OTHER REGULATORY AND SUPERVISORY MATTERS. THE FDIC REFUNDED $193,000 TO THE CORPORATION IN SEPTEMBER, 1995 AS A RESULT OF THE FDIC LOWERING THE INSURANCE PREMIUM FOR BANK INSTITUTIONS MEETING CERTAIN CAPITAL REQUIREMENTS. IN ADDITION, THE CORPORATION EXPECTS SUBSTANTIALLY LOWER FDIC EXPENSE IN 1996.\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 CANNOT BE PREDICTED.\nMANAGEMENT IS NOT AWARE OF ANY CURRENT RECOMMENDATIONS BY REGULATORY AUTHORITIES WHICH, IF THEY WERE TO BE IMPLEMENTED, WOULD HAVE A MATERIAL EFFECT ON THE LIQUIDITY, CAPITAL RESOURCES, OR OPERATIONS OF THE CORPORATION.\nCOMPETITION - ----------------\nALL PHASES OF CENTURY'S BUSINESS ARE HIGHLY COMPETITIVE. CENTURY'S MARKET AREA INCLUDES ALL OF BEAVER COUNTY IN ADDITION TO SELECTED COMMUNITIES IN NEIGHBORING BUTLER (CRANBERRY TOWNSHIP AREA) COUNTY. CENTURY COMPETES WITH LOCAL COMMERCIAL BANKS AND THRIFT INSTITUTIONS WITH BRANCHES IN CENTURY'S MARKET AREA. CENTURY CONSIDERS ITS MAJOR COMPETITION TO BE MELLON BANK, N.A. AND INTEGRA\/PITTSBURGH, BOTH HEADQUARTERED IN PITTSBURGH, PENNSYLVANIA ALONG WITH FIRST WESTERN BANK, N.A, HEADQUARTERED IN NEW CASTLE, PENNSYLVANIA.\nCENTURY COMPETES WITH COMMERCIAL BANKS, SAVINGS BANKS, SAVINGS AND LOAN ASSOCIATIONS, INSURANCE COMPANIES, REGULATED SMALL LOAN COMPANIES AND CREDIT UNIONS WITH RESPECT TO ATTRACTING LOAN ACTIVITY AND DEMAND DEPOSITS.\nITEM 1. DESCRIPTION OF BUSINESS (CONTINUED) - -----------------------\nCOMPETITION (CONTINUED) - ----------------------- CENTURY IS GENERALLY COMPETITIVE WITH ALL FINANCIAL INSTITUTIONS IN ITS SERVICE AREAS WITH RESPECT TO INTEREST RATES PAID ON TIME AND SAVINGS DEPOSITS, SERVICE CHARGES ON DEPOSIT ACCOUNTS, AND INTEREST RATES AND FEES CHARGED ON LOANS.\nLOAN COMMITMENTS AS OF DECEMBER 31, 1995 AND 1994, WERE APPROXIMATELY $29,307,000 AND $27,783,000, RESPECTIVELY.\nCENTURY 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). CENTURY HAS NOT EXPERIENCED ANY SIGNIFICANT SEASONAL FLUCTUATIONS IN THE AMOUNT OF ITS DEPOSITS. NONE OF THE BANK'S DEPOSITS ARE FROM OUTSIDE OF THE UNITED STATES.\nMARKET AREA - -----------\nCENTURY HAS TWELVE OFFICES IN BEAVER COUNTY AND ONE OFFICE IN BUTLER COUNTY, BORDERING BEAVER COUNTY. THE BANK IS HEADQUARTERED IN ROCHESTER, PENNSYLVANIA. BEAVER COUNTY IS APPROXIMATELY 20 MILES NORTHWEST OF PITTSBURGH.\nTHE BEAVER COUNTY AREA WAS ONCE LARGELY DEPENDENT ON HEAVY INDUSTRY MANUFACTURING, PRIMARILY STEEL. DUE TO THE NATIONWIDE RECESSION IN THE EARLY 1980s AND COMPETITION FROM IMPORTED STEEL, THE COUNTY EXPERIENCED REDUCED EMPLOYMENT WHICH CAUSED A SEVERE RECESSION. BEAVER COUNTY HAS NOW MOVED TO A MORE DIVERSIFIED ECONOMIC BASE CONSISTING OF LIGHT INDUSTRIAL, HIGH TECHNOLOGY, EDUCATIONAL AND HEALTH RELATED INDUSTRIES.\nBEAVER COUNTY'S LARGEST EMPLOYER IS USAIR WHICH OPERATES ITS HUB FROM THE PITTSBURGH AIRPORT. OTHER MAJOR EMPLOYERS INCLUDE THE MEDICAL CENTER, BEAVER COUNTY GOVERNMENT, STATE GOVERNMENT AND DUQUESNE LIGHT CORPORATION.\nSTATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES INFORMATION REGARDING STATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES REQUIRED BY GUIDE 3, IS SET FORTH AS FOLLOWS:\n(1) FOR THE PURPOSE OF THESE COMPUTATIONS, NONACCRUING LOANS ARE INCLUDED IN THE DAILY AVERAGE LOAN AMOUNTS OUTSTANDING. (2) INTEREST ON LOANS INCLUDES FEE INCOME. (3) YIELDS WERE COMPUTED ON A TAX EQUIVALENT BASIS USING A 34% FEDERAL INCOME TAX RATE AND WERE DETERMINED ON THE BASIS OF COST, ADJUSTED FOR AMORTIZATION OF PREMIUM OR ACCRETION OF DISCOUNT.\nSTATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES INFORMATION REGARDING STATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES REQUIRED BY GUIDE 3, IS SET FORTH AS FOLLOWS:\n(1) FOR THE PURPOSE OF THESE COMPUTATIONS, NONACCRUING LOANS ARE INCLUDED IN THE DAILY AVERAGE LOAN AMOUNTS OUTSTANDING. (2) INTEREST ON LOANS INCLUDES FEE INCOME. (3) YIELDS WERE COMPUTED ON A TAX EQUIVALENT BASIS USING A 34% FEDERAL INCOME TAX RATE AND WERE DETERMINED ON THE BASIS OF COST, ADJUSTED FOR AMORTIZATION OF PREMIUM OR ACCRETION OF DISCOUNT.\nSTATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES INFORMATION REGARDING STATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES REQUIRED BY GUIDE 3, IS SET FORTH AS FOLLOWS:\n(1) FOR THE PURPOSE OF THESE COMPUTATIONS, NONACCRUING LOANS ARE INCLUDED IN THE DAILY AVERAGE LOAN AMOUNTS OUTSTANDING. (2) INTEREST ON LOANS INCLUDES FEE INCOME. (3) YIELDS WERE COMPUTED ON A TAX EQUIVALENT BASIS USING A 34% FEDERAL INCOME TAX RATE AND WERE DETERMINED ON THE BASIS OF COST, ADJUSTED FOR AMORTIZATION OF PREMIUM OR ACCRETION OF DISCOUNT.\nCENTURY FINANCIAL CORPORATION ANALYSIS OF CHANGES IN NET INTEREST INCOME\n(1) CHANGES IN INTEREST INCOME\/EXPENSE NOT ARISING SOLELY AS A RESULT OF VOLUME OR RATE VARIANCES ARE ALLOCATED PROPORTIONATELY TO RATE AND VOLUME.\n(2) ADJUSTED TO TAXABLE EQUIVALENT BASIS OF 34% TAX RATE.\nCENTURY FINANCIAL CORPORATION ANALYSIS OF CHANGES IN NET INTEREST INCOME\n(1) CHANGES IN INTEREST INCOME\/EXPENSE NOT ARISING SOLELY AS A RESULT OF VOLUME OR RATE VARIANCES ARE ALLOCATED PROPORTIONATELY TO RATE AND VOLUME.\n(2) ADJUSTED TO TAXABLE EQUIVALENT BASIS OF 34% TAX RATE.\nCENTURY FINANCIAL CORPORATION AVAILABLE FOR SALE INVESTMENT SECURITIES AS OF DECEMBER 31, 1995 (IN THOUSANDS)\nWEIGHTED AVERAGE YIELDS WERE COMPUTED ON A TAX EQUIVALENT BASIS USING A 34% FEDERAL INCOME TAX STATUTORY RATE AND WERE DETERMINED ON THE BASIS OF COST, ADJUSTED FOR AMORTIZATION OF PREMIUM OR ACCRETION DISCOUNTED.\nCENTURY FINANCIAL CORPORATION INVESTMENT SECURITIES\nAS OF DECEMBER 31,\nEXCLUDING 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 CORPORATION'S SHAREHOLDERS EQUITY AT DECEMBER 31, 1995.\nLOAN MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF COMMERCIAL AND REAL ESTATE-CONSTRUCTION LOANS:\nTHERE ARE NO LOAN CONCENTRATIONS EXCEEDING 10% OF TOTAL LOANS AS OF DECEMBER 31, 1995.\nCENTURY MAINTAINS A WRITTEN LENDING POLICY REQUIRING CERTAIN UNDERWRITING STANDARDS BE MET PRIOR TO FUNDING ANY LOAN, INCLUDING REQUIREMENTS FOR CREDIT ANALYSIS, COLLATERAL VALUE COVERAGE, DOCUMENTATION AND TERMS. THE PRINCIPAL FACTOR USED TO DETERMINE POTENTIAL BORROWERS' CREDITWORTHINESS IS BUSINESS CASH FLOWS OR CONSUMER INCOME AVAILABLE TO SERVICE DEBT PAYMENTS. SECONDARY SOURCES OF REPAYMENT, INCLUDING COLLATERAL OR GUARANTEES, ARE FREQUENTLY OBTAINED. THE BANK GENERALLY LENDS WITHIN THE MARKET AREAS SERVED BY THE BANK'S BRANCHES.\nCOMMERCIAL LOANS ARE GRANTED GENERALLY TO SMALL AND MIDDLE MARKET CUSTOMERS FOR OPERATING, EXPANSION OR ASSET ACQUISITION PURPOSES. OPERATING CASH FLOWS OF THE BUSINESS ENTERPRISE ARE IDENTIFIED AS THE PRINCIPAL SOURCE OF REPAYMENT, WITH BUSINESS ASSETS HELD AS COLLATERAL. COLLATERAL MARGINS AND LOAN TERMS ARE BASED UPON THE PURPOSE AND STRUCTURE OF THE TRANSACTION AS SET FORTH IN LOAN POLICY.\nCOMMERCIAL REAL ESTATE LOANS ARE GRANTED FOR THE ACQUISITION OR IMPROVEMENT OF REAL PROPERTY. GENERALLY, COMMERCIAL REAL ESTATE LOANS DO NOT EXCEED 80% OF THE APPRAISED VALUE OF PROPERTY PLEDGED TO SECURE THE TRANSACTION. REPAYMENT OF SUCH LOANS ARE EXPECTED FROM THE OPERATIONS OF THE SUBJECT REAL ESTATE AND ARE CAREFULLY ANALYZED PRIOR TO APPROVAL.\nREAL ESTATE CONSTRUCTION LOANS ARE GRANTED FOR THE PURPOSES OF CONSTRUCTING IMPROVEMENTS TO REAL PROPERTY, BOTH COMMERCIAL AND RESIDENTIAL. REAL ESTATE LOANS SECURED BY 1-4 FAMILY RESIDENTIAL HOUSING PROPERTIES ARE GRANTED SUBJECT TO STATUTORY LIMITS REGARDING THE MAXIMUM PERCENTAGE OF APPRAISED VALUE OF THE MORTGAGED PROPERTY. RESIDENTIAL LOAN TERMS ARE NORMALLY ESTABLISHED IN COMPLIANCE WITH REGULATORY REQUIREMENTS. RESIDENTIAL MORTGAGE PORTFOLIO INTEREST RATES ARE ESTABLISHED BASED UPON FACTORS SUCH AS INTEREST RATES IN GENERAL, THE SUPPLY OF MONEY AVAILABLE TO THE BANK AND THE DEMAND FOR SUCH LOANS.\nLOANS TO INDIVIDUALS REPRESENT FINANCING EXTENDED TO CONSUMERS FOR PERSONAL OR HOUSEHOLD PURPOSES, INCLUDING AUTOMOBILE FINANCING, EDUCATION, HOME IMPROVEMENT AND PERSONAL EXPENDITURES. THESE LOANS ARE GRANTED IN THE FORM OF INSTALLMENT, INDIRECT AUTOMOBILE LOANS, CREDIT CARD OR REVOLVING CREDIT TRANSACTIONS. CONSUMER CREDITWORTHINESS IS EVALUATED ON THE BASIS OF ABILITY TO REPAY, STABILITY OF INCOME SOURCES AND PAST CREDIT HISTORY.\nSUMMARY OF LOAN LOSS EXPERIENCE\nINCLUDED IN NON-ACCRUAL LOANS AT DECEMBER 31, 1994 ARE THREE COMMERCIAL LOANS. TWO OF THE THREE LOANS WERE SUBSEQUENTLY BROUGHT CURRENT IN 1995, RESULTING IN A REDUCTION IN THE NON-ACCRUAL BALANCE AT DECEMBER 31, 1995.\nIN ESTABLISHING A CHARGE TO THE PROVISION FOR LOAN LOSSES, AND THE RELATED BALANCE IN THE ALLOWANCE FOR LOAN LOSSES, MANAGEMENT CONSIDERS A VARIETY OF FACTORS, INCLUDING ACTUAL LOSSES INCURRED, THE LEVEL OF THE ALLOWANCE FOR LOAN LOSSES, LOAN GROWTH, DELINQUENCY TRENDS AND RATIOS, THE EXISTING ECONOMIC CLIMATE, AND MANAGEMENT'S ASSESSMENT OF POTENTIAL FUTURE LOSSES ON OUTSTANDING LOANS.\nCENTURY MONITORS ITS LOAN PORTFOLIO AND ON A MONTHLY BASIS PROVIDES DETAILED ANALYSIS OF DELINQUENCIES, NON-PERFORMING ASSETS, AND POTENTIAL PROBLEM LOANS TO THE PROBLEM LOAN COMMITTEE OF THE BOARD. MANAGEMENT CONDUCTS A FORMAL, QUALITATIVE ANALYSIS OF THE ADEQUACY OF CENTURY'S ALLOWANCE FOR LOAN LOSSES. ALL LOAN RELATIONSHIPS IN EXCESS OF $250,000 ARE REVIEWED ANNUALLY BY THE EXECUTIVE COMMITTEE OF CENTURY'S BOARD OF DIRECTORS. ON A QUARTERLY BASIS, ALL LOAN RELATIONSHIPS IN EXCESS OF $250,000 RATED SUBSTANDARD OR LOWER ARE REVIEWED BY CENTURY'S LOAN REVIEW OFFICER AND THE PROBLEM LOAN COMMITTEE. THESE LOANS ARE REVIEWED FOR PAYMENT HISTORY, ANY CHANGES IN COLLATERAL AND ANY EXPOSURE IS SPECIFICALLY RESERVED FOR. ALL SPECIAL MENTION LOANS ARE POOLED AND A RESERVE IS DETERMINED FROM BOTH CENTURY'S HISTORICAL EXPERIENCE AND HISTORICAL LOSS PERCENTAGES FROM ROBERT MORRIS ASSOCIATES.\nALL OTHER HOMOGENEOUS LOAN POOLS SUCH AS CONSUMER INSTALLMENT LOANS, CASH RESERVE AND 1-4 FAMILY MORTGAGE LOANS ARE POOLED AND THE ADEQUACY OF THE RESERVE IS DETERMINED BASED ON SUCH FACTORS AS GENERAL ECONOMIC CONDITIONS, HISTORICAL CHARGE-OFF EXPERIENCE AND DELINQUENCY TRENDS. ADDITIONALLY, CONSIDERATION IS GIVEN TO COMMITMENTS TO EXTEND CREDIT BASED ON THE CHARACTERISTICS OF THE RISKS ASSOCIATED WITH THESE SPECIFIC COMMITMENTS. MANAGEMENT CONSIDERS THE LEVEL OF ITS ALLOWANCE TO BE ADEQUATE. NON-PERFORMING LOANS AT DECEMBER 31, 1995, WERE 0.45% OF OUTSTANDING LOANS NET OF UNEARNED INCOME VERSUS 0.79% AT DECEMBER 31, 1994.\nWHILE IT IS IMPOSSIBLE TO PREDICT WHAT 1996 LOAN LOSSES WILL BE, MANAGEMENT ESTIMATES THAT GROSS LOSSES SHOULD NOT EXCEED APPROXIMATELY 0.25% OF LOANS OUTSTANDING AT DECEMBER 31, 1995.\nINFORMATION WITH RESPECT TO NONACCRUAL LOANS AT DECEMBER 31, 1995 THRU 1991 IS AS FOLLOWS:\nTHE GROSS AMOUNT OF INTEREST WHICH WOULD HAVE BEEN RECORDED IF ALL NONACCRUAL LOANS HAD BEEN ACCRUING INTEREST AT THEIR ORIGINAL TERMS IS:\nLOANS CLASSIFIED FOR REGULATORY PURPOSES AS LOSS, DOUBTFUL, SUBSTANDARD, OR SPECIAL MENTION DO NOT REPRESENT OR RESULT FROM TRENDS OR UNCERTAINTIES WHICH WILL MATERIALLY IMPACT FUTURE OPERATING RESULTS, LIQUIDITY OR CAPITAL RESOURCES; NOR DOES MANAGEMENT HAVE ANY INFORMATION WHICH WOULD CAUSE IT TO HAVE SERIOUS DOUBTS AS TO THE ABILITY OF SUCH BORROWERS TO COMPLY WITH LOAN REPAYMENT TERMS.\nSUMMARY OF DEPOSITS\nTHE AVERAGE DAILY AMOUNT OF DEPOSITS AND RATES PAID ON SUCH DEPOSITS IS SUMMARIZED FOR THE PERIODS INDICATED IN THE FOLLOWING TABLE:\nTHE FOLLOWING TABLE SETS FORTH, BY TIME REMAINING TO MATURITY, TIME CERTIFICATES OF DEPOSIT OF $100,000 OR MORE.\nCENTURY FINANCIAL CORPORATION\nTHE FOLLOWING TABLE SHOWS CONSOLIDATED CAPITAL RATIOS FOR THE CORPORATION FOR EACH OF THE LAST THREE YEARS:\nMANAGEMENT IS NOT AWARE OF ANY KNOWN TRENDS, EVENTS, OR UNCERTAINTIES THAT WILL HAVE OR ARE LIKELY TO HAVE A MATERIAL EFFECT ON THE LIQUIDITY, CAPITAL RESOURCES OR OPERATIONS OF THE CORPORATION.\nITEM 1. DESCRIPTION OF BUSINESS (CONTINUED) - -----------------------\nAS OF DECEMBER 31, 1995, CENTURY HAD A TOTAL OF 158 FULL-TIME EMPLOYEES AND 44 WHO WERE PART-TIME.\nTRUST SERVICES PROVIDED BY CENTURY INCLUDE SERVICES AS EXECUTOR AND TRUSTEE UNDER WILL AND DEEDS, AS GUARDIAN AND CUSTODIAN AND AS TRUSTEE AND AGENT FOR PENSION, PROFIT SHARING AND OTHER EMPLOYEE BENEFIT TRUSTS AS WELL AS VARIOUS INVESTMENT, PENSION AND ESTATE PLANNING SERVICES. TRUST SERVICES ALSO INCLUDE SERVICE AS TRANSFER AGENT AND REGISTRAR OF STOCK AND BOND ISSUES AND AS ESCROW AGENT. ON JANUARY 1, 1996, THE CORPORATION APPOINTED CHEMICAL MELLON SHAREHOLDER SERVICES AS OUR TRANSFER AGENT AND REGISTRAR OF STOCK.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ----------\nTHIS INFORMATION IS INCLUDED IN ITEM 1 DESCRIPTION OF BUSINESS.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -----------------\nON JANUARY 2, 1996, A FORMER EMPLOYEE OF THE BANK FILED A CIVIL ACTION IN U.S. DISTRICT COURT IN PITTSBURGH AGAINST THE BANK. THE LAWSUIT ALLEGES WRONGFUL DISCHARGE AND THAT THE BANK VIOLATED THE AGE DISCRIMINATION IN EMPLOYMENT ACT (ADEA) AND PENNSYLVANIA PUBLIC POLICY. MANAGEMENT BELIEVES THAT THE LIABILITY, IF ANY, ARISING FROM SUCH ACTIONS WILL NOT HAVE A MATERIAL EFFECT ON THE CORPORATION'S FINANCIAL POSITION.\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED MATTERS - ------------------------------------------------------------\nTHE INFORMATION REQUIRED BY THIS ITEM IS INCORPORATED BY REFERENCE TO THE INFORMATION APPEARING UNDER THE CAPTION \"MARKET AND DIVIDEND INFORMATION\" ON PAGE XXIV IN THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -----------------------\nTHE INFORMATION REQUIRED BY THIS ITEM IS INCORPORATED BY REFERENCE TO THE INFORMATION APPEARING UNDER THE CAPTION \"SELECTED FINANCIAL DATA\" ON PAGE XVII IN THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ----------------------------------------------------------- AND OPERATING RESULTS - ---------------------\nTHE INFORMATION REQUIRED BY THIS ITEM IS INCORPORATED BY REFERENCE TO THE INFORMATION APPEARING UNDER THE CAPTION \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS\" ON PAGES XVIII THROUGH XXIII IN THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - -------------------------------------------\nTHE INFORMATION REQUIRED BY THIS ITEM AND THE INDEPENDENT ACCOUNTANT'S REPORT THEREON ARE INCORPORATED BY REFERENCE ON PAGES I THROUGH XVII TO THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ----------------------------------------------------\nNO REPORTS ON FORM 8-K REPORTING A CHANGE OF ACCOUNTANTS HAVE BEEN FILED SINCE THE INCEPTION OF CFC (JUNE 1, 1988) AND NEITHER A CHANGE IN ACCOUNTANTS NOR ANY DISAGREEMENTS WITH ACCOUNTANTS HAS OCCURRED FOR THE SUBSIDIARY - CENTURY NATIONAL BANK AND TRUST COMPANY.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nTHE INFORMATION REQUIRED BY THIS ITEM REGARDING DIRECTORS IS INCORPORATED BY REFERENCE FROM THE DEFINITIVE PROXY STATEMENT OF THE REGISTRANT WHICH WAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 1996.\nTHE INFORMATION REQUIRED BY THIS ITEM REGARDING EXECUTIVE OFFICERS OF THE CORPORATION IS AS FOLLOWS:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nTHE INFORMATION REQUIRED BY THIS ITEM IS INCORPORATED BY REFERENCE FROM THE DEFINITIVE PROXY STATEMENT OF THE REGISTRANT WHICH WAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 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 DEFINITIVE PROXY STATEMENT OF THE REGISTRANT WHICH WAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nTHE INFORMATION REQUIRED BY THIS ITEM IS INCORPORATED BY REFERENCE FROM THE DEFINITIVE PROXY STATEMENT OF THE REGISTRANT WHICH WAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 1996.\nITEM 14.","section_14":"ITEM 14. EXHIBITS - FINANCIAL STATEMENT SCHEDULES AND REPORTS ON -------- -------------------------------------------- FORM 8-K -------- (A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT, EXCEPT AS INDICATED:\n(1) (2) THE FINANCIAL STATEMENTS FILED HEREWITH OR INCORPORATED BY REFERENCE ARE LISTED IN THE ACCOMPANYING INDEX TO FINANCIAL STATEMENTS.\n(3) EXHIBITS FILED HEREWITH OR INCORPORATED BY REFERENCE HEREIN ARE SET FORTH IN THE FOLLOWING TABLE PREPARED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K. NO REPORTS ON FORM 8-K WERE REQUIRED TO BE FILED DURING THE LAST QUARTER OF THE PERIOD COVERED BY THIS REPORT. EXHIBIT TABLE -------------\n(3) ARTICLES OF INCORPORATION AND BY-LAWS A. ARTICLES OF INCORPORATION OF THE REGISTRANT ARE INCORPORATED BY REFERENCE TO FORM S-4 OF THE REGISTRANT, NO. 0-17413.\nB. BY-LAWS OF THE REGISTRANT ARE INCORPORATED BY REFERENCE TO FORM S-4 OF THE REGISTRANT, 0-17413.\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES.\nARTICLES OF INCORPORATION AND BY-LAWS: SEE ITEM 14 (A) (3) ABOVE.\n(13) ANNUAL REPORT TO SECURITY HOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995 (FILED HEREWITH AS EXHIBIT 13).\n(21) SUBSIDIARY OF THE REGISTRANT.\n(27) FINANCIAL DATA SCHEDULE FOR THE YEAR ENDED DECEMBER 31, 1995 (FILED HEREWITH AS EXHIBIT 27).\nNAME STATE OF INCORPORATION ---- ---------------------- CENTURY NATIONAL BANK & TRUST COMPANY PENNSYLVANIA\n3. EXHIBITS -------- THE EXHIBITS LISTED ON THE EXHIBIT INDEX ON PAGE 26 ARE FILED HEREWITH IN RESPONSE TO THIS ITEM.\n(B) REPORTS ON FORM 8-K THE REGISTRANT FILED NO FORM 8-K CURRENT REPORT DURING THE FOURTH QUARTER OF THE YEAR ENDED DECEMBER 31, 1995.\nINDEX TO FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS - -----------------------------------------------------\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTHE REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS AS PERTAINING TO THE CONSOLIDATED FINANCIAL STATEMENTS OF CENTURY FINANCIAL CORPORATION AND RELATED NOTES IS INCORPORATED BY REFERENCE TO THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nCONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES ARE INCORPORATED BY REFERENCE TO THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1995.\nBALANCE SHEETS, DECEMBER 31, 1995 AND 1994.\nSTATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993.\nSTATEMENTS OF CHANGES IN 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.\nTHE CORPORATION DOES NOT MEET BOTH OF THE TESTS REQUIRED UNDER ITEM 302(a)(5) OF REGULATION S-K AND THEREFORE IS NOT REQUIRED TO PROVIDE SUPPLEMENTARY FINANCIAL DATA.\nEXHIBITS - --------\nFOR INFORMATION REGARDING EXHIBITS, INCLUDING THOSE INCORPORATED BY REFERENCE, SEE PAGE 25 OF THIS REPORT.\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.\n(REGISTRANT) CENTURY FINANCIAL CORPORATION\nBY \/s\/ Joseph N. Tosh, II ----------------------------------------------------------- JOSEPH N. TOSH, II - PRESIDENT AND CHIEF EXECUTIVE OFFICER\nDATE: March 21, 1996 --------------------------------------------------------\nBY \/s\/ Donald A. Benziger ----------------------------------------------------------- DONALD A. BENZIGER - SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nDATE: March 21, 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.\nSIGNATURES\n(CONTINUED)","section_15":""}
{"filename":"34046_1995.txt","cik":"34046","year":"1995","section_1":"Item 1. Business\nEXOLON-ESK COMPANY\n(a) General Development of the Business\nThe Exolon Company was founded in 1914 as a Massachusetts corporation and reincorporated as a Delaware corporation in 1976. On April 27, 1984, ESK Corporation merged into the Exolon Company and the resulting company was renamed Exolon-ESK Company. (As used herein, the Company refers to Exolon-ESK Company and its wholly owned Canadian Subsidiary.) The Company issued 499,219 shares of its Class A Common Stock and 31,523 shares of its Series B Convertible Preferred Stock to Wacker Chemical Corporation as a result of the merger. In December of 1995, Wacker Chemical Corporation transferred all of its Company stock to Wacker Chemicals (USA), Inc. ( Wacker USA ).\nThe Company is engaged in the business of manufacturing and selling products which are used principally for abrasive, refractory and metallurgical applications. The primary products of the Company are fused aluminum oxide and silicon carbide. Other product lines include fused specialty products sold to the refractory industry.\nEffective at the time of the merger, the Company entered into a Restated Patent License Agreement with Elektroschmelzwerk Kempten GmbH (\"Kempten\"). Both Kempten and Wacker USA are wholly owned subsidiaries of Wacker Chemie GmbH. At the time of the merger, the Company also entered into an exclusive distributorship and sales representation agreement with Kempten for the United States and Canada relating to silicon carbide products. The Company makes sales as a distributor and as a sales representative under this agreement. The Company is currently in discussions with Kempten with regard to amendments of this agreement. Should the agreement be terminated, the Company believes that purchases of the products now covered by the agreement can be made in sufficient quantities and at prevailing market prices from alternative suppliers, including from its Norwegian joint venture. In addition, the Company represents Kempten as a distributor of boron carbide grains to selected markets.\n(b) Financial Information about Industry Segments\nThe Company has only one business segment, the manufacture of abrasive materials and products for abrasive, metallurgical and refractory uses. The Company regards its principal business as being in a single industry segment.\n(c) Narrative Description of Business\nThe Company's crude silicon carbide is produced at the Company's plant in Hennepin, Illinois. The Company produces crude aluminum oxide and certain other products at its plant in Thorold, Canada owned by Exolon-ESK Company of Canada, Ltd. (\"Exolon Ltd.\"), its wholly owned subsidiary. Some of the crude products are sold directly to customers, but most of the crude products are shipped to the Company's plant in Tonawanda, New York, where the Company crushes, grades and formulates the crude products into granular products for sale to customers.\nMethods of distribution. While most of the Company's products are sold directly to its customers by sales representatives employed by the Company, a portion of the sales are made through industrial distributors located throughout the United States and Canada. Export sales are made on a direct basis and through agents.\nRaw materials. The principal raw materials used by the Company are abrasive grade bauxite, petroleum coke, silica sand and cast iron borings.\nThe Company purchases many other products such as fiber drums, wood pallets, bags, oil, natural gas, chemicals, electrodes and carbon products.\nThe abrasive grade bauxite used by the Company presently comes from the Republic of Guinea in West Africa, Australia and The People's Republic of China. Petroleum coke and silica sand originate from United States sources.\nLarge quantities of electric power are purchased from Ontario Hydro for use by the Company's Canadian furnace plant and from the Illinois Power Company for use in its Hennepin plant. The Company believes that adequate supplies of power will continue to be available. Adequate supplies of raw materials have in general been available to the Company at competitive prices.\nEmployees. As of December 31, 1995, the Company had 267 employees. A new collective bargaining agreement was negotiated at the Tonawanda, New York plant in the third quarter of 1995. In 1993 and 1994, the Company negotiated new three year agreements with its Hennepin, Illinois and Thorold, Ontario manufacturing employees, respectively. In 1993, 1994 and 1995, agreement was reached on methods to further reduce employment levels, consolidate jobs and improve operational efficiencies.\nMajor Customers. Sales to one customer accounted for 8% and 12% of consolidated net sales of the Company for the years ended December 31, 1995 and 1994. As of December 31, 1995 this customer's accounts receivable balance accounted for approximately 8% of the Company's total trade receivables. In management's opinion, the loss of this customer would not have a material adverse effect on the Company.\nCompetition. The industry in which the Company is engaged is highly competitive. Principal North American competition is from three well established North American companies. In addition, substantial quantities of grain are imported and sold in North America by foreign based producers of abrasive grain. Each of the North American competitors, in addition to the Company, have silicon carbide grain processing facilities. Two of the three also have aluminum oxide crude and grain production operations, and all but one have silicon carbide crude production facilities.\nCompetition in the industry is based upon pricing, service, and product performance. The Company's products are sold to other manufacturers and, as a result, the distribution to the industry markets is highly competitive. Major customers are continually striving to remain competitive by controlling the costs for raw materials purchased from the Company. In order to meet customer demand and for competitive purposes, the Company maintains substantial inventories. In addition, it has been Company policy to confine its primary operations to the electric furnace production and processing of grain products.\nBacklog. As of December 31, 1995, the Company had a consolidated backlog of $5,235,000 as compared to $2,873,000 a year earlier. The increase in backlog principally results from increased 1995 sales recorded and reduced shipment levels in December 1995 resulting from the Company s holiday shut down between Christmas and New Years Day. All of this backlog is expected to be shipped in 1996.\nSeasonal Effect. The Company's business is generally not seasonal. However, vacation shutdowns by a number of its customers can influence third quarter sales.\nPollution Control. The Company is involved in operations in which there is a continued risk that the environment could be adversely affected. The Company is in frequent contact with the various environmental agencies in the jurisdictions in which it operates in an attempt to maintain environmental compliance. The following represents the primary outstanding environmental issues currently being addressed.\nThe Government of Norway has held discussions with certain Norwegian industries including the abrasive industry concerning the implementation of reduced gaseous emission standards. The Company's Norwegian joint venture is participating in these discussions to help achieve the Norwegian Government's objectives as well as assuring long term economic viability for the joint venture.\nThe Company s joint venture appointed a project group to complete a study and define a project to minimize sulfur and dust emissions which was presented to the Norwegian State Pollution Control Authority ( Authority ) on March 1, 1995. The Authority has prepared an internal study of the report and the Authority s draft for new concessions was presented to the joint venture in February 1996. Based on a consensus for the metallurgical industry, the joint venture has initiated discussions with the Authority to obtain acceptable emissions levels. The costs associated with the implementation of environmental expenditures are uncertain as a result of various alternatives presently being considered by the Norwegian joint venture.\nThe Company has been directed by the Illinois Environmental Protection Agency to control its sulfur emissions at its Hennepin, Illinois silicon carbide furnace plant. Reference is made to the information contained in Note 14(a) of the Notes to Financial Statements beginning on page 40, which is hereby incorporated herein by reference.\nManagement believes all necessary pollution control equipment at the Company's plants in Tonawanda, New York and Thorold, Ontario are in place, and all current pollution control requirements are being met at both plants.\nNorwegian Operations. The Company's wholly-owned subsidiary, Norsk Exolon A\/S is a limited partner in a Norwegian partnership, Orkla Exolon K\/S (the \"Partnership\"), which is engaged in the manufacture and sale of silicon carbide crude and grain products.\nNorsk Exolon A\/S has a 50% interest in the Partnership, with another Norwegian company, Orkla A\/S, owning the balance. The furnace plant, processing plant and other facilities of the Partnership were constructed in the early 1960's under the guidance and technical direction of the Company. The partnership began manufacturing operations during 1963.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\nFinancial information about foreign and domestic operations and export sales is incorporated by reference to Note 5 of Notes to Consolidated Financial Statements, appearing on pages 26-28 of Part II, Item 8.\nThe financial statements of Orkla Exolon K\/S are also included in this Form 10-K on the financial statement schedules on pages 49-64. The Company's interest in the Norwegian partnership is subject to the usual risks of foreign investment, including currency fluctuations. Currency fluctuation is also a risk associated with the Company's Canadian plant operations. The Company reduces Canadian currency exposure with the use of foreign currency forward contracts as hedges against certain commitments in Canadian dollars.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's main office and grain processing plant are located in Tonawanda, New York. The plant and office buildings, which are owned by the Company, contain 273,000 square feet of space, and occupy 6 of 34 acres owned by the Company at this site. The facilities were originally completed in 1943, and substantial additions to the plant have been made since that date.\nThe Company has an electric furnace plant situated in Thorold, Ontario, Canada. All plant and office buildings at the plant are owned by the Company, as well as the 43 acres of land on which the facilities are located. In total, the buildings consist of 251,000 square feet of space. The plant was originally built in 1914. Substantial additions have been made in subsequent years, including the construction of a new aluminum oxide furnace in 1985.\nThe Company's Hennepin, Illinois plant includes four outdoor furnace groups and buildings of 47,800 square feet, located on a 78 acre site which is owned by the Company. Construction began in late 1977 and was completed in the Spring of 1979 for three furnace groups. The expansion to a fourth furnace group was completed in 1989.\nThe Company also has operations in Norway conducted through a joint venture, Orkla Exolon K\/S, of which the Company owns 50% through the Company's wholly-owned subsidiary, Norsk Exolon A\/S, a holding company. The office and plant of the Norwegian joint venture are located in Gjolme, Norway. The plant and office building, and the land upon which it is situated, are owned by the joint venture. In total, the plant and office consist of 154,000 square feet of space, on 88 acres of land. The plant and office were constructed from 1961-1963, with substantial additions made thereafter.\nThe Company believes that all of these plants are in good condition and suited for the purposes for which they are operated.\nItem 3.","section_3":"Item 3. Legal Proceedings\na. Environmental Proceedings - Hennepin, Illinois Plant\nReference is made to the information presented under the heading \"Environmental Issues - Hennepin, Illinois Plant\" appearing under Note 14(a) to the Notes to Consolidated Financial Statements contained in this Form 10-K Report, which is hereby incorporated herein by reference.\nb. Exolon-ESK Company and Exolon-ESK Company of Canada, Ltd. v. Michael Perrotto, et al.\nReference is made to the information contained in \"PART II, Item 1. Legal Proceedings, under the heading \"Exolon-ESK Company and Exolon-ESK Company of Canada, Ltd. v. Michael Perrotto, et al.\" (the Perrotto Case ) in the Company's Form 10-Q Report for the period ended September 30, 1993, which is hereby incorporated herein by reference.\nOn February 29, 1996, the Company and Exolon-Canada entered into a Final Release (the Release ) with their insurance carriers whereby they agreed to release the carriers from all claims based on the activities of the defendants in the Perrotto Case, in consideration of a payment of $535,000 Canadian (approximately $390,000 U.S.). Under the terms of the Release, the insurance carriers denied any liability, and the payment may not be indicative of the amount of any recovery that may be obtained from the defendants.\nc. Federal Proceedings\nReference is made to the information contained in Part I, \"Item 3. Legal Proceedings\" under the heading \"e. Federal Indictments\" in the Company's Form 10-K Report for the year ended December 31, 1993, which is hereby incorporated herein by reference. The proceedings described thereunder are hereinafter referred to as the \"Antitrust Proceedings\".\nReference is made to information concerning the DLA suspension contained in Note 14(b) \"Legal Matters\" of Part II, Item 8, Notes to Consolidated Financial Statements beginning on page 41, which is hereby incorporated herein by reference\nd. General Refractories Company v. Washington Mills Electro Minerals Corporation and Exolon-ESK Company\nThe description of a class action lawsuit relating to claims under the Sherman Act brought by General Refractories Company against Washington Mills Electro Mineral Corporation and the Company, appearing under the heading Legal Matters under Note 7(b) to the Notes to Consolidated Financial Statements on Page 10 of the Company s Form 10-Q reported for the period ended March 31, 1995, is hereby incorporated herein by reference. On or about July 17, 1995, a law suit captioned Arden Architectural Specialties, Inc. v. Washington Mills Electro Minerals Corporation and Exolon-ESK Company, (95-CV-05745(m)), was commenced in the United States District Court for the Western District of New York. The Arden Architectural Specialties complaint purports to be a class action that is based on the same matters alleged in the General Refractories complaint.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone. PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters\nThe Company's Common Stock is traded on the Boston Stock Exchange. The quarterly common stock price ranges are as follows:\nPRICE RANGE OF COMMON STOCK BOSTON STOCK EXCHANGE\nQUARTER\n1 2 3 4 _________ __________ ______________ _____________ High-Low $17-1\/2 -16 $18-1\/2 -15 $18-1\/2 -18-1\/2 $22 - 18-5\/8\nHigh-Low $22 - 20 $20 - 18 $18 - 17 $17-1\/4 -17-1\/4\nInformation concerning limitations on the payment of dividends on the Company's Common Stock is hereby incorporated by reference to Notes 8 and 10 to Notes to Consolidated Financial Statements beginning on pages 29 and 33, respectively.\nThe number of stockholders of record of the Company's Common Stock, $1 par value, was 178 as of February 6, 1996. The Company did not pay any dividends on its Common Stock in 1995 or 1994.\nThe shares of the Company's Class A Common Stock, all of which are owned by Wacker Chemical (USA), Inc., are not publicly traded.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe \"Selected Financial Information\" for the five years ended December 31, 1995 appears on pages 8 and 9.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion and analysis reviews certain factors which produced significant changes in the Company's results of operations during the three years ended December 31, 1995.\nRESULTS OF OPERATIONS 1995 COMPARED TO 1994 In 1995, the Company s net sales increased $9,098,000 to $68,592,000, an increase of 15% compared to net sales of $59,494,000 in 1994. The 1995 increase was primarily a result of an 18% increase in the Company s shipment volume of its principal manufactured and purchased products due to a strong demand for abrasive products during 1995, when compared to 1994. Average selling prices for the Company s principal manufactured and purchased products increased by approximately 1% during 1995, when compared to 1994.\nConsolidated net earnings were $3,462,000 or $3.55 per common share for the year ended December 31, 1995. This compares to consolidated net earnings of $1,516,000 or $1.53 per share for the 1994 year. During 1995, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106 (SFAS 106) for its Canadian subsidiary, which resulted in a one time non- cash after tax charge of $502,000 or $.52 per share. This statement requires that the cost of postretirement benefits, including health care and life insurance, be accrued during an employee s active working career. In years prior to 1995, these costs were expensed as paid. The Company s U.S. operations adopted SFAS 106 during 1993. Prior to the effect of this charge related to SFAS 106, the Company s consolidated net earnings were $3,964,000 for the 1995 year or $4.07 per share, when compared to $1,516,000 or $1.53 per share for 1994. In addition, 1994's net earnings were adversely affected by a $1,357,000 unusual charge related to the 1994 settlement of environmental litigation. (This charge is discussed further within Note 14(a) of the Notes to Consolidated Financial Statements, which is incorporated herein by reference and within the operating expense comparisons to follow.)\nCost of sales, excluding depreciation, as a percentage of sales declined to 77.6% in 1995, when compared to 78.4% in 1994; therefore gross margins, as a percent of sales increased to 22.4% in 1995 compared to 21.6% in 1994. The 1995 enhancement is due primarily to the economies of scale available at the higher sales levels recognized in 1995 and the continued focus on increased manufacturing efficiencies at all Company facilities.\nTotal operating expenses including depreciation were $7,853,000 during 1995 versus $9,677,000 during 1994. As a result operating income increased to $7,527,000 in 1995 compared to $3,186,000 for the 1994 year. The 1995 decrease in operating expenses of $1,824,000 is a result of the decreases of $119,000, 81,000, $267,000 and $1,357,000 in depreciation, selling and general and administrative, research and development and environmental compliance charges, respectively.\nDepreciation, as a percent of sales, was 4.2% for 1995 compared to 5.0% for 1994.\nSelling, general and administrative expense decreased by $81,000 in 1995, due principally to a $334,000 reduction in legal fees recorded during 1995 versus the prior year. Other selling and general and administrative expense categories were generally increased, with the exception of reduced health care costs, due to the increased 1995 sales volume of products shipped. As a percent of net sales, selling and general and administrative expense decreased to 7.2% in 1995, from 8.5% for the 1994 year.\nResearch and development expense decreased by $267,000 for 1995 mainly as a result of the $188,000 decrease in expenses associated with R&D costs related to specialty refractory products at the Company s Canadian operation. During 1995, the Company eliminated R&D spending related to one of its specialty products produced at its Canadian plant.\nInterest expense from continuing operations declined to $1,469,000 in 1995 from $1,480,000 in 1994. Higher average interest rates experienced on the Company s variable rate debt were offset by lower average borrowing levels during 1995 versus the 1994 year. The average interest rate on the U.S. revolving and demand lines of credit was 8.4% during 1995 compared to 7.3% in 1994. The Company recorded lower average borrowing levels in 1995 on its U.S. and Canadian revolving and demand lines of credit and its U.S. term loan. The average total borrowing outstanding for the three revolving lines of credit combined with the term loan was $8.9 million for 1995, when compared to $10.5 million for the 1994 year.\nThe Company s Norwegian joint venture, Orkla Exolon K\/S, reported the Company s 50% share in the pre-tax income of the venture was $793,000 for the 1995 year versus pre-tax income of $431,000 for the 1994 year. The Company s share of the venture s net sales increased 19% in 1995 to $8,140,000 compared to $6,832,000 in 1994. Net sales, in terms of native currency, increased by 8% in 1995 compared to 1994. The increase in net sales was a result of the 1995 improved product mix and increases in selling prices. The joint venture s gross margins, prior to depreciation, increased to 24% for the 1995 year versus 18% for 1994, principally due to increased operational efficiency and a more favorable product mix.\nThe 1995 income tax provision was $2,893,000, representing an effective rate of 42%. The 1995 effective rate reflects a rate which is more than the U.S. Federal statutory rate of 34% principally due to the inclusion of state and provincial income taxes. In addition, the Company has reserved $571,000 included in the 1995 tax provision for future taxes payable related to the repatriation of earnings of the Company s foreign subsidiaries.\nRESULTS OF OPERATIONS 1994 COMPARED TO 1993 Net sales in 1994 were $59,494,000, representing an increase of 2.2% when compared to $58,225,000 in the year ended December 31, 1993. The Company's shipment volume for its primary products, which include manufactured and purchased products, increased by 3.2% in 1994 when compared to 1993. Average selling prices of the Company's primary products declined by approximately 1% in 1994, principally resulting from a less favorable product mix in 1994 when compared to the previous year.\nConsolidated net earnings were $1,516,000 for the year ended December 31, 1994 compared to net earnings, prior to the cumulative effect of an accounting change, of $1,206,000 during 1993. In 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106 (SFAS 106) for its U.S. operations. This statement requires that the costs of postretirement benefits, including health care and life insurance, be accrued during an employee's active working career. In years prior to 1993, these costs were expensed as paid. The cumulative effect of this one-time non-cash accounting change was $1,173,000 after taxes, therefore, net earnings after this one- time accounting change were $33,000 for the year ended December 31, 1993.\nGross margins, prior to depreciation expense, increased to 21.6% in 1994 versus 21.2% in 1993. Depreciation expense decreased to $2,992,000 for the year ended December 31, 1994 when compared to $3,210,000 for the 1993 year. Depreciation as a percent of sales, was 5.0% for 1994 versus 5.5% for 1993.\nSelling, general and administrative expense decreased to $5,039,000 in 1994, when compared to $5,478,000 in 1993. The $439,000 reduction was primarily a result of a $400,000 decrease in bad debt expense during the 1994 year when compared to bad debt expense recorded for 1993. In 1993, a separate bad debt expense of $400,000 was recorded to reflect the estimated unrealizable portion of the outstanding receivable in connection with the Hennepin desulfurization project. In addition, the Company decreased office expenses by approximately $57,000 in 1994. Several of the remaining categories included in selling, general and administrative expense increased marginally in 1994 when compared to the previous year.\nResearch and development expense increased to $289,000 in 1994 when compared to $54,000 during 1993. The increase primarily related to the 1994 additional research and development spending for specialty refractory products at the Company's Canadian facility.\nEnvironmental compliance charges of $1,357,000 were recorded in 1994 related to a $1,300,000 civil penalty associated with the October, 1994 settlement with the Illinois Environmental Protection Agency (IEPA). See \"Liquidity and Capital Resources\", below. In addition, the Company increased a reserve for its Canadian subsidiary by $57,000 for the environmental penalties assessed by the Ontario Ministry of Environment (MOE) upon a settlement between the Company and the MOE in August, 1994.\nInterest expense from continuing operations increased to $1,480,000 in 1994 from $1,441,000 for the 1993 year. The $39,000 increase in primarily to result of higher average interest rates during 1994 compared to average rates during 1993. The 1994 increase in average interest rates for the Company's revolving lines of credit was approximately 20%. The average interest rate on the U.S. revolving and demand lines of credit was 7.3% during 1994 versus 6.1% during 1993. The Company recorded lower average borrowing levels in 1994 on its U.S. and Canadian revolving and demand lines of credit. The average borrowing outstanding for the three revolving lines of credit was $10.5 million in 1994, when compared to $11.2 million during 1993. This 1994 reduction of average bank debt contributed to partially offset the adverse effect of the higher average interest rates incurred. The interest rate increases resulted from higher U.S. and Canadian prime rates experienced during 1994 versus the prior year.\nThe Company's Norwegian joint venture, Orkla Exolon K\/S, reported the Company's 50% share in the pre-tax income of the venture was $431,000 for the 1994 year versus a pre-tax loss of $32,000 for the 1993 year. The Company's share of the venture's net sales increased 25.5% in 1994 to $6,832,000 compared to $5,445,000 in 1993. The increase in net sales was a result of the 1994 increase in shipment volume, an improved product mix and increases in selling prices due to the strengthening European economy. The joint venture's gross margins, prior to depreciation, increased to 18% for the 1994 year versus 11% for 1993, principally due to increased operational efficiency and a more favorable product mix.\nOther expense of $195,000 was recorded in 1994, when compared to $232,000 in 1993. The continued stronger U.S. dollar against the Canadian dollar accounted for the recognition of transaction losses in translating the Canadian subsidiary's balance sheet from Canadian dollars to U.S. dollars.\nThe 1994 income tax provision was $426,000 representing an effective rate of 22%. The 1994 effective rate reflects a rate which is less than the U.S. Federal statutory rate of 34% principally due to the 1994 recognition of Canadian investment tax credit carryforwards on the Company's books as deferred tax assets which were not recorded in the prior year. In addition, the Company's Norwegian joint venture eliminated a substantial income tax reserve related to a tax case which was settled during 1994. The aforementioned reduction in the Company's 1994 income tax provision were partially offset, however, by the recording of an increase to the current year provision of $442,000 due to the non-deductibility of $1,357,000 of environmental compliance charges which were discussed above.\nLIQUIDITY AND CAPITAL RESOURCES As of December 31, 1995, working capital (current assets less current liabilities) has increased to $21,414,000, when compared to $18,054,000 as of December 31, 1994. Accounts receivable increased by $1,960,000 as of December 31, 1995 versus 1994 year end primarily as a result of the increase in net sales during 1995 versus 1994. Inventory increased by $2,596,000 at December 31, 1995 when compared to December 31, 1994. Income taxes payable and accounts payable increased by $1,194,000 and $424,000, respectively, as of December 31, 1995 versus December 31, 1994. The adverse effect of the income taxes payable and accounts payable increase was offset by an $800,000 net decrease in notes payable and long-term debt during 1995.\nFor the year ended December 31, 1995, net cash provided by operating activities was $3,539,000. Outstanding bank indebtedness decreased by $800,000, and cash reserves decreased by $27,000 at December 31, 1995 compared to December 31, 1994. Net cash provided by operating activities was sufficient to fund $2,695,000 of capital expenditures in the year ended December 31, 1995.\nThe Company's current ratio increased to 3.7 to 1.0 at December 31, 1995 from 3.5 to 1.0 as of December 31, 1994. The ratio of total liabilities to shareholder's equity was 1.3 to 1.0 as of December 31, 1995 and 1.4 to 1.0 as of December 31, 1994.\nCurrent financial resources including the availability of the revolving and short-term lines of credit financing and anticipated funds from operations are expected to be adequate to meet normal requirements for the year ahead. The Company currently has lines of credit with borrowing capacities of $12,000,000 in the U.S. and $800,000 in Canada.\nThe Company in its long-term cash planning normally covers capital expenditures with funds generated internally. Where abnormally large capital expenditure programs are involved, long- term financing vehicles are sometimes used. Total 1996 normal capital expenditures are forecasted at $3,000,000 to maintain and upgrade production facilities. The Company believes that funds generated internally should be sufficient to finance normal capital expenditure requirements in 1996. In addition to the Company s recurring capital expenditures of approximately $3,000,000 during 1996, the Company will incur capital costs within the range of $12,000,000 to $14,000,000 over the next two years to comply with its environmental permit in Illinois. As of December 31, 1995, the Company has incurred approximately $1,400,000 of capital costs related to the facility improvements. The Company expects to finance the costs of the required capital improvements through a bond offering possibly on a tax-exempt basis. The Company has obtained a modification of its Industrial Revenue Bond Agreement to allow for the required capital expenditures under the Consent Order. For further information see Note 14(a) to the Notes to Consolidated Financial Statements beginning on page 40, which is incorporated herein by reference.\nReference is made to the descriptions of the following legal matters, under the caption Legal Matters beginning on page 41 of this Form 10-K Report, which descriptions are incorporated herein by reference: (i) a legal action commenced in June 1993 by the Company in Ontario, Canada seeking $2,000,000 in damages against certain former officers and employees and a related insurance settlement; (ii) antitrust proceedings commenced in February 1994 against the Company and others; (iii) a temporary suspension imposed upon the Company and others in December 1994 by the U.S. Defense Logistics Agency; and (iv) civil law suits brought against the Company and others commenced by General Refractories Company in October 1994 and by Arden Architectural Specialties, Inc. in July 1995.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Consolidated Financial Statements, together with the reports thereon of Ernst & Young LLP and Arthur Andersen LLP dated January 12, 1996 and January 27, 1994 respectively, appear on pages 16 through 43 to follow.\nReport of Independent Auditors\nBoard of Directors Exolon-ESK Company\nWe have audited the accompanying consolidated balance sheets of Exolon-ESK Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders equity, and cash flows for the years then ended. 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. The financial statements and schedule of Exolon-ESK Company and subsidiaries for the year ended December 31, 1993, were audited by other auditors whose report dated January 27, 1994, expressed an unqualified opinion on those statements and included an explanatory paragraph that described the accounting change discussed in Note 11 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 consolidated financial position of Exolon-ESK Company and subsidiaries 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. 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 financial statements, in 1995 the Company changed its method of accounting for postretirement benefits other than pensions for its Canadian subsidiary.\nS\/ Ernst & Young LLP\nBuffalo, New York January 12, 1996 Except for Note 14 b.(ii), as to which the date is February 29, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Exolon-ESK Company:\nWe have audited the accompanying consolidated statements of operations, changes in stockholders equity and cash flows of Exolon-ESK Company (a Delaware corporation) and subsidiaries for the year ended December 31, 1993. These consolidated financial statements and the schedules referred to below are the responsibility of the Company s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Exolon-ESK Company and subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 11 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits for U.S. employees in accordance with Statement of Financial Accounting Standards No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules per Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission s rules and are not a required part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nRochester, New York, S\/ Arthur Andersen LLP January 27, 1994 (Except with respect to the matters discussed in Note 14, as to which the date is March 24, 1994 and October 6, 1994.)\nEXOLON-ESK COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, (thousands of dollars except per share amounts) 1995 1994 1993 _____ _____ _____\nNet Sales $68,592 $59,494 $58,225 Cost of Goods Sold 53,212 46,631 45,860 ______ ______ ______ Gross Profit Before Depreciation 15,380 12,863 12,365 Depreciation 2,873 2,992 3,210\nSelling, General & Administrative 4,958 5,039 5,478 Expenses Research and Development 22 289 54 Environmental Compliance Charges - 1,357 - ______ ______ ______ Operating Income 7,527 3,186 3,623 Other (Income) Expenses:\nInterest Expense 1,469 1,480 1,441 Equity in (Income) Loss of (793) (431) 32 Norwegian Joint Venture Other (6) 195 232 ______ ______ ______\nEarnings before Income Taxes and Cumulative Effect of Accounting Change 6,857 1,942 1,918 Income Tax Expense 2,893 426 712 ______ ______ ______\nEarnings before Cumulative Effect of 3,964 1,516 1,206 Accounting Change Cumulative Effect of Accounting Change - Net of Income Tax Benefit (502) - (1,173) ______ ______ ______ Net Earnings $3,462 $1,516 $33 ====== ====== ======\nPrimary Earnings (Loss) Per Common Share: Earnings before Cumulative Effect $4.07 $1.53 $1.21 of Accounting Change Cumulative Effect of Accounting ($0.52) - ($1.22) Change ______ ______ ______ Net Earnings (Loss) $3.55 $1.53 ($0.01) ====== ====== ====== Primary Earnings (Loss) Per Class A Common Share:\nEarnings before Cumulative Effect $3.82 $1.44 $1.14 of Accounting Change Cumulative Effect of Accounting ($0.49) - ($1.15) Change ______ ______ ______ Net Earnings (Loss) $3.33 $1.44 ($0.01) ====== ====== ====== Fully Diluted Earnings Per Common Share: Earnings before Cumulative Effect $3.93 $1.50 - of Accounting Change\nCumulative Effect of Accounting ($0.49) - - Change ______ ______ ______ Net Earnings $3.44 $1.50 - ====== ====== ====== Fully Diluted Earnings Per Class A Common Share: Earnings before Cumulative Effect $3.71 $1.42 - of Accounting Change\nCumulative Effect of Accounting ($0.47) - - Change ______ ______ ______ Net Earnings $3.24 $1.42 - ====== ====== ====== Weighted Average Shares Outstanding (in thousands): Common Stock 482 482 482 ====== ====== ====== Class A Common Stock 513 513 513 ====== ====== ======\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nEXOLON-ESK COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\n(thousands of dollars except share amounts) DECEMBER 31,\n1995 1994 ______ ______ Assets Current assets:\nCash $440 $467\nAccounts receivable (less allowance for 8,896 6,936 doubtful accounts of $419 in 1995 and $309 in 1994) Inventories 19,700 17,104\nPrepaid expenses 359 399 Deferred income taxes - 535 ______ ______ Total Current Assets 29,395 25,441 ______ ______ Investment in Norwegian joint venture 5,230 4,173 Property, plant and equipment, net of accumulated depreciation 15,193 15,395 Other assets 397 300 ______ ______ Total Assets $50,215 $45,309 ====== ====== Liabilities and Stockholders' Equity\nCurrent liabilities: Notes payable - $2,000 Current maturities of long-term debt 1,550 800 Current maturities of capital lease - 25 obligations Accounts payable 3,229 2,805\nAccrued expenses 1,713 1,622 Income taxes payable 1,329 135 Deferred income taxes 160 - ______ ______ Total Current Liabilities 7,981 7,387 ______ ______\nDeferred income taxes 1,300 1,548 Long-term debt 15,350 14,900 Other long-term liabilities 3,286 2,846 Commitments and Contingencies Stockholders' equity: Preferred stock\nSeries A (liquidation preference - 276 276 $484) Series B (liquidation preference - 166 166 $484) Common stock, issued 512,897 ($1 par 513 513 value) Class A common stock, issued 512,897 ($1 513 513 par value) Additional paid-in capital 4,345 4,345\nRetained earnings 16,952 13,545 Cumulative translation adjustment (99) (362) Treasury stock, at cost (368) (368) ______ ______ Total Stockholders' Equity 22,298 18,628 ______ ______\nTotal Liabilities and Stockholders' Equity $50,215 $45,309 ====== ======\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nEXOLON-ESK COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONT'D.)\nCUMU- ADDI- LATIVE TIONAL TRANS- (thousands of dollars PAID-IN RETAINED LATION TREASURY STOCK except share amounts) CAPITAL EARNINGS ADJ SHARES AMOUNT ______ ________ ______ ______ ______\nBalance at December 31, $4,345 $12,071 ($703) (30,902) ($368)\nNet earnings 33\nDividends declared: Preferred stock Series A - (22) $1.1250 per share Preferred stock Series B - (21) $1.0517 per share Change in cumulative (33) translation adjustment\n______ _______ ______ _______ _____ Balance at December 31, $4,345 $12,061 ($736) (30,902) ($368)\nNet earnings 1,516\nDividends declared: Preferred stock Series A - (16) $.8437 per share Preferred stock Series B - (16) $.8437 per share\nChange in cumulative 374 translation adjustment\n______ ______ ______ _______ _____ Balance at December 31, $4,345 $13,545 ($362) (30,902) ($368)\nNet earnings 3,462\nDividends declared: Preferred stock Series A - (28) $1.4062 per share Preferred stock Series B - (27) $1.4062 per share Change in cumulative 263 translation adjustment\n______ _______ _____ _______ _____ Balance at December 31, $4,345 $16,952 ($99) (30,902) ($368) 1995 ====== ======= ===== ======= =====\nThe accompanying notes to consolidated financial statements are an integral part of these statements\nEXOLON-ESK COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 and 1993\n1. Summary of significant accounting policies\na. Principles of consolidation\nThe accompanying consolidated financial statements include the accounts of the Exolon-ESK Company and its wholly-owned subsidiaries (The Company\"): (Exolon-ESK Company of Canada, Ltd; Norsk-Exolon A\/S; Exolon-ESK International Sales Corporation.) All significant intercompany balances and transactions have been eliminated.\nb. Investment in Norwegian joint venture\nNorsk Exolon A\/S, a wholly-owned Norwegian nonoperating subsidiary, has as its only significant asset a 50% investment in a Norwegian partnership, Orkla Exolon K\/S, engaged in the manufacture of silicon carbide abrasive products. The investment is stated at cost plus the Company's share of undistributed earnings and translation adjustments since acquisition. The earnings of the joint venture are reportable for Norwegian tax purposes by the partners. Taxes attributable to Norsk Exolon A\/S's share of earnings from the joint venture are included as a component of income taxes (Note 9).\nc. Inventories\nInventories are stated at the lower of cost or market. Approximately 75% and 74% of the dollar value of inventories is stated at last-in, first-out (LIFO) cost at December 31, 1995 and 1994, with the balance being stated at average cost.\nd. Property, plant and equipment\nProperty, plant and equipment is stated at cost. Depreciation is computed for financial reporting purposes using straight-line and declining balance methods over the estimated useful lives of the assets as follows:\nYears Buildings 15-50\nMachinery and 3-20 Equipment\nThe cost of assets sold or otherwise disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the results of operations. Maintenance and repairs are charged to expense as incurred and renewals and betterments are capitalized.\ne. Foreign currency translation\nThe Company has determined that the United States dollar is the functional currency of the Canadian subsidiary and that the Norwegian krone is the functional currency of the Norwegian subsidiary and the joint venture.\nProperty, plant and equipment of the Canadian subsidiary are translated at historical exchange rates and all other assets and liabilities are translated at year-end exchange rates. Income statements of the Canadian subsidiary are translated at average rates for the year, except for depreciation, which is translated at historical rates. Gains and losses arising as a result of the translation of the financial statements of the Canadian subsidiary are reflected directly in the results of operations.\nAssets and liabilities of the Norwegian subsidiary and joint venture are translated at year-end exchange rates and the income statements are translated at the average exchange rates for the year. Resulting translation adjustments are recorded as a separate component of equity.\nNet gains (losses) arising as a result of the remeasurement of the Canadian subsidiary's financial statements into the United States dollar and from other foreign currency transactions amounted to ($30,000), ($143,000), and ($188,000) in 1995, 1994, and 1993, respectively.\nf. Income taxes\nThe liability method prescribed in Statement of Financial Accounting Standards No. 109 (SFAS 109) 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 as measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.\nThe Company does not provide U.S. Federal income taxes on the entire balance of the undistributed earnings of foreign subsidiaries as these earnings are permanently reinvested. In 1995, the Company decided to repatriate up to $3,100,000 of undistributed earnings from its Canadian subsidiary through a future stock redemption and has provided for all applicable income taxes in the 1995 statement of operations. At December 31, 1995, undistributed earnings of the Canadian and Norwegian foreign subsidiaries combined were $8,657,000.\ng. Pension and other retirement plans\nPension benefits under the Company's Tonawanda defined benefit pension plan for hourly employees are based principally on years of service. Benefits under the Tonawanda and Hennepin salaried employees defined contribution plan are based on a percentage of compensation for eligible employees. Pension cost and related disclosures for these plans are determined under the provisions of SFAS 87 (see Note 11).\nh. Earnings per share\nPrimary earnings per share of Common Stock and Class A Common Stock are based on the weighted average number of shares of the respective classes outstanding during each year. Earnings applicable to Common Stock and Class A Common Stock are determined by using the earnings entitlement of each (as discussed in Note 10) and giving effect to the total current dividend requirements on the preferred stock. On a fully-diluted basis, both net earnings and shares outstanding are adjusted to assume the conversion of convertible Series A and Series B Preferred Stock from the date of issue. The effects of considering conversion of convertible Series A and Series B Preferred Stock in 1993 was anti-dilutive, therefore, it is not presented.\ni. Currency forward contracts\nFrom time to time, the Company enters into currency forward contracts in management of foreign currency transaction exposure. Forward foreign currency exchange contracts are purchased to reduce the impact of foreign currency fluctuations on operating results. Realized and unrealized gains and losses on these contracts are recorded in net income currently, with the exception of gains and losses on contracts designated to hedge specific foreign currency commitments which are deferred and recognized in net income in the period of the commitment transaction. The discount or premium of the forward contract is recognized over the life of the contract. At December 31, 1995, the Company had open currency forward contracts to purchase the U.S. dollar equivalent of $3,861,000 of Canadian dollars, all of which mature within 12 months. Their fair market value, at December 31, 1995 market exchange rates, was $3,903,000.\nj. Environmental remediation and compliance\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 cost can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or the Company's commitment to a formal plan of action. At December 31, 1995 and 1994, liabilities for environmental costs of $780,000 and $1,097,000 were recorded in other accrued liabilities.\nk. Other\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.\nLong-Lived Assets: 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 , 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.\n2. Business segment information\nThe Company has only one business segment, the manufacture of abrasive materials and products for abrasive, metallurgical and refractory uses. The Company regards its principal business as being in a single industry segment.\nThe Company had sales to one major customer which accounted for approximately 12% and 11% of consolidated net sales in 1994 and 1993, respectively. This customer's receivable balance was approximately 8% and 14% of total trade receivables at December 31, 1994 and 1993, respectively. No one customer accounted for 10% or more of net sales in 1995.\n3. Inventories\nIf the average cost method, which would approximate current or replacement costs, had been used for valuing all inventories of the Company, inventories would have been $2,070,000 and $2,083,000 higher than reported at December 31, 1995 and 1994, respectively. The Company generally records the adjustment for LIFO inventory in the fourth quarter. In 1995 and 1994 this adjustment reduced cost of goods sold by approximately $12,000 and $375,000, respectively.\nThe following are the major classes of inventories as of\nDecember 31 (in thousands):\n1995 1994 1993 _____ _____ _____\nRaw Materials $2,119 $3,051 $2,868\nSemi-Finished and 18,640 15,085 15,379 Finished Goods\nSupplies and Other 1,011 1,051 967 ______ ______ ______ 21,770 19,187 19,214\nLess: LIFO Reserve (2,070) (2,083) (2,457) _______ _______ _______\n$19,700 $17,104 $16,757 ======= ======= =======\n4. Property, Plant and Equipment\nProperty, plant and equipment consists of (in thousands): 1995 1994 _______ _______\nLand $283 $170\nBuildings 8,233 8,227 Machinery & equipment 45,087 44,620\nConstruction in progress 2,300 421 _______ _______\n55,903 53,438 Less - accumulated 40,710 38,043 depreciation _______ _______\n$15,193 $15,395 ======= =======\n5. Operations\nThe Company conducts operations through its manufacturing facilities in the United States and Canada, and its equity interest in a Norwegian joint venture.\nTransfers between Canada and the United States are based upon established arm's length prices for the Canadian operation.\nOperating income represents total revenues less operating expenses before general corporate expenses. General corporate expenses include directors and officers salaries, and donations. Identifiable assets are those assets of the Company that are identified with the operations in each geographic area. Information about the Company's operations in different geographic areas is set forth below.\n(thousands of dollars) YEAR ENDED DECEMBER 31, 1995 UNITED ELIMINA- STATES CANADA TIONS CONSOLIDATED _______ _______ _______ ___________\nSales to unaffiliated customers $62,799 $5,793 - $68,592 Transfers between geographic areas - 11,888 (11,888) - _______ _______ _________ __________ Total revenue $62,799 $17,681 ($11,888) $68,592 ======= ======= ======== ======= Operating income, before general\ncorporate expense $5,483 $2,441 - $7,924 ======= ======= ======== General corporate expenses (391) Income before income taxes of Norwegian joint venture 793 Interest Expense (1,469) _______\nEarnings before income taxes and cumulative effect of account $6,857 change ======= Identifiable assets $37,714 $9,720 ($2,449) $44,985 ======= ======= ========\nInvestment in Norwegian joint venture 5,230 _______\nTotal assets at December 31, 1995 $50,215 =======\n(thousands of dollars) YEAR ENDED DECEMBER 31, 1994 UNITED ELIMINA- CONSOLI- STATES CANADA TIONS DATED ______ ______ ______ ______ Sales to unaffiliated customers $55,997 $3,497 - $59,494 Transfers between geographic areas - 11,457 (11,457) - _______ ______ _______ _______ Total revenue $55,997 $14,954 ($11,457) $59,494 ======= ====== ======== ======= Operating income, before general\ncorporate expense $2,161 $1,415 - $3,576 ====== ====== ======= General corporate expenses (585) Income before taxes of Norwegian joint venture 431\nInterest Expense (1,480) _______ Earnings before income taxes $1,942 ======= Identifiable assets $36,078 $9,952 ($4,894) $41,136 ======= ====== ======= Investment in Norwegian joint 4,173 venture _______ Total assets at December 31, 1994 $45,309 =======\n(thousands of dollars) YEAR ENDED DECEMBER 31, 1993 UNITED ELIMIN- CONSOLI- STATES CANADA ATIONS DATED ______ ______ _______ _______ Sales to unaffiliated $55,154 $3,071 - $58,225 customers Transfers between - 10,590 (10,590) - geographic areas _______ ______ ________ _______\nTotal revenue $55,154 $13,661 ($10,590) $58,225 ======== ======= ======== ======= Operating income, before general corporate expense $3,265 $740 - $4,005 ====== ====== ======= General corporate expenses (614) (Loss) before income taxes of\nNorwegian joint venture (32) Interest Expense (1,441) ________ Earnings before income taxes and cumulative effect of accounting change $1,918 =======\nIdentifiable assets $37,928 $10,986 ($6,434) $42,480 ======= ======= ======== Investment in Norwegian joint 3,354 venture ________ Total assets at December 31, 1993 $45,834 =======\n6. Investment in Norwegian Joint Venture\nThe Company's 50% share of the results of operations of the Norwegian joint venture has been determined after adjustments to reflect the application of United States generally accepted accounting principles relating principally to the recording of depreciation and pension expenses and adjustments to the carrying values of the ventures's year-end inventories. The Company's share of the venture's assets, liabilities, and results of operations is set forth in the following condensed financial information (in thousands):\nDECEMBER 31, Balance Sheet Data 1995 1994 ______ ______\nCurrent assets $4,704 $4,093 Non-current assets 2,644 1,951\nCurrent liabilities 1,458 1,243\nNon-current Liabilities 363 375\nStatement of Operations 1995 1994 1993 ______ ______ ______\nNet Sales $8,140 $6,832 $5,445 Gross profit 2,097 1,221 629\nIncome (Loss) before income 793 431 (32) taxes\nThe Company does not provide U.S. Federal income taxes on the undistributed earnings of the Norwegian joint venture as these earnings are permanently reinvested. At December 31, 1995, undistributed earnings of the joint venture were $4,285,000.\n7. Notes payable\nThe Company's Canadian subsidiary has a $1,000,000 (Canadian funds) operating demand loan available as part of a credit facility provided by a Canadian bank. The demand loan had a zero balance as of December 31, 1995, 1994 and 1993. The approximate average borrowings (Canadian funds) outstanding during 1995, 1994 and 1993 equaled $83,000, $204,000, and $242,000, respectively, with the approximate weighted average interest rates of 9.9%, 6.9% and 7.0%, respectively. The maximum amount of short-term debt (Canadian funds) outstanding as of any month-end during 1995, 1994 and 1993 was $200,000, $425,000 and $650,000, respectively.\nThe Canadian agreement requires the subsidiary to maintain specified financial ratios and minimum net worth levels. The maintenance of financial covenants may preclude the Canadian subsidiary's transfer, by dividend or otherwise, funds to the U.S. parent company. All borrowings under the Canadian agreement are guaranteed by the Company and the Canadian bank has a security interest in the Canadian accounts receivable, inventory and machinery and equipment. Interest on the borrowings is based upon the Canadian prime rate.\nAt December 31, 1994 borrowings of $2,000,000 were outstanding under the demand line of credit portion of a Credit Agreement with a U.S. bank. The U.S. Credit Agreement is discussed further in Note 8 to follow.\n8. Long-Term debt\nLong-term debt consists of (in thousands): 1995 1994 ______ ______\nRevolving credit and term loan $7,100 $5,100 agreement with a U.S. Bank. Interest at prime rate plus % (8.75% at December 31, 1995).\nTerm loan agreement with a U.S. Bank. 1,800 2,600 Interest at prime rate plus % (9.0% at December 31, 1995). Industrial revenue bond held by an 8,000 8,000 insurance company. Interest is at a fixed rate of 8 %. Bond maturity is ______ ______ January 1, 2018.\n$16,900 $15,700\nLess - current maturities 1,550 800 ______ ______ $15,350 $14,900 ======= =======\nU.S. Credit Agreement\nThe Company entered into a Credit Agreement on December 22, 1992 with a U.S. bank. The proceeds were used to refinance the Company's previous Revolving Credit and Term Loan Agreement with a different U.S. bank. The Credit Agreement provides for borrowings up to $10,000,000 under the revolving portion of the agreement, a $4,000,000, 5 year, term loan and for borrowing up to $2,000,000 under a demand line of credit.\nAt December 31, 1995 borrowings of $7,100,000 were outstanding under the revolving portion of the Credit Agreement. The revolving portion converts, in whole or any portion, to a term note on March 31, 1996. Any principal balance of the revolver which is not converted is required to be repaid by the conversion date. Upon conversion, the term loan is payable in sixteen quarterly principal installments as follows: fifteen equal quarterly installments, each equal to the lesser of $250,000 or 2.5% of the principal balance of the revolver converted on the conversion date beginning April 1, 1996 and continuing to October 1, 1999 and one final payment on January 1, 2000 in an amount equal to the remaining balance of the term note.\nAt December 31, 1995 borrowings of $1,800,000 were outstanding under the term loan portion of borrowings under the Credit Agreement. The term loan is due in twenty equal quarterly principal payments of $200,000 which began April 1, 1993 and end January 1, 1998.\nIn addition to the revolver and term loan under the Credit Agreement, the Company has a $2,000,000 demand line of credit. At December 31, 1995 the line had a zero balance.\nBorrowings under the three segments of the Credit Agreement bear interest at either a defined base rate, contingent upon the bank's prime lending rate, or a rate based on the London Interbank Offered Rate (LIBOR). The Company has the option to convert the interest rate on all or a portion of the principal of its borrowings from the base rate to the rate based on LIBOR. Interest is payable monthly.\nThe U.S. Credit Agreement requires the Company to maintain certain financial covenants and include, the maintenance of specified working capital; debt to tangible net worth ratios; minimum tangible net worth levels; a minimum current ratio; and minimum cash flow ratios. In addition, the agreement sets forth limits on capital expenditures and dividends. The agreement contains certain other covenants including restriction on mergers, consolidations and sales of assets. The Company is precluded from paying or declaring any dividends or other distributions on its Common Stock without written consent from its U.S. bank. The Company may declare Preferred Stock dividends not to exceed $50,000 in the aggregate in any fiscal year.\nAs collateral for the U.S. Credit Agreement, the bank has security interest in all U.S. accounts receivable and inventory as well as certain additional assets of the Tonawanda, New York facility.\nIndustrial Revenue Bonds\nThe Company is liable for making payments with respect to $8,000,000 of Industrial Revenue Bonds issued by the Village of Hennepin, Illinois and purchased by an insurance company upon refinancing of the bonds on January 22, 1993. The bonds mature on January 1, 2018 and require quarterly interest payments which began March 1, 1993. The bonds bear interest, payable to a bank as trustee at a fixed rate of 8 %. Amortization of principal commences in January, 1999 until maturity in the year 2018. The Bond Agreement requires the Company to maintain specified financial ratios including, cash flow ratios, current ratios and debt to tangible net worth ratios. Additionally, the Company is required to maintain minimum working capital and tangible net worth levels.\nThe Bond Agreement limits new (non-replacement) capital expenditures, with the exception of capital expenditures incurred in 1995 or 1996 related to a desulfurization unit, to $500,000 per year at the Company's Illinois facility. The Agreement further restricts the Company by disallowing any new liens incurred on the Hennepin facility with the exception of existing liens as of January 22, 1993 and liens to secure indebtedness arising under the U.S. Credit Agreement or liens arising from the financing of the aforementioned new equipment at Hennepin of up to $500,000 per year.\nAggregate annual maturities of long-term debt under the U.S. Credit Agreement and the term loan with a Canadian bank are as follows: 1996 - $1,550,000; 1997 - $1,800,000; 1998 - $1,200,000, ; 1999 - $1,000,000; 2000 - $1,000,000; 2001 and beyond - $10,350,000.\n9. Income taxes\nThe components of income tax expense are as follows (in thousands):\n1995 1994 1993 ______ ______ ______ Current provision (benefit): United States\nFederal $1,226 $68 $848\nState 178 76 145 Foreign 768 112 47 ______ ______ ______\nTotal Current 2172 256 1040 ______ ______ ______ Deferred provision (benefit): United States\nFederal 494 152 (151)\nState (36) 65 (141)\nForeign 263 (47) (36) ______ ______ ______ Total Deferred 721 170 (328) ______ ______ ______\nTotal $2,893 $426 $712 ====== ====== ======\nAs of December 31, 1995, the Company has available investment tax credit carryforwards of approximately $24,000 for state purposes.\nThe actual tax expense differs from the \"expected\" tax expense (computed by applying the U.S. Federal corporate tax rate of 34% in 1995, 1994 and 1993 to earnings before income taxes) as follows:\n(thousands of dollars) 1995 1994 1993 ______ ______ ______\nComputed \"expected\" tax expense $2,332 $660 $652\nEffect of differing tax rates applicable to foreign subsidiary income (267) (109) -\nUtilization of Norwegian net operating losses not previously recognized - (149) -\nForeign subsidiary losses not benefited for\nFederal tax purposes - - 9\nRecognition of investment tax credits - (214) -\nEffect of permanent differences 9 (16) 25\nState and Provincial taxes, net of 465 217 192 Federal benefit\nNon-deductible environmental - 442 - penalties\nNorwegian tax reserve - (225) (130)\nU.S. reserve for dividend 571 - - repatriation\nOther (217) (180) (36) ______ ______ ______\nTotal income tax expense $2,893 $426 $712 ====== ====== ======\nEffective tax rate 42.2% 21.9% 37.1% ====== ====== ======\nDeferred income taxes for 1995 and 1994 reflect the impact of \"temporary differences\" between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. These \"temporary differences\" are determined in accordance with SFAS 109 (see Note 1(f)). The types of \"temporary differences\" that give rise to significant portions of deferred tax liabilities or (assets) are as follows (in thousands):\n1995 1994 ______ ______\nExcess tax depreciation $2,235 $2,347 Canadian NOL -- (25)\nNorwegian NOL (180) --\nCanadian ITC carryforwards -- (214) Inventory accounting methods (192) (311)\nNorwegian tax assessment 59 --- reserve\nDividend repatriation reserve 571 -- Pension and payroll accruals 52 1\nAccounts receivable and other (22) (122) asset reserves\nPost retirement accrual (1,044) (771) Other, net (19) 108 ______ ______\nNet deferred tax liability at 1,460 1,013 end of year Less:\nEffect of Norwegian 8 6 translation\nTax benefit recorded on cumulative effect of (282) --- accounting change Net deferred tax liability at 1,013 837 beginning of year ______ ______\nDeferred expense for income $721 $170 taxes ====== ======\n10. Capital Stock\nThe Company has two classes of Common Stock. At December 31, 1995 there were 600,000 shares of $1 par value Common Stock authorized, of which 512,897 shares were issued and 481,995 shares were outstanding. At the same date there were 600,000 shares of $1 par value Class A Common Stock, of which 512,897 shares were issued and outstanding.\nAdditionally, there were 100,000 shares of no par value Preferred Stock authorized. At December 31, 1995 there were 19,364 shares of Series A and 19,364 shares of Series B Preferred Stock outstanding.\nAt December 31, 1995, the shares of Series A and Series B Preferred Stock are entitled to receive, when declared by the Board of Directors, cumulative annual cash dividends at the rate of $1.125 per share. The Series A and Series B Preferred Stock have a preference upon liquidation of $25.00 each per share. Each share of Series A and Series B Preferred Stock is convertible into 1.125 shares of Common Stock and Class A Common Stock, respectively. The shares of Common Stock, voting with the shares of the Series A Preferred Stock, have the right to elect one-half of the members of the Board of Directors and the shares of Class A Common Stock voting with the Series B Preferred Stock, owned by Wacker Chemical (USA), Inc. (\"Wacker USA\"), have the right to elect the remaining one-half of the members of the Board of Directors.\n11. Pension and other retirement benefits\nThe Company sponsors contributory and non-contributory pension plans in the United States and Canada covering substantially all hourly and salaried employees with the exception of union employees at the Company's Hennepin plant, who are covered by a union-sponsored pension plan. The Company's U.S. defined contribution plan which covers all of its domestic salaried employees and its Canadian defined contribution plan covering substantially all Canadian employees, provide for the Company to make regular contributions based on salaries of eligible employees. Payments upon retirement or termination of employment are based on vested amounts credited to individual accounts. Contributions to the U.S. defined contribution plan totaled $146,000 in 1995, $147,000 in 1994 and $158,000 in 1993. Contributions to the Canadian defined contribution plan were $66,000 in 1995 and $65,000 in 1994. Contributions to the Canadian plan were not made in 1993 due to a surplus in the plan.\nThe Company also provides a defined benefit plan for hourly employees at the Tonawanda plant. Benefits are based primarily on years of service. Total pension expense for all plans amounted to $361,000, $391,000 and $405,000 in 1995, 1994 and 1993, respectively.\nThe following table summarizes the funded status of the Company's Tonawanda hourly employees defined benefit plan and the related amounts recognized in the Company's consolidated balance sheet as of December 31, 1995 and 1994:\nDECEMBER 31, (thousands of dollars) 1995 1994 ______ ______\nActuarial present value of benefit obligations: Accumulated benefit obligations, including vested benefit obligations of $1,475 at December 31, 1995 and $1,324 at December 31, 1994 ($1,475) ($1,327) ======= ======= Projected benefit obligations ($1,475) ($1,327)\nPlan assets at fair value, primarily long-term fixed income investments 2,036 1,494 ______ ______ Plan assets in excess of plan 561 167 obligations Unrecognized net loss at transition, being\namortized approximately 17 years 137 154 Unrecognized prior service cost 162 173 Unrecognized net (gain) arising since (428) (141) transition ______ ______ Prepaid pension expense $432 $353 ====== ====== Prepaid pension asset 295 199\nIntangible asset, net of amortization 137 154 ______ ______ Prepaid pension expense $432 $353 ====== ======\nThe actuarially computed pension cost for 1995, 1994 and 1993 included the following\ncomponents: (thousands of dollars) 1995 1994 1993 ______ ______ _____ _\nService costs $54 $59 $70 Interest on projected benefit obligation 106 100 98\nActual (return) on plan assets (404) (54) (178) Amortization of transition liability and 324 (18) 142 deferrals _____ _____ _____\nNet periodic pension expense $80 $87 $132 ====== ====== ====\nUnrecognized gain (losses) and prior service costs are amortized on a straight-line basis over a period approximating the average remaining service period for active employees.\nAn assumed discount rate of 8% has been used in determining the actuarial present value of the projected benefit obligation. The expected long-term rate of return on plan assets is 7%.\nBenefits under the Canadian subsidiary's pension plans are based on employee and employer matching contributions for the defined contribution plan and years of service for the defined benefit plan. The Company has applied for the termination of the Canadian defined benefit plan with the Pension Commission of Ontario. Upon formal procedural approval by the Pension Commission of Ontario, the defined benefit plan will be terminated and a projection of the employees benefit at retirement age will be calculated and subsequently rolled over into the defined contribution plan. The defined benefit plan had a surplus of approximately $120,000 (Canadian) as of December 31, 1993, the date of the most recent actuarial valuation. Assets of the plan at December 31, 1995 and 1994 included 26,000 shares of the Common Stock of Exolon-ESK Company valued at $780,000 (Canadian) at December 31, 1995.\nIn addition to providing pension benefits, the Company provides certain health care and life insurance benefits to eligible retired employees and their spouses. Participants generally become eligible for these benefits after achieving certain age and years of service requirements. These benefits are subject to deductibles, co-payment provisions and other limitations. The Company may amend or change the plan periodically.\nEffective January 1, 1993, the Company adopted for its U.S. operations only, Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires that the estimated cost of postretirement benefits be accrued over the period earned. The Company recognized the initial obligation as a one-time, after- tax charge to earnings of $1,173,000 (net of income tax effect of $703,000) in the year ended December 31, 1993. Prior to 1993, the Company recognized the costs of these benefits on the pay-as- you-go basis. The Company's current policy is to fund these benefits on a pay-as-you-go basis.\nThe amounts recognized in the Company's December 31, 1995 and 1994 balance sheets for its U.S. operations were as follows (in thousands):\nDECEMBER 31, 1995 1994 _____ _____\nAccumulated postretirement benefits obligation:\nRetirees $887 $756\nFully eligible active 366 348 participants Terminated participants not 39 73 yet receiving benefits _____ _____\nTotal accumulated postretirement $1,292 $1,177 benefits obligation\nUnrecognized net (gain) (623) (777) ______ ______\nAccrued postretirement benefit $1,915 $1,954 obligation ====== ======\nThese obligations are included in other long-term liabilities on the Company's December 31, 1995 and 1994 balance sheets.\nNet periodic postretirement benefit costs for 1995 and 1994 included the following components (in thousands):\n1995 1994 1993 ______ _____ ____\nService cost - benefits earned $12 $14 $12 during the period Interest cost 92 115 145\nAmortization (42) (4) - _____ _____ ____\nNet periodic postretirement $62 $125 $157 benefit cost ===== ==== ====\nFor measuring the postretirement benefit obligation as of December 31, 1995 an 8% annual rate of increase in health care rates was assumed for the next 7 years and 6% per year thereafter applicable to Blue Cross and Medicare Reimbursements. It was also assumed that reimbursable expenses for post-1990 retirees would be at least equal to the dollar reimbursement limitation. Increasing the annual rate of increase in health care rates by one percentage point would increase the accumulated post- retirement obligation by $55,000 and would increase the periodic post-retirement cost by $7,000. Group life insurance premiums and limitations on dollar reimbursements (applicable to post-1990 retirees) are not assumed to be subject to increases. An assumed discount rate of 8% has been used in determine the actuarial present value of the projected benefit obligation.\nUnrecognized gains and losses are amortized on a straight- line basis over the average remaining service period of active participants.\nThe Company's Canadian subsidiary also provides certain health care and life insurance benefits to eligible retired employees and their spouses. Participants generally become eligible for these benefits after achieving certain age and years of service requirements. The Company adopted SFAS No. 106 effective January 1, 1995 for its Canadian subsidiary and recognized the initial obligation as a one-time, after-tax charge to earnings of $502,000 (net of income tax effect of $282,000) in the year ended December 31, 1995.\nThe accumulated post-retirement benefits obligation at January 1, 1995 for the Canadian subsidiary includes the following (in thousands):\nRetirees and beneficiaries $600\nFully eligible active participants 184 _____\nTotal accumulated post-retirement $784 benefits obligation =====\nThe amounts recognized in the Canadian subsidiary's December 31, 1995 balance sheet was as follows (in thousands):\nDECEMBER 31, ______\nAccumulated postretirement benefits obligation:\nRetirees $445\nFully eligible active 151 participants ______ Total accumulated postretirement $596 benefits obligation\nUnrecognized net (gain) (233) ______\nAccrued postretirement benefit $829 obligation ======\nThese obligations are included in other long-term liabilities on the Canadian subsidiary s December 31, 1995 balance sheet.\nNet periodic postretirement benefit costs for 1995 included the following components (in thousands):\n_____\nService cost - benefits earned during $13 the period Interest cost 61\nAmortization - ______\nNet periodic postretirement benefit $74 cost ======\nThe pro forma effect of the change on years prior to 1995 was not determinable.\nFor measuring the post-retirement benefits obligation as of January 1, 1995, an 8% annual rate of increase in the health care rates was assumed for the next 6 years and 6% per year thereafter. Increasing the annual rate of increase in the health care rates by one percentage point in each year would increase the accumulated post-retirement benefits obligation by $73,000 (Canadian) and would increase the periodic post-retirement benefits cost by $11,000 (Canadian). The group life insurance premiums are not assumed to be subject to increase. An assumed discount rate of 8% was used.\nUnrecognized gains and losses are amortized on a straight- line basis over the average remaining service period of active participants.\nThe Company's current policy is to fund these benefits on a pay-as-you-go basis.\n12. Related party transactions\nThe Company purchased combined totals of $4,320,000, $2,626,000 and $4,426,000 of products from its affiliates, Elektroschmelzwerk Kempten GmbH, and its Norwegian joint venture during 1995, 1994 and 1993, respectively.\nThe Company has two royalty agreements with affiliates of a shareholder of the Company as described in Note 13(c).\n13. Commitments\na. Lease agreements\nThe Company leases certain machinery and equipment under operating leases. Amounts charged to expense for the years ended December 31, 1995, 1994 and 1993 were $370,000, $351,000 and $448,000, respectively. Total minimum lease payments, at December 31, 1995, under operating leases are summarized as follows (in thousands):\nOperating Year Leases _______ _________\n1996 334\n1997 249\n1998 205 _____ $788 =====\nb. Purchase Commitments\nThe Company has entered into a one-year agreement to purchase abrasive grade bauxite. Total cost remaining at December 31, 1995 under the agreement is approximately $1,928,000 and is scheduled for payment by March, 31, 1996.\nc. Royalty Agreements\nThe Company has a royalty agreement covering production of crude aluminum oxide at its Thorold, Ontario plant using process technology acquired as part of the construction and completion of a new furnace plant. A separate royalty agreement covers production of specialty product for refractory markets. The agreements are for a period of 10 years each and expire July 31, 1996 and April 30, 2001 respectively. The royalty expense in U.S. dollars amounted to $725,000, $543,000 and $641,000 in the twelve months ended December 31, 1995, December 31, 1994 and December 31, 1993, respectively. The expiration of the royalty agreement in July 1996 covering production of crude aluminum oxide will reduce operating costs by approximately $475,000 per year beginning August 1, 1996.\n14. Contingencies a. Environmental Issues\n(i) Hennepin, Illinois Plant\nOn October 6, 1994, the Company entered into a Consent Order (the Consent Order ) with the Illinois Attorney General and the Illinois Environmental Protection Agency ( IEPA ) in complete settlement of a complaint brought by them which alleged that the Company had violated certain air quality requirements in the operating permit for its Hennepin, Illinois plant. The Consent Order provides a schedule for the Company to install a Continuous Emissions Monitoring System ( CEMS ) and to implement the required Best Available Control Technology ( BACT ) for air emissions, pursuant to an IEPA approved construction and operating permit. The Company is in the process of obtaining a construction permit to implement the BACT.\nUnder the terms of the Consent Order the Company has also agreed to pay a civil penalty of $1,300,000, payable in installments of $260,000 each on November 1, 1994, April 1, 1995, February 1, 1996, January 1, 1997 and November 1, 1997. The Company recorded an expense of $1,300,000 in the year ended December 31, 1994, which represents the civil penalty.\nIn order to comply with the Consent Order and complete facility improvements, the Company expects to incur capital costs within the range from $12,000,000 to $14,000,000 over the next two years. As of December 31, 1995, the Company has incurred approximately $1,400,000 of capital costs related to the facility improvements. The Company expects to finance the costs of the required capital improvements through an underwritten credit enhanced bond offering possibly on a tax-exempt basis. The Company has obtained a modification of its Industrial Revenue Bond Agreement to allow for the required capital expenditures under the Consent Order.\n(ii) Norwegian Joint Venture\nThe Government of Norway has held discussions with certain Norwegian industries including the abrasive industry concerning the implementation of reduced gaseous emission standards. The Company's joint venture is participating in these discussions to help achieve the Norwegian Government's objectives as well as assuring long term economic viability for the joint venture.\nThe Company s joint venture appointed a project group to complete a study and define a project to minimize sulfur and dust emissions which was presented to the Norwegian State Pollution Control Authority ( Authority ) on March 1, 1995. The Authority has prepared an internal study of the report and the Authority s draft for new concessions was expected to be presented to the joint venture in February 1996. Based on a consensus for the metallurgical industry, the joint venture has initiated discussions with the Authority to obtain acceptable emissions levels. The costs associated with the implementation of environmental expenditures are uncertain as a result of various alternatives presently being considered by the Norwegian joint venture.\nb. Legal Matters\n(i) Federal Proceedings and Related Matters\nIn February 1994, the Company, its former President, its former Executive Vice President and certain other parties were the subject of an indictment under federal antitrust laws (the \"Antitrust Proceedings\") which alleged, among other things, that: (a) sometime prior to the mid-1980's and continuing into 1992, the defendants and unnamed co-conspirators entered into and engaged in a combination and conspiracy to fix the prices of artificial abrasive grain in restraint of interstate trade; (b) during the same period, the Company and its former President willfully violated the terms of a permanent injunction dated November 16, 1948 on the Company and its officers against entering into conspiracies or combinations to fix prices of artificial abrasive grain; and that c) the Company's former Executive Vice President destroyed documents and made false declarations in response to a grand jury subpoena issued in an investigation of price fixing for artificial abrasive grain.\nOn December 8, 1994, in an ex parte proceeding the U.S. Defense Logistics Agency (the \"DLA\") issued a Memorandum of Decision that temporarily suspended the defendants in the Antitrust Proceedings from contracting with the U.S. Government under procurement or non-procurement programs pending the completion of the Antitrust Proceedings. On January 31, 1995, the DLA amended the Memorandum of Decision (as amended, the \"DLA Suspension\") to include under the DLA Suspension sixteen alleged affiliates of the defendants including the Company's subsidiary, Exolon-ESK Company of Canada Ltd., and Orkla-Exolon K\/S, the Norwegian partnership in which the Company's subsidiary, Norsk Exolon A\/S, has a 50% partnership interest. The DLA Suspension alleges as causes for the suspension (I) the indictments of the parties in the Antitrust Proceedings, and (ii) on separate occasions in October and November of 1994 the Company s former President and former Executive Vice President individually made alleged false certifications in DLA sales contracts denying the existence within the past three years of any indictments of the kind involved in the pending Antitrust Proceedings. A jury trial on a separate criminal complaint against the Company and the former Executive Vice President based on the alleged false certifications in DLA sales contracts found the Company and the former Executive Vice President not guilty of all charges.\nIn general, the DLA Suspension provides, during the term of the suspension, that the suspended parties will be prohibited from entering into new contracts, or renewing or extending old contracts with the U.S. government or its agencies, unless the head of the contracting agency states in writing that there is a compelling reason to do so; that the suspended parties may not conduct business with the U.S. Government as an agent or representative of other contractors; that no U.S. Government contractor may award a suspended party a subcontract in excess of $25,000 unless there is compelling reason to do so and the contracting party complies with certain notification provisions; and, that each suspended party's relationship to any organization doing business with the government will be examined to determine the impact of those ties on the responsibility of the other organization to be a government contractor or subcontractor.\nAt this time, the Company is not able to predict the amount and nature of criminal penalties or fines that might be imposed against the Company or its former President or former Executive Vice President, if any of them were convicted of any of the charges alleged in the Antitrust Proceedings, but if the Antitrust Proceedings were resolved in a manner adverse to the Company, such penalties or fines could be substantial and could materially adversely affect the Company. The Company believes there are meritorious defenses to the alleged violations and, accordingly, the Company believes that the DLA Suspension against it will be lifted at the conclusion of the Antitrust Proceedings. The Company intends to vigorously defend against the Antitrust Proceedings and to seek to have the DLA Suspension against it lifted as soon as possible.\nThe DLA Suspension, for so long as it remains in force, will prevent the Company from purchasing crude abrasive grains from U.S. Government stockpiles, but is not otherwise expected to impact the Company's operations as the Company does not otherwise deal with the U.S. Government as a contractor or subcontractor. As long as there is an adequate supply of crude abrasive grains and the U.S. Government does not sell from its stockpiles of such grains at below market prices, the DLA Suspension is not expected to have a material adverse effect on the Company's operations. Presently, and for at least the next one year period, the Company expects crude abrasive grains to be in adequate supply. However, the Company is unable to predict under what circumstances the U.S. Government might choose to sell from its stockpiles, and if it were to undertake an aggressive program of selling abrasive grains at below market prices the Company could be placed at a disadvantage in relation to its competitors.\nOn October 18, 1994, a law suit was commenced in the U.S. District court for the Eastern District of Pennsylvania (No. 94- CV-6332) under the title \"General Refractories Company v. Washington Mills Electro Minerals Corporation and Exolon-ESK Company.\" The suit purports to be a class action seeking treble damages from the defendants for allegedly conspiring with unnamed co-conspirators during the period from January 1, 1985 through the date of the complaint to fix, raise, maintain and stabilize the price of artificial abrasive grains and to allocate among themselves their major customers or accounts for purchases of artificial grains, in violation of Section 1 of the Sherman Act, 15 U.S.C. 1. The plaintiffs allegedly paid more for abrasive grain products than they would have paid in the absence of such anti-trust violations and were allegedly damaged in an amount that they are presently unable to determine. On or about July 17, 1995, a law suit captioned Arden Architectural Specialties, Inc. v. Washington Mills Electro Minerals Corporation and Exolon-ESK Company, (95-CV-05745(m)), was commenced in the United States District Court for the Western District of New York. The Arden Architectural Specialties complaint purports to be a class action that is based on the same matters alleged in the General Refractories complaint. The Company believes that it has meritorious defenses to the allegations, and it intends to vigorously defend against the charges.\nIn addition to the potential liabilities that the Company may experience in the legal proceedings brought by the Department of Justice and third parties, the Company may incur material expenses in defending against the actions, and it may incur such expenses even if it is found to have no liability for any of the charges asserted against it.\n(ii) Exolon-ESK Company of Canada, LTD.\nIn June 1993, the Company commenced a legal action (the Perrotto Case ) in Ontario, Canada Court (General Division) against one of its former officers and certain former employees of Exolon-ESK Company of Canada, LTD. (Exolon-Canada) on various charges related to allegations that they defrauded the Company and Exolon-Canada of money, property and services over many years. The Company is seeking $2,000,000 in damages together with such other damages that may be determined. A reasonable estimation of the Company's potential recovery, if any, cannot be made at this time.\nOn February 29, 1996, the Company and Exolon-Canada entered into a Final Release (the Release ) with their insurance carriers whereby they agreed to release the carriers from all claims based on the activities of the defendants in the Perrotto Case in consideration of a payment of $535,000 Canadian (approximately $390,000 U.S.). Under the terms of the Release, the insurance carriers denied any liability, and the payment may not be indicative of the amount of any recovery that may be obtained from the defendants.\n15. Quarterly Financial Data (unaudited)\nSummarized quarterly financial data for 1995 and 1994 is as follows:\nQUARTER\n(thousands of dollars FIRST SECOND THIRD FOURTH except per share amounts) ______ _______ _______ _______\nYear Ended December 31,\nNet Sales $17,177 $17,131 $17,094 $17,190 Gross Profit Before 3,788 3,922 4,052 3,628 Depreciation\nEarnings Before Cumulative Effect of Accounting Change 938 1,014 1,175 837\nCumulative Effect of (762) - - 260 Accounting Change ______ ______ ______ ______\nNet Income $176 $1,014 $1,175 $1,097 ====== ====== ====== ======\nPrimary Earnings Per Common Share Before Cumulative $0.96 $1.04 $1.21 $0.86 Effect of Accounting Change\nCumulative Effect of (0.79) - - 0.27 Accounting Change ______ ______ ______ ______\nPrimary Earnings Per Common $0.17 $1.04 $1.21 $1.13 Share Primary Earnings Per Class A Common Share Before $0.90 $0.98 $1.14 $0.80 Cumulative Effect of Accounting Change\nCumulative Effect of ($0.74) - - $0.25 Accounting Change ______ ______ ______ ______\nPrimary Earnings Per Class $0.16 $0.98 $1.14 $1.05 A Common Share ====== ====== ====== ======\nYear Ended December 31, Net Sales $14,155 $15,252 $15,185 $14,902\nGross Profit Before 2,644 3,159 3,435 3,625 Depreciation\nNet Income (Loss) 121 75 (171) 1,491 ====== ====== ====== ======\nPrimary Earnings (Loss) Per $0.11 $0.07 ($0.17) $1.52 Common Share Primary Earnings (Loss) Per Class A Common Share $0.11 $0.06 ($0.16) $1.43 ====== ====== ====== ======\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nReference is made to the form 8-K s dated October 12, 1994 and October 24, 1994 which are hereby incorporated herein by reference.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nSee the information relating to directors and officers of the Company under the captions \"The Election of Directors\", contained in the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 24, 1996, which is hereby incorporated by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nSee the information relating to \"Compensation of Executive Officers\" presented in the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 24, 1996, which is incorporated herein by reference, except that information appearing under the headings \"Report of the Executive Committee on Executive Compensation\" and \"Summary Share Performance Graph\" is not incorporated herein and should not be deemed to be included in this document for any purpose.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSee the information relating to directors and officers of the Company under the captions \"Security Ownership of Certain Beneficial Owners and Management\", contained in the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 24, 1996, which is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee the information relating to directors and officers of the Company under the captions \"Certain Relationships and Related Transactions\", contained in the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 24, 1996, which is hereby incorporated by reference.\nPART IV Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this report Page In Form 10-K\n1) Report of Independent Accountants:\nFinancial Statements: Consolidated Statements of Operations, three years ended 18 December 31, 1995 Consolidated Balance Sheets at 19 December 31, 1995 and 1994 Consolidated Statements of Cash Flows, three years ended December 31, 20 Consolidated Statements of Changes in Stockholders' Equity, three years 21-22 ended December 31, 1995\nNotes to Consolidated Financial 23-43 Statements 2) Financial Statement Schedule for three years ended December 31, 1995:\nII. Valuation and qualifying accounts 48\nAll other required schedules have been omitted because they do not apply to the Company.\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n(a) (3) Exhibits Exhibit No. Description Reference\n3A Restated Certificate of Exhibit 3A. Incorporation\n3A(1) Certificate of Merger Exhibit 3A(1). 3E Amendment to By-Laws dated Exhibit 3E to the Report March 23, 1991 on Form 10-Q dated March 31, 1991*\n3F Certificate of Amendment of Exhibit 3F to the Report Restated Certificate of on Form 10-K for the Incorporation dated April year ended December 31, 23, 1986 1994* 3G Certificate of Amendment of Exhibit 3G to the Report Restated Certificate of on Form 10-K for the Incorporation dated May 4, year ended December 31, 1987 1994*\n3H By-Laws Exhibit 3H to the Report on Form 10-K for the year ended December 31, 1994*\n4 Instruments Defining Rights Articles of of Security Holders Incorporation, Exhibits 3A, and Exhibits 3F and 3G to the Report on Form 10-K for the year ended December 31, 1994* 10D(23) Revolving Credit Agreement Exhibit 10D(23) to the dated December 22, 1992 Report on Form 10-K for the year ended December 31, 1992*\n10D(24) Industrial Revenue Bond Exhibit 10D(24) to the Agreement dated January 1, Report on Form 10-K for 1993. the year ended December 31, 1992* 10F Stockholder's Agreement Exhibit 10F. dated as of April 26, 1984 between the Registrant and Wacker Chemical Corporation\n10G Restated License Agreement Exhibit 10G. dated as of April 26, 1984 among Elektroschmelzwerk Kempten GmbH, ESK Corporation and the Registrant\n10H Distributorship Agreement Exhibit 10H. dated April 27, 1984 between Elektroschmelzwerk Kempten GmbH, and the Registrant 10I Indemnification Agreement Exhibit 10I. dated as of December 15, 1984 between Wacker Chemical Corporation and the Registrant\n10K Contract between Theeb, Ltd. Exhibit 10K to the and The Exolon-ESK Company Report on Form 10-K for of Canada, Ltd. dated the year ended December February 28, 1985 31, 1992* 10M Federal Indictments dated Exhibit 10M to the February 11, 1994 Report on Form 10-K for the year ended December 31, 1993*\n11 Statement of computation of Exhibit 11 per share earnings\n21 Amendment of Certificate of Exhibit 21 to the Report Incorporation dated October of Form 10-Q for the 28, 1992 quarter ended September 30, 1992.\n22 Subsidiaries of the Exhibit 22 registrant 27 Financial Data Schedule Exhibit 27\n(b) Reports on Form 8-K:\nNone.\n(c) All exhibits required by Item 601 of Regulation S-K are included in Item 14(a)(3).\n(d) Separate Financial Statements of Subsidiary Not Consolidated and 50% Owned\nSee the accompanying index to Orkla Exolon K\/S financial statements and financial statement schedules on pages 49-64.\nSchedule II\nEXOLON-ESK COMPANY AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1995 (thousands of dollars)\nADDITIONS NET BALANCE CHARGED ACCOUNTS AT TO COSTS RECEIVABLE BALANCE BEGINNING AND CHARGED AT END DESCRIPTION OF YEAR EXPENSES OFF OF YEAR ___________________ ________ ________ _________ _______\nDeducted from assets - Allowance for doubtful accounts\nYear ended December $309 $110 -- $419 31, 1995 Year ended December $307 $20 ($18) $309 31, 1994\nYear ended December $293 $20 ($6) $307 31, 1993\nOrkla Exolon KS, Orkanger - Norway\nPage\nReport of independent auditor 2\nBalance sheets at December 31, 1995 and 1994 3 - 4\nStatements of income and retained earnings for the three years ended December 31, 1995, 1994 and 1993 5\nStatements of cash flows for the three years ended December 31, 1995, 1994 and 1993 6 - 7\nNotes to the financial statements 8 - 13\nFinancial schedules for the three years ended December 31, 1995, 1994 and 1993:\nII Valuation and qualifying accounts and reserves 14\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nTo The Partners of\nOrkla Exolon KS\nTrondheim, February 9, 1996\nReport of Independent Public Accountant.\nWe have audited the accompanying balance sheets of Orkla Exolon KS as of December 31, 1995 and 1994, and the related statements of income and cash flows for each of the three years in the period ended December 31, 1995. These financial statements and related schedules 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 audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Orkla Exolon KS as of December 31, 1995 and 1994, and the results of its operations and cash flows for 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 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, .\nERNST & YOUNG - TRONDHEIM AS\nHans J Jonassen State Authorized Public Accountant, (Norway)\nBALANCE SHEET AT DECEMBER 31st\nAssets NOK 1995 NOK 1994\nCurrent Assets\nCash 14,461,939 9,386,111 Trade receivables, less allowance for doubtful accounts of NOK 380 000 16,499,168 17,120,092\nOther accounts receivable and prepayments 2,776,714 2,665,939\nReceivable from related parties 5,570,011 5,214,232 (Note 4)\nInventories (Note 3) 20,194,000 20,960,000 __________ __________\nTotal current assets 59,501,832 55,346,374\nLong-Term Receivables and Other 7,025,136 6,466,136 Assets (Note 5)\nProperty, Plant and Equipment\nAt cost Land 507,930 507,930\nBuildings 18,127,175 17,988,414\nMachinery, equipment and installations 43,779,235 35,526,285 __________ __________\n62,414,340 54,022,629\nAccumulated depreciation (35,989,31) (34,109,640) ___________ ____________\nNet property, plant and equipment 26,425,030 19,912,989 __________ __________\nTotal assets 92,951,998 81,725,499\nThe accompanying notes are an integral part of these financial statements.\nBALANCE SHEET AT DECEMBER 31st\nLiabilities and Partners' Interest NOK 1995 NOK 1994\nCurrent Liabilities\nBank indebtedness (Note 6) 3,000,000 3,000,000\nAccounts payable and accruded expenses 14,960,958 13,329,427 Portion of long-term debt repayable within one year (Note 7) 483,334 483,334 __________ __________\nTotal current liabilities 18,444,292 16,812,761\nLong-Term Debt\nMortgage loans (Note 7) 5,074,999 5,558,333\nPortion repayable within one year (483,334) (483,334) (Note 7) __________ __________\nTotal long-term debt 4,591,665 5,074,999\nPartners' Interest\nPaid-in capital (Note 8) 11,349,100 11,349,100\nRetained earnings 58,566,941 48,488,639 __________ __________\nTotal partners' interest 69,916,041 59,837,739 __________ __________\nTotal liabilities and partners' 92,951,998 81,725,499 interest\nCommitments and Contingent Liabilities (Note 9)\nThe accompanying notes are an integral part of these financial statements.\nSTATEMENT OF INCOME AND RETAINED EARNINGS\nFOR THE YEARS ENDED DECEMBER 31st\nIncome from Operations NOK 1995 NOK 1994 NOK 1993\nSales 103,426,909 96,220,973 77,449,041\nCost of sales exclusive of depreciations shown below 78,782,750 79,020,248 68,495,781\nGross income 24,644,159 17,200,725 8,953,260\nDepreciation 2,129,670 1,597,094 1,423,216 Selling, general and administrative expenses 12,742,064 9,129,804 10,402,262\nBad debts, net (107,430) 94,260 (867,869) __________ __________ __________\nIncome\/loss from operations 9,879,855 6,379,567 (2,004,349)\nOther Income\/Expense\nInterest on mortgage loans and bank overdraft (394,659) (631,827) (620,949)\nInterest income 489,941 156,774 53,744\nForeign exchange gain\/loss 103,165 (245,073) 884,133\nGain on investments 0 0 0 __________ __________ __________\nIncome\/loss from other activities 198,447 (720,126) 316,928\nIncome\/loss for the yr. 10,078,302 5,659,441 (1,687,421)\nRetained earnings at January 1st 48,488,639 42,829,198 44,516,619 __________ __________ __________\nRetained earnings at December 31st 58,566,941 48,488,639 42,829,198\nThe accompanying notes are an integral part of these financial statements.\nSTATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31st\nCash Flows from Operating Activities NOK 1995 NOK 1994 NOK 1993\nNet income 10,078,302 5,659,441 (1,687,421)\nAdjustments to reconcile net income to net\ncash provided by operating activities:\nDepreciations 2,129,670 1,597,094 1,423,216\nGain\/Loss sale property, (250,000) (452,521) 28,500 plant & equipment Gain\/Loss on other 0 0 0 investments\nChange in assets and liabilities:\nIncrease\/Decrease 154,370 1,302,797 (6,449,710) inreceivables and prepayments\nIncrease\/Decrease in 766,000 892,000 3,021,000 inventories\nIncrease\/Decrease in (559,000) (585,129) (659,084) pension benefit plan\/prepaid pension premiums\nIncrease\/Decrease in 1,631,531 1,557,980 105,008 accounts payable and _________ _________ _________ accrued expenses\n3,872,571 4,312,221 (2,531,070) __________ _________ __________\nCash flow from operating 13,950,873 9,971,662 (4,218,491) activities\nSTATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31st\nCash Flow from Investment Activities NOK 1995 NOK 1994 NOK 1993\nCapital expenditures (8,641,711) (2,575,169) (392,000)\nSales of bonds 0 0 0 Sale of property, plant 250,000 715,000 84,000 and equipment __________ __________ __________\nCash flow from (8,391,711) (1,860,169) (308,000) investment activities\nCash Flow from Financial Activities\nIncrease in bank 0 2,282,000 3,518,000 indebtedness\nRepayment of long-term (483,334) (2,230,762) (435,722) debt __________ __________ __________ Cash from financial (483,334) 51,238 3,082,278 activities __________ __________ __________ Net increase\/decrease 5,075,828 8,162,731 (1,444,213) in cash and cash equivalents\nCash and cash 9,386,111 1,223,380 2,667,593 equivalents at the __________ __________ __________ beginning of year\nCash and cash 14,461,939 9,386,111 1,223,380 equivalents at the end of year\nSupplemental disclosure of cash flow information\nCash paid during the 403,178 584,058 640,468 year for interest:\nThe accompanying notes are an integral part of these financial statements.\nOrkla Exolon KS\nNOTES TO THE FINANCIAL STATEMENTS (All amounts expressed in NOK)\n1) Operations\nThe company is organized as a limited partnership under Norwegian law. The main business activity is the manufacture and processing in Norway of Silicon Carbide, an abrasive product.\n2) Summary of Significant Accounting Policies\na. Taxes\nNo provisions for taxes are made in the financial statements of the company because, as a limited partnership, it is not subject to income tax, the tax effect of its activities accruing to the partners.\nb. Inventories\nFinished goods and work in progress are stated at the lower of average production cost and market. Cost comprises raw materials, power, direct labour and manufacturing overhead. Raw materials and supplies are stated at the lower of average purchase cost and market. Cost comprises materials, freight and handling.\nc. Property, plant and equipment and related depreciation\nProperty, plant and equipment are stated at cost. Depreciation has been recorded on the basis of cost using the straight line method at the following rates which are estimated to depreciate the assets over their useful lives in the business:\nLand 0% Buildings 2% Machinery and installations 6% Equipment and vehicles 10%\nMaintenance and repairs are expensed as incurred, major renewals and betterments are capitalized.\nTransactions denominated in foreign currencies are translated into Norwegian kroner at the approximate exchange rates ruling at the date of the individual transaction. Foreign currency denominated assets and liabilities are translated into Norwegian kroner at the approximate exchange rates ruling at the year end.\ne. Pension\nThe company has an insured pension plan which provides pension for eligible employees on retirement at the age of 67 years or earlier in the event of disability, and for widows, widowers and dependent children of deceased employees covered by the plan. The basis for the pension on retirement is the final salary at that date. Number of service years required to obtain full pension is 30 years. The pension benefits are secured by collective insurance policy. The company's insured pension is coordinated with the obligatory state pension scheme and is a benefit plan per. FASB 87.\nf. 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 estimates.\n3) Inventories\nInventories consist of: 1995 1994 ________ ________\nFinished Goods 7,385,000 7,895,000 Work in progress 8,937,000 8,469,000 Raw materials 2,836,000 2,800,000 Supplies (net)*) 1,036,000 1,796,000 __________ __________\n20,194,000 20,960,000\n*) Supplies are included net of an obsolescence provision of NOK 1 282 000.\n4) Related Party Transactions\nAmounts receivable from\/payable to related parties consist of:\nReceivable from: 1995 1994 ______ ______\nThe Exolon - ESK Company, 963,436 522,343 New York, USA\nOrkla Exolon AS 4,606,575 4,691,889\nNorsk Exolon AS 0 0 _________ _________\nTotal receivable from 5,570,011 5,214,232 related parties\nPayable to:\nOrkla AS 106,440 76,600\nSales: 1995 1994 1993 _______ _______ _______\nExolon ESK Comp 5,255,893 5,567,746 4,641,462\nESK Germany 0 679,386 0\nThe Exolon - ESK Company, New York, USA is the ultimate holding company of Norsk Exolon AS.\nPurchases\nPurchases of goods and services from related parties during the year were as follows:\n1995 1994 1993 _____ _____ _____\nOrkla AS 341,607 337,633 302,845\nBorregaard 297,422 0 0\nThe Exolon - ESK Company, New York, USA 0 0 77,750 Elektrosmeltzwerk, Kempten, Germany 371,500 215,100 334,900 _______ _______ _______\nTotal purchases from related parties 1,010,529 552,733 715,495\n5) Pensions\nFor the calculation for Orkla Exolon KS is used main assumptions of 5% interest, 7% rate of return and 2% salary increases. The company's funding exeed their obligations and net value of funding and obligations is classified as long term receivables. Total assets of the pension plan at December 31, 1995 were NOK 26 286 000.\nPrior years the company has booked pension premium fund only. Pension premium fund is used for advance payments for insured collective pensions plan to obtain deductions for tax purposes. Some changes to the fund, such as bonuses, was booked upon as revaluation and amortized over 12 years. This amortization plan is continued and will cause yearly credit of NOK 209 000.\nThis years movements in caption for long term receivables and other assets can be summarized as follows:\n_________\nNet value of benefit plan as of 1.1.95 7,224,279\nDifference between actuarial calculation and pension premium fund as of 1.1.95 0\nRest revaluation pension premium fund as of 1.1.95 (758,143)\nPrepaid pension premium as of 1.1.95 0\nBooked pension premium fund as of 12.31.94 6,466,136\nNet pension premium 1995 350,000\nRevaluation pension premium fund 1995 209,000 ________\nBooked value of benefit plan as of 12.31.95 7,025,136\nRest revaluation pension premium fund as of 299,269 12.31.95 ________\nNet value of benefit plan as of 12.31.95 7,324,405\n6) Bank Indebtedness\nThe company has an overdraft facility of NOK 3 000 000. The company pays a commission on the total facility of 1%. Interest on the amount utilised is the banks prime rate + 0.5%. In addition, the bank is comitted to lend the company up to NOK 3 000 000 in equivalent DEM amount until September 31, 1996. The interest rate is LIBOR + 1.5%. These loan-facilities are secured on properties, plant and equipment, raw materials, work in progress and finished goods. Unused line of credit at December 31, 1995 was NOK 3 000 000 and NOK 3 000 000 at December 31, 1994.\n7) Long-Term Debt\nLong-term debt consist of:\nINTEREST LENDER SECURITY RATE 1995 1994 1993 __________ _________ ________ _______ _______ _______\nDen Norske First 12.70% 0 0 0 Industribank mortgage Second 12.70% 0 0 175,000 mortgage (Buildings, machinery & equipment)\nDen Norske Third 8.00% 0 0 123,526 Industribank mortgage (Buildings, machinery & equipment)\nDen Norske Fourth 9.70% 0 0 461,540 Industribank mortgage\nDen Norske Fifth 8.00% 0 0 861,529 Industribank mortgage (Buildings, machinery & equipment)\nDen Norske Sixth 12.00% 0 0 367,500 Industribank mortgage _______ (Buildings, machinery & equipment)\nSND First 6.80% 5,075,000 5,558,333 mortgage _________ _________ (Buildings, machinery & equipment)\nMortgage loans as of December 31st 5,075,000 558,333 1,989,095\nREPAYMENT TERMS\n1996 483,333 1997 483,333 1998 483,333 1999 483,333 2000 onwards 3,141,668 __________ 5,075,000\n8) Paid-in Capital\nTHE PAID-IN CAPITAL IS AS FOLLOWS:\nSHARE IN PARTNERSHIP NOK\nNorsk Exolon AS, Orkanger 42.3285% 4,803,900 Orkla AS, Oslo 42.3285% 4,803,900 Orkla Exolon AS, Orkanger 15.3430% 1,741,300 ________ _________\n100.0000% 11,349,100\n9) Commitments and Contingent Liabilities\nEnvironmental standards\nThe company is still involved in discussions with the Norwegian State Pollution Control Authority (SFT) regarding environmental issues. These issues are mainly related to dust and SO2-emission.\nFollowing open issues exists:\nAuthorities have not yet specified which environmental requirements the company has to follow.\nThese are uncertainties connected to which technological methods to use to meet environmental requirements.\nThere exist uncertainty regarding the financial consequences connected to environmental requirements.\nThe Authorities (SFT) has announced that the existing permission for emission is withdrawn from January 1, 1996. The company has presented plans to SFT for how to solve environmental issues. These plans will form basis for the Authorities evaluation of further permission for future emission.\nSFT's draft for a new concession will be presented in February 1996.\n10) Unrecorded Adjustments\nThe adjustments shown below have been made to present the accompanying financial statements in accordance with US generally accepted accounting principles and Exolon ESK company accounting principles:\nIncrease(+)\/decreace(-) in:\nSTATEMENT RETAINED OF INCOME EARNINGS\n1995 *) 16,579 9,670,117\n1994 *) (56,955) 9,653,538\n1993 (Change in N GAAP re. (261,450) Acc. principles for pensions)\n1993 766,758 9,971,943 1992 **) (9,667,305) 9,205,185\n1991 ***) (13,401,790) 18,872,490\n*) Differences in 1995 and 1994 is due to:\nStatement of income: 1995 1994 _______ _______\nEffect of different (392,421) (265,955) depreciation rates Effect of different capital 200,000 0 expenditures\nEffect on accounting of 209,000 209,000 pension per FASB 87\nEffect on different loss on 0 0 disposal fixed assets\n16,579 (56,955)\nRetained earnings:\nInventory obsolensence (1,282,000) (1,282,000) (supplies)\nBenefit plan per FASB 87 (299,268) (508,268)\nFixed assets 11,251,385 11,443,806 __________ __________\n9,670,117 9,653,538\n**) The decrease in difference between retained earnings per US GAAP and local books in 1992 is mostly due to change in Norwegian accounting principles.\n***) The decrease in difference between retained earning per US GAAP and local books in 1991 is mostly due to changes in Norwegian tax regulation as some of the tax related reserves were made permanent as of January 1, 1991. This does not effect the financial statements of Orkla Exolon KS per US GAAP (see note 2a)\nValuation and Qualifying Accounts and Reserves Schedule II\nREALIZED ADDITION LOSSES BALANCE CHARGED BALANCE ON AT TO AT END ACCOUNTS BEGINNING COST AND OF RECEIV- CLASSIFICATIONS OF PERIOD EXPENSES PERIOD ABLES ________________ _________ _________ ______ ________\nYear ended December 31, 1995\nAllowance for 380,000 doubtful accounts\nYear ended December 31,1994\nAllowance for 343,000 37,000 380,000 57,260 doubtful accounts\nYear ended December 31,1993\nAllowance for 1,230,000 (887,000) 343,000 19,131 doubtful accounts\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.\nMarch 15, 1996 EXOLON-ESK COMPANY\nS\/ J. Fred Silver By:________________________ J. Fred Silver, 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.\nS\/ J. Fred Silver _____________________\nJ. Fred Silver, President and Chief Executive Officer\nS\/ James A. Bernardoni _____________________ James A. Bernardoni, Vice President Finance, and Principal Accounting Officer\nS\/ Theodore E. Dann, Jr. ________________________\nTheodore E. Dann, Jr. Chairman of the March 15, 1996 Board\nS\/ Brent D. Baird ________________________ Brent D. Baird Director March 15, 1996\nS\/ Dirk Benthien _______________________\nDirk Benthien Director March 15, 1996\nS\/ Dr. Hans Essler _______________________\nDr. Hans Essler Director March 15, 1996\nS\/ Dr. Hans Herrmann _______________________ Dr. Hans Herrmann Director March 15, 1996\nS\/ Patrick W. E. Hodgson ________________________\nPatrick W.E. Hodgson Director March 15, 1996\nS\/ Joseph R. Pinotti _______________________ Joseph R. Pinotti Director March 15, 1996\nEXHIBIT INDEX Exhibit No. Description Reference\n3A Restated Certificate of Exhibit 3A on pages 68-84 Incorporation\n3A(1) Certificate of Merger Exhibit 3A(1) on pages 85-93 3 Amendment to By-Laws dated Exhibit 3E to the report March 23, 1991 on Form 10-Q for the quarter ended March 23, 1991*\n3F Certificate of Amendment of Exhibit 3F to the report Restated Certificate of on Form 10-K for the year Incorporation dated April ended December 31, 1994* 23, 1986 3G Certificate of Amendment of Exhibit 3G to the report Restated Certificate of on Form 10-K for the year Incorporation dated May 4, ended December 31, 1994*\n3H By-Laws Exhibit 3H to the report on Form 10-K for the year ended December 31, 1994*\n4 Instruments Defining Rights Articles of of Security Holders Incorporation, Exhibits 3A, and Exhibits 3F and 3G to the report on Form 10-K for the year ended December 31, 1994*\n10D(23) Revolving Credit Agreement Exhibit 10D(23) to the dated December 22, 1992 Report on Form 10-K for the year ended December 31, 1992*\n10D(24) Industrial Revenue Bond Exhibit 10D(24) to the Agreement dated January 1, Report on Form 10-K for 1993. the year ended December 31, 1992* 10F Stockholder's Agreement Exhibit 10F on pages 94- dated as of April 26, 1984 100 between the Registrant and Wacker Chemical Corporation\n10G Restated License Agreement Exhibit 10G on pages 101- dated as of April 26, 1984 115 among Elektroschmelzwerk Kempten GmbH, ESK Corporation and the Registrant\n10H Distributorship Agreement Exhibit 10H on pages 116- dated April 27, 1984 129 between Elektroschmelzwerk Kempten GmbH and the Registrant\n10I Indemnification Agreement Exhibit 10I on pages 130- dated as of December 15, 131 1984 between Wacker Chemical Corporation and the Registrant\n10K Contract between Theeb, Exhibit 10K to the Ltd. and the Exolon-ESK Report on Form 10-K for company of Canada, Ltd. the year ended December dated February 28, 1985 31, 1992* 10M Federal Indictments dated Exhibit 10M to the Report February 11, 1994 on Form 10-K for the year ended December 31, 1993*\n11 Statement of computation of Page 132 per share earnings 21 Amendment of Certificate of Exhibit 21 to the Report Incorporation dated October on Form 10-Q for the 28, 1992 quarter ended September 30, 1992*\n22 Subsidiaries of the Page 133 registrant\n27 Financial Data Schedule Submitted Electronically\n* Incorporated herein by reference\nExhibit 3A\nRESTATED\nCERTIFICATE OF INCORPORATION\nOF\nThe Exolon Company\nThe original Certificate of Incorporation of The Exolon Company was filed with the Secretary of State of the State of Delaware on December 5, 1975. This Restated Certificate of Incorporation was duly adopted by the stockholders on April 12, 1984, in accordance with the provisions of Sections 245 & 242 of the General Corporation Law of the State of Delaware.\nFIRST. The name of the Corporation is Exolon-ESK Company.\nSECOND. The address of its registered office in the State of Delaware is 100 West Tenth Street in the City of Wilmington, County of New Castle. The name of the registered agent at such address is The Corporation Trust Company.\nTHIRD. The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.\nFOURTH. The number of shares of all classes which the Corporation is authorized to have outstanding is 1,300,000 shares, consisting of (I) one hundred thousand (100,000) preferred shares without par value, issuable in series (hereinafter designated \"Preferred Stock\"), (ii) six hundred thousand (600,000) common shares with a par value of one Dollar ($l) per share (hereinafter designated \"Common Stock\"), and (iii) six hundred thousand (600,000) common shares with a par value of $1 (hereinafter designated \"Class A Common Stock\"). The express terms and provisions of the shares of each class are as follows:\nSUBDIVISION A PREFERRED STOCK ISSUABLE IN SERIES\nThe Preferred Stock may from time to time be divided into and issued in one or more series. Except to the extent herein provided, the different series shall be established and designated, the rights and preferences thereof established and the variations in the relative rights and preferences as between the different series shall be established by the Board of Directors as herein provided. In all other respects all shares of Preferred Stock shall be identical.\nThe Preferred Stock may be issued from time to time by authority of the Board of Directors for such consideration as from time to time may be fixed by vote of the Board of Directors.\nThe Board of Directors is hereby expressly authorized, subject to the provisions of these Articles, to establish one or more additional series of Preferred Stock and, with respect to each such series, to establish:\n(1) the number of shares constituting such series and the distinctive designation thereof;\n(2) the dividend rate on the shares of such series and the dividend payment dates, and whether the shares of such series shall be entitled to any participating or other dividends in addition to dividends at such rate, and if so on what terms;\n(3) whether or not the shares of such series shall be redeemable and, if redeemable, the redemption prices and the terms and manner of redemption;\n(4) the preferences, if any, and the amount or amounts per share which the shares of such series shall be entitled to receive upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation;\n(5) whether or not the shares of such series shall be subject to the operation of retirement or sinking funds to be applied for redemption of such shares and, if so, the annual amount thereof and the terms and provisions relative to the operation thereof;\n(6) the terms and conditions, if any, upon which shares of such series shall be convertible into, or exchangeable for, shares of stock of 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(7) the conditions under which and matters on which the shares of such series shall vote as a separate class;\n(8) limitations or restrictions, if any, on the issuance of additional shares of such series or any shares of any other series of Preferred Stock; and\n(9) such other preferences or restrictions or qualifications thereof as the Board of Directors may deem advisable and as are not inconsistent with law and the provisions of this Restated Certificate of Incorporation.\nEach share of Preferred Stock of any series shall be entitled to one vote per share, each such series voting as a single class with the holder of common shares of a stated class of the Corporation. Votes need not be written ballot unless requested by the holder of shares entitled to vote thereon.\nNotwithstanding the fixing of the number of shares constituting a particular series, the Board of Directors may any time thereafter authorize the issuance of additional shares of the same series.\nHolders of Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available therefor, cumulative cash dividends at the annual rates fixed hereby or by the Board of Directors for the respective series. Until all accrued dividends on all series of Preferred Stock shall have been declared and set apart for payment through the last preceding dividend date set for all such series, no cash payment or distribution shall be made to holders of any other class of stock of the Corporation. Arrearages in the payment of dividends shall not bear interest. No dividend shall be declared and set apart for payment on any series of Preferred Stock if dividends are in arrears on any other series. Nothing herein contained shall be deemed to limit the right of the corporation to purchase or otherwise acquire at any time any shares of its capital stock, provided that no shares of capital stock shall be repurchased at any time when dividends on any series of Preferred Stock are in arrears.\nAny shares of Preferred Stock which shall have been purchased or redeemed, or which shall at any time have been surrendered for conversion o r exchange or for cancellation pursuant to any retirement or sinking fund provision with respect to any series of Preferred Stock, shall be retired and shall thereafter have the status of authorized and unissued shares of Preferred Stock undesignated as to series.\nSUBDIVISION B SPECIAL TERMS AND PROVISIONS APPLICABLE TO $1.12-1\/2 SERIES A CONVERTIBLE PREFERRED STOCK\nThere shall be a series of Preferred Stock which shall consist of Thirty-one Thousand Five Hundred Twenty-three (31,523) shares of said Preferred Stock and which shall constitute a series designated as the $1.12-1\/2 Series A Convertible Preferred Stock (hereinafter referred to as the \"Series A Preferred Stock\").\n(1) Dividends.\nThe holders of the Series A Preferred Stock shall be entitled to receive, as and when declared by the Board of Directors out of any funds legally available therefor, cumulative cash dividends at the annual rate of $1.12-1\/2 per share held, payable quarterly on the last day of November, February, May and August in each year.\n(2) Redemption.\n(a) The Corporation may, pursuant to a resolution adopted by the Board of Directors, redeem on any dividend payment date all or any part of the Series A Preferred Stock at the time outstanding at a redemption price of $25 per share, together with all dividends accrued thereon to the date fixed for such redemption. If less than all of the outstanding shares of the Series A Preferred Stock are to be redeemed, the shares to be redeemed, the shares to be redeemed shall be determined by lot or pro rata in such manner as the Board of Directors may prescribe.\n(b) Notice of every redemption shall be mailed, addressed to the holders of record of the shares to be redeemed at their respective addresses as they shall appear on the books of the Corporation, at least twenty (20) days and not more than sixty (60) days prior to the date fixed for redemption.\n(c) If on or before the redemption date the redemption price, together with accrued dividends to the date fixed for redemption, shall have been set aside by the Corporation, separate from its other funds in trust for the pro rata benefit of the holders of the shares called for redemption, then after the date of redemption notwithstanding that any certificate for shares of the Series A Preferred Stock so called for redemption shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the dividends thereon shall cease to accrue, and all rights with respect to such shares shall terminate on the redemption date, except for the right of the holders thereof to receive the redemption price of and dividends accrued on the shares so redeemed without interest.\n(3) Liquidation, Dissolution and Winding-Up.\n(a) In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the affairs of the Corporation, then before any distribution or payment shall be made to the holders of the common shares of any class, the holders of the Series A Preferred Stock shall be entitled to be paid in full an amount equal to $25 per share, together with all dividends accrued thereon to such distribution or payment date. If the amounts so payable are not paid in full, the holders of all of the outstanding shares of Series A Preferred Stock shall share ratably in any distribution of assets in proportion to the full amounts to which they would otherwise be respectively entitled.\n(b) Neither a consolidation nor merger of the Corporation with or into any other corporation, nor a reorganization of the Corporation, nor a sale or transfer of the business or assets of the Corporation as or substantially as an entirety, shall be considered a liquidation, dissolution or winding-up of the affairs of the Corporation within the meaning of the foregoing provisions.\n(c) As used herein, the term \"dividends accrued\" means, with respect to the shares of the Series A Preferred Stock, an amount equal to simple interest at the rate of $1.12-1\/2 per share per annum from the date of issuance, or from the last date on which a dividend was paid on such shares, to the date as of which the computation is to be made, as the case may be.\n(4) Retirement Fund.\nShares of the Series A Preferred Stock shall not be subject to the operation of a retirement or sinking fund to be applied for redemption of such shares.\n(5) Conversion Rights.\n(a) Shares of the Series A Preferred Stock shall be convertible into fully paid and non-assessable shares of the Corporation's Common Stock at the rate of 1.12-1\/2 shares of the Common Stock for each share of Series A Preferred Stock. Such shares shall be converted by giving written notice of the election to convert to any Transfer Agent and surrendering the certificate or certificates for such shares to such Transfer Agent in transferable form. In case of the Corporation's redemption of any shares of the Series A Preferred Stock, such right of conversion shall end, as to the shares called for redemption, at the close of business on the sixth business day prior to the date fixed for redemption, unless default shall be made in the payment of the redemption price. In the event of the liquidation or dissolution of the Corporation, such right of conversion shall end at the close of business on the tenth business day prior to the date fixed for the first distribution to the holders of Series A Preferred Stock. Upon conversion, the Corporation shall make no payment or adjustment on account of dividends accrued on the shares of Series A Preferred Stock surrendered for conversion, except that in the case of shares called for redemption accrued dividends shall be paid through the date fixed for redemption.\n(b) The number of shares of the Common Stock into which each share of the Series A Preferred Stock is convertible shall be subject to the following adjustments from time to time after the happening of the following events as follows:\n(i) In case the Corporation shall (1) declare a dividend on the Common Stock payable in shares of the Common Stock, (2) subdivide the outstanding shares of the Common Stock, (3) combine the outstanding shares of the Common Stock into a smaller number of shares, or (4) issue by reclassification of the Common Stock any shares of the Corporation, each holder of the Series A Preferred Stock shall thereafter be entitled upon conversion to receive for each share the number of shares of the Corporation which he would have owned or have been entitled to receive after the happening of such event had such share been converted immediately prior to the happening of such event. Such adjustment shall become effective immediately after the close of business on the record day for such dividend or the day upon which any subdivision, combination or reclassification shall become effective.\n(ii) In case the Corporation shall consolidate or merge into or with another corporation, or in case the Corporation shall sell or convey all or substantially all of its property, each share of the Series A Preferred Stock then outstanding shall thereafter be convertible into the kind and amount of shares of stock, other securities, cash and\/or property received by a holder of the number of shares of Common Stock into which such share might have been converted immediately prior to such event, and shall have no other conversion rights. In any such event, effective provision shall be made in the certificate or articles of incorporation or organization of the resulting or surviving corporation or otherwise or in any contracts of sale and conveyance for said conversion rights of the shares of the Series A Preferred Stock.\n(iii) In case the Corporation shall issue rights to the holders of the Common Stock entitling them to subscribe for or purchase shares of the Common Stock at a price per share less than the current market price of the Common Stock (as defined in Subsection (v) below) on the record date thereof the number of shares of the Common Stock into which each share of the Series A Preferred Stock shall thereafter be convertible shall be determined by multiplying the number of shares of the Common Stock into which such shares of the Series A Preferred Stock was theretofore convertible by a fraction, of which the numerator shall be the number of shares of the Common Stock outstanding on the record date plus the number of additional shares of the Common Stock offered for subscription or purchase, and of which the denominator shall be the number of shares of the Common Stock outstanding on the record date plus the number of shares of the Common Stock which the aggregate offering price of the total number of shares so offered would purchase at such current market price. Such adjustment shall be made whenever such rights are issued and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights.\n(iv) In case the Corporation shall distribute to all holders of its Common Stock rights to subscribe to-its debt securities or equity securities other than Common Stock, then in each such case the number of shares of Common Stock into which each such share of Series A Preferred Stock shall be convertible after the record date for such distribution shall be determined by multiplying the number of shares of Common Stock into which such share of Series A Preferred Stock was theretofore convertible by a fraction, of which the numerator shall be the current market price per share of the Common Stock (as defined in Subsection (v) below) on such record date and of which the denominator shall be the current market price per share of the common Stock on such record date less the value of the subscription rights so distributed applicable to one of the outstanding shares of Common Stock. Value shall be determined by the Board of Directors of the Corporation, whose determination shall be conclusive and shall be described in a statement filed with the Transfer Agent or Transfer Agents for such shares of such series and for the Common Stock and sent to the holders of the Series A Preferred Stock.\n(v) The current market price per share of the Common Stock on any date shall be deemed to be the average of the daily closing prices for the fifteen (15) consecutive business days commencing thirty (30) business days before such record date. The closing price for each day shall be the last reported sales price regular way or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices regular way, in either case on the Boston Stock Exchange or the American Stock Exchange or, if the Common Stock is not listed on either Exchange, the average of the closing bid and asked prices as furnished by any member of the New York Stock exchange selected from time to time by the Corporation. The term \"business day\" means any day on which such Exchange shall be open for trading.\n(vi) No fractional shares of the Common Stock shall be issued upon any conversion but, in lieu thereof, there shall be paid to each holder of shares of the Series A Preferred Stock surrendered for conversion who would otherwise be entitled to receive a fraction of a share on such conversion, as soon as practicable after the date such shares are surrendered for conversion, an amount in cash equal to the same fraction of the market value of a full share of the Common Stock, unless the Board of Directors shall determine to adjust fractional shares by the issue of fractional scrip certificates or in some other manner. For such purpose, the market value of a share of the Common Stock shall be the last reported sales price regular way on the day immediately preceding the date upon which shares are surrendered for conversion, or, in case no such sale takes place on such day, the average of the reported closing bid and asked prices regular way on such day, in either case on the Boston Stock Exchange or American Stock Exchange, or, if the shares of Common Stock are not listed on either Exchange, the average of the closing bid and asked prices as furnished by any member of the New York Stock Exchange selected from time to time by the Corporation.\n(vii) No adjustment in the number of shares of the Common Stock into which each share of the Series A Preferred Stock is convertible shall be required unless such adjustment would require an increase or decrease of more than 1\/5Oth of a share in the number of shares of the Common Stock into which such share is then convertible; provided, however, that any adjustments which are not required to be made shall be carried forward cumulatively and taken into account in any subsequent calculation.\n(viii) Whenever any adjustment is required in the shares of Common Stock into which each share of the Series A Preferred Stock is convertible, the Corporation shall keep available at each of its offices and the offices of each Transfer Agent or Transfer Agents for such shares of such series and for the Common Stock a statement describing in reasonable detail the adjustment and the method of calculation used, and shall cause a copy of such statement to be mailed to the holders of record of the shares of the Series A Preferred Stock.\n(c) The Corporation shall at all times reserve and keep available out of the authorized but unissued shares of the Common Stock the full number of shares of the Common Stock into which all shares of the Series A Preferred Stock from time to time outstanding are convertible, but shares of the Common Stock held in the treasury of the Corporation may in its discretion be delivered upon any conversion of shares of the Series A Preferred Stock.\n(d) Shares of the Series A Preferred Stock converted into Common Stock shall have the status of authorized but unissued shares of Preferred Stock and any such shares may be reissued as shares of the Series A Preferred Stock or of any other series.\n(e) In case securities other than Common Stock, cash or property shall be issuable, payable or deliverable by the Corporation upon conversion as aforesaid, then all references in this paragraph shall be deemed to apply, so far as appropriate and as nearly as may be, to such other securities.\n(6) Voting.\nEach share of the Series A Preferred Stock shall be entitled to one vote per share, voting as a single class with the shares of Common Stock. So long as any shares of the Series A Preferred Stock are outstanding, no provisions hereof relating to such stock may be amended without the consent of the holders of at least two-thirds of all outstanding shares of the Series A Preferred Stock, which consent may be given in writing without a meeting or at a meeting duly held for such purpose.\n(7) Issuance of Other Shares of Preferred Stock.\nThe Board of Directors of the Corporation may authorize the issuance of additional shares of Series A Preferred Stock and of shares Of one or more other series of Preferred Stock, provided that no other series shall have any preference over the Series A Preferred Stock upon any liquidation, dissolution or\nwinding-up of the affairs of the Corporation, but other series may be so authorized ranking on a parity with the series A Preferred Stock in such respects pro rata based on the amount of the respective preferences on liquidation.\nSUBDIVISION C SPECIAL TERMS AND PROVISIONS APPLICABLE TO $1.12-1\/2 SERIES B CONVERTIBLE PREFERRED STOCK\nThere shall be a series of Preferred Stock which shall consist of Thirty-one Thousand Five Hundred Twenty-three (31,523) shares of said Preferred Stock and which shall constitute a series designated as the $1.12-1\/2 series B Convertible Preferred Stock (hereinafter referred to as the \"Series B Preferred Stock\").\nThe shares of Series B Preferred Stock shall have the same per share rights, preferences, voting powers and privileges as the Series A Preferred Stock except as otherwise expressly provided in this Restated Certificate of Incorporation and as follows:\n(1) Dividends.\nThe holders of the Series B Preferred stock shall be entitled to receive, as and when declared by the Board of Directors out of any funds legally available therefor, cumulative dividends from January 1, 1984 at the annual rate of 0.8315 per share held, payable quarterly on the last day of November, February, May and August in each year until the earliest of (i) December 31, 1992, (ii) the sale of all or substantially all of the assets of the Corporation, or (iii) the transfer of a controlling interest in the Common Stock and the Series A Preferred Stock (taken together as a whole), and thereafter at the annual rate of $1.12-1\/2. In the event of an adjustment of the Common Stock Percentage from 57.5%, the amount of such cumulative dividend shall be adjusted, effective on the date of issuance of the Series B Preferred Stock, to an amount that bears the same relation to $1.12-1\/2 as (a) 100% minus, the adjusted Common Stock Percentage bears to (b) the adjusted Common Stock Percentage.\n(2) Redemption.\nFor purposes of Subdivision B, Section (2) hereof, as made applicable to the shares of Series B Preferred Stock hereof, the redemption price shall be the same amount as the amount of the preference under Section (3) of this Subdivision C.\n(3) Liquidation, Dissolution and Winding-Up.\n(a) The holders of the Series B Preferred Stock shall be entitled to a preference of $18.48 per share in the event of any liquidation, dissolution or winding-up of the\naffairs of the Corporation until the earliest of (i) December 31, 1992, (ii) the sale of all or substantially all of the assets of the Corporation (other than a sale as a result of proceedings under the Bankruptcy Act or other insolvency law), (iii) a voluntary liquidation, or (iv) the transfer of a controlling interest in the Common Stock and the Series A Preferred Stock (taken together as a whole), and thereafter of $25 per share. In the event of an adjustment of the Common Stock Percentage from 57.5%, the amount of such preference shall be adjusted to an amount that bears the same relation to $25 as (a) 100% minus the adjusted Common Stock Percentage bears to (b) the adjusted Common Stock Percentage.\n(b) Neither a consolidation nor merger of the Corporation with or into any other corporation, nor a reorganization of the Corporation, nor a sale or transfer of the business or assets of the Corporation as or substantially as an entirety, shall be considered a liquidation, dissolution or w winding-up of the affairs of the Corporation within the meaning of the foregoing provision.\n(c) As used herein, the term \"dividends accrued\" means, with respect to the shares of the Series B Preferred Stock, an amount equal to simple interest at the annual dividend rate in effect during the period involved from January 1, 1984, or from the last date on which a dividend was paid on such shares, to the date as of which the computation is to be made, as the case may be.\n(4) Retirement Fund.\nShares of Series B Preferred Stock shall not be subject to the operation of a retirement or sinking fund to be applied for redemption of such shares.\n(5) Conversion Rights.\nShares of Series B Preferred Stock shall be convertible into shares of Class A Common Stock, at the same rate and on the same terms and conditions as contained in Subdivision B, Section (5) hereof, as the shares of Series A Preferred Stock are convertible into shares of Common Stock, and for the purposes hereof references to \"Common Stock\" in said section 5 shall be deemed to be to \"Class A Common Stock\" and references to \"Series A Preferred Stock\" shall be deemed to be to \"Series B Preferred Stock.\" For purposes of clause (v) and (vi) of Section 5(b) as applied to the Class A Common Stock hereunder the market value of the shares of Class A Common Stocks shall be as determined in good faith by the Board of Directors by the affirmative vote of not less than five members thereof based upon the value of the shares of Common Stock at the times provided in said Clauses (v) and (vi).\n(6) Voting.\nEach share of the Series B Preferred Stock shall be entitled to one vote per share, voting as a single class with the shares of Class A Common Stock. So long as any shares of the Series B Preferred Stock are outstanding, no provisions hereof relating to such stock may be amended without the Consent of the holders of at least two-thirds of all outstanding shares of the Series B Preferred Stock, which consent may be given in writing without a meeting or at a meeting duly held for such purpose.\n(7) Issuance of Other Shares of Preferred Stock.\nThe Board of Directors of the Corporation may authorize the issuance of additional shares of Series B Preferred Stock and of shares of one or more other series of Preferred Stock, provided that no other series shall have any preference over the Series B Preferred Stock upon any liquidation, dissolution or winding-up of the affairs of the Corporation, but other series may be so authorized ranking on a parity with the Series B Preferred Stock in such respects pro rata based on the amount of the respective preferences on liquidation.\nSUBDIVISION D PROVISIONS APPLICABLE TO COMMON STOCK AND CLASS A COMMON STOCK\nEach of the shares of Class A Common Stock and each of the shares of Common Stock shall have the same rights, preferences, voting powers and privileges, except as otherwise expressly provided in this Restated Certificate of Incorporation.\n(1) Voting Rights.\n(a) Except as provided with respect to the shares of Preferred Stock and except as hereinafter provided, the holders of Common Stock and of the Class A Common Stock shall have exclusive voting rights for the election of directors and for all other purposes and shall be entitled to one vote for each share held.\n(b) The holders of a majority of the shares of Class A Common Stock and the Series B Preferred Stock, voting together as a class, shall be entitled to elect one-half of the members of the Board of Directors of the Corporation. The directors thus elected shall be entitled to appoint one-half of members of any Executive Committee established by the Board of Directors pursuant to the By-Laws of the Corporation and shall further be entitled to cause the Corporation to appoint such directors' designees to one-half of the directorships in any subsidiary of the Corporation other than Norsk Exolon A\/S.\n(c) The holders of a majority of the shares of Common Stock and the Series A Preferred Stock, voting together as a class, shall be entitled to elect one-half of the members of the Board of Directors of the Corporation. The directors thus elected shall be entitled to appoint one-half of the members of any Executive Committee established by the Board of Directors pursuant to the By-Laws of the Corporation and shall further be entitled to cause the Corporation to appoint such directors' designees to one-half of the directorships in any subsidiary of the Corporation other than Norsk Exolon A\/S.\n(d) Votes for the election of directors and on other matters need not be by written ballot unless requested by the holder of shares entitled to vote thereon.\n(2) Dividends.\nOut of any assets of the Corporation available for dividends remaining after full cumulative dividends up to the then current dividend period on all shares of Preferred Stock then outstanding shall have been paid or declared and a sum sufficient for the payment thereof set apart, and after or concurrently with making payment of or declaring full dividends on all shares of Preferred Stock then outstanding for the then current dividend period for such stock and setting aside a sum sufficient for the payment thereof, then, and not otherwise, dividends may be paid upon the shares of Common Stock and the Class A Common Stock to the exclusion of the shares of Preferred Stock. Until (a) an amount equal to 45% of the Corporation's consolidated net earnings after taxes and Preferred Stock dividends for the period January 1, 1984 through December 31, 1992 has been paid as dividends on the shares of the common stock and the Class A Common Stock, or (b) until the earlier sale of all or substantially all of the assets of the Corporation or the transfer of a controlling interest in the Common Stock and the Series A Preferred Stock (taken together as a whole), the shares of the Common Stock shall be entitled to the Common Stock Percentage of the aggregate amount of dividends on the shares of Common Stock and Class A Common Stock as and when paid and the shares of Class A Common Stock to the remainder thereof; thereafter shares of Common Stock and Class A Common Stock shall be entitled to equal dividends on a share for s hare basis regardless of class; provided that in the event of the transfer of a controlling stock interest referred to in clause (b) the shares of Common Stock and of Class A Preferred Stock not so transferred shall continue to have the same rights as if such transfer had not taken place, i.e., such shares shall continue to be entitled to their pro rata share of the Common Stock Percentage of the aggregate amount of dividends on the Common Stock and Class A Common Stock until 45% of such net earnings have been paid as dividends; such dividend rights shall be determined by multiplying the aggregate amount of the dividend declared for both the Common Stock and the Class A Common Stock by the Common Stock Percentage, and then dividing such amount by the number of all outstanding shares of Common Stock; the dividend for each other share of Common Stock and for each share of Class A Common Stock shall be equal on a share for share basis regardless of class.\n(3) Distribution of Assets.\nIn the event of any dissolution, liquidation or winding-up of the Corporation, after there shall have been paid or set aside in cash for the holders of shares of Preferred Stock the full preferential amounts to which they are entitled, the holders of the shares of Common Stock and Class A Common Stock shall be entitled to receive pro rata all of the remaining assets of the Corporation available for distribution to its stockholders, except as hereinafter provided. The Board of Directors by vote of a majority of the members thereof may distribute in kind to the holders of the shares of Common Stock and Class A Common such remaining assets of the Corporation or may sell, transfer, or otherwise dispose of any or all of the remaining assets of the Corporation to any other corporation and receive payment therefor wholly or in part in cash or in stock or obligations of such other corporation and may sell all or any part of the consideration received therefor and distribute the balance thereof in kind to the holders of the Common Stock and Class A Common Stock. Until December 31, 1992, or the earlier sale of all or substantially all of the assets of the Corporation (other than a sale as a result of proceedings under the Bankruptcy Act or other insolvency law), or a transfer of a controlling interest in the Common Stock and the Series A Preferred Stock (taken together as a whole), the shares of Common Stock shall be entitled to the Common stock Percentage of such remaining assets of the Corporation and the shares of Class A Common Stock to the remainder thereof; provided, that after December 31, 1992 or at the time of any such sale of assets the shares of Common Stock shall first be entitled to receive the amount of dividends then payable with respect to such shares in of the amount payable on the shares of Class A Common Stock prior to any such distribution to the shares of Class A Common Stock; and further provided, that in the event of any such transfer of a controlling interest in the Common Stock and the Series A Preferred Stock, the shares of Common Stock not so transferred shall continue to be entitled to such amount of dividends payable on such shares prior to any distribution to the shares of Common Stock so transferred or to the shares of Class A Common Stock, and shall be entitled to the amount of assets of the Corporation to which such shares would have been entitled in the absence of such transfer of a controlling interest, determined by multiplying the aggregate amount of the assets of the Corporation by the Common Stock Percentage, and then dividing such amount by the number of all outstanding shares of Common Stock, with each other share of Common Stock and each share of Class A Common Stock entitled to an equal amount of assets on a share for share basis regardless of class.\n(4) The Common Stock Percentage.\nAs used in this Restated Certificate of incorporation, the term \"the Common Stock Percentage\" means 57.5%, (I) reduced, if more the 10,000 shares of Common Stock and Series A Preferred Stock demand appraisal in connection with the merger of ESK Corporation into the Corporation, to a percentage determined by multiplying 57.5% by a fraction of the numerator of which is the number of shares of Common Stock and Series A preferred Stock not demanding appraisal and the denominator of which is 534,682; and (ii) reduced, if additional federal taxes (including interest thereon net of tax benefit from its deductibility) in excess of $100,000 are assessed against the corporation for years prior to 1983, by .025% for each whole $10,000 of such additional payments (i.e., from 57.5% to 57.25% if there are $100,000 of additional payments); and (iii) increased, if the tax loss carry forward for federal income tax purposes of ESK Corporation available to the Corporation after the merger of ESK Corporation into the Corporation is less than $2,893,000, by .025% for each $21,700 by which the tax loss carry forward is less than $2,893,000 (i.e., from 57.5% to 57.75% if the tax loss carry forward is $217,000 less than $2,893,000).\n(5) Determination of Earnings.\nConsolidated net earnings for purposes of this Subdivision D shall be computed on a pooling of interests basis without regard to non-cash amortization of the excess of the fair market value over the historical cost of the assets of ESK Corporation.\nFIFTH. The number of directors shall be eight. A vacancy in the membership of the Board of Directors shall be filled by a vote of the directors elected by the shares of Common Stock and Series A Preferred Stock or by vote of such shares if the previous director was elected by such shares, and by vote of the directors elected by the shares of Class A Common Stock and Series B Preferred Stock or by vote of such shares if the previous director was elected by such shares. In no event shall the term of a director expire until his successor shall be elected and shall qualify. The Corporation may also have one or more Consulting Directors appointed by the directors elected by the shares of Common Stock and Class A Preferred Stock.\nSIXTH. (1) The Board of Directors by the affirmative vote of not less than five directors is hereby authorized to amend the By-Laws of the Corporation.\n(2) The holders of a majority of the shares of Common Stock and the Series A Preferred Stock, voting together as a class, and the holders of a majority of the shares of Class A Common Stock and the Series B Preferred Stock, voting together as a separate class, may amend the by-laws of the Company.\nSEVENTH. The Corporation shall, to the fullest extent permitted by Section 145 of the General Corporation Law of the State of Delaware, as the same may be amended and supplemented from time to time, indemnify ant and all directors and officers which it shall have power to indemnify under said section 145 from and against any and all expenses, liabilities or other matters referred to in or covered by said Section. The indemnification provided for herein shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any By-Law, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in their official capacities 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 or officer, and shall inure to the benefit of the heirs, executors and administrators of such a person.\nEIGHTH. The Corporation hereby reserves the right to amend or repeal any provision contained in this Restated 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.\nNINTH. A stockholder of the Company shall have the right to demand payment of the value of his stock in the event of a merger or consolidation notwithstanding the fact that the Corporation's stock may be listed on a national securities exchange.\nTENTH. Except as provided in Article Eleventh, this Restated Certificate of Incorporation may be amended by vote of the holders of a majority of the shares of Common Stock and the Series A Preferred Stock, voting together as a class, and the vote of a majority of the shares of Class A Common Stock and the Series B Preferred Stock, voting together as a separate class.\nELEVENTH. Notwithstanding any provision of the General Corporation Law of the State of Delaware now or hereafter in force requiring for any corporate action the vote or consent of a lesser number of directors or a lesser portion of the shares of the Corporation or of any class of shares thereof or of any other securities having voting power, the affirmative vote or consent of a majority of all of the directors, and of the holders of two- thirds of the aggregate number of outstanding shares (1) of the Common Stock and the Series A Preferred Stock voting as one class and also (2) of the Class A Common Stock and the Series B Preferred Stock voting as a second class, shall be required:\n(a) to approve (I) the sale, lease or exchange by the Corporation of all or substantially all of its property and assets to any other corporation, person or other entity, or (ii) the merger or consolidation of the Corporation with or into any other corporation or corporations;\n(b) to approve any agreement, contract or other arrangement with any corporation or corporations providing for any of the transactions described in subparagraph (a) above; or\n(c) to effect any amendment of the Restated Certificate of Incorporation of the Corporation which amends, alters, changes or repeals any of the provisions of this Article Eleventh.\nExecuted at Boston, Massachusetts on April 12, 1984.\nTHE EXOLON COMPANY Attest: (now Exolon-ESK Company)\nS\/ L. Harrison Thayer II By: S\/ John K. Shurie Secretary President\nEXHIBIT 3A(1)\nAGREEMENT OF MERGER\nAGREEMENT OF MERGER dated April 12, 1984, between THE EXOLON COMPANY, a Delaware corporation having its registered office in Wilmington, Delaware (\"Exolon\"), and E S K CORPORATION, a Delaware corporation having its registered office in Wilmington, Delaware (\"ESK\").\nWITNESSETH:\nWHEREAS, the Boards of Directors of Exolon and ESK (the \"Constituent Corporations\") have approved this Agreement of Merger providing for the merger of ESK into Exolon upon the terms and conditions hereinafter set forth; and\nWHEREAS, Exolon is authorized to have outstanding 600,000 shares of Common Stock, $1 par value (\"Exolon Common Stock\"), of which 499,219 shares were issued and outstanding on the date hereof, and 60,000 shares of Preferred Stock, without par value, of which 31,523 shares are designated Series A $1.12 Convertible Preferred Stock and are issued and outstanding (\"Series A Preferred Stock\") and will have, upon completion of the merger to be effected herewith, an authorized capitalization of 600,000 shares of such Common Stock, $1 par value, 600,000 shares of Class A Common Stock, $1 par value (the \"Class A Common Stock\"), and 100,000 shares of Preferred Stock, without par value, of which (a) 31,523 shares will be designated such Series A Preferred Stock and will be issued and outstanding, and (b) 31,523 shares will be designated Series B Convertible Preferred Stock and will be issued and outstanding (\"Series B Preferred Stock\"); and\nWHEREAS, ESK is authorized to have outstanding 1,000 shares of Common Stock, $10 par value (\"ESK Common Stock\"), 11 of which shares are now issued and outstanding and are owned by Wacker Chemical Corporation, a New York corporation (\"Wacker\"); and\nWHEREAS, this Agreement of Merger was submitted to the stockholders of Exolon at a special meeting of stockholders held on April 12, 1984, duly called for such purpose, and was duly approved by the affirmative note of the holders of at least two thirds of the Exolon Common Stock and Exolon Series A Preferred Stock (voting together as a single class); and\nWHEREAS, the Agreement of Merger has been approved by Wacker, the sole stockholder of ESK, pursuant to a Written Consent of Sole Stockholder dated January 9, 1984;\nNOW, THEREFORE, in consideration of the premises and of the mutual agreements herein contained and in accordance with the laws of the State of Delaware, Exolon and ESK (the \"Constituent Corporations\") hereby agree that, subject to the conditions hereinafter set forth, ESK shall be merged into Exolon and Exolon shall be the surviving corporation, and that the terms and conditions of such merger (the \"Merger\") shall be as follows:\nFIRST: The name of the surviving corporation shall be Exolon-ESK Company (the \"Surviving Corporation\"), and it shall exist by virtue of, and be governed by, the laws of the State of Delaware. The Restated Certificate of Incorporation shall be the Certificate of Incorporation of the Surviving Corporation.\nSECOND: The address of the registered office of the Surviving Corporation in the State of Delaware shall be 100 West Tenth Street, in the City of Wilmington, County of New Castle.\nTHIRD: The purpose of the Surviving Corporation shall be to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.\nFOURTH: The directors of the Surviving Corporation shall be the following: Kurt M. Hertzfeld, L. Harrison Thayer II, Edward R. Speare, Hollis French, Dr. Ludwig Eberle, Mr. Hans Pfingstl, Dr. Dieter Normann and\nFIFTH: The officers of the Surviving Corporation shall be as follows:\nKurt M. Hertzfeld Chairman of the Board and Chief Executive Officer\nJohn K. Shurie President\nDr. Ludwig Eberle Executive Vice President and Vice Chairman of the Board\nR. Philip Harty Senior Vice President\nWilliam H. Nehill Vice President-Finance, and Treasurer\nDavid A. Matthew Vice President-Marketing and Sales\nL. Harrison Thayer II Secretary\nAll corporate acts, approvals, contracts and authorizations of Exolon and of ESK, their respective shareholders, Boards of Directors, committees elected or appointed by their Board of Directors, their officers and agents, which were valid and effective immediately prior to the Effective Time of the Merger (as that term is defined in Article Eighth), shall be taken for all purposes as the acts, approvals, contracts and authorizations of the Surviving Corporation and shall be as effective and binding thereon as the same were with respect to Exolon or ESK. The employees of Exolon shall continue to be, and the employees of ESK shall become, the employees of the Surviving Corporation, and continue to be entitled to the same rights and benefits which they enjoyed heretofore.\nSIXTH: At the Effective Time of the Merger, the separate existence of ESK shall cease, and the Surviving Corporation shall possess all assets and property of every description, and every interest therein, wherever located, and the rights, privileges, immunities, powers, franchises and authority, of a public as well as of a private nature, of ESK shall be vested in the Surviving Corporation without further act or deed. Title to any real estate or any interest therein vested in ESK shall not revert or in any way be impaired by reason of the Merger.\nThe Surviving Corporation shall be liable for all of the obligations of ESK. Any claim existing, or action or proceeding pending, by or against ESK, may be prosecuted to judgment, with right of appeal, as if the Merger had not taken place, or the Surviving Corporation may be substituted in its place.\nAll of the rights of creditors of ESK shall be preserved unimpaired, and all liens upon the property of ESK shall be preserved unimpaired, on only the property affected by such liens, immediately prior to the Effective Time of the Merger.\nSEVENTH: The terms of the Merger, the mode of carrying the same into effect, and the manner and basis of making distributions to the stockholders of the Constituent Corporations in extinguishment of and in substitution for shares of the Constituent Corporations, shall be as follows:\n(d) At the Effective Time of the Merger each share of ESK Common Stock outstanding immediately prior to the Merger or held in the treasury of ESK, and all rights in respect thereof, shall forthwith cease to exist and shall be cancelled.\n(e) At the Effective Time of the Merger, each share of Common Stock and of Series A Preferred Stock of Exolon other than treasury stock and the certificates representing such shares outstanding shall remain outstanding and shall be and represent such Common Stock and Series A Preferred Stock of the Surviving Corporation with the rights and preferences provided in the Restated Certificate of Incorporation of Exolon, except for any shares as to which dissenters' appraisal rights may be demanded by the holders thereof.\n(f) At the Effective Time of the Merger, all of the issued and outstanding shares of ESK Common Stock shall be converted into 499,219 shares of the Surviving Corporation's Class A Common Stock and 31,523 shares of the Surviving Corporation's Series B Preferred Stock.\n(g) From and after the Effective Time of the Merger, the holder of the certificate or certificates representing shares of ESK Common Stock outstanding immediately prior to the Effective Time of the Merger shall, upon presentation of such certificate or certificates for surrender to the Surviving Corporation or its agent, be entitled to receive in exchange therefor certificates representing the shares of fully paid and non-assessable Class A Common Stock and Series B Preferred Stock of the Surviving Corporation to which such holder shall be entitled upon the aforesaid basis of exchange. Until so surrendered, each outstanding certificate which prior to the Merger represented shares of ESK Common Stock shall be deemed, for all corporate purposes, to evidence ownership of the number of shares of Class A Common Stock and Series B Preferred Stock of the Surviving Corporation into which the same shall have been converted and exchanged; provided, however, that no dividends or other distributions declared with respect to the Class A Common Stock and Series B Preferred Stock of the Surviving Corporation shall be paid to the holder of any unsurrendered certificate or certificates of ESK Common Stock until such holder shall surrender such certificate or certificates, at which time the holder shall be paid the amount of dividends and other distributions, without interest, which theretofore became payable with respect to the shares of Class A Common Stock and Series B Preferred Stock of the Corporation evidenced by such certificate or certificates.\nEIGHTH: The Merger shall not become effective until, and shall become effective at, the time (the \"Effective Time of the Merger\") at which an executed copy of this Agreement of Merger is filed with the Secretary of State of the State of Delaware in accordance with Section 251 of the General Corporation Law of the State of Delaware.\nNINTH: Each of the Constituent Corporations hereby agrees to do promptly all such acts and to take promptly all such measures as may be appropriate to enable it to perform as early as practicable the covenants and agreements herein provided to be performed by it.\nTENTH: ESK and Exolon, by mutual consent and majority vote of their respective Boards of Directors, may amend, modify and supplement this Agreement of Merger in such manner as may be agreed upon by them in writing at any time before or after action thereon by the stockholders of ESK or Exolon or both; provided, however, that no such amendment, modification or supplement made following such action by stockholders shall affect the rights of the stockholders of ESK or Exolon in a manner which is materially adverse to such stockholders in the judgment of the Board of Directors of ESK or Exolon, as the case may be, or shall change any of the principal terms of this Agreement of Merger. ESK or Exolon may, by a majority vote of its Board of Directors, by an instrument in writing, extend the time for or waive the performance of any of the obligations of the other or waive compliance by the other with any of the covenants or conditions contained herein; provided, however, that no such waiver or extension shall affect the rights of the stockholders of ESK or Exolon in a manner which is materially adverse to such stockholders in the judgment of their respective Board of Directors.\nELEVENTH: This Agreement of Merger shall terminate, without further action by or on behalf of the Constituent Corporations, if an affirmative vote of the holders of two-thirds of the outstanding shares of the Common Stock and Series A Preferred Stock of Exolon (voting together as a single class) is not obtained prior to April 30, 1984. In addition, prior to the Effective Time of the Merger, this Agreement of Merger may be terminated, at the option of the respective Boards of Directors of the Constituent Corporations and notwithstanding the adoption of this Agreement by the respective stockholders of the Constituent Corporations by (a) mutual consent of the Board of Directors of both Constituent Corporations; or (b) the Board of Directors of either Constituent Corporation if:\n1. The holders of an aggregate of more than 53,000 shares of the Common Stock and of the Series A Preferred Stock of Exolon have filed written demands for the payment of fair cash value of their shares; or\n2. Such Board of Directors determines in good faith that, in its judgment, the Merger does not then appear to be in the best interests of the stockholders of that corporation.\nIn the event of any such termination, the Merger shall thereupon be abandoned.\nTWELFTH: The By-laws of the Surviving Corporation shall be the By-laws of Exolon in effect at the Effective Time of the Merger.\nTHIRTEENTH: This Agreement may be executed in any number of counterparts, each of which shall be an original, but such counterparts shall together constitute but one and the same instrument.\nIN WITNESS WHEREOF, each of the Constituent Corporations has caused this Agreement of Merger to be signed by its officers thereunto duly authorized and its corporate seal to be hereunto affixed, all as of the day and year first above written.\nTHE EXOLON COMPANY, a Delaware Corporation\n(Corporate Seal) By: S\/ John K. Shurie President\nAttest:\nS\/ L. Harrison Thayer II Secretary\nESK CORPORATION, a Delaware Corporation\n(Corporate Seal) By:___________________________ President\nAttest:\nS\/ William Schurtman Secretary\nTHE UNDERSIGNED, President of ESK Corporation, who executed on behalf of said corporation the foregoing Agreement of Merger, of which this certificate is made a part, hereby acknowledges, in the name and on behalf of said corporation, the foregoing Agreement of Merger to be the corporate act of said corporation and further certifies that, to the best of his knowledge, information and belief, the matters and facts set forth therein with respect to the approval thereof are true in all material respects, under the penalties of perjury.\n__________________________________ President\nSubscribed and sworn to before me this 12th day of April, 1984.\nS\/ Thomas L. Krawczyk Notary Public\nMy Commission expires: 3\/30\/86\nTHE UNDERSIGNED, President of The Exolon Company, who executed on behalf of said corporation the foregoing Agreement of Merger, of which this certificate is made a part, hereby acknowledges, in the name and on behalf of said corporation, the foregoing Agreement of Merger to be the corporate act of said corporation and further certifies that, to the best of his knowledge, information and belief, the matters and facts set forth therein with respect to the approval thereof are true in all material respects, under the penalties of perjury.\nS\/ John K. Shurie President\nSubscribed and sworn to before me this 12th day of April, 1984.\nS\/ Thomas L. Krawczyk Notary Public\nMy commission expires: 3\/30\/86\nI, L. Harrison Thayer II, Secretary of The Exolon Company, a corporation organized and existing under the laws of the State of Delaware, hereby certify as such Secretary under the seal of said corporation, that the Agreement of Merger dated April 12, 1984, between the Exolon Company and ESK Corporation to which this certificate is attached was duly submitted to the stockholders of The Exolon Company at a meeting of said stockholders duly called and held after at least 20 days' notice by mail as provided in Section 251 of the Delaware General Corporation Law on the 12th day of April, 1984, for the purpose, among other things, of considering and taking action upon the Agreement of Merger; that 499,219 shares of Common Stock and 32,881 shares of Series A Preferred Stock of said Corporation were issued and outstanding on the record date for such meeting; that said Agreement of Merger was approved and adopted by the affirmative vote of the holders of at least two-thirds of the shares of such Common and Preferred Stock, voting together as a single class, said shares of Common and Preferred Stock being the only shares of said Corporation then outstanding and entitled to vote thereon; that thereby the Agreement of Merger was at said meeting duly adopted in the manner required by Section 251 of the Delaware General Corporation Law and the Certificate of Incorporation of the Exolon Company, as the act of the stockholders of The Exolon Company and the duly adopted agreement of said Corporation.\nWITNESS my hand and seal of The Exolon Company on this 12th day of April, 1964.\nS\/ L. Harrison Thayer II, Secretary\nI, William Schurtman, Secretary of ESK Corporation, a corporation organized and existing under the laws of the State of Delaware, hereby certify as such Secretary under the seal of said corporation, that the Agreement of Merger dated as of April 2, 1984, between The Exolon Company and ESK Corporation to which this certificate is attached was duly adopted by the written consent of the sole stockholder of ESK Corporation on the 9th day of January, 1984, in accordance with the provisions of Section 228 of the Delaware General Corporation Law; that 11 shares of Common Stock of said Corporation were issued and outstanding on the date of such consent; that said Agreement of Merger was approved and adopted by the affirmative vote of the holders of said 11 shares of Common Stock, being the only shares of said Corporation then outstanding and entitled to vote thereon; that thereby the Agreement of Merger was duly adopted in the manner required by Section 251(c) of the Delaware General Corporation Law as the act of the stockholders of ESK Corporation and the duly adopted agreement of said Corporation.\nWITNESS my hand and seal of ESK Corporation on this 12th day of April, 1984. S\/ William Schurtman Secretary\nThe above Agreement of Merger, having been approved by the Board of Directors of each corporate party thereto, and having been approved and adopted separately by the stockholders of each corporate party thereto, in accordance with the provisions of the General Corporation Law of the State of Delaware, and that fact having been certified on said Agreement of Merger by Secretary of The Exolon Company and the Secretary of ESK Corporation, the undersigned do now hereby execute the said Agreement of Merger under the corporate seals of their respective corporations, by authority of the directors and stockholders thereof, as the respective act, deed and agreement of each of said corporations, on this 12th day of April, 1984.\nTHE EXOLON COMPANY\n(SEAL) By:S\/ John K. Shurie President\nAttest:\nBy: L. Harrison Thayer II Secretary\nTHE EXOLON COMPANY\n(SEAL) By: ____________________________ President\nAttest:\nBy: S\/ William Schurtman Secretary\nEXHIBIT 10F\nSTOCKHOLDERS AGREEMENT\nAGREEMENT dated as of April 26, 1984, between The Exolon Company (\"Exolon\"), a Delaware corporation, and Wacker Chemical Corporation (\"Wacker\"), a New York corporation.\nWHEREAS, Exolon, Wacker and ESK Corporation (\"ESK\"), a Delaware corporation and a wholly-owned subsidiary of Wacker, have entered into a Plan and Agreement of Reorganization provid- ing for the merger of ESK into Exolon, and\nWHEREAS, Exolon has presently outstanding shares of Common Stock and $1.12-1\/2 Series A Convertible Preferred Stock (\"Series A Preferred Stock\"), of which 99,938 shares of Common Stock are beneficially owned (as \"beneficial ownership\" is defined in Rule 13d-3 of the Securities Exchange Act of 1934) by officers and directors of Exolon immediately prior to such merger (the \"Management Group\"), and\nWHEREAS, upon the effectiveness of such merger, Wacker will receive shares of the Class A Common Stock and $1.12-1\/2 Series B Convertible Preferred Stock (\"Series B Preferred Stock\") of Exolon, the name of which will be changed to Exolon-ESK Company, and\nWHEREAS, the parties wish to provide for certain rights and obligations with respect to the shares of the Class A Common Stock of Exolon and to regulate Wacker's purchase of Common Stock and Series A Preferred Stock,\nNOW, THEREFORE, it is hereby agreed as follows:\n3. Acquisition For Investment. Wacker acknowledges that it is acquiring the shares of stock of Exolon to be issued to it upon the merger of ESK into Exolon for investment with no present intention of selling or distributing such shares.\n4. Right of Wacker to Participate in Registration for Sale by Exolon at Exolon's Expense. In case of any proposed registration no sooner than September 30, 1984, by Exolon of Common Stock of Exolon on Form S-3 or other applicable form for public sale by Exolon under the Securities Act of 1933 (the \"Act\"), Exolon will give written notice to Wacker of its intention to do so and, on the written request of Wacker given within 21 days after receipt of any such notice (which request shall specify the number of shares of Class A Common Stock intended to be sold), Exolon will, at its expense (excluding Wacker's pro rata share of underwriters' commissions and expenses and the fees of counsel for Wacker other than counsel for Exolon), use its best efforts to cause all such shares specified in the request to be registered under the Act concurrently with the registration of such Common Stock. All expenses, disbursements and fees in connection with such registration except as specifically provided above shall be borne by Exolon, whether so specified or not.\nIf the underwriters advise Exolon that the sale of shares owned by Wacker would materially interfere with the public offering of Common Stock of Exolon pursuant to the proposed registration statement, then Exolon shall have the right to reduce the number of shares of Class A Common Stock that may be offered for sale as part of the public offering of Common Stock pro rata with a reduction in the number of shares to be sold by other selling stockholders (other than a selling stockholder who is bearing all or part of the costs of such registration), but without any reduction in the number of shares to be sold by Exolon or other selling stockholders bearing such costs. Nevertheless, Wacker shall have the right to have any of its shares specified in its request to Exolon but not included in the public offering of Common Stock included in the registration on a \"to be sold\" basis, provided that any sale of such shares shall not occur earlier than 90 days after the effective date of the public offering of Common Stock and that Wacker shall bear any additional costs resulting from keeping such registration statement effective after the sale of the shares of Common Stock.\n5. Right of Wacker to Registration for Sale by It at Its Expense. Exolon will, upon written request made no sooner than September 30, 1984, that Wacker wishes to dispose of at least 100,000 shares of Exolon Class A Common Stock, file a registration statement under the Act on Form S-3 or other applicable form covering the number of shares of Exolon Class A Common Stock specified in such request and shall use its best efforts to have such registration statement declared effective, provided that Exolon shall have an obligation to register such shares on only two occasions. Any such sales shall be through a broker or principal underwriter which is a member of the New York Stock Exchange and which shall be subject to the reasonable approval of Exolon. Wacker shall pay all of the expenses of such registration, including applicable legal, accounting and printing expenses; provided, however, that if Exolon causes Common Stock of other shareholders of Exolon to be registered under the Act concurrently with the registration of such Class A Common Stock, such other shareholders shall pay their pro rata (based on the number of shares offered for sale by each) shares of such expenses.\nIf the underwriters or brokers advise Wacker that the sale of shares owned by such other shareholders would materially interfere with the public offering of Wacker's Class A Common Stock, then Exolon will, on demand by Wacker, reduce the number of shares that may be offered for sale by the other Shareholders in connection with such public offering.\n6. Right of Wacker at Its Expense to Participate in Registration for Sale by Other Shareholders of Exolon. In case of any proposed registration no sooner than September 30, 1984, of Common Stock of Exolon on Form S-3 or other applicable form for public sale by shareholders of Exolon under the Act, Exolon will give written notice to Wacker of its intention to do so and, on the written request of Wacker given within 21 days after receipt of any such notice (which request shall specify the number of shares of Class A Common Stock), Exolon will use its best efforts to cause all such shares specified in the request to be registered under the Act concurrently with the registration of such Common Stock.\nIf the underwriters or brokers advise Exolon that the sale of shares owned by Wacker would materially interfere with the public offering of shares pursuant to the proposed registration statement, then Exolon shall have the right to reduce the number of Shares of Class A Common Stock that may be offered for sale in connection with such public offering. Nevertheless, Wacker shall have the right to have any of its shares specified in its notice to Exolon but not included in such public offering included in the registration on a \"to be sold\" basis, provided that any sale of such shares shall not occur earlier than 90 days after the effective date of such public offering, and Wacker shall bear any additional costs resulting from keeping such registration statement effective after the sale.\nAll expenses, disbursements and fees in connection with such registration, including extraordinary accountants' fees, shall be paid by the selling stockholders pro rata based on the number of shares offered for sale by each.\n7. Effectiveness of Registration Statements. Exolon shall use its best efforts to cause any such registration statement to become effective as promptly as possible and to keep effective and maintain any such registration or qualification for a period of not less than 180 days after the registration statement becomes effective and from time to time shall amend or supplement the prospectus used in connection therewith to the extent necessary in order to comply with applicable law. Exolon may terminate the effectiveness of any such registration statement at any time after it has been effective for a period of 180 days. Exolon shall give Wacker five days' notice prior to any such termination.\n8. Exercise of Wacker's Conversion Right. If Wacker chooses to exercise its right under Exolon's Certificate of Incorporation to have some or all of its shares of Series B Preferred Stock converted into shares of Class A Common Stock for purposes of including such shares in a registration under paragraphs 2, 3, or 4 hereof, its written notice or request to Exolon in connection with such registration shall include a statement of its intention to exercise its conversion right. Thereafter, Wacker and Exolon shall cooperate to complete such conversion of shares in time to have the converted shares included in the proposed registration.\n9. Indemnification.\n(a) By Underwriters. Whenever Wacker enters into an underwriting agreement in connection with the disposition of Exolon Class A Common Stock, such underwriting agreement will contain an agreement by the underwriter or underwriters in customary form to indemnify and hold harmless, to the extent permitted by law, Exolon, each of its directors, each of its officers who have signed such registration statement and each other such person, if any, who controls Exolon within the meaning of the Act, against all losses, claims, damages or liabilities and expenses (including legal fees), joint or several, to which Exolon or any such director, officer or controlling person may become subject under the Act or common law or otherwise, insofar as such losses, claims, damages or liabilities and expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in such registration statement, or preliminary prospectuses or final or summary prospectuses contained therein, or any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but only if, and only to the extent that, such statement or omission was in reliance upon and in conformity with written information furnished to Exolon by such underwriter or underwriters specifically for use in the preparation thereof.\n(b) By Exolon. Exolon will indemnify and hold harmless, to the extent permitted by law, Wacker against all losses, claims, damages, liabilities and expenses (including legal fees), joint or several (under the Act or common law or otherwise), caused by any untrue statement or alleged untrue statement of a material fact contained in such registration statement or preliminary prospectus or final or summary prospectus contained therein, or in any documents specifically incorporated therein by reference, or any amendments or supplements thereto, or caused by 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 except insofar as such losses, claims, damages, liabilities or expenses are caused by any untrue statement or omission contained in information furnished in writing to Exolon by Wacker expressly for use therein.\n(c) By Wacker. In connection with any registration statement in which Wacker is participating, Wacker will furnish to Exolon in writing such information as shall reasonably be requested by Exolon for use in any such registration statement or prospectus and will indemnify and hold harmless, to the extent permitted by law, Exolon, its directors and officers and each person, if any, who controls Exolon within the meaning of the Act, against any losses, claims, damages, liabilities and expenses (including legal fees) resulting from any untrue statement or alleged untrue statement of a material fact or any omission or alleged omission of a material fact required to be stated in the registration statement or prospectus and necessary to make the statements therein not misleading, but only to the extent that such untrue statement or omission is contained in information so furnished in writing by Wacker expressly for use therein.\n(d) Of Underwriters by Exolon and Wacker. If Exolon and\/or Wacker enter into an underwriting agreement it shall be in customary form with Exolon and\/or Wacker agreeing to indemnify such underwriters, their officers and directors and each person who controls such underwriters within the meaning of the Act to the same extent as herein provided with respect to the indemnification of each other.\n10. Registration Not Required.\nExolon shall not be required to register any shares pursuant to the provisions of this Agreement if in the opinion of counsel for Exolon such registration is not necessary and all of the shares which Wacker proposes to sell or transfer may be sold or transferred without violating the Act and any applicable blue sky laws. In any such instance, Exolon shall cause its counsel to deliver a formal written opinion addressed to Wacker in form and substance reasonably satisfactory to counsel for Wacker.\n11. Stop Orders; Blue Sky Qualifications. In connection with any registration statement herein described being effective, if any stop order shall be issued by the Securities and Exchange Commission, Exolon shall use its best efforts to obtain the removal of the same. In connection with any public offering of Exolon stock referred to herein which is required to be registered under the Securities Act of 1933, Exolon will use its best efforts simultaneously to qualify, under the securities or blue sky laws of not more than 20 jurisdictions designated by Wacker, the securities being offered and maintain such qualifications in effect for the duration of the corresponding registration statement.\n12. Restriction on Purchase of Exolon Stock. Wacker agrees that before January 1, 1993, it will not, directly or indirectly, purchase any shares of Common Stock or Series A Preferred Stock of Exolon. Wacker further agrees to use its best efforts to cause its parent corporation, and any corporation or entity affiliated with its parent corporation, not to purchase or otherwise acquire any shares of Exolon's Common Stock or Series A Preferred Stock before January 1, 1993. This restriction shall not be applicable:\n(a) In the event of a publicly announced tender offer for shares of Exolon's common and\/or preferred stock; or\n(b) In the event of a filing under the Williams Act of a public announcement indicating an intention of a person or group to acquire a controlling interest in the shares of Exolon's common and\/or preferred stock; or\n(c) In the event of a determination in good faith by five members of Exolon's Board of Directors that some person or group is seeking to acquire such control; or\n(d) If more than 50% of the shares of Exolon beneficially owned by the Management Group is transferred by the holder(s) thereof, excluding, however, transfers of shares to or among affiliates of such members. \"Affiliates\" means spouses, children, relatives with whom members of the Management Group share their homes, corporations and trusts with which such members are associated, and beneficiaries under such trusts with respect to transfers in distribution of trust assets; or\n(e) If any person or group of persons acting in concert (including existing shareholders of Exolon but not including members of the Management Group) in any one transaction or series of transactions beneficially acquires shares of Common Stock or Series A Preferred equal to 10% of the outstanding shares of both classes taken together, unless such person or group indicates support of the Management Group; or\n(f) If holders of Common Stock and Series A Preferred Stock, who, following the merger, exercise such control as to be able to cause the election of their nominees to one-half of the directorships of Exolon, in fact lose such control.\n13. Miscellaneous. This Agreement shall be binding upon and inure to the benefit of the successors and assigns of the parties. This Agreement shall be governed by the laws of the State of Delaware.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their officers thereunto duly authorized this 26th day of April, 1984.\nTHE EXOLON COMPANY\nBy_________________________ Chairman of the Board\nWACKER CHEMICAL CORPORATION\nEXHIBIT 1OG\nRESTATED LICENSE AGREEMENT\nThis Restated License Agreement (\"Agreement\"), dated as of 26th of April 1984, is by and among ELEKTROSCHMELZWERK KEMPTEN GMBH, a West German limited liability company (\"ESK\"); ESK CORPORATION, a Delaware corporation (\"ESK Corp.\"); and the EXOLON COMPANY, a Delaware corporation (\"Exolon\").\nR E C I T A L S\nPursuant to a license agreement (the \"License Agreement\") dated 15 December 1978 and 19 January 1979 ESK licensed to ESK Corp. a novel, environmentally acceptable technology for the production of silicon carbide (\"SiC\") - hereinafter referred to as the \"Process\" - which had been applied since 1973 by its affiliated company, Elektroschmelzwerk Delfzijl B.V.\nESK Corp. and Exolon now intend to merge in the near future in such a way that ESK Corp. will be merged into Exolon (the \"Merger\"), and Exolon, as the surviving corporation will change its name as of the time the Merger becomes effective to Exolon-ESK Company (Exolon-ESK Company, as the corporation resulting after the effective date of the Merger, is hereinafter referred to as the \"Licensee\").\nThe parties hereto desire that on the effective date of the Merger Licensee shall succeed to the rights, benefits, duties, and obligations of ESK Corp. pursuant to the License Agreement effective January 1, 1984.\nThe parties further desire to amend and restate the License Agreement, effective as of the effective date of the Merger, in order to, among other things, modify the terms of the License Agreement and to expand the scope thereof.\nNOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements hereinafter set forth, the parties hereto hereby covenant and agree as follows:\nAs of the time and date that the Merger shall become effective, the License Agreement shall be amended and restated to provide in its entirety as follows, provided, however, that if the Merger shall not have occurred on or before 30 April 1984, then this Agreement shall be null and void ab initio, and the License Agreement shall remain in full force and effect as if this Agreement were never executed:\n14. Definitions\na. Affiliates. Those companies controlling, controlled by, or under the common control of Licensee or Wacker Chemie GmbH, the ultimate parent company of ESK, respectively, but excluding, in the case of Wacker Chemie GmbH, Hoechst AG and any entity controlled by it not otherwise an affiliate of ESK, and excluding, in the case of Licensee, Norsk Exolon A\/S. \"Control\" of a company shall mean when and for so long as a fifty percent interest in distribution and dividend rights or voting interests of such company is owned directly or indirectly by the relevant party.\nb. Hennepin Plant. The current manufacturing facilities of Licensee at Hennepin, Illinois, which utilizes the Process in the manufacture of SiC.\nc. Improvements. All improvements of the Technology occurring before, during, or after the Term hereof, whether by ESK or by Licensee or any of their respective Affiliates except as provided in Section 1.6.\nd. Know-How. All trade secrets, secret processes, procedures, formulae, data, manuals, test procedures and results and other information of ESK or Licensee or their respective Affiliates, whether now existing or hereafter developed, relating to the Process and considered by ESK or Licensee, as the case may be, to be confidential and secret, and marked as confidential or secret if in writing or some other physical state, and such Know-How shall include the technology, data, drawings and calculations required for the construction and operation of a complete SiC manufacturing plant, particulars concerning the production of green and dark SiC, and specifications relating to all supplementary procedures and equipment needed or appropriate in connection with constructing and operating such an SiC manufacturing plant.\ne. Patents. Those letters patent listed on Exhibit A hereto, and any patents hereafter issued or assigned to ESK or its Affiliates in the Territory in regard to the Process or the Improvements, as well as any patent applications hereafter filed by or assigned to ESK or its Affiliates in regard to the Process or the Improvements.\nf. Technology. Collectively, the Process, the Patents, the Know-How, and any Improvements thereof, except that, when used in relation to Improvements of Licensee, Improvements and technology shall not include any new technology, improvements, inventions and developments which (I) are not derivative from the Technology and (ii) are useful otherwise than solely in connection with the Process.\ng. Term. The period commencing with the effective date of the License Agreement and terminating on 31 December 1992, unless earlier terminated by the provisions hereof.\n1.8 Territory. The United States of America and its territories and possessions and the Dominion of Canada.\n15. Grant of License\na. Grant. Subject to the limits of grant described in Section 2.3 hereof, ESK hereby grants to Licensee in perpetuity (unless this Agreement is terminated pursuant to Article 8 hereof) the exclusive right and license to use the Technology to manufacture an unlimited quantity of SiC at the Hennepin Plant and, with the prior written consent of ESK (which consent shall not be unreasonably withheld), at any other facility within the Territory owned by Licensee or any of its Affiliates, and to sell in the Territory the said SiC so produced at the Hennepin Plant and such other plants, as well as the non-exclusive right, upon subsequent separate mutual discussion and agreement between ESK and Licensee, to sell such SiC so produced at the Hennepin Plant or at such other plant in the Territory in other parts of the world.\nb. Improvements. Except for certain patentable Improvements of ESK governed by Section 4.3 hereof, the foregoing license shall include any Improvements developed or owned by ESK, to the extent that ESK has the right to license the same to Licensee and its Affiliates (except for Norsk Exolon A\/S).\nc. Limit of Grant. The exclusive rights granted pursuant to Sections 2.1 and 2.2 are subject to the exceptions that (I) a license has been granted by ESK to General Abrasives, a division of Dresser Industries, Inc., 2000 College Avenue, Niagara Falls, New York 14305, pursuant to a license agreement dated 1 December 1983; (ii) ESK has the right to sell in the Territory certain products, manufactured using the Process outside the Territory, pursuant to a Distributorship Agreement dated 27 April 1984 between ESK and Licensee; (iii) if the said distributorship agreement is no longer in force, ESK or its Affiliates shall have the right to sell in the Territory products manufactured outside the Territory using the Process and the Technology, but ESK and its Affiliates may not so sell crude SiC if and for so long as Licensee is manufacturing and selling such product in the Territory in appreciable quantities on a regular basis; and (iv) if ESK or any of its Affiliates shall no longer for any reason have the right to nominate and elect at least one-half of the members of the Board of Directors of Licensee, ESK shall have the right to sell (but, until after the Term hereof has expired, not to manufacture) in the Territory any products manufactured outside the Territory using the Process and the Technology; (v) if the Hennepin Plant shall be conveyed to ESK or any of its Affiliates or any third person, whether by foreclosure sale or otherwise, as a consequence of Wacker Chemie GmbH having to pay any sums under a certain Guaranty Agreement by Wacker Chemie GmbH (or any agreement creating security in regard to the reimbursement of any amounts paid under such Guaranty Agreement) in regard to certain Industrial Revenue Bonds issued by ESK Corp., and the Hennepin Plant having been conveyed as security for the repayment of such sums by ESK Corp. or its successor to Wacker Chemie GmbH, ESK shall have the right itself to operate the Hennepin Plant using the Technology and ESK shall also have the right to grant a non-exclusive license of the Technology to any of ESK's Affiliates or any third person who shall acquire such Hennepin plant as a consequence of such a guaranty payment and conveyance of the Hennepin Plant as security, which license shall be on such terms as ESK shall deem appropriate and shall be assignable by such Affiliates or third parties to any transferees or successors thereof (and their respective transferees and successors) who shall thereafter acquire the title to the Hennepin Plant, but in any event shall be restricted to a license to operate the Hennepin Plant, as thereafter operated, renovated, replaced or expanded. Licensee shall have no right to sublicense, assign, transfer, pledge, or encumber the said Technology or any of its right, title, and interest in and to this Agreement to any party other than an Affiliate of Licensee without the prior written permission of ESK.\n16. Technical Assistance\na. Extent of Assistance by ESK. If and to the extent that Licensee's own personnel are not familiar with the Technology, ESK shall make available to Licensee, to such a degree and at such times as shall be mutually agreed upon by ESK and Licensee, basic engineering assistance in connection with the construction of any new SiC manufacturing plant using the Technology. ESK also shall make available to Licensee, to such a degree and at such times as shall be mutually agreed upon by ESK and Licensee, technical and other necessary assistance in regard to the use of any Improvements developed by ESK or its Affiliates.\nb. Extent of Assistance by Licensee. Licensee shall make available to ESK, to such a degree and at such times as shall be mutually agreed upon by ESK and Licensee, technical and other necessary assistance in regard to the use of any Improvements developed by Licensee or its Affiliates.\nc. Cost of Assistance. The out-of-pocket expenses and costs incurred in providing such technical assistance as set forth in Sections 3.1 and 3.2 hereof (but not the salaries or other compensation of any employees of the party providing such assistance) shall be borne by the party receiving such assistance.\n17. Exchange of Information and Rights a. Duty to Exchange. ESK and Licensee each shall be deemed hereunder automatically to have licensed to the other and its Affiliates, and shall promptly advise the other of, all Improvements of the Technology relating to the Process which it or any of its Affiliates shall have developed at any time during the Term hereof or any time after the Term hereof until 31 December 1999 and shall forthwith make available to the other such Improvements (in regard to such nonpatentable Improvements, such Improvements shall be deemed licensed exclusively to the extent and only to the extent that patentable Improvements by the licensing party are exclusively licensed under Section 4.2 or Section 4.3 hereof to the licensee party), conditional however on the payment of any royalty due pursuant to either Section 4.2 or Section 4.3 hereof and except to the extent that such license and duty of exchange of ESK shall be limited by the provisions of Section 4.5 hereof.\nb. Patentable Improvements by Licensee. To the extent that Licensee or any of its Affiliates shall develop an Improvement which is patentable, Licensee shall be deemed to have granted to ESK and its Affiliates, subject to a royalty to be mutually agreed upon by Licensee and ESK (or, in the absence of such agreement, determined by arbitration as provided hereinafter by this Agreement), payable for the period mutually agreed upon by Licensee and ESK, an exclusive (except for Licensee and its Affiliates) and non-transferable license (but with right of sub-license) to use the same for any purpose and in any jurisdiction or territory other than Norway not specifically denied to ESK and its Affiliates under the terms hereof, which license shall be in perpetuity. In the event that any patent application in regard to such Improvement shall be finally denied by the Patent and Trademark Office or any court of competent jurisdiction or if the patent application is withdrawn by Licensee, any royalties previously paid in regard to such Improvement shall be refunded to ESK or its relevant Affiliate, without interest. In the event any patent application is filed by any employee or agent of Licensee as inventor, Licensee covenants and agrees to cause such patent application or such resulting patent to be assigned to it or one of its Affiliates.\nc. Patentable Improvements by ESK. To the extent that ESK or any of its Affiliates shall develop an Improvement which is patentable, ESK shall be deemed to have granted to Licensee and its Affiliates, subject to a royalty to be mutually agreed upon by ESK and Licensee (or, in the absence of such agreement, determined by arbitration as provided hereinafter in this Agreement), payable for the period mutually agreed upon by ESK and Licensee, a non-transferable license, without right of sublicense, to use the same for the purposes specified in this Agreement in regard to the Technology but only in the Territory as specified in this Agreement and other jurisdictions expressly consented to by ESK, which license shall be exclusive in the Territory (but subject to the limits on exclusivity specified in Section 2.3 hereof) and which license shall be in perpetuity, except to the extent that Licensee's license under this Agreement in regard to the Technology generally shall be terminated by some other provision of this Agreement. In the event that any patent application in regard to such Improvement shall be finally denied by the Patent and Trademark Office or any court of competent jurisdiction or if the patent application is withdrawn by ESK, any royalties previously paid in regard to such Improvement shall be refunded to Licensee or its relevant Affiliate, without interest.\nd. Abandonment. If ESK or Licensee or any of their respective Affiliates shall at any time during the Term hereof intend to abandon or not pursue a patent right or patent application in regard to the Technology or any of the Improvements (including any patentable Improvement of Licensee or ESK licensed to the other pursuant to Section 4.2 or Section 4.3 hereof), it will notify the other in writing, and the notified party shall be entitled to assume, without further consideration, the said patent right or patent application within thirty days after such notification upon written notice to the abandoning party. In such event the abandoning party shall make available to the other all records and documents necessary for such assumption. If the notified party shall fail to give such notice of assumption of such patent right or patent application to be abandoned within the thirty day period herein specified, the abandoning party shall be free to abandon the same. Any patent right or patent application assumed by the notified party shall be deemed licensed to the abandoning party on a royalty-free, non-exclusive basis in perpetuity.\ne. Limitations on License and Duty of Exchange. Anything in Sections 4.1 through 4.4 hereof to the contrary notwithstanding, any duty of ESK to license and make available its Improvements shall be terminated by the occurrence of any of the following:\n(a) this Agreement shall be terminated other than by the expiration of time;\n(b) ESK or any of its Affiliates shall no longer have the right to nominate and elect at least one half of the members of the Board of Directors of Licensee;\n(c) the current Management Group (as that term is defined in that certain stockholders agreement between Licensee and Wacker Chemical Corporation dated as of 18 April 1984) of the Licensee shall no longer control the election of one half of the members of the Board of Directors of Licensee.\nUpon such termination of the exchange obligation, unless this Agreement shall otherwise have been terminated pursuant to Article 8, the right of Licensee to use the Improvements of ESK previously licensed to Licensee, and the license of Licensee to use such patentable Improvements previously licensed to Licensee pursuant to Section 4.3, shall continue, but ESK shall have no further obligation to make available and license any additional Improvements, whether or not patentable, developed subsequent to such termination pursuant to this Section 4.5. The provisions of this Section 4.5 are not ESK's exclusive remedy in the event of the breach of this Agreement by Licensee or any of its Affiliates, and in the event of such breach ESK shall have all the rights and remedies herein provided or available at law or in equity.\n18. Secrecy\na. Duty of Licensee. At all times during the Term hereof and thereafter Licensee and its Affiliates shall keep the Know-How and all Improvements thereof not otherwise patented confidential, and shall take reasonable precautions that their employees and agents are also contractually bound to maintain such confidentiality.\nb. Duty of ESK. At all times during the Term hereof and at all times thereafter while Licensee shall have the right to require ESK to exchange Improvements with it pursuant to Article IV hereof, ESK and its Affiliates shall keep secret and confidential all Improvements developed by Licensee or its Affiliates and deemed by the same to be confidential and shall take reasonable precautions to make sure that its employees, agents and sublicensees are also contractually bound to maintain such confidentiality.\nc. Limitations of Duty. The foregoing duty of confidentiality shall not apply to any such Know-How or such Improvements thereof which (I) was previously known to Licensee or ESK or their respective Affiliates prior to the receipt thereof by it; (ii) shall become known to Licensee or ESK or their respective Affiliates hereafter from some other source other than as a direct or indirect result of a breach of this covenant of confidentiality by Licensee or ESK or their respective Affiliates, as the case may be; or (iii) shall become generally known in the industry.\nd. Limitation on Confidentiality Exception. Neither ESK nor Licensee nor their respective Affiliates shall be permitted to justify disregard of its obligation of confidentiality under this Agreement by using the disclosed Know-How or Improvements to guide a search of publications and other publicly available material and by selecting a series of items of knowledge from unconnected sources in the public domain and fitting them together through use of the relevant Know-How or Improvements.\n19. Warranties\na. Of Non-Infringement. ESK warrants that to the best of its knowledge the Technology licensed hereunder to Licensee does not infringe the patents or proprietary rights of any third party nor does the licensing hereof constitute a breach of any contractual obligations in regard thereto to which ESK or any of its Affiliates are a party or by which any of them are bound. Licensee warrants that to the best of its knowledge any Improvements made available by it to ESK hereunder will not infringe the patent or proprietary rights of any third party or constitute the breach of any contractual obligations in regard thereto to which Licensee or any of its Affiliates are a party or by which any of them is bound. In the event any claim is made that any of the foregoing warranties have in fact been breached, the party hereto so warranting (\"Warrantor\") shall promptly undertake the defense of such claim and may retain appropriate counsel to defend against the same, provided that such counsel shall be reasonably acceptable to the other of ESK and Licensee (\"Warrantee\"), and the control and expenses of such defense, including any settlement of the said claim or the abandonment of any allegedly infringing patent rights, shall be the responsibility of and within the sole discretion of Warrantor. Warrantee shall have the right to retain its own counsel at its own cost and expense and, subject to the right of Warrantor so to control the defense of such claim, to participate in such defense. Warrantor shall indemnify Warrantee in regard to any such claim of breach of warranty, but only to the extent of the out-of-pocket cost and expense (including reasonable attorneys' fees and court costs until Warrantor has assumed liability for and defense of the claim) and liability to third parties imposed upon Warrantee which results from the breach of such warranty by Warrantor.\nb. Of Reliability. ESK and Licensee each warrants to the other that the Technology or any Improvement which it provides to the other under this Agreement was properly and duly prepared by qualified and reliable engineers and technicians and that the appropriateness of such Technology or Improvement has been established through technical experimentation and use.\nc. Disclaimer. Licensee and ESK each disclaims any and all other warranties, whether expressed or implied, in regard to the Technology and the Improvements. Each acknowledges that the remedies specified in Section 6.1 shall be exclusive in regard to the breach of the warranties specified therein.\nd. Nonwarranty Claims of Infringement. In the event any claim is made by a third party that the Technology or any Improvement licensed hereunder by ESK or Licensee to the other infringes the patents or proprietary rights of a third party, and such claim does not constitute a breach of the warranties of the respective parties in Section 6.1 hereof, the licensing party shall promptly undertake the defense of such claim and may retain appropriate counsel to defend against the same, provided that such counsel shall be reasonably acceptable to the other of ESK and Licensee (the \"licensee party\"), and the control and expenses of such defense, including any settlement of the said claim or the abandonment of any allegedly infringing patent rights, shall be the responsibility of and within the sole discretion of the licensing party except that the licensing party may not agree to any settlement which imposes liability upon the licensee party in excess of the licensing party's liability limit for indemnification under this Section 6.4. The licensee party shall have the right to retain its own counsel at its own cost and expense and, subject to the right of the licensing party so to control the defense of such claim, to participate in such defense. The licensing party shall indemnify the licensee party in regard to any such claim of infringement, but only to the extent of out-of-pocket costs and expense (including reasonable attorneys' fees and court costs until the licensing party has assumed liability for and defense of the claim) and liability to third parties imposed upon the licensee party as a result of such infringement claim, but the maximum amount of the licensing party's duty of indemnity hereunder in regard to licensee party's liability to third parties (including any obligation to pay royalties for past or future use) is limited to the amount of royalties which the licensing party has received or which has been accrued by the licensee party (provided, however, that if any such royalties have accrued but have not yet been paid to the licensing party, the licensing party may deduct such accrued but unpaid royalties from any amounts which it may owe to the licensee party hereunder, thereby cancelling the Licensee party's obligation to pay such amount of accrued but unpaid royalties) under this Agreement since the date of the Merger. Nothing in this Section 6.4 shall be construed to obligate the licensing party to continue any defense against such claim if the licensing party reasonably considers such defense to be legally or economically impractical, but licensee party may continue such defense if it may still be subject to liability.\ne. Other Claims Regarding the Technology or Improvements. ESK and Licensee will promptly give notice to the other, in writing, of any infringement or possible infringement of, or of attack or threatened attack on, any of the Technology. To the extent that such matter is not within the scope of Section 6.1 or Section 6.4 hereof, the parties will thereupon consult with one another as to the course of action to be taken, but the licensor of such Technology, be it ESK or Licensor, will remain the final arbiter of whether or not legal proceedings are to be undertaken with respect to any infringement(s) or such attack defended against. If affirmative action is decided upon, the parties agree to cooperate wholeheartedly with one another and to decide, taking into account all of the relevant circumstances, whether and how the costs of any action are to be apportioned between them.\n20. Royalties\na. Royalty. As consideration for the grant of the licenses provided herein, as well as the covenant of ESK to make Improvements hereafter developed available to Licensee, Licensee hereby agrees to pay to ESK a royalty of 3.5% of the aggregate net proceeds (based upon the invoice price of the Products, less any charges for freight, insurance, or taxes and also less any rebates, discounts or allowances) in fact received by Licensee or any of its Affiliates from the sale of any of the Products manufactured using the Process or any part of the Technology as licensed hereunder. The royalty due hereunder on any sales between Licensee and any of its Affiliates shall be based upon the average net invoice price, weighted as to quantity sold, of all sales of the same product in the same calendar year subject to these royalty provisions which were made between Licensee or any of its Affiliates and any Non-Affiliate.\nb. Payment. Licensee agrees to keep a complete record regarding the sale and delivery of products subject to such royalty obligation, indicating all particulars that are necessary for computing such royalties. Within eight weeks after the close of each calendar year during the Term hereof, Licensee shall send ESK an accounting of sales made in the aforementioned calendar year which were subject to such royalty obligation, and with such accounting Licensee shall submit payment of the royalty due for such period in regard to the proceeds of such sales. ESK shall have the right to conduct at any time, through an auditor obligated to maintain confidentiality, an audit of the accounting of Licensee in regard to the sale and delivery of such products subject to the royalty obligation and the proceeds thereof. The cost of such audit, if made by Licensee's regular accountant, shall be borne by Licensee, otherwise by ESK.\nc. Withholding. Licensee may deduct from the payments which it is obligated to make to ESK pursuant to this Article 7 any taxes which Licensee is required to withhold pursuant to the laws of the United States of America or the Dominion of Canada, or any of the subdivision of either, but only insofar as ESK may set off or credit such sums withheld against its German tax obligations.\nd. Abatement. Licensee and ESK hereby stipulate and agree that the royalty obligations due hereunder constitute, among other things, consideration for the licensing of the various aspects of the Technology as a whole, as well as the competitive advantage gained by Licensee (and Licensee's predecessor) in having available the Know-How at the commencement of the Term hereof. Licensee and ESK stipulate and agree that if any of the Patents shall be held invalid, or if ESK shall for any reason abandon any Patent, the royalty payments which would be otherwise payable during the remainder of the Term after such finding of invalidity or abandonment shall be ratably abated upon the mutual agreement of ESK and Licensee (or, in the absence of such agreement, the amount of such abatement shall be determined by arbitration as provided hereinafter in this Agreement), taking into account any competitive advantage otherwise obtained by Licensee and its predecessor and the fact that the claims protected by U.S. Patents (and their Canadian equivalents) 3,950,602 and 3,976,829 are substantially more significant than the claims protected by the other two U.S. Patents (and their Canadian equivalents). If any patent application and\/or patents in regard to any of the patentable Improvements of either ESK or Licensee shall be ruled invalid or abandoned, the royalty shall be abated to the extent that a royalty was established and paid as set forth in Section 4.2 or Section 4.3 in regard to the patentable Improvement in question developed by ESK or Licensee.\n21. Termination\na. Right of ESK to Terminate. Provided ESK is not in default hereunder, ESK shall have the right to terminate this Agreement, whether before or after the expiration of the Term hereof, at once upon written notice to Licensee if any of the following shall occur:\n(a) Licensee shall default in the performance or observance of any covenant or agreement hereunder (other than the covenant to pay royalties or other sum due), and Licensee shall fail to cure such default (or shall not be undertaking bona fide efforts to cure such default as promptly as possible if such cure shall require more than thirty days) for at least thirty days after ESK shall have given Licensee written notice hereof, specifying with particularity the nature of the default;\n(b) Licensee shall fail to pay any royalties due hereunder and shall fail to cure such default within fifteen days after it shall have received written notice thereof;\n(c) Licensee shall become bankrupt or insolvent or shall enter into any voluntary bankruptcy or reorganization proceeding, shall become the purported bankrupt in any involuntary proceeding or reorganization proceeding which is not dismissed within sixty days after it has been commenced, shall make an assignment for the benefit of creditors, or shall generally be unable to pay its debts when they become due for a period of sixty days.\nb. Termination by Licensee. Provided Licensee is not in default hereunder, Licensee may terminate this Agreement at once, whether before or after the expiration of the Term hereof, upon written notice to ESK if any of the following shall occur:\n(a) ESK shall default in the performance or observance of any covenant or agreement of ESK herein set forth and ESK shall fail to cure such default (or shall not be undertaking bona fide efforts to cure such default as promptly as possible if such cure requires more than thirty days) for at least thirty days after Licensee has given ESK written notice thereof, specifying with particularity the nature of the default; or\n(b) Licensee shall irrevocably abandon all use and exploitation of the Technology.\nc. Effect of Termination. Upon the termination of this Agreement under this Article 8, Licensee shall at once pay all royalties accrued up to the date of termination, even if not otherwise at that time due and payable pursuant to the terms hereof. Such termination shall be without prejudice to any rights or remedies available to either Licensee or ESK against the other which may have accrued prior to the date of termination. Upon such termination Licensee and its Affiliates shall at once return any and all written material and items in their possession incorporating any part of the Technology and Improvements made available by ESK or its Affiliates to Licensee, as well as all copies thereof. Any covenants or agreements in this Agreement in regard to secrecy and confidentiality and in regard to the return of certain items to ESK shall survive such termination, shall remain in full force and effect, and shall be fully enforceable.\n22. Force Majeure and Special Conditions\na. Force Majeure. In the event that the fulfillment of any covenant or obligation under this Agreement shall be interrupted or delayed by acts of God, war, blockades, labor disputes of any kind, insufficient or delayed provision of transportation, fuel, raw materials, or otherwise, acts of officials, or seizure by any governmental authority, or any other circumstance which delays or interferes with the fulfillment of the covenants of either Licensee or ESK pursuant to this Agreement and are beyond the control of the parties so affected, both parties shall be relieved, during the continued existence of such cause, from the performance of their respective obligations hereunder, without the right of either party to any claim for damages. Immediate notice to the other party must be given in any case of force majeure, and it is understood that the party asserting such force majeure shall take all reasonable effort to reduce to a minimum the consequences of the delay which has occurred.\nb. Special Conditions. Should there occur such a gross fundamental change in general economic and technical conditions existing at the time when the Term hereof commenced, that the carrying out of this Agreement would represent an undue hardship for either party, the party affected by such change shall have the right to ask for an appropriate modification of this Agreement.\n23. Miscellaneous\na. Choice of Law. This Agreement shall be governed by and construed and interpreted in accordance with the law of the State of New York.\nb. Arbitration. Any controversy or claim arising out of or relating to this Agreement, or the negotiation of breach thereof, shall be settled by arbitration in accordance with the rules of the American Arbitration Association, and judgment upon award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. Arbitration shall be held at a site mutually agreeable to Licensee and ESK, or if no agreement can be reached then in New York, New York.\nc. Interest. Any sum owing by Licensee to ESK not paid when due shall accrue interest at a varying interest rate equal to the varying prime rate of interest announced from time to time by Citibank N.A., New York, New York.\nd. Notice. Any notice required or permitted to be given hereunder shall be deemed given when mailed, postage prepaid, by first class mail (air mail if to an address overseas from the point of mailing), certified or registered, with return receipt requested, to the address of the party to receive such notice as set forth below the signatures of the respective parties below, or to such other address as the party to receive such notice may give notice of pursuant to the provisions of this Section 10.4.\ne. Binding Effect, Assignability. This Agreement shall be binding upon and shall inure to the benefit of the respective successors and assigns of the parties hereto. Anything in the previous sentence to the contrary notwithstanding, Licensee and ESK shall not have the right to assign this Agreement or their respective rights and obligations hereunder to any person or party other than one of their own Affiliates without the prior written consent of the other of ESK and Licensee.\nf. Severability. Each and every provision in this Agreement shall be deemed severable, separable, and independent from the other provisions hereof, and in the event that any such provision hereof is later held unenforceable, the validity or enforceability of any other provision hereof shall not be thereby affected, and Licensee and ESK hereby covenant that in the event any such provision is in fact void or unenforceable, they shall use their best efforts mutually to agree upon a substitution therefor achieving the same economic result as the void or unenforceable provision.\ng. Entire Agreement. This Agreement, the Exhibits attached hereto (which for the purposes hereof shall be deemed a part of and incorporated into this Agreement), and the documents and instruments referred to herein, constitute the entire agreement of the parties in regard to the subject matter of this Agreement and no amendment or modification thereof may be made except by a written agreement signed by both Licensee and ESK.\nh. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original and all of which, upon execution, shall be deemed and constitute one and the same instrument.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.\nELEKTROSCHMELZWERK KEMPTEN GMBH THE EXOLON COMPANY\nBy S\/ Norman Pfingstl ByS\/ Kurt M. Hertzfeld\nName: Norman Pfingstl Name: Kurt M. Hertzfeld Title: Managing Director Title: Chairman Herzog-Wilhelm-Str. 16 1000 East Niagara Street D-8000 Muenchen 2 Tonawanda, New York 14150 Federal Republic of Germany Attention: Chairman of the Board\nESK CORPORATION\nBy S\/ Ludwig Eberle Name: Ludwig Eberle Title: President P.O. Box 412 Hennepin, Illinois 61327 Attention: President\nEXHIBIT A\nUS-Patent Issue Date CD-Patent Issue Date\n3,950,602 4\/30\/76 1,038,432 9\/12\/78 3,976,829 8\/24\/76 1,066,019 11\/13\/79 3,989,883 11\/02\/76 1,048,092 2\/06\/79 4,158,744 6\/19\/79 1,070,477 1\/29\/80\nEXHIBIT 10H\nDISTRIBUTORSHIP AGREEMENT\nBetween: EXOLON-ESK COMPANY 1000 East Niagara Street TONAWANDA, New York 14150 (hereinafter referred to as the \"Distributor\") and\nELEKTROSCHMELZWERK KEMPTEN GMBH Herzog-Wilhelm-Strasse 16 D-8000 MUENCHEN 2 (hereinafter referred to as \"ESK\")\nI. Subject and Definitions\nA. Subject to the terms and conditions of this Agreement, ESK hereby appoints the Distributor its sole and exclusive Distributor of the products listed in Appendix A (\"Products\") in the Territory as defined in Section 1.2 hereof.\nB. The Territory shall be the United States of America and its territories (including the Commonwealth of Puerto Rico) and Canada.\nC. This Agreement shall become effective on January 1, 1984, and the initial term thereof shall expire on December 31, 1988; provided, however, that the term of this Agreement shall be automatically extended for additional successive three year terms, commencing on January 1, 1989, and each succeeding third anniversary thereafter unless either party shall give written notice of termination by June 30 of the last contract year of the original term or the renewal term hereof then in effect, in which event this Agreement shall terminate on the following December 31 of the same contract year.\nD. As used in this Agreement, \"Buyer\" shall mean the original ultimate purchaser or user of any of the Products, after purchase from Distributor or from any middleman, who has ultimately acquired the Product in question in any series of non-final sales originating with Distributor.\nII. Promotion and Sale\nA. Distributor shall use its best efforts to develop and exploit the maximum sales potential for the entire line of the Products in the Territory.\n2.2 Distributor shall suitably promote the Products in the Territory through the appropriate means.\n2.3 Distributor shall establish and maintain a sales organization, which shall be properly trained and which shall competently and conscientiously promote and sell the Products and maintain the good will of customers throughout the Territory.\n2.4 The parties shall consult with one another concerning Distributor's performance of its obligations under this paragraph 2 and ESK shall render to Distributor such assistance as it deems appropriate.\n2.5 ESK shall provide Distributor such technical assistance as may reasonably be required by Distributor in the promotion and sale of the Products, and the cost of such technical assistance shall be borne by ESK, except however, that Distributor shall reimburse ESK for all travel, meal, lodging, and related out of pocket expenses incurred by personnel of ESK or its affiliates while in the Territory in providing such technical assistance.\n2.6 ESK's personnel shall have the right periodically to visit Distributor's facilities. Distributor shall assist where necessary in making arrangements for such visits. Deficiencies in regard to proper storage of the inventory, prompt processing of customer orders, inquiries, or complaints, appropriate limitation of warranties and liability (as previously agreed upon by the parties), and maintenance of appropriate inventory of Products noted during such visits to such centers or otherwise shall be remedied without delay by Distributor.\nIII. Reports; Planning\nA. Not more than twenty-one (21) days after each June 30 and January 31, starting with June 30, 1984, while this Agreement is in force, Distributor shall mail a report in writing to ESK. In such semi-annual report Distributor shall:\n1. advise ESK of the inventories of the Products held by Distributor, if any, at the end of the just-completed quarter, by classes and sub-classes, in the form mutually agreed upon by the parties hereto, showing grade, size, and product type to the extent differentiated on ESK's invoices to Distributor, cost thereof and quantity on hand;\n2. advise ESK of its anticipated requirements, if any, of the Products in the coming two calendar quarters; thereafter the parties shall jointly plan Distributor's inventory requirements, if any, and determine the quantities of the Products by classes and sub-classes to be ordered by Distributor from ESK.\nB. In November of each year during the term of this Agreement, Distributor shall furnish ESK with a report on Distributor's marketing plans for the coming calendar year and setting forth the activities of the competition, the market for the Products, the price structure of the market, and reactions of Distributor's customers to the Products.\nC. Within ninety days (90) after the end of each fiscal year (or portion thereof) of Distributor falling within the term hereof, Distributor shall furnish to ESK a report of the total gross sales in tonnage of the Products by Distributor during such fiscal year, with the average price per ton for each such Product during such year. Distributor agrees that ESK shall have the right to examine and copy (at ESK's expense), from time to time, Distributor's books and records in regard to Distributor's inventory of the Products.\nIV. Prices, Payment, Sales and Delivery Terms\nA. Distributor will purchase the Products for its own account from ESK at the net list prices set by ESK for the Territory, CIF at port of entry. Title to the Products and risk of loss thereof shall pass from ESK to Distributor, irrespective of any agreement between them as to purchase of insurance or shipment terms, upon delivery by ESK of the Products to the carrier loaded on board at the port of shipment. Any port of entry shall be mutually agreed upon by ESK and Distributor. Prices are subject to change from time to time by ESK and ESK shall give Distributor sixty (60) days written notice prior to the effective date of any such change; however, ESK shall not be required to give such sixty day notice if the price increase is caused by increased customs duties or import surcharges. Price changes shall apply to orders submitted before the expiration of the sixty-day period unless delivery is scheduled by Distributor to take place after such period expires, provided, however, that Distributor's scheduling of such delivery conforms to the normal and customary delivery schedules arranged between Distributor and ESK previously and is for normal and customary quantities of Products previously ordered by Distributor from ESK.\nB. Distributor shall be invoiced in the currency of the Federal Republic of Germany (DM) and payment of the invoice prices shall be made in such currency. Payment terms shall be net sixty (60) days. All bank fees and other charges and expenses shall be paid by Buyer. Any sum not paid when due shall accrue interest at a varying rate equal to three points above the varying discount rate in effect from time to time as announced by the West German Bundesbank. Any demand or collection of interest by Seller shall not be deemed in lieu of any other claim for damages which Seller may have.\nC. The latest edition of the \"Incoterms\" issued by the International Chamber of Commerce shall be applicable to any sales or deliveries hereunder, but in the event of any conflict between the terms hereof and Incoterms, the terms hereof shall prevail.\nD. Unless otherwise provided in this Agreement, the terms and conditions of sale of ESK attached hereto, which are based on ESK's standard terms and conditions for export sales, shall be deemed a part of this Agreement and shall govern all sales transactions entered into within the framework of this Agreement. Such terms and conditions may only be modified with the prior written consent of both parties hereto. In the event of any conflict between such standard terms and conditions of sale and the provisions of this Agreement, this Agreement shall prevail. Any terms and conditions appearing on any quotation, purchase order, or acknowledgment form of either party made hereto in connection with any sales transactions within the framework of this Agreement shall be without force or effect.\nE. In the event that Distributor intends to grant any lien or security interest in its inventory (other than machinery and parts inventory) to secure obligations of any kind, Distributor will, prior to such grant of any such lien or security interest, grant to ESK, as security for its payment to ESK of any and all amounts due to ESK under any section of this paragraph 4 or any other provision of this Agreement, including any and all attorney's fees and legal costs incurred by ESK in enforcing this Agreement or collecting any monies due to ESK from Distributor for any reason, a first security interest and lien in the inventory of Distributor to the extent such inventory is comprised of any Products sold to Distributor by ESK pursuant to this Agreement or otherwise, as well as all products derived from such Products, all rights of Distributor as a seller of such Products or products derived from such Products under Article 2 of the Uniform Commercial Code, all such Products or products derived from the Products which are sold or transferred by Distributor which have been subsequently returned, reclaimed or repossessed, and all proceeds thereof, including any cash or accounts receivable resulting from the sale of such inventory or proceeds of any insurance policy (collectively, the \"Collateral\"). Distributor agrees to keep the inventory identified so that it can be distinguished from any goods not subject to this security interest, to keep such inventory insured against the customary casualties and risks for at least its replacement costs, to protect the inventory from waste, damage by the elements, theft and vandalism, and to pay all taxes of any kind which may be imposed upon the inventory or which, if not paid, could result in a lien upon the inventory. Distributor agrees that in the event Distributor intends to grant such lien or security interest to another, it will at any time and from time to time execute any financing and continuation statements reasonably requested by ESK to perfect or to continue the perfection of such security interest and further appoints ESK its attorney-in-fact to execute and file such financing and continuation statements if Distributor fails to execute and deliver the same within 5 days after the same is requested by ESK. Distributor warrants that such security interest shall be superior to any and all liens and encumbrances upon such Collateral. Failure of Distributor to observe the covenants and warranties of this Section 4.5, or to observe the other covenants, warranties and agreements of this Agreement, or to pay any sum when due under this Agreement shall constitute grounds for ESK, at its option, to declare all sums immediately due and owing and to exercise its rights under this Section 4.5. Any rights of ESK under this Section 4.5 are cumulative of any other rights and remedies which ESK may have at law or in equity.\nV. Sales by ESK in the Territory\nA. Notwithstanding paragraph 1 hereof and subject to the following conditions, ESK shall have the right after consulting with Distributor, to sell and to make delivery of the Products to those customers who wish to negotiate and deal directly with ESK. In regard to such customers, ESK hereby appoints Distributor its exclusive sales representative for the Territory during the term hereof, and Distributor agrees to cooperate with ESK to promote and bring about such business between ESK and such customers who wish to deal directly with ESK, but the acceptance or refusal of such orders procured by Distributor from such customers for ESK shall in all instances be reserved to ESK, and ESK, not Distributor, shall establish the selling prices as well as the terms and conditions of sale and delivery to such customers, provided, however, that ESK shall not make such sales at prices which are less than the prices of Distributor for sales to its customers of the same product of the same quality in the same quantity and under the same delivery and payment terms.\nB. In such cases of direct sale by ESK, ESK shall pay to Distributor, in consideration of the performance of Distributor's obligations hereunder, a commission equal to two percent (2%) of the invoice amount charged by ESK to such customers (less freight, taxes, insurance, customs duties, and any discounts, rebates, and allowances) and in fact paid by such customers. If for any reason any orders shall remain unexecuted or unpaid, Distributor shall have no claim for any compensation or allowance with respect thereto.\nC. Notwithstanding Section 5.2 hereof, Distributor shall have no claim for commissions on triangle and switch business into third countries, nor shall any commission be paid to Distributor in the event that American or Canadian companies purchase Products, in their own name and on their own account, for direct or indirect shipment to a location outside the Territory.\nVI. Expenses of Performance\nUnless otherwise herein provided, each of the parties hereto shall bear the entire cost of performing its obligations hereunder. In particular, Distributor shall not be compensated or reimbursed for the advertising, servicing and other expenses incurred by it in performing its obligations under paragraph 2 hereof.\nVII. Limitation of Warranty\nA. ESK warrants only that the Products sold to Distributor under this Agreement will meet ESK's specifications or the relevant sample or any independent standard accepted expressly by ESK, under normal use in accord with ESK's specifications and instructions. If any failure to conform to this warranty is reported to ESK in writing within thirty (30) days after the date of the receipt of the Products by Distributor or any Buyer receiving through Distributor (in the case of any nonconformity discoverable through reasonable inspection by Distributor or such Buyer) or within thirty (30) days after the discovery of the nonconformity (in the case of any nonconformity not discoverable through such reasonable inspection, but in any event notice of any nonconformity, whether or not discoverable by reasonable inspection, must be given to ESK within one hundred eighty (180) days after delivery of the Products to Buyer), ESK, upon being satisfied of the existence of such nonconformity, will correct the same by, at ESK's sole option, delivering replacement Products or refunding the purchase price (or, where appropriate, the unit price for such relevant quantity of the Products as have the nonconformity) paid by Distributor or Buyer. If the Products are found by ESK to be nonconforming, ESK will pay shipping costs for return to ESK. No Products shall be returned to ESK, however, without its express written consent.\nTHE FOREGOING WARRANTY IS THE SOLE WARRANTY OF ESK. ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WARRANTIES OF MERCHANTABILITY AND FITNESS FOR PURPOSE, ARE EXCLUDED AND DISCLAIMED.\nESK SHALL NOT BE LIABLE TO DISTRIBUTOR, BUYER OR TO ANY OTHER PERSON, EITHER DIRECTLY OR BY WAY OF INDEMNIFICATION, CONTRIBUTION OR OTHERWISE, FOR CONSEQUENTIAL, INCIDENTAL, SPECIAL OR DIRECT DAMAGES, WHETHER THE CLAIM FOR ANY SUCH DAMAGES IS BASED ON WARRANTY, TORT, CONTRACT, OR OTHERWISE.\nB. Distributor agrees to undertake all reasonable efforts requested by ESK to assure that ESK's product warranty is distributed to all Buyers, and Distributor agrees not to give any broader warranty or more restricted limitation of liability on its own behalf to Buyers that those given by ESK to such Buyers or to Distributor without the prior written approval of ESK.\nVIII. Product Liability Insurance\nDistributor shall carry product liability insurance, covering the Products which it has modified prior to resale by it and ESK shall carry product liability insurance covering the Products which Distributor has not modified prior to resale by it, each in such amounts as shall be reasonably satisfactory to both parties from time to time. In the event of any dispute between ESK and Distributor as to whether the amount of such insurance is adequate, such dispute shall be resolved by referral to an insurance broker mutually satisfactory to the parties.\nIX. Termination\nA. This Agreement may be terminated:\n1. At once by either party if the other party hereto commits a material breach or default under this Agreement, which breach or default shall not be remedied within 30 days after the giving of notice thereof to the party in breach or default; or\n2. At once by either party if the other party hereto is unable to pay its debts as they fall due for a period of sixty (60) days or enters into liquidation or dissolution or becomes insolvent, or if a trustee or receiver is appointed for such party, whether by voluntary act or otherwise, or if any proceeding is instituted by or against such party under the provisions of any bankruptcy act or amendment thereto and is not dismissed within sixty (60) days, or if it enters into a voluntary arrangement with its creditors; or\n3. At once by ESK if (I) either direct or indirect control of the Common Stock and Series A Preferred Stock of Distributor is transferred, either voluntarily or involuntarily, to any person or entity other than the current control group; or (ii) if all or a substantial part of the assets of Distributor shall be sold in other than the ordinary course of business; or (iii) if Distributor attempts to assign this Agreement without ESK's prior written consent.\nB. It is expressly understood and agreed that neither party hereto is under any obligation to continue this Agreement in effect, nor to continue the distributorship arrangement established hereunder, after termination of this Agreement in accordance with this paragraph 9. Both parties recognize the necessity of making expenditures in preparing to perform and in performing this Agreement, and they recognize the possibility and the likelihood of losses or damages resulting from its termination. The parties nevertheless agree that neither party shall be liable to the other for termination of this Agreement in accordance with this paragraph 9, and each party specifically agrees not to hold the other liable for any losses or damages resulting from such termination, including, but not limited to, loss of or damage to investments, leases and sales, advertising and promotional activities, whether incurred in connection with the preparation to perform or the performance of this Agreement or in the expectation of its renewal or extension.\nC. After notice of termination is given by either party under this paragraph 9, ESK is entitled to restrict or even stop entirely deliveries of the Products to Distributor, including deliveries on orders already received at the time of notice of termination. However, ESK is required to make the Products available to Distributor in order to enable Distributor to maintain its own legally binding delivery commitments existing before termination becomes effective, subject to proof thereof being given by Distributor to ESK.\nD. Upon termination of this Agreement, whether pursuant to this paragraph 9 or by expiration of the term hereof, Distributor shall deliver to ESK at once a complete list of all customers of Distributor (including the name and address thereof only) who have bought any Products from Distributor at any time in the three (3) years preceding such termination, and Distribu- tor acknowledges that ESK shall have the right directly or through another distributor or agent to approach such customers and to solicit purchases by them of the Products, and ESK shall have the option, exercisable within a period of sixty (60) days following the effective date of termination, to repurchase from Distributor such of the inventory of the Products as it shall determine, at Distributor's cost therefor, without interest. \"Distributor's cost\" shall mean the price paid by Distributor to ESK for such Products plus all costs incurred by Distributor to lay down the Products in its facilities, less an appropriate allowance for depreciation, obsolescence or damage.\nE. Upon termination of this Agreement, ESK shall have the option to reclaim all advertising and printed matter, if any, made available by it to Distributor.\nX. Special and Consequential Damages\nThe parties agree that the remedies provided in this Agreement are adequate, and that therefore neither party shall be liable to the other for special or consequential damages arising from the breach of any obligation hereunder or for any other reason whatsoever other than as specifically provided for herein.\nXI. Miscellaneous Provisions\nA. The relationship between Distributor and ESK is that of independent contractor and not of employer-employee or principal-agent. Distributor is not the legal representative of ESK nor is ESK the legal representative of Distributor, and neither shall hold itself out as such. Neither Distributor nor ESK has the right or authority to assume or undertake any obligation or make any representation on behalf of the other.\nB. Both parties acknowledge and agree that any internal and confidential knowledge or information or trade secrets about the activities, processes or products of either party hereto which the other shall receive or learn in the performance of its obligations hereunder shall be kept strictly confidential and secret, even after termination of this Agreement, and shall not be used by such other party hereto in its own business without the prior written consent of the owner of the same or unless pursuant to a separate license agreement between the parties or unless the same shall have become known in the industry through no fault of the party seeking to use the other's information or unless the same shall have become known to such party from other sources not involving a breach of any contractual obligation. Each party shall be responsible for seeing that its own employees and agents observe the agreements of this Section 11.2.\nC. ESK agrees to inform Distributor of all inquiries and orders received by it directly from the Territory for delivery in the Territory of the Products. In return, Distributor shall send to ESK all inquiries and orders received by it either for delivery outside the Territory or in regard to customers who wish to deal directly with ESK.\nD. This Agreement, including any claims arising out of or connected with this Agreement, may not be assigned by Distributor except with the prior written consent of ESK.\nE. The failure of any party hereto to require the performance of any term of this Agreement or waiver by any party of any breach under this Agreement shall not prevent a subsequent enforcement of such term nor be deemed waiver of any subsequent breach. Subject to the provisions of paragraph 9 hereof in regard to notice of default and right to cure, time is of the essence in the performance of each party's obligations hereunder.\nF. The captions set forth herein are for convenience of reference only and shall not be considered as part hereof or in any way to limit or amplify the terms and provisions hereof.\nG. Neither of the parties hereto shall be responsible for or liable to the other party for any damage or loss of any kind, directly or indirectly, resulting from fire, flood, explosion, riot, rebellion, revolution, war, labor trouble (whether or not due to the fault of any party hereto), requirements or acts of any government or subdivisions thereof, mechanical breakdown or any other causes beyond the reasonable control of the party. The occurrence and the termination of such force majeure shall be promptly communicated to the other parties.\nXII. Notices\nAny notice required or permitted to be given hereunder shall be in writing and shall be deemed to have been given after the same has been mailed by registered or certified mail (air mail if overseas), return receipt requested, to the respective addresses appearing on the first page of this instrument, or to such other addresses as the parties may from time to time designate in writing.\nXIII. Controversies\nAny controversy or claim arising out of or relating to this Agreement, or the negotiation or breach thereof, shall be settled by arbitration in accordance with the Rules of the American Arbitration Association, and the judgment upon the award rendered by the Arbitrator(s) may be entered in any court having jurisdiction thereof. The arbitration shall be held in such location as shall be mutually agreeable to the parties, but in the absence of such agreement in New York, New York.\nXIV. Alterations of the Contract\nAlterations of and amendments to this Agreement must be confirmed by both parties in writing in order to be binding.\nXV. Severability of the Contract\nShould any provision of this contract lack validity or become void, the remaining provisions hereof will remain in force.\nXVI. Applicable Law\nThis contract is subject to and shall be construed in accordance with the law of the State of New York.\nIN WITNESS WHEREOF, the parties have duly executed this Agreement this 27th day of April, 1984.\nELEKTROSCHMELZWERK KEMPTEN GMBH EXOLON-ESK COMPANY\nS\/ Norman Pfingstl S\/ Kurt M. Hertzfeld\nAPPENDIX A\nSilicon carbide except submicrofine powder and sintered shapes\nELEKTROSCHMELZWERK KEMPTEN GMBH EXOLON-ESK COMPANY\nS\/ Norman Pfingstl S\/ Kurt M. Hertzfeld\nTERMS AND CONDITIONS OF SALE AND DELIVERY\nI. Any delivery dates given to Distributor by ESK are estimates only, and shall not bind ESK to ship or deliver the Products on the dates indicated, although ESK will use its best efforts to meet such delivery dates, and ESK shall not be liable for any direct, indirect, consequential or special damages as a result of delay. In the event that ESK fails to make delivery within the time agreed upon by ESK and Distributor, and within a reasonable period thereafter, Distributor's sole remedy shall be to cancel its order. ESK reserves the right to make partial shipments of the Products ordered and to submit separate invoices to Distributor for such partial shipments.\nII. If Distributor shall default in the timely performance of its obligations in regard to any order or invoice, or any partial shipment under a larger order, ESK may suspend its performance under any subsequent order or in regard to any further partial shipments under such larger order unless and until Distributor shall have cured such default.\nIII. Distributor shall have no right to set off any amount or claim against any amount due and owing to ESK from Distributor unless such amount or claim is fully liquidated and is uncontested or is the subject of a final nonappealable judgment.\nIV. The term \"force majeure\" means any cause not within the reasonable control of the party affected thereby, including without limitation acts of God, strikes or labor disturbances, war, embargoes, shortages of raw materials or transportation or fuel or electric power, failure or destruction of production facilities, and any governmental decree. The occurrence of force majeure shall not excuse either party from the performance of its obligations to the other party, but shall only suspend the same during the continuance of the force majeure. If any force majeure shall prevail for 45 consecutive days, either party shall have the right to terminate at once by written notice to the other party that portion of any order between Distributor and ESK which is still fully executory on the part of both parties. Neither party shall be liable to the other party for any direct, indirect, consequential, incidental or special damages arising out of or relating to the suspension or termination of any contractual relationship between the parties as a result of force majeure.\nV. The provisions hereof may be changed by specific agreement as regards any individual case.\n27 April 1984\nExolon-ESK Company 1000 East Niagara Street Tonawanda, New York 14150\nGentlemen:\nThis letter is being delivered to you in conjunction with the execution and delivery of that certain Restated License Agreement dated 26 April 1984 among Elektroschmelzwerk Kempten (\"ESK\"), ESK Corporation (\"ESK Corp.\"), and The Exolon Company (\"Exolon\"), and also that certain Distributorship Agreement of even date herewith between ESK and Exolon-ESK Company (\"Exolon-ESK\"), the surviving corporation after the merger today of ESK Corp. and Exolon.\nWe wish to assure you that ESK has no current intention upon the termination of the Distributorship Agreement to sell or offer to sell in the Territory (as defined in the Restated License Agreement), either directly or indirectly, any silicon carbide crude or grain products covered by the Distributorship Agreement and currently manufactured and offered for sale by Exolon-ESK in the Territory other than through Exolon-ESK as distributor or sales representative so long as our parent company, Wacker-Chemie GmbH, is directly or indirectly a 50% shareholder of Exolon-ESK and Wacker Chemie has the right directly or indirectly to nominate and elect one-half of the members of the board of directors of Exolon-ESK. In addition, we wish to advise you that we do not believe that ESK will have any intention in the future to sell such products in the Territory other than through Exolon-ESK as distributor or sales representative so long as Wacker-Chemie GmbH directly or indirectly is a 50% shareholder of Exolon-ESK and has the right directly or indirectly to nominate and elect one-half of the members of the board of directors of Exolon-ESK, unless extraordinary conditions shall arise, extraordinary conditions which do not currently exist and which we do not currently foresee, which would make such sales after the termination of the Distributorship Agreement by ESK in the Territory compelling.\nIn acting under this letter agreement, we would expect to base our conduct on concepts of fair dealing (\"Treu und Glauben\"),\nAccepted: Very truly yours,\nExolon-ESK Company Elektroschmelzwerk Kempten GmbH\nBy S\/ Kurt M. Hertzfeld By S\/ Norman Pfingstl\nEXHIBIT 10I\nINDEMNIFICATION AGREEMENT\nAGREEMENT, made as of the 15th day of December, 1984, by and between EXOLON-ESK COMPANY (the \"Company\"), with its principal office at 1000 East Niagara Street, Tonawanda, New York 14150; and WACKER CHEMICAL CORPORATION (\"WCC\"), with its principal office at 964 Third Avenue, New York, New York 10022.\nW I T N E S S E T H:\nWHEREAS, WCC has heretofore entered into an indemnification agreement with respect to the tax exempt status of interest on the $8,000,000 Industrial Development Revenue Bonds, Series 1984 (ESK Corporation Project), dated February 15, 1984, (the \"ESK Bonds\"); and\nWHEREAS, the ESK Bonds are being refunded through the issuance of $8,000,000 Industrial Revenue Bonds, Series 1984 (Exolon-ESK Company Project) (the \"Bonds\") and it is agreed that such indemnification shall be continued with respect to the Bonds;\nNOW, THEREFORE, the parties hereby agree as follows:\n1. WCC will pay to the Company any Additional Payments, as hereinafter defined, due to the holders of the Bonds or to an indenture trustee of the Bonds with respect to the period ending January 15, 1999, inclusive, provided that the amounts payable to the Company with respect to the period beginning January 16, 1994, and ending January 15, 1999, shall in no event exceed three percent (3%) of the average principal amount of the Bonds outstanding during such period. For this purpose, the term \"Additional Payments\" shall mean any amounts which may from time to time be due as a result of the interest on the Bonds becoming taxable for Federal income tax purposes because the $10,000,000 capital expenditure limitation of Section 103(b)(6)(D) of the Internal Revenue Code of 1954, as amended, was exceeded with respect to the $8,000,000 Industrial Project Revenue Bonds, Series A (ESK Corporation Project), heretofore refunded by the ESK Bonds, but only to the extent such amounts do not constitute principal of the Bonds and are in excess of the amounts which would be due under the Bonds if said $10,000,000 capital expenditure limitation had not been exceeded.\n2. WCC shall have all of the rights of the Company with respect to contesting any claim that interest on the Bonds is taxable during the period ending January 15, 1994, and shall be entitled to participate in contesting any such claim for the period January 16, 1994, to January 15, 1999.\n3. Any notice or other communication required or permitted hereunder shall be in writing and shall be deemed to have been given upon mailing by registered or certified mail (air mail if overseas), return receipt requested, to the respective addresses appearing on the first page of this Agreement, or to such other addresses as the parties may from time to time designate in writing.\n4. This Agreement may be executed in one or more counterparts and together shall constitute but one and the same agreement. This Agreement may be amended only by a writing executed by the parties hereto. This Agreement shall be governed by and construed in accordance with the laws of the State of New York.\n5. Nothing in this Agreement shall affect any of the obligations of WCC under the Indemnification Agreement dated April 26, 1984, between it and The Exolon Company (now Exolon-ESK Company), which obligations shall continue in full force and effect.\nIN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed as of the day and year first hereinabove written.\nWACKER CHEMICAL CORPORATION\nBy:S\/ Harold Seeberg Harald Seeberg, President\nEXOLON-ESK COMPANY\nBy:S\/ L. Harrison Thayer II\nExhibit 11 Exolon-ESK Company and Subsidiaries Computation of Earnings Per Share (In Thousands, Except Per Share Data)\nYears Ended December 31, 1995 1994 1993 ______ ______ ______\nNet earnings $3,462 $1,516 $33\nLess Preferred Stock Dividends: Series A (22) (22) (22)\nSeries B (22) (22) (21) ______ ______ ______\nUndistributed earnings (loss) $3,418 $1,472 ($10) Net earnings (loss) attributable to:\nCommon Stock (50.0% in 1993, $1,709 $736 ($5) 1994 and 1995) Class A Common Stock (50.0% $1,709 $736 ($5) in 1993, 1994 and 1995) ______ ______ ______\n$3,418 $1,472 ($10) ====== ====== ======\nNet earnings (loss) per share of Common Stock: $3.55 $1.53 ($0.01) Primary Fully Diluted $3.44 $1.50 $0.03(a)\nNet earnings (loss) per share of Class A Common Stock:\nPrimary $3.33 $1.44 ($0.01)\nFully Diluted $3.24 $1.42 $0.03(a)\nWeighted Average Shares Outstanding: Primary: 482,000 482,000 482,000 Common Stock\nClass A Common Stock 513,000 513,000 513,000 Fully Diluted:\nCommon Stock 504,000 504,000 504,000\nClass A Common Stock 535,000 535,000 535,000\n(a) Assumed conversion of Preferred Stock would have anti dilutive effect in computations and therefore fully diluted earnings per share is not presented on the face of the income statement for the year ended December 31, 1993.\nExhibit 22\nSUBSIDIARIES OF THE REGISTRANT\nThe subsidiaries listed below have been included in the Consolidated Financial Statements of the Registrant. See Note 1 of Notes to Consolidated Financial Statements.\nSubsidiaries of the Registrant Place of Percentage Incorporation Owned Exolon-ESK Company of Canada, Dominion of 100% Ltd. Canada\nNorsk-Exolon A\/S Kingdom of 100% Norway Exolon-ESK International Sales U.S. Virgin 100% Corp. Islands","section_15":""}
{"filename":"36678_1995.txt","cik":"36678","year":"1995","section_1":"Item 1. BUSINESS Description of Business............................................5\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.........................................................6\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS..................................................6\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a).............\nPart II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS................................................6\nItem 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.............................None\nPart III\nItem 10. DIRECTORS OF THE REGISTRANT (a)..................................... EXECUTIVE OFFICERS OF THE REGISTRANT...............................7\nItem 11. EXECUTIVE COMPENSATION (a)..........................................\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a)......................................................\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (a)..................\n(a) Incorporated by reference from Star Banc Corporation's (the Corporation) Proxy Statement for the Annual Meeting of Shareholders on April 9, 1996.\n- 2 -\nPart IV Item 14. EXHIBITS, REPORTS ON FORM 8-K, AND FINANCIAL STATEMENT SCHEDULES(b)\nEXHIBITS: Exhibit 3.1 Amended Articles of Incorporation of Star Banc Corporation (previously filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference)\nExhibit 3.2 Code of Regulations (previously filed as an exhibit to the registrant's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference)\nExhibit 4 Rights Agreement (previously filed as an exhibit to the registrant's Current Report on Form 8-K, dated October 27, 1989, and incorporated herein by reference)\nExhibit 10.1 1986 Stock Incentive Plan (previously filed as an exhibit to Registration Statement No. 33-9494 and incorporated herein by reference)\nExhibit 10.2 Amended 1991 Stock Incentive Plan (previously filed as an exhibit to 1993 Proxy Statement and incorporated herein by reference)\nExhibit 10.3 1987 Deferred Compensation Plan (previously filed as an exhibit to Registration Statement No.33-10085 and incorporated herein by reference)\nExhibit 10.4 Severance and Employment Agreements\nExhibit 11 Computation of Earnings Per Share\nExhibit 13 Annual Report to Security Holders\nExhibit 21 Subsidiaries of the Registrant\nExhibit 23 Consent of Independent Public Accountants in regards to the previously filed Registration Statements No. 2-94845, No. 33-9494, No. 33-10085, No. 33-24672, No. 33-46018 and No. 33-61308\nExhibit 24 Power of Attorney\nExhibit 27 Financial Data Schedules\nFORM 8-K During the fourth quarter of 1995, the Corporation filed no Current Reports on Form 8-K.\nThe Corporation will file with the Commission its long-term debt instruments upon request.\nSIGNATURES..................................................................9\n(b) Certain documents filed as a part of the From 10-K Financial Statements and Financial statement schedules have been omitted due to inapplicability or because required information is shown in the consolidated financial statements or notes thereto. Copies of exhibits may be obtained at a cost of 30 cents per page upon written request to the chief financial officer of the Corporation.\nANNUAL REPORT CROSS-REFERENCE INDEX STAR BANC CORPORATION\nThe page numbers used in this index represent pages in the Star Banc Corporation 1995 Annual Report.\nPART I Annual Report Page(s)\nItem 1. Statistical Disclosure By Bank Holding Companies: Financial Ratios..............................................15 Average Balance Sheets and Average Rates......................18 Volume\/Rate Variance Analysis.................................19 Investment Securities......................................27-28 Loans......................................................23-24 Risk Elements of Loan Portfolio............................24-26 Summary of Loan Loss Experience...............................25 Deposits......................................................29 Short-Term Borrowings.........................................40\nPART II\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........................16-31\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data: Report of Independent Public Accountants......................52 Consolidated Balance Sheets as of December 31, 1995 and 1994..32\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.............................33 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993.................34 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993..............................35 Notes to Consolidated Financial Statements.................36-51 Selected Quarterly Financial Data for the periods ended December 31, 1995 and 1994...................................51\nPart III\nItem 10.","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ..........53\nDESCRIPTION OF BUSINESS\nStar Banc Corporation (\"the Corporation\") was organized as a Delaware corporation in 1973 under the name First National Cincinnati Corporation. In 1988, it was reincorporated under the laws of the State of Ohio and in 1989 changed its name to the current form. Executive offices are maintained in Cincinnati, Ohio. The Corporation is a bank holding company as defined by the Bank Holding Company Act of 1956, as amended, and is registered with the Board of Governors of the Federal Reserve System. As such, it is subject to regulation and examination by the Federal Reserve. Through its banking subsidiaries, the Corporation is engaged in commercial banking and trust business, providing a full range of consumer, commercial and trust financial products and investment services throughout Ohio, Kentucky and Indiana. The Corporation competes for loans and\/or deposits with numerous other banks and financial institutions throughout its market area, as well as with mutual funds, brokerage firms and other types of financial service providers. Types of loans offered through its banking subsidiaries include; commercial loans, commercial leasing, commercial and residential mortgages, real estate construction and a variety of consumer loan products including installment loans, credit cards and retail leasing. The Corporation's loan portfolio is well diversified between wholesale and consumer loans, with none of the above mentioned loan types exceeding 30 percent of the total portfolio. See note 4 to the Consolidated Financial Statements, on page 39 of the Corporation's Annual Report, for additional loan information. The Corporation invests in U.S. Treasury and a variety of mortgage-backed securities in order to, 1) facilitate the management of interest rate risk, 2) provide liquidity, 3) provide a degree of credit diversification and flexibility in the balance sheet, and 4) provide collateral as necessary for public deposits. See the Management's Discussion and Analysis section on pages 27 and 28 of the Corporation's Annual Report, for additional information on investment securities. In the past five years the Corporation has continued to expand through the acquisition of branch offices or other smaller banking institutions throughout its market area of Ohio, Kentucky and Indiana. These institutions included Fir-Ban Inc. (Verona, Kentucky) and Kentucky Bancorporation Inc. (Covington, Kentucky). Most recently the Corporation purchased 24 Columbus, Ohio area branch offices from Household Bank, Federal Savings Bank. This followed the 1994 purchase of 47 former TransOhio Federal Savings Bank branch offices in the Cleveland and Akron, Ohio areas, from the Resolution Trust Corporation and the 1992 purchase of 28 branches in the Cleveland, Ohio area from Ameritrust, N.A. The Corporation continues to explore other acquisition opportunities in its tri-state market area. In 1993, as part of a comprehensive restructuring program, the Corporation merged its six Ohio banks in Columbus, Eaton, Hillsboro, Ironton, Sidney and Troy with Star Bank, N.A. In addition, the Corporation merged its two Indiana banks in Lawrenceburg and Richmond to form Star Bank, N.A., Indiana. This resulted in the Corporation wholly owning three bank subsidiaries directly. All bank subsidiaries are national banks. The primary regulator of all national banks is the Office of the Comptroller of the Currency. As federally insured institutions and members of the Federal Reserve System, the Corporation's national banks are also subject to regulation by the Federal Deposit Insurance Corporation (\"FDIC\") and the Federal Reserve. The Miami Valley Insurance Company, a wholly-owned subsidiary of the Corporation, is incorporated under the laws of the State of Arizona and is engaged solely in the business of issuing credit life and accident and health insurance in connection with the lending activities of the Corporation's Ohio and Indiana bank subsidiaries. First National Cincinnati Corporation is a wholly-owned subsidiary which holds a 75.5 percent ownership of the Corporation's headquarters building. The remaining 24.5 percent ownership is held directly by the Corporation. In 1995, the Corporation formed a wholly-owned consumer finance company, known as Star Banc Finance, Inc. The finance company offers consumers a broad mix of credit products and services, such as indirect and direct auto loans, second mortgages and personal loans. A tabulation of pertinent financial and operational data of all Star Banc Corporation banking subsidiaries as of December 31, 1995, is shown in the following table.\nBANKING SUBSIDIARIES\nThe Corporation and its subsidiaries had a total of 3,850 full-time equivalent employees at December 31, 1995. The Corporation's banking subsidiaries operated a total of 248 full service offices at December 31, 1995.\nPROPERTIES\nStar Banc Corporation and Star Bank, N.A. maintain their offices in Star Bank Center, a 26-story office tower in downtown Cincinnati, which is wholly-owned by the Corporation. This office building contains approximately 562,000 square feet of space of which the Corporation and Star Bank, N.A. occupy approximately 248,000 square feet or 44 percent of the space in the building. The Corporation's banking subsidiaries operate 248 banking offices throughout their market areas. Of those, 117 are owned and 131 are leased.\nLEGAL PROCEEDINGS\nNeither the Corporation nor any of its subsidiaries presently is involved in litigation which in the opinion of management will result in a material effect upon the Corporation's consolidated financial position or results of operations. See Note 16 to the Consolidated Financial Statements, on page 47 of the Corporation's Annual Report, for additional information.\nMARKET AND DIVIDEND\nThe Corporation's common stock (symbol: \"STB\") is traded on the New York Stock Exchange. The following table sets forth the high and low sales prices of the common stock for each quarterly period during 1995 and 1994 as reported by the National Association of Securities Dealers, Inc., as well as dividends per share which have been declared on a quarterly basis.\nAt December 31, 1995, there were 7,955 holders of record of the Corporation's common stock.\nEXECUTIVE OFFICERS\nJerry A. Grundhofer Chairman since 1994. 51 President and Chief Executive Officer since 1993. Director since 1993.\nJerry A. Grundhofer joined Star Banc Corporation in May 1993 as President and was named Chief Executive Officer in June 1993. He has served as Chairman of the Board since January 1, 1994. He has served as President and Chief Executive Officer of Star Bank, N.A. since January 1, 1995 and as Chairman of Star Bank, N.A. since June 1993. He has served on the Board of Directors of the Corporation and Star Bank, N.A. since June 1993. Prior to joining Star, he had served as Vice Chairman of the Board for BankAmerica Corporation since 1992. Prior to the merger between BankAmerica Corporation and Security Pacific Corporation, he had served as President and Chief Executive Officer of Security Pacific National Bank since 1990.\nDaniel B. Benhase Member of the Managing Committee since 1994. 36 Executive Vice President since 1994.\nDaniel B. Benhase has served as Executive Vice President and Head of the Trust Financial Services Group and Private Banking since 1994. Previously he had served as Senior Vice President since 1992 and Director of Corporate Trust and Employee Benefits since 1987.\nJoseph A. Campanella Member of the Managing Committee since 1991. 53 Executive Vice President since 1991.\nJoseph A. Campanella served as President and Chief Executive Officer of Star Bank, N.A., Cleveland from its founding in 1988 to June 1991, at which time he was elected Executive Vice President of Star Banc Corporation.\nRichard K. Davis Member of the Managing Committee since 1993. 37 Executive Vice President since 1993.\nRichard K. Davis joined Star Banc Corporation in November 1993 as Executive Vice President. Prior to joining Star, he had served as Executive Vice President of BankAmerica Corporation since 1992. Prior to the merger between BankAmerica Corporation and Security Pacific Corporation, he had served as Executive Vice President at Security Pacific National Bank since 1990. He has been President and a Director of The Miami Valley Insurance Company since 1993.\nTimothy J. Fogarty Member of the Managing Committee since 1993. 38 Executive Vice President since 1995.\nTimothy J. Fogarty has served as Executive Vice President, Residential Mortgage Banking since 1995. Previously he had served as Senior Vice President, Residential Mortgage Banking since 1993 and Senior Vice President, Operations since 1989.\nS. Kay Geiger Member of the Managing Committee since 1995. 39 Executive Vice President since 1995.\nS. Kay Geiger has served as Executive Vice President and Head of International Banking since 1995. Previously she served as Senior Vice President and Manager of the International Division since 1993. She joined Star in 1989 as Vice President and Manager of International Banking.\nJerome C. Kohlhepp Member of the Managing Committee since 1994. 50 Executive Vice President since 1994.\nJerome C. Kohlhepp has served as Executive Vice President and Head of Specialized Lending since 1994. Previously he had served as Senior Vice President, Specialized Lending for the Corporation since 1992 and Head of Specialized Lending since 1990. He joined Star Bank, N.A. in 1987 as Senior Vice President, Asset-Based Lending.\nThomas J. Lakin Member of the Managing Committee since 1993. 53 Executive Vice President since 1994. General Counsel and Secretary since 1994.\nThomas J. Lakin has served as Executive Vice President, General Counsel and Secretary since 1994. Previously he had served as Senior Vice President, Operations and Administration since 1992 and as Executive Vice President of Star Bank, N.A. since 1989 and as Senior Vice President and Head of Trust Financial Services since 1986.\nDavid M. Moffett Member of the Managing Committee since 1993. 43 Executive Vice President and Chief Financial Officer since 1993.\nDavid M. Moffett joined Star Banc Corporation in September 1993 as Executive Vice President and Chief Financial Officer. Prior to joining Star, he had served as Senior Vice President and Assistant Treasurer of BankAmerica Corporation since 1992. Prior to the merger between BankAmerica Corporation and Security Pacific Corporation, he had served as Senior Vice President and Director of Corporate Treasury at Security Pacific National Bank since 1990. He has served as Treasurer and a Director of First National Cincinnati Corporation.\nDaniel R. Noe Member of the Managing Committee since 1994. 44 Executive Vice President since 1994.\nDaniel R. Noe has served as Executive Vice President and Head of Credit Administration since 1994. Previously he had served as Senior Vice President, Credit Administration since 1990 and Vice President, Loan Review since 1986.\nAndrew E. Randall Member of the Managing Committee since 1995. 43 Executive Vice President since 1995.\nAndrew E. Randall joined Star Banc Corporation in 1995 as Executive Vice President and Regional Chairman in Northeast Ohio. Prior to joining, he served as Senior Vice President and Regional Sales Director at Bank of America.\nWayne J. Shircliff Member of the Managing Committee since 1994. 45 Executive Vice President since 1994.\nWayne J. Shircliff has served as Executive Vice President and Head of Commercial Lending since 1994. Previously he had served as Senior Vice President, Commercial Lending for the Corporation and Executive Vice President, Commercial Lending for Star Bank, N.A. since 1990.\nStephen E. Smith Member of the Managing Committee since 1993. 48 Executive Vice President since 1995.\nStephen E. Smith has served as Executive Vice President, Corporate Human Resources since 1995. Previously he had served as Senior Vice President, Corporate Human Resources since 1993. He joined Star Banc Corporation in 1991. Prior to joining Star, he had served as Senior Vice President, Human Resources at Ameritrust Company since 1986.\nFORM 10-K 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 twenty-seventh day of March 1996.\nStar Banc Corporation\n\/s\/ Jerry A. Grundhofer Jerry A. Grundhofer 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 by the following persons on behalf of the Registrant and in the capacities indicated as of the twenty-seventh day of March 1996.\n\/s\/ David M. Moffett \/s\/ James D. Hogan David M. Moffett James D. Hogan Executive Vice President and Senior Vice President and Chief Financial Officer Controller\nJames R. Bridgeland, Jr., Director* Thomas J. Klinedinst Jr., Director*\nLaurance L. Browning, Jr., Director* Charles S. Mechem, Jr., Director*\nVictoria B. Buyniski, Director* Daniel J. Meyer, Director*\nSamuel M. Cassidy, Director* David B. O'Maley, Director*\nRaymond R. Clark, Director* O'dell M. Owens, M.D., M.P.H., Director*\nV. Anderson Coombe, Director* Thomas E. Petry, Director*\nJohn C. Dannemiller, Director* William C. Portman, Director*\nJ.P. Hayden, Jr., Director* Oliver W. Waddell, Director*\nRoger L. Howe, Director*\n\/s\/ Jerry A. Grundhofer Jerry A. Grundhofer Attorney-in-fact\n*Pursuant to Power of Attorney","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"717720_1995.txt","cik":"717720","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nOn June 4, 1993, the Company entered into a new lease agreement for approximately 80,000 square feet that provided for the relocation of its office space to 220 East 42nd Street, New York, New York. The Company owns a distribution facility of approximately 23,OOO square feet in North Bergen, New Jersey. The primary purpose of this location is the distribution of the Company's publication products. Compupower leases its approximately 8,OOO - -square foot-office and computer facility in Secaucus, New Jersey. The Company believes the capacity of these facilities is sufficient to meet the Company's current and expected future requirements.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of the stockholders during the fourth quarter of the fiscal year ended April 30, l995.\nPart II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Registrant's Common Stock is traded in the over-the-counter market. The approximate number of record holders of the Registrant's Common Stock at April 3O, l995 was 990. Over-the-counter price quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The range of the bid and asked quotations and the dividends paid on these shares during the past two fiscal years were as follows:\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nEarnings per share for each of the fiscal years shown below are based on the weighted average number of shares outstanding.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOperating Results\nThe Company's fiscal 1995 earnings were the fourth highest historical earnings results. This accomplishment comes after three consecutive years of record earnings. Net earnings for the fiscal year ended April 30, 1995 were $23,168,000 or $2.32 per share compared with net earnings of $28,902,000 or $2.90 per share for fiscal year 1994 and net earnings of $27,723,000 or $2.78 per share for fiscal year 1993. The decrease in net earnings for fiscal 1995 from the fiscal 1994 level was primarily due to a decline in Income from Securities Transactions (formerly called Investment Income) of $7,047,000, including losses of $4,980,000 related to the Company's strategy of realizing capital losses in order to reduce income taxes. The $1,550,000 expended in support of The Value Line Cash Fund also contributed to the decrease.\nRevenues of $79,094,000 for fiscal 1995 compare to revenues of $82,050,000 and $78,401,000 for the twelve months ended April 30, 1994 and 1993, respectively. Publication revenues of $55,912,000 for the fiscal year ended April 30, 1995 decreased 3.3% from fiscal 1994. The decrease in publications revenues is primarily a result of the decline in subscription levels for the Value Line Investment Survey due to the uncertain financial market conditions that existed during the first three quarters of fiscal 1995. Revenues from the Company's publications for fiscal 1994 of $57,830,000 increased 3.0% from fiscal 1993 with the increase largely attributable to a higher average level of subscriptions to the Value Line Investment Survey. Investment management fees and services revenues of $23,182,000 for the fiscal year ended April 30, 1995 decreased 4.3% from the fiscal 1994 level. The decrease in fiscal 1995 was primarily a result of a 6.5% decline in the average annual assets under management in the Value Line mutual funds during the fiscal year. Mutual fund net assets under management at April 30, 1995 were approximately equal to the net assets under management at April 30, 1994. Investment management fees and services revenues for fiscal 1994 increased $1,945,000 or 8.7% from the 1993 levels as a result of an increase in the average level of assets under management in the Company's mutual funds. Mutual fund assets under management at fiscal year end 1994 increased during the year from $2.9 billion to $3.0 billion.\nExpenses for the fiscal year ended April 30, 1995, exclusive of the non-recurring expense of $1,550,000, were $47,884,000, a decrease of $1,702,000 or 3.4% over last year's level of $49,586,000. Advertising expenses of $14,749,000 for the twelve months ended April 30, 1995 decreased $3,596,000 from expenses of $18,345,000 for the comparable period in fiscal 1994. The decrease in advertising expenses resulted from management's decision to cut back marketing expenditures during uncertain financial market conditions and increase sales efforts during improved financial market conditions. Salaries and employee benefit expenses of $18,935,000 for the twelve months of fiscal 1995 were $1,662,000 above the prior level of $17,273,000 primarily as a result of the additional staff in support of the Mutual Fund Survey and the cost of replacement staff and recruiting fees at Compupower and the Company's investment management and research divisions. Office and administration expenses of $8,003,000 increased $838,000 or 11.70% from the prior year's level as a result of a $445,000 increase in depreciation and amortization expenses associated with the new office facility and the computer hardware upgrade, $315,000 of accelerated amortization resulting from a decision to upgrade the fulfillment software at Compupower and an increase in professional fees. These increases were offset by a reduction in rent expense of $767,000 or 34% and the receipt of $617,000 in partial settlement of a lawsuit. Fiscal 1994 expenses also include the receipt of $408,000 of proceeds from a partial settlement of this lawsuit. Expenses for fiscal 1994 increased $1,852,000 as compared with fiscal 1993. The net increase is a result of increased advertising for the Value Line Investment Survey, the promotional effort and associated personnel costs incurred in launching the Value Line Mutual Fund Survey, offset by a $3,050,000 expense incurred in fiscal 1993 related to the Company's relocation.\nIncome from Securities Transactions of $8,659,000 for the fiscal year ended April 30, 1995 decreased by $7,047,000 or 44.87% from $15,706,000 at April 30, 1994. In addition to a $764,000 decrease in capital gains produced by the Hedge, Tilt and Stem portfolios, the Company also incurred losses of $4,980,000 related to its tax planning strategy. Sales of mutual fund shares, unrelated to the tax planning strategy, have produced $326,000 of capital losses this year as compared to a $101,000 gain last fiscal year. The decline was largely the result of a decision to liquidate an investment in one of the Company's mutual funds during the latter part of fiscal 1995 in order to redeploy these assets in other investment vehicles. Investment income in fiscal 1994 was $15,706,000, an increase of 10.4% from fiscal 1993. The increase was principally a result of a higher level of capital gains from the Company's portfolio of marketable securities.\nLiquidity and Capital Resources\nThe Company has liquid resources which are used in its business totaling $208,324,000 at April 30, 1995. In addition to $90,311,000 in working capital, the Company has marketable securities with a market value of $118,013,000, that, although classified as non-current assets are also readily marketable as the need for capital arises. The Company has entered into agreements to sell and repurchase U.S. Government Agency debt securities included in working capital with a market value of $39,099,000 at April 30, 1995. The repurchase obligations of $36,994,000 have been entered into on a short term basis. The securities, currently available for sale, mature during calendar year 1997 and are readily marketable should management decide to liquidate the Company's holdings and related obligations. The Company's cash position, including its investment in The Value Line Cash Fund has increased $30,696,000 at April 30, 1995 largely as a result of the liquidation of certain of the Company's equity and fixed income holdings in the Value Line Mutual Funds. The holdings in these funds were sold primarily to realize certain tax benefits during fiscal 1995.\nManagement believes that the Company's cash and other liquid asset resources used in its business, together with future cash flows from operations, will be sufficient to finance current and forecasted operations.\nManagement anticipates no significant borrowing requirements during fiscal 1995 other than the short term refinancing of the repurchase obligations.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the registrant and its subsidiaries are included as a part of this Form lO-K:\nPage Numbers Reports of independent accountants 21 Consolidated balance sheets--April 3O, 1995 and 1994 23 Consolidated statements of income and retained earnings --years ended April 3O, 1995, 1994 and 1993 24 Consolidated statements of cash flows --years ended April 3O, 1995, 1994 and 1993 25 Notes to the consolidated financial statements 26 Supplementary schedules 35\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 and financial disclosure matters.\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 annual proxy statement to be filed with the Securities and Exchange Commission within 12O days after April 3O, l995, except that the information pertaining to Executive Officers is set forth in Part I herein under the caption \"Executive Officers of the Registrant.\"\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nInformation required by this item is incorporated herein by reference to the annual proxy statement to be filed with the Securities and Exchange Commission within 12O days after April 3O, 1995.\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 annual proxy statement to be filed with the Securities and Exchange Commission within 12O days after April 3O, 1995.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this item is incorporated herein by reference to the annual proxy statement to be filed with the Securities and Exchange Commission within 12O days after April 3O, 1995.\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.\n2. Schedules Schedule I - Marketable Securities. Schedule XIII - Other Investments.\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 Articles of Incorporation of the Company, as amended through April 17, 1983 are incorporated by reference to the Registration Statement - Form S-1 of Value Line, Inc. Part II, Item 16.(a) 3.1 filed with the Securities and Exchange Commission on April 7, 1983. 10.8 Form of tax allocation arrangement between the Company and AB&Co. incorporated by reference to the Registration Statement - Form S-1 of Value Line, Inc. Part II, Item 16.(a) 10.8 filed with the Securities and Exchange Commission on April 7, 1983. 10.9 Form of Servicing and Reimbursement Agreement between the Company and AB&Co., dated as of November 1, 1982 incorporated by reference to the Registration Statement - Form S-1 of Value Line, Inc. Part II, Item 16.(a) 10.9 filed with the Securities and Exchange Commission on April 7, 1983. 10.10 Value Line, Inc. Profit Sharing and Savings Plan incorporated by reference to the Registration Statement - Form S-1 of Value Line, Inc. Part II, Item 16.(a) 10.10 filed with the Securities and Exchange Commission on April 7, 1983. 10.13 Lease for the Company's premises at 220 East 42nd Street, New York, N.Y. incorporated by reference to the Annual Report on Form 10K for the year ended April 30, 1994. 20.10 Subsidiaries of the Registrant.\n(b) Reports on Form 8-K.\nNo matters were reported on Form 8-K.\n(c) Exhibits.\nSubsidiaries of the Registrant, Exhibit 22 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 on Form 1O-K for the fiscal year ended April 3O, 1995, to be signed on its behalf by the undersigned, thereunto duly authorized.\nVALUE LINE, INC. (Registrant)\nBy: \/s\/ Jean Bernhard Buttner ____________________________\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/Jean Bernhard Buttner ____________________________ Jean Bernhard Buttner Principal Executive Officer\nBy: \/s\/ Stephen R. Anastasio ____________________________ Principal Financial and Accounting Officer\nDated: July 18, 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 on Form 1O-K for the fiscal year ended April 3O, 1995, to be signed on its behalf by the undersigned as Directors of the Registrant.\n\/s\/Jean Bernhard Buttner \/s\/William S. Kanaga - ------------------------ -------------------- Jean Bernhard Buttner William S. Kanaga\n\/s\/Arnold Van H. Bernhard \/s\/Howard A. Brecher - ------------------------- -------------------- Arnold Van H. Bernhard Howard A. Brecher\n\/s\/Harold Bernard, Jr. \/s\/Samuel Eisenstadt - ---------------------- -------------------- Harold Bernard, Jr. Samuel Eisenstadt\n\/s\/W. Scott Thomas \/s\/David T. Henigson - ------------------ -------------------- W. Scott Thomas David T. Henigson\nDated: July 18, 1995\nExhibit 22\nSubsidiaries of the Registrant ------------------------------\nPercentage of Voting Securities State of Owned By Incorporation Registrant ------------- -----------\nCompupower Corporation Delaware 99.9%\nValue Line Securities, Inc. New York l00%\nThe Vanderbilt Advertising Agency, Inc. New York l00%\nValue Line Publishing, Inc. New York 100%\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Value Line, Inc.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and retained earnings and of cash flows present fairly, in all material respects, the financial position of Value Line, Inc. and its subsidiaries 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 reasonable basis for the opinion expressed above.\nOur audits of the consolidated financial statements referred to above 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\nNew York, New York June 26, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the registration statement on Form S-8 (No. 2-90593) of our report dated June 26, 1995 relating to the consolidated financial statements of Value Line, Inc. and subsidiaries for the years ended April 30, 1995 and 1994, which appears on page 22 of this Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules, which appears in this Form 10-K.\n\/S\/ PRICE WATERHOUSE LLP - ------------------------ PRICE WATERHOUSE LLP\nNew York, New York July 26, 1995\nValue Line, Inc. Consolidated Balance Sheets (in thousands, except share amounts)\nThe accompanying notes are an integral part of these financial statements.\nValue Line, Inc. Consolidated Statements of Cash Flows (in thousands)\nThe accompanying notes are an integral part of these financial statements.\nValue Line, Inc. Consolidated Statements of Income and Retained Earnings (in thousands, except per share amounts)\nThe accompanying notes are an integral part of these financial statements.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 1-Organization and Summary of Significant Accounting Policies:\nValue Line, Inc. (the \"Company\") is incorporated in New York State and carries on the investment periodicals and related publications and investment management activities formerly performed by Arnold Bernhard & Co., Inc. (the \"Parent\") which owns approximately 80% of the issued and outstanding common stock of the Company.\nPrinciples of consolidation: The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nRevenue recognition: Subscription revenues are recognized ratably over the terms of the subscriptions which range from three months to three years. Accordingly, the amount of subscription fees to be earned by servicing subscriptions after the date of the balance sheet is shown as unearned revenue. The unearned revenue shown on the balance sheet is a noncurrent deferred credit. This classification recognizes that the fulfillment of this commitment will require the use of significantly less current assets than the amount of the unearned revenues and, accordingly, combining it with current liabilities would significantly understate the liquidity position of the Company.\nInvestment management fees are recorded as revenue as the related services are performed.\nSecurities Sold Under Agreements to Repurchase:\nThe Company has entered into agreements to sell and repurchase U.S. Government Agency debt securities. The securities are recorded at market value and are included in \"Short-term securities available for sale\" on the Consolidated Balance Sheets.\nValuation of Securities:\nEffective May 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\"). As a result of adopting SFAS 115, the Company changed the method by which it values its long-term securities portfolio, which consists of shares of the Value Line Mutual Funds, and short-term securities portfolio, which the Company classifies as available for sale, from the lower of aggregate cost or market to market value. Unrealized gains and losses on these securities are reported, net of applicable taxes, as a separate component of Shareholders' Equity. Realized gains and losses on sales of the securities are recorded in earnings on trade date and are determined on the identified cost method. SFAS 115 cannot be retroactively applied to the financial statements of periods prior to May 1, 1994.\nTrading securities, which consist of securities held by Value Line Securities, Inc., the Company's broker-dealer subsidiary, and certain adjustable rate preferred shares held by the Company, are valued at market with unrealized gains and losses included in earnings.\nGoodwill: Goodwill represents the excess of the purchase price over the fair value of net assets acquired and is being amortized over a period of 40 years.\nValue Line, Inc. Notes to Consolidated Financial Statements\nEarnings per share: Earnings per share are based on the weighted average number of shares of common stock and common stock equivalents outstanding during each year.\nCash and Cash Equivalents: For purposes of the Consolidated Statements of Cash Flows, the Company considers all cash held at banks and short term liquid investments with an original maturity of less than three months to be cash and cash equivalents. As of April 30, 1995 and 1994, cash equivalents included $41,503,000 and $10,266,000, respectively, invested in the Value Line money market funds.\nReclassification: Certain prior year amounts disclosed in the Consolidated Financial Statements and Notes thereto have been reclassified to conform to current year presentation.\nNote 2-Supplementary Cash Flow Information:\nCash payments for income taxes were $12,974,000, $20,171,000, and $18,123,000, in 1995, 1994 and 1993, respectively. Interest payments of $1,315,000, $183,000 and $201,000 were made in 1995, 1994, and 1993, respectively.\nNote 3-Related Party Transactions:\nThe Company acts as investment adviser and manager for fifteen open-end investment companies known as the Value Line Family of Funds (see Note 4). The Company earns investment management fees calculated based upon the average daily net asset values of the respective funds. The Company also earns brokerage commission income, net of clearing fees, on securities transactions executed by Value Line Securities, Inc. on behalf of the funds and other advisory clients of the Company that are cleared on a fully disclosed basis through non-affiliated brokers. For the years ended April 30, 1995, 1994 and 1993, investment management fees and brokerage commission income, net of clearing fees, amounted to $17,782,000, $19,098,000 and $17,050,000, respectively. The related receivables from the funds for management advisory fees included in Receivable from affiliates in the Consolidated Balance Sheets were $1,352,000 and $1,379,000 at April 30, 1995 and 1994, respectively.\nFor the years ended April 30, 1995, 1994 and 1993, the Company was reimbursed $414,000, $454,000 and $309,000, respectively, for payments it made on behalf of and services it provided to the Parent. At April 30, 1995 and 1994, Receivable from affiliates included a receivable from the Parent of $257,000 and $36,000, respectively. For the years ended April 30, 1995, 1994 and 1993, the Company made federal income tax payments to to the Parent amounting to $10,225,000, $16,020,000 and $14,014,000, respectively. At April 30, 1995 and 1994, accrued taxes payable included $438,000 payable to and $92,000 receivable from the Parent, respectively. These data are in accordance with the tax sharing arrangement described in Note 6.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 4-Investments:\nTrading Securities:\nSecurities held by Value Line Securities, Inc. had an aggregate cost of $40,767,000 and $39,475,000 and a market value of $48,187,000 and $43,549,000 at April 30, 1995 and April 30, 1994, respectively. The adjustable rate preferred stock securities held by Value Line, Inc. which were sold during fiscal 1995 are recorded at the lower of aggregate cost or market at April 30, 1994. The aggregate cost and market value of these securities at April 30, 1994 was $2,347,000 and $2,737,000, respectively.\nShort-Term Securities Available for Sale:\nShort-term securities available for sale consists of Value Line, Inc.'s holdings in the following securities:\nFederal National Mortgage Association (FNMA), floating rate notes due August 5, 1997; par value $30,325,000.\nFederal Farm Credit Bank (FFCB), floating rate notes due February 12, 1997; par value $10,000,000.\nThe market value of the Company's holdings in the FNMA and FFCB, which approximates cost, at April 30, 1995 was $29,438,000 and $9,661,000, respectively. These notes were purchased at a discount from their respective face values. The accretion of this discount has been included as an addition to the cost of the securities and reflected as interest income in the Consolidated Statements of Income and Retained Earnings.\nLong-Term Securities Available for Sale:\nThe aggregate cost of the long-term securities was $104,749,000 and $121,626,000 and the market value was $118,013,000 and $127,993,000 at April 30, 1995 and April 30, 1994, respectively. At April 30, 1995, gross unrealized gains on these securities of $13,264,000, net of deferred taxes of $4,642,000, were included in shareholders' equity. Realized losses and the proceeds received from sales of these securities during the fiscal year ended April 30, 1995 were $5,306,000 and $46,934,000, respectively. At April 30, 1994, these securities were recorded at the lower of aggregate cost or market.\nFor the years ended April 30, 1995, 1994 and 1993, total net income from securities consisted of $4,938,000, $5,094,000 and $5,244,000 of dividend income; $396,000, $11,789,000 and $9,159,000 of net capital gains; $1,912,000, $56,000 and $53,000 of interest income; and $1,865,000, $183,000 and $195,000 of related interest expense, respectively. Net income from securities also included $3,279,000 of unrealized gains for the year ended April 30, 1995 and $1,060,000 and $33,000 of unrealized losses on marketable securities for the years ended April 30, 1994 and 1993, respectively.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 5-Property and Equipment:\nProperty and equipment are carried at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, or in the case of leasehold improvements, over the remaining terms of the leases. For income tax purposes, depreciation is computed using accelerated methods.\nProperty and equipment consisted of the following:\nNote 6-Federal, State and Local Income Taxes:\nThe Company computes its tax in accordance with the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\".\nThe provision for income taxes includes the following:\nValue Line, Inc. Notes to Consolidated Financial Statements\nDeferred taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The tax effect of temporary differences giving rise to the Company's deferred tax (liability)\/asset are as follows:\nIncluded in accrued taxes payable in current liabilities in the Consolidated Balance Sheets are deferred federal tax liabilities of $1,373,000 and $401,000 at April 30, 1995 and 1994, respectively. Also included in accrued taxes payable are deferred state and local tax benefits of $413,000 and $271,000 at April 30, 1995 and 1994, respectively.\nThe provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory income tax rate to pretax income as a result of the following:\nThe Company is included in the consolidated federal income tax return of the Parent. The Company has a tax sharing arrangement which requires it to make tax payments to the Parent equal to the Company's liability as if it filed a separate return.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 7-Employees' Profit Sharing and Savings Plan:\nSubstantially all employees of the Company and its subsidiaries are members of the Value Line, Inc. Profit Sharing and Savings Plan (the \"Plan\"). In general, this is a qualified, contributory plan which provides for a discretionary annual Company contribution which is determined by a formula based upon the salaries of eligible employees and the amount of consolidated net operating income as defined in the Plan. Plan expense, included in salaries and employee benefits in the Consolidated Statements of Income and Retained Earnings, for the years ended April 30, 1995, 1994 and 1993 was $968,000, $1,470,000 and $1,159,000, respectively.\nNote 8-Incentive Stock Options:\nOn April 17, 1993, the Incentive Stock Option Plan expired. On the date of expiration, 22,550 options available for grant were cancelled. Information on the 1983 Incentive Stock Option Plan for the three years ended April 30, 1995, is as follows:\nOptions outstanding at April 30, 1995 expire at various dates through March 2003. At April 30, 1995, 3,750 of the outstanding options were exercisable. Of the common stock held in treasury at April 30, 1995, 6,250 shares were held for exercise of stock options.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 9-Treasury Stock:\nTreasury stock, at cost, for the three years ended April 30, 1995, consists of the following:\nThe Company's Board of Directors authorized the purchase of up to 1,000,000 shares of the Company's common stock from time to time in negotiated transactions.\nNote 10-Securities Sold under Agreements to Repurchase:\nOn June 28, 1994, the Company entered into short-term agreements to repurchase certain securities sold. These agreements were entered into to repurchase the Federal National Mortgage Association Floating Rate Notes due August 5, 1997 (FNMA), par value $30,325,000, and Federal Farm Credit Bank Floating Rate Notes due February 12, 1997 (FFCB), par value $10,000,000, stated in Note 4. The outstanding balance of the obligations under the repurchase agreements in the aggregate amount of $36,977,000 accrue interest at a stated annual interest rate of 6.3125% and mature on May 5, 1995 ($27,899,000) with respect to the FNMA and May 12, 1995 ($9,095,000) for the obligation to repurchase the FFCB securities. The Company intends to refinance these obligations on a short term basis.\nNote 11-Lease Commitments:\nOn June 4, 1993, the Company entered into a 15 year lease agreement that provides new primary office space, replacing the previous lease that expired during the second quarter of fiscal year 1994. The lease includes free rental periods as well as scheduled base rent escalations over the term of the lease. The total amount of the base rent payments is being charged to expense on the straight-line method over the term of the lease. The Company has recorded a Deferred charge on its Consolidated Balance Sheets to reflect the excess of annual rental expense over cash payments since inception of the lease.\nValue Line, Inc. Notes to Consolidated Financial Statements\nFuture minimum payments, exclusive of forecasted increases in real estate taxes and wage escalations, under operating leases for office space, with remaining terms of one year or more, are as follows:\nRental expense for the years ended April 30, 1995, 1994 and 1993 under operating leases covering office space was $1,481,000, $2,248,000 and $2,422,000, respectively.\nNote 12-Relocation Cost:\nIn fiscal 1994, the Company relocated its corporate office facility to a new location within New York City. Included in Relocation expense in the Consolidated Statements of Income and Retained Earnings in 1993 is the estimated operating cost of the second facility during the estimated period of construction, the disposal and clean-up expenses at the previously occupied office site and the charges related to the acceleration of depreciable lives of the Company's office and computer equipment that was replaced in connection with the relocation.\nNote 13-Term Loan Facility:\nThe Company has repaid its $3,000,000 obligation and terminated the bank term loan agreement during fiscal 1995. The agreement provided for collateralization and the maintenance of certain ratios and net worth limitations. At April 30, 1994, the bank held marketable securities with a market value of $7,031,000 as collateral against the loan. These securities were sold during fiscal 1995 with the proceeds used to repay the bank obligation.\nInterest charged on the loan was at the bank's prime lending rate which averaged 7.5%, 6.1% and 6.1% for the years ended April 30, 1995, 1994 and 1993, respectively. Interest expense for the years ended April 30, 1995, 1994 and 1993 was $119,000, $183,000 and $195,000, respectively.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 14-Business Segments:\nThe Company operates in two business segments: Investment periodicals and Publications, and Investment Management. Identifiable assets consisted of:\nRevenues and income from operations were as follows:\nNote 15-Net Capital:\nThe Company's wholly owned broker\/dealer subsidiary, Value Line Securities, Inc., is subject to the net capital provisions of Rule 15c3-1 under the Securities Exchange Act of 1934, which requires the maintenance of minimum net capital of $100,000 and requires that aggregate indebtedness, as defined, shall not exceed fifteen times net capital, as defined. Additionally, dividends may only be declared if aggregate indebtedness is less than twelve times net capital.\nAt April 30, 1995, Value Line Securities', Inc. net capital, as defined, of $39,331,748 exceeded required net capital by $38,550,090 and the ratio of aggregate indebtedness to net capital was .30 to 1.\nValue Line, Inc. Notes to Consolidated Financial Statements\nNote 16-Financial Instruments with Off-Balance-Sheet Risk and Concentration of Credit Risk:\nThe Company executes, as agent, securities transactions on behalf of the Value Line mutual funds. If either the mutual fund or a counterparty fail to perform, the Company may be required to discharge the obligations of the nonperforming party. In such circumstances, the Company may sustain a loss if the market value of the security is different from the contract value of the transaction.\nIn the normal course of business, the Company enters into contractual commitments, principally financial futures contracts for securities indices. Financial futures contracts provide for the delayed delivery of financial instruments for which the seller agrees to make delivery at a specified future date, at a specified price or yield. The contract or notional amount of these contracts reflects the extent of involvement the Company has in these contracts. At April 30, 1995, the underlying notional value of such commitments was $5,942,625. Risk arises from the potential inability of counterparties to meet the terms of their contracts and from movements in securities values. The Company limits its credit risk associated with such instruments by entering exclusively into exchange traded futures contracts.\nNo single customer accounted for a significant portion of the Company's sales in 1995, 1994 or 1993, nor accounts receivable for 1995 or 1994.\nNote 17-Estimated Fair Value of Financial and Derivative Instruments:\nStatement of Accounting Standards No. 119, \"Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments,\" requires disclosure of information regarding derivative instruments, which include financial index futures contracts.\nDerivative instruments held for trading purposes are reflected at fair value at April 30, 1995. The fair value and the average fair value of derivative instruments at April 30, 1995 and for the year then ended consists of liabilities of $332,925 and $50,102, respectively.\nNet trading gains related to equity securities aggregated $5,227,790 for the year ended April 30, 1995. Net trading losses related to derivative financial instruments amounted to $570,552 for the year ended April 30, 1995.\nNote 18-Mutual Fund Support Expenses:\nOn June 28, 1994, the Company purchased, as part of its investment management operations for which it receives fee income, U.S. Government Agency notes with a market value as of that date of $38,615,000 from the Value Line Cash Fund, for which it is the investment adviser. In order to maintain a $1.00 per share net asset value, as part of the same transaction, the Company reimbursed the Value Line Cash Fund $1,550,000 for losses the Fund incurred on the sale which the Company may recoup in the future.","section_15":""}
{"filename":"353394_1995.txt","cik":"353394","year":"1995","section_1":"ITEM 1. BUSINESS.\nTHE COMPANY\nScience Applications International Corporation (the \"Company\") provides diversified professional and technical services (\"Technical Services\") and designs, develops and manufactures high-technology products (\"Products\"). The Company's Technical Services and Products are primarily sold to departments and agencies of the U.S. Government, including the Department of Defense (\"DOD\"), Department of Energy (\"DOE\"), Department of Transportation (\"DOT\"), Department of Veterans Affairs (\"VA\"), Environmental Protection Agency (\"EPA\") and National Aeronautics and Space Administration (\"NASA\"). Revenues generated from the sale of Technical Services and Products to the U.S. Government as a prime contractor or subcontractor accounted for 86%, 88% and 88% of revenues in fiscal years 1995, 1994 and 1993, respectively. The balance of the Company's revenues are attributable to the sales of Technical Services and Products to foreign, state and local governments, commercial customers and others. The percentage of revenues attributable to Technical Services and Products has remained relatively constant at approximately 91% and 9%, respectively, for fiscal year 1995 and approximately 92% and 8%, respectively, for fiscal years 1994 and 1993. The Company provides Technical Services primarily in the areas of \"National Security,\" \"Environment,\" \"Energy\" and \"Other Technical Services,\" the last of which includes the Company's health, space, transportation and commercial information technology business areas. For certain financial information regarding the Company's business segments, see Note C of Notes to Consolidated Financial Statements of the Company set forth on page of this Form 10-K.\nThe principal office and corporate headquarters of the Company is located in San Diego, California at 10260 Campus Point Drive, San Diego, California 92121 and its telephone number is (619) 546-6000. All references to the Company include, unless the context indicates otherwise, the Company and its predecessor and subsidiary corporations.\nTECHNICAL SERVICES\nNATIONAL SECURITY\nThe Company currently provides a wide array of national security related Technical Services to its customers, including advanced research and technology development, systems engineering and systems integration and technical, operational and management support services. Examples of the Company's Technical Services in the national security area include the following:\n- Development and integration of command, control and intelligence applications software, middleware, and data bases in client-server architectures to provide situational awareness and decision-aiding to military commanders and organizations and architectural definition, systems and software engineering, systems installation, training and site support.\n- Information system engineering and support services, including requirements analysis and acquisition support, computer system design, information and user environment modeling and data communication systems support.\n- Defense studies and analyses for various defense and intelligence agencies of the U.S. Government, including studies regarding conventional and nuclear warfare issues, treaty negotiation and verification, and the integration of military operational and technological considerations with defense policy issues.\n- Development of core technology for advanced distributed simulation and applications for the DOD and other government and commercial customers.\n- Support of numerous DOD test and evaluation requirements of ground, air, sea and space systems, assistance to the U.S. Air Force, U.S. Navy, U.S. Army, U.S. Marine Corps and the\nOffice of the Secretary of Defense in assessing the military effectiveness and suitability of major communication, sensor, navigation, weapon and related systems that support primary service and\/or joint service roles and missions.\n- Logistics engineering services and turnkey logistics information management systems to a wide variety of government customers.\n- Design, integration, implementation and operation of battle field simulation training ranges on land, air and sea.\n- Systems engineering and technical assistance for cruise missiles, future aircraft and ballistic missile concepts, systems analysis of sensors for the detection and tracking of aircraft and ballistic missiles and studies regarding the survivability of tactical aircraft and strategic missiles.\n- Support to the DOD in imagery collection, processing, exploitation and dissemination systems for digital processing, technology intelligence communications and information management.\n- Engineering support for a wide variety of naval avionics systems, including scientific and engineering studies, hardware design, development and fabrication, computer engineering and support, and reliability, maintainability and logistics engineering.\n- Maintenance engineering and training, including field technical services and repair, electronic system design and hands-on operational support, primarily to the U.S. Navy.\n- Independent verification and validation and software quality assurance support services for shipboard anti-submarine warfare combat systems, mission planning functions, operational flight software command and control processors, nuclear surety systems, soft copy imagery processing, data storage and dissemination systems and various submarine, surface ship and command, control and communications systems.\n- Engineering, environmental, quality assurance, integration and program support to the U.S. Army's chemical demilitarization and remediation activity.\nENVIRONMENT\nIn the environment area, the Company performs site assessments, remedial investigation and feasibility studies, remedial actions, technology evaluations, sampling, monitoring and regulatory compliance support and training. Examples of the Company's Technical Services in the environment area include the following:\n- Management and technical support to the DOE for the characterization of the nation's first potential high level waste repository, including the preparation and coordination of environmental assessments, field testing, technical evaluations, public information, quality assurance and information systems and training.\n- Development, demonstration and evaluation of new technologies for hazardous waste treatment, including bioremediation and high-energy plasma treatment systems.\n- Solid and hazardous waste services to federal, state and local governments and the private sector, including environmental assessments, environmental impact statements, design engineering, remedial investigations and feasibility studies, remedial actions, regulatory and enforcement support, pollution prevention and engineering services.\n- Analysis of a broad range of environmental issues associated with the marine sciences such as ocean dumping, mineral exploration, global change and global ocean circulation and temperature trends.\n- Support associated with the development of treatment technologies, including treatability studies, development of protocols for technology evaluation, pollution prevention assessments, waste minimization and technology assessments.\n- Development and implementation of information systems.\nENERGY\nThe energy related Technical Services of the Company include safety evaluations, security, reliability and availability engineering evaluations, technical reviews, quality assurance, information systems, plant monitoring systems and project management. Examples of the Company's Technical Services in the energy area include the following:\n- Engineering and support services to nuclear, electric, gas and other utility operations in the areas of computer systems, information processing, configuration management, risk assessment, safety analysis, nuclear engineering, reliability and availability evaluations, simulator upgrades, energy policy analysis and alternative energy evaluation.\n- Support to DOE in planning, facility transitions, safety analysis, transportation, waste management, quality assurance, emergency preparedness and public outreach.\n- Design, fabrication and application of alternative energy sources such as solar generators and fuel cells.\n- Information systems services to the DOE, including collection, analysis and storage of energy information, the development of geographic information systems and the overall management of large computer facilities.\n- Support to DOE in fusion energy research, including facility management, computer system development and project management support in connection with an international thermonuclear experimental reactor.\n- Systems integration services to the utility industry, including design, development and installation of plant process computer systems, supervisory control and data acquisition (SCADA) systems, and electronic security systems.\n- Management, operation and technical services for fossil energy research laboratories.\nOTHER TECHNICAL SERVICES\nThe Company provides Technical Services to government and commercial customers in such other areas as health, space, transportation and commercial information technology. The health related Technical Services of the Company include medical information systems, technology development and adolescent counseling. The Company also provides a wide variety of Technical Services in the space, transportation, commercial information technology and other areas. Examples of the Technical Services provided by the Company in these areas are described below:\n- Applied research, systems integration and customer support services to both commercial and federal health care clients, including research initiatives for the U.S. Advanced Research Projects Agency, developing and operating a nationwide health care frame relay-based telecommunications system for the VA and automating the information systems for the DOD's medical treatment facilities worldwide.\n- Development, installation and operation of computer and telecommunications systems for various transportation applications, including automated toll revenue collection, rail asset and freight management, intermodal terminal operation, advanced traffic and congestion management, rail electrification, traffic control, air traffic control, commercial vehicle electronic clearance, explosive and contraband detection, and state motor vehicle registration.\n- Strategic planning, operational analysis and evaluation, surface transportation planning and engineering, software development and reengineering, safety and human factors research, and hazardous material transportation safety.\n- Development and integration of fuel cell technology for alternative fuel vehicles and support to the FAA in flight testing helicopter instrumented approaches using the satellite based global positioning system (GPS).\n- Information technology and automatic data processing outsourcing services for commercial clients.\n- Support to the U.S. Army in the biomedical area, including providing expert analysis, research planning, program design and review, and topical research on a variety of military medical issues, including medical countermeasures to chemical and biological warfare, casualty care, battlefield hazards and the U.S. Army's breast cancer research program and biomedical service and management of government facilities.\n- Scientific and computing services to federal agencies involved in global change research, including processing, utilization and scientific analysis of space, airborne and ground based remotely sensed data.\n- Security services for the U.S. Government and commercial customers, including material control and accountability, computer security, technical surveillance countermeasures, intrusion detection, access control and physical plant threat assessments and vulnerability analysis.\nPRODUCTS\nThe Company designs, develops and manufactures high-technology products for government and commercial customers. Examples of the Company's Products are described below:\n- Automatic equipment identification technology for rail, truck, air and sea transportation modes.\n- Ruggedized\/militarized computers for various military and industrial applications.\n- A portable ultrasonic imaging system primarily used for nondestructive inspection of aircraft and nuclear power plant piping.\n- Hardware products for multi-lateration based range instrumentation systems, including transponders, airborne instrumentation pods and ground reference interrogator\/relay stations.\n- A variety of flat panel displays for military applications based on plasma and electroluminescent technology and liquid crystal display technology.\nRESOURCES\nThe technical services and products provided by the Company utilize a wide variety of resources. The Company anticipates the continued availability of the resources required for the products and services provided to customers. A substantial portion of the computers and other equipment, materials and subcontracted work required by the Company could be procured from alternate supply sources. However, with respect to certain products and programs, the Company depends on a particular source or vendor. While a temporary or permanent disruption in the supply of these materials or services could cause inconvenience or delay or impact the profitability of the affected programs or products, the Company believes it would not materially affect the profitability or operations of the Company as a whole.\nThe availability of skilled employees who have the necessary education and\/or experience in specialized scientific and technological disciplines remains critical to the future growth and profitability of the Company. To date, the Company has not experienced any significant difficulty in obtaining or retaining the services of such employees. As an inducement, the Company maintains a variety of\nbenefit programs for its employees, including retirement and bonus plans, group life, health, accident and disability insurance, and offers its employees the opportunity to participate in the Company's employee ownership program. See \"Business -- Employees And Consultants.\"\nMARKETING\nThe Company's marketing activities are primarily conducted by its own professional staff of engineers, scientists, analysts and other personnel. The Company's marketing approach for its technical services begins with the development of information concerning the requirements of the U.S. Government and other potential customers for the types of services provided by the Company. Such information is gathered in the course of contract performance and from formal briefings, participation in professional organizations and published literature. This information is then evaluated and exchanged among marketing groups within the Company (organized along functional, geographic and other lines) in order to devise and implement, subject to management review and approval, the best means of taking advantage of available business opportunities, including the preparation of proposals responsive to the stated and perceived needs of customers.\nThe Company's high-technology products are marketed primarily through the Company's own sales force, which is augmented by independent sales representatives.\nCOMPETITION\nThe businesses in which the Company is engaged are highly competitive. The Company has a large number of competitors, some of which have been established longer and have substantially greater financial resources and larger technical staffs than the Company. Some of the other competitors, although smaller in size, are more highly specialized. In addition, the U.S. Government's own in- house capabilities and federal non-profit contract research centers are also competitors of the Company because they perform certain types of services which might otherwise be performed by the Company.\nThe primary competitive factors in the business areas in which the Company is engaged are technical, management and marketing competence and price. The Company's continued success is dependent upon its ability to hire and retain highly qualified scientists, engineers, technicians, management and professional personnel who will provide superior service and performance on a cost-effective basis.\nSIGNIFICANT CUSTOMERS\nDuring the fiscal years ended January 31, 1995, 1994 and 1993, approximately 88%, 89% and 89%, respectively, of the Company's contract revenues from the Technical Services segment and 68%, 72% and 82%, respectively, of the Company's contract revenues from the Products segment, were attributable to prime contracts with the U.S. Government or to subcontracts with other contractors engaged in work for the U.S. Government.\nIn fiscal years 1995, 1994 and 1993, the U.S. Air Force accounted for 11%, 12%, and 12%, respectively, of consolidated revenues, the U.S. Army accounted for 19%, 17% and 15%, respectively, of consolidated revenues, the U.S. Navy accounted for 10%, 10% and 12%, respectively, of consolidated revenues and the DOE accounted for 11%, 10% and 5%, respectively, of consolidated revenues. No single contract in the Technical Services segment accounted for 10% or more of consolidated revenues in fiscal years 1995, 1994 and 1993.\nNo single customer or contract in the Products segment accounted for 10% or more of consolidated revenues in fiscal years 1995, 1994 and 1993.\nGOVERNMENT CONTRACTS\nMany of the U.S. Government programs in which the Company participates as a contractor or subcontractor may extend for several years; however, such programs are normally funded on an annual basis. All U.S. Government contracts and subcontracts may be modified, curtailed or terminated at the convenience of the government if program requirements or budgetary constraints change. In the event that a contract is terminated for convenience, the Company would be reimbursed for its allowable costs through the date of termination and would be paid a proportionate amount of the stipulated profit or fee attributable to the work actually performed.\nTermination or curtailment of major programs or contracts of the Company could have a material adverse effect on the results of the Company's operations. Although such contract and program terminations have not had a material adverse effect on the Company in the past, no assurance can be given that curtailments or terminations of U.S. Government programs or contracts will not have a material adverse effect on the Company in the future.\nThe Company's business with the U.S. Government and other customers is generally performed under cost-reimbursement, time-and-materials, fixed-price level-of-effort or firm fixed-price contracts. Under cost-reimbursement contracts, the customers reimburse the Company for its direct costs and allocable indirect costs, plus a fixed fee or incentive fee. Under time-and-materials contracts, the Company is paid for labor hours at negotiated, fixed hourly rates and reimbursed for other allowable direct costs at actual costs plus allocable indirect costs. Under fixed-price level-of-effort contracts, the customer pays the Company for the actual labor hours provided to the customer at negotiated hourly rates. Under firm fixed-price contracts, the Company is required to provide stipulated products, systems or services for a fixed price. Because the Company assumes the risk of performing a firm fixed-price contract at the stipulated price, the failure to accurately estimate ultimate costs or to control costs during performance of the work could result, and in some instances has resulted, in losses.\nDuring the fiscal years ended January 31, 1995, 1994 and 1993, approximately 64%, 65% and 62%, respectively, of the Technical Services revenues were derived from cost-reimbursement type contracts and 13%, 12% and 16%, respectively, of the Technical Services revenues were from firm fixed-price type contracts with the balance from time-and-materials and fixed-price level-of-effort type contracts. In contrast, the majority of the Products revenues in these three years were derived from firm fixed-price type contracts.\nAny costs incurred by the Company prior to the execution of a contract or contract amendment are incurred at the Company's risk, and it is possible that such costs will not be reimbursed by the customer. Unbilled receivables in this category which were included in the Technical Services revenues, exclusive of related fees, at January 31, 1995 were $13,393,000. Unbilled receivables in this category which were included in the Products revenues, exclusive of related fees, at January 31, 1995 were $383,000. Although no assurance can be given that the contracts or contract amendments will be received or that the related costs will be recovered, the Company expects to recover substantially all such costs.\nContract costs for services or products supplied to the U.S. Government, including allocated indirect costs, are subject to audit and adjustment by negotiations between the Company and U.S. Government representatives. The majority of the Company's indirect contract costs have been agreed upon through the fiscal year ended January 31, 1991 and substantially all of the Company's indirect contract costs have been agreed upon through the fiscal year ended January 31, 1990. Contract revenues for subsequent years have been recorded in amounts which are expected to be realized upon final settlement. However, no assurance can be given that audits and adjustments for subsequent years will not result in decreased revenues or profits for those years.\nPATENTS AND PROPRIETARY INFORMATION\nAlthough the Company owns or has made application for patents on certain products and processes, the nature of the technical services and products provided by the Company is such that the Company does not presently consider its competitive position to be dependent upon patent protection. The Company claims a proprietary interest in certain of its products, software programs, methodology and know-how. Such proprietary information is protected by trademarks, tradenames, copyrights, trade secrets, licenses, contracts and other means.\nThe U.S. Government has certain rights to data, computer codes and related material developed by the Company under U.S. Government-funded contracts and subcontracts. Generally, the U.S. Government may disclose such information to third parties, including competitors. In the case of subcontracts, the prime contractor may also have certain rights to the programs and products developed by the Company under the subcontract.\nBACKLOG\nBacklog includes only the funded dollar amount of contracts in process and does not include the dollar amount of projects for which the Company has been given permission by the customer (i) to begin work but for which a formal contract has not yet been entered into or (ii) to extend work under an existing contract prior to the formal amendment or modification of the existing contract. In these cases, either contract negotiations have not been completed or a contract or contract amendment has not been executed. When a contract or contract amendment is executed, the backlog will be increased by the difference between the dollar value of the contract or contract amendment and the revenue recognized to date.\nThe backlog for the Technical Services segment at January 31, 1995 and 1994 amounted to approximately $858,000,000 and $695,000,000, respectively, and the backlog for the Products segment at those dates amounted to approximately $119,000,000 and $109,000,000, respectively. The Company expects that a substantial portion of its backlog at January 31, 1995 will be recognized as revenues prior to January 31, 1996. Some contracts associated with the backlog are incrementally funded and may continue for more than one year.\nEMPLOYEES AND CONSULTANTS\nAs of March 10, 1995, the Company employed approximately 17,000 persons on a full-time basis and approximately 1,250 persons on a part-time basis. The Company also utilizes the services of consultants to provide specialized technical and other services on specific projects.\nThe highly technical and complex services and products provided by the Company are dependent upon the availability of professional, administrative and technical personnel having high levels of training and skills. The Company has not experienced any significant difficulty in recruiting or retaining such personnel. Management believes the Company's orientation towards employee ownership is a major factor in the Company's ability to attract and retain qualified personnel. As of March 10, 1995, approximately 9,950 employees, consultants and their family members were stockholders of record.\nNone of the Company's employees are represented by a labor union. To date, no strikes or work stoppages have been experienced and the Company considers its relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAs of March 10, 1995, the Company conducted its operations in more than 310 offices and manufacturing and laboratory facilities located in 41 states, the District of Columbia and various\nforeign countries, and occupied a total of approximately 4,800,000 square feet of space. The Company has principal locations in the San Diego, California and the Washington, D.C. metropolitan areas and occupies over 1,000,000 square feet of space in each of these locations.\nThe Company owns and occupies six buildings totalling approximately 550,000 square feet of space situated on 22.2 acres of land owned by the Company in the Golden Triangle area of San Diego, California and leases a 128,500 square foot office building located on that land. The Company also leases approximately 140,000 square feet of space in the Sorrento-Mesa area of San Diego, California. The Company has options to purchase all of these leased facilities.\nAt the principal location of the Company in the Washington, D.C. metropolitan area (McLean, Virginia), the Company owns a building consisting of approximately 287,000 square feet of space situated on 10 acres of land. In McLean, Virginia, the Company also occupies two buildings containing a total of approximately 425,000 square feet of space. The Company has certain rights to purchase these leased buildings. In addition, the Company owns and occupies a 62,000 square foot building on 2.6 acres of land in Reston, Virginia.\nThe Company owns and occupies a 62,500 square foot building on approximately 13 acres of land in Virginia Beach, Virginia and owns and occupies an 83,000 square foot building on approximately 8.4 acres of land in Oak Ridge, Tennessee. The Company also owns and occupies a 95,500 square foot building situated on approximately 7.3 acres of land in Columbia, Maryland. In addition, the Company leases approximately 3.1 acres of land in Richland, Washington and owns a 23,700 square foot building on such land. This building was occupied in February 1995.\nThe Company also leases an office building containing approximately 100,000 square feet of space in Huntsville, Alabama and an office building in Orlando, Florida containing approximately 30,000 square feet of space. The Company has options to purchase these buildings in the future.\nThe nature of the Company's business is such that there is no practicable way to relate occupied space to industry segments. The Company considers its facilities suitable and adequate for its present needs. See Note K of Notes to Consolidated Financial Statements of the Company on page of this Form 10-K for information regarding commitments under leases.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn February 15, 1994, the Company was served with search warrants and a subpoena for documents and records associated with the performance by the SAIT operating unit of the Company under three contracts with the DOD. The search warrants and subpoena state that the U.S. Government is seeking evidence regarding the making of false statements and false claims to the DOD, as well as conspiracy to commit such offenses. The search warrants and subpoena appear to be based upon allegations contained in a civil complaint that had been filed under seal on March 13, 1993 by an employee of the Company's SAIT operating unit. The complaint was filed in the U.S. District Court for the Southern District of California and sought damages on behalf of the U.S. Government under the Federal False Claims Act. On August 1, 1994, the Department of Justice on behalf of the U.S. Government announced its intention to intervene in the case. Based on the Company's motion, on November 8, 1994, the District Court dismissed the employee who had originally filed the complaint from the lawsuit, leaving only the U.S. Government and the Company as parties. The employee has appealed the District Court's order to the U.S. Court of Appeals for the Ninth Circuit. The Company has engaged in a series of presentations and submissions with the Department of Justice in which the Company responded to issues raised by the Department of Justice. At this stage of the proceedings, the Company is unable to assess the impact, if any, of this investigation and lawsuit on its consolidated financial position, results of operations or ability to conduct business.\nThe Company is involved in various other investigations, claims and lawsuits arising in the normal conduct of its business, none of which, in the opinion of the Company's management, will have a material adverse effect on its consolidated financial position, results of operations or its ability to conduct business.\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 fiscal year 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of General Instructions to Form 10-K, the following list is included as an unnumbered Item in Part I of this Form 10-K in lieu of being incorporated by reference to the Company's definitive Proxy Statement used in connection with the solicitation of votes for the Company's 1995 Annual Meeting of Stockholders (the \"1995 Proxy Statement\").\nThe following is a list of the names and ages (as of April 14, 1995) of all Executive Officers of the Company, indicating all positions and offices with the Company held by each such person and each such person's principal occupation or employment during at least the past five years. All such persons have been elected to serve until their successors are elected, or until their earlier resignation or retirement. Except as otherwise noted, each of the persons listed below has served in his present capacity for at least the past five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nTHE LIMITED MARKET\nSince its inception, the Company has followed a policy of remaining essentially employee owned. As a result, there has never been a general public market for any of the Company's securities. In order to provide liquidity for its stockholders, however, the Company has maintained a limited secondary market (the \"Limited Market\") through its wholly-owned subsidiary, Bull, Inc., which was organized in 1973 for the purpose of maintaining the Limited Market.\nThe Limited Market generally permits existing stockholders to sell shares of Class A Common Stock on four predetermined days each year (each a \"Trade Date\"). All shares of Class B Common Stock to be sold in the Limited Market must first be converted into five times as many shares of Class A Common Stock. All sales are made at the prevailing fair market value of the Class A Common Stock determined pursuant to the formula and valuation process described below (the \"Formula Price\") to employees, consultants and directors of the Company who have been approved by the Board of Directors or the Operating Committee as being entitled to purchase up to a specified number of shares of Class A Common Stock. In addition, the trustees of the Company's Employee Stock Ownership Plan, Cash or Deferred Arrangement (\"CODA\"), 1993 Employee Stock Purchase Plan, 1995 Employee Stock Purchase Plan (if approved by the Company's stockholders at the 1995 Annual Meeting of Stockholders), Stock Compensation Plan, Management Stock Compensation Plan and certain retirement plans of the Company's subsidiaries may also purchase shares of Class A Common Stock for their respective trusts in the Limited Market. All sellers in the Limited Market (other than the Company and its retirement plans) pay Bull, Inc. a commission equal to two percent of the proceeds from such sales. No commission is paid by purchasers in the Limited Market.\nIn the event that the aggregate number of shares offered for sale is greater than the aggregate number of shares sought to be purchased by authorized buyers and the Company, offers to sell 500 or less shares of Class A Common Stock, or up to the first 500 shares if more than 500 shares of Class A Common Stock are offered by any seller, will be accepted first. Offers to sell shares in excess of 500 shares of Class A Common Stock will be accepted on a pro-rata basis determined by dividing the total number of shares remaining under purchase orders by the total number of shares remaining under sell orders. If, however, there are insufficient purchase orders to support the primary allocation of 500 shares of Class A Common Stock for each proposed seller, then the purchase orders will be allocated equally among all of the proposed sellers up to the total number of shares offered for sale. To the extent that the aggregate number of shares sought to be purchased exceeds the aggregate number of shares offered for sale, the Company may, but is not obligated to, sell authorized but unissued shares of Class A Common Stock in the Limited Market.\nThe Company is currently authorized, but not obligated, to purchase up to 1,250,000 shares of Class A Common Stock in the Limited Market on any Trade Date, but only if and to the extent that the number of shares offered for sale by stockholders exceeds the number of shares sought to be purchased by authorized buyers and the Company, in its discretion, determines to make such purchases. In fiscal year 1995, the Company purchased 279,658 shares in the Limited Market. The Company did not purchase shares in the Limited Market in fiscal year 1994. The Company's purchases in fiscal year 1995 accounted for 16% of the total shares purchased by all buyers in the Limited Market during that year.\nDuring the 1995 and 1994 fiscal years, the trustees of the Company's Profit Sharing Retirement Plan II (consolidated as of January 1, 1995 with the Company's Profit Sharing Retirement Plan), Employee Stock Ownership Plan, CODA and 1993 Employee Stock Purchase Plan purchased an aggregate of 1,065,741 shares and 1,824,077 shares, respectively, in the Limited Market. These purchases accounted for approximately 61% and 81% of the total shares purchased by all buyers in the\nLimited Market during fiscal years 1995 and 1994, respectively. Such purchases may change in the future, depending on the levels of participation in and contributions to such plans and the extent to which such contributions are invested in Class A Common Stock. To the extent that purchases by the trustees of the Company's employee benefit plans decrease and purchases by the Company do not increase, the ability of stockholders to resell their shares in the Limited Market will likely be adversely affected. No assurance can be given that a stockholder desiring to sell all or a portion of his or her shares of the Company's Class A Common Stock in any trade will be able to do so.\nThe Company received a no-action letter from the Securities and Exchange Commission (the \"SEC Letter\") that authorizes the Company and the Employee Stock Ownership Plan to commence on an annual basis, at the Company's discretion, a joint tender offer (a \"Tender Offer\") to purchase all shares of the Company's Class A Common Stock held by persons who are not directors, employees or consultants of the Company (or family members of, or trustees for, such employees, directors or consultants of the Company) as of the date the Tender Offer is commenced (the \"Outside Stockholders\"). Under current federal income tax laws, the Tender Offer, as structured, would allow Outside Stockholders who tender certain shares purchased by the Employee Stock Ownership Plan to defer the payment of federal income tax under Section 1042 of the Internal Revenue Code of 1986, as amended, on any capital gain derived from the sale, provided certain conditions are met.\nThe Company and the Employee Stock Ownership Plan have completed one Tender Offer pursuant to which the Employee Stock Ownership Plan purchased on November 20, 1992 an aggregate of 700,444 shares of Class A Common Stock from 186 Outside Stockholders. The Company has not yet determined whether it will commence a Tender Offer during calendar year 1995. There can be no assurance that a Tender Offer will be commenced in the future or, if commenced, that it will be completed. If a Tender Offer is undertaken in the future, the Company will be required to take certain actions to ensure that such Tender Offer does not negatively affect the liquidity of the Limited Market on the Trade Date upon which such Tender Offer is completed.\nPRICE RANGE OF CLASS A COMMON STOCK AND CLASS B COMMON STOCK\nThe fair market value of the Class A Common Stock is established pursuant to the valuation process described below, which uses the formula set forth below to determine the Formula Price at which the Class A Common Stock trades in the Limited Market. The Formula Price is reviewed by the Board of Directors at least four times each year, generally in conjunction with Board of Directors meetings which are currently scheduled for January, April, July and October. Pursuant to the Certificate of Incorporation, the price applicable to shares of Class B Common Stock is equal to five times the Formula Price.\nThe following formula (\"Formula\") is used in determining the Formula Price: the price per share is equal to the sum of (i) a fraction, the numerator of which is the stockholders' equity of the Company at the end of the fiscal quarter immediately preceding the date on which a price revision is to occur (\"E\") and the denominator of which is the number of outstanding common shares and common share equivalents at the end of such fiscal quarter (\"W(1)\") and (ii) a fraction, the numerator of which is 5.66 multiplied by the market factor (\"M\" or \"Market Factor\"), multiplied by the earnings of the Company for the four fiscal quarters immediately preceding the price revision (\"P\"), and the denominator of which is the weighted average number of outstanding common shares and common share equivalents for those four fiscal quarters, as used by the Company in computing primary earnings per share (\"W\"). The number of outstanding common shares and common share equivalents described above assumes the conversion of each share of Class B Common Stock into five shares of Class A Common Stock. The 5.66 multiplier is a constant which was first included in the Formula in March 1976. The Market Factor is a numerical factor which yields a fair market value for the Class A Common Stock and the Class B Common Stock by reflecting existing securities market conditions relevant to the valuation of such stock. In establishing the Market Factor, the Board of Directors considers the performance of the general securities markets and relevant industry groups, the financial performance of the Company versus comparable public companies, general economic conditions, input from\nan independent appraisal firm and other relevant factors. The Market Factor is generally reviewed quarterly by the Board of Directors in conjunction with an appraisal which is prepared by an independent appraisal firm for the committee administering the Company's qualified retirement plans (the \"Committee\") and which is relied upon by the Committee and the Board of Directors. The Market Factor, as determined by the Board of Directors, remains in effect until subsequently changed by the Board of Directors. The Formula Price of the Class A Common Stock, expressed as an equation, is as follows:\nE 5.66MP FORMULA PRICE = --- + ------ W(1) W\nThe Formula was modified by the Board of Directors on April 14, 1995 to delete a limitation that the Formula Price not be less than 90% of the net book value per share of the Class A Comon Stock at the end of the quarter immediately preceding the date on which a price revision is to occur (the \"book value floor\"). The modification was intended to ensure that the Formula Price would be a fair market value as required by law. The Formula Price has always exceeded the book value floor, and the book value floor has never been used to establish the Formula Price. With the exception of this modification, the Formula has not been modified by the Board of Directors since March 23, 1984.\nThe following table sets forth information concerning the Formula Price for the Class A Common Stock, the applicable price for the Class B Common Stock and the Market Factor in effect for the periods beginning on the dates indicated. There can be no assurance that the Class A Common Stock or the Class B Common Stock will in the future provide returns comparable to historical returns.\nThe Board of Directors believes that the valuation process and Formula result in a fair market value for the Class A Common Stock within a broad range of financial criteria. Other than the quarterly review and possible modification of the Market Factor, the Board of Directors will not change the Formula unless (i) in the good faith exercise of its fiduciary duties and after consultation with the Company's independent accountants as to whether the change would result in a charge to earnings upon the sale of Class A Common Stock or Class B Common Stock, the Board of Directors, including a majority of the directors who are not employees of the Company, determines that the Formula no longer results in a fair market value for the Class A Common Stock or (ii) a change in the Formula or the method of valuing the Class A Common Stock is required under applicable law.\nHOLDERS OF CLASS A COMMON STOCK AND CLASS B COMMON STOCK\nAs of March 10, 1995, there were 11,228 holders of record of Class A Common Stock and 139 holders of record of Class B Common Stock. As of such date, approximately 92% of the Class A Common Stock and approximately 44% of the Class B Common Stock were beneficially owned by employees and consultants of the Company and their respective family members.\nDIVIDEND POLICY\nThe Company has never declared or paid any cash dividends on its capital stock and no cash dividends on the Class A Common Stock or Class B Common Stock are contemplated in the foreseeable future. The Company's present intention is to retain any future earnings for use in its business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following data has been derived from consolidated audited financial statements. The consolidated balance sheet at January 31, 1995 and 1994 and the related consolidated statements of income and of cash flows for the three years ended January 31, 1995 and notes thereto appear elsewhere in this Form 10-K Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nRevenues increased 15%, 11% and 17% in 1995, 1994 and 1993, respectively, over the prior year. Revenues in 1995 from the Company's principal customer, the U.S. Government, continued to shift toward lower cost service type contracts as also occurred in 1994 from 1993. This trend reflects the increasingly competitive business environment in the Company's traditional business areas, as well as the Company's increased success in the engineering and field services market, which typically involve lower cost contracts.\nThe sale of Technical Services and Products to the U.S. Government as a prime contractor or subcontractor accounted for 86% of revenues in 1995, and 88% in 1994 and 1993. This decrease is attributable to growth in non-U.S. Government revenues as a result of the Company's efforts to\nincrease revenues from state and local governments and commercial clients in certain focused business areas. The revenue mix between the Technical Services segment and the Products segment shifted slightly to 91% and 9%, respectively, of consolidated revenues in 1995 from 92% and 8%, respectively, of consolidated revenues in 1994 and 1993.\nWithin the Technical Services segment, revenues are further classified between \"National Security,\" \"Environment,\" \"Energy\" and \"Other Technical Services.\" Other Technical Services includes the health, space, transportation and commercial information technology business areas. Revenues in each of the business area classifications within the Technical Services segment increased in 1995 over 1994.\nNational Security revenues decreased to 46% of total revenues in 1995 from 50% in 1994 and 51% in 1993. Although National Security revenues declined as a percentage of total revenues, these revenues increased 7% in 1995, 9% in 1994 and 13% in 1993 over the prior year, in spite of declines in the overall defense market during these periods. The U.S. Government maintained funding in areas in which the Company has strong capabilities, such as research and development, training, simulation and test and evaluation. Revenues in the Environment business area decreased slightly as a percentage of total revenues to 14% in 1995 from 15% in 1994 and 1993. Energy revenues remained constant at 9% of total revenues for 1995 and 1994, down slightly from 10% in 1993. Other Technical Services revenues have increased to 22% of total revenues in 1995 from 17% in 1994 and 16% in 1993. The continued growth in Other Technical Services reflects the Company's expansion into the health, transportation and commercial information technology markets and mirrors the country's shift of priorities and resources from defense programs to civilian programs in areas such as health care and transportation. The Company expects this trend to continue. In order for the Company to maintain or exceed historical revenue growth rates, it will need to continue to increase its market share in the National Security business area or its revenues from the environment, energy, health, space, transportation and commercial information technology business areas.\nProduct revenues increased 22%, 21% and 28% in 1995, 1994 and 1993, respectively, over the prior year. The increases in Product revenues have primarily occurred on existing mature product lines.\nRevenues are generated from the efforts of the Company's technical staff as well as the pass through of costs for materials and subcontract efforts, which primarily occur on large, multi-year contracts. At the end of 1995, the Company had 16,700 full-time employees compared to 15,400 and 14,200 at the end of 1994 and 1993, respectively. Material and subcontract (\"M&S\") revenues were $560 million in 1995, $458 million in 1994 and $402 million in 1993. As a percentage of total revenues, M&S revenues were 29% in 1995 and 27% in 1994 and 1993 and have increased due to the growth in the pass through of M&S costs on certain large, multi-year systems integration contracts and the growth of Product revenues. Product revenues generally have a very high percentage of M&S cost content.\nThe Company's business is directly related to the receipt of contract awards and contract performance. There were 333 contracts with annual revenues greater than $1 million in 1995, compared with 294 such contracts in 1994. These larger contracts represented 77% of the Company's revenues in each of these years. Of these contracts, 20 contracts had individual revenues greater than $10 million in 1995 and 1994. The remainder of the Company's revenues are derived from a large number of contracts with individual revenues less than $1 million. Although the Company has committed substantial resources and personnel required to pursue larger contracts, the Company believes it maintains a suitable environment for the performance of smaller, highly technical, research and development contracts. These smaller programs often provide the foundation for the Company's success on larger procurements.\nThe following table summarizes revenues by contract type for the last three years:\nCost-reimbursement contracts provide for the reimbursement of direct costs and allowable indirect costs, plus a fee or profit component. Time-and-materials (\"T&M\") contracts typically provide for the payment of negotiated fixed hourly rates for labor hours incurred plus reimbursement of other allowable direct costs at actual cost plus allocable indirect costs. Fixed-price level-of-effort (\"FP-LOE\") contracts are similar to T&M contracts since ultimately revenues are based upon the labor hours provided to the customer. Firm fixed-price contracts require the Company to provide stipulated products, systems or services for a fixed price. The Company assumes greater performance risk on firm fixed-price contracts and the failure to accurately estimate ultimate costs or to control costs during performance of the work may result in reduced profits or losses.\nThe cost of revenues as a percentage of revenues (excluding interest income) was 88.2% in 1995, 88.5% in 1994 and 88.3% in 1993. This relatively constant cost of revenues percentage represents a number of offsetting effects. Trends which increased the cost of revenues percentage are faster revenue growth in M&S revenues, which have nearly all their associated costs in the cost of revenues category; faster revenue growth in lower cost service type contracts, which typically have more of their associated costs in cost of revenues and less costs in selling, general and administrative (\"SG&A\") expenses; and overruns during the performance of certain firm fixed-price contracts in 1995, 1994 and 1993, which resulted in losses or lower profits for such contracts. The primary trend which decreased the cost of revenues percentage is the growth in commercial revenues, which have more of their associated costs in SG&A as opposed to cost of revenues.\nSG&A expenses as a percentage of revenues (excluding interest income) were 7.6%, 7.2% and 7.5% in 1995, 1994 and 1993, respectively. SG&A is comprised of general and administrative (\"G&A\"), bid and proposal (\"B&P\") and independent research and development (\"IR&D\") expenses. B&P costs have remained constant in relation to revenues over the past three years. The level of B&P activity and costs has historically fluctuated depending on the availability of bidding opportunities and resources. During 1995, IR&D costs increased as a percentage of revenues due to a focused effort by the Company to build core capabilities in areas which it believes are key to its future growth: distributed interactive simulation, imagery, medical, environmental and software development. G&A expenses increased 21% over 1994 and increased as a percentage of total revenues to 5.2% in 1995 from 5.0% in 1994. This relative increase was driven by the growth in revenues from commercial contracts, which have more of their associated costs in G&A, and an increase in goodwill amortization costs due to an increase in the number of business acquisitions in 1995 and 1994. The Company continues to closely monitor G&A expenses as part of an on-going program to control indirect costs.\nOperating profit margins by segment are strongly correlated to the Company's financial performance on the contracts within each segment. The operating profit margin in the Technical Services segment increased to 4.3% in 1995 from 3.8% in 1994 and 4.1% in 1993. The National Security operating profit margin was 2.8% in 1995, compared to 3.3% in 1994 and 4.3% in 1993. The lower operating profit margins in 1995 and 1994 as compared to 1993 were a result of overruns on certain firm fixed-price contracts in the National Security area. Environment operating profit margins were 4.9%, 4.5% and 4.2%, respectively, for 1995, 1994 and 1993. Energy operating profit margins increased to 5.8% in 1995 from 5.1% in 1994 and 4.2% in 1993, primarily due to higher profit margins on\ncontracts with commercial utilities. The operating profit margin in Other Technical Services increased to 6.3% in 1995 from 4.1% in 1994 and 3.2% in 1993. The increase in operating profit margins in Other Technical Services in 1995 and 1994 over 1993 was a result of an improvement in the performance of certain firm fixed-price contracts. The operating profit margin in the Products segment decreased to 3.9% in 1995 from 9.3% in 1994 and 4.9% in 1993. The 1995 decrease is attributable to overruns on certain firm fixed-price contracts, while the 1994 increase in profit margin was attributable to higher margins on existing product lines. In general, overall operating profit margins for the Company in 1995, 1994 and 1993 are lower than historical margins due to increased competition and overruns on certain firm fixed-price contracts.\nInterest expense in 1995, 1994 and 1993 primarily relates to interest on a building mortgage, deferred compensation and borrowings outstanding under the Company's credit\/term loan agreements. Although interest expense on borrowings under the Company's credit\/term loan agreements decreased in 1995 from 1994 and 1993, overall interest expense increased primarily due to interest accrued on the deferred compensation plans.\nThe provision for income taxes as a percentage of income before income taxes was 38.5% in 1995, 40.6% in 1994 and 36.7% in 1993. The decrease in the effective rate for 1995 from 1994 was primarily related to a final settlement of certain issues related to the Company's 1986 and 1987 federal and state income tax returns. The increase in the effective rate for 1994 was primarily attributable to the increase in the federal statutory rate as a result of the Omnibus Budget Reconciliation Act of 1993, as well as a lower level of downward revisions of prior year tax estimates as a result of ongoing resolutions of certain issues relating to prior year federal and state income tax returns.\nAs described in the Notes to Consolidated Financial Statements, effective February 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" and Statement of Position (\"SOP\") 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\" Adoption of SFAS No. 112, which required the Company to recognize an obligation to provide postemployment benefits in accordance with previously issued standards, did not have a material effect on the Company's financial position or results of operations in 1995. Adoption of SFAS No. 115, SFAS No. 119 and SOP 93-6, which required certain disclosures in the Notes to Consolidated Financial Statements, did not have an effect on the Company's financial position or results of operations in 1995.\nOn February 15, 1994, the Company was served with search warrants and a subpoena for documents and records associated with the performance by the SAIT operating unit of the Company under three contracts with the Department of Defense (DOD). The search warrants and subpoena state that the U.S. Government is seeking evidence regarding the making of false statements and false claims to the DOD, as well as conspiracy to commit such offenses. The search warrants and subpoena appear to be based upon allegations contained in a civil complaint that had been filed under seal on March 13, 1993 by an employee of the Company's SAIT operating unit. The complaint was filed in the U.S. District Court for the Southern District of California and sought damages on behalf of the U.S. Government under the Federal False Claims Act. On August 1, 1994, the Department of Justice on behalf of the U.S. Government announced its intention to intervene in the case. Based on the Company's motion, on November 8, 1994, the District Court dismissed the employee who had originally filed the complaint from the lawsuit, leaving only the U.S. Government and the Company as parties. The employee has appealed the District Court's order to the U.S. Court of Appeals for the Ninth Circuit. The Company has engaged in a series of presentations and submissions with the Department of Justice in which the Company responded to issues raised by the Department of Justice. At this stage of the proceedings, the Company is unable to assess the impact, if any, of this investigation and lawsuit on its consolidated financial position, results of operations or its ability to conduct business.\nThe Company is involved in various other investigations, claims and lawsuits arising in the normal conduct of its business, none of which, in the opinion of the Company's management, will have a material adverse effect on its consolidated financial position, results of operations or its ability to conduct business.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's primary sources of liquidity continue to be funds provided by operations and revolving credit\/term loan agreements. At January 31, 1995 and 1994, there were no borrowings outstanding under such agreements and cash and cash equivalents and long-term investments totaled $48 million and $60 million, respectively. Cash flows generated from operating activities increased to $117 million in 1995 from $86 million and $76 million in 1994 and 1993, respectively. The Company continues to actively monitor receivables with emphasis placed on collection activities and the negotiation of more favorable payment terms. As a result, average receivable days outstanding decreased to 63 in 1995 from 64 in 1994.\nCash flows spent on investing activities increased to $120 million in 1995 compared to $47 million and $37 million in 1994 and 1993, respectively. Expenditures for the acquisition of businesses were $71 million in 1995 compared to $14 million in 1994 and $18 million in 1993. Acquisitions of businesses in 1995 were primarily made to complement the Company's capabilities in the areas of transportation, environment, health and energy. Additional acquisitions were also made in the National Security business area to improve the Company's capabilities in areas in which the Company expects continued DOD funding. The Company expects to continue to acquire businesses for these and other purposes in the future. Capital expenditures, excluding land and buildings, were $20 million in 1995 and $18 million in 1994 and 1993 and are expected to be approximately $28 million for 1996. Expenditures for land and buildings were $15 million, $9 million and $2 million in 1995, 1994 and 1993, respectively, and are expected to be approximately $7 million for 1996.\nThe Company used $22 million for financing activities in 1995 compared to $1 million and $24 million in 1994 and 1993, respectively. In 1995, funds were utilized primarily for common stock repurchases and retirement of outstanding debt associated with businesses acquired in 1995. The 1995 increase in utilization of funds from 1994 was primarily due to a reduction in sales of the Company's common stock. The 1994 decrease in utilization of funds from 1993 was primarily due to increased sales of the Company's common stock and decreased borrowing activity.\nSubsequent to January 31, 1995, the Company increased its borrowing capacity by replacing its credit\/term loan agreements with new unsecured credit agreements with three banks totaling $105 million, which allow borrowings on a revolving basis until March 31, 2000. The Company's cash flows from operations plus borrowing capacity are expected to provide sufficient funds for the Company's operations, business acquisitions, common stock repurchases, capital expenditures and future long-term debt requirements.\nEFFECTS OF INFLATION\nThe majority of the Company's contracts are cost-reimbursement type contracts or are completed within one year. As a result, the Company has been able to anticipate increases in costs when pricing its contracts. Bids for longer term fixed-price and T&M type contracts typically include labor and other cost escalations in amounts expected to be sufficient to cover cost increases over the period of performance. Consequently, because costs and revenues include an inflationary increase commensurate with the general economy, net income, as a percentage of revenues, has not been significantly impacted by inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee the Consolidated Financial Statements of the Company attached hereto and listed on the Index to Consolidated Financial Statements set forth on page of this Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nDuring the fiscal years ended January 31, 1995 and 1994, the Company did not have a change in accountants or a disagreement with accountants required to be reported hereunder.\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 Company, see \"Executive Officers of the Registrant\" at the end of Part I of this Form 10-K. For information with respect to the Directors of the Company, see \"Election of Directors\" appearing in the 1995 Proxy Statement, which information is incorporated by reference into this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nFor information with respect to executive compensation, see the information set forth under the caption \"Executive Compensation\" in the 1995 Proxy Statement, which information (except for the information under the sub-captions \"Compensation Committee Report on Executive Compensation\" and \"Stockholder Return Performance Presentation\") is incorporated by reference into this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nFor information with respect to the security ownership of certain beneficial owners and management, see the information set forth under the caption \"Beneficial Ownership of the Company's Securities\" in the 1995 Proxy Statement, which information is incorporated by reference into this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nFor information with respect to the interests of the Company's management and others in certain transactions, see the information set forth under the captions \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\" in the 1995 Proxy Statement, which information is incorporated by reference into this Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements\nThe Consolidated Financial Statements of the Company are attached hereto and listed on the Index to Consolidated Financial Statements set forth on page of this Form 10-K.\n2. Financial Statement Schedules\nAll schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or the notes thereto.\n3. Exhibits\nA Report on Form 8-K was filed on November 14, 1994. Disclosure was made 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.\n(Registrant) SCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nBy \/s\/ J.R. BEYSTER\n----------------------------------- J.R. Beyster CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER\nDate: April 14, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nFinancial statement schedules are omitted because they are not applicable or the required information is shown on the consolidated financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Science Applications International Corporation\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Science Applications International Corporation and its subsidiaries at 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. These financial 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 Diego, California March 31, 1995\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENT OF INCOME\nSee accompanying notes to consolidated financial statements.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEET ASSETS\nSee accompanying notes to consolidated financial statements.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCONSOLIDATION\nThe consolidated financial statements of the Company include the accounts of Science Applications International Corporation and its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation. Investments in affiliates and corporate joint ventures owned twenty to fifty percent are accounted for under the equity method. Other investments are generally carried at cost.\nCONTRACT REVENUES\nThe major portion of the Company's revenues results from contract services performed for the United States Government or from subcontracts with other contractors engaged in work for the United States Government under a variety of contracts, some of which provide for reimbursement of cost plus fees and others which are fixed-price or time-and-materials type contracts. Generally, revenues and fees on contracts are recognized as services are performed, using the percentage-of-completion method of accounting, primarily based on contract costs incurred to date compared with total estimated costs at completion. Revenues from the sale of manufactured products are recorded when the products are shipped.\nThe Company provides for anticipated losses on contracts by a charge to income during the period in which the losses are first identified. Unbilled receivables are stated at estimated realizable value. Contract costs, including indirect costs, are subject to audit and adjustment by negotiations between the Company and government representatives. The majority of the Company's indirect contract costs have been agreed upon through 1991 and substantially all of the Company's indirect contract costs have been agreed upon through 1990. Contract revenues have been recorded in amounts that are expected to be realized upon final settlement.\nCASH AND CASH EQUIVALENTS\nCash equivalents are highly liquid investments purchased with an original maturity of three months or less. Of the $28,203,000 total cash and cash equivalents at January 31, 1995, $24,382,000 was invested in commercial paper. The carrying amounts approximate fair value due to the short maturity of these instruments.\nINVENTORIES\nInventories are valued at the lower of cost or market. Cost is determined using the moving average and first-in, first-out methods.\nBUILDINGS, PROPERTY AND EQUIPMENT\nDepreciation and amortization of buildings and related improvements are provided using the straight-line method over estimated useful lives of thirty to forty years and ten years, respectively. Depreciation and amortization of property and equipment are provided over the estimated useful lives of the assets, primarily using a declining-balance method. The useful lives are three to ten years for equipment and the shorter of the useful lives or the terms of the leases for leasehold improvements.\nAdditions to property and equipment together with major renewals and betterments are capitalized. Maintenance, repairs and minor renewals and betterments are charged to expense. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is recognized.\nDEBT SECURITIES\nEffective February 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" prospectively. Adoption of SFAS No. 115 did not have an effect on the Company's financial position or results of operations in 1995. Long-term debt securities are included in other assets and consist of long-term\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) municipal bonds which have been recorded at amortized cost and classified as \"held-to-maturity.\" As of January 31, 1995, debt securities of $20,100,000 had a fair value of $19,488,000 maturing between 1996 and 1998. Gross unrealized losses amounted to $612,000.\nINTANGIBLE ASSETS\nIntangible assets consist primarily of goodwill. Goodwill represents the excess of the purchase cost over the fair value of net assets acquired in an acquisition and is amortized by a straight line method generally over five to ten years. Amortization of intangible assets amounted to $6,257,000, $3,007,000 and $1,859,000 in 1995, 1994 and 1993, respectively. Accumulated amortization was $15,987,000 and $9,730,000 at January 31, 1995 and 1994, respectively.\nINCOME TAXES\nIncome taxes are provided utilizing the liability method under SFAS No. 109. The liability method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities. Additionally, under the liability method, changes in tax rates and laws will be reflected in income in the period such changes are enacted.\nCOMMON STOCK AND EARNINGS PER SHARE\nClass A and Class B common stock are collectively referred to as common stock in the Notes to Consolidated Financial Statements unless otherwise indicated.\nComputations of earnings per share are based on the weighted average number of shares of common stock outstanding, increased by the effect of dilutive options using the modified treasury stock method. Fully diluted earnings per share was substantially the same as primary earnings per share in 1995, 1994 and 1993.\nA general public market for the Company's common stock does not exist. Periodic determinations of the fair market value of the common stock are made by the Board of Directors pursuant to a stock price formula and valuation process which includes an appraisal prepared by an independent appraisal firm. The Board of Directors reserves the right to alter the formula and valuation process.\nOTHER FINANCIAL INSTRUMENTS\nIn October 1994, SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" was issued. The Company has adopted the disclosure requirements of SFAS No. 119 for the year ended January 31, 1995.\nIt is the Company's policy not to enter into derivative financial instruments for speculative purposes. During 1995, the Company entered into foreign currency forward exchange contracts to protect against currency exchange risks associated with certain firm and identifiable foreign currency commitments entered into in the ordinary course of business. At January 31, 1995, the Company had approximately $5,066,000 of foreign currency forward exchange contracts in Australian dollars and Spanish pesetas outstanding with net unrealized losses of $98,000. These contracts were executed with creditworthy banks for terms of less than eight months.\nCONCENTRATION OF CREDIT RISK\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash equivalents and long-term investments. The Company invests its excess cash principally in U.S. Government and municipal debt securities and commercial paper and has established guidelines relative to diversification and maturities in an effort to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nConcentrations of credit risk with respect to receivables are limited because the Company's primary customers are various agencies of the United States Government as well as commercial customers engaged in work for the United States Government. As of January 31, 1995, there were no significant concentrations of receivables with these commercial customers.\nRECLASSIFICATIONS\nCertain amounts from previous years have been reclassified in the consolidated financial statements to conform to the 1995 presentation.\nNOTE B -- ACQUISITIONS:\nAcquisitions of certain business assets and companies have been accounted for by the purchase method of accounting. The 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 has been included in intangible assets as goodwill. The aggregate effect of the purchased acquisitions was not material, therefore, pro forma financial information is not required.\nNOTE C -- BUSINESS SEGMENT INFORMATION:\nThe Company's principal business involves the application of scientific expertise, together with computer and systems technology, to solve complex technical problems for government agencies and industrial customers. The skills of the professional staff encompass a variety of scientific and technical disciplines and the management structure is based upon broad technological groupings, not necessarily related to any particular industry, line of business, geographical area, market or class of customer.\nFor purposes of analyzing and understanding the Company's financial statements, its operations have been classified into two broad segments: Technical Services and Products. The Technical Services segment is further classified between the National Security, Environment, Energy and Other business areas. Other business areas include health, space, transportation and commercial information technology.\nTechnical services consist of applied and basic research; analysis and development of new and existing policies, concepts, systems and programs; design and development of computer software; systems engineering; systems integration; test and evaluation of new products or systems; technical operational and management support; environmental engineering; and engineering support to existing facilities, laboratories and systems.\nProducts include custom designed and standard hardware and software products such as data display devices, \"ruggedized\" personal computers, sensors and nondestructive imaging instruments. These products typically incorporate Company-developed hardware and software as well as hardware and software manufactured by others.\nSegment information from previous years has been reclassified to conform to the 1995 presentation. The reclassifications had no effect on the consolidated financial position or results of operations for the years ended January 31, 1994 and 1993.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIndustry segment information is as follows:\nBecause of the nature of the Company's business, sales between segments are not material. Segment operating results reflect general corporate expense allocations because all such expenses are allocated to individual cost objectives by the Company, as required by Government Cost Accounting Standards. Identifiable assets of the respective industry segments consist of receivables, inventories and goodwill. All other assets are either corporate in nature, are not identifiable with particular segments or are not material. Capital expenditures and depreciation and amortization are not identified as to industry segments for similar reasons.\nDuring 1995, 1994 and 1993, approximately 86%, 88% and 88%, respectively, of the Company's contract revenues were attributable to prime contracts with the United States Government or to subcontracts with other contractors engaged in work for the United States Government. Foreign operations and revenues directly attributable to foreign customers are not material.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE D -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS:\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE E -- RECEIVABLES:\nReceivables consist of the following:\nUnbilled receivables at January 31, 1995 and 1994 include $13,776,000 and $16,228,000 respectively, related to costs incurred on projects for which the Company has been requested by the customer to begin work under a new contract or extend work under a present contract, but for which formal contracts or contract modifications have not been executed. The balance of unbilled receivables consist of costs and fees billable on contract completion or other specified events, the majority of which is expected to be billed and collected within one year. The majority of the retention balance is expected to be collected beyond one year.\nNOTE F -- NOTES PAYABLE:\nThe Company has substantially equivalent unsecured revolving credit\/term loan agreements with three banks totaling $67,500,000 which allow borrowings on a revolving basis until July 1, 1996. At that time, the Company has the option to borrow under three-year term notes, payable in twelve quarterly installments. The agreements enable borrowings at various interest rates, at the Company's option, based on prime, money market, London interbank borrowing, certificate of deposit, bankers' acceptance, or other negotiated rates. Annual facility fees are 1\/4 of 1% of the total commitment during the initial revolving credit term.\nThere were no balances outstanding under the credit\/term loan agreements at January 31, 1995, 1994 and 1993. As of January 31, 1995, the entire $67,500,000 was available under the most restrictive debt covenants of the credit\/term loan agreements. The maximum amounts outstanding were $12,800,000, $19,200,000 and $31,000,000 in 1995, 1994 and 1993, respectively. The average amount outstanding was $197,000, $541,000 and $6,724,000 during 1995, 1994 and 1993, respectively. The weighted average interest rate in 1995, 1994 and 1993 was 4.9%, 3.5% and 4.5%, respectively, based upon average daily balances.\nNOTE G -- EMPLOYEE BENEFIT PLANS:\nEffective February 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" and Statement of Position (\"SOP\") 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\" Adoption of SFAS No. 112, which required the Company to recognize an obligation to provide postemployment benefits in accordance with previously issued standards, had an immaterial effect on net income in 1995. While adoption of SOP 93-6 required certain disclosures in the Notes to Consolidated Financial Statements, it did not have an effect on the Company's financial position or results of operations in 1995.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nEffective January 1, 1995, the Company merged two of its former profit sharing retirement plans into one principal Profit Sharing Retirement Plan in which eligible employees participate. Participants' interests vest 25% per year in the third through sixth year of service. Participants also become fully vested upon reaching age 59 1\/2, permanent disability or death. Contributions charged to income under the plans were $27,420,000, $20,471,000 and $19,114,000 for 1995, 1994 and 1993, respectively.\nThe Company has an Employee Stock Ownership Plan (the \"Plan\") in which eligible employees participate. Cash contributions to the Plan are based upon amounts determined annually by the Board of Directors and are allocated to participants' accounts based on their annual compensation. The Company recognizes compensation expense as the fair value of the Company common stock or cash in the year of contribution. The vesting requirements for the Plan are the same as for the Profit Sharing Retirement Plan. Shares of Company common stock distributed from the Plan bear a limited put option that, if exercised, would require the Company to repurchase the shares at their current fair value. At January 31, 1995, the Plan held 15,974,000 shares of Class A common stock and 37,100 shares of Class B common stock with a combined fair value of $254,031,000. Contributions charged to income under the Plan were $10,516,000, $15,096,000, and $13,904,000 for 1995, 1994 and 1993, respectively.\nThe Company has one principal Cash or Deferred Arrangement (CODA) which allows eligible participants to defer a portion of their income through contributions. Such deferrals are fully vested, are not taxable to the participant until distributed from the CODA upon termination, retirement, permanent disability or death and may be matched by the Company. The Company's matching contributions to the CODA of $10,977,000, $7,673,000, and $6,608,000 were charged to income in 1995, 1994 and 1993, respectively. Effective January 1, 1995, the Company's matching contributions to employees hired after such date will be subject to the same vesting requirements as for the Profit Sharing Retirement Plan, while the Company's matching contributions for existing employees remain fully vested.\nThe Company has a Bonus Compensation Plan which provides for bonuses to reward outstanding employee performance. Bonuses are paid in the form of cash, fully vested shares of Class A common stock or vesting shares of Class A common stock. Awards of vesting shares of Class A common stock made prior to July 10, 1992, vest at the rate of 10%, 20%, 30% and 40% after one, two, three and four years, respectively, from the date of award. Awards of vesting shares of Class A common stock made after July 10, 1992, vest at the rate of 20%, 20%, 20% and 40% after one, two, three and four years, respectively. The amounts charged to income under this plan were $23,831,000, $20,111,000, and $19,234,000 for 1995, 1994 and 1993, respectively.\nDuring 1995, the Company adopted the Stock Compensation Plan and the Management Stock Compensation Plan, together referred to as the \"Stock Compensation Plans.\" The Stock Compensation Plans provide for awards of share units to eligible employees, which share units generally correspond to shares of Class A common stock which are held in trust for the benefit of participants. Participants' interests in these share units vest on a seven year schedule at the rate of one-third at the end of each of the fifth, sixth and seventh years following the date of the award. The amount charged to income under these plans was $160,000 for 1995.\nThe Company also has an Employee Stock Purchase Plan which allows eligible employees to purchase shares of the Company's Class A common stock, with the Company contributing 5% of the existing fair market value. There are no charges to income under this plan.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE H -- INCOME TAXES:\nThe provision for income taxes includes the following:\nDeferred income taxes are provided for significant income and expense items recognized in different years for tax and financial reporting purposes. Deferred tax assets (liabilities) are comprised of the following temporary differences:\nA reconciliation of the provision for income taxes to the amount computed by applying the statutory federal income tax rate (35% for 1995 and 1994, and 34% for 1993) to income before income taxes follows:\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOther assets include deferred income taxes of $10,906,000 and $3,606,000 at January 31, 1995 and 1994, respectively. Income taxes paid in 1995, 1994 and 1993 amounted to $35,600,000, $38,392,000, and $25,480,000, respectively. The effective rates for 1995, 1994 and 1993 have been reduced as a result of ongoing resolutions of certain issues relating to prior year federal and state income tax returns as well as a favorable settlement of 1986 and 1987 tax years.\nNOTE I -- LONG-TERM LIABILITIES:\nLong-term liabilities consist of the following:\nIn connection with the purchase of land and a building in 1991, the Company assumed a mortgage note of $12,800,000. Terms of the note include an 8.88% interest rate and monthly payments of principal and interest of $102,000 until July 1, 1997 when the remaining principal balance becomes due.\nThe Company maintains a Keystaff Deferral Plan for the benefit of key executives and directors, pursuant to which eligible participants may elect to defer a portion of their compensation. The Company makes no contributions to the accounts of participants under this plan but does credit participant accounts for deferred compensation amounts and for interest earned on such deferred compensation. Interest is accrued based on the Moody's Seasoned Corporate Bond Rate (7.26% in 1995). Deferred balances will generally be paid upon the later of ten years of plan participation or retirement, unless participants elect an early pay-out.\nThe carrying amount of the Company's long-term liabilities approximates fair value. The fair value of the Company's long-term liabilities is estimated based on the current rates offered to the Company for similar debt of the same remaining maturities.\nMaturities of long-term liabilities are as follows:\nNOTE J -- COMMON STOCK AND OPTIONS:\nThe Company has options outstanding under two stock option plans, the 1992 Stock Option Plan (the 1992 Plan), which was adopted effective July 10, 1992, and the 1982 Stock Option Plan (the 1982 Plan). Under the 1992 and 1982 Plans, options are granted at prices not less than the fair market\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) value at the date of grant and for terms not greater than ten years. Options granted prior to July 10, 1992 generally become exercisable 10%, 20%, 30% and 40% after one, two, three and four years, respectively, from the date of grant. Options granted after July 10, 1992 generally become exercisable 20%, 20%, 20% and 40% after one, two, three and four years, respectively, from the date of grant. No options have been granted under the 1982 Plan after July 10, 1992, the date the 1982 Plan terminated. The Company makes no charge to income in connection with these Plans.\nAs of January 31, 1995, 17,633,000 shares of Class A common stock were reserved for issuance upon exercise of options which are outstanding or which may be granted. As of January 31, 1995, options for 4,014,000 shares of Class A common stock were exercisable and 5,980,000 shares of Class A common stock were available for future grants.\nA summary of changes in outstanding options under the Plans during the three years ended January 31, 1995, is as follows:\nThe Company has agreed to make available for issuance, purchase or options approximately 1,114,000 shares of Class A common stock to employees, prospective employees and consultants, generally contingent upon commencement of employment or the occurrence of certain events. The selling price of shares and the exercise price of options are to be the fair market value at the date such shares are made available or options are granted.\nNOTE K -- COMMITMENTS AND CONTINGENCIES:\nThe Company occupies most of its facilities under operating leases. Most of the leases require the Company to pay maintenance and operating expenses such as taxes, insurance and utilities and also contain renewal options extending the leases from one to twenty years. Certain of the leases contain purchase options and provisions for periodic rate escalations to reflect cost-of-living increases. Certain equipment, primarily computer-related, is leased under short-term or cancelable leases. Rental expenses for facilities and equipment totaled $58,538,000, $57,213,000 and $54,050,000 in 1995, 1994 and 1993, respectively.\nSCIENCE APPLICATIONS INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nMinimum rental commitments, primarily for facilities, under all noncancelable operating leases in effect at January 31, 1995, are payable as follows:\nThe Company leases a general purpose office building and has guaranteed a $12,250,000 loan on behalf of the building owner. Certain financial ratios and balances required by the guarantee have been maintained.\nOther commitments at January 31, 1995 include outstanding letters of credit aggregating $11,676,000, principally related to guarantees on contracts with commercial and foreign customers, and outstanding surety bonds aggregating $86,324,000, principally related to performance and payment type bonds.\nOn February 15, 1994, the Company was served with search warrants and a subpoena for documents and records associated with the performance by the SAIT operating unit of the Company under three contracts with the DOD. The search warrants and subpoena state that the U.S. Government is seeking evidence regarding the making of false statements and false claims to the DOD, as well as conspiracy to commit such offenses. The search warrant and subpoena appear to be based upon allegations contained in a civil complaint that had been filed under seal on March 13, 1993 by an employee of the Company's SAIT operating unit. The complaint was filed in the U.S. District Court for the Southern District of California and sought damages on behalf of the U.S. Government under the Federal False Claims Act. On August 1, 1994, the Department of Justice on behalf of the U.S. Government announced its intention to intervene in the case. Based on the Company's motion, on November 8, 1994, the District Court dismissed the employee who had originally filed the complaint from the lawsuit, leaving only the U.S. Government and the Company as parties. The employee has appealed the District Court's order to the U.S. Court of Appeals for the Ninth Circuit. The Company has engaged in a series of presentations and submissions with the Department of Justice in which the Company responded to issues raised by the Department of Justice. At this stage of the proceedings, the Company is unable to assess the impact, if any, of this investigation and lawsuit on its consolidated financial position, results of operations or ability to conduct business.\nThe Company is involved in various other investigations, claims and lawsuits arising in the normal conduct of its business, none of which, in the opinion of the Company's management, will have a material adverse effect on its consolidated financial position, results of operations or its ability to conduct business.\nNOTE L -- SUPPLEMENTARY INCOME STATEMENT INFORMATION:\nCharges to costs and expenses for depreciation and amortization of buildings, property and equipment were $21,481,000, $20,120,000 and $19,956,000 for 1995, 1994 and 1993, respectively.\nThe Company expensed $8,490,000, $5,689,000 and $8,238,000 of independent research and development costs during 1995, 1994 and 1993, respectively.\nTotal interest paid in 1995, 1994 and 1993 amounted to $1,514,000, $1,449,000 and $1,743,000 respectively.","section_15":""}
{"filename":"55529_1995.txt","cik":"55529","year":"1995","section_1":"Item 1. Business - ------------------\nGeneral -------\nThe principal business of the Registrant is the manufacture and sale of scientific laboratory and technical workstations and equipment for professionals, including wood and metal furniture for use in chemistry, physics, biology and other general science laboratories, and benches for electronic light assembly and testing. Other products for laboratory use include fume hoods and accessories, apparatus benches, work surfaces, sinks and sink assemblies, and glove boxes.\nScientific laboratory and technical workstations and equipment and related installation accounted for 100 percent of the Registrant's sales in each of the fiscal years ended April 30, 1995, 1994 and 1993.\nThe scientific laboratory and technical workstations and equipment produced by the Registrant include general science workstations for use in chemistry, physics and biology laboratories, fume hoods, apparatus benches, work surfaces, sinks and sink assemblies. These products are sold principally to industrial and commercial research laboratories, educational institutions, health-care institutions and governmental entities. The Registrant's products are primarily sold through purchase orders and contracts submitted by customers, through Registrant's commissioned dealers, through a national distributor and through competitive bids submitted by the Registrant. It is common in the scientific laboratory furniture industry for customer orders to require delivery at extended future dates, because the products are frequently to be installed in buildings yet to be constructed. Changes or delays in building construction may cause further delayed delivery dates. Since prices are normally quoted on a firm basis in the industry, the Registrant bears the burden of possible increases in labor and material costs between receipt of an order and delivery of the product.\nThe need for working capital and the credit practices of the Registrant are comparable to those of other companies selling similar products in similar markets. Payments for products which the Registrant manufactures and installs are received over longer periods of time and require greater working capital than for manufacturers of most products. In addition, payment terms of some building projects allow for a percentage retention amount which extends the collection period of accounts receivable, thus requiring more working capital.\nThe principal raw materials and products manufactured by others used by the Registrant in its products are cold-rolled carbon and stainless steel, hardwood lumber and plywood, paint, chemicals, resins, hardware, plumbing and electrical fittings. Such materials and products are purchased from multiple suppliers and are readily available.\nThe Registrant holds various patents and patent rights but does not consider that its success or growth is dependent upon its patents or patent rights. The Registrant's business is not dependent upon licenses, franchises or concessions.\nThe Registrant's scientific laboratory and technical workstation and equipment business is neither cyclical nor seasonal, nor is it dependent on any one or a few customers. However, sales to VWR Corporation (\"VWR Scientific\") represented 17 percent, 13 percent, and 15 percent of the Registrant's total sales, for fiscal years 1995, 1994 and 1993, respectively. VWR Scientific is a distributor of the Registrant's products. In the event that VWR Scientific were not a sales channel, the Registrant would distribute these products through its other sales agents, dealers, and direct sales force or through another outside distributor or distributors.\nThe Registrant's sales backlog as of April 30, 1995 was $24.1 million compared to $25.3 million and $27.9 million as of April 30, 1994 and 1993, respectively. In the Registrant's business, planning for purchases frequently commences several years before installation; therefore, increases and decreases in the business activities of the Registrant usually trail the normal economic cycle. It is expected that the amount of the backlog as of the beginning of the fiscal year, together with orders received for current delivery, will be sufficient to permit the Registrant to operate at satisfactory levels during the current year. All but $1.2 million of the backlog as of the beginning of the current fiscal year is scheduled for shipment during the year; however, it may reasonably be expected that delays in shipments will occur because of customer rescheduling or delay in completion of buildings in which the Registrant's products are to be installed. Based on past experience, the Registrant expects that more than 90 percent of its backlog scheduled for shipment in the current fiscal year will be shipped in the current fiscal year.\nCompetition -----------\nThe scientific laboratory and technical workstation and equipment industry is highly competitive. The Registrant believes that the principal competitive factors in the scientific laboratory and technical workstation and equipment industry are price, product performance, and customer service. A substantial portion of the business of the Registrant is based upon competitive public bidding.\nResearch and Development ------------------------\nThe amount spent during the fiscal year ended April 30, 1995 on company-sponsored research and development activities related to new products or services or improvement of existing products or services was $527,647. The amounts spent for similar purposes in the fiscal years ended April 30, 1994 and 1993 were $490,481 and $440,580, respectively. Six professional employees were engaged in such research at April 30, 1995.\nEnvironmental Compliance ------------------------\nIn the last three fiscal years, compliance with federal, state or local provisions enacted or adopted regulating the discharge of materials into the environment has had no material effect on the Registrant. There are no material capital expenditures anticipated for such purposes, and no material effect therefrom is anticipated on the earnings or competitive position of the Registrant.\nEmployees ---------\nThe number of persons employed by the Registrant at April 30, 1995 was 575.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - --------------------\nThe Registrant owns and operates three plants in Statesville, North Carolina and one in Lockhart, Texas. The plants are involved in the production of scientific laboratory and technical workstations and equipment.\nThe plants in Statesville, North Carolina are located in three separate adjacent buildings which contain manufacturing facilities. Office, engineering and drafting personnel and facilities are located in two of the three buildings. The Registrant's corporate offices are located in the largest building. The plant buildings together comprise approximately 382,000 square feet and are located on approximately 20 acres of land. In addition, the Registrant leases a warehouse of 22,000 square feet in Statesville, North Carolina.\nThe plant in Lockhart, Texas is housed in a building of approximately 129,000 square feet located on approximately 30 acres. In addition, a separate 10,000 square foot office building on this site houses certain administrative personnel.\nAt April 30, 1995, the Registrant's land and buildings were pledged as collateral securing borrowings and letters of credit outstanding under a revolving credit facility. The Registrant believes its facilities are suitable for their respective uses and are adequate for its 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.\nExecutive Officers - ------------------\nInformation regarding the executive officers of the Registrant is contained in Part III of this report, Item 10(b), and is incorporated into Part I of this report in reliance on General Instruction G(3) to Form 10-K, by reference.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related - ----------------------------------------------------------- Stockholder Matters -------------------\nIncorporated by reference from the Registrant's annual report to stockholders for the fiscal year ended April 30, 1995, page 20, sections entitled \"Range of Market Prices\" and \"Quarterly Financial Data\". As of July 7, 1995, the Registrant estimates there were approximately 1,400 stockholders of Kewaunee common shares, of which 439 were stockholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data - ---------------------------------\nIncorporated by reference from the Registrant's annual report to stockholders for the fiscal year ended April 30, 1995, pages 18-19, section entitled \"Summary of Selected Financial Data\".\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial - ----------------------------------------------------------- Condition and Results of Operations -----------------------------------\nIncorporated by reference from the Registrant's annual report to stockholders for the fiscal year ended April 30, 1995, pages 6-8, section entitled \"Management's Discussion and Analysis\".\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - -----------------------------------------------------\nIncorporated by reference from the Registrant's annual report to stockholders for the fiscal year ended April 30, 1995, pages 9-20.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on - ---------------------------------------------------------- Accounting and Financial Disclosure -----------------------------------\nNot Applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------\n(a) Incorporated by reference from the Registrant's proxy statement for use in connection with its annual meeting of stockholders to be held on August 30, 1995, pages 1-3, section entitled \"Election of Directors\".\n(b) The names and ages of the Registrant's executive officers and their business experience during the past five years are set forth below:\nExecutive Officers of the Registrant ------------------------------------\nName Age Position ---- --- --------\nEli Manchester, Jr. 64 President and Chief Executive Officer\nRobert M. Cecchini 61 Vice President-Finance; Treasurer; Secretary; and Chief Financial Officer\nT. Ronald Gewin 52 Vice President-Manufacturing\nWilliam A. Shumaker 46 Vice President-Sales and Marketing\nEli Manchester, Jr. was elected a director of the Registrant in November 1990. He was elected President and Chief Executive Officer of the Registrant on July 11, 1990. For eighteen years prior thereto, he was President and Chief Executive Officer of BIW Cables Systems, Inc., a manufacturer of electrical and electronic components.\nRobert M. Cecchini was elected Vice President of Finance, Chief Financial Officer, Secretary and Treasurer in November 1990. Mr. Cecchini joined the Registrant in July 1989 as Corporate Director of Operational Accounting and Costs. Mr. Cecchini has elected to retire, effective July 31, 1995.\nT. Ronald Gewin joined the Registrant in December 1992 as Vice President of Manufacturing. Prior to joining the Registrant, Mr. Gewin was General Manager of a Division of the Grinnell Corporation from 1990 to 1992. He was a Vice President of Manufacturing for a division of White Consolidated Industries from 1987 to 1990.\nWilliam A. Shumaker joined the Registrant in December 1993 as Vice President of Sales and Marketing. Prior to joining the Registrant, Mr. Shumaker was with the St. Charles Companies of St. Charles, Illinois, where he served as Vice President of Sales and Marketing with their Institutional Division from 1989 to 1993, and as National Sales Manager with another division from 1984 to 1988. He held various other sales and customer service positions with The St. Charles Companies from 1969 through 1984.\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nIncorporated by reference from the Registrant's proxy statement for use in connection with its annual meeting of stockholders to be held on August 30, 1995, pages 4-5, section entitled \"Executive Compensation,\" pages 6-7, section entitled \"Compensation Committee Report on Executive Compensation,\" and page 9, section entitled \"Agreements with Certain Executives\".\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners - ---------------------------------------------------------\nand Management --------------\nIncorporated by reference from the Registrant's proxy statement for use in connection with its annual meeting of stockholders to be held on August 30, 1995, pages 10-12, sections entitled \"Security Ownership of Directors and Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\".\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nIncorporated by reference from the Registrant's proxy statement for use in connection with its annual meeting of stockholders to be held on August 30, 1995, pages 1-3, section entitled \"Election of Directors\".\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports - ------------------------------------------------------------- on Form 8-K -----------\nThe following documents are filed or incorporated by reference as part of this report:\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.\n(a)(3) Exhibits --------\nExhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index which is attached hereto at pages S-2 through S-4 and which is incorporated herein by reference.\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed during the fourth quarter of the Registrant's fiscal year ended April 30, 1995.\n____________________ * Matters incorporated by reference from the Registrant's annual report to stockholders for the year ended April 30, 1995.\n[LETTERHEAD OF DELOITTE & TOUCHE LLP]\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Board of Directors Kewaunee Scientific Corporation Statesville, North Carolina\nWe have audited the balance sheets of Kewaunee Scientific Corporation as of April 30, 1995 and 1994, and the related statements of operations, retained earnings, and cash flows for each of the three years in the period ended April 30, 1995; such financial statements are included in your 1995 Annual Report to Stockholders. 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 financial statements present fairly, in all material respects, the financial position of Kewaunee Scientific Corporation as of April 30, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended April 30, 1995 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, present fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP June 2, 1995\n[LOGO OF DELOITTE TOUCHE TOHMATSU INTERNATIONAL]\nSchedule II\nKewaunee Scientific Corporation Valuation and Qualifying Accounts ($ in thousands)\n* 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.\nKEWAUNEE SCIENTIFIC CORPORATION\nBy: \/s\/ Eli Manchester, Jr. -------------------------------------- Eli Manchester, Jr. President and Chief Executive Officer\nDate: July 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 dates indicated.\n(i) Principal Executive Officer ) ) ) \/s\/ Eli Manchester, Jr. ) ------------------------------- ) Eli Manchester, Jr., President ) and Chief Executive Officer ) ) (ii) Principal Financial and Accounting Officer ) ) ) \/s\/ R. M. Cecchini ) ------------------------------- ) R. M. Cecchini, ) Vice President-Finance, Treasurer ) ) (iii) A majority of the Board of Directors: ) July 26, 1995 ) ) \/s\/ Margaret B. Bruemmer \/s\/ Eli Manchester, Jr. ) - ------------------------- -------------------------- ) Margaret B. Bruemmer Eli Manchester, Jr. ) ) ) \/s\/ W. N. Caldwell \/s\/ James T. Rhind ) - ------------------------- -------------------------- ) W. N. Caldwell James T. Rhind ) ) ) \/s\/ John C. Campbell, Jr. \/s\/ Thomas F. Pyle ) - ------------------------- -------------------------- ) John C. Campbell, Jr. Thomas F. Pyle ) ) ) \/s\/ Kingman Douglass ) - ------------------------- ) Kingman Douglass )\nS-1\nKEWAUNEE SCIENTIFIC CORPORATION\nExhibit Index -------------\nS-2\n- --------------- All footnotes located on page S-4.\n(All other exhibits are either inapplicable or not required.)\nS-3\n- --------------- All footnotes located on page S-4.\nS-4","section_15":""}
{"filename":"716133_1995.txt","cik":"716133","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCincinnati Bell Inc. (including its wholly owned subsidiaries, except as the context may otherwise require, the \"Company\") is incorporated under the laws of Ohio and has its principal executive offices at 201 East Fourth Street, Cincinnati, Ohio 45202 (telephone number 513-397-9900).\nThe Company is a holding company engaged in operations through its subsidiaries. Its principal subsidiaries are divided into three industry segments. The telephone operations segment, Cincinnati Bell Telephone Company (\"CBT\"), provides telecommunications services and products, mainly local service, network access and toll telephone services in the Greater Cincinnati area. The information systems segment, Cincinnati Bell Information Systems Inc. (\"CBIS\"), provides data processing and software development services primarily to the telecommunications industry in the United States. The marketing services segment, MATRIXX Marketing Inc. (\"MATRIXX\"), provides telephone marketing, research, fulfillment and database services. Other businesses include Cincinnati Bell Long Distance Inc. (\"CBLD\") which provides resale of long distance telecommunications services and products as well as voice mail and paging services, Cincinnati Bell Directory Inc. (\"CBD\") which provides Yellow Pages and other directory products and services and information and advertising services, and companies having interests in cellular mobile telephone service, the purchase, sale and reconditioning of telecommunications and computer equipment, and the ownership of real estate used by the Company.\nTELEPHONE OPERATIONS\nGENERAL. CBT is engaged principally in the business of furnishing telecommunications services and products, mainly local service, network access and toll telephone services, in four counties in southwestern Ohio, six counties in northern Kentucky and parts of two counties in southeastern Indiana. On December 31, 1995, CBT had approximately 906,000 network access lines in service. The principal cities in which CBT furnishes local service are Cincinnati, Norwood and Hamilton in Ohio and Covington, Newport and Florence in Kentucky. Approximately 98% of CBT's network access lines are in a single calling local service area. Other communications services offered by CBT include voice, data and video transmission, custom calling services and billing services. In addition, CBT is a sales agent for certain products and services of AT&T Corp. (\"AT&T\") and also sells products of other companies.\nCBT's local exchange, network access and toll telephone operations are subject to regulation by the regulatory authorities of the states in which it operates with respect to intrastate rates and services, issuance of securities and other matters. CBT is also subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate rates, services and other matters.\nThe access lines provided by CBT to customer premises can be interconnected with the access lines of other telephone companies in the United States and with telephone systems in most other countries. Interconnection is made through the facilities of interexchange carriers and local exchange carriers.\nThe following table sets forth for CBT the number of network access lines at December 31:\nRecurring charges for network access lines and other local services for the year ended December 31, 1995 accounted for approximately 45% of CBT revenues and sales.\nINTRASTATE RATES. Rates for intrastate services offered by CBT are either non-regulated by state regulatory authorities in Ohio and Kentucky or regulated by the Public Utilities Commission of Ohio (the \"PUCO\") and the Public Service Commission of Kentucky (the \"PSCK\"). Approximately 77% of CBT's 1995 revenues were derived from intrastate service. Approximately 82% of 1995 intrastate revenues were derived from Ohio service, approximately 18% were derived from Kentucky service and minor amounts were derived from Indiana and other states service. Of the total 1995 intrastate revenues, local service accounted for approximately 73%, intrastate long distance service and network access accounted for approximately 11% and miscellaneous revenue accounted for approximately 16% of such revenues.\nIn 1984, the PUCO issued orders providing the format to be employed by local exchange telephone companies in Ohio for setting charges for intrastate access by interexchange carriers. The PUCO determined that the Ohio intrastate access charges should mirror the interstate access charges set by the FCC (see \"Interstate Rates\"), with the exception that the PUCO did not order mirroring of subscriber line charges or carrier common line charges.\nPursuant to procedures established by the PUCO, local exchange companies are permitted to file plans proposing alternate forms of regulation for competitive services and basic service rates. CBT filed for a threshold increase in rates together with an alternative regulation proposal in 1993. Thereafter, CBT and the intervenors signed a settlement agreement which was approved by the PUCO on May 5, 1994 approving an alternative regulation plan and increasing revenues by $11.9 million annually or 3.75% on Ohio regulated services. The alternative regulation provisions and new rates became effective May 6, 1994. CBT's authorized rate of return on capital is 11.18%, but CBT can earn up to 11.93% in a monitoring period without any retargeting of rates. Earnings higher than 11.93% will trigger a revenue retargeting formula. This formula will allow for certain adjustments in the subsequent annual monitoring period. This alternative regulation plan provides increased pricing flexibility in some areas, which allows CBT to be more responsive to customers and the market.\nIn 1991, the PSCK issued an order amending its prior format to be used by local exchange companies in Kentucky for setting charges for intrastate access for interexchange carriers. In this order, the PSCK ordered that rates and regulations should mirror those of the FCC with certain exceptions that may be considered for future mirroring based on the merits of each situation.\nIn October 1994, CBT filed a proposal with the PSCK for new regulated rates for telephone services provided to its Kentucky customers. This proposal sought to continue uniform rates for basic service in CBT's Kentucky and Ohio metropolitan service areas and annually increase revenues by $3.4 million. By an order dated May 23, 1995, the PSCK ordered reductions in certain rates for vertical services such as touch tone, the establishment of extended area service in the three southern counties in CBT's Kentucky operating territory and maintained rate uniformity with CBT's Ohio rates.\nINTERSTATE RATES. Approximately 23% of CBT's 1995 revenues were derived from interstate and foreign services under FCC tariffs. The FCC has regulatory jurisdiction over services, rates and other matters relating to CBT's interstate operations. The FCC prescribes a uniform system of accounts applicable to telephone companies, separations procedures to be utilized in separating investments, revenues, expenses, taxes and reserves between the federal and state regulatory jurisdictions, and depreciation rates for interstate plant and facilities.\nThe FCC's cost allocation rules specify requirements relative to the allocation of costs between regulated and non-regulated activities, as well as transactions between affiliated entities. CBT's cost allocation manual, setting forth its method for separating regulated and non-regulated activities consistent with the FCC's cost allocation rules, was approved, as modified by the FCC. CBT continues to review its cost allocation manual and to modify it as appropriate to reflect CBT's circumstances.\nThe FCC also prescribes the rate of return which regulated carriers are authorized to earn on their regulated interstate business. The FCC has yet to design a valid refund mechanism to replace its automatic refund rule to address instances where earnings exceed authorized levels for any monitoring period. The United States Court of Appeals for the District of Columbia Circuit previously found the FCC's automatic refund rule to be arbitrary and capricious. In the absence of FCC action, several complaints were filed pursuant to Section 208 of the Communications Act seeking refunds related to prior access periods in which CBT had allegedly exceeded the authorized rate of return. The FCC has awarded damages in these cases, thereby attempting to achieve the same results that were found improper in the previously overturned FCC rule. On August 1, 1995 the United States Court of Appeals for the District of Columbia Circuit issued an opinion upholding the FCC order awarding damages and reversing the FCC's allowance of offsets between different monitoring categories. CBT and other affected carriers have filed a petition with the United States Supreme Court seeking review of the lower court's decision.\nCBT receives its principal interstate compensation from access charges paid by interexchange carriers and end users. Specifically, traffic sensitive switched access charges apply on a usage sensitive basis to recover costs associated with the use of CBT's switching and transmission facilities. Special access charges recover costs of private line connections. CBT's non-traffic sensitive costs are recovered from subscribers on a flat rate basis (Subscriber Line Charges) and from interexchange carriers on a usage sensitive basis (Carrier Common Line Charges). Residential and single line business Subscriber Line Charges have a cap of $3.50 and multi-line customers' Subscriber Line Charges have a $6.00 cap. The Carrier Common Line rate recovers the remaining non-traffic sensitive costs.\nFor interstate services, CBT began to operate under an Optional Incentive Regulation (\"OIR\") plan in January 1994. This is an alternative form of regulation (i.e. departure from traditional rate of return regulation) for small and mid-sized companies. Under OIR more emphasis is placed on price regulation similar to price caps. Every two years CBT compares actual return with authorized rate of return, currently 11.25%. In addition, CBT has some pricing flexibility. Rate changes can become effective on a 14-day notice without cost support if the rate changes do not increase \"aggregate service basket\" rates. New services can be offered on a 14-day notice without cost support if CBT sets rates no higher than a geographically adjacent price cap local exchange carrier. This allows CBT to be more responsive to customers and the market.\nIn January 1994, CBT completed a successful triennial depreciation represcription with regulators from the FCC, the PUCO and the PSCK. The new depreciation rates were effective January 1, 1994 in the interstate and Kentucky jurisdictions, and were effective July 1, 1994 in the Ohio jurisdiction.\nCOMPETITION. Customer demands, technology, the preferences of policy makers and the convergence of other industries with the telecommunications industry are causes for increasing competition in the telecommunications industry for CBT. The range of communications services, the equipment available to provide and access such services, and the number of competitors offering such services continue to increase. Moreover, recent federal and state initiatives to accelerate the development of competition in all segments of the telecommunications industry are likely to heighten the competitive pressures facing CBT.\nAt the federal level, Congress recently passed the Telecommunications Act of 1996 (the \"Act\") which mandates the development of competitive markets. Under the Act, incumbent local exchange carriers like CBT are required to interconnect with the networks of other service providers, unbundle certain network components and make them available to competing providers at wholesale rates, and remove other perceived barriers to competitive entry by alternative providers of local exchange service. While the Act clearly mandates these and other requirements, it does so in very general terms and leaves it to the FCC and the states to implement them. Thus, the full impact of the Act on CBT will not be known until the FCC and the states complete the numerous rulemakings mandated by the Act. The Act contains a provision that allows local exchange carriers serving fewer than 2% of the nation's access lines to petition their state commissions to delay certain requirements of the Act. CBT falls within this 2% threshold and is currently evaluating this option. CBT plans to participate actively in any FCC proceeding that will have an impact on its rights or obligations under the Act.\nAt the state level, the PUCO has initiated a generic rulemaking proceeding to establish rules to govern the introduction of local exchange competition. On September 27, 1995, the PUCO issued an entry inviting interested parties to file comments on a set of proposed rules developed by the staff of the PUCO. CBT has filed comments on those proposed rules. It is expected that the PUCO will issue its rules during the second quarter of this year. The PSCK has initiated a similar proceeding in Kentucky. CBT is actively participating in that proceeding.\nIn addition to initiating the above-mentioned generic rulemaking proceeding, the PUCO, on August 24, 1995, issued an order granting Time Warner Communications of Ohio, L.P. (\"TWCO\") a certificate of public convenience and necessity to provide basic local exchange service in CBT's operating territory. TWCO's ability to begin operations pursuant to that certificate has been postponed until the PUCO approves TWCO's tariffs. Such tariff approval is vaguely tied to issues under consideration in a separate proceeding being conducted by the PUCO to establish rules to govern the implementation of local exchange competition. CBT believes the PUCO exceeded its statutory authority by granting TWCO a certificate and has filed an appeal of the PUCO's order with the Ohio Supreme Court. MCI Metro Access Transmission Services, Inc. and MFS Intelenet of Ohio, Inc. have also been granted certificates to provide basic local exchange service in Ohio, although not in CBT's operating territory. Other entities requesting similar authority in Ohio include: AT&T Communications of Ohio, Inc., ICG Access Services, Inc., and CableVision Lightpath, Inc.\nOther means of communications that permit bypass of CBT's local exchange facilities either completely or partially are available and are increasing, although CBT is unable to determine precisely to what extent CBT's facilities are being bypassed. Alternative access providers, cable companies and wireless providers have all made clear their intent to compete for segments of the local exchange business. In addition, interexchange carriers are creating new value- added services based on Signaling System 7 and Advanced Intelligent Network technologies, similar to those under development by the local exchange companies. CBT's competitors include small service bureaus, large interexchange carriers and multi-state cellular companies, joint ventures and other combinations of telecommunications and other companies.\nThe effect of this competition on CBT will ultimately be determined by federal and state regulatory, legislative, and court actions and the type, quality and cost of CBT's services. CBT continues to adjust its position in this rapidly changing and convergent environment. For example, CBT is redesigning and streamlining its processes and work activities to improve responsiveness to\ncustomer needs, permit more rapid introduction of new products and services, improve the quality of products and service offerings, and reduce costs. In addition, CBT has upgraded and will continue to upgrade its telephone plant and network and to explore new services and technologies as sound business judgment dictates. It has constructed several optical fiber rings in and around the metropolitan Cincinnati area to permit it to offer redundancy in telecommunications services for business customers. CBT offers custom calling features that include Caller ID, Call Return, Call Block, Priority Forward, Repeat Dialing and Number Privacy.\nIf regulatory agencies require new competitors to follow long-held principles such as universal service, CBT believes that it will be well positioned to meet the demand of the changing market. If regulatory agencies allow competitors to skim the market, taking only the most profitable customers, CBT believes that it will be more difficult for it to maintain current revenue and profit objectives.\nINFORMATION SYSTEMS\nGENERAL. CBIS provides customer care and billing services to the communications industry, and is the leading supplier of billing systems to the cellular telecommunications industry. CBIS also provides network systems services primarily to international markets. CBIS's headquarters are in Cincinnati, Ohio. Domestically, CBIS also has offices in Orlando, Florida; Chicago, Illinois; Fairfax, Virginia; Coral Springs, Florida; and Atlanta, Georgia. Internationally, CBIS maintains offices in both Slough and Bristol, England; Bern, Switzerland; and Utrecht, The Netherlands.\nDuring 1995 CBIS made two acquisitions. In December, CBIS acquired Information Systems Development (\"ISD\"), a developer of advanced billing systems for the cable television industry. This acquisition strengthened and broadened CBIS's position in customer care and billing for the communications industry to include cable television. As a result, CBIS now owns CableMaster 2000-TM-, a multi-service billing system in the cable industry, and services clients that include some of the larger cable systems operated by Cox Communications, Comcast and Time Warner. In March, CBIS acquired X International (\"XI\"), an established information technology company located in Bristol, England, that provides customer care and billing software for a wide range of telecommunications companies.\nCBIS serves clients principally by processing data and creating bills using proprietary software. CBIS provides and manages billing systems in a service bureau environment where its extensive experience can result in demonstrable advantages to clients. These advantages include the freedom to concentrate on core competencies, predictable costs, information management expertise and access to advanced technology without capital expense. CBIS provides these services primarily through long-term contracts ranging in length from three to ten years.\nCBIS provides data processing services from data centers located in Cincinnati, Ohio and Orlando, Florida. CBIS computers process over 140 million transactions and over 12 million bills per month. CBIS's goal is to provide state-of-the-art facilities that will provide reliability and responsiveness. CBIS expects to complete construction of a new, state-of-the-art facility in Orlando, Florida, housing both a hardened data center and an office complex by July 1996. This will give CBIS the ability for each data center to backup the other with on-line and disaster recovery coldsite capabilities. This project will result in a major expansion of capacity -- sharply increasing the processing power of CBIS's mainframe computers and nearly doubling the data center's information storage capacity. The combined processing power will exceed 1.6 billion instructions per second, and storage capacity contained in additional disk access storage devices will be nearly 9 trillion bytes of data.\nIn addition, CBIS has improved fault tolerance through the installation of redundant uninterruptable power supplies and through the development of detailed, company-wide disaster recovery plans, including enhanced backup and recovery processes.\nMARKETS. CBIS's largest market is cellular telecommunications, which has been growing in excess of 30 percent per year. CBIS has been the market leader of billing systems to the cellular industry for more than 10 years and has gained experience with many of the top cellular carriers. CBIS systems generate bills for cellular telephone customers in 23 of the 25 largest United States metropolitan areas. CBIS's service bureaus handled approximately 30 percent of the United States cellular market in 1995 and, overall, CBIS systems supported nearly 50 percent of the United States cellular market. CBIS's revenue from cellular clients has increased from $144 million in 1993 to $198 million in 1994 and to $257 million in 1995.\nCBIS's domestic clients are primarily cellular telephone providers and their resellers, cable television operators, interexchange carriers, independent telephone companies and regional Bell operating companies. Internationally, CBIS's clients primarily include Post, Telegraph and Telephone organizations, mobile telecommunications providers and their resellers, and new competing networks. In the United Kingdom, CBIS Ltd. is an ISO-9001 certified supplier with TickIT accreditation.\nCBIS expects that increased competition and the introduction of new services will contribute to continuing growth in telecommunications. Carriers will need billing and customer care systems that address customer loyalty, customer care, and marketing. Deregulation and convergence will further drive the need for complex, but flexible marketing-oriented billing services and systems.\nThe primary business needs of the carriers across market segments will focus on acquiring and retaining customers, decreasing time-to-market for services, increasing revenues through new services, and improving cost efficiencies. As a result, carriers will need to provide individual and consolidated billing and address the diversity of billing and customer care needs by service and market.\nThe United States communications industry alone represents a sizable opportunity. The domestic market for billing and customer care systems in 1995 for services like those offered by CBIS is estimated to be over $5 billion. The international market for these billing and customer care services in 1995 is estimated to be nearly $6 billion.\nCOMPETITION. The telecommunications information systems and services market is becoming increasingly competitive. Competition is based mainly on product quality, performance, price and the quality of client service. CBIS's competitors include Alltel Information Services, AMDOCS, AMS, Andersen Consulting, CSC and EDS, as well as, near-market players, and niche vendors. In addition, CBIS's clients and potential clients are generally large companies with substantial resources and are capable of providing such services for themselves.\nPRODUCT DEVELOPMENT AND SUPPORT. CBIS designs and develops both mainframe and client server software. Changes in client requirements, increasing competition and the development of new products and markets create the need to continually update and modify existing software and systems offered to clients. CBIS intends to continue to maintain, improve and expand the functions and capabilities of its software products over the next several years.\nCBIS's new flagship product is its Precedent 2000-TM- system, which is a third-generation family of business management systems for the wireless industry. It features an open system distributed processing approach to computing, and employs graphical user interfaces, real-time processing, and relational database technologies. CBIS is generating billing information for cellular customers under a beta trial of Precedent 2000. CBIS will continue to develop this system through 1996.\nOTHER. CBIS primarily conducts its business under long-term contracts (three to ten years) and has generally been successful in retaining its clients. Due to the nature of its business, CBIS must stay competitive to receive new bids. Through new contracts and extensions of existing relationships, CBIS has over 86% of its revenues coming from long-term customer relationships. In 1995 CBIS signed a five-year extension of its billing agreement with AT&T for business calling card services. In 1994 CBIS signed a 5 1\/2 year contract with McCaw Cellular Communications Inc. (now known as AT&T Wireless Services). In addition, CBIS had several smaller contracts renewed in both 1994 and 1995. CBIS's business with AT&T for residence card services was phased down in the latter part of 1995. Also, one of CBIS's clients, representing about 5% of its business, indicated that it may transition to another provider of billing services no sooner than early 1997. The impact of these phase-outs, if fully implemented and not offset by new contracts, might be to slow future growth. The ISD acquisition allows CBIS to enter the large, growing market of billing for cable television and broadband services. While pursuing new opportunities, CBIS must continue to focus on the needs of its existing client base. A contract non-renewal from a significant client could have a material impact on the future earnings of CBIS.\nMARKETING SERVICES\nGENERAL. MATRIXX is a provider of telephone marketing and related marketing services. MATRIXX's headquarters are in Cincinnati, Ohio. MATRIXX operates domestically in Salt Lake City, Ogden and Cedar City in Utah; Colorado Springs and Pueblo in Colorado; Tucson, Arizona; Neenah, Wisconsin; and also in Omaha, Nebraska. MATRIXX also has offices in Paris, France and Newcastle, England. MATRIXX's clients include large companies with growing needs for outsourcing and cost effective means of contacting and servicing current and prospective customers. The majority of MATRIXX's customers come from the telecommunications, financial services, consumer products, high technology and direct marketing industries. MATRIXX concentrates on servicing business needs in the telephone marketing and related marketing service areas by offering an integrated package of services to its customers including, without limitation, inbound and outbound telephone marketing, business-to-business telephone marketing, marketing research, fulfillment, database management, and facilities management. MATRIXX operates over 6,000 computerized workstations in its 16 call centers located in the United States and Europe.\nMATRIXX's inbound and outbound telephone marketing services enable clients to manage high volumes of inbound and outbound customer contacts in an environment of shared resources and also increases market awareness with rapid response to consumer requests for information or services. MATRIXX also designs customized client systems for consumer markets with dedicated staff and services uniquely tailored to the needs of each client. Its business-to-business telephone marketing provides sales and customer service personnel who act as the sales arm and\/or marketing service representatives for their clients. They take orders, sell by telephone and provide information about clients' promotion plans, quantity discounts and new products, both to retailers and distributors. MATRIXX's marketing research services assist clients in finding and qualifying customers before they offer a new product or service to the market. By offering full service marketing research, MATRIXX can support its clients in their strategic planning and tactical decision-making processes.\nMATRIXX's international operations offer business-to-business and business- to-consumer telephone marketing, including toll-free services, direct response services and facilities management.\nCOMPETITION. The telephone marketing agency business in the United States is highly competitive and highly fragmented, with MATRIXX's competitors ranging in size from very small firms offering special applications or short-term projects to large independent firms and \"in-house\" operations of potential client companies with size and capabilities equal to or greater than those of MATRIXX. The continued trend in the outsourcing of telephone marketing is important for MATRIXX's continued growth. The telephone marketing agency business in Europe is in the early stages of development. The business is very competitive and overcapacity exists in a market that has not developed very rapidly during the past several years. MATRIXX believes the principal competitive factors in the telephone marketing and related marketing services industry are reputation for quality, sales and marketing results, price, technological expertise, and the ability to promptly provide clients with customized systems for their customer service, sales and marketing needs.\nOTHER BUSINESSES\nGENERAL. Most of the Company's business other than CBT, CBIS and MATRIXX is conducted by other subsidiaries of the Company or by partnerships in which the Company owns an interest.\nCBLD is a reseller of long distance telecommunications services. CBLD sells high-quality, competitively-priced long distance services and products to residential customers and small to medium-sized businesses in Ohio, Indiana, Kentucky, Western Pennsylvania and Michigan. CBLD also provides paging, voice messaging, enhanced fax services and conference calling.\nCBD provides printed Yellow Pages directories and other directory services. In addition, CBD publishes and provides the White Pages directories for CBT. CBD continually evaluates new product offerings in both the print and emerging electronic categories of distribution.\nCincinnati Bell Supply Company engages in the purchase, sale and reconditioning of telecommunications and computer equipment to customers nationwide.\nThe Company (through its wholly owned subsidiary, Cincinnati Bell Cellular Systems Company) is a limited partner with a 45% interest in a limited partnership, Cincinnati SMSA Limited Partnership (\"CSLP\") (of which Ameritech Mobile Phone Service of Cincinnati, Inc. is the general partner) in the cellular mobile telephone service business in the Greater Cincinnati, Columbus and Dayton areas. Cincinnati Bell Cellular Systems Company has commenced a lawsuit against Ameritech Mobile Phone Service of Cincinnati, Inc. asking that the partnership be dissolved. See \"Legal Proceedings\".\nCOMPETITION. CBLD, CBD and Cincinnati Bell Supply Company are faced with fierce competition from businesses offering similar products and services. Their success will be determined by how well they meet the changing needs of their customers.\nCSLP presently competes with a single wireless service provider, Airtouch, doing business as Cellular One-Registered Trademark-. However, the FCC has initiated auctions of wireless spectrum which can be used for competitive services. Two licenses have been awarded to AT&T and GTE, and four additional licenses will be awarded soon. The new businesses will provide a service known as PCS which may be superior in capacity and transmission quality to that offered by CSLP, using digital instead of analog technology. It's anticipated that the new competitors will begin service by reselling existing cellular services until their facilities have been constructed.\nRELATIONSHIP WITH AT&T\nThe Company and its subsidiaries are parties to several agreements with AT&T and its affiliates pursuant to which the Company and its subsidiaries either purchase equipment, materials and services from AT&T and its affiliates or derive significant revenues from AT&T and its affiliates by providing to them network, data processing, software development, and marketing services. During 1995, the Company's revenues from AT&T and its affiliates were approximately $345 million or 26% of the Company's consolidated revenues. Excluding network access revenues, revenues from AT&T and its affiliates were approximately $294 million or 22% of the Company's consolidated revenues. The Company purchased approximately $69 million of goods and services from AT&T and its affiliates.\nCBT and AT&T are discussing whether to revise portions of the companies' agreement governing their joint provision of certain telecommunications services. Revenues subject to discussion represent substantially less than 10% of CBT's revenues, but portions of the contract provide above-average profit contribution. The discussions are in a preliminary stage and their outcome cannot be predicted. The worst case scenario, which is not expected, could have a significant impact on CBT's earnings beginning in mid-1996. The discussions do not involve AT&T's relationships with other Company subsidiaries.\nCAPITAL ADDITIONS\nThe Company has been making large expenditures for construction of telephone plant and investments in its existing subsidiaries and new businesses. As a result of these expenditures, the Company expects to be able to introduce new products and services, respond to competitive challenges and increase its operating efficiency and productivity.\nThe following is a summary of capital additions for the years 1991 through 1995:\nThe total investment in telephone plant increased from approximately $1,296 million at December 31, 1990 to approximately $1,503 million at December 31, 1995, after giving effect to retirements but before deducting accumulated depreciation at either date.\nCapital additions in 1996 by the Company and its subsidiaries are anticipated to be approximately $145 million, with approximately $90 million designated for telephone plant.\nEMPLOYEES\nAt December 31, 1995 the Company and its subsidiaries had approximately 15,100 employees. CBT and CBIS had approximately 2,200 employees covered under collective bargaining agreements with the Communications Workers of America (\"CWA\"), which is affiliated with the AFL-CIO. Those agreements expire in May 1996 for CBT and September 1996 for CBIS. Negotiations with representatives of the CWA began in March 1996, and the outcome cannot be determined at this time.\nIn the first quarter of 1995, the Company approved a restructuring plan for CBT and the Company. The restructuring plan results in the need for fewer people to operate the businesses. The reduction in CBT's work force is the result of the offer of early retirement incentives to eligible employees. More than 1,300 employees accepted the early retirement offer, including 1,000 hourly employees. At the end of 1995, approximately 250 management and 450 hourly employees had retired. The Company has the option to delay the retirement date of the hourly employees until March 31, 1997.\nBUSINESS SEGMENT INFORMATION\nThe amounts of revenues, operating income, assets, capital additions, depreciation and amortization attributable to each of the business segments of the Company for the year ended December 31, 1995 are set forth in the table relating to business segment information in Note 18 of the Notes to Financial Statements in the Company's annual report to security holders, and such table is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe property of the Company is principally telephone plant which does not lend itself to description by character and location of principal units. Other property of the Company is principally computer equipment, computer software, furniture and fixtures.\nThe gross investment in telephone plant and other property, in millions of dollars, at December 31, 1995 was as follows:\nSubstantially all of the installations of central office equipment and garages are located in buildings owned by CBT situated on land which it owns. Some CBT business and administrative offices are in rented quarters, some of which are included in capitalized leases.\nOn March 20, 1996, the Company sold to a third party a 112,000 square foot building in Erlanger, Kentucky, which was a training and education facility.\nIn March 1995, CBIS entered into a build-to-suit lease agreement for a new office building and data center in Orlando, Florida. Under the terms of the agreement, the lease is a 15 year lease term with four 5-year renewal options. The office building will contain 125,000 square feet and the data center will be in a separate building of 60,000 square feet. The annual base rent will be approximately $3.7 million for an initial total commitment of $55.5 million over the 15 year term.\nCBIS, MATRIXX and other Company subsidiaries lease office space in various cities on commercially reasonable terms. Upon the expiration or termination of any such leases, these companies could obtain comparable office space. CBIS also leases some of the computer hardware, computer software and office equipment necessary to conduct its business pursuant to short term leases, some of which are capitalized leases.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone, except as described below.\nCincinnati Bell Cellular Systems Company (\"CBCSC\") is a limited partner in a partnership (of which Ameritech Mobile Phone Service of Cincinnati, Inc. is the general partner) which provides cellular mobile telephone service in the Greater Cincinnati, Dayton and Columbus areas. The partnership operates in a 9,500 square mile area that contains a population of approximately five million people. On February 23, 1994, CBCSC filed an action in the Court of Chancery of the State of Delaware for New Castle County in which CBCSC seeks a dissolution of the limited partnership, the appointment of a liquidating trustee and damages against the general partner because of poor performance. On October 20, 1995, CBCSC filed a motion for summary judgment on certain counts and Ameritech filed a Motion for Summary Judgment on another count. The Court has not yet decided these motions, but the Court did issue an Order requesting that the parties brief certain additional issues. CINCINNATI BELL CELLULAR SYSTEMS COMPANY V. AMERITECH MOBILE PHONE SERVICE OF CINCINNATI, INC., ET AL.\nIn connection with the above-described litigation, recent changes in the structure of the telecommunications industry, including the enactment of the Telecommunications Act of 1996, have positioned the partnership in direct competition with its two major partners, including the Company, creating irreconcilable conflicts of interest among them. The Company has pursued this litigation to maximize the value of this asset for the benefit of the shareholders. There are many possible outcomes of the litigation. The potential impact of a settlement from the lawsuit is an extremely broad range depending upon the form of distribution and the amount of damages awarded. At this time, the Company believes that it will recover its approximately $50 million investment in the partnership as of February 29, 1996.\nOn October 4, 1995, the Department of Agriculture filed a claim for approximately $4 million allegedly representing damages incurred as a result of a latent defect in the work that CBIS performed under Task 1A of a Task Order Contract with the Department of Agriculture. The Company is in the process of appealing this claim to the Court of Federal Claims. Related to this claim, on January 16, 1996, DynCorp pursuant to the provisions of a Stock Purchase Agreement dated October 31, 1994, and as amended May 30, 1995, in which DynCorp purchased 100% of the outstanding capital stock of CBIS Federal Inc., filed demand for arbitration under the procedures of the American Arbitration Association. DynCorp's demand for arbitration seeks damages and other relief as follows: $2.5 million for monies withheld by the United States Government on certain Department of Agriculture task order contracts, a declaration that CBIS must indemnify DynCorp for additional claims or losses on certain government contracts, an award of $5 million in punitive damages, and fees and expenses relating to the arbitration proceedings.\nAT&T Corp. filed a collection action in the United States District Court, Southern District of Ohio, Western Division, to collect damages awarded by the Federal Communications Commission requiring CBT to refund to interexchange carriers certain amounts based on CBT's having exceeded targeted earning levels for interstate access services for the 1987-1988 access period. CBT has moved to dismiss this action on the grounds that AT&T may be barred from collecting such amounts due to the expiration of the statute of limitations. AT&T CORP. V. CINCINNATI BELL TELEPHONE CO.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE 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 (DURING 1995).\nThe names, ages and positions of the executive officers of the Company are as follows:\nName Age Title - ---- --- ----- (as of 3\/31\/96)\nDwight H. Hibbard (a,b) 72 Chairman of the Board\nJohn T. LaMacchia (a,b) 54 President and Chief Executive Officer\nRaymond R. Clark (c) 58 Former Executive Vice President of the Company and President and Chief Executive Officer of CBT\nBrian C. Henry 39 Executive Vice President and Chief Financial Officer\nDavid S. Gergacz (d) 47 Executive Vice President of the Company and President and Chief Executive Officer of CBT\nJames F. Orr 50 Executive Vice President of the Company and President and Chief Executive Officer of CBIS\nWilliam H. Zimmer III 42 Secretary and Treasurer\nWilliam D. Baskett III 56 General Counsel and Chief Legal Officer\nDavid F. Dougherty 41 President and Chief Executive Officer of MATRIXX\nBarbara J. Stonebraker 51 Senior Vice President of CBT\nBarry L. Nelson 49 President and Chief Executive Officer of CBLD\n(a) Member of the Board of Directors\n(b) Member of the Executive Committee\n(c) Served as Executive Vice President of the Company and President and Chief Executive Officer of CBT until July 31, 1995.\n(d) Mr. Gergacz was elected President and Chief Executive Officer of CBT effective August 1, 1995.\nOfficers are elected annually but are removable at the discretion of the Board of Directors.\nDWIGHT H. HIBBARD, Chairman of the Board since January 1, 1985; Chief Executive Officer of the Company, 1985-September 30, 1993; Chairman of Cincinnati Bell Telephone Company, 1985-October 31, 1993. Director of Teradyne, Inc.\nJOHN T. LAMACCHIA, President and Chief Executive Officer of the Company since October 1, 1993; President of the Company since January 1, 1988; Chief Operating Officer of the Company, 1988-September 30, 1993; Chairman of Cincinnati Bell Information Systems Inc. since October 1988. Director of The Kroger Company.\nRAYMOND R. CLARK, Executive Vice President of the Company, January 1, 1987 - July 31, 1995; Chief Executive Officer of Cincinnati Bell Telephone Company, January 1, 1988 - July 31, 1995; President of Cincinnati Bell Telephone Company, January 1, 1987 - July 31, 1992. Director of Star Banc Corporation, Ohio National Life Insurance Company and Xtek, Inc.\nBRIAN C. HENRY, Executive Vice President and Chief Financial Officer of the Company since March 29, 1993; Vice President and Chief Financial Officer of Mentor Graphics, February 1986 to March 28, 1993.\nDAVID S. GERGACZ, Executive Vice President of the Company since August 1, 1995; President and Chief Executive Officer of Cincinnati Bell Telephone Company since August 1, 1995. President and Chief Executive Officer of Rogers Communications\/Cantel, 1993-1995; President and Chief Executive Officer of Boston Technology 1991-1993; President and Chief Operating Officer of Network Systems Division of U.S. Sprint, 1988-1991.\nWILLIAM H. ZIMMER III, Secretary and Treasurer of the Company since August 1, 1991; Secretary and Assistant Treasurer of the Company, December 1, 1988-July 31, 1991.\nJAMES F. ORR, Executive Vice President of the Company since June 1, 1995; President and Chief Executive Officer of Cincinnati Bell Information Systems Inc. since January 1, 1995; Chief Operating Officer of CBIS, February 4, 1994- December 31, 1994; President and Chief Executive Officer of MATRIXX Marketing Inc., January 1, 1993-December 31, 1994; Vice President-Market Development, January 1, 1989-December 31, 1992.\nDAVID F. DOUGHERTY, President and Chief Executive Officer of MATRIXX Marketing Inc. since January 1, 1995; Senior Vice President and Chief Operating Officer U.S. Operations, January 1, 1993 - December 31, 1994; President of the Consumer Division, January 1, 1991 - December 31, 1992.\nBARRY L. NELSON, Chief Executive Officer of Cincinnati Bell Long Distance Inc. since January 1, 1995; President since May 1, 1987.\nWILLIAM D. BASKETT III, General Counsel and Chief Legal Officer of the Company since July 1993; Partner of Frost & Jacobs since 1970.\nBARBARA J. STONEBRAKER, Senior Vice President of Cincinnati Bell Telephone Company since 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS.\nCincinnati Bell Inc. (symbol: CSN) common shares are listed on the New York Stock Exchange and on the Cincinnati Stock Exchange. As of February 29, 1996 there were approximately 19,664 holders of record of the 66,923,079 outstanding Common Shares of the Company. The high and low sales prices and dividends declared per common share each quarter for the last two fiscal years are listed below:\nITEMS 6 THROUGH 8.\nThe Selected Financial Data, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Financial Statements and Supplementary Data required by these items are included in the registrant's annual report to security holders for the fiscal year ended December 31, 1995 included in Exhibit 13 and are incorporated herein by reference pursuant to General Instruction G(2).\nITEM 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo disagreements with accountants on any accounting or financial disclosure occurred during the period covered by this report.\nPART III\nITEMS 10 THROUGH 13.\nInformation regarding executive officers required by Item 401 of Regulation S-K is furnished in a separate disclosure in Part I of this report under the caption \"Executive Officers of the Registrant\" since the registrant did not furnish such information in its definitive proxy statement prepared in accordance with Schedule 14A.\nThe other information required by these items is included in the registrant's definitive proxy statement dated March 14, 1996 in the first paragraph on page 2, the accompanying notes on page 2 and the last paragraph on page 2, the information under \"Election of Directors\" on pages 6 and 7, the information under \"Share Ownership of Directors and Officers\" on page 5, the information under \"Executive Compensation\" on page 11 through 16, and the information under \"Compensation Committee Interlocks and Insider Participation\" on page 4. The foregoing is incorporated herein by reference pursuant to General Instruction G(3).\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 this report:\n(1) Consolidated Financial Statements: Page ----\nReport of Management *\nReport of Independent Accountants *\nConsolidated Statements of Income *\nConsolidated Statements of Common Shareowners' Equity *\nConsolidated Balance Sheets *\nConsolidated Statements of Cash Flows *\nNotes to Financial Statements *\n(2) Financial Statement Schedule:\nReport of Independent Accountants 24\nII - Valuation and Qualifying Accounts 25\nFinancial statements and financial statement schedules other than that listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n.......................\n* Incorporated herein by reference to the appropriate portions of the registrant's annual report to security holders for the fiscal year ended December 31, 1995. (See Part II)\n(3) Exhibits\nExhibits identified in parenthesis below, on file with the Securities and Exchange Commission (\"SEC\"), are incorporated herein by reference as exhibits hereto.\nExhibit NUMBER\n(3)(a) Amended Articles of Incorporation effective November 9, 1989. (Exhibit (3)(a) to Form 10-K for 1989, File No. 1-8519).\n(3)(b) Amended Regulations of the registrant. (Exhibit 3.2 to Registration Statement No. 2-96054).\n(4)(a) Provisions of the Amended Articles of Incorporation and the Amended Regulations of the registrant which define the rights of holders of Common Shares and the Preferred Shares are incorporated by reference to such Amended Articles filed as Exhibit (3)(a) hereto and such Amended Regulations filed as Exhibit (3)(b) hereto.\n(4)(b)(i) Rights Agreement dated as of October 27, 1986 between the Company and Morgan Shareholder Services Trust Company, Rights Agent. (Exhibit (1) to Form 8-A, File No. 1-8519).\n(4)(b)(ii) First Amendment to Rights Agreement, dated as of October 3, 1988, between the Company and Morgan Shareholder Services Trust Company,Rights Agent. (Exhibit (4)(b)(ii) to Form 10-K for 1988, File No. 1-8519).\n(4)(c)(i) Indenture dated December 15, 1992 between Cincinnati Bell Inc., Issuer, and The Bank of New York, Trustee, in connection with $100,000,000 of Cincinnati Bell Inc. 6.70% Notes Due December 15, 1997. A copy of this Indenture is not being filed because it is similar in all material respects to the Indenture filed as Exhibit (4)(c)(ii) to Form 10-K for 1992, File No. 1-8519.\nIndenture dated July 1, 1993 between Cincinnati Bell Inc., Issuer, and The Bank of New York, Trustee, in connection with $50,000,000 of Cincinnati Bell, Inc. 7 1\/4% Notes Due June 15, 2023. Exhibit 4-A to Form 8-K, date of report July 12, 1993, File No. 1-8519.\n(4)(c)(ii) Indenture dated August 1, 1962 between Cincinnati Bell Telephone Company and Bank of New York, Trustee (formerly, The Central Trust Company was trustee), in connection with $20,000,000 of Cincinnati Bell Telephone Company Forty Year 4 3\/8% Debentures, Due August 1, 2002. (Exhibit 4(c)(iii) to Form 10-K for 1992, File No. 1-8519).\nIndenture dated August 1, 1971 between Cincinnati Bell Telephone Company and Bank of New York, Trustee (formerly The Fifth Third Bank was trustee), in connection with $50,000,000 of Cincinnati Bell Telephone Company Forty Year 7 3\/8% Debentures, Due August 1, 2011. A copy of this Indenture is not being filed because it is similar in all material respects to the Indenture filed as Exhibit (4)(c)(ii) above.\n(4)(c)(iii) Indenture dated as of October 27, 1993 among Cincinnati Bell Telephone Company, as Issuer, Cincinnati Bell Inc., as Guarantor, and The Bank of New York, as Trustee. (Exhibit 4-A to Form 8-K, date of report October 27, 1993, File No. 1-8519).\n(4)(c)(iv) No other instrument which defines the rights of holders of long term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n(10)(ii)(B) Agreement Establishing Cincinnati SMSA Limited Partnership between Advanced Mobile Phone Service, Inc. and Cincinnati Bell Inc. executed on December 9, 1982. (Exhibit (10)(k) to Registration Statement No. 2-82253).\n(10)(iii)(A)(1)(i)* Short Term Incentive Plan of Cincinnati Bell Inc., as amended January 1, 1995.\n(10)(iii)(A)(2)* Cincinnati Bell Inc. Deferred Compensation Plan for Non-Employee Directors, as amended July 1, 1983. (Exhibit (10)(iii)(A)(3) to Form 10-K for 1986, File No. 1-8519).\n(10)(iii)(A)(3)* Cincinnati Bell Inc. Pension Program, as amended effective (November 4, 1991). (Exhibit (10)(iii)(A)(4)(ii) to Form 10-K for 1994, File No. 1- 8519).\n(10)(iii)(A)(4)* Cincinnati Bell Inc. 1988 Incentive Award Deferral Plan, as amended (effective November 11, 1988). (Exhibit (10)(iii)(A)(5) to Form 10-K for 1988, File No. 1-8519).\n(10)(iii)(A)(5)(i)* Cincinnati Bell Inc. Senior Management Incentive Award Deferral Plan, as amended January 1, 1984. (Exhibit (10)(iii)(A)(6) to Form 10-K for 1986, File No. 1-8519).\n(10)(iii)(A)(5)(ii)* Amendment to Cincinnati Bell Senior Management Incentive Award Deferral Plan (effective December 5, 1988). (Exhibit (10)(iii)(A)(6)(ii) to Form 10-K for 1988, File No. 1-8519).\n(10)(iii)(A)(6)* Agreement dated February 1, 1994 between the Company and Dwight H. Hibbard. (Exhibit (10)(iii)(A)(8)(iii) to Form 10-K for 1993, File No. 1-8519).\n(10)(iii)(A)(7)* Executive Employment Agreement dated December 1, 1987 between the Company and John T. LaMacchia. (Exhibit (10)(iii)(A)(10) to Form 10-K for 1987, File No. 1-8519).\n(10)(iii)(A)(8)* Executive Employment Agreement dated December 1, 1987 between the Company and Raymond R. Clark. (Exhibit (10)(iii)(A)(11) to Form 10-K for 1987, File No. 1- 8519).\n(10)(iii)(A)(9)* Employment Agreement dated as of July 17, 1995 between the Company and David S. Gergacz.\n(10)(iii)(A)(10)* Employment Agreement dated as of January 1, 1995 between the Company and Barry L. Nelson.\n(10)(iii)(A)(11)* Employment Agreement dated as of January 1, 1995 between the Company and David F. Dougherty.\n(10)(iii)(A)(12)* Amendment to Employment Agreement dated as of January 1, 1995 between the Company and David F. Dougherty.\n(10)(iii)(A)(13)* Executive Employment Agreement dated as of March 29, 1993 between the Company and Brian C. Henry. (Exhibit (10)(iii)(A)(14) to Form 10-K for 1993, File No. 1- 8519).\n(10)(iii)(A)(14)(i)* Employment Agreement dated as of August 19, 1994 between the Company and James F. Orr. (Exhibit (10)(iii)(A)(17)(i) to Form 10-K for 1994, File No. 1- 8519).\n(10)(iii)(A)(14)(ii)* Amendment to Employment Agreement dated as of October 31, 1994 between the Company and James F. Orr. (Exhibit (10)(iii)(A)(17)(ii) to Form 10-K for 1994, File No. 1-8519).\n(10)(iii)(A)(15)* Employment Agreement dated as of December 30, 1994 between Cincinnati Bell Telephone Company and Barbara J. Stonebraker. (Exhibit (10)(iii)(A)(18) to Form 10-K for 1994, File No. 1-8519).\n(10)(iii)(A)(16)(i)* Cincinnati Bell Inc. Executive Deferred Compensation Plan. (Exhibit (10)(iii)(A)(17) to Form 10-K for 1993, File No. 1-8519).\n(10)(iii)(A)(16)(ii)* Amendment to Cincinnati Bell Inc. Executive Deferred Compensation Plan effective January 1, 1994. (Exhibit (10)(iii)(A)(20)(ii) to Form 10-K for 1994, File No. 1- 8519).\n(10)(iii)(A)(17)(i)* Cincinnati Bell Inc. 1988 Long Term Incentive Plan. (Exhibit (10)(iii)(A)(12)(i) to Form 10-K for 1988, File No. 1-8519).\n(10)(iii)(A)(17)(ii)* Amendment to Cincinnati Bell Inc. 1988 Long Term Incentive Plan effective December 5, 1988. (Exhibit (10)(iii)(A)(12)(ii) to Form 10-K for 1988, File No. 1-8519).\n(10)(iii)(A)(18)* Cincinnati Bell Inc. 1988 Stock Option Plan for Non-Employee Directors. (Exhibit (10) (iii)(A)(13) to Form 10-K for 1988, File No. 1-8519).\n(10)(iii)(A)(19)* Cincinnati Bell Inc. 1989 Stock Option Plan. (Exhibit (10)(iii)(A)(14) to Form 10-K for 1989, File No. 1-8519).\n(10)(iii)(A)(20)* Cincinnati Bell Inc. Retirement Plan for Outside Directors. (Exhibit (10)(iii)(A)(21) to Form 10-K for 1993, File No. 1-8519).\n(11) Computation of Earnings (Loss) per Common Share.\n(12) Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends.\n(13) Portions of the Cincinnati Bell Inc. annual report to security holders for the fiscal year ended December 31, 1995 as incorporated by reference including the Selected Financial Data, Report of Management, Report of Independent Accountants, Management's Discussion and Analysis and Consolidated Financial Statements.\n(21) Subsidiaries of the Registrant.\n(23) Consent of Independent Accountants.\n(24) Powers of Attorney.\n(27) Financial Data Schedules.\n(99)(a) Annual Report on Form 11-K for the Cincinnati Bell Inc. Retirement Savings Plan for the year 1995 will be filed by amendment on or before June 30, 1996.\n(99)(b) Annual Report on Form 11-K for the Cincinnati Bell Inc. Savings and Security Plan for the year 1995 will be filed by amendment on or before June 30, 1996.\n(99)(c) Annual Report on Form 11-K for the MATRIXX Marketing Inc. Profit Sharing\/401(k) Plan for the year 1995 will be filed by amendment on or before June 30, 1996.\n(99)(d) Annual Report on Form 11-K for the CBIS Retirement and Savings Plan for the year 1995 will be filed by amendment on or before June 30, 1996.\n........................ * Management contract or compensatory plan required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nThe Company will furnish, without charge, to a security holder upon request, a copy of the documents, portions of which are incorporated by reference (Annual Report to security holders and proxy statement), and will furnish any other exhibit at cost.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCINCINNATI BELL INC.\nMarch 28, 1996 By \/S\/ JAMES M. DAHMUS ------------------------ James M. Dahmus, Vice President and Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nSIGNATURE TITLE DATE\nPrincipal Executive Officer; President, Chief Executive JOHN T. LAMACCHIA* Officer and Director - ------------------ John T. LaMacchia\nPrincipal Accounting and Financial Officer; Executive Vice President and BRIAN C. HENRY* Chief Financial Officer - --------------- Brian C. Henry\nJOHN F. BARRETT* Director - ---------------- John F. Barrett\nPHILLIP R. COX* Director - --------------- Phillip R. Cox\nWILLIAM A. FRIEDLANDER* Director - ----------------------- William A. Friedlander Chairman of the Board and DWIGHT H. HIBBARD* Director - ------------------ Dwight H. Hibbard\nROBERT P. HUMMEL, M.D.* Director - ----------------------- Robert P. Hummel, M.D.\nJAMES D. KIGGEN* Director - ---------------- James D. Kiggen\nSIGNATURE TITLE DATE\nCHARLES S. MECHEM, JR.* Director - ------------------------- Charles S. Mechem, Jr.\nMARY D. NELSON* Director - ---------------- Mary D. Nelson\nDAVID B. SHARROCK* Director - ------------------- David B. Sharrock\n*By \/s\/ BRIAN C. HENRY March 28, 1996 ------------------- Brian C. Henry as attorney-in-fact and on his behalf as Executive Vice President and Chief Financial Officer\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareowners of Cincinnati Bell Inc.\nOur report on the consolidated financial statements of Cincinnati Bell Inc. has been incorporated by reference in this Form 10-K from page 25 of the 1995 annual report of Cincinnati Bell Inc. In connection with our audits of such consolidated financial statements, we have also audited the related financial statement schedule on page 25 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.\n\/s\/ COOPERS & LYBRAND L.L.P.\nCOOPERS & LYBRAND L.L.P.\nCincinnati, Ohio February 14, 1996\n(a) Primarily includes amounts previously written off which were credited directly to this account when recovered and an allocation of the purchase price for receivables purchased from Interexchange Carriers.\n(b) Primarily includes amounts written off as uncollectible.","section_15":""}
{"filename":"14693_1995.txt","cik":"14693","year":"1995","section_1":"Item 1. Business (a) General development of business:\nBrown-Forman Corporation was incorporated under the laws of the State of Delaware in 1933, successor to a business founded in 1870 as a partnership and subsequently incorporated under the laws of Kentucky in 1901. Its principal executive offices are located at 850 Dixie Highway, Louisville, Kentucky 40210 (mailing address: P.O. Box 1080, Louisville, Kentucky 40201-1080). Except as the context may otherwise indicate, the terms \"Brown-Forman\" and \"company\" refer to Brown-Forman Corporation and its subsidiaries.\n(b) Financial information about industry segments:\nInformation regarding net sales, operating income, and total assets of each of the company's business segments is in Note 11 of Notes to Consolidated Financial Statements on page 37 of the company's 1995 Annual Report to Stockholders, which information is incorporated herein by reference in response to Item 8.\n(c) Narrative description of business:\nThe following is a description of the company's operations.\nWines and Spirits Segment\nWines and Spirits operations include manufacturing, bottling, importing, exporting, and marketing a wide variety of alcoholic beverage brands. This Segment also manufactures and markets new and used oak barrels, plastic closures, and plastic bottles.\nBrands are grouped into three categories: North American Spirits, Imported and Specialty Items, and Wines.\nNorth American Spirits consists of the following brands:\nJack Daniel's Tennessee Whiskey Canadian Mist Canadian Whisky Jack Daniel's Country Cocktails Southern Comfort Early Times Old Style Kentucky Whisky Old Forester Kentucky Straight Bourbon Whisky Gentlemen Jack Rare Tennessee Whiskey Korbel California Brandies ** Pepe Lopez Tequila\nStatistics based on case sales, published annually by a leading trade publication, rank Jack Daniel's as the largest selling Tennessee whiskey in the United States, Canadian Mist as the largest selling Canadian whisky in the United States, and Southern Comfort as the largest selling domestic proprietary liqueur in the United States.\nImported and Specialty Items consists of the following brands:\nBushmills Irish Whiskies* Black Bush Special Irish Whiskey* Glenmorangie Single Highland Malt Scotch Whisky* Usher's Scotch Whisky* Tropical Freezes\nWines consists of the following brands:\nFetzer Vineyards California Wines Korbel California Champagnes** Korbel California Wines* Bolla Italian Wines* Jekel Vineyards California Wines Bel Arbor California Wines Fontana Candida Italian Wines* Brolio Italian Wines* Carmen Vineyards Chilean Wines* Fontanafredda Italian Wines* Armstrong Ridge California Champagne* Noilly Prat Vermouths*\n* Brands marketed by Brown-Forman in the U.S. and other select markets by agency agreements. ** Brands marketed by Brown-Forman worldwide by agency agreement.\nA leading industry trade publication reported Korbel California Champagnes as the largest selling premium champagne in the United States. This trade publication also reported that, among numerous imported wines, Bolla Italian Wine is the leading premium imported table wine in the United States. Fetzer was ranked seventeenth among all table wines.\nBrown-Forman believes that statistics used to rank these products are reasonably accurate.\nBrown-Forman's strategy with respect to the Wines and Spirits Segment is to market high quality products that satisfy consumer preferences and support them with extensive international, national, and regional marketing programs. These programs are intended to extend consumer brand recognition and brand loyalty.\nSales managers and representatives or brokers represent the Segment in all states. The Segment distributes its spirits products domestically either through state agencies or through wholesale distributors. The contracts which Brown-Forman has with many of its distributors have formulas which determine reimbursement to distributors if Brown-Forman terminates them; the amount of reimbursement is based primarily on the distributor's length of service and a percentage of its purchases over time. Some states have statutes which limit Brown-Forman's ability to terminate distributor contracts.\nJack Daniel's Tennessee Whiskey and Southern Comfort are the principal products exported by the Segment. These brands are sold through contracts with brokers and distributors in most countries.\nThe principal raw materials used in manufacturing and packaging distilled spirits are corn, rye, malted barley, glass, cartons, and wood for new white oak barrels, which are used for storage of bourbon and Tennessee\nwhiskey. None of these raw materials are in short supply, and there are adequate sources from which they may be obtained.\nProduction of whiskies is scheduled to meet demand three to five years in the future. Accordingly, inventories are larger in relation to sales and total assets than would be normal for most other business segments.\nThe industry is highly competitive and there are many brands sold in the consumer market. Trade information indicates that Brown-Forman is one of the largest wine and spirit suppliers in the United States in terms of revenues.\nThe wine and spirits industry is regulated by the Bureau of Alcohol, Tobacco, and Firearms of the United States Treasury Department with respect to production, blending, bottling, sales, advertising, and transportation of its products. Also, each state regulates advertising, promotion, transportation, sale, and distribution of such products.\nUnder federal regulations, whisky must be aged for at least two years to be designated \"straight whisky.\" The Segment ages its straight whiskies for a minimum of three to five years. Federal regulations also require that \"Canadian\" whisky must be manufactured in Canada in compliance with Canadian laws and must be aged in Canada for at least three years.\nConsumer Durables Segment\nThe Consumer Durables Segment includes the manufacturing and\/or marketing of the following:\nFine China Dinnerware Contemporary Dinnerware Crystal Stemware Crystal Barware China and Crystal Giftware China and Crystal Lamps Collectibles and Jewelry Sterling Silver, Pewter and Silver-Plated Giftware Sterling Silver and Stainless Steel Flatware Fine Table Linens Luggage Business Cases and Folios Personal Leather Accessories\nAll of the products of the Segment are sold by segment-employed sales representatives under various compensation arrangements, and where appropriate to the class of trade, by specialized independent commissioned sales representatives.\nThe Segment's products are marketed domestically through authorized retail stores consisting of department stores and specialty and jewelry shops and through retail stores operated by the Segment. Products are also distributed domestically through the institutional, incentive, premium, business gift and military exchange classes of trade, and internationally through authorized retailers and\/or distributors in selected foreign markets. Specially created collectible products are distributed both domestically and in selected foreign markets through the Segment's direct response\/mail-order division.\nFine china and crystal products are marketed under both the Lenox and Gorham trademarks. Contemporary dinnerware, glassware and flatware products are marketed under the Dansk trademark. Sterling silver flatware and giftware and stainless steel flatware products are marketed under both the Gorham and Kirk Stieff trademarks. Kirk Stieff also markets pewter and silver-plated giftware. Luggage, business cases, and personal accessories are marketed under the Hartmann, Wings and Crouch & Fitzgerald trademarks. The direct response\/mail- order sales in the United States of specially designed collectibles are marketed under the Lenox, Princeton Gallery and Gorham trademarks while such sales abroad are marketed primarily under the Brooks & Bentley trademark.\nThe Lenox, Dansk, Gorham, and Hartmann brand names hold significant positions in their industries. The Segment has granted to a producer of high quality table linens a license for use of the Lenox trademarks on selective fine table linens, subject to the terms of a licensing agreement.\nThe Segment believes that it is the largest domestic manufacturer and marketer of fine china dinnerware, fine crystal stemware, and pewter giftware, and the only significant domestic manufacturer of fine quality china giftware. The Segment is also a leading manufacturer and distributor of fine quality luggage, business cases, and personal leather accessories. The Segment competes with a number of other companies and is subject to intense foreign competition in the marketing of its fine china and contemporary dinnerware, crystal stemware and giftware, and luggage products.\nIn the Segment's china and crystal businesses, competition is based primarily on quality, design, brand, style, product appeal, consumer satisfaction, and price. In its luggage, business case and personal leather accessories business, competition is based primarily on brand awareness, quality, design, style, and price. In its direct response\/mail-order business, the most important competitive factors are the brand, product appeal, design, sales\/marketing program, service, and price of the products. In its sterling silver, silver- plated, and stainless steel business, competition is based primarily on price, with quality, design, brand, style, product appeal, and consumer satisfaction also being factors. In its pewter business, competition is based primarily on quality, design, brand, and delivery, with price being a less significant factor.\nClay is the principal raw material used to manufacture china products and silica is the principal raw material used to manufacture crystal products. Leather and nylon fabric are the principal raw materials used to manufacture luggage and business cases. Fine silver is the principal raw material used to manufacture sterling silver giftware and flatware products, and tin is the principal raw material used to manufacture pewter products. It is anticipated that raw materials used by the Segment will be in adequate supply. The acquisition price of fine silver and tin is, however, influenced significantly by world-wide economic events and commodity trading.\nSales of certain Segment products are traditionally greater in the second quarter of the fiscal year, primarily because of seasonal holiday buying.\nOther Segment\nThis segment was discontinued effective November 1, 1993.\nOther Information\nAs of April 30, 1995, the company employs approximately 7,300 persons, including 900 employed on a part-time basis.\nThe company is an equal opportunity employer and recruits and places employees without regard to race, color, national origin, sex, age, religion, disability, or veteran status.\nThe company believes its employee relations are good.\nFor information on the effects of compliance with federal, state, and local environmental regulations, refer to Note 13, \"Environmental,\" on page 37 of the company's 1995 Annual Report to Stockholders, which information is incorporated herein by reference in response to Item 8.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------- ----------\nThe corporate offices consist of office buildings, including renovated historic structures, all located in Louisville, Kentucky.\nSignificant properties by business segments are as follows:\nWines and Spirits Segment - -------------------------\nThe facilities of the Wines and Spirits Segment are shown below. The owned facilities are held in fee simple.\nOwned facilities: . Production facilities: - Distilled Spirits and Wines: - Lynchburg, Tennessee - Louisville, Kentucky - Collingwood, Ontario - Shively, Kentucky - Frederiksted, St. Croix, U.S. Virgin Islands - Mendocino County, California - Monterey County, California - Oak Barrels: - Louisville, Kentucky - Mendocino County, California - Plastic Closures and Plastic Bottles: - Louisville, Kentucky\n. Bottling facilities: - Lynchburg, Tennessee - Louisville, Kentucky - Frederiksted, St. Croix, U.S. Virgin Islands - Monterey County, California\n. Warehousing facilities: - Lynchburg, Tennessee - Louisville, Kentucky - Collingwood, Ontario - Shively, Kentucky - Monterey County, California - Mendocino County, California\nLeased facilities: . Production and bottling facility in Dublin, Ireland . Wine production, warehousing and bottling facility in Mendocino County, California . Vineyards in Monterey County, California\nThe company believes that the productive capacities of the Wines and Spirits Segment are adequate for the business, and such facilities are maintained in a good state of repair.\nConsumer Durables Segment - -------------------------\nThe facilities of the Consumer Durables Segment are shown below. The owned facilities are held in fee simple.\nOwned facilities: . Office facilities: - Lenox corporate - Lawrenceville, New Jersey - Headquarters for Lenox Direct Response\/Mail-Order Division - Langhorne, Pennsylvania\n. Production and office facilities: - Lenox - Pomona, New Jersey (includes retail store); Oxford, North Carolina; Kinston, North Carolina; and Mt. Pleasant, Pennsylvania (includes retail store) - Gorham - Smithfield, Rhode Island - Hartmann - Lebanon, Tennessee (includes retail store)\n. Warehousing facilities: - Lenox\/Dansk\/Gorham - Williamsport, Maryland\nLeased facilities: . Office facilities: - Lenox Manufacturing - Egg Harbor Township, New Jersey - Dansk headquarters - Harrison, New York - Lenox corporate - Lawrenceville, New Jersey\n. Production\/Warehousing\/Office facilities: - Kirk Stieff - Baltimore City, Maryland (includes retail store)\n. Warehousing facilities: - Lenox - South Brunswick, New Jersey (includes retail stores); Oxford, North Carolina; Kinston, North Carolina; and Mt. Pleasant, Pennsylvania - Hartmann - Lebanon, Tennessee\n. Retail stores:\n- The segment operates 22 Lenox China Outlet stores in 16 states. The Segment also operates 48 Dansk Outlet stores in 29 states, 7 Dansk Lifestyle stores in 6 states and 8 Gorham Outlet stores in 7 states. In addition, the Segment operates 2 Crouch & Fitzgerald luggage stores in 2 states.\nThe lease terms expire at various dates and are generally renewable, except for the Crouch & Fitzgerald store leases.\nThe company is of the opinion that the Segment's facilities are in good condition and are adequate for the business.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------- -----------------\n(a) Adams, et al. v. Brown-Forman Corporation (U.S. District Court, Middle District of Florida, Tampa Division):\nAs previously reported, Brown-Forman Corporation was a defendant in a number of cases, consolidated for trial in federal district court in Tampa, Florida, alleging age discrimination as a result of a 1986 company reorganization. The case has been resolved in a manner that will not have a material adverse effect on the company's financial position or results of operations. As part of the resolution, all claims against the company have been dismissed.\n(b) Brune v. Brown-Forman Corporation (214th District Court, Neuces County, Texas):\nAs previously reported, Brown-Forman Corporation was sued by the estate of Marie Brinkmeyer, an 18 year old college student who died after consuming massive quantities of beverage alcohol, including Pepe Lopez Tequila (a Brown-Forman product.) A jury determined Brown- Forman to be 35% responsible for Marie's death and Marie to be 65% responsible.\nThe Texas Court of Appeals reversed the jury award against Brown- Forman and dismissed the plaintiff's claims in their entirety, holding that the Company had no legal duty to warn consumers of the well-known risks of abusive overconsumption of beverage alcohol.\nOn April 27, 1995, the Texas Supreme Court denied the plaintiff's petition for review. The judgment of the Texas Court of Appeals in favor of Brown-Forman is now final and the case is concluded.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------- ---------------------------------------------------\nNone.\n(1) In 1993, in connection with a civil proceeding brought by the Securities and Exchange Commission, Mr. Jozoff consented, without admitting or denying the allegations, to the entry of an order enjoining him from violating Section 10(b) of the Securities Exchange Act of 1934.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder - ------------------------------------------------------------------------ Matters - -------\nExcept as presented below, for the information required by this item refer to the section entitled \"Quarterly Financial Information\" appearing on the \"Highlights\" page of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference.\nHolders of record of Common Stock at May 25, 1995: Class A Common Stock (Voting) 2,870 Class B Common Stock (Nonvoting) 5,018\nThe principal market for Brown-Forman Corporation common shares is the New York Stock Exchange.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nFor the information required by this item, refer to the section entitled \"Consolidated Selected Financial Data\" appearing on pages 18 and 19 of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference in response to Item 8.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations - -------------\nFor the information required by this item, refer to the section entitled \"Financial Review\" appearing on pages 22 through 26 of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference in response to Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------\nFor the information required by this item, refer to the Report of Management, Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Report of Independent Accountants appearing on pages 17 and 27 through 38 of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference. For selected quarterly financial information, refer to the section entitled \"Quarterly Financial Information\" appearing on the \"Highlights\" page of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure - --------------------\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------\nFor the information required by this item, refer to the following sections of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held July 27, 1995, which information is incorporated herein by reference: (a) \"Election of Directors\" on page 1 through the footnote on page 2 (for information on directors); and (b) the last paragraph on page 4 (for information on delinquent filings). Also, see the information with respect to \"Executive Officers of the Registrant\" under Part I hereof, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation - -------------------------------\nFor the information required by this item, refer to the section entitled \"Executive Compensation\" on pages 5 through 16 of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held July 27, 1995, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\nFor the information required by this item, refer to the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" appearing on pages 3 and 4 of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held July 27, 1995, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------\nFor the information required by this item, refer to the section entitled \"Transactions with Management\" appearing on page 17 of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held July 27, 1995, which information is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------\n(a) 1 and 2 - Index to Consolidated Financial Statements and Schedules:\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted either because they are not required under the related instructions, because the information required is included in the consolidated financial statements and notes thereto, or because they are inapplicable.\n* Incorporated by reference to Item 8 herein.\n(a) 3 - Exhibits: Filed Herewith:\nExhibit Index - --------------\n4(a) Credit agreement dated as of November 30, 1994, among the company and a group of United States and international banks.\n10(a) Description of compensation arrangement with W. L. Lyons Brown, Jr.\n13 Company's Annual Report to Stockholders for the year ended April 30, 1995, but only to the extent set forth in Items 1, 3, 5, 6, 7, and 8 of the company's Annual Report on Form 10-K for the year ended April 30, 1995.\n21 Subsidiaries of the Registrant.\n23 Consent of Coopers & Lybrand L.L.P. independent accountants.\n27 Financial Data Schedule (not considered to be filed).\nPreviously Filed: Exhibit Index - -------------\n3(a) Restated Certificate of Incorporation of registrant which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 19, 1994.\n3(b) Certificate of Amendment to Restated Certificate of Incorporation of registrant which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 19, 1994.\n3(c) Certificate of Ownership and Merger of Brown-Forman Corporation into Brown-Forman, Inc. which is incorporated herein by reference to Brown- Forman Corporation's 10-K filed on July 19, 1994.\n3(d) Certificate of Amendment to Restated and Amended Certificate of Incorporation of Brown-Forman Corporation which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 19, 1994.\n3(e) The by-laws of registrant, as amended on May 25, 1988, which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 26, 1993.\n4(b) The Form of Indenture dated as of March 1, 1994 between the company and The First National Bank of Chicago, as Trustee, which is incorporated herein by reference to Brown-Forman Corporation's Form S-3 (Registration No. 33-52551) filed on March 8, 1994.\n10(b) Brown-Forman Management Incentive Compensation Plan which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 19, 1994.\n10(c) Brown-Forman Corporation Restricted Stock Plan which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 19, 1994.\n10(d) Brown-Forman Corporation Supplemental Excess Retirement Plan, which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 23, 1990.\n10(e) Brown-Forman Corporation Stock Appreciation Rights Plan, which is incorporated herein by reference to Brown-Forman Corporation's 10-K filed on July 23, 1990.\n10(f) A description of the Brown-Forman Savings Plan is incorporated herein by reference to page 10 of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on July 27, 1995.\n10(g) A description of the Brown-Forman Flexible Reimbursement Plan is incorporated herein by reference to page 11 of the registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on July 27, 1995.\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.\nBROWN-FORMAN CORPORATION ------------------------ (Registrant)\n\/s\/ Owsley Brown II ------------------- Date: May 25, 1995 By: Owsley Brown 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 on May 25, 1995 as indicated:\nREPORT OF INDEPENDENT ACCOUNTANTS\nBrown-Forman Corporation Louisville, Kentucky\nWe have audited the consolidated financial statements of Brown-Forman Corporation and Subsidiaries as of April 30, 1995, 1994, and 1993, and for the years then ended, which financial statements are included on pages 27 through 38 of the 1995 Annual Report to Stockholders of Brown-Forman Corporation and incorporated by reference herein. We have also audited the financial statement schedule listed in the index on page 14 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 Brown-Forman Corporation and Subsidiaries as of April 30, 1995, 1994, and 1993 and the consolidated results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Notes 2 and 15 to the consolidated financial statements, in 1994 the company adopted changes in its methods of accounting for postretirement benefits other than pensions, postemployment benefits, and contributions.\n\/s\/ Coopers & Lybrand L.L.P. Coopers & Lybrand L.L.P. Louisville, Kentucky June 8, 1995\nS-1\nBROWN-FORMAN CORPORATION AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended April 30, 1995, 1994, and 1993 (Expressed in thousands)\n\/(1)\/ Relates to businesses acquired during the year. \/(2)\/ Doubtful accounts written off, net of recoveries.\nS-2","section_15":""}
{"filename":"780348_1995.txt","cik":"780348","year":"1995","section_1":"ITEM 1. BUSINESS -------- OWNERSHIP STRUCTURE -------------------\nCapital Income Properties - C Limited Partnership (the Partnership) was formed as of December 15, 1984, under the District of Columbia Uniform Limited Partnership Act for the purpose of investing in a mixed use development located in Bethesda, Maryland, consisting of a hotel, an office building containing both office and retail space, a retail pavilion and a parking facility (the Development). The investment was accomplished through the purchase of a limited partnership interest in Bethesda Metro Center Limited Partnership (BMCLP), a Maryland limited partnership which owns, operates and maintains the Development.\nBetween October 21, 1985 and December 31, 1985, 600 limited partnership interests (Units) were sold to the public through a private placement offering with an aggregate offering price of $60,000,000 (reduced to $59,639,200 for Units paid in full at a discount at inception) conducted pursuant to Section 4(2) of the Securities Act of 1933, as amended and Regulation D promulgated thereunder. As a result of the sale of half-units, the 600 units outstanding are held by 698 limited partners (Investors) of the Partnership. As of December 31, 1990, the Partnership had received capital contributions from Investors in an aggregate amount equal to $59,599,769. No additional capital contributions have been received since December 31, 1990.\nThe Partnership made all of its payments of capital contributions totaling $42,500,100 to BMCLP in nine installments commencing in December 1985 and ending in March 1990 in return for its 92.5% limited partnership interest in BMCLP. Such capital contributions were funded with the proceeds of the Investors' capital contributions to the Partnership. Effective June 15, 1992 the Investors voted in connection with a loan modification to remove the managing general partners of BMCLP and to make an affiliate of the Managing General Partner of the Partnership the managing general partner of BMCLP. The affiliate of the Managing General Partner of the Partnership is able to exercise significant control over the operating, financing and investing activities of BMCLP. Accordingly, effective June 15, 1992, the Partnership commenced reporting of its financial statements on a consolidated basis of accounting for its investment in BMCLP. Prior to the assumption by an affiliate of the Partnership of the managing general partner duties, the Partnership recorded its investment in BMCLP under the equity method.\nBMCLP was organized on November 30, 1981 and owns and operates the Development. The Development consists of a 381-room hotel known as the Hyatt Regency Bethesda (the Hotel), an office building including The Market at Bethesda Metro, which contains approximately 336,000 square feet of net rentable office space and 18,000 square feet of net rentable retail space, known as Bethesda Metro Office Building, a parking garage and an outdoor plaza with cafes, fountains and a performing arts center that converts into an ice skating rink in the winter months (collectively, the Office Building). The Development is located on top of the subway station in downtown Bethesda, Maryland upon approximately 3.5 acres of land leased from the Washington Metropolitan Area Transit Authority (WMATA). The five floors of underground parking, with a total of approximately 1,300 parking spaces, allow direct access to the Office Building.\nThe Partnership has four general partners, C.R.I., Inc. (CRI), William B. Dockser, Martin C. Schwartzberg and H. William Willoughby (the General Partners) and one affiliated initial limited partner, CRICO-Bethesda Growth Partners Limited Partnership, and the 698 Investors. The Managing General Partner of the Partnership is CRI. The Partnership is a limited partnership owning a 92.5% limited partnership interest in BMCLP. The other limited partners of BMCLP are\nI-1\nPART I ------\nITEM 1. BUSINESS - Continued --------\nAlan I. Kay, Allen E. Rozansky (Special Limited Partners) and R & K Bethesda Metro Limited Partnership. C.R.C.C. of Bethesda, Inc. (CRCC), an affiliate of CRI, acts as BMCLP's managing general partner.\nThe Hotel is managed by the Hyatt Corporation and the Office Building is managed by Realty Management Company, an affiliate of one of the Special Limited Partners.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nTHE HOTEL ---------\nThe Hotel is a 12-story, 381 room luxury hotel which includes 13 suites, 181 king bedded rooms, 11 queen bedded rooms and 176 double bedded rooms with a 120-foot high central atrium lobby. The Hotel is managed by the Hyatt Corporation.\nThe Hotel has a 104-seat restaurant and a lobby bar, and contains two levels of convention, meeting and banquet facilities. The 7,300 square foot Crystal Ballroom can accommodate over 480 people school-room style and seat approximately 700 people for banquets. There are thirteen additional conference rooms capable of accommodating from 30-150 people for banquets and from 40-200 people for receptions. In addition, there are two executive conference rooms.\nTHE OFFICE BUILDING -------------------\nThe Office Building is a 17-story deluxe office building featuring a lobby atrium garden and a 130-foot hanging sculpture, with The Market at Bethesda Metro, a glass enclosed retail pavilion of European design containing three levels of shopping, restaurants, convenience stores, services and offices, connected to it at the plaza level. An outdoor plaza offers year-round activities. In the winter months, an outdoor ice arena is centrally located in the plaza. During the warmer months, the ice arena converts into an outdoor eating plaza and performing arts center, where outdoor cafes, vendors, sculptures, fountains and various activities are located. The Office Building is managed by Realty Management Company, an affiliate of one of the Special Limited Partners.\nI-2\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nAs of December 31, 1995, the Office Building contains approximately 336,000 square feet of net rentable office space and approximately 18,000 square feet of net rentable retail and marketplace space, accessible to Metrobus and Metrorail.\nLAND LEASE ----------\nBMCLP entered into a non-recourse Land Lease with WMATA, dated December 1, 1981, pursuant to which BMCLP leases the land on which the Development is built for a term of 50 years, renewable at the option of BMCLP for an additional term of 49 years.\nAs of December 1, 1985 and continuing throughout the remainder of the initial lease term, BMCLP is required to pay WMATA a minimum annual rental of $1,600,000 in equal quarterly installments in advance. Further, BMCLP is obligated to pay WMATA additional rent in an amount equal to 7.5% of all Gross Income (which is defined in the Land Lease as gross receipts) in excess of $31,000,000, commencing in calendar year 1986 and payable within 90 days of the end of the calendar year to which each payment relates. In 1995, total land lease rental payments of $1,600,000 were made with no additional rent due for the calendar year 1995.\nWMATA may terminate the Land Lease at least thirty (30) days after giving BMCLP notice if (1) BMCLP fails to make a payment of minimum or additional rent for 30 days after notice of such failure from WMATA or (2) BMCLP fails to perform any other covenants contained in the Land Lease for 60 days after notice of such failure from WMATA.\nMANAGEMENT OF THE DEVELOPMENT -----------------------------\nHotel Management - ----------------\nHyatt Corporation (Hyatt) manages the Hotel under the name of Hyatt Regency Bethesda, in accordance with the terms and conditions of the Hotel Management Agreement dated March 1, 1982. The Hotel Management Agreement will expire on December 31, 2015, unless earlier terminated in accordance with its terms. Hyatt is given substantial control and discretion in the operation of the Hotel, including the right on behalf of BMCLP to negotiate all agreements necessary to the operation of the Hotel and the right to determine the charges for rooms, entertainment, food and beverages, labor policies, and all phases of promotion and publicity relating to the Hotel.\nPursuant to the Hotel Management Agreement, Hyatt also provides \"chain services\" to the Hotel consisting of: (i) conventions, business and sales promotion services, (ii) advertising, publicity and public relations services, (iii) food and beverage, personnel and other departmental supervision and control services, and (iv) centralized reservations services, for which BMCLP is to pay its allocable share of the Hyatt expense.\nHyatt will be relieved from its obligation to operate the Hotel as a first-class hotel and may, in addition, terminate the Hotel Management Agreement if: (i) prevented from performing its obligations by events beyond Hyatt's control, (ii) in the event a breach by BMCLP of any provision of the Hotel Management Agreement, or (iii) there is a limitation upon Hyatt's ability to\nI-3\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nexpend funds for the Hotel, such as would result from BMCLP's failure to provide adequate working capital or replacement reserves, as required under the Hotel Management Agreement.\nBMCLP can terminate the Hotel Management Agreement upon no less than 60 days written notice if, for two successive fiscal years after December 31, 1991 (referred to as the Sixth Full Year), the Hotel does not produce enough income to permit Hyatt to remit to BMCLP the sum of $6,250,000 for each such fiscal year (referred to as the Owner's Remittance). Notwithstanding the above, BMCLP has agreed that Hyatt may not be removed for so long as the basic fee is reduced from 4% to 3% as described below. BMCLP may not sell or transfer the Hotel or any portion thereof without the prior approval of Hyatt, which may not be unreasonably withheld and will be based upon, among other things, the ability of the prospective purchaser or transferee to fulfill BMCLP's financial obligations under the Hotel Management Agreement.\nThe Hotel Management Agreement places the following financial obligations upon BMCLP:\na. BMCLP must set aside 3% of gross receipts (as defined in the Hotel Management Agreement as all revenues and income of any kind from the Hotel) as a reserve for the replacement of the Hotel's furnishings and equipment.\nb. BMCLP must assure that there is sufficient working capital on hand to make timely payment of all current obligations of the Hotel (including the annual management fee) and to assure the uninterrupted and efficient operation of the Hotel as a first class hotel development.\nc. BMCLP must reimburse Hyatt for the Hotel's pro rata share of Hyatt's reservation expenses incurred in providing the chain services.\nd. BMCLP must pay Hyatt an annual management fee of (i) a basic fee, equal to 4%, as set forth below, of the gross receipts of the Hotel; and (ii) a contingent incentive fee equal to the amount by which 20% of the profit, before management fees, for such fiscal year exceeds the basic fee payable for such fiscal year.\nPursuant to an amendment to its management agreement in connection with the 1992 loan modification with BMCLP's prior lender, which remains in effect as to Hyatt under the newly amended and restated first and second mortgage loans, Hyatt agreed to reduce its basic management fee from 4% to 3% from December 31, 1991 to December 31, 1995. In return for this reduction, BMCLP agreed to modify the Owner's Remittance of the Hotel Management Agreement, as discussed above, by extending the Sixth Full Year by one additional year for each year that Hyatt reduced its basic fee. In addition, the calculation of the contingent incentive fee includes the basic fee at the original 4%. Management fees paid to Hyatt for the years ended December 31, 1995, 1994 and 1993 were approximately $520,000, $482,000 and $422,000, respectively. The incentive fee earned for the year ended December 31, 1995 and 1994 was approximately $232,000 and $134,000, respectively. No incentive fee was earned in 1993.\nAs of December 31, 1995 these financial obligations were met by BMCLP.\nI-4\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nOffice Building Management - --------------------------\nThe Office Building is managed by Realty Management Company (Realty), an affiliate of one of the Special Limited Partners. BMCLP entered into an agreement with Realty dated January 31, 1985, in which Realty was to manage the Office Building for a term of twenty years commencing from the date the Office Building opened. Under this agreement, Realty received a management fee equal to 4% of all income collected from the operation of the Office Building, to be paid monthly. However, Realty agreed to allow BMCLP to defer payment of its management fees, effective January 1, 1992, through the date of restructuring of the original debt.\nIn connection with the debt restructuring which occurred November 16, 1994, BMC Lender Partnership (BMC), the holder of the amended and restated second mortgage loan, paid Realty $1,000,000 to terminate its former twenty year management contract with BMCLP (which amount is not part of any financing for which BMCLP is liable). At that time BMCLP entered into a new management contract with Realty for a term of one year which will automatically renew for successive one year periods so long as Realty is not then in default of the management contract. The agreement provides for a management fee in the amount of 4% of total revenues. Of this amount, one-half or 2% shall be paid by Realty to BMC, during the term of the amended and restated second mortgage loan, in partial consideration for the $1,000,000 payment to terminate the original contract. Management fees for the years ended December 31, 1995, 1994 and 1993 were approximately $391,000, $357,000 and $328,000, respectively.\nRealty was formed in 1976. It has informed the Partnership that it now has 20 employees and manages approximately 1,000,000 gross square feet of space which includes two office buildings owned by Alan I. Kay, Allen E. Rozansky or affiliates and five office buildings owned by unrelated third parties, all in the Washington, D.C. area.\nAs of December 31, 1995, there was approximately 11,000 square feet of office space available for rent in the Office Building. Retail and marketplace space was 98% occupied as of December 31, 1995. See page II-8 for average occupancy percentages.\nI-5\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nParking Garage Management - -------------------------\nMonument Parking Co., Inc. (Monument) entered into a garage lease with BMCLP, dated March 14, 1983, pursuant to which BMCLP leased the underground parking garage from the date that it opened. Under the garage lease, Monument pays rent to BMCLP in an amount equal to the gross receipts of the parking garage less all operating expenses thereof, including an annual management fee to Monument in the amount of $65,000, until adjusted gross receipts (defined as all cash, revenue and compensation received from garage operations, reduced by parking taxes and other operating expenses) equal $1,500,000.\nMonument retains 10% of all adjusted gross receipts in excess of $1,500,000 until the adjusted gross receipts reach $2,000,000, as an incentive fee. In addition, Monument retains 30% of all adjusted gross receipts in excess of $2,000,000, as a further incentive fee. In 1995, adjusted gross receipts equaled $1,680,088.\nThe garage lease requires Monument to provide parking privileges to tenants of the Office Building, their guests and employees and the guests and employees of the Hotel on a priority basis.\nBMCLP FINANCING ---------------\nOriginal Mortgage Debt - ----------------------\nOn December 23, 1985, BMCLP entered into a ten-year, nonrecourse mortgage note (the First Mortgage Note) with Great Western Bank (Great Western) in the amount of $120,000,000. The First Mortgage Note provided for a variable interest rate, adjustable monthly, of 2.75% in excess of the Federal Home Loan Bank Board Eleventh District weighted-average cost of funds.\nOn July 1, 1987, BMCLP entered into a five-year nonrecourse mortgage note (the Second Mortgage Note) with Great Western for $10,000,000 together with a modification of the First Mortgage Note. Principal and accrued interest were due at maturity. The proceeds of this loan were used to fund operating deficit requirements. The Second Mortgage Note also provided for a variable interest rate, adjustable monthly, of 4% in excess of the Federal Home Loan Bank Board Eleventh District weighted-average cost of funds.\nEffective March 1, 1988, BMCLP entered into a second loan modification, which superseded the first loan modification. Under the second loan modification, principal and interest payments were modified during the period April 1, 1988 to January 1, 1992.\nOn October 12, 1990, BMCLP was notified by Great Western that an event of default had occurred related to the nonpayment of its debt- service obligation under the First and Second Mortgage Notes (collectively, the Notes). BMCLP failed to remedy the default within the time period allowed and, consequently, was in default as defined in the Notes. Pursuant to the default, Great Western exercised its right to collect rents under leases of the Office Building. In 1992, BMCLP reached an agreement with Great Western to modify the terms of the Notes as discussed below.\nI-6\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nModifications to Original Mortgage Debt - ---------------------------------------\nEffective June 15, 1992, Great Western and BMCLP entered into a modification which superseded all previous modifications and was in effect until the restructuring on November 16, 1994, as discussed below. The following is a summary of the principal terms of this modification:\na. The maturity date of the Notes was extended to January 1, 1996, the original maturity date of the First Mortgage Note.\nb. Interest was accrued at the stated rate, adjusted as set forth in the original Notes, and interest payments in an amount equal to all of BMCLP's net cash flow, as defined, were due and payable monthly. All accrued but unpaid interest was added to principal and was to be due in full at maturity. No regular principal payments were required.\nc. The following payments (the Excess Payments) were scheduled to be due to Great Western on the last day of the months indicated. All amounts due through the debt restructuring on November 16, 1994 were paid.\nThe Excess Payments were applied: first, against expenses incurred by Great Western in connection with the restructuring of the Notes; second, to pay late charges owing on the Second Mortgage Note; third, to reduce accrued interest on the First Mortgage Note and then the Second Mortgage Note; and finally, to reduce principal on the First Mortgage Note and then the Second Mortgage Note. BMCLP paid all net cash flow to Great Western, and, therefore, did not itself have cash to make the Excess Payments. These Excess Payments were partially funded to Great Western from management fees waived by Hyatt and those deferred by Realty and Capitol Hotel Group, an affiliate of the General Partners which managed another hotel owned by a partnership of which Alan I. Kay and Allen E. Rozansky were limited partners. During 1994, BMCLP was advanced a total of $107,103, including accrued interest, from CRI for the payments of the Excess Payments due. Under the restructured debt, which occurred November 16, 1994, as discussed below, no further Excess Payments were required.\nThe funding of the Excess Payments was guaranteed by Alan I. Kay and Allen E. Rozansky. However, these guarantees were unsecured and were in addition to other obligations Alan I. Kay and Allen E. Rozansky may have to BMCLP or its partners for funding of operating deficits. As of December 31, 1995 and 1994, Alan I. Kay and Allen E. Rozansky have\nI-7\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nloaned $2,243,984 and $2,120,800, respectively, including accrued interest, as advances for such deficits. This amount is net of $342,734 which is due from the Alan I. Kay Companies, an affiliate of Alan I. Kay, for advances from BMCLP. Alan I. Kay and Allen E. Rozansky have each represented that their current net worth is insignificant and illiquid and they do not have resources to meet the operating deficit obligations.\nd. BMCLP agreed to allow Great Western to take title to the Development without contest in the event of any default under the terms of the Notes, as modified, provided the fair market value of the Development was less than the then outstanding indebtedness payable. Therefore, BMCLP deposited in escrow, in recordable form, documents to immediately convey title to Great Western (the Documents) in the event of a default under any of the terms of the Notes, as modified. Great Western had the right to record the Documents and immediately take title to the Development if, on the maturity date, the fair market value of the Development was less than the then outstanding indebtedness payable and BMCLP had been otherwise unable to pay off the Notes. As discussed below, however, BMCLP restructured the Notes prior to the maturity date. As a condition to the 1994 debt restructuring, the new holder of the amended and restated Second Mortgage Note required that BMCLP deposit a deed in lieu of foreclosure in escrow to be recordable in the event of a default under that note.\ne. CRI and certain of its affiliates agreed not to: (1) cause CRCC to (a) file for bankruptcy, (b) make any general assignments for the benefit of creditors, or (c) seek appointment of a receiver or trustee; (2) admit in writing CRCC's inability to pay its debts as they mature; and (3) take any action which could impede delivery of the Documents ((1) through (3) collectively, the No Bankruptcy Agreement). The No Bankruptcy Agreement was secured by the loan guarantee by CRI in the amount of $5,000,0001. Similarly, Alan I. Kay entered into a separate No Bankruptcy Agreement with respect to BMCLP. [In connection with the 1994 debt restructuring, the various No Bankruptcy Agreements were released, although similar unsecured no bankruptcy agreements were made by CRCC and the Partnership. Should an entity other than CRCC become a general partner of BMCLP (and potentially be able to put BMCLP in bankruptcy), the amended and restated Second Mortgage Note would be deemed to be in default.]\n1 Great Western was also the first mortgage lender for a similar mixed-use property owned by another partnership in which a CRI sponsored partnership invested and in which Alan I. Kay and Allen E. Rozansky were partners. A loan modification agreement was entered into with Great Western on terms similar to those described herein with respect to the property, including a No Bankruptcy Agreement. The guarantees securing the No Bankruptcy Agreement described above were aggregate guarantees for both the BMCLP loans and the other loan. On July 18, 1994, Great Western took title to the other property.\nI-8\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nf. The Partnership agreed not to enforce any rights and remedies it may have against Alan I. Kay and Allen E. Rozansky or Rozansky and Kay Construction Company (including any rights with regard to operating deficit funding obligations) until the earlier of (a) the date on which the Notes are fully repaid or (b) the day immediately following the last day on which any person may commence a proceeding seeking to avoid or set aside the transfer of the Development to Great Western as a fraudulent conveyance or preferential transfer pursuant to any applicable State or Federal law. Alan I. Kay, Allen E. Rozansky and Rozansky & Kay Construction Company agreed to waive any statute of limitations until such time.\ng. The terms of the Limited Partnership Agreement (LPA) governing the operations of BMCLP were amended. Alan I. Kay and Allen E. Rozansky converted their aggregate 4.5% general partnership interests in BMCLP to special limited partnership interests totalling 3.51%. CRCC increased its general partnership interest in BMCLP by receiving the 0.99% partnership interest which Alan I. Kay and Allen E. Rozansky gave up. As a result, CRCC became the sole managing general partner with a 1.00% partnership interest; however, CRCC did not assume any operating deficit or other obligations of Alan I. Kay and Allen E. Rozansky that arose under the terms of BMCLP's LPA or other agreements executed in connection therewith.\nh. Great Western agreed to provide funds to pay for capital improvements, tenant improvements, leasing commissions, real estate taxes and ground rent to WMATA. Any such payments made by Great Western were added to First Mortgage Note principal.\nRestructuring of Original Mortgage Debt - ---------------------------------------\nOn November 16, 1994, Great Western sold the Notes to BMC Lender Partnership (BMC), an unaffiliated entity. BMC sold the First Mortgage Note to General Electric Capital Corporation (GECC) which amended and restated the First Mortgage Note (the Restated First Mortgage Note) to a principal amount of $48,000,000. BMC amended and restated the Second Mortgage Note (the Restated Second Mortgage Note) (collectively, the Restated Notes) to a principal amount of $10,000,000 advanced at closing. Of the total $58 million principal amount of the Restated Notes, $55 million was paid to Great Western in consideration for the Notes, approximately $1.8 million was used to fund loan fees and related costs on behalf of BMCLP, approximately $200,000 was used to fund interest and insurance premiums at the closing date and the remaining amount of approximately $1.0 million was deposited into an escrow account restricted for working capital requirements, as discussed in Note 2 to the consolidated financial statements.\nThe Restated First Mortgage Note requires monthly interest payments in arrears, payable at 4.25% in excess of the GECC Composite Commercial Rate which at December 31, 1995 and 1994 was 5.81% and 5.73%, respectively. In addition to monthly interest payments, monthly principal payments are due in the amount of $108,333. Furthermore, if a major tenant of the Office Building, as defined in the Restated First Mortgage Note agreement, shall not exercise their option to renew or cancels their lease, additional principal payments equal to 100% of net cash flow, as defined, must be remitted to GECC. These payments must continue until the space vacated is 93% rented and other minimum financial conditions are met. All unpaid principal is due at the maturity date which is November 30,\nI-9\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\n2001. Additional advances may be made by GECC in an aggregate amount not to exceed 50% of all previously made principal payments. Any additional advances are generally intended to fund tenant improvements, leasing costs and other capital improvements but may be used to fund other cash flow needs as well. For the year ended December 31, 1995, GECC advanced $216,666 to BMCLP for tenant improvements.\nAnnual principal payments due on the Restated First Mortgage Note are as follows:\n1996 $ 1,299,996 1997 1,299,996 1998 1,299,996 1999 1,299,996 2000 1,299,996 Thereafter 40,417,016 ------------ Total $ 46,916,996 ============\nAdditionally, under the terms of the Restated First Mortgage Note, an interest reserve account to be used as additional collateral under the Restated First Mortgage Note must be established. Monthly payments of $23,125 must be made into this reserve beginning January 1, 1995, as discussed in Note 2 to the consolidated financial statements.\nThe Restated Second Mortgage Note stipulates that 16% interest is payable monthly from available cash flow as defined on a cumulative basis. Based on the provisions of the Restated Second Mortgage Note, BMCLP s cash flow from operations shall be disbursed in the following priority:\na. Debt service and reserves on the Restated First Mortgage Note\nb. Establishment of working capital reserves of $50,000 plus an amount reasonably required to pay ordinary and necessary expenses of operations.\nc. Debt service on the Restated Second Mortgage Note (to the extent of available cash flow).\nd. Principal and interest on additional advances, as discussed below, if any, made to BMCLP by BMC.\ne. 75% of the remaining net cash flow (as defined) to BMC and 25% of the remaining net cash flow to BMCLP (less up to $50,000 per year to cover management and administrative costs of the Partnership and\/or CRCC), subject to the establishment of the reserves as stipulated in the agreement, as discussed below.\nFurthermore, BMC is entitled to an Economic Value Participation Interest as defined which requires BMCLP to pay the following at the sale of the property or maturity date of the Restated Notes.\na. 75% of the amount by which the Economic Value of the Development as defined up to $100 million exceeds the unpaid principal balance and accrued interest under the Restated Notes, and\nI-10\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nb. 50% of the Economic Value in excess of $100 million.\nIn general, the Economic Value is defined by the Restated Second Mortgage Note as the value of the Development as determined by the Partnership or the average of three independent appraisals if deemed necessary by BMC.\nIn 1995, $150,000 was paid to BMC as 75% of remaining net cash flow for 1994 and is included in net cash flow participation in the accompanying consolidated statement of operations. Also in 1995, $50,000 was paid to CRCC as management fees and is included in management fees in the accompanying consolidated statement of operations. Additionally, $150,000 and $50,000 were accrued as of December 31, 1995 for fiscal year 1995 net cash flow participation and management fees, respectively.\nThe Restated Second Mortgage Note is due on November 30, 2001 and no principal payments are required until then. However, any amounts remitted to BMC with respect to its 75% net cash flow participation described above may be re-advanced to BMCLP for payment of debt service on the Restated First Mortgage Note, repairs, capital improvements, leasing commissions, tenant concessions and improvements, taxes and ground lease payments. These advances are limited to 75% of the total amount required to fund these items. The remaining 25% must be funded by BMCLP. BMC has reserved the right, but does not have the obligation, to make up to $5 million in additional advances that would be secured under its Restated Second Mortgage Note. These additional advances would carry an interest rate of 18% payable from available net cash flow, as defined, and would also be due on November 30, 2001. Subsequent to December 31, 1995, the Partnership received an additional advance of $580,000 from BMC.\nA purchase money mortgage had been placed upon the Development as of September 17, 1985 upon the redemption by BMCLP of the partnership interest in BMCLP held by Iroquois Financial Corporation (Iroquois), a Maryland corporation, which is owned 50% by Alan I. Kay and Allen E. Rozansky and 50% by an individual unaffiliated with Alan I. Kay and Allen E. Rozansky or the General Partners. This purchase money mortgage (the Third Mortgage Note) was subordinated to the Second Mortgage Note as of July, 1987. The Third Mortgage Note collateralizes the payment by BMCLP of the $3,000,000 purchase money note given by BMCLP to Iroquois in exchange for Iroquois' interest in BMCLP. The Third Mortgage Note bears simple interest at 9%. Payments of principal and interest were contingent upon available net cash flow as defined in the agreement. In connection with the debt restructuring on November 16, 1994, the Third Mortgage Note was amended to provide that interest is due and payable annually only to the extent funds are available after taking into account payment of amounts due and payable on the Restated Notes and a payment of up to $50,000 per year to CRCC and\/or the Partnership to cover costs of management and administration. Accrued but unpaid interest shall be deferred without interest and be paid, together with the outstanding principal balance of the Third Mortgage Note, upon the earliest of: (i) sale of the assets of BMCLP; (ii) refinancing of the Restated Notes for an amount in excess of the aggregate outstanding principal balances due thereunder; or (iii) one day later than the later of any Maturity Date under the Restated Notes. As of December 31, 1995 and 1994, accrued interest of $2,779,500 and $2,509,500, respectively, has been added to the outstanding principal balance of $3,000,000 in accordance with the amended Third Mortgage Note. No net cash flow as defined in the agreement was available for repayment of this note during 1995, 1994 or 1993.\nI-11\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\nSubstantially all of BMCLP's property and equipment is pledged as collateral to the amended and Restated First and Second Mortgage Notes and to the Third Mortgage Note.\nDEBT FORGIVENESS ----------------\nBMCLP's outstanding obligation under the First Restated Note prior to the restructuring was $178,373,753. The carrying amount of the outstanding principal and accrued interest that was forgiven based on the assignment and subsequent restatement of the First Mortgage Note is presented as deferred gain on debt forgiveness in the accompanying consolidated balance sheets. This amount is being amortized as an extraordinary gain over the remaining term of the Restated First Mortgage Note based on a constant effective yield as required by Statement of Financial Accounting Standards No. 15 (SFAS 15), \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\".\nBased on the Restated First Mortgage Note s interest rate of 10.06% and 9.98% in effect at December 31, 1995 and 1994, respectively, and the monthly principal curtailments of $108,333 as stipulated in the Restated First Mortgage Note, the estimated total future obligation for principal and interest is $73,150,159 and $74,620,628 at December 31, 1995 and 1994, respectively. Although these obligations are lower than the combined obligations of the Restated First Mortgage Note and the deferred gain on debt forgiveness (which totalled $156,408,615 and $176,521,019 at December 31, 1995 and 1994, respectively) SFAS 15 does not permit the entire difference to be recognized as an extraordinary gain at the time of the restructuring as the Restated First Mortgage Note s interest rate is variable, which makes the amount of future debt-service payments contingent upon changes in the index upon which the interest rate is calculated. Accordingly, the $83,258,456 and $101,900,391 difference between the carrying value and total future obligation of the debt at December 31, 1995 and 1994, respectively, was deferred and is being amortized as an extraordinary gain in the accompanying consolidated statements of operations using the effective interest method over the term of the Restated First Mortgage Note.\nAs a result of the fluctuations of the interest rate on the Restated First Mortgage Note, the Partnership continues to remeasure the total future obligation for principal and interest based upon changes in the underlying index, as discussed above. Differences in the future obligation resulting from interest rate changes are reflected as a reclassification between the Restated First Mortgage Note and deferred gain on debt forgiveness. For the year ended December 31, 1995, $4,556,760 was reclassified from the deferred gain on debt forgiveness to the Restated First Mortgage Note resulting from an increase in the future obligation based on changes in the underlying index. For the year ended December 31, 1994, no portion of the deferred gain on debt forgiveness was reclassified. The adjusted deferred gain on debt forgiveness will be amortized as extraordinary gain over the remaining term of the Restated First Mortgage Note.\nFor the years ending December 31, 1995 and 1994, amortization of this deferred debt forgiveness amounted to $14,085,175 and $1,852,734, respectively. The amortization of deferred gain is included in the extraordinary item of $13,825,315 and $1,820,252 at December 31, 1995 and 1994, respectively, in the\nI-12\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\naccompanying consolidated statements of operations, as it is shown net of the interest expense on the Restated Second Mortgage Note of $259,860 and $32,482 as discussed below.\nWith regard to the Restated Second Mortgage Note, the total estimated future obligation for payment of principal and interest based on the fixed interest rate of 16% is $21,200,000. This amount exceeds the carrying value of the Restated Second Mortgage Note at November 16, 1994, of $19,380,974. In accordance with SFAS 15, this difference of $1,819,026 represents a constant additional interest obligation based on the fixed interest rate, and is to be amortized as a reduction of the extraordinary gain on the Restated First Mortgage Note at $21,655 per month through maturity, using the effective interest method, over the term of the Restated Second Mortgage Note. Accordingly, accrual of this additional interest for the years ended December 31, 1995 and 1994 amounted to $259,860 and $32,482, respectively, and were added to the principal balance of the Restated Second Mortgage Note.\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Investments\" (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 the total future obligation of the Restated First Mortgage Note, which represents the estimated total future obligation of principal and interest, approximates fair value based on the variable nature of the Restated First Mortgage Note's interest rate. Because future debt-service payments are contingent upon changes in the underlying index upon which the interest rate is calculated, the total future obligation of the Restated First Mortgage Note is expected to fluctuate with changing market rates of interest. The Partnership has determined that it is not practicable to estimate the fair value for the Restated Second Mortgage Note or the Third Mortgage Note due to: (1) the lack of an active market for these types of financial instruments, (2) the variable nature of the remaining net cash flow payments payable to BMC under the Restated Second Mortgage Note, as discussed above, (3) the variable nature of the Third Mortgage Note's interest payments as a result of its dependance on available cash flow from BMCLP, and (4) the excessive costs associated with an independent appraisal of the Restated Second Mortgage Note and the Third Mortgage Note.\nOPERATING DEFICIT OBLIGATION ----------------------------\nFor operating deficits which arise, the LPA provides that Alan I. Kay and Allen E. Rozansky and their affiliates (collectively, R&K) are required to loan, or cause to be loaned, all amounts necessary to pay operating deficits (Operating Deficit Loans) up to an aggregate principal amount of $15,600,000. R&K and the Partnership have agreed that the former Second Mortgage Note of $10,000,000 was an Operating Deficit Loan \"caused to be\" made to BMCLP by R&K. Further, R&K's Operating Deficit Loan obligation limit of $15,600,000 was increased by (i) an amount equal to the net positive difference between the interest due and payable under the original terms of the First Mortgage Note and the interest due and payable under the original First Mortgage Note as a result of the third loan modification and (ii) the amount that interest accruing on the original Second Mortgage Note exceeded the interest that would have accrued had the loan been made directly by R&K. At December 31, 1995, BMCLP estimates that R&K's total operating deficit obligation has increased to approximately $29,000,000, although R&K do not concur with this amount. As of December 31,\nI-13\nPART I ------\nITEM 2. PROPERTIES - Continued ----------\n1995 and 1994, R&K have provided $2,243,984 and $2,120,800, respectively, including accrued interest, to BMCLP to fund operating deficits under this provision of the LPA. This amount is net of $342,734 which is due from the Alan I. Kay Companies, an affiliate of Alan I. Kay, for advances from BMCLP. Interest on amounts advanced to BMCLP for operating deficits is accrued at the prime rate plus 1% and will be repaid subject to the terms of the Restated Notes and then out of 50% of cash flow available after payment of certain priorities as set forth in the BMCLP partnership agreement. These Operating Deficit Loans shall be repaid in full upon the earlier to occur of (i) fifteen (15) years from the date of such loans or (ii) liquidation, sale or refinancing of the Development (except a refinancing which does not exceed the outstanding principal balance of the original First Mortgage Note).\nThe obligation of R&K to make or cause to be made Operating Deficit Loan(s) is jointly and severally guaranteed by Alan I. Kay and Allen E. Rozansky and further secured by the expense allowance payable to Alan I. Kay and Allen E. Rozansky, the Incentive Management Fee payable to Rozansky & Kay Construction Company, one-half (1\/2) of the disposition fee payable to Alan I. Kay and Allen E. Rozansky from the proceeds of any sale of the Development, and any distributions made to Alan I. Kay and Allen E. Rozansky from the net cash flow of BMCLP or from the proceeds of any sale or refinancing of BMCLP. All obligations of Rozansky and Kay Construction Company have been assumed by affiliates of Alan I. Kay and Allen E. Rozansky.\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 ---------------------------------------------------\nNone.\nI-14\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S PARTNERSHIP INTERESTS ------------------------------------------------- RELATED PARTNERSHIP MATTERS ---------------------------\nThere is no established public trading market for the Units and it is not anticipated that a public trading market for the Units will develop. Article VII of the Partnership Agreement governs transfer or assignment by an Investor of his or her limited partnership interest in the Partnership. Transfer or assignment by an Investor of his or her limited partnership interest is restricted and may not be made without the consent of the Managing General Partner.\nSection 7.02 of the Partnership Agreement describes the procedure for transferring a limited partnership interest. Units may be sold, transferred, assigned or otherwise disposed of by an Investor only if, in the opinion of counsel for the Partnership, registration is not required under the Securities Act of 1933 and such transfer and assignment would not violate state securities or \"blue sky\" laws (including investment suitability standards).\nAs of December 31, 1995, there were 698 holders of record of 600 limited partnership units and there have been no cash distributions to the Investors since the inception of the Partnership.\nII-1\nPART II -------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA-REGISTRANT ----------------------------------\n(1) The Managing General Partner of the Partnership has a 0.01% interest. Other general partner interests which total 0.99% are held by three individuals affiliated (or formerly affiliated) with CRI. 98.99% of the 99% remaining interest is widely held by unrelated parties. On June 15, 1992, pursuant to a debt modification agreement with BMCLP's former first mortgage lender, CRCC replaced the unrelated managing general partners of BMCLP. Since CRCC is an affiliate of CRI, the Partnership's financial\nII-2\nPART II -------\nITEM 6. SELECTED FINANCIAL DATA-REGISTRANT - Continued ----------------------------------\nstatements as of December 31, 1992 and for the period June 16 through December 31, 1992 have been consolidated with BMCLP.\n(2) The loss attributable to minority interest at consolidation date of $77,472,839 represents BMCLP's cumulative losses prior to June 15, 1992 which have not been recognized by the Partnership as these losses exceeded the Partnership's investment in BMCLP. Prior to June 15, 1992 the Partnership recorded its investment in BMCLP under the equity method of accounting.\n(3) The cumulative net loss attributable to minority interest of $92,993,658, $109,210,986 and $100,434,426 as of December 31, 1995, 1994 and 1993, respectively, represents losses not attributable to the partners of the Partnership. Rather, they are attributable to the Special Limited Partners of BMCLP. (See the Consolidated Statements of Partners' Deficit in the Consolidated Financial Statements located in Part IV of this document.) Cumulative BMCLP losses in excess of the Partnership's investment in BMCLP are comprised of $77,472,839 (as discussed in #2 above) plus net cumulative additional excess BMCLP losses at December 31, 1995, 1994 and 1993 of $15,520,819, $31,738,147 and $22,961,587, respectively. The cumulative BMCLP losses in excess of the Partnership's investment have been reflected as loss attributable to minority interest at consolidation date, and the BMCLP losses subsequent to June 15, 1992, have been consolidated into the operating accounts of the Partnership for the years ended December 31, 1995, 1994 and 1993.\nII-3\nPART II -------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nLiquidity ---------\nThe Partnership's sole investment is its limited partnership interest in BMCLP. BMCLP has experienced cash deficits in recent years as cash flow from operations has been insufficient to fund capital and debt service requirements.\nHowever, pursuant to the purchase and subsequent to restructuring of its First and Second Mortgage Notes by new lenders, BMCLP's management is projecting break-even cash flow from operations for the year ended December 31, 1996 after funding anticipated capital and debt-service requirements. To the extent that any cash deficits arise, management plans to utilize certain working capital reserves established in 1994 and additional borrowing capacity under its Restated Notes. However, since access to reserves and additional borrowings are contingent upon the approval of the Restated First and Second Mortgage Note lenders, there can be no assurances that management will be available to fund cash flow deficits should they arise.\nThe Partnership does not have adequate cash reserves or any source of cash to fund its projected cash requirements in 1996, which are principally comprised of professional fees and administrative expenses. Additionally, based on the projected operating performance of BMCLP, it is unlikely that the Partnership will receive any cash distribution from its investment in BMCLP in 1996 due to priorities established for distribution of excess cash flow pursuant to the restructuring of BMCLP's mortgage notes. However, the Managing General Partner has represented a willingness to fund projected cash flow requirements of the Partnership for the year ending December 31, 1996.\nAt December 31, 1995 and 1994, the Partnership had $116 and $113, respectively, in available cash.\nDuring 1995, the Partnership recorded a slight increase in available cash and a $31,601 increase in accounts payable. The increase in accounts payable includes an increase of $31,287 in loan payable to its Managing General Partner for administrative expenses and an increase of $314 in third-party payables.\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 cash approximates fair value.\nII-4\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\nCapital Resources -----------------\nBMCLP, of which the Partnership owns a 92.5% limited partnership interest, had unrestricted cash and cash equivalents of $1,351,408 and $1,649,448 at December 31, 1995 and 1994, respectively. BMCLP had restricted cash and cash equivalents of $1,607,970 and $1,450,904 at December 31, 1995 and 1994, respectively. During 1995, unrestricted cash and cash equivalents decreased $298,040 despite net income of $16,217,328. This was due largely as the result of the non-cash gain on debt forgiveness of $13,825,315, as well as the net debt payments of $7,867,044, which were partially offset by depreciation and amortization totalling $5,335,679.\nIn accordance with SFAS 107, the Partnership has determined that the carrying amounts of BMCLP's cash and cash equivalents and restricted cash and cash equivalents approximate fair value.\nOperating Deficit Reserve -------------------------\nFor operating deficits which arise, the Limited Partnership Agreement (LPA) provides that Alan I. Kay and Allen E. Rozansky and their affiliates (collectively, R&K) are required to loan, or cause to be loaned, all amounts necessary to pay operating deficits (Operating Deficit Loans) up to an aggregate principal amount of $15,600,000. R&K and the Partnership have agreed that the former Second Mortgage Note of $10,000,000 was an Operating Deficit Loan \"caused to be\" made to BMCLP by R&K. Further, R&K's Operating Deficit Loan obligation limit of $15,600,000 was increased by (i) an amount equal to the net positive difference between the interest due and payable under the original terms of the First Mortgage Note and the interest due and payable under the original First Mortgage Note as a result of the third loan modification and (ii) the amount that interest accruing on the original Second Mortgage Note exceeded the interest that would have accrued had the loan been made directly by R&K. At December 31, 1995, BMCLP estimates that R&K's total operating deficit obligation has increased to approximately $29,000,000, although R&K do not concur with this amount. As of December 31, 1995 and 1994, R&K have provided $2,243,984 and $2,120,800, respectively, including accrued interest, to BMCLP to fund operating deficits under this provision of the LPA. This amount is net of $342,734 which is due from the Alan I. Kay Companies, an affiliate of Alan I. Kay, for advances from BMCLP. Interest on amounts advanced to BMCLP for operating deficits is accrued at the prime rate plus 1% and will be repaid subject to the terms of the Restated Notes and then out of 50% of cash flow available after payment of certain priorities as set forth in the BMCLP partnership agreement. Cumulative interest accrued on these advances was $1,005,097 and $881,913 at December 31, 1995 and\nII-5\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\n1994, respectively and has been added to the original advance amount. For the years ended December 31, 1995 and 1994, no amounts were advanced to the BMCLP for operating deficits because R&K have represented that their net worth is not significant, their assets are very illiquid and they do not have resources to meet their operating deficit obligations.\nIn accordance with the terms of the Restated First and Second Mortgage Notes dated November 16, 1994, BMCLP has several additional resources to fund current operating deficits. If BMCLP requires funds to pay for capital improvements, tenant improvements, leasing commissions, etc., and is in compliance with the conditions stated in the Restated First Mortgage Note, GECC shall advance for such purposes up to 50% of the amounts previously paid by BMCLP as principal payments. In 1995, GECC advanced $216,666 to BMCLP for tenant improvements.\nUpon approval of BMC Lender Partnership (BMC), BMCLP may draw upon the $1,038,654 that was placed in an escrow account at the closing of the Restated Second Mortgage Note. These funds may be used to pay operating expenses of the Development including payments under the Restated First and Second Mortgage Notes. On April 3, 1995, BMCLP withdrew $400,000 from the escrow account to help pay the interest due on the Restated Second Mortgage Note. BMCLP deposited $100,000 into the escrow account on April 18, 1995.\nBMC may advance additional amounts up to $5,000,000 to BMCLP in accordance with the Restated Second Mortgage Note. Also, BMC may re-advance funds received from BMCLP as additional interest payments (75% net cash flow) if BMCLP pays its 25% share of net cash flow held in reserves. No advances were made by BMC to BMCLP in 1995. On February 1, 1996, BMC advanced $580,000 to BMCLP for capital improvements.\nResults of Operations ---------------------\nPartnership - ----------\nYEAR ENDED DECEMBER 31, 1995\nThe Partnership recorded a net loss for 1995 of $31,598 as compared with a net loss of $27,050 for 1994. Operating expenses during 1995 were $4,551 higher than 1994 primarily due to an increase in accounting and auditing fees.\nYEAR ENDED DECEMBER 31, 1994\nThe Partnership recorded a net loss for 1994 of $27,050 as compared with a net loss of $109,941 for 1993. Operating expenses in 1994 were $82,891 lower than 1993 primarily due to the decrease in professional fees.\nII-6\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\nBethesda Metro Center Limited Partnership - -----------------------------------------\nYEAR ENDED DECEMBER 31, 1995\nBMCLP had net income for 1995 of $16,217,328 as compared with a net loss of $8,776,560 for 1994. This was primarily the result of a gain on debt forgiveness of $13,825,315 and a reduction of interest expense of $11,981,468 relating to the restructuring of the First and Second Mortgage Notes in November 1994.\nRoom revenue increased by $739,670, or 7% from 1994. The Hotel experienced an increase in occupancy from 75% to 77% and an increase in average room rate of $4 from 1994 due to the completion of hotel renovations in 1994. Food and beverage revenues increased by $359,372, or 8% from 1994 as a result of increased banquet patronage. The increases in room and food and beverage revenues, along with the hotel's cost control efforts, resulted in gross operating profits which exceeded last year by approximately $857,000 or 15%.\nIn 1995, the Hotel received the AAA Four Diamond Award for overall excellence.\nOffice building revenue increased $333,237 or 4% during 1995 compared with 1994. The occupancy of the Office Building increased from 95% to 97% while the rental rate remained unchanged at $24 in 1995. The retail and marketplace occupancy increased from 75% to 98% primarily due to the reclassification of 11,375 square feet of retail space to office space in mid-1994. The retail and marketplace average rental rate increased from $35 in 1994 to $38 in 1995.\nOperating expenses for the Office Building for 1995 decreased by $80,703, or 3%, from 1994.\nYEAR ENDED DECEMBER 31, 1994\nBMCLP recorded a net loss for 1994 of $8,776,560 as compared with a net loss of $12,959,305 for 1993.\nHotel rooms revenue increased by $219,344 or 2.1% from 1993. The Hotel experienced an increase in occupancy of 1.0% and an increase in an average rate of $1.00 compared to 1993. Food and beverage revenues increased by $125,225 or 2.8% from prior years due to a higher volume of banquet and catering sales. The Hotel completed the renovation of the ballroom meeting rooms, guest rooms and corridors which was begun in late 1993. The newly refurbished ballroom has benefited Hotel revenues from additional banquet and catering sales. Operating expenses for the Hotel increased only slightly in 1994 resulting in year to date gross operating profits exceeding last year by $379,015 or 7.2%.\nII-7\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\nIn 1994, the Hotel received the AAA Four Diamond Award for overall excellence.\nOffice, retail and parking income increased in 1994 by $738,657 or 9.3%. As tenants vacated, the building space was relet to new tenants without any free rent concessions resulting in increased revenues. In addition, the Office Building received an early termination fee in the amount of $109,000. The occupancy of the office space has remained constant while the rental rate has increased $1.00 compared to 1993. The retail and market place occupancy increased by 27% while the rental rate has decreased $2.00 from 1993. This increase in occupancy was due to the conversion of 11,375 square feet from retail to office space, as discussed above. Operating expenses for the Office Building remained fairly constant from prior year.\nInterest expense decreased largely as a result of the reduction in the Federal Home Loan Bank Board Eleventh District weighted average cost of funds on which the First and Second Mortgage Note interest rates were based until the debt restructuring on November 16, 1994.\nAn extraordinary gain resulted from the debt restructuring on November 16, 1994. See Restructuring of Original Mortgage Debt on page I-10 for further discussion on the restructuring and calculation of the extraordinary gain.\nManagement fees increased from the prior year due to an incentive management fee of $133,558 earned by Hyatt and a management and administrative fee of $50,000 earned by CRCC.\nThe following tables outline pertinent data regarding the operations of the Hotel and Office Building:\nII-8\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\nOffice Building ---------------\nHOTEL -----\nII-9\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - Continued ---------------------\nIt should be noted that BMCLP's investment in the Development is a high-risk investment involving many factors beyond the control of its General Partner. Such factors could adversely affect the operation and value of the Development and, consequently, the value of an interest in the Partnership, to an extent not currently ascertainable. These factors, include, but are not limited to, over building of office, hotel or commercial space; changes in the general or local economic conditions including changes in interest rates; adjacent land utilization; changes in demand or use with respect to the proximate business facilities; demographic trends; increases in real estate taxes; changes in the federal income tax laws, which could be applied retroactively; local, state and federal environmental, energy, and other regulations (including regulations governing the maintenance of liquor licenses); possible restrictive changes in the uses applicable to real estate, zoning and similar land use and environmental laws and regulations; and acts of God. As of February 20, 1996, the local government in Montgomery County, Maryland, where the hotel is located, is contemplating an increase in room taxes from 5% to 7%.\nIn addition, Hotel occupancy and room rates may be adversely affected by a downturn in the business cycle or by shortages of gasoline or increases in the price of gasoline, increases in airline fare rates or the curtailment of airline service, or other constraints upon travel. Furthermore, in the event mortgage payment and\/or tax assessment obligations are not met, the Partnership may sustain a loss of its equity investment as a result of foreclosure of the Restated First or Second Mortgage Notes and\/or a tax sale as previously discussed.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe financial statements and supplementary data required by this Item are included in Part IV, Item 14 of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURES ---------------------\nNone.\nII-10\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\n(a), (b) and (c)\nThe Partnership has no directors, executive officers or significant employees of its own.\n(a), (b), (c) and (e)\nThe 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.\nIII-1\nPART III --------\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - Continued --------------------------------------------------\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.\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.\nIII-2\nPART III --------\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\n(a), (b), (c) and (d)\nAs described above in Item 10, the Partnership has no officers, directors or any employees. Under the Partnership Agreement, however, the General Partners have the exclusive right to conduct the business and affairs of the Partnership. Set forth below are all fees and other consideration payable to the General Partners and their affiliates, and to Alan I. Kay and Allen E. Rozansky and their affiliates, in fiscal year 1995.\nA. Operational Period ------------------\n1. General Partnership No distributions of net cash Interests of C.R.I., flow have been made through Inc., Dockser, December 31, 1995. Schwartzberg and Willoughby, and Limited Partnership Interest of CRICO-Bethesda in the Partnership.\n2. Partnership Management No incentive management fee Fee CIP Management 14, was paid. Inc.\n3. Partnership Interests of No distributions of net cash CRCC, Alan I. Kay, Allen flow have been made through E. Rozansky and R&K December 31, 1995. Construction.\n4. Expense Allowances to (A) There was no net cash flow Alan I. Kay, Allen E. generated by BMCLP, as Rozansky and CRCC; defined, for fiscal year 1995, Management Fee and therefore, no expense Incentive Management Fee allowances were paid to Alan to R&K Construction. I. Kay, Allen E. Rozansky and CRCC; (B) $3,000,000 payable to R&K Construction for its management services to BMCLP in 1986 through 1990. As of December 31, 1986, no additional management fee was payable to R&K Construction and since then all additional amounts owed have been used to fund operating deficits of BMCLP in accordance with the terms of LPA; and (C) there was no cash flow, as defined, generated by BMCLP in fiscal year 1995, therefore, no incentive management fee was paid to R&K Construction.\n5. Additional Purchase Price (A) In fiscal year 1995, there to Sellers and an were no funds available in the Additional Incentive Operating Deficit Reserve to\nIII-3\nPART III --------\nITEM 11. EXECUTIVE COMPENSATION - Continued ----------------------\nManagement Fee to CRCC, pay additional purchase price Alan I. Kay and Allen E. to the sellers; (B) there was Rozansky. no net cash flow, as defined, generated by BMCLP for fiscal year 1995, therefore, no additional incentive management fee was paid.\n6. Office Building Management fees of $391,092 Management Fees to Realty were paid in 1995. Management Management Company. fees of $50,592 were paid for the period November 16, 1994 through December 31, 1994. Fees deferred in 1994, (prior to November 16, 1994) and 1993 amounted to $332,435 and $328,488, respectively.\n7. Management and Management and Administration Administration Fees to fees relating to 1994 of CRCC and\/or the $50,000 were paid in 1995. Partnership Management and Administration fees relating to 1995 of $50,000 were accrued as of December 31, 1995.\nB. Termination Period ------------------\n1. General Partners' and 1.00% to the General Partners CRICO-Bethesda's Share of and 0.1% to CRICO-Bethesda of Liquidation, Sale and Liquidation, Sale and Refinancing Proceeds of Refinancing Proceeds remaining the Partnership after all payments and distributions have been made, and a return of their capital contributions. In addition, 9.08% to CRICO-Bethesda of the amount remaining prior to the final distribution in accordance with partnership interests. The General Partners and CRICO-Bethesda will also receive a return of their nominal capital contributions.\nIII-4\nPART III --------\nITEM 11. EXECUTIVE COMPENSATION - Continued ----------------------\n2. Disposition Fee payable 3.00% of the gross sales price to CRICO-Bethesda upon of the Development, payable sale of the Development after payment of all debts of the Partnership, return of capital contributions to the Investors, and payment of the Preferred Distribution, as may be multiplied by the Tax Bracket Adjustment Factor, if applicable.\n3. Alan I. Kay, Allen E. (A) 1.00% to CRCC and 6.5% in Rozansky, R&K the aggregate to Alan I. Kay, Construction and CRCC's Allen E. Rozansky and R&K Share of Liquidation, Construction of Liquidation, Sale or Refinancing Sale or Refinancing Proceeds Proceeds remaining after all payments and distributions have been made; plus (B) 18.928% to Alan I. Kay and Allen E. Rozansky of the amount remaining after payment of the Disposition Fee described in C-4 below. Alan I. Kay, Allen E. Rozansky, R&K Construction and CRCC will also receive a return of their nominal capital contributions.\n4. Disposition Fee to Alan The lesser of (i) 0.75% of the I. Kay and Allen E. gross sales price of the Rozansky Development of (ii)\n$2,500,000, as such fee shall be increased by an amount equal to 25% of the amount by which the Preferred Distribution is increased by the Tax Bracket Adjustment Factor, if any, payable after payment of all debts of BMCLP, repayment to the Partnership of its capital contributions to BMCLP, and payment of the Preferred Distribution, as adjusted by the Tax Bracket Adjustment Factor, if applicable.\n5. Loan Repayment to Repayment to Iroquois of the Iroquois purchase money Third Mortgage Note, including all accrued but unpaid interest thereon.\n(e) Termination of employment and change in control arrangement.\nNone.\nIII-5\nPART III --------\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 owned of record, or owned beneficially, more than 5% of the total number of Units.\nThe General Partners own as a group a 1.00% interest in the Partnership. Alan I. Kay and Allen E. Rozansky and their affiliates own as a group a 6.50% interest in BMCLP.\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.\n(c) Changes in control.\nThe Partnership is not aware of any arrangement 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 ----------------------------------------------\n(a) Transactions with Management and Others.\nThe Partnership has no directors or officers. The Partnership has had no transactions with individual officers or directors of the 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 or by virtue of their stock ownership in CRI. See Item 11 for a discussion of fees and other compensation paid or accrued by the Partnership to the General Partners or affiliates.\nIroquois, which is an affiliate of the Special Limited Partners, has provided financing through the Third Mortgage Note.\nA summary of indebtedness to related parties as of December 31, 1995 and 1994 is presented below:\nIII-6\nPART III --------\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Continued ----------------------------------------------\nThe $289,659 and $235,879 due to CRI as of December 31, 1995 and 1994, respectively, is partially comprised of $107,103 of advances to BMCLP to fund Excess Payments due on its mortgages with Great Western. The remaining amount due to CRI is comprised of advances to the Partnership to fund operating deficits and accrued interest on advances. In addition, $1,040,285 of the $1,128,700 and $1,040,285 due to CHG as of December 31, 1995 and 1994, and $972,233 due to Realty as of December 31, 1995 and 1994 were also advanced to BMCLP to fund Excess Payments on the Great Western mortgages, as discussed in Note 4 to the consolidated financial statements. The advances from CRI and CHG accrue interest at the prime rate plus 1% in accordance with the Partnership Agreement whereas the amount due to Realty is non-interest bearing. These advances plus any accrued interest will be repaid subject to cash availability as defined by the partnership agreement and the Restated Notes Agreements, as discussed in Note 4 to the consolidated financial statements. Finally, the $639,053 and $320,264 due to Hyatt as of December 31, 1995 and 1994, respectively, consists of $463,821 and $233,193, respectively, of incentive management fees earned under its management agreement with BMCLP and is due subject to Hyatt meeting certain performance standards as defined in the Management Agreement. The remaining balance consists of trade payables to Hyatt for various services as described in Note 7 to the consolidated financial statements.\nCRCC and\/or the Partnership may receive an annual payment of up to $50,000 to cover costs of management and administration, to the extent that funds are available after payment of amounts due on the Restated First and Second Mortgage Notes, as discussed in Note 4 to the consolidated financial statements. CRCC received a payment of $50,000 on January 31, 1995 from remaining net cash flow relating to 1994. Additionally, $50,000 was accrued as of December 31, 1995 for fiscal year 1995 management fees as described in Note 8 to the consolidated financial statements.\nCIP Management 14, Inc., an affiliate of the Managing General Partner, may receive an incentive management fee on a noncumulative annual basis commencing in 1987 equal to 9.08% of net cash flow after payment of certain priorities set forth in the Partnership agreement. No incentive management fee has been incurred or paid in 1995, 1994 and 1993.\nIII-7\nPART III --------\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Continued ----------------------------------------------\nDuring 1995, 1994 and 1993, BMCLP entered into transactions with the Keystone Group, an affiliate of one of BMCLP's Special Limited Partners, to provide for the construction of tenant improvements and capital improvements in the Office Building. For the years ended December 31, 1995, 1994 and 1993, $379,298, $503,305 and $335,243, respectively, was paid to the Keystone Group. Amounts paid during 1993 and through November 16, 1994 were paid directly by Great Western to Keystone Group. In 1995, the Partnership was informed by the Special Limited Partner that the Keystone Group was no longer affiliated with the Special Limited Partner. As of February 20, 1996, the Partnership had not received verification of the change in affiliation.\nRealty Management Company, which is an affiliate of one of Special Limited Partners, provides management services related to the Office Building, while Iroquois, which is also an affiliate of the Special Limited Partners, has provided financing through the Third Mortgage Note.\nProvident Commercial, an affiliate of one of BMCLP's Special Limited Partners, may receive free use of 9,719 square feet of office space until October 31, 2000. BMCLP estimates that the value of this rent-free office space is approximately $119,500 per year ($12.30 per square foot).\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 General Partners of the Partnership are officers, directors or equity owners other than as set forth in the Partnership's response of Item 13(a).\n(c) Indebtedness of management.\nNone.\n(d) Transaction with promoters.\nNot applicable.\nIII-8\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM 8-K --------------------------------------------------------------\n(a) (1) Financial Statements Page -------------------- ------\nReports of Independent Public Accountants IV-6\nConsolidated Balance Sheets as of December 31, 1995 and 1994 IV-7\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 IV-9\nConsolidated Statements of Changes in Partners' Capital (Deficit) for the years ended December 31, 1995, 1994 and 1993 IV-10\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 IV-11\nNotes to Consolidated Financial Statements IV-12\n(2) Financial Statement Schedules -----------------------------\nAll financial statement schedules are omitted since they are not required, are inapplicable, or the required information is included in the financial statements or notes thereto.\n(3) Exhibits (listed according to the number assigned in the -------- table in Item 601 of Regulation S-K).\nExhibit No. 4 - Instruments defining the rights of security holders, including indentures\na. Second Amended Certificate and Limited Partnership Agreement of Capital Income Properties-C Limited Partnership (Incorporated by reference from Exhibit 4 to Registrant's Regulation D filing as amended, dated October 1, 1985)\nb. Bethesda Metro Center Limited Partnership Indemnification and Hold Harmless Agreement dated July 1, 1987 (Incorporated by reference to the 1987 Annual Report on Form 10-K filed on March 30, 1988)\nc. Bethesda Metro Center Limited Partnership Second Amendment to Second Restated Certificate and Agreement of Limited Partnership dated July 1, 1987 (Incorporated by reference to the 1987 Annual Report on Form 10-K filed on March 30, 1988)\nd. Bethesda Metro Center Limited Partnership Second Restated Agreement of Limited Partnership (related to Second Amendment to Restated Certificate of Limited Partnership) (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\nIV-1\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM ---------------------------------------------------------- 8-K - Continued ---\ne. Bethesda Metro Center Limited Partnership Second Restated Certificate and Agreement of Limited Partnership (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\nf. Bethesda Metro Center Limited Partnership Third Amendment to the Second Restated Certificate and Agreement to Limited Partnership (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\ng. Bethesda Metro Center Limited Partnership Amended and Restated Promissory Note (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nh. Bethesda Metro Center Limited Partnership Amended and Restated First Leasehold Deed of Trust and Security Agreement (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\ni. Bethesda Metro Center Limited Partnership Assignment of Rents and Leases (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nj. Bethesda Metro Center Limited Partnership Amended and Restated Second Deed of Trust Note (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nk. Bethesda Metro Center Limited Partnership Loan Agreement (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nl. Bethesda Metro Center Limited Partnership Amended and Restated Second Leasehold Deed of Trust and Security Agreement (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nm. Bethesda Metro Center Limited Partnership Second Assignment of Rents and Leases (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nn. Collateral Assignment of Partnership Interests Bethesda Metro Center Limited Partnership (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\no. Bethesda Metro Center Limited Partnership Amended and Restated Escrow Agreement (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\np. Bethesda Metro Center Limited Partnership First Allonge to Non-negotiable Non-recourse Purchase Money Promissory Note (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nIV-2\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM ---------------------------------------------------------- 8-K - Continued ---\nExhibit No. 10 - Material Contracts\na. Management services agreement between Capital Income Properties-C Limited Partnership and CIP Management-14, Inc. (Incorporated by reference from Exhibit 10 to the Registrant's Regulation D filing as amended, dated October 1, 1985)\nb. Management Agreement with Hyatt Corporation (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\nc. Amendment to Management Agreement with Hyatt Corporation (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\nd. Garage Lease with Monument Parking Co., Inc. (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\ne. Land Lease (Incorporated by reference to the 1992 Annual Report on Form 10-K filed on April 15, 1993)\nf. Management Agreement with Realty Management Company (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\ng. Collateral Assignment of Management Agreement with Hyatt Corporation (Incorporated by reference to the 1994 Annual Report on Form 10-K filed on March 31, 1995)\nExhibit No. 27 - Financial Data Schedule\n(b) Reports on Form 8-K -------------------\nNo reports of Form 8-K were filed during the quarter ended December 31, 1995.\n(c) Exhibits --------\nThe list of Exhibits required by Item 601 at Regulation S-K is included in Item (a)(3) above.\n(d) Financial Statement Schedules ------------------------------\nSee (a)(2), above.\nIV-3\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.\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nBy: CRI, Inc. Managing General Partner\nMarch 29, 1996 \/s\/ William B. Dockser - ----------------- --------------------------------- DATE William B. Dockser, Director Chairman of the Board, Treasurer and Principal Executive Officer\nMarch 29, 1996 \/s\/ H. William Willoughby - ----------------- --------------------------------- DATE H. William Willoughby Director, President and Secretary\nMarch 29, 1996 \/s\/ Richard J. Palmer - ----------------- --------------------------------- DATE Richard J. Palmer Senior Vice President, Finance Principal Financial and Principal Accounting Officer\nIV-4\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo Partners of Capital Income Properties-C Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of Capital Income Properties-C Limited Partnership (the Partnership ), a District of Columbia limited partnership, and Subsidiary 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. These financial statements are the responsibility of the Partnership s management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Partnership 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.\nArthur Andersen LLP\nWashington, D.C., February 20, 1996\nIV-5\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-6\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED BALANCES SHEETS - Continued\nLIABILITIES AND PARTNERS DEFICIT\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-7\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS ------------ ------------ ------------\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-8\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS - Continued\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-9\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF PARTNERS DEFICIT\nFor the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-10\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-11\nCAPITAL INCOME PROPERTIES-C LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS - Continued\nThe accompanying notes are an integral part of these consolidated financial statements.\nIV-12\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. THE PARTNERSHIP\nCapital Income Properties - C Limited Partnership (the Partnership), a District of Columbia limited partnership, was organized as of December 15, 1984. The purpose of the Partnership is to invest in real estate by acquiring and holding a limited partnership interest in Bethesda Metro Center Limited Partnership (BMCLP). BMCLP owns and operates a 381-room hotel known as the Hyatt Regency Bethesda Hotel (the Hotel) and an office building known as Bethesda Metro Office Building (the Office Building) located in Bethesda, Maryland containing approximately 336,000 square feet of net rentable office space and approximately 18,000 square feet of net rentable retail space. In addition, attached to the structure is a parking facility for approximately 1,300 cars serving the entire development.\nThe Managing General Partner of the Partnership is C.R.I., Inc. (CRI), which has a 0.01% general partner interest. Other general partner interests which total 0.99% are held by three individuals affiliated (or formally affiliated) with CRI. The total limited partner interest of 99% is comprised of 0.01% owned by CRICO-Bethesda Growth Partners Limited Partnership, the affiliated Initial Limited Partner, and the remaining 98.99% interest is widely held by unrelated parties. On June 15, 1992, pursuant to a debt modification with BMCLP s former first mortgage lender, as discussed in Note 4, C.R.C.C. of Bethesda, Inc. (CRCC) replaced the managing general partners of BMCLP (unrelated parties hereinafter the Special Limited Partners). Since CRCC is a wholly owned affiliate of CRI, the accompanying financial statements as of December 31, 1995 and 1994, and for each of the three years ended December 31, 1995 have been consolidated with BMCLP.\nAlthough an entity affiliated with the Partnership has assumed responsibility for management of BMCLP and the Partnership has consolidated its interest therein in the accompanying financial statements, the Partnership has not assumed responsibility for any past or future operating deficits of BMCLP. The deficit in partners capital generated by activity at BMCLP remains the obligation of the Special Limited Partners of BMCLP.\nTherefore, of the total partners deficit of $93,170,936 and $109,356,666 as of December 31, 1995 and 1994, respectively, $92,993,658 and $109,210,986, respectively, are not attributable to the partners of the Partnership. Rather, they are attributable to the Special Limited Partners of BMCLP. The amounts attributable to the Special Limited Partners as of December 31, 1995 and 1994 are comprised of cumulative BMCLP losses in excess of the Partnership s investment in BMCLP as of June 15, 1992 of $77,472,839, and cumulative net BMCLP losses of $15,520,819 and $31,738,147 as of December 31, 1995 and 1994, respectively. BMCLP losses subsequent to June 15, 1992, have been consolidated into the operating accounts of the Partnership in the accompanying consolidated statements of operations.\nIV-13\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. THE PARTNERSHIP - Continued\nLiquidity ---------\nAs discussed above, the Partnership s sole investment is its limited partnership interest in BMCLP. BMCLP has experienced cash deficiencies in recent years as cash flow from operations has been insufficient to fund capital and debt service requirements.\nHowever, pursuant to the purchase and subsequent restructuring of its First and Second Mortgage Notes by new lenders in November 1994, as discussed in Note 4, BMCLP s management is projecting break-even cash flow from operations for the year ending December 31, 1996, after funding all anticipated capital and debt- service requirements. To the extent that any cash deficits arise, management plans to utilize certain working capital reserves established in conjunction with the restructuring in 1994, as discussed in Note 2, and additional borrowing capacity under its Restated Notes, as discussed in Note 4. However, since access to such reserves and additional borrowings are contingent upon the approval of the Restated First and Second Mortgage Note lenders, no assurances can be made that the Partnership will have the ability to fund cash flow deficits should they arise.\nThe Partnership does not have adequate cash reserves or any source of cash to fund its projected cash requirements in 1996, which are principally comprised of professional fees and administrative expenses. Additionally, based on the projected operating performance of BMCLP, it is unlikely that the Partnership will receive any cash distribution from its investment in BMCLP in 1996 due to priorities established for distribution of excess cash flow pursuant to the restructuring of BMCLP s mortgage notes. However, the Managing General Partner has represented a willingness to fund projected cash flow requirements of the Partnership for the year ending December 31, 1996.\n2. SIGNIFICANT ACCOUNTING POLICIES\na. Basis of presentation ---------------------\nThe consolidated financial statements of the Partnership are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles.\nb. Consolidation -------------\nAs discussed in Note 1, the Partnership consolidated its interest in BMCLP in 1992. The accompanying balance sheets as of December 31, 1995 and 1994, reflect all the accounts of both the Partnership and BMCLP. Additionally, the consolidated statements of operations for the years ended December 31, 1995, 1994 and 1993, include the Partnership s and BMCLP s operations for the entire year.\nIV-14\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nc. 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.\nd. Cash and cash equivalents -------------------------\nCash and cash equivalents consist of all time and demand deposits with original maturities of three months of less. The Partnership has determined that the carrying value of its cash and cash equivalents approximates fair value.\ne. Restricted cash and cash equivalents ------------------------------------\nThe $1,607,970 and $1,450,904 as of December 31, 1995 and 1994, respectively, in restricted cash and cash equivalents consists of $1,016,154 and $1,038,654 in working capital reserves as of December 31, 1995 and 1994, respectively. The Partnership received the working capital reserves as proceeds in connection with the restructuring of its mortgage debt, as discussed in Note 4. These funds are held in an escrow account and can be used by BMCLP to fund any operating expenses without limitation by demonstrating the need for such funds to the refinance lenders. Of this amount, $277,500 of the working capital reserves were held by the Restated First Mortgage Note lender as of December 31, 1995. Additionally, $738,654 and $1,038,654 of the working capital reserves are held by the Restated Second Mortgage Note lender as of December 31, 1995 and 1994, respectively. The remaining $591,816 and $412,250 of the restricted cash and cash equivalents balance as of December 31, 1995 and 1994, respectively, represents the balances in an escrow account for property taxes and ground rent as required by the Restated First Mortgage Note lender. Amounts in the escrow account are funded from cash flow from operations. The Partnership has determined that the carrying value of its restricted cash and cash equivalents approximates fair value.\nf. Accounts receivable -------------------\nAccounts receivable, consisting primarily of trade related receivables, is stated at cost less an allowance for accounts deemed uncollectible of $35,413 and $70,249 at December 31, 1995 and 1994, respectively.\ng. Property and equipment ----------------------\nProperty and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:\nIV-15\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nBuildings 40 years Tenant improvements 5-15 years Furniture and equipment (half year convention) 5 years\nAdditions to property and equipment were $1,407,445 and $2,693,456 in 1995 and 1994, respectively. The additions in each year were less than 10% of the beginning balance of property and equipment and were primarily comprised of hotel furniture and fixtures, renovations performed on the Hotel, and leasehold improvements to the Office Building. There were no significant retirements in 1995 or 1994.\nh. Deferred charges ----------------\nDeferred charges include mortgage note financing costs and costs related to leasing space to tenants of the Office Building. Deferred financing costs are amortized as interest expense using the effective interest method over the life of the related debt. Deferred leasing costs are amortized over the term of the related lease using the straight line method.\nNet deferred charges of $2,292,912 and $2,630,629 as of December 31, 1995 and 1994, respectively, consist of $1,759,336 of deferred financing costs related to the mortgage debt restructuring, as discussed in Note 4, and $2,377,495 and $1,940,452, respectively, of leasing costs incurred to lease office space at the Office Building. These deferred amounts are presented in the accompanying consolidated balance sheets net of accumulated amortization of $1,843,919 and $1,069,159 as of December 31, 1995 and 1994, respectively.\nNet deferred financing costs at November 16, 1994, remaining from the previous mortgage debt, of $310,918 were written off as interest expense in the accompanying consolidated statement of operations for the year ended December 31, 1994. Additionally, $2,763,807 of fully amortized deferred financing costs at December 31, 1994 were written off in the accompanying consolidated balance sheets.\nj. Reclassifications -----------------\nCertain reclassifications were made to the 1994 and 1993 consolidated financial statements in order to conform with the 1995 presentation.\nk. Deferred revenue and security deposits --------------------------------------\nDeferred revenue and security deposits represent funds received in advance from tenants of the Office Building.\nl. Rental income and deferred rent receivable ------------------------------------------\nOffice and retail rental income consists of base annual rents, as adjusted by scheduled and cost of living increases, and the reimbursement of certain operating costs of the Office Building. The lease arrangements with tenants are classified as operating leases. The Partnership\nIV-16\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nrecognizes rental income for financial statement purposes using the straight-line method over the terms of the respective leases, as discussed in Note 9.\nl. Income taxes ------------\nNo provision is made for income taxes in the accompanying consolidated financial statements because the Partnership allocates profits and losses to the individual partners for Federal and state income tax purposes.\nm. Use of estimates ----------------\nIn preparing the consolidated 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, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates.\n3. INVESTMENT IN BETHESDA METRO CENTER LIMITED PARTNERSHIP\nThe Partnership has invested $42,500,100 in cash in BMCLP through December 31, 1995, to acquire a 92.5% limited partnership interest. Prior to June 15, 1992, the Partnership s investment in BMCLP was accounted for under the equity method which prohibits the recognition of investment losses in excess of the original investment. However, as discussed in Note 1, subsequent to June 15, 1992, the Partnership s investment in BMCLP has been consolidated in the accompanying consolidated financial statements.\nIV-17\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. INVESTMENT IN BETHESDA METRO CENTER LIMITED PARTNERSHIP - Continued\nCondensed financial information of the Partnership on an unconsolidated basis is as follows:\nIV-18\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. INVESTMENT IN BETHESDA METRO CENTER LIMITED PARTNERSHIP - Continued\nCondensed financial information of BMCLP on an unconsolidated basis is as follows:\nDuring 1995 and 1994, the Partnership did not invest any cash in BMCLP. No cash distributions were made to the Partnership by BMCLP in 1995, 1994 or 1993.\nThe following represents a reconciliation of BMCLP's financial statement net income (loss) to its tax return net (loss) income for each of the three years in the period ended December 31, 1995:\nIV-19\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. INVESTMENT IN BETHESDA METRO CENTER LIMITED PARTNERSHIP - Continued\n4. MORTGAGE DEBT\nOriginal Mortgage Debt ----------------------\nOn December 23, 1985, BMCLP entered into a ten-year, nonrecourse mortgage note (the First Mortgage Note) with Great Western Bank (Great Western) in the amount of $120,000,000. The First Mortgage Note provided for a variable interest rate, adjustable monthly, of 2.75% in excess of the Federal Home Loan Bank Board Eleventh District weighted-average cost of funds.\nOn July 1, 1987, BMCLP entered into a five-year nonrecourse mortgage note (the Second Mortgage Note) with Great Western for $10,000,000 together with a modification of the First Mortgage Note. Principal and accrued interest were due at maturity. The proceeds of this loan were used to fund operating deficit requirements. The Second Mortgage Note also provided for a variable interest rate, adjustable monthly, of 4% in excess of the Federal Home Loan Bank Board Eleventh District weighted-average cost of funds.\nOn September 17, 1985, BMCLP entered into a nonrecourse mortgage note (the Third Mortgage Note) in the amount of $3,000,000 with Iroquois Financial Corporation (Iroquois), an affiliate of the Special Limited Partners of BMCLP, with interest at a rate of 9.0%. Payments of principal and interest were contingent upon available net cash flow as defined in the agreement.\nSubstantially all of BMCLP s property and equipment was pledged as collateral to the Restated First and Second Mortgage Notes and the Third Mortgage Note.\nIV-20\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nModifications to Original Mortgage Debt ---------------------------------------\nOn October 12, 1990, BMCLP was notified by Great Western that an event of default had occurred related to the nonpayment of its debt- service obligation under the First and Second Mortgage Notes (collectively, the Notes). BMCLP failed to remedy the default within the time period allowed and, consequently, was in default as defined in the Notes. Pursuant to the default, Great Western exercised its right to collect rents under leases of the Office Building. In 1992, BMCLP reached an agreement with Great Western to modify the terms of the Notes as discussed below.\nIn connection with the debt modification described below, the mortgage principal and related accrued interest were classified as a current obligation. In addition, all accrued interest on the three mortgage notes was added to the principal balances. However in fiscal 1994, prior to the restructuring, accrued interest on the First Mortgage Note was net of cash transfers from the Hotel and Office Building as required under the debt modifications. For the year ended December 31, 1994, Great Western had collected and received net transfers of cash from BMCLP of $8,346,407. Pursuant to the terms of the Notes, a late fee equal to 3% of the required principal payment could have been assessed by Great Western. However, the potential late fee of approximately $1,100,000 at the time of the restructuring is not reflected in the accompanying consolidated financial statements because Great Western agreed not to accelerate payment or impose the penalty as part of the modification described below.\nEffective June 15, 1992, Great Western and BMCLP entered into a modification which superseded all previous modifications and was in effect until the restructuring on November 16, 1994, as discussed below. The following is a summary of the principal terms of this modification:\na. The maturity date of the Notes was extended to January 1, 1996, the original maturity date of the First Mortgage Note.\nb. Interest was accrued at the stated rate, adjusted as set forth in the original Notes, and interest payments in an amount equal to all of BMCLP's net cash flow, as defined, were due and payable monthly. All accrued but unpaid interest was added to principal and was to be due in full at maturity. No regular principal payments were required.\nc. The following payments (the Excess Payments) were scheduled to be due to Great Western on the last day of the months indicated. All amounts due through the debt restructuring on November 16, 1994 were paid.\nIV-21\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nThe Excess Payments were applied: first, against expenses incurred by Great Western in connection with the restructuring of the Notes; second, to pay late charges owing on the Second Mortgage Note; third, to reduce accrued interest on the First Mortgage Note and then the Second Mortgage Note; and finally, to reduce principal on the First Mortgage Note and then the Second Mortgage Note. BMCLP paid all net cash flow to Great Western and, therefore, did not itself have cash to make the Excess Payments. Realty Management Company (Realty), an affiliate of one of the Special Limited Partners of BMCLP, receives a management fee for managing the Office Building equal to 4% of the Office Building s gross revenues. Realty agreed to defer its entire management fee, effective January 1, 1992, extending through January 1, 1996, and apply it toward payment of the Excess Payments. These amounts will be repaid in the future should sufficient funds exist. The Hyatt Corporation (Hyatt) also received a management fee for managing the Hotel equal to 4% of the Hotel s gross revenues. Hyatt agreed to a reduction of its management fee to 3% through December 31, 1995, which was applied toward payment of the Excess Payments. In addition, Capitol Hotel Group (CHG), an affiliate of the Managing General Partner, which managed another hotel owned by another partnership of which Alan I. Kay and Alan E. Rozansky were limited partners, had agreed to contribute certain management fees to fund the Excess Payments.\nd. BMCLP agreed to allow Great Western to take title to the Hotel and Office Building (the Development) without contest in the event of any default under the terms of the Notes, as modified, provided the fair market value of the Development was less than the then outstanding indebtedness payable. Therefore, BMCLP deposited in escrow, in recordable form, documents to immediately convey title to Great Western (the Documents) in the event of a default under any of the terms of the Notes, as modified. Great Western had the right to record the Documents and immediately take title to the Development if, on the maturity date, the fair market value of the Development was less than the then outstanding indebtedness payable and BMCLP had been otherwise unable to pay off the Notes. As discussed below, however, BMCLP restructured the Notes prior to the maturity date. As a condition to the 1994 debt restructuring, the new holder of the amended and restated Second Mortgage Note required that BMCLP deposit a deed in lieu of foreclosure in escrow to be recordable in the event\nIV-22\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nof a default under that note.\nRestructuring of Original Mortgage Debt ---------------------------------------\nOn November 16, 1994, Great Western sold the Notes to BMC Lender Partnership (BMC), an unaffiliated entity. BMC sold the First Mortgage Note to General Electric Capital Corporation (GECC) which amended and restated the First Mortgage Note (the Restated First Mortgage Note) to a principal amount of $48,000,000. BMC amended and restated the Second Mortgage Note (the Restated Second Mortgage Note) (collectively, the Restated Notes) to a principal amount of $10,000,000 advanced at closing. Of the total $58 million principal amount of the Restated Notes, $55 million was paid to Great Western in consideration for the Notes, approximately $1.8 million was used to fund loan fees and related costs on behalf of BMCLP, approximately $200,000 was used to fund interest and insurance premiums at the closing date and the remaining amount of approximately $1.0 million was deposited into an escrow account restricted for working capital requirements, as discussed in Note 2.\nThe Restated First Mortgage Note requires monthly interest payments in arrears, payable at 4.25% in excess of the GECC Composite Commercial Rate which at December 31, 1995 and 1994 was 5.81% and 5.73%, respectively. In addition to monthly interest payments, monthly principal payments are due in the amount of $108,333. Furthermore, if a major tenant of the Office Building, as defined in the Restated First Mortgage Note agreement, shall not exercise their option to renew or cancels their lease, additional principal payments equal to 100% of net cash flow, as defined, must be remitted to GECC. These payments must continue until the space vacated is 93% rented and other minimum financial conditions are met. All unpaid principal is due at the maturity date which is November 30, 2001. Additional advances may be made by GECC in an aggregate amount not to exceed 50% of all previously made principal payments. Any additional advances are generally intended to fund tenant improvements, leasing costs and other capital improvements but may be used to fund other cash flow needs as well. For the year ended December 31, 1995, GECC advanced $216,666 to BMCLP for tenant improvements.\nAnnual principal payments due on the Restated First Mortgage Note are as follows:\n1996 $ 1,299,996 1997 1,299,996 1998 1,299,996 1999 1,299,996 2000 1,299,996 Thereafter 40,417,016 ------------ Total $ 46,916,996 ============\nAdditionally, under the terms of the Restated First Mortgage Note, an interest reserve account to be used as additional collateral under the Restated First Mortgage Note must be established. Monthly payments of $23,125 must be made into this reserve beginning January 1, 1995, as discussed in Note 2.\nThe Restated Second Mortgage Note stipulates that 16% interest is payable monthly from available cash flow, as defined, on a cumulative basis. Based on\nIV-23\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nthe provisions of the Restated Second Mortgage Note, BMCLP s cash flow from operations shall be disbursed in the following priority:\na. Debt service and reserves on the Restated First Mortgage Note\nb. Establishment of working capital reserves of $50,000 plus an amount reasonably required to pay ordinary and necessary expenses of operations.\nc. Debt service on the Restated Second Mortgage Note (to the extent of available cash flow).\nd. Principal and interest on additional advances, as discussed below, if any, made to BMCLP by BMC.\ne. 75% of the remaining net cash flow (as defined) to BMC and 25% of the remaining net cash flow to BMCLP (less up to $50,000 per year to cover management and administrative costs of the Partnership and\/or CRCC), subject to the establishment of the reserves as stipulated in the agreement, as discussed below.\nFurthermore, BMC is entitled to an Economic Value Participation Interest as defined which requires BMCLP to pay the following at the sale of the property or maturity date of the Restated Notes.\na. 75% of the amount by which the Economic Value of the Development as defined up to $100 million exceeds the unpaid principal balance and accrued interest under the Restated Notes, and\nb. 50% of the Economic Value in excess of $100 million.\nIn general, the Economic Value is defined by the Restated Second Mortgage Note as the value of the Development as determined by the Partnership or the average of three independent appraisals if deemed necessary by BMC.\nIn 1995, $150,000 was paid to BMC as 75% of remaining net cash flow for 1994 and is included in net cash flow participation in the consolidated statement of operations. Also in 1995, $50,000 was paid to CRCC as management fees and is included in management fees in the consolidated statement of operations. Additionally, $150,000 and $50,000 were accrued as of December 31, 1995 for fiscal year 1995 net cash flow participation and management fees, respectively.\nThe Restated Second Mortgage Note is due on November 30, 2001 and no principal payments are required until then. However, any amounts remitted to BMC with respect to its 75% net cash flow participation described above may be re-advanced to BMCLP for payment of debt service on the Restated First Mortgage Note, repairs, capital improvements, leasing commissions, tenant concessions and improvements, taxes and ground lease payments. These advances are limited to 75% of the total amount required to fund these items. The remaining 25% must be funded by BMCLP. BMC has reserved the right, but does not have the obligation, to make up to $5 million in additional advances that would be secured under its Restated Second Mortgage Note. These additional advances would carry an interest rate of 18% payable from available net cash flow, as defined, and would also be due on November 30, 2001. Subsequent to December 31, 1995, the Partnership received an additional advance of $580,000 from BMC.\nIV-24\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nIn connection with the debt restructuring on November 16, 1994, the Third Mortgage Note was amended to provide that interest is due and payable annually only to the extent funds are available after taking into account payment of amounts due and payable on the Restated Notes and a payment of up to $50,000 per year to CRCC and\/or the Partnership to cover costs of management and administration. Accrued but unpaid interest shall be deferred without interest and be paid, together with the outstanding principal balance of the Third Mortgage Note, upon the earliest of: (i) sale of the assets of BMCLP; (ii) refinancing of the Restated Notes for an amount in excess of the aggregate outstanding principal balances due thereunder; or (iii) one day later than the later of any Maturity Date under the Restated Notes. As of December 31, 1995 and 1994, accrued interest of approximately $2,779,500 and $2,509,500, respectively, has been added to the outstanding principal balance of $3,000,000 in accordance with the amended Third Mortgage Note. No net cash flow as defined in the agreement was available for repayment of this note during 1995, 1994 or 1993.\nDebt Forgiveness ----------------\nBMCLP's outstanding obligation under the First Restated Note prior to the restructuring was $178,373,753. The carrying amount of the outstanding principal and accrued interest that was forgiven based on the assignment and subsequent restatement of the First Mortgage Note is presented as deferred gain on debt forgiveness in the consolidated balance sheets. This amount is being amortized as an extraordinary gain over the remaining term of the Restated First Mortgage Note based on a constant effective yield as required by Statement of Financial Accounting Standards No. 15 (SFAS 15), \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\".\nBased on the Restated First Mortgage Note s interest rate of 10.06% and 9.98% in effect at December 31, 1995 and 1994, respectively, and the monthly principal curtailments of $108,333 as stipulated in the Restated First Mortgage Note, the estimated total future obligation for principal and interest is $73,150,159 and $74,620,628 at December 31, 1995 and 1994, respectively. Although these obligations are lower than the combined obligations of the Restated First Mortgage Note and the deferred gain on debt forgiveness (which totalled $156,408,615 and $176,521,019 at December 31, 1995 and 1994, respectively) SFAS 15 does not permit the entire difference to be recognized as an extraordinary gain at the time of the restructuring as the Restated First Mortgage Note s interest rate is variable, which makes the amount of future debt-service payments contingent upon changes in the index upon which the interest rate is calculated. Accordingly, the $83,258,456 and $101,900,391 difference between the carrying value and total future obligation of the debt at December 31, 1995 and 1994, respectively, was deferred and is being amortized as an extraordinary gain in the consolidated statements of operations using the effective interest method over the term of the Restated First Mortgage Note.\nAs a result of the fluctuations of the interest rate on the Restated First Mortgage Note, the Partnership continues to remeasure the total future obligation for principal and interest based upon changes the underlying index, as discussed above. Differences in the future obligation resulting from interest rate changes are reflected as a reclassification between the Restated First Mortgage Note and deferred gain on debt forgiveness. For the year ended December 31, 1995, $4,556,760 was reclassified from the deferred gain on debt forgiveness to the Restated First Mortgage Note resulting from an increase in\nIV-25\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. MORTGAGE DEBT - Continued\nthe future obligation based on changes in the underlying index. For the year ended December 31, 1994, no portion of the deferred gain on debt forgiveness was reclassified. The adjusted deferred gain on debt forgiveness will be amortized as extraordinary gain over the remaining term of the Restated First Mortgage Note.\nFor the years ending December 31, 1995 and 1994, amortization of this deferred debt forgiveness amounted to $14,085,175 and $1,852,734, respectively. The amortization of deferred gain is included in the extraordinary item of $13,825,315 and $1,820,252 at December 31, 1995 and 1994, respectively, in the consolidated statements of operations, as it is shown net of the interest expense on the Restated Second Mortgage Note of $259,860 and $32,482 as discussed below.\nWith regard to the Restated Second Mortgage Note, the total estimated future obligation for payment of principal and interest based on the fixed interest rate of 16% is $21,200,000. This amount exceeds the carrying value of the Restated Second Mortgage Note at November 16, 1994, of $19,380,974. In accordance with SFAS 15, this difference of $1,819,026 represents a constant additional interest obligation based on the fixed interest rate, and is to be amortized as a reduction of the extraordinary gain on the Restated First Mortgage Note at $21,655 per month through maturity, using the effective interest method, over the term of the Restated Second Mortgage Note. Accordingly, accrual of this additional interest for the years ended December 31, 1995 and 1994 amounted to $259,860 and $32,482, respectively, and were added to the principal balance of the Restated Second Mortgage Note.\nAs discussed in Note 2, SFAS 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 the carrying amount of the total future obligation of the Restated First Mortgage Note, which represents the estimated total future obligation of principal and interest, approximates fair value based on the variable nature of the Restated First Mortgage Note's interest rate. Because future debt-service payments are contingent upon changes in the underlying index upon which the interest rate is calculated, the total future obligation of the Restated First Mortgage Note is expected to fluctuate with changing market rates of interest. The Partnership has determined that it is not practicable to estimate the fair value for the Restated Second Mortgage Note or the Third Mortgage Note due to: (1) the lack of an active market for these types of financial instruments, (2) the variable nature of the remaining net cash flow payments payable to BMC under the Restated Second Mortgage Note, as discussed above, (3) the variable nature of the Third Mortgage Note's interest payments as a result of its dependance on available cash flow from BMCLP, and (4) the excessive costs associated with an independent appraisal of the Restated Second Mortgage Note and the Third Mortgage Note.\n5. ALLOCATION OF PROFITS, LOSSES AND DISTRIBUTIONS OF CASH FLOW\nAs discussed in Note 1, the Partnership is not obligated to fund the operating deficits of BMCLP. As a result, only the portion of net loss associated with activity of the Partnership (the Allocable Net Loss) has been allocated to the partners of the Partnership.\nIn accordance with the Partnership Agreement, 1% of the Allocable Net Loss has been allocated to the general partners, and 99% of the Allocable Net Loss has been allocated to the limited partners. Allocations of cash flow\nIV-26\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. ALLOCATION OF PROFITS, LOSSES AND DISTRIBUTIONS OF CASH FLOW - Continued\ndistributions are specified in the Partnership Agreement. See Note 4 for discussion of how BMCLP and the lenders of the Restated Notes participate in cash flow from BMCLP.\n6. RECONCILIATION OF NET INCOME (LOSS) PER FINANCIAL STATEMENTS TO NET INCOME (LOSS) PER TAX RETURN\nThe following represents a reconciliation of the Partnership s financial statement net income (loss) to its tax return net income (loss) for the three years ended December 31, 1995, 1994 and 1993:\nIV-27\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. RECONCILIATION OF NET INCOME (LOSS) PER FINANCIAL STATEMENTS TO NET INCOME (LOSS) PER TAX RETURN - Continued\n7. COMMITMENTS AND CONTINGENCIES\nManagement Agreements ---------------------\nBMCLP entered into a management agreement with Hyatt in March 1982, pursuant to which Hyatt is to manage the Hotel commencing from the date the Hotel opened through December 31, 2015. Based on the management agreement, Hyatt is to be paid a management fee consisting of a base management fee of 3% (as modified) of gross revenues, as defined, and an incentive management fee which is calculated based on 20% of the adjusted gross operating profit, as defined. Management fees paid to Hyatt for the years ended December 31, 1995, 1994 and 1993, were approximately $520,000, $482,000 and $422,000, respectively. The incentive fees earned, as discussed in Note 8, for the years ending December 31, 1995 and 1994 were approximately $232,000 and $134,000, respectively, which are included in due to related parties in the accompanying consolidated balance sheets. No incentive fee was earned in 1993.\nPursuant to the management agreement, Hyatt also provides chain services to Hotel such as promotion services, advertising, centralized reservation services, for which BMCLP is to pay its allocable share of Hyatt expenses. As of December 31, 1995 and 1994, approximately $175,000 and $87,000, respectively, of this related party payable are recorded as due to affiliates in the accompanying financial statements.\nThe management agreement provides for the establishment of a property improvement fund. Contributions to the property improvement fund are equal to 3% of gross Hotel revenues (as defined) in fiscal year 1995 and 1994, respectively. Unexpended reserves are recorded as escrows and deposits within the accompanying financial statements. The reserve balances included in escrows and deposits at December 31, 1995 and 1994, were approximately $114,000 and $256,000, respectively.\nIV-28\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. COMMITMENTS AND CONTINGENCIES - Continued\nBMCLP entered into a management agreement with Realty, an affiliate of one of the Special Limited Partners, dated January 31, 1985, pursuant to which Realty is to manage the Office Building for a term of 20 years commencing from the date the Office Building opened. Under the terms of this agreement, Realty receives a monthly management fee equal to 4% of all income collected from the operation of the Office Building. As discussed in Note 4, Realty had agreed to allow BMCLP to defer payments of all management fees, effective January 1, 1992, through the date of the restructuring of the original mortgage debt. In connection with the debt restructuring which occurred November 16, 1994, BMC paid Realty $1,000,000 to terminate its former management contract with BMCLP. At that time BMCLP entered into a new management contract with Realty for a term of one year which will automatically renew for successive one year periods so long as Realty is not then in default of the management contract. The agreement provides for a management fee in the amount of 4% of total revenues. Of this amount, one-half shall be paid by Realty to BMC, during the term of the Restated Second Mortgage Note, in partial consideration for the $1,000,000 payment to terminate the original contract. Management fees for the years ended December 31, 1995, 1994 and 1993, were approximately $391,000, $373,000 and $328,000, respectively.\nGround Leases -------------\nBMCLP has entered into an agreement for a ground lease on land. The land lease expires on November 31, 2031, and can be renewed for an additional 49 years at the option of BMCLP. The agreement provides for $400,000 minimum quarterly rental payments. Additional rent is payable at the rate of 7.5% of annual gross receipts in excess of $31,000,000. No additional rent was due or paid for 1995, 1994 or 1993.\nFuture minimum rental payments under the ground lease are as follows:\nYear Ended December 31, ------------\n1996 $ 1,600,000 1997 1,600,000 1998 1,600,000 1999 1,600,000 2000 1,600,000 Thereafter 51,200,000 ------------ Total future minimum payments $ 59,200,000 ============\n8. RELATED-PARTY TRANSACTIONS\nA summary of indebtedness to affiliates of $3,029,645 and $2,568,661 as of December 31, 1995 and 1994, respectively, is presented below:\nIV-29\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. RELATED-PARTY TRANSACTIONS - Continued\nThe $289,659 and $235,879 due to CRI as of December 31, 1995 and 1994, respectively, is partially comprised of $107,103 of advances to BMCLP to fund Excess Payments due on its mortgages with Great Western. The remaining amount due to CRI is comprised of advances to the Partnership to fund operating deficits and accrued interest on advances. In addition, $1,040,285 of the $1,128,700 and $1,040,285 due to CHG as of December 31, 1995 and 1994, and $972,233 due to Realty as of December 31, 1995 and 1994 were also advanced to BMCLP to fund Excess Payments on the Great Western mortgage notes, as discussed in Note 4. The advances from CRI and CHG accrue interest at the prime rate plus 1% in accordance with the Partnership Agreement whereas the amount due to Realty is non-interest bearing. These advances plus any accrued interest will be repaid subject to cash availability as defined by the Partnership Agreement and the Restated Notes Agreements, as discussed in Note 4. Finally, the $639,053 and $320,264 due to Hyatt as of December 31, 1995 and 1994, respectively, consists of $463,821 and $233,193, respectively, of incentive management fees earned under its management agreement with BMCLP and is due subject to Hyatt meeting certain performance standards as defined in the Management Agreement. The remaining balance consists of trade payables to Hyatt for various services as described in Note 7.\nCRCC and\/or the Partnership may receive an annual payment of up to $50,000 to cover costs of management and administration, to the extent that funds are available after payment of amounts due on the Restated First and Second Mortgage Notes, as discussed in Note 4. CRCC received a payment of $50,000 on January 31, 1995 from remaining net cash flow relating to 1994. Additionally, $50,000 was accrued as of December 31, 1995 for fiscal year 1995 management fees in the consolidated balance sheet.\nCIP Management 14, Inc., an affiliate of the Managing General Partner, may receive an incentive management fee on a noncumulative annual basis commencing in 1987 equal to 9.08% of net cash flow after payment of certain priorities set forth in the partnership agreement. No incentive management fee has been incurred or paid in 1995, 1994 and 1993.\nIV-30\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. RELATED-PARTY TRANSACTIONS - Continued\nDuring 1995, 1994 and 1993, BMCLP entered into transactions with the Keystone Group, an affiliate of one of BMCLP's Special Limited Partners, to provide for the construction of tenant improvements and capital improvements in the Office Building. For the years ended December 31, 1995, 1994, and 1993, $379,298, $503,305 and $335,243, respectively was paid to the Keystone Group. Amounts paid during 1993 and through November 16, 1994 were paid directly by Great Western to Keystone Group, and thus this activity is included as a noncash investing activity in the accompanying statements of cash flows. In 1995, the Partnership was informed by the Special Limited Partner that the Keystone Group was no longer affiliated with the Special Limited Partner. As of February 20, 1996, the Partnership had not received verification of the change in affiliation.\nAs discussed in Note 7, Realty, an affiliate of one of the Special Limited Partners, provides management services related to the Office Building and, as discussed in Note 4, Iroquois, which is also an affiliate of the Special Limited Partners, has provided financing through the Third Mortgage Note.\nProvident Commercial, an affiliate of one of BMCLP's Special Limited Partners, may receive free use of 9,719 square feet of office space until October 31, 2000. BMCLP estimates that the value of this rent-free office space is approximately $119,500 per year ($12.30 per square foot).\n9. RENTAL INCOME UNDER OPERATING LEASES\nBMCLP s principal leasing activities consist of office space rentals under operating leases. Future minimum rental receipts under noncancelable leases subsequent to December 31, 1995, are as follows.\nYear Ended December 31, ------------\n1996 $ 7,063,555 1997 5,506,904 1998 4,109,868 1999 2,430,260 2000 2,287,437 Thereafter 5,166,303 ------------ Total future minimum rental receipts $ 26,564,327 ============\nBMCLP has entered into a parking lease with Monument Parking Co., Inc., dated March 14, 1983, for a term of 30 years commencing from the date the garage opened. Under the terms of this agreement, BMCLP receives all adjusted net gross receipts up to $1,500,000 and a percentage of fees in excess of $1,500,000, as stipulated in the agreement.\n10. DUE TO GUARANTOR OF OPERATING DEFICITS\nPursuant to the BMCLP partnership agreement and operating deficit guarantee agreement, R&KCC, an affiliate of the Special Limited Partner, has guaranteed the funding of all BMCLP operating deficits up to $15,600,000. To satisfy a portion of this obligation, the shareholders of R&KCC arranged for the original\nIV-31\nCAPITAL INCOME PROPERTIES - C LIMITED PARTNERSHIP\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. DUE TO GUARANTOR OF OPERATING DEFICITS - Continued\nSecond Mortgage Note as described in Note 4. Upon R&KCC s discontinuance of business, the Special Limited Partners assumed the obligations for funding operating deficits. The total due to R&KCC with respect to operating deficit loans, including accrued interest, is $2,243,984 and $2,120,800 as of December 31, 1995 and 1994, respectively. These amounts are net of $342,734 which is due from the Alan I. Kay Companies, an affiliate of the Special Limited Partners, for advances from BMCLP. Interest on amounts advanced to BMCLP for operating deficits is 1% over the prime rate and will be repaid subject to the terms of the Restated Notes and then out of 50% of cash flow available after payment of certain priorities as set forth in the BMCLP partnership agreement. Cumulative interest accrued on these advances was $1,005,097 and $881,913 at December 31, 1995 and 1994, respectively, and has been added to the original advance amount and classified as due to guarantor of operating deficits in the accompanying consolidated balance sheets. For the years ended December 31, 1995 and 1994, no amounts were advanced to the BMCLP for operating deficits because the Special Limited Partners have represented that their net worth is not significant, their assets are very illiquid, and they do not have resources to meet their operating deficit obligations.\nIV-32\nEXHIBIT INDEX -------------\nExhibit Method of Filing - ------- -----------------------------\n27 Financial Data Schedule Filed herewith electronically\nIV-33","section_15":""}
{"filename":"104030_1995.txt","cik":"104030","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Wackenhut Corporation was incorporated in Florida in 1958 as a successor corporation to a partnership founded in 1954 by George R. Wackenhut and three associates. The Wackenhut Corporation, together with its consolidated subsidiaries (the corporation), engages in the business of providing security and other support services to business, industrial and government clients. The corporation's business is conducted from more than 275 domestic and foreign offices and site locations.\nA subsidiary of the corporation, Wackenhut Corrections Corporation (WCC) provides facility management and construction services to detention and correctional facilities. WCC operates in a different industry segment than other divisions of the corporation.\nThe corporation had record revenues of $747.7 million for fiscal 1994, or an increase of $83.5 million (13%). The increase in revenues over fiscal 1993 was due principally to the Security Services Division, which reported an increase in revenues of $37.6 million over fiscal 1993 and to Wackenhut Corrections Corporation whose 1994 revenues exceeded 1993 revenues by $42.7 million. Operating income was also at a record $15.3 million in 1994. Net income, however, was $1.4 million, primarily due to a charge against earnings of $8.7 million ($5.4 million after income taxes) in the fourth quarter of 1994 to write-down the carrying value of the corporation's headquarters building and an extraordinary charge of $1.4 million ($887,000 after income taxes) for the early retirement of senior debt.\nSERVICES\nThe corporation is engaged in a variety of services, with security guard services as the largest contributor to the corporation's revenues. Other services provided by the corporation include, correctional food service, integrated security programs, job corps facilities management, nuclear power plant security and consulting services and investigative services. WCC provides correctional and detention facilities management and construction services to detention and correctional facilities.\nSECURITY GUARD SERVICES\nThe corporation furnishes security officers (armed and unarmed)to protect its clients' property against fire, theft, intrusion, vandalism, and other physical harm. Specialized physical security services offered by the corporation include executive protection, crash-fire-rescue services and fire protection services at airports and governmental installations, pre-departure screening of passengers and luggage at airport terminals and emergency and security services during natural disasters and labor-management disputes. The corporation also provides security consulting services to survey, analyze and minimize client security problems and trains security officers and fire and crash-fire-rescue personnel employed by its clients.The contracts of the corporation with private industry for security guard services usually are for a term of one year with automatic renewal from year to year unless terminated by either party. Most of these contracts are subject to termination by either party on thirty days prior notice. Billing rates are based on a specified rate per hour and generally are subject to renegotiation or escalation if related costs increase because of changes in mini-\nmum wage laws or other events beyond the control of the corporation. Higher hourly rates apply to guard services requested by the client and emergency security services during labor-management disputes.\nSecurity guard services are provided to governmental agencies under contracts awarded pursuant to competitive bidding. Service fees are based on one of several accepted methods: fixed price; specified rate per guard hour; or the corporation's cost plus either a fixed fee, an award fee or an incentive fee. All federal government contracts are subject to termination at the convenience of the government.\nCORRECTIONAL FOOD SERVICE\nThe corporation's food service division provides over 21 million meals annually to over 46 jail and prison facilities in 14 states throughout the United States. Food for regular, therapeutic and religious diets are prepared on-site using conventional or cook-chill methods. Dietary support is provided to facility medical departments by registered dietitians, in addition to safety, training and quality assurance programs. Services are provided on a cost per meal basis. Complete food service management, commissary, laundry and janitorial chemical programs are also available to clients.\nINTEGRATED SECURITY PROGRAMS\nThe corporation designs, engineers, and installs integrated security programs utilizing both security officers and electronic equipment. These services include planning a master security program for a particular facility, custom designing the security system, procuring the requisite electronic equipment, contract and construction management, installing the system, training the security personnel, and post-installation review and evaluation of the security program. Contracts for these integrated security services generally provide for a fixed fee and are awarded pursuant to competitive bidding.\nJOB CORPS FACILITIES MANAGEMENT\nThe corporation manages job corps facilities for the U. S. Department of Labor through its subsidiary Wackenhut Educational Services, Inc., (WESI). These services include facility support and management services, administration, medical and food services, instructional programs, counseling, and vocational training and job placement. Services are billed on a cost plus fixed fee basis. WESI will discontinue operations of the McKinney Job Corps Center in the first quarter of 1995 as a result of a mutual agreement with the Department of Labor. WESI continues to operate two Job Corp Centers at Guthrie, Oklahoma and Gainesville, Florida.\nNUCLEAR POWER PLANTS\nThe corporation provides specialized security and management consulting services for nuclear power generating facilities. These services include highly trained and qualified security personnel, emergency planning, electronic detection equipment and integrated security systems. The services are provided pursuant to a variety of fee arrangements, depending on the particular service performed. A major portion of these services are furnished to the private sector.\nINVESTIGATIVE SERVICES The corporation complements physical security services provided to its clients with investigative services. These services include, but are not limited to, employee background screening and insurance fraud investigations. The corporation maintains a National Research Center with the latest information technology for public record searches and a \"fraud-waste- criminal\" hot line for client employees to report work place abuses. Clients ordinarily are charged an hourly rate for investigative services and a flat rate for background records searches.\nWACKENHUT CORRECTIONS CORPORATION\nIn July and September 1994, WCC, a formerly wholly-owned subsidiary of the corporation, completed an initial public offering (IPO) in which it sold 2,185,000 shares of common stock at an offering price of $9 per share. Following the completion of the IPO, the corporation owns approximately 73.3% of the issued and outstanding shares of common stock of WCC.\nWCC is a leading developer and manager of privatized correctional and detention facilities in six different states, the United Kingdom and Australia. WCC offers governmental agencies a comprehensive range of prison management services from individual consulting projects to the integrated design, construction and management of correctional and detention facilities. WCC also provides a wide array of in-facility rehabilitative and educational programs, such as chemical dependency counseling and treatment, basic education, and job and life skills training. As of year end, WCC had contracts to manage 22 correctional and detention facilities with an aggregate design capacity of 13,732 beds, including the joint-venture in England. The services are provided pursuant to a variety of fee arrangements, depending on the particular type of facility and services performed.\nWCC operates in a different industry segment than other divisions of the corporation. For additional information concerning WCC reference is made to information set forth in Note 2 to Consolidated Financial Statements on page 31 of the corporation's Annual Report to Shareholders, which is incorporated herein by reference.\nMARKETING\nThe corporation provides physical security and investigative services throughout the United States and in numerous foreign countries under the trade name \"Wackenhut\". During 1994, the corporation provided services to more than 14,000 clients. The largest client of the corporation was the U.S. Department of Energy, which accounted for about 20% of the corporation's consolidated revenue. The contracts at the Savannah River site (9%) and the Rocky Flats Plant (5%) are the largest of the contracts with the U. S. Department of Energy.\nCOMPETITION\nThe corporation believes it is the third largest labor-intensive security and protective service organization in the United States. Borg-Warner Security Corporation, principally through three of its subsidiaries (Wells Fargo, Burns International and Globe Security) combine to make the largest organization. Pinkerton's, Inc. is the second largest. The corporation competes domestically with these two organizations and numerous local and regional companies. The corporation believes that its foreign operations are more extensive than those of its principal domestic competitors, although there may be certain foreign competitors that have more extensive foreign operations than does the corporation.\nDomestic competition in the security business is intense and is based primarily on price in relation to quality of service, the scope of services performed, and the extent of security officer training and supervision. The corporation believes that it enjoys a favorable competitive position because of its emphasis on professionalism and quality of service. The corporation's principal business is labor intensive, and is affected substantially by the availability of qualified personnel and the cost of labor. The corporation has not experienced any material difficulty in employing sufficient numbers of suitable security officers.\nWCC competes with a number of companies domestically and internationally, including, but not limited to, Corrections Corporation of America, United States Corrections Corp., Group 4 International Corrections Service, Securicor Group and others. Some of the international competitors are larger and have greater resources than WCC. WCC also competes on a localized basis in some markets with small companies and in other markets, with governmental agencies that are responsible for correctional facilities.\nNON-U.S. OPERATIONS\nAlthough most of the operations of the corporation are within the United States, its international operations make a significant contribution to income. Non-U.S. operations of the corporation provide physical security and private investigative services in Canada, Central America, South America, the Caribbean, Asia, Europe and Africa, and correctional and detention facilities management in Australia. The table below (in thousands) summarizes the consolidated revenue, profit (before allocation of general and administrative expenses of the home office of the corporation and before income taxes) and assets for the last three fiscal years attributable to the corporation's foreign operations. The effect of 100% ownership of Australasian Correctional Management PTY., Ltd. (ACM), a formerly 50% owned joint venture of WCC, has been reflected beginning in 1994.\nThe corporation has affiliates (50% or less owned) that operate security service businesses in Europe, the Far East and Central and South America. In addition, the corporation owns 50% of a joint venture for the management of a correctional facility in the United Kingdom. The following table (in thousands) summarizes certain financial information pertaining to these unconsolidated foreign affiliates, on a combined basis, for the last three fiscal years.\nEMPLOYEES\nAs of January 1, 1995, the corporation had more than 39,000 full-time employees (excluding those of the affiliate companies noted above), most of whom were security officers and other personnel providing physical security services. A small percentage of the employees of the corporation are covered by collective bargaining agreements. Relations with employees have been generally satisfactory and the corporation has not experienced any significant work stoppages attributable to labor disputes. Security officers and other personnel supplied to its clients are employees of the corporation, even though stationed regularly at a client's premises.\nBUSINESS REGULATIONS AND LEGAL CONSIDERATIONS\nThe corporation is subject to a myriad of city, county, and state firearm and occupational licensing laws that apply to security officers and private investigators. In addition, many states have laws requiring training and registration of security officers, regulating the use of badges and uniforms, prescribing the use of identification cards or badges, and imposing minimum bond, surety, or insurance standards. Many foreign countries have laws that restrict the corporation's ability to render certain services, including laws prohibiting security guard services or limiting foreign investment. Under the law of negligence, the corporation can be vicariously liable for acts or omissions of its agents or employees performed in the course of their employment. In addition, some states have statutes that expressly impose on the corporation legal responsibility for the conduct of its employees. The nature of the services provided by the corporation (such as armed security officers and fire rescue and protection) ostensibly expose it to greater risks of liability for employee acts or omissions than are posed to other non-security service businesses. The corporation maintains public liability insurance to mitigate against this potential risk exposure, although the laws of many states limit or prohibit insurance coverage of liability for punitive damages arising from willful, wanton or grossly negligent conduct.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporation's executive offices are located in a 164,000 square foot office building at 1500 San Remo Avenue, Coral Gables, Florida. The building is owned by the corporation. The corporation utilizes approximately 54% of the building and the majority of the remainder is leased to various non-affiliated parties.\nOn January 30, 1995, the corporation announced that it would take a special, one-time charge in the fourth quarter of fiscal 1994, to provide for a loss resulting from the write-down in the carrying value of its headquarters building in Coral Gables, Florida. The charge is approximately $8.7 million ($5.4 million or 56 cents per share after taxes). The write-down in the carrying value of the headquarters building was due to management's decision to sell the corporation's headquarters building in Coral Gables, Florida. It is anticipated that the sale will generate approximately $15 million in cash and tax benefits.\nThe corporation owns a 66,000 square foot building in Aurora, Colorado, which is operated as a detention center under a contract with the U.S. Government and a 15,000 square foot warehouse building in Miami, Florida. In addition, the corporation owns three office buildings in Chile, two in Ecuador and one each in the Dominican Republic, Costa Rica and Puerto Rico that are used for the operations of its foreign subsidiaries in those countries. All other offices of the corporation are in leased space. The aggregate annual rent for all\nnoncancelable operating leases of office space, automobiles, data processing and other equipment is approximately $4,993,000. The corporation owns substantially all uniforms, firearms, and accessories used by its security officers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring the first quarter of 1994, the corporation and its insurance carriers settled a $6,000,000 judgment for $4,500,000. The corporation's insurance carriers contributed funds for that settlement, but these carriers dispute their legal obligation for the amounts paid. In the opinion of management, after consultation with outside counsel, it is more likely than not that the judgment will be covered by the corporation's insurance carriers (\"International Surplus Lines Insurance Company, Century Indemnity Company, Insurance Company of North America and United National Insurance Company vs The Wackenhut Corporation and Home Indemnity Company,\" Civil Action No. 93-10022K - United States District Court, District of Massachusetts). In a second case, a former employee has obtained a $1.8 million judgment against the corporation which includes $1.7 million in punitive damages. The corporation is cautiously optimistic that its appeal will at least result in the diminution of the punitive damages awarded (\"Cindy Boyle vs The Wackenhut Corporation,\" Appeal from Cause No 92-S-0334-C - 130th Judicial District Court, Matagorda County, Texas). Finally, in a case alleging tortious interference with contract and other related torts, plaintiff claims multi-million dollar damages, which the insurance carrier for the corporation has denied coverage (\"Essex Corporation vs Wackenhut Services, Inc.,\" Case No. 94-908 JC\/DJS United States District Court for the District of New Mexico). The corporation denies these claims and intends to vigorously defend the action. While there can be no absolute assurance that the reserves provided by the corporation are adequate, management has made its best estimate of the potential exposure in these matters.\nThe nature of the corporation's business results in claims or litigation alleging that the corporation is liable for damages arising from the conduct of its employees or others. In the opinion of management, there are no other pending legal proceedings that would have a material effect on the consolidated financial statements of the corporation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nGEORGE R. WACKENHUT is Chairman of the Board and Chief Executive Officer of the corporation. He was President of the Corporation from the time it was founded until April 26, 1986. He formerly was a Special Agent of the Federal Bureau of Investigation. He is a member of the Board of Directors of SSJ Medical Development, Inc., Miami, Florida, and is on the Dean's Advisory Board of the University of Miami School of Business. He is on the National Council of Trustees, Freedoms Foundation at Valley Forge, and the President's Advisory Council for the Small Business Administration, Region IV. He is a past participant in the Florida Governor's War on Crime and a past member of the Law Enforcement Council, National Council on Crime and Delinquency, and the Board of Visitors of the U.S. Army Military Police School. He is also a member of the American Society for Industrial Security. He was a recipient in 1990 of the Labor Order of Merit, First Class, from the government of Venezuela. Mr. Wackenhut received his B.S. degree from the University of Hawaii and\nhis M.Ed. degree from Johns Hopkins University. Mr. Wackenhut is married to Ruth J. Wackenhut, Secretary of the Corporation. His son, Richard R. Wackenhut, is President and Chief Operating Officer of the corporation and also a director. (Age 75)\nRICHARD R. WACKENHUT has been President and Chief Operating Officer of the corporation and a member of the Board of Directors since April 26, 1986, and was formerly Senior Vice President of Operations from 1983-86. He was Manager of Physical Security from 1973-74. He also served as Manager, Development at the corporation's Headquarters from 1974-76; Area Manager, Columbia, South Carolina, from 1976-77; District Manager, Columbia, South Carolina from 1977-79; Director, Physical Security Division at Corporate Headquarters from 1979-80; Vice President, Operations from 1981-1982; and Senior Vice President, Domestic Operations from 1982-1983. Mr. Wackenhut is Director of Wackenhut del Ecuador, S.A.; Wackenhut UK Limited; Wackenhut Dominicana, S.A.; and a Director of several domestic subsidiaries of the corporation. He is a member of the St. Thomas University Advisory Board and a Director of the Florida Chamber of Commerce Crime and Drugs Task Force. He is also a member of the American Society for Industrial Security, the International Association of Chiefs of Police and the International Security Management Association. He received his B.A. degree from The Citadel in 1969, and completed the Advanced Management Program of the Harvard University School of Business Administration in 1987. Mr. Wackenhut is the son of George R. Wackenhut, Chairman of the Board and Chief Executive Officer of the corporation, and Ruth J. Wackenhut, Secretary of the Corporation. (Age 47).\nALAN B. BERNSTEIN has been Executive Vice President and President, Domestic Operations Group since April 27, 1991. Prior to that, Mr. Bernstein was Senior Vice President, Domestic Operations. He has been employed by the corporation since 1976, except for a brief absence during 1982 when he was a partner in a family-owned security alarm business in New York State. Mr. Bernstein has served in the following positions with the corporation or its subsidiaries: Vice President of Domestic Operations, 1985; Vice President, Corporate Business Development, 1984; Acting President, Wackenhut Systems Corporation, 1983; Director of Integrated Guard Security, 1981; Manager of Wackenhut Electronic Systems Corporation (Miami) from 1976 to 1981. He received his B.S.E.E. degree from the University of Rochester, and an M.B.A. degree from Cornell University. (Age 47)\nFERNANDO CARRIZOSA has been Senior Vice President, International Operations since January 28, 1989. Mr. Carrizosa was Vice President of International Operations from January 31, 1988 to January 28, 1989. He joined Wackenhut de Colombia in 1968 as Manager of Investigations. He was promoted to Manager of Human Resources, and then to Assistant to the President in 1974. He moved to Headquarters as a trainee in 1974, and was promoted to Manager of Latin American Operations, 1976 to 1979; Director of Latin American Operations, 1979 to 1980; Vice President of Latin American Operations, 1980 to 1983; Executive Vice President of Wackenhut International, 1983 to 1984; and President of Wackenhut International, 1984 to 1988. He is a Director of several subsidiaries and affiliates of the corporation. He received a B.B.A from Universidad Javeriana in Colombia, and an M.B.A. with honors from Florida International University in 1976. (Age 51)\nTIMOTHY P. COLE has been Executive Vice President and President, Government Services Group since April 27, 1991. Mr. Cole was Senior Vice President Government Services from 1989 to 1991. He joined the Corporation as President of Wackenhut Services, Incorporated in 1988. Mr. Cole was associated with the Martin Marietta Corporation from 1982 to 1988 and served in various capacities, including Program Director, Director of Sub-contracts and Material, and Director of Sub-contracts. He received his B.B.A degree from the University of Oklahoma and his M.B.A. from Pepperdine University. Mr. Cole completed the Advanced Management Program of the Harvard University School of Business Administration in 1987. (Age 51)\nRICHARD C. DeCOOK, Senior Vice President and Chief Financial Officer, joined the corporation in July, 1993. Mr. DeCook had spent fifteen years with Trinova Corporation, most recently as Vice President - Financial Planning and Control, and as Vice President - Treasurer. Prior to joining Trinova, he was with Ernst & Young for twelve years. He is a graduate of the University of Michigan and a Certified Public Accountant (CPA). (Age 52)\nROBERT C. KNEIP, Senior Vice President, Corporate Planning and Development, joined the corporation in 1982. Mr. Kneip has held various positions in the corporation including Director, Power Generating Services; Director, Contracts Management; Vice President, Contracts Management; and Vice President, Planning and Development. Prior to joining the corporation, Mr. Kneip was with the Atomic Energy Commission, the Nuclear Regulatory Commission and Dravo Utility Constructors, Inc. He received a B.A. (Honors) from the University of Iowa, and an M.A. and Ph.D. from Tulane University. (Age 47)\nJAMES P. ROWAN is Vice President and General Counsel, and Assistant Secretary of the corporation. He joined the corporation in 1979 as Assistant General Counsel, became Associate General Counsel in 1982 and a Vice President in 1986. He is an attorney admitted to the Bar of the States of Indiana, Iowa and Michigan. He holds the degrees of B.S.C. (Accounting) and J.D. (Law) from the University of Iowa, and a CPA from the University of Illinois. (Age 61)\nRUTH J. WACKENHUT has been Secretary of the corporation since 1958. She is married to George R. Wackenhut, Chairman of the Board and Chief Executive Officer of the corporation and her son, Richard R. Wackenhut, is President and Chief Operating Officer of the corporation and also a director. (Age 72)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this Item is incorporated by reference to Exhibit 13, the Registrant's 1994 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference to Exhibit 13, the Registrant's 1994 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this Item is incorporated by reference to Exhibit 13, the Registrant's 1994 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to Exhibit 13, the Registrant's 1994 Annual Report to Shareholders, except for the Financial Statement Schedules listed in Item 14 (a) (2).\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 Form 10-K (except such information as is furnished in a separate caption \"Executive Officers of the Registrant\" and included in Part I, hereto) will be contained in, and is incorporated by reference from, the proxy statement (with the exception of the Board Compensation Committee Report and the Performance Graph) for the corporation's 1995 Annual Meeting of Shareholders, which will 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 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) 1. REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe following consolidated financial statements of the corporation, included in the Registrant's Annual Report to its Shareholders for the fiscal year ended January 1, 1995 are incorporated by reference in Item 8:\nConsolidated Balance Sheets - January 1, 1995 and January 2, 1994\nConsolidated Statements of Income -Fiscal years ended January 1, 1995, January 2, 1994 and January 3, 1993.\nConsolidated Statements of Cash Flows - Fiscal years ended January 1, 1995, January 2, 1994 and January 3, 1993.\nConsolidated Statements of Shareholders' Interest -Fiscal years ended January 1, 1995, January 2, 1994 and January 3, 1993.\nNotes to Consolidated Financial Statements\nWith the exception of the information incorporated by reference from the 1994 Annual Report to Shareholders in Items 5, 6, 7, 8, and 14 of Parts II and IV of this Form 10-K, the Registrant's 1994 Annual Report to shareholders is not to be deemed filed as a part of this Report.\n2. FINANCIAL STATEMENT SCHEDULES\nSchedule VIII - Valuation and Qualifying Accounts,\nAll other schedules specified in the accounting regulations of the Securities and Exchange Commission have been omitted because they are either inapplicable or not required. Individual financial statements of The Wackenhut Corporation have been omitted because it is primarily an operating company and all significant subsidiaries included in the consolidated financial statements filed with this Annual Report are majority-owned.\n3. EXHIBITS\nThe following exhibits are filed as part of this Annual Report:\nEXHIBIT 3(a) - Amended and Restated Articles of Incorporation (incorporated by reference to the corporation's Form 10-K Annual Report for the year ended January 3, 1993).\nEXHIBIT 3(b) - Bylaws currently in effect, as amended through October 27, 1990 (incorporated by reference to the corporation's Form 10-K Annual Report for the year ended December 30, 1990).\nEXHIBIT 4(a) - Revolving Credit and Reimbursement Agreement by and among The Wackenhut Corporation, the company - NationsBank of Florida, N. A., and Bank of America Illinois, as Lenders - and NationsBank of Florida, N.A., as Agent dated January 5, 1995\nEXHIBIT 4(b) - Receivables Purchase Agreement dated as of January 5, 1995 Among The Wackenhut Corporation, as Seller, and Receivables Capital Corporation and Enterprise Funding Corporation, each as a Purchaser and Bank of America National Trust and Savings Association and NationsBank of North Carolina, N.A., each as a Managing Agent and Bank of America National Trust and Savings Association as the Administrative Agent\nEXHIBIT 4(c) - $15,000,000 Credit Agreement dated as of December 12, 1994 between Wackenhut Corrections Corporation as Borrower and Barnett Bank of South Florida, N.A. as Lender.\nEXHIBIT 10(a) - Amendments to the Deferred Compensation Agreements for Executive Officers (the \"Senior Plan\"): Alan B. Bernstein, Richard R. Wackenhut, Fernando Carrizosa, Timothy P. Cole, Robert C. Kneip (incorporated by reference to the Corporation's Form 10-K Annual Report for the year ended December 29, 1991).\nEXHIBIT 10(b) - Deferred Compensation Agreement (the \"Senior Plan\") for Richard C. DeCook (incorporated by reference to the Corporation's Form 10-K Annual Report for the year ended January 2, 1994).\nEXHIBIT 10(c) - Executive Retirement Plan adopted during fiscal year 1989 by the Board of Directors (incorporated by reference to the Corporation's Form 10-K Annual Report for the year ended December 31, 1989).\nEXHIBIT 10(d) - Amended, Split Dollar arrangement with George R. and Ruth J. Wackenhut adopted by the Board of Directors in October of 1989 (incorporated by reference to the corporation's Form 10-K Annual Report for the year ended December 31, 1989).\nEXHIBIT 10(e) - Amended and Restated Revolving Credit and Reimbursement Agreement between The Wackenhut Corporation and NationsBank of Florida, National Association dated July 1, 1993 (incorporated by reference to the Corporation's Form 10-K Annual Report for the year ended January 2, 1994).\nEXHIBIT 10(f) - Amendment dated March 7, 1995 to the Amended and Restated Revolving Credit and Reimbursement Agreement between The Wackenhut Corporation and NationsBank of Florida, N.A., dated July 1, 1993.\nEXHIBIT 13 - Annual Report to Shareholders for the year ended January 1, 1995, beginning with page 21 to the Annual Report (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K).\nEXHIBIT 21 - Subsidiaries of the Corporation.\n(b). REPORTS ON FORM 8-K.\nOn August 12, 1994, the corporation filed a current report on Form 8-K to report the initial public offering of Wackenhut Corrections Corporation, a subsidiary of the corporation. After the completion of the sale, the corporation owns 73.3% of the issued and outstanding shares of common stock of the subsidiary. Financial statements and pro forma financial information were not required since the transaction did not meet materiality requirements.\nOn January 30, 1995, the corporation filed a current report on Form 8-K to report that it will take a special, one-time charge in the fourth quarter of fiscal 1994 to provide for a loss resulting from the write-down in the carrying value of its headquarters building in Coral Gables, Florida. The loss resulting from the write-down of the headquarters building carrying value of $8.7 million is due to management's decision to sell the Corporation's headquarters building.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 WACKENHUT CORPORATION\nDate: March 20, 1995 By:\/s\/ Richard C. DeCook ---------------------- Richard C. DeCook, Senior Vice President - Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: March 20,1995 \/s\/ George R. Wackenhut ----------------------- GEORGE R. WACKENHUT, Chairman of the Board and Chief Executive Officer (principal executive officer)\nDate: March 20,1995 \/s\/ Richard C. DeCook --------------------- Richard C. DeCook, Senior Vice President - Finance and Chief Financial Officer\nDate: March 20, 1995 \/s\/ Juan D. Miyar ----------------- Juan D. Miyar, Vice President - Accounting Services and Corporate Controller (principal accounting officer)\n\/s\/ Julius W. Becton, Jr.* ------------------------- JULIUS W. BECTON, JR. Director\n\/s\/ Richard G. Capen, Jr.* ------------------------- RICHARD G. CAPEN, JR. Director\n\/s\/ Anne N. Foreman * ------------------- ANNE N. FOREMAN Director\n\/s\/ Edward L. Hennessy, Jr. * --------------------------- EDWARD L. HENNESSY, JR. Director\n\/s\/ P. X. Kelley * -------------------- PAUL X. KELLEY Director\n\/s\/ Robert Q. Marston * --------------------- ROBERT Q. MARSTON Director\n\/s\/ Jorge L. Mas Canosa * ----------------------- JORGE L. MAS CANOSA Director\n\/s\/ Nancy Clark Reynolds * ------------------------ NANCY CLARK REYNOLDS Director\n\/s\/ Thomas P. Stafford * ---------------------- THOMAS P. STAFFORD Director\n\/s\/ George R. Wackenhut * ----------------------- GEORGE R. WACKENHUT Director\n\/s\/ Richard R. Wackenhut * ------------------------ RICHARD R. WACKENHUT Director\nDated: March 20, 1995 * By \/s\/ James P. Rowan ------------------------ JAMES P. ROWAN, Attorney-in-fact\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Shareholders of The Wackenhut Corporation:\nWe have audited the accompanying consolidated balance sheets of The Wackenhut Corporation (a Florida corporation) and subsidiaries as of January 1, 1995 and January 2, 1994, and the related consolidated statements of income, cash flows and shareholders' equity for each of the three fiscal years in the period ended January 1, 1995. These financial statements and the schedule referred to below are the responsibility of the Corporation's management. Our responsibility is to express and opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Wackenhut Corporation 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 fiscal years in the period ended January 1, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purposes 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 our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nMiami, Florida, February 17, 1995.\nSCHEDULE VIII\nTHE WACKENHUT CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE FISCAL YEARS ENDED JANUARY 1, 1995, JANUARY 2, 1994 AND JANUARY 3, 1993\n(In thousands)\nEXHIBIT INDEX\nExhibit No.\n4(a) Revolving Credit and Reimbursement Agreement by and among The Wackenhut Corporation, the Company - NationsBank of Florida, N. A., and Bank of America Illinois, as Lenders - and NationsBank of Florida, N.A., as Agent dated January 5,1995\n4(b) Receivables Purchase Agreement dated as of January 5, 1995 Among The Wackenhut Corporation, as Seller and Receivables Capital Corporation and Enterprise Funding Corporation, each as a Purchaser and Bank of America National Trust and Savings Association and NationsBank of North Carolina, N.A., each as a Managing Agent and Bank of America National Trust and Savings Association as the Administrative Agent\n4(c) $15,000,000 Credit Agreement dated as of December 12, 1994 between Wackenhut Corrections Corporation as Borrower and Barnett Bank of South Florida, N.A., as lender\n10(f) Amendment dated March 7, 1995 to the Amended and Restated Revolving Credit and Reimbursement Agreement between The Wackenhut Corporation and NationsBank of Florida, N.A., dated July 1, 1993\n13 Annual Report to shareholders for the year ended January 1, 1995, (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K).\n21 Subsidiaries of the Corporation\nSee Item 14(a)(3) for a complete listing of exhibits, including those exhibits not attached to this Form 10-K Annual Report but incorporated by reference to prior Form 10-K Annual Reports.","section_15":""}
{"filename":"721538_1995.txt","cik":"721538","year":"1995","section_1":"ITEM 1. BUSINESS\nSterling Drilling Fund 1983-1, L.P., formerly Sterling-Fuel Resources Drilling Fund 1983-1 (the \"Registrant\" or the \"Partnership\") is a limited partnership formed under the laws of the State of New York on March 18, 1983. The sole business of the Partnership was the drilling of formation extension wells principally for natural gas in various locations in the State of West Virginia. No exploratory drilling was undertaken.\nThe principal place of business of the Partnership is at One Landmark Square, Stamford, Connecticut 06901, telephone (203) 358-5700. The Managing General Partner of the Partnership is PrimeEnergy Management Corporation, a New York corporation which is a wholly-owned subsidiary of PrimeEnergy Corporation, a publicly held Delaware corporation. Messrs. Charles E. Drimal, Jr., Oliver J. Sterling and Samuel R. Campbell also are General Partners. Mr. Drimal is a Director, President and Chief Executive Officer of PrimeEnergy Management Corporation and PrimeEnergy Corporation, and Mr. Campbell is a Director of PrimeEnergy Corporation.\nThe aggregate contributions to the Partnership were $11,077,000, all of which, net of the organization expenses of the Partnership, was expended in the drilling of such formation extension wells. Such properties are located in Clay, Roane, Calhoun, Gilmer, Wirt, Kanawha, Lincoln and Putnam Counties, West Virginia. The Partnership does not operate any of the properties in which it has an interest, but generally such properties are operated and serviced by Prime Operating Company, a Texas corporation, and Eastern Oil Well Service Company, a West Virginia corporation, both wholly-owned subsidiaries of PrimeEnergy Corporation.\nDuring 1995, the Partnership did not engage in any development drilling activities or the acquisition of any significant additional properties, but engaged in the production of oil and gas from its producing properties in the usual and customary course. Since January 1, 1996, and to the date of this Report, the Partnership has not engaged in any drilling activities nor participated in the acquisition of any material producing oil and gas properties.\nCOMPETITION AND MARKETS\nCompetitors of the Partnership in the marketing of its oil and gas production include oil and gas companies, independent concerns, and individual producers and operators, many of which have financial resources, staffs and facilities substantially greater than those available to the Partnership. Furthermore, domestic producers of oil and gas must not only compete with each other in marketing their output, but must also compete with producers of imported oil and gas and alternative energy sources such as coal, nuclear power and hydroelectric power.\nThe availability of a ready market for any oil and gas produced by the Partnership at acceptable prices per unit of production will depend upon numerous factors beyond the control of the Partnership, including the extent of domestic production and importation of oil and gas, the proximity of the Partnership's producing properties to gas pipelines and the availability and capacity of such pipelines, the marketing of other competitive fuels, fluctuation in demand, governmental regulation of production, refining, transportation and sales, general national and worldwide economic conditions, and pricing, use and allocation of oil and gas and their substitute fuels.\nThe Partnership does not currently own or lease any bulk storage facilities or pipelines, other than adjacent to and used in connection with producing wells. The Partnership deals with a number of major and independent companies for the purchase of its oil and gas production, in the areas of production. In 1995, approximately $220,000, or 92%, of the Partnership's gas production was sold to one unaffiliated purchaser, Phoenix Energy Sales Company. Sales are made under short-term contractual arrangements. The Partnership believes that its current purchasers will continue to purchase oil and gas products and, if not, could be replaced by other purchasers.\nENVIRONMENTAL MATTERS\nThe petroleum industry is subject to numerous federal and state environmental statutes, regulations and other pollution controls. In general, the Partnership is, and will be subject to, present and future environmental statutes and regulations, and in the future the cost of its activities may materially increase as a result thereof. The Partnership's expenses relating to preserving the environment during 1995 as they relate to its oil and gas operations were not significant in relation to operating costs and the Partnership expects no material change in the near future. The Partnership believes that environmental regulations should not, in the future, result in a curtailment of production or otherwise have a materially adverse effect on the Partnership's operations or financial condition.\nREGULATION\nThe Partnership's oil and gas operations are subject to a wide variety of federal, state and local regulations. Administrative agencies in such jurisdictions may promulgate and enforce rules and regulations relating to, among other things, drilling and spacing of oil and gas wells, production rates, prevention of waste, conservation of natural gas and oil, pollution control, and various other matters, all of which may affect the Partnership's future operations and production of oil and gas. The Partnership's natural gas production and prices received for natural gas are regulated by the Federal Energy Regulatory Commission (\"FERC\") and the Natural Gas Policy Act of 1978 and various state regulations. The Partnership was subject to the Crude Oil Windfall Profit Tax Act of 1980, which imposed an excise tax on producers of crude oil at various rates for prices received in excess of certain historical base prices. That Act was repealed in August, 1988. The Partnership is also subject to state drilling and proration regulations affecting its drilling operations and production rates.\nThe FERC continues to regulate interstate natural gas pipeline transportation rates and service conditions pursuant to the NGA and NGPA. Federal regulation of interstate\ntransporters affects the marketing of natural gas produced by the Partnership as well as the revenues received by the Partnership for sales of such natural gas. Since the latter part of 1985, through its Order Nos. 436, 500 and 636 rulemakings, the FERC has endeavored to make natural gas transportation accessible to gas buyers and sellers on an open and non-discriminatory basis. The FERC's efforts have significantly altered the marketing and pricing of natural gas. No prediction can be made as to what additional legislation may be proposed, if any, affecting the competitive status of a gas producer, restricting the prices at which a producer may sell its gas, or the market demand for gas, nor can it be predicted which proposals, including those presently under consideration, if enacted, might be effective.\nA number of legislative proposals have been introduced in Congress and the state legislatures of various states, that, if enacted, would significantly affect the petroleum industry. Such proposals involve, among other things, the imposition of land and use controls and certain measures designed to prevent petroleum companies from acquiring assets in other energy areas. In addition, there is always the possibility that if market conditions change dramatically in favor of oil and gas producers that some new form of \"windfall profit\" or severance tax may be proposed for and imposed upon either oil or gas. At the present time it is impossible to predict which proposals, if any, will actually be enacted by Congress or the various state legislatures. The Partnership believes that it will comply with all orders and regulations applicable to its operations. However, in view of the many uncertainties with respect to the current controls, including their duration and possible modification together with any new proposals that may be enacted, the Partnership cannot predict the overall effect, if any, of such controls on its operations.\nTAXATION\nThe Partnership received an opinion of its counsel that the Partnership would be classified as a partnership and the holders of Partnership Units would be treated as limited partners for federal income tax purposes. The Partnership itself, to the extent that it is treated for federal income tax purposes as a partnership, is not subject to any federal income taxation, but it is required to file annual partnership returns. Each holder of Partnership Units will be allocated his distributive shares of the Partnership's income, gain, profit, loss, deductions, credits, tax preference items and distributions for any taxable year of the Partnership ending within or with his taxable year without regard as to whether such holder has received or will receive any cash distributions from the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership has no interest in any properties other than its oil and gas properties. The information set forth below summarizes the Partnership's oil and gas wells, production and reserves, for the periods indicated.\nPRODUCING WELLS AND OPERATING INFORMATION\nThe Partnership, following its formation, and in November, 1983, contracted for the drilling of 38 development wells, which resulted in 37 producing wells and one dry hole.\nAs of December 31, 1995, the Partnership had ownership interests in the following gross and net producing oil and gas wells and gross and net producing acres(1). The Partnership has no material undeveloped leasehold, mineral or royalty acreage.\nProducing wells:\n- ---------------\n(1) A gross well is a well in which an interest is owned; a net well is the sum of the interests owned in gross wells. Wells are classified by their primary product. Some wells produce both oil and gas.\nThe following table sets forth the Partnership's oil and gas production, average sales prices and average production costs as of and for the periods indicated:\nOIL AND GAS RESERVES\nThe Partnership's interests in proved developed oil and gas properties have been evaluated by Ryder Scott Company for the periods indicated below. All of the Partnership's reserves are located in the continental United States. The following table summarizes the Partnership's oil and gas reserves at the dates shown (figures rounded):\nThe estimated future net revenue (using current prices and costs as of the dates indicated, exclusive of income taxes (at a 10% discount for estimated timing of cash flow) for the Partnership's proved developed oil and gas reserves for the periods indicated are summarized as follows (figures rounded):\nSince January 1, 1995, the Partnership has not filed any estimates of its oil and gas reserves with, nor were any such estimates included in any reports, to any federal authority or agency, other than the Securities and Exchange Commission.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not a party to, nor is any of its property the subject of, any legal proceedings actual or threatened, which would have a material adverse effect on the business and affairs of the Partnership.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during 1995 for vote by the holders of Partnership Units.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThere is no market for the Limited Partnership Units (the \"Units\") of the Partnership. As of March 15, 1996, there were 828 holders of record of the Units.\nThe Units are not regarded as stock and payments or distributions to holders of Units are not made in the form of dividends. Cash distributions to the holders of Units for 1995 aggregated $27,693. Aggregate cash distributions to the holders of the Units as of December 31, 1995, is $2,215,400.\nThe Managing General Partner may purchase Units directly from the unit holders if presented to the Managing General Partner, subject to conditions, including limitations on numbers of Units, and at a price to be fixed by the Managing General Partner in accordance with certain procedures, all as provided for in the Limited Partnership Agreement of the Partnership.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes certain selected financial data to highlight significant trends in the Registrant's financial condition and results of operations for the periods indicated. The selected financial data should be read in conjunction with the financial statements and related notes included elsewhere in this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENTS DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS\n1. Liquidity: The oil and gas industry is intensely competitive in all its phases. There is also competition between this industry and other industries in supplying energy and fuel requirements of industrial and residential consumers. It is not possible for the Partnership to calculate its position in the industry as the Partnership competes with many other companies having substantially greater financial and other resources. In accordance with the terms of the Agreement of Limited Partnership of the Partnership, the General Partners of the Partnership will make cash distributions of as much of the Partnership cash credited to the capital accounts of the partners as the General Partners have determined is not necessary or desirable for the payment of any contingent debts, liabilities or expenses for the conduct of the Partnership business. As of December 31, 1995, the General Partners have distributed to the Limited Partners $2,215,400 or 20.00% of the total Limited Partner capital contributions to the Limited Partnership.\nThe net proved oil and gas reserves of the Partnership are considered to be a primary indicator of financial strength and future liquidity. The present value of unescalated future net revenue (S.E.C. case) associated with such reserves, discounted at 10% as of December 31, 1995, was approximately $893,700 as compared to the discounted reserves as of December 31, 1994, which were approximately $782,000. The increase in total estimated discounted future net revenue was due primarily to higher year end gas prices as of December 31, 1995, when\ncompared to the low gas price in effect as of December 31, 1994. It is the opinion of management, and the general consensus in the industry, that gas prices are unlikely to fall significantly below the December 31, 1995, price in the near future. However, there can be no assurances that such price declines will not occur, and will not pose a threat to the Partnership's continued viability.\n2. Capital resources: The Partnership was formed for the sole intention of drilling oil and gas wells. The Partnership entered into a drilling contract with an independent drilling contractor in November, 1983, for $9,400,000. Pursuant to the terms of this contract, thirty-eight wells were drilled resulting in thirty-seven producing wells and one dry-hole.\n3. Results of Operations:\n1995 compared to 1994\nOperating revenue declined from $345,484 in 1994 to $279,580 in 1995. The Partnership's oil production remained consistent with prior years, 1,521 barrels of oil in 1994, compared with 1,508 barrels of oil 1995, while the gas production increased slightly from 104,386 mcf in 1994 to 116,201 mcf in 1995. Oil revenue was up due to consistent production and higher average oil price from $12.89 in 1994 to $17.82 in 1995. Gas revenue was lower even with increased production due to the average gas price per mcf of $2.17 in 1995 as compared to the higher average mcf price of $3.12 for 1994.\nThe Partnership was paid spot prices throughout all of 1995 for its gas produced. Spot prices fluctuate and were low during off peak usage times of the year. The Partnership generally renews contracts as they come due for an additional twelve month period. The Partnership was under a fixed contract price for the first nine months of 1994. The price offered in 1994, at the renewal date for the 1994-1995 contracts, was lower than was deemed favorable. Therefore, the price remained at spot prices during 1994 and 1995. During the fourth quarter of 1995 the Partnership locked into a twelve month fixed price contract.\nColumbia Gas Transmission Corp., a gas purchaser of the Partnership's gas, filed a Chapter 11 petition in the U.S. Bankruptcy Court in Wilmington, Delaware, on July 31, 1991. At that time, the Bankruptcy Court released Columbia from any active contracts. The Partnership filed a claim with the Bankruptcy Court to recover revenues suspended at the time the bankruptcy occurred. Such amounts were not recorded during the applicable period since the claim amount was undetermined and open-ended. The Court's settlement of the Columbia bankruptcy proceedings were finalized in November of 1995. The Partnership received $75,375, which was reported as other income for 1995.\nProduction expenses decreased from $181,570 in 1994 to $147,306 in 1995. The higher production costs experienced in 1994 can be attributed to higher general labor, repairs and location costs associated with the inclement weather conditions throughout 1994. The weather caused line damages, floods and other situations that increased normal maintenance costs. Most of the production expenses incurred in 1995 were to maintain the general upkeep of the wells and well sites. General and administrative costs declined from $181,739 in 1994 to $106,973 in 1995. Amounts in both years are substantially less then the $553,850 allocable to the\nPartnership under the Partnership Agreement. The lower amounts reflect management's efforts to limit costs, both incurred and allocated to the Partnership.\nThe Partnership records additional depreciation, depletion and amortization to the extent that the net capitalized costs exceeds the undiscounted future net cash flows attributable to the Partnership. Additional depletion was needed of $450,000 in 1994 and no revision was needed in 1995. Depreciation, depletion and amortization rates were significantly higher in 1994 compared to 1995, resulting in a higher depletion expense, $148,120 for 1994, as compared to $86,358 for 1995.\n1994 compared to 1993\nOperating revenue declined from $388,480 in 1993 to $345,484 in 1994. This decline can be attributed to both a production decline as well as low prices during the last quarter of 1994. The Partnership generally renews contracts as they come due for an additional twelve month period. The price offered at the renewal date for the contracts was lower than was deemed favorable. The Partnership is currently selling, at spot prices, to its normal purchasers until the Partnership can lock into a twelve month contract with a favorable price. The contract price in effect for three months of 1993 and nine months of 1994 resulted in a slightly higher average mcf price of $3.12 for 1994, as compared with $2.61 for 1993. The price increase was offset by a decline in production from 135,378 mcf in 1993 to 104,386 mcf in 1994.\nProduction expenses increased from $158,495 in 1993 to $181,570 in 1994. This increase can be attributed to higher general labor, repairs and location costs associated with the inclement weather conditions in early 1994. The weather caused line damages, floods and other situations that increased normal maintenance costs. General and administrative costs declined slightly from $215,070 in 1993 to $181,739 in 1994. Amounts in both years are substantially less than the $553,850 allocable to the Partnership under the Partnership Agreement. The lower amounts reflect management's efforts to limit costs, both incurred and allocated to the Partnership.\nThe Partnership records additional depreciation, depletion and amortization to the extent that the net capitalized costs exceeds the undiscounted future net cash flows attributable to the Partnership. Additional depletion was needed of $450,000 in 1994 and no revision was needed in 1993. Depreciation, depletion and amortization rates were significantly higher in 1994 compared to 1993 resulting in a higher depletion expense, $148,120 for 1994 as compared to $126,579 in 1993. The higher rates are directly attributable to a downward revision in the oil and gas reserves due to lower year-end prices.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Sterling Drilling Fund 1983-1, L.P.:\nWe have audited the accompanying balance sheets of Sterling Drilling Fund 1983-1, L.P. (a New York limited 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 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 Sterling Drilling Fund 1983-1, L.P. as of December 31, 1995 and 1994, and the results of its operations and 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 to financial statements and schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the examination 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\/ PUSTORINO, PUGLISI & CO., LLP PUSTORINO, PUGLISI & CO., LLP New York, New York March 5, 1996\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nAssets ------\nThe Notes to Financial Statements are an integral part of these statements.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nSTATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe Notes to Financial Statements are an integral part of these statements.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe Notes to Financial Statements are an integral part of these statements.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nSTATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe Notes to Financial Statements are an integral part of these statements.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(1) Organization and Capital Contributions:\nSterling Drilling Fund 1983-1, L.P., formerly Sterling-Fuel Resources Drilling Fund 1983-1, a New York limited partnership (the \"Partnership\"), was formed on March 18, 1983 for the primary purpose of acquiring, developing and producing oil and gas in the state of West Virginia. The general partners are: PrimeEnergy Management Corporation (PEMC), a wholly owned subsidiary of PrimeEnergy Corporation (PEC), Charles E. Drimal, Jr., Oliver J. Sterling and Samuel R. Campbell. Eleven thousand seventy-seven limited partnership units, (11,077), were sold at $1,000 per unit aggregating total limited partner contributions of $11,077,000. The general partners' contributions amounted to $902,847. Partnership operations commenced on November 10, 1983.\n(2) Summary of Significant Accounting Policies:\nRevenue Recognition:\nThe Partnership recognizes operating revenues, consisting of sales of oil and gas production, in the month of sale. Uncollected revenue is accrued based on known facts and trends of the relevant oil and gas properties on a monthly basis.\nBasis of Accounting-\nThe accounts of the Partnership are maintained in accordance with accounting practices permitted for federal income tax reporting purposes. Under this method of accounting, (a) substantially all exploration and development costs except leasehold and equipment costs are expensed as paid, (b) costs of abandoned leases and equipment are expensed when abandoned, and (c) depreciation (for equipment placed in service) is provided on an accelerated basis. In order to present the accompanying financial statements in accordance with generally accepted accounting principles, memorandum adjustments have been made to account for oil and gas properties, as discussed below.\nOil and Gas Producing Activities-\nThe Partnership accounts for its oil and gas operations using the successful efforts method of accounting on a property by property basis. The Partnership only participates in developmental drilling. Accordingly, all costs of drilling and equipping these wells, together with leasehold acquisition costs, are capitalized. These capitalized costs are amortized on a property by property basis by the unit-of-\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(2) Summary of Significant Accounting Policies - (Cont'd):\nproduction method based upon the ratio of production to proved oil and gas reserves. Additional depreciation, depletion and amortization is recorded to the extent that net capitalized costs exceed the undiscounted future net cash flows attributable to Partnership properties. (See Note 4)\nFederal Income Taxes -\nAs federal income taxes are the liability of the individual partners, the accompanying financial statements do not include any provision for federal income taxes. (See Note 8)\nLimited Partners' Loss Per Equity Unit:\nThe limited partners' loss per equity unit is computed on the 11,077 limited partner equity units.\nCash and Cash Equivalents -\nFor purposes of the statements of cash flows the Partnership considers all highly liquid debt instruments with a maturity of three months or less to be cash 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 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.\nRecently Issued Accounting Standards:\nThe Partnership has elected to implement the provisions of FAS Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" The implementation of this standard has had no material effect on the financial statements.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(3) Oil and Gas Properties:\nThe Partnership acquired leases or farmouts from PEMC at its cost. Cost is defined as any amount paid for delay rentals, lease bonuses, if any, surveys and other expenses including such portion of any of the general partners', or their affiliates' reasonable, necessary and actual expenses for geological, geophysical, seismic, land, engineering, drafting, accounting, legal and other services. The Partnership currently pays royalties of approximately 12.5% to 17.9% of the selling price of the oil and gas extracted.\nThe following table sets forth certain revenue and expense data concerning the Partnership's oil and gas activities for the years ended December 31, 1995, 1994 and 1993:\n(4) Quantities of Oil and Gas Reserves:\nThe amount of proved developed reserves presented below have been estimated by an independent firm of petroleum engineers as of January 1, 1996. Petroleum engineers on the staff of PEC have reviewed the data presented below, as of December 31, 1995, for consistency with current year production and operating history. All of the Partnership's oil and gas reserves are located within the United States:\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(4) Quantities of Oil and Gas Reserves - (Cont'd):\nShould current prices continue into the future, operation of certain wells would become uneconomic, on a pretax basis, as production levels decline with age. In accordance with the rules and regulations of the Securities and Exchange Commission, proved reserves exclude production which would be uneconomic. The partners are entitled to certain tax benefits and credits which, if available in the future, may result in production continuing beyond the level included in the above table.\nRevisions arise from changes in current prices, as well as engineering and geological data which would alter the useful life and therefore the overall predicted production of each well. Future changes in these estimates are common and would impact the reserve quantities used to calculate depreciation, depletion and amortization.\nAs discussed in Note 2, the Partnership records additional depreciation, depletion and amortization to the extent that net capitalized costs exceed the undiscounted future net cash flows attributable to Partnership properties. No price declines affect estimated future net revenues both directly and as a consequence of their impact on estimates of future production. The Partnership has recorded no additional provision for 1995 or 1993, however, an additional provision of $450,000 was recorded in 1994. If the additional provision had been computed based on the limited partners' interest in capitalized costs and estimated future net revenues, rather than on the basis of total Partnership interests, the limited partners income for 1995 would not have been reduced, however, in 1994 and 1993 it would have been reduced by an additional $225,000 and $8,500, respectively.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(5) Allocation of Partnership Revenues, Costs and Expenses:\nUnder the terms of the Limited Partnership Agreement, all Partnership revenues and expenses, including deductions attributable thereto, are to be allocated as follows:\n(6) Transactions With Affiliates:\n(a) The due to\/from affiliates at December 1995 and 1994, represents general and administrative and certain other expenses incurred on behalf of the Partnership by PEC and its subsidiaries, and amounts due for production operator's fees (Note 6(b)), net of production revenues collected on behalf of the Partnership.\n(b) As operator of the Partnership's properties, Prime Operating Company (POC), a subsidiary of PEC, receives, as compensation from the Partnership, a monthly production operator's fee of $379 for each producing gas well and $525 for each producing oil or combination gas and oil well, based on the Partnership's\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(6) Transactions With Affiliates - (Cont'd):\npercentage of working interest in the well. Such fee is subject to annual adjustment by the percentage increase in the Cost of Living Index published by the U.S. Department of Labor over the year in which production began. During 1995, 1994 and 1993, $71,148, $100,509 and $93,704 of production operator's fees were incurred, respectively.\n(c) In accordance with the terms of the Partnership Agreement, the general partners are required to pay 8.5% of drilling and completion costs, lease acquisition costs and certain other costs, of which 1% will be paid for by the general partners out of revenues received by them from the Partnership. At December 31, 1995, $22,880 was due from certain general partners for such costs.\n(7) General and Administrative Expenses:\nIn accordance with the Management Agreement, the general partners are reimbursed for the portion of their in- house overhead, including salaries and related benefits, attributable to the affairs and operations of the Partnership.\nThis amount, combined with certain direct expenses for geology, engineering, legal, accounting, auditing, insurance and other items shall not exceed an annual amount equal to 5% of limited partner capital contributions. Excess expenses shall be borne by the general partners.\nDuring 1995, 1994 and 1993, the Partnership accrued general and administrative expenses incurred on its behalf by a general partner of $85,000, $160,000 and $192,516, respectively.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(8) Federal Income Taxes:\nThe following is a reconciliation between the net income (loss) as reported on the Partnership's federal income tax return and the net income (loss) reported in the accompanying financial statements:\nThe tax returns of the Partnership, the qualifications of the Partnership as such for tax purposes, and the amount of Partnership income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes with respect to Partnership's qualifications or in changes to its income or loss, the tax liability of the partners would be changed accordingly.\nThe Tax Reform Act of 1976 provides that no part of any depletion deduction with respect to oil and gas wells is to be determined by the Partnership but must be computed separately by the partners. Thus, cost or percentage depletion, as applicable, must be computed by each partner so that a specific depletion computation can be made when each partner files his U.S. income tax return. Information is furnished to the partners to compute the depletion deduction.\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(9) Major Customers:\nA schedule of the major purchases of the Partnership's production is as follows:\nThe Partnership renewed its gas purchase contract in December, 1995 resulting in a fixed price for one year.\n(10) Other Matters:\nEffective October 1, 1988, Fuel Resources, Inc., a subsidiary of Brooklyn Union Gas Company and also a general partner sold for cash its interests in the revenues, costs and expenses, and profits and losses of the Partnership to PrimeEnergy Assets and Income Fund L.P. A-1 and PrimeEnergy Asset and Income Fund L.P. A-2 whose general partners are also general partners of this Partnership. Effective March 1, 1993, Fuel Resources, Inc. withdrew as a general partner.\n(11) Other Revenue:\nOther revenue represents settled claims against Columbia Gas Transmission Corp. (Columbia) arising from amounts due from Columbia when they declared bankruptcy. No significant additional claims are expected concerning this matter.\nSCHEDULE V\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nPROPERTY AND EQUIPMENT - OIL AND GAS PROPERTIES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE VI\nSTERLING DRILLING FUND 1983-1, L.P. (a New York limited partnership)\nACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION - OIL AND GAS PROPERTIES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nINDEX TO EXHIBITS","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"772572_1995.txt","cik":"772572","year":"1995","section_1":"ITEM 1. BUSINESS. ---------\nGeneral - -------\nEdac Technologies Corporation (\"Edac\") was formed in 1985 for the purpose of acquiring Gros-Ite Industries, Incorporated (which had three operating divisions: Time Engineering, Gros-Ite and Spectrum). In 1988 and 1989 Edac sold the assets of its other operations and now operates only the Gros-Ite division (\"Gros-Ite\").\nProducts - --------\nEdac currently offers design and manufacturing services for the aerospace industry in areas such as special tooling, equipment and gauges, and components used in the manufacture, assembly and inspection of jet engines. Edac also offers design and manufacturing services for the medical instruments industry in such areas as components used in the manufacture of medical instruments and special tooling. Edac also designs and manufactures specialized machines for a variety of other applications.\nEdac maintains manufacturing facilities with computerized numerically controlled machining centers, and grinding, welding, and sheet metal fabrication, painting and assembly capabilities. Items manufactured by Edac include precision rings, and other components for jet engines, components for medical instruments, as well as industrial spindles, environmental test chambers and specialized machinery designed by Edac or others and other assemblies requiring close tolerances.\nPatents and Trademarks - ----------------------\nEdac currently holds no patents or registered trademarks, tradenames or similiar intellectual property. The Company believes that the nature of its business presently does not require the development of patentable products or registered tradenames or trademarks to maintain market growth.\nMarketing and Competition - -------------------------\nEdac has numerous competitors both in design and manufacturing. Many of the independent design firms with which it competes are smaller than Edac and do not provide the variety of services that Edac provides. Edac also competes with its customers' in-house design and technical services capabilities. Edac believes that it is able to compete effectively with independent design firms and in-house design staffs because of its experience and the timeliness and competitive pricing of its services.\nMany firms also compete with Edac's manufacturing operations. However, Edac believes that it will be able to compete effectively with these firms on price, ability to meet customer deadlines and the stringent quality control standards it employs. Edac also believes that its integration of design and manufacturing capabilities offers a competitive advantage.\nEdac's manufactured products are sold primarily through individual purchase orders on a quotation or bid basis. Its sales personnel and management maintain contacts with purchasing sources to keep informed as to manufacturing projects available for quotation. Edac occasionally enters into annual manufacturing contracts on specific components.\nFor its fiscal year ended December 31, 1995, approximately 69% and 10% of Edac's net sales were derived from sales to United Technologies Corporation and Zapata Technologies Inc., respectively.\nApproximately 70% of Edac's design business is done on a time and material basis based on hourly rates established annually. Most of Edac's manufacturing is done on a firm quotation basis. Less than 10% of Edac's net sales are attributed to government contracts subject to termination or renegotiation at the option of the U.S. Government. United Technologies Corporation annually negotiates hourly billing rates for design work and is free to audit costs actually charged.\nBacklog - -------\nEdac's backlog as of December 31, 1995, was approximately $24,677,000 compared to $24,487,000 as of December 31, 1994. Backlog consists of accepted purchase orders that are cancellable by the customer without penalty, except for payment of costs incurred, and may involve delivery times that extend over periods as long as two or three years. Edac presently expects to complete approximately $15,900,000 of its December 31, 1995 backlog within the next 12 months.\nEmployees - ---------\nAs of March 29, 1996 Edac had approximately 171 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. -----------\n(1) Property subject to mortgage securing certain corporate indebtedness.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------------------\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS. -----------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED ------------------------------------------------- STOCKHOLDERS MATTERS. ---------------------\nInformation in response to this item is incorporated herein by reference to \"Market Information\" on page 3 of the Registrant's 1995 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------------------------\nInformation in response to this item is incorporated herein by reference to \"Selected Financial Information\" on page 3 of the Registrant's 1995 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS. --------------------------\nInformation in response to this item is incorporated herein by reference to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 4 through 7 of the Registrant's 1995 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. --------------------------------------------\nInformation in response to this item is incorporated herein by reference to pages 8 through 20 of the Registrant's 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\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ---------------------------------------------------\nInformation in response to this item is incorporated herein by reference to \"Election of Directors\" in the Registrant's definitive Information Statement for its 1996 Annual Meeting of Shareholders, which will be filed within 120 days after the end of the Registrant's fiscal year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. -----------------------\nInformation in response to this item is incorporated herein by reference to \"Executive Compensation\" in the 1996 Information Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ---------------------------------------------------------------\nInformation in response to this item is incorporated herein by reference to \"Principal Security Holders and Security Holdings of Management\" in the 1996 Information Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -----------------------------------------------\nInformation in response to this item is incorporated herein by reference to \"Certain Transactions\" in the 1996 Information Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K. ----------------------------------------------------------------\n(a) Documents filed: ---------------\n1. Financial Statements.\nThe financial statements required to be filed by Item 8 hereof have been incorporated by reference to the Registrant's 1995 Annual Report to Shareholders and consist of the following:\nReport of Independent Public Acountants\nConsolidated Statements of Operations--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 Changes in Shareholders' Equity--Years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\n2. Financial statement schedule. -----------------------------\nThe following financial statement schedule of Edac is included in Item 14(d) hereof:\nReport of Independent Public Accountants on Schedule\nSchedule II: Valuation and qualifying accounts\nAll other schedules for which provisions are made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(b) Reports on Form 8-K -------------------\nNone.\n(c) Exhibits: --------\nSee Exhibit Index included as the last part of this Report, which Index is incorporated herein by this reference.\n(d) Financial Statements and Schedules ----------------------------------\nRefer to Item 14a above for listing of financial statements and schedule.\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE ----------------------------------------------------\nTo the Shareholders and Board of Directors of\nEdac Technologies Corporation:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Edac Technologies Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated March 1, 1996, except with respect to certain matters as to which the date was April 10, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule presented on page 9 of this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nHartford, Connecticut March 1, 1996\n---------------------------------------------------- SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS EDAC TECHNOLOGIES CORPORATION AND SUBSIDIARIES ----------------------------------------------------\n(1) Represents write-off of specific accounts receivable.\nSIGNATURES\nPursuant to the requirements of section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEDAC TECHNOLOGIES CORPORATION\nBY \/s\/ Robert T. Whitty . ------------------------------- Robert T. Whitty, Chief Executive Officer\nBY \/s\/ Glenn L. Purple . ------------------------------- Glenn L. Purple Vice President-Finance (Principal Financial and Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX\n(1) Exhibit incorporated by reference to the Company's registration statement on Form S-1 dated August 6, 1985, commission File No. 2-99491, as amended.\n(2) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n(3) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n(4) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n(5) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.","section_15":""}
{"filename":"93469_1995.txt","cik":"93469","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nPittway Corporation (\"Pittway\" or \"Registrant\"), formerly Standard Shares, Inc. (\"Standard\"), was incorporated under Delaware law in 1925. Pittway and its subsidiaries are referred to herein collectively as the \"Company\".\nThe Company operates in two reportable industry segments: alarm and other security products, and publishing.\nAcquisitions and dispositions of businesses by the Company, other than the discontinued operations discussed below, in each of the three years ended December 31, 1995 were not significant to the Company's sales or results of operations.\nDuring the first half of 1994, the Company sold its 16.67% ownership in First Alert, Inc., a manufacturer of residential fire protection products, as part of an initial public offering of that company's common stock. Financial information relating to this transaction is set forth in Note 10 (\"Fair Value of Financial Instruments\") to the Consolidated Financial Statements contained in the 1995 Annual Report to Stockholders, pages 39-40, which Note is incorporated herein by reference.\nIn April 1993, the Company distributed its investment in the AptarGroup, Inc. (formerly known as the Seaquist Division packaging group) to stockholders in a tax-free spinoff. AptarGroup, Inc. is a manufacturer of aerosol valves, dispensing pumps and closures which are sold to packagers and marketers in the personal care, fragrance\/cosmetics, pharmaceutical, household products and food industries. In October 1992, the Company sold its Barr Company, a contract packager for marketers of aerosol and liquid fill (non-aerosol) personal and household products, to a Canadian packaging company. In July 1992, the Company sold its First Alert\/BRK Electronics business to a new company formed by BRK management and an investment firm. Financial information relating to these transactions is set forth in Note 1 (\"Discontinued Operations\") to the Consolidated Financial Statements contained in the 1995 Annual Report to Stockholders, page 36, which Note is incorporated herein by reference.\n(b) Financial Information about Industry Segments\nFinancial information relating to industry segments for each of the three years ended December 31, 1995 is set forth in Note 13 (\"Segment Information\") to the Consolidated Financial Statements contained in the 1995 Annual Report to Stockholders, pages 41-42, which Note is incorporated herein by reference.\n(c) Narrative Description of Business\nThe principal operations, products and services rendered by the Company:\nAlarm and Other Security Products Segment\nThis segment involves the design, manufacture and sale of an extensive line of burglar alarm, commercial fire detection, closed circuit television,\naccess control and other alarm components and systems as well as the distribution of alarm and other security products manufactured by other companies. By offering a broad line of alarm products needed for security systems, the Company provides a full range of services to independent alarm dealers and installers which range in size from one-person operations to the largest national alarm service companies. In every major domestic market area, quick delivery is provided through the Company's computerized regional warehouses and convenience center outlets, authorized distributors and dealers. Various products sold through the alarm system distribution group are purchased from non-affiliated suppliers and manufacturers to offer a broad range of products. Some of the products purchased are resold under the Company's Ademco brand name, others are resold under brand names owned by its suppliers. In the Canadian and overseas markets, alarm and other security products are sold through the Company's distribution centers, authorized distributors and sales agents. The Company also offers AlarmNet to alarm companies in major U.S. markets. AlarmNet is a wireless cellular-like communication network designed to transmit security alarm signals by radio instead of over telephone lines.\nCommercial fire detectors and fire controls are sold through the Company's regional warehouses, electrical and building supply wholesalers and alarm and fire safety distributors.\nRaw materials essential to the Company's businesses are purchased worldwide in the ordinary course of business from numerous suppliers. The vast majority of these materials are generally available from more than one supplier and no serious shortages or delays have been encountered. Certain raw materials used in producing some of the Company's products can be obtained only from one or two suppliers, the shortage of which could adversely impact production of alarm equipment and commercial fire detectors by the Company. The Company believes that the loss of any other single source of supply would not have a material adverse effect on its overall business.\nThrough its NESCO subsidiary the Company offers a wide variety of services to independent distributors of its fire alarm systems products, including assistance with system design, bonding, technical help, training, marketing and administrative support. The Company also offers a brand name marketing program to independent burglar alarm dealers.\nSales and marketing methods common to this industry segment include communications through the circulation of catalogs and merchandising bulletins, direct mail campaigns, and national and local advertising in trade publications. The Company's principal advantages in marketing are its reputation, broad product line, high quality products, extensive integrated distribution network, efficient customer service, competitive prices and brand names.\nWithin the industry there is competition from large and small manufacturers in both the domestic and foreign markets. While competitors will continue to introduce new products similar to those sold by the Company, the Company believes that its research and development efforts and the breadth and quality of its distribution network will permit it to remain competitive.\nPublishing Segment\nThis segment is a publisher of 33 national business and trade publications. A variety of magazine-related products are also offered including directories, readership lists, CD-ROMs, on-line computer services, and custom publishing. The Company's publications serve both specific industries and broad functional markets which include specialized manufacturing, service industries, technical and professional fields and general management. Most publications are distributed on a monthly basis with several others distributed on a biweekly, annual or biennial frequency. The publications are generally distributed free through controlled circulation. The principal source of revenue is from the sale of advertising space within the magazines. Other facets of the business include: the operation of a printing plant for the printing and production of most of the Company's publications and those of other publishers; a national direct mail-marketing organization serving the pharmaceutical, health care and business services markets; a printer which provides mailing service capabilities to the Company's direct mail-marketing organization and to outside customers; research and telemarketing services; direct-response card mailer service; trade shows and special publications.\nWithin the publishing and marketing communications fields, competition exists in the form of other publications and media communication businesses. Reductions in advertising schedules by domestic industrial companies due to economic and other competitive pressures directly impacts the display advertising levels of the Company's publishing segment. The Company competes with one or more other magazines for advertising revenue in each of its magazine titles. The Company's principal sales advantages include relevant editorial content and innovative marketing complemented by specialized multi-magazine supplements. The Company believes that its competitive position also benefits from improvements in productivity and from cost control programs. The Company places great emphasis on providing quality products and services to its customers.\nReal Estate and Other Ventures\nThe Company is involved in the marketing, sale and development of land near Tampa, Florida for residential and commercial use. Saddlebrook Village, a 2,000 acre parcel of land nearby, is approved for development as a master planned community. Saddlebrook Corporate Center, a nearby 450 acre parcel, was originally planned as a business park for mixed use development, although the partial conversion to a residential community is being considered due to the demand for residential housing. Principal competition comes from other residential and commercial developments in Florida.\nThe Company owns 8,606,085 shares of Cylink Corporation (Cylink) a leading supplier of network information security products that enable the secure transmission of data over private local area networks and wide area networks and public packet switched networks, such as the Internet. Cylink further offers a line of spread spectrum radio products that are used for wireless voice and data communications. The Company also owns 4,157,375 shares of United States Satellite Broadcasting Company Inc. (USSB), a company which provides subscription television programming via high-power direct broadcast satellite to households throughout the Continental U.S. Both of these companies made initial public offerings of their respective stocks in February of 1996. Additionally, the Company has approximately an\n11% interest in a joint venture that develops wireless signaling equipment for communication between fixed points.\nThe Company has a limited partnership interest in a real estate developer with major commercial and residential high rise properties in Chicago, Dallas, Los Angeles and Boston. See Item 7 of this Form 10-K. The Company also has invested, as a 5% limited partner, in four rental apartment complexes located in Chicago, Indianapolis and Washington, D.C. which provide certain tax advantages.\nOther Information\nPatents and Trademarks -\nWhile the Company owns or is licensed under a number of patents which are cumulatively important to each of its business units, the loss of any single patent or group of patents would not have a material adverse effect on the Company's overall business.\nProducts manufactured by the Company are sold primarily under its own trademarks and tradenames. Some products purchased and resold by the Company's alarm and security products business are sold under the Company's tradenames while others are sold under tradenames owned by its suppliers.\nCustomers -\nNeither of the Company's industry segments is dependent upon a single customer or a few customers. The loss of any one or more of these customers would not have a material adverse effect on the Company's results of operations.\nResearch and Development -\nThe Company is engaged in programs to develop and improve products as well as develop new and improved manufacturing methods. Expenditures for Company sponsored research and development activities in the alarm and other security products segment were $16.6 million in 1995, $11.8 million in 1994 and $10.8 million in 1993. These costs, which are expensed in the Company's consolidated income statement, were associated with a number of products in varying stages of development, none of which represents a significant item of cost or is projected to be a significant addition to the Company's line of products.\nProduct Liability -\nDue to the nature of the alarm security business, the Company has been, and continues to be, subjected to numerous claims and lawsuits alleging defects in its products. This exposure has been lessened by the sale of First Alert\/BRK Electronics. It is likely, due to the present litigious atmosphere in the United States, that additional claims and lawsuits will be filed in future years. The Company believes that it maintains sufficient insurance to cover this exposure.\nWhile it believes that resolution of existing claims and lawsuits will not have a material adverse effect on the Company's financial statements, management is unable to estimate the financial impact of claims and lawsuits which may be filed in the future.\nEnvironmental Matters -\nThe Company anticipates that compliance with various laws and regulations relating to protection of the environment will not have a material effect on its capital expenditures, earnings or competitive position.\nEmployees -\nAt December 31, 1995, there were approximately 6,000 persons employed by the Company, including 4,800 employed in the United States. Approximately 1,200 of the employees working in the United States were represented by labor unions. The Company considers its relations with its employees and the unions representing its employees to be good.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nFinancial information concerning foreign and domestic operations and export sales is set forth in Note 13 (\"Segment Information\") to the Consolidated Financial Statements contained in the 1995 Annual Report to Stockholders, pages 41-42, which Note is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal properties and their general characteristics are as follows: Principal Lease Approximate Location Use Expiration Square Feet Alarm and Other Security Products Segment- Syosset, New York (1) N\/A 340,000 Syosset, New York (3) 1997 14,000 Syosset, New York (1) 1997 6,000 Syosset, New York (1) 2000 17,000 Syosset, New York (1) 2014 10,000 Torrance, California (1) 1998 48,000 Miami, Florida (2) 2000 14,000 El Paso, Texas (2) 2001 19,000 Louisville, Kentucky (3) 2001 4,000 Raleigh, North Carolina (1) 1998 8,000 Northford, Connecticut (1) N\/A 179,000 St. Charles, Illinois (1) 2003 158,000 St. Charles, Illinois (1) 2004 50,000 West Chicago, Illinois (1) 1998 21,000 Norcross, Georgia (3) 1998 6,000 Melbourne, Australia (2) 1998 5,000 Sydney, Australia (2) 1998 25,000 Alleur, Belgium (2) 1997 5,000 Toronto, Canada (2) 1998 7,000 Concord, Ontario, Canada (2) 1997 7,000 Brighton, England (1) 1997 24,000 Lichfield Staffs, England (4) 2014 20,000 East Kilbride, Scotland (1) N\/A 15,000 Hilden, Germany (2) 1999 8,000 Tsuen Wan, TN, Hong Kong (2) 1997 5,000\nPrincipal Lease Approximate Location Use Expiration Square Feet Alarm and Other Security Products Segment- (continued) Milan, Italy (1) N\/A 14,000 Milan, Italy (2) 2001 8,000 Trieste, Italy (1) N\/A 40,000 Juarez, Mexico (4) 1999 68,000 Madrid, Spain (2) 2000 8,000 Barcelona, Spain (2) 2005 6,000\nDistribution Centers Hub Locations: Atlanta, Georgia (2) 2005 29,000 Boston, Massachusetts (2) 1999 14,000 Los Angeles, California (2) 1999 30,000 Chicago, Illinois (2) 2005 40,000 Clearwater, Florida (2) 2004 27,000 Memphis, Tennessee (2) 2006 15,000 Fairfield, New Jersey (2) 1996 16,000 Richmond, Virginia (2) 2004 14,000 Louisville, Kentucky (2) 1999 60,000 Phoenix, Arizona (2) 2004 15,000 Toronto, Canada (2) 1997 11,000\nPublishing Segment- Cleveland, Ohio (3) 2000 179,000 Cleveland, Ohio (2) 1996 30,000 Berea, Ohio (5) N\/A 100,000 New York, New York (3) 2000 10,000 Dunedin, Florida (3) 2000 8,000 Safety Harbor, Florida (1) 1997 19,000 Tampa, Florida (5) 1999 30,000\nGeneral Corporate- Chicago, Illinois (3) 2001 12,000\nOther properties in the alarm and other security products segment include 82 full-line convenience centers in addition to those hub locations listed above which function as retail-like sales distribution outlets to serve the North American market. These 82 centers are under leases expiring through 2002 and range in size from 1,500 to 11,500 square feet. Other properties in the publishing segment include 12 sales and\/or editorial offices under leases expiring through 2003 located in major cities throughout the United States. The Company believes the above facilities are adequate for its present needs.\n(1) Offices, Manufacturing and Warehousing (2) Warehousing (3) General Offices (4) Manufacturing (5) Printing N\/A Not applicable - facilities are owned by the Company\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn May 10, 1989, the Circuit Court of the Sixth Judicial Circuit in and for Pasco County, Florida, entered a judgment against Saddlebrook Resorts, Inc. (\"Saddlebrook\"), a former subsidiary of the Company, in a lawsuit which arose out of the development of Saddlebrook's resort and a portion of the adjoining residential properties owned and currently under development by the Company. The lawsuit (James H. Porter and Martha Porter, Trustees, et al. vs. Saddlebrook Resorts, Inc. and The County of Pasco, Florida; Case No. CA83- 1860), alleges damage to plaintiffs' adjoining property caused by surface water effects from improvements to the properties. Damages of approximately $8 million were awarded to the plaintiffs and an injunction was entered requiring, among other things, that Saddlebrook work with local regulatory authorities to take corrective actions. Saddlebrook made two motions for a new trial, based on separate grounds. One such motion was granted on December 18, 1990. Such grant was appealed by the plaintiffs. The other such motion was denied on February 28, 1991. Saddlebrook appealed such denial. The appeals were consolidated, fully briefed and heard in February 1992. Saddlebrook received a favorable ruling on March 18, 1992, dismissing the judgment and remanding the case to the Circuit Court for a new trial. An agreed order has been entered by the Court preserving the substance of the injunction pending final disposition of this matter. As part of its plan to comply with the agreed order, Saddlebrook filed applications with the regulatory agency to undertake various remediation efforts. Plaintiffs, however, filed petitions for administrative review of the applications, which administrative hearing was concluded in February 1992. On March 31, 1992, the hearing officer issued a recommended order accepting Saddlebrook's expert's testimony. The agency's governing board was scheduled to consider this recommended order on April 28, 1992, however, shortly before the hearing, the plaintiffs voluntarily dismissed their petitions and withdrew their challenges to the staff's proposal to issue a permit.\nAt the April 28, 1992 hearing the governing board closed its file on the matter and issued the permits. Saddlebrook appealed the board's refusal to issue a final order. On July 9, 1993 a decision was rendered for Saddlebrook remanding jurisdiction to the governing board for further proceedings, including entry of a final order which was issued on October 25, 1993. The plaintiffs appealed the Appellate Court decision to the Florida Supreme Court and appealed the issuance of the final order to the Second District Court of Appeals. The Florida Supreme Court heard the appeal on May 3, 1994 and denied plaintiffs' appeal. The other appeal was voluntarily dismissed by the plaintiffs on June 17, 1994. On remand to the trial court, Saddlebrook's motion for summary judgment, based on collateral estoppel on the ground that plaintiffs' claims were fully retried and rejected in a related administrative proceeding was granted on December 7, 1994. Plaintiffs filed for a rehearing which was denied. Plaintiffs have appealed the trial court's decision granting summary judgment.\nUntil October 14, 1989, Saddlebrook disputed responsibility for ultimate liability and costs (including costs of corrective action). On that date, the Company and Saddlebrook entered into an agreement with regard to such matters. The agreement, as amended and restated on July 16, 1993, provides for the Company and Saddlebrook to split equally the costs of the defense of the litigation and the costs of certain related litigation and proceedings, the costs of the ultimate judgment, if any, and the costs of any mandated remedial work. Subject to certain conditions, the agreement\npermits Saddlebrook to obtain subordinated loans from the Company to enable Saddlebrook to pay its one-half of the costs of the latter two items. No loans have been made to date.\nThe Company believes that the ultimate outcome of the aforementioned lawsuit 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\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market For Registrant's Common Equity and Related Stock- holder Matters\nThe information set forth under the heading \"Market Prices, Security Holders and Dividend Information\" appearing on page 45 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 set forth under the heading \"Supplemental Information -Five Year Summary of Selected Financial Data\" appearing on page 44 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 set forth under the heading \"Management's Discussion and Analysis\" appearing on pages 46-47 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 Company's Consolidated Financial Statements and Summary of Accounting Policies and Notes thereto, together with the report thereon of Price Waterhouse LLP dated February 21, 1996, appearing on pages 29-43 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\nInformation required to be furnished in this part of the Form 10-K has been omitted because the Registrant will file with the Securities and Exchange Commission a definitive proxy statement pursuant to Regulation 14A under the Securities Exchange Act of 1934 not later than April 30, 1996.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information set forth under the headings \"Nominees for Election by the Holders of Class A Stock\", \"Nominees for Election by the Holders of Common Stock\", \"Executive Officers\" and \"Section 16(a) Reports\" in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on May 9, 1996 is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the headings \"Compensation Committee Interlocks and Insider Participation\", \"Compensation\", \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\" in the Registrant's Proxy Statement for the annual meeting of stockholders 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\nThe information set forth under the heading \"Security Ownership of Certain Beneficial Owners and Management\" in the Registrant's Proxy Statement for the annual meeting of stockholders to be held on 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 headings \"Certain Transactions\" (and the information set forth under the heading \"Compensation Committee Interlocks and Insider Participation\" which is cross-referenced under the heading \"Certain Transactions\") in the Registrant's Proxy Statement 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 Schedules and Reports on Form 8-K\n(a) Financial statements and financial statement schedule filed as a part of this report are listed in the Index to Consolidated Financial Statements and Financial Statement Schedules on page 13 of this Form 10-K and are incorporated herein by reference.\nExhibits required by Item 601 of Regulation S-K are listed in the Index to Exhibits on pages 16-17 of this Form 10-K, which is incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an Exhibit to this report pursuant to Item 14 (c) of Form 10-K is so identified on the Index to Exhibits.\n(b) Reports on Form 8-K: The registrant announced a potential significant increase in the value of its investments in United States Satellite Broadcasting, Inc. and Cylink Corporation in a filing on Form 8-K dated December 21, 1995.\nThe registrant announced a three for two stock split in its Common and Class A stock in a filing on Form 8-K dated January 23, 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.\nPITTWAY CORPORATION (Registrant)\nBY \/s\/ Paul R. Gauvreau Paul R. Gauvreau Financial Vice President and Treasurer Date: 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 indicated on March 27, 1996.\n\/s\/ Neison Harris \/s\/ Anthony Downs Neison Harris, Director and Anthony Downs, Director Chairman of the Board\n\/s\/ King Harris \/s\/ Leo A. Guthart King Harris, Director, President Leo A. Guthart, Director and Chief Executive Officer\n\/s\/ Paul R. Gauvreau \/s\/ Irving B. Harris Paul R. Gauvreau, Principal Irving B. Harris, Director Financial and Accounting Officer\n\/s\/ Eugene L. Barnett \/s\/ William W. Harris Eugene L. Barnett, Director William W. Harris, Director\n\/s\/ Sidney Barrows \/s\/ Jerome Kahn, Jr Sidney Barrows, Director Jerome Kahn, Jr., Director\n\/s\/ Fred Conforti \/s\/Leo F. Mullin Fred Conforti, Director Leo F. Mullin, Director\n\/s\/ E. David Coolidge III E. David Coolidge III, Director\nPITTWAY CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following documents are filed as a part of this report:\nPage reference in Annual Report to Stockholders\nFinancial Statements required by Item 8 of this Form:\nConsolidated Balance Sheet at December 31, 1995 and 1994........................................ 30-31 For each of the three years ended December 31, 1995 - Consolidated Statement of Income................... 29 Consolidated Statement of Cash Flows............... 32 Consolidated Statement of Stockholders' Equity..... 33 Summary of Accounting Policies and Notes to Consolidated Financial Statements.................... 34-42 Report of Independent Accountants...................... 43\nPage reference in Form 10-K\nFinancial Statement Schedule required by Article 12 of Regulation S-X:\nReport of Independent Accountants on Financial Statement Schedule................................... 14 Consolidated Financial Statement Schedule - II. Valuation and Qualifying Accounts............... 15\nThe consolidated financial statements of Pittway Corporation, listed in the above index together with the Report of Independent Accountants, which are included in the Company's 1995 Annual Report to Stockholders, are incorporated herein by reference.\nAll other schedules have been omitted because the required information is not present, or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto. Summarized financial information for the limited real estate partnerships and other ventures is omitted because, when considered in the aggregate, they do not constitute a significant subsidiary.\nWith the exception of the aforementioned information and information incorporated by reference in Part I (in Item 1) and Part II (in Items 5, 6, 7 and 8) of this Form 10-K, the Company's 1995 Annual Report to Stockholders is not deemed to be filed as part of this report.\nReport of Independent Accountants on Financial Statement Schedule\nTo the Board of Directors of Pittway Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 21, 1996 appearing on page 43 of the 1995 Annual Report to Stockholders of Pittway 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 on page 13 of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nAs discussed in Notes 5 and 7 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes and for postretirement benefits other than pensions.\n\/s\/ Price Waterhouse LLP Price Waterhouse LLP\nChicago, Illinois February 21, 1996\nINDEX TO EXHIBITS\nSequential Number and Description of Exhibit Page Number***\n3.1 Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 of the Registrant's Annual Report on Form 10-K for the year ended February 29, 1988).\n3.2 Certificate of Amendment to Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 4.2 of the Registrant's Form S-8 Registration Statement No. 33 - 33312 filed with the Commission on February 2, 1990).\n3.3 Bylaws of Registrant, as amended (incorporated by reference to Exhibit 3.3 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995).\n4. Composite Conformed Copy of separate Note Purchase Agreements Dated as of December 15, 1995, each, between the Registrant and one of Metropolitan Life Insurance Company, Metropolitan Property and Casualty Insurance Company, Nationwide Life Insurance Company, Employers Life Insurance Company of Wausau, and West Coast Life Insurance Company without exhibits.\n10.1 Pittway Corporation 1990 Stock Awards Plan, as amended, (incorporated by reference to Exhibit 4.4 to the Registrant's Form S-8 Registration Statement No. 33 - 54753 filed with the Commission on July 27, 1994).\n10.2 Agreement of employment dated as of July 1, 1990 with Sal F. Marino, as amended (incorporated by reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.)**\n10.3 Second Extension and Amendment of Agreement of Employment with Sal F. Marino dated December 31, 1993 (incorporated by reference to Exhibit 10.4 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)**\n10.4 Third Extension and Amendment of Agreement of Employment with Sal F. Marino dated December 31, 1994 (incorporated by reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)**\nINDEX TO EXHIBITS - cont'd.\nSequential Number and Description of Exhibit Page Number***\n10.5 Fourth Extension and Amendment of Agreement of Employment with Sal F. Marino dated December 31, 1995.**\n10.6 Employment Agreement with King Harris dated as of January 1, 1996.**\n10.7 Employment Agreement with Leo A. Guthart dated as of January 1, 1996.**\n13. 1995 Annual Report to Stockholders.*\n21. Subsidiaries of the Registrant.\n23. Consent of Independent Accountants.\n27. Financial Data Schedule (submitted only in electronic format).\n* Such report, except to the extent incorporated herein by reference, is being furnished for the information of the Securities and Exchange Commission only and is not to be deemed filed as a part of this Form 10-K.\n** This document is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14 (c) of Form 10-K.\n*** This information appears only in the manually signed original of this Form 10-K.","section_15":""}
{"filename":"758004_1995.txt","cik":"758004","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nNovell, Inc. (\"Novell\" or the \"Company\") is a leading provider of network software. Novell software products provide the infrastructure for a networked world, enabling customers to connect with other people and the information they need, anytime and anyplace. Novell partners with other technology and market leaders to make networks an integral part of everyday life.\nThe Company was incorporated in Delaware on January 25, 1983. Novell's executive offices are located at 1555 North Technology Way, Orem, Utah 84057. Its telephone number at that address is (801) 222-6000.\nThe Company markets its products through 40 U.S. and 60 international sales offices. The Company sells its products primarily to distributors and national retail chains, who in turn sell the Company's products to retail dealers. The Company also sells its products to OEMs, system integrators, and VARs as well as direct to large corporations.\nThe Company primarily conducts product development activities in San Jose, California; Summit, New Jersey; and Orem and Provo, Utah. It also contracts out some product development activities to third-party developers.\nOver the past several years, the Company has issued common stock or paid cash to acquire technology companies, invested cash in other technology companies, and formed strategic alliances with still other technology companies. Novell undertook these transactions to promote a pervasive computing environment, and in many cases to also broaden the Company's business as a system and application software supplier.\nIn June 1993, the Company acquired UNIX System Laboratories, Inc. (USL) by issuing approximately 11 million shares Novell common stock valued at $332 million in exchange for all of the outstanding stock of USL not previously owned by Novell and assumed liabilities of $9 million. The transaction was accounted for as a purchase and, on this basis, resulted in a one-time write-off of $269 million for purchased research and development in the third quarter of fiscal 1993.\nIn June 1994, the Company completed a merger with WordPerfect Corporation (WordPerfect), whereby WordPerfect was merged into Novell. Approximately 51 million shares of Novell common stock were exchanged for all of the outstanding common stock of WordPerfect. In addition, the outstanding employee stock options to purchase WordPerfect common stock were converted into options to purchase approximately 8 million shares of Novell common stock. The transaction was accounted for as a pooling of interests and therefore all prior financial statements incorporated by reference herein have been restated as if the merger took place at the beginning of such periods.\nAdditionally, in June 1994, the Company acquired from Borland International, Inc. (Borland) its Quattro Pro spreadsheet product line for $110 million of cash and assumed liabilities of $10 million, and purchased a three-year license to reproduce and distribute up to one million copies of current and future versions of Borland's Paradox relational database product for $35 million of cash. The transaction was accounted for as a purchase and, on this basis, resulted in a one-time write-off of $114 million for purchased research and development.\nOn October 30, 1995, the Company announced its intention to sell its personal productivity applications product line. Novell's personal productivity applications product line was acquired in the WordPerfect and Quattro Pro transactions. Certain other acquired product lines such as GroupWise are not being sold. The Company is actively negotiating with several parties regarding the sale of the personal productivity applications product line and anticipates that it will announce a sale in early 1996.\nOn December 6, 1995, Novell completed the sale of its UnixWare product line to the Santa Cruz Operation, Inc. (SCO). The Company expects to report a gain on this transaction in the first quarter of fiscal 1996. Under the agreement, Novell received approximately 6.1 million shares of SCO common stock,\nresulting in an ownership position of approximately 17% of the outstanding SCO common stock. The agreement also calls for Novell to receive a revenue stream from SCO based on revenue performance of the purchased UnixWare product line. This revenue stream is not to exceed $84 million net present value, and will end by the year 2002. In addition, Novell will continue to receive revenue from existing licenses for older versions of UNIX System source code.\nBUSINESS STRATEGY\nNovell believes that the definition of computer networks is changing as traditional stand-alone computer resources and new categories of computing devices increasingly become integrated across networks. Networks are expanding into every area of life, providing access to valuable information wherever people work, live, or travel. In the process, the boundaries of geography and technology that once separated private and public data networks are falling away to create a single information resource for businesses and consumers.\nThe Company sees its business opportunity in providing software to enable this convergence of networks into a managed Internet or Smart Global Network providing access to information anytime, anyplace. It has enhanced its NetWare network operating system products to make networks smart -- affordable to own and operate, easy to manage and use, and capable of connecting heterogeneous systems. It has also expanded its product line beyond NetWare to include products for accessing, managing, and interconnecting smart networks, and for extending networks beyond personal computer workgroups to connect office equipment such as printers and fax machines, industrial controls, utility meters, cable TV set-top boxes, and other intelligent devices.\nThe Company believes that the convergence of information resources in the Smart Global Network is shifting the value of information technology from the power of stand-alone systems to the ability of systems to connect into the network. Together with its partners, the Company intends to be a driving force in expanding the value of networks for customers worldwide.\nTECHNOLOGIES\nMaking Networks Smart. Novell delivers advanced network services in the NetWare network operating system and in compatible products that add functionality for administrators and end users. These services add intelligence to the network to reduce costs of ownership and administration, simplify management tasks for administrators, and make access to network-based information easier for end users. In the first release of NetWare eleven years ago, those services were file and print only. Over the past decade the services provided by Novell and third parties have expanded significantly to include directory, network and systems management, messaging, multiprotocol routing, and security. The Company's NetWare 4 operating system includes NetWare Directory Services (NDS), a distributed database of users, network equipment, computer systems, and other network resources. NDS provides centralized network management, security, and information access capabilities to enable organizations to efficiently maintain and expand complex networks. The capabilities of NDS are also integrated with compatible Novell network software products and over 140 third-party solutions. An additional Novell product, the TUXEDO System, provides tools to help customers develop and deploy transaction-intensive client\/server applications for distribution across networks. The Company shipped its first product integrating TUXEDO with NetWare and NDS in 1995.\nInterconnecting Smart Networks. Novell is developing network software to support NetWare Connect Services (NCS), a managed class of wide-area networking and Internet services made available to customers through major telecommunications carriers. These services enable organizations to out-source the complexity and some of the cost of maintaining wide-area networks, to make Internet access more manageable, reliable, and secure, and to extend local-area-networks beyond the immediate enterprise to support communication and collaboration with customers, partners, and suppliers. Novell in partnership with AT&T made the service available in the U.S. in 1995. International partners Deutsche Telecom, Telstra, NTT, and UniSource will be among the first to make the service widely available in Europe and the Pacific Rim in 1996. NCS partners worldwide are cooperating to provide interoperability among their networks and maintain a common directory for the service based on NetWare Directory Services.\nExtending Networks Beyond Personal Computer Workgroups. The NetWare network operating system and related Novell products provide a platform for extending networks beyond traditional personal computer local-area networks (LANs) and integrating diverse technologies. This includes the seamless integration of multiple desktop systems and host environments. Novell believes that customer environments are inherently heterogeneous and therefore require an information system that integrates dissimilar technologies. The goal of Novell's strategy of integrating various desktop systems is to allow IBM, IBM-compatible, Apple Macintosh, and UNIX-based PCs and workstations to access and share simultaneously a common set of network resources and information. This gives customers the freedom to choose the desktop and application server systems that best fit their application requirements. In addition to the integration of desktops, host environments from vendors such as IBM, DEC, HP and Olivetti and numerous other UNIX system vendors are integrated into the NetWare network so that users can access host-based resources and information from their desktops across the network. Through Novell Embedded Systems Technology (NEST), the Company continues to extend NetWare services to connect office and industrial equipment, TV cable set-top boxes, electric utility energy management equipment, and a broad range of other intelligent devices. In addition, Novell is working with leading software developers and manufacturers to network computers and telephone PBX switches in a new class of integrated solutions.\nProviding Network Access. Novell network access products connect desktop PC and Macintosh users with applications and services that run on UNIX host computers and the Internet through TCP\/IP communications protocols. The company also provides dial-in client and server products for remote access to network resources. Novell mobile NetWare client technology allows users to maintain a virtual network on their portable computers, even when disconnected, and then synchronize files when they reconnect to the network. NetWare Web Server provides a complete add-on solution for NetWare 4 servers to support both internal communication and external publishing on the Internet's World Wide Web. A three dimensional network browser is also in development to provide point-and-click access to network services, electronic publishing that simplifies creation and access to network-based information, and intelligent browsing capabilities for accessing distributed network resources. Novell products also include the GroupWise family of workgroup collaboration products for electronic mail, calendaring and scheduling, document management and forms processing. The Company is expanding the functionality of GroupWise in 1996 for greater integration with network directories, management and Internet access applications.\nPROGRAMS\nTechnical Support Alliance. In May 1991 Novell announced the formation of the Technical Support Alliance (TSA), with 40 current members including Apple, Compaq, Hewlett-Packard, Intel, IBM, Lotus, Microsoft, and Oracle. The TSA was organized to provide one-stop multivendor support. Member companies provide cooperative efforts to support their customers.\nCertified Novell Engineer Program. Through the Certified Novell Engineer (CNE) program, Novell is strengthening the networking industry's Level I support self-sufficiency. CNEs are individuals who receive high-level training, information, and advanced technical telephone support (Level II) from Novell. CNEs may be employed by resellers, independent support organizations, or Novell Support Organizations (NSOs). The NSO program pools the capabilities of the industry's best support providers. NSOs have contractual agreements with Novell that are designed to ensure quality service on a national or global level for NetWare, UnixWare, and other Novell products.\nNovell Authorized Education Centers. Novell offers education to end users through nearly 1,300 independent Novell Authorized Education Centers (NAECs) worldwide, which use Novell-developed courses to instruct students in the use and maintenance of Novell products. Novell also offers self-paced training products.\nNovell Labs. Through its Independent Manufacturer Support Program (IMSP), Novell works with third-party manufacturers to test and certify hardware and software components designed to interoperate with the NetWare and UnixWare operating systems. Novell distributes these test results to inform customers about products that have formally demonstrated NetWare and UnixWare compatibility. In effect, IMSP certifica-\ntion programs help vendors to market their products through Novell's distribution channels. The primary goal of IMSP is to foster working relationships between Novell and third-party hardware and software suppliers. Secondary goals include promoting certified products to industry resellers, anticipating industry products' direction through comarketing efforts, and working with vendors to codevelop critical network components.\nDeveloperNet Novell delivers products, software development kits, information, and support services to software developers through the DeveloperNet subscription program, its primary communications channel to the developer community. Over 1,000 independent software vendors and corporate developers now subscribe to the program. Novell launched DeveloperNet in September 1995 as part of its renewed network focus and initiative code-named Net2000 to provide developers with common interfaces to a rich set of network services.\nPARTNERSHIPS\nDevelopment Partners. When customers request a new service or function be added to Novell products, Novell investigates the most effective way to deliver that functionality to the user. Very often the best way is for Novell to partner with a company who has expertise in that specific area. By partnering, the combination of Novell's core expertise in networks and the partner's expertise in the given product area combine to deliver a better solution faster than if Novell would have attempted to develop it alone.\nSystems Partners. Novell partners with companies who have complimentary software and hardware. The resulting solution is a powerful combination of products that deliver enterprise-wide connectivity solutions. These partners include system suppliers like IBM, DEC and HP, as well as system integration experts like Memorex Telex, Arthur Andersen, and EDS.\nApplication Partners. Novell works very closely with application developers to provide integrated software products and support for end users. As network applications grow in importance, this program will help assure broad availability of well integrated multivendor applications.\nEnterprise Consulting Partners. This select group of the industry's leading systems integrators and consulting organizations work with Novell to deliver distributed client\/server solutions for customers with large enterprise-wide networks.\nMultiple Channel Distribution Network. The Company markets its products through a broad range of distributors, dealers, value added resellers, systems integrators, and OEMs as well as to major end users.\nWorldwide Service and Support. The Company is committed to providing service and support on a worldwide basis to its resellers and to their end-user customers. The Company has established agreements with third party service vendors to expand and complement the service provided directly by the Company's service personnel and the Company's resellers.\nNOVELL PRODUCTS\nThe Company's products fall within three categories: systems software, information access and management products, and groupware. Novell products work together, interoperate with thousands of third-party solutions, and span data networks from workgroup LANs to the Internet.\nSystems Products provide a foundation of network services that can be extended across heterogeneous computing platforms and intelligent devices in the Smart Global Network. These products include the NetWare 3 network operating system, which provides users with access to data and resources controlled by a single server, and the more advanced NetWare 4, which features NetWare Directory Services and provides the user with access to the resources of the entire enterprise or wide-area network. The Company also offers NetWare Symmetrical Processing for use on cost-effective multiprocessor hardware that can be readily scaled to meet the requirements of large and complex networks. Novell system software also includes development kits to enable manufacturers to embed Novell Embedded Systems Technology in microprocessor-based products. In addition, the Company develops and markets the TUXEDO System for the development and deployment of distributed client\/server applications.\nInformation Access and Management Products extend and leverage NetWare services to enable customers to access and manage data, applications and resources distributed across enterprise networks and the Internet. These products include the LAN Workplace TCP\/IP solution for connecting personal computer users to UNIX systems and the Internet ; the ManageWise strategic management solution for end-to-end management of the Novell environment; the LANalyzer monitoring and analysis tool for troubleshooting NetWare networks; the NetWare Connect server product and NetWare Mobile client product for remote access to network resources; the NetWare Navigator for centralized, automated software and data distribution for Novell networks; the NetWare for SAA solution for connecting NetWare and IBM mainframe environments, and other host connectivity products. In addition, the Company's NetWare Telephony Services platform and Telephony Services API (TSAPI) enable customers to connect computer and telephone PBX systems in integrated network solutions.\nNovell information access and management products are also integral to the NetWare Connect Service, the secure business Internet made available in the U.S. by AT&T. The Company also offers PerfectWorks products that combine network access technology with PC applications and thus bring networking to small-office and home-office users.\nGroupware Products utilize NetWare network services to provide rich access to network-based information. The Company's GroupWise family of groupware products now serves over 5 million users with integrated E-Mail, group calendaring, scheduling, online conferencing, forms and document management. GroupWise integrates these capabilities along with Internet E-mail, fax and voice messages in a \"Universal In-Box\" for network-based communication and collaboration.\nPRODUCT DEVELOPMENT\nDue to the rapid pace of technological change in its industry, the Company believes that its future success will depend, in part, on its ability to enhance and develop its software products to satisfactorily meet dynamic market needs.\nDuring fiscal 1995, 1994, and 1993, product development expenses were approximately $368 million, $347 million, and $290 million, respectively. The Company's product development effort consists primarily of work performed by employees; however, the Company also utilizes third-party technology partners to assist with product development.\nSALES AND MARKETING\nNovell markets its NetWare family of network products, the UnixWare operating system and its personal productivity applications products through distributors, dealers, vertical market resellers, systems integrators, and OEMs who meet the Company's criteria, as well as to major end users. In addition, the Company conducts sales and marketing activities and provides technical support, training, and field service to its customers from its offices in San Jose, California; Summit, New Jersey; Provo and Orem, Utah; and from its 40 U.S. and 60 international sales offices.\nDistributors. Novell has established a network of independent distributors, which resell the Company's products to dealers, VARs, and computer retail outlets. As of December 31, 1995, there were approximately 15 U.S. distributors and approximately 80 international distributors.\nDealers. The Company also markets its products to large-volume dealers and regional and national computer retail chains.\nVARs and Systems Integrators. Novell also sells directly to value added resellers and systems integrators who market data processing systems to vertical markets, and whose volume of purchases warrants buying directly from the Company.\nOEMs. The Company licenses its systems software to domestic and international OEMs for integration with their products. With the acquisition of USL, the number of OEM agreements has increased significantly, both domestically and internationally.\nEnd Users. Generally, the Company refers prospective end-user customers to its resellers. However, the Company has the internal resources to work directly with major end users and has developed U.S. and international master license agreements with approximately 450 of them to date. Additionally, some upgrade products are sold directly to end users.\nInternational Sales. In fiscal 1995, 1994, and 1993, approximately 47%, 43%, and 43%, respectively, of the Company's net sales were to customers outside the U.S. -- primarily distributors. To date, substantially all international sales except Japanese sales, Indian sales, and certain European sales to non-multinational distributors that were shipped from a new distribution center in Dublin, Ireland have been invoiced by the Company in U.S. dollars. In fiscal 1996 the Company anticipates that a substantial portion of international revenues will continue to be invoiced in U.S. dollars. The exceptions to the U.S. dollar invoicing will be Japanese sales through the Company's joint venture in Japan, Indian sales through the Company's joint venture in India and its distribution center in Dublin, Ireland. No one foreign country accounted for more than 10% of net sales in any period. In fiscal 1995 and 1994, the Company had one multinational distributor, which accounted for 15% and 12% of revenue, respectively. The Company had two multinational distributors, which accounted for 15% and 11% of revenue in fiscal 1993. Otherwise, no customer accounted for more than 10% of revenue in any period.\nMarketing. The Company's marketing activities include distribution of sales literature and press releases, advertising, periodic product announcements, support of NetWare user groups, publication of technical and other articles in the trade press, and participation in industry seminars, conferences, and trade shows. The marketing departments of the Company employ many technical laboratories which test and evaluate networked computer equipment and individual devices. The knowledge derived from these laboratories is the basis for the technical publications published by the Company. These activities are designed to educate the market about local area networks in general, as well as to promote the Company's products. Through the Professional Developers Program, the Company strongly supports independent software and hardware vendors in developing products that work on Novell networks. Thousands of multiuser application software packages are now compatible with the NetWare operating system. In March 1995, the eleventh annual BrainShare Conference (formerly Developers' Conference) was held to inform and educate developers about Novell product strategy, Novell open architecture programming interfaces, and Novell third-party product certification programs.\nSERVICE, SUPPORT, AND EDUCATION\nThe purpose of any service program is to help users get the most out of the products they buy. Novell offers a variety of support alternatives and encourages users to select the services that best meet their needs. These include the worldwide service and support organization, the Technical Support Alliance, the Certified Novell Engineer program, Novell Authorized Education Centers, the Independent Manaufacturer Support Program, and the Client-Server Testing Program.\nMANUFACTURING SUPPLIERS\nThe Company's products, which consist primarily of software diskettes and manuals, are duplicated by outside vendors. This allows the Company to minimize the need for expensive capital equipment in an industry in which multiple high-volume manufacturers are available.\nBACKLOG\nLead times for the Company's products are typically short. Consequently, the Company does not believe that backlog is a reliable indicator of future sales or earnings. The absence of significant backlog may contribute to unpredictability in the Company's net income and to fluctuations in the Company's stock price. See \"Factors Affecting Earnings and Stock Price.\" The Company's backlog of orders at January 20, 1996, was approximately $112 million, compared with $51 million at January 20, 1995.\nCOMPETITION\nNovell competes in the highly competitive market for computer software. Novell believes that the principal competitive factors are technical innovation to meet dynamic market needs, hardware independence and compatibility, marketing strength, system\/performance, customer service and support, reliability, ease of use, price\/performance, and connectivity with minicomputer and mainframe hosts.\nThe market for computer software, has become increasingly competitive due to Microsoft's growing presence in all sectors of the software business. The Company does not have the product breadth and market power of Microsoft. Microsoft's dominant position provides it with competitive advantages, including the ability to unilaterally determine the direction of future operating systems and to leverage its strength in one or more product areas to achieve a dominant position in new markets. This position may enable Microsoft to increase its market position even if the Company succeeds in introducing products with performance and features superior to those offered by Microsoft.\nMicrosoft's ability to offer networking functionality in future versions of MS Windows and MS Windows NT and in any other Microsoft operating systems and application software, or to provide incentives to customers to purchase certain products in order to obtain favorable sales terms or necessary compatibility or information with respect to other products, may significantly inhibit the Company's ability to maintain its business. Moreover, Microsoft's ability to offer products on a bundled basis can be expected to impair the Company's competitive position with respect to particular products. In addition, as Microsoft creates new operating systems and applications, there can be no assurance that Novell will be able to ensure that its products will be compatible with those of Microsoft.\nAs the Company sharpened its focus, it decided to sell two lines of business -- UnixWare and the WordPerfect personal productivity applications, which did not contribute to Novell's network focus. Even with a sharpened focus, the Company is aware of several new competitive operating systems currently under development and scheduled for introduction within the next year and beyond. If any of these competing products achieves market acceptance, Novell's business and results of operations could be materially adversely affected.\nLICENSES, PATENTS AND TRADEMARKS\nThe Company 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. Additionally, the Company has numerous patents pending. No assurance can be given that such patents pending will be issued or, if issued, will provide protection for the Company's competitive position. Although Novell intends to protect its 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 the Company 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. The loss of patent protection on the Company's technology or the circumvention of its patent protection by competitors could have a material adverse effect on the Company's ability to compete successfully in its products business.\nThe software industry is characterized by frequent litigation regarding copyright, patent and other intellectual property rights. The Company has from time to time had infringement claims asserted by third parties against it and its products. While there are no known or pending threatened claims against the Company, the unsatisfactory resolution of which would have a material adverse effect on the Company's results of operations and financial condition, there can be no assurance that such third party claims will not be asserted, or if asserted, will be resolved in a satisfactory manner. In addition, there can be no assurance that third parties will not assert other claims against the Company with respect to any third-party technology. In the event of litigation to determine the validity of any third-party claims, such litigation could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel, whether or not such litigation is determined in favor of the Company.\nIn the event of an adverse result in any such litigation, the Company 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 the Company would be successful in such development or that any such licenses would be available. In addition, the laws of certain countries in which Novell's products are or may be developed, manufactured or sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States.\nEMPLOYEES\nAs of December 31, 1995, the Company had 7,272 employees. The functional distribution of its employees was: sales and marketing -- 2,004; product development -- 2,556; general and administrative -- 972; service, support, education, and operations -- 1,740. Of these, 404 employees are located in U.S. field offices, and 1,733 employees are in offices outside the U.S. All other Company personnel are based at the Company's facilities in Utah, California, and New Jersey. None of the employees is represented by a labor union, and the Company considers its employee relations to be excellent.\nCompetition for qualified personnel in the computer industry is intense. To make a long-term relationship with the Company rewarding, Novell endeavors to give its employees and consultants challenging work, educational opportunities, competitive wages, sales commission plans, bonuses, and through stock option and purchase plans, opportunities to participate financially in the ownership and success of the Company.\nFACTORS AFFECTING EARNINGS AND STOCK PRICE\nIn addition to factors described above under \"Competition\" which may adversely affect the Company's earnings and stock price, other factors may also adversely affect the Company's earnings and stock price. The ability of the Company to maintain its competitive technological position will depend, in large part, on its ability to attract and retain highly qualified development and managerial personnel. Competition for such personnel is intense and there is a risk of departure due to the competitive environment in the software industry. The loss of a significant group of key personnel would adversely affect the Company's product development efforts.\nThe Company recently announced the sale of its UnixWare product line and its intention to sell its personal productivity application product line. The Company's ability to successfully transition out of these product lines in fiscal 1996 is important to the success of the Company. The extent that management can quickly devote most of its attention on its core business is important to the ongoing success of the Company.\nA reason the Company is seeking to sell its personal productivity applications product line is to reduce non-leveraged sales, marketing, and customer support expenditures. Nevertheless, the Company will retain the Groupware applications line and may incur relatively higher expenditures than are incurred in the sale of network operating systems.\nAs is common in the computer software industry, Novell has experienced delays in the introduction of new products, due to the complexity of software products, the need for extensive testing of software to ensure compatibility of new releases with a wide variety of application software and hardware devices and the need to \"debug\" products prior to extensive distribution. Significant delays in developing, completing or shipping new or enhanced products would adversely affect the Company.\nMoreover, the Company may experience delays in market acceptance of new releases of its products as the Company engages in marketing and education of the user base regarding the advantages and system requirements for the new products and as customers evaluate the advantages and disadvantages of upgrading. The Company has encountered these issues on each major new release of its products, and expects that it will encounter such issues in the future. Novell's ability to achieve desired levels of sales growth depends at least in part on the successful completion, introduction and sale of new versions of its products. There can be no assurance that the Company will be able to respond effectively to technological changes or new product announcements by others, or that the Company's research and development efforts will be successful. Should\nNovell experience material delays or sales shortfalls with respect to new product releases, the Company's sales and net income could be adversely affected.\nA fundamental goal of the Company will be the delivery of groupware application solutions combining network services and workgroup applications. The future success of this strategy will depend in part on the Company's ability to develop and market new competitive products for workgroup productivity and information processing. Development of these products has already required and will continue to require a substantial investment in research and development, particularly as a result of the decision to offer products across multiple operating environments. Although Novell's existing network of distributors should assist in this transition, marketing and distribution of these products may require developing new marketing and sales strategies and will entail significant expense. The Company has had only limited experience in the market for these products, and there can be no assurance that the Company will be successful in developing and marketing these new products.\nThe Company's future earnings and stock price could be subject to significant volatility, particularly on a quarterly basis. The Company's revenues and earnings may be unpredictable due to its shipment patterns. As is typical in the software industry, a high percentage of the Company's revenues are expected to be earned in the third month of each fiscal quarter and will tend to be concentrated in the latter half of that month. Accordingly, quarterly financial results will be difficult to predict and quarterly financial results may fall short of anticipated levels. Because the Company's backlog early in a quarter will not generally be large enough to assure that it will meet its revenue targets for any particular quarter, quarterly results may be difficult to predict until the end of the quarter. A shortfall in shipments at the end of any particular quarter may cause the results of that quarter to fall significantly short of anticipated levels. Due to analysts' expectations of continued growth and the historically high price\/earnings ratio at which Novell's Common Stock trades, any such shortfall in earnings can be expected to have an immediate and very significant adverse effect on the trading price of Novell's Common Stock in any given period. The past pattern of new application and operating system product introductions has caused revenues to fluctuate, sometimes significantly, on a quarter-by-quarter basis. Such revenue fluctuations may contribute to the volatility of the trading price of Novell Common Stock in any given period.\nIn addition, the market prices for securities of software companies have been volatile in recent years. The market price of Novell Common Stock, in particular, has been subject to wide fluctuations in the past. As a result of the foregoing factors and other factors that may arise in the future, the market price of Novell's Common Stock may be subject to significant fluctuations within a short period of time. These fluctuations may be due to factors specific to the Company, to changes in analysts' earnings estimates, or to factors affecting the computer industry or the securities markets in general.\nITEM 1A.","section_1A":"ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names, ages, titles with Novell, and present and past positions of the persons currently serving as executive officers of Novell.\nRobert J. Frankenberg joined the Company in April 1994 as President and Chief Executive Officer. In August 1994 he became Chairman of the Board of Directors. Prior to joining Novell, he was with Hewlett Packard, an international computation and measurement company, for 25 years in various engineering, management and marketing positions. Most recently he served as Vice President and General Manager of the Personal Information Products Group.\nMary M. Burnside joined the Company in January 1988 and in January 1989 she became Senior Vice President, Operations and was elected a corporate officer. In November 1991 she became Executive Vice President, Corporate Services Group. In August 1993 she joined the Office of the President as Chief Operating Officer. In April 1994 she became Executive Vice President and Chief Operating Officer.\nRichard W. King joined the Company in 1985 and became Vice President, Software Development in April 1986. In September 1987 he became Vice President, NetWare Products Division and in September 1991 he became Vice President, Service and Support. In August 1993 he was promoted to Executive Vice President, NetWare Systems Group and was elected a corporate officer.\nJoseph A. Marengi joined the Company in June 1989 through the Excelan merger and held various sales positions with the Company until October 1992 when he became Senior Vice President, Worldwide Sales. In August 1993 he was elected a corporate officer. In April 1994 he became Executive Vice President, Worldwide Sales.\nSteven Markman joined the Company in August 1994 as Executive Vice President, Information Access & Management Group. From March 1994 to August 1994 he was with First Pacific Networks, Inc., a cable telephony company as Vice President of Engineering. From April 1991 to February 1994 he was with Network Equipment Technologies, Inc., a network systems company as Senior Vice President and General Manager. From June 1988 to April 1991 he was with Hewlett Packard, an international computation and measurement company, where he served most recently as General Manager for the Information Networks Division.\nJames R. Tolonen, a Certified Public Accountant, joined the Company in June 1989 through the Excelan merger and became a Senior Vice President and Chief Financial Officer in August 1989 and was elected a corporate officer. In August 1993 he joined the Office of the President as Chief Financial Officer. In April 1994 he became Executive Vice President and Chief Financial Officer.\nJeffrey H. Waxman joined the Company in June 1995 as Executive Vice President, Applications Group. From December 1992 to June 1995 he was President and Chief Executive Officer of ServiceSoft Corporation, a developer of customer service software and hardware. From January 1992 to November 1992 he was an independent consultant in the software industry. From June 1988 to January 1992 he was President and CEO of Uniplex, Inc. a developer and publisher of core office technology for Open Systems.\nDavid R. Bradford joined the Company in October 1985 as Corporate Counsel. He became Corporate Secretary in January 1986, Senior Corporate Counsel in April 1986, and Senior Vice President, General Counsel, and Corporate Secretary in April 1989.\nChristine G. Hughes joined the Company in December 1994 as Senior Vice President, Corporate Marketing. From July 1991 to November 1994 she was with Xerox Corporation, a worldwide provider of document services, in various positions, most recently as Vice President, Integrated Marketing -- U.S. Operations. From January 1990 to July 1991 she was President of Myriad Technologies, a market research and consulting company.\nR. Duff Thompson joined the Company in June 1994 through the WordPerfect merger and became Senior Vice President, Corporate Development in October 1994 and was elected a corporate officer. He joined WordPerfect in December 1986 and served most recently as Executive Vice President in the Office of the President and General Counsel.\nStephen C. Wise joined the Company in June 1989 through the Excelan merger and became Vice President, Accounting and Planning in January 1990 and was elected a corporate officer. In January 1991 he became Vice President and Corporate Controller and in December 1993 he became Senior Vice President, Finance.\nDarcy G. Mott, a Certified Public Accountant, joined the Company in September 1986. He served in various finance positions and became Corporate Controller in February 1989. He was elected a corporate officer in November 1989 and became Treasurer in January 1991. In December 1995 he became Vice President and Treasurer.\nITEM 2.","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns and occupies a 1,000,000 square-foot office complex on 99 acres in Orem, Utah, which is used as corporate headquarters and a product development center. It also owns and occupies a 550,000 square-foot office complex on 46 acres in Provo, Utah, which is used as a product development center. It also owns a 380,000 square-foot manufacturing and distribution facility on 23 acres in Lindon, Utah, all of which is leased to a third party manufacturer. The Company also owns a 100,000 square-foot office building in Herndon, Virginia. The Company occupies approximately 1\/3 of the space in this building and leases the remainder to tenants. The Company also owns a 52,000 square foot building in San Jose, California, which it had previously leased. It is used primarily for product development. Additionally, the Company owns approximately 48 acres of undeveloped land in San Jose, California and has capacity to expand on its land in Orem and Provo, Utah.\nThe Company has subsidiaries in Argentina, Australia, Austria, Belgium, Brazil, Canada, Colombia, Czech Republic, Denmark, Finland, France, Germany, Hong Kong, Hungary, India, Ireland, Italy, Japan, Korea, Mexico, Netherlands, Norway, Poland, Portugal, Singapore, South Africa, Spain, Sweden, Switzerland, United Kingdom, and Venezuela -- each of which leases its facilities.\nThe Company leases offices for product development in San Jose and Scotts Valley, California; Summit, New Jersey; and Hungerford, U.K.; and a distribution facility in San Jose, California. The Company also leases sales and support offices in Arizona, California (7), Colorado, Connecticut, District of Columbia, Florida (2), Georgia, Illinois (2), Massachusetts, Michigan, Minnesota, Missouri (2), New Jersey, New York (2), North Carolina, Ohio (3), Oregon, Pennsylvania (2), Tennessee, Texas (2), Utah, Washington, Chile, China, New Zealand, Russia, Taiwan, and United Arab Emirates.\nThe terms of such leases vary from month to month to up to ten years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn December of 1991, Roger Billings and his International Academy of Science, (the Academy) filed suit against Novell alleging that the Company infringes on a patent allegedly owned by the Academy. In June 1994, Novell filed a petition with the U.S. Patent and Trademark Office (Patent Office) requesting it invalidate the patent. In August 1994, the Patent Office granted Novell's request for re-examination of the patent, finding a \"substantial new question of patentability.\" Also, in August 1994, the trial court issued a ruling, which among other things, vacated the trial date which had been previously set in the action. In June 1995, the Patent Office, upon re-examiniation, overturned the Academy patent, stating that there was no patentable subject matter. In December 1995, the Academy filed a petition with the Patent Office seeking to amend its patent. The Company believes that the ultimate resolution of this legal proceeding will not have a material adverse effect on its financial position, results of operation, or cash flows.\nThe Company is a party to a number of additional legal claims arising in the ordinary course of its business. The Company believes the ultimate resolution of these claims will not have a material adverse effect on its financial position, results of operations, or cash flows.\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 STOCKHOLDER MATTERS\nThe information required by Item 5 of Form 10-K is incorporated herein by reference to the information contained in the section captioned \"Selected Consolidated Quarterly Financial Data\" on page 39 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by Item 6 of Form 10-K is incorporated herein by reference to the information contained in the section captioned \"Selected Consolidated Financial Data\" on page 20 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 1995.\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 incorporated herein by reference to the information contained in the section captioned \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 21 through 25 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by Item 8 of Form 10-K is incorporated herein by reference to the Company's consolidated financial statements and related notes thereto, together with the report of the independent auditors presented on pages 26 through 38 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 1995, and to the information contained in the section captioned \"Selected Consolidated Quarterly Financial Data\" on page 39 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 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 information required with respect to identification of directors is incorporated herein by reference to the information contained in the section captioned \"Election of Directors\" of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held April 10, 1996, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended. Information regarding executive officers of Novell is set forth under the caption \"Executive Officers\" in Item 1a hereof.\nEach director and each officer of the Company who is subject to Section 16 of the Securities Exchange Act of 1934 (the \"Act\") is required by Section 16(a) of the Act to report to the Securities and Exchange Commission by a specified date his or her transactions in the Company's securities. In fiscal 1995, there were no compliance exceptions to this requirement.\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 sections captioned \"Executive Compensation\" of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held April 10, 1996, to be filed 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 12 of Form 10-K is incorporated by reference to the information contained in the section captioned \"Securities Ownership of Certain Beneficial Owners and Management\" of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held April 10, 1996, to be filed 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 13 of Form 10-K is incorporated by reference to the information contained in the section captioned \"Certain Transactions\" of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 10, 1996, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities 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) The following documents are filed as a part of this annual report on Form 10-K for Novell, Inc.:\n1. The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Report of Ernst & Young LLP, Independent Auditors, listed below are incorporated herein by reference to pages 26 through 38 of the Company's Annual Report to Shareholders for the fiscal year ended October 28, 1995.\nConsolidated Statements of Income for the fiscal years ended October 28, 1995, October 29, 1994, and October 30, 1993.\nConsolidated Balance Sheets at October 28, 1995 and October 29, 1994.\nConsolidated Statements of Shareholders' Equity for the fiscal years ended October 28, 1995, October 29, 1994, and October 30, 1993.\nConsolidated Statements of Cash Flows for the fiscal years ended October 28, 1995, October 29, 1994, and October 30, 1993.\nNotes to Consolidated Financial Statements.\nReport of Ernst & Young LLP, Independent Auditors.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the 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.\nNovell, Inc. (Registrant)\nDate: January 22, 1996 By \/s\/ ROBERT J. FRANKENBERG\n------------------------------------ (Robert J. Frankenberg 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.\nREPORT OF PRICE WATERHOUSE LLP, INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF WORDPERFECT CORPORATION\nIn our opinion, the consolidated balance sheet and the related consolidated statements of income, shareholders' equity and of cash flows (not presented separately herein) of WordPerfect Corporation present fairly, in all material respects, the financial position of WordPerfect Corporation and its subsidiaries at December 31, 1993 and the results of their operations and their cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our 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 provide a reasonable basis for the opinion expressed above.\n\/s\/ Price Waterhouse LLP\nSalt Lake City, Utah March 22, 1994\nNOVELL, INC.\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\n- --------------- (1) Write-off of uncollectible accounts\nEXHIBIT INDEX","section_15":""}
{"filename":"814429_1995.txt","cik":"814429","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 LEGAL PROCEEDINGS\nDuring the third quarter of 1994, the Pacific Rivers Council and the Wilderness Society (collectively the \"PRC\"), in a lawsuit filed in Federal District Court in Idaho (Pacific Rivers Council v. Thomas), sought an injunction against all ongoing and future forest activities including mining, which may affect endangered salmon, within various national forests in Idaho including the Salmon National Forest in which the Beartrack property is located. In that lawsuit, the PRC sought to require the U.S. Forest Service to consult under the Endangered Species Act (the \"Act\") with the National Marine Fisheries Service (\"NMFS\") regarding existing land resource management plans for the subject forests and their potential impacts on endangered Snake River salmon. The government defendants and the plaintiffs have subsequently negotiated a stipulated dismissal of most of the lawsuit. Under the terms of the stipulation, the parties dismissed from this litigation all projects which have undergone site-specific consultation. The company's Beartrack mine was identified by the government defendants as a project for which consultation has been completed. The Court issued an Order on Pending Claims on December 11, 1995 regarding the remaining specified projects (not including the Beartrack mine) which have not yet completed consultation. Under the terms of that Order, the Court has retained jurisdiction in this lawsuit for further proceedings regarding those projects. The Beartrack mine is not subject to or a part of the Court's order.\nIn October 1994, the Sierra Club Legal Defense Fund, Inc. (\"Sierra\"), on behalf of certain other organizations, filed a lawsuit in Federal District Court for the Western District of Washington at Seattle against NMFS and other federal agencies for violation of the Act, alleging the NMFS' biological opinion failed to satisfy the requirements of the Act. Sierra, the federal agencies and the company, as intervenor, each filed a motion for summary judgment. In November 1995, the Court ordered the federal agencies to reinitiate consultation under Section 7 of the Act on the potential environmental impacts of the Beartrack mine project on endangered salmon or the designated critical habitat for salmon. The plaintiffs did not seek, and the Court did not impose, any injunction or other restriction on the operation of the Beartrack mine pending completion of such consultation. If, upon remand, the Forest Service were to determine that an activity associated with Beartrack mine operations could preclude the development of reasonable and prudent alternatives to the project pending completion of the reinitiated consultation, such activities could be required to cease pending completion of consultation. Under the Act's regulations, consultation must be completed within 135 days of the date consultation is initiated. An extension of 60 days can be imposed by the agencies. Under the relevant statutory and regulatory authorities, the results of a consultation can range from no impact on the activities under review on the one hand to modest to significant impacts on the other. In an extreme situation, a consultation could result in the cessation of activities altogether, a potential result the company believes to be remote in the case of the Beartrack mine, which has been in operation and production since mid-1995. The company believes that the ongoing operation of the Beartrack mine will not jeopardize endangered salmon or adversely modify or destroy designated critical habitat, and that upon completion of consultation, the mine will be permitted to continue operation.\nOn February 16, 1996, the company settled a dispute with a subcontractor on the Beartrack project. The subcontractor made claims against the prime contractor alleging overruns for work performed which exceeded the original estimated costs for the project by approximately $8 million. These claims were disputed by the prime contractor. Arbitration of the subcontractor's claims against the prime contractor was concluded, and the company agreed to pay a settlement of $3.1 million as part of the overall arbitrated settlement. The settlement will be charged to property, plant and equipment and depreciated over the remaining life of the Beartrack property.\nThe company sought and obtained from the U.S. Army Corps of Engineers (the \"Corps\") a permit authorizing dredging and filling of wetlands in connection with construction of the Beartrack mine under Section 404 of the Clean Water Act. That permit was set to expire on October 11, 1994. On June 16, 1994, the company sought an extension of the permit under applicable regulations. Under those regulations, the filing of a request for extension operates to extend the permit until the agency acts upon the request for extension. As of this time, the Corps has not taken action upon the company's request.\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 three months ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of FMC Gold Company as of March 1, 1996, together with the offices in FMC Gold Company presently held by them, their business experience since January, 1991, and their ages are as follows:\nEach of the company's executive officers has been employed by the company and\/or by FMC Corporation for the past five years. No family relationship exists between any of the above-listed officers and there are no arrangements or understandings between any of them and any other persons pursuant to which they were selected as an officer. All officers are elected to hold office for one year or until their successors are elected and qualify.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal public trading market for FMC Gold common stock is the New York Stock Exchange. The quarterly high and low trading prices of FMC Gold common stock as reported on the New York Stock Exchange and cash dividends paid for years ended December 31, 1995 and 1994 are set forth in the table of Supplementary Data on page 31.\nYear-end 1995 and 1994 market prices of FMC Gold shares were $4.125 and $3.125 respectively.\nFMC Gold had 763 shareholders of record as of December 31, 1995.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nThe following selected financial data, as it relates to the years 1991 through 1995, has been derived from the consolidated financial statements of FMC Gold, including the consolidated balance sheets at December 31, 1995 and 1994 and the related consolidated statements of income and consolidated statements of cash flows for the three years ended December 31, 1995, and the notes thereto, appearing elsewhere herein.\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL REVIEW\nSALES AND EARNINGS\nSales decreased to $57.4 million from $63.4 million in 1994, reflecting the winding down of residual heap leach production at Paradise Peak and the July 1994 shutdown of Royal Mountain King, offset by the start-up of the Beartrack mine in July 1995 and slightly higher precious metals prices. Gold production declined 7 percent and silver production declined 82 percent. At Jerritt Canyon, the company's 30 percent share of gold production was even with 1994 production of 98,000 ounces as higher mill ore grades offset slightly lower throughput and recoveries. At Paradise Peak, gold production declined to 4,000 ounces in 1995 due to residual heap leaching. The Royal Mountain King mine was shut down in July 1994, producing 26,000 ounces of gold prior to closing. Partly offsetting the lost production at Paradise Peak and Royal Mountain King was the start up of the Beartrack mine, where gold production reached 49,000 ounces in 1995. Silver production in 1995 continued to decline to 27,000 ounces compared with 154,000 ounces in 1994, as the Paradise Peak heap leach operation came to a close.\nThe average realized price of gold increased to $389 per ounce from $384 in 1994, reflecting higher market prices and the benefit of hedging positions on gold production from Beartrack.\nOn November 30, 1995, the company sold the stock of FMC Paradise Peak Corporation to Arimetco, Inc. for $4.0 million and the assumption by Arimetco of all reclamation liabilities. The company recorded a pre-tax gain on the transaction of $1.7 million and reversed $4.5 million of accrued reclamation liability through cost of sales.\nCost of sales decreased to $51.0 million in 1995 from $53.8 million in 1994 due to lower cash mining and milling costs at Jerritt Canyon, the 1994 shutdown of Royal Mountain King and the reversal of the accrued reclamation costs at Paradise Peak. Partly offsetting these reductions was the incremental production cost at Beartrack. Average cash costs of production decreased to $221 per gold equivalent ounce from $246 in 1994, reflecting the addition of lower-cost production from Beartrack. Jerritt Canyon cash costs per gold equivalent ounce decreased to $250 from $283 due to lower mining and milling costs per ton. Beartrack cash costs per gold equivalent ounce were $166. Cash costs at Paradise Peak increased to $155 per gold equivalent ounce in 1995 from $124 in 1994 as costs were spread over significantly fewer ounces of production.\nExploration spending of $11.0 million in 1995 was virtually unchanged from $11.2 million in 1994. Spending was primarily focused on the El Penon project in northern Chile and the Rossi project on the Carlin Trend in Nevada. Selling, general and administrative expenses decreased to $5.2 million in 1995 from $6.6 million in 1994 due to lower allocated costs from FMC, and continued cost reduction efforts. Costs allocated from FMC are determined as a percentage of the company's revenues relative to FMC consolidated revenue, multiplied by FMC corporate overhead. See Note 12 to the company's consolidated financial statements. Interest income decreased to $5.9 million in 1995 from $8.7 million in 1994 due to lower cash balances on loans to FMC as well as lower interest rates.\nNet income was $2.3 million in 1995 compared with net income of $0.2 million in 1994. The company recognized tax benefits of $4.5 million in 1995 associated the utilization of net operating loss carrybacks. The tax benefits were made available through the company's tax sharing agreement with FMC. Earnings per share were $0.03 for 1995 compared with break-even earnings per share in 1994.\nTAXES\nThe company's 1995 tax provision includes a $4.5 million benefit associated with the utilization of tax benefits (operating loss carrybacks) made available through the company's tax sharing agreement with FMC. In 1994, depletion tax benefits and net operating loss carryover benefits were offset by increases to the valuation allowance to fully reserve deferred tax assets. In 1995, portions of these previously reserved deferred tax assets were recognized. The 1994 tax provision primarily reflected a prior-year adjustment to the company's foreign sales corporation tax benefits generated upon completion of the company's 1993 tax return.\nLIQUIDITY AND CAPITAL RESOURCES\nCash to meet the company's operating needs, finance capital expenditures and fund exploration activities was provided from existing cash reserves (including loans to FMC). At December 31, 1995, cash and cash equivalents totaled $79.2 million, primarily in the form of loans to FMC, which have varying maturities and are payable on demand. As of December 31, 1995, FMC's cash on hand and available credit lines were more than adequate to allow repayment of these loans.\nCapital expenditures decreased to $36.9 million in 1995 from $56.2 million in 1994. Capital expenditures in 1995 related to Beartrack were $25.1 million versus $48.0 million in 1994. In 1995, $11.9 million of mine development and equipment additions were made at Jerritt Canyon.\nOn December 31, 1995, the company paid a dividend on common stock of $0.05 per share to stockholders of record on December 7, 1995.\nExpected cash requirements for 1996 include approximately $16.0 million for planned capital expenditures, primarily associated with mine development at Jerritt Canyon and ongoing project development at Beartrack. Exploration spending for 1996 is expected to approximate $7.9 million and $3.7 million is planned for dividends based on the current dividend rate. The company expects to fund these requirements from cash flow from operations and existing cash and cash equivalents. In addition, in the event that the ongoing strategic review process results in any significant proceeds from asset sales, it is possible that a distribution of such proceeds and some portion of existing cash balances may occur.\nShould mine development at any of the company's existing properties prove beneficial, significant cash requirements may be necessary. The company believes that any unexpected cash requirements could be funded by existing cash reserves, loans due from FMC or borrowings from third parties.\nOUTLOOK\nAnnual production is estimated to be approximately 200,000 ounces per year in 1996 and 1997 based upon continued operation of the Beartrack and Jerritt Canyon mines. This higher production level should further reduce cash costs per gold equivalent ounce and improve operating profitability in both years. The production from Beartrack will help offset a decline at Jerritt Canyon, where production through 1997 will primarily come from underground sources. Exploration at both the Chilean and Rossi properties has been successful in delineating mineralization.\nAs discussed in Note 13 to the consolidated financial statements, management is pursuing, in consultation with FMC, an ongoing strategic review process that may result in one or more transactions involving the company, some or all of its assets, or FMC's 80 percent equity interest in the company. See \"1995 Developments\" under Items 1 and 2 on page 7 for additional information regarding this process.\nSee Item 3 to Form 10-K on page 9 for a description of legal proceedings relating to the Beartrack mine and the company's assessment of risks related thereto.\n1994 COMPARED WITH 1993\nSales decreased to $63.4 million from $118.9 million in 1993, reflecting the July 1994 shutdown of the mill at Royal Mountain King and heap-leach only production at Paradise Peak, offset slightly by higher precious metals prices. Gold production declined 49 percent and silver production declined 82 percent. At Paradise Peak, gold production declined to 39,000 ounces in 1994, due to the May 1993 mill shutdown and the winding down of the heap-leach operation. At Jerritt Canyon, the company's 30 percent share of gold production declined to 98,000 ounces due to lower ore grades and recoveries in both the ore- roasting process and the wet mill. The Royal Mountain King mine produced 26,000 ounces of gold in 1994, a 53 percent decrease from 1993. Silver production continued to decline in 1994, to 154,000 ounces compared with 863,000 ounces in 1993, with the winding down of the Paradise Peak heap-leach operation.\nThe average realized price of gold increased to $384 per ounce from $357 in 1993. Average realized silver prices rose to $5.29 per ounce from $3.94 per ounce in 1993. The company's average precious metal prices were essentially equal to commodity market averages.\nCost of sales decreased to $53.8 million in 1994 due to the mills shutdown at Paradise Peak and Royal Mountain King and a $4.0 million reversal of previously accrued reclamation expense. Of this amount, $2.8 million in previously accrued reclamation was reversed for Paradise Peak, and another $1.2 million was reversed for the Austin joint venture, which went out of production in 1989. The reversals were based on the latest estimates for total reclamation spending for these properties. Offsetting some of these cost reductions was an increase in Jerritt Canyon depletion expense of $4.8 million due to a deterioration of mineable tons in several open pits. Average cash costs of production increased to $246 per gold equivalent ounce from $194 in 1993, reflecting the exhaustion of low-cost mill ore at Paradise Peak. Cash costs at Paradise Peak increased to $124 per gold equivalent ounce in 1994, as costs were spread over fewer ounces produced. Royal Mountain King cash\ncosts per ounce declined to $296 from $336 in 1993 due to lower mining costs. Jerritt Canyon cash costs per gold equivalent ounce increased to $283 per ounce from $240 in 1993 due to a 9 percent decline in production and higher mining costs per ton.\nExploration spending declined to $11.2 million in 1994 as a result of the capitalization of $2.9 million of exploration spending at Jerritt Canyon, and slightly lower spending for grassroots programs. Selling, general and administrative expenses decreased slightly to $6.6 million in 1994, due to lower allocated costs from FMC, as well as continued cost reduction efforts. Costs allocated from FMC are determined as a percentage of the company's revenues relative to FMC consolidated revenue, multiplied by FMC Corporate overhead. See Note 12 to the company's consolidated financial statements. Interest income increased to $8.7 million in 1994 as improved interest rates on loans to FMC overcame the decrease in cash and cash equivalents that occurred in the second half of 1994 due to development spending at Beartrack.\nNet income was $0.2 million in 1994 compared with net income of $9.3 million before the impact of write-downs and other charges in 1993. After $60.6 million of write-downs and other charges the company reported a net loss of $51.3 million in 1993. Earnings per share were break-even for 1994 compared with losses per share of $0.70 in 1993.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders, FMC Gold Company:\nWe have audited the consolidated balance sheets of FMC Gold Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and changes in stockholders' equity for each of the years in the three-year period ended 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 FMC Gold 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.\nKPMG Peat Marwick LLP\nSalt Lake City, Utah January 18, 1996\nMANAGEMENT REPORT ON FINANCIAL STATEMENTS\nThe consolidated financial statements and related information have been prepared by management, which is responsible for the integrity and objectivity of that information. Where appropriate, they reflect estimates based on judgments of management. The statements have been prepared in conformity with accounting principles generally accepted in the United States. Financial information included elsewhere in this annual report is consistent with that contained in the consolidated financial statements.\nFMC Gold maintains a system of internal control over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition which is designed to provide reasonable assurance as to the reliability of financial records and the safeguarding of such assets. The system is maintained by the selection and training of qualified personnel, by establishing and communicating sound accounting and business policies, and by an internal auditing program which constantly evaluates the adequacy and effectiveness of such internal controls, policies and procedures.\nThe Audit Committee of the Board of Directors, composed of outside directors of the company, inquires into the company's financial and accounting organization, accounting controls and the quality of financial reporting. The independent auditors and the internal auditors have free access to the Audit Committee to discuss their audits.\nJay A. Nutt Principal Accounting Officer\nAlan L. Lowe Chief Financial Officer\nReno, Nevada January 18, 1996\nFMC GOLD COMPANY\nCONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nFMC GOLD COMPANY\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nFMC GOLD COMPANY\nCONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nSupplemental disclosure of cash flow information:\nCash paid and (refunds received) for income taxes during 1995, 1994 and 1993 were $(2,857), $895 and $3,180, respectively.\nSee notes to consolidated financial statements.\nFMC GOLD COMPANY\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 PRINCIPAL ACCOUNTING POLICIES\nNature of Operations\nFMC Gold Company (\"FMC Gold\" or \"the company\") is a producer of precious metals.\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 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 reporting period. Actual results could differ from those estimates.\nConsolidation\nThe consolidated financial statements include the accounts of FMC Gold Company and all majority-owned subsidiaries. The accounts of joint ventures in which the company holds an interest are consolidated on a pro rata basis. All significant intercompany accounts are eliminated in consolidation.\nRevenue Recognition\nRevenue is generally recognized upon shipment of gold and silver dore to third parties.\nCash and Cash Equivalents\nCash and cash equivalents consists of loans and amounts due from FMC Corporation (\"FMC\") less outstanding checks in excess of bank balances.\nLoans due from FMC consist of three notes, with varying maturities, due upon demand. Terms and conditions of these loans are covered by the management services agreement between the company and FMC (Note 12).\nAs a result of the company's participation in FMC's centralized cash management system, the company reported a liability at December 31, 1995, 1994 and 1993 for outstanding checks in excess of bank balances due to the timing of cash transfers from FMC.\nInventories\nFinished goods inventories are stated at the lower of the average cost or market, and include labor, materials, other production costs and depreciation. No inventory value is assigned to stockpiled ore or in-process material, except for certain stockpiled leach-pad ore where cost includes labor, materials and other production costs.\nProperty, Plant and Equipment\nProperty, plant and equipment, including development costs and capitalized interest associated with the construction of certain capital assets, is recorded at cost. Depreciation and amortization for financial reporting purposes is provided principally on the straight-line basis over the shorter of the estimated lives of the assets or the estimated proven and probable recoverable reserves. Some assets are depreciated on a units of production basis, with depreciation rates established according to estimated producible units at the time the assets are placed in service. Gains and losses are reflected in income upon sale or retirement of assets.\nMaintenance and repairs are charged to expense in the year incurred. Expenditures that extend the useful life of property, plant and equipment or increase its productivity are capitalized.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nMineral Exploration and Development Costs\nMineral exploration and preliminary development costs are expensed as incurred. Development costs applicable to mineralized properties deemed capable of commercial production are capitalized and then amortized over units of production.\nReclamation\nReclamation and shutdown costs to be incurred when mining operations are closed are estimated and accrued over the life of the mine.\nIncome Taxes\nDeferred tax liabilities and assets are recognized for expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities. The company is subject to a tax sharing agreement with FMC, which is further described in Note 8. The application of the tax sharing agreement does not materially affect the company's accounting for income taxes under Statement of Financial Accounting Standards (\"SFAS\") No. 109.\nForward Sales and Hedging\nIn order to minimize exposure to decreasing prices for portions of its gold production, the company has hedged future gold production by entering into contracts, such as fixed forward sales contracts and put options. Costs associated with the purchase of certain hedge instruments for open put options included in other assets were $3.4 million as of December 31, 1995 and $4.0 million as of December 31, 1994. These costs were deferred and are recognized in the period the revenues related to the hedged production are recorded.\nEarnings Per Common Share\nEarnings per common share are computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents (incentive plan shares) outstanding during the year (73,484,395 shares in 1995, 1994 and 1993).\nFinancial Instruments\nThe fair values of financial instruments (primarily short-term deposits) approximated their carrying values at December 31, 1995, 1994 and 1993. Fair values have been determined through information obtained from both market sources and management estimates.\nAccounting Standards Not Adopted\nSFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of\" will be adopted by the company effective January 1, 1996. SFAS No. 121 establishes criteria for recognizing, measuring and disclosing impairments of long-lived assets. The company plans to adopt the new standard on January 1, 1996 but does not expect a significant impact on its consolidated financial position or results of operations at the date of adoption.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" also effective for fiscal years beginning after December 15, 1995. Upon adoption of SFAS No. 123, the company plans to continue its current accounting for employee stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, as permitted under SFAS No. 123, and, if material, to disclose the pro forma effect of the fair value accounting method in the notes to its consolidated financial statements.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2 ACQUISITIONS AND DIVESTITURES\nOn November 30, 1995, the company's 100 percent interest in Paradise Peak Corporation was sold to Arimetco, Inc. for $4 million in the form of cash and a note receivable, resulting in a $1.7 million gain on the sale of the assets and the reversal of $4.5 million of accrued reclamation liability through cost of sales.\nIn June 1994, the company agreed to purchase the remaining 14 percent interest in the Beartrack joint venture from MINEX for $6.0 million, bringing the company's ownership in the property to 100 percent. The first installment of $1.5 million was made to Minex in June, 1994. Another $1.5 million payment was made in June 1995, with the balance owed to Minex to be paid in $1.0 million installments in 1996 and 1997, and $0.5 million installments in 1998 and 1999.\nIn April 1993, the company purchased the remaining 50 percent interest in the Humboldt Gold Venture from TRE Management Company for $5.5 million, bringing the company's ownership interest in all gold and precious metal- bearing ores in the related property to 100 percent. The former Humboldt Gold Venture is targeting deep gold mineralization at the \"Rossi Property\" on the Carlin Gold Trend in Nevada.\nNOTE 3 WRITE-DOWNS AND OTHER CHARGES\nIn December 1993, the company recorded a special charge of $60.6 million, or $0.82 per share. This charge included a write-down of $51.0 million for the Beartrack development property and related investments. The Beartrack property was acquired for stock in 1990. Gold prices did not increase as projected and, therefore, the book value of the property was written down to reflect the lower prices. As a result of improved prices and project economics, the company decided in May 1994 to invest $57 million to develop the project.\nAlso included in the December, 1993 special charge was $4.6 million associated with the write-down of fixed assets at the Royal Mountain King mine, which completed production in mid-1994. A charge of $5.0 million was also recorded at Paradise Peak for additional mine closure costs in 1994 and beyond. The Paradise Peak mill shut down in May, 1993.\nNOTE 4 INVENTORIES\nInventories (at cost) consist of the following:\nGold and silver inventories are in the form of dore, which is suitable for delivery to precious metal treatment facilities. These inventories are generally sold to and further processed by these facilities into forms suitable for end uses.\nHeap leach pad ore increased to $11.4 million at December 31, 1995, from $2.7 million at December 31, 1994. The increase represents the cost of loading ore on the heap leach pads at the Beartrack mine, and includes labor, materials and other production costs. Mining at the Beartrack operation commenced in August 1994, and at December 31, 1995 there were approximately 4.7 million tons of ore under leach containing approximately 113,000 ounces of gold.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5 PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consists of the following:\nNOTE 6 ACCRUED AND OTHER LIABILITIES\nAccrued and other liabilities comprise the following:\nNOTE 7 OTHER LONG-TERM LIABILITIES\nOther long-term liabilities comprise the following:\nShutdown and reclamation accruals represent estimated costs of earthwork such as detoxification and recontouring, revegetation, and stabilization. Also included are heap-leach encapsulation and facility decommissioning costs.\nIn determining the estimated costs, the company considers such factors as changes in laws and regulations, the likelihood of additional permits being required, requirements under existing operating permits, and estimated operating costs. Such analyses are performed on an ongoing basis.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1995, accrued reclamation costs, including those identified in Note 6--Accrued and Other Liabilities, associated with Royal Mountain King were $5.2 million, Beartrack $0.7 million, Austin $0.3 million, and Jerritt Canyon $2.9 million. Reclamation spending at each of these facilities is expected to continue in 1996 and beyond.\nNOTE 8 INCOME TAXES\nOn March 31, 1994, FMC increased its ownership interest in the company to 80 percent. Thereafter, the company agreed to be included in FMC's consolidated federal income tax return. Under a tax-sharing agreement, the company pays to FMC amounts generally equal to the tax the company would have been required to pay had it filed a separate return, and FMC pays to the company amounts generally equal to any tax benefits the company would have realized through carryover on a separate return basis.\nFor state tax purposes, the company generally continues to be included in FMC's combined returns. The tax-sharing agreement for periods beginning after April 1, 1994 provides that the company will be liable for the incremental impact the company has on FMC's state tax liability in states where FMC files combined returns. In addition, in the states where the company files separate state tax returns, the company is responsible for the tax due thereunder.\nThe company's management believes that all determinations under the agreements have been made in a manner that is fair and reasonable in the circumstances.\nThe provision (benefit) for income taxes is presented below. The 1995 benefit of $4.5 million resulted from tax benefits realized under the tax sharing agreement with FMC.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSignificant components of the company's deferred tax assets and liabilities are as follows:\nThe valuation allowance for deferred tax assets as of December 31, 1995 was $29.1 million. The net decrease in the allowance during 1995 of $1.7 million includes an increase in the allowance against benefits to be realized through loss carryforwards more than offset by the realization of benefits through loss carrybacks pursuant to the tax sharing agreement.\nAt December 31, 1995, the company has an AMT credit carryover of $12.8 million. Generally, this credit can be carried forward to offset regular tax to the extent it exceeds the AMT in a carryover year. During 1995, FMC Gold reduced its deferred asset for AMT by $3.3 million as a result of loss carrybacks allowed pursuant to the tax sharing agreement with FMC.\nThe effective income tax provision (benefit) differs from that computed by applying the applicable federal statutory rate of 35 percent for 1995 and 1994 and 34 percent for 1993 to income before taxes for the following reasons:\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 9 EXPORT SALES AND SALES TO MAJOR CUSTOMERS\nU.S. export sales to unaffiliated customers by destination of sale are as follows:\nThe company's products may be purchased and refined by several Canadian, European and domestic refiners. Sales to two refiners in 1995, three refiners in 1994, and four refiners in 1993 each represented 10 percent or more of consolidated sales. Specifically, sales to these companies amounted to $55.8 million in 1995, $62.8 million in 1994 and $118.5 million in 1993. The company believes that because there are several alternative refiners, each capable of refining the company's products, no adverse effect will result should any of the current refiners discontinue buying the company's products.\nNOTE 10 EMPLOYEE PLANS\nAll company employees are covered by FMC's defined contribution postretirement health care and life insurance benefit program. The cost of these benefits is included in the allocation of overhead from FMC (Note 12). Employees, other than hourly employees at the Royal Mountain King operating mine, are included in FMC's employee thrift plan and funded retirement plan. Charges for these benefits were $0.2 million, $0.5 million and $1.1 million in 1995, 1994 and 1993, respectively, and are included in the costs paid under the management services agreement as discussed in Note 12. Hourly employees at Royal Mountain King participated in a separate thrift and stock purchase plan which is qualified under Section 401(k) of the Internal Revenue Code. Charges against income for contributions made to this plan were negligible in 1995, 1994 and 1993 and are included in the costs paid under the management services agreement discussed in Note 12. As of December 1995, there are 203 employees under this plan. The company has no pension obligations other than the payment of charges from FMC under the management services agreement.\nIn 1989, the stockholders approved the FMC Gold Company 1988 Long-Term Incentive Compensation Plan, which authorized the Board of Directors of the company (the Board) to grant awards, payable in the form of cash and non- qualified stock options, to key employees of the company if certain specified performance objectives were met over a four-year period ended December 31, 1991. The Board established as a base performance objective the discovery of a certain quantity of profitable gold reserves. The stock options granted in 1988 bear an exercise price ranging from $9.625 to $11.25, the fair market value at the date of grant, and expire May 6, 1998. During 1992, additional options for 223,000 shares of common stock were granted at an exercise price of $4.25 and with an expiration date of April 2007.\nNOTE 11 COMMITMENTS AND CONTINGENT LIABILITIES\nDuring the second quarter of 1994, the company purchased put options and entered into certain forward contracts in connection with gold production from the Beartrack property. The forward contracts were for 23,800 ounces of gold, deliverable between April 1995 and April 1996. The options were originally purchased for $4 million and provide the company the right to sell gold at an agreed-upon price. At December 31, 1995, the carrying value of the remaining options (at cost) was $3.4 million. The market values of the options as of December 31, 1995 and 1994 were approximately $2.8 million and $1.1 million, respectively. The cost of the options was recognized concurrently with the revenues related to the hedged production.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1995 the company held forward contracts for 10,500 ounces of gold. Contracts for 3,000 ounces expire January 31, 1996 with the remaining contracts for 7,500 ounces expiring April 30, 1996. The options are recorded in other assets and will be amortized in accordance with utilization. The options carry a strike price of $400 per ounce. The value of these options varies with changes in market prices of the commodity and management continually evaluates the desirability of exercise in relation to current market prices. The options expire according to the following schedule:\nThe company's mining operations and exploration activities are subject to various federal, state and local laws, and regulation governing protection of the environment. These laws are continually changing and, as a general matter, are becoming more restrictive. The company's policy is to conduct its business in a manner that safeguards public health and the environment. The company believes that its operations are in compliance with all applicable laws and regulations, and has no reason to believe that compliance problems exist at operations in which it holds a joint-venture interest. To comply with these federal, state and local laws, the company has made, and in the future will be required to make, capital and operating expenditures on environmental projects. However, the company currently has no environmental projects that will require substantial and extraordinary expenditures. Expenditures for environmental projects were not substantial in 1995, nor are they expected to be substantial in 1996.\nThe company leases office and warehouse space in Reno and Denver and various types of equipment (primarily mobile mining equipment at the Beartrack mine). Total rent expense under all leases amounted to $1.1 million, $0.5 million and $0.6 million for 1995, 1994 and 1993 respectively. Minimum future rentals under noncancellable leases aggregated approximately $9.8 million as of December 31, 1995, and are estimated to be payable $1.9 million in 1996, $1.8 million in 1997, $1.5 million in 1998, $1.5 million in 1999, $1.5 million in 2000, and $1.7 million beyond.\nAs discussed in Note 13, the company has hired financial advisers in connection with the possible sale of the company. Due to the possibility of a sale, selected employees were informed of severance benefits that would become available in the event of a change in control of the company, resulting in the loss of employment. Because it is unclear whether a sale will take place or how such a transaction may be structured, the company has not accrued severance benefits. Should a transaction be agreed upon, resulting in the company incurring severance costs, management estimates the cost of such benefits could be as much as $2.0 million, primarily covering employees based in Reno, Denver, and Chile.\nThe company has certain other contingent liabilities resulting from litigation, claims and commitments incident to the ordinary course of business. Management believes that the probable resolution of such contingencies will not materially affect the financial position or results of operations of the company.\nNOTE 12 RELATED PARTY TRANSACTIONS\nAt December 31, 1995, 80 percent of the outstanding common stock of the company was held by FMC.\nCertain agreements exist between the company and FMC concerning income taxes (Note 8) and management services.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nUnder the management services agreement, the company will be charged at FMC's direct and indirect cost, including allocated overhead, for certain general, administrative and other services provided by FMC. Overhead allocations of $1.0 million, $1.6 million and $2.6 million in 1995, 1994 and 1993, respectively, are based generally on the level of company sales to aggregate FMC sales. The company's management believes that all determinations with respect to direct and indirect costs, including allocated overhead, have been made in a reasonable and consistent manner.\nIn addition, the agreement states that either the company or FMC may borrow up to $50 million from the other on a short-term basis. Borrowings exceeding $50 million are made upon the review and approval of the lending company. All such borrowings are payable on a demand basis and bear interest at a floating rate equal to FMC's current weighted average rate on its borrowings under its credit facilities, or its investing rate, for the relevant period. The company's management believes that any demand by FMC Gold for repayment of FMC's borrowings under the management services agreement is legally enforceable. During 1995, FMC decreased its total borrowings from the company by $39.5 million, ending the year with a balance of $80.8 million (consisting of three notes with varying maturities), and paid $5.7 million in interest at an average rate of 6.2 percent. During the year, the highest outstanding balance owed was $120.3 million. The company believes it has received an equal or better yield on its loans to FMC than it could have received from comparable investments and plans to continue this cash management arrangement in the future. The company is an unsecured creditor of FMC, and as such it receives the same treatment as any other FMC unsecured creditor. In the opinion of management, FMC's cash on hand and available credit lines at year- end were more than adequate to allow repayment of these loans.\nThe following schedule summarizes the activity of indebtedness to and from FMC in 1995, 1994 and 1993.\nFMC GOLD COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED) FMC is obligated under a $75 million issue of exchangeable senior subordinated debentures in Europe. The debentures bear interest at 6 3\/4 percent and are exchangeable at $15 1\/8 per share, subject to change as defined in the offering circular, into FMC Gold Company common stock currently held by FMC. If exchanged at $15 1\/8, non-FMC ownership of the company would increase to 28 percent and FMC's ownership would be reduced to 72 percent.\nThe company purchases liquid sodium cyanide from the Alkali Chemicals Division of FMC. Such purchases amounted to $1.0 million, $1.9 million and $2.0 million in 1995, 1994 and 1993, respectively. Contracts are in effect to purchase sodium cyanide through 1996 for approximately $1.2 million. The purchases from FMC were transacted on terms no less favorable to the company than those which the company believes could have been obtained from an unaffiliated third party.\nFMC, as controlling stockholder, will be able to control all decisions with respect to the use of cash generated by the company, including dividend policy. Any determination as to the use of cash generated by the company may be affected by factors related to FMC's cash requirements, which may differ from those of other stockholders of the company and may conflict with the use that the company would otherwise make of its cash, such as for new exploration or the funding of development activity. No such conflict is presently anticipated.\nFMC has engaged in hedging transactions with respect to its portion of production of precious metals. FMC may engage in such transactions in the future for its own account as a means of offsetting the decline in the company's income that could result if gold prices should decrease.\nNOTE 13 SUBSEQUENT EVENTS (UNAUDITED)\nIn September 1995, the company engaged the investment banking firm of CIBC Wood Gundy Securities Inc. (\"Wood Gundy\") to act as its financial adviser in connection with the possible sale of the company. On February 9, 1996, the company announced that it had determined that it will augment its previously- announced sale process to include a range of options based on current gold equity market conditions and interest in individual properties. The company is retaining J. P. Morgan & Co., Inc. to join Wood Gundy as financial advisers for this process. At this time, there can be no assurance as to whether any transaction will result from the company's work with Wood Gundy and J. P. Morgan & Co., Inc. or as to the value, timing or structure of any such transaction. Management's decisions with respect to the value or structure of a potential sale could have a material impact on the valuation of the company and its assets.\nOn February 16, 1996 the company settled a dispute with a subcontractor on the Beartrack project. The subcontractor made claims against the prime contractor alleging overruns for work performed which exceeded the original estimated costs for the project by approximately $8 million. These claims were disputed by the prime contractor. Arbitration of the subcontractor's claims against the prime contractor was concluded in February 1996, and the company agreed to pay a settlement of $3.1 million as part of the overall arbitrated settlement. The settlement will be charged to property, plant and equipment and depreciated over the remaining life of the Beartrack property.\nSUPPLEMENTARY DATA\nFMC GOLD COMPANY QUARTERLY RESULTS AND STOCK MARKET DATA\n- -------- (1) Quarterly earnings per common share and net income (loss) may differ from the full-year amounts due to rounding.\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable for the two-year period ended December 31, 1995.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item with respect to directors is incorporated by reference to page 2 of FMC Gold's Proxy Statement dated March 26, 1996. Executive Officers of the Registrant are identified under Item 4 on page 10 of this Form 10-K.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nThe information required by this item is incorporated by reference to page 6 of FMC Gold's Proxy Statement dated March 26, 1996. The information related to Board Compensation is identified separately therein and is not incorporated herein.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF THE COMPANY\nThe information required by this item is incorporated by reference to page 3 of FMC Gold's Proxy Statement dated March 26, 1996.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this item is incorporated by reference to page 4 of FMC Gold's Proxy Statement dated March 26, 1996.\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 Reports\nSee Index to Financial Statements and Supplementary Data on page 14.\nSchedules not included in this 10-K have been omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto.\n3. Exhibits: See attached Index to Exhibits, page 34.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the three months ended December 31, 1995.\n(c) Exhibits\nSee Index to Exhibits, page 34.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFMC Gold Company (Registrant)\nBrian J. Kennedy President\n\/s\/ Brian J. Kennedy By: ______________________________________ Brian J. Kennedy\nDate: March 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 DATE INDICATED.\n\/s\/ Alan L. Lowe *By ______________________________ March 26, 1996 Alan L. Lowe\nINDEX TO EXHIBITS FILED WITH OR INCORPORATED BY REFERENCE INTO FORM 10-K OF FMC GOLD COMPANY FOR YEAR ENDED DECEMBER 31, 1995\n- -------- * Indicates a compensatory plan or arrangement.","section_15":""}
{"filename":"703361_1995.txt","cik":"703361","year":"1995","section_1":"ITEM 1. BUSINESS\nIntegrated Device Technology, Inc. was incorporated in California in 1980 and reincorporated in Delaware in 1987. The terms the \"Company\" and \"IDT\" refer to Integrated Device Technology, Inc. and its consolidated subsidiaries, unless the context indicates otherwise.\nIDT designs, develops, manufactures and markets a broad range of high-performance semiconductor products for the desktop computer, communications, office automation and workstation\/server markets using advanced CMOS (Complimentary Metal Oxide Silicon) and BiCMOS (A Combination of Bipolar and CMOS) process technologies. The Company focuses its development efforts on providing proprietary and enhanced industry-standard products that improve the performance of systems incorporating high-performance microprocessors. The Company offers over 5,000 product configurations in four product families: SRAM components and modules, specialty memory products, logic circuits and RISC (Reduced Instruction Set Computers) microprocessors and subsystems. The Company has made significant investments and commitments in becoming a supplier of RISC based microprocessors and now offers a family of 20 microprocessor and related peripheral products for the desktop computing and embedded systems markets.\nThe Company markets its products on a worldwide basis primarily to OEMs through a variety of channels, including a direct sales force, distributors and independent sales representatives. The Company's end-user customers include Alcatel, AT&T, Apple Computer, Bay Networks, Canon, Cisco Systems, Compaq Computer, Dell Computer, Digital Equipment, FORE Systems, Hewlett Packard, IBM, Intel, Motorola, NEC, Nokia, Olivetti, Siemens Nixdorf, Silicon Graphics, Sun Microsystems and Tektronix.\nThe Company attempts to differentiate itself from competitors through unique architecture, enhanced system cost\/performance, and packaging options.\nPRODUCTS AND MARKETS\nIDT offers over 5,000 product configurations in four product families: SRAM components and modules, specialty memory products, logic circuits, and RISC microprocessors and subsystems. During fiscal 1995, these product families accounted for 40%, 28%, 21% and 11%, respectively, of product revenues. The Company markets its products primarily to OEMs in the desktop computer, communications, office automation and workstation\/server markets. IDT's product design efforts are focused on developing proprietary components and integrating its components into single devices, modules or subsystems to meet the needs of customers.\nSRAMs. SRAMs are memory circuits used for storage and retrieval of data during a computer system's operation. SRAMs do not require electrical refreshment of the memory contents to ensure data integrity, allowing them to operate at high speeds. SRAMs include substantially more circuitry than DRAMs, resulting in higher production costs for a given amount of memory, and generally command higher selling prices than the equivalent density DRAM. The market for SRAMs is fragmented by differing demands for speed, power, density, organization and packaging. As a result, there are a number of niche markets for SRAMs.\nThe Company is focused primarily on the cache memory segment of the SRAM market. The Company's SRAM product strategy is to offer high-performance 5 volt and 3.3 volt SRAM components and modules that have differentiated features optimized to work with specified microprocessors, such as the Intel 486 and Pentium families of microprocessors, the PowerPC microprocessor and MIPS RISC microprocessors. Cache memory provides an intermediate storage solution between fast microprocessors and relatively slow DRAM main memory. Cache memory operates at the speed of the microprocessor and increases the microprocessor's efficiency by temporarily storing the most frequently used instructions and data. Special cache tag SRAMs provide a look-up table function that tells the cache controller which blocks of data are currently stored in the cache SRAMs.\nIDT is a leading supplier of cache SRAM components and modules to personal computer manufacturers. The Company offers a range of cache SRAMs, including burst-mode cache SRAMs that support the Intel and PowerPC microprocessors, and cache tag SRAMs. The Company's cache SRAM components are often integrated into cache memory modules. These modules include the cache controller, cache tag SRAM and cache SRAM components and are ready to plug into sockets on a computer system's motherboard. IDT offers a series of standard and custom cache memory modules for IBM and IBM- compatible PCs and PowerPC-based personal computers as well as for certain RISC microprocessor-based systems.\nThe Company continues to develop its next generation SRAM products to meet the growing cache memory needs of increasingly faster microprocessors. IDT's new products are being designed to operate at higher speeds and provide greater levels of integration.\nIn order to provide SRAM products that meet the varying needs of its customers, IDT uses primarily CMOS and, to a lesser extent, BiCMOS process technologies and offers 16K, 64K, 256K and 1 Meg density SRAMs in a number of speed, organization, power and packaging configurations.\nSpecialty Memory Products. The Company's proprietary specialty memory products include FIFOs and multi-port memory products that offer high-performance features which allow communications and computer systems to operate more effectively. FIFOs are used as rate buffers to transfer large amounts of data at high speeds between separate devices or pieces of equipment operating at different speeds within a system. Multi-port memory products are used to speed data transfers and act as the link between multiple microprocessors or between microprocessors and peripherals when the order of the data to be transferred needs to be controlled. These products are currently used primarily in peripheral interface, communications and networking products, including bridges, hubs, routers and switches.\nIDT is a leading supplier of both synchronous and asynchronous FIFOs and has increasingly focused its resources on the design of synchronous FIFOs. Synchronous FIFOs have been gaining greater market acceptance because they are faster and provide an easier user interface. IDT's family of 9-bit SyncFIFOs are being used in many of the newer networking products.\nThe Company is a leading supplier of multi-port memory products. IDT's family of multi-port memory products is composed primarily of dual-port asynchronous devices. The Company also offers four-port products, a synchronous dual-port device and a new device, known as a SARAM, that combines the flexibility of a multi-port product with the ease of a FIFO. In addition, the Company is developing a family of specialty memory products for the emerging asynchronous transfer mode (\"ATM\") market. The first member of this ATM family, a SAR (segmentation and reassembly), is a highly integrated, low cost interface device for ATM network cards. Other members of the ATM family will include low-cost physical media interface devices, as well as more highly-integrated SAR devices for ATM networks.\nLogic Circuits. IDT is a leading manufacturer of high-speed byte-wide and double-density 16-bit CMOS logic circuits for high-performance applications. Logic circuits control data communication between various elements of electronic systems, such as between a microprocessor and a memory circuit. IDT offers a wide range of logic circuit products, which support bus and backplane interfaces, memory interfaces and other logic support applications where high-speed, low power and high-output drive are critical. IDT's logic circuits are used in a broad range of markets.\nIDT's 16-bit family of logic products is available in small packages, enabling board area to be reduced, and has gained increasing market acceptance. These products are designed for new applications in which small size, low power and extra low noise are as important as high speeds. IDT also supplies a series of 8-bit and 16-bit 3.3 volt logic products and a 3.3 volt to 5 volt translator circuit directed at the growing requirements for 3.3 volt systems in the notebook and laptop computer and other markets. The Company also offers a family of clock drivers and clock generators. These devices, placed at critical positions in a system, correct the degradation of timing that occurs the further the impulses travel from the main system clock.\nRISC Microprocessor Components and Subsystems. IDT is a licensed manufacturer of MIPS RISC microprocessors. IDT now manufactures MIPS architecture 32-bit and 64-bit standard microprocessors and IDT derivative products for the communications, office automation, workstation\/server and desktop computer markets.\nThe Company focuses its RISC microprocessor design and marketing efforts primarily on the embedded controller market. Embedded controllers are microprocessors that control a single device such as a printer, copier or network router. The Company sells several proprietary 32-bit derivative products for the embedded controller market, including devices with on-circuit SRAM cache memory and floating point functions.\nIn 1993, the Company introduced its ORION R4600 microprocessor, which is capable of clock speeds of up to 150 MHz. The R4600 is a higher performance, lower cost derivative of the 64-bit R4000 and R4400 microprocessors developed by MIPS Computer Systems, which was acquired by Silicon Graphics in 1992 (\"MIPS\"), and introduced by the Company and other MIPS licensees in 1992 and 1993, respectively. The R4600 was developed for the Company and to the Company's specifications by Quantum Effect Design, Inc. (\"QED\"), a consolidated subsidiary. Systems based on the ORION family of microprocessors are targeted at both embedded and desktop applications.\nThe Company also manufactures RISC subsystems, which are board level products that contain MIPS RISC architecture microprocessors, cache SRAMs, logic circuits and supporting software. These products are used in development systems for the evaluation and design of hardware and software or are integrated into customers' end-user systems, thereby reducing design cycle time.\n* R4600 and Orion are trademarks of Integrated Device Technology, Inc.\nCUSTOMERS\nThe Company markets and sells its products primarily to OEMs in the desktop computer, communications, office automation and workstation\/server markets. Customers often purchase products from more than one of the Company's product families.\nMARKETING AND SALES\nIDT markets and sells its products primarily to OEMs through a variety of channels, including a direct sales force, distributors and independent sales representatives.\nThe Company had 50 direct sales personnel in the United States at April 2, 1995. Such personnel are located at the Company's headquarters and in 17 sales offices in Alabama, California, Colorado, Florida, Illinois, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon and Texas, and are primarily responsible for marketing and sales in those areas. IDT also utilizes three national distributors, Hamilton Hallmark, Future Electronics and Wyle Laboratories, and several regional distributors in the United States. Hamilton Hallmark accounted for 15% and 13% of the Company's revenues in fiscal 1994 and 1995, respectively. In addition, IDT uses independent sales representatives, which generally take orders on an agency basis while the Company ships directly to the customer. The representatives receive commissions on all products shipped to customers in their geographic area.\nThe Company had 31 direct sales personnel and eight sales offices located outside of the United States at April 2, 1995. Sales activities outside North America are generally controlled by IDT's subsidiaries located in France, Germany, Hong Kong, Italy, Japan, Sweden and the United Kingdom. The Company also has a sales office in Taiwan. The Company has recently increased its direct marketing efforts to OEMs in Europe and to United States companies with operations in the Asia\/Pacific area. A significant portion of export sales, however, continues to be made through international distributors, which tend not to carry inventory or carry significantly smaller levels compared to domestic distributors. During fiscal 1993, 1994 and 1995, export sales accounted for 36%, 32% and 39% of total revenues. Sales outside the United States are generally denominated in local currencies. Export sales are subject to certain risks, including currency controls and fluctuations, changes in local economic conditions, import and export controls, and changes in tax laws, tariffs and freight rates.\nThe Company's distributors typically maintain an inventory of a wide variety of products, including products offered by IDT's competitors, and often handle small or rush orders. Pursuant to distribution agreements, the Company grants distributors the right to return slow-moving products for credit against other products and offers protection to the distributors against inventory obsolescence or price reductions. Revenue recognition of sales to distributors is deferred until the products are resold by the distributor.\nMANUFACTURING\nIDT believes that maintaining its own wafer fabrication capability facilitates the implementation of advanced process technologies and new higher-performance product designs, provides it with a reliable source of supply of semiconductors and allows it to be more flexible in shifting production according to product demand. The Company currently operates sub-micron wafer fabrication facilities in San Jose and Salinas, California. The Salinas facility, first placed in production in fiscal 1986, includes a 24,000 square foot, class 3 (less than three particles 0.5 micron or greater in size per cubic foot) fabrication line. The San Jose facility includes a 24,000 square foot, class 1 (less than one particle 0.5 micron or greater in size per cubic foot), six-inch wafer fabrication line that was first placed in production in March 1991. IDT also operates 145,000 square foot component assembly and test facilities in Penang, Malaysia. Substantially all of the Company's test operations and a significant portion of its assembly operations are performed at its Malaysian facility. IDT also uses subcontractors, principally in Korea, the Philippines and Malaysia, to perform certain assembly operations. If IDT were unable to assemble or test products offshore, or if air transportation to these locations were curtailed, the Company's operations could be materially adversely affected. Additionally, foreign manufacturing exposes IDT to certain risks generally associated with doing business abroad, including foreign governmental regulations, currency controls and fluctuation, changes in local economic conditions and changes in tax rates, tariffs and freight rates. In addition to this offshore assembly and test capability, the Company has the capacity for low-volume, quick-turn assembly in Santa Clara as well as limited test capability in Santa Clara, San Jose and Salinas. Assembly and test of memory modules and RISC subsystems takes place both domestically and offshore.\nThe Company has been operating its wafer fabrication facilities in Salinas and San Jose and its assembly operations in Malaysia near installed equipment capacity since fiscal 1994. To address its capacity requirements, in fiscal 1995 the Company initiated and substantially completed the conversion of its Salinas wafer fabrication facility from five-inch to six-inch wafers, and recently commenced its last manufacturing start of five-inch wafers in this facility. In fiscal 1995 the Company also added incremental production equipment to its San Jose facility and completed a 40,000 square foot expansion of assembly and test facilities in Penang, Malaysia. In addition, in August 1994, construction commenced on a 192,000 square foot facility containing a 48,000 square foot, class 1, eight-inch wafer fabrication line in Hillsboro, Oregon. The Company currently estimates that the cost to construct and equip the Oregon facility will be approximately $400 to $500 million. The Company believes the construction of a facility in Oregon reduces the Company's risk of a natural disaster affecting all of its wafer fabrication facilities which are currently located in Northern California. It is expected that the Oregon facility will commence production during fiscal 1996; however, the Oregon facility is not expected to contribute to revenues until fiscal 1997. In late fiscal 1995 the Company acquired an interest in approximately 10 acres of land in the Philippines and intends to construct a 240,000 square foot assembly and test facility. Construction of the building is expected to begin in the second half of fiscal 1996 and is projected to be completed in fiscal 1997. The Company projects the cost to acquire the land, construct the building and equip the facility in multiple phases will total approximately $75 million in capital expenditures, of which less than $10 million will be spent in fiscal 1996 and approximately $40 million in fiscal 1997. The Company faces a number of risks in order to accomplish its goals to increase production in its existing plants and to construct, equip and commence operations of the Oregon and Philippines facilities. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company utilizes proprietary CMOS and BiCMOS process technologies permitting sub-micron geometries. BiCMOS is a combination of bipolar and CMOS technologies and is used for applications requiring higher speeds. The majority of IDT's current products are manufactured using its proprietary 0.65 micron processes, an increasing number are being manufactured using the Company's new 0.5 micron processes and the Company is currently developing several sub-0.5 micron CMOS processes.\nWafer fabrication involves a highly sophisticated, complex process that is extremely sensitive to contamination. Integrated circuit manufacturing costs are primarily determined by circuit size because the yield of good circuits per wafer generally increases as a function of smaller die. Other factors affecting costs include wafer size, number of process steps, costs and sophistication of manufacturing equipment, packaging type, process complexity and cleanliness. IDT's manufacturing process is complex, involving a number of steps including wafer fabrication, plastic or ceramic packaging, burn-in and final test. The Company continually makes changes to its manufacturing process to lower costs and improve yields. From time to time the Company has experienced manufacturing problems that have caused delays in shipments or increased costs. There can be no assurance that IDT will not experience manufacturing problems in the future.\nThe Company generally has been able to arrange for multiple sources of raw materials, but the number of vendors capable of delivering certain raw materials, such as silicon wafers, ultra-pure metals and certain chemicals and gases is very limited. Some of the Company's packages, while not unique, have very long lead times and are available from only a few suppliers. From time to time vendors have extended lead times or limited supply to the Company due to capacity constraints. These circumstances could reoccur and could adversely affect IDT.\nBACKLOG\nIDT manufactures and markets primarily standard products. Sales are generally made pursuant to standard purchase orders, which are frequently revised during the agreement term to reflect changes in the customer's requirements. The Company has also entered into master purchase agreements with several of its OEM customers. These agreements do not require the OEMs to purchase minimum quantities of the Company's products. Product deliveries are scheduled upon the Company's receipt of purchase orders under the related OEM agreements. Generally, these purchase orders and OEM agreements also allow customers to reschedule delivery dates and cancel purchase orders without significant penalties. Orders are frequently rescheduled, revised or cancelled. In addition, distributor orders are subject to price adjustments both prior to, and occasionally after, shipment. For these reasons, IDT believes that its backlog, while useful for scheduling production, is not necessarily a reliable indicator of future revenues.\nRESEARCH AND DEVELOPMENT\nIDT's competitive position has been established, to a large extent, through its emphasis on the development of proprietary and enhanced performance industry-standard products, and the development of advanced CMOS and BiCMOS processes. IDT believes that its focus on continually advancing its process technologies has allowed the Company to achieve cost reductions in the manufacture of most of its products. The Company believes that a continued high level of research and development expenditures is necessary to retain its competitive position. The Company maintains research and development centers in Northern California and Atlanta, Georgia and recently opened a facility in Austin, Texas that will be focused on microprocessor related research and development. In addition the new plant start-up costs associated with the Oregon wafer fabrication facility will significantly increase research and development expenditures in fiscal 1996. Research and development expenditures as a percentage of revenues were 19%, 19% and 23% in fiscal 1995, 1994 and 1993, respectively.\nThe Company's product development activities are focused on the design of new circuits and modules that provide enhanced performance for growing applications. In the SRAM family, IDT is utilizing its 5 volt and 3.3 volt SRAM and subsystem design expertise to develop advanced SRAM cache memories and modules for microcomputer systems based on Intel's 486 and Pentium families of microprocessors and the PowerPC microprocessors, as well as MIPS RISC microprocessors. IDT's efforts in the specialty memory products area are concentrated on the development for the communications market of advanced synchronous FIFOs and more sophisticated multi-port memory products. The Company is also developing a family of specialty memory products for the emerging ATM market, and a family of lower voltage logic devices for a broad range of applications. In the RISC component and subsystems product family, the Company is emphasizing the design of products for embedded control applications, such as printers and telecommunications switches. The Company also continues to refine its CMOS and BiCMOS process technologies to increase the speed and density of circuits in order to provide customers with advanced products at competitive prices, thus enhancing their competitive positions. The Company is currently refining its CMOS process technology to achieve several sub-0.5 micron geometry processes and converting the production of many products, particularly 3.3 volt devices, to newer generation processes.\nIn fiscal 1992, the Company purchased an equity interest in QED, a newly formed corporation. Pursuant to a development agreement between QED and the Company, QED developed the ORION R4600 microprocessor for IDT. The Company recently announced two new ORION derivative products being designed for IDT by QED, the R4700 microprocessor targeted to desktop systems running WindowsNT or UNIX operating systems, and the R4650 microprocessor targeted to embedded applications. The Company owns such products, subject to the payment of royalties and other fees to QED. IDT has licensed Toshiba and NKK to manufacture and market certain of these products. There can be no assurance that QED will continue to design products for the Company or be successful in developing such products.\nCOMPETITION\nThe semiconductor industry is intensely competitive and is characterized by rapid technological advances, cyclical market patterns, price erosion, evolving industry standards, occasional shortages of materials, intellectual property disputes and high capital equipment costs. Many of the Company's competitors have substantially greater technical, marketing, manufacturing and financial resources than IDT. In addition, several foreign competitors receive assistance from their governments in the form of research and development loans and grants and reduced capital costs, which could give them a competitive advantage. The Company competes in different product areas, to varying degrees, on the basis of technical innovation and performance of its products, as well as quality, price and product availability.\nIDT's competitive strategy is to differentiate its products through high-performance, innovative configurations and proprietary features or to offer industry-standard products with higher speeds and\/or lower power consumption. There can be no assurance that price competition, introductions of new products by IDT's competitors, delays in product introductions by IDT or other competitive factors will not have a material adverse effect on the Company in the future.\nINTELLECTUAL PROPERTY AND LICENSING\nIDT has obtained 49 patents in the United States and 18 abroad and has numerous inventions in various stages of the patent application process. The Company intends to continue to increase the scope of its patents. The Company also relies on trade secret, copyright and trademark laws to protect its products, and a number of the Company's circuit designs are registered pursuant to the Semiconductor Chip Protection Act of 1984. This Act gives protection similar to copyright protection for the patterns which appear on integrated circuits and prohibits competitors from making photographic copies of such circuits. There can be no assurance that any patents issued to the Company will not be challenged, invalidated or circumvented, that the rights granted thereunder will provide competitive advantages to the Company, or that the Company's efforts generally to protect its intellectual property rights will be successful.\nIn recent years, there has been a growing trend of companies to resort to litigation to protect their semiconductor technology from unauthorized use by others. The Company in the past has been involved in patent litigation which adversely affected its operating results. Although the Company has obtained patent licenses from certain semiconductor manufacturers, the Company does not have licenses from a number of semiconductor manufacturers who have a broad portfolio of patents. IDT has been notified that it may be infringing patents issued to certain semiconductor manufacturers and other parties, and is currently involved in several license negotiations. There can be no assurance that additional claims alleging infringement of intellectual property rights, including infringement of patents that have been or may be issued in the future, will not be made against the Company in the future or that licenses, to the extent required, will be available. Should licenses from any such claimant be unavailable, or not be available on terms acceptable to the Company, the Company may be required to discontinue its use of certain processes or the manufacture, use and sale of certain of its products, to incur significant litigation costs and damages, or to develop noninfringing technology. If IDT is unable to obtain any necessary licenses, pass any increased cost of patent licenses on to its customers or develop noninfringing technology, the Company could be materially adversely affected. In addition, IDT has received patent licenses from several companies that expire over time, and the failure to renew or renegotiate certain of these licenses as they expire or significant increases in amounts payable under these licenses could have an adverse effect on the Company.\nOn May 1, 1992, IDT and AT&T entered into a five-year royalty-free patent cross-license agreement. As part of this agreement, patent litigation instituted by AT&T was settled and dismissed. Under the agreement, IDT made a lump sum payment and issued shares of its Common Stock to AT&T, granted a discount on future purchases, and gave credit for future purchases of technology on a nonexclusive basis.\nOn December 10, 1992, IDT and Texas Instruments (\"TI\") entered into a five-year patent cross- license agreement. As part of this agreement, patent litigation instituted by TI was dismissed. Under the agreement, IDT granted to TI a license to certain IDT technology and products and guaranteed TI that it will realize certain revenues from the technology and products, and IDT will develop certain products which will be manufactured and sold by both IDT and TI. See Note 4 of Notes to Consolidated Financial Statements.\nEMPLOYEES\nAt April 2, 1995, IDT and its subsidiaries employed approximately 2,965 people worldwide, of whom approximately 1,045 were in Penang. IDT's success depends in part on its ability to attract and retain qualified personnel, who are generally in great demand. Since its founding, the Company has implemented policies enabling its employees to share in IDT's success. Examples are stock option, stock purchase, profit sharing and special bonus plans for key contributors. IDT has never had a work stoppage, no employees are represented by a collective bargaining agreement, and the Company considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company presently occupies six major facilities in California and Malaysia as follows:\nLOCATION FACILITY USE SQUARE FEET ---------------- ------------------------------------- ------------- Salinas ........... Wafer fabrication, SRAM and multi- 98,000 port memory operations\nSanta Clara ....... Logic and RISC microprocessor 62,000 operations\nSanta Clara ....... Administration and sales 43,700\nSanta Clara ....... Administration and RISC subsystems 50,000 operations\nPenang, Malaysia .. Assembly and test 145,000\nSan Jose .......... Wafer fabrication, process technology 135,000 development, FIFO and memory subsystems operations, and research and development\nThe Company leases its Salinas facility from Carl E. Berg, a director, and in October 1994 purchased a 5.5 acre parcel adjacent to its Salinas facility for $653,000 from Mr. Berg. IDT leases its Salinas and Santa Clara facilities under leases expiring in 1999 through 2005. The lease for the Salinas facility has two five-year renewal options. The Company owns its Malaysian and San Jose facilities, although the Malaysian facilities are subject to long-term ground leases and the San Jose facility is subject to a mortgage. IDT leases offices for its sales force in 17 domestic locations as well as Hong Kong, London, Milan, Munich, Paris, Stockholm, Taipei and Tokyo. See Note 7 of Notes to Consolidated Financial Statements for information concerning IDT's obligations under operating and capital leases. The Company has purchased a 23 acre parcel in Hillsboro, Oregon and construction has commenced on a 192,000 square foot facility containing a 48,000 square foot, class 1, eight-inch wafer fabrication line. It is expected that the Oregon facility will commence production during fiscal 1996; however, the Oregon facility is not expected to contribute to revenues until fiscal 1997. In late fiscal 1995 the Company acquired an interest in approximately 10 acres of land in the Philippines and intends to construct a 240,000 square foot assembly and test facility.\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 Registrant or any of its subsidiaries is a party, or of which any of their property is the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS\nNo matters were submitted to a vote of the Company's securityholders during the last quarter of the fiscal year ended April 2, 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information as of May 18, 1995 is provided with respect to each executive officer of the Company.\nName Age Position\nD. John Carey 59 Chairman of the Board Leonard C. Perham 51 President & Chief Executive Officer William B. Cortelyou 39 Vice President, Wafer Operations Robin H. Hodge 55 Vice President, Assembly and Test Alan H. Huggins 42 Vice President, Memory Division Larry T. Jordan 50 Vice President, Marketing Daniel L. Lewis 46 Vice President, Sales Chuen-Der Lien 32 Vice President, Technology Development Jack Menache 51 Vice President, General Counsel and Secretary Richard R. Picard 47 Vice President, Logic and Microprocessor Products Robert Phillips 50 Vice President, Manufacturing William D. Snyder 50 Vice President, Finance and Chief Financial Officer\nMr. Carey was elected to the Board of Directors in 1980 and has been Chairman of the Board since 1982. He served as Chief Executive Officer from 1982 until his resignation in April 1991 and was President from 1982 until 1986. Mr. Carey was a founder of Advanced Micro Devices (\"AMD\") in 1969 and was an executive officer there until 1978.\nMr. Perham joined IDT in October 1983 as Vice President and General Manager, SRAM Division. In October 1986, Mr. Perham was appointed President and Chief Operating Officer and a director of the Company. In April 1991, Mr. Perham was elected Chief Executive Officer. Prior to joining IDT, Mr. Perham held executive positions at Optical Information Systems Incorporated and Zilog Inc.\nMr. Cortelyou joined IDT in 1982. In January 1990, he was elected Vice President, Wafer Operations, Salinas. Mr. Cortelyou currently serves as Vice President, Wafer Operations. Prior to joining IDT, Mr. Cortelyou was an engineer at AMD.\nMr. Hodge joined IDT as Director of Assembly Operations in March 1989. In January 1990, Mr. Hodge was elected Vice President, Assembly Operations. Mr. Hodge currently serves as Vice President, Assembly and Test. From 1983 until joining IDT, Mr. Hodge was Director of Assembly Operations for Maxim Integrated Products.\nMr. Huggins joined IDT in 1983 and was elected Vice President in 1987. Mr. Huggins currently serves as Vice President, Memory Division. Prior to joining the Company, Mr. Huggins held various engineering positions at AMD.\nMr. Jordan joined IDT in July 1987 as Vice President, Marketing. Prior to joining the Company, Mr. Jordan held management positions in marketing and sales at SEEQ Technology, Inc. and Intel Corporation.\nMr. Lewis joined IDT in 1984 as Eastern Area Sales Manager. In June 1991, he was elected Vice President, Sales. Prior to joining IDT, Mr. Lewis held management positions at Avatar Technologies, Inc., Data General and Zilog.\nDr. Lien joined IDT in 1987 and was elected Vice President, Technology Development in April 1992. Prior to joining the Company, he held engineering positions at Digital Equipment Corporation and AMD.\nMr. Menache joined IDT as Vice President, General Counsel and Secretary in September 1989. From April 1989 until joining IDT, he was General Counsel of Berg & Berg Developers. From 1986 until April 1989, he was Vice President, General Counsel and Secretary of The Wollongong Group Inc.\nMr. Picard joined IDT in 1985. In 1989 he was elected Vice President, Static RAM Product Line. In April 1990 he was appointed Vice President and General Manager, Logic Products. He was elected Vice President, Logic and Microprocessor Products in May 1993. Prior to joining IDT, Mr. Picard held management positions at International Micro Circuits, Zilog and AMD.\nMr. Phillips joined IDT in March 1995 as Vice President, Manufacturing. Prior to joining IDT, Mr. Phillips was Vice President of Fab, Assembly and Test Operations at Vitesse Semiconductor and Edsun Labs, and was President of PMT Manufacturing Technology, Inc.\nMr. Snyder joined the Company as Treasurer in 1985. In May 1990, he was elected Vice President, Corporate Controller, and in September 1990 Mr. Snyder was elected Vice President, Finance and Chief Financial Officer. Prior to joining the Company, Mr. Snyder held financial management positions at Actrix Computer, Zilog and Digital Equipment Corporation.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock\nThe Common Stock of the Company is traded on The Nasdaq National Market under the symbol \"IDTI.\" The following table sets forth the high and low last reported sale prices for the Common Stock as reported by the Nasdaq National Market during the fiscal quarters indicated.\nHIGH LOW -------- ------- Fiscal 1996: First Quarter (through May 24, 1995) ...49-7\/8 36-1\/16\nFiscal 1995: First Quarter ...........................31-3\/8 23-7\/8 Second Quarter ..........................28-7\/8 16-1\/4 Third Quarter ...........................30-1\/16 18-1\/2 Fourth Quarter ..........................40-3\/4 28-3\/8\nFiscal 1994: First Quarter ...........................11-1\/8 6-1\/2 Second Quarter ..........................19-5\/8 10-1\/2 Third Quarter ...........................18-7\/8 12-3\/8 Fourth Quarter ..........................33-5\/8 16-3\/4\nOn May 24, 1995, the last reported sale price of the Common Stock was $46 7\/8 per share. As of May 18, 1995, there were approximately 820 record holders of the Common Stock.\nThe Company intends to retain any future earnings for use in its business and, accordingly, does not anticipate paying any cash dividends on its Common Stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial data as of April 2, 1995 and April 3, 1994 and for each of the years in the three-year period ended April 2, 1995 have been derived from IDT's Consolidated Financial Statements included elsewhere in this Form 10-K, which have been audited by Price Waterhouse LLP, independent accountants, as indicated in their report thereon appearing elsewhere herein. The following selected financial data as of March 28, 1993, March 29, 1992, March 31, 1991 and for each of the years in the two-year period ended March 29, 1992 have been derived from audited consolidated financial statements not included herein. The data set forth below are qualified in their entirety by reference to, and should be read in conjunction with, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Consolidated Financial Statements and related notes thereto included elsewhere in this Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nIDT designs, develops, manufactures and markets a broad range of high-performance semiconductor products for the desktop computer, communications, office automation and workstation\/server markets. The Company's revenues have increased from $236 million in fiscal 1993 to $330 million in fiscal 1994 and to $422 million in fiscal 1995. This growth has been due to increasing market acceptance of new products, the expansion of production output through additions of capital equipment and improved manufacturing processes and associated die shrinks and yield improvements, and improvements in overall market conditions, including strong demand for SRAMS. During these periods, the Company has achieved unit volume growth across all of its market segments. In fiscal 1995 as a result of strong demand for fast SRAMs used as secondary cache for 32-bit and 64-bit micropressors the Company shifted product mix in favor of SRAMs. The higher selling prices of SRAMs in fiscal 1995 resulted in increasing average selling prices on a company-wide basis for the year.\nThe Company's gross profit and operating profit margins have improved significantly from 44.0% and 4.7%, respectively, in fiscal 1993 to 51.7% and 15.8%, respectively, in fiscal 1994 and to 57.5% and 23.6%, respectively, in fiscal 1995. These improvements were due to economies of scale associated with increased unit shipments, higher utilization of manufacturing capacity, wafer fabrication process improvements, die shrinks and a mix shift to higher margin products, particularly SRAMs.\nThe Company has been operating near installed equipment capacity since fiscal 1994. To address this situation, the Company initiated a significant capacity expansion program in 1995, including conversion of the Company's Salinas wafer fabrication facility from five-inch to six-inch wafers, purchase of incremental wafer fabrication equipment for the Company's San Jose facility, expansion of assembly and test facilities in Penang, Malaysia, construction of a new eight-inch wafer fabrication facility in Oregon and the construction of a new assembly and test facility in the Philippines. These programs required substantial capital expenditures in fiscal 1995 and are expected to require a substantially higher level of expenditures in fiscal 1996 and beyond. See \"Business--Manufacturing--Properties.\" The Company initiated and substantially completed the equipment conversion of the Salinas facility in fiscal 1995, and recently commenced its last manufacturing start of five-inch wafers in this facility. The substantial portion of the addition of new equipment to the San Jose facility has occurred and additional equipment will be added in fiscal 1996. The 40,000 square foot expansion of the Penang facilities was completed at the end of fiscal 1995. It is expected that the Oregon facility will commence production during fiscal 1996; however, the Oregon facility is not expected to contribute to revenues until fiscal 1997. The Company has recently completed the acquisition of land for the new test and assembly facility in the Philippines.\nThe increased operating expenses associated with the Company's capacity expansion programs will adversely affect operating results until the Company achieves volume production utilizing the new facilities and equipment. Although the Company does not expect to generate revenues from its new Oregon fabrication facility until fiscal 1997, the Company will recognize substantial operating expenses associated with the facility in fiscal 1996 and 1997. The Company will also begin to recognize in fiscal 1997 substantial depreciation expenses upon commencement of commercial production but before production of substantial volumes is achieved.\nThe following table sets forth certain amounts, as a percentage of revenues, from the Company's consolidated statements of operations for the three fiscal years ended April 2, 1995, April 3, 1994 and March 28, 1993.\nFISCAL YEAR ENDED -------------------------- April 2, April 3, March 28, 1995 1994 1993 ----- ------ ------ Revenues ....................................... 100.0% 100.0% 100.0% Cost of revenues ............................... 42.5 48.3 56.0 ----- ------ ------ Gross margin ................................... 57.5 51.7 44.0 ----- ------ ------ Operating expenses: Research and development ....................... 18.6 19.4 22.6 Selling, general and administrative ............ 15.3 16.5 16.7 ----- ------ ------ Total operating expenses ....................... 33.9 35.9 39.3 ----- ------ ------ Operating income ............................... 23.6 15.8 4.7 Net interest income ............................ 1.2 (0.6) (2.0) ----- ------ ------ Income before provision for income taxes ....... 24.8 15.2 2.7 Provision (benefit) for income taxes ........... 6.2 3.0 0.4 ----- ------ ------ Net income ..................................... 18.6% 12.2% 2.3% ===== ====== ======\nRESULTS OF OPERATIONS\nRevenues increased 27.8% to $422.2 million in fiscal 1995, as compared to revenues of $330.5 million in fiscal 1994, which in turn represented a 39.9% increase over revenues of $236.3 million in fiscal 1993. The increase in fiscal 1995 was attributable to the higher unit volumes across all product families and sales channels. Sales in Asia-Pacific (excluding Japan) and Europe increased substantially in fiscal 1995. In addition, much of the increase in revenues was driven by increasing demand for fast SRAM memory utilized by more powerful microprocessors, such as the Pentium and PowerPC, which utilize secondary cache memory for enhanced system performance. As a result of strong industry-wide demand and capacity constraints, SRAM prices were generally higher throughout fiscal 1995 as compared to the prior year, particularly in the second half of fiscal 1995. The Company also achieved in fiscal 1995 higher unit sales of specialty memories and embedded microprocessors, particularly in the telecommunications and networking markets. In fiscal 1995 microprocessor sales were flat as compared to fiscal 1994, due to a decline in sales of nonembedded microprocessors as a result of the Company's strategic shift of focus toward sales of embedded microprocessors. Growth in fiscal 1994 was due to increased unit sales across all product segments, with the largest percentage increase in the microprocessor segment, as well as favorable pricing during the fiscal year on certain products, offset in part by lower selling prices for some products. Revenue growth in fiscal 1993 was attributed to increases in product shipments across all market segments, offset in part by price reductions on several major products. Toward the end of fiscal 1993, pricing firmed in the memory business segment, reversing a trend of steady price erosion over several years, which had been driven in part by increased demand across all market segments.\nGross profit in fiscal 1995 increased 42.0% to $242.5 million, or 57.5% of revenues, as compared to $170.8 million or 51.7% of revenues in fiscal 1994. Gross profit increased 64.3% in fiscal 1994 from $104.0 million or 44.0% of revenues in fiscal 1993. The improvements in gross profit and gross margins in fiscal 1995 were primarily attributable to higher prices on certain products, particularly SRAMs, higher manufacturing capacity utilization and lower costs achieved through die shrinks. In fiscal 1995 the Company also continued a shift to more advanced designs and wafer fabrication processes, which resulted in increased die per wafer yields and therefore lower unit costs. More efficient test and burn-in procedures also contributed to improved yields and reduced manufacturing costs. In addition, selective acceptance of new orders as a result of continued strong demand allowed the Company to shift manufacturing capacity to higher-margin products. Gross profit also benefited in fiscal 1995 as compared to fiscal 1994 as a result of a $3.5 million reduction in patent and royalty expenses related to license agreements. However, the Company's industry is characterized by patent claims and license agreements, and there can be no assurance royalty expenses will not increase in the future. In recent periods the pricing environment for SRAMs has been favorable, notwithstanding the long-term trend of price declines in the semiconductor market. Significant price declines for SRAMs or other products in the future could adversely affect the Company's operating results. The improvement in gross profit in fiscal 1994 was primarily attributable to greater capacity utilization, which lowered average wafer manufacturing costs, significant increases in die per wafer due to wafer fabrication process improvements, and a mix shift to products with higher average selling prices, particularly microprocessors.\nResearch and development expenses increased 22.1% to $78.4 million or 18.6% of revenues in fiscal 1995, as compared to $64.2 million or 19.4% of revenues in fiscal 1994. In fiscal 1993, R&D expenses were $53.5 million or 22.6% of revenues. The increases in R&D expenses were due primarily to continued investments by the Company in both process technology and new product design and development. In fiscal 1995, the Company introduced over 50 new products, with more than 600 configurations, and continued to develop its CMOS processes at 0.5 micron geometries and below. A number of activities will cause absolute R&D spending to increase substantially, including expansion of R&D activity in both Atlanta, Georgia and Austin, Texas, new plant start-up costs associated with the Oregon wafer fabrication facility, particularly in fiscal 1996, and further development of new products and processes. IDT believes that the continuation of a high level of R&D investment is essential to continue the flow of new products.\nSelling, general and administrative expenses increased 19% to $64.6 million in fiscal 1995 or 15.3% of revenues, as compared to $54.3 million or 16.5% of revenues in fiscal 1994. In fiscal 1993, SG&A expenses were $39.5 million or 16.7% of revenues. The increase in SG&A expenses in fiscal 1995 was attributable to higher costs associated with the higher level of sales, including higher sales commissions, employee profit sharing and management bonuses, and an increase in sales personnel, particularly in Europe, although SG&A expenses did not increase as rapidly as sales. The fiscal 1994 increase was primarily due to increases in management bonuses, employee profit sharing and the variable selling expenses associated with the revenue increase.\nInterest expense totaled $3.3 million in fiscal 1995, compared to $5.2 million in fiscal 1994 and $5.9 million in fiscal 1993. Interest expense has decreased as IDT has retired outstanding debt, primarily equipment financing. IDT continues to impute interest on a long-term obligation associated with a patent cross-license.\nInterest income and other, net, increased to $8.2 million in fiscal 1995 compared to $3.1 million and $1.1 million in fiscal years 1994 and 1993, respectively. The increase in interest income resulted from significantly higher cash balances available for investments, due to cash generated from operations and net proceeds from Common Stock offerings of $46.8 million in October 1993 and $97.6 million in December 1994. In fiscal 1995 interest income also reflected the general increase in interest rates available for investment funds. IDT also received approximately $1.0 million of royalty income in fiscal 1995 compared to $0.3 million in fiscal 1994 and none in fiscal 1993.\nThe effective tax rates for fiscal 1995, 1994 and 1993 of 25%, 20% and 15%, respectively, differed from the U.S. statutory rate of 35% in fiscal 1995 and 1994 (34% for fiscal 1993) primarily due to earnings of foreign subsidiaries being taxed at lower rates, as well as the utilization of research and development credits. In addition, fiscal years 1995 and 1994 benefited from the realization of certain deferred tax benefits for which a valuation allowance was previously required. The Company expects that its effective tax rate in 1996 will increase to approximately 32% due to decreased tax benefits associated with its Malaysian subsidiary. See Note 11 of Notes to Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial condition improved during fiscal 1995. Cash and cash equivalents and short-term investments increased from $121.8 million at the end of fiscal 1994 to $232.1 million at the end of fiscal 1995. Working capital increased from $143.2 million at April 3, 1994 to $271.7 million at April 2, 1995. These increases were due to improved profitability, as well as a public stock offering in fiscal 1995 yielding net proceeds of approximately $97.6 million. As of April 2, 1995, the Company had $6.1 million available under unsecured lines of credit, all of which are overseas. See Note 6 of Notes to Consolidated Financial Statements.\nDuring fiscal 1993, 1994 and 1995, the Company generated $37.2 million, $100.1 million and $115.8 million, respectively, of cash flow from operations. The largest single factor influencing cash flow from operations during fiscal 1993 was the depreciation resulting from the Company's San Jose wafer fabrication facility. The improved operating results in fiscal 1994 and 1995 also had a significant impact on cash flow during those periods. The Company anticipates that significant depreciation relating to the San Jose facility will continue through at least fiscal 1996.\nDuring fiscal 1993, 1994 and 1995, the Company's net cash used in investing activities was $28.8 million, $68.9 million and $163.2 million, respectively, of which $28.0 million, $37.4 million and $94.7 million, respectively, were used for capital equipment and property and plant improvements. During fiscal 1993, the Company's net cash used in financing activities was $5.9 million, due primarily to net repayments of $8.8 million related primarily to capital equipment financing. In fiscal 1994, financing activities generated $34.8 million, the primary source of which was net cash of $46.8 million as a result of the Company's public equity offering in October 1993. This source was partially offset by net repayments of equipment financing of $20.5 million. In fiscal 1995 the Company's financing activities generated $89.2 million, the primary source of which was net cash of $97.6 million as a result of the Company's public equity offering in December 1994; these funds were partially offset by net debt repayments of $14.4 million. See Notes 4, 5, 6 and 7 of Notes to Consolidated Financial Statements for information regarding the Company's various financing arrangements.\nThe Company has international subsidiaries which operate and sell products or manufacture products in foreign markets. In addition, the Company's export sales are generally denominated in local currencies. The Company also purchases materials and equipment from foreign suppliers, and incurs labor costs, particularly at its Malaysia assembly facility, in foreign currencies. As a result, the Company is exposed to international factors such as changes in foreign currency exchange rates, imposition of currency exchange controls or changes in the economic conditions of the countries in which the Company operates. The Company utilizes forward exchange contracts to hedge against the short-term impact of foreign currency fluctuations on certain assets or liabilities denominated in foreign currencies. At April 2, 1995, the Company had outstanding various forward exchange contracts valued at approximately $18.5 million. There can be no assurance that the above factors will not adversely affect the Company's operations in the future or that the Company will be successful in its hedging efforts. See Note 2 of Notes to Consolidated Financial Statements.\nIn view of current and anticipated capacity requirements, the Company anticipates capital expenditures of approximately $260 million in fiscal 1996, principally in connection with its capacity expansion programs. In January 1995 the Company entered into a five-year, $60 million Tax Ownership Lease transaction with respect to the new Oregon wafer fabrication facility. The lease obligations are secured by the building and collateralized by cash and\/or investments (restricted securities) up to 105% of the lessor's construction cost until completion of the building and 85% thereafter. Restricted securities collateralizing this lease were $10.5 million at April 2, 1995 and are expected to reach approximately $50 million by the completion of the facility in fiscal 1996. The Company is also contingently liable at the end of the lease to the extent the lessor is not able to realize 85% of the construction costs of the building upon sale or other disposition of the building by the lessor. The lease requires monthly payments which vary based upon the London Interbank Offered Rate (LIBOR) plus 0.3% (6.425% at April 2, 1995). See Note 7 to Consolidated Financial Statements. The Company may consider additional forms of financing to help meet its anticipated capital needs for its new Oregon facility, including a possible bond financing through the State of Oregon, which could yield proceeds of up to $20 million or more. The Company currently estimates that the cost to construct and equip the Oregon and Philippines facilities will be approximately $400 to $500 million and $75 million, respectively. Accordingly, the Company anticipates significant continuing capital expenditures in the next several years. See \"Risk Factors--Current Capacity Limitations and Risks Associated with Planned Expansion\" and \"--Capital Needs.\"\nThe Company believes that existing cash and cash equivalents, cash flow from operations, existing credit facilities and possible other financing arrangements for the new facilities, will be adequate to fund its anticipated capital expenditures and working capital needs through fiscal 1996. There can be no assurance, however, that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company.\nFACTORS AFFECTING FUTURE RESULTS\nDuring fiscal 1995 the Company experienced strong growth in both revenues and earnings particularly in the last six months. Nonetheless, the Company and the semiconductor industry in general are subject to a number of uncertainties.\nThe Company's operating results have been, and in the future may be, subject to fluctuations due to a wide variety of factors including the timing of or delays in new product and process technology announcements and introductions by the Company or its competitors, competitive pricing pressures, fluctations in manufacturing yields, changes in the mix of products sold, availability and costs of raw materials, the cyclical nature of the semiconductor industry, industry-wide wafer-processing capacity, economic conditions in various geographic areas and costs associated with other events, such as an underutilization or expansion of production capacity, intellectual property disputes or other litigation. The semiconductor industry is highly cyclical and has been subject to significant downturns at various times that have been characterized by diminished product demand, production overcapacity and accelerated erosion of average selling prices. In recent periods, the markets for the Company's products, in particular SRAMs, have been characterized by excess demand over supply and resultant favorable pricing. These conditions represent a departure from the long-term trend of declining average selling prices in the semiconductor market. A material increase in industry-wide production capacity, shift in industry capacity toward products competitive with the Company's products, reduced demand, or other factors could result in a rapid decline in product pricing and could adversely affect the Company's operating results.\nThe Company ships a substantial portion of its quarterly sales in the last month of a quarter. If anticipated shipments in any quarter do not occur, the Company's operating results for that quarter could be adversely affected. In addition, a substantial percentage of the Company's products are incorporated into computer and computer-related products, which have historically been characterized by significant fluctuations in demand. Furthermore, any decline in the demand for advanced microprocessors which utilize SRAM cache memory could adversely affect the Company's operating results. In addition, demand for certain of the Company's products is dependent upon growth in the communications market. A slowdown in the computer and related peripherals or communications markets could also adversely affect the Company's operating results.\nAs a result of production capacity constraints, the Company has not been able to take advantage of all market opportunities presented to it. Due to long production lead times and current capacity constraints, any failure by the Company to adequately forecast the mix of product demand could adversely affect the Company's sales and operating resuls. To address its capacity requirements, in fiscal 1995 the Company initiated extensive production expansion programs, which face a number of substantial risks including, but not limited to, delays in construction, cost overruns, equipment delays or shortages, manufacturing startup or process problems and difficulties in hiring key managers and technical personnel. In addition, the Company has never operated an eight-inch wafer fabrication facility, like the one being built in Oregon, and eight-inch facilities and production equipment are relatively new to the industry. Accordingly, the Company could incur unanticipated process or production problems. To remain competitive, the Company must continue to invest in advanced manufacturing and test equipment. From time to time, the Company has experienced production difficulties that have caused delivery delays and quality problems. There can be no assurance that the Company will not experience manufacturing problems and product delivery delays in the future as a result of among other things, changes to its process technologies, ramping production, installing new equipment at its facilities and constructing facilities in Oregon and the Philippines. Further, the Company's existing wafer fabrication facilities are located relatively near each other in Northern California. If the Company were unable to use these facilities, as a result of a natural disaster or otherwise, the Company's operations would be materially adversely affected until the Company were able to obtain other production capability.\nThe Company's capacity additions will result in a significant increase in fixed and operating expenses. If revenue levels do not increase sufficiently to offset these additional expense levels, the Company's operating results could be adversely impacted in future periods. In this regard, the Company has historically expensed as period costs, rather than capitalized, the operating expenses associated with bringing a fabrication facility to commercial production. Although the Company does not expect the Oregon fabrication facility to contribute to revenues until fiscal 1997, the Company will recognize substantial operating expenses associated with the facility in fiscal 1996 and 1997. In addition, in fiscal 1997, the Company will begin to recognize substantial depreciation expenses upon commencement of commercial production but before production of substantial volume is achieved.\nTo remain competitive, the Company must continue to devote significant resources to research and development of new products and processes. There can be no assurance that the Company will be able to develop and introduce new products in a timely manner, that new products will gain market acceptance or that new process technologies can be successfully implemented. Further, the ability of the Company to compete successfully depends upon a number of factors, including new product and process technology introductions by the Company and its competitors customer acceptance of the Company's products, cost effective manufacturing, assertion of intellectual property rights and general market and economic conditions. There can be no assurance that the Company will be able to compete successfully in the future against existing or potential competitors or that the Company's operating results will not be adversely affected by increased price competition.\nThe semiconductor industry is extremely capital intensive. To remain competitive, the Company must continue to invest in advanced manufacturing and test equipment. In fiscal 1996 the Company expects to expend approximately $260 million for the purchase of equipment for the Oregon facility, other ongoing capital expenditures and initial funding for the Philippines assembly and test facility. The Company currently estimates that the cost to construct and equip the Oregon and Philippines facilities will be approximately $400 and $500 million and $75 million, respectively. Accordingly, the Company anticipates significant continuing capital expenditures in the next several years. There can be no assurance that the Company will not be required to seek financing to satisfy its cash and capital needs or that such financing would be available on terms satisfactory to the Company. In this regard, any adverse effect upon the Company's operating results due to a significant downturn in industry pricing or otherwise could accelerate the Company's need to seek additional outside capital.\nThe semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which have resulted in significant and often protracted and expensive litigation. In recent years, there has been a growing trend of companies to resort to litigation to protect their semiconductor technology from unauthorized use by others. The Company in the past has been involved in patent litigation which adversely affected its operating results. Although the Company has obtained patent licenses from certain semiconductor manufacturers, the Company does not have licenses from a number of semiconductor manufacturers who have a broad portfolio of patents. The Company has been notified that it may be infringing patents issued to certain semiconductor manufacturers and other parties, and is currently involved in several license negotiations. There can be no assurance that additional claims alleging infringement of intellectual property rights will not be asserted in the future. The intellectual property claims that have been or may be asserted against the Company could require the Company to discontinue the use of certain processes or cease the manufacture, use and sale of infringing products, to incur significant litigation costs and damages, and to develop noninfringing technology or to acquire licenses to the alleged infringed technology. There can be no assurance that the Company would be able to obtain such licenses on acceptable terms or to develop noninfringing technology. Further, the failure to renew or renegotiate existing licenses or significant increases in amounts payable under these licenses could have an adverse effect on the Company.\nThe Company is subject to a variety of regulations related to hazardous materials used in its manufacturing process. Any failure by the Company to control the use of, or to restrict adequately the discharge of, hazardous materials under present or future regulations could subject it to substantial liability or could cause its manufacturing operations to be suspended.\nThe Company's Common Stock has experienced substantial price volatility and such volatility may occur in the future, particularly as a result of quarter to quarter variations in the actual or anticipated financial results of the Company or other companies in the semiconductor industry or in the markets served by the Company, or announcements by the Company or its competitors regarding new product introductions. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies' stocks in particular, these factors may adversely affect the price of the Common Stock.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORT OF INDEPENDENT ACCOUNTANTS\nConsolidated Financial Statements included in Item 8:\nReport of Independent Accountants\nConsolidated Balance Sheets at April 2, 1995 and April 3, 1994\nConsolidated Statements of Operations for each of the three fiscal years in the period ended April 2, 1995\nConsolidated Statements of Cash Flows for each of the three fiscal years in the period ended April 2, 1995\nConsolidated Statements of Stockholder's Equity for each of the three fiscal years in the period ended April 2, 1995\nNotes to consolidated financial statements\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 schedules, or because the information required is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Integrated Device Technology, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Integrated Device Technology, Inc. and its subsidiaries at April 2, 1995 and April 3, 1994, and the results of their operations and their cash flows for each of the three years in the period ended April 2, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsiblity 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 Jose, California April 21, 1995\nINTEGRATED DEVICE TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nFISCAL YEAR ENDED --------------------------------- APRIL 2, APRIL 3, MARCH 28, 1995 1994 1993 ---------- --------- ----------- Revenues ..................................... $422,190 $330,462 $236,263 Cost of revenues ............................. 179,652 159,627 132,285 ---------- --------- ----------- Gross profit ................................. 242,538 170,835 103,978 ---------- --------- ----------- Operating expenses: Research and development ................... 78,376 64,237 53,461 Selling, general and administrative ....... 64,647 54,329 39,511 ---------- ---------- ---------- Total operating expenses ................... 143,023 118,566 92,972 ---------- ---------- ---------- Operating income ............................. 99,515 52,269 11,006 Interest expense ............................. (3,298) (5,165) (5,855) Interest income and other, net ............... 8,186 3,102 1,127 ---------- ---------- ---------- Income before provision for income taxes .... 104,403 50,206 6,278 Provision for income taxes ................... 26,101 10,041 942 ---------- ---------- ---------- Net income ................................... $ 78,302 $ 40,165 $ 5,336 ========== ========== ========== Net income per share ......................... $ 2.09 $ 1.21 $ .18 ========== ========== ========== Shares used in computing net income per share 37,382 33,116 29,701 ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation. The consolidated financial statements include the accounts of Integrated Device Technology, Inc. (IDT or the Company) and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nFiscal Year. The Company's fiscal year ends on the Sunday nearest March 31. Fiscal years 1993 and 1995 each included 52 weeks. The fiscal year ended on April 3, 1994 was a 53-week year. The fiscal year-end of certain of the Company's foreign subsidiaries is March 31, and the results of their operations as of their fiscal year end have been combined with the Company's results of operations as of April 2, 1995. Transactions during the intervening period were not significant.\nCash, Cash Equivalents and Short-term Investments. Cash equivalents are highly liquid investments with original maturities of three months or less at the time of acquisition or with guaranteed on-demand buy-back provisions. Short-term investments are valued at amortized cost, which approximates market.\nThe Company adopted Statement of Financial Accounting Standards (FAS) 115, \"Accounting for Certain Investments in Debt and Equity Securities\" effective April 4, 1994 as required by that pronouncement. The Statement requires reporting of investments as either held to maturity, trading or available for sale. The cumulative effect of adopting FAS 115 was not material to the Company's financial position or results of operations. The Company's investments are classified as available-for-sale as of April 2, 1995. Investment securities classified as available-for-sale are measured at market value and net unrealized gains or losses are recorded as a separate component of stockholders' equity until realized. Any gains or losses on sales of investments are computed on specific identification. As of April 2, 1995, gross realized and unrealized gains and losses on investments available for sale were not material. Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates the classification at each reporting date.\nAVAILABLE-FOR-SALE SECURITIES APRIL 2, 1995 --------------------------------- --------------- (IN THOUSANDS) U.S. Government agency securities ........................... $ 36,262 State and local governments ................................... 94,345 Corporate securities .......................................... 73,160 Others ........................................................ 8,215 ------- Total debt and equity securities .............................. 211,982 ------- Less cash equivalents ......................................... 110,108 ------- Short-term investments ........................................ $101,874 =======\nShort-term investments of $47,949,000 mature in less than one year and $53,925,000 have maturities between one and four years.\nInventory. Inventory is stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market. Market is based upon estimated realizable value reduced by normal gross margin. Inventory at April 2, 1995 and April 3, 1994 was:\nAPRIL 2, 1995 APRIL 3, 1994 --------------- --------------- (IN THOUSANDS) Inventory: Raw materials .......................... $ 4,404 $ 2,834 Work-in-process ........................ 16,977 10,201 Finished goods ......................... 16,078 16,820 -------- -------- $ 37,459 $ 29,855 ======== ========\nProperty, Plant and Equipment. Property, plant and equipment are stated at cost. Depreciation is computed for property, plant and equipment using the straight-line method over estimated useful lives of the assets. Leasehold improvements and leasehold interests are amortized over the shorter of the estimated useful lives of the assets or the remaining term of the lease. Accelerated methods of depreciation are used for tax computations. Property, plant and equipment at April 2, 1995 and April 3, 1994 were:\nAPRIL 2, 1995 APRIL 3, 1994 --------------- -------------- (IN THOUSANDS) Property, plant and equipment: Land ........................................... $ 6,076 $ 4,382 Machinery and equipment ........................ 332,680 248,095 Building and leasehold improvements ............ 40,576 40,063 Construction-in-progress ....................... 5,553 76 --------- ---------- 384,885 292,616 Less accumulated depreciation and amortization ... 206,105 171,778 --------- ---------- $ 178,780 $ 120,838 ========= ==========\nIncome Taxes. The Company accounts for income tax in accordance with Statement of Financial Accounting Standards (FAS) 109, \"Accounting for Income Taxes\". FAS 109 is an asset and liability approach which requires that the expected future tax consequences of temporary differences between book and tax bases of assets and liabilities be recognized as deferred tax assets and liabilities.\nNet Income Per Share. Net income per share is computed using the weighted average number of shares of common stock outstanding during the year, plus incremental common equivalent shares, if dilutive. Common stock equivalents consist of stock options (using the treasury stock method).\nRevenue Recognition. Revenue from product sales is generally recognized upon shipment and a reserve is provided for estimated returns and discounts. A portion of the Company's sales is made to distributors under agreements which allow certain rights of return and price protection on products unsold by the distributors. Related gross profits thereon are deferred until the products are resold by the distributors.\nTranslation of Foreign Currencies. Accounts denominated in foreign currencies have been translated in accordance with Statement of Financial Accounting Standard (FAS) 52. The functional currency for the Company's sales operations is the applicable local currency with the exception of the Hong Kong sales subsidiary whose functional currency is the U.S. dollar. For subsidiaries whose functional currency is the 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. For the Malaysian manufacturing and the Hong Kong sales subsidiaries, where the functional currency is the U.S. dollar, gains and losses resulting from the process of remeasuring foreign currency financial statements into U.S. dollars are included in income. Aggregate net foreign currency transaction gains (losses) totaled $(93,000), $(232,000) and $348,000 in fiscal 1993, 1994 and 1995, respectively. The effect of foreign currency exchange rate fluctuations on cash balances held in foreign currencies have not been material.\nFair Value Disclosures of Financial Instruments. The estimated fair value of financial instruments has been determined by the Company, using available market information and valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, these estimates may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies could have a material effect on the estimated fair value amounts. The estimated fair value of all of the Company's financial instruments at April 2, 1995 was not materially different from the values presented in the consolidated balance sheet.\nConcentration of Credit Risk and Off-Balance-Sheet Risk. The Company markets high-speed integrated circuits to OEMs and distributors primarily in the United States, Europe and the Far East. The Company performs on-going credit evaluations of its customers' financial conditions and limits the amount of credit extended when deemed necessary but generally does not require collateral. Management believes that any risk of loss is significantly reduced due to the diversity of its products, customers and geographic sales areas. The Company maintains a provision for potential credit losses and write-offs of accounts receivable were insignificant in each of the three years ended April 2, 1995.\nThe Company sells a significant portion of its products through third-party distributors. As a result of the merger of two of the Company's national distributors, the receivable balance from the merged company is significant in aggregate for fiscal 1994 and 1995. If the financial condition and operations of this distributor deteriorate below critical levels, the Company's operating results could be adversely affected. This distributor's receivable balance represented 6% and 11% of total accounts receivable at April 2, 1995, and April 3, 1994, respectively.\nNOTE 2--DERIVATIVE FINANCIAL STATEMENTS\nThe Company has foreign subsidiaries which operate and sell or manufacture the Company's products in various global markets. As a result, the Company is exposed to changes in foreign currency exchange rates. The Company primarily utilizes forward exchange contracts to hedge against the short- term impact of foreign currency fluctuations on certain assets or liabilities denominated in foreign currencies. The total amount of these contracts is offset by the underlying assets denominated in foreign currencies. The gains or losses on these contracts are included in income as the exchange rates change. Management believes that these forward contracts do not subject the Company to undue risk due to foreign exchange movements because gains and losses on these contracts are offset by losses and gains on the underlying assets, and transactions being hedged. These forward exchange contracts are considered identifiable hedges and realized and unrealized gains and losses are deferred until settlement of the underlying commitments. At April 2, 1995 deferred losses aggregated $1,160,000 and there were no deferred gains.\nForeign exchange hedge positions, generally with maturities of less than four months are as follows:\nAPRIL 2, 1995 APRIL 3, 1994 --------------- --------------- (IN THOUSANDS OF U.S. DOLLARS) Japanese Yen--Sell ........................... $ 10,357 $ 7,234 Japanese Yen--Buy ............................ 1,898 -- British Pound Sterling--Sell ................. 992 534 British Pound Sterling--Buy .................. -- 140 German Deutsche Mark--Sell ................... 142 1,736 German Deutsche Mark--Buy .................... -- 84 French Franc--Sell ........................... 69 2,079 French Franc--Buy ............................ -- 168 Malaysian Ringgits--Sell ..................... 3,022 -- Malaysian Ringgits--Buy ...................... 2,003 -- -------- -------- $ 18,483 $ 11,975 ======== ========\nThe Company is exposed to credit-related losses if counterparties to financial instruments fail to perform their obligations. However, it does not expect any counterparties, which presently have high credit ratings, to fail to meet their obligations. The Company controls credit risk through credit approvals, limits and monitoring procedures including the use of high credit quality counterparties.\nNOTE 3--OTHER ASSETS--INTANGIBLES\nDuring fiscal 1993, IDT entered into various royalty-free patent cross-license agreements. The patents licenses granted to IDT under these agreements have been recorded at their cost of approximately $8,200,000 and are being amortized on a straight-line basis over five years. The amortization relating to patents licenses was $1,647,000 for both fiscal years 1995 and 1994.\nNOTE 4--LONG-TERM OBLIGATIONS\nThe Company leases certain equipment under long-term leases or finances purchases of equipment under bank financing agreements. Leased assets and assets pledged under financing agreements which are included under property, plant and equipment are as follows:\nAPRIL 2, 1995 APRIL 3, 1994 --------------- --------------- (IN THOUSANDS) Building improvements ........................ $ -- $ 6,907 Machinery and equipment ...................... 39,316 65,403 ------- -------- Less accumulated depreciation and amortization ............................ 27,396 43,949 ------- -------- $11,920 $28,361 ======= ========\nThe capital lease agreements and equipment financings are collateralized by the related leased equipment and contain certain restrictive covenants.\nFuture minimum payments under capital leases and equipment financing agreements, at varying interest rates (4.9%-11.0%) are as follows:\nFISCAL YEAR (IN THOUSANDS) -------------------------------------- -------------- 1996 ..................................$ 5,845 1997 ................................... 3,023 1998 ................................... 1,480 1999 ................................... 3 2000 ................................... -- ------- Total minimum payments ................. 10,351 Less interest .......................... 948 ------- Present value of net minimum payments .. 9,403 Less current portion ................... 5,219 ------- $ 4,184 =======\nDuring fiscal 1993, IDT recorded a long-term obligation in connection with the dismissal of certain litigation and entering into a patent cross-license agreement. The present values of the amount due at the end of the license term were $7,581,000 and $7,471,000 at April 2, 1995 and April 3, 1994, respectively. During the year, this amount payable has been reduced by an amount of royalty income pursuant to certain guaranteed revenues realized on sales of IDT's products. The Company is accreting $2,500,000 in future interest charges, reflecting an 8% discount rate, from the recorded amount at April 2, 1995 to the amount due at the end of the term using the effective interest method.\nNOTE 5--LONG-TERM DEBT\nLong-term debt consists of the following:\nAPRIL 2, 1995 APRIL 3, 1994 --------------- ------------- (IN THOUSANDS) Mortgage payable bearing interest at 9.625% due in monthly installments of $142,000 including interest through April 1, 2005 The note is secured by property and improvements in San Jose, California ............ $10,922 $11,543 Term loan payable to a Malaysian bank at 8% due in monthly installments of $54,000 .......... -- 791 ------- ------- 10,922 12,334 Less current portion ............................. 684 1,306 ------- ------- $10,238 $11,028 ======= =======\nPrincipal payments required in the next five years and beyond are as follows (in thousands): $684 (1996), $752 (1997), $828 (1998), $911 (1999) and $7,747 (2000 and beyond).\nNOTE 6--LINES OF CREDIT\nThe Company's Malaysian subsidiary has unsecured revolving lines of credit that allow borrowings up to $2,600,000 with three local banks. These lines have no expiration date. At April 2, 1995 there were no outstanding borrowings against these lines. The borrowing rate for these lines would be incurred at the local bank's cost of funds plus 0.75% to 1% (7.25%-7.30% on April 2, 1995).\nIn fiscal 1995, the Company's Japanese subsidiary had a secured revolving line of credit that allowed borrowings up to approximately $3,500,000. The line of credit automatically extends until the Company requests termination. As of April 2, 1995, no amounts were outstanding under this line of credit. The borrowing rate for this line of credit is the local bank's short-term prime rate existing at the borrowing date plus 0.2%. At April 2, 1995 this short-term borrowing rate was 3.2%.\nThe Company also has foreign exchange facilities with several banks that allow the Company to enter into foreign exchange contracts of up to $55,000,000, of which $36,518,000 was available at April 2, 1995.\nNOTE 7--COMMITMENTS\nLease Commitments. The Company leases most of its administrative and manufacturing facilities under operating lease agreements which expire at various dates through 2005. One facility was leased from a principal shareholder and a director. The annual rent paid to this shareholder totaled approximately $1,527,000, $1,396,000 and $1,396,000 in fiscal 1995, 1994 and 1993, respectively. This stockholder lease expired during fiscal 1995 and was renewed through June 2005.\nIn January 1995, the Company entered into a five-year $60 million Tax Ownership Lease transaction to lease the wafer fabrication facility being constructed for its use in Hillsboro, Oregon. This lease requires monthly payments which vary based on the London Interbank Offered Rate (LIBOR) plus 0.3% (6.425% at April 2, 1995). This lease also provides the Company with the option of either acquiring the building at its original cost or arranging for the building to be acquired at the end of the respective lease term. The Company's obligations under the lease are secured by a line of credit trust deed on the building and collateralized by cash and\/or investments (restricted securities) up to 105% of the lessor's construction costs until completion of the building which is scheduled for the third quarter of fiscal 1996 and 85% thereafter. Restricted securities collateralizing this lease were $10,500,000 at April 2, 1995 and are expected to reach approximately $50,000,000 upon the completion of the facility. The Company is also\ncontingently liable under a first-loss clause for up to 85% of the constructed costs of the building. In addition, the Company must maintain compliance with certain financial convenants. Management believes that this contingent liability will not have a material adverse effect on the Company's financial position or results of operations.\nThe aggregate minimum rent commitments under all operating leases, including the Hillsboro facility, which will be approximately $3,800,000 per year beginning when the facility is completed, estimated to be the third quarter of fiscal 1996, are as follows:\n(FISCAL YEAR) (IN THOUSANDS) -------------------- -------------- 1996 ................$ 5,803 1997 ................. 7,567 1998 ................. 7,321 1999 ................. 7,309 2000 ................. 6,916 2001 and thereafter .. 6,861 ------- $41,777 =======\nRent expense for the years ended April 2, 1995, April 3, 1994 and March 28, 1993 totaled approximately $3,326,000, $3,488,000 and $3,303,000 respectively.\nIn March 1995, the Company paid a down payment of $925,000 on a conditional purchase of land in the Philippines for the development of a test and manufacturing facility. The total purchase commitment for this land is $3,100,000.\nAs of April 2, 1995, five secured standby letters of credit were outstanding totaling $8,635,000. Two letters of credit are held in connection with the Company's workers compensation insurance and mature on June 30, 1995 and June 30, 1996. The other three letters of credit are required for international purchases and expire in June and December of 1995.\nNOTE 8--SALE OF COMMON STOCK\nIn December 1994, the Company completed a public offering of 3,810,000 shares of its Common Stock and received net proceeds of $97,600,000. The Company will use the net proceeds from the offering for construction of its eight-inch wafer fabrication facility in Hillsboro, Oregon, expansion of existing wafer fabrication facilities in San Jose and Salinas, California, acquisition of capital equipment and general corporate purposes, including working capital.\nNOTE 9--STOCKHOLDERS' EQUITY\nStock Option Plans. The Company has stock option plans under which key employees, officers, directors and consultants may be granted options to purchase shares of the Company's common stock at prices which are not less than fair market value at the date of grant. Options granted are generally exercisable in 25% increments each year beginning one year after the grant date.\nAt April 2, 1995, options for 1,383,018 shares were exercisable at an aggregate exercise price of $6,990,000. At April 3, 1994, options for 1,172,000 shares were exercisable at an aggregate exercise price of $4,856,000.\nActivity under the plans is summarized as follows:\nStock Purchase Plan. The Company has a stock purchase plan under which employees and officers may purchase shares of the Company's common stock. The purchase price at which shares may be purchased under this plan is 85% of the lower of the fair market value on the first or last day of each quarterly plan period. As of April 2, 1995 and April 3, 1994, 1,594,905 and 1,457,771 shares, respectively, had been purchased by employees, net of repurchases by the Company, under the terms of the plan agreements. At April 2, 1995, 430,095 shares were reserved and available for issuance under this plan.\nStockholder Rights Plan. In February 1992, the Board approved certain amendments to the Company's Stockholder Rights Plan. Under the plan, the Company declared a dividend of one preferred share purchase right (a \"Right\") for each outstanding share of common stock. Each Right entitles the holder, under certain circumstances, to purchase common stock of the Company with a value of twice the exercise price of the Right. In addition, the Board of Directors may, under certain circumstances, cause each Right to be exchanged for one share of common stock or substitute consideration. The Rights are redeemable by the Company and expire in 1998.\nNOTE 10--EMPLOYEE BENEFITS PROFIT SHARING PLAN\nPrior to September 24, 1993, under the Company's Profit Sharing Plan, the Board of Directors could authorize semiannual contributions for the benefit of employees of up to 10% of pre-tax earnings, before profit sharing. Half of the annual contribution, net of expenses, was in the form of cash payments directly to all domestic and Malaysian employees meeting certain service criteria, and the residual half was contributed directly to the Company's Long-Term Incentive Plan for the purchase of IDT Common Stock on behalf of the Company's employees.\nThe Company received approval from the IRS to terminate the Long-Term Incentive Plan effective September 24, 1993. Effective this date, all shares were 100% vested and no additional shares of IDT stock will be added to this account. Beginning September 27, 1993, all IDT employees received an increase in their cash profit sharing from 5% to 7% and the Company contributed an additional 1% of pre-tax profits, divided equally among all domestic employees, to the Company's 401(k) plan.\nAdministrative expenses are netted against the Profit Sharing Plan contribution. Contributions for the years ended April 2, 1995, April 3, 1994 and March 28, 1993 for this plan were $8,360,000, $5,128,000 and $477,000 respectively. There were no contributions for the year ended March 29, 1992.\nNOTE 11--INCOME TAXES\nThe components of income before provision for income taxes are as follows:\nAPRIL 2, APRIL 3, MARCH 28, 1995 1994 1993 ---------- ---------- ----------- (IN THOUSANDS) United States ............... $ 96,524 $ 44,808 $ 2,240 Foreign ..................... 7,879 5,398 4,038 --------- -------- --------- $104,403 $ 50,206 $ 6,278 ========= ======== =========\nThe provisions (benefits) for income taxes consist of the following:\nAPRIL 2, APRIL 3, MARCH 28, 1995 1994 1993 ---------- ---------- ----------- (IN THOUSANDS) Current income taxes (benefits): United States ...................... $ 21,164 $ 14,699 $ (2,467) State .............................. 3,902 4,039 -- Foreign ............................ 668 798 102 --------- -------- --------- 25,734 19,536 (2,365) --------- -------- -------- Deferred (prepaid) income taxes: United States ...................... (182) (5,379) 3,307 State .............................. 549 (4,116) -- --------- -------- -------- 367 (9,495) 3,307 --------- -------- ---------- Provision for income taxes ........... $ 26,101 $ 10,041 $ 942 ========= ======== ==========\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of deferred assets and liabilities are as follows:\nAPRIL 2, APRIL 3, 1995 1994 -------- --------- (IN THOUSANDS) Deferred tax assets: Deferred income on shipments to distributors ..... $ 8,768 $ 7,466 Non-deductible accruals and reserves ............. 8,980 13,527 Capitalized inventory and other expenses ......... 5,817 4,071 Capitalized research and development ............. 423 825 Other ............................................ 935 273 Refund receivables ............................... 1,520 2,451 -------- --------- Total deferred tax asset ......................... 26,443 28,613 Valuation allowance .............................. -- (2,337) -------- --------- Net deferred tax asset ........................... 26,443 26,276 -------- --------- Deferred tax liabilities:\nDepreciation ..................................... (7,570) (8,517) -------- --------- Total deferred tax liability ..................... (7,570) (8,517) -------- --------- Net deferred tax asset ........................... $ 18,873 $ 17,759 ======== =========\nThe provision for income taxes differs from the amount computed by applying the U.S. statutory income tax rate of 35% for the years ended April 3, 1994 and April 2, 1995 (34% for the year ended March 28, 1993) to income before the provision (benefit) for income taxes as follows:\nAPRIL 2, APRIL 3, MARCH 28, 1995 1994 1993 -------- -------- -------- (IN THOUSANDS) Provision at U.S. statutory rate ................$ 36,541 $ 17,572 $ 2,134 Earnings of foreign subsidiaries considered permanently reinvested, less foreign taxes .... (2,444) (951) (1,701) General business credits ........................ (6,504) (2,710) 0 Tax rate differential ........................... -- (1,167) 574 State tax, net of federal benefit ............... 3,245 3,558 -- Valuation allowance ............................. (2,337) (6,108) 414 Other ........................................... (2,400) (153) (479) -------- -------- -------- Provision (benefit) for income taxes ............ $26,101 $ 10,041 $ 942 ======== ======== ========\nThe Company's Malaysian subsidiary operates under a tax holiday which extended through July 1993. Management believes it is likely that carryovers of depreciation from the tax holiday period along with expected additional depreciation grants will defer the time when the Malaysian subsidiary will first begin to pay local taxes beyond its year ended April 2, 1995.\nThe Company's intention is to permanently reinvest its earnings in all of its foreign subsidiaries, except its German subsidiary, Integrated Device Technology, GmbH. Accordingly, U.S. taxes have not been provided on approximately $26,900,000 of unremitted earnings, of which approximately $23,200,000 were earned by the Company's Malaysian subsidiary. Upon distribution of those earnings in the form of dividends or otherwise, the Company will be subject to both U.S. income taxes and various foreign country withholding taxes.\nNOTE 12--INDUSTRY SEGMENT, FOREIGN OPERATIONS AND SIGNIFICANT CUSTOMERS\nIDT operates predominantly in one industry segment and is engaged in the design, development, manufacture and marketing of high-performance integrated circuits. No single customer or distributor accounted for more than 10% of net revenues in fiscal 1993. During fiscal 1994, two of the Company's national distributors became one entity. Sales through this national distributor accounted for 13% and 15% of net revenues for fiscal 1995 and 1994, respectively. If these two distributors had been a single entity during fiscal 1993, it would have accounted for 16% of IDT's total revenues.\nMajor operations outside the United States include manufacturing facilities in Malaysia and sales subsidiaries in Japan, the Pacific Rim, and throughout Europe.\nAt April 2, 1995, and April 3, 1994 total liabilities for operations outside of the United States were $42,065,000 and $20,704,000, respectively.\nThe following is a summary extract of IDT's foreign operations by geographic areas for fiscal 1995, 1994 and 1993:\nTransfers between geographic areas are accounted for at amounts which are generally above cost and consistent with the rules and regulations of governing tax authorities. Such transfers are eliminated in the consolidated financial statements. Operating income by geographic areas reflect foreign earnings reported by the foreign entities and does not include an allocation of general corporate expenses. Identifiable assets are those assets that can be directly associated with a particular foreign entity and thus do not include assets used for general corporate purposes: cash and cash equivalents, short-term investments and prepaid income taxes.\nNOTE 13--CROSS-LICENSE AGREEMENT\nDuring fiscal 1993, the Company entered into a patent cross-license agreement which obligated the payment of an amount of royalties dependent upon the level of the Company's profitability. The amount of royalties accrued during fiscal 1994 was approximately $4,400,000 and has been included in other accrued liabilities. The Company was not impacted by any further royalty payment from this agreement beginning fiscal 1995.\nSUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)\nQUARTERLY RESULTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nYEAR ENDED APRIL 2, 1995\nFIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER* --------- ---------- ----------- --------- Revenues............ $95,043 $95,585 $105,765 $125,797 Gross profit........ 54,632 55,574 60,528 71,804 Net income.......... 16,878 17,006 19,799 24,619 Net income per share......... $ .47 $ .47 $ .54 $ .61\nYEAR ENDED APRIL 3, 1994\nRevenues............ $72,766 $80,295 $85,330 $92,071 Gross profit........ 33,948 39,967 45,419 51,501 Net income.......... 4,628 7,733 11,625 16,179 Net income per share......... $ .15 $ .24 $ .35 $ .45\n* represents a 14-week quarter in fiscal 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended April 2, 1995, and the information from the section entitled \"Executive Officers of the Registrant\" in Part I, Item 4A of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy statement for the 1995 Annual Meeting of Stockholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements The following consolidated financial statements are included in Item 8: - Consolidated Balance Sheets at April 2, 1995 and April 3, 1994 - Consolidated Statements of Operations for each of the three fiscal years in the period ended April 2, 1995 - Consolidated Statements of Cash Flows for each of the three fiscal years in the period ended April 2, 1995 - Consolidated Statements of Stockholders' Equity for each of the three fiscal years in the period ended April 2, 1995 - Notes to Consolidated Financial Statements\n(a) 2. Financial Statements Schedules No Financial Statement Schedules have been presented since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\n(a) 3. Listing of Exhibits\nExhibit No. Description Page\n3.1* Restated Certificate of Incorporation (previously filed as Exhibit 3A to Registration Statement on Form 8-B dated September 23, 1987).\n3.2* Certificate of Amendment of Restated Certificate of Incorporation (previously filed as Exhibit 3(a) to the Registration Statement on Form 8 dated March 28, 1989).\n3.3* Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock (previously filed as Exhibit 3(a) to the Registration Statement on Form 8 dated March 28, 1989).\n3.4* Bylaws dated January 25, 1993 (previously filed as Exhibit 3.4 to Annual Report on Form 10-K for the Fiscal Year Ended March 28, 1993).\n4.1* Amended and Restated Rights Agreement dated as of February 27, 1992, between the Company and The First National Bank of Boston (previously filed as Exhibit 4.1 to Current Report on Form 8-K dated February 27, 1992).\n4.2* Form of Indenture between the Company and The First National Bank of Boston, as Trustee, including Form of Notes (previously filed as Exhibit 4.6 to the S-3 Registration Statement (File number 33-59443).\n10.1* Lease for 1566 Moffet Street, Salinas, California, dated June 28, 1985 between the Company and Carl E. Berg and Clyde J. Berg, dba Berg & Berg Developers (previously filed as Exhibit 10.7 to Form S-1 Registration Statement (File No. 33-3189)).\n10.2* Assignment of Lease dated October 30, 1985 between the Company and Synertek Inc. relating to 2975 Stender Way, Santa Clara, California (previously filed as Exhibit 10.4 to Annual Report on Form 10-K for the Fiscal Year Ended April 1, 1990).\n10.3* Assignment of Lease dated October 30, 1985 between the Company and Synertek Inc. relating to 3001 Stender Way, Santa Clara, California (previously filed as Exhibit 10.5 to Annual Report on Form 10-K for Fiscal Year Ended April 1, 1990).\n10.4* Lease dated October 23, 1989 between Integrated Device Technology International Inc. and RREEF USA FUND - III relating to 2972 Stender Way, Santa Clara, California (previously filed as Exhibit 10.6 to Annual Report on Form 10-K for the Fiscal Year Ended April 1, 1990).\n10.5* First Deed of Trust and Assignment of Rents, Security Agreement and Fixture Filing dated March 28, 1990 between the Company and Santa Clara Land Title Company for the benefit of The Variable Annuity Life Insurance Company relating to 2670 Seeley Avenue, San Jose, California (previously filed as Exhibit 10.7 to Annual Report on Form 10-K for the Fiscal Year Ended April 1, 1990).\n10.6* Amended and Restated 1984 Employee Stock Purchase Plan (previously filed as Exhibit 10.16 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).**\n10.7* 1994 Stock Option Plan and related documents (previously filed as Exhibit 10.17 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).**\n10.8* 1994 Directors Stock Option Plan and related documents (previously filed as Exhibit 10.18 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).**\n10.9* Form of Indemnification Agreement between the Company and its directors and officers(previously filed as Exhibit 10.68 to Annual Report on Form 10-K for the Fiscal Year Ended April 2, 1989).**\n10.10* Manufacturing, Marketing and Purchase Agreement between the Company and MIPS computer Systems, Inc. dated January 16, 1988 (previously filed as Exhibit 10.12 to Annual Report on Form 10-K for the Fiscal Year Ended March 29, 1992) (Confidential Treatment Granted).\n10.11* Preferred Stock Purchase Agreement dated January 14, 1992 among the Company, Berg & Berg Enterprises, Inc. and Quantum Effect Design, Inc. (previously filed as Exhibit 10.13 to Annual Report on Form 10-K for the Fiscal Year Ended March 29, 1992).\n10.12* Patent License Agreement between the Company and American Telephone and Telegraph Company dated May 1, 1992 (previously filed as Exhibit 19.1 to Quarterly Report on Form 10-Q for the Quarter Ended June 28, 1992) (Confidential Treatment Granted).\n10.13* Patent License Agreement dated September 22, 1992 between the Company and Motorola, Inc. (previously filed as Exhibit 19.1 to Quarterly Report on Form 10-Q for the Quarter Ended September 27, 1992) (Confidential Treatment Granted).\n10.14* Agreement between the Company and Texas Instruments Incorporated effective December 10, 1992, including all related exhibits, among others, the Patent Cross-License Agreement and the OEM Purchase Agreement (previously filed as Exhibit 19.1 to Quarterly Report on Form 10-Q for the Quarter Ended December 27, 1992) (Confidential Treatment Granted).\n10.15* Series A Preferred Stock Purchase Agreement dated July 16, 1992 among Monolithic System Technology, Inc. and certain purchasers (previously filed as Exhibit 10.12 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).\n10.16* Series B Preferred Stock Purchase Agreement dated March 1994 among Monolithic System Technology, Inc. and certain purchasers (previously filed as Exhibit 10.13 to the Quarter Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).\n10.17* Series C Preferred Stock Purchase Agreement dated June 13, 1994 among Monolithic System Technology, Inc. and certain purchasers (previously filed as Exhibit 10.14 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).\n10.18* Domestic Distributor Agreement between the Company and Wyle Laboratories, Inc. Electronic Marketing Group dated as of April 15, 1994 (previously filed as Exhibit 10.15 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).\n10.19* Lease Extension and Modification Agreement between the Company and Baccarat Silicon, Inc. dated as of September 1, 1994, relating to 1566 Moffet Street, Salinas, California (previously filed as Exhibit 10.16 to the Quarterly Report on Form 10-Q for the Fiscal Quarter Ended October 2, 1994).\n10.20 Promissory Note dated April 28, 1995 between L. Robert Phillips and the Company and related document.\n10.21 Sublease of the Land and Lease of the Improvement by and between Sumitomo Bank Leasing and Finance, Inc. and the Company dated January 27, 1995 and related agreements thereto.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Price Waterhouse LLP.\n27.1* Financial Data Schedule (EDGAR version only)(previously filed as Exhibit 27.1 to the S-3 Registration Statement (File No. 33-59443)).\n* These exhibits were previously filed with the Commission as indicated and are incorporated herein by reference.\n** These exhibits are management contracts or compensatory plans or arrangements required to be filed pursuant to Item 14 (c) of Form 10-K.\n(b) Reports on Form 8-K\nNot applicable.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTEGRATED DEVICE TECHNOLOGY, INC. Registrant\nMay 24, 1995 By: \/s\/ Leonard C. Perham 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\/ D. John Carey Chairman of the Board May 24, 1995 (D. John Carey)\n\/s\/ Leonard C. Perham Chief Executive Officer May 24, 1995 (Leonard C. Perham) and Director (Principal Executive Officer)\n\/s\/ William D. Snyder Vice President, Chief May 24, 1995 (William D. Snyder) Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ Carl E. Berg Director May 24, 1995 (Carl E. Berg)\n\/s\/ John C. Bolger Director May 24, 1995 (John C. Bolger)\n\/s\/ Federico Faggin Director May 24, 1995 (Federico Faggin)","section_15":""}
{"filename":"786620_1995.txt","cik":"786620","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCimetrix Incorporated ( the \"Registrant\") is a Nevada corporation primarily engaged in the development, production, and sale of computer software and hardware for manufacturing automation. Currently, the Registrant is marketing a number of products aimed at current users of industrial automated devices seeking alternative methods to lower the cost of automation and improve production efficiency.\nIn October 1989, the Registrant commenced the business of developing and marketing software products that control the motion of automated manufacturing devices by entering into an exclusive license agreement with Brigham Young University. The agreement granted the Registrant the rights to develop and market robot inaccuracy compensation techniques developed in conjunction with an off-line programming system (known as ROBLINE) and an inaccuracy calibration technique (known as ROBCAL). ROBLINE and ROBCAL, together with other technology developed by the Company, have enabled the Registrant to develop the Cimetrix Open Development Environment (\"CODE\") which includes \"open architecture,\" standards-based, operating systems software and controller hardware that allow manufacturing engineers to replace cumbersome proprietary systems with open systems when designing automated device workcells. The Registrant's products are designed to allow the customer to select \"best of class\" automation components and to help reduce the costs and time involved in designing, implementing and maintaining automation systems. The \"open architecture\" controller is designed to introduce more flexibility into the design process as it is intended to be compatible with most industrial automated equipment, i.e. different equipment from different vendors, performing different functions, can now be controlled by the same operator. Also, the Registrant's software is developed to use the popular UNIX and Windows NT operating systems.\nOpen Architecture, Standards-Based Controllers\nThe traditional configuration for industrial workcells includes automation equipment controlled by the equipment vendor's own controller, which is, in turn, operated using the equipment vendor's proprietary software. This \"closed\" system configuration accounts for nearly all of the sales of controllers in the automation industry today, and has been a successful marketing tool for equipment vendors to maintain a degree of inflexibility in which a customer is tied to the equipment vendor of its choice. Once a particular vendor's configuration has been chosen, it may be expensive to switch to another vendor's closed, proprietary system. Under the traditional configurations, mixing the automation equipment of different vendors in the same workcell environment has been very difficult. It should be noted that all of the equipment manufacturers are large, international corporations with much greater resources than the Registrant.\nThe Registrant's open architecture, standards-based controller was designed based on the theory of \"open standards\" used by microcomputer hardware and software vendors. The open architecture controller, by design, operates the automated equipment of most vendors, and can be configured in a workcell to operate various different pieces of equipment simultaneously, thereby easing the proprietary tie-in to any one vendor, and creating a significant flexibility for automation engineers. The Registrant is not aware of any other open architecture, standards-based controller that is currently commercially available. In December 1994, the Registrant was selected by Motorola, Inc. as the \"primary partner in developing the prototype Motorola Open Architecture Robot Controller,\" which management has viewed as a validation of the \"open architecture\" concept by a significant end user of automation products. There is one robot manufacturer that offers a stand-alone controller for sale, which is run by proprietary software that can be adapted to the various automated equipment of different vendors in a one to one situation; however, it currently does not offer simultaneous control of more than one device.\nIn summary, the Registrant believes its open architecture, standards-based controllers and software represent the only commercially available control systems which incorporate the concept of \"open standards.\" However, the implementation of \"open standards\" in the marketplace is new, and acceptance is very limited at the current time. Success in selling the open architecture, standards-based control systems is dependent upon the Registrant's ability to convince industrial users to abandon the traditional approach of vendor proprietary systems in exchange for the greater flexibility and adaptability of the new technology.\nSoftware\nThe competitive environment for the Registrant's software products is similar to the environment for its hardware products. The traditional type of product which currently dominates the market place is proprietary to the equipment vendor and is basically useful only within the closed system of the particular vendor. Typically, software that controls one vendor's equipment cannot be used to control the equipment of another vendor. Hence, the market place is dominated by large equipment manufacturers.\nThe CODE system of the Registrant has been designed to operate the hardware controllers of nearly all automation and machine equipment vendors, thereby allowing the manufacturing customer to control the equipment of multiple vendors simultaneously. This open architecture approach allows the manufacturer greater flexibility in assembling the automated workcell where the manufacturing functions are performed, and has been developed to use popular operating systems such as UNIX, and what some engineers believe will grow to be the dominant operating system of the future, Windows NT. However, as stated before, the open architecture approach is new, and the success of the Registrant in selling its CODE software is dependent upon its ability to gain acceptance by manufacturing users who are currently using the closed proprietary systems of the equipment vendors.\nPart of the CODE software system can be sold and used as simulation software, or software that is used by automation engineers to design, by simulation, their manufacturing assembly lines and workcells. There are companies who sell only simulation software, and who represent established competitors to the Registrant. Some of those companies sell software that is more sophisticated than the simulation software sold by the Registrant. However, the simulation software offered by the Registrant has the feature that whatever is being created in the simulation environment can be transferred to the actual control environment without modification or reprogramming, potentially providing a substantial reduction in the design \/ implementation expense and time requirements. Management of the Registrant believes this feature is not found in any competitor's software offerings. The simulation products offered by competitors are believed by management to be significantly more expensive than the simulation software products sold by the Registrant.\nSIGNIFICANT EVENTS During the fiscal year ended December 31, 1995 and in subsequent months, a number of significant events occurred related to the business of the Registrant. The following paragraphs give a brief summary of the individual events.\nInvestment Banker Engaged\nIn an agreement signed January 8, 1996, the Registrant engaged Cowen & Company (\"Cowen\") to act as the Registrant's investment banker. The Registrant intends to explore with Cowen the possibility of establishing strategic and financial relationships with one or more companies, which may include the sale or merger of the Registrant. The term of this engagement extends through December 31, 1996.\nBoard and Management Changes\nOn March 1, 1995, Douglas A. Davidson was named to fill the vacant seat on the Board, but no replacement Chief Executive Officer has been named.\nAs disclosed in the Registrant's Form 8-K, dated September 20, 1995, Mr. Kitt R. Finlinson, Vice President of Finance for the Registrant, resigned as a Director of the Registrant, effective September 20, 1995. He continues as the Chief Financial Officer of the Registrant.\nAt a meeting of the Board of Directors on September 20, 1995, the Board elected David L. Redmond, Mark A. Filippell, Dwight L. Barker, Samuel W. Shoen, and Paul A. Bilzerian to fill current vacancies on the Board until the next annual meeting of the Registrant or until their successors are duly elected and qualified. Messrs. Filippell, Barker and Shoen have previously served on an Advisory Panel to the Registrant. The new members of the Board were invited to serve on the Board of the Registrant due to their business experience, some of which is delineated at Part III, Item 10. \"DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\"\nAs compensation for their service as Board members, Messrs. Barker, Filippell, Redmond, and Shoen have each received non-qualified stock options to purchase 50,000 shares of the Registrant, exercisable at $5.00 per share, which will vest 4,000 shares immediately, 2,000 shares per month until December 1996, and 14,000 on December 31, 1996. All options vest immediately upon a change of control of the Registrant.\nDuring the year ended December 31, 1995, the Registrant hired 17 new people, some as replacements, but mostly to new duties. In connection with the hiring of these new employees, the Registrant granted options to purchase 333,000 shares of common stock at exercise prices of either $4.00 or $5.00 per share. The options have an exercise term of five years, with full or partial vesting occurring on the anniversaries of the individual grant dates. As of December 31, 1995, seven employees had terminated their employment with the Registrant, thereby forfeiting options representing 171,000 shares of common stock.\nOn December 15, 1995, the Board of Directors elected Mr. Ron Lumia (See Part III, Item 10. \"DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\") to serve on the Board of the Registrant, effective January 1, 1996 until the election of directors at the next annual shareholders' meeting in July 1996. In connection with his compensation for service as a Board member, the Registrant restructured its obligations under a previous option agreement negotiated with Mr. Lumia pursuant to a consulting agreement dated July 15, 1995. In exchange for his release of the Registrant from its previous obligations, the Registrant granted Mr. Lumia non-qualified options to purchase 40,000 shares of restricted common stock at $5.00 per share, which vested immediately.\nEffective January 12, 1996, Mr. Bilzerian resigned from the Board of Directors where he had served since September 20, 1995.\nMerger of Subsidiary\nEffective August 31, 1995, Cimetrix (USA), Inc., a Florida corporation and the majority owned subsidiary of the Registrant, was merged into the Registrant pursuant to articles of merger in which the Registrant agreed to exchange one share of restricted common stock of the Registrant for each share of the 2,829,419 common shares of the subsidiary held by the minority interest shareholders. The financial information presented herein includes the consolidated entities through August 31, 1995, and the information of the Registrant as the surviving entity subsequent to that date.\nManagement originally formed the subsidiary in an effort to isolate the current operations from the past operating history of the Registrant. At the time, the Registrant was involved in negotiating the settlement of numerous debts, including various tax liens resulting from previous failures to remit payroll withholdings, all of which have been satisfied. Because the concerns existing at the time the subsidiary was formed have been resolved, management felt that the need for two corporations had expired and consolidated them into one.\nAnnual Shareholders' Meeting\nOn July 29, 1995, the Registrant held its 1995 Annual Meeting of Shareholders in Salt Lake City, Utah. All nominees for election as director were elected, and all proposals included in the Registrant's Proxy Statement dated June 28, 1995, were approved by the requisite shareholder votes.\nAt the Annual Meeting, management discussed the Registrant's successful product debut at the Detroit trade show. (See \"Detroit Trade Show.\") Management also discussed some of the opportunities and challenges related to the size of the open architecture, standards-based motion control market, and the Registrant's preparations to satisfy the anticipated demand from that market. Management noted that the Registrant's present size and capacity could make it difficult for the Registrant to meet anticipated product demand. Management discussed the probable need to explore strategic alliances and similar opportunities during 1995 and 1996 in order to optimize the market position of the Registrant's products and attempt to maximize shareholders' values.\nPurchase of Technology\nAs disclosed in the Registrant's Form 8-K dated July 5, 1995, the Registrant purchased certain intellectual property known as the \"ROBLINE Technology\" from Brigham Young University (BYU) for cash payments of $50,000 per year for ten years (totaling $500,000), plus 120,000 shares of previously unissued, restricted common stock of the Registrant, valued at $3.75 per share.\nPrior to the technology purchase, the Registrant had licensed the ROBLINE Technology from BYU through an exclusive license agreement dated October 16, 1989. Under that license agreement, the Registrant has been paying minimum royalty payments of $40,000 per year against a royalty obligation of two percent (2%) of net sales on products created from the licensed technology. Much of the technology originally licensed by the Registrant was developed by Dr. Edward Red, a current director of the Registrant, along with three other individuals who are now employed by the Registrant. Dr. Red continues as a Professor of Mechanical Engineering at BYU. Detroit Trade Show\nOn May 9th through the 12th of 1995, the Registrant participated in the International Robot and Vision Trade Show held in Detroit, Michigan. Significant time, effort and resources were expended in an effort to highlight the Registrant's products in this exhibition aimed at the robotics industry. Management enlisted professional help in designing the product demonstrations and presentations used for the show. Management believes the show was a success in terms of acquainting potential purchasers of the Registrant's products with Cimetrix as an emerging company, and in generating a significant number of sales leads for those products.\nPrivate Placement\nPursuant to a private placement offering dated March 3, 1995, the Registrant sold 1,000,000 shares of common stock at a price of $4.00 per share for a total gross cash proceeds of $4,000.000. Legal costs and broker's commissions associated with the offering totaled $28,553. Net proceeds of the offering have been added to the other general cash funds of the Registrant and have been used to further the operating goals of the Registrant. (See Part II, Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operation.\")\nOPEN ARCHITECTURE SOFTWARE AND HARDWARE BUSINESS\nThe Registrant's open architecture CODE task-planing and simulation software and CX3000 and CX4000 series open architecture, standards-based controllers are designed to reduce the effort required to develop automated applications, while giving automation engineers power and flexibility to enhance the manufacturing workcell. These products are also designed to release the customer's technical personnel from the constraints of using previously proprietary systems.\nSoftware--Cimetrix Open Development Environment (CODE)\nThe Registrant's CODE software is a complete workcell environment that offers off-line programming, rapid application development, and simulation for creating workcells and testing actual equipment in real-time, multi-tasking environments. It is a complete suite of intuitive automation tools that allows the applications engineer to conceptualize, design, simulate, test, debug, and control an automated workcell. It enables systems engineers and programmers to model \"what if\" scenarios off line, helping to validate purchasing decisions before the equipment is actually ordered. CODE helps automation professionals avoid potential \"collisions\" and determine optimal equipment placements to minimize cycle times. In addition, it allows modifications to be made to existing workcells without taking them \"off line\" during the software development and debugging stages.\nThe CODE automation control software is based on open systems and conforms to universal standards. It runs using popular operating systems such as UNIX and Windows NT. As integrated, modular components within CODE, the Registrant offers the following products:\nCIMulation- a graphic-based workcell simulation environment, CIMulation enables engineers to design, test and debug applications off-line--totally independent of the physical workcell. It can also perform accurate cycle-time predictions, validate error handling, detect collisions or near misses, and model I\/O devices. CIMulation provides the tools to rapidly assemble a virtual workcell using a library of popular mechanisms, or a mechanism can be custom designed and verified.\nCIMControl - Software for controlling the runtime operation of the workcell. CIMControl operates on a VME, ISA, or PCI platform with a real-time UNIX (LynxOS) or Windows NT operating system. CIMControl supports accurate and predictable motion control of coordinated axes kinematics. Workcell applications developed in CIMulation can be used without modification with CIMControl.\nCODE API - the complete set of standard C\/C++ function calls that form the framework for the CODE family of products, the CODE API's (Application Programming Interface) extensibility allows for use of third-party APIs (vision, statistical process control, databases, etc.). The CODE API is included with CIMulation and CIMControl.\nCIMBuilder - a standards-based, object-oriented rapid application development (RAD) environment for programmers and non-programmers that significantly reduces the time it takes to develop automation applications. CIMBuilder features a graphical user interface (GUI) builder and includes three developers' languages: C\/C++; Tcl (tool command language)an interpretive programming environment; and a point-and-click, non-programmer's interface (NPI). CIMBuilder provides the option of executing in an interpretive environment or compiling for speed. Its open software architecture enables third-party suppliers to create specialized modules for machine vision, motion control, I\/O control and other functions.\nCIMTools - a collection of GUI-based tools that provide access to the CODE shared workcell database for both simulation and control. CIMTools offers the following: supervisory control of applications (launch, halt, pause, step, continue); a shared workcell database browser \/ navigator and inspecting \/ editing tools; software teach pendant; a view control panel (zoom, rotate, 3-D solid \/ wire frame models); a collision and minimum distance-checking tool; and a software and I\/O signal monitor. CIMTools is included with CIMulation and CIMControl.\nCIMVision - software to link standard vision systems (e.g. Cognex) with CODE software. CIMVision allows users to conveniently access the underlying vision system with CODE API-like function calls or through pre-defined CIMBuilder templates.\nCIMTune - a software utility for set-up, testing and tuning of the servo system. CIMTune is an easy-to-use (GUI) that offers automatic servo system tuning, graphical display for servo performance, set-up and testing of safety limits and I\/O testing and monitoring.\nCIMCal - calibration software for the CODE shared workcell database, CIMCal compensates for differences between the shared workcell database information and the physical inaccuracies of the mechanism and parts. It makes specific compensations in rigid body (part location) corrections, tool and camera calibrations, and mechanism accuracy enhancement.\nCIMCNC - software to allow CODE to be readily applied to machine tools. CIMCNC provides full support of Computer Numeric Code (CNC) programming methods (M&G codes).\nGEM Manager - a family of software products that provide a framework for obtaining compliance to the Semiconductor Equipment and Materials International (SEMI) communication standards (e.g. SECS-I\/II, HSMS and GEM) within the CODE environment\nCX3000 and CX4000 Series Open Architecture Controllers\nCX3000 By bringing real-time UNIX and C\/C++ to the manufacturing cell, the CX3000 controllers facilitate the replacement of proprietary systems and programs with open standards. The CX3000 series allows the customer to \"plug in\" a variety of dissimilar automation equipment and machine tools, regardless of the type of actuator or feedback mechanism used. The CX3000 controllers can be combined with the ROBLINE software system for rapid programming and uniform control of all devices in a workcell. Ethernet and NFS capabilities are built into every CX3000 controller. Additionally, the CX3000 controllers are built from standard components that are compatible with most low-cost peripherals, including touch screens and CD-ROM drives. POSIX-compliant, real-time UNIX and standard hardware platforms allow automation engineers to take advantage of new software and hardware components when available. The CX3000 controllers are available in VME, ISA, and PCI bus configurations, and use specialized DSP-based coprocessors for servo control.\nCX4000\nThe CX4000 Open Architecture Controller (OAC) is a new family of low-cost, compact form, standards-based control solutions for motion-based applications. It has been designed as an embedded solution for OEM automation and machine equipment manufacturers. Utilizing standard PC hardware technology, the CX4000 uses the PC\/104 format to ensure a small footprint and low component cost. All CX4000 controllers come standard with a hard disk, SVGA video card, and an Ethernet connection, and are designed to be mounted in 19\" racks or on doors or walls of cabinets.\nMANUFACTURING\nThe Registrant is involved in both the manufacture of its hardware products and the production of its software products. All software is prepared and packaged at the current location. However, the Registrant has made a decision to out source approximately 90 percent of the manufacture of its hardware to have the flexibility to meet projected equipment demands, and to minimize the amount of its capital investment in production facilities and personnel. The Registrant has discussed such work with several parts distributors and contract assemblers in the electronics industry. The subcontractors provide all inventory necessary for assembly and deliver mostly complete controllers to the Registrant who, in turn, finishes the assembly and subsequent quality control testing. Manufacturing and hardware testing activities occupy approximately 6,000 square feet of the Registrant's facilities.\nPRODUCT COMPONENTS\nThe Registrant utilizes electronic components in the manufacture of its hardware that are basically \"off-the-shelf\" components available from a number of electronics parts vendors. This availability of parts will be helpful to the Registrant in its limited production of hardware, and allow its subcontract manufacturers of hardware to more easily meet required delivery schedules.\nMARKETING AND DISTRIBUTION\nThe Registrant currently markets its products through the efforts of in- house marketing personnel. Management believes the market for the Registrant's products consists mainly of industrial users of robots, machine tools, and other automation equipment, and those systems integrators who sell automation systems to large industrial users. Based on management's appraisal of the target markets, marketing efforts to date have focused on: 1.) personal contacts by the Registrant's marketing personnel; 2.) mailers aimed at automation engineers employed by automation intensive manufacturers; 3.) advertising in automation trade magazines; and 4.) participation at automation trade shows. Serious marketing efforts were first launched during the later part of the fiscal year ended December 31, 1994, as the Registrant's products reached a point of commercial viability.\nEssentially, the Registrant is investing in both image building and direct product advertising. This exposure takes many forms, including establishing demonstration test sites with major users of automated work cells, exhibitions at trade shows, company-sponsored training classes, direct technical demonstrations, and industry publication ads. The Registrant has budgeted resources to support its belief that effective and continued exposure is required to establish product awareness, greater name recognition, and overall positive market perception.\nCURRENT ORDERS\nAs of March 25, 1996, the Registrant continues to receive orders for 1-5 systems purchased as evaluation systems as customers become more familiar with the product offerings. Management anticipates continued growth in the demand for its products in the near future.\nRESEARCH AND DEVELOPMENT\nDuring 1994 and 1995, the Registrant incurred significant expenditures in development activities. Although the Registrant left the \"development stage\" during fiscal 1994, continuing work to complete new software tools resulted in $341,416 of software development costs being capitalized by the Registrant during fiscal 1995. Even with the capitalization of certain software costs, the Registrant still expensed $930,119 in research and developments costs for the year ended December 31, 1995, which highlights the significant effort being made to perfect the current products, and develop additional complimentary products.\nPATENTS, COPYRIGHTS, AND TRADEMARKS The technology owned by the Registrant is proprietary in nature. Certain of the older technology is covered by patent, but for the most part the Registrant relies on copyrights, confidentiality and nondisclosure agreements with its employees and customers, appropriate security measures, and the encoding of its software in order to protect the proprietary nature of its technology rather than patents which are difficult and expensive to obtain and maintain, require public disclosure, and may be successfully avoided through \"reverse engineering\" by sophisticated computer programmers. The Registrant has registered \"CIMETRIX\" to use as a trademark in the field of robotics and automation devices with the United States Office of Patents and Trademarks.\nCOMPETITION\nThe manufacture and sale of automation technology is a competitive industry. The Registrant believes that its competition is divided into four (4) groups: robot manufacturers, machine tool controller manufacturers, simulation developers, and electronic manufacturers. The Registrant competes primarily on product design, selection, and price.\nThere are several robot manufacturers who design and sell proprietary controllers and software for their robots. Most of these companies are much larger than the Registrant and include Adept Technologies, Asea Brown Boveri Group (ABB), Fanuc, Kawasaki, Kuka Welding, Mitsubishi Electric, Nachi, Panasonic, Sankyo, Seiko, Sony, Staubli, Yamaha, and Yaskawa Electric (Motoman), and have significantly greater resources than the Registrant. While their hardware is generally considered very good, management believes the competition's software and controllers are limited in their applications because of the closed, proprietary design. While the Registrant will not be manufacturing robot devices in direct competition with those companies, its controllers and software will directly compete with their proprietary controllers. Management believes the Registrant's products are generally less expensive than the competing products, and that the Registrant's products generally permit greater flexibility of function and ease of use.\nThere are two or three other manufacturers of robot controllers that claim to have \"open architecture\" design (i.e., useable with robots made by different manufacturers). Management believes that they are not \"open architecture\" designs. Management believes the most popular of these, made by Adept Technologies, Inc. (Adept), uses a closed, proprietary computer language that is translatable into other proprietary languages, but that is not easily expandable. This can make modification of the controller's functions difficult. Additionally, management understands that it is difficult for Adept's controllers to interface across a local area network.\nMachine tools consist of metal forming equipment such as press brakes, turret punches and tube benders and metal cutting machines such as milling machine equipment, lathes and lasers, and are used by a wide variety of manufacturers. Machine tools utilize a computer numeric control, or CNC type controller. Despite the PC revolution that has taken place over the past decade, the underlying technology and software for machine tool controllers has changed very little during the same period. Most major machine tool manufacturers purchase proprietary controllers from several CNC control system vendors, including Allen-Bradley, Fanuc, Mitsubishi, Siemens, and Toshiba.\nThe Registrant has identified at least three major competitors in the field of robot software simulation development and robot accuracy correction, including Deneb Robotics, Inc., Silma (subsidiary of Adept Technologies), and Technomatics. While these three companies market systems which are competitive on a stand alone basis, management believes they are unable to match the Registrant's ability to achieve simulation and control with the same program, enabling concurrent engineering and reduced implementation time. Management also believes that other simulation companies do not have the same flexibility of off-line programming or precision robot control in their products as compared to the Registrant's products.\nThe final group of competitors is composed of electronics assembly equipment manufacturers who supply controllers with their electronics assembly equipment. This group includes Fuji, Panasonic, Universal Instruments, and numerous others.\nManagement believes that most, if not all, of the Registrant's competitors currently have greater financial resources and market presence than the Registrant. Accordingly, these competitors may be able to compete very effectively on pricing and to develop technology to increase the flexibility of their products.. Further, each of these competitors has already established a share of the market for their products, and may find it easier to limit market penetration by the Registrant because of the natural tie-in of their controllers and software to their robots. Management is uninformed as to whether any of these competitors are presently developing additional technology that will directly compete with the Registrant's product offerings.\nMAJOR CUSTOMERS AND FOREIGN SALES\nFor the year ended December 31, 1995, the Registrant had four significant customers, AT & T (16%), Cybex Technologies (10%), Hewlett-Packard (26%) and Motorola (29%), which accounted for approximately 81% of its total revenue. Although there has been increased sales activity amongst a number of customers in 1995, because of the special relationship established in December, 1994 (See Part I, Item 1. \"Business: Open Architecture, Standards-Based Controllers\") Motorola is considered an important customer, and the loss of that customer could have a material adverse effect on the Registrant. For the year ended December 31, 1995, the Registrant had no sales to foreign customers. However, the Registrant expects to develop sales in locations outside the United States during 1996.\nPERSONNEL\nThe Registrant currently has 43 employees, 28 of which are involved in the technical development of products, 4 in manufacturing, 5 in sales and marketing, and 6 in administrative and clerical. None of the employees of the Registrant are represented by a union or subject to a collective bargaining agreement, and the Registrant considers its relations with its employees to be favorable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDuring the year ended December 31, 1994, the Registrant built a new, 18,500 square foot facility in the East Bay Business Center in Provo, Utah. The facility was built for an approximate cost of $850,000 and was paid for out of the cash resources of the Registrant. The building includes approximately 13,000 square feet of administrative, engineering, and research and development space, and approximately 5,500 square feet of manufacturing , testing, inventory storage, and shipping space. Pursuant to their decision to subcontract most of the manufacturing of hardware to outside vendors, management considers the existing manufacturing facilities and non-manufacturing facilities to be sufficient to accommodate the anticipated growth of the Registrant for the immediate future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS On February 8, 1996, the Registrant filed a suit seeking declaratory relief and a determination of the validity of the issuance of 1,931,662 shares of the Registrant's common stock to two former members of management and certain family members of one of the former managers. Because the suit was only recently filed, Registrant's counsel cannot predict the probability of success.\nOther than as stated above, the Registrant is not a party to any material pending legal proceedings and, to the best of its knowledge, no such proceedings by or against the Registrant have been threatened. To the knowledge of management, there are no material proceedings pending or threatened against any director or executive officer of the Registrant, whose position in any such proceeding would be adverse to that of the Registrant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the Registrant's fiscal quarter ended December 31, 1995, the Registrant did not have any matters that were submitted to a vote of security holders of the Registrant through the solicitation of proxies or otherwise.\nThe Registrant anticipates holding an annual shareholders' meeting in Salt Lake City, Utah, on Saturday, July 27, 1996.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of the Registrant is being quoted on the National Association of Securities Dealers, Inc.'s OTC Bulletin Board under the symbol \"CMXX.\" Permission to list the common shares on the OTC Bulletin Board was granted October 20, 1994. Prior to that time, no active public trading market was available to the shareholders of the Registrant.\nThe following table sets forth the approximate range of high and low bids for the common stock of the Registrant during the periods indicated. Prior to the quarter ended December 31, 1994 there was no public trading market, and, hence, no reliable information from which to establish the \"high\" and \"low\" bids. The quotations presented reflect inter-dealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions in the common stock.\nQuarter Ended High Bid Low Bid\nDecember 31, 1994 $ 7.25 $1.00 March 31, 1995 $ 6.37 $4.25 June 30, 1995 $ 6.25 $3.50 September 30, 1995 $ 6.12 $3.75 December 31, 1995 $10.25 $4.37\nOn March 25, 1996, the closing quotation for the common stock on the OTC Bulletin Board was $11.50 per share. Potential investors should be aware that the price of the common stock in the trading market can change dramatically over short periods as a result of factors unrelated to the earnings and business activities of the Registrant.\nOn March 25, 1996, there were 18,771,428 shares of common stock issued and outstanding, held by approximately 1200 beneficial shareholders.\nThe Registrant has not paid dividends with respect to its common stock. There are no restrictions on the declaration or payment of dividends set forth in the articles of incorporation of the Registrant or any other agreement with its shareholders. Management anticipates retaining any potential earnings for working capital and investment in growth and expansion of the business of the Registrant and does not anticipate paying dividends on the common stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data of the Registrant is not covered by an opinion of independent certified public accountants and should be read in conjunction with the financial statements and related notes of the Registrant herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSIGNIFICANT FINANCIAL CHANGES--STATEMENTS OF OPERATIONS\nNet Sales\nNet sales for the three fiscal years ended December 31, 1995, 1994, and 1993, are $664,288, $462,817, and $1,141,561, respectively. Revenues for 1995 represent sales of regular inventory to customers for use in their normal manufacturing operations and represent an approximate 44% increase over the previous year. Revenues for the two years ended December 31, 1994 represent periodic purchases of \"beta site,\" prototype equipment by Motorola, Inc., Hewlett-Packard, and Idaho Nuclear Engineering Laboratories. Sales in 1993 were primarily due to volume purchases of prototype equipment by Hewlett-Packard. The Registrant was unable to sustain the 1993 sales volume in 1994, primarily because its products needed additional development, and the Registrant concentrated on that final product development throughout most of 1994, rather than on marketing additional prototypes. For the two fiscal years ending December 31, 1994, the Registrant was a \"development stage\" enterprise as defined by generally accepted accounting principles.\nManagement of the Registrant believes that the emphasis placed on strengthening existing products by transporting them to new software platforms, plus the introduction of new products that address most of the markets for motion control of manufacturing automation, should put the Registrant in a position to aggressively pursue new customers for its products. In early 1996, the Registrant hired an East Coast and a West Coast Sales Manager to pursue those industrial markets. Management also continues to believe the working arrangement with Motorola, Inc. should result in significantly more sales to Motorola that would exceed any previous year, further validating the commercial viability of the Registrant's products.\nCost of Sales\nThe Registrant's costs of sales as a percentage of net sales for the years ended December 31, 1995,1994, and 1993, are approximately 67%, 64% , and 64%, respectively, reflecting the fluctuations inherent in the beginning of a company's sales cycles. The larger percentage for 1995 reflects management's decision to keep gross profit margins narrow in order to encourage potential buyers to become acquainted with the products offered. Also, when software and hardware products are bundled together, typically the combined margin is smaller than the sum of what the individual margins would be for hardware and software products sold separately. As the manufacturing and production routines become established as part of normal operations, management expects the on-going trends in costs related to sales to emerge and fluctuations to be greatly reduced.\nSelling, Marketing and Customer Support\nSelling, marketing and customer support costs have increased significantly each year from $114,942 in 1993, to $216,621 in 1994, and $946,753 in 1995. In 1994, the increase was due to renewed emphasis on marketing as the Registrant's products reached commercial viability and reliability. Marketing actions taken during the latter part of fiscal year 1994 include 1.) hiring a vice president for marketing, 2.) creating new product and company brochures with attendant revised artwork, 3.) hiring a public relations and advertising firm to develop a corporate image, 4.) placing ads in trade publications for the first time, and 5.) sending mass mailing flyers to potential simulation users. As indicated in the Registrant's Form 10-K from the prior fiscal year, management planned for a dramatic rise in expenditures in this area during 1995. Significant resources were committed to hiring additional marketing and customer support personnel, to creating a market image for the Registrant's products through trade exhibitions, and to making personal contact with potential customers. The major components of the current year's expense are wages and benefits ($420,562), travel and entertainment ($172,071), trade shows and exhibitions ($154,665), and sales literature and advertising ($61,953).\nResearch and Development\nResearch and development costs have fluctuated over the past three fiscal years from $506,675 in the year ended December 31, 1993, to $198,534 and $930,119 for years ended December 31, 1994 and 1995, respectively. The decrease from 1993 to 1994 was due to management's conclusion that the Registrant's software products had achieved \"technological feasibility\" and subsequent development costs were capitalized during 1994. Including the $519,984 capitalized, the Registrant's overall expenditure for research and development costs was higher in 1994 than any previous year. During 1995, some $341,416 in software development costs were capitalized, representing efforts to create new software tools (GEM for CODE, CIMBuilder, etc.) to compliment the CODE basic programs. The $930,119 expensed represents a significant commitment to software programming efforts, to the development of a CNC controller, and to the development of applications engineering. Wages and benefits ($579,302) and prototype materials and supplies ($109,446) constitute the major aspects of research and development expense for 1995. Research and development expenditures should continue to be significant as the Registrant explores all motion control automation markets.\nGeneral and Administrative General and administrative expenses increased slightly from $1,216,798 for the year ended December 31, 1994 to $1,231,093 for the year ended December 31, 1995. The increase from $856,622 in 1993 to $1,216, 798 in 1994 was due primarily to: 1.) additional costs of outside professional services to bring SEC filings current, and to negotiate settlement of issues with vendors, taxing authorities, and other legal matters; 2.) additional payroll costs and consulting fees associated with the hiring of professional management personnel in positions never occupied previously, and to obtain the input of successful business people interested in the Registrant; 3.) additional costs for employee benefit programs deemed necessary to maintain and elevate the quality of employees working for the Registrant, and 4.) the additional costs incurred in constructing and moving to an expanded facility to permit anticipated growth. The increase also included the expense of sponsoring bi-monthly meetings of an advisory panel consisting of nine successful professionals from outside the Registrant. The advisory panel has been used by management of the Registrant as a sounding board for management's deliberations and planning. However, subsequent to the Annual Shareholder's Meeting in July of 1995, additional outside individuals, as well as certain individuals from the advisory panel, were added to the Board of Directors of the Registrant (See Part I, \"Business: Board and Management Changes\").\nSIGNIFICANT FINANCIAL CHANGES--BALANCE SHEET\nCash\nThe balance of cash decreased from $3,365,186 at December 31, 1994 to a balance of $2,345,483 at December 31, 1995. Although the Registrant received $3,971,447 net proceeds from the sale of 1,000,000 restricted common shares, it used $2,944,444 in operating activities, spent $979,862 for property and equipment and capitalized software costs, and retired the $1,000,000 in short term debt that was outstanding at December 31, 1994. Management believes the balance of cash on hand at December 31, 1995, together with anticipated sales revenues, will be sufficient to fund the Registrant's operations through 1996.\nInventories\nThe balance of inventories increased from $298,266 at December 31, 1994 to a balance of $619,192 at December 31, 1995. Inventories have increased as the Registrant entered the production and shipping phases of planned operations and increased the work-in-process and finished goods inventory in anticipation of sales to new customers.\nPrepaid Expenses\nThe increase in prepaid expenses from $108,008 in 1994 to $217,818 at December 31, 1995 is composed, for the most part, of the unamortized portion of the additional deposit paid to a software vendor during 1995 ($125,000).\nProperty and Equipment\nThe Registrants' investment in plant and equipment increased from a net balance of $1,271,045 at December 31, 1994 to a net balance of $1,732,247 at December 31, 1995. The majority of that increase is attributable to the purchase of a residential home located in the northeast part of Provo, Utah at a cost of approximately $248,268 (See Part III, Item 13. \"Certain Relationships and Related Transactions\") and the cost of providing computer equipment and work cubicles for new employees.\nCapitalized Software Costs\nIn the opinion of management, the Registrant reached the point of technological feasibility for its CODE software system in early 1994. Development costs incurred subsequent to that point have been capitalized according to generally accepted accounting principles. A total of $519,984 was capitalized during the fiscal year ended December 31, 1994, and an additional $341,416 was capitalized in the fiscal year ended December 31, 1995.\nShort Term Borrowing\nAs of December 31, 1994, the Registrant had borrowed $1,000,000 from its short-term line of credit which is collateralized by certain current assets of the Registrant. The line of credit was established during the fourth quarter of the fiscal year ended December 31, 1994, with a maximum borrowing limit of $5,000,000. There was no similar arrangement in the prior year. The $1,000,000 outstanding at December 31, 1994, was paid off in early 1995, and there has been no further use of this line of credit by the Registrant.\nCAPITAL AND LIQUIDITY\nAt December 31, 1995, the Registrant had total current assets of $3,267,764 and total current liabilities of $337,643, resulting in a working capital ratio of 9.68:1. Included in total liabilities as of December 31, 1994 is approximately $1,000,000 representing funds borrowed against the Registrant's $5,000,000 line of credit. The borrowing limit on this $5,000,000 line of credit is adjusted from time to time based on ratios involving certain of the current assets of the Registrant. This line of credit is reviewed annually.\nAs of December 31, 1995, the Registrant's liquidity position continues to be healthy as a result of a sale of 1,000,000 shares of common stock through private placement at $4.00 per share for net cash proceeds, after offering costs, of $3,971,447. Currently, all accounts payable are paid on a net \/ 30 basis, taking advantage of earlier discounts where offered. Additionally, funds have been available to allow the hiring of critical path personnel, and to fund the purchase of equipment and software tools needed to continue the commercialization of the Registrant's products. Management believes that the Registrant is capable of financially meeting the demands inherent as normal sales and manufacturing continue to develop for 1996.\nThe Registrant has previously entered into third-party leasing arrangements in securing capital equipment; however, the Registrant anticipates that its capital requirements for the purchase of equipment in the immediate future will be met by the use of cash resources. Management anticipates that spending for additional capital equipment necessary to meet anticipated growth may exceed $200,000 during the 1996 fiscal year.\nThe cash needs of the Registrant for the year ended December 31, 1995 were provided by the sale of common stock and the collection of accounts receivable. During the fiscal year ended December 1995, the Registrant received capital funds from the equity stock sales in the amount of $3,971,447. In February 1996, option holders, including Mr. Claude O. Goldsmith, former Director and Chief Executive Officer, exercised their right to purchase 315,000 shares of common stock at $2.00 per share and 325 shares at $3.00 per share for total gross proceeds to the Registrant of $630,975. The Registrant believes there may be sales of additional common stock during the upcoming year through the exercise of options to purchase its common stock.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data are included beginning at page 34. See page 30 for the index to the financial statements. ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Registrant 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 THE REGISTRANT\nSet forth below is the name and age of each executive officer and director of the Registrant, together with all positions and offices of the Registrant held by each and the period during which each has served:\nA director's regular term is for a period of one year or until his successor is duly elected and qualified. On March 1, 1995, Douglas A. Davidson was named to fill the vacant seat on the Board and was designated as Chairman of the Board. Paul A. Bilzerian, consultant to the Registrant, has been heavily involved in the day to day operations of the Registrant, and in early 1996 was named as Acting President.\nThere is no family relationship among the current directors and executive officers. The following sets forth brief biographical information for each director and executive officer of the Registrant.\nDouglas A. Davidson has been managing partner, since 1991, of Pensar, a consulting company that provides executive and consulting services to information and technology companies. During 1993 and 1994, he served as a consultant to and, later, Executive Vice President for XVT Software, Inc. of Boulder, Colorado, a leader in cross platform Graphical User Interface building tools. From 1989 to 1991, Mr. Davidson served as President and Vice Chairman for Network Management, Inc., a privately-held systems integration and services company specializing in network management for local and wide area networks. Prior to 1989, Mr. Davidson had other similar executive experiences with Honeywell Information Systems, Mohawk Data Sciences, Display Data Corporation, and Science Management Corporation for over 20 years. He received a Bachelor of Arts in Business Administration and Economics from Colby College in 1960.\nDr. W. Edward Red has been a Professor of Manufacturing and Mechanical Engineering at Brigham Young University since 1983. From 1979 through 1983, Dr. Red was an Associate Professor at Texas A & M University where he served as the Systems Group Leader and Director of the Simulations, Robotics, and Productivity Laboratories. Dr. Red has also taught at the University of New Mexico, the University of Southwestern Louisiana, and Arizona State University. He has recently been elected to the Board of RI\/SME and also serves on the SME\/CASA Committee. He is the author of three books and over 60 technical articles in the areas of applied mechanics, robotics, and automation.\nMark A. Filippell is a Managing Director of McDonald & Company Securities, Inc., where he is the Practice Leader of the Mergers and Acquisitions Group. He has served with McDonald & Company Securities, Inc. for the past 11 years. He was previously Assistant to the General Manager of Comau, SPA, a $300 million dollar factory automation company in Torino, Italy, then owned by Fiat and Bendix, and an Associate with McKinsey and Company, where he focused on machine tools.\nDwight L. Barker, a retired Managing Director of Salomon Brothers Inc, is currently self-employed as a financial consultant. During 1994 and 1995, he also served as Acting Chief Operations Officer for Pacific Investment Management Company of Newport Beach, California. From 1992 through 1993, he served as Chief Executive Officer of Salomon Brothers Tampa Product Support Division. During 1991, he served as the Chief Administrative Officer of Salomon Brothers' Asia Ltd. (SBAL).\nDavid L. Redmond has served as the Executive Vice President and Chief Financial Officer of Pharmacy Corporation of America, a wholly-owned subsidiary of Beverly Enterprises Inc., a publicly-held corporation, since July 1995. He was previously the Chief Financial Officer of Pharmacy Management Services, Inc., a publicly-held company, from 1991 through July 1995, and previously was a partner of KPMG Peat Marwick for six years. Samuel W. Shoen has been President of KATABASIS International, Inc., a private investment holding company, since January, 1991. Concurrently from January, 1991 through February, 1993, he served as Special Assistant to the Administrator, U. S. Agency For International Development. He was formerly President of U-Haul International and President and CEO of Amerco.\nDr. Ron Lumia is a Professor in the Mechanical Engineering Department of the University of New Mexico since October, 1994. From 1986 through September, 1994, Dr. Lumia served as Group Leader at the National Institute of Standards and Technology (NIST), performing research in the areas of advanced automation, robotics, machine vision, and systems integration. Previously, he taught at ESIEE (Paris, France), Virginia Tech, and the National University of Singapore, where he consulted for a variety of companies. Dr. Lumia received a B.S. from Cornell University and an M.S. and Ph.D. from the University of Virginia, all in electrical engineering. He is the author of over 100 technical papers.\nPaul A. Bilzerian is President of Bicoastal Holding Company, a privately- held company. He has extensive experience in business management and the field of mergers and acquisitions. Since March of 1994, he has served as a consultant to the Registrant. (See also, Part III, Item 10. \"Directors and Executive Officers of the Registrant: Consultant\" below.)\nKitt R. Finlinson joined the Registrant on August 8, 1994 as the Vice President of Finance and Treasurer. From 1991 through July 1994, Mr. Finlinson served as the Controller and Chief Accounting Officer for Larson Davis, Inc., a publicly-held manufacturer of sound and vibration monitoring instruments. From 1972 to 1990, he was engaged in the practice of public accounting, having been employed by three of the Big Six accounting firms for nine years, and serving an equal period of time as a partner in accounting firms local to Salt Lake City, Utah. During this period, he concentrated his professional efforts in the arena of small, public, hi-tech companies. His past services have included tax, audit, SEC filings, management consulting, business plan creation and review, and the raising of start-up venture capital. He received a Bachelor of Science in Accounting from Brigham Young University in 1972.\nDr. Steven K. Sorensen has worked for the Registrant since 1991, and has served in various capacities during that time. He was appointed Executive Vice President of Engineering in February 1996, having previously served as the Vice President of Product Development since May 1, 1994. Prior to joining the Registrant, Dr. Sorensen was an Associate Professor of Engineering at Brigham Young University where he received his Ph.D. in Mechanical Engineering in 1989. Along with two other employees, and a Director, Dr. Edward Red, he was instrumental in the creation of much of the Registrant's technology at Brigham Young University.\nRobert H. Reback is the Vice President of Sales. He has been involved in the sales and engineering aspects of state-of-the-art factory automation for the past 14 years. Just prior to joining the Registrant, he spent two years as a District Manager for FANUC Robotics, the largest supplier of industrial robots in North America. Previous to FANUC, Mr. Reback worked for Thesis, Group, Inc. for eight years as a Director of Sales and Marketing, and three years as a Senior Engineer for Texas Instruments where he was responsible for implementing robotics and other technologies into state-of-the-art flexible manufacturing systems. Mr. Reback received a Bachelor's degree in Mechanical Engineering, and a Masters degree in Industrial Engineering from Purdue University.\nDr. Xuguang Wang joined the Registrant in 1990. He was appointed as a Vice President on November 10, 1994. He received his Ph.D. in Mechanical Engineering from Brigham Young University in 1988. He has worked primarily with computer graphics, robot kinematics and control, tool and sensor calibration, and robot inaccuracy compensation.\nDr. Peter Manley is the Vice President of Special Projects. Dr. Manley joined the Registrant in 1989, but has been working to develop the Registrant's technology for the past nine years. In 1990, he received his Ph.D. in Mechanical Engineering from Brigham Young University. He received a Bachelor of Science in Mechanical Engineering from McGill University in 1984. He is an expert in collision avoidance and device interface architecture.\nJohn Snow is the Vice President of Hardware Design. Prior to joining the Registrant, he worked for Evans and Sutherland Computer Corporation, a publicly- held company, for 14 years. He has a degree in Electrical Engineering from Brigham Young University and is an expert in high speed digital logic design, multi-processor computer architecture, embedded microprocessor applications, real-time computer graphics, programmable logic design and computer peripheral interface design.\nW. Chad Sumsion is Vice President of Customer Service. He has been involved in the world of electronic automation for the past 10 years. Prior to joining the Registrant, Mr. Sumsion worked for Evans and Sutherland Computer Corporation for seven years, where he was a Manager, Design Technology. Prior to that, Mr. Sumsion worked for FMC Corporation. He has also served for two years as the Chair of the West Coast Workview Users Group. He has a degree in Electrical Engineering from Brigham Young University.\nRiley Astill joined the Registrant on July 27, 1994 as Secretary, Controller and Principal Accounting Officer. During the years 1992 through July 1994, Mr. Astill served as the Controller for Artbeats, Inc., based in Salt Lake City, Utah. Prior to 1992, he was employed by Oryx Energy Company of Dallas for two years and the Big Six accounting firm of Ernst & Young in the Dallas office for one year. Mr. Astill earned a Masters of Accountancy degree with an emphasis in taxation from Utah State University in 1988. Cara Shillingford graduated from Brigham Young University in 1992 with a Bachelor of Arts in English. She spent two years working as the Associate Editor for E. Excel International's magazine, The Excellent Word. She joined the Registrant in April, 1994. Her duties include inventory control and accounting assistant.\nConsultant\nIn March, 1994, the Registrant entered into an agreement with Paul A. Bilzerian to serve as a management consultant. Mr. Bilzerian was engaged to provide general management advice to the Registrant. He exercises a strong influence over the day to day operations and in February, 1996 was appointed Acting President for the Registrant. Mr. Bilzerian has a broad range of experience in business, having been involved in the financing or acquisition of several publicly-held companies. He presently serves as the President of Bicoastal Holding Company.\nCertain Legal Proceedings\nA. Paul A. Bilzerian filed a voluntary liquidation petition under Chapter 7 of the Federal Bankruptcy Code (11 U.S.C.) in 1991; Case No. 91-10046-8P7, filed in the United States Bankruptcy Court for the Middle District of Florida, Tampa Division. The case is still pending as of the date of this filing.\nB. On April 9, 1991, Paul A. Bilzerian was permanently enjoined by the United States District Court for the District of Columbia from violating the following sections of the Securities Exchange Act of 1934: 7 (C) and (f) (relating to margin requirements), 10(b) (relating to manipulative practices), 13(d) (relating to reports by five-percent owners), 14(d) and (e) (relating to tender offers), and 17(a)(1) (relating to reports by brokers). He was simultaneously enjoined from violating corresponding regulations of the SEC.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the cash compensation paid by the Registrant and its subsidiaries for the fiscal years ended December 31, 1995, 1994, and 1993 to the Chief Executive Officer and Vice President of Sales of the Registrant. No other officers of the Registrant received compensation in excess of $100,000.\nNo outstanding options were exercised during the year ended December 31, 1995. However, in February, 1996, Mr. Claude O. Goldsmith, former Director and Chief Executive Officer, exercised his option to purchase 125,000 shares at an exercise price of $2.00 per share.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of March 25, 1996, the number of shares of the Registrant's common stock, par value $0.0001, held of record or beneficially by each person who held of record or was known by the Registrant to own beneficially, more than 5% of the Registrant's common stock, and the name and share holdings of each officer and director and of all officers and directors as a group.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nTRANSACTIONS WITH FORMER OFFICERS AND DIRECTORS\nDuring the year ended December 31, 1994, the Registrant entered into agreements with certain former officers and directors wherein 2,798,223 shares of the Registrant's common stock were returned and canceled. The former officers and directors also released the Registrant from obligations payable to them totaling $242,270. In return, the Registrant indemnified the former officers and directors for their past services rendered and released them from certain obligations payable to the Registrant totaling $120,068. All related party payables and receivables were forgiven by the action noted above, and as of December 31, 1994, the balance of related party receivables and payables was zero.\nAlso during 1994, the Registrant extended a cost of living expense allowance to its president in lieu of requiring the filing of expense reports monthly. The monthly allowance of $2,000 began on September 1, 1994 and was paid for up until December 1, 1994. The expense has been accounted for as compensation paid to the individual.\nBUY OUT OF BUILDING CONTRACT\nOn July 31, 1994, the Registrant purchased a building contract for a cash payment of $75,000 paid to a partnership in which Paul A. Bilzerian, current Acting President of the Registrant with proxy voting rights, was a partner. The contract provided for the construction of the new facility now occupied by the Registrant.\nCONSULTING AGREEMENT\nIn March, 1994, the Registrant hired Paul A. Bilzerian to perform consulting services. The Registrant was in financial crisis and turned to Mr. Bilzerian because of his extensive prior business and management experience. As a condition of his agreement to provide consulting services to the Registrant, Mr. Bilzerian received proxies to vote all shares held by the Registrant's former management. The proxies are irrevocable until December 31, 1998. Mr. Bilzerian received no cash compensation from the Registrant, other than expense reimbursements until late 1994, when the Board voted to pay him or Bicoastal Holding Company $2,000 per month. He received warrants to acquire 6,000,000 shares of the Registrant's common stock. The warrants are exercisable at any time before June 1, 1999, for an aggregate price of $1,000,000. In a supplemental consulting agreement dated August 8, 1995, the Registrant renegotiated its contract with Mr. Bilzerian in order to retain his services for an extended period of time and request him to temporarily relocate his family to Provo, Utah. In connection with the renegotiation, Bicoastal Holding Company is now paid $50,000 annually, and has rent-free use of the Registrant's residential property. Mr. Bilzerian is currently serving as Acting President of the Registrant, with no additional compensation.\nADVISORY PANEL\nDuring 1995 and 1994, the Registrant retained the services of an advisory panel of experienced business persons to consult with officers and employees of the Registrant on matters relating to management, finance, marketing, and product development. The advisors receive no cash compensation, other than expense reimbursement, but during 1994 each of the nine members of the panel received options, with immediate vesting, to purchase 50,000 shares of the Registrant's common stock at an exercise price of $3.00 per share.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS AND SCHEDULES\nThe following financial statements and schedules are included immediately following the signatures to this report.\nPage\nReport of Pritchett, Siler & Hardy (formerly Peterson, Siler & Stevenson), independent public accountants 34\nBalance Sheets, December 31, 1995 and 1994 35\nStatements of Operations for the years ended December 31, 1995, 1994, and 1993 37\nStatement of Stockholders' Equity (Deficit) for the years ended December 31, 1995, 1994 and 1993 38\nStatements of Cash Flows for the years ended December 31, 1995, 1994, and 1993 40\nNotes to Financial Statements 43\nFinancial Statement Schedules are omitted because they are not applicable or because the required information is contained in the Financial Statements or the Notes thereto.\nREPORTS ON FORM 8-K\nThere were no reports filed 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, as amended, the Registrant has caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.\nCIMETRIX INCORPORATED\nDated: February 28, 1996 By \/s\/ Kitt R. Finlinson Kitt R. Finlinson, Vice President of Finance (Principal Executive and Financial Officer)\nDated: February 28, 1996 By \/s\/ Riley Astill Riley Astill, Secretary (Principal Accounting 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: Dated: February 28, 1996 By \/s\/ Douglas A. Davidson Douglas A. Davidson Chairman of the Board\nDated: February 28, 1996 By \/s\/ W. Edward Red W. Edward Red, Director\nDated: February 28, 1996 By \/s\/ Dwight L. Barker Dwight L. Barker, Director\nDated: February 28, 1996 By \/s\/ Dr. Ron Lumia Dr. Ron Lumia, Director\nDated: February 28, 1996 By \/s\/ Mark A. Filippell Mark A. Filippell, Director\nDated: February 28, 1996 By \/s\/ David L. Redmond David L. Redmond\nDated: February 28, 1996 By \/s\/ Samuel W. Shoen Samuel W. Shoen\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors CIMETRIX INCORPORATED Provo, Utah We have audited the accompanying balance sheets of Cimetrix Incorporated at December 31, 1995 and 1994 and the related statements of operations, stockholders' equity (deficit) 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 audited by us present fairly, in all material respects, the financial position of Cimetrix Incorporated 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.\n\/s\/ Pritchett, Siler & Hardy, P.C.\nPRITCHETT, SILER & HARDY, P.C.\nJanuary 26, 1996\nCIMETRIX INCORPORATED\nBALANCE SHEETS\nASSETS\n[Continued]\nCIMETRIX INCORPORATED\nBALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nCIMETRIX INCORPORATED\nSTATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements. CIMETRIX INCORPORATED\nSTATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nThe accompanying notes are an integral part of this financial statement. CIMETRIX INCORPORATED\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSupplemental Schedule of Noncash Investing and Financing Activities: For the year ended December 31, 1995:\nIn July, 1995, the Company purchased the technology it had been licensing from Brigham Young University by issuing 120,000 shares of common stock valued at $3.75 per share, and signing an agreement to make 10 annual payments of $50,000 cash. A note payable of $343,765 was recorded to reflect the discounted present value of the 10 annual payments. [See Note 5]\nIn July 1995, the Company entered into a 36-month capital lease covering the new voice mail equipment and software for the Company's phone system. The cost of the leased equipment was $9,987.00.\nEffective August 31, 1995, the Company purchased the interest held by minority shareholders in the Company's subsidiary by issuing 2,829,419 restricted shares of Cimetrix Incorporated (\"Parent\") in exchange for an equal number of shares of the subsidiary, Cimetrix (USA) Incorporated, held by those minority shareholders. The subsidiary was then merged into the Parent, effective August 31, 1995. The effect of the purchase of the minority interest was to create \"goodwill\" in the amount of $3,260,646 that was recorded by the Parent. The goodwill is being amortized on a straight line basis over 15 years. [See Note 11]\nFor the year ended December 31, 1994:\nIn accordance with the terms of a settlement agreement, the Company canceled 2,963 shares of common stock previously issued for services rendered. The Company issued 116,667 shares of common stock to employees for services rendered, valued at $.0001 per share. [See Note 11].\nThe Company issued 558,761 shares valued at $.0001 per share to shareholders who had previously paid $5.00 per share, in order to give those shareholders an average $2.00 per share basis [See Note 11].\nRelated party accounts payable of $242,270 net of related party accounts receivable of $120,068 were forgiven. [See Note 13] Automobiles accounted for as capital leases with a net book value of $3,651 were assumed by former officers [See Note 14].\nTrade payables amounting to $62,334 were forgiven by vendors [See Note 21].\nThe Company entered into a lease for telephone equipment costing $53,127 [See Note 9].\n$635,000 of notes payable with their related interest of $23,834 were converted into common shares of the subsidiary [See Note 8].\nFormer officers, directors and other related parties returned 2,798,223 common shares valued at $.0001 per share for cancellation [See Note 11].\nSupplemental Schedule of Noncash Investing and Financing Activities:\nFor the year ended December 31, 1993:\nThe Company issued 195,657 shares of common stock valued at $.0001 per share for services rendered [See Note 11].\nThe Company issued 29,708 shares of common stock valued at $5.00 per share in payment of related party notes payable [See Note 13].\nThe accompanying notes are an integral part of these financial statements.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization - Cimetrix Incorporated [ the PARENT] was organized under the laws of the State of Utah on December 23, 1985. In September 1990, the Parent merged with a newly incorporated Nevada company, effectively changing its domicile to that state. Cimetrix (USA) Incorporated [the SUBSIDIARY] was organized under the laws of the State of Florida on June 7, 1994. In July 1994, the Parent acquired 20,000,000 shares of the common stock of the Subsidiary in exchange for the transfer of substantially all of the assets of the Parent, and the assumption of $635,000 of convertible promissory notes payable. The Subsidiary subsequently sold shares of its common stock to private investors resulting in an approximate 12% minority interest [See Note 19]. Effective August 31, 1995, the Parent purchased the minority interest in the subsidiary by exchanging one share of the Parent common stock for one share of subsidiary stock held by the minority shareholders. In all, 2,829,419 shares of the Parent were issued to the minority shareholders in exchange for their stock in the subsidiary. Simultaneously, the Subsidiary was merged into the Parent, effective August 31, 1995, leaving the Parent, Cimetrix Incorporated, as the surviving single entity.\nNet Loss Per Common Share - The computation of loss per share of common stock is based on the weighted average shares outstanding during the periods presented. Fully diluted loss per share is not presented, except for extraordinary items, because its effect is anti-dilutive.\nCash and Cash 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. At December 31, 1995, the Company had cash equivalents of $2,019,927 invested in commercial paper maturing in January 1996 which are readily convertible into cash and are not subject to significant risk from fluctuation in interest rates; there were no cash equivalents at the previous year end. At December 31, 1995 and 1994, the Company had cash of $98,855 and $3,184,588, respectively, in excess of federally insured amounts in its bank accounts.\nInventories - Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.\nDepreciation Methods - The cost of property and equipment is depreciated using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives range from 3 - 40 years.\nResearch and Development - The Company expenses software development costs incurred prior to the establishment of technological feasibility as research and development costs. The Company also expenses hardware design and prototype expenses as incurred as research and product development costs.\nCapitalized Software Costs - The Company capitalizes software development costs incurred after technological feasibility of the software product has been established. Amortization of the capitalized costs is computed on a product by product basis over the estimated useful lives of the products. Software costs are carried at the net of unamortized cost or net realizable value. Net realizable value is reviewed on an annual basis after assessing potential sales of the product.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [Continued]\nGoodwill - Goodwill represents the excess of the cost of purchasing the minority interest of Subsidiary over the fair value of the net assets at the date of acquisition, and is being amortized on the straight line method over 15 years. Amortization expense charged to operations for 1995 and 1994 was $72,460 and $0, respectively.\nAllowance for doubtful accounts - Through December 31, 1995, the Company has had no bad debt experience; therefore no allowance for doubtful accounts has been established.\nReclassification - On the financial statements shown for the periods prior to December 31, 1995, certain accounts have been reclassified to conform to the headings, titles and format used in the presentation of the December 31, 1995 and later financial statements.\nNOTE 2 - INVENTORIES\nInventories consist of the following:\nThe Company's inventory is pledged as collateral for a line of credit. [See Note 8]\nNOTE 3 - PROPERTY AND EQUIPMENT\nThe following is a summary of property and equipment, at cost, less accumulated depreciation:\nDepreciation expense for the years ended December 31, 1995, 1994 and 1993 was $186,727, $72,380, and $35,207, respectively.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 4 - LICENSE AGREEMENTS\nDuring the early part of 1994, the Company entered into a license\/royalty agreement with Lynx Real-Time Systems, Inc. (\"LYNX\"), wherein the Company will be allowed to incorporate certain binary products of LYNX into the controller products of the Company. The Company will pay a fee of $235 per each unit sold which contains a LYNX run-time license product.\nPursuant to an agreement dated July 26, 1995, the Company entered into an additional agreement with LYNX allowing the Company to resell development licenses to its customers. The Company will pay a fee of $500 per development license for each license sold, and has committed to pay an up- front royalty\/license fee for the purchase of 250 licenses, for a total of $125,000. This additional agreement also provides the Company with the option, expiring on July 25, 1998, to purchase all existing LYNX development operating system source code. In addition, the company will receive a substantial discount from the standard list price for any new LYNX source code product through July 25, 1998.\nThe original up-front royalty of $58,750, combined with the additional $125,000 from the latest agreement (for a total of $183,750), will be amortized through the purchase of LYNX products and services until the total payment has been consumed. The unamoritzed portion as of December 31, 1995 included in prepaid expenses is $164,829.\nNOTE 5 - TECHNOLOGY\nEffective July 5, 1995, the Company purchased the technology that was then being licensed from Brigham Young University (BYU), referred to as ROBLINE and ROBCAL. The Company purchased all rights, title, interest and benefit in and to the intellectual property for cash payments of $50,000 per year for ten years which were discounted using an incremental borrowing rate of 9.5% per annum and has been recorded as a note payable of $343,765 [See Note 8], plus 120,000 shares of previously unissued, restricted common stock of the Company valued at $3.75 per share [See Note 11], for a total purchase value of $793,765. The technology is being amortized over a period of 15 years on a straight-line basis. Amortization expense for the year ended December 31, 1995 is $26,459. This technology consists primarily of robot inaccuracy compensation technologies, as integrated by an off-line programming system, and an inaccuracy calibration technique. The proprietary robot inaccuracy calibration technology can be configured to function with virtually any off- line programming software and any robot.\nPursuant to the now canceled license agreement with BYU, the Company was required to make royalty payments of 3\/4 of one percent of net sales to the Company. Minimum royalty payments equaled $40,000 per year. In connection with the original licensing of the technology, in 1989 the Company issued 180,000 shares of restricted stock common stock to BYU, valued at $.10 per share. In 1989, the Company also issued a total of 440,000 shares of restricted common stock, valued at $.01 per share, to a director and other employees of the Company for their efforts in the development of the licensed technology. Subsequently, the Company issued 180,000 restricted common shares in 1990 and another 180,000 restricted common shares in 1991 (both valued at $.0001 per share) to employees who are currently officers of the Company for their continued active participation in the commercialization and distribution of the licensed technology.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 6 - SOFTWARE DEVELOPMENT COSTS\nIn 1994, it was determined the Company had passed the point of \"technological feasibility\" with its Cimetrix Open Development Environment (\"CODE\", formerly \"ROBLINE\") system software, and hence, according to FASB 86 - \"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,\" further development costs should be capitalized. During 1995 and 1994, the Company capitalized $341,416 and $519,984, respectively, of direct and indirect costs associated with the effort to bring the Company's software products to a point of general release to customers. Amortization began in January 1995, and is computed as the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or (b) the straight-line method over five years. Amortization expense for the years ended 1995 and 1994 was $104,000 and $0, respectively. As the Company develops additional ancillary, complementary software tools and applications products, it is expected there may be capitalization of additional software development costs.\nNOTE 7 - PATENTS AND COPYRIGHTS\nThe technology purchased from BYU, along with other technology developed internally, is proprietary in nature. The Company has obtained two patents on certain of the technology, issued in May 1989, and March 1994, respectively. In addition, the Company has registered its entire CODE software system products with the Copyright Office of the United States, and will continue to register on a timely basis any updates to current products or any new products. For the most part, other than the two patents and the copyright registrations, the Company relies on confidentiality and nondisclosure agreements with its employees and customers, appropriate security measures, and the encoding of its software in order to protect the proprietary nature of its technology. No cost has been capitalized in respect to the patents.\nNOTE 8 - NOTES PAYABLE\nIn connection with the purchase of the technology from BYU [See Note 5] the Company agreed to make payment of $50,000 each year for ten years. This stream of payments was discounted using an incremental borrowing rate of 9.5% per annum, and has been recorded as a note payable with a beginning balance of $343,765. The first payment was due and paid on September 1, 1995.\nThe Company entered into a $5,000,000, variable rate revolving line of credit with a bank on October 20, 1994. The line provides for interest at the rate of one half of one percent over the prime rate of the bank. The initial rate was 8.25% per annum. The line expires on October 31, 1996. Interest payments are to be paid monthly, and any outstanding principal balance is to be paid in full on October 31, 1996. The prepaid finance charges of $15,000 have been classified as a deferred asset and are being amortized over the term of the line. At December 31, 1995, no funds have been borrowed against the line. The amount available under the revolving line of credit is calculated based upon a formula of eligible current assets, including cash, receivables and inventories which serve as collateral for amounts borrowed.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 8 - NOTES PAYABLE [Continued]\nOn April 29, 1994, the Company issued three Convertible Notes Payable with a maturity date of April 29, 1997. The aggregate amount of the notes issued was $635,000, and the notes provided for interest at a rate of 10%. The notes were convertible into shares of common stock of the Company at the rate of $2.00 per share at anytime during the term of the notes. During July 1994, the notes and the related accrued interest were converted by agreement into common shares of the subsidiary at $2.00 per share and note holders were issued warrants to purchase 317,500 common shares of the Parent Company [See Note 11].\nNOTE 9 - CAPITAL LEASES\nOn various occasions, the Company has entered into different leases for office equipment. Based on the provisions of Statement No. 13, issued by the Financial Accounting Standards Board, many of these leases meet the criteria of a capital lease. At December 31, 1995 and 1994 the cost of the assets amounted to $63,114 and $53,127, net of accumulated depreciation of $15,961 and $3,542, respectively. Depreciation expense for the year ended December 31, 1995 and 1994 was $12,419 and $3,542, respectively.\nFuture minimum lease payments under the capital lease obligations as of December 31, 1995, for each of the next five years and in the aggregate are as follows:\nNOTE 10 - OPERATING LEASES\nThe Company entered into an automobile lease agreement in July, 1995. The lease provides for monthly payments of $246 through June 1997.\nThe Company entered into an automobile lease agreement in May, 1994. The lease provides for monthly payments of $238 through April, 1996.\nThe Company previously leased office space under operating leases expiring at various dates through February 1994. The Company then rented the facilities on a month to month basis until it moved into its current facilities in November 1994.\nOffice and equipment rental expense was $6,318, $99,990 and $152,185, for the years ended December 31, 1995, 1994 and 1993, respectively.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 11 - COMMON STOCK TRANSACTIONS\nStock Issued\nOn August 11, 1995, the Board of Directors of the Company gave final approval to a merger between Cimetrix Incorporated, and it's majority owned subsidiary, Cimetrix (USA) Inc., which was completed effective August 31, 1995. Under the merger, the minority interest shareholders of the subsidiary received one share of common stock of the Company for each share of subsidiary common stock that they own. This resulted in the issuance of 2,829,419 shares of restricted common stock of the Company and the recording of goodwill of $3,260,646 [See Note 1]. Subsequent to the merger, all business of the Company is being conducted through Cimetrix Incorporated, a Nevada corporation, the former parent corporation.\nPursuant to the purchase of technology from BYU [See Note 5] the Company issued 120,000 shares of previously unissued restricted common stock valued at $3.75 per share.\nOn March 31, 1995, the Company closed a private placement offering in which 1,000,000 shares of restricted common stock were sold at $4.00 per share for gross proceeds of $4,000,000. Attorneys' fees and brokerage commissions associated with the offering totaled approximately $28,553.\nIn February, 1994, the Company issued to three of its employees a total of 116,667 shares of previously unissued restricted common stock valued at $.0001 per share pursuant to a previous action of the Board of Directors in 1993.\nDuring 1994, the Company sold 53,566 restricted common shares at $5.00 per share for total cash proceeds of $267,830. Subsequently, the Board of Directors approved the issuance of 558,761 additional restricted shares to all shareholders who had previously purchased shares from the Company at $5.00 per share during the periods from 1990 through 1994. The additional issuance was intended to reduce the average cost of a share to $2.00 per share for those who had previously paid $5.00 per share.\nAs indicated in Note 13, pursuant to agreements with the Company in 1994, certain former officers and directors agreed to return 2,798,223 shares held by them for cancellation. During the year ended December 31, 1993, the Company issued 195,657 shares of restricted common stock valued at $.0001 per share to employees for services rendered [See Historical Basis of Stock Issued for Services]. The Company also issued 167,115 shares for total cash proceeds of $835,575.\nAlso during 1993, the Board of Directors approved the annual issuance of 116,667 shares of common stock, beginning in January 1994 and extending through January 1998, to certain key employees, dependent upon their continued satisfactory employment with the corporation. The board also approved the annual issuance of options to the same employees to purchase a total of 100,000 shares per year for $5 per share. Both of these actions were voided by the Board's adoption of the new stock option plan during 1994 as noted below.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 11 - COMMON STOCK TRANSACTIONS [Continued]\nHistorical Basis of Stock Issued for Services Prior to 1994 - The majority of stock issued for services was issued to individuals who could have been deemed to be promoters and control individuals. Consequently, the Company has determined that, due to the control exercised by the beneficiaries, the stock should be valued based on the historical cost of any services transferred to the Company. Since management is unable to determine a reasonable methodology for valuing services rendered for stock, the Company is valuing the stock at par value ($.0001).\nStock Options and Warrants During the year ended December 31, 1995, the Company awarded stock options representing the right to buy 333,000 shares of restricted common stock in connection with the hiring of new personnel for the Company. The options all have an exercise term of five years, with full or partial vesting occurring on the anniversaries of the individual grant dates. The exercise prices are either $4.00 or $5.00 per share depending on the market price of the Company's common shares on the date of grant of the options.\nAdditionally, during 1995, stock options representing 200,000 shares were granted to new members of the Board of Directors of the Company in connection with their service on the Board. The options vest over the next 15 months, and have an exercise price of $5.00, with an exercise term of 5 years.\nAlso, in September 1995, a consultant to the Company was granted an option representing 10,000 shares in connection with his help in the development of the CNC controller. The options vested immediately and are exercisable over a term of five years at $5.00 per share.\nAt the close of the year ending December 31, 1995, seven (7) employees had terminated their employment with the Company, thereby forfeiting options representing a total of 171,000 shares of common stock. Taking into account the forfeited option shares, together with warrants granted to outside consultants, and warrants issued in connection with convertible notes payable, the options issued to employees, advisory panel members, and members of the Board of Directors bring the total number of shares represented by outstanding options and warrants to 8,493,166 shares at December 31, 1995.\nOn December 21, 1994, the Board of Directors adopted a stock option plan for employees which became effective immediately, subject to shareholder approval at the annual meeting of shareholders conducted in July, 1995. The plan specifically replaces all prior option agreements between the Company and its employees. The plan provides for the issuance of stock options from time to time to employees of the Company as approved by the Board of Directors. The maximum number of shares reserved for issuance under this plan cannot exceed 1,993,816 shares. For any options granted pursuant to this plan, one half will vest on the first anniversary date of the date of grant, and the remaining one half will vest on the second anniversary date of the date of grant. Continued employment with the Company is one of the requirements of vesting. The option period and exercise price will be specified for each option granted, as determined by the Board of Directors, but in no case shall the option period exceed five years from the date of grant, and the exercise price cannot be less than one half the market price of the Company's common shares on the date of grant. Pursuant to the plan, on December 21, 1994, the Board granted options totaling 1,804,166 shares to the employees of the Company and advisory panel members. A total of 415,000 options were granted with an exercise price of $2.00 per share and 1,389,166 options with an exercise price of $3.00 per share.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 11 - COMMON STOCK TRANSACTIONS [Continued]\nOn September 12, 1994, the Board of Directors approved the issuance of common stock options to members of its advisory panel. Each panel member was granted options to purchase 50,000 restricted shares at an exercise price of $3.00 per share for a period of five years. At the time of the grant, there was no trading market for either the Company's common shares or for options on those shares, although the Company had received a price of $2.00 per share for common stock of the Company's privately-owned, sole subsidiary [See Note 19]. Consequently, no compensation has been recorded in connection with the granting of these options.\nAs of December 31, 1995 none of the above options have been exercised [See Note 22]\nOn March 21, 1994 in connection with the execution of the proxy agreement [See note 12], the Company entered into a separate consulting agreement with this outside consultant granting him warrants to purchase 6,000,000 restricted common shares for a cash payment of $1,000,000. The warrants are irrevocable and exercisable for a period of five years. At December 31, 1995 none of the warrants have been exercised.\nDuring July 1994, in connection with conversion of three notes payable into common shares of the subsidiary [See Note 8], the Company issued warrants to purchase up to an aggregate of 317,500 shares of common stock of the Parent Company upon payment of $2.00 per share. The warrants are exercisable until April 29, 1997. At December 31, 1995, none of the warrants have been exercised.\nThe following table is a summary of option and warrant transactions for the years ending:\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 12 - CHANGE IN CONTROL\nOn March 21, 1994, and later amended in June, 1994 and August 1995, certain officers, directors and controlling shareholders of the Company entered into a proxy agreement wherein they assigned the voting rights of their common stock (voting control of approximately 43.0%) to an individual with experience and expertise in managing various businesses and who became an outside consultant, to the Company. The proxy agreement has a term expiring on December 31, 1998 and is irrevocable [See Note 13].\nOn July 1, 1994, a meeting of the Board of Directors was held and the officers and directors submitted their resignations. Their positions have been filled subsequently by persons newly-hired by the Company.\nNOTE 13 - RELATED PARTY TRANSACTIONS\nDuring the year ended December 31, 1995, the Company paid consulting fees of $51,600 and provided the use of a furnished home to a corporation controlled by an outside consultant who has proxy voting control of the Company [See Note 12] and is the holder of certain warrants to purchase shares of the Company's common Stock [See Note11]. Rental income and offsetting consulting fees expense of $4,800 was recorded. On July 31, 1994, the Company purchased a building contract for a cash payment of $75,000. The contract provided for the construction of the new facility now occupied by the Company. The purchase price was paid to a partnership in which the outside consultant with proxy voting rights was a partner.\nIn connection with the voting rights of the former officers and directors being assigned by proxy to an outside consultant, the Company entered into agreements with certain former officers and directors wherein 2,798,223 shares of the Company's common stock were returned and canceled. [See Note 12]. The former officers and directors released the Company from obligations payable to them totaling $242,270. The Company indemnified the former officers and directors for their past services rendered, and released them from certain obligations payable to the Company totaling $120,068. Prior to this simultaneous release of obligations, a relative of one of the directors made non-interest bearing cash advances to the Company totaling $32,900. All related party payables and receivables were forgiven by the action noted above, and as of December 31, 1994, the balance of related party receivables and payables was zero.\nDuring the year ended December 31, 1993, the Company received $30,750 from an officer and director and a related party to such officer. The amounts bore no interest and were payable upon demand. Amounts payable at December 31, 1993 was $35,462. Amounts receivable from the officer and director at December 31, 1993 was $3,474. During 1994 the receivables and payables were forgiven in connection with an indemnity agreement, see above.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS NOTE 13 - RELATED PARTY TRANSACTIONS [Continued]\nDuring the years ended December 31, 1993, the Company loaned amounts to, and received loans from, a director and a related party to such director. Amounts bore no interest and were payable on demand. Amounts payable to the director and related party to such director at December 31, 1993 was $147,452. Amounts receivable from the same individuals at December 31, 1993 were $71,581. During 1994 the receivables and payables were forgiven in connection with indemnity agreement, see above.\nAlso during 1994, the Company extended a cost of living expense allowance to its president, Mr. Claude Goldsmith, in lieu of requiring the filing of expense reports monthly. The monthly allowance of $2,000 began on September 1, 1994 and was paid to Mr. Goldsmith up until his resignation due to illness in December, 1994. The expense reimbursement arrangement was a non- accountable plan and was treated as compensation paid to Mr. Goldsmith.\nDuring 1993, a director and related party to such director accepted 29,708 shares of common stock, at $5.00 a share, as payment for $148,540 of payables.\nNOTE 14 - CONTINGENCIES\nPayroll Taxes - Certain of the Company's compensation practices prior to the year ended December 31, 1990 fall under section 3401 of the Internal Revenue Code. The complexity of this section results in areas of uncertainty and requires interpretation. The IRS may question the current interpretation. If the Company's interpretation does not prevail, payroll taxes and the related penalties could be assessed. The possible assessment and penalty cannot be determined at this time. Any payments by reason of an adverse determination in this matter will be charged to earnings in the period of determination. In connection with the resignation of previous officers, a former officer took ownership of a truck which was under lease by the Company and accounted for as a capital lease. The former officer is personally making the payments on the lease. However, the lease obligation is in the Company's name and, thus, the Company is contingently liable should the former officer fail to make the required payments. At December 31, 1995 the unpaid balance of the lease was $12,311. The lease also contains a buy-out option of $7,447.\nProduct Warranties - The Company provides certain product warranties to customers including repair or replacement for defects in materials and workmanship of hardware products. The Company also warrants that software and firmware products will conform to published specifications and not fail to execute the Company's programming instructions due to defects in materials and workmanship. In addition, if the Company is unable to repair or replace any product to a condition warranted, within a reasonable time, the Company will provide a refund to the customer. As of December 31, 1995 and 1994, no provision for warranty claims has been established since the Company has not incurred substantial sales from which to develop reliable estimates. Also, no refunds have been paid to any customer as of December 31, 1995. However, management believes the allowance for warranty would be currently immaterial to the financial condition of the Company.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 14 - CONTINGENCIES [Continued]\nLitigation - The Company is involved in various litigation's as part of its normal business operations. In the opinion of management and counsel, the ultimate resolution of these cases will not have a material adverse effect on the Company's financial position.\nNOTE 15 - SIGNIFICANT CUSTOMERS\nFor the year ended December 31, 1995, the Company had four significant customers, AT & T (16%), Cybex Technologies (10%), Hewlett-Packard (26%) and Motorola (29%), which accounted for 81% of its total revenue. During 1994, 90% of the Company's total revenues came from four significant customers. During 1993, 86% of the Company's total revenue came from three significant customers.\nNOTE 16 - CONTINUING OPERATIONS\nDuring its existence, the Company has incurred operating losses from inception totaling of $(7,087,673) including $(2,544,247), $(1,145,056), and $(1,073,985) during the years ended December 31, 1995, 1994, and 1993, respectively. Net cash used by operations amounted to approximately $2,944,444, $1,817,209, and $775,557 during the same periods.\nHistorically, the Company has raised the required financing for its activities through the sale of the Company's common shares and from short- term borrowings. During 1995, the Company used these same methods in raising what management believes will be sufficient cash funds to finance the projected cash requirements through 1996 when accompanied by projected sales revenues. In March, 1995, the Company sold 1,000,000 of its common shares at a price of $4.00 per share raising a total of $4,000,000 in cash. Additionally, the Company has arranged with a financial institution a $5,000,000 line of credit. Borrowings against this line are secured by certain current assets of the Company including cash. Management of the Company believes that at December 31, 1995, the Company is capable of financially meeting the demands inherent as normal sales and manufacturing continue to develop during 1996.\nNot withstanding the above, as disclosed in a recently filed Form 8-K, pursuant to the desire of management of the Company to enhance the capability of the Company to distribute its products to a world wide market in an accelerated time frame, the Company has engaged Cowen & Company to act as the Company's investment banker in exploring the possibility of establishing strategic and financial relationships with one or more companies, which may include the sale or merger of the Company [See Note 22].\nIn addition to these considerations, the Company continues to participate with Motorola, Inc. in the development of an \"open architecture\" controller standard for Motorola's manufacturing divisions world wide. Management believes this represents a significant opportunity for the Company to further the commercial acceptance of its products, both by Motorola and other customers.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 16 - CONTINUING OPERATIONS [Continued]\nBecause of the cash position of the Company at December 31, 1995, the accompanying financial statements do not contain any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities that might be necessary, should the Company be unable to achieve profitable operations and generate sufficient working capital to fund operations and pay or refinance its current obligations.\nNOTE 17 - AGREEMENTS During the year ended December 31, 1992, the Company entered into a business referral agreement and a capital referral agreement with A-K Associates, Inc. [A-K]. The purpose of such agreements was to generate customers and\/or capital investments for the Company. The term of each agreement was ten years from the date that the Company approves the referral. During 1994, the Company entered into negotiations with A-K to terminate said agreements, believing the long-term effect was not beneficial to the Company. An agreement was reached in early 1995 to settle this matter for a cash payment of $10,000. The Company also canceled 2,963 shares of common stock which had previously been accounted for as issued.\nNOTE 18 - INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes [FASB 109] during Fiscal 1993. FASB 109 requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carryforwards. At December 31, 1995 and 1994, the total of all deferred tax assets was $3,309,029 and $2,150,780 and the total of the deferred tax liabilities was $1,622,594 and $245,751. The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. Because of the uncertainty surrounding the realization of the deferred tax assets, the Company has established a valuation allowance of $1,686,435 and $1,905,028 as of December 31, 1995 and 1994, which has been offset against the deferred tax assets. The net change in the valuation allowance during the year ended December 31, 1995, was $(218,593).\nThe Company has available at December 31, 1995, unused tax operating loss carryforwards of approximately $8,228,256, which may be applied against future taxable income and which expire in various years beginning 2004 through 2010.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 18 - INCOME TAXES [Continued]\nThe components of income tax expense from continuing operations for the years ended December 31, 1995 and 1994 consist of the following:\nDeferred income tax expense results primarily from the reversal of temporary timing differences between tax and financial statement income. There is no portion of current or deferred tax expense that is required to be allocated to the extraordinary item.\nA reconciliation of income tax expense at the federal statutory rate to income tax expense at the Company's effective rate is as follows:\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 18 - INCOME TAXES [Continued]\nThe temporary differences gave rise to the following deferred tax asset (liability) at December 31, 1995 and 1994:\nThe deferred taxes are reflected in the balance sheet as follows:\nNOTE 19 - MINORITY INTEREST\nOn July 31, 1994, the Company's subsidiary sold by private placement memorandum 2,500,000 shares of its common stock at $2.00 per share for total cash proceeds of $5,000,000. The sale of the common stock, along with the conversion of $635,000 of convertible notes payable to the subsidiary's common stock, created a 12.4% minority interest in the subsidiary.\nIn July 1995, the shareholders of the Company's subsidiary approved a merger of the subsidiary into the Parent company through the exchange of one share of the Company's restricted common stock for each of the 2,829,419 shares of the Subsidiary's common stock held by the minority interest shareholders. The merger was effective August 31, 1995, and left the Parent as the sole surviving entity. The purchase of the minority interest by the Parent created \"goodwill\" of $3,260,646 which has been recorded and is being amortized by the Parent. [See Note 1 and 11]\nNOTE 20 - 401(K) RETIREMENT SAVINGS PLAN\nDuring 1994, the Company adopted a 401(k) Retirement Savings Plan. All employees at least 21 years old who have completed 3 months of service are eligible to enroll in the plan. Employees may contribute up to 15% of their pay each period to the plan. The Company will match 50% of the employee's contribution to the plan up to a maximum of 2% of the employees annual pay. The employees will vest in the employers contribution over a five year period. For the year ended December 31, 1995 and 1994, the Company contributed $16,284 and $5,685 to the plan, respectively.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 21 - EXTRAORDINARY ITEM\nPursuant to the change in control described in Note 12, the Company negotiated a forgiveness of certain related party payables and receivables. Related party payables forgiven exceeded related party receivables forgiven by approximately $126,000. Additionally, new management succeeded in negotiating forgiveness of approximately $62,000 in lease, royalty, and other trade payables. The net forgiveness of payables has been treated as an extraordinary item in these financial statements.\nNOTE 22 - SUBSEQUENT EVENTS\nStock Options\nIn connection with matters relating to new and existing personnel and a new board member in early 1996, the Board of Directors granted additional options to purchase 125,000 shares of common stock exercisable at either $5.00 or $9.00 per share. Employees who have left the Company since December 31, 1995 have forfeited options representing a total of 30,000 shares with an exercise price of $5.00 per share.\nIn February 1996, four option holders, who are no longer employed or under contract with the Company, elected to exercise all or part of their options to purchase restricted shares from the Company. A total of 315,000 shares were purchased at the option exercise price of $2.00 per share. Also, 325 shares were purchased for an option exercise price of $3.00 per share. Based on a quoted market price at the time of exercise of approximately $10.00 per share, the Company for tax purposes will recognize a compensation deduction of approximately $1,002,300 in 1996. After giving effect to the transactions occurring during January through February 15, 1996, the total number of stock options and warrants outstanding and unexercised represent 8,588,166 shares.\nInvestment Banker Engaged\nIn an agreement signed January 8, 1996, the Company engaged Cowen & Company (\"Cowen\") to act as the Company's investment banker. The Company intends to explore with Cowen the possibility of establishing strategic and financial relationships with one or more companies, which may include the sale or merger of the Company. The term of this engagement extends through December 31, 1996 [See Note 12].\nChanges in the Board of Directors\nOn December 15, 1995, the Board of Directors elected a new director to the Board of the Company, effective January 1, 1996 and until the election of directors at the next annual Shareholders' meeting. In connection with his compensation for service as a Board member, the Company restructured its obligations under a previous option agreement negotiated with the individual pursuant to a consulting agreement dated July 15, 1995. In exchange for the consultant's release of the Company from its previous obligations, the Company has granted him non-qualified options to purchase 40,000 shares of restricted common stock at $5.00 per share, which will vest immediately.\nCIMETRIX INCORPORATED\nNOTES TO FINANCIAL STATEMENTS\nNOTE 22 - SUBSEQUENT EVENTS [Continued] Sale of Residential Property\nOn January 13, 1996, the Company accepted an earnest money offer to purchase the residential real estate owned by the Company. The offer was tendered by a shareholder of the Company at a purchase price of $275,000. The closing is scheduled to take place in May, 1996.\nLawsuit\nOn February 8, 1996, the Company filed a suit seeking declaratory relief and a determination of the validity of the issuance of certain shares of the Company's common stock to former members of management and their families. The suit was only recently filed and counsel cannot predict the probability of success.\nDate Filed: March 28, 1996 SEC File No. 0-16454\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D. C. 20549\nEXHIBITS\nTO\nFORM 10-KSB\nUNDER\nTHE SECURITIES EXCHANGE ACT OF 1934\nCIMETRIX INCORPORATED","section_15":""}
{"filename":"763563_1995.txt","cik":"763563","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General development of business\nChemung Financial Corporation (Corporation) was incorporated on January 2, 1985, under the laws of the State of New York. The Corporation was organized for the purpose of acquiring a majority holding of Chemung Canal Trust Company (Bank). The Bank was established in 1833 under the name Chemung Canal Bank, and was subsequently granted a New York State bank charter in 1895. In 1902, the Bank was reorganized as a New York State trust company under the name Elmira Trust Company, which name was changed to Chemung Canal Trust Company in 1903.\nOn June 1, 1985, after the approval by the New York State Superintendent of Banks and the Board of Governors of the Federal Reserve System of the Plan of Acquisition and holding company application, the Bank became a wholly-owned subsidiary of the Corporation. There have been no material changes in the mode of conducting business of either the Corporation or the Bank since the acquisition of the Bank by the Corporation.\nThe Corporation is subject to applicable federal laws relating to bank holding companies as well as federal securities laws, State Corporation Law and State Banking Law.\n(b) Financial information about industry segments\nThe Corporation and the Bank are engaged only in banking and bank-related businesses. The Selected Financial Data Exhibit included in \"Management's Discussion and Analysis of Financial Condition and Results of Operation\" (\"MD&A\") for the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, sets forth financial information with respect to bank-related industry segments. The MD&A including the Selected Financial Data Exhibit is incorporated herein by reference.\n(c) Narrative description of business\nBusiness\nThe Bank is a New York State chartered, independent commercial bank which engages in full-service commercial and consumer banking and trust business. The Bank's services include accepting time, demand and savings deposits including NOW accounts, Super NOW accounts, regular savings accounts, insured money market accounts, investment certificates, fixed-rate certificates of deposit and club accounts. Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions either directly or participating with regional industrial development and community lending corporations, making commercial, residential and home equity mortgage loans, revolving credit loans with overdraft checking protection, small business loans and student loans. Additional services include renting of safe deposit facilities, selling uninsured annuity and mutual fund investment products, and the use of networked automated teller facilities.\nTrust services provided by the Bank include services as executor, trustee under wills and agreements, guardian and custodian and trustee and agent for pension, profit-sharing and other employee benefit trusts as well as various investment, pension, estate planning and employee benefit administrative services.\nFor additional information which focuses on the results of operation of the Corporation and the Bank, see Management's Discussion and Analysis of Financial Condition and Results of Operations, incorporated herein by reference.\nThere have been no material changes in the manner of doing business by the Corporation or the Bank during the fiscal year ended December 31, 1995.\nCompetition\nSix (6) of the Bank's thirteen (13) full-service branches, in addition to the main office, are located in Chemung County. The other seven (7) full-service branches are located in the adjacent counties of Schuyler, Steuben, and Tioga. All facilities are located in New York State.\nWithin these market areas, the Bank encounters intense competition in its banking business from several other financial institutions offering comparable products. These competitors include other commercial banks (both locally-based independent banks and local offices of regional and major metropolitan-based banks), as well as stock savings banks and credit unions. In addition, the Bank experiences competition in marketing some of its services from local operations of insurance companies, brokerage firms and retail financial service businesses.\nDependence Upon a Single Customer\nNeither the Corporation nor the Bank is dependent upon a single or limited number of customers.\nResearch and Development\nExpenditures for research and development were immaterial for the years 1995, 1994, and 1993.\nEmployees\nAs of December 31, 1995, the Bank employed 281 persons on a full-time equivalent basis.\n(d) Financial information about foreign and domestic operations and export sales\nNeither the Corporation nor the Bank relies on foreign sources of funds or income.\n(e) Statistical disclosure by bank holding companies\nThe following disclosures present summarized statistical data covering the Corporation and the Bank.\nThe following table sets forth for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:\nInvestment Portfolio\nThe following table sets forth the carrying amount of investment securities at the dates indicated:\nInvestment Portfolio (continued)\nThe following tables set forth the maturities of investment securities at December 31, 1995 and the weighted average yields of such securities (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security). Federal tax equivalent adjustments have been made in calculating yields on municipal obligations.\nLoan Portfolio\nThe following table shows the Corporation's loan distribution at the end of each of the last five years:\nThe following table shows the maturity of loans (excluding residential real estate mortgages and installment loans) outstanding as of December 31, 1995. Also provided are the amounts due after one year classified according to the sensitivity to changes in interest rates:\nNonaccrual and Past Due Loans\nThe following table summarizes the Corporation's nonaccrual and past due loans:\nInformation with respect to nonaccrual loans at December 31, 1995, 1994 and 1993 is as follows:\nPotential Problem Loans\nAt December 31, 1995, the Corporation has no commercial loans for which payments are presently current but the borrowers are currently experiencing severe financial difficulties. Those loans are subject to constant management attention and their classification is reviewed by the Board of Directors at least semi-annually.\nLoan Concentrations\nAt December 31, 1995, the Corporation has no loan concentrations to borrowers engaged in the same or similar industries that exceed 10% of total loans.\nOther Interest-Bearing Assets\nAt December 31, 1995, the Corporation has no interest-bearing assets other than loans that meet the nonaccrual, past due, restructured or potential problem loan criteria.\nSummary of Loan Experience\nThis table summarizes the Corporation's loan loss experience for each year in the five-year period ended December 31, 1995:\nThis table summarizes the Corporation's allocation of the loan loss reserve for each year in the five-year period ended December 31, 1995.\nDeposits\nThe average daily amounts of deposits and rates paid on such deposits are summarized for the periods indicated in the following table:\nMaturities of certificates of deposit $100,000 or more outstanding at December 31 are summarized as follows:\nThere were no other time deposits of $100,000 or more.\nReturn on Equity and Assets\nThe following table shows consolidated operating and capital ratios of the Corporation for each of the last three years:\nShort-Term Borrowings\nFor each of the three years in the period ended December 31, 1995, the average outstanding balance of short-term borrowings did not exceed 30% of shareholders' equity.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Corporation and the Bank currently conduct all their business activities from the Bank's main office, thirteen (13) branch locations situated in a four-county area, owned office space adjacent to the Bank's main office, and five (5) off-site automated teller facilities (ATMs), three (3) of which are located on leased property. The main office is a six-story structure located at One Chemung Canal Plaza, Elmira, New York, in the downtown business district. The main office consists of approximately 62,000 square feet of space entirely occupied by the Bank. The combined square footage of the thirteen (13) branch banking facilities totals approximately 46,350 square feet. The office building adjacent to the main office was acquired during 1995 and consists of approximately 18,213 square feet of which 8,202 square feet are occupied by operating departments of the Bank and 10,011 square feet are leased. The leased automated teller facility spaces total approximately 150 square feet.\nThe Bank holds two (2) of its branch facilities (Arnot Mall Office and Bath Office) and three (3) automated teller facilities (Elmira\/Corning Regional Airport, Elmira College and WalMart Store) under lease arrangements; and owns the rest of its offices including the main office and the adjacent office building.\nThe Corporation holds no real estate in its own name.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNeither the Corporation nor its subsidiary are a party to any material pending legal proceeding required to be disclosed under this item.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nThere were no matters submitted to a vote of shareholders during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS SECURITIES AND RELATED SHAREHOLDER MATTERS\nThe Corporation's stock is traded in the over-the-counter market. Incorporated herein by reference to portions of the Corporation's Annual Report to Shareholders for the year ended December 31, 1995, are the quarterly market price ranges for the Corporation's stock for the past three (3) years, based upon actual transactions as reported by securities brokerage firms which maintain a market or conduct trades in the Corporation's stock and other transactions known by the Corporation's management. Also incorporated herein by reference to a part of the Corporation's 1995 Annual Report are the dividends paid by the Corporation for each quarter of the last three (3) years. The number of shareholders of record on February 29, 1996 was 834.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Selected Financial Data Exhibit included in Management's Discussion and Analysis of Financial Condition and Results of Operations and presented in the Corporation'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 Financial Condition and Results of Operations presented in the Corporation'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 Independent Auditors' Report and consolidated financial statements as presented in the Corporation's Annual Report to Shareholders for the year ended December 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, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nThe information set forth under the captions \"Election of Directors\" and \"Executive Officers\" and the Section 16(a) disclosure set forth under the caption \"Security Ownership of Management\", as presented in the registrant's Proxy Statement, dated March 5, 1996, relating to the Annual Meeting of Shareholders to be held on April 2, 1996, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Directors Compensation\"; \"Directors' Personnel Committee Report on Executive Compensation\"; \" Comparative Return Performance Graph\"; \"Executive Compensation\"; \"Retirement Plan\"; \"Profit- Sharing, Savings and Investment Plan\"; \"Management Incentive Plan\"; \"Employment Contracts\"; and \"Other Compensation Agreements\", presented in the registrant's Proxy Statement, dated March 5, 1996, relating to the Annual Meeting of Shareholders to be held on April 2, 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 captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\", presented in the registrant's Proxy Statement, dated March 5, 1996, relating to the Annual Meeting of Shareholders to be held on April 2, 1996, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the caption \"Certain Transactions\", presented in the registrant's Proxy Statement, dated March 5, 1996, relating to the Annual Meeting of Shareholders to be held on April 2, 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) List of Financial Statements and Independent Auditors' Report\nThe following consolidated financial statements and Independent Auditors' Report of Chemung Financial Corporation and subsidiary, included in the Annual Report of the registrant to its shareholders as of December 31, 1995 and 1994, and for each of the years in the three-year period ended December 31, 1995 are incorporated by reference in Item 8:\n- Independent Auditors' Report - Consolidated 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 and\n(2) List of Financial Schedules\nSchedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(3) Listing of Exhibits\nExhibit (3.1) -- Certificate of Incorporation is filed as Exhibit 3.1 to Registrant's Registration Statement on Form S-14, Registration No. 2-95743, and is incorporated herein by reference.\n-- Certificate of Amendment to the Certificate of Incorporation, filed with the Secretary of State of New York on April 1, 1988, is incorporated herein by reference to Exhibit A of the Registrant's Form 10-K for the year ended December 31, 1988, File No. 0-13888.\n(3.2) -- Bylaws of the Registrant, as amended September 13, 1995, are incorporated herein by reference to Exhibit A of the Registrant's Form 10-Q for the period ended September 30, 1995, File No. 0-13888.\nExhibit (13) -- Annual Report to Shareholders for the year ended December 31, 1995.\n-- Table of Quarterly Market Price Ranges. EXHIBIT A\n-- Table of Dividends Paid. EXHIBIT B\n-- Management's Discussion and Analysis of EXHIBIT C Financial Condition and Results of Operations including the Selected Financial Data Exhibit.\n-- Consolidated Financial Statements and EXHIBIT D Independent Auditors' Report.\nExhibit (21) -- Subsidiaries of the registrant. EXHIBIT E\nExhibit (22) -- Registrant's Notice of Annual Meeting, EXHIBIT F Proxy Statement dated March 5, 1996, and Proxy Form\nExhibit (27) -- Financial Disclosure Schedule (EDGAR version only)\n(b) Reports on Form 8-K\nThere were no reports filed on Form 8-K during the three months ended December 31, 1995.\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\nNone\nANNUAL REPORT ON FORM 10-K\nITEM 14(c)\nCERTAIN EXHIBITS\nYEAR ENDED DECEMBER 31, 1995\nCHEMUNG FINANCIAL CORPORATION\nELMIRA, NEW YORK ____________________________________\nEXHIBIT LISTING EXHIBIT\nEXHIBIT 13 Annual Report To Shareholders For The Year Ended December 31, 1995\nA - Table of Quarterly Market Price Ranges\nB - Table of Dividends Paid\nC - Management's Discussion and Analysis of Financial Condition and Results of Operations Including the Selected Financial Data Exhibit\nD - Consolidated Financial Statements and Independent Auditors' Report\nEXHIBIT 21 E - Subsidiaries of the Registrant EXHIBIT 22 F - Notice of Annual Meeting, Proxy Statement dated March 5, 1996, and Proxy Form\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCHEMUNG FINANCIAL CORPORATION DATED: MARCH 13, 1996\nBy \"signature\" John W. Bennett Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been executed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\"signature\" Director 3\/13\/96 Robert E. Agan\n\"signature\" Director, Chairman & 3\/13\/96 John W. Bennett Chief Executive Officer\nDirector Donald L. Brooks, Jr.\n\"signature\" Director 3\/13\/96 David J. Dalrymple\n\"signature\" Director 3\/13\/96 Robert H. Dalrymple\n\"signature\" Director 3\/13\/96 Richard H. Evans\n\"signature\" Director 3\/13\/96 Natalie B. Kuenkler\n\"signature\" Director 3\/13\/96 Edward B. Hoffman\n\"signature\" Director 3\/13\/96 Stephen M. Lounsberry III\n\f Signature Title Date\nDirector Boyd McDowell II\n\"signature\" Director 3\/13\/96 Thomas K. Meier\n\"signature\" Director 3\/13\/96 Ralph H. Meyer\nDirector John F. Potter\n\"signature\" Director 3\/13\/96 Samuel J. Semel\n\"signature\" Director 3\/13\/96 Charles M. Streeter, Jr.\n\"signature\" Director 3\/13\/96 Richard W. Swan\n\"signature\" Director 3\/13\/96 William A. Tryon\nDirector William C. Ughetta\n\"signature\" Director, President & 3\/13\/96 Jan P. Updegraff Chief Operating Officer\n\"signature\" Director 3\/13\/96 Nelson Mooers van den Blink\n\"signature\" Treasurer and Principal 3\/13\/96 Accounting Officer\nAttest\n\"signature\" Secretary 3\/13\/96 Jerome F. Denton","section_15":""}
{"filename":"745544_1995.txt","cik":"745544","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant is a stock life insurance company incorporated under the laws of Delaware on January 12, 1970. Its Executive Office mailing address is One Sun Life Executive Park, Wellesley Hills, Massachusetts 02181, Tel. (617) 237-6030. It has obtained authorization to do business in 48 states, the District of Columbia and Puerto Rico and it is anticipated that it will be authorized to do business in all states except New York. The Registrant has formed a wholly-owned subsidiary, Sun Life Insurance and Annuity Company of New York, which issues individual fixed and combination fixed\/variable annuity contracts and group life and long-term disability insurance in New York. The Registrant's other wholly-owned subsidiaries are Massachusetts Financial Services Company and Sun Capital Advisers, Inc., registered investment advisers; Sun Investment Services Company, a registered broker-dealer and investment adviser; Sun Benefit Services Company, Inc., which offers claims, actuarial and administrative services; Massachusetts Casualty Insurance Company, a life and accident and health insurance company which currently issues only individual disability insurance contracts; New London Trust, F.S.B., a federally chartered savings bank and Sun Life Financial Services Limited, which provides off-shore administrative services to the Registrant and Sun Life Assurance Company of Canada. Effective January 1, 1994, The New London Trust Company, a subsidiary of the Registrant, acquired all of the outstanding shares of Danielson Federal Savings and Loan Association of Danielson, Connecticut and was merged into New London Trust, F.S.B.\nThe Registrant is a wholly-owned subsidiary of Sun Life Assurance Company of Canada, 150 King Street West, Toronto, Ontario, Canada. Sun Life Assurance Company of Canada is a mutual life insurance company incorporated pursuant to Act of Parliament of Canada in 1865 and currently transacts business in all of the Canadian provinces and territories, all states except New York, the District of Columbia, Puerto Rico, the Virgin Islands, Great Britain, Ireland, Hong Kong, Bermuda and the Philippines.\nGENERAL\nThe Registrant is currently engaged in the sale of individual and group fixed and variable annuities, and group pension contracts. These contracts are sold in both the tax qualified and non-tax qualified markets. These products are distributed through individual insurance agents, insurance brokers and broker-dealers.\nThe following table sets forth premiums and deposits by major product categories for each of the last three years. Purchase payments received from the sale of variable annuity contracts are not included in these amounts as they are treated as direct increases to the Registrant's separate account liabilities.\n(In 000's) 1995 1994 1993 ---- ---- ----\nIndividual insurance $214,226 $ 245,770 $ 286,620\nIndividual annuities 18,623 21,474 594,097\nGroup annuities 763,722 744,970 794,120 -------- ---------- ----------\n$996,571 $1,012,214 $1,674,837 -------- ---------- ---------- -------- ---------- ----------\nREINSURANCE\nThe Registrant has agreements with its parent company which provide that the parent company will reinsure the mortality risks of the individual life insurance contracts previously sold by the Registrant. Under these agreements basic death benefits and supplementary benefits are reinsured on a yearly renewable term basis and coinsurance basis, respectively. Reinsurance transactions under these agreements in 1995 had the effect of decreasing net income from operations by $2,184,000.\nEffective January 1, 1991 the Registrant entered into an agreement with the parent company under which 100% of certain fixed annuity contracts issued by the Registrant were reinsured. Effective December 31, 1993 this agreement was terminated.\nEffective January 1, 1991 the Registrant entered into an agreement with the parent company under which certain individual life insurance contracts issued by the parent were reinsured by the Registrant on a 90% coinsurance basis. Also effective January 1, 1991 the Registrant entered into an agreement with the parent which provides that the parent will reinsure the mortality risks in excess of $500,000 per policy for the individual life insurance contracts assumed by the Registrant in the reinsurance agreement described above. Death benefits are reinsured on a yearly renewable term basis. These agreements had the effect of increasing income from operations by approximately $11,821,000 for the year ended December 31, 1995.\nThe life reinsurance assumed agreement requires the reinsurer to withhold funds in amounts equal to the reserves assumed.\nThe Registrant also has executed a reinsurance agreement with an unaffiliated company which provides reinsurance of certain individual life insurance contracts on a modified coinsurance basis and under which all deficiency reserves are ceded.\nRESERVES\nIn accordance with the life insurance laws and regulations under which the Registrant operates it is obligated to carry on its books, as liabilities, actuarially determined reserves to meet its obligations on its outstanding contracts. Reserves are based on mortality tables in general use in the United States and are computed to equal amounts that, with additions from premiums to be received, and with interest on such reserves compounded annually at certain assumed rates, will be sufficient to meet the Registrant's policy obligations at their maturities or in the event of an insured's death. In the accompanying Financial Statements these reserves are determined in accordance with statutory regulations which are generally accepted accounting principles for the Registrant.\nINVESTMENTS\nOf the Registrant's total assets of $12.5 billion at December 31, 1995, 58.5% consisted of unitized and non-unitized separate account assets, 22.8% were invested in bonds and similar securities, 8.5% in mortgages, 1.1% in subsidiaries, .7% in real estate, and the remaining 8.4% in cash and other assets.\nCOMPETITION\nThe Registrant is engaged in a business that is highly competitive because of the large number of stock and mutual life insurance companies and other entities marketing insurance products. There are approximately 1,800 stock, mutual and other types of insurers in the life insurance business in the United States. The Registrant's excellent financial ratings are an important part of its competetive position. The Registrant and its parent company, Sun Life Assurance Company of Canada, are among the 50 companies assigned A.M. Best's highest rating of A++ according to the 1995 Best's Insurance Reports for Life and Health Companies. Standard & Poor's and Duff and Phelps have also assigned the Registrant and its parent company their highest ratings for claims ability, AAA.\nEMPLOYEES\nThe Registrant and Sun Life Assurance Company of Canada have entered into a Service Agreement which provides that the latter will furnish the Registrant, as required, with personnel as well as certain services and facilities on a cost reimbursement basis. As of December 31, 1995 the Registrant had 255 direct employees who are employed at its Principal Executive Office in Wellesley Hills, Massachusetts and at its Annuity Service Center in Boston, Massachusetts.\nSTATE REGULATION\nThe Registrant is subject to the laws of the State of Delaware governing life insurance companies and to regulation by the Commissioner of Insurance of Delaware. An annual statement is filed with the Commissioner of Insurance on or before March 1st in each year relating to the operations of the Registrant for the preceding year and its financial condition on December 31st of such year. Its books and records are subject to review or examination by the Commissioner or his agents at any time and a full examination of its operations is conducted at periodic intervals.\nThe Registrant is also subject to the insurance laws and regulations of the other states and jurisdictions in which it is licensed to operate. The laws of the various jurisdictions establish supervisory agencies with broad administrative powers with respect to licensing to transact business, overseeing trade practices, licensing agents, approving policy forms, establishing reserve requirements, fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values, prescribing the form and content of required financial statements and regulating the type and amount of investments permitted. Each insurance company is required to file detailed annual reports with supervisory agencies in each of the jurisdictions in which it does business and its operations and accounts are subject to examination by such agencies at regular intervals.\nIn addition, many states regulate affiliated groups of insurers, such as the Registrant, its parent and its affiliates, under insurance holding company legislation. Under such laws, inter-company transfers of assets and dividend payments from insurance subsidiaries may be subject to prior notice or approval, depending on the size of such transfers and payments in relation to the financial positions of the companies involved.\nUnder insurance guaranty fund laws in most states, insurers doing business therein can be assessed (up to prescribed limits) for policyholder losses incurred by insolvent companies. The amount of any future assessments of the Registrant under these laws cannot be reasonably estimated. However, most of these laws do provide that an assessment may be excused or deferred if it would threaten an insurer's own financial strength and may also permit the deduction of all or a portion of any such assessment from any future premium or similar taxes payable.\nAlthough the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include employee benefit regulation, removal of barriers preventing banks from engaging in the insurance business and tax law changes affecting the taxation of insurance companies, the tax treatment of insurance products and its impact on the relative desirability of various personal investment vehicles.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant occupies office space owned by it and leased to its parent, Sun Life Assurance Company of Canada, and certain unrelated parties for lease terms not exceeding five years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant and its subsidiaries are engaged in various kinds of routine litigation which, in management's judgement, is not of material importance to their respective total assets.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted by the Registrant to a vote of security holders during the three months ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Registrant is a wholly-owned subsidiary of Sun Life Assurance Company of Canada and as such there is no market for its common stock.\nNo dividends were paid in 1993, 1994 or 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee Note 1 to financial statements for the effect of the reinsurance agreements on net income\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n(1) FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nASSETS\nFor management purposes it is the Registrant's practice to segment its general account to facilitate the matching of assets and liabilities; however, all general account assets stand behind all general account liabilities. A majority of the Registrant's assets are income producing investments. Particular attention is paid to the quality of these assets.\nThe Registrant's bond holdings consist of a diversified portfolio of both public and private issues. It is the Registrant's policy to acquire only investment grade securities. Private placements are rated internally with reference to the National Association of Insurance Commissioners (\"NAIC\") designation issued by the NAIC Securities Valuation Office. The overall quality of the Registrant's bond portfolio remains high. At December 31, 1995, 2.3% of the Registrant's holdings of bonds were rated below investment grade (i.e. below NAIC rating \"1\" or \"2\"). Net unrealized gains on below investment grade bonds were $2,133,727 at December 31, 1995. Bond write downs resulting from intrinsic impairments amounted to $3,500,000 during 1995.\nThe Registrant holds real estate primarily because such investments historically have offered better yields over the long-term than fixed income investments. Real estate investments are used to enhance the yield of products with long-term liability durations. Properties for which market value is lower than cost adjusted for depreciation (book value) are reported at market value. During 1995, the change in the difference between the market value and book value for properties reported at market value was $3,583,000.\nSignificant attention has been given to insurance companies' exposure to mortgage loans secured by real estate. The Registrant had a mortgage portfolio of $1,066,911,000 at December 31, 1995, representing 25.3% of cash and invested assets. At December 31, 1994, mortgage loans represented 28.9% of cash and invested assets. The Registrant underwrites commercial mortgages with a maximum loan to value ratio of 75%. The Registrant as a rule invests only in properties that are almost fully leased. The portfolio is diversified by region and by property type. The level of arrears in the portfolio is substantially below the industry average. At December 31, 1995, 0.77% of the Registrant's portfolio was 60 days or more in arrears, compared to the most recent industry delinquency ratio published by the American Council of Life Insurance of 2.35%. The expense in the year for the provision for losses and for losses on foreclosures was $4,133,000.\nIn 1994, the Registrant entered into a leveraged lease agreement under which a fleet of rail cars was leased for a term of 9.75 years. The investment is classified as other invested assets in the attached balance sheet.\nIn the normal course of business, the Registrant makes commitments to purchase investments at a future date. As of December 31, 1995 the Registrant had outstanding mortgage commitments of $13,100,000 which will be funded during 1996.\nLIABILITIES\nThe majority of the Registrant's liabilities consist of reserves for life insurance and annuity contracts and deposit funds.\nCAPITAL AND SURPLUS\nTotal capital stock and surplus of the Registrant was $792,452,000 at December 31, 1995. The Registrant issued surplus notes during 1995 totalling $315,000,000 to an affiliate, Sun Canada Financial Co. The Registrant repaid $335,000,000 of surplus notes to its parent in 1996. During 1994, the Registrant reduced its carrying value of MCIC, a wholly-owned subsidiary, by $18,397,000, the unamortized amount of goodwill. The reduction was accounted for as a direct charge to surplus. The Registrant's management considers its surplus position to be adequate.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nIncome from operations before surplus note interest, equity in income of subsidiaries and federal income taxes increased by $33,947,000 from $12,499,000 in 1994 to $46,446,000 in 1995. Reinsurance agreements with the parent had the effect of decreasing net income by $31,327,000 in 1994 as compared to increasing net income by $9,637,000 in 1995. The increase in net income associated with the reinsurance agreements is due to the lack of surplus strain associated with the assumption of new contracts issued. No contracts issued in 1994 or thereafter have been assumed by the Registrant. It is the acquisition costs of new contract issues which caused the loss from the reinsurance agreements in prior years. Prior to reinsurance, net income from operations decreased by $7,017,000 from $43,826,000 in 1994 to $36,809,000 in 1995. Realized losses on investments and amortization of the interest maintenance reserve decreased by $2,315,000 primarily due to fewer writedowns in the group pension product line. Operating expenses increased by $5,261,000 from $32,231,000 in 1994 to $37,492,000 in 1995, reflecting increased expenses allocated from the parent and increased salaries due to additional staffing. The remaining decrease in net income in 1995 as compared to 1994 of approximately $4,071,000 reflects the strain associated with the Registrant's market value adjusted annuity product, partially offset by profits associated with the maturing block of individual and group fixed annuities.\nTotal income decreased by approximately $73,330,000 from $1,535,039,000 in 1994 to $1,461,709,000 in 1995. Revenues from reinsurance transactions decreased by $4,307,000 reflecting the assumed block of business being closed as of December 31, 1993. Premiums and annuity considerations on a pre-reinsurance basis decreased by $7,728,000 reflecting decreased group pension lottery sales of $22,084,000 offset by increased annuitizations of $14,356,000. Fixed annuity deposits decreased by $26,091,000 as interest rates remained at low levels. Sales of group pension guaranteed investment contracts increased by $49,229,000 reflecting the transfer of the parent's agents' pension fund from the parent to the Registrant. Net transfers from the separate accounts decreased by $80,758,000 reflecting the decline in interest rates. Pre-reinsurance net investment income increased by $2,219,000 reflecting an increase in the Registrant's invested asset base. Realized losses and amortization of the interest maintenance reserve decreased by $2,315,000. Other income decreased by $16,711,000 from $33,377,000 in 1994 to $16,666,000 reflecting a decrease in the surplus transfer from the separate accounts. Mortality and expense risk charges increased by $8,616,000 as a result of market appreciation in the separate accounts.\nBenefits and expenses decreased by approximately $107,277,000 from $1,522,540,000 in 1994 to $1,415,263,000 in 1995. Reinsurance had the effect of decreasing benefits and expenses by $45,272,000, primarily from lower commissions due to no assumption of new contract issues. Prior to reinsurance, benefits and expenses decreased by approximately $62,004,000. The change in the liability for annuity and other deposit funds increased by $83,094,000 as a result of fewer maturities of contracts for which the guarantee periods have expired, and increased sales of group pension guaranteed investment contracts described above. The change in reserves decreased by $16,694,000 reflecting the decrease in group pension lottery sales. Annuity and other deposit fund withdrawals decreased by $8,424,000 reflecting fewer maturities. Transfers to the non-unitized separate account decreased by $124,285,000 from $455,688,000 in 1994 to $331,403,000 reflecting fewer sales and transfers from unitized separate accounts of individually marketed fixed annuities as a result of the decline in interest rates. Operating expenses increased by $5,261,000 reflecting the increased expenses described above.\n1994 COMPARED TO 1993\nIncome from operations before surplus note interest, equity in income of subsidiaries and federal income taxes was $12,499,000 in 1994 versus a loss of $10,818,000 in 1993. The increase in income is a result of reinsurance agreements with the parent which decreased income from operations by approximately $31,327,000 in 1994 and $54,567,000 in 1993. The relatively flat change in income before reinsurance results from a combination of factors: realized losses on investments decreased by $6,237,000; mortality and expense risk charges increased by $9,357,000; general expenses increased by $8,061,000 and approximately $6,000,000 of additional surplus strain (selling costs and reserves required on new business in excess of the premium) was incurred reflecting the increased volume of new sales.\nTotal revenues decreased by $ 481,502,000 from $2,016,541,000 in 1993 to $1,535,039,000 in 1994. Revenues from reinsurance transactions decreased by $690,973,000, from $959,536,000 in 1993 to $268,563,000 in 1994. 1993 revenues include the termination of the reinsurance agreement under which the Registrant reinsured with its parent 100% of certain fixed annuity contracts. Before the impact of the reinsurance agreements, total revenues increased by $209,471,000 in 1994. Sales of individually marketed fixed annuities increased by $389,745,000 as a\nresult of improved interest rates and product enhancements. This was offset by decreased sales of group pension deposit contracts of $271,913,000, reflecting management's decision to limit sales due to the volatility of interest rates and changes in the competitive marketplace. Realized losses on investments decreased, reflecting fewer mortgage writedowns in 1994. Mortality and expense risk charges increased, reflecting the increase in separate account net assets.\nBenefits and expenses decreased by $504,819,000 from $2,027,359,000 in 1993 to $1,522,540,000 in 1994. Reinsurance had the effect of increasing benefits and expenses by $299,890,000 in 1994 as compared to $1,014,103,000 in 1993. As noted above, the 1993 results include the termination of the reinsurance agreement with the parent under which 100% of certain fixed annuity contracts were reinsured. Before the impact of reinsurance, benefits increased by $209,394,000. Before reinsurance, the liability for annuity and other deposit funds and actuarial reserves decreased as a result of lower sales of group pension deposit contracts and increased surrender activity. Annuity and other deposit fund withdrawals increased as a result of increased surrenders of fixed annuities for which interest rate guarantee periods have expired. Transfers to the non-unitized separate account increased reflecting the increase in fixed annuity sales described above. Prior to reinsurance, commissions increased by $35,497,000 reflecting increased sales of individual combination fixed\/variable annuity contracts. General expenses increased due to an increase in the amount allocated from the parent under the service agreement, and costs of selling and administration associated with the increased sales and inforce block of individually marketed fixed\/variable annuity contracts. Federal income tax expense increased as net operating loss carry forwards were utilized in 1993.\n(2) LIQUIDITY\nThe Registrant's cash inflow consists primarily of premiums on insurance and annuity products, income from investments, repayments of investment principal and sales of investments. The Registrant's cash outflow is primarily to meet death and other maturing insurance and annuity contract obligations, to pay out on contract terminations, to fund investment commitments and to pay normal operating expenses and taxes. Cash outflows are met from the normal net cash inflows.\nThe Registrant segments its business internally and matches projected cash inflows and outflows within each segment. Targets for money market holdings are established for each segment, which in the aggregate meet the day to day cash needs of the Registrant. If greater liquidity is required, government issued bonds, which are highly liquid, are sold to provide the necessary funds. Government and publicly traded corporate bonds comprise 65.9% of the Registrant's long-term bond holdings.\nManagement believes that the Registrant's sources of liquidity are more than adequate to meet its anticipated needs.\n(3) NEW ACCOUNTING PRONOUNCEMENTS\nIn April, 1993, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 40, \"Applicability of Generally Accepted Accounting Principles to Mutual Life Insurance and Other Enterprises.\" Under this new interpretation, annual financial statements of mutual life insurance enterprises for fiscal years beginning after December 15, 1992, shall provide a brief description that financial statements prepared on the basis of statutory accounting practices will no longer be described as prepared in conformity with generally accepted accounting principles. In January, 1995, Statement of Financial Accounting Standards No. 120 (SFAS No. 120) \"Accounting and Reporting by Mutual Life Insurance Enterprises for Certain Long Duration Participating Contracts\" was issued. SFAS No. 120 delays the effective date of Interpretation No. 40 until fiscal years beginning after December 15, 1995.\nBeginning in 1996, the Registrant will file financial statements prepared in accordance with all applicable pronouncements that define generally accepted accounting principles for all enterprises.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements, in the form required by Regulation S-X, are set forth below. The Registrant is not subject to the requirement to file supplementary financial data specified by Item 302 of Regulation S-K.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada) BALANCE SHEETS\nSEE NOTES TO FINANCIAL STATEMENTS.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada) STATEMENTS OF OPERATIONS\nSEE NOTES TO FINANCIAL STATEMENTS.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada) STATEMENTS OF CAPITAL STOCK AND SURPLUS\nSEE NOTES TO FINANCIAL STATEMENTS.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nSTATEMENTS OF CASH FLOWS\nSEE NOTES TO FINANCIAL STATEMENTS.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nGENERAL--\nSun Life Assurance Company of Canada (U.S.) (the Company) is incorporated as a life insurance company and is currently engaged in the sale of individual fixed and variable annuities, group fixed and variable annuities and group pension contracts. The Company also underwrites a block of individual life insurance business through a reinsurance contract with its parent. Sun Life Assurance Company of Canada (the parent company) is a mutual life insurance company. The Company, which is domiciled in the State of Delaware, prepares its financial statements in accordance with statutory accounting practices prescribed or permitted by the State of Delaware Insurance Department. Statutory accounting practices are considered to be generally accepted accounting principles for mutual insurance companies and subsidiaries of mutuals. Prescribed accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations and general administrative rules. Permitted accounting practices encompass all accounting practices not so prescribed. The permitted accounting practices adopted by the Company are not material to the financial statements. Preparation of the financial statements requires management to make certain estimates and assumptions.\nAssets in the balance sheets are stated at values prescribed or permitted to be reported by state regulatory authorities. Bonds are carried at cost adjusted for amortization of premium or accrual of discount. Investments in subsidiaries are carried on the equity basis. Mortgage loans acquired at a premium or discount are carried at amortized values and other mortgage loans at the amounts of the unpaid balances. Real estate investments are carried at the lower of cost or appraised value, adjusted for accumulated depreciation, less encumbrances. Depreciation of buildings and improvements is calculated using the straight line method over the estimated useful life of the property. For life and annuity contracts, premiums are recognized as revenues over the premium paying period, whereas commissions and other costs applicable to the acquisition of new business are charged to operations as incurred. Furniture and equipment acquisitions are capitalized but treated as nonadmitted assets. Furniture and equipment depreciation is calculated on a straight line basis over the useful life of the assets.\nMANAGEMENT AND SERVICE CONTRACTS--\nThe Company has an agreement with its parent company which provides that the parent company will furnish, as requested, personnel as well as certain services and facilities on a cost reimbursement basis. Expenses under this agreement amounted to approximately $20,293,000 in 1995, $18,452,000 in 1994, and $13,883,000 in 1993.\nREINSURANCE--\nThe Company has agreements with the parent company which provide that the parent company will reinsure the mortality risks of the individual life insurance contracts sold by the Company. Under these agreements basic death benefits and supplementary benefits are reinsured on a yearly renewable term basis and coinsurance basis, respectively. Reinsurance transactions under these agreements had the effect of decreasing income from operations by approximately $2,184,000, $2,138,000, and $1,046,000, for the years ended December 31, 1995, 1994 and 1993, respectively.\nEffective January 1, 1991, the Company entered into an agreement with the parent company under which 100% of certain fixed annuity contracts issued by the Company were reinsured. Effective December 31, 1993 this agreement was terminated. This agreement had the effect of decreasing income from operations by approximately $9,930,000 in 1993.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Effective January 1, 1991, the Company entered into an agreement with the parent company under which certain individual life insurance contracts issued by the parent company were reinsured by the Company on a 90% coinsurance basis. Also, effective January 1, 1991, the Company entered into an agreement with the parent company which provides that the parent company will reinsure the mortality risks in excess of $500,000 per policy for the individual life insurance contracts assumed by the Company in the reinsurance agreement described above. Such death benefits are reinsured on a yearly renewable term basis. These agreements had the effect of increasing income from operations by approximately $11,821,000 in 1995, and decreasing income by approximately $29,188,000, and $43,591,000 for the years ended December 31, 1994 and 1993, respectively.\nThe life reinsurance assumed agreement requires the reinsurer to withhold funds in amounts equal to the reserves assumed.\nThe following are summarized pro-forma results of operations of the Company for the years ended December 31, 1995, 1994 and 1993 before the effect of reinsurance transactions with the parent company.\nThe Company has an agreement with an unrelated company which provides reinsurance of certain individual life insurance contracts on a modified coinsurance basis and under which all deficiency reserves related to these contracts are reinsured. Reinsurance transactions under this agreement had the effect of decreasing income from operations by $1,599,000 in 1995, increasing income from operations by $1,854,000 in 1994 and decreasing income from operations by $390,000 in 1993.\nSEPARATE ACCOUNTS--\nThe Company has established unitized separate accounts applicable to various classes of contracts providing for variable benefits. Contracts for which funds are invested in separate accounts include variable life insurance and individual and group qualified and non-qualified variable annuity contracts.\nAssets and liabilities of the separate accounts, representing net deposits and accumulated net investment earnings less fees, held primarily for the benefit of contract holders are shown as separate captions in the financial statements. Assets held in the separate accounts are carried at market values.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): Deposits to all separate accounts are reported as increases in separate account liabilities and are not reported as revenues. Mortality and expense risk charges and surrender fees incurred by the separate accounts are included in income of the Company.\nThe Company has established a non-unitized separate account for amounts allocated to the fixed portion of certain combination fixed\/variable deferred annuity contracts. The assets of this account are available to fund general account liabilities and general account assets are available to fund liabilities of this account.\nAny difference between the assets and liabilities of the separate accounts is treated as payable to or receivable from the general account of the Company. Amounts payable to the general account of the Company were $148,675,000 in 1995 and $132,496,000 in 1994.\nOTHER--\nIncome on investments is recognized on the accrual method.\nThe reserves for life insurance and annuity contracts, developed by accepted actuarial methods, have been established and maintained on the basis of published mortality tables using assumed interest rates and valuation methods that will provide reserves at least as great as those required by law and contract provisions.\nNet income reported in the Company's statutory Annual Statement differs from net income reported in these financial statements. Dividends from subsidiaries are included in income and undistributed income (losses) of subsidiaries are included as gains (losses) in unassigned surplus in the statutory Annual Statement. Both the dividends and the undistributed income (losses) are included in net income in these financial statements.\nInvestments in non-insurance subsidiaries are carried at their stockholders' equity value, determined in accordance with generally accepted accounting principles. Investments in insurance subsidiaries are carried at their statutory surplus values.\nCertain reclassifications have been made in the 1993 and 1994 financial statements to conform to the classifications used in 1995.\n2. INVESTMENTS IN SUBSIDIARIES: The Company owns all of the outstanding shares of Massachusetts Financial Services Company (MFS), Sun Life Insurance and Annuity Company of New York (Sun Life (N.Y.)), Sun Investment Services Company (Sunesco), Sun Benefit Services Company, Inc. (Sunbesco), Massachusetts Casualty Insurance Company (MCIC), New London Trust, F.S.B. (NLT), Sun Capital Advisers, Inc. (Sun Capital), and Sun Life Finance Corporation (Sunfinco).\nEffective January 1, 1994, NLT acquired all of the outstanding shares of Danielson Federal Savings and Loan Association of Danielson, Connecticut. These two banks have been merged into a newly formed federally chartered savings bank now called New London Trust, F.S.B.\nMFS, a registered investment adviser, serves as investment adviser to the mutual funds in the MFS family of funds and certain mutual funds and separate accounts established by the Company, and the MFS Asset Management Group provides investment advice to substantial private clients.\nClarendon Insurance Agency, Inc., a wholly-owned subsidiary of MFS, serves as the distributor of certain variable contracts issued by the Company and Sun Life (N.Y.). Sun Life (N.Y.) is engaged in the sale of individual fixed and variable annuity contracts and group life and disability insurance contracts in the state of\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. INVESTMENTS IN SUBSIDIARIES (CONTINUED): New York. Sunesco is a registered investment adviser and broker-dealer. MCIC is a life insurance company which issues only individual disability income policies. Sun Capital, a registered investment adviser, Sunfinco, and Sunbesco are currently inactive.\nIn 1994, the Company reduced its carrying value of MCIC by $18,397,000, the unamortized amount of goodwill. The reduction was accounted for as a direct charge to surplus.\nDuring 1995, 1994 and 1993, the Company contributed capital in the following amounts to its subsidiaries:\nSummarized combined financial information of the Company's subsidiaries as of December 31, 1995, 1994 and 1993 and for the years then ended, follows:\n3. STOCK, SURPLUS NOTES, CONTRIBUTIONS AND NOTE RECEIVABLE: The Company has issued surplus notes to its parent of $335,000,000 during the years 1982 through 1993 at interest rates between 7.25% and 10%. The Company subsequently repaid all principal and interest associated with these surplus notes on January 16, 1996. On December 19, 1995 the Company issued surplus notes totalling $315,000,000 to an affiliate, Sun Canada Financial Co., at interest rates between 5.75% and 7.25%. Of these notes, $157,500,000 will mature in the year 2007, and $157,500,000 will mature in the year 2015. Interest on these notes is payable semi-annually. Principal and interest on surplus notes are payable only to the extent that the Company meets specified requirements as regards free surplus exclusive of the principal amount and accrued interest, if any, on these notes; and, in the case of principal repayments, with the consent of the Delaware Insurance Commissioner. Interest payments require the consent of the Delaware Insurance Commissioner after December 31, 1993. Payment of principal and interest on the notes issued in 1995 also requires the consent of the Canadian Office of the Superintendent of Financial Institutions. The Company expensed $31,813,000, $31,150,000 and $26,075,000 in respect of interest on surplus notes for the years 1995, 1994 and 1993, respectively. On December 19, 1995, the parent borrowed $120,000,000 at 5.6 % through a short term note from the Company maturing on January 16, 1996. The note, which is classified under short-term bonds at December 31, 1995, was repaid in full by the parent at maturity.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. BONDS: The amortized cost and estimated market value of investments in debt securities are as follows:\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. BONDS (CONTINUED): The amortized cost and estimated market value of bonds at December 31, 1995 and 1994 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.\nProceeds from sales of investments in debt securities during 1995, 1994, and 1993 were $1,510,553,000, $1,390,974,000, and $911,644,000, gross gains were $24,757,000, $15,025,000, and $43,674,000 and gross losses were $5,742,000, $30,041,000 and $687,000, respectively.\nLong-term bonds at December 31, 1995 and 1994 included $20,000,000 of bonds issued to the Company by a subsidiary company, MFS, during 1987. These bonds will mature in 2000.\nBonds included above with an amortized cost of approximately $2,059,000 and $1,561,000 at December 31, 1995 and 1994, respectively, were on deposit with governmental authorities as required by law.\nAt year end 1995, the Company had outstanding mortgage-backed securities (MBS) forward commitments amounting to a par value of $137,675,000 to be funded through the sale of certain short-term securities shown above.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. SECURITIES LENDING: The Company has a securities lending program operated on its behalf by the Company's primary custodian, Chemical Bank of New York. The custodian has indemnified the Company against losses arising from this program. The total par value of securities out on loan was $250,729,000 at December 31, 1995.\n6. MORTGAGE LOANS: The Company invests in commercial first mortgage loans throughout the United States. The Company monitors the condition of the mortgage loans in its portfolio. In those cases where mortgages have been restructured, appropriate provisions have been made. In those cases where, in management's judgement, the mortgage loans' values are impaired, appropriate losses are recorded.\nThe following table shows the geographic distribution of the mortgage portfolio.\nThe Company has restructured mortgage loans totalling $49,846,000, against which there are provisions of $8,799,000 at December 31, 1995.\nThe Company has made commitments of mortgage loans on real estate into the future. The outstanding commitments for these mortgages amount to $13,100,000 at December 31, 1995.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n7. INVESTMENTS--GAINS AND LOSSES:\nRealized capital gains and losses on bonds and mortgages which relate to changes in levels of interest rate risk are charged or credited to an interest maintenance reserve and amortized into income over the remaining contractual life of the security sold. The realized capital gains and losses credited or charged to the interest maintenance reserve were a credit of $12,714,000 in 1995, a charge of $14,070,000 in 1994 and a credit of $40,993,000 in 1993. All gains and losses are net of applicable taxes.\n8. INVESTMENT INCOME: Net investment income consisted of:\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n9. DERIVATIVES: The Company uses derivative instruments for interest risk management purposes, including hedges against specific interest rate risk and to minimize the Company's exposure to fluctuations in interest rates. The Company's use of derivatives has included U.S. Treasury futures, conventional interest rate swaps, and forward spread lock interest rate swaps.\nIn the case of interest rate futures, gains or losses on contracts that qualify as hedges are deferred until the earliest of the completion of the hedging transaction, determination that the transaction will no longer take place, or determination that the hedge is no longer effective. Upon completion of the hedge, gains or losses are deferred in IMR and amortized over the remaining life of the hedged assets. At December 31, 1995, there were no futures contracts outstanding.\nIn the case of interest rate and foreign currency swap agreements and forward spread lock interest rate swap agreements, gains or losses on terminated swaps are deferred in IMR and amortized over the shorter of the remaining life of the hedged asset or the remaining term of the swap contract. The net differential to be paid or received on interest rate swaps is recorded monthly as interest rates change.\nThe market values of interest rate swaps and forward spread lock agreements are primarily obtained from dealer quotes. The market value is the estimated amount that the Company would receive or pay on termination or sale, taking into account current interest rates and the current creditworthiness of the counter parties. The Company is exposed to potential credit loss in the event of non-performance by counterparties. The counterparties are major financial institutions and management believes that the risk of incurring losses related to credit risk is remote.\n10. LEVERAGED LEASES: The Company is a lessor in a leveraged lease agreement entered into on October 21, 1994 under which equipment having an estimated economic life of 25-40 years was leased for a term of 9.75 years. The Company's equity investment represented 22.9% of the purchase price of the equipment. The balance of the purchase price was furnished by third party long-term debt financing, secured by the equipment and non-recourse to the Company. At the end of the lease term, the Master Lessee may exercise a fixed price purchase option to purchase the equipment.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n10. LEVERAGED LEASES (CONTINUED): The Company's net investment in leveraged leases is composed of the following elements:\nThe net investment is classified as other invested assets in the accompanying balance sheets.\n11. WITHDRAWAL CHARACTERISTICS OF ANNUITY ACTUARIAL RESERVES AND DEPOSIT LIABILITIES: Withdrawal characteristics of general account and separate account annuity reserves and deposits:\n12. RETIREMENT PLANS: The Company participates with its parent company in a non-contributory defined benefit pension plan covering essentially all employees. The benefits are based on years of service and compensation.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n12. RETIREMENT PLANS (CONTINUED): The funding policy for the pension plan is to contribute an amount which at least satisfies the minimum amount required by ERISA. The Company is charged for its share of the pension cost based upon its covered participants. Pension plan assets consist principally of a variable accumulation fund contract held in a separate account of the parent company.\nOn January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 87, which is in accordance with generally accepted accounting principles.\nThe following table sets forth the funded status for the pension plan (for the parent, Sun Life (U.S.), Sun Life (N.Y.) and Sunesco) at December 31, 1995 and 1994:\nThe components of the 1995 and 1994 pension cost for the pension plan were:\nThe Company's share of the group's accrued pension cost at December 31, 1995 and 1994 was $420,000 and $417,000, respectively. The Company's share of net periodic pension cost was $3,000 and $417,000, respectively.\nThe discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.5% and 4.5%, respectively. The expected long-term rate of return on assets was 7.5%.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n12. RETIREMENT PLANS (CONTINUED): The Company also participates with its parent and certain affiliates in a 401(k) savings plan for which substantially all employees are eligible. The Company matches, up to specified amounts, employees' contributions to the plan. Employer contributions were $185,000, $152,000 and $124,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\n13. OTHER POST-RETIREMENT BENEFIT PLANS: In addition to pension benefits the Company provides certain health, dental, and life insurance benefits (\"post-retirement benefits\") for retired employees and dependents. Substantially all employees may become eligible for these benefits if they reach normal retirement age while working for the Company, or retire early upon satisfying an alternate age plus service condition. Life insurance benefits are generally set at a fixed amount.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers Accounting for Post-retirement Benefits other than Pensions\". SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. SFAS No. 106 allows recognition of the cumulative effect of the liability in the year of adoption or the amortization of the obligation over a period of up to 20 years. The Company has elected to recognize this obligation of approximately $400,000 over a period of ten years. The Company's cash flows are not affected by implementation of this standard, but implementation decreased net income by $142,000, $114,000, and $120,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company's post-retirement health care plans currently are not funded.\nThe following table sets forth the plan's funded status, reconciled with amounts recognized in the Company's balance sheet:\nThe discount rate used in determining the accumulated post-retirement benefit obligation was 7.5% in 1995 and 8% in 1994, and the assumed health care cost trend rate was 12.0% graded to 6% over 10 years after which it remains constant.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n13. OTHER POST-RETIREMENT BENEFIT PLANS (CONTINUED): The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the post-retirement benefit obligation as of December 31, 1995 by $149,000 and the estimated service and interest cost components of the net periodic post-retirement benefit cost for 1995 by $29,000.\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS: The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994:\nThe major methods and assumptions used in estimating the fair values of financial instruments are as follows:\nThe fair values of short-term bonds are estimated to be the amortized cost. The fair values of long-term bonds which are publicly traded are based upon market prices or dealer quotes. For privately placed bonds, fair values are estimated using prices for publicly traded bonds of similar credit risk and maturity and repayment characteristics.\nThe fair values of the Company's general account reserves and liabilities under investment-type contracts (insurance, annuity and pension contracts that do not involve mortality or morbidity risks) are estimated using discounted cash flow analyses or surrender values. Those contracts that are deemed to have short term guarantees have a carrying amount equal to the estimated market value.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED): The fair values of mortgages are estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.\n15. STATUTORY INVESTMENT VALUATION RESERVES: The asset valuation reserve (AVR) provides a reserve for losses from investments in bonds, stocks, mortgage loans, real-estate and other invested assets with related increases or decreases being recorded directly to surplus.\nRealized capital gains and losses on bonds and mortgages which relate to changes in levels of interest rate risk are charged or credited to an interest maintenance reserve (IMR) and amortized into income over the remaining contractual life of the security sold.\nThe tables shown below present changes in the major elements of the AVR and IMR.\n16. FEDERAL INCOME TAXES: The Company and its subsidiaries file a consolidated federal income tax return. Federal income taxes are calculated for the consolidated group based upon amounts determined to be payable as a result of operations within the current year. No provision is recognized for timing differences which may exist between financial statement and taxable income. Such timing differences include reserves, depreciation and accrual of market discount on bonds. Cash payments for federal income taxes were approximately $12,429,000, $43,200,000 and $25,000,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n17. RISK-BASED CAPITAL: Effective December 31, 1993 the NAIC adopted risk-based capital requirements for life insurance companies. The risk-based capital requirements provide a method for measuring the minimum acceptable amount of adjusted capital that a life insurer should have, as determined under statutory accounting practices, taking into account the risk characteristics of its investments and products. The Company has met the minimum risk-based capital requirements for 1995 and 1994.\n18. NEW ACCOUNTING PRONOUNCEMENT: In April, 1993, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 40, \"Applicability of Generally Accepted Accounting Principles to Mutual Life Insurance and Other Enterprises.\" Under this interpretation, annual financial statements of mutual life insurance enterprises for fiscal years beginning after December 15, 1992, shall provide a brief description that financial statements prepared on the basis of statutory accounting practices will no longer be described as prepared in conformity with generally accepted accounting principles. In January 1995, Statement of Financial Accounting Standards\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) (Wholly-owned subsidiary of Sun Life Assurance Company of Canada)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n18. NEW ACCOUNTING PRONOUNCEMENT (CONTINUED): No. 120 (SFAS No. 120) \"Accounting and Reporting by Mutual Life Insurance Enterprises for Certain Long Duration Participating Contracts\" was issued. SFAS No. 120 delays the effective date of interpretation No. 40 until fiscal years beginning after December 15, 1995.\nBeginning in 1996, the Company will file financial statements prepared in accordance with all applicable pronouncements that define generally accepted accounting principles for all enterprises.\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDER SUN LIFE ASSURANCE COMPANY OF CANADA (U.S.) WELLESLEY HILLS, MASSACHUSETTS\nWe have audited the accompanying balance sheets of Sun Life Assurance Company of Canada (U.S.) (a wholly-owned subsidiary of Sun Life Assurance Company of Canada) as of December 31, 1995 and 1994, and the related statements of operations, capital stock and surplus, 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 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 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.\nDELOITTE & TOUCHE LLP Boston, Massachusetts February 7, 1996\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo events have occurred which are required to be reported by Item 304 of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and principal officers of the Registrant are listed below, together with information as to their ages, dates of election and principal business occupations during the last five years (if other than their present business occupations). Except as otherwise indicated, the directors and officers of the Registrant who are associated with Sun Life Assurance Company of Canada and\/or its subsidiaries have been associated with Sun Life Assurance Company of Canada for more than five years either in the position shown or in other positions.\nRichard B. Bailey, 69, Director (1983*) 500 Boylston Street Boston, Massachusetts 02116\nHe is a Director of Sun Life Insurance and Annuity Company of New York and a Director\/Trustee of certain Funds in the MFS Family of Funds. Prior to October 1, 1991 he was Chairman and a Director of Massachusetts Financial Services Company.\nA. Keith Brodkin, 60, Director (1990*) 500 Boylston Street Boston, Massachusetts 02116\nHe is Chairman and a Director of Massachusetts Financial Services Company; a Director of Sun Life Insurance and Annuity Company of New York; and a Director\/Trustee and\/or Officer of the Funds in the MFS Family of Funds.\nM. Colyer Crum, 63, Director (1986*) Harvard Business School Soldiers Field Road Boston, Massachusetts 02163\nHe is a Professor at the Harvard Business School and a Director of Sun Life Assurance Company of Canada, Sun Life Insurance and Annuity Company of New York, Merrill Lynch Basic Value Fund, Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch Natural Resources Trust, Merrill Lynch Ready Assets Trust, Merrill Lynch Special Value Fund, Inc., Merrill Lynch U.S.A. Government Reserves, Merrill Lynch U.S. Treasury Money Fund, MuniVest California Insured Fund, Inc., MuniVest Florida Fund, Inc., MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured Fund, Inc., MuniYield Florida Insured Fund, MuniYield Insured Fund II, Inc., MuniYield Michigan Insured Fund, Inc., MuniYield New Jersey Insured Fund, Inc., MuniYield New York Insured Fund III, Inc., and MuniYield Pennsylvania Fund.\nJohn R. Gardner, 58, President and Director (1986*) 150 King Street West Toronto, Ontario, Canada M5H 1J9\nHe is President and a Director of Sun Life Assurance Company of Canada and Sun Life Insurance and Annuity Company of New York and a Director of Massachusetts Financial Services Company, Massachusetts Casualty Insurance Company and Sun Life Financial Services Limited.\n_____________ * Year Elected Director\nJohn S. Lane, 61, Director (1991*) 150 King Street West Toronto, Ontario, Canada M5H 1J9\nHe is Senior Vice President, Investments of Sun Life Assurance Company of Canada and a Director of Sun Investment Services Company, Sun Life Insurance and Annuity Company of New York and Sun Capital Advisers, Inc.\nDavid D. Horn, 54, Senior Vice President and General Manager and Director (1970, 1985*) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Senior Vice President and General Manager for the United States of Sun Life Assurance Company of Canada; Chairman and President and a Director of Sun Investment Services Company; President and a Director of Sun Benefit Services Company, Inc., Sun Canada Financial Co., and Sun Life Financial Services Limited; Senior Vice President and a Director of Sun Life Insurance and Annuity Company of New York; Vice President and a Director of Sun Growth Variable Annuity Fund, Inc.; a Director of Sun Capital Advisers, Inc; Chairman and a Director of Massachusetts Casualty Insurance Company; a Trustee of MFS\/Sun Life Series Trust; and a Member of the Boards of Managers of Money Market Variable Account, High Yield Variable Account, Capital Appreciation Variable Account, Government Securities Variable Account, Total Return Variable Account, Managed Sectors Variable Account and World Governments Variable Account.\nAngus A. MacNaughton, 64, Director (1985*) 950 Tower Lane, Metro Tower, Suite 1170 Foster City, California 94404\nHe is President of Genstar Investment Corporation and a Director of Sun Life Assurance Company of Canada, Sun Life Insurance and Annuity Company of New York, Canadian Pacific, Ltd., Stelco Inc. and Varian Associates, Inc.\nJohn D. McNeil, 62, Chairman and Director (1982*) 150 King Street West Toronto, Ontario, Canada M5H 1J9\nHe is Chairman and a Director of Sun Life Assurance Company of Canada and Sun Life Insurance and Annuity Company of New York; a Director of Massachusetts Financial Services Company; President and a Director of Sun Growth Variable Annuity Fund, Inc.; Chairman and a Trustee of MFS\/Sun Life Series Trust; Chairman and a Member of the Boards of Managers of Money Market Variable Account, High Yield Variable Account, Capital Appreciation Variable Account, Government Securities Variable Account, Total Return Variable Account, Managed Sectors Variable Account and World Governments Variable Account; and a Director of Shell (Canada) Limited and Canadian Pacific, Ltd.\nRobert A. Bonner, 51, Vice President, Pensions (1986) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President, Pensions for the United States of Sun Life Assurance Company of Canada.\nRobert E. McGinness, 54, Vice President and Counsel (1983) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President and Counsel for the United States of Sun Life Assurance Company of Canada; Vice President and Counsel and a director of Sun Investment Services Company and Sun Benefit Services Company, Inc.; and a Director of New London Trust, F.S.B. and Massachusetts Casualty Insurance Company.\n_____________ * Year Elected Director\nS. Caesar Raboy, 59, Vice President, Individual Insurance (1991) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President, Individual Insurance for the United States of Sun Life Assurance Company of Canada; Vice President of Sun Life Insurance and Annuity Company of New York; and Vice President and a Director of Sun Life Financial Services Limited. Prior to 1990 he was President and Chief Operating Officer of Connecticut Mutual Life Insurance Company.\nC. James Prieur, 44, Vice President, Investments (1993) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President, Investments for the United States of Sun Life Assurance Company of Canada; Vice President, Investments of Sun Investment Services Company and Sun Life Insurance and Annuity Company of New York; and a Director of Sun Capital Advisers, Inc., New London Trust, F.S.B. and Sun Canada Financial Co.\nBonnie S. Angus, 54, Secretary (1974) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nShe is Assistant Secretary for the United States of Sun Life Assurance Company of Canada; and Secretary of Sun Investment Services Company, Sun Benefit Services Company, Inc., MFS\/Sun Life Series Trust, Sun Growth Variable Annuity Fund, Inc., Money Market Variable Account, High Yield Variable Account, Capital Appreciation Variable Account, Government Securities Variable Account, Total Return Variable Account, Managed Sectors Variable Account, World Governments Variable Account, Sun Life Insurance and Annuity Company of New York, Sun Capital Advisers, Inc., New London Trust, F.S.B., Sun Life Financial Services Limited and Sun Canada Financial Co.\nL. Brock Thomson, 54, Vice President and Treasurer (1974) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President, Portfolio Management for the United States of Sun Life Assurance Company of Canada; Vice President and Treasurer of Sun Investment Services Company, Sun Benefit Services Company, Inc., Sun Life Insurance and Annuity Company of New York and Sun Capital Advisers, Inc.; and Assistant Treasurer of Massachusetts Casualty Insurance Company.\nRobert P. Vrolyk, 42, Vice President and Actuary (1986) One Sun Life Executive Park Wellesley Hills, Massachusetts 02181\nHe is Vice President, Finance for the United States of Sun Life Assurance Company of Canada; Vice President, Controller and Actuary of Sun Life Insurance and Annuity Company of New York; Vice President and a Director of Sun Canada Financial Co.; and Chief Actuary and a Director of Massachusetts Casualty Insurance Company.\nThe directors, officers and employees of the Registrant, are covered under a commercial blanket bond and a liability policy.\n_____________ * Year Elected Director\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nAll of the executive officers of the Registrant also serve as officers of Sun Life Assurance Company of Canada and receive no compensation directly from the Registrant. Allocations have been made as to such officers time devoted to duties as executive officers of the Registrant and its subsidiaries. The allocated cash compensation of all executive officers of the Registrant as a group for services rendered in all capacities to the Registrant and its subsidiaries during 1995, totalled $812,410. The allocated compensation of the named executive officers is as follows:\nDirectors of the Registrant who are also officers of Sun Life Assurance Company of Canada or its affiliates receive no compensation in addition to their compensation as officers of Sun Life Assurance Company of Canada or its affiliates. Messrs. Bailey, Crum and MacNaughton receive compensation in the amount of $5,000 per year, plus $800 for each board or committee meeting attended, plus expenses.\nNo shares of the Registrant are owned by any executive officer or director. The Registrant is a wholly-owned subsidiary of Sun Life Assurance Company of Canada, 150 King Street West, Toronto, Ontario, Canada.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis item is not applicable since the Registrant is wholly-owned by Sun Life Assurance Company of Canada.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS REINSURANCE\nSee discussion of Reinsurance in Item 1.\nSERVICE CONTRACT\nThe Registrant has an agreement with its parent company which provides that the parent company will furnish, as requested, personnel as well as certain services and facilities on a cost reimbursement basis. Expenses under this agreement amounted to approximately $20,293,000 in 1995.\nLEASES\nThe Registrant leases office space to the parent company under lease agreements with terms expiring in September, 1999 and options to extend the terms for each of thirteen successive five year terms at fair market rental not to exceed 125% of the fixed rent for the term which is ending. Rent received by the Registrant under the leases for 1995 amounted to approximately $4,891,000.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial statements (set forth in Item 8):\n- Balance Sheets as of December 31, 1995 and December 31, 1994.\n- Statements of Operations for each of the three years ended December 31, 1995, December 31, 1994 and December 31, 1993.\n- Statements of Capital Stock and Surplus for each of the three years ended December 31, 1995, December 31, 1994 and December 31, 1993.\n- Statements of Cash Flows for each of the three years ended December 31, 1995, December 31, 1994 and December 31, 1993.\n- Notes to Financial Statements.\n- Independent Auditors' Report.\n(a) 2. Financial statement schedules (set forth below):\n- Schedule I - Summary of Investments, Other than Investments in Related Parties.\n- Schedule VI - Reinsurance.\n- Independent Auditors' Report.\nFinancial Statement Schedules not included in this Form 10-K have been omitted because the required information either is not applicable or is presented in the consolidated financial statements or notes thereto.\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.)\nSCHEDULE I\nSUMMARY OF INVESTMENTS, OTHER THAN INVESTMENTS IN RELATED PARTIES\n*Net of provision for unrealized loses of $10,689\nSUN LIFE ASSURANCE COMPANY OF CANADA (U.S.)\nSCHEDULE VI\nREINSURANCE\nINDEPENDENT AUDITOR'S REPORT TO THE BOARD OF DIRECTORS AND STOCKHOLDER Sun Life Assurance Company of Canada (U.S.) Wellesley Hills, Massachusetts\nWe have audited the balance sheets of Sun Life Assurance Company of Canada (U.S.) (wholly-owned subsidiary of Sun Life Assurance Company of Canada) as of December 31, 1995 and 1994 and the related statements of operations, capital stock and surplus and cash flows for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated February 7, 1996 (which report is included elsewhere in this Form 10-K). Our audits also included the financial statement schedules listed in Item 14 (a) 2 in this Form 10-K. 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 therein set forth.\nDeloitte & Touche LLP Boston, Massachusetts February 7, 1996\n(A) 3 AND (C). EXHIBITS:\nThe following Exhibits are incorporated herein by reference unless otherwise indicated:\n(B) REPORTS ON FORM 8-K\nNo reports have been filed on Form 8-K.\n(D) NO ADDITIONAL FINANCIAL STATEMENTS ARE REQUIRED TO BE FILED.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, Sun Life Assurance Company of Canada (U.S.), has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nSun Life Assurance Company of Canada (U.S.) (Registrant)\nBy:* \/s\/ JOHN D. McNEIL ------------------------ John D. McNeil, Chairman\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 in the capacities and on the dates indicated.\n*\/s\/ JOHN D. McNEIL * \/s\/ RICHARD B. BAILEY - ------------------------------------ --------------------------------- John D. McNeil Richard B. Bailey Chairman and Director Director (Principal Executive Officer)\nDate: March 28, 1996 Date: March 28, 1996 ----------------------------- ---------------------------\n* \/s\/ ROBERT P. VROLYK * \/s\/ A. KEITH BRODKIN - ------------------------------------ --------------------------------- Robert P. Vrolyk A. Keith Brodkin Vice President and Actuary Director (Principal Financial & Accounting Officer)\nDate: March 28, 1996 Date: March 28, 1996 ----------------------------- ---------------------------\n- ----------------------------------------------------------------- *By Bonnie S. Angus pursuant to Power of Attorney filed herewith.\n* \/s\/ DAVID D. HORN * \/s\/ JOHN R. GARDNER - ------------------------------------ --------------------------------- David D. Horn John R. Gardner Senior Vice President and President and Director General Manager and Director\nDate: March 28, 1996 Date: March 28, 1996 ----------------------------- ---------------------------\n* \/s\/ JOHN S. LANE * \/s\/ M. COLYER CRUM - ------------------------------------ --------------------------------- John S. Lane M. Colyer Crum Director Director\nDate: March 28,1996 Date: March 28, 1996 ----------------------------- ---------------------------\n* \/s\/ ANGUS A. MACNAUGHTON - ------------------------------------ Angus A. MacNaughton Director\nDate: March 28,1996 -----------------------------\n- ----------------------------------------------------------------- *By Bonnie S. Angus pursuant to Power of Attorney filed herewith.","section_15":""}
{"filename":"844162_1995.txt","cik":"844162","year":"1995","section_1":"Item 1. Business -----------------\nGeneral\nThe Corporation. Northbay Financial Corporation (the \"Corporation\") was incorporated under the laws of the State of Delaware on October 5, 1988 for the purpose of becoming a savings and loan holding company. On April 10, 1989, the Corporation acquired all of the outstanding stock of Northbay Savings and Loan Association (\"Northbay Savings\" or the \"Bank\") issued in connection with Northbay Savings' conversion from a California chartered mutual to a California chartered stock institution.\nPrior to the acquisition of all of the outstanding stock of Northbay Savings, the Corporation had no assets or liabilities and engaged in no business activities. Subsequent to the acquisition of Northbay Savings, the Corporation has engaged in no significant activity other than holding the stock of Northbay Savings and operating through Northbay Savings a savings and loan business. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to Northbay Savings and its subsidiary.\nThe Corporation's executive offices are located at 1360 Redwood Way, Petaluma, California. Its telephone number is (707) 792-7400.\nThe Bank. Northbay Savings was organized as a federally chartered mutual savings and loan association in 1965 and converted to a California chartered mutual savings and loan association in 1972. In January, 1990, Northbay Savings amended its charter to adopt the name \"Northbay Savings Bank.\" In June 1990, Northbay Savings converted to a federally chartered stock savings bank with the name \"Northbay Savings Bank, F.S.B.\" At June 30, 1995, Northbay Savings had total assets of $391.1 million, deposits of $283.9 million, and stockholders' equity of $34.6 million. Based on total assets at that date, the Bank was the second largest savings and loan institution headquartered in Sonoma County, California insured by the Savings Association Insurance Fund (\"SAIF\") administered by the Federal Deposit Insurance Corporation (\"FDIC\").\nThe Bank is primarily engaged in the business of attracting deposits from the general public and using those deposits, together with other funds, to originate mortgage loans for the purchase or construction of residential real estate, multi-family real estate and commercial real estate. At June 30, 1995, substantially all of the Bank's real estate loans were secured by properties located in California. To a lesser extent, the Bank also originates consumer loans and commercial business loans. The Bank has been a participant in the secondary mortgage market as both a purchaser and seller of loans. In the past, the Bank also engaged to a limited extent in real estate development activities. In March 1994, the Bank established full-service brokerage capabilities and alternative investment services within each of the Bank's branch offices pursuant to an agreement with PRIMEVEST Financial Services Inc., an independent registered broker-dealer.\nNorthbay Savings conducts operations through its main office in Petaluma, California, seven full service branch offices and one loan production office, all within Sonoma County. Petaluma is located approximately 40 miles north of San Francisco. The Bank considers its\nprimary market area for savings and lending activities to be Sonoma County, but such activities have expanded to Marin and surrounding counties.\nNorthbay Savings is subject to examination and comprehensive regulation by the Office of Thrift Supervision (\"OTS\"), a bureau within the Department of Treasury. Northbay Savings is a member of and owns capital stock in the Federal Home Loan Bank (\"FHLB\") of San Francisco, which is one of the twelve regional banks in the FHLB system. Northbay Savings is further subject to regulations of the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") governing reserves to be maintained against deposits and certain other matters. See \"Regulation.\"\nLending Activities\nGeneral. The principal lending activity of the Bank is the origination of conventional mortgage loans (i.e., loans that are neither insured nor partially guaranteed by government agencies) for the purpose of constructing, financing or refinancing one-to-four family residential properties, multifamily (over four family) properties and commercial properties. As of June 30, 1995, $242.4 million or 68% of the Bank's loan portfolio (before the deduction of undisbursed funds, unearned fees, and loan loss allowance) consisted of loans secured by one-to-four family residential properties. The Bank also originates second mortgage loans, consumer loans (including automobile loans, equity lines of credit, loans secured by savings accounts and personal loans), commercial business loans and land loans.\nIn recent years the Bank has implemented a number of measures to make the yield on its loan portfolio more interest rate sensitive. These measures include an emphasis on the origination of adjustable-rate residential mortgage loans, construction and commercial real estate loans, consumer loans and commercial business loans. These measures were adopted to shorten the average life of the Bank's portfolio and to make it less susceptible to interest rate volatility. Due to the fact that approximately 81% of the Bank's loan portfolio is indexed to the 11th District Cost of Funds Index (\"COFI\"), an index which by its nature lags movements in interest rates generally, the Bank has recently undertaken a strategy of attempting to diversify indexes to which its assets will reprice. As a result, the Bank has on its books at June 30, 1995, approximately $17.6 million of adjustable rate assets, that reprice to \"current\" indices, such as prime and the one year Constant Maturity Treasury (\"CMT\"). Further, the Bank has in recent years attempted to build a portfolio of more rate sensitive COFI based products such as those that adjust monthly rather than semi-annually. As a result of this strategy, the Bank held in portfolio approximately $18 million of such loans and investments. At June 30, 1995, approximately $326 million (or 91%) of the Bank's total loans receivable, before net items, consisted of loans that were other than 15-30 year, fixed-rate loans.\nLoan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio by type of loan and type of security as of the dates indicated.\n(Continued on the following page)\n\/(1)\/ Excludes mortgage-backed securities, which amounted to (in thousands) $10,114, $7,943, $6,863, $10,071 and $4,122 at June 30, 1995, 1994, 1993, 1992 and 1991, respectively, most of which were secured by single family\nResidential Real Estate Loans. The Bank's primary lending activity consists of the origination of one-to-four family, owner-occupied residential mortgage loans secured by property located in the Bank's primary market area. The majority of the Bank's residential mortgage loans consists of loans secured by single family residences. At June 30, 1995, the Bank had $255.8 million, or 71.4%, of its total loan portfolio (before deduction of loans in process, unearned fees and allowance for loan losses) in loans secured by single family residences. The Bank's real estate loan portfolio also includes loans on two-to-four family dwellings, and loans made for the development of unimproved real estate to be used for residential housing. At June 30, 1995, approximately 82.30% of the Bank's total loan portfolio consisted of loans secured by residential real estate.\nThe Bank's mortgage loan originations are generally for terms of 15 to 30 years, amortized on a monthly basis, with principal and interest due each month. Residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option.\nThe Bank has offered adjustable rate loans since 1983. Historically, the Bank has offered residential mortgage loans with interest rates that adjust every six months based upon the FHLB's Eleventh District COFI. The interest rates on these mortgages are adjustable on each six month anniversary date of the loan generally with a cap of 1% per adjustment and 4.75% to 6.25% over the life of the loan. During the fiscal year ended June 30, 1994, the Bank attempted to diversify its adjustable rate portfolio to products tied to indices other than the Eleventh District COFI. During fiscal year 1994, the Bank completed the purchase of approximately $10 million of adjustable rate residential mortgage loans, all indexed to the one-year constant maturity treasury index. Total adjustable rate residential mortgage loans amounted to $217.4 million or approximately 61% of the Bank's total loan portfolio at June 30, 1995.\nThe Bank also originates fully amortizing fixed rate loans on one- to four-family units with maturities ranging from 10 to 30 years. In addition, the Bank offers a fixed rate loan with a 30-year amortization schedule and a balloon payment of remaining principle of five and seven years. The Bank generally charges a higher interest rate on such loans if the property is not owner occupied. Fixed rate mortgage loans are underwritten according to Federal Home Loan Mortgage Corporation (\"FHLMC\") guidelines, so that the loans qualify for sale in the secondary market.\nThe Bank has been an active seller of fixed rate loans in the secondary market. At the time of origination, it is the Bank's policy to classify the loan as held for sale or held to maturity. The decision to classify loans as held for sale or held to maturity is based upon the Bank's asset\/liability management goals as well as an analysis of the economic benefit of such sales versus cash flows generated from holding such loans in portfolio. Those loans that have been designated as held for sale are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized in a valuation allowance by charges to income. During the quarter ended June 30, 1994, the Bank elected to alter its classification of approximately $6 million of loans from held for sale to held for investment. The Bank took this action for the following reasons: (1) having written down the value of these assets to the lower of cost or market at March 31, 1994, during a period of rapidly rising rates, the Bank believed there was a greater economic value in holding these loans to maturity rather than selling the assets at a substantial discount into the market; and (2) upon review of the Bank's concentration of assets and a favorable exposure to a long-term rising interest rate environment, the addition\nof these predominantly fixed rate loans provides an acceptable diversification to the volume of adjustable rate products within the Bank's portfolio. There were no sales of such long-term fixed rate loans during fiscal 1995 as the Bank continued the policy of holding all originations of such loans in portfolio. Management believes that while these loans may carry higher interest rate risk than other more interest rate sensitive assets, the Bank's held to maturity portfolio can absorb additional long-term, fixed-rate loans. In the past the Bank has also exchanged fixed-rate, long-term mortgage loans for mortgage backed securities guaranteed by FHLMC and Federal National Mortgage Association (\"FNMA\"), which were either sold in the secondary market or retained by the Bank. At June 30, 1995, approximately $32.1 million or 9% of the Bank's total loan portfolio, consisted of long-term, fixed-rate residential mortgage loans.\nThe Bank's lending policies generally limit the maximum loan-to-value ratio on residential mortgage loans to 90% of the lesser of the appraised value or purchase price, with the condition that private mortgage insurance is required on loans with loan to value ratios in excess of 80%. The majority of the Bank's residential loan portfolio has loan-to-value ratios of 80% or less. The Bank requires title insurance and hazard insurance on all properties securing real estate loans made by the Bank.\nConstruction Loans and Land Development Loans. The Bank originates loans to finance the construction of one-to-four family dwellings, housing developments, multi-family apartments and condominiums and commercial real estate. It also originates loans for the acquisition and development of unimproved property to be used for residential and commercial purposes. In fiscal 1993 and 1994, the Bank increased its emphasis on the origination of construction and land development loans in the $1 million to $3 million range, including loans for the construction of multi-family residential properties and housing for lower income families in cooperation with non-profit organizations. As a result of its continued commitment to provide financing for the construction of low income housing, the Bank originated $3.7 million of such loans during the fiscal year ended June 30, 1995. Gross construction and land development loans amounted to $33.3 million, or 9.3% of the Bank's total loan portfolio at June 30, 1995. The decrease in such loans was principally due to reduced demand for new constructions in the Bank's market area. Of the total construction and land development portfolio, $21 million or 63% were for residential one-to-four family construction, $3.5 million or 10.5% were for multifamily construction, $1.7 million or 5% were for non- residential or commercial construction, and $7.1 million or 21.5% were for land development. The average loan balance is estimated to be less than $500,000. However, the Bank currently has 18 loans in amounts in excess of $1 million, totalling $28.7 million, most of which are construction and land development loans. The Bank's construction loans to individuals typically range in size from $100,000 to $400,000.\nAs a federally chartered savings association, the Bank is subject to regulatory loan-to-one-borrower limits. Management believes that these limits have not had a material adverse effect on the Bank and, in fact, have benefitted the Bank by creating opportunities to participate in other banks' loans when those banks reach their own limits. At June 30, 1995, the Bank's lending limit was $5 million. As of such date, there were no loans in excess of this limit. For additional information regarding the Bank's regulatory loan-to-one-borrower limits, see \"Regulation--Federal Regulation of Savings Associations.\"\nConstruction loans generally have terms of up to 12 months. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. In addition to\nbuilders' projects, the Bank finances the construction of individual, owner- occupied houses on the basis of underwriting and construction loan management guidelines. Construction loans are structured either to be converted to permanent loans at the end of the construction phase or to be paid off upon receiving financing from another financial institution. Construction loans on residential properties are generally made in amounts up to 80% of appraised value, and loans on commercial property are made in amounts up to 75% of appraised value.\nConstruction loans afford the Bank the opportunity to increase the interest rate sensitivity of its loan portfolio and to receive yields higher than those obtainable on loans secured by existing one-to-four family residential properties. These higher yields correspond to the higher risks associated with construction lending. The Bank's risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property's value at completion of construction and the bid price (including interest) of construction. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project with a value which is insufficient to assure full repayment.\nThe Bank's underwriting criteria are designed to evaluate and minimize the risks of each construction loan. Among other things, the Bank considers the reputation of the borrower and the contractor, the amount of the borrower's equity in the project, independent valuations and reviews of cost estimates, pre-construction sale and leasing information, and cash flow projections of the borrower. The Bank generally makes construction loans within its primary market area. In fiscal 1995, the Bank's losses on construction loans were not material. As a result of the existing real estate market in the Bank's primary market area, the Bank incurred losses on land development loans of approximately $108,000 of which was concentrated in four properties within its primary market area. There can be no assurance that the Bank will not experience additional losses on construction loans and land development loans in the future.\nLoans Secured by Commercial and Multi-family Properties. Loans secured by commercial real estate and multifamily properties of five or more units constituted approximately $60.4 million or 16.9% of the Bank's total loans at June 30, 1995. Federal law permits the Bank to make non-residential real estate loans up to 400% of capital; non-residential real estate loans in excess of such amount must be approved by the Director of the OTS.\nThe Bank originates both construction loans and permanent loans on commercial properties. Permanent commercial real estate loans are generally made in amounts up to 75% of the lesser of appraised value or purchase price of the property. Commercial real estate loans range in amount up to $1.2 million, although the average loan balance is estimated to be $250,000. The Bank's permanent commercial real estate loans are secured by improved property such as office buildings, medical facilities, retail centers, warehouses and other types of buildings, most of which are located in the Bank's primary market area. Commercial real estate and multi-family property loans generally are variable rate in nature, with interest rate adjustments at periods of six months at a rate indexed to the FHLB's Eleventh District Cost of Funds. Commercial real estate and multifamily residential loans are generally balloon loans which mature in 10 years with principal amortization over a maximum 30-year period.\nLoans secured by commercial and multifamily residential properties are generally larger and involve greater risks than residential mortgage loans. Because payments on loans secured\nby commercial and multifamily residential properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks in a variety of ways, including limiting the size of its commercial and multifamily real estate loans and generally restricting such loans to its primary market area.\nConsumer Loans. Federal regulations permit thrift institutions to make secured and unsecured consumer loans up to 30% of the institution's assets. In addition, a thrift institution has lending authority above the 30% category for certain consumer loans, such as equity lines of credit, property improvement loans, mobile home loans and loans secured by savings accounts. The Bank began offering consumer loans in 1983. As of June 30, 1995, total consumer loans constituted approximately $18.6 million or 5.2% of the Bank's total loan portfolio, consisting principally of home equity lines of credit of $15 million. The consumer loans granted by the Bank have included automobile loans, equity lines of credit, personal loans (secured and unsecured), boat loans, and loans (including credit card accounts) secured by savings accounts.\nThe Bank believes that the shorter terms and the normally higher interest rates available on various types of consumer loans have been helpful in maintaining a profitable spread between the Bank's average loan yield and its cost of funds. Consumer loans do, however, pose additional risks of collectibility when compared to traditional types of loans granted by thrift institutions such as residential mortgage loans. The Bank has sought to reduce the risk of this type of lending by granting primarily secured consumer loans. In many instances the Bank is required to rely on the borrower's ability to repay since the collateral may be of reduced value at the time of collection. Thus, the initial determination of the borrower's ability to repay is of primary importance in the underwriting of consumer loans.\nCommercial Business Loans. The Bank offered various types of commercial business loans until June 1992, when the Bank ceased offering such loans to new customers and began limiting the origination of such loans to rollovers and refinancings of existing loans. As a result, at June 30, 1995, such loans represented only $1.6 million, or .5% of the Bank's total loan portfolio. These remaining loans primarily consist of term loans, lines of credit and equipment financing. These loans were primarily underwritten in the Bank's primary market area on the basis of the borrowers' ability to service such debt from income, although the Bank as a general practice takes as collateral any available real estate, equipment or other chattel. These loans generally have remaining terms of one year or less at interest rates which adjust monthly based upon the FHLB's Eleventh District COFI.\nUnlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his employment and other income and which are secured by real property whose value tends to be easily ascertainable, commercial loans typically are made on the basis of the borrower's ability to make payment from the cash flow of his business and are generally secured by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, occasionally cannot be appraised with as much precision as residential real estate, and may fluctuate in value based on the success of the business.\nLoan Maturity Schedule\nThe following table sets forth certain information at June 30, 1995, regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.\nThe following table sets forth, as of June 30, 1995, the dollar amount of all loans maturing or repricing more than one year after June 30, 1995 which have predetermined interest rates and have floating or adjustable interest rates.\nLoan Solicitation and Processing. Loan originations are derived from a number of sources including \"walk-in\" customers at the Bank's offices, referrals from real estate professionals, building contractors and mortgage brokers. Loan applications, whether originated through the Bank's branch system or an outside broker, are underwritten and closed based on the same standards.\nIn September 1992, a loan center was established in the city of Santa Rosa to conduct residential mortgage lending with exclusive loan agents. In February 1993, a wholesale loan division was implemented to accept loans from the mortgage brokerage community. Such division was effectively closed in fiscal 1995 due to reduced demand as a result of the higher pricing of wholesale loans relative to the Bank's other loans and management's decision to emphasize the origination of loans by its own lending agents.\nUpon receipt of a loan application, a credit report is ordered to verify specific information relating to the loan applicant's employment, income, and credit standing. In the case of a real estate loan, an appraisal of the real estate intended to secure the proposed loan is undertaken by the Bank's in- house appraiser or an approved outside licensed appraiser. In the case of commercial and multi-family properties, appraisals will be performed by an independent\nfee appraiser approved by the Bank. The loan application file is then reviewed, depending upon the dollar amount of the loan, by either a loan officer, the Vice President for Loan Administration, the President, or the Board of Directors.\nThe Bank's consumer lending officers are authorized to approve unsecured consumer loans up to $10,000 and secured loans up to $20,000. The Bank's Assistant Vice President and Consumer\/Commercial Loan Manager, as well as the President, have the authority to approve non-mortgage loans up to $100,000. Mortgage lending officers are authorized to approve residential mortgage loans up to $650,000. The Bank's Vice President for Loan Administration has authority to approve loans up to $750,000, and the President has the authority to approve loans up to $1.0 million. The Bank's loan committee has authority to approve loans over $1.0 million up to $4.0 million, and the Board of Directors of the Bank approves all loans over $4.0 million. In order to increase origination of loans secured by single-family residences, the Bank instituted an exclusive loan-agent program for the procurement of such loans on July 1, 1992. The underwriting of loans presented by the loan agents continue to be undertaken by salaried employee underwriters.\nLoan Originations, Purchases and Sales. The Bank has engaged, from time to time, in the sale of loans and loan participations in the secondary mortgage market. Such sales have consisted generally of long-term, fixed-rate loans, which have been sold in an effort to minimize the effects of volatile interest rates or as a source of funds for other investment or lending activities. The Bank has also occasionally sold adjustable-rate loans in the secondary market. The timing of such sales generally is based upon the Bank's asset\/liability management strategies, the Bank's need for funds and market opportunities that permit loan sales on terms favorable to the Bank. The Bank sometimes exchanges long-term, fixed-rate loans for mortgage-backed securities guaranteed by the FHLMC, and then sells the securities in the secondary market. From time to time, the Bank has also sold loans or loan participations in private sales to savings institutions or other institutional investors. The Bank's practice in recent years has been to sell loans or loan participations without recourse. The Bank generally retains the servicing on the loans sold, for which it receives a servicing fee. At June 30, 1995, the Bank's total loans serviced for others amounted to $55.5 million.\nFor the purpose of transferring the interest rate risk associated with holding to maturity 30-year, fixed-rate mortgage loans, the Bank followed a policy of selling in the secondary market all current originations of such loans through the period ended March 31, 1994. During the quarter ended June 30, 1994, the Bank elected to reclassify all loans held for sale, totaling approximately $6 million and consisting primarily of long-term, fixed-rate loans, to held for investment. During that quarter, the Bank also revised its asset\/liability management policy to provide, in general, that fixed-rate loan originations would be held to maturity. The Bank continued this policy during fiscal 1995 and did not sell any long-term fixed rate loans during the period. The participations sold in fiscal 1995 consisted of construction loans for which the Bank sought to reduce its exposure due to credit risk or lending limits. During recent periods, loan sales provided a significant source of funds for the Bank's lending and other activities and management believes that the absence of loans available for sale has contributed to and may continue to result in reduced loan originations.\nIn addition to originating loans, the Bank has purchased real estate loans in the secondary market. The Bank purchased approximately $422,000 of construction loan participations from local institutions during the fiscal year ended June 30, 1995. The Bank's purchases in the\nsecondary market are dependent upon the demand for mortgage credit in the local market area and the inflow of funds from traditional sources. Purchases of loans enable the Bank to utilize available funds more quickly.\nThe following table shows the loan origination, purchase and sales activity of the Bank for the periods indicated.\nLoan Commitments. The Bank issues standby loan origination commitments to real estate developers and qualified borrowers primarily for the construction and purchase of residential real estate and commercial real estate. Such commitments are made on specified terms and conditions and are usually for terms of up to 15 days. Historically, fewer than 10% of the Bank's commitments expire without being funded. At June 30, 1995 the Bank had outstanding loan origination commitments of approximately $29.9 million. See Note 15 of Notes to Consolidated Financial Statements.\nLoan Origination and Other Fees. In addition to interest earned on loans, the Bank receives loan origination fees or \"points\" for originating loans. Loan points are a percentage of the principal amount of the mortgage loan which are charged to the borrower for creation of the loan. Loan origination fees and certain related direct loan origination costs are offset, and the resulting net amount is deferred and amortized over the life of the related loan as an adjustment to the yield of such loan.\nThe Bank's loan origination fees range from 0% to 2.25% of residential loans, 2% on commercial real estate loans and up to 3% on construction loans. The total amount of net deferred loan fees at June 30, 1995 was $1.03 million.\nDelinquencies. The Bank's collection procedures provide that when a loan is 15 days past due, the borrower is contacted by mail and payment requested. If the delinquency continues, subsequent efforts are made to contact the delinquent borrower. Additional attempts are made to contact the borrower and if the loan continues in a delinquent status for 75 days or more, the Bank generally initiates foreclosure proceedings. At June 30, 1995, the Bank owned eight properties acquired as the result of foreclosure. The properties, seven of which are single family residences and one of which is land, are located in Sonoma County and are carried at a fair market value, less estimated selling costs, of $1.56 million.\nNon-Performing Assets and Asset Classification. Loans are reviewed on a regular basis and are placed on a non-accrual status when either principal or interest is 90 days or more past due or when, in the opinion of management, the collection of additional interest is doubtful. Consumer loans generally are charged off when the loan becomes over 120 days delinquent. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income.\nReal estate acquired by the Bank as a result of foreclosure is classified as real estate owned until such time as it is sold. When such property is acquired, it is recorded at the lower of the unpaid principal balance of the related loan or its fair market value. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. The recognition of subsequent declines in the market value of the property are charged to the provision for loss on real estate owned.\nThe following table sets forth information with respect to the Bank's non-performing assets for the periods indicated. During the periods shown, the Bank had no restructured loans within the meaning of Statement of Financial Accounting Standards No. 15.\n\/(1)\/ Other non-performing assets represented the net book value of property acquired by the Bank through foreclosure or repossession. Upon acquisition, this property is recorded at the lower of its fair market value or the recorded investment in the related loan.\nThe majority of these non-performing loans are concentrated in single family residential housing units. Sixteen of such single residential properties account for $2.3 million of the total non-performing assets.\nDuring the year ended June 30, 1995, gross interest income of $53,000 would have been recorded on loans set forth above as accounted for on a non-accrual basis if the loans had been current throughout the year. Interest income of $53,000 on these loans was recorded during the year.\nUnder federal regulations, each institution is required to classify its own assets on a regular basis. In addition, in connection with examinations of institutions, OTS examiners have authority to identify problem assets and, if appropriate, classify them Under the regulation, assets are subject to evaluation under a classification system with three categories: (i) Substandard, (ii) Doubtful and (iii) Loss. An asset could fall within more than one category and a portion of the asset could remain unclassified.\nAn asset is classified Substandard if it is determined to involve a distinct possibility that the institution could sustain some loss if deficiencies associated with the loan, such as inadequate documentation, were not corrected. An asset is classified as Doubtful if full collection is highly questionable or improbable. An asset is classified as Loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations create a Special Mention category, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as Substandard or Doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified Loss, the institution must either establish specified allowances for loan losses in the amount of 100 percent of the portion of the asset classified Loss, or charge off such amount.\nAllowance for Loan Losses. The Bank establishes specific reserves in accordance with the asset classification regulations discussed above. The Bank also provides an allowance for unspecified potential losses, based on historical experience and other factors. As of June 30, 1995 the Bank's total unspecified reserves were $2.2 million in addition to $42,000 in specific loss reserves.\nThe following table sets forth an analysis of the Bank's allowance for possible loan losses for the periods indicated. ====== ====== ====== ====== =====\nThe following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category. Also set forth are allowances for losses on real estate owned.\n\/(1)\/ Gross loans less undisbursed loans in process.\nFinancial institutions throughout the United States have incurred losses in recent years due to increases in loan loss provisions and charge-offs resulting largely from higher levels of loan delinquencies and foreclosures. Depressed real estate market conditions have adversely affected the economies of various regions and have had an adverse impact on the financial condition and businesses of many of the financial institutions doing business in these areas. Uncertainty exists as to the future improvement or deterioration of the real estate markets in these regions, or of its ultimate impact on these financial institutions. As a result of the instability in real estate market conditions and the impact on financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions, undertaken as part of the examination of the institutions by the FDIC, the OTS or other federal or state regulators. While the Bank believes it has established its existing allowances for loan losses in accordance with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase its allowance for loan losses, thereby negatively affecting the Bank's financial condition and earnings.\nInvestment Activities\nNorthbay Savings is required under federal regulations to maintain a minimum amount of liquid assets which may be invested in specified short-term securities and is also permitted to make certain other investments. See \"Regulation\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity\" in the 1995 Annual Report to Stockholders. It has generally been Northbay Savings' policy to maintain a liquidity portfolio in excess of regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in the Bank's loan origination and other activities. The Bank does not actively trade investments. At June 30, 1995, Northbay Savings had an investment portfolio of approximately $21.1 million consisting primarily of Federal Agency securities, various mutual funds investing in Federal Agency securities and mortgage related products, insured certificates of deposit and interest earning accounts. For more information on the Bank's investment activities see Note 2 of Notes to Consolidated Financial Statements.\nThe following table sets forth the carrying value of the Bank's investment portfolio (including interest bearing deposits, overnight federal funds and FHLB stock) at the dates indicated.\n\/(1)\/Interest bearing deposits consists of certificates of deposit in other institutions, as well as interest earning accounts in the amounts of $513,190, $690,999 and $543,000 at June 30, 1995, 1994 and 1993, respectively.\nAt June 30, 1995, the market value of the Bank's investment securities portfolio was $21 million, compared to a carrying value of $21.1 million. The Corporation adopted Statement of Financial Accounting Standards No. 115 (\"SFAS No. 115\"), Accounting for Certain Investments in Debt and Equity Securities, on June 30, 1994. SFAS No. 115 addresses the accounting and reporting for certain investments in debt and marketable equity securities.\nUnder SFAS No. 115, institutions are required to classify investments in debt securities and equity securities as \"held to maturity,\" \"trading\" or \"available-for-sale.\" SFAS No. 115 modified the accounting treatment for debt and equity securities by replacing the \"held for sale\" categorization (with lower-of-cost or market accounting treatment) with an \"available-for-sale\" categorization (with fair value accounting treatment). Further, it imposes strict criteria over securities accounted for as \"held to maturity.\" Upon the adoption of SFAS No. 115 on June 30, 1994, debt securities that may not be held until maturity and marketable equity securities are considered available- for-sale and, as such, are classified as securities carried at fair value net of applicable taxes, with unrealized gains and losses, reported in a separate component of stockholders' equity. Declines in the value of debt securities and marketable equity securities that are considered other than temporary are recorded in non-interest income as loss on investment securities. See Notes 1(b) and 2 of Notes to Consolidated Financial Statements.\nAt June 30, 1995, the Bank also owned mortgage-backed securities which had a book value of approximately $10.1 million (market value: $10.1 million).\nInvestment Portfolio\nThe following table sets forth the scheduled maturities, amortized costs, market values and average yields for the Bank's investment portfolio and mortgage-backed securities at June 30, 1995.\n____________________ (1) This table includes mortgage-backed securities classified in the statement of financial condition as mortgage-backed securities available for sale totalling $8.4 million.\nSubsidiary Activities\nAs a federally chartered savings association, Northbay Savings is permitted to invest an amount equal to 2% of its assets in subsidiaries with an additional investment of 1% of assets where such investment serves primarily community, inner-city, and community development purposes. Under such limitations, as of June 30, 1995, Northbay Savings was authorized to invest up to approximately $11.7 million in the stock of or loans to subsidiaries. In addition, institutions such as the Bank which meet regulatory capital requirements may invest up to 50% of their regulatory capital in conforming first mortgage loans to subsidiaries.\nIn 1985, Northbay Savings organized Northbay Service Corporation for the purpose of acting as a trustee on deeds of trust and also to enter into agreements for the sale of insurance products. Thereafter, in December 1987, the Bank, pursuant to a directive of the FHLB of San Francisco, purchased all of the outstanding stock of Sonoma Service Company (\"Sonoma Service\") from six of the Bank's directors for a nominal purchase price. Sonoma Service conducted the same activities as Northbay Service Corporation. Upon the acquisition of Sonoma Service, Northbay Service Corporation became inactive and was dissolved after the end of fiscal 1992. At June 30, 1995, the Bank's investment in its wholly-owned subsidiary aggregated $175,000. To date, the activities of the Bank's subsidiary have not been material to the Bank.\nFederal regulations require SAIF-insured savings institutions to give the FDIC and the Director of OTS 30 days prior notice before establishing or acquiring a new subsidiary, or commencing any new activity through an existing subsidiary. Both the FDIC and the Director of OTS have authority to order termination of subsidiary activities determined to pose a risk to the safety or soundness of the institution.\nDeposit Activities and Other Sources of Funds\nGeneral. Deposits are the major source of the Bank's funds for lending and other investment purposes. In addition to deposits, Northbay Savings derives funds from loan principal repayments, the sale of loans or participation interests therein, and borrowings. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer term basis for general business purposes. Special purpose borrowings also may be obtained often at discounted rates for certain purposes, such as for financing the construction of low-income housing. The Bank has a substantial borrowing capacity with the FHLB of San Francisco, and the Bank's borrowings from the FHLB of San Francisco totalled $60 million at June 30, 1995. These borrowings have provided the Bank flexibility in matching a stable source of funds with financial assets of similar maturities (see \"Borrowings\" below).\nDeposits. Deposits are attracted from within the Bank's primary market area through the offering of a broad selection of deposit instruments including NOW accounts, money market accounts, regular savings accounts, checking accounts, certificates of deposit and retirement savings plans. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. The Bank attempts to control its cost of funds by emphasizing passbook, money market and NOW and\nchecking accounts. At June 30, 1995, such accounts totalled $99.6 million or 35.1% of the Bank's total savings accounts.\nThe Bank regularly evaluates the internal cost of funds, surveys rates offered by competing institutions, reviews the Bank's cash flow requirements for lending and liquidity and executes rate changes when deemed appropriate. The Bank's primary strategy for attracting and retaining deposits is to emphasize customer service and personal attention. The Bank generally has not been aggressive in pricing its deposit products relative to the competition. The Bank does not have any brokered deposits and has no present intention to accept or solicit such deposits.\nThe following table sets forth the various types of deposit accounts offered by the Bank and the balance in these accounts at June 30, 1995.\nTime Deposit Rates. The following table sets forth the time deposits in the Bank classified by rates as of the dates indicated.\nTime Deposit Maturity Schedule. The following table sets forth the amount and maturities of the Bank's time deposits at June 30, 1995.\nTime Deposits of $100,000 or Greater. The following table indicates the amount of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity as of June 30, 1995.\nDeposit Flow. The following table sets forth the change in dollar amount of deposits in the various types of deposit programs offered by the Bank between the dates indicated.\nAverage Deposit Balances and Rates\nThe following table sets forth certain information concerning the average month end balances and interest rates for the Bank's deposit accounts by type of deposit for the periods indicated.\nDeposit Activity. The following table sets forth the deposit activities of the Bank for the periods indicated.\nBorrowings. Savings deposits are the primary source of funds of Northbay Savings' lending and investment activities and for its general business purposes. If the need arises, the Bank may rely upon advances from the FHLB of San Francisco to supplement its supply of lendable funds. Advances from the FHLB typically are secured by the Bank's stock in the FHLB and a portion of the Bank's first mortgage loans. At June 30, 1995, the Bank had $60.0 million of advances from the FHLB of San Francisco, including $3.6 million of fixed-rate Community Investment Program (\"CIP\") advances, which are lower rate bearing advances allocated for specific low income housing projects. The increase in FHLB of San Francisco advances was attributable to the Bank's policy of funding loans through FHLB advances when necessary rather than pursuing growth in the loan portfolio with higher rate paying retail\ndeposits. This strategy has contributed to the Bank's ability to maintain a low cost of funds. The following table sets forth the year of maturity and weighted average interest rate for all FHLB advances outstanding at June 30, 1995.\nThe FHLB functions as a central reserve bank providing credit for savings and loan associations and certain other member financial institutions. As a member, Northbay Savings is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an association's net worth or on the FHLB's assessment of the association's creditworthiness. Under its current credit policies, the FHLB limits advances to 30% of a member's assets and, consequently, the Bank has an unused credit line at the FHLB of San Francisco of approximately $57 million at June 30, 1995.\nIn addition to the FHLB advances noted above, at June 30, 1995, the Bank had the following borrowings outstanding: $742,000 in short term banking controlled disbursement accounts, $7.8 million in reverse repurchase agreements and $603,000 in retail repurchase agreements which are secured by mortgage-backed securities, and the Corporation had $188,000\nof a ten-year employee stock ownership plan loan. Under the reverse repurchase agreements, the Bank has sold U.S. Government and mortgage-backed securities, and is obligated to repurchase the securities at some time in the future (which period not exceed 270 days under agreements as of June 30, 1995).\nFor further information concerning the Bank's borrowings, see Notes 8 and 9 of the Notes to Consolidated Financial Statements.\nThe following table sets forth certain information regarding short-term borrowings by the Bank at the dates and during the periods indicated:\n(1) Based on average month end balances.\nCompetition\nThe Bank encounters strong competition both in the attraction of deposits and in the making of real estate and other loans. Its most direct competition for deposits has historically come from commercial banks and other savings and loan institutions in its market area. The Bank competes for savings by offering depositors a high level of personal service together with a wide range of savings accounts, checking accounts, convenient office locations, drive up facilities, automatic teller machines and other various financial services.\nThe competition for real estate and other loans comes principally from savings institutions, commercial banks and mortgage banking companies. This competition for loans has increased substantially in recent years due to the large number of institutions choosing to compete in its market area.\nThe Bank competes for loans primarily through the interest rates and loan fees it charges, and the efficiency and quality of services it provides borrowers, real estate brokers and builders. Factors which affect competition include the general and local economic conditions, current interest rate levels and volatility in the mortgage markets. There are six savings and loan associations and eight commercial banks headquartered in the Bank's market area. Based on its asset size as of June 30, 1995, the Bank is the fifth largest of these financial institutions based in the market area. The other financial institutions in the Bank's market area are branches of statewide organizations and rank above the Bank in terms of aggregate asset size.\nPersonnel\nAs of June 30, 1995, the Corporation, including its subsidiaries, had 111 full-time employees and 12 part-time employees. The employees are not represented by a collective bargaining unit. The Corporation believes its relationship with its employees to be good.\nREGULATION\nGeneral\nNorthbay Savings is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations. The Bank is a member of the FHLB of San Francisco and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"). As the savings and loan holding company of Northbay Savings, the Corporation also is subject to federal regulation and oversight. The purpose of the regulation of the Corporation and other holding companies is to protect subsidiary savings associations. Northbay Savings is a member of the SAIF and the deposits of the Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Bank.\nCertain of these regulatory requirements and restrictions are discussed below or elsewhere in this document.\nFederal Regulation of Savings Associations\nThe OTS has extensive authority over the operations of savings associations. As part of this authority, Northbay Savings is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS and FDIC examina tions of the Bank were as of December 31, 1994 and March 31, 1990, respectively. Under agency scheduling guidelines, it is likely that another examination will be initiated in the near future. When these examinations are conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. All savings associations are subject to a semi- annual assessment, based upon the savings association's total assets. The Bank's OTS assessment for the fiscal year ended June 30, 1995, was $89,000.\nThe OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and the Corporation. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required.\nIn addition, the investment, lending and branching authority of Northbay Savings is prescribed by federal laws and regulations, and it is prohibited from engaging in any activities not permitted by such laws and regulations. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal associations in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings associations are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions.\nThe Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At June 30, 1995, the Bank's lending limit under this restriction was $5.03 million. The Bank did not have any lending relationships in excess of this limit.\nThe OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on certain matters including loan underwriting and documentation, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan. A failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action. The OTS and the other federal banking agencies have also proposed additional guidelines on asset quality. No assurance can be given as to the final form of the proposed regulations or the effect of such regulations on the Bank.\nInsurance of Accounts and Regulation by the FDIC\nNorthbay Savings is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.\nThe FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets (\"Tier 1 risk-based capital\") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period.\nThe FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC also may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.\nAs is the case with the SAIF, the FDIC is authorized to adjust the insurance premium rates for banks that are insured by the Bank Insurance Fund (the \"BIF\") of the FDIC in order to maintain the reserve ratio of the BIF at 1.25% of BIF insured deposits. The FDIC has revised the premium schedule for BIF insured institutions to provide a range of .04% to .31% of deposits in anticipation of the BIF achieving its statutory reserve ratio. As a result, such institutions generally will pay lower insurance premiums than SAIF insured institutions. The revisions became effective in the third quarter of 1995.\nThe SAIF is not expected to attain the designated reserve ratio until the year 2002 due to the shrinking deposit base for SAIF assessments and the requirement that SAIF premiums be used to make the interest payments on bonds issued by the Financing Corporation (\"FICO\") in order to finance the costs of resolving thrift failures in the 1980s. As a result, SAIF insured members will generally be subject to higher deposit insurance premiums than banks until, all things being equal, the SAIF attains the required reserve ratio.\nThe effect of this potential disparity on Northbay Savings and other SAIF members is uncertain at this time. It may have the effect of permitting BIF- insured banks to offer loan and deposit products on more attractive terms than SAIF members due to the cost savings achieved through lower deposit premiums, thereby placing SAIF members at a competitive disadvantage. No assurance can be given as to whether or in what form the FDIC proposal will be adopted. A number of proposals are being considered to recapitalize the SAIF in order to eliminate this disparity. One plan currently being considered by the Treasury Department, the FDIC, the OTS and the Congress provides for a one time assessment of .85% to .90% to be imposed on all deposits assessed at SAIF rates as of March 31, 1995, including those held by commercial banks, and for BIF deposit insurance premiums to be used to pay the FICO bond interest on a pro rata basis together with SAIF premiums. The BIF and SAIF would be merged into one fund as soon as practicable, but no later than January 1, 1998. There can be no assurance that any particular proposal will be implemented or that premiums for either BIF or SAIF members will not be adjusted in the future by the FDIC or by legislative action.\nRegulatory Capital Requirements\nFederally insured savings associations, such as Northbay Savings, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis.\nThe capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital for calculating compliance with the requirement. At June 30, 1995, the Bank had intangible assets in the form of a premium paid to acquire deposits of another institution of $74,000.\nThe OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers are \"includable\" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital. The Bank's subsidiary is an includable subsidiary.\nAt June 30, 1995, the Bank had tangible capital of $33.6 million, or 8.58% of adjusted total assets, which is approximately $27.7 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date.\nThe capital standards also require core capital equal to at least 3% of adjusted total assets. Core capital generally consists of tangible capital plus certain intangible assets, including\na limited amount of purchased credit card relationships. As a result of the prompt corrective action provisions discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio.\nAt June 30, 1995, the Bank had core capital equal to $33.6 million, or 8.60% of adjusted total assets, which is $21.9 million above the minimum leverage ratio requirement of 3% as in effect on that date.\nThe OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings association to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. At June 30, 1995, the Bank had no capital instruments that qualify as supplementary capital and $2.1 million of general loss reserves, which was less than 1.25% of risk- weighted assets.\nCertain exclusions from capital and assets are required to be made for the purpose of calculating total capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. Northbay Savings had no such exclusions from capital and assets at June 30, 1995.\nIn determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by the FNMA or FHLMC.\nThe OTS has adopted a final rule that requires every savings association with more than normal interest rate risk exposure to deduct from its total capital, for purposes of determining compliance with such requirement, an amount equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. This exposure is a measure of the potential decline in the net portfolio value of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). Net portfolio value is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule provides for a two quarter lag between calculating interest rate risk and recognizing any deduction from capital. The rule will not become effective until the OTS evaluates the process by which savings associations may appeal an interest rate risk deduction determination. It is uncertain as to when this evaluation may be completed. Any savings association with less than $300 million in assets and a total capital ratio in excess of 12% is exempt from this requirement unless the OTS determines otherwise. Based upon the Bank's level of adjustable rate loans, shorter term assets\nand strong level of regulatory capital, management does not expect the Bank's interest rate risk component to have a material impact on the Bank's regulatory capital level or its compliance with regulatory capital requirements.\nOn June 30, 1995, the Bank had total capital of $35.7 million (including $33.6 million in core capital and $2.1 million in qualifying supplementary capital) and risk-weighted assets of $245 million (including $16.5 million in converted off-balance sheet assets); or total capital of 14.56% of risk- weighted assets. This amount was $16.1 million above the 8% requirement in effect on that date.\nThe OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against savings associations that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an \"undercapitalized association\" (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. Any undercapitalized association is also subject to the general enforcement authority of the OTS or the FDIC, including the appointment of a receiver or conservator. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. The OTS is also authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations.\nAny savings association that fails to comply with its capital plan or is \"significantly undercapitalized\" (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions which may cover all aspects of its operations and include a forced merger or acquisition of the association. An association that becomes \"critically undercapitalized\" (i.e., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized.\nThe OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.\nThe imposition by the OTS or the FDIC of any of these measures on Northbay Savings may have a substantial adverse effect on the Bank's operations and profitability. Corporation stockholders do not have preemptive rights, and therefore, if the Corporation is directed by the OTS or the FDIC to issue additional shares of common stock, such issuance may result in the dilution in the percentage of ownership of the Corporation.\nLimitations on Dividends and Other Capital Distributions\nOTS regulations impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion.\nThe OTS utilizes a three-tiered approach to permit associations, based on their capital level and supervisory condition, to make capital distributions which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account (see \"--Regulatory Capital Requirements\").\nGenerally, Tier 1 associations, which are associations that before and after the proposed distribution meet their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 association. However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. The Bank meets the requirements for a Tier 1 association and has not been notified of a need for more than normal supervision. Tier 2 associations, which are associations that before and after the proposed distribution meet their current minimum capital requirements, may make capital distributions of up to 75% of net income over the most recent four quarter period.\nTier 3 associations (which are associations that do not meet current minimum capital requirements) that propose to make any capital distribution and Tier 2 associations that propose to make a capital distribution in excess of the noted safe harbor level must obtain OTS approval prior to making such distribution. Tier 2 associations proposing to make a capital distribution within the safe harbor provisions and Tier 1 associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. As a subsidiary of the Corporation, the Bank is required to give the OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See \"- Regulatory Capital Requirements.\"\nThe OTS has proposed regulations that would revise the current capital distribution restrictions. The proposal eliminates the current tiered structure and the safe-harbor percentage limitations. Under the proposal a savings association may make a capital distribution without notice to the OTS (unless it is a subsidiary of a holding company) provided that it has a CAMEL 1 or 2 rating, is not in troubled condition (as defined by regulation) and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess\nregulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted.\nAt the time of Northbay Savings' conversion from the mutual to the stock form of organization, the Bank entered into a dividend limitation agreement with the OTS which provides that the Bank may pay dividends of up to 100% of cumulative net income, less dividends paid for the previous eight quarters, if the Bank meets its fully phased-in capital requirements. If the Bank does not meet its fully phased-in capital requirements, its dividends to the Corporation would be limited to 50% of net income, less dividends paid for the previous eight quarters. This requirement has not had a material adverse effect on the Bank's dividend practices and management does not expect this requirement to have any such effect on the Bank's dividend practices in the future. See Note 16 to Notes to Consolidated Financial Statements.\nLiquidity\nAll savings associations, including Northbay Savings, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. For a discussion of what the Bank includes in liquid assets, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" in the Corporation's Annual Report to Stockholders. This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the required minimum liquid asset ratio is 5%.\nIn addition, short-term liquid assets (e.g., cash, certain time deposits, certain bankers acceptances and short-term United States Treasury obligations) currently must constitute at least 1% of the association's average daily balance of net withdrawable deposit accounts and current borrowings. Penalties may be imposed upon associations for violations of either liquid asset ratio requirement. At June 30, 1995, the Bank was in compliance with both requirements, with an overall liquid asset ratio of 6.40% and a short- term liquid assets ratio of 3.68%.\nAccounting\nAn OTS policy statement applicable to all savings associations clarifies and re-emphasizes that the investment activities of a savings association must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with GAAP. Under the policy statement, management must support its classification of and accounting for loans and securities (i.e., whether held for investment, sale or trading) with appropriate documentation. The Bank is in compliance with these amended rules.\nThe OTS has adopted an amendment to its accounting regulations, which may be made more stringent then GAAP by the OTS, to require that transactions be reported in a manner that\nbest reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS.\nQualified Thrift Lender Test\nAll savings associations, including Northbay Savings, are required to meet a qualified thrift lender (\"QTL\") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. Such assets primarily consist of residential housing related loans and investments. At June 30, 1995, the Bank met the test and has always met the test since its effectiveness.\nAny savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See \"- Holding Company Regulation.\"\nCommunity Reinvestment Act\nUnder the Community Reinvestment Act (\"CRA\"), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices 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 OTS, in connection with the examination of Northbay Savings, 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, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS.\nThe federal banking agencies, including the OTS, have recently revised the CRA regulations and the methodology for determining an institution's compliance with the CRA. Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank\nwas last examined by the OTS for CRA compliance in January 1995 and received a rating of outstanding.\nTransactions with Affiliates\nGenerally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to affiliates, are restricted to a percentage of the association's capital. Affiliates of Northbay Savings include the Corporation and any company which is under common control with the Bank. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The Bank's subsidiary is not deemed an affiliate, however, the OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis.\nCertain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals.\nHolding Company Regulation\nThe Corporation is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Corporation is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Corporation and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.\nAs a unitary savings and loan holding company, the Corporation generally is not subject to activity restrictions. If the Corporation acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Corporation and any of its subsidiaries (other than the Bank or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in a supervisory acquisition.\nIf the Bank fails the QTL test, the Corporation must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure the Corporation must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See \"--Qualified Thrift Lender Test.\"\nThe Corporation must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a\nmultiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association.\nFederal Securities Law\nThe stock of the Corporation is registered with the SEC under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). The Corporation is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.\nCorporation stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Corporation may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Corporation meets specified current public information requirements, each affiliate of the Corporation is able to sell in the public market, without registration, a limited number of shares in any three-month period.\nFederal Reserve System\nThe Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At June 30, 1995, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See \"--Liquidity.\"\nSavings associations are authorized to borrow from the Federal Reserve Bank \"discount window,\" but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank.\nFederal Home Loan Bank System\nNorthbay Savings is a member of the FHLB of San Francisco, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing.\nAs a member, the Bank is required to purchase and maintain stock in the FHLB of San Francisco. At June 30, 1995, the Bank had $3.29 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on\nits FHLB stock. Over the past five fiscal years ended June 30, such dividends have averaged 4.40% and were 4.91% for the fiscal year ended June 30, 1995.\nUnder federal law the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to low- and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital.\nFor the fiscal year ended June 30, 1995, dividends paid by the FHLB of San Francisco to the Bank totaled $170,000 which constitute an $80,000 increase over the amount of dividends received in fiscal year 1994. The $45,000 dividend received for the quarter ended June 30, 1995 reflects an annualized rate of 4.74%, or .46% above the rate for the fiscal year ended June 30, 1995.\nFederal and State Taxation\nSavings associations such as the Bank that meet certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended (the \"Code\"), are permitted to establish reserves for bad debts and to make annual additions thereto which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction for \"non-qualifying loans\" is computed under the experience method. The amount of the bad debt reserve deduction for \"qualifying real property loans\" (generally loans secured by improved real estate) may be computed under either the experience method or the percentage of taxable income method (based on an annual election).\nUnder the experience method, the bad debt reserve deduction is an amount determined under a formula based generally upon the bad debts actually sustained by the savings association over a period of years.\nThe percentage of specially computed taxable income that is used to compute a savings association's bad debt reserve deduction under the percentage of taxable income method (the \"percentage bad debt deduction\") is 8%. The percentage bad debt deduction thus computed is reduced by the amount permitted as a deduction for non-qualifying loans under the experience method. The availability of the percentage of taxable income method permits qualifying savings associations to be taxed at a lower effective federal income tax rate than that applicable to corporations generally (approximately 31.3% assuming the maximum percentage bad debt deduction).\nIf an association's specified assets (generally, loans secured by residential real estate or deposits, educational loans, cash and certain government obligations) constitute less than 60% of its total assets, the association may not deduct any addition to a bad debt reserve and generally must include existing reserves in income over a four year period. No representation can be made as to whether the Bank will meet the 60% test for subsequent taxable years.\nUnder the percentage of taxable income method, the percentage bad debt deduction cannot exceed the amount necessary to increase the balance in the reserve for \"qualifying real property loans\" to an amount equal to 6% of such loans outstanding at the end of the taxable year or the greater of (i) the amount deductible under the experience method or (ii) the amount which when added to the bad debt deduction for \"non-qualifying loans\" equals the amount by which 12% of the amount comprising savings accounts at year-end exceeds the sum of surplus, undivided profits and reserves at the beginning of the year. At June 30, 1995, the 6% and 12% limitations did not restrict the percentage bad debt deduction available to the Bank. It is not expected that these limitations would be a limiting factor in the foreseeable future.\nIn addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. For taxable years beginning after 1986 and before 1996, corporations, including savings associations such as the Bank, are also subject to an environmental tax equal to 0.12% of the excess of alternative minimum taxable income for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2 million.\nTo the extent earnings appropriated to a savings association's bad debt reserves for \"qualifying real property loans\" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans (\"Excess\"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a stockholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses).\nThe Corporation files consolidated federal income tax and combined California franchise tax returns with the Bank and its subsidiary. Savings associations, such as the Bank, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member.\nThe consolidated federal income tax returns for years ended June 30, 1989, 1990 and 1991 were examined by the Internal Revenue Service. The exam was finalized in September 1994 and resulted in no adjustments to taxable income for any of the years under examination. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Bank) would not result in a deficiency which could have a material adverse effect on the financial condition of the Bank and its consolidated subsidiary.\nState Income Taxation. For the most part, except for bad debt deductions, California conformed its tax laws to the federal income tax law adopted by the Tax Reform Act of 1986. The following is a summary of some of the key provisions of the California law effected by conforming legislation.\n1. In general, one half of the Net Operating Losses incurred after 1986 are permitted to be carried forward for 5 years. California Net Operating Loss Carryforwards may not be utilized in 1991 and 1992 due to California Legislation.\n2. The add-on preference tax was repealed and replaced with an alternative minimum tax based on the federal structure.\n3. Most of the base broadening changes in the 1986 Act were followed, including the change to the accrual method of accounting.\n4. The tax rate for taxpayers other than banks and financial corporations was reduced to 9.3%.\nThe California franchise tax applicable to savings institutions is a variable rate tax, computed under a formula that results in a rate higher than the rate applicable to non-financial corporations, because it reflects an amount \"in lieu\" of local personal property and business license taxes paid by such corporations (but not generally paid by banks or financial institutions such as the Bank). The tax rate for fiscal 1995 was 11.55%. The California alternative minimum tax rate is 9.25%.\nAs a Delaware corporation, the Corporation is subject to an annual franchise tax based on the number of shares of common and preferred stock authorized under its Certificate of Incorporation.\nFor information regarding federal and state taxes, see Note 10 of the Notes to Consolidated Financial Statements in the Corporation's Annual Report to Stockholders.\nExecutive Officers of the Corporation\nThe executive officers of the Corporation are as follows:\nHerold Mahoney is Chairman of the Board and President of the Corporation. Mr Mahoney is the President and 50% owner of Royal Petroleum Co., Petaluma, California, an independent petroleum products company.\nAlfred A. Alys is Executive Vice President and Chief Executive Officer of the Corporation. Mr. Alys joined the Bank in 1970 and served as Executive Vice President and Chief Executive Officer from July 1984 to October 1988. Since October 1988 he has served as President, Chief Executive Officer and Director of the Bank. Mr. Alys is a Director and Chairman of the Investment Committee of the Sonoma County Employee Retirement Association. He is a Director and Chairman of the Sonoma County Open Space Authority and is active in various other charitable and civic organizations.\nGranville I. Stark is Senior Vice President of Real Estate Loan Administration for Northbay Savings. Mr. Stark joined the Bank in 1975 and has served as Vice President of Real Estate Loans from July 1982 to July 1989. In July 1989, Mr. Stark was named as Senior Vice President of Northbay Savings. Mr. Stark is on the California League of Savings Institutions Secondary Market Committee and is active in various other charitable and civic organizations.\nBertha Balfour is Senior Vice President of Savings and Branch Administration for Northbay Savings. Mrs. Balfour joined the Bank in 1970 and has served as Vice President of Savings and Branch Administration from July 1973 to July 1989. In July 1989, Mrs. Balfour was named as Senior Vice President of Northbay Savings. Mrs. Balfour is also active in local charitable organizations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties -------------------\nProperties\nThe following table sets forth the location of the Bank's offices, as well as certain additional information relating to these offices as of June 30, 1995.\n\/(1)\/ Represents the net book value of land, building, furniture, fixtures and equipment owned by the Bank.\nThe net book value of the Bank's investment in premises and equipment totaled $2.47 million at June 30, 1995. See Note 5 of Notes to Consolidated Financial Statements in the Annual Report to Stockholders.\nItem 3.","section_3":"Item 3. Legal Proceedings --------------------------\nThe Corporation is not engaged in any legal proceedings of a material nature at the present time. There are various claims and law suits in which the Bank is periodically involved, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.\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 June 30, 1995.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters -----------------------------------------------------\nThe information contained under the section captioned \"Stock Market Information\" in the Annual Report to Stockholders for the Fiscal Year Ended June 30, 1995 (the \"Annual Report\") is incorporated herein by reference.\nIn addition to other regulatory restrictions on payment of dividends by the Bank, federal regulations impose certain limitations on the payment of dividends and other capital distributions by Northbay Savings. Under the regulations, a savings association that, immediately prior to, and on a pro forma basis after giving effect to, a proposed capital distribution, has total capital (as defined by OTS regulation) that is equal to or greater than the amount of its fully phased-in capital requirements (a \"Tier 1 Association\") generally is permitted, after notice, to make capital distributions during a calendar year in the amount equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceed its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 Association (as defined below). A savings institution with total capital in excess of current minimum capital ratio requirements but not in excess of the fully phased-in requirements (a \"Tier 2 Association\") generally is permitted, after notice, to make capital distributions without OTS approval of up to 75% of its net income for the previous four quarters, less dividends already paid for such period. A savings institution that fails to meet current minimum capital requirements (a \"Tier 3 Association\") is prohibited from making any capital distributions without the prior approval of the OTS. A Tier 1 Association that has been notified by the OTS that its is in need of more than normal supervision will be treated as either a Tier 2 or Tier 3 Association. Despite the above authority, the OTS may prohibit any savings institution from\nmaking a capital distribution that would otherwise be permitted by the regulation, if the OTS were to determine that the distribution constituted an unsafe or unsound practice. Furthermore, under the OTS prompt corrective action regulations, which took effect on December 19, 1992, the Bank would be prohibited from making any capital distributions if, after making the distribution, the Bank would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%. See \"Regulation -- Limitations on Dividends and Other Capital Distributions.\"\nAt the time of Northbay Savings' conversion from the mutual to the stock form of organization, the Bank entered into a dividend limitation agreement with the OTS which provides that the Bank may pay dividends of up to 100% of cumulative net income, less dividends paid for the previous eight quarters, if the Bank meets its fully phased-in capital requirements. If the Bank does not meet its fully phased-in capital requirements, its dividends to the Corporation would be limited to 50% of net income, less dividends paid for the previous eight quarters. This requirement has not had a material adverse effect on the Bank's dividend practices and management does not expect this requirement to have any such effect on the Bank's dividend practices in the future. See \"Regulation -- Limitations on Dividends and Other Capital Distributions\" and Note 16 to Notes to Consolidated Financial Statements.\nItem 6.","section_6":"Item 6. Selected Financial Data --------------------------------\nThe information contained in the table captioned \"Selected Consolidated 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 the section captioned \"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 Statement and Supplementary Data ---------------------------------------------------\nThe financial statements listed in Item 14 herein 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 contained under the section captioned \"Proposal I -- Election of Directors\" in the Corporation's definitive proxy statement for the Corporation's 1995 Annual Meeting of Stockholders (the \"Proxy Statement\") is incorporated herein by reference.\nThe information contained in \"Item 1. Business -- Executive Officers of the Corporation\" is incorporated herein by reference.\nPursuant to the Securities Exchange Act of 1934, the Corporation's officers and directors and persons who own more than ten percent of the Common Stock are required to file reports detailing their ownership and changes of ownership in the Common Stock with the SEC. Officers, directors and persons who own more than ten percent of the Common Stock are also required to furnish the Corporation with copies of all such ownership reports that are filed. Based solely on the Corporation's review of the copies of such ownership reports, or written representations from officers, directors and persons who own more than ten percent of the Common Stock that no annual report of change in beneficial ownership is required, the Corporation believes that during the fiscal year ended June 30, 1995 all of its officers, directors and stockholders owning in excess of ten percent of the Common Stock have complied with the required reporting requirements.\nItem 11.","section_11":"Item 11. Executive Compensation --------------------------------\nThe information contained under the section captioned \"Proposal I -- Election of Directors - 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(a) Security Ownership of Certain Beneficial Owners\nInformation required by this item is incorporated herein by reference to the Section captioned \"Voting Securities and Principal Holders Thereof\" of the Proxy Statement.\n(b) Security Ownership of Management\nInformation required by this item is incorporated herein by reference to the section captioned \"Proposal I -- Election of Directors\" of the Proxy Statement.\n(c) Management of the Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, 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 --------------------------------------------------------\nThe information required by this item is incorporated herein by reference to the section captioned \"Proposal I -- Election of Directors - Transactions with Management\" of the Proxy Statement.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, and Reports on Form 8-K -----------------------------------------------------------------\n(a) 1. Independent Auditors' Report\nNorthbay Financial Corporation and Subsidiaries\n(a) Consolidated Statements of Financial Condition at June 30, 1995 and 1994\n(b) Consolidated Statements of Operations for the years ended June 30, 1995, 1994 and 1993\n(c) Consolidated Statements of Stockholders' Equity for the years ended June 30, 1995, 1994 and 1993\n(d) Consolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993\n(e) Notes to Consolidated Financial Statements\n2. All schedules have been omitted as the required information is either inapplicable or included in this Form 10-K, the Consolidated Financial Statements or the Notes to Consolidated Financial Statements.\n3. Exhibits\n3.1 Certificate of Incorporation (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n3.2 Bylaws (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n10.1 Stock Option and Incentive Plan (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n10.2 Salary Continuation Agreement between Northbay Savings and Alfred A. Alys (Incorporated by reference to the Registrant's Form S-1 Registration Statement No. 33-26172)\n10.3 Employment Agreement between the Registrant and Alfred A. Alys (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994)\n10.4 Employment Agreement between Northbay Savings and Alfred A. Alys (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994)\n10.5 Severance Agreement between Northbay Savings and Granville I. Starke\n10.6 Severance Agreement between Northbay Savings and Bertha Balfour\n13 Portions of Annual Report to Stockholders for Fiscal Year Ended June 30, 1995\n21 Subsidiaries of the Registrant\n23 Consent of Independent Accountants\n27 Financial Data Schedule\n(b) No reports on Form 8-K dated were filed during the last quarter of the fiscal year covered by this report.\n(c) All required exhibits are filed as attached.\n(d) No financial statement schedules are required.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTHBAY FINANCIAL CORPORATION\nDate: September 27, 1995 By: \/s\/ Alfred A. Alys ------------------------------ Alfred A. Alys, Executive Vice President and Chief Executive Officer (Duly Authorized Representative)\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.\nSignatures Dated ---------- -----\n\/s\/ Alfred A. Alys September 27, 1995 ----------------------------------- Alfred A. Alys Principal Executive Officer and Director\n\/s\/ Greg Jahn September 27, 1995 ----------------------------------- Greg Jahn Principal Financial and Accounting Officer\n\/s\/ Victor L. DeCarli September 27, 1995 ----------------------------------- Victor L. DeCarli Director\n\/s\/ Herold Mahoney September 27, 1995 ----------------------------------- Herold Mahoney Director\n\/s\/ Raymond Nizibian September 27, 1995 ----------------------------------- Raymond Nizibian, D.D.S. Director\n\/s\/ Donald P. Ramatici September 27, 1995 ----------------------------------- Donald P. Ramatici Director\n\/s\/ Martin A. Stinar September 27, 1995 ----------------------------------- Martin A. Stinar Director\nSignatures Dated ---------- -----\n\/s\/ Eugene W. Traverso September 27, 1995 ----------------------------------- Eugene W. Traverso Director\nINDEX TO EXHIBITS\n3.1 Certificate of Incorporation (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n3.2 Bylaws (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n10.1 Stock Option and Incentive Plan (Incorporated by reference to the Registrant's Form S-1 Registration Statement, No. 33-26172)\n10.2 Salary Continuation Agreement between Northbay Savings and Alfred A. Alys (Incorporated by reference to the Registrant's Form S-1 Registration Statement No. 33-26172)\n10.3 Employment Agreement between the Registrant and Alfred A. Alys (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994)\n10.4 Employment Agreement between Northbay Savings and Alfred A. Alys (Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994)\n10.5 Severance Agreement between Northbay Savings and Granville I. Starke\n10.6 Severance Agreement between Northbay Savings and Bertha Balfour\n13 Portions of Annual Report to Stockholders for Fiscal Year Ended June 30, 1995\n21 Subsidiaries of the Registrant\n23 Consent of Independent Accountants\n27 Financial Data Schedule","section_15":""}
{"filename":"63073_1995.txt","cik":"63073","year":"1995","section_1":"Item 1. BUSINESS THE SYSTEM\nSYSTEM ORGANIZATION\nNew England Electric System (NEES) is a voluntary association created under Massachusetts law on January 2, 1926, and is a registered holding company under the Public Utility Holding Company Act of 1935 (the 1935 Act). NEES owns voting stock in the amounts indicated of the following companies, which together constitute the System.\n% Voting Securities State of Type of Owned by Name of Company Organization Business NEES --------------- ------------ -------- ---------\nSubsidiaries:\nGranite State Electric Company N.H. Retail 100 (Granite State) Electric\nMassachusetts Electric Company Mass. Retail 100 (Mass. Electric) Electric\nThe Narragansett Electric Company R.I. Retail 100 (Narragansett) Electric\nNarragansett Energy Resources R.I. Wholesale 100 Company (Resources) Electric Generation\nNew England Electric Resources, Inc. (NEERI) Mass. Development 100 Services\nNew England Electric Transmission N.H. Electric 100 Corporation (NEET) Transmission\nNew England Energy Incorporated Mass. Oil and Gas 100 (NEEI) Exploration & Development\nNew England Hydro-Transmission N.H. Electric 53.97(a) Corporation (N.H. Hydro) Transmission\nNew England Hydro-Transmission Mass. Electric 53.97(a) Electric Company, Inc. Transmission (Mass. Hydro)\nNew England Power Company (NEP) Mass. Wholesale 98.85(b) Electric Generation & Transmission\nNew England Power Service Company Mass. Service 100 (Service Company) Company\n(a) The common stock of these subsidiaries is owned by NEES and certain participants (or their parent companies) in Phase II of the Hydro-Quebec project. See Interconnection with Quebec, page 28.\n(b) Holders of common stock and 6% Cumulative Preferred Stock of NEP have general voting rights. The 6% Cumulative Preferred Stock represents 1.15% of the total voting power.\nThe facilities of NEES' three retail electric subsidiaries, Mass. Electric, Narragansett, and Granite State (collectively referred to as the Retail Companies), and of its principal wholesale electric subsidiary, NEP, constitute a single integrated electric utility system that is directly interconnected with other utilities in New England and New York State, and indirectly interconnected with utilities in Canada. See ELECTRIC UTILITY OPERATIONS, page 3.\nNEET owns and operates a portion of an international transmission interconnection between the electric systems of Hydro-Quebec and New England. Mass. Hydro and N.H. Hydro own and operate facilities in connection with an expanded second phase of this interconnection. See Interconnection with Quebec, page 28.\nNEEI is engaged in various activities relating to fuel supply for the System. These activities primarily include participation (principally through a partnership with a non-affiliated oil company) in domestic oil and gas exploration, development, and production (see OIL AND GAS OPERATIONS, page 50) and the sale to NEP of fuel purchased in the open market.\nResources is a general partner, with a 20% interest, in each of two partnerships formed in connection with the Ocean State Power project. See Ocean State Power, page 28.\nThe Service Company has contracted with NEES and its subsidiaries to provide, at cost, such administrative, engineering, construction, legal, and financial services as the companies request.\nNEERI is a wholly-owned, non-utility subsidiary of NEES which provides consulting and independent project development services domestically and internationally to non-affiliates and seeks investment opportunities in power plant modernization, transmission, and environmental improvement. NEERI also provides maintenance and construction services under contract to certain non-affiliated utility customers.\nEMPLOYEES\nAs of December 31, 1995, NEES subsidiaries had approximately 4,830 employees. As of that date, the total number of employees was approximately 800 at NEP, 1,715 at Mass. Electric, 765 at Narragansett, 75 at Granite State, and 1,475 at the Service Company. Of the 4,830 employees, approximately 3,100 are members of labor organizations. Collective bargaining agreements with the Brotherhood of Utility Workers of New England, Inc., the International Brotherhood of Electrical Workers, and the Utility Workers Union of America, AFL-CIO were signed in May, 1995 and expire in May, 1999.\nELECTRIC UTILITY OPERATIONS\nGENERAL\nNEP's business is principally generating, purchasing, transmitting, and selling electric energy in wholesale quantities. In 1995, 95% of NEP's revenue from the sale of electricity was derived from sales for resale to affiliated companies and 5% from sales for resale to municipal and other utilities. NEP is the wholesale supplier of the electric energy requirements of the Retail Companies under contracts that require seven years notice of termination. Narragansett receives credits against its purchases of power from NEP for the cost of generation from its Providence units, which are functionally integrated with NEP's facilities to achieve maximum economy and reliability. Discussions of NEP's generating properties, load growth, energy mix, and fuel supplies include the related properties of Narragansett. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 27 of the New England Power Company 1995 Annual Report to Stockholders (the NEP 1995 Annual Report). (For a discussion of electric utility operations in a more competitive environment, see COMPETITIVE CONDITIONS, page 7).\nThe combined service area of the Retail Companies constitutes the retail service area of the System and covers more than 4,400 square miles with a population of about 3,000,000 (1990 census). See Map, page 24. The largest cities served are Worcester, Mass. (population 170,000) and Providence, R.I. (population 161,000).\nMass. Electric and Narragansett are engaged principally in the distribution and sale of electricity at retail. Mass. Electric provides approximately 950,000 customers with electric service at retail in a service area comprising approximately 43% of the area of The Commonwealth of Massachusetts. The population of the\nservice area is about 2,160,000 or 36% of the total population of the Commonwealth (1990 Census). Mass. Electric's territory consists of 146 cities and towns including rural, suburban, and urban communities with Worcester, Lowell, and Quincy being the largest cities served. The economy of the area is diversified. Principal industries served by Mass. Electric include electrical and industrial machinery, computer manufacturing and related products, plastic goods, fabricated metals and paper, and chemical products. In addition, a broad range of professional, banking, high-technology, medical, and educational concerns is served. During 1995, 41% of Mass. Electric's revenue from the sale of electricity was derived from residential customers, 37% from commercial customers, 21% from industrial customers, and 1% from others. In 1995, the 20 largest customers of Mass. Electric accounted for approximately 7% of its electric revenue. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 21 of Mass. Electric's 1995 to Stockholders (the Mass. Electric 1995 Annual Report).\nNarragansett provides approximately 328,000 customers with electric service at retail. Its service territory, which includes urban, suburban, and rural areas, covers about 839 square miles or 80% of the area of Rhode Island, and encompasses 27 cities and towns including the cities of Providence, Warwick, Cranston, and East Providence. The population of the area is about 725,000 (1990 Census) which represents about 72% of the total population of the state. The economy of the territory is diversified. Principal industries served by Narragansett produce fabricated metal products, jewelry, silverware, electrical and industrial machinery, transportation equipment, textiles, and chemical and allied products. In addition, a broad range of professional, banking, medical, and educational institutions is served. During 1995, 42% of Narragansett's revenue from the sale of electricity was derived from residential customers, 41% from commercial customers, 15% from industrial customers, and 2% from others. In 1995, the 20 largest customers of Narragansett accounted for approximately 9% of its electric revenue. For details of sales of energy and operating revenue for the last five years see OPERATING STATISTICS on page 21 of Narragansett's 1995 Annual Report to Stockholders (the Narragansett 1995 Annual Report).\nGranite State provides approximately 36,000 customers in 21 New Hampshire communities with electric service at retail in the State of New Hampshire in a service area having a population of about 73,000 (1990 Census), including the city of Lebanon and the towns of Hanover, Pelham, Salem and surrounding communities. During 1995, 48% of Granite State's revenue from the sale of electricity was derived from commercial customers, 39% from residential customers, 12% from industrial customers, and 1% from others. In\n1995, the 10 largest customers of Granite State accounted for about 18% of its electric revenue. Granite State is not subject to the reporting requirements of the Securities Exchange Act of 1934, and its financial impact on the System is relatively small. Information on Granite State is provided herein solely for the purpose of furnishing a more complete description of System operations.\nOn March 22, 1995, NEES agreed to acquire Nantucket Electric Company for $3.5 million. Completion of the acquisition occured on March 22, 1996.\nThe electric utility business of NEP and the Retail Companies is not highly seasonal. For NEP and the Retail Companies, industrial customers are broadly distributed among standardized industrial classifications. No single industrial classification exceeds 3% of operating revenue, and no single customer of the System contributes more than 1% of operating revenue.\nKilowatt hour (kWh) sales to ultimate customers increased less than 1 percent in 1995. This increase was primarily due to a return to more normal weather in the fourth quarter of 1995, along with a warmer summer in 1995, partially offset by lower sales in the first quarter of 1995, due to unusually mild weather. In 1994, kWh sales to ultimate customers increased 1.6 percent over 1993, reflecting an improved economy.\nCOMPETITIVE CONDITIONS\nThe electric utility business is being subjected to rapidly increasing competitive pressures, stemming from a combination of trends, including the presence of surplus generating capacity, a disparity in electric rates among regions of the country, improvements in generation efficiency, increasing demand for customer choice, and new regulations and legislation intended to foster competition. To date, this competition has been most prominent in the bulk power market, in which non-utility generators have significantly increased their market share. Electric utilities have had exclusive franchises for the retail sale of electricity in specified service territories. As a result, competition in the retail market has been limited to (i) competition with alternative fuel suppliers, primarily for heating and cooling, (ii) competition with customer-owned generation, and (iii) direct competition among electric utilities to attract major new facilities to their service territories. These competitive pressures have led the subsidiaries of NEES (NEES Companies) and other utilities to offer, from time to time, special discounts or service packages to certain large customers.\nIn states across the country, including Massachusetts, Rhode Island, and New Hampshire, there have been an increasing number of proposals to allow retail customers to choose their electricity supplier, with incumbent utilities required to deliver that electricity over their transmission and distribution systems (also known as \"retail wheeling\"). If electric customers were allowed to choose their electricity supplier, the Retail Companies' role would change and they would provide only distribution services. Power would be provided by power generators and marketers, which could be either affiliated or non-affiliated companies. In these competitive circumstances, utilities across the country that operate generation plants, such as NEP, would face the risk that market prices may not be sufficient to recover the costs of the commitments incurred to supply customers under a regulated industry structure. The amount by which costs exceed market prices is commonly referred to as \"stranded costs\".\nThe NEES Companies derive approximately 70 percent, 23 percent, and 3 percent of their electric sales revenues from ultimate customers in Massachusetts, Rhode Island, and New Hampshire, respectively. Each of the Retail Companies purchases electricity under wholesale all-requirements contracts with NEES's wholesale generating subsidiary, NEP and resell it to their customers. Legislative or utility initiatives, such as Choice: New England, could ultimately result in changes in the relationship between NEP and its all-requirements customers.\nChoice: New England\nIn October 1995, the NEES Companies announced a plan to allow all customers of electric utilities in Massachusetts, Rhode Island, and New Hampshire to choose their power supplier beginning in 1998. The plan, Choice: New England, was developed in response to 1995 decisions by the Massachusetts Department of Public Utilities (MDPU) and the Rhode Island Public Utilities Commission (RIPUC) that approved a set of principles for industry restructuring. These principles include allowing utilities the opportunity to recover stranded costs. Choice: New England was formally filed by Mass. Electric with the MDPU in February 1996. In March 1995, the RIPUC ordered all utilities in Rhode Island to file restructuring plans by April 12, 1996. In response to a RIPUC order, Narragansett plans to file a similar version of Choice: New England with the RIPUC in April 1996.\nUnder Choice: New England, the Retail Companies would no longer sell electricity to their customers. Instead, customers would purchase electricity from a supplier of their choice, with the Retail Companies remaining responsible for providing distribution services to customers under regulated rates. Transmission services would be provided by a new affiliate, NEES Transmission Services, Inc. (NEES Trans), which would be formed by NEES to provide comparable service across the NEES Companies' transmission system. NEP has recently filed a proposed tariff rate with the Federal Energy Regulatory Commission (FERC) whereby its transmission facilities would be operated by NEES Trans subsidiary pursuant to a support agreement. See RATES, page 14.\nUnder Choice: New England, the pricing of generation would be deregulated. However, customers would have the right to receive service under a \"standard offer\" from the incumbent utility or its affiliate, the pricing of which would be approved in advance by legislators or regulators. Customers electing the standard offer would be eligible to choose an alternative power supplier at any time, but would not be allowed to return to the standard offer. Under Choice: New England, transmission and distribution rates would remain regulated.\nUnder Choice: New England, the Retail Companies' wholesale contracts with NEP would be terminated. In return, Choice: New England proposes that the cost of NEP's past generation commitments be recovered from the Retail Companies through a contract termination charge. The Retail Companies would, in turn, seek to recover the payments to NEP through a wires access or transition charge to retail customers. Those commitments, which are currently estimated at approximately $4 billion on a present value basis, primarily consist of (i) generating plant commitments, (ii) regulatory assets, (iii) purchased power contracts, and (iv) the operating cost of nuclear plants which cannot be mitigated by shutting down the plants (otherwise referred to as \"nuclear costs independent of operation\"). Sunk costs associated with utility generating plants, such as past capital investments, and regulatory assets would be recovered over ten years. The return on equity related to the unrecovered capital investments and regulatory assets would be reduced to one percentage point over the rate on long-term \"BBB\" rated utility bonds. Purchased power contract costs and nuclear costs independent of operation would be recovered as incurred over the life of those obligations, a period expected to extend beyond ten years. The access charge would be set at three cents per kWh for the first three years. Thereafter, the access charge would vary, but is expected to decline. The provisions of Choice: New England, including the proposed access charge, are subject to state approval and FERC approval.\nIn March 1996, Mass. Electric filed a request with the MDPU to allow the implementation of two pilot programs to test the plan. The first would allow certain high technology customers in Massachusetts representing 1 percent of the NEES Companies' retail sales to have direct access to alternative power suppliers beginning in July 1996. The second would allow residential and small business customers in Massachusetts representing 0.5 percent of the NEES Companies' retail sales to have direct access beginning September 1, 1996.\nThree other utilities and the Massachusetts Division of Energy Resources (DOER) also filed plans with the MDPU in February 1996. The DOER's plan calls for direct access for all customers beginning in 1998 with a pilot program beginning in 1997. The DOER plan, however, proposes that, in exchange for stranded cost recovery, utilities divest their generating assets, either through sale or spinoff. The NEES Companies do not support the DOER mandatory divestiture proposal. The MDPU is expected to issue regulations on industry restructuring in September 1996 and to issue orders on the individual utility plans in 1997.\nRhode Island Legislation\nIn February 1996, the Speaker and Majority Leader of the House of Representatives of the Rhode Island Legislature announced the filing of legislation which would allow electric consumers in Rhode Island to choose their power supplier. Under the proposed legislation, large manufacturing customers and new large non- manufacturing customers would gain access to alternative power suppliers over a two-year period beginning in 1998. These customers represent approximately 14 percent of Narragansett's retail kWh sales. The balance of Rhode Island customers would gain access over a two- year period beginning in the year 2000, or earlier if consumers of 50 percent of the electricity in New England gain similar rights to choose their power supplier. The NEES Companies have announced their support for the proposed legislation.\nA key provision of the legislation authorizes utilities to recover the cost of past generation commitments through a transition access charge on utility distribution wires. The legislation divides those past commitments in the same manner as Choice: New England. The legislation proposes a 12-year recovery period for utility generation commitments and regulatory assets. The legislation would require Narragansett to transfer its 10 percent share of the Manchester Street Station and its transmission facilities to separate affiliates at net book value. (For further discussion on the Manchester Street Station repowering project, see Construction and Financing, page 44.)\nThe legislation also establishes performance-based rates for distribution utilities, such as Narragansett. Under the legislation, Narragansett would be entitled to increase its distribution rates by approximately $10 million annually, for the period 1997 through 1999, less any increases in wholesale base rates from NEP passed on by Narragansett to customers. For those three years, Narragansett's return on equity would be subject to a floor of 6 percent and a ceiling of 11 percent. Earnings over the ceiling would be shared equally between customers and shareholders up to an absolute cap on return on equity of 12.5 percent. To the extent that earnings fall below the floor, Narragansett would be authorized to surcharge customers for the shortfall. Consideration by the Rhode Island Legislature of the proposed legislation is expected to be completed by the summer of 1996.\nPreviously, in 1995, the Rhode Island Legislature passed legislation that would have allowed certain industrial customers to buy power from alternative suppliers, rather than through the local electric utility. Narragansett urged the Governor of Rhode Island\nto veto the legislation because Narragansett believed it would result in piecemeal deregulation that would not be fair to customers or shareholders. The Governor vetoed the proposed legislation, in part because of commitments by Narragansett to provide a two-year rate discount to manufacturing customers (see RATES, page 14) and to submit a specific and detailed proposal to the RIPUC addressing the issues associated with providing large customers with access to Narragansett's distribution system for the purpose of choosing an alternative power supplier.\nOther Legislative and Regulatory Initiatives\nIn February 1996, the New Hampshire House of Representatives passed a bill requiring utilities in that state to file plans by June 1996 with the New Hampshire Public Utilities Commission (NHPUC) to provide customers with access to alternative suppliers. The bill allows the NHPUC significant discretion in determining the appropriate level of stranded cost recovery. The bill would authorize the NHPUC to impose a plan on utilities if none is filed and approved by July 1997. The bill is pending in the state Senate.\nIn January 1996, Granite State reached an agreement with the NHPUC staff to conduct a retail access pilot for 3 percent of Granite State's customers. If approved by the NHPUC and the FERC, participating customers in the pilot will pay access charges that are on average over 90 percent of the charges proposed under Choice: New England. The agreement was reached in response to 1995 legislation which directed the NHPUC to establish a pilot program for the state's utilities. The agreement includes more favorable terms regarding stranded cost recovery than preliminary pilot guidelines issued by the NHPUC. In February 1996, the NHPUC indicated that further review of certain assumptions made in the agreement was necessary. The Commission also expanded the pilot to include new large commercial and industrial customers. Separately, in June 1995, the NHPUC issued a decision stating that franchise territories in New Hampshire are not exclusive as a matter of law. That decision is under appeal.\nIn February 1996, the MDPU denied the recovery of stranded power generation costs in the context of the town of Stow, Massachusetts, attempting to purchase the distribution assets in that town owned by the neighboring Hudson Municipal Light Department. Although the MDPU reaffirmed its general position that utilities should have a reasonable opportunity to recover net, non- mitigable, stranded costs, it refused to allow recovery in this case stating that Hudson had not sufficiently demonstrated that stranded costs would be incurred and made no effort to mitigate any such costs. Both parties have appealed the MDPU decision, and the MDPU has stayed its decision pending appeal.\nIn August 1995, the MDPU issued an order requiring a customer of another utility who installed cogenerating equipment to pay 75 percent of that utility's stranded costs attributable to serving the customer's load. The MDPU indicated the decision did not set a precedent for stranded cost recovery as part of industry restructuring. In March 1996, the FERC ruled that it would not review the MDPU's decision. The customer is expected to appeal the decision to the courts.\nIn March 1995, the FERC issued a Notice of Proposed Rulemaking (NOPR) in which it stated that it is appropriate that legitimate and verifiable stranded costs be recovered from departing customers as a result of wholesale competition. The FERC also indicated that costs stranded as a result of retail competition would be subject to state commission review if the necessary statutory authority exists and subject to FERC review if the state commission does not have such authority. A final decision is expected during 1996. The NOPR also addressed open access transmission and indicated that those utilities owning transmission facilities would be required to file a tariff to make available comparable transmission service. For further discussion, see RATES, page 14.\nRisk Factors\nThe major risk factors affecting recovery of at-risk assets are: (i) regulatory and legal decisions, (ii) the market price of power, and (iii) the amount of market share retained by the NEES Companies. First, there can be no assurance that a final restructuring plan ordered by regulatory bodies, or the courts, or through legislation will include an access charge that would fully recover stranded costs. If laws are enacted or regulatory decisions are made that do not offer an opportunity to recover stranded costs, NEES believes it has strong legal arguments to challenge such laws or decisions. Such a challenge would be based, in part, on the assertion that subjecting utility generating assets to competition without compensation for stranded costs, while requiring utilities to open access to their wires at historic cost-based rates, would constitute an unconstitutional taking of property without just compensation. Second, the access charge proposed under Choice: New England recovers only sunk costs, such as plant expenditures and contractual commitments. Because of a regional surplus of electric generation capacity, current wholesale power prices in the short-term market are based on the short-run fuel costs of generating units. Such wholesale prices are not currently providing a significant contribution toward other marginal costs, such as operation and maintenance expenses. The NEES Companies expect this situation to continue in a retail\nmarket. Third, revenues will also be affected by the NEES Companies' ability to retain existing customers and attract new customers in a competitive environment. As a result of the pressure on market prices and market share, it is likely that, even if Choice: New England is implemented, the NEES Companies would experience losses in revenue for an indeterminate period and increased revenue volatility.\nThe major risk factors affecting the Retail Companies relate to the possibility of adverse regulatory decisions or legislation which limit the level of revenues the Retail Companies are allowed to charge for their services. Each of the Retail Companies' all- requirements purchased power contract with NEP requires either party to give seven years notice prior to terminating the contract. Termination of the contract would create stranded costs at NEP that NEP would seek to recover from the Retail Companies pursuant to the contract. In that event, the Retail Companies would seek recovery of such stranded costs from their customers. However, there is no assurance that the final restructuring plans ordered by state regulatory bodies or state legislatures will include provisions that allow the Retail Companies to fully recover any stranded costs passed on to the Retail Companies by NEP. In such an event, the Retail Companies could be faced with a significant amount of costs being billed to them by NEP that the Retail Companies could not fully recover from retail customers, for which the Retail Companies would seek a remedy in the courts. In addition, there is no assurance that any performance incentive system, which regulators might ultimately adopt with respect to any of the Retail Companies' distribution activities, would allow the Retail Companies to fully recover prudently incurred costs and earn a reasonable return on investment.\nHistorically, electric utility rates have been based on a utility's costs. As a result, electric utilities are subject to certain accounting standards that are not applicable to other business enterprises in general. Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS 71), requires regulated entities, in appropriate circumstances, to establish regulatory assets and liabilities, and thereby defer the income statement impact of certain costs that are expected to be recovered in future rates. The effects of regulatory, legislative, or utility initiatives could, in the near future, cause all or a portion of the NEES Companies' operations to cease meeting the criteria of FAS 71. In that event, the application of FAS 71 to such operations would be discontinued and a non-cash write-off of previously established regulatory assets and liabilities related to such operations would be required. At December 31, 1995, NEES had consolidated pre-tax regulatory assets (net of regulatory liabilities) of approximately $600 million, of\nwhich about $500 million is related to its subsidiaries' generation business (including approximately $200 million related to oil and gas properties regulated as part of the generation business which is recoverable in its entirety from NEP), $54 million is related to Mass. Electric, and $48 million is related to Narragansett. If competitive or regulatory change should cause a substantial revenue loss or lead to the permanent shutdown of any generating facilities, a write-down of plant assets could be required pursuant to 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 addition, FAS 121 requires that all regulatory assets, which must have a high probability of recovery to be initially established, must continue to meet that high probability standard to avoid being written off. FAS 121, which is effective for NEES and its subsidiaries in January 1996, is not expected to have a material adverse impact on the financial condition or results of operations upon adoption, based on the current regulatory environment in which NEES's subsidiaries operate. However, the impact in the future may change as competitive factors and potential restructuring influence the electric utility industry.\nRATES\nGeneral\nIn 1995, 73% of the System's electric utility revenues was attributable to NEP, whose rates are subject to regulation by the FERC. The rates of Mass. Electric, Narragansett, and Granite State are subject to the respective jurisdictions of the state regulatory commissions in Massachusetts, Rhode Island, and New Hampshire.\nThe rates of each of the Retail Companies contain a purchased power cost adjustment clause (PPCA). The PPCA is designed to allow the Retail Companies to pass on to their customers changes in purchased power expense resulting from changes allowed by the FERC in NEP's rates. PPCA changes become effective on the dates specified in the filing of the adjustments with the state regulatory commission (not earlier than 30 days after such filing) unless the state regulatory commission orders otherwise. There have been, on occasion, regulatory delays in permitting PPCA increases. Narragansett and Granite State rates have PPCA clauses that fully reconcile on an annual basis purchased power expenses incurred by the companies against purchased power related revenues.\nUnder a case decided by the Rhode Island Supreme Court in 1977 (Narragansett v. Burke), NEP's wholesale rates must be accepted as\nallowable expenses for rate-making purposes by state commissions in retail rate proceedings. In 1986 and 1988 the U.S. Supreme Court reaffirmed this doctrine in two cases that did not involve NEP. However, the Narragansett v. Burke doctrine has been indirectly challenged by a number of state regulatory commissions which have held that federal preemption of the regulation of wholesale electric rates does not preclude the state commission from reviewing the prudence of a utility's decision to purchase power under a FERC-approved rate, and from disallowing costs if it finds that the purchase was an imprudent choice among alternative sources. In a 1985 opinion, the New Hampshire Supreme Court took this position on the issue of state regulation of wholesale power purchases. Also, legislation has been filed from time to time in Congress that would have eroded or repealed the doctrine. If state commissions were to refuse to allow the Retail Companies to include the full cost of power purchased from NEP in their rates, System earnings could be adversely affected.\nThe rates of NEP and the Retail Companies contain fuel adjustment clauses that allow the rates to be adjusted to reflect changes in the cost of fuel. NEP's fuel clause is on a current basis. Mass. Electric has a fuel clause billing procedure that provides for billing of fuel costs estimated on a quarterly basis, while fuel costs billed by Narragansett and Granite State are estimated on a semi-annual basis. Billings are adjusted in the subsequent period for any excess or deficiency in fuel cost recovery.\nFor a discussion of rates in a more competitive environment, see COMPETITIVE CONDITIONS, page 7.\nNEP Rates\nIn February 1995, the FERC approved a rate agreement filed by NEP. Under the agreement, which became effective January 1995, NEP's base rates are frozen through 1996. Before this rate agreement, NEP's rate structure contained two surcharges that were recovering the costs of a coal conversion project and a portion of NEP's investment in the Seabrook 1 nuclear unit (Seabrook 1). These two surcharges fully recovered their related costs by mid-1995. However, under the rate agreement, the revenues continue to be collected as part of base rates. The agreement also provides for (i) full recovery of costs associated with the Manchester Street Station repowering project, which began commercial operation during the second half of 1995, (ii) the recovery of approximately $50 million of deferred costs associated with terminated purchased power contracts and postretirement benefits other than pensions (PBOPs) over seven years, (iii) full recovery of currently incurred PBOP costs, (iv) the recovery over three years of $27 million of\ncosts related to the dismantling of a retired generating station in Rhode Island and the replacement of a turbine rotor at one of NEP's generating units, and (v) increased recovery of depreciation expense by approximately $8 million annually to recognize costs that will be incurred upon the eventual dismantling of its Brayton Point and Salem Harbor generating plants. Under the agreement, approximately $15 million of the $38 million in Seabrook 1 costs scheduled for recovery in 1995 pursuant to a 1988 settlement agreement were deferred for recovery in 1996.\nFinally, the agreement provided that NEP would reimburse its wholesale customers for discounts provided by those wholesale customers to their retail customers under service extension discount (SED) programs. Under these programs, retail customers are entitled to such discounts only if they have signed an agreement not to purchase power from another supplier or generate any additional power themselves for a three to five year period. Reimbursements in 1995 totaled $12 million.\nThe FERC's approval of this rate agreement applies to all of NEP's customers except the Milford Power Limited Partnership (MPLP). MPLP, owner of a gas-fired power plant in Milford, Massachusetts, has protested this rate agreement based on issues related to the Manchester Street Station repowering project. See LEGAL PROCEEDINGS , page 60.\nTransmission Rates\nIn response to the FERC NOPR discussed above, NEP and NEES Trans, a proposed new subsidiary of NEES, filed transmission tariffs in March 1996 at the FERC that will become applicable for all wholesale transmission transactions, including those of the Retail Companies. Under the proposed tariffs and accompanying support agreements, NEES Trans will provide all wholesale transmission services involving the NEES Companies' facilities under comparable, nondiscriminatory transmission rates. The existing NEES Companies would turn operational control of their transmission facilities over to NEES Trans in exchange for support payments from NEES Trans for these facilities. The existing NEES Companies may, at a later date, transfer their transmission assets to NEES Trans. The net book values of NEP's and Narragansett's transmission systems are approximately $340 million and $80 million, respectively. NEP is requesting that its filing become effective by June 1, 1996 or upon approval by the Securities and Exchange Commission (SEC), for the establishment of this new company. If approved as filed, the implementation of the tariffs would not have a significant impact on NEP's revenues.\nMass. Electric Rates\nRate schedules applicable to electric services rendered by Mass. Electric are on file with the MDPU.\nThe MDPU approved a $31 million increase to base rates for Mass. Electric, effective October 1, 1995.\nIn 1993, the MDPU approved a rate agreement filed by Mass. Electric, the Massachusetts Attorney General, and two groups of large commercial and industrial customers. Under the agreement, effective December 1, 1993, Mass. Electric implemented an 11-month general rate decrease of $26 million (annual basis). This rate reduction continued in effect through October 31, 1994, at which time rates increased to the previously approved levels. The agreement also provided for the recognition of electricity delivered but not yet billed (unbilled revenues) for accounting purposes. Unbilled revenues at September 30, 1993 of approximately $35 million were amortized to income over 13 months ending December 1994. The agreement further provided for rate discounts for large commercial and industrial customers who signed agreements to give a five year notice to Mass. Electric before they purchase power from another supplier or generate any additional power themselves. In addition, commencing in 1995 the cost of these discounts is being passed on to NEP as a result of a NEP rate settlement that was approved by the FERC in early 1995.\nThe 1993 agreement also resolved all rate recovery issues associated with environmental remediation costs of Massachusetts manufactured gas waste sites formerly owned by Mass. Electric and its affiliates, as well as certain other environmental cleanup costs. See Hazardous Substances, page 40.\nNarragansett Rates\nRate schedules applicable to electric services rendered by Narragansett are on file with the RIPUC and the Rhode Island Division of Public Utilities and Carriers.\nThe RIPUC approved a settlement agreement that provides for a $15 million increase to base rates for Narragansett effective December 1, 1995. The RIPUC also approved $3 million of new discounts for manufacturing customers, the costs of which are not being recovered from other customers. In February 1995, the FERC approved a rate agreement, effective in January 1995, for NEP. This rate agreement, among other things, increased the credits Narragansett receives from NEP for the costs of owning and operating its generation and transmission facilities\nby $14 million on an annual basis. Narragansett supplies all of the output of its generating facilities to NEP. The increase in the credits reflects Narragansett's 10 percent investment in the Manchester Street Station, which entered commercial operation in the second half of 1995, and the transmission facilities associated with the station, which were placed in service in September 1994. An additional increase in these credits of approximately $2 million took effect in January 1996.\nIn 1994, the RIPUC approved a rate agreement between Narragansett and the Rhode Island Division of Public Utilities and Carriers that provided for Narragansett to recognize, for accounting purposes, $14 million of unbilled revenues over a 21 month period which ended in December 1995. The agreement further provided for rate discounts for large commercial and industrial customers who signed agreements to give a five-year notice to Narragansett before they purchase power from another supplier or generate any additional power themselves. In addition, commencing in 1995 the cost of these discounts is being passed on to NEP as a result of the NEP rate settlement referred to above.\nEffective March 1993, the RIPUC approved a new PPCA mechanism for the recovery of all of Narragansett's purchased power costs, excluding fuel charges which continue to be recovered through a separate adjustment mechanism. Under the new mechanism any over or under-collections of purchased power expense will ultimately be passed on to customers including the effects of peak-demand billing fluctuations. Narragansett accrues the effects of this new mechanism on its books on a current basis.\nEffective January 1993, the RIPUC approved a $1.5 million increase in rates for Narragansett, representing the first step of a three-year phase-in of Narragansett's recovery of costs associated with PBOPs. The second and third $1.5 million increases took effect in January 1994 and 1995, respectively.\nA 1986 Rhode Island Supreme Court decision held that the RIPUC's rate-making power includes the authority to order refunds of amounts earned in excess of an allowed return. As a result, the RIPUC monitors Narragansett's earnings on a regular basis.\nGranite State Rates\nIn July 1995, Granite State filed a $2.6 million rate increase request with the NHPUC. On October 31, 1995, Granite State received approval to collect an interim increase of $0.9 million, effective November 1, 1995, subject to refund or surcharge pending the final outcome of the full case. The NHPUC staff is recommending a rate decrease of approximately $0.3 million. A final decision is expected in 1996.\nCommencing in 1995, Granite State began offering discounts to large commercial and industrial customers who give Granite State a five year notice before they purchase power from another supplier or generate additional power themselves. Granite State is reimbursed for these discounts by NEP. Effective July 1, 1993, the NHPUC approved a $0.7 million increase in rates for Granite State to recover costs associated with PBOPs.\nEffective March 1993, the NHPUC authorized a $2.0 million rate increase for Granite State, with a retroactive adjustment to September 15, 1992 to reflect the difference between the authorized amount and the $1.4 million Granite State had been collecting on an interim basis since September 15, 1992.\nRecovery of Demand-Side Management Expenditures\nThe three Retail Companies offer conservation and load management programs, usually referred to in the industry as Demand- Side Management (DSM) programs, which are designed to help customers use electricity efficiently, as a part of meeting the NEES Companies' future resource needs and customers' needs for energy services.\nThe Retail Companies regularly file their DSM programs with their respective regulatory agencies and have received approval to recover DSM program expenditures in rates on a current basis. Mass. Electric's expenditures were $53 million, $59 million, $47 million in 1995, 1994, and 1993, respectively. Narragansett's expenditures were $9 million, $10 million, and $12 million in 1995, 1994, and 1993, respectively. Since 1990, the Retail Companies have been allowed to earn incentives based on the results of their DSM programs. The Retail Companies must be able to demonstrate the electricity savings produced by their DSM programs to their respective state regulatory agencies before incentives are recorded. Mass Electric recorded $5.1 million, $7.1 million, and $6.7 million of before-tax incentives in 1995, 1994, and 1993, respectively. Narragansett recorded $0.5 million, $0.6 million, and $0.5 million of before-tax incentives in 1995, 1994, and 1993, respectively. The Retail Companies have received regulatory orders that will give them the opportunity to continue to earn incentives based on 1996 DSM program results.\nGENERATION\nEnergy Mix\nThe following table displays the contributions of various fuel sources and other generation to total net generation of electricity by NEP during the past three years, as well as an estimate for 1996:\nElectric Utility Properties\nThe electric utility properties of the System companies consist of NEP's and Narragansett's fossil-fuel base load and intermediate load steam and combined cycle generating units, conventional and pumped storage hydroelectric stations, internal combustion peaking units, portions of fossil fuel and nuclear generating units, the ownership interests of NEET, Mass. Hydro, and N.H. Hydro in the Hydro-Quebec Interconnection, and an integrated system of transmission lines, substations, and distribution facilities. See MAP - ELECTRIC UTILITY PROPERTIES, page 24.\nNEP's integrated system consists of 2,284 circuit miles of transmission lines, 117 substations with an aggregate capacity of 13,718,538 kVA, and 7 pole or conduit miles of distribution lines. The properties of Mass. Electric and Narragansett include substations and distribution and transmission lines, which are interconnected with transmission and other facilities of NEP. At December 31, 1995, Mass. Electric owned 256 substations, which had\nan aggregate capacity of 2,794,364 kVA, 142,636 line transformers with the capacity of 7,315,338 kVA, and 15,726 pole or conduit miles of distribution lines. Mass. Electric also owns 83 circuit miles of transmission lines. At December 31, 1995, Narragansett owned 237 substations, which had an aggregate capacity of 2,803,118 kVA, 48,828 line transformers with the capacity of 2,090,935 kVA, and 4,297 pole or conduit miles of distribution lines. Narragansett, in addition, owns 325 circuit miles of transmission lines.\nSubstantially all of the properties and franchises of Mass. Electric, Narragansett, and NEP are subject to the liens of indentures under which mortgage bonds have been issued. For details of the mortgage liens on these properties see the long-term debt note in Notes to Financial Statements in each of these companies' respective 1995 annual reports. The properties of NEET are subject to a mortgage under its financing arrangements.\n(a) These units currently burn coal, but are also capable of burning oil. In addition Brayton Point Units 1, 2, and 3 are capable of limited co-firing of natural gas.\n(b) For a discussion of the Manchester Street Station repowering project, see Construction and Financing on page 44.\n(c) Includes (i) an interest in a jointly owned oil-fired unit in Yarmouth, Maine, and (ii) diesel units at various locations.\n(d) See Hydroelectric Project Licensing, page 38.\n(e) See Nuclear Units, page 29.\n(f) Capability includes contracted purchases (1,402) less contract sales (364 MW). Net generation includes the effects of the above contracted purchases and economy interchanges through the New England Power Exchange (including a 2 MW capacity credit associated with purchases from Hydro-Quebec and purchases from non-utility generation). For further information see Non- Utility Power Producer Information, page 27.\nNEP and Narragansett are members of the New England Power Pool (NEPOOL). Mass. Electric and Granite State participate in NEPOOL through NEP. The NEPOOL Agreement provides for coordination of the planning and operation of the generation and transmission facilities of its members. The NEPOOL Agreement incorporates generating capacity reserve obligations, provisions regarding the use of major transmission lines, and provisions for payment for facilities usage. The NEPOOL Agreement further provides for New England-wide central dispatch of generation through the New England Power Exchange. Through NEPOOL, operating and capital economies are achieved and reserves are established on a region-wide rather than an individual company basis.\nThe 1995 NEPOOL peak demand of 20,499 MW occurred on July 27, 1995. This was slightly below the all time NEPOOL peak demand of 20,519 MW set on July 21, 1994.\nThe 1995 summer peak for the System of 4,381 MW occurred at the same day as the NEPOOL peak demand. The previous all-time peak load of 4,385 MW occurred on July 21, 1994. The 1995-1996 winter peak of 4,069 MW occurred on December 14, 1995.\nMAP\n(Displays electric utility properties of NEES subsidiaries)\nFuel for Generation\nNEP burned the following amounts of coal, residual oil, and gas during the past three years:\n1995 1994 1993 ---- ---- ---- Coal (in millions of tons) 3.4 3.3 3.2\nOil (in millions of barrels) 1.7 3.4 5.0\nNatural Gas (in billions of cubic feet) 16.2 4.0 0.7\nCoal Procurement Program\nDepending on coal-fired generating unit availability and the degree to which the units are dispatched, NEP's 1996 coal requirements should range between 3.5 and 3.8 million tons. NEP obtains its domestic coal under contracts of varying lengths and on a spot basis from domestic coal producers in Kentucky, West Virginia, and Virginia, and from mines in Colombia and Venezuela. Two different rail systems (CSX and Norfolk Southern) transport coal from domestic sources to loading ports on the east coast. NEP's coal is transported from east coast ports by ocean-going collier to Brayton Point and Salem Harbor. NEP has a term charter with the Energy Enterprise, a self-unloading collier, which carries most of NEP's U.S. coal and a portion of foreign coal. See LEGAL PROCEEDINGS, page 60. NEP also charters other coal-carrying vessels for the balance of foreign coal, and presently has contracts of affreightment with Canada Steamship Lines, International and Malbulk Shipping Inc.. As protection against interruptions in coal deliveries, NEP maintains average coal inventories at its generating stations of 35 to 55 days.\nTo meet environmental requirements, NEP uses coal with a relatively low sulphur content. NEP's average price for coal burned, including transportation costs, calculated on a 26 million Btu per ton basis, was $43.53 per ton in 1993, $42.90 in 1994, and $42.25 in 1995. Based on a 42 gallon barrel of oil producing 6.3 million Btu's, these coal prices were equivalent to approximately $10.57 per barrel of oil in 1993, $10.41 in 1994, and $10.25 in 1995.\nOil Procurement Program\nDepending on unit availability, dispatch, and the relationship of oil and gas prices, the System's 1996 oil requirements are expected to be approximately 1.5 to 2.0 million barrels. The System obtains its oil requirements through contracts with oil\nsuppliers and purchases on the spot market. Current contracts provide for minimum purchases of 0.4 million barrels at market related prices. The System currently has a total storage capacity for approximately 1.5 million barrels of residual and diesel fuel oil. The System's average cost of oil burned, calculated on a 6.3 million Btu per barrel basis, was $13.30 in 1993, $13.17 in 1994, and $14.46 in 1995.\nNatural Gas\nNEP uses natural gas at Manchester Street (see Construction and Financing, page 44) and, when gas is priced less than residual fuel oil, at Brayton Point Unit 4. Brayton Point Units 1, 2, and 3 also have limited capability to co-fire natural gas with coal. In 1995, approximately 56 billion cubic feet of gas were purchased at an average cost (excluding pipeline demand charges) of $1.70\/MMBTU, 16 billion cubic feet of which were consumed at Brayton Point and Manchester Street Station. This price was equivalent to approximately 10.77 per barrel of oil. The remaining gas was sold to third parties or delivered to an independent power producer project from which NEP purchases power.\nNEP's principal service agreements for firm transportation are with the following pipeline companies:\n(1) 60 million cubic feet per day on TransCanada PipeLines, Ltd (TransCanada) from western Canada supply sources to an interconnection with Iroquois Gas Transmission System (Iroquois). NEP has released 25 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(2) 60 million cubic feet per day on Iroquois to an interconnection with Tennessee Gas Pipeline Company (Tennessee).\n(3) 60 million cubic feet per day on Tennessee to an interconnection with Algonquin Gas Transmission Company (Algonquin).\n(4) 60 million cubic feet per day on ANR Pipeline Company from mid-continent supply sources to an interconnection with Columbia Gas Transmission (Columbia). NEP has released 15 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(5) 60 million cubic feet per day on Columbia to an interconnection with Algonquin. NEP has released 15 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(6) 95 million cubic feet per day on Algonquin to NEP's facilities.\n(7) 120 million cubic feet per day on an Algonquin lateral for deliveries to Brayton Point Station.\nNEP has contracts with two Canadian natural gas suppliers for a total of 35 million cubic feet per day . NEP has not signed any long-term supply arrangements with mid-continent producers. In addition, NEP has a 7.5 million cubic feet per day supply contract with Distrigas Corporation of Massachusetts (DOMAC). Service commenced December 1, 1995.\nService under the pipeline agreements listed above and the DOMAC supply contract require minimum fixed payments. NEP's minimum fixed payments under all pipeline and supply agreements (including those listed above) are currently estimated to be approximately $60 million to $65 million per year from 1996 to 2000. Remaining fixed payments from 2001 through 2014 total approximately $625 million. The amount of the fixed payments is subject to FERC regulation and will depend on FERC actions affecting the rates on each of the pipelines.\nIn connection with managing its fuel supply, NEP uses a portion of this pipeline capacity to sell natural gas. Proceeds from the sale of natural gas and pipeline capacity of $71 million, $55 million, and $21 million in 1995, 1994, and 1993, respectively, have been passed on to customers through NEP's fuel clause. Natural gas sales are expected to decrease as a result of the Manchester Street Station entering commercial operation in the second half of 1995.\nNuclear Fuel Supply\nAs noted below, NEP participates with other New England utilities in the ownership of several nuclear units. See Nuclear Units, page 29. The utilities responsible for supply for these units are not experiencing any difficulty in obtaining commitments for the supply of each element of the nuclear fuel cycle.\nNon-Utility Power Producer Information\nThe System companies purchase a portion of the electricity generated by, or provide back-up or standard service to, 136 small power producers, cogenerators, or independent power producers (a total of 5,178,209 MWh of purchases in 1995). As of December 31, 1995, these non-utility generation sources include 26 low-head\nhydroelectric plants, 49 wind or solar generators, seven waste to energy facilities, 51 cogenerators, and three independent power producers. The total capacity of these sources is as follows:\nIn Service Future Projects (12\/31\/95) Under Contract Source (MW) (MW) ------ ---------- --------------- Hydro 37 - Wind - 20 Waste to Energy 173 16 Cogeneration 304 - Independent Power Producers 380 - ---- -- Total 894 36\nThe in-service amount includes 743 MW of long-term capacity, 16 MW of short-term capacity, and 135 MW treated as load reductions and includes the Ocean State Power contracts discussed below.\nOcean State Power\nOcean State Power (OSP) and Ocean State Power II (OSP II) are general partnerships that own and operate a two unit gas-fired combined cycle electric power plant in Burrillville, R.I. The first unit began commercial operation on December 31, 1990 and the second unit went into service on October 1, 1991. The two units have a combined winter net electrical capability of approximately 562 MW. Each unit's capacity and energy output is sold under 20-year unit power agreements to a group of New England utilities, including NEP, which has contracts for 48.5% of the output of each unit. NEP is required to make certain minimum fixed payments to cover capital and fixed operating costs of these units in amounts estimated to be $75 million per year.\nResources is a general partner with a 20% interest in both OSP and OSP II and had an equity investment of approximately $36 million at December 31, 1995.\nInterconnection with Quebec\nNEET, Mass. Hydro, and New Hampshire Hydro own and operate, on behalf of NEPOOL participants in the project, a 450 kV direct current transmission line and related terminals to interconnect the New England and Quebec transmission systems (the Interconnection). The transfer capability of the Interconnection is 2,000 MW. Operating limits implemented by adjacent Power Pools covering New York, New Jersey, Pennsylvania, and Maryland often restrict the effective transfer capability to a lower level. NEPOOL members\npurchase from and sell energy to Hydro-Quebec pursuant to several agreements. The principal agreement calls for NEPOOL members to purchase 7 billion kWh of energy each year for ten years (the Firm Energy Contract). Purchases under the Firm Energy Contract totaled over 5.2 billion kWh in 1995. Net energy deliveries from Hydro- Quebec over the Interconnection totaled more than 8 billion kWh in 1995. These additional deliveries reflect the use of the Interconnection by participants to conduct independent transactions with Hydro-Quebec on a regular basis.\nNEP is a participant in both the Phase I and Phase II projects of the Interconnection. NEP's participation percentage in both projects is approximately 18%. NEP and the other participants have entered into support agreements that end in 2020, to pay monthly their proportionate share of the total cost of constructing, owning, and operating the transmission facilities. NEP accounts for these support agreements as capital leases and accordingly recorded approximately $73 million in utility plant at December 31, 1995. Under the support agreements, NEP has agreed, in conjunction with any Phase II project debt financing, to guarantee its share of project debt. At December 31, 1995, NEP had guaranteed approximately $30 million of project debt. In the event any Interconnection facilities are abandoned for any reason, each participant is contractually committed to pay its pro-rata share of the net investment in the abandoned facilities.\nNuclear Units\nGeneral\nNEP is a stockholder of Yankee Atomic Electric Company (Yankee Atomic), Vermont Yankee Nuclear Power Corporation (Vermont Yankee), Maine Yankee Atomic Power Company (Maine Yankee), and Connecticut Yankee Atomic Power Company (Connecticut Yankee). Each of these companies (collectively referred to as the Yankee Companies) owns a single nuclear generating unit. In addition, NEP is a joint owner of the Millstone 3 nuclear generating unit in Connecticut and the Seabrook 1 nuclear generating unit in New Hampshire. Millstone 3 and Seabrook 1 are operated by subsidiaries of Northeast Utilities (NU). NEP pays its proportionate share of costs and receives its proportionate share of each unit's output. NEP's interest and investment in each of the Yankee Companies, Millstone 3, and Seabrook 1 and the net capability of each plant are as follows:\nEquity Net Investment Capability (12\/31\/95) Interest (MW) (in millions) -------- ---------- ------------- Yankee Atomic 30.0% * $ 7 Vermont Yankee 20.0% 96 10 Maine Yankee 20.0% 158 15 Connecticut Yankee 15.0% 87 15 ---- ---- Subtotal 341 $47\nNet Investment in Plant** (12\/31\/95) (in millions) ------------- Millstone 3 12.2% 140 $386 Seabrook 1 9.9% 115 62 ---- ---- Subtotal 255 $448 ---- Total 595 ====\n*Operations permanently ceased **Excludes nuclear fuel\nNEP has a 30% ownership interest in Yankee Atomic which owns a 185 megawatt nuclear generating station in Rowe, Massachusetts. In 1992, the Yankee Atomic board of directors decided to permanently cease power operation of the facility and to proceed with decommissioning.\nNEP has recorded an estimate of its total future payment obligations for post-operating costs to Yankee Atomic as a liability and an offsetting regulatory asset of $68 million each at December 31, 1995, reflecting its expected future rate recovery of such costs.\nNEP purchases the output of the other Yankee nuclear electric generating plants in the same percentages as its stock ownership of the Yankee Companies, less small entitlements taken by municipal utilities for Maine Yankee and Vermont Yankee. NEP has power contracts with each Yankee Company that require NEP to pay an amount equal to its share of total fixed and operating costs (including decommissioning costs) of the plant plus a return on equity.\nThe stockholders of three Yankee Companies (Vermont Yankee, Maine Yankee, and Connecticut Yankee) have agreed, subject to regulatory approval, to provide capital requirements in the same proportion as their ownership percentages of the particular Yankee Company.\nThere is widespread concern about the safety of nuclear generating plants. The Nuclear Regulatory Commission (NRC) regularly reviews the adequacy of its comprehensive requirements for nuclear plants. Many local, state, and national public officials have expressed their opposition to nuclear power in general and to the continued operation of nuclear power plants. From time to time, various organizations and individuals file petitions raising safety concerns at particular nuclear units. It is possible that this controversy will result in cost increases and modifications to, or premature shutdown of, the operating nuclear units in which NEP has an interest.\nMaine Yankee is currently operating at 90% power (790 MW) while the NRC conducts an investigation of allegations made by an anonymous individual. The allegations contend that Yankee Atomic, acting as agent for Maine Yankee, knowingly performed inadequate analyses of the plant's cooling system and that Maine Yankee misrepresented the analyses to the NRC in order to attain two license amendments to increase the rated thermal power at which Maine Yankee may operate. Maine Yankee and Yankee Atomic are also conducting an internal investigation into the matter. Maine Yankee is performing a new cooling system analysis in order to address the NRC's concerns with the existing analyses and intends to submit the new analysis to the NRC by mid-1996. The schedule for NRC review of, and action upon, the filing is unknown. The NRC also has on- going investigations into allegations about safety violations made by a whistle blower employee at Vermont Yankee.\nIn January 1996, the NRC added the three units at Millstone Station to its Category 2 problem plant list. This designation indicates that \"weaknesses have been identified that warrant increased NRC attention until the licensee demonstrates a period of improved performance.\" Although there are significant variations in the performance of the three units, a number of problems over the last five years, combined with a failure to sustain improved performance across all three units and to resolve employee concerns, resulted in the entire station being placed on the problem plant list. In addition, the NRC has ordered Millstone 1 and 2 to remain shutdown pending safety verification. NEP has no ownership interest in either Millstone 1 or 2. In March 1996, the NRC issued a letter requiring Millstone 3 and Connecticut Yankee to demonstrate to the NRC within 30 days a plan and schedule\nto ensure that the future operation of those units will be conducted in accordance with their operating licenses and safety provisions or face license suspension. The letter was issued based upon internal documentation provided to the NRC which stated that Millstone 3 and Connecticut Yankee may have some of the same underlying problems as Millstone 1 and 2. It is unknown what effect the increased NRC scrutiny will have on the operations and cost of Millstone 3 and Connecticut Yankee. Other non-affiliated facilities which have been on the problem plant list have incurred substantial additional capital and operating expenditures before the NRC designation was changed.\nOn three occasions (most recently in 1987), referenda appeared on the ballot in Maine that, if passed, would have required the prompt shutdown of Maine Yankee. All the referenda were defeated. There is no assurance that similar measures will not appear on future ballots.\nAging Units\nThe remaining Yankee plants may experience age-related deterioration of essential plant equipment or facilities. To the extent that costly repair, replacement, or maintenance becomes necessary due to such deterioration, the overall economics of the unit would have to be re-evaluated and early shut-down of such units could occur, as was the case with the Yankee Atomic plant.\nMaine Yankee was shut down from January 1995 to January 1996 for refueling and repairs to the plant's steam generators. Analyses of the plant's steam generator tubes during the 1995 refueling revealed that approximately 60% of the tubes had sustained some level of circumferential cracking. Maine Yankee repaired the tubes by inserting reinforcing \"sleeves\" into all 17,100 tubes in its three steam generators. The sleeving repair was completed at a cost of $26.8 million ($4.8 million NEP share), significantly under the original $40 million ($7.2 million NEP share) budget. Maine Yankee has been operating at 90% capacity since January 1996, and plans to operate at 100% capacity upon resolution of the NRC investigation referred to above.\nDecommissioning\nEach of the Yankee Companies includes charges for all or a portion of decommissioning costs in its cost of energy. These charges vary depending upon rate treatment, the method of decommissioning assumed, economic assumptions, site and unit specific variables, and other factors. Any increase in these charges is subject to FERC approval.\nEach of the operating nuclear units has established decommissioning trust funds or escrow funds into which payments are being made to meet the projected cost of decommissioning and dismantling its plant. If any of the units were shut down prior to the end of its operating license, the funds collected for decommissioning to that point would be insufficient. Estimates of NEP's pro-rata share (based on ownership) of decommissioning costs, NEP's share of the actual book values of decommissioning fund balances set aside for each unit at December 31, 1995, and the expiration date of the operating license of each plant are as follows:\nNEP is currently collecting through rates amounts for decommissioning based upon cost estimates and funding methodologies authorized by FERC. Such estimates are determined periodically for each plant and may not reflect the current projected cost of decommissioning.\nThere is no assurance that decommissioning costs actually incurred by the Yankee Companies, Millstone 3, or Seabrook 1 will not substantially exceed these amounts. For example, current decommissioning cost estimates assume the availability of permanent repositories for both low-level and high-level nuclear waste which do not currently exist. NRC rules require that reasonable assurance be provided that adequate funds will be available for the decommissioning of commercial nuclear power plants. The rule\nestablishes minimum funding levels that licensees must satisfy. Each of the units in which NEP has an interest has filed a report with the NRC providing assurance that funds will be available to decommission the facility.\nA Maine statute provides that if both Maine Yankee and its decommissioning trust fund have insufficient assets to pay for the plant decommissioning, the owners of Maine Yankee are jointly and severally liable for the shortfall. The definition of owner under the statute covers NEP and may cover companies affiliated with it. NEP and the Retail Companies cannot determine, at this time, the constitutionality, applicability, or effect of this statute. If NEP or the Retail Companies were required to make payments under this statute, they would assess their legal remedies at that time. In any event, NEP and the Retail Companies would attempt to recover through rates any payments required. If any claim in excess of NEP's ownership share were enforced against a NEES company, that company would seek reimbursement from any other Maine Yankee stockholder which failed to pay its share of such costs.\nHigh-Level Waste Disposal\nThe Nuclear Waste Policy Act of 1982 provides a framework and timetable for selection of sites for repositories of high-level radioactive waste (spent nuclear fuel) from United States nuclear plants. The U.S. Department of Energy (DOE) has entered into contracts with the Yankee Companies, the Millstone 3 joint owners, and the Seabrook 1 joint owners for acceptance of title to, and transportation and storage of, this waste. Under these contracts, each operating unit will pay fees to the DOE to cover the development and creation of waste repositories. Fees for fuel burned since April 1983 have been collected by the DOE on an ongoing basis at the rate of one tenth of a cent per kWh of net generation. Fees for generation up through April 1983 were determined by the DOE as follows: $13.2 million for Yankee Atomic, $48.7 million for Connecticut Yankee, $50.4 million for Maine Yankee, and $39.3 million for Vermont Yankee. Neither Millstone 3 nor Seabrook 1 has been assessed any fees for fuel burned through April 1983, because they did not enter commercial operation until 1986 and 1990, respectively.\nThe Yankee Companies had several options to pay these fees. Yankee Atomic paid its fee to the DOE for the period through April 1983. The other three Yankee Companies elected to defer payment until a future date, thereby incurring interest expense. However, payment to the DOE must occur prior to the first delivery of spent fuel. Connecticut, Maine, and Vermont Yankee have segregated a portion of their respective DOE obligations in external accounts. The remainder of the funds have been used to support general\ncapital requirements. All expect to separately fund in full in external accounts their DOE obligation (including accrued interest) prior to payment to the DOE. To the extent that any of the three Yankee Companies is unable to fully meet its DOE obligation at the prescribed time, NEP might be required to provide additional funds.\nPrior to such time that the DOE takes delivery of a plant's spent nuclear fuel, it is stored on site in spent fuel pools. Connecticut Yankee, Maine Yankee, Millstone 3, and Seabrook are in the process of reconfiguring their spent fuel pools to allow for additional storage capability. Upon successful completion of the reconfiguring, Connecticut Yankee, Maine Yankee, and Millstone 3 will have sufficient spent fuel pool capacity to support plant operation through the expiration of their respective current NRC license. Seabrook 1's licensed storage capacity will allow a full core discharge until 2011. Vermont Yankee is able to maintain a full core discharge capability until 2001. Yankee Atomic has adequate on-site storage capacity for all its spent fuel.\nFederal legislation enacted in 1987 directed the DOE to proceed with the studies necessary to develop and operate a permanent high-level waste disposal site at Yucca Mountain, Nevada. There is local opposition to development of this site. Although originally scheduled to open in 1998, the DOE currently estimates that the permanent disposal site is not expected to open before 2015. Nuclear waste legislation mandating DOE acceptance of spent fuel at an interim storage site in Nevada by January 1, 1998 was introduced in Congress in 1995. To date, the legislation has not been brought before the House or the Senate for vote. In January 1996, oral arguments were heard in a lawsuit filed in the U.S. Court of Appeals for the District of Columbia Circuit by 25 utilities, 22 public utilities commissions, and 17 states. The lawsuit petitions the court to declare the 1998 contract date a binding legal obligation and to order DOE to report back to the court with a plan for meeting that obligation. The Court is expected to issue a decision by May 1996.\nThe legislation enacted in 1987 also provides for the development of a Monitored Retrievable Storage (MRS) facility and abandons plans to identify and select a second, permanent disposal site. An MRS facility would provide temporary storage for high-level waste prior to eventual permanent disposal. Pending a vote on the legislation mentioned above, it is not known when an MRS facility would begin accepting deliveries. Additional delays due to political and technical problems are likely.\nFederal authorities have deferred indefinitely the commercial reprocessing of spent nuclear fuel.\nLow-Level Waste Disposal\nIn 1986, the Low-Level Radioactive Waste Policy Amendments Act was enacted by Congress. This statute allowed the states in which the three existing low-level waste disposal sites were located to deny access to non-regional waste generators after 1992. Under the statute, individual states are responsible for finding local sites for disposal or forming regional disposal compacts by defined milestone dates.\nNone of the states in which NEP holds an interest in a nuclear facility has met the statutory milestones toward developing disposal sites. Currently, two low-level waste disposal sites in the U.S. are accepting non-regional waste, Chem-Nuclear Systems, Inc.'s site in Barnwell, South Carolina and Envirocare of Utah, Inc's site in Clive, Utah. The Barnwell facility reopened its services to most non-regional generators, on July 1, 1995 and is authorized to remain open until July 1, 2005. In March 1996, the South Carolina Supreme Court will hear oral arguments on a challenge to the constitutionality of the legislation re-opening the Barnwell facility to non-regional generators. Envirocare began accepting Class A low-level waste in 1995. Class A waste is the least contaminated of the three categories defining low-level waste. The Barnwell facility accepts all three categories of waste. Connecticut Yankee, Maine Yankee, Millstone 3, Seabrook, and Yankee Atomic are currently shipping low-level waste to these sites.\nThe states of Maine and Vermont have established a compact with Texas for the disposal of low-level waste in Hudspeth County, Texas. The compact agreement has been approved in all three states and is now before the U.S. Congress. If Congress approves, the site is expected to begin accepting waste during 1997 or 1998. While Maine Yankee has been shipping its low-level waste off-site, Vermont Yankee has elected to store low-level waste on-site until that time. The compact releases Maine and Vermont from having to site an in-state disposal facility. Connecticut, Massachusetts, and New Hampshire are still required to pursue local or regional low-level waste disposal facilities. However, Massachusetts is expected to suspend its search for a local disposal facility in 1996.\nNuclear Insurance\nThe Price-Anderson Act limits the amount of liability claims that would have to be paid in the event of a single incident at a nuclear plant to $8.9 billion (based upon 110 licensed reactors). The maximum amount of commercially available insurance coverage to pay such claims is only $200 million. The remaining $8.7 billion\nwould be provided by an assessment of up to $79.3 million per incident levied on each of the nuclear units in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. The maximum assessment, which was most recently adjusted in 1993, is adjusted for inflation at least every five years. NEP's current interest in the Yankee Companies (excluding Yankee Atomic), Millstone 3, and Seabrook 1 would subject NEP to a $58.0 million maximum assessment per incident. NEP's payment of any such assessment would be limited to a maximum of $7.3 million per incident per year. As a result of the permanent cessation of power operation of the Yankee Atomic plant, Yankee Atomic has received from the NRC a partial exemption from obligations under the Price-Anderson Act. However, Yankee Atomic must continue to maintain $100 million of commercially available nuclear insurance coverage.\nEach of the nuclear units in which NEP has an ownership interest also carries nuclear insurance to cover the costs of property damage, decontamination or premature decommissioning and workers' claims resulting from a nuclear incident. These policies may require additional premium assessments if losses relating to nuclear incidents at units covered by this insurance occurring in a prior six year period exceed the accumulated funds available. NEP's maximum potential exposure for these assessments, directly, or indirectly through purchased power payments to the Yankees, is approximately $17 million per year.\nOther Items\nFederal legislation requires emergency response plans, approved by federal authorities, for nuclear generating units. The Yankee Companies, Seabrook 1, and Millstone 3 are not currently experiencing difficulty in maintaining approval of their emergency response plans.\nREGULATORY AND ENVIRONMENTAL MATTERS\nRegulation\nNumerous activities of NEES and its subsidiaries are subject to regulation by various federal agencies. Under the 1935 Act, many transactions of NEES and its subsidiaries are subject to the jurisdiction of the SEC. With the intensifying competitive pressures within the electric utility industry, there has been increasing debate about modifying or repealing the 1935 Act. The System supports its repeal. (See COMPETITIVE CONDITIONS, page 7). Under the Federal Power Act, certain electric subsidiaries of NEES are subject to the jurisdiction of the FERC with respect to rates,\naccounting, and hydroelectric facilities. In addition, the NRC has broad jurisdiction over nuclear units and federal environmental agencies have broad jurisdiction over environmental matters. The electric utility subsidiaries of NEES are also subject to the jurisdiction of regulatory bodies of the states and municipalities in which they operate.\nFor more information, see: RATES, page 14, Nuclear Units, page 29, Fuel for Generation, page 25, Environmental Requirements, page 39, and OIL AND GAS OPERATIONS, page 50.\nHydroelectric Project Licensing\nNEP is the largest operator of conventional hydroelectric facilities in New England. Most of NEP's hydroelectric projects are licensed by the FERC. These licenses expire periodically and the projects must be relicensed at that time. NEP's present licenses expire over a period from 2001 to 2020, excluding the Deerfield River Project discussed below. Upon expiration of a FERC license for a hydro project, the project may be taken over by the United States or licensed to the existing, or a new licensee. If the project were taken over, the existing licensee would receive an amount equal to the lesser of (i) fair value of the project or (ii) original cost less depreciation and amounts held in amortization reserves, plus in either case severance damages. The net book value of NEP's hydroelectric projects was $241 million as of December 31, 1995.\nIn the event that a new license is not issued when the existing license expires, FERC must issue annual licenses to the existing licensee which will allow the project to continue operation until a new license is issued. A new license for a project may incorporate operational restrictions and requirements for additional non-power facilities (e.g., fish passage or recreational facilities) that could affect operation of the project, and may also require additional capital investment. For example, NEP has previously received new licenses for projects on the Connecticut River that involved construction of an extensive system of fish ladders.\nThe license for the 84 MW Deerfield River Project expired at the end of 1993. NEP filed an application for a new license in 1991, which is still under review. NEP has signed, with 15 governmental agencies and advocacy groups, an Offer of Settlement which embodies operational, environmental and recreational conditions acceptable to the parties. NEP has received water quality certifications from the Commonwealth of Massachusetts and the State of Vermont needed to complete the FERC relicensing processing. In Vermont the certificate has been appealed by two\nadvocacy groups who did not participate in the Offer of Settlement process. FERC has issued NEP an annual license to continue operation of the project under the terms and conditions of the expired license until a new license is issued or other disposition of the project takes place.\nThe next NEP project to require a new license will be the 368 MW Fifteen Mile Falls Project on the Connecticut River in New Hampshire and Vermont. This license expires in 2001. The formal process of preparing an application for a new license will begin in 1996.\nIn 1994, the FERC adopted a policy statement in which it asserted that it has authority over the decommissioning of licensed hydroelectric projects being abandoned or denied a new license. However, the FERC has recognized in the process leading to the policy statement, that mandated project removal would occur in only rare circumstances. The FERC also declined to require any generic funding mechanism to cover decommissioning costs. If a project is decommissioned, the licensee may incur substantial costs.\nEnvironmental Requirements\nExisting Operations\nThe NEES subsidiaries are subject to federal, state, and local environmental regulation of, among other things: wetlands and flood plains; air and water quality; storage, transportation, and disposal of hazardous wastes and substances; underground storage tanks; and land-use. It is likely that the stringency of environmental regulation affecting the System and its operations will increase in the future.\nSiting and Construction Activities for New Facilities\nAll New England states require, in certain circumstances, regulatory approval for site selection or construction of electric generating and major transmission facilities. Connecticut, Maine, Massachusetts, New Hampshire, and Rhode Island also have programs of coastal zone management that might restrict construction of power plants and other electrical facilities in, or potentially affecting, coastal areas. All agencies of the federal government must prepare a detailed statement of the environmental impact of all major federal actions significantly affecting the quality of the environment. The New England states have environmental laws which require project proponents to prepare reports of the environmental impact of certain proposed actions for review by various agencies. The System is not currently constructing generating plants or major transmission facilities.\nEnvironmental Expenditures\nTotal System capital expenditures for environmental protection facilities have been substantial. System capital expenditures for such facilities amounted to approximately $23 million in 1993, $51 in 1994, and $39 million in 1995, including expenditures by NEP of $14 million, $44 million, and $32 million, respectively, for those years. The System estimates that capital expenditures for environmental protection facilities in 1996 and 1997 will not be material to the System.\nHazardous Substances\nThe Federal Comprehensive Environmental Response, Compensation and Liability Act, more commonly known as the \"Superfund\" law, imposes strict, joint and several liability, regardless of fault, for remediation of property contaminated with hazardous substances. A number of states, including Massachusetts, have enacted similar laws.\nThe electric utility industry typically utilizes and\/or generates a range of potentially hazardous products and by-products in its operations. NEES subsidiaries currently have an environmental audit program in place intended to enhance compliance with existing federal, state, and local requirements regarding the handling of potentially hazardous products and by-products.\nNEES and\/or its subsidiaries have been named as potentially responsible parties (PRPs) by either the U.S. Environmental Protection Agency (EPA) or the Massachusetts Department of Environmental Protection for 22 sites at which hazardous waste is alleged to have been disposed. Private parties have also contacted or initiated legal proceedings against NEES and certain subsidiaries regarding hazardous waste cleanup. The most prevalent types of hazardous waste sites with which NEES and its subsidiaries have been associated with are manufactured gas locations. (Until the early 1970s, NEES was a combined electric and gas holding company system.) NEES is aware of approximately 40 such locations (including eight of the 22 locations for which NEES Companies are PRPs) mostly located in Massachusetts. NEES and its subsidiaries are currently aware of other sites, and may in the future become aware of additional sites, that they may be held responsible for remediating.\nNEES has been notified by the EPA that it is one of several PRPs for cleanup of the Pine Street Canal Superfund site in Burlington, Vermont, where coal tar and other materials were deposited. Between 1931 and 1951, NEES and its predecessor owned all of the common stock of Green Mountain Power Corporation (GMP).\nPrior to, during, and after that time, gas was manufactured at the Pine Street Canal site by GMP. In 1989, NEES was one of 14 parties required to pay the EPA's past response costs related to this site. NEES remains a PRP for ongoing and future response costs. In November 1992, the EPA proposed a cleanup plan estimated by the EPA to cost $50 million. In June 1993, the EPA withdrew this cleanup plan in response to public concern about the plan and its cost. The cost of any cleanup plan and NEES's share of such cost are uncertain at this time. NEES signed a settlement agreement in March 1996 establishing NEES's apportioned share of these costs. NEES believes it has adequate reserves for this site.\nIn 1993, the MDPU approved a Mass. Electric rate agreement that allows for remediation costs of former manufactured gas sites and certain other hazardous waste sites located in Massachusetts to be met from a non-rate- recoverable interest-bearing fund of $30 million established on Mass. Electric's books in 1993. Rate- recoverable contributions of $3 million, adjusted for inflation, are added to the fund annually in accordance with the agreement. Any shortfalls in the fund would be paid by Mass. Electric and be recovered through rates over seven years.\nPredicting the potential costs to investigate and remediate hazardous waste sites continues to be difficult. There are also significant uncertainties as to the portion, if any, of the investigation and remediation costs of any particular hazardous waste site that may ultimately be borne by NEES or its subsidiaries. A preliminary review by a consultant hired by the NEES Companies of the potential cost of investigating and, if necessary, remediating Rhode Island manufactured gas sites resulted in costs per site ranging from less than $1 million to $11 million. An informal survey of other utilities conducted on behalf of NEES and its subsidiaries indicated costs in a similar range. Where appropriate, the NEES Companies intend to seek recovery from their insurers and from other PRPs, but it is uncertain whether, and to what extent, such efforts would be successful. At December 31, 1995, NEES had total reserves for environmental response costs of $50 million and a related regulatory asset of $19 million. NEES believes that hazardous waste liabilities for all sites of which it is aware, and which are not covered by a rate agreement, are not be material to its financial position.\nElectric and Magnetic Fields (EMF)\nConcerns have been raised about whether EMF, which occur near transmission and distribution lines as well as near household wiring and appliances, cause or contribute to adverse health effects. Numerous studies on the effects of these fields, some of them sponsored by electric utilities (including NEES Companies), have been conducted and are continuing. Some of the studies have\nsuggested associations between certain EMF and health effects, including various types of cancer, while other studies have not substantiated such associations. It is impossible to predict the ultimate impact on NEES subsidiaries and the electric utility industry if further investigations were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems.\nMany utilities, including the NEES Companies, have been contacted by customers regarding the potential relationship between EMF and adverse health effects. To date, no court in the United States has ruled that EMF from electrical facilities cause adverse health effects and no utility has been found liable for personal injuries alleged to have been caused by EMF. In any event, the NEES Companies believe that they currently have adequate insurance coverage for personal injury claims.\nSeveral state courts have recognized a cause of action for damage to property values in transmission line condemnation cases based on the fear that power lines cause cancer. It is difficult to predict what the impact on the NEES Companies would be if this cause of action is recognized in the states in which NEES Companies operate and in contexts other than condemnation cases.\nAir\nApproximately 45 percent of NEP's electricity is produced at eight older thermal generating units in Massachusetts. Six are principally fueled by coal, one by oil, and one by oil and gas. The federal Clean Air Act requires significant reduction in utility sulfur dioxide (SO2) and nitrogen oxides (NOx) emissions that result from burning fossil fuels by the year 2000 to reduce acid rain and ground-level ozone (smog).\nNEP reduced SO2 emissions under Phase 1 of the federal acid rain program and SO2 and NOx emissions under Massachusetts regulations, all of which took effect in 1995. The SO2 and NOx reductions that were made to meet 1995 requirements have resulted in one-time operation and maintenance costs of $21 million and capital costs of $110 million through December 31, 1995. Additional capital expenditures in 1996 are expected to be less than $3 million. Depending on fuel prices, NEP also expects to incur not more than $5 million annually in increased costs to purchase cleaner fuels to meet SO2 emission reduction requirements.\nAll eight of NEP's thermal units will be subject to Phase 2 of the federal and state acid rain regulations that become effective in 2000. NEP believes that the SO2 controls already installed for the 1995 requirements will satisfy the Phase 2 acid rain regulations.\nIn connection with the federal ozone emission requirements, state environmental agencies in ozone non-attainment areas are developing a second phase of NOx reduction regulations that would have to be fully implemented by NEP no later than 1999. While the exact costs are not known, NEP estimates that the cost of implementing these regulations would not jeopardize continued operation of NEP's units.\nThe generation of electricity from fossil fuel also emits trace amounts of certain hazardous air pollutants and fine particulates. An EPA study of utility hazardous air pollutant emissions is expected to be completed in 1996. The study's conclusions could lead to new emission standards requiring costly controls or fuel restrictions on NEP plants. At this time, NEES and its subsidiaries cannot estimate the impact the findings of this research might have on NEP's operations.\nUnder the System's own 1993 corporate resource plan, also known as NEESPLAN 4, the System has a goal to reduce CO2, SOx, and NOx emissions by 2000 to 20%, 60%, and 60%, respectively, below 1990 levels. Consistent with the CO2 goal, in 1995, the NEES Companies and the DOE executed an accord in which the Companies committed to reduce greenhouse gas emissions (e.g. CO2) 20% below 1990 levels by 2000. The accord was executed pursuant to the Climate Challenge Program, a joint voluntary effort of the DOE and the electric utility industry. Climate Challenge is a component of President Clinton's Climate Change Action Plan.\nWater\nThe federal Clean Water Act prohibits the discharge of any pollutant (including heat), except in compliance with a discharge permit issued by the states or the EPA for a term of no more than five years. NEP and Narragansett have received required permits for all their steam-generating plants. NEET has received its required surface water discharge permits for all of its current operations.\nNEES facilities store substantial amounts of oil and are required to have spill prevention control and counter-measure (SPCC) plans. Currently, major System facilities such as Brayton Point and Salem Harbor have up-to-date SPCC plans. A comprehensive study of smaller facilities has been completed to determine the appropriate plans for these facilities and a five-year implementation plan is underway.\nNuclear\nThe NRC, along with other federal and state agencies, has extensive regulations pertaining to environmental aspects of nuclear reactors. Safety aspects of nuclear reactors, including design controls and inspection programs to mitigate any possibility of nuclear accidents and to reduce any damages therefrom, are also subject to NRC regulation. See Nuclear Units, page 29.\nCONSTRUCTION AND FINANCING\nIn 1995, NEES subsidiaries' completed the approximately 500 MW repowering of Manchester Street Station in Providence, R.I.\nNarragansett and NEP operated three steam electric generating units of approximately 45 MW each which went into service at Manchester Street Station in the 1940s. During 1992, NEP acquired a 90% interest in the site and the Station in anticipation of the repowering project. As part of the repowering project, three new combustion turbines and heat recovery steam generators were added to the Station, replacing the existing boilers. The existing steam turbines were replaced with new and more efficient turbines of slightly larger capacity. The fuel for generation, which was primarily residual oil, was be replaced with natural gas, using distillate oil as an emergency backup. See Fuel for Generation, page 25.\nRepowering more than tripled the power generation capacity of Manchester Street Station and has substantially increased the plant's thermal efficiency. It is expected that the plant's capacity factor will also increase. Certain air emissions are projected to decrease relative to historical levels because of the change in fuels and the increase in efficiency.\nSubstantial additions to Narragansett's high voltage transmission network were necessary in order to accommodate the output of the plant. Two 7-mile 115 kV underground transmission cables (located primarily in public ways) are in service, which connect the repowered station to existing 115 kV lines at a new substation. Total cost for the generating station will be approximately $450 million, including allowance for funds used during construction (AFDC). In addition, related transmission improvements were placed in service in September 1994 at a cost of approximately $60 million.\nEstimated construction expenditures (including nuclear fuel) for the System's electric utility companies are shown below for 1996 through 1998.\nThe System conducts a continuing review of its construction and financing programs. These programs and the estimates shown below are subject to revision based upon changes in assumptions as to System load growth, rates of inflation, receipt of adequate and timely rate relief, the availability and timing of regulatory approvals, new environmental and legal or regulatory requirements, total costs of major projects, and the availability and costs of external sources of capital.\nThe anticipated capital requirements for oil and gas operations are not included in the table below. See OIL AND GAS OPERATIONS page 50.\nFinancing\nAll of NEP's construction expenditures during the period from 1996 to 1998 will be financed by internally generated funds. The proportion of the Retail Companies' construction expenditures estimated to be financed by internally generated funds during the period from 1996 to 1998 is:\nMass. Electric 85% Narragansett 90% Granite State 75%\nThe general practice of the operating subsidiaries of NEES has been to finance construction expenditures in excess of internally generated funds initially by issuing unsecured short-term debt. This short-term debt is subsequently reduced through sales by such subsidiaries of long-term debt securities and preferred stock, and through capital contributions from NEES to the subsidiaries. NEES, in turn, generally has financed capital contributions to the operating subsidiaries through retained earnings and the sale of additional NEES shares. Since April 1991, NEES has been meeting all of the requirements of its dividend reinvestment and common share purchase plan and employee share plans through open market purchases. Under these plans, NEES may revert to the issuance of new common shares at any time.\nThe ability of NEP and the Retail Companies to issue short-term debt is limited by regulatory restrictions, by provisions contained in their charters, and by certain debt and other instruments. Under the charters or by-laws of NEP, Mass. Electric, and Narragansett, short-term debt is limited to 10% of capitalization. The preferred stockholders authorized these limitations to be increased to 20% of capitalization until 1998 for NEP and Narragansett, and until 1999 for Mass. Electric, at which time the limits will revert to 10% of capitalization. The following table summarizes the short-term debt limits at December 31, 1995, and the amount of outstanding short-term debt and lines of credit and standby bond facilities at such date.\nNEES and certain subsidiaries, with regulatory approval, operate a money pool to more effectively utilize cash resources and to reduce outside short-term borrowings. Short-term borrowing needs are met first by available funds of the money pool participants. Borrowing companies pay interest at a rate designed to approximate the cost of outside short-term borrowings. Companies which invest in the pool share the interest earned on a basis proportionate to their average monthly investment in the money pool. Funds may be withdrawn from or repaid to the pool at any time without prior notice. At December 31, 1995, NEP, Mass. Electric, and Narragansett each had money pool borrowings of approximately $1 million and Granite State had money pool borrowings of approximately $4 million.\nIn order to issue additional long-term debt and preferred stock, NEP and the Retail Companies must comply with earnings coverage requirements contained in their respective mortgages, note agreements, and preference provisions. The most restrictive of these provisions in each instance generally requires (1) for the issuance of additional mortgage bonds by NEP, Mass. Electric, and Narragansett, for purposes other than the refunding of certain outstanding mortgage bonds, a minimum earnings coverage (before income tax) of twice the pro forma annual interest charges on mortgage bonds, and (2) for the issuance of additional preferred stock by NEP, Mass. Electric, and Narragansett, minimum gross income coverage (after income tax) of one and one-half times pro forma annual interest charges and preferred stock dividends, in each case for a period of twelve consecutive calendar months within the fifteen calendar months immediately preceding the proposed new issue.\nThe respective long-term debt and preferred stock coverages of NEP and the Retail Companies under their respective mortgage indentures, note agreements, and preference provisions, are stated in the following table for the past three years:\nRESEARCH AND DEVELOPMENT\nExpenditures for the System's research and development activities totaled $9.5 million, $8.3 million, and $7.5 million in 1993, 1994, and 1995, respectively. Total expenditures are expected to be about $8.6 million in 1996.\nAbout 37% of these expenditures support the Electric Power Research Institute, which conducts research and development activities on behalf of its sponsors and provides the System with access to a wide range of relevant research results at minimum cost.\nThe System also directly funds research projects of a more site-specific concern to the System and its customers. These projects include:\n- creating options to allow the use of economically-priced fossil fuels without adversely\naffecting plant performance, and to insure safe, reliable and environmentally sound production of electric energy at the lowest cost;\n- developing and assessing new information and methods to understand and reduce the environmental impacts of System operations including investigation of offset methods for counterbalancing greenhouse gas emissions away from the source;\n- developing, assessing and demonstrating new generation technologies and fuels that will ensure economic, efficient and environmentally sound production of electric energy in the future; an example of this is the planned demonstration project linking advanced fuel cell technology to a biomass fuel at the Massachusetts Water Resources Authority Deer Island facility;\n- creating options to maintain electric service quality and reliability for customers at the lowest cost; and\n- developing conservation, load control, and rate design measures that will help customers use electric energy more efficiently.\nOIL AND GAS OPERATIONS\nGENERAL\nSince 1974, NEEI has engaged in oil and gas exploration and development, primarily through a partnership with Samedan Oil Corporation (Samedan), a subsidiary of Noble Affiliates, Inc. NEEI's oil and gas activities are regulated by the SEC under the 1935 Act.\nUnder the terms of the Samedan-NEEI partnership agreement, Samedan is the managing partner and oversees all partnership operations including the sale of production. Effective January 1, 1987, NEEI decided not to acquire new oil and gas prospects due to prevailing and expected oil and natural gas market conditions. This decision did not affect NEEI's interests and commitments in oil and gas properties owned as of December 31, 1986 by the Samedan-NEEI partnership. Samedan continues to explore, develop, and manage these properties on behalf of the partnership. Thus, the results of NEEI's operations are substantially affected by the performance of Samedan. Samedan may elect to terminate the partnership at the end of any calendar year upon one year's prior notice.\nNEEI is required to obtain SEC approval for further investment in these oil and gas properties. On December 20, 1994, the SEC issued an order authorizing NEEI to invest up to $30 million in its partnership with Samedan for the years 1995-1998. NEEI is winding down its oil and gas program. The level of expenditures for exploration and development of existing properties has declined as a result of the decision not to acquire new oil and gas prospects after December 31, 1986.\nNEEI's activities are primarily rate-regulated and consist of all prospects entered into prior to 1984. Losses from this rate-regulated program are being passed on to NEP and ultimately to retail customers, under an intercompany pricing policy (Pricing Policy) approved by the SEC. Due to declines in oil and gas prices, NEEI has incurred operating losses since 1986 and expects to generate substantial additional losses in the future. NEP's ability to pass such losses on to its customers was favorably resolved in NEP's 1988 FERC rate settlement. This settlement covered all costs incurred by or resulting from commitments made by NEEI through March 1, 1988. Other subsequent costs incurred by NEEI are subject to normal regulatory review. NEEI follows the full cost method of accounting for its oil and gas operations, under which capitalized costs (including interest paid to banks) relating to wells and leases determined to be either commercial or non-commercial are amortized using the unit of production method.\nDue to the Pricing Policy, NEEI's rate-regulated program has not been subject to certain SEC accounting rules, applicable to non-rate-regulated companies, which limit the costs of oil and gas property that can be capitalized. The Pricing Policy has allowed NEEI to capitalize all costs incurred in connection with fuel exploration activities of its rate regulated program, including interest paid to banks of which $10 million was capitalized in 1995 and 1994, and $9 million in 1993, respectively. In the absence of the Pricing Policy, the SEC's full cost \"ceiling test\" rule requires non-rate regulated companies to write-down capitalized costs to a level which approximates the present value of their proved oil and gas reserves. Based on NEEI's 1995 average oil and gas selling prices at December 31, 1995, if this test were applied, it would have resulted in a write-down of approximately $112 million after-tax.\nRESULTS OF OPERATIONS\nRevenues from natural gas sales were lower in 1995 versus 1994 due to decreased production levels and a decrease in natural gas prices. NEEI expects 1996 natural gas revenues to be lower than 1995 revenues due to lower production. NEEI's 1995 oil and gas exploration and development expenditures were $7 million.\nNEEI's estimated proved reserves decreased from 12.4 million barrels of oil and gas equivalent at December 31, 1994, to 10.8 million barrels of oil and gas equivalent at December 31, 1995. Production, primarily from offshore Gulf properties, decreased reserves by 3.0 million equivalent barrels. Additions and revisions primarily on offshore Gulf properties increased reserves by 1.4 million equivalent barrels.\nPrices received by NEEI for its natural gas from its major producing properties varied considerably during 1995, from approximately $0.85\/MCF to $1.66\/MCF, due principally to seasonal fluctuations and regional variations in gas prices. NEEI's overall average gas price in 1995 was $1.48\/MCF.\nThe results of NEEI's oil and gas program will continue to be affected by developments in the world oil market and the domestic market for natural gas, including actions by the federal government and by foreign governments, which may affect the price of oil and gas, and the terms of contracts under which gas is sold.\nThe following table summarizes NEEI's crude oil and condensate production in barrels, natural gas production in MCF, and the average sales price per barrel of oil and per MCF of natural gas produced by NEEI during the years ended December 1995, 1994, and 1993, and the average production (lifting) cost per dollar of gross revenues.\nOIL AND GAS PROPERTIES\nDuring 1995, principal producing properties, representing approximately 65% of NEEI's 1995 revenues, were (i) a 50% working interest in Brazos Blocks A-52, A-65, and A-37, located in federal waters offshore Texas, (ii) a 25% working interest in Main Pass Blocks 93, 94, 102, and 90, located in Federal waters offshore Louisiana, (iii) a 15% working interest in High Island Blocks 21, 22, 34, 50, and 51, located in Federal waters offshore Texas, (iv) a 12.5% working interest in Main Pass Blocks 107 and 108, located in Federal waters offshore Louisiana, and (v) a 7.5% working interest in High Island Blocks 365 and 376, located in Federal waters offshore Texas. Other major producing properties during 1995 included a 15% working interest in Eugene Island 28 located in Federal waters offshore Louisiana, a 15% working interest in Brazos Blocks 399, 400, 412, 413, and 435, located in Federal waters offshore Texas, a 13.3% working interest in Matagorda Island Block 587, located in Federal waters offshore Texas, a 3.2% working interest in the Sand Dunes Units, Derrick Draw Field, Converse County, Wyoming, and a 9.7% interest in Eugene Island 24, located in Federal waters offshore Louisiana.\nAs used in the tables below, (i) a productive well is an exploratory or a development well that is not a dry well, (ii) a dry well is an exploratory or development well found to be incapable of producing either oil or gas in commercial quantities, (iii) \"gross\" refers to the total acres or wells in which NEEI has a working interest, and (iv) \"net,\" as applied to acres or wells, refers to gross acres or wells multiplied by the percentage working interest owned by NEEI.\nThe following table shows the approximate undeveloped acreage held by NEEI as of December 31, 1995. Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether such acreage contains proved reserves.\nDuring the years ended December 31, 1995, 1994, and 1993 NEEI participated in the completion of the following net exploratory and development wells:\nThe following table summarizes the total gross and net productive wells and the approximate total gross and net developed acres, both as of December 31, 1995:\nAt December 31, 1995 NEEI was drilling or completing two gross wells, which represents less than one net well.\nCAPITAL REQUIREMENTS AND FINANCING\nEstimated expenditures in 1996 for NEEI's exploration and development program are approximately $15 million, of which capitalized interest costs are approximately $10 million.\nInternal funds are expected to provide 100% of NEEI's capital requirements for 1996. In April 1995, NEEI refinanced its outstanding borrowings through a credit agreement which currently provides for borrowings of up to $225 million. Borrowings under this credit agreement are principally secured by a pledge of NEEI's rights with respect to NEP under the Pricing Policy covering the rate-regulated program. The amount available for borrowing under the revolving credit agreement decreases annually, beginning April 13, 1996 and expiring April 13, 2002.\nNEEI MAP\nMajor Oil and Gas Properties\nEXECUTIVE OFFICERS\nNEES - ----\nAll executive officers are elected to continue in office subject to Article 19 of the Agreement and Declaration of Trust until the first meeting of the Board of Directors following the next annual meeting of shareholders, or the special meeting of shareholders held in lieu of such annual meeting, and until their successors are chosen and qualified. The executive officers also serve as officers and\/or directors of various subsidiary companies.\nJohn W. Rowe - Age: 50 - President and Chief Executive Officer since 1989 - Elected Chairman of NEP in 1993 - President of NEP from 1991 to 1993 - Chairman of NEP from 1989 to 1991.\nAlfred D. Houston - Age: 55 - Executive Vice President since 1994 - Senior Vice President-Finance from 1987 to 1994 - Vice President of NEP from 1987 to 1994 - Vice President of Narragansett since 1976 - Treasurer of Narragansett since 1977.\nRichard P. Sergel - Age: 46 - Elected Senior Vice President in 1996 - Vice President from 1992 to 1995 - Treasurer from 1990 to 1991 - Chairman of Mass. Electric and Narragansett since 1993 - Treasurer of NEP and Mass. Electric from 1990 to 1991 - Vice President of the Service Company from 1988 to 1993.\nJeffrey D. Tranen - Age: 49 - Elected Senior Vice President in 1996 - Vice President from 1991 to 1995 - President of NEP since 1993 - Vice President of NEP from 1984 to 1993 - President of Mass. Hydro, N.H. Hydro, and NEET since 1991.\nCheryl A. LaFleur - Age: 41 - Elected Vice President, Secretary, and General Counsel in 1995 - Vice President of Mass. Electric from 1993 to 1995 - Vice President of the Service Company from 1992 to 1993 - Senior Counsel for the Service Company from 1989 to 1991 - Elected Vice President of NEP in 1995.\nMichael E. Jesanis - Age: 39 - Treasurer since 1992 - Director of Corporate Finance from 1990 to 1991.\nNEP - ---\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive\nofficers are elected by the Board of Directors to hold office subject to the pleasure of the directors and until the first meeting of directors after the next annual meeting of stockholders and until their successors are duly chosen and qualified. Certain officers of NEP are, or at various times in the past have been, officers and\/or directors of the System companies with which NEP has entered into contracts and had other business relations. John W. Rowe* - Chairman since 1993 - President from 1991 to 1993 - Chairman from 1989 to 1991.\nJeffrey D. Tranen* - President since 1993 - Vice President from 1984 to 1993.\nAndrew H. Aitken - Age: 51 - Elected Vice President in 1995 - Director of Environmental and Safety for the Service Company since 1993 - Director, Environmental Affairs for the Service Company from 1981 to 1993.\nLawrence E. Bailey - Age: 52 - Vice President since 1989 - Plant Manager of Brayton Point Station from 1987 to 1991.\nJeffrey A. Donahue - Age: 37 - Vice President since 1993 - various engineering positions with the Service Company since 1983 - Director of Construction since 1992 - Chief Electrical Engineer since 1991.\nCheryl A. LaFleur* - Elected Vice President effective December 31, 1995.\nJohn F. Malley - Age: 47 - Vice President since 1992 - Manager of Generation Planning for the Service Company from 1986 to 1991.\nArnold H. Turner - Age: 55 - Vice President since 1989 - Director of Transmission Marketing since 1993.\nJeffrey W. VanSant - Age: 42 - Vice President since 1993 - Manager of Oil and Gas Exploration and Development for the Service Company from 1985 to 1993 - Manager of Oil and Gas Procurement from 1992 to 1993 - Manager of Natural Gas Supply from 1989 to 1992.\nMichael E. Jesanis* - Treasurer since 1992.\nHoward W. McDowell - Age: 52 - Controller since 1987 - Controller of Mass. Electric and Narragansett since 1987 - Treasurer of Granite State since 1984.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding this officer.\nMass. Electric - --------------\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive officers are elected by the board of directors to hold office subject to the pleasure of the directors and until the first meeting of the directors after the next annual meeting of stockholders. Certain officers of Mass. Electric are, or at various times in the past have been, officers and directors of System companies with which Mass. Electric has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nJohn H. Dickson - Age: 53 - President since 1990.\nJohn C. Amoroso - Age: 57 - Vice President since 1993 - District Manager, Southeast District from 1992 to 1993 - Manager, Southeast District from 1985 to 1992.\nEric P. Cody - Age: 45 - Elected Vice President in 1995 - Vice President and Director, Information Services for the Service Company from 1991 to 1995.\nPeter H. Gibson - Age: 50 - Vice President since 1995 - Director of Business Marketing since 1995 - Director of Business Marketing for the Service Company from 1993 to 1994 -Director of Conservation and Load Management (C&LM) and Commercial and Industrial Services for the Service Company from 1992 to 1993 - Manager of C&LM for the Service Company from 1987 to 1991.\nCharles H. Moser - Age: 55 - Vice President since 1993 - Chief Protection and Planning Engineer for the Service Company from 1984 to 1993.\nLydia M. Pastuszek - Age: 42 - Vice President since 1993 - Vice President of NEP from 1990 to 1993 - President of Granite State since 1990.\nAnthony C. Pini - Age: 43 - Vice President since 1993 - Assistant Controller for the Service Company from 1985 to 1993.\nThomas E. Rogers - Age: 45 - Elected Vice President in 1995 - Project Director for the Service Company from 1991 to 1995.\nChristopher E. Root - Age: 36 - Elected Vice President in 1995 - Director, Retail Distribution Services for the Service Company from 1993 to 1995 - Chief of Division Engineering for the Service Company from 1992 to 1993 - Manager, Distribution Engineering for Narragansett from 1990 to 1992.\nNancy H. Sala - Age: 44 - Vice President since 1992 - Central District Manager since 1992 - Assistant to the President of Mass. Electric from 1990 to 1992.\nDennis E. Snay - Age: 54 - Vice President and Merrimack Valley District Manager since 1990.\nMichael E. Jesanis - Treasurer since 1992 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Jesanis.\nHoward W. McDowell - Controller since 1987 and Assistant Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nNarragansett - ------------\nOfficers are elected by the board of directors or appointed, as appropriate, to serve until the meeting of directors following the annual meeting of stockholders, and until their successors are chosen and qualified. Officers other than the President, Treasurer, and Secretary, serve also at the pleasure of the directors. Certain officers of Narragansett are, or at various times in the past have been, officers and directors of System companies with which Narragansett has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nRobert L. McCabe - Age: 54 - President since 1986.\nWilliam Watkins, Jr. - Age 63 - Executive Vice President since 1992 - Vice President of the Service Company from 1981 to 1992.\nFrancis X. Beirne - Age: 52 - Vice President since 1993 - Manager, Southern District from 1988 to 1993.\nRichard W. Frost - Age: 56 - Vice President since 1993 - District Manager - Southern District from 1990 to 1993.\nAlfred D. Houston - Vice President since 1976 - Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Houston.\nRichard Nadeau - Age: 60 - Vice President since 1994 - Director of Customer Service since 1993 - Assistant to the President from 1990 to 1993.\nMarcy L. Reed - Age: 32 - Elected Vice President in 1995 - Assistant Controller for the Service Company from 1993 to 1995 - Manager, Internal Audit for the Service Company from 1991 to 1993.\nMichael F. Ryan - Age: 44 - Vice President since 1994 - Rhode Island Director for U.S. Senator John H. Chafee from 1986 to 1994.\nHoward W. McDowell - Controller since 1987 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nSee Item 1. Business - ELECTRIC UTILITY PROPERTIES, page 20 and OIL AND GAS PROPERTIES, page 53.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn October 1994, NEP was sued by MPLP, a venture of Enron Corporation and Jones Capital that owns a 149 megawatt gas-fired power plant in Milford, Massachusetts. NEP purchases 56 percent of the power output of the facility under a long-term contract with MPLP. The suit alleges that NEP has engaged in a scheme to cause MPLP and its power plant to fail and has prevented MPLP from finding a long-term buyer for the remainder of the facility's output. The complaint includes allegations that NEP has violated the Federal Racketeer Influenced and Corrupt Organizations Act, engaged in unfair or deceptive acts in trade or commerce, and breached contracts. MPLP also asserts that NEP deliberately misled\nregulatory bodies concerning the Manchester Street Station repowering project. MPLP seeks compensatory damages in an unspecified amount, as well as treble damages. NEP believes that the allegations of wrongdoing are without merit. NEP has filed counterclaims and crossclaims against MPLP, Enron Corporation, and Jones Capital, seeking monetary damages and termination of the purchased power contract.\nMPLP also intervened in NEP's current rate filing before the FERC, making similar allegations to those asserted in MPLP's lawsuit. Hearings on this claim concluded in October 1995. An Administrative Law Judge initial decision is expected by mid-1996.\nIn August 1995, an arbitration panel upheld NEP's right to terminate its charter of a ship, the SS. Energy Independence, to purchase the ship from its owner, Intercoastal Bulk Carriers, Inc. (\"IBC\"), and sell the ship to a nominee of International Shipping Company (\"ISC\"). That same month, the Massachusetts Superior Court dismissed a lawsuit filed against NEP by Keystone Shipping Company (\"Keystone\"), an affiliate of IBC, challenging NEP's right to do so. In September 1995, the ship was transferred to ISC's nominee and sent to dry dock for routine maintenance and inspection, which revealed that further work was needed to make the ship seaworthy. Under NEP's charter with IBC, these costs, which are estimated to be in excess of $10 million, are IBC's responsibility. NEP therefore initiated arbitration against both IBC and Keystone before the same panel. Hearings are tentatively scheduled to commence in June 1996. Keystone has filed an action in federal district court seeking to stay the arbitration as to Keystone.\nSee Item 1. COMPETITIVE CONDITIONS, page 7; RATES, page 14; Coal Procurement Program, page 25; Nuclear Units, page 29; Hydroelectric Project Licensing, page 38; Environmental Requirements, page 39; OIL AND GAS OPERATIONS, page 50.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nNEES information in response to the disclosure requirements specified by this Item 5. appears under the captions in the NEES Annual Report indicated below:\nRequired Information Annual Report Caption -------------------- ---------------------\n(a) Market Information Shareholder Information\n(b) Holders Shareholder Information\n(c) Dividends Financial Highlights\nThe information referred to above is incorporated by reference in this Item 5.\nNEP, Mass. Electric, and Narragansett - The information required by this item is not applicable as the common stock of all these companies is held solely by NEES. Information pertaining to payment of dividends and restrictions on payment of dividends is incorporated herein by reference to each company's 1995 Annual Report.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to page 23 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to page 28 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to page 22 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to page 22 of the Narragansett 1995 Annual Report.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 14 through 22 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 2 through 9 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 2 through 7 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 2 through 7 of the Narragansett 1995 Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 23 through 42 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 1, 10 through 26, and 28 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 1, 8 through 20, and 22 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 1, 8 through 20, and 22 of the Narragansett 1995 Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNEES, NEP, Mass. Electric, and Narragansett - None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption ELECTION OF DIRECTORS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated. Reference is also made to the information under the caption EXECUTIVE OFFICERS - NEES in Part I of this report.\nNEP ---\nThe names of the directors of NEP, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - NEP in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok - Director since 1979 - Age: 66 - Chairman of the Board of NEES - Chairman or Vice Chairman of the Company from 1988 to 1994 - Chairman of NEES from 1984 to 1994 (Chairman, President, and Chief Executive Officer from July 26, 1988 until February 13, 1989). Directorships of NEES System companies: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company. Other directorships: Avery Dennison Corporation, John Hancock Mutual Life Insurance Company, and Monsanto Company.\nAlfred D. Houston* - Director since 1984. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\nCheryl A. LaFleur* - Elected Director effective December 31, 1995. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro- Transmission Electric Company, Inc., and New England Power Service Company.\nJohn W. Rowe* - Director since 1989. Directorships of NEES System companies and affiliates: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., New England Power Service Company, and Maine Yankee Atomic Power Company. Other directorships: Bank of Boston Corporation and UNUM Corporation.\nJeffrey D. Tranen* - Director since 1991. Directorships of NEES System affiliates: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric\nTransmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro- Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES and EXECUTIVE OFFICERS - NEP in Part I of this report for other information regarding this director.\nMass. Electric --------------\nThe names of the directors of Mass. Electric, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Mass. Electric in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nUrville J. Beaumont - Director since 1984 - Age: 64 - Treasurer and Director, law firm of Beaumont & Campbell, P.A.\nJoan T. Bok* - Director since 1979.\nSally L. Collins - Director since 1976 - Age: 60 - Director of Workplace Health Services since 1993 - Health Services Administrator at Kollmorgen Corporation EOD from 1989 to 1993.\nJohn H. Dickson - Director since 1990 - Reference is made to material supplied under the caption EXECUTIVE OFFICERS - Mass. Electric for other information regarding Mr. Dickson. Other directorship: Worcester Business Development Corporation.\nKalyan K. Ghosh - Director since 1995 - Age: 58 - President of Worcester State College since 1992 - CEO and Acting President, Worcester State College from 1990 to 1992.\nCharles B. Housen - Director since 1979 - Age: 63 - Chairman, President, and Director of Erving Industries, Inc., Erving, Mass.\nPatricia McGovern - Director since 1994 - Age: 54 - Director of law firm of Goulston & Storrs, P.C. since 1995 - Counsel to Goulston & Storrs, P.C. from 1993 to 1995 - Massachusetts State Senator and Chair of the Senate Ways and Means Committee from 1985 to 1992.\nJohn F. Reilly - Director since 1988 - Age: 63 - President and CEO of Fred C. Church, Inc., Lowell, Mass. - Other directorships: Colonial Gas Company, Family Bank, and New England Insurance Co., Ltd.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Director since 1993.\nRoslyn M. Watson - Director since 1992 - Age: 46 - President of Watson Ventures (commercial real estate development and management) Boston, Mass. since 1993 - Vice President of the Gunwyn Company (commercial real estate development) Cambridge, Mass. from 1986 - 1993 - Other directorships: The Dreyfus Laurel Funds and American Express Centurion Bank.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES in Part I of this report and\/or the material supplied under the caption DIRECTORS AND OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nNarragansett ------------\nThe names of the directors of Narragansett, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Narragansett in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok* - Director since 1979.\nStephen A. Cardi - Director since 1979 - Age: 54 - Treasurer of Cardi Corporation (construction), Warwick, R.I.\nFrances H. Gammell - Director since 1992 - Age: 46 - Director, Senior Vice President, Treasurer, and Secretary of Original Bradford Soap Works, Inc.\nJoseph J. Kirby - Director since 1988 - Age: 64 - President of Washington Trust Bancorp, Inc., Westerly, R.I. and President and Director of the Washington Trust Company.\nRobert L. McCabe - President and Director of Narragansett since 1986 - Other directorship: Citizens Savings Bank - Please refer to the material supplied under the caption EXECUTIVE OFFICERS - Narragansett in Part I of this report for other information regarding Mr. McCabe.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Chairman and Director since 1993.\nWilliam E. Trueheart - Director since 1989 - Age: 53 - President of Bryant College, Smithfield, Rhode Island - Other directorships: Fleet National Bank.\nJohn A. Wilson, Jr. - Director since 1971 - Age: 66 - Consultant to and former President of Wanskuck Co., Providence, R.I., - Consultant to Hinckley, Allen, Snyder & Comen (attorneys), Providence, R.I.\n*Please refer to the material supplied under the caption DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nSection 16(a) of the Securities Exchange Act of 1934 requires the System's officers and directors, and persons who own more than 10% of a registered class of the System's equity securities, to file reports on Forms 3, 4, and 5 of share ownership and changes in share ownership with the SEC and the New York Stock Exchange and to furnish the System with copies of all Section 16(a) forms they file.\nBased solely on NEP's, Mass. Electric's, and Narragansett's review of the copies of such forms received by them, or written representations from certain reporting persons that such forms were not required for those persons, NEP, Mass. Electric, and Narragansett believe that, during 1995, all filing requirements applicable to its officers, directors, and 10% beneficial owners were complied with.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the captions BOARD STRUCTURE AND COMPENSATION, EXECUTIVE COMPENSATION, PAYMENTS UPON A CHANGE IN\nCONTROL, PLAN SUMMARIES, and RETIREMENT PLANS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT -------------------------------------\nEXECUTIVE COMPENSATION\nThe following tables give information with respect to all compensation (whether paid directly by NEP, Mass. Electric, or Narragansett or billed to it as hourly charges) for services in all capacities for NEP, Mass. Electric, or Narragansett for the years 1993 through 1995 to or for the benefit of the Chief Executive Officer and the four other most highly compensated executive officers for each company.\nNEP\n(a) Certain officers of NEP are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by NEP. See description under Plan Summaries.\n(d) Includes amounts reimbursed by NEP for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. Rowe 20,370 shares, $807,161 value; Mr. Tranen 4,582 shares, $181,561 value; Mr. Newsham 4,117 shares, $163,136 value; Mr. Greenman 5,961 shares, $236,204 value; and Mr. Bailey 2,807 shares, $111,227 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes NEP contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by NEP.\n(g) For Mr. Rowe, the amount and type of compensation in 1995 is as follows: $876 for contributions to the thrift plan and $511 for life insurance.\n(h) For Mr. Tranen, the amount and type of compensation in 1995 is as follows: $2,831 for contributions to the thrift plan and $545 for life insurance.\n(i) For Mr. Newsham, the amount and type of compensation in 1995 is as follows: $2,870 for contributions to the thrift plan, $1,609 for life insurance, and $119,315 one-time supplemental cash payment upon retirement.\n(j) For Mr. Greenman, the amount and type of compensation in 1995 is as follows: $2,027 for contributions to the thrift plan and $949 for life insurance.\n(k) For Mr. Bailey, the amount and type of compensation in 1995 is as follows: 2,894 for contributions to the thrift plan and $704 for life insurance.\nMASS. ELECTRIC\n(a) Certain officers of Mass. Electric are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Mass. Electric. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Mass. Electric for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. Sergel 4,355 shares, $172,567 value; Mr. Dickson 4,036 shares, $159,926 value; Mr. Holt 2,953 shares, $117,012 value; Ms. LaFleur 2,166 shares, $85,827 value; Ms. Sala 1,227 shares, $48,619 value; and Mr. Pini 1,966 shares, $77,902 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes Mass. Electric contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Mass. Electric.\n(g) For Mr. Sergel, the type and amount of compensation in 1995 is as follows: $2,002 for contributions to the thrift plan and $283 for life insurance.\n(h) For Mr. Dickson, the type and amount of compensation in 1995 is as follows: $3,000 for contributions to the thrift plan and $601 for life insurance.\n(i) For Mr. Holt, the type and amount of compensation in 1995 is as follows: 1,778 for contributions to the thrift plan and $629 for life insurance.\n(j) For Ms. LaFleur, the type and amount of compensation in 1995 is as follows: $2,373 for contributions to the thrift plan and $197 for life insurance.\n(k) For Ms. Sala, the type and amount of compensation in 1995 is as follows: $2,310 for contributions to the thrift plan and $188 for life insurance.\n(l) For Mr. Pini, the type and amount of compensation in 1995 is as follows: $2,225 for contributions to the thrift plan and $177 for life insurance.\n(m) Mr. Holt resigned as of December 20, 1995 to take a position at an affiliate company, Ms. LaFleur resigned as of December 31, 1995 to take a position at an affiliate company.\nNARRAGANSETT\n(a) Certain officers of Narragansett are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Narragansett. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Narragansett for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. McCabe 3,799 shares, $150,535 value; Mr. Watkins 2,140 shares, $84,797 value; Mr. Frost 1,672 shares, $66,253 value, Mr. Beirne 375 shares, $14,859 value; and Mr. Nadeau 335 shares, $13,275 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes Narragansett contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Narragansett.\n(g) For Mr. McCabe, the type and amount of compensation in 1995 is as follows: $2,720 for contributions to the thrift plan and $2,130 for life insurance.\n(h) For Mr. Watkins, the type and amount of compensation in 1995 is as follows: $2,563 for contributions to the thrift plan and $1,491 for life insurance.\n(i) For Mr. Frost, the type and amount of compensation in 1995 is as follows: $2,065 for contributions to the thrift plan and $722 for life insurance.\n(j) For Mr. Beirne, the type and amount of compensation in 1995 is as follows: $1,919 for contributions to the thrift plan and $412 for life insurance.\n(k) For Mr. Nadeau, the type and amount of compensation in 1995 is as follows: $1,916 for contributions to the thrift plan and $986 for life insurance.\nDirectors' Compensation\nMembers of the Mass. Electric and Narragansett Boards of Directors, except Dickson, McCabe, Rowe, and Sergel receive a quarterly retainer of $1,250, a meeting fee of $600 plus expenses, and 50 NEES common shares each year. Since all members of the NEP Board are employees of NEES System companies, no fees are paid for service on the Board except as noted below for Mrs. Bok.\nMrs. Bok retired as an employee of the System on January 1, 1994 (remaining as Chairman of the Board of NEES and a director for NEES subsidiaries). Mrs. Bok has agreed to waive the normal fees and annual retainers otherwise payable for services by non-employees on NEES subsidiary boards and receives in lieu thereof a single annual stipend of $60,000. Mrs. Bok also serves as a consultant to NEES. Under the terms of her contract, she receives an annual retainer of $100,000.\nMass. Electric and Narragansett permit directors to defer all or a portion of their retainers and meeting fees. Special accounts are maintained on Mass. Electric's and Narragansett's books showing the amounts deferred and the interest accrued thereon.\nOther\nNEP, Mass. Electric, and Narragansett do not have any share option plans.\nThe NEES Compensation Committee administers certain of the incentive compensation plans, and the Management Committee administers the others (including the incentive share plan).\nRetirement Plans\nThe following table shows estimated annual benefits payable to executive officers under the qualified pension plan and the supplemental retirement plan, assuming retirement at age 65 in 1996.\nFor purposes of the retirement plans, Messrs. Rowe, Tranen, Newsham, Greenman, and Bailey currently have 18, 26, 45, 30, and 27 credited years of service, respectively. Mr. Sergel, Mr. Dickson, Mr. Holt, Ms. LaFleur, Ms. Sala, and Mr. Pini currently have 17, 22, 24, 10, 26, and 17 credited years of service, respectively. Messrs. McCabe, Watkins, Frost, Beirne, and Nadeau currently have 27, 23, 33, 24, and 40 credited years of service, respectively.\nBenefits under the pension plans are computed using formulae based on percentages of highest average compensation computed over five consecutive years. The compensation covered by the pension plan includes salary, bonus, and incentive share awards. The benefits listed in the pension table are not subject to deduction for Social Security and are shown without any joint and survivor benefits.\nThe Pension Table above does not include annuity payments to be received in lieu of life insurance for Messrs. Rowe, Houston, and Greenman. The policies are described below under Plan Summaries.\nMr. Newsham will also receive a supplemental pension payment of $5,000 per year.\nUnder the Retirement Supplement Plan, participants receive an annual adjustment to their pension benefits. The amount of the adjustment is equal to the rate of interest on AAA bonds for the prior year less two percent (but in no case more than the increase in the cost of living).\nThe System contributes the full amount toward post-retirement health benefits for senior executives.\nPAYMENTS UPON A CHANGE OF CONTROL\nNEES has approved agreements with certain of its executives, including Ms. LaFleur, and Messrs. Greenman, Newsham, Rowe, Sergel, and Tranen, which provide severance benefits in the event of certain terminations of employment following a Change in Control of NEES (as defined below). If, following a Change in Control, the executive's employment is terminated other than for cause (as defined) or if the executive terminates employment for good reason (as defined), NEES will pay to the executive a lump sum cash payment equal to three times (two times for some executives) the sum of the executive's most recent annual base compensation and the average of his or her bonus amounts for the prior three years. If Mr. Rowe receives payments under his severance agreement that would subject him to any federal excise tax due under section 280G of the Internal Revenue Code, he will receive a cash \"gross-up\" payment so he would be in the same net after-tax position he would have been in had such excise tax not been applied. In addition, NEES will provide disability and health benefits to the executive for two to three years, provide such post-retirement health and welfare benefits as the executive would have earned within such two to three years, and grant two or three additional years of pension credit. Mr. Rowe would become eligible for benefits under the Retirement Supplement Plan described above prior to the five-year vesting term.\nChange in Control, including potential change of control, occurs (1) when any person becomes the beneficial owner of 20% of the voting securities of NEES, (2) when the prior members of the Board of NEES no longer constitute a 2\/3 majority of the Board, or (3) NEES enters into an agreement that could result in a Change in Control.\nThe terms of the agreements are for three years with automatic annual extensions, unless terminated by NEES.\nThe System's bonus plans, including the incentive compensation plans, the Incentive Thrift Plan I, and the Goals Program, provide for payments equal to the average of the bonuses for the three prior years in the event of a Change of Control. This payment would be made in lieu of the regular bonuses for the year in which the Change in Control occurs. The new Long-Term Performance Share Award Plan provides for a cash payment equal to the value of the performance shares in the participants' account times the average target achievement percentage for the Incentive Thrift Plan I for the three prior years. The System's Retirees Health and Life Insurance Plan I has provisions preventing changes in benefits\nadverse to the participants for three years following a Change in Control. The Incentive Share Plan and the related Incentive Share Deferral Agreements provide that, upon the occurrence of a change in control (defined more narrowly than in other plans), restrictions on all shares and account balances would cease.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT PLAN SUMMARIES\nA brief description of the various plans through which compensation and benefits are provided to the named executive officers is presented below to better enable shareholders to understand the information presented in the tables shown earlier. The amounts of compensation and benefits provided to the named executive officers under the plans described below (and charged to NEP, Mass. Electric, or Narragansett) are presented in the Summary Compensation Tables.\nGoals Program\nThe goals program covers all employees who have completed one year of service with any NEES subsidiary. Goals are established annually. For 1995, these goals related to earnings per share, customer costs, safety, absenteeism, demand-side management, generating station availability, transmission reliability, environmental and OSHA compliance, and customer satisfaction. Some goals apply to all employees, while others apply to particular functional groups. Depending upon the number of goals met, and provided the minimum earnings goal is met, employees may earn a cash bonus of 1% to 4-1\/2% of their compensation.\nIncentive Thrift Plan\nThe incentive thrift plan (a 401(k) program) provides for a match of 40% of up to the first 5% of base compensation contributed to the System's incentive thrift plan (shown under All Other Compensation in the Summary Compensation Tables) and, based on an incentive formula tied to earnings per share, may fully match the first 5% of base compensation contributed (the additional amount, if any, is shown under Bonus in the Summary Compensation Tables). Under Federal law, contributions to these plans are limited. In 1995, the salary reduction amount was limited to $9,240.\nIncentive Compensation Plan\nThe System bonus plan for certain senior employees provides that in order for cash bonuses to be awarded, NEES must achieve a return on equity that places NEES in the top 50% of the electric\nutilities listed in the Duff & Phelps Utility Group or in the top 50% of the New England\/New York regional utilities. Bonuses are also dependent upon the achievement of individual goals. In order to provide a long-term component to the incentive compensation plan, participants may also be awarded NEES common shares. An individual's award of shares under the incentive share plan is a fixed percentage of her or his cash bonus for that year. If no cash award is made, no shares are distributed.\nLong-Term Performance Share Award Plan\nThis plan was established in 1996. There will be no payments under the plan until the Spring of 1999. Awards under the plan are based upon various measures of NEES performance over a three-year period. Each award factor or measurement functions independently. The factors include financial and operating performance. Performance is rated on rolling three-year periods, with a new cycle beginning each year. An individual's potential award under the plan is a fixed percentage (ranging from 15% to 50%) of base pay. At the end of the three-year cycle, the participant receives NEES shares based upon the performance against the various factors.\nDeferred Compensation Plan\nThose executives whose contributions to the Incentive Thrift Plan were limited by Federal law may make further contributions to the Deferred Compensation Plan and the System will match them under the Deferred Compensation Plan on the same terms as if the full amount had been contributed to the Incentive Thrift Plan. However, these amounts under the Deferred Compensation Plan may only be invested at the then applicable prime rate or in NEES shares.\nLife Insurance\nNEES has established for certain senior executives life insurance plans funded by individual policies. The combined death benefit under these insurance plans is three times the participant's annual salary.\nAfter termination of employment, participants in one of the insurance plans may elect, commencing at age 55 or later, to receive an annuity income equal to 40% of annual salary. In that event, the life insurance is reduced over fifteen years to an amount equal to the participant's final annual salary. Due to changes in the tax law, this plan was closed to new participants, and an alternative was established with only a life insurance benefit. The individuals listed in the NEP summary compensation\ntable and Ms. LaFleur and Messrs. Dickson, McCabe, and Sergel are in one or the other of these plans. These plans are structured so that, over time, the System should recover the cost of the insurance premiums.\nFinancial Counseling\nNEP, Mass. Electric, and Narragansett pay for personal financial counseling for senior executives. As required by the IRS, a portion of the amount paid is reported as taxable income for the executive. Financial counseling is also offered to other employees through a limited number of seminars conducted at various locations each year.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption TOTAL COMMON EQUITY BASED HOLDINGS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, Mass. Electric, and Narragansett -------------------------------------\nNEES owns 100% of the voting securities of Mass. Electric and Narragansett. NEES owns 98.85% of the voting securities of NEP.\nSECURITY OWNERSHIP\nThe following tables list the holdings of NEES common shares as of March 1, 1996 by NEP, Mass. Electric, and Narragansett directors, the executive officers named in the Summary Compensation Tables, and all directors and executive officers, as a group.\n(a) Number of shares beneficially owned includes: (i) shares directly owned by certain relatives with whom directors or officers share voting or investment power; (ii) shares held of record individually by a director or officer or jointly with others or held in the name of a bank, broker, or nominee for such individual's account; (iii) shares in which certain directors or officers maintain exclusive or shared investment or voting power whether or not the securities are held for their benefit; and (iv) with respect to the executive officers, allocated shares in the Incentive Thrift Plan described above.\n(b) Deferred share equivalents are held under the Deferred Compensation Plan or pursuant to individual deferral agreements. Under the Plan or deferral agreements, executives may elect to defer cash compensation and share awards. There are various deferral periods available under the plans. At the end of the deferral period, the compensation may be paid out in NEES common shares, cash, or a combination thereof. The rights of the executives to payment are those of general, unsecured creditors. While deferred, the shares do not have\nvoting rights or other rights associated with ownership. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in NEES common shares.\n(c) Amount is less than 1% of the total number of shares of NEES outstanding.\n(d) Mr. Beaumont disclaims a beneficial ownership interest in 200 of these shares held under an irrevocable trust.\n(e) Ms. Sala disclaims a beneficial ownership interest in 247 shares held under the Uniform Gift to Minors Act.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe construction company of Mr. Stephen A. Cardi, a director of Narragansett, was paid approximately $77,000 in 1995 pursuant to a contract to provide gravel to Narragansett.\nMr. John A. Wilson, Jr., a director of Narragansett, is a consultant to Hinckley, Allen, Snyder & Comen (Attorneys). Hinckley, Allen, Snyder & Comen was retained by Narragansett and its affiliates in 1995.\nMs. Patricia McGovern, a director of Mass. Electric, was paid a retainer of $15,000 by Mass. Electric for serving as a member of a Massachusetts policy advisory committee regarding external relations in Massachusetts.\nReference is made to Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT and Item 11. EXECUTIVE COMPENSATION.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS AND REPORTS ON FORM 8-K\nList of Exhibits\nUnless otherwise indicated, the exhibits listed below are incorporated by reference to the appropriate exhibit numbers and the Commission file numbers indicated in parentheses.\nNEES ----\n(3) Agreement and Declaration of Trust dated January 2, 1926, as amended through April 28, 1992 (Exhibit 3 to 1994 NEES Form 10-K, File No. 1-3446).\n(4) Instruments Defining the Rights of Security Holders\n(a) Massachusetts Electric Company First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty-one supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1993 Form 10-K, File No. 1-3446; Twenty-first Supplemental Indenture (filed herewith)).\n(b) The Narragansett Electric Company First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-two supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4 to 1991 Form 10-K, File No. 0-898; Exhibit 4(b) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(b) to 1993 Form 10-K, File No. 1-3446; Twenty-second Supplemental Indenture (filed herewith)).\n(c) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1- 3446).\n(d) New England Power Company Indentures General and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and twenty supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(d) to 1993 Form 10-K, File No. 1-3446; Twentieth Supplemental Indenture (filed herewith)).\n(10) Material Contracts\n(a) Boston Edison Company et al. and New England Power Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and New England Power Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986; (Exhibit 10(b), to 1990 Form 10-K, File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to NEP with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and New England Power Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-23006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 1-3446); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006);\nTransmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to 1979 Form 10-K, File No. 1-3446); Amendment revising Transmission Agreement dated as of January 19, 1994 (filed herewith); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and New England Power Company: Capital Funds Agreement dated May 20, 1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to 1983 Form 10-K, File No. 1-3446), October 1, 1984, and August 1, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20, File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446).\n(e) New England Energy Incorporated Contracts\n(i) Capital Funds Agreement with NEES dated November 1, 1974 (Exhibit 10-29(b), File No. 2-52969); Amendment dated July 1, 1976, and Amendment dated July 26, 1979 (Exhibit 10(g)(i) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(i) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1990 (Exhibit 10(e)(i) to 1990 Form 10-K, File No. 1-3446).\n(ii) Loan Agreement with NEES dated July 19, 1978 and effective November 1, 1974, and Amendment dated July 26, 1979 (Exhibit 10(g)(iii) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(ii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(ii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(ii) to 1989 Form 10-K, File No. 1-3446);\nAmendment dated as of June 1, 1990 (Exhibit 10(e)(ii) to 1990 Form 10-K, File No. 1-3446).\n(iii) Fuel Purchase Contract with New England Power Company dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 Form 10-K, File No. 1-3446).\n(iv) Partnership Agreement with Samedan Oil Corporation as Amended and Restated on February 5, 1985 (Exhibit 10(e)(iv) to 1984 Form 10-K, File No. 1-3446); Amendment dated as of January 14, 1992 (Exhibit 10(e)(iv) to 1991 Form 10-K, File No. 1- 3446).\n(v) Credit Agreement dated as of April 13, 1995 (filed herewith).\n(vi) Capital Maintenance Agreement dated November 15, 1985, and Assignment and Security Agreement dated November 15, 1985 (Exhibit 10(e)(vi) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(vi) to 1989 Form 10-K, File No. 1-3446).\n(f) New England Power Company and New England Electric Transmission Corporation et al.: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit (10)(f) 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of New England Power Company's Transmission System dated as of April 1, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Upper Development - Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446).\n(g) New England Electric Transmission Corporation and PruCapital Management, Inc. et al: Note Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Mortgage, Deed of Trust and Security Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Equity Funding Agreement with New England Electric System dated as of December 1, 1985 (Exhibit 10(g) to 1991 Form 10-K, File No. 1-3446).\n(h) Vermont Electric Transmission Company, Inc. et al. and New England Power Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(g) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to 1986 Form 10-K, File No. 1-3446).\n(i) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (filed herewith).\n(j) Public Service Company of New Hampshire et al. and New England Power Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, December 31, 1980 (Exhibit 10(i) to 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984, June 15, 1984 (Exhibit 10(j) to 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986 and September 19, 1986 (Exhibit 10(j) to 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of November 1, 1990 (Exhibit 10(j) to 1991 Form 10-K, File No. 1- 3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to NEP with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 10-16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent (Exhibit 10(j) to 1991 Form 10-K, File No. 1- 3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10-K, File No. 1- 3446); Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, and amendment to Seabrook Project Managing Agent Agreement dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10- K, File No. 1-3446).\n(k) Vermont Yankee Nuclear Power Corporation et al. and New England Power Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968, and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972 and April 15, 1983 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446) and April 24, 1985 (Exhibit 10(k) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(k) to 1987 Form 10-K, File No.\n1-3446); Amendments dated as of May 6, 1988 (Exhibit 10(k) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to 1981 Form 10-K, File No. 1-3446).\n(l) Yankee Atomic Electric Company et al. and New England Power Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10(l) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(n) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (filed herewith).\n*(o) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1,1995 (filed herewith).\n*(p) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(q) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(r) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (filed herewith).\n*(s) New England Electric System Directors Deferred Compensation Plan as amended dated November 24, 1992 (Exhibit 10(s) to 1992 Form 10-K, File No. 1-3446).\n*(t) Forms of Life Insurance Program (Exhibit 10(s) to 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to 1991 Form 10-K, File No. 1-3446).\n*(u) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (filed herewith).\n(v) New England Power Company and New England Hydro-Transmission Electric Company, Inc. et al: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10(u) to 1990 Form 10-K, File No. 1-3446).\n(w) New England Power Company and New England Hydro-Transmission Corporation et al: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1,1988 (Exhibit 10(v) to 1988 Form 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10(v) to 1990 Form 10-K, File No. 1-3446).\n(x) New England Power Company et al: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to 1988 Form 10-K, File No. 1-3446).\n(y) New England Hydro-Transmission Electric Company, Inc. and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated\nas of September 1, 1987 (Exhibit 10(x) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(x) to 1988 Form 10-K, File No. 1-3446).\n(z) New England Hydro-Transmission Corporation and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of September 1, 1987 (Exhibit 10(y) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(y) to 1988 Form 10-K, File No. 1-3446).\n(aa) Ocean State Power, et al., and Narragansett Energy Resources Company: Equity Contribution Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power, et al., and New England Electric System: Equity Contribution Support Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K, File No. 1-3446); Ocean State Power II, et al., and Narragansett Energy Resources Company: Equity Contribution Agreement dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power II, et al., and New England Electric System: Equity Contribution Support Agreement dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446).\n*(bb) New England Power Service Company and Joan T. Bok: Service Credit Letter dated October 21, 1982 (Exhibit 10(cc) to 1992 Form 10-K, File No. 1-3446).\n*(cc) New England Electric System and John W. Rowe: Service Credit Letter dated December 5, 1988 (Exhibit 10(dd) to 1992 Form 10-K, File No. 1-3446).\n*(dd) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 Form 10-K, File No. 1-3446).\n*(ee) New England Electric System and Frederic E. Greenman: Service Credit Letter dated February 23, 1994 (Exhibit 10(ee) to 1994 Form 10-K, File No. 1- 3446).\n*(ff) New England Electric System and John W. Newsham; Pension Service Credit Agreement dated February 23, 1994 (Exhibit 10(ff) to 1994 Form 10-K, File No. 1- 3446).\n* Compensation related plan, contract, or arrangement.\n(13) 1995 Annual Report to Shareholders (filed herewith).\n(21) Subsidiary list appears in Part I of this document.\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nNEP ---\n(3) (a) Articles of Organization as amended through June 27, 1987 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-1229).\n(b) By-laws of the Company as amended May 10, 1995 (filed herewith).\n(4) General and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and twenty supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1988 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(d) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(d) to 1995 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and the Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986 (Exhibit 10(b) to NEES' 1990 Form 10-K File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to the Company with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and the Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-2006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 0-1229); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006); Transmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to NEES' 1979 Form 10-K, File No. 1-3446); Amendment revising Transmission Agreement dated as of January 19, 1994 (Exhibit 10(c) to NEES' 1995 Form 10-K, File No. 1-3446; Five Year Capital Contribution Agreement dated November 1, 1980 (Exhibit 10(e) to NEES' 1980 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to NEES' 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to NEES' 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and the Company: Capital Funds Agreement dated May 20, 1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to NEES' 1983 Form 10-K, File No. 1-3446); October 1, 1984, and August 1, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20; File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446).\n(e) Mass. Electric and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated June 22, 1983 (Exhibit 10(b) to Mass. Electric's 1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(e) to 1993 Form 10-K, File No. 0-1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 Form 10-K, File No. 0-1229).\n(f) The Narragansett Electric Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service Agreement dated July 26, 1990 (Exhibit 4(f) to New England Power Company's 1990 Form 10-K, File No. 0-1229). Amendment of Service Agreement dated July 24, 1991 (Exhibit 10(f) to 1991 Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(f) to 1993 Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 Form 10-K, File No. 0-1229); Amendment of Service Agreement effective January 1, 1995 (filed herewith).\n(g) Time Charter between International Shipholding Corp., and New England Power Company dated as of October 27, 1994 (filed herewith); Amendments dated as of September 22, 1995 (filed herewith).\n(h) Consent and Agreement among New England Power Company, Central Gulf Lines, Inc., Enterprise Ship Company, Inc., and The Bank of New York dated as of September 28, 1995 (filed herewith).\n(i) New England Electric Transmission Corporation et al. and the Company: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(f) to NEES' 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of the Company's\nTransmission System dated as of April 1, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446); Upper Development-Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446).\n(j) Vermont Electric Transmission Company, Inc. et al. and the Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(g) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to NEES' 1986 Form 10-K, File No. 1-3446).\n(k) New England Energy Incorporated and the Company: Fuel Purchase Contract dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 NEES Form 10-K, File No. 1-3446).\n(l) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, March 1, 1973 (Exhibit 10-15, File No. 2-48543);Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File\nNo. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to 1995 NEES Form 10-K, File No. 1-3446).\n(m) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(l) to 1994 Form 10-K, File No. 0-1229).\n(n) Public Service Company of New Hampshire et al. and the Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, and December 31, 1980 (Exhibit 10(i) to NEES' 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984, and June 15, 1984 (Exhibit 10(j) to NEES' 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986, and September 19, 1986 (Exhibit 10(j) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to NEES' 1990 Form 10-K, File No. 1-3446); Seventh Amendment as of November 1, 1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to the Company with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1,\n1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446). Settlement Agreement dated as of July 19, 1990 between Northeast Utilities Service Company and the Company (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, Amendment to Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446).\n(o) Vermont Yankee Nuclear Power Corporation et al. and the Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968 and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972, April 15, 1983 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 0-1229) and April 24, 1985 (Exhibit 10(n) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendments dated May 6, 1988 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 NEES Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to NEES' 1981 Form 10-K, File No. 1-3446).\n(p) Yankee Atomic Electric Company et al. and the Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to NEES' 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10(l) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 NEES Form 10-K, File No. 1-3446).\n*(q) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(r) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(s) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(t) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446); New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(u) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(v) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(w) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10 (u) to NEES 1995 Form 10-K, File No. 1-3446).\n(x) New England Hydro-Transmission Electric Company, Inc. et al. and the Company: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10(u) to NEES' 1990 Form 10-K, File No. 1-3446).\n(y) New England Hydro-Transmission Corporation et al. and the Company: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to NEES' 1987 Form 10-K, File No. 1-3446). Amendment dated as of August 1, 1988 (Exhibit 10(v) to NEES' 1988\nForm 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10 (v) to NEES' 1990 Form 10-K, File No. 1-3446).\n(z) Vermont Electric Power Company et al. and the Company: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446). Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to NEES' 1988 Form 10-K, File No. 1-3446).\n(aa) TransCanada Pipelines Limited and the Company: Firm Service Contract for Firm Transportation Service for natural gas dated as of January 6, 1992; Amendment dated as of March 2, 1992 (Exhibit 10(y) to 1992 Form 10-K, File No. 0-1229); Amendment dated as of October 29, 1993 (Exhibit 10(y) to 1994 Form 10-K, File No. 0-1229); Temporary Assignment effective as of October 26, 1995 (filed herewith).\n(bb) Renaissance Energy Ltd. and the Company: Temporary Transportation Contract Assignment (capacity swap) for Firm Transportation Service for natural gas dated as of October 27, 1993; Amendment dated as of October 25, 1994 (Exhibit 10(z) to 1994 Form 10-K, File No. 0-1229).\n(cc) Algonquin Gas Transmission Company and the Company: X-38 Service Agreement for Firm Transportation of natural gas dated July 3, 1992; Amendment dated July 31, 1992 (Exhibit 10(aa) to 1992 Form 10-K, File No. 0-1229); Amendment dated April 15, 1994 (Exhibit 10(aa) to 1994 Form 10-K, File No. 0- 1229).\n(dd) ANR Pipeline Company and the Company: Gas Transportation Agreement dated July 18, 1990 (Exhibit 10(bb) to 1992 Form 10-K, File No. 0-1229).\n(ee) Columbia Gas Transmission Corporation and the Company: Service Agreement for Service under FTS Rate Schedule dated June 13, 1991 (Exhibit 10(cc) to 1993 Form 10-K, File No. 0-1229).\n(ff) Iroquois Gas Transmission System, L.P. and the Company: Gas Transportation Contract for Firm Reserved Service dated as of June 5, 1991 (Exhibit 10(dd) to 1992 Form 10-K, File No. 0-1229).\n(gg) Tennessee Gas Pipeline Company and the Company: Firm Natural Gas Transportation Agreement dated July 9, 1992 (Exhibit 10(ee) to 1992 Form 10-K, File No. 0-1229).\n* Compensation related plan, contract, or arrangement.\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(21) Subsidiary list (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nMass. Electric --------------\n(3) (a) Articles of Organization of the Company as amended March 5, 1993, August 11, 1993, September 20, 1993, and November 15, 1993 (Exhibit 3(a) to 1993 Form 10-K, File No. 0-5464).\n(b) By-Laws of the Company as amended February 4, 1993, July 30, 1993, and September 15, 1993 (Exhibit 3(b) to 1993 Form 10-K, File No. 0-5464).\n(4) First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty-one supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464); Exhibit 4 to 1988 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1995 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated July 22, 1983 (Exhibit 10(b) to\n1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(e) to 1993 NEP Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 NEP Form 10-K, File No. 0-1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446). Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to 1995 NEES Form 10-K, File No. 1- 3446).\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(l) to 1994 NEP Form 10-K, File No. 0-1229).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 4(e), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(i) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(n) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10(u) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(o) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Mass. Electric registration statement on Form S-3, Commission File No. 33-59145 (filed herewith).\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nNarragansett ------------\n(3) (a) Articles of Incorporation as amended June 9, 1988 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-898).\n(b) By-Laws of the Company (Exhibit 3 to 1980 Form 10-K, File No. 0-898).\n(4) (a) First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-two supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4(b) to 1991 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1995 NEES Form 10- K, File No. 1-3446).\n(b) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1- 3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service\nAgreement dated July 26, 1990 (Exhibit 10(f) to 1990 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement dated July 24, 1991 (Exhibit 4(f) to 1991 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(f) to 1993 NEP Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(f) to 1994 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement effective January 1, 1995 (Exhibit 10(f) to 1995 NEP Form 10-K, File No. 0-1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10 (i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES' Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to NEES' 1992 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to NEES' 1995 Form 10-K, File No. 1-3446).\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 4(l) to 1994 NEP Form 10-K, File No. 0-1229).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 3(d), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan for Officers, as amended January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan, as amended December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan, as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(i) New England Companies' Incentive Compensation Plan, as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(n) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10(u) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(o) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Narragansett registration statement on Form S-3, Commission File No. 33-61131 (filed herewith).\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nReports on Form 8-K\nNEES ----\nNEES filed reports on Form 8-K dated January 12, 1995, February 8, 1995, March 1, 1995, March 15, 1995, May 17, 1995, July 3, 1995, August 16, 1995, September 8, 1995, and September 29, 1995, all of which contained Item 5.\nNEP ---\nNEP filed reports on Form 8-K dated January 12, 1995, February 8, 1995, May 17, 1995, and August 16, 1995, all of which contained Item 5.\nMass. Electric --------------\nMass. Electric filed reports on Form 8-K dated March 15, 1995, August 16, 1995, and September 29, 1995, all of which contained Item 5.\nNarragansett ------------\nNarragansett filed reports on Form 8-K dated March 1, 1995, July 3, 1995, August 16, 1995, September 8, 1995, and October 11, 1995, all of which contained Item 5.\nNEW ENGLAND ELECTRIC SYSTEM\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf, by the undersigned thereunto duly authorized.\nNEW ENGLAND ELECTRIC SYSTEM*\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer March 28, 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.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Executive Vice President and Chief Financial Officer\nPrincipal Accounting Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nDirectors (a majority)\nJoan T. Bok Paul L. Joskow John M. Kucharski Edward H. Ladd Joshua A. McClure John W. Rowe s\/John G. Cochrane George M. Sage All by: Charles E. Soule John G. Cochrane Anne Wexler Attorney-in-fact James Q. Wilson James R. Winoker\nDate (as to all signatures on this page)\nMarch 28, 1996\n*The name \"New England Electric System\" means the trustee or trustees for the time being (as trustee or trustees but not personally) under an agreement and declaration of trust dated January 2, 1926, as amended, which is hereby referred to, and a copy of which as amended has been filed with the Secretary of the Commonwealth of Massachusetts. Any agreement, obligation or liability made, entered into or incurred by or on behalf of New England Electric System binds only its trust estate, and no shareholder, director, trustee, officer or agent thereof assumes or shall be held to any liability therefor.\nNEW ENGLAND POWER COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nNEW ENGLAND POWER COMPANY\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nJoan T. Bok Alfred D. Houston s\/John G. Cochrane Cheryl A. LaFleur All by: John G. Cochrane Attorney-in-fact\nDate (as to all signatures on this page)\nMarch 28, 1996\nMASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nMASSACHUSETTS ELECTRIC COMPANY\ns\/John H. Dickson\nJohn H. Dickson President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John H. Dickson\nJohn H. Dickson President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nUrville J. Beaumont Sally L. Collins John H. Dickson Kalyan K. Ghosh Charles B. Housen s\/John G. Cochrane Patricia McGovern All by: John F. Reilly, Jr. John G. Cochrane Richard M. Shribman Attorney-in-fact Roslyn M. Watson\nDate (as to all signatures on this page)\nMarch 28, 1996\nTHE NARRAGANSETT ELECTRIC COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nTHE NARRAGANSETT ELECTRIC COMPANY\ns\/Robert L. McCabe\nRobert L. McCabe President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Robert L. McCabe\nRobert L. McCabe President\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Vice President and Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nJoan T. Bok Stephen A. Cardi s\/John G. Cochrane Joseph J. Kirby All by: Robert L. McCabe John W. Rowe John G. Cochrane Willliam E. Trueheart Attorney-in-fact\nDate (as to all signatures on this page)\nMarch 28, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe consent to the incorporation by reference in the registration statements of New England Electric System on Form S-3 of the Dividend Reinvestment and Common Share Purchase Plan (File No. 33-12313) and on Forms S-8 of the New England Electric System Companies Incentive Thrift Plan (File No. 33-26066), the New England Electric System Companies Incentive Thrift Plan II (File No. 33-35470) and the Yankee Atomic Electric Company Thrift Plan (File No. 2-67531) of our report dated March 1, 1996 on our audits of the consolidated financial statements of New England Electric System and subsidiaries as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, which report is incorporated by reference in this Annual Report on Form 10-K.\nWe also consent to the incorporation by reference in the registration statements of New England Power Company on Forms S-3 (File Nos. 33-48257, 33-48897, and 33-49193) Massachusetts Electric Company on Form S-3 (File No. 33-59145) and The Narragansett Electric Company on Form S-3 (File No. 33-61131) of our reports dated March 1, 1996 on our audits of the financial statements of New England Power Company, Massachusetts Electric Company and The Narragansett Electric Company, respectively, as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, which reports are incorporated by reference in this Annual Report on Form 10-K.\ns\/ Coopers & Lybrand L.L.P.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. March 28, 1996","section_15":""}
{"filename":"844048_1995.txt","cik":"844048","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nLocation Size of Net Rentable No. of Completion Parcel Area Rental Date\nWhittier, CA(1) 3.92 acres 60,249 513 3\/90\nBloomingdale, IL(2) 3.542 acres 60,624 571 1\/31\/91\nEdgewater,NJ(2) 4.118 acres 52,940 447 8\/21\/90\nSterling Heights, MI(4) 3.76 acres 58,198 515 7\/17\/91\n(1) The Partnership owns a 90% interest in this property. (2) The Partnership owns a 90% interest in this property. (3) The Partnership owns an 85% interest in this property. (4) The Partnership owns a 75% interest in this property.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nRegistrant is not a party to any material pending 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, had approximately 583 Limited Partners at December 31, 1995. The Registrant completed its public offering of limited partnership Units. There is no public market for the resale of these Units.\nAverage cash distributions of $10.00 per Limited Partnership Unit were declared and paid each quarter for the year ended December 31, 1995 and $8.75 per Limited Partnership Unit 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\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership) - ----------------------------------------------\nSELECTED FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993, 1992, AND 1991 - ----------------------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nREVENUES $1,710,104 $1,596,378 $ 973,811 $ 676,810 $ 615,041\nEXPENSES 1,072,358 1,003,797 $ 750,453 490,406 $ 409,269\nMINORITY INTEREST IN EARNINGS OF REAL ESTATE JOINT VENTURE (142,554) (134,982) -0- (6,624) -0- --------- --------- --------- --------- ---------\nNET INCOME $ 495,192 $ 457,599 $ 223,358 $ 179,780 $ 205,772 ========= ========= ========= ========= =========\nTOTAL ASSETS $6,913,137 $7,236,568 $7,517,751 $8,031,229 $8,531,949 ========== ========== ========== ========== ==========\nNET CASH PROVIDED BY OPERATING ACTIVITIES $ 950,492 $ 897,978 $ 618,343 $ 588,162 $ 494,236 ========= ========== ========== ========= =========\nNET INCOME PER LIMITED PARTNERSHIP UNIT $ 24.51 $ 22.65 $ 11.06 $ 8.90 $ 10.20 ======== ========= ======== ======= ========\nCASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 40.00 $ 35.00 $ 35.00 $ 35.00 (1) ======== ======== ======== ======= ========\n(1) Quarterly cash distributions were $8.75 prorated per quarter based upon the month the Limited Partners were admitted to the Partnership.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAs of December 31, 1993, the Partnership had purchased a 90% interest in a joint venture that owns a mini-storage facility in Whittier, California, an 85% interest in an operating mini-storage facility in Edgewater Park, New Jersey, a 90% interest in an operating mini-storage facility in Bloomingdale, Illinois and a 75% interest in an operating facility in Sterling Heights, Michigan. Occupancy levels for the Partnership's four mini-storage facilities on December 31, 1995, were: Bloomingdale 88%, Edgewater Park 89%, Whittier 87% and Sterling Heights 83%.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nTotal revenues increased from $1,596,378 in 1994 to $1,710,104 in 1995 and total expenses increased from $1,003,797 to $1,072,358 contributing to an increase in net income from $457,599 to $495,192. Rental revenues increased to $1,698,994 in 1995 from $1,582,952 in 1994 while guaranteed payments from the seller of the properties decreased from $7,300 to zero over the same periods. These fluctuations were primarily a result of the Edgewater Park and Bloomingdale properties emergence from their initial operating periods in 1993 and Sterling Heights in 1994. Once the properties emerge from their initial operating period, guaranteed payments are no longer received from the seller of the properties, rather, the Partnership begins to recognize the actual operating revenues and expenses of each property (see notes 1 and 2 to financial statements). Operating expenses increased approximately $55,000 primarily as a result of properties emergence from their initial operating periods. General and administrative expenses increased by approximately $4,000 (2.7%) primarily as a result of higher property management fees, which are computed as a percentage of rental revenues. The incentive management fee, which is based on distributions paid to partners, increased approximately $9,000 (14.1%) as a result of the special distribution declared and paid December 15, 1995.\n1994 COMPARED TO 1993\nTotal revenues increased from $973,811 in 1993 to $1,596,378 in 1994 and total expenses increased from $750,453 to $1,003,797 contributing to an increase in net income from $223,358 to $457,599. Rental revenues increased to $1,582,952 in 1994 from $799,523 in 1993 while guaranteed payments from the seller of the properties decreased from $170,323 to $7,300 over the same periods. These fluctuations were primarily a result of the Edgewater Park and Bloomingdale properties emergence from their initial operating periods in 1993 and Sterling Heights in 1994. Once the properties emerge from their initial operating period, guaranteed payments are no longer received from the seller of the properties, rather, the Partnership begins to recognize the actual operating revenues and expenses of each property (see notes 1 and 2 to financial statements). Operating expenses increased approximately $209,000 primarily as a result of properties emergence from their initial operating periods. General and administrative expenses increased by approximately $44,000 (43%) primarily as a result of higher professional and property management fees, which are computed as a percentage of rental revenues.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities increased by approximately $53,000 in 1995 as compared to 1994 primarily as a result of the increase in net income. Net cash provided by operating activities increased by approximately $280,000 in 1994 as compared to 1993 as a result of the increase in net income which was partially offset by net changes in operating assets and liabilities requiring the use of cash.\nCash flows used in financing activities consisted of cash distributions to partners in 1995, 1994 and 1993. Additionally, cash distributions were paid to the minority interests in the real estate joint ventures in 1995, 1994 and 1993. In December 1995, the General Partners declared and paid a special distribution equal to 1% of capital contributed by the limited partners.\nCash used in investing activities, as set forth in the statement of cash flows, consists of acquisitions of equipment for the Partnership's mini storage facilities in 1994 and 1995. Cash flows provided by investing activities in 1993 consisted solely of the guaranteed payments received from Dahn. In 1993, $100,577 of cash was received as guaranteed payments from the seller of the properties in excess of revenue recognized (see notes 1 and 2 to financial statements). 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 the 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. 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'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, Robert J. Conway and Joseph W. Conway, brothers. 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. MANAGEMENT REMUNERATION AND TRANSITIONS\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 the Registrant to any of the General Partners or to any officer or director of the corporate General Partner;\n(b) No standard or other agreement exists by which directors of the Registrant are compensated;\n(c) 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 the December 31, 1995, no person of record owns more than 5% of the limited partnership units of the Registrant, nor was any person known by the 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 the 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.\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 the Registrant's Financial Statements and Financial Statement Schedule for it 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 for its fiscal year ended December 31, 1995, together with the reports of its independent auditors, Deloitte, & Touche LLP.\n(a)(2) Attached hereto and incorporated herein by this reference as Exhibit 2 is Registrant's Letter to Limited Partners regarding the Annual Report for its fiscal year ended December 31, 1995.\n(b) There have been no 8K's filed during the last quarter of the period covered by this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDSI REALTY INCOME FUND XI 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 and Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nDSI REALTY INCOME FUND XI 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 XI\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 XI (A California Real Estate Limited Partnership)\nSELECTED FINANCIAL DATA FIVE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993 1992 1991\nREVENUES $1,710,104 $1,596,378 $ 973,811 $ 676,810 $ 615,041\nEXPENSES 1,072,358 1,003,797 750,453 490,406 409,269 ---------- ---------- ---------- ---------- ---------- MINORITY INTERESTS IN EARNINGS OF REAL ESTATE JOINT VENTURES (142,554) (134,982) (6,624) ---------- ---------- ---------- ---------- ----------\nNET INCOME $ 495,192 $ 457,599 $ 223,358 $ 179,780 $ 205,772 ========== ========== ========== ========== ========== TOTAL ASSETS $6,913,137 $7,236,568 $7,517,751 $8,031,229 $8,531,949 ========== ========== ========== ========== ========== NET CASH PROVIDED BY OPERATING ACTIVITIES $ 950,492 897,978 $ 618,343 $ 588,162 $ 494,236 ========== ========== ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 24.51 $ 22.65 $ 11.06 $ 8.90 $ 10.20 ========== ========== ========== ========== ========== CASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 40.00 $ 35.00 $ 35.00 $ 35.00 $ (1) ========== ========== ========== ========== ==========\n(1) Quarterly cash distributions were $8.75, prorated per quarter based upon the month the limited partners were admitted to the Partnership.\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 $ 495,192 $ 6,667,632 Excess financial statement depreciation 114,948 604,264 Deferred rental revenues (1,600) 44,500 Accrued incentive management fees 443,214 Capitalization of syndication costs 1,033,223 Accrued partner distributions 176,768 ----------- ----------- Per Partnership income tax return $ 608,540 $ 8,969,601 =========== =========== Net Taxable income per $500 limited partnership unit $ 30.43 ===========\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE\nPage\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Income for the Three Years Ended December 31, 1995\nConsolidated Statements of Changes in Partners' 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\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 XI:\nWe have audited the accompanying balance sheets of DSI Realty Income Fund XI, 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 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.\nJanuary 31, 1996 Deloitte Touche LLP Long Beach, California\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 - --------------------------------------------------------------------------------\nASSETS 1995 1994\nCASH AND CASH EQUIVALENTS $ 277,455 $ 299,707\nPROPERTY, At cost (net of accumulated depreciation of $1,692,649 in 1995 and $1,369,539 in 1994) (Notes 1, 2 and 3) 6,616,116 6,917,295\nOTHER ASSETS (Note 2) 19,566 19,566 ----------- ----------- TOTAL $ 6,913,137 $ 7,236,568 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY\nLIABILITIES: Distribution due partners (Note 4) $ 176,768 $ 176,768 Other liabilities 68,737 79,281 ----------- ----------- Total liabilities 245,505 256,049 ----------- ----------- PARTNERS' EQUITY (Notes 2 and 4): General partners (22,992) (19,863) Limited partners (20,000 limited partnership units outstanding at December 31, 1995 and 1994) 6,690,624 7,000,382 ------------ ----------- Total partners' equity 6,667,632 6,980,519 ------------ ----------- TOTAL $ 6,913,137 $ 7,236,568 ============ ===========\nSee accompanying notes to consolidated financial statements.\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF INCOME THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nREVENUES: Rental revenues $1,698,994 $1,582,982 $ 799,523 Interest income 11,110 6,126 3,965 Guaranteed payments from Dahn (Note 1 and 2) 7,300 170,323 ---------- ---------- ---------- Total revenues 1,710,104 1,596,378 973,811 ---------- ---------- ---------- EXPENSES: Depreciation and amortization (Note 2) 323,290 322,792 322,792 Operating expenses 526,171 470,926 261,662 General and administrative 150,170 146,443 102,363 General partners' incentive management fee (Note 4) 72,727 63,636 63,636 ---------- ---------- ---------- Total expenses 1,072,358 1,003,797 750,453 ---------- ---------- ---------- INCOME BEFORE MINORITY INTERESTS IN INCOME OF REAL ESTATE JOINT VENTURES 637,746 592,581 223,358 ---------- ---------- ---------- MINORITY INTERESTS IN INCOME OF REAL ESTATE JOINT VENTURES (Note 1) (142,554) (134,982) ---------- ---------- ---------- NET INCOME $ 495,192 $ 457,599 $ 223,358 ========== ========== ========== AGGREGATE NET INCOME ALLOCATED TO (Note 4): Limited partners $ 490,240 $ 453,023 $ 221,124 General partners 4,952 4,576 2,234 ---------- ---------- ---------- TOTAL $ 495,192 $ 457,599 $ 223,358 ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT (Notes 2 and 4) $ 24.51 $ 22.65 $ 11.06 ========== ========== ==========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nGeneral Limited Partners Partners Total\nBALANCE AT JANUARY 1, 1993 ($12,531) $ 7,726,235 $ 7,713,704\nNet income 2,234 221,124 223,358\nDistributions (Note 4) (7,071) (700,000) (707,071) ------- ---------- ---------- BALANCE AT DECEMBER 31, 1993 (17,368) 7,247,359 7,229,991\nNet income 4,576 453,023 457,599\nDistributions (Note 4) (7,071) (700,000) (707,071) ------- ---------- ----------- BALANCE AT DECEMBER 31, 1994 (19,863) 7,000,382 6,980,519\nNet income 4,952 490,240 495,192\nDistributions (Note 4) (8,081) (799,998) (808,079) ------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 ($22,992) $ 6,690,624 $ 6,667,632 ======= =========== ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: Interest received $ 11,110 $ 6,126 $ 3,965 Guaranteed payments from Dahn 0 29,100 275,623 Cash received from customers 1,698,994 1,582,952 792,057 Cash paid to suppliers and employees (759,612) (720,200) (453,302) ----------- ----------- ----------- Net cash provided by operating activities 950,492 897,978 618,343 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES - Distributions to partners (808,079) (707,071) (707,071) Distributions paid to minority inter- ests in real estate joint ventures (142,554) (134,982) (6,624) ----------- ----------- ----------- Net cash used in financing activities (950,633) (842,053) (713,695) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES - Guaranteed payments received from Dahn in excess of revenue recognized 100,577 Additions to property (22,111) (16,683) ----------- ----------- ----------- Net cash (used in) provided by investing activities (22,111) (16,683) 100,577 ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (22,252) 39,242 5,225\nCASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 299,707 260,465 255,240 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 277,455 $ 299,707 $ 260,465 =========== =========== =========== RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Net income $ 495,192 $ 457,599 $ 223,358 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 323,290 322,792 322,792 Minority interests in income of real estate joint ventures 142,554 134,982 Changes in assets and liabilities: Guaranteed payments receivable from Dahn 21,800 105,300 Other assets (7,484) (9,966) Incentive management fee payable (63,636) (63,304) Other liabilities (10,544) 31,925 40,163 ----------- ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 950,492 $ 897,978 $ 618,343 =========== =========== ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\n1. GENERAL\nDSI Realty Income Fund XI, a California Real Estate Limited Partnership (the \"Partnership\"), has three general partners (DSI Properties, Inc., Robert J. Conway and Joseph W. Conway) and limited partners owning 20,000 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 March 27, 1981 under the California Uniform Limited Partnership Act for the primary purpose of acquiring and operating real estate. The offering of limited partnership units was completed on February 12, 1991.\nThe Partnership has entered into four joint venture arrangements with affiliates of Dahn Corporation (\"Dahn\"). The Partnership and its joint venture partners have acquired four mini-storage properties located in Whittier, California; Edgewater, New Jersey; Bloomingdale, Illinois; and Sterling Heights, Michigan. The properties were acquired from Dahn.\nUnder the terms of the property purchase agreements, the Partnership and its joint venture partners (Whittier Mini, Bloomingdale Mini, Edgewater Mini and Streling Heights Mini, each a California Limited Partnership and an affiliate od Dahn, and hereinafter referred to as the \"Joint Venture Partners\") own an undivided interest in the mini-storage facilities as follows:\nJoint Venture Mini-Storage Property Partnership Partner\nWhittier, CA 90% 10% Bloomingdale, IL 90% 10% Edgewater, NJ 85% 15% Sterling Heights, MI 75% 25%\nThe Joint Venture Partners have made no cash contributions to any of the joint ventures. Rather, each Joint Venture Partner's interest in each respective mini-storage property was obtained in consideration of a reduction in the purchase price of the property by Dahn.\nPursuant to the terms of each joint venture agreement, annual profits (before depreciation) of each joint venture will be allocated to the Joint Venture Partners on the basis of actual distributions received, while annual losses (before depreciation) are to be allocated in proportion to the ownership percentages as specified above. Cash distributions are to be made to each Joint Venture Partner based upon each Joint Venture Partner's ownership percentage. However, the Joint Venture Partners have subordinated their rights to any distributions to the Partnership's receipt of an annual, noncumulative, 8% return (7.75% for the Whittier Mini) from the operation of the joint ventures. Requirements under the subordination agreement were met during 1995. A minority interest in real estate joint venture is recorded to the extent of any distributions due to the Joint Venture partners. The Joint Venture Partners are also entitled to receive a percentage, based upon a predetermined formula, of the net proceeds from the sale of the properties.\nThe mini-storage facilities are operated by Dahn under various management agreements. In accordance with the agreements, Dahn is to pay all oper- ating expenses through the construction period and an initial operating period. In addition, Dahn is required to make guaranteed payments, as defined, through the same period. The guaranteed payments by Dahn are to be offset by amounts owed to Dahn representing interest earned on the net offering proceeds allocable to the purchase of the property less the cash down payment and progress payments related to each property. The last of the Partnership's properties to emerge from the initial operating period, Sterling Heights did so on January 31, 1994.\nOnce the construction and initial operating periods of the mini-storage facilities have been completed, the Partnership is required by the agreements to pay Dahn a management fee equal to 5% of gross revenue from operations, as defined.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrincipals of Consolidation - The accompanying finacial statements include the accounts of the Partnership and its joint venture investments. All significant intercompany balances and transactions have been eliminated.\nCash and Cash Equivalents - The Partnership classifies its short-term investments purchased with an original maturity of three months or less as cash equivalents.\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.\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 20 years for the facilities.\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 period (20,000 in 1995, 1994 and 1993).\nOrganization Costs - Organization costs have bee capitalized and are being amortized using the straight-line method over a five-year period. Capitalized organization costs are included in other assets in the accompanying balance sheet.\nGuaranteed Payments from Dahn - Guaranteed payments expected to be received from Dahn during the initial operating period are accrued and offset against the cost of the related mini-storage property to the extent that such payments are expected to exceed the forcasted operating results of the mini-storage property during the initial operating period.\nEstimates - The preparation of financial statements in conformity with generally accepted accounting principles 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 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 $ 1,894,250 $ 1,894,250 Buildings 6,414,515 6,392,404 ----------- ----------- Total 8,308,765 8,286,654 Less accumulated depreciation (1,692,649) (1,369,359) ----------- ----------\nProperty, net $ 6,616,116 $ 6,917,295 =========== ===========\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 the project.\nThe general partners are entitled to receive an incentive management fee for supervising the operations of the Partnership. The fee is equal to 9% per annum of the Partnership distributions made from cash available for distribution from operations, as defined.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund XI:\nWe have audited the financial statements of DSI Realty Income Fund XI (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 XI, 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 Deloitte Touche LLP Long Beach, California\nDSI REALTY INCOME FUND XI (A California Real Estate Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION - --------------------------------------------------------------------------------\nReal Estate Accumulated at Cost Depreciation\nBalance at January 1, 1993 $ 8,269,971 $ 731,775 Additions 318,792 ----------- ---------- Balance at December 31, 1993 8,269,971 1,050,567 Additions 16,683 318,792 ----------- ---------- Balance at December 31, 1994 8,286,654 1,369,359 Additions 22,111 323,290 ----------- ---------- Balance at December 31, 1995 $ 8,308,765 $1,692,649 =========== ==========\nThe total cost at the end of the period for Federal income tax purposes was approximately $10,250,000\nEXHIBIT 2 March 28, 1996\nANNUAL REPORT TO LIMITED PARTNERS OF\nDSI REALTY INCOME FUND XI\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 seven mini-storage facilities, including two in Santa Rosa, California. 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 four 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\nWhittier, CA(1) 87% 89%\nBloomingdale, IL(2) 88% 88%\nEdgewater, NJ(3) 89% 91%\nSterling Heights, MI(4) 83% 85% (1) The Partnersip owns a 90% interest in this property. (2) The Partnersip owns a 90% interest in this property (3) The Partnersip owns an 85% interest in this property (4) The Partnersip owns a 75% interest in this property\nWe will keep you informed of the activities of DSI Realty Income Fund XI as they develop. If you have any questions, please contact us at your convenience at (310) 424-2655. If 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 VI By: DSI Properties, Inc.\nBy_______________________________ ROBERT J. CONWAY, President","section_15":""}
{"filename":"313044_1995.txt","cik":"313044","year":"1995","section_1":"Item 1. Business\nPaine Webber Income Properties Two Limited Partnership (the \"Partnership\") is a limited partnership formed on September 5, 1979 under the Uniform Limited Partnership Act of the State of Delaware for the purpose of investing in a diversified portfolio of existing income-producing operating properties such as shopping centers, office buildings and apartment complexes. The Partnership sold $15,445,000 in Limited Partnership units (the \"Units\"), representing 15,445 units at $1,000 per Unit, during the offering period pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration No. 2-65435).\nThe Partnership originally invested in three operating properties. It was expected that the Partnership's assets would be sold from time to time and that the Partnership would be, in effect, self-liquidating after an anticipated holding period of approximately ten years. As of September 30, 1995, two of the three original investments have been sold. As discussed further in Item 7, the Partnership has reached a tentative agreement to sell its interest in the remaining property, Spanish Trace Apartments, to an affiliate of the co-venture partner. It is the intention of the Partnership to seek opportunities that will maximize the returns to the Limited Partners. A sale of this final asset would initiate a liquidation of the Partnership, which could occur in fiscal 1996. However, there can be no assurances that this potential transaction will be completed.\nAs of September 30, 1995, the Partnership has one remaining operating property investment, which was acquired through a joint venture partnership, as set forth below:\nName of Joint Venture Date of Name and Type of Property Acquisition Type of Location Size of Interest Ownership (1)\nSpanish Trace Associates 372 12\/23\/80 Fee ownership Spanish Trace Apartments Units of land and St. Louis County, Missouri improvements (through joint venture)\n(1) See Notes to the Consolidated Financial Statements filed with this Annual Report for a description of the long-term mortgage indebtedness secured by the Partnership's operating property investment and a description of the agreement through which the Partnership has acquired this investment.\nThe Partnership's original investment objectives were to:\n(i) provide the Limited Partners with cash distributions which, to some extent, will not constitute taxable income;\n(ii) preserve and protect the Limited Partners' capital;\n(iii) obtain long-term appreciation in the value of its properties; and\n(iv) provide a build-up of equity through the reduction of mortgage loans on its properties.\nFor the most part, the Partnership has achieved its objectives. Through September 30, 1995, the Limited Partners had received cumulative cash distributions totalling approximately $21,635,000 or $1,404 per original $1,000 investment for the Partnership's earliest investors. This return includes approximately $16,418,000, or $1,063 per original $1,000 investment, of net proceeds from the sale and refinancing transactions completed to date. The remaining distributions of $341 per original $1,000 investment represents cash flow from operations. A substantial portion of such distributions has been sheltered from current taxable income. Regular quarterly distributions of excess operating cash flow were suspended in fiscal 1990. As discussed above, the Partnership has sold two of its three original investment properties. Despite selling one of the properties (Cherry Hill Plaza) at a loss on the original invested capital, distributions from sales and refinancings have already exceeded the Limited Partners' total contributed capital due to the substantial appreciation realized on the Partnership's Meridian Mall investment property and the partial return of capital realized on the Spanish Trace investment as a result of a 1985 refinancing transaction. The Partnership expects to receive net proceeds of approximately $2.3 million from the sale of the Spanish Trace, which is expected to close in late December 1995. In addition, the Partnership will be entitled to its share of the net cash flow generated by the Spanish Trace joint venture through September 30, 1995 and a 10% return on the sale price of $2.3 million from October 1, 1995 through the date of sale. Combined with current Partnership cash reserves, and after payment of all liquidation-related expenses, the Partnership is expected to have sufficient cash to make a final distribution payment to the Limited Partners of approximately $149 per original $1,000 investment.\nThe Partnership's operating property investment is subject to significant competition for the revenues it generates from numerous properties of similar type in the local St. Louis real estate market. The apartment project competes with the other properties generally on the basis of price, location and amenities. As in all markets, the apartment project also competes with the local single family home market for prospective tenants. The continued availability of low interest rates on home mortgage loans has increased the level of this competition over the past few years. However, the impact of the competition from the single-family home market has been offset by the lack of significant new construction activity in the multi-family apartment market over this period.\nThe Partnership has no real property investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser\"), a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber Group, Inc. (\"PaineWebber\"), which is responsible for managing the day-to-day operations of the Partnership.\nThe Managing General Partner of the Partnership is Second Income Properties, Inc., 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.\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 an interest in one remaining operating property investment, the Spanish Trace Apartments, which it acquired through a joint venture partnership. The joint venture partnership and the related property is referred to under Item 1 above to which reference is made for the name, location and description of the property.\nOccupancy figures for each fiscal quarter during 1995, along with an average for the year, are presented below for the remaining operating property:\nPercent Occupied At Fiscal 1995 12\/31\/94 3\/31\/95 6\/30\/95 9\/30\/95 Average\nSpanish Trace Apartments 92% 95% 95% 92% 94%\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 Income Properties, Inc., an affiliate of PaineWebber and the Managing General Partner in the Partnership. 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 Income Properties Two Limited Partnership, PaineWebber and Second Income Properties, Inc. (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 Income Properties Two Limited Partnership, also allege that following the sale of the partnership interests, PaineWebber and Second Income Properties, Inc. misrepresented financial information about the Partnership's value and performance. The amended complaint alleges that PaineWebber and Second Income Properties, Inc. 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 Income Properties, Inc. and its affiliates for costs and liabilities in connection with this litigation. The Managing General Partner intends to vigorously contest the allegations of the action, and believes 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.\nII-2 PART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt September 30, 1995 there were 1,415 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.\nThe Partnership made no cash distributions to the Limited Partners during 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data\nPaine Webber Income Properties Two Limited Partnership For the years ended September 30, 1995, 1994, 1993, 1992 and 1991 (In thousands, except per Unit data)\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nRevenues $ 2,588 $ 2,401 $ 2,325 $ 2,283 $ 2,307\nOperating income (loss) $ 514 $ (214) $ (475) $ (359) $ (277)\nVenture partner's share of venture's operations $ (126) $ 157 $ 181 $ 117 $ 128\nNet income (loss) $ 388 $ (57) $ (294) $ (242) $ (149)\nNet income (loss) per Limited Partnership Unit $ 24.86 $(3.65) $(18.85) $(15.49) $ (9.58)\nTotal assets $ 6,337 $ 6,074 $ 6,290 $ 5,177 $ 5,593\nMortgage note payable $ 9,856 $ 9,924 $ 9,988 $ 8,427 $ 8,467\nThe above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\nThe above net income and cash distributions per Limited Partnership Unit are based upon the 15,445 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 April, 1980 to December, 1980 pursuant to a Registration Statement filed under the Securities Act of 1933. Gross proceeds of $15,445,000 were received by the Partnership and, after deducting selling expenses and offering costs, approximately $12,700,000 was invested in joint venture interests in three operating investment properties. Two of the three investment properties were sold in prior years. The Partnership's remaining investment is a joint venture interest in the Spanish Trace Apartments, located in St. Louis, Missouri. Spanish Trace Apartments is a 372-unit, twenty-four year old, garden-style rental property. Notwithstanding the sale of the Cherry Hill Plaza property at a loss on the original invested capital, the Partnership has already returned more than the Limited Partners' initial capital contributions from sale and refinancing transactions due to the substantial appreciation realized on the Meridian Mall investment property and the partial return of capital realized on the Spanish Trace investment as a result of a 1985 refinancing transaction.\nDuring fiscal 1995, the Partnership reached a tentative agreement to sell its interest in the Spanish Trace Apartments to an affiliate of the co-venture partner for a net price of approximately $2.3 million. The net sale price for the Partnership's equity interest is based on an agreed upon fair market value of the property of approximately $13.3 million. The agreed upon fair market value is supported by management's most recent independent appraisal of the Spanish Trace Apartments and by the marketing efforts to third-parties which have been conducted over the last year and a half. Under the terms of the Spanish Trace joint venture agreement, the co-venture partner has the right to match any third-party offer to purchase the property. Accordingly, a negotiated sale to the co-venturer or its affiliate at the appropriate market price represents the most expeditious and advantageous way for the Partnership to sell this remaining investment. Conditions in the markets for multi-family residential properties across the country have demonstrated gradual improvement throughout fiscal 1995. The absence of significant new construction activity has allowed the oversupply which existed in many markets as a result of the overbuilding of the late 1980s to be absorbed. The results of this absorption have been stabilized occupancy levels and a gradual improvement in rental rates, which have had a positive impact on cash flow levels and, consequently, property values. In addition, the implementation of the capital improvement program made possible by the 1993 refinancing of Spanish Trace has supported management's ability to increase rents and add value to the property. As a result, management believes that it is an opportune time to sell the Partnership's remaining asset.\nThe Partnership has already returned capital of approximately $3,344,000 to the Limited Partners from the Spanish Trace investment as a result of the 1985 refinancing transaction. As previously reported, on August 31, 1993 the Partnership completed a second refinancing of the existing debt on the Spanish Trace Apartments with a loan insured by the U.S. Department of Housing and Urban Development (HUD). As part of the HUD insured loan program, the Spanish Trace joint venture was required to establish an escrow account of approximately $1.8 million for a replacement reserve and payment of other required repairs, real estate taxes and insurance premiums. The balance of these restricted escrow deposits totalled approximately $774,000 as of September 30, 1995. These escrowed funds continue to be used to provide the capital necessary to address certain deferred maintenance and capital improvement items that have significantly upgraded individual units and the property as a whole. The capital improvement program commenced during fiscal 1994. To date, the joint venture has incurred over $1.5 million in improvement costs. A substantial portion of such costs have been reimbursed from the restricted escrow deposits.\nIf the Partnership is successful in closing the sale of its interest in Spanish Trace, the net sale proceeds, after reserves for expenses associated with the liquidation of the Partnership, would be distributed to the partners in accordance with the Partnership Agreement. The Partnership expects to receive net proceeds of approximately $2.3 million from the sale of the Spanish Trace, which is expected to close in late December 1995. In addition, the Partnership will be entitled to its share of the net cash flow generated by the Spanish Trace joint venture through September 30, 1995 and a 10% return on the $2.3 million sale price from October 1, 1995 through the date of sale. Combined with current Partnership cash reserves, and after payment of all liquidation-related expenses, the Partnership is expected to have sufficient cash to make a final distribution payment to the Limited Partners of approximately $149 per original $1,000 investment. If the sale closes as expected, the final distribution payment to the Limited Partners is expected to be made in February 1996. A sale of the remaining investment would initiate a liquidation of the Partnership, which is expected to occur in fiscal 1996. The Partnership will recognize a sizable gain for both book and tax purposes on the sale of its interest in the Spanish Trace joint venture due to the appreciation in value of the operating property and the non-cash depreciation charges recorded to date.\nAt September 30, 1995, the Partnership and its consolidated joint venture had cash and cash equivalents of approximately $638,000. A portion of such cash and cash equivalents belongs to the co-venture partner in the consolidated Spanish Trace joint venture in accordance with the terms of the joint venture agreement. The majority of such cash and cash equivalents will be utilized for the Partnership's working capital requirements through its anticipated liquidation date. The source of future liquidity and final distribution to the partners is expected to be from the proceeds received from the eventual sale of the Spanish Trace Apartments.\nResults of Operations 1995 Compared to 1994\nThe Partnership reported net income of $388,000 for the fiscal year ended September 30, 1995, as compared to a net loss of $57,000 recognized for fiscal 1994. This favorable change in net operating results can be primarily attributed to the absence of depreciation recorded on the remaining operating investment property for the fiscal year ended September 30, 1995. As of September 30, 1994, the Spanish Trace property was classified as an asset held for sale. The estimated market value of the Spanish Trace Apartments is substantially higher than the net carrying value of the property on the accompanying balance sheets. As a result, the Partnership expects to realize a sizable gain upon the sale of the property, which is expected to occur in fiscal 1996. Therefore, no further depreciation will be recorded unless the Partnership's plans for holding the asset change at some future date.\nIncreases in rental revenues and interest income both contributed to the favorable change in net operating results for the fiscal year ended September 30, 1995. Rental revenues increased by $141,000, or 6%, for the current year. Such improvement reflects the increases in rental rates made possible by the capital improvement program at Spanish Trace, as discussed further above, as well as the strengthening market conditions for multi-family properties in general. Interest income increased by $46,000 partly due to an increase in the interest rates earned on the restricted escrow funds related to the debt refinancing. In addition, interest expense and related financing fees declined by $21,000 in fiscal 1995 primarily due to the scheduled principal amortization of the Spanish Trace mortgage loan. Increases in property operating expenses and general and administrative charges partially offset the favorable changes in net operating results. The increase in property operating expenses, of $11,000, is mainly attributable to higher repairs and maintenance costs resulting from the ongoing general upgrading program at Spanish Trace. Partnership general and administrative expenses increased by $12,000 primarily due to an increase in required professional services.\n1994 Compared to 1993\nThe Partnership reported a net loss of $57,000 for the fiscal year ended September 30, 1994, which represents a decrease of $237,000 when compared to the net loss of $294,000 recognized for fiscal 1993. The major portion of the decrease in net loss can be attributed to lower mortgage interest expense of the Spanish Trace joint venture. This is a direct result of the HUD refinancing completed at the end of fiscal 1993 which reduced the annual interest rate on the venture's debt from 11.33% to 7.35%. In addition, rental revenue increased by $50,000 in fiscal 1994 as a result of the generally improving market conditions referred to above. A decrease in property operating expenses also contributed to the Partnership's improved net operating results in fiscal 1994. The decline in property operating expenses was mainly the result of an $87,000 decrease in repairs and maintenance expenses. Prior to the Spanish Trace loan refinancing in fiscal 1993, the joint venture implemented an improvement program to address certain deferred maintenance items. Expenditures for improvements at Spanish Trace during fiscal 1994 were primarily of a capital nature. The favorable changes in the Partnership's net loss were partially offset by an increase in depreciation and general and administrative expenses during fiscal 1994. The increase in depreciation expense was due to the capital improvement program which began in fiscal 1994 at the Spanish Trace Apartments. The Partnership's general and administrative expenses increased mainly as a result of certain professional fees incurred in connection with an independent valuation of the Partnership's remaining investment property which was initiated in fiscal 1994.\n1993 Compared to 1992\nThe Partnership reported a net loss of $294,000 for the fiscal year ended September 30, 1993, an increase of $52,000 when compared to the net loss of $242,000 for the fiscal year ended September 30, 1992. The increase in net loss resulted primarily from the added expenses incurred in fiscal 1993 for the remodeling of the clubhouse and other improvements performed in an effort to increase occupancy rates at the Spanish Trace Apartments. Increases in salary-related costs, insurance and mortgage interest expense also contributed to the increase in net loss. Salary-related costs increased mainly due to an in-house training program implemented to focus on improving customer service for the leasing agents at Spanish Trace. Insurance expense increased due to an increase in the property's liability insurance premium. The increase in property operating expenses was partially offset by increased revenues generated by an increase in occupancy during fiscal 1993. A decrease in interest income resulted from a decrease in cash balances and lower interest rates. Interest expense increased as a result of an extension fee paid in April 1993 in conjunction with the above mentioned refinancing.\nInflation\nThe Partnership completed its fifteenth full year of operations in 1995 and the effects of inflation and changes in prices on revenues and expenses on the Partnership's operating results to date have not been significant.\nInflation in future periods may increase revenues, as well as operating expenses, at the Partnership's operating investment property. Rental rates at the Partnership's residential apartment property can be adjusted to keep pace with inflation, to the extent market conditions permit, 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 property and Partnership 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 the Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nIII-4 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 Income Properties, Inc., a Delaware corporation, which is a wholly-owned subsidiary of PaineWebber. 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 PaineWebber Properties Incorporated (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 and Chief Executive Officer 42 8\/30\/88 Albert Pratt Director 84 11\/3\/78 * 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\/5\/80 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 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.\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.\nAlbert Pratt is a Director of the Managing General Partner and a Consultant of PWI. 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.\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.\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 September 30, 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.\nUnder certain circumstances, the Partnership is required to pay management fees to the Adviser, and the Managing General Partner is entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described under Item 13.\nThe Partnership paid cash distributions to the Unitholders on a quarterly basis at rates ranging from 3% to 6% per annum on remaining invested capital from inception through November 1989, at which time such distributions were suspended indefinitely. 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 Income Properties, Inc., is owned by PaineWebber. No Limited Partner is known by the Partnership to own beneficially more than 5% of the outstanding units of Limited Partnership Interest in the Partnership.\n(b) A director of the Managing General Partner of the Partnership owns one unit of limited partnership interest in the Partnership.\nNo director or officer of the Managing General Partner of the Partnership 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 Income Properties, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"). The Associate General Partner is Properties Associates, a Massachusetts general partnership, with certain general partners who 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 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 and disposition of Partnership investments. In connection with investing Partnership capital, the Adviser received acquisition fees paid by the joint ventures and sellers.\nAll distributable cash, as defined, for each fiscal year is distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. Sale or refinancing proceeds will be distributed first 100% to the Limited Partners until the Limited Partners have received their original capital contributions and a cumulative annual return of 7% based upon a Limited Partner's adjusted capital contributions, as defined in the Partnership Agreement. Next, any remaining sale or refinancing proceeds are payable to the Adviser as a disposition fee up to an amount equal to 3\/4% of the aggregate selling prices of the Partnership's properties. Any remaining sale or refinancing proceeds are to be distributed 85% to the Limited Partners and 15% to the General Partners. As discussed further in Item 7, the Partnership has executed a contract for the sale of its final remaining investment. Based on the expected proceeds from this potential sale transaction, the Limited Partners would receive a final distribution in an amount sufficient to make aggregate distributions to the Limited Partners since inception equal to a return of the original capital contributions plus a cumulative 7% annual return. Based on the estimate of final liquidation-expenses, there will be residual cash proceeds available to pay some, but not all, of the aforementioned disposition fee to the Adviser.\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 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. Taxable income arising from disposition of Partnership investments will be allocated to the Limited and General Partners generally as residual proceeds are distributed. Tax losses arising from disposition of Partnership investments and taxable income for which there are no residual proceeds will be allocated 99% to the Limited Partners and 1% to the General 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 September 30, 1995 is $35,000 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 $1,000 (included in general and administrative expenses) for managing the Partnership's cash assets during the year ended September 30, 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 Schedule:\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 listed on the accompanying index to exhibits at Page IV-3 are filed as part of this Report.\n(b) No Current 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 Schedule at page.\nIV-1\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 INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nBy: Second Income 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: 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 Partnership in the capacity and on the dates indicated.\nBy:\/s\/ Albert Pratt Date:December 28, 1995 Albert Pratt Director\nBy:\/s\/ J. Richard Sipes Date December 28, 1995 J. Richard Sipes Director\nIV-2\nANNUAL REPORT ON FORM 10-K Item 14(a)(3)\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nINDEX TO EXHIBITS\nPage Number in the Exhibit No. Description of Document Report or Other Reference - ---------------- ----------------------------------- ---------------------\n(3) and (4) Prospectus of the Registrant Filed with the dated Commission pursuant April 13, 1980, as supplemented, to Rule 424(c) and with incorporated herein particular reference to the by reference. Restated Certificate and Agreement of Limited Partnership.\n(10) Material contracts previously Filed with the filed as Commission pursuant exhibits to registration to Section 13 or statements 15(d) of the and amendments thereto of the Securities Exchange registrant together with all such Act of 1934 and contracts filed as exhibits of incorporated 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 September 30, 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 1 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 and Financial Statement Schedule required by Item 14.\nIV-3\nANNUAL REPORT ON FORM 10-K Item 14(a)(1) and (2) and 14 (d)\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReference\nPaine Webber Income Properties Two Limited Partnership:\nReport of independent auditors\nConsolidated balance sheets as of September 30, 1995 and 1994\nConsolidated statements of operations for the years ended September 30, 1995, 1994 and 1993\nConsolidated statements of changes in partners' capital (deficit) 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\nNotes to consolidated 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 consolidated financial statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners Paine Webber Income Properties Two Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of Paine Webber Income Properties Two Limited Partnership as of September 30, 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 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 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 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 the Partnership's management, as well as evaluating the overall financial statement presentation. We believe that our 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 Paine Webber Income Properties Two Limited Partnership 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, presents fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nBoston, Massachusetts December 20, 1995\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS September 30, 1995 and 1994 (In thousands, except per Unit data)\nASSETS\n1995 1994\nInvestment property held for sale, net of accumulated depreciation of $7,795 $ 4,670 $ 3,911\nCash and cash equivalents 638 203 Restricted escrow deposits 774 1,695 Accounts receivable - affiliates - 13 Prepaid expenses 33 23 Deferred expenses (net of accumulated amortization of $15 in 1995 and $8 in 1994, respectively) 222 229 ---------- -------- $ 6,337 $ 6,074 ======== ========\nLIABILITIES AND PARTNERS' DEFICIT\nMortgage note payable $ 9,856 $ 9,924 Accounts payable and accrued expenses 87 204 Real estate taxes payable 106 144 Accrued interest payable 60 61 Deferred revenues 4 21 Tenant security deposits 97 94 ---------- -------- Total liabilities 10,210 10,448\nVenture partner's subordinated deficit (1,713) (1,826)\nPartners' deficit: General Partners: Capital contribution 5 5 Cumulative net income 57 53 Cumulative cash distributions (53) (53)\nLimited Partners ($1,000 per Unit; 15,445 Units issued): Capital contributions, net of offering costs 13,758 13,758 Cumulative net income 5,708 5,324 Cumulative cash distributions (21,635) (21,635) Total partners' deficit (2,160) (2,548) -------- --------- $ 6,337 $ 6,074 ======== ========\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS For the years ended September 30, 1995, 1994 and 1993 (In thousands, except per Unit data)\n1995 1994 1993\nRevenues: Rental revenues $ 2,497 $ 2,356 $ 2,306 Interest income 91 45 19 ---------- ------ ------- 2,588 2,401 2,325\nExpenses: Property operating expenses 937 926 997 Depreciation - 530 524 Interest expense and related financing fees 826 847 982 Real estate taxes 193 206 210 General and administrative 118 106 87 ---------- ---------- ----------- 2,074 2,615 2,800 --------- --------- ---------\nOperating income (loss) 514 (214) (475)\nVenture partner's share of venture's operations (126) 157 181 ------- --------- ---------\nNet income (loss) $ 388 $ (57) $ (294) ======== ========= ==========\nNet income (loss) per Limited Partnership Unit $24.86 $(3.65) $(18.85) ====== ====== ========\nThe above net income (loss) per Limited Partnership Unit is based upon the 15,445 Limited Partnership Units outstanding during each year.\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended September 30, 1995, 1994 and 1993 (In thousands)\nGeneral Limited Partners Partners Total\nBalance at September 30, 1992 $ 9 $(2,206) $(2,197)\nNet loss (3) (291) (294) -------- ----------- ----------\nBalance at September 30, 1993 6 (2,497) (2,491)\nNet loss (1) (56) (57) -------- ---------- ----------\nBalance at September 30, 1994 5 (2,553) (2,548)\nNet income 4 384 388 -------- --------- ----------\nBalance at September 30, 1995 $ 9 $(2,169) $(2,160) ====== ======= =======\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended September 30, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (In thousands)\n1995 1994 1993 Cash flows from operating activities: Net income (loss) $ 388 $ (57) $ (294) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation - 530 524 Amortization of deferred financing costs 7 7 1 Venture partner's share of venture's operations 126 (157) (181) Changes in assets and liabilities: Restricted escrows deposits 921 82 6 Accounts receivable - - 2 Accounts receivable - affiliates - - 1 Prepaid expenses (10) 99 41 Accounts payable and accrued expenses (117) 57 53 Real estate taxes payable (38) 3 (17) Accrued interest payable (1) - (18) Deferred revenues (17) 21 - Accounts payable - affiliates - (13) 9 Tenant security deposits 3 (7) 1 ------- ------- -------- Total adjustments 874 622 422 ------- ------- -------- Net cash provided by operating activities 1,262 565 128\nCash flows from investing activities: Capital expenditures (759) (709) (18) Net cash used for investing activities (759) (709) (18)\nCash flows from financing activities: Restricted escrows funded by debt proceeds - - (1,626) Prepaid expenses funded by debt proceeds - - (100) Proceeds from long-term debt - - 9,988 Payment of deferred financing costs - (10) (226) Principal payments on mortgage note payable (68) (63) (8,427) ----------- --------- --------- Net cash used for financing activities (68) (73) (391)\nNet increase (decrease) in cash and cash equivalents 435 (217) (281)\nCash and cash equivalents, beginning of year 203 420 701 --------- --------- ---------\nCash and cash equivalents, end of year $ 638 $ 203 $ 420 =========== ========= =========\nCash paid during the year for interest $ 764 $ 732 $ 999 =========== ========= =========\nSee accompanying notes.\nPAINE WEBBER INCOME PROPERTIES TWO LIMITED PARTNERSHIP Notes to Consolidated Financial Statements\n1. Organization\nPaine Webber Income Properties Two Limited Partnership (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Delaware in 1979 for the purpose of investing in a diversified portfolio of income-producing properties. The Partnership authorized the issuance of units (at $1,000 per Unit) of which 15,445 were subscribed and issued. The Partnership originally invested the proceeds of its public offering in joint venture interests in three operating investment properties. The Partnership sold one of the operating properties in fiscal 1984 and sold its interest in a second property during fiscal 1989, leaving the Partnership with one remaining investment interest as of September 30, 1995; a joint venture interest in the Spanish Trace Apartments. As discussed further in Note 4, during fiscal 1995, the Partnership reached a tentative agreement to sell its interest in the Spanish Trace Apartments to an affiliate of the co-venture partner for a net price of approximately $2.3 million. If the Partnership is successful in closing such a sale, the net sale proceeds, after reserves for expenses associated with the liquidation of the Partnership, would be distributed to the partners in accordance with the Partnership Agreement. The sale is expected to close in late December 1995. As a result of this pending transaction, management expects to complete a liquidation of the Partnership during fiscal 1996.\n2. Summary of Significant Accounting Policies\nThe accompanying consolidated financial statements include the consolidation of the accounts of the Partnership and its investment in one joint venture, which owns an operating investment property. The effects of all transactions between the Partnership and the consolidated joint venture have been eliminated in consolidation.\nThe Partnership's policy is to carry its operating investment property 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 Partnership's investment through expected future cash flows on an undiscounted basis, which may exceed the property's market value. The net realizable value of a property held for sale approximates its current market value. The Partnership's remaining operating investment property was considered to be held for sale as of September 30, 1995 and 1994. Accordingly, the net carrying value of the operating investment property is classified as investment property held for sale in the accompanying consolidated balance sheets. The property's net carrying value is substantially below its estimated fair market value.\nThe cost basis of the operating investment property includes an amount of $1,510,000, representing a nonmonetary interest brought into the joint venture by the co-venture partner. Professional fees and other costs related to the acquisition of the property have been capitalized in the cost of the buildings. Depreciation was calculated on a component basis by using the straight-line method through September 30, 1994. As noted above, as of September 30, 1994, the operating investment property was classified as an asset held for sale. The Partnership expects to realize a sizable gain upon the sale of the property, which is expected to occur in fiscal 1996. Therefore, no further depreciation will be recorded subsequent to September 30, 1994 unless the Partnership's plans for holding the asset change at some future date. The estimated useful lives of the components range from 5 to 31 years. Minor maintenance and repair expenses are charged to expense as incurred. Betterments and improvements are capitalized.\nSeparate escrow accounts for property taxes, insurance premiums and a reserve for replacements at the operating investment property are required by the U.S. Department of Housing and Urban Development (HUD) which insures the long-term debt (see Note 5). Use of these funds must be approved by HUD.\nDeferred expenses at September 30, 1995 and 1994 consist of financing costs which are being amortized using the straight-line method over the term of the mortgage note payable. Such amortization is included in interest expense on the accompanying statements of operations.\nThe consolidated joint venture leases apartment units under leases with terms usually of one year or less. Rental income is recorded on the accrual basis as earned. Security deposits typically are required of all tenants.\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 Income Properties, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"). 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 Managing General Partner, 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 properties.\nAll distributable cash, as defined, for each fiscal year is distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. Sale or refinancing proceeds will be distributed first 100% to the Limited Partners until the Limited Partners have received their original capital contributions and a cumulative annual return of 7% based upon a Limited Partner's adjusted capital contributions, as defined in the Partnership Agreement. Next, any remaining sale or refinancing proceeds are payable to the Adviser as a disposition fee up to an amount equal to 3\/4% of the aggregate selling prices of the Partnership's properties. Any remaining sale or refinancing proceeds are to be distributed 85% to the Limited Partners and 15% to the General Partners. As discussed further in Note 4, the Partnership has executed a contract for the sale of its final remaining investment. Based on the expected proceeds from this potential sale transaction, the Limited Partners would receive a final distribution in an amount sufficient to make aggregate distributions to the Limited Partners since inception equal to a return of the original capital contributions plus a cumulative 7% annual return. Based on the estimate of final liquidation-expenses, there will be residual cash proceeds available to pay some, but not all, of the aforementioned disposition fee to the Adviser.\nPursuant to the terms of the Partnership Agreement, taxable income or tax loss from the operations of the Partnership is 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 Partners 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 is due to be paid a basic management fee (4% of adjusted cash flow) and an incentive management fee (5% of adjusted cash flow subordinated to a noncumulative annual return to the limited partners equal to 6% based upon their adjusted capital contributions) for services rendered. No basic or incentive management fees were earned during the three-year period ending September 30, 1995.\nThe 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 operation of the Partnership's real estate investments. The General Partner may be called upon to fund certain temporary advances to pay for Partnership operating expenses during fiscal 1996 until the proposed sale transaction closes or until the consolidated joint venture receives approval from HUD to release surplus cash and certain excess reserve funds (see Notes 4 and 5).\nIncluded in general and administrative expenses for the years ended September 30, 1995, 1994 and 1993 is $35,000, $20,000 and $20,000, 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 $1,000 per year (included in general and administrative expenses) for managing the Partnership's cash assets during each of the three years in the period ended September 30, 1995.\n4. Real Estate Investment\nAt September 30, 1995 the Partnership has an investment in one consolidated joint venture which owns an operating investment property. A description of the property and the terms of the joint venture agreement are summarized below:\nSpanish Trace Associates\nOn December 23, 1980 the Partnership acquired a joint venture interest in Spanish Trace Associates, a Missouri general partnership (\"Spanish Trace\"), organized to purchase and operate a 372-unit apartment complex in St. Louis County, Missouri. The joint venture was formed with St. Louis Spanish Trace Company, Ltd. (the \"Co-Venturer\"), an affiliate of the Paragon Group. The Partnership is a general partner in the joint venture.\nDuring fiscal 1995, the Partnership reached a tentative agreement to sell its interest in the Spanish Trace Apartments to an affiliate of the Co-venturer for a net price of approximately $2.3 million. Under the terms of the sale agreement, the Co-Venturer will purchase the Partnership's interest in the property and will assume the mortgage loan secured by the property and the related escrow deposits. The net sale price for the Partnership's equity interest is based on an agreed upon fair market value of the property of approximately $13.3 million. The agreed upon fair market value is supported by management's most recent independent appraisal of Spanish Trace and by the marketing efforts to third-parties which have been conducted over the last year and a half. Under the terms of the Spanish Trace joint venture agreement, the co-venture partner has the right to match any third-party offer to purchase the property. Accordingly, a negotiated sale to the Co-venturer or its affiliate at the appropriate market price represents the most expeditious and advantageous way for the Partnership to sell this remaining investment. Under the terms of the sale agreement, which is expected to close in late December 1995, the Partnership would receive net proceeds of $2.3 million plus the share of the venture's cash flow through September 30, 1995 to which the Partnership is entitled in accordance with the joint venture agreement and a 10% return on the $2.3 million sale price from October 1, 1995 through the date of the sale. If the Partnership is successful in closing such a sale, the net sale proceeds, after reserves for expenses associated with the liquidation of the Partnership, would be distributed in accordance with the Partnership Agreement. A sale of the remaining investment would initiate a liquidation of the Partnership, which is expected to occur in fiscal 1996. The Partnership would recognize a sizable gain under the terms of the sale agreement calculated as the sum of the cash proceeds of the sale and the carrying value of the mortgage note in excess of the carrying value of the property, adjusted for closing costs and certain deferred charges. The gain is expected to be sufficient to offset the venture partner's subordinated deficit as well as the Partners' deficit.\nThe aggregate cash investment by the Partnership for its interest was approximately $4,603,000 (including an acquisition fee of $410,000 paid to the Adviser). The Partnership's interest was acquired subject to two nonrecourse mortgages totalling approximately $4,252,000. On September 30, 1985 the joint venture refinanced the property by replacing the original mortgages, which had remaining balances of approximately $3,711,000, with a new first mortgage loan of $8,500,000. The Partnership and the Co-Venturer received $3,338,000 and $1,112,500, respectively, as distributions of the refinancing proceeds in fiscal 1986. The distribution of refinancing proceeds, along with cash flow distributions and net losses to date allocated to the venture partners in accordance with the joint venture agreement, have resulted in deficit venturers' capital accounts for both the Partnership and the Co-Venturer as of September 30, 1995. As further discussed in Note 5, during fiscal 1993 the property's existing debt was refinanced again through the receipt of a loan issued in conjunction with an insured loan program of the U.S. Department of Housing and Urban Development (HUD). The new loan, which had an initial principal balance of $9,987,500, is a nonrecourse obligation which is secured by the operating investment property and an assignment of rents and leases. As part of the HUD insured loan program, the joint venture was required to establish an escrow account for a replacement reserve and other required repairs. The excess loan proceeds, after repayment of the outstanding indebtedness, were used to pay transaction costs and to fund certain of the aforementioned capital reserve requirements.\nThe joint venture agreement and an amendment thereto dated September 30, 1985 provide that the distribution of cash flow for any year shall first be distributed to a partner in the amount of the other partner's deficit. The other partner's deficit is defined to be an amount equal to 10% of the excess aggregate amount required to be loaned to the joint venture over the aggregate amount actually so loaned to the joint venture by such partner. In 1993, the Partnership advanced 100% of the funds required to close the refinancing transaction referred to above, which totalled approximately $320,000. During fiscal 1995, $113,000 of such advances were repaid leaving an unpaid balance of $207,000 as of September 30, 1995. The joint venture agreement further provides that, from available cash flow, an annual amount of $138,000 will be distributed to the Partnership and then an annual amount of $37,000 will be distributed to the Co-Venturer. The next $14,500 in excess of such preferred returns in any year would be distributed 75% to the Partnership and 25% to the Co-Venturer; the next $43,600 would be distributed 65% to the Partnership and 35% to the Co-Venturer; the next $64,600 would be distributed 55% to the Partnership and 45% to the Co-Venturer; and any remaining cash flow would be distributed 50% to the Partnership and 50% to the Co-Venturer. The amount and timing of actual cash distributions are restricted by the Computation of Surplus Cash, Distributions and Residual Receipts as defined under the HUD financing agreement.\nThe joint venture agreement also provides that the taxable income or tax loss without regard to depreciation expense in each year will be allocated to the joint venture partners according to a formula which generally follows the distribution of cash flow. The depreciation expense resulting from the adjustment of the operating property basis is allocated to the Co-Venturer. Other depreciation expense is allocated equally to the Partnership and the Co-Venturer in the amount of the respective payments made to the reserves of the joint venture, with any remaining balance allocated in the same proportions as the preference returns in such fiscal year. Allocations of the venture's operations between the Partnership and the Co-Venturer for financial reporting purposes have been made in conformity with the allocations of taxable income or tax loss. It is expected that the venture partner's subordinated deficit, which totalled approximately $1,713,000 as of September 30, 1995, will be more than offset by the future gain to be allocated to the Co-Venturer on the sale of the operating investment property.\nUnder the terms of the joint venture agreement, the Partnership is to receive $1,162,500 as a first priority in distributions of sale or refinancing proceeds after the repayment of any loans from the Partnership and the Co-Venturer to the joint venture. The next $407,500 of such proceeds would be distributed to the Co-Venturer. The next $2,500,000 of such proceeds would be distributed 65% to the Partnership and 35% to the Co-Venturer. Any remaining proceeds would be distributed 50% to the Partnership and 50% to the Co-Venturer.\nIf additional cash is required in connection with the joint venture, the joint venture agreement calls for such funds to be provided by the Partnership and the Co-Venturer, in equal amounts, as loans to the joint venture.\nThe joint venture has entered into a management agreement with an affiliate of the Co-Venturer, cancellable at the Partnership's option upon the occurrence of certain events, that provides for a management fee of 5% of gross revenues. Management fees of $123,000, $119,000 and $116,000 were received by the property manager for the years ended September 30, 1995, 1994 and 1993, respectively.\nIncluded in the balance of cash and cash equivalents at September 30, 1995 and 1994 is approximately $110,000 and $97,000, respectively, of security deposits received from tenants of the Spanish Trace Apartments.\nAccounts receivable - affiliates at September 30, 1994 consisted of prepaid distributions of $13,000 received by the Co-Venturer. Such distributions were earned in fiscal 1995.\nThe following is a summary of property operating expenses for the years ended September 30, 1995, 1994 and 1993 (in thousands):\n1995 1994 1993 ---- ---- ---- Property operating expenses: Repairs and maintenance $ 293 $ 262 $ 349 Salaries and related costs 256 291 285 Management fees 123 120 116 Utilities 143 138 120 Administrative and other 110 85 78 Insurance 12 30 49 -------- --------- ------- $ 937 $ 926 $ 997 ======= ======= =====\n5. Mortgage Note Payable\nThe mortgage note payable on the consolidated balance sheet relates to the Spanish Trace joint venture and is secured by that venture's operating investment property.\nMortgage note payable consists of the following at September 30 (in thousands):\n1995 1994 ---- ----\n7.35% nonrecourse mortgage loan secured by the Spanish Trace Apartments, payable in monthly installments, including principal and interest of $66,000 through August 1, 2028. The remaining balance of principal and interest is due September 1, 2028 (see discussion below) $9,856 $9,924 ====== ======\nIn addition to the monthly principal and interest payment, the property submits monthly escrow deposits of $21,000 for tax and insurance escrows and replacement reserves. The loan is insured by the U.S. Department of Housing and Urban Development (HUD). Under the HUD loan program, the venture is required to obtain mortgage insurance to cover the outstanding principal balance of the loan. Mortgage insurance premiums paid during fiscal 1995 and 1994 totalled $76,000 and $108,000, respectively, and are included in interest expense and related financing fees on the accompanying statements of operations.\nScheduled maturities of the long-term debt are as follows (in thousands):\n1996 $ 73 1997 79 1998 85 1999 91 2000 97 Thereafter 9,431 ---------- $ 9,856 6. 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":"778426_1995.txt","cik":"778426","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nNRP Inc., operating under its trade name, ATC Communications Group (hereinafter \"ATC\" or the \"Company\"), is a provider of outsourced telecommunications-based marketing and information services to major corporations in the United States.\nThe Company has shifted its strategic focus to building upon and enhancing this core business, and away from its previous plan to assemble an integrated direct marketing company comprised of direct mail marketing and mailing list services in addition to telecommunications-based marketing services. In the year ended June 30, 1993 (\"fiscal 1993\"), management examined the Company's overall business plan and each operating segment's operating performance and concluded that (i) the integrated company strategy had not achieved the expected synergies and economies of scale to management's satisfaction, and (ii) the telecommunications-based marketing business possessed significantly greater growth potential than the other two segments. Accordingly, in the year ended June 30, 1994 (\"fiscal 1994\"), the Company divested of its direct mail publishing subsidiary, and in the year ended June 30, 1995 (\"fiscal 1995\"), divested of its mailing list services business, thereby enabling the Company to concentrate on growing and creating long-term value in its telecommunications-based subsidiary. Management believes this shift in strategy has enabled the Company to grow revenues and improve operating results, while positioning the Company to compete effectively as a provider of telecommunications-based marketing and information services.\nThe Company's headquarters are located at 5950 Berkshire Lane, Suite 1650, Dallas, Texas 75225, and its telephone number is (214) 361-9870. The Company was incorporated in Delaware on August 2, 1985 under the name of Kenneth Resources, Inc. and changed its name to NRP Inc. on July 12, 1988. The Company recently began using the tradename ATC Communications Group to reflect its new operating focus and plans to seek shareholder approval at the next annual meeting to change its legal name to ATC Communications Group, Inc.\nTELECOMMUNICATIONS-BASED SERVICES\nDescription of Services\nThe Company, through its subsidiary, Advanced Telemarketing Corporation (\"Advanced\"), designs, manages, and conducts large-scale, complex telecommunications-based marketing and customer services programs on an outsourced basis to a broad range of companies and organizations in a variety of industries. Advanced performs its services through two distinct divisions.\nThrough its ATC Marketing division, Advanced offers clients customized, large-volume inbound and outbound call processing services featuring \"live\" operators to interact with clients' customers and prospects. Additionally, through its ATC Call Management division, Advanced manages call center facilities for clients under multi-year contracts which usually require the development of proprietary software systems. Both divisions also provide clients with high speed analysis and delivery of marketing and other analytical information valuable to the client which Advanced captures while performing its services.\nOverall, during fiscal 1995, approximately 46.4% of Advanced's revenues were generated by inbound call volume and 53.6% by outbound call volume. Advanced does not engage in any form of outbound calling which uses computerized voice presentations or requires unsolicited financial requests (i.e. fundraising) and is not involved in the \"900\" number business.\nDescription of Operations\nThe Company operates and manages six fully-automated call centers with a capacity of more than 2,900 workstations located in the Dallas area, in Chicago and in San Francisco. These call centers operate six Rockwell automatic call distributors. The data system itself is based on an open architecture which permits real-time interface of the Company's data processing systems with the client's host systems to provide a seamless, rapid flow of data to the client. Outbound calling is enhanced by a Rockwell predictive dialing system which escalates dialing activity in advance of workstation availability and automatically eliminates calls not answered by a human respondent. This predictive dialing system enhances efficiency and productivity by minimizing operator non-productive time. Advanced also maintains a substantial information systems staff which permits flexibility by creating customized software applications for its clients as well as the capability to react quickly to its clients' changing needs.\nBecause Advanced's marketing and service representatives deal directly with its clients' customers and sales prospects, the Company places a heavy emphasis on its training and quality control process. System-wide, Advanced has in excess of 30,000 square feet dedicated to these functions. At the subsidiary's headquarters, Advanced has built a 14,000 square foot education center adjacent to a 14,700 square foot call center which is equipped for live role playing when not in use as a client call center. Advanced employs 15 full and part-time trainers dedicated to conducting both primary and recurrent training for all representatives. Depending on the complexity of the clients' applications, training can require up to six weeks to complete. Quality control is measured by various organizations within the Company on both a quantitative and qualitative basis through multiple processes. This attentiveness to training and customer service enables Advanced's representatives to perform a variety of highly complex and proprietary functions for its clients in both inbound and outbound calling programs.\nMarketing and Clients\nThe business of providing call handling services is highly competitive, although very fragmented, consisting of a few large outsourcing companies, a significant number of small independent providers and numerous \"in-house\" operations. In 1992 alone, it is estimated that over $300 billion in goods and services were sold via telecommunications. This figure does not include the substantial costs incurred by businesses in processing incoming customer service calls. Increasingly, companies are outsourcing these call handling services in an effort to focus their resources on their core competencies, improve operating quality and efficiencies, and reduce costs.\nAdvanced targets its marketing efforts towards large corporations in selected industries that utilize telecommunications as an integral, ongoing element in their core marketing and\/or customer service strategy. These corporations' call handling requirements demand the sophistication, volume and quality requirements to capitalize effectively on Advanced's technology and client support infrastructure in addition to having the greatest potential for growth. Advanced seeks to produce recurring revenue and develop long-term alliances with its clients by concentrating on service, quality and flexibility and by integrating its technological capabilities with its clients' internal systems.\nAdvanced believes its competitive advantages include its capacity, its emphasis on quality and service to the client, its technological capabilities, and its flexibility, allowing Advanced to respond to the clients' changing requirements. These advantages have enabled ATC to grow rapidly in the last two fiscal years by attracting a variety of new clients in various industries and by expanding the services provided to its existing clients. The following entities accounted for ten percent or more of the gross revenues of the Company in 1994: AT&T, Chemical Bank, GTE Service Corporation and AT&T Universal Card, while AT&T and AT&T Universal Card accounted for ten percent or more of the gross revenues of the Company in fiscal 1995.\nGovernmental Regulations\nDuring the past five years the industry in which the Company operates has been impacted by state and federal government regulations directed specifically at the industry. In addition, certain state and federal governmental bodies have proposed legislation to further regulate the industry. While the Company cannot predict what any governmental body may do, management does not believe the currently existing or proposed legislation will alter the Company's operating procedures or increase its compliance cost because the Company adheres to self-imposed standards that management believes are more restrictive than such currently existing and proposed regulations.\nRevenues and Seasonal Nature of Business\nThe Company's revenues are affected by the timing and magnitude of its clients' marketing programs and the commencement of new programs; thus the Company experiences and expects to continue to experience quarterly variations in revenues. Although the business is not seasonal in nature, historically Advanced has generated a slightly larger percentage of its annual revenues in the second and fourth quarters of its fiscal year. Revenues generated by Advanced accounted for approximately 100%, 68% and 48% of the Company's consolidated revenues of both continuing and discontinued operations for the years ended June 30, 1995, 1994, and 1993, respectively.\nEMPLOYEES\nAs of August 31, 1995, the Company employed approximately 2,617 persons in the following areas: 130 in management and general administration, 3 in marketing and sales, 168 in direct supervision of marketing agents and 2,316 marketing agents. The Company has not experienced any material difficulty in attracting and retaining qualified personnel in the geographic regions where it currently conducts business.\nINDUSTRY SEGMENT INFORMATION\nAs a result of the divestitures of the direct mail marketing and mail list businesses, the Company discontinued the operations of the two business segments. The financial results of the operations of the Company's remaining business segment, outsourced telecommunications-based services, are included in Item 8. - \"Financial Statements and Supplementary Data\". Summary financial information related to the discontinued business segments is included in Note 14. Disposition of Assets of Item 8. - \"Financial Statements and Supplementary Data\".\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's operating subsidiary, Advanced, currently performs its services in six call centers with a total capacity of 2,946 workstations (compared to approximately 1,400 workstations reported in the prior year): (i) 686 positions located in Las Colinas, Texas in a 52,866 square foot facility, (ii) 240 positions located in Garland, Texas occupying 12,963 square feet, (iii) an Irving, Texas facility comprised of a 14,069 square foot education center and a 20,209 square foot call center housing 460 positions, (iv) a 90,000 square foot call center in Dallas, Texas with a capacity of 1,270 positions, (v) a 60 position call center in Chicago, Illinois dedicated to a single client and (vi) a 32,616 square foot call center with 230 positions in San Francisco, California which also serves a single client. All of Advanced's facilities are occupied pursuant to various lease arrangements, except the Chicago facility, which is owned by Advanced's client and is occupied by Advanced at the client's expense. While Advanced's current capacity is sufficient to handle its current production demands, as Advanced's growth continues additional call center facilities may be needed.\nThe Company's principal executive offices in Dallas, Texas are occupied pursuant to a lease expiring November 30, 1996 and contain approximately 4,170 square feet. The lease calls for a monthly rental of approximately $5,386 per month.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOther than ordinary routine litigation incidental to its and its subsidiaries' businesses, neither the Company nor its subsidiaries are parties to, nor are their properties the subject of, 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 THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nMARKET INFORMATION\nThe Company's Common Stock, $.01 par value, trades on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol \"ATCT\". As of August 31, 1995 there were approximately 13,563,361 shares of Common Stock outstanding held by approximately 655 holders of record.\nThe table below lists the range of high and low bids for the Company's Common Stock as reported by NASDAQ for the two-year period ended June 30, 1995 and the subsequent interim period.\nThe above quotations represent prices between dealers and do not include retail mark-up, mark-down or commissions and may not represent actual transactions.\nDIVIDENDS\nSince its inception the Company has not declared a cash dividend on its Common Stock and does not anticipate doing so in the foreseeable future. The Company pays an annual dividend of $.36 per share on its 29,778 outstanding shares of Series B Preferred Stock and the Company pays an annual dividend of $.11 per share on its 840,000 outstanding shares of Series C Preferred Stock. Pursuant to Advanced's working capital line of credit and equipment term loan credit agreements, Advanced is restricted in its ability to pay dividends to ATC.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe table on the following page sets forth certain selected consolidated financial data for the Company and its subsidiaries for the last five years. 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.\nLIQUIDITY AND CAPITAL RESOURCES\nAs discussed previously, in fiscal 1993 management determined that its Advanced subsidiary possessed a greater potential for growth than the Company's other lines of business. Accordingly, the Company consummated several transactions which resulted in the strengthening of the Company's balance sheet, increasing the Company's liquidity and focusing the Company's efforts on Advanced. These transactions included: (i) the sale of the assets and the discontinuation of the M\/B Ltd. business segment, (ii) the issuance of 840,000 shares of Series C Convertible Preferred Stock upon the conversion of approximately $3.1 million in 15% short-term debt, and (iii) the sale of the assets and discontinuation of the NRL business segment.\nWith these transactions completed, management then focused on securing adequate working capital and equipment financing to fund Advanced's near-term growth. Advanced is a labor intensive business, incurring multiple payrolls before clients are invoiced and remittances are received. During times of growth it is virtually impossible for Advanced to fund its working capital needs solely via operating cash flow due to its labor intensive nature and the timing of its receipts. Therefore, to meet its growth related working capital needs, in May 1994, Advanced secured a three year $15 million working capital facility with a major commercial bank to replace its previous receivable financing arrangement. Availability under this new facility is based on Advanced's accounts receivable balance. In addition to increasing Advanced's availability from $5 million to $15 million, the new working capital facility also decreased the rate Advanced pays for working capital borrowings.\nIn addition to the new working capital facility, Advanced also secured a $1.5 million equipment term loan from the same commercial bank which was utilized to partially fund the acquisition of additional telecommunications and computer equipment and furniture necessary to support the doubling of Advanced's production capacity in the 1995 fiscal year. Additionally, Advanced secured operating leases to acquire approximately $4.0 million in equipment, secured capital lease arrangements of approximately $1.6 million, and utilized operating cash flow to fund this increase in production capacity.\nManagement believes the transactions described above have provided the liquidity and access to sufficient working capital financing to fund Advanced near-term growth and have reduced borrowing costs, strengthened the balance sheet, and have allowed Advanced to increase its production capacity. While Advanced's current capacity is sufficient to handle its current production demands, as Advanced's growth continues, management believes that additional call centers will be needed to facilitate the increased business and that furniture and equipment, as well as certain technological upgrades to Advanced's existing equipment, will be needed for such call centers. Advanced may have to secure additional financing for these capital needs as its current commitments may be inadequate. Although no assurances can be made in this regard, management anticipates that, based on ATC's ability to secure such financing to date, the Company will be able to secure funding for such future capital equipment needs.\nThe $15 million receivable credit facility and the $1.5 million term loan secured by Advanced from a major commercial bank, mentioned above, contain various covenants which limit, among other things, Advanced's indebtedness, capital expenditures, investments, payments and dividends to the Company and requires Advanced to meet certain financial tests. Similarly, under the terms of the guaranty\narrangement, the Company is subject to certain covenants limiting, among other things, its ability to incur indebtedness, enter into guaranties, and acquire other companies. These credit facilities are secured by liens on Advanced's accounts receivables, furniture, and equipment and are guaranteed by ATC. See Notes 3 and 4 to Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee pages through of this Form 10-K Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nOn June 2, 1995 the Audit Committee of the Board of Directors of the Company unanimously approved the dismissal of Grant Thornton as the independent certified public accountants and auditors for the Company. Grant Thornton performed the audit for the Company for the fiscal years ended June 30, 1992, 1993 and 1994. Grant Thornton's reports on the financial statements of the Company for those years did not contain an adverse opinion, nor a disclaimer of opinion, nor were qualified or modified as to uncertainty, audit scope or accounting principles. Except as described below, there were no disagreements with Grant Thornton 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 Grant Thornton, would have caused it to make reference to the subject matter of the disagreements in connection with its report during the Company's two most recent fiscal years and any subsequent interim period preceding this dismissal.\nWith regard to the financial statements of the Company for the year ended June 30, 1993, there was an initial disagreement as to the amount of the deferred taxes to be recognized for net operating losses carried forward. With regard to the financial statements of the Company for the year ended June 30, 1994, there was an initial disagreement as to the accounting treatment for the recognition of a deferred tax asset for net operating loss carryforwards acquired in a business combination for which goodwill was recorded. Both disagreements, however, were resolved to the mutual satisfaction of Grant Thornton and the Company.\nNeither the Company's Audit Committee nor its Board of Directors discussed the subject matter of the above described disagreements with Grant Thornton. The Company has authorized Grant Thornton to respond fully to the inquiries of the successor accountant concerning the subject matter of such disagreements. The Audit Committee's decision to dismiss Grant Thornton was unrelated to the initial disagreements described above.\nAlso on June 2, 1995, the Audit Committee of the Board of Directors unanimously approved the appointment of the firm of Price Waterhouse LLP to serve as the independent accountants for the Company for the fiscal year ending June 30, 1995.\nOn June 9, 1995 the Company filed a report on Form 8-K related to the dismissal of Grant Thornton as independent accountants for the Company.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.\nThis information will be contained in the definitive proxy statement of the Company for the 1995 Annual Meeting of Stockholders under the captions \"Election of Directors\" and \"Executive Officers\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThis information will be contained in the definitive proxy statement of the Company for the 1995 Annual Meeting of Stockholders under the caption \"Compensation of Directors and Executive Officers\" and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThis information will be contained in the definitive proxy statement of the Company for the 1995 Annual Meeting of Stockholders under the caption \"Beneficial Ownership of Common Stock\" and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThis information will be contained in the definitive proxy statement of the Company for the 1995 Annual Meeting of Stockholders under the captions \"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.\nFINANCIAL STATEMENTS\nSee \"Index to Consolidated Financial Statements\" included on page of this Form 10-K Annual Report for a listing of the financial statements and schedules filed as a part of this Form 10-K Annual Report.\nEXHIBITS\nThe following exhibits are filed as a part of this Form 10-K Annual Report:\n3.1 Certificate of Incorporation of Kenneth Resources, Inc. (Incorporated by reference from Company's Amendment No. 1 to Form S-1 Registration Statement - File No. 33-6268).\n3.2 Certificate of Amendment of Kenneth Resources, Inc. to reflect change of name to National Reference Publishing, Inc. (Incorporated by reference from Company's Amendment No. 1 to Form S-1 Registration Statement - File No. 33-6268).\n3.3 Certificate of Amendment of National Reference Publishing, Inc. to reflect change of name to NRP Inc. (Incorporated by reference from Company's Form 10-K Annual Report for the year ended June 30, 1994).\n3.4 Bylaws of Kenneth Resources, Inc. (Incorporated by reference from Company's Amendment No. 1 to Form S-1 Registration Statement - File No. 33-6268).\n3.5 Amendment to Bylaws of Kenneth Resources, Inc. (Incorporated by reference from Company's Amendment No. 1 to Form S-1 Registration Statement - File No. 33-6268).\n4.1 Specimen of Share Certificate of Company's Common Stock. (Incorporated by reference from Company's Form 10-K Annual Report for the year ended June 30, 1994).\n4.2 Form of Series B Preferred Stock, as amended. (Incorporated by reference from Company's Form 10-K Annual Report for the year ended June 30, 1994).\n4.3 NRP Inc. Series C Preferred Stock certificate issued to Codinvest Limited with attached designations. (Incorporated by reference from Company's Form 8-K Current Report dated June 16, 1994).\n10.8 Lease Agreement dated January 1, 1991 by and between Royal Tech Properties, Ltd. and Advanced Telemarketing Corporation. (Incorporated by reference from Company's Form 10-K Annual Report for the year ended June 30, 1991).\n10.9 Settlement Agreement and Promissory Note dated September 18, 1992 by and between Advanced Telemarketing Corporation and Merrill Lynch Private Capital Inc. (Incorporated by reference from Company's Form 10-K Annual Report for the year ended June 30, 1992).\n10.10 Asset Purchase Agreement by and between Advanced Telemarketing Corporation and GTE Market Resources, Inc. dated December 31, 1992. (Incorporated by reference from Company's Form 10-Q Quarterly Report for the quarter ended December 31, 1992).\n10.11 Asset Purchase Agreement by and among M\/B Ltd. Services, Inc., NRP Inc., and United Communications Group executed July 26, 1993. (Incorporated by reference from Company's Form 8-K Current Report dated August 13, 1993).\n10.12 Non-Competition Agreement by and among M\/B Ltd. Services, Inc., NRP Inc., and United Communications Group executed July 26, 1993. (Incorporated by reference from Company's Form 8-K Current Report dated August 13, 1993).\n10.13 Loan and Security Agreement dated May 17, 1994 among Continental Bank N.A., Advanced Telemarketing Corporation and American Telesales Corporation. (Incorporated by reference from Company's Form 8-K Current Report dated June 16, 1994).\n10.14 Guaranty dated May 17, 1994 by NRP Inc. in favor of Continental Bank, N.A. (Incorporated by reference from Company's Form 8-K Current Report dated June 16, 1994).\n10.15 Investment Letter dated June 16, 1994 by Codinvest Limited. (Incorporated by reference from Company's Form 8-K Current Report dated June 16, 1994).\n10.16 Asset Purchase Agreement by and among NRL Brokerage, Inc., NRL Management, Inc., S.D. Bogner, Inc., NRP Inc., and Stephen D. Bogner executed August 30, 1994 (including promissory notes and guaranties). (Incorporated by reference from Company's Form 8-K Current Report dated August 30, 1994).\n21 Subsidiaries of Company:\nThe Company as of June 30, 1995 had the following operating subsidiary:\n27 Financial Data Schedule.\nDuring fiscal 1994 the Company conducted its telecommunications-based operations through two subsidiaries, Advanced and American Telesales Corporation (\"American\"). Effective January 1, 1995, the Company merged the wholly owned American subsidiary into Advanced. As a result of the merger, all of the Company's telecommunications-based operations are currently conducted by Advanced.\nCopies of the above Exhibits are available to stockholders of record at a charge of $.50 per page, minimum of $5.00 each. Direct requests to:\nNRP Inc. Attention: Secretary 5950 Berkshire Lane, Suite 1650 Dallas, Texas 75225\nREPORTS ON FORM 8-K\nOn June 9, 1995 the Company filed a report on Form 8-K reporting, under \"Item 4. - Changes in Registrant's Certifying Accountant\", the dismissal of Grant Thornton as independent certified public accountants and auditors for the Company. See \"Item 9. - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\".\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.\nNRP INC. (The Registrant)\nDated: September 27, 1995 By: \/s\/ Michael G. Santry -------------------------------------- Michael G. Santry 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 the Company and in the capacities and on the dates indicated.\nDated: September 27, 1995 By: \/s\/ Michael G. Santry ---------------------------------------- Michael G. Santry, Director\nDated: September 27, 1995 By: \/s\/ Patrick V. Stark ---------------------------------------- Patrick V. Stark, Director\nDated: September 27, 1995 By: \/s\/ Thomas Bijou ---------------------------------------- Thomas Bijou, Director\nDated: September 27, 1995 By: \/s\/ Jerry L. Sims, Jr. ---------------------------------------- Jerry L. Sims, Jr., Controller and Director\nDated: September 27, 1995 By: ---------------------------------------- J. Michael Allred, Director\nDated: September 27, 1995 By: ---------------------------------------- J. Frank Mermoud, Director\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nAND FINANCIAL STATEMENT SCHEDULES (ITEM 14(A))\nAll other schedules are omitted since the required information is not applicable or is not material or because the information required is included in the consolidated financial statements and notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of NRP Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of NRP Inc. and its subsidiary at June 30, 1995, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our 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.\nPrice Waterhouse LLP\nDallas, Texas August 29, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors and Shareholders NRP Inc.\nWe have audited the accompanying consolidated balance sheet of NRP Inc. and Subsidiaries as of June 30, 1994 and the related consolidated statements of income, shareholders' equity and cash flows 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. An audit 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 NRP Inc. and Subsidiaries as of June 30, 1994 and the consolidated results of their operations and cash flows for each of the two years in the period then ended, in conformity with generally accepted accounting principles.\nWe have also audited Schedule II of NRP Inc. and Subsidiaries for each of the two years in the period ended June 30, 1994. In our opinion, this schedule presents fairly, in all material respects, the information required to set forth therein.\nAs discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993.\nGRANT THORNTON\nDallas, Texas September 7, 1994\nNRP INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 1995, 1994, AND 1993\nSee accompanying notes\nNRP INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 1995 AND 1994\nSee accompanying notes.\nNRP INC.\nCONSOLIDATED STATEMENTS OF SHAREH0LDERS' EQUITY\nYEARS ENDED JUNE 30, 1995, 1994 AND 1993\nSee accompanying notes.\nNRP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1995, 1994, AND 1993\nSee accompanying notes.\nNRP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND ACQUISITIONS\nNRP Inc., operating under the trade name ATC Communications Group (\"ATC\" or the \"Company\"), was incorporated in 1985. Through its subsidiary, ATC engages in the telecommunications-based marketing and information services business. Prior to the disposition of the assets of its other business segments, ATC engaged in the businesses of direct mail marketing (primarily Zip Code directory packages) and mail list management and brokerage services. (See Note 14. Disposition of Assets).\nAt June 30, 1995, ATC has the following operating subsidiary:\nDuring fiscal 1994 the Company conducted its telecommunications-based operations through two subsidiaries, Advanced and American Telesales Corporation (\"American\"). Effective January 1, 1995, the Company merged the wholly owned American subsidiary into Advanced. As a result of the merger, all of the Company's telecommunications-based operations are currently conducted by Advanced.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation - The consolidated financial statements include the accounts of ATC and its majority- owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.\nRevenues - Revenues are recognized as services are performed.\nProperty and equipment - Property and equipment are carried at cost. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets. Equipment, furniture and fixtures, and computer software are depreciated over five-year to eight-year lives.\nCapitalization of start-up costs - Advanced capitalizes certain up-front costs associated with the start-up of new business which is to be performed for its clients pursuant to long-term contracts (typically 3-5 years). Such costs are amortized over the life of such long-term contracts.\nCost in excess of net assets acquired - The cost in excess of net assets acquired recognized in the acquisition of Advanced is being amortized using the straight-line method over 25 years.\nIncome taxes - ATC joins with its subsidiaries in filing consolidated federal income tax return. In 1993 ATC adopted the Financial Accounting Standards Board's SFAS No. 109 \"Accounting for Income Taxes\", which requires an asset and liability approach for financial accounting and reporting for income taxes. The cumulative effect of this change was not material to financial statements for years prior to 1993; therefore, it was not necessary to restate prior year balances.\nStatements of cash flows - For the purposes of the statements of cash flows, the Company considers all highly liquid instruments purchased with original maturities of three months or less to be cash equivalents.\nReclassifications - Certain 1994 and 1993 balances have been reclassified to conform with the 1995 presentation.\nConcentration of credit risk - The Company sells to customers in diversified industries throughout the United States. The Company performs periodic credit evaluations of its customers' financial conditions and generally does not require collateral. Receivables are generally due within 30 days. Credit losses from customers have been within management's expectations. Advanced currently has five major customers (see Note 11).\n3. NOTES PAYABLE\nNotes payable at June 30, 1995 and 1994, are summarized below:\n4. LONG-TERM DEBT\nLong-term debt at June 30, 1995 and 1994, is summarized below:\nBoth the note payable to the commercial bank and the revolving line of credit discussed in Note 3 above contain various covenants which limit Advanced's indebtedness, capital expenditures, investments and payment and dividends to ATC. Additionally, Advanced is required to meet certain financial tests. The note payable and the revolving line of credit are guaranteed by ATC. The guaranty agreement limits ATC's ability to incur indebtedness, enter into guaranties and to acquire other companies.\nThe unsecured note payable by Advanced to Merrill Lynch Private Capital Inc. (\"MLPC\") also contains a provision requiring semi-annual prepayments of principal if Advanced achieves certain net income levels. As of June 30, 1995 the entire principal balance under the note was due and payable to MLPC as a result of the cumulative effect of the achievement of such net income levels by Advanced. Currently, Advanced is in discussions with MLPC regarding a restructuring of the payment terms of the note. At June 30, 1995 the entire balance of the note was classified as current on ATC's balance sheet.\nFuture maturities of long-term debt at June 30, 1995, are as follows:\nThe Company paid interest in the amount of $920,059, $518,291, and $442,677 in 1995, 1994 and 1993, respectively.\n5. LEASES\nA portion of Advanced's computer equipment was purchased in 1994 and 1995 under capital leases totaling $4,070,490. These capital leases are included in the accompanying consolidated balance sheet under the following captions at June 30, 1995:\nFuture minimum lease payments for all noncancelable leases with initial or remaining terms of one year or more at June 30, 1995, are as follows:\nIn 1994 the Company renegotiated one of its operating leases and recognized as a reduction of rent expense approximately $100,000 of straight-line rents which had been previously deferred. Rent expense on operating leases for the years ended June 30, 1995, 1994, and 1993 was $2,791,550, $976,745, and $960,467, respectively.\n6. PREFERRED STOCK\nOn January 21, 1994, 127,044 shares of Series B preferred stock were converted into 254,088 shares of common stock.\nOn June 16, 1994 approximately $3.1 million in short-term debt was converted into 840,000 shares of a newly created Series C Preferred Stock. The Series C Preferred Stock entitles the registered owners to the following rights and preferences: (i) beginning June 30, 1995, preferential cumulative cash dividends at the annual rate of $0.11 per share, (ii) at any time prior to June 30, 2014, the right to convert each share into shares of NRP Inc. Common Stock, $.01 par value, at a conversion ratio of one share of Series C Preferred Stock for five shares of Common Stock, (iii) a liquidation preference of $3.66 per share, (iv) cash dividends on parity with shareholders of Common Stock based on the number of shares of Common Stock into which each share of Series C Preferred Stock is convertible and, (v) the right to a number of votes for each share of Series C Preferred Stock that is equal to the number of shares of Common Stock into which shares of Series C Preferred Stock is convertible.\n7. EARNINGS PER SHARE\nPrimary and fully diluted earnings per common share is computed by dividing adjusted net income by the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the period. Common stock equivalents consist of common stock issuable under the assumed exercise of stock options and warrants and the assumed conversion of the Company's issued and outstanding preferred stock. A computation of earnings per share follows:\n(1) Based on the treasury stock method using the average market price. (2) Based on the treasury stock method using the greater of the average or ending market price.\n(3) As discussed in Note 12, the Company's Advanced subsidiary has granted options to purchase Advanced's common stock to certain of its key employees and officers. The Company's net income from continuing operations is therefore adjusted for the dilutive effect of such options on Advanced's income applicable to the Company.\n8. OTHER RELATED PARTY TRANSACTIONS\nThe Company holds a note receivable from Freiburghaus & Partners, S.A. (\"F&P\"), a shareholder of record. The note bears interest at 11% per annum. At June 30, 1995 and 1994, unpaid principal and accrued interest amounted to $73,696 and $86,284, respectively. Interest income from this note amounted to $8,853, $9,462, and $14,300, in 1995, 1994 and 1993, respectively. In 1995, 1994, and 1993, the Company applied $21,440, $56,456, and $56,456, respectively, of accrued preferred stock dividends due to F&P against the note.\nAt June 30, 1995 and 1994, an officer of the Company had outstanding borrowings and accrued interest of approximately $793,773 and $150,727, respectively, pursuant to a line of credit. The borrowing bears 6% annual interest and is due in full on June 30, 1996. Interest income from the receivable amounted to approximately $19,000, $21,000 and $22,000 in 1995, 1994 and 1993, respectively. As of September 27, 1995 payments had been received from the officer which reduced the balance of such borrowings to approximately $294,000.\nAs part of the purchase of M\/B Ltd. (see Note 14), the Company entered into a five-year management agreement with FEM, Inc. (\"FEM\"), a company controlled by a shareholder of the Company, effective March 1, 1986. In return for consulting and administrative services, the Company paid FEM $165,000 per year in monthly installments of $13,750 through March 1994. ATC paid FEM consulting fees of $110,000 and $165,000 for each of the years ended June 30, 1994 and 1993, respectively. At June 30, 1995 FEM had outstanding borrowings and accrued interest of $123,650 pursuant to a note receivable to the Company. The note bears 3% annual interest and is due in full on June 30, 1996.\nIn August 1994 the Company sold certain of the assets of its list services subsidiaries to an officer of such subsidiaries. See further discussion in Note 14.\n9. INCOME TAXES\nAs discussed in Note 2, during 1993 the Company adopted Statement of Financial Accounting Standards No. 109 (the \"Statement\"). The Statement changes the method of accounting for deferred income taxes by requiring an asset and liability approach for financial accounting and reporting purposes. As a result of the change in accounting, the Company recognized a deferred tax benefit for the year ended June 30, 1993. During 1994 the Company corrected its 1993 consolidated net operating loss carryforwards by approximately $1,252,000 and corrected its 1993 classification of certain of the net operating loss carryforwards by reducing costs in excess of net assets acquired by approximately $285,000. Accordingly, the deferred income tax benefit and net income was reduced approximately $700,000. There was no cumulative effect on previous years as a result of the accounting change.\nDuring the years ended June 30, 1995 and 1994, the Company reduced cost in excess of net assets acquired by approximately $570,000 and $340,000, respectively by recording such net operating loss carryforwards on the Company's balance sheet.\nThe components of the income tax expense (benefit) applicable to continuing operations for the fiscal year ended June 30 are as follows:\nA reconciliation of the statutory federal income tax rate and the effective rate as a percentage of pre-tax income for the fiscal year ending June 30 is as follows:\nThe components of deferred taxes included in the accompanying consolidated balance sheet as of June 30 are as follows:\nAt June 30, 1995 the Company had net operating loss carryforwards of approximately $2,200,000 which are available to be carried forward to future periods. Due to the ownership changes which have taken place in prior years, the net operating loss carry forwards are subject to limitations set forth in regulations under the Internal Revenue Code. Under those regulations, future utilization is limited to approximately $279,000 per year. In fiscal 1995, the Company concluded, based on an assessment of all available evidence, that it is more likely than not that future taxable income will be sufficient to realize the tax benefits available; therefore, the Company reduced the valuation allowance $570,279. Changes in the valuation allowance related to the utilization of these net operating loss carryforwards reduced the costs in excess of net assets acquired.\n10. COMMITMENTS\nAdvanced entered into an employment agreement with an officer of the company through December 1995. The agreement specifies an annual base salary of $250,000 plus bonuses based on the Company's performance.\n11. MAJOR CUSTOMERS\nThe Company had sales to major customers comprising the following percentages of consolidated revenues for the years ended June 30:\n12. STOCK OPTIONS AND WARRANTS\nIn February 1993 the Company's shareholders approved the NRP Inc. 1992 Stock Option Plan (the \"Plan\") which provides for the granting of options to purchase up to a maximum of 3,000,000 shares of Common Stock to key employees, officers, and directors of the Company and its subsidiaries. The Company granted, pursuant to the Plan, options to purchase 1,140,000 and 475,000 shares of Common Stock in fiscal 1994 and fiscal 1995, respectively, at the market price on the date of grant. Such options granted are exercisable for 10 years from the date of grant. At June 30, 1995, 1,203,000 of these options were fully vested with 164,334, 137,333 and 110,333 options vesting in fiscal years 1996, 1997 and 1998, respectively. The Company may grant additional options at any time prior to December 11, 2002.\nIn May 1994 the Company granted warrants, which expire May 30, 1999, to a financial advisory services firm entitling the firm to purchase 650,000 shares of Common Stock at a purchase price of $1.625 per share, the market price on the date granted.\nIn April 1993, Advanced initiated the Advanced Telemarketing Corporation 1993 Stock Option Plan which provides for the granting of options to Advanced's key employees, officers, and directors to purchase up to a maximum of 436,471 shares of Advanced's common stock. To date options to purchase 414,652 shares of Advanced's common stock have been granted. 185,946 options have vested with 137,662, 73,912 and 17,132 options vesting in the fiscal years ending June 30 1996, 1997 and 1998, respectively. Advanced granted such options at management's best estimate of the common stock's market value at the date of grant.\nPursuant to the Advanced Telemarketing Corporation 1993 Stock Option Plan, in October, 1993, Advanced granted to the president of Advanced options to purchase 680,908 shares of Advanced's common stock (representing 15% of the fully diluted common stock of Advanced) at $0.01 per share. In March 1995, the president of Advanced surrendered such options in exchange for stock options to purchase a total of 2,410,880 shares of ATC Common Stock at $0.8125 per share, the market price at the date of grant. The ATC options granted became fully exercisable on August 1, 1995 and are exercisable for 10 years from the date of grant.\n13. EMPLOYEE BENEFIT PLAN\nDuring fiscal 1991 Advanced adopted a defined contribution 401(k) plan covering all eligible employees, as defined. Eligible employees may elect to contribute up to 15% of their compensation, not to exceed $9,000 per year. Advanced may, at its discretion, match employee contributions. There was no employer matching contribution made in 1995, 1994 or 1993.\n14. DISPOSITION OF ASSETS\nOn August 30, 1994, pursuant to an asset purchase agreement, NRL Direct, Inc., a wholly-owned subsidiary of NRP, sold certain of its assets consisting primarily of cash, accounts receivable, fixed assets, tradenames, and other assets for promissory notes aggregating approximately $745,000. As a result of the asset disposition, effective July 1, 1994 ATC no longer engages in the list brokerage and list management businesses. The net assets conveyed were reclassified on the June 30, 1994 balance sheet to separately identify them as assets held for sale.\nOn August 13, 1993 M\/B Ltd. Services, Inc., a wholly-owned subsidiary of NRP (\"M\/B Ltd.\"), pursuant to an asset purchase agreement, sold substantially all of the assets related to the marketing, publishing and distribution of the National Five Digit ZIP Code Directory package (the \"Directory\"). M\/B Ltd. received net cash consideration of approximately $4.7 million and recognized a one-time after-tax gain of approximately $2.5 million in the fiscal year ending June 30, 1994. As a result of the asset disposition, M\/B Ltd. no longer sells the Directory.\nSummary financial information related to the discontinued business segments was as follows:\nThe net after-tax income or loss derived from the operation of these business segments has been classified on the statement of income to separately identify them as income from operations of discontinued business segments, net of applicable taxes.\n15. INDUSTRY SEGMENT INFORMATION\nATC, through its subsidiary, operates principally in one industry segment: telecommunications based marketing and information services.\nNRP INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED JUNE 30, 1995, 1994, AND 1993\nEXHIBIT INDEX","section_15":""}
{"filename":"40834_1995.txt","cik":"40834","year":"1995","section_1":"Item 1. Business\nGeneral Developments General Signal Corporation, incorporated in New York in 1904, is a manufacturer of equipment for the Process Controls, Electrical Controls and Industrial Technology industries. The company's key Process industry products include pumps, mixers, and valves for municipal water supply and wastewater treatment, pulp, paper, food, pharmaceutical and chemical manufacturing and ultra low-temperature freezers for life science research. In the Electrical industry, key products include uninterruptible power supply and conditioning equipment, power transformers, and fire detection systems. Products serving the Industrial Technology industry include auto and bicycle components, data networking equipment, and fare collection and vending equipment.\nIn November 1994, the company adopted a plan to sell Leeds & Northrup, formerly a part of the Process Controls business sector, and Dynapower\/Stratopower, formerly a part of the Industrial Technology business sector. In 1995, the Company sold the majority of these businesses. The remainder are expected to be sold or shut down in 1996.\nDuring the last five years, the company invested approximately $440 million in cash and 4.4 million shares of common stock to acquire 20 businesses and\/or product lines. The notes to the financial statements on pages 32 and 33 of the Shareholders' Report provide additional information for significant acquisitions during the last three years and are incorporated herein by reference.\nFinancial Information about Business Segments Selected business segment information for the last five fiscal years is summarized on page 35 of the Shareholders' Report and is incorporated herein by reference. There were no classes of similar products or services that exceeded 10 percent of consolidat ed sales.\nA summary of information by geographic area for the last five fiscal years is included on page 36 of the Shareholders' Report and is incorporated herein by reference.\nNarrative Description of Business\nMajor Markets and Products and Method of Distribution A description of the registrant's business is included on pages 6 and 7 of the Shareholders' Report and is incorporated herein by reference. The company's products are sold by its own sales organization and through distributors and manufacturers' representatives.\nMaterials and Supplies The company manufactures many of the components used in its products, but it also purchases a variety of basic materials and component parts. Although some basic materials and components have been and may be in short supply from time to time, the company believes that generally it will be able to obtain adequate supplies of major items or reasonable substitutes.\nPatents The company holds many patents and has continued to secure other patents that cover many of its products. While patents are important in the aggregate to the company's competitive position, the loss of any single patent, patent application or patent license agreement, or group thereof, would not materially affect the conduct of its business as a whole. The company is both a licensor and licensee of patents.\nWorking Capital A discussion of working capital is included on pages 19 and 20 of the Shareholders' Report and is incorporated herein by reference.\nBacklog The amount of unfilled orders was approximately $435.8 million as of December 31, 1995 and $307.2 million as of December 31, 1994 (excluding unfilled orders of businesses sold or discontinued). All unfilled orders are expected to be filled within the next succeeding year.\nCompetition Although the businesses of the company are highly competitive, the competitive position cannot be determined accurately in the aggregate or by segment since none of its competitors offers all of the same product lines or serves all of the same markets, nor are reliable comparative figures available for its competitors. In most product groups, competition comes from numerous concerns, both large and small. The principal methods of competition are price, service, product performance and technical innovation. These methods vary with the type of product sold. The company believes that it can compete effectively on the basis of each of these factors as they apply to the various products offered.\nResearch and Development Research and development information for the last three years is included on page 36 of the Shareholders' Report and is incorporated herein by reference.\nEnvironmental Matters The company is involved in various stages of investigation and remediation relative to environmental protection matters, arising from its own initiative, from indemnification of purchasers of divested operations, or from legal or administrative proceedings, some of which involve waste disposal sites. The company has a comprehensive environmental compliance program which includes environmental audits conducted by internal and outside independent environmental professionals and regular communications with the company's operating units regarding environmental compliance requirements and anticipated regulations.\nPursuant to the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), the company has been notified that it has been named as a potentially responsible party (\"PRP\") at 34 CERCLA sites which are listed on the National Priorities List (\"NPL\") maintained by the U.S. Environmental Protection Agency (\"EPA\"). The law governing CERCLA sites provides that PRPs may be jointly and severally liable for the total costs of investigation and remediation. Based on information available to the company, at five of these sites (Byron Barrell in Byron, NY; Iron Horse Park in Billerica, MA; M.T. Richards in Crossville, IL; Doepke-Holliday in Holliday, KS; and North Penn Water Authority in Montgomery Co., PA), the company believes that its aggregate probable remaining liability will not exceed $3.0 million. At five sites (Berks Associates in Douglasville, PA;\nCommercial Oil Services in Oregon, OH; West KL in Kalamazoo, MI; Spectron in Elkton, MD; and Stringfellow in Riverside, CA) the company is of the opinion, based on information currently available, that it contributed less than one percent of the total volume, weight or other allocation criteria at each site and the company believes its aggregate probable remaining liability for these sites will not exceed $350,000. At 16 of the remaining 24 CERCLA NPL sites, the company has resolved its liability by entering into de minimis settlements or buy-out agreements with either the EPA or PRP groups and paying its proportionate share of costs of site investigation and remediation (at an aggregate cost to the company of less than $600,000). The company believes, based on information currently available, that it has no liability at seven CERCLA NPL sites since the company's investigation has not revealed either a record of its having transported or arranged for disposal of hazardous substances to such sites or verifiable evidence of its responsibility for the release or threatened release of hazardous substances at these sites, but the company believes that it could incur future costs (including legal expenses) related to the foregoing which would not exceed approximately $100,000 in the aggregate. Finally, the company received a contractual indemnification claim with respect to a CERCLA NPL site (Cork Street, Kalamazoo Co., MI). No information regarding the company's involvement at such site is currently available.\nThe company has also received requests for information from the EPA at nine NPL sites for which the company believes, based on its investigation of such matters, that its potential aggregate remaining liability will not exceed $200,000.\nThe company recently received a notification of potential liability from the EPA under the Toxic Substances Control Act of 1976 with respect to a multi-party site, which is not a CERCLA site, based on the company's alleged generation of toxic substances present at the site. The company's liability, based on currently available information, is estimated to be approximately $100,000. At six sites which are not CERCLA NPL sites, the company has been cited by the EPA with respect to removal actions. The company has entered into settlements and paid its proportionate share of costs at five of these sites, and the company believes that its probable remaining liability at the sixth site is less than $50,000.\nThe company has received notices of potential liability from various state environmental authorities pursuant to state environmental laws regarding ten multi-party sites based on the company's alleged generation of hazardous materials present at those sites. The company's liability has been resolved and satisfied at two sites and, based on the company's investigation, the company believes that its aggregate probable remaining liability at the eight other sites will not exceed $2.5 million. Although the company has received requests for information from state environmental authorities at two additional sites, the company's investigation has revealed no record of its having disposed of hazardous substances at, or arranged for transportation of hazardous substances to, such sites.\nThe company is engaged in site investigation and\/or remediation at the following sites presently or formerly owned by the company:\nNew York Air Brake Landfill\/Kelsey Creek Site In February 1990, the company entered into a consent order with the New York State Department of Environmental Conservation (\"NYSDEC\") to conduct an investigation and remediation at the company's discontinued New York Air Brake facility in Watertown, New York. On March 30, 1994, NYSDEC issued a Record of Decision (\"ROD\") with respect to site remediation. The remedial action will consist of consolidation of contamination in the existing industrial landfill, capping the landfill, collecting contaminated groundwater downgradient of the landfill, and the removal of certain sediments in Kelsey Creek and a tributary creek. The future cost estimated by the company for site remediation is approximately $11 million. The company has filed litigation against the City of Watertown to challenge an increase in sewer discharge fees for leachate at the landfill and believes that it will ultimately prevail in such litigation.\nHevi-Duty Facility In August 1990, the EPA placed this manufacturing facility of the company, located in Goldsboro, North Carolina, on the NPL; subsequently, the company challenged the listing and the EPA delisted the facility in June 1993. Following the delisting, the company investigated site contamination at this facility and conducted limited initial remediation. The company is participating in a voluntary clean-up program of the state of North Carolina and has entered into an Administrative Order on Consent with the North Carolina Department of Environmental Health and Natural Resources. The company currently believes that the probable aggregate remaining liability for clean-up of this site will be approximately $3 million.\nFairbanks Morse Facility On December 2, 1994, the company acquired Fairbanks Morse, Inc. Based on the company's pre-acquisition environmental assessment and site testing performed at the Fairbanks Morse facility located in Kansas City, Kansas, the company determined that there is soil and groundwater contamination at the site. The company has entered into an Interim Agreement with the Kansas Department of Environment and Health with respect to additional site investigation. The company believes that up to $5 million could be required to investigate and remediate contaminated soil and groundwater at the site. The company is accounting for the foregoing, and for any liability of Fairbanks Morse at the Doepke-Holliday and Stringfellow sites discussed above, under purchase accounting.\nThe company has reported site contamination to environmental authorities with respect to eight sites which the company formerly owned or operated. The company is undertaking site investigations and remediations at seven of those sites and site investigations at one site. The company believes that the probable aggregate remaining liability for investigation and remediation will not exceed approximately $1.4 million. At one present manufacturing facility and two former manufacturing facilities, the company is performing voluntary site investigation and remediation at a remaining cost not estimated to exceed approximately $600,000, based on information currently available.\nIt is the company's policy not to offset expected insurance recoveries against expected obligations when determining the amount of environmental accruals.\nThe potential costs related to the matters described above and the possible impact on future operations are uncertain due in part to the complexity of government laws and regulations and their interpretations, the varying costs and effectiveness of clean-up technologies, the uncertain level of insurance or other types of recovery, and the questionable level of the company's responsibility. In management's opinion, after considering reserves established for such purposes, remedial actions for compliance with the present laws and regulations governing the protection of the environment are not expected to have a material adverse impact on the company's results of operations or financial position.\nEmployees At December 31, 1995, the company had approximately 12,900 employees, excluding employees of businesses held for sale. Approximately 2,600 employees are represented by 33 different collective bargaining units. The company has generally experienced satisfactory labor relations at its various locations.\nExecutive Officers of the Registrant\nName, Position, Age at December 31 and Other Information Age - -------------------------------------------------------------------------------- Michael D. Lockhart...................................................... 46 Chairman and Chief Executive Officer since October 19, 1995. Previously President and Chief Operating Officer since October 3, 1994. Prior to joining the company, Vice President and General Manager of General Electric's Commercial Engines and Services division, along with several other key executive positions at GE. Prior to joining GE, served as vice president and director, The Boston Consulting Group.\nTerence D. Martin........................................................ 52 Executive Vice President and Chief Financial Officer since February 2, 1995. Previously, Chief Financial Officer of American Cyanamid Company since 1991 and Treasurer since 1988.\nElizabeth D. Conklyn..................................................... 48 Senior Vice President Human Resources since December 14, 1995. Previously, Senior Vice President, Human Resources and Organization for Mobile Telecommunications Technologies since 1994. Served in various human resource management positions with IBM from 1977 to 1994.\nWilliam W. Clark......................................................... 54 Vice President - Sourcing since June 15, 1995. Previously, Vice President - Operations of Tau-tron unit since 1992. Served in various management positions with Eastman Kodak Company from 1968 to 1992.\nNino J. Fernandez........................................................ 54 Vice President - Investor Relations since May 1, 1987. Previously, Director of Communications since 1974.\nTerry J. Mortimer........................................................ 50 Vice President and Controller since May 25, 1990. Previously Director Finance and Chief Accountant for Apple Computer since June, 1988. Previously with Becton Dickinson and Company from January, 1981 to June, 1988, most recently as Medical Sector Controller.\nEdgar J. Smith, Jr....................................................... 61 Vice President, General Counsel, and Secretary since April 19, 1984, and Vice President and General Counsel since January 1, 1980. Previously, Assistant General Counsel since 1967.\nThomas E. Taylor......................................................... 49 Vice President - Taxes since September 1, 1993. Previously with Elf Aquitaine, Inc. as Vice President - Taxes since 1985.\nJulian B. Twombly........................................................ 49 Vice President and Treasurer since December 17, 1991. Prior to joining the company, associated with United Dominion Industries, Ltd. since 1974, most recently as Senior Vice President and Treasurer.\nThe executive officers are elected annually by the Board of Directors.\nThere are no family relationships between any of the directors or executive officers of the company.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Process Controls sector's operations consist of 27 manufacturing facilities in 11 states and eight foreign countries, containing approximately 2.9 million square feet, of which 91 percent is owned and nine percent is leased. The Electrical Controls sector's operations consist of 39 manufacturing facilities in 14 states and seven foreign countries, containing approximately 3.4 million square feet, of which approximately 72 percent is owned and 28 percent is leased. The Industrial Technology sector's operations consist of 11 manufacturing facilities in four states, containing approximately 0.9 million square feet, of which approximately 88 percent is owned and 12 percent is leased.\nIn addition to manufacturing plants, the company as lessee occupies executive offices in Stamford, Connecticut, and various sales and service locations throughout the world. All of these properties, as well as the related machinery and equipment, are considered to be well maintained, suitable and adequate for their intended purposes. Assets subject to lien are not significant.\nAs a result of business divestitures and restructuring activities, the company holds 1.7 million square feet of idle facilities and facilities related to discontinued operations for sale or sublease.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe company and certain of its subsidiaries are defendants in legal proceedings incidental to its business. Although the ultimate disposition of these proceedings is not presently determinable, management does not expect the outcome to have a material adverse impact on the company's financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPart II - ------- Item 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Shareholder Matters\nThe company's common stock is listed on the New York and Pacific stock exchanges under the symbol \"GSX\". Information as to quarterly prices for the last two years, and dividends paid is included on pages 24 and 37 of the Shareholders' Report and is incorporated herein by reference. There were approximately 14,400 holders of record of the company's common stock on March 15, 1996.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected financial data of the company for the last five fiscal years are incorporated herein by reference to pages 38 and 39 of the Shareholders' Report.\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 17 through 20 of the Shareholders' Report and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and related notes are incorporated herein by reference to pages 22 through 37 of the Shareholders' Report. Quarterly financial information is incorporated herein by reference to page 37 of the Shareholders' Report. The Report of Independent Auditors, dated January 25, 1996, except for the capital stock note to the financial statements, as to which the date is February 1, 1996, is incorporated herein by reference to page 21 of the Shareholders' Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPart III - -------- Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers\nThis information is incorporated herein by reference to pages 5 through 10 of the Proxy Statement for the 1996 annual meeting of shareholders. Also see page 3 of this 10-K as to information related to executive officers.\nItem 11.","section_11":"Item 11. Executive Compensation\nThis information is incorporated by reference to pages 11 through 20 of the Proxy Statement for the 1996 annual meeting of shareholders.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is incorporated by reference to pages 2 through 4 of the Proxy Statement for the 1996 annual meeting of shareholders.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot applicable.\nPart IV - ------- Item 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K\n(a) (1) Financial Statements and Other Financial Data.\nThe financial statements of the company and consolidated subsidiaries are incorporated herein by reference to pages 22 through 37 of the Shareholders' Report. The Independ-ent Auditors' Report of Ernst & Young LLP, dated January 25, 1996, except for the capital stock note to the financial statements, as to which the date is February 1, 1996, is incorporated herein by reference to page 21 of the Shareholders' Report.\nPage\n(2) Schedule II Valuation and Qualifying Accounts...................... 8\nAll other schedules are omitted as the required information is not applicable or the information is presented in the financial statements or related notes.\n(3) Exhibits.\n3.1 Restated Certificate of Incorporation of General Signal Corporation, as amended through April 21, 1994 incorporated herein by reference to Exhibit 3.1 of the registrant's 1994 10-K filed March 21, 1995.\n3.2 By-laws of General Signal Corporation, as amended through February 1, 1996.\n4.1 Copies of the instruments with respect to the company's long-term debt are available to the Securities and Exchange Commission upon request.\n4.2 Copies of the Credit Agreements among General Signal Corporation and Various Commercial Banking Institutions, through June 1, 1995, as described in the Notes to Financial Statements incorporated herein by reference in (a)(1) above, are available to the Securities and Exchange Commission upon request.\n10.1 Description of General Signal Corporation Incentive Compensation Plan is incorporated herein by reference to Exhibit 10.1 of the registrant's 1991 Form 10-K filed March 25, 1992.\n10.2 Retirement Plan for Directors of General Signal Corporation is incorporated herein by reference to Exhibit 10.7 of the registrant's 1988 Form 10-K filed March 17, 1989.\n10.3 General Signal Corporation Change in Control Severance Pay Plan, as amended, is incorporated herein by reference to Exhibit 10.8 of the registrant's 1989 Form 10-K filed March 16, 1990.\n10.4 General Signal Corporation Deferred Compensation Plan, dated October 14, 1993, is incorporated herein by reference to Exhibit 10.4 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.5 General Signal Corporation Benefit Equalization Plan as amended and restated October 14, 1993, is incorporated herein by reference to Exhibit 10.5 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.6 General Signal Corporation 1992 Stock Incentive Plan as amended and restated July 7, 1993, is incorporated herein by reference to Exhibit 10.6 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.7 General Signal Corporation 1989 Stock Option and Incentive Plan as amended July 7, 1993, is incorporated herein by reference to Exhibit 10.7 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.8 General Signal Corporation 1985 Stock Option Plan as amended and restated July 7, 1993, is incorporated herein by reference to Exhibit 10.8 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.9 General Signal Corporation 1981 Stock Option Plan as amended and restated July 7, 1993, is incorporated herein by reference to Exhibit 10.9 of the registrant's 1993 Form 10-K filed March 21, 1994.\n10.10 Employment agreement between Michael D. Lockhart and the registrant dated October 3, 1994 is incorporated herein by reference to exhibit 10.12 of the registrant's 1994 Form 10-K filed March 21, 1995.\n10.11 Employment agreement between Terence D. Martin and the registrant dated February 2, 1995 is incorporated herein by reference to exhibit 10.13 of the registrant's 1994 Form 10-K filed March 21, 1995.\n10.12 Severance agreement between Edmund M. Carpenter and the registrant dated October 19, 1995.\n10.13 Severance agreement between Joel S. Friedman and the registrant dated December 21, 1995.\n10.14 Severance agreement between George Falconer and the registrant dated November 7, 1995.\n10.15 Shareholder Rights Plan dated February 1, 1996.\n11.0 Computation of Earnings per Share. See page 9 of this report.\n12.0 Calculation of Ratios of Earnings to Fixed Charges. See page 10 of this report.\n13.0 1995 Annual Report to Shareholders. Except for those portions specifically incorporated herein by reference, the company's 1995 Annual Report to Shareholders is furnished for the information of the Commission and is not deemed to be \"filed.\" Pages 17 through 39, including the Independent Auditors' Report on page 21, are specifically incorporated herein by reference.\n21.0 Subsidiaries. See pages 10 through 12 of this report.\n23.0 Consent of Ernst & Young LLP. See page 13.\n27 Financial Data Schedule (EDGAR version only)\n(b) Reports on Form 8-K\nA report on Form 8-K was filed on November 2, 1995, reporting the resignation of Edmund M. Carpenter as chairman, chief executive officer and director of the registrant.\nSignatures\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGeneral Signal Corporation\n\/s\/ Michael D. Lockhart - ------------------------------ (Michael D.Lockhart, Chairman) March 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 dates indicated.\n\/s\/ Michael D. Lockhart - ------------------------------ (Michael D. Lockhart) March 21, 1996 Chairman and Director (Principal Executive Officer)\n\/s\/ Terence D. Martin - ------------------------------ (Terence D. Martin) March 21, 1996 Executive Vice President and Chief Financial Officer\n\/s\/ Terry J. Mortimer - ------------------------------ (Terry J. Mortimer) March 21, 1996 Vice President and Controller (Chief Accounting Officer)\n\/s\/ Ralph E. Bailey - ------------------------------ (Ralph E. Bailey) March 21, 1996 Director\n\/s\/ Van C. Campbell - ------------------------------ (Van C. Campbell) March 21, 1996 Director\n\/s\/ Ursula F. Fairbairn - ------------------------------ (Ursula F. Fairbairn) March 21, 1996 Director\n\/s\/ Ronald E. Ferguson - ------------------------------ (Ronald E. Ferguson) March 21, 1996 Director\n\/s\/ John P. Horgan - ------------------------------ (John P. Horgan) March 21, 1996 Director\n\/s\/ Roland W. Schmitt - ------------------------------ (Roland W. Schmitt) March 21, 1996 Director\n\/s\/ John R. Selby - ------------------------------ (John R. Selby) March 21, 1996 Director","section_15":""}
{"filename":"351231_1995.txt","cik":"351231","year":"1995","section_1":"Item 1. BUSINESS\nThere are no patents, trademarks, franchises or concessions held by the Registrant. Software licenses held by the Registrant are considered ordinary and replaceable. Although the Registrant has individual customers that comprise more than 10% of its total annual revenues, the Registrant does not consider the loss of any individual customer to have a material adverse effect on the Registrant due to the demand for the Registrant's services and for the services of the industry in which the Registrant competes. Competitors of the Registrant consist primarily of subsidiary companies of large corporations. Services provided by competitor companies other than provided by the Registrant may include marine geophysics, speculative acquisition of seismic data, a library of seismic data, or a combination of these factors. The Registrant considers price and quality of service to be its principal methods of competition. Indicative of its level of commitment to the proprietary data of its customers, the Registrant does not maintain a library of seismic data or participate in speculative seismic data acquisition. Although the business of the Registrant is not considered seasonal, it does depend on favorable weather.\nAdditional information required by this Item 1 is hereby incorporated by reference to the Registrant's 1995 Annual Report (first page after front cover, page 2 and page 21) filed or to be filed by the Registrant with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities and Exchange Act of 1934 within 120 days after the end of the fiscal year covered by this Form 10-K. (Exhibit 13 hereto.)\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe principal facilities of the Registrant are summarized in the table below.\nThe Registrant owns additional undeveloped real property consisting of approximately 21,000 square feet in Midland, Texas, adjacent to the headquarters office building.\nThe Registrant operates only in one industry segment and only in the United States.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nOn July 1, 1995, an automobile accident claimed the lives of four employees which involved an automobile owned by the Company. The Company is a defendant in a lawsuit filed by the families of two of the employees whose deaths resulted from the accident. The families filed suit against the Company under the gross negligence provisions of the Texas Workers' Compensation Act. Accordingly, the Company believes its exposure is limited to exemplary damages of $36 million. The litigation is currently in the discovery stage. The Company has approximately $12 million of insurance coverage available to provide against an unfavorable outcome in this matter. Due to the uncertainties inherent in litigation, no absolute assurance can be given as to the ultimate outcome of this suit. However, the Company believes, based on knowledge of the facts to date and consultation with its legal advisors, that liabilities, if any, from this suit should not have a material adverse effect on the Company's financial position.\nThe Company is party to other legal actions arising in the ordinary course of its business, none of which management believes will result in a material adverse effect on the Company's financial position or results of operations, as the Company believes it is adequately insured.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter has been submitted during the fourth quarter of the 1995 fiscal year to a vote of security holders, through the solicitation of proxies or otherwise. However, please refer to the Registrant's Proxy Statement dated November 10, 1995, filed or to be filed with the Commission no later than 120 days after the end of the fiscal year covered by this Form 10-K, notifying as to the election of Directors and selection of KPMG Peat Marwick LLP as independent public accountants of the Company (requiring an affirmative vote of a majority of shares present or represented by proxy), at the Annual Meeting to be held on January 9, 1996.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this Item 5 is hereby incorporated by reference to the Registrant's 1995 Annual Report (page 28, \"Common Stock Information\") referred to in Item 1 above.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe information required by this Item 6 is hereby incorporated by reference to the Registrant's 1995 Annual Report (page 1, \"Financial Highlights\") referred to above in 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 7 is hereby incorporated by reference to the Registrant's 1995 Annual Report (pages 14 to 16) referred to in Item 1.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe report of independent public accountants appearing on page 27 and the financial statements appearing on pages 17 through 26 of Registrant's 1995 Annual Report for the year ended September 30, 1995, referred to above in Item 1, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. CHANGES IN AND 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 10 with respect to Directors and Executive Officers is hereby incorporated by reference to the Registrant's Proxy Statement dated November 10, 1995 (page 2) filed or to be filed by the Registrant with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities and Exchange Act of 1934 within 120 days after the end of the fiscal year covered by this Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is hereby incorporated by reference to the Registrant's Proxy Statement (page 3) referred to above in Item 10.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 with respect to security ownership of certain beneficial owners is hereby incorporated by reference to the Registrant's Proxy Statement (page 5, \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\") referred to above in Item 10.\nThe information required by this Item 12 with respect to security ownership of management is hereby incorporated by reference to the Registrant's Proxy Statement (page 5, \"SECURITY OWNERSHIP OF MANAGEMENT\") referred to above in Item 10.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe following financial statements of the Registrant, included in pages 17 through 26 of the Registrant's 1995 Annual Report to Shareholders for the year ended September 30, 1995, and the Independent Auditors' Report on page 27 of such report, are incorporated herein by reference:\nDescription\nBalance Sheets, September 30, 1995 and 1994\nStatements of Operations For the Years Ended September 30, 1995, 1994 and 1993\nStatements of Cash Flows For the Years Ended September 30, 1995, 1994 and 1993\nStatements of Stockholders' Equity For the Years Ended September 30, 1995, 1994 and 1993\nNotes to Financial Statements\nIndependent Auditors' Report\n(a) 2. All 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\nThe exhibits and financial statement schedules filed as a part of this report are listed below according to the number assigned to it in the exhibit table of Item 601 of Regulation S-K:\n(3) Restated Articles of Incorporation and Bylaws.\n(4) Instruments defining the rights of security holders, including indentures.\n(9) Voting Trust Agreement -- None; consequently, omitted.\n(10) Material Contracts.\n(11) Statement re: computation of per share earnings -- Not Applicable.\n(12) Statement re: Computation of ratios -- Not Applicable.\n(13) 1995 Annual Report.\n(18) Letter re: change in accounting principles -- Not Applicable.\n(19) Previously unfiled documents -- No documents have been executed or in effect during the reporting period which should have been filed; consequently, this exhibit has been omitted.\n(22) Subsidiaries of the Registrant -- There are no subsidiaries of the Registrant; consequently, this exhibit has been omitted.\n(23) Published report regarding matters submitted to vote of security holders -- None; consequently, omitted.\n(24) Consent of experts and counsel -- Not applicable.\n(25) Power of Attorney -- There are no signatures contained within this report pursuant to a power of attorney; consequently, this exhibit has been omitted.\n(b) Reports on Form 8-K\nThe Registrant has not filed any reports on Form 8-K during the last quarter of the year ended September 30, 1995.\n(27) Financial Data Schedule.\n(28) Additional Exhibits -- None.\n(29) Information from reports furnished to state insurance regulatory authorities -- 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, in the City of Midland, and the State of Texas, on the 10th day of November, 1995.\nDAWSON GEOPHYSICAL COMPANY\nBy: \/s\/ L. Decker Dawson -------------------------------- L. Decker Dawson, President\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.\nEXHIBIT INDEX\n*This exhibit is not required to be filed in accordance with Item 601 of Regulation S-K.\n**Incorporated by reference to Registrant's Form 10-K, dated September 30, 1994 (Commission File No. 0-10144).","section_15":""}
{"filename":"19731_1995.txt","cik":"19731","year":"1995","section_1":"Item 1. Business\nGENERAL\nChesapeake Corporation, a Virginia corporation organized in 1918, is a packaging and paper company, whose primary businesses include packaging, tissue and kraft products. Our operating businesses include: Chesapeake Packaging Co. (point-of-sale displays, graphic packaging and corrugated shipping containers); Wisconsin Tissue Mills Inc. (commercial and industrial tissue products); Chesapeake Paper Products Company and Chesapeake Forest Products Company (kraft products, building products and woodlands operations); and Delmarva Properties, Inc. and Stonehouse Inc. (land development).\nChesapeake competes in the large, capital-intensive paper and forest products industry. Until the mid 1980s, Chesapeake's products were primarily kraft commodity products manufactured by Chesapeake Paper Products. In commodity markets, selling prices are controlled by total market supply and demand. Success in these markets hinges on maximizing production and minimizing operating costs. Selling prices and profits for commodity products are typically cyclical and tend to follow general economic conditions.\nDuring the past several years, Chesapeake has pursued a strategy of focusing on specialty products in markets that management believes have growth potential or in which the Company has or may be able to achieve competitive advantages. The Company's strategy for success with its specialty products is to utilize its recycling expertise creatively, to differentiate itself from its competition by manufacturing products which are distinctive and to utilize its superior ability to respond to customers' requirements. Management believes this strategy allows the Company to achieve less cyclical and greater profits than with commodity products and to better utilize Chesapeake's strengths. During 1995, sales of specialty products were more than 60% of Chesapeake's total sales. During the three years prior to 1994, low selling prices for commodity products offset much of the benefit derived from specialty product sales. In 1994 and 1995, sales prices for the paper industry recovered significantly. See \"Financial Review 1993-1995\" of the Company's 1995 Annual Report to Stockholders (the \"1995 Annual Report\"), incorporated herein by reference.\nBecause we understand the service needs of our customers, we believe we are able to provide quality products quickly and efficiently. Our decentralized management style allows quick and creative decision making. Our operations are designed to be flexible to changing customer demands and business conditions.\nChesapeake's businesses are managed to generate cash flow and earn an acceptable long-term return on investment for stockholders.\nOur manufacturing and converting processes are capital intensive; property, plant and equipment, including timber and timberlands, comprise approximately 68% of our total assets. Our tissue and kraft products operations require major investments in paper machines, fiber preparation equipment and converting equipment. In 1992, the Company completed an eight- year $600 million capital spending program for machinery, equipment and new technology to increase production of specialty products while reducing the Company's emphasis on commodity products such as brown paperboard and bleached hardwood pulp. About one-half of these expenditures were for paper machine projects for our tissue and kraft products businesses. Included in the program was a $100 million project for a recovery boiler, evaporators and related equipment for our kraft products business. In 1995, we expanded our tissue business with the acquisition of two paper mills, and the announcement of plans for two more converting facilities, in keeping with our strategic goals and customer requirements. Growth in our packaging segment continued with the successful start-up of a new plant in California in 1995, and the announcement of plans for a new facility in Mississippi to begin operation in 1996. Capital expenditures intended to enhance efficiency, and to improve product quality and productivity were made at one-half of our existing packaging facilities during 1995.\nOur businesses are grouped into three major segments: packaging, tissue and kraft products. The information presented in \"Notes to Consolidated Financial Statements, Note 14 - Business Segment Information\" of the 1995 Annual Report is incorporated herein by reference. Information with respect to the Company's working capital practices is set forth under the caption \"Financial Review 1993-1995, Liquidity and Capital Structure\" of the 1995 Annual Report and is incorporated herein by reference. Information regarding the Company's anticipated capital spending is set forth under the caption \"Financial Review 1993-1995, Capital Expenditures\" of the 1995 Annual Report and is incorporated herein by reference.\nPACKAGING\nChesapeake Packaging Co.\nChesapeake Packaging has three marketing thrusts: point-of-sale displays, graphic packaging and corrugated shipping containers.\nWe believe that our packaging group is a leader in serving the point-of- sale display and specialty packaging needs of major national consumer products companies. Through a network of regional sales and design offices, the point-of-sale group, Chesapeake Display and Packaging Company, provides creative design services to our customers to meet their promotional and permanent display needs. Our manufacturing facilities utilize modern production, assembly and packaging processes to meet our customers' stringent quality and shipment demands. We have two strategically located point-of-sale display and specialty packaging manufacturing plants and three custom packing plants which provide service to customers throughout the United States. An additional custom packing plant in Memphis is scheduled to begin operation in 1996. Also, Chesapeake recently announced the planned acquisition of the Display Division of Dyment Limited, with operations in Erlanger, Kentucky, and Toronto, Canada.\nOur Color-Box subsidiary, the fastest growing area of our packaging segment, supplies graphic packaging to customers nationwide that require attractive full litho-laminated retail packaging. The final phase of a $13 million expansion project to double the capacity of this business was completed in 1993. In January 1994, Chesapeake Packaging acquired Lawless Holding Corporation, which included Lawless Packaging and Display, a graphic packaging plant in Buffalo, New York, which is now operated as the Buffalo division of Color-Box. Our new graphic packaging plant in Visalia, California, began operation late in the second quarter of 1995. In addition, in late 1995 Color-Box announced plans for a fourth graphic packaging facility, to be located in Pelahatchie, Mississippi, which is scheduled to begin operation by mid-year 1996.\nEleven corrugated shipping container plants located in seven states manufacture corrugated boxes and specialty packaging for customers within each plant's geographic area. The raw materials for the packaging plants include paperboard and corrugating medium (purchased both from independent suppliers and from Chesapeake Paper Products) that are converted to make the walls of the packaging unit. Various converting equipment is used to print, cut, slot and glue the container to customer specifications. The Lawless acquisition in January 1994 included the Lawless Container Corporation corrugated container plant in North Tonawanda, New York and corrugated sheet plants in Scotia, New York; Le Roy, New York; and Madison, Ohio.\nTISSUE\nChesapeake's tissue segment consists of Wisconsin Tissue, which produces tissue for industrial and commercial markets. Chesapeake Consumer Products Company, a converter of tissue products for the consumer market, was also part of this segment until December 29, 1995, when it was sold to The Fonda Group, Inc. of St. Albans, Vermont.\nWisconsin Tissue Mills Inc.\nWisconsin Tissue, acquired in 1985, manufactures napkins, tablecovers, toweling, placemats, wipers and facial and bathroom tissue for commercial and industrial markets at its paper mills in Menasha, Wisconsin; Flagstaff, Arizona; and Chicago, Illinois. Wisconsin Tissue operates a converting facility in Neenah, Wisconsin, and plans to begin operation in 1996 of two new converting facilities at Bellemont, Arizona, and Greenwich, New York. The 1995 addition of the paper mills in Arizona and Illinois is part of our growth strategy of providing a full line of disposable products for the commercial and industrial tissue markets, and increased primary tissue production capacity by 90,000 tons per year, or approximately 50%. Our 2,200 products are found in full-menu and fast-food restaurants, hotels, motels, clubs, health care facilities, schools and office locations and on airlines.\nThe raw material for the paper manufactured by Wisconsin Tissue is 100% recovered paper. Seven paper machines manufacture base tissue stock that is converted on over 100 specialized machines in Neenah, Wisconsin, with additional converting machines scheduled to come on-line in 1996 at the new facilities in Arizona and New York. The Company believes that its computerized warehouse inventory and distribution systems give it an advantage over many of its competitors in product shipping efficiency and inventory control. Our tissue products are sold throughout the United States and in Canada using our own sales force or brokers. Shipments by Wisconsin Tissue were 235,000 tons in 1995, 217,000 tons in 1994 and 220,000 tons in 1993.\nKRAFT PRODUCTS\nChesapeake's kraft products segment consists of Chesapeake Paper Products Company, our kraft products operations, and Chesapeake Forest Products Company, our woodlands and building products operations, both based in West Point, Virginia. Chesapeake Building Products Company, a wholly-owned subsidiary of Chesapeake Forest Products Company, was formed in 1993 with the merger of the company's lumber division and Chesapeake Wood Treating Co.\nChesapeake Paper Products Company\nChesapeake Paper Products manufactures white top paperboard, which accounts for approximately 90% of the total paperboard product mix, kraft paperboard, kraft paper, corrugating medium and bleached hardwood pulp at its mill located in West Point, Virginia. Paperboard and corrugating medium, the outer and inner materials of a corrugated container, are sold to external and company-owned container and packaging plants. Kraft paper is sold to external converters to make bags and wrappings. Bleached hardwood pulp is sold primarily to non-pulp producing paper manufacturers which manufacture predominantly printing and writing paper. Most of our customers are located in the eastern half of the United States, primarily in the mid-Atlantic and northeastern states, where we have the advantage of lower freight costs compared to many of our competitors. We also sell to international customers, primarily in Europe, Asia and Canada. Our sales force markets these products to integrated and independent converters and manufacturers.\nDuring 1995, Chesapeake Paper Products completed the rebuild of the No.2 paper machine at the West Point, Va., mill. While lost production associated with the rebuild reduced shipments for 1995, the project increased the mill's capacity by 70,000 tons per year while permitting a more profitable product mix. Total shipments from the West Point mill were 769,000 tons in 1995, 850,000 tons in 1994 and 798,000 tons in 1993.\nIn 1995, approximately 68% of the raw material for products manufactured by our kraft products mill was virgin wood fiber, with the remainder being recycled fiber recovered through our recycling system. Two company-owned recycling centers collect recycled fiber for the mill, which has the capacity to use 360,000 tons of recycled fiber annually. About 73% of the virgin wood fiber used in 1995 was purchased from wood producers or independent timberland owners and the rest was from company-owned timberlands. In addition to our three paper machines and a market pulp machine, the West Point facility includes wood storage, wood pulping, paper recycling and steam and power generation equipment.\nIn recent years much emphasis has been placed on training, problem-solving and employee involvement in all phases of the mill's operation. These factors, as well as the installation of new equipment, have enabled the mill to improve product quality and lower reject levels. A mill optimization program is also in place to improve efficiency in the manufacturing process.\nChesapeake Forest Products Company, Woodlands Division\nChesapeake Forest Products, Woodlands Division, owns and actively manages approximately 325,000 acres of timberland located in Virginia, Maryland and Delaware. The primary objective of our woodlands operation is to provide an adequate supply of wood at a competitive cost to the kraft products mill located at West Point. Wood is delivered to our mill from our company-owned lands and from independent landowners. Our foresters use environmentally sound, modern forestry methods intended to ensure a long-term, low-cost fiber supply. Our genetically superior pine seedlings, which are used in our reforestation program on company-owned land and made available to private landowners, grow quicker and provide higher quality, more uniform fibers at the time of harvest than traditional seedlings. We are actively utilizing natural reforestation techniques to generate new hardwood timber stands on company-owned and privately held land. For more than 25 years, Chesapeake has participated in research programs that have improved the quality, disease resistance and growth rate of our planted trees. In addition, in 1995 Chesapeake Forest Products Company pledged to comply with new American Forest and Paper Association guidelines of conduct that will govern the way we grow and nurture our forests, known as the \"Sustainable Forestry Initiative\".\nChesapeake Building Products Company\nChesapeake Building Products operates four sawmills in Virginia and Maryland, manufacturing pine and hardwood lumber. The raw materials are provided both from company-owned timberlands and from other landowners. Our sawmill products are sold by our own sales force to independent users.\nSubstantially all of the assets of the former Chesapeake Wood Treating Co. were conveyed to Universal Forest Products, Inc. under lease and purchase agreements in October 1993. Chesapeake Wood Treating Co. produced chemically treated pine lumber for the home improvement and residential construction markets.\nOTHER BUSINESSES\nDelmarva Properties, Inc. and Stonehouse Inc.\nDelmarva Properties develops and markets land that has potential for value greater than as timberland. Nearly all of Delmarva Properties' present land inventory of approximately 8,500 acres was formerly timberland owned by Chesapeake Forest Products. Delmarva Properties develops land in Virginia, Maryland and Delaware primarily for residential housing. Sales also include large lots and acreage for others to develop for both residential and commercial uses. A major project involves the development of a mixed-use site next to a proposed horse racing track in New Kent, Virginia.\nStonehouse Inc. is managing the planning for development of a new 7,400 acre planned community near Williamsburg, Va. Stonehouse Inc.'s pending joint venture with Dominion Capital, Inc. will form a partnership for development of the first residential phase of the planned community. Significant sales are not anticipated for several more years. Most of Stonehouse's land was formerly timberland owned by Chesapeake Forest Products.\nRAW MATERIALS\nMost of the Company's raw materials are readily available at competitive prices. Prices of recycled fiber, a major raw material, reached historic highs in 1994 and early 1995, but moderated by year-end 1995. See \"Financial Review 1993-1995\" of the 1995 Annual Report, incorporated herein by reference.\nENVIRONMENTAL\nThe information presented under the caption \"Financial Review 1993-1995, Environmental\" of the 1995 Annual Report is incorporated herein by reference.\nEMPLOYEES\nAs of December 31, 1995, the Company had 5,305 employees. The Company believes that its relations with its employees are good. In 1992, Wisconsin Tissue and Chesapeake Paper Products entered into five-year collective bargaining agreements with the unions representing employees at the mills in Menasha, Wisc., and West Point, Va. During 1994, a five-year labor contract extension was negotiated with the union representing employees at Chesapeake Paper Products. During 1994 and 1995, Chesapeake Paper Products Company and Chesapeake Forest Products Company implemented enhanced retirement programs affecting both hourly and salaried employees at these operations. See \"Financial Review 1993-1995\" of the 1995 Annual Report incorporated herein by reference.\nCOMPETITION AND SEASONALITY\nWith its diversity of products, Chesapeake has many customers buying different products and is not dependent on any single customer, or group of customers, in any market segment. Longstanding relationships exist with many of our customers who place orders on a continuing basis. Because of the nature of our business, order backlog is not large. The third and fourth quarters of each year are usually the highest in sales and earnings. Our major businesses generally experience peak activity during the months of August through October.\nCompetition is intense in all business segments from much larger companies and from local and regional producers and converters. The Company believes that competitive factors in our industry preclude a meaningful estimate of the number of competitors and, except as noted, the Company's relative competitive position. The Company does not have any appreciable market share in commodity products, such as bleached hardwood pulp and brown paperboard. For this reason, the Company has de-emphasized these products to pursue specialty products that we believe will provide less pricing volatility and increased profitability. We believe that, with our strengths of customer service and competitive products, we are well positioned to compete in these specialized markets.\nRESEARCH AND DEVELOPMENT\nIn addition to forestry research programs, the Company conducts limited continuing technical research and development projects relating to new products and improvements of existing products and processes. Expenditures for research and development activities are not material.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAt year-end 1995, Chesapeake manufactured or converted paper and wood products at 40 facilities in 14 states. The information presented under \"Operating Managers and Locations\" in the 1995 Annual Report is incorporated herein by reference. The Company owns most of its production facilities, which are well maintained and in good operating condition, and are utilized at practical capacities that vary in accordance with product mixes, market conditions and machine configurations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information presented in \"Notes to Consolidated Financial Statements, Note 10 - Litigation\" of the 1995 Annual Report is incorporated herein by reference.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers of the Registrant\nThe name and age of each executive officer of the Company as of February 13, 1996, together with a brief description of the principal occupation or employment of each such person during the past five years, is set forth below. Executive officers serve at the pleasure of the board of directors and are elected at each annual organizational meeting of the board of directors.\nJ. Carter Fox (56) Chairman since 1994 Chief Executive Officer since 1980 President 1980-1995 Paul A. Dresser, Jr. (53) President since 1995 Chief Operating Officer since 1991 Executive Vice President 1990-1995 Chief Financial Officer 1981-1991 Group Vice President-Finance & Administration 1984-1990 Thomas Blackburn (44) Group Vice President-Kraft Products since 1991 President, Chesapeake Paper Products Company and Chesapeake Forest Products Company since 1991 Kraft Products-Executive Vice President 1990-1991 General Manager, Crossett, Arkansas, Georgia-Pacific Corporation 1988-1990 Andrew J. Kohut (37) Group Vice President-Finance & Strategic Development since 1995 Chief Financial Officer since 1991 Vice President-Finance 1991-1995 President and General Manager, Color-Box, Inc. 1989-1991 William A. Raaths (49) Group Vice President-Tissue Products since 1995 President-Wisconsin Tissue Mills Inc. since 1995 Executive Vice President- Wisconsin Tissue Mills Inc. 1994-1995 President, Chesapeake Consumer Products Company 1989-1994 Samuel J. Taylor (56) Group Vice President-Packaging since 1988 President, Chesapeake Packaging Co. since 1988 J. P. Causey Jr. (52) Senior Vice President, Secretary & General Counsel since 1986 Thomas A. Smith (49) Vice President-Human Resources & Assistant Secretary since 1987\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe dividend and stock price information presented under the caption \"Recent Quarterly Results\" of the 1995 Annual Report is incorporated herein by reference. The Company's common stock is listed on the New York Stock Exchange under the symbol - \"CSK\". As of February 29, 1996, there were 7,231 stockholders of record of the Company's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information for the years 1991-1995 presented under the caption \"Eleven-Year Comparative Record\" of 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 Operation\nThe information presented under the caption \"Financial Review 1993-1995\" of the 1995 Annual Report is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements of the Company and its subsidiaries, including the notes thereto, and the information presented under the caption \"Recent Quarterly Results\" of the 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\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information presented under the captions \"Information Concerning Nominees\" and \"Directors Continuing in Office\" of the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 24, 1996 (the \"1996 Proxy Statement\") is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information presented under the captions \"Compensation of Directors\" and \"Executive Compensation\" of the 1996 Proxy Statement (excluding, however, the information presented under the subheadings \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\") is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information presented under the caption \"Security Ownership of Certain Beneficial Owners and Management\" of the 1996 Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information presented under the caption \"Certain Transactions\" of the 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\na. Documents\n(i) Financial Statements\nThe consolidated balance sheet of Chesapeake 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, including the notes thereto, are presented in the Company's 1995 Annual Report and are incorporated herein by reference. The \"Report of Independent Accountants\" as presented in the Company's 1995 Annual Report, is incorporated herein by reference. With the exception of the aforementioned information, and the information incorporated by reference in numbered Items 1, 2, 3, 5, 6, 7 and 8, no other data appearing in the 1995 Annual Report is deemed to be \"filed\" as part of this Form 10-K.\n(ii) Financial Statement Schedules\nNo schedules are filed as part of this report because they are not applicable or are not required.\n(iii) Exhibits filed or incorporated by reference\nThe exhibits that are required to be filed or incorporated by reference herein are listed in the Exhibit Index found on pages 14-15 hereof. Exhibits 10.1-10.9 hereto constitute management contracts or compensatory plans or arrangements required to be filed as exhibits hereto.\nb. Reports on Form 8-K\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCHESAPEAKE CORPORATION (Registrant)\nFebruary 13, 1996 By \/s\/ CHRISTOPHER R BURGESS Christopher R. Burgess Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated.\nBy \/s\/ PAUL A. DRESSER, JR. By \/s\/ WALLACE STETTINIUS Paul A. Dresser, Jr. Wallace Stettinius Director; President & Director Chief Operating Officer\nBy \/s\/ M. KATHERINE DWYER By M. Katherine Dwyer John Hoyt Stookey Director Director\nBy \/s\/ J. CARTER FOX By \/s\/ RICHARD G. TILGHMAN J. Carter Fox Richard G. Tilghman Chairman of the Board Director of Directors; Chief Executive Officer\nBy \/s\/ ROBERT L. HINTZ By \/s\/ JOSEPH P. VIVIANO Robert L. Hintz Joseph P. Viviano Director Director\nBy \/s\/ WILLIAM D. McCOY By \/s\/ HARRY H. WARNER William D. McCoy Harry H. Warner Director Director\nBy By \/s\/ ANDREW J. KOHUT C. Elis Olsson Andrew J. Kohut Director Group Vice President - Finance & Strategic Development & Chief Financial Officer\nBy \/s\/ JOHN W. ROSENBLUM By \/s\/ CHRISTOPHER R. BURGESS John W. Rosenblum Christopher R. Burgess Director Controller\nBy \/s\/ FRANK S. ROYAL Frank S. Royal Director\nEach of the above signatures is affixed as of February 13, 1996. EXHIBIT INDEX\n3.1 Articles of Incorporation (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n3.2 Amended and Restated Bylaws (filed as Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference)\n4.1 Indenture, dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to Form S-3 Registration Statement No. 33-30900 and incorporated herein by reference)\n4.2 First Supplemental Indenture, dated as of September 1, 1989, to the Indenture dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed October 9, 1990, and incorporated herein by reference)\n4.3 Rights Agreement, dated as of March 15, 1988, between the Registrant and Crestar Bank (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated March 15, 1988, and incorporated herein by reference)\n4.4 Rights Agreement Amendment, dated as of August 24, 1992, between the Registrant and Harris Trust and Savings Bank, as successor rights agent (filed as Exhibit 4.4 to the Registrant's Registration Statement on Form S-8, File No. 33-56473, and incorporated herein by reference)\nThe registrant agrees to furnish to the Securities and Exchange Commission, upon request, copies of those agreements defining the rights of holders of long-term debt of the registrant and its subsidiaries that are not filed herewith pursuant to Item 601(b)(4)(iii) of Regulation S-K.\n10.1 1987 Stock Option Plan (filed as Exhibit A to the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders held April 22, 1987 and incorporated herein by reference)\n10.2 Directors' Deferred Compensation Plan (filed as Exhibit VII to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.3 Non-Employee Director Stock Option Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-53478 and incorporated herein by reference)\n10.4 Executive Supplemental Retirement Plan (filed as Exhibit VI to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.5 Retirement Plan for Outside Directors (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n10.7 Chesapeake Corporation Salaried Employees' Benefits Continuation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.8 Chesapeake Corporation Long-Term Incentive Plan (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.9 Chesapeake Corporation 1993 Incentive Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-67384 and incorporated herein by reference)\n11.1 Computation of Net Income Per Share of Common Stock\n13.1 Portions of the Chesapeake Corporation Annual Report to Stockholders for the year ended December 31, 1995\n21.1 Subsidiaries\n23.1 Consent of Coopers & Lybrand L.L.P.\n27.1 Financial Data Schedule\n99.1 Form 11-K Annual Report, Hourly Employees' Stock Purchase Plan for the plan fiscal year ended November 30, 1995","section_15":""}
{"filename":"818815_1995.txt","cik":"818815","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF BUSINESS\nInaCom Corp., a Delaware corporation (\"Inacom\" or the \"Company\") is a leading provider of technology management services which includes technology procurement services such as distribution of information technology products, including microcomputer systems, workstations, networking and telecommunications equipment; system support services; and systems integration services. The Company distributes such products and services through a network of 1,017 business centers located throughout the United States. At December 30, 1995, the business centers included 45 business centers owned and operated by the Company and 972 reseller channel locations comprised of independently owned business centers. Through Inacom Communications the Company delivers voice, data and video convergence equipment. The Company emphasizes tailored solutions to computer and tele-communications needs of business and professional customers and provides its customers with comprehensive consulting, training, technical support and service.\nThe Company currently distributes products for leading manufacturers such as IBM, COMPAQ, Hewlett-Packard, Toshiba, Apple, NEC, Epson, Okidata, Lexmark, AT&T, NCR, Novell, Banyan, Microsoft, Oracle, 3Com, SynOptics, SCO and Network General.\nThe Company has been engaged in the distribution of microcomputer products and services since October 1982. The Company was established as a division of Valmont Industries, Inc. (\"Valmont\") in 1982 and became a wholly-owned subsidiary of Valmont in March 1985 under the name ValCom, Inc. The Company completed an initial public offering of its common stock in 1987 and changed its name to InaCom Corp. in 1991.\nThe Company has effected two significant acquisitions in the past five years. The Company acquired Inacomp Computer Centers, Inc. in a 1991 merger for $53.9 million in cash and stock; Inacomp had revenues of $516.0 million in its fiscal year preceding the merger from 322 business center locations. In 1993, the Company purchased certain assets of Sears Business Centers (\"SBC\") from Sears, Roebuck and Co. (\"Sears\"). The cost of the acquired assets was approximately $5.8 million for 35 former SBC locations which generated approximately $456 million of revenue for Sears in 1992.\nThe Company has traditionally reported operating results based on revenues and earnings from Company-owned and independent reseller channels. In 1995 the Company began a process of evaluating its revenues and earnings from the services provided through the life cycle of the products it sells. The Company offers technology management services to all of the customers it serves. Technology management services consist of technology procurement, support services and system integration.\nPRODUCTS AND SERVICES\nThe Company provides a variety of services ranging from procurement of product; support services such as help desk, training and maintenance; and system integration services such as consulting, design, implementation and monitoring.\nAs a result of its quantity purchasing capability, the Company generally obtains volume discounts from its vendors, thus enabling it to sell products to independently owned or Company-owned business centers on a more favorable basis than such business centers could attain on their own. Independently owned business centers are not contractually obligated to the Company to purchase their full product requirements from the Company.\nThe Company's program of hardware maintenance service and support enables business centers to provide customers with on-site support and service coverage at multiple locations. The program is supported by central service dispatch and service call tracking. The Company uses Logistics Management Inc., an unaffiliated entity, based in Memphis, Tennessee, for the distribution and management of its repair parts.\nThe Company offers its distribution channel a direct interactive communications on-line system through the use of a series of IBM AS400's utilizing multiple local-area and wide-area communications networks. The on-line system provides access to a complete range of services and data including product availability, price lists, automatic quotes, order entry, order status and electronic mail. The system saves both the Company and the business centers time and money through lower cost communication and more effective utilization of personnel. The Company believes that the on-line communication services provide a competitive advantage in recruiting new business centers.\nThe Company offers the business centers toll-free hotline support to professionals that manage computer networks operating on a variety of network environments, including Novell, Banyan, Microsoft, IBM, Apple and SCO. The hotline support program has a wide range of telephone support options. The design of the central telephone support center gives the business center and the customers a single point of contact on all technical issues. Customers have access to the Company's on-line data base and technical support information and the Company's Communications Research Center. Customers may choose from a wide variety of technical support options, depending upon which is most effective for their business.\nIn its configuration centers, the Company assembles or modifies independently produced products to meet the customers' needs. Through its \"Direct Express\" program the Company ships the configured product directly to the ultimate customer rather than to a reseller location. The Direct Express program provides independently owned business centers benefits in the form of lower freight costs, reduced working capital requirements, and reduced support staff required to handle and configure products at local levels. Customers benefit from improved delivery times and standardized quality configuration. All configuration is performed by the Company at three configuration centers located in California, New Jersey and Nebraska.\nTo assist business centers and the customers with the purchase of products and services, the Company provides several types of finance programs that offer a wide range of services. The most traditional method of financing for qualified business centers is 30 day interest free financing from the date that the product is shipped; after this period, the business center has the option to roll over the outstanding amounts into financing through various financial institutions. Other programs and promotions are designed to meet business centers and customer needs as market and business conditions change.\nDISTRIBUTION NETWORK\nAt December 30, 1995, the Company's network of business centers consisted of business centers owned and operated by the Company and the reseller channel comprised of independently owned business centers.\nThe following table sets forth information with respect to the number of business centers participating in the Company's distribution network:\nThe decrease in the number of independent resellers in 1995 and 1994 resulted from actions taken by the Company to tier the independent reseller channel into various categories due to the varying cost levels associated with conducting business with different size resellers. As a result of this process some of the smaller dealers in the independent reseller channel chose other sources for product procurement due to the decreased service levels and subsequent increased pricing. The loss of these independent resellers did not have a material negative impact on revenue during 1995 nor 1994.\nThe Company-owned business centers provide a variety of computer products and technology management services which include technology procurement services, systems integration services and support services.\nThe Company's independent reseller channel consists of franchisees, systems integrators and value added resellers. Franchisees operate computer stores and typically pay the Company (i) a base monthly royalty and\/or (ii) the purchase price plus markup of the product and services acquired from the Company. Contracts for franchisees are for a period of up to 10 years with certain options for renewal. System integrators and value added resellers operate businesses that focus on higher service levels providing customers with installation and support of networks, business applications and program design. The term of agreements within these groups range from 1 month to 5 years and the agreements specify the products that may be purchased. Products are typically purchased at a cost plus a volume based fee with varying levels of support services provided by the Company on a fee basis.\nThe Company's communications division, which operates through Company-owned business centers and independent resellers, provides a variety of voice, data and telephony products and related services.\nVENDORS\nThe Company has negotiated purchase arrangements, including price, delivery, training and support, directly with certain vendors. During the fiscal year ended December 30, 1995, sales of IBM, COMPAQ and Hewlett-Packard products accounted for approximately 22%, 20% and 15%, respectively, of the Company's revenues.\nThe IBM supply agreement is in effect for an indefinite period; however, IBM may terminate the agreement on 90 days' written notice to the Company, or immediately upon notice in the event of a breach. The distributor agreements with other suppliers, including COMPAQ and Hewlett-Packard, may be terminated by the supplier upon prior written notice, which generally ranges from 30 to 60 days. The Company believes that the terms and provisions offered by the vendors are standard in the computer reseller industry.\nThe agreements with vendors generally contain provisions with respect to product cost, price protection, returns and product allocations. The Company is entitled to price protection with all major vendors on eligible product in the Company's inventory in the event of price reductions made by a vendor. Additionally, contracts with most vendors provide for the return for credit of slower moving product or overstock product.\nCertain vendors sponsor payment programs with several financial service organizations to facilitate product sales through the business centers. These programs provide the business centers with extended credit terms and interest free financing for a period of time. Under these programs the Company receives payments for product sales within three days, which reduces the working capital requirements of the Company.\nThe primary vendors of the Company provide various incentives for promoting and marketing their product offerings. Funds received by the Company are based either on the sales of the vendor's products through the independent reseller and Company-owned channels, or on the Company's purchases from the respective vendor. These funds from the Company's primary vendors typically range from 1% to 3% of purchases. The funds are earned through performance of specific marketing programs or upon completion of objectives outlined by the vendors. The three major forms of vendor incentives received by the Company are coop funds, market development funds and vendor rebates. Coop funds are earned based upon the sale of the vendor's products and generally must be utilized to offset the costs associated with advertising and promotion pursuant to programs established by the respective vendor. Market development funds are earned based upon the Company's purchases from the vendor and generally must be used for market development activities approved by the respective vendor. Vendor rebates are based upon the Company attaining purchase volume targets established with the vendor. Rebates generally can be used at the Company's discretion.\nThe Company's business is dependent in large measure upon its relationship with key vendors since a substantial portion of the Company's revenue is derived from the sales of the products of such key vendors, including IBM, COMPAQ, and Hewlett-Packard. Although the Company considers its relationships with its key vendors to be good, there can be no assurance that these relationships will continue as presently in effect or that changes in marketing by one or more such key vendors and the volume discount schedules or other programs applicable to the Company and other purchasers would not adversely affect the Company. Termination of, or a material change to, or a nonrenewal of the Company's agreements with IBM, COMPAQ and Hewlett-Packard, or a material decrease in the level of marketing development programs offered by manufacturers, or an insufficient or interrupted supply of vendors' product would have a material adverse effect on the Company's business.\nSERVICE MARK AND TRADEMARK\nThe Company holds United States service mark and trademark registrations for the marks \"Inacom\", \"ValCom\" and \"Inacomp\". The Company also has certain state registrations. The Company claims common law rights to the marks based on adoption and use. To the Company's knowledge, there are no pending interference, opposition or cancellation proceedings, or litigation threatened or claimed, with respect to the marks in any jurisdiction.\nGOVERNMENT REGULATION\nThe Company is subject to a substantial number of state laws regulating franchise relationships. The Company is also subject to Federal Trade Commission rules governing disclosure requirements in the granting of franchises. Such laws generally impose registration and\/or disclosure requirements on the Company in the offer and sale of franchises and also regulate related advertisements. The Company believes it is in substantial compliance with all such regulations.\nSEASONAL FACTORS IN BUSINESS\nThe fourth quarter of the Company's fiscal year generally produces higher revenues, due principally to year-end purchases made by business customers.\nCUSTOMERS\nThe Company is not dependent for a material part of its business upon a single or a few customers and loss of any one customer would not have a material adverse effect on the Company's financial condition.\nBACKLOG\nThe backlog of orders for products distributed by the Company was $35.5 million at the close of the 1995 fiscal year compared to $43.8 million at year end 1994 and $98.4 million at year end 1993. The decrease in backlog of orders is primarily due to the increase in availability of products from the Company's major vendors. Such orders are not necessarily firm since large customers may place orders with several computer resellers and accept products from the first computer reseller to provide delivery.\nCOMPETITION\nAll aspects of the information technology industry are highly competitive. The Company's distribution network competes for potential customers, including national accounts, with numerous other master resellers and distributors. Several manufacturers have expanded their channels of distribution, pricing and product positioning and compete with the Company's distribution network for potential customers. Additionally, several manufacturers during 1994 lessened or eliminated requirements upon independent resellers to purchase products from a single source resulting in \"open sourcing\" of their products; previously, manufacturers had typically required independent resellers having contractual relationships with the Company to purchase their products from the Company. Certain competitors and manufacturers are substantially larger than the Company and may have greater financial, technical, service and marketing resources. Other competitors operate mail-order or\ndiscount stores offering clones of major vendor products. The Company's distribution network competes primarily on the basis of professionalism and customer contact, quality of product line, availability of products, service, after-sale support, price, and quality of end-user training. The Company also competes with other information technology sellers in the recruitment and retention of franchisees and independently-owned resellers.\nThe computer manufacturers' expansion of their channels of distribution including direct distribution, open sourcing, employment of selective resellers, pricing and product positioning has put pressure on hardware gross margins. The Company believes its ability to deliver technology management services which consist of technology procurement services, systems integration services and support services provides its customer base with value added services that will differentiate the Company from alternative distribution channels and will mitigate the impact of added competitive pressures caused by economic conditions and manufacturers' continuing expansion of their channels of distribution, pricing and product positioning.\nThe level of future sales and earnings achieved by the Company in any period may be adversely affected by a number of competitive factors, including an increase in direct sales by manufacturers to independent resellers and\/or customers, increased customer preference for mail-order or discount store purchases of clones of major vendor products, and reduction in the benefits realizable by the Company from vendor marketing incentive programs.\nNUMBER OF EMPLOYEES\nAt December 30, 1995, the number of employees was 2,196. None of the employees are covered by a collective bargaining agreement. The Company considers its relations with employees to be good.\nFINANCIAL INFORMATION ABOUT FOREIGN OPERATIONS AND EXPORT SALES\nThe Company has no foreign locations or material export sales. The Company has access to international logistics and configuration services through affiliations with the International Computer Group (Europe and Asia); GE Hamilton Technology Services, Inc. (Canada) and InaCom Latin America (Mexico, the Caribbean, Central and South America).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive and administrative operations are located in approximately 63,000 square feet of commercial office space in Omaha, Nebraska, which is under a lease expiring in July 1998. The lease contains a renewal option.\nThe Company leases a distribution and configuration facility in Omaha, Nebraska, with approximately 128,000 square feet under a lease expiring in May 2003; a distribution and configuration facility in Swedesboro, New Jersey, with approximately 121,700 square feet expiring in October 2002 and a distribution and configuration facility in Fontana, California, with approximately 71,800 square feet expiring in July 1996. Upon expiration of the lease on the Fontana, California facility, the Company will lease a 178,000 square foot distribution and configuration facility in Ontario, California for a term expiring in April 2006. These facilities serve as the distribution and configuration points for the Company.\nThe land and buildings for all other Company-owned business centers and warehouse facilities are leased. Most of these leases are operating leases, under which the Company pays maintenance, insurance, repairs and utility costs. Average terms of these leases are one to five years with options to renew or terminate.\nITEM 3.","section_3":"ITEM 3. PENDING LEGAL PROCEEDINGS\nThe Company is involved in a limited number of legal actions arising in the ordinary course of business, none of which is expected to 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\nNot Applicable.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company as of March 1, 1996 are listed below, together with their ages and all Company positions and offices held by them.\nExcept as set forth below, all of the officers have been associated with the Company in their present position or other capacities for more than the past five years.\nBILL L. FAIRFIELD has been President, Chief Operating Officer and a Director of the Company since March 1985. He was named Chief Executive Officer in September 1987.\nROBERT A. SCHULTZ was named President and General Manager of Direct Operations in April 1994 in addition to his position as President and General Manager of Client Service Division which he has held since January 1993. Mr. Schultz was responsible for Direct Operations and the Advanced Systems and Services Group for the Company from August 1991 to January 1993.\nGEORGE DESOLA was named Group President of Communications and Corporate Marketing in December 1994. Prior to December 1994, Mr. DeSola was President and General Manager of Communications, a position he has held since he joined the Company in March 1994. Prior to March 1994, Mr. DeSola was the Vice President of Marketing and Customer Service for MCI Communications Corp, a telecommunications company.\nMICHAEL A. STEFFAN was named President and General Manager of the Distribution and Operations in December 1995. Mr. Steffan was responsible for the Reseller Division from December 1994 to December 1995 in addition to his position as President and General Manager of Distribution and Operations, a position he had held since May 1993. Prior to May 1993, Mr. Steffan was Vice President of Corporate Development and Secretary for the Company.\nDAVID C. GUENTHNER was named Executive Vice President and Chief Financial Officer in November 1991. Prior to November 1991, Mr. Guenthner was Senior Vice President of Finance and Chief Financial Officer for the Company.\nLARRY FAZZINI was named Vice President of Corporate Resources in February 1993 when he joined the Company. Prior to February 1993, Mr. Fazzini was the Director of Human Resources for Sears Business Centers, Inc., a distributor of information technology products and services.\nSTEVEN ROSS joined the Company in December 1995 as President and General Manager of the Reseller Division. Mr. Ross was Vice President of Sales and Business Development at Intelligent Electronics Inc., a distributor of information technology products, from September 1993 to November 1995. Prior to September 1993, Mr. Ross was the Executive Vice President of Ultimate\/Allerion Corp., an international systems integrator company.\nCRIS FREIWALD was named President and General Manager of the International Division in November 1994. Mr. Freiwald was Vice President of Corporate Development from May 1993 to November 1994. Prior to May 1993, Mr. Freiwald was Director of Business Development.\nGARY GOLDSBERRY was named Vice President in May 1993. Mr. Goldsberry has been Corporate Treasurer since December 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThis information is included with the information set forth under Item 8 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 RESULTS OF OPERATIONS\nThe following table sets forth, for the indicated periods, certain data as percentages of total revenue, together with the percentage change in the line items for the periods indicated.\n1995 COMPARED TO 1994\nCustomer expectations of computer resellers have evolved from requests for delivery of computer products in a cost effective manner to requests for providing services beyond the sale of products. The Company has therefore increased its focus on providing services to customers throughout the entire life cycle of the products it sells.\nThe Company generates revenue, gross margin and earnings throughout the life cycle of the products. These revenues, gross margin and earnings are comprised of three main classifications; (i) computer product sales, (ii) technology management services and (iii) communication products and services. Computer product sales are derived from the sale of microcomputer systems, workstations and related products through the Company's independent reseller channel, Company-owned business centers and other distribution facilities. Technology management services are derived from the sale of technology procurement services, systems integration services and systems support services through the Company's independent reseller channel, Company-owned business centers and other distribution facilities. Communication products and services are derived from the sale of voice and data equipment, long distance services and convergence technology through the Company's communications division.\nThe discussion that follows provides information on the business in terms of services provided throughout the life cycle of the products sold by the Company (results by classification) and an analysis in terms of operations as historically reported (results by channel).\nREVENUES BY CLASSIFICATION\nThe following table sets forth, for the indicated periods, revenue by classification and mix of revenue.\nComputer product sales increased $366.8 million or 21.8% to $2.0 billion during 1995. Computer services increased $10.1 million or 11.8% to $95.5 million during 1995. Communications products and services revenue increased $22.9 million or 66% to $57.7 million during 1995.\nRevenues from computer product sales increased as a result of broad based growth within both the independent reseller channel and the Company-owned business centers. Technology management services revenue increased as a result of the increase in computer product sales. Revenues from communication products and services increased as a result of broad based growth within the Company's communications division.\nREVENUES BY CHANNEL\nThe following table sets forth, for the indicated periods, revenue by channel and the mix of revenue.\nRevenues for 1995 increased $399.8 million or 22.2% to $2.2 billion when comparing the fiscal year ended December 30, 1995 with the fiscal year ended December 31, 1994. Revenue generated from the independent reseller channel (which includes franchises, system integrators and other value added resellers) was approximately $1.1 billion, or 50.3% of 1995 total revenue, compared to $920.4 million or 51.1% of total revenue in 1994. Company-owned business centers generated $994.1 million\nor 45.2% of total revenue for 1995, compared to $807.6 million or 44.9% of total revenue in 1994. Revenue from other sources was $99.6 million or 4.5% of total revenue in 1995, compared to $72.5 million or 4.0% of total revenue in 1994.\nRevenues from the independent reseller channel increased as a result of growth within the Company's existing reseller channel, an increase in products shipped directly to the end-user customer on instruction from the reseller and an increase in second source revenue. Second source revenue is generated from sales to independent resellers who are not Inacom resellers by contract. These revenues are primarily a result of open sourcing which resulted from certain manufacturers, beginning in 1994, lessening or eliminating requirements from independent resellers to purchase product from one source. Revenues from the Company-owned business centers increased as a result of broad based growth across all regional locations. Revenue from other sources increased primarily as a result of the growth in voice and data equipment sales as well as growth in product liquidation sales.\nGROSS MARGINS BY CLASSIFICATION\nThe following table sets forth, for the indicated periods, gross margin and gross margin percentages by classification.\n- ------------------------ (1) The amounts for 1994 exclude the impact of the non-recurring charges recognized in the second quarter of 1994. See 1994 compared to 1993 -- Nonrecurring Charges below.\nComputer product margins increased $8.3 million or 7.5% to $122.4 million during 1995 and the gross margin percentage, exclusive of non-recurring charges recognized in the second quarter of 1994, decreased 0.8 percentage points to 6.0% in 1995. Technology management services margin increased $15.1 million or 28.7% to $67.6 million during 1995 and the gross margin percentage, exclusive of non-recurring charges recognized in the second quarter of 1994, increased 9.3 percentage points to 70.8% in 1995. Communications product and services margin increased $6.3 million or 83.9% to $13.8 million during 1995 and the gross margin percentage increased 2.4 percentage points to 24.0% in 1995. Computer products margin was 60.1% of total 1995 gross margin versus 65.5% of total 1994 gross margin. Technology management services gross margin was 33.2% of total 1995 gross margin versus 30.2% of total 1994 gross margin. Communications products and services gross margin was 6.7% of total 1995 gross margin versus 4.3% of total 1994 gross margin.\nThe increase in gross margin dollars for computer products was a result of the increase in revenues. The decline in gross margin percentage for computer products was a result of market pricing pressures related to open sourcing, which began in the independent reseller channel during the second quarter of 1994, and an overall decline in hardware margins realized on end user sales. The increase in gross margin dollars and gross margin percentage for technology management services resulted from the increased revenues and an increase in mix of services revenues to include more higher margin systems integration services versus the support and technology procurement services.\nThe increase in gross margin dollars and gross margin percentage for the communication products and services was a result of the increased revenues and the increase in the mix of revenues to include more higher margin long distance and services.\nGROSS MARGINS BY CHANNEL\nThe following table sets forth, for the indicated periods, gross margin and gross margin percentage by channel.\n- ------------------------ (1) Excludes the impact of non-recurring charges recognized in the second quarter of 1994.\nIncluding the effect of the 1994 non-recurring charges, gross margin dollars increased $35.1 million or 20.8% to $203.8 million during 1995. Gross margin dollars from the independent reseller channel decreased $775 thousand or 2.1% during 1995. Gross margin dollars from Company-owned business centers increased $29.1 million or 25.5% during 1995. Gross margin dollars from other sources increased $6.8 million or 37.6% during 1995.\nIncluding the effect of the 1994 non-recurring charges, gross margin for the Company as a percentage of sales was 9.3% for the year ended December 30, 1995 compared to 9.4% for the year ended December 31, 1994. The gross margin percentage from the independent reseller channel was approximately 3.2% in 1995 compared to 4.0% in 1994. The gross margin percentage for Company-owned business centers was 14.4% in 1995 and 14.1% in 1994. The gross margin percentage from other sources was 24.9% in both 1995 and 1994.\nExcluding the impact of the non-recurring charges recognized in the second quarter of 1994, gross margin dollars increased $30.0 million or 17.3% during 1995 and the gross margin percentage decreased 0.4 percentage points during 1995. Excluding the 1994 non-recurring charges, the gross margin dollars for the independent reseller channel decreased $3.1 million or 7.9% during 1995 and the gross margin percentage decreased 1.0 percentage point during 1995. Excluding the 1994 non-recurring charges, the gross margin dollars for the Company-owned business centers increased $26.3 million or 22.5% during 1995 and the gross margin percentage decreased 0.1 percentage point during 1995.\nThe decrease in gross margin dollars for the independent reseller channel resulted from the decrease in gross margin percentage. The decrease in gross margin percentage was a result of market pricing pressures. These market pricing pressures were primarily attributable to open sourcing which began in the second quarter of 1994.\nThe increase in gross margin dollars from the Company-owned business centers resulted from the increased revenues during 1995. The decrease in gross margin percentages resulted from the mix of revenues. While hardware margin percentages decreased during 1995, the increase in the mix of\nrevenues to include more training, technical and support services offset the negative impact of declining hardware margins. The increase in gross margin dollars from other sources was primarily due to the increased revenues.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative (SG&A) expenses increased $8.9 million or 5.6% to $169.3 million in 1995. As a percentage of gross margin, these expenses decreased 12.0 percentage points from to 95.1% in 1994 to 83.1% in 1995. Excluding the impact of 1994 non-recurring charges, SG&A expenses increased $10.9 million or 6.9% during 1995. SG&A as a percent of gross margin, excluding the impact of non-recurring charges recognized in the second quarter of 1994, decreased 8.1 percentage points during 1995.\nThe increase in SG&A during 1995 resulted primarily from increased spending partially offset by an increase in market development funds earned from various vendors and credited against SG&A. The increase in spending was primarily a result of employee increases and contract labor expenses to support the increasing service revenue component of the Company-owned business centers. The increase in vendor funds earned resulted from attainment of program objectives outlined by vendors primarily driven by higher revenues in 1995. The decrease in SG&A as a percent of margin during 1995 resulted from operational efficiencies achieved through investments in distribution center automation and information systems.\nINTEREST EXPENSE\nNet interest expense for 1995 increased by $2.6 million to $14.6 million. The increase was due primarily to the increase in borrowing rates. The Company's short-term borrowing rates for 1995 increased approximately 1.3 percentage points during the year while the average daily borrowings decreased to $178.8 million in 1995 from $201.9 million in 1994.\nPRE-TAX EARNINGS\n- ------------------------ (1) Excludes the impact of non-recurring charges recognized in the second quarter of 1994.\nThe effective income tax rate was approximately 41% in 1995 and 40% in 1994.\nNET EARNINGS\nFor the reasons described above, the net earnings for 1995 were $11.7 million compared to a net loss of $2.3 million in 1994 which includes 1994 non-recurring charges of $4.2 million; an increase of $14.0 million. Earnings per share for 1995 were $1.14 compared to a loss per share of $0.22 in 1994 which includes 1994 non-recurring charges of $.41 per share.\n1994 COMPARED TO 1993\nNON-RECURRING CHARGES\nDuring the second quarter of 1994 the Company reported a loss due in part to non-recurring charges relating to (i) a Department of Defense contract, (ii) settlement of certain warranty claims, (iii) a receivable from a supplier that filed bankruptcy and (iv) severance costs for corporate staff reductions.\nThe Company incurred a second quarter non-recurring charge of $3.5 million relating to a contract with the Department of Defense. The contract, which was assumed by the Company in the Sears Business Center (SBC) acquisition in 1993, expired in December 1994. While the contract was marginally profitable in the fourth quarter of 1993 and first quarter of 1994, the Defense Department began ordering lower-margin product for the remainder of the contract. The Company was unable to deliver profitably the product specified by the government under the terms of the contract and therefore accrued in the second quarter losses expected to be realized through the remainder of the year. The non-recurring charge for anticipated future losses at the end of the second quarter increased cost of sales by approximately $2.2 million and selling, general and administrative (SG&A) expenses by approximately $1.3 million. In addition to the charge taken at the end of the quarter, the second quarter operations impact of the contract reflected in cost of sales an additional charge of approximately $600,000 and SG&A reflected an additional charge of approximately $400,000.\nThe warranty claims resulted from a contract relating to specialized software applications and involved claims against the Company and the hardware suppliers. The Company agreed to settle for $1.0 million payable over two years. The non-recurring charge increased cost of sales by approximately $700,000 at the end of the second quarter and increased the reserves to the level required for the settlement. In addition to the charge taken at the end of the quarter, cost of sales reflected an additional charge of approximately $300,000 during the second quarter to increase the reserve position to the amount required to cover the potential loss.\nThe Company had a receivable and an inventory return judgment against a California-based supplier of hardware that filed bankruptcy in the second quarter. As a result, payment of the judgment amount outstanding appeared doubtful and the Company increased its reserve position to $1.3 million to cover the potential loss. The non-recurring charge at the end of the second quarter increased cost of sales by approximately $500,000. In addition to the charge taken at the end of the quarter, cost of sales reflected an additional charge of approximately $800,000 during the second quarter to increase the reserve position to the amount required to cover the potential loss.\nThe Company also instituted staff reductions in the second quarter and accrued $320,000 relating to severance costs for the reductions.\nREVENUES\nRevenues for 1994 increased $255.3 million or 16.5% to $1.8 billion when comparing the fiscal year ended December 31, 1994 with the fiscal year ended December 25, 1993. Revenue generated from the independent reseller channel was approximately $920.4 million, or 51.1% of 1994 total revenue, compared to $742.4 million or 48.0% of total revenue in 1993. Company-owned business centers generated $807.6 million or 44.9% of total revenue for 1994, compared to $750.8 million or 48.6% of total revenue in 1993. Revenue from other sources was $72.5 million or 4.0% of total revenue in 1994, compared to $52.0 million or 3.4% of total revenue in 1993.\nRevenue from the independent reseller channel increased as a result of industry growth and an increase in products shipped to the end-user customer rather than the reseller location under the Company's Direct Express Program. The revenue growth from the Company-owned business centers was primarily in the last six months of the year due to an increase in large corporate sales and educational institution sales in the Northeast (New York, New Jersey and Pennsylvania); revenue in the first six months of the year was lower than expected in the West (California) and Northeast due to the departure of sales representatives, an earthquake in California and severe winter weather in the\nNortheast. Revenue from other sources increased as a result of growth in both voice and data equipment sales and from services such as extended warranty contracts, consulting and network design.\nGROSS MARGIN\nGross margin dollars decreased $0.7 million or 0.4% to $168.7 million during 1994. Gross margin dollars from the independent reseller channel decreased $12.0 million or 24.7% during 1994. Gross margin dollars from Company-owned business centers increased $7.3 million or 6.8% during 1994. Gross margin dollars from other sources increased $4.0 million or 28.7% during 1994. The decrease in gross margin dollars from the independent reseller channel is primarily due to market pricing pressures, open sourcing, freight costs incurred that were in excess of freight collected from customers, and non-recurring charges that occurred in the second quarter (described above). Freight costs incurred in excess of freight charged to customers resulted primarily from shipments through the Company's Direct Express program. The increase in Direct Express shipments resulted in higher freight costs as the average value per shipment to customers decreased causing a difference between freight paid to carriers and freight billed to customers. Beginning in August the Company changed its freight program to bill actual freight cost on all shipments under Direct Express, which significantly reduced the negative impact of freight charges on gross margins in the second half of the year.\nThe increase in gross margin dollars from the Company-owned business centers occurred in the last six months of the year as a result of the increased revenue and the result of the mix of revenues to include more higher margin products, and the sale of more technical and support services. Gross margins were negatively impacted by the non-recurring charges (described above) in the second quarter relating to the Department of Defense contract. The increase in gross margin dollars from other sources was primarily due to the increased revenue.\nGross margin for the Company as a percentage of sales was 9.4% for the year ended December 31, 1994 compared to 11.0% for the year ended December 25, 1993. The gross margin percentage from the independent reseller channel was approximately 4.0% in 1994 compared to 6.6% in 1993. The gross margin percentage for Company-owned business centers was 14.1% in 1994 and 14.2% in 1993. The gross margin percentage from other sources was 24.9% in 1994 compared to 27.0% in 1993. The decrease in gross margin percentage from the independent reseller channel was primarily due to market pricing pressures resulting from open sourcing, non-recurring charges incurred in the second quarter (described above), and freight costs. The decrease in gross margin percentages for company- owned business centers in 1994 resulted from the non-recurring charges. The decrease in gross margin percentage from other sources was attributable to the mix of revenue between voice and data equipment, repair and maintenance contracts and extended warranty contracts.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative (SG&A) expenses increased $19.3 million or 13.7% to $160.4 million in 1994. As a percentage of gross margin, these expenses increased to 95.1% in 1994 from 83.3% in 1993. The increase in SG&A dollars and SG&A to gross margin dollars was primarily due to increased advertising and promotional spending by the Company in both the independent reseller channel and the Company-owned business centers, reduced vendor marketing reimbursements to offset such promotional costs, and increased spending in relation to operating the service division of the Company as a result of the SBC acquisition. The Company-owned business centers' SG&A expenses also increased over 1993 due to higher revenues and gross margins as well as realizing a full year's expense of operating the SBC locations which were purchased in March 1993.\nOperating income decreased $20 million or 70.7% to $8.3 million in 1994 when compared to 1993. The decrease resulted primarily from the reduction in gross margin dollars and the increase in SG&A expenses as discussed above.\nINTEREST EXPENSE\nNet interest expense for 1994 increased by $3.4 million to $12 million. The increase was due primarily to the increase in average daily borrowings and an increase in the borrowing rates. Average daily borrowings for the year ended December 31, 1994 were $201.9 million compared to $148.3 million for the year ended December 25, 1993. The increase in borrowings resulted from higher working capital needs as a result of carrying high levels of inventory and also higher levels of accounts receivable due to increased revenues, and taking advantage of early pay discounts from the manufacturers. The Company's short-term borrowing rates for 1994 increased approximately two percentage points during the year.\nThe effective income tax rate was approximately 40% in 1994 and 1993.\nNET EARNINGS (LOSS)\nFor the reasons described above, the net loss for 1994 was $2.3 million, which includes non-recurring charges of $4.2 million, compared to net earnings of $12.0 million in 1993; a decrease of $14.3 million. Loss per share for 1994 was $.22, which includes non-recurring charges of $.41 per share, compared to earnings per share of $1.26 in 1993.\nFINANCIAL CONDITION AND LIQUIDITY\nThe Company's primary sources of liquidity are provided through a working capital financing agreement for $350.0 million and $30.3 million in two private placement notes.\nThe Company entered into a working capital financing agreement in June 1995 with a financial services organization and terminated previous revolving credit facilities. The $350.0 million working capital financing agreement expires June 29, 1998. At December 30, 1995, $76.9 million was outstanding under the working capital line and the interest rate was 7.68% based on LIBOR. The working capital financing agreement is secured by accounts receivable and inventory.\nThe two private placement notes are held by unaffiliated insurance companies. The principal amount of the first note, $13.3 million, is payable in two annual installments of $6.7 million commencing on May 31, 1996 and bears interest at 10.31% payable quarterly. The principal amount of the second note, $17 million, is payable in five annual installments of $3.4 million commencing on February 28, 1997 and bears interest at 6.83% payable quarterly. The notes are secured by accounts receivable and inventory.\nThe working capital and debt agreements contain certain restrictive covenants, including the maintenance of minimum levels of working capital, tangible net worth, fixed charge coverage, limitations on incurring additional indebtedness and restrictions on the amount of net loss that the Company can incur. The Company was in compliance with the covenants contained in the agreements at December 30, 1995.\nLong-term debt was 13.7% of total long-term debt and equity at December 30, 1995 versus 18.3% at December 31, 1994. The decrease was primarily a result of the reduction in long term debt due to the scheduled payment of $6.7 million on one of the private placement notes.\nThe Company entered into an agreement in June 1995 (which agreement was amended and restated in August 1995) to sell $100 million of accounts receivable, with limited recourse, to an unrelated financial institution. New qualifying receivables are sold to the financial institution as collections reduce previously sold receivables in order to maintain a balance of $100 million sold receivables. On December 30, 1995, $21.4 million of additional accounts receivable were designated to offset potential obligations under limited recourse provisions; however, historical losses on Company receivables have been substantially less than such additional amount. At December 30, 1995, the implicit interest rate on the receivables sale transaction was 6.31%.\nOperating activities used cash of $57.7 million in 1995 compared to cash provided by operating activities of $80.4 million in 1994. The primary factor contributing to the change in cash used by\noperating activities was a $75.3 million increase in accounts receivable and a $124.3 million increase in inventory, with a portion of these increases financed through a $105.1 million increase in accounts payable. Accounts receivable levels increased due to the increased revenues. The increase in inventory levels was primarily a result of the Company's focus on increasing the availability of products to its customers and the related increase in accounts payable was primarily a result of the Company's efforts to match accounts payable terms better with inventory turns.\nThe Company used $10.3 million in cash to purchase fixtures and equipment and advanced, net of collections, $1.9 million of notes receivable through investing activities in 1995.\nNet cash provided by financing for 1995 totaled $81.2 million, of which $100 million was provided from the sale of accounts receivable. The expended proceeds were used, in part, to reduce long term and short term borrowings by $6.7 million and $13.2 million, respectively.\nThe Company believes the funding expected to be generated from operations and provided by the revolving credit facility will be sufficient to meet working capital and capital investment needs in 1996.\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) and (2) hereof are filed as part of this Annual Report on Form 10-K and are incorporated by reference in this Item 8. See also \"Index to Financial Statements\" on page 21 hereof. Certain quarterly financial data is set forth below.\nDollars in thousands except per share amounts.\n- ------------------------ (1) Includes a charge of $4.2 million or $0.41 per share resulting from non-recurring items.\nThe Company's Common Stock is traded in the over-the-counter market and is quoted on the National Association of Securities Dealers Automated Quotations (\"NASDAQ\") National Market System under the symbol INAC. As of March 1, 1996, the Company estimates there were 4,300 beneficial holders of the Company's Common Stock.\nThe Company has never declared or paid a cash dividend to stockholders. The Board of Directors presently intends to retain all earnings to finance the expansion of the Company's operations and does not expect to authorize cash dividends in the foreseeable future. Any payment of cash dividends in the future will depend upon the Company's earnings, capital requirements and other factors.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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\nExcept for the information relating to the executive officers of the Company set forth in Part I of this Report, the information called for by items 10, 11, 12 and 13 is incorporated herein by reference to the following sections of the Company's Proxy Statement for its Annual Meeting of Stockholders to be held on April 18, 1996: Certain Stockholders; Election of Directors; Directors Meetings and Compensation; Summary Compensation Table; Option Grants in Fiscal Year 1995; Option Exercises in Fiscal 1995 and Fiscal Year-End Values; and Employment, Consulting and Other Agreements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) (2) FINANCIAL STATEMENTS. See index to consolidated financial statements and supporting schedules.\n(a) (3) EXHIBITS. See exhibit index, which index is incorporated herein by reference.\n(b) The Company did not file a report on Form 8-K during the last quarter of the period covered by this report.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors InaCom Corp.:\nWe have audited the accompanying consolidated financial statements of InaCom Corp. and subsidiaries as listed in the accompanying index. 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 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 InaCom Corp. and subsidiaries at December 30, 1995 and December 31, 1994, and the results of their operations and their cash flows for each of the years in the three-year 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in Note 4 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES, IN 1993.\nKPMG PEAT MARWICK LLP \/s\/ KPMG Peat Marwick LLP\nOmaha, Nebraska February 16, 1996\nINACOM CORP. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nAll other schedules have been omitted as the required information is inapplicable or the information is included in the consolidated financial statements or related notes.\nINACOM CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nINACOM CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 30, 1995 AND DECEMBER 31, 1994 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nASSETS\nSee accompanying notes to consolidated financial statements.\nINACOM CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nTHREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nINACOM CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (AMOUNTS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) ORGANIZATION\nThe consolidated financial statements include the accounts of InaCom Corp. (Company) and its wholly-owned subsidiaries. The Company is a leading provider of management technology services which include technology procurement and distribution of microcomputer systems, workstations, networking and telecommunications equipment, systems integration and support services. All significant intercompany balances and transactions have been eliminated in consolidation.\n(B) ACCOUNTS RECEIVABLE\nThe Company entered into an agreement in June 1995 (which agreement was amended and restated in August 1995) to sell $100 million of accounts receivable, with limited recourse, to an unrelated financial institution. New qualifying receivables are sold to the financial institution as collections reduce previously sold receivables in order to maintain a balance of $100 million sold receivables. On December 30, 1995, $21.4 million of additional accounts receivable were designated to offset potential obligations under limited recourse provisions; however, historical losses on Company receivables have been substantially less than such additional amount. At December 30, 1995, the interest rate was 6.31%.\n(C) INVENTORIES\nInventories are stated at the lower of cost (first-in, first-out) or market and consist of computer hardware, software, voice and data equipment and related materials.\n(D) OTHER ASSETS\nOther assets include vendor authorization rights and long-term notes receivable. Vendor authorization rights are being amortized over 10 years.\n(E) COST IN EXCESS OF NET ASSETS OF BUSINESS ACQUIRED\nThe excess of the cost over the carrying value of assets of business acquired is being amortized over 20 years. The Company assesses the recoverability of 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 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.\n(F) DEPRECIATION\nDepreciation is provided over the estimated useful lives of the respective assets ranging from 3 to 31 years using the straight-line method.\n(G) INCOME TAXES\nDeferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. 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.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (H) EARNINGS\/(LOSS) PER COMMON SHARE\nEarnings\/(loss) per share of common stock have been computed on the basis of the weighted average number of shares of common stock outstanding after giving effect to equivalent common shares from dilutive stock options.\n(I) REVENUE AND EXPENSE RECOGNITION\nThe Company recognizes revenue from product sales upon shipment to the customer. Revenues from consulting and other services are recognized as the Company performs the services. Revenues from maintenance and extended warranty agreements are recognized ratably over the term of the agreement. Extended warranty costs are accounted for on an accrual basis and are recognized under the sales method.\n(J) MARKETING DEVELOPMENT FUNDS\nPrimary vendors of the Company provide various incentives for promoting and marketing their product offerings. The funds received are based on the purchases or sales of the vendor's products and are earned through performance of specific marketing programs or upon completion of objectives outlined by the vendors. Funds earned are applied to direct costs or selling, general and administrative expenses depending on the objectives of the program. Funds from the Company's primary vendors typically range from 1% to 3% of purchases.\n(K) RISKS AND UNCERTAINTIES\nFinancial instruments which potentially expose the Company to a concentration of credit risk principally consist of accounts receivable. The Company sells product to a large number of customers in many different industries and geographies. To minimize credit concentration risk, the Company utilizes several financial services organizations which purchase accounts receivable and perform ongoing credit evaluations of its customers' financial conditions.\nThe Company's business is dependent in large measure upon its relationship with key vendors since a substantial portion of the Company's revenue is derived from the sales of the products of such key vendors. Termination of, or a material change to the Company's agreements with these vendors, or a material decrease in the level of marketing development programs offered by manufacturers, or an insufficient or interrupted supply of vendors' product would have a material adverse effect on the Company's business.\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. Actual results could differ from those estimates.\n(L) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL STATEMENTS\nThe carrying amounts for cash and cash equivalents, accounts receivable, accounts payable and notes payable approximates fair value because of the short maturity of these instruments. 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 the Company's current borrowing rate for similar debt instruments of comparable maturity. The estimated fair value of the Company's long-term debt at December 30, 1995 approximate book value.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (M) CASH EQUIVALENTS\nFor purposes of the consolidated statements of cash flows, the Company considers cash and temporary cash investments with a maturity of three months or less to be cash equivalents.\n(2) BUSINESS COMBINATION In February 1993, the Company completed the acquisition of certain assets and operations of the Sears Business Centers (the SBC Acquisition) division from Sears, Roebuck and Co. (Sears). The Company acquired certain fixed assets, inventory and other assets for approximately $3.8 million, and assumed certain liabilities, in a transaction accounted for as a purchase. Certain noncompetition payments are scheduled to Sears for each of the first two years following the closing date. The minimum payment is $1.0 million annually and the Company made the first of the two payments in 1994. The 1995 payment was not made based on offsets claimed by the Company against Sears in pending litigation. Additional payments were also required based on net revenues (as defined in the agreement) and gross margins of the acquired SBC operations, ranging from 1\/2% of such net revenues for gross margins of more than 17.5% up to 1% of such net revenues for gross margins over 20%. The Company was not required to make such payments in either 1995 or 1994 since the required revenue and gross margin targets were not achieved. The excess purchase price over the estimated fair value of the assets was $7.8 million and is being amortized using the straight-line method over 20 years.\n(3) PROPERTY AND EQUIPMENT A summary of property and equipment follows:\n(4) INCOME TAXES Income tax expense (benefit) consists of the following:\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(4) INCOME TAXES (CONTINUED) The reconciliation of the statutory Federal income tax rate and the effective tax rate are as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:\nIn 1993, the Company adopted Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES, and has reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of operations.\nThere was no valuation allowance for deferred tax assets at December 30, 1995 or December 31, 1994.\n(5) NOTES PAYABLE AND LONG-TERM DEBT The Company's primary sources of liquidity are provided through a working capital financing agreement for $350.0 million and $30.3 million in two private placement notes.\nThe Company entered into a working capital financing agreement in June 1995 with a financial services organization and terminated previous revolving credit facilities. The $350.0 million working capital financing agreement expires June 29, 1998. At December 30, 1995, $76.9 million was outstanding under the working capital line and the interest rate based on LIBOR was 7.68%. The working capital financing agreement is secured by accounts receivable and inventory.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(5) NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED) A summary of long-term debt follows:\n- ------------------------ (a) The two private placement notes are held by unaffiliated insurance companies. The remaining principal amount of the first note, $13.3 million, is payable in two annual installments of $6.7 million commencing on May 31, 1996 and bears interest at 10.31% payable quarterly. The principal amount of the second note, $17.0 million, is payable in five annual installments of $3.4 million commencing on February 28, 1997 and bears interest at 6.83% payable quarterly. The notes are secured by accounts receivable and inventory.\nThe working capital and debt agreements contain certain restrictive covenants, including the maintenance of minimum levels of working capital, tangible net worth, fixed charge coverage, limitations on incurring additional indebtedness and restrictions on the amount of net loss that the Company can incur. The Company was in compliance with the covenants contained in the agreements at December 30, 1995.\nThe minimum aggregate maturities of long-term debt are $6.7 million in 1996, $10.0 million in 1997 and $3.4 million in 1998 through 2001.\n(6) COMMON STOCK In May 1993, the Company completed the sale of 1.4 million shares of newly issued common stock in an underwritten public offering at $16.00 per share. The net proceeds to the Company from the sale were approximately $21.2 million.\n(7) CREDIT ARRANGEMENTS The Company has floor plan agreements to take advantage of vendor financing programs. The agreements were secured by $111.9 million of the Company's inventory at December 30, 1995 and $86.0 million at December 31, 1994. The Company has entered into dealer working capital financing agreements with several financial services organizations which purchase, primarily, accounts receivable from the Company. The Company had contingent liabilities of $7.9 million at December 30, 1995 and $3.2 million at December 31, 1994 relating to these agreements.\n(8) LEASES The Company operates in leased premises which include the general offices, warehouse facilities and Company-owned branches. Operating lease terms range from monthly to ten years and generally provide for renewal options.\nRent expense for operating leases was approximately $9.8 million, $8.6 million and $7.0 million for the three years ended December 30, 1995, respectively.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(8) LEASES (CONTINUED) Future minimum operating lease obligations for the years 1996 through 2000 are $7.8 million, $6.6 million, $4.7 million, $3.2 million and $1.8 million, respectively. It is anticipated that leases will be renewed or replaced as they expire such that future lease obligations will approximate rent expense for 1995.\n(9) EMPLOYEE RETIREMENT BENEFIT PLAN The Company maintains a qualified savings plan under Section 401(k) of the Internal Revenue Code which covers substantially all full-time employees. Annual contributions to the qualified plan, based on participant's annual pay, are made by the Company. Participants may also elect to make contributions to the plan. Employee contributions are matched by the Company up to limits prescribed by the Internal Revenue Code. Company contributions to the plan approximated $2.4 million in 1995, $1.8 million in 1994 and $2.0 million in 1993.\nThe Company maintains a nonqualified savings plan for employees whose benefits under the qualified savings plans are reduced because of limitations under Federal tax laws. Contributions made to this plan were not significant.\n(10) LITIGATION The Company is involved in a limited number of legal actions. Management believes that the ultimate resolution of all pending litigation will not have a material adverse effect on the Company's consolidated financial statements.\n(11) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest and income taxes paid are summarized as follows:\nComponents of cash used for acquisitions as reflected in the consolidated statements of cash flows are summarized as follows:\n(12) STOCK OPTION AND AWARD PROGRAMS The Company has two stock plans approved by the shareholders in 1994 and 1990, and a nonqualified stock option plan approved by shareholders in 1987. Options granted under the stock plans may be either nonqualified or incentive stock options. The option price is set by the Compensation Committee of the Board of Directors of the Company but may not be less than the fair market value per share at the time the option is granted, and the term of any option granted may not exceed ten years. The stock plans also permit the issuance of restricted or bonus stock awards by the Compensation Committee. Options granted under the nonqualified stock option plan are for a term not to exceed ten years at a price set by the Compensation Committee but may not be less than the fair market value per share at the time the option is granted. At December 30, 1995, the Company had approximately 132,000 shares available for issuance pursuant to subsequent grants under the plans.\nINACOM CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THREE-YEAR PERIOD ENDED DECEMBER 30, 1995 (COLUMNAR DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(12) STOCK OPTION AND AWARD PROGRAMS (CONTINUED) Additional information as to shares subject to options is as follows:\nSCHEDULE II\nINACOM CORP. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS)\n- ------------------------ (1) The deductions from reserves are net of recoveries.\nSIGNATURES\nPursuant to the requirements of Section 13 or 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, in the City of Omaha, State of Nebraska, on the 22nd day of March, 1996.\nInaCom Corp.\nBy _______\/S\/_BILL L. FAIRFIELD_______ Bill L. Fairfield, 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 InaCom Corp. and in the capacities indicated on the 22nd day of March, 1996.\nINDEX TO EXHIBITS\nPursuant to Item 601(h)(4) of Regulation S-K, certain instruments with respect to the Company's long-term debt are not filed with this Form 10-K. The Company will furnish a copy of such long-term debt agreements to the Securities and Exchange Commission upon request.\nManagement contracts and compensatory plans are set forth as Exhibits 10.4 through 10.15 above.","section_15":""}
{"filename":"771729_1995.txt","cik":"771729","year":"1995","section_1":"Item 1. Business.\nA. GENERAL\nPrecision Standard, Inc. (\"the Company\") is a diversified aerospace company with executive offices in Denver, Colorado. The Company is composed of two operating groups, the Aircraft Maintenance and Modification Group and the Manufacturing and Overhaul Group.\nThe Aircraft Maintenance and Modification Group, which maintains and modifies large transport aircraft for the U.S. and foreign governments and commercial customers, includes the Aeroplex Group of Pemco Aeroplex, Inc. (\"Pemco\" or the \"Aeroplex\") and Pemco World Air Services, A\/S, located in Copenhagen, Denmark. The primary military element of the Aircraft Maintenance and Modification Group is located in Birmingham, Alabama and operates as the Birmingham division of the Aeroplex. The primary commercial element of the Aircraft Maintenance and Modification Group, which operates under the name Pemco World Air Services, includes the Dothan, Alabama division of the Aeroplex and Pemco World Air Services, A\/S.\nThe Manufacturing and Overhaul Group includes the Hayes Targets division of Pemco Aeroplex, Inc., which designs and manufactures aerial target systems for domestic and foreign military customers; Space Vector Corporation, which develops and manufactures rocket launch vehicles and guidance systems for the U.S. Government as well as foreign and commercial customers; Pemco Engineers Aircraft Cargo Systems division, which designs and manufactures aircraft cargo handling systems; Pemco Engineers Springs and Components division, which designs and manufactures precision springs and components; Pemco Air Support Services, Inc. (\"PASS\"), which sells parts for large transport aircraft and provides support of aircraft which have been converted or modified by Company affiliates; and Pemco Nacelle Services, Inc. (\"Nacelle\"), which maintains and overhauls engine nacelles and thrust-reversers for large jet transport aircraft.\nB. SIGNIFICANT DEVELOPMENTS\nConversion of a Boeing 727 to a \"Combi\" Configuration\nThe Company received Federal Aviation Administration (\"FAA\") certification and Transport Canada certification in 1995 for the conversion of a Boeing 727-200 to a configuration that incorporates main deck compartments for both passengers and cargo. The aircraft can be dispatched as a full passenger aircraft, a full freighter or a \"combi\" aircraft, having up to six different combinations of cargo pallets plus corresponding passenger loads. The Company is the first to accomplish a conversion that incorporates a multi- position, passenger and cargo compartment, with variable smoke detection and fire suppression systems. First Air of Ottawa, Ontario, the world's foremost Artic air carrier, was the Company's launch customer for this program.\nAgreement with Bombardier Business Aircraft\nIn the second quarter of 1995, the Company reached an agreement with Bombardier Business Aircraft for the development and marketing of a Cargo Variant (\"CV\") of the Canadair Challenger widebody business jet. Under the terms of the agreement, Pemco World Air Services will design and install the cargo conversions while Canadair will provide the technical documentation and support for the aircraft. Both companies will work to market the Challenger CV and are currently seeking a launch customer for this program.\nLease Renewal of the Company's Birmingham Facility\nThe Company accepted an offer from the Birmingham Airport Authority for a twenty year extension of its lease for the facility located at the Birmingham International Airport. The lease extension offer sets a new expiry date of September 30, 2019 and provides for the release of certain, limited parcels to the Authority but otherwise contains the same terms and conditions as are in effect under the Company's present lease. Formal documentation of this renewal is currently in progress.\nAgreement with San Bernardino International Airport Authority\nIn May of 1995, the Company entered into a memorandum of understanding for the lease of hangar, manufacturing and warehouse space on the former Norton Air Force Base at San Bernardino, California. The memorandum provides for a lease under which approximately 650,000 square feet would be used by the Company as an aircraft maintenance and modification center. The facility would allow the Company to add substantially to its wide-body aircraft maintenance capabilities and broaden the range of military and commercial aircraft that it can service. The parties continue to negotiate appropriate terms under an exclusive option arrangement.\nC. BUSINESS OUTLOOK\nIn general, demand for aircraft maintenance and modification services is increasing. As aircraft operators strive to reduce their operating expenses, both military and commercial operators are looking to independent service providers. These operators are also delaying expensive fleet renewal programs which results in the need to keep aging fleets in flight-worthy condition. For both reasons, signs are positive that the third-party maintenance and modification industry will be the beneficiary of these trends over the next few years.\nMilitary Maintenance and Modification Industry\nThe amount and type of military maintenance and modification work required by the U.S. Armed Services depends primarily upon the nation's national security objectives in view of perceived global political instability. Recently American personnel strength in Europe has decreased from over 500,000 at the height of the Cold War to approximately 100,000 presently. The growing integration of Europe and the rise of new security structures competing with NATO may cause that number to decrease even further in the future. The clear pattern seems to be one of global retrenchment and the inevitable return of most forward deployed forces to the United States.\nHowever, while the U.S. is being compelled by budget cuts and other imperatives to pull back its forces, its vital interests and obligations around the world are not undergoing a corresponding decline. The U.S. still has commitments or vital interests in Europe, the Middle East, throughout the Pacific region, and the Western Hemisphere. Without globally deployed forces close to the scene of potential conflicts, the U.S. must replace withdrawn forward deployed forces with the ability to rapidly re-deploy armament, equipment and supplies to these future trouble spots. This strategic plan depends ultimately on the overall heavy air lift capability of the U.S. Military.\nThis need for immediate rapid deployment of force has insulated the military maintenance and modification industry from many of the effects of the shrinking defense budget. In fact, it can be argued that the budget cuts have actually aided the sector in certain ways. By limiting future expenditures, the military has been unable to initiate programs to replace substantial portions of their aging transport fleets. These aging aircraft require more service than newer aircraft, generating greater revenue for the military maintenance and modification sector of the industry.\nFurthermore, budget cutbacks have forced the military to close a number of its bases and depots. As major repair depots are closed, the military is less capable of maintaining and servicing its aircraft internally. As a result, the military has stated its intention to contract a greater portion of the maintenance and service of its air fleet with the private sector. As a means to reduce overall costs, the military has begun to privatize many of the services that were traditionally provided internally. This too, has expanded the demand for government contract services such as those provided by the Company. Additionally, the Company benefits from its forty-plus years of experience as a systems integrator for both military and commercial customers.\nCommercial Maintenance Industry\nOn the commercial maintenance front, there are many indicators that point to the increasing use of third-party maintenance businesses in the foreseeable future, as airlines continue to search for ways to reduce costs without compromising their competitive edge or reducing profitability. A number of airlines have discovered that the work done by third-party companies is in many instances relatively faster and cheaper, as compared with similar work performed in-house. According to \"Overhaul Maintenance Quarterly, September 1995\", America West contracted approximately 40% of its maintenance in 1994, Continental 44% and industry trendsetter Southwest Airlines contracted 73%.\nMoreover, across the industry, the demand for contract overhaul, maintenance and modification services is escalating. This increased flow has been partially driven by the airlines' reluctance to ramp up their fleet renewal programs. As a result, the airlines are forced to have their aging fleets maintained more frequently to keep them in flight-worthy condition.\nCommercial Modification Industry\nThe rapid increase in worldwide freight movements has spawned a demand for dedicated cargo aircraft. Few companies have the capital to purchase factory new all-cargo aircraft, and thus the majority of air cargo planes have been converted from a pure passenger configuration. Overnight package delivery, a service which has experienced much growth in the last fifteen years in the U.S., is beginning to blossom in Europe. These package carriers are a driving force in commercial modification, and their anticipated success in Europe and elsewhere is expected to increase the demand for cargo conversions.\nAir cargo traffic is forecasted to grow at a rate of approximately (7%) annually through the year 2013 and the number of all-cargo planes is expected to approximately double over the next two decades, increasing the demand for aircraft modification commensurately. Passenger to freighter conversions are typically performed on aircraft which offer high cargo capacity and low capital costs. These include the DC-8, DC-9, DC-10, B-707, B-727, B-747, L-1011 and the BAe-146, making the potential market for this type work quite substantial.\nHowever, new aircraft such as the B-737, B-757 and MD-80, which offer favorable operating and maintenance cost trade-offs, are also attractive candidates for conversion. As an example, passenger-to- quick-change conversions have been performed solely on new or late model B-737 aircraft. The passenger-to-quick-change conversion, which was innovated by the Company, enables the carrier to convert the aircraft from passenger to freighter configuration in approximately thirty minutes, allowing the carrier to supplement its passenger business with cargo operations.\nD. PRINCIPAL PRODUCTS AND SERVICES\nAIRCRAFT MAINTENANCE AND MODIFICATION\nGeneral\nThe Company's aircraft maintenance and modification services include custom airframe design and modification and complete airframe maintenance and repair together with technical publications. A majority of the services are provided under multi- year contracts for both military and commercial customers. The Company's military customers include the United States Armed Forces (\"Armed Forces\") and certain foreign military services. The Company's commercial customers include the major global lessors of aircraft as well as airlines, couriers and air-freight carriers.\nThe Company employs a large skilled work force and a permanent engineering, design and analysis staff. The principal services performed are Programmed Depot Maintenance (\"PDM\"), Scheduled Depot Level Maintenance (\"SDLM\"), commercial C-level and D-level heavy maintenance checks, passenger-to-freighter conversions, passenger- to-quick-change conversions, aircraft stripping and painting, component overhaul, rewiring, parts fabrication and engineering support. Some of these services are performed exclusively for the military while others are performed for the Company's commercial customers; however, most of these services are offered to both customer groups.\nThe Company's competition for military aircraft maintenance contracts includes Boeing Military Aircraft, Aerocorp, Lockheed- Martin Aeromod, Raytheon-E Systems and Chrysler Technologies. The Company's competition for its commercial work in the United States consists of approximately 10 to 15 independent, unlimited repair and modification stations ranging from $10 million to $150 million in annual revenues. However, while many of the Company's domestic competitors tend to specialize on specific portions of the aircraft, the Company focuses on total airframe repair, maintenance and conversion. Outside the United States, the majority of the Company's competitors are affiliated with an airline.\nThe Company considers its competitive strengths to be its product support, proprietary products, engineering and systems integration capability, trained labor force, substantial capacity and strong customer base. Additionally, the Company believes itself to be the first U.S. independent operator to have established a base in Europe. This will allow the Company to expand its relationships with aircraft leasing companies and to offer its conversion products and support capabilities to leasing companies' fleets on two continents simultaneously.\nMilitary Maintenance and Modification\nThe Company provides aircraft maintenance and modification services on a contract basis to the Armed Forces and other agencies of the U.S. Government, as well as foreign military services. The majority of the aircraft that the Company services are large transport planes used to move troops, supplies, equipment and armor, such as the C-130 \"Hercules\", or are logistical in nature, such as the KC-135 in-flight refueling aircraft. These planes provide the Armed Forces with the ability to quickly move troops and forces to areas of conflict. These aircraft are essential to the Armed Forces' \"Global Reach, Global Power\" concept, which places an emphasis on the military's ability to rapidly mobilize its forces and equipment on foreign land when needed. Due to the focus on this new strategy, the Company is confident that these aircraft will remain the military's work horses well into the future. As this role will put tremendous demand and strain on these aircraft, they will continually require the Company's maintenance services.\nMilitary modification and maintenance contracts average three to five years in term. The contracts are originally set for a certain number of aircraft for the duration of the program. In addition to the number of aircraft originally agreed to in the program, the military typically increases this number as aircraft that were not scheduled for maintenance require servicing. These \"drop-in\" aircraft generally increase the value of each contract. The Company has a successful history with the military and expects this history to help it retain the contracts that it currently holds as well as increase the likelihood of securing additional contracts in the future.\nThe principal services performed under military contracts are PDM, SDLM, systems integration and modification of fixed and rotary wing aircraft. The PDM\/SDLM is the most thorough scheduled maintenance \"check-up\" for a military aircraft, entailing a bolt-by-bolt, wire- by-wire and section-by-section examination of the entire aircraft. The process can average up to 148 days per aircraft. The typical PDM program involves a nose to tail inspection and a repair program on a four or five-year cycle. In addition to heavy maintenance, the program can include airframe corrosion prevention and control, rewiring, component overhauls and structural, avionics and various other system modifications.\nPDMs are performed primarily at the Birmingham division of the Aeroplex on a flow-through system. Throughout the duration of the maintenance procedure, the aircraft moves through the facility from one work station to the next. Each station is responsible for certain objectives, and once these tasks are completed, the aircraft is moved to the next bay.\nAt the onset of the PDM, the aircraft is completely defueled and, generally, stripped of paint in an acidic wash. The entire airframe, including the ribbings, skins and wings undergoes a thorough structural examination which can result in modifications to the airframe. The plane's avionics, which essentially are the electronics that control the flight of the aircraft, receive examination and repair or modification as required. At the completion of the overhaul, the aircraft is repainted.\nIn order for the Company to efficiently complete its maintenance procedures, it maintains hydraulics, sheet metal and machine shops to satisfy all of its hydraulic testing and assembly needs and to fabricate, repair and restore parts and components for aircraft structural modification. The Company also performs in-house heat- treatment on alloys used in aircraft modifications and repairs and has complete non-destructive testing capabilities and test laboratories.\nThe Company's skilled work force and engineering staff are familiar with all aspects of aerodynamics, propulsion, fluid mechanics, flight operations, fuel and induction systems, controls, communications, radar, instrumentation and support research and development functions.\nThe Company has provided quality maintenance, integration and modification work on a wide variety of military aircraft over the past 45 years, including C-130, KC-135, C-9, P-3, T-34, A-10,,,, T-38 and U.S. Navy H-2 and H-3 helicopters.\nKC-135 Aircraft Contract\nThe KC-135 is a United States Air Force (\"USAF\") tanker aircraft which is used primarily for the in-flight refueling of combat and combat-support aircraft. Currently, the U.S. KC-135 tanker fleet is understood to number in the hundreds, and the aircraft is projected to be serviceable through 2030.\nIn August of 1994, the USAF awarded the Company a new contract for the PDM of its KC-135 aircraft. The contract is expected to last seven years and involve the maintenance of as many as 389 aircraft. The KC-135 PDM program involves a nose to tail inspection and repair program on a scheduled five-year cycle. The funding approved by the USAF under the first year of the contract is projected to be $54.9 million and $49.0 million has been awarded under the second year of the contract. The total value of the contract over a seven year period, if fully funded, is expected to be over $307.0 million. The Company first performed PDM on the KC- 135 in 1968 and has since processed 2,067 such aircraft.\nIn addition to the KC-135 PDM maintenance contract, the USAF also awarded the Company a KC-135 battery system modification contract in August 1995. As the USAF continues to upgrade and modernize the KC-135 fleet to ensure its viability through 2030, the KC-135 PDM program is anticipated to further expand to include additional upgrades such as new cockpit and avionics systems. The Company has performed other major upgrades in the past including wing re-skin, major re-wire, corrosion prevention control and flight director, auto pilot and fuel savings advisory system modifications.\nC-130 Aircraft Contract\nThe C-130 is a four-engine, turboprop all-purpose military transport and utility cargo aircraft. The aircraft has been built by Lockheed since the mid-1950's and is still in production. The current U.S. C-130 fleet is also understood to number in the hundreds, and the aircraft is also projected to be serviceable through 2030.\nIn 1991, the USAF awarded the Company a five year contract for the PDM of its C-130 aircraft. The PDM program involves a nose to tail inspection and repair program on a four-year cycle. The contract expires in 1996, at which time the Company intends to vigorously pursue its re-award. However, the government's re-bid process is behind schedule which will likely result in the current contract being extended through early 1997. The new contract is expected to run for five years and will potentially involve 40 aircraft per year versus an average of 12 aircraft under the current contract. The increase in aircraft is anticipated due to depot closures and the repatriation of work from foreign depots.\nThe Company has held the C-130 contract for approximately 30 years and has provided service to approximately 1,844 aircraft.\nH-3 Helicopter Contract\nThe H-3 helicopter is a utility, search and rescue, anti-submarine warfare and VIP transport helicopter. The helicopter was built by Sikorsky and is projected to be serviceable through 2010.\nIn 1994, the Navy awarded the Company a five year contract for SDLM work of its H-3 aircraft. This contract is for a nose to tail inspection and repair program on a four-year cycle. The Navy input only two aircraft in the first year of the contract, the contract minimum number. The Navy was still performing in-house SDLM work during the first year of the contract, prior to its closing the Naval Aviation Depot in Pensacola, Florida. The Company anticipates working eleven aircraft in the second year of the contract.\nCommercial Aircraft Maintenance and Modification\nThe Company provides commercial aircraft maintenance and modification services on a contract basis to both the owners and operators of large commercial transport aircraft (i.e. leasing companies, banks, airlines, air cargo carriers). Contracts for commercial maintenance can range from the single aircraft which might be in-house for a few days, to multi-plane efforts that can span a year or longer. Modification contracts involve greater effort per aircraft and often involve multiple units which range in term from six months to three years. The principal services performed under commercial maintenance and modification contracts are \"C\" and \"D\" checks, which are similar to the PDM and SDLM programs performed by the Company for military aircraft, passenger- to-freighter conversions, passenger-to-quick-change conversions, combination passenger and freighter conversions (combi), and strip and paint.\nThe \"C\" check is an intermediate level service inspection that, depending upon the FAA approved maintenance program being used, includes systems operational tests, thorough exterior cleaning, and cursory interior cleaning and servicing. It also includes engine and operation systems lubrication and filter servicing. Visual inspection of the external structure and the internal structure through access panels is part of the \"C\" check. The normal intervals between \"C\" checks can be as little as 1,000 flight hours and as many as 5,000 flight hours, depending upon the type of aircraft and the requirements of the operator's approved FAA maintenance program.\nThe \"D\" check requires a more intense inspection. The \"D\" check includes all of the work accomplished in the \"C\" check but places a more detailed emphasis on the integrity of the systems and structural functions. In the \"D\" check, the aircraft is disassembled to the point where the whole structure can be inspected and tested. Once the structure has been inspected and repaired, the aircraft and its various systems are reassembled to the detailed tolerances demanded in each system's functional test series. The normal intervals between \"D\" checks can be as little as 10,000 flight hours and as many as 25,000 flight hours, depending upon the type of aircraft and the requirements of the approved FAA maintenance program.\nThe form, function and interval of the \"C\" and \"D\" check is different with each operator's program. Each operator must have their particular maintenance program approved by the FAA and there are a number of variables which dictate the final form of a given program. Those variables include the age of the aircraft, the environment in which the aircraft flies, the number of hours that the aircraft regularly flies, the number of take-offs and landings (called flight cycles) that the aircraft regularly endures and the technical abilities of the entities performing the maintenance. In particular, flight cycles can effect the intervals required for major components to be changed or overhauled, thus effecting the amount of work required during any given check.\nIn addition to the tasks required in the \"C\" and \"D\" check, there are other associated tasks that are accomplished with these checks. There are structural inspections, which focus on known problem areas, that are required by the manufacturers. These are called Supplemental Structure Inspections (SSI). With the recent institution of the Aging Aircraft Programs by the manufacturers, there are also inspection programs for areas of known corrosion problems that are called Corrosion Prevention and Control Programs (\"CPCP\"). These additional inspections supplement and, in some cases, overlay the \"C\" and \"D\" check tasks.\nThe process of converting a passenger plane to freighter configuration entails completely stripping the interior; strengthening the load-bearing capacity of the flooring; installing the bulkhead or cargo net; cutting into the fuselage for the installation of a large cargo door; reinforcing the surrounding structures for the new door; replacing windows with metal plugs; and fabricating and installing the cargo door itself. The aircraft interior may also need to be lined to protect cabin walls from pallet damage, the air conditioning system modified and smoke detection system installed. Additionally, the Company installs the on-board cargo handling system. Conversion contracts also typically require \"C\" or \"D\" maintenance checks as these converted aircraft have often been out of service for some time and maintenance is required to bring the plane up to current FAA standards. In addition, while the conversion and maintenance work is being completed, many aircraft are fitted with hush-kits to enable their engines to comply with FAA noise regulations.\nThe Company also regularly provides other modification and integration services for its commercial customers under its own or customer-provided Supplementary Type Certificates (\"STC\") including integration of new avionics systems, installation of new galleys and airstairs and reconfiguration of interior layouts and seating. The Company believes that its facilities, tooling, engineering capabilities and experienced labor force enable it to perform virtually any air frame modification a commercial customer may require.\nContracts for commercial aircraft are performed primarily at the Dothan division of the Aeroplex and Pemco World Air Services, A\/S in Copenhagen, Denmark. The commercial aircraft are typically docked and serviced in one bay for the duration of their particular program.\nThe Company has performed maintenance work on a wide variety of commercial aircraft and has approximately a 40% share of the after- market cargo conversion business for large transport aircraft. The Company has converted over 130 Boeing 727s, 29 BAe-146s, and 33 Boeing 737's.\nThe Company holds STCs from the FAA for the conversion of various aircraft from passenger-to-freighter, passenger-to-quick-change, and combination passenger and freighter conversions. Each type of aircraft is certified by the FAA under a specific certificate. Subsequent modifications to the aircraft require the review, flight-testing and approval of the FAA and are then certified by an additional STC. The Company holds passenger-to-freighter configuration STCs for the conversion of Boeing 727-100, 727-200, 737-200, 737-300, and 747 aircraft, C-9 aircraft, and BAe-146 aircraft. Additionally, the Company holds a passenger-to-quick- change configuration STC for the conversion of Boeing 737-300 aircraft and a combi configuration STC for the conversion of Boeing 727 aircraft.\nSUPERSONIC AND SUBSONIC AERIAL TOW TARGETS AND WING TIP INFRARED PODS\nThe Company designs and manufactures supersonic and subsonic aerial tow targets and wing tip infrared pods. The family of low cost, high speed targets is known as the Hayes Universal Tow Target System (HUTTS). The targets can be flown from any commercial or military aircraft capable of carrying external stores as well as from most drone aircraft. The targets are available in various detection configurations: 1) visual smoke 2) visual light 3) infrared (simulates a jet aircraft engine) 4) radar and 5) visual fiber streamer. A maneuvering tow target and a low altitude sea-skimming target are also available in each of the above configurations. The various targets and equipment associated with the HUTTS are fully-developed and operational in the U.S. military services and in the services of many foreign countries.\nThe infrared wing tip pods are utilized on sub and full scale drones or droned excess military aircraft. Hayes Targets has supplied 100% of infrared augmentation for the U.S. Air Force for the last 21 years. Hayes Targets is presently designated as an Air Force \"Blue Ribbon Contractor\".\nThe targets and pods are produced by the Company's Hayes Targets division at Leeds, Alabama. The principal markets for the targets are the U.S. armed forces as well as markets in Europe, the Middle East, Australia and South America. The Company's competition consists of one competitor on the west coast of the United States and two foreign entities. The Company considers its competitive strength in this market to be its patented and proprietary products, its superior product performance and its innovative engineering capabilities.\nSPACE VEHICLES AND SUPPORT SYSTEMS\nThe Company maintains a large research, development and engineering staff dedicated to the design and manufacture of space related systems such as sounding rockets, launch vehicles, guidance and control subsystems, vehicle structures and recovery systems. The staff serves in the capacity of a subcontractor on most of the large U.S. Government Department of Defense programs with which it is involved. The staff has prime contracts with NASA in support of space science and does a limited amount of commercial space work.\nThe Company's largest current contract in this arena is the HERA program which will provide realistic ballistic targets for Theater Missile Defense (TMD) interceptor deployment. The HERA program, initiated in 1992, provides for twenty-five target vehicles to be utilized during interceptor testing of various TMD systems through the year 1997. Options to provide an additional fifty target vehicles to continue Army testing and to accommodate Air Force and Navy TMD missions through the year 2000 are part of the long-range HERA program. The Company successfully completed its third HERA test flight in February, 1996 and is well positioned to support the upcoming intercept tests for the Theater High Altitude Area Defense missile and radar system. The HERA program is sponsored by the U.S. Army Space and Strategic Defense Command. Its contractor team is comprised of Coleman Research Corporation as the system prime contractor, Space Vector Corporation as the booster subcontractor, and Aerotherm Corporation as the ballistic reentry target subcontractor.\nThis product line is produced by the Company's Space Vector subsidiary, which is located at Chatsworth, California with a satellite office at Fountain Valley, California. The Company's principal markets for its space and missile products are the U.S. Government, prime contractors to the U.S. Government, and the scientific community in general. The Company's competition ranges from very small organizations for the component subsystems to major corporations for the design and manufacture of spacecraft and launch vehicles. The Company considers its competitive strength to be its technical and managerial competence. The Company's contracts are awarded in accordance with the government's competitive bidding practices.\nCARGO HANDLING SYSTEMS\nThe Company designs and manufactures on-board cargo-handling systems for all types of large transport aircraft, including B-747, B-727, B-737, DC-8, DC-9\/C-9B, DC-10\/KC-10, L-1011, L-100 and L-188, and certain other military aircraft. Robotics and fully-computerized machinery are used to produce a wide variety of aircraft cargo handling systems as well as individual parts used in the Company's proprietary systems and in other systems. These cargo systems represent state-of-the-art technology in their design, efficient use of floor space and maximum strength, with a minimum of added weight. The systems meet all of the FAA and JAA Quality Assurance Standards, MIL-I and MIL-Q qualifications as required.\nThis product line is produced by the Company's Pemco Engineers Aircraft Cargo Systems division located at Corona, California. The Company's principal markets for the cargo handling system are all major United States and foreign airlines and aircraft manufacturers. The Company has approximately eight competitors and considers its strength in this industry to be its innovation, quality and response time.\nPRECISION SPRINGS AND COMPONENTS\nThe Company manufactures precision springs and components and employs custom design, tooling and precision stamping in the production of these high tolerance parts. The springs and components are used in a variety of industrial, commercial and residential applications.\nThis product line is produced by the Company's Pemco Engineers Springs and Components division. This division is also located at Corona, California and shares state-of-the-art equipment with Pemco Engineers Aircraft Cargo System division. The Company markets its precision springs and components to a wide range of manufacturers in numerous industries. There are approximately 500 manufacturers of springs and components in the United States making it a $1 billion industry. The Company's competitors range in size from \"single-machine\" shops to companies with revenues exceeding $20 million. Most of the competitors, however, produce a broader mix of products while the Company focuses on the manufacture of precision springs and components.\nPARTS SUPPORT AND COMPONENT OVERHAULS\nThe Company's Parts Support and Component Overhaul service provides a comprehensive source for aircraft spares and component overhauls. The Company uses its inventory and on-line tracking and sales system to provide support to the cargo conversion customers of Pemco World Air Services as well as to users and owners of a wide range of commercial and military aircraft. This service provides the Company with the capability of locating spare parts for its customers virtually anywhere in the world, an inventory of critical spare parts for the Company's conversion programs and 24 hour \"Aircraft on Ground\" service.\nThis service is provided by Pemco Air Support Services, Inc. (\"PASS\"). PASS has three locations. PASS facilities at Denver, Colorado and Clearwater, Florida serve North and South America as well as the Pacific Rim. The PASS facility in Copenhagen, Denmark serves Europe, Africa, and the Middle East. The Company markets its parts support and component overhaul service to commercial carriers worldwide as well as to foreign armed services.\nIn the area of supporting and selling the Company's designed and manufactured parts, the Company often benefits from a captive market situation. In the second area of competition, which is the brokerage of non-proprietary parts, the industry is comprised of several large companies and as many as a thousand smaller companies. While the Company is still a small player in this market segment, its goal is to market quality products that interest the users of the Company's products, thus creating a sales synergy. To this end, the Company has obtained several European distributorships for U.S. based companies and expects to increase the number of distributorships to 15-20 over the next few years. Its future market strength will depend on the Company's ability to create innovative pricing structures, provide higher quality service and the acquisition of parts inventories or teaming arrangements upon beneficial terms.\nNACELLE OVERHAUL AND REPAIR\nThe Nacelle Overhaul and Repair service provides a comprehensive source for the overhaul, repair and modification to nacelles and thrust reversers for engines supplied by General Electric, Pratt & Whitney and Rolls-Royce.\nThis service is provided by Pemco Nacelle Services, Inc. which is located at Clearwater, Florida. The Company markets its nacelle overhaul and repair service to commercial carriers worldwide and supports turbofan-powered aircraft manufactured by Airbus, Boeing and McDonnell Douglas. There are approximately five competitors in the United States and abroad. The Company entered this line of business in March of 1993 and is building its competitive strength on turnaround time, the convenience of customer exchange in lieu of repair, quality, and price.\nE. RESEARCH AND DEVELOPMENT\nThe Company charged the cost it incurred for company sponsored research and development costs, which totalled $0.5 million in 1995, $0.8 million in 1994 and $0.4 million in 1993 directly to earnings. The research and development activities in 1995 were principally in support of the Company's aircraft and Targets programs. In 1996, research and development costs are expected to be in the $0.5 to $1.0 million range, principally in support of the same programs. The Company was not engaged in any customer sponsored research and development efforts in 1993, 1994, or 1995.\nF. SALES\nForeign and Domestic Operations and Export Sales\nThe majority of the Company's revenues were generated in the United States and the majority of the Company's assets are located in the United States. The Company has two foreign operations, Pemco World Air Services, A\/S, which is registered as a Danish limited liability company and Pemco Air Support Services, which is registered as a Danish branch of a U.S. company. These foreign operations contributed less than six percent of the Company's consolidated revenue in 1995 and own less than five percent of the Company's identifiable consolidated assets.\nThe Company provides maintenance and modification services to foreign-based aircraft owners and operators at its U.S. facilities and its Copenhagen, Denmark facility. The Company's Targets, Space Vector, Nacelle and Aircraft Cargo Systems divisions also sell in export markets. The services and products sold at the Company's U.S. locations are payable only in U.S. dollars. The Company's Copenhagen locations accept payments in Danish kroner and U.S. dollars, as well as other foreign currencies.\nThe following table presents the percentages of total sales for each principal product and service rendered for the last three fiscal years and the percentage of export sales for the last three fiscal years. (See also footnote number 13 to the accompanying financial statements of the Company which are included under Item 8 hereof):\nMajor Customers\nG. BACKLOG\nAs of December 31, 1995, 89% of the Company's backlog was for the U.S. Government versus 65% for the period ending December 31, 1994. The Company's U.S. Government backlog increased primarily due to an increase in backlog under the Company's KC-135 contract. In September of 1995, the U.S. Air Force exercised its option for the second year of a seven year contract for KC-135 PDM aircraft. The Company's KC-135 backlog at December 31, 1995 was $91.0 million versus $79.8 million in 1994. Also in September of 1995, the U.S. Air Force exercised its option for the fifth and final year of its contract for C-130 PDM aircraft. The Company's C-130 backlog at the end of 1995 was $10.4 million versus $13.5 million in 1994. Other changes in the Company's U.S. Government backlog include an increase of $2.4 million for the targets product line, an increase of $3.1 million associated with the H-3 Helicopter contract, and an increase of $0.7 million under the Company's HERA contract.\nThe Company's commercial backlog at December 31, 1995 changed from prior year primarily due to a reduction of $38.5 million under the Company's 737 cargo conversion program. Approximately $11.3 million is due to revenues recognized over the past twelve months. The Company believes at least some of these ships eventually will be converted under new or renegotiated contracts. Other changes in the Company's commercial backlog include an increase of $2.1 million of backlog at the Company's Copenhagen facility, offset by a $7.8 million decrease in 727 cargo conversion backlog. Approximately $27.2 million of the reduction is due to the elimination of assumed option ships, some of which were under contracts that have expired.\nApproximately $8.9 million of commercial backlog at December 31, 1995 (compared to $27.2 million at December 31, 1994) may not be considered firm orders because it pertains to maintenance and modification work to be performed under contracts that are approaching their expiry. Additionally, the Company has approximately $203 million of firm but unfunded backlog associated with the five follow-on years of the KC-135 contract, which is not included in the figures cited above. Approximately $99.8 million of the December 31, 1995 backlog is expected to be filled in 1996.\nH. RAW MATERIALS\nThe Company purchases a variety of raw materials including aluminum sheets and plates, extrusion, alloy steel and forgings. Excepting as noted below, the Company experienced no significant shortages of raw material essential to its business during 1995 and does not anticipate any shortages of critical commodities over the longer term; although, this is difficult to assess because many factors causing such possible shortages are outside its control.\nThe Company procures many components, parts and equipment items from various domestic companies. The Company faces some dependence on suppliers for certain types of parts involving highly technical processes; however, this risk has lessened in the past few years as additional high technology suppliers have entered the market. The Company does not believe this dependence has significance for its business as a whole; rather, any adverse consequence that might result from the failure of a sole supplier to provide a particular part would be felt on an individual contract basis.\nA significant portion of the equipment and components used by the Company in the fulfillment of its services under United States Government contracts is furnished without charge to the Company by the U.S. Government. The Company is dependent upon U.S. Government furnished material to meet delivery schedules, and untimely receipt of such material adversely affects production schedules and contract profitability. The Company has encountered late delivery of Government-Furnished Material (GFM) in 1993, 1994, 1995 and 1996 and as a result, has experienced a disruption in scheduled work flow.\nOne example of late GFM is the government's failure to provide the Company with production break fittings that are used in the performance of the KC-135 PDM contract. Late availability of parts caused the average production time required per KC-135 to increase substantially. The disruption and subsequent acceleration impacts on the Company's production line which resulted from these parts shortages negatively impacted the profitability of the contract from 1993-1995. The Company requested equitable adjustment of approximately $10.3 million to compensate it for some of the costs caused by the delay. In February 1996, the Company received $7.7 million plus $0.4 million in related interest in a negotiated settlement with the government. The Company and the government are working on ways to minimize the likelihood of a repetition of such delays in the future, but there can be no assurance that such delays will not recur. The Company anticipates submitting one or more additional Requests for Equitable Adjustment (REAs) to cover other cost impacts of late GFM not included in the REA settled in February of 1996. (See Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations under the heading \"KC-135 Contract\" for a detailed discussion.)\nI. PATENTS, TRADEMARKS, COPYRIGHTS AND STCs\nThe Company holds 50 FAA-issued Supplementary Type Certificates (STCs) which authorize it to perform certain modifications to aircraft. These modifications include air-stair installation and the conversion of commercial aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. The STCs are applicable to Boeing 707, 727, 737, 747, Douglas DC-6, DC-8, DC-9, BAe-146 and Convair 580 Series Aircraft. The Company also holds 21 STCs related to its cargo handling systems for various types of large transport aircraft. STCs are not patentable; rather, they indicate a procedure that is acceptable to the FAA to perform a given air-worthiness modification.\nThe Company also holds FAA-issued Parts Manufacturing Approvals (PMAs) which give it authorization to manufacture parts of its own design or that of other manufacturers related to its cargo handling system. The Company holds numerous other PMAs which give the Company authority to manufacture certain parts used in the conversion of aircraft from passenger-to-freighter and passenger- to-Quick Change configurations.\nThe Company holds two active utility patents and three active design patents related to the Hayes Targets product line. Three of the patents (one utility expiring in 2001 and two designs expiring in 1998) concern infrared augmentation. The second utility patent is a British patent (expiring in 1997) and concerns visual augmentation. The remaining design patent (expiring in 1998) concerns a portable ground scoring unit developed for the purpose of scoring ground-based target emplacements on ground-to-air gunnery ranges. All of the patents except the British patent are U.S. patents. The Company does not believe that the expiration or invalidation of any or all of these patents would have a material adverse impact upon its financial condition.\nThe Company holds copyrights to the computer software developed in-house for the operation of the Power Drive Unit System and Cargo Door Electro-Mechanical System used in the conversion of commercial aircraft, as well as copyrights to the software for the development of the control computer codes for the TLX-1 sea-skimming, height-keeping tow target, and the TMX class maneuvering target. These copyrights are not registered and will begin to expire after the year 2028.\nThe Company firmly believes that the value of its patents, trademarks, copyrights and STCs exceed the amounts of its related intangibles and deferred inventory.\nJ. ENVIRONMENTAL COMPLIANCE\nThe Company has requirements to comply with environmental regulations at the federal, state and local levels. These requirements apply especially to the stripping, cleaning and painting of aircraft. The requirements to comply with environmental regulations have not had, and are not expected to have, a material effect on the Company's capital expenditures, earnings and competitive position.\nThe Company has been designated as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. It is difficult to estimate the total cleanup costs and to predict the method that will be used to allocate such costs among the responsible parties. However, based upon presently known facts, the Company does not believe that the resolution of this matter will have a material adverse effect on the Company's financial position, results of operations or cash flows.\nK. EMPLOYEES\nAt February 29, 1996, the Company employed approximately 2,012 persons, of whom approximately 1,395 were covered by collective bargaining agreements. Approximately 20 of these employees are employed on a part-time basis.\nThe two primary collective bargaining agreements are with the International Association of Machinists at the Company's Dothan, Alabama location and the United Auto Workers at the Company's Birmingham, Alabama and Leeds, Alabama locations.\nThe collective bargaining agreement with the International Association of Machinists was successfully negotiated without a work stoppage in August of 1992 and was extended for five years to August 1997. The collective bargaining agreement with the United Auto Workers was successfully negotiated without a work stoppage in July of 1993 and was extended for three years to July of 1996. Good relations continue between labor and management at each of the facilities.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAll of the Company's properties are generally well maintained and in good operating condition. All facilities were adequately utilized during 1995 except the Company's Clearwater, Florida facility. The Company suspended aircraft maintenance operations in Clearwater during the second quarter of 1994 in order to adjust its overall staffing to anticipated work levels. The Company continued, however, to operate the PASS aircraft parts distribution center at the Clearwater facility. In the second quarter of 1995, the Company relocated Pemco Nacelle Services to the Clearwater facility in an effort to accommodate the current and anticipated needs of Nacelle. The relocation of Nacelle to Clearwater increased the utilization of the Clearwater facility but did not bring it to a level of full utility.\nPemco World Air Services Marketing Offices and Precision Standard, Inc. Executive Offices - Denver, Colorado\nPemco World Air Services relocated its marketing staff to Denver, Colorado from Birmingham, Alabama in the first quarter of 1995 and Precision Standard, Inc. established executive offices at the same location later in 1995. The lease for this office space expires in May, 2001.\nPemco Aeroplex, Inc. - Birmingham, Alabama\nThe Birmingham division of the Aeroplex is located at the Birmingham International Airport, at Birmingham, Alabama. The facility is located on 208 acres of land with approximately 1,935,000 square feet of production and administrative floor space. The facility includes ten flow-through bays, each 40 feet high, 160 feet wide and 725 feet long, permitting continual production line operation. The facility also includes a number of ancillary buildings such as a paint hangar, a shipping and receiving warehouse, a wing rehabilitation shop, a sheet metal shop and a 54,904 square foot general office building which houses the Aeroplex administrative staff. Available ramp area exceeding 3,000,000 square feet is adjacent to the municipal airport runways. Additionally, the facility operates a control tower which supplements the FAA-managed municipal air control tower and a fire fighting unit which supplements fire fighting equipment operated by both the City of Birmingham and the Alabama Air National Guard.\nThe Birmingham facility is in every material respect a complete aircraft modification and maintenance center. The facility is an approved FAA and JAA Repair Station and maintains Department of Defense \"SECRET\" security clearance.\nThe facility is leased from the Birmingham Airport Authority. During 1995, the Company accepted an offer from the Birmingham Airport Authority for a twenty year extension of its lease for the facility. The lease extension offer sets a new expiry date of September 30, 2019 and provides for the release of certain, limited parcels to the Authority but otherwise contains the same terms and conditions as are currently in effect under Pemco's present lease. Formal documentation of this renewal is currently in progress.\nPemco Aeroplex, Inc. - Dothan, Alabama\nThe Dothan division of the Aeroplex is located at the Dothan Municipal Airport, at Dothan, Alabama. The facility is located on 91.5 acres of land with approximately 521,000 square feet of production and administrative floor space. The facility includes 352,000 square feet of aircraft hangar space which is comprised of 13 bays and one wide-body aircraft hangar. The facility also includes four warehouses, two paint hangars, support shops and 26,000 square feet of administrative offices. The facility has 850,000 square feet of aircraft flight line and parking ramp space and is served by an airport consisting of two runways of 5,600 and 8,500 feet, a FAA Flight Service Station and a control tower.\nThe facility is leased from the Dothan\/Houston County Airport Authority under a lease agreement which, inclusive of a five year option period, expires in June of 2015.\nPemco World Air Services A\/S - Copenhagen, Denmark\nPemco World Air Services, A\/S is located at the Copenhagen Airport. The facility is located on 87 acres of land with approximately 252,000 square feet of production and administrative floor space. The facility was built in 1988 and has two large, modern hangars comprised of four bays. The hangars can accommodate DC10\/MD11- sized aircraft and are equipped with overhead work platforms. Each hangar also includes stockroom, backshop and office space. The JAA and FAA approved facility has 103,300 square feet of ramp space and is served by an airport consisting of three runways.\nThe facility is leased from the bankruptcy estate of Sterling Airways under a five year lease agreement that includes a purchase option at the end of the lease term. The five year lease expires in May of 1999.\nThe Clearwater Facility\nThe Company's Clearwater facility is located at the St. Petersburg\/Clearwater International Airport at Clearwater, Florida. The facility is located on 22 acres of land with approximately 133,000 square feet of production and administrative floor space. The facility includes 2 bays of approximately 92,000 square feet as well as supply and support shops and administrative offices. The facility has 782,000 square feet of ramp space and is served by airport facilities consisting of five runways (from 4,000 to 8,500 feet), a FAA Flight Service Station and a control tower. The facility houses Pemco Nacelle Services, Inc. and administrative staff of PASS. PASS also utilizes a warehouse at the Clearwater facility.\nThe facility is leased from Pinellas County, a political subdivision of the State of Florida, under a lease agreement that expires in September 2000, exclusive of four optional renewal periods of five years each which would extend the lease until September 2020.\nThe Targets Division\nThe Targets division is located at Leeds, Alabama. The facility is located on 4 acres of land and consists of one metal building with approximately 32,000 square feet of manufacturing and office floor space. The Targets division occupies this building under a lease agreement which, inclusive of a twelve year option period, expires in December of 2006.\nPemco Nacelle Services, Inc.\nPemco Nacelle Services is located at the Clearwater, Florida facility (see description under \"The Clearwater Facility\").\nSpace Vector Corporation\nSpace Vector Corporation is located at Chatsworth, California. The Company relocated its operations in February, 1994 due to irreparable earthquake damage to the buildings it had been leasing previously. The new location is in close proximity of its former Chatsworth location and consists of two industrial buildings of approximately 67,000 square feet. Space Vector Corporation occupies these buildings under a lease agreement which expires in April, 1999.\nSpace Vector also leases a 3,400 square foot research and development and administrative office in Fountain Valley, California. This lease expires in October of 1997.\nPemco Engineers Aircraft Cargo Systems and Springs and Components Divisions\nPemco Engineers is located at Corona, California. The facility consists of 28,000 square feet of production and administrative floor space. The facility is under a lease agreement which, inclusive of a five year option period, expires in December of 2001.\nPemco Air Support Services (PASS)\nPASS has three locations: administrative offices at the Denver, Colorado location, a warehouse at the Clearwater facility, and administrative offices and a warehouse at the Pemco World Air Services A\/S facility in Copenhagen, Denmark.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nVarious claims of employment discrimination, including race, sex, age and disability, have been made against the Company's subsidiary, Pemco Aeroplex, Inc., in proceedings before the Equal Employment Opportunity Commission and, in some cases, in U.S. District Court in Alabama by several current and former employees at its Birmingham, Alabama and Dothan, Alabama facilities. The Company is also defending several workers compensation claims brought by employees in Alabama state court. The Company believes that these claims, no one of which is material to the Company as a whole, are more reflective of the general increase in employment related litigation in the U.S. and in Alabama than of any actual discriminatory employment practices by the Company. The Company believes that these claims have no merit and intends to vigorously defend itself in all litigation arising therefrom.\nThe Company is also a party to other, non-employee related litigation, the results of which are not expected to be material to the Company's financial condition.\nThe Company has been designated as a potentially responsible party under The Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. See Item 1. Business, Environmental Compliance, for further disclosure.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted for a vote of the Company's shareholders in the fourth quarter of fiscal 1995.\nItem 5.","section_5":"Item 5. Market for Company's Common Equity and Related Stockholder Matters.\nThe Company's common stock trades on The NASDAQ National Market System under the symbol \"PCSN.\" Approximately 67% of the outstanding shares of the Company's common stock is held by Matthew L. Gold, the Company's Chairman, President and Chief Executive Officer.\nThe following table sets forth what the Company believes to be the range of high and low bid quotations for its common stock on a quarterly basis for each of the Company's last two fiscal years. Quotations represent prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.\nOn December 31, 1995, there were 12,793,215 shares of common stock issued. There are 12,455,955 shares outstanding held by 230 owners of record, which the Company believes were held by more than 500 beneficial owners. The Company also granted a warrant to its primary lender in connection with its Senior Subordinated Loan to purchase 4,215,753 shares of the Company's common stock at an exercise price of approximately $.24 per share. The warrants have not been exercised and expire on September 9, 2000.\nThe Company has never paid cash dividends on its common stock and currently intends to continue its policy of retaining all of its earnings for use in its business.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations.\nINTRODUCTION\nThe following discussion should be read in conjunction with the Company's consolidated financial statements and notes thereto included herein as Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplemental Data.\nThe following financial statements and financial statement schedules are submitted herewith:\nFinancial Statements:\nReports of Independent Accountants\nConsolidated Balance Sheets\nConsolidated Statements of Operations\nConsolidated Statements of Stockholder's Equity\nConsolidated Statements of Cash Flow\nNotes to Consolidated Financial Statements\nFinancial Statement Schedules:\nReport of Independent Accountants\nSchedule II - Amounts Receivable From Related Parties, and Underwriters, Promoters and Employees Other Than Related Parties\nSchedule II - Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders Precision Standard, Inc.\nWe have audited the accompanying consolidated balance sheets of Precision Standard, Inc. and Subsidiaries as of December 31, 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Precision Standard, Inc. and Subsidiaries as of December 31, 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 1, 9 and 11 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes and certain postretirement benefits.\nCOOPERS & LYBRAND L.L.P.\nBirmingham, Alabama March 31, 1996, except for Notes 6 and 7 as to which the date is April 15, 1996\nPRECISION STANDARD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION, OPERATIONS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Operations - Precision Standard, Inc. (the Company) is primarily engaged in the maintenance and modification of large transport aircraft; the design, development, and manufacture of aerial target systems; the development and manufacture of rocket launch vehicles and guidance systems; the design and manufacture of cargo handling systems; and the manufacture of precision springs and components.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.\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. Actual results could differ from those estimates.\nContract Accounting - The Company recognizes revenue on aircraft and aerial target system programs principally under the percentage-of-completion method of accounting, using an output measure of progress, units of delivery for contracts with provisions for multiple deliveries, and an input measure by which the extent of progress is measured by the ratio of cost incurred to date to the estimated total cost of the contract (cost to cost) for contracts which the units of delivery method is not appropriate. The Company's contracts for its rocket launch vehicles and guidance systems are primarily cost reimbursement contracts. As such, revenues are recorded as costs are incurred and as fees are earned. Provision is made to recognize estimated losses in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.\nInventories - Materials and supplies are stated at the lower of average cost or market (replacement cost). Work in process includes materials, direct labor, manufacturing overhead, and other indirect costs incurred under each contract, less progress payments, amounts in excess of estimated realizable value, and amounts charged to cost of goods sold on units delivered or progress completed. Inventoried costs on long- term commercial programs and U.S. Government fixed price contracts include direct engineering, production and tooling costs, and applicable overhead. In addition, inventoried costs on U.S. Government fixed price contracts include research and development and general and administrative expenses estimated to be recoverable. In accordance with industry practice, inventoried costs are classified as current assets and include amounts related to contracts having production cycles longer than one year.\nProperty, Plant, and Equipment - Leasehold improvements and machinery and equipment are stated at cost, less accumulated depreciation. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:\nMaintenance and repairs are charged to expense as incurred, while major renewals and improvements are capitalized.\nThe cost and related accumulated depreciation of assets sold or otherwise disposed of are deducted from the related accounts and resulting gains or losses are reflected in operations. Depreciation charged to operations was $2,499,774, $2,493,948, and $2,336,694 for the years ended December 31, 1995, 1994, and 1993, respectively.\nIntangible Assets - Intangible assets are being amortized using the following methods and estimated useful lives:\nSupplemental type certificates are granted by the Federal Aviation Administration in order to allow certain modifications to be made to a particular model of aircraft for commercial use. All intangible assets associated with the acquisition of Hayes International Corporation have been reduced to zero as net operating loss carryforwards not established as deferred tax assets in the initial purchase price allocation have been utilized. The debt issuance costs are amortized over the life of the related debt.\nIncome Taxes - The Company accounts for income taxes under the liability method in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES.\nNonpension Postretirement Benefits - In the first quarter of 1993, the Company adopted SFAS No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred. Prior years' financial statements have not been restated for the accounting change (see Note 11).\nProvision for Warranty Expenses - The Company warranties certain work performed for a given time period, in accordance with the terms of each specific contract. The Company provides for future warranty expenses based on actual warranty history, company practice, and specific warranty terms. In 1995, the Company decreased its warranty reserve by $340,043 to $1,178,636 due to warranties expiring and the payment of warranty items, partially offset by warranties related to new deliveries and the modification of terms on certain outstanding warranties. This reserve is management's best estimate of anticipated costs related to aircraft that were under warranty at December 31, 1995. Actual experience may be different than that anticipated for warranty work.\nCash Equivalents - For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nEarnings Per Common Share - The 1995 primary and fully diluted earnings per share is based on the weighted average number of outstanding common shares, excluding restricted shares and stock options, as this presentation was the most dilutive. The 1994 primary and fully diluted earnings per share is based on the weighted average number of outstanding common shares including restricted shares and assuming the exercise of certain stock options. Stock warrants were treated as equity rather than debt, as this presentation was the most dilutive. The 1993 primary and fully diluted earnings per share is based on weighted average number of outstanding common shares assuming the exercise of certain stock options. Stock warrants were treated as debt rather than equity, as this presentation was the most dilutive. The shares used in the computations for the three years were as follows (in thousands):\nForeign Currency Translation - The financial position and results of operations of the Company's foreign operations in Copenhagen, Denmark are measured using local currency as the functional currency. Assets and liabilities of this foreign subsidiary are translated at the exchange rate in effect at each year-end. Income statement accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from differences in exchange rates from period to period are included in the accumulated foreign currency translation adjustments account in shareholders' equity. The cash flows from foreign operations are translated at the average rate of exchange prevailing during the year. These translated cash flows are combined with the U.S. domestic company's cash flows to arrive at amounts reported on the Consolidated Statements of Cash Flows for the year ended December 31, 1995.\nRecently Issued Accounting Standards - Statement of Financial Accounting Standards No. 121 (SFAS No. 121), ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS, establishes guidance beginning in 1996, for recognizing and measuring impairment losses and would require that the carrying amount of impaired assets be reduced to fair value. Management does not believe that the adoption of SFAS No. 121 will have a material effect on the consolidated financial statements of the Company.\nStatement of Financial Accounting Standards No. 123 (SFAS No. 123), ACCOUNTING FOR STOCK-BASED COMPENSATION, establishes fair value-based financial accounting and reporting standards for all transactions involving, or relating to the Company's equity instruments. The Company will adopt SFAS No. 123 and will, accordingly, comply with the disclosure requirements set forth in the statement. Management does not believe that the effect of SFAS No. 123 will be material to the Company's pro forma net income or pro forma earnings per share.\nReclassifications - Certain prior year amounts have been reclassified to conform with the presentation used in 1995.\n2. TRADE ACCOUNTS RECEIVABLE\nRecoverable costs and accrued profit not billed consist principally of amounts of revenue recognized on contracts, for which billings had not been presented to the contract owners because the amounts were not billable at December 31, 1995 and 1994.\n3. INVENTORIES\nA portion of the above inventory balances relates to U.S. Government contracts. The Company receives progress payments on the majority of its government contracts. The title to all inventory on which the Company receives these payments is vested in the government to the extent of the progress payment balance.\nIncluded in work in process are unrecovered costs at the estimated recoverable value of $1,331,891 and $516,439 at December 31, 1995 and 1994, respectively. These costs relate primarily to certain over-and-above type work performed on government contracts. Recoverability of these costs is subject to future determination through negotiation or other procedures not complete at the balance sheet dates. These unrecovered costs relate to contracts under which all goods have been delivered at December 31, 1995 and 1994, respectively. All of the unrecovered costs at December 31, 1994 were settled during 1995. Management expects to recover the 1995 costs in accordance with past experience.\nAlso included in work in process is $2,683,124 and $3,160,586 of deferred production, initial tooling, and related nonrecurring costs (collectively referred to as deferred costs) at December 31, 1995 and 1994, respectively. The recovery of a significant portion of these deferred costs is dependent on the number of conversions performed and actual contract prices. Sales significantly under estimates or costs significantly over estimates could result in the realization of substantial losses. Realization of approximately $507,531 and $1,352,082 of deferred costs at December 31, 1995 and 1994, respectively, is dependent on the profitability of firm contracts. Recoverability of the remaining $2,175,593 and $1,808,504 of deferred costs at December 31, 1995 and 1994, respectively, is dependent upon the profitability of anticipated contracts. Based on studies by the Company, management believes there exists a sufficient market to enable the Company to recover these costs.\nThe aggregate amounts of general and administrative costs incurred during 1995, 1994, and 1993 were $18,956,954, $14,560,608, and $15,684,055, respectively. The amounts of general and administrative costs remaining in inventories at December 31, 1995 and 1994 were $1,786,373 and $1,508,537, respectively, and are associated with government contracts.\nInventory related to modification and maintenance of aircraft is subject to technological obsolescence and potential decertification due to failure to meet design specifications. The Company actively reserves for obsolete inventory. However, future technological changes could render some inventory obsolete. No estimate can be made of a range of amounts of loss that are reasonably possible should current design specifications change.\n4. INTANGIBLE ASSETS\nAmortization charged to operations was $204,331, $210,168 and $1,283,366 for the years ended December 31, 1995, 1994, and 1993, respectively.\n5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\n6. Standby Financing Commitment\nThe financial statements of the Company have been prepared contemplating the realization of assets and the satisfaction of liabilities in the normal course of business. During the year the Company experienced disruption in scheduled work flow which occurred as a result of the late delivery of government- furnished material. This disruption inhibited the ability of the Company to meet current obligations as they became due; as a result, the Company failed to timely pay interest and principal on its Term Credit facility, Revolving Credit facility and Senior Subordinated Loan, payroll taxes and payroll tax penalties, certain vendor payables and other obligations. In February of 1996 the Company realized its Request for Equitable Adjustment (see Note 12) and was able to settle the majority of its obligations exclusive of debt service. In April the Company's primary lender extended the maturity date of all accrued interest and principal to March 31, 1997 (see Note 7). The Company has also arranged a standby financing commitment with its principal shareholder which provides for the extension by the principal shareholder of up to $2.0 million in short-term advances upon demonstration of certain need factors by the Company. The commitment which contains cross default provisions to the Company's principal loan agreements, expires in January 1997 and bears a fee of two percentage points. Advances under the commitment bear interest at prime plus three percentage points, have maturities of six months and are secured by a subordinated security interest in the Company's assets and the pledge of stock issuance to the extent of ninety percent of the amount advanced. To date no advances have been made under this commitment.\n7. LONG-TERM DEBT\nThe rates of interest applicable under the Revolving and Term Credit facilities are variable, depending upon the general level of interest rates and the timing and nature of elections which the Company is entitled to make in respect to renewals of outstanding debt or increments of additional debt.\nThe Senior Subordinated Loan payable bears interest at 14.5 percent.\nFor the years ended December 31, 1995 and 1994, the effective interest rate for the Revolving Credit facility was 10.04 percent and 6.97 percent, respectively. For the years ended December 31, 1995 and 1994, the effective interest rate for the Term Credit facility was 9.88 percent and 6.99 percent, respectively.\nThe Company defaulted on its Credit facility and Senior Subordinated Loan monthly interest payments from July through December of 1995 in the aggregate, approximate amount of $1,500,000. In addition, the Company defaulted on its third and fourth quarter 1995 principal payments in the aggregate amount of $9,000,000.\nOn April 15, 1996 the Company received an Amended and Restated Credit facility and an Amended and Restated Senior Subordinated Loan. In accordance with these amendments, interest accrued through March 1996 in the amount of $2,207,799 is capitalized into the principal balance of the debt. In accordance with the amendments, the maturity date of the Credit facility and the Senior Subordinated Debt has been extended to March 31, 1997, at which date the unpaid principal and deferred interest balance is due in its entirety.\nThe above loans are collateralized by substantially all of the assets of the Company and have various covenants which limit the Company to incur or prohibit the Company from incurring additional indebtedness, dispose of assets, merge with other entities, declare dividends, or make capital expenditures in excess of certain amounts in any fiscal year. Additionally, the Company is required to maintain various financial ratios and minimum net worth amounts. At December 31, 1995, the Company was in violation of its tangible net worth requirement for the fourth quarter of 1995 and was in violation of its leverage ratio and fixed charge coverage ratio requirements for the second, third, and fourth quarter of 1995. On April 15, 1996, the Company's primary lender issued waivers regarding these covenants and modified certain financial and nonfinancial covenants for each of the four quarters in 1996.\nAt December 31, 1994, the Company was in violation of both of its leverage ratio and fixed charge coverage ratio requirements for the third and fourth quarter of 1994. In addition, the Company was in violation of certain nonfinancial covenants in the fourth quarter of 1994. On April 14, 1995, the Company's primary lender issued waivers regarding these covenants and modified certain financial covenants for the first six months of 1995. In addition, the primary lender issued a Sixth Amendment to the Amended and Restated Credit Agreement (the Amendment).\nThe Company reached an agreement in March 1994 with its primary lender to extend the maturity date of both the Revolving Credit facility and Term Credit facility. Both of these instruments were previously due in September 1994. The restated credit agreement provided that the maturity date of the Revolving Credit facility is September 30, 1995. The agreement also provided that the maturity date of the Revolving Credit facility could be extended to March 31, 1996 pursuant to the payment of the extension fee specified in the agreement. The provisions of the Revolving Credit facility agreement required a commitment fee of one-half of one percent per annum on the unused portion. The restated Term Credit facility provided for six equal quarterly installments of $2.0 million beginning on March 31, 1994 and continuing through June 30, 1995 and a final payment of $7.0 million on September 30, 1995. The agreement provided that the maturity date of the Term Credit facility could be extended pursuant to the payment of the extension fee specified in the agreement. This extension would allow the Company to repay the balance in two installments of $2.0 million each on September 30 and December 31, 1995 and a final payment equal to the remaining unpaid balance on March 31, 1996. At December 31, 1994, the Company had assumed this extension and, accordingly, the debt has been classified as long term in accordance with the agreement.\nAt December 31, 1993, the Company had failed to assign certain leasehold interests to the bank. In addition, the Company was in violation of both of its tangible net worth requirements at December 31, 1993. Subsequently, the bank issued waivers regarding these covenants.\nIn connection with the Senior Subordinated Loan, the Company granted a warrant to the bank to purchase 4,215,753 shares of the Company's common stock at an exercise price of approximately $.24 per share. The warrant provided for mandatory repurchase periods between June 15 and December 14 during 1991, 1992, and 1993. Upon written notice from the warrant holder during the mandatory repurchase periods, the Company was required to repurchase the warrant for the per share difference between the then current appraised value of the Company's common stock and the exercise price of the warrant (put price). At December 31, 1994, the estimated aggregate put price for all shares, pursuant to the warrant, of $4,200,000, is included in the mezzanine section of the Company's consolidated financial statements.\nChanges in the estimated put price prior to the first put date (June 15, 1991) were accreted; changes in the estimated put price after the first put date were recorded directly to interest expense. The $2,300,000 accretion in 1993 was recorded as an increase to interest expense.\nDuring the periods January 15, 1993 through April 14, 1993 and January 15, 1994 through September 14, 1994, the Company had the option to repurchase the warrants for the then current put price, if the warrants had not been previously exercised or repurchased. Additionally, the warrant holders had rights to demand registration of the warrants under certain circumstances. In accordance with the eighth amendment to the Revolving Credit facility the expiration date of the warrants has been extended to September 9, 2000.\nThe warrant was neither put nor exercised by the lender as of December 31, 1993. On April 1, 1993, pursuant to the provisions of the warrant agreement, the Company called the warrant for repurchase. The call was rescindable and subject to negotiation pursuant to the terms of the warrant agreement. The amount included in the mezzanine section of the balance sheet as of December 31, 1994 represented management's estimate of the amount to be paid to the lender.\nAs one of the conditions to the granting of the 1994 waivers and the Amendment necessary to cure the debt covenant violations at September 30, 1994 and December 31, 1994, the primary lender required rescission of the Company's call of the warrant. In conjunction with the recision of the Company's call of the warrant during 1995, the Company has reclassified the warrant from the mezzanine section of the balance sheet to additional paid-in capital at December 31, 1995. The warrant otherwise remains as a binding and enforceable agreement between the Company and its primary lender.\n8. ESTIMATED LOSSES ON CONTRACTS IN PROGRESS\nThe Company provides for losses on uncompleted contracts in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues. These estimates are reviewed periodically and any revisions are charged or credited to operations in the period in which the change is determined.\nManagement expects that the losses provided for in the allowance for future losses on uncompleted contracts at December 31, 1995 will be incurred in 1996.\nAt December 31, 1995 the Company had twenty-one KC-135 aircraft in process from the first year of the 1994 contract, all at various stages of completion. These aircraft in process continue to be impacted by late government furnished material (GFM), excess major structural repairs and other direct and constructive changes to the contract (see Note 12). The Company's independent management consultant has determined a preliminary rough order magnitude of the cost impact of late GFM and excess major structural repairs for the twenty-one aircraft in work under the first year of the 1994 contract. Based on this preliminary rough order magnitude, the Company has considered the impact of this assessment in determining that a provision for losses on the contract is not needed. Should the Company not ultimately receive an equitable adjustment from the U.S. Government, the Company's management estimates a contract loss of approximately $1,000,000.\nIn addition to the twenty-one KC-135 aircraft in process from the first year of the 1994 contract there are also six aircraft in process as of December 31, 1995 from the second year. It is the opinion of management that the U.S. Government has changed the work scope beginning with the second year of the contract. This change in work scope relates to the fact that the U.S. Government has increased the PDM cycle from a 48-month PDM cycle to a 60-month PDM cycle. As a result of this change in work scope, the Company has submitted a significant contract price revision proposal to the U.S. Government. The Company has obtained an opinion from outside legal counsel specializing in government procurement law that there is a reasonable basis to support this proposed contract price revision. Due to this price revision and the low, aggregate percent complete of ships delivered to the Company under the second year of the contract, it is the opinion of management that the profitability or range of loss on aircraft delivered, and to be delivered, is neither probable, nor estimable.\nIncluded in the allowance for estimated losses on contracts in progress is a provision at December 31, 1995 of $542,550 related to a certain contract on which it is more likely than not that a total contract loss will be recognized on the remaining units to deliver. Of the $542,550 allowance, $438,628 relates to recoverability of work in process and $103,922 relates to aircraft to be delivered to the Company during 1996.\nIncluded in the allowance for future losses on uncompleted contracts is a provision of $690,788 at December 31, 1994, for a certain contract. These losses were dependent upon the number of aircraft delivered to the Company prior to December 31, 1995, as specified in the contract. At December 31, 1995, this reserve was removed due to the expiration of the delivery time period, as specified in the contract.\nAlso included in the allowance for future losses on uncompleted contracts at December 31, 1994 is a provision of $654,388 that relates to a certain contract on which the Company has agreed to perform additional work. At December 31, 1995, it is management's best estimate that the likelihood of this additional work being performed is only reasonably possible, not probable, and has accordingly removed this reserve.\nDuring 1995, 1994, and 1993, a provision for estimated losses on contracts in progress in the amount of $203,922, $849,843 and $583,122, respectively, was recognized through a charge to operations to provide for reserves on specific contracts in progress at December 31, 1995, 1994, and 1993, respectively.\n9. INCOME TAXES\nThe Company follows SFAS No. 109, ACCOUNTING FOR INCOME TAXES, which accounts for income taxes under the liability method.\nSFAS No. 109 specifies that deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has established valuation allowances primarily for certain state net operating loss carryforwards and foreign tax losses of which the realization is uncertain. Based on the Company's projected taxable income, management believes it is more likely than not that the Company will realize the benefit of the net deferred tax assets existing at December 31, 1995.\nDuring 1994, the Company reduced its valuation allowance resulting in an increase of net deferred tax assets and an increase in the benefit for income taxes of approximately $10.5 million. This reduction in the valuation allowance was attributable to the award of a significant seven-year governmental contract which was in negotiation at December 31, 1993. Upon receipt of this award, realization of certain deferred tax assets became, in the opinion of management, more likely than not.\nIn 1993, the Company utilized approximately $10 million of preacquisition loss carryforwards associated with the purchase of Hayes, and, in accordance with SFAS No. 109, the utilization of these carryforwards was first used to offset all of the unamortized intangible assets associated with the acquisition. This resulted in a $2,756,755 reduction in intangible assets. The remaining operating loss carryforwards utilized during the year ended December 31, 1993 were used to reduce tax expense.\nThe alternative minimum tax credit carryforwards of $709,291 included in the deferred tax assets above do not expire.\n10. STOCK OPTIONS AND RESTRICTED SHARE PLANS\nOn September 8, 1989, the stockholders approved an Incentive Stock Option and Appreciation Rights Plan and a Nonqualified Stock Option Plan, pursuant to which a maximum aggregate of 2,000,000 shares of common stock have been reserved for grant to key personnel. The plans expire by their terms on July 10, 1999 and September 8, 1999, respectively.\nUnder both plans, the option price may not be less than the fair market value of the stock at the time the options are granted. Generally, these options become exercisable over staggered periods but may not be exercised after ten years after the date of grant.\nDeferred Compensation - In December 1994, the Company adopted a Restricted Share Plan (the Plan) designed to attract, retain, and motivate executive officers of the Company. The Plan authorizes the issuance of 105,657 common shares of beneficial interest pursuant to restricted shares issued under the Plan. In connection with the grant of shares under the Plan, the Compensation Committee determines any vesting requirements. In December of 1994 the Company issued $175,000 of restricted shares which will be amortized over the period earned by the employee. In December 1994, the Company also established certain other nonvested cash bonuses which will be amortized to compensation expense over the vesting period of two years.\n11. EMPLOYEE BENEFIT PLANS\nPension - The Company has a defined benefit pension plan in effect, which covers substantially all employees at its Birmingham, Dothan, and Leeds, Alabama facilities who meet minimum eligibility requirements. Benefits for nonunion employees are based on salary and years of service, while benefits for union employees are based upon a fixed benefit rate and years of service. The funding policy is consistent with the funding requirements of federal law and regulations concerning pensions. Pursuant to this practice, the Company made contributions of $1,250,002, $1,271,740, and $908,496 in 1995, 1994, and 1993, respectively. Plan assets consist primarily of stocks, bonds, and cash equivalents.\nPursuant to the requirements of SFAS No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, an additional minimum pension liability of $12,659,525 and $14,444,846, representing the excess of the accumulated benefit obligation over plan assets plus prepaid pension cost, was recognized at December 31, 1995 and 1994, respectively. The additional liability has been offset by intangible assets to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost are recorded as a reduction of stockholders' equity. The intangible asset and reduction of stockholders' equity are $4,171,287 and $7,017,031 (net of tax) and $4,750,776 and $7,748,850 (net of tax) at December 31, 1995 and 1994, respectively.\nThe discount rate decreased from 8.75% at December 31, 1994 to 7.25% at December 31, 1995 resulting in an increase to the accumulated benefit obligation of $11,000,000. The additional minimum liability adjustment decreased primarily due to higher than anticipated returns on plan assets in 1995.\nAlthough the discount rate increased from 7.5 percent at December 31, 1993 to 8.75 percent at December 31, 1994 (which reduced the accumulated benefit obligation by $9,260,000), the additional minimum liability adjustment increased primarily due to lower than anticipated returns on plan assets attributable to rising interest rates.\nThe projected benefit obligation is the actuarial present value of that portion of the projected benefits attributable to employee service rendered to date. Service cost is the actuarial present value of the portion of the projected benefits attributable to employee service rendered during the year.\nIncreases in benefit obligations due to plan amendments are amortized over the average future service of active participants. Cumulative net actuarial gains and losses in excess of the 10 percent corridor amount are amortized over the average future service of active participants.\nLiabilities related to pension benefits are calculated using actuarial assumptions which are estimates. Actual experience may differ from estimated assumptions and the Company's liability may change based on actual experience. A decrease in the weighted-average discount rate used at December 31, 1995 from 7.25% to 7.00% would have increased the accumulated benefit obligation and thus the minimum pension liability adjustment and change to equity $1,950,000.\nNonpension Postretirement Benefits - Effective January 1, 1993, the Company adopted SFAS No. 106, EMPLOYER'S ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred.\nThe Company provides health care benefits to both salaried and hourly retired employees at its Birmingham, Leeds, and Dothan facilities. The retirees' spouse and eligible dependents are also entitled to coverage under this defined benefit plan, as long as the retiree remains eligible for benefits. To be eligible for coverage the retiree must have attained age 62 and the benefits cease once age 65 is reached.\nThe retirees pay premiums based on the full active coverage rates. These premiums are assumed to increase at the same rate as health care costs. Benefits under the plan are subject to certain deductibles, co-payments, and yearly and lifetime maximums. Currently, the plan is unfunded.\nThe health care cost trend rate assumption has a significant effect on the amounts reported. Rates listed above represent assumed increases in per capita cost of covered health care benefits for 1995, 1994 and 1993, respectively. For future years the rate was assumed to decrease gradually and remain at the ultimate trend rate thereafter.\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25 and 8.75 percent at December 31, 1995 and 1994, respectively. At January 1, 1994, the weighted average discount rate used was 7.5 percent. At January 1, 1993, the date of adoption of SFAS No. 106, the weighted average discount rate used was 8.5 percent. In addition to these changes in assumption, the mortality, retirement ages, and termination rates were also changed. These changes in assumptions were the primary cause of the $(83,000), $176,000 and $211,000 unrecognized (gains)\/losses at December 31, 1995, 1994 and 1993, respectively.\nThe Company recognized $123,000, $91,000 and $120,000 of expense associated with the plan in 1995, 1994 and 1993, respectively.\nLiabilities related to postretirement benefits are calculated using actuarial assumptions which are estimates. Actual experience may differ from estimated assumptions and the Company's liability may change based on actual experience. A decrease of the discount rate used at December 31, 1995 from 7.25% to 7.0% would have increased the accumulated postretirement benefit obligation by $18,000.\nSelf-Insurance - It is generally the policy of the Company to act as a self-insurer for certain insurable risks consisting primarily of employee health insurance programs and workers' compensation. Losses and claims are accrued as incurred. The Company maintains a self-insured health insurance plan for the Birmingham, Leeds, and Dothan divisions of its Pemco Aeroplex subsidiary. The Company has reserves established in the amounts of $1,435,251 and $1,964,176 for reported and incurred but not reported claims at December 31, 1995 and 1994, respectively. Expense incurred for this plan was $8,748,411, $8,121,138, and $6,561,761 for 1995, 1994, and 1993, respectively.\nThe Company also has a self-insured workers' compensation program. The Company has a self-insured retention of $250,000 per occurrence. Claims in excess of this amount are covered by insurance. Included in deposits and other, at December 31, 1995 and 1994, is $850,000 that has been placed on deposit with the state of Alabama in connection with the Company's self-insured workers' compensation plan. Use of these funds is limited by the state. The Company has reserves of $4,868,000 and $4,780,716 for reported and incurred but not reported claims at December 31, 1995 and 1994, respectively. Expense incurred on this plan was $1,650,901, $1,399,100, and $3,351,608 for 1995, 1994, and 1993, respectively. The workers' compensation liability at December 31, 1995 does not include the effect of the settlement of numerous claims regarding an issue for which no estimate can be made of a range of amounts of loss that are reasonably possible should these claims be settled unfavorably.\nSelf-insurance reserves are developed based on prior experience and actuarial assumptions to predict future experience. These reserves are estimates and actual experience may differ from these estimates.\nDefined Contribution Plan - Effective November 1, 1990, the Company adopted a 401(k) savings plan for employees who are not covered by any collective bargaining agreement, have attained age 21, and have completed one year of service. Employee and Company matching contributions are discretionary. The Company made no matching contributions during 1995, 1994, or 1993. Employees are always 100 percent vested in their contributions.\n12. COMMITMENTS AND CONTINGENCIES\nOperating Leases - The Company's manufacturing and service operations are performed principally on leased premises owned by municipal units or authorities. Remaining lease terms range from two to eighteen years and provide for basic rentals, plus contingent rentals based upon a graduated percentage of sales. The Company also leases vehicles and equipment under various leasing arrangements.\nTotal rent expense charged to operations for the years ended December 31, 1995, 1994, and 1993 amounted to $3,909,557, $3,128,796, and $3,116,118, respectively. Contingent rental amounts included in rent expense amounted to $934,731, $1,196,481, and $1,443,128 for the years ended December 31, 1995, 1994, and 1993, respectively.\nUnited States Government Contracts - The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. The Company believes, based on all available information, that the outcome of the U.S. Government's audits, reviews, and investigations will not have a materially adverse effect on the Company's consolidated results of operations, financial position, or cash flows.\nU.S. Government Request for Equitable Adjustment (REA) - During 1995 the Company recorded revenue and a current receivable of $4,200,000 in anticipation of settlement of a contract REA involving the KC-135 Programmed Depot Maintenance (PDM) contract. This amount relates to, and is in addition to, the $3,500,000 REA receivable recorded in 1994. The REA, which was certified by the Company and submitted to the U.S. Government, was for equitable adjustment of the cost effect of late delivery of government-furnished materials (GFM). The disruption in scheduled work flow which occurred as a result of the late delivery of GFM began in the second quarter of 1993 and continues to impact ships in work at December 31, 1995. This total equitable adjustment is classified as a current receivable at December 31, 1995 and was received in its entirety subsequent to December 31, 1995.\nIn addition to the receivable mentioned above, the Company has recorded revenue and a long-term unbilled receivable of $4,100,000 in anticipation of the submission and settlement of another contract REA involving the KC-135 PDM contract. The receivable is for equitable adjustment of the cost effect of late delivery of GFM, excess major structural repairs on certain KC-135 aircraft and other direct and constructive changes to the contract. The Company feels strongly that the evidence in support of the REA is objective and verifiable, and the costs associated with the REA are reasonable in view of the work performed and are not the result of any deficiencies in the Company's performance. The Company has obtained an opinion from outside legal counsel specializing in government procurement law which states that the Company is entitled to compensation for additional costs associated with late GFM and excess major structural repairs. The Company's independent management consultant has determined a preliminary rough order magnitude of the cost impact of the late GFM and excess structural repairs, and the Company has recorded this receivable based on this rough order magnitude, net of reserves. The reserves are deemed necessary by the Company due to uncertainties inherent in the process of receiving equitable adjustment. The Company cannot reasonably estimate the length of time before the formal filing of this REA nor can it reasonably estimate the length of time before its realization. Should the Company not ultimately receive an equitable adjustment from the U.S. Government, the Company would realize a pre-tax reduction of revenue of $4,100,000.\nLitigation - The Company is involved in various legal proceedings arising in the normal course of business. Management does not believe the ultimate outcome of such litigation will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.\n13. RELATED PARTY TRANSACTIONS\nThe Company has arranged a standby financing commitment with its principal shareholder which provides for the extension by the principal shareholder of up to $2.0 million in short-term advances upon demonstration of certain need factors by the Company. (See Note 6).\nThe related party receivable reflected in the consolidated balance sheet consists of various notes receivables from Matthew L. Gold, who is an officer, director, and majority stockholder of the Company.\n14. GEOGRAPHIC SEGMENTS AND MAJOR CUSTOMERS\nThe Company's operations are primarily concentrated in one industry segment, the maintenance and modification of large transport aircraft. Aggregate sales to customers in foreign countries, principally in Europe, account for approximately 15 percent, 7 percent, and 10 percent of the Company's net sales for the years ended December 31, 1995, 1994, and 1993, respectively. Sales to major customers which accounted for 10 percent or more of the Company's net sales were as follows:\n15. CONCENTRATION OF CREDIT RISK\nThe Company provides aircraft modification and maintenance, as well as engineering services, primarily to the United States Government, various cargo companies, leasing companies, and commercial airlines. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains an adequate allowance for potential credit losses. When the Company grants credit, with the exception of the United States Government, it is primarily to customers whose ability to pay is dependent upon the economics prevailing in the air passenger and cargo traffic industries.\nThe Company invests its excess cash in deposits with major banks with strong credit ratings. These investments are typically overnight repurchase agreements and, therefore, bear minimal risk. The Company has not experienced any losses on these investments.\n16. EXTRAORDINARY ITEM\nIn June 1989, Rolando F. Sablon, a former stockholder and director of the Company, named the Company and other related defendants in a suit alleging theories of breach of contract, breach of fiduciary duty, common law fraud, violations of the Racketeer Influenced and Corrupt Organization Act, and violations of the Securities and Exchange Act of 1934, as well as corresponding violations of certain Florida state statutes. During 1993, this claim was settled out of court by the Company for $1.3 million. The Company's remaining indebtedness under this settlement is $-0- at December 31, 1995 and 1994. At December 31, 1993, the settlement was recorded as an extraordinary item and reduced net income by $1,274,000, net of the income tax benefit of $26,000.\n17. FOURTH QUARTER ADJUSTMENTS\nIn the fourth quarter of 1995, the Company recorded year-end adjustments to the Company's inventory and inventory reserves, uncollectible accounts receivable, warranty reserve, year-end bonuses, deferred tax asset valuation allowance and Request for Equitable Adjustment which, in the aggregate, increased net income for the quarter and the year ended December 31, 1995 by approximately $2,084,000.\nIn the fourth quarter of 1994, the Company recorded year-end adjustments to the Company's inventory and inventory reserves, uncollectible accounts receivable, warranty reserve, year-end bonuses, and deferred tax asset valuation allowance which, in the aggregate, increased net income for the quarter and the year ended December 31, 1994 by approximately $9,916,900.\nIn the fourth quarter of 1993, the Company recorded year-end adjustments to the Company's self-insured workers' compensation reserve, common stock purchase warrant, inventory, and inventory reserves which, in the aggregate, increased net income for the quarter and year ended December 31, 1993 by approximately $700,000.\n18. LABOR CONTRACT\nIn June of 1993, the Birmingham Division of Pemco Aeroplex and the Targets Division negotiated a three year labor contract with Local 1155 of the United Automobile Aerospace Workers of America. The agreement currently covers approximately 934 employees or 76% of the Company's work force.\nThis contract expires in June of 1996. In the past, the Company has been affected by work stoppages in the course of contract negotiations; however, they have always been short in duration, and none have had a significant effect on the Company's consolidated financial position, results of operations or cashflows. Management does not anticipate that the June 1996 contract negotiations will have a significant effect on the Company's consolidated financial position, results of operations or cashflows. No estimate can be made of a range of amounts of loss that are reasonably possible should a work stoppage occur during contract negotiations.\nSUPPLEMENTARY INFORMATION\nREPORT OF INDEPENDENT ACCOUNTANTS ON SUPPLEMENTARY INFORMATION\nBoard of Directors and Stockholders Precision Standard, Inc.\nOur report on the consolidated financial statements of Precision Standard, Inc. and Subsidiaries is included on page of this Form 10-K. In connection with our audit of such financial statements, we have also audited the related financial statement schedules listed in the index on page __ 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.\nBirmingham, Alabama March 31, 1996, except for Notes 6 and 7 as to which the date is April 15, 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 Company.\nInformation regarding the directors and executive officers of the Company is incorporated by reference from the \"ELECTION OF DIRECTORS\" section of the Company's definitive 1996 Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation regarding management remuneration and transactions is incorporated by reference from the \"EXECUTIVE COMPENSATION\" section of the Company's definitive 1996 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation regarding the security ownership of certain beneficial owners and management is incorporated by reference from the \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\" section of the Company's definitive 1996 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation regarding certain relationships and related transactions is incorporated by reference from the \"TRANSACTIONS WITH MANAGEMENT AND OTHERS\" section of the Company's definitive 1996 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nFinancial Statement Schedules. The Financial Statement Schedules listed below appear in Part II, Item 8 hereof.\na. Financial Statements: Report of Independent Accountants Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nSchedule II. Valuation and Qualifying Accounts.\nAll other financial statement schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or the notes thereto.\nb. Reports on Form 8-K. No Reports on Form 8-K were filed with the Commission during the quarter ended December 31, 1995.\nc. Exhibits.\n2 Not applicable.\n3.1 Amended and First Restated Articles of Incorporation of the Company. (1)\n3.2 Amended and First Restated Bylaws of the Company. (1)\n3.3 Articles of Amendment to the Articles of Incorporation. (2)\n4.1 Asset Sales and Purchase Agreement dated July 19, 1984, among Monarch Equities, Inc., Pemco Engineers, Inc., Robert D. Lang, Georgia L. Lang and Monarch Aviation, Inc. (3)\n4.2 Promissory Note dated July 17, 1987, from Monarch Equities, Inc., to Pemco Engineers, Inc. (3)\n4.3 Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated September 5, 1988. (1)\n4.4 Amended and Restated U.S. $10,000,000 Senior Subordinated Loan Agreement dated as of September 9, 1988, among Precision Standard, Inc., as Borrower, and the Financial Institutions listed on the Signature Pages hereof as Lender. (1)\n4.5 Amended and Restated Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated November 30, 1988. (1)\n4.6 First Amendment to Amended and Restated Credit Agreement dated as of June 14, 1989. (1)\n4.7 First Amendment to Amended and Restated Senior Subordinated Loan Agreement dated June 14, 1989. (1)\n4.8 Specimen Certificate for Common Stock. (4)\nPursuant to Paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company has not filed certain instruments with respect to other long-term debt of the Company or its consolidated subsidiaries. Copies of such documents will be furnished to the Commission upon request.\n9 Not applicable.\n10.1 Sale of Assets Agreement dated June 2, 1986 among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., Rolando Sablon and Matthew Gold. (3)\n10.2 Amendment to Sale of Assets Agreement and Closing Statement dated June 3, 1986, among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., and SG Trading Corp. (3)\n10.3 Assignment and Assumption Agreement executed July 30, 1987, effective June 4, 1986, between SG Trading Corp. and Matthew Gold. (3)\n10.4 Purchase Agreement dated December 31, 1986, between the Company and Matthew Gold. (3)\n10.5 Purchase Agreement executed August 6, 1987, effective April 30, 1987, between the Company and Matthew Gold. (3)\n10.6 Contract No. N68520-87-0007 between Monarch Aviation, Inc., and the United States Navy. (3)\n10.7 Novation Agreement between Monarch Aviation, Inc., and the Company dated August 6, 1987. (5)\n10.8 Lease dated November 1, 1986, between Monarch Properties and Pemco Engineers, Inc. (3)\n10.9 Amended and Restated Incentive Stock Option and Appreciation Rights Plan. (6)\n10.10 Amended and Restated Nonqualified Stock Option Plan. (6)\n10.11 Amended Executive Employment Agreement between the Company and Walter M. Moede effective June 1, 1993, as amended March 11, 1994. (7)\n10.12 Amended Executive Employment Agreement between the Company and Matthew L. Gold effective June 1, 1993, as amended March 11, 1994. (7)\n10.13 Executive Employment Agreement between the Company and C. Fredrik Groth effective June 1, 1993. (7)\n11 Not applicable. 12 Not applicable.\n13 Not applicable.\n16 Not applicable.\n18 Not applicable.\n21 Subsidiaries of the Company.\n22 Not applicable.\n23 Consent of Coopers & Lybrand to the incorporation by reference of their report in Company's Form S-8 Registration Statement (File No. 33-34206 and 33-79676).\n24 Not applicable.\n27 Financial Data Schedule - Electronic Data Gathering Analysis and Retrieval (EDGAR).\n28 Not applicable.\n99 Not applicable. ____________________\n(1) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, and incorporated by reference herein.\n(2) Filed as an exhibit to the Company's Registration Statement on Form S-8 dated June 1, 1994, and incorporated by reference herein.\n(3) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1987, and incorporated by reference herein.\n(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated by reference herein.\n(5) Filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended April 30, 1988, and incorporated by reference herein.\n(6) Filed as exhibits to the Company's Definitive Proxy Statement for the 1994 Annual Meeting of Shareholders, and incorporated by reference herein.\n(7) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated by reference herein.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPRECISION STANDARD, INC.\nDated: April 15, 1996 By: \/s\/Matthew L. Gold Matthew L. Gold, President (Principal Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nSignature Capacity Date\n\/s\/Matthew L. Gold Chairman, President 4\/15\/96 Matthew L. Gold Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/Walter M. Moede Executive Vice President 4\/15\/96 Walter M. Moede Chief Financial Officer, Secretary and Director (Principal Financial Officer)\n\/s\/Donald C. Hannah Director 4\/15\/96 Donald C. Hannah\n\/s\/George E.R. Kinnear II Director 4\/15\/96 George E. R. Kinnear II\n\/s\/Thomas C. Richards Director 4\/15\/96 Thomas C. Richards\n\/s\/Ben J. Shapiro, Jr. Director 4\/15\/96 Ben J. Shapiro, Jr.","section_15":""}
{"filename":"887983_1995.txt","cik":"887983","year":"1995","section_1":"Item 1. Business..................................................... 1 Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nFor information regarding the Company's properties, see Item 1 - \"Business.\"\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nAs of December 31, 1995, there are no material pending legal proceedings to which the Company or its property is subject.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nNo matters were submitted to a vote of security holders 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 listed and traded on the New York Stock Exchange (\"NYSE\") and on the Pacific Stock Exchange (\"PSE\") under the symbol \"SWP.\"\nThe following table sets forth the high and low prices per common share on the NYSE, for the two-year period ended December 31, 1995:\nAt February 15, 1996, management estimated that there were approximately 609 holders of record of the Company's common stock. The closing price of the common stock on February 15, 1996 was $14.50.\nBecause the Company's securities are listed on a national stock exchange, they are marginable if they otherwise meet the minimum price requirements for marginability.\nThe Company paid a dividend of $.22 per share for first quarter of 1994; $.23 per share for each of the second, third and fourth quarters of 1994; and $.25 per share for each of the four quarters of 1995. The Company has raised its quarterly dividend to $.26 per share for the quarter ending March 31, 1996.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\nThe following table sets forth selected financial data with respect to the Company and its subsidiaries for each of the five years in the period ended December 31, 1995 and should be read in conjunction with the Consolidated Financial Statements and Notes thereto which are contained elsewhere in this report (in thousands, except per share data):\nNOTES TO SELECTED FINANCIAL DATA:\n(1) Earnings per share is based on the net income or loss attributable to the common stock and the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the periods presented. Earnings per share for the year ended December 31, 1995 was based on 18,627,322 weighted average shares of common stock outstanding during the period (15,633,291 in 1994, 8,099,900 in 1993, 961,870 in 1992, and 708,391 in 1991).\nThe 1995, 1994 and 1993 per share computations include options and warrants outstanding during the period to purchase common stock, as calculated by application of the \"treasury stock\" method. Under generally accepted accounting principles, the Company's debentures were not common stock equivalents and therefore were not considered in the primary earnings per share computations; the debentures were antidilutive to the computation of fully-diluted earnings per share.\nFor periods prior to 1993, SRL's preferred depositary receipts were not common stock equivalents, and were not considered in primary earnings per share computation; SRL's warrants, options, and specified acquisition convertible limited partnership interests were antidilutive to the computation of fully-diluted earnings per share.\n(2) The Company paid a dividend of $.175 per share for the fourth quarter of 1992; $.20 per share for each of the first, second and third quarters of 1993; $.22 per share for each of the fourth quarter of 1993 and the first quarter of 1994; $.23 per share for each of the second, third and fourth quarters of 1994; and $.25 per share for each of the four quarters of 1995. The Company has raised its quarterly dividend to $.26 per share for the quarter ending March 31, 1996.\n(3) The Reorganization of SRL into the Company has been accounted for similar to a pooling of interests and has been applied by restating the financial statements of SRL, with the only impact being the classification of certain equity accounts and disclosures with respect to earnings per share.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following discussion and analysis should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and Notes appearing elsewhere herein.\nResults of Operations\nYear ended December 31, 1995 compared to year ended December 31, 1994. Rental revenues in 1995 were $70,396,000, an increase of 22% from $57,625,000 for 1994. This increase was due to the acquisition of eight apartment properties in 1994, an approximate 4% rental rate increase on existing properties and the first contribution from the Company's development properties. Other income was $1,466,000 in 1995, compared to $1,303,000 for 1994. Total revenues were $71,862,000 in 1995, compared to $58,928,000 for 1994.\nOperating expenses (property operating expenses plus general and administrative expenses) were $35,038,000 for 1995, compared to $30,083,000 for the same period in 1994. This increase was primarily attributable to the acquisition of eight apartment properties in 1994 and initial operating expenses from three of the Company's development properties.\nNet operating income per unit (total revenues less operating expenses, divided by the weighted average number of apartment unit owned during the period) increased in 1995 for the seventh consecutive year. Net operating income per unit in 1995 was $2,826, a 4% increase from $2,713 in 1994. This increase is the result of increases in both gross income and operating expenses per unit of 4%.\nInterest on debt was $10,878,000 for 1995, compared to $8,470,000 for 1994. This increase is primarily attributable to interest on the construction loans and the line of credit.\nAdditions to property in 1995 were $6,441,000 compared to $7,764,000 in 1994. Depreciation and amortization expense increased $2,461,000 in 1995 compared to 1994 as a result of a full year of depreciation on the properties acquired in 1994, depreciation on completed construction and depreciation on capitalized improvements made to the properties.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993. Rental revenues in 1994 were $57,625,000, an 80% increase from $31,959,000 in 1993. This increase was due primarily to the acquisition of 26 apartment properties in 1993 and 1994, and to an approximate 2% increase in economic occupancy and a 5% increase in rental rates. Other income was $1,303,000 in 1994, compared to $1,131,000 for 1993. Total revenues were $58,928,000 in 1994, compared to $33,090,000 for 1993.\nOperating expenses (property operating expenses plus general and administrative expenses) were $30,083,000 for 1994, compared to $17,868,000 for the same period in 1993. This increase was attributable to the acquisition of 26 apartment properties during 1993 and 1994.\nNet operating income per unit (total revenues less operating expenses, divided by the weighted average number of apartment units owned during the period) in 1994 was $2,713, a 25% increase from $2,176 in 1993. This increase is due to an increase in gross income per unit of 10% and a decrease in operating expenses per unit of 2% (which is the result of a combination of expense control at the property level and general and administrative expenses being spread over a larger number of units).\nInterest on fixed-rate mortgage debt and the debentures was $8,470,000 for 1994, compared to $5,146,000 for 1993. This increase is primarily attributable to the REMIC financing which closed in December 1993 and June 1994.\nAdditions to property in 1994 were $7,764,000 compared to $3,615,000 in 1993. Depreciation and amortization expense increased $3,694,000 in 1994 compared to 1993 as a result of the acquisition of properties and capitalized improvements made to the properties. About 71% of the 1994 additions to property was for improvements to building exteriors, parking lots, unit interiors, exterior lighting, carports and limited access perimeter fencing.\nLiquidity and Capital Resources\nCash and cash equivalents at December 31, 1995 aggregated $2,406,000, compared to $1,334,000 at December 31, 1994. In addition, the Company has accumulated cash reserves of $4,643,000 to fund recurring additions to its properties. The estimate of the requirements for these reserves is based on the replacement cost and useful lives of exterior paint, boilers, roofs, asphalt and miscellaneous items. Annual cash reserve requirements in 1996 are estimated to be $105 per unit. Management anticipates that cash generated from property operations and cash on hand will be adequate to fund working capital requirements for the foreseeable future.\nIn September 1994, the Company obtained a revolving line of credit in the maximum amount of $75,000,000. The Company can currently draw up to a total of $41,800,000 on the line of credit, which amount may be increased as additional properties are added as security for the loan. At December 31, 1995, the outstanding balance on the line of credit was $16,500,000.\nAt December 31, 1995, the Company had an interest rate swap agreement with a notional amount of $48,851,000. The Company has entered into the interest rate swap agreement to convert floating rate liabilities to fixed rate liabilities. The agreement fixes the interest rate on the Company's expected variable rate debt at 7.9% through April 1997. The Company does not hold or issue interest rate swap agreements for trading purposes. The Company is exposed to possible credit risk if the counterparty fails to perform, however, this risk is minimized by entering into the agreement with a highly rated counterparty. At December 31, 1995, there were no defaults under this agreement.\nThe Company plans to complete construction of four properties and additions or modifications to three existing properties in 1996 and 1997. The total cost of the four properties and one addition currently under construction is estimated to be $109,500,000, and the Company has construction loans available totaling $68,506,000. The Company has committed to fund the remaining $40,994,000 from available funds or draws on the Company's line of credit. As of December 1995, the Company has funded all but $3,814,000 of its commitment.\nSWP plans to spend approximately $4,000,000 in 1996 on capital improvements to increase the revenue-generating capabilities of its existing properties. Funds for these improvements will come from cash on hand or cash generated from property operations.\nSWP plans to repay the $8,873,000 mortgage on Sunset Pointe Apartments on March 1, 1996, with funds from its line of credit.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nThe independent auditor's report, consolidated financial statements and schedule listed in the accompanying index are filed as part of this report. See Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule 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.\nDirectors and Officers of the Company\nThe Bylaws of the Company and the provisions of the Maryland General Corporation Law (the \"Maryland Law\"), under which the Company was formed, generally provide that the Company will be managed by its Board of Directors, which may appoint officers to handle the administration of the Company. The Bylaws of the Company further provide that a majority of the Company's Board of Directors shall at all times consist of independent Directors.\nThe Directors and Officers of the Company as of February 15, 1996 are:\nName Age Principal Occupation\nJohn S. Schneider.................. 57 Chairman of the Board and Chief Executive Officer Robert F. Sherman.................. 53 President, Chief Operating Officer and Director Lewis H. Sandler................... 59 Executive Vice President,Secretary, General Counsel and Director Mark J. Sandler.................... 53 Director Ira T. Wender...................... 69 Director Larrie A. Weil..................... 52 Director Robert W. Scharar.................. 46 Director David L. Johnston.................. 51 Executive Vice President - Real Estate Investments Diana M. Laing..................... 41 Executive Vice President, Chief Financial Officer and Treasurer\nJohn S. Schneider has been Chief Executive Officer of the Company and its predecessor-in-interest, SRL, since 1983 and is the Chairman of the Board of Directors. He is primarily responsible for the overall direction of the Company. Mr. Schneider graduated from the Harvard Business School in 1967 and was employed by the investment banking firm of Donaldson, Lufkin and Jenrette until 1973, when he cofounded a predecessor firm to SWP.\nRobert F. Sherman has been in charge of SWP's (or its predecessors') management division since 1973 and is President and Chief Operating Officer and a Director of the Company, in charge of management services and responsible for the on-site management of the properties owned or managed by the Company. Mr. Sherman has served as president of both the National Apartment Association and the Dallas Apartment Association, and has been a director of the National, Texas and Dallas Apartment Associations.\nLewis H. Sandler has been General Counsel of the Company and its predecessors since 1983 and is Executive Vice President, Secretary, General Counsel and a Director of the Company. He was admitted to the Bar of the State of New York in 1962 and has since then been a practicing attorney. He was admitted to the Bar of the State of Texas in 1981. He has acted as counsel to Messrs. Schneider and Sherman, and their respective companies and partnerships, since 1973.\nMark J. Sandler was a senior managing director of Bear, Stearns & Co. Inc., an investment banking firm, in charge of its real estate operations from prior to 1987 until his retirement in October 1988. Since that time, Mr. Sandler has managed his personal and family investments. Mr. Sandler is a Director of the Company and a member of the Compensation and Audit Committees. Mark Sandler is not related to Lewis Sandler.\nIra T. Wender is a former partner and is currently of counsel to the law firm of Patterson, Belknap, Webb & Tyler, New York, NY, since July 1986. He is also a Director of Dime Savings Bank of New York and REFAC Technology, Inc. Mr. Wender is a Director of the Company and a member of the Compensation and Audit Committees.\nLarrie A. Weil has been President and Chief Executive Officer of QuickCall Corporation, an international producer and distributor of wireless pay phones, since June 1995. On January 4, 1996, QuickCall Corporation filed a voluntary petition under Chapter 11, of the Federal Bankruptcy Code. From March 1991 to June 1995, he was a principal and in charge of corporate finance for Barre & Company, Inc., an investment banking firm. From 1985 to 1989, he was employed by Underwood, Neuhaus & Co., Incorporated, an investment banking firm, serving as Chief Operating Officer from 1987 to 1989 and from January 1990 to March 1992 as President of its successor, 909 Corp. He was Senior Vice President of Eppler, Guerin & Turner, Inc., an investment banking firm, from 1981 to 1985. Mr. Weil is a Chartered Financial Analyst. Mr. Weil is a Director of the Company and a member of the Compensation and Audit Committees.\nRobert W. Scharar is President and a Director of FCA Corporation, a registered investment advisor which he founded in 1983. He is also president and a director of FCA Investment Company, a Small Business Investment Company, and serves as a trustee of First Commonwealth Mortgage Trust and of United Investors Realty Trust, both of which are REITs. Mr. Scharar is also past president of the American Association of Attorneys - CPAs. Mr. Scharar is a Director of the Company and a member of the Compensation and Audit Committees.\nDavid L. Johnston has been Executive Vice President - Real Estate Investments since joining the Company in October 1992. From 1989 to 1992, Mr. Johnston was Senior Vice President of Property Company of America, responsible for the Southwestern Region, acquiring approximately 5,000 apartment units for that company. From 1982 to 1988, he was a Division President and Senior Partner of the Trammell Crow Residential Company. During his more than 20 years of real estate experience, Mr. Johnston has developed more than 10,000 apartment units, primarily in Texas.\nDiana M. Laing has been employed by the Company and its predecessors since 1982. She is Executive Vice President and Chief Financial Officer of the Company. She has previously served as Controller, Treasurer and Vice President-Finance of the Company and its predecessors. Ms. Laing is a Certified Public Accountant and a member of the American Institute of CPA's and the Texas Society of CPA's. Ms. Laing is a Director of Sterling House Corporation, a publicly-traded operator of assisted living centers.\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nGeneral\n.........The following table sets forth certain information regarding the annual compensation the Company paid to the Chief Executive Officer and to the four executive officers each of whose aggregate remuneration exceeded $100,000 during 1995:\nIndemnification. The Charter and Bylaws of the Company provide for indemnification of the officers and Directors of the Company to the fullest extent permitted under Maryland Law and permit the indemnification, at the discretion of the Board of Directors, of all other persons permitted to be indemnified to the extent the Board deems advisable as permitted under such law. The Charter also contains a provision that limits the liability of the Directors to the Company and its stockholders for monetary damages for a breach of a Director's duty of care.\nEmployment Agreements. The Company has entered into employment agreements with each of Messrs. Schneider, Sherman, Sandler and Johnston and Ms. Laing for the payment of certain severance compensation in the event of the voluntary or involuntary termination of their employment. These agreements, which may be terminated by either party upon 90 days' notice, also provide for annual incentive compensation calculated as a percentage of base salary, based upon the increase in funds from operations per share of common stock for the current year over the prior year. Such agreements also provide that in the event of termination of employment by the Company (other than for cause or in the event of death) the executive is entitled to severance pay equal to at least his then current annual base salary plus the unpaid portion of any incentive\/bonus compensation payable and\/or earned in that year. In the event of termination, at the option of the executive, the Company is obligated to repurchase the common stock owned by him at the then market price per share. If the executive proposes to sell 10% or more of his current holdings of common stock, such shares are subject to the Company's right of first refusal at the then market price during the term of employment and for a period of one year thereafter.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of February 15, 1996, there were 20,413,649 shares of common stock outstanding. In addition, there were vested options to purchase 420,200 shares of common stock at exercise prices ranging from $11.00 to $13.00 per share. The following ownership tables do not include ownership of shares which are represented by unvested options to purchase common stock.\nThe following table sets forth certain information as to the number of shares of common stock beneficially owned as of February 15, 1996 by each person (including any \"group\" as that term is used in Section 13(d)(3) of the Exchange Act) who is known to the Company to own beneficially 5% or more of the common stock:\nThe following table sets forth certain information as to the number of shares of common stock beneficially owned as of February 15, 1996, by each Director and nominee for Director, by each of the named Executive Officers, and by all officers and Directors of the Company as a group:\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nExcept as hereafter noted, there have been no transactions, or series of similar transactions, since the beginning of the Company's last fiscal year, nor are there any currently proposed transactions, or series of similar transactions, to which the Company or any of its subsidiaries was or is to be a party, in which the amount involved exceeds $60,000, and in which any director or officer of the Company (or any investor beneficially owning more than 5% of any class of the Company's voting securities) had, or will have, a direct or indirect material interest.\nDuring 1995, the Company accepted notes receivable totaling $1,945,000 from certain officers and directors to exercise options to purchase common stock. The notes receivable, which mature on December 31, 2002, are in amounts up to 80% of the option exercise price and bear interest at the Applicable Federal Rate (as published by the Internal Revenue Service) at the date of exercise. Principal in the amount of 50% of the exercise price will be forgiven ratably over seven years beginning January 1, 1997, contingent upon continued service as an officer or director and the absence of any default on the notes. The balance of such loans will be payable ratably over the same period. The loans are secured by the common stock purchased. Options to purchase 275,000 shares of common stock were exercised, and 85,967 previously issued shares of common stock were applied (at the market price of such shares at the date of such application) to the exercise price of the options and were retired.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) The index to the audited Consolidated Financial Statements and Consolidated Financial Statement Schedule is included on page of this report.\n(b) Reports on Form 8-K for the quarter ended December 31, 1995:\nNone\n(c) Exhibits:\nFiled herewith or incorporated herein by Number Title reference\n3.1 Articles of Incorporation of the Exhibit No. 99.1 to Form 10-Q for Company, as amended the quarter ended June 30, 1994 (File No. 1-11224)\n3.2 Bylaws of the Company Exhibit No. 3.2 to Amendment No. 2 to Form S-4 filed July 8, 1992 (File No. 33-48122)\n3.3 Rights Agreement dated August 17, 1994 Exhibit No. 1 to Form 8-K filed between South West Property Trust Inc. August 17, 1994 and Society National Bank, as Rights (File No. 1-11224) Agent\n4.1 Form of Indenture governing the Exhibit No. 4.1 to Amendment No. 2 Convertible Debentures to Form S-11 filed July 8, 1992 (File No. 33-48121)\n4.2 Form of Convertible Debenture Exhibit No. 4.2 to Amendment No. 2 to Form S-11 filed July 8, 1992 (File No. 33-48121)\n4.3 Form of Certificate representing Exhibit No. 4.1 to Form S-2 filed common stock of the Company March 15, 1993 (File No. 33-59528)\n10.1 Employment Agreement between the Company Exhibit No. 10.1 to Form 10-K for and John S. Schneider the year ended December 31, 1994 (File No. 1-11224)\n10.2 Employment Agreement between the Company Exhibit No. 10.2 to Form 10-K for and Lewis H. Sandler the year ended December 31, 1994 (File No. 1-11224)\n10.3 Employment Agreement between the Exhibit No. 10.3 to Form 10-K for Company and Robert F. Sherman the year ended December 31, 1994 (File No. 1-11224)\n10.4 1992 Stock Option Plan (as amended) Exhibit No. 10.5 to Amendment No. 3 to Form S-4 filed July 22, (File No. 33-48122)\nFiled herewith or incorporated herein by Number Title reference\n10.5 Lease Agreement dated March 14, 1994 Exhibit No. 10.4 to Form 10-K for between Sterling Plaza Limited the year ended December 31, 1994 Partnership, as landlord, and the (File No. 1-11224) Company, as Tenant\n10.7 Dividend and Interest Reinvestment and Exhibit No. 10.1 to Post-Effective Share Purchase Plan Amendment No. 2 to Form S-3 filed February 10, 1995 (File No. 33-59526)\n10.8 Credit Agreement dated December 1, Exhibit No. 99.1 to Form 8-K dated 1993 among SWP Properties, Inc., SWP December 23, 1993 Woodscape Properties, Inc., and SWP (File No. 1-11224) Creeks Properties, Inc. and National Westminster Bank, PLC\n10.9 Collection Account Agreement dated Exhibit No.99.2 to Form 8-K dated December 1, 1993 among SWP Properties, December 23, 1993 Inc., SWP Woodscape Properties, Inc. (File No. 1-11224) and SWP Creeks Properties, Inc. (Mortgagor), Norwest Bank Minnesota, N.A. (Account Agent),Southwestern Property Trust, Inc. (PropertyManager), and Norwest Bank Minnesota,N.A. (Trustee)\n10.10 Property Management Agreement dated Exhibit No. 99.3 to Form December 1, 1993 for properties covered 8-K dated December 23, 1993 by the Credit Agreement described in Exhibit No. 10.8 hereto between SWP Properties, Inc., SWP (File No. 1-11224) Woodscape Properties, Inc., SWP Creeks Properties, Inc., and Southwestern Property Trust, Inc.\n10.11 Property Manager Subordination Agreement Exhibit No. 99.4 to Form 8-K dated December 1, 1993 between National dated December 23, 1993 Westminster Bank, PLC, and Southwestern (File No. 1-11224) Property Trust, Inc.\n10.12 Certificate Purchase Agreement dated Exhibit No. 99.5 to Form 8-K December 22, 1993 between SWP dated December 23, 1993 Depositor, Inc, Southwestern Property (File No. 1-11224) Trust, Inc., and National Westminster Bank, PLC\n10.13 Loan Purchase Agreement dated December 22, Exhibit No. 99.6 to Form 8-K 1993 between National Westminster Bank, PLC dated December 23, 1993 and SWP Depositor, Inc. (File No. 1-11224)\n10.14 Employment Agreement between the Company Exhibit No. 10.14 to Form and David L. Johnston 10-K for the year ended December 31, 1994 (File No. 1-11224)\n10.15 Employment Agreement between the Company Exhibit No. 10.15 to Form and Diana M. Laing 10-K for the year ended December 31, 1994 (File No. 1-11224)\n10.16 Credit Agreement dated March 1, 1994 Exhibit No. 99.1 to Form 10-Q between SWP REMIC Properties II-A, L.P. for quarter ended March 31, and National Westminster Bank, PLC, 1994 New York Branch (File No. 1-11224)\n10.17 Property Management Agreement dated Exhibit No. 99.2 to Form March 10, 1994 between SWP REMIC 10-Q for quarter ended Properties II-A, L.P. and Southwestern March 31, 1994 Property Trust, Inc. (File No. 1-11224)\n10.18 Property Manager Subordination Exhibit No. 99.3 to Form 10-Q Agreement datedMarch 10, 1994 between for quarter ended March 31, National WestminsterBank, PLC, and 1994 Southwestern Property Trust, Inc. (File No. 1-11224)\n10.19 Note Purchase Agreement dated March Exhibit No. 99.4 to Form 10-Q 10, 1994 between SWP Depositor, Inc., for quarter ended March 31, Southwestern Property Trust, Inc. and 1994 National Westminster Bank, PLC (File No. 1-11224)\n10.20 Form of Promissory Note dated March 10, Exhibit No.99.5 to Form 10-Q 1994 in connection with REMIC Financing for quarter ended March 31, (File No. 1-11224)\n10.21 Form of Mortgage dated March 10, 1994 Exhibit No. 99.6 to Form 10-Q in connection with REMIC Financing for quarter ended March 31, (File No. 1-11224)\n10.22 Indenture dated March 10, 1994 between Exhibit No. 99.1 to Form 10-Q SWP Depositor, Inc. and Bankers Trust for quarter ended June 30, Company, as Trustee 1994 (File No. 1-11224)\n10.23 Loan Purchase Agreement dated June 30, Exhibit No. 99.2 to Form 10-Q 1994, between National Westminster Bank, for quarter ended June 30, PLC and SWP Depositor, Inc. 1994 (File No. 1-11224)\n10.24 Collection Account Agreement dated Exhibit No. 99.3 to Form 10-Q June 30, 1994 among SWP REMIC Properties for quarter ended June 30, II-A, L.P., BankersTrust Company, as 1994 Account Agent, South West Property Trust, (File No. 1-11224) as Property Manager, and Bankers Trust Company, as Indenture Trustee\n10.25 Line of Credit Agreement dated Exhibit No. 99.7 to Form 10-Q September 15, 1994 between South West for quarter ended September Properties, L.P., South West Property 30, 1994 Trust Inc. and Lehman Brothers Holdings (File No. 1-11224) Inc.\n10.26 Promissory Note dated September 15, 1994 Exhibit No. 99.8 to Form 10-Q made by South West Properties, L.P. in for quarter ended September 30, favor of Lehman Brothers Holdings Inc. 1994 in the principal amount of $41,000,000 (File No. 1-11224)\n10.27 Form of Deed of Trust and Security Exhibit No. 99.9 to Form 10-Q dAgreement ated September 15, 1994 for quarter ended September 30, from South West Properties, L.P. in 1994 favor of Robert J. Banta, as trustee, (File No. 1-11224) and Lehman Brothers Holdings Inc., as beneficiary\n22.1 Subsidiaries of the Registrant Filed herewith\n23.1 Consent of Ernst & Young LLP Filed herewith\n================================================================================\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.\nSOUTH WEST PROPERTY TRUST INC.\nBy: \/s\/ JOHN S. SCHNEIDER John S. Schneider, Chairman of the Board and Chief Executive Officer\nFebruary 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 in the capacities and on the dates indicated.\nCapacities in Signature which signed Date\n\/s\/ JOHN S. SCHNEIDER Chairman of the Board, February 26, 1996 - ------------------------------- and Chief Executive Officer John S. Schneider\n\/s\/ ROBERT F. SHERMAN President, Chief Operating February 26, 1996 - ------------------------------- Officer and Director Robert F. Sherman\n\/s\/ LEWIS H. SANDLER Executive Vice President, February 26, 1996 - ------------------------------- Secretary, General Counsel Lewis H. Sandler and Director\n\/s\/ DIANA M. LAING Executive Vice President, February 26, 1996 - ------------------------------- Chief Financial Officer and Diana M. Laing Treasurer (Principal Financial and Accounting Officer)\n- ---------------------- Director Mark J. Sandler\n- ---------------------- Director Ira T. Wender\n\/s\/ LARRIE A. WEIL Director February 26, 1996 - ---------------------- Larrie A. Weil\n- ---------------------- Director Robert W. Scharar\n===============================================================================\n===============================================================================\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE\nReport of Independent Auditors............................................. Consolidated Financial Statements: Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993................................ Consolidated Balance Sheets at December 31, 1995 and 1994............ Consolidated Statements of Stockholders' Equity (Deficit) 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........................... Consolidated Financial Statement Schedule: Schedule III - Real Estate and Accumulated Depreciation....................\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders South West Property Trust Inc.\nWe have audited the accompanying consolidated balance sheets of South West Property Trust Inc. (\"SWP\") 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 consolidated financial statement schedule of SWP listed in the Index at. These financial statements and schedule are the responsibility of SWP'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 SWP 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.\nERNST & YOUNG LLP\nDallas, Texas January 30, 1996\nSee accompanying notes.\nSOUTH WEST PROPERTY TRUST INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SOUTH WEST PROPERTY TRUST INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization - South West Property Trust Inc., formerly Southwestern Property Trust, Inc. (\"SWP\" or the \"Company\"), a Maryland corporation, was formed in 1992 for the purpose of acquiring all of the assets subject to the liabilities of Southwest Realty, Ltd. (\"SRL\") in connection with the reorganization of SRL into a corporation which would elect to qualify as a real estate investment trust (\"REIT\") for federal income tax purposes.\nConsolidation and presentation - The consolidated financial statements include the accounts of the Company, its wholly owned corporate subsidiaries, and the partnerships in which the Company owns at least a 50% controlling interest. The portion of net income or loss attributable to minority interests in consolidated partnerships is presented as a single line item in the Company's statement of operations. Investments in partnerships in which the Company owns less than a 50% interest are accounted for on the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nProperties - Properties are stated at the Company's cost or the historical cost of SRL. For financial reporting purposes, the properties are depreciated over their estimated useful lives ranging from 5 to 35 years using the straight-line method.\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 adopted Statement 121 in 1995 and the adoption has no effect.\nIncome taxes - The Company has elected to be taxed as a REIT and intends to operate in such manner as to continue to qualify as a REIT under the Internal Revenue Code. Under the Internal Revenue Code, if certain requirements are met in a taxable year, a corporation that is treated as a REIT will generally not be subject to federal income tax with respect to income which it distributes to its stockholders. The Company made distributions in excess of its taxable income for 1995, 1994 and 1993. Accordingly, no provision for income taxes has been reflected in the statements of operations.\nEarnings and profits, which will determine the taxability of distributions to stockholders, will differ from net income reported for financial reporting purposes, due primarily to differences in the historical cost and tax bases of the assets and the estimated useful lives used to compute depreciation.\nCash and cash equivalents - Cash and cash equivalents consist primarily of cash in demand deposit and money market accounts and short-term commercial paper carried at cost, which approximates fair value. Highly liquid debt instruments purchased with a maturity of three months or less are considered to be cash equivalents.\nCash reserved for additions to property - At December 31, 1995 and 1994, the Company has set aside cash reserves in the amount of $2,230,000 and $1,123,000, respectively, to provide for the payment of planned additions to its wholly-owned properties. In addition, reserves in the amount of $2,413,000 and $2,794,000 at December 31, 1995 and 1994, respectively, are being held by trustees and certain mortgage holders for recurring replacements to the properties which secure the REMIC Financing (see Note 5) and two other first mortgages. The carrying amount of these deposits approximates their fair value.\nEscrow deposits - Escrow deposits consist of amounts on deposit with lenders for payment of property taxes and insurance premiums.\nDeferred charges - Deferred charges include loan origination costs, commitment fees and debt issue costs which are amortized over the life of the related debt.\nOther assets - Other assets consist primarily of office furniture, fixtures and equipment, miscellaneous accounts receivable and prepaid expenses. Furniture, fixtures and equipment are depreciated over their estimated useful lives ranging from three to five years using the straight-line method.\nRevenue recognition - The apartment properties are leased to individual tenants on short-term leases. Rental revenue is recognized monthly as it is earned.\nEarnings per share - Earnings per share is based on the net income or loss attributable to the common stock and the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the periods presented. Earnings per share for the years ended December 31, 1995, 1994 and 1993 were based on 18,627,322, 15,633,291 and 8,099,900, respectively, weighted average shares of common stock outstanding.\nThe number of shares assumed outstanding related to options to purchase common stock has been calculated by application of the treasury stock method. The Company's Debentures were not common stock equivalents as defined under generally accepted accounting principles and, therefore, during the years they were outstanding, were not considered in the primary earnings per share computations and are antidilutive to the computation of fully-diluted earnings per share.\nNOTE 2 - ACQUISITION OF PROPERTIES\nIn August 1995, the Company sold the Meridian Business Park located in Oklahoma City, Oklahoma, for total consideration of $3,000,000. In September 1995, the Company sold the third-party property management business in Little Rock, Arkansas, for total consideration of $25,000. The Company recognized a net gain on the sale of real estate assets of $10,000 from these two transactions.\nIn August 1995, the Company acquired the remaining ownership interests in Foxfire Apartments, Phases I and II, located in Dallas, Texas, for a gross purchase price of $5,493,000 and subject to two first mortgage loans. Prior to the purchase, the Company held a 5% interest in the partnership which owned Phase I of the property. The Company sold its partnership interest immediately prior to this acquisition for $128,000.\nIn March, May and June 1994, the Company purchased six apartment properties (in separate transactions) aggregating 1,734 units for a total purchase price of $50,350,000. Funds for the acquisitions came primarily from the second phase of the REMIC Financing which closed on June 30, 1994 (see Note 5). The properties are located in Fort Worth and Euless, Texas; Little Rock, Arkansas; and Raleigh, North Carolina. In September and November 1994, the Company purchased two apartment properties (in separate transactions) aggregating 600 units for a total purchase price of $22,633,000. Funds for the acquisitions came primarily from draws on the line of credit (see Note 7). The properties are located in Las Vegas, Nevada, and Grapevine, Texas (a Dallas suburb).\nIn January 1993, the Company acquired the 316-unit Bluff Creek Apartments in Oklahoma City, Oklahoma, for $6,250,000. The acquisition was financed, in part, by a new three-year first mortgage loan in the amount of $3,468,000 which was repaid in June 1993. Prior to this acquisition, the Company held a 32% interest in the partnership that owned the property. On June 4, 1993, the Company acquired ten properties totaling 2,588 apartment units located in the Dallas metropolitan area, San Antonio and El Paso, Texas, and Phoenix, Arizona, for an aggregate cost of approximately $73,836,000. The Company acquired three other apartment properties in 1993 (in separate transactions) aggregating 674 units for a total purchase price of $17,450,000. The properties are located in San Antonio, Corpus Christi and Houston, Texas. Funds for these acquisitions came primarily from the net proceeds from the sale of common stock (see Note 11). On December 23, 1993, the Company acquired five properties totaling 1,349 apartment units located in the Dallas metropolitan area and Albuquerque, New Mexico, for an aggregate price of approximately $43,610,000. Funds for this acquisition came primarily from the net proceeds from the first phase of the REMIC Financing which closed December 22, 1993 (see Note 5).\nNOTE 4 - MORTGAGE NOTES RECEIVABLE\nAs of December 31, 1994, the Company had a seven-year purchase money all-inclusive note receivable collateralized by the Highland Oaks Apartments with a balance outstanding of $3,636,000. Monthly installments of $31,875, including principal and interest at 9.625% per annum, were payable on the underlying first mortgage loan until its maturity in April 1995. In February 1995, the maturity date was extended to April 30, 1995. On April 27, 1995, the borrower repaid the notes.\nOn June 4, 1993, the Company acquired the first mortgage loan on the Phase I Foxfire Apartments in Dallas (in which the Company held a 5% partnership interest) for $2,645,000. Under the terms of a modified loan agreement, the Company also advanced an additional $162,000 for capital improvements to the property. On June 16, 1995, the borrower repaid the note in full.\nIn 1993, the Company purchased for $4,751,000 the first mortgage loans on the Phase II Foxfire Apartments in Dallas and the Pecan Grove Apartments in Austin. The Company also held the first mortgage loan on the Windridge Apartments. As a result of the Company's 1994 purchase of the remaining partnership interests in the Pecan Grove Apartments and the Windridge Apartments, the related notes receivable and notes payable have been discharged. The Company held a majority interest in the Phase II Foxfire Apartments and accordingly, the mortgage note receivable held by the Company and the related mortgage note payable have been eliminated for consolidated financial reporting purposes at December 31, 1994. In June 1995, the partnership owning the Phase II Foxfire Apartments refinanced its mortgage and repaid the Company's mortgage note receivable.\nNOTE 5 - MORTGAGE LOANS PAYABLE\nGeneral - Mortgage loans payable are collateralized by land, buildings and improvements and are non-recourse to the Company. Such debt bears interest at a weighted average rate of approximately 7.9%, and consists of interest rates ranging from 7.01% to 8.50%. Such debt has a weighted average maturity of 5.4 years, with maturity or call dates ranging from 1996 to 2025. The carrying values of the mortgage loans payable approximate fair value.\nREMIC Financing - The Company, through wholly-owned subsidiaries, closed a $100,000,000 first mortgage financing package (the \"REMIC Financing\"). The two $50,000,000 phases of the REMIC Financing closed on June 30, 1994 and December 22, 1993. The REMIC Financing is collateralized by 27 of the Company's wholly-owned properties, bears interest at an average fixed rate of 7.75% per annum and is non-recourse to the Company. Monthly principal and interest payments in the amount of $821,893 are required. The first phase of the REMIC Financing matures on December 10, 2000, at which time the principal balance of this phase is expected to be approximately $39,953,000, and the second phase of the REMIC Financing matures on February 10, 2001, at which time the principal balance of this phase is expected to be approximately $41,735,000. The balance of the REMIC Financing as of December 31, 1995 and 1994 was $96,212,000 and $98,511,000, respectively.\nThe REMIC Financing requires that a debt service coverage ratio of not less than 1.9 to 1.0 be maintained on the mortgaged properties (to be computed quarterly on the basis of the trailing four quarters). If such debt service coverage ratio falls to less than 1.6 to 1.0, after notice and failure to cure (which could be effected by paying down the principal), the Company is required to deposit all collections from the mortgaged properties into a debt service coverage reserve account until such time as the debt service coverage ratio equals or exceeds 1.9 to 1.0. As of December 31, 1995, the Company is in compliance.\nThe mortgage loan documents also require the Company to maintain escrow deposits with the REMIC trustees for: (i) \"basic carrying costs,\" i.e., insurance premiums, property taxes and management fees; (ii) capital improvements, at a rate of $100 per year per apartment unit; and (iii) tenant security deposits. As of December 31, 1995 and 1994, the Company had such escrow deposits with the REMIC trustees aggregating $8,347,000 and $8,258,000, respectively.\nOther Mortgage Loans - In addition to the REMIC Financing, the Company has five non-recourse first mortgages payable including: (i) a first mortgage payable secured by the Sunset Pointe Apartments in the principal amount of $8,873,000, which matures on June 1, 1996, bears interest at 8.5%, requires monthly interest only payments of $62,850 through March 1, 1996 and monthly payments of $105,937 from April 1, 1996 through June 1, 1996; (ii) a first mortgage payable secured by the Turtle Creek Apartments in the principal amount of $5,110,000, which bears interest at 8.5%, requires monthly payments of principal and interest of $40,353 and matures on October 1, 1999; (iii) a first mortgage payable secured by the High Ridge Apartments in the principal amount of $4,693,000, which bears interest at 8.5%, requires monthly payments of principal and interest of $36,335 and matures on January 1, 2000; (iv) a first mortgage payable secured by Phase I of the Foxfire Apartments in the principal amount of $2,791,000, which bears interest at the cost of funds index, as published by the San Francisco National Bank, plus 2.75%, adjusted monthly, requires monthly payments of principal and interest of $20,073 and matures on July 1, 2025; and (v) a first mortgage payable secured by Phase II of the Foxfire Apartments in the principal amount of $997,000, which bears interest at the cost of funds index, as published by the San Francisco National Bank, plus 2.75%, adjusted monthly, requires monthly payments of principal and interest of $7,169 and matures on July 1, 2025.\nIn June 1994, the Company closed a construction mortgage note in the maximum amount of $10,864,000 for the development of the Oak Forest Apartments. The note which is recourse to the Company, bears interest at LIBOR plus 2.25% and has an original maturity date of June 30, 1997, with two optional one-year extensions. At December 31, 1995, the outstanding balance of the note was $10,609.000.\nUnder the terms of the loans, principal amortization requirements at December 31, 1995 are as follows for each of the next five years (in thousands):\nDuring 1993, the Company purchased the first mortgage loans on the Phase II Foxfire Apartments in Dallas and the Pecan Grove Apartments in Austin (properties in which the Company held, majority interests). The Pecan Grove first mortgage loan had a balance of $3,785,000 at December 31, 1993. The loan was discharged when the Company purchased the balance of the ownership interest in the Pecan Grove Apartments in 1994. The Phase II Foxfire (Dallas) first mortgage loan had a balance of $1,023,000 at December 31, 1994. Concurrent with the Company's acquisition of the loan, the mortgage note agreement was modified whereby an additional $74,000 was advanced to the property for capital improvements. In June 1995, the partnership that owned Phase II Foxfire refinanced the note. In August 1995, the Company purchased the remaining interest in the property and assumed the mortgage payable.\nAs a result of the sale of common stock in June 1993, the Company retired all of the remaining first mortgage indebtedness on its wholly-owned properties for $11,836,000 and purchased the first mortgage note underlying the mortgage note receivable on the Highland Oaks Apartments for $3,188,000 (see Note 4). Interest rates on these mortgage loans ranged from 8.75% to 9.5% per annum.\nNOTE 6 - CONSTRUCTION LOANS PAYABLE\nThe construction projects are financed with construction loans for approximately 70% of the estimated project costs. The Company funds the initial 30% of the estimated project costs from available funds or from draws on its line of credit (see Note 7). Thereafter, construction lenders fund construction costs upon periodic draws in accordance with specific construction loan agreements.\nOn January 13, 1994, the Company closed a construction mortgage note in the maximum amount of $19,800,000 for the development of the Promontory Pointe Apartments in San Antonio, Texas. The note, which is recourse to the Company, bears interest at a variable rate based on LIBOR plus 2.25% and has an original maturity date of January 13, 1996, with an optional six-month extension. In December 1995, the mortgage note was modified whereby the original maturity was extended to July 12, 1996, with three optional one-year extensions. At December 31, 1995 and 1994, the outstanding balance was $17,573,000 and $4,584,000, respectively.\nIn June 1994, the Company closed a construction mortgage note in the maximum amount of $7,354,000 for the development of Ashley Oaks Phase II in San Antonio, Texas. The note, which is recourse to the Company, bears interest at LIBOR plus 2.25% with an original maturity date of June 30, 1997, with two optional one-year extensions. At December 31, 1995, the outstanding balance of this note is $6,297,000. At December 31, 1994, no draws had been funded on this note.\nIn December 1994, the Company closed a construction mortgage note in the maximum amount of $12,402,000 for the development of the Sierra Palms Apartments in Chandler, Arizona. The note, which is recourse to the Company, bears interest at a variable rate based on LIBOR plus 2.25% and has an original maturity date of December 29, 1996, with three optional one-year extensions. At December 31, 1995, the outstanding balance was $3,884,000. At December 31, 1994, no draws had been funded on this note.\nIn April 1995, the Company closed a construction mortgage note in the maximum amount of $10,700,000 for the development of the Copper Mill Apartments in Durham, North Carolina. The note, which is recourse to the Company, bears interest at a variable rate based on LIBOR plus 2% and has an original maturity date of April 13, 1997, with three one-year extensions, each at the Company's option. At December 31, 1995, the outstanding balance was $4,501,000.\nIn September 1995, the Company closed a construction mortgage loan in the maximum amount of $18,250,000 for the development of the Providence Court Apartments in Charlotte, North Carolina. The note, which is recourse to the Company, bears interest at a variable rate based on LIBOR plus 2% and has an original maturity date of March 12, 1998, with two one-year and one six-month extensions, each at the Company's option. At December 31, 1995, the outstanding balance was $1,000.\nFor the years ended December 31, 1995 and 1994, the Company has capitalized interest expense of approximately $2,561,000 and $739,000, respectively, related to construction and development of properties.\nAt December 31, 1995, the Company had an interest rate swap agreement with a notional amount of $48,851,000. The Company has entered into the interest rate swap agreement to convert floating rate liabilities to fixed rate liabilities. The agreement fixes the interest rate on the Company's expected variable rate debt at 7.9% through April 1997. The Company does not hold or issue interest rate swap agreements for trading purposes. The Company is exposed to possible credit risk if the counterparty fails to perform, however, this risk is minimized by entering into the agreement with a highly rated counterparty. At December 31, 1995, there were no defaults under this agreement.\nNOTE 7 - REVOLVING LINE OF CREDIT\nOn September 15, 1994, the Company obtained a revolving line of credit in the maximum amount of $75,000,000. The line of credit, which is recourse to the Company, has a revolving period of 18 months, with a one-year extension at the lender's option, followed by an amortization period of two years. In October 1995, the Company requested and received a one-year extension to March 1997. The extension modified the interest rate during the revolving period from LIBOR plus 1.75% to LIBOR plus 1.50%. The agreement requires quarterly payments of a non-use fee equal to .25% per year calculated on the average unused portion of the line of credit. The Company can currently draw up to a total of $41,800,000 on the line of credit, which is secured by first liens on seven of the Company's wholly-owned properties. This amount may be increased as additional properties are added as security for the line of credit.\nNOTE 8 - CONVERTIBLE DEBENTURES\nIn 1992, the Company concluded an initial public offering of $55,000,000 in principal amount of 8% Convertible Debentures Due 2003. The Debentures could be converted into shares of common stock at any time after October 15, 1993 on the basis of $10.00 per share. In September 1995, the Company called the Debentures for redemption on October 16, 1995. As of October 16, 1995, $8,875,000 of the outstanding Debentures at September 30, 1995, were converted to 887,500 shares of common stock. The remaining $14,000 in Debentures were redeemed on October 16, 1995.\nDuring the year ended December 31, 1995 prior to call date, $4,640,000 in principal amount of Debentures due were converted to 464,000 shares of common stock. In addition, $220,000 of accrued Debenture interest that was forfeited by Debenture holders and $409,000 of unamortized Debenture issue costs were reclassified to equity.\nDuring the year ended December 31, 1994, $14,849,000 in principal amount of Debentures was converted to 1,484,900 shares of common stock. In addition, $115,000 of accrued Debenture interest that was forfeited by Debenture holders during 1994 and $617,000 of unamortized Debenture issue costs were reclassified to equity.\nNOTE 9 - RELATED PARTY TRANSACTIONS\nThe Company - The Company generally receives a computer services fee, and property and asset management fees in consideration for services provided for properties in which the Company has ownership interests. The Company received fees for these services aggregating $68,000 in 1995, $75,000 in 1994 and $92,000 in 1993 from affiliated, unconsolidated partnerships which have been included in other income for financial reporting purposes.\nIn connection with the Company's acquisition of the remaining partnership interests in the Sunflower Apartments in 1993, two of the Executive Officers and a Director of the Company received a total of $172,000 as consideration for their partnership interests.\nNOTE 10 - COMMITMENTS AND CONTINGENCIES\nOffice and equipment leases - The Company is obligated under a five-year lease for its main office in Dallas, Texas, which commenced in 1994. The Company is also obligated under leases for its regional offices. The regional office leases have terms ranging from nine months to five years. Minimum annual future rental payments under all leases are $278,000 in 1996, $248,000 in 1997, $234,000 in 1998, $171,000 in 1999 and $7,000 in 2000. The related rental expense in 1995, 1994 and 1993 was $261,000, $243,000 and $120,000, respectively.\nNOTE 11 - STOCKHOLDERS' EQUITY (DEFICIT)\nCapital stock - Common stockholders are entitled to one vote for each share held on all matters presented for a vote of stockholders. There is no right of cumulative voting in connection with the election of Directors. Stockholders are entitled to receive pro rata, any dividends declared by the Board of Directors in their discretion from funds legally available therefor. Upon liquidation or dissolution, stockholders are entitled to share ratably in all assets available for distribution to the stockholders, subject to the right of the holders of the Debentures then outstanding and to the rights of any preferred class of the Company's securities (if any are outstanding). The common stock issued is fully paid and non-assessable, has no conversion rights, and is not subject to redemption, except under certain circumstances determined by the Board of Directors.\nThe Company declared a special dividend to each record holder of shares of common stock on March 17, 1995, of one non-transferable right for each share held on such date. Four rights entitled the holder to purchase one share of common stock at a price of $11.875 per share (the \"Rights Transaction\"). On April 10, 1995, the Rights Transaction concluded with 985,440 shares purchased for total proceeds of $11,702,100. The net proceeds of approximately $11,400,000 were used to repay a portion of the line of credit.\nIn April 1995, the Company concluded a public offering of 1,714,560 shares of common stock at a price of $11.875 per share for gross proceeds of $20,360,400. The net proceeds of approximately $18,600,000 were used to repay a portion of the line of credit. During 1995, non-qualified options were exercised to purchase 275,000 shares of common stock at exercise prices ranging from $11.00 to $13.00. As of December 31, 1995, the Company had outstanding 20,319,405 shares of common stock and 1,718,000 non-qualified options to purchase common stock (of which 204,500 were vested) at exercise prices ranging from $11.00 to $13.00 per share.\nOn June 3, 1993, the Company closed its public offering of 10,350,000 shares of common stock at a price of $13.50 per share. The net proceeds from the offering (in the amount of $130,684,000) and the net proceeds from the REMIC Financing (See Note 5) were applied as follows: (i) approximately $141,146,000 (aggregate purchase price) to acquire a total of 19 apartment properties totaling 4,927 units (see Note 2); (ii) approximately $10,820,000 to acquire first mortgage debt on certain properties in which the Company held an interest; (iii) approximately $8,407,000 to retire all of the remaining debt on its wholly-owned properties; (iv) $12,500,000 to repay the revolving line of credit debt; and (v) approximately $2,600,000 as a reserve for additions to properties.\nDuring 1994, non-qualified options were exercised to purchase 55,000 shares of common stock at an exercise price of $11.00 each. In addition, $14,849,000 in principal amount of Debentures were converted to 1,484,900 shares of common stock. As of December 31, 1994, the Company had outstanding 16,182,019 shares of common stock and non-qualified options to purchase 1,467,000 shares of common stock (of which 161,500 were vested) at exercise prices ranging from $11.00 to $13.625 per share. The Company also had outstanding $13,529,000 in principal amount of Debentures (convertible into 1,352,900 shares of common stock).\nDuring 1995, the Company accepted notes receivable totaling $1,945,000 from certain officers and directors to exercise options to purchase common stock. The notes receivable, which mature on December 31, 2002, are in amounts up to 80% of the option exercise price and bear interest at the Applicable Federal Rate (as published by the Internal Revenue Service) at the date of exercise. Principal in the amount of 50% of the exercise price will be forgiven ratably over seven years beginning January 1, 1997, contingent upon continued service as an officer or director and the absence of any default on the notes. The balance of such loans will be payable ratably over the same period. The loans are secured by the common stock purchased. Options to purchase 275,000 shares of common stock were exercised, and 85,967 previously issued shares of common stock were applied (at the market price of such shares at the date of such application) to the exercise price of the options and were retired.\nEffective April 1, 1994, the Company entered into an employment agreement with an officer of the Company, Senior Vice President for the Charlotte Regional Office of the Company. In connection with this agreement, the officer purchased from the Company 115,000 shares of the Company's common stock for approximately $1,509,000 ($13.125 per share). In January 1995, his employment agreement was terminated, and pursuant to that agreement, the Company repurchased such shares at the purchase price he paid and cancelled such shares.\nFor the Company to qualify as a REIT under the Internal Revenue Code, not more than 50% in value of its outstanding common stock may be owned, directly or indirectly, by five or fewer individuals. In order to meet these requirements, the Directors of the Company are given power to refuse to recognize the transfer of a sufficient number of shares of common stock to maintain or bring the ownership of common stock of the Company into conformity with such requirements and to refuse the transfer of common stock to persons whose acquisitions thereof would result in a violation of such requirements.\nDividends - The Company paid dividends of $.25 per share of common stock for the first three quarters of 1995. The Company also declared a dividend of $.25 per share for the fourth quarter of 1995 (which it paid on January 17, 1996). Eighty-seven percent of the dividends paid in 1995 were characterized as ordinary income and eight percent of the dividends were characterized as capital gains for federal income tax purposes and five percent of the 1995 dividends were a return of capital.\nThe Company paid dividends of $.22 per share of common stock for the first quarter of 1994. The Company paid dividends of $.23 per share of common stock for the second, third and fourth quarters of 1994. Eighty-seven percent of the dividends paid in 1994 were characterized as ordinary income for federal income tax purposes and 13 percent of the 1994 dividends were a return of capital.\nThe characterization of the dividends for federal income tax purposes is made based upon the earnings and profits of the Company, as defined in the Internal Revenue Code, for the years ended December 31, 1995, 1994 and 1993, respectively.\nBeginning in 1995, the Company introduced a dividend reinvestment program that will allow its shareholders to acquire additional common shares from the Company at a 5% discount to the fair market price. The dividend reinvestment program also permits stockholders to purchase a limited number of additional shares of common stock on the same basis by making optional cash payments.\nStock Option Plans - In May 1992, the Company adopted an incentive and non-qualified stock option plan (the \"Stock Option Plan\") for the purpose of attracting and retaining the Company's directors, executive officers and other key employees (including any officer or director who is also an employee). A maximum of 1,200,000 shares of common stock were reserved for issuance under the Stock Option Plan. The Stock Option Plan allows for the grant of \"incentive\" and \"non-qualified\" options (within the meaning of the Internal Revenue Code) that are exercisable at a price that is at least equal to the fair market value of the shares of common stock at the date of the grant as established by the Compensation Committee of the Board of Directors. In May 1994, the Company's stockholders approved an amendment to the Stock Option Plan that increased the amount of shares reserved for issuance under the Stock Option Plan by 600,000 shares to a maximum of 1,800,000 shares. In 1995, the Company's stockholders approved the 1995 Omnibus Incentive Plan, which provides for the granting of stock options, SAR's, restricted shares and performance units. Under the 1995 plan, 3,000,000 shares were reserved for issuance subject to the limitation that the aggregate number of shares underlying outstanding awards (including those outstanding under the 1992 plan) not exceed approximately 10% of the Company's outstanding capital stock on a fully diluted basis. The shares vest over a period of up to 5 years and once vested must be exercised within 5 years. The Company accounts for its options to purchase shares of common stock in accordance with APB No. 25.\nDuring 1993, the Company granted options covering 75,000 shares of common stock to other key employees of the Company. These options also vest 20% per year over five years. The options have an exercise price equal to the closing market price of the stock at the date of grant (exercise prices range from $13.625 to $14.75); and once vested, these options may be exercised over a period of five years from the date of vesting.\nDuring 1994, the Company granted 600,000 options to purchase a like number of shares of common stock at an exercise price of $13.00 and 100,000 options to purchase a like number of shares at $11.00. The exercise prices reflect the closing price of the shares on the date of each grant. The options vest over a period of up to five years (the first vesting date generally being one year from the date of grant). Once vested, these options may be exercised over a period of five years from the date of vesting. Additionally, 233,000 options previously granted were forfeited (and became available for reissuance) due to employee attrition.\nDuring 1995, 626,000 options to purchase shares of common stock at exercise prices ranging from $11.50 to $13.00 each were granted pursuant to the Company's non-qualified employee stock option plan, and 100,000 options previously granted were forfeited due to employee attrition. As of December 31, 1995, the Company had outstanding 1,718,000 options to purchase common stock (of which 204,500 are vested).\nRights Agreement - In August 1994, the Company declared a dividend of one right (the \"Right\") for each outstanding share of the Company's common stock. The Rights do not become detached from the common stock until the occurrence of a triggering event such as a tender offer or acquisition by a person (or related parties) of 10% or more of the Company's outstanding common stock. At that time, the Rights (which expire in August 2004) may be exercised, except by the party causing the triggering event, to purchase for $30 an amount of common stock from the Company having an aggregate market value of $60.\nNOTE 12 - PROFIT SHARING AND SAVINGS PLAN\nThe Company has a 401(k) plan for all full-time employees who have been employed for at least 12 months. Eligible employees may contribute up to 15% of their gross pay, subject to certain limitations. In 1995, 1994 and 1993 the Company matched 50% of the amount contributed by the employee, up to 10% of the employee's gross pay. In 1995, 1994 and 1993, expenses include $76,000, $53,000 and $44,000, respectively, representing the employer's matching contribution to the plan.\nNOTE 13 - QUARTERLY FINANCIAL DATA (Unaudited)\nUnaudited summarized financial data by quarter for 1995 and 1994 is as follows (in thousands, except per share data):\nExhibit 22.1\nSubsidiaries of the Registrant\nSOUTH WEST PROPERTY TRUST INC. SUBSIDIARIES AND AFFILIATES OF THE COMPANY As of December 31, 1995\nSWP Properties, Inc. SWP REMIC Properties II-A, L.P. SWP Creeks Properties, Inc. Windridge Apartments SWP Woodscape Properties, Inc. Pecan Grove Apartments SWPT II Arizona Properties, Inc. Westlake Villas Apartments SWP REMIC Properties II, Inc. Foxfire (Amarillo) Apartments South West REIT Holding, Inc. Woodtrail Apartments SWP Developers, Inc. Bluffs Apartments Little Rock Apartment Management, Inc. Chandlers Mill Apartments SWP Depositor, Inc. Alvarado Apartments SRL Amarillo Investors, Inc. Catalina Apartments SWP Arkansas Properties, Inc. Citiscape Apartments Turtle Creek Apartments Park Trails Apartments MF-SWP Joint Venture Pavilion Apartments Promontory Pointe Apartments Preston Oaks Apartments SWP Creeks, L.P. Vista Point Apartments Creeks Apartments South West Properties, L.P. SWP Woodscape I, L.P. Sunflower Apartments Woodscape Apartments Shadow Lake Apartments SWP Properties I, L.P. Hunters Ridge Apartments Rock Creek Apartments Timbercreek Apartments Bluff Creek Apartments Southern Oaks Apartments Preston Trace Apartments Oak Park Apartments Wimbledon Court Apartments Dove Park Apartments Autumnwood Apartments Sunset Pointe Apartments Cobblestone Apartments Ashley Oaks 2 Apartments Summergate Apartments Oak Forest Apartments Lakeridge Apartments Foxfire (Dallas) Apartments Ryan's Mill Apartments High Ridge Apartments Greenway Park Apartments Sierra Palms Apartments Ashley Oaks Apartments Copper Mill Apartments Providence Court Apartments\nExhibit 23.1\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Form S-3 No. 33-70858, Form S-3 No. 33-59526, Form S-8 No. 33-67452 (pertaining to the 1992 Nonqualified Stock Option Plan) of South West Property Trust Inc. and in the related Prospectuses of our report dated January 30, 1996, with respect to the consolidated financial statements and schedule of South West Property Trust Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1995.\nERNST & YOUNG LLP\nDallas, Texas February 20, 1996","section_15":""}
{"filename":"777201_1995.txt","cik":"777201","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nNoble Drilling Corporation is a leading provider of diversified services for the oil and gas industry worldwide. The Company's activities include offshore and land drilling services, turnkey drilling services and engineering and production management services. The Company's drilling fleet is broadly diversified, allowing it to work in a variety of operating conditions.\nNoble Drilling Corporation (\"Noble Drilling\") was organized as a Delaware corporation in 1939. Noble Drilling and its predecessors have been engaged in the contract drilling of oil and gas wells for others domestically since 1921 and internationally during various periods since 1939. As used herein, unless otherwise required by the context, the term \"Noble Drilling\" refers to Noble Drilling Corporation and the term \"Company\" refers to Noble Drilling and its consolidated subsidiaries.\nBUSINESS STRATEGY\nThe Company's business strategy has been to expand its international and deepwater offshore capabilities through acquisitions, redeployments and rig modifications, and to position itself in geologically promising areas. The Company has actively pursued its strategy in recent years. During 1995, the Company increased its international presence by transferring two independent leg jackup rigs and one mat slot rig from the U.S. Gulf of Mexico to the West Coast of Africa. The Company also transferred one of its two rigs located in Mexico to Qatar during 1995. The domestic land drilling operations of the Company have become less significant as the Company has emphasized its offshore and international operations.\nThe offshore contract drilling industry has, in recent years, experienced a series of asset sales and consolidations among drilling contractors, and the Company expects this trend to continue as drilling contractors position themselves strategically in the market. The Company, from time to time, has discussions with third parties regarding asset acquisitions or business combinations and intends to continue to consider business opportunities that it believes promote this business strategy.\nThe Company's revenues are balanced between international and domestic sources. The following table sets forth, for the periods indicated, the percentages of international and domestic operating revenues:\nACQUISITION OF ASSETS\nIn October 1995, the Company purchased two jackup drilling units and related equipment for a total of $10,100,000 in cash. The Azteca, which the Company plans to rename the Gene Rosser after the pending purchase of that rig is completed, and the Maya are both Levingston 111, 300-foot, independent leg jackup rigs. The Azteca is currently located in a shipyard undergoing refurbishment and conversion to a cantilever rig. The Maya is scheduled to commence such refurbishment and cantilever modification in the second quarter of 1996.\nRECENT DEVELOPMENTS\nLETTER OF INTENT TO PURCHASE ASSETS OF NEDDRILL\nOn March 13, 1996, the Company entered into a letter of intent with Royal Nedlloyd N.V. and its wholly owned subsidiary, Neddrill Holding B.V. and its subsidiaries (collectively, \"Neddrill\"), to acquire the assets, including $25,000,000 in net working capital, and the personnel used by Neddrill in its offshore contract drilling, accommodation and other oil and gas exploration and production related service businesses. The purchase price would be $300,000,000 in cash plus 5,000,000 shares of Noble Drilling common stock. The Company currently plans to access the public securities markets to finance the cash portion of the purchase price.\nNeddrill's operations are managed from its headquarters in Rotterdam, The Netherlands. Its fleet includes two dynamically positioned drillships, one of which is currently operating in Angola, the second in Brazil; one second generation semisubmersible rig operating in the North Sea, and six harsh environment jackup drilling rigs (five operating in the North Sea and one in Argentina). Neddrill operates a third dynamically positioned drillship in which it owns a partial interest through a joint venture arrangement. In addition, the Company would acquire rights, under a bareboat charter, to a seventh harsh environment jackup rig operating as a hotel accommodation unit in the North Sea. All the above units are currently under contract, with commitments extending through 1997 to 2001, depending on the unit.\nNegotiations have reached the stage that justifies the expectation that an agreement on the proposed acquisition can be reached. Notices have been given by Nedlloyd to the Social and Economic Council in The Netherlands and the Central Works Council of Nedlloyd in accordance with applicable laws, regulations and practices in The Netherlands.\nConsummation of the acquisition is subject to customary due diligence, execution and delivery of an agreement of sale and purchase, financing being obtained by the Company, and satisfaction of customary closing conditions expected to be contained in the agreement of sale and purchase.\nASSET RATIONALIZATION PROGRAM\nConsistent with the Company's plan to focus on deepwater drilling, the Company has sold one of its posted barge units (Gus Androes) and has contracted to sell a second posted barge unit (Gene Rosser). The closing of the sale of this second barge unit is scheduled to occur on or before March 29, 1996.\nThe Company plans to use the net proceeds from these sales, together with working capital if needed, to enhance the deepwater capability of its fleet. On February 26, 1996, the Company purchased the Odin Explorer, to be renamed the Gus Androes, a 300-foot independent leg cantilevered jackup rig located offshore Sharjah, U.A.E. This rig has been stacked and will require substantial refurbishment prior to being returned to service. In addition, the Company received notification on March 6, 1996 of acceptance of its offer to purchase the rig Dana, a 250-foot independent leg cantilevered jackup rig, which is currently under a management contract in Qatar.\nLINN RICHARDSON DAMAGE\nOn December 15, 1995, the Linn Richardson, a 250-foot mat slot rig, lost overboard approximately 200 feet of leg while under tow to perform a contract offshore Senegal, Africa. On the following day, the rig lost overboard approximately 240 feet of a second leg which also caused damage to equipment and facilities on the deck of the rig. Pursuant to a preliminary assessment plan developed jointly by the Company and its insurance underwriters, the third leg of the rig has been removed and the rig has been towed to the U.S. Gulf of Mexico where a complete evaluation will take place. A charge of $1,778,000 related to the cost of mobilizing the rig to Senegal was accrued in the fourth quarter of 1995. This amount represents management's best estimate of the total loss. Management does not believe this incident will have any other material adverse effect on its financial condition or results of operations.\nRIG UTILIZATION\nThe following table sets forth the average rig utilization rates for the Company's rig fleet for the periods indicated:\n- ------------------------\n(1) Information reflects the policy of the Company to report utilization rates based on the number of actively marketed rigs owned in the fleet. During the periods presented, the Company purchased and sold certain drilling rigs. Utilization rates for the periods prior to sales and purchases of such rigs have not been adjusted.\nDRILLING CONTRACTS\nThe Company's drilling contracts are obtained through competitive bidding or as a result of negotiations with customers. Contracts for land rigs are normally for a single well, while contracts involving offshore drilling frequently are\nfor a period of time and may involve several wells. The Company's offshore drilling is normally contracted on a dayrate basis, except for its turnkey operations (see \"Business - Turnkey Drilling and Engineering Services\"). Land drilling is performed on either a dayrate or a footage basis. The risk of loss to the Company on wells drilled on a turnkey or footage basis is significantly higher than on wells drilled on a dayrate basis.\nOFFSHORE DRILLING OPERATIONS\nThe Company's offshore drilling operations are conducted worldwide. Principal regions of operations currently include the Gulf of Mexico, West Africa, Venezuela and, to a lesser extent, India, Mexico and Qatar. The offshore fleet consisted of 46 rigs, comprising 35 jackup drilling rigs, eight submersible rigs and three posted barges at February 26, 1996. For information regarding recent changes in the composition of the Company's fleet, see \"Business - Recent Developments.\"\nIn 1995, one of the Company's customers, Lagoven, a subsidiary of the government-owned oil company of Venezuela, accounted for approximately 11 percent of the Company's total operating revenues.\nINTERNATIONAL CONTRACT DRILLING\nThe Company's international offshore contract drilling operations are conducted in Nigeria, Venezuela, Qatar, Zaire, Mexico, and India. At February 26, 1996, the Company's international offshore contract drilling fleet consisted of 19 rigs, of which 15 were working under contract, one was available for bidding, one was under contract for sale, one was in the shipyard, and one was under evaluation following damages sustained during transportation.\nIn 1995, approximately 55 percent of the Company's international offshore contract drilling revenues was derived from contracts with major oil and gas companies, 37 percent from government-owned companies and the balance from contracts with independent operators.\nThe Company has seven jackup rigs and two posted barges located along the West Coast of Africa. Six of the jackup rigs are under long-term contracts extending through dates ranging from December 1996 to June 1998, with major oil companies. The seventh jackup rig is available for work. The two posted barges are under contract through June 1996. A third posted barge has been transported recently from Nigeria to Singapore in connection with its impending sale.\nThe Company has four jackup rigs located in Venezuela. Three of these rigs are under long-term contracts extending through dates ranging from July 1997 to June 2000. The fourth is working under a well-to-well contract.\nThe Company also has a jackup rig working in Qatar under a long-term contract that expires in 1998, a jackup rig working in India under a long-term bareboat charter agreement that expires in September 1996 and a jackup rig working in Mexico under a long-term contract that expires in November 1996. The recently purchased Odin Explorer is located in Sharjah, U.A.E.\nDOMESTIC CONTRACT DRILLING\nThe Company's domestic offshore contract drilling fleet consisted of 27 rigs at February 26, 1996, of which 18 were working under contract, two were being refurbished, and seven were being held in various stages of readiness to enter the marketplace. The Company continually evaluates the economics of re-entering the market with these rigs and expects to do so when conditions warrant.\nTwo of the Company's independent slot rigs, the Eddie Paul and the John Sandifer, completed refurbishment projects in 1995. The Eddie Paul was converted to an Extended Reach Cantilever (\"ERC\") rig to enable this unit to drill over larger platforms. This rig's legs were extended from 467 feet to 500 feet to increase the water depth capacity to approximately 390 feet. A top drive drilling system and cascading mud system were also installed on this rig. The modifications make the Eddie Paul the largest rig in the Gulf of Mexico in terms of cantilever reach and one of the largest in terms of water depth. The John Sandifer was converted to a cantilever rig with a top drive system and cascading mud system to make the rig more versatile. The total cost of these two projects approximated $35,134,000 over 1994 and 1995. Both rigs were contracted for work prior to completion of shipyard work and have been under contract since departure from the shipyard.\nIn 1995, approximately 55 percent of the Company's domestic offshore contract drilling revenues was derived from contracts with major oil and gas companies and the remaining 45 percent was derived from contracts with independent operators.\nLABOR CONTRACTS\nThe Company's offshore operations also include labor contracts for drilling and workover activities covering 13 rigs operating in the U.K. North Sea and one offshore rig operating in Qatar. These rigs are not owned or leased by the Company. Under its labor contracts, the Company provides the personnel necessary to manage and perform the drilling operations from drilling platforms owned by the operator. The contracts are generally renewable no more frequently than on an annual basis. After drilling operations are completed, workover operations usually become an important element of each platform's activity. Thus, drilling contractor crews usually remain on the platform until a field is depleted by production.\nThe Company was awarded a contract in 1994 by Hibernia Management and Development Company Ltd. for offshore production drilling and related services. The contract calls for the Company to commission, operate and maintain two state-of-the-art platform rigs to be installed on the concrete gravity-based structure that will be used to develop the Hibernia field off the coast of Newfoundland. The Company established an office in St. Johns, Newfoundland in late 1994. A team of six experienced personnel are employed in St. Johns and are presently participating in the preparation of operating, equipment maintenance and procedures manuals, and the procurement of equipment. Commissioning of the drilling and related equipment will commence in May 1996 through November 1996. The gravity-based structure is scheduled for tow out to location in May 1997, with commencement of the first well scheduled to occur in early September 1997. The Company has a five-year contract with Hibernia with an option for a five-year extension. It is anticipated that the Company will have approximately 120 employees assigned to this project at its peak in 1997.\nLAND DRILLING OPERATIONS\nThe Company's land drilling operations are conducted in Canada, Texas and Louisiana. At February 26, 1996, 19 of the Company's 46 land rigs were available for active bidding by the Company. Of these 19 rigs, 10 were located in the United States and nine were located in Canada. Thirteen of the 19 actively-marketed rigs were operating under contract and six were available for bidding at that date. Twenty-seven rigs were stacked and not being actively marketed. The remaining net book value of these stacked rigs is not material. The Company's domestic land drilling operations have become less significant as the Company has emphasized its offshore and international operations.\nTURNKEY DRILLING AND ENGINEERING SERVICES\nThrough its wholly owned subsidiary, Triton Engineering Services Company (\"Triton\"), the Company provides turnkey drilling, drilling project management, drilling and completion planning and design, specialized drilling tools and services, and contract engineering and consulting manpower. Turnkey drilling, Triton's major service, involves the coordination of all equipment, materials, services and management to drill a well to a specified depth, for a fixed price. Under turnkey drilling contracts, Triton bears the financial risk of delays in the completion of the well. In providing its services, Triton can use drilling rigs owned either by the Company or by a third party, depending on availability. The drilling of a turnkey well is generally completed within 30 to 50 days. Twenty-seven wells were completed by Triton in 1995 compared to 35 wells for 1994. Seven of the 35 wells were completed prior to the Company's acquisition of Triton in April 1994. Revenues from turnkey drilling services represented 22 percent and 16 percent of consolidated operating revenues in 1995 and 1994, respectively. The revenue percentage for 1994 consists of Triton's revenues from the time of the acquisition in April 1994 through year end 1994.\nThe Company provides engineering services relating primarily to the design of drilling equipment for offshore development and production services and to the recertification of oilfield equipment. The Company works, on a contract basis, with operators and prime construction contractors of drilling and production platforms in the design of drilling equipment configurations aimed at optimizing the operational efficiency of developmental drilling by maximizing platform space utilization and load capability.\nThrough its operations in Venezuela, the Company provides engineering services in the form of an alliance program with Lagoven. The Company utilizes its own drilling rigs and employs Triton personnel for the engineering and operating expertise.\nCOMPETITION AND RISKS\nThe contract drilling industry is a highly competitive and cyclical business characterized by high capital and maintenance costs. Although conditions in recent years in the oil and gas industry have precipitated consolidation of industry participants, there remains an oversupply of drilling equipment. As a consequence, there has been intense competition for available drilling contracts resulting in much equipment being idle for long periods of time and generally unfavorable terms and prices for contract drilling. Certain competitors of the Company may have access to greater financial resources than the Company.\nCompetition in contract drilling involves numerous factors, including price, the experience of the work force, rig availability and suitability, efficiency, condition of equipment, operating integrity, reputation, industry standing and customer relations. Price is the major consideration in most markets, especially with respect to domestic drilling. The Company believes it competes favorably with respect to all these factors. The acquisition of Triton has enabled the Company to compete more effectively in the turnkey drilling market. Competition is primarily on a regional basis and may vary significantly by region at a particular time. Demand for land and offshore drilling equipment is also dependent on the exploration and development programs of oil and gas producers, which are in turn influenced by the financial condition of such producers, by general economic conditions and prices of oil and gas, and, from time to time, by political considerations and policies.\nIt is impracticable to estimate the number of competitors of the Company. Many independent drilling contractors in recent years have sought protection from creditors under bankruptcy laws or have combined with other companies as a result of the depressed conditions in the contract drilling industry. Although this has reduced the total number of competitors, management of the Company believes that competition for drilling contracts will continue to be intense for the foreseeable future.\nThe Company follows a policy of keeping its equipment well maintained and technologically competitive. However, its equipment could be made obsolete by the development of new techniques and equipment. In addition, industry-wide shortages of supplies, services, skilled personnel and equipment necessary to conduct the Company's business, such as drill pipe, have occurred from time to time in the past, and such shortages could occur again.\nThe Company's operations are subject to the many hazards inherent in the drilling business, including blowouts, cratering, fires and collisions or groundings of offshore equipment, which could cause substantial damage to the environment. In addition, the Company's operations are subject to damage or loss from adverse weather and seas. These hazards could cause personal injury and loss of life, suspend drilling operations or seriously damage or destroy the property and equipment involved and, in addition to environmental damage, could cause substantial damage to producing formations and surrounding areas. Although the Company maintains insurance against many of these hazards, such insurance is subject to substantial deductibles and provides for premium adjustments based on claims. It also excludes certain matters from coverage, such as loss of earnings on certain rigs. Also, while the Company generally obtains indemnification from its customers for environmental damage with respect to offshore drilling, such indemnification is generally only in excess of a specified amount, which typically ranges from $100,000 to $250,000.\nIn the case of the turnkey drilling operations, the Company maintains insurance against pollution and environmental damage in amounts ranging from $5,000,000 to $50,000,000 depending on location, subject to self-insured retentions of $25,000 to $1,000,000. Under turnkey drilling contracts, Triton generally assumes the risk of pollution and environmental damage, but on occasion receives indemnification from the customer for environmental and pollution liabilities in excess of Triton's pollution insurance coverage. Further, Triton is not insured against certain drilling risks that could result in delays or nonperformance of a turnkey drilling contract, although it generally maintains insurance against delays related to loss of well control. Triton typically obtains contractual indemnification from the drilling contractors that provide the rigs for Triton's turnkey drilling operations for pollution arising from certain acts of such contractors.\nThe Company's international operations are also subject to certain political, economic and other uncertainties including, among others, risks of war and civil disturbances, expropriation, nationalization, renegotiation or modification of existing contracts, taxation policies, foreign exchange restrictions, international monetary fluctuations and other hazards arising out of foreign governmental sovereignty over certain areas in which the Company conducts operations. The Company has insurance covering expropriation and other political risks to the extent available to the Company at rates it considers prudent to pay.\nGOVERNMENTAL REGULATION AND ENVIRONMENTAL MATTERS\nMany aspects of the Company's operations are affected by domestic and foreign political developments and are subject to numerous governmental regulations that may relate directly or indirectly to the contract drilling industry. The regulations applicable to the Company's operations include certain provisions that regulate the discharge of materials into the environment or require remediation of contamination, under certain circumstances. Usually these environmental laws and regulations impose \"strict liability,\" rendering a person liable without regard to negligence or fault on the part of such person. Such environmental laws and regulations may expose the Company to liability for the conduct of, or conditions caused by, others, or for acts of the Company that were in compliance with all applicable laws at the time such acts were performed.\nThe U.S. Oil Pollution Act of 1990 (\"OPA '90\") and the regulations promulgated pursuant thereto impose certain additional operational requirements on the Company's domestic offshore rigs and govern liability for leaks, spills and blowouts. Regulations under OPA '90 may increase the level of financial assurance required of owners and operators of rigs in the waters of the United States. The Company has monitored these regulations and does not believe that they are likely to have a material adverse effect on the Company's financial condition or results of operations.\nThe Company has made and will continue to make expenditures to comply with environmental requirements. The Company does not believe that it has to date expended material amounts in connection with such activities or that compliance with such requirements will have a material adverse effect upon its capital expenditures, results of operations or competitive position. Although such requirements do have a substantial impact upon the energy and energy services industries, generally they do not appear to affect the Company any differently or to any greater or lesser extent than other companies in the energy services industry.\nThe Company believes that insurance in place and indemnities the Company generally seeks to include in its drilling contracts provide the Company with an appropriate degree of protection from liability resulting from current governmental regulation that might have a material adverse effect on the Company, including environmental regulation. However, notwithstanding the indemnity coverage provided to, and insurance coverage carried by, the Company, the occurrence of a significant event not fully indemnified against or insured for or the failure of a customer to meet its indemnification obligations could materially and adversely affect the Company's operations and financial condition.\nThe modification of existing laws or regulations or the adoption of new laws or regulations curtailing exploratory or development drilling for oil and gas for economic, environmental or other reasons could materially and adversely affect the Company's operations by limiting drilling opportunities.\nEMPLOYEES\nAt December 31, 1995, the Company had approximately 2,977 employees, of whom 56 percent were engaged in international operations and 44 percent were engaged in domestic operations. Over many years, the Company has developed and maintained a well-trained and experienced workforce.\nThe Company is not a party to any collective bargaining agreements that are material to the Company. The Company considers its employee relations to be satisfactory.\nAlthough there continues to be an oversupply of drilling equipment industry-wide, shortages of supplies and equipment, as well as qualified personnel for rig crews, have occurred from time to time in the past. A substantial increase in demand for oilfield services could make it more difficult to retain and recruit qualified rig crew members without significant increases in compensation.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS\nInformation regarding operating revenues, operating income and loss, and identifiable assets attributable to each of the Company's geographic areas of operations for the last three fiscal years is presented in Note 15 of Notes to Consolidated Financial Statements included elsewhere herein.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDRILLING RIG FLEET\nOFFSHORE DRILLING RIGS\nThe Company's offshore drilling rig fleet consisted of 35 jackup rigs, eight submersible rigs and three posted barges at February 26, 1996. Each type of rig is described further below. There are several factors that determine the type of rig most suitable for a particular job, the more significant of which include the water depth and bottom conditions at the proposed drilling location, whether the drilling is being done over a platform or other structure, and the intended well depth.\nSeventeen of the Company's 46 offshore rigs have a top drive unit, and the Company has three additional top drive units which have not been installed on rigs. A top drive unit is a technologically-advanced drilling tool used in many drilling applications both offshore and on land. Twenty-eight of the Company's 46 offshore rigs are equipped with cascading solids control systems. A cascading solids control system is a highly efficient method for controlling the solids in drilling mud, the use of which enhances removal of well bore cuttings and results in better bit performance and reduced mud conditioning costs to the operator. In addition, ten of the Company's 46 offshore rigs are equipped with zero discharge capability.\nJACKUP RIGS. The Company had 35 jackup rigs in the fleet at February 26, 1996. Jackup rigs are mobile self-elevating drilling platforms equipped with legs which can be lowered to the ocean floor until a foundation is established to support the drilling platform. The rig hull includes the drilling rig, jacking system, crew quarters, loading and unloading facilities, storage areas for bulk and liquid materials, helicopter landing deck and other related equipment. The rig legs may operate independently or have a mat attached to the bottom of them in order to provide a more stable foundation in soft bottom areas. Twenty-two of the Company's jackup rigs are independent leg rigs and 13 are mat supported rigs. Moving a rig to the drill site involves jacking up its legs until the hull is floating on the surface of the water. The hull is then towed to the drill site by tugs and the legs are jacked down to the ocean floor. The jacking operation continues until the hull is raised out of the water and drilling operations are conducted with the hull in its raised position. A cantilevered jackup has a feature that permits the drilling platform to be extended out from the hull, allowing it to perform drilling or workover operations over pre-existing platforms or structures. Slot type jackup rigs are configured for the drilling operations to take place through a slot in the hull. The Company's jackup rigs are capable of drilling to a maximum depth of 25,000 feet in water depths ranging between 8 and 390 feet, depending on the jackup rig.\nSUBMERSIBLE RIGS. The Company had eight submersibles in the fleet at February 26, 1996. Submersible rigs are mobile drilling platforms which are towed to the drill site and submerged to drilling position by flooding the lower hull until it rests on the sea floor, with the upper deck above the water surface. The Company's submersible rigs are capable of drilling to a maximum depth of 30,000 feet in water depths ranging between 12 and 100 feet, depending on the submersible rig.\nPOSTED BARGES. The Company had three posted barges in the fleet at February 26, 1996. Use of the posted barge is not part of the Company's long-term strategic objectives. See \"Business - Business Strategy\" and \"Business - - Recent Developments.\"\nThe following table sets forth certain information concerning the Company's offshore drilling rig fleet at February 26, 1996. The table does not include 14 offshore rigs owned by operators for which the Company had labor contracts as of February 26, 1996. Unless otherwise indicated, the Company owns and operates the rigs included in the table.\nOFFSHORE DRILLING RIGS\n- ------------------------ (1) Type codes are defined as follows: IC .... Independent Leg Cantilevered jackup rig IS .... Independent Leg Slot jackup rig MC .... Mat Supported Cantilevered jackup rig MS .... Mat Supported Slot jackup rig (2) Rigs designated with an \"R\" were modified, refurbished, or otherwise upgraded in such year by capital expenditures in an amount material to the net book value of such rig.\n(FOOTNOTES CONTINUED ON FOLLOWING PAGE)\n(3) Rigs listed as \"active\" were operating under contract and rigs listed as \"available\" were available for bidding as of February 26, 1996. Rigs listed as \"stacked\" were not operating under contract and were either in need of expenditures to reactivate or not being actively marketed at such date. Rigs listed as \"shipyard\" are undergoing refurbishment. The rigs listed as \"stacked\" were protected at the time of deactivation, utilizing procedures recommended by the original equipment manufacturer. A rig that has undergone this deactivation procedure generally takes less cost and lead time in order to be returned to active service than a rig that has not undergone such procedure.\n(4) Equipped with a top drive unit.\n(5) Bareboat chartered to a third party under which the Company maintains operating control of the rig.\n(6) Although the rig is designed to drill in a maximum water depth of 300 feet, the rig is currently equipped with legs adequate to drill in approximately 125 feet of water. The Company has fabricated an additional 120 feet of legs, which will be installed in 1996.\n(7) Owned by NN-1 Limited Partnership, of which Noble Drilling is the general partner and in which it has a majority interest. The rig is mortgaged under a first preferred ship mortgage in favor of the United States government to secure repayment of the U.S. Government Guaranteed Ship Financing Sinking Fund Bonds issued in 1978 by the predecessor of the partnership in connection with the construction and purchase of the rig.\n(8) Reactivation project completed in January 1996.\n(9) Purchased February 26, 1996.\nLAND DRILLING RIGS\nThe Company's land drilling fleet consists of 46 rigs, of which 19 are being or can be actively bid by the Company. See \"Business - Land Drilling Operations.\" Intended well depth, drill site conditions and drilling applications are the principal factors in determining the size and type of land rig to be used for a particular job. Of the 19 actively bid rigs in the fleet, seven are mechanical and 12 are electric. Mechanical land rigs transmit the engine power to the rig equipment through converters, compounds, chains and V-belts. Electric land rigs transmit the engine power to rig equipment through generators and electric cables to electric motors on the rig components.\nThe following table sets forth certain information concerning the Company's 19 actively bid land drilling rigs at February 26, 1996. The table does not include 27 mothballed or stacked rigs.\nLAND DRILLING RIGS\n(FOOTNOTE ON FOLLOWING PAGE)\n- ------------------------\n(1) Rigs listed as \"active\" were operating under contract and rigs listed as \"available\" were available for bidding at February 26, 1996.\nNoble Canada Ltd. owns nine land rigs, five of which are pledged as collateral to secure a $1,000,000 credit facility of such company. There was no amount outstanding under such facility at December 31, 1995.\nFACILITIES\nThe Company's principal executive offices are located in Houston, Texas, and leased through the year 2000. The Company also leases administrative and marketing offices, and sites used primarily for storage, maintenance and repairs for drilling rigs and equipment in Williston, North Dakota; Evanston and Casper, Wyoming; New Orleans and Lafitte, Louisiana; Calgary and St. Johns, Canada; Warri, Lagos and Port Harcourt, Nigeria; Aberdeen, Scotland; Maracaibo and Cuidad Ojeda, Venezuela; and Doha, Qatar.\nThe Company owns certain tracts of land, including office and administrative buildings, warehouse facilities and a manufacturing facility, in Harris and Waller Counties, Texas; Lafayette, Shreveport and Bayou Black, Louisiana; Nisku, Canada; Aberdeen, Scotland; and Tulsa and Oklahoma City, Oklahoma.\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 certain of its property is the subject. The Company is involved in certain routine litigation incidental to the business of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information as of March 4, 1996 with respect to the executive officers of Noble Drilling.\nJames C. Day has served as Chairman of Noble Drilling since October 22, 1992, and as President and Chief Executive Officer since January 1, 1984. From January 1983, until his election as President and Chief Executive Officer, Mr. Day served as Vice President of Noble Drilling. Prior to 1983, Mr. Day served as Vice President and Assistant Secretary of Noble Affiliates, Inc. He has been a director of Noble Drilling since 1984. Mr. Day is also a director of Global Industries Limited, Noble Affiliates, Inc., and the YMCA of Greater Houston.\nByron L. Welliver has served as Senior Vice President - Finance of Noble Drilling since April 1989, as Treasurer of Noble Drilling since July 1986, and as Controller of Noble Drilling since September 1994. Mr. Welliver had served as Controller from April 1989 to April 1991. From July 1986 to April 1989, he also served as Vice President - Finance for Noble Drilling. He joined Noble Drilling in October 1985, as Controller. Prior to joining Noble Drilling, Mr. Welliver served consecutively as Tax Manager, Controller and Treasurer of Noble Affiliates, Inc. beginning in March 1981.\nJulie J. Robertson has served as Corporate Secretary of Noble Drilling since December 1993, and as Vice President - Administration of Noble Drilling Services Inc. since September 1994. From January 1989 to September 1994, Ms. Robertson served consecutively as Manager of Benefits and Director of Human Resources. Prior to 1989, she served in the capacities of Risk and Benefits Manager and Marketing Services Coordinator for Bawden Drilling Inc. Ms. Robertson joined Bawden Drilling Inc. in 1979.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nNoble Drilling's Common Stock, par value $.10 per share (\"Common Stock\"), is traded in the Nasdaq National Market under the symbol \"NDCO.\" The following table sets forth for the periods indicated the high and low sales prices of the Common Stock as reported in the Nasdaq National Market. Application has been made to list the Common Stock and the $1.50 Convertible Preferred Stock on the New York Stock Exchange.\nThe Company has not paid any cash dividends on the Common Stock since becoming a publicly held corporation in October 1985, and does not anticipate paying dividends on the Common Stock at any time in the foreseeable future. The outstanding $1.50 Convertible Preferred Stock of the Company has priority as to dividends over the Common Stock, and no dividend (other than dividends payable solely in Common Stock) may be declared, paid or set apart for payment on the Common Stock unless all accrued and unpaid dividends on such preferred stock have been paid or declared and set apart for payment. Furthermore, certain provisions of the indenture governing the Company's 9 1\/4% Senior Notes Due 2003 issued in 1993 restrict the Company's ability to pay cash dividends on the Common Stock.\nAt March 4, 1996, there were 2,360 record holders of Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- -------------------\n(1) The Selected Financial Data presents the restatement of the Company's historical financial statements for 1994 and prior periods to reflect the 1994 merger of Chiles Offshore Corporation (\"Chiles\") into Noble Offshore Corporation (\"NOC\"), a wholly-owned subsidiary of the Company, which was accounted for as a pooling of interests. The Selected Financial Data also includes the acquisition of Triton in April 1994 and the October 1993 acquisition of nine offshore rigs and associated assets from The Western Company of North America, both of which were accounted for under the purchase method.\n(2) Consists of operating costs and expenses other than depreciation and amortization, selling, general and administrative, minority interest, restructuring charges and write-down of assets charges.\n(3) Effective January 1, 1995, the Company revised its estimates of salvage values and remaining depreciable lives of certain rigs. The effect of this change was a reduction to depreciation and amortization of $6,160,000, or $0.07 per common share for the year ended December 31, 1995.\n(4) Consists of provisions resulting from write-downs of certain assets, facility consolidation costs and, to a lesser extent, severance costs.\n(5) Consists of a gain on extinguishment of debt in 1993 and a gain on an insurance settlement in 1991.\n(6) Net (loss) income applicable to common shares per share before extraordinary item was $0.20 and $(0.92) for the years ended December 31, 1993 and 1991, respectively. Loss applicable to common shares per share from discontinued operations was $(0.07) and $(0.04) for the years ended December 31, 1992 and 1991, respectively.\n(7) Chiles reclassified $50,500,000 of its outstanding indebtedness from long-term to current liabilities in 1991.\n(footnotes continued on following page)\nThis reclassification was made because as of December 31, 1991, Chiles anticipated not being able to remain in compliance, and subsequently was not able to remain in compliance, with all of the terms of its debt agreements.\n(8) Consists of short-term debt and current installments of long-term debt and long-term debt.\n(9) Includes the $0.02 per share effect of the March 1995 preferred conversion payment related to the conversion of 923,862 shares of the Company's $2.25 Convertible Exchangeable Preferred Stock. The payment of $1,524,000 was accounted for as a reduction of net earnings applicable to common shares when calculating the net loss per common share.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe following discussion is intended to assist in understanding the Company's financial position as of December 31, 1995 and 1994, and its results of operations for each of the three years in the period ended December 31, 1995. Reference is also made to the Consolidated Financial Statements and the Notes thereto, included elsewhere herein, which should be read in conjunction with this discussion.\nFor information regarding a proposed acquisition by the Company, see \"Business - Recent Developments - Letter of Intent to Purchase Assets of Neddrill.\"\nOUTLOOK\nThe Company's operating strategy has been to pursue drilling opportunities in the U.S. and various international markets. Worldwide drilling conditions vary substantially from region to region; however, the Company operates in many markets where there is a demand for offshore rigs. During late 1992, U.S. natural gas prices improved, resulting in greater demand and higher dayrates for drilling rigs. Increasing U.S. natural gas prices resulted in significant improvements in the U.S. Gulf of Mexico (\"U.S. Gulf\") rig demand and dayrates during the second half of 1993. Declining world oil prices during this period reduced rig demand outside the U.S. Gulf. As a result of declining international rig demand and improved market conditions in the U.S. Gulf, many contractors mobilized rigs from international markets to the U.S. Gulf in late 1993 and early 1994. The increased supply of drilling rigs in the U.S. Gulf more than offset the increased level of U.S. Gulf rig demand during 1994 and the first half of 1995, causing increased pressure on dayrates. By mid-year 1995, rig demand in the international arena began to strengthen. Improved political stability and strengthened world oil prices caused more favorable market conditions which led the Company to mobilize rigs out of the U.S. Gulf of Mexico to international markets. Simultaneously, the U.S. Gulf of Mexico market strengthened due to improved gas prices, subsalt drilling, and deepwater drilling.\nThe Company anticipates that the domestic offshore market will experience significant activity levels in the first two quarters of 1996. However, the Company is cautious and does not predict these robust levels to continue all year. The international market is anticipated to remain strong, assuming oil prices remain at current levels and the political environment remains stable. If the price of natural gas decreases in the near future, the Company's dayrates and utilization rates in the U.S. Gulf could be adversely affected. The Company can predict neither the future level of demand for its drilling services nor the future conditions in the offshore contract drilling industry.\nThe Company had seven offshore drilling rigs under contract and one offshore drilling rig available for bidding in Nigeria at February 26, 1996. The contracts under which the seven rigs are operating each contain provisions permitting the operator to suspend operations in the event of force majeure and to terminate the contract if the force majeure continues; however, no operator has elected to suspend operations pursuant to these provisions. The Company maintains war and political risk insurance (covering physical damage or loss up to the insured value of each rig), subject, in the case of certain coverages, to immediate termination upon certain events or upon termination by the underwriter on seven days' notice. In recent periods, the Nigerian economy has experienced high inflation. During these periods, the Company's operations were not materially affected, and the Company received timely payment for its services in U.S. dollars. Revenues from drilling activities in Nigeria accounted for approximately 14 percent and 13 percent, respectively, of the Company's operating revenues in 1995 and 1994.\nThe Company began to operate in Venezuela in late 1993 and currently has four rigs located in that country. Three jackup rigs were under contract with Lagoven, a subsidiary of the government-owned oil company of Venezuela, and one jackup rig was under contract with Shell Venezuela S.A. as of February 26, 1996. In recent periods, the Venezuelan economy has experienced high inflation and a shortage of foreign currency. During a banking crisis in July 1994, the Venezuelan government imposed a program of currency exchange controls and taxes on certain financial transactions that temporarily limited the ability of the government-owned oil companies and their affiliates to make payment in U.S. dollars or other hard currencies to oilfield service contractors. During this period, the Company's operations were not materially affected, and the Company received timely payment for its services in U.S. dollars. Although timely U.S. dollar payments are currently being made to the Company, future exchange control actions of the Venezuelan government could adversely\naffect the Company's operations in Venezuela. Revenues from drilling activities in Venezuela accounted for approximately 10 percent of the Company's operating revenues in each of 1995 and 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company had working capital of $101,623,000 and $157,885,000 as of December 31, 1995 and 1994, respectively. The decrease in working capital of $56,262,000 was primarily due to 1995 capital expenditures of $87,428,000 offset by cash provided by operating activities. The ratio of current assets to current liabilities at December 31, 1995, was 2.18:1 compared to 2.92:1 at December 31, 1994. The decrease in the current ratio was primarily the result of decreased cash and marketable securities utilized for capital projects during 1995. In addition, the Company had long-term debt related to the financing of the Company's insurance package, of which the short-term portion was $11,690,000 at December 31, 1995. The ratio of long-term debt to long-term debt plus shareholders' equity was 0.20:1 and 0.19:1 at December 31, 1995, and December 31, 1994, respectively.\nThe Company continues to have cash requirements for debt interest and principal payments, and for preferred dividends, when and if declared. In 1996, debt interest and principal payments are estimated to be approximately $23,900,000. Cumulative dividends on the 4,025,000 outstanding shares of Noble Drilling's $1.50 Convertible Preferred Stock (\"$1.50 Preferred Stock\") are estimated to be approximately $6,038,000 for 1996. The Company expects to fund these 1996 obligations of $29,938,000 out of cash and short-term investments as well as cash expected to be provided by operations.\nAt December 31, 1995, the Company had planned capital expenditures for 1996 of approximately $66,000,000 related to upgrades of several drilling rigs and replacements of equipment and drill pipe. The Company expects to fund these improvements to its assets out of cash provided by operations, to the extent available, and\/or existing cash balances.\nCREDIT FACILITIES AND LONG-TERM DEBT\nOn November 3, 1995, the Company entered into a financing agreement with Transamerica Insurance Finance for a period of 18 months related to the renewal of its Marine Package, Protection and Indemnity, and Excess Liability insurance policies. The amount financed totaled $16,561,000 at a fixed interest rate of 6.23 percent.\nOn June 16, 1994, the Company entered into a credit agreement with First Interstate Bank of Texas, N.A. for a $25,000,000 revolving credit facility and a $5,000,000 letter of credit facility (see Note 5 of Notes to Consolidated Financial Statements included elsewhere herein). At December 31, 1995, the Company had lines of credit totaling $26,000,000 and letter of credit facilities aggregating $5,000,000, subject to the Company's maintenance of certain levels of collateral. Based on the levels of collateral at December 31, 1995, the Company had $26,000,000 available under these lines of credit and $895,000 available to support the issuance of letters of credit. No amounts were outstanding under the lines of credit at December 31, 1995.\nIn 1993, the Company issued $125,000,000 aggregate principal amount of 9 1\/4% Senior Notes Due 2003 (the \"Senior Notes\"), which will mature on October 1, 2003. Interest on the Senior Notes is payable semi-annually on April 1 and October 1 of each year. The Senior Notes are redeemable at the option of the Company, in whole or in part, on or after October 1, 1998 at 103.47 percent of the principal amount, declining ratably to par on or after October 1, 2001, plus accrued interest. Mandatory sinking fund payments of 25 percent of the original principal amount of the Senior Notes at par plus accrued interest will be required on October 1, 2001 and October 1, 2002. The indenture governing the Senior Notes contains certain restrictive covenants, including limitations on additional indebtedness and the ability to secure such indebtedness, restrictions on dividends and certain investments, and limitations on sale of assets, sales and leasebacks, transactions with affiliates, and merger or consolidations.\nIn connection with the initial construction of the NN-1, the predecessor of NN-1 Limited Partnership issued its U.S. Government Guaranteed Ship Financing Sinking Fund Bonds, of which $1,546,000 was outstanding at December 31, 1995. The bonds are secured by the vessel, and the applicable security agreement contains certain restrictions, including restrictions on distributions to partners, dispositions of assets and services to related parties. In addition, there are minimum working capital, net worth and long-term debt to net worth requirements applicable to NN-1 Limited Partnership. The Company's sharing percentage in NN-1 Limited Partnership's distributions from operations is generally 90 percent.\nMinimum principal payments on the long-term debt as described above are $12,210,000 in 1996, $4,417,000 in 1997, $506,000 in 1998, and $125,000,000 due in 2003.\nSUBSEQUENT EVENTS\nIn March 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, was issued. This 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. The Company adopted this standard effective January\n1, 1996. The Company expects the adoption of this standard to require a charge to net income of approximately $7,000,000 in the first quarter of 1996.\nSubsequent to December 31, 1995, the Company sold for cash a posted barge rig located in the U.S. Gulf of Mexico. The Company will record a gain on the sale of this asset of approximately $4,815,000 in the first quarter of 1996.\nRESULTS OF OPERATIONS\nThe following table sets forth selected consolidated financial information of the Company expressed as a percentage of total operating revenues for the periods indicated.\n- -------------------\n(1) Consists of minority interest in 1995 and 1993 and minority interest and restructuring charges in 1994.\n1995 COMPARED WITH 1994\nOPERATING REVENUES. During 1995, the Company generated operating revenues of $327,968,000 compared to operating revenues of $351,988,000 in 1994. This decrease of $24,020,000 was due primarily to reduced contract drilling services revenue caused by a softening of market conditions in the U.S. Gulf of Mexico and Canada. This decrease was partially offset by increased turnkey engineering and consulting services revenues.\nThe Company's contract drilling fleet statistics are shown below.\nLabor contract drilling services revenue decreased by $1,067,000 due to the decrease in labor contracts and fewer operating days in the U.K.\nTurnkey drilling services revenues were $71,273,000 in 1995, compared to $56,380,000 in 1994, an increase of $14,893,000. Twenty-seven wells were completed in 1995, compared to twenty-eight in 1994. The increase in revenues was due to completion of turnkey wells of longer duration in 1995. In 1995, the average turnkey well was drilled in 50 days compared to the 1994 average of 30 days. Triton's turnkey success ratio deteriorated in 1995, primarily because of significant operational problems on two domestic wells which caused losses of $7,293,000.\nEngineering and consulting revenues increased from $3,796,000 in 1994 to $11,264,000 in 1995. The increase of $7,468,000 is mainly attributable to bonus revenues generated from the alliance program (\"Alliance\") between the Company and Lagoven, a subsidiary of the government-owned oil company in Venezuela.\nOPERATING COSTS. Operating costs (\"Operating Costs\") consist of operating costs and expenses other than depreciation and amortization, selling, general and administrative costs, minority interest and restructuring charges. Operating Costs were $240,102,000, or 73 percent of operating revenues, during 1995 compared to $243,208,000, or 69 percent of operating revenues, in 1994. Contract drilling services costs in 1995 decreased $21,769,000 from 1994 as a result of reduced offshore activity levels, primarily in the U.S. Gulf of Mexico and the Bay of Campeche, Mexico.\nLabor contract drilling services costs in 1995 decreased $1,815,000 as compared to 1994. This decrease was due to a reduced number of operating days in 1995 compared to 1994.\nTurnkey drilling services costs increased $17,585,000 during 1995. As noted above, Triton's average turnkey well drilling time increased in 1995, partially due to operational issues on certain domestic wells. These operational issues were also the primary cause of the decline in turnkey profit margins to 10 percent in 1995 compared to 17 percent in 1994.\nEngineering and consulting services costs in 1995 increased $4,353,000 from 1994. This increase was due primarily to the fact that the 1994 costs only include amounts from the date the Company acquired Triton in April 1994 through year end.\nDEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expenses were $36,492,000 in 1995 compared to $39,519,000 in 1994. The decrease of $3,027,000 was primarily due to a change in accounting estimates offset by the effects of 1995 capital spending. Effective January 1, 1995, the estimated salvage values and remaining depreciable lives of certain rigs were adjusted to better reflect their economic lives and to be consistent with other similar assets owned by the Company. The effect of this change in estimate was a decrease in depreciation and amortization of $6,160,000, or $0.07 per share.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative (\"SG&A\") expenses were $40,139,000 during 1995 as compared to $47,606,000 in 1994, a decrease of $7,467,000. SG&A expenses decreased from 1994 due in part to reductions in overhead achieved as a result of restructuring and consolidation efforts. The 1994 SG&A expenses included approximately $5,300,000 in pooling expenses related to the Chiles Merger.\nRESTRUCTURING CHARGES. A restructuring charge of $3,661,000 related to the Chiles Merger was recorded in 1994 as a result of facility consolidation, including the write-down of certain of the Company's owned properties and, to a lesser extent, severance costs.\nOTHER, NET. Other, net was $250,000 during 1995 compared to $15,743,000 during 1994. This decrease was principally due to the 1994 gain of $8,000,000 on the sale of a drilling rig, net unrealized gains of $4,162,000 on marketable equity investments, and a gain of $1,530,000 on the recovery of a previously written-off note receivable, offset by realized losses on marketable debt securities of $2,199,000.\nINCOME TAX PROVISION. Provisions for income taxes of $3,272,000 and $5,672,000 were recorded in 1995 and 1994, respectively. This decrease was primarily due to a $2,100,000 U.S. separate return year loss carryback benefit recorded by Triton.\nAt December 31, 1995, the Company had approximately $6,000,000 in withholding tax receivables related to withholding taxes in Nigeria. Management believes that this amount will be realized by obtaining the required tax certificates from the related operators.\n1994 COMPARED WITH 1993\nOPERATING REVENUES. During 1994, the Company generated operating revenues of $351,988,000 compared to operating revenues of $264,531,000 in 1993. This increase of $87,457,000 was due primarily to the acquisition of Triton and to recording a full year's revenue from the assets purchased from The Western Company of North America in October 1993. The Company's contract drilling fleet statistics are shown below.\nLabor contract drilling services revenue increased by $1,729,000 in 1994 due to the increased number of labor contracts compared to 1993.\nTurnkey drilling services revenues were $56,380,000 in 1994, which represents revenue from the date of the acquisition of Triton. Twenty-eight wells were completed in 1994, subsequent to the acquisition of Triton, for average revenues per completed well of approximately $2,000,000.\nThe 1994 increases in engineering and consulting services revenues and other revenue of $1,504,000 and $1,345,000, respectively, were primarily due to the Triton acquisition.\nOPERATING COSTS. Operating Costs were $243,208,000, or 69 percent of operating revenues, during 1994, compared to $178,684,000, or 68 percent of operating revenues, in 1993. The increase in Operating Costs is due to the increase in turnkey drilling services expense and the increase in operating days as discussed above.\nDEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expenses were $39,519,000 in 1994, as compared to $28,886,000 in 1993. The increase of $10,633,000 was principally due to a full year's depreciation on the assets purchased from Western in October 1993 and the increase of approximately $35,000,000 in capital expenditures compared to 1993.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses were $47,606,000 during 1994, as compared to $28,284,000 in 1993, an increase of $19,322,000. SG&A expenses increased from 1993 due to the Triton acquisition ($7,800,000), pooling expenses related to the Chiles Merger ($5,300,000), and a full year of administrative expense from the Venezuela and Zaire operations ($2,800,000), with the balance due to an increased level of corporate personnel.\nRESTRUCTURING CHARGES. A restructuring charge of $3,661,000 related to the Chiles Merger was recorded in 1994 as a result of facility consolidation, including the write-down of certain of the Company's owned properties and, to a lesser extent, severance costs.\nINTEREST EXPENSE, NET OF INTEREST INCOME. Interest expense, net of interest income, was $6,711,000 in 1994, as compared to net interest expense of $5,541,000 in 1993. This increase in net interest expense was due to increased interest expense of $4,313,000 related to the issuance of the Senior Notes in October 1993, partially offset by additional interest income of $3,143,000. The increase in interest income is attributable to the cash proceeds from Chiles' preferred stock offering in October 1993 (see Note 6 of Notes to Consolidated Financial Statements included elsewhere herein).\nOTHER, NET. Other, net was $15,743,000 during 1994, compared to $1,047,000 in 1993. This increase was principally due to a gain of $8,000,000 on the sale of a drilling rig, net unrealized gains of $4,162,000 on marketable equity investments, and a gain of $1,530,000 on the recovery of a previously written-off note receivable, offset by realized losses on marketable debt securities of $2,199,000.\nINCOME TAX PROVISION. Provisions for income taxes of $5,672,000 and $3,333,000 were recorded in 1994 and 1993, respectively. This increase was due to the foreign deferred tax provision of $3,073,000 in 1994, related to the book and tax depreciation differences for the assets deployed in Venezuela and Mexico.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements are filed in this Item 8:\nReport of Independent Accountants (Price Waterhouse LLP)\nReport of Independent Public Accountants (Arthur Andersen LLP)\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Operations for each of the three years in the period ended December 31, 1995\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995\nConsolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1995\nNotes to Consolidated Financial Statements\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Noble Drilling Corporation\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of changes in shareholders' equity present fairly, in all material respects, the financial position of Noble Drilling Corporation and its subsidiaries (the \"Company\") at December 31, 1995 and 1994, and the results of their operations and their cash flows for the two years 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 Houston, Texas January 31, 1996, except as to Note 16, which is as of March 13, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Noble Drilling Corporation:\nWe have audited the accompanying consolidated statements of operations, cash flows and shareholders' equity of Noble Drilling Corporation (a Delaware corporation) and subsidiaries for the year ended December 31, 1993. These financial statements reflect a restatement of the Company's previously reported amounts for the merger with Chiles Offshore Corporation (\"Chiles\"), see Note 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Noble Drilling Corporation and subsidiaries (including Chiles) for year ended December 31, 1993, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHouston, Texas September 15, 1994\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except par value amounts)\nSee accompanying notes to the consolidated financial statements.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)\nSee accompanying notes to the consolidated financial statements.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nSee accompanying notes to the consolidated financial statements.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)\nSee accompanying notes to the consolidated financial statements.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY -- (CONTINUED) (In thousands)\nSee accompanying notes to the consolidated financial statements.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nNOTE 1 -- ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND BUSINESS\nNoble Drilling Corporation (\"Noble Drilling\" or, together with its consolidated subsidiaries, unless the context requires otherwise, the \"Company\") is primarily engaged in domestic and international contract oil and gas drilling and workover operations. The Company's international operations are conducted in the United Kingdom, Nigeria, Zaire, India, Venezuela, Mexico, Canada, and Qatar. On September 15, 1994, Chiles Offshore Corporation (\"Chiles\") merged with Noble Offshore Corporation (\"NOC\"), a wholly owned subsidiary of Noble Drilling (the \"Chiles Merger\"). See Note 2.\nThe contract drilling industry is a highly competitive and cyclical business characterized by high capital and maintenance costs. Although conditions in recent years in the oil and gas industry have precipitated consolidation of industry participants, there remains an oversupply of drilling equipment. As a consequence, there has been intense competition for available drilling contracts resulting in equipment being idle for long periods of time and at generally unfavorable terms and prices for contract drilling.\nThe Company follows a policy of keeping its equipment well maintained and technologically competitive. However, its equipment could be made obsolete by the development of new techniques and equipment. In addition, industry-wide shortages of supplies, services, skilled personnel, and equipment necessary to conduct the Company's business, such as drill pipe, have occurred from time to time in the past and such shortages could occur again.\nThe Company's operations are subject to the many hazards inherent in the drilling business, including blowouts, cratering, fires and collisions or groundlings of offshore equipment, which could cause substantial damage to the environment. In addition, the Company's operations are subject to damage or loss from adverse weather and seas. These hazards could cause personal injury and loss of life, suspend drilling operations or seriously damage or destroy the property and equipment involved and, in addition to the environmental damage, could cause substantial damage to producing formations and surrounding areas. Although the Company maintains insurance against many of these hazards, such insurance is subject to substantial deductibles and provides for premium adjustments based on claims. It also excludes certain matters from coverage, such as loss of earnings on certain rigs.\nUnder turnkey drilling contracts, Triton Engineering Services Company (\"Triton\") generally assumes the risk of pollution and environmental damage, but on occasion receives indemnification from the customer for environmental and pollution liabilities in excess of Triton's pollution insurance coverage. Further, Triton is not insured against certain drilling risks that could result in delays or nonperformance of a turnkey drilling contract, although it generally maintains insurance against delays related to loss of well control.\nThe Company's international operations are also subject to certain political, economic and other uncertainties including, among others, risks of war and civil disturbances, expropriation, nationalization, renegotiation or modification of existing contracts, taxation policies, foreign exchange restrictions, international monetary fluctuations and other hazards arising out of foreign governmental sovereignty over certain areas in which the Company conducts operations. The Company has insurance covering expropriation and other political risks to the extent available to the Company at rates it considers prudent to pay.\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, and the Company's share of the assets, liabilities and operations of Perforadora Faja de Oro, S.A. de C.V. (\"Faja Joint Venture\") and NN-1 Limited Partnership, of which the Company is the general partner. The minority interest in Faja Joint Venture (10 percent) and NN-1 Limited Partnership (approximately 10 percent) is included in the balance sheets and the statements of operations as minority interest. In 1994, the Company made distributions of $4,500,000 to its partner in Faja Joint Venture. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCertain reclassifications have been made in the 1994 and 1993 consolidated financial statements to conform to the classifications used in the 1995 consolidated financial statements. These reclassifications have no impact on net income or loss.\nFOREIGN CURRENCY TRANSLATION\nThe Company follows a translation policy in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 52, Foreign Currency Translation. The U.S. dollar has been designated as the functional currency where appropriate, based on an evaluation of such factors as the markets in which the subsidiary operates, generation of cash flow, financing\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nactivities and intercompany arrangements. For the Company's subsidiaries in the United Kingdom and Canada, the local currency is the functional currency. Assets and liabilities are translated at the rates of exchange on the balance sheet date. Income and expense items are translated at average rates of exchange. The resulting gains or losses arising from the translation of accounts from the functional currency to the U.S. dollar are included as a separate component of shareholders' equity designated as cumulative translation adjustment.\nCASH AND CASH EQUIVALENTS\nCash and cash equivalents include cash on hand, demand deposits with banks and all highly liquid investments with original maturities of three months or less.\nIn accordance with SFAS No. 95, Statement of Cash Flows, cash flows from the Company's operations in the United Kingdom and Canada are calculated based on their functional currency. As a result, amounts related to assets and liabilities reported on the Consolidated Statements of Cash Flows will not necessarily agree with changes in the corresponding balances on the Consolidated Balance Sheets. The effect of exchange rate changes on cash balances held in foreign currencies is reported on a separate line below cash (used in) provided by financing activities.\nThe restricted cash balance of $898,000 at December 31, 1994, was restricted as a result of collateral requirements imposed by a lender of the Company. This restriction was lifted in 1995.\nINVESTMENT IN MARKETABLE SECURITIES\nPursuant to the cash management policy implemented in 1992, the Company invests in marketable debt securities. Effective January 1, 1994, the Company adopted SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company classifies its investments in marketable debt securities as available for sale and its investments in marketable equity securities as trading. See Note 3.\nINVESTMENT IN UNCONSOLIDATED AFFILIATES\nThe Company uses the equity method to account for affiliates in which it does not have voting control.\nINVENTORIES\nInventories of spare parts, material and supplies held for consumption are stated principally at average cost.\nPROPERTY AND EQUIPMENT\nProperty and equipment is stated at cost, reduced by provisions to recognize economic impairment in value when management determines that such impairment has occurred. Drilling equipment and facilities are depreciated using the straight-line method over estimated remaining useful lives ranging from three to twenty-five years from the date of construction or major refurbishment. All other property and equipment is depreciated using the straight-line method over useful lives ranging from three to twenty years.\nEffective January 1, 1995, the Company revised its estimates of salvage values and remaining depreciable lives of certain rigs to better reflect their economic lives and to be consistent with other similar assets owned by the Company. The effect of this change in estimates was a reduction in the net loss applicable to common shares of $6,160,000, or $0.07 per common share, for the year ended December 31, 1995.\nMaintenance and repairs on drilling equipment are charged to expense as incurred. Total maintenance and repair expenses for the years ended December 31, 1995, 1994, and 1993, were approximately $26,189,000, $33,700,000, and $25,900,000, respectively. When assets are sold, retired or otherwise disposed of, the cost and related accumulated depreciation are eliminated from the accounts and the gain or loss is recognized.\nIn March 1995, SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, was issued. This 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. The Company adopted this standard effective January 1, 1996. The Company expects the adoption of this standard to require a charge to net income of approximately $7,000,000 in the first quarter of 1996.\nOTHER ASSETS\nIn 1995, other assets primarily included deferred debt issuance costs in connection with the October 7, 1993, issuance of debt securities (see Note 4), the long-term portion of prepaid insurance costs and goodwill related to the Triton acquisition. The deferred debt issuance costs in connection with the October 7, 1993 issuance of debt securities (see Note 4)\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\ntotaled $4,015,000 and are being amortized over the life of the debt securities. The accumulated amortization at December 31, 1995 and 1994, was $864,000 and $540,000, respectively. The prepaid insurance costs totaled $3,230,000 at December 31, 1995, and are being amortized over the term of the insurance policy. The goodwill related to Triton totaled $1,775,000 at December 31, 1995, and is being amortized over seventeen years.\nREVENUE RECOGNITION\nRevenues generated from the Company's dayrate-basis drilling contracts are recognized as services are performed. The Company's turnkey drilling contracts are of a short-term, fixed fee nature, and accordingly, revenues and expenses are recognized using the completed contract method. When estimates of projected revenues and costs indicate a loss, the total estimated loss is accrued.\nCONCENTRATION OF CREDIT RISK\nThe primary market for the Company's services is the offshore oil and gas industry, and the Company's customers consist primarily of major oil companies, independent oil and gas producers and government-owned oil companies. The Company performs ongoing credit evaluations of its customers and generally does not require material collateral. The Company provides allowances for potential credit losses when necessary.\nNET (LOSS) INCOME APPLICABLE TO COMMON SHARES PER SHARE\nNet (loss) income applicable to common shares per share has been computed on the basis of the weighted average number of common shares and, where dilutive, common share equivalents, outstanding during the indicated periods. Each outstanding share of the $2.25 Preferred Stock and $1.50 Convertible Preferred Stock (\"$1.50 Preferred Stock\") was assumed to be converted, at January 1, 1995, into 5.41946 and 2.4446 shares of common stock, respectively, for purposes of calculating fully diluted earnings per share. The calculation of net (loss) income applicable to common shares per share assuming full dilution was antidilutive; therefore, fully diluted amounts are not presented. The Preferred Conversion Payment of approximately $1,524,000 in March 1995 (see Note 6) was accounted for as a reduction of net earnings applicable to common shares for purposes of calculating the net loss per common share. This accounting treatment increased the net loss applicable to common shares per share from $0.06 to $0.08 for the year ended December 31, 1995. See Note 13.\nCERTAIN SIGNIFICANT 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.\nNOTE 2 -- ACQUISITIONS AND MERGERS\nThe Chiles Merger was consummated on September 15, 1994 through the exchange of 28,598,777 shares of Noble Drilling common stock for all the outstanding common stock of Chiles and the exchange of 4,025,000 shares of Noble Drilling $1.50 convertible preferred stock (\"$1.50 Preferred Stock\") (liquidation preference $25.00 per share), par value $1.00 per share, for all the outstanding shares of Chiles $1.50 convertible preferred stock. The Chiles Merger was accounted for as a pooling of interests and all financial information for the year of the transaction and prior periods has been restated to reflect this merger. In addition, Noble Drilling issued an additional 480,000 shares of its common stock in exchange for the cancellation of outstanding Chiles stock options.\nOn April 22, 1994, the Company acquired all of the issued and outstanding shares of common stock (the \"Shares\") of Triton pursuant to the terms of the Stock Purchase Agreement dated April 22, 1994. In consideration for the Shares, the Company paid approximately $4,085,000 in cash, issued promissory notes in the aggregate amount of $4,000,000, and issued 751,864 shares of Noble Drilling common stock valued at $5,169,000. The promissory notes were paid on October 21, 1994. In addition, the Company has a contingent obligation to pay additional consideration on April 22, 1996, including issuance of up to 254,551 shares of Noble Drilling common stock, if certain financial conditions are achieved. The acquisition of Triton has been accounted for under the purchase method, and accordingly, Triton's operating results have been included in the consolidated operating results since the date of acquisition.\nThe Company acquired nine mobile offshore jackup drilling rigs and associated assets (the \"Western Acquisition\") from The Western Company of North America (\"Western\") for $150,000,000 in cash on October 7, 1993. The Western\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nAcquisition has been accounted for under the purchase method, and accordingly, the operating results have been included in the consolidated operating results since the date of acquisition.\nThe following table summarizes certain unaudited pro forma condensed consolidated results of operations data that give effect to the acquisition of Triton as if it had occured on January 1, 1994 and January 1, 1993 and the acquisition of Western as it had occurred on January 1, 1993.\nOn September 16, 1994, the Company exchanged its interest in Grasso Corporation for 645,656 shares of common stock of Offshore Logistics, Inc. This investment is classified as a marketable equity security. See Note 3.\nNOTE 3 -- MARKETABLE SECURITIES\nEffective January 1, 1994, the Company adopted SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under the provisions of SFAS No. 115, investments in debt and equity securities are required to be classified into one of three categories: held to maturity, available for sale or trading securities. At each reporting date, the appropriateness of such classification is required to be reassessed. Realized gains and losses on sales of investments are included in income on a specific identification basis.\nAs of December 31, 1995, the Company classified all of its debt securities with original maturities of more than three months as available for sale. These investments are classified as marketable securities within current assets on the accompanying consolidated balance sheets. The following table highlights information applicable to the Company's investments classified as available for sale as of December 31, 1995 and December 31, 1994:\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nThe unrealized loss on debt securities of $115,000 and $1,847,000 as of December 31, 1995 and 1994, respectively, is included as a reduction of shareholders' equity in accordance with SFAS No. 115. Total realized losses related to short-term investments for the twelve months ended December 31, 1995 and 1994, were $15,000 and $2,199,000, respectively.\nThe Company categorizes its investments in marketable equity securities as trading securities. These investments are classified as current assets and were recorded at a fair value of $6,131,000 at December 31, 1995. Total proceeds from the sale of these securities were $3,670,000 and $0 for the years ended December 31, 1995 and 1994, respectively. Total realized gains on these equity investments for the years ended December 31, 1995 and 1994 were $371,000 and $0, respectively. Total net unrealized (losses) and gains related to these equity investments for the years ended December 31, 1995 and 1994, were $(56,000) and $4,162,000, respectively.\nNOTE 4 -- DEBT\nOn November 3, 1995, the Company entered into a financing agreement with Transamerica Insurance Finance for a period of eighteen months related to the renewal of its Marine Package, Protection and Indemnity, and Excess Liability insurance policies. The amount financed totaled $16,561,000 at a fixed interest rate of 6.23 percent per annum.\nOn October 14, 1993, the Company prepaid a promissory note with proceeds from the Public Offerings (as defined below). The terms of the note provided that interest did not accrue from September 1, 1991 through December 31, 1992, after which date interest on the unpaid principal amount accrued at a fixed rate of 7.5 percent per annum. The Company had accrued interest on the note at 4.9 percent for all periods, which was the imputed rate based on the revised note terms. An extraordinary gain of $1,770,000 for extinguishment of debt was recognized in 1993 (see Note 10) from the prepayment of the note, representing excess accrued interest.\nOn October 7, 1993, in connection with the Western Acquisition and the issuance of 12,041,000 shares of Noble Drilling common stock in an underwritten public offering (the \"Stock Offering\") (see Note 6), the Company issued $125,000,000 principal amount of 9 1\/4% Senior Notes Due 2003 (\"Senior Notes\") (the Stock Offering and the issuance of Senior Notes are collectively referred to as the \"Public Offerings\"). The Senior Notes will mature on October 1, 2003. Interest on the Senior Notes is payable semi-annually on April 1 and October 1 of each year. The Senior Notes are redeemable at the option of the Company, in whole or in part, on or after October 1, 1998 at 103.47 percent of principal amount, declining ratably to par on or after October 1, 2001, plus accrued interest. Mandatory sinking fund payments of 25 percent of the original principal amount of the Senior Notes at par plus accrued interest will be required on October 1, 2001 and October 1, 2002. The indenture governing the Senior Notes contains certain restrictive covenants, including limitations on additional indebtedness and the ability to secure such indebtedness, restrictions on dividends and certain investments and limitations on sales of assets, sales and leaseback, transactions with affiliates, and mergers or consolidations.\nIn connection with the initial construction of the NN-1, the predecessor of NN-1 Limited Partnership issued U.S. Government Guaranteed Ship Financing Sinking Fund Bonds, of which $1,546,000 principal amount was outstanding at December 31, 1995. The bonds mature in 1998, and bear interest at the rate of 8.95 percent per annum, payable semi-annually on June 15 and December 15. The bonds are secured by the vessel, and the applicable security agreement contains certain restrictions, among others, on distributions to partners, dispositions of assets and services to related parties. In addition, there are minimum working capital, net worth and long-term debt to net worth requirements applicable to NN-1 Limited Partnership. The net book value of the vessel at December 31, 1995, was $12,131,000. The Company's sharing percentage in NN-1 Limited Partnership's distribution from operations is generally 90 percent. The NN-1 has not been under contract since March of 1993.\nThe Company and its wholly owned subsidiary, Noble Drilling (West Africa) Inc. (\"NDWA\"), were parties to a secured loan agreement (the \"Project Loan Agreement\") with US WEST Financial Services, Inc. dated as of October 31, 1990, as amended, pursuant to which NDWA borrowed $52,500,000 for the purpose of financing, in part, the equipping, refurbishment and mobilization to Nigeria of four offshore drilling rigs: the NN-1, Gene Rosser, Lewis Dugger and Chuck Syring. On July 2, 1993, the final installment of $6,562,000 plus accrued interest was paid in accordance with the terms of the Project Loan Agreement. Interest was charged under the Project Loan Agreement at the fixed rate of 11.12 percent per annum.\nAnnual maturities of long-term debt are $12,210,000 in 1996, $4,417,000 in 1997, $506,000 in 1998, and $125,000,000 due in 2003.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nThe following table summarizes the Company's long-term debt:\nThe fair value of the Company's long-term debt at December 31, 1995, estimated based on the quoted market prices for similar issues or on the current rates offered to the Company for debt of similar remaining maturities, was approximately $130,300,000.\nNOTE 5 -- CREDIT FACILITIES\nAt December 31, 1995, the Company had available credit facilities aggregating $31,000,000, as described below, of which $26,000,000, subject to certain limitations, is related to lines of credit and $5,000,000 is related to letter of credit facilities. Based on the level of the borrowing base at December 31, 1995, the Company had $26,000,000 available under the credit lines and $895,000 available to support issuance of letters of credit at that date.\nThe Company has an unsecured credit agreement with First Interstate Bank of Texas, N.A., which provided for a $25,000,000 revolving credit line facility and $5,000,000 letter of credit facility at December 31, 1995. The Company pays a quarterly commitment fee on the unused portion of the facility. The agreement contains certain restrictive and financial covenants, including those related to indebtedness, net worth and fixed charges, and provides for guarantees of the indebtedness by certain subsidiaries of Noble Drilling.\nNOTE 6 -- SHAREHOLDERS' EQUITY\nOn October 25, 1993, the Company issued 626,410 shares of common stock to purchase two rigs from Portal as discussed in Note 12. The shares were issued to Portal pursuant to a private placement, and the Company does not have an obligation to register the resale of the shares under the Securities Act of 1933, as amended.\nChiles completed a public offering of $1.50 convertible preferred stock on October 21, 1993 with the sale and issuance to the public of 4,025,000 shares by Chiles at $25.00 per share. Net proceeds to Chiles were approximately $96,500,000 after underwriting discounts and issuance costs. Chiles utilized approximately $45,200,000 of these proceeds to retire all of Chiles' outstanding long-term indebtedness, including principal and interest, during the fourth quarter of 1993. In the Chiles Merger, this series of preferred stock was converted into and exchanged for an equivalent number of shares of $1.50 Preferred Stock having substantially the same rights, privileges, preferences and voting power as the Chiles preferred stock. Holders of the $1.50 Preferred Stock are entitled to receive cumulative cash dividends at an annual rate of $1.50 per share, when, as and if declared by the board of directors of Noble Drilling, payable quarterly. Each share of $1.50 Preferred Stock is convertible, at the option of the holder, into 2.4446 shares of common stock (subject to adjustment in certain circumstances). The $1.50 Preferred Stock is not redeemable prior to December 31, 1996. On or after such date, the $1.50 Preferred Stock is redeemable at the option of the Company, in whole or part, at $26.05 per share if redeemed prior to December 31, 1997, and at prices decreasing in increments of $0.15 per year to $25.00 per share on and after December 31, 2003, plus accrued and unpaid dividends to the redemption date.\nOn October 7, 1993, the Company issued and sold 12,041,000 shares of common stock in the Stock Offering (see Note 4) at an initial offering price of $8.375 per share. This resulted in net proceeds of $94,900,000, after deducting underwriting discounts, commissions and other related costs. The net proceeds of the Public Offerings (see Note 4) were used to purchase the nine jackup rigs and related assets discussed previously in Note 2, and to prepay a promissory note discussed in Note 4, with the balance of the proceeds, approximately $26,000,000, used for general corporate purposes.\nIn 1991, the Company issued and sold 2,990,000 shares of a new series of $2.25 Convertible Exchangeable Preferred Stock (\"$2.25 Preferred Stock\"), par value $1.00 per share. Holders of the $2.25 Preferred Stock received a cash dividend at an annual rate of $2.25 per share. In March 1995, an aggregate of 923,862 shares of $2.25 Preferred Stock were\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nconverted into 5,006,830 shares of Noble Drilling common stock. The Company paid an aggregate of approximately $1,524,000 in cash (\"Preferred Conversion Payment\") in the first quarter in connection with this conversion. In the second quarter of 1995, the Company called for the redemption of all remaining outstanding shares of the $2.25 Preferred Stock. Of the 2,065,238 shares then outstanding, 2,062,537 were surrendered for conversion and 2,701 were redeemed by the Company, resulting in the Company's issuance of 11,192,359 shares of common stock (including 14,637 shares sold to a standby underwriter).\nNOTE 7 -- STOCK OPTIONS\n1991 STOCK OPTION PLAN\nThe Company's 1991 Stock Option and Restricted Stock Plan (the \"1991 Plan\") was amended and restated (\"Amended 1991 Plan\") in September 1994. The Amended 1991 Plan was adopted by the board of directors of Noble Drilling in July 1994 and approved by stockholders on September 15, 1994. The Company's two other employee stock option plans, adopted in 1985 and 1987, were amended in connection with the adoption of the 1991 Plan to provide that no further grants would be made under those plans after April 25, 1991; however, all options outstanding at that date (\"Pre-1991 Options\") remained in effect in accordance with their respective terms.\nUnder the Amended 1991 Plan, a maximum of 5,200,000 shares of the Company's common stock may be subject to grants of options or awards of restricted stock to participants, who are selected from regular salaried officers or other employees of the Company. Options may be either incentive options or nonqualified options, and may be with or without stock appreciation rights (\"SARs\"). The option price under the Amended 1991 Plan may not be less than 100 percent of the fair market value of the common stock at the time of grant, in the case of an incentive option, and may not be less than 50 percent of the fair market value of the common stock at the time of grant, in the case of a nonqualified option. The Amended 1991 Plan also limits to 1,500,000 the total number of shares of common stock that may be made subject to grants of options or stock appreciation rights or awards of restricted stock to any one person during any five-year period. All Pre-1991 Options were granted at an option price of at least 100 percent of the fair market value of the common stock at the time of grant. The exercise of either the tandem SAR or the option serves to cancel the other. At December 31, 1995, 2,571,767 shares were available for grant under the Amended 1991 Plan.\nAs of January 1, 1995, there were 250,000 shares of common stock held by the Company as treasury shares. During February 1995, 211,500 treasury shares were issued to certain employees pursuant to the terms of the Amended 1991 Plan and the applicable restricted stock agreements. The issued shares of restricted stock have been placed in escrow subject to satisfaction of various performance criteria during a three-year period. In June 1995, 26,000 of these shares were returned to treasury stock following the resignation of one employee. As of December 31, 1995, 64,500 shares were held as treasury stock. Subsequent to December 31, 1995, 250,000 shares of common stock were purchased by the company and returned to treasury stock, increasing the balance of treasury stock to 314,500 shares. In January 1996, 108,750 shares of treasury stock were issued to certain employees as restricted stock under the Amended 1991 Plan and have been placed in escrow under the aforementioned terms.\nThe following is a summary of option transactions under the plans:\nOptions granted in 1995 under the Amended 1991 Plan become exercisable on certain dates that range from February 2, 1996, through February 2, 1998, at a price $5.188 per share.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nOTHER STOCK OPTIONS\nDuring 1987, in addition to the options described above, options to purchase a total of 300,000 shares of Noble Drilling's common stock at $2.50 per share were granted to certain non-employee directors of the Company pursuant to stock option agreements which were approved by stockholders at the 1988 annual meeting. Options to purchase 160,000 shares were outstanding and exercisable at December 31, 1995.\nIn 1993, the stockholders approved the 1992 Nonqualified Stock Option Plan for Non-Employee Directors (the \"1992 Option Plan\"). Under the 1992 Option Plan, non-employee directors received a one-time grant of an option to purchase 10,000 shares of common stock, and thereafter, after each annual meeting of shareholders of the Company, receive an annual grant of an option to purchase 3,500 shares of common stock. The options are granted at fair market value on the grant date and are exercisable from time to time over a period commencing one year from the grant date and ending on the expiration of ten years from the grant date, unless terminated sooner as described in the 1992 Option Plan. Options to purchase 77,500 shares were outstanding and exercisable at December 31, 1995.\nSFAS NO. 123 - ACCOUNTING FOR STOCK-BASED COMPENSATION\nIn October 1995, SFAS No. 123, Accounting for Stock-Based Compensation, was issued. This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. Those plans include all arrangements by which employees receive shares of stock or other equity instruments of the employer or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. The Company adopted this standard effective January 1, 1996. As provided in the statement, the Company elected to continue to measure compensation cost using the guidelines of APB Opinion No. 25 and to include disclosures of net income and earnings per share as if the fair value based method of accounting were utilized.\nSTOCKHOLDER RIGHTS PLAN\nThe Company adopted a stockholder rights plan on June 28, 1995, designed to assure that the Company's stockholders receive fair and equal treatment in the event of any proposed takeover of the Company and to guard against partial tender offers and other abusive takeover tactics to gain control of the Company without paying all stockholders a fair price. The rights plan was not adopted in response to any specific takeover proposal. Under the rights plan, the Company declared a dividend of one right (\"Right\") on each share of Noble Drilling common stock. Each Right will entitle the holder to purchase one one-hundredth of a share of a new Series A Junior Participating Preferred Stock, par value $1.00 per share, at an exercise price of $35.00. The Rights are not currently exercisable and will become exercisable only in the event a person or group acquires beneficial ownership of 15 percent or more of Noble Drilling common stock. The dividend distribution was made on July 10, 1995 to stockholders of record at the close of business on that date. The Rights will expire on July 10, 2005.\nNOTE 8 -- INCOME TAXES\nThe Company follows SFAS No. 109, Accounting for Income Taxes, which requires the use of the liability method of accounting for deferred income taxes. Under SFAS No. 109, deferred tax assets and liabilities are recognized based upon differences between the financial statement and tax bases of assets and liabilities using presently enacted tax rates. 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.\nAmounts of deferred tax assets and liabilities are as follows at:\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nThe components of and changes in the net deferred taxes were as follows:\nIncome (loss) from continuing operations before income taxes and extraordinary items consisted of the following:\nThe income tax provision consisted of the following:\nIncluded in the current domestic tax benefit for the year ended December 31, 1995, is $2,100,000 related to a separate return year loss carryback benefit recorded by Triton.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nA reconciliation of Federal statutory and effective income tax rates is shown below:\nThe Company had available at December 31, 1995, unused investment tax credits, which may be used to offset future U.S. taxes payable, of $1,457,000 expiring in various years from 1998 to 2001. In addition, Noble Drilling had net operating loss carryforwards (\"NOLs\") for tax purposes of approximately $145,902,000 at December 31, 1995, which expire in the years 2000 through 2010, and NOC has NOLs for tax purposes of approximately $67,756,000 which expire in the years 2004 through 2009.\nThe Chiles Merger qualifies as a tax-free reorganization. NOC, as the surviving entity, inherited all of Chiles' tax attributes, including NOL carryforwards. In accordance with the \"Separate Return Limitation Year\" rules of the Internal Revenue Code of 1986, as amended (the \"Code\"), Chiles' NOL carryforwards may only be used to reduce Noble Drilling's future taxable income to the extent of NOC's taxable income.\nIf a corporation undergoes an \"ownership change\" within the meaning of Section 382 of the Code, the corporation's right to use its then existing NOLs (and certain other tax attributes) is limited during each future year to a percentage of the fair market value of such corporation's stock immediately before the ownership change (the \"Section 382 Limitation\"). In general, there is an \"ownership change\" under Section 382 if over a three-year period certain shareholders increase their percentage ownership of a corporation by more than 50 percent. To the extent the amount of the NOLs existing at the time of an ownership change that are used in any subsequent year is less than the annual Section 382 Limitation, the otherwise available Section 382 Limitation is correspondingly increased for future years. An ownership change for purposes of Section 382 took place on September 15, 1994, as a result of the Chiles Merger. The cumulative Section 382 Limitation attributable to the Noble Drilling pre-merger carryforwards is $47,231,000. The cumulative Section 382 Limitation attributable to NOC is $22,185,000.\nApplicable U.S. income and foreign withholding taxes have not been provided on undistributed earnings of the Company's international subsidiaries. Management does not intend to repatriate such undistributed earnings for the foreseeable future except for distributions upon which incremental income taxes would not be material.\nNOTE 9 -- ADDITIONAL BALANCE SHEET AND STATEMENT OF OPERATIONS INFORMATION\nOther current assets consisted of the following:\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nOther current liabilities consisted of the following:\nRent expense was $1,918,000, $1,200,000, and $1,297,000 for 1995, 1994, and 1993, respectively.\nWithholding tax receivables include approximately $6,000,000 related to withholding taxes in Nigeria. To recognize these receivables, the Company must receive tax certificates from the applicable operators. Management believes that the full amount of these receivables will be realized.\nOperating costs and mobilization for the year ended December 31, 1995 consists of costs incurred in mobilizing rigs from the U.S. Gulf of Mexico to various international locations. Such costs are amortized over the term of the related contract.\nOther income - other, net consisted of the following:\nOn December 15, 1995, the Linn Richardson, a 250-foot mat slot rig, lost overboard approximately 200 feet of leg while under tow to perform a contract offshore Senegal, Africa. On the following day, the rig lost overboard approximately 240 feet of a second leg which also caused damage to equipment and facilities on the deck of the rig. Pursuant to a preliminary assessment plan developed jointly by the Company and its insurance underwriters, the third leg of the rig has been removed and the rig has been towed to the U.S. Gulf of Mexico where a complete evaluation will take place. A charge of $1,778,000 related to the cost of mobilizing the rig to Senegal was accrued in the fourth quarter of 1995. This amount represents management's best estimate of the total loss. Management does not believe this incident will have any other material adverse effect on its financial condition or results of operations.\nA restructuring charge of $3,661,000 related to the Chiles Merger was recorded in 1994 as a result of facility consolidation, including the write-down of certain of the Company's owned properties, and to a lesser extent severance costs. This restructuring plan was developed in the fourth quarter of 1994 and approved by the board of directors of Noble Drilling.\nNOTE 10 -- EXTRAORDINARY ITEM\nThe Company prepaid a promissory note in the fourth quarter of 1993 with proceeds from the Public Offerings (see Notes 4 and 6). This prepayment resulted in an extraordinary gain from extinguishment of debt of $1,770,000 ($0.02 per common share), representing excess accrued interest.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nNOTE 11 -- EMPLOYEE BENEFIT PLANS\nThe Company has a noncontributory defined benefit plan which covers substantially all salaried employees and a noncontributory defined benefit pension plan which covers certain field employees. The benefits from these plans are based primarily on years of service and employees' compensation near retirement. The Company's funding policy is consistent with funding requirements of applicable laws and regulations. The assets of these plans consist of corporate equity securities, municipal and government bonds, and cash equivalents. The Company, when required, makes contributions to the domestic plan in the form of Noble Drilling common stock. As of September 30, 1995, the domestic plan assets included $2,067,000 of Noble Drilling's common stock valued at fair value at that date. The Company changed the measurement date of the plan to September 30 beginning in 1995. This change did not have a material impact to the financial results of the Company.\nNoble Drilling (U.K.) Limited, a wholly owned subsidiary of Noble Drilling, maintains a pension plan which covers all of its salaried, nonunion employees. Benefits are based on credited service and the average of the highest three years of qualified salary within the past ten years of participation.\nPension cost includes the following components:\nThe funded status of the plans is as follows:\nIn accordance with SFAS No. 87, Employers' Accounting for Pensions, the Company recorded an additional minimum liability of $3,403,000 and $3,825,000 at December 31, 1995 and 1994, respectively. This liability represents the excess of the accumulated benefit obligations over the fair value of plan assets and accrued pension liabilities of the domestic salaried pension plan. This additional minimum pension liability is reported as a separate reduction of shareholders' equity.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nThe projected benefit obligations for the international and domestic plans were determined using an assumed discount rate of 8.5 percent and 7.5 percent, respectively, in 1995, 9.0 percent and 8.5 percent, respectively, in 1994 and 8.0 percent and 7.25 percent, respectively, in 1993. Assumed long-term rate of return on international plan assets was 9.25 percent, 9.75 percent and 8.75 percent in 1995, 1994 and 1993, respectively. Assumed long-term rate of return on domestic plan assets was 9.0 percent in each of the years presented. The projected benefit obligations for the international plan assume a compensation increase of 6.25 percent, 6.75 percent and 5.75 percent in 1995, 1994 and 1993, respectively, and 6.0 percent per annum for the domestic plan in each of the years presented.\nThe Company presently sponsors medical and other plans for the benefit of its employees. The cost of maintaining these plans aggregated $6,628,000, $5,500,000, and $3,793,000 in 1995, 1994, and 1993, respectively.\nThe Company does not provide post-retirement benefits (other than pensions) or any post-employment benefits to its employees.\nNOTE 12 -- COMMITMENTS, CONTINGENCIES AND OBLIGATIONS\nOn October 25, 1993, the Company purchased two submersible offshore drilling rigs from Portal Rig Corporation (\"Portal\") for 626,410 shares of Noble Drilling common stock. The Company acquired the rigs subject to certain federal income tax \"safe harbor leases\" and a related preferred ship mortgage relating to a tax benefit transaction entered into in 1982 by a predecessor of Portal. Portal has agreed to indemnify the Company for any potential liabilities as a result of this earlier tax benefit transaction.\nDuring 1993, Chiles entered into severance agreements with its officers and certain managerial employees, including Chiles' rig management personnel. These agreements provide for severance payments equal to between six months and two years of such person's annual salary in the event a person's employment is terminated otherwise than for cause within one year following the occurrence of a change in control of Chiles or in the event that a person voluntarily terminates his employment within one year of a change in control of Chiles for \"good reason,\" as defined in the agreement.\nThe Company is a defendant in certain other claims and litigation arising out of operations in the normal course of business. In the opinion of management, uninsured losses, if any, will not be material to the Company's financial position or results of operations.\nIn connection with the damage sustained on the Linn Richardson, the Company has recorded an estimated loss of $1,778,000 related to mobilization costs. See Note 9.\nAt December 31, 1995, the Company had certain noncancellable long-term operating leases, principally for office space and facilities, with various expiration dates. Future minimum rentals under sub-leases aggregate $1,630,000 for 1996, $1,292,000 for 1997, $1,169,000 for 1998, $1,148,000 for 1999, $866,000 for 2000, and $2,923,000 thereafter.\nNOTE 13 --SUPPLEMENTAL LOSS PER SHARE DISCLOSURE\nAssuming that all shares of $2.25 Preferred Stock had been converted on January 1, 1995 the supplemental primary net loss applicable to common shares per share for the year ended December 31, 1995 would have changed from $0.08 to $0.06. Supplemental fully diluted net loss applicable to common shares per share for the year ended December 31, 1995 is the same as supplemental primary net loss applicable to common shares per share since the effect of the conversion is anti-dilutive.\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nNOTE 14 -- UNAUDITED INTERIM FINANCIAL DATA\nUnaudited interim financial information for the years ended December 31, 1995 and 1994 is as follows:\n- --------\n(1) Included in the quarters ended September 30, 1995 and December 31, 1995 were $800,000 ($0.01 per share) and $1,300,000 ($0.01 per share), respectively of separate return year loss carryback benefit related to Triton. See Note 8.\nIncluded in the quarter ended December 31, 1995 is a credit of $1,078,000 ($0.01 per share) related to the adjustment of the Triton acquisition contingency.\nIncluded in the quarter ended December 31, 1995 is a charge of $1,778,000 ($0.02 per share) related to the mobilization costs of the Linn Richardson to the West Coast of Africa. See Note 9.\n(2) Included in the quarter ended March 31, 1995 results is the $0.02 per share impact of the $1,524,000 Preferred Conversion Payment made in conjunction with the conversion of 923,862 shares of $2.25 Preferred Stock into common stock. See Note 6.\n(3) Included in the quarters ended March 31, June 30, September 30 and December 31, 1995 were $1,116,000 ($0.01 per share), $1,116,000 ($0.01 per share), $1,116,000 ($0.01 per share) and $2,812,000 ($0.03 per share), respectively, related to the effect of change in estimates of salvage values and remaining depreciable lives. See Note 1.\nNOTE 15 - GEOGRAPHICAL INFORMATION\nNOBLE DRILLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(Unless otherwise indicated, dollar amounts in tables are in thousands, except per share amounts)\nCustomer A accounted for approximately 11 percent of the Company's consolidated operating revenues during 1995. Customer B accounted for approximately 11 percent and 17 percent of the Company's consolidated operating revenues during 1994 and 1993, respectively. Customer C accounted for approximately 13 percent of the Company's consolidated operating revenues during 1993.\nNOTE 16 -- SUBSEQUENT EVENTS\nSubsequent to December 31, 1995, the Company sold for cash a posted barge rig located in the U.S. Gulf of Mexico. The Company will record a gain on the sale of this asset of approximately $4,815,000 in the first quarter of 1996.\nOn March 13, 1996, the Company entered into a letter of intent with Royal Nedlloyd N.V. and its wholly owned subsidiary, Neddrill Holding B.V. and its subsidiaries (collectively, \"Neddrill\"), to acquire the assets, including $25,000,000 in net working capital, and the personnel used by Neddrill in its offshore contract drilling, accommodation and other oil and gas exploration and production related service businesses. The purchase price would be $300,000,000 in cash plus 5,000,000 shares of Noble Drilling common stock. The Company currently plans to access the public securities markets to finance the cash portion of the purchase price.\nConsummation of the acquisition is subject to customary due diligence, execution and delivery of an agreement of sale and purchase, financing being obtained by the Company, and satisfaction of customary closing conditions expected to be contained in the agreement of sale and purchase.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Board of Directors of the Company has appointed the accounting firm of Price Waterhouse LLP, which has audited the Company's financial statements since October 7, 1994, as independent accountants to audit the financial statements of the Company for the year ending December 31, 1996.\nThe accounting firm of Arthur Andersen LLP served as the independent accountant for the Company from August 1, 1988 until October 7, 1994. The decision to change accountants was recommended by the audit committee of the board of directors of Noble Drilling. Arthur Andersen LLP's report on the financial statements of the Company for the year ended December 31, 1993, contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles, or as to any other matter. During the year ended December 31, 1993, and the subsequent interim period preceding the dismissal, there were no disagreements with Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure, or accounting scope or procedure, which disagreements if not resolved to the satisfaction of Arthur Andersen LLP would have caused it to make reference thereto in its reports on the financial statements of the Company for such years. Additionally, no \"reportable events\" (as such term is defined under the applicable rules and regulations of the Securities and Exchange Commission) occurred during the year ended December 31, 1993, or the subsequent interim periods preceding Arthur Andersen LLP's dismissal.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe sections entitled \"Election of Directors\" and \"Section 16(a) Reporting Delinquencies\" appearing in Noble Drilling's proxy statement for the annual meeting of stockholders to be held on April 25, 1996 (the \"1996 Proxy Statement\"), set forth certain information with respect to the directors of Noble Drilling and with respect to reporting under Section 16(a) of the Securities Exchange Act of 1934, and are incorporated herein by reference.\nCertain information with respect to the executive officers of Noble Drilling 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\" appearing in the 1996 Proxy Statement sets forth certain information with respect to the compensation of management of Noble Drilling, and, except for the report of the compensation and stock option committees of the board of directors of Noble Drilling on executive compensation and the information therein under \"Performance Graph,\" is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe sections entitled \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" appearing in the 1996 Proxy Statement set forth certain information with respect to the ownership of voting securities and equity securities of Noble Drilling, and are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) A list of the financial statements filed as a part of this report is set forth in Item 8 on page 18 and is incorporated herein by reference.\n(2) Financial Statement Schedules:\nAll schedules are omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto.\n(3) Exhibits:\nThe information required by this Item 14(a)(3) is set forth in the Index to Exhibits accompanying this Annual Report on Form 10-K.\n(4) Financial Statements required by Form 11-K for the fiscal year ended December 31, 1995, with respect to the Noble Drilling Corporation Thrift Plan (to be filed by amendment).\n(b) No reports on Form 8-K were filed by the Registrant 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.\nNOBLE DRILLING CORPORATION\nDate: March 13, 1996\nBy: JAMES C. DAY --------------------------------- James C. Day, Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following individuals on behalf of the Registrant and in the capacities and on the dates indicated.\nINDEX TO EXHIBITS\nEXHIBIT NUMBER EXHIBIT - --------------------------------------------------------------------------------\n2.1 -Assets Purchase Agreement dated as of August 20, 1993 (the \"Western Assets Purchase Agreement\"), between the Registrant and The Western Company of North America (filed as Exhibit 2.1 to the Registrant's Registration Statement on Form S-3 (No. 33-67130) and incorporated herein by reference).\n2.2 -Agreement dated as of October 7, 1993, among the Registrant, Noble Drilling (U.S.) Inc., Noble International Limited, The Western Company of North America and Offshore International Ltd., amending the Western Assets Purchase Agreement (filed as Exhibit 2.2 to the Registrant's Form 8-K dated October 15, 1993 and incorporated herein by reference).\n2.3 -Exchange Agreement dated as of June 4, 1993, by and among the Registrant, Grasso Corporation, Offshore Logistics, Inc., PPI-Seahawk, Inc. and Noble Production Services Inc. (filed as Exhibit 2.2 to the Registrant's Registration Statement on Form S-3 (No. 33-67130) and incorporated herein by reference).\n2.4 -Amendment No. 1 dated October 29, 1993 to the Exchange Agreement by and among the Registrant, Grasso Corporation, Offshore Logistics, Inc., PPI-Seahawk Services, Inc. and Noble Production Services Inc. (filed as Exhibit 2.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n2.5 -Assets Purchase Agreement dated as of August 20, 1993 (the \"Portal Assets Purchase Agreement\"), between the Registrant and Portal Rig Corporation (filed as Exhibit 2.3 to the Registrant's Registration Statement on Form S-3 (No. 33-67130) and incorporated herein by reference).\n2.6 -Agreement dated as of October 25, 1993, among the Registrant, Noble (Gulf of Mexico) Inc. and Portal Rig Corporation, amending the Portal Assets Purchase Agreement (filed as Exhibit 2.5 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n2.7 -Assignment and Assumption Agreement made as of October 28, 1993 by and between Noble Production Management Inc., Noble Production Services Inc., OLOG Production Management Inc., PPI-Seahawk Services, Inc. and Grasso Corporation (filed as Exhibit 2.7 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n2.8 -Stock Purchase Agreement dated April 22, 1994 among Joseph E. Beall, George H. Bruce, Triton Engineering Services Company and the Registrant (filed as Exhibit 2.1 to the Registrant's Form 8-K dated May 6, 1994 and incorporated herein by reference).\n2.9 -Agreement and Plan of Merger dated June 13, 1994 among the Registrant, Chiles Offshore Corporation and Noble Offshore Corporation (filed as Appendix I to the joint proxy statement\/prospectus of the Registrant and Chiles Offshore Corporation dated August 12, 1994 constituting Part I of the Registration Statement on Form S-4 (No. 33-54495) and incorporated herein by reference).\n2.10 -Letter of Intent dated March 13, 1996 among the Registrant, Neddrill Holding B.V. and Royal Nedlloyd N.V.\n3.1 -Restated Certificate of Incorporation of the Registrant dated August 29, 1985 (filed as Exhibit 3.7 to the Registrant's Registration Statement on Form 10 (No. 0-13857) and incorporated herein by reference).\n3.2 -Certificate of Amendment of Restated Certificate of Incorporation of the Registrant dated May 5, 1987 (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-3 (No. 33-67130) and incorporated herein by reference).\n3.3 -Certificate of Amendment of Restated Certificate of Incorporation of the Registrant dated June 1, 1987 (filed as Exhibit 4.3 to the Registrant's Registration Statement on Form S-3 (No. 33-67130) and incorporated herein by reference).\n3.4 -Certificate of Amendment of Restated Certificate of Incorporation of the Registrant dated April 28, 1988 (filed as Exhibit 3.12 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n3.5 -Certificate of Amendment of Restated Certificate of Incorporation of the Registrant dated April 27, 1989 (filed as Exhibit 3.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, as amended, and incorporated herein by reference).\n3.6 -Certificate of Amendment of Certificate of Incorporation of the Registrant dated August 1, 1991 (filed as Exhibit 3.16 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n3.7 -Certificate of Designations of $2.25 Convertible Exchangeable Preferred Stock, par value $1.00 per share, of the Registrant, dated as of November 18, 1991 (filed as Exhibit 3.17 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n3.8 -Certificate of Designations of $1.50 Convertible Preferred Stock, par value of $1.00 per share, of the Registrant, dated as of September 15, 1994 (filed as Exhibit 3.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n3.9 -Certificate of Amendment of Certificate of Incorporation of the Registrant dated September 15, 1994 (filed as Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended March 31, 1995 and incorporated herein by reference).\n3.10 -Certificate of Elimination of shares of $2.25 Convertible Exchangeable Preferred Stock of the Registrant dated June 8, 1995 (filed as Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended June 30, 1995 and incorporated herein by reference).\n3.11 -Certificate of Designations of Series A Junior Participating Preferred Stock, par value $1.00 per share, of the Registrant dated as of June 29, 1995 (filed as Exhibit 3.2 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended June 30, 1995 and incorporated herein by reference).\n3.12 -Composite copy of the Bylaws of the Registrant as currently in effect (filed as Exhibit 3.4 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended June 30, 1995 and incorporated herein by reference).\n4.1 -Indenture governing the Senior Notes (filed as Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n4.2 -Form of Senior Notes (included in Section 2.02 of the Indenture filed as Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n4.3 -Rights Agreement dated as of June 28, 1995 between the Registrant and Liberty Bank and Trust Company of Oklahoma City, N.A. (filed as Exhibit 4 to the Registrant's Form 8-K dated June 30, 1995 and incorporated herein by reference).\n10.1 -Amended and Restated Noble-National Joint Venture Partnership Agreement between the Registrant and National Enerdrill Corporation dated December 7, 1990 (filed as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference).\n10.2 -Limited Partnership Agreement between the Registrant and National Enerdrill Corporation dated as of January 16, 1992 (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.3 -Certificate of Limited Partnership of NN-1 Limited Partnership (filed as Exhibit 10.6 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.4* -Noble Drilling Corporation 1991 Stock Option and Restricted Stock Plan (as amended and restated through September 15, 1994) (filed as Exhibit 10.1 to the Registrant's Form 8-K dated December 8, 1994 and incorporated herein by reference).\n10.5* -Noble Drilling Corporation 1987 Stock Option Plan (filed as Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986, as amended, and incorporated herein by reference).\n10.6* -Noble Drilling Corporation Thrift Trust Agreement (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (No. 33-18966) and incorporated herein by reference).\n10.7* -Amendment No. 1 to the Noble Drilling Corporation Thrift Trust dated January 27, 1992 (filed as Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.8* -Noble Drilling Corporation Thrift Plan, as amended and restated, dated July 27, 1989 (filed as Exhibit 10.12 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.9* -Amendment No. 1 to the Noble Drilling Corporation Thrift Plan dated February 13, 1992 (filed as Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.10* -Directors' Option Agreements dated October 29, 1987, between the Registrant and each of Michael A. Cawley, Johnnie W. Hoffman and John F. Snodgrass (filed as Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n10.11 -Registration Rights Agreement dated as of January 29, 1988 between the Registrant and General Electric Capital Corporation (filed as a part of Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated February 11, 1988 and incorporated herein by reference).\n10.12 -First Amendment to Registration Rights Agreement dated as of February 5, 1993 between the Registrant and General Electric Capital Corporation (filed as Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.13 -Guarantee Agreement dated as of August 10, 1989 between the Registrant and The Royal Bank of Canada (filed as Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, as amended, and incorporated herein by reference).\n10.14 -Credit Agreement dated as of October 29, 1990 between Noble Drilling (Canada) Ltd. and The Royal Bank of Canada (filed as Exhibit 10.27 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.15 -Letter Agreement amending the Credit Agreement between Noble Drilling (Canada) Ltd. and The Royal Bank of Canada dated October 25, 1993 (filed as Exhibit 10.18 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n10.16 -Credit Agreement dated as of October 29, 1990 between Noble Enterprises Limited and The Royal Bank of Canada (filed as Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n10.17 -Letter Agreement amending the Credit Agreement between Noble Enterprises Limited and The Royal Bank of Canada dated October 25, 1993 (filed as Exhibit 10.21 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n10.18 -Guarantee and Subordination Agreement dated as of July 30, 1992 between the Registrant and The Royal Bank of Canada (filed as Exhibit 10.34 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.19* -Amendment No. 2 to the Noble Drilling Corporation Thrift Plan dated effective as of August 1, 1992 (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (No. 33-50270) and incorporated herein by reference).\n10.20 -Amended and Restated Letter of Credit Agreement, dated as of October 25, 1993, among Portal Rig Corporation, Noble (Gulf of Mexico) Inc., NationsBank of Texas, N.A., as agent and as one of the \"Banks\" thereunder, and Marine Midland Bank, N.A., Bank of America National Trust and Savings Association, and Norwest Bank Minnesota, National Association (collectively, the \"Banks\") (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n10.21 -Assignment, Assumption and Amended and Restated Preferred Ship Mortgage, dated October 25, 1993, by Noble (Gulf of Mexico) Inc. to the Banks (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n10.22 -Security Agreement and Assignment, dated October 25, 1993, by Noble (Gulf of Mexico) Inc. to the Banks (filed as Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n10.23 -Noble Support Agreement, dated October 25, 1993, among the Registrant and the Banks (filed as Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended September 30, 1993 and incorporated herein by reference).\n10.24* -Noble Drilling Corporation 1992 Nonqualified Stock Option Plan for Non-Employee Directors (filed as Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 (No. 33-62394) and incorporated herein by reference).\n10.25* -Amendment No. 3 to the Noble Drilling Corporation Thrift Plan dated effective as of January 1, 1994 (filed as Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n10.26 -Registration Agreement dated April 22, 1994 between the Registrant and Joseph E. Beall (filed as Exhibit 10.1 to the Registrant's Form 8-K dated May 6, 1994 and incorporated herein by reference).\n10.27 -Employment Agreement dated April 22, 1994 between Triton Engineering Services Company and Joseph E. Beall (filed as Exhibit 10.2 to the Registrant's Form 8-K dated May 6, 1994 and incorporated herein by reference).\n10.28 -Lease Indemnity Agreement dated April 22, 1994 among Joseph E. Beall, Triton Engineering Services Company, 1201 Dairy Ashford Ltd. and the Registrant (filed as Exhibit 10.3 to the Registrant's Form 8-K dated May 6, 1994 and incorporated herein by reference).\n10.29 -Credit Agreement dated as of June 16, 1994 among the Registrant, First Interstate Bank of Texas, N.A., in its individual capacity and as agent, and Credit Lyonnais Cayman Island Branch (filed as Exhibit 10.1 to the Registrant's Registration Statement on Form S-4 (No. 33-54495) and incorporated herein by reference).\n10.30 -Revolving Credit Note dated June 16, 1994 of the Registrant in the amount of $12,500,000 in favor of Credit Lyonnais Cayman Island Branch (filed as Exhibit 10.2 to the Registrant's Registration Statement on Form S-4 (No. 33-54495) and incorporated herein by reference).\n10.31 -Revolving Credit Note dated June 16, 1994 of the Registrant in the amount of $12,500,000 in favor of First Interstate Bank of Texas, N.A. (filed as Exhibit 10.3 to the Registrant's Registration Statement on Form S-4 (No. 33-54495) and incorporated herein by reference).\n10.32 -Guaranty Agreement dated as of June 16, 1994 by and among Noble Drilling (U.S.) Inc., Noble Drilling (West Africa) Inc. and Noble Drilling (Mexico) Inc. (filed as Exhibit 10.4 to the Registrant's Registration Statement on Form S-4 (No. 33-54495) and incorporated herein by reference).\n10.33 -Registration Rights Agreement dated as of September 15, 1994 between the Registrant and P.A.J.W. Corporation (filed as Exhibit 10.1 to the Registrant's Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference).\n10.34 -Severance Agreement dated as of July 1, 1993 between Noble Offshore Corporation (as successor by merger to Chiles Offshore Corporation) and C.R. Bearden (filed as Exhibit 10.2 to the Registrant's Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference).\n10.35* -Amendment No. 2 to the Noble Drilling Corporation Thrift Trust dated June 24, 1994 (filed as Exhibit 10.42 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.36* -Amendment No. 4 to the Noble Drilling Corporation Thrift Plan dated December 30, 1994 (filed as Exhibit 10.43 to the Registrant's Form 10-K\/A (Amendment No. 1) for the year ended December 31, 1994 and incorporated herein by reference).\n10.37* -Amendment No. 1 to the Noble Drilling Corporation 1992 Nonqualified Stock Option Plan for Non-Employee Directors dated as of July 28, 1994 (filed as Exhibit 10.44 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.38 -Guarantee dated August 26, 1994 between the Registrant and Hibernia Management and Development Company Ltd. (filed as Exhibit 10.45 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.39* -Noble Drilling Corporation Amended and Restated Thrift Restoration Plan (filed as Exhibit 10.46 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.40* -Amendment No. 4 to the Noble Drilling Corporation Thrift Plan, as in effect as of August 1, 1994, dated December 30, 1994 (filed as Exhibit 10.47 to the Registrant's Annual Report on Form 10-K\/A (Amendment No. 1) for the year ended December 31, 1994 and incorporated herein by reference).\n10.41* -Amendment No. 5 to the Noble Drilling Corporation Thrift Plan, dated effective as of May 1, 1995 (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended March 31, 1995 and incorporated herein by reference).\n10.42* -Noble Drilling Corporation Retirement Restoration Plan dated April 27, 1995 (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the three-month period ended March 31, 1995 and incorporated herein by reference).\n10.43* -Noble Drilling Corporation Short-Term Incentive Plan (revised April 1995).\n10.44 -First Amendment dated as of June 30, 1995 to Credit Agreement dated as of June 16, 1994 among the Registrant, First Interstate Bank of Texas, N.A., in its individual capacity and as Agent, and Credit Lyonnais Cayman Island Branch.\n10.45 -Second Amendment dated as of February 28, 1996 to Credit Agreement dated as of June 16, 1994 among the Registrant, First Interstate Bank of Texas, N.A., in its individual capacity and as Agent, and Credit Lyonnais Cayman Island Branch.\n10.46* -Form of Indemnity Agreement entered into between the Registrant and each of the Registrant's directors and bylaw officers.\n21.1 -Subsidiaries of the Registrant.\n23.1 -Consent of Price Waterhouse LLP.\n23.2 -Consent of Arthur Andersen LLP.\n27 -Financial Data Schedule.\n- -------------- * Management contract or compensatory plan or arrangement required to be filed as an exhibit hereto.","section_15":""}
{"filename":"22764_1995.txt","cik":"22764","year":"1995","section_1":"ITEM 1. BUSINESS\nThis Annual Report on Form 10-K contains certain forward looking statements that are subject to risk and uncertainty. There can be no assurance that these future results will be achieved. Readers are cautioned that a number of factors, including those identified below, could adversely affect the Company's ability to obtain these results: (a) increased payor pressures in the domestic psychiatric industry with respect to negotiated rates and other cost-containment measures, (b) uncertainties in the regulatory environment due to proposed health care reform legislation, including changes in Medicare and Medicaid reimbursement programs, and (c) increased competition among hospitals, managed care providers and other health care providers.\nThe following discussion should be read in conjunction with the industry segment information presented in the notes to the financial statements appearing in Item 8.\nOVERVIEW\nThe Company is a leading provider of psychiatric services for adults adolescents and children with acute psychiatric, emotional, substance abuse and behavioral disorders. The Company currently offers a broad spectrum of inpatient, partial hospitalization, outpatient and residential treatment programs through 28 hospitals in 15 states and Puerto Rico, and 15 hospitals in the United Kingdom. The Company also offers long-term critical care services in 12 states through 13 freestanding hospitals, a satellite hospital and one hospital that shares a building with one of the Company's psychiatric hospitals. The company operated 35 hospitals in the U.S. Psychiatric Division until November 1995 when the Company discontinued psychiatric operations at six of these facilities. One additional psychiatric hospital was closed in January of 1996. Two of these facilities shared space with the long-term critical care division. Long-term critical care services will continue to be provided at these locations and will expand to use all of the previously shared buildings.\nRECENT DEVELOPMENTS\nHospital Closures and Restructuring. Since November 1995, the Company has begun a restructuring by closing unprofitable hospitals and reducing regional and corporate overhead. Six underperforming hospitals were closed in November 1995, two of which shared space with the Company's long-term critical care division. These two previously shared facilities are now being completely converted to THC long-term critical care facilities. A seventh psychiatric facility was closed in January 1996. The Company's historic multi-regional structure (which had been consolidated since 1993 from 9 regions to 2), was further consolidated in November 1995 into one centralized organizational structure under one management team to enhance cost-effectiveness and corporate responsiveness to field operations. The Company also centralized marketing operations. Further reductions in overhead costs were implemented in January 1996, and poorly performing facilities will continue to be monitored closely for potential closure or sale if their financial performance does not improve on a timely basis.\nNew Management. In November 1995 the Company put in place a new management team with extensive experience in psychiatric\/behavioral health operations to manage the U.S. psychiatric business and to improve profitability. William Hale, who had joined Community Psychiatric Centers (\"CPC\") in May 1995 to serve as chief operating officer of its Managed Care Services division, was appointed president. Charles Smith, formerly senior vice president responsible for Eastern Division operations, was promoted to a newly-created chief operating officer position. The Company developed a wide variety of initiatives and programs to strengthen operations for the new management team to implement, including (i) expanding the psychiatric and behavioral health services offered, (ii) placing a heavier emphasis on cost containment and collections, (iii) establishing a centralized marketing function and expanding marketing and business development efforts directed to managed care organizations, (iv) enhancing account management services to clients and (v) establishing and expanding creative forms of partnerships and other alliances with medical\/surgical hospitals and various payer organizations. However, there can be no assurance that the new management team or the Company will be successful in the short-term in significantly improving operating results. The new management team also plans to move quickly on a hospital closure when circumstances warrant such action.\nSpin-off Transaction. On December 20, 1995, the Company announced that the CPC Board of Directors had preliminarily approved a plan to spin-off the U.S. psychiatric business in the form of a taxable dividend to\nthe CPC shareholders. The plan calls for CPC to be split into two independent publicly held corporations, one providing psychiatric services in the U.S. and one operating THC, U.K. psychiatric operations and Puerto Rico psychiatric operations. The spin-off is subject to a number of conditions, including regulatory and other third party approvals, market conditions, final approval of the Board of Directors and shareholder approval, accordingly, there can be no assurance that the Company will be successful in consummating the spin-off. However, it is anticipated that the spin-off and related matters will be submitted to shareholders at the Annual Meeting to be scheduled at a later date. The special dividend is expected to be distributed by mid 1996.\nIndications of Interest Received for PHG. The Company has received a number of unsolicited indications of interest to acquire its United Kingdom subsidiary--the Priory Hospitals Group (\"PHG\"). There can be no assurance that these inquiries and related discussions will result in a sale of PHG. The Company is giving each indication of interest received to date careful consideration, and does not intend to make further announcements until these discussions are terminated or the Company enters into a definitive agreement.\nPSYCHIATRIC SERVICES\nThe Company is a leading provider of psychiatric\/behavioral services for adults, adolescents and children with acute psychiatric, emotional, substance abuse and behavioral disorders. The Company currently offers a broad spectrum of inpatient, partial hospitalizations, outpatient and residential treatment programs through 28 hospitals in 15 states and Puerto Rico and also provides comprehensive managed care\/case management services for payors throughout the U.S.\nThe psychiatric\/behavioral care industry in the United States continues to undergo significant change due to the expanding influence of managed care and cost-containment measures imposed by governmental and third party payors and employers. Providers such as the Company continue to experience a significant increase in the percentage of revenues from payors that reimburse on negotiated per diem or case rates, episodes of care or length of stay rates, or on a discounted basis. In addition, this same trend has resulted in higher deductibles and co-insurance for patients. Negotiated rates with managed care, government and other third parties have decreased, and the use of less intensive settings of behavioral care in place of inpatient treatment has increased. Providers such as the Company have also been affected by the aggressive privatization of state and county psychiatric\/behavioral services which has generally resulted in lower rates. Payors also have adopted increasingly stringent admission and length of stay criteria and other treatment constraints. All of these factors adversely affect utilization and reimbursement for psychiatric services. As a result, psychiatric care providers in the U.S. have been forced to adapt their clinical practices, business practices and operating strategies.\nThe Company's operating results for the periods presented have been adversely affected by several factors, including: (i) expansion of managed care and its penetration into new markets throughout the U.S.; (ii) significant reduction in reimbursement from government, state and county payors that are aggressively trying to reduce their costs for all forms of health care; (iii) management in certain markets who have not changed rapidly enough to meet the demands of a changing marketplace; and (iv) erosion of length of stay due to the development of alternative services such as partial programs, intensive outpatient services and behavioral home care, all of which can be delivered in a more cost effective setting. Due in part to these issues, the Company has gone through a major restructuring, as described above in \"Recent Developments\" and is in the process of implementing the initiatives discussed under \"Business--Business Strategy,\" below.\nLONG-TERM CRITICAL CARE\nIn November 1992, to diversify beyond psychiatric care, the Company, through its wholly-owned subsidiary Transitional Hospitals Corporation (\"THC\"), began to offer long-term critical care services in converted, previously underutilized psychiatric hospitals and newly-acquired freestanding acute care facilities. The Company incurs significant capital and start-up costs in connection with the acquisition and conversion of each facility, and each of the new facilities is expected to generate significant operating losses until the facility is certified as a long-term critical care hospital at which time it qualifies for cost-based reimbursement. Pending such certification, these start-up hospitals are reimbursed under the Medicare Prospective Payment System (\"PPS\") which does not pay the full cost of treating Medicare patients with the severity of illness treated at\nTHC facilities. Such certification typically occurs after the facility's first six months of operations during which the facility establishes an average length of stay in excess of 25 days.\nOf the 14 THC hospitals in operation during fiscal year 1995, 13 were certified as long-term care hospitals and therefore received cost-based reimbursement under Medicare, whereas at the same time in 1994, 13 facilities were in operation and eleven had been open long enough to receive their long- term care hospital certification. In addition, 11 facilities completed their \"TEFRA\" (Tax Equity and Fiscal Responsibility Act of 1982) rate setting period during fiscal year 1995 and are now eligible for an additional incentive payment if their costs are less than the targeted rate per discharge. See \"Business--Regulation and Reimbursement--Medicare and Medicaid\".\nBUSINESS STRATEGY\nPsychiatric Hospitals--United States\nThe Company has refocused its business strategy to meet the needs of the current U.S. psychiatric care industry by ensuring the most cost-effective delivery of quality care in an environment of reduced reimbursement and inpatient hospital stays. However, there can be no assurance that the Company will be successful in achieving its business strategy objectives. The Company's present operating strategy includes the following key elements:\nFocus on Core Business\n. Focus on Core Business Operation. Management has instituted an intense refocusing on core business operations. As part of this action plan, management is monitoring on a regular basis and holding all hospital CEOs accountable for key operating indicators such as labor costs and staffing levels, clinician compensation, purchased services and ancillary costs. Management also continues to focus on cash collections and reducing contractual and bad debt expenses by more closely monitoring managed care contracts, collecting at time of patient admission, scrutinizing in more detail all denials and appeals, and establishing clear communication and coordination among all the hospital departments and the hospital business office. Furthermore, management has both expanded and increased its utilization of its national managed care contract data base to ensure consistent contract negotiations and coordinate account management among all the Company's operations and payors across the country.\n. Align Hospital Management Incentives. The Company maintains an emphasis on ensuring that hospital CEO and management team compensation incentives are aligned with corporate objectives. Accordingly, the Company measures and rewards hospital CEOs and management teams for their facility's quality of care, ability to meet payor and patient needs and achievement of financial objectives. CEOs and their management teams are encouraged to establish ventures that provide future avenues of growth while still being rewarded for growth in their core businesses.\n. Reengineer the Organizational Structure to Establish a Result-oriented Management Infrastructure. The Company has recently completed a significant reduction in overhead, including the entire regional management infrastructure. The Company believes that the elimination of costly and redundant personnel as well as the cumbersome authorization protocols inherent in that structure will result in an organizational structure that is both effective and efficient. The Company has also implemented a centralized management recruiting effort to improve the standardization of quality and skills at senior levels, hospital CEOs, CFOs, marketing directors and physicians. The Company plans to continue monitoring its management infrastructure and will continue to reengineer its control structure in order to maintain an efficiently managed organization.\nFocused Development\n. Strengthen Alliances with General Medical\/Surgical Hospitals. The Company has targeted the top general medical\/surgical hospitals in each of its local markets to establish alliances including joint purchasing arrangements of laboratory, pharmacy and ancillary services; packaged bids to privatize the local community's public health care programs; and joint ventures, partnerships or other entities that offer health care services designed to address the specific needs of each particular local market\n(including home health care, gero-psychiatric\/behavioral services or disease management of psychiatric\/behavioral services within the general medical\/surgical hospital's emergency room or psychiatric care unit).\n. Develop Integrated Delivery Systems. Management recognizes the need to be a part of Integrated Delivery Systems, and as a result, is establishing relationships with other health care providers in each of its markets. As part of this strategy, the Company may consolidate certain of its operations within the facilities of other health care providers associated with the IDS, or the operations of such health care provider may be consolidated within the Company's facilities.\n. Pursue Government Contracts. The Company believes that the privatization of health care represents a strong area of potential growth given the current fiscal pressures faced by governments. Consequently, the Company is actively pursuing opportunities to provide the psychiatric health care services to state, county or municipal governments within the markets that it serves. The Company's response to privatization efforts are supported by other corporate initiatives including the establishment of IDSs and its plan to affiliate with general medical\/surgical hospitals.\n. Strengthen Relationships with Payors. The Company continually examines and assesses the \"user friendliness\" and attractiveness of its programs in meeting the needs of the Company's payors. Based on this analysis, the Company refines its program offerings and business protocol. Programs developed to better meet the needs of payors include length of stay contracts, case rates and episodes of care rates. The Company's efforts are directed at cultivating a cooperative environment with payors. The Company has refined its management and clinical outcome capabilities to further integrate them with these functions as performed by payors and the other health care providers serving payors.\n. Strengthen Youth Service Programs and Develop Other Alternative Behavioral Health Care Regimens. Youth service programs represent one of the fastest areas of growth in behavioral health care. The current short supply of such programs is forcing many state and county governments to send their young offenders to programs out of state. The Company will continue to strengthen its position as a provider of youth services and will also look to develop other forms of alternative behavioral care that provide similar growth opportunities.\nWhile the Company believes that implementing the above described programs and strategies will enable the Company to improve operations, there can be no assurance that the Company will be successful in doing so.\nPsychiatric Hospitals and Dialysis Units--United Kingdom\nCurrently, the Company operates 12 psychiatric hospitals and two smaller treatment units in the United Kingdom through which it provides primarily inpatient treatment to patients covered by private health insurance. It also operates a substance abuse clinic, a secure psychiatric facility and two kidney dialysis facilities for Britain's National Health Service (\"NHS\"). Based on the number of licensed hospital beds, the Company is the leading commercial provider of psychiatric services in the United Kingdom where psychiatric services are generally available to residents without charge from government-owned NHS hospitals. Approximately 12% of the British population is covered by private health insurance.\nThe Company also operates two adolescent care units for children who have been traumatized by abuse, or who have emotional and behavioral problems and learning difficulties. These children are placed at the units by local statutory authorities.\nManagement intends to continue to explore acquisitions and alliances to take advantage of an increasing willingness on the part of the British government to contract with private providers, and to expand the Company's dialysis business in the United Kingdom.\nTHC Hospitals\nTraditionally, patients suffering from long-term complex medical problems have stayed in the intensive care unit of general acute care hospitals until they were sufficiently well to be transferred to less intensive care settings. Such stays are relatively expensive, reflecting the cost of intensive on-site equipment and services that,\nwhile necessary for hospitals to accomplish their primary missions, are not required for the ongoing treatment of these patients. Over the past ten years, hospitals have come under increasing pressure to reduce the length of patient stays as a means of containing costs. Managed care organizations have limited hospitalization costs by controlling hospital utilization and negotiating discounted rates for hospital services. Traditional third party indemnity insurers have begun to limit reimbursement to pre-determined amounts of \"reasonable charges,\" regardless of actual costs, and to increase the co- payments required to be paid by patients. In 1983, Congress sought to contain Medicare hospital costs by adopting the Prospective Payment System (\"PPS\") under which hospitals generally receive a specified reimbursement rate regardless of how long the patient remains in the hospital or the volume of ancillary services ordered by the attending physician. The effect of these various cost-containment measures have provided hospitals with an incentive to discharge patients more quickly.\nTHC has primarily targeted larger-population markets which have significant populations of persons over the age of 65. The aging of the population, advancements in medical care, the desire of payors and patients for lower cost and more specialized alternatives to traditional acute care hospitals and the disincentive for such hospitals to provide long-term care to critically ill patients has led to a growing demand for long-term critical care services. The Company believes that providers such as skilled nursing facilities and home care providers are not in the best position to efficiently provide health care services to these critically ill patients. Traditional skilled nursing facilities have generally focused on providing long-term custodial care to persons eligible for Medicaid. As a result of Medicaid \"cost ceilings\" on reimbursement for each patient, nursing homes face an economic disincentive to treat medically complex patients. Home health care is not a viable alternative to inpatient care for such patients because of their continued need for (i) intensive and specialized medical care and equipment, (ii) the availability of physicians and 24-hour nursing care, and (iii) a comprehensive array of rehabilitative therapy. As a result of its improved operating results in 1995, the Company continues to believe that a market opportunity exists for providers dedicated exclusively to providing long-term critical care. However, there can be no assurance that the Company will be able to successfully execute its expansion plans of THC operations or that health care reform will not adversely affect THC's financial performance. See \"Business--Regulation and Reimbursement.\"\nTo capitalize on this opportunity, THC offers long-term critical care to patients who are stabilized and do not require the complete spectrum of intensive care services provided by traditional acute care hospitals, but who are too ill to return home or be placed in a nursing home. THC provides care to those suffering from pulmonary diseases, kidney failure and other complex medical problems; such patients require a variety of intensive services including life-support systems, post-surgical stabilization, intravenous therapy, subacute rehabilitation and wound care. THC's strategy is to provide a comprehensive range of long-term critical care that will enable it to treat most types of critical care patients, regardless of their diagnosis or medical condition, with the objectives of returning these patients to full activity.\nTHC offers managed care organizations and indemnity insurance payors a single source from which to obtain long-term critical care services. The Company believes THC addresses cost-containment pressures affecting the health care industry by offering a high quality, cost-effective alternative to traditional acute care hospitals.\nTHC's immediate expansion plan is to open two facilities in fiscal 1996. The Company will expand THC's operations primarily by (i) leasing beds in acute care facilities owned by others, (ii) acquiring and converting freestanding acute care and psychiatric facilities and (iii) converting selective previously underutilized psychiatric hospitals owned by the Company to long- term critical care use.\nPSYCHIATRIC CARE OPERATIONS\nServices and Programs\nOver the past several years, the Company has significantly expanded the scope of its psychiatric treatment programs to create a continuum of care from which the most appropriate and cost-effective treatments can be selected to meet the needs of its payors and patients. In addition to offering traditional inpatient treatment\nprograms, the Company provides less costly treatment alternatives such as partial hospitalization, residential treatment and intensive and non-intensive outpatient programs. By offering such programs through a single organization, the Company believes that patients receive the most appropriate treatment, and that the transition among differing intensities of care occurs rapidly and cost effectively from the perspective of the patient, clinical team (including the medical director, the clinical or nursing director, the admissions director and the program director) and payor. The Company's patient programs include:\n. Inpatient. Inpatient treatment is provided when the patient's disorder prevents him or her from safely performing routine daily activities without 24-hour supervision. Intensive individual or group therapy is provided and the patient's daily activities are highly structured. Treatment regimens are designed to enable transition to a less intensive treatment program as soon as feasible.\n. Residential. Residential treatment programs specialize in providing treatment for adolescents who need more structured treatment than can be provided through outpatient care. The Company also operates several acute residential treatment programs for adults. The Company's 19 residential treatment centers typically have 10 to 30 beds and each are staffed with a psychiatrist, 24-hour nursing and an on-site licensed program therapist.\n. Partial Hospitalization. Partial hospitalization (including outpatient visits) is provided when the patient's disorder does not require 24-hour supervision and is such that the patient may be treated while living at home. Treatment regimens are generally for 6-12 hours per day, up to 7 days per week, and are structured to meet the patient's specific clinical needs as well as the patient's work, school and home life requirements.\n. Intensive Outpatient. Intensive outpatient programs are provided when a patient's disorder necessitates routine observation, supervision or intervention but does not require inpatient or partial hospitalization treatment. Treatment is generally provided for 3-4 hours per day, typically 3-4 days per week, according to the patient's clinical needs and daily routine.\n. Outpatient. Outpatient treatment is offered when a patient's disorder requires therapeutic intervention at a level that is less intensive than the Company's other psychiatric services. This type of treatment generally involves individual, family or group therapy of 45-90 minutes per session on a scheduled basis. Typically, the Company will refer these types of patients to community-based clinicians as appropriate to the needs and location of the patient.\nThe Company also offers payor services for the above described programs designed to be attractive, effective and efficient for payors:\n. Managed Care\/Case Management. The Company offers case management services to payors such as health maintenance organizations (\"HMOs\"), preferred provider organizations (\"PPOs\") and firms specializing in psychiatric\/behavioral health care managed care services. The managed care\/case management programs also include case reviews and claims payment services. These services may be attractive to payors that no longer wish to directly provide psychiatric\/behavioral case management services or that may desire access to a larger network of patient care programs.\n. Clinical Outcome Information. The Company's information system, \"CPC- INFO,\" is designed to gather and synthesize patient satisfaction data, clinical outcomes data, clinical views of symptomology and demographic, program, payor and resource data in a common data base. The consolidated data provides useful information for the professional treatment team, the payor and the regulatory agency. CPC-INFO better enables the Company to demonstrate to payors effectiveness and quality of care, standardized clinical operations, clinical outcomes, regulatory compliance, patient satisfaction and overall value.\nFor the year ended November 30, 1995, the average length of stay for the 35 U.S. psychiatric hospitals' inpatient and residential treatment programs was 9.2 days and 94.5 days, respectively. Adjusted patient days for inpatient, partial hospitalization (including outpatient visits), and residential treatment programs were 332,649, 152,309 and 57,311, respectively, for the same period.\nPsychiatric Hospitals\nAs of November 30, 1995, the Company operated the following psychiatric hospitals:\n- -------- * Joint venture, Residential Treatment Center. ** Closed January 19, 1996.\nUNITED KINGDOM\nSources of Psychiatric Hospital Revenues--U.S.\nPatients are typically referred to the Company by physicians and other health care professionals, managed care organizations, employee assistance programs, the clergy, law enforcement officials, schools, emergency rooms and crisis intervention services. In some areas, the Company provides a community outreach program called the Psychiatric Assessment Team which is able to respond on a 24-hour basis to emergency calls for help in assessing people's problems and making referrals to the appropriate mental health service or setting. Psychiatrists and, in some states, psychologists are authorized to admit patients to the Company's facilities. It is against Company policy, as well as state and federal law, to pay referral sources for hospital admissions. See \"Business--Regulation and Reimbursement--Relationships With Physicians and Clinicians\". The Company believes it obtains referrals from both physicians and secondary sources primarily as a result of its competitive pricing and the quality and scope of its programs.\nThe Company receives payment for its psychiatric hospital services from patients, private health insurers, managed care organizations, and from the Medicare, Medicaid and CHAMPUS governmental programs. While variations or hybrid programs may exist, the following five categories include all methods by which the Company's hospitals receive payment for services:\n. Medicare. Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and certain disabled persons. Reimbursement is predicated on the allowable cost of services, plus an incentive payment where costs fall below a target rate.\n. Medicaid. Medicaid is a medical assistance program under which benefits are available to the indigent. Reimbursement received by the Company's hospitals varies as each state has its own methodology for making payment for services provided to Medicaid patients.\n. CHAMPUS. CHAMPUS is a federal program which provides health insurance for certain active and retired military personnel and their dependents. CHAMPUS reimbursement is at either (i) regionally set rates, (ii) 1988 charges adjusted upward by the Medicare Market Basket Index, or (iii) a fixed rate\nper day at certain of the Company's California facilities where CHAMPUS contracts with a benefit administration group.\n. Managed Care. Reimbursement is at prices established in advance by negotiation or competitive bidding for contracts with insurers and other payors such as health maintenance organizations, preferred provider organizations and other similar plans.\n. Private Pay. Payment by patients and their private indemnity health insurance plans is generally based on the Company's schedule of rates for that location. The Company's general policy is to set rates for services at amounts equal to or less than the average rates of its competitors' comparable facilities in each hospital market.\nThe following table summarizes, as a percentage of net operating revenues for all of the Company's United States psychiatric hospitals, the percentage of net operating revenues from each reimbursement method for the periods presented.\nSources of Psychiatric Hospital Revenues--U.K.\nApproximately 12% of United Kingdom's population has private health insurance which provides benefits for psychiatric and substance abuse treatment. There are few private psychiatric hospitals in the United Kingdom because NHS hospitals (British government-owned) are available to its residents without charge. Approximately 59% (76% in 1994 and 85% in 1993) of the Company's 1995 revenues for services in its psychiatric hospitals and alcoholism treatment facilities in the United Kingdom were derived from private sources not subject to any governmental payment limitations, but which are being affected by reimbursement restrictions imposed by private insurers.\nLONG-TERM CRITICAL CARE\nThe Company, through THC, provides long-term critical care in converted psychiatric facilities, freestanding acute care facilities and hospital space shared with a psychiatric facility. Although THC's patients range in age from pediatric to geriatric, a substantial portion of THC's patients are over 65 years of age. THC's long-term critical care facilities include the equipment and physician and other professional staff necessary to care for most types of critically ill patients regardless of their diagnosis or medical condition. THC's professional staffs work in inter-disciplinary teams to evaluate patients upon admission to determine a treatment plan with an appropriate level and intensity of care. Where appropriate, the treatment programs may involve the services of several disciplines, such as pulmonary and rehabilitation therapy. Currently, THC offers a complex medical care program, ventilator management program, wound care program and low tolerance rehabilitation program. Patients who successfully complete treatment programs are discharged to skilled nursing homes, rehabilitation hospitals or home care settings.\nLong-Term Critical Care Hospitals\nAs of November 30, 1995, THC operated the following 14 long-term critical care hospitals and one satellite hospital:\n- -------- (1) Shared facility with CPC. (2) Shared facility with CPC through November 1995. Will be fully converted to THC in fiscal year 1996. (3) Fully converted from a CPC psychiatric hospital. (4) Leased facility. (5) In September of 1995, the Company opened an 80 bed satellite to this facility in Fort Worth, Texas.\nNote: Two additional facilities are under development in San Diego, CA (38 beds) and Chicago, IL (104 beds).\nThe Company conducts market research prior to opening a new facility to determine (i) the need for placement of ventilator-dependent patients and other classes of critically ill patients, (ii) the existing physician referral patterns, (iii) the presence of competitors, (iv) the payor mix and (v) the political and regulatory climate. The Company generally seeks to purchase or lease hospitals with fewer than 100 beds in major metropolitan areas and also considers hospitals in other markets where its research indicates the need for such hospitals.\nPatient Admission\nSubstantially all of the patient admissions to THC's hospitals are transfers from other health care providers. Patients are referred from general acute care hospitals, rehabilitation hospitals, skilled nursing facilities and home\ncare settings. The majority of THC's admissions are directly from the intensive care units of general acute care hospitals. Referral sources include discharge planners, case managers of managed care plans, social workers, physicians, third party administrators, HMOs and insurance companies.\nTHC has directors of patient referrals who educate health care professionals from traditional acute care hospitals as to the unique nature of the services provided by THC's hospitals. The directors of patient referrals develop an annual admission plan for each hospital, with assistance from the hospital's administrator. The admission plans involve ongoing education of local physicians and the employees of managed care organizations and acute care hospitals. THC anticipates that it will direct increased admission efforts toward insurance company case managers and managed care organizations.\nSources of Long-Term Critical Care Revenues\nFor long-term critical care services rendered to patients, THC receives payment from (i) the federal government under Medicare, (ii) certain states under Medicaid, (iii) commercial insurers and patients and (iv) managed care organizations. After certification of the THC facility as no longer subject to PPS limitations, payments from Medicare and Medicaid are generally based upon cost; payments from commercial insurers are generally based upon charges and payments from managed care organizations are based on negotiated rates. Net Medicare revenue for THC totalled 72% (69% and 77% for fiscal years 1994 and 1993) of total THC net operating revenues for fiscal year 1995. The Company anticipates reimbursement from Medicare will continue to constitute a significant portion of THC's revenues in the future. See \"Business--Regulation and Reimbursement.\"\nSELECTED HOSPITAL OPERATING DATA\nThe following is a comparison of the quarterly and annual statistical data for fiscal years 1995 and 1994 for the Company's 35 United States psychiatric hospitals that were operated in 1995 (six facilities were closed in November 1995 and one facility was closed in January 1996), its 12 United Kingdom psychiatric hospitals and its 13 THC hospitals which were open in both years. In all periods presented, adjusted patient days include inpatient days and equivalent days for partial hospitalization and outpatient programs.\nCOMPETITION\nThe Company's psychiatric hospitals compete with other free-standing psychiatric hospitals, psychiatric units in medical\/surgical hospitals as well as with other specialty psychiatric hospitals. Some competing hospitals are either owned or supported by government agencies. Others are owned by nonprofit corporations and supported by endowments and charitable contributions. Such governmental and nonprofit entities are substantially exempt from income and property taxation. The competitive position of a hospital is, to a significant degree, dependent upon the number and quality of physicians practicing at the hospital and the members of its medical staff. The Company also believes that the competitive position of a hospital is dependent upon the variety of services offered by a facility, and the Company strives to implement programs best suited to the needs of patients and payors in each particular market.\nTHC's hospitals compete with medical\/surgical hospitals, certain long-term care hospitals, sub-acute facilities, rehabilitation hospitals and nursing homes specializing in providing care to critically ill patients. Many of these providers are larger and more established than THC. The Company believes that to offer programs providing a cost-effective continuum of care, nursing homes and other companies are converting their facilities and developing programs that will be competitive with THC's hospitals. This trend is expected to continue due to cost-containment pressures and the efforts of nursing homes to expand their existing markets.\nThe competitive position of a hospital, including the Company's psychiatric hospitals and THC's hospitals, is affected by the ability of its management to negotiate service contracts with purchasers of group health care services, including private employers, PPOs and HMOs. Such organizations attempt to obtain discounts from established hospital charges. The importance of obtaining contracts with PPOs, HMOs and other organizations which finance health care, and its effect on a hospital's competitive position, vary from market to market, depending on the number and market strength of such organizations. It is the Company's policy to enter into these contracts wherever feasible. Generally, hospitals holding major contracts with managed care organizations are able to attract more doctors to their active medical staffs than hospitals without such contracts.\nEMPLOYEES\nAs of November 30, 1995, the Company had approximately 9,400 employees, of which approximately half were employed full time and half were employed part time. The employees at two of the Company's psychiatric hospitals and one THC hospital are covered by union agreements. The Company considers its labor relations to be satisfactory.\nREGULATION AND REIMBURSEMENT\nThe health care environment in which the Company operates is highly regulated and subject to frequent and substantial changes and proposals for change. There can be no assurance that state or federal regulatory and legislative bodies will not propose or enact rules or laws that could have a material adverse effect on the Company.\nThe Company's hospitals are subject to substantial and continuous federal, state and local government regulation. Such regulations provide for periodic inspections and other reviews by state and local agencies, the United States Department of Health and Human Services (\"HHS\") and CHAMPUS to determine compliance with their respective standards pertaining to medical care, staffing utilization, safety and equipment necessary for continued licensing or participation in the Medicare, Medicaid or CHAMPUS programs. The admission and treatment of patients at the Company's psychiatric hospitals are also subject to state and federal regulation relating to confidentiality of medical records.\nAccreditation and State Licensing\nState licensing of hospitals is a prerequisite to the operation of each hospital and to participation in all federally-funded programs. Once a hospital has been licensed, it must continue to comply with federal, state and local licensing requirements in addition to local building and life safety codes. All of the Company's hospitals have obtained the necessary licenses to conduct business.\nHospitals may seek an accreditation from The Joint Commission on Accreditation of Healthcare Organizations (\"JCAHO\"), a nationwide commission which establishes standards relating to the physical plant, administration, quality of patient care and operation of medical staffs of hospitals. Generally, hospitals and certain other health care facilities are required to have been in operation at least six months in order to be eligible for accreditation by JCAHO. After conducting on-site surveys, JCAHO awards accreditation for up to three years to hospitals found to be in substantial compliance with JCAHO standards. Accredited hospitals are periodically resurveyed, including, at the option of JCAHO, upon a major change in facilities or organization and after a merger or consolidation. All of the Company's hospitals are accredited by JCAHO. The Company intends to seek and obtain JCAHO accreditation for any additional hospitals it may purchase or lease.\nCertain states have certificate of need (\"CON\") laws which generally provide that prior to the expansion of an existing facility, the construction of a new facility, the addition of beds, the acquisition of existing facilities or major items of equipment or certain changes in services, or the undertaking of a capital expenditure on behalf of a facility, approval must be obtained from the designated state health planning agency. The stated objective of the CON process is to promote quality health care at the lowest possible cost and avoid unnecessary duplication of services, equipment and facilities. If the Company is unable to obtain the requisite CONs, the growth of its business and especially that of THC could be adversely affected.\nMedicare and Medicaid\nDuring fiscal 1995, approximately 38% of the Company's United States psychiatric operating revenues were derived from patients covered by Medicare and Medicaid programs, and the Company anticipates that this participation will increase in the future. Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and certain disabled persons. Medicaid is a medical assistance program administered by the states and partially funded by the federal government under which health care benefits are available to the indigent. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative rulings, interpretations and discretion which may affect payments made to providers.\nIn order to receive Medicare reimbursement, each hospital must meet the applicable conditions of participation set forth by HHS relating to the type of hospital, its equipment, personnel and standard of medical care, as well as comply with state and local laws and regulations. Hospitals undergo periodic on-site Medicare certification surveys. The Medicare survey is limited if the hospital is JCAHO accredited. All but one of the U.S. psychiatric hospitals and all of THC's operating hospitals are certified as Medicare providers. The one U.S. psychiatric hospital that is not Medicare certified treats adolescents only. All but two of the Company's operating hospitals are certified by their respective state Medicaid programs. A loss of certification could adversely affect a hospital's ability to receive payments from Medicare and Medicaid.\nPrior to 1983, Medicare reimbursed hospitals for the reasonable direct and indirect cost of the services provided to beneficiaries. The Social Security Amendments of 1983 implemented PPS in an effort to reduce and control Medicare costs. Under PPS, inpatient costs are reimbursed based upon a fixed payment amount per discharge using diagnosis related groups (\"DRGs\"). The DRG payment under PPS is based upon the national average cost of treating Medicare patients with the same diagnosis. Although the average length of stay varies for each DRG, the average stay for all Medicare patients subject to PPS is approximately six days. An additional outlier payment is made for patients with unusually long lengths of stay or higher treatment costs. Outlier payments are designed to cover only marginal costs. Additionally, PPS payments can only be made once every 60 days for each patient. Thus, PPS creates an economic incentive for general acute care hospitals to discharge Medicare patients as soon as clinically possible.\nThe Social Security Amendments of 1983 exempted psychiatric, rehabilitation, cancer, children's and long-term care hospitals from PPS. A long-term care hospital is defined as a hospital which has an average length of stay of greater than 25 days. The Company's experience is that THC's facilities are able to meet this definition. Under current law, inpatient operating costs for long-term care and psychiatric hospitals are reimbursed under a cost-based reimbursement system. The one exception to this rule is the initial six months of operations of a long-term care hospital which is subject to PPS reimbursement. As a result of the Tax Equity and Fiscal Responsibility Act of 1982 (\"TEFRA\"), reimbursement under the cost-based system is subject to a computed target amount\nper discharge (the \"Target\") for inpatient operating costs. A hospital's Target rate is the per discharge (case) limitation, derived from the hospital's allowable net Medicare inpatient operating costs in the hospital's base year, and updated for each subsequent hospital cost reporting period by the appropriate annual rate-of-increase percentage. If allowable net inpatient operating costs do not exceed the hospital's Target, payment to the hospital will be determined on the basis of the lower of (i) Net inpatient operating costs plus 50% of the difference between inpatient operating costs and the Target; or (ii) Net inpatient operating costs plus 5% of the Target. Prior to October 1, 1991, allowable Medicare operating costs per discharge in excess of the Target were not reimbursed. Effective October 1, 1991, if a hospital's allowable net inpatient operating costs exceed the Target, Medicare reimburses the lower of (i) the hospital's target amount plus 50% of the allowable Medicare operating costs per discharge in excess of the Target or (ii) 110% of the Target. With regard to hospitals certified prior to October 1, 1992, the TEFRA Target provisions do not apply with respect to hospitals that have been in operation for less than three full years. For hospitals certified on or after October 1, 1992, the TEFRA Target provisions do not apply with respect to hospitals that have been in operation for less than two full years. Under the Omnibus Budget Reconciliation Act of 1993 (\"OBRA\"), increases in the Target for fiscal years 1994 through 1997 are generally limited to the hospital market basket increase minus one percentage point.\nIn October 1993, HHS, acting through the Health Care Financing Administration, issued a memorandum to its regional offices directing them to review carefully Medicare certification requests by long-term care hospitals operating in space leased from another hospital. The memorandum mandated new rules for long-term care hospitals to qualify for exclusion from PPS in a \"hospital within a hospital\" setting. The new rules require a separate governing body, separate medical and financial staffs, and 75% or more of the admissions must be referred from sources other than the \"host\" hospital. THC is currently in compliance with the new regulations with no exceptions.\nMedicare and Medicaid reimbursement is generally determined from annual cost reports filed by the Company. These cost reports are subject to audit by Medicare and Medicaid. The Company has established reserves for possible adjustments at levels which management believes to be adequate to cover any downward adjustments resulting from audits of these cost reports.\nFederal regulations provide that admission to and utilization of hospitals by Medicare and Medicaid patients must be reviewed by peer or utilization review organizations (\"PROs\") in order to ensure efficient utilization of hospitals and services. A PRO may conduct such review either prospectively or retroactively and may, as appropriate, recommend denial of payments upon admission or retrospectively for services provided to a patient. Such review is subject to administrative and judicial appeal.\nRate Setting Laws\nIn recent years various forms of prospective reimbursement legislation have been proposed or enacted in states in which the Company owns hospitals. For example, the Company's Florida hospitals are governed by a prospective reimbursement law which generally allows rate increases based on the Consumer Price Index. There has been a trend this last fiscal year in many of the states in which the Company operates psychiatric hospitals, to change to prospective reimbursement systems based upon data from prior year cost reports. These prospective rates have had positive and adverse effects on operations based upon each facility's ability to control costs. As this trend continues, even in states where the Company does not now have established hospitals, the decision to acquire or establish psychiatric facilities in such states will be impacted.\nHealth Care Reform\nDuring 1995, the focus of health care legislation in Congress has been on budgetary and related funding mechanism issues. A number of reports, including the 1995 Annual Report of the Board of Trustees of the Federal Hospital Insurance Program (Medicare) have projected that the Medicare \"trust fund\" is likely to become insolvent by the year 2002 if the current growth rate of approximately 10% per year in Medicare expenditures continues. Similarly, federal and state expenditures under the Medicaid program are projected to\nincrease significantly during the same seven-year period. In response to these projected expenditure increases, and as part of an effort to balance the federal budget, both the Congress and the Clinton Administration have made proposals to reduce the rate of increase in projected Medicare and Medicaid expenditures and to change funding mechanisms and other aspects of both programs. Congress has passed legislation that would substantially reduce payments to providers and would make significant changes in the Medicare and the Medicaid programs. While President Clinton vetoed this bill, the Clinton Administration has proposed alternate measures to reduce, to a lesser extent, projected increases in Medicare and Medicaid expenditures. To date neither proposal has become law.\nThe Medicare legislation that was adopted by Congress would have, among other things reduced payments to providers (including the Company), and created incentives for Medicare beneficiaries to enroll in managed care plans. Earlier versions of this legislation also contained cost controls effecting long-term care hospitals, and the Administration's proposal included a moratorium on the designation of additional medicare long-term care hospitals. Changes in the Medicaid program would have reduced the number and extent of federal mandates concerning how state Medicaid programs operate (including levels of benefits provided and levels of payments to providers) and would have changed the funding mechanism from a sharing formula between the federal government and a state to \"block grant\" funding. The Company cannot predict the effect of any such legislation, if adopted, on its operations.\nReimbursement Limitations and Cost-Containment\nRegardless of the outcome of any proposed health care reform bills, there will likely continue to be vigorous efforts to effectuate cost savings in the Medicare program. These efforts could include change in the reimbursement of the Company's long-term critical care hospitals to the DRG method. In fact, the conference report accompanying the 1993 OBRA urged prompt completion of a study of methods to subject hospitals such as THC's to PPS, from which they are currently exempt. Similar language was introduced in 1995 Legislation, but not incorporated into the final bill adopted by Congress. Even if cost-based reimbursement for the THC facilities continues, additional reimbursement limits may be imposed. Such cost-containment initiatives may vary substantially from the proposed structural reforms discussed above and may impact the Company more quickly and directly. Similar changes in reimbursement of psychiatric services could also adversely impact the Company's business and results of operations.\nRelationships With Physicans and Clinicians\nThe Company is subject to federal and state laws that regulate its relationships with physicians and other providers of health care services. These laws include the Medicare and Medicaid anti-kickback statute, under which criminal penalties can be imposed upon persons who pay or receive any remuneration in return for referrals of patients for items or services reimbursed under the Medicare, Medicaid or certain state health care programs. Violations of this law also result in automatic exclusion from these programs. The Company is also subject to state and federal laws prohibiting false claims.\nThe Department, courts and officials of the Office of Inspector General have broadly construed the anti-kickback statute. \"Safe harbor\" regulations promulgated by the Department define a narrow range of practices that will be exempted from prosecution or other enforcement action under this statute. To the extent that offers to pay or payments made are deemed to be for purposes of inducing referrals and do not satisfy all the criteria for a safe harbor, the arrangements could be found to violate the anti-kickback laws. Similarly, state fraud and abuse laws, which vary from state to state, are often vague and have infrequently been interpreted by courts or regulatory agencies. Given the breadth of these laws and the dearth of court rulings dealing with businesses like the Company's, there can be no assurance that the Company's arrangements with its providers will not be challenged. However, the Company has in place a compliance program, whereby all personnel including clinicians are required to execute Certificates of Understanding of and compliance with the CPC Mission and Standards of Business Conduct. Additionally, the evolving Compliance Program includes the establishment of a \"hotline\" where all employees are encouraged to call if they believe there is any illegal conduct or wrongdoing.\nOBRA of 1993 contains provisions (\"Stark Act\") prohibiting physicians having a financial relationship with the provider from making referrals for \"designated health services\" rendered by the provider which are paid for by the Medicare or Medicaid programs. These services include radiation therapy services; durable medical equipment; parenteral and enteral nutrients, equipment, and supplies; prosthetics, orthotics, and prosthetic devices; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services. In addition, if such a financial relationship exists, the entity is prohibited from billing for or receiving reimbursement on account of such referral. These provisions took effect January 1, 1995.\nNumerous exceptions are allowed under the Stark Act for financial arrangements that would otherwise trigger the referral prohibitions. These provide, under certain conditions, exceptions for relationships involving rental of office space and equipment, employment relationships, personal service arrangements, payments unrelated to designated services, physician recruitment, and certain isolated transactions. While the Department has issued regulations governing physician self-referrals of Medicare patients for clinical laboratory services, the Department has not yet issued regulations pertaining to referrals involving the other designated health services.\nThe Company has contracts with physicians to provide hospital services and in some instances patient services. These contracts have been revised to meet the requirements of the Stark Act. However, until final regulations are promulgated or the contracts are otherwise tested, there can be no assurance that the contracts, or other applicable policies of the Company, will be found to be in compliance with the Stark Act.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThis item incorporates by reference the tables of psychiatric and long-term critical care hospital and dialysis facility locations set forth in Item 1. Ownership information is set forth in the text of this item.\nU.S. Psychiatric Hospital Properties\nThe Company operated 35 hospitals in the U.S. psychiatric division until November 1995 when the Company discontinued psychiatric operations at six of these facilities. One additional psychiatric hospital was closed in January of 1996.\nThe Company owns, in fee simple, all of the real property on which its acute psychiatric hospital facilities are located except for one facility where the Company is a joint venture partner.\nThe Company's existing hospital facilities range in size from 36,000 to 100,000 square feet and each psychiatric facility has sufficient acreage to allow space for outdoor recreation. All of the existing hospital buildings meet all state and local requirements for licensing as hospitals to provide the services indicated. Six facilities are being held for sale. The Company has entered into an agreement to sell one additional facility in March of 1996.\nAs of November 30, 1995, one of the above-described facilities was shared with THC. As of November 30, 1995, the Company was in the process of converting two other previously shared facilities into dedicated long-term critical care facilities.\nThe Company has four separate mortgage loans with lenders, each of which is secured by one of the Company's hospitals.\nOther Properties\nThe Company leases office space for its Corporate office in Las Vegas, Nevada. The leases for this space aggregate approximately 22,000 square feet of office space with lease terms that expire in August 1996. The Company is currently building a new Corporate office which will be situated on the campus of the THC Las Vegas Hospital in Las Vegas, Nevada. THC Las Vegas will utilize a portion of this new building for administrative offices which will provide space within the existing hospital to be converted to direct patient care utilized space.\nThe Company also owns a three-story building completed in 1988 used for a portion of its Corporate headquarters; medical office buildings adjacent to 13 of its hospital facilities; three parcels of land for potential\nhospital development or future sale, two parcels of land being developed for sale for investment purposes (non-hospital related), and one apartment in a location central to the Company's operations for use by employees whose duties require them to travel.\nUnited Kingdom Psychiatric Hospital Properties\nThe Company owns the real property for 12 of its psychiatric hospitals. The real property of one hospital is owned as approximately one-half in fee simple and one-half leasehold. The Company also owns, in fee simple, one clinic specializing in the treatment of substance abuse. The Company leases one of its psychiatric hospitals. The Company operates two dialysis centers and a secure psychiatric facility from buildings located on National Health Service properties. All of the Company's existing facilities range in size from one- half acre to 24 acres.\nTHC Properties\nThe Company owns, in fee simple, the real property for 13 of its long-term critical care facilities. The Company also leases one long-term critical care facility. All of the Company's facilities are located on sites ranging from one to forty-two acres. As of November 30, 1995, THC operated one unit within one of the Company's psychiatric hospitals.\nThe Company currently occupies an unused medical office building on the campus of a CPC psychiatric facility in Atlanta for its THC eastern regional office in Atlanta, Georgia.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 28, 1995, the Company reached an agreement to settle certain consolidated securities class action lawsuits and a related shareholder derivative action. During the third and fourth quarter of 1995, the Company recorded charges totalling $46.0 million ($28.9 million after tax) relating to settlement of the lawsuits and associated legal fees and expenses. The suits, filed in late 1991, alleged violations of the federal securities laws by the Company and certain individuals between September 1990 and November 1991 arising from the activities of the U.S. Psychiatric Division.\nThe principal terms of the agreement call for a settlement amount of $42.5 million consisting of a cash settlement fund of $21.25 million and the Company's common stock with an expected value of $21.25 million. The cash amount, plus interest, was paid in November 1995. The shares to be issued to the plaintiff class were previously repurchased by the Company pursuant to a stock buyback program during late 1991 through early 1993. The number of shares of common stock to be issued will be equal to $21.25 million divided by the average market value of the common stock over a 10-day trading period prior to the distribution of shares to settle claims, provided that in any event the minimum number of shares that will be issued is 1,931,818 and the maximum number of shares that will be issued is 3,035,714. The maximum limits would be triggered if the average market value of the common stock is at $7 per share or below. Upon issuance, these shares will have a dilutive effect on earnings per share. The agreement is subject to final court approval.\nWhile these cases allege actions taken before present management was in place, management continues to believe that the claims asserted in the shareholder suits lack merit. Nevertheless, the Company believed that it was prudent to settle these cases due to the continuing substantial costs of defense, the distraction of management's attention and the risks associated with litigation.\nOn August 17, 1995 the Company reported developments pertaining to CPC Southwind Hospital in Oklahoma City, Oklahoma, which is operated by the Company's subsidiary, CPC Oklahoma, Inc. The first was the filing of a whistleblower suit against CPC Oklahoma, Inc. under the Federal False Claims Act, and the second concerned the seizure of certain of Southwind's records pursuant to a search warrant. On January 19, 1996, the Government filed an amended complaint alleging that Southwind Hospital submitted false claims to various federally-funded health care programs. The amended complaint contained an attached schedule of claims covering periods from 1990 through mid-1992. Since the service of the original complaint, Southwind Hospital has provided information to the Government on numerous issues based on internal review. The Company is currently in the process of reviewing the amended complaint. Management is presently unable to evaluate the potential impact of the suit on the Company.\nThe Company is subject to ordinary and routine litigation incidental to its business, including those arising from patient treatment, injuries or death for which it is covered by liability insurance, and those arising from actions involving employees. Management believes that the ultimate resolution of such proceedings will not have a material adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Market Information\n(1) (i) The Common Stock of Community Psychiatric Centers is traded on the New York and Pacific Stock Exchanges. Ticker symbol: CMY.\n(ii) The information in response to this portion of Item 5 is incorporated herein by reference from footnote 15 to the financial statements in Item 8.\n(b) Holders\n(1) Approximate number of holders of the $1.00 Par Value Common Stock of the Company at February 8, 1996: 1,913. The number of record holders includes banks and brokerage houses which are holding shares of the Company's Common Stock for an undetermined number of beneficial owners.\n(c) Dividends\n(1) The information in response to this portion of Item 5 is incorporated by reference from footnote 15 to the financial statements in Item 8.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\n- -------- * See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\"--\"Restructuring Charges (Credits)\" and \"Recent Accounting Pronouncements\". See Note 14 to the Financial Statements regarding settlement costs--\"Commitments and Contingencies\".\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the selected financial data on the preceding page, the consolidated financial statements and the notes to the consolidated financial statements appearing in Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information in response to this item is incorporated by reference from Exhibit 1 in Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Board of Directors of the Company approved on September 28, 1995 the dismissal of Ernst & Young LLP and the engagement of Price Waterhouse LLP as the independent accountants of the Company for the fiscal year ending November 30, 1995, effective September 29, 1995, based on the recommendation of the Company's Audit Committee.\nThe reports of Ernst & Young for the fiscal years ended November 30, 1993 and 1994 contained no adverse opinion, disclaimer of opinion or qualification or modification as to uncertainty, audit scope or accounting principles.\nDuring the fiscal years ended November 30, 1993 and 1994 and the interim period from December 1, 1994 through September 29, 1995, the date of dismissal, there were no disagreements between the Company and Ernst & Young on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of Ernst & Young would have caused it to make reference to the subject matter of the disagreement in connection with its report. No event described in paragraph (a)(1)(v) of Item 304 of Regulation S-K occurred during the Company's fiscal years ended November 30, 1993 or 1994, or the period from December 1, 1994 through September 29, 1995, except that Ernst & Young advised management and the Board of Directors in a letter dated January 28, 1994, that, in connection with the audit of the Company's 1993 fiscal year its representatives had identified certain matters involving the internal control structure of the Company's subsidiary, Transitional Hospitals Corporation and its operations which Ernst & Young considered to be material weaknesses as defined under standards established by the American Institute of Certified Public Accountants. Ernst & Young further stated in that letter that these conditions were considered in determining the nature, timing, and extent of the procedures performed in their audit for the Company's 1993 fiscal year. Ernst & Young's letter to the Board of Directors dated January 27, 1995 issued in conjunction with the audit of the Company's 1994 fiscal year stated that they noted no matters involving the internal control structure and its operations that they considered to be material weaknesses as defined under standards established by the American Institute of Certified Public Accountants.\nPART III\nInformation under the following items required by Part III of Form 10-K is incorporated by reference from Registrant's definitive Proxy Statement applicable to Registrant's 1996 Annual Meeting of Shareholders, or will be provided by Amendment to Form 10-K on Form 10-K\/A, to be filed with the Commission by Registrant no later than 120 days subsequent to the end of its 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 SCHEDULE AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements. The Financial Statements listed in response to Item 8 are filed herewith.\n2. The following Financial Statement Schedule is filed herewith:\nValuation and Qualifying Accounts\n3. Exhibits:\n(3) Articles of Incorporation and By-laws\n(b) Report on Form 8-K: On November 6, 1995, the Registrant filed Form 8-K\/A disclosing a change in the Registrant's certifying accountants. - -------- * Required to be filed as an exhibit pursuant to item 14(c) of this Form.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOMMUNITY PSYCHIATRIC CENTERS\nBy: \/s\/ RICHARD L. CONTE ---------------------------------- Date: February 26, 1996 Richard L. Conte Chairman of the Board of Directors 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.\nAnnual Report Form 10-K\nItem 8, Item 14(a)(1) and (2), (c) and (d) Financial Statements and Supplementary Data List of Financial Statements and Financial Statement Schedule Certain Exhibits\nFinancial Statement Schedule\nCommunity Psychiatric Centers and Subsidiaries Las Vegas, Nevada\nYear Ended November 30, 1995\n(THIS PAGE INTENTIONALLY LEFT BLANK)\nCOMMUNITY PSYCHIATRIC CENTERS\nFORM 10-K ITEM 14(A)(1) AND (2)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Community Psychiatric Centers and Subsidiaries are included in Item 8:\nReport of Independent Accountants--Year ended November 30, 1995--Price Waterhouse LLP\nReport of Independent Auditors--Years ended November 30, 1994 and 1993-- Ernst & Young LLP\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--November 30, 1995\nThe following consolidated financial statement schedule of Community Psychiatric Centers and Subsidiaries is included in Item 14(d):\nReport of Independent Accountants on Financial Statement Schedule--Year ended November 30, 1995\nSchedule II--Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Board of Directors and Shareholders of Community Psychiatric Centers\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations and stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Community Psychiatric Centers and its subsidiaries at 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. These 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 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.\nAs discussed in Note 3 of the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" in 1995.\nPRICE WATERHOUSE LLP Los Angeles, California January 31, 1996\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Community Psychiatric Centers\nWe have audited the accompanying consolidated balance sheet of Community Psychiatric Centers and Subsidiaries as of November 30, 1994 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended November 30, 1994. Our audits also included the financial statement schedule listed in the index at Item 14(a) as it relates to the two year period ended November 30, 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 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 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 Community Psychiatric Centers and Subsidiaries at November 30, 1994 and the consolidated results of their operations and their cash flows for each of the two years in the period ended November 30, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule as it relates to the two year period ended November 30, 1994, 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, California January 27, 1995\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS--(CONTINUED)\nSee notes to consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOVEMBER 30, 1995 AND 1994\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions have been eliminated in the accompanying consolidated financial statements.\nThe Company provides long-term critical care services to patients suffering from long-term complex medical problems in the United States. The Company also provides psychiatric services in the United States and United Kingdom. The Company currently offers a broad spectrum of services including inpatient, partial hospitalization, outpatient and residential treatment programs.\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 revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Those highly liquid assets with a maturity of more than three months are classified as short-term investments.\nPROPERTY, BUILDINGS AND EQUIPMENT\nDepreciation is computed on the straight-line method based on the estimated useful lives of fixed assets of 31.5 to 40 years for buildings and three to ten years for furniture and equipment.\nINTANGIBLE ASSETS\nIntangible assets consist mainly of goodwill, which represents the excess of investment in subsidiaries over the fair value of net assets acquired from acquisitions. Goodwill acquired in acquisitions prior to fiscal year 1995 is being amortized on a straight-line basis over 40 years. The amortization period for goodwill acquired in 1995 is 20 years. The Company also has intangible assets related to covenants not to compete with two former Chairmen of the Board of Directors. The covenants are amortized over the life of the agreements (see Note 9).\nThe Company monitors changes in circumstances that could indicate that the carrying amounts of intangible assets may not be recoverable. When events or changes in circumstances are present that indicate the carrying amount of intangible assets may not be recoverable, the Company assesses the recoverability of the asset by determining whether the carrying amount will be recovered through future expected cash flows. The Company recorded an impairment loss of approximately $9.7 million related to intangible assets in 1995 (see Note 3).\nPREOPENING COSTS\nCosts incurred prior to the opening of new facilities are deferred and amortized on a straight-line basis over a five-year period.\nCAPITALIZATION OF INTEREST\nInterest incurred in connection with development and construction of hospitals is capitalized as part of the related property.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNET OPERATING REVENUES\nNet operating revenues include amounts for hospital services estimated by management to be reimbursable by federal and state government programs (Medicare, Medicaid and CHAMPUS); managed care programs (managed care companies, health maintenance organizations and preferred provider organizations) and private pay payors (private sources and insurance companies which base reimbursement on the Company's price schedule).\nThe following table summarizes the percent of net operating revenue generated from all payors.\nAmounts received are generally less than the established billing rates of the Company and the difference is reported as a contractual allowance and deducted from operating revenues. Final determination of amounts earned for hospital services is subject to audit by the payors. 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 and credits to operating revenues in the year the audit reports are finalized. In the current year, the Company received approximately $5.5 million in excess of recorded amounts related to prior year Medicare settlements. These amounts are included in operating revenue.\nCONCENTRATION OF CREDIT RISK\nFinancial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and short-term investments and receivables from government programs.\nThe Company maintains cash equivalents and short-term investments with various financial institutions. The Company's policy is designed to limit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing to those financial institutions that are considered in the Company's investment strategy. The Company and management do not believe that there are any significant credit risks associated with receivables from governmental programs. Negotiated and private receivables consist of receivables from various payors, including individuals involved in diverse activities, subject to differing economic conditions, and do not represent any concentrated credit risks to the Company. Furthermore, management continually monitors and adjusts its reserves and allowances associated with these receivables.\nSTOCK OPTIONS\nProceeds from the exercise of stock options are credited to common stock, to the extent of par value, and the balance to additional paid-in capital, except when shares held in the treasury are issued. The difference between the cost of the treasury stock and the option price is charged or credited to additional paid-in capital. No charges or credits are made to earnings with respect to options granted or exercised. Income tax benefits derived from exercise of non-incentive stock options and from sales of stock obtained from incentive stock options before the minimum holding period are credited to additional paid-in capital.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nEARNINGS (LOSS) PER SHARE\nEarnings (loss) per share have been computed based upon the weighted average number of shares of common stock outstanding during the year. Dilutive common stock equivalents have not been included in the computation of earnings (loss) per share because the aggregate potential dilution resulting therefrom is less than 3%.\nTRANSLATION OF FOREIGN CURRENCIES\nThe financial statements of the Company's foreign subsidiaries have been translated into U.S. dollars in accordance with FASB Statement No. 52. All balance sheet accounts have been translated at year-end exchange rates. Statements of earnings amounts have been translated at the average exchange rate for the year. The resulting currency translation adjustments were made directly to a separate component of Stockholders' Equity. The effect on the statement of earnings of translation gains and losses is insignificant for all years presented.\nRECENT ACCOUNTING PRONOUNCEMENTS\nIn the fourth quarter of fiscal year 1995, the Company elected to adopt early the provisions 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\". The statement 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 assets' carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. The statement also requires that assets to be disposed of should be written down to fair value less selling costs. The adoption of FAS 121 resulted in the Company recording impairment losses of $46.0 million (see Note 3 to the financial statements for further discussion).\nIn October 1995, the FASB issued Statement of Financial Accounting Standards No. 123 (\"FAS 123\"), \"Accounting for Stock-Based Compensation\", which becomes effective for fiscal years beginning after December 15, 1995. FAS 123 establishes new financial accounting and reporting standards for stock-based compensation plans. Entities will be allowed to measure compensation expense for stock-based compensation under FAS 123 or APB Opinion No. 25, \"Accounting for Stock Issued to Employees\". Entities electing to remain with the accounting in APB Opinion No. 25 will be required to make pro forma disclosures of net income and earnings per share as if the provisions of FAS 123 had been applied. The Company is in the process of evaluating the Statement. The potential impact on the Company of adopting the new standard has not been quantified at this time. The Company must adopt FAS 123 no later than December 1, 1996.\nRECLASSIFICATIONS\nCertain amounts have been reclassified to conform with 1995 presentations.\nNOTE 2--RESTRUCTURING CHARGES (CREDITS)\nEffective February 28, 1993, the Company recorded a pre-tax charge of $55.0 million ($35.0 million after tax) in connection with the decision to close seven of its U.S. psychiatric hospitals. The charge comprised $35.3 million to write down buildings and other fixed assets, $2.1 million to write off intangibles, $14.4 million for future operating losses of the seven hospitals and related corporate restructuring costs associated with terminating employees, and $3.2 million for additional accounts receivable allowances at the seven hospitals. Six of the restructured hospitals have ceased operations. The seventh hospital returned to operating status effective March 1, 1994. This facility was subsequently closed in November 1995 (see discussion below). Of the six closed hospitals, five have been sold and one has been converted into a long-term critical care hospital\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\noperated by the Company's wholly owned subsidiary, THC. The Company received cash proceeds of approximately $5.0 million and $5.3 million, respectively, in the first quarter of 1994 and the second and third quarters of 1995 from the sale of the five hospitals. The Company continues to hold property for sale with a remaining book value of $.3 million that was part of the 1993 restructuring.\nEffective February 28, 1994, the Company recorded a restructuring credit totalling $7.2 million ($4.3 million after tax) from the resolution of the previously restructured psychiatric assets. The restructuring credit resulted from the Company's success in controlling hospital closure costs and in divesting one of its restructured properties at a higher price than the 1993 writedown of the facility anticipated.\nEffective February 28, 1994, the Company recorded a restructuring charge of $6.3 million ($3.8 million after tax) in connection with the decision to close three additional psychiatric facilities. The charge comprised $2.2 million for future operating losses, $1.5 million for restructuring costs associated with terminating employees and $2.6 million for additional accounts receivable allowances and reserves for other assets at the three hospitals. Approximately 225 employees of the restructured hospitals were terminated. Amounts charged against the reserve for estimated operating losses and termination benefits paid approximated amounts originally accrued. Total revenue and net operating income or (loss) for the three closed hospitals totalled $2.8 million and ($1.1 million) for the first quarter of 1994, $20 million and $.6 million for fiscal year 1993, and $23.5 million and $2.3 million for fiscal year 1992. Of the three closed hospitals, one is being held for sale (carrying value of $1.5 million), one was converted into a THC facility after the restructuring, and one was converted into a satellite hospital of a THC facility in September 1995.\nEffective May 31, 1995, the Company recorded a restructuring credit totalling $2.5 million ($1.5 million after tax) from the resolution of previously restructured psychiatric assets. The restructuring credit resulted from divesting two restructured properties at higher prices than the 1993 writedown of the facilities anticipated and the Company's success in collecting accounts receivable balances that were reserved for as part of the February 28, 1994 restructuring charge.\nEffective November 30, 1995, the Company recorded a restructuring charge totalling $4.6 million ($2.8 million after tax), determined in accordance with the provisions of the January 1995 Financial Accounting Standards Board Emerging Issues Task Force Consensus No. 94-3 \"Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs incurred in a Restructuring)\", (\"EITF 94-3\"), in connection with the decision to close six psychiatric facilities and three regional offices. EITF 94-3 requires the accrual of certain employee termination costs and costs resulting from a plan to exit an activity that are not associated with or that do not benefit activities that will continue and prohibits accrual of expected future operating losses of the activity exited. The charge comprised $3.4 million for employee termination benefits related to hospital operations and overhead personnel and $1.2 million for non-cancelable operating leases and other exit costs. Approximately 314 hospital employees and 65 corporate and regional employees were terminated. To date, amounts charged against the reserve for employee termination benefits paid approximated amounts accrued. Net operating revenue and net operating income or (loss) for the six closed hospitals totalled $28.5 million and ($2.8 million) for fiscal year 1995, $40.9 million and $2.1 million for fiscal year 1994, and $38.3 million and $6.9 million for fiscal year 1993. Of the six closed hospitals, three are being held for sale, two will become fully converted THC hospitals, and one will be exchanged for a similar building held by another health care provider and will be converted into a THC facility.\nManagement continually reviews all facilities to evaluate potential closures, divestitures or conversions. Management may elect to close additional psychiatric facilities in the future which could result in additional charges to income for the costs necessary to exit the hospital operations.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 3--IMPAIRMENT OF ASSETS\nIn the fourth quarter of fiscal year 1995, the Company elected early adoption of the provisions of FASB Statement 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 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 assets' carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. The statement also requires that assets to be disposed of should be written down to fair value less selling costs. Based on a comparison of the recorded values of long-lived assets (defined as land, buildings, fixed assets and goodwill) against the expected future cash flows to be generated by the assets of three U.S. Psychiatric facilities that were closed in November 1995 as well as three U.S. Psychiatric facilities which have experienced recent declines in operating performance, and after applying the principles of measurement contained in the Statement, the Company recorded an asset impairment charge of approximately $26.5 million. Using the same principles as described above, the Company recorded an asset impairment charge of approximately $5.3 million on land that is being held for sale. The closed facilities as well as the land held for sale are classified as assets held for sale with a carrying value of $13.7 million after the impairment writedown. All assets held for sale pertain to the U.S. Psychiatric Division.\nThe Company completed its installation of a new computer system in the first quarter of 1995. As several of the promised applications did not function as specified, an impairment loss of approximately $8.1 million ($6.8 million related to the U.S. Psychiatric Division and $1.3 million related to THC) was recorded in the fourth quarter of 1995 to write down a portion of the total cost of the system. The Company also shortened the estimated useful life of the system to two years in anticipation of implementing a new alternative.\nIn November of 1995, the Company closed Harvard Medical Limited, a patient liaison business in West Germany due to recent declines in operating performance. Based on these factors, the Company recorded an impairment loss of $4.1 million to write off the goodwill related to this Company.\nNOTE 4--ACQUISITIONS\nDuring 1995, the Company acquired two hospitals in the United Kingdom for $3.3 million. The Company also purchased for $5.8 million, the land, building, and fixed assets for a THC facility that had been managed by THC since May of 1994. The excess of the purchase price over the fair value of these assets totalled $.5 million and is being amortized over 20 years.\nDuring 1994, the Company acquired two hospitals in the United Kingdom for a total purchase price of $5.7 million.\nDuring 1993, the Company acquired six buildings and the related fixed assets and modified the buildings into six long-term critical care facilities. Total consideration paid was $33.0 million. The Company also acquired a substance abuse center in the United Kingdom for a purchase price of $4.3 million.\nThe aggregate total costs of the acquisitions in fiscal 1993 and fiscal 1994 exceeded the fair value of the assets acquired by approximately $5.3 million. The excess is being amortized on a straight-line basis over a 40-year period.\nThe acquisitions have been accounted for as purchases and, accordingly, the results of operations of the acquired facilities have been included in the consolidated statement of earnings since the date of acquisition. The results of operations of the acquired businesses prior to the date of acquisition were not material to the consolidated financial statements.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5--PROPERTY, BUILDINGS AND EQUIPMENT\nProperty, buildings and equipment are summarized as follows:\nThe Company incurred interest expense of $7.2 million, $4.8 million and $2.5 million in 1995, 1994 and 1993, respectively, including $1.9 million, $1.3 million and $.2 million which was capitalized in 1995, 1994 and 1993, respectively.\nInterest paid was $7.3 million, $4.1 million, and $2.5 million during 1995, 1994 and 1993, respectively.\nNOTE 6--INCOME TAXES\nThe Company accounts for income taxes under the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes\". Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of November 30, 1995 and November 30, 1994, are as follows (in thousands):\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDeferred tax liabilities and assets by tax jurisdictions are as follows as of November 30, 1995 (in thousands):\nFor financial reporting purposes, income before income taxes includes the following components:\nSignificant components of the provision for income taxes attributable to continuing operations are as follows:\nThe reconciliation of income tax attributable to continuing operations computed at the U.S. federal statutory tax rate to income tax expense is:\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Company made income tax payments of $8.0 million in 1995. The Company received income tax refunds (net of income taxes paid of $4.5 million and $3.2 million) of $2.3 million and $3.2 million in 1994 and 1993, respectively.\nNOTE 7--LONG TERM DEBT\nLong term debt is summarized as follows:\nDuring May 1994, the Company, Transitional Hospitals Corporation (THC--the Company's wholly-owned long-term care subsidiary) and Bank of America National Trust and Savings Association (\"the Bank\") entered into a credit agreement (\"the Agreement\") whereby the Company or THC may borrow, repay and reborrow up to $50 million through February 28, 1997. Interest is payable at LIBOR plus 2.75% through February 28, 1995. Interest through February 28, 1997 is payable at LIBOR plus 1-2%, based on calculated ratios as documented in the Agreement. As of November 30, 1995, $50 million is outstanding under this Agreement.\nDuring September 1993, the Company entered into a credit agreement (\"the Agreement\") whereby the Company was able to borrow up to $25 million through November 30, 1995 (the revolving loan period), at which time the amount outstanding was converted into a term loan payable in equal quarterly installments through November 30, 1998. Interest is payable at the lesser of (1) LIBOR plus 1.25% during the revolving loan period and LIBOR plus 1.50% during the term loan period or (2) the greater of (a) the Bank's reference rate or (b) the Fed Funds rate plus .5%. As of November 30, 1995, $25 million is outstanding under this Agreement.\nDuring October 1993, the Company's subsidiary in the United Kingdom entered into a temporary revolving credit facility whereby the Company was allowed to borrow up to $7.5 million through December 31, 1993. Interest was to be calculated at the rate of interest at which sterling pounds deposits would be offered to major banks in the London interbank market, plus 1.25%. A final loan agreement was signed in December 1993 to replace the temporary facility whereby the Company was able to borrow up to 10 million sterling pounds through November 30, 1995, at which time the amount outstanding was converted into a term loan payable in equal quarterly installments through November 30, 1998. Interest on five million sterling pounds of this facility is fixed at 8.95%. Interest on the balance is payable at the sterling pounds LIBOR rate plus 1.25% up to the conversion\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\ndate and LIBOR plus 1.50% after the conversion date. As of November 30, 1995, $15.6 million is outstanding under this facility.\nThe Agreements contain provisions which, among other things, place restrictions on borrowing, capital expenditures and the payment of dividends, and requires the maintenance of certain financial ratios including tangible net worth, fixed charge coverage and funded debt. The Company is currently in compliance with or has received a waiver for all material covenants and restrictions contained in the Agreements. Borrowings are unsecured and are guaranteed by the Company's domestic subsidiaries.\nUnder the terms of the Debenture Payment Assumption Agreement, Vivra Incorporated was obligated to pay $4.1 million of the 8 1\/2% Subordinated Guaranteed Debentures that were paid off in 1995. The balance as of November 30, 1994 was reduced by that amount.\nThe conversion price of the convertible debentures is subject to antidilutive provisions.\nThe annual maturities of debt for five years ending November 30, 2000 are as follows (in thousands):\nNOTE 8--CAPITAL STOCK AND STOCK OPTIONS\nThe Company has stock option plans whereby options may be granted at not less than 100% of fair market value at the date of grant and are exercisable at any time thereafter for a period of ten years, or five years for options granted prior to November 8, 1990. Options granted on and after November 8, 1990, are exercisable 20% at date of grant with the remaining 80% becoming exercisable at the rate of 20% each December 1 thereafter, with the exception of 100,000 options re-issued to certain officers of the Company (see below) which vested immediately. At the time of exercise, at least one-third is payable in cash and the balance, if any, with a five-year note bearing interest at 8%. The unpaid portion of options exercised, evidenced by a note, has been deducted from Stockholders' Equity in the accompanying Consolidated Balance Sheets. Stock options may also be exercised by the return of previously acquired shares of common stock. Shares obtained by such exercises are included in treasury stock and valued at the market value at date of exercise.\nThe Compensation Committee of the Board of Directors recommended at their January 25, 1996 meeting that future stock options granted to certain key employees be related to the performance of the Company's stock. The Committee authorized management to utilize an outside compensation consultant to devise such a plan.\nOn May 20, 1993, the Company issued 860,000 of non-qualified options to several key executives. The option price is $20 above the closing price of the Company's stock on the date of grant, or $29.50 per share. During fiscal year 1994, 146,000 shares of converging options were issued at an option price of $24.50 per share. For each year during which the Company meets specified performance targets, the option price will decrease by $5.00 until the option price and market price converge. The option price will be fixed at the market price on the date of convergence and the options will vest. If convergence does not occur during the first five years after grant of the options, the options will be cancelled and the shares will revert to the 1989 Stock Incentive Plan and be available for reissuance. The Company met these targets for fiscal 1993. The Company did not meet these targets in fiscal 1994 or 1995.\nOn February 14, 1992, 315,200 outstanding options granted in previous years at prices ranging from $18.54 to $34.13 were revalued to $14.63, the market price on that day. Options granted previously to the five then most highly- compensated officers were not revalued. On January 29, 1993, 717,249 options granted previously to those individuals were cancelled, revalued, and re-issued at a 1 to 2 ratio. The options were granted in previous\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nyears at prices ranging from $24.08 to $26.81. The options were revalued to $10.88, $.25 higher than the closing market price on that day.\nA summary of activity under the plans during 1995, 1994 and 1993 is as follows:\nThe market value of the Company's common stock at the date the options were exercised was $10.88-$13.63, $11.88-$18.75, and $13.00-$13.88 for 1995, 1994, and 1993, respectively.\nAt November 30, 1995, 1.7 million options were exercisable and .7 million (1.7 million and 2.7 million at November 30, 1994 and 1993) were available for grant under the plans.\nNOTE 9--DEFERRED COMPENSATION\nOn May 21, 1992, the then Chairman of the Board of Directors of the Company resigned. During the course of his employment with the Company, the former Chairman had an employment contract which provided for consideration for consulting services and a noncompetition agreement to commence in 1995 or earlier in the event of permanent disability. Based on a computation of the present value of the contractually due amount, a payment of $6.3 million was made in December 1992. Of this amount, $3.4 million was provided for in the financial statements of the Company through November 30, 1992. The remaining amount, $2.9 million, is being amortized as consideration (approximately $244,000 annually) for services rendered over the term of the consulting and non-competition agreements which extend to November 30, 2004.\nEffective November 30, 1989, a former Chairman of the Board of Directors terminated his employment with the Company and began receiving deferred compensation benefits. Approximately $162,000 of the annual payment of $323,000 is charged to expense as consideration for services rendered over the term of the consulting and noncompetition agreements which extend to November 30, 2000. Such former Chairman has notified the Company of his position that certain provisions in the contract that accelerate the payment of certain deferred compensation have been triggered and that up to $4.5 million is now due from the Company thereunder. The Board of Directors has established a committee of directors to evaluate such claims of this former Chairman and to recommend the appropriate action to be taken by the Company.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--OPERATING LEASES\nThe Company leases its Corporate headquarters for a term of two years ending in August 1996. The Company also leases one hospital at THC, one hospital in the United Kingdom, and various other clinics, outpatient operations and equipment over terms ranging generally from one to five years. Rent expense related to noncancellable operating leases amounted to $3.5 million and $2.2 million for the years ended November 30, 1995 and 1994, respectively. Rent expense related to noncancellable leases was immaterial for 1993.\nFuture minimum lease payments required under noncancellable operating leases as of November 30, 1995 are as follows: 1996--$3.4 million; 1997--$2.5 million; 1998--$2 million; 1999--$1.7 million; and 2000--$1.5 million.\nNOTE 11--PROFIT SHARING PLAN\nThe Company has a noncontributory, trusteed profit sharing plan which is qualified under Section 401 of the Internal Revenue Code. All regular non- union employees in the United States (union employees are eligible if the collective bargaining agreement so specifies) with at least 1,000 hours of service per annum, over 21 years of age, and employed at year-end are eligible for participation in the plan after one year of employment. The Company's contribution to the plan for any fiscal year, as determined by the Board of Directors, is discretionary, but is limited to an amount which is deductible for federal income tax purposes. Contributions to the plan are allocated among eligible participants in the proportion of their salaries to the total salaries of all participants. There were no contributions made by the Company in 1995, 1994 and 1993. During 1993, a 401(k) segment was added to the plan which allows employees to defer a portion of their salary on a pre-tax basis. The Company may match a portion of the amount deferred. The Company's matching contribution is determined by the Board of Directors each year. During 1995, 1994, and 1993 no matching contribution was made.\nNOTE 12--BUSINESS SEGMENT INFORMATION\nThe Company is engaged in two principal business segments. The Company provides psychiatric services for adults, adolescents, and children with acute psychiatric, emotional, substance abuse, and behavioral disorders in the United States (plus Puerto Rico) and the United Kingdom. The Company also offers long-term critical care services in the United States.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following tables have been prepared in accordance with the requirements of FASB Statement No. 14. This information has been derived from the Company's accounting records.\n- -------- (1) Excludes assets acquired in business acquisitions of $8.6 million, $4.8 million and $1 million in 1995, 1994 and 1993, respectively.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--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.\nShort-Term Investments: The fair values for marketable securities are based on quoted market prices which approximate their carrying values.\nLong-Term and Short-Term Debt: The carrying amounts of the Company's long- term and short-term debt approximates its fair value.\nNOTE 14--COMMITMENTS AND CONTINGENCIES\nOn September 28, 1995, the Company reached an agreement to settle certain consolidated securities class action lawsuits and a related shareholder derivative action. During the third and fourth quarter of 1995, the Company recorded charges totalling $46.0 million ($28.9 million after tax) relating to settlement of the lawsuits and associated legal fees and expenses. The suits, filed in late 1991, alleged violations of the federal securities laws by the Company and certain individuals between September 1990 and November 1991 arising from the activities of the U.S. Psychiatric Division.\nThe principal terms of the agreement call for a settlement amount of $42.5 million consisting of a settlement fund of $21.25 million and the Company's common stock with an expected value of $21.25 million. The cash amount, plus interest, was paid in November 1995. The shares to be issued to the plaintiff class were previously repurchased by the Company pursuant to a stock buyback program during late 1991 through early 1993. The number of shares of common stock to be issued will be equal to $21.25 million divided by the average market value of the common stock over a 10-day trading period prior to the distribution of shares to settle claims, provided that in any event the minimum number of shares that will be issued is 1,931,818 and the maximum number of shares that will be issued is 3,035,714. The maximum limits would be triggered if the average market value of the common stock is at $7 per share or below. Upon issuance, these shares will have a dilutive effect on earnings per share. The agreement is subject to final court approval.\nWhile these cases allege actions taken before present management was in place, management continues to believe that the claims asserted in the shareholder suits lack merit. Nevertheless, the Company believed that it was prudent to settle these cases due to the continuing substantial costs of defense, the distraction of management's attention and the risks associated with litigation.\nOn August 17, 1995 the Company reported developments pertaining to CPC Southwind Hospital in Oklahoma City, Oklahoma, which is operated by the Company's subsidiary, CPC Oklahoma, Inc. The first was the filing of a whistleblower suit against CPC Oklahoma, Inc. under the Federal False Claims Act, and the second concerned the seizure of certain of Southwind's records pursuant to a search warrant. On January 19, 1996, the Government filed an amended complaint alleging that Southwind Hospital submitted false claims to various federally-funded health care programs. The amended complaint contained an attached schedule of claims covering periods from 1990 through mid-1992. Since the service of the original complaint, Southwind Hospital has provided information to the Government on numerous issues based on internal review. The Company is currently in the process of reviewing the amended complaint. Management is presently unable to evaluate the potential impact of the suit on the Company.\nThe Company is subject to ordinary and routine litigation incidental to its business, including those arising from patient treatment, injuries or death for which it is covered by liability insurance, and those arising from actions involving employees. Management believes that the ultimate resolution of such proceedings will not have a material adverse effect on the Company.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a tabulation of the unaudited quarterly data for the three years ended November 30, 1995:\n- -------- * Included in earnings per share for the second quarter of 1995 is a restructuring credit $(.03) totalling $2.5 million ($1.5 million after tax) from the resolution of previously restructured psychiatric assets. Earnings per share in the third quarter of 1995 include $(.65) for a pre-tax charge of $45.0 million ($28.4 million after tax) relating to the settlement of shareholder litigation. Earnings per share in the fourth quarter of 1995 include a charge of $(.01) related to legal expenses associated with the legal settlement and $(.65) for a pre-tax charge of $46.0 million ($28.4 million after tax) related to impairment of assets. Also included in the fourth quarter of 1995 is a pre-tax restructuring charge of $4.6 million ($2.8 million after tax) or $.07 per share related to employee termination benefits and other costs in connection with the decision to close six psychiatric hospitals and three regional offices.\n** Earnings per share in the first quarter of 1994 include $(.09) for a pre- tax charge of $6.3 million ($3.8 million after tax) in connection with the decision to close three psychiatric facilities. Also included in earnings per share for the first quarter is a restructuring credit $(.10) totalling $7.2 million ($4.3 million after tax) from the resolution of previously restructured psychiatric assets.\n*** Earnings per share in the first quarter of 1993 include $(.81) for a pre- tax charge of $55.0 million ($34.9 million net of tax) in connection with the restructuring of certain of its psychiatric hospitals.\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--SUBSEQUENT EVENTS\nOn December 20, 1995, the Company announced that its Board of Directors has preliminarily approved a plan to spin-off its U.S. Psychiatric Division in the form of a taxable dividend distribution of U.S. Psychiatric Division common stock to the Community Psychiatric Centers Shareholders.\nThe spin-off is subject to a number of conditions, including regulatory and other third party approvals, market conditions, final approval of the Board of Directors and Shareholder approval. It is anticipated that the spin-off and related matters will be submitted to Shareholders at the Annual Meeting which will be scheduled at a later date. The special dividend is expected to be distributed by mid 1996.\nOn January 19, 1996, the Company closed Parkwood Hospital, a U.S. Psychiatric hospital located in Atlanta, Georgia. The fixed assets of this hospital were written down to their estimated fair market values as part of the FASB 121 writedown (see footnote 3, Impairment of Assets). In the first quarter of 1996, the Company expects to record a restructuring charge of an undetermined amount related to termination benefits to be paid to the employees of the closed hospital.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo The Board of Directors of Community Psychiatric Centers\nOur audit of the consolidated financial statements of Community Psychiatric Centers and its subsidiaries referred to in our report dated January 31, 1996 with respect to consolidated financial statements included in this Annual Report on Form 10-K also included an audit of Financial Statement Schedule II of Community Psychiatric Centers and its subsidiaries for the year ended November 30, 1995. In our opinion, this Financial Statement Schedule of Community Psychiatric Centers and its subsidiaries for the year ended November 30, 1995 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements for the year ended November 30, 1995.\nPrice Waterhouse LLP Los Angeles, California January 31, 1996\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nCOMMUNITY PSYCHIATRIC CENTERS AND SUBSIDIARIES\n- -------- (1)Write-offs, net of recoveries. (2)Foreign currency translation adjustment.\nEXHIBIT INDEXES\n- -------- * Required to be filed as an exhibit pursuant to item 14(c) of this Form.","section_15":""}
{"filename":"7536_1995.txt","cik":"7536","year":"1995","section_1":"Item 1. Business. \t -------- Arrow Electronics, Inc. (the \"company\") is the world's largest distributor of electronic components and computer products to industrial and commercial customers. As the global electronics distribution industry's leader in state- of-the-art operating systems, employee productivity, value-added programs, and total quality assurance, the company is the distributor of choice for over 500 suppliers.\nThe company's global distribution network spans the world's three dominant electronics markets - North America, Europe, and the Asia\/Pacific region. The company is the largest electronics distributor in each of these vital industrialized regions, serving a diversified base of original equipment manufacturers (OEMs) and commercial customers worldwide. OEMs include manufacturers of computer and office products, industrial equipment (including machine tools, factory automation, and robotic equipment), telecommunications products, aircraft and aerospace equipment, and scientific and medical devices. Commercial customers are mainly value-added resellers (VARs) of computer systems. The company maintains 162 sales facilities and 17 distribution centers in 31 countries. \t In January 1995, the company formed a joint venture with the Lite-On Group, one of Taiwan's largest semiconductor distributors, in which Arrow holds a 45% interest. During 1995, Spoerle Electronic Handelsgesellschaft mbH (\"Spoerle\"), the company's majority-owned German affiliate, acquired HED Heinrich Electronic Distribution GmbH. In addition, the company acquired Ally, Inc. in Taiwan and Arrow Components (NZ) Limited in New Zealand. The company also increased its interests in Silverstar Ltd., S.p.A. (\"Silverstar\"), the company's Italian subsidiary, to 86%; Amitron S.A. and ATD Electronica S.A., the company's subsidiaries serving Spain and Portugal, to 75% and 87%, respectively; and The Megachip Group, one of the company's French subsidiaries, to 100%.\nDuring 1994, the company acquired Gates\/FA Distributing, Inc. (\"Gates\") and Anthem Electronics, Inc. (\"Anthem\") in transactions accounted for as poolings of interests. Accordingly, the company's consolidated financial statements for 1993 have been restated to include the operations of Gates and Anthem. In January 1994, the company increased its holdings in Spoerle to 70% and Silverstar to 61%. During 1994, the company also acquired Field Oy in Finland; TH:s Elektronik AB in Sweden; Exatec A\/S in Denmark; Texny Glorytact (HK) in Hong Kong; The Megachip Group in France; and, Veltek Australia Pty Ltd. and Zatek Australia Pty Ltd.\nIn North America, the company is organized into five product-specific sales and marketing groups: The Arrow\/Schweber Electronics Group is the largest dedicated semiconductor distributor in the world. Anthem Electronics, Inc. is a leading distributor of semiconductors and computer products. Zeus Electronics is the only specialist distributor serving the military and high- reliability markets. Capstone Electronics focuses exclusively on the distribution of passive, electromechanical, and interconnect products. And Gates\/Arrow Distributing, Inc. distributes commercial computer products and systems.\nThrough its wholly-owned subsidiary, Arrow Electronics Distribution Group- Europe B.V., Arrow is the largest pan-European electronics distributor. The company's European strategy stresses two key elements: strong, locally-managed distributors to satisfy widely varying customer preferences and business practices; and an electronic backbone uniting Arrow's European partners with one another and with Arrow worldwide to leverage inventory investment and better meet the needs of customers in all of Europe's leading industrial electronics markets. In most of these markets, Arrow companies hold the number one position: Arrow Electronics (UK) Ltd. in Britain; Spoerle Electronic in Central Europe; Silverstar in Italy; and Amitron and ATD Electronica S.A. in Spain and Portugal. Arrow Electronique and The Megachip Group form the largest electronics distribution group in France, and Arrow's Nordic companies, Field Oy, TH:s Elektronik AB, and Exatec A\/S, are among the largest distributors in the markets of Finland, Norway, Sweden, and Denmark.\nArrow is the largest American electronics distributor in the Asia\/Pacific region. Arrow's Components Agent Limited (C.A.L.), the Lite-On Group, and the Melbourne-based Veltek and Zatek companies in Australia are the region's leading multi-national distributors. C.A.L., headquartered in Hong Kong, maintains additional facilities in key cities in Singapore, Malaysia, the People's Republic of China, and South Korea. Lite-On, headquartered in Taipei, serves customers in Taiwan, South Korea, Singapore, and Malaysia. Ally serves customers in Taipei. Arrow Components (NZ) services customers in New Zealand. Within these dynamic markets, Arrow is benefiting from two important growth factors: the decision by many of Arrow's traditional North American customers to locate production facilities in the region; and the surging demand for electronic products resulting from rising living standards and massive investments in infrastructure.\nThe company distributes a broad range of electronic components, computer products, and related equipment manufactured by others. About 66% of the company's consolidated sales are comprised of semiconductor products; industrial and commercial computer products, including microcomputer boards and systems, design systems, desktop computer systems, terminals, printers, disc drives, controllers, and communication control equipment account for about 25%; and the remaining sales are of passive, electromechanical, and interconnect products, principally capacitors, resistors, potentiometers, power supplies, relays, switches, and connectors.\nMost manufacturers of electronic components and computer products rely on independent authorized distributors, such as the company, to augment their product marketing operations. As a stocking, marketing, and financial intermediary, the distributor relieves its manufacturers of a portion of the costs and personnel associated with stocking and selling their products (including otherwise sizable investments in finished goods inventories and accounts receivable), while providing geographically dispersed selling, order processing, and delivery capabilities. At the same time, the distributor offers a broad range of customers the convenience of diverse inventories and rapid or scheduled deliveries. The growth of the electronics distribution industry has been fostered by the many manufacturers who recognize their authorized distributors as essential extensions of their marketing organizations.\nThe company and its affiliates serve approximately 150,000 industrial and commercial customers. Industrial customers range from major original equipment manufacturers to small engineering firms, while commercial customers include value-added resellers, small systems integrators, and large end-users.\nMost of the company's customers require delivery of the products they have ordered on schedules that are generally not available on direct purchases from manufacturers, and frequently their orders are of insufficient size to be placed directly with manufacturers. No single customer accounted for more than 1% of the company's 1995 or 1994 sales.\nThe electronic components and other products offered by the company are sold by field sales representatives, who regularly call on customers in assigned market areas, and by telephone from the company's selling locations, from which inside sales personnel with access to pricing and stocking data provided by computer display terminals accept and process orders. Each of the company's North American selling locations, warehouses, and primary distribution centers is electronically linked to the business' central computer, which provides fully integrated, on-line, real-time data with respect to nationwide inventory levels and facilitates control of purchasing, shipping, and billing. The company's foreign operations utilize Arrow's Worldwide Stock Check System, which affords access to the company's on-line, real-time inventory system.\nThere are approximately 500 manufacturers whose products are sold by the company. Intel Corporation accounted for approximately 14% of the business' purchases because of the market demand for microprocessors, while Texas Instruments accounted for approximately 10% of the business' purchases. No other supplier accounted for more than 8% of 1995 purchases. The company does not regard any one supplier of products to be essential to its operations and believes that many of the products presently sold by the company are available from other sources at competitive prices. Most of the company's purchases are pursuant to authorized distributor agreements which are typically cancellable by either party at any time or on short notice.\nApproximately 65% of the company's inventory consists of semiconductors. It is the policy of most manufacturers to protect authorized distributors, such as the company, against the potential write-down of such inventories due to technological change or manufacturers' price reductions. Under the terms of the related distributor agreements, and assuming the distributor complies with certain conditions, such suppliers are required to credit the distributor for inventory losses incurred through reductions in manufacturers' list prices of the items. In addition, under the terms of many such agreements, the distributor has the right to return to the manufacturer for credit a defined portion of those inventory items purchased within a designated period of time.\nA manufacturer who elects to terminate a distributor agreement is generally required to purchase from the distributor the total amount of its products carried in inventory. While these industry practices do not wholly protect the company from inventory losses, management believes that they currently provide substantial protection from such losses.\nThe company's business is extremely competitive, particularly with respect to prices, franchises, and, in certain instances, product availability. The company competes with several other large multi-national, national, and numerous regional and local distributors. As the world's largest electronics distributor, the company is greater in terms of financial resources and sales than most of its competitors.\nThe company and its affiliates employ approximately 7,200 people worldwide.\nExecutive Officers\nThe following table sets forth the names and ages of, and the positions and offices with the company held by, each of the executive officers of the company.\nName Age Position or Office Held ---- --- -----------------------\nStephen P. Kaufman \t 54 Chairman and Chief Executive Officer Robert E. Klatell 50 Executive Vice President, Chief \t\t\t\t Financial Officer, General Counsel, \t\t\t\t Secretary, and Treasurer Carlo Giersch \t58 Chief Executive Officer of Spoerle Electronic Steven W. Menefee 51 Senior Vice President Michael J. Long \t37 Vice President; President, Gates\/Arrow \t\t\t\t Distributing John J. Powers, III \t41 Vice President; President, Anthem Electronics Wesley S. Sagawa 48 Vice President; President, Capstone Electronics Jan S. Salsgiver \t39 Vice President; President, \t\t\t\t Arrow\/Schweber Electronics Group Robert S. Throop 58 Vice President; Chairman, Anthem Electronics\nSet forth below is a brief account of the business experience during the past five years of each executive officer of the company.\nStephen P. Kaufman has been Chairman since May 1994 and President and Chief Executive Officer of the company for more than five years prior thereto.\nRobert E. Klatell has been Executive Vice President since July 1995 and has served as Senior Vice President, General Counsel, Secretary, and Treasurer of the company for more than five years. He has been Chief Financial Officer since January 1992.\nCarlo Giersch has been Chief Executive Officer of Spoerle Electronic for more than five years.\nSteven W. Menefee has been a Senior Vice President of the company since July 1995 and Senior Vice President of Corporate Marketing since November 1995. Prior thereto he was a Vice President of the company, and President of the company's Arrow\/Schweber Electronics Group since November 1990.\nMichael J. Long became a Vice President of the company and President of Gates\/Arrow Distributing, Inc. in November 1995. Prior thereto he held a variety of positions at Capstone Electronics since 1991, the most recent of which was acting President since March 1994.\nJohn J. Powers, III became a Vice President of the company in November 1994, following the acquisition of Anthem Electronics, Inc. He has been President of Anthem Electronics, Inc. since June 1992; prior thereto he was Senior Vice President.\nWesley S. Sagawa has been a Vice President of the company and President of Capstone Electronics for more than five years. During 1994, he was managing director of Arrow U.K. \t Jan S. Salsgiver has been a Vice President of the company since September 1993 and President of the Arrow\/Schweber Electronics Group since November 1995. Prior thereto she had been President of Zeus Electronics. Prior to July 1993, she held a variety of senior marketing positions in the company, the most recent of which was Vice President of Semiconductor Marketing of the Arrow\/Schweber Electronics Group. \t Robert S. Throop has been Chairman and Chief Executive Officer of Anthem Electronics, Inc. for more than five years. He became a Vice President of the company in March 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. \t ----------\nThe company's executive office, located in Melville, New York, is owned by the company. The company occupies additional locations under leases due to expire on various dates to 2016. Six additional facilities are owned by the company, and another facility has been sold and leased back in connection with the financing thereof.\nItem 3.","section_3":"Item 3. Legal Proceedings. \t -----------------\nThrough a wholly-owned subsidiary, Schuylkill Metals Corporation, the company was previously engaged in the refining and selling of lead. In September 1988, the company sold its refining business.\nIn mid-1986 the refining business ceased operations at its battery breaking facility in Plant City, Florida, which facility had been placed on the list of hazardous waste sites targeted for cleanup under the federal Super Fund program. The Plant City site was not sold to the purchaser of the refining business, and the company remains subject to various environmental cleanup obligations at the site under federal and state law. The company and the EPA became parties to a consent decree which was entered by a federal court in Florida and became effective on April 22, 1992. The consent decree requires the company to fund, design, and implement remediation addressing environmental impacts to site soils and sediment, underlying ground water, and wetland areas. Substantial progress has been made in each of these areas. Remediation of the wetlands areas on the site, including the creation of certain new wetlands areas under agreement with the EPA and the Florida Department of Environmental Conservation, was substantially completed in 1994. A waste water treatment plant has been built on site by the company's contractors, and processing of ground and pond water for discharge to the Plant City Treatment Works commenced in July 1994. Soil stabilization facilities have been erected and soil processing began in November 1994. The company believes it reasonably likely that soil stabilization will be completed before the end of 1996 and that water treatment will continue, at least through 1996. The extent of such remediation activities (including the estimated cost thereof and the time necessary to complete them), however, is subject to change based upon conditions actually encountered during remediation. Moreover, the EPA reserves the right to seek additional action if it subsequently finds further contamination or other conditions rendering the work insufficiently protective of human health or the environment. The company believes that the amount expected to be expended in any year to fund such activities will not have a material adverse impact on the company's liquidity, capital resources or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. \t ---------------------------------------------------\nNone.\n\t\t\t\t PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and \t --------------------------------------------- \t Related Stockholder Matters. \t ---------------------------\nMarket Information\nThe company's common stock is listed on the New York Stock Exchange (trading symbol: \"ARW\"). The high and low sales prices during each quarter of 1995 and 1994 were as follows:\nYear High Low - ---- ---- ---\n1995: Fourth Quarter $55-1\/4 $39-1\/4 Third Quarter 59-3\/4 48-1\/2 Second Quarter 50-7\/8 40 First Quarter 44-5\/8 35-1\/8\n1994: Fourth Quarter $38-5\/8 $33-3\/4 Third Quarter 40-1\/8 35-1\/8 Second Quarter 41-1\/8 33-5\/8 First Quarter 45-1\/8 36-1\/8\nHolders\nOn March 1, 1996, there were approximately 4,500 shareholders of record of the company's common stock.\nDividend History and Restrictions\nThe company has not paid cash dividends on its common stock during the past five years. While the board of directors considers the payment of dividends on the common stock from time to time, the declaration of future dividends will be dependent upon the company's earnings, financial condition, and other relevant factors.\nThe terms of the company's global multi-currency credit facility and its 8.29% senior notes (see Note 4 of the Notes to Consolidated Financial Statements) limit, among other things, the payment of cash dividends and the incurrence of additional borrowings and require that working capital, net worth, and certain other financial ratios be maintained at designated levels.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth certain selected consolidated financial data and should be read in conjunction with the company's consolidated financial state- ments and related notes appearing elsewhere in this Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial \t ------------------------------------------------- \t Condition and Results of Operations. \t -----------------------------------\nFor an understanding of the significant factors that influenced the company's performance during the past three years, the following discussion should be read in conjunction with the consolidated financial statements and other information appearing elsewhere in this report.\nDuring 1994, the company acquired Gates\/FA Distributing, Inc. (\"Gates\") and Anthem Electronics, Inc. (\"Anthem\") in transactions accounted for as poolings of interests. Accordingly, the company's consolidated financial statements for 1993 have been restated to include the operations of Gates and Anthem. The 1994 and 1993 consolidated financial statements do not reflect the cost savings and synergies achieved during 1995 or the sales attrition which may have resulted from the merger of Gates and Anthem with the company. Beginning in 1994, the consolidated financial statements include the results of Silverstar Ltd., S.p.A. (\"Silverstar\"), which had been accounted for under the equity method prior to January 1994 when the company increased its holdings to 61%. See Note 2 of the Notes to Consolidated Financial Statements for information with respect to the acquisitions.\nSales\nIn 1995, consolidated sales increased to a record $5.9 billion, a 27% increase over 1994 sales of $4.6 billion. This sales growth reflects strong activity levels in each of the company's core businesses as well as the impact of key strategic alliances and acquisitions forged around the world during 1994.\nConsolidated sales of $4.6 billion in 1994 were 31% higher than 1993 sales of $3.6 billion. This increase principally reflected increased activity levels in each of the company's distribution groups throughout the world, the consolidation of Silverstar and, to a lesser extent, acquisitions in Europe and the Asia\/Pacific region.\nIn 1993, consolidated sales of $3.6 billion were 47% ahead of 1992 sales of $2.4 billion. Excluding Spoerle Electronic (\"Spoerle\"), which had been accounted for under the equity method prior to January 1993, sales were $3.2 billion, an advance of 32% over the year-earlier period. This sales growth was principally due to increased activity levels in each of the company's distribution groups and, to a lesser extent, acquisitions in North America, Europe, and the Asia\/Pacific region, offset in part by weaker currencies in Europe.\nOperating Income\nIn 1995, the company's consolidated operating income increased to $423.2 million, compared with operating income of $256 million in 1994. Included in the 1994 results are special charges of $45.3 million associated with the acquisition and integration of Gates and Anthem into Arrow. The improvement in operating income outpaced the growth in sales as the company benefited from cost savings following the integration of Gates and Anthem. These cost savings principally reflect reductions in personnel performing duplicative functions and the elimination of duplicative administrative facilities, computer and telecommunications equipment, and selling and stocking locations. Operating expenses as a percentage of sales declined to 10.3% in 1995, the lowest in the company's history.\nThe company's consolidated operating income increased to $256 million in 1994, compared with operating income of $226.1 million in 1993. Excluding the special charges relating to Gates and Anthem, operating income was $301.3 million. The improvement in operating income, excluding the special charges, reflected the impact of increased sales, continued economies of scale and expense containment efforts reducing operating expenses as a percentage of sales, and the consolidation of Silverstar, offset in part by lower gross profit margins. Gross profit margins decreased from 1993 as a result of proportionately higher sales of low-margin microprocessors and commercial computer products, coupled with competitive pricing pressures. Operating expenses as a percentage of sales, excluding the special charges, were 11.1%.\nIn 1993, the company's consolidated operating income increased to $226.1 million, compared with 1992 operating income of $163.7 million. The significant improvement in operating income reflected the impact of increased sales and the consolidation of Spoerle, offset in part by lower gross profit margins primarily reflecting proportionately higher sales of low-margin microprocessors and commercial computer products. Operating income in 1993 included a restructuring charge of $7.8 million associated with the sale by Anthem of its Eagle Technology Business Unit. Excluding this restructuring charge, operating income was $233.9 million.\nInterest\nIn 1995, interest expense increased to $46.4 million from $36.2 million in 1994, reflecting increases in working capital required to support higher sales, interest related to borrowings associated with acquisitions, and capital expenditures.\nInterest expense of $36.2 million in 1994 increased by $9.6 million from the 1993 level. The increase principally reflected the consolidation of Silverstar and, to a lesser extent, interest related to borrowings associated with acquisitions.\nIn 1993, interest expense decreased to $26.6 million from $31.6 million in 1992. The decrease principally reflected the full-year effect of the retirement during 1992 of $46 million of the company's 13-3\/4% subordinated debentures and the refinancing of the company's remaining high-yield debt with securities bearing lower interest rates offset in part by the consolidation of Spoerle and borrowings associated with acquisitions.\nIncome Taxes\nIn 1995, the company recorded a provision for taxes at an effective tax rate of 40.4% compared with 40.6%, excluding the special charges associated with the Gates and Anthem acquisitions, in 1994.\nThe company recorded a provision for taxes at an effective tax rate of 40.6% in 1994, compared with 41% in 1993. The lower effective tax rate was the result of increased earnings in foreign countries with lower tax rates.\nIn 1993, the company's effective tax rate was 41%, compared with 38.8% in 1992. The higher effective tax rate reflected increased U.S. taxes resulting from higher statutory rates and the consolidation of Spoerle.\nNet Income\nIn 1995, the company's net income advanced to $202.5 million from $140.7 million in 1994, before the special charges of $45.3 million ($28.8 million after taxes) associated with Gates and Anthem. The significant improvement in net income was principally the result of the increase in operating income offset in part by higher interest expense.\nNet income in 1994 was $111.9 million, an advance from $106.6 million in 1993. Excluding the special charges associated with Gates & Anthem, net income in 1994 was $140.7 million. Excluding the restructuring charge associated with the sale by Anthem of its Eagle Technology Business Unit, net income was $111.1 million in 1993. The increase in net income was due principally to increased operating income offset in part by higher interest expense.\nNet income in 1993 was $106.6 million, an advance from $79.5 million in 1992, which included extraordinary charges of $5.4 million reflecting the net unamortized discount and issuance expenses associated with the redemption of high-coupon subordinated debentures and other debt in 1992. The increase in net income was due principally to the increase in operating income and lower interest expense offset in part by higher taxes.\nLiquidity and Capital Resources\nThe company maintains a high level of current assets, primarily accounts receivable and inventories. Consolidated current assets as a percentage of total assets were approximately 78% in 1995 and 76% in 1994.\nWorking capital increased by $349 million, or 40%, compared with 1994, primarily as a result of increased sales and, to a lesser extent, acquisitions in Europe and the Asia\/Pacific region.\nThe net amount of cash used for the company's operating activities in 1995 was $114.1 million, as the growth in accounts receivable and inventories outpaced the increase in net income. The net amount of cash used for investing activities was $132.7 million, including $90.7 million for various investments and acquisitions. The net amount of cash provided by financing activities was $228.1 million, principally reflecting the company's borrowings to finance investments and acquisitions, distributions to partners, and the repayment of certain debt.\nIn October 1995, the company called for the redemption of its 5-3\/4% convertible subordinated debentures due 2002, which resulted in the issuance of 3,772,254 shares of common stock and eliminated approximately $125 million in long-term debt and $7.2 million of annual interest charges.\nIn 1994, working capital increased by $103.6 million, or 14%, compared with 1993, as a result of increased sales, the consolidation of Silverstar, and acquisitions.\nThe net amount of cash provided by operations in 1994 was $125.2 million, the principal element of which was the cash flow resulting from higher net earnings offset in part by increased working capital needs to support sales growth. The net amount of cash used by the company for investing purposes was $122.9 million, including $108.5 million for various acquisitions. Cash flows from financing activities were $13.4 million, principally from increased borrowings in part to finance acquisitions in Europe and the Asia\/Pacific region.\nWorking capital increased in 1993 by $204.7 million, or 37%, compared with 1992, as a result of increased sales, the consolidation of Spoerle, and acquisitions.\nThe net amount of cash provided by operations in 1993 was $35.7 million, the principal element of which was the cash flow resulting from higher net earnings offset by increased working capital needs to support sales growth. The net amount of cash used by the company for investing activities amounted to $114.8 million, including $87.9 million for various acquisitions. Cash flows from financing activities were $122.2 million, principally resulting from increased borrowings to finance the 1993 acquisitions in the U.S., Europe, and the Asia\/Pacific region.\nIn September 1993, the company completed the conversion of all of its outstanding series B $19.375 convertible exchangeable preferred stock into 1,009,086 shares of its common stock. This conversion eliminated the company's obligation to pay $1.3 million of annual dividends.\nAccounting Matters\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"SFAS 123\"), \"Accounting for Stock-Based Compensation,\" which establishes a fair value based method of accounting for stock-based compensation plans. SFAS 123 encourages, but does not require, adoption of a fair value based method. The company has not yet determined if it will adopt the fair value based method or continue to report under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\".\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements. \t --------------------\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Arrow Electronics, Inc.\nWe have audited the accompanying consolidated balance sheet of Arrow Electronics, Inc. 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 the Index at 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 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 Arrow Electronics, 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.\n\t\t\t\t\t\tERNST & YOUNG LLP\nNew York, New York February 22, 1996\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe consolidated financial statements of Arrow Electronics, Inc. have been prepared by management, which is responsible for their integrity and objectivity. These statements, prepared in accordance with generally accepted accounting principles, reflect our best use of judgment and estimates where appropriate. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements.\nThe company's system of internal controls is designed to provide reasonable assurance that company assets are safeguarded from loss or unauthorized use or disposition, and that transactions are executed in accordance with management's authorization and are properly recorded. In establishing the basis for reasonable assurance, management balances the costs of the internal controls with the benefits they provide. The system contains self-monitoring mechanisms, and compliance is tested through an extensive program of site visits and audits by the company's operating controls staff.\nThe Audit Committee of the Board of Directors, consisting entirely of outside directors, meets regularly with management, operating controls staff, and independent auditors, and reviews audit plans and results as well as management's actions taken in discharging its responsibilities for accounting, financial reporting, and internal controls. Management, operating controls staff, and independent auditors have direct and confidential access to the Audit Committee at all times.\nThe company's independent auditors, Ernst & Young LLP, were engaged to audit the consolidated financial statements in accordance with generally accepted auditing standards. These standards include a study and evaluation of internal controls for the purpose of establishing a basis for reliance thereon relative to the scope of their audit of the consolidated financial statements.\nStephen P. Kaufman Chairman and Chief Executive Officer\nRobert E. Klatell Executive Vice President and Chief Financial Officer\n\t\t\t\t ARROW ELECTRONICS, INC. \t\t\t\t CONSOLIDATED BALANCE SHEET \t\t\t (Dollars in thousands)\n\t\t\t\t ARROW ELECTRONICS, INC. \t\t\t\t CONSOLIDATED STATEMENT OF INCOME \t\t\t\t(In thousands except per share data)\n\t\t\t\t ARROW ELECTRONICS, INC. \t\t\tCONSOLIDATED STATEMENT OF CASH FLOWS \t\t\t\t \t (In thousands)\n\t\t\t\t\t ARROW ELECTRONICS, INC. \t\t\t\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nBasis of Presentation - ---------------------\nIn 1994, the company acquired Gates\/FA Distributing, Inc. (\"Gates\") and Anthem Electronics, Inc. (\"Anthem\") in transactions accounted for as poolings of interests. Accordingly, the consolidated financial statements for 1993 have been restated to include the operations of Gates and Anthem.\nPrinciples of Consolidation - ---------------------------\nThe consolidated financial statements include the accounts of the company and its majority-owned subsidiaries. The company's investments in affiliated companies which are not majority-owned are accounted for using the equity method. All significant intercompany transactions are 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 amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.\nInventories - -----------\nInventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out (FIFO) method.\nProperty and Depreciation - -------------------------\nDepreciation is computed on the straight-line method for financial reporting purposes and on accelerated methods for tax reporting purposes. Leasehold improvements are amortized over the shorter of the term of the related lease or the life of the improvement.\nCost in Excess of Net Assets of Companies Acquired - --------------------------------------------------\nThe cost in excess of net assets of companies acquired is being amortized on a straight-line basis, principally over 40 years.\nForeign Currency - ----------------\nThe assets and liabilities of foreign operations are translated at the exchange rates in effect at the balance sheet date, with the related translation gains or losses reported as a separate component of shareholders' equity. The results of foreign operations are translated at the weighted average exchange rates for the year.\nIncome Taxes - ------------\nIncome taxes are accounted for under the liability method. Deferred taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts.\nNet Income Per Share - --------------------\nNet income per share for 1995 and 1994 is based upon the weighted average number of shares outstanding and dilutive common share equivalents of 749,216 and 634,739, respectively. For 1995, the weighted average includes the conver- sion to common stock of the 5-3\/4% convertible subordinated debentures (the \"debentures\") from October 1995. Net income per share on a fully diluted basis assumes that the debentures were converted into common stock at the beginning of the year and the related interest expense, net of taxes, was eliminated.\nNet income per share for 1993 is based upon the weighted average number of common shares outstanding and dilutive common share equivalents of 828,212 after deducting preferred stock dividends related to the series B $19.375 convertible exchangeable preferred stock (the \"preferred stock\"), which was converted into common stock in September 1993. Net income per share on a fully diluted basis assumes that the preferred stock and the debentures were converted into common stock at the beginning of the year and the dividends related to the preferred stock and the interest expense on the debentures, net of taxes, were eliminated.\nCash and Short-term Investments - -------------------------------\nShort-term investments which have a maturity of ninety days or less at time of purchase are considered cash equivalents in the consolidated statement of cash flows. The carrying amount reported in the consolidated balance sheet for short- term investments approximates fair value.\n2. Acquisitions\nDuring 1995, Spoerle Electronic Handelsgesellschaft mbH (\"Spoerle\"), the company's majority-owned German affiliate, acquired HED Heinrich Electronic Distribution GmbH. In addition, the company acquired Ally, Inc. in Taiwan and Arrow Components (NZ) Limited in New Zealand. The company also increased its interests in Silverstar Ltd., S.p.A. (\"Silverstar\"), the company's Italian subsidiary, to 86%; Amitron S.A. and ATD Electronica S.A., the company's subsidiaries serving Spain and Portugal, to 75% and 87%, respectively; and The Megachip Group, one of the company's French subsidiaries, to 100%.\nThe company acquired Gates in August 1994 and Anthem in November 1994 through the exchange of 3,743,000 and 10,803,000 shares of newly issued company stock, respectively. These acquisitions were accounted for as poolings of interests. The 1994 and 1993 consolidated financial statements do not reflect the cost savings achieved from the combination of Gates and Anthem with the company's business or the sales attrition which may have resulted. These cost savings were principally from reductions in personnel performing duplicative functions and the elimination of duplicative administrative facilities, computer and telecommunications equipment, and selling and stocking locations. The consolidated financial statements for 1994 include special charges of $28,850,000 after taxes ($.62 per share on a primary basis) of costs assoc- iated with the acquisition and integration of the Gates and Anthem businesses and related transaction fees. Such integration costs included real estate termination costs and severance and other expenses related to personnel perform- ing duplicative functions.\nIn January 1994, the company increased its holdings in Spoerle to 70% and Silverstar to 61%. During 1994, the company also acquired Field Oy in Finland; TH:s Elektronik AB in Sweden; Exatec A\/S in Denmark; Texny Glorytact (HK) in Hong Kong; The Megachip Group in France; and Veltek Australia Pty Ltd. and Zatek Australia Pty Ltd.\nThe cost of each acquisition has been allocated among the net assets acquired on the basis of the respective fair values of the assets acquired and liabilities assumed. For financial reporting purposes, the acquisitions are accounted for as purchase transactions beginning in the respective month of acquisition. The aggregate consideration paid for these acquisitions exceeded the net assets acquired by $30,671,000 and $96,791,000 in 1995 and 1994, respectively.\nIn connection with certain acquisitions, the company may be required to make additional payments that are contingent upon the acquired businesses achieving certain operating goals. During 1995 and 1994, the company made additional payments of $14,884,000 and $9,744,000, respectively, which have been capitalized as cost in excess of net assets of companies acquired.\n3. Investments in Affiliated Companies\nDuring 1995, the company acquired a 45% interest in Strong Electronics Co., Ltd. (\"Strong Electronics\"), a joint venture with Lite-On Inc., a Taiwan-based electronics distributor.\nAt December 31, 1993, the company had a 50% interest in Silverstar, which was accounted for using the equity method; thereafter, it has been consolidated.\n4. Debt\nLong-term debt consisted of the following at December 31 (in thousands):\n\t\t\t\t\t 1995 1994 \t\t\t\t\t ---- ---- \t\t\t Global multi-currency credit facility $294,903 $ 20,000 8.29% senior notes 75,000 75,000 Lines of credit 70,000 47,100 U.S. loan agreement due 1995 - 20,000 Deutsche mark term loan due 2000 - 45,170 Pound sterling term loan due 2000 - 28,823 Other obligations with various interest rates and due dates 13,968 14,541 \t\t\t\t\t -------- -------- \t\t\t\t\t 453,871 250,634 Less installments due within one year 2,165 26,236 \t\t\t\t\t -------- -------- \t\t\t\t\t $451,706 $224,398 \t\t\t\t\t ======== ========\nThe company's revolving credit agreement (the \"global multi-currency credit facility\") was amended in August 1995 to increase to $500,000,000 the amount of available credit, to allow the company's foreign subsidiaries to borrow under this facility, and to extend the maturity date to August 2000. The interest rate for loans under this facility is at the applicable Eurocurrency Rate (5.6875% for U.S. dollar denominated loans at December 31, 1995) plus a margin of .225%. The company may also utilize the facility's competitive advance option to obtain loans, generally at a lower rate. The company pays the banks a facility fee of .125% per annum.\nThe senior notes are payable in three equal annual installments commencing in 1998.\nThe global multi-currency credit facility and the senior notes limit, among other things, the payment of cash dividends and the incurrence of additional borrowings and require that working capital, net worth, and certain other financial ratios be maintained at designated levels.\nThe company maintains uncommitted lines of credit with a group of banks under which up to $118,000,000 could be borrowed at December 31, 1995 on such terms as the company and the banks may agree. Borrowings under the lines of credit are classified as long-term debt as the company has the ability to renew them or refinance them with the global multi-currency credit facility. There are no fees or compensating balances associated with these borrowings. Outstanding borrowings under the lines of credit at December 31, 1995 were at an average interest rate of 6.17%.\nThe deutsche mark and pound sterling term loans were repaid during 1995 with proceeds from the global multi-currency credit facility.\nThe aggregate annual maturities of long-term debt for each of the five years in the period ending December 31, 2000 are: 1996-$2,165,000; 1997-$2,429,000; 1998-$25,341,000; 1999-$25,360,000; and 2000-$396,560,000.\nShort-term borrowings are principally utilized to support the working capital requirements of certain foreign operations. The weighted average interest rates of these borrowings at December 31, 1995 and 1994 were 10.4% and 10%, respectively.\nThe estimated fair market value of the senior notes at December 31, 1995 was 108% of par. The balance of the company's borrowings approximate their fair value.\n5. Income Taxes\nThe provision for income taxes consists of the following (in thousands):\n\t\t\t\t 1995 1994 1993 \t\t\t\t ---- ---- ---- Current Federal $ 78,639 $53,465 $56,519 State 19,989 15,317 13,600 Foreign 37,330 28,063 9,376 \t\t\t\t-------- ------- ------- \t\t\t\t 135,958 96,845 79,495 \t\t\t-------- ------- -------\nDeferred Federal 2,625 (8,437) (67) State 600 (2,824) (241) Foreign 13,956 5,622 3,222 \t\t\t\t-------- ------- ------- \t\t\t\t 17,181 (5,639) 2,914 \t\t\t\t-------- ------- ------- \t\t\t\t$153,139 $91,206 $82,409 \t\t\t\t======== ======= =======\nThe principal causes of the difference between the U.S. statutory and effective income tax rates are as follows (in thousands):\n\t\t\t\t 1995 1994 1993 \t\t\t\t ---- ---- ---- \t\t\t\t\t\t Provision at statutory rate $132,769 $76,932 $70,381 State taxes, net of federal benefit 13,383 8,120 8,715 Foreign tax rate differential 4,959 4,841 3,448 Other 2,028 1,313 (135) \t\t\t\t-------- ------- ------- \t\t\t\t$153,139 $91,206 $82,409 \t\t\t\t======== ======= =======\nFor financial reporting purposes, income before income taxes attributable to the United States was $252,894,000 in 1995, $184,241,000 excluding the special charges of $45,350,000 in 1994, and $163,073,000 in 1993, and income before income taxes attributable to foreign operations was $126,447,000 in 1995, $80,915,000 in 1994, and $38,116,000 in 1993.\nThe significant components of the company's deferred tax assets, which are included in other assets, are as follows (in thousands):\n\t\t\t\t 1995 1994 \t\t\t ---- ---- \t\t\t\t\t\t Inventory reserves $10,268 $ 7,183 Allowance for doubtful accounts 6,712 4,552 Accrued expenses 6,217 9,282 Other 3,303 3,783 \t\t\t\t ------- ------- \t\t\t\t $26,500 $24,800 \t\t\t ======= =======\nIn France, the company has approximately $8,000,000 of net operating loss carryforwards, of which approximately $5,000,000 were acquired, which expire through 2000. Included in other liabilities are deferred tax liabilities of $33,310,000 and $19,626,000 at December 31, 1995 and 1994, respectively. The deferred tax liabilities are principally the result of the differences in the bases of the German assets and liabilities for tax and financial reporting purposes.\n6. Shareholders' Equity\nThe company has 2,000,000 authorized shares of serial preferred stock with a par value of $1.\nIn 1988, the company paid a dividend of one preferred share purchase right on each outstanding share of common stock. Each right, as amended, entitles a shareholder to purchase one one-hundredth of a share of a new series of preferred stock at an exercise price of $50 (the \"exercise price\"). The rights are exercisable only if a person or group acquires 20% or more of the company's common stock or announces a tender or exchange offer that will result in such person or group acquiring 30% or more of the company's common stock. Rights owned by the person acquiring such stock or transferees thereof will automatically be void. Each other right will become a right to buy, at the exercise price, that number of shares of common stock having a market value of twice the exercise price. The rights, which do not have voting rights, expire on March 2, 1998 and may be redeemed by the company at a price of $.01 per right at any time until ten days after a 20% ownership position has been acquired. In the event that the company merges with, or transfers 50% or more of its consolidated assets or earning power to, any person or group after the rights become exercisable, holders of the rights may purchase, at the exercise price, a number of shares of common stock of the acquiring entity having a market value equal to twice the exercise price.\n7. Employee Stock Plans\nRestricted Stock Plan - ---------------------\nUnder the terms of the Arrow Electronics, Inc. Restricted Stock Plan (the \"Plan\"), a maximum of 1,480,000 shares of common stock may be awarded at the discretion of the board of directors to key employees of the company. As many as 100 employees may be considered for awards under the Plan.\nShares awarded under the Plan may not be sold, assigned, transferred, pledged, hypothecated, or otherwise disposed of, except as provided in the Plan. Shares awarded become free of vesting restrictions over a four-year period. The company awarded 51,500 shares of common stock in early 1996 to 62 key employees in respect of 1995, 106,350 shares of common stock to 79 key employees during 1995, 77,350 shares of common stock to 50 key employees during 1994, and 49,250 shares of common stock to 35 key employees during 1993. Forfeitures of shares awarded under the Plan were 10,425, 1,000, and 7,625 during 1995, 1994, and 1993, respectively. The aggregate market value of outstanding awards under the Plan at the respective dates of award is being amortized over a four-year period and the unamortized balance is included in shareholders' equity as unamortized employee stock awards.\nStock Option Plan - -----------------\nUnder the terms of the Arrow Electronics, Inc. Stock Option Plan (the \"Option Plan\"), both nonqualified and incentive stock options for an aggregate of 6,000,000 shares of common stock were authorized for grant to key employees at prices determined by the board of directors in its discretion or, in the case of incentive stock options, prices equal to the fair market value of the shares at the dates of grant. Options currently outstanding have terms of ten years and become exercisable in equal annual installments over two or three-year periods from date of grant. The options issued and outstanding under the option plans of Gates and Anthem at the dates of their acquisition have been converted into options to purchase shares of the company's common stock at the same exchange ratio as utilized in acquiring these businesses, and all unissued options under those plans were cancelled.\nThe following information relates to the option plans for the years ended December 31:\n\t\t\t\t\t 1995 1994 1993 \t\t\t\t ---- ---- ---- Options outstanding at beginning of year 2,164,038 1,806,818 1,827,305 Granted 917,450 789,123 680,228 Exercised (566,504) (336,481) (546,857) Forfeited (76,409) (95,422) (153,858) \t\t\t\t\t --------- --------- --------- Options outstanding at end of year 2,438,575 2,164,038 1,806,818 \t\t\t\t\t ========= ========= ========= Prices per share of options outstanding $3.63-55.38 $2.53-52.43 $2.53-52.43\nAverage price per share of options exercised $24.21 $14.44 $9.49 Average price per share of options outstanding $33.38 $27.82 $21.61 Exercisable options 1,339,987 1,262,715 1,071,270 Options available for future grant: Beginning of year 2,667,389 2,446,345 1,270,619 End of year 1,793,281 2,667,389 2,446,345\nStock Ownership Plan - --------------------\nThe company maintains a noncontributory employee stock ownership plan which enables most North American employees to acquire shares of the company's common stock. Contributions, which are determined by the board of directors, are in the form of common stock or cash which is used to purchase the company's common stock for the benefit of participating employees. Contributions to the plan for 1995, 1994, and 1993 aggregated $3,878,000, $2,765,000, and $2,525,000, respectively.\n8. Retirement Plan\nThe company has a defined contribution plan for eligible employees, which qualifies under Section 401(k) of the Internal Revenue Code. The company's contribution to the plan, which is based on a specified percentage of employee contributions, amounted to $3,966,000, $3,235,000, and $3,055,000 in 1995, 1994, and 1993, respectively. Certain domestic and foreign subsidiaries maintain separate defined contribution plans for their employees and made contributions thereunder which amounted to $822,000, $956,000, and $651,000 in 1995, 1994, and 1993, respectively.\nThe company maintains an unfunded supplemental retirement plan for certain executives. The company's board of directors determines those employees eligible to participate in the plan and their maximum annual benefit upon retirement.\n9. Lease Commitments\nThe company leases certain office, warehouse, and other property under noncancellable operating leases expiring at various dates through 2016. Rental expenses of noncancellable operating leases amounted to $27,594,000 in 1995, $21,736,000 in 1994, and $19,495,000 in 1993. Aggregate minimum rental commitments under all noncancellable operating leases approximate $134,889,000 exclusive of real estate taxes, insurance, and leases related to facilities closed in connection with the integration of the acquired businesses. Such commitments on an annual basis are: 1996-$26,133,000; 1997-$22,070,000; 1998- $19,584,000; 1999-$16,463,000; 2000-$12,082,000; and $38,557,000 thereafter. The company's obligations under capitalized leases are reflected as a component of other liabilities.\n10. Financial Instruments\nThe company enters into foreign exchange forward contracts (the \"contracts\") to reduce risk due to changes in currency exchange rates, principally French francs, deutsche marks, Italian lira, and pounds sterling. These contracts hedge firm commitments of inventory purchases and generally are settled within three months. Gains or losses on these contracts are deferred and recognized when the underlying future purchase is recognized. The risk of loss on a contract is the risk of nonperformance by the counterparties. The fair value of the contracts is estimated using market quotes. The notional amount of the contracts at December 31, 1995 was $52,345,000. The carrying amount, which is nominal, approximates fair value.\n11. Segment and Geographic Information\nThe company is engaged in one business, the distribution of electronic components, systems, and related products. The geographic distribution of consolidated sales, operating income, and identifiable assets is as follows (in thousands):\n\t\t\t Sales to Identifiable \t\t Unaffiliated Operating Assets at \t\t\t Customers Income (Loss) December 31, \t\t ------------ ------------- ------------- - ----\nNorth America $3,929,016 $295,941 $1,476,420 Europe 1,719,523 135,519 1,018,755 Asia\/Pacific 270,881 8,884 134,947 Corporate - (17,135) 34,863 Investment in affiliated company - - 36,031 \t\t\t ---------- -------- ---------- \t\t\t $5,919,420 $423,209 $2,701,016 \t\t ========== ======== ==========\n- ----\nNorth America $3,339,210 $224,007 $1,176,196 Europe 1,146,726 89,879 739,863 Asia\/Pacific 163,298 4,288 96,773 Corporate - (16,850) 25,942 Integration charges - (45,350) - \t\t\t ---------- -------- ---------- \t\t\t $4,649,234 $255,974 $2,038,774 \t ========== ======== ========== \t\t\t\n- ----\nNorth America $2,915,887 $208,371 $1,095,414 Europe 600,935 40,153 367,102 Asia\/Pacific 44,034 1,706 57,416 Corporate - (16,331) 35,849 Restructuring charge - (7,810) - Investment in affiliated company - - 13,371 \t\t\t ---------- -------- ---------- \t\t\t $3,560,856 $226,089 $1,569,152 \t\t\t ========== ======== ==========\nDuring 1995, Strong Electronics, the company's Taiwanese affiliate, recorded sales of approximately $97,000,000, which are not reflected in the company's 1995 consolidated financial statements.\n12. Quarterly Financial Data (Unaudited)\nA summary of the company's quarterly results of operations follows (in thousands except per share data):\n\t\t\t\t First Second Third Fourth \t \t\t\tQuarter Quarter Quarter Quarter \t\t \t\t------- ------- ------- ------- - ---- Sales $1,440,353 $1,458,213 $1,459,591 $1,561,263 Gross profit 246,330 262,838 256,794 264,712 Net income 44,851 51,752 50,958 54,983 Per common share: Primary .96 1.09 1.07 1.09 Fully diluted .91 1.03 1.01 1.08\n- ---- Sales $1,117,679 $1,113,991 $1,161,423 $1,256,141 Gross profit 197,584 201,362 200,916 217,203 Net income 33,379 32,903 21,779 23,828 Per common share: Primary .72 .71 .47 .51 Fully diluted .68 .68 .45 .49\nExcluding the special charges associated with the acquisition and integration of Gates and Anthem, net income and net income per share on a primary basis in the third and fourth quarters of 1994 would have been $34,904,000 and $.75 and $39,553,000 and $.85, respectively.\nItem 9.","section_9":"Item 9. Changes In and Disagreements with Accountants on \t ------------------------------------------------ \t Accounting and Financial Disclosure. \t -----------------------------------\nNone.\n\t\t\t\t Part III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. \t --------------------------------------------------\nSee \"Executive Officers\" in the response to Item 1 above. In addition, the information set forth under the heading \"Election of Directors\" in the company's Proxy Statement filed in connection with the Annual Meeting of Shareholders scheduled to be held May 14, 1996 hereby is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation. \t ----------------------\nThe information set forth under the heading \"Executive Compensation and Other Matters\" in the company's Proxy Statement filed in connection with the Annual Meeting of Shareholders scheduled to be held May 14, 1996 hereby is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. \t --------------------------------------------------------------\nThe information on page 3 and under the heading \"Election of Directors\" in the company's Proxy Statement filed in connection with the Annual Meeting of Shareholders scheduled to be held May 14, 1996 hereby is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. \t ----------------------------------------------\nThe information set forth under the heading \"Executive Compensation and Other Matters\" in the company's Proxy Statement filed in connection with the Annual Meeting of Shareholders scheduled to be held May 14, 1996 hereby is incorporated herein by reference.\n\t\t\t\t Part IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. \t ---------------------------------------------------------------\n(a)1. Financial Statements. --------------------\nThe financial statements listed in the accompanying index to financial statements and financial statement schedules are filed as part of this annual report.\n2. Financial Statement Schedules. -----------------------------\nThe financial statement schedule listed in the accompanying index to financial statements is filed as part of this annual report.\nAll other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto.\n\t\t\t ARROW ELECTRONICS, INC. \t\t AND FINANCIAL STATEMENT SCHEDULES \t\t\t\t (Item 14 (a)) \t \t\t\t\t\t\t\t\t\t Page \t\t\t\t\t\t\t\t\t ----\nReport of Ernst & Young LLP, independent auditors 13\nManagement's responsibility for financial reporting 14\nConsolidated balance sheet at December 31, 1995 and 1994 15\nFor the years ended December 31, 1995, 1994 and 1993:\nConsolidated statement of income 16\nConsolidated statement of cash flows 17\nConsolidated statement of shareholders' equity 18\nNotes to consolidated financial statements for the years ended December 31, 1995, 1994 and 1993 20\nConsolidated schedule for the three years ended December 31, 1995:\nII - Valuation and qualifying accounts 39\n3. Exhibits.\n\t (2)(a)(i) Share Purchase Agreement dated as of October 10, 1991 among EDI Electronics Distribution International B.V., Aquarius Investments Ltd., Andromeda Investments Ltd., and the other persons named therein (incorporated by reference to Exhibit 2.2 to the company's Registration Statement on Form S-3, Registration No. 33-42176).\n\t\t (ii) Standstill Agreement dated as of October 10, 1991 among Arrow Electronics, Inc., Aquarius Investments Ltd., Andromeda Investments Ltd., and the other persons named therein (incorporated by reference to Exhibit 4.1 to the company's Registration Statement on Form S-3, Registration No. 33-42176).\n\t\t (iii) Shareholder's Agreement dated as of October 10, 1991 among EDI Electronics Distribution International B.V., Giorgio Ghezzi, Germano Fanelli, and Renzo Ghezzi (incorporated by reference to Exhibit 2(f)(iii) to the company's Annual Report on Form 10-K for the year ended December 31, 1993, Commission File No. 1-4482).\n\t\t (b) Agreement and Plan of Merger, dated as of June 24, 1994, by and among Arrow Electronics, Inc., AFG Acquisition Company and Gates\/FA Distributing, Inc. (incorporated by reference to Exhibit 2 to the company's Registration Statement on Form S-4, Commission File No. 35- 54413).\n\t\t (c) Agreement and Plan of Merger, dated as of September 21, 1994, by and among Arrow Electronics, Inc., MTA Acquisition Company and Anthem Electronics, Inc. (incorporated by reference to Exhibit 2 to the company's Registration Statement on Form S-4, Commission File No. 33-55645).\n\t (3)(a) Amended and Restated Certificate of Incorporation of the company, as amended (incorporated by reference to Exhibit 3(a) to the company's Annual Report on Form 10-K for the year ended December 31, 1994 Commission File No. 1-4482).\n\t\t (b) By-Laws of the company, as amended (incorporated by reference to Exhibit 3(b) to the company's Annual Report on Form 10-K for the year ended December 31, 1986, Commission File No. 1-4482).\n\t (4)(a)(i) Rights Agreement dated as of March 2, 1988 between Arrow Electronics, Inc. and Manufacturers Hanover Trust Company, as Rights Agent, which includes as Exhibit A a Certificate of Amendment of the Restated Certificate of Incorporation for Arrow Electronics, Inc. for the Participating Preferred Stock, as Exhibit B a letter to shareholders describing the Rights and a summary of the provisions of the Rights Agreement and as Exhibit C the forms of Rights Certificate and Election to Exercise (incorporated by reference to Exhibit 1 to the company's Current Report on Form 8-K dated March 3, 1988, Commission File No. 1-4482).\n\t\t (ii) First Amendment, dated June 30, 1989, to the Rights Agreement in (4)(a)(i) above (incorporated by reference to Exhibit 4(b) to the Company's Current Report on Form 8-K dated June 30, 1989, Commission File No. 1-4482).\n\t\t (iii) Second Amendment, dated June 8, 1991, to the Rights Agreement in (4)(a)(i) above (incorporated by reference to Exhibit 4(i)(iii) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1-4482).\n\t\t (iv) Third Amendment, dated July 19, 1991, to the Rights Agreement in (4)(a)(i) above (incorporated by reference to Exhibit 4(i)(iv) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1-4482).\n\t\t (v) Fourth Amendment, dated August 26, 1991, to the Rights Agreement in (4)(a)(i) above (incorporated by reference to Exhibit 4(i)(v) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1-4482).\n\t (10) (a)(i) Arrow Electronics Savings Plan, as amended and restated through January 1, 1989 (incorporated by reference to Exhibit 10(b)(i) to the company's Annual Report on Form 10-K for the year ended December 31, 1989, Commission File No. 1-4482).\n\t\t (ii) Amendment No. 1, dated December 7, 1989, to the Arrow Electronics Savings Plan in (10)(a)(i) above (incorporated by reference to Exhibit 10(b)(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (iii) Amendment No. 2, dated January 18, 1990, to the Arrow Electronics Savings Plan in (10)(a)(i) above (incorporated by reference to Exhibit 10(b)(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1-4482).\n\t\t (iv) Amendment No. 3, dated February 21, 1992, to the Arrow Electronics Savings Plan in (10)(a)(i) above (incorporated by reference to Exhibit 10(b)(iv) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (v) Supplement, dated September 27, 1991, to the Arrow Electronics Savings Plan in (10)(a)(i) above (incorporated by reference to Exhibit 10(b)(v) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (vi) Supplement No. 3, dated August 24, 1993, to the Arrow Electronics Savings Plan in 10(a)(i) above (incorporated by reference to Exhibit 10(b)(vi) in the company's Annual Report on Form 10-K for the year ended December 31, 1993, Commission File No. 1-4482).\n\t\t (vii) Supplement No. 4, dated December 28, 1994, to the Arrow Electronics Savings Plan in 10(a)(i) above (incorporated by reference to Exhibit 10(b)(vii) in the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (viii) Arrow Electronics Stock Ownership Plan, as amended and restated through January 1, 1989 (incorporated by reference to Exhibit 10(b)(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1989, Commission File No. 1-4482).\n\t\t (ix) Amendment No. 1, dated November 29, 1989, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(vii) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (x) Amendment No. 2, dated December 7, 1989, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(viii) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (xi) Amendment No. 3, dated January 18, 1990, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(iv) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1-4482).\n\t\t (xii) Amendment No. 4, dated December 31, 1992 to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(x) to the company's Annual Report on Form 10- K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (xiii) Supplement No. 1, dated September 8, 1992, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(xi) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (xiv) Supplement No. 3, dated August 24, 1993, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(xiii) in the company's Annual Report on Form 10-K for the year ended December 31, 1993, Commission File No. 1-4482).\n\t\t (xv) Supplement to No. 4, dated December 28, 1994, to the Arrow Electronics Stock Ownership Plan in (10)(a)(viii) above (incorporated by reference to Exhibit 10(b)(xv) in the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (xvi) Capstone Electronics Corp. Profit-Sharing Plan, effective January 1, 1990 (incorporated by reference to Exhibit 10(b)(iii) to the company's Annual Report on Form 10-K for the year ended December 31, 1990, Commission File No. 1-4482).\n\t\t (xvii) Supplement No. 1, dated September 8, 1992, to the Capstone Electronics Profit-Sharing Plan in (10)(a)(xvi) above (incorporated by reference to Exhibit 10(b)(xiii) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (xviii) Supplement No. 2, dated August 24, 1993, to the Capstone Electronics Profit Sharing Plan in (10)(a)(xvi) above (incorporated by reference to Exhibit 10(b)(xvi) in the company's Annual Report on Form 10-K for the year ended December 31, 1993, Commission File No. 1-4482).\n\t\t (xix) Supplement No. 3, dated December 28, 1994 to the Capstone Electronics Profit Sharing Plan in 10(a)(xvi) above (incorporated by reference to Exhibit 10(b)(xix) to the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (b)(i) Employment Agreement, dated as of October 16, 1990, between the company and John C. Waddell (incorporated by reference to Exhibit 10(c)(i) to the company's Annual Report on Form 10-K for the year ended December 31, 1990, Commission File No. 1-4482).\n\t\t (ii) Employment Agreement, dated as of February 22, 1995, between the company and Stephen P. Kaufman (incorporated by reference to Exhibit 10(c)(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482). \t\t\t\t \t\t (iii) Employment Agreement, dated as of March 13, 1991, between the company and Robert E. Klatell (incorporated by reference to Exhibit 10(c)(iii) to the company's Annual Report on Form 10-K for the year ended December 31, 1990, Commission File No. 1-4482).\n\t\t (iv) Form of agreement between the company and the employees parties to the Employment Agreements listed in 10(b)(i), (ii), and (iii) above providing extended separation benefits under certain circumstances (incorporated by reference to Exhibit 10(c)(iv) to the company's Annual Report on Form 10-K for the year ended December 31, 1988, Commission File No. 1-4482). \t\t \t\t (v) Form of Employment Agreement, dated as of September 1, 1994 between the company and Steven W. Menefee (incorporated by reference to Exhibit 10(c)(v) to the company's Annual Report on Form 10- K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (vi) Form of Employment Agreement, dated as of September 21, 1994, between the company and Robert S. Throop (incorporated by reference to Exhibit 10(c)(x) to the company's Annual Report on Form 10- K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (vii) Form of agreement between the company and all corporate Vice Presidents, including the employees parties to the Employment Agreements listed in 10(c)(v)-(vi) above, providing extended separation benefits under certain circumstances (incorporated by reference to Exhibit 10(c)(ix) to the company's Annual Report on Form 10-K for the year ended December 31, 1988, Commission File No. 1-4482).\n\t\t (viii) Form of agreement between the company and non-corporate officers providing extended separation benefits under certain circumstances (incorporated by reference to Exhibit 10(c)(x) to the company's Annual Report on Form 10-K for the year ended December 31, 1988, Commission File No. 1-4482).\n\t\t (ix) Unfunded Pension Plan for Selected Executives of Arrow Electronics, Inc., as amended (incorporated by reference to Exhibit 10(c)(xiii) to the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (x) English translation of the Service Agreement, dated January 19, 1993, between Spoerle Electronic and Carlo Giersch (incorporated by reference to Exhibit 10(f)(v) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (c)(i) Senior Note Purchase Agreement, dated as of December 29, 1992, with respect to the company's 8.29% Senior Secured Notes due 2000 (incorporated by reference to Exhibit 10(d) to the company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 1-4482).\n\t\t (ii) First Amendment, dated as of December 22, 1993, to the Senior Note Purchase Agreement in 10(c)(i) above (incorporated by reference to Exhibit 10(d)(ii) in the company's Annual Report on form 10-K for the year ended December 31, 1993, Commission File No. 1-4482).\n\t\t (d) Amended and Restated Credit Agreement, dated as of August 16, 1995 among Arrow Electronics, Inc., the several Banks from time to time parties hereto, Bankers Trust Company and Chemical Bank, as agents.\n\t\t (e)(i) Arrow Electronics, Inc. Stock Option Plan, as amended (incorporated by reference to Exhibit 10(i)(i) to the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (ii) Form of Stock Option Agreement under (e)(i) above (incorporated by reference to Exhibit 10(k)(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1986, Commission File No. 1-4482).\n\t\t (iii) Form of Nonqualified Stock Option Agreement under (e)(i) above (incorporated by reference to Exhibit 10(k)(iv) to the company's Registration Statement on Form S-4, Registration No. 33-17942).\n\t\t (f)(i) Restricted Stock Plan of Arrow Electronics, Inc., as amended and restated (incorporated by reference to Exhibit 10(j)(i) to the company's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 1-4482).\n\t\t (ii) Form of Award Agreement under (f)(i) above (incorporated by reference to Exhibit 10(l)(iv) to the company's Registration Statement on Form S-4, Registration No. 33-17942).\n\t\t (g) Form of Indemnification Agreement between the company and each director (incorporated by reference to Exhibit 10(m) to the company's Annual Report on Form 10-K for the year ended December 31, 1986, Commission File No. 1-4482). \t\t \t (11) Statement Re: Computation of Earnings Per Share.\n\t (21) List of Subsidiaries.\n\t (23) Consent of Ernst & Young\n\t (28) (i) Record of Decision, issued by the EPA on September 28, 1990, with respect to environmental clean-up in Plant City, Florida (incorporated by reference to Exhibit 28 to the company's Annual Report on Form 10-K for the year ended December 31, 1990, Commission File No. 1-4482).\n\t\t (ii) Consent Decree lodged with the U.S. District Court for the Middle District of Florida, Tampa Division, on December 18, 1991, with respect to environmental clean-up in Plant City, Florida (incorporated by reference to Exhibit 28(ii) to the company's Annual Report on Form 10-K for the year ended December 31, 1991, Commission File No. 1- 4482).\n\t (b) Reports on Form 8-K\n\t During the quarter ended December 31, 1995, the following Current Reports on Form 8-K were filed:\n\t Date of Report (Date of Earliest Event Reported) Items Reported --------------------------------- --------------\n\t None\nExhibit 10(d) CONFORMED COPY\n\t\nSECOND AMENDED AND RESTATED CREDIT AGREEMENT\namong\nARROW ELECTRONICS, INC.,\nTHE FOREIGN SUBSIDIARY BORROWERS\nThe Several Banks from Time to Time Parties Hereto,\nNATWEST BANK N.A., as Lead Manager\nBANKERS TRUST COMPANY\nand\nCHEMICAL BANK, as Agents\nCHEMICAL SECURITIES INC., as Arranger\nand\nCHEMICAL BANK, as Administrative Agent\nDated as of August 16, 1995\n\t\n\tPage\nSECTION 1.\tDEFINITIONS\t 2\n\t1.1\tDefined Terms\t 2 \t1.2\tOther Definitional Provisions\t 23 \t1.3.\tAccounting Determinations\t 23\nSECTION 2.\tTHE COMMITTED RATE LOANS\t 24\n\t2.1\tCommitted Rate Loans\t 24 \t2.2\tProcedure for Committed Rate Loan Borrowing\t 24 \t2.3\tRepayment of Committed Rate Loans; Evidence of Debt\t 24 \t2.4\tTermination or Reduction of Commitments\t 25 \t2.5\tOptional Prepayments\t 25 \t2.6\tConversion and Continuation Options\t 26 \t2.7\tMinimum Amounts of Tranches\t 26 \t2.8\tInterest Rates and Payment Dates for Committed Rate Loans\t 26 \t2.9\tInability to Determine Interest Rate\t 27\nSECTION 3.\tTHE COMPETITIVE ADVANCE LOANS\t 27\n\t3.1\tCompetitive Advance Loans\t 27 \t3.2\tProcedure for Competitive Advance Loan Borrowing\t 28 \t3.3\tRepayment of Competitive Advance Loans; Evidence of Debt\t 29 \t3.4\tPrepayments\t 30\nSECTION 4.\tTHE SWING LINE LOANS\t 30\n\t4.1\tSwing Line Loans\t 30 \t4.2\tProcedure for Swing Line Borrowing\t 30 \t4.3\tRepayment of Swing Line Loans; Evidence of Debt\t 31 \t4.4\tAllocating Swing Line Loans; Swing Line Loan Participations\t 31\nSECTION 5.\tTHE LETTERS OF CREDIT\t 33\n\t5.1\tL\/C Commitment.\t 33 \t5.2\tProcedure for Issuance of Letters of Credit under this \t\tAgreement.\t 34 \t5.3\tFees, Commissions and Other Charges.\t 34 \t5.4\tL\/C Participations.\t 35 \t5.5\tReimbursement Obligation of the Specified Borrowers.\t 35 \t5.6\tObligations Absolute.\t 36 \t5.7\tLetter of Credit Payments.\t 37 \t5.8\tApplication.\t 37\nSECTION 6.\tLOCAL CURRENCY FACILITIES\t 37\n\t6.1\tTerms of Local Currency Facilities\t 37 \t6.2\tReporting of Local Currency Outstandings\t 39 \t6.3\tRefunding of Local Currency Loans\t 39\nSECTION 7.\tCERTAIN PROVISIONS APPLICABLE TO THE LOANS AND \t\t LETTERS OF CREDIT\t 41\n\t7.1\tFacility Fee, Other Fees\t 41 \t7.2\tComputation of Interest and Fees\t 41 \t7.3\tPro Rata Treatment and Payments\t 41 \t7.4\tIllegality\t 42 \t7.5\tRequirements of Law\t 42 \t7.6\tTaxes\t 44 \t7.7\tCompany's Options upon Claims for Increased Costs and Taxes\t 46 \t7.8\tIndemnity\t 47 \t7.9\tDeterminations\t 48 \t7.10\tChange of Lending Office\t 48 \t7.11\tCompany Controls on Exposure; Calculation of Exposure; \t\t Prepayment if Exposure exceeds Commitments\t 48\nSECTION 8.\tREPRESENTATIONS AND WARRANTIES\t 49\n\t8.1\tFinancial Condition\t 50 \t8.2\tNo Change\t 50 \t8.3\tCorporate Existence; Compliance with Law\t 50 \t8.4\tCorporate Power; Authorization; Enforceable Obligations\t 51 \t8.5\tNo Legal Bar\t 51 \t8.6\tNo Material Litigation\t 51 \t8.7\tNo Default\t 51 \t8.8\tOwnership of Property; Liens\t 51 \t8.9\tIntellectual Property\t 52 \t8.10\tNo Burdensome Restrictions\t 52 \t8.11\tTaxes\t 52 \t8.12\tFederal Regulations\t 52 \t8.13\tERISA\t 53 \t8.14\tInvestment Company Act; Other Regulations\t 53 \t8.15\tSubsidiaries\t 53 \t8.16\tAccuracy and Completeness of Information\t 54 \t8.17\tPurpose of Loans\t 54 \t8.18\tSenior Indebtedness\t 54 \t8.19\tEnvironmental Matters\t 54\nSECTION 9.\tCONDITIONS PRECEDENT\t 55\n\t9.1\tConditions to Closing Date\t 55 \t9.2\tConditions to Each Extension of Credit\t 57\nSECTION 10.\tAFFIRMATIVE COVENANTS\t 58\n\t10.1\tFinancial Statements\t 58 \t10.2\tCertificates; Other Information\t 59 \t10.3\tPayment of Obligations\t 60 \t10.4\tConduct of Business and Maintenance of Existence\t 60 \t10.5\tMaintenance of Property; Insurance\t 60 \t10.6\tInspection of Property; Books and Records; Discussions\t 61 \t10.7\tNotices\t 61 \t10.8\tEnvironmental Laws\t 62 \t10.9\tAdditional Subsidiary Guarantees\t 62\nSECTION 11.\tNEGATIVE COVENANTS\t 62\n\t11.1\tFinancial Condition Covenants\t 62 \t11.2\tLimitation on Indebtedness of Domestic Subsidiaries\t 62 \t11.3\tLimitation on Liens\t 63 \t11.4\tLimitation on Fundamental Changes\t 63 \t11.5\tLimitation on Restricted Payments\t 64 \t11.6\tLimitation on Negative Pledge Clauses\t 64 \t11.7\tLimitation on Modifications of Debt Instruments\t 64\nSECTION 12.\tEVENTS OF DEFAULT\t 65\nSECTION 13.\tTHE ADMINISTRATIVE AGENT; THE AGENTS AND \t\t\t\tTHE COLLATERAL AGENT; THE ARRANGER\t 68\n\t13.1\tAppointment\t 68 \t13.2\tDelegation of Duties\t 68 \t13.3\tExculpatory Provisions\t 68 \t13.4\tReliance by Administrative Agent\t 69 \t13.5\tNotice of Default\t 69 \t13.6\tNon-Reliance on Administrative Agent and Other Banks\t 69 \t13.7\tIndemnification\t 70 \t13.8\tAdministrative Agent in Its Individual Capacity\t 70 \t13.9\tSuccessor Administrative Agent\t 70 \t13.10\tThe Agents and the Arranger; The Collateral Agent\t 71\nSECTION 14.\tMISCELLANEOUS\t 71 \t \t14.1\tAmendments and Waivers\t 71 \t14.2\tNotices\t 73 \t14.3\tNo Waiver; Cumulative Remedies\t 74 \t14.4\tSurvival of Representations and Warranties\t 74 \t14.5\tPayment of Expenses and Taxes\t 75 \t14.6\tSuccessors and Assigns; Participations and Assignments\t 75 \t14.7\tAdjustments; Set-off\t 79 \t14.8\tPower of Attorney\t 79 \t14.9\tJudgment\t 80 \t14.10\tCounterparts\t 80 \t14.11\tSeverability\t 80 \t14.12\tIntegration\t 80 \t14.13\tGOVERNING LAW\t 81 \t14.14\tSubmission To Jurisdiction; Waivers\t 81 \t14.15\tAcknowledgements\t 82 \t14.16\tWAIVERS OF JURY TRIAL\t 82\nSCHEDULES\nI\t\t- Banks and Commitments II\t\t- Foreign Subsidiary Borrowers III\t\t- Certain Information Concerning Swing Line \t\t Loans and Letters of Credit IV\t\t- Administrative Schedule 8.13\t\t- Excluded ERISA Arrangements 8.15\t\t- Subsidiaries 8.19\t\t- Environmental Matters\nEXHIBITS\nExhibit A\t-\tForm of Joinder Agreement Exhibit B\t-\tForm of Schedule Amendment Exhibit C\t-\tForm of Local Currency Facility Addendum Exhibit D\t-\tForm of Consent and Confirmation Exhibit E\t- \tForm of Borrowing Certificate Exhibit F\t-\tForm of Company Guarantee Exhibit G-1 \t-\tForm of Opinion of Winthrop, Stimson, Putnam Exhibit G-2 \t- \tForm of Opinion of Robert E. Klatell Exhibit G-3\t-\tOpinions Relating to Foreign Subsidiary Borrowers\t Exhibit H \t- \tForm of Certificate Pursuant to Subsection 10.2 Exhibit I \t-\tForm of Assignment and Acceptance Exhibit J\t-\tNotice of Guarantee Ceiling Amount\n1\/ Insert short description of terms of Local Currency Facility. 2\/ Copies of the Documentation must accompany the Local Currency Facility Addendum, together with, if applicable, an English translation thereof. 3\/ Provide citation to relevant provision from the Documentation. 4\/\tCalculate the Commitment Percentage that is assigned to at least 15 decimal places and show as a percentage of the aggregate commitments of all Lenders. 5\/\tConsents only required if Assignee is not already a Bank or an Affiliate thereof.\n\t\tSECOND AMENDED AND RESTATED CREDIT AGREEMENT, dated as of August 16, 1995, among:\n\t\t\t(i) \tARROW ELECTRONICS, INC., a New York corporation (the \"Company\");\n\t\t\t(ii) \tthe FOREIGN SUBSIDIARY BORROWERS (as hereinafter defined);\n\t\t\t(iii) \tthe several banks and other financial institutions from time to time parties to this Agreement (the \"Banks\");\n\t\t\t(iv) \tNATWEST BANK N.A., as Lead Manager (in such capacity the \"Lead Manager\");\n\t\t\t(v) \tCHEMICAL SECURITIES INC., as Arranger (in such capacity, the \"Arranger\");\n\t\t\t(vi) \tBANKERS TRUST COMPANY, a New York banking corporation (\"Bankers Trust\"), and CHEMICAL BANK, a New York banking corporation (\"Chemical\"), as agents for the Banks hereunder (in such capacity, the \"Agents\");\n\t\t\t(vii) \tBANKERS TRUST, as Collateral Agent (in such capacity, the \"Collateral Agent\"); and\n\t\t\t(viii) \tCHEMICAL, as administrative agent for the Banks hereunder (in such capacity, the \"Administrative Agent\").\n\tW I T N E S S E T H :\n\t\tWHEREAS, the Company, several banks and other financial institutions (including certain of the Banks) (the \"Existing Banks\"), Chemical, as administrative agent for the Existing Banks (in such capacity, the \"Existing Administrative Agent\") and the Collateral Agent are parties to the Amended and Restated Credit Agreement, dated as of January 28, 1994 (as the same has been amended, supplemented or otherwise modified through the date hereof, the \"Existing Credit Agreement\");\n\t\tWHEREAS, each of (i) Capstone Electronics Corp., a Delaware corporation (\"Capstone\"), and Arrow Electronics International, Inc., a United States Virgin Island corporation (\"AEI\"), executed and delivered in favor of the Collateral Agent for the benefit of the Existing Banks a Guarantee, dated as of September 27, 1991, (ii) Anthem Electronics, Inc., a Delaware corporation (\"Anthem\") executed and delivered in favor of the Collateral Agent for the benefit of the Existing Banks and the Purchasers (as defined below) a Guarantee, dated November 28, 1994, and (iii) Gates\/Arrow Distributing, Inc., a Delaware corporation (\"Gates\"), executed and delivered in favor of the Collateral Agent for the benefit of the Existing Banks and the Purchasers a Guarantee, dated as of September 30, 1994 (as each of the foregoing Guarantees has been amended, supplemented or otherwise modified through the date hereof, collectively, the \"Existing Subsidiary Guarantees\");\n\t\tWHEREAS, (i) the Company entered into several Note Purchase Agreements, dated as of December 29, 1992, as amended, pursuant to which the Purchasers party thereto (the \"Purchasers\") purchased Senior Notes of the Company (as hereafter defined, the \"1992 Private Placement Notes\") and (ii) in connection therewith and with the Existing Credit Agreement, (A) amendments were entered into with respect to the Existing Subsidiary Guarantees made by Capstone and AEI in order to provide that such Existing Subsidiary Guarantees would thereafter guarantee, equally and ratably, obligations owing in respect of the 1992 Private Placement Notes and obligations owing in respect of the Existing Credit Agreement (including as amended and restated hereby) and (B) the Company, the Collateral Agent, certain of the Existing Banks and the Purchasers executed and delivered an Intercreditor Agreement, dated as of December 29, 1992 (as the same may have been amended, supplemented or otherwise modified through the date hereof, the \"Intercreditor Agreement\"), pursuant to which the Collateral Agent now holds the Existing Subsidiary Guarantees as guarantees of the Company's obligations under the 1992 Private Placement Notes and the Existing Credit Agreement, in each case, as amended, supplemented or otherwise modified from time to time;\n\t\tWHEREAS, on the Closing Date (as hereinafter defined), (i) all amounts owing under or in connection with the Existing Credit Agreement will be paid in full, (ii) all commitments and obligations of each Existing Bank under the Existing Credit Agreement will terminate, (iii) the Existing Credit Agreement will be amended and restated in its entirety as set forth in this Agreement and (iv) the Borrowers may then and thereafter make borrowings from the Banks under this Agreement in accordance with the Commitments hereunder;\n\t\tWHEREAS, from and after the Closing Date the Collateral Agent will continue to hold the Existing Subsidiary Guarantees as guarantees of the Company's obligations under the 1992 Private Placement Notes and this Agreement, in each case as amended, supplemented or otherwise modified from time to time; and\n\t\tWHEREAS, the Company has requested that the Existing Credit Agreement be amended and restated in its entirety in order to provide a multi-currency, multi-option credit facility which will be available to the Company and certain of its foreign Subsidiaries as hereafter set forth;\n\t\tNOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, the parties hereto hereby agree that, effective on the Closing Date, the Existing Credit Agreement shall be and hereby is amended and restated in its entirety to read as follows:\n\tSECTION 1. DEFINITIONS\n\t\t1.1 Defined Terms. As used in this Agreement, the following terms shall have the following meanings:\n\t\t\"ABR\": for any day, a rate per annum (rounded upwards, if necessary, to the next 1\/100 of 1%) equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Base CD Rate in effect on such day plus 1% and (c) the Federal Funds Effective Rate in effect on such day plus 1\/2 of 1%. For purposes hereof: \"Prime Rate\" shall mean the rate of interest per annum publicly announced from time to time by Chemical as its prime rate in effect at its principal office in New York City (the Prime Rate not being intended to be the lowest rate of interest charged by Chemical in connection with extensions of credit to debtors); \"Base CD Rate\" shall mean the sum of (a) the product of (i) the Three-Month Secondary CD Rate and (ii) a fraction, the numerator of which is one and the denominator of which is one minus the C\/D Reserve Percentage and (b) the C\/D Assessment Rate; \"Three-Month Secondary CD Rate\" shall mean, for any day, the secondary market rate for three-month certificates of deposit reported as being in effect on such day (or, if such day shall not be a Business Day, the next preceding Business Day) by the Board through the public information telephone line of the Federal Reserve Bank of New York (which rate will, under the current practices of the Board, be published in Federal Reserve Statistical Release H.15(519) during the week following such day), or, if such rate shall not be so reported on such day or such next preceding Business Day, the average of the secondary market quotations for three-month certificates of deposit of major money center banks in New York City received at approximately 10:00 A.M., New York City time, on such day (or, if such day shall not be a Business Day, on the next preceding Business Day) by the Administrative Agent from three New York City negotiable certificate of deposit dealers of recognized standing selected by it; and \"Federal Funds Effective Rate\" shall mean, for any day, the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for the day of such transactions received by the Administrative Agent from three federal funds brokers of recognized standing selected by it. If for any reason the Administrative Agent shall have determined (which determination shall be conclusive absent manifest error) that it is unable to ascertain the Base CD Rate or the Federal Funds Effective Rate, or both, for any reason, including the inability or failure of the Administrative Agent to obtain sufficient quotations in accordance with the terms thereof, the ABR shall be determined without regard to clause (b) or (c), or both, of the first sentence of this definition, as appropriate, until the circumstances giving rise to such inability no longer exist. Any change in the ABR due to a change in the Prime Rate, the Base CD Rate or the Federal Funds Effective Rate shall be effective as of the opening of business on the effective day of such change in the Prime Rate, the Base CD Rate or the Federal Funds Effective Rate, respectively.\n\t\t\"ABR Loans\": Loans denominated in Dollars the rate of interest applicable to which is based upon the ABR.\n\t\t\"Additional Local Currencies\": Australian Dollars, Belgian Francs, Italian Lira, Singapore Dollars, Spanish Pesetas, New Taiwan Dollars and any other available and freely convertible non-Dollar currency selected by the Company and approved by the Administrative Agent in the manner described in subsection 14.1(b). \t\t\"Adjusted Consolidated EBITDA\": for any fiscal period, (a) the Consolidated Net Income of the Company and its Subsidiaries for such period, plus (b) to the extent deducted from earnings in determining Consolidated Net Income for such period, the sum, in each case for such period, of income taxes, interest expense, depreciation expense, amortization expense, including amortization of any goodwill or other intangibles, minus (c) to the extent included in determining Consolidated Net Income for such period, non-cash equity earnings of unconsolidated Affiliates, plus (d) to the extent excluded in determining Consolidated Net Income for such period, cash distributions received by the Company from unconsolidated Affiliates, all as determined on a consolidated basis in accordance with GAAP.\n\t\t\"Administrative Schedule\": Schedule IV to this Agreement, which contains interest rate definitions and administrative information in respect of each Currency and each Type of Loan.\n\t\t\"Administrative Agent\": as defined in the preamble hereto.\n\t\t\"AEI\": as defined in the recitals hereof.\n\t\t\"Affected Bank\": any Bank affected by the events described in subsection 7.4, 7.5 or 7.6, as the case may be, but only for the period during which such Bank shall be affected by such events.\n\t\t\"Affiliate\": as to any Person, (a) any other Person (other than a Subsidiary) which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person or (b) any Person who is a director or officer of the Company or any of its Subsidiaries. For purposes of this definition, \"control\" of a Person means the power, directly or indirectly, either to (i) vote 10% or more of the securities having ordinary voting power for the election of directors of such Person or (ii) direct or cause the direction of the management and policies of such Person, whether by contract or otherwise.\n\t\t\"Agents\": as defined in the preamble hereto (individually, each an \"Agent\").\n\t\t\"Agreement\": this Second Amended and Restated Credit Agreement, as amended, supplemented or otherwise modified from time to time.\n\t\t\"Allocable Share\": as to any Assenting Bank at any time, a fraction, the numerator of which shall be the Commitment of such Assenting Bank then in effect and the denominator of which shall be the aggregate of the Commitments of all Assenting Banks then in effect.\n\t\t\"Anthem\": as defined in the recitals hereof.\n\t\t\"Applicable Margin\": for each Type of Loan, the rate per annum determined from time to time based upon the Ratings in effect by Moody's and S&P set forth under the relevant column heading below opposite such Ratings:\n\t\t Ratings\t\t\t\t Applicable Margin \t\t\t\t\t\t\t (in basis points)\n\t\t\t\t\t\tEurocurrency\t\t \t\tS&P\/Moody's\t\t Loans \t\t ABR Loans\n\tA-\/A3\t\t\t\t\t20.00\t\t\t0 \tor higher\n\tGreater than \tor equal to \tBBB\/Baa2\t\t\t\t\t22.50\t\t\t0\n\tGreater than \tor equal to \tBBB-\/Baa3\t\t\t\t\t35.00\t\t\t0 \t \tLess than \tor equal to \tBB+\/Ba1\t\t\t\t\t37.50\t\t\t0\n\t; provided that, in the event that the Ratings of S&P and Moody's do not coincide, the Applicable Margin set forth above opposite the higher of such Ratings will apply, unless one of the Ratings is BB+\/Ba1 or lower, in which case the Applicable Margin will be that applicable to BB+\/Ba1. Notwithstanding the foregoing, in the event that no Ratings are in effect at such time of determination, the Applicable Margin will be determined in a manner to be mutually agreed upon by the Administrative Agent and the Company and not disapproved by the Required Banks and provided, further, that at any time when no Ratings are in effect and prior to the time a manner for determination of the Applicable Margin is mutually agreed upon by the Administrative Agent and the Company, the Applicable Margin shall be the Applicable Margin in effect immediately prior to the initial time when no Ratings were in effect.\n\t\t\"Application\": an application, in such form as the Issuing Bank may specify from time to time, requesting the Issuing Bank to issue a Letter of Credit.\n\t\t\"Assenting Bank\": as defined in subsection 7.7(a).\n\t\t\"Assignee\": as defined in subsection 14.6(c).\n\t\t\"Assignment and Acceptance\": each Assignment and Acceptance, substantially in the form of Exhibit I, executed and delivered pursuant to subsection 14.6(c).\n\t\t\"Available Foreign Currencies\": Deutsche Marks, Pounds Sterling, Hong Kong Dollars, French Francs, Danish Kroner, Norwegian Kroner, Finnish Markka, Swedish Kroner and Dutch Guilder, and any other available and freely-convertible non-Dollar currency selected by the Company and approved by the Administrative Agent in the manner described in subsection 14.1(b).\n\t\t\"Bankers Trust\": as defined in the preamble hereto.\n\t\t\"Banks\": as defined in the preamble hereto.\n\t\t\"Board\": the Board of Governors of the Federal Reserve System or any successor.\n\t\t\"Borrowers\": the collective reference to the Company, the Foreign Subsidiary Borrowers and the Local Currency Borrowers.\n\t\t\"Borrowing Date\": any Business Day on which the Company or any Foreign Subsidiary Borrower requests the Banks to make Loans hereunder.\n\t\t\"Borrowing Percentage\": with respect to Committed Rate Loans to be made by any Bank at any time, the ratio (expressed as a percentage) of the amount of such Bank's Undrawn Commitment at such time to the aggregate amount of the Undrawn Commitments of all the Banks at such time; provided, that in determining any Bank's Undrawn Commitment for purpose of determining such Bank's Borrowing Percentage of any Committed Rate Loans whose proceeds will be simultaneously applied to repay Swing Line Loans or Local Currency Loans or to pay Reimbursement Obligations, such Bank's Commitment Percentage of the amount of such Swing Line Loans and Reimbursement Obligations, and the amount of such Local Currency Loans owing to such Bank, will not be considered Committed Exposure of such Bank. The Borrowing Percentage of each Bank at any time will be calculated by the Administrative Agent on the basis of its most recent calculations of the Undrawn Commitments of the Banks.\n\t\t\"Business\": as defined in subsection 8.20(b).\n\t\t\"Business Day\": (a) when such term is used in respect of a day on which a Loan in a Foreign Currency is to be made, a payment is to be made in respect of such Loan, an Exchange Rate is to be set in respect of such Foreign Currency or any other dealing in such Foreign Currency is to be carried out pursuant to this Agreement, such term shall mean a London Banking Day which is also a day on which banks are open for general banking business in the city which is the principal financial center of the country of such Foreign Currency, (b) when such term is used to describe a day on which a request is to be made to an Issuing Bank for issuance of a Letter of Credit or on which a Letter of Credit is to be issued, such term shall mean a day other than a Saturday, Sunday or other day on which commercial banks in the city in which such Issuing Bank's Issuing Office is located is authorized or required by law to close and (c) when such term is used in any context in this Agreement, such term shall mean a day other than a Saturday, Sunday or other day on which commercial banks in New York City are authorized or required by law to close.\n\t\t\"C\/D Assessment Rate\": for any day as applied to any ABR Loan, the net annual assessment rate (rounded upward to the nearest 1\/100th of 1%) determined by Chemical to be payable on such day to the Federal Deposit Insurance Corporation or any successor (\"FDIC\") for FDIC's insuring time deposits made in Dollars at offices of Chemical in the United States.\n\t\t\"C\/D Reserve Percentage\": for any day as applied to any ABR Loan, that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board, for determining the maximum reserve requirement for a Depositary Institution (as defined in Regulation D of the Board) in respect of new non-personal time deposits in Dollars having a maturity of 30 days or more.\n\t\t\"Capital Stock\": any and all shares, interests, participations or other equivalents (however designated) of capital stock of a corporation, any and all equivalent ownership interests in a Person (other than a corporation) and any and all warrants, options or rights to purchase any of the foregoing.\n\t\t\"Capitalization Documents\": the collective reference to the Governing Documents of the Company and each of its Subsidiaries, the certificates of designation and other agreements governing the issuance of, or setting forth the terms of, any Capital Stock (including, without limitation, the common stock) issued or to be issued by the Company or any of its Subsidiaries and the Rights Agreement.\n\t\t\"Capstone\": as defined in the recitals hereof.\n\t\t\"Change in Control\": one or more of the following events:\n\t\t\t(a) less than a majority of the members of the Company's board of directors shall be persons who either (i) were serving as directors on the Closing Date or (ii) were nominated as directors and approved by the vote of the majority of the directors who are directors referred to in clause (i) above or this clause (ii); or\n\t\t\t(b) the stockholders of the Company shall approve any plan or proposal for the liquidation or dissolution of the Company; or\n\t\t\t(c) a Person or group of Persons acting in concert (other than the direct or indirect beneficial owners of the Capital Stock of the Company as of the Closing Date) shall, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, have become the direct or indirect beneficial owner (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934, as amended from time to time) of securities of the Company representing 40% or more of the combined voting power of the outstanding voting securities for the election of directors or shall have the right to elect a majority of the board of directors of the Company.\n\t\t\"Chemical\": as defined in the recitals hereof.\n\t\t\"Closing Date\": the date on which the conditions precedent set forth in subsection 9.1 shall be satisfied.\n\t\t\"Code\": the Internal Revenue Code of 1986, as amended from time to time.\n\t\t\"Commitment\": as to any Bank, the obligation of such Bank to make and\/or acquire participating interests in Committed Rate Loans or Swing Line Loans hereunder and\/or under Local Currency Facilities and issue and\/or acquire participating interests in Letters of Credit hereunder in an aggregate Dollar Equivalent Amount at any one time outstanding not to exceed the amount set forth opposite such Bank's name on Schedule I, as such amount may be changed from time to time in accordance with the provisions of this Agreement.\n\t\t\"Commitment Percentage\": as to any Bank at any time, the percentage which such Bank's Commitment then constitutes of the aggregate Commitments (or, at any time after the Commitments shall have expired or terminated, the percentage which the amount of such Bank's Exposure at such time constitutes of the aggregate amount of the Exposure of all the Banks at such time).\n\t\t\"Commitment Period\": the period from and including the Closing Date to but not including the Termination Date or such earlier date on which the Commitments shall terminate as provided herein.\n\t\t\"Committed Exposure\": as to any Bank, the sum of (a) the aggregate Dollar Equivalent Amount of the principal amount of all outstanding Committed Rate Loans and Local Currency Loans made by such Bank or its Local Currency Bank affiliates, agencies or branches plus (b) such Bank's Commitment Percentage of the aggregate Dollar Equivalent Amount of the principal or face amount of all outstanding Swing Line Loans and L\/C Obligations.\n\t\t\"Committed Rate Loan\": as defined in subsection 2.1; a Committed Rate Loan bearing interest based upon the ABR shall be a \"Committed Rate ABR Loan\", and a Committed Rate Loan bearing interest based upon a Eurocurrency Rate shall be a \"Committed Rate Eurocurrency Loan\".\n\t\t\"Commonly Controlled Entity\": an entity, whether or not incorporated, which is under common control with the Company within the meaning of Section 4001 of ERISA or is part of a group which includes the Company and which is treated as a single employer under Section 414 of the Code.\n\t\t\"Company\": as defined in the preamble hereto.\n\t\t\"Company Guarantee\": the Guarantee of the Company, substantially in the form of Exhibit F, as amended, supplemented or otherwise modified from time to time.\n\t\t\"Company Guarantee Ratio\": at any time, the ratio (expressed as a percentage) of (a) the excess of (i) the aggregate Exposure of the Foreign Subsidiary Borrowers and the Local Currency Borrowers at such time over (ii) the Guarantee Ceiling Amount at such time (the \"Excess Exposure\") to (b) the aggregate Exposure of the Foreign Subsidiary Borrowers and Local Currency Borrowers at such time; provided that, if the Excess Exposure at any time is less than or equal to zero, the Company Guarantee Ratio shall be zero.\n\t\t\"Competitive Advance Loan\": as defined in subsection 3.1.\n\t\t\"Competitive Advance Loan Offer\": with respect to any Competitive Advance Loan Request in any Currency, an offer from a Bank in respect of such Competitive Advance Loan Request, containing the information in respect of such Competitive Advance Loan Offer and delivered to the Person, in the manner and by the time specified for a Competitive Advance Loan Offer in respect of such Currency in the Administrative Schedule.\n\t\t\"Competitive Advance Loan Request\": with respect to any Competitive Advance Loan in any Currency, a request from the Specified Borrower in respect of such Loan, containing the information in respect of such Competitive Advance Loan and delivered to the Person, in the manner and by the time specified for a Competitive Advance Loan Request in respect of such Currency in the Administrative Schedule.\n\t\t\"Consent and Confirmation\": the Consent and Confirmation to be executed and delivered by Capstone, AEI, Anthem and Gates, substantially in the form of Exhibit D.\n\t\t\"Consolidated Cash Interest Expense\": for any period, (a) the amount which would, in conformity with GAAP, be set forth opposite the caption \"interest expense\" or any like caption on a consolidated income statement of the Company and its Subsidiaries minus (b) the amount of non-cash interest (including interest paid by the issuance of additional securities) included in such amount.\n\t\t\"Consolidated Net Income\": for any fiscal period means the consolidated net income (or loss) of the Company and its Subsidiaries after excluding all unusual, extraordinary and non-recurring gains and after adding all unusual, extraordinary and non-recurring losses, in all cases of the Company and its Subsidiaries determined on a consolidated basis during the relevant period in accordance with GAAP.\n\t\t\"Consolidated Net Worth\": at a particular date, all amounts which would be included under shareholders' equity on a consolidated balance sheet of the Company and its Subsidiaries determined on a consolidated basis in accordance with GAAP.\n\t\t\"Consolidated Total Capitalization\": at a particular date, the sum of (a) Consolidated Net Worth plus (b) Consolidated Total Debt as at such date.\n\t\t\"Consolidated Total Debt\": all Indebtedness of the Company and its Subsidiaries (excluding Indebtedness of the Company owing to any of its Subsidiaries or Indebtedness of any Subsidiary of the Company owing to the Company or any other Subsidiary of the Company), as determined on a consolidated basis in accordance with GAAP.\n\t\t\"Contractual Obligation\": as to any Person, any provision of any security issued by such Person or of any agreement, instrument or other undertaking to which such Person is a party or by which it or any of its property is bound.\n\t\t\"Credit Documents\": this Agreement, the Applications, the Subsidiary Guarantees, the Company Guarantee and the Local Currency Facilities.\n\t\t\"Currencies\": the collective reference to Dollars and Foreign Currencies.\n\t\t\"Default\": any of the events specified in Section 12, whether or not any requirement for the giving of notice, the lapse of time, or both, or any other condition, has been satisfied.\n\t\t\"Dollar Equivalent Amount\": with respect to (i) the amount of any Foreign Currency on any date, the equivalent amount in Dollars of such amount of Foreign Currency, as determined by the Administrative Agent using the Exchange Rate and (ii) any amount in Dollars, such amount.\n\t\t\"Dollars\" and \"$\": dollars in lawful currency of the United States of America.\n\t\t\"Domestic Subsidiary\": as to any Person, a Subsidiary of such Person organized under the laws of a State of the United States or the District of Columbia.\n\t\t\"Environmental Laws\": any and all applicable foreign, Federal, state, local or municipal laws, rules, orders, regulations, statutes, ordinances, codes, decrees, requirements of any Governmental Authority or other Requirements of Law (including, without limitation, common law) regulating, relating to or imposing liability or standards of conduct concerning protection of human health or the environment, as now or may at any time hereafter be in effect.\n\t\t\"ERISA\": the Employee Retirement Income Security Act of 1974, as amended from time to time.\n\t\t\"Eurocurrency Loan\": any Loan bearing interest based upon a Eurocurrency Rate.\n\t\t\"Eurocurrency Rate\": in respect of Dollars and each Available Foreign Currency, the rate determined as the Eurocurrency Rate for Dollars or such Available Foreign Currency in the manner set forth in the Administrative Schedule.\n\t\t\"Event of Default\": any of the events specified in Section 12, provided that any requirement for the giving of notice, the lapse of time, or both, or any other condition, has been satisfied.\n\t\t\"Exchange Rate\": with respect to any Foreign Currency on any date, the rate at which such Foreign Currency may be exchanged into Dollars, as set forth on such date on the relevant Reuters currency page at or about 11:00 A.M. London time on such date. In the event that such rate does not appear on any Reuters currency page, the \"Exchange Rate\" with respect to such Foreign Currency shall be determined by reference to such other publicly available service for displaying exchange rates as may be agreed upon by the Administrative Agent and the Company or, in the absence of such agreement, such \"Exchange Rate\" shall instead be the Administrative Agent's spot rate of exchange in the interbank market where its foreign currency exchange operations in respect of such Foreign Currency are then being conducted, at or about 10:00 A.M., local time, at such date for the purchase of Dollars with such Foreign Currency, for delivery two Business Days later; provided, that if at the time of any such determination, no such spot rate can reasonably be quoted, the Administrative Agent may use any reasonable method as it deems applicable to determine such rate, and such determination shall be conclusive absent manifest error (without prejudice to the determination of the reasonableness of such method).\n\t\t\"Existing Subsidiary Guarantees\": as defined in the recitals hereof.\n\t\t\"Exposure\": at any date, (a) as to all the Banks, the aggregate Dollar Equivalent Amount of (i) the outstanding principal amount of all Loans then outstanding and (ii) all L\/C Obligations then outstanding, and (b) as to any Bank, the aggregate Dollar Equivalent Amount of (i) the outstanding principal amount of all Committed Rate Loans, Local Currency Loans and Competitive Advance Loans made by such Bank or its Local Bank affiliates, branches or agencies and (ii) such Bank's Commitment Percentage of the outstanding principal amount of all Swing Line Loans and L\/C Obligations.\n\t\t\"Extensions of Credit\": the collective reference to the making of any Loans and the issuance of any Letters of Credit but excluding the continuation or conversion of any Loan pursuant to a Notice of Conversion or a Notice of Continuation.\n\t\t\"Facility Fee Rate\": a rate per annum determined from time to time based upon the Ratings in effect by Moody's and S&P set forth under the column below opposite such Ratings:\n\t\t Ratings Facility Fee Rate \t\tS&P\/Moody's (in basis points)\n\t\tA-\/A3\t \t\t10.00\t \t\tor higher\n\t\tGreater than \t\tor equal to \t\tBBB\/Baa2\t\t12.50\t\n\t\tGreater than \t\tor equal to \t\tBBB-\/Baa3\t\t15.00\t\n\t\tLess than \t\tor equal to \t\tBB+\/Ba1\t\t25.00\t \t\t \t; provided that, in the event that the Ratings of S&P and Moody's do not coincide, the Facility Fee Rate set forth above opposite the higher of such Ratings will apply, unless one of the Ratings is BB+\/Ba1 or lower, in which case the Facility Fee Rate will be that applicable to BB+\/Ba1. Notwithstanding the foregoing, in the event that no Ratings are in effect at such time of determination, the Facility Fee Rate will be determined in a manner to be mutually agreed upon by the Administrative Agent and the Company and not disapproved by the Required Banks and provided, further, that at any time when no Ratings are in effect and prior to the time a manner for determination of the Facility Fee Rate is mutually agreed upon by the Administrative Agent and the Company, the Facility Fee Rate shall be the Facility Fee Rate in effect immediately prior to the initial time when no Ratings were in effect.\n\t\t\"Financing Lease\": any lease of property, real or personal, the obligations of the lessee in respect of which are required in accordance with GAAP to be capitalized on a balance sheet of the lessee.\n\t\t\"Foreign Currencies\": the collective reference to the Available Foreign Currencies and the Additional Local Currencies.\n\t\t\"Foreign Currency Exposure\": at any date, the aggregate Dollar Equivalent Amount of (a) the outstanding principal amount of all Loans then outstanding which are denominated in a currency other than Dollars and (b) all L\/C Obligations then outstanding which are denominated in a currency other than Dollars.\n\t\t\"Foreign Subsidiary Borrower\": each Subsidiary of the Company listed as a Foreign Subsidiary Borrower in Schedule II as amended from time to time in accordance with subsection 14.1(b)(i); provided that with respect to any Subsidiary for which a Foreign Subsidiary Opinion has not previously been delivered, if the aggregate Exposure of such Subsidiary owing to all Banks exceeds $20,000,000 for a period of 30 consecutive days, then, unless a Foreign Subsidiary Opinion is delivered within 30 days after the end of such period, such Subsidiary shall cease to be a Foreign Subsidiary Borrower 30 days after the end of such period with respect to all Exposure of such Subsidiary owing to the Banks in excess of $20,000,000.\n\t\t\"Foreign Subsidiary Opinion\": with respect to any Foreign Subsidiary Borrower, a legal opinion of counsel to such Foreign Subsidiary Borrower addressed to the Administrative Agent and the Banks concluding that such Foreign Subsidiary Borrower and the Credit Documents to which it is a party substantially comply with the matters listed on Exhibit G-3 hereto, with such deviations therefrom as the Administrative Agent shall consent (such consent not to be unreasonably withheld).\n\t\t\"Funding Office\": for each Type of Committed Rate Loan and each Currency, the Funding Office set forth in respect thereof in the Administrative Schedule.\n\t\t\"Funding Time\": for each Type of Committed Rate Loan and each Currency, the Funding Time set forth in respect thereof in the Administrative Schedule.\n\t\t\"GAAP\": generally accepted accounting principles in the United States of America in effect from time to time.\n\t\t\"Gates\": as defined in the recitals hereof.\n\t\t\"Governing Documents\": as to any Person, the certificate or articles of incorporation and by-laws or other organizational or governing documents of such Person.\n\t\t\"Governmental Authority\": any nation or government, any state or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government.\n\t\t\"Guarantee Ceiling Amount\": at any time, the aggregate amount of obligations that, pursuant to the restrictions contained in the Note Purchase Agreement, may be guaranteed by the Company under the Company Guarantee on a basis pari passu with the 1992 Private Placement Notes.\n\t\t\"Guarantee Obligation\": as to any Person (the \"guaranteeing person\"), any obligation of (a) the guaranteeing person or (b) another Person (including, without limitation, any bank under any letter of credit) to induce the creation of which the guaranteeing person has issued a reimbursement, counterindemnity or similar obligation, in either case guaranteeing or in effect guaranteeing any Indebtedness, leases, dividends or other obligations (the \"primary obligations\") of any other third Person (the \"primary obligor\") in any manner, whether directly or indirectly, including, without limitation, any obligation of the guaranteeing person, whether or not contingent, (i) to purchase any such primary obligation or any property constituting direct or indirect security therefor, (ii) to advance or supply funds (1) for the purchase or payment of any such primary obligation or (2) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency of the primary obligor, (iii) to purchase property, securities or services primarily for the purpose of assuring the owner of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation or (iv) otherwise to assure or hold harmless the owner of any such primary obligation against loss in respect thereof; provided, however, that the term Guarantee Obligation shall not include endorsements of instruments for deposit or collection in the ordinary course of business. The amount of any Guarantee Obligation of any guaranteeing person shall be deemed to be the lower of (a) an amount equal to the stated or determinable amount of the primary obligation in respect of which such Guarantee Obligation is made and (b) the maximum amount for which such guaranteeing person may be liable pursuant to the terms of the instrument embodying such Guarantee Obligation, unless such primary obligation and the maximum amount for which such guaranteeing person may be liable are not stated or determinable, in which case the amount of such Guarantee Obligation shall be such guaranteeing person's maximum reasonably anticipated liability in respect thereof as determined by the Company in good faith.\n\t\t\"Guarantor\": the Company or any Subsidiary in its capacity as a party to the Company Guarantee or a Subsidiary Guarantee, as the case may be.\n\t\t\"Hedging Agreements\": (a) Interest Rate Agreements and (b) any swap, futures, forward or option agreements or other agreements or arrangements designed to limit or eliminate the risk and\/or exposure of a Person to fluctuations in currency exchange rates.\n\t\t\"Hedging Banks\": any Bank or any of its subsidiaries or affiliates which from time to time enter into Hedging Agreements with the Company or any of its Subsidiaries.\n\t\t\"Indebtedness\": of any Person at any date, without duplication, (a) the principal amount of all indebtedness of such Person for borrowed money or for the deferred purchase price of property or services (other than current trade liabilities incurred in the ordinary course of business and payable in accordance with customary practices), (b) the principal amount of any other indebtedness of such Person which is evidenced by a note, bond, debenture or similar instrument, (c) the portion of all obligations of such Person under Financing Leases which must be capitalized in accordance with GAAP, (d) the principal or stated amount of all obligations of such Person in respect of letters of credit, banker's acceptances or similar obligations issued or created for the account of such Person, (e) all liabilities arising under Hedging Agreements of such Person, (f) the principal or stated amount of all Guarantee Obligations of such Person (other than guarantees by the Company or any Subsidiary in respect of current trade liabilities of the Company or any Subsidiary incurred in the ordinary course of business and payable in accordance with customary terms), and (g) the principal amount of all liabilities secured by any Lien on any property owned by such Person even though such Person has not assumed or otherwise become liable for the payment thereof.\n\t\t\"Insolvency\": with respect to any Multiemployer Plan, the condition that such Plan is insolvent within the meaning of Section 4245 of ERISA.\n\t\t\"Insolvent\": pertaining to a condition of Insolvency.\n\t\t\"Intercreditor Agreement\": as defined in the recitals hereof.\n\t\t\"Interest Payment Date\": (a) as to any ABR Loan, the last day of each March, June, September and December, (b) as to any Committed Rate Eurocurrency Loan having an Interest Period of three months or less, the last day of such Interest Period, (c) as to any Committed Rate Eurocurrency Loan having an Interest Period longer than three months, each day which is three months after the first day of such Interest Period and the last day of such Interest Period, (d) as to any Swing Line Loan, the last Business Day of each calendar month during which such Swing Line Loan is outstanding, and (e) as to any Competitive Advance Loan, the date or dates set forth in the applicable Competitive Advance Loan Request or otherwise agreed upon by the relevant Borrower and Bank at the time the terms of such Competitive Advance Loan are determined as provided in Section 3.\n\t\t\"Interest Period\": with respect to any Committed Rate Eurocurrency Loan:\n\t\t\t\t(i) initially, the period commencing on the borrowing or conversion date, as the case may be, with respect to such Eurocurrency Loan and ending one, two, three or six months thereafter, as selected by the relevant Borrower in its Notice of Borrowing or Notice of Conversion, as the case may be, given with respect thereto; and\n\t\t\t\t(ii) thereafter, each period commencing on the last day of the next preceding Interest Period applicable to such Eurocurrency Loan and ending one, two, three or six months thereafter, as selected by the relevant Borrower by a Notice of Continuation with respect thereto;\n\tprovided that, all of the foregoing provisions relating to Interest Periods are subject to the following:\n\t\t\t(1) if any Interest Period would otherwise end on a day that is not a Business Day, such 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\t\t\t(2) any Interest Period that would otherwise extend beyond the Termination Date shall end on the Termination Date; and\n\t\t\t(3) any Interest Period 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.\n\t\t\"Interest Rate Agreement\": any interest rate protection agreement, interest rate future, interest rate option, interest rate swap, interest rate cap or other interest rate hedge or arrangement under which the Company is a party or a beneficiary.\n\t\t\"Issuing Bank\": in respect of any Currency, each Bank listed as an Issuing Bank in Schedule III in respect of such Currency.\n\t\t\"Issuing Office\": in respect of each Issuing Bank, the Issuing Office set forth for such Issuing Bank in Schedule III.\n\t\t\"Joinder Agreement\": each Joinder Agreement, substantially in the form of Exhibit A, from time to time executed and delivered hereunder pursuant to subsection 14.1 (b).\n\t\t\"L\/C Commitment\": $35,000,000.\n\t\t\"L\/C Obligations\": at any time, an amount equal to the sum of the Dollar Equivalent Amount of (a) the aggregate then undrawn and unexpired amount of the then outstanding Letters of Credit and (b) the aggregate amount of drawings under Letters of Credit which have not then been reimbursed pursuant to subsection 5.5(a).\n\t\t\"L\/C Participant\": in respect of each Letter of Credit, each Bank (other than the Issuing Bank in respect of such Letter of Credit) in its capacity as the holder of a participating interest in such Letter of Credit.\n\t\t\"Letters of Credit\": as defined in subsection 5.1(b).\n\t\t\"Lien\": any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), charge or other security interest or any preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever (including, without limitation, any conditional sale or other title retention agreement and any Financing Lease having substantially the same economic effect as any of the foregoing).\n\t\t\"Limited Subsidiary Borrower\": any Foreign Subsidiary Borrower which may not have Exposure in excess of $20,000,000 by operation of the proviso to the definition of \"Foreign Subsidiary Borrower\" in this subsection 1.1; provided such Foreign Subsidiary Borrower will cease to be a Limited Subsidiary Borrower upon the earlier of (a) six months from the date it became a Limited Subsidiary Borrower or (b) delivery of a Foreign Subsidiary Opinion with respect to it.\n\t\t\"Loan\": any Committed Rate Loan, Competitive Advance Loan, Swing Line Loan or Local Currency Loan.\n\t\t\"Loan Parties\": the Company and each Subsidiary of the Company which is a party to a Credit Document.\n\t\t\"Local Currency Bank\": any Bank (or, if applicable, any affiliate, branch or agency thereof) party to a Local Currency Facility.\n\t\t\"Local Currency Bank Maximum Borrowing Amount\": as defined in subsection 6.1(b).\n\t\t\"Local Currency Borrower\": each Subsidiary of the Company organized under the laws of a jurisdiction outside the United States that the Company designates as a \"Local Currency Borrower\" in a Local Currency Facility Addendum. \t\t \t\t\"Local Currency Facility\": any Qualified Credit Facility that the Company designates as a \"Local Currency Facility\" pursuant to a Local Currency Facility Addendum.\n\t\t\"Local Currency Facility Addendum\": a Local Currency Facility Addendum received by the Administrative Agent, substantially in the form of Exhibit C and conforming to the requirements of Section 6.\n\t\t\"Local Currency Facility Agent\": with respect to each Local Currency Facility, the Local Currency Bank acting as agent for the Local Currency Banks party thereto.\n\t\t\"Local Currency Facility Maximum Borrowing Amount\": as defined in subsection 6.1(b).\n\t\t\"Local Currency Loan\": any loan made pursuant to a Local Currency Facility.\n\t\t\"London Banking Day\": any day on which banks in London are open for general banking business, including dealings in foreign currency and exchange.\n\t\t\"Material Adverse Effect\": a material adverse effect on (a) the business, operations, property, condition (financial or otherwise) or prospects of the Company and its Subsidiaries taken as a whole, (b) the ability of the Company to perform its obligations under this Agreement or other Credit Documents or (c) the validity or enforceability of this Agreement, any Application or any of the other Credit Documents or the rights or remedies of the Administrative Agent, the Collateral Agent, the Agents or the Banks hereunder or thereunder.\n\t\t\"Materials of Environmental Concern\": any gasoline or petroleum (including crude oil or any fraction thereof) or petroleum products or any hazardous or toxic substances, materials or wastes, defined or regulated as such in or under any Environmental Law, including, without limitation, asbestos, polychlorinated biphenyls and urea-formaldehyde insulation.\n\t\t\"Moody's\": Moody's Investors Service, Inc.\n\t\t\"Multiemployer Plan\": a Plan which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA.\n\t\t\"1992 Private Placement Notes\": the $75,000,000 Senior Secured Notes issued by the Company, as any of the same may be amended, supplemented, endorsed or otherwise modified from time to time; provided the aggregate principal amount thereof is not increased.\n\t\t\"Non-Excluded Taxes\": as defined in subsection 7.6.\n\t\t\"Note Purchase Agreement\": the collective reference to the several Senior Note Purchase Agreements, each dated as of December 29, 1992, among the Company and the respective financial institutions party thereto as purchasers, as the same may be amended, supplemented or otherwise modified from time to time.\n\t\t\"Notice of Borrowing\": with respect to a Committed Rate Loan of any Type in any Currency, a notice from the Specified Borrower in respect of such Loan, containing the information in respect of such Loan and delivered to the Person, in the manner and by the time specified for a Notice of Borrowing in respect of such Currency and such Type of Loan in the Administrative Schedule.\n\t\t\"Notice of Continuation\": with respect to a Committed Rate Eurocurrency Loan in any Currency, a notice from the Specified Borrower in respect of such Loan, containing the information in respect of such Loan and delivered to the Person, in the manner and by the time specified for a Notice of Continuation in respect of such Currency in the Administrative Schedule.\n\t\t\"Notice of Conversion\": with respect to a Committed Rate Loan in Dollars which a Specified Borrower wishes to convert from a Eurocurrency Loan to an ABR Loan, or from an ABR Loan to a Eurocurrency Loan, as the case may be, a notice from such Borrower setting forth the amount of such Loan to be converted, the date of such conversion and, in the case of conversions of ABR Loans to Eurocurrency Loans, the length of the initial Interest Period applicable thereto. Each Notice of Conversion shall be delivered to the Administrative Agent at its address set forth in subsection 14.2 and shall be delivered before 12:00 Noon, New York City time, on the Business Day of the requested conversion in the case of conversions to ABR Loans, and before 12:00 Noon, New York City time, three Business Days before the requested conversion in the case of conversions to Eurocurrency Loans.\n\t\t\"Notice of Guarantee Ceiling Amount\": a certificate of the Company substantially in the form of Exhibit J delivered to the Administrative Agent and calculating the Guarantee Ceiling Amount.\n\t\t\"Notice of Local Currency Outstandings\": with respect to each Local Currency Facility Agent, a notice from such Local Currency Facility Agent containing the information, delivered to the Person, in the manner and by the time, specified for a Notice of Local Currency Outstandings in the Administrative Schedule.\n\t\t\"Notice of Prepayment\": with respect to prepayment of any Committed Rate Loan of any Type in any Currency, a notice from the Specified Borrower in respect of such Loan, containing the information in respect of such prepayment and delivered to the Person, in the manner and by the time specified for a Notice of Prepayment in respect of such Currency and such Type of Loan in the Administrative Schedule.\n\t\t\"Notice of Swing Line Borrowing\": with respect to a Swing Line Loan of any Type in any Currency, a notice from the Specified Borrower in respect of such Loan, containing the information in respect of such Swing Line Loan and delivered to the Person, in the manner and by the time agreed by the Company and the applicable Swing Line Bank in respect of such Currency and such Type of Loan.\n\t\t\"Notice of Swing Line Outstandings\": with respect to each Swing Line Bank, a notice from such Swing Line Bank containing the information, delivered to the Person, in the manner and by the time, specified for a Notice of Swing Line Outstandings in the Administrative Schedule.\n\t\t\"Notice of Swing Line Refunding\": with respect to each Swing Line Bank, a notice from such Swing Line Bank containing the information, delivered to the Person, in the manner and by the time, specified for a Notice of Swing Line Refunding in the Administrative Schedule.\n\t\t\"Participant\": as defined in subsection 14.6(b).\n\t\t\"Participating Creditor\": as defined in the Intercreditor Agreement.\n\t\t\"Payment Office\": for each Type of Committed Rate Loan and each Currency, the Payment Office set forth in respect thereof in the Administrative Schedule.\n\t\t\"Payment Time\": for each Type of Committed Rate Loan and each Currency, the Payment Time set forth in respect thereof in the Administrative Schedule.\n\t\t\"PBGC\": the Pension Benefit Guaranty Corporation established pursuant to Subtitle A of Title IV of ERISA.\n\t\t\"Person\": an individual, partnership, corporation, business trust, joint stock company, trust, unincorporated association, joint venture, Governmental Authority or other entity of whatever nature.\n\t\t\"Plan\": at a particular time, any employee benefit plan which is covered by ERISA and in respect of which the Company or a Commonly Controlled Entity is (or, if such plan were terminated at such time, would under Section 4069 of ERISA be deemed to be) an \"employer\" as defined in Section 3(5) of ERISA.\n\t\t\"Properties\": as defined in subsection 8.20(a).\n\t\t\"Qualified Credit Facility\": a credit facility (a) providing for one or more Local Currency Banks to make loans denominated in an Additional Local Currency to a Local Currency Borrower, (b) providing for such loans to bear interest at a rate or rates determined by the Company and such Local Currency Bank or Local Currency Banks and (c) otherwise conforming to the requirements of Section 6.\n\t\t\"Quotation Day\": in respect of the determination of the Eurocurrency Rate for any Interest Period for any Currency, the day on which quotations would ordinarily be given by prime banks in the London interbank market (or, if such Currency is Sterling, in the Paris interbank market) for deposits in such Currency for delivery on the first day of such Interest Period; provided, that if quotations would ordinarily be given on more than one date, the Quotation Day for such Interest Period shall be the last of such dates. On the date hereof, the Quotation Day in respect of any Interest Period for any Currency is customarily the last day prior to the beginning of such Interest Period which is (i) at least two London Banking Days prior to the beginning of such Interest Period and (ii) a day on which banks are open for general banking business in the city which is the principal financial center of the country of such Currency (and, in the case of Sterling, in Paris).\n\t\t\"Ratings\": the implied senior unsecured debt ratings of the Company in effect from time to time by Moody's, S&P or a similar rating agency.\n\t\t\"Register\": as defined in subsection 14.6(d).\n\t\t\"Regulation U\": Regulation U of the Board as in effect from time to time.\n\t\t\"Reimbursement Obligation\": in respect of each Letter of Credit, the obligation of the account party thereunder to reimburse the Issuing Bank for all drawings made thereunder in accordance with Section 5 and the Application related to such Letter of Credit.\n\t\t\"Reorganization\": with respect to any Multiemployer Plan, the condition that such plan is in reorganization within the meaning of Section 4241 of ERISA.\n\t\t\"Replacement Bank\": as defined in subsection \t7.7(b).\n\t\t\"Reportable Event\": any of the events set forth in Section 4043(c) of ERISA, other than those events as to which the thirty day notice period is waived under subsections .13, .14, .16, .18, .19 or .20 of PBGC Reg. 2615.\n\t\t\"Required Banks\": at any time, Banks the Commitment Percentages of which aggregate more than 50%.\n\t\t\"Requirement of Law\": as to any Person, the Governing Documents of such Person, and any law, treaty, rule or regulation or determination of an arbitrator or a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject.\n\t\t\"Responsible Officer\": as to any Person, the chief executive officer, the chairman of the board, the president, the chief financial officer, the chief accounting officer, any executive or senior vice president or the treasurer of such Person.\n\t\t\"Restricted Payments\": as defined in subsection 11.5.\n\t\t\"Rights Agreement\": the Rights Agreement, dated as of March 2, 1988, between the Company and Chemical Bank, as successor by merger to Manufacturers Hanover Trust Company, as rights agent, as amended, supplemented or otherwise modified from time to time.\n\t\t\"S&P\": Standard & Poor's Ratings Group.\n\t\t\"Schedule Amendment\": each Schedule Amendment, substantially in the form of Exhibit B, executed and delivered pursuant to subsection 14.1.\n\t\t\"Single Employer Plan\": any Plan which is covered by Title IV of ERISA, but which is not a Multiemployer Plan.\n\t\t\"Specified Borrower\": the collective reference to the Company and the Foreign Subsidiary Borrowers.\n\t\t\"Subordinated Debentures\": the Company's 5-3\/4% Convertible Subordinated Debentures due 2002.\n\t\t\"Subordinated Indebtedness\": Indebtedness outstanding under the Subordinated Debentures.\n\t\t\"Subsidiary\": as to any Person, a corporation, partnership or other entity of which shares of stock or other ownership interests having ordinary voting power (other than stock or such other ownership interests having such power only by reason of the happening of a contingency) to elect a majority of the board of directors or other managers of such corporation, partnership or other entity are at the time owned, or the management of which is otherwise controlled, directly or indirectly through one or more intermediaries, or both, by such Person. Unless otherwise qualified, all references to a \"Subsidiary\" or to \"Subsidiaries\" in this Agreement shall refer to a Subsidiary or Subsidiaries of the Company.\n\t\t\"Subsidiary Guarantee\": each of (a) the Existing Subsidiary Guarantees and (b) each other Subsidiary Guarantee, substantially in the form of the Existing Subsidiary Guarantees with such changes as shall be approved by the Administrative Agent, to be executed and delivered from time to time by any other Domestic Subsidiary that accounts for more than 5% of Total Assets at any date, in each case, as the same may be amended, supplemented or otherwise modified from time to time.\n\t\t\"Swing Line Bank\": in respect of any Specified Borrower and any Currency, each Bank listed as a Swing Line Bank in respect of such Specified Borrower and Currency in Schedule III.\n\t\t\"Swing Line Currency\": in respect of any Specified Borrower, the Currency set forth for such Specified Borrower in Schedule III.\n\t\t\"Swing Line Limit\": in respect of any Specified Borrower, the amount listed as the Swing Line Limit in respect of such Specified Borrower in Schedule III, but not in any case for all Specified Borrowers to exceed a Dollar Equivalent Amount equal to $75,000,000.\n\t\t\"Swing Line Loan\": as defined in subsection 4.1.\n\t\t\"Swing Line Rate\": in respect of each Swing Line Currency for each Swing Line Bank, the interest rate agreed from time to time between the Company and such Swing Line Bank.\n\t\t\"Termination Date\": August 16, 2000.\n\t\t\"Total Assets\": at a particular date, the assets of the Company and its Subsidiaries, determined on a consolidated basis in accordance with GAAP.\n\t\t\"Tranche\": the collective reference to Committed Rate Eurocurrency Loans in any Currency the then current Interest Periods with respect to all of which begin on the same date and end on the same later date (whether or not such Loans shall originally have been made on the same day).\n\t\t\"Transferee\": as defined in subsection 14.6(f).\n\t\t\"Type\": in respect of any Loan, its character as a Committed Rate Loan, Competitive Advance Loan or Swing Line Loan, as the case may be.\n\t\t\"UCC\": the Uniform Commercial Code as from time to \ttime in effect in the relevant jurisdiction.\n\t\t\"Undrawn Commitment\": as to any Bank at any time, the amount of such Bank's Commitment minus the amount of such Bank's Committed Exposure at such time.\n\t\t\"Uniform Customs\": the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500 as the same may be amended from time to time.\n\t\t1.2 Other Definitional Provisions. (a) Unless otherwise specified therein, all terms defined in this Agreement shall have the defined meanings when used in any certificate or other document made or delivered pursuant hereto.\n\t\t(b) As used herein and in any certificate or other document made or delivered pursuant hereto, accounting terms relating to the Company and its Subsidiaries not defined in subsection 1.1 and accounting terms partly defined in subsection 1.1, to the extent not defined, shall have the respective meanings given to them under GAAP.\n\t\t(c) The words \"hereof\", \"herein\" and \"hereunder\" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and Section, subsection, Schedule and Exhibit references are to this Agreement unless otherwise specified.\n\t\t(d)\tThe meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms.\n\t\t(e)\tThe phrases \"to the knowledge of the Company\" and \"of which any Subsidiary is aware\" and phrases of similar import when used in this Agreement shall mean to the actual knowledge of a Responsible Officer of the Company or any such Subsidiary, as the case may be.\n\t\t1.3. Accounting Determinations. Unless otherwise specified herein, all accounting determinations for purposes of calculating or determining compliance with the terms found in subsection 1.1 or the standards and covenants found in subsection 11.1 and otherwise to be made under this Agreement shall be made in accordance with GAAP applied on a basis consistent in all material respects with that used in preparing the financial statements referred to in subsection 8.1. If GAAP shall change from the basis used in preparing such financial statements, the certificates required to be delivered pursuant to subsection 10.1 demonstrating compliance with the covenants contained herein shall set forth calculations setting forth the adjustments necessary to demonstrate how the Company is in compliance with the financial covenants based upon GAAP as in effect on the Closing Date.\n\tSECTION 2. THE COMMITTED RATE LOANS\n\t\t2.1 Committed Rate Loans. (a) Subject to the terms and conditions hereof, each Bank severally agrees to make loans on a revolving credit basis (\"Committed Rate Loans\") to any Specified Borrower from time to time during the Commitment Period; provided, that (i) no Committed Rate Loan shall be made if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, (A) the aggregate amount of the Exposure of all the Banks would exceed the aggregate amount of the Commitments or (B) the aggregate amount of the Foreign Currency Exposure would exceed $250,000,000, and (ii) no Committed Rate Loan shall be made to any Foreign Subsidiary Borrower if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, the Company Guarantee Ratio would exceed 25%. During the Commitment Period, the Specified Borrowers may use the Commitments by borrowing, prepaying the Committed Rate Loans in whole or in part, and reborrowing, all in accordance with the terms and conditions hereof.\n\t\t(b)\tThe Committed Rate Loans may be made in Dollars or any Available Foreign Currency and may from time to time be (i) Committed Rate Eurocurrency Loans, (ii) in the case of Committed Rate Loans in Dollars only, Committed Rate ABR Loans or (iii) a combination thereof, as determined by the relevant Specified Borrower and set forth in the Notice of Borrowing or Notice of Conversion with respect thereto; provided, that no Committed Rate Eurocurrency Loan shall be made after the day that is one month prior to the Termination Date.\n\t\t2.2 Procedure for Committed Rate Loan Borrowing. Any Specified Borrower may request the Banks to make Committed Rate Loans on any Business Day during the Commitment Period by delivering a Notice of Borrowing. Each borrowing of Committed Rate Loans (other than pursuant to a Swing Line Refunding pursuant to subsection 4.4, pursuant to subsection 5.5(c) or pursuant to subsection 6.3) shall be in an amount equal to (a) in the case of ABR Loans, $1,000,000 or a whole multiple of $500,000 in excess thereof (or, if the then aggregate undrawn amount of the Commitments is less than $1,000,000, such lesser amount) and (b) in the case of Eurocurrency Loans, (i) if in Dollars, $2,000,000 or increments of $500,000 thereafter, and (ii) if in any Available Foreign Currency, an amount in such Available Foreign Currency of which the Dollar Equivalent Amount is at least $2,000,000. Upon receipt of any such Notice of Borrowing from a Specified Borrower, the Administrative Agent shall promptly notify each Bank of receipt of such Notice of Borrowing and of such Bank's Borrowing Percentage of the Committed Rate Loans to be made pursuant thereto. Subject to the terms and conditions hereof, each Bank will make its Borrowing Percentage of each such borrowing available to the Administrative Agent for the account of such Specified Borrower at the Funding Office, and at or prior to the Funding Time, for the Currency of such Loan in funds immediately available to the Administrative Agent in the applicable Currency. The amounts made available by each Bank will then be made available to such Specified Borrower at the Funding Office, in like funds as received by the Administrative Agent.\n\t\t2.3 Repayment of Committed Rate Loans; Evidence of Debt. (a) Each Specified Borrower hereby unconditionally promises to pay to the Administrative Agent for the account of each Bank on the Termination Date (or such earlier date on which the Loans become due and payable pursuant to Section 12), the then unpaid principal amount of each Committed Rate Loan made by such Bank to such Specified Borrower. Each Specified Borrower hereby further agrees to pay interest on the unpaid principal amount of the Committed Rate Loans made to such Specified Borrower from time to time outstanding from the date hereof until payment in full thereof at the rates per annum, and on the dates, set forth in subsection 2.8.\n\t\t(b) Each Bank shall maintain in accordance with its usual practice an account or accounts evidencing indebtedness of each Specified Borrower to such Bank resulting from each Committed Rate Loan of such Bank from time to time, including the amounts of principal and interest payable and paid to such Bank from time to time under this Agreement.\n\t\t(c) The Administrative Agent shall maintain the Register pursuant to subsection 14.6(d), and a subaccount therein for each Bank, in which shall be recorded (i) the amount of each Committed Rate Loan made hereunder and each Interest Period (if any) applicable thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from each Specified Borrower to each Bank under Committed Rate Loans and (iii) the amount of any sum received by the Administrative Agent from each Specified Borrower in respect of Committed Rate Loans, and the amount of each Bank's share thereof.\n\t\t(d) The entries made in the Register and the accounts of each Bank maintained pursuant to subsection 2.3(b) shall, to the extent permitted by applicable law, be prima facie evidence of the existence and amounts of the obligations of each Specified Borrower therein recorded; provided, however, that the failure of any Bank or the Administrative Agent to maintain the Register or any such account, or any error therein, shall not in any manner affect the obligation of each Specified Borrower to repay (with applicable interest) the Committed Rate Loans made to such Specified Borrower by such Bank in accordance with the terms of this Agreement.\n\t\t2.4 Termination or Reduction of Commitments. The Company shall have the right, upon not less than five Business Days' notice to the Administrative Agent, to terminate the Commitments or, from time to time, to reduce the amount of the Commitments. Any such reduction shall be in an amount equal to $5,000,000 or a whole multiple thereof and shall reduce permanently the Commitments then in effect; provided that the Commitments may not be optionally reduced at any time to an amount which is less than the amount of the Exposure of all the Banks at such time; and provided further that the Commitments may not be reduced to an amount which is less than $50,000,000 unless they are terminated in full.\n\t\t2.5 Optional Prepayments. By giving a Notice of Prepayment, any Specified Borrower may, at any time and from time to time, prepay the Committed Rate Loans made to such Specified Borrower, in whole or in part, without premium or penalty (except as provided in subsection 7.8). Upon receipt of any such notice the Administrative Agent shall promptly notify each Bank thereof. If any such notice is given, the amount specified in such notice shall be due and payable on the date specified therein, together with any amounts payable pursuant to subsection 7.8. Partial prepayments shall be in an aggregate principal amount of $1,000,000 or a whole multiple of $500,000 in excess thereof or an aggregate principal Dollar Equivalent Amount of at least $1,000,000 for Loans denominated in a Foreign Currency.\n\t\t2.6 Conversion and Continuation Options. (a) By giving a Notice of Conversion, any Specified Borrower may elect from time to time (i) to convert such Specified Borrower's Eurocurrency Loans in Dollars to ABR Loans or (ii) to convert such Specified Borrower's ABR Loans to Eurocurrency Loans in Dollars. Upon receipt of any Notice of Conversion the Administrative Agent shall promptly notify each Bank thereof. All or any part of Eurocurrency Loans outstanding in Dollars or ABR Loans may be converted as provided herein, provided that (i) no ABR Loan may be converted into a Eurocurrency Loan when any Event of Default has occurred and is continuing and the Administrative Agent has or the Required Banks have determined that such a conversion is not appropriate and (ii) no ABR Loan may be converted into a Eurocurrency Loan after the date that is one month prior to the Termination Date.\n\t\t(b) By giving a Notice of Continuation, any Specified Borrower may continue any of such Specified Borrower's Eurocurrency Loans as Eurocurrency Loans in the same Currency for additional Interest Periods.\n\t\t(c) Any Specified Borrower may convert Committed Rate Loans outstanding in Dollars or one Available Foreign Currency to Committed Rate Loans in Dollars or a different Currency by repaying such Loans in the first Currency and borrowing Loans of such different Currency in accordance with the applicable provisions of this Agreement.\n\t\t(d) If any Specified Borrower shall fail to timely give a Notice of Continuation or a Notice of Conversion in respect of any of such Specified Borrower's Eurocurrency Loans with respect to which an Interest Period is expiring, such Specified Borrower shall be deemed to have given a Notice of Continuation for an Interest Period of one month.\n\t\t2.7 Minimum Amounts of Tranches. All borrowings, conversions and continuations of Committed Rate Loans and all selections of Interest Periods shall be in such amounts and be made pursuant to such elections so that, after giving effect thereto, the aggregate principal amount of the Committed Rate Loans comprising (i) each Tranche in Dollars shall be not less than $2,000,000 and (ii) each Tranche in any Available Foreign Currency shall be not less than the Dollar Equivalent Amount in such Currency of $2,000,000.\n\t\t2.8 Interest Rates and Payment Dates for Committed Rate Loans. (a) Each Committed Rate Eurocurrency Loan shall bear interest for each day during each Interest Period with respect thereto at a rate per annum equal to the Eurocurrency Rate for such Interest Period plus the Applicable Margin.\n\t\t(b) Each Committed Rate ABR Loan shall bear interest at a rate per annum equal to the ABR.\n\t\t(c) If all or a portion of (i) the principal amount of any Committed Rate Loan or (ii) any interest payable thereon shall not be paid when due (whether at the stated maturity, by acceleration or otherwise), such overdue amount shall bear interest at a rate per annum which is (x) in the case of overdue principal, the rate that would otherwise be applicable thereto pursuant to the foregoing provisions of this subsection plus 2% or (y) in the case of overdue interest, the rate described in paragraph (b) of this subsection plus 2%, in each case from the date of such non-payment until such amount is paid in full (as well after as before judgment).\n\t\t(d) Interest on Committed Rate Loans shall be payable in arrears on each Interest Payment Date; provided, that interest accruing pursuant to paragraph (c) of this subsection shall be payable from time to time on demand.\n\t\t2.9 Inability to Determine Interest Rate. If on or prior to the Quotation Day for any Interest Period in respect of any Eurocurrency Loan in any Currency:\n\t\t(a) the Administrative Agent shall have determined (which determination shall be conclusive absent manifest error) that, by reason of circumstances affecting the relevant market generally, adequate and reasonable means do not exist for ascertaining the Eurocurrency Rate for such affected Currency or such affected Interest Period, or\n\t\t(b) the Administrative Agent shall have received notice from Banks having Commitments comprising at least 25% of the aggregate amount of the Commitments that the Eurocurrency Rate determined or to be determined for such affected Interest Period will not adequately and fairly reflect the cost to such Banks (as conclusively certified by such Banks) of making or maintaining their affected Committed Rate Loans during such affected Interest Period,\nthe Administrative Agent shall give telecopy or telephonic notice thereof to the Company and the Banks as soon as practicable thereafter. If such notice is given (x) any Eurocurrency Loans requested to be made in such affected Currency on the first day of such affected Interest Period shall be made as ABR Loans in Dollars in the Dollar Equivalent Amount, (y) any Committed Rate Loans that were to have been converted on the first day of such affected Interest Period from ABR Loans to Eurocurrency Loans shall be continued as ABR Loans and (z) any Eurocurrency Loans in such affected Currency that were to have been continued as such shall be converted, on the first day of such Interest Period, to ABR Loans in Dollars in the Dollar Equivalent Amount. Until such notice has been withdrawn by the Administrative Agent, no further Eurocurrency Loans in such affected Currency shall be made, converted to or continued as such.\n\tSECTION 3. THE COMPETITIVE ADVANCE LOANS\n\t\t3.1 Competitive Advance Loans. (a) Subject to the terms and conditions hereof, any Specified Borrower may, from time to time during the Commitment Period, request the Banks to offer bids, and any Bank may, in its sole discretion, offer such bids, to make competitive advance loans (\"Competitive Advance Loans\") to such Specified Borrower on the terms and conditions set forth in such bids. Each Competitive Advance Loan shall bear interest at the rates, be payable on the dates, and shall mature on the date, agreed between such Specified Borrower and Bank at the time such Competitive Advance Loan is made; provided, that (i) each Competitive Advance Loan shall mature not earlier than 1 day and not later than 180 days, after the date such Competitive Advance Loan is made and (ii) no Competitive Advance Loan shall mature after the Termination Date. During the Commitment Period, the Specified Borrowers may accept bids from Banks from time to time for Competitive Advance Loans, and borrow and repay Competitive Advance Loans, all in accordance with the terms and conditions hereof; provided, that (i) no Competitive Advance Loan shall be made if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, (A) the aggregate amount of the Exposure of all the Banks would exceed the aggregate amount of the Commitments or (B) the aggregate amount of the Foreign Currency Exposure would exceed $250,000,000, and (ii) no Competitive Advance Loan shall be made to any Foreign Subsidiary Borrower if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, the Company Guarantee Ratio would exceed 25%. Subject to the foregoing, any Bank may, in its sole discretion, make Competitive Advance Loans in an aggregate outstanding amount exceeding the amount of such Bank's Commitment.\n\t\t(b)\tThe Competitive Advance Loans may be made in Dollars or any Available Foreign Currency, as agreed between the Specified Borrower and Bank in respect thereof at the time such Competitive Advance Loan is made.\n\t\t3.2 Procedure for Competitive Advance Loan Borrowing.\n\t\t(a) Any Specified Borrower may request Competitive Advance Loans by delivering a Competitive Advance Loan Request. The Administrative Agent shall notify each Bank promptly by facsimile transmission of the contents of each Competitive Advance Loan Request received by the Administrative Agent. Each Bank may elect, in its sole discretion, to offer irrevocably to make one or more Competitive Advance Loans to the Specified Borrower by delivering a Competitive Advance Loan Offer to the Administrative Agent.\n\t\t(b) Before the acceptance time set forth in the applicable Competitive Advance Loan Request, the Specified Borrower, in its absolute discretion, shall:\n\t\t\t(i) cancel such Competitive Advance Loan Request by giving the Administrative Agent telephone notice to that effect, or\n\t\t(ii) by giving telephone notice to the Administrative Agent immediately confirmed in writing or by facsimile transmission (1) subject to the provisions of subsection 3.2(c) accept one or more of the offers made by any Bank or Banks pursuant to subsection 3.2(a) of the amount of Competitive Advance Loans for each relevant maturity date and (2) reject any remaining offers made by Banks pursuant to subsection 3.2(a).\n\t\t(c) The Specified Borrower's acceptance of Competitive Advance Loans in response to any Competitive Advance Loan Request shall be subject to the following limitations:\n\t\t(i) The amount of Competitive Advance Loans accepted for each maturity date specified by any Bank in its Competitive Advance Loan Offer shall not exceed the maximum amount for such maturity date specified in such Competitive Advance Loan Offer;\n\t\t\t(ii) the aggregate amount of Competitive Advance Loans accepted for all maturity dates specified by any Bank in its Competitive Advance Loan Offer shall not exceed the aggregate maximum amount specified in such Competitive Advance Loan Offer for all such maturity dates;\n\t\t\t(iii) the Specified Borrower may not accept offers for Competitive Advance Loans for any maturity date in an aggregate principal amount in excess of the maximum principal amount requested in the related Competitive Advance Loan Request; and\n\t\t\t(iv) if the Specified Borrower accepts any of such offers, it must accept offers based solely upon pricing for such relevant maturity date and upon no other criteria whatsoever and if two or more Banks submit offers for any maturity date at identical pricing and the Specified Borrower accepts any of such offers but does not wish to (or by reason of the limitations set forth in this subsection 3.2(c)(iii) cannot) borrow the total amount offered by such Banks with such identical pricing, the Administrative Agent shall allocate offers from all of such Banks in amounts among them pro rata according to the amounts offered by such Banks (or as nearly pro rata as shall be practicable).\n\t\t(d) If the Specified Borrower notifies the Administrative Agent that a Competitive Advance Loan Request is cancelled, the Administrative Agent shall give prompt telephone notice thereof to the Banks.\n\t\t(e) If the Specified Borrower accepts one or more of the offers made by any Bank or Banks, the Administrative Agent promptly shall notify each Bank which has made such a Competitive Advance Loan Offer of (i) the aggregate amount of such Competitive Advance Loans to be made for each maturity date and (ii) the acceptance or rejection of any offers to make such Competitive Advance Loans made by such Bank. Before the Funding Time for Committed Rate Loans of the applicable Currency, each Bank whose Competitive Advance Loan Offer has been accepted shall make available to the Administrative Agent for the account of the Specified Borrower at the Funding Office for Committed Rate Loans of the applicable Currency the amount of Competitive Advance Loans in the applicable Currency to be made by such Bank, in immediately available funds.\n\t\t3.3 Repayment of Competitive Advance Loans; Evidence of Debt. (a) Each Specified Borrower that borrows any Competitive Advance Loan hereby unconditionally promises to pay to the Bank that made such Competitive Advance Loan on the maturity date, as agreed by such Specified Borrower and Bank (or such earlier date on which all the Loans become due and payable pursuant to Section 12), the then unpaid principal amount of such Competitive Advance Loan. Each Specified Borrower hereby further agrees to pay interest on the unpaid principal amount of the Competitive Advance Loans made by any Bank to such Specified Borrower from time to time outstanding from the date thereof until payment in full thereof at the rate per annum, and on the dates, agreed by such Specified Borrower and Bank at the time such Competitive Advance Loan is made. All payments in respect of Competitive Advance Loans shall be made by such Specified Borrower to the Administrative Agent for the account of the Bank that makes such Competitive Advance Loan to the Payment Office and by the Payment Time specified for Committed Rate Loans in the applicable Currency.\n\t\t(b) Each Bank shall maintain in accordance with its usual practice an account or accounts evidencing indebtedness of each Specified Borrower to such Bank resulting from each Competitive Advance Loan of such Bank from time to time, including the amounts of principal and interest payable and paid to such Bank from time to time in respect of Competitive Advance Loans. The entries made in the accounts of each Bank maintained pursuant to this subsection 3.3(b) shall, to the extent permitted by applicable law, be prima facie evidence of the existence and amounts of the obligations of each Specified Borrower therein recorded, absent manifest error; provided, however, that the failure of any Bank to maintain any such account, or any error therein, shall not in any manner affect the obligation of each Specified Borrower to repay (with applicable interest) the Competitive Advance Loans made to such Specified Borrower by such Bank in accordance with the terms of this Agreement.\n\t\t3.4 Prepayments. Unless otherwise agreed by the Bank making a Competitive Advance Loan, upon giving a Notice of Prepayment at the address and time specified for Committed Rate Loans in the applicable Currency such Competitive Advance Loan may be optionally prepaid prior to the scheduled maturity date thereof.\n\tSECTION 4. THE SWING LINE LOANS\n\t\t4.1 Swing Line Loans. Subject to the terms and conditions hereof, each Specified Borrower may borrow from such Specified Borrower's Swing Line Bank swing line loans (\"Swing Line Loans\") from time to time during the Commitment Period in a Swing Line Currency of such Specified Borrower; provided, that (i) no Swing Line Loan shall be made if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, (A) the aggregate amount of the Exposure of all the Banks would exceed the aggregate amount of the Commitments, (B) the aggregate amount of the Foreign Currency Exposure would exceed $250,000,000, or (C) the aggregate Dollar Equivalent Amount of all outstanding Swing Line Loans of such Specified Borrower would exceed the Swing Line Limit for such Specified Borrower or the Dollar Equivalent Amount of all outstanding Swing Line Loans would exceed $75,000,000, and (ii) no Swing Line Loan shall be made to any Foreign Subsidiary Borrower if, after giving effect to the making of such Loan and the simultaneous application of the proceeds thereof, the Company Guarantee Ratio would exceed 25%. During the Commitment Period, the Specified Borrowers may borrow and prepay the Swing Line Loans, in whole or in part, all in accordance with the terms and conditions hereof.\n\t\t4.2 Procedure for Swing Line Borrowing. (a) Any Specified Borrower may borrow Swing Line Loans during the Commitment Period on any Business Day by giving a Notice of Swing Line Borrowing in respect of such Swing Line Loan. Subject to the terms and conditions hereof, on the Borrowing Date of each Swing Line Loan, the relevant Swing Line Bank shall make the proceeds thereof available to the relevant Specified Borrower in immediately available funds in the applicable Currency in the manner from time to time agreed by such Specified Borrower and such Swing Line Bank.\n\t\t(b) Upon request of the Administrative Agent and on the last Business Day of each month on which a Swing Line Bank has any outstanding Swing Line Loans, such Bank shall deliver to the Administrative Agent a Notice of Swing Line Outstandings. The Administrative Agent will, at the request of any Swing Line Bank, advise such Swing Line Bank of the Exchange Rate used by the Administrative Agent in calculating the Dollar Equivalent Amount of Swing Line Loans of such Swing Line Bank on any date.\n\t\t4.3 Repayment of Swing Line Loans; Evidence of Debt. (a) Each Specified Borrower hereby unconditionally promises to pay to its Swing Line Bank on the Termination Date (or such earlier date on which such Swing Line Loans become due and payable pursuant to subsection 4.4 or on which all the Loans become due and payable pursuant to Section 12), the then unpaid principal amount of all Swing Line Loans made to such Specified Borrower. Each Specified Borrower hereby further agrees to pay interest on the unpaid principal amount of all Swing Line Loans made to such Specified Borrower from time to time outstanding from the date thereof until payment in full thereof at the Swing Line Rate for the Currency of such Swing Line Loan, payable on the last Business Day of each calendar month on which such Swing Line Loans are outstanding. All payments in respect of Swing Line Loans shall be made by such Specified Borrower to its Swing Line Bank at the address set forth in Schedule III for such Swing Line Bank and Swing Line Loans in such Currency.\n\t\t(b) Each Swing Line Bank shall maintain in accordance with its usual practice an account or accounts evidencing indebtedness of each Specified Borrower to such Swing Line Bank resulting from each Swing Line Loan of such Bank from time to time, including the amounts of principal and interest payable and paid to such Swing Line Bank from time to time under this Agreement. The entries made in the accounts of each Swing Line Bank maintained pursuant to this subsection 4.3(b) shall, to the extent permitted by applicable law, be prima facie evidence of the existence and amounts of the obligations of each Specified Borrower therein recorded; provided, however, that the failure of any Swing Line Bank to maintain any such account, or any error therein, shall not in any manner affect the obligation of each Specified Borrower to repay (with applicable interest) the Swing Line Loans made to such Specified Borrower by such Swing Line Bank in accordance with the terms of this Agreement.\n\t\t4.4 Allocating Swing Line Loans; Swing Line Loan Participations. (a) If any Event of Default shall occur and be continuing, any Swing Line Bank may, in its sole and absolute discretion, direct that the Swing Line Loans owing to it be refunded, by delivering a Notice of Swing Line Refunding. Upon receipt of a Notice of Swing Line Refunding the Administrative Agent shall promptly give notice of the contents thereof to the Banks and, unless an Event of Default described in Section 12(h) in respect of the Company or the relevant Specified Borrower has occurred, to the Company and the relevant Specified Borrower. Each such Notice of Swing Line Refunding shall be deemed to constitute delivery by such Specified Borrower of a Notice of Borrowing of Committed Rate Eurocurrency Loans in the amount and Currency of the Swing Line Loans to which it relates, for an Interest Period of one month's duration. Subject to the terms and conditions hereof, each Bank (including each Swing Line Bank in its capacity as a Bank having a Commitment) hereby agrees to make a Committed Rate Loan to such Specified Borrower pursuant to Section 2 in an amount equal to such Bank's Borrowing Percentage of the aggregate amount of the Swing Line Loans to which such Notice of Swing Line Refunding relates. Unless any of the events described in Section 12(h) in respect of the Company or such Specified Borrower shall have occurred (in which case the procedures of subsection 4.4(b) shall apply), each Bank shall make the amount of such Committed Rate Loan available to the Administrative Agent at the Funding Office, and at or prior to the Funding Time, for the Currency of such Loan in funds immediately available to the Administrative Agent. The proceeds of such Committed Rate Loans shall be immediately made available to such Swing Line Bank by the Administrative Agent and applied by such Swing Line Bank to repay the Swing Line Loans to which such Notice of Swing Line Refunding related.\n\t\t(b) If prior to the time a Committed Rate Loan would have otherwise been made pursuant to subsection 4.4(a), one of the events described in Section 12(h) shall have occurred in respect of the Company or the relevant Specified Borrower, each Bank (other than the relevant Swing Line Bank) shall, on the date such Committed Rate Loan would have been made pursuant to the Notice of Swing Line Refunding referred to in subsection 4.4(a) (the \"Refunding Date\"), purchase an undivided participating interest in the outstanding Swing Line Loans to which such Notice of Swing Line Refunding related, in an amount equal to (i) such Bank's Commitment Percentage times (ii) the aggregate principal amount of such Swing Line Loans then outstanding which were to have been repaid with Committed Rate Loans (the \"Swing Line Participation Amount\"). On the Refunding Date, (x) each Bank shall transfer to such Swing Line Bank, in immediately available funds, such Bank's Swing Line Participation Amount, and upon receipt thereof such Swing Line Bank shall, if requested by any Bank, deliver to such Bank a participation certificate dated the date of such Swing Line Bank's receipt of such funds and evidencing such Bank's ownership of its Swing Line Participation Amount and (y) the interest rate on the applicable Swing Line Loan will automatically be converted to the applicable Eurocurrency Rate with an Interest Period of one month plus the Applicable Margin. If any amount required to be paid by any Bank to any Swing Line Bank pursuant to this subsection 4.4 in respect of any Swing Line Participation Amount is not paid to such Swing Line Bank on the date such payment is due from such Bank, such Bank shall pay to such Swing Line Bank on demand an amount equal to the product of (i) such amount, times (ii) (A) in the case of any such payment obligation denominated in Dollars, the daily average Federal funds rate, as quoted by such Swing Line Bank, or (B) in the case of any such payment obligation denominated in an Available Foreign Currency, the rate customary in such Currency for settlement of similar inter-bank obligations, as quoted by such Swing Line Bank, in each case during the period from and including the date such payment is required to the date on which such payment is immediately available to the Swing Line Bank, times (iii) a fraction the numerator of which is the number of days that elapse during such period and the denominator of which is 360. A certificate of a Swing Line Bank submitted to any Bank with respect to any amounts owing under this subsection shall be conclusive in the absence of manifest error.\n\t\t(c) Whenever, at any time after any Swing Line Bank has received from any Bank such Bank's Swing Line Participation Amount, such Swing Line Bank receives any payment on account of the related Swing Line Loans, such Swing Line Bank will distribute to such Bank its Commitment Percentage of such payment on account of its Swing Line Participation Amount (appropriately adjusted, in the case of interest payments, to reflect the period of time during which such Bank's participating interest was outstanding and funded); provided, however, that in the event that such payment received by such Swing Line Bank is required to be returned, such Bank will return to such Swing Line Bank any portion thereof previously distributed to it by such Swing Line Bank.\n\t\t(d) Each Bank's obligation to make Committed Rate Loans pursuant to subsection 4.4(a) and to purchase participating interests pursuant to subsection 4.4(b) shall be absolute and unconditional and shall not be affected by any circumstance, including, without limitation, (i) any set-off, counterclaim, recoupment, defense or other right which such Bank may have against any other Bank or any Specified Borrower, or any Specified Borrower may have against any Bank or any other Person, as the case may be, for any reason whatsoever; (ii) the occurrence or continuance of a Default or an Event of Default; (iii) any adverse change in the condition (financial or otherwise) of the Company or any of its Subsidiaries; (iv) any breach of this Agreement by any party hereto; or (v) any other circumstance, happening or event whatsoever, whether or not similar to any of the foregoing.\n\tSECTION 5. THE LETTERS OF CREDIT\n\t\t5.1 L\/C Commitment. (a) Subject to the terms and conditions hereof, each Issuing Bank agrees to issue letters of credit for the account of any Specified Borrower on any Business Day during the Commitment Period in such form as shall be reasonably acceptable to such Issuing Bank; provided, that (i) no Letter of Credit shall be issued if, after giving effect thereto (A) the aggregate amount of the Exposure of all the Banks would exceed the aggregate amount of the Commitments, (B) the aggregate amount of the Foreign Currency Exposure would exceed $250,000,000 or (C) the aggregate amount of the L\/C Obligations would exceed $35,000,000, and (ii) no Letter of Credit shall be issued for the account of any Foreign Subsidiary Borrower if, after giving effect thereto, the Company Guarantee Ratio would exceed 25%.\n\t\t(b) Each Letter of Credit shall:\n\t\t\t(i) be denominated in Dollars or an Available Foreign Currency and shall be either (A) a standby letter of credit issued to support obligations of a Specified Borrower, contingent or otherwise, to provide credit support for workers' compensation, other insurance programs and other lawful corporate purposes (a \"Standby Letter of Credit\") or (B) a commercial letter of credit issued in respect of the purchase of goods and services in the ordinary course of business of the Company and its Subsidiaries (a \"Commercial Letter of Credit\"; together with the Standby Letters of Credit, the \"Letters of Credit\") and,\n\t\t\t(ii) expire no later than the earlier of 365 days after its date of issuance and 5 Business Days prior to the Termination Date although any such Letter of Credit may be automatically extended for periods of one year from the current or any future expiration date of the Letter of Credit unless the Issuing Bank elects not to extend such Letter of Credit and the extended maturity date is not beyond the Termination Date.\n\t\t(c) Each Letter of Credit shall be subject to the Uniform Customs and, to the extent not inconsistent therewith, the laws of the State of New York or, if acceptable to the Required Banks and the relevant account party, the jurisdiction of the Issuing Office at which such Letter of Credit is issued.\n\t\t(d) No Issuing Bank shall at any time be obligated to issue any Letter of Credit hereunder if such issuance would conflict with, or cause such Issuing Bank or any Bank to exceed any limits imposed by, any change after the date hereof in any applicable Requirement of Law.\n\t\t5.2 Procedure for Issuance of Letters of Credit under this Agreement. Any Specified Borrower may from time to time request that an Issuing Bank issue a Letter of Credit by delivering to such Issuing Bank at its Issuing Office an Application therefor (with a copy to the Administrative Agent), completed to the satisfaction of the Issuing Bank, and such other certificates, documents and other papers and information as such Issuing Bank may reasonably request. Upon receipt by an Issuing Bank of any Application, and subject to the terms and conditions hereof, such Issuing Bank will process such Application and the certificates, documents and other papers and information delivered to it in connection therewith in accordance with its customary procedures and shall promptly issue the Letter of Credit requested thereby (but in no event shall any Issuing Bank be required to issue any Letter of Credit earlier than five Business Days after its receipt of the Application therefor and all such other certificates, documents and other papers and information relating thereto) by issuing the original of such Letter of Credit to the beneficiary thereof or as otherwise may be agreed by such Issuing Bank and such Specified Borrower. Such Issuing Bank shall advise the Administrative Agent of the terms of such Letter of Credit on the date of issuance thereof and shall promptly thereafter furnish copies thereof and each amendment thereto to the Company and through the Administrative Agent each Bank.\n\t\t5.3 Fees, Commissions and Other Charges. (a) Each Specified Borrower for whose account a Letter of Credit is issued hereunder shall pay to the Administrative Agent, for the account of the Banks (including the Issuing Bank) pro rata according to their Commitment Percentages, a letter of credit commission with respect to each Letter of Credit, computed at a rate equal to the then Applicable Margin for Eurocurrency Loans on the daily average undrawn face amount of such Letter of Credit. Such commissions shall be payable in arrears on the last Business Day of each March, June, September and December to occur after the date of issuance of each Letter of Credit and on the expiration date of such Letter of Credit and shall be nonrefundable. Each Specified Borrower for whose account a Letter of Credit is issued hereunder shall also pay to the Issuing Bank in respect of each Letter of Credit such commission as shall be agreed from time to time by the Company and such Issuing Bank.\n\t\t(b) In addition to the foregoing fees and commissions, each Specified Borrower for whose account a Letter of Credit is issued hereunder shall (i) pay or reimburse the Issuing Bank for such normal and customary costs and expenses as are incurred or charged by such Issuing Bank in issuing, effecting payment under, amending or otherwise administering such Letter of Credit and (ii) pay the Issuing Bank such other fees as shall be agreed by the Issuing Bank and such Specified Borrower.\n\t\t(c) The Administrative Agent shall, promptly following its receipt thereof, distribute to the Issuing Bank and the Banks all fees and commissions received by the Administrative Agent for their respective accounts pursuant to this subsection.\n\t\t5.4 L\/C Participations. (a) Each Issuing Bank irrevocably agrees to grant and hereby grants to each L\/C Participant, and, to induce the Issuing Bank to issue Letters of Credit hereunder, each L\/C Participant irrevocably agrees to accept and purchase and hereby accepts and purchases from such Issuing Bank, on the terms and conditions hereinafter stated, for such L\/C Participant's own account and risk, an undivided interest equal to such L\/C Participant's Commitment Percentage in such Issuing Bank's obligations and rights under each Letter of Credit issued by such Issuing Bank hereunder and the amount of each draft paid by such Issuing Bank thereunder. Each L\/C Participant unconditionally and irrevocably agrees with each Issuing Bank that, if a draft is paid under any Letter of Credit issued by such Issuing Bank for which the Specified Borrower which is the account party under such Letter of Credit has not reimbursed such Issuing Bank to the full extent required by the terms of this Agreement, such L\/C Participant shall pay to such Issuing Bank upon demand at such Issuing Bank's Issuing Office an amount equal to such L\/C Participant's Commitment Percentage of the amount of such draft, or any part thereof, which is not so reimbursed.\n\t\t(b) If any amount required to be paid by any L\/C Participant to any Issuing Bank pursuant to subsection 5.4(a) in respect of any unreimbursed portion of any payment made by such Issuing Bank under any Letter of Credit is not paid to such Issuing Bank on the date such payment is due from such L\/C Participant, such L\/C Participant shall pay to such Issuing Bank on demand an amount equal to the product of (i) such amount, times (ii) (A) in the case of any such payment obligation denominated in Dollars, the daily average Federal funds rate, as quoted by such Issuing Bank, or (B) in the case of any such payment obligation denominated in an Available Foreign Currency, the rate customary in such Currency for settlement of similar inter-bank obligations, as quoted by such Issuing Bank, in each case during the period from and including the date such payment is required to the date on which such payment is immediately available to the Issuing Bank, times (iii) a fraction the numerator of which is the number of days that elapse during such period and the denominator of which is 360. A certificate of an Issuing Bank submitted to any L\/C Participant with respect to any amounts owing under this subsection shall be conclusive in the absence of manifest error.\n\t\t(c) Whenever, at any time after an Issuing Bank has made payment under any Letter of Credit and has received from any L\/C Participant its pro rata share of such payment in accordance with subsection 5.4(a) the Issuing Bank receives any payment related to such Letter of Credit (whether directly from the account party or otherwise, including by way of set-off or proceeds of collateral applied thereto by such Issuing Bank), or any payment of interest on account thereof, such Issuing Bank will distribute to such L\/C Participant its pro rata share thereof; provided, however, that in the event that any such payment received by such Issuing Bank shall be required to be returned by the Issuing Bank, such L\/C Participant shall return to such Issuing Bank the portion thereof previously distributed by such Issuing Bank to it.\n\t\t5.5 Reimbursement Obligation of the Specified Borrowers. (a) Each Specified Borrower for whose account a Letter of Credit is issued hereunder agrees to reimburse the Issuing Bank in respect of such Letter of Credit on each date on which such Issuing Bank notifies such Specified Borrower (with a copy to the Administrative Agent at its address in the Administrative Schedule for Notices of Borrowing for the applicable Currency) of the date and amount of a draft presented under such Letter of Credit and paid by such Issuing Bank for the amount of (i) such draft so paid and (ii) any taxes, fees, charges or other costs or expenses incurred by such Issuing Bank in connection with such payment; provided if any Issuing Bank shall notify the Specified Borrower of a drawing after 2:00 p.m. local time of such Issuing Bank's Issuing Office on the date of any drawing under a Letter of Credit, the Specified Borrower will not be required to reimburse such Issuing Bank until the next succeeding Business Day. Each such payment shall be made to such Issuing Bank at its Issuing Office in the Currency in which payment of such draft was made and in immediately available funds.\n\t\t(b) Interest shall be payable on any and all amounts remaining unpaid by any Specified Borrower under this subsection from the date such amounts become payable (whether at stated maturity, by acceleration or otherwise) until payment in full at the rate which is (i) in the case of such amounts payable in Dollars, 2% above the ABR from time to time and (ii) in the case of such amounts payable in any other currency, 2% above the rate reasonably determined by the Issuing Bank as the cost of funding such overdue amount from time to time on an overnight basis.\n\t\t(c) Each notice of a drawing under any Letter of Credit denominated in Dollars shall constitute a request by the Specified Borrower for a borrowing pursuant to subsection 2.2 of ABR Loans in the amount of such drawing plus any amounts payable pursuant to subsection 5.5(a)(ii) in respect of such drawing. The Borrowing Date with respect to such borrowing shall be the date of such drawing.\n\t\t5.6 Obligations Absolute. (a) The obligations of the Specified Borrowers under this Section 5 shall be absolute and unconditional under any and all circumstances and irrespective of any set-off, counterclaim or defense to payment which any Specified Borrower may have or have had against the Issuing Bank or any beneficiary of a Letter of Credit.\n\t\t(b) Each Specified Borrower for whose account a Letter of Credit is issued hereunder also agrees with the Issuing Bank in respect of such Letter of Credit that such Issuing Bank shall not be responsible for, and such Specified Borrower's Reimbursement Obligations under subsection 5.5(a) shall not be affected by, among other things, (i) the validity or genuineness of documents or of any endorsements thereon, even though such documents shall in fact prove to be invalid, fraudulent or forged, provided, that reliance upon such documents by such Issuing Bank shall not have constituted gross negligence or wilful misconduct of such Issuing Bank or (ii) any dispute between or among such Specified Borrower and any beneficiary of any Letter of Credit or any other party to which such Letter of Credit may be transferred or (iii) any claims whatsoever of any Specified Borrower against any beneficiary of such Letter of Credit or any such transferee.\n\t\t(c) No Issuing Bank shall be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit, except for errors or omissions caused by such Issuing Bank's gross negligence or willful misconduct.\n\t\t(d) Each Specified Borrower for whose account a Letter of Credit is issued hereunder agrees that any action taken or omitted by any Issuing Bank under or in connection with any Letter of Credit or the related drafts or documents, if done in the absence of gross negligence or willful misconduct and in accordance with the standards of care specified in the Uniform Customs, shall be binding on such Specified Borrower and shall not result in any liability of such Issuing Bank to such Specified Borrower.\n\t\t5.7 Letter of Credit Payments. If any draft shall be presented for payment to an Issuing Bank under any Letter of Credit, such Issuing Bank shall promptly notify the account party of the date and amount thereof. The responsibility of the Issuing Bank to the account party in connection with any draft presented for payment under any Letter of Credit shall, in addition to any payment obligation expressly provided for in such Letter of Credit, be limited to determining that the documents (including each draft) delivered under such Letter of Credit in connection with such presentment are in conformity with such Letter of Credit.\n\t\t5.8 Application. To the extent that any provision of any Application related to any Letter of Credit is inconsistent with the provisions of this Section 5, the provisions of this Section 5 shall apply.\nSECTION 6. LOCAL CURRENCY FACILITIES\n\t\t6.1 Terms of Local Currency Facilities. (a) Subject to the provisions of this Section 6, the Company may in its discretion from time to time designate any Subsidiary of the Company organized under the laws of any jurisdiction outside the United States as a \"Local Currency Borrower\" and any Qualified Credit Facility to which such Local Currency Borrower and any one or more Banks (or its affiliates, agencies or branches) is a party as a \"Local Currency Facility\", with the consent of each such Bank in its sole discretion, by delivering a Local Currency Facility Addendum to the Administrative Agent and the Banks (through the Administrative Agent) executed by the Company, each such Local Currency Borrower and each such Bank, provided, that on the effective date of such designation no Event of Default shall have occurred and be continuing. Concurrently with the delivery of a Local Currency Facility Addendum, the Company or the relevant Local Currency Borrower shall furnish to the Administrative Agent copies of all documentation executed and delivered by any Local Currency Borrower in connection therewith, together with, if applicable, an English translation thereof. Except as otherwise provided in this Section 6 or in the definition of \"Qualified Credit Facility\" in subsection 1.1, the terms and conditions of each Local Currency Facility shall be determined by mutual agreement of the relevant Local Currency Borrower(s) and Local Currency Bank(s). The documentation governing each Local Currency Facility shall (i) contain an express acknowledgement that such Local Currency Facility shall be subject to the provisions of this Section 6 and (ii) designate a Local Currency Facility Agent for such Local Currency Facility. Each of the Company and, by agreeing to any Local Currency Facility designation as contemplated hereby, each relevant Local Currency Bank (if any) party thereto which is an affiliate, branch or agency of a Bank, acknowledges and agrees that each reference in this Agreement to any Bank shall, to the extent applicable, be deemed to be a reference to such Local Currency Bank. In the event of any inconsistency between the terms of this Agreement and the terms of any Local Currency Facility, the terms of this Agreement shall prevail.\n\t\t(b) The documentation governing each Local Currency Facility shall set forth (i) the maximum amount (expressed in Dollars) available to be borrowed from all Local Currency Banks under such Local Currency Facility (as the same may be reduced from time to time, a \"Local Currency Facility Maximum Borrowing Amount\") and (ii) with respect to each Local Currency Bank party to such Local Currency Facility, the maximum Dollar Equivalent Amount available to be borrowed from such Local Currency Bank thereunder (as the same may be reduced from time to time, a \"Local Currency Bank Maximum Borrowing Amount\").\n\t\t(c) Except as otherwise required by applicable law, in no event shall the Local Currency Banks party to a Local Currency Facility have the right to accelerate the Local Currency Loans outstanding thereunder, or to terminate their commitments (if any) to make such Local Currency Loans prior to the earlier of the stated termination date in respect thereof or the Termination Date, except, in each case, in connection with an acceleration of the Loans or a termination of the Commitments pursuant to Section 12 of this Agreement, provided, that nothing in this paragraph (c) shall be deemed to require any Local Currency Bank to make a Local Currency Loan if the applicable conditions precedent to the making of such Local Currency Loan set forth in the relevant Local Currency Facility have not been satisfied. No Local Currency Loan may be made under a Local Currency Facility if (i) after giving effect thereto, the conditions precedent in subsection 9.2 would not be satisfied or (ii) after giving effect to the making of such Local Currency Loan and the simultaneous application of the proceeds thereof, (A) the aggregate amount of the Exposure of all the Banks would exceed the aggregate amount of the Commitments, (B) the aggregate amount of the Foreign Currency Exposure would exceed $250,000,000, (C) the Company Guarantee Ratio would exceed 25%, or (D) the amount of such Local Currency Bank's Committed Exposure would exceed the amount of such Local Currency Bank's Commitment.\n\t\t(d) The relevant Local Currency Borrower shall furnish to the Administrative Agent copies of any amendment, supplement or other modification (including any change in commitment amounts or in the Local Currency Banks participating in any Local Currency Facility) to the terms of any Local Currency Facility promptly after the effectiveness thereof (together with, if applicable, an English translation thereof). If any such amendment, supplement or other modification to a Local Currency Facility shall (i) add a Local Currency Bank as a Local Currency Bank thereunder or (ii) change the Local Currency Facility Maximum Borrowing Amount or any Local Currency Bank Maximum Borrowing Amount with respect thereto, the Company shall promptly furnish an appropriately revised Local Currency Facility Addendum, executed by the Company, the relevant Local Currency Borrower and the affected Local Currency Banks (or any agent acting on their behalf), to the Administrative Agent and the Banks (through the Administrative Agent).\n\t\t(e) The Company may terminate its designation of a facility as a Local Currency Facility, with the consent of each Local Currency Bank party thereto in its sole discretion, by written notice to the Administrative Agent, which notice shall be executed by the Company, the relevant Local Currency Borrower and each Local Currency Bank party to such Local Currency Facility (or any agent acting on their behalf). Once notice of such termination is received by the Administrative Agent, such Local Currency Facility and the loans and other obligations outstanding thereunder shall immediately cease to be subject to the terms of this Agreement and shall cease to benefit from the Company Guarantee.\n\t\t6.2 Reporting of Local Currency Outstandings. On the date of the making of any Local Currency Loan having a maturity of 30 or more days to a Local Currency Borrower and on the last Business Day of each month on which a Local Currency Borrower has any outstanding Local Currency Loans, the Local Currency Facility Agent for such Local Currency Borrower, shall deliver to the Administrative Agent a Notice of Local Currency Outstandings. The Administrative Agent will, at the request of any Local Currency Facility Agent, advise such Local Currency Facility Agent of the Exchange Rate used by the Administrative Agent in calculating the Dollar Equivalent Amount of Local Currency Loans under the related Local Currency Facility on any date.\n\t\t6.3 Refunding of Local Currency Loans. (a) Notwithstanding noncompliance with the conditions precedent set forth in subsection 9.2, if any Local Currency Loans are outstanding on (i) any date on which an Event of Default pursuant to Section 12(h) shall have occurred with respect to the Company, (ii) any date (the \"Acceleration Date\") on which the Commitments shall have been terminated and\/or the Loans shall have been declared immediately due and payable pursuant to Section 12 or (iii) any date on which an Event of Default pursuant to Section 12(a)(ii) shall have occurred and be continuing for three or more Business Days and, in the case of clause (iii) above, any Local Currency Bank party to the affected Local Currency Facility shall have given notice thereof to the Administrative Agent requesting that the Local Currency Loans (\"Affected Local Currency Loans\") outstanding thereunder be refunded pursuant to this subsection 6.3, then, at 10:00 A.M., New York City time, on the second Business Day immediately succeeding (x) the date on which such Event of Default occurs (in the case of clause (i) above), (y) such Acceleration Date (in the case of clause (ii) above) or (z) the date on which such notice is received by the Administrative Agent (in the case of clause (iii) above), the Administrative Agent shall be deemed to have received a notice from the Company pursuant to subsection 2.2 requesting that ABR Loans be made pursuant to subsection 2.1 on such second Business Day in an aggregate amount equal to the Dollar Equivalent Amount of the aggregate amount of all Local Currency Loans (in the case of clause (i) or (ii) above) or the Affected Local Currency Loans (in the case of clause (iii) above), and the procedures set forth in subsection 2.2 shall be followed in making such ABR Loans. The proceeds of such ABR Loans shall be applied to repay such Local Currency Loans.\n\t\t(b) If, for any reason, ABR Loans may not be made pursuant to paragraph (a) of this subsection 6.3 to repay Local Currency Loans as required by such paragraph, effective on the date such ABR Loans would otherwise have been made, (i) the principal amount of each relevant Local Currency Loan shall be converted into Dollars (calculated on the basis of the Exchange Rate as of the immediately preceding Business Day) (\"Converted Local Currency Loans\") and (ii) each Bank severally, unconditionally and irrevocably agrees that it shall purchase in Dollars a participating interest in such Converted Local Currency Loans in an amount equal to the amount of ABR Loans which would otherwise have been made by such Bank pursuant to paragraph (a) of this subsection 6.3. Each Bank will immediately transfer to the Administrative Agent, in immediately available funds, the amount of its participation, and the proceeds of such participation shall be distributed by the Administrative Agent to each relevant Local Currency Bank in such amount as will reduce the amount of the participating interest retained by such Local Currency Bank in the Converted Local Currency Loans to the amount of the ABR Loans which were to have been made by it pursuant to paragraph (a) of this subsection 6.3. All Converted Local Currency Loans shall bear interest at the rate which would otherwise be applicable to ABR Loans. Each Bank shall share on a pro rata basis (calculated by reference to its participating interest in such Converted Local Currency Loans) in any interest which accrues thereon and in all repayments thereof.\n\t\t(c) If, for any reason, ABR Loans may not be made pursuant to paragraph (a) of this subsection 6.3 to repay Local Currency Loans as required by such paragraph and the principal amount of any Local Currency Loans may not be converted into Dollars in the manner contemplated by paragraph (b) of this subsection 6.3, (i) the Administrative Agent shall determine the Dollar Equivalent Amount of such Local Currency Loans (calculated on the basis of the Exchange Rate determined as of the Business Day immediately preceding the date on which ABR Loans would otherwise have been made pursuant to said paragraph (a)) and (ii) effective on the date on which ABR Loans would otherwise have been made pursuant to said paragraph (a), each Bank severally, unconditionally and irrevocably agrees that it shall purchase in Dollars a participating interest in such Local Currency Loans in an amount equal to the amount of ABR Loans which would otherwise have been made by such Bank pursuant to paragraph (a) of this subsection 6.3. Each Bank will immediately transfer to the Administrative Agent, in immediately available funds, the amount of its participation, and the proceeds of such participation shall be distributed by the Administrative Agent to each relevant Local Currency Bank in such amount as will reduce the Dollar Equivalent as of such date of the amount of the participating interest retained by such Local Currency Bank in such Local Currency Loans to the amount of the ABR Loans which were to have been made by it pursuant to paragraph (a) of this subsection 6.3. Each Bank shall share on a pro rata basis (calculated by reference to its participating interest in such Local Currency Loans) in any interest which accrues thereon, in all repayments of principal thereof and in the benefits of any collateral furnished in respect thereof and the proceeds of such collateral.\n\t\t(d)\tIf any amount required to be paid by any Bank to any Local Currency Bank pursuant to this subsection 6.3 in respect of any Local Currency Loan is not paid to such Local Currency Bank on the date such payment is due from such Bank, such Bank shall pay to such Local Currency Bank on demand an amount equal to the product of (i) such amount, times (ii) the daily average Federal funds rate, as quoted by such Local Currency Bank during the period from and including the date such payment is required to the date on which such payment is immediately available to the Local Currency Bank, times (iii) a fraction the numerator of which is the number of days that elapse during such period and the denominator of which is 360. A certificate of a Local Currency Bank submitted to any Bank through the Administrative Agent with respect to any amounts owing under this subsection (d) shall be conclusive in the absence of manifest error.\n\tSECTION 7. CERTAIN PROVISIONS APPLICABLE TO THE LOANS AND LETTERS OF CREDIT\n\t\t7.1 Facility Fee, Other Fees. (a) The Company agrees to pay to the Administrative Agent for the account of each Bank a facility fee for the period from and including the Closing Date to, but excluding, the Termination Date, computed at the Facility Fee Rate in effect from time to time on the average daily amount of the Commitment (used and unused) of such Bank during the period for which payment is made, payable quarterly in arrears on the last day of each March, June, September and December and on the Termination Date or such earlier date on which the Commitments shall terminate as provided herein, commencing on the first of such dates to occur after the date hereof.\n\t\t(b) The Company agrees to pay to the Administrative Agent, for its own account and for the account of the Arranger, the fees in the amounts and on the dates agreed to by such parties in writing prior to the date of this Agreement.\n\t\t7.2 Computation of Interest and Fees. (a) Facility fees and, whenever it is calculated on the basis of the Prime Rate, interest shall be calculated on the basis of a 365- (or 366-, as the case may be) day year for the actual days elapsed; and, otherwise, interest and Letter of Credit commissions shall be calculated on the basis of a 360- day year for the actual days elapsed. The Administrative Agent shall as soon as practicable notify the relevant Specified Borrower and the Banks of each determination of a Eurocurrency Rate. Any change in the ABR due to a change in the Prime Rate, the Base CD Rate or the Federal Funds Effective Rate shall be effective as of the opening of business on the effective day of such change in the Prime Rate, the Base CD Rate or the Federal Funds Effective Rate, respectively. The Administrative Agent shall as soon as practicable notify the relevant Borrower and the Banks of the effective date and the amount of each such change in interest rate.\n\t\t(b) Each determination of an interest rate by the Administrative Agent pursuant to any provision of this Agreement shall be conclusive and binding on the Borrowers and the Banks in the absence of manifest error.\n\t\t7.3 Pro Rata Treatment and Payments. (a) Each payment by the Company on account of any facility fee hereunder and any reduction of the Commitments of the Banks shall be made pro rata according to the respective Commitment Percentages of the Banks. Each disbursement of Committed Rate Loans shall be made by the Banks pro rata according to the respective Borrowing Percentages of the Banks. Each payment (including each prepayment) by any Borrower on account of principal of and interest on any Loans shall be made pro rata according to the respective principal amounts of the Loans of such Borrower then due and owing to the Banks. All payments (including prepayments) to be made by any Borrower hereunder, whether on account of principal, interest, fees, Reimbursement Obligations or otherwise, shall be made without set off or counterclaim. All payments in respect of Committed Rate Loans or Letters of Credit in any Currency shall be made in such Currency and in immediately available funds at the Payment Office, and at or prior to the Payment Time, for such Type of Loans and such Currency, on the due date thereof. The Administrative Agent shall distribute to the Banks any payments received by the Administrative Agent promptly upon receipt in like funds as received. If any payment hereunder becomes due and payable on a day other than a Business Day, such payment shall be extended to the next succeeding Business Day, and, with respect to payments of principal, interest thereon shall be payable at the then applicable rate during such extension.\n\t\t(b) Unless the Administrative Agent shall have been notified in writing by any Bank prior to a Borrowing Date in respect of Committed Rate Loans that such Bank will not make the amount that would constitute its Borrowing Percentage of such borrowing available to the Administrative Agent, the Administrative Agent may assume that such Bank is making such amount available to the Administrative Agent, and the Administrative Agent may, in reliance upon such assumption, make available to the relevant Borrower a corresponding amount. If such amount is not made available to the Administrative Agent by the required time on the Borrowing Date therefor, such Bank shall pay to the Administrative Agent, on demand, such amount with interest thereon at a rate equal to (A) in the case of any such Committed Rate Loans denominated in Dollars, the daily average Federal funds rate, as quoted by the Administrative Agent, or (B) in the case of any Committed Rate Loans denominated in an Available Foreign Currency, the rate customary in such Currency for settlement of similar inter-bank obligations, as quoted by the Administrative Agent, in each case for the period until such Bank makes such amount immediately available to the Administrative Agent. A certificate of the Administrative Agent submitted to any Bank with respect to any amounts owing under this subsection shall be conclusive in the absence of manifest error. If such Bank's Borrowing Percentage of such borrowing is not made available to the Administrative Agent by such Bank within three Business Days of such Borrowing Date, the Administrative Agent shall also be entitled to recover such amount with interest thereon at the rate per annum applicable to Swing Line Loans in such Currency hereunder, on demand, from the relevant Borrower.\n\t\t7.4 Illegality. Notwithstanding any other provision herein, if the adoption of or any change in any Requirement of Law or in the interpretation thereof by any Governmental Authority charged with the administration or interpretation thereof shall make it unlawful for any Bank to make or maintain Eurocurrency Loans or to make or maintain Extensions of Credit to one or more Foreign Subsidiary Borrowers or Local Currency Borrowers contemplated by this Agreement, the commitment of such Bank hereunder to make Eurocurrency Loans, continue Eurocurrency Loans as such, convert Loans to Eurocurrency Loans and maintain Extensions of Credit to such Foreign Subsidiary Borrowers or Local Currency Borrowers shall forthwith be cancelled to the extent necessary to remedy or prevent such illegality. Nothing in this subsection 7.4 shall affect the obligation of the Banks to make and maintain ABR Loans to the Company and, to the extent not unlawful, to Foreign Subsidiary Borrowers, notwithstanding that a Requirement of Law may make it unlawful to make and maintain Eurocurrency Loans to such Borrowers.\n\t\t7.5 Requirements of Law. (a) If the adoption of or any change in any Requirement of Law (other than the Certificate of Incorporation and By-Laws or other organizational or governing documents of the Banks) or in the interpretation or application thereof or compliance by any Bank or Issuing Bank with any request or directive (whether or not having the force of law) from any central bank or other Governmental Authority made subsequent to the date hereof:\n\t\t\t(i) shall subject any Bank or Issuing Bank or any corporation controlling such Bank or from which such Bank obtains funding or credit to any tax of any kind whatsoever with respect to this Agreement, any Letter of Credit or any Eurocurrency Loan or Local Currency Loan made by it, or change the basis of taxation of payments to such Bank or such corporation in respect thereof (except for Non- Excluded Taxes covered by subsection 7.6 (including taxes excluded under the first sentence of subsection 7.6(a)) and changes in the rate of tax on the overall net income of such Bank or Issuing Bank or such corporation);\n\t\t\t(ii) shall impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of, advances, loans or other extensions of credit by, or any other acquisition of funds by, any office of such Bank or Issuing Bank or any corporation controlling such Bank or Issuing Bank or from which such Bank obtains funding or credit which is not otherwise included in the determination of the Eurocurrency Rate hereunder or the interest rate on such Local Currency Loans under the relevant Local Currency Facility; or\n\t\t\t(iii)\t shall impose on such Bank or Issuing Bank or any corporation controlling such Bank or from which such Bank obtains funding or credit any other condition;\nand the result of any of the foregoing is to increase the cost to such Bank or Issuing Bank or such corporation, by an amount which such Bank or Issuing Bank or such corporation deems to be material, of making, converting into, continuing or maintaining Eurocurrency Loans or Local Currency Loans or issuing or participating in Letters of Credit or to reduce any amount receivable hereunder in respect thereof, then, in any such case, the Company shall promptly pay such Bank or Issuing Bank, within five Business Days after its demand, any additional amounts necessary to compensate such Bank or Issuing Bank for such increased cost or reduced amount receivable, together with interest on each such amount from the date due until payment in full at a rate per annum equal to the ABR plus 2%. If any Bank or Issuing Bank becomes entitled to claim any additional amounts pursuant to this subsection, it shall promptly notify the Company, through the Administrative Agent, of the event by reason of which it has become so entitled. A certificate as to any additional amounts payable pursuant to this subsection submitted by such Bank or Issuing Bank, through the Administrative Agent, to the Company shall be conclusive in the absence of manifest error. This covenant shall survive the termination of this Agreement and the payment of Loans and all other amounts payable hereunder.\n\t\t(b) If any Bank shall have determined that the adoption of or any change in any Requirement of Law regarding capital adequacy or in the interpretation or application thereof or compliance by such Bank or any corporation controlling such Bank or Issuing Bank or from which such Bank or Issuing Bank obtains funding or credit with any request or directive regarding capital adequacy (whether or not having the force of law) from any Governmental Authority made subsequent to the date hereof does or shall have the effect of reducing the rate of return on such Bank's or Issuing Bank or such corporation's capital as a consequence of its obligations hereunder or under any Letter of Credit to a level below that which such Bank or Issuing Bank or such corporation could have achieved but for such change or compliance (taking into consideration such Bank's or Issuing Bank or such corporation's policies with respect to capital adequacy) by an amount deemed by such Bank or Issuing Bank to be material, then from time to time, after submission by such Bank or Issuing Bank to the Company (with a copy to the Administrative Agent) of a written request therefor (which written request shall be conclusive in the absence of manifest error), the Company shall pay to such Bank or Issuing Bank such additional amount or amounts as will compensate such Bank or Issuing Bank for such reduction.\n\t\t(c) In addition to, and without duplication of, amounts which may become payable from time to time pursuant to paragraphs (a) and (b) of this subsection 7.5, each Borrower agrees to pay to each Bank which requests compensation under this paragraph (c) by notice to such Borrower, on the last day of each Interest Period with respect to any Committed Rate Eurocurrency Loan made by such Bank to such Borrower, at any time when such Bank shall be required to maintain reserves against \"Eurocurrency liabilities\" under Regulation D of the Board (or, at any time when such Bank may be required by the Board or by any other Governmental Authority, whether within the United States or in another relevant jurisdiction, to maintain reserves against any other category of liabilities which includes deposits by reference to which the Eurocurrency Rate is determined as provided in this Agreement or against any category of extensions of credit or other assets of such Bank which includes any such Committed Rate Eurocurrency Loans), an additional amount (determined by such Bank's calculation or, if an accurate calculation is impracticable, reasonable estimate using such reasonable means of allocation as such Bank shall determine) equal to the actual costs, if any, incurred by such Bank during such Interest Period as a result of the applicability of the foregoing reserves to such Committed Rate Eurocurrency Loans.\n\t\t(d) A certificate of each Bank, Issuing Bank, Swing Line Bank or Local Currency Bank setting forth such amount or amounts as shall be necessary to compensate such Bank, Issuing Bank, Swing Line Bank or Local Currency Bank as specified in paragraph (a), (b) or (c) above, as the case may be, and setting forth in reasonable detail an explanation of the basis of requesting such compensation in accordance with paragraph (a) or (b) above, including calculations in detail comparable to the detail set forth in certificates delivered to such Bank in similar circumstances under comparable provisions of other comparable credit agreements, shall be delivered to the relevant Borrower and shall be conclusive absent manifest error. The relevant Borrower shall pay each Bank, Issuing Bank, Swing Line Bank or Local Currency Bank the amount shown as due on any such certificate delivered to it within 10 days after its receipt of the same.\n\t\t(e)\tThe agreements in this subsection shall survive the termination of this Agreement and the payment of the Loans and all other amounts payable hereunder.\n\t\t7.6 Taxes. (a) All payments made by any Borrower under this Agreement shall be made free and clear of, and without deduction or withholding for or on account of, any present or future income, stamp or other taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed by any Governmental Authority, excluding, in the case of the Administrative Agent and each Bank, (i) net income taxes, capital taxes, doing business taxes and franchise taxes imposed on the Administrative Agent or such Bank (including, without limitation, each Bank in its capacity as an Issuing Bank or as a Swing Line Bank), as the case may be, as a result of a present or former connection between the jurisdiction of the government or taxing authority imposing such tax and the Administrative Agent or such Bank (excluding a connection arising solely from the Administrative Agent or such Bank having executed, delivered or performed its obligations or received a payment under, or enforced, this Agreement) or any political subdivision or taxing authority thereof or therein, (ii) taxes required to be withheld because of a failure to deliver any certificate described in this subsection 7.6 or subsection 14.6 for any reason and (iii) any and all withholding taxes payable with respect to payments under this Agreement other than any such withholding taxes imposed as a result of any change in or amendment to the laws of any jurisdiction affecting taxation (including any regulation or ruling proposed or promulgated by a taxing authority thereof and any treaty provisions) or any change in the official application, enforcement or interpretation of such laws, regulations, rulings or treaties or any other action taken by a taxing authority or a court of competent jurisdiction, which change, amendment, application, enforcement, interpretation or action becomes effective after the date hereof (all such non-excluded taxes, levies, imposts, duties, charges, fees, deductions and withholdings being hereinafter called \"Non-Excluded Taxes\"). If any Non-Excluded Taxes are required to be withheld from any amounts payable to the Administrative Agent or any Bank hereunder, the amounts so payable to the Administrative Agent or such Bank shall be increased to the extent necessary to yield to the Administrative Agent or such Bank (after payment of all Non-Excluded Taxes) interest or any such other amounts payable hereunder at the rates or in the amounts specified in this Agreement. Whenever any Non-Excluded Taxes are payable by any Borrower, as promptly as possible thereafter such Borrower shall send to the Administrative Agent for its own account or for the account of such Bank, as the case may be, a certified copy of an original official receipt received by such Borrower showing payment thereof. If such Borrower fails to pay any Non-Excluded Taxes when due to the appropriate taxing authority or fails to remit to the Administrative Agent the required receipts or other required documentary evidence, such Borrower shall indemnify the Administrative Agent and such Bank for any incremental taxes, interest or penalties that may become payable by the Administrative Agent or such Bank as a result of any such failure. The agreements in this subsection 7.6(a) shall survive the termination of this Agreement and the payment of the Loans and all other amounts payable hereunder.\n\t\t(b)\t(i) Each Bank that is not incorporated under the laws of the United States of America or a state thereof agrees that it will deliver to the Company and the Administrative Agent (x) two duly completed copies of United States Internal Revenue Service Form 1001 or 4224 or successor applicable form, as the case may be, and (y) an Internal Revenue Service Form W-8 or W-9 or successor applicable form, as the case may be. Each such Bank also agrees to deliver to the Company and the Administrative Agent two further copies of the said Form 1001 or 4224 and Form W-8 or W-9, or successor applicable forms or other manner of certification, as the case may be, on or before the date that any such form expires or becomes obsolete or after the occurrence of any event (including, without limitation, a change in such Bank's lending office) requiring a change in the most recent form previously delivered by it to the Company and the Administrative Agent, and such extensions or renewals thereof as may reasonably be requested by the Company or the Administrative Agent, unless in any such case an event (including, without limitation, any change in treaty, law or regulation) has occurred prior to the date on which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Bank from duly completing and delivering any such form with respect to it and such Bank so advises the Company and the Administrative Agent. Such Bank shall certify (x) in the case of a Form 1001 or 4224, that it is entitled to receive payments under this Agreement without deduction or withholding of any United States federal income taxes and (y) in the case of a Form W-8 or W-9, that it is entitled to an exemption from United States backup withholding tax.\n\t\t\t(ii)\t Upon the written request of any Borrower, each Bank promptly will provide to such Borrower and to the Administrative Agent, or file with the relevant taxing authority (with a copy to the Administrative Agent) such form, certification or similar documentation (each duly completed, accurate and signed) as is required by the relevant jurisdiction in order to obtain an exemption from, or reduced rate of Non-Excluded Taxes to which such Bank or the Administrative Agent is entitled pursuant to an applicable tax treaty or the law of the relevant jurisdiction; provided, however, such Bank will not be required to (x) disclose information which in its reasonable judgment it deems confidential or proprietary or (y) incur a cost if such cost would, in its reasonable judgment, be substantial in comparison to the cost of the Borrower under this subsection 7.6 of such Bank's failure to provide such form, certification or similar documentation. Such Bank shall certify in the case of any such form, certification or similar documentation so provided (to the extent it may accurately and properly do so) that it is entitled to receive payments under this Agreement without deduction or withholding, or at a reduced rate of deduction or withholding of Non-Excluded Taxes.\n\t\t\t(iii)\t A Bank shall be required to furnish a form under this paragraph (b) only if it is entitled to claim an exemption from or a reduced rate of withholding under applicable law. A Bank that is not entitled to claim an exemption from or a reduced rate of withholding under applicable law, promptly upon written request of the applicable Borrower, shall inform the applicable Borrower in writing.\n\t\t(c) If any Bank is, in its sole opinion, able to apply for any tax credit, tax deduction or other reduction in tax (a \"Tax Benefit\") by reason of any increased amount paid by the Company under this subsection 7.6, such Bank will use reasonable efforts to obtain such Tax Benefit and, upon receipt thereof will pay to the Company such amount, not exceeding the increased amount paid by the Company, as it considers, in its sole opinion, to be equal to the net after-tax value to such Bank of the Tax Benefit or such part thereof allocable to such withholding or deduction, having regard to all of such Bank's dealings giving rise to similar credits and to the cost of obtaining the same, less any and all expenses incurred by such Bank in obtaining such Tax Benefit (including any and all professional fees incurred therewith); provided, however, that (i) no Bank shall be obligated by this subsection 7.6 to disclose to the Company any information regarding its tax affairs or computations, (ii) nothing in this subsection 7.6 shall interfere with the right of each Bank to arrange its tax affairs as it deems appropriate and (iii) nothing in this subsection 7.6 shall impose an obligation on a Bank to obtain any Tax Benefit if, in such Bank's sole opinion, to do so would (x) impose undue hardships, burdens or expenditures on such Bank or (y) increase such Bank's exposure to taxation by the jurisdiction in question.\n\t\t7.7 Company's Options upon Claims for Increased Costs and Taxes. In the event that any Affected Bank shall decline to make Eurocurrency Loans pursuant to subsection 7.4 or shall have notified the Company that it is entitled to claim compensation pursuant to subsection 7.5 or 7.6, the Company may exercise any one or both of the following options:\n\t\t(a)\tThe Company may request one or more of the Banks which are not Affected Banks to take over all (but not part) of any Affected Banks's then outstanding Loans and to assume all (but not part) of any Affected Bank's Commitments, if any, and obligations hereunder, and if applicable, under any Local Currency Facility. If one or more Banks shall so agree in writing (collectively, the \"Assenting Banks\"; individually, an \"Assenting Bank\") with respect to an Affected Bank, (i) the Commitments, if any, of each Assenting Bank and the obligations of such Assenting Bank under this Agreement shall be increased by its respective Allocable Share of the Commitments, if any, and of the obligations of such Affected Bank under this Agreement and if applicable, under any Local Currency Facility and (ii) each Assenting Bank shall make Loans to the Company, according to such Assenting Bank's respective Allocable Share, in an aggregate principal amount equal to the outstanding principal amount of the Loans and, if applicable, Local Currency Loans, of such Affected Bank, on a date mutually acceptable to the Assenting Banks, such Affected Bank and the Company. The proceeds of such Loans, together with funds of the Company, shall be used to prepay the Loans, and if applicable, Local Currency Loans, of such Affected Bank, together with all interest accrued thereon and all other amounts owing to such Affected Bank hereunder (including any amounts payable pursuant to subsection 7.8 in connection with such prepayment), and, upon such assumption by the Assenting Bank and prepayment by the Company, such Affected Bank shall cease to be a \"Bank\" for purposes of this Agreement and shall no longer have any obligations or rights hereunder (other than any obligations or rights which according to this Agreement shall survive the termination of this Agreement).\n\t\t(b)\tThe Company may designate a replacement bank (a \"Replacement Bank\") to assume the Commitments, if any, and the obligations of any such Affected Bank hereunder and if applicable, under any Local Currency Facility, and to purchase the outstanding Loans of such Affected Bank and such Affected Bank's rights hereunder and with respect thereto, without recourse upon, or warranty by, or expense to, such Affected Bank (unless such Affected Bank agrees otherwise), for a purchase price equal to the outstanding principal amount of the Loans and, if applicable, Local Currency Loans, of such Affected Bank plus (i) all interest accrued and unpaid thereon and all other amounts owing to such Affected Bank hereunder and (ii) any amount which would be payable to such Affected Bank pursuant to subsection 7.8, and upon such assumption and purchase by the Replacement Bank, such Replacement Bank shall be deemed to be a \"Bank\" for purposes of this Agreement and such Affected Bank shall cease to be a \"Bank\" for purposes of this Agreement and shall no longer have any obligations or rights hereunder (other than any obligations or rights which according to this Agreement shall survive the termination of this Agreement).\n\t\t7.8 Indemnity. Each Borrower agrees to indemnify each Bank and to hold each Bank harmless from any loss or expense (but excluding any lost profits) which such Bank may sustain or incur as a consequence of (a) default by such Borrower in payment when due of the principal amount of or interest on any Eurocurrency Loan, (b) default by such Borrower in making a borrowing of, conversion into or continuation of Eurocurrency Loans after such Borrower has given a notice requesting the same in accordance with the provisions of this Agreement, (c) default by such Borrower in making any prepayment of Eurocurrency Loans after such Borrower has given a notice thereof in accordance with the provisions of this Agreement, (d) the making of a prepayment or conversion of Eurocurrency Loans on a day which is not the last day of an Interest Period with respect thereto or (e) the prepayment of any Competitive Advance Loan, including, without limitation, in each case, any such loss or expense arising from the reemployment or repayment of funds obtained by such Bank or from fees payable to terminate the deposits from which such funds were obtained. This covenant shall survive the termination of this Agreement and the payment of the Loans and all other amounts payable hereunder.\n\t\t7.9 Determinations. In making the determinations contemplated by Subsection 7.5, 7.6 and 7.8, each Bank may make such estimates, assumptions, allocations and the like that such Bank in good faith determines to be appropriate. Upon request of the Company, each Bank shall furnish to the Company, at any time after demand for payment of an amount under subsection 7.5(a) or 7.8, a certificate outlining in reasonable detail the computation of any amounts owing. Any certificate furnished by a Bank shall be binding and conclusive in the absence of manifest error.\n\t\t7.10 Change of Lending Office. If an event occurs with respect to any Bank that makes operable the provisions of subsection 7.4 or entitles such Bank to make a claim under subsection 7.5 or 7.6, such Bank shall, if requested in writing by the Company, to the extent not inconsistent with such Bank's internal policies, use reasonable efforts to (a) designate another office or offices for the making and maintaining of its Loans or (b) obtain a different source of funds or credit, as the case may be, the designation or obtaining of which will eliminate such operability or reduce materially the amount such Bank is so entitled to claim, provided that such designation or obtaining would not, in the sole discretion of such Bank, result in such Bank incurring any costs unless the Company has agreed to reimburse such Bank therefor.\n\t\t7.11 Company Controls on Exposure; Calculation of Exposure; Prepayment if Exposure exceeds Commitments. (a) The Company will implement and maintain internal accounting controls to monitor the borrowings and repayments of Loans by the Borrowers and the issuance of and drawings under Letters of Credit, with the object of preventing any request for an Extension of Credit that would result in (i) the Exposure of the Banks being in excess of the Commitments, (ii) the Foreign Currency Exposure exceeding $250,000,000 or (iii) the Company Guarantee Ratio exceeding 25% and of promptly identifying and remedying any circumstance where, by reason of changes in exchange rates, (i) the aggregate amount of the Exposure does exceed the Commitments, (ii) the amount of the Foreign Currency Exposure exceeds $250,000,000 or (iii) the Company Guarantee Ratio exceeds 25%. In the event that at any time the Company determines that (i) the aggregate amount of the Exposure of the Banks exceeds the aggregate amount of the Commitments by more that 5%, (ii) the amount of the Foreign Currency Exposure exceeds $250,000,000 or (iii) the Company Guarantee Ratio exceeds 25%, the Company will, as soon as practicable but in any event within five Business Days of making such determination, make or cause to be made such repayments or prepayments of Loans as shall be necessary to cause (i) the aggregate amount of the Exposure of the Banks to no longer exceed the Commitments, (ii) the amount of the Foreign Currency Exposure not to exceed $250,000,000 or (iii) the Company Guarantee Ratio not to exceed 25%.\n\t\t(b) The Administrative Agent will calculate the aggregate amount of the Exposure of the Banks from time to time, and in any event not less frequently than once during each calendar month. In making such calculations, the Administrative Agent will rely on the information most recently received by it from the Swing Line Banks in respect of outstanding Swing Line Loans, from Banks in respect of outstanding Competitive Advance Loans, from Local Currency Facility Agents in respect of outstanding Local Currency Loans and Issuing Banks in respect of L\/C Obligations. Upon making each such calculation, the Administrative Agent will inform the Company and the Banks of the results thereof.\n\t\t(c) In the event that on any date the Administrative Agent calculates that (i) the aggregate amount of the Exposure of the Banks exceeds the aggregate amount of the Commitments by more than 5%, (ii) the Foreign Currency Exposure exceeds $250,000,000 or (iii) the Company Guarantee Ratio exceeds 25%, the Administrative Agent will give notice to such effect to the Company. Within five Business Days after receipt of any such notice, the Company will, as soon as practicable but in any event within five Business Days of receipt of such notice, make or cause to be made such repayments or prepayments of Loans as shall be necessary to cause (i) the aggregate amount of the Exposure of the Banks to no longer exceed the Commitments, (ii) the Foreign Currency Exposure not to exceed $250,000,000 or (iii) the Company Guarantee Ratio not to exceed 25%.\n\t\t(d) If at the time any Foreign Subsidiary Borrower becomes a Limited Subsidiary Borrower the Exposure of such Limited Subsidiary Borrower owing to the Banks exceeds $20,000,000, within five Business Days after such Foreign Subsidiary Borrower becomes a Limited Subsidiary its Exposure owing to the Banks in excess of $20,000,000 shall be repaid and thereafter, for so long as such Foreign Subsidiary Borrower remains a Limited Subsidiary Borrower, it will not, and the Company will ensure it does not, have Exposure owing to the Banks in excess of $20,000,000.\n\t\t(e)\tIf at any time the Committed Exposure of any Bank exceeds such Bank's Commitment, upon demand of such Bank, the Company will within one Business Day prepay Loans in such amounts that after giving effect to such prepayment the Committed Exposure of such Bank does not exceed its Commitment.\n\t\t(f) Any prepayment required to be made pursuant to this subsection 7.11 shall be accompanied by payment of amounts payable, if any, pursuant to subsection 7.8 in respect of the amount so prepaid.\n\tSECTION 8. REPRESENTATIONS AND WARRANTIES\n\t\tTo induce the Agents, the Administrative Agent and the Banks to enter into this Agreement and to make the Loans and issue or participate in the Letters of Credit, the Company and each Foreign Subsidiary Borrower (in so far as the representations and warranties by such Foreign Subsidiary Borrower relate to it) hereby represents and warrants to each Agent, the Administrative Agent and each Bank that:\n\t\t8.1 Financial Condition. The audited consolidated balance sheets of the Company and its consolidated Subsidiaries as at December 31, 1994 and the related consolidated statements of operations and of cash flows for the fiscal year ended on such date, reported on by Ernst & Young LLP, copies of which have heretofore been furnished to each Bank, present fairly the consolidated financial condition of the Company and its consolidated Subsidiaries as at such date, and the consolidated results of their operations and their consolidated cash flows for the fiscal year then ended. The unaudited consolidated balance sheet of the Company and its consolidated Subsidiaries as at March 31, 1995 and the related unaudited consolidated statements of operations and of cash flows for the three-month period ended on such date, certified by a Responsible Officer, copies of which have heretofore been furnished to each Bank, present fairly the consolidated financial condition of the Company and its consolidated Subsidiaries as at such date, and the consolidated results of their operations and their consolidated cash flows for the three-month period then ended (subject to normal year-end audit adjustments). The unaudited consolidating balance sheet of the Company and its consolidated Subsidiaries by principal operating group as at December 31, 1994 and the related unaudited consolidating statements of operations for the fiscal year ended on such date, certified by a Responsible Officer, copies of which have heretofore been furnished to each Bank, present fairly the consolidating financial condition of the Company and its consolidated Subsidiaries by principal operating group as at such date, and the consolidating results of their operations for the fiscal year then ended. All such financial statements, including the related schedules and notes thereto, have been prepared in accordance with GAAP applied consistently throughout the periods involved (except as approved by such accountants or Responsible Officer, as the case may be, and as disclosed therein). Neither the Company nor any of its consolidated Subsidiaries had, at the date of the most recent balance sheet referred to above, any material Guarantee Obligation, contingent liability or liability for taxes, or any long- term lease or unusual forward or long-term commitment, including, without limitation, any interest rate or foreign currency swap or exchange transaction, which is not reflected in the foregoing statements or referred to in the notes thereto. During the period from December 31, 1994 to and including the date hereof there has been no sale, transfer or other disposition by the Company or any of its consolidated Subsidiaries of any material part of its business or property and no purchase or other acquisition of any business or property (including any Capital Stock of any other Person) material in relation to the consolidated financial condition of the Company and its consolidated Subsidiaries at December 31, 1994 (except as otherwise disclosed in writing to the Banks prior to the Closing Date).\n\t\t8.2 No Change. Since December 31, 1994 there has been no development or event which has had or could reasonably be expected to have a Material Adverse Effect.\n\t\t8.3 Corporate Existence; Compliance with Law. Each of the Company and its Subsidiaries (a) is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, (b) has the corporate or other power and authority, and the legal right, to own and operate its property, to lease the property it operates as lessee and to conduct the business in which it is currently engaged, (c) is duly qualified as a foreign corporation or other entity and in good standing under the laws of each jurisdiction where its ownership, lease or operation of property or the conduct of its business requires such qualification, except where the failure to be duly qualified or in good standing could not reasonably be expected to have a Material Adverse Effect, and (d) is in compliance with all Requirements of Law except to the extent that the failure to comply therewith could not, in the aggregate, reasonably be expected to have a Material Adverse Effect.\n\t\t8.4 Corporate Power; Authorization; Enforceable Obligations. The Company and each of its Subsidiaries has the corporate or other power and authority, and the legal right, to make, deliver and perform the Credit Documents to which it is a party and to borrow hereunder and has taken all necessary corporate action to authorize the borrowings on the terms and conditions of this Agreement and the execution, delivery and performance of the Credit Documents to which it is a party. No consent or authorization of, filing with, notice to or other act by or in respect of, any Governmental Authority or any other Person is required in connection with the borrowings hereunder or with the execution, delivery, performance, validity or enforceability of the Credit Documents. This Agreement has been, and each other Credit Document to which the Company or any of its Subsidiaries is a party will be, duly executed and delivered on behalf of the Company or such Subsidiary, as the case may be. This Agreement constitutes, and each other Credit Document to which it is a party when executed and delivered will constitute, a legal, valid and binding obligation of the Company or any of its Subsidiaries party thereto enforceable against the Company or such Subsidiary, as the case may be, 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 and by general equitable principles (whether enforcement is sought by proceedings in equity or at law).\n\t\t8.5 No Legal Bar. The execution, delivery and performance of the Credit Documents to which the Company or any of its Subsidiaries is a party, the borrowings hereunder and the use of the proceeds thereof will not violate any Requirement of Law or Contractual Obligation of the Company or of any of its Subsidiaries (except for violations of Contractual Obligations which, individually or in the aggregate, could not reasonably be expected to have a Material Adverse Effect) and will not result in, or require, the creation or imposition of any Lien on any of its or their respective properties or revenues pursuant to any such Requirement of Law or Contractual Obligation, except for the Liens expressly permitted by subsection 11.3.\n\t\t8.6 No Material Litigation. No litigation, investigation or proceeding of or before any arbitrator or Governmental Authority is pending or, to the knowledge of the Company, threatened by or against the Company or any of its Subsidiaries or against any of its or their respective properties or revenues (a) with respect to any of the Credit Documents or any of the transactions contemplated hereby or thereby, or (b) which, if adversely determined, would have a Material Adverse Effect.\n\t\t8.7 No Default. Neither the Company nor any of its Subsidiaries is in default under or with respect to any of its Contractual Obligations in any respect which could reasonably be expected to have a Material Adverse Effect. No Default or Event of Default has occurred and is continuing.\n\t\t8.8 Ownership of Property; Liens. Each of the Company and its Subsidiaries has good record and marketable title in fee simple to, or a valid leasehold interest in, all its real property, and good title to, or a valid leasehold interest in, all its other property, except where the failure to have such title or such leasehold interest, as the case may be, could not reasonably be expected to have a Material Adverse Effect, and none of such property is subject to any Lien except as permitted by subsection 11.3.\n\t\t8.9 Intellectual Property. The Company and each of its Subsidiaries owns, or is licensed to use, all domestic and foreign trademarks, tradenames, copyrights, technology, know-how and processes necessary for the conduct of its business as currently conducted (the \"Intellectual Property\") except for those the failure to own or license which could not reasonably be expected to have a Material Adverse Effect. No claim has been asserted and is pending or, to the knowledge of the Company, has been threatened by any Person challenging or questioning the use of any such Intellectual Property or the validity or effectiveness of any such Intellectual Property which could reasonably be expected to have a Material Adverse Effect, nor does the Company know of any valid basis for any such claim. The use of such Intellectual Property by the Company and its Subsidiaries does not infringe on the rights of any Person, except for such claims and infringements that, in the aggregate, could not reasonably be expected to have a Material Adverse Effect.\n\t\t8.10 No Burdensome Restrictions. No Requirement of Law or Contractual Obligation of the Company or any of its Subsidiaries has or could reasonably be expected to have a Material Adverse Effect.\n\t\t8.11 Taxes. Each of the Company and its consolidated Subsidiaries has filed or caused to be filed all tax returns which, to the knowledge of the Company, are required to be filed and has paid all taxes shown to be due and payable on said returns or on any assessments made against it or any of its property and all other taxes, fees or other charges imposed on it or any of its property by any Governmental Authority (other than any unfiled tax returns for taxes, and unpaid taxes, fees and other charges, (a) the amount or validity of which are currently being contested in good faith by appropriate proceedings and with respect to which reserves in conformity with GAAP have been provided on the books of the Company or its consolidated Subsidiaries, as the case may be, or (b) which in each case, individually or in the aggregate, would not cause the Company and its consolidated Subsidiaries to have a liability in excess of $5,000,000 or the Dollar Equivalent Amount thereof); no notice of tax Lien has been filed, and, to the knowledge of the Company, no claim is being asserted by any taxing authority, with respect to any such tax, fee or other charge except for claims the amount or validity of which are currently being contested in good faith by appropriate proceedings and with respect to which reserves in conformity with GAAP have been provided on the books of the Company or its consolidated Subsidiaries, as the case may be, and claims for amounts which, in the aggregate, do not exceed $5,000,000.\n\t\t8.12 Federal Regulations. No part of the proceeds of any Loans will be used for \"purchasing\" or \"carrying\" any \"margin stock\" within the respective meanings of each of the quoted terms under Regulation U of the Board of Governors of the Federal Reserve System as now and from time to time hereafter in effect or for any purpose which violates the provisions of the regulations of such Board of Governors. If requested by any Bank or the Administrative Agent, the Company will furnish to the Administrative Agent and each Bank a statement to the foregoing effect in conformity with the requirements of FR Form U-1 referred to in said Regulation U.\n\t\t8.13 ERISA. Each Plan which is intended to be qualified under Section 401(a) (or 403(a) as appropriate) of the Code and each related trust agreement, annuity contract or other funding instrument which is intended to be tax-exempt under Section 501(a) of the Code is so qualified and tax-exempt and has been so qualified and tax-exempt during the period from its adoption to date. No event has occurred in connection with which the Company or any Commonly Controlled Entity or any Plan, directly or indirectly, could reasonably be expected to be subject to any material liability under ERISA, the Code or any other law, regulation or governmental order or under any agreement, instrument, statute, rule of law or regulation pursuant to or under which the Company or a Subsidiary has agreed to indemnify or is required to indemnify any person against liability incurred under, or for a violation or failure to satisfy the requirements of, any such statute, regulation or order. No Reportable Event has occurred during the five- year period prior to the date on which this representation is made or deemed made with respect to any Plan, and each Plan has complied in all material respects with the applicable provisions of ERISA and the Code. The present value of all accrued benefits under each Single Employer Plan maintained by the Company or any Commonly Controlled Entity or for which the Company or any Commonly Controlled Entity has or could have any liability (based on those assumptions used to fund the Plans) did not, as of the last annual valuation date prior to the date on which this representation is made or deemed made, exceed the value of the assets of such Plan allocable to such accrued benefits. Neither the Company nor any Commonly Controlled Entity has had a complete or partial withdrawal from any Multiemployer Plan, and neither the Company nor any Commonly Controlled Entity could reasonably be expected to become subject to any liability under ERISA if the Company or any such Commonly Controlled Entity were to withdraw completely from all Multiemployer Plans as of the valuation date most closely preceding the date on which this representation is made or deemed made. No such Multiemployer Plan is in Reorganization or Insolvent. The present value (determined using actuarial and other assumptions which are reasonable in respect of the benefits provided and the employees participating) of the unfunded liability of the Company and each Commonly Controlled Entity for benefits under all unfunded retirement or severance plans, programs, policies or other arrangements (including, without limitation, post retirement benefits to be provided to their current and former employees under Plans which are welfare benefit plans (as defined in Section 3(1) of ERISA)), whether or not funded does not, in the aggregate, exceed $5,000,000 (excluding those arrangements set forth on Schedule 8.13).\n\t\t8.14 Investment Company Act; Other Regulations. Neither the Company nor any Subsidiary of the Company is an \"investment company\", or a company \"controlled\" by an \"investment company\", within the meaning of the Investment Company Act of 1940, as amended. Neither the Company nor any Subsidiary of the Company is subject to regulation under any Federal or State statute or regulation which limits its ability to incur Indebtedness.\n\t\t8.15 Subsidiaries. On the Closing Date, the only Subsidiaries of the Company, and the only material partnerships or joint ventures in which the Company or any Subsidiary has an interest, are those set forth on Schedule 8.15. On the Closing Date, the Company owns the percentage of the issued and outstanding Capital Stock or other evidences of the ownership of each Subsidiary, partnership or joint venture set forth on Schedule 8.15 as set forth on such Schedule. On the Closing Date, except as set forth on Schedule 8.15, no such Subsidiary, partnership or joint venture has issued any securities convertible into shares of its Capital Stock. The outstanding stock and securities (or other evidence of ownership) of such Subsidiaries, partnerships or joint ventures owned by the Company and its Subsidiaries are owned by the Company and its Subsidiaries free and clear of all Liens, warrants, options or rights of others of any kind whatsoever except for Liens permitted by subsection 11.3.\n\t\t8.16 Accuracy and Completeness of Information. No document furnished or statement made in writing to the Banks by the Company in connection with the negotiation, preparation or execution of this Agreement or any of the other Credit Documents contains any untrue statement of a material fact, or omits to state any such material fact necessary in order to make the statements contained therein not misleading, in either case which has not been corrected, supplemented or remedied by subsequent documents furnished or statements made in writing to the Banks. All other written information, reports and other papers and data with respect to the Company and its Subsidiaries (other than financial statements), furnished to the Banks by the Company, or on behalf of the Company, were (a) in the case of those not prepared for delivery to the Banks, to the Company's knowledge, at the time the same were so furnished, complete and correct in all material respects for the purposes for which the same were prepared and (b) in the case of those prepared for delivery to the Banks, to the Company's knowledge, complete and correct in all material respects, or have been subsequently supplemented by other information, reports or other papers or data, to the extent necessary to give the Banks a true and accurate knowledge of the subject matter in all material respects, it being understood that financial projections as to future events are not to be viewed as facts and that actual results may differ from projected results. No fact is known to the Company or any of its Subsidiaries which has had or could reasonably be expected to have a Material Adverse Effect, which has not been set forth in the financial statements referred to in subsection 8.1 (or otherwise disclosed in writing to the Banks prior to the Closing Date).\n\t\t8.17 Purpose of Loans. The proceeds of the Loans shall be used by the Company for working capital purposes in the ordinary course of business and for general corporate purposes of the Company and, to the extent permitted hereunder, its Subsidiaries.\n\t\t8.18 Senior Indebtedness. The principal of and interest on the Loans, the Reimbursement Obligations and the Company's obligations under the Company Guarantee are and will continue to be within the definition of \"Senior Indebtedness\" or any similar term under the Subordinated Debentures.\n\t\t8.19 Environmental Matters. Except as set forth on Schedule 8.19 or insofar as there is no reasonable likelihood of a Material Adverse Effect arising from any combination of facts or circumstances inconsistent with any of the following:\n\t\t(a) The facilities and properties owned or operated by the Company or any of its Subsidiaries (the \"Properties\") do not contain, and to the knowledge of the Company or its Subsidiaries, have not previously contained, any Materials of Environmental Concern in amounts or concentrations which (i) constitute or constituted a violation of, or (ii) could reasonably be expected to give rise to liability under, any applicable Environmental Law.\n\t\t(b) The Properties and all operations at the Properties are in compliance with all applicable Environmental Laws, and there is no contamination at, under or to the knowledge of the Company about the Properties or violation of any Environmental Law with respect to the Properties or the business operated by the Company or any of its Subsidiaries (the \"Business\") which could materially interfere with the continued operation of the Properties.\n\t\t(c) Neither the Company nor any of its Subsidiaries has received any notice of violation, alleged violation, non-compliance, liability or potential liability regarding environmental matters or compliance with Environmental Laws with regard to any of the Properties or the Business, nor does the Company or any of its Subsidiaries have knowledge or reason to believe that any such notice will be received or is being threatened.\n\t\t(d) To the knowledge of the Company or any of its Subsidiaries, Materials of Environmental Concern have not been transported or disposed of from the Properties in violation of, or in a manner or to a location which could reasonably be expected to give rise to liability under, any Environmental Law, nor have any Materials of Environmental Concern been generated, treated, stored or disposed of at, on or under any of the Properties in violation of, or in a manner that could reasonably be expected to give rise to liability under, any applicable Environmental Law.\n\t\t(e) No judicial proceeding or governmental or administrative action is pending or, to the knowledge of the Company or any of its Subsidiaries, threatened, under any Environmental Law to which the Company or any Subsidiary is or will be named as a party with respect to the Properties or the Business, nor are there any consent decrees or other decrees, consent orders, administrative orders or other orders, or other analogous administrative or judicial requirements outstanding under any Environmental Law with respect to the Properties or the Business.\n\t\t(f) There has been no release or threat of release of Materials of Environmental Concern at or from the Properties, or arising from or related to the operations of the Company or any Subsidiary in connection with the Properties or otherwise in connection with the Business, in violation of or in amounts or in a manner that could reasonably give rise to liability under any applicable Environmental Laws.\n\tSECTION 9. CONDITIONS PRECEDENT\n\t\t9.1 Conditions to Closing Date. The occurrence of the Closing Date, and the agreement of each Bank to make the initial Extension of Credit requested to be made by it on or after the Closing Date, shall be subject to the satisfaction, on or prior to the Closing Date, of the following conditions precedent:\n\t\t(a) Credit Documents. The Administrative Agent shall have received (i) this Agreement, executed and delivered by a duly authorized officer of the Company, with a counterpart for each Bank, (ii) for the account of each Bank, the Company Guarantee executed and delivered by a duly authorized officer of the Company, with a counterpart or conformed copy for each Bank and (iii) each Existing Subsidiary Guarantee, together with the related Consent and Confirmation, executed and delivered by a duly authorized officer of the Guarantor party thereto, with a counterpart or a conformed copy for each Bank.\n\t\t(b) Borrowing Certificate. The Administrative Agent shall have received with a counterpart for each Bank, a certificate of the Company, dated the Closing Date, substantially in the form of Exhibit E, with appropriate insertions and attachments, satisfactory in form and substance to the Administrative Agent, executed by the President, Executive Vice President or any Vice President and the Secretary or any Assistant Secretary of the Company.\n\t\t(c) Corporate Proceedings of Company. The Administrative Agent shall have received, with a counterpart for each Bank, a copy of the resolutions, in form and substance satisfactory to the Administrative Agent, of the Board of Directors of the Company authorizing (i) the execution, delivery and performance of this Agreement and the other Credit Documents to which it is a party and (ii) the borrowings contemplated hereunder, certified by the Secretary or an Assistant Secretary of such Loan party as of the Closing Date, which certificate shall be in form and substance satisfactory to the Administrative Agent and shall state that the resolutions thereby certified have not been amended, modified, revoked or rescinded.\n\t\t(d) Fees and Expenses. The Administrative Agent shall have received the fees and expenses to be received on or prior to the Closing Date pursuant to subsection 7.1(b).\n\t\t(e) Legal Opinions. The Administrative Agent shall have received, with a counterpart for each Bank, the following executed legal opinions:\n\t\t\t\t(i)\t the executed legal opinion of Winthrop, Stimson, Putnam & Roberts, counsel to the Company, substantially in the form of Exhibit G-1, with such modifications therein as shall be reasonably requested or approved by the Administrative Agent;\n\t\t\t\t(ii)\t the executed legal opinion of Robert E. Klatell, general counsel of the Company, substantially in the form of Exhibit G-2, with such modifications therein as shall be reasonably requested or approved by the Administrative Agent; and\n\t\t\t\t(iii)\t the executed Foreign Subsidiary Opinion of counsel to each Foreign Subsidiary Borrower located in England or Germany that is a party to this Agreement on the Closing Date.\n\tEach such legal opinion shall cover such other matters incident to the transactions contemplated by this Agreement and the other Credit Documents as the Administrative Agent may reasonably require.\n\t\t(f) No Material Litigation. No litigation, inquiry, injunction or restraining order shall be pending, entered or threatened (including any proposed statute, rule or regulation) which in the reasonable judgment of any Bank could have a Material Adverse Effect.\n\t\t(g) Payment of Amounts under Existing Credit Agreement. All principal of and interest on the Loans (as defined in the Existing Credit Agreement) and all other amounts (including, without limitation, compensation in respect of prepayments of such Loans) owing under or in connection with the Existing Credit Agreement shall have been paid in full.\n\t\t(h)\tNotice of Guarantee Ceiling Amount. The Administrative Agent shall have received with a counterpart for each Bank, a Notice of Guarantee Ceiling Amount, dated the Closing Date, with appropriate insertions, executed by a Responsible Officer of the Company.\n\t\t(i)\tCalculation of Guarantee Ceiling Amount. The Banks shall have received confirmation satisfactory to them that the obligations of the Domestic Subsidiaries under the Subsidiary Guarantees will not be included in the indebtedness of the Domestic Subsidiaries for purposes of calculating the Guarantee Ceiling Amount in accordance with the Note Purchase Agreement.\n\t\t(j) Additional Matters. All corporate and other proceedings, and all documents, instruments and other legal matters in connection with the transactions contemplated by this Agreement and the other Credit Documents shall be reasonably satisfactory in form and substance to the Administrative Agent.\n\t\t9.2 Conditions to Each Extension of Credit. The agreement of each Bank to make any Extension of Credit requested to be made by it on any date (including, without limitation, its initial Extension of Credit, but excluding any Committed Rate Loan made pursuant to a Notice of Swing Line Refunding, pursuant to subsections 5.5(c) or 6.3 or pursuant to subsection 2.6(c) if the Dollar Equivalent Amount thereof is not increased) is subject to the satisfaction of the following conditions precedent:\n\t\t(a) Representations and Warranties. Each of the representations and warranties made by the Company and its Subsidiaries in or pursuant to the Credit Documents shall be true and correct in all material respects on and as of such date as if made on and as of such date.\n\t\t(b) No Default. No Default or Event of Default shall have occurred and be continuing on such date after giving effect to the Loans requested to be made on such date.\n\t\t(c)\tNo Material Adverse Change in Foreign Subsidiary Borrowers. If such Extension of Credit is to or for a Foreign Subsidiary Borrower, no event which has or could reasonably expected to have a material adverse effect on the ability of such Foreign Subsidiary Borrower to perform its obligations under this Agreement shall have occurred.\nEach borrowing by and Letter of Credit issued on behalf of any Borrower shall constitute a representation and warranty by the Company and each Foreign Subsidiary Borrower as of the date of such Loan and\/or Letter of Credit that the conditions contained in this subsection 9.2 have been satisfied.\n\tSECTION 10. AFFIRMATIVE COVENANTS\n\t\tThe Company hereby agrees that, so long as the Commitments remain in effect, any Letter of Credit remains outstanding and unpaid or any other amount is owing to any Bank, any Agent or the Administrative Agent hereunder or under any Local Currency Facility, the Company shall and (except in the case of delivery of financial information, reports and notices) shall cause each of its Subsidiaries to:\n\t\t10.1 Financial Statements. Furnish to each Bank:\n\t\t(a) as soon as available, but in any event within 120 days after the end of each fiscal year of the Company, a copy of the audited consolidated balance sheet of the Company and its consolidated Subsidiaries as at the end of such year and the related consolidated statements of operations and shareholders equity and of cash flows for such year, setting forth in each case in comparative form the figures for the previous year, reported on without a \"going concern\" or like qualification or exception, or qualification arising out of the scope of the audit, by Ernst & Young or other independent certified public accountants of nationally recognized standing reasonably acceptable to the Required Banks;\n\t\t(b) as soon as available, but in any event within 120 days after the end of each fiscal year of the Company, the unaudited consolidating balance sheet of the Company and its consolidated Subsidiaries by principal operating group as at the end of such year and the related unaudited consolidating statements of operations of the Company and its consolidated Subsidiaries by principal operating group for such year, setting forth in each case in comparative form the figures for the previous year, certified pursuant to subsection 10.2(b) by a Responsible Officer as fairly presenting the consolidating financial condition and results of operations of the Company and its consolidated Subsidiaries by principal operating group;\n\t\t(c) as soon as available, but in any event within 60 days after the end of each of the first three quarterly periods of each fiscal year of the Company, the unaudited consolidated balance sheet of the Company and its consolidated Subsidiaries as at the end of such quarter and the related unaudited consolidated statements of operations and shareholders' equity and of cash flows of the Company and its consolidated Subsidiaries for such quarter and the portion of the fiscal year through the end of such quarter, setting forth in each case in comparative form the figures for such quarter of the previous year, certified by a Responsible Officer as fairly presenting in all material respects when considered in relation to the consolidated financial statements of the Company and its consolidated Subsidiaries (subject to normal year-end audit adjustments); provided that the Company may in lieu of furnishing such unaudited consolidated balance sheet furnish to each Bank its Form 10-Q filed with the Securities and Exchange Commission or any successor or analogous Governmental Authority for the relevant quarterly period; and\n\t\t(d) as soon as available, but in any event within 60 days after the end of each of the first three quarterly periods of each fiscal year of the Company, the unaudited consolidating balance sheet of the Company and its consolidated Subsidiaries by principal operating group as at the end of such quarter and the related unaudited consolidating statements of operations of the Company and its consolidated Subsidiaries by principal operating group for such quarter and the portion of the fiscal year through the end of such quarter, in the case of the unaudited consolidating balance sheet setting forth in comparative form the figures for the previous year (but not the corresponding figures for such quarter of the previous year) and in the case of the statements of operations setting forth in comparative form the figures for such quarter of the previous year, certified by a Responsible Officer as fairly presenting the consolidating financial condition and results of operations of the Company and its consolidated Subsidiaries by principal operating group (subject to normal year-end audit adjustments);\nthe financial statements to be furnished pursuant to this subsection 10.1 shall fairly present the consolidated (or consolidating by principal operating group, as appropriate) financial position and results of operations of the Company and its consolidated Subsidiaries in accordance with GAAP (subject, in the case of subsections 10.1(c) and (d), to normal year-end audit adjustments and the absence of complete footnotes) applied consistently throughout the periods reflected therein and with prior periods (except as approved by such accountants or Responsible Officer, as the case may be, and disclosed therein).\n\t\t10.2 Certificates; Other Information. Furnish to each Bank:\n\t\t(a) concurrently with the delivery of the financial statements referred to in subsection 10.1(a), a certificate of the independent certified public accountants reporting on such financial statements stating that in making the examination necessary therefor no knowledge was obtained of any Default or Event of Default, except as specified in such certificate;\n\t\t(b) concurrently with the delivery of the financial statements referred to in subsections 10.1(a) and 10.1(b), a certificate of a Responsible Officer substantially in the form of Exhibit H;\n\t\t(c) concurrently with the delivery of the financial statements referred to in subsection 10.1(c), a certificate of a Responsible Officer (i) stating that, to the best of such Responsible Officer's knowledge, the Company has observed and performed all of its covenants and other agreements contained in this Agreement and the other Credit Documents to which it is a party to be observed or performed by it, (ii) that such Responsible Officer has obtained no knowledge of any Default or Event of Default except as specified therein and (iii) setting forth calculations supporting compliance with subsections 11.1(a), (b) and (c), 11.2 and 11.5;\n\t\t(d) as soon as delivered, a copy of the letter, addressed to the Company, of the certified public accountants who prepared the financial statements referred to in subsection 10.1(a) for such fiscal year and otherwise referred to as a \"management letter\";\n\t\t(e) within five days after the same are sent, copies of all financial statements and reports which the Company sends to its stockholders generally, and within five days after the same are filed, copies of all financial statements and reports which the Company or any of its Subsidiaries may make to, or file with, the Securities and Exchange Commission or any successor or analogous Governmental Authority;\n\t\t(f)\tconcurrently with the delivery of the financial statements referred to in subsections 10.1(a) and 10.1(c) and upon any incurrence or prepayment of any lien, guarantee or indebtedness which decreases the Guarantee Ceiling Amount by more than 5%, a Notice of Guarantee Ceiling Amount as of the last day of such fiscal period or as the date of such occurrence; and\n\t\t(g) promptly, such additional documents, instruments, legal opinions or financial and other information as the Administrative Agent or any Bank may from time to time reasonably request.\n\t\t10.3 Payment of Obligations. Pay, discharge or otherwise satisfy at or before maturity or before they become delinquent, as the case may be, all its obligations of whatever nature, including, without limitation, all obligations in respect of taxes, except where the amount or validity thereof is currently being contested in good faith by appropriate proceedings and reserves in conformity with GAAP with respect thereto have been provided on the books of the Company or its Subsidiaries, as the case may be, or where the failure to pay, discharge or otherwise satisfy could not reasonably be expected to have a Material Adverse Effect.\n\t\t10.4 Conduct of Business and Maintenance of Existence. Continue to engage in business of the same general type as now conducted by it and preserve, renew and keep in full force and effect its corporate existence and take all reasonable action to maintain all rights, privileges and franchises necessary or desirable in the normal conduct of its business except as otherwise permitted pursuant to subsection 11.4; comply with all Contractual Obligations and Requirements of Law except to the extent that failure to comply therewith could not, in the aggregate, reasonably be expected to have a Material Adverse Effect.\n\t\t10.5 Maintenance of Property; Insurance. Keep all property useful and necessary in its business in good working order and condition, except where the failure to do so could not reasonably be expected to have a Material Adverse Effect; maintain with financially sound and reputable insurance companies insurance on all its property in at least such amounts and against at least such risks (but including in any event public liability, product liability and business interruption) as are usually insured against in the same general area by companies engaged in the same or a similar business; and furnish to each Bank, upon written request, full information as to the insurance carried.\n\t\t10.6 Inspection of Property; Books and Records; Discussions. Keep proper books of records and account in which the entries are, in all material respects, full, true and correct in conformity with sound business practice and all Requirements of Law shall be made of all dealings and transactions in relation to its business and activities; and, upon reasonable notice under the circumstances, permit representatives of the Administrative Agent to visit and inspect any of its properties and examine and make abstracts from any of its books and records at any reasonable time and as often as may reasonably be desired and to discuss the business, operations, properties and financial and other condition of the Company and its Subsidiaries with officers and employees of the Company and its Subsidiaries and with its independent certified public accountants.\n\t\t10.7 Notices. Promptly, after the Company becomes aware thereof, give notice to the Administrative Agent and each Bank of:\n\t\t(a) the occurrence of any Default or Event of Default;\n\t\t(b) any (i) default or event of default under any Contractual Obligation of the Company or any of its Subsidiaries or (ii) litigation, investigation or proceeding which may exist at any time between the Company or any of its Subsidiaries and any Governmental Authority, which in either case, if not cured or if adversely determined, as the case may be, could reasonably be expected to have a Material Adverse Effect or cause a Default or an Event of Default;\n\t\t(c) any litigation or proceeding affecting the Company or any of its Subsidiaries (i) in which the amount involved is $5,000,000 or more and not covered by insurance or (ii) in which injunctive or similar relief is sought which could reasonably be expected to have a Material Adverse Effect;\n\t\t(d) the following events: (i) the occurrence or expected occurrence of any Reportable Event with respect to any Plan, a failure to make any required contribution to a Plan, the creation of any Lien in favor of the PBGC or a Plan or any withdrawal from, or the termination, Reorganization or Insolvency of, any Multiemployer Plan or (ii) the institution of proceedings or the taking of any other action by the PBGC or the Company or any Commonly Controlled Entity or any Multiemployer Plan with respect to the withdrawal from, or the terminating (other than a standard termination under Section 4041(b) of ERISA), Reorganization or Insolvency of, any Plan;\n\t\t(e) any change, development or event involving a prospective change, which has had or could reasonably be expected to have a Material Adverse Effect; and\nEach notice pursuant to this subsection shall be accompanied by a statement of a Responsible Officer setting forth details of the occurrence referred to therein and stating what action the Company proposes to take with respect thereto.\n\t\t10.8 Environmental Laws. (a) Comply with, and take all reasonable efforts to ensure compliance by all tenants and subtenants, if any, in all material respects with, all applicable Environmental Laws and obtain and comply in all material respects with and maintain, and undertake all reasonable efforts to ensure that all tenants and subtenants obtain and comply in all material respects with and maintain, any and all licenses, approvals, notifications, registrations or permits required by applicable Environmental Laws.\n\t\t(b)\tConduct and complete all investigations, studies, sampling and testing, and all remedial, removal and other actions required under Environmental Laws and promptly comply in all material respects with all lawful orders and directives of all Governmental Authorities regarding Environmental Laws except to the extent that the same are being contested in good faith by appropriate proceedings and the pendency of such proceedings could not reasonably be expected to have a Material Adverse Effect.\n\t\t10.9 Additional Subsidiary Guarantees. In the event that any Domestic Subsidiary which is not a Guarantor shall account for more than 5% of Total Assets at any date, take all actions necessary to cause such Domestic Subsidiary to execute and deliver a Subsidiary Guarantee, within 60 days of the occurrence of such event.\n\tSECTION 11. NEGATIVE COVENANTS\n\t\tThe Company hereby agrees that, so long as the Commitments remain in effect, any Letter of Credit remains outstanding and unpaid or any other amount is owing to any Bank, any Agent or the Administrative Agent hereunder or under any Local Currency Facility:\n\t\t11.1 Financial Condition Covenants. The Company shall not:\n\t\t(a) Maintenance of Indebtedness. Permit Consolidated Total Debt at any time to exceed an amount equal to 55% of Consolidated Total Capitalization.\n\t\t(b) Maintenance of Net Worth. Permit Consolidated Net Worth at any time to be less than an amount equal to the sum of $750,000,000 plus 40% of cumulative Consolidated Net Income for the fiscal quarter commencing April 1, 1995 and for each fiscal quarter thereafter (without subtraction for any fiscal quarter during which Consolidated Net Income is a negative number).\n\t\t(c) Interest Coverage. Permit for any period of four consecutive fiscal quarters at any time the ratio of Adjusted Consolidated EBITDA to Consolidated Cash Interest Expense to be less than 3.0 to 1.0.\n\t\t11.2 Limitation on Indebtedness of Domestic Subsidiaries. The Company shall not permit any of its Domestic Subsidiaries to, and the Domestic Subsidiaries shall not, directly or indirectly, create, incur, assume or suffer to exist any Indebtedness, except (a) Indebtedness in an aggregate amount not to exceed 10% of Consolidated Net Worth and (b) any Indebtedness of Domestic Subsidiaries pursuant to any of the Credit Documents.\n\t\t11.3 Limitation on Liens. The Company shall not, and shall not permit any of its Domestic Subsidiaries to, directly or indirectly, create, incur, assume or suffer to exist any Lien upon any of its property, assets or revenues, whether now owned or hereafter acquired, except for:\n\t\t(a) Liens for taxes not yet due or which are being contested in good faith by appropriate proceedings, provided that adequate reserves with respect thereto are maintained on the books of the Company or its Domestic Subsidiaries, as the case may be, in conformity with GAAP;\n\t\t(b) carriers', warehousemen's, mechanics', materialmen's, repairmen's or other like Liens arising in the ordinary course of business which are not overdue for a period of more than 60 days or which are being contested in good faith by appropriate proceedings;\n\t\t(c) pledges or deposits in connection with workers' compensation, unemployment insurance and other social security legislation and deposits securing liability to insurance carriers under insurance or self-insurance arrangements;\n\t\t(d) deposits to secure the performance of bids, trade contracts (other than for borrowed money), leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business;\n\t\t(e) easements, rights-of-way, restrictions and other similar encumbrances incurred in the ordinary course of business which, in the aggregate, are not substantial in amount and which do not in any case materially detract from the value of the property subject thereto or materially interfere with the ordinary conduct of the business of the Company or such Domestic Subsidiary; and\n\t\t(f) Liens (not otherwise permitted hereunder) which secure obligations not exceeding (as to the Company and all Domestic Subsidiaries) a Dollar Equivalent Amount equal to 5% of Consolidated Net Worth at any time outstanding.\n\t\t11.4 Limitation on Fundamental Changes. The Company (a) shall not, and shall not permit any of its Domestic Subsidiaries to, directly or indirectly, enter into any merger, consolidation or amalgamation, or liquidate, wind up or dissolve itself (or suffer any liquidation or dissolution), or convey, sell, lease, assign, transfer or otherwise dispose of, all or substantially all of its property, business or assets and (b) shall not, and shall not permit any of its Subsidiaries, to make any material change in its present method of conducting business, except:\n\t\t\t(i) \tany Subsidiary may be merged or consolidated with or into the Company (provided that the Company shall be the continuing or surviving corporation) or with or into any one or more wholly-owned Domestic Subsidiaries or Capstone; and\n\t\t\t(ii) \tany Subsidiary may sell, lease, transfer or otherwise dispose of any or all of its assets (upon voluntary liquidation or otherwise) to the Company or any other wholly owned Domestic Subsidiary or Capstone.\n\t\t11.5 Limitation on Restricted Payments. The Company shall not, and shall not permit any of its Subsidiaries to, directly or indirectly declare or pay any dividend (other than dividends payable solely in common stock of the Company) on, or make any payment on account of, or set apart assets for a sinking or other analogous fund for, the purchase, redemption, defeasance, retirement or other acquisition of, any shares of any class of Capital Stock of the Company or any warrants or options or rights to purchase any such Stock, whether now or hereafter outstanding, or make any other distribution in respect thereof, either directly or indirectly, whether in cash or property or in obligations of the Company or any Subsidiary (such declarations, payments, setting apart, purchases, redemptions, defeasances, retirements, acquisitions and distributions being herein called \"Restricted Payments\"), except that, so long as no Default or Event of Default has occurred and is continuing or would result therefrom, the Company may declare and make Restricted Payments in a cumulative aggregate amount from the date hereof not exceeding $20,000,000 plus 30% of cumulative Consolidated Net Income from and including October 1, 1993.\n\t\t11.6 Limitation on Negative Pledge Clauses. The Company shall not, and shall not permit any of its Domestic Subsidiaries to, directly or indirectly enter into with any Person other than the Banks pursuant hereto any agreement, other than (a) this Agreement, (b) the Capitalization Documents, (c) the 1992 Private Placement Notes, (d) any industrial revenue bonds, purchase money mortgages, Financing Leases permitted by this Agreement or agreements with suppliers (in which cases, any prohibition or limitation shall only be effective against the assets financed thereby or inventory purchased from such supplier, as the case may be), and (e) other agreements provided the net book value of the property, assets or revenues subject thereto at any time does not exceed 5% of the Consolidated Net Worth of the Company, which prohibits or limits the ability of the Company or any of its Domestic Subsidiaries to create, incur, assume or suffer to exist any Lien upon any of its property, assets or revenues, whether now owned or hereafter acquired.\n\t\t11.7 Limitation on Modifications of Debt Instruments. The Company shall not, and shall not permit any of its Subsidiaries to, directly or indirectly, amend, modify or change, or consent or agree to any amendment, modification or change to any of the terms of any Subordinated Indebtedness or any agreement which sets forth the terms of any Subordinated Indebtedness, except amendments, modifications or changes which would not (directly or indirectly) increase the amount of any payment of principal thereof, increase the interest rate or premium payable thereon, increase the amount of fees or any other amounts payable with respect thereto, shorten the scheduled amortization or average weighted life thereof, shorten the date for payment of interest thereon, shorten the final maturity thereof or modify the subordination provisions thereof.\n\tSECTION 12. EVENTS OF DEFAULT\n\t\tIf any of the following events shall occur and be continuing:\n\t\t(a) (i) Any Specified Borrower shall fail to pay any principal of any Loan or any Reimbursement Obligation owing by it when due (whether at the stated maturity, by acceleration or otherwise) in accordance with the terms hereof; or (ii) any Local Currency Borrower shall fail to pay any principal of or interest on any Local Currency Loan when due in accordance with the applicable terms of the relevant Local Currency Facility; or (iii) any Specified Borrower shall fail to pay any interest on any Loan or any fee or any other amount payable hereunder, within five days after any such interest or other amount becomes due in accordance with the terms thereof or hereof; or\n\t\t(b) Any representation or warranty made or deemed made by the Company or any Subsidiary herein or in any other Credit Document or which is contained in any certificate, document or financial or other statement furnished by it at any time under or in connection with this Agreement or any such other Credit Document shall prove to have been incorrect in any material respect on or as of the date made or deemed made; or\n\t\t(c) The Company or any Subsidiary shall default in the observance or performance of any agreement contained in Section 11 and, with respect to subsections 11.2 and 11.3, such default shall continue unremedied for a period of 30 days; or\n\t\t(d) The Company or any Subsidiary shall default in the observance or performance of any other agreement contained in this Agreement or any other Credit Document (other than as provided in paragraphs (a) through (c) of this Section), and such default shall continue unremedied for a period of 30 days after the Company has knowledge thereof; or\n\t\t(e) Any of the Credit Documents shall cease, for any reason, to be in full force and effect, or the Company shall so assert in writing (except for the termination of any Local Currency Facility if all Local Currency Loans and other amounts owing thereunder are paid in full); or\n\t\t(f) The subordination provisions applicable to any Subordinated Indebtedness, for any reason, cease to be in full force and effect, or any Person shall so assert to the Company in writing and the Company shall not promptly contest such assertion; or\n\t\t(g) The Company or any of its consolidated Subsidiaries shall (i) default in any payment of principal of or interest of any Indebtedness (other than the Loans and Reimbursement Obligations) or in the payment of any Guarantee Obligation, in either case with an outstanding principal amount in excess of a Dollar Equivalent Amount equal to $5,000,000 when due beyond the period of grace, if any, provided in the instrument or agreement under which such Indebtedness or Guarantee Obligation was created; or (ii) default in the observance or performance of any other agreement or condition relating to any such Indebtedness or Guarantee Obligation or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event shall occur or condition exist, the effect of which default or other event or condition is to cause, or to permit the holder or holders of such Indebtedness or beneficiary or beneficiaries of such Guarantee Obligation (or a trustee or agent on behalf of such holder or holders or beneficiary or beneficiaries) to cause, with the giving of notice if required, such Indebtedness to become due prior to its stated maturity or such Guarantee Obligation to become payable; or\n\t\t(h) (i) Any Specified Borrower or any Subsidiary that accounts for more than 5% of Total Assets at any date shall commence any case, proceeding or other action (A) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (B) seeking appointment of a receiver, trustee, custodian, conservator or other similar official for it or for all or any substantial part of its assets, or the Company or any such Subsidiary shall make a general assignment for the benefit of its creditors; or (ii) there shall be commenced against any Specified Borrower or any Subsidiary any case, proceeding or other action of a nature referred to in clause (i) above which (A) results in the entry of an order for relief or any such adjudication or appointment or (B) remains undismissed, undischarged or unbonded for a period of 60 days; or (iii) there shall be commenced against any Specified Borrower or any Subsidiary any case, proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or any substantial part of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, or stayed or bonded pending appeal within 60 days from the entry thereof; or\n\t\t(i) (i) Any Person shall engage in any \"prohibited transaction\" (as defined in Section 406 of ERISA or Section 4975 of the Code) involving any Plan, (ii) any \"accumulated funding deficiency\" (as defined in Section 302 of ERISA), whether or not waived, shall exist with respect to any Plan or any Lien in favor of the PBGC or a Plan shall arise on the assets of the Company or any Commonly Controlled Entity, (iii) a Reportable Event shall occur with respect to, or proceedings shall commence to have a trustee appointed, or a trustee shall be appointed, to administer or to terminate, any Single Employer Plan, which Reportable Event or commencement of proceedings or appointment of a trustee is, in the reasonable opinion of the Required Banks, likely to result in the termination of such Plan for purposes of Title IV of ERISA, (iv) any Single Employer Plan shall terminate for purposes of Title IV of ERISA, (v) the Company or any Commonly Controlled Entity shall, or in the reasonable opinion of the Required Banks is likely to, incur any liability in connection with a withdrawal from, or the Insolvency or Reorganization of, a Multiemployer Plan or (vi) any other event or condition shall occur or exist with respect to a Plan; and in each case in clauses (i) through (vi) above, such event or condition, together with all other such events or conditions, if any, could reasonably be expected to subject the Company to any tax, penalty or other liabilities in the aggregate material in relation to the business, operations, property or financial or other condition of the Company; or\n\t\t(j) One or more judgments or decrees shall be entered against the Company or any of its Subsidiaries involving in the aggregate a liability (not paid or fully covered by insurance) of a Dollar Equivalent Amount equal to $5,000,000 or more, and all such judgments or decrees shall not have been vacated, discharged, stayed or bonded pending appeal within 60 days from the entry thereof; or\n\t\t(k) The Company Guarantee or any Subsidiary Guarantee shall cease, for any reason, to be in full force and effect or any Guarantor party thereto shall so assert; or\n\t\t(l) A Change in Control shall occur;\nthen, and in any such event, (A) if such event is an Event of Default specified in clause (i) or (ii) of paragraph (h) above with respect to the Company, automatically the Commitments shall immediately terminate and the Loans hereunder (with accrued interest thereon) and all other amounts owing under this Agreement (including, without limitation, all amounts of L\/C Obligations, whether or not the beneficiaries of the then outstanding Letters of Credit shall have presented the documents required thereunder) shall become immediately due and payable and (B) if such event is any other Event of Default, either or both of the following actions may be taken: (i) with the consent of the Required Banks, the Administrative Agent may, or upon the request of the Required Banks, the Administrative Agent shall, by notice to the Company declare the Commitments to be terminated forthwith, whereupon the Commitments shall immediately terminate; and (ii) with the consent of the Required Banks, the Administrative Agent may, or upon the request of the Required Banks, the Administrative Agent shall, by notice to the Company, declare the Loans hereunder (with accrued interest thereon) and all other amounts owing under this Agreement (including, without limitation, all amounts of L\/C Obligations, whether or not the beneficiaries of the then outstanding Letters of Credit shall have presented the documents required thereunder) to be due and payable forthwith, whereupon the same shall immediately become due and payable. With respect to all Letters of Credit with respect to which presentment for honor shall not have occurred at the time of an acceleration pursuant to the preceding sentence, the applicable Borrower shall at such time deposit in a cash collateral account opened by the Administrative Agent an amount equal to the aggregate then undrawn and unexpired amount of Letters of Credit issued for its account. Each Borrower hereby grants to the Administrative Agent, for the benefit of the Issuing Banks and the L\/C Participants, a security interest in such cash collateral to secure all obligations of such Borrower under this Agreement and the other Loan Documents. Amounts held in such cash collateral account shall be applied by the Administrative Agent to the payment of drafts drawn under such Letters of Credit, and the unused portion thereof after all such Letters of Credit shall have expired or been fully drawn upon, if any, shall be applied to repay other obligations of the applicable Borrower hereunder. After all such Letters of Credit shall have expired or been fully drawn upon, all Reimbursement Obligations shall have been satisfied and all other obligations of the applicable Borrower hereunder shall have been paid in full, the balance, if any, in such cash collateral account shall be returned to the applicable Borrower. The Borrowers shall execute and deliver to the Administrative Agent, for the account of the Issuing Banks and the L\/C Participants, such further documents and instruments as the Administrative Agent may request to evidence the creation and perfection of the within security interest in such cash collateral account.\n\t\tExcept as expressly provided above in this Section, presentment, demand, protest and all other notices of any kind are hereby expressly waived.\n\tSECTION 13.\tTHE ADMINISTRATIVE AGENT; THE AGENTS AND \t\t\t\tTHE COLLATERAL AGENT; THE ARRANGER\n\t\t13.1 Appointment. Each Bank hereby irrevocably designates and appoints Chemical as the Administrative Agent of such Bank under this Agreement and the other Credit Documents, and each such Bank irrevocably authorizes Chemical, as the Administrative Agent for such Bank, to take such action on its behalf under the provisions of this Agreement and the other Credit Documents and to exercise such powers and perform such duties as are expressly delegated to the Administrative Agent by the terms of this Agreement and the other Credit Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in this Agreement, the Administrative Agent shall not have any duties or responsibilities, except those expressly set forth herein, or any fiduciary relationship with any Bank, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into this Agreement or any other Credit Document or otherwise exist against the Administrative Agent.\n\t\t13.2 Delegation of Duties. The Administrative Agent may execute any of its duties under this Agreement and the other Credit Documents by or through agents or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. The Administrative Agent shall not be responsible for the negligence or misconduct of any agents or attorneys in-fact selected by it with reasonable care.\n\t\t13.3 Exculpatory Provisions. Neither the Administrative Agent nor any of its officers, directors, employees, agents, attorneys- in-fact or Affiliates shall be (i) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with this Agreement or any other Credit Document (except for its or such Person's own gross negligence or willful misconduct) or (ii) responsible in any manner to any of the Banks for any recitals, statements, representations or warranties made by the Company or any officer thereof contained in this Agreement or any other Credit Document or in any certificate, report, statement or other document referred to or provided for in, or received by the Administrative Agent under or in connection with, this Agreement or any other Credit Document or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or any other Credit Document or for any failure of the Company to perform its obligations hereunder or thereunder. The Administrative Agent shall not be under any obligation to any Bank to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any other Credit Document, or to inspect the properties, books or records of the Company.\n\t\t13.4 Reliance by Administrative Agent. The Administrative Agent shall be entitled to rely, and shall be fully protected in relying, upon any writing, resolution, notice, consent, certificate, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel (including, without limitation, counsel to the Company), independent accountants and other experts selected by the Administrative Agent. The Administrative Agent shall be fully justified in failing or refusing to take any action under this Agreement or any other Credit Document unless it shall first receive such advice or concurrence of the Required Banks or all of the Banks, as may be required hereunder, as it deems appropriate or it shall first be indemnified to its satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Administrative Agent shall in all cases be fully protected from liability to the Banks in acting, or in refraining from acting, under this Agreement and the other Credit Documents in accordance with a request of the Required Banks or all of the Banks, as may be required hereunder, and such request and any action taken or failure to act pursuant thereto shall be binding upon all the Banks and their respective successors and assigns.\n\t\t13.5 Notice of Default. The Administrative Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Event of Default hereunder unless the Administrative Agent has received notice from a Bank or the Company referring to this Agreement, describing such Default or Event of Default and stating that such notice is a \"notice of default\". In the event that the Administrative Agent receives such a notice, the Administrative Agent shall give notice thereof to the Banks. The Administrative Agent shall take such action with respect to such Default or Event of Default as shall be reasonably directed by the Required Banks or all of the Banks, as may be required hereunder; provided that unless and until the Administrative Agent shall have received such directions, the Administrative Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem advisable in the best interests of the Banks.\n\t\t13.6 Non-Reliance on Administrative Agent and Other Banks. Each Bank expressly acknowledges that neither the Administrative Agent nor any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates has made any representations or warranties to it and that no act by the Administrative Agent hereinafter taken, including any review of the affairs of the Company, shall be deemed to constitute any representation or warranty by the Administrative Agent to any Bank. Each Bank represents to the Administrative Agent that it has, independently and without reliance upon the Administrative Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, operations, property, financial and other condition and creditworthiness of the Company and made its own decision to make its Loans hereunder and enter into this Agreement and the other Credit Documents to which it is or will be a party. Each Bank also represents that it will, independently and without reliance upon the Administrative Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, appraisals and decisions in taking or not taking action under this Agreement and the other Credit Documents, and to make such investigation as it deems necessary to inform itself as to the business, operations, property, financial and other condition and creditworthiness of the Company and its Subsidiaries. Except for notices, reports and other documents expressly required to be furnished to the Banks by the Administrative Agent hereunder, the Administrative Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the business, operations, property, condition (financial or otherwise), prospects or creditworthiness of the Company and its Subsidiaries which may come into the possession of the Administrative Agent and any Issuing Bank or any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates.\n\t\t13.7 Indemnification. The Banks agree to indemnify the Administrative Agent and each Issuing Bank in their respective capacities as such (to the extent not reimbursed by the Company and without limiting the obligation of the Company to do so), ratably according to their respective Commitment Percentages in effect on the date on which indemnification is sought under this subsection (or, if indemnification is sought after the date upon which the Commitments shall have terminated and the Loans shall have been paid in full, ratably in accordance with their Commitment Percentages immediately prior to such date), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind whatsoever which may at any time (including, without limitation, at any time following the payment of the Loans) be imposed on, incurred by or asserted against the Administrative Agent or any Issuing Bank in any way relating to or arising out of this Agreement, any of the other Credit Documents or any documents contemplated by or referred to herein or therein or the transactions contemplated hereby or thereby or any action taken or omitted by the Administrative Agent or any Issuing Bank under or in connection with any of the foregoing; provided that no Bank shall be liable for the payment of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting solely from the Administrative Agent's or Issuing Bank's, as the case may be, gross negligence or willful misconduct. The agreements in this subsection shall survive the payment of the Loans, the Reimbursement Obligations and all other amounts payable hereunder.\n\t\t13.8 Administrative Agent in Its Individual Capacity. The Administrative Agent and its Affiliates may make loans to, accept deposits from and generally engage in any kind of business with the Company and any of its Subsidiaries as though the Administrative Agent were not the Administrative Agent hereunder and under the other Credit Documents. With respect to its Loans made or renewed by it and with respect to any Letter of Credit issued or participated in by it, the Administrative Agent shall have the same rights and powers under this Agreement and the other Credit Documents as any Bank and may exercise the same as though it were not the Administrative Agent, and the terms \"Bank\" and \"Banks\" shall include the Administrative Agent in its individual capacity.\n\t\t13.9 Successor Administrative Agent. The Administrative Agent may resign as Administrative Agent upon 10 days' notice to the Banks; provided that any such resignation shall not be effective until a successor agent has been appointed and approved in accordance with this subsection 13.9, and such successor agent has accepted its appointment. If the Administrative Agent shall resign as Administrative Agent under this Agreement and the other Credit Documents, then the Required Banks shall appoint from among the Banks a successor administrative agent for the Banks, which successor agent shall be approved by the Company (which approval shall not be unreasonably withheld), whereupon such successor administrative agent shall succeed to the rights, powers and duties of the Administrative Agent, and the term \"Administrative Agent\" shall mean such successor agent effective upon such appointment and approval, and the former Administrative Agent's rights, powers and duties as Administrative Agent shall be terminated, without any other or further act or deed on the part of such former Administrative Agent or any of the parties to this Agreement. After any retiring Administrative Agent's resignation as Administrative Agent, the provisions of this subsection shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent under this Agreement and the other Credit Documents.\n\t\t13.10 The Agents and the Arranger; The Collateral Agent. (a) Each Bank acknowledges that the Agents, the Arranger and the Lead Manager, in such capacities, shall have no duties or responsibilities, and shall incur no liabilities, under this Agreement or the other Credit Documents.\n\t\t(b) Each Bank (including each Hedging Bank) acknowledges and confirms that Bankers Trust is Collateral Agent under the Intercreditor Agreement and in such capacity shall have such duties, responsibilities, liabilities, rights and indemnities as are provided for in the Intercreditor Agreement.\n\tSECTION 14. MISCELLANEOUS\n\t\t14.1 Amendments and Waivers. (a) Neither this Agreement nor any other Credit Document, nor any terms hereof or thereof may be amended, supplemented or modified except in accordance with the provisions of this subsection. The Required Banks may, or, with the written consent of the Required Banks, the Administrative Agent may, from time to time, (i) enter into with the Loan Parties party thereto written amendments, supplements or modifications to this Agreement and the other Credit Documents for the purpose of adding any provisions to this Agreement or the other Credit Documents or changing in any manner the rights of the Banks or of the Loan Parties hereunder or thereunder or (ii) waive, on such terms and conditions as the Required Banks or the Administrative Agent, as the case may be, may specify in such instrument, any of the requirements of this Agreement or the other Credit Documents or any Default or Event of Default and its consequences; provided, however, that no such waiver and no such amendment, supplement or modification shall (i) reduce the amount or extend the scheduled date of maturity of any Loan or reduce the stated rate of any interest or fee payable hereunder or extend the scheduled date of any payment thereof or increase the aggregate amount or extend the expiration date of any Bank's Commitment, in each case without the consent of each Bank directly affected thereby, or (ii) amend, modify or waive any provision of this subsection or reduce the percentage specified in the definition of Required Banks, or consent to the assignment or transfer by the Company of any of its rights and obligations under this Agreement and the other Credit Documents or amend, modify or waive subsection 7.3(a) or 14.6(a), or release any Subsidiary from its Subsidiary Guarantee or release the Company from the Company Guarantee, in each case without the written consent of all the Banks, or (iii) amend, modify or waive any provision of Section 13 without the written consent of the then Administrative Agent. Any such waiver and any such amendment, supplement or modification shall apply equally to each of the Banks and shall be binding upon the Company, the Foreign Subsidiary Borrowers, the Banks, the Agents, the Administrative Agent and all future holders of the Loans. In the case of any waiver, the Company, the Banks and the Administrative Agent shall be restored to their former position and rights hereunder and under any other Credit Documents, and any Default or Event of Default waived shall be deemed to be cured and not continuing; but no such waiver shall extend to any subsequent or other Default or Event of Default, or impair any right consequent thereon.\n\t\t(b) In addition to amendments effected pursuant to the foregoing paragraph (a), Schedules II, III and IV may be amended as follows:\n\t\t\t(i) \tSchedule II will be amended to add Subsidiaries of the Company as additional Foreign Subsidiary Borrowers upon (A) execution and delivery by the Company, any such Foreign Subsidiary Borrower and the Administrative Agent, of a Joinder Agreement providing for any such Subsidiary to become a Foreign Subsidiary Borrower, and (B) delivery to the Administrative Agent of (1) if reasonably requested by the Administrative Agent, a Foreign Subsidiary Opinion in respect of such additional Foreign Subsidiary Borrower and (2) such other documents with respect thereto as the Administrative Agent shall reasonably request.\n\t\t\t(ii) \tSchedule II will be amended to remove any Subsidiary as a Foreign Subsidiary Borrower upon (A) execution and delivery by the Company of a Schedule Amendment providing for such amendment, (b) repayment in full of all outstanding Loans of such Foreign Subsidiary Borrower and (c) cash collateralization of all outstanding Letters of Credit issued for the account of such Foreign Subsidiary Borrower.\n\t\t\t(iii) \tSchedule III will be amended to designate other Banks as additional or replacement Swing Line Banks or additional Issuing Banks, upon execution and delivery by the Company, the Administrative Agent and such additional or replacement Swing Line Bank or additional Issuing Bank, as the case may be, of a Schedule Amendment providing for such amendment. In the case of any replacement of a Swing Line Bank pursuant to a Schedule Amendment, the existing Swing Line Bank replaced pursuant thereto shall cease to be a Swing Line Bank upon the effectiveness of such Schedule Amendment and the repayment of all Swing Line Loans owing to such replaced Swing Line Bank.\n\t\t\t(iv) \tSchedule III will be amended to change administrative information (including the Swing Line Rate definition) with respect to Swing Line Banks or Issuing \tBanks, upon execution and delivery by the Company, the Administrative Agent and such Swing Line Bank or Issuing Bank, as the case may be, of a Schedule Amendment providing for such amendment.\n\t\t\t(v) \tSchedule IV will be amended to change administrative information contained therein (other than any interest rate definition, Funding Time, Payment Time or notice time contained therein) or to add Available Foreign Currencies (and related interest rate definitions and administrative information), upon execution and delivery by the Company and the Administrative Agent of a Schedule Amendment providing for such amendment.\n\t\t\t(vi) \tSchedule IV will be amended to conform any Funding Time, Payment Time or notice time contained therein to then- prevailing market practices, upon execution and delivery by the Company, the Required Banks and the Administrative Agent of a Schedule Amendment providing for such amendment.\n\t\t\t(vii) \tSchedule IV will be amended to change any interest rate definition contained therein, upon execution and delivery by the Company, all the Banks and the Administrative Agent of a Schedule Amendment providing for such amendment.\n\t\t(c)\tThe Administrative Agent shall give prompt notice to each Bank of any amendment effect pursuant to subsection 14.1(b).\n\t\t(d)\tNotwithstanding the provisions of this subsection 14.1, any Local Currency Facility may be amended, supplemented or otherwise modified in accordance with its terms so long as after giving effect thereto either (i) such Local Currency Facility ceases to be a \"Local Currency Facility\" and (x) the Company so notifies the Administrative Agent and (y) the Company Guarantee Ratio does not exceed 25% or (ii) the Local Currency Facility continues to meet the requirements of a Local Currency Facility set forth herein.\n\t\t14.2 Notices. All notices, requests and demands to or upon the respective parties hereto to be effective shall be in writing (including by telecopy), and, unless otherwise expressly provided herein, shall be deemed to have been duly given or made when delivered by hand, or five days after being deposited in the mail, postage prepaid, or, in the case of telecopy notice, when received, addressed as follows in the case of the Company, the Foreign Subsidiary Borrowers and the Administrative Agent, and as set forth in Schedule I in the case of the other parties hereto, or to such other address as may be hereafter notified by the respective parties hereto and any future holders of the Loans:\n\tThe Company:\t\t\tArrow Electronics, Inc. \t\t\t\t\t25 Hub Drive \t\t\t\t\tMelville, New York 11747 \t\t\t\t\tAttention: Robert E. Klatell and \t\t\t\t\t \tIra M. Birns \t\t\t\t\tTelecopy: (516) 391-1683 \t\t\t\t\tTelecopy: (516) 391-1848\n\tThe Administrative \t\tAgent:\t\t\tChemical Bank \t\t\t\t\t270 Park Avenue \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Robert Gaynor \t\t\t\t\tTelecopy: (212) 972-0009\n\twith a copy to:\n\t\t\t\t\tChemical Bank Agent Bank Services \t\t\t\t\t Group \t\t\t\t\t140 East 45th Street \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Maggie Swales \t\t\t\t\tTelephone No: 212-622-8433 \t\t\t\t\tFax No: 212-622-0122\n\tThe Collateral \t\tAgent:\t\t\tAs provided in the Intercreditor Agreement\n\tThe Foreign \t\tSubsidiary Borrowers:\tc\/o Arrow Electronics, Inc. \t\t\t\t\t25 Hub Drive \t\t\t\t\tMelville, New York 11747 \t\t\t\t\tAttention: Robert E. Klatell and \t\t\t\t\t Ira M. Birns \t\t\t\t\tTelecopy: (516) 391-1683 \t\t\t\t\tTelecopy: (516) 391-1848\n; provided that any Notice of Borrowing, Notice of Continuation, Notice of Conversion, Notice of Swing Line Outstandings, Notice of Swing Line Refunding, Notice of Local Currency Outstandings, Notice of Guarantee Ceiling Amount, Notice of Prepayment, Notice of Swing Line or Borrowing, or any notice pursuant to subsections 2.4, 2.5 or 5.2 shall not be effective until received.\n\t\t14.3 No Waiver; Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of the Administrative Agent or any Bank, any right, remedy, power or privilege hereunder or under the other Credit Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges herein provided are cumulative and not exclusive of any rights, remedies, powers and privileges provided by law.\n\t\t14.4 Survival of Representations and Warranties. All representations and warranties made hereunder, in the other Credit Documents and in any document, certificate or statement delivered pursuant hereto or in connection herewith shall survive the execution and delivery of this Agreement and the other Credit Documents and the making of the Loans hereunder and the issuance of Letters of Credit.\n\t\t14.5 Payment of Expenses and Taxes. The Company agrees (a) to pay or reimburse the Administrative Agent and the Arranger for all its reasonable out-of-pocket costs and expenses incurred in connection with the development, preparation and execution of, and any amendment, supplement or modification to, this Agreement and the other Credit Documents and any other documents prepared in connection herewith or therewith, and the consummation and administration of the transactions contemplated hereby and thereby, including, without limitation, the fees and disbursements of counsel to the Administrative Agent and the Arranger, (b) to pay or reimburse each Bank and the Administrative Agent and any Issuing Bank for all its reasonable costs and expenses incurred in connection with the enforcement or preservation of any rights under this Agreement, the other Credit Documents and any such other documents upon the occurrence of an Event of Default, including, without limitation, the fees and disbursements of counsel to the Administrative Agent and to the several Banks and any Issuing Bank, and (c) to pay, indemnify, and hold each Bank, each Agent, the Arranger and the Administrative Agent and any Issuing Bank harmless from, any and all recording and filing fees and any and all liabilities with respect to, or resulting from any delay in paying, stamp, excise and other taxes, if any, which may be payable or determined to be payable in connection with the execution and delivery of, or consummation or administration of any of the transactions contemplated by, or any amendment, supplement or modification of, or any waiver or consent under or in respect of, this Agreement, the other Credit Documents and any such other documents, and (d) to pay, indemnify, and hold each Bank, each Agent, the Arranger and the Administrative Agent and any Issuing Bank (and their respective directors, officers, employees and agents) (collectively, the \"indemnified person\") harmless from and against any and all other liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever with respect to the execution, delivery, enforcement, performance and administration of this Agreement, the other Credit Documents and any such other documents, including, without limitation, any of the foregoing relating to the use of proceeds of the Loans or the violation of, noncompliance with or liability under, any Environmental Law applicable to the operations of the Company, any of its Subsidiaries or any of the Properties (it being understood that costs and expenses incurred in connection with the enforcement or preservation of rights under this Agreement and the other Credit Documents shall be paid or reimbursed in accordance with clause (b) above rather than this clause (d)) (all the foregoing in this clause (d), collectively, the \"indemnified liabilities\"), provided, that the Company shall have no obligation hereunder to any indemnified person with respect to indemnified liabilities arising from (i) the gross negligence or willful misconduct of such indemnified person or (ii) legal proceedings commenced against the Administrative Agent, any Issuing Bank or any Bank by any security holder or creditor thereof arising out of and based upon rights afforded any such security holder or creditor solely in its capacity as such. Any payments required to be made by the Company under this subsection 14.5 shall be made within 30 days of the demand therefor. The agreements in this subsection shall survive repayment of the Loans and all other amounts payable hereunder.\n\t\t14.6 Successors and Assigns; Participations and Assignments. (a) This Agreement shall be binding upon and inure to the benefit of the Company, the Foreign Subsidiary Borrowers, the Banks, the Administrative Agent, all future holders of the Loans and their respective successors and assigns, except that no Specified Borrower may assign or transfer any of its rights or obligations under this Agreement without the prior written consent of each Bank.\n\t\t(b) Any Bank may, in the ordinary course of its commercial lending business and in accordance with applicable law, at any time sell to one or more banks or other entities (\"Participants\") participating interests in any Loan owing to such Bank, any Commitment of such Bank or any other interest of such Bank hereunder and under the other Credit Documents. In the event of any such sale by a Bank of a participating interest to a Participant, such Bank's obligations under this Agreement to the other parties to this Agreement shall remain unchanged, such Bank shall remain solely responsible for the performance thereof, such Bank shall remain the holder of any such Loan for all purposes under this Agreement Credit and the other Documents, and the Company, the Foreign Subsidiary Borrowers and the Agent shall continue to deal solely and directly with such Bank in connection with such Bank's rights and obligations under this Agreement and the other Credit Documents. Each of the Company and the Foreign Subsidiary Borrowers agrees that if amounts outstanding under this Agreement are due or unpaid, or shall have been declared or shall have become due and payable upon the occurrence of an Event of Default, each Participant shall be deemed to have the right of setoff in respect of its participating interest in amounts owing under this Agreement to the same extent as if the amount of its participating interest were owing directly to it as a Bank under this Agreement, provided that, in purchasing such participating interest, such Participant shall be deemed to have agreed to share with the Banks the proceeds thereof as provided in subsection 14.7(a) as fully as if it were a Bank hereunder. Each of the Company and the Foreign Subsidiary Borrowers also agrees that each Participant shall be entitled to the benefits of subsections 7.5, 7.6 or 7.8 with respect to its participation in the Commitments and the Loans outstanding from time to time as if it was a Bank; provided that, in the case of subsection 7.6, such Participant shall have complied with the requirements of said subsection and provided, further, that no Participant shall be entitled to receive any greater amount pursuant to any such subsection than the transferor Bank would have been entitled to receive in respect of the amount of the participation transferred by such transferor Bank to such Participant had no such transfer occurred. Each participating interest under this Agreement sold by a Bank to a Participant after the Closing Date shall be under terms providing that such Participant's rights to consent or withhold consent in respect of actions by such selling Bank under this Agreement shall be limited to such actions that, pursuant to subsection 14.1, require the consent of all the Banks. Each Bank selling or granting a participation shall indemnify the Borrowers and the Administrative Agent for any taxes and liabilities that they may sustain as a result of such Bank's failure to withhold and pay any taxes applicable to payments by such Bank to its participant in respect of such participation.\n\t\t(c) Any Bank may, in the ordinary course of its commercial lending business and in accordance with applicable law, at any time and from time to time assign to any Bank or any affiliate thereof or, with the consent of the Administrative Agent and the Company (which shall not be unreasonably withheld), to an additional bank or financial institutions (\"an Assignee\") all or any part of its rights and obligations under this Agreement and the Loans pursuant to an Assignment and Acceptance, executed by such Assignee, such assigning Bank (and, in the case of an Assignee that is not then a Bank or an affiliate thereof, by the Administrative Agent and the Company) and delivered to the Administrative Agent for its acceptance and recording in the Register; provided that after giving effect to any such assignment, the transferor Bank's aggregate Dollar Equivalent Amount of its Local Currency Bank Maximum Borrowing Amount under all Local Currency Facilities may not exceed its Commitment hereunder. Upon such execution, delivery, acceptance and recording, from and after the effective date determined pursuant to such Assignment and Acceptance, (x) the Assignee thereunder shall be a party hereto and, to the extent provided in such Assignment and Acceptance, have the rights and obligations of a Bank hereunder with a Commitment as set forth therein, and (y) the assigning Bank thereunder shall, to the extent provided in such Assignment and Acceptance, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Bank's rights and obligations under this Agreement, such assigning Bank shall cease to be a party hereto). Notwithstanding anything herein to the contrary, no Assignee shall be entitled to receive any greater amount pursuant to subsections 7.5, 7.6 or 7.8 than the transferor Bank would have been entitled to receive in respect of the amount of the Commitment transferred by such transferor Bank to such Assignee had no such transfer occurred, unless following the date of such assignment, a change in any applicable Requirement of Law or any interpretation thereof shall have occurred which entitles such Assignee to claim additional amounts pursuant to such subsections.\n\t\t(d) The Administrative Agent shall maintain at its address referred to in subsection 14.2 a copy of each Assignment and Acceptance delivered to it and a register (the \"Register\") for the recordation of the names and addresses of the Banks and the Commitment of, and principal amount of the Loans owing hereunder to, each Bank from time to time. The entries in the Register shall be conclusive, in the absence of manifest error, and the Company, the Administrative Agent and the Banks may treat each Person whose name is recorded in the Register as the owner of the Loan recorded therein for all purposes of this Agreement. The Register shall be available for inspection by the Company or any Bank at any reasonable time and from time to time upon reasonable prior notice.\n\t\t(e) Upon its receipt of an Assignment and Acceptance executed by an assigning Bank and an Assignee (and, in the case of an Assignee that is not then a Bank or an affiliate thereof, by the Administrative Agent) together with payment to the Administrative Agent of a registration and processing fee of $3,500, the Administrative Agent shall (i) promptly accept such Assignment and Acceptance and (ii) on the effective date determined pursuant thereto record the information contained therein in the Register and give notice of such acceptance and recordation to the Banks and the Company.\n\t\t(f) The Company authorizes each Bank to disclose to any Participant or Assignee (each, a \"Transferee\") and any prospective Transferee any and all financial information in such Bank's possession concerning the Company and its Affiliates which has been delivered to such Bank by or on behalf of the Company pursuant to this Agreement or which has been delivered to such Bank by or on behalf of the Company in connection with such Bank's credit evaluation of the Company and its Affiliates prior to becoming a party to this Agreement so long as each such prospective Transferee shall execute a confidentiality agreement containing provisions substantially similar to the provisions contained in the next succeeding sentences of this paragraph (f). The Administrative Agent and each Bank shall hold nonpublic information obtained pursuant to the requirements of this Agreement other than information (i) that is, or generally becomes, available to the public, (ii) that was or becomes available to the Administrative Agent or any Bank on a nonconfidential basis or (iii) that becomes available to the Administrative Agent or any Bank from a Person or other source that is not, to the best knowledge of the Administrative Agent or such Bank, as the case may be, otherwise bound by a confidentiality obligation to the Company, in accordance with its customary procedures for treatment of confidential information and in accordance with safe and sound banking practices and in any event, may make disclosure reasonably required by any Governmental Authority or representative thereof pursuant to subpoena or other legal process or as otherwise required by law, order or regulation. Unless specifically prohibited by applicable law, regulation, rule or court order, the Administrative Agent and each Bank shall notify the Company of any request by any Governmental Authority or representative thereof (other than any such request in connection with an examination of the financial condition of the Administrative Agent or such Bank by such Governmental Authority) for disclosure of such information by the Administrative Agent or such Bank so that any of them may seek an appropriate protective order. Except as may be required by an order of a court of competent jurisdiction and to the extent set forth therein, neither the Administrative Agent nor any Bank shall be obligated or required to return any materials furnished by the Company. Nothing in this paragraph (f) shall prohibit the Administrative Agent or any Bank from disclosing nonpublic information to its examiners, regulators and professional advisors.\n\t\t(g) If, pursuant to this subsection, any interest in this Agreement is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any state thereof, the transferor Bank shall cause such Transferee, concurrently with the effectiveness of such transfer, (i) to represent to the transferor Bank (for the benefit of the transferor Bank, the Administrative Agent and the Company) that under applicable law and treaties no United States federal income taxes or United States backup withholding taxes will be required to be withheld by the Administrative Agent or any Specified Borrower or the transferor Bank with respect to any payments to be made to such Transferee in respect of the Loans (excluding any such taxes that would be required to be withheld with respect to any payments made or to be made to such transferor Bank at the time of such transfer had such transfer not occurred), (ii) to furnish to the transferor Bank (and, in the case of any Purchasing Bank registered in the Register, the Administrative Agent and the Company) two copies of each of (x) either United States Internal Revenue Service Form 4224 or United States Internal Revenue Service Form 1001 or successor applicable form, as the case may be (wherein such Transferee claims entitlement to complete exemption from United States federal withholding tax on all payments hereunder), and (y) either United States Internal Revenue Service Form W-8 or W-9 or successor applicable form, as the case may be (wherein such Transferee claims entitlement to complete exemption from United States federal backup withholding tax on all payments hereunder), and (iii) to agree (for the benefit of the transferor Bank, the Administrative Agent and the Company) to provide the transferor Bank (and, in the case of any Purchasing Bank registered in the Register, the Administrative Agent and the Company) a new Form 4224, Form 1001, Form W-8 or Form W-9 or successor applicable form, as the case may be, duly executed and completed by such Transferee, on or before the date that any such form expires or becomes obsolete or after the occurrence of any event (including, without limitation, a change in such Transferee's lending office) requiring a change in the most recent form previously delivered by it to the Company and the Administrative Agent in accordance with applicable United States laws and regulations and amendments and to comply from time to time with all applicable United States laws and regulations with regard to such withholding tax exemption.\n\t\t(h) Nothing herein shall prohibit any Bank from pledging or assigning any Loan to any Federal Reserve Bank in accordance with applicable law.\n\t\t14.7 Adjustments; Set-off. (a) If any Bank (a \"benefitted Bank\") shall at any time receive any payment of all or part of its Loans or the Reimbursement Obligations then due and owing to it, or interest thereon, or receive any collateral in respect thereof (whether voluntarily or involuntarily, by set-off, pursuant to events or proceedings of the nature referred to in Section 12(h), or otherwise), in a greater proportion than any such payment to or collateral received by any other Bank, if any, in respect of such other Bank's Loans or the Reimbursement Obligations then due and owing to it, or interest thereon, such benefitted Bank shall purchase for cash from the other Banks a participating interest in such portion of each such other Bank's Loan or the Reimbursement Obligations owing to it, or shall provide such other Banks with the benefits of any such collateral, or the proceeds thereof, as shall be necessary to cause such benefitted Bank to share the excess payment or benefits of such collateral or proceeds ratably with each of the Banks; provided, however, that if all or any portion of such excess payment or benefits is thereafter recovered from such benefitted Bank, such purchase shall be rescinded, and the purchase price and benefits returned, to the extent of such recovery, but without interest. Each of the Company and the Foreign Subsidiary Borrowers agrees that each Bank so purchasing a portion of another Bank's Loan may exercise all rights of payment (including, without limitation, rights of set-off) with respect to such portion as fully as if such Bank were the direct holder of such portion.\n\t\t(b) In addition to any rights and remedies of the Banks provided by law, each Bank shall have the right, without prior notice to the Company or any Foreign Subsidiary Borrower, any such notice being expressly waived by the Company and the Foreign Subsidiary Borrowers to the extent permitted by applicable law, upon any amount becoming due and payable by the Company hereunder or under this Agreement or the other Credit Documents (whether at the stated maturity, by acceleration or otherwise) to set-off and appropriate and apply against such amount any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by such Bank or any branch or agency thereof to or for the credit or the account of the Company or such Foreign Subsidiary Borrower, as the case may be. Each Bank agrees promptly to notify the Company and the Administrative Agent after any such set-off and application made by such Bank, provided that the failure to give such notice shall not affect the validity of such set-off and application.\n\t\t14.8 Power of Attorney. Each Foreign Subsidiary Borrower hereby grants to the Company an irrevocable power of attorney to act as its attorney-in-fact with regard to matters relating to this Agreement, the Applications and each other Credit Document, including, without limitation, execution and delivery of any amendments, supplements, waivers or other modifications hereto or thereto, receipt of any notices hereunder or thereunder and receipt of service of process in connection herewith or therewith. Each Foreign Subsidiary Borrower hereby explicitly acknowledges that the Administrative Agent and each Bank has executed and delivered this Agreement and each other Credit Document to which it is a party, and has performed its obligations under this Agreement and each other Credit Document to which it is a party, in reliance upon the irrevocable grant of such power of attorney pursuant to this subsection 14.8. The power of attorney granted by each Foreign Subsidiary Borrower hereunder is coupled with an interest.\n\t\t14.9 Judgment. (a) If for the purpose of obtaining judgment in any court it is necessary to convert a sum due hereunder in one currency into another currency, the parties hereto agree, to the fullest extent that they may effectively do so, that the rate of exchange used shall be that at which in accordance with normal banking procedures the Administrative Agent could purchase the first currency with such other currency on the Business Day preceding the day on which final judgment is given.\n\t\t(b)\tThe obligation of the Company or any Foreign Subsidiary Borrower in respect of any sum due to any Bank or the Administrative Agent hereunder shall, notwithstanding any judgment in a currency (the \"Judgment Currency\") other than that in which such sum is denominated in accordance with the applicable provisions of this Agreement or the other Credit Documents (the \"Agreement Currency\"), be discharged only to the extent that on the Business Day following receipt by such Bank or the Administrative Agent (as the case may be) of any sum adjudged to be so due in the Judgment Currency such Bank or the Administrative Agent (as the case may be) may in accordance with normal banking procedures purchase the Agreement Currency with the Judgment Currency; if the amount of the Agreement Currency so purchased is less than the sum originally due to such Bank or the Administrative Agent (as the case may be) in the Agreement Currency, the Company or such Foreign Subsidiary Borrower (as the case may be) agrees, as a separate obligation and notwithstanding any such judgment, to indemnify such Bank or the Administrative Agent (as the case may be) against such loss, and if the amount of the Agreement Currency so purchased exceeds the sum originally due to any Bank or the Administrative Agent (as the case may be), such Bank or the Administrative Agent (as the case may be) agrees to remit to the Company or such Foreign Subsidiary Borrower (as the case may be) such excess.\n\t\t14.10 Counterparts. This Agreement may be executed by one or more of the parties to this Agreement on any number of separate counterparts (including by telecopy), and all of said counterparts taken together shall be deemed to constitute one and the same instrument. A set of the copies of this Agreement signed by all the parties shall be lodged with the Company and the Administrative Agent.\n\t\t14.11 Severability. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction.\n\t\t14.12 Integration. This Agreement and the other Credit Documents represent the agreement of the Company, the Foreign Subsidiary Borrowers, the Agents, the Administrative Agent and the Banks with respect to the subject matter hereof, and there are no promises, undertakings, representations or warranties by the Administrative Agent or any Bank relative to subject matter hereof not expressly set forth or referred to herein or in the other Credit Documents.\n\t\t14.13 GOVERNING LAW. THIS AGREEMENT AND THE OTHER CREDIT DOCUMENTS (OTHER THAN ANY LOCAL CURRENCY FACILITY) AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AGREEMENT AND THE OTHER CREDIT DOCUMENTS (OTHER THAN ANY LOCAL CURRENCY FACILITY) SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.\n\t\t14.14 Submission To Jurisdiction; Waivers. (a) Each of the Company and the Foreign Subsidiary Borrowers hereby irrevocably and unconditionally:\n\t\t(i) submits for itself and its property in any legal action or proceeding relating to this Agreement and the other Credit Documents to which it is a party, or for recognition and enforcement of any judgement in respect thereof, to the non-exclusive general jurisdiction of the Courts of the State of New York, the courts of the United States of America for the Southern District of New York, and appellate courts from any thereof;\n\t\t(ii) consents that any such action or proceeding may be brought in such courts and waives any objection that it may now or hereafter have to the venue of any such action or proceeding in any such court or that such action or proceeding was brought in an inconvenient court and agrees not to plead or claim the same;\n\t\t(iii) agrees that service of process in any such action or proceeding may be effected by mailing a copy thereof by registered or certified mail (or any substantially similar form of mail), postage prepaid, to the Company at its address set forth in subsection 14.2 or at such other address of which the Administrative Agent shall have been notified pursuant thereto;\n\t\t(iv) agrees that nothing herein shall affect the right to effect service of process in any other manner permitted by law or shall limit the right to sue in any other jurisdiction; and\n\t\t(v) waives, to the maximum extent not prohibited by law, any right it may have to claim or recover in any legal action or proceeding referred to in this subsection any special, exemplary, punitive or consequential damages.\n\t\t(b) Each Foreign Subsidiary Borrower hereby irrevocably appoints the Company as its agent for service of process in any proceeding referred to in subsection 14.14(a) and agrees that service of process in any such proceeding may be made by mailing or delivering a copy thereof to it care of the Company at its address for notice set forth in subsection 14.2.\n\t\t14.15 Acknowledgements. Each of the Company and the Foreign Subsidiary Borrowers hereby acknowledges that:\n\t\t(a) it has been advised by counsel in the negotiation, execution and delivery of this Agreement and the other Credit Documents;\n\t\t(b) none of the Agents, the Administrative Agent, the Collateral Agent or any Bank has any fiduciary relationship with or duty to the Company and the Foreign Subsidiary Borrowers arising out of or in connection with this Agreement or any of the other Credit Documents, and the relationship between the Agents, the Administrative Agent, the Collateral Agent and the Banks, on one hand, and the Company and the Foreign Subsidiary Borrowers, on the other hand, in connection herewith or therewith is solely that of debtor and creditor; and\n\t\t(c) no joint venture is created hereby or by the other Credit Documents or otherwise exists by virtue of the transactions contemplated hereby among the Banks or among the Company and the Foreign Subsidiary Borrowers and the Banks.\n\t\t14.16 WAIVERS OF JURY TRIAL. THE COMPANY, THE FOREIGN SUBSIDIARY BORROWERS, THE AGENTS, THE ADMINISTRATIVE AGENT, THE COLLATERAL AGENT AND THE BANKS HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVE TRIAL BY JURY IN ANY LEGAL ACTION OR PROCEEDING RELATING TO THIS AGREEMENT OR ANY OTHER CREDIT DOCUMENT AND FOR ANY COUNTERCLAIM THEREIN.\n\t\tIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered by their proper and duly authorized officers as of the day and year first above written.\nARROW ELECTRONICS, INC.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW ELECTRONICS DISTRIBUTION GROUP EUROPE B.V.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW ELECTRONICS GmbH\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nSPOERLE ELECTRONIC HANDELSGESELLSCHAFT mbH & CO.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW ELECTRONICS (UK) LTD.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nMICROPROCESSOR AND MEMORY DISTRIBUTION LTD.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW-EXATEC A\/S\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW-FIELD OY\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW-TH:S ELEKTRONIK AB\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW-TAHONIC A\/S\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nCOMPONENTS AGENT LTD.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nTEXNY GLORYTACT (HK) LIMITED\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nARROW ELECTRONIQUE S.A.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nMEGACHIP S.A.\nBy:\/s\/ Robert E. Klatell Title: Vice-President\nCHEMICAL SECURITIES INC., as Arranger\nBy:\/s\/ Elizabeth F. Allen Title: Vice-President\nCHEMICAL BANK, as Administrative Agent, as an Agent and as a Bank\nBy:\/s\/ Robert K. Gaynor Title: Vice-President\nABN AMRO BANK NV NEW YORK BRANCH\nBy:\/s\/ Ann Schwalbenberg Title: Vice-President\nBy:\/s\/ Laura G. Fazio Title: Vice-President\nBANCA COMMERCIALE ITALIANA\nBy:\/s\/ Edward C. Bermant Julia M. Welch Title: FVP\t \t\tAVP\nBANCA POPOLARE DI MILANO\nBy:\/s\/ Anthony Franco Esperanza Quintero Title: FVP & General Manager VP\nBANK OF MONTREAL\nBy:\/s\/ W.T. Calder Title: Director\nTHE BANK OF NEW YORK\nBy:\/s\/ William A. Kerr Title: Vice President\nBANK OF NOVA SCOTIA\nBy:\/s\/ John W. Campbell Title: Unit Head\nBANKERS TRUST COMPANY, as an Agent, as Collateral Agent and as a Bank\nBy:\/s\/ Edward G. Benedict Title: Vice President\nBANQUE NATIONALE DE PARIS\nBy:\/s\/ Richard L. Sted Title: Senior Vice President\nBy:\/s\/ Richard Pace Title: Assistant Vice President\nBAYERISCHE LANDESBANK, CAYMAN ISLANDS BRANCH\nBy:\/s\/ Karl-Heinz Wallner Title: Senior VP and Manager of Operations and Administration\nBy:\/s\/ Peter Obermann Title: Senior VP, Manager Lending Division\nBAYERISCHE VEREINSBANK AG, NEW YORK BRANCH\nBy:\/s\/ Ernst Luthi Title: Senior Vice President\nBy:\/s\/ Ramon Espinosa Title: Credit Analyst\nBHF-BANK AG\nBy:\/s\/ Linda Pace Perry Foreman Title: VP\t\t Assistant VP\nCARIPLO-CASSA DI RISPARMIO DELLE PROVINCIE LOMBARDE S.P.A.\nBy:\/s\/ Anthony F. Giobbi Title: Vice President\nBy:\/s\/ Bernato Bassi Title: First Vice President\nCHASE MANHATTAN BANK\nBy:\/s\/ Sal Trifilletti Title: Vice President\nCREDIT INDUSTRIEL ET COMMERCIAL (CIC PARIS)\nBy:\/s\/ Robert Gaynor Title: Attorney-in-fact\nCREDIT LYONNAIS NEW YORK BRANCH\nBy:\/s\/ Mark Campellone Title: Vice President\nCREDIT LYONNAIS CAYMAN ISLAND BRANCH\nBy:\/s\/ Mark Campellone Title: Authorized Signature\nDEN DANSKE BANK AKTIESELSKAB, CAYMAN ISLANDS BRANCH\nBy:\/s\/ Mogens Sondergaard\t Title: Vice President\nBy:\/s\/ John O'Neill \t Title: Vice President\nDEUTSCHE BANK AG\nBy:\/s\/ Jean M. Hannigan\tJ. Tracy Mehr Title: Assistant VP\t\tVice President\nTHE FIRST NATIONAL BANK OF CHICAGO\nBy:\/s\/ Steven Kim \t Title: Corporate Banking Officer\nMIDLAND BANK PLC, NEW YORK BRANCH\nBy:\/s\/ Rochelle Forster \t Title: Vice President\nLTCB TRUST COMPANY\nBy:\/s\/ Rene O. LeBlanc \t Title: Senior Vice President\nNATWEST BANK N.A., as Lead Manager and as a Bank\nBy:\/s\/ Stephan Ramerini \t Title: Vice President\nNATIONAL WESTMINSTER BANK AG\nBy:\/s\/ Barbara Bauer Bruno Oestreicher \t Title: Asst. Mgr. Sr. Asst. Mgr.\nNATIONSBANK OF TEXAS, N.A.\nBy:\/s\/ Yousuf Omar \t Title: Senior Vice President\nPNC BANK, NATIONAL ASSOCIATION\nBy:\/s\/ Tom Partridge \t Title: Commercial Banking Officer\nTHE SANWA BANK, LIMITED, NEW YORK BRANCH\nBy:\/s\/ Jean-Michel Fatovic \t Title: Vice President\nSHAWMUT BANK, N.A.\nBy:\/s\/ Olaperi Onipede \t Title: Director, Electronics\/Technology\nSOCIETE GENERALE\nBy:\/s\/ Gordon Saint-Denis \t Title: Vice President\nSTANDARD CHARTERED BANK\nBy:\/s\/ Stephen H. Wahl \t Title: Vice President\n\tSCHEDULE I\n\tBANKS AND COMMITMENTS\n\t\t\t\t\t\t\t\t\t\t\t\t Banks\t\t\t\t\t\t\t Commitment - ---------------------------------------\t\t\t\t--------------------- Chemical Bank \t\t\t\t\t\t $30,000,000.00\t c\/o Chemical Securities Inc. 270 Park Avenue New York, New York 10017 Attention: Robert Gaynor Telephone: (212) 270-3838 Telecopy: (212) 972-0009\nABN AMRO Bank NV New York Branch\t\t\t $16,000,000.00 500 Park Avenue New York, New York 10022 Attention: Mr. Clarke Moody Telephone: (212) 446-4142 Telecopy: (212) 832-7129\nBanca Commerciale Italiana\t\t\t\t $16,000,000.00 One William Street New York, New York 10004 Attention: Mr. Charles Dougherty Telephone: (212) 607-3656 Telecopy: (212) 809-2124\nBanca Popolare di Milano\t\t\t\t $16,000,000.00 375 Park Avenue New York, New York 10152 Attention: Mr. Nicholas Cinosi Telephone: (212) 758-5040 Telecopy: (212) 838-1077\nThe Bank of Montreal\t\t\t\t\t $16,000,000.00\t 430 Park Avenue New York, New York 10022 Attention: Mr. Tom Brino Telephone: (212) 605-1666 Telecopy: (212) 605-1455\nThe Bank of New York\t\t\t \t\t$16,000,000.00 One Wall Street 8th Floor New York, New York 10286 Attention: Mr. Roger Grossman Telephone: (212) 635-1309 Telecopy: (212) 635-1480\nThe Bank of Nova Scotia\t\t\t\t $16,000,000.00 One Liberty Plaza New York, New York 10006 Attention: Mr. Dan Foote Telephone: (212) 225-5012 Telecopy: (212) 225-5090\nBankers Trust\t\t\t\t\t \t$30,000,000.00 One Bankers Trust Plaza, 23rd Floor New York, New York 10006 Attention: Mr. Ned Benedict Telephone: (212) 250-3708 Telecopy: (212) 250-6815\nBanque Nationale de Paris \t\t$16,000,000.00 499 Park Avenue New York, New York 10022-1278 Attention: Mr. Richard Pace Telephone: (212) 415-9720 Telecopy: (212) 415-9606\nBayerische Landesbank \t\t\t\t$16,000,000.00 560 Lexington Avenue New York, New York 10022 Attention: Ms. Joanne Cicino Telephone: (212) 310-9834 Telecopy: (212) 310-9868\nBayerische Vereinsbank AG \t\t\t\t$16,000,000.00 335 Madison Avenue, 19th Floor New York, New York 10017 Attention: Ms. Marianne Weinzinger Telephone: (212) 210-0352 Telecopy: (212) 880-9724\nBHF-Bank AG\t \t\t\t\t\t$16,000,000.00 590 Madison Avenue New York, New York 10022 Attention: Ms. Linda Pace Telephone: (212) 756-5915 Telecopy: (212) 756-5536\nCARIPLO-Cassa di Risparmio delle\t \t\t$16,000,000.00 Provincie Lombarde S.p.A. 10 East 53rd Street New York, New York 10022 Attention: Mr. Anthony F. Giobbi Telephone: (212) 527-8737 Telecopy: (212) 527-8777\nChase Manhattan Bank \t\t\t\t\t$16,000,000.00\t 1 Greeway Plaza 135 Pinelawn Road Melville, New York 11747 Attention: Mr. Gary Olson Telephone: (212) 753-9670 Telecopy: (212) 753-0878\nCredit Industriel Et Commercial (CIC Paris)\t\t$16,000,000.00 57, rue de la Victoire 75009 Paris Attention: Mr. Steve Francis Telephone: (1) 45.96.90.04 Telecopy:\t(1) 45.96.90.11 or 90.71 \t Credit Lyonnais New York Branch\t \t\t$16,000,000.00 Credit Lyonnais Cayman Island Branch 1301 Avenue of the Americas New York, New York 10019 Attention: Mr. Mark Campellone Telephone: (212) 261-7120 Telecopy: (212) 459-3176\nDen Danske Bank Aktieselskab, \t\t\t$16,000,000.00 Cayman Islands Branch 280 Park Avenue 4th Floor - East Building New York, New York 10017 Attention: Mr. Mogens Sondergard Telephone: (212) 984-8472 Telecopy: (212) 370-9239\nDeutsche Bank AG\t\t \t\t\t$16,000,000.00 31 West 52nd Street, 24th Floor New York, New York 10019 Attention: Mr. Gregory Hill Telephone: (212) 474-8240 Telecopy: (212) 474-82 12\nThe First National Bank of Chicago\t \t$16,000,000.00 153 West 51st Street, Mail Suite 4000 New York, New York 10019 Attention: Mr. James Peterson Telephone: (212) 373-1108 Telecopy: (212) 373-1388\nHong Kong Bank\t\t\t\t\t $16,000,000.00 140 Broadway, 4th Floor New York, New York 10005 Attention: Ms. Rochelle Forster Telephone: (212) 658-5114 Telecopy: (212) 658-5109\nThe Long-Term Credit Bank of Japan, Ltd.\t \t$16,000,000.00 165 Broadway, 49th Floor New York, New York 10006 Attention: Ms. Laura Buckley Telephone: (212) 335-4518 Telecopy: (212) 608-2371\nNatWest Bank N.A. \t \t\t\t\t$24,000,000.00 190 Vanderbilt Motor Parkway Hauppauge, New York 11788 Attention: Mr. Stephen Ramerini Telephone: (516) 436-2021 Telecopy: (516) 436-2030\nNational Westminster Bank AG\t \t\t\t$16,000,000.00 Postfach, P.O. Box 11 10 51 60045 Frankfurt am Main, Germany Attention: Ms. Barbara Bauer Telephone: 011-49-69-17006-223 Telecopy:\t011-49-69-17006-335\nNationsBank of Texas, N.A.\t \t\t\t$16,000,000.00 901 Main Street, 67th Floor Dallas, Texas 75283-1000 Attention: Mr. Yousuf Omar Telephone: (214) 508-3347 Telecopy: (214) 508-0980\nPNC Bank, National Association\t \t\t\t$16,000,000.00 335 Madison Avenue New York, New York 11017 Attention: Mr. Tom Partridge Telephone: (212) 557-5356 Telecopy: (212) 557-5461\nThe Sanwa Bank, Limited,\t\t\t\t $16,000,000.00 New York Branch 55 East 52nd Street New York, New York 10055 Attention: Mr. Jean-Michel Fatovic Telephone: (212) 339-6397 Telecopy: (212) 754-1304\nShawmut Bank, N.A.\t\t\t \t\t$16,000,000.00 One Federal Street Boston, Massachusetts 02211 Attention: Ms. Peri Onipede Telephone: (617) 292-4048 Telecopy: (617) 292-3241\nSociete Generale\t\t \t\t\t$16,000,000.00 1221 Avenue of the Americas New York, New York 10020 Attention: Mr. Gordon Saint-Denis Telephone: (212) 278-7141 Telecopy: (212) 278-7430 \t\t Standard Chartered Bank \t\t\t\t$16,000,000.00 160 Water Street New York, New York 10038-4995 Attention: Mr. Stephen H. Wahl Telephone: (212) 612-0469 Telecopy: (212) 612-0225\nSchedule II \t\t\t\t\t\t\t\t\t\tpage 1 of 4 \tFOREIGN SUBSIDIARY BORROWERS\nName and Address\t\t\t\t \t \tJurisdiction of \t\t\t\t\t\t\t\tIncorporation - ----------------------------------------------------\t \t------\nArrow Electronics Distribution Group Europe B.V.\t \tNetherlands c\/o Executive Management Trustmij B.V. Drentestraat 20 1083 HK Amsterdam The Netherlands p 020-549-7777 f 020-661-0654\nArrow Electronics GmbH\t\t\t\t\t Germany Max-Planck StraBe 1-3 D-63303 Dreieich Germany p 49-6103-30-40 f 49-6103-35465\nSpoerle Electronic Handelsgesellschaft mbH & Co.\t\t Germany Max-Planck StraBe 1-3 D-63303 Dreieich Germany p 49-6103-30-40 f 49-6103-35465\nArrow Electronics (UK) Ltd.\t\t\t\t\t England St. Martins Business Centre Cambridge Road Bedford, MK42 OLF England p 011-44-1-234-270-272 f 011-44-1-234-211-434\nSchedule II \t\t\t\t\t\t\t\t\t\tpage 2 of 4\n\tFOREIGN SUBSIDIARY BORROWERS\nName and Address\t\t\t\t\t \t Jurisdiction of \t\t\t\t\t\t\t\t Incorporation - ------------------------------------- --------------- Microprocessor and Memory Distribution Ltd.\t \t\tEngland 3 Bennet Court Bennet Road, Reading Berkshire, RG2 OQX England p 011-44-734-313-232 f 011-44-734-313-255\nArrow-Exatec A\/S\t\t\t\t\t \tDenmark Mileparken 20E DK-2740 Skovlunde Denmark p 45-44-92-70-00 f 45-44-92-60-20\nArrow-Field OY\t\t\t\t\t \t\tFinland Niittyl@ntie 5 SF-00620, Helsinki Finland p 011-358-2-777-571 f 011-358-0-798-853\nArrow-TH:s Elektronik AB\t\t\t\t\t Sweden Arrendev@gen 36 Box 3027 S-16303 Spaga Sweden p 46-8-36-2970 f 46-8-761-3065\nSchedule II \t\t\t\t\t\t\t\t\t\tpage 3 of 4 \tFOREIGN SUBSIDIARY BORROWERS \t\t\t \t\t\t\t\t\t\t\tJurisdiction of\t\t \tName and Address\t\t\t\t\t Incorporation - --------------------------------------------- \t\t------------------ Arrow-Tahonic A\/S\t\t\t\t \t\tNorway Sagveien 17 PO Box 4554 Torshov 0404 Oslo Norway p 47-2-237-6020 f 47-2-237-4140\nComponents Agent Limited\t\t\t\t\t Hong Kong 36\/F Metroplaza, Tower 1 Hing Fong Road, Kwai Chung Hong Kong p 011-852-922-02388 f 011-852-487-1268\nTexny Glorytact (HK) Limited\t \t\t\t\tHong Kong Unit M, 6\/F., Kaiser Estate Phase 3, 11 Hok Yuen Street Hunghom, Kowloon Hong Kong p 011-852-765-0118 f 011-852-765-0557\nArrow Electronique S.A.\t\t \t\t\t\tFrance 73\/39, rue des Solets Silic 585 94663 Rungis Cedex France p 011-33-1-49-78-49-78 f 011-33-1-49-78-05-96\nMegachip S.A.\t\t\t \t\t\t\tFrance 7, avenue du Canada Z.A. Courtaboeuf 91966 LES ULIS cPdex France p 33-1-69-29-04-04 f 33-1-69-29-00-39\nSchedule III\n\tCERTAIN INFORMATION CONCERNING SWING LINE \tLOANS AND LETTERS OF CREDIT\nI.\tIssuing Banks and Issuing Offices\nName of Issuing Bank\t \tIssuing Office\t\t Currencies - ---------------------- \t---------------- \t---------------- Chemical Bank\t\t\t 55 Water Street\t \t \tAll Available \t\t\t\t17th Floor\t\t\t Foreign Currencies \t\t\t\t New York, New York 10041 \t\t\t \tAttention: Standby Letter \t\t\t \tof Credit Dept. \t\t \t\tTelecopy: (212) 363-5656\nBayerische Vereinsbank AG \t335 Madison Avenue \t\tU.S.Dollars New York Branch\t \t19th Floor \t \t\tDeutsche Marks \t\t\t \tNew York, NY 10017\t \tHong Kong Dollars \t\t \t\tAttn: Letter of Credit\t\tFrench Francs \t\t\t\tDept.\t \t\t\tDanish Kroner \t\t\t \tTelecopy: (212) 210-0330\tDutch Guilder \t\t\t\t \t\t\t\tPounds Sterling\nStandard Chartered Bank \t9\/F Parklane Square \t\tAll Available \t\t \t\tChiwan Tower,\t \t\tForeign Currencies \t \t\t\t1 Kimberly Road \t\t\t\tTsimshatsui, Kowloon, \t\t\t\tHong Kong \t\t\t\tPhone: 011-852-2378-6771 \t\t\t \tTelecopy: 011-852-2376-1144\nBanque Nationale de Paris \t200 Liberty Street \tAll Available \t\t\t \t20th Floor\t \t\tForeign Currencies \t\t\t \tWorld Financial Center \t\t\t \tTower A \t\t\t\tNew York, New York 10281 \t\t\t\tAttention: Standby Letter \t\t\t\t of Credit Section \t\t\t\tTelecopy: (212) 978-1669\t\t\nI.\tIssuing Banks and Issuing Offices (con=t)\nName of Issuing Bank\t \tIssuing Office\t \t\tCurrencies - ---------------------------------\t--------------------\t\t\t---------------- Bank of New York\t \tOne Wall Street\t \t\tAll Available \t\t\t \t8th Floor \t\t\tForeign Currencies \t\t\t \tNY Corporate Division \t\t\t\tNew York, New York 10286 \t\t\t\tPhone: (212) 635-1311 \t\t\t\tTelecopy: (212) 635-1480\nII.\tSwing Line Loans\t\t\t\t\t\t\t\nDollar Equivalent Amount of Swing Line Name of Borrower \t \tSwing Line Bank \tSwing Line Currency Limit - ---------------- -------------- ------------------- -------\t Arrow Electronics, Inc. \t \tChemical Bank \t\tU.S. Dollars \t$10,000,000\nComponents Agent Limited\/ \tStandard Chartered\tHong Kong Dollar\/ $ 5,000,000 Texny Glorytact (HK) Limited Bank \t \tU.S. Dollars\nArrow -Exatec A\/S\t\t Den Danske Bank\t Danish Kroner \t\t$ 6,000,000\nArrow Electronique S.A.\/ \tCredit Industriel \tFrench Franc \t\t$13,000,000 Megachip S.A.\t \t\tet Commercial\nSpoerle Electronic\t \tBHF Bank\t \tDeutschemarks \t\t$ 5,000,000 Handelsgesellschaft mbH & Co.\nArrow Electronics (UK) Ltd. \tNatWest Bank N.A.\tPounds Sterling \t\t$11,000,000 \t\t\t\t\t\t\tU.S. Dollars\nIII.\tSwing Line Lenders -- Addresses of Lending Offices\nBerliner Handels-und Frankfurter Bank AG\t\t\t Neue Mainzer Strasse 74\t\t\t\t\t D-60311 Frankfurt am Main\t\t\t\t\t Germany\t\t\t\t\t\t\t Attn: Hansjorg Burk\t\t\t\t\t\t phone: 011-49-69-718-2523\t\t\t\t\t telecopy: 011-49-69-718-3131\nChemical Bank 270 Park Avenue New York, NY 10017 Attention: Robert Gaynor phone: 212-270-3838 telecopy: 212-972-0009\nCredit Industriel et Commercial 57 rue de la Victoire Paris France 75009 Attn: Stephen Francis phone: 011-331-4596-9004 telecopy: 011-331-4596-9011\t\nDen Danske Bank\n[ to be agreed ]\nNatWest Bank N.A. 190 Vanderbilt Motor Parkway Hauppauge, NY 11788 Attn: James Thompson phone: 516-436-2043 telecopy: 516-436-2030\t\nStandard Chartered Bank 9\/F Parklane Square Chiwan Tower, 1 Kimberly Road Tsimshatsui, Kowloon, Hong Kong phone: 011-852-2378-6771 telecopy: 011-852-2376-1144\n\t\t\t\t\t\t\t\t\tSCHEDULE IV\n\t\t\t\tADMINISTRATIVE SCHEDULE\nI. COMMITTED RATE LOANS\n\tA. Interest Rates for Each Currency\n\tDollars:\n\t\t1. Committed Rate ABR Loans: ABR\n\t\t2. Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Dollars for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Telerate Page 3750 (or, if no such quotation appears on such Telerate Page, on the appropriate Reuters Screen) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tDanish Kroner: \t\t \t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Danish Kroner for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Reuters Screen DKNH (or, if no such quotation appears on such Reuters Screen, on the appropriate Telerate Page) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tDeutsche Marks: \t\t \t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Deutsche Marks for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Telerate Page 3750 (or, if no such quotation appears on such Telerate Page, on the appropriate Reuters Screen) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\t\t \tFrench Francs: \t\t \t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in French Francs for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Telerate Page 3740 (or, if no such quotation appears on such Telerate Page, on the appropriate Reuters Screen) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period. \t \t\t \tSterling: \t\t \t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate per annum equal to the average (rounded upward to the nearest 1\/16th of 1%) of the rates at which Chemical Bank is offered deposits in Sterling in the Paris interbank market at or about 11:00 A.M., Paris time, on the Quotation Day for such Interest Period for delivery on the first day of such Interest Period for the number of days comprised therein and in an amount comparable to Chemical Bank's Borrowing Percentage of the applicable Committed Rate Loan.\n\tHong Kong Dollars: \t\t \t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Hong Kong Dollars for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Reuters Screen HIBO (or, if no such quotation appears on such Reuters Screen, on the appropriate Telerate Page) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tNorwegian Kroner:\n\t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Norwegian Kroners for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Telerate Page 20818 (or, if no such quotation appears on such Telerate Page, on the appropriate Reuters Screen) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tFinnish Markka:\n\t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Finnish Markka for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Reuters Screen SPFB (or, if no such quotation appears on such Reuters Screen, on the appropriate Telerate Page) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tSwedish Kroner:\n\t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Swedish Kroners for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Reuters Screen SIOR (or, if no such quotation appears on such Reuters Screen, on the appropriate Telerate Page) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tDutch Guilder:\n\t\t Committed Rate Eurocurrency Loans:\n\t\t\tfor any Interest Period in respect of any Tranche, the rate for deposits in Dutch Guilders for a period beginning on the first day of such Interest Period and ending on the last day of such Interest Period which appears on the Telerate Page 3740 (or, if no such quotation appears on such Telerate Page, on the appropriate Reuters Screen) as of 11:00 a.m., London time, on the Quotation Day for such Interest Period.\n\tB.\tFunding Office, Funding Time, Payment Office, Payment Time for Each Currency.\n\tDollars (If Specified Borrower is the Company):\n\t\t1. Funding Office:\tChemical Bank \t\t\t\t\t270 Park Avenue \t\t\t\t\tNew York, New York\n\t\t2. Funding Time: \t11:00 A.M., New York time for Eurocurrency Loans \t\t\t\t\t1:00 P.M., New York time for ABR Loans\n\t\t3. Payment Office: \tChemical Bank \t\t\t\t\t270 Park Avenue \t\t\t\t\tNew York, New York\n\t\t4. Payment Time: \t12:00 Noon, New York time.\n\tDollars (If Specified Borrower is a Foreign Subsidiary Borrower):\n\t\t1. Funding Office: \tChemical Investment Bank Limited \t\t\t\t\tAccount of:\tChemical Investment \t\t \t\t\t\t\t\t\t Bank Limited \t\t\t\t\tAccount No:\tCHAPS 40 52 06 \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ\n\t\t2. Funding Time: \t11:00 A.M., New York time for Eurocurrency Loans \t\t\t\t\t1:00 P.M., New York time for ABR Loans\n\t\t3. Payment Office: \tChemical Investment Bank Limited \t\t\t\t\tAccount of: Chemical Investment \t\t\t \t\t\t\t\t\t\tBank Limited \t\t\t\t\tAccount No: CHAPS 40 52 06 \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ\n\t\t4. Payment Time: 12:00 Noon, London time.\n\tDanish Kroner:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t5000001963 \t\t\t\t\tUnibank Populaires \t\t\t\t\tCopenhagen \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t5000001963 \t\t\t\t\tUnibank Populaires \t\t\t\t\tCopenhagen \t \t\t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tDeutsche Marks:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t0101-080002101 \t\t\t\t\tChemical Bank \t\t\t\t\tFrankfurt \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t0101-080002101 \t\t\t\t\tChemical Bank \t\t\t\t\tFrankfurt \t \t\t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tFrench Francs:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t905 01735 \t \t\t\t\tCaisse Centrale des Banques \t\t\t\t\tParis\n\t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t905 01735 \t \t\t\t\tCaisse Centrale des Banques \t\t\t\t\tParis \t \t\t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tSterling:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\tCHAPS 40 52 06 \t\t\t\t\tChemical Bank \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\tCHAPS 40 52 06 \t\t\t\t\tChemical Bank \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t \t\t\t\t \t\t4. Payment Time: 11:00 A.M., local time. \t\t\t\t\t\t\n\tHong Kong Dollars:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited London \t\t\tAccount No:\t0001-039230103 \t\t\t\t\tChemical Bank \t\t\t\t\tHong Kong \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t0001-0392301 \t\t\t\t\tChemical Bank \t\t\t\t Hong Kong \t\t\t \t\t4. Payment Time: 11:00 A.M., local time. \t\t\n\tNorwegian Kroner:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t110100334350 \t\t\t\t\tChemical Bank \t\t\t\t\tNorge A\/S, Oslo\t \t\t\t\t\t \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t110100334350 \t\t\t\t\tChemical Bank \t\t\t\t \tNorge A\/S, Oslo \t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tFinnish Markka:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Bank, London [Swift CHEMGB2L] \t\t\t\t\tfor further favour Chemical Investment Bank \t\t\t\t\tLimited Account No:\t20006700145116 \t\t\t\t\tMerita Bank, Helsinki [Swift UNITFIHH] \t\t\t\t\t \t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Bank, London [Swift CHEMGB2L] \t\t\t\t\tfor further favour Chemical Investment Bank \t\t\t\t\tLimited \t\t\tAccount No:\t20006700145116 \t\t\t\t\tMerita Bank, Helsinki [Swift UNITFIHH] \t \t\t4. Payment Time: 11:00 A.M., local time.\n\tSwedish Kroner:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t5201-8519395 \t\t\t\t\tSkandinaviska Banken Enskllda Banken, \t\t\t\t\tStockholm \t\t\t\t\t \t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t5201-8519395 \t\t\t\t\tSkandinaviska Banken Enskllda Banken, \t\t\t\t\tStockholm \t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tDutch Guilder:\n\t\t1. Funding Office:\t \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t540419400 \t\t\t\t\tABN\/Amro Bank NV \t\t\t\t\tNederlandsche, Amsterdam\n\t\t2. Funding Time: 11:00 A.M., local time.\n\t\t3. Payment Office: \t\t\tAccount of:\tChemical Investment Bank Limited \t\t\tAccount No:\t540419400 \t\t\t\t\tABN\/Amro Bank NV \t\t\t\t\tNederlandsche, Amsterdam \t\t\t \t\t4. Payment Time: 11:00 A.M., local time.\n\tC.\tNotice of Borrowing:\n\tDollars (If Specified Borrower is the Company):\n\t\t1. Deliver to: \tChemical Bank Agent Bank Services Group \t\t\t\t\t140 East 45th Street \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Maggie Swales \t\t\t\t\tTelephone No: 212-622-8433 \t\t\t\t\tFax No: 212-622-0122\n\t\t2. Time: \t\t\t(i) ABR Loans--Not later than 12:00 Noon, New York \t\t\tCity time, on the Borrowing Date\n\t\t\t(ii) Eurocurrency Loans--Not later than 12:00 Noon, \t\t\tNew York City time, three Business Days prior to the Borrowing Date.\n\t\t3.\tInformation Required: Name of Borrower, amount to be \t\tborrowed, whether ABR Loans or Eurocurrency Loans, amounts of each \t\tsuch type, and Interest Periods for Eurocurrency Loans.\n\tDollars (If Specified Borrower is a Foreign Subsidiary Borrower):\n\t\t1. Deliver to: \tChemical Investment Bank Limited \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t\t\t\t\tAttention: Steve Clarke \t\t\t\t\tTelephone No: 011-44-171 777 2353 \t\t\t\t\tFax No: 011-44-171 777 2360\n\t\t2. Time: \t\t\t(i) ABR Loans--Not later than 11:00 A.M., London time, \t\t\ton the Borrowing Date\n\t\t\t(ii) Eurocurrency Loans--Not later than 11:00 A.M., \t\t\tLondon time, three Business Days prior to the Borrowing Date.\n\t\t3.\tInformation Required: Name of Borrower, amount to be \t\tborrowed, whether ABR Loans or Eurocurrency Loans, amounts of each \t\tsuch type, and Interest Periods for Eurocurrency Loans.\n\tAvailable Foreign Currencies:\n\t\t1. Deliver to: \tChemical Investment Bank Limited \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t\t\t\t\tAttention: Steve Clarke \t\t\t\t\tTelephone No: 011-44-171 777 2353 \t\t\t\t\tFax No: 011-44-171 777 2360\n\t\t2. Time:\tNot later than 11:00 A.M., London time, on the last \t\tBusiness Day preceding the Quotation Day in respect of such Borrowing \t\tDate.\n\t\t3.\tInformation Required: Name of Borrower, amount to be \t\tborrowed, and Interest Periods.\n\tD. Notice of Continuation; Notice of Prepayment;\n\tDollars (If Specified Borrower is the Company):\n\t\t1. Deliver to: \tChemical Bank Agent Bank Services Group \t\t\t\t\t140 East 45th Street \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Maggie Swales \t\t\t\t\tTelephone No: 212-622-8433 \t\t\t\t\tFax No: 212-622-0122 \t\t\t\t\t\t \t\t2. Time:\t \t\t\t(i) ABR Loans--Not later than 12:00 Noon, New York \t\tCity time, on the prepayment date\n\t\t\t(ii) Eurocurrency Loans----Not later than 12:00 Noon, \t\tNew York City time, three Business Days prior to the last day of the \t\tcurrent Interest Period for continuations or the prepayment date, as \t\tthe case may be.\n\t\t3.\tInformation Required: Name of Borrower, amount to be \t\tcontinued or prepaid, as the case may be, whether ABR Loans or \t\tEurocurrency Loans, amounts of each such Type, and Interest Periods \t\tfor Eurocurrency Loans to be continued.\n\tDollars (If Specified Borrower is a Foreign Subsidiary Borrower):\n\t\t1. Deliver to: \tChemical Investment Bank Limited \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t\t\t\t\tAttention: Steve Clarke \t\t\t\t\tTelephone No: 011-44-171 777 2353 \t\t\t\t\tFax No: 011-44-171 777 2360\n\t\t2. Time: \t\t\t(i) ABR Loans--Not later than 11:00 A.M., London time, \t\t\ton the prepayment date\n\t\t\t(ii) Eurocurrency Loans--Not later than 11:00 A.M., \t\t\tLondon time, three Business Days prior to the last day of the current \t\t\tInterest Period for continuations or the prepayment date, as the case \t\t\tmay be \t\t3.\tInformation Required: Name of Borrower, amount to be \t\tcontinued or prepaid, as the case may be, whether ABR Loans or \t\tEurocurrency Loans, amounts of each such Type, and Interest Periods \t\tfor Eurocurrency Loans to be continued.\n\tAvailable Foreign Currencies:\n\t\t1. Deliver to: \tChemical Investment Bank Limited \t\t\t\t\t125 London Wall \t\t\t\t\tLondon EC2Y 5AJ \t\t\t\t\tAttention: Steve Clarke \t\t\t\t\tTelephone No: 011-44-171 777 2353 \t\t\t\t\tFax No: 011-44-171 777 2360 \t \t\t \t\t2. Time: \t\t\tNot later than 11:00 A.M., London time, on the last \t\tBusiness Day preceding the Quotation Day for the next Interest Period.\n\t\t3.\tInformation Required: Name of Borrower, amount to be \t\tcontinued or prepaid, as the case may be, and Interest Periods.\nII.\tCOMPETITIVE ADVANCE LOANS\n\tA.\tCompetitive Advance Loan Request by Company\n\t\t1. Deliver to:\t\tChemical Bank Agent Bank Services Group \t\t\t\t\t140 East 45th Street \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Maggie Swales \t\t\t\t\tTelephone No: 212-622-8433 \t\t\t\t\tFax No: 212-622-0122\n\t\t2. Delivery time:\tBy 9:30 A.M. New York time on the date \t\ton which Competitive Advance Loan Offers are requested.\n\t\t3. Information to be set forth: \t\t Name of Borrower. \t\t Amount and Currency of Competitive Advance Loan. \t\t Date of Competitive Advance Loan. \t\t Maturity Date. \t\t Interest Payment Dates. \t\t Date on which Competitive Advance Loan Offers are due. \t\t\t \tB.\tCompetitive Advance Loan Offer to Company\n\t\t1. Deliver to:\tChemical Bank Agent Bank Services Group \t\t\t\t\t140 East 45th Street \t\t\t\t\tNew York, New York 10017 \t\t\t\t\tAttention: Maggie Swales \t\t\t\t\tTelephone No: 212-622-8433 \t\t\t\t\tFax No: 212-622-0122\n\t\t2. Delivery time:\tBy 11:00 A,M. New York time on date set \t\tforth in Competitive Advance Loan Request.\n\t\t3.\tInformation to be set forth: \t\t\tName of Bank. \t\t\tAmount and Currency of Competitive Advance Loan offered \t\t\tfor each maturity date. \t\t\tinterest rate. \t\t\tIf Competitive Advance Loans may not be prepaid. \t\t \t\t\t \tC.\tCompetitive Advance Loan Request by Foreign Subsidiary Borrower\n\t\t1. Deliver to:\tChemical Investment Bank Limited \t\t\t\t \t125 London Wall \t\t\t\t \tLondon EC2Y 5AJ \t\t\t\t \tAttention: Steve Clarke \t\t\t\t \tTelephone No: 011-44-171 777 2353 \t\t\t\t \tFax No: 011-44-171 777 2360\n\t\t2. Delivery time:\tBy 11:00 A.M. London time one Business \t\tDays prior to the date on which Competitive Advance Loan Offers are \t\trequested.\n\t\t3.\tInformation to be set forth: \t\t\tName of Borrower. \t\t\tAmount and Currency of Competitive Advance Loan. \t\t\tDate of Competitive Advance Loan. \t\t\tMaturity Date. \t\t\tInterest Payment Dates. \t\t\tDate on which Competitive Advance Loan Offers are due. \t\t\t \tD.\tCompetitive Advance Loan Offer to Foreign Subsidiary Borrower\n\t\t1. Deliver to:\tChemical Investment Bank Limited \t\t\t\t \t125 London Wall \t\t\t\t \tLondon EC2Y 5AJ \t\t\t\t \tAttention: Steve Clarke \t\t\t\t \tTelephone No: 011-44-171 777 2353 \t\t\t\t \tFax No: 011-44-171 777 2360\n\t\t2. Delivery time:\tBy close of business London time on \t\tBusiness Day preceding the requested Competitive Advance Loan.\n\t\t3.\tInformation to be set forth: \t\t\tName of Bank. \t\t\tAmount and Currency of Competitive Advance Loan offered \t\t\tfor each Borrower for each maturity date. \t\t\tinterest rate. \t\t\tIf Competitive Advance Loans may not be prepaid.\nIII. NOTICE OF SWING LINE OUTSTANDINGS\n\tA.\tDeliver to: \t\tChemical Investment Bank Limited \t\t\t\t\t125 London Wall \t\t\t\t \tLondon EC2Y 5AJ \t\t\t\t \tAttention: Steve Clarke \t\t\t\t \tTelephone No: 011-44-171 777 2353 \t\t\t\t \tFax No: 011-44-171 777 2360\n\tB.\tDelivery time:\tBy close of business in London on the date of \trequest by Administrative Agent and on the first Business Day of each \tmonth on which a Swing Line Lender has any outstanding Swing Line \tLoans as of the opening of business on such first day.\n\tC.\tInformation to be set forth: \t\tName of Borrower \t\tNumber of Swing Line Loans \t\tAmount and Currency of each Swing Line Loan \t\tDate of each Swing Line Loan\nIV. NOTICE OF SWING LINE REFUNDING\n\tA.\tDeliver to: \t\tChemical Investment Bank Limited \t\t\t\t \t125 London Wall \t\t\t\t \tLondon EC2Y 5AJ \t\t\t\t \tAttention: Steve Clarke \t\t\t\t \tTelephone No: 011-44-171 777 2353 \t\t\t\t \tFax No: 011-44-171 777 2360\n\tB.\tInformation to be set forth: \t\tName of Borrower \t\tNumber of Swing Line Loans \t\tAmount and Currency of each Swing Line Loan \t\tDate of each Swing Line Loan\nV. NOTICE OF LOCAL CURRENCY OUTSTANDINGS\n\t\t1. Deliver to:\tChemical Investment Bank Limited \t\t\t\t \t125 London Wall \t\t\t\t \tLondon EC2Y 5AJ \t\t\t\t \tAttention: Steve Clarke \t\t\t\t \tTelephone No: 011-44-171 777 2353 \t\t\t\t \tFax No: 011-44-171 777 2360\n\t\t2. Delivery time:\tBy close of business in London on the \t\tdate of making of each Local Currency Loan and on the last Business \t\tDay of each month on which the applicable Local Currency Borrower has \t\toutstanding any Local Currency Loans.\n\t\t3.\tInformation to be set forth: \t\t\tName of Borrower \t\t\tAmount and Currency of outstanding Local Currency Loans\n\t \t\t\t\t\t\t\tSchedule 8.13\n1.\tExtended Separation Benefits\n\tThe Company maintains a broad-based program to shelter employees at all levels from any adverse consequences which might result from a change in control of the Company. A change in control is defined in the program to include such time that any person becomes the beneficial owner, directly or indirectly, of 30% or more of the combined voting power of the Company's voting securities or certain changes occur in the constitution of the Company's Board of Directors. Pursuant to a policy adopted by the Board of Directors in 1988, the period of salary continuation normally extended to employees whose employment is terminated as a result of a workforce reduction or reorganization (which period ranges from 2 to 12 weeks depending upon length of service with the Company) is tripled if employment is terminated by the Company (other than for cause) as a result of a change in control. In addition to this policy, the Company has entered into one-year employment agreements with approximately 65 management-level employees, pursuant to which among other matters, such employees will receive one year's compensation and continuation for up to one year of medical and life insurance benefits if their employment is terminated by the Company (other than for cause) within 12 months following a change in control. The Company also has agreements with approximately 20 divisional and group vice presidents who are not executive officers, which provide such vice presidents with two times their annualized includible compensation (as defined in the Code) and continuation for up to three years of medical, life, and other welfare benefits if their employment is terminated by the Company (other than for cause), if their responsibilities or base salaries are materially diminished, or if certain other adverse changes occur within 24 months following a change in control. Similar agreements provide the executive officers with three times their annualized includible compensation and continuation for up to three years of their benefits if their employment is terminated by the Company(other than for cause approved by three-fourths of the directors then serving), if their responsibilities or base salaries are materially diminished, or if certain other adverse changes occur within 24 months following a change in control. The amounts payable pursuant to such agreements to the executive officers (other than Messrs. Waddell, Kaufman, and Klatell) and to the other vice presidents will be reduced, if necessary, to avoid excise tax under Section 4999 of the Code.\n2. Unfunded Pension Plan\n\tThe Company maintains the Unfunded Pension Plan for Selected Executives of the Company (the \"SERP\"). Under the SERP, the Company's Board of Directors determines those employees who are eligible to participate in the SERP and the amount of their maximum annual pension upon retirement on or after attaining age 60. Of the named executive officers, Messrs. Kaufman, Klatell and Menefee have been designated by the Company as participants in the SERP, with maximum annual pensions of $300,000, $150,000 and $175,000 respectively. If a designated participant retires between the ages of 55 and 60, the amount of the annual pension is reduced based upon a formula contained in the SERP. In addition, if there is a change of control of the Company and the employment of a designated participant who is at least age 50 with 15 years of service is involuntarily terminated other than for cause or disability, or such participant terminates employment for good reason, the participant will receive the maximum annual pension\n\t\t\t\t\tSchedule 8.15 \t\t\t\t\tPage 1 of 2 \tARROW ELECTRONICS, INC. \tSUBSIDIARY LISTING\n1.\tArrow Electronics, Inc. a New York corporation 2.\tArrow Electronics International, Inc., a Virgin Islands \tcorporation 3.\tArrow Electronics Canada Ltd., a Canadian Corporation 4.\tLex Electronics, Ltd., a Canadian Corporation 5.\tArrow Electronics Credit Corporation, a Delaware Corporation 6.\tSchuylkill Metals of Plant City, Inc., a Delaware Corporation 7.\tArrow Electronics International, Inc., a Delaware Corporation 8.\tArrow Electronics (UK) Inc., a Delaware Corporation 9.\tArrow\/TEK Ltd., a Japanese Joint Venture (50% owned) 10.\tCapstone Electronics Corp., a Delaware Corporation 11.\tHigh Tech Ad, Inc., a New York Corporation 12.\tGates\/Arrow Distributing, Inc., a Delaware Corporation 13.\tAnthem Electronics, Inc., a Delaware Corporation, including \tsubsidiaries: \tA. \tAnthem Enterprises \tB. \tLionex Corp. \tC. \tAnthem Technology Systems 14.\tArrow-Field Oy, and subsidiaries, a Finnish Company 15.\tArrow-TH:s Elektronik AB, and subsidiaries, a Swedish Company \t(85% owned) 16.\tArrow-Exatec A\/S, and subsidiaries, a Danish company (85% owned) 17.\tArrow Electronics Distribution Group - Europe B.V., a Dutch \t company, and Subsidiaries which include: \tA. \tArrow Electronics (UK) Limited, a British Company, and subsidiaries: \t \t1. \tRR Electronics Limited, a British Company \t\t2. \tAxiom Electronics Ltd., a British Company \t\t3. \tJermyn Holdings Limited, a British Company & Subsidiaries \t\t4.\t Techdis Limited, a British company, and subsidiary: \t\t \ta. \tMicroprocessor & Memory Distribution Ltd., a \t\t \t British Company \tB. \tEDI Electronics Distribution International (France) SA, \t \ta French Company and subsidiaries: \t \t1. \tArrow Electronique S.A., a French Company, and subsidiaries: \t\t \ta. \tGenerim S.A., a French Company \t\t \tb. \tFeutrier S.A., a French Company \t\t \tc. \tCCI Electronique S.A., a French Company \t\t \td. \tArrow Computer Products S.N.C. (formerly Megachip \t\t\t \tS.A.)and subsidiaries \tC. \tArrow Electronics GmbH, a German Company (which owns \t \t 70% interest of Spoerle Electronic Handelsgesellschaft mbH, \t \ta German company, and subsidiaries)\n\t\t\t\t\tSchedule 8.15 \t\t\t\t\tPage 2 of 2 \tSUBSIDIARY LISTING\n\tD. \tArrow ATD Netherlands B.V., a Dutch company (which owns 87% \t \tof ATD Electronica S.A., a Spanish company \tE. \tARROW-Amitron Netherlands B.V., a Dutch company (which owns \t \t75% of the shares of Amitron-Arrow S.A.) \tF. \tSilverstar Ltd. S.p.A. (86% owned) & subsidiaries \tG. \tArrow Electronics Australia Pty Ltd. (100% owned) and \t \tsubsidiaries: \t \t1. \tVeltek Australia Pty Ltd. (75% owned) \t \t2. \tZatek Australia Pty Ltd. (75% owned)\n18.\tComponents Agent Limited, a British Virgin Island company (90% \towned) and Subsidiaries which include: \tA. \tComponents Agent Limited, a Hong Kong company \tB. \tComponents Agent China Limited, a Hong Kong company \tC. \tComponents Agent Korea Limited, a Hong Kong company \tD. \tComponents Assembly & Sales Pte Ltd, a Singapore company \tE. \tCasl. (M) Sdn. Berhad, a Malaysian company, and subsidiaries \tF. \tSalson Holdings Limited, a British Virgin Islands company, \t \t \tand subsidiary: \t \t1. \tQinhuangdao Arrow Electronics Company Limited, a company of \t\t \tthe People=s Republic of China \tG. \tComponents Korea Company Limited, a Korean company\n19.\tTexny (Holdings) Limited, a British Virgin Islands company (95% \towned) and Subsidiaries: \tA. \tTexny (H.K.) Limited, a Hong Kong company, and subsidiary: \t \t1. \tGlorytact Company Limited, a Hong Kong company \tB. \tIntex-semi Limited, a Hong Kong company (inactive company) \tC. \tColourmedia Animation Limited, a Hong Kong company (inactive \t \tcompany)\n20.\tStrong Electronics Co., Ltd. and subsidiaries, a Taiwanese Joint \tVenture (45% owned)\n21.\tArrow\/Ally, Inc. a Taiwanese company (75% owned)\n22.\tArrow Components (NZ) Limited, a New Zealand company (75% owned)\n\t\t\t\t\t\t\t\t\tSchedule 8.19\nEnvironmental Matters\n\tThrough a wholly-owned subsidiary, Schuylkill Metals Corporation, the Company was previously engaged in the refining and selling of lead. In September 1988, the Company sold its refining business.\n\t1.\tIn mid-1986 the refining business ceased operations at its battery breaking facility in Plant City, Florida, which facility had been placed on the list of hazardous waste sites targeted for cleanup under the federal Superfund Program. The Plant City site was not sold to the purchaser of the refining business, and the Company remains subject to various environmental cleanup obligations at the site under federal and state law. During 1991, the Company engaged in settlement negotiations with the EPA, resulting in the execution of a consent decree defining those obligations which was entered by a federal court in Florida and became effective on April, 1992. The consent decree requires the Company to fund and implement remedial design and remedial action activity addressing environmental impacts to site soils and sediment, underlying ground water, and wetland areas. The Company, through its technical contractors, has begun implementation of these requirements and substantial progress has been made in each of the areas requiring remediation. Remediation of the wetlands areas on the site, including the creation of certain new wetlands areas under agreement with the EPA and the Florida Department of Environmental Conservation, has been substantially completed. A waste water treatment plant has been built on site by the Company's contractors, and processing of ground and pond water for discharge to the Plant City Treatment Works has commenced. A contract for the stabilization of contaminated soils has been let and stabilization facilities erected. Soil processing has begun and material meeting the specifications of the consent decree are being produced.\n\t2.\tIron Horse Landfill Superfund Site (Massachusetts): The Federal government has identified Lex Electronics Inc. (\"LEI\") as a contributor of waste to a site identified as a toxic waste site now controlled by the remedial provisions of federal law. LEI has responded that it has no knowledge of the generation or disposal of toxic material at that site. Insurance coverage neither exists nor is available for this type of claim.\n\t\t\t\t\t\t\t\tEXHIBIT A TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tJOINDER AGREEMENT\n\t\tJOINDER AGREEMENT, dated as of the date set forth below, entered into pursuant to the SECOND AMENDED AND RESTATED CREDIT AGREEMENT, dated as of August __, 1995 (as amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"; terms defined therein being used herein as therein defined), among ARROW ELECTRONICS, INC., the Foreign Subsidiary Borrowers parties thereto, the Banks, Lead Manager and Agents parties thereto, CHEMICAL SECURITIES INC., as Arranger and CHEMICAL BANK, as Administrative Agent.\n\tW I T N E S S E T H:\n\t\tWHEREAS, the parties to this Joinder Agreement wish to amend Schedule II to the Credit Agreement in the manner hereinafter set forth; and\n\t\tWHEREAS, this Joinder Agreement is entered into pursuant to subsection 14.1(b) of the Credit Agreement;\n\t\tNOW, THEREFORE, in consideration of the premises, the parties hereto hereby agree as follows:\n\t\t1. Each of the undersigned Subsidiaries of the Company hereby acknowledges that it has received and reviewed a copy (in execution form) of the Credit Agreement, and agrees to:\n\t(a)\tjoin the Credit Agreement as a Foreign Subsidiary Borrower;\n\t(b)\tbe bound by all covenants, agreements and acknowledgements attributable to a Foreign Subsidiary Borrower in the Credit Agreement; and\n\t(c)\tperform all obligations required of it by the Credit Agreement.\n\t\t2. Each of the undersigned Subsidiaries of the Company hereby represents and warrants that the representations and warranties with respect to it contained in, or made or deemed made by it in, Section 8 of the Credit Agreement are true and correct on the date hereof.\n\t\t3. The address and jurisdiction of incorporation of each undersigned Subsidiary of the Company is set forth in Annex I to this Joinder Agreement.\n\t\t4. THIS JOINDER AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK.\n\t\tIN WITNESS WHEREOF, each of the undersigned has caused this Joinder Agreement to be duly executed and delivered in New York, New York by its proper and duly authorized officer as of the date set forth below. \t\t\t\t\t\t[NAME OF SUBSIDIARY], Dated:________________\t\t\tas a Foreign Subsidiary Borrower \t\t\t\t\t\t\n\t\t\t\t\t\tBy:__________________________ \t\t\t\t\t\t Title:\n\t\t\t\t\t\tARROW ELECTRONICS, INC.\n\t\t\t\t\t\tBy:_______________________ \t\t\t\t\t\tTitle:\nACKNOWLEDGED AND AGREED TO:\nCHEMICAL BANK, as Administrative Agent\nBy:_______________________ Title:\n\tANNEX I\n[Insert administrative information concerning Subsidiaries]\n\t\t\t\t\t\t\t\tEXHIBIT B TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tSCHEDULE AMENDMENT\n\t\tSCHEDULE AMENDMENT, dated as of the date set forth below, entered into pursuant to the SECOND AMENDED AND RESTATED CREDIT AGREEMENT, dated as of _________ __, ____ (as amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"; terms defined therein being used herein as therein defined), among ARROW ELECTRONICS, INC., the Foreign Subsidiary Borrowers parties thereto, the Banks, Lead Manager and Agents parties thereto, CHEMICAL SECURITIES INC., as Arranger and CHEMICAL BANK, as Administrative Agent.\n\tW I T N E S S E T H:\n\t\tWHEREAS, the parties to this Schedule Amendment wish to amend Schedule [III] [IV], as specified in Annex I hereto, to the Credit Agreement in the manner hereinafter set forth; and\n\t\tWHEREAS, this Schedule Amendment is entered into pursuant to subsection 14.1(b) of the Credit Agreement;\n\t\tNOW, THEREFORE, in consideration of the premises, the parties hereto hereby agree as follows:\n\t\t1. Schedule [III] [IV], as specified in Annex I hereto, is hereby amended as set forth in Annex I hereto.\n\t\t2. The Company hereby represents and warrants that, after giving effect to the amendments effected hereby, the representations and warranties contained in Section 8 of the Credit Agreement are true and correct on the date hereof.\n\t\t3. THIS SCHEDULE AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK.\n\t\tIN WITNESS WHEREOF, each of the undersigned has caused this Schedule Amendment to be duly executed and delivered in New York, New York by its proper and duly authorized officer as of the date set forth below. \t\t\t\t\t\t Dated:_________________\n\t\t\t\t\t\tARROW ELECTRONICS, INC. \t\t\t\t\t\t\n\t\t\t\t\t\tBy:_______________________ \t\t\t\t\t\tTitle:\nACKNOWLEDGED AND AGREED TO:\nCHEMICAL BANK, as Administrative Agent\nBy:_______________________ Title:\n[NAMES OF OTHER PARTIES, IF ANY, REQUIRED PURSUANT TO SUBSECTION 14.1 (b)]\n\tANNEX I\n[Describe amendments]\n\t\t\t\t\t\t\t\tEXHIBIT C TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\t[FORM OF LOCAL CURRENCY FACILITY ADDENDUM]\n\tLOCAL CURRENCY FACILITY ADDENDUM\nTo:\tChemical Bank, as Administrative Agent\nFrom: Arrow Electronics, Inc.\n\t\tI.\tThis Local Currency Facility Addendum is being delivered to you pursuant to subsection 6.1 of the Second Amended and Restated Credit Agreement, dated as of ________ __, 1995, among Arrow Electronics, Inc., each Foreign Subsidiary Borrower party thereto, the Banks, the Lead Manager and the Agents named therein, Chemical Securities Inc., as Arranger and Chemical Bank, as Administrative Agent (as the same may be amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"). Terms defined in the Credit Agreement and used herein shall have the meanings given to them in the Credit Agreement.\n\t\t2.\tThe effective date (the \"Effective Date\") of this Local Currency Facility Addendum will be ______________________ __, 19__.\n\t\t3.\tPlease be advised that, as of the Effective Date, the credit facility described below is hereby designated as a \"Local Currency Facility\" for the purposes of the Credit Agreement.\nType of Facility:1\/\nAdditional Local Currenc(y)(ies):\nLocal Currency Facility Maximum Borrowing Amount:\t\t\t\t$\nLocal Currency Banks:\t\t\t\t\tLocal Currency Bank \t\t\t\t\tName of Lender\tMaximum Borrowing Amount \t\t\t\t\t \t\t\t\t\t\t\t\t$\nList of Documentation Governing Local Currency Facility (the \"Documentation\"):1\/ \t\n\t\t4. Arrow Electronics, Inc. hereby represents and warrants that (i) the Documentation complies in all respects with the requirements of Section 6 of the Credit Agreement and (ii) ______________ of ______________1\/ contains an express acknowledgement that such Local Currency Facility shall be subject to the provisions of Section 6 of the Credit Agreement.\n\t\t\t\t\t\tARROW ELECTRONICS, INC.\n\t\t\t\t\t\tBy _______________________________ \t\t\t\t\t\t Title: \t\t\t\t\t\t\t \t\t\t\t\t\t\t\nAccepted and Acknowledged:\nCHEMICAL BANK, as Administrative Agent\nBy________________________________ Title:\n\t\t\t\t\t\t\t\tEXHIBIT D TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tFORM OF CONSENT AND CONFIRMATION\n\t\tCONSENT AND CONFIRMATION, dated as of _______ __, 1995 (this \"Consent and Confirmation\"), made by the undersigned, [CAPSTONE ELECTRONICS CORP., a Delaware corporation] [ARROW ELECTRONICS INTERNATIONAL, INC., a United States Virgin Islands corporation] [ANTHEM ELECTRONICS, INC., a Delaware corporation] [GATES\/ARROW DISTRIBUTING, INC., a Delaware corporation], as Guarantor (the \"Guarantor\") under the Subsidiary Guarantee (as hereinafter defined).\n\tW I T N E S S E T H:\n\t\tWHEREAS, the Guarantor executed and delivered a Guarantee, dated as of [September 27, 1991] [November __, 1994] [September __, 1994] (a copy of which is attached hereto as Exhibit A) [(as amended by the First Amendment thereto, dated as of December 29, 1992 (a copy of which is attached hereto as Exhibit B)], and as the same may be further amended, supplemented or otherwise modified from time to time, the \"Subsidiary Guarantee\") in favor of Bankers Trust Company, as collateral agent (the \"Collateral Agent\"), for (i) the several banks and financial institutions (the \"Existing Banks\") parties to the Amended and Restated Credit Agreement, dated as of January 28, 1994 (as amended, supplemented or otherwise modified prior to the date hereof, the \"Existing Credit Agreement\"), among Arrow Electronics, Inc. (the \"Company\"), the Existing Banks, Chemical Bank, as Administrative Agent and the Collateral Agent and (ii) the purchasers named in the several Senior Note Purchase Agreements, dated as of December 29, 1992 between such purchasers and the Company (as amended, supplemented or otherwise modified from time to time); and\n\t\tWHEREAS, the Existing Credit Agreement is being amended and restated as hereinafter described.\n\t\tNOW, THEREFORE, in consideration of the foregoing premises, the Guarantor hereby acknowledges, consents and confirms as follows:\n\t\t1. The Guarantor acknowledges that the Existing Credit Agreement is being amended and restated concurrently herewith by a Second Amended and Restated Credit Agreement, dated as of ___________ __, 1995 (as amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among the Company, the Banks named therein, the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents (the \"Agents\"), the Collateral Agent, Chemical Securities Inc., as Arranger, and Chemical Bank, as Administrative Agent (the \"Administrative Agent\").\n\t\t2. The Guarantor confirms and agrees that, after giving effect to the amendment and restatement of the Existing Credit Agreement by the Credit Agreement, the Subsidiary Guarantee is and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects, and the Credit Agreement is the Credit Agreement referred to in the Subsidiary Guarantee.\n\t\t3. This Consent and Confirmation is made for the benefit of the Agents, the Collateral Agent, the Administrative Agent and the Banks from time to time parties to the Credit Agreement and is executed and delivered to induce such parties to enter into the Credit Agreement and to extend credit to the Company thereunder.\n\t\t4. This Consent and Confirmation shall be governed by and construed in accordance with the laws of the State of New York.\n\t\tIN WITNESS WHEREOF, the undersigned has caused this Consent and Confirmation to be duly executed and delivered by its proper and duly authorized officer as of the day and year first above written.\n[CAPSTONE ELECTRONICS CORP.] [ARROW ELECTRONICS INTERNATIONAL, \t INC.] [ANTHEM ELECTRONICS, INC.] [GATES\/ARROW DISTRIBUTING, INC.]\nBy ____________________________ Title:\nACCEPTED:\nBANKERS TRUST COMPANY, as Collateral Agent\nBy _________________________ Title:\n\tExhibit A to Consent \t and Confirmation\n\t[Subsidiary Guarantee]\n\tExhibit B to Consent \t and Confirmation\n\t[First Amendment to Subsidiary Guarantee]\n\t\t\t\t\t\t\t\tEXHIBIT E TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tFORM OF BORROWING CERTIFICATE\n\t\tPursuant to subsection 9.1(b) of the Second Amended and Restated Credit Agreement, dated as of _______ __, 1995 (as the same may be amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among Arrow Electronics, Inc., a New York corporation (the \"Company\"), the several banks and other financial institutions from time to time parties thereto (the \"Banks\"), the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents for the Banks, Bankers Trust Company, as collateral agent, Chemical Securities Inc., as arranger, and Chemical Bank, as administrative agent for the Banks, the Company hereby certifies as follows:\n\t1. The representations and warranties of the Company set forth in the Credit Agreement and each of the other Credit Documents or which are contained in any certificate, document or financial or other statement furnished pursuant to or in connection with the Credit Agreement are true and correct in all material respects on and as of the date hereof with the same effect as if made on the date hereof, except for representations and warranties expressly stated to relate to a specific earlier date, in which case such representations and warranties are true and correct as of such earlier date;\n\t2. No Default or Event of Default has occurred and is continuing as of the date hereof or will occur after giving effect to the making of the Loans and the issuance of the Letters of Credit on the date hereof and the consummation of each of the transactions contemplated by the Credit Documents;\n\t3. There are no liquidation or dissolution proceedings pending or to the knowledge of the Company threatened against the Company, any of its Domestic Subsidiaries or any Foreign Subsidiary Borrower, nor to the knowledge of the Company has any other event occurred affecting or threatening the existence of the Company or any Foreign Subsidiary Borrower, except as permitted by the Credit Agreement, or any of its Subsidiaries;\n\t4. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of New York;\n\t5. No litigation, investigation or proceeding of or before any arbitrator or Governmental Authority is pending or, to the knowledge of the Company, threatened by or against the Company or any of its Subsidiaries or against any of its or their respective properties or revenues (a) with respect to any of the Credit Documents or any of the transactions contemplated hereby or thereby, or (b) which, if adversely determined, would have a Material Adverse Effect;\n\t\tUnless otherwise defined herein, capitalized terms which are defined in the Credit Agreement and used herein are so used as so defined.\n\t\tIN WITNESS WHEREOF, the undersigned has hereunto set his or her name and affixed the corporate seal.\n\t\t\t\t\t\tARROW ELECTRONICS, INC.\n\t\t\t\t\t\tBy: _____________________ \t\t\t\t\t\tTitle: Date: __________ __, 1995\n\t\t\t\t\t\t\t\tEXHIBIT F TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tGUARANTEE\n\tGUARANTEE, dated as of , 1995, made by ARROW ELECTRONICS, INC., a New York corporation (the \"Guarantor\"), in favor of CHEMICAL BANK, as administrative agent (in such capacity, the \"Administrative Agent\") for the several banks and other financial institutions (the \"Banks\") parties to the Second Amended and Restated Credit Agreement, dated as of __, 1995 (as amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among the Guarantor, the Foreign Subsidiary Borrowers parties thereto, the Banks, the Lead Manager named therein, the Agents parties thereto, Chemical Securities Inc., as arranger, and the Administrative Agent.\n\tW I T N E S S E T H:\n\tWHEREAS, pursuant to the Credit Agreement, the Banks have severally agreed to make loans to, and issue or participate in letters of credit for the account of, the Foreign Subsidiary Borrowers upon the terms and subject to the conditions set forth therein; and\n\tWHEREAS, pursuant to the Local Currency Facilities, the Local Currency Banks have severally agreed, and will agree, to make loans to the Local Currency Borrowers upon the terms and subject to the conditions set forth therein; and\n\tWHEREAS, it is a condition precedent to the obligation of the Banks to make their respective loans and other extension of credit to the Foreign Subsidiary Borrowers and the Local Currency Borrowers under the Credit Agreement and the Local Currency Facilities, respectively, that the Guarantor shall have executed and delivered this Guarantee to the Administrative Agent for the ratable benefit of the Banks; and\n\tWHEREAS, the Guarantor is the parent of each Foreign Subsidiary Borrower and Local Currency Borrower, and it is to the advantage of Guarantor that the Banks make their loans and other extensions of credit to the Foreign Subsidiary Borrowers and Local Currency Borrowers;\n\tNOW, THEREFORE, in consideration of the premises and to induce the Administrative Agent, the Agents, the Arranger and the Banks to enter into the Credit Agreement and the Local Currency Facilities, and to induce the Banks to make their respective loans to the Foreign Subsidiary Borrowers and the Local Currency Borrowers under the Credit Agreement and the Local Currency Facilities, respectively, the Guarantor hereby agrees with the Administrative Agent, for the ratable benefit of the Banks, as follows:\n\t1. Defined Terms. (a) Unless otherwise defined herein, terms defined in the Credit Agreement and used herein shall have the meanings given to them in the Credit Agreement.\n\t(b) As used herein, (i) \"Obligations\" means the collective reference to the unpaid principal of and interest on the Loans to Foreign Subsidiary Borrowers and on the Local Currency Loans and all other obligations and liabilities of the Foreign Subsidiary Borrowers and Local Currency Borrowers to the Administrative Agent and the Banks (including, without limitation, interest accruing at the then applicable rate provided in the Credit Agreement or any applicable Local Currency Facility after the maturity of the Loans or the Local Currency Loans and interest accruing at the then applicable rate provided in the Credit Agreement or any applicable Local Currency Facility after the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding, relating to any Foreign Subsidiary Borrower or Local Currency Borrower whether or not a claim for post-filing or post-petition interest is allowed in such proceeding), whether direct or indirect, absolute or contingent, due or to become due, or now existing or hereafter incurred, which may arise under, out of, or in connection with, the Credit Agreement, any Local Currency Facility or any other Credit Documents or any other document made, delivered or given in connection therewith, in each case whether on account of principal, interest, reimbursement obligations, fees, indemnities, costs, expenses or otherwise (including, without limitation, all fees and disbursements of counsel to the Administrative Agent or to the Banks that are required to be paid by the Guarantor, any Foreign Subsidiary Borrower or any Local Currency Borrower pursuant to the terms of the Credit Agreement, any Local Currency Facility, this Agreement or any other Credit Document) and (ii) \"Senior Obligations\" means the obligations of the Guarantor now or hereafter existing in favor of the purchasers named in the Note Purchase Agreement (the \"Note Purchasers\") and each promissory note issued under the Note Purchase Agreement, security agreement, pledge agreement, mortgage, subordination agreement, guaranty, foreign exchange agreement and other agreement and instrument executed and delivered to the Collateral Agent by any person or entity pursuant to the terms of the Note Purchase Agreement or the Intercreditor Agreement (such agreements and instruments, as amended or otherwise modified from time to time, collectively, the \"Note Documents\"), whether for principal (in an aggregate principal amount not to exceed $75,000,000 less all prepayments, repayments or redemptions of the 1992 Private Placement Notes since the date of their original issuance), interest (including interest as provided in the promissory notes issued pursuant to the terms of the Note Purchase Agreement accruing subsequent to the filing of any petition initiating any proceeding referred to in Section 10(c) hereof), fees, expenses or otherwise.\n\t(c) The words \"hereof,\" \"herein\" and \"hereunder\" and words of similar import when used in this Guarantee shall refer to this Guarantee as a whole and not to any particular provision of this Guarantee, and section and paragraph references are to this Guarantee unless otherwise specified.\n\t(d) The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms.\n\t2. Guarantee. (a) The Guarantor hereby unconditionally and irrevocably guarantees to the Administrative Agent, for the ratable benefit of the Banks and their respective successors, indorsees, transferees and assigns, the prompt and complete payment and performance by each Foreign Subsidiary Borrower and each Local Currency Borrower when due (whether at the stated maturity, by acceleration or otherwise) of the Obligations. If at any time the Dollar Equivalent Amount of the Obligations exceeds the Guarantee Ceiling Amount at such time, the portion of the Obligations which so exceeds the Guarantee Ceiling Amount will be subordinated to the prior repayment of the 1992 Private Placement Notes as set forth in Section 10; provided that no more than 25% of the Dollar Equivalent Amount of the Obligations at any time shall be so subordinated.\n\t(b) The Guarantor further agrees to pay any and all expenses (including, without limitation, all reasonable fees and disbursements of counsel) which may be paid or incurred by the Administrative Agent or any Bank in enforcing, or obtaining advice of counsel in respect of, any rights with respect to, or collecting, any or all of the Obligations and\/or enforcing any rights with respect to, or collecting against, the Guarantor under this Guarantee. This Guarantee shall remain in full force and effect until the Obligations are paid in full and the Commitments are terminated, notwithstanding that from time to time prior thereto the Foreign Subsidiary Borrowers and the Local Currency Borrowers or any of them may be free from any Obligations.\n\t(c) No payment or payments made by any Foreign Subsidiary Borrower, any Local Currency Borrower or any other Person or received or collected by the Administrative Agent or any Bank from any Foreign Subsidiary Borrower, any Local Currency Borrower or any other Person by virtue of any action or proceeding or any set-off or appropriation or application, at any time or from time to time, in reduction of or in payment of the Obligations shall be deemed to modify, reduce, release or otherwise affect the liability of the Guarantor hereunder which shall, notwithstanding any such payment or payments until the Obligations are paid in full and the Commitments are terminated.\n\t(d) The Guarantor agrees that whenever, at any time, or from time to time, it shall make any payment to the Administrative Agent or any Bank on account of its liability hereunder, it will notify the Administrative Agent and such Bank in writing that such payment is made under this Guarantee for such purpose.\n\t3. Right of Set-off. Upon the occurrence of any Event of Default, the Administrative Agent and each Bank is hereby irrevocably authorized at any time and from time to time without notice to the Guarantor, any such notice being expressly waived by the Guarantor, to set off and appropriate and apply any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by the Administrative Agent or such Bank to or for the credit or the account of the Guarantor, or any part thereof in such amounts as the Administrative Agent or such Bank may elect, against or on account of the obligations and liabilities of the Guarantor to the Administrative Agent or such Bank hereunder and claims of every nature and description of the Administrative Agent or such Bank against the Guarantor, in any currency, whether arising hereunder, under the Credit Agreement, any Credit Document or otherwise, as the Administrative Agent or such Bank may elect, whether or not the Administrative Agent or such Bank has made any demand for payment and although such obligations, liabilities and claims may be contingent or unmatured. The Administrative Agent and each Bank shall notify the Guarantor promptly of any such set-off and the application made by the Administrative Agent or such Bank, as the case may be, of the proceeds thereof; provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of the Administrative Agent and each Bank under this paragraph are in addition to other rights and remedies (including, without limitation, other rights of set-off) which the Administrative Agent or such Bank may have.\n\t4. No Subrogation. Notwithstanding any payment or payments made by the Guarantor hereunder, or any set-off or application of funds of the Guarantor by the Administrative Agent or any Bank, the Guarantor shall not be entitled to be subrogated to any of the rights of the Administrative Agent or any Bank against the Guarantor or against any collateral security or guarantee or right of offset held by the Administrative Agent or any Bank for the payment of the Obligations, nor shall the Guarantor seek or be entitled to seek any contribution or reimbursement from the Guarantor in respect of payments made by the Guarantor hereunder, until all amounts owing to the Administrative Agent and the Banks by the Guarantor on account of the Obligations and on account of all other obligations of the Guarantor to the Administrative Agent and the Banks under the Credit Documents are paid in full and the Commitments are terminated. If any amount shall be paid to the Guarantor on account of such subrogation rights at any time when all of the Obligations and such other amounts shall not have been paid in full, such amount shall be held by the Guarantor in trust for the Administrative Agent and the Banks, segregated from other funds of the Guarantor, and shall, forthwith upon receipt by the Guarantor, be turned over to the Administrative Agent in the exact form received by the Guarantor (duly indorsed by the Guarantor to the Administrative Agent, if required), to be applied against the Obligations and the other obligations of the Guarantor under the Credit Documents, whether matured or unmatured, in such order as the Administrative Agent may determine.\n\t5. Amendments, etc. with respect to the Obligations; Waiver of Rights. The Guarantor shall remain obligated hereunder notwithstanding that, without any reservation of rights against the Guarantor, and without notice to or further assent by the Guarantor, any demand for payment of any of the Obligations made by the Administrative Agent or any Bank may be rescinded by the Administrative Agent or such Bank, and any of the Obligations continued, and the Obligations, or the liability of any other party upon or for any part thereof, or any collateral security or guarantee therefor or right of offset with respect thereto, may, from time to time, in whole or in part, be renewed, extended, amended, modified, accelerated, compromised, waived, surrendered or released by the Administrative Agent or any Bank, and the Credit Agreement and the other Credit Documents and any other documents executed and delivered in connection therewith may be amended, modified, supplemented or terminated, in whole or in part, as the Administrative Agent (or the Required Banks or all the Banks, as the case may be) may deem advisable from time to time, and any collateral security, guarantee or right of offset at any time held by the Administrative Agent or any Bank for the payment of the Obligations may be sold, exchanged, waived, surrendered or released. Neither the Administrative Agent nor any Bank shall have any obligation to protect, secure, perfect or insure any Lien at any time held by it as security for the Obligations or for this Guarantee or any property subject thereto. When making any demand hereunder against the Guarantor, the Administrative Agent or any Bank may, but shall be under no obligation to, make a similar demand on any Foreign Subsidiary Borrower or any Local Currency Borrower or any other guarantor, and any failure by the Administrative Agent or any Bank to make any such demand or to collect any payments from any Foreign Subsidiary Borrower or any Local Currency Borrower or any such other guarantor or any release of any Foreign Subsidiary Borrower or any Local Currency Borrower or such other guarantor shall not relieve the Guarantor of its obligations or liabilities hereunder, and shall not impair or affect the rights and remedies, express or implied, or as a matter of law, of the Administrative Agent or any Bank against the Guarantor. For the purposes hereof \"demand\" shall include the commencement and continuance of any legal proceedings.\n\t6. Guarantee Absolute and Unconditional. The Guarantor waives any and all notice of the creation, renewal, extension or accrual of any of the Obligations and notice of or proof of reliance by the Administrative Agent or any Bank upon this Guarantee or acceptance of this Guarantee; the Obligations, and any of them, shall conclusively be deemed to have been created, contracted or incurred, or renewed, extended, amended or waived, in reliance upon this Guarantee; and all dealings between any Foreign Subsidiary Borrower or any Local Currency Borrower or the Guarantor, on the one hand, and the Administrative Agent and the Banks, on the other, shall likewise be conclusively presumed to have been had or consummated in reliance upon this Guarantee. The Guarantor waives diligence, presentment, protest, demand for payment and notice of default or nonpayment to or upon any Foreign Subsidiary Borrower or any Local Currency Borrower or the Guarantor with respect to the Obligations. This Guarantee shall be construed as a continuing, absolute and unconditional guarantee of payment without regard to (a) the validity, regularity or enforceability of the Credit Agreement, any Local Currency Facility, or any other Credit Document, any of the Obligations or any other collateral security therefor or guarantee or right of offset with respect thereto at any time or from time to time held by the Administrative Agent or any Bank, (b) any defense, set-off or counterclaim (other than a defense of payment or performance) which may at any time be available to or be asserted by any Foreign Subsidiary Borrower or any Local Currency Borrower against the Administrative Agent or any Bank, or (c) any other circumstance whatsoever (with or without notice to or knowledge of any Foreign Subsidiary Borrower or any Local Currency Borrower or the Guarantor) which constitutes, or might be construed to constitute, an equitable or legal discharge of any Foreign Subsidiary Borrower or any Local Currency Borrower for the Obligations, or of the Guarantor under this Guarantee, in bankruptcy or in any other instance. When pursuing its rights and remedies hereunder against the Guarantor, the Administrative Agent and any Bank may, but shall be under no obligation to, pursue such rights and remedies as it may have against any Foreign Subsidiary Borrower or any Local Currency Borrower or any other Person or against any collateral security or guarantee for the Obligations or any right of offset with respect thereto, and any failure by the Administrative Agent or any Bank to pursue such other rights or remedies or to collect any payments from any Foreign Subsidiary Borrower or any Local Currency Borrower or any such other Person or to realize upon any such collateral security or guarantee or to exercise any such right of offset, or any release of any Foreign Subsidiary Borrower or any Local Currency Borrower or any such other Person or of any such collateral security, guarantee or right of offset, shall not relieve the Guarantor of any liability hereunder, and shall not impair or affect the rights and remedies, whether express, implied or available as a matter of law, of the Administrative Agent or any Bank against the Guarantor. This Guarantee shall remain in full force and effect and be binding in accordance with and to the extent of its terms upon the Guarantor and its successors and assigns thereof, and shall inure to the benefit of the Administrative Agent and the Banks, and their respective successors, indorsees, transferees and assigns, until all the Obligations and the obligations of the Guarantor under this Guarantee shall have been satisfied by payment in full and the Commitments shall be terminated, notwithstanding that from time to time during the term of the Credit Agreement any Foreign Subsidiary Borrower or any Local Currency Borrower may be free from any Obligations.\n\t7. Confirmation. (a) Each Joinder Agreement delivered by the Guarantor to the Administrative Agent shall constitute a confirmation by the Guarantor that the Obligations guaranteed hereby include all Obligations of each Foreign Subsidiary Borrower named in such Joinder Agreement.\n\t(b) Each Local Currency Facility Addendum delivered by the Guarantor to the Administrative Agent shall constitute a confirmation by the Guarantor that the Obligations guaranteed hereby include all Obligations of each Local Currency Borrower under each Local Currency Facility named in such Local Currency Facility Addendum.\n\t8. Reinstatement. This Guarantee shall continue to be effective, or be reinstated, as the case may be, if at any time payment, or any part thereof, of any of the Obligations is rescinded or must otherwise be restored or returned by the Administrative Agent or any Bank upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of any Foreign Subsidiary Borrower or any Local Currency Borrower or upon or as a result of the appointment of a receiver, intervenor or conservator of, or trustee or similar officer for, any Foreign Subsidiary Borrower or any Local Currency Borrower or any substantial part of its respective property, or otherwise, all as though such payments had not been made.\n\t9. Payments. (a) The Guarantor hereby agrees that the Obligations will be paid to the Administrative Agent without set-off or counterclaim in the Currency in which they are denominated at the office for payment thereof set forth in the Credit Agreement or the applicable Local Currency Facility, as the case amy be.\n\t(b)\tThe obligation of the Guarantor in respect of any sum due to any Bank or the Administrative Agent hereunder shall, notwithstanding any judgment in a currency (the \"Judgment Currency\") other than that in which such sum is denominated in accordance with the applicable provisions of the Credit Agreement, any Local currency Facility or the other Credit Documents (the \"Agreement Currency\"), be discharged only to the extent that on the Business Day following receipt by such Bank or the Administrative Agent (as the case may be) of any sum adjudged to be so due in the Judgment Currency such Bank or the Administrative Agent (as the case may be) may in accordance with normal banking procedures purchase the Agreement Currency with the Judgment Currency; if the amount of the Agreement Currency so purchased is less than the sum originally due to such Bank or the Administrative Agent (as the case may be) in the Agreement Currency, the Guarantor agrees, as a separate obligation and notwithstanding any such judgment, to indemnify such Bank or the Administrative Agent (as the case may be) against such loss, and if the amount of the Agreement Currency so purchased exceeds the sum originally due to any Bank or the Administrative Agent (as the case may be), such Bank or the Administrative Agent (as the case may be) agrees to remit to the Guarantor such excess.\n\t10.\tSubordination.\n\t(a) Agreement to Subordinate. To the extent that at any time the Dollar Equivalent Amount of the Obligations exceeds the Guarantee Ceiling Amount at such time, each of the Administrative Agent, the Banks and the Guarantor agrees that the lesser of (i) 25% of the Dollar Equivalent Amount of the Obligations at such time and (ii) the amount of the Obligations equal to the Dollar Equivalent Amount of such excess over the Guarantee Ceiling Amount shall be subordinate, to the extent and in the manner hereinafter set forth, in right of payment to the prior payment in full of the Senior Obligations. For the purposes of this Agreement the Senior Obligations shall not be deemed to have been paid in full until 90 days following the date on which the holders or owners thereof shall have received payment in full of the Senior Obligations in cash (the \"Termination Date\").\n\t(b) Restrictions on Payment of the Obligations. Neither the Administrative Agent nor any Bank (collectively, the \"Subordinated Creditors\") will ask, demand, sue for, commence any action seeking, or take or receive, directly or indirectly, from the Guarantor in cash, securities, or other property, by setoff, by realizing upon collateral or in any other manner, payment of, or security for, any or all of the portion of the Obligations subordinated pursuant to this Section 10 (the \"Subordinated Guarantee Obligations\"), or seek any other remedy against the Guarantor with respect to the Subordinated Guarantee Obligations, whether at law or in equity, unless and until the Senior Obligations shall have been paid in full. The provisions of this Section 10 shall not apply to, and shall not prevent the Administrative Agent or any Bank from asking, demanding, suing for, commencing any action seeking, or taking or receiving, directly or indirectly, from the Guarantor in cash, securities, or other property, by setoff, by realizing upon collateral or in any other manner, payment of, or security for, any or all of the portion of the Obligations not subordinated pursuant to this Section 10 or seeking any other remedy against the Guarantor with respect to the Obligations, whether at law or in equity, at any time.\n\t(c) Additional Provisions Concerning Subordination. Each of the Subordinated Creditors and the Guarantor agrees as follows:\n\t\ti)\tIn the event of any dissolution, winding up, liquidation, arrangement or reorganization relating to the Guarantor, whether in any bankruptcy, insolvency, arrangement, reorganization or receivership proceedings or upon an assignment for the benefit of creditors or any other marshalling of the assets and liabilities of the Guarantor or otherwise, any payment or distribution of any kind (whether in cash, securities or other property) which otherwise would be payable or deliverable upon or with respect to the portion of the Obligations constituting Subordinated Guarantee Obligations shall be paid or delivered directly to the Collateral Agent for application (in the case of cash) to, or as collateral (in the case of securities or other non-cash property) for, the payment or prepayment of the Senior Obligations until the Senior Obligations shall have been paid in full.\n\t\tii)\tIn any proceeding referred to in subsection (c)i) of this Section 10 commenced by or against the Guarantor, no Subordinated Creditors will take any action, or fail to take any action, with respect to the portion of the Obligations constituting Subordinated Guarantee Obligations which is inconsistent with, or in opposition to, the action or position requested by notice hereunder from the Collateral Agent to be taken by the Subordinated Creditors so long as such request is made in good faith by the Collateral Agent to obtain payment of the Subordinated Guarantee Obligation and the Senior Obligations as contemplated hereby.\n\t\tiii)\tAll payments or distributions upon or with respect to the Subordinated Guarantee Obligations which are received by any Subordinated Creditor contrary to the provisions of this Section 10 shall be received in trust for the benefit of the Note Purchasers, shall be segregated from other funds and property held by such Subordinated Creditor and shall be forthwith paid over to the Collateral Agent in the same form as so received (with any necessary indorsement) to be applied (in the case of cash) to or held as collateral (in the case of securities or other non-cash property) for the payment or prepayment of the Senior Obligations until the Senior Obligations shall have been paid in full.\n\t\tiv)\tThe Collateral Agent is hereby authorized to demand specific performance of this Agreement at any time when any Subordinated Creditor shall have failed to comply with any of the provisions of this Section 10 applicable to such Subordinated Creditor whether or not the Guarantor shall have complied with any of the provisions hereof applicable to the Guarantor, and each Subordinated Creditor hereby irrevocably waives any defense based on the adequacy of a remedy at law which might be asserted as a bar to such remedy of specific performance.\n\t(d) Senior Obligations Unconditional. i) All rights and interests of the Collateral Agent and the Note Purchasers under this Section 10, and all agreements and obligations of the Subordinated Creditors and the Guarantor under this Section 10, shall remain in full force and effect irrespective of: (i) any lack of validity or enforceability of any Note Document or any other agreement or instrument relating thereto, (ii) any change in the time, manner or place of payment of, or in any other term in respect of, all or any of the Senior Obligations (except any increase in the principal amount thereof), or any other amendment or waiver of or any consent to departure from any Note Document, (iii) any exchange or release of, or non-perfection of any lien on or security interest in, collateral, or any release or amendment or waiver of or consent to departure from any guaranty, for all or any of the Senior Obligations, or (iv) any other circumstance which might otherwise constitute a defense available to, or a discharge of, the Guarantor in respect of the Senior Obligations or the Subordinated Creditors or the Guarantor in respect of this Section 10.\n\tii)\tThis Agreement shall continue to be effective or shall be reinstated, as the may be, if at any time any payment of any of the Senior Obligations is rescinded or must otherwise be returned by the Collateral Agent or any Note Purchaser upon the insolvency, bankruptcy or reorganization of the Guarantor or otherwise, all as though such payment had not been made.\n\t(e) Waivers. Each of the Subordinated Creditors and the Guarantor hereby waives (i) promptness and diligence, (ii) notice of acceptance and notice of the incurrence of any Senior Obligation by the Guarantor, (iii) notice of any actions taken by the Collateral Agent or any Note Purchaser or the Guarantor or any other party under any Note Document or any other agreement or instrument relating thereto, (iv) all other notices, demands and protests, and all other formalities of every kind in connection with the enforcement of the Senior Obligations or of the obligations of the Subordinated Creditors and the Guarantor hereunder, the omission of or delay in which, but for the provisions of this Section 10(e), might constitute grounds for relieving any Subordinated Creditor or the Guarantor of its obligations hereunder, and (v) any requirement that the Collateral Agent or any Note Purchaser protect, secure, perfect or insure any security interest or other lien or any property subject thereto or exhaust any right to take any action against the Guarantor or any other person or any collateral of the Guarantor.\n\t(f) Subrogation. No payment or distribution to the Collateral Agent or any Note Purchaser pursuant to the provisions of this Section 10 shall entitle any Subordinated Creditor to exercise any rights of subrogation in respect thereof until the Senior Obligations shall have been paid in full.\n\t(g)\tRelative Rights. This Section 10 defines the relative rights of Subordinated Creditors and Note Purchasers. Nothing in this Agreement shall impair, as between the Guarantor and Subordinated Creditors, the obligation of the Guarantor, which is absolute and unconditional, to pay and perform the Obligations in accordance with their terms.\n\t11. Authority of Administrative Agent. The Guarantor acknowledges that the rights and responsibilities of the Administrative Agent under this Guarantee with respect to any action taken by the Administrative Agent or the exercise or non-exercise by the Administrative Agent of any option, right, request, judgment or other right or remedy provided for herein or resulting or arising out of this Guarantee shall, as between the Administrative Agent and the Banks, be governed by the Credit Agreement and by such other agreements with respect thereto as may exist from time to time among them, but, as between the Administrative Agent and the Guarantor, the Administrative Agent shall be conclusively presumed to be acting as agent for the Banks with full and valid authority so to act or refrain from acting, and the Guarantor shall not be under any obligation, or entitlement, to make any inquiry respecting such authority.\n\t12. Notices. All notices, requests and demands to or upon the Administrative Agent, any Bank or the Guarantor to be effective shall be in writing (or by telex, telecopy or similar electronic transfer confirmed in writing) and shall be deemed to have been duly given or made (a) when delivered by hand or (b) if given by mail, when deposited in the mails by certified mail, return receipt requested, or (c) if by telex, telecopy or similar electronic transfer, when sent and receipt has been confirmed, addressed as follows:\n\t(i) if to the Administrative Agent or any Bank, at its address or transmission number for notices provided in subsection 14.2 of the Credit Agreement; and\n\t(ii) if to the Guarantor, at its address or transmission number for notices provided in subsection 14.2 of the Credit Agreement.\n\tThe Administrative Agent, each Bank and the Guarantor may change its address and transmission numbers for notices by notice in the manner provided in this Section.\n\t13. Severability. Any provision of this Guarantee which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction.\n\t14. Integration. This Guarantee represents the agreement of the Guarantor with respect to the subject matter hereof and there are no promises or representations by the Administrative Agent or any Bank relative to the subject matter hereof not reflected herein.\n\t15. Amendments in Writing; No Waiver; Cumulative Remedies. (a) None of the terms or provisions of this Guarantee may be waived, amended, supplemented or otherwise modified except by a written instrument executed by the Guarantor and the Administrative Agent, provided that any provision of this Guarantee may be waived by the Administrative Agent and the Banks in a letter or agreement executed by the Administrative Agent or by telex or facsimile transmission from the Administrative Agent.\n\t(b) Neither the Administrative Agent nor any Bank shall by any act (except by a written instrument pursuant to Section 15(a) hereof), delay, indulgence, omission or otherwise be deemed to have waived any right or remedy hereunder or to have acquiesced in any Default or Event of Default or in any breach of any of the terms and conditions hereof. No failure to exercise, nor any delay in exercising, on the part of the Administrative Agent or any Bank, any right, power or privilege hereunder shall operate as a waiver thereof. No single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver by the Administrative Agent or any Bank of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Administrative Agent or such Bank would otherwise have on any future occasion.\n\t(c) The rights and remedies herein provided are cumulative, may be exercised singly or concurrently and are not exclusive of any other rights or remedies provided by law.\n\t16. Section Headings. The section headings used in this Guarantee are for convenience of reference only and are not to affect the construction hereof or be taken into consideration in the interpretation hereof.\n\t17. Successors and Assigns. This Guarantee shall be binding upon the successors and assigns of the Guarantor and shall inure to the benefit of the Administrative Agent and the Banks and their successors and assigns. The Note Purchasers shall be third party beneficiaries of Section 10 hereof.\n\t18. Governing Law. This Guarantee shall be governed by, and construed and interpreted in accordance with, the law of the State of New York.\n\tIN WITNESS WHEREOF, the undersigned has caused this Guarantee to be duly executed and delivered by its duly authorized officer as of the day and year first above written.\nARROW ELECTRONICS, INC.\nBy Title\n\t\t\t\t\t\t\t\tEXHIBIT G-1 TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\t[Letterhead of Winthrop, Stimson, Putnam & Roberts]\n\t\t\t\t\t\t\t\t\t[Closing Date]\nTo each of the banks and other \tfinancial institutions from time \tto time parties to the Credit \tAgreement referred to below\nLadies and Gentlemen:\n\t\tWe have acted as counsel to Arrow Electronics, Inc., a New York corporation (the \"Company\"), Capstone Electronics Corp., a Delaware corporation (\"Capstone\"), Anthem Electronics, Inc. a Delaware corporation (\"Anthem\"), Gates\/Arrow Distributing, Inc. Inc., a Delaware corporation (\"Gates\" and, together with the Company, Capstone and Anthem, the \"Domestic Loan Parties\"), the Foreign Subsidiary Borrowers parties to the Credit Agreement referred to below and Arrow Electronics International, Inc., a United States Virgin Islands corporation (\"AEI\" and, together with the Foreign Subsidiary Borrowers and the Domestic Loan Parties, the \"Loan Parties\") in connection with the preparation, execution, and delivery of the Amended and Restated Credit Agreement dated as of _______ __, 1995 among the Company, the Foreign Subsidiary Borrowers parties thereto, the several banks and other financial institutions from time to time parties thereto (the \"Banks\"), the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents for the Banks thereunder, Bankers Trust Company, as collateral agent, Chemical Securities Inc., as arranger, and Chemical Bank, as administrative agent for the Banks thereunder (the \"Credit Agreement\"), and each of the documents listed on Annex A hereto (the Credit Agreement and such listed documents, collectively, the \"Transaction Documents\").\n\t\tThis opinion is furnished to you at the request of the Company pursuant to subsection 9.1(e)(i) of the Credit Agreement. Unless otherwise defined herein, capitalized terms used herein that are defined in the Credit Agreement are used herein as therein defined.\n\t\tIn connection with this opinion, we have examined copies of (a) each of the Transaction Documents[, (b) the indenture under which the Subordinated Debentures are outstanding,] (c) the Purchase Agreements, as amended to the date hereof, under which the 1992 Private Placement Notes were issued and (d) such corporate documents and records of the Company and its Subsidiaries, certificates and instruments of public officials and officers of the Company and its Subsidiaries and other documents as we have deemed relevant or proper as a basis for our opinions set forth herein.\n\t\tIn arriving at the opinions contained herein, we have made such investigations of law, in each case as we have deemed appropriate as a basis for such opinions.\n\t\tFor the purposes of the opinions contained herein, we have assumed:\n\t\t\t(i) \tthe genuineness of all signatures and the conformity to the original of all copies submitted to us as photocopies or conformed copies;\n\t\t\t(ii) \tthe accuracy of (A) the copies of the corporate documents of the Domestic Loan Parties furnished to the Administrative Agent pursuant to Section 9.1(c) of the Credit Agreement and (B) good standing certificates received by us with respect to the Domestic Loan Parties;\n\t\t\t(iii) \t for the purposes of paragraph 5, that (A) except as such matters are expressly opined on in paragraph 2, (1) each party to the Transaction Documents has the corporate power and authority and the legal right, and has taken all necessary action to authorize it, to execute, deliver and perform each Transaction Document to which it is a party and (2) each Transaction Document has been duly executed and delivered by each party thereto, (B) all consents and authorizations of, filings with and other acts by or in respect of any Governmental Authority or any other Person required to be obtained or made by any party to the Transaction Documents (other than the Loan Parties) in connection with the execution, delivery and performance thereof have been obtained or made and are in full force and effect and (C) the execution, delivery and performance of the Transaction Documents do not and will not violate any Contractual Obligation under which any party to the Transaction Documents (other than the Loan Parties) is bound or any Requirement of Law to which any such party is subject; and\n\t\t\t(iv) \t for the purposes of paragraphs 4(a)(ii) and 5, insofar as they relate to the proviso to Section 2(a) and clause 10(a)(i) of the Company Guarantee, that the Company Guarantee Ratio does not exceed 25%.\n\t\tWe are members of the Bar of the State of New York and we express no opinion as to any matters governed by any laws other than the laws of the State of New York, the General Corporation Law of the State of Delaware and the Federal laws of the United States of America.\n\t\tBased upon the foregoing and subject to the qualifications, limitations and exceptions set forth below, we are of the opinion that:\n\t\t1.\tEach Domestic Loan Party is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation.\n\t\t2.\tEach Domestic Loan Party has the corporate power and authority and the legal right, and has taken all necessary corporate action to authorize it, to execute, deliver and perform the Transaction Documents to which it is a party and, in the case of the Company, to borrow under the Credit Agreement.\n\t\t3.\tExcept for (a) consents or authorizations that have been obtained or filings that have been made, and that in either case are, to the best of our knowledge, in full force and effect and (b) consents or authorizations the failure to obtain which or filings the failure to make which could not reasonably be expected to have a Material Adverse Effect, no consent or authorization of, filing with or other act by or in respect of, any Governmental Authority or any other Person is required under applicable laws, rules or regulations within the scope of this opinion or under Contractual Obligations or court orders known to us that are binding upon the Company or any of its Subsidiaries, in connection with the execution, delivery, performance, validity or enforceability of the Transaction Documents or the borrowings under the Credit Agreement.\n\t\t4.\tThe execution, delivery and performance of the Transaction Documents, the consummation of the transactions contemplated thereby, the compliance by each Loan Party with any provisions thereof and the borrowings under the Credit Agreement do not and (absent a changes in any applicable law, rule, regulation, Contractual Obligation or court order) will not (a) violate, or constitute a default under, (i) any laws, rules or regulation within the scope of this opinion or (ii) any Contractual Obligation or court orders known to us that are binding upon the Company or any of its Subsidiaries (except for violations of Contractual Obligations that, individually or in the aggregate, could not reasonably be expected to have a Material Adverse Effect) or (b) result in or require the creation or imposition of any Lien on any of its or their respective properties or revenues pursuant to any such law, rule, regulation, Contractual Obligation or court order, except for the Liens expressly permitted by subsection 11.3 of the Credit Agreement.\n\t\t5.\tEach Transaction Document constitutes a legal, valid and binding obligation of each Loan Party that is a party thereto, enforceable against such Loan Party in accordance with its terms.\n\t\t6.\tTo the best of our knowledge, and except as set forth on Schedule 8.19 to the Credit Agreement, no litigation, investigation or proceeding of or before any arbitrator or Governmental Authority is pending or threatened by or against the Company or any of its Subsidiaries or against any of its or their respective properties or revenues (a) with respect to the Transaction Documents or any of the transactions contemplated thereby or (b) that, if adversely determined, would have a Material Adverse Effect.\n\t\t7.\tNone of the Loan Parties is (a) an \"investment company\", or a company \"controlled\" by an \"investment company\", within the meaning of the Investment Company Act of 1940, as amended from time to time, or (b) a \"holding company\" as defined in, or otherwise subject to regulation under, the Public Utility Holding Company Act of 1935.\n\t\t8.\tThe principal of, and interest on, the Loans, the Company's Reimbursement Obligations in respect of the Letters of Credit and the Company's Obligations under the Company Guarantee are within the definition of \"Senior Indebtedness\" under the Subordinated Debentures.\n\t\tAnything to the contrary expressly stated or implied notwithstanding, the opinions expressed herein are subject to the following qualifications, limitations and exceptions, whether or not such opinions refer to such qualifications, limitations and exceptions:\n\t\t(a)\tThe opinions set forth in paragraph 5 are also subject to the following additional qualifications, limitations, and exceptions:\n\t\t\t(i) \t We express no opinion as to the effect of any violation of a Contractual Obligation known to parties to the Transaction Documents (other than the Loan Parties) but not known to us.\n\t\t\t(ii) \tSuch opinions are subject to the effect of applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally.\n\t\t\t(iii) \tTo the extent such opinions relate to enforceability, such opinions are subject to (A) the requirement that the Transaction Documents be performed and enforced in good faith and (B) the effect of general principles of equity, including (without limitation) (1) principles relating to the availability of equitable remedies, including, without limitation, specific performance and (2) concepts of materiality and reasonableness.\n\t\t\t(iv) \tCertain indemnities and exculpatory provisions, including certain waivers (other than the waiver of jury trial), may be unenforceable if they are violative of public policy.\n\t\t\t(v) \tWithout limiting the generality of the foregoing, we express no opinion with respect to the legality, validity, binding effect or enforceability of the following provisions:\n\t\t\t(A)\tany provision specifying that any Transaction Document may be waived or amended only in writing;\n\t\t\t(B)\tany purported waiver of the right to seek the transfer of a case to another jurisdiction;\n\t\t\t(C)\tSection 14.7(b) of the Credit Agreement to the extent that it provides for (1) a right of set-off in respect of claims, credits or other obligations that are contingent, or (2) a right of set-off in respect of Exposures of a Specified Borrower against deposits, indebtedness or other obligations of any entity other than the entity to which such Exposures are payable;\n\t\t\t(D)\tthe third sentence of Section 14.6(b) of the Credit Agreement;\n\t\t\t(E)\tas to (1) whether a United States Federal court or a court of the State of New York would render a money judgment in a currency other than United States Dollars or enforce a judgment expressed in a foreign currency in a currency other than United States Dollars and (2) the rate of exchange a United States Federal court or a court of the State of New York would apply;\n\t\t\t(F)\tas to Section 14.14(a)(ii) of the Credit Agreement insofar as it relates to an action brought in the United States District Court for the Southern District of New York; and\n\t\t\t(G)\tas to Section 9(b) of the Company Guarantee.\n\t\t(b)\tWhenever an opinion herein is qualified by the phrase \"to the best of our knowledge\" or \"known to us\" or phrases of similar import, such phrases refer only to the actual knowledge of the attorneys in our firm who have spent a significant amount of time representing the Loan Parties in connection with the Transaction Documents, based on facts that have come to their attention in the course of such representation or other recent representation of the Loan Parties or their affiliates.\n\t\tThis opinion has been rendered solely for the benefit of the addressees hereof and their respective Transferees in connection with the Transaction Documents and the transactions contemplated thereby and may not be used, circulated, quoted, relied upon or otherwise referred to by any other Person or for any purpose without our prior written consent.\n\t\t\t\t\t\t\t\tVery truly yours,\n\tANNEX A\n\tOther Transaction Documents\n1.\tEach Subsidiary Guarantee, as amended, in the case of Capstone and AEI, by the First Amendment thereto and, in each case, as consented to by the Guarantor party thereto\n2.\tSubordination Agreement\n3.\tCompany Guarantee\n\t\t\t\t\t\t\t\tEXHIBIT G-2 TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\t[Letterhead of Arrow Electronics, Inc.]\n\t\t\t\t\t\t\t\t\t[Closing Date]\nTo each of the banks and other \tfinancial institutions from time \tto time parties to the Credit \tAgreement referred to below\nLadies and Gentlemen:\n\t\tI am Senior Vice President and General Counsel of Arrow Electronics, Inc., a New York corporation (the \"Company\"). As such, I have acted as counsel for the Company, Capstone Electronics Corp., a Delaware corporation (\"Capstone\"), Anthem Electronics, Inc., a Delaware corporation (\"Anthem\"), Gates\/Arrow Distributing, Inc., a Delaware corporation (\"Gates\" and together with the Company, Capstone and Anthem, the \"Domestic Loan Parties\"), the Foreign Subsidiary Borrowers parties to the Credit Agreement referred to below and Arrow Electronics International, Inc., a United States Virgin Islands corporation (\"AEI\" and, together with the Foreign Subsidiary Borrowers and the Domestic Loan Parties, the \"Loan Parties\") in connection with the preparation, execution, and delivery of the Second Amended and Restated Credit Agreement dated as of _________ __, 1995 among the Company, the several banks and other financial institutions from time to time parties thereto (the \"Banks\"), the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents for the Banks thereunder, Bankers Trust Company, as collateral agent, Chemical Securities, Inc., as arranger, and Chemical Bank, as administrative agent for the Banks thereunder (the \"Credit Agreement\") and each of the documents listed on Annex A hereto (the Credit Agreement and such listed documents, collectively, the \"Transaction Documents\").\n\t\tThis opinion is furnished to you pursuant to subsection 9.1(e)(ii) of the Credit Agreement. Unless otherwise defined herein, capitalized terms used herein that are defined in the Credit Agreement are used herein as therein defined.\n\t\tIn connection with this opinion, I have examined copies of (a) each of the Transaction Documents and (b) such corporate documents and records of the Company and its Subsidiaries, certificates and instruments of public officials and officers of the Company and its Subsidiaries and other documents as I have deemed relevant or proper as a basis for my opinions set forth herein.\n\t\tIn arriving at the opinions contained herein, I have made such investigations of law, in each case as I have deemed appropriate as a basis for such opinions.\n\t\tFor the purposes of the opinions contained herein, I have assumed:\n\t\t\t(i) \tthe genuineness of all signatures and the conformity to the original of all copies submitted to me as photocopies or conformed copies; and\n\t\t\t(ii) \tthe accuracy of (A) certified copies of the certificates of incorporation of the Domestic Loan Parties and (B) good standing certificates for the Domestic Loan Parties.\n\t\tI am a member of the Bar of the State of New York and I express no opinion as to any matters governed by any laws other than the laws of the State of New York, the General Corporation Law of the State of Delaware and the Federal laws of the United States of America.\n\t\tBased upon the foregoing and subject to the qualifications, limitations and exceptions set forth below, I am of the opinion that:\n\t\t1.\tEach Domestic Loan Party (a) has the corporate power and authority and the legal right to own and operate its property, to lease the property it operates as lessee and to conduct the business in which it is currently engaged and (b) is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership, lease or operation of property or the conduct of its business requires such qualification except where the failure to be duly qualified or in good standing could not reasonably be expected to have a Material Adverse Effect.\n\t\t2.\tEach Transaction Document has been duly executed and delivered on behalf of each Loan Party that is a party thereto.\n\t\t3.\tTo the best of my knowledge, and except as set forth on Schedule 8.19 to the Credit Agreement, no litigation, investigation or proceeding of or before any arbitrator or Governmental Authority is pending or threatened by or against the Company or any of its Subsidiaries or against any of its or their respective properties or revenues (a) with respect to the Transaction Documents or any of the transactions contemplated thereby or (b) that if adversely determined would have a Material Adverse Effect.\n\t\t4.\tTo the best of my knowledge, neither the Company nor any of its Subsidiaries is in default under or with respect to any of its Contractual Obligations in any respect that could reasonably be expected to have a Material Adverse Effect.\n\t\t5.\tThe Company is not subject to regulation under any federal or state statute or regulation within the scope of this opinion that limits its ability to incur Indebtedness under the Credit Agreement.\n\t\tAnything to the contrary expressly stated or implied notwithstanding, I express no opinion as to the effect of any law, rule or regulation outside the express scope of the opinions.\n\t\tThis opinion has been rendered solely for the benefit of the addressees hereof and their respective Transferees in connection with the Transaction Documents and the transactions contemplated thereby and may not be used, circulated, quoted, relied upon or otherwise referred to by any other Persons or for any purpose without my prior written consent.\n\t\t\t\t\t\t\tVery truly yours,\n\tANNEX A\n\tOther Transaction Documents\n1.\tEach Subsidiary Guarantee, as amended, in the case of Capstone and AEI, by the First Amendment thereto and, in each case, as consented to by the Guarantor party thereto\n2.\tSubordination Agreement\n3.\tCompany Guarantee\n\t\t\t\t\t\t\t\t\n\t\t\t\t\t\t\t\tEXHIBIT G-3 TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tOPINIONS RELATING TO THE \tFOREIGN SUBSIDIARY BORROWERS\nOpinions for the Foreign Subsidiary Borrowers:\n1. The Foreign Subsidiary Borrower is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization (the \"Jurisdiction\").\n2. The Foreign Subsidiary Borrower has the power and authority, and the legal right, to make, deliver and perform its obligations under the Credit Agreement and to borrow under the Credit Agreement. The Foreign Subsidiary Borrower has taken all necessary corporate action to authorize the performance of its obligations as a \"Foreign Subsidiary Borrower\" under the Credit Agreement and to authorize the execution, delivery and performance of the Credit Agreement.\n3. Except for consents, authorizations, approvals, notices and filings described on an attached schedule, all of which have been obtained, made or waived and are in full force and effect, no consent or authorization of, approval by, notice to, filing with or other act by or in respect of, any Governmental Authority is required in connection with the borrowings by the Foreign Subsidiary Borrower under the Credit Agreement or with the execution, delivery, performance, validity or enforceability of the Credit Agreement.\n\t\t4. The Credit Agreement has been duly executed and delivered on behalf of the Foreign Subsidiary Borrower.\n\t\t5. The execution and delivery of the Credit Agreement by the Foreign Subsidiary Borrower, the performance of its obligations thereunder, the consummation of the transactions contemplated thereby, the compliance by the Foreign Subsidiary Borrower with any of the provisions thereof, the borrowings under the Credit Agreement and the use of proceeds thereof, all as provided therein, (a) will not violate, or constitute a default under, any Requirement of Law the Foreign Subsidiary Borrower and (b) will not result in, or require, the creation or imposition of any Lien on any of its properties or revenues pursuant to any such Requirement of Law.\n\t\t6. There are no taxes imposed by the Jurisdiction (a) on or by virtue of the execution, delivery, enforcement or performance of the Credit Agreement or (b) on any payment to be made by the Foreign Subsidiary Borrower pursuant to the Credit Agreement other than any Non-Excluded Taxes payable by the Foreign Subsidiary Borrower as provided in subsection 6.6 of the Credit Agreement.\n\t\t7. To ensure the legality, validity, enforceability or admissibility in evidence of the Credit Agreement, it is not necessary that the Credit Agreement or any other Loan Documents or any other document be filed, registered or recorded with, or executed or notarized before, any court of other authority of the Jurisdiction or that any registration charge or stamp or similar tax be paid on or in respect of the Credit Agreement.\n\t\t8. The Credit Agreement is in proper legal form under the laws of the Jurisdiction for the enforcement thereof against the Foreign Subsidiary Borrower under the laws of the Jurisdiction.\n\t\t9. In any action or proceeding arising out of or relating to the Credit Agreement in any court in the Jurisdiction, such court would recognize and give effect to the choice of law provisions in the Credit Agreement wherein the parties thereto agree that the Credit Agreement shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York.\n\t\t10. It is not necessary under the laws of the Jurisdiction (a) in order to enable the Administrative Agent and the Lenders or any of them to enforce their respective rights under the Credit Agreement or (b) by reason of the execution of the Credit Agreement [or the Joinder Agreement to which the Foreign Subsidiary Borrower is a party] or the performance of the Credit Agreement that any of them should be licensed, qualified or entitled to carry on business in the Jurisdiction.\n\t\t11. Neither the Administrative Agent nor any of the Lenders will be deemed to be resident, domiciled, carrying on business or subject to taxation in the Jurisdiction merely by reason of the execution of the Credit Agreement [or the Joinder Agreement to which the Foreign Subsidiary Borrower is a party] or the performance or enforcement of any thereof. The performance by the Administrative Agent and the Lenders or any of them of any action required or permitted under the Credit Agreement will not violate any law or regulation, or be contrary to the public policy, of the Jurisdiction.\n\t\t12. If any judgment of a competent court outside the Jurisdiction were rendered against the Foreign Subsidiary Borrower in connection with any action arising out of or relating to the Credit Agreement, such judgment would be recognized and could be sued upon in the courts of the Jurisdiction, and such courts would grant a judgment which would be enforceable against the Foreign Subsidiary Borrower in the Jurisdiction without any retrial unless it is shown that (a) the foreign court did not have jurisdiction in accordance with its jurisdictional rules, (b) the party against whom the judgment of such foreign court was obtained had no notice of the proceedings or (iii) the judgment of such foreign court was obtained through collusion or fraud or was based upon clear mistake of fact or law.\n\t\t\t\t\t\t\t\tEXHIBIT H TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tFORM OF \tCERTIFICATE OF RESPONSIBLE OFFICER \tPURSUANT TO SUBSECTION 10.2(b)\n\t\tPursuant to subsection 10.2(b) of the Second Amended and Restated Credit Agreement, dated as of ______________ __, 1995 (as the same may be amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among Arrow Electronics, Inc., a New York corporation (the \"Company\"), the Foreign Subsidiary Borrowers named therein, the several banks and other financial institutions from time to time parties thereto (the \"Banks\"), the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents for the Banks, Bankers Trust Company, as collateral agent, Chemical Securities Inc., as arranger, and Chemical Bank, as administrative agent for the Banks, the undersigned, [Responsible Officer of the Company], hereby certifies, to the best of his\/her knowledge, as follows:\n\t1. For the fiscal year of the Company ending ________ __, 199_, the Company has observed or performed all of its covenants and other agreements contained in the Credit Agreement and the other Credit Documents to which it is a party to be observed or performed by it, and that such Responsible Officer has obtained no knowledge of any Default or Event of Default except as specified herein [specify Default or Event of Default, if any];\n\t2. The financial statements delivered concurrently herewith pursuant to subsections 10.1(a) and (b) of the Credit Agreement fairly present the consolidated (or consolidating by principal operating group, as appropriate) financial position and results of operations of the Company and its consolidated Subsidiaries in accordance with GAAP applied consistently throughout the periods reflected therein and with the prior periods (except as approved by the accountants performing such audit or the Responsible Officer making such certification, as the case may be, and disclosed therein).\n\t3. The calculations set forth on Schedule A hereto support the statement in paragraph 1 above in respect of subsections 11.1(a), (b) and (c), 11.2 and 11.5 of the Credit Agreement.\n\t\tUnless otherwise defined herein, capitalized terms which are defined in the Credit Agreement and used herein are so used as so defined.\n\t\tIN WITNESS WHEREOF, the undersigned has hereunto set his or her name and affixed the corporate seal.\n\t\t\t\t\t\t\tARROW ELECTRONICS, INC.\n\t\t\t\t\t\t\tBy: _____________________ \t\t\t\t\t\t\tTitle:\nDate: _________ __, 199_\t\t\t\t\t\t\t\t\t \t\t\t\t\t\n\t\t\t\t\t\t\t\tEXHIBIT I TO \t\t\t\t\t\t\t\tSECOND AMENDED \t\t\t\t\t\t\t\tAND RESTATED \t\t\t\t\t\t\t\tCREDIT AGREEMENT\n\tASSIGNMENT AND ACCEPTANCE\n\t\tReference is made to the Second Amended and Restated Credit Agreement, dated as of August , 1995 (as amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among Arrow Electronics, Inc. (the \"Company\"), the Foreign Subsidiary Borrowers named therein, the several Banks, the Lead Manager and the Agents parties thereto, Chemical Securities Inc., as arranger, and Chemical Bank, as administrative agent (in such capacity, the \"Administrative Agent\"). Unless otherwise defined herein, terms defined in the Credit Agreement and used herein shall have the meanings given to them in the Credit Agreement.\n_____________________ (the \"Assignor\") and _________________ the \"Assignee\") agree as follows:\n\t\t1. The Assignor hereby irrevocably sells and assigns to the Assignee without recourse to the Assignor, and the Assignee hereby irrevocably purchases and assumes from the Assignor without recourse to the Assignor, as of the Effective Date (as defined below), an interest (the \"Assigned Interest\") in and to the Assignor's rights and obligations under the Credit Agreement, in a principal amount as set forth on SCHEDULE 1.\n\t\t2. The Assignor (a) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Credit Agreement or with respect to the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement, any other Loan Document or any other instrument or document furnished pursuant thereto, other than that the Assignor has not created any adverse claim upon the interest being assigned by it hereunder and that such interest is free and clear of any such adverse claim; and (b) makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Company, any of its Subsidiaries or any other obligor or the performance or observance by the Company, any of its Subsidiaries or any other obligor of any of their respective obligations under the Credit Agreement or any other Loan Document or any other instrument or document furnished pursuant hereto or thereto.\n\t\t3. The Assignee (a) represents and warrants that it is legally authorized to enter into this Assignment and Acceptance; (b) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements delivered pursuant to subsection 8.1 thereof and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Acceptance; (c) agrees that it will, independently and without reliance upon the Assignor, the Administrative Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Agreement, the other Credit Documents or any other instrument or document furnished pursuant hereto or thereto; (d) appoints and authorizes the Administrative Agent, each Swing Line Bank and each Issuing Bank to take such action as agent on its behalf and to exercise such powers and discretion under the Credit Agreement, the other Credit Documents or any other instrument or document furnished pursuant hereto or thereto as are delegated to the Administrative Agent, each Swing Line Bank and each Issuing Bank, as the case may be, by the terms thereof, together with such powers as are incidental thereto; and (e) agrees that it will be bound by the provisions of the Credit Agreement and will perform in accordance with its terms all the obligations which by the terms of the Credit Agreement are required to be performed by it as a Bank including its obligation pursuant to subsection 7.6(b) of the Credit Agreement.\n\t\t4. The effective date of this Assignment and Acceptance shall be , (the \"Effective Date\"). Following the execution of this Assignment and Acceptance, it will be delivered to the Administrative Agent for acceptance by it and recording by the Administrative Agent pursuant to the Credit Agreement, effective as of the Effective Date (which shall not, unless otherwise agreed to by the Administrative Agent, be earlier than five Business Days after the date of such acceptance and recording by the Administrative Agent).\n\t\t5. Upon such acceptance and recording, from and after the Effective Date, the Administrative Agent shall make all payments in respect of the Assigned Interest (including payments of principal, interest, fees and other amounts) which accrue subsequent to the Effective Date to the Assignee. The Assignor and the Assignee shall make all appropriate adjustments in payments by the Administrative Agent for periods prior to the Effective Date or with respect to the making of this assignment directly between themselves.\n\t\t6. From and after the Effective Date, (a) the Assignee shall be a party to the Credit Agreement and, to the extent provided in this Assignment and Acceptance, have the rights and obligations of a Lender thereunder and under the other Loan Documents and shall be bound by the provisions thereof and (b) the Assignor shall, to the extent provided in this Assignment and Acceptance, relinquish its rights and be released from its obligations under the Credit Agreement.\n\t\t7. This Assignment and Acceptance shall be governed by and construed in accordance with the laws of the State of New York.\n\tIN WITNESS WHEREOF, the parties hereto have caused this Assignment and Acceptance to be executed as of the date first above written by their respective duly authorized officers on Schedule 1 hereto.\nSCHEDULE 1 TO ASSIGNMENT AND ACCEPTANCE RELATING TO THE CREDIT AGREEMENT, DATED AS OF AUGUST , 1995, AMONG ARROW ELECTRONICS, INC. (THE \"COMPANY\"), THE FOREIGN SUBSIDIARY BORROWERS NAMED THEREIN, THE SEVERAL BANKS, THE LEAD MANAGER AND THE AGENTS PARTIES THERETO, CHEMICAL SECURITIES INC., AS ARRANGER, AND CHEMICAL BANK, AS AGENT (IN SUCH CAPACITY, THE \"ADMINISTRATIVE AGENT\")\nName of Assignor:\nName of Assignee:\nEffective Date of Assignment: \tPrincipal \tAmount Assigned Commitment Percentage Assigned1\/\n\t$ \t . %\n\t[NAME OF ASSIGNEE]\nBy Name: Title: \t[NAME OF ASSIGNOR]\nBy Name: Title:\nAccepted [and Consented to]:\nCHEMICAL BANK, as Administrative Agent\nBy Name: Title:\nConsented To:1\/\nARROW ELECTRONICS, INC.\nBy Name: Title:\n\t\tEXHIBIT J TO \t\tSECOND AMENDED \t\tAND RESTATED \t\tCREDIT AGREEMENT\nFORM OF GUARANTEED CEILING AMOUNT CERTIFICATE\n\tPursuant to subsection [9.1(h)][10.2(f)] of the Second Amended and Restated Credit Agreement, dated as of ______________, (as the same may be amended, supplemented or otherwise modified from time to time, the \"Credit Agreement\"), among Arrow Electronics, Inc., a New York corporation (the \"Company\"), the Foreign Subsidiary Borrowers named therein, the several banks and other financial institutions from time to time parties thereto (the \"Banks\"), the Lead Manager named therein, Bankers Trust Company and Chemical Bank, as agents for the Banks, Bankers Trust Company, as collateral agent, Chemical Securities Inc., as arranger, and Chemical Bank, as administrative agent for the Banks, the undersigned, Ira Birns, hereby certifies, to the best of his knowledge, as follows:\n\t\t1. The Guarantee Ceiling Amount as of June 30, 1995, is \t$124,873,000 calculated as follows:\n\ta. Consolidated Net Worth of the company as of June 30, 1995 \t(calculated as defined in and in accordance with the \tprovisions of the Note Purchase Agreement).\n\t\t\t$965,817,000\n\tb. 15% of Line a.\n\t\t\t$144,873,000 \t\t\t \tc. all Indebtedness (including, without limitation, Capitalized\tLease Obligations) of the company and its subsidiaries (other than its Foreign Subsidiaries) secured by Liens other than Permitted Liens under subclauses (a) through (I) and (k) through (q) of Section 8.0(j) of the Note Purchase Agreement (calculated as defined in and in accordance with the provisions of the Note Purchase Agreement). \t\t\t$0\n\td. the total Indebtedness of the Company's Subsidiaries (other than its Foreign Subsidiaries) (calculated as defined in and in accordance with the provisions of the Note Purchase Agreement).\n\t\t\t$20,000,000\n\te. Guarantees by the Company of the Indebtedness of the Foreign Subsidiaries permitted pursuant to Section 8.08(iv) of the Note Purchase Agreement (calculated as defined in and in accordance with the provisions of the Note Purchase Agreement) but excluding the aggregate Dollar Equivalent Amount of the Exposure of the Foreign Subsidiary Borrowers and the Local Currency Borrowers.\n\t\t\t$0\n\tf. Guarantee Ceiling Amount calculated as Line b. minus the sum of Lines c., d. and e.\n\t\t\t$124,873,000\n\t\t2. The aggregate Dollar Equivalent Amount of the Exposure of the Foreign Subsidiary Borrowers and Local Currency Borrowers on the date hereof is $66,743,000.\n\t\t3. The Company Guarantee Ratio is (calculated as the ratio \tof (a)2. minus 1.f to (b) 2., but not less than zero)\n\t\t\t0%\n\t\tUnless otherwise defined herein, capitalized terms which are defined in the Credit Agreement and used herein are so used as so defined.\n\t\tIN WITNESS WHEREOF, the undersigned has hereunto set his or her name and affixed the corporate seal.\n\t\t\tARROW ELECTRONICS, INC.\n\t\t\tBy: ______________________ \t\t\tTitle: Assistant Treasurer\n\t\t\tDate: ____________________ \t\t\t\n\t\t\t ARROW ELECTRONICS, INC. \t\t\t SUBSIDIARY LISTING Exhibit 21 \t\t\t\t\t\t\t\t\n1. Arrow Electronics, Inc. a New York corporation 2. Arrow Electronics International, Inc., a Virgin Islands corporation 3. Arrow Electronics Canada Ltd., a Canadian Corporation 4. Lex Electronics, Ltd., a Canadian Corporation 5. Arrow Electronics Credit Corporation, a Delaware Corporation 6. Schuylkill Metals of Plant City, Inc., a Delaware Corporation 7. Arrow Electronics International, Inc., a Delaware Corporation 8. Arrow Electronics (UK) Inc., a Delaware Corporation 9. Arrow\/TEK Ltd., a Japanese Joint Venture (50% owned) 10. Capstone Electronics Corp., a Delaware Corporation 11. High Tech Ad, Inc., a New York Corporation 12. Gates\/Arrow Distributing, Inc., a Delaware Corporation 13. Anthem Electronics, Inc., a Delaware Corporation, \t including subsidiaries: \t A Anthem Enterprises \t B. Lionex Corp. \t C. Anthem Technology Systems 14. Arrow-Field OY and subsidiaries, a Finnish Company 15. Arrow-TH:s Elektronik AB, and subsidiaries, a Swedish \t Company (owned 85%) 16. Exatec A\/S, and subsidiaries, a Danish company (owned 85%) 17. Arrow Electronics Distribution Group - Europe B.V., a Dutch company, \t and Subsidiaries which include: \t A. Arrow Electronics (UK) Limited, a British Company, and \t\t subsidiaries: \t\t 1. RR Electronics Limited, a British Company \t\t 2. Axiom Electronics Ltd., a British Company \t\t3. Jermyn Holdings Limited, a British Company & \t\t\tSubsidiaries \t\t 4. Techdis Limited, a British company, and subsidiary: \t\t\ta. Microprocessor & Memory Distribution Ltd., a \t\t\t\tBritish Company \t B. EDI Electronics Distribution International (France) SA, a \t\t French Company and subsidiaries: \t\t 1. Arrow Electronique S.A., a French Company, and \t\t\tsubsidiaries: \t\t\ta. Generim S.A., a French Company \t\t\tb. Feutrier S.A., a French Company \t\t\tc. CCI Electronique S.A., a French Company \t\t\td. Arrow Computer Products S.N.C. (formerly \t\t\t\tMegachip S.A.) and subsidiaries\n\tC. Arrow Electronics GmbH, a German Company (which owns 70% \t\tinterest of Spoerle Electronic Handelgesellschaft mbH, a German \t\t company, and subsidiaries)\n\tD. Arrow ATD Netherlands B.V., a Dutch company (which owns 87% of \t \tATD Electronica S.A., a Spanish company \tE. Arrow-Amitron Netherlands B.V., a Dutch company (which owns 75% \t \tof the shares of Amitron-Arrow S.A.) \tF. Silverstar Ltd. S.p.A. (86% owned) & subsidiaries \tG. Arrow Australia Pty Ltd. (100% owned) and subsidiaries: \t\t 1. Veltek Australia Pty Ltd. (75% owned) \t\t2. Zatek Australia Pty Ltd. (75% owned)\n18. Components Agent Limited, a British Virgin Island company (owned 90%) \tand Subsidiaries which include: \tA. Components Agent Limited, a Hong Kong company \tB. Components Agent China Limited, a Hong Kong company \tC. Components Agent Korea Limited, a Hong Kong company \tD. Components Assembly & Sales Pte Ltd, a Singapore company \tE. Casl. (M) Sdn. Berhad, a Malaysian company, and subsidiaries \tF. Salson Holdings Limited, a British Virgin Islands company, and \t\tsubsidiary: \t\t1. Qinhuangdao Arrow Electronics Company Limited, a \t\t\tcompany of the People's Republic of China \tG. Components Korea Company Limited, a Korean company\n19. Texny (Holdings) Limited, a British Virgin Islands company (owned 95%) \tand Subsidiaries: \tA. Texny (H.K.) Limited, a Hong Kong company, and subsidiary: \t\t 1. Glorytact Company Limited, a Hong Kong company \tB. Intex-semi Limited, a Hong Kong company (inactive company) \tC. Colourmedia Animation Limited, a Hong Kong company (inactive \t\tcompany)\n20. Strong Electronics Co., Ltd. and subsidiaries, a Taiwanese Joint \tVenture (owned 45%)\n21. Ally\/Arrow, Inc., a Taiwanese company (75% owned)\n22. Arrow Components (NZ) Limited, a New Zealand company (75% owned)\nEXHIBIT 23\n\t\t CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Forms S-8 No. 33-55565, 33-66594, No. 33-48252, No. 33-20428 and No. 2- 78185) and in the related Prospectuses pertaining to the employee stock plans of Arrow Electronics, Inc., in Amendment No. 1 to the Registration Statement (Form S-3 No. 33-54473) and in the related Prospectus pertaining to the registration of 1,376,843 shares of Arrow Electronics, Inc. Common Stock, in Amendment No. 1 to the Registration Statement (Form S-3 No. 33- 67890) and in the related Prospectus pertaining to the registration of 1,009,086 shares of Arrow Electronics, Inc. Common Stock, and in Amendment No. 1 to the Registration Statement (Form S-3 No. 33-42176) and in the related Prospectus pertaining to the registration of up to 944,445 shares of Arrow Electronics, Inc. Common Stock held by Aquarius Investments Ltd. and Andromeda Investments Ltd. of our report dated February 22, 1996 with respect to the consolidated financial statements and schedule of Arrow Electronics, Inc. included in this Annual Report on Form 10-K for the year ended December 31, 1995.\n\t\t\t\t\t\t ERNST & YOUNG LLP\nNew York, New York March 27, 1996\n\t\t\t ARROW ELECTRONICS, INC.\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 annual report to be signed on its behalf by the undersigned, thereunto duly authorized.\n\t\t\t\t\t ARROW ELECTRONICS, INC.\nBy\/s\/ Robert E. Klatell ------------------------ \t\t\t\t\t\tRobert E. Klatell \t\t\t\t\t\tExecutive Vice President\n\t\t\t\t\t\tMarch 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:\nBy\/s\/ Stephen P. Kaufman March 27, 1996 -------------------------------------------------------------- Stephen P. Kaufman, Chairman, Principal Executive Officer, and Director\nBy\/s\/ Robert E. Klatell March 27, 1996 -------------------------------------------------------------- Robert E. Klatell, Executive Vice President, Principal Financial Officer, and Director\nBy\/s\/ Paul J. Reilly March 27, 1996 -------------------------------------------------------------- Paul J. Reilly, Controller and Principal Accounting Officer \t By\/s\/ Daniel W. Duval March 27, 1996 -------------------------------------------------------------- Daniel W. Duval, Director\nBy\/s\/ Carlo Giersch March 27, 1996 -------------------------------------------------------------- Carlo Giersch, Director\nBy\/s\/ March 27, 1996 -------------------------------------------------------------- Roger King, Director\nBy\/s\/ Karen Gordon Mills March 27, 1996 -------------------------------------------------------------- Karen Gordon Mills, Director\nBy\/s\/ Richard S. Rosenbloom March 27, 1996 -------------------------------------------------------------- Richard S. Rosenbloom, Director\nBy\/s\/ Robert S. Throop March 27, 1996 -------------------------------------------------------------- Robert S. Throop, Director\nBy\/s\/ John C. Waddell March 27, 1996 -------------------------------------------------------------- John C. Waddell, Vice Chairman","section_15":""}
{"filename":"6845_1995.txt","cik":"6845","year":"1995","section_1":"ITEM 1. BUSINESS --------\nThe Company - -----------\nApogee Enterprises, Inc. is a holding company incorporated under the laws of the State of Minnesota in 1949. The Company, through its operating subsidiaries, is primarily engaged in the fabrication, distribution and installation of curtainwall (exterior wall panels), aluminum windows systems, glass panels, and related glass products and services for the nonresidential construction, replacement automotive glass and selected consumer products markets. Two business segments comprise Apogee's operations: Building Products & Services (BPS) serves certain sectors of the commercial and institutional, detention and security building and consumer products markets. Automotive Glass (AG) serves the automotive glass replacement market. Financial information about the Company's segments can be found at Note 17 - Business Segments of the notes to consolidated financial statements of Apogee Enterprises, Inc. contained in a separate section of this report. See \"Index of Financial Statements and Schedules\"\nUnless the context otherwise requires, the terms \"Company\" and \"Apogee\" as used herein refer to Apogee Enterprises, Inc. and its subsidiaries.\nBuilding Products & Services - ----------------------------\nThe Company's Building Products & Services segment operates principally in the design, engineering, manufacturing and installation of custom and standard curtainwall and window systems for commercial, institutional and detention and security buildings, as well as some specialized consumer products. BPS operating units are organized under four groups: Nonresidential Construction, Architectural Metals, Architectural Glass and Consumer.\nNonresidential Construction\nBPS's Harmon Contract unit is one of the world's largest designers and installers of curtainwall and window systems for nonresidential construction. It has six offices throughout the United States as well as five in Europe and Asia. BPS acquired an 80% interest in CFEM Facades (CFEM), in fiscal 1994, a French company engaged in both the manufacture and installation of curtainwall. This office, in addition to the other European and Asian offices, has given the division a stronger presence in overseas markets. All of the offices typically design, assemble and install a building's exterior skin. The enclosure usually consists of a metal framing system which is glazed (filled) with glass in the vision areas and opaque glass or panels in the non-vision (spandrel) areas. Panels are usually made from aluminum, precast concrete or natural stone. The segment procures its materials from a number of independent fabricators, including the BPS's architectural metals and architectural glass units. Harmon Contract also serves as a stone subcontractor, setting stone on both the exterior and interior of buildings, including floors, benches and lavatories.\nBPS also has seven Harmon full service operations located around the country. These centers offer complete replacement or remodeling glass services for residential and commercial buildings. In addition, the full service units offer 24-hour replacement service for storm or vandalism damage. Superior engineering capabilities allow the units to duplicate the original design or create a completely new appearance for renovated buildings.\nThe Harmon detention and security units manufacture and install windows, doors, guard booths and monitoring systems, primarily for prisons and jails. The units' products are also sold to convenience stores, hospitals, schools and other governmental facilities. BPS competes in the detention and security market through its Norment operating unit which is a leader in the design, manufacture and installation of institutional and governmental security and detention systems. BPS also includes Airteq, which assembles pneumatic locks used in Norment's and other detention and security systems, and EMSS, a detention equipment contractor.\nBPS is subject to normal subcontractor's risks, including material and wage increases, construction and transportation work stoppages and contractor credit worthiness. In addition, office vacancy rates, tax laws concerning real estate and interest rates are important factors which affect nonresidential construction markets. Reduced competition on larger projects, custom designing capability and a trend toward the use of more sophisticated materials for energy conservation and design flexibility have helped BPS increase its market share over the past several years.\nArchitectural Metals\nThe Architectural Metals unit of BPS designs and manufactures high-quality, thermally-efficient aluminum window and curtainwall systems under the \"Wausau Metals and Milco\" trade names. These products meet high standards of wind load capacity and resistance to air and moisture seepage. Architectural Metals' aluminum window frame designs are engineered to be thermally efficient, utilizing high-strength polyurethane to limit the transfer of heat or cold through the window frame. Products are marketed through a nationwide network of distributors and a direct sales staff. Sales are made to building contractors, including Harmon Contract, for new construction and to building owners for retrofitting older buildings. Wausau Metals maintains design and product engineering staffs to prepare aluminum window and curtainwall system designs to fit customers' needs and to originate new product designs. Wausau Metals occasionally joins Harmon Contract in pursuing certain projects, as many architects and general contractors prefer to work with an experienced curtainwall subcontractor and manufacturer team.\nOperating under the \"Linetec\" name, the architectural metals unit also has two metal coating facilities which provide anodized and fluoropolymer coatings to metal. Anodizing is the electrolytic process of putting a protective, often colored, oxide film on light metal, typically aluminum. Fluoropolymer coatings are high quality paints which are sometimes preferred over anodizing because of the wide color selection. Coatings are applied to window and curtainwall components for the Company, as well as other companies' architectural and industrial aluminum products.\nArchitectural Glass\nBPS's Architectural Glass unit fabricates finished glass products and provides glass coating services, primarily under the \"Viracon\" and \"Marcon Coatings\" names. These operating units purchase flat, unprocessed glass in bulk quantities from which a variety of glass products are fabricated, including insulating, tempered and laminated architectural glass; security glass; laminated and tempered industrial glass; anti-reflection and UV-light blocking picture framing glass; and provide reflective and low-emissivity coatings on glass.\nTempered glass is a heat-processed safety glass which is four to five times stronger than ordinary glass, breaks into \"pebbles\" rather than sharp pieces and has architectural, automotive and industrial applications. Laminated glass consists of two or more pieces of glass fused with a plastic interlayer and is used primarily for strength and safety in skylights and in security applications. Sales of laminated and tempered safety glass products have increased with the adoption of federal and state safety glazing standards. Insulating glass, comprised of two or more pieces of glass separated by a sealed air space, is used in architectural and residential applications for thermal control.\nThe Viracon unit is able to fabricate all types of architectural glass (insulating, laminated, tempered and combinations of all three) at its Owatonna complex. Combined with the adjacent Marcon Coatings' glass coating capabilities, the segment is able to provide a full range of products from a central location. It markets its products nationally and overseas to glass distributors, glazing contractors (including Harmon Contract) and industrial glass fabricators. A substantial portion of its glass products is delivered to customers by Viracon's fleet of company-owned trucks, providing \"backhaul\" capability for its raw materials, thereby reducing shipping time, transportation costs and breakage expense.\nViracon is a 50% owner of Marcon Coatings, Inc., (Marcon) a joint venture glass coating facility with Marvin Windows (\"Marvin\"). Marcon provides glass coating services from its Owatonna, Minnesota facility to Marvin and Viracon, as well as outside customers. Marcon's reflective and low-emissivity coatings reduce energy costs and provide innovative design features for window and curtainwall systems. Low-emissivity coatings are an invisible, metallic film deposited on glass which selectively limits the transfer of heat through the glass. Low-emissivity coated glass represents a fast-growing segment of both residential and nonresidential glass markets.\nConsumer\nTru Vue, located in Chicago, Illinois, is one of the largest domestic manufacturers of picture framing glass. Tru Vue provides its customers with a full array of picture framing glass products, including clear, reflection control, which diminishes reflection, and conservation glass, which blocks ultraviolet rays. The products are distributed primarily through independent distributors who, in turn, supply local picture framing markets. During 1993, Tru Vue acquired the assets of Miller Artboard (Miller). Miller is a manufacturer of conservation picture framing matboard, which complements Tru Vue's glass product offerings.\nThe segment also offers several types of window coverings for residential, commercial and institutional markets, under the \"Nanik\" and \"The Shuttery\" names. Nanik manufactures various types of custom aluminum, wood and polycarbonate venetian blinds, and markets them primarily to interior designers through independent distributors. The Shuttery is a\nmanufacturer of custom wooden and vinyl interior shutters. Nanik Wood Products was formed in 1991 to provide a reliable source of wood mouldings for both Nanik and The Shuttery, while allowing both units to improve inventory control and production efficiency. All three units operate manufacturing facilities in Wausau, Wisconsin.\nAutomotive Glass - ----------------\nThe Automotive Glass (AG) segment is engaged in the automotive replacement glass business through its Harmon Glass service centers (retail), Glass Depot distribution centers (wholesale) and Curvlite fabrication center.\nHarmon Glass operates automotive glass service centers in 36 states. The centers replace auto glass on the premises and also provide mobile installation service. Primary customers include insurance companies (on behalf of their insured clients), fleet owners and car owners. The service centers also carry limited inventories of flat glass, which are sold at retail for such purposes as home window repair and table tops. Some automotive accessories are also sold and installed at certain service centers. Quality service is emphasized in all service centers. The Company believes Harmon Glass is the second-largest auto glass retailer in the United States. The unit also operates a centralized service for handling auto glass claims under the name \"National Call Center\" (Center). The Center, on behalf of its insurance company and fleet customers, handles replacement glass claims made by policyholders or fleet owners. Calls are placed through a toll-free number to the Center located in Orlando, Florida. Customer service agents arrange for the prompt replacement or repair of auto glass by either a Harmon Glass service center or an affiliated shop member of the Center's network and begins the process of filing the claim electronically with the applicable insurance company. The Center subcontracts for replacement and repair services with over 3,300 auto glass stores nationwide. The unit seeks to maximize the electronic exchange of information, which reduces claim costs and eliminates errors. This type of service is a fast-growing segment for the segment.\nThe auto glass distribution centers, known as \"Glass Depot\", supply the Harmon Glass service centers with auto and flat glass and related products, as well as selling wholesale to other glass installers. Due to the variety of makes and models of automobiles, automotive glass service centers typically stock only windshields for the most popular models. As a result, there is a demand for distributors to maintain inventories of automotive glass and to provide prompt delivery. The Glass Depot distribution centers maintain a broad selection of automotive glass. Purchases of fabricated automotive glass are made from several primary glass manufacturers and fabricators, including the segment's Curvlite unit.\nCurvlite fabricates replacement windshields for foreign and domestic automobiles and tempered and laminated glass parts for the transportation industry. It fabricates approximately 800 types of replacement windshields which are marketed nationally to distributors and glass shops, including the Glass Depot distribution centers. Curvlite seeks to offer a broad selection of windshields by promptly adding new windshields as new models are introduced.\nIn fiscal 1995, the AG segment acquired or opened 9 new distribution centers and 33 service centers, while closing 1 distribution and 7 service centers, bringing its year-end total to 53 and 256 respectively. This includes a chain of 13 retail stores and one warehouse in the Washington, D.C. area, acquired in January, 1995. The segment continues to evaluate opportunities to expand both its retail and wholesale auto glass segments, while closely monitoring existing units' profitability.\nUnder a franchise agreement with Midas International Corporation in 1980, the segment operates seven Midas Muffler locations in Minnesota, South Dakota, North Dakota and Wisconsin.\nViratec Thin Films - ------------------\nIn addition to its two primary segments, Apogee owns 50% of Viratec Thin Films, Inc. (Viratec), an optical-quality glass coating joint venture with Marvin Windows, which was organized in fiscal 1989 in Faribault, Minnesota and began production in early 1990. Viratec develops advanced, optical-display and imaging coatings for glass and other surfaces. These products are used in aftermarket anti-glare computer screens, high-quality optical components and high performance mirror products for the imaging industry. Viratec markets optical display and imaging products to both domestic and overseas customers. These customers provide further assembly, marketing and distribution to end users. The Company accounts for its investment in Viratec using the equity method.\nCompetition - -----------\nAll segments of the Company's business, other than Viratec, are fairly mature and are highly competitive. The curtainwall subcontractor business is primarily price competitive, although the Harmon Contract's reputation for quality engineering\nand service is an important factor in receiving invitations to bid on large complex projects. In addition to the above factors, Harmon Contract has the advantage of having the financial strength and long-term viability of Apogee, which allows Harmon Contract to be bonded on even the largest, most complex jobs. This is an important competitive advantage in the bidding of larger contracts. The Architectural Metals group competes against several major aluminum window manufacturers. Wausau Metals primarily serves the custom portion of this market in which the primary competitive factors are product quality, reliable service and the ability to provide technical engineering and design services. The Architectural Glass unit competes with several large integrated glass manufacturers and numerous smaller specialty fabricators. Product pricing and service are the primary competitive factors in this market. AG competes with other auto glass shops, glass distributor warehouses, car dealers, body shops and fabrication facilities on the basis of pricing and customer service. Its competition consists of national and regional chains as well as significant local competition. Viratec Thin Films has both domestic and foreign competitors, several of whom are older and more established.\nMarkets - -------\nBPS serves the domestic nonresidential construction market, which tends to be cyclical and has been on a slow comeback, both in terms of dollars and square feet of new contract awards. This market has been hard hit due to the overbuilding in past years, tax law changes, recession, tightening credit standards, business restructurings and other factors. The resulting contraction in demand for building materials and construction services has intensified competition, squeezed profit margins and contributed to some business failures in the market sectors served by the Company. In response to weak markets, the BPS segment has consolidated manufacturing facilities, closed offices and reduced personnel and discretionary expenses. It has also redirected its marketing focus to sectors with relative strength, including remodeling, institutional (including detention and security) and certain international markets such as Asia and Europe. These international markets have recently been an important source of growth for BPS. See \"Foreign Operational Export Sales,\" below.\nAG services the automotive glass aftermarket which is influenced by a variety of factors, including new car sales, gasoline prices, speed limits, road conditions, the economy, weather and average number of miles driven. A transformation of the industry's pricing structure has intensified competition. In recent years, major purchasers of auto glass, such as insurance companies, have increasingly requested volume pricing and awarded regions to glass providers at significant discounts from historical levels. As a result, margins have narrowed at the retail level and, to a lesser extent, at wholesale and manufacturing levels.\nSources and Availability of Raw Materials - -----------------------------------------\nNone of the Company's operating units are significantly dependent upon any one supplier. The Company believes a majority of its raw materials (bulk flat glass, aluminum extrusions, automotive glass and related materials) are available from a variety of domestic sources.\nTrademarks and Patents - ----------------------\nThe Company has several nationally recognized trademarks and trade names which it believes have significant value in the marketing of its products. Harmon Glass(R), Harmon Contract(R), Norment(R), Airteq(R), EMSS(R), Viratec(R), Tru Vue(R), The Glass Depot(R), Nanik(R), The Shuttery(R), and Linetec(R) are registered trademarks of the Company. Viratec Thin Films has obtained several patents pertaining to its glass coating methods. However, no single patent is considered to be materially important to the Company.\nForeign Operations and Export Sales - -----------------------------------\nBPS has sales offices in Europe and Asia. Sales for those offices were approximately $66,580,000, $65,021,000 and $6,490,000 for the years ended February 25, 1995, February 26, 1994 and February 27, 1993, respectively. Operating losses for 1995, 1994 and 1993, were $6,575,000, $887,000 and $1,328,000, respectively. At February 25, 1995 and February 26, 1994, the identifiable assets of foreign operations totaled $41,880,000 and $31,786,000, respectively. At February 25, 1995, the backlog of work for European and Asian projects was $100 million, $60,000,000 of which is not expected to be reflected as revenue in fiscal 1996. In addition, during the years ended February 25, 1995, February 26, 1994 and February 27, 1993, the Company's export sales, principally from BPS operations, amounted to approximately $30,241,000, $27,643,000 and $22,808,000, respectively.\nEmployees - ---------\nThe Company employed 6,184 persons at February 25, 1995, of whom 1,079 were represented by labor unions. The Company is a party to 108 collective bargaining agreements with several different unions. Seventy (70) of the collective bargaining agreements will expire during fiscal 1996. The number of collective bargaining agreements to which the Company is a party will vary with the number of cities with active nonresidential construction contracts. The Company considers its employee relations to be very good and has not recently experienced any significant loss of work days due to strike.\nBacklog - -------\nThe backlog of orders is significant in the Company's construction-related BPS segment. At February 25, 1995, the Company's total backlog of orders considered to be firm was $364,000,000, compared with $405,000,000 at February 26, 1994. Approximately $84,000,000 is not expected to be reflected as revenue in fiscal 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe following table lists, by division, the Company's major facilities, the general use of the facility and whether it is owned or leased by the Company.\n(1) 50% owned joint ventures.\nThe Harmon Contract operating unit has 12 sales offices, 7 glazing service centers and 11 fabrication facilities generally located in major metropolitan areas in the United States, Europe and Asia, virtually all of which are leased.\nThe Automotive Glass segment has 309 retail service and distribution centers located nationally and seven Midas Muffler franchises located in the Midwest, the majority of which are leased.\nThe Curvlite plant, a Wausau Metals facility, the Linetec paint facility, an addition to one of the Wausau Metals plants and the National Call Center administrative center were constructed with the use of proceeds from industrial revenue bonds issued by those cities. These properties are considered owned, since at the end of the bond term, title reverts to the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nThere are no material pending legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nExecutive officers are elected annually by the Board of Directors and serve for a one-year period. With the exception of Gerald K. Anderson, has a post- employment consulting agreement with the Company. Richard Gould has an employment contract with the Company that covers the period through 2000. No other officers have employment contracts with the Company. None of the executive officers or directors of the Company are related.\nAll of the above named executive officers have been employees of the Company for more than the last five years with the exception of Mr. Gould joined the company in May 1994 and Mr. Hall who joined the Company in April, 1995. Prior to joining the Company, Mr. Gould was president of Gould Associates, a strategic management consulting firm to a wide range of companies. Prior to joining the Company, Mr. Hall was Chief Financial Officer of Tyco International from 1993 to 1995 and Vice President and Treasurer of United Airlines from 1990 to 1993.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ----------------------------------------------------------------- MATTERS -------\nApogee common stock is traded in the National Market System of the NASDAQ over-the-counter market, under the ticker symbol APOG. Stock price quotations are printed daily in major newspapers. During the fiscal year ended February 25, 1995, the average trading volume of Apogee common stock was 806,506 shares per month, according to NASDAQ.\nAs of March 31, 1995, there were 13,443,163 shares of common stock outstanding, of which about 6.9 percent were owned by officers and directors of Apogee. At that date, there were approximately 2,187 shareholders of record and 2,942 shareholders for whom securities firms acted as nominees.\nThe following chart shows the quarterly range and year-end close of the company's common stock over the past five fiscal years.\nIt is Apogee's policy to pay quarterly cash dividends in May, August, November and February. Cash dividends have been paid each quarter since 1974 and have been increased each year since then. The chart below shows quarterly cash dividends per share for the past five years.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nThe following information should be read in conjunction with Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL GOALS - ---------------\nThe strategies undertaken by Apogee in fiscal 1995 to improve quality, reduce costs, resize our profit centers to better fit available business and become more responsive to customer needs has brought us closer to our goal of resuming historical growth rates in sales and earnings. Further improvements were made by our auto glass and architectural glass businesses during the past year. Our nonresidential construction businesses significantly cut their operating losses, while implementing strengthened bidding and project management practices. However, the ongoing review of our varied operations continues to warrant a delay in the setting of new financial targets. In fiscal 1995, we are again reporting record sales. Nonetheless, earnings still lag our fiscal 1991 record by more than 20%. Our primary goal is to overcome that lag. We have a reasonable basis to believe we can do so in fiscal 1996. Our optimism is based in part on the positive developments detailed in this financial review.\nPERFORMANCE - ----------- FISCAL 1995 COMPARED TO FISCAL 1994 The following table illustrates the relationship between various components of operations, stated as a percent of net sales, for the three years ended February 25, 1995.\nConsolidated net sales rose 10% to $757 million in fiscal 1995, primarily due to strong replacement auto glass markets, robust demand for architectural glass products, and higher detention and security contracting revenues. Our gross margin increased nearly two percentage points as pricing improved slightly for replacement auto glass and architectural glass products. Productivity improved as sales outpaced moderate increases in wages and benefits, including lower medical plan costs. In addition, the margin gains reflected operating improvements by our nonresidential construction and architectural metals operations, despite the continuation of depressed margins for those units' markets.\nAs a percentage of net sales, selling, general and administrative expenses (SG&A) crept slightly higher, but grew substantially in absolute dollars. The majority of the increase resulted from expenditures by our auto glass retail and wholesale businesses for the development of improved information systems to better meet customer needs, as well as for expanded marketing programs related to windshield repair and claims administration.\nNet interest expense rose 51% , due to the combination of higher interest rates and increased borrowing levels required to meet working capital and capital investment needs.\nOur effective income tax rate fell substantially, from 60.9% in fiscal 1994, to 40.2% in 1995, as increased domestic earnings were taxed at essentially the statutory rate. The fiscal 1994 rate was unusually high due to an increase in our deferred tax asset valuation.\nEquity in net earnings of affiliated companies dropped 67%, to $800,000 in fiscal 1995. New product and process development costs at Viratec Thin Films substantially offset strong earnings of the unit's anti-glare screen business. Minority interest differed from a year ago as Harmon\/CFEM Facades, our French curtainwall unit, reported a loss in fiscal 1995 compared to net earnings in the prior year.\nFiscal 1995 consolidated net earnings grew 240%, to $13.1 million, or $.97 per share, up from $3.8 million or 29 cents per share a year ago, which includes the $525,000 or 4 cents per share cumulative effect of the change in accounting for income taxes reported last year. Return on average shareholders' equity grew to 10.9%, up from 3.4% a year earlier.\nAt year end, our consolidated backlog was $364 million, down 10% from $405 million a year ago. Decreases in our domestic and Asian construction backlogs exceeded the combined increases in other areas. While our backlog declined, we believe that recently recorded orders will provide margin improvement over that realized in the past couple of years. Approximately $84 million of the February 1995 backlog will not be reflected as revenue in fiscal 1996.\nIn order to better inform shareholders and readers, Apogee has redefined its business segments information and discussion. We believe the changes will provide more effective communication concerning our business units and the markets we serve. Apogee consists of two segments, Building Products & Services (BPS) and Automotive Glass (AG). These segments, plus the Viratec Thin Films joint venture, are discussed below.\nBuilding Products & Services\nBPS made significant strides in fiscal 1995, increasing revenues 9% to $508 million, and reporting a modest $4.4 million operating profit. Within the segment, 19% revenue growth was achieved at the detention and security unit, largely due to fast-track projects entered into at the beginning of the year. Also, high demand and firmer pricing for Viracon's architectural glass products boosted its sales 22%. These factors led to margin gains and strong profit growth for both units.\nMarcon Coatings, our building glass coating joint venture, reported healthy sales and earnings growth, as the company benefitted from rapidly growing Viracon sales.\nHarmon Contract, our curtainwall subcontractor, reported a 2% decline in domestic revenues, but slashed its operating loss by 85%. With a lower cost structure and improved project management, Harmon worked through much of its narrow-margin backlog, obtained in the intensely competitive pricing environment of 1991-1993.\nHarmon Contract's overseas operations recorded flat revenues compared to a year ago, with higher Asian revenues offset by less activity in Europe. Operating results suffered from low-margin projects and overhead growth related to brisk bidding activity in both Europe and Asia.\nThe segment's architectural metals group also rebounded sharply. Sales grew 9%, with firmer pricing, beefed-up engineering and better factory utilization nearly eliminating last year's significant operating loss.\nBPS's picture framing products and window coverings units recorded steady sales gains and solid earnings although behind historical levels.\nOverall, BPS made progress in controlling its costs, with a $500,000 reduction in SG&A expenses, the result of restructuring measures taken late last year, as well as ongoing cost control this year. The segment believes the aggressive steps taken to strengthen margins and reduce overhead, along with the elevated demand for architectural glass products and the slow recovery of U.S. nonresidential construction, should help it make improvements in profitability next year.\nAutomotive Glass\nThe Automotive Glass (AG) segment achieved net sales of $249 million, up 12% over a year ago, while reporting operating income of $19.1 million, modestly ahead of the prior year's strong performance. High demand for replacement auto glass, along with share gains in selected markets, helped to boost revenues. Price increases early in the year were somewhat eroded by volume discounts to major customers. Despite the sales increase, operating income for the segment was flat with a year ago, as costs to expand marketing programs and develop state-of-the-art information systems offset gross profit gains.\nBoth Harmon Glass (retail) and Glass Depot (wholesale) advanced same-location sales by 7% reflecting overall market growth. The higher volume contributed to gross margin growth, but higher SG&A costs limited the units' operating income gain to 4%.\nThe National Call Center, (formerly the Harmon Glass Network), which arranges auto glass repair and replacement orders received from insurance and fleet customers, reported 9% unit growth over fiscal 1994. About two-thirds of the Call Center's volume is handled by company-owned stores.\nViracon\/Curvlite, our windshield fabricator, maintained high factory utilization throughout the year, producing record sales and strong earnings. Windshield unit shipments grew 8%. Also, Curvlite invested in equipment to expand capacity and lower production costs.\nDuring the year, the AG segment acquired or started up 33 retail stores and nine wholesale depots, including a chain of 13 retail stores and one warehouse in the Washington, D.C. area, acquired in January, 1995. This acquisition gives AG a significant position in this attractive East Coast market. The group closed seven retail and one distribution locations during the year, to end the year with 256 retail stores, 53 wholesale depots and 7 Midas Muffler locations.\nIncreased demand for new and better auto glass products and services, combined with sophisticated information systems, should enable AG to expand internally and through acquisitions, and to improve results.\nViratec Thin Films\nViratec Thin Films (Viratec) is Apogee's second joint venture with Marvin Windows. The unit develops and applies optical-grade coatings to glass and other substrates. Revenues rose 8%, while pre-tax earnings were down 74% from last year. Demand for Viratec's coated glass for anti-glare computer screens remained strong, especially in overseas markets, as the European Community has adopted stricter safety regulations for limiting computer emissions. Viratec invested heavily in research and development costs during fiscal 1995 to begin limited direct-coating of cathode ray tubes (CRTs), thus reducing bottom-line results. At February 25, 1995, Viratec's backlog stood at $14.5 million, up 11% from a year ago. Accordingly, the unit is anticipating improved revenues in the upcoming year. However, operating results will be highly dependent upon Viratec's ability to ramp up production of CRT coatings within a reasonable cost structure.\nFISCAL 1994 COMPARED TO FISCAL 1993\nConsolidated net sales rose 20%, to $688 million, in fiscal 1994, primarily due to strong replacement auto glass sales, higher overseas nonresidential construction activity and improved demand for architectural glass products.\nApogee's gross profit, as a percent of sales, fell for the second straight year. Stronger auto and architectural glass markets allowed for firmer pricing, but were more than offset by very low gross margins in curtainwall contracting, ineffective project management and poor factory utilization at some units within the Building Products & Services segment.\nSelling, general and administrative expenses decreased slightly from a year earlier, due to cost containment efforts throughout the company. Greater expenditure levels for improved information systems and expanded marketing programs, primarily in the Automotive Glass segment, were offset by reductions elsewhere in the company.\nDuring the fourth quarter of fiscal 1994, Apogee recorded a $5.6 million ($4.5 million after tax, or 34 cents per share) provision for business restructuring and asset valuation. The charge reflected the costs of consolidating or closing certain Harmon Contract offices and facilities, writing down particular assets and reorganizing the architectural metals group. The provision consisted of $2.5 million of asset write-downs plus projected cash outlays of $3.1 million. Most of the $3.1 million was planned for equipment relocation, employee severance and facility closing costs. The asset valuation component included a $1.6 million write-off of intangible assets, principally patents and non-compete agreements, which were\ndetermined to hold no future value. A facility scheduled for closure was written down by $850,000 to its estimated net realizable value.\nDespite lower interest rates, net interest expense jumped 52% to $2.7 million in fiscal 1994, as borrowing levels increased to meet significant working capital needs.\nIn the first quarter of fiscal 1994, a $525,000 gain, or 4 cents a share, was recorded to reflect the adoption of Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes (FAS 109). Under FAS 109, deferred tax liabilities declined, primarily reflecting the fact that deferred taxes on depreciation were originally booked at higher tax rates than those currently prevailing. Other deferred tax assets and liabilities were essentially unchanged.\nThe effective tax rate for fiscal 1994 was 60.9%, up from 42.3% in fiscal 1993. The rise was primarily due to low earnings relative to permanent tax-to-book differences and the increase in our deferred tax asset valuation allowance related to a capital loss carryforward.\nEquity in net earnings of affiliated companies rose 22% in fiscal 1994. Significant earnings improvement at Viratec Thin Films was somewhat offset by lower earnings at Marcon Coatings and the taxability of a portion of Marcon's and Viratec's earnings as their net operating loss carryforwards were fully utilized.\nThe provision for business restructuring and asset valuation and the poor performance of the Building Products & Services segment combined to offset the strong results of the Automotive Glass segment. Consolidated net earnings, including the FAS 109 accounting change, fell 15% to $3.8 million, or 29 cents per share, from $4.5 million, or 34 cents per share, in 1993. Return on average shareholders' equity was 3.4% compared with 4.0% in 1993.\nBuilding Products & Services Growth in overseas and domestic institutional construction coupled with high demand for architectural glass caused revenues to rise 21% for BPS. A slight improvement in architectural glass pricing was not enough to offset the highly competitive pricing of curtainwall projects. In addition, the complexity of many projects stretched the architectural metals group's ability to effectively manage its book of work and these difficult conditions contributed to erratic order flow, poor pricing and inconsistent factory utilization. Along with the high costs of international marketing and setting up overseas offices, the aforementioned factors caused the segment to record a $14.5 million operating loss, compared to a $2.4 million operating loss in fiscal 1993.\nDuring the year, BPS's Harmon Contract unit acquired majority ownership of one of Europe's leading curtainwall contracting firms, CFEM Facades (CFEM). The acquisition provided BPS with substantial backlog, manufacturing facilities and expertise in European construction techniques. CFEM generated significant sales and operating income during fiscal 1994.\nBPS achieved sharp backlog growth in 1994, finishing the year with $403 million in backlog, up 26% from 1993. The growth came from the European and Asian markets, primarily the addition of the $80 million Kuala Lumpur City Centre project in Kuala Lumpur, Malaysia. At February 26,1994, it was estimated that approximately $115 million of backlog would not be reflected as revenue in fiscal 1995.\nAutomotive Glass AG grew sales by 19% and operating income 114% in fiscal 1994. Strong demand for replacement auto glass required Curvlite, the segment's auto glass fabricating unit, to operate at near-capacity levels throughout the year. The increased volume led to sharp unit cost reduction, offsetting price weakness.\nIn fiscal 1993, the segment changed the structure of its installation and distribution businesses from a regional alignment to a national retail and wholesale business unit arrangement. This realignment helped the division capitalize on increased unit movement and firmer pricing in the auto glass market. Same-store retail sales rose 15%, reflecting industry growth and increased market penetration. The National Call Center reported a 53% jump in sales.\nThe division also increased its market penetration by adding 5 wholesale depots during the year, for a year-end total of 45 locations. At February 26, 1994, the segment also had 231 retail glass stores and 7 Midas Muffler franchises in 37 states.\nViratec Thin Films Viratec achieved both sales and earnings growth for the third consecutive year, reporting a 71% sales jump and a seven-fold increase in pre-tax earnings. Strong demand for computer anti-glare screens, particularly in overseas markets, combined with healthy margins to produce the outstanding results. Viratec's backlog increased 22% from a year earlier, to $13 million at year end.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nFinancial Condition Major balance sheet items as a percentage of total assets at February 25, 1995 and February 26, 1994 are presented below:\nNet receivables rose 14% in fiscal 1995, due to BPS's fourth quarter, 17% revenue gain. Inventories rose 27% due mainly to higher AG inventories, fueled by more wholesale depots and the proliferation in the number of auto glass parts. Costs in excess of billings more than doubled, reflecting volume growth, contract complexity and variation in stages of completion on contracts.\nTotal long-term debt, at February 25, 1995, stood at $80.6 million, up from $35.7 million a year earlier. The increase reflected working capital growth and record capital spending. During the year, Apogee expanded its revolving credit facilities to $70 million. Ten million dollars outstanding under these facilities, as well as $60 million of our short-term bank borrowings, are classified as long-term debt based on the terms of the revolving credit agreements. In fiscal 1996, we believe cash flow from operations, along with existing and reasonably available sources of financing, will enable us to maintain liquidity and continue our growth strategy.\nCapital Investment\nNew capital investment in fiscal 1995 totaled $39.6 million, versus $19.4 million and $13.6 million in fiscal 1994 and 1993, respectively. Expenditures for new property, plant and equipment totaled $25.0 million, and consisted of information systems, facility additions and manufacturing equipment additions and upgrades. We also invested $8.8 million to fund AG's acquisition of retail stores and wholesale depots.\nCapital investment for fiscal 1996 is estimated at $36 million. Further upgrading of information and communication systems and construction of a major distribution center are the primary components of AG's plan, while BPS's plans primarily consist of expenditures for capacity expansion and productivity improvements.\nShareholders' Equity\nApogee's book value rose 9% in fiscal 1995 to $124.6 million, or $9.27 per share. Net earnings less dividends, along with common stock issued in connection with long-term compensation plans, accounted for the increase. During fiscal 1995, we increased our quarterly dividend by 7%, to 8 cents per share, our 20th consecutive year of increase.\nImpact of Inflation\nApogee's financial statements are prepared on a historical cost basis, which does not completely account for the effects of inflation. However, since the cost of most of our inventories is determined using the last-in, first-out (LIFO) method of accounting, cost of sales, except for depreciation expense included therein, generally reflects current costs.\nThe cost of glass, one of Apogee's primary raw materials, increased slightly in fiscal 1995 due to strong demand from both U.S. residential construction and new car sales. We expect the cost of glass to rise moderately in fiscal 1996. Aluminum prices were volatile and rose sharply in 1995. While our construction and supply contracts are at fixed prices, the material components are usually based on firm quotes obtained from suppliers. Labor cost increases, including taxes and fringe benefits, can be reasonably anticipated. Through new efficiencies and cost containment programs set up at most operating units, many selling, general and administrative expenses were reduced or held relatively constant.\nOUTLOOK - -------\nWe believe that improving market conditions for nonresidential construction and steady demand for automotive replacement glass will allow Apogee to improve earnings in fiscal 1996. Better project selection and management, continued cost containment programs and efficiencies and competitive advantages from information management technology should also contribute to earnings growth.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe information called for by this Item is contained in a separate section of this report. See \"Index of Financial Statements and Schedules\".\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nNone.\nPART III --------\nITEMS 10, 11, 12 and 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; --------------------------------------------------- EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL ---------------------------------------------------------------- OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED ------------------------------------------------------------ TRANSACTIONS. ------------\nThe information required by these Items, other than the information set forth above in \"Executive Officers of the Registrant,\" is included on pages 1 to 10 of the Proxy Statement for the Annual Meeting of Shareholders to be held June 20, 1995, which is incorporated herein by reference.\nPART IV -------\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ----------------------------------------------------------------\n(a) and (d) Financial Statements and Financial Statement Schedules -\nThe consolidated financial statements and schedules of the Registrant listed on the accompanying \"Index to Financial Statements and Schedules\" together with the report of KPMG Peat Marwick LLP, independent auditors, are filed as part of this report.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended February 25, 1995.\n(c) Exhibits -\nThe information called for by this Item is contained in a separate section of this report. See \"Exhibit Index\".\n- SIGNATURES -\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: May 24, 1995 APOGEE ENTERPRISES, INC.\nBy: \/s\/ Donald W. Goldfus ------------------------------ Donald W. Goldfus Chairman of the Board of Directors and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE - -------------------------------------------------------------\nChairman of the Board of Directors and \/s\/ Donald W. Goldfus Chief Executive Officer May 24, 1995 - ---------------------------- ----------------------------- ---------------- Donald W. Goldfus\n\/s\/ Gerald K. Anderson President and Director May 24, 1995 - ---------------------------- ----------------------------- ---------------- Gerald K. Anderson\n\/s\/ Laurence J. Niederhofer Director May 24, 1995 - ---------------------------- ------------------------------ ----------------- Laurence J. Niederhofer\n\/s\/ James L. Martineau Vice President and Director May 24, 1995 - ---------------------------- ------------------------------ ---------------- James L. Martineau\n\/s\/ D. Eugene Nugent Director May 24, 1995 - ---------------------------- ------------------------------ ---------------- D. Eugene Nugent\n\/s\/ Richard Gould Senior Vice President May 24, 1995 - --------------------------- ------------------------------ ----------------\n\/s\/ William G. Gardner Treasurer and Secretary May 24, 1995 - ---------------------------- ------------------------------- ---------------- William G. Gardner\n\/s\/ Terry L. Hall Chief Financial Officer May 24, 1995 - ---------------------------- -------------------------------- ---------------- Terry L. Hall\nAPOGEE ENTERPRISES, INC. FORM 10-K ITEMS 8, 14(A) AND 14(D)\nINDEX OF FINANCIAL STATEMENTS AND SCHEDULES\nAll other schedules are omitted because they are not required, or because the required information is included in the consolidated financial statements or noted thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Apogee Enterprises, Inc.:\nWe have audited the consolidated financial statements of Apogee Enterprises, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility or 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 Apogee Enterprises, Inc. and subsidiaries as of February 25, 1995 and February 26, 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended February 25, 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 notes 1 and 9, the company changed its method of accounting for income taxes in fiscal 1994 to adopt the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.\nKPMG Peat Marwick LLP\nMinneapolis, Minnesota April 21, 1995\nCONSOLIDATED BALANCE SHEETS APOGEE ENTERPRISES, INC.\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED RESULTS OF OPERATIONS APOGEE ENTERPRISES, INC.\nSee accompanying notes to consolidated financial statements.\nQUARTERLY DATA (UNAUDITED) (Dollar amounts in thousands, except per share data)\nNET SALES GROSS PROFIT\nNET EARNINGS (LOSS) EARNINGS (LOSS) PER SHARE\n*During the first quarter of 1994, Apogee adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The cumulative effect of the change in accounting for income taxes increased net earnings by $525,000, or 4 cents per share, and is included in fiscal 1994 figures.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Apogee Enterprises, Inc.\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Apogee Enterprises, Inc.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA\nPRINCIPLES OF CONSOLIDATION Our consolidated financial statements include the accounts of Apogee and all majority-owned subsidiaries. We use the equity method to account for our 50%-owned joint ventures. Intercompany transactions have been eliminated. Certain amounts from prior-years financial statements have been reclassified to conform with this year's presentation.\nCASH AND CASH EQUIVALENTS Investments with an original maturity of three months or less are included in cash and cash equivalents. Restricted funds represent collateral for outstanding bank guarantees required by certain construction contracts' terms.\nINVENTORIES Inventories, which consist primarily of purchased glass and aluminum, are valued at cost, principally by using the last-in, first-out (LIFO) method, which does not exceed market. If the first-in, first-out (FIFO) method had been used, our inventories would have been $2,700,000 and $1,825,000 higher than reported at February 25, 1995 and February 26, 1994, respectively.\nPROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are carried at cost. Significant improvements and renewals are capitalized. Repairs and maintenance are charged to expense as incurred. Apogee computes depreciation on a straight-line basis, based on estimated useful lives of 20 to 40 years for buildings and 2 to 15 years for equipment. When property is retired or otherwise disposed of, the cost and related depreciation are removed from the accounts and related gains or losses are included in income.\nINTANGIBLE ASSETS AND AMORTIZATION Intangible assets consist principally of goodwill and non-compete agreements. We review the ongoing value of intangibles on an annual basis. The continuing benefit of such assets is evaluated based upon an assessment of relevant economic and other criteria, including projections of future results. Goodwill is the excess of cost over the fair value of acquired assets of purchased businesses. Goodwill is amortized over periods ranging from 10 to 40 years, except for $923,000, which is not being amortized. In our opinion, there has been no diminution of its value. Non-compete agreements are contracts with the previous management of purchased businesses not to enter into competition with us for a certain period of time. Non-compete agreements are amortized ratably over the term of the agreements. Amortization expense amounted to $288,000, $2,328,000 and $2,123,000 in 1995, 1994 and 1993, respectively.\nOTHER LONG-TERM LIABILITIES Other long-term liabilities include deferred compensation and the long-term portion of accrued insurance costs.\nREVENUE RECOGNITION We recognize revenue from construction contracts on a percentage-of-completion basis, measured by the percentage of costs incurred to date to estimated total costs for each contract. Contract costs include materials, labor and other direct costs related to contract performance. We establish provisions for estimated losses, if any, on uncompleted contracts in the period in which such losses are determined. Revenue from the sale of products and the related cost of sales are recorded upon shipment.\nINCOME TAXES Apogee files a consolidated federal income tax return. Effective February 28, 1993, Apogee adopted the provisions of Statement of Financial Accounting Standards No. 109 (FAS 109). FAS 109 requires the asset and liability method be used to account for income taxes. This method recognizes deferred tax assets and liabilities based upon the future tax consequences of temporary differences between financial and tax reporting. Previously, Apogee followed the provisions of Accounting Principles Board Opinion No. 11. The cumulative effect of the change in accounting for income taxes is included in the fiscal 1994 Consolidated Results of Operations.\nEARNINGS PER SHARE Apogee computes earnings per share by dividing net earnings by the weighted average number of common shares and common share equivalents outstanding during the year. Our average common shares and common share equivalents outstanding during 1995, 1994 and 1993 were 13,501,000, 13,289,000 and 13,293,000, respectively.\nTRANSLATION OF FOREIGN CURRENCIES The financial statements of our foreign operations have been translated to U.S. dollars, using the rules of Statement of Financial Accounting Standard No. 52. Balance sheet accounts are stated in U.S. dollars at either the year- end or historical exchange rate. Results of operations are translated at average exchange rates for the respective period.\nACCOUNTING PERIOD Apogee's fiscal year ends on the Saturday closest to February 28. Interim quarters end on the Saturday closest to the end of the months of May, August and November.\nApogee provides products and services to the commercial and institutional new construction and remodeling markets, the automotive replacement glass market and selected consumer markets. We do not believe a concentration of credit risk exists, due to the diversity of our markets and channels of distribution, and the geographic location of our customers. We perform ongoing credit evaluations of our customers' financial condition and limit the amount of credit extended when deemed necessary. We also routinely file liens to protect our interest whenever possible. We generally require no collateral. Allowances are maintained for potential credit losses and such losses have been within management's expectations. The provision for bad debt expense was $3,817,000, $2,388,000 and $2,061,000 in 1995, 1994 and 1993, respectively.\nDepreciation expense was $14,903,000, $13,397,000 and $12,987,000 in 1995, 1994 and 1993, respectively.\nLong-term debt maturities are as follows:\nThe terms of the 9.65% promissory note include certain dividend and debt level restrictions and requirements to maintain minimum levels of tangible net worth and certain financial ratios. Retained earnings available for dividends under the terms of the promissory note were approximately $35 million at February 25, 1995.\nAt February 25, 1995, we were party to revolving credit agreements with four banks. The agreements allow us to borrow up to $70 million at fixed or floating rates tied to the banks' cost of funds. The revolving credit terms will expire in March 1996 and March 1997. Through March 1996, we can convert $50 million of the outstanding loans into a three-year term loan. The agreements require us to maintain minimum levels of tangible net worth and certain financial ratios. At February 25, 1995, there were $10 million of borrowings outstanding under the committed credit facilities.\nWe also had access to short-term credit on an uncomitted basis with several major banks. At February 25, 1995, $67.1 million in bank borrowings were outstanding under these agreements. We may refinance these short-term borrowings on a long-term basis under the revolving credit agreements discussed above. Accordingly, $60 million of our short-term bank borrowings, which were not expected to be paid within one year, is classified as long-term debt, and the debt maturity schedule above is based on the terms of the revolving credit agreements. The remaining $7.1 million of short-term bank borrowings was classified as notes payable at February 25, 1995.\nInterest rates on the year-end bank under committed and uncommitted credit facilities, borrowings ranged from 6.38 % to 6.75 %.\nSelected information related to bank borrowings under credit agreements is as follows:\nIn 1992, we entered into three interest rate swap agreements with a notional amount of $25 million that effectively converted a portion of our fixed rate, long-term borrowings into variabvle rate obligations. During 1993, we sold two of the swap agreements at net gains. The gains are being recognized as reductions in interest expense through 1997. The third agreement expired in 1995.\nThe net book value of property, plant and equipment pledged as collateral under industrial development bonds was approximately $1 million at February 25, 1995.\nA class of 200,000 shares of junior preferred stock with a par value of $1.00 is authorized, but unissued.\nApogee has a Shareholders' Rights Plan, under which each share of our outstanding common stock has an associated preferred share purchase right. The rights are exercisable only under certain circumstances, including the acquisition by a person or group of 10% of the outstanding shares of the Company's common stock. Upon exercise, the rights would allow holders of such rights to purchase common stock of Apogee or an acquiring company at a discounted price, which generally would be 50% of the respective stock's current fair market value.\nInterest payments were $4,778,000, $3,714,000 and $2,556,000 in 1995, 1994 and 1993, respectively.\n9. INCOME TAXES\nAs discussed in Note 1, Apogee adopted Statement of Financial Accounting Standards No. 109 (FAS 109) in 1994. The cumulative effect of this change in accounting for income taxes is reported separately in the accompanying Consolidated Results of Operations. Financial statements for 1993 were not restated to apply the provisions of FAS 109.\nThe components of income tax expense for each of the last three fiscal years are as follows:\nIncome tax payments, net of refunds, were $5,790,000, $5,934,000 and $7,371,000 in 1995, 1994 and 1993, respectively.\nThe components of deferred income tax expense (benefit) for 1993 are as follows:\nThe differences between statutory federal tax rates and our consolidated effective tax rates are as follows:\nDeferred tax assets and deferred tax liabilities at February 25, 1995 and February 26, 1994 are as follows:\nApogee's valuation allowance increased by $318,000 in 1995 and related primarily to foreign tax credits. The valuation allowance at February 25, 1995 also included prior year amounts for foreign tax credits and a capital loss carryforward.\n10. INVESTMENT IN AFFILIATED COMPANIES\nApogee, through its Building Products and Services segment, is party to a joint venture agreement with Marvin Windows of Warroad, Minnesota, forming Marcon Coatings, Inc. and its subsidiary, Viratec Thin Films, Inc. (Marcon\/Viratec). Marcon\/Viratec operates two glass coating facilities. Our 50% ownership investment in Marcon\/Viratec is accounted for using the equity method. Apogee and Marvin have leased certain glass coating equipment to Marcon and made cash advances to Marcon\/Viratec. Our net investment in Marcon\/Viratec as of February 25, 1995, February 26, 1994 and February 27, 1993 was $14,278,000, $10,652,000 and $8,858,000, respectively. Our equity in Marcon\/Viratec's net earnings is included in the accompanying Consolidated Results of Operations. Marcon\/Viratec's net earnings for 1994 and 1993 included tax benefits from net operating loss carryforwards in the amounts of $437,000 and $1,200,000, respectively.\nA summary of assets, liabilities and results of operations for Marcon\/Viratec is presented below:\n11. EMPLOYEE BENEFIT AND STOCK OPTION PLANS\nWe maintain a qualified defined contribution pension plan that covers substantially all full-time, non-union employees. Contributions to the plan are based on a percentage of employees' base earnings. Benefits for each employee vary based on total contributions and earnings on invested funds. We deposit pension costs with the trustee annually. All pension costs were fully funded or accrued as of year end. Contributions to the plan were $3,394,000, $3,014,000 and $2,848,000 in 1995, 1994 and 1993, respectively.\nWe also maintain a 401(k) Savings Plan, which allows employees to contribute 1% to 13% of their pretax compensation. Apogee matches 30% of the first 6% of the employee contributions. Amounts contributed by us to the plan were $1,242,000, $1,206,000 and $1,069,000 in 1995, 1994 and 1993, respectively.\nThe 1987 Stock Option Plan provides for the issuance of up to 1,250,000 options to purchase company stock. Options awarded under this plan, either in the form of incentive stock options or nonstatutory options, are exercisable at an option price equal to the fair market value at the date of award. Changes in stock options outstanding for each of the last three fiscal years are as follows:\nThe 1987 Partnership Plan, a plan which is designed to increase the ownership of Apogee stock by key employees, allows participants selected by the Compensation Committee of the Board of Directors to use earned incentive compensation to purchase Apogee stock. The purchased stock is then matched by an equal award of restricted stock, which vests over a predetermined period. There are 1,100,000 shares of common stock authorized for issuance or repurchase under the plan. As of February 25, 1995, 575,000 shares have been issued under the plan. We expensed $708,000, $478,000 and $287,000 in conjunction with the Partnership Plan in 1995, 1994 and 1993, respectively.\n12. ACQUISITIONS\nIn 1995, our Automotive Glass segment purchased the assets of 16 retail auto glass stores and one distribution center in four separate transactions. The aggregate purchase price of the acquisitions was $8.8 million, including $4.6 million of cost in excess of the fair value of acquired assets. Promissory notes of $5.3 million were issued in connection with the transactions.\nIn 1994, the Building Products & Service segment's Tru Vue unit purchased the assets of a company serving another sector of the picture framing market. Also in 1994, the segment purchased certain assets of CFEM Facades, a curtainwall company based in France. In 1993, the Automotive Glass segment purchased the assets of three retail auto glass stores and two distribution centers in four separate transactions. The value of the assets acquired in 1994 and 1993 was $3.2 million and $1.7 million, respectively.\nNo liabilities were assumed in any of the transactions. All of the above transactions were accounted for by the purchase method. Accordingly, Apogee's consolidated financial statements include the net assets and results of operations from the dates of acquisition.\n13. PROVISION FOR BUSINESS RESTRUCTURING AND ASSET VALUATION\nDuring 1994, we recorded a business restructuring and asset valuation provision of $5.6 million ($4.5 million after tax) in our Building Products and Services segment. The charge was principally related to the consolidation or closing of 10 Harmon Contract offices and facilities, the write-down of certain assets and the reorganization of the architectural metals operations. The provision consisted of asset writedowns of $2.5 million and projected cash outlays of $3.1 million. At February 25, 1995, the remaining reserve for projected expenditures stood at approximately $700,000.\n14. LEASES\nAs of February 25, 1995, we were obligated under noncancelable operating leases for buildings and equipment. Certain leases provide for increased rentals based upon increases in real estate taxes or operating costs. Future minimum rental payments under noncancelable operating leases are:\nTotal rental expense was $18,242,000, $17,129,000 and 15,653,000 in 1995, 1994 and 1993, respectively.\n15. COMMITMENTS AND CONTINGENT LIABILITIES\nApogee has entered into a number of non-compete agreements. Non-compete agreements represent contractual agreements with the previous management of purchased businesses not to enter into competition with us for a certain period of time. As of February 25, 1995, we were committed to make future payments of $658,000 under such agreements.\nApogee has ongoing letters of credit related to risk management programs, construction contracts and certain industrial development bonds. The total value of letters of credit under which the company is obligated as of February 25, 1995 was approximately $53,922,000.\nApogee, like other participants in the construction business, is routinely involved in disputes and claims arising out of construction projects, sometimes involving significant monetary damages. Although it is impossible to predict the outcome of such disputes, we believe, based on facts currently available to us, that none of such claims will result in losses that would have a material adverse effect on our financial condition.\n16. FAIR VALUE DISCLOSURES\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107.\nEstimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and\/or estimating methodologies may have a material effect on the estimated fair value amounts.\nEstimated fair values of our financial instruments at February 25, 1995 are as follows:\nFor cash and cash equivalents, receivables, accounts payable and notes payable, carrying value is a reasonable estimate of fair value.\nThe carrying values (face amounts) of our long-term debt that have variable interest rates are reasonable estimates of fair value. For borrowings that have fixed interest rates, fair value is estimated by discounting the projected cash flows using the rate at which similar borrowings could currently be made.\n17. BUSINESS SEGMENTS\nSales, operating income, identifiable assets and other related data for our operations in different business segments, are listed below and are an integral part of these financial statements. Fiscal 1991 and 1992 segment data are not covered by the Independent Auditors' Report.\nBUSINESS SEGMENTS INFORMATION Apogee Enterprises, Inc.\nNotes: Apogee's Building Products & Servieces segment has subsidiaries in Europe and Asia. During 1995 and 1994, such operations had net sales of $66,580,000 and $65,021,000, respectively. Operating losses for 1995 and 1994 were $6,575,000 and $887,000 respectively. At February 25, 1995, identifiable assets of the subsidiaries totaled $41,880,000 and $31,786,000, respectively. In 1993, net sales and identifiable assets of these units were less than 10% of Apogee's consolidated figures. Foreign currency transaction gains or losses included in net earnings for 1995, 1994 and 1993 were immaterial.\nApogee's export sales are less than 10% of consolidated net sales. No single customer, including government agencies, accounts for 10% or more of consolidated net sales. Segment operating income (loss) is net sales less cost of sales and operating expenses. Operating income does not include provision for interest expense or income taxes. Corporate and other includes miscellaneous corporate activity not allocable to business segments.\nSCHEDULE II -----------\nAPOGEE ENTERPRISES, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts (In thousands)\n(1) Net of recoveries\nEXHIBIT INDEX\nExhibit (3A) Restated Articles of Incorporation Filed in Registrant's Annual Report on Form 10-K for year ended February 27, 1988.\nExhibit (3B) Restated By Laws of Apogee Enterprises, Inc., as amended to date. Filed in Registrant's Annual Report on Form 10-K for year ended February 29, 1992.\nExhibit (4A) Specimen certificate for shares of common stock of Apogee Enterprises, Inc. Filed in Registrant's Annual Report on Form 10- K for year ended February 29, 1992.\nExhibit (10A) Deferred Incentive Compensation Plan dated February 27, 1986 between Registrant and certain executive officers. Filed in Registrant's Annual Report on Form 10-K for year ended March 1, 1986.\nExhibit (10B) Amended and Restated 1987 Apogee Enterprises, Inc. Partnership Plan is incorporated by reference to Registrant's S-8 registration statement (File No. 33-60400)\nExhibit (10C) 1987 Apogee Enterprises, Inc. Stock Option Plan is incorporated by reference to Registrant's S-8 registration statement (File No. 33-35944)\nExhibit (10D) Note Agreement dated June 1, 1988 between the registrant and Teachers Insurance and Annuity Association of America ($25,000,000). Filed in Registrant's Quarterly Report on Form 10- Q for quarter ended August 27, 1988.\nExhibit (10E) Incentive Compensation Agreement between Registrant and Gerald K. Anderson dated February 23, 1987. Filed with Registrant's Annual Report on Form 10-K for year ended March 2, 1991.\nExhibit (10F) Consulting Agreement between Registrant and Gerald K. Anderson dated March 1, 1989. Filed with Registrant's Annual Report on Form 10-K for year ended March 2, 1991.\nExhibit (10G) Rights Agreement between Registrant and American Stock Transfer Co. dated October 19, 1990. Filed with Registrant's Form 8-A on October 19, 1990.\nExhibit (10H) $25 million Credit Facilities agreements between Apogee Enterprises, Inc., First Bank National Association and NBD Bank, N.A. Filed with Registrant's Annual Report on Form 10-K for year ended February 27, 1993.\nExhibit (10I) Consulting Agreement between Registrant and Laurence J. Niederhofer dated November 1, 1993. Filed with Registrant's Annual Report on Form 10-K for year ended February 26, 1994.\nExhibit (10J) Credit Agreement between Apogee Enterprises, Inc. and Credit Lyonnais Chicago Branch and Credit Lyonnais Cayman Island Branch. Filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended August 27, 1994.\nExhibit (10K) Credit Agreement between Apogee Enterprises, Inc. and The Mitsubishi Bank, Limited, Chicago Branch. Filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended November 26, 1994.\nExhibit (10I) Employment Agreement between Registrant and Richard Gould dated May 23, 1994.\nExhibit (11) Statement of Determination of Common Shares and Common Share Equivalents\nExhibit (21) Subsidiaries of the Registrant","section_15":""}
{"filename":"858661_1995.txt","cik":"858661","year":"1995","section_1":"Item 1. BUSINESS\nFidelity Leasing Income Fund VII, L.P. (the \"Fund\"), a Delaware limited partnership, was organized in 1989 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 the 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.\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 $ 388,491 1.68% Disk Storage Systems 10,937,904 47.32 Mini Computer Systems 1,018,518 4.41 Network Communications 1,037,473 4.49 Personal Computers, Terminals and Display Stations 2,708,081 11.72 Printers 3,004,564 13.00 Tape Storage Systems 1,536,906 6.65 Other 2,483,930 10.75 ___________ ______\nTotals $23,115,867 100.00% =========== ======\nBreakdown of Equipment Usage By Industrial Classification\nPurchase Price Percentage of Type of Business of Equipment Total Equipment\nComputers\/Data Processing $ 3,101,799 13.42% Diversified Financial\/ Banking\/Insurance 5,382,142 23.28 Manufacturing\/Refining 7,440,301 32.19 Retailing\/Consumer Goods 6,052,518 26.18 Telephone\/Telecommunications 1,139,107 4.93 ___________ ______\nTotals $23,115,867 100.00% =========== ======\nAverage Initial Term of Leases (in months): 38\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 2,396\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\nFidelity Leasing Income Fund VII, L.P. had revenues of $5,636,048, $8,309,679 and $9,881,829 for the years ended December 31, 1995, 1994 and 1993, respectively. Rental income from the leasing of computer equipment accounted for 94%, 91% and 92% of total revenues in 1995, 1994 and 1993, respectively. The decrease in total revenues in 1995 and 1994 is primarily attributable to the decrease in rental income. In 1995, rental income decreased by approximately $3,904,000 because of equipment that came off lease and was re-leased at lower rental rates or sold. This decrease, however, was offset by rental income of approximately $1,612,000 generated from equipment on operating leases purchased during 1995 as well as rental income earned 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 $2,740,000 due to renewals of leases at lower rates and lease termination or sales of equipment. However, this decrease was offset by approximately $1,217,000 of rental income generated from equipment purchased in 1994 as well as rental income generated from 1993 equipment purchases for which a full year of rent 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 $76,124, $447,736 and $534,307 for the years ended December 31, 1995, 1994 and 1993, respectively which also contributed to the decrease in revenues during these years.\nExpenses were $5,653,736, $7,869,432 and $9,498,292 for the twelve months ended December 31, 1995, 1994 and 1993, respectively. Depreciation and amortization comprised 75% of total expenses in 1995 and 83% of total expenses in both 1994 and 1993. The decrease in expenses in 1995 and 1994 was primarily related to a decrease in depreciation expense because of equipment which came off lease, terminated or was sold. The decrease in management fee to related party, resulting from the decrease in rental income in 1995 and 1994, also contributed to the decrease in overall expenses during these years. 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 releasing of equipment, technological developments and information provided in third party publications. In 1995, 1994 and 1993, approximately $711,000, $582,000 and $757,000, 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 sale of its rental equipment. 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. In 1995, general and administrative expenses to related party increased because of the increase in administrative expenses incurred to the General Partner which offsets the decrease in overall expenses. Furthermore, general and administrative expense decreased in 1995 but increased in 1994 because of the fluctuation in equipment remarketing expenses incurred for these periods.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nThe Fund's net income (loss) was ($17,688), $440,247 and $383,537 for the years ended December 31, 1995, 1994 and 1993, respectively. The earnings (loss) per equivalent limited partnership unit, after earnings (loss) allocated to the General Partner, were ($0.50), $9.16 and $6.08 based on a weighted average number of equivalent limited partnership units outstanding of 35,095, 43,457 and 54,121 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Fund generated funds from operations, of $4,852,588, $7,077,709 and $8,528,294 for the purpose of determining cash available for distribution, and distributed 74%, 54% and 60% of these amounts to partners in 1995, 1994 and 1993, respectively, and 0%, 5% and 4% of these amounts to partners in January 1996, 1995 and 1994, respectively. 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 continues 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 $4,514,330, $5,711,158, and $4,357,021 respectively, of equipment.\nSubsequent to December 31, 1995, the Fund purchased $173,000 of computer peripheral equipment subject to an operating lease.\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 AND 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. 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 $289,802(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 1989, 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 1% of cash distributions until the Limited Partners have received an amount equal to the purchase price of their Units plus a 12% 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 $255,245 of management fees by the General Partner. The General Partner will continue to receive 5% or 2% of rental payments on equipment under operating and full pay-out leases, respectively, for administrative and management services performed on behalf of the Fund. Full pay-out leases are noncancellable leases for which rental payments due during the initial term of the leases are at least sufficient to recover the purchase price of the equipment, including acquisition fees. This management fee is paid monthly only if and when the Limited Partners have received distributions for the period from January 1, 1991 through the end of the most recent quarter equal to a return for such period at a rate of 12% per year on the aggregate amount paid for their units.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nThe General Partner also receives 1% of cash distributions until the Limited Partners have received an amount equal to the purchase price of their Units plus a 12% cumulative compounded Priority Return. Thereafter, the General Partner will receive 10% of cash distributions. During the year ended December 31, 1995, the General Partner received $35,771 of cash distributions.\nThe Fund incurred $360,832 of reimbursable costs to the General Partner for services and materials provided in connection with the administration of the Fund during 1995.\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 12% cumulative compounded Priority Return. During 1995, the Fund incurred a sales fee of $34,557 to the General Partner for services performed in connection with the disposition of equipment in 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 VII, L.P. A Delaware limited partnership\nBy: FIDELITY LEASING CORPORATION\nFreddie M. Kotek, Chairman 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 VII, L.P.\nWe have audited the accompanying balance sheets of Fidelity Leasing Income Fund VII, 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 VII, 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 VII, L.P.\nBALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND VII, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND VII, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND VII, L.P.\nFIDELITY LEASING INCOME FUND VII, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nFidelity Leasing Income Fund VII, L.P. (the \"Fund\") was formed in November 1989 with Fidelity Leasing Corporation (\"FLC\") as the General Partner. FLC is a wholly owned subsidiary of FML Leasehold Inc., a wholly owned subsidiary of The Fidelity Mutual Life Insurance Company (in Rehabilitation). 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 equipment, primarily 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's investment securities consist of U.S. Government Securities and certificates of deposit with maturities of less than thirteen months and cost approximates market. The adoption of this new standard had no 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 receivable 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 VII, 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.\nOrganization Costs\nOrganization costs were amortized over a five year period.\nAccounting for Leases\nThe Fund's leasing operations consist primarily of operating leases whereby 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 plus deferred revenue recognized. 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.\nThe Fund does have direct financing leases, as well. Under the direct financing method, income (the excess of the aggregate future rentals and estimated additional amounts recoverable upon expiration of the lease over the related equipment cost) is recognized over the life of the lease using the interest method.\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.\nFIDELITY LEASING INCOME FUND VII, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 semiannually. 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 party publications. Based upon this review, the Fund recorded an adjustment of approximately $435,000, $432,000 and $757,000 or $12.39 $9.94 and $13.99 per equivalent limited partnership unit to write down its rental equipment in the fourth quarter of 1995, 1994 and 1993, respectively.\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, if any, are made monthly as follows: 99% to the Limited Partners and 1% to the General Partner, until the Limited Partners have received an amount equal to the purchase price of their Units, plus a 12% compounded Priority Return (an amount equal to 12% 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.\nFIDELITY LEASING INCOME FUND VII, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\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 16 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 $711,000, $582,000 and $757,000, 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.\nDuring the year ended December 31, 1995, the Fund leased equipment under the direct financing method in accordance with SFAS No. 13. This method provides for recognition of income (the excess of the aggregate future rentals and estimated additional amounts recoverable upon expiration of the lease over the related equipment cost) over the life of the lease using the interest method.\nThe net investment in direct financing leases as of December 31, 1995 is as follows:\nNet minimum lease payments to be received $ 45,484 Less unearned income 6,523 Add expected future residuals - ________ $ 38,961 ========\nThe future approximate minimum rentals to be received on non- cancelable operating and direct financing leases as of December 31 are as follows:\nDirect Operating Financing\n1996 $4,089,000 $13,000 1997 2,465,000 13,000 1998 783,000 13,000 1999 268,000 6,000 Thereafter 112,000 - __________ _______\n$7,717,000 $45,000 ========== =======\nFIDELITY LEASING INCOME FUND VII, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n4. EQUIPMENT LEASED (Continued)\nSubsequent to December 31, 1995, the Fund purchased $173,000 of equipment subject to operating leases with initial lease terms of 20 to 36 months. The future approximate minimum rentals to be received on these noncancellable operating leases are $83,000 in 1996, $77,000 in 1997, $64,000 in 1998 and $5,000 in 1999.\n5. RELATED PARTY TRANSACTIONS\nThe General Partner receives 5% or 2% 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 for which rental payments during the initial term are at least sufficient to recover the purchase price of the equipment, including acquisition fees. This management fee is paid monthly only if and when the Limited Partners have received distributions for the period form January 1, 1991 through the end of the most recent quarter equal to a return for such period at a rate of 12% per year on the aggregate amount paid for their units.\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 12% cumulative compounded Priority Return.\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 $255,245 $352,997 $421,833 Reimbursable costs 360,832 290,813 290,053 Sales fee 34,557 52,226 60,632\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 VII, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n6. MAJOR CUSTOMERS\nFor the year ended December 31, 1995, two customers accounted for approximately 20% and 16% of the Fund's rental income. For the year ended December 31, 1994, one customer accounted for approximately 11% of the Fund's rental income. For the year ended December 31, 1993, two customers accounted for approximately 14% and 13% of the Fund's rental income.\n7. CASH DISTRIBUTIONS\nBelow is a summary of the cash distributions paid to partners during the years ended December 31:","section_15":""}
{"filename":"832177_1995.txt","cik":"832177","year":"1995","section_1":"ITEM 1. BUSINESS\nRiser Foods, Inc. (\"Riser\" or the \"Company\") was incorporated under the laws of the State of Delaware on December 18, 1987. The Company and its subsidiaries are engaged in the distribution of groceries and related items through its retail supermarket subsidiary, Rini-Rego Supermarkets, Inc., and its wholesale subsidiary, American Seaway Foods, Inc. All references to Riser or the Company include Riser and its consolidated subsidiaries.\nRetail Supermarket Operations - -----------------------------\nAs of July 1, 1995, the Company operated 38 retail supermarkets in the greater Cleveland area, 33 of which operate under the conventional \"Rini-Rego Stop-N-Shop\" format, and five of which operate under the updated and expanded \"Rini-Rego Stop-N-Shop Marketplace\" format.\nThe Company's merchandising strategy is to offer a broad selection of quality products at competitive prices with an emphasis on superior customer service, quality and convenience. The Company sells most nationally known brands of merchandise, regional brands and a variety of private label products. The private label products are generally sold at prices lower than those of nationally known products.\nThe Company's retail stores offer a large selection of food items, including dry groceries, meat, dairy, produce, frozen foods, deli products and baked goods, as well as a number of non-food items such as greeting cards and health and beauty care items. Certain of the Company's stores also contain specialty departments such as \"fresh to go\" prepared foods, service meat, service seafood, floral and general merchandise departments. Services, which include pharmacies, banking and debit and credit card payment options, are also available in certain locations.\nDuring the fiscal year ended July 2, 1994 (the \"1994 Fiscal Year\"), the Company introduced its \"Marketplace\" format with the opening of three new or expanded supermarket locations. The Company's Marketplace stores are larger than the Company's conventional stores, ranging in size from approximately 60,000 to 70,000 square feet, and feature updated decor packages and fixturing with broader selections of traditional merchandise and additional emphasis on fresh, high quality perishables, prepared food items and a variety of service departments such as one-hour photo processing and full service in-store banking. During the fiscal year ended July 1, 1995 (the \"1995 Fiscal Year\"), the Company converted two of its conventional stores to the Marketplace format and expanded and remodeled two of its conventional stores.\nAdvertising and promotion are important factors in the Company's merchandising strategy. All of the Company's stores are affiliated with the Association of Stop-N-Shop Supermarkets, an association of independent grocery retailers established as a cooperative advertising and purchasing organization (the \"Association\"). The Association advertises in newspapers, circulars, and television and radio advertising comparable to the other supermarket companies which operate in the northeast Ohio market area. This advertising generally features high demand products at competitive prices. During the 1995 Fiscal Year, the Association introduced the Preferred Shoppers Club program, which is a free membership club that offers special values to member-customers and, in the future, will allow the Company to focus on specific customer segments and better understand household buying behavior.\nWholesale Operations - --------------------\nThe Company operates one of the largest wholesale grocery distribution operations in the Midwest doing business as \"Seaway\". The Company supplies national brand, regional brand and private label products to Company-operated retail stores, other independently-operated retail grocery chains and independent grocers, primarily in northeastern Ohio, and to a lesser extent, in central Ohio, western Pennsylvania and southeastern Michigan. During the 1995 Fiscal Year, in connection with the Company's expansion of its wholesale operations into the greater Detroit metropolitan area, the Company opened a sales office in a suburb of Detroit.\nThe Company is continually in the process of expanding its wholesale customer base by upgrading its available product lines to include a wider assortment of grocery, frozen foods, dairy, meat, produce and bakery items. The Company offers its wholesale customers a wide variety of operational support services which include advertising, promotion, marketing and merchandising services, retail operations counseling, and technical and information systems support. In addition, the Company assists wholesale customers in the upgrading and\/or enlarging of their stores by providing inventory and equipment financing, store layout, equipment planning and design, and engineering and construction services.\nThe Company utilizes an on-line computerized buying and inventory control system for the purchase and sale of its inventory. The Company purchases the majority of its products from large, national manufacturers of consumer foods and grocery-related products and the remainder of its products from several other suppliers. The Company is also a member of various purchasing cooperatives which provide the Company with enhanced purchasing opportunities and assistance with the development of its private label program.\nThe Company operates its own health and beauty care\/general merchandise (\"HBC\/GM\") distribution facility which supplies Company-operated retail stores, other independently-operated retail grocery chains, independent grocers, a deep discount drug chain and a mass merchandising chain. The Company also operates the Eagle Ice Cream Company, which manufactures branded ice cream and distributes purchased ice cream and novelty products to Company-operated retail stores, other independently-operated retail grocery chains, independent stores and a national food service distribution company.\nConsistent with the industry practices of other food distribution retailers and wholesalers, the Company maintains inventory levels at its distribution centers and retail locations at levels which minimize out of stock products for its customers. The Company permits the return of damaged or defective products from customers.\nCompetition - -----------\nThe supermarket industry is highly competitive and may be affected by general economic conditions. During the past several years, competition in the northeast Ohio market area has been extremely intense due in part to a stagnant or declining consumer population and the entry of a number of significant new competitors. The Company estimates that it is one of the largest retailers, in terms of grocery sales, in the northeast Ohio market area.\nCompany-operated retail stores primarily compete with regional supermarket chains and voluntary supermarket associations. The Company also competes with general merchandise stores that also sell grocery products, warehouse\/wholesale clubs, convenience stores and deep discount drug stores. The principal areas of competition pertain to price, selection and quality of perishables and other food products, customer service, store condition and store location. These companies compete with the Company's stores at the retail level and the Company's wholesale customers at the wholesale level.\nSince demographic trends reflect a shift in consumer population from those heavy-industry based regions of the U.S., like northeast Ohio, to service oriented and sun-belt regions, the Company must continually emphasize customer service and value to maintain its market share and compensate for the lack of population growth in the Company's market area.\nThe wholesale food distribution industry is also highly competitive in the market area served by the Company. Management believes that the principal competitive factors include price, breadth of product line and the availability of support services to its wholesale customers. The Company competes directly with regional and national wholesalers.\nSeasonality and Regulation - --------------------------\nThe Company's business is generally not seasonal in nature. The Company anticipates that its compliance with federal, state and local laws relating to the protection of the environment has not had and is not expected to have a significant effect on the Company's capital expenditures, earnings or competitive position.\nCustomers and Suppliers - -----------------------\nNo single customer or group of customers under common control accounted for 10% or more of the Company's consolidated revenues for the 1995 Fiscal Year. Groceries, general merchandise and raw materials are generally available from many sources.\nEmployees - ---------\nAs of July 1, 1995, the Company employed approximately 5,300 persons, on both a full and part-time basis. The majority of the Company's work force is unionized and are members of either the United Food and Commercial Workers Union, Local No. 880 (retail) (\"Local 880\") or the International Brotherhood of Teamsters, Local No. 507 (wholesale) (\"Local 507\"). The Company's contract with Local 880, which is negotiated through the Cleveland Food Industry Committee whose members include other members of the Stop-N-Shop Association and the Company's primary competitors, First National Supermarkets, Inc. and Heinen's, is in effect until September 8, 1996. The Company's contract with Local 507 is in effect until April 1, 1998.\nCorporate Background - --------------------\nRiser was formed to act as the parent holding company in connection with the combination of Fisher Foods, Inc. (\"Fisher\"), Rini Holding Company (\"Rini\"), Rego Supermarkets, Inc. (\"Rego\"), and American Seaway Foods, Inc. and two of its affiliated partnerships (collectively, \"Seaway\"), through the exchange of Riser stock for the stock of Fisher, Rini, Rego and Seaway, and a merger which was effective June 8, 1988 (the \"Combination\"). Following the Combination, the Company consolidated the wholesale operations of Seaway and Fisher into one operating unit and consolidated its retail operations through the merger of Rini and Rego into Fisher and changed Fisher's name to Rini-Rego Supermarkets, Inc.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRiser owns a warehouse and office facility in Bedford Heights, Ohio containing approximately 850,000 square feet which serves as the Company's corporate headquarters and principal distribution center. The Company also owns the following properties: a warehouse, office facility and garage in Maple Heights, Ohio containing approximately 356,000 square feet, approximately 349,000 square feet of which is used in its HBC\/GM operations and approximately 7,000 square feet is subleased to an unaffiliated company; a warehouse facility in Bedford Heights, Ohio containing approximately 305,000 square feet, all of which is subleased to three unaffiliated parties; a warehouse and office facility in Cuyahoga Heights, Ohio containing approximately 187,000 square feet of which approximately 140,000 square feet is leased to others and the remainder is used in its wholesale operations; a warehouse facility in Cleveland, Ohio containing approximately 29,100 square feet which is used in its wholesale operations; and an ice cream plant in Bedford, Ohio containing approximately 39,000 square feet.\nFive retail store properties are owned by the Company through its Rini-Rego Supermarkets, Inc. subsidiary, three of which are used in its retail operations and two of which are subleased to unaffiliated parties. Most of the Company's leased properties are under long-term leases of varying terms, the majority of which obligate the Company to pay certain increases in property taxes and insurance and to pay additional rent based on a percentage of sales at that particular location. As of July 1, 1995, the aggregate minimum annual rentals of all operating and capital leases with initial noncancellable terms of more than one year were approximately $15,723,000.\nIn July 1995, pursuant to put options contained in leases with Seaway Development Company (\"Seaway Development\"), the Company was required to purchase two buildings which it had been leasing at a purchase price of $6,000,000. Seaway Development is an Ohio general partnership whose partners were shareholders of Seaway prior to the Combination. During the 1995 Fiscal Year, an unaffiliated Company which had been leasing a warehouse facility from the Company exercised its option to purchase this building for $1,580,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no pending legal proceedings to which the Company 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\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 Class A Common Stock is traded on the American Stock Exchange. There is no established public trading market for the Company's Class B Common Stock.\nInformation regarding the quarterly price of the Company's Class A Common Stock for the fiscal years ended July 1, 1995 and July 2, 1994 is set forth below:\nStockholders - ------------\nAs of September 8, 1995 there were 1,072 stockholders of record of the Company's Class A Common Stock and 28 stockholders of record of the Company's Class B Common Stock.\nDividends - ---------\nOn September 8, 1995, the Board of Directors declared an initial regular quarterly dividend of $.05 per share on each outstanding share of its Class A Common Stock and Class B Common Stock payable on October 10, 1995 to shareholders of record at the close of business on September 29, 1995. The declaration and payment of dividends is subject to the discretion of the Company's Board of Directors, and there can be no assurance that dividends will be paid in the future. In determining whether to pay dividends (as well as the amount and timing thereof), the Board of Directors considers a number of factors, including the Company's results of operations, financial condition and capital and surplus requirements. The payment of dividends on the Company's common stock is limited by the Company's credit facility to $2,424,000, $2,828,000 and $3,232,000 during the fiscal years ending in 1996, 1997 and 1998, respectively. The payment of dividends is prohibited if the Company does not meet certain financial and other covenants contained in the credit facility.\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\nThe following table sets forth items from the Company's Consolidated Statements of Income as a percentage of net sales:\nThe results of operations for the fiscal year ended July 1, 1995 reflect the successful implementation of strategic initiatives which were designed to improve operating performance and counter competitive and economic pressures. The food distribution industry has encountered little or no inflation over the past three years while operating costs, particularly labor and occupancy, have contractually risen. The industry has also experienced increased competition from non-traditional sources, such as convenience stores and national mass merchandising chains, that has unfavorably impacted overall industry sales and operating margins.\nNet Sales - ---------\nNet sales increased 5.7% to $1.185 billion in 1995, 1.2% to $1.122 billion in 1994 and 13.2% to $1.108 billion in 1993. This trend of sales increases over that of the prior year is the result of strategic initiatives to remodel and reposition Company-operated retail stores, aggressive merchandising in Company-operated stores, expansion of the product lines offered to its independently-operated wholesale customers and an improved economic climate in the Company's primary market area. Additionally, 1995 sales were favorably impacted by a full fifty-two weeks of operations of the\nCompany's Health and Beauty Care\/General Merchandise (HBC\/GM) distribution facility which was acquired in 1994. Sales in 1993 included an extra week of sales, including two Fourth of July sell weeks.\nThe Company's strategic initiatives to remodel and reposition Company-operated retail stores have resulted in the consolidation of Company-operated retail stores. The following table details the number and format of the Company-operated retail stores between years:\nDuring 1995, sales in Company-operated retail stores increased 8.0% over the prior year as same store sales increases of 9.1% more than offset sales reductions resulting from fewer Company-operated retail stores. Adjusted for the 53rd week of sales in 1993, total sales in Company-operated retail stores declined 5.4% in 1994 and 5.3% in 1993. Declines in 1994 and 1993 were attributed to a reduction in the number of Company-operated retail stores between years coupled with declining same store sales of .4% in 1994 and 2.6% in 1993. The reversal of same store sales declines in 1995 was attributed to the Company's retail remodeling and repositioning programs, aggressive merchandising, which included the introduction of the Company's Preferred Shoppers Club, and an improved economic climate. Additionally, the loss of sales associated with the closing of nine Company-operated stores between 1995 and 1994 was offset by the addition of two newer, larger Company-operated retail stores in May 1994.\nThe Company's retail remodeling and repositioning initiatives, where certain non-core stores were closed and certain core stores were remodeled, expanded or consolidated into larger retail facilities, has proven successful, yielding continued sales growth and improved operating leverage. Since the first quarter of 1994, the Company has constructed or converted five former Rini-Rego Stop-N-Shop stores to its Marketplace format. The Marketplace stores are larger, containing approximately 65,000 square feet, and meet the consumer's basic grocery needs while offering an expanded product line, with emphasis on high quality perishable departments and a variety of full service, consumer-oriented departments.\nDuring 1995, the Association of Stop-N-Shop Supermarkets, a northeast Ohio advertising cooperative which includes all Company-operated retail stores, introduced a new target marketing campaign, the Preferred Shoppers Club. Participating shoppers receive a Preferred Shoppers Club card which entitles them to extra markdowns below weekly sales prices. This program was the first of its kind in northeast Ohio and allows the Company to offer its customers greater value and will ultimately enhance the Company's ability to track customer purchasing habits and preferences. The success of this program has increased sales in Company-operated retail stores and proven a valuable merchandising tool to combat competitive pressures from both traditional and non-traditional grocery retailers.\nAfter adjusting for the 53rd week of sales in 1993, sales to independently-operated retail stores continued the trend of increased sales over that of the prior year with increases of 3.4% in 1995, 13.9% in 1994 and 40.3% in 1993. The large sales increase in 1993 was primarily attributed to new customers gained as a result of a major competitor closing its northeast Ohio distribution center in the Spring of 1992. The acquisition of an HBC\/GM distribution facility from the Company's former HBC\/GM supplier increased sales in 1994. Fiscal 1995 sales continued to benefit from these acquisitions as well as the improving economic climate which, in turn, increased sales to independently-operated retail stores.\nThe Company has continued to increase its wholesale sales penetration to existing customers, primarily in the perishable and HBC\/GM product lines. The Company continues to evaluate other markets outside its primary market area for potential distribution opportunities. As part of the acquisition of its HBC\/GM distribution facility, the Company began servicing approximately 150 Hills Department Stores throughout the eastern third of the United States during 1994. The Company also opened a sales office in the Detroit area in 1995 focusing on meat distribution and has recently began servicing a regional discount drug chain in Ohio and Pennsylvania.\nTotal Company sales also benefited from an improved economy in the Company's primary market area. The economy in northeast Ohio, which was stagnant in 1993 and 1994, began to expand early in 1995 and continued to improve throughout the fiscal year. The improved economic climate combined with the Company's merchandising programs in Company-operated retail stores resulted in consumers increasing their average purchase and trading-up in many commodity lines.\nGross Profit - ------------\nGross profits, as a percentage of sales, increased from 19.53% in 1993 and 19.27% in 1994 to 19.79% in 1995. The fluctuation in the gross profit percentage is principally a function of the\nshifting sales mix between years. Sales to independently-operated retail stores carry a lower gross profit percentage than sales in Company-operated retail stores. As such, a shift in the mix of these sales impacts gross profit percentages. Sales generated in Company-operated retail stores as percentage of total Company sales decreased from 55.3% in 1993 to 50.6% in 1994 and then increased to 51.7% in 1995. This mirrors the shift in the gross profit percentage.\nSelling, General And Administrative (SG&A) Expenses - ---------------------------------------------------\nSG&A expenses, as a percentage of sales, were 17.60% in 1995, 17.35% in 1994 and 17.60% in 1993. These shifts also reflect the change in the sales mix between years. Sales shifted in 1995 to more sales from Company-operated retail stores, which require higher SG&A costs than sales to independently-operated retail stores. Accordingly, the SG&A percentage increased with the sales mix. The Company minimized the 1995 increase in the SG&A percentage through improved productivity resulting from the implementation of Total Quality Management initiatives. The decline of the SG&A percentage from 1993 to 1994 was also impacted by the closing of seven underperforming Company-operated retail stores which operated at relatively higher SG&A percentages. Their disposition, and the change in sales mix, helped offset contractual increases in labor and occupancy costs in remaining Company-operated retail stores.\nRestructuring Charge - --------------------\nThe Company recorded restructuring charges in 1994 and 1993 reflecting costs associated with the Company's long range strategic initiatives to reposition its Company-operated retail store operations. These initiatives include the disposition of non-core stores and the consolidation of certain Company-operated retail store locations into larger retail facilities. The Company utilized $1.2 million of cash for its restructuring charges in 1995.\nIn 1994, the Company recorded a $12 million restructuring charge which included a $4 million non-cash charge to write down fixed assets to their net realizable value and an $8 million charge for future cash expenditures, principally occupancy costs net of expected sublease income, related to the closing of thirteen Company-operated retail stores. The Company closed five of these stores in fiscal 1994, four of these stores in 1995 and plans to close four additional Company-operated retail stores over the next three to four years. The Company plans to operate approximately 35 to 38 expanded or newly remodeled Company-operated retail stores by the end of 1998, which is expected to result in a limited reduction of overall employee levels.\nThe $5 million restructuring charge recorded in 1993 reflected\nthe Company's plan to dispose of five non-core stores in the Akron\/Canton market and two other non-core stores. The 1993 charge included a $1.8 million non-cash charge to write down fixed assets to their net realizable value and a $3.8 million charge for future cash expenditures, principally occupancy costs net of expected sublease income and pension withdrawal liabilities. Overall, employee levels were reduced as a result of the Company's decision to exit the Akron\/Canton market.\nTaken as a whole, the Company's restructuring charges reflect the Company's overall plan to reposition its Company-operated retail stores, focusing on its core-store format: Rini-Rego Stop-N-Shop. The Company does not currently anticipate any future restructuring charges.\nInterest Expense, Net - ---------------------\nInterest expense, net of interest income, decreased $465,000 in 1995 to $6.5 million, after increasing $646,000 to $7.0 million in 1994 and $82,000 to $6.4 million in 1993. The 1995 decrease is a function of lower borrowing levels under the Company's bank credit facilities resulting from programs to reduce the investment in distribution inventories and increase inventory turns. Lower debt levels were partially offset by an increase in the Company's average interest rate charged under its bank credit facilities from 6.57% in 1993 to 6.74% in 1994 to 8.68% in 1995. These increases are a function of increases in the Bank's Prime Lending Rate. Increases in interest expense in 1994 and 1993 were a function of increased borrowings required to fund planned capital expenditures associated with the Company's remodeling programs. The Company earned .25% interest rate reductions in each of 1993 and 1994. The Company currently borrows funds under its bank credit facilities at either .25% over the Bank's Prime Lending Rate or 2.5% over LIBOR.\nIncome Taxes - ------------\nThe Company provided income taxes at an effective tax rate of 40.3% in 1995, 37.0% in 1994 and 38.3% in 1993. The increase in the Company's effective tax rate in 1995 represents a higher provision for federal income taxes as a result of the Company being taxed at a higher federal tax rate and a higher state income tax provision because of higher book income. The decrease in 1994 was the result of a lower provision for state income taxes due to lower book income. The Company accounts for the franchise tax portion of its state income tax provision as an operating expense.\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109) in 1994. The Company elected not to restate prior year's financial statements and recorded the cumulative effect of the accounting change. As a result, the Company recorded a one-time income item of $6.9 million to reflect the cumulative effect of the\nchange in accounting for income taxes in 1994. The one-time income item was principally the result of benefiting the expected utilization of net operating loss carryforwards (NOL) and the adjustment of deferred tax balances to reflect changes in statutory rates. The Company recorded an extraordinary income item of $253,000 in 1993 benefiting a portion of its pre-acquisition NOL. See Note 4 of the Notes to Consolidated Financial Statements for further discussion.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's primary source of capital has historically come from internally generated funds. However, the Company's intensified capital expenditure requirements and higher working capital needs associated with the acquisition of its HBC\/GM distribution facility increased the Company's reliance on its bank credit facilities in 1994. During 1995, debt levels decreased due to the increase in cash generated by operating activities, an increase in the distribution inventory turns and reduced working capital requirements.\nOperating activities generated $46.8 million of cash in 1995 compared to $13.6 million in 1994 and $16.5 million in 1993. The success of Company programs to lower distribution inventories and increase inventory turns, resulted in a greater percentage of 1995 distribution inventories being financed through trade accounts payable, without extending vendor terms, rather than through the Company's revolving credit facilities. Net income in 1995 of $11.6 million contained non-cash charges for depreciation and amortization of $17.4 million. Significant balance sheet changes include the aforementioned increase in accounts payable of $6.6 million, increases in self insurance reserves of $1.3 million and accrued expenses and other liabilities of $11.7 million. The increase in accrued expenses and other liabilities is related to the Company's improved operating results which caused increases in accrued payroll and related expenses, accrued income taxes, and accrued customer rebates.\nLower levels of cash provided by operations in 1994 and 1993 were a function of lower earnings coupled with the increased working capital requirements of expanded sales to independently-operated retailers. Net income in 1994 was impacted by a $6.9 million non-cash credit for the adoption and SFAS No. 109. Restructuring charges of $12 million and $5 million in 1994 and 1993, respectively, contributed to the increase in accrued expenses and other liabilities.\nThe food distribution industry requires a significant investment in receivables and inventories to meet customer needs. Increased levels of inventory were required to support the new HBC\/GM distribution facility and forward buy opportunities. Additional wholesale customer financing was also made available to\nsupport the acquisition by two independently-operated wholesale customers of four former Company-operated retail stores in the Akron\/Canton area.\nWorking capital, exclusive of deferred income taxes, decreased to $13.9 million in 1995 from $36.4 million in 1994 and $24.3 million in 1993. The Company's ratio of current assets to current liabilities, exclusive of deferred income taxes also decreased to 1.13:1 at the end of 1995 from 1.43:1 and 1.26:1 at the end of 1994 and 1993, respectively. These shifts reflect the changes in working capital components that are discussed above.\nAs a result of the decrease in the Company's debt levels and improved operating results in 1995, the Company's ratio of liabilities to equity decreased from 3.14:1 at the end of 1993 and 2.98:1 at the end of 1994 to 2.61:1 at the end of 1995. The decrease in the ratio of liabilities to equity in 1993 was due to the favorable impact of the Company's adoption of SFAS No. 109 during 1994.\nThe Company utilized $28.1 million of 1995 cash flow for capital expenditures. This amount is slightly higher than 1994 and 1993 levels and reflects the continuance of Company programs to enhance its retail core-stores ($23.2 million), upgrade its data processing systems and corporate facilities ($2.5 million) and improve distribution facilities and equipment ($2.4 million).\nRetail capital expenditures were made to modernize and expand retail locations. At the end of 1995, the Company operated 38 retail locations compared to 42 retail locations at the same time last year. The stores which were closed continue the Company's strategic initiatives to focus on its core-store format.\nThe Company anticipates it will maintain its current level of capital expenditures ($25-35 million) over the next four fiscal years until it has completed the remodeling or expansion of its core stores. The Company is also required, pursuant to the terms of its lease with Seaway Development, to purchase its Aurora Road warehouse facility and Cash-N-Carry branch in July 1995 for $6 million. The Company believes that cash flow from operations and the unused portion of the bank credit facilities ($29.2 million at the end of fiscal 1995) will adequately fund planned capital expenditures, normal ongoing business activities and scheduled debt principal repayments.\nIMPACT OF INFLATION\nInflation increases the Company's major costs, inventory and labor. Because of the high velocity of inventory turnover in the food distribution industry and the Company's use of the Last-in, First-out (LIFO) valuation method for a majority of its inventory, the impact of inflation is normally reflected very quickly in the\nresults of operations. The food distribution industry has experienced little or no food inflation over the last three years. Accordingly, the Company's provisions for LIFO inventories for the past three years were as follows: expense of $69,000 in 1995, income of $486,000 in 1994, and expense of $211,000 in 1993. Experience indicates that highly competitive market conditions may prevent the Company from fully recovering inflation-driven costs through retail pricing alone.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of the Company are set forth in Item 14 of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement, to be filed no later than October 30, 1995, appearing under the caption \"Election of Directors.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement, to be filed no later than October 30, 1995, appearing under the caption \"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 from the Company's Proxy Statement, to be filed no later than October 30, 1995, appearing under the caption \"Security Ownership of Certain Beneficial Owners and Management.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement, to be filed no later\nthan October 30, 1995, appearing under the caption \"Certain Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n2. Financial Statement Schedules -----------------------------\nFinancial Statement Schedules to the Consolidated Financial Statements required by Article 12 of Regulation S-X are not required under the related instruction or are inapplicable and therefore have been omitted.\n3. Exhibits --------\n3.1 Certificate of Incorporation (previously filed as Exhibit 3.1 to the Company's Registration Statement on Form S-8 filed with Securities and Exchange Commission (the \"Commission\") on May 15, 1995 and incorporated herein by reference)\n3.2 By-Laws (previously filed as Exhibit 3.2 to the Company's Registration Statement on Form S-8 filed with the Commission on May 15, 1995 and incorporated herein by reference)\n4.1 9-3\/4% Subordinated Debentures due December 30, 2001 of Rini-Rego Supermarkets, Inc. (\"Rini-Rego\") (previously filed as Exhibit 4.3 to the Company's Annual Report on Form 10-K filed with the Commission on September 25, 1992 and incorporated herein by reference)\n4.2 Trust Indenture between American Seaway Foods, Inc. (\"American\") and Ameritrust Company National Association as Trustee dated as of December 1, 1991 (previously filed as Exhibit 4.4 to the Company's Annual Report on Form 10-K filed with the Commission on September 25, 1992 and incorporated herein by reference)\n10.1 Amended and Restated Credit Agreement by and among Rini-Rego, Society National Bank as agent (\"Society\") for Society, The Bank of New York Commercial Corporation, PNC Bank, National Association and Star Bank, N.A. (collectively, the \"Banks\") dated as of May 27, 1993 (previously filed as Exhibit 10.42 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.2 Amended and Restated Credit Agreement by and among American, Society and the Banks dated as of May 27, 1993 (previously filed as Exhibit 10.43 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.3 Amended and Restated Security Agreement by and among Rini-Rego, Society and the Banks dated as of May 27, 1993 (previously filed as Exhibit 10.44 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.4 Amended and Restated Security Agreement by and among American, Society and the Banks dated as of May 27, 1993 (previously filed as Exhibit 10.45 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.5 Amended and Restated Security Agreement by and among Seaway Food Service, Inc., Society and the Banks dated as of May 27, 1993 (previously filed as Exhibit 10.46 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.6 Amended and Restated Security Agreement by and among Fisher Properties, Inc., Society and the Banks dated as of May 27, 1993 (previously filed as Exhibit 10.47 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.7 Amended and Restated Guaranty Agreement by Riser dated as of May 27, 1993 (previously filed as Exhibit 10.48 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.8 Amended and Restated Guaranty Agreement by Rini-Rego dated as of May 27, 1993 (previously filed as Exhibit 10.49 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.9 Amended and Restated Guaranty Agreement by American dated as of May 27, 1993 (previously filed as Exhibit 10.50 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.10 Amended and Restated Guaranty Agreement by Seaway dated as of May 27, 1993 (previously filed as Exhibit 10.51 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.11 Amended and Restated Guaranty Agreement by Fisher dated as of May 27, 1993 (previously filed as Exhibit 10.52 to the Company's Annual Report on Form 10-K filed with the Commission on October 1, 1993 and incorporated herein by reference)\n10.12 Form of Amendment No. 1 to Amended and Restated Guaranty Agreement by Riser (executed as of May 16, 1994) (previously filed as Exhibit 10.53 to the Company's Annual Report on Form 10-K filed with the Commission on September 29, 1994 and incorporated herein by reference)\n10.13 Form of Amendment No. 1 to Amended and Restated Credit Agreement by and among Rini-Rego, Society and the Banks (executed as of May 16, 1994) (previously filed as Exhibit 10.54 to the Company's Annual Report on Form 10-K filed with the Commission on September 29, 1994 and incorporated herein by reference)\n10.14 Form of Amendment No. 1 to Amended and Restated Credit Agreement by and among American, Society and the Banks (executed as of October 6, 1994) (previously filed as Exhibit 10.57 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n10.15 Form of Amendment No. 2 to Amended and Restated Guaranty Agreement by Riser (executed as of October 6, 1994) (previously filed as Exhibit 10.55 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n10.16 Form of Amendment No. 2 to Amended and Restated Credit Agreement by and among Rini-Rego, Society and the Banks (executed as of October 6, 1994) (previously filed as Exhibit 10.56 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n10.17 Form of Amendment No. 2 to Amended and Restated Credit Agreement by and among American, Society and the Banks (executed as of April 28, 1995) (previously filed as Exhibit 10.60 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n10.18 Form of Amendment No. 3 to Amended and Restated Guaranty Agreement by Riser (executed as of April 28, 1995) (previously filed as Exhibit 10.58 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n10.19 Form of Amendment No. 3 to Amended and Restated Credit Agreement by and among Rini-Rego, Society and the Banks (executed as of April 28, 1995) (previously filed as Exhibit 10.59 to the Company's Quarterly Report on Form 10-Q filed with the Commission on May 17, 1995 and incorporated herein by reference)\n21 Subsidiaries of the Registrant\n23 Consent of Arthur Andersen LLP\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, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nRISER FOODS, INC.\nBy: \/s\/ Anthony C. Rego ------------------------- Anthony C. Rego 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.\nReport of Independent Public Accountants\nTo Riser Foods, Inc. and Subsidiaries:\nWe have audited the accompanying consolidated balance sheets of RISER FOODS, INC. (a Delaware corporation) AND SUBSIDIARIES as of July 1, 1995 and July 2, 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three fiscal 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 financial statements referred to above present fairly, in all material respects, the financial position of Riser Foods, Inc. 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 fiscal years in the period ended July 1, 1995, in conformity with generally accepted accounting principles.\nAs explained in Note 4 to the Financial Statements, effective July 4, 1993, the Company changed its method of accounting for income taxes as required by Statement of Financial Accounting Standards No. 109.\nARTHUR ANDERSEN LLP Cleveland, Ohio, September 7, 1995.\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- CONSOLIDATED BALANCE SHEETS --------------------------- (dollars in thousands)\nASSETS ------\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- CONSOLIDATED BALANCE SHEETS --------------------------- (dollars in thousands, except share data)\nLIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF INCOME --------------------------------- (in thousands, except share and per share data)\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ----------------------------------------------- (in thousands)\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (in thousands)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nRISER FOODS, INC. ----------------- AND SUBSIDIARIES ---------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\n(1) Summary of Significant Accounting Policies: ------------------------------------------- SEGMENT INFORMATION -- Riser Foods, Inc. (Riser or the Company) is engaged in one business segment, the food distribution industry. The Company distributes national brand and private label products through Company-operated and other independently-operated retail stores throughout northeast and central Ohio, southeastern Michigan and western Pennsylvania. The Company operates 38 retail locations in northeast Ohio. The following is a detail of the number of Company-operated stores by year:\nPRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of Riser and its subsidiaries. All material intercompany accounts and transactions have been eliminated.\nFISCAL YEAR -- The Company's fiscal year ends on the Saturday closest to June 30. Fiscal 1995 and 1994 consist of the 52 weeks ended July 1, 1995 and July 2, 1994, respectively. Fiscal 1993 consists of the 53 weeks ended July 3, 1993.\nCASH EQUIVALENTS -- The Company considers all highly liquid investments with an initial maturity of three months or less to be cash equivalents.\nINVENTORIES -- Inventories are stated at the lower of cost or market. Cost is determined through the use of the last-in, first-out (LIFO) method for a majority of consolidated inventories: 77% at July 1, 1995 and 72% at July 2, 1994. The first-in, first-out (FIFO) method is used to determine cost for the remaining inventories which consist principally of perishable products and warehouse health and beauty care and general merchandise products.\nIf the FIFO method had been used to determine cost for all Company inventories, total inventories would have been higher than reported by approximately $6,452,000 at July 1, 1995 and $6,383,000 at July 2, 1994.\nPROPERTY, EQUIPMENT AND CAPITAL LEASE -- Property and equipment are recorded at cost and depreciated using the straight-line method at annual rates sufficient to amortize the cost of the assets during their estimated useful lives. Accelerated depreciation methods are used for income tax purposes. Amortization of property under capital leases is computed using the straight-line method over the shorter of the estimated life of the asset or the term of the lease. The following range of depreciable lives are used:\nSELF INSURANCE RESERVE -- The Company is primarily self insured for property loss, general liability costs and workers' compensation. Estimated costs of these self insurance programs are accrued at current cost based on projected settlements for claims and include estimates for claims incurred but not reported. Any adjustments made to previously recorded reserves are reflected in current operating results. Amounts charged to expense for self insured liabilities were $4,726,000, $3,940,000, $4,170,000 in 1995, 1994, and 1993, respectively.\nREVENUE RECOGNITION -- Revenues from product sales are recognized upon shipment of the product from warehouse distribution to independently-operated retail stores and at the point of sale for Company-operated retail stores.\nSTORE PRE-OPENING COST -- Store pre-opening costs, primarily employee training, inventory stocking and advertising, are charged to expense concurrent with store openings.\nRECLASSIFICATIONS -- Certain reclassifications have been made to prior year financial statements to conform with current year presentation. These reclassifications did not affect results of operations previously reported.\nNET INCOME PER SHARE -- Net income per share is computed by dividing net income less preferred stock dividends by the weighted average number of common shares outstanding. Outstanding stock options do not have a significant dilutive effect on net income per share.\n(2) Trade Accounts and Notes Receivable: ----------------------------------- The Company's trade accounts and notes receivable are primarily with various wholesale customers which are engaged in retail food distribution in northeast and central Ohio, western Pennsylvania and southeastern Michigan.\nThe Company's notes receivable principally arise from the financing of store leaseholds, inventory and fixed assets related to the Company's independently-operated wholesale customers. Loans to independent retailers, as well as trade accounts receivable, are primarily collateralized by the retailers' inventory, equipment and fixtures. The notes range in length from 1 to 7 years and primarily bear interest at prime plus 1.0% or 1.5%. Management believes the estimated fair market value of the notes approximates net carrying value at July 1, 1995 and July 2, 1994.\nTrade accounts receivable include $5,386,000 and $4,664,000 of the current portion of notes receivable at July 1, 1995 and July 2, 1994, respectively. Trade accounts receivable are net of an allowance for doubtful accounts of $2,953,000 at July 1, 1995 and $3,295,000 at July 2, 1994.\n(3) Accrued Expenses: ---------------- Accrued expenses include the following (in thousands):\n(4) Income Taxes: ------------\nAt the beginning of 1994, the Company adopted the provisions of SFAS No. 109 \"Accounting for Income Taxes\". This statement requires that the liability method of accounting for income taxes be used rather than the deferred method previously used. The Company elected not to restate prior years' financial statements and the cumulative effect of this accounting change was to increase 1994 net income by $6,866,000 or $.85 per share. The cumulative effect is principally the result of benefiting the expected utilization of tax net operating loss carryforwards (NOL) and the adjustment of deferred tax balances to reflect changes in statutory rates.\nThe income tax provision in the accompanying consolidated statements of income differs from the provision at statutory rates as follows (in thousands):\nSignificant components of the Company's net deferred tax asset at July 1, 1995 and July 2, 1994, are as follows (in thousands):\nThe Company has gross NOL totaling $21,046,000 which expire as follows (in thousands):\nSFAS No. 109 requires that the tax benefit of such NOL be recognized as an asset to the extent the Company assesses the utilization of such NOL to be \"more likely than not\". Based upon the Company's history of prior earnings in a competitive industry, expectations for future earnings and tax regulations which limit the annual amount of NOL available for deduction and carryforward period, the Company does not currently believe it is more likely than not that the entire amount of NOL will be utilized before they expire. As such, the valuation allowance of $4,648,000 established upon the adoption of SFAS No. 109 is maintained. To the extent it is determined that such valuation allowance is no longer appropriate, income tax expense of future periods will be favorably impacted.\nPrior to the Company's adoption of SFAS No. 109, realization of these NOL was recognized as a reduction of purchase accounting for non-current assets until such time as the carrying values were written off. The Company utilized $2,166,000 of these NOL in 1993. On an after tax basis, $253,000 of the 1993 utilization was recognized as an extraordinary item after $483,000 was utilized to write-off the remaining balance of non-current purchase price assets.\n(5) Long-Term Debt: --------------- Long-term debt is comprised of the following (in thousands):\nThe Company's bank credit facilities (Facilities) provide for revolving lines of credit, letters of credit and a term loan up to an aggregate of $77.6 million. During the fourth quarter of fiscal 1995, the Facilities were amended and the due date for borrowings under the revolving lines of credit was extended to July 6, 1998. The term loan is payable in quarterly installments of $428,571 over five years with a balloon payment due in April 1998. The amendment also provided the Company with an option to borrow funds under its revolving lines and term loan at either .25% over the Bank's Prime Interest Rate or 2.50% over LIBOR. Commitment fees representing .25% per annum of the unused facilities plus agency fees of $2,500\nper month are also paid monthly. Available unused borrowing capacity under these Facilities at July 1, 1995 was approximately $29.2 million.\nThe Facilities consist of separate credit agreements for each of the Company's significant operating entities (collectively the Consolidated Credit Agreement). Borrowings under each entity's individual facility cannot exceed 85% of the respective entity's qualified receivables, plus from 55% to 65% of eligible inventory and 100% of eligible cash and cash equivalents, less certain reserves and obligations, all as defined in the Consolidated Credit Agreement. The Facilities are secured by substantially all the assets of Riser and each individual credit facility is cross-guaranteed by all other subsidiaries and guaranteed by Riser.\nAmong other covenants, the Consolidated Credit Agreement requires that the Company maintain, on a consolidated basis, minimum levels of tangible net worth and cash flows and minimum ratios of liabilities to tangible net worth and capital expenditures to cash flows, which vary each fiscal year. The agreement further provides for limitations on dividends and capital expenditures. The Company is in compliance with all covenants at July 1, 1995.\nThe Company's Taxable Variable Rate Demand Notes (Notes) bear interest at a variable rate based on the higher of the average 30-day or 90-day commercial paper rate, plus a market increment which at July 1, 1995 was .125%, payable monthly. Principal under the Notes is payable in annual installments of $2,000,000 through December 1, 1997 and $3,000,000 on December 1, 1998. The Notes are secured by a bank letter of credit. The bank letter of credit expires in June 1996, has an annual fee of 1% on the outstanding note balance, and is secured by the Facilities.\nConcurrent with the issuance of the Notes, the Company entered into an exchange transaction which fixed the higher of the 30-day or 90-day commercial paper rate at 6.50% through December 1, 1994 at dollar amounts which correspond to the Notes outstanding. Until the expiration of the exchange contract, the Company recorded interest expense on the Notes as if the interest rate was fixed at 6.5%.\nThe 9.75% Subordinated Debentures are recorded net of an original issue discount, based on an imputed interest rate of 12%, which is being amortized over the term of the indebtedness using the effective interest method. These debentures, originally issued by a subsidiary of the Company, require semiannual interest payments and may be redeemed at the Company's option at 100% of the principal amount.\nThe Company finances certain store fixtures and equipment associated with programs to remodel and remerchandise its Company-\noperated retail stores under financing agreements with seven year terms and bearing interest at rates ranging from 6.9% to 9.2%.\nCertain property with an aggregate net value for financial reporting purposes of $23,179,000, was pledged to secure real estate first mortgages on July 1, 1995.\nFuture maturities of long-term debt as of July 1, 1995, are summarized as follows (in thousands):\nNo quoted market prices are available for any of the Company's long-term debt as it is not actively traded. Management however, believes the carrying values of the Company's borrowings under its bank credit facility, the notes and real estate mortgages approximate their fair values as all bear interest at current market rates. It is not practical to estimate the fair value of the Company's 9.75% subordinated debentures because of the inability to estimate fair value without incurring excessive costs.\n(6) Leases: ------- The Company leases many of its retail store locations, warehouse facilities and certain operating equipment under capital and operating leases. Most of the retail store leases contain contingent rent clauses based on sales levels. In most instances, the Company has the option to extend the term of the lease. Some of the retail store locations and the warehouse facilities are leased from parties that are related through common ownership and control.\nLeased property under capital leases, which is included in property, equipment and capital leases, consisted of the following amounts (in thousands):\nThe following is a schedule of future minimum lease payments under noncancelable operating and capital leases as of July 1, 1995 (in thousands):\nThe Company also subleases certain of its leased retail store locations and a portion of its warehouses. Future minimum rental income under subleases of operating and capital leases at July 1, 1995 amounted to $15,892,00.\nTotal rental expense for unrelated operating leases was as follows (in thousands):\nTotal rental expense for related operating leases was as follows (in thousands):\n(7) Disposition of Facilities: -------------------------- The Company provides for the estimated costs of closing facilities concurrent with making the decision to close. The types of costs provided primarily include future lease payments net of estimated sublease income and expected losses on disposal of assets.\nAn analysis of the activity in the closed facilities reserve is as follows (in thousands):\nThe 1994 restructuring charge represented estimated costs associated with the Company's retail store consolidation plan to close smaller, outdated Company-operated retail stores representing approximately 456,000 square feet. Certain of these stores will be replaced by newer, larger stores representing approximately 431,000 square feet. Some of these newer stores will be operated by wholesale customers and the remaining stores will be new or expanded Company-operated retail stores. At July 1, 1995, the Company has closed nine stores included in the 1994 restructuring charge with an additional four stores to be closed over the next three to four years.\nThe 1993 restructuring charge represented the estimated costs associated with the closing of seven retail stores including six Carl's or former Carl's stores. These closings were the result of the Company's decision to focus efforts on its core store format, Rini-Rego Stop-N-Shop.\nAt July 1, 1995 the net book value of fixed assets and property pertaining to closed facilities was $4,722,000. An allowance to reduce these assets to their estimated net realizable value is included in the allowance for depreciation, amortization and loss on disposal, while the long-term portion of the reserve for closing facilities is classified in other liabilities on the accompanying balance sheets.\n(8) Employee Benefit Plans: ---------------------- The Company sponsors an employee savings plan (401(k)) for all non-union employees. Contributions to the plan are in the form of employee salary deferrals and Company matching funds. Amounts contributed and expensed for Company matching funds were $342,000 in 1995, $227,000 in 1994 and $65,000 in 1993.\nThe Company also participates in various multi-employer pension plans. The plans provide for defined benefits to substantially all of the Company's union employees. Amounts charged to pension cost and contributed to the plans were approximately $5,012,000, $4,789,000 and $4,860,000, for 1995, 1994 and 1993, respectively. At the dates of the latest actuarial valuations, the aggregate withdrawal liability for the multi-employer pension plans totaled approximately $1,680,000.\nThe Company maintains retirement benefit arrangements for certain former key executives of the Company. The plans primarily provide for payments to these executives for life with a three-year extension for surviving spouses. The Company recorded expense of $300,000 in 1995, no expense in 1994 and $472,000 in 1993. The amount accrued for these plans was $2,923,000 at July 1, 1995 and $2,711,000 at July 2, 1994.\nDuring fiscal 1995, the Company established a Supplemental Executive Retirement Plan (SERP) which will provide retirement benefits to participating executives supplementing amounts currently limited under the Company's 401(k) Plan by Internal Revenue Service regulations. These benefits will be made upon the retirement, death or disability of the executive. Payments are made for the life of the executive with a minimum of 15 years benefit to either the executive or their beneficiary. The SERP also provides for reduced benefits in the event of early retirement, death or disability. The Company discounts the net present value of benefits under the SERP utilizing a 7.50% discount factor. Vested benefits are not required to be funded however, the Company has elected to insure the lives of these executives to\nassist in the funding of the SERP liability. The Company recorded $1,284,000 of expense related to the SERP in fiscal 1995, of which $943,000 represented the vesting of prior service costs.\n(9) Capital Stock: -------------\nEach share of Series A Preferred stock is convertible, at the option of the holder, into 9.79 shares of Class A Common Stock and is redeemable, at the option of the Company, at $105 per share.\nThe Company's Board of Directors unanimously approved the redemption of the Series A Preferred Stock on June 9, 1995 at $105 per share and accordingly, the Series A Preferred Stock's redemption price has been classified in accrued expenses at July 1, 1995.\nThe holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to 10 votes per share, except with respect to the election of directors, at which time holders of Class A Common Stock will vote as a separate class and be entitled to elect 25% of the total number of directors and the Class B Common Stockholders will elect the remaining directors. Amounts shown on the balance sheets are net of 1,553,630 shares of Class A Common stock outstanding that are held by a Riser subsidiary.\nThe Company has a Stock Incentive Plan which provides for both qualified and non-qualified stock options, as well as stock appreciation rights and restricted stock grants for employees, officers and directors of Riser. Under the terms of the plan, up to 500,000 Class A Common Shares may be the subject of options, stock appreciation rights or restricted stock grants. Stock options must be issued at not less than fair value of the Class A Common Stock at the date of grant and are exercisable for up to ten years from the date of grant. Options outstanding under this plan are as follows:\nThe options granted in 1995 and 1993 are non-qualified options for federal income tax purposes and are not exercisable until two years after grant.\nAt the date of Riser's business combination, options to purchase shares of a Riser subsidiary's common stock, issued pursuant to that subsidiary's Stock Option Plan, were converted into options to acquire Class A Common Stock. These outstanding options, totaling 7,000 at July 1, 1995, are at option prices ranging from $9.25 to $15.13.\n(10) Investment in Stop-N-Shop Supermarkets: -------------------------------------- The Company has a 69% ownership and 38% voting interest in the Association of Stop-N-Shop Supermarkets (Association), an association of Cleveland grocery retailers that provides combined advertising and other services to members. The Company accounts for this investment using the equity method of accounting.\nAmounts paid to the Association for services provided to the Company totaled approximately $7,519,000, $7,265,000 and $6,604,000 for 1995, 1994 and 1993, respectively. The trade accounts payable balance in the accompanying balance sheets include amounts due the Association of approximately $1,229,000 at July 1, 1995 and $895,000 at July 2, 1994. The trade accounts receivable balance in the accompanying balance sheets include amounts due from the Association of approximately $774,000 at July 1, 1995 and $744,000 at July 2, 1994.\n(11) Contingent Liabilities: -----------------------\nThe Company, through one of its subsidiaries, is the guarantor of certain lease obligations and mortgages of Dominick's Finer Foods, Inc., a former subsidiary. The lease obligations covered total approximately $12,686,000 over the noncancelable term of the obligations, some of which extend to the year 2006. The Company has no collateral or security interests in the lease obligations or mortgages. Management believes that the contingent liability, if any, resulting from the guarantee of the obligations will not have a material adverse effect on the Company's consolidated financial position or results of its operations.\nEffective September 1988, the Company entered into an agreement with Electronic Data Systems Corporation (EDS) for the management and operation of the Company's data center. This agreement provides for minimum payments summarized as follows (in thousands):\nThe agreement expires in December, 1998 and may be terminated by either party upon six months notice and upon the payment of certain fees for termination.\nThe Company is also involved in a number of other legal proceedings incidental to its business. Management believes that the liability, if any, resulting from all pending legal proceedings will not have a material adverse effect on the Company's consolidated financial position or the results of its operations.\n(12) QUARTERLY FINANCIAL DATA (UNAUDITED): -------------------------------------\n(in thousands, except per share data)\nExhibit Index -------------","section_15":""}
{"filename":"856979_1995.txt","cik":"856979","year":"1995","section_1":"ITEM 1. BUSINESS\nYES Clothing Co.(R), \"the Company\", designs, contracts for the manufacture of and markets diversified lines of apparel for women in junior sizes, young men and kids. The Company sells its apparel to retail department stores and specialty chains and stores. The Company's garments are made in the United States and to a lesser extent in the Far East.\nThe Company was incorporated in California in 1982. Its principal executive offices are located at 1380 West Washington Boulevard, Los Angeles, California 90007, and its telephone number at that address is (213) 765-7800.\nACQUISITION TRANSACTION\nOn January 31, 1995, control of the Company changed when its two principal owners sold all of their shares, amounting to approximately 80% of the Company's outstanding stock, to affiliates of Georges Marciano, founder and former Chairman of Guess, Inc.\nIn November 1994, former Company Chairman of the Board and Chief Executive Officer, George Randall, and former Company President, Moshe Tsabag, signed an agreement to sell their holdings in the Company to affiliates of Georges Marciano. The transaction closed on January 31, 1995, resulting in the acquisition by Marciano affiliates of approximately 80% of the outstanding common stock of the Company. As a result of the Acquisition Transaction, George Randall resigned his positions with the Company in January 1995 and Moshe Tsabag resigned as President in January 1995 and as a Board Member and employee in April 1995. This transaction is known herein as the Acquisition Transaction.\nBUSINESS STRATEGY\nSubsequent to the Acquisition Transaction by affiliates of Georges Marciano, the Company has embarked upon several new manufacturing, design and sales relationships. The Company has changed its product focus in styles produced, the price of its products and targeted gross margins. Most of its senior executive officers and a substantial portion of its Board of Directors have been replaced, its design staff has been supplemented, it has acquired new trademarks and terminated its previous agreements with licensees in Canada and the United States. The Company has shifted its focus from primarily using cotton\/spandex knit, cotton jersey and denim in the production of dresses, skirts, pants, tank tops, jackets, leggings and jeans to using primarily denim and knit\/woven cotton for shirts, pants, shorts, vests, jackets, dresses, T-shirts and sweatshirts.\nAPPAREL AND APPAREL DESIGN\nThe Company offers clothing for the women's \"junior\" market and for young men's and children's markets. The Company's business is generally divided among five retail selling seasons: Spring, Summer, Fall, Back-to-School and Holiday. For each selling season, the Company introduces a separate apparel collection each year. Seasonal factors can cause some variance in production and sales levels among fiscal quarters in any fiscal year, but the Company does not regard its overall business as highly seasonal.\nJunior's. The Company's clothing for the \"junior\" market incorporates current styles, fabrics and colors with a look that is designed to appeal to a broad cross-section of young women. Clothing for the junior market is characterized by sizes tailored for youthfully figured women. Prior to the Acquisition Transaction, the Company's Junior lines incorporated fabrics, primarily of cotton\/spandex knit, cotton jersey and denim, in the production of dresses, skirts, pants, tank tops, jackets, leggings and jeans. Subsequent to the Acquisition Transaction, the Company changed its focus to using primarily denim and, to a lesser degree, twill, for shirts, pants, shorts, vests, jackets and dresses and knit and woven cotton for T-shirts, sweatshirts and other types of shirts. In addition, the Company has developed novelty knits for tops, using fabrics such as second skin satin,\nprinted mesh and printed nylon. The GM Surf(TM) women's line uses novelty fabrics of printed denim and pencel (a mixture of denim and nylon) for shirts, pants, vests, dresses and jackets.\nThe Company's in-house design staff, under the direction of Georges Marciano, is responsible for all phases of product development.\nYoung Men's. Prior to the Acquisition Transaction, the Company offered casual apparel for young men, principally between the ages of 15 to 30, in collections of knits and woven shirts, jackets, vests, and denim and casual pants and jeans. These were marketed under the YES Clothing Co.(R), and Sedan(R) brands and the YES Men(R) trademark. Subsequent to the Acquisition Transaction, the Company discontinued marketing under the Sedan(R) brand and began marketing under the YES U.S.A.(TM) label, denim jeans, shorts, jackets and vests and cotton and denim shirts, T-shirts and sweatshirts. The GM Surf(TM) men's line, with its distinctive Hawaiian look, uses denim, flannel, polar fleece, corduroy, cotton and rayon twill, wool and rayon gabardine, cotton pique and nylon in the production of T-shirts, sweatshirts, shirts, shorts, vests, jackets and pants.\nChildren's Wear. Prior to fiscal 1994, the Company had manufactured children's wear, mainly for girls aged 7 to 14. In fiscal 1994, the Company discontinued the manufacture of children's wear and licensed out the YES(R) name for the production of children's apparel. Subsequent to the Acquisition Transaction, the Company reacquired the children's wear license and began marketing, under the YES Kids(R) label, denim jeans, overalls, shorts, shortalls, skirts, skirtalls, vests, and jackets, cotton T-shirts and sweatshirts and denim and cotton shirts.\nPRODUCTION\nManufacturing. The Company manufactures its garments using independent cutting and sewing contractors located principally in the Los Angeles area. Prior to the Acquisition Transaction, the Company manufactured certain goods in Hong Kong and other locations in the Far East. The Company substantially decreased these overseas activities after the Acquisition Transaction. The Company seeks to produce high quality garments through its use of quality fabrics, insistence on quality workmanship and use of comprehensive fabric and garment inspection programs.\nThe Company acquires fabric from suppliers and supplies such fabric, together with the garment pattern, to an independent contractor for cutting. The cut fabric and any buttons, zippers and other trim to be used on the garments are then delivered to independent sewing contractors. Under the Company's supervision, these contractors assemble and sew the fabric and add trim in accordance with production samples. The Company also employs a production coordinator and three full time production assistants who regularly visit the Company's contractors to review the quality of the work in progress. Prior to distribution, the garments are delivered to the Company's warehouse for final inspection in the Quality Control Department, which has two full time employees.\nThe lead time to fill new orders placed by the Company with its manufacturing contractors generally ranges from three to four weeks for domestically produced garments. The Company generally schedules the manufacture of apparel based on orders received to reduce the risk of obsolescence of its garment inventory. The Company continuously monitors for obsolete and damaged inventory. Such inventory is usually sold to customers who specialize in merchandising off-price clothing and sold through a Company owned factory outlet store.\nThe Company has long-standing relationships with its cutting contractor and many of its sewing production contractors but does not have written agreements with any of its contractors. For its domestically produced garments, the Company currently utilizes only one cutting contractor (who is located in the Company's facility and who works mainly for the Company) and approximately 25 sewing contractors (all of whom are located in the Los Angeles area).\nThe Company believes that its relationships with its cutting and sewing contractors are satisfactory. The Company does not believe that the loss of any contractor would have a material adverse effect on the Company's\noperations as there are a large number of domestic and foreign cutting and sewing contractors who can manufacture the Company's garments. However, the Company believes that it is the largest customer of certain of its sewing contractors.\nFabric. Prior to the Acquisition Transaction, the fabrics used by the Company in its domestically produced garments were primarily cotton\/spandex knit, which was acquired from suppliers located in Hong Kong, and cotton jersey and denim, which were acquired from suppliers located in the United States. The Company made its foreign purchases of fabric from its resident agent in Hong Kong, who placed orders with a number of fabric suppliers. Subsequent to the Acquisition Transaction, the Company substantially reduced its use of cotton\/spandex knit. The Company primarily uses denim, cotton knits (jersey) and woven cotton (chambray and poplin), which are purchased domestically.\nThe Company believes that during the fiscal year ended March 31, 1995, approximately 82% of its expenditures for fabrics used in its domestically produced garments were paid to suppliers located in the United States. For the fiscal year ended March 31, 1995, approximately 16% of the Company's expenditures for domestically purchased fabrics was accounted for by its largest domestic fabric supplier, approximately 41% of such expenditures was accounted for by the Company's four largest domestic suppliers and approximately 58% of such expenditures was accounted for by the Company's ten largest domestic suppliers.\nThe Company does not have any long-term arrangements with any of its fabric suppliers. To date, the Company has not experienced any difficulty in satisfying its fabric requirements and it believes that the large number and diversity of potential suppliers minimizes the risk of the loss of any one supplier. The Company believes that the effect of the loss of one or a few of its fabric suppliers on the Company's operations would be minimal due to the large number and diversity of potential suppliers and the relative ease with which new supplier relationships may be established.\nSALES AND MARKETING\nThe Company sells its apparel throughout the United States to retail department stores, specialty chains and specialty stores. Prior to the Acquisition Transaction, the Company had nominal sales in England, Europe, Japan and Korea. For the fiscal year ended March 31, 1995, the Company sold its apparel to over 1,300 retailing customers. Approximately 44% of sales were made to the Company's ten largest customers and approximately 89% of sales were made to the Company's 100 largest customers.\nSales of the Company's garments are made through independent sales organizations and directly by the Company's sales staff. The Company maintains showrooms in New York City and Los Angeles for women's and men's apparel. The Company also engages the services of independent sales organizations located in Miami, Dallas, Chicago, Atlanta, and Philadelphia, which operate showrooms displaying the Company's products. Prior to the Acquisition Transaction, the Company had also engaged the services of an independent sales organization in Puerto Rico. Sales representatives at each showroom are responsible for marketing the Company's apparel within an assigned territory. Each sales representative meets with customers in the showroom, makes sales calls to customers and represents the Company at trade shows within the assigned territory. The sales organizations are retained on a non-exclusive basis. All of the Company's independent sales organizations are compensated on a commission basis on terms consistent with industry practice. The Company does not sell its garments on consignment.\nThe Company generally sells its products on net-30 day terms, except for Misfits and GM Junior products which are sold on 8\/10 end of month terms.\nThe Company's backlog consists of purchase orders that have been received but not shipped, and amounted to approximately $3,200,000, $9,137,000 and $8,400,000 as of June 20, 1995, June 20, 1994, and June 20, 1993, respectively. The Company expects to ship substantially all of the orders comprising the backlog prior to\nSeptember 30, 1995. Subsequent to the Acquisition Transaction the Company's backlog decreased significantly due to a restructuring of product lines and the discontinuance of the Sedan(R) brand division.\nWhile the failure to fill orders on a timely basis could have a material adverse effect on the Company's sales, the Company has generally not experienced difficulty in shipping orders by the dates requested by its customers. The Company does not generally accept returns except for damaged or defective garments or with respect to late deliveries. However, the Company does grant markdown money for slow moving goods.\nADVERTISING AND PROMOTION\nPrior to the Acquisition Transaction, the Company's advertising strategy was to promote an image that associated a fashionable look and youthful style and to promote the YES Clothing Co.(R) name. The Company advertised in national magazines, including Details, In Fashion, Sportswear International, Vogue, Seventeen Magazine, Elle and Source, among others. The Company had no cooperative advertising program for its retailers although it did, with advance approval, reimburse its customers for advertising the Company's products. The Company's expenditures for advertising and promotion were approximately $442,000 during fiscal 1995 (1.5% of net sales), $524,000 during fiscal 1994 (1.9% of net sales), and approximately $779,000 during fiscal 1993 (2.1% of net sales). Subsequent to the Acquisition Transaction, the Company has promoted the YES Clothing Co.(R) name in Women's Wear Daily, a trade newspaper, and Sportswear International and the GM Surf(TM) and Misfits(R) brands in In Fashion, Los Angeles Magazine, Surfer and Sportswear International.\nBRANDS AND TRADEMARKS\nThe Company's principal trademarks, YES Clothing Co.(R), YES Men(R), YES Kids(R) and YES Jeans(R) are registered with the United States Patent and Trademark Office. The Company also has registered or has trademark applications pending, for these trademarks in other countries. The Company believes that these trademarks have significant value in the marketing of its apparel. While the Company is not aware of any claims against its right to these trademarks, the loss of the right to use these trademarks would have a material adverse effect on the Company's operations.\nThere are other companies in the apparel and apparel-related industries that incorporate the word \"yes\" in their trademarks, and there can be no assurance that these or future trademarks which may be granted will not diminish the value of the Company's \"YES Clothing Co.(R)\" or \"YES(R)\" trademarks. Subsequent to the Acquisition Transaction, the Company applied for domestic and foreign trademarks for YES U.S.A.(TM) in a diamond design.\nPrior to the Acquisition Transaction, the Company sold under the YES Clothing Co.(R) and Sedan(R) brand names. The Company also manufactured and marketed its garments under private label for several large customers. Subsequent to the Acquisition Transaction, the Company discontinued private label and Sedan(R) brand sales, and, in addition to the YES(R) brand, began marketing under the GM Surf(TM) and Misfits(R) labels which are licensed to the Company under an agreement with Marble Sportswear, Inc., a company controlled by Georges Marciano (see Related Party Transactions).\nCOMPETITION\nThe segments of the apparel industry in which the Company competes are highly fragmented. The Company competes with numerous other apparel manufacturers, which vary in size and in the products with which they design and manufacture. In addition, department stores, including some of the Company's customers, sell competing apparel under their own labels. Many of the Company's competitors are larger and have greater financial resources than the Company.\nThe marketing of apparel is highly competitive. The Company believes that the ability to gauge effectively and to respond to changes in consumer demands and tastes as well as the ability to produce and deliver its products on a timely bases are necessary to compete successfully in the apparel industry. The Company believes\nthat consumer acceptance depends on the image, design, quality and price of its garments, and that its continuity will depend on its ability to remain competitive in these areas. The failure to design garments that meet with acceptance in the marketplace in the future could result in the material deterioration of customer loyalty and the Company's image and could adversely affect the Company's business.\nEMPLOYEES\nAs of March 31, 1995, the Company employed 98 persons. None of the Company's employees are represented by a labor union. The Company considers its relations with employees to be satisfactory.\nENVIRONMENTAL REGULATION\nThe cost and effect of complying with environmental regulations are not material due to the nature of the Company's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nEffective May 1, 1992, the Company's executive offices, merchandising, production, shipping and warehousing facilities became located in a facility in Los Angeles totaling approximately 75,000 square feet, occupied pursuant to a lease expiring in May 1997. The Company also leases the following showrooms pursuant to leases expiring as indicated: Los Angeles Women's (August 1997) and Men's (August 1996) and New York City Women's (September 1997), Men's (June 1996) and combined Women's\/Men's showroom (June 2000). The Company is attempting to sublease its Women's New York showroom and does not anticipate any significant losses associated with the subleasing activity. Management expects that in the normal course of business, such leases will be renewed or replaced by other leases. The Company believes its current facilities are generally in good operating condition and are suitable and adequate for its foreseeable needs. The Company does not believe the loss of any of these facilities would have a material adverse effect on its operations as equivalent facilities are readily available. The Company also operates an Outlet Store located in Park City, Utah for the sale of slow moving\/off season merchandise.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not involved in any legal proceeding.\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 security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE OF COMMON STOCK\nThe Company's Common stock is traded on the Nasdaq National Market under the symbol YSCO. The following table sets forth the range of high and low sales prices of the Common stock, as reported by The Nasdaq Stock Market, Inc. for each quarterly period during the past two fiscal years:\nMARKET PRICES\nAPPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK SECURITIES\nThe Company had approximately 775 holders of record of Common stock as of March 31, 1995.\nDIVIDENDS\nThe Company has never paid cash dividends on its common equity. The Company is not restricted from making any cash dividend payments under its current credit agreement with its factor. However, the Company intends to retain any earnings within the Company for the foreseeable future.\nPOTENTIAL DELISTING\nOn June 14, 1995 the NASD notified the Company that its net worth as of March 31, 1995 had been reduced below the NASD's minimum standards for continued listing and suggested that the Company would be delisted from the NASD\/NMS. In light of the capital infusion by Mr. Marciano--See \"Management's Discussion and Analysis of Financial Condition--Subsequent Events\", the Company believes its net worth is now in excess of the minimum standards and has applied to the NASD for a waiver from delisting. There is no assurance that the waiver will be granted.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data of the Company as of and for each of the five years in the period ended March 31, 1995 are derived from the audited Financial Statements of the Company and should be read in conjunction with such Financial Statements and related notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere in this report.\n- -------- (a) Weighted average number of shares have been computed based on the number of shares outstanding each period. The effect of options granted but not exercised has not been included as the effect would have either been immaterial or antidilutive.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following table sets forth, for the periods indicated, the percentage of net sales represented by certain items in the Company's statements of operations.\nFISCAL YEARS 1995, 1994 AND 1993\nNET SALES increased by $697,000 or 2.5% to $28,580,000 in fiscal 1995 due to the addition of the GM Surf(TM) and Misfits(R) product lines.\nIn fiscal 1994, net sales decreased by $10,060,000 or 26.5% to $27,883,000 due to significantly decreased sales in all divisions except for an increase in sales in the Sedan(R) line of young men's and boy's knits and woven shirts. The decline in sales reflects both continued intense competition as well as a general decline in apparel purchases by consumers.\nGROSS PROFIT as a percentage of net sales decreased to 11.8% in fiscal 1995 from 13.2% in fiscal 1994 due to higher levels of markdowns and a reduction in prices negotiated by retailers in response to cost conscious consumers. Gross profit as a percentage of net sales decreased to 13.2% in fiscal 1994 from 21.2% in fiscal 1993. The significant decrease in gross profit percentage in 1994 reflects a number of factors, including decreased sales volume, significant price competition, increased materials costs primarily for trim, washing, bleaching and dying, and an increased unit cost for design and production salaries and expenses (as these total costs are spread over the decreased production).\nCOMMISSION INCOME decreased by $306,000 or 44.4% to $383,000 due to the discontinuation of commission transactions subsequent to the acquisition transaction. Commission income is generated from shipments of goods manufactured in the Orient to domestic and overseas customers. In fiscal 1994, commission income decreased $264,000 or 27.7% to $689,000 from $953,000 in fiscal 1993 due to a general decline in sales.\nROYALTY INCOME decreased by $9,000 to $51,000 in fiscal 1995 from $60,000 in fiscal 1994 due to the termination of licensee agreements in Canada and the United States. In fiscal 1994, royalty income decreased by $81,000 from $141,000 in fiscal 1993. The main reason for the decrease was the transition from a bankrupt licensee in Canada to a new licensee in 1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES (\"S,G&A\") decreased to $7,972,000 in fiscal 1995 from $8,816,000 in fiscal 1994, which represented 27.9% and 31.7% of net sales, respectively. (When commission and royalty income is added to net sales, the percentage of S,G&A is reduced to 27.5% and 30.8%, respectively.)\nThe main factors reducing S,G&A in fiscal 1995 were as follows:\n(1) Payroll and payroll tax decreased to $2,795,000 in fiscal 1995 from $3,364,000 in fiscal 1994 due to a reduction in the number of employees.\n(2) Insurance expense decreased to $467,000 or 1.64% of net sales in fiscal 1995 from $712,000 in fiscal 1994 or 2.56% of net sales due to renegotiated insurance rates and a workers' compensation insurance rebate.\n(3) Advertising, travel, contributions and profit sharing expenses were reduced to $775,000 in fiscal 1995 from $1,064,000 in fiscal 1994 in order to conserve working capital.\nS,G&A expenses decreased to $8,816,000 in fiscal 1994 from $10,564,000 is fiscal 1993 primarily due to decreases in advertising, legal and accounting expenses incurred in connection with the Company's business interruption claim and lower than anticipated bad debt expenses.\nOTHER INCOME--INSURANCE--Subsequent to March 31, 1992, the Company incurred the loss of substantially all of its finished goods inventory in connection with civil disturbances in the City of Los Angeles. During the fiscal year ended March 31, 1993 the Company recovered, from one insurance company, the cost of the inventory lost and its normal gross profit which would have been derived from the sales of those goods. During the fiscal year ended March 31, 1994 the Company recovered $1,658,000, net of costs, from a second insurance company for business interruption losses related to the civil disturbance.\nINTEREST INCOME decreased to $3,000 in fiscal 1995 from $74,000 in fiscal 1994 due to a net loss of $4,652,000 for fiscal 1995 and less funds being available for investment. Interest income increased to $74,000 in fiscal 1994 from $39,000 in fiscal 1993 due to more funds held on deposit with the factor in 1994.\nINTEREST EXPENSE increased to $255,000 in fiscal 1995 from $128,000 in fiscal 1994 due to increased working capital requirements and borrowings from the Company's Factor. Interest expense increased to $128,000 in fiscal 1994 from $107,000 in fiscal 1993 due to decreased borrowings from the Company's Factor.\nINCOME TAXES in fiscal 1995 includes a valuation allowance of $3,109,000 which is equal to 100% of the net deferred tax asset. This valuation allowance is considered appropriate since the Company cannot conclude that it is more likely than not that the net deferred tax asset will be realized.\nCAPITAL RESOURCES AND LIQUIDITY\nOn June 17, 1995, Georges Marciano agreed to provide $3,300,000 in additional capital to the Company in exchange for 2,640,000 shares of common stock and to convert additional shares of common stock at $1.25 per share in exchange of approximately $700,000 owed by the Company to Mr. Marciano and his affiliates for advances and expenses incurred by them on the Company's behalf, subject in both cases to the receipt of a formal valuation and fairness opinion. Without the infusion of these funds and due to continuing losses, the Company would have completely depleted its working capital by June of 1995. Prior to receipt of the opinion, the Company operated on overdrafts from its factor guaranteed by letters of credit supplied by Mr. Marciano. The opinion, which is included as an exhibit to this Form 10-K was delivered on July 7, 1995 and the Company issued 3,184,693 shares to Mr. Marciano shortly thereafter.\nPrior to the capital infusion and its recent liquidity crisis, the Company had funded its activities principally from cash flow generated from operations and credit facilities with its institutional lender.\nThe Company had an agreement with a factor and through June 1994 with a bank, whereby the factor purchased accounts receivable from the Company on a non-recourse basis and remitted the funds on a maturity basis. The bank provided the Company with an unsecured $3,000,000 facility for commercial letters of credit and at March 31, 1994, the Company had $1,618,000 of letters of credit outstanding. Under the facility agreement, the Company was prohibited from declaring or paying any dividends on any class of its stock.\nThe Company entered into a new factoring agreement with Republic Factors and a letter of credit facility with Republic National Bank of New York (the financing bank) effective through March 1996. Both the old and new agreements are non-recourse (ie, the factor purchases the Company's accounts receivable that it has preapproved, without recourse, except in cases where there are merchandise disputes in the normal course of business).\nUnder the new factoring agreement, the Company sells substantially all of its trade accounts receivable, without recourse, and may request advances, up to 80% on the net sales factored at any time before their maturity date. The factor is responsible for the accounting and collection of all accounts receivable sold to it by the Company and receives a commission of 0.6% of purchased net receivables on a guaranteed minimum volume for the contract year of $30,000,000. The commission rate will increase to 0.75% of total invoices factored and be applied retroactively for the contract year if the guaranteed minimum volume is not attained.\nUnder the letter of credit facility, the financing bank provides a credit line for letters of credit, ledger debt and factor guaranties up to the 80% advance rate provided under the factoring agreement with an additional over advance facility of $1,050,000. Commitments outstanding under the letter of credit facility as of March 31, 1995 amounted to $652,000.\nThe agreements are collateralized by accounts receivable and inventory imported under letters of credit. The Company or the factor may terminate the credit agreement on the anniversary date of the agreement with at least 60 days prior written notice.\nAs of March 31, 1995, the Company had net working capital of $866,000, as compared to $5,250,000 as of March 31, 1994. The Company's current ratio as of March 31, 1995 was 1.3, as compared to 3.0 as of March 31, 1994. The decreases in working capital and current ratio are primarily due to net losses amounting to $4,652,000. Funds due from factor as of March 31, 1995 was $678,000 as compared to $3,383,000 as of March 31, 1994 due to increased working capital requirements.\nInventories at March 31, 1995 were $2,158,000 as compared to $3,213,000 at March 31, 1994, a decrease of $1,055,000. The decrease was due to a reduction of inventories to levels consistent with seasonal requirements, reduced backlog and the discontinuation of various product lines.\nThe Company has funded its activities principally from cash flow generated from operations and credit facilities with its institutional lender.\nIn recent years, the Company has experienced financial difficulties due to major customers filing for reorganization proceedings under bankruptcy laws and the unfavorable economic climate being experienced in the apparel industry. These conditions have had a significant negative impact on the Company's operations being reflected in declining sales and eroding margins, resulting in net losses amounting to $4,652,000 and $2,934,000 in fiscal 1995 and 1994, respectively. On January 31, 1995, control of the Company changed when approximately 80% of the Company's outstanding stock was acquired by affiliates of Georges Marciano. Georges Marciano has subsequently made unsecured non-interest bearing advances from an entity affiliated through common ownership, due on demand, and amounted to $538,000 as of March 31, 1995. Additional material financial difficulties encountered by the Company would require additional borrowing to avoid a negative impact on the Company's future operations.\nThe Company believes that the working capital infusion provided by Georges Marciano and affiliates and the availability of credit under current lending agreements and other financial sources available to it will provide\nsufficient resources to finance the Company's currently anticipated working capital needs and capital expenditures through the end of summer of 1995. Continued financial difficulties encountered by the Company would require additional borrowings and infusions of capital to avoid a negative impact on the Company's continued future operations after that time period.\nThe Company has continued to cut its payroll. It has also reduced other operating costs such as advertising and payroll related costs. Notwithstanding the foregoing measures, the Company anticipates that it may not be profitable for the fiscal year ending March 31, 1996.\nSUBSEQUENT EVENTS\nOn June 17, 1995, Georges Marciano agreed to become Chief Executive Officer and Chairman of the Board of the Company, to provide additional capital for the Company, and to license to YES certain trademarks controlled by Marciano affiliates. The additional capital was received by the Company on July 12, 1995 after receipt of a required valuation opinion.\nAs Chief Executive Officer and Chairman of the Board of YES Clothing Co.(R), Mr. Marciano will receive a salary of $1 per year plus options to acquire 500,000 shares of common stock per year at $1.25 per share for four years (the closing price of the Company's common stock on June 13, 1995) vesting monthly during continued employment. In addition to his duties as Chairman and Chief Executive Officer, Mr. Marciano will supervise all of the Company's design departments.\nMr. Marciano agreed to contribute $3,300,000 in additional capital to the Company in exchange for 2,640,000 shares of common stock and to convert additional shares of common stock at $1.25 per share in exchange of approximately $700,000 owed by the Company to Mr. Marciano and his affiliates for advances and expenses incurred by them on the Company's behalf subject in both cases to the receipt of a formal valuation and fairness opinion. In addition, the Company has granted Mr. Marciano a two-year warrant to acquire an additional 2,000,000 shares at $1.25 per share.\nThe Company has also agreed to enter into five-year trademark license agreements for Mr. Marciano's \"GM Surf(TM)\" and \"Misfits(R)\" lines of clothing at royalties of 7% of gross sales, plus an additional 2% for advertising.\nIn connection with the employment of the principal shareholder as Chief Executive Officer and Chairman of the Board, the Company has granted an option for 500,000 shares per year at $1.25 per share over four years, vesting ratably, expiring in ten years.\nIf all of the shares, warrants and options described above are issued and exercised, Mr. Marciano and his affiliates' ownership of the Company may increase to approximately 93% by the end of four years. Shareholder approval will be sought for the grant of the options and warrant to Mr. Marciano.\nCopies of all of the agreements reflecting the foregoing are attached here to as exhibits.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF MANAGEMENT\nThe accompanying financial statements have been prepared by management in conformity with generally accepted accounting principles, and necessarily include some amounts that are based on management's best estimates and judgments.\nYes Clothing Co. maintains a system of internal accounting controls designed to provide management with reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordance with management's authorization and recorded properly. The concept of reasonable assurance is based on the recognition that the cost of a system of internal control should not exceed the benefits derived and that the evaluation of those factors requires estimates and judgments by management. Further, because of inherent limitations in any system of internal accounting control, errors or irregularities may occur and not be detected. Nevertheless, management believes that a high level of internal control is maintained by Yes Clothing Co. through the selection and training of qualified personnel, and the establishment and communication of accounting and business policies.\nThe Audit Committee of the Board of Directors, composed solely of outside directors, meets periodically with management and with Yes Clothing Co.'s independent auditors to review matters relating to the quality of financial reporting and internal accounting control, and the nature, extent and results of their audits. Yes Clothing Co.'s independent auditors have free access to the Audit Committee.\nGEORGES MARCIANO GUY ANTHOME JEFFREY BUSSE CHAIRMAN, PRESIDENT CHIEF FINANCIAL CHIEF EXECUTIVE OFFICER OFFICER\nREPORT OF CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors Yes Clothing Co.\nWe have audited the accompanying balance sheet of Yes Clothing Co. as of March 31, 1995 and the related statements of operations, changes in shareholders' equity and cash flows for the year then ended. We have also audited the financial statement schedule for the year ended March 31, 1995, listed under item 14. 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 financial position of Yes Clothing Co. 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. In our opinion, the schedule for the year ended March 31, 1995 presents fairly, in all material respects, the information set forth therein.\nMOSS ADAMS\nLos Angeles, California May 24, 1995 (except for Note 1(b), as to which the date is July 12, 1995)\nREPORT OF CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors Yes Clothing Co.\nWe have audited the accompanying balance sheet of Yes Clothing Co. as of March 31, 1994 and the related statements of operations, changes in shareholders' equity and cash flows for each of the two years in the period ended March 31, 1994. We have also audited the financial statement schedules listed under Item 14. 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 presentation. We believe that our 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 Yes Clothing Co. as of March 31, 1994, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 12 to the financial statements, the Company changed its method of accounting for income taxes.\nAlso, in our opinion, the schedules for the years ended March 31, 1994 and 1993 presents fairly, in all material respects, the information set forth therein.\nBDO SEIDMAN, LLP\nLos Angeles, California May 27, 1994 (except for Note 20 which is as of June 21, 1994)\nYES CLOTHING CO.\nBALANCE SHEET\nMARCH 31, 1995 AND 1994\nASSETS\nSee accompanying notes.\nYES CLOTHING CO.\nSTATEMENT OF OPERATIONS\nYEARS ENDED MARCH 31, 1995, 1994, AND 1993\nSee accompanying notes.\nYES CLOTHING CO.\nSTATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY\nYEARS ENDED MARCH 31, 1995, 1994 AND 1993\nSee accompanying notes.\nYES CLOTHING CO.\nSTATEMENT OF CASH FLOWS\nYEARS ENDED MARCH 31, 1995, 1994 AND 1993\nSee accompanying notes.\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS\nMARCH 31, 1995 AND 1994\nNOTE 1--ORGANIZATION AND FINANCIAL CONDITION\nA) ORGANIZATION--Yes Clothing Co.(R) (the \"Company\") was incorporated on July 1, 1982, in the State of California. The Company designs, manufactures and markets a diversified line of apparel primarily for women and young men. The Company sells its garments throughout the United States and Canada to retail department stores, specialty chains and specialty stores.\nThe Company also arranged for the manufacture, in the Orient, of certain of its styles, which are shipped directly from the manufacturer to customers in the United States, Europe and Japan. In connection therewithin, the Company received a percentage of the sales price charged by the manufacturer and recognized this amount as commission income in the accompanying statement of operations. Subsequent to the acquisition transaction as described below, the Company discontinued these commission transactions.\nIn January 1995, control of the Company changed when its two principal shareholders sold all of their shares, amounting to approximately 80% of the Company's outstanding stock, to affiliates of an individual. This transaction is herein referred to as the \"Acquisition Transaction\" and the collective new majority interest as the \"Principal Shareholder\". The principal shareholder currently holds approximately 88% of the Company's outstanding stock.\nB) FINANCIAL CONDITION--The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. The Company sustained a substantial loss for the year ended March 31, 1995 and has experienced operating and net losses each year since 1992. The operating results for the three months ended June 30, 1995 are anticipated to reflect continued net losses. At this time, the Company is not able to sustain operations without a significant infusion of capital. The Company is currently operating on short-term overdrafts provided by the factor (Note 3) which are guaranteed by limited letters of credit totaling $2,000,000 supplied by the principal shareholder.\nIn June 1995, the Company's principal shareholder expressed an intent to provide additional capital in return for common stock, stock option, warrant and other considerations. The Company's Board of Directors has approved the transaction which was consummated after receipt of a formal valuation and fairness opinion (the grant of options remains subject to shareholder approval.) The significant terms of the transaction are as follows:\n. Contribution of $3,300,000 cash in exchange for common stock at $1.25 per share.\n. Conversion of amounts owed to the principal shareholder and his affiliate (Note 10) into approximately 560,000 shares of common stock, at a rate of $1.25 per share.\n. Issuance of 2,000,000 common stock warrant immediately exercisable, expiring in two years, at $1.25 per share.\n. Five year trademark license agreement with affiliates of the principal shareholder for \"GM Surf(TM)\" and \"Misfits(R)\" lines at a royalty rate of 7% of gross sales plus 2% for advertising.\n. In connection with the employment of the principal shareholder as Chief Executive Officer and Chairman of the Board, the Company has granted an option for 500,000 shares per year at $1.25 per share over four years, vesting ratably, expiring in ten years.\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994\nNOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nINVENTORIES--Inventories are stated at the lower of cost (first-in, first-out basis) or market.\nDEPRECIATION AND AMORTIZATION--Depreciation and amortization of property and equipment are provided principally by the straight-line method over the following estimated useful lives:\nINCOME TAXES--Income taxes are accounted for using an asset and liability approach. Deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Income taxes are further explained in Note 13.\nLOSS PER SHARE--Loss per share is based on the weighted average number of shares of common stock outstanding during each period. Stock options have not been considered in the loss per share calculations since the effect would be antidilutive.\nSTATEMENT OF CASH FLOWS--For purposes of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents, including matured funds held by the factor.\nNOTE 3--TRANSACTIONS WITH FACTOR AND BANK BORROWING\nThe Company has a factoring agreement with a factor and a letter of credit facility with a related financing bank through March 1996. Under the factoring agreement, the Company sells substantially all of its trade accounts receivable, without recourse, and may request advances, up to 80%, on the net sales factored at any time before their maturity date. Under the letter of credit facility, the financing bank provides a credit line for letters of credit, ledger debt and factor guarantees up to the 80% advance rate provided under the factoring agreement with an additional overadvance facility of $1,050,000.\nThe factor charges a commission on the net sales factored and interest on advances at prime plus a negotiated rate. The agreements are collateralized by accounts receivable and inventory imported under letters of credit.\nOpen letters of credit at March 31, 1995 amounted to $426,000. Included in accounts payable at March 31, 1995 is $226,000 due to the factor for piece good purchases.\nDue from factor consists of the following:\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994\nNOTE 3--TRANSACTIONS WITH FACTOR AND BANK BORROWING (CONTINUED)\nDuring fiscal 1995, the maximum amount of advances outstanding was approximately $3,770,000. The average advances based upon month-end balances, was approximately $2,665,000. The average cost of borrowing, which includes factoring commission and interest, was approximately 17.2% during 1995.\nNOTE 4--ACCOUNTS RECEIVABLE\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994 NOTE 9--CONTRACTS PAYABLE\nThe Company leases equipment under capital leases which expire on various dates through March 1998. The remaining obligations under these capital leases for future years ended March 31 are as follows:\nEquipment under capital leases and related accumulated depreciation amount to $248,000 and $98,000, respectively.\nNOTE 10--DUE TO RELATED PARTY\nAn unsecured $330,000 note payable to the principal shareholder bears interest at the lessor of 8% or the prime rate of interest less 1%. The note is due thirteen months from demand or on the closing date of a public offering or private placement with gross proceeds of at least $6 million and at not less than $6 per share.\nUnsecured non-interest bearing advances of $208,000 were made to the Company by an entity affiliated through common ownership with the principal shareholder.\nAs indicated in Note 1, these amounts were converted to common stock subsequent to March 31, 1995.\nNOTE 11--COMMITMENTS\nThe Company leases its office, warehouse, retail store and showrooms under various operating leases expiring through August 1999. Minimum payments under non-cancelable operating leases for future years ending March 31 are as follows:\nRent expense for the years ended March 31, 1995, 1994 and 1993, was approximately $609,000 (net of $115,000 sublease income), $593,000 and $639,000, respectively.\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994\nNOTE 12--EMPLOYEE BENEFIT PLAN\nThe Company has a profit sharing plan for the benefit of qualified employees. The amount of the contribution to the plan is discretionary and is determined annually by the Board of Directors. The Company has not accrued contributions for the years ended March 31, 1995 or 1994. In 1993, the Company contributed $374,000 to the Plan.\nEffective February 14, 1995, the Company terminated the plan pending IRS approval. The net assets of the plan will be distributed to participants according to their account balances.\nNOTE 13--INCOME TAXES\nIncome taxes are summarized as follows:\nThe primary differences between the income tax provision (benefit) computed at the U.S. statutory corporate income tax rate and the effective income tax rate are as follows:\nEffective at the beginning of fiscal 1994, the Company changed its method of accounting for income taxes by adopting the provisions of Financial Accounting Standards Statement No. 109. The cumulative effect on prior years of this change was not significant.\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994 NOTE 13--INCOME TAXES (CONTINUED)\nAt March 31, 1995 and 1994, deferred tax assets and liabilities are comprised of the following elements:\nThe Company has established a valuation allowance equal to the net deferred tax asset as the Company cannot conclude that it is more likely than not that the net deferred tax asset will be realized.\nThe Federal and State net operating loss carryforwards of approximately $6,550,000 and $8,286,000, respectively, expire from the years 2007 through 2010. Because ownership of the Company changed control during the year, a portion of the net operating loss carryforwards will be limited. Approximately $5,826,000 and $7,598,000 of Federal and State net operating losses, respectively, are subject to a maximum annual utilization totalling approximately $522,000.\nDeferred income taxes arise from temporary differences between financial and tax reporting. The effects of these differences on income taxes are as follows:\nYES CLOTHING CO.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nMARCH 31, 1995 AND 1994\nNOTE 14--SHAREHOLDERS' EQUITY\nSTOCK OPTION PLAN--The Company has a stock option plan (the \"Plan\") for key employees, directors, officers and consultants of the Company. The plan provides for the issuance of up to 400,000 shares of common stock. Outstanding options are exercisable for a period of up to ten years and one week from the date of grant. Activity under this plan for 1993 through 1995 is as follows:\nAt March 31, 1995, there are 125,000 options exercisable at prices from $1.88 to $6.00 per share; 30,000 options at prices of $1.88 and $3.00 were subsequently exercised. As indicated in Note 1, subsequent to March 31, 1995, 4,000,000 additional options have been granted, subject to shareholder approval, at an exercise price of $1.25 per share.\nREPURCHASE OF STOCK OPTIONS--In conjunction with the change of principal ownership in January 1995, the Company repurchased various stock options for a total of $330,000. Funds for this transaction were provided by the new principal shareholder (Note 10).\nBUY BACK OF LICENSE AGREEMENTS--In connection with the change in principal ownership in 1995, the Company reacquired certain licenses for a total of $295,000. This amount is reflected as an \"other expense\" in the statement of operations.\nNOTE 15--INSURANCE RECOVERIES\nSubsequent to March 31, 1992, the Company incurred the loss of substantially all of its finished goods inventory in connection with civil disturbances in the City of Los Angeles. During the fiscal year ended March 31, 1993 the Company recovered from one insurance company, the cost of the inventory lost and its normal gross profit which would have been derived from the sale of those goods. For the years ended March 31, 1995 and 1994, the Company recovered a net $63,000 and $1,658,000, respectively, from a second insurance company for business interruption losses related to the civil disturbances.\nNOTE 16--OTHER RELATED PARTY TRANSACTIONS\nA law firm in which one member of the Board of Directors is a partner, was paid $93,000, $62,000 and $50,000 for legal services for the years ended March 31, 1995, 1994 and 1993, respectively. This Board member resigned effective May 16, 1995.\nOne former member of the Board of Directors served as a consultant to the Company and was paid $111,000 for consulting services for the year ended March 31, 1994, $100,000 of which was a special bonus in connection with the settlement of the Company's business interruption claim (Note 15), and $6,000 and $7,000 annually for the years ended March 31, 1995 and 1993, respectively. Another former member of the Board of Directors served as a consultant to the Company and was paid $4,000 for consulting services for the year ended March 31, 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\nInformation required by this item is hereby incorporated by reference to the Company's proxy statement to be filed pursuant to Regulation 14A which involves the election of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required by this item is hereby incorporated by reference to the Company's proxy statement to be filed pursuant to Regulation 14A which involves the election of Directors.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is hereby incorporated by reference to the Company's proxy statement to be filed pursuant to Regulation 14A which involves the election of Directors.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is hereby incorporated by reference to the Company's proxy statement to be filed pursuant to Regulation 14A which involves the election of Directors.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBIT, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS AND SCHEDULES\nThe following financial statements of Yes Clothing Co. are included in Item 8:\nBalance sheet\nStatement of operations\nStatement of changes in shareholders' equity\nStatement of cash flows\nNotes to financial statements\nFinancial Statement Schedule:\nII--Valuation and qualifying accounts\nEXHIBITS\nSee index to exhibits.\nREPORTS ON FORM 8-K\nMarciano transaction January 31, 1995.\nYES CLOTHING CO.\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED MARCH 31, 1995, 1994 AND 1993\n- -------- (a) Represents net write-offs of uncollectible accounts against the allowance. (b) Represents write-offs of uncollectible accounts against the reserve.\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.\nYES Clothing Co.\nBy: Georges Marciano ---------------------------------- CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER\nJuly 12, 1995\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nSIGNATURE TITLE DATE\nGeorges Marciano Chairman of the Board July 12, 1995 - ------------------------------------- Chief Executive GEORGES MARCIANO Officer and Director PRINCIPAL EXECUTIVE OFFICER\nGuy Anthome President and Director July 12, 1995 - ------------------------------------- GUY ANTHOME\nJeffrey P. Busse Chief Financial July 12, 1995 - ------------------------------------- Officer and Director JEFFREY P. BUSSE PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER\nIrving B. Kroll Director July 12, 1995 - ------------------------------------- IRVING B. KROLL\nMaurice Schoenholz Director July 12, 1995 - ------------------------------------- MAURICE SCHOENHOLZ\nINDEX TO EXHIBITS\n- -------- *Management contract or executive compensation plan or arrangement. (1) Filed as an exhibit to the annual Report on Form 10-K for the fiscal year ended March 31, 1990, and incorporated herein by this reference. (2) Filed as an exhibit to the annual Report on Form 10-K for the fiscal year ended March 31, 1991 and incorporated herein by this reference. (3) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended March 31, 1992, and incorporated herein by this reference. (4) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended March 31, 1993 and incorporated herein by this reference. (5) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended March 31, 1994.","section_15":""}
{"filename":"52428_1995.txt","cik":"52428","year":"1995","section_1":"Item 1. Business\nIDS Certificate Company (IDSC) is incorporated under the laws of Delaware. Its principal executive offices are located in the IDS Tower, Minneapolis, Minnesota, and its telephone number is (612) 671-3131. American Express Financial Corporation (formerly know as IDS Financial Corporation), a Delaware corporation, IDS Tower 10, Minneapolis, Minnesota 55440-0010, owns 100% of the outstanding voting securities of IDSC. As of January 1, 1995, IDS Financial Corporation changed its name to American Express Financial Corporation. American Express Financial Corporation is a wholly owned subsidiary of American Express Company (American Express), a New York Corporation, with headquarters at American Express Tower, World Financial Center, New York, New York.\nIDSC is a face-amount certificate investment company registered under the Investment Company Act of 1940 (1940 Act). IDSC is in the business of issuing face-amount certificates. Face-amount certificates issued by IDSC entitle the certificate owner to receive, at maturity, a stated amount of money and interest or credits declared from time to time by IDSC, in its discretion.\nIDSC is continuously engaged in new product development. IDSC currently offers seven certificates to the public: \"IDS Future Value Certificate\", \"IDS Cash Reserve Certificate\", \"IDS Flexible Savings Certificate\" (formerly \"IDS Variable Term Certificate\"), \"IDS Installment Certificate\", \"IDS Stock Market Certificate\", \"IDS Investors Certificate\" and \"IDS Special Deposits\". The IDS Special Deposits is only offered for sale in England and is not registered for sale in the United States. All certificates are currently sold without a sales charge. The IDS Installment Certificate, the IDS Flexible Savings Certificate, the IDS Stock Market Certificate, the IDS Investors Certificate and the IDS Special Deposits currently bear surrender charges for premature surrenders. All of the above described certificates, except the IDS Special Deposits, are distributed pursuant to a Distribution Agreement with American Express Financial Advisors Inc. (formerly known as IDS Financial Services Inc.), an affiliate of IDSC. With respect to the IDS Investors Certificate and the IDS Stock Market Certificate, American Express Financial Advisors Inc., in turn, has Selling Agent Agreements with American Express Bank International (AEBI), a subsidiary of American Express, and Coutts & Co. (USA) International (Coutts), a subsidiary of NatWest PLC, for selling the certificates. American Express Financial Advisors Inc. also distributes the IDS Stock Market Certificate. With respect to the IDS Special Deposits, IDSC has a Marketing Agreement with American Express Bank Ltd. (AEB), a subsidiary of American Express, for marketing the certificate. IDSC's board of directors has approved a Distribution Agreement with American Express Service Corporation (AESC) under which AESC could distribute IDS Stock Market Certificate and potentially other IDS certificates through a direct marketing channel of distributions, but there is no assurance that IDS certificates will be so distributed. AEBI and Coutts are Edge Act corporations organized under the provisions of Section 25(a) of the Federal Reserve Act. American Express Financial Advisors Inc. has entered into a consulting agreement with AEBI under which AEBI provides consulting services related to any selling agent agreements between American Express Financial Advisors Inc. and other Edge Act corporations.\nIDSC also offers one certificate in connection with certain employee benefit plans available to eligible American Express Financial Corporation employees, financial advisors and retirees. This certificate is called the Series D-1 Investment Certificate.\nExcept for the IDS Investors Certificate and the IDS Special Deposits, all of the certificates are available as qualified investments for Individual Retirement Accounts (IRAs), or 401(k) plans and other qualified retirement plans.\nThe specified maturities of the certificates range from four to twenty years. Within that maturity period, most certificates have terms ranging from three to thirty-six months. Interest rates change and certificate owners can surrender their certificates without penalty at term end.\nThe IDS Future Value Certificate is a single payment certificate on which IDSC guarantees interest in advance for a 4, 5, 6, 7, 8, 9 or 10-year maturity, at the buyer's option.\nThe IDS Cash Reserve Certificate is a single pay certificate that permits additional investments and on which IDSC guarantees interest in advance for a three-month term.\nThe IDS Flexible Savings Certificate is a single payment certificate that permits a limited amount of additional payments and on which IDSC guarantees interest in advance for a term of 6, 12, 18, 24, 30 or 36 months, and potentially other terms, at the buyer's option.\nThe IDS Installment Certificate is an installment payment certificate that declares interest in advance for a three-month period and offers bonuses in the third through sixth years for regular investments.\nThe IDS Stock Market Certificate is a single payment certificate that offers the certificate owner the opportunity to have all or part of his\/her interest tied to stock market performance, as measured by a broad stock market index, with return of principal guaranteed by IDSC. After the first term, the holder can also choose to earn a fixed rate of interest. In addition to being sold to clients of American Express Financial Advisors Inc. pursuant to a Distribution Agreement with American Express Financial Advisors Inc., this certificate is sold by AEBI and Coutts under Selling Agent Agreements with American Express Financial Advisors Inc. to AEBI's clients and certain of Coutts' clients, respectively, who are neither citizens nor residents of the United States.\nThe IDS Investors Certificate is a single payment certificate that generally permits additional payments within 15 days of term renewal. Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3, 6, 12, 24 or 36 months, at the buyer's option. This certificate is currently sold by AEBI and Coutts, through Selling Agent Agreements with American Express Financial Advisors Inc., only to AEBI's clients and certain of Coutts' clients, respectively, who are neither citizens nor residents of the United States.\nThe IDS Special Deposits is a single payment certificate that generally permits additional payments within 15 days of term renewal. Interest rates are guaranteed in advance by IDSC for a term of 1, 2, 3, 6, 12, 24 or 36 months, at the buyer's option. This certificate is currently marketed by AEB in the London office, through a Marketing Agreement with IDSC, only to AEB's clients who are neither citizens nor residents of the United States. This certificate is not registered for sale in the United States.\nIDSC is by far the largest issuer of face-amount certificates in the United States. However, such certificates compete with many other investments offered by banks, savings and loan associations, mutual funds, broker-dealers and others, which may be viewed by potential clients as offering a comparable or superior combination of safety and return on investment. In particular, some of IDSC's products are designed to be competitive with the types of investment offered by banks and thrifts. Since IDSC's face-amount certificates are securities, their offer and sale are subject to regulation under federal and state securities laws. IDSC's certificates are backed by its qualified assets on deposit and are not insured by any governmental agency or other entity.\nFor all of the certificates, except for the IDS Investors Certificate and the IDS Special Deposits, IDSC's current policy is to re-evaluate the certificate rates weekly to respond to marketplace changes. For the IDS Investors Certificate and the IDS Special Deposits, IDSC's current policy is to re-evaluate the rates on a daily basis. For each product, IDSC refers to an independent index to set the rates for new sales. Except for IDS Special Deposits, IDSC must set the rates for an initial purchase of the certificate within a specified range of the rate from such index. For renewals, IDSC uses such rates as an indication of the competitors' rates, but is not required to set rates within a specified range.\nFor the IDS Flexible Savings Certificate, IDS Future Value Certificate, IDS Cash Reserve Certificate and the IDS Series D-1 Investment Certificate, the published rates of the BANK RATE MONITOR Top 25 Market Averagetm for various length bank certificates of deposit are used as the guide in setting rates. For the IDS Installment Certificate, the average interest rate for money market deposit accounts, as published by the BANK RATE MONITOR Top 25 Market Average (the BRM Average), is used as a guide in setting rates. For the IDS Investors Certificate and IDS Special Deposits, the published average rates for comparable length dollar deposits available on an interbank basis, referred to as the London Interbank Offered Rates (LIBOR), are used as a guide in setting rates. To compete with popular short-term investment vehicles such as certificates of deposit, money market certificates and money market mutual funds that offer comparable yields, liquidity and safety of principal, IDSC offers the IDS Cash Reserve Certificate and the IDS Flexible Savings Certificate. The yields and features on these products are designed to be competitive with such short-term products. The IDS Investors Certificate and IDS Special Deposits also compete with short-term products but use LIBOR rates. The IDS Future Value Certificate has certain features similar to those of zero coupon bonds and is intended to compete with that type of investment as well as with intermediate to long-term certificates of deposit. The IDS Installment Certificate is intended to help clients save systematically and may compete with passbook savings and NOW accounts. The IDS Stock Market Certificate is designed to offer interest tied to a major stock market index and principal guaranteed by IDSC. Certain banks offer certificates of deposit that have features similar to the Stock Market Certificate.\nIDSC's gross income is derived principally from interest and dividends generated by its investments. IDSC's net income is determined by deducting from such gross income its provision for certificate reserves, and other expenses, including taxes, the fee paid to American Express Financial Corporation for advisory and other services, the distribution fees paid to American Express Financial Advisors Inc., and marketing fees paid to AEB.\nThe following table shows IDSC's certificate payments received and certificate surrenders for the three years ended December 31, 1995:\n1995 1994 1993 Single Payment Certificates ($ in millions) Non-Qualified Payments through American Express Financial Advisors Inc. $1,090.0 $ 802.4 $ 581.5 AEBI, AEB and Coutts 429.4 436.0 243.0 Surrenders through American Express Financial Advisors Inc. 662.0 753.6 882.8 AEBI, AEB and Coutts 292.0 429.2 395.3 Qualified Payments through American Express Financial Advisors Inc. 236.0 264.9 166.8 Surrenders through American Express Financial Advisors Inc. 205.5 238.5 276.7\nInstallment Payment Certificates - through American Express Financial Advisors Inc.\nNon-Qualified Payments 109.5 107.6 108.2 Surrenders 112.4 116.6 103.6 Qualified Payments 1.9 2.9 3.9 Surrenders 4.8 7.8 8.0 In 1995, approximately 25% of single payment certificate payments were through AEBI, AEB and Coutts and approximately 14% of single payment certificate payments and 2% of installment certificate payments were of tax-qualified certificates for use in IRAs, 401(k) plans and other qualified retirement plans.\nThe certificates offered by American Express Financial Advisors Inc. are sold pursuant to a distribution agreement which is terminable on 60 days' notice and is subject to annual approval by IDSC's Board of Directors, including a majority of the directors who are not \"interested persons\" of American Express Financial Advisors Inc. or IDSC as that term is defined in the 1940 Act. The agreement provides for the payment of distribution fees to American Express Financial Advisors Inc. for services provided thereunder. American Express Financial Advisors Inc. is a wholly owned subsidiary of American Express Financial Corporation. For the distribution of the IDS Investors Certificate, American Express Financial Advisors Inc., in turn, has Selling Agent Agreements with AEBI and Coutts. For marketing IDS Special Deposits, IDSC has a Marketing Agreement with AEB. These agreements are terminable upon 60 days' notice and subject to annual review by the directors who are not \"interested persons\" of American Express Financial Advisors Inc. or IDSC.\nIDSC receives advice, statistical data and recommendations with respect to the acquisition and disposition of securities for its portfolio from American Express Financial Corporation, under an investment management agreement which is subject to annual renewal by IDSC's Board of Directors, including a majority of the directors who are not \"interested persons\" of American Express Financial Corporation or IDSC.\nIDSC is required to maintain \"qualified investments\" meeting the standards of Section 28(b) of the 1940 Act. The amortized cost of said investments must be at least equal to IDSC's net liabilities on all outstanding face-amount certificates plus $250,000. IDSC's qualified assets consist of cash and cash equivalents, first mortgage loans on real estate, U.S. government and government agency securities, municipal bonds, corporate bonds, preferred stocks and other securities meeting specified standards. IDSC is subject to annual examination and supervision by the State of Minnesota, Department of Commerce (Banking Division).\nDistribution fees on sales of certain certificates are deferred and amortized over the estimated lives of the related certificates, which is approximately 10 years. Upon surrender, unamortized deferred distribution fees are charged against income. Thus, these certificates must remain in effect for a period of time to permit IDSC to recover such costs.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nNone.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRegistrant has no material pending legal proceedings other than ordinary routine litigation incidental to its business.Item 4.","section_4":"","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThere is no market for the Registrant's common stock since it is a wholly owned subsidiary of American Express Financial Corporation and, indirectly, of American Express. Frequency and amount of dividends declared during the past two years are as follows:\nDividend Payable Date Cash\nFor year ended December 31, 1995: $ None\nDividend Payable Date Cash\nFor year ended December 31, 1994: February 10, 1994 $12,400,000 May 10, 1994 12,400,000 August 10, 1994 12,400,000 December 29, 1994 3,000,000 Total $40,200,000\nRestriction on the Registrant's present or future ability to pay dividends:\nCertain series of installment certificates outstanding provide that cash dividends may be paid by IDSC only in calendar years for which additional credits of at least 1\/2 of 1% on such series of certificates have been authorized by IDSC. This restriction has been removed for 1996 and 1997 by action of IDSC on additional credits in excess of this requirement.\nAppropriated retained earnings resulting from the predeclaration of additional credits to IDSC's certificate holders are not available for the payment of dividends by IDSC. In addition, IDSC will discontinue issuance of certificates subject to the predeclaration of additional credits and will make no further predeclaration as to outstanding certificates if at any time the capital and unappropriated retained earnings of IDSC should be less than 5% of net certificate reserves (certificate reserves less certificate loans). At December 31, 1995, the capital and unappropriated retained earnings amounted to 5.65% of net certificate reserves. Item 6.","section_6":"Item 6. Selected Financial Data\nSummary of selected financial information\nThe following selected financial information has been derived from the audited financial statements and should be read in conjunction with those statements and the related notes to financial statements. Also see Management's Discussion and Analysis of Financial Condition and Results of Operations for additional comments.\nSee notes to financial statements.\nNotes to Financial Statements ($ in thousands unless indicated otherwise)\n1. Nature of business and summary of significant accounting policies\nNature of business\nIDS Certificate Company (IDSC) is a wholly owned subsidiary of American Express Financial Corporation (Parent), which is a wholly owned subsidiary of American Express Company. IDSC is registered as an investment company under the Investment Company Act of 1940 (\"the 1940 Act\") and is in the business of issuing face-amount investment certificates. The certificates issued by IDSC are not insured by any government agency. IDSC's certificates are sold primarily by American Express Financial Advisors Inc.'s (an affiliate) field force operating in 50 states, the District of Columbia and Puerto Rico. IDSC's Parent acts as investment advisor for IDSC.\nIDSC currently offers eight types of certificates with specified maturities ranging from four to twenty years. Within their specified maturity, most certificates have interest rate terms of one to thirty-six months. In addition, one type of certificate has interest tied, in whole or in part, to any upward movement in a broad-based stock market index. Except for two types of certificates, all of the certificates are available as qualified investments for Individual Retirement Accounts or 401(k) plans and other qualified retirement plans.\nIDSC's gross income is derived primarily from interest and dividends generated by its investments. IDSC's net income is determined by deducting from such gross income its provision for certificate reserves, and other expenses, including taxes, the fee paid to Parent for investment advisory and other services, and the distribution fees paid to American Express Financial Advisors Inc.\nDescribed below are certain accounting policies that are important to an understanding of the accompanying financial statements.\nBasis of financial statement presentation\nThe accompanying financial statements are presented in accordance with generally accepted accounting principles. IDSC uses the equity method of accounting for its wholly owned unconsolidated subsidiary, which is the method prescribed by the Securities and Exchange Commission (SEC) for issuers of face-amount certificates. Certain amounts from prior years have been reclassified to conform to the current year 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 and the reported amounts of income and expenses during the year then ended. Actual results could differ from those estimates.\nFair values of financial instruments\nThe fair values of financial instruments disclosed in the notes to financial statements are estimates based upon current market conditions and perceived risks, and require varying degrees of management judgment.\nPreferred stock dividend income\nIDSC recognizes dividend income from cumulative redeemable preferred stocks with fixed maturity amounts on an accrual basis similar to that used for recognizing interest income on debt securities.\nSecurities\nCash equivalents are carried at amortized cost, which approximates fair value. IDSC has defined cash and cash equivalents as cash in banks and highly liquid investments with a maturity of three months or less at acquisition and are not interest rate sensitive.\nDebt securities that IDSC has both the positive intent and ability to hold to maturity are carried at amortized cost. Debt securities IDSC does not have the positive intent to hold to maturity, as well as 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, net of deferred income taxes, as a separate component of stockholder's equity.\nThe basis for determining cost in computing realized gains and losses on securities is specific identification. When there is a decline in value that is other than temporary, the securities are carried at estimated realizable value with the amount of adjustment included in income.\nFirst mortgage loans on real estate\nMortgage loans are carried at amortized cost, less reserves for losses, which is the basis for determining any realized gains or losses.\nCertificates\nInvestment certificates may be purchased either with a lump-sum payment or by installment payments. Certificate holders are entitled to receive at maturity a definite sum of money. Payments from certificate holders are credited to investment certificate reserves. Investment certificate reserves accumulate at specified percentage rates. Reserves also are maintained for advance payments made by certificate holders, accrued interest thereon, and for additional credits and accrued interest thereon. On certificates allowing for the deduction of a surrender charge, the cash surrender values may be less than accumulated investment certificate reserves prior to maturity dates. Cash surrender values on certificates allowing for no surrender charge are equal to certificate reserves. The payment distribution, reserve accumulation rates, cash surrender values, reserve values and other matters are governed by the 1940 Act.\nDeferred distribution fee expense\nOn certain series of certificates, distribution fees are deferred and amortized over the estimated lives of the related certificates, which is approximately 10 years. Upon surrender, unamortized deferred distribution fees are charged against income.\nFederal income taxes\nIDSC's taxable income or loss is included in the consolidated federal income tax return of American Express Company. IDSC provides for income taxes on a separate return basis, except that, under an agreement between Parent and American Express Company, tax benefits are recognized for losses to the extent they can be used in the consolidated return. It is the policy of Parent and its subsidiaries that Parent will reimburse a subsidiary for any tax benefits recorded.\n2. Deposit of assets and maintenance of qualified assets\nA) Under the provisions of its certificates and the 1940 Act, IDSC was required to have qualified assets (as that term is defined in Section 28(b) of the 1940 Act) in the amount of $3,619,188 and $2,895,226 at Dec. 31, 1995 and 1994, respectively. IDSC had qualified assets of $3,838,482 at Dec. 31, 1995 and $3,040,416 at Dec. 31, 1994, excluding net unrealized appreciation on available-for-sale securities of $45,265 at Dec. 31, 1995 and net unrealized depreciation of $35,627 at Dec. 31, 1994.\nQualified assets are valued in accordance with such provisions of Minnesota Statutes as are applicable to investments of life insurance companies. Qualified assets for which no provision for valuation is made in such statutes are valued in accordance with rules, regulations or orders prescribed by the SEC. These values are the same as financial statement carrying values, except for debt securities classified as available for sale and all marketable equity securities, which are carried at fair value in the financial statements but are valued at amortized cost for qualified asset and deposit maintenance purposes.\nB) Pursuant to provisions of the certificates, the 1940 Act, the central depositary agreement and to requirements of various states, qualified assets of IDSC were deposited as follows:\nThe assets on deposit at Dec. 31, 1995 and 1994 consisted of securities having a deposit value of $3,435,074 and $2,659,676, respectively; mortgage loans of $229,554 and $252,263, respectively; and other assets of $14,081 and $28,016, respectively. Mortgage loans on deposit include an affiliated mortgage loan.\nAmerican Express Trust Company is the central depositary for IDSC. See note 7C.\n3. Investments in securities\nA) Fair values of investments in securities represent market prices and estimated fair values when quoted prices are not available. Estimated fair values are determined by IDSC using established procedures, involving review of market indexes, price levels of current offerings and comparable issues, price estimates and market data from independent brokers and financial files. The procedures are reviewed annually. IDSC's vice president - investments reports to the board of directors on an annual basis regarding such pricing sources and procedures to provide assurance that fair value is being achieved.\nThe following is a summary of securities held to maturity and securities available for sale at Dec. 31, 1995 and Dec. 31, 1994.\nThe amortized cost and fair value of securities held to maturity and available for sale, by contractual maturity, at Dec. 31, 1995, are shown below. Cash flows will differ from contractual maturities because issuers may have the right to call or prepay obligations.\nSales of held-to-maturity securities, due to significant credit deterioration, during the years ended Dec. 31, 1995 and 1994, were as follows:\nDuring the year ended Dec. 31, 1995, securities with an amortized cost and fair value of $111,967 and $116,882, respectively, were reclassified from held to maturity to available for sale. The reclassification was made on Dec. 4, 1995, as a result of IDSC adopting the FASB Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\"\nB) Investments in securities with fixed maturities comprised 90% and 84% of IDSC's total invested assets at Dec. 31, 1995 and 1994, respectively. Securities are rated by Moody's and Standard & Poors (S&P), or by Parent's internal analysts, using criteria similar to Moody's and S&P, when a public rating does not exist. A summary of investments in securities with fixed maturities by rating of investment is as follows:\nOf the securities rated Aaa\/AAA, 92% at Dec. 31, 1995 and 88% at Dec. 31, 1994 are U.S. Government Agency mortgage-backed securities that are not rated by a public rating agency. Approximately 11% at Dec. 31, 1995 and 17% at Dec. 31, 1994 of other securities with fixed maturities are rated by Parent's internal analysts. At Dec. 31, 1995 and 1994 no one issuer, other than U.S. Government Agency mortgage-backed securities, is greater than 1% of IDSC's total investment in securities with fixed maturities.\nC) IDSC reserves freedom of action with respect to its acquisition of restricted securities that offer advantageous and desirable investment opportunities. In a private negotiation, IDSC may purchase for its portfolio all or part of an issue of restricted securities. Since IDSC would intend to purchase such securities for investment and not for distribution, it would not be acting as a distributor if such securities are resold by IDSC at a later date.\nThe fair values of restricted securities are determined by the board of directors using the procedures and factors described in paragraph A of note 3.\nIn the event IDSC were to be deemed to be a distributor of the restricted securities, it is possible that IDSC would be required to bear the costs of registering those securities under the Securities Act of 1933, although in most cases such costs would be borne by the issuer of the restricted securities.\n4. Investments in first mortgage loans on real estate\nAs of Jan. 1, 1995, IDSC adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS No. 114), as amended by Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\" (SFAS No. 118). The adoption of the new rules did not have a material impact on IDSC's results of operations or financial condition.\nSFAS No. 114 applies to all loans except for smaller-balance homogeneous loans that are collectively evaluated for impairment. Impairment is measured as the excess of the loan's recorded investment over its present value of expected principal and interest payments discounted at the loan's effective interest rate, or the fair value of collateral. The amount of the impairment is recorded in a reserve for loss on mortgage loans.\nBased on management's judgment as to the ultimate collectibility of principal, interest payments received are either recognized as income or applied to the recorded investment in the loan until it has been recovered.\nThe reserve for loss on mortgage loans is maintained at a level that management believes is appropriate to absorb estimated credit losses in the mortgage loan portfolio. The level of the reserve account is determined based on several factors, including historical experience, expected future principal and interest payments, estimated collateral values, and current and anticipated economic and political conditions. Management regularly evaluates the adequacy of the reserve for loss on mortgage loans.\nAt Dec. 31, 1995, IDSC's recorded investment in impaired mortgage loans was $1,004 and the reserve for loss on that amount was $611. During 1995, the average recorded investment in impaired mortgage loans was $1,052.\nIDSC recognized $53 of interest income related to impaired mortgage loans for the year ended Dec. 31, 1995.\nThere were no changes in the reserve for loss on mortgage loans of $611 during the year ended Dec. 31, 1995.\nAt Dec. 31, 1995 and 1994, approximately 6% and 9%, respectively, of IDSC's invested assets were first mortgage loans on real estate.\nA summary of first mortgage loans by region and by type of real estate is as follows:\nThe carrying amounts and fair values of first mortgage loans on real estate are as follows at Dec. 31. The fair values are estimated using discounted cash flow analysis, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.\nAt Dec. 31, 1995 and 1994, there were no commitments for fundings of first mortgage loans. If there were any commitments, IDSC employs policies and procedures to ensure the creditworthiness of the borrowers and that funds will be available on the funding date. IDSC's first mortgage loan fundings are restricted to 75% or less of the market value of the real estate at the time of the loan funding. 5. Certificate reserves\nReserves maintained on outstanding certificates have been computed in accordance with the provisions of the certificates and Section 28 of the 1940 Act. The average rates of accumulation on certificate reserves at Dec. 31, 1995 and 1994 were:\nA) There is no minimum rate of accrual on these reserves. Interest is declared periodically, quarterly or annually, in accordance with the terms of the separate series of certificates.\nB) On certain series of single payment certificates, additional interest is predeclared for periods greater than one year. At Dec. 31, 1995, $18,878 of retained earnings had been appropriated for the predeclared additional interest, which represents the difference between certificate reserves on these series, calculated on a statutory basis, and the reserves maintained per books.\nC) Certain series of installment certificates guarantee accrual of interest on advance payments at an average of 3.13%. IDSC has increased the rate of accrual to 4.85% through April 30, 1997. An appropriation of retained earnings amounting to $50 has been made, which represents the estimated additional accrual that will result from the increase granted by IDSC.D) IDS Stock Market Certificate enables the certificate holder to participate in any relative rise in a major stock market index without risking loss of principal. Generally the certificate has a term of 12 months and may continue for up to 14 successive terms. The reserve balance at Dec. 31, 1995 and 1994 was $211,093 and $263,494, respectively.\nE) The carrying amounts and fair values of certificate reserves consisted of the following at Dec. 31, 1995 and 1994. Fair values of certificate reserves with interest rate terms of one year or less approximated the carrying values less any applicable surrender charges.\nThe fair values for other certificate reserves are determined by a discounted cash flow analysis using interest rates currently offered for certificates with similar remaining terms, less any applicable surrender charges.\n6. Dividend restriction\nCertain series of installment certificates outstanding provide that cash dividends may be paid by IDSC only in calendar years for which additional credits of at least one-half of 1% on such series of certificates have been authorized by IDSC. This restriction has been removed for 1996 and 1997 by action of IDSC on additional credits in excess of this requirement.\n7. Fees paid to Parent and affiliated companies ($ not in thousands)\nA) The basis of computing fees paid or payable to Parent for investment advisory and services is:\nThe investment advisory and services agreement with Parent provides for a graduated scale of fees equal on an annual basis to 0.75% on the first $250 million of total book value of assets of IDSC, 0.65% on the next $250 million, 0.55% on the next $250 million, 0.50% on the next $250 million and 0.45% on the amount in excess of $1 billion. The fee is payable monthly in an amount equal to one-twelfth of each of the percentages set forth above. Excluded from assets for purposes of this computation are first mortgage loans, real estate and any other asset on which IDSC pays a service fee.\nB) The basis of computing fees paid or payable to American Express Financial Advisors Inc. (an affiliate) for distribution services is:Fees payable to American Express Financial Advisors Inc. on sales of IDSC's certificates are based upon terms of agreements giving American Express Financial Advisors Inc. the exclusive right to distribute the certificates covered under the agreements. The agreements provide for payment of fees over a period of time. The aggregate fees payable under the agreements per $1,000 face amount of installment certificates and $1,000 purchase price of single payments, and a summary of the periods over which the fees are payable, shown by series are:\nFees on Cash Reserve and Flexible Savings (formerly Variable Term) certificates are paid at a rate of 0.25% of the purchase price at the time of issuance and 0.25% of the reserves maintained for these certificates at the beginning of the second and subsequent quarters from issue date.\nFees on the Investors Certificate are paid at an annualized rate of 1% of the reserves maintained for the certificates. Fees are paid at the end of each term on certificates with a one, two or three-month term. Fees are paid each quarter from date of issuance on certificates with a six, 12, 24 or 36-month term.\nFees on the Stock Market Certificate are paid at a rate of 1.25% of the purchase price on the first day of the certificate's term and 1.25% of the reserves maintained for these certificates at the beginning of each subsequent term.\n(a) At the end of the sixth through the 10th year, an additional fee is payable of 0.5% of the daily average balance of the certificate reserve maintained during the sixth through the 10th year, respectively.\nC) The basis of computing depositary fees paid or payable to American Express Trust Company (an affiliate) is:\nA transaction consists of the receipt or withdrawal of securities and commercial paper and\/or a change in the security position. The charges are payable quarterly except for maintenance, which is an annual fee. D) The basis for computing fees paid or payable to American Express Bank Ltd. (an affiliate) for the distribution of the IDS Special Deposits certificate on an annualized basis is:\n1.25% of the reserves maintained for the certificates on an amount from $100,000 to $249,000, 0.80% on an amount from $250,000 to $499,000, 0.65% on an amount from $500,000 to $999,000 and 0.50% on an amount $1,000,000 or more. Fees are paid at the end of each term on certificates with a one, two or three-month term. Fees are paid at the end of each quarter from date of issuance on certificates with a six, 12, 24 or 36-month term.\n8. Income taxes\nIncome tax expense (benefit) as shown in the statement of operations for the three years ended Dec. 31, consists of:\nIncome tax expense (benefit) differs from that computed by using the U.S. Statutory rate of 35%. The principal causes of the difference in each year are shown below:\nDeferred income taxes result from the net tax effects of temporary differences. Temporary differences are differences between the tax bases of assets and liabilities and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years. Principal components of IDSC's deferred tax assets and liabilities as of Dec. 31, are as follows.\n9. Derivative financial instruments\nIDSC enters into transactions involving derivative financial instruments as an end user (nontrading). IDSC uses these instruments to manage its exposure to interest rate risk, including hedging specific transactions. IDSC manages risks associated with these instruments as described below.\nMarket risk is the possibility that the value of the derivative financial instrument will change due to fluctuations in a factor from which the instrument derives its value, primarily an interest rate or a major market index. IDSC is not impacted by market risk related to derivatives held because derivatives are largely used to manage risk and, therefore, the cash flows and income effects of the derivatives are inverse to the effects of the underlying hedged transactions.\nCredit exposure is the possibility that the counterparty will not fulfill the terms of the contract. IDSC monitors credit exposure related to derivative financial instruments through established approval procedures, including setting concentration limits by counterparty, reviewing credit ratings and requiring collateral where appropriate. The majority of IDSC's counterparties to the interest rate caps are rated A or better by nationally recognized rating agencies. The counterparties to the call options are five major broker\/dealers.\nThe notional or contract amount of a derivative financial instrument is generally used to calculate the cash flows that are received or paid over the life of the agreement. Notional amounts do not represent market risk or credit exposure and are not recorded on the balance sheet.\nCredit exposure related to derivative financial instruments is measured by the replacement cost of those contracts at the balance sheet date. The replacement cost represents the fair value of the instrument, and is determined by market values, dealer quotes or pricing models.\nIDSC's holdings of derivative financial instruments were as follows at Dec. 31, 1995 and 1994.\nThe fair values of derivative financial instruments are based on market values, dealer quotes or pricing models. The interest rate caps expire on various dates from 1996 to 1997. The options expire in 1996.\nInterest rate caps and options are used to manage IDSC's exposure to rising interest rates. These instruments are used primarily to protect the margin between the interest rate earned on investments and the interest rate accrued to related investment certificate holders.\nThe interest rate caps are quarterly reset caps and IDSC earns interest on the notional amount to the extent the London Interbank Offering Rate exceeds the reference rates specified in the cap agreements. These reference rates range from 4% to 9%. The cost of these caps of $3,362 at Dec. 31, 1995 is being amortized over the terms of the agreements on a straight line basis and is included in other qualified assets. The amortization, net of any interest earned, is included in investment expenses.\nIDSC offers a series of certificates which pay interest based upon the relative change in a major stock market index between the beginning and end of the certificates' term. The certificate holders have the option of participating in the full amount of increase in the index during the term (subject to a specified maximum) or a lesser percentage of the increase plus a guaranteed minimum rate of interest. As a means of hedging its obligations under the provisions of these certificates, IDSC purchases and writes call options on the major market index. The options are cash settlement options, that is, there is no underlying security to deliver at the time the contract is closed out.\nThe option contracts are less than one year in term. The premiums paid or received on these index options are reported in other qualified assets or other liabilities, as appropriate, and are amortized into investment expenses over the life of the option. The intrinsic value of these index options is also reported in other qualified assets or other liabilities, as appropriate. The unrealized gains and losses related to the changes in the intrinsic value of these options are recognized currently in provision for certificate reserves.\nFollowing is a summary of open option contracts at Dec. 31, 1995 and 1994.\n10. Fair values of financial instruments\nIDSC is required to disclose fair value information for most on- and off-balance sheet financial instruments for which it is practical to estimate that value. The carrying value of certain financial instruments such as trade receivables and payables approximates the fair value. Non-financial instruments, such as deferred distribution fees, are excluded from required disclosure. IDSC's off-balance sheet intangible assets, such as IDSC's name and future earnings of the core business are also excluded. IDSC's management believes the value of these excluded assets is significant. The fair value of IDSC, therefore, cannot be estimated by aggregating the amounts presented.\nA summary of fair values of financial instruments as of Dec. 31, is as follows:\nNOTES:\n(a) The classification \"residential\" includes single dwellings only. Residential multiple dwellings are included in \"apartment and business\".\n(b) Real estate taxes and easements, which in the opinion of the Company are not undue burden on the properties, have been excluded from the determination of \"prior liens\".\n(c) In this schedule III, carrying amount of mortgage loans represents unpaid principal balances plus unamortized premiums less unamortized dicounts and allowance for loss.\n(d) Interest in arrears for less than three months has been disregarded in computing the total amount of principal subject to delinquent interest. The amounts of mortgage loans being forclosed are also included in amounts subject to delinquent interest.\n(e) Information as to interest due and accrued at the end of the period is shown by type of mortgage loan. Information as to interest due and accrued for the various classes within the types of mortgage loans is not readily available and the obtaining thereof would involve unreasonable effort and expense.\nThe Company does not accrue interest on loans which are over three months delinquent.\n(f) Information as to interest income by type and class of loan has been omitted because it is not readily available and the obtaining thereof would involve unreasonable effort and expense. In lieu thereof, the average gross interest rates (exclusive of amort- tization of discounts and premiums) on mortgage loans held at December 31, 1995 are shown by type and class of loan.\nThe average gross interest rates on mortgage loans held at December 31, 1995, 1994 and 1993 are summarized as follows:\n1995 1994 1993 First mortgages: ----- ----- ----- Insured by Federal Housing Administration 0.000% 7.186% 7.076% Partially guaranteed under Servicemen's Readjustment Act of 1944, as amended 0.000 8.000 8.000 Other 8.901 8.884 9.055 ----- ----- -----\nCombined average 8.901% 8.884% 9.055% ===== ===== =====\n(g) Following is a reconciliation of the carrying amount of mortgage loans for the years ended December 31, 1995, 1994 and 1993.\n1995 1994 1993 ---- ---- ---- [S] [C] [C] [C] Balance at beginning of period $ 253,968 $ 281,865 $ 233,796 Additions during period: New loans acquired: Nonaffiliated companies 9,000 0 59,183 Allowance for loss transferred to real estate 0 350 530 Allowance for loss reversed 0 0 220 Amortization of discount\/premium 0 51 90 ---------- ---------- ----------\nTotal additions 9,000 401 60,023 ---------- ---------- ---------- 262,968 282,266 293,819 ---------- ---------- ---------- Deductions during period: Collections of principal 29,533 28,298 5,908 Cost of mortgages sold 41 0 6,046 ---------- ---------- ---------- Total deductions 29,574 28,298 11,954 ---------- ---------- ----------\nBalance at end of period $ 233,394 $ 253,968 $ 281,865 ========== ========== ==========\n(h) The aggregate cost of mortgage loans for federal income tax purposes at December 31, 1995 was $234,005.\n(i) At December 31, 1995, an allowance for loss of $611 is recorded which represents the amount of impairment on mortgage loans.","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":"20947_1995.txt","cik":"20947","year":"1995","section_1":"Item 1. Business - -----------------\nTHE CENTERIOR SYSTEM --------------------\nCenterior Energy is a public utility holding company and the parent company of six wholly owned subsidiaries, including the Operating Companies and the Service Company. Centerior was incorporated under the laws of the State of Ohio in 1985 for the purpose of enabling Cleveland Electric and Toledo Edison to affiliate by becoming wholly owned subsidiaries of Centerior. The affiliation of the Operating Companies became effective in April 1986. Nearly all of the consolidated operating revenues of the Centerior System are derived from the sale of electric energy by Cleveland Electric and Toledo Edison.\nThe Operating Companies' combined service areas encompass approximately 4,200 square miles in northeastern and northwestern Ohio with an estimated population of about 2,450,000. At December 31, 1995, the Centerior System had 6,821 employees. Centerior Energy has no employees.\nCleveland Electric, which was incorporated under the laws of the State of Ohio in 1892, is a public utility engaged in the generation, purchase, transmission, distribution and sale of electric energy in an area of approximately 1,700 square miles in northeastern Ohio, including the City of Cleveland. Cleveland Electric also provides electric energy at wholesale to other electric utility companies and to two municipal electric systems (directly and through AMP-Ohio) in its service area. Cleveland Electric serves approximately 749,000 customers and derives approximately 77% of its total electric retail revenue from customers outside the City of Cleveland. Principal industries served by Cleveland Electric include those producing steel and other primary metals; automotive and other transportation equipment; chemicals; electrical and nonelectrical machinery; fabricated metal products; and rubber and plastic products. Nearly all of Cleveland Electric's operating revenues are derived from the sale of electric energy. At December 31, 1995, Cleveland Electric had 3,636 employees of which about 55% were represented by one union having a collective bargaining agreement with Cleveland Electric.\nToledo Edison, which was incorporated under the laws of the State of Ohio in 1901, is a public utility engaged in the generation, purchase, transmission, distribution and sale of electric energy in an area of approximately 2,500 square miles in northwestern Ohio, including the City of Toledo. Toledo Edison also provides electric energy at wholesale to other electric utility companies and to 13 municipally owned distribution systems (through AMP-Ohio) and one rural electric cooperative distribution system in its service area. Toledo Edison serves approximately 291,000 customers and derives approximately 54% of its total electric retail revenue from customers outside the City of Toledo. Principal industries served by Toledo Edison include metal casting, forming and fabricating; petroleum refining; automotive equipment and assembly; food processing; and glass. Nearly all of Toledo Edison's operating revenues are derived from the sale of electric energy. At December 31, 1995, Toledo Edison had 1,809 employees of which about 59% were represented by three unions having collective bargaining agreements with Toledo Edison.\n- 1 - The Service Company, which was incorporated in 1986 under the laws of the State of Ohio, is also a wholly owned subsidiary of Centerior Energy. It provides management, financial, administrative, engineering, legal, governmental and public relations and other services to Centerior Energy and the Operating Companies. At December 31, 1995, the Service Company had 1,373 employees.\nCenterior's other three wholly owned subsidiaries are Centerior Properties Company, CCO Company and Market Responsive Energy, Inc. These three subsidiaries, individually or in the aggregate, do not have a material impact on the consolidated financial statements of Centerior.\nMERGER OF THE OPERATING COMPANIES ---------------------------------\nIn March 1994, Centerior Energy announced a plan to merge Toledo Edison into Cleveland Electric. Since Cleveland Electric and Toledo Edison affiliated in 1986, efforts have been made to consolidate operations and administration as much as possible to achieve maximum cost savings. In May 1994, the Operating Companies filed a joint application for authorization and approval of the merger with the FERC. The PUCO, AMP-Ohio and the cities of Cleveland, Clyde and Bryan, Ohio have intervened in the FERC proceedings. The PUCO intervened as the state commission having jurisdiction, but has not opposed the Cleveland Electric and Toledo Edison application. The PUCO approved the merger in December 1994. The PaPUC approved the merger in July 1994. The other intervenors have opposed the merger citing concerns primarily relating to the merger's impact on competition. In December 1994, the FERC advised the Operating Companies by letter that the application to merge would be rejected unless they provide additional information and file a single system open-access transmission tariff offering comparable service. In May 1995, Cleveland Electric and Toledo Edison filed the additional information requested by the FERC and an open-access transmission tariff offering comparable service. The FERC has deferred action on the merger application until the merits of the Operating Companies' proposed open-access transmission tariffs are addressed in hearings. The Operating Companies do not expect the NRC to take action on their request for authorization to transfer certain NRC licenses to the merged entity until approval has been obtained from the FERC.\nOn June 14, 1995, special meetings of the preferred stock share owners of each of the Operating Companies was held. Cleveland Electric preferred stock share owners approved the Amended Articles of Incorporation which provide for an increased number of authorized shares of Cleveland Electric preferred stock. Toledo Edison preferred stock share owners approved the Agreement of Merger between Toledo Edison and Cleveland Electric.\nSee Note 15 to the Operating Companies' Financial Statements for further discussion of this matter and \"3. Combined Pro Forma Condensed Financial Statements (Unaudited)\" contained under Item 14. of this Report for selected historical and combined pro forma financial information of Cleveland Electric and Toledo Edison.\n- 2 -\nCAPCO GROUP -----------\nCleveland Electric and Toledo Edison are members of the CAPCO Group, a power pool created in 1967 with Duquesne, Ohio Edison and Pennsylvania Power. This pool affords greater reliability and lower cost of providing electric service through coordinated generating unit operations and maintenance and generating reserve back-up among the five companies. In addition, the CAPCO Group has completed programs to construct larger, more efficient electric generating units and to strengthen interconnections within the pool.\nThe CAPCO Group companies have placed in service nine major generating units, of which the Operating Companies have ownership or leasehold interests in seven (three nuclear and four coal-fired). Each CAPCO Group company owns, as a tenant-in-common, or leases a portion of certain of these generating units. Each company has the right to the net capability and associated energy of its respective ownership and leasehold portions of the units and is, severally and not jointly, obligated for the capital and operating costs equivalent to its respective ownership and leasehold portions of the units and the required fuel, except that the obligations of Pennsylvania Power are the joint and several obligations of that company and Ohio Edison and the leasehold obligations of Cleveland Electric and Toledo Edison are joint and several. (See \"Operations--Fuel Supply\".) For all plants but one, the company in whose service area a generating unit is located is responsible for the operation of that unit for all the owners, except for the procurement of nuclear fuel for a nuclear generating unit. The Mansfield Plant, which is located in Duquesne's service area, is operated by Pennsylvania Power. Each company owns the necessary interconnecting transmission facilities within its service area, and the other CAPCO Group companies contribute toward fixed charges and operating costs of those transmission facilities.\nOn October 18, 1995, Cleveland Electric filed a Demand for Arbitration seeking unpaid operating costs of Eastlake Unit 5 which had been invoiced to Duquesne in respect of Duquesne's partial ownership interest in that Unit. In that arbitration proceeding, Duquesne countered with allegations that certain management practices of Cleveland Electric in the operation of Unit 5 have been detrimental to Duquesne. Among the remedies sought by Duquesne is the partition of the property held as tenants in common. On October 24, 1995, Cleveland Electric filed a complaint for injunctive and declaratory relief against Duquesne in Lake County (Ohio) Common Pleas Court seeking a court order prohibiting Duquesne from taking action to partition or sell its ownership interest in Eastlake Unit 5. The Lake County action was removed to the United States District Court for the Northern District of Ohio, Eastern Division. Duquesne subsequently filed counterclaims in the federal court action restating all claims made in the arbitration proceeding.\nAll of the CAPCO Group companies are members of ECAR, which is comprised of 29 major electric power suppliers and 11 associate members located in nine east-central states, serving 36,000,000 people. ECAR's purpose is to improve reliability of bulk power supply through coordination of planning and operation of member companies' generation and transmission facilities.\n- 3 - CONSTRUCTION AND FINANCING PROGRAMS -----------------------------------\nConstruction Program - --------------------\nThe Centerior System carries on a continuous program of constructing transmission, distribution and general facilities and modifying existing generating facilities to meet anticipated demand for electric service and to comply with governmental regulations. Centerior Energy's 1995 long-term (20-year) forecast, as filed with the PUCO (see \"General Regulation--State Utility Commissions\"), projects long-term annual growth rates in peak demand and kilowatt-hour sales of 0.5% and 1.0%, respectively, after demand-side management considerations. The Centerior System's integrated resource plan for the 1990s (which is included in the long-term forecast) combines peak clipping demand-side management programs with maximum utilization of existing generating capacity to postpone the need for new generating units until the next decade. Lake Shore Unit 18, a 45,000-kilowatt unit which was placed on cold standby status in October 1993, is scheduled to resume active status in 2001.\nAccording to the current long-term integrated resource plan, the Centerior System does not plan to put into service any new generating capacity until 2008.\nThe following tables show, categorized by major components, the construction expenditures by Cleveland Electric and Toledo Edison and, by aggregating them, for the Centerior System during 1993, 1994 and 1995 and the estimated cost of their construction programs for 1996 through 2000, in each case including AFUDC and excluding nuclear fuel:\n- 4 -\nEach company in the CAPCO Group is responsible for financing the portion of the capital costs of nuclear fuel equivalent to its ownership and leased interest in the unit in which the fuel will be utilized. See \"Operations--Fuel Supply--Nuclear\" for information regarding nuclear fuel supplies and Note 6 regarding leasing arrangements to finance nuclear fuel capital costs. Nuclear fuel capital costs incurred by Cleveland Electric, Toledo Edison and the Centerior System during 1993, 1994 and 1995 and their estimated nuclear fuel capital costs for 1996 through 2000 are as follows:\n- 5 - Financing Program - -----------------\nReference is made to Centerior Energy's, Cleveland Electric's and Toledo Edison's Management's Financial Analysis contained under Item 7 of this Report and to Notes 11 and 12 for discussions of the Centerior System's financing activity in 1995; debt and preferred stock redemption requirements during the 1996-2000 period; expected external financing needs during such period; restrictions on the issuance of additional debt securities and preferred stock; short-term and long-term financing capability; and securities ratings for the Operating Companies.\nIn 1996, Cleveland Electric and Toledo Edison expect to complete the sale of a AAA-rated security backed by their accounts receivable, thereby raising approximately $150,000,000. In addition, Cleveland Electric and Toledo Edison plan to arrange for alternate financing to replace $234,000,000 of nuclear fuel financing which expires in 1996 (see Note 6).\nOn February 28, 1996, Moody's Investors Service, Inc. announced that it had placed its ratings of securities issued by the Operating Companies under review for possible downgrade. The rating agency indicated that the ratings for the following securities were being reviewed: first mortgage bonds, debentures and preferred stock issued by the Operating Companies; secured pollution control bonds and unsecured pollution control notes issued by public authorities and secured by the Operating Companies' first mortgage bonds and notes; and secured lease obligation bonds issued by CTC Beaver Valley Funding Corporation, Beaver Valley II Funding Corporation and CTC Mansfield Funding Corporation which are secured by rental payments made by Cleveland Electric and Toledo Edison.\nGENERAL REGULATION ------------------\nHolding Company Regulation - --------------------------\nCenterior Energy is currently exempt from regulation under the Holding Company Act.\nThe Energy Act contains, among other provisions, amendments to the Holding Company Act and the Federal Power Act. The Energy Act also adopted nuclear power licensing and related regulations, energy efficiency standards and incentives for the use of alternative transportation fuels. Amendments to the Holding Company Act create a new class of independent power producers known as \"Exempt Wholesale Generators\", which are exempt from the Holding Company Act corporate structure regulations and operate without SEC approval or regulation. Exempt Wholesale Generators may be owned by holding companies, electric utility companies or any other person.\n- 6 - State Utility Commissions - -------------------------\nThe Operating Companies are subject to the jurisdiction of the PUCO with respect to rates, service, accounting, issuance of securities and other matters. Under Ohio law, municipalities may regulate rates, subject to appeal to the PUCO if not acceptable to the utility. See \"Electric Rates\" for a description of certain aspects of Ohio rate-making law. The Operating Companies are also subject to the jurisdiction of the PaPUC in certain respects relating to their ownership interests in generating facilities located in Pennsylvania.\nThe PUCO is composed of five commissioners appointed by the Governor of Ohio from nominees recommended by a Public Utility Commission Nominating Council. Nominees must have at least three years' experience in one of several disciplines. Not more than three commissioners may belong to the same political party.\nUnder Ohio law, a public utility must file annually with the PUCO a long-term forecast of customer loads, facilities needed to serve those loads and prospective sites for those facilities. This forecast must include the following:\n(1) Demand Forecast--the utility's 20-year forecast of sales and peak demand, before and after the effects of demand-side management programs.\n(2) Integrated Resource Plan (required biennially)--the utility's projected mix of resource options to meet the projected demand.\n(3) Short-Term Implementation Plan and Status Report (required biennially)-- the utility's discussion of how it plans to implement its integrated resource plan over the next four years. Estimates of annual expenditures and security issuances associated with the integrated resource plan over the four-year period must also be provided.\nThe PUCO must hold a public hearing on the long-term forecast at least once every five years to determine the reasonableness of the forecast. The PUCO and the OPSB are required to consider the record of such hearings in proceedings for approving facility sites, changing rates, approving security issues and initiating energy conservation programs. In April 1995, the PUCO approved Centerior Energy's 1994 long-term forecast. Ohio law also permits electric utilities under PUCO jurisdiction to submit environmental compliance plans for PUCO review and approval. Ohio law requires that the PUCO make certain statutory findings prior to approving the environmental compliance plan, which includes that the plan is a reasonable least cost strategy for compliance with air quality requirements. In July 1995, the PUCO approved Centerior's updated environmental compliance plan which was filed in January 1995.\nThe PUCO has jurisdiction over certain transactions by companies in an electric utility holding company system if it includes at least one Ohio electric utility and is exempt from regulation under Section 3(a)(1) or (2) of the Holding Company Act. Consequently, the Operating Companies must obtain PUCO\n- 7 - approval to invest in, lend funds to, guarantee the obligations of or otherwise finance or transfer assets to any nonutility company in the Centerior System, unless the transaction is in the ordinary course of business operations in which one company acts for or with respect to another company. Also, Centerior must obtain PUCO approval to make any investment in any nonutility subsidiaries, affiliates or associates if such investment would cause all such capital investments to exceed 15% of Centerior's consolidated capitalization unless such funds were provided by nonutility subsidiaries, affiliates or associates.\nThe PUCO has a reserve capacity policy for electric utilities in Ohio stating that (i) 20% of service area peak load excluding interruptible load is an appropriate generic benchmark for an electric utility's reserve margin; (ii) a reserve margin exceeding 20% gives rise to a presumption of excess capacity, but may be appropriate if it confers a positive net present benefit to customers or is justified by unique system characteristics; and (iii) appropriate remedies for excess capacity (possibly including disallowance of costs in rates) will be determined by the PUCO on a case-by-case basis.\nOhio Power Siting Board - -----------------------\nThe OPSB has state-wide jurisdiction, except to the extent pre-empted by federal law, over the location, need for and certain environmental aspects of electric generating units with a capacity of 50,000 kilowatts or more and transmission lines with a rating of at least 125 kV.\nFederal Energy Regulatory Commission - ------------------------------------\nThe Operating Companies are each subject to the jurisdiction of the FERC with respect to the transmission and sale of power at wholesale in interstate commerce, interconnections with other utilities, accounting and certain other matters. Cleveland Electric is also subject to FERC jurisdiction with respect to its ownership and operation of the Seneca Plant.\nNuclear Regulatory Commission - -----------------------------\nThe nuclear generating units in which the Operating Companies have an interest are subject to regulation by the NRC. 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 impacts.\nOwners of nuclear units are required to purchase the full amount of nuclear liability insurance available. See Note 5(b) for a description of nuclear insurance coverages.\nOther Regulation - ----------------\nThe Operating Companies are subject to regulation by federal, state and local authorities with regard to the location, construction and operation of certain facilities. The Operating Companies are also subject to regulation by local authorities with respect to certain zoning and planning matters.\n- 8 - ENVIRONMENTAL REGULATION ------------------------\nGeneral - -------\nThe Operating Companies are subject to regulation with respect to air quality, water quality and waste disposal matters. Federal environmental legislation affecting the operations and properties of the Operating Companies includes the Clean Air Act, the Clean Air Act Amendments, the Clean Water Act, Superfund, and the Resource Conservation and Recovery Act. The requirements of these statutes and related state and local laws are continually changing due to the promulgation of new or revised laws and regulations and the results of judicial and agency proceedings. Compliance with such laws and regulations may require the Operating Companies to modify, supplement, abandon or replace facilities and may delay or impede construction and operation of facilities, all at costs which could be substantial. The Operating Companies expect that the impact of such costs would eventually be reflected in their respective rate schedules. Cleveland Electric and Toledo Edison plan to spend, during the period 1996-2000, $45,809,000 and $40,850,000, respectively, for pollution control facilities, including Clean Air Act Amendments compliance costs.\nThe Operating Companies believe that they are currently in compliance in all material respects with all applicable environmental laws and regulations, or to the extent that one or both of the Operating Companies may dispute the applicability or interpretation of a particular environmental law or regulation, the affected company has filed an appeal or has applied for permits, revisions to requirements, variances or extensions of deadlines.\nConcerns have been raised regarding the possible health effects associated with electric and magnetic fields. Although scientific research as to such effects has yielded inconclusive results, additional studies are being conducted. If electric and magnetic fields are ultimately found to pose a health risk, the Operating Companies may be required to modify transmission and distribution lines or other facilities.\nAir Quality Control - -------------------\nUnder the Clean Air Act, the Ohio EPA has adopted emission limitations for particulate matter and sulfur dioxide for each of the Operating Companies' plants. The Clean Air Act provides for civil penalties of up to $25,000 per day for each violation of an emission limitation. The U.S. EPA has approved the Ohio EPA's emission limitations and the related state implementation plan except for some particulate matter emissions and certain sulfur dioxide emissions.\nIn November 1990, the Clean Air Act Amendments imposed more stringent restrictions on nitrogen oxide emissions and sulfur dioxide emissions beginning in 1995. See Note 4(a) for a description of the Operating Companies' compliance strategy, which was included in the agreement approved by the PUCO in April 1995 in connection with the Operating Companies' 1994 long-term forecast. The Clean Air Act Amendments also require studies to be conducted on the emission of certain potentially hazardous air pollutants which could lead to additional restrictions.\n- 9 - Global warming, or the \"greenhouse effect\", has been the subject of scientific study and debate within the United States and internationally. One area of study involves the effect on global warming of the emissions of gases such as those resulting from the burning of coal. Based on a 1992 United Nations treaty, the United States has developed a voluntary plan to reduce the emissions of certain gases thought to contribute to global warming to 1990 levels by the year 2000. The Operating Companies will work with the DOE and other utilities to develop a plan for limiting such emissions.\nWater Quality Control - ---------------------\nThe Clean Water Act requires that power plants obtain permits under the NPDES program that contain certain effluent limitations (that is, limits on discharges of pollutants into bodies of water). It also requires the states to establish water quality standards which could result in more stringent effluent limitations. Violators of effluent limitations and water quality standards are subject to a civil penalty of up to $25,000 per day for each such violation.\nThe Operating Companies have received NPDES permit renewals from the Ohio EPA or have applied for such renewals for all of their power plants. In those situations in which a permit application is pending, the affected plant may continue to operate under the expired permit while such application is pending. Any violation of an NPDES permit is considered to be a violation of the Clean Water Act subject to the penalty discussed above.\nThe Clean Water Act permits thermal effluent limitations to be established for a facility which are less stringent than those which otherwise would apply if the owner can demonstrate that such less stringent limitations are sufficient to assure the protection and propagation of aquatic and other wildlife in the affected body of water. By 1978, the Operating Companies had submitted to the Ohio EPA such demonstrations for review with respect to their Ashtabula, Avon Lake, Lake Shore, Eastlake, Acme and Bay Shore plants. The Ohio EPA has taken no action on the submittals.\nIn 1990, the Ohio EPA issued revised water quality standards applicable to Lake Erie and waters of the State of Ohio. Based upon these revised water quality standards, the Ohio EPA placed additional effluent limitations in their most recent NPDES permits. The revised standards also may serve as the basis for more stringent effluent limitations in future NPDES permits. Such limitations could result in the installation of additional pollution control equipment and increased operating expenses. The Operating Companies are monitoring discharges at their plants to support their position that additional effluent limitations are not justified.\nIn March 1995, the U.S. EPA issued guidelines for water quality standards applicable to all states abutting the Great Lakes, including Ohio. These states are required to adopt state water quality standards and procedures consistent with the guidelines by April 1997. Preliminary reviews indicate that the cost of compliance could be significant. However, the Operating Companies cannot determine the operational impact of compliance until such guidelines are incorporated into Ohio regulations.\n- 10 - Waste Disposal - --------------\nSee \"Outlook--Hazardous Waste Disposal Sites\" in Management's Financial Analysis contained under Item 7 of this Report and Note 4(c) for a discussion of the Operating Companies' potential involvement in certain hazardous waste disposal sites, including those subject to Superfund. See \"Operations--Nuclear Units\" for a discussion concerning the disposal of nuclear waste.\nThe Resource Conservation and Recovery Act exempts certain fossil fuel combustion waste products, such as fly ash, from hazardous waste disposal requirements and requires the U.S. EPA to evaluate the need for future regulation. On August 9, 1994, the U.S. EPA issued its final regulatory determination that regulation of coal ash as a hazardous waste is unnecessary.\nELECTRIC RATES -------------- General - -------\nUnder Ohio law, rate base is the original cost less depreciation of a utility's total plant adjusted for certain items. The law permits the PUCO, in its discretion, to include construction work in progress in rate base under certain conditions.\nCurrent Ohio law further provides that requested rates can be collected by a public utility, subject to refund, if the PUCO does not make a decision within 275 days after the rate request application is filed. If the PUCO does not make its final decision within 545 days, revenues collected thereafter are not subject to refund. A notice of intent to file an application for a rate increase cannot be filed before the issuance of a final order in any prior pending application for a rate increase or until 275 days after the filing of the prior application, whichever is earlier. The minimum period by which the notice of intent to file must precede the actual filing is 30 days. The test year for determining rates may not end more than nine months after the date the application for a rate increase is filed.\nUnder Ohio law, electric rates are adjusted every six months to reflect changes in fuel costs. The PUCO reviews such adjustments annually. Any difference between actual fuel costs during a six-month period and the fuel revenues recovered in that period is deferred and is taken into account in setting the fuel recovery factor for a subsequent six-month period.\nAlso, under Ohio law, municipalities may regulate rates charged by a utility, subject to appeal to the PUCO if not acceptable to the utility. If municipally fixed rates are accepted by the utility, such rates are binding on both parties for the specified term and cannot be changed by the PUCO. See \"Operations--Competitive Conditions--Cleveland Electric\" for information on a 1994 rate reduction ordinance in Garfield Heights.\n- 11 - 1995 Rate Case - --------------\nIn April 1995, Cleveland Electric and Toledo Edison filed requests with the PUCO for price increases aggregating $119,000,000 annually to be effective in 1996. Cleveland Electric's requested increase of $84,000,000 in annual revenues reflects an average increase of 4.9% in Cleveland Electric's existing prices. Toledo Edison's requested increase of $35,000,000 reflects an average increase of 4.7% in Toledo Edison's existing prices.\nThe rate increases are necessary to recover capital investment and increases in costs incurred since the Operating Companies' last rate cases, which were decided in January 1989, and to recover certain costs deferred since 1992 pursuant to a Rate Stabilization Program that was approved by the PUCO for the Operating Companies in October 1992.\nFor a full discussion and analysis of the Operating Companies' 1995 rate case, the Rate Stabilization Program, financial accounting requirements and the potential implications of these accounting requirements for Centerior's and the Operating Companies' results of operations and financial position, see Note 7.\nOPERATIONS ---------- Sales of Electricity - --------------------\nKilowatt-hour sales by the Operating Companies follow a seasonal pattern marked by increased customer usage in the summer for air conditioning and in the winter for heating. Historically, Cleveland Electric has experienced its heaviest demand for electric service during the summer months because of a significant air conditioning load on its system and a relatively low amount of electric heating load in the winter. Toledo Edison, although having a significant electric heating load, has experienced in recent years its heaviest demand for electric service during the summer months because of heavy air conditioning usage.\nThe Centerior System's largest customer is a steel manufacturer which has two major steel producing facilities served by Cleveland Electric. Sales to these facilities accounted for 2.5% and 3.6% of the 1995 total electric operating revenues of Centerior Energy and Cleveland Electric, respectively. The loss of these facilities would reduce Centerior Energy's and Cleveland Electric's net income by about $28,000,000 based on 1995 sales levels.\nThe largest customer served by Toledo Edison is a major automobile manufacturer. Sales to this customer accounted for 1.5% and 4.3% of the 1995 total electric operating revenues of Centerior Energy and Toledo Edison, respectively. The loss of this customer would reduce Centerior Energy's and Toledo Edison's net income by about $16,000,000 based on 1995 sales levels.\nOperating Statistics - --------------------\nFor data on operating revenues by service category, electric sales by service category, customers by service category and electric energy generation for 1985 and 1991 through 1995, see the attached Pages and for Centerior Energy, and for Cleveland Electric and and for Toledo Edison.\n- 12 - Nuclear Units - -------------\nThe Operating Companies' generating facilities include, among others, three nuclear units owned or leased by the CAPCO Group--Perry Unit 1, Beaver Valley Unit 2 and Davis-Besse. These three units are in commercial operation. Cleveland Electric has responsibility for operating Perry Unit 1, Duquesne has responsibility for operating Beaver Valley Unit 2 and Toledo Edison has responsibility for operating Davis-Besse. Cleveland Electric and Toledo Edison own, respectively, 31.11% and 19.91% of Perry Unit 1, 24.47% and 1.65% of Beaver Valley Unit 2 and 51.38% and 48.62% of Davis-Besse. Cleveland Electric and Toledo Edison also lease, as joint lessees, an additional 18.26% of Beaver Valley Unit 2 as a result of a September 1987 sale and leaseback transaction (see Note 2).\nDavis-Besse was placed in commercial operation in 1977, and its operating license expires in 2017. Perry Unit 1 and Beaver Valley Unit 2 were placed in commercial operation in 1987, and their operating licenses expire in 2026 and 2027, respectively.\nIn 1989, the PUCO approved nuclear plant performance standards for the Operating Companies based on rolling three-year industry averages of availability for pressurized water reactors and for boiling water reactors over the 1988-1998 period. Availability is the ratio of the number of hours a unit is available to generate electricity (whether or not the unit is operated) to the number of hours in the period, expressed as a percentage. The three-year availability averages of the Operating Companies' nuclear units are compared against the industry averages for the same three-year period with a resultant penalty or banked benefit. If the industry performance standards are not met, a penalty would be incurred which would require the Operating Companies to refund incremental replacement power costs to customers through the semiannual fuel cost rate adjustment. However, if the performance of the Operating Companies' nuclear units exceeds the industry standards, a banked benefit results which can be used to offset disallowances of incremental replacement power costs should future performance be below industry standards.\nThe relevant industry standards for the 1993-1995 period (as of October 31, 1995) are 80.9% for pressurized water reactors such as Davis-Besse and Beaver Valley Unit 2 and 76.7% for boiling water reactors such as Perry Unit 1. The 1993-1995 combined availability average for Davis-Besse and Beaver Valley Unit 2 was 88.5% and the availability average for Perry Unit 1 was 61.6%. At December 31, 1995, the total banked benefit for the Operating Companies is estimated to be between $27,000,000 and $31,000,000.\nAll three nuclear units have received generally favorable evaluations from the NRC in their most recent SALP reviews, with Davis-Besse receiving the best possible scores. Each of the functional areas evaluated is rated according to three performance categories, with category 1 indicating performance substantially exceeding regulatory requirements and that reduced NRC attention may be appropriate; category 2 indicating performance above that needed to meet regulatory requirements and that NRC attention may be maintained at normal levels; and category 3 indicating performance does not significantly exceed that needed to meet minimal regulatory requirements and that NRC attention should be increased above normal levels.\n- 13 - The most recent review periods and SALP review scores for Beaver Valley Unit 2, Perry Unit 1 and Davis-Besse are:\nIn 1980, Congress passed the Low-Level Radioactive Waste Policy Act which provides that the disposal of low-level radioactive waste is the responsibility of the state where such waste is generated. The Act encourages states to form compacts among themselves to develop regional disposal facilities. Failure by a state or compact to begin implementation of a program could result in access denial to the two facilities currently accepting low-level radioactive waste. Ohio is part of the Midwest Compact and has responsibility for siting and constructing a disposal facility. In June 1995, the Ohio legislature authorized the siting, construction and operation of a disposal facility. In addition, the South Carolina legislature voted to allow out-of-region generators (such as Centerior's nuclear units) to resume shipments of low-level radioactive waste to the Barnwell disposal facility. Nonetheless, the Operating Companies' ability to ship offsite in the future depends on whether the State of Ohio proceeds with the development of a low-level radioactive waste disposal facility. As an interim solution to disposal availability, the Operating Companies have constructed storage facilities to house the waste at each nuclear site.\nOff-site disposal of spent nuclear fuel is unavailable, but the CAPCO Group companies have contracts with the DOE which provide for the future acceptance of spent fuel for disposal by the federal government. Pursuant to the Nuclear Waste Policy Act of 1982, the federal government has indicated it will begin accepting spent fuel from utilities by the year 2010. On-site storage capacity at Davis-Besse, Perry Unit 1 and Beaver Valley Unit 2 should be sufficient through 2017, 2013 and 2011, respectively.\nSee Note 4(b) for a discussion of the write-off of Perry Unit 2, and see \"Outlook--Nuclear Operations\" in Management's Financial Analysis contained under Item 7 of this Report for a discussion of potential risks facing Centerior and the Operating Companies as owners of nuclear generating units.\nCompetitive Conditions - ----------------------\nGENERAL. The Operating Companies compete in their respective service areas with suppliers of natural gas to satisfy customers' energy needs with regard to heating and appliance usage. The Operating Companies also are engaged in competition to a lesser extent with suppliers of oil and liquefied natural gas for heating purposes and with suppliers of cogeneration equipment. One competitor provides steam for heating purposes and provides chilled water for cooling purposes in certain areas of downtown Cleveland.\n- 14 - The Operating Companies also compete with municipally owned electric systems within their respective service areas. Several communities have evaluated municipalization of electric service and decided to continue service from the Operating Companies. Officials in other communities have indicated an interest in evaluating the municipalization issue.\nThe Operating Companies face continuing competition from locations outside their service areas which are promoted by governmental and private agencies in attempts to influence potential and existing commercial and industrial customers to locate in their respective areas.\nThe Operating Companies also periodically compete with other producers of electricity for sales to electric utilities which are in the market for bulk power purchases. The Operating Companies have interconnections with other electric utilities (see \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - -------------------\nGENERAL -------\nThe Centerior System - --------------------\nThe wholly owned, jointly owned and leased electric generating facilities of the Operating Companies in commercial operation as of February 28, 1996 provide the Centerior System with a net demonstrated capability of 5,996,000 kilowatts during the winter. These facilities include 20 fossil-fired steam electric generating units (3,650,000 kilowatts) at five generation stations; three nuclear generating units (1,856,000 kilowatts); a 351,000 kilowatt share of the Seneca Plant; seven combustion turbine generating units (135,000 kilowatts) and one diesel generator (4,000 kilowatts). In addition, two fossil-fired generating units (320,000 kilowatts) are currently on cold standby status. All of the Centerior System's generating facilities are located in Ohio and Pennsylvania.\nThe Centerior System's net 60-minute peak load of its service area for 1995 was 5,779,000 kilowatts and occurred on August 15. The net seasonal capability at the time of the 1995 peak load was 5,924,000 kilowatts. The Centerior System's 1996 native peak load is forecasted to be 5,220,000 kilowatts, after demand-side management considerations. The net seasonal capability expected to be available to serve the Centerior System's 1996 peak is 5,885,000 kilowatts. Over the 1996-1998 period, Centerior Energy forecasts its capacity margins at the time of the projected Centerior System peak loads to range from 10% to 12%, excluding the capacity on cold standby.\nEach Operating Company owns the electric transmission and distribution facilities located in its respective service area. Cleveland Electric and Toledo Edison are interconnected by 345 kV transmission facilities, some portions of which are owned and used by Ohio Edison. The Operating Companies have a long-term contract with the CAPCO Group companies, including Ohio Edison, relating to the use of these facilities. These interconnection facilities provide for the interchange of power between the two Operating Companies. The Centerior System is interconnected with Ohio Edison, Ohio Power, Penelec and Detroit Edison.\nCleveland Electric - ------------------\nThe wholly owned, jointly owned and leased electric generating facilities of Cleveland Electric in commercial operation as of February 28, 1996 provide a net demonstrated capability of 4,164,000 kilowatts during the winter. These\n- 27 -\nfacilities include 16 fossil-fired steam electric generating units (2,725,000 kilowatts) at four generation stations; its share of three nuclear generating units (1,026,000 kilowatts); a 351,000 kilowatt share of the Seneca Plant; two combustion turbine generating units (58,000 kilowatts) and one diesel generator (4,000 kilowatts). In addition, one fossil-fired generating unit (245,000 kilowatts) is currently on cold standby status. All of Cleveland Electric's generating facilities are located in Ohio and Pennsylvania.\nThe net 60-minute peak load of Cleveland Electric's service area for 1995 was 4,049,000 kilowatts and occurred on August 15. The capacity resources available at the time of the 1995 peak were 4,273,000 kilowatts. Cleveland Electric's 1996 native peak load is forecasted to be 3,700,000 kilowatts, after demand-side management considerations. The capacity resources expected to be available to serve Cleveland Electric's 1996 peak are 4,234,000 kilowatts. Over the 1996-1998 period, Cleveland Electric forecasts its capacity margins at the time of its projected peak loads to range from 12% to 13%, excluding the capacity on cold standby.\nCleveland Electric owns the facilities located in the area it serves for transmitting and distributing power to all its customers. Cleveland Electric has interconnections with Ohio Edison, Ohio Power and Penelec. The interconnections with Ohio Edison provide for the interchange of electric power with the other CAPCO Group companies and for transmission of power from the tenant-in-common owned or leased CAPCO Group generating units as well as for the interchange of power with Toledo Edison. The interconnection with Penelec provides for transmission of power from Cleveland Electric's share of the Seneca Plant. In addition, these interconnections provide the means for the interchange of electric power with other utilities.\nCleveland Electric has interconnections with each of the municipal systems operating within its service area.\nToledo Edison - -------------\nThe wholly owned, jointly owned and leased electric generating facilities of Toledo Edison in commercial operation as of February 28, 1996 provide a net demonstrated capability of 1,832,000 kilowatts during the winter. These facilities include six fossil-fired steam electric generating units (925,000 kilowatts) at two generation stations; its share of three nuclear generating units (830,000 kilowatts) and five combustion turbine generating units (77,000 kilowatts). In addition, one fossil-fired generating unit (75,000 kilowatts) is currently on cold standby status. All of Toledo Edison's generating facilities are located in Ohio and Pennsylvania.\nThe net 60-minute peak load of Toledo Edison's service area for 1995 was 1,738,000 kilowatts and occurred on August 15. The capacity resources available at the time of the 1995 peak were 1,651,000 kilowatts. Toledo Edison's 1996 native peak load is forecasted to be 1,540,000 kilowatts, after demand-side management considerations. The capacity resources expected to be available to serve Toledo Edison's 1996 peak are 1,651,000 kilowatts. Over the 1996-1998 period, Toledo Edison forecasts its capacity margins at the time of its projected peak loads to range from 3.7% to 7%, excluding the capacity on cold standby.\n- 28 - Toledo Edison owns the facilities located in the area it serves for transmitting and distributing power to all its customers. Toledo Edison has interconnections with Ohio Edison, Ohio Power and Detroit Edison. The interconnection with Ohio Edison provides for the interchange of electric power with the other CAPCO Group companies and for transmission of power from the tenant-in-common owned or leased CAPCO Group generating units as well as for the interchange of power with Cleveland Electric. In addition, these interconnections provide the means for the interchange of electric power with other utilities.\nToledo Edison has interconnections with each of the municipal systems operating within its service area.\nTITLE TO PROPERTY -----------------\nThe generating plants and other principal facilities of the Operating Companies are located on land owned in fee by them, except as follows:\n(1) Cleveland Electric and Toledo Edison lease from others undivided 6.5%, 45.9% and 44.38% tenant-in-common interests in Units 1, 2 and 3, respectively, of the Mansfield Plant located in Shippingport, Pennsylvania, and an 18.26% undivided tenant-in-common interest in Beaver Valley Unit 2 located in Shippingport, Pennsylvania. These leases extend through 2017 and are the result of sale and leaseback transactions completed in September 1987. Cleveland Electric and Toledo Edison own another 24.47% interest and 1.65% interest, respectively, in Beaver Valley Unit 2 as a tenant-in-common. Cleveland Electric and Toledo Edison continue to own as a tenant-in-common the land upon which the Mansfield Plant and Beaver Valley Unit 2 are located, but have leased to others certain portions of that land relating to the above-mentioned generating unit leases.\n(2) Most of the facilities of Cleveland Electric's Lake Shore Plant are situated on artificially filled land, extending beyond the natural shore- line of Lake Erie as it existed in 1910. As of December 31, 1995, the cost of Cleveland Electric's facilities, other than water intake and discharge facilities, located on such artificially filled land aggregated approximately $116,650,000. Title to land under the water of Lake Erie within the territorial limits of Ohio (including artificially filled land) is in the State of Ohio in trust for the people of the State for the public uses to which it may be adapted, subject to the powers of the United States, the public rights of navigation, water commerce and fishery and the rights of upland owners to wharf out or fill to make use of the water. The State is required by statute, after appropriate pro- ceedings, to grant a lease to an upland owner, such as Cleveland Electric, which erected and maintained facilities on such filled land prior to October 13, 1955. Cleveland Electric does not have such a lease from the State with respect to the artificially filled land on which its Lake\n- 29 - Shore Plant facilities are located, but Cleveland Electric's position, on advice of counsel for Cleveland Electric, is that its facilities and occupancy may not be disturbed because they do not interfere with the free flow of commerce in navigable channels and constitute (at least in part) and are on land filled pursuant to the exercise by it of its property rights as owner of the land above the shoreline adjacent to the filled land. Cleveland Electric holds permits, under federal statutes relating to navigation, to occupy such artificially filled land.\n(3) The facilities of Cleveland Electric's Seneca Plant in Warren County, Pennsylvania, are located on land owned by the United States and occupied by Cleveland Electric and Penelec pursuant to a license issued by the FERC for a 50-year period starting December 1, 1965 for the construction, operation and maintenance of a pumped-storage hydroelectric plant.\n(4) The water intake and discharge facilities at the electric generating plants of Cleveland Electric and Toledo Edison located along Lake Erie, the Maumee River and the Ohio River are extended into the lake and rivers under their property rights as owners of the land above the water line and pursuant to permits under federal statutes relating to navigation.\n(5) The transmission systems of the Operating Companies are located on land, easements or rights-of-way owned by them. Their distribution systems also are located, in part, on interests in land owned by them, but, for the most part, their distribution systems are located on lands owned by others and on streets and highways. In most cases, permission has been obtained from the apparent owner of the property or, if the distribution system is located on streets and highways, from the apparent owner of the abutting property. Their electric underground transmission and distri- bution systems are located, for the most part, in public streets. The Pennsylvania portions of the main transmission lines from the Seneca Plant, the Mansfield Plant and Beaver Valley Unit 2 are not owned by Cleveland Electric or Toledo Edison.\nAll Cleveland Electric and Toledo Edison properties, with certain exceptions, are subject to the lien of their respective mortgages.\nCleveland Electric has entered into an agreement with Jersey Central under which Jersey Central will lease Cleveland Electric's ownership share of the Seneca Plant (351,000 kilowatts). The lease will run for a period beginning on June 1, 1996 or on the date of receipt of appropriate regulatory approvals (whichever occurs later) and ending May 31, 2004.\nThe fee titles which Cleveland Electric and Toledo Edison acquire as tenant-in-common owners, and the leasehold interests they have as joint lessees, of certain generating units do not include the right to require a partition or sale for division of proceeds of the units without the concurrence of all the other owners and their respective mortgage trustees and the trustees under Cleveland Electric's and Toledo Edison's mortgages. As discussed under \"Item 1. Business--CAPCO Group\", Duquesne is attempting to partition its interest in Eastlake Unit 5.\n- 30 -\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\nPROCEEDINGS REGARDING AN ATTEMPT BY THE CITY OF CLYDE, OHIO TO REMOVE TOLEDO EDISON. See \"Item 1. Business--Operations--Competitive Conditions--Toledo Edison\".\nPROCEEDINGS BEFORE THE PUCO REGARDING ACTIONS BY THE CITY OF GARFIELD HEIGHTS, OHIO TO REDUCE CLEVELAND ELECTRIC'S RATES WITHIN THE CITY. See \"Item 1. Business--Operations--Competitive Conditions--Cleveland Electric\".\nPROCEEDINGS BEFORE THE FERC REGARDING THE PROPOSED MERGER OF THE OPERATING COMPANIES. See \"Item 1. Business--Merger of the Operating Companies\".\nPROCEEDINGS BEFORE THE PUCO REGARDING THE REQUESTS FOR RATE INCREASES FILED BY THE OPERATING COMPANIES. See \"Item 1. Business--Electric Rates--1995 Rate Case\".\nWESTINGHOUSE LAWSUIT. In April 1991, the CAPCO Group companies filed a lawsuit against Westinghouse in the United States District Court for the Western District of Pennsylvania. The suit alleges that six steam generators supplied by Westinghouse for Beaver Valley Power Station Units 1 and 2 contain serious defects, particularly defects causing tube corrosion and cracking. Steam generator maintenance costs have increased due to these defects and will likely continue to increase. The condition of the steam generators is being monitored closely. If the corrosion and cracking continue, replacement of the steam generators could be required earlier than their 40-year design life. The suit seeks monetary and corrective relief. In December 1994, a jury rendered a verdict in favor of Westinghouse on a fraud claim. (The court had previously dismissed four other claims against Westinghouse.) The CAPCO Group companies have appealed the decision to the United States Court of Appeals for the Third Circuit. The Operating Companies believe that the outcome of this lawsuit will not have a materially adverse effect on their financial positions or results of operation.\nDUQUESNE LAWSUIT. See \"Item 1. Business--CAPCO Group\".\nPROCEEDINGS BEFORE THE PUCO AND THE FERC REGARDING THE ELECTRIC SERVICE CONTRACT BETWEEN CPP AND MEDICAL CENTER CO. See \"Item 1. Business-- Operations--Competitive Conditions--Cleveland Electric\".\nPROCEEDINGS BEFORE WILLIAMS COUNTY (OHIO) COMMON PLEAS COURT RELATING TO ELECTRIC SERVICE BEING PROVIDED TO CHASE BRASS BY FOUR MUNICIPALS AND AMP-OHIO. See \"Item 1. Business--Operations--Competitive Conditions--Toledo Edison\".\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - -------------------------------------------------------------\nCENTERIOR ENERGY, CLEVELAND ELECTRIC AND TOLEDO EDISON ------------------------------------------------------\nNone.\n- 31 - PART II\nItem 5.","section_5":"Item 5. Market for Registrants' Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------\nThe information regarding common stock prices and number of share owners required by this Item is not applicable to Cleveland Electric or Toledo Edison because all of their common stock is held solely by Centerior Energy.\nMarket Information - ------------------\nCenterior Energy's common stock is traded on the New York, Chicago and Pacific Stock Exchanges. The quarterly high and low prices of Centerior common stock (as reported on the composite tape) in 1994 and 1995 were as follows:\nShare Owners - ------------\nAs of March 5, 1996, Centerior Energy had 133,729 common stock share owners of record.\nDividends - ---------\nSee Note 14 to Centerior's Financial Statements for quarterly dividend payments in the last two years. Future dividend action by Centerior's Board of Directors will continue to be decided on a quarter-to-quarter basis after the evaluation of financial results, potential earning capacity and cash flow.\nAt December 31, 1995, Centerior Energy had a retained earnings deficit of $336 million and capital surplus of $1.963 billion, resulting in an overall surplus of $1.627 billion that was available to pay dividends under Ohio law. Any current period earnings in 1996 will increase surplus under Ohio law. See Note 11(b) for discussions of dividend restrictions affecting Cleveland Electric and Toledo Edison.\nDividends paid in 1995 on each of the Operating Companies' outstanding series of preferred stock were fully taxable.\nItem 6.","section_6":"Item 6. Selected Financial Data - --------------------------------\nCENTERIOR ENERGY ----------------\nThe information required by this Item is contained on Pages and attached hereto.\n- 32 - CLEVELAND ELECTRIC ------------------\nThe information required by this Item is contained on Pages and attached hereto.\nTOLEDO EDISON -------------\nThe information required by this Item is contained on Pages and attached hereto.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations - ---------------------\nCENTERIOR ENERGY ----------------\nThe information required by this Item is contained on Pages through attached hereto.\nCLEVELAND ELECTRIC ------------------\nThe information required by this Item is contained on Pages through attached hereto.\nTOLEDO EDISON -------------\nThe information required by this Item is contained on Pages through attached hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------\nCENTERIOR ENERGY ----------------\nThe information required by this Item is contained on Pages through attached hereto.\nCLEVELAND ELECTRIC ------------------\nThe information required by this Item is contained on Pages through attached hereto.\nTOLEDO EDISON -------------\nThe information required by this Item is contained on Pages through attached hereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure - --------------------\nCENTERIOR ENERGY, CLEVELAND ELECTRIC AND TOLEDO EDISON ------------------------------------------------------\nNone.\n- 33 - PART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrants - -------------------------------------------------------------\nCENTERIOR ENERGY ----------------\nThe information required by this Item for Centerior regarding directors is incorporated herein by reference to Pages 4 through 7 and Page 15 of Centerior's definitive proxy statement dated March 12, 1996. Reference is also made to \"Executive Officers of the Registrants and the Service Company\" in Part I of this Report for information regarding the executive officers of Centerior Energy.\nCLEVELAND ELECTRIC ------------------\nSet forth below are the name and other directorships held, if any, of each director of Cleveland Electric. The year in which the director was first elected to Cleveland Electric's Board of Directors is set forth in parenthesis. Reference is made to \"Executive Officers of the Registrants and the Service Company\" in Part I of this Report for information regarding the directors and executive officers of Cleveland Electric. The directors received no remuneration in their capacity as directors.\nRobert J. Farling* - ----------------- Mr. Farling is a director of National City Bank. (1986)\nMurray R. Edelman - ----------------- Mr. Edelman is a director of Society Bank & Trust and Society National Bank. (1993)\nFred J. Lange, Jr. - ----------------- (1993)\n*Also a director of Centerior Energy and the Service Company.\nTOLEDO EDISON -------------\nSet forth below are the name and other directorships held, if any, of each director of Toledo Edison. The year in which the director was first elected to Toledo Edison's Board of Directors is set forth in parenthesis. Reference is made to \"Executive Officers of the Registrants and the Service Company\" in Part I of this Report for information regarding the directors and the executive officers of Toledo Edison. The directors received no remuneration in their capacity as directors.\nRobert J. Farling* - ----------------- Mr. Farling is a director of National City Bank. (1988)\nMurray R. Edelman - ----------------- Mr. Edelman is a director of Society Bank & Trust and Society National Bank. (1993)\nFred J. Lange, Jr. - ------------------\n(1993)\n*Also a director of Centerior Energy and the Service Company.\n- 34 - Item 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nCENTERIOR ENERGY, CLEVELAND ELECTRIC AND TOLEDO EDISON ------------------------------------------------------\nThe information required by this Item for Centerior is incorporated herein by reference to the information concerning compensation of directors on Page 8 and the information concerning compensation of executive officers, stock option transactions, long-term incentive awards and pension benefits on Pages 21 through 24 of Centerior's definitive proxy statement dated March 12, 1996. The named executive officers for Centerior are included for Cleveland Electric and Toledo Edison regardless of whether they were officers of Cleveland Electric or Toledo Edison because they were key policymakers for the Centerior System in 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nCENTERIOR ENERGY ----------------\nThe following table sets forth the beneficial ownership of Centerior common stock by individual directors of Centerior, the named executive officers and all directors and executive officers of Centerior Energy and the Service Company as a group as of February 28, 1996:\n- 35 - (2) Includes the following numbers of shares which are not owned but could have been purchased within 60 days after February 28, 1996 upon exercise of options to purchase shares of Centerior common stock: Mr. Farling - 10,000; Mr. Edelman - 5,000; Mr. Shelton - 3,400; Mr. Lange - 3,000; Mr. Temple - 2,150; and all directors and executive officers as a group - 33,550. None of those options have been exercised as of March 22, 1996.\n(3) Owned by the Sisters of Notre Dame.\nCLEVELAND ELECTRIC ------------------\nIndividual directors of Cleveland Electric, the named executive officers and all directors and executive officers of Cleveland Electric as a group beneficially owned the following number of shares of Centerior common stock as of February 28, 1996:\nTOLEDO EDISON -------------\nIndividual directors of Toledo Edison, the named executive officers and all directors and executive officers of Toledo Edison as a group beneficially owned the following number of shares of Centerior common stock as of February 28, 1996:\n- 36 -\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nCENTERIOR ENERGY, CLEVELAND ELECTRIC AND TOLEDO EDISON ------------------------------------------------------\nNone.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------\n(a) Documents Filed as a Part of the Report ---------------------------------------\n1. Financial Statements: --------------------\nFinancial Statements for Centerior Energy, Cleveland Electric and Toledo Edison are listed in the Index to Selected Financial Data; Management's Discussion and Analysis of Financial Condition and Re- sults of Operations; and Financial Statements. See Page.\n2. Financial Statement Schedules: -----------------------------\nFinancial Statement Schedules for Centerior Energy, Cleveland Electric and Toledo Edison are listed in the Index to Schedules. See Page S-1.\n- 37 - 3. Combined Pro Forma Condensed Financial Statements (Unaudited): -------------------------------------------------------------\nCombined Pro Forma Condensed Financial Statements (unaudited) for Cleveland Electric and Toledo Edison related to their pending merger. See Pages P-1 to P-4.\n4. Exhibits: --------\nExhibits for Centerior Energy, Cleveland Electric and Toledo Edison are listed in the Exhibit Index. See Page E-1.\n(b) Reports on Form 8-K -------------------\nDuring the quarter ended December 31, 1995, Centerior Energy, Cleveland Electric and Toledo Edison did not file any Current Reports on Form 8-K.\n- 38 - 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.\nCENTERIOR ENERGY CORPORATION ---------------------------- Registrant\nMarch 28, 1996 By J. T. PERCIO ------------------------- J. T. Percio, 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 date indicated:\n- 39 - SIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE CLEVELAND ELECTRIC ILLUMINATING COMPANY -------------------------------------------- Registrant\nMarch 28, 1996 By J. T. PERCIO ------------------------- J. T. Percio, 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 date indicated:\n- 40 - SIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE TOLEDO EDISON COMPANY ------------------------- Registrant\nMarch 28, 1996 By J. T. PERCIO ----------------------- J. T. Percio, 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 date indicated:\n- 41 -\nINDEX TO -------- SELECTED FINANCIAL DATA; MANAGEMENT'S DISCUSSION ------------------------------------------------ AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF ------------------------------------------------- OPERATIONS; AND FINANCIAL STATEMENTS ------------------------------------\nMANAGEMENT'S FINANCIAL ANALYSIS\nOUTLOOK\nSTRATEGIC PLAN\nWe continued to make progress during the second year of our eight-year strategic plan, but we remain keenly aware of the magnitude of the problems that face us. The strategic plan was created to achieve two major goals: strengthening our financial condition and improving our competitive position. Its objectives are to maximize share owner return, achieve profitable revenue growth, become a leader in customer satisfaction, build a winning employee team and attain increasingly competitive power supply costs. We are not yet positioned to compete in a less regulated electric utility industry, but every major action being taken -- strategic planning, revenue enhancement, cost reduction, improvement of work practices and application for increased prices -- is part of a comprehensive effort to succeed in an increasingly competitive environment.\nA primary objective of the strategic plan is continued and significant revenue growth even as our markets become more competitive. Retail revenues adjusted for weather and fuel costs have grown about 1% annually since 1990. During 1995, we took aggressive steps to increase revenues through enhanced marketing strategies. Also, our economic development efforts proved successful in attracting major new customers and supporting the expansion of existing ones. Although we are not satisfied with our growth rate, we expect that our marketing activity will improve revenue growth.\nThe rate case we filed with The Public Utilities Commission of Ohio (PUCO) in April 1995 is a critical factor to the success of the strategic plan. We do not see this rate case as a continuation of business as usual but as an important turning point which should, if we are successful in accomplishing the objectives discussed below, bring an end to price increases for the foreseeable future. A successful conclusion of the case would speed our transition to a more competitive company by providing additional cash to lower costs by accelerating the pay-down of debt and preferred stock. In our view, a successful conclusion would include approval of the full price increase requested with a regulatory commitment to maintain the established price levels over an appropriate transition period. This should be coupled with a means to accelerate recognition of regulatory assets (described in Note 7(a)) and nuclear generating assets concurrent with our cost control and revenue enhancement efforts in order to earn a fair return for share owners over time.\nAnother key part of our strategy is offering long-term contracts to those large customers who could have incentives to change power suppliers. In 1995, 68% of our industrial kilowatt-hour sales and 15% of our commercial kilowatt-hour sales were under long-term contracts. We are renegotiating contracts before they expire and in most cases are retaining customers under new long-term contracts.\nWe are continuing efforts to reduce fixed financing costs in order to strengthen our financial condition. During 1995, utilizing strong cash flow and refinancing at favorable terms, we reduced interest expense and preferred dividends by $8 million and outstanding debt and preferred stock by $134 million.\nOur overall costs are high relative to many of our neighboring utilities as a result of our substantial nuclear investment. The strategic plan calls for making us more competitive by continuing to reduce operating expenses and capital expenditures. In 1995, to improve our focus on cost reduction and other strategic plan objectives, we restructured into six business groups. The new organization includes groups to manage our generation, distribution and transmission businesses; provide services and administrative functions; and invest in nonregulated enterprises. This arrangement will also enhance each group's ability to identify cost reductions by focusing on margins and improving work practices and customer service. We will also continue to aggressively pursue initiatives to reduce the heavy tax burden imposed upon us by the state and local tax structure in Ohio.\nRATE CASE AND REGULATORY ACCOUNTING\nIn April 1995, our subsidiaries, The Cleveland Electric Illuminating Company (Cleveland Electric) and The Toledo Edison Company (Toledo Edison) (collectively, Operating Companies), filed requests with the PUCO for price increases aggregating $119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program discussed below and in Note 7. If their requests are approved, the Operating Companies intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will obviate the need for further price increases. If circumstances make it impossible to earn a fair return for share owners over time, we would ask for a further increase -- but only after taking all appropriate actions to make such a request unnecessary.\n(Centerior Energy) (Centerior Energy)\nIn December 1995, the PUCO ordered an investigation into the financial conditions, rates and practices of the Operating Companies.\nIn its report on the Operating Companies' rate request, the PUCO Staff recommended approval of the $119 million requested, subject to a commitment by the Operating Companies to significantly revalue their assets. In late January 1996, the Staff proposed that the Operating Companies significantly revalue their nuclear plant and regulatory assets within a five-year period. The Staff's asset revaluation proposal is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the Staff's recommendations. A decision by the PUCO is anticipated in the second quarter of 1996.\nThe outcome of the rate case could affect the Operating Companies' ability to meet the criteria of Statement of Financial Accounting Standards (SFAS) 71 for all or part of their operations which could result in the write-off of all or a part of the regulatory assets shown in Note 7(a). In our changing industry, other events independent of the outcome of the rate case could also result in write-offs or write-downs of assets.\nSee Note 7 for a full discussion and analysis of the rate case, SFAS 71 and other financial accounting requirements and the potential implications of these accounting requirements for our results of operations and financial position.\nRATE STABILIZATION PROGRAM\nUnder a Rate Stabilization Program approved by the PUCO in 1992, we agreed to freeze base rates until 1996 and limit rate increases through 1998. In exchange, we were permitted to defer through 1995 and subsequently recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits. Deferral of those costs and amortization of those benefits were completed in November 1995 and aggregated $159 million in 1995. Recovery is expected to begin with the effective date of the PUCO's orders in the pending rate case. Annual amortization of the deferred costs is $25 million which began in December 1995. Consequently, earnings in 1996 will be sharply lower than in 1995. Also contributing to lower earnings are the expectations that the requested price increase will not be effective until the second quarter of 1996 and results from increased marketing and cost reduction efforts will take time to achieve.\nCOMPETITION\nMajor structural changes are taking place in the electric utility industry which are expected to place downward pressure on prices and to increase competition for customers' business. The changes are coming from both federal and state authorities. Many of the changes began when the Energy Policy Act of 1992 permitted competition in the electric utility industry through broader access to a utility's transmission system. In March 1995, the Federal Energy Regulatory Commission (FERC) issued proposed rules relating to open access transmission services by public utilities, recovery of stranded investment and other related matters. The open access transmission rules require utilities to deliver power from other utilities or generation sources to their wholesale customers. In May 1995, the Operating Companies filed open access transmission tariffs with the FERC which used the proposed rules as a guideline. These tariffs are currently pending.\nSeveral groups in Ohio are studying the possible application of retail wheeling. Retail wheeling occurs when a customer obtains power from a utility company other than its local utility. The PUCO is sponsoring informal discussions among a group of business, utility and consumer interests to explore ways of promoting competitive options without unduly harming the interests of utility company share owners or customers. Legislative proposals are being drafted for submission to the Ohio House of Representatives and several utilities in the state have offered their own proposed transition plans for introduction of retail wheeling. The current retail wheeling efforts in Ohio are exploratory and we cannot predict when and to what extent retail wheeling will be implemented in Ohio.\nThe term \"stranded investment\" generally refers to fixed costs approved for recovery under traditional regulatory methods that would become unrecoverable, or \"stranded\", as a result of wider competition. Although competitive pressures are increasing, the traditional regulatory framework remains in place and is expected to continue for the foreseeable future. We cannot predict when and to what extent competition will be allowed. We believe that pure competition (unrestricted retail wheeling for all customer classifications) is at least several years away and that any transition to pure competition will be in phases. The FERC and the PUCO have acknowledged the need to provide at least partial recovery of stranded investment as greater competition is permitted and, therefore, we believe that there will be a mechanism developed for the recovery of stranded investment.\n(Centerior Energy) (Centerior Energy)\nHowever, due to the uncertainty involved, there is a risk that some of our assets may not be fully recovered.\nIn 1995, we continued to experience significant competition from municipal electric systems. Cleveland Public Power (CPP), the largest municipal system in our service area, continued to construct new distribution facilities extending into additional portions of Cleveland. Their progress has slowed significantly during the past year because of the discovery of a large number of safety violations in the CPP system resulting in substantial cost overruns. In Toledo, the City Council responded to a petition drive by appropriating funds to complete a consultant's study on whether to create a municipal electric utility. This study is expected to be completed by mid-1996.\nIn March 1995, one of Cleveland Electric's large commercial customers which has provided annual net income of $6 million, Medical Center Co., signed a five-year contract with CPP for electric service beginning in September 1996, when its contract with Cleveland Electric terminates. In both our appeal to the Ohio Supreme Court and petition to the FERC, it is our position that the purchase of power from CPP by this customer is in reality a direct purchase from another utility in violation of Ohio's certified territory statute. In October 1995, Chase Brass & Copper Co. Inc., which has provided annual net income of $2 million, terminated its service from Toledo Edison and began to receive its electric service from a consortium of other providers. Toledo Edison has filed lawsuits contending that this arrangement violates the legal limits of sales and delivery of power by municipal electric systems outside their boundaries. We will continue to pursue all legal and regulatory remedies to these situations.\nIn 1995, our economic development efforts proved successful in attracting major new customers, such as North Star BHP Steel, Worthington Steel and Aluminum Company of America, while supporting the expansion of existing ones, for example, American Steel & Wire and Ford Motor Company. We expect that our continued emphasis on economic development along with a newly developed market segment focus will be major ingredients in providing improved revenue growth.\nNUCLEAR OPERATIONS\nWe have interests in three nuclear generating units -- Davis-Besse Nuclear Power Station (Davis-Besse), Perry Nuclear Power Plant Unit 1 (Perry Unit 1) and Beaver Valley Power Station Unit 2 (Beaver Valley Unit 2) -- and operate the first two. Davis-Besse and Beaver Valley Unit 2 both operated extremely well in 1995. Their average three-year unit availability factors at year-end 1995 of 90% and 87%, respectively, exceeded the industry average of 81% for similar reactors. In 1995, the availability factor for Davis-Besse was 100%. The plant continues to have its best run ever operating at or near full capacity for 463 straight days through February 21, 1996.\nIn 1995, Perry Unit 1 improved its average three-year unit availability factor to 62% with a 1995 availability factor of 93%. Perry Unit 1 operated at or near capacity for 506 of 531 days since the end of its last refueling and maintenance outage in August 1994. Work on the comprehensive course of action plan developed in 1993 to improve the operating performance of Perry Unit 1 will be completed during the current refueling outage which began January 27, 1996.\nA significant part of the strategic plan involves ongoing efforts to increase the availability and lower the cost of production of our nuclear units. In 1995, we made great progress regarding unit availability while continuing to lower production costs. The goal of our nuclear improvement program is to replicate Davis-Besse's operational excellence and cost reduction gains at Perry Unit 1 while improving performance ratings.\nWe externally fund the estimated costs for the future decommissioning of our nuclear units. In 1993 and 1994, we increased our decommissioning expense accruals because of revisions in our cost estimates. See Note 1(d).\nOur nuclear units may be impacted by activities or events beyond our control. Operating nuclear units have experienced unplanned outages or extensions of scheduled outages because of equipment problems or new regulatory requirements. A major accident at a nuclear facility anywhere in the world could cause the Nuclear Regulatory Commission to limit or prohibit the operation or licensing of any domestic nuclear unit. If one of our nuclear units is taken out of service for an extended period for any reason, including an accident at such unit or any other nuclear facility, we cannot predict whether regulatory authorities would impose unfavorable rate treatment. Such treatment could include taking our affected unit out of rate base, thereby not permitting us to recover our investment in and earn a return on it, or disallowing certain construction or maintenance costs. An extended outage coupled with unfavorable rate treatment could have a material adverse effect on our financial condition\n(Centerior Energy) (Centerior Energy)\nand results of operations. Premature plant closings could also have a material adverse effect on our financial condition and results of operations because the estimated cost to decommission the plant exceeds the current funding in the decommissioning trust.\nHAZARDOUS WASTE DISPOSAL SITES\nThe Operating Companies have been named as \"potentially responsible parties\" (PRPs) for three sites listed on the Superfund National Priorities List (Superfund List) and are aware of their potential involvement in the cleanup of several other sites. Allegations that the Operating Companies disposed of hazardous waste at these sites, and the amount involved, are often unsubstantiated and subject to dispute. Federal law provides that all PRPs for a particular site be held liable on a joint and several basis. If the Operating Companies were held liable for 100% of the cleanup costs of all of the sites referred to above, the cost could be as high as $500 million. However, we believe that the actual cleanup costs will be substantially lower than $500 million, that the Operating Companies' share of any cleanup costs will be substantially less than 100% and that most of the other PRPs are financially able to contribute their share. The Operating Companies have accrued a liability totaling $12 million at December 31, 1995, based on estimates of the costs of cleanup and their proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations.\nMERGER OF THE OPERATING COMPANIES\nWe continue to seek the necessary regulatory approvals to complete the merger of the Operating Companies which we announced in 1994. The FERC has deferred action on the merger application until the merits of the Operating Companies' proposed open access transmission tariffs are addressed in hearings.\nCAPITAL RESOURCES AND LIQUIDITY\n1993-1995 CASH REQUIREMENTS\nA key part of our strategic plan is to significantly reduce the Operating Companies' level of debt and preferred stock. In 1995, we were able to continue the reduction pattern begun in 1994. These obligations were reduced by $136 million in 1994 and by $134 million in 1995. We intend to continue and to accelerate redemptions.\nWe need cash for normal corporate operations, retirement of maturing securities, and an ongoing program of constructing and improving facilities to meet demand for electric service and to comply with government regulations. Our cash construction expenditures totaled $209 million in 1993, $205 million in 1994 and $201 million in 1995. Our debt and preferred stock maturities and sinking fund requirements totaled $368 million in 1993, $120 million in 1994 and $377 million in 1995. In addition, we optionally redeemed approximately $470 million in the period 1993-1995. This amount includes $237 million of tax-exempt issues refunded in 1995 resulting in approximately $7 million of interest savings. In May 1995, Cleveland Electric issued $300 million of first mortgage bonds due in 2005 with an interest rate of 9.50%. The embedded cost of the Operating Companies' debt at the end of 1995 was 8.98% versus 9.12% in 1994 and 9.06% in 1993. In 1995, the Operating Companies renewed for a four-year term approximately $225 million in bank letters of credit supporting the equity owner participants in the Beaver Valley Unit 2 lease. See Note 11(d).\n1996 AND BEYOND CASH REQUIREMENTS\nOur 1996 cash requirements for construction are $128 million for Cleveland Electric and $74 million for Toledo Edison and for debt and preferred stock maturities and sinking fund requirements are $177 million for Cleveland Electric and $58 million for Toledo Edison. We expect to meet these requirements with internal cash generation, cash reserves and about $150 million from the sale of a AAA-rated security backed by our accounts receivable.\nWe expect to meet all of our 1997-2000 cash requirements with internal cash generation. Estimated cash requirements for our construction program during this period total $603 million for Cleveland Electric and $262 million for Toledo Edison. Debt and preferred stock maturities and sinking fund requirements total $400 million and $233 million for Cleveland Electric and Toledo Edison, respectively, for the same period. If economical, additional securities may be redeemed under optional redemption provisions, with funding expected to be provided through internal cash generation. Additional funding may be required to support investments in nonregulated business opportunities.\n(Centerior Energy) (Centerior Energy)\nLIQUIDITY\nAdditional first mortgage bonds may be issued by the Operating Companies under their respective mortgages on the basis of property additions, cash or refundable first mortgage bonds. If the applicable interest coverage test is met, each Operating Company may issue first mortgage bonds on the basis of property additions and, under certain circumstances, refundable bonds. At December 31, 1995, Cleveland Electric and Toledo Edison would have been permitted to issue approximately $379 million and $288 million of additional first mortgage bonds, respectively.\nThe Operating Companies also are able to raise funds through the sale of debt and preferred and preference stock. Under its articles of incorporation, Toledo Edison cannot issue preferred stock unless certain earnings coverage requirements are met. At December 31, 1995, Toledo Edison would have been permitted to issue approximately $158 million of additional preferred stock at an assumed dividend rate of 10.5%. There are no restrictions on Cleveland Electric's ability to issue preferred or preference stock or Toledo Edison's ability to issue preference stock. Centerior Energy may raise funds through the sale of common stock under various employee and share owner plans.\nThe Operating Companies have $307 million in financing vehicles available to support their nuclear fuel leases, portions of which mature this year. See Note 6. We plan to renew a $125 million revolving credit facility which matures in May 1996. See Note 12. At the end of 1995, we had $179 million in cash and temporary investments.\nThe foregoing financing resources are expected to be sufficient for the Operating Companies' needs over the next several years. However, the availability and cost of capital to meet external financing needs also depend upon such factors as financial market conditions and their credit ratings. Current credit ratings for the Operating Companies are as follows:\nRESULTS OF OPERATIONS\n1995 VS. 1994\nFactors contributing to the 3.9% increase in 1995 operating revenues are as follows:\nFor the third year in a row, industrial kilowatt-hour sales increased. The increase in 1995 was 0.8%, but sales grew 2.2% excluding reductions at two low-margin steel producers (representing 5% of industrial revenues). Residential and commercial sales increased 3.5% and 2.8%, respectively, primarily because of the hot summer weather, although there was about 1% nonweather-related growth in commercial sales. Other sales increased 26% because of a 43% increase in wholesale sales due principally to the hot summer and good availability of our generating units. Weather accounted for approximately $38 million of the $61 million increase in 1995 base rate (nonfuel) revenues. Higher 1995 fuel cost recovery revenues resulted from an increase in the fuel cost factor for Cleveland Electric. The weighted average of these fuel cost factors increased 7% for Cleveland Electric but decreased 6% for Toledo Edison.\nFor 1995, operating revenues were 32% residential, 30% commercial, 31% industrial and 7% other and kilowatt-hour sales were 23% residential, 25% commercial, 40% industrial and 12% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.10 and $.06, respectively.\nOperating expenses increased 4.5% in 1995. Fuel and purchased power expenses increased as higher fuel expense was partially offset by lower purchased power expense. The higher fuel expense was attributable to increased generation and more amortization of previously deferred fuel costs than the amount amortized in 1994. The higher other operation and maintenance expenses resulted primarily from charges for an ongoing inventory reduction program and the recognition of costs associated with preliminary engineering studies. Federal income taxes increased as a result of higher pretax operating income. Taxes, other than federal income taxes, increased primarily due to property tax increases resulting from plant additions, real estate valuation increases and a nonrecurring tax credit recorded in 1994.\n(Centerior Energy) (Centerior Energy)\n1994 VS. 1993\nFactors contributing to the 2.1% decrease in 1994 operating revenues are as follows:\nWe experienced good retail kilowatt-hour sales growth in the industrial and commercial categories in 1994; the sales growth for the residential category was lessened by weather conditions, particularly during the summer. The revenue decrease resulted primarily from milder weather conditions in 1994 and 39% lower wholesale sales. Weather reduced base rate revenues approximately $15 million from the 1993 amount. Although total sales decreased by 1.9%, industrial sales increased 3.3% on the strength of increased sales to large automotive manufacturers and the broad-based, smaller industrial customer group. This growth substantiated an economic resurgence in our service area, particularly in Northwestern Ohio. Residential and commercial sales increased 0.1% and 2.4%, respectively. Other sales decreased by 28% because of the lower sales to wholesale customers attributable to expiration of a wholesale power agreement, softer wholesale market conditions and limited power availability for bulk power transactions at certain times because of generating plant outages. Lower 1994 fuel cost recovery revenues resulted from favorable changes in the fuel cost factors. The weighted averages of these factors dropped by 5% and 6% for Cleveland Electric and Toledo Edison, respectively.\nFor 1994, operating revenues were 31% residential, 30% commercial, 31% industrial and 8% other and kilowatt-hour sales were 24% residential, 25% commercial, 41% industrial and 10% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.10 and $.06, respectively. The changes from 1993 were not significant.\nOperating expenses were 15% lower in 1994. Operation and maintenance expenses for 1993 included $218 million of net benefit expenses related to an early retirement program, called the Voluntary Transition Program (VTP), and other charges totaling $54 million. A smaller work force and ongoing cost reduction measures also lowered operation and maintenance expenses. More nuclear generation and less coal-fired generation accounted for a large part of the lower fuel and purchased power expenses in 1994. Depreciation and amortization expenses increased primarily because of higher nuclear plant decommissioning expenses as discussed in Note 1(d). Deferred operating expenses were greater primarily because of the write-off of $172 million of phase-in deferred operating expenses in 1993 as discussed in Note 7(e). The 1993 deferrals also included $84 million of postretirement benefit curtailment cost deferrals related to the VTP. See Note 9(b). Federal income taxes increased as a result of higher pretax operating income.\nAs discussed in Note 4(b), $583 million of our Perry Unit 2 investment was written off in 1993. Also, as discussed in Note 7, phase-in deferred carrying charges of $705 million were written off in 1993. The change in the federal income tax credit amounts for nonoperating income was attributable to these write-offs.\n(Centerior Energy) (Centerior Energy)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Share Owners and Board of Directors of Centerior Energy Corporation:\nWe have audited the accompanying consolidated balance sheet and consolidated statement of preferred stock of Centerior Energy Corporation (an Ohio corporation) 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. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Centerior Energy 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 further in Note 9, a change was made in the method of accounting for postretirement benefits other than pensions in 1993.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of Centerior Energy Corporation and subsidiaries listed in the Index to 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.\nArthur Andersen LLP\nCleveland, Ohio February 21, 1996\n(Centerior Energy) (Centerior Energy)\nINCOME STATEMENT Centerior Energy Corporation and Subsidiaries\nRETAINED EARNINGS\nThe accompanying notes are an integral part of these statements.\n(Centerior Energy) (Centerior Energy)\nBALANCE SHEET\nThe accompanying notes are an integral part of this statement.\n(Centerior Energy) (Centerior Energy)\nCenterior Energy Corporation and Subsidiaries\n(Centerior Energy) (Centerior Energy)\nCASH FLOWS Centerior Energy Corporation and Subsidiaries\n- ---------------\n(2) Increases in Nuclear Fuel and Nuclear Fuel Lease Obligations in the Balance Sheet resulting from the noncash capitalizations under nuclear fuel agreements are excluded from this statement.\nThe accompanying notes are an integral part of this statement.\n(Centerior Energy) (Centerior Energy)\nSTATEMENT OF PREFERRED STOCK Centerior Energy Corporation and Subsidiaries\nThe accompanying notes are an integral part of this statement.\n(Centerior Energy) (Centerior Energy)\nNOTES TO THE FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) GENERAL\nCenterior Energy is a holding company with two electric utility subsidiaries, Cleveland Electric and Toledo Edison, with service areas in Northern Ohio. The consolidated financial statements also include the accounts of Centerior Energy's wholly owned subsidiary, Centerior Service Company (Service Company), and its three other wholly owned subsidiaries, which in the aggregate are not material. The Service Company provides management, financial, administrative, engineering, legal and other services at cost to Centerior Energy, the Operating Companies and the other subsidiaries. The Operating Companies operate as separate companies, each serving the customers in its service area. The preferred stock, first mortgage bonds and other debt obligations of the Operating Companies are outstanding securities of the issuing utility. All significant intercompany items have been eliminated in consolidation.\nCenterior Energy and the Operating Companies follow the Uniform System of Accounts prescribed by the FERC and adopted by the PUCO. Rate-regulated utilities are subject to SFAS 71 which governs accounting for the effects of certain types of rate regulation. Pursuant to SFAS 71, certain incurred costs are deferred for recovery in future rates. See Note 7. The Service Company follows the Uniform System of Accounts for Mutual Service Companies prescribed by the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act of 1935.\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, and the disclosure of contingent assets and liabilities. The estimates are based on an analysis of the best information available. Actual results could differ from those estimates.\nThe Operating Companies are members of the Central Area Power Coordination Group (CAPCO). Other members are Duquesne Light Company, Ohio Edison Company and its wholly owned subsidiary, Pennsylvania Power Company. The members have constructed and operate generation and transmission facilities for their joint use.\n(B) REVENUES\nCustomers are billed on a monthly cycle basis for their energy consumption based on rate schedules or contracts authorized by the PUCO or on ordinances of individual municipalities. An accrual is made at the end of each month to record the estimated amount of unbilled revenues for kilowatt-hours sold in the current month but not billed by the end of that month.\nA fuel factor is added to the base rates for electric service. This factor is designed to recover from customers the costs of fuel and most purchased power. It is reviewed and adjusted semiannually in a PUCO proceeding.\n(C) FUEL EXPENSE\nThe cost of fossil fuel is charged to fuel expense based on inventory usage. The cost of nuclear fuel, including an interest component, is charged to fuel expense based on the rate of consumption. Estimated future nuclear fuel disposal costs are being recovered through base rates.\nThe Operating Companies defer the differences between actual fuel costs and estimated fuel costs currently being recovered from customers through the fuel factor. This matches fuel expenses with fuel-related revenues.\nOwners of nuclear generating plants are assessed by the federal government for the cost of decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy. The assessments are based upon the amount of enrichment services used in prior years and cannot be imposed for more than 15 years (to 2007). The Operating Companies have accrued the liability for their share of the total assessments. These costs have been recorded in a deferred charge account since the PUCO is allowing the Operating Companies to recover the assessments through their fuel cost factors.\n(D) DEPRECIATION AND DECOMMISSIONING\nThe cost of property, plant and equipment is depreciated over their estimated useful lives on a straight-line basis. The annual straight-line depreciation provision for nonnuclear property expressed as a percent of average depreciable utility plant in service was 3.5% in 1995, 3.4% in 1994 and 3.5% in 1993. The annual straight-line depreciation rate for nuclear property is 2.5%. In conjunction with the Operating Companies' pending rate case, we have asked the PUCO to approve an increase of this depreciation rate to approximately 3%.\nThe Operating Companies accrue the estimated costs of decommissioning their three nuclear generating units.\n(Centerior Energy) (Centerior Energy)\nThe accruals are required to be funded in an external trust. The PUCO requires that the expense and payments to the external trusts be determined on a levelized basis by dividing the unrecovered decommissioning costs in current dollars by the remaining years in the licensing period of each unit. This methodology requires that the net earnings on the trusts be reinvested therein with the intent of having net earnings offset inflation. The PUCO requires that the estimated costs of decommissioning and the funding level be reviewed at least every five years.\nIn 1994, the Operating Companies increased their annual decommissioning expense accruals to $24 million from the $12 million level in 1993. The accruals are reflected in current rates. The increased accruals in 1994 were derived from updated, site-specific studies for each of the units. The revised estimates reflect the DECON method of decommissioning (prompt decontamination), and the locations and cost characteristics specific to the units, and include costs associated with decontamination, dismantlement and site restoration.\nThe revised estimates for the units in 1993 and 1992 dollars and in dollars at the time of license expiration, assuming a 4% annual inflation rate, are as follows:\n- ---------------\n(1) Dollar amounts in 1993 dollars. (2) Dollar amount in 1992 dollars.\nThe updated estimates reflect substantial increases from the prior PUCO-recognized aggregate estimates of $257 million in 1987 and 1986 dollars.\nThe classification, Accumulated Depreciation and Amortization, in the Balance Sheet at December 31, 1995 includes $130 million of decommissioning costs previously expensed and the earnings on the external trust funding. This amount exceeds the Balance Sheet amount of the external Nuclear Plant Decommissioning Trusts because the reserve began prior to the external trust funding. The trust earnings are recorded as an increase to the trust assets and the related component of the decommissioning reserve (included in Accumulated Depreciation and Amortization).\nThe staff of the SEC has questioned certain of the current accounting practices of the electric utility industry, including those of the Operating Companies, regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations in the financial statements. In response to these questions, the Financial Accounting Standards Board (FASB) is reviewing the accounting for removal costs, including decommissioning. If current accounting practices are changed, the annual provision for decommissioning could increase; the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation; and trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense. The FASB issued an exposure draft on the subject on February 7, 1996.\n(E) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at original cost less amounts disallowed by the PUCO. Construction costs include related payroll taxes, retirement benefits, fringe benefits, management and general overheads and allowance for funds used during construction (AFUDC). AFUDC represents the estimated composite debt and equity cost of funds used to finance construction. This noncash allowance is credited to income. The AFUDC rates averaged 11.5% in 1995, 9.8% in 1994 and 9.9% in 1993.\nMaintenance and repairs for plant and equipment are charged to expense as incurred. The cost of replacing plant and equipment is charged to the utility plant accounts. The cost of property retired plus removal costs, after deducting any salvage value, is charged to the accumulated provision for depreciation.\n(F) DEFERRED GAIN AND LOSS FROM SALES OF UTILITY PLANT\nThe sale and leaseback transactions discussed in Note 2 resulted in a net gain for the sale of the Bruce Mansfield Generating Plant (Mansfield Plant) and a net loss for the sale of Beaver Valley Unit 2. The net gain and net loss were deferred and are being amortized over the terms of leases. See Note 7(a). These amortizations and the lease expense amounts are reported in the Income Statement as Generation Facilities Rental Expense, Net.\n(G) INTEREST CHARGES\nDebt Interest reported in the Income Statement does not include interest on obligations for nuclear fuel under construction. That interest is capitalized. See Note 6.\nLosses and gains realized upon the reacquisition or redemption of long-term debt are deferred, consistent\n(Centerior Energy) (Centerior Energy)\nwith the regulatory rate treatment. See Note 7(a). Such losses and gains are either amortized over the remainder of the original life of the debt issue retired or amortized over the life of the new debt issue when the proceeds of a new issue are used for the debt redemption. The amortizations are included in debt interest expense.\n(H) FEDERAL INCOME TAXES We use the liability method of accounting for income taxes in accordance with SFAS 109. See Note 8. This method requires that deferred taxes be recorded for all temporary differences between the book and tax bases of assets and liabilities. The majority of these temporary differences are attributable to property-related basis differences. Included in these basis differences is the equity component of AFUDC, which will increase future tax expense when it is recovered through rates. Since this component is not recognized for tax purposes, we must record a liability for our tax obligation. The PUCO permits recovery of such taxes from customers when they become payable. Therefore, the net amount due from customers through rates has been recorded as a deferred charge and will be recovered over the lives of the related assets. See Note 7(a).\nInvestment tax credits are deferred and amortized over the lives of the applicable property as a reduction of depreciation expense. See Note 7(d) for a discussion of the amortization of certain unrestricted excess deferred taxes and unrestricted investment tax credits under the Rate Stabilization Program.\n(2) UTILITY PLANT SALE AND LEASEBACK TRANSACTIONS\nThe Operating Companies are co-lessees of 18.26% (150 megawatts) of Beaver Valley Unit 2 and 6.5% (51 megawatts), 45.9% (358 megawatts) and 44.38% (355 megawatts) of Units 1, 2 and 3 of the Mansfield Plant, respectively. These leases extend through 2017 and are the result of sale and leaseback transactions completed in 1987.\nUnder these leases, the Operating Companies are responsible for paying all taxes, insurance premiums, operation and maintenance expenses and all other similar costs for their interests in the units sold and leased back. They may incur additional costs in connection with capital improvements to the units. The Operating Companies have options to buy the interests back at the end of the leases for the fair market value at that time or renew the leases. The leases include conditions for mandatory termination (and possible repurchase of the leasehold interest) for events of default.\nFuture minimum lease payments under the operating leases at December 31, 1995 are summarized as follows:\nRental expense is accrued on a straight-line basis over the terms of the leases. The amount recorded in 1995, 1994 and 1993 as annual rental expense for the Mansfield Plant leases was $115 million. The amounts recorded in 1995, 1994 and 1993 as annual rental expense for the Beaver Valley Unit 2 lease were $63 million, $64 million and $63 million, respectively. Amounts charged to expense in excess of the lease payments are classified as Accumulated Deferred Rents in the Balance Sheet.\nToledo Edison is selling 150 megawatts of its Beaver Valley Unit 2 leased capacity entitlement to Cleveland Electric. We anticipate that this sale will continue indefinitely.\n(3) PROPERTY OWNED WITH OTHER UTILITIES AND INVESTORS\nThe Operating Companies own, as tenants in common with other utilities and those investors who are owner-participants in various sale and leaseback transactions (Lessors), certain generating units as listed below. Each owner owns an undivided share in the entire unit. Each owner has the right to a percentage of the generating capability of each unit equal to its ownership share. Each utility owner is obligated to pay for only its respective share of the construction costs and operating expenses. Each Lessor has leased its capacity rights to a utility which is obligated to pay for such Lessor's share of the construction costs and operating expenses. The Operating Companies' share of the operating expenses of these generating units is included in the Income Statement. The Balance Sheet classification of Property, Plant and Equipment at December 31, 1995 includes the following\n(Centerior Energy) (Centerior Energy)\nfacilities owned by the Operating Companies as tenants in common with other utilities and Lessors:\nDepreciation for Eastlake Unit 5 has been accumulated with all other nonnuclear depreciable property rather than by specific units of depreciable property.\n(4) CONSTRUCTION AND CONTINGENCIES\n(A) CONSTRUCTION PROGRAM\nThe estimated cost of our construction program for the 1996-2000 period is $1.107 billion, including AFUDC of $40 million and excluding nuclear fuel.\nThe Clean Air Act Amendments of 1990 (Clean Air Act) requires, among other things, significant reductions in the emission of sulfur dioxide and nitrogen oxides by fossil-fueled generating units. Our strategy provides for compliance primarily through greater use of low-sulfur coal at some of our units and the use of emission allowances. Total capital expenditures from 1991 through 1995 in connection with Clean Air Act compliance amounted to $50 million. The plan will require additional capital expenditures over the 1996-2005 period of approximately $90 million for nitrogen oxide control equipment and other plant process modifications. In addition, higher fuel and other operation and maintenance expenses will be incurred. Cleveland Electric may need to install sulfur emission control technology at one of its generating plants after 2005 which could require additional expenditures at that time.\n(B) PERRY UNIT 2\nPerry Unit 2, including its share of the facilities common with Perry Unit 1, was approximately 50% complete when construction was suspended in 1985 pending consideration of various options. We wrote off our investment in Perry Unit 2 at December 31, 1993 after we determined that it would not be completed or sold. The write-off totaled $583 million ($425 million after taxes) for our 64.76% ownership share of the unit.\n(C) HAZARDOUS WASTE DISPOSAL SITES\nThe Operating Companies are aware of their potential involvement in the cleanup of three sites listed on the Superfund List and several other sites. The Operating Companies have accrued a liability totaling $12 million at December 31, 1995 based on estimates of the costs of cleanup and their proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations. See Management's Financial Analysis -- Outlook-Hazardous Waste Disposal Sites.\n(5) NUCLEAR OPERATIONS AND CONTINGENCIES\n(A) OPERATING NUCLEAR UNITS\nOur three nuclear units may be impacted by activities or events beyond our control. An extended outage of one of our nuclear units for any reason, coupled with any unfavorable rate treatment, could have a material adverse effect on our financial condition and results of operations. See the discussion of these and other risks in Management's Financial Analysis -- Outlook-Nuclear Operations.\n(B) NUCLEAR INSURANCE\nThe Price-Anderson Act limits the public liability of the owners of a nuclear power plant to the amount provided by private insurance and an industry assessment plan. In the event of a nuclear incident at any unit in the United States resulting in losses in excess of the level of private insurance (currently $200 million), our maximum potential assessment under that plan would be $155 million per incident. The assessment is limited to $20 million per year for each nuclear incident. These assessment limits assume the other CAPCO companies contribute their proportionate share of any assessment.\nThe utility owners and lessees of Davis-Besse, Perry and Beaver Valley also have insurance coverage for damage to property at these sites (including leased fuel and cleanup costs). Coverage amounted to $2.75 billion for each site as of January 1, 1996. Damage to property could exceed the insurance coverage by a substantial amount. If it does, our share of such excess amount could have a material adverse effect on our financial condition and results of operations. In addition, we can be assessed a maximum of $42 million under these policies during a policy year if the reserves available to the insurer are inadequate to pay claims arising out of an accident at any nuclear facility covered by the insurer.\n(Centerior Energy) (Centerior Energy)\nWe also have extra expense insurance coverage. It includes the incremental cost of any replacement power purchased (over the costs which would have been incurred had the units been operating) and other incidental expenses after the occurrence of certain types of accidents at our nuclear units. The amounts of the coverage are 100% of the estimated extra expense per week during the 52-week period starting 21 weeks after an accident and 80% of such estimate per week for the next 104 weeks. The amount and duration of extra expense could substantially exceed the insurance coverage.\n(6) NUCLEAR FUEL\nNuclear fuel is financed for the Operating Companies through leases with a special-purpose corporation. The total amount of financing currently available under these lease arrangements is $307 million ($157 million from intermediate-term notes and $150 million from bank credit arrangements). The intermediate-term notes mature in 1996 and 1997 ($84 million in September 1996 and $73 million in September 1997). The bank credit arrangements terminate in October 1996. The special-purpose corporation plans to obtain alternate financing in 1996 to replace the $234 million of financing expiring in 1996. At December 31, 1995, $236 million of nuclear fuel was financed. The Operating Companies severally lease their respective portions of the nuclear fuel and are obligated to pay for the fuel as it is consumed in a reactor. The lease rates are based on various intermediate-term note rates, bank rates and commercial paper rates.\nThe amounts financed include nuclear fuel in the Davis-Besse, Perry Unit 1 and Beaver Valley Unit 2 reactors with remaining lease payments of $79 million, $55 million and $35 million, respectively, at December 31, 1995. The nuclear fuel amounts financed and capitalized also included interest charges incurred by the lessors amounting to $5 million in 1995, $11 million in 1994 and $14 million in 1993. The estimated future lease amortization payments based on projected consumption are $96 million in 1996, $82 million in 1997, $68 million in 1998, $65 million in 1999 and $62 million in 2000.\n(7) REGULATORY MATTERS\n(A) REGULATORY ACCOUNTING REQUIREMENTS AND REGULATORY ASSETS\nThe Operating Companies are subject to the provisions of SFAS 71 and have complied with its provisions. SFAS 71 provides, among other things, for the deferral of certain incurred costs that are probable of future recovery in rates. We monitor changes in market and regulatory conditions and consider the effects of such changes in assessing the continuing applicability of SFAS 71. Criteria that could give rise to discontinuation of the application of SFAS 71 include: (1) increasing competition which significantly restricts the Operating Companies' ability to charge prices which allow us to recover operating costs, earn a fair return on invested capital and recover the amortization of regulatory assets and (2) a significant change in the manner in which rates are set by the PUCO from cost-based regulation to some other form of regulation. Regulatory assets represent probable future revenues to the Operating Companies associated with certain incurred costs, which they will recover from customers through the rate-making process.\nEffective January 1, 1996, the Operating Companies adopted SFAS 121 which imposes stricter criteria for carrying regulatory assets than SFAS 71 by requiring that such assets be probable of recovery at each balance sheet date. The criteria under SFAS 121 for plant assets require such assets to be written down only if the book value exceeds the projected net future cash flows.\nRegulatory assets in the Balance Sheet are as follows:\n* Represent deferrals of operating expenses and carrying charges for Perry Unit 1 and Beaver Valley Unit 2 in 1987 and 1988 which are being amortized over the lives of the related property.\nAs of December 31, 1995, customer rates provide for recovery of all the above regulatory assets, except those related to the Rate Stabilization Program discussed below. The remaining recovery periods for all of the regulatory assets listed above range from 16 to 33 years.\n(B) RATE CASE\nIn April 1995, the Operating Companies filed requests with the PUCO for price increases aggregating $119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program. If their requests are approved, the Operating Companies intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will preclude the need for further price increases. If circumstances make it impossible to earn a fair return for share owners\n(Centerior Energy) (Centerior Energy)\nover time, we would ask for a further increase, but only after taking all appropriate actions to make such a request unnecessary.\nIn November 1995, the PUCO Staff issued its report addressing the Operating Companies' rate case. The Staff recommended that the PUCO grant the full $119 million price increase requested. However, the Staff also recommended that the price increase be conditioned upon the Operating Companies' commitment \"to a significant revaluation of their asset bases over some finite period of time.\"\nIn December 1995, the PUCO ordered an investigation into the financial condition, rates and practices of the Operating Companies to identify outcomes and remedies other than those routinely applied during the rate case process.\nIn late January 1996, the Staff proposed an incremental reduction (currently, $1.25 billion) beyond the normal level in nuclear plant and regulatory assets within five years. The Staff proposed that the Operating Companies have flexibility to determine how to achieve this incremental asset revaluation, but no additional price increases to recover the accelerated asset revaluation were proposed. Any incremental revaluation of assets would be for regulatory purposes and would cause prices and revenues after the five-year period to be lower than they otherwise would be in conjunction with any rate case following such revaluation. The Staff's asset revaluation proposal represents a substantial change in the form of rate-making traditionally followed by the PUCO and is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the recommendations of the Staff. A decision by the PUCO is anticipated in the second quarter of 1996.\n(C) ASSESSMENT OF POTENTIAL OUTCOMES\nWe continually assess the effects of competition and the changing industry and regulatory environment on operations, our ability to recover regulatory assets and our ability to continue application of SFAS 71. If, as a result of the pending rate case or other events, we determine that the Operating Companies no longer meet the criteria for SFAS 71, we would be required to record a before-tax charge to write off the regulatory assets shown above and evaluate whether property, plant and equipment should be written down. In the more likely event that only a portion of operations (such as nuclear operations) no longer meets the criteria of SFAS 71, a write-off would be limited to regulatory assets, if any, that are not reflected in our cost-based prices established for the remaining regulated operations. In addition, we would be required to evaluate whether the changes in the competitive and regulatory environment which led to discontinuing the application of SFAS 71 to a portion of our operations would also result in a write-down of property, plant and equipment pursuant to SFAS 121.\nWe believe application of SFAS 121 in that event will not result in a write-off of regulatory assets unless the PUCO denies recovery of such assets or if we conclude, as a result of the outcome of our pending rate case or some other event, that recovery is not probable for some or all of the regulatory assets. Furthermore, a write-down under SFAS 121 of property, plant and equipment is not expected.\n(D) RATE STABILIZATION PROGRAM\nThe Rate Stabilization Program that the PUCO approved in October 1992 allowed the Operating Companies to defer and subsequently amortize and recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits during the 1992-1995 period. Recovery of the deferrals will begin with the effective date of the PUCO's orders in the pending rate case. The regulatory assets recorded included the deferral of post-in-service interest carrying charges, depreciation expense and property taxes on assets placed in service after February 29, 1988, the deferral of incremental expenses resulting from the adoption of SFAS 106 (see Note 9(b)), and the deferral by Toledo Edison of the operating expenses equivalent to an accumulated excess rent reserve for Beaver Valley Unit 2 (which resulted from the April 1992 refinancing of Secured Lease Obligation Bonds issued by a special purpose corporation). The cost deferrals recorded in 1995, 1994 and 1993 pursuant to these provisions were $113 million, $112 million and $191 million, respectively. The regulatory accounting measures also provided for the accelerated amortization of certain unrestricted excess deferred tax and unrestricted investment tax credit balances and an excess interim spent fuel storage accrual balance for Davis-Besse. The total annual amount of such accelerated benefits was $46 million in 1995, 1994 and 1993.\n(E) PHASE-IN DEFERRALS\nIn 1993, upon completing a comprehensive study which led to our strategic plan, we concluded that projected revenues would not provide for recovery of deferrals recorded pursuant to phase-in plans approved by the PUCO in 1989 and, consequently, that the deferrals would have to be written off. Such deferrals were scheduled to be recovered in 1994 through 1998. The total\n(Centerior Energy) (Centerior Energy)\nphase-in deferred operating expenses and carrying charges written off at December 31, 1993 were $172 million and $705 million, respectively (totaling $598 million after taxes).\n(8) FEDERAL INCOME TAX The components of federal income tax expense (credit) recorded in the Income Statement were as follows:\nThe deferred federal income tax expense results from the temporary differences that arise from the different years certain expenses are recognized for tax purposes as opposed to financial reporting purposes. Such temporary differences affecting operating expenses relate principally to depreciation and deferred operating expenses whereas those affecting nonoperating income principally relate to deferred carrying charges and the 1993 write-offs.\nFederal income tax, computed by multiplying the income before taxes and preferred dividend requirements of subsidiaries by the 35% statutory rate, is reconciled to the amount of federal income tax recorded on the books as follows:\nFor tax reporting purposes, the Perry Unit 2 abandonment was recognized in 1994 and resulted in a $327 million loss with a corresponding $114 million reduction in federal income tax liability. Because of the alternative minimum tax (AMT), $65 million of the $114 million was realized in 1994. The remaining $49 million will not be realized until 1999. Additionally, a repayment of approximately $29 million of previously allowed investment tax credits was recognized in 1994.\nUnder SFAS 109, temporary differences and carryforwards resulted in deferred tax assets of $604 million and deferred tax liabilities of $2.479 billion at December 31, 1995 and deferred tax assets of $596 million and deferred tax liabilities of $2.374 billion at December 31, 1994. These are summarized as follows:\nFor tax purposes, net operating loss (NOL) carryforwards of approximately $322 million are available to reduce future taxable income and will expire in 2005 through 2009. The 35% tax effect of the NOLs is $113 million. Additionally, AMT credits of $213 million that may be carried forward indefinitely are available to reduce future tax.\n(9) RETIREMENT BENEFITS\n(A) RETIREMENT INCOME PLAN\nWe sponsor a noncontributing pension plan which covers all employee groups. The amount of retirement benefits generally depends upon the length of service. Under certain circumstances, benefits can begin as early as age 55. Our funding policy is to comply with the Employee Retirement Income Security Act of 1974 guidelines.\nIn 1993, we offered the VTP, an early retirement program. Operating expenses for 1993 included $205 million of pension plan accruals to cover enhanced VTP benefits offset by a credit of $81 million resulting from a settlement of pension obligations through lump sum payments to almost all the VTP retirees.\nPension and VTP costs (credits) for 1993 through 1995 were comprised of the following components:\n(Centerior Energy) (Centerior Energy)\nThe following table presents a reconciliation of the funded status of the plan.\nA September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995, the settlement (discount) rate and long-term rate of return on plan assets assumptions were 8% and 11%, respectively. The long-term rate of annual compensation increase assumption was 3.5% in 1996 and 1997 and 4% thereafter. At December 31, 1994, the settlement rate and long-term rate of return on plan assets assumptions were 8.5% and 10%, respectively. The long-term rate of annual compensation increase assumption was 3.5% for 1995 and 1996 and 4% thereafter. Plan assets consist primarily of investments in common stock, bonds, guaranteed investment contracts, cash equivalent securities and real estate.\n(B) OTHER POSTRETIREMENT BENEFITS\nWe sponsor a postretirement benefit plan which provides all employee groups certain health care, death and other postretirement benefits other than pensions. The plan is contributory, with retiree contributions adjusted annually. The plan is not funded. We adopted SFAS 106, the accounting standard for postretirement benefits other than pensions, effective January 1, 1993. The standard requires the accrual of the expected costs of such benefits during the employees' years of service. Prior to 1993, the costs of these benefits were expensed as paid, which was consistent with rate-making practices.\nThe components of the total postretirement benefit costs for 1993 through 1995 were as follows:\nIn 1995, 1994 and 1993, we deferred incremental SFAS 106 expenses (in excess of the amounts paid) of $4 million, $6 million and $96 million, respectively, pursuant to a provision of the Rate Stabilization Program. See Note 7(d).\nThe accumulated postretirement benefit obligation and accrued postretirement benefit cost are as follows:\nA September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995 and 1994, the settlement rate and the long-term rate of annual compensation increase assumptions were the same as those discussed for pension reporting in Note 9(a). At December 31, 1995, the assumed annual health care cost trend rates (applicable to gross eligible charges) were 8% for medical and 7.5% for dental in 1996. Both rates reduce gradually to a fixed rate of 4.75% by 2003. Elements of the obligation affected by contribution caps are significantly less sensitive to the health care cost trend rate than other elements. If the assumed health care cost trend rates were increased by one percentage point in each future year, the accumulated postretirement benefit obligation as of December 31, 1995 would increase by $6 million and the aggregate of the service and interest cost\n(Centerior Energy) (Centerior Energy)\ncomponents of the annual postretirement benefit cost would increase by $0.5 million.\n(10) GUARANTEES\nCleveland Electric has guaranteed certain loan and lease obligations of two coal suppliers under two long-term coal supply contracts. Toledo Edison is a party to one of these contracts. At December 31, 1995, the principal amount of the loan and lease obligations guaranteed by the Operating Companies under both contracts was $53 million. In addition, under the contract to which Toledo Edison is not a party, Cleveland Electric may be responsible for mine closing costs when the contract is terminated. At December 31, 1995, the unfunded costs of closing this mine as estimated by the supplier were $32 million.\nThe prices under both contracts which include certain minimum payments are sufficient to satisfy the loan and lease obligations and mine closing costs over the lives of the contracts. If either contract is terminated early for any reason, the Operating Companies would attempt to reduce the termination charges and would ask the PUCO to allow recovery of such charges from customers through the fuel factor of the respective Operating Company.\n(11) CAPITALIZATION\n(A) CAPITAL STOCK TRANSACTIONS AND COMMON SHARES RESERVED FOR ISSUE\nShares sold, retired and purchased for treasury during the three years ended December 31, 1995 are listed in the following table.\nShares of common stock required for our stock plans in 1995 were acquired in the open market.\nThe Board of Directors has authorized the purchase in the open market of up to 1,500,000 shares of our common stock until June 30, 1996. As of December 31, 1995, 225,500 shares had been purchased at a total cost of $4 million. Such shares are being held as treasury stock.\nThe number of common stock shares reserved for issue under the Employee Savings Plan and the Employee Purchase Plan was 1,702,849 and 423,797, respectively, at December 31, 1995.\nUnder an Equity Compensation Plan (Plan) adopted in 1994, options to purchase shares of common stock and awards of restricted common stock were granted to management employees. In 1995, options were issued for 285,000 shares at an exercise price of $14.58. In 1994, options were issued for 264,900 shares at an exercise price of $13.20 but options for 9,500 shares were surrendered in 1995. The options expire 10 years from the date of the grant and vest over four years. The number of shares available for issuance under the Plan each year is determined by formula, generally 0.5% of outstanding shares. Shares of common stock required for the Plan may be either issued as new shares, issued from treasury stock or acquired in the open market specifically for distribution under the Plan.\nIn 1995, the FASB issued SFAS 123, a new accounting standard for stock-based compensation, effective for 1996. The standard encourages accounting for stock-based compensation awards based on their fair value at the grant date with the resulting cost recorded as an expense. Entities electing not to record the cost are required to disclose in the notes to the financial statements what the impact on net income and earnings per share would have been had they followed the suggested accounting. We expect to adopt the disclosure method of implementing SFAS 123, which will have no impact on our results of operations.\n(B) EQUITY DISTRIBUTION RESTRICTIONS\nThe Operating Companies can make cash available for the funding of Centerior Energy's common stock dividends by paying dividends on their respective common stock, which is held solely by Centerior Energy. Federal law prohibits the Operating Companies from paying dividends out of capital accounts. However, the Operating Companies may pay preferred and common stock dividends out of appropriated retained earnings and current earnings. At December 31, 1995, Cleveland Electric and\n(Centerior Energy) (Centerior Energy)\nToledo Edison had $212 million and $183 million, respectively, of appropriated retained earnings for the payment of dividends. However, Toledo Edison is prohibited from paying a common stock dividend by a provision in its mortgage that essentially requires such dividends to be paid out of the total balance of retained earnings, which currently is a deficit. (C) PREFERRED AND PREFERENCE STOCK\nAmounts to be paid for preferred stock which must be redeemed during the next five years are $32 million in 1996, $32 million in 1997, $16 million in 1998, $35 million in 1999 and $33 million in 2000. The annual mandatory redemption provisions are as follows:\n* All outstanding shares to be redeemed on December 1, 2001. In 1995, Cleveland Electric purchased 1,000 shares of Serial Preferred Stock, $90.00 Series S, which will reduce the 2002 redemption requirement shown in the above table.\nThe annualized preferred dividend requirement for the Operating Companies at December 31, 1995 was $59 million.\nThe preferred dividend rates on Cleveland Electric's Series L and M and Toledo Edison's Series A and B fluctuate based on prevailing interest rates and market conditions. The dividend rates for these issues averaged 7.23%, 7.02%, 7.75% and 8.58%, respectively, in 1995.\nPreference stock authorized for the Operating Companies are 3,000,000 shares without par value for Cleveland Electric and 5,000,000 shares with a $25 par value for Toledo Edison. No preference shares are currently outstanding for either company.\nWith respect to dividend and liquidation rights, each Operating Company's preferred stock is prior to its preference stock and common stock, and each Operating Company's preference stock is prior to its common stock.\n(D) LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS\nLong-term debt, less current maturities, for the Operating Companies was as follows:\n* Secured by first mortgage bonds.\n** Secured by subordinated mortgage collateral.\nLong-term debt matures during the next five years as follows: $203 million in 1996, $90 million in 1997, $113 million in 1998, $273 million in 1999 and $41 million in 2000.\nThe mortgages of the Operating Companies constitute direct first liens on substantially all property owned and franchises held by them. Excluded from the liens, among other things, are cash, securities, accounts receivable, fuel, supplies and, in the case of Toledo Edison, automotive equipment.\nCertain credit agreements of the Operating Companies contain covenants relating to fixed charge coverage ratios and limitations on secured financing other than through first mortgage bonds or certain other transactions. In June 1995, the Operating Companies replaced letters of credit in connection with the sale and leaseback of Beaver Valley Unit 2 that were due to expire with new letters of credit expiring in June 1999. The letters of credit are in an aggregate amount of approximately $225 million and are secured by first mortgage bonds of Cleveland Electric and\n(Centerior Energy) (Centerior Energy)\nToledo Edison in the proportion of 40% and 60%, respectively. At December 31, 1995, the Operating Companies had outstanding $54 million of bank loans and notes secured by subordinated mortgage collateral.\n(12) SHORT-TERM BORROWING ARRANGEMENTS\nCenterior Energy has a $125 million revolving credit facility through May 1996. Centerior Energy and the Service Company may borrow under the facility, with all borrowings jointly and severally guaranteed by the Operating Companies. Centerior Energy plans to transfer any of its borrowed funds to the Operating Companies. The credit agreement is secured with first mortgage bonds of Cleveland Electric and Toledo Edison in the proportion of 40% and 60%, respectively. The banks' fee is 0.625% per annum payable quarterly in addition to interest on any borrowings. There were no borrowings under the facility at December 31, 1995. Also, the Operating Companies may borrow from each other on a short-term basis.\n(13) FINANCIAL INSTRUMENTS\nThe estimated fair values at December 31, 1995 and 1994 of financial instruments that do not approximate their carrying amounts in the Balance Sheet are as follows:\nNoncash investments in the Nuclear Plant Decommissioning Trusts are summarized in the following table.\nThe fair value of these trusts is estimated based on the quoted market prices for the investment securities. As a result of adopting the new accounting standard for certain investments in debt and equity securities, SFAS 115, in 1994, the carrying amount of these trusts approximates fair value. The fair value of the Operating Companies' preferred stock, with mandatory redemption provisions, and long-term debt is estimated based on the quoted market prices for the respective or similar issues or on the basis of the discounted value of future cash flows. The discounted value used current dividend or interest rates (or other appropriate rates) for similar issues and loans with the same remaining maturities.\nThe estimated fair values of all other financial instruments approximate their carrying amounts in the Balance Sheet at December 31, 1995 and 1994 because of their short-term nature.\n(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a tabulation of the unaudited quarterly results of operations for the two years ended December 31, 1995.\n(Centerior Energy) (Centerior Energy)\nFINANCIAL AND STATISTICAL REVIEW\nOPERATING REVENUES (millions of dollars)\n- --------------------------------------------------------------------------------\nOPERATING EXPENSES (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars) COMMON STOCK (dollars per share & %)\n- --------------------------------------------------------------------------------\nNOTE: 1985 data is the result of combining and restating data for the Operating Companies.\n(a) Includes early retirement program expenses and other charges of $272 million. (b) Includes write-off of phase-in deferrals of $877 million, consisting of $172 million of deferred operating expenses and $705 million of deferred carrying charges. (c) The Operating Companies adopted a change in accounting for nuclear plant depreciation, changing from the units-of-production method to the straight-line method at a 2.5% rate.\n(Centerior Energy) (Centerior Energy)\nCenterior Energy Corporation and Subsidiaries\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCAPITALIZATION (millions of dollars & %)\n- --------------------------------------------------------------------------------\n(d) Includes write-off of Perry Unit 2 of $583 million.\n(e) Average shares outstanding and related per share computations reflect the Cleveland Electric 1.11-for-one exchange ratio and the Toledo Edison one-for-one exchange ratio for Centerior Energy shares at the date of affiliation, April 29, 1986.\n(f) Reduced by net energy used by the Seneca Pumped Storage Plant for pumping.\n(Centerior Energy) (Centerior Energy)\nMANAGEMENT'S FINANCIAL ANALYSIS\nOUTLOOK\nSTRATEGIC PLAN\nWe continued to make progress during the second year of our eight-year strategic plan, but we remain keenly aware of the magnitude of the problems that face us. The strategic plan was created by Centerior Energy Corporation (Centerior Energy), along with The Cleveland Electric Illuminating Company (Company) and The Toledo Edison Company (Toledo Edison), to achieve two major goals: strengthening their financial conditions and improving their competitive positions. The Company and Toledo Edison are the two wholly owned electric utility subsidiaries of Centerior Energy. The plan's objectives relate to the combined operations of all three companies. The objectives are to achieve profitable revenue growth, become a leader in customer satisfaction, build a winning employee team, attain increasingly competitive power supply costs and maximize share owner return on Centerior Energy common stock. We are not yet positioned to compete in a less regulated electric utility industry, but every major action being taken -- strategic planning, revenue enhancement, cost reduction, improvement of work practices and application for increased prices -- is part of a comprehensive effort to succeed in an increasingly competitive environment.\nA primary objective of the strategic plan is continued and significant revenue growth even as our markets become more competitive. The Company's retail revenues adjusted for weather and fuel costs have grown about 1% annually since 1990. During 1995, we took aggressive steps to increase revenues through enhanced marketing strategies. Also, our economic development efforts proved successful in attracting new customers and supporting the expansion of existing ones. Although we are not satisfied with our growth rate, we expect that our marketing activity will improve revenue growth.\nThe rate case which the Company and Toledo Edison filed with The Public Utilities Commission of Ohio (PUCO) in April 1995 is a critical factor to the success of the strategic plan. We do not see this rate case as a continuation of business as usual but as an important turning point which should, if we are successful in accomplishing the objectives discussed below, bring an end to price increases for the foreseeable future. A successful conclusion of the case would speed our transition to a more competitive company by providing additional cash to lower costs by accelerating the pay-down of debt and preferred stock. In our view, a successful conclusion would include approval of the full price increase requested with a regulatory commitment to maintain the established price levels over an appropriate transition period. This should be coupled with a means to accelerate recognition of regulatory assets (described in Note 7(a)) and nuclear generating assets concurrent with our cost control and revenue enhancement efforts in order to earn a fair return for Centerior Energy common stock share owners over time.\nAnother key part of our strategy is offering long-term contracts to those large customers who could have incentives to change power suppliers. In 1995, 64% of our industrial kilowatt-hour sales and 24% of our commercial kilowatt-hour sales were under long-term contracts. We are renegotiating contracts before they expire and in most cases are retaining customers under new long-term contracts.\nWe are continuing efforts to reduce fixed financing costs in order to strengthen our financial condition. During 1995, utilizing strong cash flow and refinancing at favorable terms, the Company reduced interest expense and preferred dividends by $1 million and outstanding debt and preferred stock by $13 million.\nOur overall costs are high relative to many of our neighboring utilities as a result of our substantial nuclear investment. The strategic plan calls for making us more competitive by continuing to reduce operating expenses and capital expenditures. In 1995, to improve the focus on cost reduction and other strategic plan objectives, Centerior Energy and its subsidiaries restructured into six business groups. The new organization includes groups to manage the generation, distribution and transmission businesses; provide services and administrative functions; and invest in nonregulated enterprises. This arrangement will also enhance each group's ability to identify cost reductions by focusing on margins and improving work practices and customer service. We will also continue to aggressively pursue initiatives to reduce the heavy tax burden imposed upon us by the state and local tax structure in Ohio.\nRATE CASE AND REGULATORY ACCOUNTING\nIn April 1995, the Company and Toledo Edison filed requests with the PUCO for price increases aggregating\n(Cleveland Electric) (Cleveland Electric)\n$119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program discussed below and in Note 7. If their requests are approved, the Company and Toledo Edison intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will obviate the need for further price increases. If circumstances make it impossible to earn a fair return for Centerior Energy common stock share owners over time, the Company and Toledo Edison would ask for a further increase -- but only after taking all appropriate actions to make such a request unnecessary.\nIn December 1995, the PUCO ordered an investigation into the financial conditions, rates and practices of the Company and Toledo Edison.\nIn its report on the rate request, the PUCO Staff recommended approval of the $119 million requested ($84 million for the Company and $35 million for Toledo Edison), subject to a commitment by the Company and Toledo Edison to significantly revalue their assets. In late January 1996, the Staff proposed that the Company and Toledo Edison significantly revalue their nuclear plant and regulatory assets within a five-year period. The Staff's asset revaluation proposal is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the Staff's recommendations. A decision by the PUCO is anticipated in the second quarter of 1996.\nThe outcome of the rate case could affect the Company's ability to meet the criteria of Statement of Financial Accounting Standards (SFAS) 71 for all or part of its operations which could result in the write-off of all or a part of the regulatory assets shown in Note 7(a). In our changing industry, other events independent of the outcome of the rate case could also result in write-offs or write-downs of assets.\nSee Note 7 for a full discussion and analysis of the rate case, SFAS 71 and other financial accounting requirements and the potential implications of these accounting requirements for the Company's results of operations and financial position.\nRATE STABILIZATION PROGRAM\nUnder a Rate Stabilization Program approved by the PUCO in 1992, we agreed to freeze base rates until 1996 and limit rate increases through 1998. In exchange, we were permitted to defer through 1995 and subsequently recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits. Deferral of those costs and amortization of those benefits were completed in November 1995 and aggregated $103 million for the Company in 1995. Recovery is expected to begin with the effective date of the PUCO's order in the pending rate case. Annual amortization of the deferred costs for the Company is $15 million which began in December 1995. Consequently, earnings in 1996 will be sharply lower than in 1995. Also contributing to lower earnings are the expectations that the requested price increase will not be effective until the second quarter of 1996 and results from increased marketing and cost reduction efforts will take time to achieve.\nCOMPETITION\nMajor structural changes are taking place in the electric utility industry which are expected to place downward pressure on prices and to increase competition for customers' business. The changes are coming from both federal and state authorities. Many of the changes began when the Energy Policy Act of 1992 permitted competition in the electric utility industry through broader access to a utility's transmission system. In March 1995, the Federal Energy Regulatory Commission (FERC) issued proposed rules relating to open access transmission services by public utilities, recovery of stranded investment and other related matters. The open access transmission rules require utilities to deliver power from other utilities or generation sources to their wholesale customers. In May 1995, the Company and Toledo Edison filed open access transmission tariffs with the FERC which used the proposed rules as a guideline. These tariffs are currently pending.\nSeveral groups in Ohio are studying the possible application of retail wheeling. Retail wheeling occurs when a customer obtains power from a utility company other than its local utility. The PUCO is sponsoring informal discussions among a group of business, utility and consumer interests to explore ways of promoting competitive options without unduly harming the interests of utility company share owners or customers. Legislative proposals are being drafted for submission to the Ohio House of Representatives and several utilities in the state have offered their own proposed transition plans for introduction of retail wheeling. The current retail wheeling efforts in Ohio\n(Cleveland Electric) (Cleveland Electric)\nare exploratory and we cannot predict when and to what extent retail wheeling will be implemented in Ohio.\nThe term \"stranded investment\" generally refers to fixed costs approved for recovery under traditional regulatory methods that would become unrecoverable, or \"stranded\", as a result of wider competition. Although competitive pressures are increasing, the traditional regulatory framework remains in place and is expected to continue for the foreseeable future. We cannot predict when and to what extent competition will be allowed. We believe that pure competition (unrestricted retail wheeling for all customer classifications) is at least several years away and that any transition to pure competition will be in phases. The FERC and the PUCO have acknowledged the need to provide at least partial recovery of stranded investment as greater competition is permitted and, therefore, we believe that there will be a mechanism developed for the recovery of stranded investment. However, due to the uncertainty involved, there is a risk that some of our assets may not be fully recovered.\nIn 1995, we continued to experience significant competition from Cleveland Public Power (CPP), the largest municipal electric system in our service area. CPP continued to construct new distribution facilities extending into additional portions of Cleveland. CPP's progress has slowed significantly during the past year because of the discovery of a large number of safety violations in its system resulting in substantial cost overruns.\nIn March 1995, one of our large commercial customers which has provided annual net income of $6 million, Medical Center Co., signed a five-year contract with CPP for electric service beginning in September 1996, when its contract with us terminates. In both our appeal to the Ohio Supreme Court and petition to the FERC, it is our position that the purchase of power from CPP by this customer is in reality a direct purchase from another utility in violation of Ohio's certified territory statute. We will continue to pursue all legal and regulatory remedies to this situation.\nIn 1995, our economic development efforts proved successful in attracting new customers, while supporting the expansion of existing ones, for example, American Steel & Wire and Ford Motor Company. We expect that our continued emphasis on economic development along with a newly developed market segment focus will be major ingredients in providing improved revenue growth.\nNUCLEAR OPERATIONS\nThe Company has interests in three nuclear generating units -- Davis-Besse Nuclear Power Station (Davis-Besse), Perry Nuclear Power Plant Unit 1 (Perry Unit 1) and Beaver Valley Power Station Unit 2 (Beaver Valley Unit 2). Toledo Edison operates Davis-Besse and the Company operates Perry Unit 1. Davis-Besse and Beaver Valley Unit 2 both operated extremely well in 1995. Their average three-year unit availability factors at year-end 1995 of 90% and 87%, respectively, exceeded the industry average of 81% for similar reactors. In 1995, the availability factor for Davis-Besse was 100%. The plant continues to have its best run ever operating at or near full capacity for 463 straight days through February 21, 1996.\nIn 1995, Perry Unit 1 improved its average three-year unit availability factor to 62% with a 1995 availability factor of 93%. Perry Unit 1 operated at or near capacity for 506 of 531 days since the end of its last refueling and maintenance outage in August 1994. Work on the comprehensive course of action plan developed in 1993 to improve the operating performance of Perry Unit 1 will be completed during the current refueling outage which began January 27, 1996.\nA significant part of the strategic plan involves ongoing efforts to increase the availability and lower the cost of production of our nuclear units. In 1995, we made great progress regarding unit availability while continuing to lower production costs. The goal of our nuclear improvement program is to replicate Davis-Besse's operational excellence and cost reduction gains at Perry Unit 1 while improving performance ratings.\nWe externally fund the estimated costs for the future decommissioning of our nuclear units. In 1993 and 1994, we increased our decommissioning expense accruals because of revisions in our cost estimates. See Note 1(e).\nOur nuclear units may be impacted by activities or events beyond our control. Operating nuclear units have experienced unplanned outages or extensions of scheduled outages because of equipment problems or new regulatory requirements. A major accident at a nuclear facility anywhere in the world could cause the Nuclear Regulatory Commission (NRC) to limit or prohibit the operation or licensing of any domestic nuclear unit. If one of our nuclear units is taken out of service for an extended period for any reason, including an accident at such unit or any other nuclear facility, we cannot predict whether\n(Cleveland Electric) (Cleveland Electric)\nregulatory authorities would impose unfavorable rate treatment. Such treatment could include taking our affected unit out of rate base, thereby not permitting us to recover our investment in and earn a return on it, or disallowing certain construction or maintenance costs. An extended outage coupled with unfavorable rate treatment could have a material adverse effect on our financial condition and results of operations. Premature plant closings could also have a material adverse effect on our financial condition and results of operations because the estimated cost to decommission the plant exceeds the current funding in the decommissioning trust.\nHAZARDOUS WASTE DISPOSAL SITES\nThe Company has been named as a \"potentially responsible party\" (PRP) for three sites listed on the Superfund National Priorities List (Superfund List) and is aware of its potential involvement in the cleanup of several other sites. Allegations that the Company disposed of hazardous waste at these sites, and the amount involved, are often unsubstantiated and subject to dispute. Federal law provides that all PRPs for a particular site be held liable on a joint and several basis. If the Company were held liable for 100% of the cleanup costs of all of the sites referred to above, the cost could be as high as $350 million. However, we believe that the actual cleanup costs will be substantially lower than $350 million, that the Company's share of any cleanup costs will be substantially less than 100% and that most of the other PRPs are financially able to contribute their share. The Company has accrued a liability totaling $7 million at December 31, 1995, based on estimates of the costs of cleanup and its proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations.\nCOMMON STOCK DIVIDENDS\nCenterior Energy's common stock dividend has been funded in recent years primarily by common stock dividends paid by the Company. We expect this practice to continue for the foreseeable future. In 1994, Centerior Energy lowered its common stock dividend which reduced its cash outflow by over $110 million annually. This action, in turn, reduced the common stock cash dividend demand on the Company. The Company is using the increased retained cash to redeem debt and preferred stock more quickly than would otherwise be the case.\nMERGER OF TOLEDO EDISON INTO THE COMPANY\nWe continue to seek the necessary regulatory approvals to complete the merger of Toledo Edison into the Company which was announced in 1994. The FERC has deferred action on the merger application until the merits of the open access transmission tariffs proposed by the Company and Toledo Edison are addressed in hearings. See Note 15.\nCAPITAL RESOURCES AND LIQUIDITY\n1993-1995 CASH REQUIREMENTS\nA key part of the strategic plan is to significantly reduce the Company's level of debt and preferred stock. In 1995, we were able to continue the reduction pattern begun in 1994. The Company's obligations were reduced by $77 million in 1994 and by $13 million in 1995. We intend to continue and to accelerate redemptions.\nWe need cash for normal corporate operations, retirement of maturing securities, and an ongoing program of constructing and improving facilities to meet demand for electric service and to comply with government regulations. Our cash construction expenditures totaled $167 million in 1993, $164 million in 1994 and $148 million in 1995. Our debt and preferred stock maturities and sinking fund requirements totaled $310 million in 1993, $62 million in 1994 and $286 million in 1995. In addition, we optionally redeemed approximately $270 million in the period 1993-1995. This amount includes $143 million of tax-exempt issues refunded in 1995 resulting in approximately $3 million of interest savings. In May 1995, the Company issued $300 million of first mortgage bonds due in 2005 with an interest rate of 9.50%. The embedded cost of the Company's debt at the end of 1995 was 8.88% versus 8.96% in 1994 and 8.82% in 1993. In 1995, the Company and Toledo Edison renewed for a four-year term approximately $225 million in bank letters of credit supporting the equity owner participants in the Beaver Valley Unit 2 lease. See Note 11(d).\nThe Company also utilized short-term borrowings to help meet its cash needs. The Company had $5 million of notes payable to affiliates at December 31, 1995. See Note 12.\n1996 AND BEYOND CASH REQUIREMENTS\nThe Company's 1996 cash requirements for construction are $128 million and for debt and preferred stock maturities and sinking fund requirements are $177 million. We\n(Cleveland Electric) (Cleveland Electric)\nexpect to meet these requirements with internal cash generation, cash reserves and about $110 million from the sale of a AAA-rated security backed by our accounts receivable.\nWe expect to meet all of our 1997-2000 cash requirements with internal cash generation. Estimated cash requirements for the Company's construction program during this period total $603 million. Debt and preferred stock maturities and sinking fund requirements total $400 million for the same period. If economical, additional securities may be redeemed under optional redemption provisions, with funding expected to be provided through internal cash generation.\nLIQUIDITY\nAdditional first mortgage bonds may be issued by the Company under its mortgage on the basis of property additions, cash or refundable first mortgage bonds. If the applicable interest coverage test is met, the Company may issue first mortgage bonds on the basis of property additions and, under certain circumstances, refundable bonds. At December 31, 1995, the Company would have been permitted to issue approximately $379 million of additional first mortgage bonds.\nThe Company also is able to raise funds through the sale of debt and preferred and preference stock. There are no restrictions on the Company's ability to issue preferred or preference stock.\nThe Company and Toledo Edison have $307 million in financing vehicles available to support their nuclear fuel leases, portions of which mature this year. See Note 6. The Company is a party to a $125 million revolving credit facility which is expected to be renewed when it matures in May 1996. See Note 12. At the end of 1995, the Company had $70 million in cash and temporary investments.\nThe foregoing financing resources are expected to be sufficient for the Company's needs over the next several years. However, the availability and cost of capital to meet the Company's external financing needs also depend upon such factors as financial market conditions and its credit ratings. Current credit ratings for the Company are as follows:\nRESULTS OF OPERATIONS\n1995 VS. 1994\nFactors contributing to the 4.2% increase in 1995 operating revenues are as follows:\nFor the second year in a row, industrial kilowatt-hour sales increased. The increase in 1995 was 0.3%, but sales grew 2.4% excluding reductions at two low-margin steel producers (representing 7.6% of industrial revenues). Residential and commercial sales increased 2.8% and 3%, respectively, primarily because of the hot summer weather, although there was about 2% nonweather-related growth in commercial sales. Other sales increased 36% because of a 58% increase in wholesale sales due principally to the hot summer and good availability of our generating units. Weather accounted for approximately $24 million of the $41 million increase in 1995 base rate (nonfuel) revenues. Higher 1995 fuel cost recovery revenues resulted from an increase in the fuel cost factors. The weighted average of these fuel cost factors increased approximately 7%. Miscellaneous revenues decreased in 1995 primarily because the 1994 amount included the billings to other utility owners and lessees for overhead expenses related to the 1994 refueling and maintenance outage of the jointly owned Perry Unit 1.\nFor 1995, operating revenues were 32% residential, 32% commercial, 29% industrial and 7% other and kilowatt-hour sales were 24% residential, 28% commercial, 38% industrial and 10% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.09 and $.07, respectively.\nOperating expenses increased 5.3% in 1995. Fuel and purchased power expenses increased as higher fuel expense was partially offset by lower purchased power expense. The higher fuel expense was attributable to increased generation and more amortization of previously deferred fuel costs than the amount amortized in 1994. The higher other operation and maintenance expenses resulted primarily from charges for an ongoing inventory reduction program and the recognition of costs associated with preliminary engineering studies. Federal income taxes increased as a result of higher pretax operating income. Taxes, other than federal income taxes, increased primarily due to property tax increases resulting from\n(Cleveland Electric) (Cleveland Electric)\nplant additions, real estate valuation increases and a nonrecurring tax credit recorded in 1994.\n1994 VS. 1993\nFactors contributing to the 3% decrease in 1994 operating revenues are as follows:\nThe Company experienced good retail kilowatt-hour sales growth in the commercial and industrial categories in 1994; the residential category was negatively impacted by weather conditions, particularly during the summer. The revenue decrease resulted primarily from milder weather conditions in 1994 and 53% lower wholesale sales. Weather reduced base rate revenues approximately $8 million from the 1993 amount. Although total sales decreased by 4.6%, commercial sales increased 2.4%. Industrial sales increased 0.7% on the strength of increased sales to large automotive manufacturers and the broad-based, smaller industrial customer group. This growth substantiated an economic resurgence in Northeastern Ohio. Residential sales declined 0.2% because of the weather factor. Other sales decreased by 42% because of the lower sales to wholesale customers attributable to expiration of a wholesale power agreement, softer wholesale market conditions and limited power availability for bulk power transactions at certain times because of generating plant outages. Lower 1994 fuel cost recovery revenues resulted from favorable changes in the fuel cost factors. The weighted average of these fuel cost factors dropped by approximately 5%.\nFor 1994, operating revenues were 31% residential, 32% commercial, 30% industrial and 7% other and kilowatt-hour sales were 24% residential, 29% commercial, 39% industrial and 8% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.09 and $.06, respectively. The changes from 1993 were not significant.\nOperating expenses were 15% lower in 1994. Operation and maintenance expenses for 1993 included $130 million of net benefit expenses related to an early retirement program, called the Voluntary Transition Program (VTP), and other charges totaling $35 million. The VTP benefit expenses in 1993 consisted of $102 million of costs for the Company plus $28 million for the Company's pro rata share of the costs for its affiliate, Centerior Service Company (Service Company). A smaller work force and ongoing cost reduction measures also lowered operation and maintenance expenses. More nuclear generation and less coal-fired generation accounted for a large part of the lower fuel and purchased power expenses in 1994. Depreciation and amortization expenses increased primarily because of higher nuclear plant decommissioning expenses as discussed in Note 1(e). Deferred operating expenses were greater primarily because of the write-off of $117 million of phase-in deferred operating expenses in 1993 as discussed in Note 7(e). The 1993 deferrals also included $52 million of postretirement benefit curtailment cost deferrals related to the VTP. See Note 9(b). Federal income taxes increased as a result of higher pretax operating income.\nAs discussed in Note 4(b), $351 million of our Perry Unit 2 investment was written off in 1993. Also, as discussed in Note 7(e), phase-in deferred carrying charges of $519 million were written off in 1993. The change in the federal income tax credit amounts for nonoperating income was attributable to these write-offs.\n(Cleveland Electric) (Cleveland Electric)\nINCOME STATEMENT The Cleveland Electric Illuminating Company and Subsidiaries\n- ---------------\n(1) Includes purchased power expense of $102 million, $111 million and $120 million in 1995, 1994 and 1993, respectively, for all purchases from Toledo Edison.\nRETAINED EARNINGS\nThe accompanying notes are an integral part of these statements.\n(Cleveland Electric) (Cleveland Electric)\nBALANCE SHEET\nThe accompanying notes are an integral part of this statement.\n(Cleveland Electric) (Cleveland Electric)\nThe Cleveland Electric Illuminating Company and Subsidiaries\n(Cleveland Electric) (Cleveland Electric)\nCASH FLOWS The Cleveland Electric Illuminating Company and Subsidiaries\n- ---------------\n(2) Increases in Nuclear Fuel and Nuclear Fuel Lease Obligations in the Balance Sheet resulting from the noncash capitalizations under nuclear fuel agreements are excluded from this statement.\nThe accompanying notes are an integral part of this statement.\n(Cleveland Electric) (Cleveland Electric)\nSTATEMENT OF PREFERRED STOCK The Cleveland Electric Illuminating Company and Subsidiaries\nThe accompanying notes are an integral part of this statement.\n(Cleveland Electric) (Cleveland Electric)\nNOTES TO THE FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) GENERAL\nThe Company is an electric utility and a wholly owned subsidiary of Centerior Energy. The Company's financial statements have historically included the accounts of the Company's wholly owned subsidiaries, which in the aggregate were not material. In 1995, the Company formed a wholly owned subsidiary to serve as the transferor in connection with an asset-backed securitization expected to be completed in 1996. At December 31, 1995, the subsidiary was not yet funded. In 1994, the Company transferred its investments in three wholly owned subsidiaries to Centerior Energy at cost ($26 million) via property dividends.\nThe Company follows the Uniform System of Accounts prescribed by the FERC and adopted by the PUCO. Rate-regulated utilities are subject to SFAS 71 which governs accounting for the effects of certain types of rate regulation. Pursuant to SFAS 71, certain incurred costs are deferred for recovery in future rates. See Note 7.\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, and the disclosure of contingent assets and liabilities. The estimates are based on an analysis of the best information available. Actual results could differ from those estimates.\nThe Company is a member of the Central Area Power Coordination Group (CAPCO). Other members are Toledo Edison, Duquesne Light Company, Ohio Edison Company and its wholly owned subsidiary, Pennsylvania Power Company. The members have constructed and operate generation and transmission facilities for their joint use.\n(B) RELATED PARTY TRANSACTIONS\nOperating revenues, operating expenses and interest charges include those amounts for transactions with affiliated companies in the ordinary course of business operations.\nThe Company's transactions with Toledo Edison are primarily for firm power, interchange power, transmission line rentals and jointly owned power plant operations and construction. See Notes 2 and 3.\nThe Service Company provides management, financial, administrative, engineering, legal and other services at cost to the Company and other affiliated companies. The Service Company billed the Company $141 million, $136 million and $167 million in 1995, 1994 and 1993, respectively, for such services.\n(C) REVENUES\nCustomers are billed on a monthly cycle basis for their energy consumption based on rate schedules or contracts authorized by the PUCO. An accrual is made at the end of each month to record the estimated amount of unbilled revenues for kilowatt-hours sold in the current month but not billed by the end of that month.\nA fuel factor is added to the base rates for electric service. This factor is designed to recover from customers the costs of fuel and most purchased power. It is reviewed and adjusted semiannually in a PUCO proceeding.\n(D) FUEL EXPENSE\nThe cost of fossil fuel is charged to fuel expense based on inventory usage. The cost of nuclear fuel, including an interest component, is charged to fuel expense based on the rate of consumption. Estimated future nuclear fuel disposal costs are being recovered through base rates.\nThe Company defers the differences between actual fuel costs and estimated fuel costs currently being recovered from customers through the fuel factor. This matches fuel expenses with fuel-related revenues.\nOwners of nuclear generating plants are assessed by the federal government for the cost of decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy. The assessments are based upon the amount of enrichment services used in prior years and cannot be imposed for more than 15 years (to 2007). The Company has accrued a liability for its share of the total assessments. These costs have been recorded in a deferred charge account since the PUCO is allowing the Company to recover the assessments through its fuel cost factors.\n(E) DEPRECIATION AND DECOMMISSIONING\nThe cost of property, plant and equipment is depreciated over their estimated useful lives on a straight-line basis. The annual straight-line depreciation provision for nonnuclear property expressed as a percent of average depreciable utility plant in service was 3.5% in 1995 and 3.4% in both 1994 and 1993. The annual straight-line depreciation rate for nuclear property is 2.5%. In conjunction with its pending rate case, the Company has asked the PUCO to\n(Cleveland Electric) (Cleveland Electric)\napprove an increase of this depreciation rate to approximately 3%.\nThe Company accrues the estimated costs of decommissioning its three nuclear generating units. The accruals are required to be funded in an external trust. The PUCO requires that the expense and payments to the external trusts be determined on a levelized basis by dividing the unrecovered decommissioning costs in current dollars by the remaining years in the licensing period of each unit. This methodology requires that the net earnings on the trusts be reinvested therein with the intent of having net earnings offset inflation. The PUCO requires that the estimated costs of decommissioning and the funding level be reviewed at least every five years.\nIn 1994, the Company increased its annual decommissioning expense accruals to $13 million from the $6 million level in 1993. The accruals are reflected in current rates. The increased accruals in 1994 were derived from updated, site-specific studies for each of the units. The revised estimates reflect the DECON method of decommissioning (prompt decontamination), and the locations and cost characteristics specific to the units, and include costs associated with decontamination, dismantlement and site restoration.\nThe revised estimates for the units in 1993 and 1992 dollars and in dollars at the time of license expiration, assuming a 4% annual inflation rate, are as follows:\n- ---------------\n(1) Dollar amounts in 1993 dollars. (2) Dollar amount in 1992 dollars.\nThe updated estimates reflect substantial increases from the prior PUCO-recognized aggregate estimates of $142 million in 1987 and 1986 dollars.\nThe classification, Accumulated Depreciation and Amortization, in the Balance Sheet at December 31, 1995 includes $71 million of decommissioning costs previously expensed and the earnings on the external trust funding. This amount exceeds the Balance Sheet amount of the external Nuclear Plant Decommissioning Trusts because the reserve began prior to the external trust funding. The trust earnings are recorded as an increase to the trust assets and the related component of the decommissioning reserve (included in Accumulated Depreciation and Amortization).\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry, including those of the Company, regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations in the financial statements. In response to these questions, the Financial Accounting Standards Board (FASB) is reviewing the accounting for removal costs, including decommissioning. If current accounting practices are changed, the annual provision for decommissioning could increase; the estimated cost for decommis- sioning could be recorded as a liability rather than as accumulated depreciation; and trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense. The FASB issued an exposure draft on the subject on February 7, 1996.\n(F) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at original cost less amounts disallowed by the PUCO. Construction costs include related payroll taxes, retirement benefits, fringe benefits, management and general overheads and allowance for funds used during construction (AFUDC). AFUDC represents the estimated composite debt and equity cost of funds used to finance construction. This noncash allowance is credited to income. The AFUDC rate was 10.33% in 1995, 9.68% in 1994 and 9.63% in 1993.\nMaintenance and repairs for plant and equipment are charged to expense as incurred. The cost of replacing plant and equipment is charged to the utility plant accounts. The cost of property retired plus removal costs, after deducting any salvage value, is charged to the accumulated provision for depreciation.\n(G) DEFERRED GAIN FROM SALE OF UTILITY PLANT\nThe sale and leaseback transaction discussed in Note 2 resulted in a net gain for the sale of the Bruce Mansfield Generating Plant (Mansfield Plant). The net gain was deferred and is being amortized over the term of the leases. The amortization and the lease expense amounts are reported in the Income Statement as Generation Facilities Rental Expense, Net.\n(Cleveland Electric) (Cleveland Electric)\n(H) INTEREST CHARGES\nDebt Interest reported in the Income Statement does not include interest on obligations for nuclear fuel under construction. That interest is capitalized. See Note 6.\nLosses and gains realized upon the reacquisition or redemption of long-term debt are deferred, consistent with the regulatory rate treatment. See Note 7(a). Such losses and gains are either amortized over the remainder of the original life of the debt issue retired or amortized over the life of the new debt issue when the proceeds of a new issue are used for the debt redemption. The amortizations are included in debt interest expense.\n(I) FEDERAL INCOME TAXES\nThe Company uses the liability method of accounting for income taxes in accordance with SFAS 109. See Note 8. This method requires that deferred taxes be recorded for all temporary differences between the book and tax bases of assets and liabilities. The majority of these temporary differences are attributable to property-related basis differences. Included in these basis differences is the equity component of AFUDC, which will increase future tax expense when it is recovered through rates. Since this component is not recognized for tax purposes, the Company must record a liability for its tax obligation. The PUCO permits recovery of such taxes from customers when they become payable. Therefore, the net amount due from customers through rates has been recorded as a deferred charge and will be recovered over the lives of the related assets. See Note 7(a).\nInvestment tax credits are deferred and amortized over the lives of the applicable property as a reduction of depreciation expense. See Note 7(d) for a discussion of the amortization of certain unrestricted excess deferred taxes and unrestricted investment tax credits under the Rate Stabilization Program.\n(2) UTILITY PLANT SALE AND LEASEBACK TRANSACTIONS\nThe Company and Toledo Edison are co-lessees of 18.26% (150 megawatts) of Beaver Valley Unit 2 and 6.5% (51 megawatts), 45.9% (358 megawatts) and 44.38% (355 megawatts) of Units 1, 2 and 3 of the Mansfield Plant, respectively. These leases extend through 2017 and are the result of sale and leaseback transactions completed in 1987.\nUnder these leases, the Company and Toledo Edison are responsible for paying all taxes, insurance premiums, operation and maintenance expenses and all other similar costs for their interests in the units sold and leased back. They may incur additional costs in connection with capital improvements to the units. The Company and Toledo Edison have options to buy the interests back at the end of the leases for the fair market value at that time or renew the leases. The leases include conditions for mandatory termination (and possible repurchase of the leasehold interest) for events of default.\nAs co-lessee with Toledo Edison, the Company is also obligated for Toledo Edison's lease payments. If Toledo Edison is unable to make its payments under the Beaver Valley Unit 2 and Mansfield Plant leases, the Company would be obligated to make such payments. No such payments have been made on behalf of Toledo Edison.\nFuture minimum lease payments under the operating leases at December 31, 1995 are summarized as follows:\nRental expense is accrued on a straight-line basis over the terms of the leases. The amount recorded in 1995, 1994 and 1993 as annual rental expense for the Mansfield Plant leases was $70 million. Amounts charged to expense in excess of the lease payments are classified as Accumulated Deferred Rents in the Balance Sheet.\nThe Company is buying 150 megawatts of Toledo Edison's Beaver Valley Unit 2 leased capacity entitlement. Purchased power expense for this transaction was $98 million, $108 million and $103 million in 1995, 1994 and 1993, respectively. We anticipate that this purchase will continue indefinitely. The future minimum lease payments through 2017 associated with Beaver Valley Unit 2 aggregate $1.35 billion.\n(3) PROPERTY OWNED WITH OTHER UTILITIES AND INVESTORS\nThe Company owns, as a tenant in common with other utilities and those investors who are owner-participants in various sale and leaseback transactions (Lessors), certain generating units as listed below. Each owner owns an undivided share in the entire unit. Each owner has the right to a percentage of the generating capability of each\n(Cleveland Electric) (Cleveland Electric)\nunit equal to its ownership share. Each utility owner is obligated to pay for only its respective share of the construction costs and operating expenses. Each Lessor has leased its capacity rights to a utility which is obligated to pay for such Lessor's share of the construction costs and operating expenses. The Company's share of the operating expenses of these generating units is included in the Income Statement. The Balance Sheet classification of Property, Plant and Equipment at December 31, 1995 includes the following facilities owned by the Company as a tenant in common with other utilities and Lessors:\nDepreciation for Eastlake Unit 5 has been accumulated with all other nonnuclear depreciable property rather than by specific units of depreciable property.\n(4) CONSTRUCTION AND CONTINGENCIES\n(A) CONSTRUCTION PROGRAM\nThe estimated cost of the Company's construction program for the 1996-2000 period is $761 million, including AFUDC of $30 million and excluding nuclear fuel.\nThe Clean Air Act Amendments of 1990 (Clean Air Act) requires, among other things, significant reductions in the emission of sulfur dioxide and nitrogen oxides by fossil-fueled generating units. Our strategy provides for compliance primarily through greater use of low-sulfur coal at some of our units and the use of emission allowances. Total capital expenditures from 1991 through 1995 in connection with Clean Air Act compliance amounted to $46 million. The plan will require additional capital expenditures over the 1996-2005 period of approximately $49 million for nitrogen oxide control equipment and other plant process modifications. In addition, higher fuel and other operation and maintenance expenses will be incurred. The Company may need to install sulfur emission control technology at one of its generating plants after 2005 which could require additional expenditures at that time.\n(B) PERRY UNIT 2\nPerry Unit 2, including its share of the facilities common with Perry Unit 1, was approximately 50% complete when construction was suspended in 1985 pending consideration of various options. We wrote off our investment in Perry Unit 2 at December 31, 1993 after we determined that it would not be completed or sold. The write-off totaled $351 million ($258 million after taxes) for the Company's 44.85% ownership share of the unit.\n(C) HAZARDOUS WASTE DISPOSAL SITES\nThe Company is aware of its potential involvement in the cleanup of three sites listed on the Superfund List and several other sites. The Company has accrued a liability totaling $7 million at December 31, 1995 based on estimates of the costs of cleanup and its proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations. See Management's Financial Analysis -- Outlook-Hazardous Waste Disposal Sites.\n(5) NUCLEAR OPERATIONS AND CONTINGENCIES\n(A) OPERATING NUCLEAR UNITS\nThe Company's three nuclear units may be impacted by activities or events beyond our control. An extended outage of one of our nuclear units for any reason, coupled with any unfavorable rate treatment, could have a material adverse effect on our financial condition and results of operations. See the discussion of these and other risks in Management's Financial Analysis -- Outlook-Nuclear Operations.\n(B) NUCLEAR INSURANCE\nThe Price-Anderson Act limits the public liability of the owners of a nuclear power plant to the amount provided by private insurance and an industry assessment plan. In the event of a nuclear incident at any unit in the United States resulting in losses in excess of the level of private insurance (currently $200 million), the Company's maximum potential assessment under that plan would be $85 million per incident. The assessment is limited to $11 million per year for each nuclear incident. These assessment limits assume the other CAPCO companies contribute their proportionate share of any assessment.\nThe utility owners and lessees of Davis-Besse, Perry and Beaver Valley also have insurance coverage for damage to property at these sites (including leased fuel and cleanup costs). Coverage amounted to $2.75 billion for each site\n(Cleveland Electric) (Cleveland Electric)\nas of January 1, 1996. Damage to property could exceed the insurance coverage by a substantial amount. If it does, the Company's share of such excess amount could have a material adverse effect on its financial condition and results of operations. In addition, the Company can be assessed a maximum of $23 million under these policies during a policy year if the reserves available to the insurer are inadequate to pay claims arising out of an accident at any nuclear facility covered by the insurer.\nThe Company also has extra expense insurance coverage. It includes the incremental cost of any replacement power purchased (over the costs which would have been incurred had the units been operating) and other incidental expenses after the occurrence of certain types of accidents at our nuclear units. The amounts of the coverage are 100% of the estimated extra expense per week during the 52-week period starting 21 weeks after an accident and 80% of such estimate per week for the next 104 weeks. The amount and duration of extra expense could substantially exceed the insurance coverage.\n(6) NUCLEAR FUEL\nNuclear fuel is financed for the Company and Toledo Edison through leases with a special-purpose corporation. The total amount of financing currently available under these lease arrangements is $307 million ($157 million from intermediate-term notes and $150 million from bank credit arrangements). The intermediate-term notes mature in 1996 and 1997 ($84 million in September 1996 and $73 million in September 1997). The bank credit arrangements terminate in October 1996. The special-purpose corporation plans to obtain alternate financing in 1996 to replace the $234 million of financing expiring in 1996. At December 31, 1995, $142 million of nuclear fuel was financed for the Company. The Company and Toledo Edison severally lease their respective portions of the nuclear fuel and are obligated to pay for the fuel as it is consumed in a reactor. The lease rates are based on various intermediate-term note rates, bank rates and commercial paper rates. The amounts financed include nuclear fuel in the Davis-Besse, Perry Unit 1 and Beaver Valley Unit 2 reactors with remaining lease payments for the Company of $41 million, $34 million and $20 million, respectively, at December 31, 1995. The nuclear fuel amounts financed and capitalized also included interest charges incurred by the lessors amounting to $4 million in 1995, $7 million in 1994 and $9 million in 1993. The estimated future lease amortization payments for the Company based on projected consumption are $55 million in 1996, $48 million in 1997, $40 million in 1998, $37 million in 1999 and $35 million in 2000.\n(7) REGULATORY MATTERS\n(A) REGULATORY ACCOUNTING REQUIREMENTS AND REGULATORY ASSETS\nThe Company is subject to the provisions of SFAS 71 and has complied with its provisions. SFAS 71 provides, among other things, for the deferral of certain incurred costs that are probable of future recovery in rates. We monitor changes in market and regulatory conditions and consider the effects of such changes in assessing the continuing applicability of SFAS 71. Criteria that could give rise to discontinuation of the application of SFAS 71 include: (1) increasing competition which significantly restricts the Company's ability to charge prices which allow it to recover operating costs, earn a fair return on invested capital and recover the amortization of regulatory assets and (2) a significant change in the manner in which rates are set by the PUCO from cost-based regulation to some other form of regulation. Regulatory assets represent probable future revenues to the Company associated with certain incurred costs, which it will recover from customers through the rate-making process.\nEffective January 1, 1996, the Company adopted SFAS 121 which imposes stricter criteria for carrying regulatory assets than SFAS 71 by requiring that such assets be probable of recovery at each balance sheet date. The criteria under SFAS 121 for plant assets require such assets to be written down only if the book value exceeds the projected net future cash flows.\nRegulatory assets in the Balance Sheet are as follows:\n* Represent deferrals of operating expenses and carrying charges for Perry Unit 1 and Beaver Valley Unit 2 in 1987 and 1988 which are being amortized over the lives of the related property.\nAs of December 31, 1995, customer rates provide for recovery of all the above regulatory assets, except those related to the Rate Stabilization Program discussed below. The remaining recovery periods for all of the regulatory assets listed above range from 16 to 33 years.\n(Cleveland Electric) (Cleveland Electric)\n(B) RATE CASE\nIn April 1995, the Company and Toledo Edison filed requests with the PUCO for price increases aggregating $119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program. If their requests are approved, the Company and Toledo Edison intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will preclude the need for further price increases. If circumstances make it impossible to earn a fair return for Centerior Energy common stock share owners over time, the Company and Toledo Edison would ask for a further increase, but only after taking all appropriate actions to make such a request unnecessary.\nIn November 1995, the PUCO Staff issued its report addressing the rate case. The Staff recommended that the PUCO grant the full $119 million price increase requested ($84 million for the Company and $35 million for Toledo Edison). However, the Staff also recommended that the price increase be conditioned upon the commitment by the Company and Toledo Edison \"to a significant revaluation of their asset bases over some finite period of time.\"\nIn December 1995, the PUCO ordered an investigation into the financial conditions, rates and practices of the Company and Toledo Edison to identify outcomes and remedies other than those routinely applied during the rate case process.\nIn late January 1996, the Staff proposed an incremental reduction (currently, an aggregate of $1.25 billion for the Company and Toledo Edison) beyond the normal level in nuclear plant and regulatory assets within five years. The Staff proposed that the Company and Toledo Edison have flexibility to determine how to achieve this incremental asset revaluation, but no additional price increases to recover the accelerated asset revaluation were proposed. Any incremental revaluation of assets would be for regulatory purposes and would cause prices and revenues after the five-year period to be lower than they otherwise would be in conjunction with any rate case following such revaluation. The Staff's asset revaluation proposal represents a substantial change in the form of rate-making traditionally followed by the PUCO and is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the recommendations of the Staff. A decision by the PUCO is anticipated in the second quarter of 1996.\n(C) ASSESSMENT OF POTENTIAL OUTCOMES\nWe continually assess the effects of competition and the changing industry and regulatory environment on operations, the Company's ability to recover regulatory assets and the Company's ability to continue application of SFAS 71. If, as a result of the pending rate case or other events, we determine that the Company no longer meets the criteria for SFAS 71, the Company would be required to record a before-tax charge to write off the regulatory assets shown above and evaluate whether the Company's property, plant and equipment should be written down. In the more likely event that only a portion of operations (such as nuclear operations) no longer meets the criteria of SFAS 71, a write-off would be limited to regulatory assets, if any, that are not reflected in the Company's cost-based prices established for the remaining regulated operations. In addition, we would be required to evaluate whether the changes in the competitive and regulatory environment which led to discontinuing the application of SFAS 71 to a portion of the Company's operations would also result in a write-down of the Company's property, plant and equipment pursuant to SFAS 121.\nWe believe application of SFAS 121 in that event will not result in a write-off of regulatory assets unless the PUCO denies recovery of such assets or if we conclude, as a result of the outcome of the Company's pending rate case or some other event, that recovery is not probable for some or all of the regulatory assets. Furthermore, a write-down under SFAS 121 of the Company's property, plant and equipment is not expected.\n(D) RATE STABILIZATION PROGRAM\nThe Rate Stabilization Program that the PUCO approved in October 1992 allowed the Company to defer and subsequently amortize and recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits during the 1992-1995 period. Recovery of the deferrals will begin with the effective date of the PUCO's order in the pending rate case. The regulatory assets recorded included the deferral of post-in-service interest carrying charges, depreciation expense and property taxes on assets placed in service after February 29, 1988 and the deferral of incremental expenses resulting from the adoption of SFAS 106 (see Note 9(b)). The cost deferrals recorded in 1995, 1994 and 1993 pursuant to these provisions were $75 million, $70 million and $116 million, respectively. The regulatory accounting measures also provided for the accelerated amortization of certain unrestricted excess deferred tax and unrestricted investment tax credit balances and an excess interim spent fuel\n(Cleveland Electric) (Cleveland Electric)\nstorage accrual balance for Davis-Besse. The total annual amount of such accelerated benefits was $28 million in 1995, 1994 and 1993.\n(E) PHASE-IN DEFERRALS\nIn 1993, upon completing a comprehensive study which led to our strategic plan, we concluded that projected revenues would not provide for recovery of deferrals recorded pursuant to a phase-in plan approved by the PUCO in 1989 and, consequently, that the deferrals would have to be written off. Such deferrals were scheduled to be recovered in 1994 through 1998. The total phase-in deferred operating expenses and carrying charges written off at December 31, 1993 by the Company were $117 million and $519 million, respectively (totaling $433 million after taxes).\n(8) FEDERAL INCOME TAX\nThe components of federal income tax expense (credit) recorded in the Income Statement were as follows:\nThe deferred federal income tax expense results from the temporary differences that arise from the different years certain expenses are recognized for tax purposes as opposed to financial reporting purposes. Such temporary differences affecting operating expenses relate principally to depreciation and deferred operating expenses whereas those affecting nonoperating income principally relate to deferred carrying charges and the 1993 write-offs.\nFederal income tax, computed by multiplying income before taxes by the 35% statutory rate, is reconciled to the amount of federal income tax recorded on the books as follows:\nThe Company joins in the filing of a consolidated federal income tax return with its affiliated companies. The method of tax allocation reflects the benefits and burdens realized by each company's participation in the consolidated tax return, approximating a separate return result for each company.\nFor tax reporting purposes, the Perry Unit 2 abandonment was recognized in 1994 and resulted in a $204 million loss with a corresponding $71 million reduction in federal income tax liability. Because of the alternative minimum tax (AMT), $40 million of the $71 million was realized in 1994. The remaining $31 million will not be realized until 1999. Additionally, a repayment of approximately $29 million of previously allowed investment tax credits was recognized in 1994.\nUnder SFAS 109, temporary differences and carryforwards resulted in deferred tax assets of $425 million and deferred tax liabilities of $1.723 billion at December 31, 1995 and deferred tax assets of $418 million and deferred tax liabilities of $1.652 billion at December 31, 1994. These are summarized as follows:\nFor tax purposes, net operating loss (NOL) carryforwards of approximately $192 million are available to reduce future taxable income and will expire in 2005 through 2009. The 35% tax effect of the NOLs is $67 million. Additionally, AMT credits of $133 million that may be carried forward indefinitely are available to reduce future tax.\n(9) RETIREMENT BENEFITS\n(A) RETIREMENT INCOME PLAN\nCenterior Energy sponsors jointly with its subsidiaries a noncontributing pension plan (Centerior Pension Plan) which covers all employee groups. The amount of retirement benefits generally depends upon the length of service. Under certain circumstances, benefits can begin as early as age 55. The funding policy is to comply with the Employee Retirement Income Security Act of 1974 guidelines.\nIn 1993, eligible employees were offered the VTP, an early retirement program. Operating expenses for Center-\n(Cleveland Electric) (Cleveland Electric)\nior Energy and its subsidiaries in 1993 included $205 million of pension plan accruals to cover enhanced VTP benefits offset by a credit of $81 million resulting from a settlement of pension obligations through lump sum payments to almost all the VTP retirees.\nPension and VTP costs (credits) for Centerior Energy and its subsidiaries for 1993 through 1995 were comprised of the following components:\nPension and VTP costs (credits) for the Company and its pro rata share of the Service Company's costs were $(5) million, $2 million and $62 million for 1995, 1994 and 1993, respectively.\nThe following table presents a reconciliation of the funded status of the Centerior Pension Plan. The Company's share of the Centerior Pension Plan's total projected benefit obligation approximates 50%.\nA September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995, the settlement (discount) rate and long-term rate of return on plan assets assumptions were 8% and 11%, respectively. The long-term rate of annual compensation increase assumption was 3.5% in 1996 and 1997 and 4% thereafter. At December 31, 1994, the settlement rate and long-term rate of return on plan assets assumptions were 8.5% and 10%, respectively. The long-term rate of annual compensation increase assumption was 3.5% for 1995 and 1996 and 4% thereafter. At December 31, 1995 and 1994, the Company's net prepaid pension cost included in Regulatory and Other Assets -- Other in the Balance Sheet was $11 million and $7 million, respectively.\nPlan assets consist primarily of investments in common stock, bonds, guaranteed investment contracts, cash equivalent securities and real estate.\n(B) OTHER POSTRETIREMENT BENEFITS\nCenterior Energy sponsors jointly with its subsidiaries a postretirement benefit plan which provides all employee groups certain health care, death and other postretirement benefits other than pensions. The plan is contributory, with retiree contributions adjusted annually. The plan is not funded. The Company adopted SFAS 106, the accounting standard for postretirement benefits other than pensions, effective January 1, 1993. The standard requires the accrual of the expected costs of such benefits during the employees' years of service. Prior to 1993, the costs of these benefits were expensed as paid, which was consistent with rate-making practices.\nThe components of the total postretirement benefit costs for 1993 through 1995 were as follows:\nThese amounts included costs for the Company and its pro rata share of the Service Company's costs.\nIn 1995, 1994 and 1993, the Company deferred incremental SFAS 106 expenses (in excess of the amounts paid) of $3 million, $4 million and $60 million, respectively, pursuant to a provision of the Rate Stabilization Program. See Note 7(d).\n(Cleveland Electric) (Cleveland Electric)\nThe accumulated postretirement benefit obligation and accrued postretirement benefit cost for the Company and its share of the Service Company's obligation are as follows:\nThe Balance Sheet classification of Retirement Benefits at December 31, 1995 and 1994 includes only the Company's accrued postretirement benefit cost of $65 million and $59 million, respectively, and excludes the Service Company's portion since the Service Company's total accrued cost is carried on its books. A September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995 and 1994, the settlement rate and the long-term rate of annual compensation increase assumptions were the same as those discussed for pension reporting in Note 9(a). At December 31, 1995, the assumed annual health care cost trend rates (applicable to gross eligible charges) were 8% for medical and 7.5% for dental in 1996. Both rates reduce gradually to a fixed rate of 4.75% by 2003. Elements of the obligation affected by contribution caps are significantly less sensitive to the health care cost trend rate than other elements. If the assumed health care cost trend rates were increased by one percentage point in each future year, the accumulated postretirement benefit obligation as of December 31, 1995 would increase by $3 million and the aggregate of the service and interest cost components of the annual postretirement benefit cost would increase by $0.3 million.\n(10) GUARANTEES\nThe Company has guaranteed certain loan and lease obligations of two coal suppliers under two long-term coal supply contracts. At December 31, 1995, the principal amount of the loan and lease obligations guaranteed by the Company under both contracts was $39 million. In addition, the Company may be responsible for mine closing costs when one of the contracts is terminated. At December 31, 1995, the unfunded costs of closing this mine as estimated by the supplier were $32 million.\nThe prices under both contracts which include certain minimum payments are sufficient to satisfy the loan and lease obligations and mine closing costs over the lives of the contracts. If either contract is terminated early for any reason, the Company would attempt to reduce the termination charges and would ask the PUCO to allow recovery of such charges from customers through the fuel factor.\n(11) CAPITALIZATION\n(A) CAPITAL STOCK TRANSACTIONS\nPreferred stock shares sold and retired during the three years ended December 31, 1995 are listed in the following table.\n(B) EQUITY DISTRIBUTION RESTRICTIONS\nFederal law prohibits the Company from paying dividends out of capital accounts. However, the Company may pay preferred and common stock dividends out of appropriated retained earnings and current earnings. At December 31, 1995, the Company had $212 million of appropriated retained earnings for the payment of preferred and common stock dividends.\n(C) PREFERRED AND PREFERENCE STOCK\nAmounts to be paid for preferred stock which must be redeemed during the next five years are $30 million in both 1996 and 1997, $15 million in 1998 and $33 million in both 1999 and 2000.\nThe annual preferred stock mandatory redemption provisions are as follows:\n* All outstanding shares to be redeemed on December 1, 2001.\n(Cleveland Electric) (Cleveland Electric)\nIn 1995, the Company purchased 1,000 shares of Serial Preferred Stock, $90.00 Series S, which will reduce the 2002 redemption requirement shown in the above table.\nThe annualized preferred dividend requirement at December 31, 1995 was $41 million.\nThe preferred dividend rates on the Company's Series L and M fluctuate based on prevailing interest rates and market conditions. The dividend rates for these issues averaged 7.23% and 7.02%, respectively, in 1995.\nPreference stock authorized for the Company is 3,000,000 shares without par value. No preference shares are currently outstanding.\nWith respect to dividend and liquidation rights, the Company's preferred stock is prior to its preference stock and common stock, and its preference stock is prior to its common stock.\n(D) LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS\nLong-term debt, less current maturities, was as follows:\n* Secured by first mortgage bonds. Long-term debt matures during the next five years as follows: $147 million in 1996, $51 million in 1997, $74 million in 1998, $154 million in 1999 and $10 million in 2000.\nThe Company's mortgage constitutes a direct first lien on substantially all property owned and franchises held by the Company. Excluded from the lien, among other things, are cash, securities, accounts receivable, fuel and supplies.\nCertain credit agreements of the Company contain covenants relating to fixed charge coverage ratios and limitations on secured financing other than through first mortgage bonds or certain other transactions. In June 1995, the Company and Toledo Edison replaced letters of credit in connection with the sale and leaseback of Beaver Valley Unit 2 that were due to expire with new letters of credit expiring in June 1999. The letters of credit are in an aggregate amount of approximately $225 million and are secured by first mortgage bonds of the Company and Toledo Edison in the proportion of 40% and 60%, respectively. At December 31, 1995, the Company had outstanding $2 million of bank loans secured by subordinated mortgage collateral.\n(12) SHORT-TERM BORROWING ARRANGEMENTS\nCenterior Energy has a $125 million revolving credit facility through May 1996. Centerior Energy and the Service Company may borrow under the facility, with all borrowings jointly and severally guaranteed by the Company and Toledo Edison. Centerior Energy plans to transfer any of its borrowed funds to the Company and Toledo Edison. The credit agreement is secured with first mortgage bonds of the Company and Toledo Edison in the proportion of 40% and 60%, respectively. The banks' fee is 0.625% per annum payable quarterly in addition to interest on any borrowings. There were no borrowings under the facility at December 31, 1995. Also, the Company and Toledo Edison may borrow from each other on a short-term basis. At December 31, 1995, the Company had total short-term borrowings of $5 million from its affiliates with an interest rate of 6.25%.\n(13) FINANCIAL INSTRUMENTS\nThe estimated fair values at December 31, 1995 and 1994 of financial instruments that do not approximate their carrying amounts in the Balance Sheet are as follows:\nNoncash investments in the Nuclear Plant Decommissioning Trusts are summarized in the following table.\n(Cleveland Electric) (Cleveland Electric)\nThe fair value of these trusts is estimated based on the quoted market prices for the investment securities. As a result of adopting the new accounting standard for certain investments in debt and equity securities, SFAS 115, in 1994, the carrying amount of these trusts approximates fair value. The fair value of the Company's preferred stock, with mandatory redemption provisions, and long-term debt is estimated based on the quoted market prices for the respective or similar issues or on the basis of the discounted value of future cash flows. The discounted value used current dividend or interest rates (or other appropriate rates) for similar issues and loans with the same remaining maturities.\nThe estimated fair values of all other financial instruments approximate their carrying amounts in the Balance Sheet at December 31, 1995 and 1994 because of their short-term nature.\n(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a tabulation of the unaudited quarterly results of operations for the two years ended December 31, 1995.\n(15) PENDING MERGER OF TOLEDO EDISON INTO THE COMPANY\nIn March 1994, Centerior Energy announced a plan to merge Toledo Edison into the Company. Since the Company and Toledo Edison affiliated in 1986, efforts have been made to consolidate operations and administration as much as possible to achieve maximum cost savings.\nVarious aspects of the merger are subject to the approval of the FERC and other regulatory authorities. The FERC has deferred action on the merger application until the merits of the open access transmission tariffs proposed by the Company and Toledo Edison are addressed in hearings. The PUCO and the Pennsylvania Public Utility Commission have approved the merger. NRC action on the request by the Company and Toledo Edison for authorization to transfer certain NRC licenses to the merged entity is not expected until approval has been obtained from the FERC.\nIn June 1995, share owners of Toledo Edison's preferred stock approved the merger and share owners of the Company's preferred stock approved the authorization of additional shares of preferred stock. When the merger becomes effective, share owners of Toledo Edison's preferred stock will exchange their shares for preferred stock shares of the Company having substantially the same terms. Debt holders of the merging companies will become debt holders of the Company.\nFor the merging companies, the combined pro forma operating revenues were $2.516 billion, $2.422 billion and $2.475 billion and the combined pro forma net income (loss) was $281 million, $268 million and $(876) million for the years 1995, 1994 and 1993, respectively. The pro forma data is based on accounting for the merger on a method similar to a pooling of interests. The pro forma data is not necessarily indicative of the results of operations which would have been reported had the merger been in effect during those years or which may be reported in the future. The pro forma data should be read in conjunction with the audited financial statements of both the Company and Toledo Edison.\n(Cleveland Electric) (Cleveland Electric)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Share Owners and Board of Directors of The Cleveland Electric Illuminating Company:\nWe have audited the accompanying consolidated balance sheet and consolidated statement of preferred stock of The Cleveland Electric Illuminating Company (a wholly owned subsidiary of Centerior Energy Corporation) 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. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Cleveland Electric Illuminating Company 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 further in Note 9, a change was made in the method of accounting for postretirement benefits other than pensions in 1993.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of The Cleveland Electric Illuminating Company and subsidiaries listed in the Index to 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.\nArthur Andersen LLP\nCleveland, Ohio February 21, 1996\n(Cleveland Electric) (Cleveland Electric)\nFINANCIAL AND STATISTICAL REVIEW\nOPERATING REVENUES (millions of dollars)\n- --------------------------------------------------------------------------------\nOPERATING EXPENSES (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars)\n- --------------------------------------------------------------------------------\n(a) Includes early retirement program expenses and other charges of $165 million. (b) Includes write-off of phase-in deferrals of $636 million, consisting of $117 million of deferred operating expenses and $519 million of deferred carrying charges. (c) A change in accounting for nuclear plant depreciation was adopted, changing from the units-of-production method to the straight-line method at a 2.5% rate.\n(Cleveland Electric) (Cleveland Electric)\nThe Cleveland Electric Illuminating Company and Subsidiaries\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCAPITALIZATION (millions of dollars & %)\n- --------------------------------------------------------------------------------\n(d) Includes write-off of Perry Unit 2 of $351 million.\n(e) Reduced by net energy used by the Seneca Pumped Storage Plant for pumping.\n(Cleveland Electric) (Cleveland Electric)\nMANAGEMENT'S FINANCIAL ANALYSIS\nOUTLOOK\nSTRATEGIC PLAN\nWe continued to make progress during the second year of our eight-year strategic plan, but we remain keenly aware of the magnitude of the problems that face us. The strategic plan was created by Centerior Energy Corporation (Centerior Energy), along with The Toledo Edison Company (Company) and The Cleveland Electric Illuminating Company (Cleveland Electric), to achieve two major goals: strengthening their financial conditions and improving their competitive positions. The Company and Cleveland Electric are the two wholly owned electric utility subsidiaries of Centerior Energy. The plan's objectives relate to the combined operations of all three companies. The objectives are to achieve profitable revenue growth, become a leader in customer satisfaction, build a winning employee team, attain increasingly competitive power supply costs and maximize share owner return on Centerior Energy common stock. We are not yet positioned to compete in a less regulated electric utility industry, but every major action being taken -- strategic planning, revenue enhancement, cost reduction, improvement of work practices and application for increased prices -- is part of a comprehensive effort to succeed in an increasingly competitive environment.\nA primary objective of the strategic plan is continued and significant revenue growth even as our markets become more competitive. The Company's retail revenues adjusted for weather and fuel costs have grown about 1% annually since 1990. During 1995, we took aggressive steps to increase revenues through enhanced marketing strategies. Also, our economic development efforts proved successful in attracting major new customers and supporting the expansion of existing ones. Although we are not satisfied with our growth rate, we expect that our marketing activity will improve revenue growth.\nThe rate case which the Company and Cleveland Electric filed with The Public Utilities Commission of Ohio (PUCO) in April 1995 is a critical factor to the success of the strategic plan. We do not see this rate case as a continuation of business as usual but as an important turning point which should, if we are successful in accomplishing the objectives discussed below, bring an end to price increases for the foreseeable future. A successful conclusion of the case would speed our transition to a more competitive company by providing additional cash to lower costs by accelerating the pay-down of debt and preferred stock. In our view, a successful conclusion would include approval of the full price increase requested with a regulatory commitment to maintain the established price levels over an appropriate transition period. This should be coupled with a means to accelerate recognition of regulatory assets (described in Note 7(a)) and nuclear generating assets concurrent with our cost control and revenue enhancement efforts in order to earn a fair return for Centerior Energy common stock share owners over time.\nAnother key part of our strategy is offering long-term contracts to those large customers who could have incentives to change power suppliers. In 1995, 74% of our industrial kilowatt-hour sales and 13% of our commercial kilowatt-hour sales were under long-term contracts. We are renegotiating contracts before they expire and in most cases are retaining customers under new long-term contracts.\nWe are continuing efforts to reduce fixed financing costs in order to strengthen our financial condition. During 1995, utilizing strong cash flow and refinancing at favorable terms, the Company reduced interest expense and preferred dividends by $7 million and outstanding debt and preferred stock by $113 million.\nOur overall costs are high relative to many of our neighboring utilities as a result of our substantial nuclear investment. The strategic plan calls for making us more competitive by continuing to reduce operating expenses and capital expenditures. In 1995, to improve the focus on cost reduction and other strategic plan objectives, Centerior Energy and its subsidiaries restructured into six business groups. The new organization includes groups to manage the generation, distribution and transmission businesses; provide services and administrative functions; and invest in nonregulated enterprises. This arrangement will also enhance each group's ability to identify cost reductions by focusing on margins and improving work practices and customer service. We will also continue to aggressively pursue initiatives to reduce the heavy tax burden imposed upon us by the state and local tax structure in Ohio.\nRATE CASE AND REGULATORY ACCOUNTING\nIn April 1995, the Company and Cleveland Electric filed requests with the PUCO for price increases aggregating $119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program discussed below and in\n(Toledo Edison) (Toledo Edison)\nNote 7. If their requests are approved, the Company and Cleveland Electric intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will obviate the need for further price increases. If circumstances make it impossible to earn a fair return for Centerior Energy common stock share owners over time, the Company and Cleveland Electric would ask for a further increase -- but only after taking all appropriate actions to make such a request unnecessary.\nIn December 1995, the PUCO ordered an investigation into the financial conditions, rates and practices of the Company and Cleveland Electric.\nIn its report on the rate request, the PUCO Staff recommended approval of the $119 million requested ($35 million for the Company and $84 million for Cleveland Electric), subject to a commitment by the Company and Cleveland Electric to significantly revalue their assets. In late January 1996, the Staff proposed that the Company and Cleveland Electric significantly revalue their nuclear plant and regulatory assets within a five-year period. The Staff's asset revaluation proposal is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the Staff's recommendations. A decision by the PUCO is anticipated in the second quarter of 1996.\nThe outcome of the rate case could affect the Company's ability to meet the criteria of Statement of Financial Accounting Standards (SFAS) 71 for all or part of its operations which could result in the write-off of all or a part of the regulatory assets shown in Note 7(a). In our changing industry, other events independent of the outcome of the rate case could also result in write-offs or write-downs of assets.\nSee Note 7 for a full discussion and analysis of the rate case, SFAS 71 and other financial accounting requirements and the potential implications of these accounting requirements for the Company's results of operations and financial position.\nRATE STABILIZATION PROGRAM\nUnder a Rate Stabilization Program approved by the PUCO in 1992, we agreed to freeze base rates until 1996 and limit rate increases through 1998. In exchange, we were permitted to defer through 1995 and subsequently recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits. Deferral of those costs and amortization of those benefits were completed in November 1995 and aggregated $56 million for the Company in 1995. Recovery is expected to begin with the effective date of the PUCO's order in the pending rate case. Annual amortization of the deferred costs for the Company is $10 million which began in December 1995. Consequently, earnings in 1996 will be sharply lower than in 1995. Also contributing to lower earnings are the expectations that the requested price increase will not be effective until the second quarter of 1996 and results from increased marketing and cost reduction efforts will take time to achieve.\nCOMPETITION\nMajor structural changes are taking place in the electric utility industry which are expected to place downward pressure on prices and to increase competition for customers' business. The changes are coming from both federal and state authorities. Many of the changes began when the Energy Policy Act of 1992 permitted competition in the electric utility industry through broader access to a utility's transmission system. In March 1995, the Federal Energy Regulatory Commission (FERC) issued proposed rules relating to open access transmission services by public utilities, recovery of stranded investment and other related matters. The open access transmission rules require utilities to deliver power from other utilities or generation sources to their wholesale customers. In May 1995, the Company and Cleveland Electric filed open access transmission tariffs with the FERC which used the proposed rules as a guideline. These tariffs are currently pending.\nSeveral groups in Ohio are studying the possible application of retail wheeling. Retail wheeling occurs when a customer obtains power from a utility company other than its local utility. The PUCO is sponsoring informal discussions among a group of business, utility and consumer interests to explore ways of promoting competitive options without unduly harming the interests of utility company share owners or customers. Legislative proposals are being drafted for submission to the Ohio House of Representatives and several utilities in the state have offered their own proposed transition plans for introduction of retail wheeling. The current retail wheeling efforts in Ohio are exploratory and we cannot predict when and to what extent retail wheeling will be implemented in Ohio.\nThe term \"stranded investment\" generally refers to fixed costs approved for recovery under traditional regulatory methods that would become unrecoverable, or \"stranded\", as a result of wider competition. Although\n(Toledo Edison) (Toledo Edison)\ncompetitive pressures are increasing, the traditional regulatory framework remains in place and is expected to continue for the foreseeable future. We cannot predict when and to what extent competition will be allowed. We believe that pure competition (unrestricted retail wheeling for all customer classifications) is at least several years away and that any transition to pure competition will be in phases. The FERC and the PUCO have acknowledged the need to provide at least partial recovery of stranded investment as greater competition is permitted and, therefore, we believe that there will be a mechanism developed for the recovery of stranded investment. However, due to the uncertainty involved, there is a risk that some of our assets may not be fully recovered.\nIn 1995, we continued to experience significant competition from municipal electric systems. Also, in Toledo, the City Council responded to a petition drive by appropriating funds to complete a consultant's study on whether to create a municipal electric utility. This study is expected to be completed by mid-1996.\nIn October 1995, Chase Brass & Copper Co. Inc., which has provided annual net income of $2 million, terminated its service from the Company and began to receive its electric service from a consortium of other providers. We have filed lawsuits contending that this arrangement violates the legal limits of sales and delivery of power by municipal electric systems outside their boundaries. We will continue to pursue all legal and regulatory remedies to this situation.\nIn 1995, our economic development efforts proved successful in attracting major new customers, such as North Star BHP Steel, Worthington Steel and Aluminum Company of America, while supporting the expansion of existing ones. We expect that our continued emphasis on economic development along with a newly developed market segment focus will be major ingredients in providing improved revenue growth.\nNUCLEAR OPERATIONS\nThe Company has interests in three nuclear generating units -- Davis-Besse Nuclear Power Station (Davis-Besse), Perry Nuclear Power Plant Unit 1 (Perry Unit 1) and Beaver Valley Power Station Unit 2 (Beaver Valley Unit 2) -- and operates the first one. Cleveland Electric operates Perry Unit 1. Davis-Besse and Beaver Valley Unit 2 both operated extremely well in 1995. Their average three-year unit availability factors at year-end 1995 of 90% and 87%, respectively, exceeded the industry average of 81% for similar reactors. In 1995, the availability factor for Davis-Besse was 100%. The plant continues to have its best run ever operating at or near full capacity for 463 straight days through February 21, 1996.\nIn 1995, Perry Unit 1 improved its average three-year unit availability factor to 62% with a 1995 availability factor of 93%. Perry Unit 1 operated at or near capacity for 506 of 531 days since the end of its last refueling and maintenance outage in August 1994. Work on the comprehensive course of action plan developed in 1993 for Cleveland Electric to improve the operating performance of Perry Unit 1 will be completed during the current refueling outage which began January 27, 1996.\nA significant part of the strategic plan involves ongoing efforts to increase the availability and lower the cost of production of our nuclear units. In 1995, we made great progress regarding unit availability while continuing to lower production costs. The goal of our nuclear improvement program is for Cleveland Electric to replicate Davis-Besse's operational excellence and cost reduction gains at Perry Unit 1 while improving performance ratings.\nWe externally fund the estimated costs for the future decommissioning of our nuclear units. In 1993 and 1994, we increased our decommissioning expense accruals because of revisions in our cost estimates. See Note 1(e).\nOur nuclear units may be impacted by activities or events beyond our control. Operating nuclear units have experienced unplanned outages or extensions of scheduled outages because of equipment problems or new regulatory requirements. A major accident at a nuclear facility anywhere in the world could cause the Nuclear Regulatory Commission (NRC) to limit or prohibit the operation or licensing of any domestic nuclear unit. If one of our nuclear units is taken out of service for an extended period for any reason, including an accident at such unit or any other nuclear facility, we cannot predict whether regulatory authorities would impose unfavorable rate treatment. Such treatment could include taking our affected unit out of rate base, thereby not permitting us to recover our investment in and earn a return on it, or disallowing certain construction or maintenance costs. An extended outage coupled with unfavorable rate treatment could have a material adverse effect on our financial condition and results of operations. Premature plant closings could also have a material adverse effect on our financial condition and results of operations because the estimated cost to decommission the plant exceeds the current funding in the decommissioning trust.\n(Toledo Edison) (Toledo Edison)\nHAZARDOUS WASTE DISPOSAL SITES\nThe Company is aware of its potential involvement in the cleanup of several sites. Although these sites are not on the Superfund National Priorities List, they are generally being administered by various governmental entities in the same manner as they would be administered if they were on such list. Allegations that the Company disposed of hazardous waste at these sites, and the amount involved, are often unsubstantiated and subject to dispute. Federal law provides that all \"potentially responsible parties\" (PRPs) for a particular site be held liable on a joint and several basis. If the Company were held liable for 100% of the cleanup costs of all of the sites referred to above, the cost could be as high as $150 million. However, we believe that the actual cleanup costs will be substantially lower than $150 million, that the Company's share of any cleanup costs will be substantially less than 100% and that most of the other PRPs are financially able to contribute their share. The Company has accrued a liability totaling $5 million at December 31, 1995, based on estimates of the costs of cleanup and its proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations.\nCOMMON STOCK DIVIDENDS\nIn recent years, the Company has retained all of its earnings available for common stock. The Company has not paid a common stock dividend to Centerior Energy since February 1991. The Company is currently prohibited from paying a common stock dividend by a provision in its mortgage. See Note 11(b). The Company does not expect to pay any common stock dividends prior to its merger into Cleveland Electric, as discussed below.\nMERGER OF THE COMPANY INTO CLEVELAND ELECTRIC\nWe continue to seek the necessary regulatory approvals to complete the merger of the Company into Cleveland Electric which was announced in 1994. The FERC has deferred action on the merger application until the merits of the open access transmission tariffs proposed by the Company and Cleveland Electric are addressed in hearings. See Note 15.\nCAPITAL RESOURCES AND LIQUIDITY\n1993-1995 CASH REQUIREMENTS\nA key part of the strategic plan is to significantly reduce the Company's level of debt and preferred stock. In 1995, we were able to continue the reduction pattern begun in 1994. The Company's obligations were reduced by $66 million in 1994 and by $113 million in 1995. We intend to continue and to accelerate redemptions.\nWe need cash for normal corporate operations, retirement of maturing securities, and an ongoing program of constructing and improving facilities to meet demand for electric service and to comply with government regulations. Our cash construction expenditures totaled $42 million in 1993, $41 million in 1994 and $53 million in 1995. Our debt and preferred stock maturities and sinking fund requirements totaled $58 million in both 1993 and 1994 and $83 million in 1995. In addition, we optionally redeemed approximately $200 million in the period 1993-1995. This amount includes $94 million of tax-exempt issues refunded in 1995 resulting in approximately $4 million of interest savings. The embedded cost of the Company's debt at the end of 1995 was 9.23% versus 9.48% in 1994 and 9.59% in 1993. In 1995, the Company and Cleveland Electric renewed for a four-year term approximately $225 million in bank letters of credit supporting the equity owner participants in the Beaver Valley Unit 2 lease. See Note 11(d).\nThe Company also utilized short-term borrowings to help meet its cash needs. The Company had $21 million of notes payable to affiliates at December 31, 1995. See Note 12.\n1996 AND BEYOND CASH REQUIREMENTS\nThe Company's 1996 cash requirements for construction are $74 million and for debt and preferred stock maturities and sinking fund requirements are $58 million. We expect to meet these requirements with internal cash generation, cash reserves and about $40 million from the sale of a AAA-rated security backed by our accounts receivable.\nWe expect to meet all of our 1997-2000 cash requirements with internal cash generation. Estimated cash requirements for the Company's construction program during this period total $262 million. Debt and preferred stock maturities and sinking fund requirements total $233 million for the same period. If economical, additional securities may be redeemed under optional redemption\n(Toledo Edison) (Toledo Edison)\nprovisions, with funding expected to be provided through internal cash generation.\nLIQUIDITY\nAdditional first mortgage bonds may be issued by the Company under its mortgage on the basis of property additions, cash or refundable first mortgage bonds. If the applicable interest coverage test is met, the Company may issue first mortgage bonds on the basis of property additions and, under certain circumstances, refundable bonds. At December 31, 1995, the Company would have been permitted to issue approximately $288 million of additional first mortgage bonds.\nThe Company also is able to raise funds through the sale of debt and preferred and preference stock. Under its articles of incorporation, the Company cannot issue preferred stock unless certain earnings coverage requirements are met. At December 31, 1995 the Company would have been permitted to issue approximately $158 million of additional preferred stock at an assumed dividend rate of 10.5%. There are no restrictions on the Company's ability to issue preference stock.\nThe Company and Cleveland Electric have $307 million in financing vehicles available to support their nuclear fuel leases, portions of which mature this year. See Note 6. The Company is a party to a $125 million revolving credit facility which is expected to be renewed when it matures in May 1996. See Note 12. At the end of 1995, the Company had $94 million in cash and temporary investments.\nThe foregoing financing resources are expected to be sufficient for the Company's needs over the next several years. However, the availability and cost of capital to meet the Company's external financing needs also depend upon such factors as financial market conditions and its credit ratings. Current credit ratings for the Company are as follows:\nRESULTS OF OPERATIONS\n1995 VS. 1994\nFactors contributing to the 1% increase in 1995 operating revenues are as follows:\nFor the second year in a row, total kilowatt-hour sales increased. Total sales increased 2.2% in 1995 primarily because of the hot summer weather. Residential and commercial sales increased 5.2% and 2.2%, respectively, which included about 1% nonweather-related growth in residential sales. Industrial sales increased 1.8% on the strength of increased sales to large glass manufacturers and the broad-based, smaller industrial customer group. Other sales increased 0.5%. Weather accounted for approximately $13 million of the $21 million increase in 1995 base rate (nonfuel) revenues. Wholesale revenues decreased because of the lower revenues associated with the Beaver Valley Unit 2 capacity sale to Cleveland Electric. See Note 2. Lower 1995 fuel costs recovery revenues resulted from favorable changes in the fuel cost factors. The weighted average of these fuel cost factors decreased approximately 6%.\nFor 1995, operating revenues were 27% residential, 21% commercial, 29% industrial and 23% other and kilowatt-hour sales were 19% residential, 16% commercial, 37% industrial and 28% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.11 and $.06, respectively.\nOperating expenses increased 0.1% in 1995. Federal income taxes increased as a result of higher pretax operating income. Fuel and purchased power expenses decreased because of lower purchased power requirements resulting from the increased availability of the nuclear generating units in 1995.\nInterest charges and preferred dividends decreased in 1995 because of the redemption of securities and refinancing at favorable terms.\n(Toledo Edison) (Toledo Edison)\n1994 VS. 1993\nFactors contributing to the 0.7% decrease in 1994 operating revenues are as follows:\nThe Company experienced good retail kilowatt-hour sales growth in the industrial and commercial categories in 1994; the sales growth for the residential category was lessened by weather conditions, particularly during the summer. The revenue decrease resulted from milder weather conditions in 1994 and both lower wholesale and fuel cost recovery revenues. Weather reduced base rate revenues approximately $7 million from the 1993 amount. Total sales increased 7.8%. Industrial sales increased 8.6% on the strength of increased sales to large automotive manufacturers and the broad-based, smaller industrial customer group. This growth substantiated an economic resurgence in Northwestern Ohio. Residential and commercial sales increased 0.8% and 2.3%, respectively. Other sales increased 16% because of increased sales to wholesale customers, although the softer wholesale market conditions in 1994 resulted in lower wholesale revenues. Lower 1994 fuel cost recovery revenues resulted from favorable changes in the fuel cost factors. The weighted average of these fuel cost factors dropped by 6%.\nFor 1994, operating revenues were 26% residential, 21% commercial, 29% industrial and 24% other and kilowatt-hour sales were 19% residential, 16% commercial, 37% industrial and 28% other. The average prices per kilowatt-hour for residential, commercial and industrial customers were $.11, $.11 and $.06, respectively. The changes from 1993 were not significant.\nOperating expenses were 12% lower in 1994. Operation and maintenance expenses for 1993 included $88 million of net benefit expenses related to an early retirement program, called the Voluntary Transition Program (VTP), and other charges totaling $19 million. The VTP benefit expenses in 1993 consisted of $75 million of costs for the Company plus $13 million for the Company's pro rata share of the costs for its affiliate, Centerior Service Company (Service Company). A smaller work force and ongoing cost reduction measures also lowered operation and maintenance expenses. Lower purchased power costs helped reduce fuel and purchased power expenses in 1994 despite an increase in the amount of power purchased. More nuclear generation and less coal-fired generation also accounted for a part of the lower fuel and purchased power expenses. Depreciation and amortization expenses increased primarily because of higher nuclear plant decommissioning expenses as discussed in Note 1(e). Deferred operating expenses were greater primarily because of the write-off of $55 million of phase-in deferred operating expenses in 1993 as discussed in Note 7(e). The 1993 deferrals also included $32 million of postretirement benefit curtailment cost deferrals related to the VTP. See Note 9(b). Federal income taxes increased as a result of higher pretax operating income.\nAs discussed in Note 4(b), $232 million of our Perry Unit 2 investment was written off in 1993. Also, as discussed in Note 7(e), phase-in deferred carrying charges of $186 million were written off in 1993. The change in the federal income tax credit amounts for nonoperating income was attributable to these write-offs.\n(Toledo Edison) (Toledo Edison)\nINCOME STATEMENT The Toledo Edison Company\n- ---------------\n(1) Includes revenues from all bulk power sales to Cleveland Electric of $102 million, $111 million and $120 million in 1995, 1994 and 1993, respectively.\nRETAINED EARNINGS\nThe accompanying notes are an integral part of these statements.\n(Toledo Edison) (Toledo Edison)\n(This page intentionally left blank)\n(Toledo Edison) (Toledo Edison)\nBALANCE SHEET\nThe accompanying notes are an integral part of this statement.\n(Toledo Edison) (Toledo Edison)\nThe Toledo Edison Company\n(Toledo Edison) (Toledo Edison)\nCASH FLOWS The Toledo Edison Company\n- ---------------\n(2) Increases in Nuclear Fuel and Nuclear Fuel Lease Obligations in the Balance Sheet resulting from the noncash capitalizations under nuclear fuel agreements are excluded from this statement.\nThe accompanying notes are an integral part of this statement.\n(Toledo Edison) (Toledo Edison)\nSTATEMENT OF PREFERRED STOCK The Toledo Edison Company\nThe accompanying notes are an integral part of this statement.\n(Toledo Edison) (Toledo Edison)\nNOTES TO THE FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) GENERAL\nThe Company is an electric utility and a wholly owned subsidiary of Centerior Energy. The Company follows the Uniform System of Accounts prescribed by the FERC and adopted by the PUCO. Rate-regulated utilities are subject to SFAS 71 which governs accounting for the effects of certain types of rate regulation. Pursuant to SFAS 71, certain incurred costs are deferred for recovery in future rates. See Note 7.\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, and the disclosure of contingent assets and liabilities. The estimates are based on an analysis of the best information available. Actual results could differ from those estimates.\nThe Company is a member of the Central Area Power Coordination Group (CAPCO). Other members are Cleveland Electric, Duquesne Light Company, Ohio Edison Company and its wholly owned subsidiary, Pennsylvania Power Company. The members have constructed and operate generation and transmission facilities for their joint use.\n(B) RELATED PARTY TRANSACTIONS\nOperating revenues, operating expenses and interest charges include those amounts for transactions with affiliated companies in the ordinary course of business operations.\nThe Company's transactions with Cleveland Electric are primarily for firm power, interchange power, transmission line rentals and jointly owned power plant operations and construction. See Notes 2 and 3.\nThe Service Company provides management, financial, administrative, engineering, legal and other services at cost to the Company and other affiliated companies. The Service Company billed the Company $67 million, $59 million and $71 million in 1995, 1994 and 1993, respectively, for such services.\n(C) REVENUES\nCustomers are billed on a monthly cycle basis for their energy consumption based on rate schedules or contracts authorized by the PUCO or on ordinances of individual municipalities. An accrual is made at the end of each month to record the estimated amount of unbilled revenues for kilowatt-hours sold in the current month but not billed by the end of that month.\nA fuel factor is added to the base rates for electric service. This factor is designed to recover from customers the costs of fuel and most purchased power. It is reviewed and adjusted semiannually in a PUCO proceeding.\n(D) FUEL EXPENSE\nThe cost of fossil fuel is charged to fuel expense based on inventory usage. The cost of nuclear fuel, including an interest component, is charged to fuel expense based on the rate of consumption. Estimated future nuclear fuel disposal costs are being recovered through base rates.\nThe Company defers the differences between actual fuel costs and estimated fuel costs currently being recovered from customers through the fuel factor. This matches fuel expenses with fuel-related revenues.\nOwners of nuclear generating plants are assessed by the federal government for the cost of decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy. The assessments are based upon the amount of enrichment services used in prior years and cannot be imposed for more than 15 years (to 2007). The Company has accrued a liability for its share of the total assessments. These costs have been recorded in a deferred charge account since the PUCO is allowing the Company to recover the assessments through its fuel cost factors.\n(E) DEPRECIATION AND DECOMMISSIONING\nThe cost of property, plant and equipment is depreciated over their estimated useful lives on a straight-line basis. The annual straight-line depreciation provision for nonnuclear property expressed as a percent of average depreciable utility plant in service was 3.8% in 1995, 3.5% in 1994 and 3.6% in 1993. The annual straight-line depreciation rate for nuclear property is 2.5%. In conjunction with its pending rate case, the Company has asked the PUCO to approve an increase of this depreciation rate to approximately 3%.\nThe Company accrues the estimated costs of decommissioning its three nuclear generating units. The accruals are required to be funded in an external trust. The PUCO requires that the expense and payments to the external trusts be determined on a levelized basis by dividing the unrecovered decommissioning costs in current dollars by the remaining years in the licensing period of each unit. This methodology requires that the net earnings on the\n(Toledo Edison) (Toledo Edison)\ntrusts be reinvested therein with the intent of having net earnings offset inflation. The PUCO requires that the estimated costs of decommissioning and the funding level be reviewed at least every five years.\nIn 1994, the Company increased its annual decommissioning expense accruals to $11 million from the $5 million level in 1993. The accruals are reflected in current rates. The increased accruals in 1994 were derived from updated, site-specific studies for each of the units. The revised estimates reflect the DECON method of decommissioning (prompt decontamination), and the locations and cost characteristics specific to the units, and include costs associated with decontamination, dismantlement and site restoration.\nThe revised estimates for the units in 1993 and 1992 dollars and in dollars at the time of license expiration, assuming a 4% annual inflation rate, are as follows:\n- ---------------\n(1) Dollar amounts in 1993 dollars. (2) Dollar amount in 1992 dollars.\nThe updated estimates reflect substantial increases from the prior PUCO-recognized aggregate estimates of $115 million in 1987 and 1986 dollars.\nThe classification, Accumulated Depreciation and Amortization, in the Balance Sheet at December 31, 1995 includes $59 million of decommissioning costs previously expensed and the earnings on the external trust funding. This amount exceeds the Balance Sheet amount of the external Nuclear Plant Decommissioning Trusts because the reserve began prior to the external trust funding. The trust earnings are recorded as an increase to the trust assets and the related component of the decommissioning reserve (included in Accumulated Depreciation and Amortization).\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry, including those of the Company, regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations in the financial statements. In response to these questions, the Financial Accounting Standards Board (FASB) is reviewing the accounting for removal costs, including decommissioning. If current accounting practices are changed, the annual provision for decommissioning could increase; the estimated cost for decommis- sioning could be recorded as a liability rather than as accumulated depreciation; and trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense. The FASB issued an exposure draft on the subject on February 7, 1996.\n(F) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at original cost less amounts disallowed by the PUCO. Construction costs include related payroll taxes, retirement benefits, fringe benefits, management and general overheads and allowance for funds used during construction (AFUDC). AFUDC represents the estimated composite debt and equity cost of funds used to finance construction. This noncash allowance is credited to income. The AFUDC rate was 12.6% in 1995, 9.87% in 1994 and 10.22% in 1993.\nMaintenance and repairs for plant and equipment are charged to expense as incurred. The cost of replacing plant and equipment is charged to the utility plant accounts. The cost of property retired plus removal costs, after deducting any salvage value, is charged to the accumulated provision for depreciation.\n(G) DEFERRED GAIN AND LOSS FROM SALES OF UTILITY PLANT\nThe sale and leaseback transactions discussed in Note 2 resulted in a net gain for the sale of the Bruce Mansfield Generating Plant (Mansfield Plant) and a net loss for the sale of Beaver Valley Unit 2. The net gain and net loss were deferred and are being amortized over the terms of the leases. See Note 7(a). These amortizations and the lease expense amounts are reported in the Income Statement as Generation Facilities Rental Expense, Net.\n(H) INTEREST CHARGES\nDebt Interest reported in the Income Statement does not include interest on obligations for nuclear fuel under construction. That interest is capitalized. See Note 6.\nLosses and gains realized upon the reacquisition or redemption of long-term debt are deferred, consistent with the regulatory rate treatment. See Note 7(a). Such losses and gains are either amortized over the remainder of the original life of the debt issue retired or amortized over the life of the new debt issue when the proceeds of a new issue are used for the debt redemption. The amortizations are included in debt interest expense.\n(Toledo Edison) (Toledo Edison)\n(I) FEDERAL INCOME TAXES\nThe Company uses the liability method of accounting for income taxes in accordance with SFAS 109. See Note 8. This method requires that deferred taxes be recorded for all temporary differences between the book and tax bases of assets and liabilities. The majority of these temporary differences are attributable to property-related basis differences. Included in these basis differences is the equity component of AFUDC, which will increase future tax expense when it is recovered through rates. Since this component is not recognized for tax purposes, the Company must record a liability for its tax obligation. The PUCO permits recovery of such taxes from customers when they become payable. Therefore, the net amount due from customers through rates has been recorded as a deferred charge and will be recovered over the lives of the related assets. See Note 7(a).\nInvestment tax credits are deferred and amortized over the lives of the applicable property as a reduction of depreciation expense. See Note 7(d) for a discussion of the amortization of certain unrestricted excess deferred taxes and unrestricted investment tax credits under the Rate Stabilization Program.\n(2) UTILITY PLANT SALE AND LEASEBACK TRANSACTIONS\nThe Company and Cleveland Electric are co-lessees of 18.26% (150 megawatts) of Beaver Valley Unit 2 and 6.5% (51 megawatts), 45.9% (358 megawatts) and 44.38% (355 megawatts) of Units 1, 2 and 3 of the Mansfield Plant, respectively. These leases extend through 2017 and are the result of sale and leaseback transactions completed in 1987.\nUnder these leases, the Company and Cleveland Electric are responsible for paying all taxes, insurance premiums, operation and maintenance expenses and all other similar costs for their interests in the units sold and leased back. They may incur additional costs in connection with capital improvements to the units. The Company and Cleveland Electric have options to buy the interests back at the end of the leases for the fair market value at that time or renew the leases. The leases include conditions for mandatory termination (and possible repurchase of the leasehold interest) for events of default.\nAs co-lessee with Cleveland Electric, the Company is also obligated for Cleveland Electric's lease payments. If Cleveland Electric is unable to make its payments under the Mansfield Plant leases, the Company would be obligated to make such payments. No such payments have been made on behalf of Cleveland Electric.\nFuture minimum lease payments under the operating leases at December 31, 1995 are summarized as follows:\nRental expense is accrued on a straight-line basis over the terms of the leases. The amount recorded in 1995, 1994 and 1993 as annual rental expense for the Mansfield Plant leases was $45 million. The amounts recorded in 1995, 1994 and 1993 as annual rental expense for the Beaver Valley Unit 2 lease were $63 million, $64 million and $63 million, respectively. Amounts charged to expense in excess of the lease payments are classified as Accumulated Deferred Rents in the Balance Sheet.\nThe Company is selling 150 megawatts of its Beaver Valley Unit 2 leased capacity entitlement to Cleveland Electric. Revenues recorded for this transaction were $98 million, $108 million and $103 million in 1995, 1994 and 1993, respectively. We anticipate that this sale will continue indefinitely. The future minimum lease payments through 2017 associated with Beaver Valley Unit 2 aggregate $1.35 billion.\n(3) PROPERTY OWNED WITH OTHER UTILITIES AND INVESTORS\nThe Company owns, as a tenant in common with other utilities and those investors who are owner-participants in various sale and leaseback transactions (Lessors), certain generating units as listed below. Each owner owns an undivided share in the entire unit. Each owner has the right to a percentage of the generating capability of each unit equal to its ownership share. Each utility owner is obligated to pay for only its respective share of the construction costs and operating expenses. Each Lessor has leased its capacity rights to a utility which is obligated to pay for such Lessor's share of the construction costs and operating expenses. The Company's share of the operating expenses of these generating units is included in the Income Statement. The Balance Sheet classification of Property, Plant and Equipment at December 31, 1995\n(Toledo Edison) (Toledo Edison)\nincludes the following facilities owned by the Company as a tenant in common with other utilities and Lessors:\n(4) CONSTRUCTION AND CONTINGENCIES\n(A) CONSTRUCTION PROGRAM\nThe estimated cost of the Company's construction program for the 1996-2000 period is $345 million, including AFUDC of $10 million and excluding nuclear fuel.\nThe Clean Air Act Amendments of 1990 (Clean Air Act) requires, among other things, significant reductions in the emission of sulfur dioxide and nitrogen oxides by fossil-fueled generating units. Our strategy provides for compliance primarily through greater use of low-sulfur coal at some of our units and the use of emission allowances. Total capital expenditures from 1991 through 1995 in connection with Clean Air Act compliance amounted to $4 million. The plan will require additional capital expenditures over the 1996-2005 period of approximately $41 million for nitrogen oxide control equipment and other plant process modifications. In addition, higher fuel and other operation and maintenance expenses may be incurred.\n(B) PERRY UNIT 2\nPerry Unit 2, including its share of the facilities common with Perry Unit 1, was approximately 50% complete when construction was suspended in 1985 pending consideration of various options. We wrote off our investment in Perry Unit 2 at December 31, 1993 after we determined that it would not be completed or sold. The write-off totaled $232 million ($167 million after taxes) for the Company's 19.91% ownership share of the unit.\n(C) HAZARDOUS WASTE DISPOSAL SITES\nThe Company is aware of its potential involvement in the cleanup of several sites. The Company has accrued a liability totaling $5 million at December 31, 1995 based on estimates of the costs of cleanup and its proportionate responsibility for such costs. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition or results of operations. See Management's Financial Analysis -- Outlook-Hazardous Waste Disposal Sites.\n(5) NUCLEAR OPERATIONS AND CONTINGENCIES\n(A) OPERATING NUCLEAR UNITS\nThe Company's three nuclear units may be impacted by activities or events beyond our control. An extended outage of one of our nuclear units for any reason, coupled with any unfavorable rate treatment, could have a material adverse effect on our financial condition and results of operations. See the discussion of these and other risks in Management's Financial Analysis -- Outlook-Nuclear Operations.\n(B) NUCLEAR INSURANCE\nThe Price-Anderson Act limits the public liability of the owners of a nuclear power plant to the amount provided by private insurance and an industry assessment plan. In the event of a nuclear incident at any unit in the United States resulting in losses in excess of the level of private insurance (currently $200 million), the Company's maximum potential assessment under that plan would be $70 million per incident. The assessment is limited to $9 million per year for each nuclear incident. These assessment limits assume the other CAPCO companies contribute their proportionate share of any assessment.\nThe utility owners and lessees of Davis-Besse, Perry and Beaver Valley also have insurance coverage for damage to property at these sites (including leased fuel and cleanup costs). Coverage amounted to $2.75 billion for each site as of January 1, 1996. Damage to property could exceed the insurance coverage by a substantial amount. If it does, the Company's share of such excess amount could have a material adverse effect on its financial condition and results of operations. In addition, the Company can be assessed a maximum of $19 million under these policies during a policy year if the reserves available to the insurer are inadequate to pay claims arising out of an accident at any nuclear facility covered by the insurer.\nThe Company also has extra expense insurance coverage. It includes the incremental cost of any replacement power purchased (over the costs which would have been incurred had the units been operating) and other incidental expenses after the occurrence of certain types of accidents at our nuclear units. The amounts of the coverage are 100% of the estimated extra expense per week during the 52-week period starting 21 weeks after an accident and 80% of such estimate per week for the next\n(Toledo Edison) (Toledo Edison)\n104 weeks. The amount and duration of extra expense could substantially exceed the insurance coverage.\n(6) NUCLEAR FUEL\nNuclear fuel is financed for the Company and Cleveland Electric through leases with a special-purpose corporation. The total amount of financing currently available under these lease arrangements is $307 million ($157 million from intermediate-term notes and $150 million from bank credit arrangements). The intermediate-term notes mature in 1996 and 1997 ($84 million in September 1996 and $73 million in September 1997). The bank credit arrangements terminate in October 1996. The special-purpose corporation plans to obtain alternate financing in 1996 to replace the $234 million of financing expiring in 1996. At December 31, 1995, $93 million of nuclear fuel was financed for the Company. The Company and Cleveland Electric severally lease their respective portions of the nuclear fuel and are obligated to pay for the fuel as it is consumed in a reactor. The lease rates are based on various intermediate-term note rates, bank rates and commercial paper rates. The amounts financed include nuclear fuel in the Davis-Besse, Perry Unit 1 and Beaver Valley Unit 2 reactors with remaining lease payments for the Company of $37 million, $21 million and $15 million, respectively, at December 31, 1995. The nuclear fuel amounts financed and capitalized also included interest charges incurred by the lessors amounting to $2 million in 1995, $4 million in 1994 and $6 million in 1993. The estimated future lease amortization payments for the Company based on projected consumption are $41 million in 1996, $34 million in 1997, $29 million in 1998, $28 million in 1999 and $27 million in 2000.\n(7) REGULATORY MATTERS\n(A) REGULATORY ACCOUNTING REQUIREMENTS AND REGULATORY ASSETS\nThe Company is subject to the provisions of SFAS 71 and has complied with its provisions. SFAS 71 provides, among other things, for the deferral of certain incurred costs that are probable of future recovery in rates. We monitor changes in market and regulatory conditions and consider the effects of such changes in assessing the continuing applicability of SFAS 71. Criteria that could give rise to discontinuation of the application of SFAS 71 include: (1) increasing competition which significantly restricts the Company's ability to charge prices which allow it to recover operating costs, earn a fair return on invested capital and recover the amortization of regulatory assets and (2) a significant change in the manner in which rates are set by the PUCO from cost-based regulation to some other form of regulation. Regulatory assets represent probable future revenues to the Company associated with certain incurred costs, which it will recover from customers through the rate-making process.\nEffective January 1, 1996, the Company adopted SFAS 121 which imposes stricter criteria for carrying regulatory assets than SFAS 71 by requiring that such assets be probable of recovery at each balance sheet date. The criteria under SFAS 121 for plant assets require such assets to be written down only if the book value exceeds the projected net future cash flows.\nRegulatory assets in the Balance Sheet are as follows:\n* Represent deferrals of operating expenses and carrying charges for Perry Unit 1 and Beaver Valley Unit 2 in 1987 and 1988 which are being amortized over the lives of the related property.\nAs of December 31, 1995, customer rates provide for recovery of all the above regulatory assets, except those related to the Rate Stabilization Program discussed below. The remaining recovery periods for all of the regulatory assets listed above range from 16 to 33 years.\n(B) RATE CASE\nIn April 1995, the Company and Cleveland Electric filed requests with the PUCO for price increases aggregating $119 million annually to be effective in 1996. The price increases are necessary to recover cost increases and amortization of certain costs deferred since 1992 pursuant to the Rate Stabilization Program. If their requests are approved, the Company and Cleveland Electric intend to freeze prices until at least 2002 with the expectation that increased sales and cost control measures will preclude the need for further price increases. If circumstances make it impossible to earn a fair return for Centerior Energy common stock share owners over time, the Company and Cleveland Electric would ask for a further increase, but only after taking all appropriate actions to make such a request unnecessary.\nIn November 1995, the PUCO Staff issued its report addressing the rate case. The Staff recommended that the PUCO grant the full $119 million price increase requested ($35 million for the Company and $84 million\n(Toledo Edison) (Toledo Edison)\nfor Cleveland Electric). However, the Staff also recommended that the price increase be conditioned upon the commitment by the Company and Cleveland Electric \"to a significant revaluation of their asset bases over some finite period of time.\"\nIn December 1995, the PUCO ordered an investigation into the financial conditions, rates and practices of the Company and Cleveland Electric to identify outcomes and remedies other than those routinely applied during the rate case process.\nIn late January 1996, the Staff proposed an incremental reduction (currently, an aggregate of $1.25 billion for the Company and Cleveland Electric) beyond the normal level in nuclear plant and regulatory assets within five years. The Staff proposed that the Company and Cleveland Electric have flexibility to determine how to achieve this incremental asset revaluation, but no additional price increases to recover the accelerated asset revaluation were proposed. Any incremental revaluation of assets would be for regulatory purposes and would cause prices and revenues after the five-year period to be lower than they otherwise would be in conjunction with any rate case following such revaluation. The Staff's asset revaluation proposal represents a substantial change in the form of rate-making traditionally followed by the PUCO and is inconsistent with the Ohio statutes that define the rate-making process. The PUCO is not bound by the recommendations of the Staff. A decision by the PUCO is anticipated in the second quarter of 1996.\n(C) ASSESSMENT OF POTENTIAL OUTCOMES\nWe continually assess the effects of competition and the changing industry and regulatory environment on operations, the Company's ability to recover regulatory assets and the Company's ability to continue application of SFAS 71. If, as a result of the pending rate case or other events, we determine that the Company no longer meets the criteria for SFAS 71, the Company would be required to record a before-tax charge to write off the regulatory assets shown above and evaluate whether the Company's property, plant and equipment should be written down. In the more likely event that only a portion of operations (such as nuclear operations) no longer meets the criteria of SFAS 71, a write-off would be limited to regulatory assets, if any, that are not reflected in the Company's cost-based prices established for the remaining regulated operations. In addition, we would be required to evaluate whether the changes in the competitive and regulatory environment which led to discontinuing the application of SFAS 71 to a portion of the Company's operations would also result in a write-down of the Company's property, plant and equipment pursuant to SFAS 121.\nWe believe application of SFAS 121 in that event will not result in a write-off of regulatory assets unless the PUCO denies recovery of such assets or if we conclude, as a result of the outcome of the Company's pending rate case or some other event, that recovery is not probable for some or all of the regulatory assets. Furthermore, a write-down under SFAS 121 of the Company's property, plant and equipment is not expected.\n(D) RATE STABILIZATION PROGRAM\nThe Rate Stabilization Program that the PUCO approved in October 1992 allowed the Company to defer and subsequently amortize and recover certain costs not currently recovered in rates and to accelerate amortization of certain benefits during the 1992-1995 period. Recovery of the deferrals will begin with the effective date of the PUCO's order in the pending rate case. The regulatory assets recorded included the deferral of post-in-service interest carrying charges, depreciation expense and property taxes on assets placed in service after February 29, 1988, the deferral of incremental expenses resulting from the adoption of SFAS 106 (see Note 9(b)), and the deferral of the operating expenses equivalent to an accumulated excess rent reserve for Beaver Valley Unit 2 (which resulted from the April 1992 refinancing of Secured Lease Obligation Bonds issued by a special-purpose corporation). The cost deferrals recorded in 1995, 1994 and 1993 pursuant to these provisions were $38 million, $43 million and $76 million, respectively. The regulatory accounting measures also provided for the accelerated amortization of certain unrestricted excess deferred tax and unrestricted investment tax credit balances and an excess interim spent fuel storage accrual balance for Davis-Besse. The total annual amount of such accelerated benefits was $18 million in 1995, 1994 and 1993.\n(E) PHASE-IN DEFERRALS\nIn 1993, upon completing a comprehensive study which led to our strategic plan, we concluded that projected revenues would not provide for recovery of deferrals recorded pursuant to a phase-in plan approved by the PUCO in 1989 and, consequently, that the deferrals would have to be written off. Such deferrals were scheduled to be recovered in 1994 through 1998. The total phase-in deferred operating expenses and carrying charges written off at December 31, 1993 by the Company were $55 million and $186 million, respectively (totaling $165 million after taxes).\n(Toledo Edison) (Toledo Edison)\n(8) FEDERAL INCOME TAX\nThe components of federal income tax expense (credit) recorded in the Income Statement were as follows:\nThe deferred federal income tax expense results from the temporary differences that arise from the different years certain expenses are recognized for tax purposes as opposed to financial reporting purposes. Such temporary differences affecting operating expenses relate principally to depreciation and deferred operating expenses whereas those affecting nonoperating income principally relate to deferred carrying charges and the 1993 write-offs.\nFederal income tax, computed by multiplying income before taxes by the 35% statutory rate, is reconciled to the amount of federal income tax recorded on the books as follows:\nThe Company joins in the filing of a consolidated federal income tax return with its affiliated companies. The method of tax allocation reflects the benefits and burdens realized by each company's participation in the consolidated tax return, approximating a separate return result for each company.\nFor tax reporting purposes, the Perry Unit 2 abandonment was recognized in 1994 and resulted in a $122 million loss with a corresponding $43 million reduction in federal income tax liability. Because of the alternative minimum tax (AMT), $25 million of the $43 million was realized in 1994. The remaining $18 million will not be realized until 1999.\nUnder SFAS 109, temporary differences and carryforwards resulted in deferred tax assets of $179 million and deferred tax liabilities of $752 million at December 31, 1995 and deferred tax assets of $178 million and deferred tax liabilities of $719 million at December 31, 1994. These are summarized as follows:\nFor tax purposes, net operating loss (NOL) carryforwards of approximately $125 million are available to reduce future taxable income and will expire in 2005 through 2009. The 35% tax effect of the NOLs is $44 million. Additionally, AMT credits of $80 million that may be carried forward indefinitely are available to reduce future tax.\n(9) RETIREMENT BENEFITS\n(A) RETIREMENT INCOME PLAN\nCenterior Energy sponsors jointly with its subsidiaries a noncontributing pension plan (Centerior Pension Plan) which covers all employee groups. The amount of retirement benefits generally depends upon the length of service. Under certain circumstances, benefits can begin as early as age 55. The funding policy is to comply with the Employee Retirement Income Security Act of 1974 guidelines.\nIn 1993, eligible employees were offered the VTP, an early retirement program. Operating expenses for Centerior Energy and its subsidiaries in 1993 included $205 million of pension plan accruals to cover enhanced VTP benefits offset by a credit of $81 million resulting from a settlement of pension obligations through lump sum payments to almost all the VTP retirees.\n(Toledo Edison) (Toledo Edison)\nPension and VTP costs (credits) for Centerior Energy and its subsidiaries for 1993 through 1995 were comprised of the following components:\nPension and VTP costs (credits) for the Company and its pro rata share of the Service Company's costs were $(3) million, $1 million and $53 million for 1995, 1994 and 1993, respectively.\nThe following table presents a reconciliation of the funded status of the Centerior Pension Plan. The Company's share of the Centerior Pension Plan's total projected benefit obligation approximates 30%.\nA September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995, the settlement (discount) rate and long-term rate of return on plan assets assumptions were 8% and 11%, respectively. The long-term rate of annual compensation increase assumption was 3.5% in 1996 and 1997 and 4% thereafter. At December 31, 1994, the settlement rate and long-term rate of return on plan assets assumptions were 8.5% and 10%, respectively. The long-term rate of annual compensation increase assumption was 3.5% for 1995 and 1996 and 4% thereafter. At December 31, 1995 and 1994, the Company's net accrued pension liability included in Retirement Benefits in the Balance Sheet was $64 million and $66 million, respectively.\nPlan assets consist primarily of investments in common stock, bonds, guaranteed investment contracts, cash equivalent securities and real estate.\n(B) OTHER POSTRETIREMENT BENEFITS\nCenterior Energy sponsors jointly with its subsidiaries a postretirement benefit plan which provides all employee groups certain health care, death and other postretirement benefits other than pensions. The plan is contributory, with retiree contributions adjusted annually. The plan is not funded. The Company adopted SFAS 106, the accounting standard for postretirement benefits other than pensions, effective January 1, 1993. The standard requires the accrual of the expected costs of such benefits during the employees' years of service. Prior to 1993, the costs of these benefits were expensed as paid, which was consistent with rate-making practices.\nThe components of the total postretirement benefit costs for 1993 through 1995 were as follows:\nThese amounts included costs for the Company and its pro rata share of the Service Company's costs.\nIn 1995, 1994 and 1993, the Company deferred incremental SFAS 106 expenses (in excess of the amounts paid) of $1 million, $2 million and $37 million, respectively, pursuant to a provision of the Rate Stabilization Program. See Note 7(d).\n(Toledo Edison) (Toledo Edison)\nThe accumulated postretirement benefit obligation and accrued postretirement benefit cost for the Company and its share of the Service Company's obligation are as follows:\nThe Balance Sheet classification of Retirement Benefits at December 31, 1995 and 1994 includes only the Company's accrued postretirement benefit cost of $39 million and $37 million, respectively, and excludes the Service Company's portion since the Service Company's total accrued cost is carried on its books.\nA September 30 measurement date was used for 1995 and 1994 reporting. At December 31, 1995 and 1994, the settlement rate and the long-term rate of annual compensation increase assumptions were the same as those discussed for pension reporting in Note 9(a). At December 31, 1995, the assumed annual health care cost trend rates (applicable to gross eligible charges) were 8% for medical and 7.5% for dental in 1996. Both rates reduce gradually to a fixed rate of 4.75% by 2003. Elements of the obligation affected by contribution caps are significantly less sensitive to the health care cost trend rate than other elements. If the assumed health care cost trend rates were increased by one percentage point in each future year, the accumulated postretirement benefit obligation as of December 31, 1995 would increase by $3 million and the aggregate of the service and interest cost components of the annual postretirement benefit cost would increase by $0.3 million.\n(10) GUARANTEES\nThe Company has guaranteed certain loan and lease obligations of a coal supplier under a long-term coal supply contract. At December 31, 1995, the principal amount of the loan and lease obligations guaranteed by the Company was $14 million. The prices under the contract which includes certain minimum payments are sufficient to satisfy the loan and lease obligations and mine closing costs over the life of the contract. If the contract is terminated early for any reason, the Company would attempt to reduce the termination charges and would ask the PUCO to allow recovery of such charges from customers through the fuel factor.\n(11) CAPITALIZATION\n(A) CAPITAL STOCK TRANSACTIONS\nPreferred stock shares retired during the three years ended December 31, 1995 are listed in the following table.\n(B) EQUITY DISTRIBUTION RESTRICTIONS\nFederal law prohibits the Company from paying dividends out of capital accounts. However, the Company may pay dividends out of appropriated retained earnings and current earnings. At December 31, 1995, the Company had $183 million of appropriated retained earnings for the payment of preferred stock dividends. The Company is prohibited from paying a common stock dividend by a provision in its mortgage that essentially requires such dividends to be paid out of the total balance of retained earnings, which currently is a deficit.\n(C) PREFERRED AND PREFERENCE STOCK\nAmounts to be paid for preferred stock which must be redeemed during the next five years are $1.665 million in each year 1996 through 1999 only.\nThe annual preferred stock mandatory redemption provisions are as follows:\nThe annualized preferred dividend requirement at December 31, 1995 was $17 million.\nThe preferred dividend rates on the Company's Series A and B fluctuate based on prevailing interest rates and market conditions. The dividend rates for these issues averaged 7.75% and 8.58%, respectively, in 1995.\nPreference stock authorized for the Company is 5,000,000 shares with a $25 par value. No preference shares are currently outstanding.\nWith respect to dividend and liquidation rights, the Company's preferred stock is prior to its preference stock and common stock, and its preference stock is prior to its common stock.\n(Toledo Edison) (Toledo Edison)\n(D) LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS\nLong-term debt, less current maturities, was as follows:\n* Secured by first mortgage bonds. ** Secured by subordinated mortgage collateral. Long-term debt matures during the next five years as follows: $56 million in 1996, $40 million in 1997, $39 million in 1998, $119 million in 1999 and $31 million in 2000. The Company's mortgage constitutes a direct first lien on substantially all property owned and franchises held by the Company. Excluded from the lien, among other things, are cash, securities, accounts receivable, fuel, supplies and automotive equipment. Certain credit agreements of the Company contain covenants relating to fixed charge coverage ratios and limitations on secured financing other than through first mortgage bonds or certain other transactions. In June 1995, the Company and Cleveland Electric replaced letters of credit in connection with the sale and leaseback of Beaver Valley Unit 2 that were due to expire with new letters of credit expiring in June 1999. The letters of credit are in an aggregate amount of approximately $225 million and are secured by first mortgage bonds of the Company and Cleveland Electric in the proportion of 60% and 40%, respectively. At December 31, 1995, the Company had outstanding $52 million of bank loans and notes secured by subordinated mortgage collateral.\n(12) SHORT-TERM BORROWING ARRANGEMENTS\nCenterior Energy has a $125 million revolving credit facility through May 1996. Centerior Energy and the Service Company may borrow under the facility, with all borrowings jointly and severally guaranteed by the Company and Cleveland Electric. Centerior Energy plans to transfer any of its borrowed funds to the Company and Cleveland Electric. The credit agreement is secured with first mortgage bonds of the Company and Cleveland Electric in the proportion of 60% and 40%, respectively. The banks' fee is 0.625% per annum payable quarterly in addition to interest on any borrowings. There were no borrowings under the facility at December 31, 1995. Also, the Company and Cleveland Electric may borrow from each other on a short-term basis. At December 31, 1995, the Company had total short-term borrowings of $21 million from its affiliates with a weighted average interest rate of 6.25%.\n(13) FINANCIAL INSTRUMENTS\nThe estimated fair values at December 31, 1995 and 1994 of financial instruments that do not approximate their carrying amounts in the Balance Sheet are as follows:\nNoncash investments in the Nuclear Plant Decommissioning Trusts are summarized in the following table.\nThe fair value of these trusts is estimated based on the quoted market prices for the investment securities. As a result of adopting the new accounting standard for certain investments in debt and equity securities, SFAS 115, in\n(Toledo Edison) (Toledo Edison)\n1994, the carrying amount of these trusts approximates fair value. The fair value of the Company's preferred stock, with mandatory redemption provisions, and long-term debt is estimated based on the quoted market prices for the respective or similar issues or on the basis of the discounted value of future cash flows. The discounted value used current dividend or interest rates (or other appropriate rates) for similar issues and loans with the same remaining maturities.\nThe estimated fair values of all other financial instruments approximate their carrying amounts in the Balance Sheet at December 31, 1995 and 1994 because of their short-term nature.\n(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a tabulation of the unaudited quarterly results of operations for the two years ended December 31, 1995.\n(15) PENDING MERGER OF THE COMPANY INTO CLEVELAND ELECTRIC\nIn March 1994, Centerior Energy announced a plan to merge the Company into Cleveland Electric. Since the Company and Cleveland Electric affiliated in 1986, efforts have been made to consolidate operations and administration as much as possible to achieve maximum cost savings.\nVarious aspects of the merger are subject to the approval of the FERC and other regulatory authorities. The FERC has deferred action on the merger application until the merits of the open access transmission tariffs proposed by the Company and Cleveland Electric are addressed in hearings. The PUCO and the Pennsylvania Public Utility Commission have approved the merger. NRC action on the request by the Company and Cleveland Electric for authorization to transfer certain NRC licenses to the merged entity is not expected until approval has been obtained from the FERC.\nIn June 1995, share owners of the Company's preferred stock approved the merger and share owners of Cleveland Electric's preferred stock approved the authorization of additional shares of preferred stock. When the merger becomes effective, share owners of the Company's preferred stock will exchange their shares for preferred stock shares of Cleveland Electric having substantially the same terms. Debt holders of the merging companies will become debt holders of Cleveland Electric.\nFor the merging companies, the combined pro forma operating revenues were $2.516 billion, $2.422 billion and $2.475 billion and the combined pro forma net income (loss) was $281 million, $268 million and $(876) million for the years 1995, 1994 and 1993, respectively. The pro forma data is based on accounting for the merger on a method similar to a pooling of interests. The pro forma data is not necessarily indicative of the results of operations which would have been reported had the merger been in effect during those years or which may be reported in the future. The pro forma data should be read in conjunction with the audited financial statements of both the Company and Cleveland Electric.\n(Toledo Edison) (Toledo Edison)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Share Owners and Board of Directors of The Toledo Edison Company:\nWe have audited the accompanying balance sheet and statement of preferred stock of The Toledo Edison Company (a wholly owned subsidiary of Centerior Energy Corporation) 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 and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Toledo Edison 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 further in Note 9, a change was made in the method of accounting for postretirement benefits other than pensions in 1993.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of The Toledo Edison Company listed in the Index to 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.\nArthur Andersen LLP\nCleveland, Ohio February 21, 1996\n(Toledo Edison) (Toledo Edison)\nFINANCIAL AND STATISTICAL REVIEW\nOPERATING REVENUES (millions of dollars)\n- --------------------------------------------------------------------------------\nOPERATING EXPENSES (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars)\n- --------------------------------------------------------------------------------\nINCOME (LOSS) (millions of dollars)\n- --------------------------------------------------------------------------------\n(a) Includes early retirement program expenses and other charges of $107 million. (b) Includes write-off of phase-in deferrals of $241 million, consisting of $55 million of deferred operating expenses and $186 million of deferred carrying charges.\n(Toledo Edison) (Toledo Edison)\nThe Toledo Edison Company\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCAPITALIZATION (millions of dollars & %)\n- --------------------------------------------------------------------------------\n(c) A change in accounting for nuclear plant depreciation was adopted, changing from the units-of-production method to the straight-line method at a 2.5% rate.\n(d) Includes write-off of Perry Unit 2 of $232 million.\n(Toledo Edison) (Toledo Edison)\nSchedules other than those listed above are omitted for the reason that they are not required or are not applicable.\nS-1\nCENTERIOR ENERGY CORPORATION\nSCHEDULE II - VALUATION AND QUALIFIYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(THOUSANDS OF DOLLARS)\n(a) Includes a provision and corresponding write-off of uncollectible accounts of $10,024,000, $4,695,000 and $4,550,000 in 1995, 1994 and 1993, respectively, relating to customers which qualify for the PUCO mandated Percentage of Income Payment Plan (PIPP). Such uncollectible accounts are recovered through a separate PUCO approved surcharge tariff.\n(b) Includes amounts for collection of accounts previously written off and deferral of PIPP uncollectibles in excess of the amounts included in the last base rate cases. The amounts deferred for future recovery were $1,716,000, $2,382,000 and $971,000 in 1995, 1994 and 1993, respectively.\n(c) Uncollectible accounts written off.\n(d) Write-off of Perry Unit 2 investment.\nS-2\nTHE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(THOUSANDS OF DOLLARS)\n(a) Includes a provision and corresponding write-off of uncollectible accounts of $6,584,000, $2,499,000 and $2,447,000 in 1995, 1994 and 1993, respectively, relating to customers which qualify for the PUCO mandated Percentage of Income Payment Plan (PIPP). Such uncollectible accounts are recovered through a separate PUCO approved surcharge amount.\n(b) Includes amounts for collection of accounts previously written off and deferral of PIPP uncollectibles in excess of the amount included in the last base rate case. The amounts deferred for future recovery were $1,273,000, $1,971,000 and $507,000 in 1995, 1994 and 1993, respectively.\n(c) Uncollectible accounts written off.\n(d) Write-off of Perry Unit 2 investment.\nS-3\nTHE TOLEDO EDISON COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(THOUSANDS OF DOLLARS)\n(a) Includes a provision and corresponding write-off of uncollectible accounts of $3,440,000, $2,196,000 and $2,103,000 in 1995, 1994 and 1993, respectively, relating to customers which qualify for the PUCO mandated Percentage of Income Payment Plan (PIPP). Such uncollectible accounts are recovered through a separate PUCO approved surcharge tariff.\n(b) Includes amounts for collection of accounts previously written off and deferral of PIPP uncollectibles in excess of the amount included in the last base rate case. The amounts deferred for future recovery were $443,000, $411,000 and $464,000 in 1995, 1994 and 1993, respectively.\n(c) Uncollectible accounts written off.\n(d) Write-off of Perry Unit 2 investment.\nS-4\nTHE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARIES AND THE TOLEDO EDISON COMPANY COMBINED PRO FORMA CONDENSED FINANCIAL STATEMENTS -------------------------------------------------\nThe following pro forma condensed balance sheets and income statements give effect to the agreement between Cleveland Electric and Toledo Edison to merge Toledo Edison into Cleveland Electric. These statements are unaudited and based on accounting for the merger on a method similar to a pooling of interests. These statements combine the two companies' historical balance sheets at December 31, 1995 and December 31, 1994 and their historical income statements for each of the three years ended December 31, 1995.\nThe following pro forma data is not necessarily indicative of the results of operations or the financial condition which would have been reported had the merger been in effect during those periods or which may be reported in the future. The statements should be read in conjunction with the accompanying notes and with the audited financial statements of both Cleveland Electric and Toledo Edison.\nP-1\nP-2\nP-3\nNOTES TO COMBINED PRO FORMA CONDENSED BALANCE SHEETS AND INCOME STATEMENTS\n(Unaudited)\nThe Pro Forma Financial Statements include the following adjustments:\n(A) Elimination of intercompany accounts and notes receivable and accounts and notes payable. (B) Reclassification of prepaid pension costs. (C) Elimination of intercompany operating revenues and operating expenses. (D) Elimination of intercompany working capital transactions. (E) Elimination of intercompany interest income and interest expense. (R) Rounding adjustments.\nP-4\nEXHIBIT INDEX -------------\nThe exhibits designated with an asterisk (*) are filed herewith. The exhibits not so designated have previously been filed with the SEC in the file indicated in parenthesis following the description of such exhibits and are incorporated herein by reference. An exhibit designated with a pound sign (#) is a management contract or compensatory plan or arrangement.\nCOMMON EXHIBITS ---------------\n(The following documents are exhibits to the reports of Centerior Energy, Cleveland Electric and Toledo Edison.)\nE-1\nE-2\nE-3\nE-4\nE-5\nCENTERIOR ENERGY EXHIBITS -------------------------\nCLEVELAND ELECTRIC EXHIBITS ---------------------------\nE-6\nE-7\nE-8\nTOLEDO EDISON EXHIBITS ----------------------\nE-9\nE-10\nDecember 31, 1995.\nPursuant to Paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, the Registrants have not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of the applicable Registrant and its subsidiaries on a consolidated basis, but each hereby agrees to furnish to the Securities and Exchange Commission on request any such instruments.\nPursuant to Rule 14a-3(b)(10) under the Securities Exchange Act of 1934, copies of exhibits filed by the Registrants with this Form 10-K will be furnished by the Registrants to share owners upon written request and upon receipt in advance of the aggregate fee for preparation of such exhibits at a rate of $.25 per page, plus any postage or shipping expenses which would be incurred by the Registrants.\nE-11\nCENTERIOR EXHIBITS","section_15":""}
{"filename":"904974_1995.txt","cik":"904974","year":"1995","section_1":"ITEM 1. BUSINESS\nOWNERSHIP\nGreat Northern Insured Annuity Corporation (GNA or the Company) was incorporated as a stock life insurance company organized under the laws of the State of Washington on June 4, 1980 and began writing business pursuant to licensing on October 15, 1980. On June 30, 1983, The Weyerhaeuser Company (Weyerhaeuser) acquired a controlling interest in GNA. In October 1984, GNA Corporation, a stock holding company, was formed to hold the Company's stock. Weyerhaeuser exchanged its shares of GNA stock for shares of GNA Corporation.\nPursuant to a Stock Purchase Agreement dated January 5, 1993, by and between Weyerhaeuser and General Electric Capital Corporation (GE Capital), 100% of the outstanding capital stock of GNA Corporation was sold to GE Capital effective April 1, 1993.\nEffective July 14, 1993, GE Capital acquired 100% of the outstanding capital stock of United Pacific Life Insurance Company (United Pacific Life). GE Capital transferred controlling ownership of United Pacific Life to GNA. Subsequently, United Pacific Life's name was changed to General Electric Capital Assurance Company (GE Capital Assurance). GE Capital Assurance, a Delaware life insurer, is licensed in the District of Columbia, and all states except Maine and New York.\nOn February 1, 1990, GNA acquired 100% of the outstanding stock of First GNA Life Insurance Company of New York (First GNA). Subsequent to the acquisition of United Pacific Life, GNA merged First GNA with United Pacific Reliance Life Insurance Company of New York, a wholly owned subsidiary of United Pacific Life. The merged company is 48% owned by GNA and 52% by GE Capital Assurance. Effective February 1, 1996, First GNA's name was changed to GE Capital Life Assurance Company of New York (GE Capital Life). GE Capital Life issues deferred and immediate annuities and life insurance in the state of New York.\nEffective October 1, 1995, GNA was party to a reorganization involving GNA Corporation and certain of its life insurance company subsidiaries (herein referred to as the Reorganization). As part of the Reorganization, GNA became a wholly-owned subsidiary of GE Capital Assurance, and GE Capital Assurance became a wholly-owned subsidiary of GNA Corporation. Previously, all of GE Capital Assurance's voting common stock was owned by GNA. The Reorganization allows all life insurance company subsidiaries of GNA Corporation to file a consolidated federal tax return.\nMARKETING\nGNA is licensed in the District of Columbia and all states except Maine, New Hampshire, New York and Vermont. GNA markets fixed-rate deferred annuities, immediate annuities and variable deferred annuities primarily through banks, thrifts and other financial institutions.\nDeferred Fixed-Rate Annuities. The predominant form of deferred annuities require either single premium or flexible premium payments and have a minimum annual guaranteed crediting rate. After the initial guarantee period, the crediting rate may be changed periodically. The policy owner is permitted to withdraw all or part of the premium paid plus interest credited, less a surrender charge for withdrawals during the initial penalty period of one to eight years. The surrender charge is initially 5% to 8% of the contract value and decreases over the penalty period. Some deferred annuities provide for penalty-free partial withdrawals of the accumulated interest credited or up to 10% annually of the accumulation value. GNA also markets a Modified Guaranteed Annuity Contract (MGA) that offers ten different guarantee periods and allows investors to increase earnings potential by combining different interest rates under one product. Early withdrawals under the MGA are subject to a market value adjustment. In 1995, the Company issued $709.5 million in deferred annuities. At December 31, 1995, deferred annuities comprised $5,452.5 million of total liabilities for future annuity and contract benefits.\nImmediate Annuities. The Company's immediate annuities are designed to provide a series of periodic payments for a fixed length of time or for life, according to the annuitant's choice at the time of issue. Once the payments have begun, the amount, frequency and length of time for which they are payable are fixed. A primary form of immediate annuities, the structured settlement annuity, is usually sold as part of a settlement resulting from a personal injury or wrongful death claim to provide scheduled payments to an injured person or his dependents. Structured settlement annuities are generally long- term and cannot be surrendered. In 1995, the Company issued $276.5 million in immediate annuities. At December 31, 1995, immediate annuities comprised $461.5 million of total liabilities for future annuity and contract benefits.\nDeferred Variable Annuities. GNA markets a Deferred Variable Annuity that offers customers a different degree of potential for return by offering eighteen investment options: eight different mutual fund portfolios and a fixed MGA account with ten different guaranteed interest rate periods. Performance of the mutual fund portfolios selected determines the variable account value. Customers may withdraw all or a portion of their account value, subject to certain charges for early withdrawals. The withdrawal charge is initially 5% and decreases over the penalty period. Customers may also make penalty-free partial withdrawals of up to 10% annually of their accumulated account value. Withdrawals from the fixed MGA account guarantee periods are also subject to market value adjustments. GNA deducts annual charges for mortality risk and administration costs equal to 1.4% of the account balance. In 1995, the Company issued $17.9 million in variable deferred annuities.\nCOMPETITION\nThe Company is engaged in a business that is highly competitive because of the large number of stock and mutual life insurance companies and other entities marketing insurance products. There are approximately 1,700 stock, mutual and other types of insurers in the life insurance business in the United States, a significant number of which are substantially larger than GNA. As of December 31, 1995, the Company has 482 employees. In addition, the Company has 230 retail sales agents selling the Company's products through an affiliated company, GNA Insurance Services, Inc.\nA.M. Best assigned to GNA an A + (Superior) rating. Duff & Phelps reaffirmed the Company's AA (Very High) rating, and Standard & Poor's reaffirmed an AA (Excellent) rating based on the Company's high claims paying ability and excellent asset quality.\nGOVERNMENT REGULATION\nGNA is subject to the laws of the State of Washington governing insurance companies and to the regulations of the Washington Insurance Department. In addition, GNA is subject to regulation under the insurance laws of other jurisdictions in which the Company operates. Regulation by other supervisory agencies includes licensing to transact business, overseeing trade practices, licensing agents, approving policy forms, establishing reserve requirements, fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values, prescribing the form and content of required financial statements and regulating the type and amounts of investments permitted. The Company's books and accounts are subject to review by each Insurance Department and other supervisory agencies at all times, and GNA files annual statements with these agencies. A full examination of the Company's operations is conducted periodically by various Insurance Departments and may include the participation of the insurance departments of other states in which GNA conducts business. Recent examinations have not resulted in significant findings.\nIn addition, many states regulate affiliated groups of insurers (including GNA) under insurance holding company legislation. Under such laws, intercompany transactions, including transfers of assets and dividend payments from insurance subsidiaries, may be subject to prior notice or approval, depending on the size of the transfers and payments in relation to the financial positions of the companies involved. Due to the Company's volume of California business, GNA is considered a California commercially domiciled insurer under California insurance holding company law.\nThe National Association of Insurance Commissioners (NAIC) has adopted Risk- Based Capital (RBC) requirements to evaluate the adequacy of statutory capital and surplus in relation to risks associated with: (i) asset quality, (ii) insurance, risk (iii) interest rate risk, and (iv) other business factors. The RBC formula is designed as an early warning tool for the states to identify possible under-capitalized companies for the purpose of initiating regulatory action. In the course of its operations, the Company monitors the level of its RBC and it exceeds the minimum required levels.\nUnder insurance guaranty fund laws in most states, insurers doing business therein can be assessed (up to prescribed limits) for policyholder losses incurred by insolvent companies. GNA has estimated assessments related to known insolvencies, primarily Executive Life Insurance Company, and has recorded a liability of $38.2 million at December 31, 1995 related to this estimated liability. The amount of any future assessments related to future insolvencies under these laws, however, cannot be reasonably estimated. Most of these laws do provide that an assessment may be excused or deferred if it would threaten an insurer's own financial strength.\nAlthough the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include employee benefit regulation, removal of barriers preventing banks from engaging in the insurance business, tax law changes affecting the taxation of insurance companies and the tax treatment of insurance products and the taxation impact on the relative desirability of various investment vehicles.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases office space in Seattle, Washington. The Company is reimbursed by its subsidiaries and affiliates for rent based on direct and indirect allocation methods. All owned properties were acquired through foreclosure and are held for sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere is no material pending litigation to which the Company is a party or of which any of the Company's property is the subject, and there are no legal proceedings contemplated by any governmental authorities against GNA of which the Company has any knowledge.\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 common stock of the Company is owned entirely by GE Capital Assurance and, therefore, there is no trading market in such stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the financial statements and notes thereto included in this Form 10-K.\nSELECTED FINANCIAL DATA (DOLLARS IN MILLIONS)\n- -------- (1) Unaudited pro forma results reflect the Reorganization as if it had occurred at the beginning of the period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nGNA derives substantially all its income from earnings on investments offset by interest credited to policyholders of predominantly deferred and immediate annuities, operating expenses, acquisition costs and taxes. Funds received for the purchase of immediate annuities with life contingencies, including options elected under annuity contracts, are reported as premium income. Other income is primarily surrender fees on deferred annuity policies.\n1995 Compared to 1994\nEffective October 1, 1995, GNA was party to a reorganization (the Reorganization) in which GNA became a wholly-owned subsidiary of GE Capital Assurance and GE Capital Assurance became a wholly-owned subsidiary of GNA Corporation. Previously, all of GE Capital Assurance's voting stock was owned by GNA; therefore, GNA's results of operations include GE Capital Assurance and subsidiaries' results for 9 months of 1995 and 12 months of 1994.\nNet investment income decreased $53.1 million to $784.7 million. This is primarily related to the Reorganization described above, which reduced earning assets by $6,506.8 million. As a result of the Reorganization, net investment income excluded GE Capital Assurance and subsidiaries' fourth quarter net investment income of $114.7 million. The remaining $61.6 million increase is primarily attributable to higher invested assets and reinvestment of net investment proceeds in higher yielding securities.\nNet realized investment gains (losses)--As part of the Company's asset\/liability risk management, net realized investment losses were $14.4 million during 1995, compared to a $6.3 million gain in 1994.\nPremiums increased $59.5 million to $177.1 million. This increase primarily relates to increased sales of GNA's structured settlement product of $67.3 million, introduced in June of 1994, offset by the effects of the Reorganization of $7.8 million.\nInterest credited on policyholder deposits decreased $27.2 million to $462.2 million. The decrease was primarily related to the Reorganization as interest crediting rates remained relatively consistent with 1994.\nChange in policy reserves increased $54.1 million to $174.5 million. Policy reserves related to life contingent products increased primarily from new structured settlement premiums and growth in annuitizations of life contingent products.\nAnnuity and surrender benefits decreased $24.2 million to $136.7 million. Offsetting the effects of the Reorganization, which decreased benefits by $40.8 million, annuity and surrender benefits increased by $16.6 million. This increase is due to structured settlements benefits and increased tax free exchanges.\nCommissions decreased $9.9 million to $42.9 million. This decrease is primarily due to decreased product sales of $125.1 million to $987.4 million.\nGeneral expenses increased $24.4 million to $71.2 million. This increase is primarily related to an accrual for guaranty association assessments of $20.4 million recorded in the fourth quarter of 1995. These assessments levied by various state regulators help to ensure payments to policyholders of impaired or insolvent companies.\nAmortization of intangibles is a result of the GNA and GE Capital Assurance acquisitions. The Company established goodwill and present value of future profits (PVFP) assets in connection with the acquisitions. For the years ended December 31, 1995 and 1994, goodwill amortization was $4.8 million and $7.8 million, respectively. The decrease is primarily related to the fact that after the Reorganization, the goodwill balance of GE Capital Assurance was dividended out and the related amortization was not included in GNA's operations for the fourth quarter of 1995.\nPVFP represents the present value of estimated gross profits embedded in acquired contracts, and is estimated using actuarial methods and assumptions related to future investment income yields, interest credited rates, contract maintenance expenses, persistency rates and surrender fees. Amortization will be based on periodic estimates of realized and remaining gross profits. Net PVFP amortization for the years ended December 31, 1995 and 1994 was $52.4 million and $50.0 million, respectively.\nIncrease in deferred acquisition costs decreased $20.2 million to $42.9 million primarily as a result of lower commissions and an increase of $10.3 million in amortization of the related balance sheet account.\nProvision for income taxes. The effective tax rate for 1995 decreased from 41.5% to 39.5% primarily due to lower state taxes caused by the Reorganization.\nMinority interest decreased $4.3 million to $11.2 million primarily due to the fact that in the fourth quarter of 1995, after the effects of the Reorganization, there was no longer minority interest recorded in GNA's financial statements. The minority interest previously recorded represented GNA Corporation's proportional ownership of GE Capital Assurance.\n1994 Compared to 1993\nNet investment income increased $258.0 million to $837.8 million. This change is attributable to additional investment income from GE Capital Assurance during 1994, as well as growth in earning assets from $12,264.2 million to $12,828.2 million. Overall investment yields have also increased as interest rates continued to rise throughout the year.\nPremiums increased $91.6 million to $117.6 million. This growth is attributable to the introduction of GNA's structured settlement product in the second quarter of 1994 and an increase in annuitization to life contingent products from single premium deferred annuity products.\nInterest credited on policyholder deposits increased $77.5 million to $489.4 million. Of the increase, GE Capital Assurance accounted for $91.0 million which was partially offset by lower interest crediting rates on policyholder deposits.\nChange in policy reserves increased $95.7 million to $120.4 million. Policy reserves related to life contingent products increased primarily from new structured settlement premiums and growth in annuitizations of life contingent products.\nAnnuity and surrender benefits increased $88.6 million to $160.9 million due to the acquisition of GE Capital Assurance and its related life contingent product mix. The mature block of business in GE Capital Assurance results in higher benefit payments.\nCommissions increased $25.0 million to $52.8 million. This increase is a result of sales volumes increasing $418.6 million to $1,112.5 million during 1994.\nGeneral expenses for 1994 were essentially the same as 1993. The additional expense volume of GE Capital Assurance was mitigated by economies of scale which maintained general expense levels.\nAmortization of intangibles is a result of the GNA and GE Capital Assurance acquisitions. The Company established goodwill of $150.6 million and present value of future profits (PVFP) of $381.6 million in connection with the acquisitions. For the years ended December 31, 1994 and 1993, goodwill amortization was $7.8 million and $2.0 million, respectively. The increase in goodwill amortization for the year ended December 31, 1994 results from the inclusion of GE Capital Assurance for twelve months compared to six months in 1993, and the adjustments for the impact of certain tax elections related to the acquisition of GNA.\nNet PVFP amortization for the years ended December 31, 1994 and 1993 was $50.0 million and $17.7 million, respectively. Amortization of PVFP has increased due to inclusion of twelve months of amortization in 1994 compared to nine months in 1993 for GNA and five and one-half months for GE Capital Assurance.\nIncrease in deferred acquisition costs increased $27.0 million to $63.1 million due to increased sales volumes and related commissions.\nProvision for income taxes. The effective tax rate for 1994 increased from 28.6% to 41.5% primarily due to the non-deductible effects of goodwill amortization and the effects in 1993 of the corporate tax rate change from 34% to 35%.\nMinority interest in net income increased $9.8 million to $15.5 million due to the full year accrual of a cumulative dividend on GE Capital Assurance's preferred stock. GE Capital Assurance's preferred stock was issued September 29, 1993 to GNA Corporation.\nINVESTMENTS\nFixed Maturities. The Company's assets must be invested in accordance with requirements of applicable state laws and regulations regarding the nature and quality of investments that may be made by life insurance companies and the percentage of its assets that may be held in certain types of investments. At December 31, 1995, approximately 44.7% of the fixed maturities were in corporate issues and U.S. Treasuries with expected maturities within five years and another 32.8% in securities backed by residential mortgages. At December 31, 1995, the Company did not hold any fixed maturity securities, other than securities issued or guaranteed by the U.S. government, which exceeded 10% of shareholder's interest before net unrealized investment gains (losses). Approximately 23.5%, 20% and 8.4% of the portfolio were concentrated in the manufacturing, financial and utility industries, respectively. As of December 31, 1995, 1.5% of the Company's portfolio was rated below investment grade and no bonds were in default as to interest and principal.\nAll of the Company's fixed maturities were designated as available-for-sale at December 31, 1995 and 1994. Accordingly, such investments were reported at fair value. Unrealized gains and losses, net of the effects of present value of future profits, deferred acquisition costs, minority interest and deferred taxes, have been included in shareholder's interest as of December 31, 1995 and 1994. Shareholder's interest included net unrealized gains of $29.9 million and net unrealized losses of $528.8 million at December 31, 1995 and 1994, respectively, a difference primarily due to an increase in the fair value of fixed maturities, principally resulting from lower interest rates and the effects of the Reorganization.\nMortgage-backed securities are subject to risks associated with variable prepayments. This may result in these securities having a different actual maturity than planned at the time of purchase. Prepayment speeds are generally dependent on the relative sensitivity of the underlying mortgages backing the assets to changing interest rates and the repayment priority of the securities in the overall securitization structure. Under certain circumstances, the Company has purchased higher risk securities which do not compromise the safety of the general portfolio, but rather serve to mitigate the Company's risk exposure to changing interest rates. There are negligible default risks in the mortgage-backed securities portfolio as a whole, as 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.\nMortgage Loans. At December 31, 1995, the mortgage loan portfolio consisted of 1,161 mortgage loans on commercial real estate properties, 47% of which are located in California. The loans, which were originated through a network of mortgage bankers, were made only on completed, leased properties and have loan- to-value ratios at the date of origination of less than 75%. GNA does not engage in construction lending or land loans. In conjunction with the GE Capital acquisition of GNA, loans and real estate with a book value of $47.4 million were sold to Weyerhaeuser Company. At December 31, 1995, four mortgage loans representing $3.9 million were in default as to interest and principal and ten mortgage loans totaling $8.5 million have been restructured.\nReal Estate Owned. All real estate holdings totaling $1.1 million are a result of mortgage loan foreclosure. In 1995, GNA acquired one real estate property through foreclosure. Properties are currently reported at net realizable value. Real estate owned decreased in 1995 by $5.2 million due to the sale of three properties. At December 31, 1995, the Company holds two properties for which management intends to market in an orderly fashion to maximize their value.\nOther Invested Assets. The Company's other invested assets consist of GNA's equity investment in GE Capital Life of $123.6 million and investments in mutual fund portfolios offered in conjunction with the Deferred Variable Annuity of $40.4 million.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's liquidity requirements are met by funds from operations and investment activity. Premiums and policyholder deposits are invested in assets that generally have durations similar to the Company's liabilities. Funds from investment activity included principal and interest payments from the bond and mortgage portfolio as well as sales, calls and maturities of certain securities. As of December 31, 1995, investments subject to certain call provisions totaled $156.1 million; and mortgage-backed securities subject to prepayment risk totaled $1,661.6 million.\nThe Company is restricted by Washington State as to the amount of dividends it may pay within a given calendar year to its parent without regulatory consent. That restriction is the greater of statutory net gain from operations for the year or 10% of the statutory surplus at the end of the year, subject to a maximum equal to statutory earned surplus. As of December 31, 1995, approximately $78.3 million was available for dividend payments in 1996.\nNEW ACCOUNTING STANDARDS\nThe Company adopted the Statement of Financial Accounting Standards (SFAS) No. 114, Accounting for Creditors for Impairment of a Loan, and the related SFAS No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures, on January 1, 1995. The adoption of these Statements had no effect on earnings or financial position as the same level of allowance for losses was appropriate under both the previous accounting policy and the newly adopted policy.\nSFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, requires, among other things, that certain long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recognized if, upon such review, the sum of expected future cash flows is less than the carrying amount of the asset. An impairment loss is measured based on the difference between the carrying amount of the asset and its fair value. The effect of adopting SFAS No. 121 is not expected to be material. Adoption is required by no later than the first quarter of 1996.\nSFAS No. 122, Accounting for Mortgage Servicing Rights, requires that rights to serve mortgage loans to be recognized when the underlying loans are sold. The standard also requires that capitalized mortgage servicing rights be assessed for impairment by individual risk stratum based on the fair value of such rights. The effect of adopting SFAS No. 122 is not expected to be material. Adoption is required by no later than the first quarter of 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Great Northern Insured Annuity Corporation:\nWe have audited the accompanying consolidated balance sheets of Great Northern Insured Annuity Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholder's interest, and cash flows for the years then ended and the nine-month period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Great Northern Insured Annuity 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 and the nine-month period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in note 1 to the consolidated financial statements, effective April 1, 1993, General Electric Capital Corporation acquired all of the outstanding stock of the Company's parent, GNA Corporation, in a business combination accounted for as a purchase. As a result of the acquisition, the consolidated financial information for the periods after the acquisition is presented on a different cost basis than that for the period before the acquisition and, therefore, is not comparable.\nKPMG Peat Marwick LLP\nSeattle, Washington January 19, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Great Northern Insured Annuity Corporation:\nWe have audited the accompanying consolidated statements of income, shareholder's interest and cash flows of Great Northern Insured Annuity Corporation (a Washington Corporation) and subsidiaries for the three months ended March 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 on the financial statements. An audit also includes 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 Great Northern Insured Annuity Corporation and subsidiaries' operations and their cash flows for the three months ended and March 31, 1993 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nSeattle, Washington July 14, 1993\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\n(DOLLAR AMOUNTS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(DOLLAR AMOUNTS IN MILLIONS)\nSee accompanying notes to consolidated financial statements.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDER'S INTEREST\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(DOLLAR AMOUNTS IN MILLIONS)\nSee accompanying notes to consolidated financial statements.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(DOLLAR AMOUNTS IN MILLIONS)\nSee accompanying notes to consolidated financial statements.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLAR AMOUNTS IN MILLIONS)\n(1) ACQUISITIONS, REORGANIZATION, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Acquisitions\nEffective April 1, 1993, General Electric Capital Corporation (GE Capital), all of whose common stock is indirectly owned by General Electric Company, completed the acquisition of 100% of GNA Corporation's capital stock from Weyerhaeuser Company and Weyerhaeuser Financial Services Inc. for a purchase price of $577.4. For tax return purposes, the parties to this purchase have agreed to treat the purchase as an acquisition of assets. Effective July 14, 1993, GE Capital acquired 100% of the issued and outstanding capital stock of United Pacific Life Insurance Company and four of its seven wholly-owned subsidiaries from Reliance Insurance Company and its parent company, Reliance Group Holdings, Inc. for a purchase price of $514.6 in cash (collectively, the Acquisitions). The Acquisitions have been accounted for using the purchase method of accounting. Accordingly, each acquisition's purchase price has been allocated to the assets acquired and the liabilities assumed based on their estimated fair values at their respective acquisition dates. The consolidated statements of income, shareholder's interest, and cash flows include the effects of purchase adjustments as of their respective acquisition dates. During 1994, United Pacific Life Insurance Company was renamed General Electric Capital Assurance Company (GE Capital Assurance).\n(b) Reorganization\nEffective October 1, 1995, Great Northern Insured Annuity Corporation (GNA or the Company) was party to a reorganization (the Reorganization) involving GNA Corporation and certain of its life insurance company subsidiaries. The Reorganization allows all life insurance company subsidiaries of GNA Corporation to file a consolidated federal tax return.\nPrior to the Reorganization, GE Capital Assurance's voting common stock was owned by GNA and its preferred and nonvoting common stock was owned by GNA Corporation, thus resulting in minority interest. As part of the Reorganization, GNA became a wholly-owned subsidiary of GE Capital Assurance and GE Capital Assurance became a wholly-owned subsidiary of GNA Corporation. Consequently, there was no minority interest recorded on the balance sheet of GNA as of December 31, 1995. In order for GE Capital Assurance to become the direct parent of GNA, GNA Corporation contributed all of the stock of GNA to GE Capital Assurance in exchange for voting shares of GE Capital Assurance. GNA distributed its holdings of GE Capital Assurance common stock to GE Capital Assurance with the result that GE Capital Assurance is now wholly- owned by GNA Corporation.\nThe accompanying consolidated financial statements include the accounts of GNA and its subsidiaries prior to the Reorganization, GE Capital Assurance and First GNA Life Insurance Company of New York (First GNA), owned 48% by GNA and 52% by GE Capital Assurance. The results subsequent to the Reorganization include GNA, as well as its proportionate share of First GNA, accounted for under the equity method. Effective February 1, 1996, First GNA was renamed GE Capital Life Insurance Company of New York (GE Capital Life).\nFollowing are pro forma results of operations of GNA for the years ended December 31, 1995 and 1994, as if the Reorganization had occurred at the beginning of the period presented:\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (c) Basis of Presentation\nThese consolidated financial statements are prepared on the basis of generally accepted accounting principles (GAAP) for stock life insurance companies, which vary in several respects from accounting practices prescribed or permitted by the Insurance Commissioners of the states of Washington, Delaware and New York, where the Company and subsidiaries are domiciled.\nThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates.\n(d) Products\nThe primary product of the Company is investment type deferred annuities. The Company has also issued life contingent structured settlement policies, single premium whole life policies and a limited number of universal life policies. Investment type immediate annuities are also issued. The Company considers the sale of annuity and life insurance products to be a single segment\/line of business.\nGNA primarily sells its products through banks, thrifts and other financial institutions. Three financial institutions accounted for 79% of all deferred and immediate annuity contracts issued during 1995.\nGNA has effective registration statements with the Securities and Exchange Commission for the purposes of marketing Modified Guaranteed Annuity (MGA) and Group Deferred Variable Annuity products. The MGA offers customers a guaranteed interest rate for a predetermined time period and subjects customers to a market value adjustment on early withdrawals. The Group Deferred Variable Annuity offers customers eighteen investment options: eight which invest in shares of a corresponding mutual fund portfolio, and ten which correspond with guaranteed interest rate periods of one to ten years.\n(e) Revenues\nInvestment income is recorded when earned. Investment gains and losses are calculated on the basis of specific identification. Premiums from the sale of life contingent annuities are recognized as revenue when contracts are issued. Surrender charges are recognized as income when the policy is surrendered.\n(f) Investments\nThe Company has designated its fixed maturities as available for sale beginning December 31, 1993. Those securities are reported at fair value, with net unrealized gains and losses included in equity, net of effects on the present value of future profits, deferred acquisition costs, and deferred income tax. Unrealized losses that are other than temporary are recognized in earnings.\nThe Company does not engage in derivatives trading, market-making or other speculative activities. Any instrument designated but ineffective as a hedge is marked to market and recognized in operations immediately. The Company uses interest rate swaps that modify reserve characteristics or designated assets. The Company requires all options to be designated and accounted for as hedges of specific assets, liabilities or committed transactions; resulting payments and receipts are recognized contemporaneously with effects of hedged transactions. A payment or receipt arising from early termination of an effective hedge is accounted for as an adjustment to the basis of the hedged transaction. The Company has no open or outstanding derivative transactions at December 31, 1995 or 1994.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nMortgage and policy loans are stated at the unpaid principal balance of such loans, net of allowances for probable uncollectible balances.\nForeclosed real estate owned is carried at lower of cost or fair value less selling costs, giving consideration to current occupancy rates and economic conditions.\n(g) Statements of Cash Flows\nAll highly liquid investments with an original maturity of three months or less are classified as short-term investments on the balance sheets and considered cash equivalents in the statements of cash flows.\nDuring the years 1995 and 1994 and the nine months ended December 31, 1993 and three months ended March 31, 1993, the Company acquired real estate through foreclosure amounting to $6.6, $1.6, $2.9 and $0.0, respectively, and paid federal and state income taxes of $1.7, $6.8, $40.9 and $0.2, respectively. Effective July 14, 1993, the Company received a capital contribution of $182.9 in the form of GE Capital Assurance's Class A common stock from GNA Corporation. Effective October 1, 1995, the Company's shareholder's interest decreased by $186.5 due to the dividend of its investment in GE Capital Assurance.\n(h) Future Annuity and Contract Benefits\nInvestment Contracts\nInvestment contracts are broadly defined to include contracts without significant mortality or morbidity risk. Payments received from sales of investment contracts are recognized by providing a liability equal to the current account value of the policyholders' contracts. Interest rates credited to investment contracts are guaranteed for the policy term with renewal rates determined by management. At December 31, 1995 and 1994, investment contracts comprised $5,668.2 and $9,769.1, respectively.\nInsurance Contracts\nInsurance contracts are broadly defined to include contracts with significant mortality and\/or morbidity risk. The liability for future benefits is the present value of such benefits based on mortality, and other assumptions which were appropriate at the time the policies were issued. These assumptions are periodically evaluated for potential premium deficiencies. At December 31, 1995 and 1994, insurance contracts comprised $309.7 and $2,437.4, respectively.\nInterest rate assumptions used in calculating the present value of future annuity and contract benefits range from 4.0% to 9.0%.\n(i) Deferred Acquisition Costs\nAcquisition costs include costs and expenses which vary with and are primarily related to the acquisition of insurance and investment contracts, such as commissions, direct advertising and printing, and certain support costs such as underwriting and policy issue expenses. Acquisition costs capitalized are determined by actual costs and expenses incurred by product in the year of issue. For investment contracts, the amortization is based on the present value of the anticipated gross profits from investments, interest credited, surrender charges, mortality and maintenance expenses. As actual gross profits vary from projected, the impact on amortization is included in net income. For insurance contracts, the acquisition costs are amortized in relation to the benefit payments.\nRecoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of expected future gross profits to the unamortized asset balances. If such comparison indicates that the expected gross profits will not be sufficient to recover the asset, the difference will be charged to expense.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn conjunction with the Acquisitions, the unamortized deferred acquisition cost balance existing on the respective purchase dates was eliminated. Activity in deferred acquisition costs was as follows:\n(j) Intangible Assets\n(1) Present Value of Future Profits\nIn conjunction with the Acquisitions, a portion of the purchase price was assigned to the right to receive future gross profits arising from existing insurance and investment contracts. This intangible asset, called the present value of future profits (PVFP), is actuarially determined based on the present value of projected future gross profits on contracts acquired.\nThe method used by the Company to value PVFP is summarized as follows: (1) identify the future gross profits attributable to certain lines of business, (2) identify the risks inherent in realizing those gross profits, and (3) discount these gross profits at the rate of return that the Company believes it must earn in order to accept the inherent risks.\nAfter PVFP is determined, the amount is amortized, net of accreted interest, based on the incidence of the expected gross profits. Interest accretes at rates credited to policyholders on underlying contracts. As actual gross profits vary from projection, the impact on amortization is included in net income.\nRecoverability of PVFP is evaluated periodically by comparing the current estimate of expected future gross profits to the unamortized asset balances. If such comparison indicates that the expected gross profits will not be sufficient to recover PVFP, the difference will be charged to expense.\nActivity in PVFP was as follows:\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Amortization of PVFP, net of accretion, as a percent of the unamortized PVFP balance for the next five years is estimated as follows:\n(2) Goodwill\nIn conjunction with the Acquisitions, $150.6 of goodwill was recorded and will be amortized over 25 years. This asset has been adjusted to reflect the final GNA purchase price. In conjunction with the Reorganization, goodwill was reduced by $103.4. During the years ended December 31, 1995 and 1994 and the period April 1 through December 31, 1993, $4.8, $7.8 and $2.0, respectively, was amortized. As of December 31, 1995, the unamortized balance of goodwill was $32.6. Goodwill in excess of associated expected operating cash flows is considered to be impaired and is written down to fair value.\n(k) Federal Income Tax\nThe Company is included with GE Capital Assurance in a life insurance consolidated federal income tax return. Prior to April 1, 1993, the Company was included in the consolidated federal income tax return of the Weyerhauser Company. Current and deferred taxes are allocated by applying the asset and liability method of accounting for deferred income taxes to members of the group as if each member was a separate taxpayer. Intercompany balances are settled annually.\n(l) Separate Accounts\nThe separate account assets and liabilities represent funds held for the exclusive benefit of the Deferred Variable Annuity contract owners. The Company receives mortality risk fees and administration fees from the variable annuity mutual fund portfolios and separate account assets.\n(m) Reclassifications\nCertain reclassifications have been made to the 1994 and 1993 consolidated financial statements to conform to the 1995 presentation. These reclassifications have no effect on reported net income or financial position.\n(2)INVESTMENTS\n(a) Fixed Maturities\nAt December 31, the amortized cost, gross unrealized gains and losses, and fair value of the Company's fixed maturities available-for-sale portfolio were as follows:\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1995, approximately 23.5%, 20% and 8.4% of the Company's investment portfolio is comprised of securities issued by the manufacturing, financial and utility industries, respectively, the vast majority of which are rated investment grade, and which are senior secured bonds. This portfolio is widely diversified among various geographic regions in the United States, and is not dependent on the economic stability of one particular region.\nAt December 31, 1995, the Company did not hold any fixed maturity securities, other than securities issued or guaranteed by the U.S. government, which exceeded 10% of shareholder's interest before net unrealized investment gains (losses).\nAs required by law, the Company has investments on deposit of $2.9 and $5.0 at December 31, 1995 and 1994, respectively, with governmental authorities and banks for the protection of policyholders.\nFor the years ended December 31, the sources of investment income of the Company were as follows:\nFor the years ended December 31, the Company realized sales proceeds, gross investment gains and losses as follows:\nThe additional proceeds from investments result from principal collected on mortgage-backed securities, maturities, calls and sinking payments.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFixed maturities are considered available for sale. Accordingly, fixed maturities are accounted for at fair value through shareholder's interest, net of the following adjustments:\nThe maturity distribution of the fixed maturities portfolio at December 31 was as follows:\nThe evaluation of investment and credit risk is undertaken by a number of rating services, such as Standard & Poor's Corporation and Moody's Investors Services. These services assign a letter rating to each security on the basis of their evaluation. Bonds with ratings ranging from AAA to BBB are generally regarded as investment grade securities. Some agencies and treasuries (that is, those securities issued by the United States government or an agency thereof) are not rated, but all are considered to be investment grade securities. Finally, some securities, such as private placements, have not been assigned a rating by any rating service and are therefore categorized as \"not rated\"; this has neither positive nor negative implications regarding the value of the security.\nThe fixed maturities portfolio at December 31 consisted of the following classes of securities:\nAt December 31, 1995, there were no bonds in default as to interest and principal.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(b) Mortgage Loans\nAt December 31, 1995 and 1994, the Company's mortgage loan portfolio consisted of 1,161 and 1,226, respectively, first mortgage loans on commercial real estate properties. The loans, which are originated by the Company through a network of mortgage bankers, are made only on completed, leased properties and have a maximum loan-to-value ratio of 75% at the date of origination. The Company does not engage in construction lending or land loans.\nThe Company originated $18.5, $62.3 and $30.9 of mortgages secured by real estate in California, which represent 13%, 16% and 22% of total originations for the years ended December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994, respectively, the Company held $519.2 and $558.3 in mortgages secured by real estate in California; this is 40% of the total mortgage portfolio, for both years\nOn January 1, 1995, GNA adopted Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and the related SFAS No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures. There was no effect of adopting the Statements on 1995 results of operations or financial position because the allowance for losses established under the previous accounting policy continued to be appropriate following the accounting change. The Statements require disclosures of impaired loans--loans for which it is probable that the lender will be unable to collect all amounts due according to original contractual terms of the loan agreement, based on current information and events. At December 31, 1995, loans that required disclosure as impaired amounted to $16.2. For $3.2 of such loans, the required allowance for losses was $0.1. The remaining $13.0 of loans represents the recorded investment in loans that are fully recoverable, but only because the recorded investment had been reduced through charge-offs or deferral of income recognition. These loans must be disclosed under the Statements' technical definition of \"impaired\" because GNA will be unable to collect all amounts due according to original contractual terms of the loan agreement. Under the Statements, such loans do not require an allowance for losses. GNA's average investment in impaired loans requiring disclosure under the Statements was $11.3 during 1995, with revenue of $1.3 recognized, principally on the cash basis.\nThe following table shows the activity in the allowance for losses during the years ended December 31:\nThe net amount of mortgages written off during 1995 include actual write- offs of $2.0. The write-offs represented 0.15% of average mortgage loans outstanding during 1995, compared with 0.07% and 0.57% during 1994 and 1993, respectively.\nThe allowance for losses on mortgage loans at December 31, 1995 and 1994 represented 2.7% and 2.3% of total mortgage loans, respectively.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(c) Investment in GE Capital Life\nA portion of other invested assets at December 31, 1995 included $123.6 for the Company's 48% investment in GE Capital Life, accounted for under the equity method. Other investment income includes $1.3 for equity in earnings of GE Capital Life subsequent to the Reorganization. Prior to the Reorganization, GE Capital Life was consolidated. Following is the summarized financial information for GE Capital Life for the year ended December 31, 1995:\n(3) INCOME TAXES\nThe total provision for income taxes for the years ended December 31 consisted of the following components:\nOn August 10, 1993, the federal income tax rate applied to corporations was increased from 34% to 35% effective January 1, 1993, due to the Omnibus Budget Reconciliation Act of 1993. This change has been reflected in net income for the nine months ended December 31, 1993.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following reconciles the federal statutory tax rate of 35% to the reported income tax provision (benefit):\nThe components of the net deferred income tax benefit (liability) at December 31 were as follows:\nThe significant change in deferred taxes is due to both lower interest rates in 1995, which affect the unrealized gain or loss, as well as the Reorganization.\nBased on an analysis of the Company's tax position, management believes it is more likely than not that the results of future operations and tax planning strategies will generate sufficient taxable income to realize deferred tax assets. No valuation allowance for deferred tax assets for 1995 was deemed necessary following the effects of the Reorganization. During the year 1994, the Company had recorded a valuation allowance of $66.6 representing the entire balance of the deferred tax asset for net operating loss carryforwards related to GE Capital Assurance.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(4) RELATED-PARTY TRANSACTIONS\nDuring the years ended December 31, 1995, 1994 and 1993, the Company received $1.6, $2.6 and $6.3, respectively, from its affiliates, GNA Securities, Inc. and GNA Distributors, Inc. for reimbursement of marketing, administrative and general office expenses.\nPrior to the Reorganization, the Company received $3.6 from GE Capital Life and paid $31.2 to GE Capital Assurance for settlement of intercompany tax payments. There were no intercompany tax payments during 1994.\n(5) COMMITMENTS AND CONTINGENCIES\n(a) Mortgage Loan Commitments\nAs of December 31, 1995 and 1994, the Company was committed to fund $20.2 and $126.7, respectively, in mortgage loans.\n(b) Leases\nThe Company leases the office space used in its operations. Lease expense for the years ended December 31, 1995 and 1994, nine months ended December 31, 1993 and three months ended March 31, 1993 amounted to $3.4, $3.4, $2.5 and $0.8, respectively.\nFuture minimum commitments under operating leases as of December 31, 1995 are summarized as follows:\nRates for certain office space leases are subject to inflationary increases. The effect of such inflationary increases has not been reflected in the future minimum commitments.\n(c) Deferred Compensation Arrangements\nThe Company has nonqualified deferred compensation arrangements with certain senior officers. Compensation earned will be paid through a ten-year annuity, commencing ten years from the date of employment or promotion. Deferred compensation vests at 10% for each year of service. The present value of accrued amounts vested at December 31, 1995 and 1994 were $3.2 and $3.6, respectively. During the years ended December 31, 1995 and 1994, nine months ended December 31, 1993 and three months ended March 31, 1993, the Company expensed $0.5, $0.6, $0.5 and $0.2, respectively, related to deferred compensation.\n(d) Guaranty Association Assessments\nThe Company is required by law to participate in the guaranty associations of the various states in which it does business. The state guaranty associations ensure payment of guaranteed benefits, with certain restrictions to policyholders of impaired or insolvent insurance companies, by assessing all other companies involved in similar lines of business.\nThere are currently several insurance companies which had substantial amounts of annuity business, in the process of liquidation or rehabilitation. The Company paid $6.6, $10.3, $3.5 and $0.9 to various state guaranty\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) associations during the years ended December 31, 1995 and 1994, nine months ended December 31, 1993 and three months ended March 31, 1993, respectively. The Company accrues its best estimate for known insolvencies. At December 31, 1995 and 1994, accounts payable and accrued expenses include $38.2 and $46.8, respectively, related to estimated assessments. The Company expensed $20.4 of related assessments during the fourth quarter of 1995.\n(e) Litigation\nThere is no material pending litigation to which the Company is a party or of which any of the Company's property is the subject, and there are no legal proceedings contemplated by any governmental authorities against the Company of which management has any knowledge.\n(6) STATUTORY BASIS DATA AND RESTRICTION OF RETAINED EARNINGS\nThe Company files financial statements with state insurance regulatory authorities which are prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Statutory accounting practices differ from GAAP in several respects, causing differences in reported net income and shareholder's interest. The Company, however, has no significant permitted accounting practices which vary from prescribed accounting practices or GAAP.\nThe National Association of Insurance Commissioners (NAIC) has adopted Risk- Based Capital (RBC) requirements to evaluate the adequacy of statutory capital and surplus in relation to risks associated with: (i) asset quality, (ii) insurance risk, (iii) interest rate risk, and (iv) other business factors. The RBC formula is designed as an early warning tool for the states to identify possible under-capitalized companies for the purpose of initiating regulatory action. In the course of its operations, the Company monitors the level of its RBC and it exceeds the minimum required levels.\nThe principal differences between GAAP and statutory accounting practices are shown in the following reconciliation of net income:\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The principal differences between GAAP shareholder's interest and statutory basis capital and surplus at December 31 are as follows:\nStatutory basis capital and surplus increased due to the Reorganization by $32.7 primarily related to the decrease in nonadmitted assets for the Company's investment in GE Capital Assurance.\nPrior to its acquisition, GE Capital Assurance had entered into reinsurance agreements with various companies (including Employers Reassurance Corporation, an affiliate of GE Capital), to cede single premium deferred annuities on a modified-coinsurance basis. The net effect of these transactions are to increase statutory surplus by $31.5 at December 31, 1994. There were no reinsurance effects at December 31, 1995 due to the Reorganization.\nThese reinsurance agreements do not relieve the Company from its primary obligation to the policyholders, and have been recorded as deposits in the accompanying consolidated financial statements.\nInsurance companies are restricted by certain states as to the amount of dividends they may pay within a given calendar year to their parent without regulatory consent. That restriction is the greater of statutory net gain from operations for the previous year or 10% of the policyholder surplus (net of common stock) at the close of the previous year, subject to a maximum limit equal to statutory earned surplus. At December 31, 1995, approximately $78.3 was available for dividend payments in 1996.\n(7) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company has no derivative financial instruments other than mortgage loan commitments of $20.2 and $126.7 at December 31, 1995 and 1994, respectively. The fair value of fixed rate mortgage loan commitments approximates the nominal amounts due to the short term nature of these commitments.\nGREAT NORTHERN INSURED ANNUITY CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe fair values of financial instruments presented in the applicable notes to the Company's consolidated financial statements are estimates of the fair values at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessarily indicative of amounts the Company could realize or settle currently. The Company does not necessarily intend to dispose of or liquidate such instruments prior to maturity.\nThe fair value of fixed maturities and other invested assets equals quoted market price, if available. If a quoted market price is not available, fair values are estimated based on management's judgment using market prices for similar instruments.\nThe fair value of mortgage loans is estimated by discounting the estimated future cash flows using current loan origination rates adjusted for credit risks.\nThe fair value of policy loans approximates the carrying values because the interest rates used in discounted cash flow analysis (current rates offered on policy loans) are substantially equal to the policy loan interest rates offered in the past.\nFor short-term investments, the carrying amount is a reasonable estimate of fair value.\nThe estimated fair value of investment contracts is the amount payable on demand (cash surrender value) for deferred annuities and the net present value, based on interest rates currently offered on similar contracts, for non-life contingent immediate annuities. Fair value disclosures are not required for insurance contracts.\nAt December 31, the carrying amounts and fair values of the Company's financial instruments 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 omitted pursuant to General Instructions J(2) (c) of Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nItem omitted pursuant to General Instructions J(2) (c) of Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem omitted pursuant to General Instructions J(2) (c) of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nItem omitted pursuant to General Instructions J(2) (c) of Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) FINANCIAL STATEMENTS\nAll schedules are omitted because of the absence of conditions under which they are required or because the required information is shown in the financial statements or notes thereto.\n(2) LISTING OF EXHIBITS\n- -------- *Previously filed\n(b) REPORTS ON FORM 8-K FILED IN THE FOURTH QUARTER OF 1995\nNo reports on Form 8-K were required to be filed by the Company 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.\nGREAT NORTHERN INSURED ANNUITY CORPORATION Registrant\nMarch 8, 1996 \/s\/ Patrick E. Welch - ------------------------- By ___________________________________________ Date Patrick E. Welch, Director, Presidentand 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 8, 1996 \/s\/ Patrick E. Welch - ------------------------- By ___________________________________________ Date Patrick E. Welch, Director, Presidentand Chief Executive Officer\nMarch 8, 1996 \/s\/ Hans L. Carstensen - ------------------------- By ___________________________________________ Date Hans L. Carstensen, Director, Senior Vice Presidentand Chief Marketing Officer\nMarch 8, 1996 \/s\/ Stephen P. Joyce - ------------------------- By ___________________________________________ Date Stephen P. Joyce, Directorand Senior Vice President\nMarch 8, 1996 \/s\/ Charles A. Kaminski - ------------------------- By ___________________________________________ Date Charles A. Kaminski, Directorand Senior Vice President\nMarch 8, 1996 \/s\/ Victor C. Moses - ------------------------- By ___________________________________________ Date Victor C. Moses, Director, Senior VicePresident and Chief Actuary\nMarch 8, 1996 \/s\/ Kenneth F. Starr - ------------------------- By ___________________________________________ Date Kenneth F. Starr, Directorand Senior Vice President\nMarch 8, 1996 \/s\/ Geoffrey S. Stiff - ------------------------- By ___________________________________________ Date Geoffrey S. Stiff, Director, Senior Vice President,Chief Financial Officer (Principal Financial Officer)\nMarch 8, 1996 \/s\/ Thomas W. Casey - ------------------------- By ___________________________________________ Date Thomas W. Casey, Vice Presidentand Controller (Principal Accounting Officer)","section_15":""}
{"filename":"805009_1995.txt","cik":"805009","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings - --------------------------\nAs a member of the NBA, the Partnership is a defendant along with the other members in various lawsuits incidental to the NBA's basketball operations. The Partnership will generally be liable, jointly and severally, with all other members of the NBA for the costs of defending such lawsuits and any liabilities of the NBA which might result from such lawsuits.\nPART II -------\nItem 5.","section_4":"","section_5":"Item 5. Market for Registrant's Common Equity and Related - ------------------------------------------------------------ Stockholder Matters -------------------\nThe Partnership's Units are listed on the New York Stock Exchange and traded under the symbol \"BOS\". The following table sets forth, for the periods, indicated, the high and low sales prices per Unit on the New York Stock Exchange and cash distributions per Unit to Unitholders for the years ended June 30, 1995 and June 30, 1994, respectively.\nAs of September 20, 1995, the approximate number of registered unitholders of the Partnership's Units was 66,056.\nItem 6","section_6":"Item 6 - Selected Financial Data - --------------------------------\nBoston Celtics Limited Partnership and subsidiaries consolidated - (000's omitted, except for per unit data)\nItem 6 - Selected Financial Data (Continued) - --------------------------------------------\nBoston Celtics Limited Partnership and subsidiaries consolidated - (000's omitted, except for per unit data)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition - ---------------------------------------------------------------------- and Results of Operations -------------------------\nGeneral\nConsolidated Income from Continuing Operations of Boston Celtics Limited Partnership and its Subsidiaries for the year ended June 30, 1995 was $5,517,000 or $0.84 per unit on revenues of $52,325,000 and Consolidated Net Income was $16,156,000 or $2.43 per unit compared with Consolidated Income from Continuing Operations of $7,337,000 or $1.11 per unit on revenues of $44,583,000 and Consolidated Net Income of $23,766,000 or $3.61 per unit during the year ended June 30, 1994.\nThe Partnership reported Consolidated Income from Continuing Operations for the three months ended June 30, 1995 of $4,403,000 or $0.67 per unit on revenues of $9,404,000 and Consolidated Net Income of $7,602,000 or $1.15 per unit compared with Consolidated Income from Continuing Operations of $42,000 or $0.01 per unit on revenues of $8,491,000 and Consolidated Net Income of $3,858,000 or $0.58 per unit for the three months ended June 30, 1994.\nThe previously reported agreement between the Partnership and Fox Television, Inc. (FTS) pursuant to which FTS acquired Boston Celtics Broadcasting Limited Partnership (BCBLP), which owned and operated television station WFXT, was closed on July 7, 1995. Accordingly, the income statement has been restated for all periods presented to report the results of operations of television station WFXT and radio station WEEI, sold on June 30, 1994, as discontinued operations. Gains from the sale to FTS of an option to acquire a 26% interest in BCBLP ($14,640,000) and the sale of radio station WEEI ($2,794,000) are included in discontinued operations in 1994, net of applicable income taxes ($3,150,000). The remaining gain from the sale of BCBLP to FTS (estimated to be $40,000,000, net of related income taxes of $20,000,000) will be included in income from discontinued operations in July 1995 when realized.\nIncome from continuing operations for the year ended June 30, 1995 includes league expansion revenue ($7,114,000), increased player compensation ($8,965,000) and increased net interest expense ($1,000,000). Income from continuing operations for the year ended June 30, 1994 includes net insurance proceeds ($5,592,000) and net losses from marketable securities ($3,596,000).\nThe Boston Celtics derive revenues principally from the sale of tickets to home games and the licensing of television, cable network and radio rights. A large portion of the Boston Celtics' annual revenues and operating expense is determinable at the commencement of each basketball season based on season ticket sales and the Boston Celtics' multi-year contracts with its players and broadcast organizations.\nThe operations and financial results of the Boston Celtics are seasonal. On a cash flow basis, the Boston Celtics receive a substantial portion of their receipts from the advance sale of season tickets during the months of July through October, prior to the commencement of the NBA regular season. Cash receipts from playoff ticket sales are received in March of any year for which the team qualifies for league playoffs. Most of the Boston Celtics' operating expenses are incurred and paid during the regular season, which extends from early November through late April.\nFor financial reporting purposes the Boston Celtics recognize revenues and expenses on a game-by-game basis. Because the NBA regular season begins in November, the first quarter which ends on September 30th, will generally include limited or no revenue and will reflect a loss attributable to general and administrative expenses incurred in the quarter. Based on the present NBA game schedule, the Partnership will generally recognize approximately one-third of its annual regular season revenue in the second quarter, approximately one-half of such revenue in the third quarter and the remainder in the fourth quarter, and it will recognize its playoff revenue, if any, in the fourth quarter.\nResults of Operations\nThe following discussion compares results of continuing operations of the Partnership and its subsidiaries for the year ended June 30, 1995 compared with the year ended June 30, 1994 and for the year ended June 30, 1994 compared with the year ended June 30, 1993.\nRevenues from regular season ticket sales increased by $1,798,000 or 9% in fiscal 1995 compared to 1994 and by less than 1% in fiscal 1994 compared to 1993. The increase in 1995 resulted primarily from an increase in ticket prices. Ticket prices were not increased in the year ended June 30, 1994.\nRegular season television and radio rights fees revenues increased by $1,788,000 or 9% in fiscal 1995 compared to 1994 and decreased by $2,693,000 or 12% in fiscal 1994 compared to 1993. The increase in fiscal 1995 compared to 1994 is primarily the result of increases in the NBA's national broadcasting contracts. The decrease in fiscal 1994 compared to fiscal 1993 is primarily the result of reductions in revenues from local television broadcast rights fees.\nOther, principally promotional advertising revenues increased by $2,242,000 or 43% in fiscal 1995 compared to 1994 and by $1,579,000 or 44% in fiscal 1994 compared to 1993. The increases in fiscal 1995 and 1994 are principally due to increased revenues from promotional activities ($1,721,000 in 1995 and $535,000 in 1994) and increased proceeds received from NBA properties from the licensing of novelty type products ($554,000 in 1995 and $1,053,000 in 1994).\nThe Boston Celtics played two home playoff games in fiscal 1995 which resulted in $1,913,481 of revenue. There were no playoff games played by the Boston Celtics in the 1993-94 season, accordingly, there were no playoff revenues or expenses in fiscal 1994. Playoff revenues vary from year to year depending on the number of home games played and the availability of such games for local television broadcast, and playoff expenses vary depending on the number of games played.\nTeam expenses increased by $8,735,000 or 39% in fiscal 1995 compared to fiscal 1994 primarily as a result of increased player compensation ($8,965,000). Team expenses decreased by $2,274,000 or 9% in fiscal 1994 compared to fiscal 1993 primarily as a result of decreases in player compensation ($1,487,000). In addition, costs were reduced in fiscal year 1994 compared with 1993 as a result of a reduction in air travel costs ($450,000) and termination of the funding requirement for the NBA Pre-Pension player plan ($375,000) in fiscal 1994.\nGame expenses, primarily arena rental payments and the NBA assessment on gate receipts, increased by $119,000 or 4% in fiscal 1995 compared to 1994 primarily as a result of increased NBA assessments ($111,000) due to the increase in ticket revenues in fiscal 1995. Game expenses decreased by $207,000 or 7% in fiscal 1994 compared to fiscal 1993 primarily from reductions in exhibition game expenses ($134,000).\nBasketball playoff expense was $696,000 in fiscal 1995, primarily expenses related to the two home games played. There were no playoff games played in fiscal 1994. The playoff expense for fiscal 1993 was $609,000 related to the two home playoff games played in that season.\nGeneral and administrative expenses increased $2,781,698 or 25% in fiscal 1995 compared to 1994 and $4,729,000 or 72% in fiscal 1994 compared to 1993. The increase in fiscal 1995 is primarily attributable to increased option expense ($2,324,000) and increased administrative salaries ($584,000). The increase in fiscal 1994 was primarily attributable to increased management fees ($1,276,000), incentive bonuses and stock option expense ($3,150,000), and increased salaries as a result of additional staffing ($1,817,000). Additionally, 1994 expenses do not include charges similar to the merger costs ($1,282,000) included in fiscal 1993.\nSelling and promotional expenses increased $1,296,000 or 93% in fiscal 1995 compared to 1994 and increased $243,000 or 21% in fiscal 1994 compared to 1993. The increase in fiscal 1995 compared to 1994 is primarily attributable to increased promotional and sponsorship costs ($740,000) and increased salary costs ($476,000). The increase in fiscal 1994 compared with 1993 was primarily attributable to increased promotional costs of the basketball operation.\nTotal depreciation and amortization increased $3,000 or 4% in fiscal 1995 compared to 1994 and $12,000 or 18% in fiscal 1994 compared to 1993. The increases in 1995 and 1994 are primarily attributable to additional depreciation related to additions to property and equipment at the basketball operation.\nInterest expense increased $5,061,000 or 126% in fiscal 1995 compared to 1994 and $2,246,000 or 127% in fiscal 1994 compared to 1993. The increase in fiscal 1995 and 1994 is primarily attributable to increased borrowings ($4,658,000 in 1995 and $2,246,000 in 1994). In addition, the 1995 increase included the effect of an increase in interest rates ($359,000).\nThe Partnership had interest income of $6,508,000 and $2,347,000 in fiscal 1995 and 1994, respectively. Interest income increased $4,160,000 or 177% in fiscal 1995 compared to 1994 and $1,563,000 or 199% in fiscal 1994 compared to 1993. The increases are attributable to interest earned on the short-term investment of larger amounts of available funds.\nLiquidity and Capital Resources\nAt June 30, 1995 the Partnership had approximately $39,563,000 of cash and cash equivalents, $45,133,000 of marketable securities and $67,558,000 of other short-term investments. In addition to these amounts, sources of funds available to the Partnership include funds generated by operations, capital contributions from partners and proceeds of $79,200,000 from the sale of BCBLP to FTS, Inc. on July 7, 1995. These resources will be used to repay commercial bank borrowings and notes related to redeemed partnership units (see Note Q of Notes to Consolidated Financial Statements) and for general partnership purposes, working capital needs or for possible acquisitions. The Partnership is not engaged in any negotiations relating to and has not made any commitments in connection with any such possible acquisitions.\nDuring the year ended June 30, 1995, a cash distribution of $1.50 per Unit was paid to the Unitholders of BCLP and an additional distribution of $1.50 per unit was declared on June 26, 1995 to unitholders of record on June 30, 1995 payable July 21, 1995. Future distributions will be determined by the General Partner based among other things on available resources and the needs of the Partnership. Management believes that its cash, cash equivalents and marketable securities together with cash from operations will provide adequate cash for the Partnership and its subsidiaries to meet their cash requirements through June 30, 1996.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ------------------------------------------------------\nSee Item 14.\nPART III --------\nItem 10.","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -------------------------------------------------------------\nGeneral Partner\nThe general partner of the Partnership is Celtics, Inc., a Delaware corporation organized in 1986 (the \"General Partner\") which is wholly owned by Walcott Partners, L.P., a Gaston family partnership, and Paul R. Dupee, Jr. The Partnership's activities are managed and controlled by the General Partner.\nThe General Partner of CLP is Boston Celtics Corporation (the \"Basketball General Partner\"). Don F. Gaston, Paul E. Gaston and Paul R. Dupee, Jr. are the sole stockholders of the Basketball General Partner. CLP's activities are managed and controlled by the Basketball General Partner.\nThe general partner of BCCLP and BCBLP is Celtics Communications, Inc. (the \"General Partner of the Broadcast Operations\"). Paul E. Gaston, Don F. Gaston (Paul Gaston's father), and Paul R. Dupee, Jr. are the sole stockholders of the General Partner of the Broadcast Operations. The Broadcast Operations' activities are managed and controlled by the General Partner of the Broadcast Operations.\nThe interest of Alan Cohen in Celtics, Inc. was acquired by Walcott Partners L.P. and his interests in Boston Celtics Corporation and Celtics Communications, Inc. were acquired by Paul E. Gaston on August 30, 1995. See Note Q of Notes to Consolidated Financial Statements for a description of these redemptions.\nManagement fee obligations of $2,333,974, $2,873,942, and $1,481,444 applicable to Celtics, Inc., general partner of the Partnership, Boston Celtics Corporation, general partner of CLP, and Celtics Communications, Inc., general partner of BCCLP and BCBLP were charged to operations during the years ended June 30, 1995, 1994, and 1993, respectively. Boston Celtics Corporation receives a management fee of $750,000 per annum subject to annual increases based on annual cash flows from basketball operations after June 30, 1989. Celtics Communications, Inc. receives management fees from BCCLP and BCBLP based on a percentage of sales. The rates of these fees were 1% through December 31, 1992 and 2% thereafter.\nIn accordance with the partnerships' partnership agreements, each item of income, gain, loss and deduction is allocated and distributions are made to the partners and Unitholders in accordance with their respective percentage interests.\nDirectors and Executive Officers\nThe following table sets forth, for each of the directors and executive officers of the General Partner, and certain officers of the Basketball Subsidiary Partnership and the Communications Group Subsidiary Partnerships, his principal occupation, age and business experience during the past five years. All of the directors and officers are U.S. citizens and the business address of each is c\/o Boston Celtics Limited Partnership, 151 Merrimac Street, Boston, Massachusetts 02114.\nThe General Partner has an Audit Committee composed of Mr. Leithead and Mr. Marsh, independent directors and Mr. Paul Gaston. The independent directors will be reimbursed for their expenses, and will receive directors' fees equal to $1,000 per month and $2,500 per meeting attended with respect to their services as directors of the General Partner. Messrs. Leithead and Marsh received $14,500 each in directors' fees in fiscal 1995. Directors are named by the stockholders of the general partner and serve until their successors are named. The General Partner's officers are appointed by, and serve at the discretion of, the Board of Directors.\nMr. Paul E. Gaston succeeded his father, Don F. Gaston, as Chairman of the Board of the CLP General Partner in September 1993. He became Chairman of the Board of the General Partner of the Partnership in December 1992 and had been a Director since September 1992. Upon its formation in November 1992, he became Managing Director of Walcott Limited Partnership, a Gaston family partnership whose investments include limited partnership interests in the Partnership and shares in Celtics, Inc., the General Partner of the Partnership. From inception in 1990 to June 1992 he was Co-chairman and since June 1992 has been Chairman of the Board of Directors of Celtics Communications, Inc., the general partner of Boston Celtics Communications Limited Partnership. Mr. Paul E. Gaston is the son of Don F. and Paula B. Gaston.\nMr. Dupee became Vice-Chairman of the Board of Directors of Boston Celtics Incorporated in September 1983 and has served as a Director of the BCCLP General Partner since its inception in 1990. Mr. Dupee was Chairman of the Board of London Investment Trust, PLC, a large international futures and options brokering and clearinghouse from 1987 to January 1988. Mr. Dupee was President of Providence Capitol, Ltd. from 1982 until its liquidation in December 1986. Prior thereto, he was associated with Gulf & Western Industries, Inc., most recently as a Vice President and President of its Providence Capitol Division. Since 1986, Mr. Dupee has been a private investor.\nMr. Schram was named President and became a Director of the General Partner of the Partnership in December 1992. He became President and Director of the BCCLP General Partner in August 1992. From 1984 to 1991, Mr. Schram was a Vice President of the Fixed Income Securities Division of Morgan Stanley & Co.\nMr. Bartlett was named Executive Vice President and became a Director of the General Partner of the Partnership in December 1992. He has been a financial consultant, primarily to BCLP and to the Principal BCLP Holders, since January 1986 and has served as a Director of BCCLP General Partner since its inception in 1990. From October 1972 to December 1985, he was associated with Gulf & Western Industries, Inc., a diversified manufacturing, services and entertainment company, most recently as a Vice President. Prior to October 1972, he was a senior audit manager with the international accounting firm of Price Waterhouse.\nMr. Pond was named Vice President, Controller and Secretary of the General Partner of the Partnership in December 1992. He has been employed by BCLP since July 1992. From July 1981 to June 1992, he was with the international accounting firm of Ernst & Young, most recently as a senior audit manager.\nMr. Don F. Gaston has served as a Director of the General Partner's of BCLP and CLP since his resignation as Chairman of the Board of BCLP in December 1992 and CLP in September 1993. He was succeeded in each of these positions by his son, Paul E. Gaston. He became Chairman of the Board of Directors of Boston Celtics Incorporated in September 1983 when he, together with Messrs. Cohen and Dupee, acquired the Boston Celtics Franchise. He has served as a Director of the BCCLP General Partner since its inception in 1990. Mr. Gaston was Chairman of the Board of Providence Capitol, Ltd. from July 1982 until its liquidation in December 1986. From 1962 to June 1982, he was associated with Gulf & Western Industries, Inc. in various capacities, including Executive Vice President, director and member of the Executive Committee. Mr. Gaston is the husband and father respectively, of Paula B. Gaston and Paul E. Gaston.\nMrs. Paula B. Gaston became a Director of the General Partner of BCLP in September 1992 and a Director of the General Partner of CLP in October 1992. She is a private investor and is the wife of Mr. Don F. Gaston and the mother of Paul E. Gaston.\nMr. Leithead became a Director of the BCLP General Partner in October 1992. Mr. Leithead worked for International Business Machines Corporation as an executive in the National Marketing Division from 1979 to 1985. From 1985 to 1993, he was an executive of R.R. Donnelley & Sons Company. Since September 1993 he has been employed as an executive at Arandell Schmidt.\nMr. Marsh became a director in September 1992. From 1985 to 1988 Mr. Marsh was a Vice President in the international arbritage department of Merrill Lynch Pierce Fenner and Smith. From 1988 to 1991 he was a Vice President at Duetsche Bank Capital Corporation where he headed an international arbritage securities trading group. Since 1991 he has been Chief Executive Officer and President of Saicor Ltd., an investment banking firm specializing in emerging markets.\nMr. Auerbach has been President of the Boston Celtics basketball operations since 1981. From 1950 to 1966, Mr. Auerbach was head coach of the Boston Celtics and, during that period, the Boston Celtics won the NBA championship 11 times. Mr. Auerbach was General Manager of Boston Celtics Incorporated, or its predecessors, from 1966 to 1983. Mr. Auerbach has been inducted into the Basketball Hall of Fame.\nMr. Carr was named Executive Vice President of Basketball Operations of the Basketball subsidiary Partnership on June 16, 1994 and coach of the Boston Celtics in June 1995. Since 1987 he has owned and operated various businesses. In 1992 he was named Executive Director of Community Affairs for the Boston Celtics. Mr. Carr played professional basketball from 1973 to 1985. From 1979 through 1985 he played for the Boston Celtics.\nMr. Gavitt became Vice Chairman of the Basketball Subsidiary Partnership on September 21, 1994. He was Senior Executive Vice President and Chief Operating Officer of the Boston Celtics basketball operations from June 1990 to September 1994. Prior to that time, he was Commissioner of the Big East Conference, a collegiate sports conference, since its inception in 1979. Mr. Gavitt is a past president of USA Basketball.\nMr. Volk has been associated with the Boston Celtics basketball operations since 1971 and has been Executive Vice President and General Manager since 1984. He was Assistant General Manager from 1981 to 1984 and General Counsel from 1974 to 1984. From 1971 to 1974, Mr. Volk was Director of Sales.\nMr. Layne has been with the Boston Celtics basketball operations since March 1994. He was named Executive Vice President of Marketing and Sales in May 1995. From March 1994 to May 1995 Mr. Layne was Vice President of Planning and Special Events. Prior to joining the Boston Celtics, Mr. Layne was with the Seattle Mariners professional baseball team as its Vice President of Marketing for four years, and he previously worked in broadcasting with CBS and Emmis Broadcasting for eleven years.\nMr. Walsh has been President of the Boston Celtics broadcast operations since it acquired Television Station WFXT - Channel 25 and Radio Station WEEI - 590 AM in May 1990. From September 1989 to May 1990, he was General Manager of WFXT, Inc., the prior owner of the television station. From 1983 until August 1989, Mr. Walsh was the President and General Manager of WLVI-TV, Channel 56 in Boston.\nItem 11.","section_11":"Item 11. Executive Compensation - ---------------------------------\nThe following Summary Compensation Table sets forth the compensation of each of the Chief Executive Officer and the four most highly compensated executive officers of the Partnership whose annual salary and bonus, if any, exceeded $100,000 for services in all capacities to the Partnership during the last three fiscal years.\nSummary Compensation Table --------------------------\nAggregated Option Exercises and Option Values ---------------------------------------------\nEmployment and Consulting Agreements\nThe Partnership\nIn August 1993, the Board of Directors of the General Partner of BCLP approved compensation arrangements and incentive plans for Paul E. Gaston, Chairman of the Board and Stephen C. Schram, President, respectively, of the Partnership. Mr. Gaston and Mr. Schram shall each be employed on an at will basis, with compensation at the rate of $400,000 per annum. The incentive plan, which is subject to annual review, provides that each of Mr. Gaston and Mr. Schram shall receive annual incentive payments, commencing with the fiscal year ending June 30, 1994, of 5% of the amount by which Consolidated Net Income before taxes on income of BCLP for the related fiscal year exceeds $8,000,000, payable not later than 10 days after the issuance of audited financial statements of BCLP. During the years ended June 30, 1995 and 1994, incentive bonuses amounted to $828,000 and $749,000, respectively, each.\nThe Basketball Operations\nUnder an agreement dated as of March 13, 1981, as amended, Red Auerbach has been retained to serve as a consultant to the Boston Celtics for the remainder of his life. For such services, Mr. Auerbach will receive compensation totalling $250,000 per year for his lifetime. In fiscal 1995, Mr. Auerbach received a bonus payment of $100,000. Upon Mr. Auerbach's death, his wife shall be entitled to receive for the balance of her life monthly payments equal to those that would have otherwise been paid to Mr. Auerbach. Mr. Auerbach shall advise the Boston Celtics with respect to, among other things, the team's selections in the NBA college draft, evaluation of college and professional players and the performance of the team and the players for as long as he is physically able to perform such services.\nUnder an agreement dated June 19, 1995, Michael L. (ML) Carr agreed to serve as Coach of the Boston Celtics and Executive Vice President of Basketball Operations of the Basketball Subsidiary through June 30, 1999 at an annual salary of $1,000,000.\nUnder an agreement dated June 1, 1990, as amended September 21, 1994, David R. Gavitt agreed to serve as Vice-Chairman of the Basketball Subsidiary through May 31, 1998. In return for Mr. Gavitt's services, he will receive an annual salary at the rate of $300,000 through June 1997, $200,000 through June 1998, $100,000 through June 2000 and $50,000 through June 2001.\nUnder the terms of an agreement effective as of July 1, 1995, Mr. Volk agreed to serve as General Manager of the Boston Celtics basketball operations through June 30, 1995 at a salary of $375,000 in fiscal 1996, rising to $425,000 in fiscal 1998.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -------------------------------------------------------------------------\nThe following table sets forth certain information regarding the Partnership's Units beneficially owned on September 20, 1995 by (i) each person who is known by the Partnership to beneficially own more than five percent (5%) of the outstanding Units, by (ii) each director of the General Partner, by (iii) each executive named in the Summary Compensation Table and by (iv) all directors and officers of the General Partner as a group. All information with respect to beneficial ownership has been furnished by the respective Unitholders to the Partnership.\nUnless otherwise indicated, all parties have both exclusive voting and investing power.\nPART IV -------\nItem 14.","section_13":"","section_14":"Item 14. Financial Statements and Exhibits\n(a) The following documents are filed as part of this report:\n1. Financial Statements:\nThe financial statements listed in the accompanying List of Financial Statements and Financial Statement Schedules are filed as part of this report.\n2. Exhibits:\nThe Exhibits listed below are filed as part of this report.\n(3) (a) -- Certificate of Limited Partnership of Boston Celtics Limited Partnership, as amended(1)\n(b) -- Agreement of Limited Partnership of Boston Celtics Limited Partnership(1)\n(c) -- Certificate of Incorporation of Celtics, Inc.(1)\n(d) -- By-laws of Celtics, Inc.(1)\n(e) -- First Amendment to Amended and Restated Agreement of Limited Partnership(7)\n(4) (a) -- Form of Certificate of Limited Partnership Interest(1)\n(b) -- Form of Unit Certificate(1)\n(c) -- Form of Eligibility Certification(1)\n(10) (a) -- Form of Transfer Agent Agreement by and among Boston Celtics Limited Partnership, The First National Bank of Boston, N.A., Celtics, Inc. and BC ALP, Inc.(1)\n(b) -- Joint Venture Agreement by and among NBA member organizations(1)\n(c) -- Constitution and By-laws of the National Basketball Association(1)\n(d) -- Agreement dated December 20, 1985 between CBS Sports, a division of CBS, Inc., and the NBA (confidential treatment previously granted)(1)\n(e) -- Agreement dated June 18, 1984, as amended on April 9, 1986, between Turner Broadcasting System, Inc. and the NBA (confidential treatment previously granted)(1)\n(f) -- Amendment dated January 19, 1988 to Agreement dated June 18, 1984, as amended on April 9, 1986, between Turner Broadcasting System Inc. and the NBA (confidential treatment previously granted)(2)\n(g) -- Telecast Rights Agreement, dated April 3, 1984, among Boston Celtics Incorporated, Gannett Massachusetts Broadcasting, Inc. and Gannett Co., Inc. (confidential treatment previously granted)(1)\n(h) -- Agreement, dated as of October 1, 1987, between Sportschannel New England Limited Partnership and Boston Celtics Limited Partnership (confidential treatment previously granted)(2)\n(i) -- Radio Broadcasting Rights Agreement dated October 27, 1986, between Boston Celtics Incorporated, Helen Broadcasting Partnership Limited Partnership and Papa Gino's of America, Inc. (confidential treatment previously granted)(1)\n(j) -- License and Lease Agreement, dated July 1, 1983, between New Boston Garden Corporation and Boston Celtics Incorporated (confidential treatment previously granted)(1)\n(k) -- Amendment to License and Lease Agreement dated July 1, 1983 between New Boston Garden Corporation and Boston Celtics Incorporated(3)\n(l) -- Promotional Agreement, dated as of July 1987, between Boston Celtics Limited Partnership and The Hartford Civic Center and Coliseum Authority (confidential treatment previously granted)(2)\n(m) -- Agreement, dated May 13, 1981, as amended, between Arnold Auerbach and Boston Celtics Incorporated(1)\n(n) -- Agreement, dated December 8, 1983, as amended, between Jan Volk and Boston Celtics Incorporated(1)\n(o) -- Form of Revolving Credit Agreement, dated as of November 24, 1986, between Boston Celtics Limited Partnership and the First National Bank of Boston(1)\n(p) -- Collective bargaining agreement, dated as of November 1, 1988, between the NBA and the National Basketball Players Association(4)\n(q) -- Asset Purchase Agreement among Boston Celtics Broadcasting Limited Partnership, Celtics Communications, Inc. and WFXT, Inc. dated as of November 21, 1989, including exhibits thereto, as amended(5)\n(r) -- Asset Purchase Agreement by and among Boston Celtics Acquisitions Limited Partnership, Celtics Communications, Inc., The Helen Broadcasting Company Limited Partnership and The Helen Broadcasting Corp. dated as of October 30, 1989, including exhibits thereto and letter agreement dated May 11, 1990(5)\n(s) -- Facility One Revolving Credit Note made by Boston Celtics Acquisitions Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. dated May 11, 1990(5)\n(t) -- Facility Two Revolving Credit Note made by Boston Celtics Acquisitions Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. dated May 11, 1990(6)\n(u) -- Revolving Credit Note made by Boston Celtics Broadcasting Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. dated May 11, 1990(6)\n(v) -- Accommodation Fee Agreement between Boston Celtics Limited Partnership, Boston Celtics Acquisitions Limited Partnership, Celtics Holdings Corp. and Boston Celtics Communications Limited Partnership dated as of May 11, 1990(6)\n(w) -- Accommodation Fee Agreement between Boston Celtics Limited Partnership, Boston Celtics Broadcasting Limited Partnership, Celtics Sub Corp. and Boston Celtics Communications Limited Partnership dated as of May 11, 1990(6)\n(x) -- Revolving Credit and Term Loan Agreement among Boston Celtics Broadcasting Limited Partnership, Celtics Sub Corp., Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of May 11, 1990(6)\n(y) -- Revolving Credit and Term Loan Agreement among Boston Celtics Acquisitions Limited Partnership, Celtics Holdings Corp., Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of May 11, 1990(6)\n(z) -- Agreement dated November 29, 1989 by and between the National Basketball Association and Turner Network Television, Inc. (confidential treatment previously granted)(7)\n(aa) -- NBA\/NBC Network Television Agreement dated November 9, 1989 by and between the National Basketball Association and NBC Sports, a division of National Broadcasting Company, Inc. (confidential treatment previously granted)(7)\n(bb) -- License\/Lease Agreement dated April 4, 1990 between Boston Celtics Limited Partnership and New Boston Garden Corporation (confidential treatment previously granted)(7)\n(cc) -- Office Lease Agreement dated April 4, 1990 between Boston Celtics Limited Partnership and New Boston Garden Corporation (confidential treatment previously granted)(7)\n(dd) -- Letter Agreement dated June 1, 1990 between Boston Celtics Limited Partnership and David R. Gavitt (confidential treatment previously granted)(7)\n(ee) -- Television Broadcasting Rights Agreement between Boston Celtics Limited Partnership and Boston Celtics Broadcasting Limited Partnership dated as of July 27, 1990(7)\n(ff) -- Extended, Amended and Restated Radio Broadcasting Rights Agreement among Boston Celtics Limited Partnership and Boston Celtics Acquisitions Limited Partnership dated May 11, 1990(7)\n(gg) -- Letter Agreement dated April 4, 1990 between the Boston Celtics Limited Partnership and New Boston Garden Corporation (confidential treatment requested)(7)\n(hh) -- Letter Agreement regarding Demand Promissory Note made by Boston Celtics Broadcasting Limited Partnership to Shawmut Bank, N.A. dated February 8, 1991(8)\n(ii) -- Demand Promissory Note made by Boston Celtics Broadcasting Limited Partnership and Boston Celtics Limited Partnership, dated as of February 11, 1991(8)\n(jj) -- Agreement dated October 23, 1990 by and among Boston Celtics Broadcasting Limited Partnership, Celtics Sub Corp., Boston Celtics Communications Limited Partnership and Boston Celtics Limited Partnership regarding the effectiveness of the Stage II Television Loan Agreement(9)\n(kk) -- Revolving Credit and Term Loan Agreement dated as of November 1, 1990 by and among Boston Celtics Broadcasting Limited Partnership, Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A.(9)\n(ll) -- Revolving Credit Note dated November 1, 1990 made by Boston Celtics Broadcasting Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A.(9)\n(mm) -- Security Agreement dated November 1, 1990 by and between Boston Celtics Broadcasting Limited Partnership and Shawmut Bank, N.A.(9)\n(nn) -- Guaranty dated November 1, 1990 executed by Boston Celtics Communications Limited Partnership in favor of Shawmut Bank, N.A.(9)\n(oo) -- Agreement dated October 23, 1990 by and among Boston Celtics Acquisitions Limited Partnership, Celtics Holdings Corp., Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. regarding the effectiveness of the Stage II Radio Loan Agreement(9)\n(pp) -- Revolving Credit and Term Loan Agreement dated November 1, 1990 by and among Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A.(9)\n(qq) -- Facility One Revolving Credit Note dated November 1, 1990 made by Boston Celtics Communications Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A.(9)\n(rr) -- Facility Two Revolving Credit Note dated November 1, 1990 made by Boston Celtics Communications Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A.(9)\n(ss) -- Security Agreement dated November 1, 1990 by and between Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A.(9)\n(tt) -- Amendment No. 1 to revolving Credit and Term Loan Agreement (Radio) (Stage Two) among Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(uu) -- Stage Two - Radio Facility One (Amended) Revolving Credit Note made by Boston Celtics Communications Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. dated April 10, 1991(9)\n(vv) -- Stage Two - Radio Facility Two (Amended) Revolving Credit Note made by Boston Celtics Communications Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. dated April 10, 1991(9)\n(ww) -- Letter Agreement Relating to Security Agreement between Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A. dated April 10, 1991(9)\n(xx) -- Amendment No. 1 to revolving Credit and Term Loan Agreement (Television) (Stage Two) among Boston Celtics Broadcasting Limited Partnership, Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(yy) -- Stage Two - Television (Amended) Revolving Credit Note made by Boston Celtics Broadcasting Limited Partnership and Boston Celtics Limited Partnership in favor of Shawmut Bank, N.A. Dated April 10,1991(9)\n(zz) -- Letter Agreement Relating to the Communications Limited Partnership Guaranty between Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A. dated April 10, 1991(9)\n(aaa) -- Letter Agreement Relating to Security Agreement between Boston Celtics Broadcasting Limited Partnership and Shawmut Bank, N.A. dated April 10, 1991(9)\n(bbb) -- Intercreditor Agreement among Boston Celtics Broadcasting Limited Partnership, WFXT, Inc. and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(ccc) -- Ten-Year Convertible Subordinated Note made by Boston celtics Broadcasting Limited Partnership in favor of WFXT, Inc. dated April 10, 1991(9)\n(ddd) -- Letter Agreement Regarding Amendments No. 1 and 2 to Revolving Credit and Term Loan Agreements between Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A. dated April 10, 1991(9)\n(eee) -- Amendment No. 2 to revolving Credit and Term Loan Agreement (Radio) (Stage Two) among Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(fff) -- Agreement Regarding Deferral of Radio Broadcast Rights Payments among Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(ggg) -- Agreement No. 2 to revolving Credit and Term Loan Agreement (Television) (Stage Two) among Boston Celtics Broadcasting Limited Partnership, Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(hhh) -- Agreement Regarding Deferral of Television Broadcast Rights Payments among Boston Celtics Broadcasting limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(iii) -- Modification Agreement Regarding Interest Rates among Boston Celtics Broadcasting Limited Partnership, Boston Celtics Communications Limited Partnership, Boston Celtics Limited Partnership and Shawmut Bank, N.A. dated as of April 10, 1991(9)\n(jjj) -- Letter of Waiver and Amendment Regarding Various Loan Agreements among Shawmut Bank, N.A., Boston Celtics Limited Partnership, Boston Celtics Broadcasting Limited Partnership and Boston Celtics Communications Limited Partnership dated March 27, 1992.(10)\n(kkk) -- Three year extension, dated July 6, 1992, of agreement dated December 8, 1983, as amended, between Jan Volk and Boston Celtics Incorporated.\n(lll) -- Credit Agreement among Celtics Limited Partnership (\"CLP\"), Boston Celtics Limited Partnership (\"BCLP\") and Shawmut Bank, N.A. (\"Shawmut\"), dated as of January 21, 1993.(11)\n(mmm) -- Revolving Credit Note from CLP to Shawmut, dated as of January 21, 1993.(11)\n(nnn) -- Security Agreement between CLP and Shawmut, dated as of January 21, 1993.(11)\n(ooo) -- Merger Agreement dated as of December 8, 1992 by and among Boston Celtics Limited Partnership, BCCLP Holding Corporation, BCCLP Acquisition Limited Partnership and Boston Celtics Communications Limited Partnership.(12)\n(ppp) -- Second Amended and Restated Agreement of Limited Partnership of Boston Celtics Communications Limited Partnership dated May 6, 1993.(13)\n(qqq) -- Agreement dated October 1, 1993, between Boston Celtics Limited Partnership and Fox Television Stations, Inc. (\"FTS\") that provides that, subject to certain conditions, a subsidiary of FTS would purchase an option to acquire ownership interests in BCBLP which, together with existing rights, could eventually result in FTS becoming the sole owner of WFXT.(13)\n(rrr) -- Financing Agreement dated October 29, 1993 by and among Boston Celtics Communications Limited Partnership Holding Corporation and Shawmut Bank, N.A.(14)\n(sss) -- Promissory Note dated October 29, 1993 executed by BCCLP Holding Corporation in favor of Shawmut Bank, N.A.(14)\n(ttt) -- Unit Option Agreement dated December 31, 1993 by and between Boston Celtics Limited Partnership and Paul E. Gaston.(15)\n(uuu) -- Unit Option Agreement dated December 31, 1993 by and between Boston Celtics Limited Partnership and Stephen C. Schram.(15)\n(vvv) -- Unit Option Agreement dated December 31, 1993 by and between Boston Celtics Limited Partnership and Thomas M. Bartlett, Jr.(15)\n(www) -- Financing Agreement dated September 15, 1994 between Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A.(16)\n(xxx) -- Promissory Note dated September 15, 1994 executed by Boston Celtics Communications Limited Partnership and Shawmut Bank, N.A.(16)\n(yyy) -- Credit Agreement dated October 31, 1994 by and among BCCLP and Shawmut Bank, N.A.(17)\n(zzz) -- Assignment and Security Agreement dated October 31, 1994 by and between BCCLP and Shawmut Bank, N.A.(17)\n(aaaa) -- Commercial Promissory Note between BCCLP and Shawmut Bank, N.A.(17)\n(bbbb) -- Support Agreement between BCLP and Shawmut Bank, N.A.(17)\n(cccc) -- Second Amendment To Agreement To Purchase Partnership Interests by and among BCBLP and CCI and FTS dated November 29, 1994.(18)\n(dddd) -- Unit Redemption Agreement dated August 30, 1995 between Boston Celtics Limited Partnership and Alan N. Cohen.(19)\n(eeee) -- Unit Redemption Agreement dated August 30, 1995 between Boston Celtics Limited Partnership and Gordon Cohen.(19)\n(ffff) -- Unit Redemption Agreement dated August 30, 1995 between Boston Celtics Limited Partnership and Laurie Cohen- Fenster.(19)\n(gggg) -- Promissory Note dated August 1, 1995 by BCLP to Alan N. Cohen.(19)\n(hhhh) -- Promissory Note dated August 1, 1995 by BCLP to Alan N. Cohen.(19)\n(iiii) -- Consulting Agreement dated August 30, 1995 between Celtics Limited Partnership and Alan N. Cohen.(19)\n(jjjj) -- Press Release dated August 30, 1995.(19)\n(1) Incorporated by reference from the exhibits filed with the Partnership's registration statement on Form S-1 filed under the Securities Act of 1933 (File No. 33-9796).\n(2) Incorporated by reference from exhibits filed with the Partnership's report on Form 10-K filed with the Securities and Exchange Commission for the year ended June 30, 1987.\n(3) Incorporated by reference from exhibits filed with the Partnerships' report on Form 10-K filed with the Securities and Exchange Commission for the year ended June 30, 1988.\n(4) Incorporated by reference from exhibits filed with the Partnership's report on Form 10-K filed with the Securities and Exchange Commission for the year ended June 30, 1989.\n(5) Incorporated by reference from the exhibits filed with the Partnership's Current Report on Form 8-K filed with the Securities and Exchange Commission on May 24, 1990.\n(6) Incorporated by reference from the exhibits filed with the Registration Statement on Form S-1 of Boston Celtics Communications Limited Partnership and the Partnership filed under the Securities Act of 1933 (File No. 33-34768).\n(7) Incorporated by reference from the exhibits filed with the Report on Form 10-K of the Registrant filed with the Securities and Exchange Commission for the year ended June 30, 1990.\n(8) Incorporated by reference from the exhibits filed with the Report on Form 10-K of Boston Celtics Communications Limited Partnership filed with the Securities and Exchange Commission for the year ended December 31, 1990.\n(9) Incorporated by reference from the exhibits filed with Boston Celtics Communications Limited Partnership's report on Form 8 filed with the Securities and Exchange Commission on April 15, 1991.\n(10) Incorporated by reference to the exhibits filed with Boston Celtics Communications Limited Partnership report on Form 10-K filed with the Securities and Exchange Commission on April 15, 1992.\n(11) Incorporated by reference to the exhibits filed with the report on Form 8-K filed with the Securities and Exchange Commission on January 22, 1993 (File No. 0-19324).\n(12) Incorporated by reference to the exhibits filed with the Boston Celtics Communications Limited Partnership report on Schedule 13E-3 filed with the Securities and Exchange Commission on December 9, 1992.\n(b) Reports on Form 8-K filed in the fourth quarter of 1993: Form 8-K dated May 14, 1993.\n(c) Exhibits - The response to this portion of Item 14 is filed as a part of this report.\n(d) Financial Statement Schedules - The response to this portion of Item 14 is filed as part of this report.\n(13) Incorporated by reference to the exhibits filed with the report on Form 10-K\/A Amendment No. 1 filed with the Securities and Exchange Commission on October 20, 1993 (File No. 0-19324).\n(14) Incorporated by reference to the exhibits filed with the report on Form 10-Q filed with the Securities and Exchange Commission on November 15, 1993 (File No. 0-19324).\n(15) Incorporated by reference to the exhibits filed with the report on Form 10-Q filed with the Securities and Exchange Commission on February 14, 1994 (File No. 0-19324).\n(16) Incorporated by reference to the exhibits filed with the report on Form 10-K filed with the Securities and Exchange Commission on September 28, 1994 (File No. 0-19324).\n(17) Incorporated by reference to the exhibits filed with the report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 1994 (File No. 0-19324).\n(18) Incorporated by reference to the exhibits filed with the report on Form 10-Q filed with the Securities and Exchange Commission on Feburary 14, 1995 (File No. 0-19324).\n(19) Incorporated by reference to the exhibits filed with the report on Form 8-K filed with the Securities and Exchange Commission on August 31, 1995 (File No. 0-19324).\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) and (2)(c) and (d)\nLIST OF FINANCIAL STATEMENTS\nFINANCIAL STATEMENTS CERTAIN EXHIBITS YEAR ENDED JUNE 30, 1995\nBOSTON CELTICS LIMITED PARTNERSHIP\nBOSTON, MASSACHUSETTS\nFORM 10-K -- ITEM 14(a)(1) and (2)\nBOSTON CELTICS LIMITED PARTNERSHIP\nLIST OF CONSOLIDATED FINANCIAL STATEMENTS\nThe following consolidated financial statements of Boston Celtics Limited Partnership and subsidiaries are included in Item 8:\nAll schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted because the required information has been disclosed in the footnotes to the Consolidated Financial Statements, or are not required under the related instructions or are inapplicable, and therefore have been omitted.\nReport of Independent Auditors\nTo the General Partner Boston Celtics Limited Partnership\nWe have audited the accompanying consolidated balance sheets of Boston Celtics Limited Partnership and subsidiaries as of June 30, 1995, and 1994, and the related consolidated statements of income, changes in partners' capital (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 Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Boston Celtics Limited Partnership 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 B to the consolidated financial statements, in 1995, the Partnership changed its method of accounting for certain investments in debt and equity securities.\n\/s\/ Ernst & Young LLP\nBoston, Massachusetts September 22, 1995\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Balance Sheets\nSee notes to consolidated financial statements.\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Statements of Income\nSee notes to consolidated financial statements.\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Statements of Changes in Partners' Capital (Deficit)\nSee notes to consolidated financial statements.\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Statements of Changes in Partners' Capital (Deficit) (Continued)\nSee notes to consolidated financial statements.\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Statements of Cash Flows\nBOSTON CELTICS LIMITED PARTNERSHIP and Subsidiaries Consolidated Statements of Cash Flows (Continued)\nSee notes to consolidated financial statements.\nNotes to Consolidated Financial Statements - ----------------------------------------------------------------------------- Boston Celtics Limited Partnership And Subsidiaries\nNote A - Basis of Presentation\nBoston Celtics Limited Partnership (the \"Boston Celtics\", \"BCLP\" or the \"Partnership\") a Delaware limited partnership, through Celtics Limited Partnership (\"CLP\"), its 99% owned limited partnership, owns and operates the Boston Celtics professional basketball team of the National Basketball Association, and through BCCLP Holding Corporation (\"Holdings\") and Celtics Investments Incorporated (\"CII\"), wholly-owned subsidiaries of BCLP and Holdings' wholly-owned subsidiary Celtics Capital Corporation (\"CCC\") (which holds investments) and Holdings' 99% owned limited partnership Boston Celtics Communications Limited Partnership (\"BCCLP\") and its 99% owned limited partnership Boston Celtics Broadcasting Limited Partnership (\"BCBLP\") which owns and operates Television Station WFXT - Channel 25 (\"WFXT\") and until its sale on June 30, 1994 owned and operated Radio Station WEEI - 590 AM both of Boston, Massachusetts. The General Partner of BCLP is Celtics, Inc. (\"CI\"); the General Partner of CLP is Boston Celtics Corporation (\"BCC\"); the General Partner of BCCLP is Celtics Communications, Inc. (\"CCI\"); and the General Partner of BCBLP is BCCLP. The General Partners of BCLP, CLP and BCCLP are Delaware corporations whose sole stockholders are Don Gaston, Paul Dupee, Paul Gaston (son of Don Gaston) and an affiliate. Alan Cohen's interest in the general partners was acquired by Paul Gaston and an affiliate on August 30, 1995 (see Note Q - Redemption of Partnership Interest Subsequent to Year End). The consolidated financial statements include the accounts of the Partnership, Holdings, CCC, CII and their subsidiary partnerships. All intercompany transactions are eliminated in consolidation.\nThe previously reported agreement between BCLP and Fox Television, Inc. (\"FTS\") pursuant to which FTS acquired BCBLP was closed on July 7, 1995, when FTS exercised its option (acquired for $15,000,000) for the acquisition of a 26% interest in BCBLP, converted $10,000,000 of convertible debt for an additional 25% interest in BCBLP and purchased the remaining 49% interest in BCBLP for $80,000,000 cash. Accordingly the income statement has been restated for all periods presented to report the results of operations of Television Station WFXT and Radio Station WEEI (sold June 30, 1994) as discontinued operations. For financial reporting purposes, the excess of the proceeds from the issuance of the option to FTS over the carrying value of the related 26% interest in BCLP and the gain on the sale of Radio Station WEEI are reported as Gain From Disposal of Discontinued Operations ($14,284,000 net of related income taxes of $3,150,000) in 1994. The gain from the conversion of the convertible note and sale of the remaining interest for cash (Estimated to be $40,000,000 net of related income taxes of $20,000,000) will be included in income when realized in July 1995.\nAssets and liabilities of discontinued operations included in the balance sheet at June 30, 1995 were:\nPursuant to terms of the agreement, as amended, $15,288,714 of available cash (as defined) ($7,338,583 to BCCLP, $152,887 to CCI and $7,797,244 to FTS), was distributed prior to the closing and the $10,000,000 convertible note was converted to a 25% interest in BCBLP at the closing.\nRevenues of discontinued operations were $51,897,000, $38,295,000 and $33,188000 for the years ended June 30, 1995, 1994 and 1993, respectively.\nNote B - Significant Accounting Policies\nCash Equivalents and Marketable Securities: Cash equivalents represent short-term investments with maturities at date of purchase of three months or less. Marketable securities represent investments with maturities greater than three months.\nConcentrations of Credit Risk: Financial instruments which potentially subject the Partnership to concentration of credit risk consist principally of cash equivalents, marketable securities and accounts receivable. The Partnership places its cash equivalents and marketable securities with highly rated financial institutions and United States government entities. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Partnership's customer base and their dispersion across many different industries and geographic areas and to the shortness of payment terms.\nMarketable Securities and Other Short Term Investments: Effective July 1, 1994, the Partnership adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (FAS 115) which established the accounting and reporting requirements for investments in equity securities that have readily determinable fair values and for all investments in debt securities. All affected investment securities must be classified as securities to be held to maturity, for trading, or available-for-sale.\nFinancial Instruments: Effective July 1, 1994, the Partnership adopted Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments.\" This Statement extends existing fair value disclosure practices for some instruments by requiring all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value. The carrying value reported in the Consolidated Balance Sheet for financial instruments approximates their fair values.\nFranchise, Network Affiliation and Other Intangible Assets: These assets, consisting principally of the National Basketball Association franchise, the value assigned to the Fox network affiliation agreement and other intangible assets are being amortized primarily on a straight-line basis over 40 years.\nProgram Broadcast Rights: Program broadcast rights for films and tapes are recorded as assets, at cost, together with the related liability when licenses are executed and the program is available for its first showing. The asset is amortized on a straight-line method generally based on the usage of the product or the term of the license. The current portion of these rights represents the estimated amount to be amortized during the next year. The liability to licensors is classified as current or noncurrent based on the payment terms of the license agreements.\nProperty and Equipment: Property and equipment acquired in the purchase of the television station is stated at the amounts based on fair value which was allocated to these assets at the time of acquisition. Other property and equipment is stated at cost. Building and leasehold improvements are depreciated over the remaining lives of the leases. Other property and equipment is being depreciated over estimated useful lives of from five to fifteen years using straight line or accelerated methods of depreciation as appropriate.\nBasketball Operations: Revenues, principally ticket sales and television and radio broadcasting fees generally are recorded as revenues at the time the game to which such proceeds relate is played. Team expenses, principally player and coaches salaries, related fringe benefits and insurance, and game and playoff expenses, principally National Basketball Association attendance assessments, arena rentals and travel, are recorded as expense on the same basis. Accordingly, advance ticket sales and payments on television and radio broadcasting contracts and payments for team and game expenses not earned or incurred are recorded as deferred revenues and deferred expenses, respectively, and amortized ratably as regular season games are played. General and administrative and selling and promotional expenses are charged to operations as incurred.\nTelevision and Radio Operations: Revenues, principally advertising sold to sponsors for commercials during program broadcasting, including Boston Celtics basketball games, are recognized when the commercials are broadcast. Operating expenses, principally broadcast production related costs, are expensed as incurred.\nIncome Taxes: No provision for income taxes is required by BCLP or, prior to their merger into Holdings in May 1993, for BCCLP or BCBLP. Their income and expenses have been or prior to the merger were taxable to or deductible to their partners. CCC, Holdings and CII, wholly-owned subsidiary corporations of BCLP, are subject to income taxes and report their income tax provision, including income (losses) of subsidiary partnerships BCCLP and BCBLP, using the liability method in accordance with Financial Accounting Standards Board (the \"Board\") Statement 109, Accounting for Income Taxes (see Note N). 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 will be in effect when the differences are expected to reverse. Although BCLP is considering strategies for exemption, under provisions of adopted legislation it may become taxable for income tax purposes as if it were a corporation effective July 1, 1998.\nNet Income Per Unit: Net income per Unit is based upon the weighted average number of units outstanding each year plus any unit equivalents attributable to options, if material.\nNote C - Marketable Securities and Other Short Term Investments\nThe following is a summary of marketable securities at June 30, 1995, which are classified as available for sale securities:\nOther short term investments, which consist primarily of private placement notes with a commercial bank with a maturity of under one year, are classified as held-to-maturity and are carried at amortized cost, which approximates market value. There were no unrealized gains or losses at June 30, 1995.\nThe gross realized gains on available-for-sale securities totaled $76,140 and $63,328, for U. S. corporate securities and U. S. government securities respectively, and the gross realized losses totaled $29,214 for U. S. government securities. The net adjustment to unrealized holding gains on available-for-sale securities included as a separate component of Partners' Capital (Deficit) totaled $511,354 in 1995.\nThe amortized cost and estimated fair value of available-for-sale securities at June 30, 1995, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.\nNote D - Property and Equipment\nProperty and equipment are summarized as follows:\nNote E - Deferred Compensation\nCertain player contracts provide for guaranteed compensation payments which are deferred until a future date. Operations are charged amounts equal to the present value of future guaranteed payments in the period in which the compensation is earned. The present value of payments due under these agreements is as follows:\nNote F - Notes Payable\nNotes payable are comprised of:\nThe CLP balance represents the outstanding borrowings under a $50,000,000 loan with its commercial bank. The loan agreement as amended permits borrowings of up to $50,000,000 through December 31, 1997, with the available amount declining thereafter by $1,250,000 per quarter. The term of the loan extends through December 31, 2002. Interest on the initial $30,000,000 is payable quarterly in arrears at an annual rate of 6.4% through December 31, 1995. Borrowings in excess of the initial $30,000,000, and all borrowings outstanding after December 31, 1995, bear interest at optional floating rates (7.375% and 4.875% at June 30, 1995 and 1994). Quarterly payments of interest only are payable in arrears through December 31, 1997. Effective January 1, 1998, the agreement related to the loan requires quarterly payments of principal in the amount necessary to reduce the outstanding principal balance to equal the declining available borrowings, if necessary, together with interest. The borrowings under the Bank Loan are secured by all of the assets and are the liability of CLP, the basketball subsidiary partnership.\nThe BCCLP balance represents the outstanding borrowings under an $85,000,000 financing agreement dated October 31, 1994 with the Partnership's commercial bank. The loan bears interest at a floating rate plus one percent (6.25% at June 30, 1995 and a weighted average interest rate of 6.85% from September 15, 1994 to June 30, 1995 ) and is due on September 30, 1995. The balance of the loan was repaid on July 7, 1995 concurrent with the sale of the remaining partnership interests in BCBLP to FTS.\nThe principal of the Convertible Subordinated Note Payable (the \"Fox Note\") is due in a single payment at May 11, 2000. The Fox Note bears interest at the rate of 10% per year payable semi-annually in arrears. The Convertible Subordinated Note Payable was converted into a 25% interest in BCBLP on July 7, 1995 (see Note A).\nThe agreements relating to both the commercial bank borrowings and the convertible subordinated note payable include various provisions and covenants customary in lending arrangements of this type including limitations on distributions to unitholders. In addition, the agreements relating to the commercial bank borrowings include covenants requiring BCBLP to achieve certain minimum cash flows, and to restrict borrowings (other than purchase money obligations) to borrowings with the consent of the bank. At June 30, 1995 BCBLP was in compliance with these covenants. Aggregate maturities of notes payable at June 30, 1995 are as follows:\nAt June 30, 1995 and 1994, $237,639 and $394,479 were included in accounts payable and accrued expenses for accrued interest.\nInterest charged to operations in connection with borrowings (including the BCBLP term loan with interest at optional floating rates (6.375% and 5.5% at June 30, 1994 and 1993) from a commercial bank which was repaid during fiscal year 1995 and a $15,000,000 short term loan with interest at 4% from the commercial bank borrowed and repaid during fiscal year 1994) were $8,478,000, $4,387,000 and $3,106,000 in the years ended June 30, 1995, 1994 and 1993, respectively.\nNote G - Related Party Transactions\nManagement fee obligations of $2,333,974, $2,873,942 and $1,481,444 applicable to Celtics, Inc., general partner of the Partnership, Boston Celtics Corporation, general partner of CLP, and Celtics Communications, Inc., general partner of BCCLP and BCBLP were charged to operations during the years ended June 30, 1995, 1994 and 1993, respectively. Boston Celtics Corporation receives a management fee of $750,000 per annum subject to annual increases based on annual cash flows from basketball operations after June 30, 1989. Prior to a restructuring on January 21, 1993 pursuant to which BCLP contributed all of its basketball assets and business, subject to all of its liabilities (including its liabilities under the $50 million commercial bank loan agreement) such fee was paid to Celtics, Inc. general partner of BCLP. Celtics Communications, Inc. received management fees from BCCLP and BCBLP based on a percentage of sales. The rates of these fees were 1% through December 31, 1992 and 2% thereafter.\nNote H - Program Broadcast Rights Obligations\nThe Partnership is committed to the following minimum payments for program broadcast rights obligations of BCBLP (see Note A - Basis of Presentation for a description of the disposition of BCBLP to FTS on July 7, 1995) for films and programs available for broadcast at June 30, 1995:\nNote I - Commitments and Contingencies\nThe Partnership has employment agreements with officers, coaches and players of the basketball team (CLP) and an executive of BCCLP. Certain of the contracts provide for guaranteed payments which must be paid even if the employee is injured or terminated. Amounts required to be paid under such contracts in effect as of September 20, 1995, including option years and $4,175,000 included in accounts payable at June 30, 1995, but excluding amounts previously earned (see Note E - Deferred Compensation), are as follows:\nBCLP maintains disability and life insurance policies on most of its key players. The level of insurance coverage maintained is based on BCLP's determination of the insurance proceeds which would be required to meet its guaranteed obligations in the event of permanent or total disability of its key players.\nUnavailable program rights commitments - The Partnership is committed to the following payments for program broadcast rights obligations of BCBLP (see Note A - Basis of Presentation for a description of the disposition of BCBLP to FTS on July 7, 1995) for film and program rights not available for broadcast at June 30, 1995:\nLease commitments - The Partnership and its subsidiaries are committed under noncancelable, long-term leases substantially all of which are related to BCBLP (see Note A - - Basis of Presentation for a description of the disposition of BCBLP to FTS on July 7, 1995) for certain of their facilities and equipment. Rent expense charged to operations during the years ended June 30, 1995, 1994 and 1993 were $2,272,000, $2,746,000 and $2,670,000, respectively. Minimum annual payments, including renewable option periods, required by these leases are:\nNote J - Options to Acquire Units of Partnership Interest\nOn December 31, 1993 the Partnership granted options to three employees to acquire 530,000 Limited Partnership Units of BCLP (Units) at the price of $16.25 per Unit less all cash distributions per Unit made by the Partnership from July 31, 1993 to the date of exercise. Options for 500,000 of such Units become exercisable in installments as follows:\nOptions for the remaining 30,000 Units became exercisable June 30, 1994. All of the options expire 10 years from the date of grant. In addition to exercising the right to purchase units pursuant to the options, a holder may exercise a Unit Appreciation Right, entitling the holder to receive an amount equal to the excess of the fair market value of a Unit, determined on the date of exercise over the exercise price of the related option on the date the Unit Appreciation Right was granted in which event options for an equivalent number of units will be cancelled. In the sole discretion of the General Partner of BCLP payments of amounts payable pursuant to Unit Appreciation Rights may be made solely in Units, solely in cash, or in a combination of cash and Units. The compensation element of the options, $3,174,000 and $850,000 in the years ended June 30, 1995 and June 30, 1994, respectively, is being charged to earnings ratably over the period from the date of grant until the date of exercise based on the exercise price of the optioned Units at the end of each quarter. The market price of Limited Units of BCLP on June 30, 1995 was $21.25.\nNote K - Benefit Plans\nEach of the Partnership's subsidiaries have defined contribution plans covering substantially all employees who meet certain eligibility requirements. Participants may make contributions to the plans from 3% to 15% of their compensation (as defined). Contributions to these plans range from 50% to 100% on the first 2.5% to 5% of compensation contributed by each participant. Contributions are fully vested after three to five years of service. Costs of the plans charged to operations amounted to $374,623, $219,819 and $226,360 during the years ended June 30, 1995, 1994 and 1993, respectively.\nA subsidiary partnership participated in a multiemployer retirement plan covering certain union employees of the radio station. This subsidiary charged $78,746 and $128,698 to operations during the years ended June 30, 1994 and 1993, respectively, for its share of plan costs.\nNote L - Cash Flows\nReconciliations of net income to net cash flows from operating activities are as follows:\nThe change in accounts receivable is after write-offs, net of recoveries, of $397,544, $6,376 and $131,903 in 1995, 1994 and 1993, respectively.\nNote M - Quarterly Results (Unaudited)\nA summary of operating results, net income per unit based on the average units outstanding throughout each year calculated for financial statement purposes only, and cash distributions for the quarterly periods in the two years ended June 30, 1994 is set forth below (000's omitted).\nNote N - Income Taxes\nNo income tax provision was made for Holdings or its subsidiary partnerships BCCLP or BCBLP at June 30, 1993 because their taxable loss for the period from May 6 (date of merger) to June 30, 1993 was not material.\nFor financial reporting purposes a valuation reserve of $11 million was established to reduce the deferred tax assets (intangibles) acquired in the merger to the amount considered realizable on a more likely than not basis. Components of deferred tax liabilities and assets, all of which relate to Holdings or its subsidiary partnerships BCCLP and BCBLP are:\nIncome taxes applicable to the sale of BCBLP to FTS, Inc. ($5,200,000) other than taxes applicable to the recognition of gain from the sale of the option to FTS, Inc. (see Note A) are included in other current assets and deferred charges on the balance sheet at June 30, 1995 and are to be charged to income when the gain on the sale is recognized upon its realization on July 7, 1995.\nAt June 30, 1995 the tax basis of the net assets of BCLP and CLP exceeded their financial bases by approximately $49,200,000, consisting primarily of Deferred Compensation of $21,200,000 and the National Basketball Franchise of $28,000,000. A substantial part of the Deferred Compensation will be paid prior to July 1, 1998, when BCLP may become subject to federal income taxes. No deferred tax assets or liabilities have been provided for these differences because BCLP and CLP are not subject to income taxes.\nThe provision for income taxes included in the consolidated statement of income is comprised of state taxes currently payable of $1,750,000 and federal taxes currently payable of $5,000,000 for the year ended June 30, 1995 and state taxes currently payable of $100,000 and deferred taxes, principally federal of $2,900,000 for the year ended June 30, 1994.\nA reconciliation of the statutory federal income tax rate applied to reported pre-tax earnings of CII, CCC, Holdings, BCCLP and BCBLP ($23,400,000 in 1995 and $17,982,000 in 1994) before deduction of taxable minority interest ($6,800,000 in 1995 and $1,700,000 in 1994) to the effective tax rate of the provision is:\nNote O - Accounts Payable and Accrued Expenses\nThe balances include accrued compensation of $8,331,000 and $1,768,000 at June 30, 1995 and 1994 and accrued management fees of $586,000 and $1,276,000 due to the general partners of the Partnership and its subsidiaries at June 30, 1995 and 1994.\nNote P - Advertising\nThe Partnership charged $1,135,000, $1,534,000 and $1,025,000 to operations for advertising during the years ended June 30, 1995, 1994 and 1993, respectively, of which $464,000 and $639,000 were included in accounts payable and accrued expenses at June 30, 1995 and 1994, respectively.\nNote Q - Redemption of Partnership Interest Subsequent to Year End\nOn August 30, 1995 the Partnership redeemed an aggregate of 758,444 units representing assignments of beneficial ownership of limited partnership interest in BCLP. The redeemed units were beneficially owned by Alan Cohen and his son and daughter. Mr. Cohen was formerly an officer and director of the corporate general partners of the Partnership and its 99% owned limited partnerships BCCLP and BCBLP.\nUnder the terms of the redemption, Mr. Cohen's son and daughter were paid $1,941,450 equal to $21.50 in cash for each of the 90,300 units acquired from them.\nMr. Cohen received two notes from BCLP in exchange for the aggregate of 668,144 units acquired by BCLP from him. The two notes have an aggregate initial face amount of $14,365,096 equal to $21.50 per unit for each unit acquired from him. The two notes, which are due and payable on July 1, 2000 (unless prepaid earlier pursuant to mandatory prepayment provisions contained therein) also provide that the amounts to be paid to Mr. Cohen pursuant to the terms of the notes will be increased by specified amounts on each July 1 during their term. If Mr. Cohen holds the two notes until July 1, 2000 he would be entitled to receive aggregate payments (excluding interest) in the amount of $20,044,320 equal to $30.00 per unit for each unit acquired from him. Each of the notes bears interest payable quarterly at the rate of 7.76% per annum.\nThe Partnership also announced that CLP has entered into a three year consulting agreement with Alan Cohen. The consulting agreement provides that Mr. Cohen is to be paid $260,000 per year in exchange for making himself available to provide consulting services to CLP. In addition, the interests of Mr. Cohen in the corporate general partners of the Partnership, CLP and BCCLP were acquired by Mr. Paul Gaston and an affilliate.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBOSTON CELTICS LIMITED PARTNERSHIP\nBy: Celtics, Inc., General Partner\nDate: September 28, 1995 By: \/s\/ Stephen C. Schram Stephen C. Schram 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.","section_15":""}
{"filename":"822690_1995.txt","cik":"822690","year":"1995","section_1":"Item 1. Business.\nGeneral Development of Business.\nPhoenix Leasing Cash Distribution Fund III, a California limited partnership (the Partnership), was organized on June 29, 1987. The Partnership was registered with the Securities and Exchange Commission with an effective date of January 5, 1988 and shall continue to operate until its termination date unless dissolved sooner due to the sale of substantially all of the assets of the Partnership or a vote of the Limited Partners. The Partnership will terminate on December 31, 1998. The General Partner is Phoenix Leasing Incorporated, a California corporation. The General Partner or its affiliates also is or has been a general partner in several other limited partnerships formed to invest in capital equipment and other assets.\nThe initial public offering was for 400,000 units of limited partnership interest at a price of $250 per unit with an option of increasing the public offering up to a maximum of 600,000 units. The Partnership sold 528,151 units for a total capitalization of $132,037,750. The public offering terminated on December 31, 1990. Of the proceeds received through the offering, the Partnership has incurred $17,240,775 in organizational and offering expenses.\nPhoenix Black Rock Cable J.V. (the \"Subsidiary\") is a majority owned subsidiary of the Partnership (hereinafter, both entities are collectively referred to as the \"Consolidated Partnership\"). The Subsidiary was formed under the laws of California on January 10, 1992 to own and operate a cable television system in the states of Nevada and California.\nNarrative Description of Business.\nThe Consolidated Partnership conducts its business in two business segments: Equipment Leasing and Financing Operations, and Cable Television System Operations. A discussion of these two segments follows:\nEquipment Leasing and Financing Operations.\nFrom the initial formation of the Partnership through December 31, 1995, the total investments in equipment leases and financing transactions (loans), including the Partnership's pro rata interest in investments made by joint ventures, approximate $219,986,000. The average initial firm term of contractual payments from equipment subject to lease was 38.64 months, and the average initial net monthly payment rate as a percentage of the original purchase price was 2.53%. The average initial firm term of contractual payments from loans was 58.53 months.\nThe Partnership's principal objective is to produce cash flow to the investors on a continuing basis over the life of the Partnership. To achieve this objective, the Partnership has invested in various types of capital equipment and other assets to provide leasing or financing of the same to third parties, including Fortune 1000 companies and their subsidiaries, middle-market companies, emerging growth companies, cable television system operators and others, on either a long-term or short-term basis. The types of equipment that the Partnership will invest in will include, but is not limited to, computer peripherals, terminal systems, small computer systems, communications equipment, IBM mainframes, IBM-software compatible mainframes, office systems, CAE\/CAD\/CAM equipment, telecommunications equipment, cable television equipment, medical equipment, production and manufacturing equipment and software products.\nThe Partnership has acquired equipment pursuant to either \"Operating\" leases or \"Financing\" leases. At December 31, 1995 approximately 74% of the equipment owned by the Partnership was classified as Financing leases. The Partnership has also provided and intends to provide financing secured by assets in the form of notes receivable. Operating leases are generally short-term leases under which the lessor will receive aggregate rental payments in an amount that is less than the purchase price of the equipment. Financing leases are generally for a longer term under which the non-cancellable rental payments due during the initial term of the lease are at least sufficient to recover the purchase price of the equipment. A significant portion of the net offering proceeds to the Partnership has been invested in capital equipment subject to Operating leases.\nThe Partnership has made secured loans to emerging growth companies, security monitoring companies, cable television systems and other businesses. These loans are asset-based and the Partnership receives a security interest in the assets financed.\nPage 4 of 37\nThe Partnership's financing activities have been concentrated in the cable television industry. The Partnership has made secured loans to operators of cable television systems for the acquisition, refinancing, construction, upgrade and extension of such systems located throughout the United States. The loans to cable television system operators are secured by a senior or subordinated interest in the assets of the cable television system, its franchise agreements, subscriber lists, material contracts and other related assets. In some cases the Partnership has also received personal guarantees from the owners of the systems.\nSeveral of the cable television system operators to whom the Partnership provided financing have experienced financial difficulties. These difficulties are believed to have been caused by several factors. Some of these factors are: a significant reduction in the availability of debt from banks and other financial institutions to finance the acquisition and operations, uncertainties related to future government regulation in the cable television industry and the economic recession in the United States. These factors have resulted in a significant decline in the demand for the acquisition of cable systems and have further caused an overall decrease in the value of many cable television systems. As a result of the above, many of the Partnership's notes receivable from cable television system operators have gone into default. The result is that the Partnership has not received scheduled payments, has had to grant loan extensions, has experienced an increase in legal and collection costs and in some cases, has had to foreclose on the cable television system. The impact of this has been a decrease in the overall return on the Partnership's investments in such notes.\nThe Partnership has obtained an ownership interest in several cable system joint ventures that it obtained through foreclosure. These cable systems currently generate a positive monthly cash flow and provided cash distributions to the Partnership during 1995 and 1994. The cable systems are managed and operated by an affiliate of the General Partner. Upon foreclosure, the assets of the cable television system were booked at the lower of the Partnership's cost (the carrying value of the note) or the estimated fair value of the cable television system.\nCompetition. The General Partner has concentrated the Partnership's activities in the equipment leasing and financing industry, an area in which the General Partner has developed an expertise. The computer equipment leasing industry is extremely competitive. The Partnership competes with many well established companies having substantially greater financial resources. Competitive factors include pricing, technological innovation and methods of financing (including use of various short-term and long-term financing plans, as well as the outright purchase of equipment). Generally, the impact of these factors to the Partnership would be the realization of increased equipment remarketing and storage costs, as well as lower residuals received from the sale or remarketing of such equipment.\nCable Television System Operations.\nPhoenix Black Rock Cable J.V. (the Subsidiary), a majority owned subsidiary of the Partnership, owns a cable television system in the states of Nevada and California that was acquired through foreclosure on a defaulted note receivable to the Partnership on January 10, 1992. The net carrying value of the Partnership's share of this defaulted note receivable was approximately $1,620,000, which was exchanged for an 81.22% ownership interest in this joint venture. Phoenix Cable Management Inc. (PCMI), an affiliate of the General Partner, provides day to day management services in connection with the operation of the system.\nThe cable television system owned by Phoenix Black Rock Cable J.V. is located in the counties of Clark and Nye in the State of Nevada and in the county of Inyo in the State of California. The cable television system consists of headend equipment in five locations and 156 miles of plant passing approximately 2,900 homes and has approximately 1,838 cable subscribers. The Subsidiary's cable television system serves the communities of Pahrumph, Beatty and Blue Diamond in Nevada and Cow Creek and Grapevine in California. The Subsidiary operates under one non-exclusive franchise agreement with the county of Nye in Nevada, which expires in 2009, and a National Park Service Permit for Death Valley, California, which expires in 1996.\nCable television systems receive signals transmitted by nearby radio and television broadcast stations, microwave relay systems and communications satellites and distribute the signals to subscribers via coaxial cable. The subscribers pay a monthly fee to the cable television system for such services. Cable television companies operate under a non-exclusive franchise agreement granted by each local government authority. As part of the franchise agreement, the franchisee typically pays a portion of the gross revenues of the system to the local government.\nPage 5 of 37\nThe Partnership intends to own and operate the cable system until market conditions would enable a sale at acceptable terms. Any excess cash generated from operations of the cable system will be used for upgrades and improvements to the system in order to maximize the value of the system.\nCompetition. The Partnership's cable operations compete with numerous other companies with far greater financial resources. In addition, cable television franchises are typically non-exclusive and the Partnership could be directly competing with other cable television systems. Cable television also competes with conventional over-the-air broadcast television and direct broadcast satellite transmission. Future technological developments may also provide additional competitive factors.\nThe newly passed Telecommunications Bill allows telephone companies to enter into the cable television business and vice-versa. Large cable television systems that have upgraded their systems with fiber and two way capabilities may find themselves getting a piece of the much larger telephone revenue. For the smaller rural cable systems, such as those owned by the Partnership or through investments in joint ventures, it is unlikely that the Partnership will enter into telephone services nor will the telephone companies try to seek our customers in the near future. The systems owned by the Partnership are too small and not dense enough to pay for the large amount of capital expenditures needed for these services.\nA favorable part of the bill is that small cable systems will be immediately deregulated from most regulations and that the definition of a small cable operator is under 600,000 subscribers. This will allow small operators to raise rates if needed, and eliminate the need to provide franchise authorities with costly rate filings and justifications. The new bill also allows the local telephone companies to buy out small cable operators in their own region as well as to joint venture with small cable operators. During 1995, the General Partner has observed a renewed market interest in small cable systems. The final impact of the newly passed Telecommunications Bill will not be known fully until a technical rewrite is completed and all the legal challenges have been made.\nPlease see Note 16 in the Partnership's financial statements for financial information about the Partnership's business segments.\nOther.\nA brief description of the type of assets in which the Partnership has invested as of December 31, 1995, together with information concerning the uses of assets is set forth in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nEquipment Leasing and Financing Operations.\nThe Partnership is engaged in the equipment leasing and financing industry. The primary assets held by the Partnership are its investments in leases and loans, either directly or through its investments in joint ventures.\nAs of December 31, 1995, the Partnership owns equipment and has outstanding loans to borrowers with an aggregate original cost of $38,539,000. The equipment and loans have been made to customers located throughout the United States. The following table summarizes the type of equipment owned or financed by the Partnership, including its pro rata interest in joint ventures, at December 31, 1995.\nPercentage of Asset Types Purchase Price(1) Total Assets ----------- ----------------- ------------- (Amounts in Thousands)\nFinancing Related to Cable Television Systems and Other Media $ 16,674 43% Computer Peripherals 11,298 29 Computer Mainframes 5,654 15 Small Computer Systems 1,698 4 Reproduction Equipment 1,670 4 Capital Equipment Leased to Emerging Growth Companies 853 2\nPage 6 of 37\nMiscellaneous 494 2 Financing of Security Monitoring Systems Companies 198 1 --------- ----- TOTAL $ 38,539 100% ========= =====\n(1) These amounts include the Partnership's pro rata interest in equipment joint ventures of $1,238,000, cost of equipment on financing leases of $979,000 and original cost of outstanding loans of $16,873,000 at December 31, 1995.\nCable Television System Operations.\nThe Subsidiary's principal plants and property consist of electronic headend equipment and its plant (cable). The headends are located on land that is leased by the Subsidiary.\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.\nNo matters were submitted to a vote of limited partners, through the solicitation of proxies or otherwise, during the year covered by this report.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Securities and Related Security Holder Matters.\n(a) The Registrant's limited partnership interests are not publicly traded. There is no market for the Registrant's limited partnership interests and it is unlikely that any will develop.\n(b) Approximate Number of Equity Security Investments:\nNumber of Unit Holders Title of Class as of December 31, 1995 -------------- -----------------------\nLimited Partners 12,801\nItem 6.","section_6":"Item 6. Selected Financial Data.\nAmounts in Thousands Except for Per Unit Amounts ------------------------------------------------ 1995(1) 1994(1) 1993 1992 1991 ---- ---- ---- ---- ----\nTotal Income $ 5,109 $ 7,697 $ 15,345 $ 25,221 $ 34,245\nNet Income (Loss) 3,800 945 194 (7,118) (4,273)\nTotal Assets 20,381 24,322 32,435 58,644 97,344\nLong-term Debt Obligations -- -- -- 1,479 6,361\nDistributions to Partners 7,751 7,751 18,886 18,323 18,382\nNet Income (Loss) per Limited Partnership Unit 7.28 .85 -- (13.53) (8.08)\nDistributions per Limited Partnership Unit 15.00 15.00 36.43 35.17 33.80\nPage 7 of 37\n(1) The 1995 and 1994 amounts reflect the consolidated activity of the Partnership and its subsidiary.\nThe above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this report.\nPage 8 of 37\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nPhoenix Leasing Cash Distribution Fund III, a California limited partnership, and Subsidiary (the Partnership) reported net income of $3,800,000 during the year ended December 31, 1995, as compared to net income of $945,000 and $194,000 during 1994 and 1993, respectively. The increase in net income during 1995, as compared to 1994, is primarily attributable to the recognition, as income, of the recovery of a portion of the allowance for loan losses.\nTotal revenues decreased by $2,588,000 and $7,648,000 during 1995 and 1994, respectively, when compared to the same period in the previous year. The decrease in total revenues is primarily the result of decreases in rental income of $2,373,000 and $4,757,000 during 1995 and 1994, respectively, as compared to the same period in the previous year. Rental income decreased primarily as the result of a decrease in the amount of equipment owned. At December 31, 1995, the Partnership owned equipment, excluding the Partnership's pro rata interest in joint ventures, with an aggregate original cost of $20.4 million, as compared to $48.6 million at December 31, 1994. During 1994, the Partnership also reported declines in interest income from notes receivable and a decreased gain on the sale of equipment.\nDuring 1995, the Partnership received payoffs on six notes receivable from cable television system operators totaling $7.8 million of which $7.5 million was from notes receivable considered to be impaired. The Partnership recognized interest income of $1.1 million from the receipt of the final payoff on these notes receivable. Included in the payoff of $7.8 million is a settlement payment of $2.7 million on a defaulted note receivable from a cable television system operator. The Partnership had provided a loan loss reserve in an amount equal to the net carrying value of this note in a prior year. Upon recovery of a portion of this defaulted note receivable, the Partnership reduced the allowance for loan losses by $2 million during 1995. This reduction in the allowance for loan losses was recognized as income during the period.\nAt December 31, 1995, the Partnership holds notes receivable from cable television system operators and security monitoring companies with a net carrying value of approximately $17 million, of which $16 million is considered to be impaired. The Partnership has suspended the accrual of interest on these impaired notes and has provided an allowance for loan losses. The General Partner is currently working with the borrowers, other creditors and the bankruptcy court in order to seek remedies that will maximize the recovery of the Partnership's investment in these notes.\nTotal expenses decreased by $5,436,000 and $8,430,000 during 1995 and 1994, respectively, as compared to the same period in the previous year. The decrease in total expenses for these periods is primarily due to the decrease in depreciation and amortization expense of $2,400,000 and $5,730,000, during 1995 and 1994, respectively, as compared to the same period in the prior year. The decrease in depreciation and amortization is a result of the reduction in the amount of equipment owned by the Partnership. Additionally, an increasing portion of the equipment owned by the Partnership has been fully depreciated. Another factor contributing to the decrease in total expenses during 1995, when compared to 1994, was a recovery of a prior provision for losses on receivables as discussed previously.\nLease related operating expenses experienced a decrease during 1995 and 1994, as compared to the same period in the previous year, primarily due to a decrease in remarketing and administrative expenses charged to the Partnership on its reproduction equipment that is leased pursuant to a vendor lease agreement. This decrease is reflective of the decrease in the amount of reproduction equipment owned by the Partnership and a corresponding decrease in the rental revenues received from such equipment.\nCable Television System Operations:\nThe Partnership reported cable subscriber revenues from its Subsidiary of $676,000 during 1995, as compared to $654,000 during 1994, and total expenses of $582,000 during 1995 as compared to $527,000 during 1994. During 1994, the Partnership determined that the financial position of this cable television system had become material to the operations of the Partnership; accordingly, the financial statements for the Partnership 1995 and 1994 have been consolidated. However, during 1993, this cable television system subsidiary was reflected as an investment in a foreclosed cable system joint venture on the balance sheet and the net earnings were reported as equity in earnings from foreclosed cable system joint ventures.\nPage 9 of 37\nThe Partnership has also foreclosed upon the collateral of several notes receivable from certain cable television system operators. As a result, the Partnership has ownership interests in the operating cable television systems organized as joint ventures with affiliates also holding ownership interests. During 1995, the Partnership foreclosed upon an additional cable television system in which it held a note receivable. The Partnership's equity interest in the earnings (losses) from the foreclosed cable system joint ventures was minimal during 1995 and 1994.\nInflation affects the Partnership in relation to the current cost of equipment placed on lease and the residual values realized when the equipment comes off-lease and is sold. During the last several years inflation has been low, thereby having very little impact upon the Partnership.\nLiquidity and Capital Resources\nThe Partnership's primary source of liquidity comes from its contractual obligations with lessees and borrowers for fixed payment terms. As the initial lease terms of the leases expire, the Partnership will continue to renew, remarket or sell the equipment. The future liquidity of the Partnership will depend upon the General Partner's success in collecting contractual amounts and re-leasing and selling the Partnership's equipment as it comes off lease. As another source of liquidity, the Partnership owns a cable television system, has investments in foreclosed cable systems joint ventures and investments in leasing joint ventures.\nThe net cash generated by operating activities decreased by $2,960,000 and $3,668,000 during 1995 and 1994, respectively, as compared to the previous year. This decrease is primarily due to a decrease in rental income, a result of the decrease in the size of the equipment portfolio. The decrease in proceeds from the sale of equipment during 1995 and 1994, as compared to the same period in the prior year, is attributable to a decrease in the value of the equipment sold.\nPrincipal payments from notes receivable increased substantially during 1995, when compared to the same period in 1994, due to payoffs from several outstanding notes receivable during 1995. During 1995, the Partnership received payoffs of notes receivable from seven cable television system operators.\nDuring the third quarter of 1995, the Partnership invested an additional $6,146,000 in a note receivable from a cable television system operator. The Partnership had previously extended credit with a net carrying value of approximately $2.9 million of subordinated debt to this cable television system operator. This cable television system operator is in default on its outstanding debt. The current funding of $6.1 million was paid to the senior lender and the Partnership has now assumed a first and second secured position in the assets of the cable television system. The General Partner believes that it is now in a better position to negotiate a settlement or foreclosure with the borrower in order to maximize the Partnership's recovery of its investment. To help finance this additional funding, the Partnership borrowed an additional $2,000,000 from a bank during 1995. The debt is repayable over 30 months with interest tied to the bank's prime rate. During 1995, the Partnership repaid $1,671,000 of this debt, which included a prepayment of $1,471,000 made in November of 1995.\nDuring 1995, the Partnership reported an overall increase in cash distributions received from its joint ventures. The overall increase in distributions reflects an increase in distributions from equipment joint ventures and foreclosed cable system joint ventures. The increased distributions from the equipment joint venture during 1995 is related to distributions received from a joint venture that was formed in October of 1994. The increased cash distributions from foreclosed cable system joint ventures for 1995 was attributable to the sale of a cable system in one joint venture and the distribution of excess cash from operations in the other remaining cable system.\nAs of December 31, 1995, the Partnership owned equipment held for lease with an aggregate original cost of $3,690,000 and a net book value of $22,000, compared to $18,707,000 and $447,000, respectively, as of December 31, 1994. The General Partner is actively engaged, on behalf of the Partnership, in remarketing and selling the Partnership's off-lease portfolio.\nThe cash distributed to limited partners during 1995, 1994 and 1993 was $7,751,000, $7,751,000 and $18,886,000, respectively. As a result, the cumulative cash distributions to the limited partners are $96,226,000, $88,475,000 and $80,724,000 as of December 31, 1995, 1994 and 1993, respectively. The General Partner did not receive cash distributions during 1995, 1994 and 1993. The General Partner has elected not to receive payment, at this time, for its share of the cash available for distribution due to its negative capital account.\nThe Partnership's asset portfolio continues to decline as a result of the ongoing liquidation of assets, and therefore it is expected that the cash generated from Partnership leasing operations will also decline. As the cash\nPage 10 of 37\ngenerated by operations continues to decline, the rate of cash distributions made to limited partners will also decline. The distributions to partners on January 15, 1996 were made at approximately the same rate as the distributions made during 1995. However, after the January 15, 1996 distribution, the Partnership will switch to annual distributions with the first annual distribution expected to be made on January 15, 1997.\nCash generated from leasing and financing operations has been and is anticipated to continue to be sufficient to meet the Partnership's continuing operational expenses and to provide for distributions to partners.\nPage 11 of 37\nItem 8.","section_7A":"","section_8":"Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY\nYEAR ENDED DECEMBER 31, 1995\nPage 12 of 37\nREPORT OF INDEPENDENT AUDITORS\nThe Partners Phoenix Leasing Cash Distribution Fund III, a California limited partnership\nWe have audited the consolidated financial statements of Phoenix Leasing Cash Distribution Fund III, a California limited partnership, and Subsidiary, listed in the accompanying index to financial statements (Item 14(a)). Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and the schedule 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 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 listed in the accompanying index to financial statements (Item 14(a)) present fairly, in all material respects, the consolidated financial position of Phoenix Leasing Cash Distribution Fund III, a California limited partnership, and Subsidiary, 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.\nERNST & YOUNG LLP\nSan Francisco, California January 19, 1996 except for Note 15, as to which the date is February 14, 1996\nPage 13 of 37\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Amounts in Thousands Except for Unit Amounts)\nDecember 31, 1995 1994 ---- ---- ASSETS\nCash and cash equivalents $ 3,619 $ 4,636\nAccounts receivable (net of allowance for losses on accounts receivable of $63 and $392 at December 31, 1995 and 1994, respectively) 254 910\nNotes receivable (net of allowance for losses on notes receivable of $3,880 and $8,357 at December 31, 1995 and 1994, respectively) 13,153 13,668\nEquipment on operating leases and held for lease (net of accumulated depreciation of $17,004 and $38,267 at December 31, 1995 and 1994, respectively) 79 959\nNet investment in financing leases (net of allowance for early terminations of $81 and $129 at December 31, 1995 and 1994, respectively) 227 971\nCable systems, property and equipment (net of accumulated depreciation of $548 and $394 at December 31, 1995 and 1994, respectively) 1,449 1,555\nInvestment in joint ventures 742 951\nCapitalized acquisition fees (net of accumulated amortization of $7,994 and $7,661 at December 31, 1995 and 1994, respectively) 283 615\nOther assets 575 57 -------- -------- Total Assets $ 20,381 $ 24,322 ======== ========\nLIABILITIES AND PARTNERS' CAPITAL\nLiabilities:\nAccounts payable and accrued expenses $ 3,637 $ 4,513\nMinority interest in subsidiary 311 311\nNote payable 329 -- -------- -------- Total Liabilities 4,277 4,824 -------- --------\nPartners' Capital:\nGeneral Partner (71) (109)\nLimited Partners, 600,000 units authorized, 528,151 units issued, 516,716 units outstanding at December 31, 1995 and 1994 15,618 19,607\nUnrealized gains on marketable securities available-for-sale 557 -- -------- -------- Total Partners' Capital 16,104 19,498 -------- -------- Total Liabilities and Partners' Capital $ 20,381 $ 24,322 ======== ========\nThe accompanying notes are an integral part of these statements.\nPage 14 of 37\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands Except for Per Unit Amounts)\nFor the Years Ended December 31, 1995 1994 1993 ---- ---- ---- INCOME\nRental income $ 2,125 $ 4,498 $ 9,255\nEarned income, financing leases 69 268 1,043\nGain on sale of equipment 356 1,019 2,371\nInterest income, notes receivable 1,171 810 2,089\nCable subscriber revenue 676 654 --\nOther income 712 448 587 ------- ------- -------\nTotal Income 5,109 7,697 15,345 ------- ------- -------\nEXPENSES\nDepreciation and amortization 1,149 3,549 9,279\nLease related operating expenses 280 805 1,571\nProgram service, cable system 181 154 --\nManagement fees to General Partner 522 381 817\nReimbursed administrative costs to General Partner 321 403 489\nProvision for (recovery of) losses on receivables (2,245) 550 1,793\nLegal expense 619 379 673\nGeneral and administrative expenses 458 500 529 ------- ------- -------\nTotal Expenses 1,285 6,721 15,151 ------- ------- -------\nNET INCOME BEFORE MINORITY INTEREST $ 3,824 $ 976 $ 194\nMinority Interest in earnings of subsidiary (24) (31) -- ------- ------- -------\nNET INCOME $ 3,800 $ 945 $ 194 ======= ======= =======\nNET INCOME PER LIMITED PARTNERSHIP UNIT $ 7.28 $ .85 $ -- ======= ======= =======\nALLOCATION OF NET INCOME:\nGeneral Partner $ 38 $ 504 $ 194\nLimited Partners 3,762 441 -- ------- ------- -------\n$ 3,800 $ 945 $ 194 ======= ======= =======\nThe accompanying notes are an integral part of these statements.\nPage 15 of 37\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (Amounts in Thousands Except for Unit Amounts)\nGeneral Partner's Limited Partners' Unrealized Total Amount Units Amount Gains Amount --------- ---------------- ---------- ------\nBalance, December 31, 1992 $ (807) 519,683 $46,049 $ -- $45,242\nDistributions to partners ($36.43 per limited partnership unit) -- -- (18,886) -- (18,886)\nRedemptions of capital -- (2,967) (246) -- (246)\nNet income 194 -- -- -- 194 -------- -------- -------- -------- --------\nBalance, December 31, 1993 (613) 516,716 26,917 -- 26,304\nDistributions to partners ($15.00 per limited partnership unit) -- -- (7,751) -- (7,751)\nNet income 504 -- 441 -- 945 -------- -------- -------- -------- --------\nBalance, December 31, 1994 (109) 516,716 19,607 -- 19,498\nDistributions to partners ($15.00 per limited partnership unit) -- -- (7,751) -- (7,751)\nChange for the year in unrealized gain on available-for-sale securities -- -- -- 557 557\nNet income 38 -- 3,762 -- 3,800 -------- -------- -------- -------- --------\nBalance, December 31, 1995 $ (71) 516,716 $ 15,618 $ 557 $ 16,104 ======== ======== ======== ======== ========\nThe accompanying notes are an integral part of these statements.\nPage 16 of 37\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands)\nFor the Years Ended December 31, 1995 1994 1993 ---- ---- ---- Operating Activities: Net income $ 3,800 $ 945 $ 194 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,149 3,549 9,279 Gain on sale of equipment (356) (1,019) (2,371) Gain on sale of securities (7) (154) -- Equity in losses (earnings) from joint ventures (240) 82 (45) Provision for early termination, financing leases -- -- 120 Provision for losses on notes receivable (2,428) 576 1,404 Provision for losses on accounts receivable 183 (26) 269 Settlement -- (106) -- Minority interest in earnings of subsidiary 24 31 -- Decrease in accounts receivable 473 578 1,534 Decrease in accounts payable and accrued expenses (876) (239) (2,065) Decrease in other assets 39 378 70 Other -- 126 -- ------- ------- --------\nNet cash provided by operating activities 1,761 4,721 8,389 ------- ------- --------\nInvesting Activities: Principal payments, financing leases 695 1,620 4,139 Principal payments, notes receivable 8,937 926 1,910 Proceeds from sale of equipment 623 1,965 4,133 Proceeds from sale of securities 7 165 -- Distributions from joint ventures 601 60 2,038 Purchase of equipment -- (107) (79) Investment in financing leases -- (40) (2) Investment in notes receivable (6,146) -- (47) Investment in joint ventures -- (117) (4) Investment in securities -- (11) -- Cable systems, property and equipment (49) (32) -- Payment of acquisition fees -- (5) (45) ------- ------- --------\nNet cash provided by investing activities 4,668 4,424 12,043 ------- ------- --------\nFinancing Activities: Proceeds from notes payable 2,000 -- -- Payments of principal, notes payable (1,671) (1,479) (5,165) Redemptions of capital -- -- (246) Distributions to partners (7,751) (7,751) (18,886) Distributions to minority partners (24) (46) -- ------- ------- --------\nNet cash used by financing activities (7,446) (9,276) (24,297) ------- ------- --------\nDecrease in cash and cash equivalents (1,017) (131) (3,865) Cash and cash equivalents, beginning of period 4,636 4,767 8,632 ------- ------- --------\nCash and cash equivalents, end of period $ 3,619 $ 4,636 $ 4,767 ======= ======= ========\nSupplemental Cash Flow Information: Cash paid for interest expense $ 31 $ 19 $ 167\nThe accompanying notes are an integral part of these statements.\nPage 17 of 37\nPHOENIX LEASING CASH DISTRIBUTION FUND III, A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNote 1. Organization and Partnership Matters.\nPhoenix Leasing Cash Distribution Fund III, a California limited partnership (the Partnership), was formed on July 30, 1985, to invest in capital equipment of various types and to lease such equipment to third parties on either a long-term or short-term basis, and to provide financing to emerging growth companies and cable television system operators. The Partnership's minimum investment requirements were met January 21, 1988. The Partnership's termination date is December 31, 1998.\nThe Partnership has also made investments in joint ventures with affiliated partnerships managed by the General Partner for the purpose of spreading the risks of financing or acquiring certain capital equipment leased to third parties. (See Note 7.)\nOn January 10, 1992, the Partnership foreclosed upon a cable television system in Nevada and California that was in default on a subordinated loan payable to the Partnership with a carrying amount of approximately $1,620,000 which was carried over to the basis in the cable system. As part of the settlement between the Partnership and the borrower, the borrower transferred ownership of all of its assets and liabilities to a subsidiary of the Partnership. Phoenix Black Rock Cable J.V. (the Subsidiary), which was formed under the laws of California on January 10, 1992 to own and operate the foreclosed cable television system (hereinafter, the Partnership and the Subsidiary are collectively referred to as the Consolidated Partnership). The acquisition of the assets and liabilities of the borrower by the Subsidiary through foreclosure was accounted for using the \"purchase method\" of accounting in which the transfer price was allocated to the net assets in accordance with the relative fair market value of the assets acquired and liabilities assumed.\nFor financial reporting purposes, Partnership income shall be allocated as follows: (a) first, to the General Partner until the cumulative income so allocated is equal to the cumulative distributions to the General Partner, (b) second, one percent to the General Partner and 99% to the Limited Partners until the cumulative income so allocated is equal to any cumulative Partnership loss and syndication expenses for the current and all prior accounting periods, and (c) the balance, if any, to the Unit Holders. All Partnership losses shall be allocated, one percent to the General Partner and 99% to the Unit Holders.\nThe General Partner is entitled to receive five percent of all cash distributions until the Limited Partners have recovered their initial capital contributions plus a cumulative return of 12% per annum. Thereafter, the General Partner will receive 15% of all cash distributions. In the event the General Partner has a deficit balance in its capital account at the time of partnership liquidation, it will be required to contribute the amount of such deficit to the Partnership. During 1993, 1994 and 1995 the General Partner did not draw its share of the 1993, 1994 and 1995 cash available for distribution.\nAs compensation for management services, the General Partner receives a fee payable quarterly, subject to certain limitations, in an amount equal to 3.5% of the Partnership's gross revenues for the quarter from which such payment is being made, which revenues shall include rental receipts, maintenance fees, proceeds from the sale of equipment and interest income.\nPhoenix Cable Management Inc. (PCMI), an affiliate of the General Partner, provides day to day management services in connection with the operation of the Subsidiary. The Subsidiary will pay a management fee equal to four and one-half percent of the System's monthly gross revenue for these services. Revneues subject to a management fee at the joint venture level will not be subject to management fees at the Partnership level.\nThe General Partner will be compensated for services performed in connection with the analysis of equipment available to the Partnership, the selection of such assets and the acquisition thereof, including negotiating and concluding agreements with equipment manufacturers and obtaining leases for the equipment. As compensation for such acquisition services, the General Partner\nPage 18 of 37\nwill receive a fee equal to four percent of (a) the purchase price of equipment acquired by the Partnership, or equipment leased by manufacturers, the financing for which is provided by the Partnership, or (b) financing provided to businesses such as cable operators, or emerging growth companies, payable upon such acquisition or financing, as the case may be. Such acquisition fees are amortized principally on a straight-line basis.\nSchedule of compensation paid and distributions made to the General Partner and affiliates for the years ended December 31, 1995 1994 1993 ---- ---- ---- (Amounts in Thousands) Management fees $ 522 $ 381 $ 817 Acquisition fees - 2 3 --------- --------- ------\n$ 522 $ 383 $ 820 ========= ========= ======\nNote 2. Summary of Significant Accounting Policies.\nPrinciples of Consolidation. The 1995 financial statements include the accounts of the Partnership and its majority owned subsidiary, Phoenix Black Rock Cable J.V. All significant intercompany accounts and transactions have been eliminated in consolidation.\nDuring 1994, the Partnership determined that the financial position and operations of Phoenix Black Rock Cable J.V. had become material to the operations of the Partnership. Accordingly, the Partnership has consolidated the financial results of this joint venture with those of the Partnership beginning in 1994. The Partnership reported this joint venture using the equity method of accounting for 1993. The effect of this change has no impact on the net income or equity of the Partnership. The impact on assets, liabilities, revenues and expenses between the consolidation versus equity method was not material to 1993.\nLeasing Operations. The Partnership's leasing operations consist of both financing and operating leases. The financing method of accounting for leases records as unearned income at the inception of the lease, the excess of net rentals receivable and estimated residual value at the end of the lease term, over the cost of equipment leased. Unearned income is credited to income monthly over the term of the lease on a declining basis to provide an approximate level rate of return on the unrecovered cost of the investment. Initial direct costs of consummating new leases are capitalized and included in the cost of equipment.\nUnder the operating method of accounting for leases, the leased equipment is recorded as an asset at cost and depreciated. The Partnerhsip's leased equipment is depreciated primarily using an accelerated depreciation method over the estimated useful life of six years.\nThe Partnership's policy is to review periodically the remaining expected economic life of its rental equipment in order to determine the probability of recovering its undepreciated cost. Such reviews address, among other things, recent and anticipated technological developments affecting computer equipment and competitive factors within the computer marketplace. Although remarketing rental rates are expected to decline in the future with respect to some of the Partnership's rental equipment, such rentals are expected to exceed projected expenses and depreciation. Where subsequent reviews of the equipment portfolio indicate that rentals plus anticipated sales proceeds will not exceed expenses in any future period, the Partnership revises its depreciation policy and provides for additional depreciation as appropriate. As a result of such periodic reviews, the Partnership recognized additional depreciation expense of $68,000, $27,000 and $588,000 ($.13, $.05 and $1.13 per limited partnership unit) for the year ended December 31, 1995, 1994 and 1993, respectively.\nRental income for the year is determined on the basis of rental payments due for the period under the terms of the lease. Maintenance, repairs and minor renewals of the leased equipment are charged to expense.\nCable Television System Operations. The consolidated statement of operations includes the operating activity of the Subsidiary for the year ended December 31, 1995 and 1994. The Subsidiary's cable television system is located in the counties of Clark and Nye in the State of Nevada and in the county of Inyo in the State of California. The cable television system consists of headend equipment in five locations and 156 miles of plant passing approximately 2,900\nPage 19 of 37\nhomes and has approximately 1,838 cable subscribers. The Subsidiary's cable television system serves the communities of Pahrumph, Beatty and Blue Diamond in Nevada and Cow Creek and Grapevine in California. The Subsidiary operates under one non-exclusive franchise agreement with the county of Nye in Nevada, which expires in 2009, and a National Park Service Permit for Death Valley, California, which expires in 1996.\nCable systems, property and equipment are depreciated using the straight-line method over estimated service lives ranging from five to ten years. Replacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nCable television services are billed monthly in advance. Revenue is deferred and recognized as the services are provided.\nInvestment in Joint Ventures. Minority investments in net assets of equipment joint ventures and foreclosed cable systems joint ventures reflect the Partnership's equity basis in the ventures. Under the equity method of accounting, the original investment is recorded at cost and is adjusted periodically to recognize the Partnership's share of earnings, losses, cash contributions and cash distributions after the date of acquisition. Foreclosed cable systems were non-performing notes receivable where foreclosure has occurred.\nNotes Receivable. Notes receivable generally are stated at their outstanding unpaid principal balances, which includes accrued interest. Interest income is accrued on the unpaid principal balance.\nImpaired Notes Receivable. Generally, notes receivable are classified as impaired and the accrual of interest on such notes are discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of the contractual payments, even though the loan may currently be performing. When a note receivable is classified as impaired, income recognition is discontinued. Any payments received subsequent to the placement of the note receivable on to impaired status will generally be applied towards the reduction of the outstanding note receivable balance, which may include previously accrued interest as well as principal. Once the principal and accrued interest balance has been reduced to zero, the remaining payments will be applied to interest income. Generally, notes receivable are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.\nAllowance for Losses. An allowance for losses is established through provisions for losses charged against income. Notes receivable deemed to be uncollectible are charged against the allowance for losses, and subsequent recoveries, if any, are credited to the allowance.\nReclassification. Certain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation.\nCash and Cash Equivalents. Cash and cash equivalents include deposits at banks, investments in money market funds and other highly liquid short-term investments with original maturities of less than 90 days. The Partnership places its cash deposits in temporary cash investments with credit worthy, high quality financial institutions. The concentration of such cash deposits and temporary cash investments is not deemed to create a significant risk to the Partnership.\nPage 20 of 37\nNon Cash Investing Activities. For the Years Ended December 31, 1995 1994 1993 ---- ---- ---- (Amounts in Thousands)\nContributions to a joint venture of assets received pursuant to a settlement agreement $ -- $212 $ --\nForeclosed notes receivable contributed to joint ventures 151 161 265\nPayoff of outstanding note receivable through receipt of cash and the issuance of a new note receivable -- -- 371 ---- ---- ----\nTotal $151 $373 $636 ==== ==== ====\nCredit and Collateral. The Partnership's activities have been concentrated in the equipment leasing and financing industry. A credit evaluation is performed by the General Partner for all leases and loans made, with the collateral requirements determined on a case-by-case basis. The Partnership's loans are generally secured by the equipment or assets financed and, in some cases, other collateral of the borrower. In the event of default, the Partnership has the right to foreclose upon the collateral used to secure such loans.\nFinancial Accounting Pronouncements. In 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 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 performing the review for recoverability, the entity would estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. Statement No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995. The Partnership does not expect the adoption of this statement to have a material impact on its financial position and results of operations. The Partnership plans to adopt Statement No. 121 on January 1, 1996.\nOn January 1, 1995, the Partnership adopted Financial Accounting Standards Board Statement 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 Disclosures.\" Statement No. 114 requires 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. Prior to 1995, the allowance for losses on notes receivable was based on the undiscounted cash flows or the fair value of the collateral dependent loans. The adoption of this statement had no impact on the overall allowance for credit losses and did not effect the Partnership's charge offs or income recognition policies.\nIn accordance with Statement No. 114, a loan is classified as in-substance foreclosure when the Company has taken possession of the collateral regardless of whether formal foreclosure proceedings take place. Notes receivable previously classified as in-substance foreclosed cable systems but for which the Company had not taken possession of the collateral have been reclassified to notes receivable.\nInvestment in Marketable Securities Available for Sale. The Partnership has investments in stock warrants in public companies. The Partnership has classified its investments in stock warrants as available-for-sale in accordance with FASB Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Available-for-sale securities are stated at their fair market value, with unrealized gains and losses reported as a separate component of partners' capital. The stock warrants held by the Partnership were granted by certain lessees or borrowers as additional compensation for leasing or financing equipment. At the date of grant, such warrants were determined to have no fair market value and were recorded at their historical cost of $0.\nPage 21 of 37\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.\nNote 3. Accounts Receivable.\nAccounts receivable consist of the following at December 31:\n1995 1994 ---- ---- (Amounts in Thousands)\nLease payments $ 271 $ 822 Reimbursement for sales and property tax 2 429 Other 37 48 General Partner 7 3 ------- ------- 317 1,302\nLess: allowance for losses on accounts receivable (63) (392) ------- ------- Total $ 254 $ 910 ======= =======\nNote 4. Notes Receivable.\nNotes receivable consist of the following at December 31:\n1995 1994 ---- ---- (Amounts in Thousands) Notes receivable from cable television system operators with stated interest ranging from 8% to 21% per annum, receivable in installments ranging from 57 to 117 months, collateralized by a security interest in the cable system assets. These notes have a graduated repayment schedule followed with a balloon payment. $ 16,791 $ 20,868\nNotes receivable from security monitoring companies with stated interest at 16% per annum, with payments to be taken out of the monthly payments received from assigned contracts, collateralized by all assets of the borrower. At the end of 48 months, the remaining balance, if any, is due and payable. 242 1,157 -------- -------- 17,033 22,025\nLess: allowance for losses on notes receivable (3,880) (8,357) -------- -------- Total $ 13,153 $ 13,668 ======== ========\nThe Partnership's notes receivable from cable television system operators provide for a monthly payment rate in an amount that is less than the contractual interest rate. The difference between the payment rate and the contractual interest rate is added to the principal and therefore deferred until the maturity date of the note. Upon maturity of the note, the original principal and deferred interest is due and payable in full. Although the contractual interest rates may be higher, the amount of interest being recognized on the Partnership's outstanding notes receivable to cable television system operators is being limited to the amount of the payments received, thereby deferring the recognition of a portion of the deferred interest until the loan is paid off.\nPage 22 of 37\nAt December 31, 1995, the recorded investment in notes that are considered to be impaired under Statement 114 was $15,978,000. Included in this amount is $11,673,000 of impaired notes for which the related allowance for losses is $3,619,000 and $4,305,000 of impaired notes for which there is no allowance. The average recorded investment in impaired loans during the year ended December 31, 1995 was approximately $16,448,000. The Partnership recognized interest income totaling $1,079,000 from these impaired notes during the year ended 1995.\nDuring the year ended December 31, 1995, the Partnership received a settlement on one of its notes receivable from a cable television system operator which was considered to be impaired under Statement No. 114. The Partnership received a partial recovery of $2,714,000 as a settlement which was applied towards the $4,562,000 outstanding note receivable balance which had been fully reserved for in a previous year. The remaining balance of $1,848,000 was written-off through its related allowance for loan losses. The Partnership received settlements from seven other impaired notes receivable, a payoff from one note receivable to a cable television system operator and foreclosed upon the assets of another note receivable to a cable television system operator during the year ended December 31, 1995. Upon receipt of the settlement and payoffs of the above-mentioned notes receivable, the Partnership reduced the allowance for loan losses by $2,428,000 during the year ended December 31, 1995. This reduction in the allowance for loan losses was recognized as income during the period.\nThe activity in the allowance for losses on notes receivable during the years ended December 31, is as follows:\n1995 1994 ---- ---- (Amounts in Thousands)\nBeginning balance $ 8,357 $7,781 Provision for (recovery of) losses (2,428) 576 Write downs (2,049) -- ------- ------ Ending balance $ 3,880 $8,357 ======= ======\nNote 5. Equipment on Operating Leases and Investment in Financing Leases.\nEquipment on lease consists primarily of computer peripheral equipment and computer mainframes subject to operating and financing leases.\nThe Partnership's operating leases are for initial lease terms of approximately 12 to 48 months. During the remaining terms of existing operating leases, the Partnership will not recover all of the undepreciated cost and related expenses of its rental equipment, and therefore must remarket a portion of its equipment in future years.\nThe Partnership has agreements with one manufacturer of its equipment, whereby such manufacturer will undertake to remarket off-lease equipment on a best efforts basis. These agreements permit the Partnership to assume the remarketing function directly if certain conditions contained in the agreements are not met. For their remarketing services, the manufacturers are paid a percentage of net monthly rentals.\nThe Partnership has also entered into direct lease arrangements with lessees consisting of Fortune 1000 companies and other businesses in different industries located throughout the United States. Generally, it is the responsibility of the lessee to provide maintenance on leased equipment. The General Partner administers the equipment portfolio of leases acquired through the direct leasing program. Administration includes the collection of rents from the lessees and remarketing of the equipment.\nThe net investment in financing leases consists of the following at December 31:\n1995 1994 ---- ---- (Amounts in Thousands)\nMinimum lease payments to be received $ 30 $ 826 Estimated residual value of leased equipment (unguaranteed) 287 336 Less: unearned income (9) (62) allowance for early termination (81) (129) --------- ---------\nNet investment in financing leases $ 227 $ 971 ========= =========\nPage 23 of 37\nMinimum rentals to be received on noncancellable operating and financing leases for the years ended December 31 are as follows:\nOperating Financing --------- --------- (Amounts in Thousands)\n1996 .................................. $ 518 $ 30 1997................................... 20 - ------- ------- Totals $ 538 $ 30 ======= =======\nThe net book value of equipment held for lease at December 31, 1995 and 1994 amounted to $22,000 and $447,000, respectively.\nNote 6. Cable Systems, Property and Equipment.\nThe cost of cable systems, property, and equipment and the related accumulated depreciation consist of the following at December 31:\n1995 1994 ---- ---- (Amounts in Thousands)\nDistributions systems $ 1,935 $ 1,899 Building 38 37 Automobiles 11 8 Headend equipment 13 5 ------- ------- 1,997 1,949 Less: accumulated depreciation (548) (394) ------- ------- Net property, cable systems and equipment $ 1,449 $ 1,555 ======= =======\nDepreciation expense totaled approximately $154,000 and $150,000 for the years ended December 31, 1995 and 1994, respectively.\nNote 7. Investment in Joint Ventures.\nEquipment Joint Ventures.\nThe Partnership owns a limited or general partnership interest in equipment joint ventures. These investments are accounted for using the equity method of accounting. The other partners of the ventures are entities organized and managed by the General Partner.\nThe purpose of the joint ventures is the acquisition and leasing of various types of equipment. The Partnership is participating in the following equipment joint ventues: Weighted Joint Venture Percentage Interest ------------- -------------------\nLeveraged Joint Venture 1990-1 35.29% Phoenix Post Joint Venture(1) 26.69 Phoenix Joint Venture 1994-1 4.64\n(1) Closed during 1995\nAn analysis of the Partnership's investment in equipment joint ventures is as follows:\nThe aggregate combined financial information of the equipment joint ventures as of December 31 and for the years then ended is presented as follows:\nCOMBINED BALANCE SHEETS\nASSETS\nDecember 31, 1995 1994 ---- ---- (Amounts in Thousands)\nCash and cash equivalents $ 532 $ 132 Accounts receivable 1,772 2,155 Operating lease equipment 1,021 2,528 Other assets 691 890 ------ ------\nTotal Assets $4,016 $5,705 ====== ======\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 918 $ 904 Partners' capital 3,098 4,801 ------ ------\nTotal Liabilities and Partners' Capital $4,016 $5,705 ====== ======\nCOMBINED STATEMENTS OF OPERATIONS\nINCOME\nFor the Years Ended December 31, 1995 1994 1993 ---- ---- ---- (Amounts in Thousands)\nRental income $3,595 $2,583 $3,791 Gain on sale of equipment 1,637 1,096 1,177 Other income 717 71 10 ------ ------ ------\nTotal Income 5,949 3,750 4,978 ------ ------ ------\nPage 25 of 37\nEXPENSES Depreciation 1,186 1,248 1,677 Lease related operating expenses 2,832 2,378 3,688 Management fee to the General Partner 286 199 291 Other expenses 268 62 57 ------ ------- -------\nTotal Expenses 4,572 3,887 5,713 ------ ------- -------\nNet Income (Loss) $1,377 $ (137) $ (735) ====== ======= =======\nAs of December 31, 1995 and 1994, the Partnership's pro rata interest in the equipment joint ventures' net book value of off-lease equipment was $5,000 and $35,000, respectively.\nThe General Partner earns a management fee of 3.5% of the Partnership's respective interest in gross revenues of each equipment joint venture. Revenues subject to management fees at the joint venture level are not subject to management fees at the Partnership level.\nForeclosed Cable Systems Joint Ventures.\nThe Partnership owns an interest in foreclosed cable system joint ventures, along with other partnerships managed by the General Partner and its affiliates. The Partnership foreclosed upon nonperforming outstanding notes receivable to cable television operators to whom the Partnership, along with other affiliated partnerships managed by the General Partner, had extended credit. The partnerships' notes receivables were exchanged for interests (their capital contribution), on a pro rata basis, in newly formed joint ventures owned by the partnerships and managed by the General Partner. Title to the cable television systems is held by the joint ventures. These investments are accounted for using the equity method of accounting.\nThe joint ventures owned by the Partnership, along with their percentage ownership is as follows:\nWeighted Joint Venture Percentage Interest ------------- -------------------\nPhoenix Black Rock Cable J.V.(2) 81.22% Phoenix Pacific Northwest J.V. 37.72 Phoenix Glacier J.V.(1) 45.78 Phoenix Country Cable J.V. 40.00 Phoenix Concept Cablevision, Inc. 14.19 Phoenix Independence Cable, LLC 28.76\n(1) cable system sold and joint venture closed during 1993. (2) cable systems operations are consolidated during 1994 and 1995.\nAn analysis of the Partnership's net investment in foreclosed cable systems joint ventures at December 31, is as follows:\n(1) Includes the reclassification effects of accounting for an unconsolidated joint venture in 1993 as a consolidated subsidiary in 1994. This foreclosed cable systems joint venture is now being consolidated with the Partnership. (See Note 2.)\nThe aggregate combined financial information of the foreclosed cable systems joint ventures as of December 31 and for the years then ended is presented as follows:\nCOMBINED BALANCE SHEETS\nASSETS\nDecember 31, 1995 1994 ---- ---- (Amounts in Thousands)\nCash and cash equivalents $ 375 $ 203 Accounts receivable 88 100 Property, plant and equipment 2,176 2,298 Cable subscriber lists and franchise rights 116 145 Other assets 22 67 Deferred income taxes 118 142 ------ ------\nTotal Assets $2,895 $2,955 ====== ======\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 323 $ 265 Notes payable -- 11 Partners' capital 2,572 2,679 ------ ------\nTotal Liabilities and Partners' Capital $2,895 $2,955 ====== ======\nPage 27 of 37\nCOMBINED STATEMENTS OF OPERATIONS\nINCOME\nFor the Years Ended December 31, 1995 1994 1993 ---- ---- ---- (Amounts in Thousands)\nSubscriber revenue $ 1,065 $ 628 $1,082 Gain on sale of cable systems 25 -- 476 Other income 14 5 25 ------- ----- ------\nTotal Income 1,104 633 1,583 ------- ----- ------\nEXPENSES\nDepreciation 321 160 255 Program services 328 192 302 General and administrative expenses 310 164 300 Management fees to an affiliate of the General Partner 48 28 98 Provision for losses on accounts receivable 11 9 11 ------- ----- ------\nTotal Expenses 1,018 553 966 ------- ----- ------\nNet Income Before Income Taxes 86 80 617 Income tax expense (39) (19) -- ------- ----- ------\nNet Income $ 47 $ 61 $ 617 ======= ===== ======\nPhoenix Cable Management Inc. (PCMI), an affiliate of the General Partner, provides day to day management services in connection with the operation of the foreclosed cable systems joint ventures. The foreclosed cable systems joint ventures will pay a management fee equal to four and one-half percent of the System's monthly gross revenue for these services. Revenues subject to a management fee at the joint venture level will not be subject to management fees at the Partnership level.\nNote 8. Accounts Payable and Accrued Expenses.\nAccounts payable and accrued expenses consist of the following at December 31:\n1995 1994 ---- ---- (Amounts in Thousands)\nGeneral Partner and affiliates $2,086 $2,068 Equipment lease operations 1,276 1,968 Security deposits -- 258 Other 275 219 ------ ------\nTotal $3,637 $4,513 ====== ======\nPage 28 of 37\nNote 9. Notes Payable.\nNotes payable consist of the following at December 31: 1995 1994 ---- ---- (Amounts in Thousands)\nNote payable to a bank, collateralized by the assets of the Partnership with interest tied to the bank's prime rate, with monthly payments of 30 months. $329 $ -- ---- ------\nTotal $329 $ -- ==== ======\nPrincipal payments due for 1996 are $329,000.\nThe interest rate was 8.75% at December 31, 1995. The loan agreement contains certain restrictions on distributions made to partners and requires pre-payment of the outstanding debt upon the sale of certain significant assets of the Partnership. The Partnership made a pre-payment of $1,471,000 on November 17, 1995.\nNote 10. Settlement.\nOn July 1, 1991, Phoenix Leasing Incorporated, as General Partner to the Partnership and sixteen other affiliated partnerships, filed suit in the Superior Court for the County of Marin, Case No. 150016, against Xerox Corporation, a corporation with which the General Partner had entered into contractual agreements for the acquisition and administration of leased equipment. The lawsuit was settled out of court effective as of October 28, 1994 pursuant to the terms of a Confidential Settlement Agreement and Mutual Release. The settlement agreement generally provides for compensation payable to the Partnership and its affiliates in cash and kind, including the assignment by Xerox of certain goods and services. The agreement further provides for the sale by Xerox to the Partnership and its affiliates of equipment subject to lease. The suit that was filed in the Superior Court for the County of Marin, Case No. 150016, has been dismissed with prejudice on the merits.\nThe Partnership's pro rata share of the Xerox settlement was $175,000, which consists of cash of $69,000, and assigned monthly rentals and credits for goods and services valued at $106,000. In addition, the Partnership purchased additional leased equipment at an aggregate cost of $107,000. The Partnership, along with sixteen other affiliated partnerships managed by the General Partner, contributed its share of the assigned monthly rentals, credits for goods and services and purchased equipment leases to a joint venture, in exchange for an interest in the joint venture.\nNote 11. Income Taxes.\nFederal and state income tax regulations provide that taxes on the income or loss of the Partnership and its majority owned subsidiary are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the accompanying financial statements.\nThe net differences between the tax basis and the reported amounts of the Partnership's assets and liabilities is as follows at December 31:\nReported Amounts Tax Basis Net Difference ---------------- --------- -------------- (Amounts in Thousands)\n- ---- Assets $19,980 $23,407 $(3,427) Liabilities 3,876 3,763 113\nPage 29 of 37\n- ---- Assets $23,909 $32,388 $(8,479) Liabilities 4,411 4,405 6\nNote 12. Related Entities.\nThe General Partner serves in the capacity of general partner in other partnerships, all of which are engaged in the equipment leasing and financing business.\nNote 13. Reimbursed Costs to the General Partner.\nThe General Partner incurs certain administrative costs, such as data processing, investor and lessee communications, lease administration, accounting, equipment storage and equipment remarketing, for which it is reimbursed by the Partnership. These expenses incurred by the General Partner are to be reimbursed at the lower of the actual costs or an amount equal to 90% of the fair market value for such services.\nThe reimbursed administrative costs to the General Partner were $321,000, $403,000 and $489,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The equipment storage, remarketing and data processing costs reimbursed to the General Partner during the years ended December 31, 1995, 1994 and 1993 were $112,000, $264,000 and $471,000, respectively.\nIn addition, the General Partner receives a management fee and an acquisition fee (see Note 1).\nNote 14. Net Income and Distributions per Limited Partnership Unit.\nNet income and distributions per limited partnership unit were based on the Limited Partner's share of consolidated net income and distributions, and the weighted average number of units outstanding of 516,716, 516,716 and 518,380 for the years ended December 31, 1995, 1994 and 1993, respectively. For the purposes of allocating consolidated income (loss) and distributions to each individual limited partner, the Partnership allocates consolidated net income (loss) and distributions based upon each respective limited partner's net capital contributions.\nNote 15. Subsequent Events.\nIn January 1996, cash distributions of $1,954,000 were made to the Limited Partners.\nOn January 17, 1996, Phoenix Black Rock Cable J.V., a majority owned subsidiary of the Partnership, sold its cable television systems for approximately $2.7 million. The identifiable assets of this cable television system at December 31, 1995 were approximately $1.7 million.\nOn February 2, 1996, Phoenix Leasing Cash Distribution Fund III and Phoenix Concept Cablevision of Indiana, L.L.C. (collectively referred to as \"the Partnership\") entered into a Commercial Code Section 9505 Agreement (the \"Agreement\") with Concept Cablevision of Indiana, Inc., a cable television company that the Partnership had extended credit. Phoenix Concept Cablevision of Indiana, L.L.C. is a newly formed limited liability company and wholly owned subsidiary of Phoenix Leasing Cash Distribution Fund III. The closing date of the Agreement was February 2, 1996. This Agreement allowed the Partnership to foreclose upon the cable television system (the collateral for the note) of Concept Cablevision of Indiana, Inc. The Partnership's net carrying value for this outstanding note receivable was $4,321,098 at December 31, 1995, for which the Partnership had no related allowance. In addition, the Partnership is required to make a cash payment of $200,000, will assume certain liabilities including a note payable of $600,000 and certain other miscellaneous accounts payable as specified in the agreement.\nOn February 14, 1996, Phoenix Leasing Cash Distribution Fund III and Phoenix Grassroots Cable Systems, L.L.C. (collectively referred to as \"the Partnership\") entered into a Settlement Agreement and Releases (the \"Agreement\") with Grassroots Cable Systems, Inc., a cable television company that the Partnership had extended credit. Phoenix Grassroots Cable Systems, L.L.C. is a\nPage 30 of 37\nnewly formed limited liability company and majority owned (98.5%) subsidiary of Phoenix Leasing Cash Distribution Fund III. The closing date of the Agreement was February 14, 1996. This Agreement allowed the Partnership to foreclose upon the cable television system (the collateral for the note) of Grassroots Cable Systems, Inc. The Partnership's net carrying value for this outstanding note receivable was $9,014,483 at December 31, 1995, for which the Partnership had an allowance for losses on notes of $2,035,301. In addition, the Partnership is required to make a cash payment of $75,000 and assume certain liabilities and miscellaneous payables as specified in the agreement.\nNote 16. Business Segments.\nThe Consolidated Partnership currently operates in two business segments: the equipment leasing and financing industry and the cable TV industry. The operations in the cable TV industry are for the year ended December 31, 1995 and 1994 (segment activity for 1993 was not material). Information about the Consolidated Partnership's operations in these two segments are as follows:\n1995 1994 ---- ---- (Amounts in Thousands)\nTotal Revenues Equipment leasing and financing $ 4,422 $ 7,035 Cable TV operations 687 662 ------- ------- Total $ 5,109 $ 7,697 ======= =======\nNet Income (Loss) Equipment leasing and financing $ 3,695 $ 810 Cable TV operations 105 135 ------- ------- Total $ 3,800 $ 945 ======= =======\nIdentifiable Assets Equipment leasing and financing $18,643 $22,571 Cable TV operations 1,738 1,751 ------- ------- Total $20,381 $24,322 ======= =======\nDepreciation and Amortization Expense Equipment leasing and financing $ 995 $ 3,399 Cable TV operations 154 150 ------- ------- Total $ 1,149 $ 3,549 ======= =======\nCapital Expenditures Equipment leasing and financing $ 6,146 $ 147 Cable TV operations 49 32 ------- ------- Total $ 6,195 $ 179 ======= =======\nNote 17. Fair Value of Financial Instruments.\nDuring the year ended December 31, 1995, the Partnership adopted Statement of Financial Accounting Standard No. 107, \"Disclosures about Fair Value of Financial Instruments,\" which requires disclosure of the fair value of financial instruments for which it is practicable to estimate fair value. The following methods and assumptions were used to estimate the fair value of each class of financial instrument which it is practicable to estimate that value.\nCash and Cash Equivalents The carrying amount of cash and cash equivalents approximates fair value because of the short maturity of these instruments.\nPage 31 of 37\nNotes Receivable The fair value of notes receivable is estimated based on the lesser of the discounted expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings, or the estimated fair value of the underlying collateral.\nMarketable Securities The fair values of investments in marketable securities are estimated based on quoted market prices.\nNotes Payable The carrying amount of the Partnership's variable rate notes payable approximates fair value.\nThe estimated fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nCarrying Amount Fair Value -------- ---------- (Amounts in Thousands)\nAssets Cash and cash equivalents $ 3,619 $ 3,619 Marketable securities 559 559 Notes receivable 13,153 16,555 Liabilities Notes payable 329 329\nPage 32 of 37\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure Matters.\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, has no executive officers or directors. The general partner of the registrant is Phoenix Leasing Incorporated, a California corporation. The directors and executive officers of Phoenix Leasing Incorporated (PLI) are as follows:\nGUS CONSTANTIN, age 58, is President, Chief Executive Officer and a Director of PLI. Mr. Constantin received a B.S. degree in Engineering from the University of Michigan and a Master's Degree in Management Science from Columbia University. From 1969 to 1972, he served as Director, Computer and Technical Equipment of DCL Incorporated (formerly Diebold Computer Leasing Incorporated), a corporation formerly listed on the American Stock Exchange, and as Vice President and General Manager of DCL Capital Corporation, a wholly-owned subsidiary of DCL Incorporated. Mr. Constantin was actively engaged in marketing manufacturer leasing programs to computer and medical equipment manufacturers and in directing DCL Incorporated's IBM System\/370 marketing activities. Prior to 1969, Mr. Constantin was employed by IBM as a data processing systems engineer for four years. Mr. Constantin is an individual general partner in four active partnerships and is an NASD registered principal. Mr. Constantin is the founder of PLI and the beneficial owner of all of the common stock of Phoenix American Incorporated.\nPARITOSH K. CHOKSI, age 42, is Senior Vice President, Chief Financial Officer and Treasurer of PLI. He has been associated with PLI since 1977. Mr. Choksi oversees the finance, accounting, information services and systems development departments of the General Partner and its Affiliates and oversees the structuring, planning and monitoring of the partnerships sponsored by the General Partner and its Affiliates. Mr. Choksi graduated from the Indian Institute of Technology, Bombay, India with a degree in Engineering. He holds an M.B.A. degree from the University of California, Berkeley.\nGARY W. MARTINEZ, age 45, is Senior Vice President of PLI. He has been associated with PLI since 1976. He manages the Asset Management Department, which is responsible for lease and loan portfolio management. This includes credit analysis, contract terms, documentation and funding; remittance application, change processing and maintenance of customer accounts; customer service, invoicing, collection, settlements and litigation; negotiating lease renewals, extensions, sales and buyouts; and management information reporting. From 1973 to 1976, Mr. Martinez was a Loan Officer with Crocker National Bank, San Francisco. Prior to 1973, he was an Area Manager with Pennsylvania Life Insurance Company. Mr. Martinez is a graduate of California State University, Chico.\nBRYANT J. TONG, age 41, is Senior Vice President, Financial Operations of PLI. He has been with PLI since 1982. Mr. Tong is responsible for investor services and overall company financial operations. He is also responsible for the technical and administrative operations of the cash management, corporate accounting, partnership accounting, accounting systems, internal controls and tax departments, in addition to Securities and Exchange Commission and other regulatory agency reporting. Prior to his association with PLI, Mr. Tong was Controller-Partnership Accounting with the Robert A. McNeil Corporation for two years and was an auditor with Ernst & Whinney (succeeded by Ernst & Young) from 1977 through 1980. Mr. Tong holds a B.S. in Accounting from the University of California, Berkeley, and is a Certified Public Accountant.\nCYNTHIA E. PARKS, age 40, is Vice President, General Counsel, Assistant Secretary and a Director of PLI. Prior to joining PLI in 1984, she was with GATX Leasing Corporation, and had previously been Corporate Counsel for Stone Financial Companies, and an Assistant Vice President of the Bank of America, Bank Amerilease Group. She has a bachelor's degree from Santa Clara University, and earned her J.D. from the University of San Francisco School of Law.\nHOWARD SOLOVEI, age 34, is Vice President, Finance, Assistant Treasurer and a Director of PLI. He has been associated with PLI since 1984. Mr. Solovei's principal activities are in the areas of arranging and managing the company's banking relationships for its various corporations, partnerships and securitized asset pools. Mr. Solovei is also involved in corporate financial planning and\nPage 33 of 37\nvarious data processing-related projects. Mr. Solovei graduated with a B.S. in Business from the University of California at Berkeley in 1984.\nNeither the General Partner nor any Executive Officer of the General Partner has any family relationship with the others.\nPhoenix Leasing Incorporated or its affiliates and the executive officers of the General Partner serve in a similar capacity to the following affiliated limited partnerships:\nPhoenix Leasing American Business Fund, L.P. Phoenix Leasing Cash Distribution Fund V, L.P. Phoenix Income Fund, L.P. Phoenix High Tech\/High Yield Fund Phoenix Leasing Cash Distribution Fund IV Phoenix Leasing Cash Distribution Fund II Phoenix Leasing Capital Assurance Fund Phoenix Leasing Income Fund VII Phoenix Leasing Income Fund VI Phoenix Leasing Growth Fund 1982 Phoenix Leasing Income Fund 1981 and Phoenix Leasing Income Fund 1977\nThe General Partner of the Registrant, which may be deemed to be a \"director\" of Registrant under the rules promulgated under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), failed to file a Statement of Changes in Beneficial Ownership of Securities on Form 4 in July 1995 to reflect the purchase by the General Partner in June 1995 of 17 units of limited partnership interest in the Registrant from a limited partner of Registrant. Such acquisition was reported on Form 5 for the fiscal year ended December 31, 1995, as filed with the Commission on behalf of the General Partner on February 5, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation.\n(1) consists of management fees.\nPage 34 of 37\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 five percent of any class of voting securities 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.\nPage No. (a) 1. Financial Statements:\nConsolidated Balance Sheets as of December 31, 1995 and 1994 13 Consolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 14 Consolidated Statements of Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993 15 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 16 Notes to Consolidated Financial Statements 17-31\n2. Financial Statement Schedule:\nSchedule II - Valuation and Qualifying Accounts and Reserves 37\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(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed for the year ended December 31, 1995.\n(c) Exhibits\n21. Additional Exhibits\na) Balance Sheet of Phoenix Leasing Incorporated E21 1-9\nPage 35 of 37\nb) Listing of all subsidiaries of the Registrant:\nPhoenix Black Rock Cable J.V., a California general partnership and majority (81.22%) owned subsidiary.\n27. Financial Data Schedule\nPage 36 of 37\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPHOENIX LEASING CASH DISTRIBUTION FUND III (Registrant)\nBY: PHOENIX LEASING INCORPORATED, A CALIFORNIA CORPORATION GENERAL PARTNER\nDate: March 28, 1996 By: \/S\/ GUS CONSTANTIN -------------- ------------------------- Gus Constantin, 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\/ GUS CONSTANTIN President, Chief Executive Officer and a March 28, 1996 - ----------------------- Director of Phoenix Leasing Incorporated -------------- (Gus Constantin) General Partner\n\/S\/ PARITOSH K. CHOKSI Chief Financial Officer, March 28, 1996 - ----------------------- Senior Vice President -------------- (Paritosh K. Choksi) and Treasurer of Phoenix Leasing Incorporated General Partner\n\/S\/ BRYANT J. TONG Senior Vice President, Financial March 28, 1996 - ----------------------- Operations of -------------- (Bryant J. Tong) (Principal Accounting Officer) Phoenix Leasing Incorporated General Partner\n\/S\/ GARY W. MARTINEZ Senior Vice President of March 28, 1996 - ----------------------- Phoenix Leasing Incorporated -------------- (Gary W. Martinez) General Partner\n\/S\/ HOWARD SOLOVEI Vice President, Finance March 28, 1996 - ----------------------- Assistant Treasurer and a -------------- (Howard Solovei) Director of Phoenix Leasing Incorporated General Partner\n\/S\/ MICHAEL K. ULYATT Partnership Controller March 28, 1996 - ----------------------- Phoenix Leasing Incorporated -------------- General Partner","section_15":""}
{"filename":"85608_1995.txt","cik":"85608","year":"1995","section_1":"Item 1. Business - - -----------------\nGeneral - - -------\nMATEC Corporation (\"MATEC\" or \"Registrant\") is incorporated under the laws of Delaware. As used herein the term \"Company\" refers to MATEC and its subsidiaries.\nIndustry Segments - - -----------------\nThe Company's business operates in three segments: Electronics, Steel Cable, and Instruments, and is conducted primarily through its four principal wholly owned operating subsidiaries.\nThe Company has two real estate complexes, located in Delaware and Massachusetts, which are operated by its wholly owned subsidiaries, RSC Realty Corporation and MEKontrol, Inc., respectively.\nFinancial information about industry segments is set forth in Note 12 of the Notes to Consolidated Financial Statements in the 1995 Annual Report to Stockholders, which Note is incorporated herein by reference.\nPrincipal Products and Services - - ------------------------------- Electronics -----------\nValpey-Fisher Corporation (\"Valpey\") is involved in the design, production, import, and sale of quartz crystals and oscillators. In addition, Valpey manufactures and provides a wide variety of piezoelectric products and related services.\nThe quartz crystals and oscillators are used in commercial, industrial, military, and aerospace products which rely on electronic rather than mechanical control of their function. To assure precise timing and control, the electronic circuitry used in these products incorporates quartz crystals and oscillators as integral components. Except for more costly atomic standards, quartz crystals and oscillators continue to be one of the most stable references for accurately controlling electronic frequencies and time.\nValpey's products and capabilities include: - high-volume, low-cost crystals and oscillators for consumer and commercial applications, - high-reliability, precision crystals and oscillators used in sophisticated industrial, military and aerospace applications. - ultra-high frequency crystals used in crystal filters and oscillators for OEM telecommunications and microwave applications.\nApplications for Valpey's products include computers, computer peripheral equipment such as modems and high resolution graphics terminals, microprocessor-based instrumentation, communications equipment, and defense and aerospace electronics. A significant portion of the high-volume, low-cost product sales is derived from imported products. Crystal and oscillator sales accounted for 40%, 30%, and 31% of the Company's sales for the years ended December 31, 1995, 1994 and 1993, respectively.\nPiezoelectric products manufactured by Valpey include ultrasonic transducer crystals and assemblies, surface acoustic wave (SAW) substrates, and precision quartz crystals. In addition, Valpey provides a variety of related services to the electronic and optical markets of the research, commercial, industrial, medical, and aerospace industries.\nProducts are sold by its direct sales personnel, independent manufacturers' representatives and distributors.\nCultured quartz, which is available from a number of domestic and foreign suppliers, is the principal raw material.\nValpey imports products from various Far East (including China, Japan, South Korea, and Taiwan) suppliers for resale to its customers. Historically, Valpey has not experienced significant quality or delivery problems with these suppliers. In order to eliminate the effects of currency fluctuations, Valpey purchases the product in U.S. dollars. However, Valpey is subject to the inherent risks involved in international trade such as political instability and restrictive trade policies.\nSteel Cable - - -----------\nBergen Cable Technologies, Inc. (\"Bergen\") is involved in the design and manufacture of custom mechanical control assemblies. In addition, Bergen manufactures or purchases and sells a wide range of small diameter cables made primarily of stainless or galvanized steel. Current cable capabilities range from a .0045\" diameter miniature cable to a 0.187\" wire rope. Bergen's sales accounted for 34%, 42% and 46% of the Company's sales for the years ended December 31, 1995, 1994 and 1993, respectively.\nA substantial portion of Bergen's cable assembly business is custom-designed to meet customers' specifications and requirements. Bergen's major markets include the OEM automotive, aerospace, medical and marine.\nBergen also produces the Safety Cable (TM) System, a fastener retention system, used in securing fasteners during the manufacture or repair of aircraft components. This System, developed by Bergen and the GE Aircraft Group, consists of Bergen's stainless steel cable, stainless steel ferrules, and an exclusive, patented crimping and cutting tool.\nBergen's principal raw materials, which include carbon steel, stainless steel and improved plow steel are available from both domestic and foreign suppliers.\nProducts are sold by its direct sales personnel and through independent manufacturers' representatives.\nSales to the aerospace and automotive markets accounted for approximately 60% of Bergen's sales during each of the three years ended December 31, 1995.\nInstruments -----------\nThe Company's Instruments segment includes Matec Applied Sciences, Inc. (\"MASI\") and Matec Instruments, Inc.(\"MI\"). These subsidiaries develop and manufacture computer-controlled ultrasonic test equipment to perform real-time measurements and analysis. The Instruments segment accounted for 21%, 24%, and 20% of the Company's sales for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe instruments are sold in the USA mainly through each subsidiary's sales personnel, while foreign sales are performed through independent manufacturers' representatives. Export sales accounted for 49%, 53%, and 41% of this segment's sales for the years ended December 31, 1995, 1994 and 1993, respectively.\nExport sales are primarily shipped to customers located in Europe, the Pacific Rim and Canada. Product is sold in U.S. dollars and may be shipped on open account (based on credit history and rating), through a letter of credit, or by payment of cash in advance.\nUnder the European Electromagnetic Compatibility (\"EMC\") Directive, instruments shipped to Europe after December 31, 1995 will require the Conformite European (\"CE\") marking signifying compliance to the EMC standards. The CE mark indicates that the product complies with certain standards set by the European nations. MASI and MI have completed the compliance testing for the CE mark on certain of its products and will complete compliance testing in the future for additional products. The companies will not seek the CE mark for certain older products. The Company does not believe that the inability to sell these older products to the European nations will have a material effect on MASI's and MI's results of operations.\nThe principal raw materials used are electronic components. Generally, most of the components are available from a number of sources. However, a few electronic components are purchased from single suppliers. The Company believes, however, that if necessary, alternate sources of supply for these items could be developed and delays in obtaining alternate sources would not have a material adverse effect on its business.\nMatec Applied Sciences, Inc. (\"MASI\") -------------------------------------\nMASI produces and sells instruments that evaluate the stability of colloidal dispersions (small particles in suspension) for fundamental and applied research in both laboratory and industrial applications. Currently, MASI sells three instruments: the ESA-8000 (\"ESA\"), the AcoustoSizer(TM) and the CHDF 1100 Particle Sizer (\"CHDF\").\nThe ESA system measures the tendency of particles in suspension either to remain in stable suspension or to precipitate out of suspension. Unlike older methods which are limited to dilute dispersions, ESA techniques permit measurements of opaque samples with particle concentrations up to 75% by weight. The major markets for this system include industries involved in the research and processing of pigments, minerals and ores, ceramics and petrochemicals.\nThe CHDF, which was introduced in 1989, determines size and size distribution of submicron particles (less than forty millionths of an inch). The primary markets for this instrument are the latex, pharmaceutical and pigment industries.\nMASI began commercial shipments of the AcoustoSizer(TM) in the fourth quarter of 1993. The AcoustoSizer(TM) was developed by MASI in a joint effort with Colloidal Dynamics Pty Limited (\"CD\") and the University of Sydney (\"University\"), both in Australia. The instrument is manufactured and marketed by MASI under an exclusive worldwide license of the basic technology patent owned by CD and the University. The AcoustoSizer(TM) has the unique, patented capability of measuring particle size distribution and particle charge of concentrated colloidal dispersions without the need for dilution. The primary markets for the AcoustoSizer(TM) are the inorganic pigments and ceramic markets.\nMatec Instruments, Inc. (\"MI\") ------------------------------ MI designs, manufactures and sells: - high power ultrasonic instrumentation and systems for the non-destructive evaluation (NDE) and non-destructive testing (NDT) of materials. - Doppler blood flow, and heart, vascular and cell function instruments, under the Crystal Biotech trade name, used mainly in cardiovascular medical research. - ultrasonic transducers and probes that allow these systems to measure flow in blood vessels as small as 0.3 mm in diameter and heart functions in all venues.\nHistorically MI's main focus was on selling instrumentation to the NDE\/NDT market. During the last two years, MI's sales growth has been due to its sales of custom designed systems used to inspect and detect for flaws in materials. These systems may be integrated with a customer's manufacturing or quality control process. MI believes that its future growth will come from sales of these custom systems that combine ultrasonic technology with custom software, hardware and mechanical design.\nInstrumentation products for the NDE\/NDT markets include the IMT-8000 and various custom Immersion Tank Imaging Test Systems, a family of ultrasonic PC plug-in board instruments and several older, manually and computer controlled toneburst instruments. Markets for these instruments include government and academic research laboratories, as well as R&D and quality assurance departments in industry.\nThe IMT-8000 system is a bench-top immersion testing system capable of providing high-definition, full-color C-Scan representations of flaws deep within materials and structures. The plug-in boards, when installed in certain computers, provide the user certain material testing features. These systems facilitate the detection of defects and anomalies in metals, ceramics, composites and other types of materials. Industrial applications for the system include the evaluation of bond quality, material integrity and delamination detection.\nCrystal Biotech(TN) products include the CBI-8000, the Myotrac System, and the DataFlow(TN). The CBI-8000, an upgradable and modular instrument introduced in 1994, replaces the older VF-1 model and measures blood flow and myocardial dimensions in laboratory instrumented animals. Modules offered by MI enhance the capabilities of the CBI-8000 to provide the user simultaneous measurements of blood flow, organ dimensions, and tissue thickness and volumetric flow. The Myotrac System, introduced in late 1994, measures cellular function and dimension. MI's DataFlow (TN) system is a data acquisition tool that enables the user to record, analyze and display data collected from the VF-1 or any other instrument. Primary markets for these products include government and university laboratories, research hospitals and the pharmaceutical industry.\nPatents and Licenses - - --------------------\nThe Company owns various patents and has additional patent applications pending. While some of these patents are deemed to have value, the business of the Company, in the opinion of management, is not substantially dependent upon such patents, but is primarily based on know-how and market acceptance.\nIn the Instruments Segment, MASI is a licensee of certain patented technology relating to its AcoustoSizer(TM) and CHDF-1100 products. Under the AcoustoSizer(TM) agreement, MASI is granted a world-wide sole and exclusive license to manufacture and market instruments for scientific and laboratory use. Under the CHDF agreement, MASI is granted the sole and exclusive worldwide right to manufacture and sell products utilizing certain technology.\nSeasonal Nature of the Business - - -------------------------------\nIn recent years, the Company has experienced some softness in third quarter sales offset by a rise in fourth quarter sales in the Instrument segment. The Company attributes this third quarter decline to vacations taken during the summer months in the research community (industry, government and university).\nWorking Capital - - ---------------\nThere are no unusual working capital requirements relating to the Company's ongoing operations.\nCustomers - - ---------\nDuring the last three years, no customer accounted for 10% of the Company's consolidated sales.\nA majority of the sales in the Electronics segment are to the computer and telecommunications markets. Approximately 33% of the Electronics' segment sales in 1995 were made to its five largest customers. Sales to the aerospace and automotive markets accounted for approximately 60% of the 1995 revenue in the Steel Cable segment. Approximately 36% of the Steel Cable's segment sales in 1995 were made to its five largest customers.\nBacklog Data - - ------------\nThe Company's backlog of firm orders at December 31, 1995 and 1994 are as follows (in thousands):\nSegment 1995 1994 ------------- ---- ---- Electronics ..................... $4,737 $3,062 Steel Cable ..................... 2,689 2,399 Instruments ..................... 373 134 ------ ------ $7,799 $5,182 ====== ======\nThe increase in the Electronics segment is attributable to the higher backlog level in the import product line, partially offset by lower backlog levels in the remaining product lines. The increase in the Steel Cable segment is mainly due to an increase in the marine market backlog. The increase in the Instruments segment is due to a higher level of custom designed systems for the NDE\/NDT market. In the Instruments segment, management believes that backlog data is not as meaningful, since customer's orders for instruments are normally shipped upon receipt of order.\nGovernment Contracts - - --------------------\nBergen's government contract-related business is in the form of firm fixed-price contracts. These contracts are subject to the standard government contract clause which permits the Government to terminate such contracts at its convenience. In the event of such termination there are provisions to enable the Company to recover its costs plus a fee. The Company does not at this time anticipate the termination of any of its major government contracts.\nCompetition - - -----------\nIn most of the markets in which the Company operates there are numerous competitors. A number of the competitors are larger and have greater resources than the Company. Larger competitors include Teleflex Industries in the Steel Cable segment and M-tron Industries, Inc. in the Electronics segment. In addition, in the Electronics segment, foreign competitors, particularly from the Far East, continue to dominate the U.S. markets. However, based on the reasons below, the Company believes it can maintain a competitive position in its businesses.\nIn the Electronics segment, the Company believes its quality, strong design and application engineering, responsive customer service and a willingness to provide specialty small quantity orders will continue to enable the Company to remain competitive in its markets.\nManagement believes that in the Steel Cable segment, Bergen has a strong competitive edge in the cable assembly market based on its reputation for design capability, service, quality, and customer responsiveness.\nIn the Instruments segment, the Company believes its strong design work, application engineering and quality will enable it to remain competitive in the markets in which it competes.\nResearch and Development - - ------------------------\nExpenditures for Company-sponsored research and development activities amounted to approximately $536,000, $962,000 and $1,056,000 in 1995, 1994 and 1993, respectively. Such amounts represent 1.8%, 4.0% and 5.3%, respectively, of sales for such periods.\nThe reduction in expenses is attributable to lower expenses in the Electronics and Instruments segments as new product and process development projects were completed in late 1994.\nEnvironmental Regulations - - -------------------------\nTo the knowledge of the Company 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, nor will have a material effect upon capital expenditures, earnings or competitive position.\nEmployees - - ---------\nNo employees at the various locations of the Company are represented by a collective bargaining unit. At December 31, 1995, the Company has 320 full-time and 19 part-time employees. The Company considers its relations with its employees to be satisfactory.\nForeign and Domestic Operations and Export Sales - - ------------------------------------------------\nFinancial information about foreign and domestic operations and export sales is set forth in Note 12 of the Notes to Consolidated Financial Statements in the 1995 Annual Report to Stockholders, which Note is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - - ------- ----------\nThe Company has the following facilities, each of which contains office and manufacturing space and all of which are owned (except as noted).\nApproximate Location Square Feet Primary Use -------- ----------- -----------\nWilmington, Delaware (1) 215,000 Real Estate Operation\nLodi, New Jersey 50,560 Steel Cable\nNorthboro, Massachusetts (2) 35,000 Real Estate Operation Instruments\nHopkinton, Massachusetts (3) 32,400 Instruments Electronics\nJuarez, Mexico (4) 20,000 Steel Cable\nCarlisle, PA (5) 3,200 Electronics\n(1) At December 31, 1995 this facility is subject to one Industrial Revenue Bond with a total balance due of $380,000. See Note 9 of the Notes to Consolidated Financial Statements in the 1995 Annual Report to Stockholders. Approximately 207,000 square feet is leased and the remaining space is available for rent.\n(2) Matec Instruments occupies approximately 5,500 square feet, approximately 6,000 square feet is leased and the remaining space is available for rent.\n(3) At December 31, 1995 this facility is subject to an Industrial Revenue Bond with a balance due of $48,333. See Note 9 of the Notes to Consolidated Financial Statements in the 1995 Annual Report to Stockholders.\n(4) Facilities under lease expiring in December 1997.\n(5) Facilities under lease expiring in May 1996. The Company intends to exercise its 1 year renewal option under the lease.\nThe Company believes its facilities (owned or leased) are suitable for their current uses and are in good repair. The Company believes that its facilities are adequate to satisfy its production capacity needs for the immediate future.\nItem 3.","section_3":"Item 3. Legal Proceedings - - ------- -----------------\nThe Company is involved in litigation in the ordinary course of business. The Company believes that the outcome of these actions should not 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 - - ------- ---------------------------------------------------\nNo matters were submitted to a vote of the Registrant's security holders during the last quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant - - ------------------------------------\nThe names, ages and offices of the executive officers of the Registrant are as follows:\nName Age Office ---- --- ------\nRobert B. Gill 54 President and Chief Executive Officer Michael J. Kroll 47 Vice President and Treasurer\nThe term of office for each officer of the Registrant is until the first meeting of the Board of Directors following the Annual Meeting of Stockholders and until a successor is chosen and qualified.\nMr. Gill has been President and Chief Executive Officer of the Registrant since December 21, 1992. He was President of Laser Diode, Inc., a manufacturer of communication equipment, from prior to 1991 to December 1992.\nMr. Kroll, a certified public accountant, has been Vice President and Treasurer of the Registrant since prior to 1991.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related - - ------- ---------------------------------------------------- Stockholder Matters -------------------\nThe information set forth on the inside front cover of the 1995 Annual Report to Stockholders under the caption \"Common Stock Information\" is incorporated by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data - - ------- -----------------------\nThe information set forth on page 4 of the 1995 Annual Report to Stockholders under the caption \"Five Year Financial Summary\" is incorporated by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial - - ------- ------------------------------------------------- Condition and Results of Operations -----------------------------------\nThe information set forth on pages 4 through 6 of the 1995 Annual Report to Stockholders under the caption \"Management's Discussion and Analysis\" is incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - - ------- -------------------------------------------\nThe information contained in the Consolidated Financial Statements, Notes to Consolidated Financial Statements and the Independent Auditors' Report appearing on pages 7 through the inside back cover of the 1995 Annual Report to Stockholders is incorporated by reference.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure - - ------- ----------------------------------------------------\nNone.\nPART III\nThe information called for by Part III is hereby incorporated by reference from the information set forth and under the headings \"Voting Securities\", \"Security Ownership of Management\", \"Election of Directors\", and \"Executive Compensation\" in Registrant's definitive proxy statement for the 1996 Annual Meeting of Stockholders, which meeting involves the election of directors, such 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 Annual Report on Form 10-K. In addition, information on Registrant's executive officers has been included in Part I above 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 8-K --------\n(a) 1. The following Consolidated Financial Statements are incorporated by reference from the indicated pages of the 1995 Annual Report to Stockholders:\nPage Number(s) in Annual Report Consolidated Balance Sheets, December 31, 1995 and 1994 .................... 7\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 ................................. 8\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 ................................. 9\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 ................................. 10\nNotes to Consolidated Financial Statements ..... 10-16\nIndependent Auditors' Report ................... Inside back cover\n(a) 2. The following schedule to the Consolidated Financial Statements and the Independent Auditors' Report on Schedule are filed as part of this report.\nPage Number -----------\nIndependent Auditors' Report ...................... 18 Schedule II - Valuation Reserves .................. 19\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.\n(a) 3. The exhibits filed in this report or incorporated by reference, listed on the Exhibit Index on page 20, are as follows:\nExhibit No. Description ----------- ---------------------------------------------\n3. (a) Certificate of Incorporation 3. (c) By-Laws 4. Instruments defining the rights of holders of long-term debt 4. (a) Common Stock Purchase Warrant 10. (a) * 1982 Incentive Stock Option Plan 10. (b) * Management Incentive Plan 10. (c) * 1992 Stock Option Plan 11. Calculation of Earnings Per Share 13. 1995 Annual Report to Stockholders 21. Subsidiaries of the Registrant 23. Consent of Independent Auditors 27. Financial Data Schedule\n* Management contract or compensatory plan or arrangement required to be filed as an Exhibit pursuant to Item 14(c) of this report.\n(b) Reports on Form 8-K\nThe Registrant did not file any reports on Form 8-K during the last quarter of its year ended December 31, 1995.\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.\nMATEC Corporation\nDate: March 25, 1996 By:\/s\/ Robert B. Gill ------------------- Robert B. Gill 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 --------- ----- ---- \/s\/ Robert B. Gill President, Chief Executive March 25, 1996 - - ------------------------ Officer, and Director Robert B. Gill\n\/s\/ Michael J. Kroll Vice President and Treasurer - - ------------------------ (Principal Financial Officer March 25, 1996 Michael J. Kroll and Principal Accounting Officer)\n\/s\/ Eli Fleisher Director March 25, 1996 - - ------------------------ Eli Fleisher\n\/s\/ Lawrence Holsborg Director March 25, 1996 - - ------------------------ Lawrence Holsborg\n\/s\/ John J. McArdle III Director March 25, 1996 - - ------------------------ John J. McArdle III\n\/s\/ Joseph W. Tiberio Director March 25, 1996 - - ------------------------ Joseph W. Tiberio\n\/s\/ Robert W. Valpey Director March 25, 1996 - - ------------------------ Robert W. Valpey\n\/s\/ Ted Valpey, Jr. Chairman of the Board and March 25, 1996 - - ------------------------ Director Ted Valpey, Jr.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders MATEC Corporation Hopkinton, Massachusetts\nWe have audited the consolidated financial statements of MATEC 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 March 1, 1996; such consolidated financial statements and report are included in the MATEC 1995 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of MATEC Corporation and subsidiaries, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDeloitte & Touche LLP Boston, Massachusetts March 1, 1996\nMATEC Corporation and Subsidiaries ----------------------------------\nSchedule II - Valuation and Qualifying Accounts -----------------------------------------------\nAdditions Balance at Charged to Balance Beginning Costs and at End Description of Period Expenses Deductions of Period ----------- ---------- ---------- ---------- ----------\nAllowance for Doubtful Accounts:\nYear ended December 31, 1995 $ 199,000 $ 23,652 $ 28,652 $ 194,000 ========= ========= ========= =========\nDecember 31, 1994 $ 194,000 $ 59,881 $ 54,851 $ 199,000 ========= ========= ========= =========\nDecember 31, 1993 $ 194,000 $ 45,604 $ 45,604 $ 194,000 ========= ========= ========= =========\nInventory Reserve:\nYear Ended: December 31, 1995 $ 853,000 $ 388,040 $ 311,040 $ 930,000 ========== ========= ========= ==========\nDecember 31, 1994 $1,121,000 $ 264,863 $ 532,863 $ 853,000 ========== ========= ========= ==========\nDecember 31, 1993 $1,164,000 $ 401,421 $ 444,421 $1,121,000 ========== ========= ========= ==========\nEXHIBIT INDEX -------------\nExhibit No. (inapplicable items are omitted) - - -----------\n3. (a) Certificate of Incorporation (incorporated by reference to Exhibit 3. (a) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992).\n3. (c) By-Laws (incorporated by reference to Exhibit 3. (c) to Registrant's Form 10-Q for the quarterly period ended April 2, 1995).\n4. Each instrument which defines the rights of holders of long-term debt of Registrant and its subsidiaries under which the amount authorized does not exceed 10% of total assets of Registrant and subsidiaries on a consolidated basis has not been filed as an exhibit to this Annual Report on Form 10-K. Registrant hereby undertakes and agrees to furnish a copy of each instrument to the Securities and Exchange Commission upon request.\n4. (a) Common Stock Purchase Warrant dated April 12, 1995 between the Registrant and Massachusetts Capital Resource Company (incorporated by reference to Exhibit 4.(a) on Form 10-Q for the quarterly period ended July 2, 1995.\n10. (a) 1982 Incentive Stock Option (incorporated by reference to Exhibit 10. (a) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992).\n10. (b) Management Incentive Plan. Filed herewith.\n10. (c) 1992 Stock Option Plan (incorporated by reference to Exhibit 10. (c) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992).\n11. Calculation of Earnings Per Share. Filed herewith.\n13. Portions of 1995 Annual Report to Stockholders. Filed herewith.\n21. Subsidiaries of the Registrant. Filed herewith.\n23. Consent of Independent Auditors. Filed herewith.\n27. Financial Data Schedule. Filed for electronic purposes only.","section_15":""}
{"filename":"215619_1995.txt","cik":"215619","year":"1995","section_1":"ITEM 1. BUSINESS\nDauphin Deposit Corporation (Dauphin or Registrant) is a bank holding company, incorporated under the laws of the Commonwealth of Pennsylvania in 1974. Dauphin's wholly-owned bank subsidiary is Dauphin Deposit Bank and Trust Company (Dauphin Bank), which includes the Bank of Pennsylvania, Valleybank and Farmers Bank Divisions, through which Dauphin provides banking services. Dauphin Bank is engaged in the commercial and retail banking and trust business including the taking of time and regular savings and demand deposits, the making of commercial and consumer loans and mortgage loans, the providing of credit cards, safe deposit services and the performance of personal, corporate and pension trust services. Auxiliary services such as cash management are provided to commercial customers. Dauphin Bank is a Pennsylvania chartered bank and trust company and a member of the Federal Reserve System. Dauphin Bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law.\nCommercial lending services provided by Dauphin Bank include short and medium term loans, revolving credit loans, lines of credit, asset-based lending, real estate construction loans, agricultural loans, and equipment leasing financial arrangements. Consumer lending services include various types of secured and unsecured loans, including installment loans, home equity loans and automobile leasing. Dauphin Bank had no foreign loans in its portfolio at December 31, 1995. Residential mortgage loans are offered by Eastern Mortgage Services, Inc. (Eastern Mortgage), a Pennsylvania mortgage banking company acquired as a wholly-owned subsidiary of Dauphin Bank in July, 1994. Eastern Mortgage offers the following types of residential mortgage loans: Conventional first and second mortgage loans; FHA\/VA loans; State housing bond loans; residential construction\/permanent financing; and special programs for low and moderate income borrowers. All conforming conventional residential mortgage loans originated for sale in the secondary mortgage market under a FNMA or FHLMC product are generally underwritten to the standards as specified in the Fannie Mae Selling Guide. All non-conforming loans are underwritten to private investor standards. FHA and VA loans are processed and underwritten in accordance with the relevant handbooks and supplementary circular letters issued respectively by the Department of Housing and Urban Development and by the Veterans Administration.\nDauphin is registered with and is subject to regulatory supervision by the Board of Governors of the Federal Reserve System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended. Dauphin is restricted to activities which are found by the Federal Reserve Board to be bank-related and which are expected to produce benefits for the public that will outweigh any potentially adverse effects. The operation of Dauphin Bank, as well as those of other banks, are significantly affected by the monetary and credit policies and regulations of the federal regulatory agencies.\nDAUPHIN DEPOSIT BANK AND TRUST COMPANY\nDauphin Bank maintains 101 offices with 87 automated teller machines located in Adams, Berks, Chester, Cumberland, Dauphin, Franklin, Lancaster, Lebanon, Lehigh, Montgomery, Northampton and York Counties, Pennsylvania. In addition to its main office in Harrisburg, Dauphin County, Dauphin Bank owns an office building in Harrisburg which is used as an administrative center. Dauphin Bank maintains multiple offices in nine south central Pennsylvania counties. Single offices are located in each of Chester, Montgomery and Northampton Counties, in near proximity to the boundary lines with Berks and Lehigh Counties. The amounts of deposits attributable to zip code areas within Chester, Montgomery and Northampton Counties are insignificant in terms of the amounts of deposits attributable to zip code areas in the other nine counties. Accordingly, the Adams, Berks, Cumberland, Dauphin, Franklin, Lancaster, Lebanon, Lehigh and York nine county region constitutes the principal geographic area for Dauphin Bank.\nAt December 31, 1995, Dauphin Bank had total deposits of $3,949,801,000, total loans of $2,981,338,000 and total assets of $5,186,082,000.\nDAUPHIN DEPOSIT CORPORATION\nNON-BANKING SUBSIDIARIES\nEastern Mortgage Services, Inc. (Eastern Mortgage) is a Pennsylvania mortgage banking corporation which was acquired by Dauphin Bank on July 1, 1994. Eastern Mortgage is a full service mortgage banking company which originates, services and sells first and second residential mortgage loans of varying types primarily to the eastern Pennsylvania and New Jersey mortgage markets.\nDauphin Life Insurance Company (Dauphin Life) is an Arizona corporation which was formed in 1979 as a wholly-owned subsidiary of Dauphin. Dauphin Life reinsures credit life, health and accident insurance directly related to extensions of credit by Dauphin Bank and is presently limited to those activities by regulations of the Federal Reserve Board. Directors of Dauphin Life are officers or directors of Dauphin.\nDauphin Investment Company (Dauphin Investment) is a Delaware corporation which was formed in 1982 as a wholly-owned subsidiary of Dauphin. Dauphin Investment manages equity investments for Dauphin. Directors of Dauphin Investment are officers or directors of Dauphin.\nHopper Soliday & Co., Inc. (Hopper Soliday) is a wholly-owned subsidiary of Dauphin acquired effective July 1, 1991. Hopper Soliday is a Delaware corporation which engages in municipal finance, institutional sales, financial advisory and other general securities businesses permitted for bank holding companies and their non-bank subsidiaries.\nCOMPETITION\nThe banking industry in Dauphin Bank'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 firms, mutual funds and credit unions. The increased competition has resulted from a changing legal and regulatory climate, as well as from the economic climate. Mortgage banking firms, real estate investment trusts, insurance companies, leasing companies, financial affiliates of industrial companies, brokerage and factoring companies and government agencies also provide additional competition for loans and for many other financial services. Some of the financial services providers operating in Dauphin's market area operate on a regional and, in some cases, national scale, and possess resources greater than those of Dauphin.\nSUPERVISION AND REGULATION\nGeneral.\nDauphin is subject to regulation by the Pennsylvania Department of Banking, the Federal Reserve Board and the Securities and Exchange Commission. The deposits of Dauphin Bank are insured by the FDIC and Dauphin Bank is a member of the Bank Insurance Fund which is administered by the FDIC. In addition, Dauphin Bank is a Pennsylvania bank and trust company and member of the Federal Reserve System subject to regulation and supervision by the Pennsylvania Department of Banking and the Federal Reserve Board. The operations of Dauphin Bank are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and limits upon the types of services which may be offered. Various consumer laws and regulations also affect the operations of Dauphin Bank and Eastern Mortgage, its wholly-owned mortgage banking company subsidiary. Regulatory approvals also are required for branching and for bank mergers.\nDauphin is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act of 1956, as amended\nDAUPHIN DEPOSIT CORPORATION (BHC Act). The Federal Reserve Board may also make examinations of Dauphin and each of its non-bank subsidiaries. The BHC Act requires each bank holding company to obtain the approval of the Federal Reserve Board before it may acquire substantially all the assets of any bank, or before it may acquire ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of such bank.\nPursuant to provisions of the BHC Act and regulations promulgated by the Federal Reserve Board thereunder, Dauphin may only engage in or own companies that engage in activities deemed by the Federal Reserve Board to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and Dauphin must gain permission from the Federal Reserve Board prior to engaging in most new business activities.\nSubsidiary banks of a bank holding company are subject to certain restrictions imposed by the BHC Act on any extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Such transfers by Dauphin Bank to Dauphin or any nonbanking subsidiary are limited in amount to 10% of Dauphin Bank's capital and surplus and, with respect to Dauphin and all nonbanking subsidiaries, to an aggregate of 20% of Dauphin Bank's capital and surplus. Such loans and extensions of credit also are required to be secured in specified amounts, and all such transactions are required to be on an arm's length basis. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nSource of Strength Doctrine.\nUnder Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations or both. This doctrine is commonly known as the \"source of strength\" doctrine.\nDividends.\nDividend payments by Dauphin Bank to Dauphin are subject to the Pennsylvania Banking Code of 1965 (Banking Code) and the Federal Deposit Insurance Act (FDIA). Under the Banking Code, no dividends may be paid except from \"accumulated net earnings\" (generally, undivided profits). Under the FDIA, no dividends may be paid by an insured bank if the bank is in arrears in the payment of any insurance assessment due to the FDIC. State and federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by banks. Adherence to such standards further limits the ability of banks to pay dividends.\nUnder these policies and subject to the restrictions applicable to Dauphin Bank, Dauphin Bank could declare without prior regulatory approval, aggregate dividends of $26.0 million, plus net profits for the remainder of 1996.\nThe payment of dividends by Dauphin Bank may also be affected by other regulatory requirements and policies, such as the maintenance of adequate capital. If, in the opinion of the applicable regulatory authority a bank under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (which,\nDAUPHIN DEPOSIT CORPORATION depending on the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.\nCapital Adequacy.\nThe Federal Reserve Board adopted risk-based capital guidelines for bank holding companies, such as Dauphin. The guidelines were phased in over a two year period ended December 31, 1992. Currently, the required minimum ratio of total capital to risk-weighted assets (including 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, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. 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 loan loss allowance. During the two-year phase-in period, a limited portion of Tier 2 capital was permitted to be included as Tier 1 capital.\nIn addition to the risk-based capital guidelines, the Federal Reserve Board established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% 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 leverage ratio of at least 1% to 2% above the 3% stated minimum. Dauphin Bank is subject to the same capital requirements since its primary federal regulator is the Federal Reserve Board. Dauphin and Dauphin Bank exceed all applicable capital requirements.\nFDICIA.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required the federal banking agencies to promulgate regulations specifying 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 of 1) and (iv) does not meet the definition of a well capitalized bank. A bank will 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 of 1); (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%. Notwithstanding the foregoing, 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).\nUndercapitalized institutions, including significantly and critically undercapitalized institutions, are required to submit capital restoration plans to the appropriate federal banking regulator and are subject to restrictions on\nDAUPHIN DEPOSIT CORPORATION operations, including prohibitions on branching, engaging in new activities, paying management fees, making capital distributions such as dividends, and growing without regulatory approval. On December 31, 1995, Dauphin and Dauphin Bank exceeded the minimum capital levels of the \"well capitalized\" category.\nOther Provisions of FDICIA.\nEach depository institution must submit audited financial statements to its primary regulator and the FDIC, which reports are made publicly available. In addition, the audit committee of each depository institution must consist of outside directors and the audit committee at \"large institutions\" (as defined by FDIC regulation) must include members with banking or financial management expertise. The audit committee at \"large institutions\" must also have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution's primary regulator of any change in the institution's independent auditor, and annual management letters must be provided to the FDIC and the depository institution's primary regulator. The regulations define a \"large institution\" as one with over $500 million in assets, which would include Dauphin Bank. Also, under the rule, an institution's independent auditor must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance with laws and regulations concerning safety and soundness.\nUnder FDICIA, each federal banking agency must prescribe certain safety and soundness standards for depository institutions and their holding companies. Three types of standards must be prescribed: Asset quality and earnings, operational and managerial, and compensation. Such standards would include a ratio of classified assets to capital, minimum earnings, and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of such institutions and holding companies. Operational and managerial standards must relate to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) interest rate exposure, (v) asset growth, and (vi) compensation, fees and benefits. In November, 1993, the federal banking agencies released proposed rules setting forth some of the required safety and soundness standards. Under such proposed rules, if the primary federal regulator determines that any standard has not been met, the regulator can require the institution to submit a compliance plan that describes the steps the institution will take to eradicate the deficiency. Failure to adopt or implement a compliance plan could lead to further sanctions by the responsible regulator. Pursuant to the Riegle Community Development and Regulatory Improvement Act of 1994, federal banking agencies have been given the discretion to adopt safety and soundness guidelines rather than regulations.\nProvisions of FDICIA relax certain requirements for mergers and acquisitions among financial institutions, including authorization of mergers of insured institutions that are not members of the same insurance fund, and provide specific authorization for a federally chartered savings association or national bank to be acquired by an insured depository institution.\nFDICIA also includes a provision that generally restricts federally insured state banks, such as Dauphin Bank, to activities permitted to national banks. Under final FDIC rules implementing Section 303, state chartered banks must obtain the FDIC's prior consent before engaging as a principal in any activity not permissible for a national bank, unless one of the exceptions contained in the rule applies. Among the exceptions are activities that the Federal Reserve Board, by regulation (Regulation Y) or order, has found to be closely related to banking for purposes of the BHC Act. Compliance with the rule is not expected to have a material adverse effect on Dauphin Bank's operations.\nUnder FDICIA, all depository institutions must provide 90 days notice to their primary federal regulator of branch closings, and penalties are imposed for false reports by financial institutions. Depository institutions with assets in excess of $250 million must be examined on-site annually by their primary federal, state regulator or the FDIC.\nDAUPHIN DEPOSIT CORPORATION\nFDICIA also sets forth Truth in Savings disclosure and advertising requirements applicable to all depository institutions.\nFDIC Insurance Assessments.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) created two deposit insurance funds to be administered by the FDIC: the Savings Association Insurance Fund (SAIF) and the Bank Insurance Fund (BIF). Dauphin Bank's deposits are insured under BIF. The 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.\nUnder the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each institution to one of three capital groups (well capitalized, adequately capitalized or undercapitalized) and further assigns 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 evaluations, including examination reports, statistical analyses 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% 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, 1994, Dauphin Bank was subject to FDIC deposit insurance assessments at the rate of $.23 for every $100 of deposits.\nIn the second quarter of 1995, the BIF reached its statutory reserve ratio requirement. Consequently, the FDIC has significantly reduced the assessment rates applicable to BIF members and refunded to BIF members that portion of the assessment for the second and third quarters of 1995 which represented an overpayment once the BIF had achieved full funding in accordance with the statutory reserve ratio requirement. Dauphin Bank received a refund from the FDIC in September 1995 in the amount of $2,215,000, which amount also includes interest on the refund from June 1 to September 14, 1995. According to the new rate schedule, BIF institutions deemed to have the highest risk will pay up to $.31 for every $100 of deposits annually while those deemed to have the least risk will pay $.04 for every $100 of deposits annually. In the case of Dauphin Bank, for the second half of 1995, it was assessed at the rate of $.04 for every $100 of deposits. At the same time, the FDIC has indicated that it anticipates that the SAIF assessment rate in even the lowest risk-based category will not fall below the current rate of $.23 for every $100 of deposits before 2002.\nInterstate Banking.\nPrior to the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal Act) in September 1994, interstate banking was restricted under the terms of the Douglas Amendment to the BHC Act which prohibited the Federal Reserve Board from approving an application by a bank holding company located in one state to acquire a bank or all of its assets located in another state unless the acquisition was specifically authorized by a reciprocal interstate banking statute, such as the statute adopted in Pennsylvania in 1990, specifically permitting interstate acquisitions. Similarly, interstate branching was prohibited for national banks and state- chartered member banks by the McFadden Act, although some states, not including Pennsylvania, had passed laws permitting limited interstate branching by non- Federal Reserve member state banks. The Riegle-Neal Act permits an adequately capitalized, adequately managed bank holding company to acquire a bank in another state as of September 29, 1994, whether or not the state permits the acquisition, subject to certain deposit concentration caps and the Federal Reserve Board's approval. A state may not impose discriminatory requirements on acquisitions by out-of-state holding companies. In addition, beginning on June 1, 1997, under the Riegle-Neal Act, a bank can expand interstate by merging with 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\nDAUPHIN DEPOSIT CORPORATION earlier than June 1, 1997 if it wishes to do so. The Riegle-Neal Act also permits de novo interstate branching as of June 1, 1997 but only if a state affirmatively opts in by appropriate legislation. Once a state opts in to interstate branching, it may not opt out at a later date. The Riegle-Neal Act also allows foreign banks to branch by merger or de novo branch to the same extent as banks from the foreign bank's home state. The Riegle-Neal Act also subjects foreign banks to some additional requirements, including extending obligations under the Community Reinvestment Act to certain foreign bank acquisitions and regulating the types of activities off-shore branches of foreign banks may conduct. The Pennsylvania Legislature amended the Pennsylvania Banking Code of 1965 in July, 1995, to opt in to all of the provisions of the Riegle-Neal Act, including interstate bank mergers and de novo interstate branching. The management of Dauphin cannot predict with any reasonable degree of certainty the effects, if any, which the Riegle-Neal Act may have on Dauphin.\nProposed Legislation.\nLegislation has been introduced in Congress to recapitalize the SAIF via a one-time special assessment on SAIF deposits and thereafter to merge the SAIF with the BIF. Legislation also is pending in Congress which would repeal certain aspects of the Glass-Steagall Act, which prohibits commercial banks from engaging in securities underwriting activities. It is not anticipated that the enactment of such legislation, in its current form, would have a material effect on the financial condition or results of operations of Dauphin.\nEmployees\nAt December 31, 1995, Dauphin and its subsidiaries employed approximately 2,681 persons.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDauphin's principal office is located in Dauphin Bank's main banking offices at 213 Market Street, Harrisburg, Pennsylvania. Dauphin owns 18 of the branch banking offices which are leased to Dauphin Bank.\nDauphin Bank owns 67 of its branch banking offices and leases 26 other facilities including two leases which are treated as capitalized leases for financial reporting purposes. Hopper Soliday & Co., Inc. leases four of its sales offices. Eastern Mortgage leases 12 of its sales offices. Leases expire intermittently through 2010 and most contain options to renew.\nAggregate annual rentals for real estate and equipment paid during Dauphin's last fiscal year did not exceed five percent of its operating expenses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVarious legal actions and proceedings are pending involving Dauphin or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material to Dauphin's financial condition or results of operations. Included among outstanding litigation is a class action law suit instituted by Dauphin seeking a declaratory judgment from the Court specifically permitting Dauphin to discontinue offering an 18 month variable rate investment product carrying a minimum interest rate of 10% for the 18 month term held in certain individual retirement accounts (IRA) and\/or to charge an annual maintenance fee and fee on rollovers or transfers into the investment product. Dauphin's right to terminate the variable rate investment product and to charge a service fee is in dispute and is being challenged by the holders of the IRA accounts in question. Management intends to vigorously assert its right to terminate the 18 month variable rate investment product in accordance with its terms. Pending the outcome of the litigation, Dauphin has continued to date to pay a 10% interest rate with regard to the product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.\nDAUPHIN DEPOSIT CORPORATION\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages and positions of all of the executive officers of Dauphin as of February 1, 1996 are listed below along with their business experience during the past five years. Executive officers are appointed by the Board of Directors. There are no family relationships among these executive officers, nor any arrangement or understanding between any executive officer and any other person pursuant to which the executive officer was selected.\nDAUPHIN DEPOSIT CORPORATION\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE OF DAUPHIN DEPOSIT CORPORATION STOCK AND DIVIDENDS PAID\nThe price information provided below reflects actual sales prices of high, low and closing trades as quoted on The Nasdaq Stock Market.\nThe approximate number of holders of common stock is 11,585 as of December 31, 1995.\nDAUPHIN DEPOSIT CORPORATION ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nDAUPHIN DEPOSIT CORPORATION ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis section presents management's discussion and analysis of the financial condition and results of operations of Dauphin Deposit Corporation and subsidiaries (Dauphin), including Dauphin Deposit Bank and Trust Company (Bank), which includes the Bank of Pennsylvania, Farmers Bank and Valleybank Divisions. The other primary subsidiaries include Hopper Soliday & Co., Inc. (Hopper Soliday), a broker\/dealer, and Eastern Mortgage Services, Inc. (Eastern Mortgage), a mortgage banking company. This discussion and analysis should be read in conjunction with the financial statements which appear elsewhere in this report.\nOn July 1, 1994, Dauphin acquired Eastern Mortgage Services, Inc., a mortgage banking company headquartered in Trevose, Pennsylvania, for approximately $21.0 million in cash pursuant to a definitive agreement signed in May 1994. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of Eastern Mortgage from the date of acquisition are included with the results of Dauphin.\nRESULTS OF OPERATIONS\nSUMMARY\nDauphin Deposit Corporation recorded net income of $65.6 million for 1995, compared with $70.0 million recorded in 1994. On a per common share basis, net income was $2.12 in 1995 compared with $2.18 in 1994 and $2.08 in 1993.\nReturn on average total assets was 1.31% for 1995, compared with 1.42% for 1994 and 1.40% for 1993. Return on average equity, excluding the SFAS 115 (as defined in \"Investment Securities and Other Short-Term Investments\") adjustment, was 12.64% for 1995 compared with 13.72% for 1994 and 14.06% for 1993. Return on average stockholders' equity, including the SFAS 115 adjustment, was 12.81% for 1995 compared with 13.81% for 1994.\nDuring 1995 average earning assets increased 1.4% to $4.7 billion and the interest rate spread decreased to 3.29% from 3.61%. The decrease in the interest rate spread was primarily the result of a shifting of deposits from transaction oriented deposits to time deposits. The result was a decrease of $5.6 million or 2.9% in fully taxable equivalent net interest income.\nDauphin continues to maintain a high quality loan portfolio. The percentage of non-performing assets, comprised of non-accrual loans, loans past due 90 or more days as to principal or interest payments, restructured loans and other real estate owned, represented .69% of year- end loans and other real estate owned, down from .82% at December 31, 1994. The allowance for loan losses was 1.40% of year-end loans at December 31, 1995 compared with 1.41% at December 31, 1994. Non-performing loans were covered 2.3 times by the allowance for loan losses. The allowance includes $ 6.7 million which is not allocated to any specific loan category. Because of this strong asset quality, the provision for loan losses was decreased by $1.9 million in 1995.\nNon-interest income, other than securities gains, increased $11.9 million, or 20.6%. Increased non-interest income was the result of growth in fiduciary activities, increase in volume of merchant credit card processing and mortgage banking activities. Offsetting these increases was a decline in commission and fee income generated by Hopper Soliday.\nNon-interest expense items increased $14.0 million, or 10.1%. Contributing to this increase were strategic initiatives implemented, normal salary adjustments and additions to staffing levels and the inclusion of a full year of results for Eastern Mortgage. Additionally, other non-interest expenses decreased due to the industry-wide reduction in FDIC insurance premiums.\nNET INTEREST INCOME\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 thereon. The amount of net interest income is affected by changes in interest rates, account balances, or volume, and the mix of earning assets and interest bearing liabilities.\nDAUPHIN DEPOSIT CORPORATION TABLE 1--AVERAGE BALANCES, RATES AND INTEREST INCOME AND EXPENSE SUMMARY (TAXABLE EQUIVALENT BASIS)\n- -------- (1) Includes fees on loans. Average loan balances include non-accruing loans. (2) Includes home equity loans. (3) Loans outstanding net of unearned income.\nDAUPHIN DEPOSIT CORPORATION For analytical purposes, net interest income is adjusted to a taxable equivalent basis. This adjustment facilitates performance comparisons among taxable and tax exempt assets by increasing tax exempt income by an amount equivalent to the federal income taxes which would have been paid if this income were taxable at the federal statutory rate of 35%.\nTable 2 presents the net interest income on a fully taxable equivalent basis for each of the years in the three year period ended December 31, 1995.\nNet interest income on a fully taxable equivalent basis totaled $188.0 million in 1995, a decrease of $5.6 million or 2.9% from $193.6 million in 1994. Net interest income in 1994 was up 1.1% from $191.4 million in 1993.\nTable 1 presents average balances, taxable equivalent interest income and expense and average rates earned and paid for Dauphin's assets and liabilities. Table 3 analyzes the changes attributable to the volume and rate components of net interest income.\nTABLE 2--NET INTEREST INCOME\nTABLE 3--RATE-VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME\nNote: The changes not due solely to change in volume or solely to change in rate are allocated proportionally to both change in volume and rate.\nDAUPHIN DEPOSIT CORPORATION\nDuring 1995 there was a decrease in net interest income of $3.1 million due to changes in volume and a decrease of $2.5 million due to changes in rate. In 1994 there was an increase of $9.4 million due to changes in volume and a decrease of $7.2 million due to changes in rate.\nThe change in the net interest margin attributable to interest rates can be understood by analyzing the interest rate spread and the net interest margin on earning assets. While the interest rate spread considers only 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 contribution of assets funded by interest free sources.\nAs reflected in Table 4, average earning assets were $4.7 billion in 1995 and $4.6 billion in 1994 and 1993. The interest rate spread for 1995 was 3.29% compared with 3.61% for 1994 and 3.67% for 1993. The net interest margin for 1995 was 4.00% compared with 4.17% for 1994 and 4.21% for 1993.\nTABLE 4--INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS\nShort-term interest rates (prime, federal funds, etc.) continued to rise during the first half of 1995 followed by a decline in the second half of 1995. Long-term interest rates, in general, declined steadily for the entire year. The net result of these interest rate movements was a flattening of the overall yield curve. The average prime rate in 1995 was 8.83% compared with 7.17% in 1994. The average federal funds rate increased to 5.84% for 1995 compared with 4.23% for 1994. During 1995, compared with 1994, the average yield on earning assets increased 53 basis points while the average cost of funds increased 85 basis points resulting in a decrease in the interest rate spread of 32 basis points. The yield on the investment portfolio increased 23 basis points due to the reinvestment of maturities at higher rates, when compared with the yield of the security maturing. Average loans, which represent the highest yielding earning assets, increased $244.8 million or 9.2% and produced a yield of 8.56% in 1995 compared with 7.92% in 1994. Average loans represented 61.6% of the average earning assets for 1995. The cost of interest bearing deposits increased to 4.47% in 1995 compared with 3.68% in 1994. Rates paid on interest bearing transaction accounts decreased throughout 1995. Interest rates offered on time deposits have been rising. Consequently, depositors have been shifting from transaction accounts to higher yielding time deposits. The increase in the cost of short- term borrowings (143 basis points) was caused primarily by the rise in the federal funds rate. The interest rate spread decreased 32 basis points which was partially offset by an increase in the value of non-interest bearing funds resulting in a net 17 basis point decline in the net interest margin.\nAverage interest rates rose during 1994 compared to 1993. The average prime rate in 1994 was 7.17% compared with 6.00% in 1993. The average federal funds rate increased to 4.23% for 1994 compared with 3.02% for 1993. During 1994, compared with 1993, the average yield on earning assets decreased 1 basis point while the average cost of funds increased 5 basis points resulting in a decrease in the interest rate spread of 6 basis points. The yield on the investment portfolio decreased 17 basis points due to the reinvestment of maturities at\nDAUPHIN DEPOSIT CORPORATION significantly lower rates when compared with the yield of the security maturing. Average loans, which represent the highest yielding earning assets, increased $191.0 million or 7.8% and produced a yield of 7.92% in 1994 compared with 7.91% in 1993. This slight increase was the result of a higher interest rate environment during 1994, somewhat offset by fee income which is included in interest income. The reduction of fees, due to lower refinancings in residential mortgages, reduced the yield by 2 basis points. Average loans represented 57.1% of the average earning assets for 1994. The cost of interest bearing deposits decreased to 3.68% in 1994 compared with 3.86% in 1993. Rates paid on interest bearing transaction accounts decreased in early 1994 and remained relatively flat throughout the year. Interest rates on time deposits have recently been rising. Consequently, depositors are shifting from transaction accounts to higher yielding time deposits, reversing the trend of the prior three years. The increase in the cost of short-term borrowings (111 basis points) was caused primarily by the rise in the federal funds rate. The interest rate spread decreased 6 basis points which was partially offset by an increase in the value of non-interest bearing funds resulting in a 4 basis point decline in the net interest margin.\nDauphin's cost of interest bearing funds is generally higher, and its net interest margin is generally lower, when compared with banking companies of Dauphin's asset size. An important factor in these comparative differences is certain individual retirement accounts which are invested in 18 month variable interest rate products with a minimum interest rate of 10% for the 18 month term as discussed herein under \"Deposits\". If these interest rate products had paid interest at Dauphin's weighted average cost of funds for all other retail certificates of deposit, Dauphin's cost of interest bearing liabilities would have been decreased by 21 basis points, 24 basis points and 21 basis points for 1995, 1994 and 1993, respectively.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses charged against earnings was $5.6 million in 1995 compared with $7.5 million in 1994, a decrease of 25.2%. This decrease was mainly due to the improved asset quality of the loan portfolio. The provision is based on management's estimate of the amount needed to maintain an adequate allowance for loan losses. This estimate is based on the review of the loan portfolio, the level of net credit losses, past loan loss experience, the general economic outlook and other factors that management feels are appropriate.\nManagement takes an aggressive approach to charging off loans. This does not necessarily indicate a decline in the asset quality of the loan portfolio.\nSeveral improvements were seen in certain measures of loan portfolio performance. The ratio of net charge-offs to average loans decreased to .14% in 1995 from .24% in 1994 and the level of non-accruing loans and restructured loans decreased to $17.9 million (.60% of year-end loans) at December 31, 1995 from $20.3 million (.71% of year-end loans) at December 31, 1994.\nNON-INTEREST INCOME\nTable 5 reflects Dauphin's total non-interest income which increased $10.8 million or 17.8% in 1995 compared with an increase of $.9 million or 1.5% in 1994. Excluding gains on investment securities, the 1995 increase was $11.9 million or 20.6% compared with an increase of $.8 million or 1.4% for 1994.\nDAUPHIN DEPOSIT CORPORATION\nTABLE 5--NON-INTEREST INCOME\nIn the banking segment of Dauphin, income from fiduciary activities increased $.4 million or 2.7% in 1995. Revenue in 1995 increased in the areas of employee benefits and personal trust. The increase of $1.1 million or 7.4% in 1994 was due to similar increases in the employee benefits and personal trust departments.\nService charges on deposit accounts decreased $.6 million or 5.0% during 1995. In 1994, a decrease of $1.0 million or 8.1% was realized. Management continuously monitors the fee structure and makes changes where appropriate. The 1995 and 1994 decrease was primarily due to a lower number of fees assessed for services.\nOther service charges and fees increased $1.3 million or 11.4% in 1995 compared with an increase of $2.1 million or 23.4% in 1994. The increase for 1995 and 1994 was due to the volume of merchant credit card processing and other fees relating to increased volume in consumer lending.\nSecurities gains totaled $2.3 million in 1995 as compared with $3.3 million in 1994 and $3.2 million in 1993. All gains in 1995 were from the sale of debt securities. During 1994 the sale of debt securities generated $2.4 million in net gains compared with $.9 million in net gains from equity securities transactions.\nOther non-interest income increased $1.2 million for 1995 compared with 1994. In 1994, compared with 1993, other non-interest income decreased $3.7 million. The increase for 1995 was primarily the result of gains realized on the disposition of certain branches (including deposits) and the realignment of the proceeds to new branch locations. In December 1993, a settlement with the Commonwealth of Pennsylvania was entered into which resulted in a refund of $3.6 million in previously paid Bank Shares Tax plus interest. This non- recurring refund was the result of litigation contesting the Commonwealth's ability to tax United States Obligations.\nThe broker\/dealer segment of Dauphin represents broker\/dealer commissions and fees generated by Hopper Soliday. This income is generated from underwriting securities which are predominantly general obligations of Central Pennsylvania municipalities, providing financial advisory services, selling securities to individual and institutional investors and other related activities. The broker\/dealer income decreased $1.4 million or 17.9% in 1995 and decreased $3.2 million or 29.3% in 1994. These decreases are due to reduced volume of business in 1995 and 1994, due primarily to a less favorable interest rate environment.\nThe mortgage banking segment of Dauphin reflects the mortgage banking subsidiary, Eastern Mortgage. The mortgage banking income increased $11.5 million or 113.6% in 1995 compared with 1994. Because Eastern\nDAUPHIN DEPOSIT CORPORATION Mortgage was acquired July 1, 1994, the income in 1994 represents a full service mortgage banking operation for only six months.\nIn addition, effective January 1, 1995, Dauphin adopted Statement of Financial Accounting Standards No. 122 (SFAS 122), \"Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65\". 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. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. For the year ended December 31, 1995 the impact of applying the provisions of SFAS 122 resulted in a net increase in mortgage banking income of $5.8 million when compared with 1994.\nNON-INTEREST EXPENSE\nTable 6 reflects Dauphin's non-interest expense which increased $14.0 million or 10.1% in 1995 compared with an increase of $2.8 million or 2.1% in 1994.\nTABLE 6--NON-INTEREST EXPENSE\nDauphin's banking segment non-interest expense increased $4.2 million or 3.4% in 1995 compared with a decrease of $4.6 million or 3.7% for 1994.\nIn Dauphin's banking segment, salaries and employee benefits increased .5% in 1995 and decreased .9% in 1994. Full-time equivalent employees increased 5.2% to 2,024 at December 31, 1995 compared with 1,924 at year-end 1994. Salaries expense increased 4.1% in 1995, while benefits expense decreased 15.1%, primarily due to a decrease in health insurance costs. Dauphin goes through a continual review to control benefit costs.\nIn the second quarter of 1995, the Bank Insurance Fund (BIF) reached its statutory reserve ratio requirement of 1.25%. Consequently, the FDIC significantly reduced the assessment rates applicable to BIF members and refunded to BIF members that portion of the assessment for the second and third quarters of 1995 which represented an overpayment once BIF had achieved full funding in accordance with the statutory reserve ratio requirement. Dauphin received a refund from the FDIC in September 1995 in the amount of $2.2 million which included interest from June 1, the date the BIF was fully funded. In addition, Dauphin's assessment rate was dropped from 23 basis points to 4 basis points effective from the date of BIF reaching its statutory reserve ratio requirement. This reduced Dauphin's deposit insurance expense by $3.8 million when compared to 1994. In 1996, Dauphin will record $1,000 for deposit insurance for the period from January through June. Deposit insurance assessments for the second half of 1996 have not yet been determined.\nDAUPHIN DEPOSIT CORPORATION\nAll other non-interest expense items increased $7.7 million or 14.5% in 1995 compared with 1994. The increase for 1995 was primarily the result of increased expenses to reflect numerous strategic initiatives implemented in 1995. The other non-interest expense items that increased include depreciation on technological investments, upgrades to branch facilities, legal, and consulting fees.\nThe broker\/dealer segment had increased non-interest expense of $.2 million or 3.0% in 1995 and a decrease of $2.1 million or 21.7% in 1994.\nThe mortgage banking segment had increased non-interest expense of $12.0 million or 119.8% in 1995 compared with 1994. This significant increase reflects twelve months of results in 1995 and six months of results in 1994. In addition, the mortgage banking segment experienced significant volume increases in 1996, including large refinancing activities in the last quarter of 1995, which resulted in significantly higher salary expense.\nPROVISION FOR INCOME TAXES\nIncome tax expense amounted to $23.2 million in 1995 as compared with $22.8 million in 1994 and $22.0 million in 1993. Dauphin's effective tax rate for 1995 was 26.1% compared with 24.5% in 1994 and in 1993. The primary increase in the effective tax rate was due to the decreased level of tax exempt income in 1995 compared with 1994 and 1993. For a more comprehensive analysis of income tax expense, refer to Note 13 of the Notes to Consolidated Financial Statements.\nFINANCIAL CONDITION\nSOURCES AND USES OF FUNDS\nDauphin's financial condition can be evaluated in terms of trends in its sources and uses of funds. The comparison of average balances in Table 7 indicates how Dauphin has managed these elements. Average funding uses increased $63.6 million or 1.4% in 1995 as compared with an increase of $88.0 million or 1.9% in 1994.\nTABLE 7--SOURCES AND USES OF FUNDS\n- -------- (1) Non-interest bearing liabilities and stockholders' equity less non-interest bearing assets.\nDAUPHIN DEPOSIT CORPORATION\nINVESTMENT SECURITIES AND OTHER SHORT-TERM INVESTMENTS\nAverage short-term investments and investment securities, in the aggregate, decreased $230.9 million or 11.8% during 1995 compared with a decrease of $96.5 million or 4.7% during 1994. During 1995 and 1994 investment securities maturing were used to fund loan growth since loan growth exceeded the growth of traditional funding sources of deposits and short-term borrowings.\nThe balances maintained for short-term investments and investment securities are, for the most part, supported by short-term deposits such as money market and interest bearing demand accounts, short-term borrowings and time deposits. As reflected in Table 8, the average maturity of the investment portfolio was 6.0 years at year-end 1995. Included in the portfolio are state and municipal securities and mortgage-backed securities that have a longer-term maturity but are sometimes either called before maturity or have repricing characteristics that occur before final maturity. The average life to call or repricing of the portfolio was 2.0 years at December 31, 1995.\nTABLE 8--ANALYSIS OF INVESTMENT SECURITIES\nDauphin had no investments in any foreign country that aggregated more than 1% of assets at December 31, 1995, 1994 or 1993.\nAt December 31, 1995, net unrealized gains in the portfolio were $21.0 million consisting of gross unrealized gains of $29.7 million and gross unrealized losses of $8.7 million. Dauphin accounts for investment securities in accordance with the provisions of Statement of Financial Accounting Standards No. 115 (SFAS 115), \"Accounting for Certain Investments in Debt and Equity Securities\". SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments are to be classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) 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; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair\nDAUPHIN DEPOSIT CORPORATION value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Management has determined that the entire investment securities portfolio should be classified as available- for-sale.\nLOANS\nAverage loans increased $244.8 million or 9.2% during 1995 compared with an increase of $191.0 million or 7.8% in 1994. Loan growth continued to increase in 1995, primarily in the area of consumer loans, as more emphasis was placed on this line of business.\nThe economy in our market area is diversified and has been relatively stable. This affords Dauphin the opportunity to select quality commercial credits and stabilizes our consumer business.\nLoan balances during 1995 were influenced by the improving economy and, as a result, balances in both the commercial and consumer areas increased. Dauphin continues to sell residential mortgages in the secondary market in order to avoid taking interest rate risk.\nDauphin's policy is to make the vast majority of its loans and commitments in the market area it serves. This tends to reduce risk and gives Dauphin the opportunity to deliver its many products to the same customer base. Dauphin had no foreign loans in its portfolio at December 31, 1995.\nTABLE 9--LOANS OUTSTANDING, NET OF UNEARNED INCOME\nTABLE 10--LOAN MATURITIES AND INTEREST SENSITIVITY (1)\n- -------- (1) Excludes residential mortgages, home equity, consumer loans and lease financing\nDAUPHIN DEPOSIT CORPORATION\nDEPOSITS\nAverage deposits, including non-interest bearing demand deposits, increased $223.6 million or 6.4% during 1995 compared with a decrease of $62.3 million or 1.7% in 1994. Dauphin, like many other commercial banks, has experienced deposit growth even as the competition for depositors' funds has become more intense. Competition for deposits has come from other commercial banks, thrift institutions, credit unions, brokerage houses and mutual funds. Deposit growth was primarily due to the increase in average interest rates during 1995. While rates paid on interest bearing transaction accounts decreased throughout 1995, rates paid on time deposits have been increasing due to rising interest rates. Depositors appear to be shifting from transaction accounts to time deposits. Included in interest bearing deposits are certain individual retirement accounts (IRA) totaling $184.8 million which are invested in 18 month variable interest rate products with a minimum interest rate of 10% for the 18 month term. During 1993, Dauphin charged a service fee on these products, and initiated the process to discontinue the products in accordance with the terms of the IRA contract. In furtherance of its right to terminate this investment product, Dauphin commenced a legal action for a declaratory judgment in 1994 seeking a judicial determination from the Court permitting Dauphin to discontinue the 18 month variable rate investment product at issue and\/or to charge an annual maintenance fee and an additional fee on rollovers or transfers into the IRA account. Dauphin's right to terminate the variable rate investment product and to charge a service fee is in dispute and is being challenged by the holders of the IRA accounts in question. It is management's opinion that continuation of the 18 month variable rate investment product is not in the best interest of Dauphin. Management intends to vigorously assert its legal right to discontinue the 18 month variable rate investment product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.\nDuring 1995 average time deposits increased $400.7 million compared with a decrease of $41.5 million during 1994. This funding source was used to replace volatile liabilities such as overnight federal funds. Additionally, the growth of non-interest bearing deposits has been relatively slow in recent years. The percentage of average non-interest bearing demand deposits to average total deposits amounted to 11.6% in 1995 and 1994 and 11.0% for 1993. Dauphin's banking subsidiary has remained interest rate competitive and has introduced new deposit products to maintain and attract deposits.\nSHORT-TERM BORROWINGS\nAverage short-term borrowings decreased $132.4 million or 17.0% during 1995 compared with an increase of $132.7 million or 20.5% in 1994. Short-term borrowings are primarily represented by federal funds purchased and securities sold under agreements to repurchase. The level of short-term borrowings is dependent upon many items such as loan growth, deposit growth and the interest rates paid for these funds. The average cost of short-term borrowings increased from 3.01% in 1993 to 4.12% in 1994 and to 5.55% in 1995.\nNON-PERFORMING ASSETS\nTable 11 reflects Dauphin's non-performing assets for the five years ended December 31, 1995. Dauphin's policy is to discontinue the accrual of interest on commercial loans on which principal or interest is past due 90 days or more and on commercial mortgages on which principal or interest is past due 120 days or more. Consumer loans, excluding residential mortgages, which are 150 days past due are charged off. Residential mortgages are placed on non-accrual status after becoming 180 days past due. When a loan is placed on non-accrual status, any unpaid interest is generally charged against income. Management believes that strict adherence to this policy with regard to non-accruals and charge-offs will insure that the historically high quality of the loan portfolio will be maintained. Other real estate owned represents property acquired through foreclosure.\nDAUPHIN DEPOSIT CORPORATION\nTABLE 11--NON-PERFORMING ASSETS\nLoan quality is maintained through diversification of risk, strict enforcement of credit control practices and continued monitoring of the loan portfolio.\nAt December 31, 1995, Dauphin had no loan concentrations exceeding 10% of total loans. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by economic or other industry specific conditions.\nThe balance of non-accrual and restructured loans is $12.1 million at December 31, 1995. Interest income on these loans of $.4 million was recorded on a cash basis. If such loans were on the accrual basis, an additional $.3 million of interest income would have been recognized.\nLoans which are not included in non-performing and are current as to payments of principal and interest but have a somewhat higher than normal risk of becoming non-accrual, impaired or reduced rate in the future are estimated to total approximately $8.1 million at December 31, 1995.\nOn January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan\", as amended by Statement of Financial Accounting Standards 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 of the fair value of the collateral if the loan is collateral dependent.\nOn December 31, 1995 the balance of impaired loans was $11.7 million. Impaired loans of $8.2 million have a related allowance for loan losses of $3.8 million and the remaining impaired loans of $3.5 million have no related allowance for loan losses. The impaired loans consist of loans where it is probable that Dauphin will be unable to collect all amounts due according to the contractual term of the loan agreement. Interest income for impaired loans that are on non-accrual status is recognized using the cash basis, while interest on impaired loans that are still accruing is recognized using the accrual method. The average balance of impaired loans for 1995 was $8.4 million and the interest recognized for the year was $.7 million. The interest income includes $.2 million that was recorded on the cash basis.\nDAUPHIN DEPOSIT CORPORATION Federal regulatory authorities have defined \"highly leveraged transactions\" (HLT's) as a credit of $20 million or more which is extended in connection with an acquisition by, or a restructuring of, an organization, and the extension of credit results in \"high leverage\" or is made to an already highly leveraged organization. It is the policy of Dauphin to consider financing HLT's for its customers or for potential customers in its market area which usually involves the change of ownership from one generation of a family to the next, or from present owners to the existing management team. The amount of HLT's, as defined by the Federal regulatory authorities, was $7.3 million at December 31, 1995 and $8.2 at December 31, 1994 and represents Dauphin's portion of a shared national credit within its market area.\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is based on management's continuing evaluation of the loan portfolio, assessment of economic conditions, the diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience and the amount and quality of non-performing loans. Table 12 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 excessive or inadequate and consequently may be re-allocated in the future to reflect then current conditions. Accordingly, the entire allowance is considered available to absorb losses in any category. In 1995, the unallocated category increased primarily as a result of Dauphin's continued improvement in loan quality which is reflected in Table 11.\nTABLE 12--ALLOCATION OF ALLOWANCE FOR LOAN LOSSES\n- -------- Gross loans represent loans before unamortized net loan fees. (1) Includes home equity loans\nManagement believes that the allowance for loan losses is adequate. While 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 Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.\nTable 13 reflects an analysis of the allowance for loan losses for the past five years.\nDAUPHIN DEPOSIT CORPORATION\nThe provision for loan losses of $5.6 million exceeded the net charge-offs of $4.1 million, thereby increasing the allowance for loan losses from $40.2 million in 1994 to $41.7 million in 1995. The allowance for loan losses as a percentage of year-end loans was 1.40% at December 31, 1995 and 1.41% at December 31, 1994.\nTABLE 13--ANALYSIS OF ALLOWANCE FOR LOAN LOSSES\n(1) Includes home equity loans\nLIQUIDITY\nLiquidity management involves meeting the funds flow requirements of customers who may be either depositors wanting to withdraw funds, or borrowers needing assurance that sufficient funds will be available to meet their credit needs.\nLiquidity from asset categories is provided primarily through investment securities with maturities of less than one year and short-term investments, such as deposits with other banks, federal funds sold and other short-term investments. Dauphin's asset liquidity position is strong because of the investment portfolio's maturity structure (Table 8), the amount of short-term investments, the funds provided by loan maturities (Table 10) and\nDAUPHIN DEPOSIT CORPORATION the funds available to Dauphin by established federal funds lines of credit. Additionally, the Bank is a member of the Federal Home Loan Bank of Pittsburgh. This established credit arrangement provides the Bank with increased liquidity.\nThe generation of deposit balances is the primary source of liquidity from liability categories. Total deposits increased by $434.7 million or 12.4% from year-end 1994 to year-end 1995. As previously mentioned, this funding source replaced overnight federal funds borrowings. Table 14 reflects the change in the major classifications of deposits by comparing the year-end balances for the past three years and Table 15 reflects the maturity of large dollar deposits for the same periods. As shown in Table 16, federal funds purchased and other forms of short-term borrowings are also significant sources of liquidity. Dauphin continues to maintain diverse liability funding sources.\nTABLE 14--DEPOSITS BY MAJOR CLASSIFICATION\nTABLE 15--MATURITY OF TIME DEPOSITS OF $100,000 OR MORE\nTABLE 16--SHORT-TERM BORROWINGS\nDAUPHIN DEPOSIT CORPORATION\nCAPITAL RESOURCES\nDuring 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 2,000,000 shares of the outstanding common stock. In February 1995, an additional 1,500,000 shares were authorized for repurchase. Available investments are being used to fund the share repurchases. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan, Stock Option Plan, the Dividend Reinvestment and Stock Purchase Plan, and other appropriate uses. During 1995 and 1994, Dauphin repurchased 630,000 shares for $16.1 million and 1,744,500 shares for $42.4 million, respectively.\nTotal stockholders' equity increased $80.0 million or 17.1% in 1995 compared with an increase of $39.4 million or 7.8% in 1994. The increase for 1995 was due to net income of $65.6 million less dividends declared of $31.2 million and was positively impacted by the change in net unrealized gains on investments available-for-sale of $54.7 million, somewhat offset by the repurchase of outstanding common stock throughout the year of $16.1 million. The decrease for 1994 was adversely impacted by the change in net unrealized losses on investments available-for-sale of $83.1 million. The ratio of average equity to average assets amounted to 10.23% for 1995, compared with 10.27% for 1994 and 9.99% for 1993. Internal capital generation is measured as the percent of return on average equity multiplied by the percent of earnings retained. The resulting internal capital generation percentage amounted to 6.7% for 1995 compared with 7.9% for 1994 and 8.6% for 1993.\nCommon measures of adequate capitalization for banking institutions are ratios of capital to assets. These ratios indicate the proportion of permanently committed funds to the total asset base. Guidelines issued by federal regulatory authorities require both banks and bank holding companies to meet minimum risk-based capital ratios in an effort to make regulatory capital more responsive to the risk exposure related to a bank's on- and off-balance sheet items. Risk-based capital guidelines redefine the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of capital requirements. The components of risk- based capital are segregated as Tier 1 and Tier 2 capital. Tier 1 capital is composed of total stockholders' equity reduced by goodwill and other intangible assets. Tier 2 capital is the allowance for loan losses (with certain limitations) and qualifying debt obligations. Regulators have also adopted minimum Tier 1 leverage ratio standards. Tier 1 capital for the leverage ratio is the same as the Tier 1 capital definition in the risk-based capital guidelines. Table 17 presents the capital ratios for Dauphin for the past three years calculated at year-end in accordance with these guidelines. At December 31, 1995, Dauphin and its banking subsidiary exceeded all capital requirements and is considered to be \"well capitalized\".\nTABLE 17--CAPITAL RATIOS\nINTEREST RATE SENSITIVITY\nInterest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.\nRates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The rate of growth in interest free sources of funds will influence the level of interest sensitive funding sources. In addition, the interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest sensitivity gap is only one factor to be considered in estimating the changes in net interest margin.\nDAUPHIN DEPOSIT CORPORATION\nTable 18 presents an interest sensitivity analysis of Dauphin's assets and liabilities at December 31, 1995 for several time intervals. This table reflects the interest sensitivity gap in two formats. The detailed presentation represents management's assumption on certain interest bearing deposits, such as passbook savings accounts, as not being subject to immediate repricing. Management is of the opinion that historical interest rate movements indicate that these products do not reprice in direct relation to the change in the interest rate environment. Additionally, these products have provided Dauphin with a stable core deposit base. Therefore, the detailed presentation within Table 18 attempts to reflect these products in the appropriate interest sensitivity time interval based on their interest sensitivity to the movement of other interest rates. Also included in Table 18 is a summary of the gap, as viewed by certain regulatory authorities, which presents these interest bearing deposits as being subject to immediate repricing.\nTABLE 18--INTEREST SENSITIVITY ANALYSIS\nAn interest sensitivity analysis is measured as of a specified date and, therefore, is subject to almost immediate change as the maturities of assets are reinvested and liabilities, such as deposits and short-term borrowings, are received or mature. The mismatch of assets and liabilities in a specific time frame is referred to as a sensitivity gap. The gap at December 31, 1995 reflects Dauphin's sensitivity at a point in time to rate changes over future periods of time. Generally, an asset sensitive gap will increase an institution's net interest income during periods of rising interest rates and the liability sensitive gap will increase an institution's net interest income during declining rates. The lower the amount of this gap, the less sensitive an institution's earnings are to interest rate changes. However, Dauphin's assets and liabilities with similar maturities or repricing will, at times, react differently in varying interest rate environments. Therefore, the interest sensitivity\nDAUPHIN DEPOSIT CORPORATION gap does not accurately predict the actual impact of market rate changes. The volume and mix of future assets and liabilities changes will also impact Dauphin's net interest income as indicated on Table 3. Dauphin continuously monitors and adjusts the gap position, taking into consideration current interest rate projections, and maintaining flexibility if rates move contrary to expectations. Dauphin uses on-balance sheet financial instruments, such as investments classified as available-for-sale, to provide flexibility in managing the interest sensitivity gap.\nEFFECTS OF INFLATION\nThe impact of inflation upon banks differs from the impact upon non-financial institutions. Banks, as financial intermediaries, have assets which are primarily monetary in nature and change corresponding to movements in the inflation rate. The precise impact of inflation upon Dauphin is difficult to measure. Inflation may cause non-interest expense items to increase at a more rapid rate than earning sources. Inflation may also affect the borrowing needs of consumers, thereby affecting the growth rate of Dauphin's assets. Inflation may also affect the general level of interest rates, which can have an effect on the profitability of Dauphin.\nRECENTLY ISSUED ACCOUNTING STANDARDS\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 for Long-Lived Assets To Be Disposed Of\". SFAS 121 provides guidance for recognition and measurement of impairment of long-lived assets, certain identifiable intangibles and goodwill related both to assets to be held and used and assets to be disposed of. SFAS 121 becomes effective January 1, 1996 and will not have a material effect on Dauphin's financial position or results of operations.\nIn October 1995, the FASB issued Statement of Financial Accounting Standards No. 123 (SFAS 123), \"Accounting for Stock-Based Compensation\". SFAS 123 becomes effective January 1, 1996, and will not have a material effect on Dauphin's financial position or results of operations. Management anticipates that upon adoption of SFAS 123 it will continue to measure compensation expense for its stock-based employee compensation plans, using the methods as prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees\" and will provide pro forma disclosures of net income and earnings per share as if the fair value- based method prescribed by SFAS 123 had been applied in measuring compensation expense.\nREGULATORY DEVELOPMENTS\nDuring 1994, Congress passed legislation to remove geographic restrictions on bank expansion. The Riegle-Neal Interstate Banking and Branch Efficiency Act of 1994 will allow banks to expand across state lines to merge existing multi- state branching operations into a single institution or to acquire new branches in other states. Interstate banking and branching authority will be subject to certain conditions and restrictions, such as capital adequacy, management, Community Reinvestment Act compliance and limits on deposit concentrations. The legislation permits a bank holding company to acquire a bank in another state as of September 29, 1994, whether or not the state permits the acquisition. Interstate bank mergers and de novo interstate branching are permitted as of June 1, 1997, although states may choose to opt in to these provisions prior to June 1, 1997, or to opt out of these provisions completely by enacting appropriate legislation. The Pennsylvania legislature amended the Pennsylvania Banking Code of 1965 in July, 1995, to opt in to the interstate bank merger and de novo branching provisions of the Riegle-Neal Act. The management of Dauphin cannot predict with any reasonable degree of certainty the effects, if any, which the Riegle-Neal Act may have on Dauphin.\nLegislation has been introduced in Congress to recapitalize the Savings Association Insurance Fund (SAIF) via a one-time special assessment on SAIF deposits and thereafter to merge the SAIF with the Bank Insurance Fund (BIF). Legislation is also pending in Congress which would repeal certain aspects of the Glass-Steagall Act, which prohibits commercial banks from engaging in securities underwriting activities. It is not anticipated that the enactment of such legislation, in its current form, would have a material effect on the financial condition or results of operations of Dauphin.\nDAUPHIN DEPOSIT CORPORATION ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following audited consolidated financial statements and documents are set forth in this Annual Report on Form 10-K on the following pages:\nDauphin Deposit Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nDauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nDauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nDauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following is a description of the more significant accounting policies of Dauphin Deposit Corporation and subsidiaries.\nBUSINESS\nDauphin Deposit Corporation (Dauphin) is a bank holding company, incorporated under the laws of the Commonwealth of Pennsylvania in 1974. Dauphin's wholly- owned bank subsidiary is Dauphin Deposit Bank and Trust Company (the Bank), through which Dauphin provides banking services. The Bank is engaged in the commercial and retail banking and trust business. The Bank's mortgage banking subsidiary, Eastern Mortgage Services, Inc. (Eastern Mortgage) is a full service mortgage banking company which originates, services and sells first and second residential mortgage loans of varying types primarily to the eastern Pennsylvania and New Jersey mortgage markets. Dauphin's wholly-owned subsidiary Hopper Soliday & Co., Inc. (Hopper Soliday) is a Delaware corporation which engages in municipal finance, institutional sales, financial advisory and other general securities businesses permitted for bank holding companies and their non-bank subsidiaries.\nBASIS OF FINANCIAL STATEMENT PRESENTATION\nThe financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. The material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Dauphin and subsidiaries, including its principal subsidiary, the Bank, which includes the Bank of Pennsylvania, Farmers Bank and Valleybank Divisions. All material intercompany balances and transactions have been eliminated in consolidation.\nINVESTMENT SECURITIES\nDauphin adopted the provisions of Statement of Financial Accounting Standards No. 115 (SFAS 115), \"Accounting for Certain Investments in Debt and Equity Securities\" on January 1, 1994. Under SFAS 115 investments are classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) 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; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Management has determined that the entire investment securities portfolio will be classified as available-for- sale.\nPremiums and discounts are amortized and accreted over the term of the related securities using a method that approximates the interest method. Realized gains or losses on the sale of investment securities (determined by the specific identification method) are shown separately in the statements of income. A decline in the fair\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 value of any investment below cost that is deemed other than temporary results in a reduction of the carrying amount to fair value through a charge to income. Dividend and interest income are recognized when earned.\nASSETS HELD FOR SALE\nAssets held for sale consist of the securities inventory of Hopper Soliday and mortages held for sale, primarily the inventory of Eastern Mortgage. The securities inventory is recorded at current quoted market value. The mortgages held for sale are carried at the lower of aggregate cost or estimated market value with unrealized losses recognized through a provision included in other income. Gains and losses on the sale of mortgages held for sale are determined using the specific identification method.\nLOANS\nLoans are carried at the principal amount outstanding, net of unearned income. Interest income is accounted for on an accrual basis. Interest income is not accrued when, in the opinion of management, its collectibility is doubtful. When a loan is designated as non-accrual, any accrued interest receivable is generally charged against current earnings. Non-accruing loans are returned to accruing status after at least six consecutive months of current performance. Lease income is recorded using the finance method which provides for a level rate of return on the investment outstanding.\nLoan fees and costs of loan origination are deferred and recognized over the life of the loan as a component of interest income. The amortization of deferred fees and costs is discontinued on non-accrual loans.\nALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is a valuation reserve to absorb losses on loans which may become uncollectible. The provision for loan losses is management's estimate of the amount required to establish a reserve adequate to reflect risks in the loan portfolio of the Bank. Loan losses are charged directly against the allowance for loan losses, and recoveries on previously charged off loans are added to the allowance.\nManagement believes that the allowance for loan losses is adequate. While 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 Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.\nDauphin adopted the provisions of Statement of Financial Accounting Standard No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan\", as amended by SFAS No. 118 (SFAS 118), \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure\" on January 1, 1995. Generally, all non-accrual loans are deemed to be impaired. In addition, management, considering current information and events regarding the borrowers ability to repay their obligations, considers a loan to be impaired when it is probable that Dauphin will be unable to collect all amounts due according to the contractual terms of the loan agreement. In evaluating whether a loan is impaired, management considers not only the amount that Dauphin expects to collect but also the timing of collection. Generally, if a delay in payment is insignificant (e.g. less than 90 days), a loan is not deemed to be impaired.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nWhen a loan is considered to be impaired, the amount of impairment is 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 fair value of the collateral if the loan is collateral dependent. The majority of loans deemed to be impaired by management are collateral dependent. Loans are evaluated individually for impairment. Dauphin excludes smaller balance, homogeneous loans (e.g. primarily consumer and residential mortgages) from the evaluation for impairment. Impairment losses are included in the allowance loan losses. Impaired loans are charged-off when management believes that the ultimate collectibility of a loan is not likely.\nIncome for impaired loans that are on non-accrual status is recognized using the cash basis, while interest on impaired loans that are still accruing is recognized using the accrual method.\nPREMISES AND EQUIPMENT\nPremises and equipment are stated at cost, including capitalized interest during construction, less accumulated depreciation and amortization. Premises and equipment under capitalized leases are recorded at the lower of the present value of minimum lease payments or the fair value of the leased assets determined at the inception of the lease term. Depreciation charged to operating expense, including amounts applicable to capitalized leases, is computed on the straight-line method for financial reporting and the straight- line and accelerated methods for income tax purposes. Leasehold improvements are capitalized and amortized over the lives of the respective leases or the estimated useful life of the leasehold improvement, whichever is shorter. 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 charged to expense as incurred; significant renewals and betterments are capitalized.\nOTHER ASSETS\nGoodwill is the excess of the purchase price over the fair value of net assets of entities acquired through business combinations that are recorded using the purchase method of accounting. Included in other assets is $15.5 million of goodwill at December 31, 1995 and 1994. Goodwill is being amortized using the straight-line method over periods not exceeding 15 years.\nExcess servicing fees are computed as the present value of the difference between the estimated future net revenues and normal servicing revenues as established by the federally sponsored secondary market makers. Upon the sale of mortgage loans, excess servicing fees are deferred and amortized over the estimated life of the related mortgages.\nEffective January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 122 (SFAS 122), \"Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65\". 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 mortgage servicing rights, Dauphin 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 mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. Such fair value is primarily based on observable market prices. Mortgage servicing rights (including purchased mortgage servicing) are amortized in proportion to, and over the period of, estimated net servicing revenue based on management's best estimate of remaining loan lives.\nDauphin measures the impairment of servicing rights based on the difference between the carrying amount of the servicing rights and their current fair value. Impairment of servicing rights is recognized through a\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nvaluation allowance. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights exceed their fair value. For the purpose of evaluating and measuring impairment of capitalized mortgage servicing rights, Dauphin stratifies those rights based on the predominant risk characteristics of the underlying loans. Dauphin primarily stratifies mortgage servicing rights by loan type (e.g. conventional or government guaranteed and adjustable-rate or fixed-rate mortgage loans). Valuation techniques for measuring fair value incorporate assumptions that market participants use in estimating future servicing income and expense, including assumptions about prepayment, default and interest rates.\nDERIVATIVES\nDauphin's mortgage subsidiary, Eastern Mortgage, has limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are primarily used to manage well-defined interest rate risks, as described in Note 16.\nTRUST ASSETS\nAssets 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. Income from fiduciary activities is recorded on an accrual basis.\nBENEFIT PLANS\nPension plan costs for Dauphin's defined benefit plans are accounted for in accordance with the provisions of Statement of Financial Accounting Standards No. 87 \"Employers' Accounting for Pensions\". The projected unit credit method is utilized for measuring net periodic pension cost over the employees' service lives.\nDauphin's cost of retiree health care and other postretirement benefits are accounted for in accordance with the provisions of Statement of Financial Acccounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\".\nDauphin provides benefits to former or inactive employees after employment but before retirement. These costs are accounted for in accordance with the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\".\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.\nNET INCOME PER SHARE\nNet income per share is computed based upon the weighted average number of common shares outstanding and dilutive common equivalent shares from stock options and performance shares using the\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\ntreasury stock method. The difference between primary and fully diluted earnings per share is not significant in any year.\nSTATEMENT OF CASH FLOWS\nFor purposes of the statement of cash flows, Dauphin considers cash and due from banks and overnight federal funds sold to be cash and cash equivalents.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior year amounts to conform with current year classifications.\n2--ACQUISITIONS\nOn July 1, 1994, Dauphin acquired Eastern Mortgage, a mortgage banking company headquartered in Trevose, Pennsylvania, for approximately $21.0 million in cash pursuant to a definitive agreement signed in May 1994. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of Eastern Mortgage from the date of acquisition are included with the results of Dauphin. The excess of the purchase price over the fair value of the net identifiable assets acquired of $12.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 15 years.\n3--RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS AND INVESTMENT SECURITIES\nThe Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of these required reserve balances at December 31, 1995 and 1994 was approximately $80,353,000 and $78,522,000, respectively.\nThe Bank is required to maintain an investment in Federal Home Loan Bank of Pittsburgh stock of $14,987,200 which is included with equity securities.\n4--INVESTMENT SECURITIES\nThe amortized cost and fair value of investment securities are as follows:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nThe amortized cost and fair value of debt securities 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.\nGains and losses from sales of investment securities are as follows:\nProceeds from sales of investment securities are as follows:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nSecurities with a carrying value of $1,053,541,000 at December 31, 1995 and $816,290,000 at December 31, 1994 are pledged to secure public deposits and for other purposes as provided by law.\n5--LOANS\nThe loan portfolio, net of unearned income, at December 31, 1995 and 1994 is as follows:\nThe Bank has granted loans to officers, directors and their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans, which excludes aggregate loans totaling less than $60,000 to any one related party, is as follows:\nIncluded within the loan portfolio are loans on which the Bank has ceased the accrual of interest and restructured loans. Such loans amounted to $12,103,000 and $15,168,000 at December 31, 1995 and 1994, respectively. If interest income had been recorded on all such loans outstanding during the years 1995, 1994 and 1993, interest income would have been increased as shown in the following table:\nThe Bank does not have any significant commitments to lend additional funds on non-accrual or restructured loans at December 31, 1995.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nAs previously discussed in Note 1, on January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan\" as amended by Statement of Financial Accounting Standards No. 118 (SFAS 118), \"Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures\".\nOn December 31, 1995 the balance of impaired loans was $11.7 million. Impaired loans of $8.2 million have a related allowance for loan losses of $3.8 million and the remaining impaired loans of $3.5 million have no related allowance for loan losses. The average balance of impaired loans for 1995 was $8.4 million and the interest recognized for the year was $.7 million. The interest income includes $.2 million that was recorded on the cash basis.\n6--ALLOWANCE FOR LOAN LOSSES\nAn analysis of the changes in the allowance for loan losses is as follows:\n7--PREMISES AND EQUIPMENT\nA summary of premises and equipment at December 31, 1995 and 1994 is as follows:\nDepreciation and amortization amounted to $7,665,000 for 1995, $6,834,000 for 1994 and $6,495,000 for 1993.\n8--MORTGAGE SERVICING RIGHTS\nMortgage loans serviced for others are not included in the consolidated balance sheet. The outstanding balance of these loans at year-end and gains on the sale of servicing during the year are presented below:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nAs previously discussed in Note 1, effective January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65\". An analysis of the activity of excess, purchased, and originated mortgage servicing rights for the years ended December 31, 1995 and 1994 is as follows:\nThe fair value of purchased and originated servicing rights was $13.7 million at December 31, 1995. As of and for the year ended December 31, 1995, there was no valuation allowance for purchased and originated servicing rights.\nThe balances and activities of excess and purchased mortgage servicing rights were not significant to the consolidated balance sheets or results of operations of Dauphin during 1993.\n9--TIME CERTIFICATES OF DEPOSIT\nTime certificates of deposit of $100,000 or more at December 31, 1995 and 1994 amounted to $459,074,000 and $270,777,000, respectively.\n10--SHORT-TERM BORROWINGS\nFederal funds purchased, securities sold under agreements to repurchase and other short-term borrowings generally mature within one to ninety days from the transaction date.\nA summary of aggregate short-term borrowings is as follows for the years ended December 31, 1995, 1994 and 1993:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nThe securities that serve as collateral for the securities sold under agreements to repurchase are under Dauphin's control.\nThe Bank has approved federal funds lines of credit that amounted to approximately $2,338,000,000 at December 31, 1995.\n11--LONG-TERM DEBT\nThe following is a summary of long-term debt at December 31, 1995 and 1994:\nIn November 1986, Dauphin issued $35,000,000, 8.70% Senior Notes due 1996 at par. These Senior Notes are not subordinated in right of payment to any other unsecured indebtedness of Dauphin.\nAggregate long-term debt maturities, for each of the next five years are as follows:\n1996--$35,095,000; 1997--$107,000; 1998--$86,000; 1999--$5,038,000; 2000-- $92,000\nAt December 31, 1995, Dauphin and its subsidiaries had unused lines of credit totaling approximately $3,000,000 with a non-affiliated bank.\n12--RESTRICTION ON PAYMENT OF DIVIDENDS\nCertain restrictions exist regarding the ability of the subsidiaries to transfer funds to Dauphin in the form of cash dividends. Dauphin and the Bank are required to maintain minimum amounts of capital to total risk weighted assets as defined by the banking regulators. The requirement is to have a minimum Tier 1 and total capital ratios of 4.00% and 8.00%, respectively. The Bank may not pay dividends to Dauphin, which would allow these risk-based capital ratios to fall below the minimum capital requirements. Under these policies and subject to the restrictions applicable to the Bank, the Bank could declare, without prior regulatory approval, aggregate dividends of $26.0 million, plus net profits for 1996.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\n13--INCOME TAXES\nThe provision for income taxes, consisting primarily of Federal income taxes, for the years 1995, 1994 and 1993, consists of the following:\nA reconciliation between the effective income tax rate and the statutory rate 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, 1994 and 1993 are as follows:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nIncluded in the table above is the recognition of certain temporary differences for which no deferred tax expense or benefit was recognized in the consolidated statements of income. Such items include unrealized gains and losses on certain investments in debt and equity securities accounted for under SFAS 115 and book and tax basis differences relating to business combinations accounted for under the purchase method of accounting.\nManagement is of the opinion that it is more likely than not that the deferred tax asset of $21,825,000 will be realized since Dauphin has had a long history of earnings and has carryback potential greater than the deferred tax asset. Management is not aware of any evidence that would preclude Dauphin from ultimately realizing this asset.\n14--BENEFIT PLANS\nThe Bank has a noncontributory defined benefit pension plan covering substantially all employees. The Plan's benefit formulas generally base payments to retired employees upon their length of service and a percentage of qualifying compensation during the final years of employment. Dauphin'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 pension plan's funded status and amounts recognized in Dauphin's consolidated financial statements at December 31, 1995 and 1994:\nThe assumptions used in determining the actuarial present value of the projected benefit obligation and the expected rate of return on plan assets are as follows:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nNet pension expense (credit) for 1995, 1994 and 1993 was comprised of the following:\nPlan assets are primarily invested in listed stocks (including 107,000 and 100,000 shares of Dauphin at December 31, 1995 and 1994) and U.S. Treasury and federal agency securities.\nDauphin's postretirement benefits other than pensions are currently not funded. The status of the plan at December 31, 1995 and 1994 is as follows:\nThe assumptions used in determining the actuarial present value of the accumulated postretirement benefit obligation are as follows:\nThe cost for postretirement benefits other than pensions for 1995, 1994 and 1993 consisted of the following components:\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nThe assumed postretirement health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 16 1\/2% in 1992, the year of adoption, decreasing per year to an ultimate rate of 5 1\/2% in 2005 (10% at December 31, 1995) and thereafter over the projected payout period of benefits.\nThe health care cost trend rate assumption has a significant effect on the amounts reported. For example, a one-percentage-point increase in the assumed health care cost trend would increase the accumulated postretirement benefit obligation by $1,760,000 at December 31, 1995 and increase the aggregate of the service and interest cost components by $190,000 for the year ended December 31, 1995.\nDauphin offers a savings plan for all eligible employees. Under the plan, Dauphin contributes 25% of the participants' contribution which cannot exceed 10% of their salaries. Participants' contributions are at all times fully vested, and Dauphin's contributions become fully vested with two years of service. Contributions to the plan amounted to $581,000, $563,000 and $468,000 during 1995, 1994 and 1993, respectively.\nIn 1993, Dauphin adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\". The adoption resulted in an incremental cost of $26,500, $30,000 and $500,000 to salaries and benefits expense in 1995, 1994 and 1993, respectively. This accrual was established to record the liability for benefits to former or inactive employees after employment but before retirement. The balance at December 31, 1995 is $556,500.\n15--EMPLOYEE STOCK PURCHASE PLAN, STOCK OPTION PLAN AND STOCKHOLDERS' EQUITY\nUnder the employee stock purchase plan, all eligible employees may purchase shares of Dauphin's common stock through payroll deductions (limited to an amount aggregating 10% of annual base pay). The purchase price, established 30 days prior to the offering date, is not less than 85% or more than 100% of the average market price on the offering date or exercise date, whichever is lower. 840,000 shares of common stock have been authorized to be offered under the plan, of which 726,974 shares have been issued. Because of a difference between the plan offering date, and Dauphin's year-end, no shares were under option at December 31, 1995.\nDuring 1987, the shareholders approved the adoption of the Stock Option Plan of 1986 (the Plan). Under the Plan, Dauphin may grant either qualified or non- qualified stock options to key employees for the purchase of up to 1,193,000 shares of common stock. The exercise price of options granted may not be less than 85% of the fair market value of Dauphin's common stock at the date of grant. Options become exercisable over periods of one to five years and expire ten years from the date of grant.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nStock option transactions during 1995, 1994 and 1993 are summarized below:\nDuring 1995, the shareholders approved the adoption of the 1995 Stock Incentive Plan (1995 Plan). Under the 1995 Plan, Dauphin may grant incentive stock options, non-qualified stock options, restricted stock awards, performance share awards and other awards that provide a participant with the right to purchase or otherwise acquire Dauphin common stock or that are valued by reference to the market value of Dauphin common stock. In 1995, Dauphin entered into Performance Share Agreements with certain key employees as permitted under the 1995 Plan. The Performance Share Agreements entitle these employees to a grant of Dauphin common stock after a three year period if specific corporate goals are realized. During 1995, Dauphin recognized $.4 million of expense related to Performance Share Agreements.\nIn connection with the adoption of a shareholder rights plan on January 22, 1990, Dauphin declared a dividend distribution of one Common Stock Purchase Right (a Right) for each outstanding share of common stock of Dauphin. The Rights are exercisable only if a person or group of affiliated persons acquires or announces an intention to acquire 18% of the common stock of Dauphin and Dauphin's Board of Directors does not redeem the Rights during the specified redemption period. Initially, each Right, upon becoming exercisable, would entitle the holder to purchase from Dauphin one share of common stock at the specified exercise price which is subject to adjustment (currently $50 per share). Once the Rights become exercisable, if any person or group acquires 18% of the common stock of Dauphin, the holder of a Right, other than the acquiring person or group, will be entitled, among other things, to purchase shares of common stock having a value equal to two times the exercise price of the Right. The Board of Directors is entitled to redeem the Rights for $.001 per Right at any time before expiration of the redemption period. The Board of Directors may, at any time after the Rights become exercisable and prior to the time any person becomes a 50% beneficial owner of Dauphin's shares of common stock, exchange each of the outstanding Rights (except Rights of the acquiring person or group which are voided) for one share of common stock, subject to adjustment. The Rights will expire on January 22, 2000, unless earlier redeemed by Dauphin.\nDuring 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 2,000,000 shares of the outstanding stock. In February 1995, an additional 1,500,000 shares were authorized for\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nrepurchase. Available investments are being used to fund the share repurchases. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan, Stock Option Plans, the Dividend Reinvestment and Stock Purchase Plan, and other appropriate uses. During 1995 and 1994, Dauphin repurchased 630,000 shares for $16.1 million and 1,744,500 shares for $42.4 million, respectively.\n16--FINANCIAL INSTRUMENTS\nOff-Balance-Sheet Risk and Concentrations of Credit Risk\nIn the normal course of business, Dauphin is a party to financial instruments with off-balance-sheet risk which\/or meet the financing needs of its customers and which reduces Dauphin's exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, financial guarantees 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 balance sheet.\nFor commitments to extend credit and standby letters of credit, Dauphin's exposure to credit loss in the event of non-performance by the other party is represented by the contractual amount of those instruments. Dauphin uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.\nDauphin had the following off-balance-sheet financial instruments at December 31:\nCommitments to extend credit, which includes loans and lines of 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. Dauphin evaluates each customer's creditworthiness on a case-by- case basis. The amount of collateral obtained, if deemed necessary by Dauphin upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.\nStandby letters of credit are conditional commitments issued by Dauphin to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The terms of the letters of\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\ncredit vary 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. Dauphin holds collateral supporting those commitments, as deemed necessary.\nMost of the Bank's business activity is with customers located within the Bank's defined market area, principally Central Pennsylvania. The Eastern Pennsylvania and New Jersey mortgage markets are served by Eastern Mortgage, the Bank's mortgage subsidiary. However, the Bank will grant commercial, residential and consumer loans throughout Pennsylvania. The loan portfolio is well diversified and the Bank does not have any significant concentrations of credit risk. However, since a significant share of the Bank's loans are within the geographic area previously defined, a substantial portion of the Bank's debtors' ability to honor their contracts may be significantly affected by the level of economic activity in this area.\nDerivative Financial Instruments\nDauphin's mortgage subsidiary, Eastern Mortgage, has limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are primarily used to manage well-defined interest rate risks.\nEastern Mortgage is exposed to interest rate risk when it extends a commitment to a borrower for future settlement. As interest rates increase, the valuation of the commitment to Eastern Mortgage declines. As interest rates decrease, a borrower is more likely to abandon the commitment, which could cause a financial loss to Eastern Mortgage if they have committed to sell that loan for future delivery in the secondary market.\nThe secondary marketing department at Eastern Mortgage is primarily responsible for mitigating the exposure to interest rate risk through the use of certain hedging techniques. This is accomplished by using a combination of charging non-refundable commitment fees when the borrower elects to lock in their interest rate; selling loans in the secondary market for future delivery on a mandatory basis (via forward and future delivery commitments with third- party investors); and purchasing options.\nForward commitments are contracts wherein Eastern Mortgage agrees to make delivery of a specified type of loan at a specified future date and price. As loans close and are pooled for delivery, forward commitments are filled and executed, and the primary objective of hedging is achieved. However, in the normal course of business, to the extent that management believes that market conditions may change favorably, or fewer loans are closed than previously anticipated, certain forward commitments may be paired-off. In instances where management paired-off forward commitments on the basis of certain expectations of market conditions, any gains or losses arising from paired-off transactions are deferred on the date of the pair-off, and are recognized as an adjustment to gains (losses) on sale of mortgage loans when the underlying pool of mortgage loans is sold. When forward commitments are paired-off due to a lack of loans to fulfill the commitment, the gain or loss is recognized on the date of the pair-off as an adjustment to gains (losses) on sale of mortgage loans.\nCertain future delivery contracts to third parties stipulate the duration of the commitment and the amount of loans deliverable under the commitment and may require the payment of a fee. Commitment fees are capitalized when paid and expensed as a component of gains (losses) on sale of mortgage loans when the commitment expires or is delivered into.\nPurchased call or put options are contracts that allow the holder of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from the seller, or \"writer,\" of the option. Eastern Mortgage purchases call options on treasury securities and put options on mortgage backed securities as part of its interest rate risk management strategy. The risk of loss is limited to the price paid for the\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\noption. The cost of all such options is expensed as an adjustment to gains (losses) on sale of mortgage loans when the options expire. Any gain realized at the time an option is exercised is deferred, and subsequently recognized when the underlying pool of loans is sold.\nIn the ordinary course of business, Eastern Mortgage deliberately exposes a portion of its mortgage loan portfolio (warehouse and pipeline, net of estimated fall-out) to interest rate risk, as volume and market conditions warrant. This exposure represents those loans which have closed or are expected to close which are not hedged at a given point in time. At December 31, 1995, the maximum exposure position authorized by management is $20 million. The secondary marketing department produces a daily exposure report summarizing the exposure position. This report is reviewed and adjustments to the exposure position, to the extent considered necessary by management, are made daily.\nFair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosure about Fair Value of Financial Instruments\" (SFAS 107) requires disclosure of the fair value of financial instruments. The majority of Dauphin's assets and liabilities are considered financial instruments. Significant assumptions and estimates were used in calculation of fair market values.\nThe following methods and assumptions were used to estimate the fair value of each class of Dauphin's financial instruments for which it is practicable to estimate that value:\nCash and short-term investments\nThe fair value for cash and short-term instruments is estimated to be book value, due to the short maturity of, and negligible credit concerns within, those instruments.\nInvestment securities\nThe fair value for debt and marketable equity securities is based on quoted market prices, if available. If quoted market price is not available, fair value is estimated using quoted market prices for similar securities.\nAssets held for sale\nThe fair value for mortgage loans held for sale is estimated using the current secondary market rates. For the securities inventory held for sale, the securities are recorded at the current quoted market value.\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. The residential mortgages and certain consumer loans include prepayment assumptions.\nOther financial assets\nThe fair value for accrued interest receivable is estimated to be the current book value. The fair value for originated mortgage servicing rights is based on observable market prices and the fair value of excess servicing fees is the estimated present value of the difference between the anticipated future servicing fees and normal servicing fees using discount rates that approximate market rates and management's estimate of future prepayment rates.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nDeposits\nThe fair value of deposits with no stated maturity, such as demand deposits, savings accounts, interest bearing demand and money market deposits, is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit, including certain 18 month variable rate certificates of deposit carrying a minimum interest rate of 10% for the 18 month term which are held in certain individual retirement accounts (as discussed herein under Note 19--Litigation), is based on the discounted value of contractual cash flows, using the rates currently offered for deposits of similar remaining maturities.\nShort-term borrowings\nThe fair value of short-term borrowings is estimated using the current rates for similar terms and maturities.\nLong-term debt\nThe fair value of long-term debt is estimated using current rates for debt with similar terms and remaining maturities.\nAccrued interest payable\nThe fair value of accrued interest payable is estimated to be the current book value.\nOff-balance-sheet financial instruments\nThe fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms and present creditworthiness 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. The fair value of options is estimated based on quoted market prices.\nLimitations\nThe fair values estimated are dependent upon subjective assumptions and involve significant uncertainties resulting in estimates that vary with changes in assumptions. Any sales of financial instruments may incur potential tax and other expenses that would not be reflected in the fair values. Any changes in assumptions or estimation methodologies may have a material effect on the estimated fair values disclosed. The reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques. Also, the estimates do not reflect any additional premium or discount that could result from the sale of Dauphin's entire holdings of a particular instrument.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nAt December 31, 1995 and 1994, Dauphin's estimated fair values of financial instruments based on disclosed assumptions are as follows:\n- -------- (1) The amounts shown under \"carrying amount\" represent accruals or deferred income arising from those unrecognized financial instruments.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\n17--CONDENSED FINANCIAL INFORMATION--PARENT COMPANY ONLY\nDauphin Deposit Corporation (Parent Company Only) Condensed Balance Sheets\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nDauphin Deposit Corporation (Parent Company Only) Condensed Statements of Income\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nDauphin Deposit Corporation (Parent Company Only) Condensed Statements of Cash Flows\nDauphin Deposit Corporation merged three subsidiaries (FARMCO Realty, Inc., Financial Realty, Inc. and Farmers Mortgage Corporation) with and into itself in 1995. The 1995 balance sheet reflects the assets held by the subsidiaries, primarily premises that are leased to the Bank. Previous periods presented have not been restated.\nDAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)\nDECEMBER 31, 1995, 1994 AND 1993\n18--CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)\n19--LITIGATION\nVarious legal actions or proceedings are pending involving Dauphin or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material to Dauphin's financial condition or results of operation. Included among outstanding litigation is a class action law suit instituted by Dauphin seeking a declaratory judgement from the Court specifically permitting Dauphin to discontinue offering an 18 month variable rate investment product carrying a minimum interest rate of 10% for the 18 month term held in certain individual retirement accounts (IRA) and\/or to charge an annual maintenance fee and fee on rollovers or transfers into the investment product. Dauphin's rights to terminate the variable rate interest product and to charge a service fee are in dispute and are being challenged by the holders of the IRA accounts in question. Management intends to vigorously assert its right to terminate the 18 month variable rate investment product in accordance with its terms. Pending the outcome of the litigation, Dauphin has continued to date to pay a 10% interest rate with regard to the product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.\n[LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Dauphin Deposit Corporation\nWe have audited the accompanying consolidated balance sheets of Dauphin Deposit 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 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 Dauphin Deposit 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.\nAs discussed in notes 1 and 8 to the consolidated financial statements, the Company changed its method of accounting for mortgage servicing rights to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights an amendment of FASB Statement No. 65\" on January 1, 1995.\n(ART)\nJanuary 26, 1996\nDAUPHIN DEPOSIT CORPORATION\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nDAUPHIN DEPOSIT CORPORATION PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relative to directors of Dauphin is incorporated herein by reference to Election of Directors in Dauphin's 1996 Proxy Statement. Information relative to executive officers of Dauphin is set forth herein in Part I under the caption \"EXECUTIVE OFFICERS OF THE REGISTRANT.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis item is incorporated by reference to Executive Compensation in the 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis item is incorporated by reference to Outstanding Stock and Principal Holders Thereof and Security Ownership of Management in the 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis item is incorporated by reference to Transactions with Management in the 1996 Proxy Statement.\nDAUPHIN DEPOSIT CORPORATION PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nDAUPHIN DEPOSIT CORPORATION\nDAUPHIN DEPOSIT CORPORATION 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.\nDauphin Deposit Corporation\nFebruary 20, 1996 \/s\/ Christopher R. Jennings By: _________________________________ CHRISTOPHER R. JENNINGS CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND DIRECTOR\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT IS SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nDATE\n\/s\/ Christopher R. Jennings Chairman of the February 20, - ------------------------------------- Board, Chief 1996 CHRISTOPHER R. JENNINGS Executive Officer and Director\n\/s\/ Robert L. Fryer, Jr. President, Chief February 20, - ------------------------------------- Operating Officer 1996 ROBERT L. FRYER, JR. and Director\n\/s\/ Paul B. Shannon Vice Chairman and February 20, - ------------------------------------- Chief Credit Policy 1996 PAUL B. SHANNON Officer\n\/s\/ Lawrence J. LaMaina, Jr. Vice Chairman and February 20, - ------------------------------------- Director 1996 LAWRENCE J. LAMAINA, JR.\n\/s\/ Dennis L. Dinger Senior Executive February 20, - ------------------------------------- Vice President, 1996 DENNIS L. DINGER Chief Fiscal and Administrative Officer (Principal Financial Officer)\n\/s\/ Joseph T. Lysczek, Jr. Senior Vice February 20, - ------------------------------------- President and 1996 JOSEPH T. LYSCZEK, JR. Treasurer\nDAUPHIN DEPOSIT CORPORATION DATE\n\/s\/ James O. Green Director February 20, 1996 - ------------------------------------- JAMES O. GREEN\n\/s\/ Derek C. Hathaway Director February 20, 1996 - ------------------------------------- DEREK C. HATHAWAY\nDirector - ------------------------------------- ALFRED G. HEMMERICH\n\/s\/ Lee H. Javitch Director February 20, 1996 - ------------------------------------- LEE H. JAVITCH\nDirector - ------------------------------------- WILLIAM J. KING\n\/s\/ William T. Kirchhoff Director February 20, 1996 - ------------------------------------- WILLIAM T. KIRCHHOFF\n\/s\/ Andrew Maier,II Director February 20, 1996 - ------------------------------------- ANDREW MAIER, II\nDirector - ------------------------------------- JAMES E. MARLEY\n\/s\/ Robert F. Nation Director February 20, 1996 - ------------------------------------- ROBERT F. NATION\nDAUPHIN DEPOSIT CORPORATION DATE\n\/s\/ Elmer E. Naugle Director February 20, - ------------------------------------- 1996 ELMER E. NAUGLE\nDirector - ------------------------------------- WALTER F. RAAB\nDirector - ------------------------------------- PAUL C. RAUB\n\/s\/ Henry W. Rhoads Director February 20, - ------------------------------------- 1996 HENRY W. RHOADS\n\/s\/ Jean D. Seibert Director February 20, - ------------------------------------- 1996 JEAN D. SEIBERT\n\/s\/ R. Champlin Sheridan, Jr. Director February 20, - ------------------------------------- 1996 R. CHAMPLIN SHERIDAN, JR.\nDAUPHIN DEPOSIT CORPORATION EXHIBIT INDEX\nDAUPHIN DEPOSIT CORPORATION","section_15":""}
{"filename":"716459_1995.txt","cik":"716459","year":"1995","section_1":"Item 1 Description of Business - ---------------------------------\nBT Financial Corporation (the \"Registrant\") is a multi-bank holding company located in Johnstown, Pennsylvania, which was incorporated under the laws of the Commonwealth of Pennsylvania on December 16, 1982.\nThe Registrant has three banking subsidiaries: Johnstown Bank and Trust Company (\"Bank and Trust\"), Laurel Bank (\"Laurel\") and Fayette Bank (\"Fayette\")(each referred to as a \"Bank\" and collectively referred to as the \"Banks\"). The Banks' principal places of business are in Johnstown, Ebensburg and Uniontown, Pennsylvania, respectively. At December 31, 1995 the Registrant had total assets of $1.2 billion. The Registrant also has two non-banking subsidiaries, Bedford Associates, Inc., which holds and leases property used by the Banks in their banking operations, and BT Management Trust Company, a trust company which provides trust and investment services.\nThe Banks conduct business through a network of 65 offices located throughout Southwestern Pennsylvania. Each Bank operates under the management of its own officers and directors, although certain financial and administrative functions, including auditing, marketing, human resources, investment, accounting, data processing and credit review, are coordinated through the Registrant. In addition, the Banks operate 42 automated teller machines (\"ATM's\") at 41 locations which are part of the \"Cirrus\" and \"MAC\" systems. \"Cirrus\" and \"MAC\" provide links to national and regional ATM networks.\nThe Banks provide a full range of financial services to individuals, businesses and governmental bodies, including accepting demand, savings and time deposits, making secured and unsecured loans, and electronic data processing of payrolls. The Banks also offer lending services, including consumer, credit cards, real estate, commercial and industrial loans. BT Management Trust Company offers a wide range of corporate pension and personal trust and trust related services. The Banks' deposits are insured by the Federal Deposit Insurance Corporation (the \"FDIC\").\nBank and Trust was formed in 1934 through the consolidation of five banks. It is a Pennsylvania bank and trust company and member of the Federal Reserve System with 39 offices in Cambria, Somerset, Bedford, Indiana, Armstrong, Butler, Allegheny, and Westmoreland Counties. At December 31, 1995, its assets totaled $592 million.\nLaurel is a Pennsylvania bank and trust company and a member of the Federal Reserve System, with total assets of $229 million at December 31, 1995. Laurel operates 14 offices in Cambria, Blair and Indiana Counties.\nFayette is a Pennsylvania bank and trust company, and a member of the Federal Reserve system. Fayette conducts business at 12 offices in Fayette, Washington, Allegheny and Greene Counties. Its assets totaled $371 million at December 31, 1995.\nBT Management Trust Company, located in Johnstown, is a Pennsylvania- chartered trust company formed on April 30, 1990. BT Management Trust Company resulted from the consolidation of the trust business of the Banks.\nThe Registrant and the Banks are subject to competition in all aspects of their businesses from banks as well as other financial institutions, including savings and loan associations, savings banks, finance companies, credit unions, money market mutual funds, brokerage firms, investment companies, credit companies and insurance companies. They also compete with nonfinancial institutions, including retail stores that maintain their own credit programs, and with governmental agencies that make loans available to certain borrowers. Some of the Registrant's competitors are larger and have greater financial resources and facilities than the Registrant.\nAs of December 31, 1995, the Registrant, the Banks, and BT Management Trust Company had a total of 683 full time equivalent banking and administrative employees. The Registrant's executive offices are located at 551 Main Street, P.O. Box 1146, Johnstown, Pennsylvania 15907-1146. Its telephone number is (814) 532-3801.\nRecent and Pending Acquisitions - ------------------------------- On October 24, 1995, the Registrant entered into an Agreement and Plan of Merger to acquire Armstrong County Trust Company (\"Armstrong\") of Kittanning, Pennsylvania. Armstrong operates one office in Kittanning, Pennsylvania and had approximately $52 million in total assets at December 31, 1995. Armstrong will be merged into Bank and Trust, with Bank and Trust as the surviving bank. The value of the total consideration for the acquisition will be approximately $12 million. The Registrant expects the merger to be completed during the second quarter of 1996, subject to shareholder and regulatory approval.\nOn December 14, 1995, the Registrant acquired The Huntington National Bank of Pennsylvania, (\"Huntington\"), Uniontown, Pennsylvania for $25.5 million in cash. Huntington operated five branches in Fayette and Greene counties. In connection with the acquisition, Huntington was merged into Fayette and approximately $102 million in assets were acquired.\nOn January 12, 1996, The Registrant entered into an Agreement and Plan of Reorganization with Moxham Bank Corporation (\"Moxham\"), Johnstown, Pennsylvania. Pursuant to the agreement, Moxham's two banking subsidiaries, Moxham National Bank, Johnstown, Pennsylvania, and First National Bank of Garrett, Garrett, Pennsylvania, will be merged into Bank and Trust, with Bank and Trust as the surviving bank. At December 31, 1995, Moxham had total assets of approximately $241 million and operated 12 branches in Cambria, Somerset and Westmoreland Counties. According to the merger agreement, each Moxham common shareholder will receive 1.15 shares of BT Financial Corporation common stock, bringing the value of the transaction to approximately $41 million. The transaction will be accounted for as a pooling of interests and is expected to be completed during the second quarter of 1996, subject to shareholder and regulatory approval.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties - -------------------- The executive offices of the Registrant are located at 551 Main Street, Johnstown, Pennsylvania, in an office building owned by Bedford Associates, Inc. The building is occupied by the Registrant, BT Management Trust Company, and other unrelated business concerns. In 1987, Bank and Trust purchased a seven-story building located on Clinton Street in Johnstown and is using the building as a storage facility.\nThe Banks operate 65 banking offices, 47 of which are owned by the Banks free of liens and encumbrances. All properties and buildings are in good condition and are continually maintained against normal wear and tear. The remaining 18 offices are operated under leases which, including renewal options, expire at various times between 1996 and 2025. Bedford Associates, Inc. owns 4 of the 18 leased properties, which are leased to the Banks as community banking offices. All properties of Bedford Associates, Inc. have been recently purchased (1983 or later), and the buildings are either newly constructed or have recently undergone major renovation. In December 1995, Fayette Bank acquired five banking offices in The Huntington National Bank of Pennsylvania acquisition.\nItem 3","section_3":"Item 3 Legal Proceedings - ---------------------------\nInformation required to be furnished pursuant to this Item is set forth on page 23 of the 1995 Annual Report in Note 9 of the Notes to Consolidated Financial Statements under the caption \"Litigation.\"\nItem 4","section_4":"Item 4 Submission of Matters to a Vote of Security Holders - -------------------------------------------------------------\nNone.\nExecutive Officers of the Registrant - ------------------------------------ Set forth below are the names of and certain information with respect to the executive officers of the Registrant. Pursuant to the Registrant's By- Laws, officers serve at the pleasure of the Board. There are no family relationships between any such persons.\nName Age Positions and Offices Held - ---- --- -------------------------- John H. Anderson 45 Chairman, Chief Executive Officer and Director of the Registrant and of Bank and Trust.\nSteven C. Ackmann 44 President and Chief Operating Officer of the Registrant.\nCarl J. Motter, Jr. 58 Vice Chairman of the Registrant.\nMark L. Sollenberger 42 Executive Vice President, Treasurer and Assistant Secretary of the Registrant. Executive Vice President and Treasurer of Bank and Trust. Treasurer and Assistant Secretary of BT Management Trust Company\nLaura L. Roth 33 Secretary and Assistant Treasurer of the Registrant, Bank and Trust and BT Management Trust Company\nDavid A. Casado 41 Vice President and Controller of the Registrant and of Bank and Trust.\nJOHN H. ANDERSON has served as Chairman and Chief Executive officer of the Registrant since 1995. He served as Chairman, President and Chief Executive Officer of the Registrant from 1993 to 1995. He served as President and Chief Operating Officer of the Registrant from 1992 to 1993 and as Vice Chairman from 1991 to 1992. He served as President of Bank and Trust from 1990 to 1991. He served as Executive Vice President of the Registrant during 1989. From 1986 to 1989 he served as Executive Vice President of Bank and Trust.\nSTEVEN C. ACKMANN has served as President and Chief Operating Officer of the Registrant since 1995. He served as a Vice Chairman of the Registrant from 1992 to 1995. He served as Executive Vice President of the Registrant from 1990 to 1992. He served as Senior Vice President of Fayette from 1988 to 1990.\nCARL J. MOTTER has served as a Vice Chairman of the Registrant since 1992. He served as Executive Vice President and Treasurer of the Registrant from 1983 to 1992 and of Bank and Trust from 1980 to 1992. He served as Treasurer and Assistant Secretary of BT Management Trust from 1990 to 1992.\nMARK L. SOLLENBERGER has served as Executive Vice President, Treasurer and Assistant Secretary of the Registrant since 1995 and Executive Vice President and Treasurer of Bank and Trust since 1992. He served as Executive Vice President and Treasurer of the Registrant from 1992 to 1995. He served as Senior Vice President and Comptroller of the Registrant from 1991 to 1992. He served as Vice President and Comptroller of the Registrant since 1986 and of Bank and Trust since 1985. He has served as Treasurer and Assistant Secretary of BT Management Trust Company since 1992.\nLAURA L. ROTH has served as Secretary and Assistant Treasurer of the Registrant, Bank and Trust and BT Management Trust Company since 1995. She served as Assistant Secretary and Assistant Treasurer of the Registrant from 1991 to 1995. She served as Assistant Secretary of the Registrant and of Bank and Trust from 1986 to 1991.\nDAVID A. CASADO has served as Vice President and Controller of the Registrant and of Bank and Trust since 1995. He served as Comptroller of the Registrant and of Bank and Trust from 1992 to 1995. He served as Assistant Comptroller of the Registrant and of Bank and Trust from 1986 to 1992.\nPart II\nInformation required to be furnished pursuant to Part II of this report is set forth in the 1995 Annual Report under the captions and on the pages indicated below, and is incorporated herein by reference.\nCertain information in \"Management's Discussion and Analysis\" and other statements contained in this report which are not historical facts may be forward-looking statements that involve risks and uncertainties. Such statements are subject to important factors that could cause actual results to differ materially from those contemplated by such statements, including without limitation, the effect of changing regional and national economic conditions; changes in interest rates; credit risks of commercial, real estate, consumer and other lending activities; changes in federal and state regulations; the presence in the Registrant's market area of competitors with greater financial resources than the Registrant; or other unanticipated external developments materially impacting the Registrant's operational and financial performance.\nPage in Caption in 1995 Annual Report 1995 Annual Report ----------------------------- -------------\nItem 5","section_5":"Item 5 Market for the Registrant's Common - ------ Equity and Related Stockholder Matters ------------------------------------- Market Price and Cash Dividends 30\nDividend Restrictions 24\nItem 6","section_6":"Item 6 Selected Financial Data - ------ ----------------------- Selected Consolidated Financial Data 29\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 30-39\nItem 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplementary Data - ------ ------------------------------------------- Independent Accountants' Report 13\nConsolidated Balance Sheets 14\nConsolidated Statements of Income 15\nConsolidated Statements of Cash Flows 16\nConsolidated Statements of Changes in Shareholders' Equity 17\nNotes to Consolidated Financial Statements 17-27\nSupplemental Financial Data 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 Executive Officers of the Registrant - ------- --------------------------------------------------\nInformation required to be furnished pursuant to this Item regarding directors of the Registrant is set forth in the 1996 Proxy Statement under the caption \"Election of Directors,\" and is incorporated herein by reference. Information required to be furnished pursuant to this Item regarding executive officers of the Registrant is set forth in Part I of this Report and is incorporated herein by reference.\nItem 11","section_11":"Item 11 Executive Compensation - ------- ---------------------- Information required to be furnished pursuant to this Item is set forth in the 1996 Proxy Statement under the captions \"Executive Compensation\" and \"Election of Directors -- Directors' Compensation,\" and is incorporated herein by reference. The \"Executive Committee Report on Compensation\" set forth in the 1996 Proxy Statement is specifically not incorporated herein by reference.\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management - ------- --------------------------------------------------------------\nInformation required to be furnished pursuant to this Item is set forth in the 1996 Proxy Statement under the captions \"Election of Directors,\" \"Executive Compensation\" and \"Principal Shareholders\" and is incorporated herein by reference.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions - ------- ---------------------------------------------- Information required to be furnished pursuant to this Item is set forth in the 1996 Proxy Statement under the caption \"Certain Relationships and 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) (1) Financial Statements -------------------- The consolidated financial statements of BT Financial Corporation and affiliates together with the report of Coopers & Lybrand LLP dated January 23, 1996, are described herein in Part II, Item 8 - Financial Statements and Supplementary Data and appear on pages 13 through 28 of the 1995 Annual Report and are incorporated herein by reference.\n(2) Financial Statement Schedules ----------------------------- All financial statement schedules are omitted because they are not required, are not applicable or the required information is given in the consolidated financial statements or notes thereto.\n(3) Exhibits: -------- The index to exhibits is on page 15.\n(b) Reports on Form 8-K: ------------------- A Form 8-K dated December 14, 1995, was filed on December 29, 1995, pursuant to Item 5 to report the completion of the acquisition of The Huntington National Bank of Pennsylvania.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBT FINANCIAL CORPORATION ------------------------- (Registrant)\nBy: \/s\/ John H. Anderson Date: March 27, 1996 ----------------------------- ---------------- John H. Anderson 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 and on the dates indicated.\nPrincipal Executive Officer:\n\/s\/ John H. Anderson Date: March 27, 1996 ----------------------------- ---------------- John H. Anderson Chairman, Chief Executive Officer and Director\nPrincipal Financial Officer:\n\/s\/ Mark L. Sollenberger Date: March 27, 1996 ----------------------------- ---------------- Mark L. Sollenberger Executive Vice President, Treasurer and Assistant Secretary\nPrincipal Accounting Officer:\n\/s\/ David A. Casado Date: March 27, 1996 ---------------------------- ---------------- David A. Casado Vice President and Controller\nDirectors:\n\/s\/ Martin L. Bearer Date: March 27, 1996 - ------------------------------ ---------------- Martin L. Bearer\nDate: March 27, 1996 - ------------------------------ ---------------- Bruno DeGol\nDate: March 27, 1996 - ------------------------------ ---------------- Louis G. Galliker\n\/s\/ William B. Kania Date: March 27, 1996 - ------------------------------ ---------------- William B. Kania\nDate: March 27, 1996 - ------------------------------ ---------------- L. Robert Kimball\n\/s\/ Edward L. Mears Date: March 27, 1996 - ------------------------------ ---------------- Edward L. Mears\n\/s\/ Roger S. Nave Date: March 27, 1996 - ------------------------------ ---------------- Roger S. Nave\n\/s\/ Ethel J. Otrosina Date: March 27, 1996 - ------------------------------ ---------------- Ethel J. Otrosina\nDate: March 27, 1996 - ------------------------------ ---------------- Robert G. Salathe, Jr.\n\/s\/ William R. Snoddy Date: March 27, 1996 - ------------------------------ ---------------- William R. Snoddy\n\/s\/ Gerald W. Swatsworth Date: March 27, 1996 - ------------------------------ ---------------- Gerald W. Swatsworth\n\/s\/ W. A. Thomas Date: March 27, 1996 - ------------------------------ ---------------- W. A. Thomas\n\/s\/ Rowland H. Tibbott, Jr. Date: March 27, 1996 - ------------------------------ ---------------- Rowland H. Tibbott, Jr.\nEXHIBIT\nINDEX -----\nThe following Exhibits are filed as a part of this Report. Documents other than those designated as being filed herewith are incorporated herein by reference. Documents incorporated by reference to an Annual Report on Form 10-K or a Quarterly Report on Form 10-Q are at Securities and Exchange Commission File No. 0-12377.\nPrior Filing or Exhibit Sequential Page Number Description No. Herein - ------- ----------- ---------------\n2.1 Agreement and plan of Incorporated by reference Reorganization dated as to Exhibit 2.1 to BT of October 24, 1995 by Financial Corporation and among BT Financial Registration Statement on Corporation, Johnstown Form S-4 (No. 333-01797). Bank and Trust Company and The Armstrong County Trust Company.\n2.2 Agreement and Plan of Incorporated by reference Reorganization by and to Exhibit 2 to current between BT Financial Report on Form 8-K dated Corporation and Moxham January 12, 1996. Bank Corporation.\n3.1 Amended and Restated Incorporated by reference Articles of Incorpora- to BT Financial Corpo- tion of BT Financial ration Registration Corporation. Statement on Form S-4 (No. 33-69112).\n3.2 By-Laws of BT Financial Incorporated by reference Corporation. to BT Financial Corpora- tion Registration Statement on Form S-4 (No. 33-69112).\nPrior Filing or Exhibit Sequential Page Number Description No. Herein - ------- ----------- ---------------\n4.1 Loan Agreement dated Not filed. In accordance December 14, 1995, with paragraph between Mellon Bank, (b)(4)(iii)(A) of Item N.A. and BT Financial 601 of Regulation S-K, Corporation BT Financial Corporation hereby agrees to furnish a copy of this instrument to the Commission upon request.\n10.1 Supplemental Benefit Incorporated by reference Plan of BT Financial to Exhibit 10.1 to BT Corporation dated Financial Corporation's June 22, 1994.* Annual Report on Form 10-K for the year ended December 31, 1994.\n13.1 All portions of the Filed herewith. BT Financial Corpora- tion 1995 Annual Report to Shareholders that are incorporated herein by reference.\n21.1 Subsidiaries of the Filed herewith. Registrant\n23.1 Consent of Coopers & Filed herewith. Lybrand LLP, indepen- dent accountants for the Registrant.\n27 Financial Data Filed herewith. Schedule\n*Indicates exhibit is a management contract or compensation plan or arrangement.\nThe Registrant will furnish to requesting shareholders a copy of any exhibit(s) listed above upon payment of $5.00 plus $0.10 per page to cover Registrant's expenses in furnishing such exhibit(s). Requests should be directed in writing to Laura L. Roth, Secretary, BT Financial Corporation, 551 Main Street, P. O. Box 1146, Johnstown, Pennsylvania 15907-1146.","section_15":""}
{"filename":"351566_1995.txt","cik":"351566","year":"1995","section_1":"Item 1. Business\nSouth Banking Company (the \"Registrant\") is a business corporation organized at the direction of Alma Exchange Bank & Trust (\"Alma Bank\") and Citizens State Bank (\"Citizens Bank\") (collectively, the \"Banks\") in 1980 under the Georgia Business Corporation Code. It was formed to obtain all the issued and outstanding shares of Common Stock of the Banks. Pursuant to the terms and provisions of a Plan of Reorganization and Agreement of Merger, dated as of January 13, 1981 and approved by the shareholders of the Banks on June 24, 1981, the Banks were reorganized into a holding company structure by merging the Banks with wholly-owned subsidiaries of the Registrant, which transaction was consummated on July 28, 1981. In connection with those mergers, the outstanding shares of Common Stock of the Banks were converted into shares of the Registrant at specified ratios and the Banks became wholly-owned subsidiaries of the Registrant. Pursuant to the terms and provision of an agreement of merger dated June 12, 1989 between South Banking and Georgia Peoples Bankshares, Inc. and approved by shareholders of Georgia Peoples on February 26, 1990, Georgia Peoples Bankshares and its subsidiary, Peoples State Bank, were merged into South Banking Company. In connection with the merger, the outstanding shares of Georgia Peoples Bankshares were converted into shares of the Registrant at specified ratios. During 1993, South Banking Company formed Banker's Data Services, Inc. (\"Banker's Data) for the purpose of handling all the computer functions of the banks. Operations began in April, 1994. South Banking entered into an agreement in October of 1995 to acquire all the stock of Pineland State Bank in Metter, Georgia. On January 11, 1996, the transaction was completed. Prior to year end and before final agreement to acquire Pineland Bank was reached, South Banking had acquired rights to approximately 39% of Pineland Bank.\nThe Banks\nThe Banks operate full service banking business in Bacon, Appling and Camden Counties, Georgia, providing such customary banking services as checking and savings accounts, various other types of time deposits, safe deposit facilities and money transfers. The Banks also finance commercial and agricultural transactions, make secured and unsecured loans, and provide other financial services to its customers. The Banks do not conduct trust activities. On December 31, 1994, Alma Bank and Peoples Bank ranked, on the basis of total deposits, as the smaller of the two banks in Bacon and Appling Counties and the 279th and 305th largest Banks among 386 banks in Georgia and Citizens Bank, one of five banking operations in Camden County, ranked the 366th largest bank among 386 banks in Georgia, Sheshunoff's Banks of Georgia (1995 edition).\nThe Banks make and service both secured and unsecured loans to individuals, firms and corporations. Commercial lending operations include various types of credit for the Banks' customers. The Banks' installment loan departments make direct loans to individuals and, to a limited extent, purchase installment obligations from retailers both with and without recourse. The Banks make a variety of residential, industrial, commercial and agricultural loans secured by real estate, including interim construction financing. Citizens Bank and Peoples Bank act as agents for another bank in offering \"Master Card\" and \"VISA\" credit cards to its customers and does not assume the credit risk on these transactions. Alma Bank offers \"Master Card\" credit cards to its customers.\nAt December 31, 1995, the Banks had correspondent relationships with 15 other commercial banks. These correspondent banks provide certain services to the banks such as processing checks and other items, buying and selling federal funds, handling money transfers and exchanges, shipping coins and currency, providing security and safekeeping of funds or other valuable items and furnishing limited management information and advice. As compensation for the services, the Banks maintain certain balances with its correspondents in noninterest bearing accounts.\nThe Banks are members through its correspondent bank of the AVAIL network. AVAIL is an organization that has established a network of automated teller machines inside the state of Georgia.\nEmployees\nOn December 31, 1995, the Registrant and its subsidiaries had 62 full-time and 10 part-time employees. The Registrant is not a party to any collective bargaining agreement and employee relations are deemed to be good.\nCompetition\nThe Banking business is highly competitive. The Banks compete primarily with other commercial banks operating in Bacon, Camden and Appling Counties. In addition, the Banks compete with other financial institutions, including savings and loan associations, credit unions and finance companies and, to a lesser extent, insurance companies and certain governmental agencies. The banking industry is also experiencing increased competition for deposits from less traditional sources such as money-market mutual funds.\nMonetary Policies\nThe results of operations of the Banks, and therefore of the Registrant, are affected by credit policies of monetary authorities, particularly the Board of Governors of the Federal Reserve System (the \"Board of Governors\"), even though the Banks are not members of the Federal Reserve.\nThe instruments of monetary policy employed by the Federal Reserve include open market operations in U. S. Government securities and changes in the discount rate on member bank borrowing changes in reserve requirements against member bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Banks.\nSupervision and Regulations\nThe Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the \"Act\"), and is required to register as such with the Board of Governors. The Registrant is required to file with the Board of Governors an annual report and such other information as may be required to keep the Board of Governors informed with respect to the Registrant's compliance with the provisions of the Act. The Board of Governors may also make examinations of the Registrant and its subsidiaries from time to time.\nThe 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 acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of such bank. In no case, however, may the Board of Governors approve the acquisition by the Registrant of the voting shares of any bank located outside Georgia, unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located.\nIn addition, a bank holding company is generally prohibited from engaging in or acquiring direct or indirect control of voting shares of any company engaged in nonbanking 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, 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 and certain types of leases; performing certain data processing services; acting as fiduciary, investment or financial advisor; making investments in corporations or projects designed primarily to promote community welfare.\nIn January, 1989, the Board of Governors issued final regulations which implement risk-based rules for assessing bank and bank holding company capital adequacy. The regulations revise the definition of capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risk.\nRisk based capital regulations were adopted by banking regulations in 1989. These new capital adequacy standards were phased in and became fully effective on December 31, 1992. Risk based capital standards generally measure the amount of a bank's required capital in relation to the degree of risk perceived in its assets and its off-balance sheet exposure. The concepts of primary and secondary capital were replaced by Tier 1 and Tier 2 capital and a new leverage ratio requirement was added. The amount of risk-based capital required is calculated by multiplying the recorded amount of each asset category and each off- balance sheet exposure item by the appropriate risk-weighting percentage. Risk adjusted total assets is the total of these risk- weighted categories. Total required capital is the product of the risk- adjusted total assets multiplied by the specific capital percentage (i.e. 8% at December 31, 1995).\nCapital for purposes of the risk-based capital calculation is divided into two categories:\n(1) Tier 1 capital includes common shareholder equity, noncumulative perpetual preferred stock and minority interest; goodwill is subtracted.\n(2) Tier 2 capital includes the allowance for loan and lease losses, qualifying perpetual preferred stock, hybrid capital instruments, term-subordinated debt and intermediate term preferred stock. The allowance and loan losses may only be included up to an amount equal to 1.25% of risk adjusted total assets. Term subordinated debt and intermediate term preferred stock may be included to a maximum of 50% of Tier 1 capital. Finally Tier 2 capital may not exceed Tier 1 capital.\nTotal qualifying capital, for purposes of risk-based capital calculation, is the total of Tier 1 capital and Tier 2 capital, less reciprocal holdings of bank capital instruments and less investments in unconsolidated subsidiaries.\nIn June 1992, the Federal Reserve Board released a proposal to add a measure of interest rate risk to the determination of supervisory capital adequacy. Under the proposal, items reported on a banks balance sheet and off-balance sheet would be reported according to maturity. A bank's reported position would be multiplied by duration based risk factions and weighted according to rate sensitivity. The objective of this computer proposal is to determine the sensitivity of a bank to a 1% change in interest rates.\nIn addition to risk-based capital, a leverage ratio test must be met. The leverage ratio is the ratio of Tier 1 capital to assets (not risk adjusted). The minimum leverage ratio is 3%.\nAs of December 31, 1995 the banks were in compliance with these regulations.\nThe written policies of the Georgia Department of Banking and Finance (the \"DBF\") require that state banks in Georgia generally maintain a minimum ratio of primary capital to total assets of 6.0%. At December 31, 1995, the Banks were in compliance with these requirements. In addition, the DBF is likely to compute capital obligations in accordance with the risk-based capital rules while continuing to require a minimum absolute level of capital.\nIt is not anticipated that such minimum capital requirements will affect the business operations of the Banks. However, the Board, in connection with granting approval for bank holding companies to acquire other banks and bank holding companies or to engage in non-banking activities, requires bank holding companies to maintain tangible capital ratios at approximate peer group levels. This requirement can result in a bank holding company maintaining more capital than it would otherwise maintain. At the present time, South Banking Company's tangible primary capital ratios are equal or above their peer group level.\nThe laws of Georgia require annual registration with the DBF by all Georgia bank holding companies. Such registration includes information with respect to the financial condition, operations and management of intercompany relationships of the bank holding company and its subsidiaries and related matters. The DBF may also require such other information as is necessary to keep informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been in compliance with; and the DBF may make examinations of the bank holding company and each bank subsidiary thereof.\nThe banks are also subject to examination by the DBF and the FDIC. The DBF regulates and monitors all areas of the operations of the banks, including reserves, loans, mortgages, issuances of securities, payment of dividends, interest rates and establishment of branches. Interest and certain other charges collected or contracted for by the Banks are also subject to state usury laws and certain federal laws concerning interest rates. The Banks' deposits are insured by the FDIC up to the maximum permitted by law.\nUnder present Georgia law, Alma Bank may operate and establish branches only in Bacon County, Georgia, Citizen Bank may operate and establish branches only in Camden County, Georgia and Peoples Bank may operate and establish branches only in Appling County, Georgia. Current legislation has passed that would allow banks to branch statewide subject to certain restriction. This law will become effective July 1, 1996.\nGeorgia banking laws permit bank holding companies to own more than one bank, subject to the prior approval of the Georgia Department of Banking and Finance; thereby, in effect, permitting statewide banking organizations. Such banks may be acquired as subsidiaries of the Registrant or merged into its existing bank subsidiaries.\nRecent Legislation\nBills are presently pending before the United States Congress and certain state legislatures and additional bills may be introduced in the future in the Congress and the state legislatures to alter the structure, regulation and competitive relationships of the nation's financial institutions. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Banks may be affected thereby.\nMore recently, the attention of the United States Congress has been focused primarily on the need for resolution of the insolvency of the Federal Savings and Loan Insurance Corporation (\"FSLIC\"), which insured deposits maintained in most savings and loan associations and savings banks and the need to provide appropriate structural reform to the thrift industry. On August 9, 1989, President Bush signed the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\"), which is designed to resolve these problems and which, among other matters, fundamentally restructures the supervision and regulation of the thrift industry and creates a special corporation to liquidate insolvent institutions and issue $30 billion in bonds to assist in\nfinancing the cost of resolving failed thrift institutions. Under the legislation, the FSLIC was merged administratively with the FDIC, and the FDIC now regulates the two deposit insurance funds for commercial banks and thrifts. Although the two insurance funds will not be co- mingled, the fees that commercial banks and thrifts would pay to their respective insurance funds will be increased. Within certain limits, assessments may be raised as high as .325% to prevent the insurance funds from declining. The FDIC will have the authority to revise the premium for institutions in either fund in certain circumstances. In addition to the insurance premium increase provisions, FIRREA also provides for these additional changes with a direct effect on commercial banks and bank holding companies: limits on the use of brokered deposits by capital deficient banks; the acquisition of savings and loan associations by bank holding companies; disclosures of the bank supervisors' assessment of community Reinvestment Act ratings for banks; and an increase in penalties for various bank related crimes both in the forms of fines and sentences. It is difficult to predict the effect of FIRREA on the operations and prospects of banks; however, the increase in deposit insurance premiums paid by the Banks will increase the Banks cost of funds and there can be no assurance that such cost can be passed on to the Banks' customers.\nIn the 1989 session, the Georgia legislature enacted a bill to authorize the DBF to promulgate regulations providing for increased securities and real estate powers for banks. The legislation does not detail these new powers, leaving the specifics to the DBF's discretion. It is not expected that the DBF will immediately grant significant new powers or that such powers will have a great impact on the Banks.\nEffective on July 1, 1985, the Georgia General Assembly adopted legislation that allows bank holding companies located in Georgia to own or control banks in certain other southeastern states and allows bank holding companies in other southeastern states to own or control banks located in Georgia on a reciprocal basis. Effective March 13, 1987, the Georgia State Legislature expanded this reciprocal regional interstate banking area to include the State of Maryland and the District of Columbia. The legislatures of Alabama, the District of Columbia, Florida, Louisiana, Kentucky, Maryland, North Carolina, South Carolina, Tennessee and Virginia have passed regional interstate banking laws which are in effect. The state of Mississippi has approved regional interstate banking effective January 1, 1990 with respect to holding company entry on a reciprocal basis by holding companies located in Georgia. During 1994, the state of Georgia approved a measure to allow nation wide interstate banking. Management of the Banks do not anticipate this new law will have any impact on their operations. Georgia passed state wide branching law in February, 1996 with an efective date of July 1, 1996. This will allow banks to cross county lines and establish branches. It is anticipated that increased competition will occur as a result.\nFederal Deposit Insurance Corporation Improvement Act of 1991\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"FDICIA\") became law. While the FDICIA primarily addressed additional sources of funding for the Bank Insurance Fund, which insures the deposits of commercial banks and savings banks, it also imposed a number of new mandatory supervisory measures on savings associations and banks.\nStandards for Safety and Soundness FDICIA requires the federal bank regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to: (i) internal controls, information systems and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees and benefits. The compensation standards would prohibit employment contracts, compensation or benefit arrangements, stock option plans, fee arrangements or other compensatory arrangements that would provide excessive compensation, fees or benefits or could lead to material financial loss. In addition, the federal banking regulatory agencies would be required to prescribe by regulation standards specifying: (i) maximum classified assets-to-capital ratios; (ii) minimum earnings sufficient to absorb losses without impairing capital; and (iii) to the extent feasible, a minimum ratio of market value to book value for publicly traded shares of depository institutions and depository institution holding companies. Final regulations implementing these standards must be promulgated by July 1, 1993 and effective by January 1, 1994. The federal banking agencies recently adopted an advance notice of proposed rulemaking regarding implementation of these standards. A recently enacted law amends certain FDICIA provisions regarding compensation standards and several pending legislative bills would amend certain other requirements of this section of FDICIA. Thus, it is uncertain whether such provisions will ever be implemented or, if implemented by the banking agencies, it is uncertain as to how the standards will be applied.\nFinancial Management Requirements FDICIA also imposes new financial reporting requirements on all depository institutions with assets of more than $150 million, their management and their independent auditors and establishes new rules for the composition, duties and authority of such institutions' audit committees and boards of directors, effective in fiscal years beginning after December 31, 1992. Among other things, all such depository institutions will be required to prepare and make available to the public annual reports on their financial condition and management, including statements of managements' responsibility for the financial statements, internal controls and compliance with certain federal banking laws and regulations relating to safety and soundness and an assessment of the institutions' compliance with such internal controls, laws and regulations. The institution's independent public accountants are required to attest to these management assessments. Each institution also is required to have an audit committee composed of independent directors. Audit committees of large institutions (to be defined by the FDIC) would have the ability to engage their own, independent legal counsel.\nPrompt Corrective Regulatory Action FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, which became effective December 19, 1992, the banking regulators are required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of\ncapitalization. Generally, subject to a narrow exception, the FDICIA requires the banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. The 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 be no less than 2% of assets.\nOther Deposit Insurance Reforms FDICIA amended the Federal Deposit Insurance Act (\"FDI Act\") to prohibit insured depository institutions that are not well-capitalized from accepting brokered deposits unless a waiver has been obtained from the FDIC. Deposit brokers will be required to register with the FDIC.\nFDICIA also directs the FDIC to establish a risk-based assessment system for deposit insurance to become effective no later than January 1, 1994. FDICIA provides that, under the risk-based system established by the FDIC, deposit insurance assessments paid by a financial institution are to be based on the probability that the deposit insurance funds (i.e. BIF or SAIF) will incur a loss with respect to the insured depository institution. The FDIC recently established a transitional risk-based insurance assessment system which was effective for the semi-annual assessment period beginning January 1, 1993 and has proposed a risk-based system to replace the transitional system. Furthermore, FDICIA authorizes the FDIC to privately reinsure up to 10% of its risk of loss with respect to an institution and base its assessment on the cost of such reinsurance.\nThe Tax Reform Act of 1986\nThe Tax Reform Act of 1986 (the \"TRA\") contains several provisions affecting banks and financial institutions, including new provisions governing tax rates, depreciation, investment tax credits, bad debt reserves, interest expense allocable to tax-exempt obligations, net operating losses and a new alternative minimum tax (\"AMT\"). The TRA reduced the maximum corporate income tax rate from 46% to 34% in 1988 when the provision was fully effective. A surcharge of 5% will also apply to income in excess of $100,000, up to a maximum surcharge of $11,750.\nFor tax years beginning after 1986, the TRA imposes an AMT on corporations. The tax is computed by applying a 20% tax rate to the sum of (1) taxable income, (2) certain preference items and (3) 50% of the excess of book income before taxes over the sum of (1) and (2). For a financial institution, the principal preference items result from bad debt deductions, accelerated depreciation and interest on certain private purpose tax exempt bonds. The taxpayer is then required to pay the greater of its regular tax or the AMT. South does not expect to incur an alternative minimum tax liability based on its current profitability and investment portfolio. If the AMT is incurred as a result of deferral preferences, a credit is generated which may be used against regular tax in subsequent years.\nThe TRA provides for disallowances of 100% of any otherwise allowable interest expense deduction that is deemed allocable to tax- exempt obligations acquired after August 7, 1986, except for certain small municipal issuers. As a result, the Banks expect to primarily invest in taxable investment securities.\nFinancial institutions with assets in excess of $500 million are no longer permitted to use the reserve method for accounting for loan losses for tax purposes. South does not exceed this asset size and, accordingly, can continue to use the reserve method.\nThe TRA also eliminated investment tax credits after December 31, 1985. As investment in premises and equipment is not significant to the assets of South, the elimination of investment tax credits is not perceived to materially affect the tax provision expense of South.\nThe foregoing is only a summary of certain Federal income tax changes caused by the TRA and is qualified in its entirety by reference to the TRA. It does not include all aspects of the TRA as it relates to financial institutions or state, local or other tax laws.\nOmnibus Budget Reconciliation Act of 1993\nThe Omnibus Budget Reconciliation Act of 1993 (the \"Tax Act\") continues the recent legislation affecting banks and financial institution. The Tax Act was designed as a deficit reduction with similarities to the 1990 Act which was also designed to slice $500 billion from the deficit.\nGenerally the Tax Act affects all corporations as to a new 35% tax rate for income in excess of 10 million and the maximum corporate capital gains rate was increased to 35%. The Registrant currently will not be affected by the change due to the income level of the Registrant. Various other provisions would restrict certain deductions and\/or change the treatment of certain transactions.\nProvisions that especially affect financial institutions included market to market Accounting for Securities. The Tax Act requires that securities that are inventory in the hands of a dealer be inventoried at fair market value (market to market). For the purposes of these rules, \"securities\" and a \"dealer\" are defined more broadly than under prior law. A \"dealer\" is any person who either regularly purchases securities from or sells securities to, customers in the ordinary course of business or regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. Banks have been determined to qualify as a dealer under the new definitions. Unless securities are properly identified as held for investment all inventory will be required to be market to market.\nA second item affecting financial institutions is the treatment of tax-free FSLIC Assistance that was credited on or after March 4, 1991 in connection with the disposition of \"covered\" assets. Financial institutions are required to treat that assistance as compensation for any losses claimed on dispositions or charge-offs of these assets, effectively denying them any tax loss for those assets. This provision should not have any effect on the Registrant.\nThe third item affecting financial institutions is the amortization of intangible assets effective for purchase after the enactment (August 10, 1993). Taxpayers are required to amortize most intangibles (including goodwill, core deposits, going concern value and covenant not to compete) used in a trade or business over a 15 year period. Exception to this rule includes mortgage service rights. The provision will have significant impact on any future purchases the holding company may decide to undertake.\nSome of the other provisions such as eliminating deductions for lobbying expense and club dues will impact the taxes payable by the Registrant.\nReigle Community Development and Regulatory Improvement Act of 1994\nThe Reigle Community Development and Regulatory Improvement Act of 1994 (CDRIA) was enacted in September, 1994. CDRIA is divided into five titles:\nTitle I. Community Development and Consumer Protection Title II. Small Business Capital Formation Title III. Paperwork Reduction and Regulatory Improvements Title IV. Money Laundering Title V. National Flood Insurance Refund\nSome of the more prominent provisions of this legislation included, consideration of regulatory burden in the rule making process, streamlining of regulatory requirements, call report simplification and repeal of publication requirements, regulatory appeals reform, truth in savings act exemption for business accounts, guidelines for examiners, expedited procedures for forming a bank holding company and holding commpany audit requirements. Management has determined that this act will have minimal effect on South Banking Company.\nReigle-Neal Interstate Banking and Branching Efficiency Act of 1994\nThe Reigle-Neal Interstate Bank and Branching Efficiency Act of 1994 expands the rights of bank and bank holding companies to own out- of-state banks and branches. After September 29, 1995, bank holding companies will be allowed to acquire banks in any state without regard to state law. States will be allowed to prevent holding companies from acquiring newly opened banks. (e.g., those in existance for less than 5 years).\nBanks will also be able to merge with out-of-state banks and establish out-of-state branches effective June 1, 1997. States, however, have the authority to prohibit out-of-state banks from opening branches.\nRecent and Proposed Changes in Accounting Rules\nThe Financial Accounting Standards Board (\"FASB\") recently adopted or issued proposals and guidelines which may have a significant impact on the accounting practices of commercial enterprises in general and financial institutions in particular.\nEffective for years beginning after December 15, 1993 the Registrant was required to implement FASB 115 \"Accounting for Certain Investments in Debt and Equity Securities\". This FASB requires securities to be classified in one of three categories:\n(1) Held to maturity (2) Trading securities (3) Securities available for sale\nThe Banks were required to classify all securities into one of the three categories. The Banks currently do not have trading accounts and do not anticipate classifying any securities into this category. Once the securities are classified FASB 115 restricts the transfer between classification except under rare circumstances. The affect on the banks will primarily be in securities classified available for sale. FASB 115 requires these securities to be market to market with unrealized gains and losses reported as a separate amount in stockholders equity section and excluded from earnings until realized. Deferred taxes will be provided in accordance with FASB 109 on the unrealized gains and losses.\nFASB 114 became effective for years beginning after December 15, 1994. FASB 114 \"Accounting by Creditors for Impairment of a Loan\" specifies how allowance for credit losses related to certain loans should be determined. When the FASB became effective, the Banks were required to modify the treatment of impaired loans to discount expected cash flows and record a valuation allowance. The Banks did not have any material change as a result of this FASB.\nIn February 1992, the FASB issued Statement of Financial Accounting Standards SFAS No. 109 relating to the method of accounting for deferred income taxes. Implementation of SFAS 109 is required for fiscal years beginning after December 15, 1992. SFAS No. 109 requires companies to take into account changes in tax rates when valuing the deferred income tax amounts recorded on the balance sheet. The statement also requires that deferred taxes be provided for all temporary differences between financial statement and tax income in addition to the timing differences in the recognition of income for financial statement and tax purposes which were covered by prior accounting rules.\nIn December 1990, FASB issued SFAS No. 106, \"Employer's Accounting for Post-Retirement Benefits Other Than Pensions\". SFAS No. 106 focuses principally on post-retirement health care benefits and will significantly change the prevalent current practice of accounting for post-retirement benefits on a cash basis to requiring accrual, during the years that the employee renders the necessary service, of the expected cost of providing those benefits to an employee and the employee's beneficiaries and covered dependents. SFAS No. 106 is effective for fiscal years beginning after December 15, 1992, and adoption is required on a prospective basis. Management believes that the provisions of SFAS No. 106 will not have a significant effect on future results of operations.\nIn December 1991, the FASB issued SFAS No. 107, \"Disclosures About Fair Value of Financial Investments\". SFAS No. 107 requires all entities to disclose, in financial statements or the notes thereto, the\nfair value of financial instruments, both assets and liabilities, recognized and not recognized, in the statement of financial condition, for which it is practicable to estimate fair value. SFAS No. 107 is effective for financial statements issued for years ending after December 15, 1992, except for entities with less than $150 million in total assets, for which it is effective in 1996. Substantially all of the Bank's assets and liabilities are financial instruments and, as a result, SFAS No. 107 requires the fair value of such assets and liabilities to be disclosed. Because such assets and liabilities are monetary in nature, their fair values may fluctuate significantly over time. The provisions of SFAS No. 107 will require certain disclosures on the part of management, but will not have a significant effect on future results of operations.\nIn April 1992, the Accounting Standards Division of the American Institute of Certified Public Accountants issued Statement of Position 92-3 (\"SOP 92-3\") \"Accounting for Foreclosed Assets\". SOP 92-3 requires all entities to value foreclosed assets held for sale at the lower of (i) fair value minus estimated costs to sell or (ii) cost. The bank is in compliance with this statement of position.\nSelected Statistical Information\nThe tables and schedules on the following pages set forth certain significant statistical data with respect to: (I) the distribution of assets, liabilities and shareholders' equity and the interest rates and interest differentials experienced by, the Registrant and its subsidiaries; (II) the investment portfolio of the Registrant and its subsidiaries; (III) the loan portfolio of the Registrant and its subsidiaries, including types of loans, maturities and sensitivity to changes in interest rates and information on nonperforming loans; (IV) summary of the loan loss experience and reserves for loan losses of the Registrant and its subsidiaries; (V) types of deposits of the Registrant and its subsidiaries; and (VI) the return on assets and equity for the Registrant and its subsidiaries.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIALS\nA. The condensed average balance sheets for the periods indicated are presented below. Year Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) ASSETS Cash and due from banks $ 4,348 $ 3,749 $ 4,788 Cash in bank - interest bearing 827 1,538 2,377 Taxable investment securities 8,518 8,222 10,610 Nontaxable investment securities 1,055 1,619 2,011 Others 273 - -\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) ASSETS (con't) Federal funds sold and securities purchased under agreements to resell $ 8,023 $ 7,883 $ 5,655 Loans - net 60,641 54,042 48,898 Other assets 5,968 5,700 5,560\nTotal Assets $ 89,653 $ 82,753 $ 79,899\nLIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand - non-interest bearing $ 13,446 $ 12,965 $ 11,701 Demand - interest bearing 15,211 17,378 17,923 Savings 6,675 7,132 6,423 Time 42,838 34,647 34,005 Total Deposits $ 78,170 $ 72,122 $ 70,052 Federal funds purchased 7 167 - Other borrowed funds 1,545 1,186 762 Other liabilities 408 468 1,128\nTotal Liabilities $ 80,130 $ 73,943 $ 71,942\nShareholders' equity $ 9,523 $ 8,810 $ 7,957\nTotal Liabilities and Shareholders' Equity $ 89,653 $ 82,753 $ 79,899\nB. Interest Rates. The tables below show for the periods indicated the average amount outstanding for major categories of interest earning assets and interest bearing liabilities; the average interest rates earned or paid; the interest income and expense earned or paid thereon; net interest earnings and the net yield on interest-earning assets. (1)\nYear Ended December 31, 1995 Average Yield\/ Balance Interest Rate (In Thousands) ASSETS Cash in banks - interest bearing $ 827 $ 41 4.96% Loans 60,641 6,996 11.54 Taxable investments 8,518 513 6.02 Non-taxable investments 1,055 59 5.59 Other 273 10 3.66 Federal funds sold and securities purchased under agreements to resell 8,023 472 5.88\nTotal Interest-bearing assets $ 79,337 $ 8,091 10.20%\nYear Ended December 31, 1995 Average Yield\/ Balance Interest Rate (In Thousands) LIABILITIES Demand - interest bearing $ 15,211 $ 407 2.68% Savings deposits 6,675 182 2.73 Other time deposits 42,838 2,580 6.02 Other short term borrowing 1,545 144 9.32 Federal funds purchased 7 1 N\/A\nTotal Interest-Bearing Liabilities $ 66,276 $ 3,314 5.00%\nNet interest earnings $ 4,777\nNet yield on interest earning assets 5.20%\nYear Ended December 31, 1994 Average Yield\/ Balance Interest Rate (In Thousands) ASSETS Cash in banks - interest bearing $ 1,538 $ 65 4.22% Loans 54,042 5,666 10.48 Taxable investments 8,222 437 5.32 Non-taxable investments 1,619 94 5.81 Federal funds sold and securities purchased under agreements to resell 7,883 306 3.88\nTotal Interest-bearing assets $ 73,304 $ 6,568 8.96%\nLIABILITIES Demand - interest bearing $ 17,378 $ 492 2.83% Savings deposits 7,132 197 2.76 Other time deposits 34,647 1,475 4.26 Other short term borrowing 1,186 101 8.52 Federal funds purchased 167 4 2.40\nTotal Interest-Bearing Liabilities $ 60,510 $ 2,269 3.75%\nNet interest earnings $ 4,299\nNet yield on interest earning assets 5.21%\nYear Ended December 31, 1993 Average Yield\/ Balance Interest Rate (In Thousands) ASSETS Cash in banks - interest bearing $ 2,377 $ 96 4.04% Loans 48,898 4,973 10.17 Taxable investments 10,610 616 5.81 Non-taxable investments 2,011 133 6.61 Federal funds sold and securities purchased under agreements to resell 5,655 164 2.90\nTotal Interest-bearing assets $ 69,551 $ 5,982 8.60%\nLIABILITIES Demand - interest bearing $ 17,923 $ 485 2.70% Savings deposits 6,423 178 2.77 Other time deposits 34,005 1,423 4.18 Other short term borrowing 762 49 6.43 Federal funds purchased - - -\nTotal Interest-Bearing Liabilities $ 59,113 $ 2,135 3.61%\nNet interest earnings $ 3,847\nNet yield on interest earning assets 4.99%\n(1) Note: Loan fees are included for rate calculation purposes. Loan fees included in interest amounted to approximately $464,456 in 1995, $521,000 in 1994 and $345,000 in 1993. Non accrual loans have been included in the average balances.\nC. Interest Differentials. The following tables set forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates.\n1995 compared to 1994 Increase (Decrease) Due to (1) Volume Rate Change (In Thousands) Interest earned on: Cash in banks - interest bearing $( 30) $ 6 $( 24) Loans 690 640 1,330 Taxable investments 16 60 76 Nontaxable investments ( 33) ( 2) ( 35) Other 10 - 10 Federal funds sold and securities purchased under agreement to resell 6 160 166\nTotal Interest-Earning Assets $ 659 $ 864 $ 1,523\n1995 compared to 1994 (con't) Increase (Decrease) Due to (1) Volume Rate Change (In Thousands) Interest paid on: NOW deposits $( 61) $( 24) $( 85) Savings deposits ( 13) ( 2) ( 15) Other time deposits 349 756 1,105 Other borrowing 30 13 43 Federal funds purchased ( 3) - ( 3)\nTotal Interest-bearing Liabilities $ 302 $ 743 $ 1,045\nNet Interest Earnings $ 357 $ 121 $ 478\n(1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year.\n1994 compared to 1993 Increase (Decrease) Due to (1) Volume Rate Change (In Thousands) Interest earned on: Cash in banks - interest bearing $( 33) $ 2 $( 31) Loans 523 170 693 Taxable investments ( 138) ( 40) ( 178) Nontaxable investments ( 23) ( 16) ( 39) Federal funds sold and securities purchased under agreement to resell 65 76 141\nTotal Interest-Earning Assets $ 394 $ 192 $ 586\nInterest paid on: NOW deposits $( 15) $ 22 $ 7 Savings deposits 19 - 19 Other time deposits 26 26 52 Other borrowing 27 25 52 Federal funds purchased 4 - 4\nTotal Interest-bearing Liabilities $ 61 $ 73 $ 134\nNet Interest Earnings $ 333 $ 119 $ 452\n(1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year.\n1993 compared to 1992 Increase (Decrease) Due to (1) Volume Rate Change (In Thousands) Interest earned on: Cash in banks - interest bearing $ 12 $( 22) $( 10) Loans 46 ( 415) ( 369) Taxable investments 56 ( 99) ( 43) Nontaxable investments ( 11) ( 8) ( 19) Federal funds sold and securities purchased under agreement to resell ( 17) ( 28) ( 45)\nTotal Interest-Earning Assets $ 86 $( 572) $( 486)\nInterest paid on: NOW deposits $ 145 $( 135) $ 10 Savings deposits 32 ( 26) 6 Other time deposits ( 344) ( 437) ( 781) Other short-term borrowing ( 6) ( 9) ( 15) Federal funds purchased - - -\nTotal Interest-bearing Liabilities $( 173) $( 607) $( 780)\nNet Interest Earnings $ 259 $ 35 $ 294\nII. INVESTMENT PORTFOLIO\nA. Types of Investments The carrying amounts of investment securities at the dates indicated are summarized as follows:\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) U. S. Treasury and other U. S. government agencies and corporations $ 7,634 $ 5,942 $ 6,750 State and political subdivisions (domestic) 1,921 1,126 1,871 Mortgage backed securities 1,897 2,065 1,897\nTotals $ 11,452 $ 9,133 $ 10,518\nB. Maturities The amounts of investment securities in each category as of December 31, 1995 are shown in the following table according to maturity classifications (1) one year or less, (2) after one year through five years, (3) after five years through ten years, (4) after ten years.\nU. S. Treasury and Other U. S. Government State Agencies and and Political Mortgage Backed Corporations Subdivisions Securities Average Average Yield Yield Average Amount (1) Amount (1)(2) Amount Yields Maturity: One year or less $ 2,248 5.63% $ - -% $ - - After one year through five years 4,680 5.92 626 7.00 1,158 6.86 After five years through ten years 706 7.66 758 7.03 - - After ten years - - 537 8.65 739 7.38\nTotals $ 7,634 6.00% $ 1,921 7.47% $ 1,897 7.06%\n(1) Yields were computed using coupon interest, adding discount accretion or subtracting premium amortization, as appropriate, on a ratable basis over the life of each security. The weighted average yield for each maturity range was computed using the acquisition price of each security in that range.\n(2) Yields on securities of state and political subdivisions are stated on a tax equivalent basis, using a tax rate of 34%.\nIII. Loan Portfolio\nA. Types of Loans The amount of loans outstanding at the indicated dates are shown in the following table according to type of loan.\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) Commercial, financial and agricultural $ 14,592 $ 13,229 $ 7,904 Real estate - mortgage 36,426 32,792 26,883 Real estate - construction 1,767 2,347 1,039 Installments 8,932 8,834 14,967 $ 61,717 $ 57,202 $ 50,793 Less - unearned income 82 59 73 Reserve for possible losses 994 975 912\nTotal Loans $ 60,641 $ 56,168 $ 49,808\nB. Maturities and Sensitivity to Changes in Interest Rates The amount of total loans by category (excluding real estate mortgage and installment loans) outstanding as of December 31, 1995 which, based on remaining repayments of principal, are due in (1) year or less, (2) more than one year but less than five and (3) more than five years are shown in the following table. The amounts due after one year are classified according to the sensitivity to changes in interest rates.\nMaturity Classification Over One One Year Through 5 Over or Less Years 5 years Total (In Thousands) Types of Loans Commercial, financial and agricultural $ N\/A $ N\/A $ N\/A $ N\/A Real estate construction $ 1,767 N\/A N\/A N\/A\nTotal loans due after one year with: Predetermined interest rate N\/A Floating interest rate N\/A\nC. Nonperforming Loans The following table presents, at the dates indicated, the aggregate amounts of nonperforming loans for the categories indicated. Year Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) Loans accounted for on a non-accrual basis $ 46 $ 56 $ 100\nLoans contractually past due ninety days or more as to interest or principal payments 276 33 58\nLoans, the terms of which have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower - - -\nLoans now current about which there are serious doubts as to the ability of the borrower to comply with present loan repayment terms - - -\nLoans are placed on non-accrual basis when loans are past due ninety days or more. Management can elect not to place loans on non- accrual status if net realizable value of collateral is sufficient to cover the balance and accrued interest.\nD. Commitments and Lines of Credit The banks provide commitments and lines of credits to their most credit worthy customers only. Commitments are for short terms, usually not exceeding 30 days, and are provided for a fee of 1% of the amount committed. Lines of credit are for periods extending up to one year. No fee is usually charged with respect to the unused portion of a line of credit. Interest rates on loans made pursuant to commitments or under lines of credit are deter- mined at the time that the commitment is made or line is established.\nE. Rate Sensitivity Analysis SOUTH BANKING COMPANY DECEMBER 31, 1995\n+-----Interest Sensitive\n0 - 0 - 0 - 90 Days 180 Days 365 Days (Thousands of Earning Assets: Loans $ 25,984 $ 30,168 $ 37,948 Investment securities 2,017 2,498 4,680 Interest bearing deposits 398 398 795 Federal funds sold and securities purchased under agreement to resell 13,335 13,335 13,335\nTotal Earning Assets $ 41,734 $ 46,399 $ 56,758\nSupporting Sources of Fund Savings $ 6,403 $ 6,403 $ 6,403 Money market and NOW 17,098 17,098 17,098 Other time deposits 11,297 19,704 31,276 CD's - $100,000 or more 2,243 4,183 7,322\nTotal Interest Bearing Deposits $ 37,041 $ 47,388 $ 62,099\nDemand deposits and other funds supporting earning assets - non interest earning $ - $ - $ -\nTotal Supporting Sources of funds $ 37,041 $ 47,388 $ 62,099\nInterest Sensitive - interest earning assets less interest bearing liabilities $ 4,693 $( 989) $( 5,341\nRatio of interest earning assets to interest bearing liabilities 1.13% .98% .91\n--------+ 0 - 5 yrs 0 - 24 2 years Months Total Dollars)\n$ 44,953 $ 55,336 $ 61,717 6,082 9,347 11,452 795 795 795\n13,335 13,335 13,335\n$ 65,165 $ 78,813 $ 87,299\n$ 6,403 $ 6,403 $ 6,403 17,098 17,098 17,098 35,824 37,526 37,526 8,656 9,372 9,372\n$ 67,981 $ 70,399 $ 70,399\n$ - $ - $ 14,145\n$ 67,981 $ 70,399 $ 84,544\n$( 2,816) $ 8,414 $ 2,755\n.96% 1.12% 1.03%\nThe rate sensitivity analysis table is designed to demonstrate South's sensitivity to changes in interest rates by setting forth in comparative form the repricing maturities of South's assets and liabilities for the period shown. A ratio of greater than 1.0 times interest earnings assets to interest bearing liabilities indicates that an increase in interest rates will generally result in an increase in net income for South and a decrease in interest rates will result in a decrease in net income. A ratio of less than 1.0 times earnings assets to interest-bearing liabilities indicates that a decrease in interest rates will generally result in a increase in net income for South and an increase in interest rates will result in an decrease in net income.\nIV. Summary of Loan Loss Experience\nThe following table summarizes loan balances at the end of each period and average balances during the year for each category; changes in the reverse for possible loan losses arising from loans charged off and recoveries on loans previously charged off; additions to the reserve which have been charged to operating expense; and the ratio of net charge-offs during the period to average loans.\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) A. Average amount of loans outstanding $ 60,641 $ 54,042 $ 48,898\nB. Balance of reserve for possible loan losses at beginning of period $ 975 $ 912 $ 738\nC. Loans charged off: Commercial, financial and agricultural $ 45 $ 53 $ 26 Real estate - mortgage - 16 9 Installments 144 24 48\n$ 189 $ 93 $ 83 D. Recoveries of loans previously charged off: Commercial, financial and agricultural $ 7 $ 39 $ 36 Real estate 46 6 63 Installment 93 57 40\n$ 146 $ 102 $ 139 E. Net loans charged off during period $ 43 $( 9) $( 56) Additions to reserve charged to operating expense during period (1) $ 62 $ 54 $ 118\nF. Balance of reserve for possible loan losses at end of period $ 994 $ 975 $ 912\nG. Ratio of net loans charged off during the period to average loans outstanding .070 ( .002) ( .01)\n(1) Although the provisions exceeded the minimum provision required by regulatory authorities, the Board of Directors believe that the provision has not been in excess of the amount required to maintain the reserve at a sufficient level to cover potential losses. The amount charged to operations and the related balance in the reserve for loan losses is based upon periodic evaluations by management of the loan portfolio. 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.\n(2) Management's review of the loan portfolio did not allocate reserves by category due to the portfolio's small size. The reserves were allocated on the bases of a review of the entire portfolio. The anticipated loan losses for the coming year are expected to be less than prior years. The portfolio does not contain excessive concentrations in any industry or loan category that might expose South to significant risk.\nV. Deposits\nA. Average deposits, classified as demand deposits, savings deposits and time certificates of deposit for the periods indicated are presented below: Year Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 (In Thousands) Demand deposits $ 13,446 $ 12,965 $ 11,701 NOW deposits 15,211 17,378 17,923 Savings deposits 6,675 7,132 6,423 Time certificates of deposits 42,838 34,647 34,005\nTotal Deposits $ 78,170 $ 72,122 $ 70,052\nB. The amounts of time certificates of deposit issued in amounts of $100,000 or more as of December 31, 1995 are shown below by category, which is based on time remaining until maturity of (1) three months or less, (2) over three through six months, (3) over six through twelve months and (4) over twelve months.\nThree months of less $ 2,243 Over three through six months 1,940 Over six through twelve months 3,139 Over twelve months 2,050\nTotal $ 9,372\nVI. Return on Assets and Shareholders' Equity\nThe following rate of return information for the periods indicated is presented below: Year Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 Return on assets (1) 1.28% 1.19% 1.16% Return on equity (2) 12.08 11.22 11.66 Dividend payout ratio (3) 19.37 22.54 24.23 Equity to assets ratio (4) 10.62 10.65 9.96\nVI. Return on Assets and Shareholders' Equity (con't)\n(1) Net income divided by average total assets. (2) Net income divided by average equity. (3) Dividends declared per share divided by net income per share. (4) Average equity divided by average total assets.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAlma Bank's main banking office and the Registrant's principal executive offices are located at 104 North Dixon Street, Alma, Georgia 31510. The building, containing approximately 13,040 square feet of usable office and banking space, and the land, approximately 1.2 acres, are owned by Alma Bank. Alma Bank also has a separate drive-in banking facility located at 505 South Pierce Street, Alma, Georgia. The building, containing 510 square feet, in which the branch is located and the land, approximately .4 acres, on which it is located are owned by Alma Bank.\nCitizens Bank's main banking office is located at 205 East King Street, Kingsland, Georgia 31548. The building, containing approximately 6,600 square feet of usable office and banking space, and the land, approximately 2 acres, are owned by Citizens Bank.\nPeoples Bank's main banking office is located at Comas and E. Parker Streets, Baxley, Georgia 31513. The building, containing approximately 7,800 square feet of usable office and banking space, and the land, approximately 2.5 acres, are owned by the Bank. The Bank does not have branches.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Registrant or its subsidiaries are parties to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Banks, nor to the knowledge of the management of the Registrant are any such proceedings contemplated or threatened against it or its subsidiaries.\nItem 4.","section_4":"Item 4. Submission of Matters to a vote of Security Holders\nNote applicable.\nPart II.\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters\n(a) There currently is no public market for the common stock of the Registrant.\n(b) As of March 1, 1996 there were approximately 481 holders of record of the Registrant's common stock.\n(c) The Registrant paid an annual dividend on its common stock of $.55 per share for a total of $222,906 for fiscal 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data Years Ended December 31, 1995 1994 1993 1992 1991 (In Thousands)\nTotal Assets $ 97,175 $ 84,477 $ 78,911 $ 79,904 $ 80,893\nOperations: Interest income $ 8,090 $ 6,568 $ 5,982 $ 6,468 $ 7,777 Interest expense 3,314 2,269 2,135 2,915 4,261\nNet Interest Income $ 4,776 $ 4,299 $ 3,847 $ 3,553 $ 3,516\nProvision for loan losses 62 53 118 224 719\nNet interest income after provision for loan losses $ 4,714 $ 4,246 $ 3,729 $ 3,329 $ 2,797\nOther income $ 1,371 $ 1,264 $ 1,251 $ 1,337 $ 1,191\nOther expenses $ 4,345 $ 4,116 $ 3,765 $ 3,566 $ 3,635\nIncome before income taxes $ 1,740 $ 1,394 $ 1,215 $ 1,100 $ 353\nFederal Income taxes $ 590 $ 405 $ 287 $ 281 74\nNet income before extraordinary items $ 1,150 $ 989 $ 928 $ 819 $ 279\nExtraordinary items $ - $ - $ - $ - $ -\nNet income $ 1,150 $ 989 $ 928 $ 819 $ 279\nPer Share Data: Income after extraordinary items $ 2.84 $ 2.44 $ 2.27 $ 2.01 $ .680\nNet income $ 2.84 $ 2.44 $ 2.27 $ 2.01 $ .680\nDividends Declared $ .55 $ .55 $ .55 $ .55 $ .55\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe purpose of this discussion is to focus on information about South Banking Company's financial condition and results of operations which is not otherwise apparent from the consolidated financial statement included in this report. Reference should be made to those statements and the selected financial data presented elsewhere in this report for an understanding of the following discussion and analysis.\nFinancial Condition and Liquidity\nFinancial Condition\nSouth functions as a financial institution and as such its financial condition should be examined in terms of trends in its sources and uses of funds. A comparison of daily average balances indicate how South has managed its sources and uses of funds. Included in the selected statistical information, the comparison of daily average balance in the business portion of the filing indicated how South has managed its sources and uses of funds. South used its funds primarily to support its lending activities.\nSouth's total assets increased to $97,174,748 at year end 1995 from $84,476,527 at year end 1994. The increase totaled $12,698,221 or approximately 15.03% which compared to a increase rate of 7.05% for 1994. The increase in growth was attributable to improvement in the local economies and South maintaining competitive rates for deposits as interest rates began to rise. South loan demand was very strong allowing South to become more active in the higher paying certificates of deposits.\nLoan demand increased during the current year as the continuing improvement in the economy maintained the confidence level of customers to a point where business activity has increased. Net loans increased to $60,641,359 in 1995 for an increase of $4,472,899 or 7.96% compared to an increase in 1994 of $6,360,363. The Banks have made an effort to retain quality loans since loans are the highest yielding assets of the Bank.\nSouth's investment portfolio, including certificate of deposits in other banks, increased to $12,246,850 from $10,401,190, an increase of $1,845,660 compared to a decrease of $2,407,361 during 1994. Federal funds purchased increased from $8,655,000 in 1994 to $13,335,000 in 1995. The change in the investment portfolio and federal funds sold is attributable to South's desire to maintain sufficient liquidity to fund higher yielding loans and to South's decision to keep investments at short-terms when rates were low to better position ourselves to take advantage of rising rates. The portfolio of South is primarily short- term securities as South has purchased these securities over the past few years when loan demand declined. As demand increased South was in position to capitalize on the upturn of the economy. Unrealized gain and losses on this portfolio is not material to the statement as South maintains a slight net unrealized gain on the portfolio.\nAs the primary source of funds, aggregate deposits, increased by $10,761,700 in 1995 and increased by $4,160,468 in 1994 or approximately 14.6% and 5.3%, respectively. However, the change is not consistent with all categories. Non-interest bearing deposits decreased $606,663. The average balance for the year on non-interest bearing deposits increased to $13,446,000 in 1995 compared to $12,965,000 in 1994. This is indicative of the stable core deposits and the improving economy. Interest bearing demand deposits increased substantially to $17,098,343 from $15,350,308 for an increase of $1,748,035. Time deposits accounted for majority of the increase in deposits. Time deposits increased by $10,389,430 or 28.4%. The shifting of deposits within the Banks was predictable due to changing rates and the need for many depositors to seek higher yield for their deposits. The returns are illustrated by the average interest rates on demand deposits which during 1995 decreased from 2.83% to 2.68% on demand accounts and 4.26% to 6.02% on time deposits.\nLiquidity\nThe primary function of asset\/liability management is to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors desiring to withdraw funds or borrowers requiring assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.\nMarketable investment securities, particularly those of shorter maturities, and federal funds sold are the principal sources of asset liquidity. Securities maturing in one year or less amounted to $2,466,182 and federal funds sold with daily maturities amounted to $13,335,000 at year end 1995, an increase from prior years as the deposit growth continues. Maturing loans and certificates of deposits in other banks are other sources of liquidity.\nHistorically, the overall liquidity of South has been enhanced by a significant aggregate amount of core deposits. These core deposits have remained constant during this period. South has utilized less stable short-term funding sources to enhance liquidity such as large denomination time deposits and money market certificates within its current customer base, but has not attempted to acquire these type of accounts from non-core deposit customers. South has utilized its core deposit base to help insure it maintains adequate liquidity.\nSouth does not have current commitments, demands or uncertainties that would affect its liquidity in a material way. South had a net loan to deposit ratio of 71.7 percent for year end 1995 down from 77.5 percent at year end 1994. The increased liquidity that South managed over the prior three years helped South to be able to fund the loan demand without any liquidity problems.\nInterest rate sensitivity varies with different types of interest- earning assets and interest bearing liabilities. Overnight federal funds on which rates change daily and loans which are tied to prime differ considerably from long-term investment and fixed rate loans. Similarly time deposits over $100,000 and money market accounts are much more interest sensitive than passbook savings and long-term capital notes. The shorter-term interest rate sensitivities are key to measuring the interest sensitivity gap, or excess interest-sensitive earning assets over interest-bearing liabilities. An interest rate sensitivity table is included elsewhere in document and it shows the interest sensitivity gaps for five different time intervals as of December 31, 1995. The first 30 days there is an excess of interest- bearing assets over interest-bearing liabilities. South becomes more sensitive to interest rate fluctuations on a short time period. While the cumulative gap declines with each time interval, South remains with a manageable position.\nCapital Resources\nSouth does not presently have commitments for significant capital expenditures. However, there are regulatory constraints placed on the South's capital.\nIn January 1989, the Federal Reserve Board released new standards for measuring capital adequacy for U. S. banking organizations. These standards are based on the original risk-based capital requirements first proposed in early 1986 by U. S. bank regulators and then developed jointly by authorities from the twelve leading industrial countries. As a result, the standards are designed to not only provide more risk- responsive capital guidelines for financial institutions in the U. S., but also incorporate a consistent framework for use by financial institutions operating in the major international financial markets.\nIn general, the standards require banks and bank holding companies to maintain capital based on \"risk-adjusted\" assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments and interest rate swaps.\nThe Federal Reserve Board standards classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 capital consists of common shareholders' equity, noncumulative and cumulative (BHCs only) perpetual preferred stock and minority interest less goodwill. Tier 2 capital consists of allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term subordinated debt and intermediate-term preferred stock. By December 31, 1992, all banks were required to meet a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets with at least 4% Tier 1 capital. Capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital.\nResults of Operations 1995 Compared to 1994\nNet interest income is an effective measurement of how well management has balanced the South's interest rate sensitive assets and liabilities. Net interest income increased by $477,147 or 11.1% in 1995 and $452,609 or 11.7% in 1994. The primary determinants of the increase were loans and time deposits. As loan demand increased, funds were channeled into higher yielding loans. The increase in loan demand continue to be sufficient to offset the higher paying deposit growth. The shifting of asset and liabilities was necessary to maintain level of net interest income as net interest yield remain constant at 5.20%. With the interest rate currently in the market and South current interest rate gap, South will continue its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, South will continue to attempt to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities.\nThe provision for loan loss was $994,027 in 1995 compared to $974,866 in 1994. The provision for loan losses has been sufficient to increase the allowance for loan losses each year. Management continues to work its loan portfolio to minimize charge-offs and place maximum efforts to collect previously charged off.\nOther income increased slightly from the prior year. Service charges decreased slightly in 1995 compared to 1994. This is an indication of the higher balance being maintained by customers as the economy has started to improve. Additionally, a small gain on securities occurred in 1994 as a small number of sales resulted in a small gain. Operations from data center increased as 1995 was the first full operational year. Sales are for one bank not owned by South.\nOperating cost grew at a rate of 5.84%. The increases are primarily personnel and equipment related. Increased demands by regulatory agencies have required some additional personnel time and other cost continue to increase. The start up of the data processing center in 1995 contributed to the increased operating cost. 1995 was the first full year of data processing center operation and costs are becomming more manageable than in the prior year of inception. Management expects the center to become more efficient as its operation matures.\nIncome tax expense was $589,746 in 1995 or 33.89% of net income compared to $405,023 in 1994 or 29.04% of net income. The reduction in tax free municipal bond interest in 1995, as bonds matured or were called, also raised the effective tax rate of South. During the year 1993, FASB 109 was adopted by South with no material effect on its financial statements; however, some adjustments were required.\nResults of operations can be measured by various ratio analysis. Two widely recognized performance indicators are the return on average equity and the returns on average assets. South's return on equity increased from 11.22% to 12.08%. The return on assets increased from 1.19% to 1.28%.\nResults of Operations 1994 Compared to 1993\nNet interest income is an effective measurement of how well management has balanced the South's interest rate sensitive assets and liabilities. Net interest income increased by $452,609 or 11.7% in 1994 and $399,302 or 11.2% in 1993. The primary determinants of the increase were loans and time deposits. As loan demand increased, funds were channeled into higher yielding loans. The increase in loan demand was sufficient to offset the higher paying deposit growth. The shifting of asset and liabilities was necessary to maintain level of net interest income as net interest yield increased to 5.21% from 4.99%. With the interest rate currently in the market and South current interest rate gap, South will continue its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, South will attempt to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities.\nThe provision for loan loss was $974,866 in 1994 compared to $911,931 in 1993. The provision for loan losses has been sufficient to increase the allowance for loan losses each year. During the year 1994, loan loss recoveries exceeded the loan charged off as management continues to work its loan portfolio to minimize charge-offs and place maximum efforts to collect previously charged off.\nOther income increased slightly from the prior year. Service charges remained level in 1994 compared to 1993. This is an indication of the higher balance being maintained by customers as the economy has started to improve. Additionally, a small loss on securities occurred in 1993 as early calls and a small number of sales resulted in a small loss.\nOperating cost grew at a rate of 9.31%. The increases are primarily personnel, data processing and regulatory in nature. Increased demands by regulatory agencies have required some additional personnel time and FDIC fees and other cost continue to increase. The start up of the data processing center in 1994 contributed to the increased operating cost. Management expects the center to become more efficient as its operation matures.\nIncome tax expense was $405,023 in 1994 or 29.04% of net income compared to $286,472 in 1993 or 23.6% of net income. In 1993, South recovered previous alternative minimum tax paid in 1991 to reduce the overall tax bite. The reduction in tax free municipal bond interest in 1994, as bonds matured or were called, also raised the effective tax rate of South. During the year 1993, FASB 109 was adopted by South with no material effect on its financial statements; however, some adjustments were required.\nResults of operations can be measured by various ratio analysis. Two widely recognized performance indicators are the return on average equity and the returns on average assets. South's return on equity decreased from 11.66% to 11.22%. The return on assets increased from 1.16% to 1.19%. Although these levels are within peer group ranges of some other bank holding companies, management believes that improvement for 1995 is realistic.\nResults of Operations 1993 Compared to 1992\nNet interest income is an effective measurement of how well management has balanced the South's interest rate sensitive assets and liabilities. Net interest income increased by $399,302 or 11.2% in 1993 and $36,908 or 1.05% in 1992. The primary determinants of the increase were loans and time deposits. As loan demand increased, funds were channeled into higher yielding loans. Management did not solicit high interest deposits and was able to maintain stable cost of funds. The shifting of assets and liabilities was necessary to maintain level of net interest income as net interest yield decreased to 4.99% from 5.17%. With the low interest rate currently in the market and South current interest rate gap, South will continue its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, South will attempt to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities.\nThe provision for loan loss was $911,931 in 1993 compared to $738,578 in 1992. The provision for loan losses has been sufficient to increase the allowance for loan losses each year. During the year 1993, loan loss recoveries exceeded the loan charged off as management continues to work its loan portfolio to minimize charge-offs and place maximum efforts to collect previously charged off.\nOther income decreased from the prior year. Service charges were down in 1993 compared to 1992. This is an indication of the higher balance being maintained by customers as economy has started to improve. Additionally, a small loss on securities occurred in 1993 as early calls and a small number of sales resulted in a small loss.\nOperating cost grew at a rate of 5.59%. The increases are primarily personnel and regulatory in nature. Increased demands by regulatory agencies have required some additional personnel time and FDIC fees and other cost continue to increase.\nIncome tax expense was $286,472 in 1993 or 23.6% of net income compared to $281,236 in 1992 or 25.6% of net income. South continued to recover previous alternative minimum tax paid in 1991 to reduce the overall tax bite. During the year 1993, FASB 109 was adopted by South with no material effect on its financial statements; however, some adjustments were required.\nResults of operations can be measured by various ratio analysis. Two widely recognized performance indicators are the return on average equity and the returns on average assets. South's return on equity increased from 11.19% to 11.66%. The return on assets increased from 1.03% to 1.16%. Although these levels are within peer group ranges of some other bank holding companies, management believes that improvement for 1994 is realistic.\nNonperforming Assets\nNonperforming assets include nonaccrual loans, accruing loans past due 90 days or more and other real estate, which include foreclosures, deeds in lieu of foreclosure and in-substance foreclosures.\nA loan is generally classified as nonaccrual when full collectibility of principal or interest is doubtful or a loan becomes 90 days past due as to principal or interest, unless management determines that the estimated net realizable value of the collateral is sufficient to cover the principal balance and accrued interest. 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. Nonperforming loans are returned to performing status when the loan is brought current and has performed in accordance with contract terms for a period of time.\nDistribution of Nonperforming Assets 1995 1994 1993 (In Thousands) Non accrual loans $ 66 $ 56 $ 100 Past due 90 days still accruing 276 33 58 Other real estate (ORE) 283 661 500\n$ 625 $ 750 $ 658 Nonperforming loans to year end loans .54% .16% 31% Nonperforming assets to year end loan and ORE 1.00% 1.31% 1.28%\nThe ratio of nonperforming assets has decreased steadily since 1992 until 1995. A slight increase occurred as ORE sales declined and a subsequent foreclosure has increased the ORE in 1994. This decrease is attributed to the sale of ORE and the general improvement of the loan portfolio. Management continues to work on nonperforming assets to further reduce this ratio.\nRegulatory Matters\nDuring the year 1995, federal and state regulatory agencies completed asset quality examinations at the South's subsidiary banks. The South's level and classification of identified potential problem loans was not revised significantly as a result of this regulatory examination process.\nExamination procedures require individual judgments about a borrower's ability to repay loans, sufficiency of collateral values and the effects of changing economic circumstances. These procedures are similar to those employed by South in determining the adequacy of the allowance for loan losses and in classifying loans. Judgments made by regulatory examiners may differ from those made by management.\nManagement and the boards of directors of South and affiliates evaluate existing practices and procedures on an ongoing basis. In addition, regulators often make recommendations during the course of their examinations that relate to the operations of South and its affiliates. As a matter of practice, management and the boards of directors of South and its subsidiaries consider such recommendations promptly.\nImpact of Inflation and Changing Prices\nThe majority of assets and liability of a financial institution are monetary in nature; therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. An important effect of this has been the reduction of asset growth to maintain appropriate levels. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation.\nManagement believes the most significant impact on financial results is South's ability to react to changes in interest rates. As discussed previously, management is attempting to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations.\nImpact of Accounting Change for Income Taxes and Tax Reform\nIn February 1992, the FASB issued Statement of Financial Accounting Standards SFAS No. 109 relating to the method of accounting for deferred income taxes. Implementation of SFAS 109 is required for fiscal years beginning after December 15, 1992. SFAS No. 109 requires companies to take into account changes in tax rates when valuing the deferred income tax amounts recorded on the balance sheet. The statement also requires that deferred taxes be provided for all temporary differences between financial statement and tax income in addition to the timing differences in the recognition of income for financial statement and tax purposes which were covered by prior accounting rules.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of the Registrant and its subsidiaries are included on pages through of this Annual 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 Changes in Stockholders' Equity - Years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flow - Year ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nItem 9.","section_9":"Item 9. Disagreement 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 Directors and Executive Officers of the Registrant and their respective ages, positions with the Registrant, principal occupation and Common Stock of the Registrant beneficially owned as of March 1, 1995 are as follows: Director (Officer) of # of shares Position with Registrator Owned Registrant of one of Beneficiary & Principal the Banks (Percent of Name (Age) Occupation Since Class)\nPaul T. Bennett (40) President, 1978(1)(2) 10,334 Treasurer and (3) ( 2.55%) Director; Vice Chairman and Director, Citizens Bank; Vice Chairman and Director, Peoples State Bank & Trust, Baxley, Georgia; President Peoples Bank, Lyons, Georgia; Director, Banker's Data Services; Director, Alma Exchange Bank and Trust\nOlivia Bennett (76) Executive Vice 1969(1)(2) 200,587 President, Secretary (3) ( 49.49%) and Director; Chairman and Director, Alma Bank; Director, Banker's Data Services Chairman of Board, President, Citizens Bank; Director Peoples Bank\nLawrence Bennett (48) President and 1987(1)(2) 3,654 Director, Alma ( .9%) Bank; Director, Banker's Data Services; Director, Peoples Bank, Baxley; Director Peoples Bank, Lyons\nCharles Stuckey (48) Director; Executive 1990(3) 200 Vice President, ( .1%) Peoples Bank; Director, Banker's Data Services\nItem 10. Directors and Executive Officers of the Registrant (con't)\nDirector (Officer) of # of shares Position with Registrator Owned Registrant of one of Beneficiary & Principal the Banks (Percent of Name (Age) Occupation Since Class)\nJames W. Whiddon (51) Director; Executive Vice President and 1989(2) 30 Director, Citizens ( -%) Bank; Director, Banker's Data Services\nKenneth F. Wade (53) Director; Executive 1980(1) 4,779 Vice President, Director ( 1.18%) and Cashier, Alma Bank; Director, Banker's Data Services\n(1) Director of Alma Bank (2) Director of Citizens Bank (3) Director of Peoples Bank\nIncluded in shares owned by Olivia Bennett are 175,501 shares owned by Estate of Valene Bennett of which she is the Executrix.\nNone of the directors are a director of a publicly-held corporation which is required to file reports with the Securities and Exchange Commission.\nEach of the Directors and Executive Officers have been engaged in his or her present principal occupation for at least five years. Olivia Bennett is the mother of Paul T. Bennett and Lawrence Bennett. There are no other family relationships between any other Director or Executive Officer. Directors serve until the next annual meeting of shareholders or until their successors are elected and qualified. Officers serve at the pleasure of the Board of Directors.\nItem 11.","section_11":"Item 11. Management Renumeration and Transactions\nThe following information is given as to the cash and cash equivalent forms of renumeration received by South's CEO.\nItem 11. Management Renumeration and Transactions (con't)\nLong-Term Compensation Annual Compensation Awards Payouts (A) (B) (C) (D) (E) (F) (G) (H) (I) Other All Name and Annual Restricted Other Principal Compen- Stock Options\/ LTIP Compen- Position Year Salary Bonus sation Award SARS # Payouts sation Valene Bennett CEO 1995 $ 72,486 $ - $ 8,985 $ - $ - $ - $ - 1994 83,582 - 11,795 - - - - 1993 80,346 - 11,900 - - - - 1992 75,746 - 11,470 - - - - 1991 72,996 - 9,725 - - - -\nPaul T. Bennett CEO 1995 $ 87,566 $ - $ 15,310 $ - $ - $ - $ -\nOlivia Bennett Secretary 1995 $100,857 $ - $ 12,200 $ - $ - $ - $ -\n(1) Does not include fees and dues for clubs and fraternal and civic organizations paid by the Banks to certain officers for business related purposes. Also does not include any amounts for use of an automobile.\nTransactions with Management\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth, as of March 1, 1995, the beneficial ownership of Common Stock of Registrant by the Only \"person\" (as that term is defined by the Securities and Exchange Commission), who owns of record or is known by the Registrant to own beneficially 5% or more of the outstanding shares of Common Stock of the Registrant and by all Executive Officers and Directors of the Registrant as a group.\nNumber of Percent of Shares Owned Outstanding Name Beneficially Shares Estate of Valene Bennett Route 4 Alma, Georgia 31510 175,501 43.27%\nOlivia Bennett Route 4 Alma, Georgia 31510 25,086 6.19%\nAll Executive Officers and Directors as a group (7 persons) 219,384 54.1%\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Banks have had, and expect to have in the future, banking transactions in the ordinary course of business with Directors and Officers of the Banks and their associates, including corporations, partnerships and other organizations in which such Directors and Officers have an interest, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. Such transactions have not involved more than the normal risk of collectibility or presented other unfavorable features.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K Item 14(a) 1. and 3. and Item 14(d)\n(a) The following documents are filed as part of this report:\n1. Financial Statements\n(a) South Banking Company and Subsidiaries: (i ) Consolidated Balance sheet - December 31, 1995 and 1994 (ii ) Consolidated Statement of Income - Year ended December 31, 1995, 1994 and 1993 (iii) Consolidated Statement of Stockholders' Equity - Years ended December 31, 1995, 1994 and 1993 (iv ) Consolidated Statement of Cash Flow - Year ended December 31, 1995, 1994 and 1993\n(b) South Banking Company (Parent Corporation Only): (i ) Balance sheet - December 31, 1995 and 1994 (ii ) Statement of Income - period ended December 31, 1995, 1994 and 1993 (iii) Statement of Stockholders' Equity - Period ended December 31, 1995, 1994 and 1993 (iv ) Statement of Cash Flow - Year ended December 31, 1995, 1994 and 1993\n3. Exhibits required by Item 7 of regulation S-K:\n(3) Articles of Incorporation and By-Laws (included as Exhibits 3(a) and (b), respectively, to Appendix II to Registrant's Registration Statement on Form S-14, File No. 2- 71249, previously filed with the Commission and incorporated herein by reference).\n(13) 1995 Annual Report to Shareholders of South Banking Company (note deemed filed except to the extent that sections thereof are specifically incorporated into this report on Form 10-K by reference).\n(22) List of the Registrant's subsidiaries:\n(1) Alma Exchange Bank & Trust (2) Citizens State Bank (3) Peoples State Bank & Trust (4) Bankers' Data Services, Inc.\nItem 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K (con't)\nAll of the Registrant's subsidiaries were incorporated under the laws of the State of Georgia and are doing business in Georgia under the above names.\n(b) The registrant has not filed a Form 8-K during the last quarter of the period.\n(c) The response to this Item 14(c) is included in item 14(a).\n(d) Financial Statements Schedules - None.\nPOWER OF ATTORNEY\nKnow all men by these present, that each person whose signature appears below constitutes and appoints Valene Bennett, his attorney-in- fact, to sign any amendments to this Report, and to file the same, with exhibits thereto, and other documents in connection therewith. 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 Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: March 26, 1996 Paul T. Bennett Principal Executive, Financial and Accounting Officer and Director\nDate: March 26, 1996 Olivia Bennett Executive Vice President and Director\nDate: March 26, 1996 Charles Stuckey Director\nDate: March 26, 1996 James W. Whiddon Director\nDate: March 26, 1996 Kenneth F. Wade Director\nDate: March 26, 1996 Lawrence Bennett 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.\nSOUTH BANKING COMPANY\nDate: March 26, 1996 By: Paul T. Bennett President, Treasurer and Director\nSUPPLEMENTAL INFORMATION\nThe following supplemental information has not been sent to the Registrant's shareholders, but will be sent subsequent to the filing of this Annual Report on Form 10-K:\n(1) 1995 annual report to shareholders.\n(2) Proxy statement for 1995 annual meeting of shareholders.\nThe foregoing materials will be furnished to the Commission when they are sent to the shareholders since the Registrant does not have securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. The foregoing materials shall not be deemed to be \"filed\" with the Commission or otherwise subject to the liabilities of Section 18 or that Act.\nSOUTH BANKING COMPANY\nALMA, GEORGIA\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors South Banking Company Alma, Georgia 31510\nWe have audited the accompanying consolidated balance sheets of South Banking Company 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. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of South Banking Company at December 31, 1995 and 1994 and the consolidated results of its operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nRespectfully submitted,\nH. H. BURNET & COMPANY February 14, 1996 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEET\nDecember 31, December 31, 1995 1994 ASSETS Cash and due from banks $ 3,989,564 $ 3,447,596\nDeposits in other banks - interest bearing $ 795,000 $ 995,000\nInvestment securities Available for sale $ 8,146,274 $ 4,063,412 Held to maturity - market value of $3,311,955 in 1995 and $4,964,722 in 1994 $ 3,305,576 $ 5,069,898\nPineland State Bank stock - at cost $ 975,141 $ -\nGeorgia Bankers stock $ 272,880 $ 272,880\nFederal Home Loan Bank stock $ 99,900 $ -\nFederal funds sold $13,335,000 $ 8,655,000\nLoans $61,717,437 $57,201,948 Less: Unearned discount ( 82,051) ( 58,622) Reserve for loan losses ( 994,027) ( 974,866))))\n$60,641,359 $56,168,460\nBank premises and equipment $ 3,104,655 $ 3,252,981\nOther assets $ 2,509,399 $ 2,551,300\nTotal Assets $97,174,748 $84,476,527\nLIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits: Demand - non-interest bearing $14,145,230 $14,751,893 Demand - interest bearing 17,098,343 15,350,308 Savings 6,403,438 7,172,540 Time 46,898,446 36,509,016 $84,545,457 $73,783,757 Borrowing 1,976,405 1,292,238 Accrued expenses and other liabilities 604,033 402,755\nTotal Liabilities $87,125,895 $75,478,750\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEET (con't)\nDecember 31, December 31, 1995 1994 Stockholder's Equity Common stock $1 par value; shares authorized - 1,000,000, shares issued and outstanding - 1995 and 1994 - 405,283 and 405,283, respectively $ 405,283 $ 405,283 Surplus 3,136,238 3,136,238 Undivided profits 6,464,741 5,537,253 Unrealized gain (loss) on securities 42,591 ( 80,997)\nTotal Stockholders' Equity $10,048,853 $ 8,997,777\nTotal Liabilities and Stockholders' Equity $97,174,748 $84,476,527\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENT OF INCOME\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 Interest Income Interest and other fees on loans $ 6,995,954 $ 5,666,373 $ 4,972,996 Interest on deposits - interest bearing 40,904 65,241 96,289 Interest on federal funds sold 472,289 305,906 164,160 Interest on investment securities: U. S. Treasury 99,131 113,783 185,308 U. S. Government agencies 273,579 218,222 285,732 Mortgage backed securities 140,159 104,969 135,560 State and municipal subdivisions 58,584 94,106 133,104 Other securities 9,893 - 8,864\nTotal Interest Income $ 8,090,493 $ 6,568,600 $ 5,982,013\nInterest Expense Interest on deposits $ 3,167,719 $ 2,164,062 $ 2,086,070 Interest - other borrowing 146,402 105,313 49,327\nTotal Interest Expense $ 3,314,121 $ 2,269,375 $ 2,135,397\nNet interest income $ 4,776,372 $ 4,299,225 $ 3,846,616 Provision for loan losses 62,200 53,500 118,000\nNet interest income after provision for loan losses $ 4,714,172 $ 4,245,725 $ 3,728,616\nOther Operating Income Service charge on deposits $ 955,791 $ 987,131 $ 982,813 Commission on insurance 63,154 57,169 72,111 Other income 163,583 213,965 215,109 Securities gains (losses) 21,591 6,000 ( 19,133) Data processing fees 167,267 - -\nTotal Other Operating Income $ 1,371,386 $ 1,264,265 $ 1,250,900\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENT OF INCOME (Con't)\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993\nOther Operating Expenses Salaries $ 1,558,381 $ 1,474,463 $ 1,353,968 Profit sharing and other personnel expenses 355,822 228,776 209,242 Occupancy expense of bank premises 269,909 300,586 230,270 Furniture and equipment expense 422,129 242,214 215,573 Stationery and supplies 136,568 124,885 83,721 Data processing 428,979 449,325 277,813 Director fees 103,436 101,405 103,385 Other real estate expenses 30,856 - 115,959 Other expenses 1,039,355 1,193,946 1,175,016\nTotal Other Operating Expenses $ 4,345,435 $ 4,115,600 $ 3,764,947\nIncome before income taxes $ 1,740,123 $ 1,394,390 $ 1,214,569 Applicable income taxes 589,746 405,523 286,472\nNet Income $ 1,150,377 $ 988,867 $ 928,097\nPer share earnings based on weighted average outstanding shares:\nWeighted average outstanding shares 405,283 405,351 408,036\nNet income before extraordinary items $ 2.84 $ 2.44 $ 2.27\nNet Income Per Share $ 2.84 $ 2.44 $ 2.27\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA STATEMENT OF STOCKHOLDERS' EQUITY\nCommon Undivided Stock Surplus Profits Balance, December 31, 1992 $ 408,070 $ 3,181,517 $ 4,009,125 Net income - - 928,097 Cash dividends - - ( 224,438) Redemption of shares ( 2,487) ( 42,279) - Prior year effect of FASB 109 - - 58,508\nBalance, December 31, 1993 $ 405,583 $ 3,139,238 $ 4,771,292 Net income - - 988,867 Cash dividends - - ( 222,906) Redemption of shares ( 300) ( 3,000) - Unrealized gain (loss) on securities available for sale - - -\nBalance, December 31, 1994 $ 405,283 $ 3,136,238 $ 5,537,253 Net income - - 1,150,377 Cash dividends - - ( 222,889) Unrealized gain (loss) on securities available for sale - - -\nBalance, December 31, 1995 $ 405,283 $ 3,136,238 $ 6,464,741\nUnrealized Gain (Loss) on Securities Total Available Stockholders' for Sale Equity\n$ - $ 7,598,712 - 928,097 -) ( 224,438) - ( 44,766)\n- 58,508\n$ - $ 8,316,113 - 988,867 -) ( 222,906) - ( 3,300)\n( 80,997) ( 80,997)\n$( 80,997) $ 8,997,777 - 1,150,377 ) - ( 222,889)\n123,588 123,588\n$ 42,591 $10,048,853\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENT OF CASH FLOWS\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993\nCash Flows From Operating Activities: Net income $ 1,150,377 $ 988,867 $ 893,898 Add expenses not requiring cash: Provision for depreciation and amortization 420,747 370,378 293,085 Provision for loan losses 62,200 53,500 118,000 Provision for loss on ORE 28,110 20,184 18,900 Bond portfolio losses (gains) ( 21,827) ( 4,000) 19,133 (Gain ) loss on sale of premises & equipment ( 1,657) - ( 2,888) Gain on sale of other real estate owned ( 17,718) ( 8,696) 57,524 Increase (decrease) in taxes payable ( 123,457) 128,798 ( 113,368) Increase (decrease) in interest payable 287,865 60,772 ( 58,114) Increase (decrease) in other liabilities 36,870 ( 17,769) ( 354,644) (Increase) decrease in interest receivable ( 73,925) ( 32,245) 87,043 Decrease (increase) in prepaid expenses 53,186 16,910 ( 17,806)) (Increase) decrease in other assets ( 224,305) ( 143,099) ( 76,356) Recognition of unearned loan income 21,887 ( 7,688) 1,811\nNet Cash Provided From Operating Activities $ 1,598,353 $ 1,425,912 $ 866,218\nCash Flows From Investing Activities: Proceeds from sales of investment securities $ 979,156 $ - $ 138,441 Proceeds from maturities of securities held to maturity 2,533,844 1,459,013 5,493,387 Purchase of securities held to maturity (1,596,546) (2,036,708) (3,074,287))\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENT OF CASH FLOWS (con't)\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 Cash Flows From Investing Activities: (con't) Net loans to customers $(4,694,955) $(6,841,156) $(4,816,495) Proceeds from maturity of securities available for sale 786,703 2,844,514 - Purchase of securities available for sale (4,849,104) (1,016,502) - Purchase of premises and equipment ( 273,546) (1,011,428) ( 538,725)) Proceed from sale of premises and equipment 4,911 - 5,300 Proceeds from sale of other real estate owned 385,215 248,439 565,473 Purchase of Pineland Bank stock ( 975,141) - - Purchase of FHLB stock ( 99,900) - -\nNet Cash Provided from Investing Activities $(7,799,363) $(6,353,828) $(2,226,906)\nCash Flows From Financing Activities: Net increase (decrease) in demand deposits, NOW and money markets $ 1,141,372 $ 414,207 $ 3,213,608 Net increase in savings and time deposits 9,620,328 3,743,262 (4,339,880) Proceeds from borrowing 825,000 650,000 - Payments on borrowing ( 140,833) ( 107,762) ( 25,000) Dividends paid ( 222,889) ( 222,906) ( 224,438) Payments to retire stock - ( 3,300) ( 44,766)\nNet Cash Provided From Financing Activities $11,222,978 $ 4,473,501 $(1,420,476)\nNet increase (decrease) in cash and cash equivalents $ 5,021,968 $( 454,415) $(2,781,164)\nCash and Cash Equivalents at Beginning of Year 13,097,596 13,552,011 16,333,175\nCash and Cash Equivalents at End of Year $18,119,564 $13,097,596 $13,552,011\nThe accompanying notes are an integral part of these financial statements.\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 1. Significant Accounting Policies\nThe accounting and reporting policies of South Banking Company, Inc. and its subsidiaries conform with generally accepted accounting principles and with practices within the banking industry.\n(a) Basis of Presentation\nDuring 1990, Georgia Peoples Bankshares, Inc. was merged with South Banking Company. The transaction was accounted for using the purchase method.\n(b) Securities:\nThe Bank adopted FASB 115 effective January 1, 1994. The Bank's investments in securities are classified in two categories and accounted for as follows.\nSecurities to be Held to Maturity. Bonds, 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 in interest income using the interest method over the period to maturity.\nSecurities Available for Sale. Securities available for sale consist of bonds, notes, debentures and certain equity securities not classified as trading securities or as securities to be held to maturity.\nDeclines in fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary have resulted in write-downs of the individual securities to their fair value. The related write-downs have been included in earnings as realized losses.\nUnrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in a separate component of shareholders' equity until realized.\nGains and losses on the sale of securities available-for- sale are determined using the specific-identification method.\n(c) Revenue Recognition:\nInterest on loans is accrued and credited to operations based upon the principal amount outstanding. Amortization of premiums on loans has been deducted from and accretion of\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 1. Significant Accounting Policies (con't)\n(c) Revenue Recognition (con't):\ndiscounts on loans has been added to the related interest income. Nonrefundable loan fees are deferred and recognized as income over the life of the loan as an adjustment of the yield. The 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 credited to 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 is sufficient to cover the principal balance and accrued interest.\n(d) Allowances for Loan Losses:\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 and international economic conditions, volume, growth and composition of the loan portfolio and other relevant factors. The allowance is increased by provisions for loan losses charged against income.\n(e) Premises and Equipment:\nPremises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is computed generally by the straight-line method.\n(f) Other Real Estate (ORE)\nReal estate acquired in satisfaction of a loan and in- substance foreclosures are reported in other assets. In- substance foreclosures are properties in which a borrower with little or no equity in the collateral, effectively abandons control of the property or has no economic interest to continue involvement in the property. The borrower's ability to rebuild equity based on current financial conditions also is considered doubtful. Properties acquired by foreclosure or deed in lieu of foreclosure and properties classified as in-substance foreclosures are transferred to ORE and recorded at the lower of cost or fair market value based on appraised value at the\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 1. Significant Accounting Policies (con't)\n(f) Other Real Estate (ORE) (con't)\ndate actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Losses on ORE due to subsequent valuation adjustments are recorded on a specific property basis.\n(g) Income Taxes\nFor income tax purposes, the bank provides for the maximum deduction for depreciation, loan loss reserves and other timing differences which may differ from the amounts shown on the financial statements. Deferred income taxes have been provided on these timing differences. The FASB recently issued pronouncement on accounting for income taxes which require a change to the liabilities method for accounting for deferred taxes. The statement includes several other provisions that may affect the bank's accounting for income taxes and allows restatement of as many years as deemed appropriate. The bank adopted the new statement which required a cumulative effect adjustment of $97,693 in 1993.\nThe bank files a consolidated federal income tax return with its subsidiaries. Each subsidiary provides for income taxes on a separate return basis and remits to the parent company amounts determined to be currently payable.\n(h) Earnings Per Share\nEarnings per share are based on the weighted average number of shares outstanding.\n(i) Cash Flow Information\nFor purposes of the statements of cash flows, the Company considers cash, federal funds sold and due from banks as cash and cash equivalents. Cash paid during the years ended December 31, 1995, 1994 and 1993 for interest was $3,026,256, $2,187,432 and $2,222,440, respectively. Total income tax payments during 1995, 1994 and 1993 were $666,401, $287,000 and $416,320, respectively.\nNote 2. Investment Securities\nThe amortized cost and estimated market values of investments in debt securities are as follows:\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 2. Investment Securities (con't)\nGross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities available for sale -\nDecember 31, 1995:\nU.S. Government and agency securities $5,150,304 $ 36,239 $ 6,588 $5,179,955 State and municipal securities 1,521,554 13,605 - 1,535,159 Mortgage backed securities 1,409,879 21,281 - 1,431,160\nTotals $8,081,737 $ 71,125 $ 6,588 $8,146,274\nDecember 31, 1994:\nU.S. Government and agency securities $3,050,739 $ 1,601 $ 94,996 $2,957,344 State and municipal securities - - - - Mortgage backed securities 1,135,395 - 29,327 1,106,068\nTotals $4,186,134 $ 1,601 $ 124,323 $4,063,412\nSecurities to be held to maturity -\nDecember 31, 1995:\nU.S. Government and agency securities $2,453,740 $ 10,798 $ 11,039 $2,453,499 State and municipal securities 386,148 6,875 - 393,023 Mortgage backed securities 465,688 1,167 1,422 465,433\nTotals $3,305,576 $ 18,840 $ 12,461 $3,311,955\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 2. Investment Securities (con't)\nGross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value\nSecurities to be held to maturity - (con't)\nDecember 31, 1994:\nU.S. Government and agency securities $2,992,366 $ - $ 90,759 $2,901,607 State and municipal securities 1,118,173 7,860 31 1,126,002 Mortgage backed securities 959,359 869 23,115 937,113\nTotals $5,069,898 $ 8,729 $ 113,905 $4,964,722\nGross realized gains on sales of available-for-sale securities were $21,591 in 1995.\nAssets, principally securities carried at approximately $3,972,330 at December 31, 1995 and $4,117,665 at December 31, 1994, were pledged to secure public deposits and for other purposes required or permitted by law.\nThe scheduled maturities of securities to be held to maturity and securities available for sale at December 31, 1995 were as follows:\nSecurities to be Securities Held to Maturity Available for Sale Amortized Amortized Cost Fair Value Cost Fair Value Due in one year or less $ 464,153 $ 464,557 $1,997,524 $2,002,029 Due from one year to five years 2,402,812 2,405,396 3,725,090 3,739,506 Due from five years to ten years 302,334 303,641 1,241,204 1,261,815 Due after ten years 136,277 138,361 1,117,917 1,142,924\n$3,305,576 $3,311,955 $8,081,735 $8,146,274\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 2. Investment Securities (con't)\nThe market value of State and Other Political Subdivision Obligations is established with the assistance of an outside bond department and is based on available market data which often reflects transactions of relatively small size and is not necessarily indicative of prices at which large amounts of particular issues could readily be sold or purchased.\nNote 3. Loans\nThe composition of the bank's portfolio was as follows:\n1995 1994 Commercial, financial and agricultural $14,591,725 $13,228,952 Real estate - mortgage 36,426,397 32,792,117 Real estate - construction 1,767,423 2,347,157 Installment and consumer 8,931,892 8,833,722 Total Loans $61,717,437 $57,201,948 Less: Unearned discount ( 82,051) ( 58,622)) Reserve for loan losses ( 994,027) ( 974,866))\nLoans, net $60,641,359 $56,168,460\nThe Company and its subsidiaries have granted loans to the officers and directors of the Company, its subsidiaries and to their associates. Related party loans are made on substan- tially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $525,535 and $590,102 at December 31, 1995 and 1994. During 1995, $149,545 of new loans were made, and repayments totaled $188,399.\nNote 4. Reserve for Loan Losses\nTransactions in the reserve for loan losses are summarized as follows: SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 4. Reserve for Loan Losses (con't)\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993\nBalance at beginning of period $ 974,866 $ 911,931 $ 738,578 Additions: Provision charged to operating expenses $ 62,200 $ 53,500 $ 118,000\nDeductions: Loans charged off $ 189,371 $ 92,986 $ 82,979 Less: recoveries 146,332 102,421 138,332\n$ 43,039 $( 9,435) $( 55,353)\nBalance at end of period $ 994,027 $ 974,866 $ 911,931\nAdditions to the reserve for loan losses are based on management's evaluation of the loan portfolio under current economic conditions, past loan loss experience and such other factors which, in management's judgment, deserve recognition in estimating loan losses. Loans are charged off when, in the opinion of management, such loans are deemed to be uncollectible. Recognized losses are charged to the reserve and subsequent recoveries added.\nNote 5. Deposits\nThe aggregate amount of short-term jumbo CDs, each with a minimum denomination of $100,000, was approximately $9,268,553 in 1995. At December 31, 1995, the scheduled maturities of CDs are as follows:\n1996 $ 38,310,333 1997 5,871,753 1998 2,248,485 1999 467,875 2000 and thereafter -\n$ 46,898,446\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 6. Premises and Equipment\nA summary of the account: Year Ended Year Ended December 31, December 31, 1995 1994 Land $ 393,148 $ 393,148 Buildings 2,345,562 2,348,036 Furniture and equipment 3,306,840 3,100,892 $ 6,045,550 $ 5,842,076 Less: Accumulated depreciation 2,940,895 2,589,095\n$ 3,104,655 $ 3,252,981\nDepreciation expense was $418,618 in 1995, $315,743 in 1994, and $248,616 in 1993.\nNote 7. Borrowings\nData relating to borrowing is as follows:\nYear Ended Year ended December 31, December 31, 1995 1994 Parent company -\nLine of credit loan in the amount of $3,675,000 for the purpose of refinancing existing loan and the acquisition of Pineland Bank stock. Interest only due until 1-31-97 at which time annual payment of 10% of original loan will be payable over ten years. Interest accrues at the prime rate basis and is paid quarterly. Additional draws on note in 1996 will increase outstanding balance to $3,100,000. $ 1,500,000 $ -\nPayable in nine equal annual principal payments beginning December 31, 1995. Interest accrues at prime rate basis and is paid quarterly - 675,000\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 7. Borrowings (con't) Year Ended Year ended December 31, December 31, 1995 1994 Subsidiary - Bankers Data Services, Inc.\nNote payable in 60 monthly principal amount of $10,833.33 plus interest. Interest accrues at prime rate basis $ 476,405 $ 542,238\nNote 8. Income Taxes\nIncome tax expense (benefit) was $589,746 for 1995, (an effective rate of 33.9%), $405,523 for 1994 (an effective rate of 29.1%) and $286,472 for 1993 (an effective rate of 23.6%). The actual expense for 1995, 1994 and 1993 differs from the \"expected\" tax expense for those years (computed by applying the federal corporate rate of 34% as follows:\n1995 1994 1993 Computed \"expected\" tax expenses $ 591,642 $ 474,093 $ 412,953 Alternative minimum tax - - ( 34,199) Decrease resulting from: Surtax exemption - - - Tax exempt interest on securities and loans ( 39,927) ( 42,804) ( 74,976) Other, net 38,031 ( 25,766) ( 17,306)\n$ 589,746 $ 405,523 $ 286,472\nThe current and deferred amounts of these tax provisions were as follows:\n1995 1994 1993\nCurrent $ 481,329 $ 425,551 $ 306,906 Deferred 108,417 ( 20,028) ( 20,434)\n$ 589,746 $ 405,523 $ 286,472\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 8. Income Taxes (con't)\nThe tax effects of each type of income and expense item that gave rise to deferred taxes are: December 31 December 31,, 1995 1994 Net unrealized appreciation on securities available for sale $( 21,942) $ 41,725 Depreciation ( 160,633) ( 122,875) Deferred loan fees 25,417 18,608 Allowance for credit losses 140,801 158,803 Other 6,768 2,567\nNet deferred tax asset (liability) $( 9,589) $ 98,828\nNote 9. Employee Benefit Plans\nThe Company maintains a 401K deferred compensation plan for all subsidiaries effective January 1, 1993. The Company elected to match 50% of employee contributions for 1995, 1994 and 1993. The expense to the Company for 1995, 1994 and 1993 was $32,256, $29,457 and $27,380, respectively.\nNote 10. Commitments and Contingent Liabilities\nIn the normal course of business, the Company offers a variety of financial products to its customers to aid them in meeting their requirements for liquidity, credit enhancement and interest rate protection. Generally accepted accounting principles recognize these transactions as contingent liabilities and, accordingly, they are not reflected in the accompanying financial statements. Following is a discussion of these transactions.\nStandby Letters of Credit. These transactions are used by the Company's customers as a means of improving their credit standing in their dealings with others. Under these agreements, the Company agrees to honor certain financial commitments in the event that its customers are unable to do so. As of December 31, 1995 the Company had $392,000 in outstanding standby letters of credit.\nLoan Commitments. As of December 31, 1995, the Company had commitments outstanding to extend credit totaling $4,921,085. These commitments generally require the customers to maintain certain credit standards. Management does not anticipate any material losses as a result of these commitments.\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 11. Restrictions on Subsidiary Dividends, Loans or Advances\nDividends are paid by the Company from its assets which are mainly provided by dividends from the Banks. However, certain restrictions exist regarding the ability of the Banks to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the Georgia Department of Banking is required to pay dividends in excess of 50% of the Bank's net profits for the prior year.\nUnder Federal Reserve regulation, the Bank also is limited as to the amount it may loan to its affiliates, including the Company, unless such loans are collateralized by specified obligations. At December 31, 1995, the maximum amount available for transfer from the Bank to the Company in the form of loans approximated 20% of consolidated net equity.\nNote 12. Restrictions on Cash and Due from Banks\nThe bank is required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the year ended December 31, 1995 was approximately $-0-.\nNote 13. Related Party Transactions\nThe Company has entered into a split dollar life insurance arrangement with a director and substantial shareholder. The Company and director's trust each contribute toward the payment of premium for life insurance policy. The Company records its contribution at the present value of anticipated future return or total cash surrender value of policy whichever is higher; however, the carrying amount cannot exceed the amount of premiums paid by the Company. The Company will receive all reimbursement from anticipated withdrawal of cash surrender value or from the proceeds of policy in the event of the death of the director. All cash surrender value of the policy accrues to the benefit of the Company until such time as the cash surrender value exceeds advances made by the Company. As of December 31, 1995, $985,175 is carried in other assets related to this arrangement.\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 14. Fair Value of Financial Instruments\nThe following table shows the estimated fair value and the related carrying values of South Banking Company's financial instruments at December 31, 1995. Items which are not financial instruments are not included. Carrying Estimated Amount Fair Value Cash and due from financial institutions $ 3,989,564 $ 3,989,564 Interest earning balances with financial institutions 795,000 795,000 Federal funds 13,335,000 13,335,000 Securities available for sale 8,146,274 8,146,274 Securities held to maturity 3,305,576 3,311,955 Federal Home Loan Bank stock 99,900 99,900 Georgia Bankers Bank - stock 272,880 307,500 Loans - net of allowances 60,641,359 59,901,705 Demand and savings deposits 37,647,011 37,647,011 Individual retirement account deposits 6,573,568 6,669,710 Time deposits 40,324,878 40,720,301\nFor purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 1995. The estimated fair value for cash and due from financial institutions and federal funds sold are considered to approximate cost. The estimated fair value for interest-earning balances with financial institutions, securities available-for- sale, securities held-to-maturity and Georgia Bankers Bank stock are based on quoted market values for the individual securities or for equivalent securities. The estimated fair value for commercial loans is based on estimates of the difference in interest rates the Company would charge the borrowers for similar such loans with similar maturities made at December 31, 1995, applied for an estimated time period until the loan is assumed to reprice or be paid. The estimated fair value for other loans is based on estimates of the rate the Company would charge for similar such loans at December 31, 1995, applied for the tie period until estimated repayment. The estimated fair value for individual retirement account deposits and time deposits is based on estimates of the rate the Company would pay on such deposits or borrowings at December 31, 1995, applied for the time period until maturity. The estimated fair value for other financial instruments and off-balance-sheet loan commitments are considered to approximate cost at December 31, 1995.\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 14. Fair Value of Financial Instruments (con't)\nWhile these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of such items at December 31, 1995, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 1995 should not necessarily be considered to apply at subsequent dates.\nIn addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in the financial statements nevertheless may have value but are not included in the above disclosures. These include among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the trained work force, customer goodwill and similar items.\nNote 15. Regulatory Matters\nThe Company and its subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities and certain off- balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.\nQuantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1995, that the Company and its subsidiaries meet all capital adequacy requirements to which it is subject.\nSOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nNote 15. Regulatory Matters (con't)\nSubsequent Events\nOn January 11, 1996, South Banking Company consummated an agreement to acquire the stock of Pineland State Bank for cash. The total acquisition cost was $2,745,716. Funding for the acquisition was through a loan from Georgia Bankers Bank.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY)\nALMA, GEORGIA\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors South Banking Company Alma, Georgia 31510\nUnder date of January 21, 1996, we reported on the consolidated balance sheets of South Banking Company, as of December 31, 1995 and 1994, and the related statements of income, cash flows and stockholders' equity for the three years in the period ended December 31, 1995.\nIn connection with our examination of the aforementioned consolidated financial statements, we also audited the accompanying balance sheets (Parent Corporation Only) as of December 31, 1995 and 1994 and the related statements of income, cash flows and stockholders' equity 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 audit.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 financial statements referred to above present fairly, in all material respects, the financial position of South Banking Company (Parent Corporation Only) as of December 31, 1995 and 1994, and the results of its operations, stockholders' equity and their cash flows for the three years then ended in conformity with generally accepted accounting principles.\nRespectfully submitted,\nH. H. BURNET & COMPANY, P. C. February 14, 1996 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA BALANCE SHEET\nDecember 31, December 31, 1995 1994\nASSETS Cash and due from banks Interest bearing $ 290,640 $ 265,846 Non-interest bearing 301,582 12,268 Investment in bank's subsidiaries 9,724,449 9,160,147 Investment in nonbank subsidiaries 177,408 127,386 Investment - Pineland State Bank - at cost 975,141 - Other assets 17,314 19,935 Costs in excess of book value 8,620 15,345 Due from subsidiaries - income taxes 10,150 151,931 Prepaid income taxes 45,793 -\nTotal Assets $11,551,097 $ 9,752,858\nLIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 2,244 $ 2,416 Other liabilities - - Accrued income taxes - 77,665 Notes payable 1,500,000 675,000 Due to subsidiaries - -\nTotal Liabilities $ 1,502,244 $ 755,081\nStockholders' Equity Common stock of $1 par value; authorized 1,000,000 shares; issued and outstanding, 1995 and 1994 $405,283 and 405,283, respectively $ 405,283 $ 405,283 Surplus 3,136,238 3,136,238 Undivided profits 6,464,741 5,537,253 Unrealized gain (loss) on securities available for sale (net) 42,591 ( 80,997)\nTotal Stockholders' Equity $10,048,853 $ 8,997,777\nTotal Liabilities and Stockholders' Equity $11,551,097 $ 9,752,858\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF INCOME\nYear Ended Year Ended Year Ended December 31 December 31, December 31,, 1995 1994 1993 Income Dividends from bank subsidiaries $ 773,430 $ 543,805 $ 445,249 Other dividends - - - Interest income 11,692 6,690 3,018 Management fees 79,400 79,200 79,200 Loss on sale of stock - - ( 19,710)\nTotal Income $ 864,522 $ 629,695 $ 507,757\nExpenses Salaries $ 73,163 $ 56,746 $ 54,996 Amortization 6,726 6,726 6,726 Interest 87,051 56,954 49,327 Professional fees 46,079 16,084 21,400 Other 49,527 40,560 47,251\nTotal Expenses $ 262,546 $ 177,070 $ 179,700\nIncome before income taxes and equity in undistributed income (loss) of subsidiaries $ 601,976 $ 452,625 $ 328,057\nProvision (credit) for income taxes ( 57,665) ( 27,700) ( 37,559)\nIncome before equity in undistributed income in subsidiaries $ 659,641 $ 480,325 $ 365,616\nEquity in undistributed income of bank subsidiaries $ 440,715 $ 597,787 $ 570,850 Equity in undistributed income (loss) of nonbank subsidiaries 50,021 ( 89,245) ( 8,369)\n$ 490,736 $ 508,542 $ 562,481\nNet Income $ 1,150,377 $ 988,867 $ 928,097\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF STOCKHOLDERS' EQUITY\nCommon Undivided Stock Surplus Profits Balance, December 31, 1992 $ 408,070 $ 3,181,517 $ 4,009,125 Net income - - 928,097 Cash dividends - - ( 224,438) Redemption of shares ( 2,487) ( 42,279) - Prior year effect of FASB 109 - - 58,508\nBalance, December 31, 1993 $ 405,583 $ 3,139,238 $ 4,771,292 Net income - - 988,867 Cash dividends - - ( 222,906) Redemption of shares ( 300) ( 3,000) - Unrealized gain (loss) on securities available for sale - - -\nBalance, December 31, 1994 $ 405,283 $ 3,136,238 $ 5,537,253 Net income - - 1,150,377 Cash dividends - - ( 222,889) Unrealized gain (loss) on securities available for sale - - -\nBalance, December 31, 1995 $ 405,283 $ 3,136,238 $ 6,464,741\nUnrealized Gain (Loss) on Securities Total Available Stockholders' for Sale Equity\n$ - $ 7,598,712 - 928,097 -) ( 224,438) - ( 44,766)\n- 58,508\n$ - $ 8,316,113 - 988,867 -) ( 222,906) - ( 3,300)\n( 80,997) ( 80,997)\n$( 80,997) $ 8,997,777 - 1,150,377 ) - ( 222,889)\n123,588 123,588\n$ 42,591 $10,048,853\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993\nCash Flows From Operating Activities: Net income $ 1,150,377 $ 988,867 $ 928,097 Add expenses not requiring cash Depreciation and amortization 13,501 12,938 13,949 Undistributed earnings of subsidiaries ( 490,736) ( 508,542) ( 562,481) Increase (decrease) in accounts payable ( 172) 172 208 Increase (decrease) in other liabilities - ( 427) 171 Increase (decrease) in accrued income taxes ( 77,665) ( 9,068) - Increase (decrease) in other assets ( 4,155) ( 473) 134,507 Increase (decrease) in prepaid income taxes ( 45,793) - - Increase (decrease) in due from subsidiary - taxes 141,781 - -\nNet Cash Used in Operating Activities $ 687,138 $ 483,467 $ 514,451\nCash Flows From Investing Activities: Basis in investments sold $ - $ - $ 64,476 Contribution to equity in nonbank subsidiary - ( 125,000) ( 100,000) Purchase of equipment - - ( 931) Purchase of Pineland State Bank ( 975,141) - -\nNet Cash Used in Investing Activities $( 975,141) $( 125,000) $( 36,455)\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS\nYear Ended Year Ended Year Ended December 31, December 31, December 31, 1995 1994 1993 Cash Flow From Financing Activities: Payments on note payable bank $ - $( 75,000) $(1,220,000) Proceeds from notes payable to banks 825,000 - 1,195,000 Dividends paid ( 222,889) ( 222,906) ( 224,438) Increase (decrease) in due to subsidiaries - - - Redemption of common stock - ( 3,300) ( 44,766)\nNet Cash Provided (Used) from Financing Activities $ 602,111 $( 301,206) $( 294,204)\nNet increase (decrease) in cash and cash equivalents $ 314,108 $ 57,261 $ 183,792 Cash and cash equivalents at beginning of year 278,114 220,853 37,061\nCash and Cash Equivalents at End of Year $ 592,222 $ 278,114 $ 220,853\nThe accompanying note is an integral part of these financial statements.\nSOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS\n(A) Summary of Significant Accounting Policies\nGeneral - The following notes to the financial statements of South Banking Corporation, formed on July 28, 1981, (parent corporation only) (the corporation) includes only that information which is in addition to information presented in the consolidated financial statements and notes to consolidated financial statements.\nInvestment in subsidiaries - The corporation reports its investment in the common stock of its subsidiaries at its equity in the net assets of the subsidiaries.\nOrganization costs - Organization costs have been deferred and are being amortized on a straight-line basis over a period of five years.","section_15":""}
{"filename":"319085_1995.txt","cik":"319085","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENTS\nCompression Labs, Incorporated (the Company or CLI(R)), incorporated in California in December 1976 and reincorporated in Delaware in October 1987, is a leader in the development, manufacture and marketing of visual communication systems based on Compressed Digital Video (CDV(TM)) technology. The Company's systems use proprietary and industry standard algorithms to compress the amount of data required to transmit digital video and audio signals, thereby significantly reducing the cost of transmitting these signals over terrestrial, microwave, cable or satellite networks. The Company's strategy has been to use its expertise in CDV technology to enhance its leadership position in videoconferencing, to develop a leadership position in the emerging broadcast and cable markets, and to monitor new markets such as the desktop and personal video markets.\nIn November 1995, the Company conducted a strategic review of its position in both the videoconferencing and broadcast and cable markets, and its ongoing prospects in these markets. As a result of this review, the Company adopted a plan to discontinue operations of its Broadcast products division and to refocus its efforts and resources on developing and marketing group and desktop videoconferencing products. The Company has held discussions with various companies regarding the possible sale of the broadcast products division. No definitive agreement has been reached, nor can there be any assurances that an agreement with terms acceptable to the Company will ultimately be reached. Unless noted otherwise, this Annual Report on Form 10-K pertains to the Company's continuing operations.\nCLI's group and desktop videoconferencing systems permit users at different locations to conduct full-color, motion videoconferences ranging from two-way informal meetings between individuals to formal meetings between large groups at multiple locations. The Company's present families of videoconferencing systems include Rembrandt(R) II\/VP and Radiance(TM) videoconferencing systems, the eclipse family of mid-range videoconferencing systems, and the CLI Desktop Video family. The Rembrandt II\/VP and Radiance videoconferencing systems operate worldwide over a broad range of transmission speeds from 56 kilobits per second (kbps) to 2.048 megabits per second (mbps). The eclipse mid-range videoconferencing systems and CLI desktop video products operate worldwide over readily available public switched digital networks at speeds up to 384 kbps. All of CLI's current videoconferencing systems are compliant with the International Telecommunication Union Telecommunication Standardizations Sector (TSS) H.320 videoconferencing standard, and most also provide customer-selectable proprietary algorithms. The Company has grown as a result of improvements in the price\/performance of its videoconferencing systems, decreases in transmission costs and increased availability of switched digital transmission services. However, there can be no assurance that this revenue growth will continue in the future.\nIn November 1991, the Company introduced the SpectrumSaver(TM), the industry's first compressed digital product for the satellite broadcast video market. The SpectrumSaver allows simultaneous transmission of as many as 15 channels on a single satellite transponder, reducing costs and increasing programming availability for applications such as business television, distance learning and satellite news gathering. Through a number of industry-related partnerships and alliances, CLI had been moving into other broadcast applications: direct broadcast satellite services, which deliver hundreds of channels of entertainment and information directly to homes through the use of satellite dishes; video-on- demand, offering dial-up access to movies, live sports, and other entertainment over copper or fiber-optic telephone lines or coaxial cable, cable head-end applications that supply programming to distribution sites, and traditional commercial television broadcast applications. To ensure broad compatibility worldwide, the products used for these services are based on MPEG-1 and MPEG-2 video and audio standards from the Moving Picture Experts Group (MPEG). This technology is used in the broadcast products division, now part of the Company's discontinued operations.\nCLI has concentrated on developing enhancements to the MPEG-based Magnitude(TM) product family which will differentiate these products from other standards-based products. In 1996, CLI was granted a patent for statistical multiplexing of multiple MPEG-compressed video signals, allowing multiple MPEG-video signals to share the entire bandwidth of the transmission channel by dynamically allocating more bandwidth to the signals that are more difficult to encode. This results in improved picture quality and allows higher compression ratios. This technology is used in the broadcast products division, now part of the Company's discontinued operations.\n- -------------------- (TM)CDV, Radiance, SpectrumSaver, and Magnitude are trademarks of Compression Labs, Incorporated. (R)Rembrandt is a registered trademark of Compression Labs, Incorporated This Form 10-K also contains the trademarks of other companies.\nINDUSTRY BACKGROUND\nOver the past two decades, the advent of compressed digital video technology has enabled the development of cost effective products for the growing videoconferencing market, increasing productivity and decreasing costs by enhancing the effectiveness of business communication.\nDecision making in today's competitive business environment demands accurate and timely exchange of information by individuals and groups, often at distant locations. Telephones and facsimile machines have become essential business tools by providing communication in convenient and inexpensive formats. In many situations, however, information cannot be transferred effectively by telephone or in writing, and more natural face-to-face communication is necessary. A substantial portion of business travel today is undertaken in order to permit such face-to- face communication. The Company believes that the utilization of visual communication systems, such as videoconferencing systems, has enhanced productivity by allowing meaningful and timely face-to-face contact, and has lowered costs by reducing business travel.\nThe concept of visual communications was introduced in 1964 at the New York World's Fair when AT&T exhibited a prototype of its picturephone. At that time, however, videoconferencing was commercially impractical because transmitting uncompressed video signals was prohibitively expensive for business users. In the late 1970s, the first video compression system, called a \"codec\" (coder-decoder), was introduced. The market acceptance of early videoconferencing systems was limited because of high hardware and transmission costs, and the limited availability of transmission facilities. The first companies to adopt videoconferencing utilized dedicated private networks established expressly for videoconferencing.\nSignificant progress was made in the early 1980s in addressing many of the problems associated with early videoconferencing efforts. A major advance in transmission cost reduction was achieved by CLI with the introduction in 1982 of a codec which provided the first economical means to communicate effectively over standard networks at a transmission rate (bandwidth) of 1.544 mbps, the standard T1 transmission rate, a reduction of approximately 60:1 from the 90 mbps bandwidth required to transmit uncompressed video signals. This lower bandwidth significantly reduced transmission costs and permitted transmission over available terrestrial, microwave, cable and satellite channels.\nSince the mid-1980s, driven primarily by competition among telecommunication carriers, the cost of transmission services has continued to decrease significantly. During this same period, the availability of private networks and switched services increased dramatically. Switched digital transmission services are now available in most U.S. metropolitan areas. Advances in compressed digital video technology during this period also resulted in the introduction of products with improved picture and audio quality. In the mid-1980s, video compression systems were introduced that operated at transmission rates below the standard T1 rate, although these low bandwidth systems often failed to achieve picture quality acceptable to most users. By the late 1980s, continued improvements in video compression technology and the increasing availability of public switched services at bandwidths up to 384 kbps had resulted in increased user acceptance of videoconferencing.\nCollectively, the dramatic decreases in transmission costs, the increased availability of switched digital services for both domestic and international networks, the improvements in picture quality and the adoption of worldwide standards have made global videoconferencing at various bandwidths increasingly practical and cost effective. Many of these factors have also created opportunities for application of CDV technology in the developing desktop and personal video markets.\nWhile CDV technology has found significant application in two-way business communication for more than a decade, this technology has only recently begun to be implemented to reduce the transmission cost and improve the availability and audio and video quality of one-way broadcast video programming. Until recently, almost all television broadcasts relied on analog technology, which requires substantial transmission capacity, or bandwidth. Digitizing and compressing video and audio signals reduces the amount of data which must be transmitted in order to achieve desired quality, thus allowing broadcasters to transmit high quality video and audio television programs on a telephone line or to simultaneously transmit a number of programs over a satellite transponder or coaxial or fiber-optic cable. Digitization and compression of video improves picture and sound quality by eliminating noise and distortion typical in transmission of analog signals, and allows video programming to be stored economically on video servers, where it is readily accessible. These technical and economic advantages of CDV compared to traditional analog technology are important factors underlying the acceptance of CLI's SpectrumSaver broadcast products for business use. The Company's Magnitude product line of high-quality, MPEG-based encoders and decoders is currently being used for digital broadcast utilizing satellite, cable, and telephone network-based transmission for the home entertainment and education markets.\nCLI STRATEGY\nThe Company is a leader in video compression technology and believes that its large worldwide installed base of videoconferencing systems affords the Company significant competitive advantages. The Company's strategy is to strengthen its position as a leading supplier of a full range of premium quality group and desktop videoconferencing systems. The Company's strategy includes several key elements:\nTechnology Leadership\nCLI has pioneered video compression technology and continues to develop videoconferencing systems with enhanced picture and audio quality and features at lower costs.\nBroad Range of Videoconferencing Products\nCLI has one of the broadest product lines in the videoconferencing industry, spanning a wide range of market applications and operating at transmission rates from 56 kbps to 2.048 mbps. The Company believes supplying a full range of products to satisfy a customer's complete video communication needs will be important to its future success.\nCompliance with Industry Standards\nCLI believes that the adoption of industry standards will further the expansion of the worldwide videoconferencing market by allowing systems from different manufacturers to communicate with one another. The Rembrandt II\/VP, Radiance, eclipse, and CLI Desktop Video product families all conform with the TSS H.320 videoconferencing standard that allows communication with CLI and other vendors' products through industry standard communication modes. The group system families provide a user-selectable option that allows enhanced video when communicating with other CLI systems through the Company's proprietary communication modes.\nCLI TECHNOLOGY\nCLI has been a leader in the evolution of digital video compression technology for videoconferencing and broadcast products since the inception of these markets. CLI's development efforts are primarily directed at achieving greater levels of compression, improving picture quality and system functionality, continuing to reduce system costs, and supporting and improving industry standards. The Company's continued success in its chosen markets is dependent in part on the results of its ongoing technology and product development efforts.\nEarly codecs, introduced in the late 1970s, used a technique called interframe coding that achieved compression by measuring differences between frames and transmitting only those differences, refreshing the unchanged elements in the frame from memory. Interframe coding is useful in scenes where there is limited motion, but can cause image degradation, such as blurring or jerkiness, in scenes that contain significant motion. This technique required a high rate of transmission to overcome its inherent limitations in motion sequences.\nIn 1982, CLI developed the first videoconferencing system that operated at T1 rates incorporating a proprietary algorithm utilizing intraframe coding. Intraframe coding does not measure differences between frames, but rather achieves compression by breaking each individual frame into blocks and assigning bits to each block based on the complexity of the scene in that block. Although intraframe coding causes a slight degradation of detail resolution in a picture, it maintains picture quality independent of the amount of motion in the picture. This algorithm technique was based on Discrete Cosine Transform (DCT) technology.\nIn 1984, CLI introduced the first sub-T1 algorithm combining both interframe and intraframe technology. This proprietary algorithm, known as Differential Transform Coding (DXC), combined the positive aspects of both intraframe and interframe coding by using intraframe coding for blocks with high motion and interframe coding for blocks with little or no motion. DXC allowed transmission with minimal picture quality degradation at transmission rates as low as 384 kbps.\nIn 1987, CLI introduced a product which achieved transmission rates as low as 56 kbps by adding motion compensation to the techniques pioneered in earlier codecs. Motion compensation was an advancement in interframe techniques that allowed detection and coding of the portions of the picture which are in motion.\nIn 1990, CLI introduced a new proprietary algorithm called Cosine Transform Extended (CTX(TM)), a further enhancement of the DCT technology which improved picture quality and motion handling techniques. In 1991, CLI announced the CTX Plus(TM) algorithm which significantly improved picture resolution and increased frame rates at transmission rates of 384 kbps and above, thereby providing near-broadcast image quality. The Company's Radiance and Rembrandt II\/VP families of large group videoconferencing products incorporate the CTX and CTX Plus algorithms, as well as the TSS H.261 standard. The eclipse 8200, 8300 and gold models are fully compliant with the most recent TSS standards, and have transmission speeds ranging from 56 kbps to 384 kbps.\nDCT technology has been the basis of all CLI products since 1982. The DCT technology has been adapted as the foundation of the international H.261 standard, as well as the evolving MPEG standards for broadcast, cable and desktop applications, and Joint Photographic Experts Group (JPEG) standard for still image compression. The Company believes that its expertise in DCT technology gives it a competitive advantage by simplifying the development of products that are compatible with industry standards, while providing superior performance through proprietary enhancements when operating in either the industry standard or proprietary modes. To achieve these enhancements in the future, the Company also continues to develop methods for pre- and post-processing video signals utilizing techniques such as detelecine, statistical multiplexing, conditional access, and motion adaptive scene filtering in order to improve performance of systems utilizing either industry standard or proprietary algorithms.\nCLI designs application specific integrated circuits (ASICs) for its products, and cooperates with certain semiconductor vendors who are developing semiconductor chips which the Company believes are important to its business. Both activities are directed at reducing costs, enhancing performance, and increasing flexibility in the Company's products. In many cases, CLI is able to add elements of its proprietary technology with the implementation of these chips in order to obtain cost and performance advantages compared to other users of such chips.\nVIDEOCONFERENCING PRODUCTS\nCLI offers a broad range of group and desktop videoconferencing products which includes the Rembrandt II\/VP large group video codec family, the Radiance family of prepackaged large group videoconferencing systems, the eclipse mid-range group videoconferencing systems, the CLI Desktop Video family, and Multipoint Control Units. The Company's videoconferencing systems offer two-way, full-color, motion videoconferencing at various bandwidths ranging from 56 kbps to 2.048 mbps. These systems enable the user to transmit video, audio, data and graphics over digital channels. System users can transmit the compressed signals over terrestrial, satellite or microwave networks. CLI's videoconferencing products are used in point-to-point or multipoint videoconferences. In a point-to-point videoconference, audio and full-color, motion images are transmitted simultaneously in both directions so that the participants at one site interact with the participants at the other site as in a normal meeting. In a multipoint conference, participants in three or more locations can interact with each location and are able to see and hear the participant who is speaking. CLI systems work in conjunction with both dedicated network facilities and a variety of switched network facilities, offering customers maximum networking flexibility.\nRembrandt II\/VP. The principal component in the Company's videoconferencing systems is the codec. One codec is required at each conference site to perform both coding and decoding functions. The Rembrandt II\/VP, which the Company began shipping in the second half of 1991, incorporates the Company's proprietary CDV technology, and was the industry's first codec to address the entire spectrum of videoconferencing applications in a single product. These codecs support transmission rates from 56 kbps to 2.048 mbps, support the CTX and CTX Plus proprietary algorithms, provide backward compatibility to the Company's older products, and support the H.261 standard. The Company believes that its proprietary algorithms (CTX at lower bandwidths and CTX Plus at bandwidths of 384 kbps and above) provide picture quality superior to the H.261 standard. The Rembrandt II\/VP list prices range from $35,000 to $48,500, excluding options.\n- ------------------- (TM)CTX and CTX Plus are trademarks of Compression Labs, Incorporated\nRadiance Group Videoconferencing Systems. The Company's Radiance large group videoconferencing systems, first shipped in January 1994, are complete, prepackaged large group systems which achieve up to 30 frames per second (fps) and 480 lines of resolution at bandwidths ranging from 56 kbps to 2.048 mbps. These systems come fully assembled for easy installation, use, and maintenance, and utilize a tabletop touchpanel based on CLI's Self-Guide(TM) user interface, which provides intuitive control via menus and icons to guide the user. Radiance systems are interoperable with CLI's Rembrandt II\/VP codecs, eclipse mid-range group systems, and CLI Desktop Video products worldwide, as well as with other codecs that meet TSS H.320 standards. The Radiance list prices range from $43,400 to $77,900, excluding options.\neclipse Group Videoconferencing Systems. The Company's eclipse mid-range group videoconferencing systems, introduced in early 1993, are complete, full-featured videoconferencing systems priced as low as $14,900. The codec is housed in an Intel 486 personal computer chassis with both a hard disk and 3-1\/2 inch floppy disk for software updates. eclipse also includes an advanced, industry standard audio system with tabletop microphones, full-duplex capability and integrated echo cancellation, which uses as little as 16 kbps of the 112\/128 kbps bandwidth for audio. The eclipse comes with high-quality video, capable of communicating with other manufacturers' systems using the TSS H.320 industry standard or providing superior video quality using CLI's CTX proprietary algorithm for communicating with other CLI systems. The eclipse offers as standard features an auto-focus camera with pan\/tilt\/zoom capabilities, easy-to-use presets, a choice of built-in line interfaces for virtually every type of network, multipoint readiness, picture-in-picture, and CLI's Self-Guide user interface. In 1995, the eclipse product family was expanded to include a variety of models ranging from table top to dual monitor systems. These new eclipse 8200 models are fully compliant with TSS standards, and offer full common intermediate format (FCIF) resolution, integrated network interface supporting highly-affordable transmission speeds up to 112\/128 kbps, wideband audio up to 7 kHz, enhanced video from customized VLSI circuits specifically designed for pre- and post-processing, far-end camera control, high-resolution graphics, 27-inch monitors, the wireless Self-Guide remote control unit, a pan\/tilt\/zoom automatic-focus camera, and a variety of auxiliary document cameras. The eclipse 8300 models include the same features as the eclipse 8200 with the additional capability of transmission speeds up to 384 kbps. In April 1996, CLI further expanded the eclipse product line with the introduction of the eclipse gold . This recently introduced model offers features identical to the eclipse 8300 with the addition of improved video quality at 30 fps and a T.120 multimedia gateway. T.120 is an evolving series of standards from the ITU that are aimed at facilitating \"audio-graphic\", multimedia conferencing for collaborative working meetings and distance learning applications. Available as options on the newer lines of eclipse are: multipoint chair control, dual monitors, the automatic focus SuperCam document camera and an inverse multiplexer. eclipse list prices range from $14,900 to $47,900, excluding options.\nCLI Desktop Video Systems. The Company announced in January 1996 a CLI Desktop Video family of products to run on PCs powered by Intel Corporation's (Intel) Pentium(TM) microprocessor under Microsoft Windows versions 3.1 and 95. This family of products will initially include two models: CLI Desktop Video 1000 and CLI Desktop Video 2000. CLI Desktop Video products are kits consisting of a fixed digital camera, a single codec board incorporating an integrated services digital network (ISDN) basic rate interface, a telephone handset, and a choice of data collaboration software, including Intel's ProShare(TM) Premier data collaboration software. In the future, the product will also support DataBeam's FarSite(TM) data collaboration software. The CLI Desktop Video 1000 and 2000 models are capable of transmission speeds ranging from 56 kbps to 384 kbps. CLI Desktop Video list prices range from $1,495 to $2,195, excluding options.\nMultipoint Control Units. The Company also offers the Multipoint 2 Control Unit (MCU), a device that allows people at multiple locations to participate in a fully interactive videoconference. During a multipoint videoconference, the MCU acts as an audio bridge and a controller, switching among different sites so participants can see the person who is speaking and hear all other participants in the conference. This switching can be voice-activated or manually controlled. The MCU is compliant with the international multipoint videoconferencing standards established by the TSS, and is compatible with videoconferencing systems from any manufacturer who supports those international standards. In addition, MCUs are compatible with the large installed base of CLI Rembrandt II\/VP and codecs with appropriate audio and communications configurations. List prices for MCUs range from approximately $26,500 for a 3-user unit to approximately $89,500 for a large system usable in a headquarters location, depending on the number of ports and options required.\n- -------------------- (TM)Pentium, and (TM)ProShare are trademarks of Intel Corporation (TM)FarSite is a trademark of DataBeam Corporation\nBROADCAST PRODUCTS\nThe Company offers the SpectrumSaver digital broadcast television system for business television, distance learning, satellite news gathering and cable applications. SpectrumSaver digitizes and compresses a full-motion analog television signal so it can be transmitted using a fraction of the bandwidth required by standard analog systems. SpectrumSaver encoders range in price from $65,000 to $85,000 and receivers from $2,600 to under $1,700, depending on quantity purchased. Typical systems employ many receivers per encoder. The SpectrumSaver product line is included in the Company's discontinued operations.\nIn 1994, the Company introduced the Magnitude family of CLI broadcast video products. Magnitude, an MPEG-2-based Compressed Digital Video product family for the delivery of entertainment and information services over telephone, cable and satellite networks, is aimed at providing high quality broadcasting for a variety of business and home entertainment applications. The system reduces bandwidth required to transmit video by six to sixty times depending on the complexity of the program content and the transmission method. CLI is supplying Magnitude encoders to a unit of GM Hughes Electronics through an agreement with Thomson Consumer Electronics for the DIRECTV(R) satellite entertainment service. The Company has also sold Magnitude products to customers in Argentina, Australia, China, India, Japan, Namibia, Russia, and Taiwan. The Magnitude product line is included in the Company's discontinued operations.\nSALES AND MARKETING\nThe Company markets its videoconferencing systems to business, government, health care and education customers. These customers frequently have multiple domestic and\/or international locations and often specify a single vendor to supply videoconferencing equipment on a worldwide basis. The Company believes that the sales effort to this sophisticated customer base requires the initiation and maintenance of multilevel contacts in order to address the customers' multi-location application and support needs. Historically, a significant portion of the Company's sales have been to its existing customer base. Nonetheless, CLI is committed to expanding sales outside of its current customer base and believes that new customers are an important part of the Company's future revenue growth.\nIn 1995 approximately 35 percent of CLI's revenues from videoconferencing products were achieved through indirect channels, which include resellers and co-marketers (collectively, Resellers). To that end, the Company has entered into strategic co-marketing agreements or arrangements with AT&T and MCI Communications. These co- marketers provide sales leads and customer prospects for direct customer sales by the Company's domestic sales force. In addition, the Company has a number of Reseller agreements in the United States with companies including Bell Atlantic, Norstan, Inc., TIE\/communications, Inter-Tel Equipment Corporation, Pacific Bell, and Williams Telecommunications, Inc. (WilTel). These Resellers sell the Company's videoconferencing products directly to end-users. The Company has also entered into distributor agreements with companies such as MicroAge Inc., and Sprint\/North Supply.\nInternationally, the Company markets its videoconferencing products in most countries outside the U.S. through distributors. CLI is attempting to increase its new customer base by expanding its distribution channels. The Company's products are distributed in over 50 countries outside the U.S. under distribution agreements and arrangements with over 30 companies, including Internet Video Communications in the U.K., J S TELECOM, a subsidiary of Bosch Telekom in France, Deutsch Telekom in Germany and worldwide, SOEI Tsusho Company, Ltd. in Japan, Samsung in Korea, Teledata in Southeast Asia, and Keytech S.A. in South America. Agreements with these distributors generally provide for pricing and volume discounts, order lead times, designation of a specific geographic territory and other terms and conditions. Distributors typically order products only upon receipt of an order from an end-user customer and generally provide local customer support, including installation and maintenance. In 1993, the Company opened its first international sales offices in Brussels, Belgium and Beijing, China. In 1995, revenue from non-U.S. customers represented 22% of videoconferencing revenues. See Note 10 of Notes to Consolidated Financial Statements.\nThe Company believes that the availability of demonstration systems and financing programs significantly enhances its direct sales and marketing efforts. CLI provides videoconferencing equipment to customers and potential customers on a short-term loan or monthly rental basis in order to allow hands-on use of the equipment.\n- -------------------- (R)DIRECTV is a registered trademark of Hughes Electronics Corporation.\nThe Company primarily distributes its broadcast products through value-added resellers, which include satellite transponder owners, full service integrators, systems integrators and broadcast programmers who can provide the end-user with a complete, installed digital satellite system. The Company has agreements in effect with Westcott Communications, AT&T, Electronic Data Systems Corporation, Keytech S.A., Radiation Systems Incorporated, National Technological University, Vitacom, and others.\nAs of February 29, 1996, the Company had 158 direct sales, marketing and customer support personnel located in 22 offices in 14 states, plus 3 foreign countries.\nCUSTOMER SERVICE AND SUPPORT\nThe Company believes that customer service and support are important competitive factors. CLI provides service and support in more than 50 countries worldwide either directly or in conjunction with its distributors, Resellers and contract service providers. CLI and its contract service providers typically provide comprehensive support to all customers to which CLI sells direct. Customers who buy CLI products indirectly generally receive their primary level of support from CLI's Resellers and supplemental support from CLI. All Distributors, Resellers and service providers are trained by the Company to provide the appropriate level of service for the Company's products. CLI's service strategy for much of its product line is predicated on designing products with diagnostic capabilities and maintaining a toll-free Customer Support Hotline staffed by technical support personnel who diagnose problems remotely. The remote diagnostic capabilities of many of CLI's products often allow the Company's Technical Support Center personnel to cost- effectively service its products without requiring on-site service visits. To further augment CLI's service capabilities, CLI signed an agreement in late 1995 with AT&T under which AT&T will supply technicians who will provide installation and service for designated CLI videoconferencing customers throughout the United States.\nThe Company provides installation and on-site service through its regionally deployed technical support staff in select major cities or regional, national, or multinational third-party service providers. The Company offers a variety of maintenance plans to accommodate the various maintenance requirements in the marketplace. Historically, maintenance revenue has accounted for less than 10% of total revenues.\nCLI generally warrants its products to be free of defects in materials and workmanship for periods ranging from three months to fourteen months from date of shipment or twelve months from date of installation, depending on the product. To date, defective product returns have not been material.\nCUSTOMERS\nThe Company's products have been sold to organizations in such diverse industries as aerospace, banking, communications, broadcasting, education, electronics, food and consumer products, and pharmaceuticals, as well as in government. In 1995 and 1994, there was no single customer that accounted for greater than 10% of total revenues. In 1993, sales to two customers accounted for approximately 17% and 10% of total revenues, respectively. During 1995, 1994 and 1993, sales to international customers represented approximately 22%, 18% and 13%, respectively, of the Company's total revenues.\nThe following is a selected list of those customers who have placed orders with the Company over the past two fiscal years:\nThere can be no assurances that any of the customers listed above will continue to purchase the Company's products in the future.\nRESEARCH AND DEVELOPMENT\nSince its inception, the Company has recognized that a strong technical base is essential to its long-term success and has made a substantial investment in research and development. The Company's total research and development expenditures in 1995, 1994 and 1993 aggregated $14.8 million, $15.1 million, and $13.4 million, respectively. Research and development expenditures consisted of research and development expense, cost of revenues related to research and development contracts and capitalized software development costs as summarized in the table below (in millions):\nThe videoconferencing market is characterized by rapid and significant change in technology and user needs, requiring substantial product development expenditures. These changes have resulted in frequent product introductions characterized by better picture quality at lower bandwidths and reduced prices. The Company's ongoing videoconferencing research and development efforts are focused on continued improvements in its CDV technology, product developments and product enhancements. The Company's future success in this market will depend to a large extent on its ability to maintain its competitive technological position and to continue to develop, on a cost effective and timely basis, technologically advanced videoconferencing products that meet changing user needs. There can be no assurance that the Company's product development efforts will be successful.\nCOMPETITION\nThe Company believes that the market for videoconferencing systems ranges from applications for more formal meetings that require very high picture quality using higher bandwidths, to applications such as informal meetings in which reduced picture quality at lower bandwidths is acceptable in return for significantly lower equipment and transmission costs.\nThe Company believes that the principal competitive factor in the videoconferencing market is the ability to provide cost effective, enterprise-wide videoconferencing solutions. Performance, price, picture quality, audio quality, bandwidth flexibility, network compatibility, standards compliance, reliability, ease of use and diversity of features are important product features; distribution and customer support are also important service factors. While the relative importance of these factors varies from customer to customer, CLI believes that it is competitive in each of these areas.\nAt the higher bandwidths, the Company believes that VTEL Corporation, General Plessey Telecommunications and British Telecom in the United Kingdom are currently its major competitors, although other companies have developed or may develop such systems. At lower bandwidths, the Company believes that PictureTel Corporation and VTEL Corporation are its primary competitors. The Company expects other competitors, some with significantly greater marketing, technical and financial resources, to enter the videoconferencing systems market. In particular, the Company expects increased competition from Japanese manufacturers, including Mitsubishi Ltd., Nippon Electric Corporation, Sony Corporation, Hitachi Limited and Fujitsu Ltd. If the Company cannot continue to offer new videoconferencing products with improved performance and reduced cost, its competitive position will erode. Moreover, competitive price reductions may adversely affect the Company's results of operations.\nIn December 1990, the TSS adopted a worldwide videoconferencing standard, commonly referred to as H.261 or px64, for transmitting video images over digital networks at data transmission rates ranging from 64 kbps to 2.048 mbps. This standard has become a part of the TSS standards, an evolving set of standards which permit interoperability among videoconferencing systems from different vendors. Although acceptance of the TSS standards is expected to increase demand for videoconferencing products in general, the widespread acceptance of these standards and other related emerging international standards may make the advantage of the Company's proprietary technology less significant. In particular, the emergence of industry standards may lower barriers to entry and result in increased price competition.\nMANUFACTURING\nThe Company has structured manufacturing as two separate organizations: one focused on videoconferencing products and the other focused on broadcast products.\nVideoconferencing Products\nThe videoconferencing products manufacturing organization performs materials planning, production scheduling, mechanical assembly, board testing, system integration, burn-in, and final system testing of videoconferencing codecs and integrated systems and broadcast encoders. The organization performs quality assurance testing on selected purchased parts, board assemblies and finished products during the course of the manufacturing process. Some components are purchased through a small number of selected component distributors who provide completed assemblies for printed circuit boards. The kitted parts are drop-shipped from the component distributor directly to selected subcontract assembly houses. Some components are purchased directly from various manufacturers, and are assembled and tested at CLI. Some videoconferencing equipment is purchased in its entirety from suppliers and shipped to CLI where it may be integrated and tested to customer specifications.\nBroadcast Products\nThe broadcast products manufacturing organization performs assessment, evaluation, qualification, selection, scheduling, management and support of its selected turnkey high-volume manufacturing subcontractors. Turnkey manufacturers provide substantial materials planning, procurement, component testing, mechanical assembly, board testing, applicable system integration, burn-in and final system testing of the Company's broadcast receivers\/decoders products. There can be no assurance that the Company will be able to develop or contract for manufacturing capabilities with the necessary volume, quality or price on acceptable terms. As noted above, in November 1995 the Company adopted a plan to discontinue operations of its broadcast products division by the end of 1996.\nSupplier Relationships\nThe Company uses many standard parts and components for its products. Several of the critical components used in the Company's products, including certain custom and programmable semiconductors, such as the MPEG-2 chipset supplied by C-Cube Microsystems, are currently available only from single or limited sources. In addition, the Company relies on a few key vendors for sourcing or turnkey manufacturing of certain of its products. The Company has executed master purchase agreements with some, but not all, of its component distributors and suppliers who provide the kits and component parts for the videoconferencing products and broadcast and cable products. While the Company has experienced few material disruptions in supply to date, there can be no assurance that the Company will be able to obtain a sufficient quantity of products or components for existing products on acceptable terms to enable it to meet the demand for those products. An interruption or reduction in supply of any key components, excessive rework costs associated with defective components, or process errors or the inability to obtain continued reduction of component prices could adversely affect the Company's operating results and could damage customer relationships.\nQUALITY\nCLI has established a quality function with a Quality Council assigned to oversee the implementation of a Total Quality Management (TQM) process and culture throughout CLI. A cross-functional TQM council has been organized to support and manage process quality improvement teams which focus on continuous improvement of CLI's various products and processes used throughout the Company. The Company has been granted the International Organization for Standardization (ISO) 9001 certification for its videoconferencing products operations.\nPATENTS AND TRADEMARKS\nThe Company currently holds eight U.S. patents relating to video compression. The patents cover CLI's scene-adaptive coding and DCT techniques and expire between November, 1998 and the year 2014. These techniques, together with the DXC, CTX and CTX Plus algorithms, serve as the basis of the Company's videoconferencing product lines. In 1996, CLI was granted a patent for statistical multiplexing of multiple compressed video signals which the Company believes may be important for certain digital broadcast applications. The Company also holds two U.S. patents relating to facsimile compression.\nThere can be no assurance that the Company's current patents will be upheld as valid. Although the Company believes its patents are valuable, it also believes that its future success depends primarily upon its technical and engineering competence and the creative skills of its personnel.\nIn addition to potential patent protection, CLI relies on the laws prohibiting unfair competition, and the laws of copyright, trademark and trade secrets to protect its proprietary rights. The Company also utilizes nondisclosure agreements and internal secrecy procedures.\nThe Company believes that its products, trademarks and other proprietary rights do not infringe on the proprietary rights of third parties. From time to time, however, the Company has received communications from third parties asserting that features or content of certain of its products may infringe intellectual property rights of such parties. To date, no such claims have had an adverse effect on the Company's ability to develop and market its products. There can be no assurance, however, that third parties will not assert or prevail in infringement claims against the Company with respect to current or future products or that any such assertion may not require the Company to enter into royalty arrangements or result in costly litigation. For example, Datapoint Corporation has filed suit claiming that certain of the Company's products infringe its patents. See \"Legal Proceedings.\" Patent litigation or royalty arrangements entered into to avoid or settle litigation could have a material adverse effect upon the Company's business, operating results and financial condition.\nEMPLOYEES\nThe Company's success depends to a large extent on the skill and competence of its employees. There can be no assurance that the Company will be able to continue to attract, retain and motivate competent employees.\nAs of February 29, 1996, the Company employed 439 people full-time in its continuing operations, including 129 in manufacturing, 94 in engineering, research and development, 158 in sales and marketing and 58 in administration. As of February 29, 1996, the Company employed 100 people full-time in its broadcast division, which is reported as a discontinued operation. In addition, the Company also employs a number of temporary employees. None of the Company's employees are represented by a collective bargaining agreement. The Company believes its relationship with its employees is good.\nDISCONTINUED OPERATIONS AND RESTRUCTURING\nOn November 30, 1995, the Company adopted a strategic plan to discontinue the operation comprising the broadcast products division. This division generally manufactures and sells broadcast video products to commercial end-users. See Note 2 in the Notes to Consolidated Financial Statements.\nAdditionally, in the first quarter of 1996, the Company decided to restructure the videoconferencing division in order to seek profitability and growth. This resulted in adjustments that were recorded as of December 31, 1995 to carrying values of assets that were impacted--primarily inventories, capitalized software and accounts receivable. In conjunction with this action, the Company also reduced its permanent and temporary workforce by approximately 90 people in March of 1996 and identified a number of offices that would be closed. Severance and other expenses associated with this action will be reflected in the results of the first quarter of 1996.\nRISK FACTORS\nThe following are among the risk factors that should be carefully considered in evaluating the Company and its business.\nNet Loss \/ Fluctuations in Quarterly Performance\nThe Company has experienced, and may continue to experience, significant fluctuations in operating results due to a variety of factors. The Company sustained a net loss of $57.6 million and $3.5 million in 1995 and 1993, respectively. In 1994 the Company had net income of $0.1 million. There is no assurance that the Company will be able to achieve a profit in 1996 or in subsequent quarters and years.\nThe Company's product sales have historically been derived primarily from the sale of videoconferencing systems and related equipment, the market for which is still developing. Most of the Company's products are complex capital equipment systems and\/or involve significant equipment deployment; and as such, these products typically involve long sales and order cycles. Additionally, the Company's revenues have occurred predominantly in the third month of each fiscal quarter. The Company believes that this is due in some part to the timing of the capital equipment budget procedures of its customers. The Company is not certain of the other reasons for the occurrence of a large portion of its sales in the third month of each fiscal quarter. Accordingly, the Company's quarterly results of operations are difficult to predict, and delays in the introduction or acceptance of new products, delays in orders for existing products in anticipation of new products, or delays in the closing of sales near the end of the quarter could cause quarterly revenues and, to a greater degree, operating results to fall substantially short of anticipated levels. The Company's total revenues and results of operations could also be adversely affected by delays in achievement of planned cost reductions, cancellations of orders, interruptions or delays in supply of key components, failure of new products to meet specifications or performance expectations, changes in customer base or product mix, seasonal patterns of capital spending by customers, delays in purchase decisions due to new product announcements by the Company or its competitors, increased competition and reductions in average selling prices.\nHigh Levels of Inventory and Accounts Receivable\nThe concentration of customer orders in the third month of each quarter, together with relatively long manufacturing lead times and the Company's growth, have required the Company to maintain high levels of inventory in order to deliver products on a timely basis. The Company also maintains equipment in inventory to provide demonstration systems to customers or potential customers on a short-term loan basis or on a monthly rental basis. Due to the rapid rate of change in CLI's industry, a large inventory poses the risk of inventory obsolescence or delay in realization of manufacturing cost improvements, either of which could have an adverse effect on the Company's financial results. In addition, the Company's accounts receivable were $46.8 million, net at December 31, 1995. CLI expects accounts receivable and inventory balances to fluctuate in the future. Among other things, introduction of new products requires the purchase and accumulation of significant amounts of inventory prior to the realization of revenue from the new products. Accordingly, the Company has in place a number of ongoing and planned measures to manage both inventories and accounts receivable; however, there can be no assurance that the Company can maintain its level of asset utilization in the future. Any significant increases in accounts receivable and inventories would result in a significant use of cash. The Company continues to finance accounts receivable and inventories through public and private offerings of equity securities, sale and leaseback arrangements and bank credit lines. There can be no assurance that the Company will be able to reduce or maintain its inventory and accounts receivable levels in the future.\nProduct Development and Rapid Technological Change\nThe videoconferencing market is characterized by rapid and significant change in technology and user needs, requiring substantial product development expenditures. These changes have resulted in frequent product introductions generally characterized by improved video and audio performance, added functionality and reduced prices. The Company's future success will depend to a large extent on its ability to maintain its competitive technological position and to continue to develop, on a cost effective and timely basis, technologically advanced products that meet changing user needs. There can be no assurance that the Company's product development efforts will be successful. In addition, customers may delay purchase decisions on existing products in anticipation of new products, which typically have higher initial manufacturing costs, higher initial component costs and lower initial overall gross margins than more mature products. The introduction of new products by the Company or its competitors may also pose the risk of inventory obsolescence.\nHighly Competitive Industry\nCompetition in the video communications markets is intense. In the videoconferencing market, the Company's primary competitors are PictureTel Corporation, General Plessey Telecommunications, British Telecom and VTEL Corporation, and the Company expects other competitors to enter the videoconferencing market. Some of these competitors have significantly greater technical and financial resources than the Company. In particular, the Company expects competition from Japanese manufacturers, including Mitsubishi Ltd., Nippon Electric Corporation, Sony Corporation, Hitachi Limited and Fujitsu Ltd. If the Company cannot continue to offer new videoconferencing products with improved performance and reduced cost, its competitive position will erode. Moreover, competitive price reductions may adversely affect the Company's results of operations.\nReliance on Key Personnel\nThe success of the Company depends to a large extent on a small number of key senior technical and managerial personnel, the loss of one or more of whom could have a material adverse effect on the business of the Company. Typically these individuals do not have employment contracts with the Company. The Company believes that its future success will depend in part on its ability to continue to attract, retain and motivate additional highly skilled personnel, who are in great demand.\nVolatility of Stock Price\nThe Company's Common Stock has historically been subject to substantial price volatility, particularly as a result of announcements of new products by the Company or its competitors, quarter-to-quarter variations in the financial results of the Company or its competitors and changes in earnings estimates by industry analysts. In addition, the stock market has experienced, and continues to experience, price and volume fluctuations which have affected the market price of many technology companies in particular and which 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 Common Stock.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company currently occupies 243,100 square feet of office and manufacturing space in a modern industrial park in San Jose, California under three leases, one for 74,000 square feet which expires in September 1997, another for 142,700 square feet which expires in December 2001, and a third lease for a warehouse facility measuring 26,400 square feet which expires in June 1997. The Company has an option to extend these leases for periods of between two years and five years beyond the specified term. The Company also leases sales offices in various locations on a short-term basis. These leases are for periods of up to ten years. The Company believes that its facilities are suitable for its videoconferencing and broadcast and cable divisions, but may be too large if the broadcast division is sold and relocated. The Company also believes it can locate and occupy additional facilities as they are needed.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCIT GROUP\/OSUERF\nOn August 24, 1993, the Company filed a complaint against Oklahoma State University Education and Research Fund, Inc. (OSUERF) in United States District Court claiming that OSUERF breached an exclusive subcontract for the Company to provide equipment to OSUERF under OSUERF's prime contract with the United States Army, TRADOC Division. On November 18, 1993, the Company amended the complaint to add Federal Leasing, Inc. (FLI) as a defendant. On February 4, 1994, the CIT Group\/Equipment Financing Inc. (CIT), as an assignee of FLI's rights under the Financing Agreement, filed a complaint against the Company in United States District Court claiming indemnification from the Company. The Company responded to CIT's complaint by denying the material charging allegations and stating certain affirmative defenses. The OSUERF and CIT actions have been consolidated. On April 21, 1995, CIT and FLI separately moved for summary judgment against the Company seeking damages in the amount of $2 million. The Company opposed the respective motions. By order dated October 11, 1995 the court denied the summary judgment motions of CIT and FLI, respectively.\nBy order dated December 20, 1995, the consolidated actions were reassigned to the Honorable Charles A. Legge. A case management conference was held before Judge Legge on January 19, 1996, at which time the matter was set for jury trial to being November 4, 1996. Discovery will close June 30, 1996.\nThe Company will vigorously defend the claims stated against it by CIT, and believes that it has meritorious defenses. However, there can be no assurance that the Company will prevail or obtain indemnity for any recovery from OSUERF. If any of CIT's claims were to be decided adversely to the Company, the Company would be liable to pay monetary damages to CIT. The Company believes that the ultimate resolution of this matter will not have a material adverse impact on the Company's consolidated financial position.\nSOUTHWESTERN BELL TELEPHONE COMPANY\nOn April 6, 1995, the Company filed a complaint against Southwestern Bell Telephone Company (SWBT) in Santa Clara, California Superior Court alleging that SWBT intentionally interfered with CLI's contracts with OSUERF and Hughes Network Systems (HNS). SWBT moved to quash service of summons for lack of personal jurisdiction, which motion was granted on July 11, 1995. On July 25, 1995, the Company refiled the complaint in the United States District Court for the Western District of Oklahoma. The complaint was served on SWBT which filed its answer on October 17, 1995, denying the material allegations of the complaint.\nOn September 6, 1995, CLI filed its notice of appeal of the Superior Court's order granting SWBT's motion to quash service of summons for lack of personal jurisdiction. The appeal has now been fully briefed and the parties are awaiting an order from the Court of Appeal setting oral argument. Pending the outcome of the appeal, CLI and SWBT have stipulated that the Oklahoma federal court action will be placed in administrative closure. An order placing the matter in administrative closure was entered on October 20, 1995.\nDATAPOINT CORPORATION\nIn a complaint filed December 20, 1993, in the United States District Court in Dallas, Texas, Datapoint Corporation (Datapoint) alleged that the Company had infringed two United States patents owned by Datapoint relating to video conferencing networks. The complaint seeks a judgment of infringement, monetary damages, injunctive relief and reasonable attorney's fees. The Company responded to the complaint on February 16, 1994 by denying the material allegations of the complaint and asserting affirmative defenses. Pursuant to court order, the parties have participated in mediation before a court-appointed mediator. Discovery in the case has commenced. On September 27, 1995, the Company filed a motion to construe the scope of the patent claims at issue in the litigation so as to elucidate whether Datapoint can assert that the Company is infringing the patents in suit or whether Datapoint's patents are invalid in light of the prior art. Briefing on the motion is complete and the motion is under submission to a special master to prepare a report to the District Court concerning the motion.\nThe Company believes that it has meritorious defenses to the allegations of the complaint, and is pursuing an aggressive defense; however, there can be no assurance that the Company will prevail. If any of the claims were to be decided adversely to the defendants, the Company could be liable for monetary damages to the plaintiff and be subject to injunctive relief. The Company believes that the ultimate resolution of this matter will not have a material adverse impact on the Company's financial position.\nJABIL CIRCUITS, INC.\nTo fulfill a purchase order from Philips Consumer Electronics Company (Philips) for the supply of certain decoder units, the Company placed a purchase order with Jabil Circuits, Inc. (Jabil) for the procurement of the component parts and the manufacture of the units. Due to the cancellation of the Philips purchase order, the Company has canceled its purchase order with Jabil. By letter dated January 11, 1996, Jabil demanded that the Company issue a purchase order for approximately $6.5 million for the components which are outside the cancellation and reschedule windows. The Company has initiated and is engaged in negotiations with Philips and Jabil regarding the disposition of the component inventory and responsibility for cost of inventory that cannot be disposed of by Jabil. A resolution of the inventory issue has been reached as between Jabil and Philips. CLI has made a claim against Philips for damages associated with the Jabil inventory. Philips has not responded to CLI's claim letter. The Company believes that the ultimate resolution of this matter will not have a material adverse impact on the Company's consolidated financial position.\nPHILIPS CONSUMER ELECTRONICS COMPANY\nThe Company entered into a Joint Development and Marketing Agreement (JDMA) with Philips dated January 12, 1994, for the supply of certain decoder units discussed in the Jabil matter above. By amendment to the JDMA on May 24, 1995, Philips agreed to pay the Company $2.6 million for all intellectual property jointly developed under the JDMA. In a related license agreement of May 12, 1995, the Company agreed to pay Philips $5.6 million for a license under background patents and other intellectual property. Philips owes the Company $1.3 million under the amendment, $0.9 million of which was due December 29, 1995. The Company owes Philips $3.3 million under the license agreement, $2.1 million of which was due December 29, 1995. The Company believes that Philips has failed to make certain technology disclosures required under the license agreement. The Company has initiated and is engaged in negotiations with Philips regarding\ndisposition of rights and monies owed under the amendment and license agreement. The Company believes that the ultimate resolution of this matter will not have a material adverse impact on the Company's consolidated financial position.\nCORPORATE COMPUTER SERVICES, INC.\nBy letter dated October 23, 1995, Corporate Computer Services, Inc. (CCS), through its counsel, has asserted that the Company is using proprietary technology of CCS without a license and is willfully misappropriating CCS' copyrights. The Company, in a letter from its counsel dated November 6, 1995, vigorously refuted CCS' assertions. The Company also tendered a payment with respect to past due royalties plus interest pursuant to the terms of the MUSICAM License Agreement with CCS. The Company and CCS are now in the process of exploring the possibility of a future license arrangement. The Company believes that the ultimate resolution of this matter will not have a material adverse impact on the Company's consolidated financial position.\nMUELLER\/SHIELDS\nOn or about March 15, 1996, a complaint was filed against the Company by Mueller\/Shields OME in Superior Court of Orange County, California alleging breach of a marketing research contract. In the action entitled Mueller\/Shields OME v. Compression Labs, Inc., Case No. 761079, Mueller\/Shields seeks $682,425 in compensatory damages, plus attorneys' fees provided by contract. Since the filing of its complaint, Mueller\/Shields has served notice of its application for a writ of attachment and has scheduled a hearing for its application on April 26, 1996. The Company and Mueller\/Shields have been discussing a possible resolution. Those negotiations continue. The Company's response to the complaint is due April 17, 1996 and its opposition to the application for writ of attachment is due April 19, 1996. If any of Mueller\/Shields' claims were to be decided adversely to the Company, the Company would be liable to pay monetary damages to Mueller\/Shields. The Company believes that the ultimate resolution of this matter will not have a material impact on the Company's consolidated financial position.\nGENERAL\nIn 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. Outcomes of such negotiations may not be determinable at any point in time; however, management does not believe that such licenses or settlements will, individually or in the aggregate, have a material adverse affect 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 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 STOCK AND RELATED STOCKHOLDER MATTERS\nThe information required by this item is incorporated by reference to page 23 of Registrant's Annual Report to security holders to be furnished to the Commission pursuant to Rule 14a-3(b) in connection with the 1996 Annual Meeting which is attached hereto as Exhibit 13.1 (the \"Annual Report\").\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated by reference to page 5 of the Annual Report, which is attached hereto as Exhibit 13.1.\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 incorporated by reference to pages 7 through 9 of the Annual Report attached hereto as Exhibit 13.1.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company, including the notes thereto and quarterly information (unaudited) are incorporated herein by reference to page 6, and pages 10 through 22 of the Annual Report attached hereto as Exhibit 13.1.\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\nThe sections entitled \"Nomination and Election of Directors\" and \"Management\" appearing on pages 2 through 5 in the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission are incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation\" appearing on pages 19 through 24 in the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section entitled \"Security Ownership of Officers, Directors and Principal Stockholders\" appearing on pages 17 through 18 in the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission 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\nThe following documents are filed as a part of this Report:\n(a)(1). The following consolidated financial statements of Compression Labs, Incorporated are included pursuant to Item 8:\n*These items have been incorporated by reference as indicated under Item 8 of this Report.\nIndex to Financial Statement Schedules\n(a)(2). The following financial statement schedules of Compression Labs, Incorporated for each of the years in the three-year period ended December 31, 1995 are included pursuant to Item 8:\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.\n(a)(3). Exhibits\n- ------------------------\n* Confidential treatment requested for portions of this agreement.\n- ------------------------- * Confidential treatment requested for portions of this agreement.\n- ------------------------- (1) Filed as an exhibit to a Registration Statement on Form S-8 filed on November 29, 1989 (Registration No. 33-32366) and incorporated herein by reference.\n(2) Filed as an exhibit to an Annual Report on Form 10-K filed on April 14, 1988 (Commission File No. 0-13218) and incorporated herein by reference.\n(3) Filed as an exhibit to a Registration Statement on Form S-3 filed on April 5, 1993 and incorporated herein by reference.\n(4) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended March 29, 1985 (Commission File No. 0-13218) and incorporated herein by reference.\n(5) Filed as an exhibit to a Registration Statement on Form S-8 filed On March 5, 1985 (Registration No. 2-96228) and incorporated herein by reference.\n(6) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended December 31, 1990 (Commission File No. 0-13218) and incorporated herein by reference.\n(7) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended December 31, 1991 (Commission File No. 0-13218) and incorporated herein by reference.\n(8) Filed as an exhibit to a Registration Statement on Form S-1 filed on July 10, 1986 (Registration No. 33-7128) or Amendment No. 1 to such Registration Statement filed on July 24, 1986 and incorporated herein by reference.\n(9) Filed as an exhibit to a Quarterly Report on Form 10-Q filed on November 10, 1989 (Commission File No. 0-13218) and incorporated herein by reference.\n(10) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended December 31, 1989 (Commission File No. 0-13218) and incorporated herein by reference.\n(11) Filed as an exhibit to a Quarterly Report on Form 10-Q filed on May 15, 1991 (Commission File No. 0-13218) and incorporated herein by reference.\n(12) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended December 31, 1992 (Commission File No. 0-13218) and incorporated herein by reference.\n(13) Filed as an exhibit to a Current Report on Form 8-K filed February 1, 1993 (Commission File No. 0-13218) and incorporated herein by reference.\n(14) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended March 31, 1993 (Commission File No. 0-13218) and incorporated herein by reference.\n(15) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended June 30, 1993 (Commission File No. 0-13218) and incorporated herein by reference.\n(16) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended September 30, 1993 (Commission File No. 0-13218) and incorporated herein by reference.\n(17) Filed as an exhibit to a report on Form 8-K dated October 20, 1993 (Commission File No. 0-13218) and incorporated herein by reference.\n(18) Management contract or compensatory plan or arrangement.\n(19) Filed as an exhibit to a report on Form 8-K dated May 5, 1994 (Commission File No. 0-13218) and incorporated herein by reference.\n(20) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended June 30, 1994 (Commission File No. 0-13218) and incorporated herein by reference.\n(21) Filed as an exhibit to previous filing (Commission File No. 0-13218).\n(22) Filed as an exhibit to an Annual Report on Form 10-K filed for the year ended December 31, 1994 (Commission File No. 0-13218) and incorporated herein by reference.\n(23) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended March 30, 1995 (Commission File No. 0-13218) and incorporated herein by reference.\n(24) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended September 30, 1995 (Commission File No. 0-13218) and incorporated herein by reference.\n(25) Filed as an exhibit to a quarterly report on Form 10-Q for the quarterly period ended June 30, 1995 (Commission File No. 0-13218) and incorporated herein by reference.\n(b) Reports on Form 8-K\nCurrent 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.\nCOMPRESSION LABS, INCORPORATED\nBY \/s\/ Michael E. Seifert ----------------------------------------- Michael E. Seifert Vice President, Finance and Chief Accounting Officer\nApril 15, 1996\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints T. Gary Trimm and Michael E. Seifert, 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 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 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.\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Board of Directors Compression Labs, Incorporated:\nUnder date of March 13, 1996, we reported on the consolidated balance sheets of Compression Labs, Incorporated 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 December 31, 1995 annual report on Form 10-K of Compression Labs, Incorporated. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed under item 14(a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nSan Jose, California March 13, 1996\nS-1 SCHEDULE II\nCOMPRESSION LABS, INCORPORATED VALUATION AND QUALIFYING ACCOUNTS For the Years ended December 31, 1995, 1994 and 1993 (In thousands)\n(1) Uncollectable accounts written off during the year. (2) Costs incurred for warranty repairs during the year. (3) Charges incurred for options and additional software features owed to customers.\nS-2","section_15":""}
{"filename":"42119_1995.txt","cik":"42119","year":"1995","section_1":"Item 1. Business.\nGold Reserve Corporation (the \"Company\") is a Montana corporation organized in 1956 to explore and develop mining properties. The Company is presently engaged, through subsidiary foreign corporations, in exploring a gold property in Venezuela for possible development, and to a lesser extent, in evaluating other mineral properties elsewhere in the world for possible acquisition or joint venture. Unless otherwise stated, all amounts specified in this report are denominated in U.S. dollars.\nThe Company's sole mining asset is the Brisas alluvial gold concession (the \"Brisas concession\"), located in the Kilometer 88 mining region (\"KM 88\") of Bolivar State in southeastern Venezuela. The concession is an exploitation concession granted by the Venezuelan Ministry of Energy and Mines (\"MEM\") covering near-surface alluvial deposits. The Company continues to await formal issuance of the veta rights to the Brisas concession. An application was submitted to the MEM in February of 1993 to obtain an exploration and exploitation concession to the hardrock (veta) mineralization (gold and copper) which is beneath the Brisas alluvial concession. MEM informed the Company the application was approved on March 3, 1995, but the MEM has not yet submitted the application, as of March 26, 1996, to the Official Gazette for public comment. The Company is not aware of any fact or circumstance which would prevent the MEM from submitting the application for public comment and ultimately granting the veta concession to the Company.\nUnless the context requires otherwise, the term the \"Company\" used throughout this report refers to Gold Reserve Corporation and the following subsidiaries: Compania Aurifera Brisas del Cuyuni, C.A. (\"Brisas\"); Gold Reserve de Venezuela, C.A. (\"GLDRV\"); Compania Minera Unicornio, C.A. (\"Unicorn\"); Great Basin Energies, Inc. (\"Great Basin\"); MegaGold Corporation (\"MegaGold\"); Gold Reserve de Aruba A.V.V. (\"Gold Reserve Aruba\"); G.L.D.R.V. Aruba A.V.V. (\"GLDRV Aruba\"); Glandon Company A.V.V. (\"Glandon\"); Stanco Investments A.V.V. (\"Stanco\"); GoldenLake A.V.V. (\"GoldenLake\"); Mont Ventoux A.V.V. (\"Mont Ventoux\") and Gold Reserve Holdings A.V.V. (\"Gold Reserve Holdings\"). Activities on the Brisas concession, are conducted through GLDRV and its subsidiary Brisas, which holds title to the alluvial gold concession and has applied to the MEM for the hardrock (veta) concession. GLDRV is owned directly and indirectly by Gold Reserve Aruba and Glandon, which are wholly-owned subsidiaries of the Company.\nThe Company has to-date announced a geologic resource of 6.7 million ounces of gold and gold equivalent, consisting of 4.9 million ounces of gold and 720 million pounds of copper (or approximately 1.8 million ounces of gold equivalent). The resource approximates 177 million tons grading 0.85 grams (0.027 ounces) per ton gold and 0.18% copper. Mineralization related to the alluvial concession is less than 15% of the deposit; the remainder of the deposit is related to the hardrock (veta) concession for which the Company has applied to the MEM but has not been formally granted as of March 26, 1996.\nDevelopment drilling continues in the Pozo Azul zone, the bulk of which will be completed in 1996. The drilling will include an estimated 129 diamond drill-holes based on 50 meter spacing, totaling some 18,000 meters. In addition, the Company will initiate a 25 x 25 meter spaced drill program on selected areas of the Pozo Azul zone in May or June of 1996. These programs are designed to delineate further the resource within the Pozo Azul zone, including the \"Blue Whale\" horizon and the mineralization below 210 meters, and to support a feasibility study. Concurrently, additional drilling is planned to identify tailings and waste disposal sites, and a number of large- diameter holes are planned for pilot-scale metallurgical testing to substantiate initial research work and provide pilot test data to generate engineering design criteria. The estimated development budget for 1996 is $6 to $8 million.\nOn a cumulative basis since inception, the Company has expended approximately $45.5 million on the Brisas concession. These costs include acquisition costs of $2 million, capitalized development and exploration costs and equipment of $21 million (including Company stock valued at $9.8 million issued to purchase the minority interest in subsidiaries which owned the Brisas concession) and litigation settlement costs of $22.5 million ($17.5 million of which was stock and warrants).\nEconomic instability continued in Venezuela throughout 1995. The Venezuelan government imposed controls over the exchange rate between the U.S. dollar and the Venezuelan bolivar in mid 1994, freezing the rate at 170 bolivares per dollar and limiting the access to dollars in exchange for bolivares. These exchange control measures remain in place as of March 26, 1996 although, in December 1995, the official exchange rate was increased to 290 bolivares per U.S. dollar. The Venezuelan government is presently negotiating with the International Monetary Fund to secure funding to restructure its economy. As a result of these negotiations, the Venezuelan government has announced it expects to lift exchange and price control measures sometime during 1996.\nIn January 1995, the Company and its Brisas subsidiary settled all outstanding litigation commenced in Venezuela in July 1992 to rescind a mining lease and purchase option agreement covering the Brisas concession. As part of the settlement the Company issued the defendants 2,750,000 common shares and 750,000 common share purchase warrants (exercisable at $10 Cdn for 18 months), and deposited $4.5 million into escrow to be released to one of the defendants upon the granting of the Brisas hardrock or veta rights to the Company. The total settlement of $22,512,500 was recorded as an expense in the consolidated statement of operations of the Company for the year ended December 31, 1994 (see Item 3. Legal Proceedings).\nPursuant to a plan of exchange approved by the Company's shareholders in May 1995, each issued and outstanding share of Gold Reserve Aruba and Glandon (indirect owners of the Brisas concession), other than shares held by the Company, was exchanged for shares of the Company. As a result of the exchange, which was completed in June 1995, the Company issued 1,329,185 common shares valued at $9.8 million, Gold Reserve Aruba and Glandon became wholly-owned subsidiaries of the Company and the Company increased its indirect ownership in the Brisas concession from 91% to 100%.\nFinancial Information about Industry Segments. --------------------------------------------- The Company is solely engaged in mining, which is a single industry segment.\nOther Activities. ----------------- The Company continually evaluates other precious metal mining opportunities in Venezuela and throughout the world for possible acquisition or joint venture and from time-to-time, engages in exploratory discussions regarding such opportunities. The Company does not at this time have any discussions underway regarding such transactions.\nExecutive Offices and Employees. -------------------------------- The Company's principal executive offices are located at 1940 Seafirst Financial Center, Spokane, Washington 99201. At March 26, 1996, the Company employed six people in its Spokane office and eighty in Venezuela, of which approximately sixty employees are located at the Brisas concession. The Company manages the day-to-day activities of its Venezuelan operations from its offices in Caracas and Puerto Ordaz.\nFinancial Information about Foreign and Domestic Operations and Export Sales. ---------------------------------------------------------------------- The following table sets out, as of and for the years ended December 31, 1995, 1994 and 1993, identifiable assets attributable to the Company's operations in the United States and Venezuela, and net losses from United States and Venezuelan operations.\nYear Ended December 31, (in thousands of dollars) --------------------------- 1995 1994 1993 Identifiable assets: United States $29,721 $33,503 $ 5,636 Venezuela 22,541 9,760 8,271 ------- ------- ------- Totals $52,262 $43,263 $13,907 ======= ======= ======= Net loss: United States $ 182 $23,434 $ 994 Venezuela 155 306 1,850 ------- ------- ------- Totals $ 337 $23,740 $ 2,844 ======= ======= =======\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Brisas Concession\nLocation. --------- The Brisas concession is located in the KM 88 mining area of southeastern Venezuela in Bolivar State. The concession is situated approximately 120 miles (200 kilometers) southeast of Puerto Ordaz, between the mining town of Las Claritas and the KM 88 distance marker on Highway 10 leading south from the town of El Dorado. The concession is 1.5 miles (2.5 kilometers) west of KM 88, and is accessible by an all-weather dirt road which divides the concession longitudinally into two halves. Supplies and accommodations are available in Las Claritas. The Brisas concession occupies a rectangular area of approximately 1,235 acres (500 hectares). The dimensions of the concession are 2,500 meters or 1.5 miles (north- south) by 2,000 meters or 1.25 miles (east-west). The concession is covered by a sparse jungle canopy not typical of the region.\nOwnership. ---------- Gold Reserve acquired the Brisas concession in late 1992. At that time the property was the subject of a lawsuit over ownership, which was ultimately settled in January 1995. The Brisas concession is an exploitation concession granted by the MEM covering near-surface alluvial deposits. Activities on the Brisas concession are conducted through GLDRV and its subsidiary Brisas, which holds title to the alluvial gold concession and has applied to the MEM for the hardrock (veta) concession. GLDRV is owned directly and indirectly by Gold Reserve Aruba and Glandon, which are wholly-owned subsidiaries of the Company. The Company applied to the MEM in February 1993 for the hardrock or veta rights to additional mineralization underlying the Brisas alluvial concession. The application was reviewed by the technical and legal departments of MEM, without objection, and was approved by MEM on March 3, 1995. The next step is for the MEM to submit the application to the Official Gazette for publication, following which interested parties, if any, who believe that the concession, if granted, would invade their property rights, may file a formal opposition and present testimony to the MEM. The Company is not aware of any fact or circumstance which would prevent the MEM from submitting the application for public comment and ultimately granting the veta concession to the Company, nor is it aware of any objection to the application or any circumstance under which an objection, if filed, would be sustained. Under Venezuelan law, only the party which holds title to the alluvial concession may be granted the hardrock or veta concession.\nGeology. -------- The general geology of the area includes thick sequences of Proterozoic volcanic flows, sediments and various intrusives of the Guayanan Shield which were folded, sheared, faulted and metamorphosed during the Proterozoic period. The prospect pits and mineralization on the Brisas concession show a northeasterly regional trend. The mineralization found in the larger existing pits on the concession has characteristics similar to other large deposits in Precambrian rocks, such as volcanogenic sulphide and structurally controlled deposits.\nThe structure identified on the Brisas property consists of two major types of materials--saprolite\/clay-hosted alluvial material occurring in the upper several meters of the concession and hard rock dacitic tuffs, basalt and andesite porphyry extending below the alluvial material to depths of over 400 meters. Gold, copper and molybdenum mineralization are found in both materials, and the structure is open at depth and in all directions.\nExploration. ------------ Exploration activities on the concession have included mapping, surface sampling and assaying, geophysics, geochemistry, preliminary metallurgical testing, airborne magnetic and radiometric surveys, and diamond and auger drilling. These activities have confirmed the existence of an anomaly approximately one mile (1.6 kilometers) in length, on strike with a deposit on Placer Dome Inc.'s Las Cristinas property to the north. Placer Dome Inc. has announced a geologic resource on its Las Cristinas property of more than 9 million ounces of gold with a total potential of up to 12 million ounces. Airborne magnetic and radiometric surveys of the Brisas concession and the surrounding region have outlined the most altered and potentially mineralized areas indicating the presence of a widespread alteration zone centered on Placer's Las Cristinas property and extending southward onto the Brisas concession.\nIn December 1993, the Company completed the first phase of its preliminary drilling program on the concession. The drilling program consisted of 47 diamond and auger drill holes totaling approximately 4,600 meters. The holes ranged from 50 meters to approximately 400 meters in depth and were concentrated in the northern end of the concession. This drilling program confirmed the existence of the Brisas-Las Cristinas trend previously identified by the Company using geophysical and geochemical sampling methodologies, and revealed gold- copper mineralization in the saprolites and the underlying hard rock. Zones of massive sulfide were also encountered in the hard rock. In 1994 approximately 120 auger and 55 diamond drill holes were completed at depths ranging from 50 to 200 meters. (A total of 3,336 meters of auger drilling and 9,777 meters of core drilling were completed during the year.) The drilling program was disrupted by a number of events related to the Brisas litigation. As a consequence, no substantive information was obtained. The Company also developed a computer model of the geologic structures on the concession in 1994. The model indicates that the geology of the concession is very complex, due to faulting and other tectonic activity. The computer model also indicates the possibility of an extension of mineralization at depth. The 1995 exploration program included approximately 23,000 meters of auger and core drilling which cost approximately $4 million, inclusive of related personnel and administrative costs. This drilling program, along with the results of the 1993 and 1994 drilling and exploration efforts, served as the basis for the Company's announced geologic resource.\nGeologic Resource. ------------------ The Company has to-date announced a geologic resource of 6.7 million ounces of gold and gold equivalent, consisting of 4.9 million ounces of gold and 720 million pounds of copper (or approximately 1.8 million ounces of gold equivalent). The resource now approximates 177 million tons grading 0.85 grams (0.027 ounces) per ton gold and 0.18% copper. Mineralization related to the alluvial concession is less than 15% of the deposit; the remainder of the deposit is related to the hardrock (veta) concession for which the Company has applied to the MEM but has not been formally granted as of the date of this report. This resource is expected to increase as additional results from the current in-fill drilling program are obtained, as the Blue Whale structure is delineated further, and as the southern part of the concession and deeper zones are explored. The resource announced to- date has been influenced only slightly by mineralization contained in the Blue Whale structure, since only limited drilling has been conducted in this area. In addition, the mineability of the deeper resource will ultimately be determined by several factors, including the price of gold and an economic feasibility study. However, it is clear that mineralization continues at depth and should be further evaluated.\nSignificant Zones or Areas of Interest. --------------------------------------- The Company is currently working in four significant areas or zones contained within the main trend in efforts to define the minerali- zation of the concession. The four significant areas or zones of interest within this trend are the Pozo Azul zone located in the northern half of the concession; the high-grade Blue Whale hardrock structure which is contained within the Pozo Azul zone; the southern part of the concession where visible gold has been observed in drill core; and the deeper material below 210 meters.\nGenerally the mineralization is characterized by a large low grade system with a higher-grade core. In addition, the Pozo Azul zone contains a high-grade gold\/copper zone called the \"Blue Whale\" which is characterized by much higher grades of gold and copper. Low grade copper is also present in the Pozo Azul zone outside the higher grade core, whereas there is little or no copper present in the southern end of the Pozo Azul zone. The Pozo Azul zone has been drilled with over 300 diamond and auger holes which indicate an area of wide spaced mineralization. Drilling has confirmed a strike length of at least 1,600 meters. The width of the mineralization ranges from 400 meters to more than 800 meters, with depths of over 300 meters and is surrounded, mainly to the east, by additional shallow mineralization as much as 800 meters wide. The mineralization is also open at depth, meaning that some of the holes bottomed in gold and\/or copper mineralization.\nThe high-grade Blue Whale horizon within the Pozo Azul zone outcrops in the northeast corner of the property in the Pozo Azul pit, and dips to the southwest of the property. This is believed to be the locus or \"feeder zone\" for the Brisas mineralization. Limited drilling has indicated the length of the Blue Whale at over 600 meters along strike and as much as 100 meters wide at surface, and up to 32 meters thick.\nThe Blue Whale has been encountered 328 meters deep and is open at depth. The Blue Whale is characterized by much higher-grade gold and copper mineralization; grades up to 6 grams or more of gold per ton, and over one percent copper have been encountered with limited drilling.\nSeveral drill-holes planned for the current in-fill drilling program should intercept the Blue Whale and may add to the total geologic resource.\nCurrent Development Program. ---------------------------- Development drilling continues in the Pozo Azul zone, the bulk of which will be completed in 1996. The drilling includes an estimated 129 diamond drill hole program based on 50 meter spacing, totaling some 18,000 meters. The first phase of in-fill drilling consists of approximately 51 holes on the existing section lines used in the resource estimate. The second phase consists of approximately 42 holes on intermediate cross section lines with holes spaced at 100 meters. The final phase consists of the remaining approximately 36 holes on the intermediate lines resulting in a 50 x 50 grid spacing. In addition, the Company will initiate a 25 x 25 meter spaced drill program on selected areas of the Pozo Azul zone in May or June of 1996. These programs are designed to delineate further the resource within the Pozo Azul zone, including the \"Blue Whale\" horizon and the mineralization below 210 meters, and to support a feasibility study. Approximately 50 additional holes are planned to identify tailings and waste disposal sites, and a number of large-diameter holes are planned for pilot-scale metallurgical testing to substantiate initial research work and provide pilot test data to generate engineering design criteria. The estimated development budget for 1996 is $6 to $8 million.\nPreliminary Mill Design and Production Plans. --------------------------------------------- The Company engaged an independent consultant to provide advice on preliminary mill design and production plans. This information, to be utilized by the Company to develop its feasibility study for the concession, is preparatory in nature and therefore not definitive. The mill is expected to be a conventional, gravity\/flotation\/cyanidation process yielding estimated recovery of gold and copper in excess of 90%. Up to 25% of the gold could be recovered by gravity, 50% by copper flotation and over 20% by cyanidation. Preliminary cost estimates of a 15,000 ton per day mill (with an error factor of -5% to +25%) are approximately $90 million.\nThe Brisas concession is expected to be mined by open pit methods commencing in the Pozo Azul pit. The gold and copper appear at surface and mining is expected to be relatively simple and low cost, characterized by a low waste to ore strip ratio (estimated to be 1 to 1). The Pozo Azul pit would ultimately be longer than 1.6 kilometers and up to 800 meters wide. It is currently contemplated that a 20,000 or more tons per day milling facility will be constructed, and that open pit mining will generate at least 40,000 tons per day, including waste rock. In the early years this mine could produce in excess of\n400,000 ounces of gold and 45 million pounds of copper, with the addition of Blue Whale material. It is anticipated that the average gold production would be between 200,000 and 300,000 ounces of gold per year over a 12-14 year mine life. Studies to be conducted in late 1996 will focus on the final recovery process to be applied to this deposit. There are two main types of material to be mined, a soft clay-like material called saprolite, which constitutes about 15 percent of the deposit, and bedrock which represents the other 85 percent. Mining will be conventional blast, shovel and haul open pit mining which would then be fed to a central crusher. Special techniques may have to be employed in mining of the surface saprolites. Also because of the high water table in the area, continuous dewatering of the pit will have to be employed.\nVenezuelan Mining and Environmental Matters. -------------------------------------------- The Company's Venezuelan mining operations are subject to laws of title that differ substantially from those of the United States, and to various mining and environmental rules and regulations that are similar in purpose to those in the United States. The more significant of these laws, rules and regulations are summarized below.\nCURRENT VENEZUELAN MINING LAW. The principal legislation governing the exploration and development of mineral resources in Venezuela is the Mining Law of 1945 and related regulations, administrative decrees and resolutions. The law governs every aspect of mineral exploration, evaluation and extraction throughout the country, and is administered by the MEM, through its Department of Mines.\nA chief distinction between the mining laws of Venezuela and those of the United States is the way in which mineral rights are owned and held. In Venezuela, all minerals, other than those used in construction, are initially owned by the government and can be explored and developed only by state-owned corporations or private entities that have applied for and obtained concessions or permits for such activities. Concessions may be granted for near-surface development (an alluvial concession) or subsurface vein development (a veta concession) or both. Generally a separate concession is granted for each mineral to be explored or exploited.\nThere are two types of concessions. The first, an exploration and exploitation concession, gives the holder up to two years to explore a property of a maximum of 5,000 hectares (12,355 acres), and the right to choose for exploitation 50% of the area granted in parcels of 500 hectares (1,235.5 acres) each; for that purpose a certificate of exploitation has to be granted by the MEM. The second, an exploitation concession, does not have an exploration period and has an established surface area of up to 500 hectares. Under an exploitation concession, a mining title is granted directly to the holder. In both kinds of concessions, the holders have, in the case of alluvial deposits, three years to initiate exploitation and, in the case of vein deposits, five years to initiate exploitation. During such period, concession holders must submit a technical and economical feasibility study for approval to the MEM within 18 months for alluvial deposits and within 36 months for vein deposits, each case determined from the date of grant of the mining title or of the certificate of exploitation.\nConcessions and certificates of exploitation are granted in respect of rectangular lots not larger than 500 hectares (1,235.5 acres), and a single holder cannot be granted a total of more than 10,000 hectares (24,710 acres) of concessions relating to vein deposits and 20,000 hectares (49,420 acres) of concessions relating to alluvial deposits. Generally each mineral to be exploited is subject to the grant of a different concession, and usually a concession granted relating to alluvial deposits constitutes a separate concession from a concession relating to the underlying vein deposits. Both concessions grant the holder 20 years to actually complete development of the concession, provided all specified requirements, including compliance with environmental laws, are met. This period can be extended for up to an additional 20 years, through two 10- year extensions, following which all rights to the concession, including improvements, revert to the Venezuelan government. Holders of concessions are required to report their activities to the Department of Mines and must submit to routine inspections by Department representatives to confirm compliance with the law.\nAll exploration and development activities must be conducted in compliance with applicable mining law, and may be undertaken only by applicants who demonstrate technical and financial capability, undertake to manufacture or refine mined ores in Venezuela, submit to Venezuela's tax laws, agree to share their mining technology with the local mining industry and recognize the reversionary interests of the Venezuelan government in the concession. In addition, an applicant for a concession must agree to certain terms, known as \"special advantages\", including the amount of royalties or mining taxes to be paid and the extent to which bonds or sureties may be posted to guarantee performance of the applicant's obligations. An applicant may also be required to make certain improvements for the benefit of the concession property and the surrounding area, such as constructing and maintaining access roads, airstrips, schools and medical dispensaries, and must agree to train local employees in modern mining exploration and production techniques.\nVenezuela has historically relied on government-owned entities to explore and develop mineral resources, although this practice is diminishing as the government seeks to encourage private investment. In the Guayana region of the country, for example, the regional Corporacion Venezolana de Guayana (the \"CVG\") and its various subsidiary state-owned companies have been granted the exclusive right to explore, evaluate and mine diamond and gold resources not previously awarded as concessions by the MEM. To accomplish this, CVG has granted mining contracts to private investors in the region and has engaged in joint venture or other arrangements with foreign and local companies. Although the Company's Brisas concession is located in the Guayana region, it was awarded by the MEM and is not subject to exploration or development claims by the CVG. The Company has been granted contracts by CVG and has pending applications on small parcels of property adjacent to the concession.\nPROPOSED MINING LAW. The former administration in Venezuela, lead by the MEM, introduced extensive amendments to Venezuela's mining law in 1993. These amendments include, among other items: the creation of a national mining council as an auxiliary entity under the Department of Mines; the introduction of the concept of assignment of mineral exploration and exploitation rights, which would facilitate joint ventures with state-owned companies; an easing of costly and time-consuming bureaucratic steps necessary to obtain a concession, coupled with the introduction of a new permitting system; expansion of the area that may be covered by a single exploration concession, and extension of the exploration period to up to six years; extension of the concession exploitation period from a maximum of 40 years to a maximum of 50 years; and a re-evaluation of the method and manner in which mining activities are taxed. Subsequently, the current MEM administration proposed new changes to the mining law which includes, among other things, granting concessionaires rights to substantially all mineralization contained in surface and deep (hardrock) material, seven year exploration periods, a royalty on gold production of 4%, (1% if sold to the Venezuelan Central Bank) and a bidding process for new concessions. The Venezuelan government, the MEM and industry representatives are currently debating the proposed changes to the mining law and there is no indication when or if any of the proposed changes will be adopted. The proposed amendments to the mining law are not expected to substantially affect existing concessions such as the Company's Brisas concession, or the terms under which such concessions can be explored or developed.\nENVIRONMENTAL LAWS AND REGULATIONS. Venezuela's environmental laws and regulations are administered through regional offices of the Ministry of the Environment and Renewable Natural Resources. Concession holders who seek to develop a mineral property must first obtain a permit granting them the right to occupy the territory for mining purposes and then submit a report outlining the environmental impact of the development and the rehabilitative or reconditioning work to be undertaken once development activities are concluded. The ministry also prescribes certain mining recovery methods deemed harmful to the environment and monitors the concessionaire's activities to ensure compliance. The Company has presented an environmental audit of the alluvial concession and the first phase of an environmental impact study to the ministry (through its Brisas subsidiary), and will soon submit the second phase of the study. The Company also expects to submit an environmental impact statement to the Ministry addressing development and reclamation of the deeper mineralization believed to underlie the Brisas concession when the Company's application for the veta concession is granted. Alternatively, the Company may amend the existing environmental study to include the effect of mining the deeper mineralization.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn January 1995, the Company and its Brisas subsidiary settled all outstanding litigation commenced in Venezuela in July 1992 to rescind a mining lease and purchase option agreement covering the Brisas concession. The Company contended throughout the lawsuit that the lease was terminable for nonpayment of rentals during a thirteen month period, and that a purchase option in the lease granting the defendant-lessee a right to purchase the concession was likewise terminable. The defendant-lessee and other parties who acquired an interest in the defendant-lessee during the course of the lawsuit and became additional defendants contended that the obligation to pay rentals during the disputed period was suspended by Brisas, and that the purchase option had not terminated. Despite the fact that the Venezuelan courts largely agreed with the Company's arguments, management and the board of directors determined that the long-term interests of the Company and its shareholders were best served by settlement of the lawsuit.\nUnder the terms of the settlement agreement, which closed in January 1995, the Company issued 1,500,000 common shares and 500,000 common share purchase warrants (exercisable at $10 Cdn for 18 months) to Marwood International Ltd. (\"Marwood\") a wholly-owned subsidiary of TVX Gold Inc. (\"TVX\") and issued 1,250,000 common shares and 250,000 common share purchase warrants (exercisable at $10 Cdn for 18 months) to Bluegrotto Trading Limited (\"Bluegrotto\"), in exchange for releases irrevocably disposing of all rights, claims or causes of action asserted or capable of being asserted against the Company or Brisas with respect to the ownership, custody and control of the Brisas concession. Inversiones 871010, C.A., the original defendant is owned 90% by Marwood and 10% by Bluegrotto. The Company also deposited the sum of $4.5 million into a special escrow account for the benefit of TVX. These funds are to be released in the event Brisas is granted a concession from MEM to exploit the veta or bedrock rights underlying the Brisas concession on or before January 1, 2000. A related standstill covenant provided that the securities issued to the defendants may be sold only in accordance with certain limitations including a limitation that not more than 75,000 shares be sold in any 30-day period, other than pursuant to certain permitted block trades--until the earlier of three years following closing or such time as the defendants and any related persons own in the aggregate 5% or less of the then outstanding shares of common stock of the Company.\nAs part of this covenant, the defendants further agreed that, for a period of four years, they would not: acquire any additional shares of common stock of the Company, whether in the open market or otherwise; directly or indirectly initiate, encourage or participate in any solicitation of proxies with respect to any matter submitted to the shareholders of the Company for vote; deposit any of their shares into a voting trust or other voting arrangement, or join in any partnership, limited partnership, syndicate or group for the purpose of owning, holding or disposing of such securities; or directly or indirectly initiate or encourage a tender or exchange offer for the securities of the Company, or agree to vote in respect of, or deposit or tender their securities in response to, any tender or exchange offer initiated, directly or indirectly, by a related party.\nOn February 15, 1996, the Company consented, for a 30 day period, to the disposal by TVX of 1,500,000 common shares and 500,000 common share purchase warrants to a prescribed group of purchasers. According to an amendment to Schedule 13D filed by TVX, these securities were sold on February 19 and 26, 1996. All other terms and conditions of the settlement remain in full force and effect.\nThe total settlement of $22,512,500 was recorded as an expense in the consolidated statement of operations of the Company for the year ended December 31, 1994. The settlement amount represents the market value, as of the settlement date, of the 2,750,000 shares of common stock issued in settlement; a value of $800,000, determined by an independent financial advisor retained by the Company, attributable to the 750,000 warrants issued in settlement; the $4.5 million placed in escrow; and related settlement costs of approximately $300,000.\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 Registrant's Common Equity and Related Stockholder Matters.\nMarket Information. ------------------- The common stock of the Company is traded on NASDAQ under the symbol \"GLDR\" and on the Toronto Stock Exchange (\"TSE\"), since September 1994, under the symbol \"GLR\". The following table sets out the high and low prices per share for the common stock for 1995 and 1994, as reported by the TSE and NASDAQ. The prices reported reflect inter-dealer prices, without regard to retail mark-ups, mark-downs or commissions, and do not necessarily reflect actual transactions.\nHolders. -------- The number of holders of common stock of record on March 26, 1996 was approximately 1,400 and total holders of common stock including those held in street name was approximately 6,000.\nDividends. ---------- The Company has declared no cash or stock dividends on its common stock since 1984, and in the opinion of management of the Company, will declare cash dividends in the future only if the earnings and capital of the Company are sufficient to justify the payment of such dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe consolidated financial data set forth below have been selected by the Company and should be read in conjunction with the Company's consolidated financial statements. The financial data for 1995, 1994, 1993 and 1992 have been derived from the Company's consolidated financial statements, which have been audited by Coopers & Lybrand L.L.P., Spokane, Washington. The consolidated financial data for 1991 have been derived from the Company's consolidated financial statements, which have been audited by McFarland & Alton, P.S., Spokane, Washington. This financial data should be read in conjunction with, and is qualified by such financial statements and the notes thereto.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nSummary. -------- The consolidated results of operations for 1995 consist of expenses related to activities other than the exploration and development of the Brisas concession partially offset by interest income from invested funds. All expenditures related to exploration activities on the concession have been capitalized as exploration and development costs. The Company has incurred losses in each of the last five years due to the lack of an operating property or other revenue generating business activity, and because of litigation, settlement costs and disposal of the Alfa concessions. Management anticipates that net losses of the Company will likely continue over the next three years as the result of increased expenditures associated with the management of exploration and development activities on the Brisas concession. Management estimates the trend of consolidated losses will reverse if and when gold and copper is produced from the Brisas concession. However, a number of significant events must occur before commercial production of the Brisas concession can begin, including the establishment of proven and probable reserves, the formal granting of the veta rights to the concession and procurement of all necessary regulatory permits and approvals.\nResults of Operations. ---------------------- 1995 COMPARED TO 1994. Consolidated net loss for the year ended December 31, 1995 was $337,303 or $0.02 per share, a decrease of approximately $23,000,000 from the prior year. The year ended December 31, 1994 included one-time litigation settlement costs as well as costs associated with the disposal of subsidiaries. Other income for 1995 was $1,418,754, which is an increase of approximately $85,000 over the previous year. The increase in other income during 1995 was principally due to increases in interest income offset by lower foreign currency gains. Interest income increased approximately $518,000 during the year due to greater levels of and returns on invested cash and foreign currency gain decreased approximately $418,000 due to the increases in currency exchange rates in Venezuela. The Venezuelan exchange rate was set at 170 bolivares per U.S. dollar during most of 1995 and was increased to 290 in December 1995. Operating expenses for the year amounted to $1,756,057, which is a decrease from the prior year of approximately $118,000, excluding settlement costs and loss on disposal of consolidated subsidiary incurred in 1994. Major components of the change in operating expenses, exclusive of settlement costs and loss on disposal of consolidated subsidiary, are a decrease in general and administrative of approximately $259,000 and legal and accounting of approximately $403,000, offset by an increase in directors' and officers' compensation of approximately $139,000 and a decrease in minority interest in net loss of consolidated subsidiaries of approximately $314,000.\nThe decrease in general and administrative expenses was generally caused by the elimination of costs associated with Unicorn and its subsidiaries which operated the Alfa concessions. The Alfa concessions were disposed of in 1994. The decrease in legal and accounting expense is principally related to the settlement of the Brisas litigation. Directors' and officers' compensation increased as a result of salary adjustments in 1995 for officers. The principal change in minority interest in net loss of consolidated subsidiaries is the minority interest share of Unicorn's net loss from the Alfa concessions.\n1994 COMPARED TO 1993. Consolidated net loss for the year ended December 31, 1994 was $23,740,478 or $1.68 per share, an increase of approximately $21,000,000 from the prior year. Other income for the year was $1,334,044, which is an increase of approximately $818,000 over the previous year. The increase in other income during 1994 was principally due to increases in interest income offset by lower foreign currency gains. Interest income increased approximately $932,000 during the year due to greater levels of invested cash and foreign currency gain decreased approximately $108,000 due to the repayment of the Brisas contract payable and exchange controls implemented by the Venezuelan government. During 1994 the Venezuelan exchange rate was set at 170 bolivares per U.S. dollar. Operating expenses for the year amounted to $25,074,522, which is an increase of approximately $21,700,000 from the prior year. The increase in operating expense was primarily due to costs related to the settlement of the Brisas litigation. Operating expenses for 1994, exclusive of the settlement costs, were approximately $2,600,000, which is a decrease from the prior year of approximately $800,000. Major components of the change in operating expenses, exclusive of settlement costs, were an increase in general and administrative of approximately $550,000 and legal and accounting of $290,000, offset by an increase in minority interest in net loss of approximately $320,000 and a decrease in loss on disposal of consolidated subsidiary of approximately $1,200,000.\nThe 1994 increase in general and administrative expenses was generally caused by increases in personnel related costs, travel, consulting, costs related to expanded shareholder communications and promotion and associated costs related to dual stock market listings. Previously, costs associated with Unicorn were recorded as capitalized exploration and development costs. In 1994, all costs associated with the operations of Unicorn were expensed and included in the consolidated results of operations. The change in legal and accounting is principally related to the Brisas litigation. The principal change in minority interest in net loss of consolidated subsidiary is the minority interest share of Unicorn's net loss. The change in the loss on disposal of consolidated subsidiary represents the difference between the adjustment for estimated net realizable value recorded in 1993 and the additional loss recorded in 1994 at the time the sale transaction was completed.\nDuring 1994, the Company exchanged all of the outstanding shares of common stock of a subsidiary, Caromin Aruba (and indirectly its ownership of the Alfa concessions) for all of the outstanding shares of Stanco, a company owned by a former employee. The former employee placed 58,333 shares of the Company and 700,000 shares of Glandon into an escrow arrangement within Stanco. These securities are held by an independent escrow agent pending future sale for the benefit of the Company. Under certain circumstances a portion of the proceeds from the sale of the securities held in escrow are payable to the former employee. The Company's total investment, through its subsidiaries, associated with the Alfa concessions was approximately $3.8 million as of the date of sale. The proceeds to be received by the Company from the securities held in escrow are $1.3 million, based on the market value of the Company's common stock as of the date of the transaction, resulting in a loss of $2.5 million from the disposal. The Company recorded $1.85 million of this loss during the year ended December 31, 1993, and recorded the remaining $690,000 in 1994.\nLiquidity and Capital Resources. -------------------------------- INVESTING. During 1995 the Company commenced development drilling in the Pozo Azul zone, the bulk of which will be completed in 1996. The drilling includes a 129 diamond drill-hole program based on 50 meter spacing, totaling some 18,000 meters. In addition, the Company will initiate a 25 x 25 meter spaced drill program on selected areas of the Pozo Azul zone in May or June of 1996. These programs are designed to delineate further the resource within the Pozo Azul zone, including the \"Blue Whale\" horizon and the mineralization below 210 meters, and to support a feasibility study. Approximately 50 additional holes are planned to identify tailings and waste disposal sites, and a number of large-diameter holes are planned for pilot-scale metallurgical testing to substantiate initial research work and provide pilot test data to generate engineering design criteria. The estimated development budget for 1996 is $6 to $8 million.\nThe Company engaged an independent consultant to provide advice on preliminary mill design and production plans. This information, to be utilized by the Company to develop its feasibility study for the concession, is preparatory in nature and therefore not definitive. The mill is expected to be a conventional, gravity\/flotation\/ cyanidation process yielding estimated recoveries of gold and copper in excess of 90%. Initial cost estimates of a 15,000 ton per day mill (with an error factor of -5% to +25%) are approximately $90 million.\nSignificant additional drilling activities remain to be undertaken on the concession. Management has not determined when commercial development of the concession, if warranted, might begin. On March 21, 1996 the Company announced a geologic resource of 6.7 million ounces of gold and gold equivalent, consisting of 4.9 million ounces of gold and 720 million pounds of copper (or approximately 1.8 million ounces of gold equivalent). The resource now approximates 177 million tons grading 0.85 grams (0.027 ounces) per ton gold and 0.18% copper. Mineralization related to the alluvial concession is\nless than 15% of the deposit, the remainder of the deposit relates to the hardrock (veta) concession for which the Company has applied to the MEM but has not been formally granted as of the date of this report. Development of the Brisas concession is contingent on the results of future drilling, obtaining the hardrock or veta rights to the property and other Venezuelan regulatory issues.\nDuring the year ended December 31, 1995, the Company expended approximately $3.7 million on the Brisas concession. These expenditures consisted of approximately $3.5 million in capitalized development and exploration costs and $0.2 million for equipment. On a cumulative basis since inception, the Company has expended approximately $45.5 million on the Brisas concession. These costs include acquisition costs of $2 million, capitalized development and exploration costs and equipment expenditures of $21 million (including Company stock valued at $9.8 million issued to purchase the minority interest in subsidiaries which owned the Brisas concession) and litigation settlement costs of $22.5 million ($17.5 million of which was stock and warrants) which was expensed in 1994. Amounts recorded as capitalized exploration and development costs include all costs associated with the Brisas concession, including personnel and related administrative expenditures, drilling and related exploration costs, capitalized interest expenses, litigation costs and general support costs related to the concession.\nThe Venezuelan government imposed controls over the exchange rate between the U.S. dollar and the Venezuelan bolivar in mid 1994, freezing the rate at 170 bolivares per dollar and limiting the access to dollars in exchange for bolivares. These exchange control measures remain in place as of March 26, 1996 although, in December 1995, the official exchange rate was increased to 290 bolivares per dollar. The Venezuelan government is presently negotiating with the International Monetary Fund to secure funding to restructure its economy. As a result of these negotiations, the Venezuelan government is expected to lift exchange and price control measures sometime during 1996.\nBeginning in the third quarter of 1995, partly in reaction to pent- up demand in Venezuela for U.S. dollars, the government sanctioned an unofficial secondary currency market by permitting deeply discounted purchases of dollar denominated Venezuelan national debt (Brady Bonds) using bolivares on the Caracas Stock Exchange. During the second half of 1995, the Company utilized the Brady Bond market mechanism to convert $1.6 million dollars into 410 million bolivares, realizing an average conversion rate of 256 bolivares per dollar compared to the official exchange rate of 170 bolivares per dollar, which helped offset the effect of inflation in Venezuela during 1995. The Company expects to continue to utilize this mechanism for substantially all of its conversions of dollars into bolivares to satisfy its bolivar denominated obligations as long as the combination of exchange controls and available secondary markets exist, although there is no certainty as to how long such conditions will continue or to what extent the officially controlled exchange rate will be exceeded by the secondary market conversion rate which as of March 22, 1996 such exchange rate was in excess of 530 bolivares per dollar.\nThe economic conditions in Venezuela have resulted in political and social turmoil on occasion, which can be expected to continue. Such conditions have not materially adversely affected the Company's operations in Venezuela to-date as substantially all of the Company's sources of funding for its Venezuelan operations are denominated in U.S. dollars and the Company does not repatriate funds from Venezuela. If exchange controls continue in Venezuela, then inflation will likely have an adverse affect on the Company's Venezuelan operations in the future. The Company does not believe its operations in Venezuela pose mining risks that are significantly greater than mining operations conducted in the United States. Although Venezuelan mining law treats mineral rights differently than they are treated in the United States, mining exploration and development activities themselves are conducted, as they are in the United States, under the auspices of the government and pursuant to published development and environmental guidelines and regulations. The Company believes such requirements are reasonable.\nFINANCING. The Company has financed its mining activities in Venezuela principally from the sale of equity securities. Future acquisition costs and exploration expenses, and the cost of placing the Brisas concession or additional future properties, if any, into production, if warranted, are expected to be similarly financed. During 1994 and 1993, the Company raised approximately $46.7 million in equity financing to support its business activities. These transactions consisted of the sale of additional shares of common stock, or warrants to purchase common stock, and the exercise of previously issued warrants and options. Management anticipates that the Company will require additional financing in order to place the concession into production. The Company continuously evaluates market and other conditions for the possible sale of common stock to finance such activities, but has no current plans to issue additional shares except in connection with the exercise of warrants and options.\nOn March 14, 1996 the board of directors of the Company approved a six month extension of the expiration date, from March 15, 1996 to September 15, 1996, of the 1,000,000 common share purchase warrants (exercisable at $13.00) issued in March of 1994 and previously extended from March 15, 1995 to March 15, 1996. In addition, the Company has 750,000 common share purchase warrants outstanding which are exercisable at $7.33 and expire in June 1996. The Company expects to raise an additional $18.5 million if and when these warrants are exercised.\nAs of March 26, 1996, the Company held approximately $24 million in cash and held-to-maturity securities. Whether and to what extent additional or alternative financing options are pursued by the Company will depend on a number of important factors, including the results of exploration and development activities on the Brisas concession, whether the Company is successful in obtaining the concession to the bedrock or veta mineralization believed to underlie the Brisas concession, management's assessment of the financial markets, the successful acquisition of additional properties or projects, if any, and the overall capital requirements of the consolidated group. At this time, management anticipates that\nits current cash and investment position, together with the proceeds expected to be received from any future exercise of outstanding warrants, will be sufficient to cover estimated operational and capital expenditures associated with the exploration and development of the Brisas concession through 1997.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS No. 123). The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. The Statement requires adoption on or before January 1, 1996 and allows a reporting 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\" as long as the entity provides pro- forma disclosure of stock-based employee compensation plans using the fair value based method of accounting in its annual financial statements.\nIn March 1995, 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\" was issued. The Statement prescribes the recognition and measurement of impaired assets, including long-lived assets. It requires that the carrying amount of impaired assets be reduced to fair value. The Statement requires a review for impairment of long-lived assets and identifiable intangibles to be held and used by an entity whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future net cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss should be recognized. However, the amount of the impairment loss to be recognized is based on discounted cash flows. Management does not expect any significant financial statement impact as a result of adopting the provisions of SFAS No. 121 as required on January 1, 1996.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIndex to Consolidated Financial Statements Report of Independent Accountants Consolidated Balance Sheets December 31, 1995 and 1994 Consolidated Statement of Operations for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\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 during the year ended December 31, 1995.\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Shareholders Gold Reserve Corporation\nWe have audited the accompanying consolidated balance sheets of Gold Reserve 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 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 Gold Reserve 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.\nAs discussed in Notes 2 and 4, the Company changed its method of accounting for investments in 1994 and income taxes in 1993.\nCOOPERS & LYBRAND L.L.P.\nSpokane, Washington March 15, 1996\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ----------- -----------\nASSETS Current Assets: Cash and cash equivalents $10,095,616 $ 6,675,771 Investments: Held-to-maturity securities, at amortized cost 10,630,963 26,079,822 Accrued interest on investments 101,793 259,780 Deposits, advances and other 628,037 493,956 Litigation settlement held in escrow 4,500,000 -- ----------- ----------- Total current assets 25,956,409 33,509,329 ----------- ----------- Property, plant and equipment, net 22,065,868 9,551,676 Investments: Available-for-sale securities 215,364 177,809 Held-to-maturity securities, at amortized cost 4,000,000 -- Other 24,066 24,066 ----------- ----------- Total assets $52,261,707 $43,262,880 =========== =========== LIABILITIES\nCurrent Liabilities: Litigation settlement payable $ 4,500,000 $ 4,500,000 Accounts payable and accrued expenses 262,219 572,713 Note payable: KSOP, current portion 149,960 25,000 ----------- ----------- Total current liabilities 4,912,179 5,097,713\nNote payable: KSOP, non-current portion 186,749 123,760 Minority interest in consolidated subsidiaries 90,160 141,651 ----------- ----------- Total liabilities 5,189,088 5,363,124 ----------- -----------\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, CONTINUED December 31, 1995 and 1994\n1995 1994 ----------- -----------\nSHAREHOLDERS' EQUITY\nShareholders' Equity: Serial preferred stock, without par value Authorized: 10,000,000 shares Issued: none Common stock, without par value Authorized: 40,000,000 shares Issued: 1995, 20,476,688 1994, 18,929,668 Outstanding, 1995, 19,995,644 1994, 18,577,175 $80,068,854 $69,453,393 Less common stock held by affiliates (1,428,565) (504,276) Unrealized gain on available-for-sale securities 85,960 79,017 Accumulated deficit (31,316,921) (30,979,618) KSOP debt guarantee (336,709) (148,760) ----------- ----------- Total shareholders' equity 47,072,619 37,899,756 ----------- ----------- Total liabilities and shareholders' equity $52,261,707 $43,262,880 =========== ===========\nThe accompanying notes are an integral part of the consolidated financial statements.\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------\nOther Income: Interest income $ 1,548,998 $ 1,031,206 $ 98,995 Foreign currency (loss) gain (130,244) 288,628 396,795 Miscellaneous -- 14,210 20,589 ------------ ------------ ------------ 1,418,754 1,334,044 516,379 ------------ ------------ ------------ Expenses: General and administrative 961,829 1,220,740 674,652 Directors' and officers' compensation 465,684 327,005 421,639 Legal and accounting 288,371 691,140 401,371 Depreciation 28,549 15,751 12,497 Interest, net of amount capitalized 8,214 3,318 2,221 Minority interest in net loss of consolidated subsidiaries (8,360) (322,348) (2,448) Loss on disposal of consolidated subsidiary -- 688,051 1,850,000 Litigation settlement 22,512,500 Net loss (gain) on investments 11,770 (61,635) -- ------------ ------------ ------------ 1,756,057 25,074,522 3,359,932 ------------ ------------ ------------ Net loss $ (337,303) $(23,740,478) $ (2,843,553) ============ ============ ============ Net loss per share $ (0.02) $ (1.68) $ (0.28) ============ ============ ============ Weighted average common shares outstanding 19,415,805 14,102,646 10,228,272 ============ ============ ============\nThe accompanying notes are an integral part of the consolidated financial statements.\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY, CONTINUED For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nGOLD RESERVE CORPORATION and SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS, CONTINUED For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements. GOLD RESERVE CORPORATION AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS\n1. The Company and Significant Accounting Policies:\nThe Company ----------- The Company was incorporated in Montana in 1956 for the purpose of acquiring, exploring and developing mining properties and placing these properties into production. The Company is currently involved in the exploration and development of the Brisas Alluvial Gold Concession (Brisas concession) a potential gold property in Venezuela.\nConsolidation ------------- The consolidated financial statements include the accounts of the Company, three Venezuelan subsidiaries, Gold Reserve de Venezuela, C.A. (GLDRV) Compania Aur'fera Brisas del Cuyun', C.A. (Brisas), Compania Minera Unicornio, C.A. (Unicorn), two domestic majority-owned subsidiaries, Great Basin Energies, Inc. (Great Basin) and MegaGold Corporation (MegaGold) and seven Aruban subsidiaries which were formed to hold the Company's interest in its foreign subsidiaries or for future transactions. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company's policy is to consolidate those subsidiaries where majority control exists and control is other than temporary.\nAt December 31, 1995 and 1994, the Company's proportionate share of the equity in its consolidated subsidiaries exceeded the Company's cost basis of its investments by $35,659 and $42,583, respectively, due to sales of the subsidiaries' common stock to minority shareholders at amounts in excess of the Company's cost basis.\nCash and Cash Equivalents ------------------------- The Company considers short-term, highly liquid investments purchased with an original maturity of three months or less to be cash equivalents for purposes of reporting cash equivalents and cash flows. At December 31, 1995, the Company had certificates of deposits totaling $149,960 pledged as security for bank loans related to the Gold Reserve KSOP Plan (see Note 5). At December 31, 1995, the Company had $95,000 in U.S. banks in excess of federally insured limits and had $927,000 in Venezuelan and off-shore banks.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n1. The Company and Significant Accounting Policies, Continued:\nInvestments ----------- Investments classified as available-for-sale are carried at quoted market value. Unrealized gains and losses are recorded as a component of shareholders' equity. Investments classified as held-to-maturity are carried at amortized cost. Realized gains and losses on the sale of investments are recorded based upon specific identification.\nExploration and Development Costs --------------------------------- Exploration costs incurred in locating areas of potential mineralization are expensed as incurred. Exploration costs of properties or working interests with specific areas of potential mineralization are capitalized pending the determination of a property's economic viability. Development costs of proven mining properties not yet producing are capitalized and classified as property, plant and equipment. Upon commencement of production, capitalized exploration and development costs will be amortized based on the estimated proven and probable ore reserves benefited. Deferred exploration and development costs of unsuccessful projects are expensed.\nProperty, Plant and Equipment ----------------------------- Property, plant and equipment are recorded at the lower of cost or estimated net realizable value. Replacements and major improvements are capitalized. Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets retired or sold are removed from the accounts and any resulting gain or loss is reflected in operations. Depreciation is provided using straight-line and accelerated methods over the useful life of the related asset. During the exploration and development phase, depreciation of mining assets is capitalized. Interest costs incurred during the construction and development of qualifying assets are capitalized. During 1994 and 1993, approximately $218,000 and $473,000 of interest was capitalized.\nIn March 1995, 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\" was issued. The Statement prescribes the recognition and measurement of impaired assets, including long-lived assets. It requires that the carrying amount of impaired assets be reduced to fair value. The Statement requires a review for impairment of long-lived assets and identifiable intangibles to be held and used by an\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n1. The Company and Significant Accounting Policies, Continued:\nProperty, Plant and Equipment, Continued ---------------------------------------- entity whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future net cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss should be recognized. However, the amount of the impairment loss to be recognized is based on discounted cash flows. Management does not expect any significant financial statement impact as a result of adopting the provisions of SFAS No. 121 as required on January 1, 1996.\nForeign Currency ---------------- The Company's Venezuelan subsidiaries operate in a highly inflationary economy. As a result, non-monetary assets and liabilities are translated at historical rates, while net monetary assets and liabilities are translated at current rates, with the resulting foreign currency translation gains and losses included in operations. Gains and losses from foreign currency transactions are also included in the results of operations.\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.\nSubstantially all of the Company's investment in property, plant and equipment represents amounts invested in the Brisas concession. Management's capitalization of exploration and development costs and assumptions regarding the future recoverability of such costs is subject to the risks and uncertainties of developing a mineable ore reserve on the Brisas concession which is based on engineering and geological estimates including gold and copper prices, estimated plant construction costs and operating costs and the procurement of all necessary regulatory permits and approvals, including the hard rock (veta) rights to the concession. These estimates could change in the future which could affect the carrying value and the ultimate recoverability of the amounts recorded as property, mineral rights and capitalized exploration and development costs.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n1. The Company and Significant Accounting Policies, Continued:\nEstimates, Continued -------------------- The Venezuelan government imposed controls over the exchange rate between the U.S. dollar and the Venezuelan bolivar in mid 1994, freezing the rate at 170 bolivares per dollar and limiting the access to dollars in exchange for bolivares. These exchange control measures remain in place as of the first quarter of 1996 although, in December of 1995, the official exchange rate was increased to 290 bolivares per dollar. The Venezuelan government is presently negotiating with the International Monetary Fund to secure funding to restructure its economy. As a result of these negotiations, the Venezuelan government is expected to lift exchange and price control measures sometime during 1996. Inflation and other economic conditions have resulted in political and social turmoil on occasion, which can be expected to continue. Such conditions have not materially adversely affected the Company's operations in Venezuela to date.\nVenezuela has generally encouraged foreign investment in the past, and the Company believes there presently exist no significant policies, license requirements or other regulations which might present barriers to its continued investment in the country. Whether and to what extent current or future economic, regulatory or political conditions may materially adversely affect the Company's financial position in the future cannot be predicted.\nNet Loss Per Share ------------------ Net loss per share is based on the weighted average number of common shares outstanding during each year, which has been reduced by the Company's proportionate ownership of common shares owned by Great Basin, MegaGold and Stanco Investments, A.V.V. (Stanco). Common stock equivalents are anti-dilutive and therefore have been excluded from the computation.\n2. Investments:\nThe Company accounts for its investment in equity securities as available-for-sale securities, and its investment in government- backed bonds as held-to-maturity securities according to the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" which was adopted by the Company January 1, 1994. The effect of applying this new standard was to increase shareholders' equity by $108,425. There was no income tax effect on the unrealized gain. Held-to-maturity securities consist primarily of U.S. bonds which are recorded at amortized cost. The bonds outstanding at December 31, 1995 mature as follows: $10,630,963 in 1996 and $4,000,000 in 1997.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n2. Investments, Continued:\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n2. Investments, Continued:\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n3. Property, Plant and Equipment:\nProperty, plant and equipment as of December 31, 1995 and 1994 consisted of the following:\n1995 1994 ----------- ----------- Domestic -------- Furniture and office equipment $ 184,271 $ 138,643 Transportation equipment 162,000 162,000 ----------- ----------- 346,271 300,643 Less accumulated depreciation (98,888) (70,339) ----------- ----------- 247,383 230,304 ----------- ----------- Foreign ------- Property and mineral rights 11,002,335 2,149,339 Capitalized exploration and development costs 10,247,988 6,737,686 Buildings 86,989 15,381 Furniture and fixtures 295,323 256,404 Transportation equipment 225,832 179,448 Machinery and equipment 286,463 163,702 ----------- ----------- 22,144,930 9,501,960 Less accumulated depreciation (326,445) (180,588) ----------- ----------- 21,818,485 9,321,372 ----------- ----------- Total $22,065,868 $ 9,551,676 =========== ===========\nIn June 1994, the Company exchanged all of the outstanding shares of common stock of a subsidiary, Compania Minera de Bajo Caroni A.V.V. (and indirectly its rights to the Alfa gold and diamond concessions) for all of the outstanding shares of Stanco, a company owned by a former employee. The Company's total investment, through its subsidiaries, associated with the Alfa concessions was approximately $3.8 million. Based on the value of the consideration received at the date of the transaction, the resulting total loss from the disposal was $2.5 million. During the year ended December 31, 1993, the Company recorded $1.85 million of this loss and during the year ended December 31, 1994, recorded the remaining $690,000 loss from the transaction.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n4. Income Tax:\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The change had no financial statement effect at January 1, 1993. No income tax benefit has been recorded for the three years ended December 31, 1995 due to net operating losses.\nThe Company's Venezuelan subsidiaries are subject to Venezuelan income tax. All costs related to the Company's Brisas concession have been recorded as capitalized exploration and development costs for tax purposes, and therefore the Company has not recorded any foreign tax attributes. No income tax has been paid or accrued by the Company's subsidiaries during 1995, 1994 and 1993. At December 31, 1995, the Company had the following U.S. federal tax basis loss carryforwards and tax credits:\nAmount Expires ----------- ----------- Regular tax net operating loss: $ 272,248 2006 1,650,395 2007 1,244,312 2008 700,536 2009 329,918 2010 ----------- $ 4,197,409 ===========\nAlternative minimum tax net operating loss: $ 289,523 2006 1,624,454 2007 1,218,023 2008 671,999 2009 300,000 2010 ----------- $ 4,103,999 ===========\nForeign tax credit $ 825 1996 Capital loss $ 832,473 1996 Investment tax credit $ 5,967 2001 Alternative minimum tax credit $ 19,871 --\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n4. Income Tax, Continued:\nThe components of the deferred tax assets and liabilities as of December 31, 1995 and 1994 were as follows:\nDeferred Tax Asset (Liability) ------------------------ 1995 1994 ----------- ----------- Accounts payable and accrued expenses $ 9,908 $ -- Accrued investment income (35,426) -- Property, plant and equipment 8,502,255 8,413,365 ----------- ----------- Total temporary differences 8,476,737 8,413,365\nNet operating loss carryforward 1,427,119 1,588,083\nInvestment tax credit 5,967 5,967 Alternative minimum tax credit 19,871 19,871 Foreign tax credit 825 17,336 Capital loss carryforward 283,041 303,978 ----------- ----------- Total temporary differences, operating losses and tax credit carryforwards 10,213,560 10,348,600 Valuation allowance (10,213,560) (10,348,600) ----------- ----------- Net deferred tax asset $ -- $ -- =========== ===========\nThe Company has recorded a valuation allowance to reflect the estimated amount of the deferred tax asset which may not be realized, principally due to expiration of net operating losses and other carryforwards. The valuation allowance for deferred tax assets may be reduced in the near term if the Company recognizes taxable income in the future. The changes in the valuation allowance for the years ended December 31, 1995, 1994 and 1993 were as follows: 1995 1994 1993 ------------ ------------ ------------ Balance, beginning of year $ 10,348,600 $ 2,031,630 $ 910,734 Change in valuation allowance due to change in deferred tax asset subject to uncertainty of recovery (135,040) 8,316,970 1,120,896 ------------ ------------ ------------ Balance, end of year $ 10,213,560 $ 10,348,600 $ 2,031,630 ============ ============ ============\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n5. Employee Benefit KSOP Plan:\nIn October, 1990, the Company adopted the Gold Reserve KSOP Plan (the KSOP Plan). The KSOP Plan is comprised of two parts, (1) the salary reduction plan, or 401(k) plan, and (2) the employee stock ownership plan, or ESOP.\nDuring 1995 and 1994, the KSOP Plan purchased from the Company 50,000 and 20,000 common shares for $280,195 and $123,760, respectively. On a cumulative basis, the KSOP Plan has purchased 323,571 common shares since inception. The purchases of stock were financed by bank loans, with varying rates of interest between 4.70 and 8.24 percent. As of December 31, 1995, $149,960 of the bank loans is due in 1996 and $186,749 is due in 1997. The loans are guaranteed by the Company and accordingly are recorded as a reduction to shareholders' equity. The Company contributed $92,247, $20,000 and $5,000 to the KSOP Plan in 1995, 1994 and 1993, respectively.\nAllocation of shares to participants' accounts is based on the combination of contributions by the Company and the participants, up to a maximum of 25 percent of the participants' annual compensation. The purchase price per share of the Company's common shares by the KSOP Plan is used to calculate the number of shares allocated to each participant.\n6. Stock Option Plans:\nThe Company has three stock option plans (the Plans) for officers, directors, and key individuals. All shares available under the 1985 and 1992 Plans have been granted and approximately 736,000 options remain unexercised as of December 31, 1995. The Company's 1994 Plan allows for the granting of up to 2,000,000 options to purchase common shares, which may be granted for terms of up to ten years. The exercise price of incentive stock options must be the average of the closing bid and ask prices of the stock on the date of grant. At December 31, 1995, options to purchase approximately 1,099,000 common shares were available for future grants under the 1994 Plan. The vesting period of options ranges from immediately to up to three years.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n6. Stock Option Plans, Continued:\nThe stock option transactions are summarized as follows:\nNumber of Option Price Shares Per Share --------- ---------------- Outstanding, December 31, 1992 802,500 $ .215 - $ 1.400 Granted 476,750 $3.375 - $15.250 Exercised (299,287) $ .215 - $ 5.080 --------- ---------------- Outstanding, December 31, 1993 979,963 $ .690 - $15.250 Granted 304,800 $5.250 - $ 6.000 Exercised (295,967) $ .690 - $5 .580 Canceled (24,168) $1.250 - $ 5.080 --------- ---------------- Outstanding, December 31, 1994 964,628 $1.000 - $ 6.000 Granted 913,334 $5.375 - $ 7.063 Exercised (167,835) $1.000 - $ 6.000 Canceled (73,334) $5.080 - $ 7.063 --------- ---------------- Outstanding, December 31, 1995 1,636,793 $1.090 - $ 7.063 ========= ================ Exercisable, December 31, 1995 1,041,483 ========= ================\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS No. 123). The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. The Statement requires adoption on or before January 1, 1996 and allows a reporting 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\" as long as the entity provides pro forma disclosure of stock-based employee compensation plans using the fair value based method of accounting in its annual financial statements. The Company is required to implement SFAS No. 123 on January 1, 1996. Management does not plan to adopt the measurement provisions of SFAS No. 123 although the Company will comply with the pro forma disclosure requirements of the statement in its 1996 annual financial statements.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n7. Common Stock Purchase Warrants:\nDuring 1994 and 1993, the Company issued 1,750,000 and 2,215,000 warrants, respectively, to purchase common stock of the Company, principally related to the private placement of common stock and the litigation settlement. Warrant holders exercised 2,134,250 and 5,750 common stock purchase warrants for approximately $12,962,750 and $17,250 in 1994 and 1993, respectively. Common stock purchase warrants outstanding at December 31, 1995 are as follows:\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n8. Related-Party Transactions:\nCommon Stock Issued ------------------- During 1994 and 1993, the Company issued 6,000 and 12,552 shares, valued at $33,000 and $48,851, respectively, for services provided to the Company by certain officers, directors, shareholders and employees.\nMegaGold -------- The President and the Vice President-Finance of the Company are also officers and a director of MegaGold. At December 31, 1995 and 1994, the Company owned 7,592,226 common shares of MegaGold and MegaGold owned 125,083 common shares of the Company. In addition, MegaGold owned 280,000 common shares of Great Basin at December 31, 1995 and 1994. The Company performs various administrative functions and sublets a portion of its office space to MegaGold for $1,200 per year.\nGreat Basin ----------- The President and the Executive Vice President of the Company are also officers and directors of Great Basin. At December 31, 1995 and 1994, the Company owned 15,177,400 common shares of Great Basin and Great Basin owned 391,161 and 374,192 common shares of the Company, respectively. Great Basin also owned 170,800 common shares of MegaGold at December 31, 1995 and 1994. The Company performs various administrative functions and sublets a portion of its office space to Great Basin for $1,200 per year.\nLegal Fees Paid to Director's Firm ---------------------------------- During 1995 and 1994, one of the Company's directors also served as Canadian legal counsel for the Company. During 1995 and 1994, the Company incurred approximately $60,000 and $440,000, respectively, for legal services performed by the director's firm, in which he is Chairman and a partner. At December 31, 1994, approximately $68,000 of these fees are included in accounts payable and accrued expenses.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n9. Geographic Segments:\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n10. Exchange of Shares for Minority Interest in Subsidiaries:\nPursuant to a plan of exchange approved by the Company's shareholders on May 19, 1995, each issued and outstanding share of Gold Reserve de Aruba A.V.V. (Gold Reserve Aruba) and Glandon Company A.V.V. (Glandon) (the companies which indirectly own 100% of the Brisas concession), other than shares held by the Company, was exchanged for common shares of the Company. The exchange ratios under the plan of exchange were established using an implied market valuation of the Brisas concession. This implied market valuation, in turn, was used to establish the value of the minority shares of Gold Reserve Aruba and Glandon. The implied market valuation of the Brisas concession was based on the total market value of the Company. Accordingly, the fair value of the Company's common shares issued to acquire the minority interests was recorded as additional property and mineral rights costs associated with the Brisas concession. As a result of the exchange which was completed on June 23, 1995, the Company issued 1,329,185 common shares valued at $9.8 million. In consequence of the exchange, Gold Reserve Aruba and Glandon became wholly- owned subsidiaries of the Company and in effect the Company increased its ownership in the Brisas concession from 91% to 100%.\n11. Litigation Settlement:\nBrisas, which was acquired by the Company in August 1992 to obtain the Brisas concession, was the plaintiff in a lawsuit commenced in Venezuela in July 1992 to rescind a mining lease and purchase option agreement covering the Brisas concession. In late December 1994, the Company, on behalf of its Brisas subsidiary, settled all outstanding litigation related to the Brisas concession and issued 2,750,000 common shares, 750,000 common share purchase warrants (exercisable at $10 Cdn for 18 months) to the defendants and deposited $4,500,000 into escrow to be released to one of the defendants upon the granting of the Brisas hardrock or veta rights to the Company. If the veta rights are not granted to the Company by January 1, 2000, the $4,500,000 plus interest earned thereon will revert to the Company. The total settlement of $22,512,500, recorded as an expense in the 1994 consolidated statement of operations, represents the market\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n11. Litigation Settlement, Continued:\nvalue, on the date of the agreement, of the consideration given and related settlement costs. A related standstill covenant provided that the securities issued to the defendants may be sold only in accordance with certain limitations. On February 15, 1996, the Company consented, for a 30 day period, to the disposal by one of the defendants of 1,500,000 common shares and 500,000 common share purchase warrants to a prescribed group of purchasers. According to an amendment to Schedule 13D filed by the defendant, these securities were sold on February 19 and 26, 1996. All other terms and conditions of the settlement remain in full force and effect.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information requested by this item is contained in the registrant's 1996 proxy statement and is incorporated by reference herein.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information requested by this item is contained in the registrant's 1996 proxy statement and is incorporated by reference herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information requested by this item is contained in the registrant's 1996 proxy statement and is incorporated by reference herein.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information requested by this item is contained in the registrant's 1996 proxy statement and is incorporated by reference herein.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\nExhibits. --------- The following exhibits are filed as part of this report. Exhibits previously filed are incorporated by reference, as noted. Exhibits filed herewith appear beginning at page 33.\nExhibit Number Exhibit ---------------------------------------------------------------------- 3.1 Copy of Articles of Incorporation of Registrant, as amended. Filed as Exhibit C to the Registrant's Registration Statement on Form 10 dated July 12, 1982 and incorporated by reference herein.\n3.2 Bylaws of Registrant, as amended March 4, 1993. Filed as Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\n10.29 Mining Operations Agreement dated July 1, 1992 between Compania Minera Bajo Caroni - Caromin, C.A. and Compania Minera Unicornio, C.A. Filed as Exhibit 10.29 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\n10.30 Stock Purchase Agreement dated August 1992 between Antonio Sosa Aviles and Servicios Escriber S.R.L., and Stock Purchase Agreement dated November 26, 1992 between Servicios Escriber S.R.L. and Gold Reserve de Venezuela. Filed as Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\n10.31 License and Technical Assistance Agreement dated September 1, 1992 between Registrant and Compania Minera Unicornio, C.A. Filed as Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\n10.32 Credit Agreement dated October 13, 1992 between Registrant and Compania Aurifera Brisas del Cuyuni, C.A. Filed as Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\nExhibit Number Exhibit ---------------------------------------------------------------------- 10.33 Services Agreement dated November 6, 1992 between Registrant and A. Douglas Belanger. Filed as Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference herein.\n10.34 Settlement Agreement dated December 21, 1994 among the Registrant, Brisas, GLDR, Marwood International Ltd., TVX Gold, Inc., BlueGrotto Trading Limited and Inversiones 871010, C.A. Filed as an exhibit to the Registrant's current report on Form 8-K dated December 21, 1994 and incorporated by reference herein. 13* 16.1* 18* 19* 22.1 Subsidiaries of Registrant. 23.1 Consent of Coopers & Lybrand L.L.P. 24* 25* 27.1 Financial Data Schedule 28* 29*\n*Items denoted by an asterisk have either been omitted or are not applicable.\nFinancial Statements. --------------------- An index to the financial statements included in this report appears at page 14. The financial statements themselves appear at pages 15 through 29 of this report.\nReports on Form 8-K. -------------------- No report on Form 8-K was issued 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.\nGOLD RESERVE CORPORATION\nBy: \/s\/ Rockne J. Timm --------------------------------------------- Rockne J. Timm, its Chairman, President and Chief Executive 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.\nBy: \/s\/ Robert A. McGuinness -------------------------------------------- Robert A. McGuinness, its Principal Financial and Accounting Officer March 27, 1996\nBy: \/s\/ A. Douglas Belanger, Director -------------------------------------------- A. Douglas Belanger, Director March 27, 1996\nBy: \/s\/ Jean Charles Potvin, Director -------------------------------------------- Jean Charles Potvin, Director March 27, 1996\nBy: \/s\/ James H. Coleman, Director -------------------------------------------- James H. Coleman, Director March 27, 1996\nBy: \/s\/ Patrick D. McChesney, Director -------------------------------------------- Patrick D. McChesney, Director March 27, 1996\nEXHIBIT 21.1\nSUBSIDIARIES OF THE REGISTRANT\nSubsidiary % Ownership\nCompania Aurifera Brisas del Cuyuni, C.A. (\"Brisas\") 100 Gold Reserve de Venezuela, C.A. (\"GLDRV\"); 100 Compania Minera Unicornio, C.A. (\"Unicorn\") 100 Great Basin Energies, Inc. (\"Great Basin\") 58 MegaGold Corporation (\"MegaGold\") 63 Gold Reserve de Aruba A.V.V. (\"Gold Reserve Aruba\") 100 G.L.D.R.V. Aruba A.V.V. (\"GLDRV Aruba\") 100 Glandon Company A.V.V. (\"Glandon\") 100 Stanco Investments A.V.V. (\"Stanco\") 100 GoldenLake A.V.V. (\"GoldenLake\") 100 Mont Ventoux A.V.V. (\"Mont Ventoux\") 100 Gold Reserve Holdings A.V.V. (\"Gold Reserve Holdings\") 100\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of Gold Reserve Corporation on Form S-3 (File No. 33-62804) and Form S-8 (File No. 33-61113) of our report, which includes an explanatory paragraph concerning changes in accounting for investments in 1994 and income taxes in 1993, dated March 15, 1996, on our audits of the consolidated financial statements of Gold Reserve Corporation and subsidiaries 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.\nCoopers & Lybrand L.L.P.\nSpokane, Washington March 26, 1996","section_15":""}
{"filename":"63118_1995.txt","cik":"63118","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nVarity Corporation and its subsidiaries (the Company), founded in 1847, is a major international industrial company with core manufacturing and distribution businesses in automotive components and diesel engines. The Company conducts and manages its businesses under two separate operating groups: the Automotive Products Group and the Perkins Group. The Company's products are marketed in more than 140 countries. Through a series of transactions completed between January 1992 and June 1994, the Company sold its worldwide Massey Ferguson farm machinery business to AGCO Corporation (AGCO).\nTHE AUTOMOTIVE PRODUCTS GROUP\nThe Company's Automotive Products Group supplies brake systems and components to domestic and foreign manufacturers of passenger cars and light trucks, through Kelsey-Hayes Company (Kelsey-Hayes), as well as medium and heavy duty trucks and trailers, through Dayton Walther. The Company acquired Dayton Walther, a major manufacturer of engineered products for the medium and heavy duty truck and trailer industries in December 1986. On November 30, 1989, the Company acquired K-H Corporation and its subsidiary, Kelsey-Hayes. Following the acquisition, the Company took actions to reduce employment levels, reorganize the business unit and management structure of Kelsey-Hayes and strengthen its international business operations. Kelsey-Hayes and Dayton Walther comprise the Automotive Products Group. The most significant automotive products manufactured and marketed by the Automotive Products Group are anti-lock braking systems (ABS), disc and drum brakes, disc brake rotors, hubs, drums, electromechanical sensors and power door lock actuators for passenger cars and light trucks.\nKelsey-Hayes is a leading producer of brake components for passenger cars and light trucks. The Company believes that Kelsey-Hayes is one of the leaders in the production of ABS, supplying both two-wheel and four-wheel systems. Kelsey- Hayes is the leading manufacturer of ABS in North America for light trucks. Kelsey-Hayes has been successful in developing new ABS products for both light trucks and passenger cars and recently introduced a new generation of four-wheel ABS that is compatible with virtually any size passenger car or light truck and any brake configuration. In order to meet increased North American ABS demand, the Company completed construction of and commenced production in a new plant in Fowlerville, Michigan during fiscal 1994. The Company also completed construction of a new ABS plant in Heerlen, The Netherlands, which will commence production in the first quarter of fiscal 1995, supplying European markets. In addition, the Company believes that Kelsey-Hayes is also one of the leaders in the production of foundation (conventional) brakes, and benefits from its strategic position as a major supplier of both ABS and foundation brakes for light trucks, vans and sport utility vehicles as North American production of these vehicles grew 16% in fiscal 1994.\nDayton Walther supplies spoke wheels, hubs, brake drums and disc brake calipers shipped as loose units or in assemblies to the medium and heavy duty truck and trailer markets. Dayton Walther derives a major share of its business from large OEMs. Dayton Walther's market share in all of its core products is substantial, ranging from 23% to 47%.\nThe Company owns 46.3% of the outstanding common stock of Hayes Wheels International, Inc. (Hayes Wheels), which the Company believes is the largest supplier of cast aluminum wheels in Europe, the second largest supplier of cast aluminum wheels in North America and the largest independent supplier of fabricated steel wheels in North America. Prior to December 1992, Hayes Wheels conducted its automotive wheels systems business jointly with the automotive brakes systems business of Kelsey-Hayes. In December 1992, Hayes Wheels sold, in separate public offerings, debt securities and common stock, decreasing the Company's ownership interest in Hayes Wheels from 100% to 46.3%. As a result,\nHayes Wheels is no longer consolidated with the Company for accounting purposes and the Company accounts for its investment in Hayes Wheels using the equity method of accounting. The Company believes that its ownership in Hayes Wheels comprises an important and continuing portion of the Automotive Products Group.\nAFTERMARKET PARTS\nThe aftermarket parts business consists of the Kelsey Parts business, which supplies maintenance and repair parts for many brands of passenger cars and light truck products. In connection with the Company's divestiture of certain non-core businesses, on December 31, 1992 the Company sold Dayton Parts, Inc., a supplier of maintenance and repair parts for heavy trucks.\nINTERNATIONAL\nOperations outside the United States, including those of Hayes Wheels, are conducted through various foreign companies in which the Group's interest ranges from minor to complete control. International manufacturing operations are located in Canada, Italy, Mexico, Spain, Venezuela, The Netherlands and the Czech Republic. The Automotive Products Group licenses its patents, designs, manufacturing technology and know-how in a number of other foreign countries.\nDuring the first quarter of fiscal 1993, the Company sold its majority interest in Brembo Kelsey-Hayes, S.p.A., an Italian specialty producer of high performance disc brakes and rotors, in connection with the Company's program to divest non-core businesses. Expanding its international position during fiscal 1993, Kelsey-Hayes established a European ABS marketing and technical center in Wiesbaden, Germany. During fiscal 1994, Kelsey-Hayes opened a sales office in Korea.\nCOMPETITION\nSuppliers to original equipment manufacturers (OEMs) operate under highly competitive conditions. Certain OEMs are capable of producing products supplied by the Automotive Products Group. The Automotive Products Group competes directly with the OEMs as well as many other suppliers with respect to price, quality, delivery and technical ability in developing products. The Company believes that, as a result of its manufacturing and engineering expertise, combined with an ongoing emphasis on cost control and quality, it has the ability to compete effectively with the OEMs and with other suppliers. With respect to brake components, the Automotive Products Group has over 15 substantial competitors, most of which are large and diversified concerns. Kelsey-Hayes estimates that its share of the North American four-wheel ABS market grew from 20% in 1993 to 24% in 1994 and is projected to increase in the future in this growth market, based on awarded contracts. Kelsey-Hayes estimates that its share of the North American foundation brake market (excluding OEM captive manufacturers) on a unit basis was approximately 35% in 1994.\nMARKETING AND DISTRIBUTION\nMost of the Automotive Products Group's sales are made directly to OEMs, with the remainder sold largely to replacement part distributors. Sales by the Automotive Products Group to its three major customers, Ford Motor Company (Ford), General Motors Corporation (GM) and Chrysler Corporation (Chrysler), accounted for 76% of the Automotive Products Group's consolidated net sales in fiscal 1994, with Ford being the largest customer during this period (36% of the Automotive Products Group's consolidated net sales). Sales to all OEMs accounted for approximately 99% of the Automotive Products Group's fiscal 1994 revenues. Although the loss of all or a substantial portion of sales to its major customers, Ford, GM or Chrysler, would have a serious adverse effect on its business, management believes that such a loss is unlikely as: the Automotive Products Group has been doing business with each of these companies for many years; sales to these companies are comprised of a number of different products and models or types of the same products, the sales of which are not dependent on each other; and sales of many products are made to individual divisions and subsidiaries of each of these companies and are not dependent upon sales to other divisions or subsidiaries of the same company.\nMARKET OVERVIEW\nSales by the Automotive Products Group are primarily dependent on the overall level of North American passenger car and light truck production, which, in turn, is sensitive to the overall level of United States economic activity. Moreover, sales of passenger cars and light trucks have, in the past, been adversely affected by recessionary business conditions and to some extent increases in the general level of interest rates. The level of economic activity in the United States was generally strong during 1994, despite interest rate increases, as North American production of cars and light trucks continued its recovery from the depressed 1991 levels. A prolonged downturn in the overall level of United States economic activity or increased competition from imported products or a prolonged strike at one or more of its major customers would adversely affect the Automotive Products Group. The Automotive Products Group continues its efforts to increase its global presence and to lessen dependence on North American car and light truck production.\nTHE PERKINS GROUP\nThrough the Perkins Group, the Company designs, produces and markets a comprehensive array of multi-cylinder water-cooled diesel engines in the 7 to 2,500 horsepower range. The 1,500 to 2,500 horsepower range was added in fiscal 1994 by the acquisition of Dorman Diesels Limited in the United Kingdom. The intended uses and markets for the Perkins Group's engines vary widely among the configurations of the particular engines. The Company adapts these basic engines to meet the specific requirements of its diverse customer base. The Perkins Group's engines are used as original equipment in virtually every application for which diesel engines are suitable, including agricultural tractors, industrial and construction machinery, material handling equipment, generators, passenger cars, trucks, vans, buses and other commercial vehicles, pleasure and commercial boats, armored personnel carriers and battle tanks. The Perkins Group, together with its associate companies and licensees, is one of the leading producers of diesel engines other than those used as original equipment in passenger cars.\nAll of the Perkins Group's fully assembled engines are manufactured in the United Kingdom, except for the sub-50 horsepower engines which are presently sourced from ISM in Japan but which from 1996 onward will also be manufactured by Perkins in the United Kingdom. In addition, the Company has associate companies and licensees in 14 countries that manufacture or assemble Perkins engines, often from kits sold to them by the Company. Tianjin Engine Works recently became its first licensee in China.\nThe Perkins Group's customer base includes over 300 OEMs. The Company believes that its associate companies and licensees sell to a similar number of additional OEMs. The Perkins Group's 10 largest customers accounted for approximately 47% of its net third party sales in fiscal 1994. No one customer accounted for more than 10%.\nIn 1994, the Perkins Group continued to build on a ten year supply agreement, commenced in 1992, with Caterpillar Inc. (Caterpillar), the world's largest construction and earth-moving machinery producer, as sales continue to increase from this agreement which covers a range of engines for back-hoe and wheeled loaders, road pavers and excavators. Aggregate sales over the ten year term of the agreement could be up to $1.0 billion. In addition, long-term supply agreements were signed in fiscal 1994 with Massey Ferguson after its divestiture by the Company to AGCO and with F.G. Wilson, the United Kingdom based generator set manufacturer now owned by Emerson Electric Co.\nPARTS\nThe Company provides replacement parts for all of the engines that it sells. The Company carries over 34,000 different replacement parts for diesel engines, many of which it manufactures or assembles and the balance of which it obtains from independent suppliers. In 1993, the Perkins Group consolidated its parts warehouses and opened a new parts distribution center in Manchester, England, managed by Caterpillar Logistics Systems. The center, believed to be the most efficient of its kind in Europe, operates its computerized order processing, retrieval and shipment services 24 hours a day for customers around the world. Sales of parts accounted for 16% of the Perkins Group's net sales in fiscal 1994.\nCOMPETITION\nMost diesel engines are used by the engine manufacturer in other products produced by it or its affiliates, including cars and trucks, agricultural equipment and industrial machinery. Consequently, competition in the diesel engine market is primarily for those customers that do not manufacture engines for their own use. The Company competes for third-party sales directly with other producers of diesel engines, which are either large companies conducting business on an international scale, with full product ranges, or small or medium-sized companies conducting business locally, often with a limited range of products. The Company also competes indirectly with manufacturers of gasoline engines. The Perkins Group's major competitors for third-party sales of diesel engines worldwide are Klockner-Humboldt-Deutz AG (Deutz), Cummins Engines Co. Inc., Caterpillar (generally for products not covered by the supply agreement described above), Detroit Diesel Corporation and several Japanese producers. The Perkins Group estimates that its share of the Western Europe diesel engine market, its primary market, has averaged approximately 12% of units sold over the three year period from fiscal 1992 to fiscal 1994. The Company believes that the most important competitive factor in the diesel engine market is the ability to design and manufacture engines specially adapted to the needs of an individual customer for a particular application. Quality, fuel efficiency, after-sale servicing and pricing are also important, as is the ability to meet increasingly stringent environmental requirements. The Company believes that the Perkins Group competes effectively on all of these bases and compares favorably with many of its competitors in its ability to design and manufacture specialized engines and in its ability to meet environmental requirements.\nMARKETING AND DISTRIBUTION\nThird-party sales of fully assembled diesel engines (mostly to OEMs) and third- party sales of diesel engines replacement parts are made both directly by the Company (primarily through sales offices in eight countries) and through a worldwide network of approximately 4,000 independent distributors and dealers in 140 countries. To facilitate direct sales by the Perkins Group, and to a lesser extent by its distributors and dealers, four of the Perkins Group's sales offices also provide engine finishing services and other support. The Company has additional distributorship agreements covering North America with Detroit Diesel Corporation and Japan with Iseki. Diesel engines manufactured or assembled by associate companies or licensees are distributed by them, generally in their home countries. Distribution arrangements in certain countries, which may involve those countries' governments, prohibit the Company from effecting sales other than through designated national distributors.\nOTHER OPERATIONS\nHYDRAULIC COMPONENTS\nThe Company also manufactures, through its Pacoma components operations, hydraulic cylinders and hydraulic valves and, to a lesser degree, allied equipment for producers of construction machines, agricultural and industrial equipment and, more recently, for the automotive passenger car industry. Pacoma's products, all of which are manufactured in Germany, are marketed by Pacoma to over 80 OEMs.\nIn recent years, Pacoma has substantially decreased its dependence on the agricultural equipment business by diversifying applications of its products and expanding its third-party customer base. All sales of components are made directly by the Company to OEMs.\nThe principal competitive factors in the sale of hydraulic cylinders to third parties vary by geographic area and application. In North America, where hydraulic cylinders have generally been standardized, competition, particularly in the agricultural equipment market, is based primarily on price. In Western Europe, where most components purchased by third parties are manufactured according to specific product requirements, competition is based primarily on product performance, pricing and reputation in the industry. The Company believes that, although there are many manufacturers of hydraulic cylinders for the OEM agricultural equipment markets, it is one of a small number of manufacturers with the ability to meet the more stringent quality and durability standards of the OEM construction machinery market and the passenger car industry.\nPOLYGON REINSURANCE\nThe Company's captive insurance subsidiary, Polygon Reinsurance Company Limited, a Bermuda corporation, provides reinsurance for product liability, property, business interruption and other risks arising from the Company's operations. Because it offers reinsurance, the Company believes that primary insurance coverage is more readily available to it and that, in certain instances, its insurance premiums may be favorably affected.\nBACKLOG\nThere is no significant backlog of unfilled equipment orders. Substantially all of the unfilled equipment orders at any time are expected to be filled within the following year.\nINFORMATION BY SEGMENT AND GEOGRAPHIC AREA\nInformation about the Company's operations and assets by industry segment and geographic area for the years ended January 31, 1995, 1994 and 1993 appears in Note 18 of the Notes to Consolidated Financial Statements and is included in Part II on pages 42 through 44 of this Form 10-K. Sales by product are included in Part II on page 51 of this Form 10-K.\nEMPLOYEES AND LABOR RELATIONS\nAt January 31, 1995, the Company had approximately 10,500 full-time employees.\nThe Company's worldwide labor force is represented by approximately 20 labor organizations. Employee-management relations vary from country to country. Certain of the Company's production facilities are located in areas where organized labor has traditionally been very active.\nSOURCES AND AVAILABILITY OF COMPONENTS AND RAW MATERIAL\nThe Company purchases numerous components in its manufacturing operations. Most of these components are available from a variety of sources, however, certain critical components are produced by a small number of suppliers and may, in certain cases, be purchased from a single source of supply. The unplanned loss of any of these single sources of supply could have a significant adverse effect on those operations.\nThere are many sources of the raw materials and other component parts essential to the conduct of the Company's operations readily available in reasonable proximity to those plants utilizing such materials. The Company has not experienced any significant supply problems for its operations for many years and the Company does not anticipate any significant supply problems in the foreseeable future.\nRESEARCH AND DEVELOPMENT; PATENTS; TRADEMARKS\nDuring fiscal 1994, 1993 and 1992 the Company expended $44.5 million, $39.6 million and $32.0 million, respectively, on research and development. Such research and development expenditures have enabled the Company to upgrade its existing product lines and introduce new products. The Company has a history of developing new technology jointly with its suppliers or customers, particularly for diesel engines. The cost of such programs with suppliers is reflected mainly in unit costs and not necessarily in research and development expenditures.\nThe Company owns numerous patents and trademarks and has patent licenses from third parties relating to products and manufacturing methods. The Company also grants patent and trademark licenses to others throughout the world. The Company is the sole owner of certain advanced diesel engine fuel injection technology and rights, in part by patent license. The Perkins Group is obtaining additional patent protection with respect to this technology. The Company believes that continued development of this technology will aid the Perkins Group in its engineering design, production and sale of advanced diesel engines. Various patents relating to the anti-lock brakes business have been issued to Kelsey-Hayes and others, including its competitors. The Company examines its own and its competitors' products to guard against infringement, both on its own initiative and, where appropriate, in response to inquiries or comments of others. The Company views its own patents and patent applications as significant. Based on examination of its own and others' patents, available existing technology and the ability to avoid infringement issues by engineering design, the Company does not believe its business is materially impacted by patents of others.\nThe Company regards its many trademarks as having significant value and as being an important factor in the marketing of its products. The Company believes that its most significant trademarks are \"Kelsey-Hayes,\" \"Perkins,\" \"Dayton\" and \"Pacoma,\" as well as Kelsey-Hayes' design trademarks. The foregoing trademarks are generally registered in the United States, Canada, the United Kingdom and a number of other countries where the Company operates. In addition, the Company owns numerous minor trademarks that are registered or for which a registration application is pending. The Company's policy is to pursue trademark registration wherever possible and to oppose infringement of its trademarks.\nENVIRONMENTAL PROTECTION AND SAFETY LAWS\nEnvironmental protection and safety laws in the countries in which the Company manufactures and sells its products have a significant effect on product design, but apply equally to competitors and have not had, nor are they expected to have, a material adverse effect on the Company's competitive position. The Company does not anticipate that the costs it expects to incur in order to meet environmental and safety standards for its products or to satisfy environmental standards relating to operation of its manufacturing and other facilities imposed by various legislative bodies around the world will be materially adverse to the Company.\nIMPACT OF GOVERNMENT POLICIES\nThe operations of the Company and its competitors are affected by government policies, such as those relating to interest rates, trade, the price and availability of oil, and exchange and price controls.\nThe Company's production facilities are located principally in the United States, United Kingdom, The Netherlands, Canada and Germany. Although there is some interdependence among certain of the Company's facilities for components and services, adverse local conditions in any one region should not have a significant adverse effect on the Company's operations.\nThe Company's production costs are affected by conditions prevailing in the countries in which its production facilities are located. The Company is exposed to currency exchange risks in the transfer of goods and services between countries. Exchange rate fluctuations also affect the Company's consolidated financial reporting as a result of the translation of its financial statements into U.S. dollars. The Company's production costs, profit margins and competitive position are materially affected by the strength of the currencies in the countries where it manufactures goods relative to the strength of the currencies in the countries where its goods are sold. To protect against fluctuations in foreign currencies, the Company from time to time enters into foreign exchange contracts, primarily to exchange dollars and various European currencies for pound sterling, for periods generally consistent with the underlying transaction exposures.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries operate 18 manufacturing facilities in the United States and Canada with aggregate space of approximately 3.2 million square feet. There are also six facilities located in Europe with a total manufacturing area of approximately 3.0 million square feet. All of these facilities are owned by the Company. The Company also leases a 30,000 square foot facility in Singapore. All of the Company's European manufacturing facilities are pledged to its lenders.\nThe automotive products segment manufactures its range of products at 18 locations in North America and one in Europe aggregating approximately 3.3 million square feet and ranging in size from approximately 500,000 square feet in Detroit, Michigan to 56,000 square feet in Carrollton, Kentucky. The locations of this segment's plants are as follows:\nThe engines segment manufactures diesel engines and parts at four locations in England (Lincoln, Peterborough, Shrewsbury and Stafford) with a total space of approximately 2.6 million square feet, the largest of which is approximately 1.8 million square feet. The Company also operates a 30,000 square foot facility in Singapore.\nThe other products segment, which presently includes the hydraulic cylinder and valve manufacturing business, operates from a 313,000 square foot facility in Eschwege, Germany.\nThe Company also operates five major parts warehouses in five countries, three of which are leased. In addition, the Company owns or leases a number of other properties in the United States, Canada, the United Kingdom and certain other countries.\nIn general, the Company believes that its facilities are in good operating condition and are suitable for their intended use. In order to meet increased ABS demand in the United States and Europe within the automotive products segment, the Company completed construction of two new plants in fiscal 1994, located in Heerlen, The Netherlands and Fowlerville, Michigan. In the engines segment the Company added three plants in 1994 through the acquisition of Dorman Diesels Limited. Current facilities are adequate for existing production needs and provide a reasonable margin for further growth and expansion in the underlying businesses. The Company believes that its plants and equipment are adequately insured. Over the last five years, the Company has disposed of a number of its manufacturing facilities as part of the rationalization of its businesses. It continues to own several facilities no longer used in its operations which are being held for sale.\nItem 3.","section_3":"Item 3. Legal Proceedings\n1. Massey Combines Corporation\nIn the case Howe et al. v. Varity Corporation and Massey-Ferguson Inc. (United States District Court, Southern District of Iowa), plaintiffs, purporting to represent a class of former salaried employees and retirees of Massey-Ferguson Inc. (MF Inc.), commenced an action in October 1988 alleging that the defendant corporations sought to avoid their contractual obligations to provide health and insurance benefits and employment termination allowances by transferring the plaintiffs to Massey Combines Corporation (MCC), a Canadian corporation, in 1986, which subsequently entered receivership in 1988.\nThe action asserts violations of the Employee Retirement Income Security Act of 1974, breach of fiduciary duty, breach of contract, promissory estoppel, wrongful interference with protected rights and fraudulent misrepresentation. Plaintiffs' motion for a preliminary injunction requiring extension of benefits to retirees and disabled persons pending trial was granted by the lower court but reversed by the appellate court as to retirees. The plaintiffs seek to compel reinstatement of benefits, compensatory damages, punitive damages and the costs of action. The jury on September 23, 1991 awarded two subclasses of former employees of MCC and ten individuals formerly employed by MF Inc., $9.8 million in compensatory damages and $36 million in punitive damages against Varity and MF Inc. On March 26, 1993, the court struck completely the punitive damage award and reduced the compensatory damage award to $8.3 million.\nUpon appeal, on September 29, 1994, the circuit court upheld the district court's denial of punitive damages. However, the court ordered the Company to reinstate the plaintiffs' medical benefits and awarded them approximately $800,000 in damages for the period during which they were not covered. On March 6, 1995, the Company filed in the Supreme Court of the United States a petition for a writ of certiorari to review the circuit court's decision.\n2. Fruehauf Trailer Corporation\nIn July, 1989, a predecessor of Fruehauf Trailer Corporation (FTC) acquired the trailer operations of Fruehauf Corporation and in that connection assumed certain liabilities. FTC is obligated to indemnify the Company's subsidiary, K-H Corporation, in respect of such assumptions. FTC has advised the Company that it does not intend, at least in the foreseeable future, to make further payments in respect to certain of such assumed liabilities. If FTC is unable to pay, then the Company's subsidiary, K-H Corporation, may be liable with respect to certain of such liabilities which arose out of operations prior to the 1989 sale, including those in respect of products manufactured or sold, environmental liabilities, worker's compensation and retiree welfare benefits. FTC appears to have taken its position at the request of its lenders for purposes of focusing the use of available cash on current operations of FTC. The actual amount of such liabilities and\/or the extent to which the Company's subsidiary, K-H Corporation, actually may be liable cannot be determined at this time. The Company intends to vigorously defend its position with respect to FTC and all other third parties.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of security holders for the quarter ended January 31, 1995.\nExecutive Officers of the Registrant\nThe following table sets out the names and ages of each of the executive officers of the Company, their positions as of January 31, 1995, the date on which they were appointed to such positions and their business experience during the past five years:\n(1) All positions shown are with the Company unless otherwise indicated.\n(2) All executive officers are appointed by the Board of Directors of the Company and serve at its pleasure.\n(3) There are no family relationships between any of the executive officers, directors or persons nominated for such positions and there is no arrangement or understanding between any of the executive officers and any other person pursuant to which he or she was selected as an officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWORLD HEADQUARTERS 672 Delaware Avenue Buffalo, New York 14209-2202 Telephone: 716 888-8000\nANNUAL MEETING The annual meeting of the Company's shareholders will be held on Thursday, May 25, 1995 at the Hyatt Hotel, Two Fountain Plaza, Buffalo, New York.\nSTOCK TRADING SYMBOL Common: VAT\nSTOCK EXCHANGE LISTINGS Common: New York, Toronto\nCommon stock has unlisted trading privileges on Boston, Chicago and Pacific stock exchanges.\nTRANSFER AGENT AND REGISTRAR Mellon Securities Trust Company 120 Broadway New York, New York 10271 Telephone 1 800 526-0801 1 412 236-8000 Telecommunications Devices for the Deaf 1 800 231-5469\nDIVIDENDS\nAs long as any shares of Class II Series A Preferred Stock are outstanding, unless all cumulative and \"additional\" dividends then payable on these shares have been declared and paid or amounts set aside for payment, the Company may not, without the prior approval of the holders of these shares:\n1) declare or pay any dividends (other than stock dividends in shares of the Company ranking junior to these shares) on any common or junior shares; 2) redeem, purchase or make any capital distribution in respect of any equal or junior shares; or 3) issue any additional shares ranking as to capital or dividends prior to or on a parity with these shares. At this time all dividends now payable have been paid or set aside for payment.\nSTATISTICAL DATA\nJanuary 31, 1995 1994 ------ ------\nNumber of registered shareholders: Common................ 19,538 21,544 Preferred............. 4 8\nShares outstanding (thousands): Common................ 41,661 43,957 Class II Preferred 2,001 2,001\nMARKET PRICE OF COMMON STOCK\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA \/(1)(2)(3)\/\nThe following selected financial data has been derived from the Consolidated Financial Statements of the Company for the fiscal years 1994, 1993, 1992, 1991 and 1990.\nThe selected financial data should be read in connection with the Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.\n(1) See Note 15 to the Consolidated Financial Statements included herein for discussion of contingent liabilities and commitments. (2) No cash dividends on common stock have been paid in any of the years in the five-year period ended January 31, 1995. (3) As a result of the fiscal 1994 sale of the farm equipment segment, prior years' financial data has been restated to conform to the current year presentation of the farm equipment segment as a discontinued operation. (4) Amounts reported for January 31, 1993 reflect the sale of a majority ownership in Hayes Wheels.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nFor the year ended January 31, 1995 (fiscal 1994), Varity Corporation earned $117.1 million ($2.61 per share) compared to $69.1 million ($1.60 per share) for fiscal 1993 and $49.5 million ($1.18 per share) for fiscal 1992 before discontinued operations, extraordinary losses and the cumulative effect of changes in accounting principles. In June 1994, the Company completed the sale of its worldwide Massey Ferguson farm machinery business to AGCO Corporation (AGCO) for $310 million in cash and 500,000 shares of AGCO common stock, resulting in a non-recurring gain of $23.2 million. As a result, the farm equipment segment, including the gain realized on sale, has been presented as a discontinued operation in the accompanying financial statements. During the first quarter of fiscal 1993, the Company recognized a one-time, non-cash $146.1 million charge ($3.98 per share) in connection with the adoption of two new accounting standards as described in Note 3 of the Notes to Consolidated Financial Statements. In addition, during fiscal 1993 and fiscal 1992 the Company incurred extraordinary losses of $1.7 million ($.05 per share) and $6.4 million ($.24 per share), respectively, with respect to the early redemption of debt. Fiscal 1992 results also included a $17.3 million non-recurring gain from the sale of a majority ownership in a Kelsey-Hayes subsidiary. As a result, net income (loss) amounted to $144.7 million, $(71.5) million and $27.0 million in fiscal 1994, 1993 and 1992, respectively.\nForeign exchange rate fluctuations between various European currencies and to a lesser extent the United States dollar can significantly affect the Company's reported results, as a substantial volume of engines and related parts are sold into other countries from manufacturing locations in the United Kingdom, where a significant portion of the costs associated with the engines segment are incurred. This cross-trading gives rise to exchange gains and losses on individual transactions in different currencies.\nThe average value of the U.S. dollar (utilized to translate foreign currency revenues and expenses) for fiscal 1994 was 3% lower against the British pound and approximately 4% lower against the other major European currencies, compared to such average values in fiscal 1993. As a result, the Company's sales and related costs transacted in the foreign countries where the Company primarily operates were at marginally higher relative values than in the prior year, based on the higher translation value of such foreign currencies. At January 31, 1995, the value of the U.S. dollar was 5% lower against the British pound and approximately 10% lower against the other major European currencies as compared to values at the previous year-end. Accordingly, the Company's consolidated assets and liabilities denominated in foreign currencies (which are translated using the respective year-end rates of exchange) are affected by the higher translation value of such foreign currencies in comparison to the prior year, the impact of which is reflected in the foreign currency translation adjustment account in stockholders' equity in the Company's consolidated balance sheet.\nThe accompanying fiscal 1992 consolidated statement of operations is not readily comparable to fiscal 1994 or fiscal 1993 as a result of the Company's disposition in the fourth quarter of fiscal 1992 of a majority ownership of Kelsey-Hayes' wheels business which is no longer included in the Company's consolidated results, as is described more fully in Note 17 of the Notes to Consolidated Financial Statements. Subsequent to the disposition, the Company's remaining ownership in the wheels business is accounted for on the equity method of accounting. Significant declines in sales and revenues, cost of goods sold, marketing, general and administration and interest, net are a direct result of this disposition.\nSEGMENT OPERATING REVIEW\n(1) Automotive products segment information for fiscal 1992 is presented on a pro forma basis to exclude $547 million of sales and revenues and $56 million of operating earnings of Hayes Wheels International, Inc. (Hayes Wheels), Brembo Kelsey Hayes, S.p.A. (Brembo) and Dayton Parts, Inc. (Dayton Parts). Subsequent to the Company's sale of its majority ownership in Hayes Wheels in the fourth quarter of fiscal 1992, such operations are not consolidated and accordingly are not included in the above segment information. The Company's 46% share of the earnings of Hayes Wheels for the last month of fiscal 1992 and subsequent thereto, excluding charges associated with first quarter fiscal 1993 accounting changes, is included in equity in earnings of associated companies in the consolidated statements of operations. Brembo and Dayton Parts were sold and as a result did not contribute to the Company's fiscal 1993 or 1994 results. Automotive products results have also been adjusted to reflect the impact of the incremental costs associated with Statement of Financial Accounting Standard (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which was adopted in the first quarter of fiscal 1993, as if it had been adopted at the beginning of fiscal 1992.\nAUTOMOTIVE PRODUCTS\nUnited States automobile and light truck demand during fiscal 1994 continued to improve, as measured by a 10% increase in vehicle sales over the comparable fiscal 1993 period, reflecting a continuation of increased consumer confidence and a generally stronger overall business environment. Correspondingly, North American industry production of these vehicles, which incorporate Kelsey-Hayes' products and influences the Company's automotive products segment, increased 11% during the same period. Within Varity's automotive products segment, Kelsey- Hayes brake systems benefitted from its strategic position as a major supplier of anti-lock braking systems (ABS) and foundation (conventional) brakes for light trucks, vans and sport utility vehicles, as North American industry production of these vehicles increased 16% during fiscal 1994. In excess of 70% of Kelsey-Hayes sales of braking systems including ABS and foundation brakes are generated from light trucks, vans and sport utility vehicles. As a result, Kelsey-Hayes brake systems recorded sales of $1.2 billion in the current year, an increase of 21% over fiscal 1993.\nIn addition to increased North American light vehicle production, higher sales also resulted from expanded ABS installation rates in new vehicles (54% penetration in fiscal 1994 versus 37% in fiscal 1993), continued industry conversion from two-wheel ABS to higher value four-wheel systems on numerous vehicle platforms and strong demand for foundation brake products.\nKelsey-Hayes brake systems segment operating income in fiscal 1994 increased by 39% to $121 million from $87 million last year. Earnings improved over the prior year as a direct result of increased sales, particularly higher margin four-wheel ABS products, and the continued focus on implementing cost reductions and productivity improvements. The current year's results were tempered, however, by expenses associated with expanding capacity, pursuing potential ABS business and product development and start up expenditures in Europe.\nIn addition, North American Kelsey-Hayes brake systems engineering and product development costs increased 28% during fiscal 1994, in support of two new, state-of-the-art four-wheel ABS offerings -- the 25 series for light truck applications and the 30 series for passenger car applications. These new product offerings are designed for higher performance, lower cost, smaller size, a 30% reduction in the number of parts and more packaging options for installation.\nThe automotive products segment also includes sales of products for the heavy and medium duty truck and trailer market by Dayton Walther, a wholly-owned subsidiary of the Company. Sales of this unit of $161 million were constant with the prior year level.\nDayton Walther heavy duty brakes sustained a segment operating loss of $5 million in fiscal 1994 compared to operating income of $3 million in fiscal 1993, reflecting the negative impact of capacity constraints and outsourcing penalties caused by continued strong medium and heavy duty truck demand as well as the cost of other management actions to return the business to profitability.\nDuring fiscal 1993, United States automobile and light truck retail sales increased 9% over the prior period, as consumer and business confidence improved. Correspondingly, industry vehicle production increased 12% during the same period, with light truck production increasing 15%.\nAs a result of the automotive products segment's significant presence in light truck products, sales increased 19% to $1.1 billion in fiscal 1993 from the prior year, as adjusted for business divestitures. Sales increased due to higher ABS sales resulting from increased vehicle production, improved market installation rates, replacement of two-wheel ABS with higher value four-wheel systems on several vehicle platforms and strong demand for foundation brake products.\nThe automotive products segment recorded operating income of $90 million during fiscal 1993 as compared to fiscal 1992 operating income of $66 million, as adjusted for business divestitures. The earnings improvement was primarily due to higher volumes and cost reduction efforts, despite increased costs incurred in pursuit of new business and penalties associated with foundation brakes capacity constraints as a result of certain high-volume vehicle platforms.\nENGINES\nDemand for diesel engines in the major market sectors in which the Company's Perkins engines segment participates (agricultural, construction, industrial and power generation) improved during fiscal 1994 as manufacturers that incorporate such equipment in their products experienced an increase in demand, particularly in the United States and Europe. For Perkins, this was particularly apparent in the European agricultural sector and the United States and United Kingdom construction markets, all of which experienced higher sales, reflecting both increased sales to certain existing accounts in connection with new engine applications and an expanding customer base arising from strategic alliances developed in recent years. Such alliances include supply contracts with Caterpillar Inc., the world's largest construction and earth-moving machinery producer, Massey Ferguson subsequent to its divestiture by the Company to AGCO and F.G. Wilson, the United Kingdom based generator set manufacturer now owned by Emerson Electric Co. In addition, during the second quarter of fiscal 1994, Perkins acquired Dorman Diesels Limited, a manufacturer of diesel and natural gas powered engines in the 1,000 to 2,500 horsepower range, designed primarily for the power generation sector, which added approximately $47 million of incremental sales. As a result, total engines segment sales increased 23% to $861 million in fiscal 1994 as compared with the prior year.\nOperating income in fiscal 1994 for the engines segment increased 50% to $69 million reflecting the benefit of higher sales and on-going success with margin improvement and cost control programs, despite an increase of $9.8 million in engineering and product development in fiscal 1994 compared to fiscal 1993. Dorman Diesels Limited contributed $4 million of operating profit in fiscal 1994.\nEngines segment sales in fiscal 1993, adjusted to neutralize the effects of differing foreign exchange rates between periods, increased by 8% to $702 million compared with fiscal 1992. (Reported engines segment sales declined $42 million due to the lower translation value of the British pound during fiscal 1993 versus fiscal 1992.) Higher sales in the United Kingdom, specifically in the agricultural and power generation sectors, the United States, Middle East and Asia\/Pacific offset lower volumes attributable to the difficult economic conditions in continental Europe during fiscal 1993.\nOperating income in fiscal 1993 increased 10% to $46 million versus fiscal 1992 as a result of the higher exchange adjusted sales, productivity improvements and cost control measures, offset in part by certain non-recurring, higher margin military sales in fiscal 1992.\nNON-SEGMENT OPERATING REVIEW\nIn June 1994, the Company completed the sale of its worldwide Massey Ferguson farm machinery business to AGCO for $310 million in cash and 500,000 shares of AGCO common stock, resulting in a non-recurring gain of $23.2 million. The transaction excluded cash, indebtedness and certain liabilities, primarily pertaining to pension and retiree medical benefits for all former North American Massey Ferguson employees. Subsequent to the sale, the Company settled its pension benefit obligation related to former Massey Ferguson employees in North America through the purchase of annuity contracts.\nAs a result of the aforementioned sale, the Company's effective tax rate increased to 18.5% in fiscal 1994, as certain foreign income could no longer be sheltered against farm equipment tax losses within the same taxing jurisdiction. The Company anticipates that its effective tax rate will be higher in fiscal 1995.\nDuring the fiscal 1994 third quarter, the Company sold its 500,000 shares of AGCO common stock, resulting in net proceeds of approximately $22 million and a gain of $3.8 million, which is included in other (income) expense, net, in the consolidated statement of operations. Offsetting this gain is a $4.0 million write-down of an unrelated foreign investment in an associated company.\nAs a result of the adoption of several new accounting standards in fiscal 1993, the Company incurred a non-cash, one-time charge of $146.1 million, primarily pertaining to postretirement benefits other than pensions.\nIn connection with the use of proceeds generated from a common equity offering during fiscal 1993, the Company incurred an extraordinary loss of $1.7 million on the early redemption of indebtedness consisting of redemption premiums and the write-off of related unamortized debt issuance costs. Similarly, the Company incurred a $6.4 million loss on the early redemption of debt in fiscal 1992.\nAs a result of such debt redemptions and other repayments from proceeds received from business divestitures during fiscal 1994, fiscal 1993 and the latter portion of fiscal 1992, the Company has continued to significantly reduce its net interest expense, which amounted to $22.5 million in fiscal 1994 compared with $32.0 million and $99.1 million in fiscal 1993 and 1992, respectively.\nDuring the fourth quarter of fiscal 1992, the Company recognized a gain from the sale of a majority ownership in a Kelsey-Hayes subsidiary (the wheels business) amounting to $17.3 million. In accordance with SFAS No. 96, no provision for taxes was made at the time of the transaction with respect to the gain due to the Company's existing tax loss carryforwards. Subsequent to the transaction, the Company accounts for its investment in Hayes Wheels on the equity method of accounting. As a result of higher underlying sales and net income at Hayes Wheels, equity in earnings of associated companies rose to $13.3 million in fiscal 1994, compared to $11.5 million in fiscal 1993.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nDuring fiscal 1994, the Company continued its strategic actions to strengthen its balance sheet and enhance its competitive position in markets around the world, including the sale of its worldwide farm machinery business. The proceeds from this sale, and those generated from ongoing operations, enabled the Company to further reduce debt levels in order to improve the Company's financial flexibility to fund increased investment in its Kelsey-Hayes and Perkins businesses. The Company also utilized approximately $63 million to make contributions to its underfunded North American pension plans in the third quarter and approximately $10 million in the fourth quarter to purchase insurance contracts to annuitize vested benefits under retained Massey Ferguson pension plans, which had the effect of eliminating the Company's ongoing liability for such benefits. In addition, the Company began its previously announced stock repurchase program during the year, pursuant to which it repurchased 2,329,500 shares of previously outstanding common stock at a cost of $84.7 million. The Company will continue the periodic repurchase of up to 4.5 million shares of its common stock as market conditions warrant.\nAs a result of the aforementioned debt repayments, long-term debt outstanding at January 31, 1995 (including current maturities) decreased to $165.7 million from $191.1 million at January 31, 1994. Similarly, short-term notes payable decreased by $65.0 million to $3.0 million at January 31, 1995 from $68.0 million at January 31, 1994, further increasing the Company's liquidity.\nUnused long-term and short-term lines of credit at January 31, 1995 were $139.0 million and $100.7 million, respectively. Management believes that Varity, as a result of its continued strategic initiatives, will have improved access to credit markets and that its credit facilities and cash flow from operations will continue to be sufficient to meet its operating needs.\nCertain of the Company's loan agreements provide for financial covenants relating to such matters as the maintenance of specified financial ratios and minimum net worth. Certain loan agreements also contain cross-default provisions. At January 31, 1995 the Company and each of its subsidiaries were in compliance with their financial covenants. Management expects that the Company and each of its subsidiaries will remain in compliance during the year ending January 31, 1996.\nReceivables increased $38.4 million to $367.7 million at January 31, 1995 from $329.3 million at January 31, 1994, primarily due to strong sales in the fourth quarter of fiscal 1994 and to a lesser extent foreign exchange fluctuations and the Dorman Diesels Limited acquisition by Perkins.\nInventories of raw materials, work-in-process and finished products increased to $154.9 million at January 31, 1995 from $127.8 million at January 31, 1994 primarily due to the impact of increased manufacturing schedules in response to customer demand and to a lesser extent foreign exchange fluctuations and the Dorman Diesels Limited acquisition.\nAccounts payable and accrued liabilities increased $60.4 million to $550.5 million at January 31, 1995 from $490.1 million at January 31, 1994 due to the Dorman Diesels Limited acquisition, the effect of higher throughput and to a lesser extent foreign currency movements.\nNet fixed assets increased $102.7 million to $624.9 million at January 31, 1995 from $522.2 million at January 31, 1994 due to higher capital expenditures in connection with the completion of construction of new ABS plants in Fowlerville, Michigan and Heerlen, The Netherlands and to a lesser extent increases due to foreign exchange and the Dorman Diesels Limited acquisition. Capital expenditures during fiscal 1994 and 1993 were $154.9 million and $135.8 million, respectively, and depreciation and amortization were $78.0 million and $65.4 million, respectively, for the same periods. Capital expenditures for fiscal 1995 should approximate $200 million, of which $56.0 million has been committed. These expenditures will be for normal equipment replacements and operating improvements related to reducing costs and increasing output.\nOther assets and intangibles increased by $25.2 million to $361.8 million at January 31, 1995 from $336.6 million at January 31, 1994, primarily due to goodwill additions resulting from Perkins' acquisition of Dorman Diesels Limited.\nOther long-term liabilities decreased by $59.1 million to $320.6 million at January 31, 1995 from $379.7 million at January 31, 1994, primarily due to pension funding contributions, partially offset by additional liabilities recorded in connection with the Massey Ferguson sale.\nStockholders' equity increased by $153.0 million to $783.7 million at January 31, 1995, due to net income and positive currency translation and pension liability adjustments, partially offset by dividends paid and treasury stock repurchases.\nVarity is primarily dependent on its subsidiaries to meet its cash requirements. Varity's ability to obtain cash from its subsidiaries or to transfer cash between subsidiaries is governed by the financial condition and operating requirements of these subsidiaries. The Company has ongoing short- term cash requirements for working capital, capital expenditures, dividends, interest and debt payments. The Company believes that its cash requirements will be met through internally and externally generated sources, existing cash balances and utilization of available borrowing facilities.\nAs a result of the Company's actions over the past three years to reduce debt and increase operating efficiencies, the Company's financial position and liquidity have improved markedly. The Company believes these actions have improved its access to capital markets and will better posture the Company to finance investment in and expansion of the growth areas of its businesses. In order to maintain financial flexibility the Company has filed with the Securities and Exchange Commission a registration statement covering $100 million of debt securities of the Company and Kelsey-Hayes but which has not yet become effective; however, the Company has no immediate plans to make an offering under such registration statement. The Company continues to explore opportunities to divest operations that do not meet its strategic objectives. The Company anticipates any such transactions would further improve its liquidity and financial flexibility.\nDuring the next five years the Company believes that its cash requirements for working capital, capital expenditures, dividends, interest and debt repayments will continue to be met through internally and externally generated sources and utilization of available borrowing sources.\nThe Company, primarily through its automotive products segment, is involved in a limited number of remedial actions under various federal and state laws and regulations relating to the environment which impose liability on parties to clean up, or contribute to the cost of cleaning up, sites on which their hazardous wastes or materials were disposed or released. The Company believes that it has made adequate provision for costs associated with known remediation efforts in accordance with generally accepted accounting principles and does not anticipate the future cash requirements of such efforts to be significant. The Company has made no provision for any unasserted claims as it is not possible to estimate the potential size of such future claims, if any.\nOUTLOOK\nThe Company believes that its automotive products segment is positioned to increase sales and margins in fiscal 1995, even if North American light vehicle production is flat, as a result of secular ABS penetration and as actions taken to relieve capacity constraints and enhance productivity continue to provide positive returns. Continued improvements in manufacturing processes, in addition to an expanding customer base arising from strategic alliances developed in prior years, have positioned its Perkins engines segment to benefit further as the European economy improves, despite anticipated increases in new product research and development expenditures in fiscal 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED STATEMENTS OF OPERATIONS\n* Anti-dilutive\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nYears ended January 31, 1995, 1994 and 1993 (Fiscal 1994, 1993 and 1992, respectively) (Dollars in millions unless otherwise stated)\n1. DISCONTINUED OPERATION\nPursuant to a plan to dispose of its farm equipment segment, in June 1994 the Company completed the sale of its worldwide Massey Ferguson farm machinery business to AGCO Corporation (AGCO) for $310 million in cash and 500,000 shares of AGCO common stock, resulting in a gain of $23.2 million. The gain is net of the recognition of $70.0 million of deferred foreign exchange losses and pension liability adjustments, previously reported in the accompanying consolidated balance sheets as a reduction in stockholders' equity. (The Company did not record an income tax provision with respect to the gain primarily due to existing tax loss carryforwards.)\nThe transaction excluded cash, indebtedness and certain liabilities, primarily pertaining to pension and retiree medical benefits for all former North American Massey Ferguson employees, for which the Company continued to be responsible. Subsequent to the sale, the Company settled its pension benefit obligation related to former Massey Ferguson employees in North America through the purchase of annuity contracts. As a result of the aforementioned plan, the farm equipment segment has been presented as a discontinued operation in the accompanying financial statements. Prior years' financial statements have been restated to conform to the current year presentation.\nThe operating results of the discontinued operation are as follows:\n\/(1)\/ Includes the period up to and including April 30, 1994, the effective date of the sale.\nA summary of the assets and liabilities of the discontinued operation is as follows:\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Basis of Presentation and Consolidation\nThe consolidated financial statements include the accounts of all wholly and majority-owned subsidiaries. Investments in associated companies in which the Company's ownership interest ranges from 20 to 50% and over which the Company exercises influence on operating and financial policies are accounted for using the equity method (see Note 19). Other investments are accounted for using the cost method. Significant intercompany balances and transactions have been eliminated in consolidation.\n(b) Cash Equivalents\nCash equivalents consist of liquid instruments with an original maturity of three months or less.\n(c) Marketable Securities\nEffective January 31, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" as described in Note 3. The Company has determined that its marketable securities portfolio is available-for-sale, as defined within the pronouncement, and has presented the unrealized net gain or loss on such portfolio as a separate component of stockholders' equity. Prior to the adoption of SFAS No. 115, marketable securities were carried at cost, which approximated market value.\n(d) Inventories\nInventories are valued at the lower of cost or net realizable value with cost determined primarily on the first-in, first-out (FIFO) basis. Cost includes the cost of material, direct labor and an applicable share of manufacturing overhead. The last-in, first-out (LIFO) method is used to determine the cost of a portion of inventory in the automotive products segment. Inventories priced at LIFO as of January 31, 1995 and 1994 were 35% and 34% of total inventories, respectively. If the FIFO method (which approximates current cost) had been used exclusively, inventories would have been higher than reported by $1.3 million and $1.1 million at January 31, 1995 and 1994, respectively.\nThe major classes of inventory are as follows:\n(e) Fixed Assets\nAdditions to fixed assets are recorded at cost. Depreciation of fixed assets is generally provided on a straight-line basis at rates which are intended to depreciate the assets over their estimated useful lives as follows:\n(f) Goodwill\nThe excess of the acquisition cost over the aggregate fair value of the underlying net assets of businesses acquired is amortized on a straight-line basis over no more than 40 years.\n(g) Revenue Recognition\nSales are recorded by the Company when products are shipped.\n(h) Research and Development Costs\nResearch and development costs, the majority of which are included in engineering and product development expenses, are charged to expense as incurred ($44.5, $39.6 and $32.0 million for fiscal 1994, 1993 and 1992, respectively).\n(i) Foreign Currency Translation\nFor most foreign subsidiaries, the local currency is considered the functional currency. Assets and liabilities of these subsidiaries are translated at year- end rates of exchange. Revenue and expense items are translated at average rates of exchange for the year. Translation adjustments, including the translation effect of intercompany transactions deemed permanent in nature, that arise due to fluctuations in exchange rates are recorded directly in stockholders' equity. Gains and losses resulting from foreign currency transactions are included in the statement of operations.\n(j) Income Taxes\nEffective February 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes,\" as described in Note 3.\nDeferred income taxes are provided on all significant temporary differences and represent the tax effect of transactions recorded for financial reporting purposes in periods different than for tax purposes.\n(k) Financial Instruments\nThe carrying values of the Company's financial instruments at January 31, 1995 approximate their estimated fair values. The carrying amounts of cash and cash equivalents and notes payable approximate fair value due to the short-term maturity of such instruments. The carrying amount of marketable securities is based on quoted market prices. The carrying amount of long-term debt approximates fair value based on the quoted market prices for the same or similar issues, or the current rates offered to the Company for debt with similar maturities and characteristics.\nDerivative financial instruments are recorded at market value, with resultant gains or losses recognized in the statement of operations immediately, unless the instrument is an effective hedge of a firm, committed transaction, in which case the associated gain or loss is deferred and recognized in connection with the underlying transaction exposure.\n3. CHANGES IN ACCOUNTING PRINCIPLES\nDuring fiscal 1993 the Company changed its method of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits and marketable securities in accordance with several new Statements of Financial Accounting Standards. Prior years' financial statements were not restated for these changes.\nEffective February 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 replaced SFAS No. 96 which the Company previously followed in accounting for income taxes. The principal difference between SFAS No. 109 and SFAS No. 96 is the ability, under SFAS No. 109, to record a deferred tax asset for net operating loss and credit carryforwards, when its ultimate realization is more likely than not. The adoption of SFAS No. 109 had no effect on the Company's results of operations or financial condition.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective February 1, 1993. This standard requires that the cost of postretirement benefits, primarily health care benefits, be recognized over employees' active working lives. In prior years, these costs were expensed as paid. The Company recorded the transition obligation, which represents costs related to service already rendered by both active and retired employees prior to fiscal 1993, as a cumulative effect of a change in accounting principle. This one-time, non-cash charge was $126.7 million. (The Company did not record an associated income tax benefit from the charge as tax operating losses in prior years diminish the Company's immediate ability to demonstrate that it is more likely than not that such benefits will be realized.) The Company will continue to follow its policy of funding postretirement benefits when due. In addition to the Company's adoption of SFAS No. 106, the cumulative effect of changes in accounting principles in the consolidated statement of operations includes a similar one-time charge ($11.4 million, net of tax benefit) for Hayes Wheels International, Inc. (Hayes Wheels), a 46.3% owned affiliate.\nEffective February 1, 1993, the Company changed its method of accounting for postemployment benefits, in accordance with SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" to recognize a charge for such benefits when it is probable that a liability has been incurred and the amount can be reasonably estimated. The adoption of SFAS No. 112 resulted in a one-time, non-cash $8.0 million charge which has been included within the cumulative effect of changes in accounting principles in the Company's consolidated statement of operations.\nEffective January 31, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 supersedes SFAS No. 12 which the Company previously followed in accounting for marketable securities. SFAS No. 115 requires that debt and equity securities not classified as either held-to-maturity securities or trading securities be classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. The Company has determined that its marketable securities portfolio is available-for-sale, as defined within the pronouncement, and has presented the unrealized net gain or loss on such portfolio as a separate component of stockholders' equity.\n4. INCOME TAXES\nEffective February 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes,\" as described in Note 3.\nIncome tax provisions have been recorded in respect of the Company's results of operations as follows:\nUnited States taxes include federal and state income taxes. State income taxes were not significant in fiscal 1993 or 1992.\nThe following table reconciles the 35%, 35% and 34% statutory United States federal income tax rates for the years ended January 31, 1995, 1994 and 1993, respectively, to the Company's effective tax rates:\nThe tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities recorded on the balance sheet as of January 31, 1995 and 1994 are as follows:\nThe valuation allowance results principally from tax operating losses in prior years which diminish the Company's immediate ability to demonstrate that it is more likely than not that future benefits will be realized.\nNo provision has been made for United States federal or foreign taxes on that portion of foreign subsidiaries' undistributed earnings ($146.5 million at January 31, 1995) considered to be permanently reinvested. There would have been no United States federal income tax liability had such earnings actually been repatriated due to the Company's existing tax loss carryforwards, however, upon repatriation, certain foreign countries would impose income and withholding taxes, which in the aggregate would be immaterial.\nDeferred income taxes for fiscal 1992 resulted primarily from differences in the depreciation methods used for financial reporting and tax purposes, and certain business acquisition adjustments.\nAt January 31, 1995, the Company had net operating loss carryforwards for tax purposes aggregating approximately $359 million. These loss carryforwards, principally in the United States, expire as follows: January 31, 1997 - $54 million; 1998 - $19 million; 1999 - $32 million and 2000 and beyond - approximately $254 million. Applicable tax laws of the United States and other countries may limit utilization of these losses, including United States federal operating loss carryforwards in the amount of $107 million generated by certain subsidiaries prior to their acquisition.\nCash payments for income taxes were $5.5, $5.1 and $4.8 million for fiscal years 1994, 1993 and 1992, respectively.\n5. PER SHARE DATA\nPrimary earnings per share of common stock have been calculated after deducting dividend entitlements on preferred stock and using the weighted average number of shares of common stock and dilutive common stock equivalents (stock options and awards) outstanding. Fully diluted earnings per share of common stock have been calculated using the fully diluted weighted average number of shares of common stock outstanding, and include the dilutive effect, if any, of convertible preferred stock outstanding.\nIn October 1993, the Company called for redemption all of the outstanding Class I Preferred Stock at a redemption price of $20.00 a share. As each share of Class I Preferred Stock was convertible into .6849 shares of the Company's common stock and as the market price of such common stock was greater than $29.20 per share, substantially all of the holders of such Class I Preferred Stock converted their shares into the Company's common stock in lieu of redemption. As a result of the foregoing, the Company issued 8,085,000 additional shares of common stock. The fully diluted weighted average number of shares of common stock outstanding assumes the conversion had taken place on the first day of fiscal 1993.\nAdditionally, in June 1993 and December 1992, the Company sold, through separate public offerings, 4,600,000 and 5,750,000 shares, respectively, of previously unissued common stock. A substantial portion of the proceeds served to reduce short-term and long-term debt. The primary and fully diluted weighted average number of shares outstanding include shares from such offerings from the actual transaction dates. The weighted average shares outstanding are summarized as follows:\n(Thousands of shares)\n6. MARKETABLE SECURITIES\nThe cost, gross unrealized gains and losses and fair value of the Company's marketable securities follows:\nAt January 31, 1995 the Company's marketable securities generally have contractual maturities that are long-term in nature, the majority of which are due after January 31, 1997.\nDuring the year ended January 31, 1995 the Company realized $4.2 million of gross gains and $1.8 million of gross losses on $70.1 million of proceeds from sales of available-for-sale securities, with cost computed using the specific identification method.\n7. RECEIVABLES\nReceivables are presented net of allowances for doubtful accounts of $5.1 million and $3.9 million at January 31, 1995 and 1994, respectively.\nCredit risk is generally concentrated within the Company's primary business segments. Geographically, such concentrations are principally within the United States and Western Europe. The Company performs ongoing credit evaluations of its customers' financial condition.\n8. OTHER ASSETS AND INTANGIBLES\nOther assets and intangibles consist of the following:\nOther assets and intangibles are presented net of accumulated amortization of $74.0 million and $64.7 million at January 31, 1995 and 1994, respectively.\nThe increase in goodwill during the current year is due primarily to the approximately $50 million acquisition of Dorman Diesels Limited, a United Kingdom based manufacturer of high horsepower diesel engines.\n9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nAccounts payable and accrued liabilities consist of the following:\n10. LONG-TERM DEBT\nDebt is repayable in United States dollars unless otherwise indicated.\n(a) Varity's 11.375% Senior Notes due November 15, 1998 are redeemable at the option of the Company, in whole or in part, at any time on or after November 15, 1996, at 100% of the principal amount thereof plus accrued interest to the date of redemption. The related indenture, among other things, restricts the Company and its subsidiaries' ability to make certain cash distributions, requires minimum levels of net worth, as defined, places restrictions on the use of proceeds from asset sales and limits the incurrence of additional indebtedness. See Note 14(b) (ii).\n(b) In connection with the Company's equity offering in June 1993, as described in Note 5, various indebtedness was retired, including certain debentures subject to early redemption premiums, which combined with the write-off of related unamortized debt issuance costs, resulted in an extraordinary loss of $1.7 million.\n(c) Certain of the Company's loan agreements provide for financial covenants affecting the Company and its principal subsidiaries. These covenants relate to such matters as the maintenance of specified financial ratios and minimum net worth. Certain loan agreements also contain cross-default provisions. At January 31, 1995 the Company and each of its subsidiaries were in compliance with their financial covenants. Management expects that the Company and each of its subsidiaries will remain in compliance during the year ending January 31, 1996.\n(d) As of January 31, 1995, debt maturities for long-term debt during the next five fiscal years are as follows: 1995 - $2.3 million; 1996 - $2.5 million; 1997 - - $3.8 million; 1998 - $152.0 million and 1999 and thereafter - $5.1 million.\n(e) The Company maintains various short-term credit facilities with lenders in certain countries for which related amounts outstanding are classified as notes payable in the consolidated financial statements. These credit facilities are generally restricted only in terms of a predefined maximum utilization and are subject to renewal annually or ongoing lender review. Certain facilities are secured by assets of the respective subsidiaries. The facilities bear interest at rates ranging from 7.0% to 10.5% at January 31, 1995. The weighted-average interest rate of the facilities outstanding at January 31, 1995 and 1994 is 8.4% and 6.9%, respectively.\nUnused long-term and short-term lines of credit at January 31, 1995 were $139.0 million and $100.7 million, respectively (January 31, 1994 - $97.6 million and $51.5 million, respectively). Approximately $525 million of consolidated assets secure such lines at January 31, 1995.\n(f) Interest, net includes interest income of $4.7, $6.3 and $7.0 million for fiscal 1994, 1993 and 1992, respectively. Cash payments of interest were $23.3, $37.8 and $98.4 million for fiscal 1994, 1993 and 1992, respectively.\n(g) Subsidiaries' debt agreements have financial covenants which may, in certain circumstances, restrict approximately $570 million of subsidiaries' net assets from being loaned, advanced or dividended to the Company.\n(h) During fiscal 1992 the Company's wholly-owned subsidiary, Dayton Walther, called its 14% Senior Subordinated Notes. The redemption premium and write-off of related unamortized debt issuance costs resulted in an extraordinary loss of $6.4 million.\n11. OTHER LONG-TERM LIABILITIES\nOther long-term liabilities consist of the following:\n12. PENSION BENEFITS\nThe Company and its subsidiaries have established pension plans in the principal countries where they operate. The majority of its employees are covered by either government or Company sponsored pension plans. Most of the Company's defined benefit plans provide pension benefits that are based on the employee's highest average eligible compensation. Plan assets consist primarily of exchange-listed stocks and bonds. The Company's funding policy is to contribute at least the amount required by law in the various jurisdictions in which the pension plans are domiciled. During the year ended January 31, 1995, the Company made approximately $63 million of additional contributions to its underfunded pension plans in excess of the minimum amount required by law.\nPension expense consists of the following:\nAs a result of the sale of its farm equipment business in fiscal 1994, the Company incurred $32.5 million of curtailment and settlement losses in connection with pension benefit obligations related to former North American Massey Ferguson employees. Such losses are included in the gain on sale of discontinued operation within the consolidated statement of operations and not in the table above.\nIn connection with the fiscal 1992 divestitures of certain non-core businesses, the Company recognized $4.6 million of curtailment and settlement losses which are included in the net amortization and deferral component of net pension expense for that year.\nThe funded status of pension plans is as follows:\nAs a result of the Company's settlement of its pension benefit obligations related to former North American Massey Ferguson employees, such obligations are not included in the table above as of January 31, 1995.\nThe fiscal 1994 additional minimum pension liability is a non-cash item which is offset by an intangible asset of $6.4 million and a direct reduction in stockholders' equity of $.5 million (corresponding offsets in fiscal 1993 were $7.2 million and $26.7 million, respectively). The Company's consolidated direct reduction in stockholders' equity also includes a component for equity investee Hayes Wheels' additional minimum liability.\nThe actuarial assumptions used to develop pension expense reflect prevailing economic conditions and interest rate environments of the different countries wherein the respective pension plans are domiciled. For the three years ended January 31, 1995, the annual discount rates range from 7.5% to 9.5% (8.25% in fiscal 1994 for plans domiciled in the United States), the remuneration increases range from 4.0% to 8.0% and the expected annual long-term rates of return on assets range from 8.25% to 11.0%.\n13. OTHER POSTRETIREMENT BENEFITS\nEffective February 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" as described in Note 3. This standard requires that the cost of postretirement benefits, primarily health care benefits, be recognized over employees' active working lives. In prior years, these costs were expensed as paid. The Company will continue to follow its policy of funding postretirement benefits when due.\nThe Company provides medical and group life benefits to substantially all North American retirees, including retirees of the divested farm equipment business who elect to participate in the Company's medical and group life plans. Medical plan contributions of the participating employees are adjusted periodically; the life insurance plan is non-contributory.\nThe components of postretirement benefits expense are as follows:\nThe recorded actuarial liabilities for postretirement benefits, including those previously recorded in connection with the fiscal 1989 acquisition of K-H Corporation (the parent of Kelsey-Hayes Company), are as follows:\nThe assumed fiscal 1995 health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 9% and was further assumed to decrease by 1% per annum to an ultimate rate of 6%. An increase in the assumed health care cost trend rate of 1 percentage point per year would increase the accumulated postretirement benefit obligation as of January 31, 1995 by approximately $19.6 million and the aggregate of the service and interest cost components of postretirement benefit expense for the year then ended by approximately $2.0 million. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.34% and 7.67% as of January 31, 1995 and 1994, respectively.\nDuring the year ended January 31, 1993, $13.5 million was charged to expense with respect to health care claims and life insurance premiums for retired employees based on the Company's previous cash-based method of accounting for these costs.\n14. STOCKHOLDERS' EQUITY\n(a) Authorized, Issued and Outstanding Stock\nThe Company is authorized to issue the following shares of stock:\n(i) Class I Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. Two series had been designated: 11,816,309 shares were designated as U.S. $1.30 Senior Cumulative Redeemable Convertible Exchangeable Preferred Class I Stock, Series A, par value $.01 per share; and 11,816,309 shares were designated as U.S. $1.30 Senior Cumulative Redeemable Convertible Exchangeable Preferred Class I Stock, Canadian Series A, stated value $5.00 per share (collectively, the Class I Preferred Stock). In October 1993 the Company called for redemption all of the previously outstanding shares of Class I Preferred Stock (see Note 5). No shares of Class I Stock are designated or outstanding at January 31, 1995.\n(ii) Class II Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. Currently, one series of 2,001,000 shares has been designated the Cdn. $1.625 Cumulative Redeemable Convertible Exchangeable Preferred Class II Stock, Series A (Class II Preferred Stock). As of January 31, 1995, 2,001,000 shares of Class II Preferred Stock were outstanding.\nThe holders of the Class II Preferred Stock are entitled to receive, as and when declared by the Board of Directors, fixed, cumulative, preferential dividends at an annual rate of Canadian $1.625 per share, payable quarterly.\nThe Class II Preferred Stock is junior to the Class I Stock in dividend and liquidation rights. Each share is convertible at any time into common stock at a conversion price of Canadian $75 per share of common stock (equivalent to .3333 shares of common stock per share of Class II Preferred Stock), subject to adjustment under certain conditions. Shares are redeemable at the Company's option. Each share is redeemable at, and has a liquidation value of, Canadian $25 plus accrued and unpaid cumulative dividends. Holders of Class II Preferred Stock have voting rights limited to a fractional vote per share. The fraction is determined by dividing 5% of the total number of shares of common stock entitled to vote by the total number of shares of Class II Preferred Stock entitled to vote.\n(iii) Class III Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. No series has been designated or issued.\n(iv) Special Purpose Preferred Stock:\n9,000,000 shares of U.S. $1.30 Redeemable Reset Special Purpose Preferred Stock authorized, par value $.01 per share, were issued for Canadian tax purposes in connection with the reincorporation of the Company from Canada to the United States in 1991. The shares do not have any financial impact on the Company. At January 31, 1995, 8,160,000 shares of this stock were outstanding and held by a wholly-owned subsidiary of the Company. These shares pay dividends at an annual rate of $1.30 per share, have no voting rights, and have a redemption and liquidation value of $20 per share. The shares are junior to the Class I Stock, Class II Stock and Class III Stock and are entitled to preference over the common stock as to dividends and the distribution of assets in the event of a liquidation of the Company.\n(v) Common Stock and Options:\n150,000,000 shares authorized, par value $.01 per share.\nDuring the second half of fiscal 1994 the Company commenced a common stock repurchase program which resulted in the repurchase of 2,329,500 shares of previously outstanding common stock. The Company will continue the periodic repurchase of up to 4.5 million shares of its common stock as conditions warrant. As a result of this program, 41,660,653 common shares were outstanding at January 31, 1995.\nDuring fiscal 1992, $6.2 million of common stock was issued pursuant to the termination of the Performance Equity Plan in a non-cash transaction.\nUnder the Shareholder Value Incentive Plan, the Company may from time to time grant options to purchase common stock at a specified price per share but not less than market value at the date of grant. Commencing in fiscal 1993, the substantial majority of such grants have been at a significant premium (29%-35%) to market value as of the grant date. The following table summarizes common stock option activity during each of the years in the three year period ended January 31, 1995:\n(1) Options have been exercised at average prices of $24.53, $15.50 and $11.59 for fiscal 1994, 1993 and 1992, respectively.\n(2) Options to purchase 1,314,000, 586,000 and 837,000 common shares were exercisable at January 31, 1995, 1994 and 1993, respectively. Options outstanding at January 31, 1995 were exercisable at prices ranging from $11.59 to $58.75 ($11.59 to $81.40 at January 31, 1994 and 1993).\n(b) Restrictions on Dividends, Issue and Reduction of Capital\n(i) As long as any Class II Preferred Stock is outstanding, and unless all dividends then payable on such shares have been declared and paid or amounts set aside for payment, the Company may not, without the prior approval of the holders of these shares:\n(1) declare or pay any dividends (other than stock dividends in shares of the Company ranking junior to such shares) on any common stock or junior ranking shares;\n(2) redeem, purchase or make any capital distribution in respect of any equal or junior ranking shares; or\n(3) issue any additional shares ranking as to capital or dividends prior to or in parity with these shares.\nAs of January 31, 1995, all dividends payable on the Class II Preferred Stock have been paid or set aside for payment.\n(ii) The indenture governing the Company's 11.375% Senior Notes due in 1998 limits the Company's ability to make certain cash distributions to its stockholders. As of January 31, 1995, the Company could pay up to approximately $352 million of cash dividends on its common stock under the most restrictive dividend covenant in such indenture.\n15. CONTINGENT LIABILITIES AND COMMITMENTS\n(a) Sale of Massey Ferguson\nPursuant to the Massey Ferguson purchase and sale agreement, the Company remains responsible for certain contingent liabilities of its former farm machinery business, principally product liability, taxes and environmental claims.\nThe total contingent liability, if any, may not exceed, in the aggregate, an amount as pre-defined in the agreement. The Company believes it made adequate provisions at the time of the sale for contingent liabilities relating to the farm machinery business and intends to fulfill its obligations under the purchase and sale agreement.\n(b) Investment in Hayes Wheels\nThe Company currently owns 46.3% of Hayes Wheels. If such ownership becomes less than 40%, the Company is required to offer to replace existing creditors under the current Hayes Wheels revolving credit agreement.\n(c) Capital Expenditure Programs\nApproved capital expenditure programs outstanding at January 31, 1995 approximated $102.0 million, including capital commitments of approximately $56.0 million.\n(d) Discounted Obligations\nThe Company has contingent liabilities relating to accounts receivable discounted, bills guaranteed and similar obligations amounting to $4.5 million and $3.8 million at January 31, 1995 and 1994, respectively.\n(e) Leases\nThe Company leases certain property and equipment under noncancellable operating leases. Payments due under these leases during the next five fiscal years and thereafter are as follows: 1995 - $14.5 million; 1996 - $13.0 million; 1997 - $9.6 million; 1998 - $4.1 million; 1999 - $2.4 million and $37.6 million thereafter.\n(f) Environmental\nThe Company, primarily through its automotive products segment, is involved in a limited number of remedial actions under various federal and state laws and regulations relating to the environment which impose liability on parties to clean up, or contribute to the cost of cleaning up, sites on which their hazardous wastes or materials were disposed or released. The Company believes that it has made adequate provision for costs associated with known remediation efforts in accordance with generally accepted accounting principles and does not anticipate the future cash requirements of such efforts to be significant in terms of its financial condition or liquidity. The Company has made no provision for unasserted claims as it is not possible to estimate the potential size of such future claims, if any.\n(g) Litigation\nThe Company is party to various litigation, certain of which involve significant claims. Management believes that the outcome of these lawsuits will not have a material adverse effect on the consolidated financial statements.\n16. FINANCIAL INSTRUMENTS\nDerivative financial instruments are utilized by the Company to reduce the risks associated with changes in interest rates and foreign exchange rates. The Company does not hold or issue financial instruments for trading purposes.\nThe Company has entered into interest rate swaps totalling 50 million pounds sterling (notional amount) which expire in September 1998, to manage its exposure to increases in interest rates on its LIBOR based, floating-rate long- term revolving credit facility. The notional amount of the swaps (approximately $79 million) represents an approximation of the average expected outstanding balance under the associated credit facility. The agreement enables the Company to make a constant, fixed interest payment regardless of any fluctuation in the underlying credit facility's contractual floating interest rate. Quarterly stabilization payments are either made to (or by) the Company from (or to) Chase Manhattan Bank N.A. to effect a\nconstant annualized net expense of 6.37% of the notional amount plus the spread over LIBOR required under the associated credit facility.\nThe Company also enters into forward exchange contracts to hedge certain firm sales commitments, net of offsetting purchases, denominated in foreign currencies. In addition, forward exchange contracts are entered into for a portion of anticipated sales commitments, net of anticipated purchases, expected to be denominated in foreign currencies. The purpose of such foreign currency hedging activities is to protect the Company from the risk that the eventual cash flows resulting from the sale of products to foreign customers (net of purchases from foreign suppliers) will be adversely affected by fluctuations in exchange rates. At January 31, 1995, the Company had $84.8 million of forward exchange contracts outstanding, primarily to exchange dollars and various European currencies for pound sterling (approximately $90.8 million at January 31, 1994). Substantially all contracts mature within a period of six months. Gains and losses on forward exchange contracts in connection with firm commitments that are designated and effective as hedges of such transactions are deferred and recognized in income in the same period as the hedged transactions. At January 31, 1995, less than $.5 million of unrecognized net losses were deferred on such contracts. Gains and losses on forward exchange contracts in connection with anticipated transactions are marked to market monthly with the resulting gain or loss recognized immediately in the consolidated statement of operations.\nThe Company is exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swaps and the forward exchange contracts. The Company does not anticipate nonperformance by any counterparty. The amount of such exposure is the amount owed to the Company, if any, related to the swaps and the deferred gains, if any, related to the forward exchange contracts.\n17. NON-RECURRING GAIN\nDuring the fourth quarter of fiscal 1992, the wheels business of Kelsey-Hayes was reorganized as Hayes Wheels and the non-wheel businesses and assets of Kelsey-Hayes, principally its automotive brake systems business, were transferred to, and the liabilities related thereto were assumed by, a newly- formed, wholly-owned subsidiary of the Company.\nThe Company reduced its ownership percentage in Hayes Wheels to 46.3% through a public offering of approximately 9.4 million common shares by Hayes Wheels in December, 1992. Subsequent to the closing date of the offering, the Company has accounted for its investment in Hayes Wheels on the equity method of accounting (see Note 19 for summarized financial information).\nThe proceeds to Hayes Wheels from the offering at $19 per share, after deducting commissions and related expenses, were approximately $162.0 million. The Company recognized a non-cash gain from this transaction amounting to $17.3 million which reflects the net increase in value of the Company's investment in Hayes Wheels at that date. In accordance with SFAS No. 96, no provision for taxes was made at the time of the transaction with respect to the gain due to the Company's existing tax loss carryforwards. An appropriate liability for such deferred taxes was recognized at the time of adoption of SFAS No. 109.\n18. BUSINESS SEGMENT INFORMATION\nThe principal industry segments and geographic regions in which the Company operates are set forth below. The automotive products segment manufactures and sells brake systems and other components primarily to the original equipment manufacturers (OEMs) of the motor vehicle industry. Prior to the sale of a majority ownership in Hayes Wheels, this segment also included the manufacture and sale of aluminum and steel wheels to OEMs and the aftermarket. In fiscal 1994, this segment had sales to two domestic OEM customers that individually comprised more than 10% of consolidated total sales and revenues. The fiscal 1994 sales to these customers were $491 million and $467 million, respectively (the amounts related to these customers in fiscal 1993 were $396 million and $358 million, respectively and in fiscal 1992 were $421 million and $393 million, respectively). The engines segment manufactures and sells multi- cylinder, multi-purpose diesel engines. \"Other\" consists of the hydraulic components business.\nINDUSTRY SEGMENT\nGEOGRAPHIC SEGMENT\nReconciliation to consolidated financial statements:\n(a) Includes exchange adjustments, non-recurring gain and general corporate expense net of miscellaneous income.\n19. INVESTMENTS IN ASSOCIATED AND OTHER COMPANIES\nVarity's investments in associated and other companies as of January 31, 1995 and 1994 consists primarily of its 46.3% interest in Hayes Wheels. During fiscal 1994 and 1993 the Company received dividends of $.5 million each year from Hayes Wheels. No dividends were received during fiscal 1992. As of January 31, 1995, the Company's investment in Hayes Wheels, a publicly traded company, had a market value of approximately $130 million.\nVarity's consolidated statement of operations for fiscal 1992 includes 100% of the revenues and expenses of Hayes Wheels prior to the completion of the public offering as described in Note 17.\nSummarized financial information of these investee companies, including Hayes Wheels prior to the deconsolidation, is presented below:\nSTATEMENTS OF OPERATIONS\n(1) Primarily relates to an investee company's adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nBALANCE SHEETS\nCertain investees' indebtedness restrict approximately $190 million of investee net assets from being loaned, advanced or dividended to the Company by such investees.\nVarity's consolidated deficit at January 31, 1995 and 1994 includes $13.0 million and $.2 million, respectively, of undistributed earnings of the above investees.\n20. KELSEY-HAYES\nEffective November 30, 1989, the Company acquired K-H Corporation (\"K-H\", formerly Fruehauf Corporation). K-H, through its wholly-owned subsidiary Kelsey-Hayes Company (Kelsey-Hayes), is a leading manufacturer of brake systems and other components for passenger cars and light trucks.\nThe following table presents summarized consolidated financial information for Kelsey-Hayes, which comprises a substantial portion of the automotive products segment.\n(i) Balance Sheets\n(ii) Statements of Operations\nIndependent Auditors' Report\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS VARITY CORPORATION:\nWe have audited the consolidated financial statements of Varity Corporation and subsidiaries listed in Item 14(a)(1) of the Annual Report on Form 10-K for the fiscal year 1994. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules listed in Item 14(a)(2) of the Annual Report on Form 10-K for the fiscal year 1994. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion of these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Varity Corporation and subsidiaries as of January 31, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended January 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.\nAs discussed in Note 3 of the Notes to Consolidated Financial Statements, in the year ended January 31, 1994, the Company changed its methods of accounting for income taxes to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" postretirement benefits to adopt the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" postemployment benefits to adopt the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" and marketable securities to adopt the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\n\/s\/ KPMG Peat Marwick LLP\nBuffalo, New York February 28, 1995\nManagement's Report on Financial Statements\nThe accompanying consolidated financial statements of the Company have been prepared by management in accordance with generally accepted accounting principles. Management is responsible for all information in the Annual Report. All financial and operating data in the Annual Report are consistent with that contained in the consolidated financial statements.\nManagement is also responsible for the integrity and objectivity of the consolidated financial statements. In the preparation of these statements, estimates are sometimes necessary when transactions affecting the current accounting period are dependent on the outcome of future events. Such estimates are based on careful judgements and have been appropriately reflected in the accompanying consolidated financial statements. Management has established systems of internal control which are designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce reliable accounting records.\nThe Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal control. The Board exercises these responsibilities principally through the Audit Committee. The Audit Committee meets periodically with management and the internal and the external auditors to satisfy itself that their responsibilities are properly discharged and to review the consolidated financial statements.\nThe Company's independent external auditors have audited the consolidated financial statements. Their audit was conducted in accordance with generally accepted auditing standards, which includes consideration of the Company's internal controls to the extent necessary to form an independent opinion on the financial statements prepared by management. The internal and external auditors have had, and continue to have, full and free access to the Audit Committee of the Board.\nManagement recognizes its responsibility for conducting the Company's affairs in compliance with established financial standards and applicable laws, and for the maintenance of proper standards of business conduct in its activities.\nFebruary 28, 1995\n\/s\/ Victor Rice\nVictor Rice Chief Executive Officer\n\/s\/ J.A. Gilroy\nJ.A. Gilroy Chief Operating Officer\n\/s\/ N.D. Arnold\nN. D. Arnold Senior Vice President Chief Financial Officer\nSUPPLEMENTARY INFORMATION (Unaudited)\n* Anti-dilutive\n(1) As a result of the fiscal 1994 sale of the farm equipment segment, as described in Note 1 to the Consolidated Financial Statements, prior year financial data has been restated to conform to the current year presentation of the farm equipment segment as a discontinued operation. (2) The fiscal 1993 second quarter extraordinary loss arose on the early extinguishment of debt as described in Note 10 to the Consolidated Financial Statements. (3) Primarily relates to the Company's adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective February 1, 1993, as described in Note 3 to the Consolidated Financial Statements. (4) Per share calculations for each of the quarters is based on the weighted average number of shares outstanding for each period; the sum of the quarters may not necessarily be equal to the full year per share amount.\nFINANCIAL STATISTICS (1) (Unaudited)\n(1) As a result of the fiscal 1994 sale of the farm equipment segment, as described in Note 1 to the Consolidated Financial Statements, prior years' financial data has been restated to conform to the current year presentation of the farm equipment segment as a discontinued operation. (2) Amounts reported for fiscal 1992 reflect the sale of a majority ownership of Hayes Wheels. (3) Extraordinary loss for fiscal 1993 and 1992 consist of $1.7 million and $6.4 million, respectively, associated with the early extinguishment of debt. (4) Amounts have been restated to reflect the one for 10 reverse stock split as of the earliest period presented.\nSALES AND REVENUES STATISTICS (1) (Unaudited)\n(Dollars in millions)\n(1) As a result of the fiscal 1994 sale of the farm equipment segment, as described in Note 1 to the Consolidated Financial Statements, prior years' financial data has been restated to conform to the current year presentation of the farm equipment segment as a discontinued operation. Sales related to the farm equipment segment have been reclassified into earnings (loss) from discontinued operation on the consolidated statements of operations.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nFor the fiscal year ended January 31, 1995, there have been no disagreements with accountants on accounting or financial disclosure.\nPART III\nThe following information contained in Varity Corporation's Proxy Statement relating to the Annual Meeting of Stockholders, is incorporated herein by reference:\nITEM 13.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nMr. William A. Corbett, a Director, is a partner of Fraser & Beatty (Barristers & Solicitors), who have provided and continue to provide legal advice to the Company.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements Page ----\nIncluded in Part II, Item 8. of this report:\nConsolidated Statements of Operations for the years ended January 31, 1995, 1994 and 1993................................. 21\nConsolidated Balance Sheets as at January 31, 1995 and 1994..... 22\nConsolidated Statements of Changes in Stockholders' Equity for the years ended January 31, 1995, 1994 and 1993................. 23\nConsolidated Statements of Cash Flows for the years ended January 31, 1995, 1994 and 1993................................. 25\nNotes to Consolidated Financial Statements...................... 26\nIndependent Auditors' Report.................................... 47\nManagement's Report on Financial Statements..................... 48\nSupplementary Information (Unaudited)\nQuarterly Condensed Unaudited Statements of Operations for the years ended January 31, 1995 and 1994......................... 49\nFinancial Statistics for the years ended January 31, 1995, 1994, 1993, 1992 and 1991..................................... 50\nSales and Revenues Statistics for the years ended January 31, 1995, 1994, 1993, 1992 and 1991............................... 51\n2. Financial Statement Schedules for the years ended January 31, 1995, 1994 and 1993\nIncluded in Part IV of this report: Schedule Number Page -------- ----\nCondensed Financial Statements of Varity Corporation (Unconsolidated):\nCondensed Statements of Operations and Deficit (Unconsolidated) for the years ended January 31, 1995, 1994 and 1993 .. III 56\nCondensed Balance Sheets (Unconsolidated) as at January 31, 1995 and 1994............... III 57\nCondensed Statements of Cash Flows (Unconsolidated) for the years ended January 31, 1995, 1994 and 1993.......................................... III 58\nNotes to Condensed Financial Statements (Unconsolidated).............................. III 59\nValuation and Qualifying Accounts................. VIII 60\nOther schedules are omitted because they are not applicable, not required or because the information required is included in the Consolidated Financial Statements and Notes thereto (see Part II).\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed with the Securities and Exchange Commission (SEC) subsequent to those listed in the Quarterly Report on Form 10-Q for the three months ended October 31, 1994, filed on December 8, 1994.\n(c) Exhibits\n(G) 3.1 - Restated Certificate of Incorporation of Varity Corporation. (H) 3.2 - By-laws. (F) 4.1 - Indenture, dated as of October 8, 1991 between Varity Corporation and Manufacturers & Traders Trust Company, as trustee, relating to 11 3\/8% Senior Notes due 1998.\n10.0 - MATERIAL CONTRACTS\n10.1 - LOAN AGREEMENTS\n(L) (a) - Amended and restated Credit Agreement dated as of June 9, 1993 between Dayton Walther Corporation, The Bank of Nova Scotia and NBD Bank, N.A. (i) Varity Corporation Guarantee dated June 9, 1993 to The Bank of Nova Scotia and NBD Bank, N.A. (L) (b) - Amended and restated Credit Agreement dated as of August 31, 1993 between Kelsey-Hayes Company, The Chase Manhattan Bank N.A., as agent, and The Bank of Nova Scotia, as co-agent. (L) (c) - Facility Agreement dated as of September 30, 1993 among Perkins Limited and others, various banks and Lloyds Bank Plc, as agent. (i) Guarantee Agreement dated September 30, 1993. (ii) Trust Agreement dated September 30, 1993. (iii) Composite Security Assignment and Deposit Charge dated September 30, 1993. (L) (d) - Facility Agreement dated as of September 30, 1993 among Perkins Group Limited and others, and Lloyds Bank Plc. (i) Composite Debenture dated September 30, 1993. (ii) Guarantee dated September 30, 1993. (iii) Omnibus Guarantee dated September 30, 1993. (O) (e) - Loan Agreement dated as of January 21, 1994 between Heerlen ABS Manufacturing C.V. and Cooperatieve Centrale Raiffeisen - Boerenleenbank B.A. and De Nationale Investeringsbank N.V. (O) (f) - Overdraft Facility Agreement dated as of January 21, 1994 between Heerlen ABS Manufacturing C.V. and Cooperatieve Centrale Raiffeisen - Boerenleenbank B.A. (O) (g) - Continuing Guarantee dated as of January 21, 1994 between Varity Corporation and Cooperatieve Centrale Raiffeisen - Boerenleenbank B.A. and De Nationale Investeringsbank N.V., reference (e) and (f). (O) (h) - Pledge Agreement dated as of April 12, 1994 between Heerlen ABS Manufacturing C.V., Heerlen ABS Manufacturing B.V., and Cooperatieve Centrale Raiffeisen - Boerenleenbank B.A. and De Nationale Investeringsbank N.V., reference (e) and (f). (O) (i) - Continuing Guaranty dated as of April 12, 1994 between Heerlen ABS Manufacturing B.V. and Cooperatieve Centrale Raiffeisen - Boerenleenbank B.A. and De Nationale Investeringsbank N.V., reference (e) and (f).\n10.2 - OTHER MATERIAL CONTRACTS\n(C) (a) - Class II Share Exchange Agreement dated April 30, 1986 among MF Limited, CDIC, ODC, Canadian Imperial Bank of Commerce (\"CIBC\") and The Secretary of State for Trade and Industry acting by the Export Credits Guarantee Department (\"ECGD\"). (J) * (b) - Form of Executive Termination Arrangements. (I) * (c) - Executive Stock Option Plan. (J) * (d) - Varity Corporation Retirement Equity and Deferred Compensation Plan. (K) * (e) - Form of Employment Agreement and Supplement to Retirement Equity and Deferred Compensation Plan of Varity Corporation. (B) * (f) - Canadian Retirement Income Plan for Designated Employees. (B) * (g) - United Kingdom Executive Pension Scheme.\n(E) (h) - Agreement dated December 17, 1990 between Varity Corporation and the Government of Canada, Canada Development Investment Corporation, the Government of Ontario and Ontario Development Corporation replacing the Governments Foundation Agreement dated as of January 27, 1986. (D) (i) - Agreement between Varity Corporation and National Automobile, Aerospace and Agricultural Implement Workers Union of Canada and its Locals 439 and 458 dated as of October 18, 1990. (M) * (j) - Shareholder Value Incentive Plan. (N) (k) - Purchase and Sale Agreement between and among AGCO Corporation and Varity Holdings Limited, Varity GmbH, Massey Ferguson GmbH, Massey Ferguson Industries Limited, Massey Ferguson (Delaware) Inc. and Varity Corporation dated as of April 26, 1994.\n(A) 11. - Earnings Per Share Computations. (A) 21. - Subsidiaries of the Registrant. (A) 23. - Consent of KPMG Peat Marwick LLP, Independent Auditors. (A) 27. - Financial Data Schedule.\nLEGEND FOR EXHIBITS (PAGES 54 THROUGH 55)\n(A) Filed herewith. (B) Incorporated by reference from the Registrant's Registration Statement No. 33-7716 on Form S-1, filed with the SEC on July 15, 1986, as amended. (C) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1986 filed with the SEC on May 15, 1986. (D) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q, for the quarter ended October 31, 1990 filed with the SEC on December 13, 1990. (E) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1991 filed with the SEC on April 30, 1991. (F) Incorporated by reference from the Registrant's Registration Statement No. 33-42401 on Form S-3, filed with the SEC on August 23, 1991. (G) Incorporated by reference from the Registrant's Registration Statement on Form 8-B, filed with the SEC on September 24, 1991. (H) Incorporated by reference from the Registrant's Registration Statement No. 41125 on Form S-4, filed with the SEC on June 13, 1991. (I) Incorporated by reference from the Registrant's Registration Statement No. 33-44266 on Form S-8, filed with the SEC on November 29, 1991. (J) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1992 filed with the SEC on April 30, 1992. (K) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1993 filed with the SEC on April 29, 1993. (L) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q, for the quarter ended October 31, 1993 filed with the SEC on December 10, 1993. (M) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1994 filed with the SEC on April 18, 1994. (N) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q, for the quarter ended April 30, 1994 filed with the SEC on June 10, 1994. (O) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q, for the quarter ended July 31, 1994 filed with the SEC on September 9, 1994.\n* Represents compensatory plans or arrangements for directors or executive officers of the Registrant.\n(d) Financial Statements of Significant Subsidiary\nFinancial statements and notes thereto and the financial statement schedules required by Articles 3 and 5 of Regulation S-X, of a 50 percent or less owned company, as defined, Hayes Wheels International, Inc. (Hayes Wheels), are incorporated herein by reference from Hayes Wheels' Annual Report on Form 10-K for the year ended January 31, 1995.\nSCHEDULE III\nVARITY CORPORATION CONDENSED STATEMENTS OF OPERATIONS AND DEFICIT (Unconsolidated) (Dollars in millions)\nSCHEDULE III\nVARITY CORPORATION CONDENSED BALANCE SHEETS (Unconsolidated) (Dollars in millions)\nSee accompanying Notes to Condensed Financial Statements.\nSCHEDULE III\nVARITY CORPORATION CONDENSED STATEMENTS OF CASH FLOWS (Unconsolidated) (Dollars in millions)\nSee accompanying Notes to Condensed Financial Statements.\nSCHEDULE III\nVARITY CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS (Unconsolidated) (Dollars in millions)\n1. These notes should be read in conjunction with the accounting policies and other significant accounting matters contained in the Notes to Consolidated Financial Statements (see Part II).\n2. Pursuant to a plan to dispose of its farm equipment segment, in June 1994 the Company completed the sale of its worldwide Massey Ferguson farm machinery business to AGCO Corporation (AGCO) for $310 million in cash and 500,000 shares of AGCO common stock, resulting in a gain of $23.2 million.\nAs a result of this plan, the farm equipment segment has been presented as a discontinued operation in the accompanying condensed financial statements. See Note 1 to the Consolidated Financial Statements (see Part II).\n3. During fiscal 1993 Varity changed its method of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits and marketable securities in accordance with several new Statements of Financial Accounting Standards. A one-time, non-cash charge of $146.1 million was recorded as a cumulative effect of changes in accounting principles and includes the cumulative effect relating to Varity's subsidiaries and associated companies. The details of these changes in accounting principles are discussed in Note 3 to the Consolidated Financial Statements (see Part II).\n4. In fiscal 1994, 1993 and 1992, Varity increased its investment in subsidiaries through non-cash transactions by approximately $44 million, $60 million and $149 million, respectively, by capitalizing intercompany loans and receivables.\nDuring fiscal 1992, $6.2 million of common stock was issued pursuant to the termination of the Performance Equity Plan in a non-cash transaction.\n5. Varity received cash dividends from its consolidated subsidiaries amounting to $72.1 million, $20.8 million and nil for the years ended January 31, 1995, 1994 and 1993, respectively.\nIn fiscal 1994, Varity received dividends in the form of marketable securities from its consolidated subsidiaries amounting to $18.6 million.\nVarity charges its subsidiaries for costs which it incurs on their behalf. The amounts of such charges for the years ended January 31, 1995, 1994 and 1993, were $16.1 million, $18.9 million and $17.1 million, respectively.\n6. Varity has guaranteed approximately $12 million of its subsidiaries' indebtedness outstanding at January 31, 1995.\n7. Varity and its subsidiaries have agreed to certain covenants and undertakings with their lenders. There are also certain contingent obligations of the Company and it subsidiaries. The details of these covenants and undertakings, and compliance therewith, and contingent obligations are discussed in Notes 10 and 15 to the Consolidated Financial Statements (see Part II).\nSCHEDULE VIII\nVARITY CORPORATION VALUATION AND QUALIFYING ACCOUNTS Years ended January 31, 1995, 1994 and 1993 (Dollars in millions)\n- ---------- (1) Charges to other accounts arise on translation of reserves of companies outside the United States and are reflected in the currency translation adjustment account.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVARITY CORPORATION\n\/s\/ J.A. Gilroy J.A. Gilroy Chief Operating Officer April 14, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nVARITY CORPORATION\nINDEX TO EXHIBITS\nFILED HEREWITH (1)\nExhibit Number - --------\n11.1 Primary Earnings Per Share Computations for the years ended January 31, 1995, 1994 and 1993\n11.2 Fully Diluted Earnings Per Share Computations for the years ended January 31, 1995, 1994 and 1993\n21 Subsidiaries of the Registrant\n23 Consent of KPMG Peat Marwick LLP, Independent Auditors\n27 Financial Data Schedule\n- ------ (1) Complete listing of all exhibits can be found on pages 54-55.","section_15":""}
{"filename":"827085_1995.txt","cik":"827085","year":"1995","section_1":"ITEM 1. BUSINESS\nPinnacle Banc Group, Inc. (the \"Corporation\") is a multi-bank holding company registered under the Bank Holding Company Act and is engaged in the business of banking through the ownership of subsidiary banks. At December 31, 1995 the Corporation had total consolidated assets of $818,697,000, total loans of $309,600,000, total deposits of $712,805,000, and total stockholders' equity of $78,961,000. The Corporation's principal office is 2215 York Road, Suite 208, Oak Brook, Illinois 60521. The Corporation has twelve banking locations in the metropolitan areas of Chicago and Quad-Cities, Illinois and Iowa.\nThe Corporation, formerly First Cicero Banc Corporation (\"FCBC\"), was organized under the laws of the State of Illinois on August 24, 1979 for the purpose of acquiring the First National Bank of Cicero (the \"Cicero Bank\"). On April 30, 1988, the Corporation merged (the \"Merger\") with First Harvey Banc Corporation (\"FHBC\"), parent company of First National Bank in Harvey (the \"Harvey Bank\"), and LaGrange Park Banc Corporation (\"LPBC\"), parent company of Bank of LaGrange Park (the \"LaGrange Park Bank\"). FHBC and LPBC were affiliated with FCBC through common ownership. In connection with the Merger, the name of the Corporation was changed to Pinnacle Banc Group, Inc.\nSince the date of the merger, SBH Corp., parent company of Bank of Silvis (the \"Silvis Bank\"), was merged into the Corporation on September 29, 1989. The Berwyn National Bank (the \"Berwyn Bank\") was purchased on February 1, 1992. The Henry County Bank was purchased on March 27, 1992. Batavia Financial Corporation, parent company of Batavia Savings Bank, F.S.B. (\"Batavia Savings\"), was merged into Pinnacle on December 31, 1992.\nOn December 7, 1992, the Silvis Bank merged with the Henry County Bank with the resultant bank named Pinnacle Bank of the Quad-Cities (\"Quad-Cities Bank\"). On July 9, 1993, the Cicero Bank, Harvey Bank and Berwyn Bank were merged with and into the LaGrange Park Bank with the resultant bank named the Pinnacle Bank. On January 6, 1995, Acorn Financial Corp (\"AFC\") and its subsidiary bank, Suburban Trust & Savings Bank (\"STSB\") were purchased. AFC was liquidated into the Corporation and concurrent with the liquidation, STSB was merged into Pinnacle Bank.\nThe Corporation owns 100% of the common stock of Pinnacle Bank, Quad-Cities Bank and Batavia Savings.\nThe Corporation is a legal entity separate and distinct from its subsidiary banks. The major source of the Corporation's revenues is dividends from its subsidiary banks.\nSUBSIDIARY BANKS\nPinnacle Bank and Quad-Cities Bank are full service commercial banks encompassing most of the usual functions of commercial and savings banking including commercial, consumer, and real estate lending; installment credit lending; collections; safe deposit operations; and other services tailored for individual customer needs. The banks also offer a full range of deposit services to individuals and businesses which include demand, savings and time deposits, as well as providing trust services to the customers. Pinnacle Bank provides nondeposit-based products, including mutual funds and annuities through affiliation with an independent broker.\nBatavia Savings is a federally-chartered savings bank which is principally engaged in the business of attracting savings and other funds from the general public and investing these funds, principally by originating residential mortgage loans and investing in investment grade securities. In addition to residential mortgage loans, Batavia Savings makes commercial, consumer and installment loans. The bank offers a full range of deposit services including demand, savings and time deposits.\nThe Pinnacle Bank, a state banking corporation organized under the laws of Illinois, was formed on July 9, 1993 through the merger of the Cicero Bank, Harvey Bank and Berwyn Bank with and into the LaGrange Park Bank. The Cicero Bank was originally organized in 1921, the Harvey Bank in 1937, the Berwyn Bank in 1937 and the LaGrange Park Bank in 1962. The Bank's main office is located in Cicero, Illinois, with full service branches in Harvey, Berwyn, Oak Park, LaGrange Park and Westmont and limited service facilities in Cicero and North Riverside. At December 31, 1995, the Bank had total assets of $624 million.\nThe Quad-Cities Bank was organized as a state banking corporation with the name Bank of Silvis under the laws of the State of Illinois in 1950. On December 7, 1992, The Henry County Bank, organized as a state banking corporation under the laws of the State of Illinois in 1968, was merged with and into Bank of Silvis and the name of the merged entity was changed to Pinnacle Bank of the Quad- Cities. The Bank's main office is located in Silvis, Illinois, with a full service branch located in Green Rock, Illinois. Each community is part of the Quad-Cities area of Illinois and Iowa. As of December 31, 1995, the Bank had total assets of $106 million.\nBatavia Savings was originally organized as an Illinois state chartered savings and loan association in 1909. The Bank converted to a federal mutual charter in 1983. The Bank amended its charter in August, 1990 in connection with the conversion from a mutual thrift to a federal stock savings bank and changed its name to Batavia Savings Bank, F.S.B. from Batavia Savings and Loan. The Bank's main office is located in Batavia, Illinois with a full service branch located in Elburn. Currently, Batavia Savings is leasing its previously owned branch in Elburn. A new Elburn branch, presently under construction, will open in the second or third quarter of 1996. As of December 31, 1995, the Bank had total assets of $67 million.\nCOMPETITION\nIntense competition exists in all aspects of business in which the Corporation and its subsidiary banks are presently engaged, not only with other commercial banks and trust companies but also with thrifts, finance companies, personal loan companies, credit unions, leasing companies, money market mutual funds, investment firms, mortgage bankers, and other financial institutions serving the metropolitan areas of Chicago and the Quad-Cities.\nCommercial and savings banks compete on the basis of price, including interest rates paid on deposits and charged on loans, convenience and quality of service. This competition includes banks which are many times larger than a banking subsidiary, including banks in the primary marketing areas of each subsidiary bank which have recently become affiliated through parent holding companies owning significantly larger banking institutions. Each subsidiary bank is encountering increased competition from non-bank financial institutions. Thrift deposits constitute a substantial portion of all financial institutions' deposits in Illinois. Thrifts are able to compete aggressively with commercial banks in the important area of consumer lending. Credit unions and small loan companies each are significant factors in the consumer loan market. Insurance companies, investment firms and retailers are all significant competitors for various types of business.\nEMPLOYEES\nAt December 31, 1995, the Corporation and its subsidiary banks employed 337 persons on a full-time equivalent basis.\nSUPERVISION AND REGULATION\nGENERAL. At the present time, various bills have been introduced in the United States Congress and the Illinois state legislature which could result in additional regulation of the business of the Corporation and any banks which are now or hereafter become affiliated with the Corporation. Future bills could also be introduced which could significantly affect the banking industry. It cannot be\npredicted whether any such legislation will be adopted or how such adoption would affect the business of the Corporation or any banks so affiliated.\nThe following references to applicable statutes and regulations are brief summaries thereof which do not purport to be complete and which are qualified in their entirety by reference to such statutes and regulations.\nBANK HOLDING COMPANY. As a bank holding company, the Corporation is subject to the supervision of the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the \"BHC Act\"). Bank holding companies are required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require. The Federal Reserve Board also makes periodic examinations of bank holding companies and their subsidiaries. As a result of the Corporation's acquisition of Batavia Savings, the Corporation is also considered a diversified savings and loan holding company subject to regulatory oversight by the Office of Thrift Supervision (\"OTS\"). As such, the Corporation is subject to regulation and examination by the OTS. The Corporation is required 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 a subsidiary bank of the Corporation, if, after such acquisition, it would own or control more than 5% of the voting shares of such bank. The BHC Act does not permit the Federal Reserve Board to approve the acquisition by the Holding Company of any voting shares of, or all or substantially all of the assets of, any bank located outside of the State of Illinois, unless such acquisition is specifically authorized by the laws of the state in which such bank is located.\nThe BHC Act limits the activities which may be engaged in by any bank holding company and its subsidiaries to certain specified activities, including those activities which the Federal Reserve Board may find by order or regulation, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nSubsidiary banks of a bank holding company (such as the bank subsidiaries of the Corporation) 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 BHC Act and regulations of the Federal Reserve Board, 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.\nBANKS. The operations of Pinnacle Bank and Quad-Cities Bank are subject to federal and state statutes and regulations applicable to banks chartered under the banking laws of the State of Illinois and to regulation by the Federal Deposit Insurance Corporation (\"FDIC\"). The operations of Batavia Savings are subject to federal statutes and regulations applicable to thrifts chartered under the Banking laws of the United States and to regulation by the OTS. Batavia Savings is a member of the Federal Home Loan Bank of Chicago.\nThe Federal Reserve System, the FDIC, the OTS and the State of Illinois Commissioner of Banks and Trust Companies regularly examine, where applicable, such areas as reserves, loans, investments, management practices and other aspects of the banks' operations. These examinations are designed for the protection of the banks' depositors and not for its stockholders. In addition to these regular examinations, the banks must furnish periodic reports to the regulatory authorities containing a full and accurate statement of its affairs. As members of the FDIC, the banks' deposits are insured as provided by law. Effective January 1, 1993, a risk-based deposit insurance assessment program was placed into effect by the FDIC. Insurance premiums are to be determined based on the level of a bank's capital and supervisory evaluation. As of the current date, each of the Corporation's subsidiary banks were in the lowest premium assessment category.\nFederal and state banking laws and regulations govern or restrict, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, the loans a bank makes and the collateral it takes, the activities of a bank with respect to mergers and consolidations, and the establishment of branches. Each banking regulatory authority has the authority to prevent a bank from engaging in an unsafe or an unsound practice in conducting its business. The payment of dividends, depending upon the financial condition of a bank, could be deemed such a practice.\nAs subsidiary banks of a bank holding company, the subsidiary banks are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Corporation or any of its other subsidiaries, on investments in the stock or other securities of the Corporation or any of its subsidiaries, and on taking such stock or securities as collateral for loans. Federal statutes and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal stockholders of its parent holding company and to related interests of such principal stockholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal stockholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.\nFurthermore, Federal statutes prohibit acquisition of \"control\" of a bank or bank holding company without prior notice to certain Federal bank regulators. \"Control\" is defined in certain cases as acquisition of as little as 5% of the outstanding shares. From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and expansions or restrictions on, the business of the banks. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of the banks.\nIn 1991, the Federal Deposit Insurance Corporation Improvement Act (\"FDICIA\") was enacted into law. FDICIA provides for, among other things, the recapitalization of the FDIC Insurance Fund; enhanced federal supervision of depository institutions, including greater authority for the appointment of a conservator or receiver for undercapitalized institutions; the adoption of safety and soundness standards by the Federal banking regulators, on matters such as loan underwriting and documentation, interest rate risk exposure and compensation and other employee benefits; the establishment of risk-based deposit insurance premiums; liberalization of the qualified thrift lender test; greater restrictions on transactions with affiliates; mandated consumer protection disclosures with respect to deposit accounts; and expanded audit requirements including statements by management regarding internal controls and regulatory compliance.\nGOVERNMENT MONETARY POLICIES\nThe earnings of banks and bank holding companies are affected by the policies of regulatory authorities including the Federal Reserve Board which regulates the money supply. Among the methods employed by the Federal Reserve Board are open market operations in U. S. Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial and savings banks in the past and are expected to continue to do so in the future.\nFINANCIAL INFORMATION\nFor financial information regarding the Corporation, see ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, and ITEM 14, EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate offices of the Corporation are located at 2215 York Road, Suite 208, Oak Brook, Illinois 60521. These offices, consisting of approximately 2,000 square feet, have been leased by the Corporation since January 1, 1989. Approximately two years remain on the term of the lease.\nPinnacle Bank owns its main banking office located at 6000 West Cermak Road, Cicero, Illinois 60650. The main office consists of approximately 41,500 square feet and was extensively remodeled in 1989.\nPinnacle Bank has five other full service banking offices. The Harvey Banking Center is located at 174 East 154th Street, Harvey, Illinois 60426 with an adjacent drive-in facility and parking lot. The main building consists of approximately 33,000 square feet. The Berwyn Banking Center is located at 7112 West Cermak Road, Berwyn, Illinois 60402. The building consists of approximately 15,000 square feet and was extensively remodeled in 1991. The Oak Park Banking Center, containing approximately 21,000 square feet, is located at 840 South Oak Park Avenue, Oak Park, Illinois 60304. The Westmont Banking Center contains approximately 23,000 square feet and is located at 640 Pasquinelli Drive, Westmont, Illinois 60559. All aforementioned buildings are owned by Pinnacle Bank. The LaGrange Park Banking Center is located in a leased office at Oak and Sherwood Streets, LaGrange Park, Illinois 60525. Eight years remain on the term of the lease. The office consists of approximately 11,500 square feet.\nPinnacle Bank has two limited service banking facilities. An owned facility containing approximately 2,500 square feet is located at 2500 South Cicero Avenue, Cicero, Illinois 60650. This facility, with certain expanded services, was constructed in 1995. A leased facility containing approximately 2,000 square feet is located at 7373 West 25th Street, North Riverside, Illinois 60546. Twelve years remain on the term of the lease.\nThe Quad-Cities Bank owns its main banking office located at Eleventh Street and First Avenue, Silvis, Illinois 61282. The banking office consists of approximately 10,600 square feet. The Quad-Cities Bank owns a branch banking office located at 107 First Street, Green Rock, Illinois 61241. The banking office consists of approximately 4,000 square feet.\nBatavia Savings owns its main banking office located at 165 West Wilson Street, Batavia, Illinois 60510. The banking office consists of 8,640 square feet. Batavia Savings currently leases a formerly owned branch banking office at 100 South Main Street, Elburn, Illinois 60119. This banking office consists of 2,300 square feet. A new banking office of approximately 2,400 square feet is presently being built in Elburn.\nEach of the subsidiary banks has sufficient space for current banking needs as well as any foreseeable expansion.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn February 17, 1994, a judgment in the amount of $2.3 million was entered in the U.S. Bankruptcy Court against Pinnacle Bank, a wholly owned subsidiary of the Corporation. The judgment is the result of a suit filed against the Bank by a trustee of a debtor in bankruptcy. The trustee claimed that the Bank honored overdrafts in the debtor's bank account without obtaining prior court approval. The Bank denied any liability on the basis that no court authorization is required for debtors who obtain unsecured credit in the ordinary course of business. The amount of the judgment represents the cumulative amount of all payments received by the Bank from the debtor to cover overdrafts. The largest outstanding overdraft as of the close of business on any day was $260,000. The judgment provides that the Bank will have an allowed claim in the bankruptcy proceeding upon its payment of the judgment. While the Bank appealed the decision in 1994, management, upon advice of legal counsel, settled the case for $1,275,000 on December 8, 1995.\nThe Corporation and the subsidiary banks are subject to other pending and threatened legal actions which arise in the normal course of business. In the opinion of management, based upon the consultation of legal counsel, the disposition of all outstanding matters will not have a material adverse effect on the 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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of the Corporation is traded in the over-the-counter market and is quoted on the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the Small-Cap issues with the ticker symbol \"PINN\".\nThe following table sets forth the high and low sales prices of the Corporation's common stock by quarter as reported by NASDAQ.\nIn 1995, the Corporation purchased 45,755 shares of its common stock at market prices in privately negotiated and market transactions as part of its announced stock repurchase program. In 1994, the Corporation purchased 88,838 shares of its common stock at market prices in privately negotiated and market transactions.\nNUMBER OF SHAREHOLDERS\nAs of March 19, 1996, the Corporation had approximately 335 shareholders of record. In addition, the Corporation believes that it has approximately 450 additional beneficial shareholders who hold shares in street name.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data of the Corporation is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information required is contained on page 22 of Exhibit 2, under the title \"Selected Financial Data.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information is contained on pages 23 through 36 of Exhibit 2.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements and Supplementary Data are incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information is contained as follows:\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\nInformation required pursuant to this item is contained on pages 1 through 3 of the Definitive Proxy Statement for the Annual Meeting to be held on April 16, 1996, under the title \"Election of Directors\", this portion which is expressly incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required pursuant to this item is contained on pages 5 through 7 of the Definitive Proxy Statement for the Annual Meeting to be held on April 16, 1996, under the title \"Executive Compensation\", this portion which is expressly incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required pursuant to this item is contained on pages 3 through 5 of the Definitive Proxy Statement for the Annual Meeting to be held on April 16, 1996, under the title \"Security Ownership of Certain Beneficial Owners and Management\", this portion which is expressly incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required pursuant to this item is contained on pages 8 and 9 of the Definitive Proxy Statement for the Annual Meeting to be held on April 16, 1996 under the title \"Certain Relationships, Related Transactions and Other Information Regarding Management\", this portion which is expressly incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following exhibits are filed as part of this Form 10-K.\nFINANCIAL STATEMENT SCHEDULES\nFinancial Statement Schedules not included in ITEM 8, FINANCIAL DATA AND SUPPLEMENTARY DATA are included on the following pages as part of this item in accordance with Guide 3, Statistical Disclosure by Bank Holding Companies.\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed by the Corporation during the fourth quarter of 1995.\nSTATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL\nANALYSIS OF NET INTEREST INCOME\nInformation required in this table, including the daily average balance outstanding for the major categories of interest bearing assets and interest bearing liabilities, and the average interest rate earned or paid thereon, is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information required is contained in Table 1, \"Analysis of Net Interest Income\" on page 25 of Exhibit 2, within the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nANALYSIS OF CHANGE IN INTEREST DIFFERENTIAL\nInformation required in this table is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information required is contained in Table 2, \"Analysis of Volume\/Rate Variance\" on page 26 of Exhibit 2, within the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nANALYSIS OF INTEREST RATE SENSITIVITY\nInformation regarding the interest rate sensitivity position of Pinnacle is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. This information is contained in Table 6, \"Interest Rate Sensitivity Position\" on page 35 and discussed on page 36 of Exhibit 2, within the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nII. INVESTMENT PORTFOLIO\nThe following table presents the book value of securities in thousands at the dates indicated:\n(1) Held for investment in 1993.\nThe following table shows the maturities of securities in thousands at December 31, 1995 and weighted average fully taxable equivalent yields:\nSecurities included in the category of no fixed maturity are mortgage-backed securities and floating rate collateralized mortgage obligations, due to their ability to prepay, as well as equity securities.\nThe average tax-equivalent yield by maturity includes the weighted average yields on tax-exempt obligations which have been computed on a fully taxable equivalent basis assuming a tax rate of 34% for December 31, 1995.\nIII. LOAN PORTFOLIO\nThe following table sets forth the outstanding loans, in thousands, at the following dates:\nThe following table sets forth the maturity distribution of the following categories of loans at December 31, 1995 in thousands.\nOf the loans listed in the maturity schedule above, a total of $193,448 are due after one year; $174,498 of these loans have predetermined interest rates and $18,950 of these loans have floating interest rates.\nCOLLATERAL AND APPRAISAL GUIDELINES\nSubsidiary banks of the Corporation make loans which are collateralized by different types of assets. A collateral guideline manual is maintained by each bank which details collateral requirements for any collateralized loan which a bank may make. The loan operations area has responsibility for monitoring all compliance with collateral requirements. Collateral requirements for the most commonly funded loans include an 85% - 95% (depending on maturity) loan-to-value ratio for loans secured by U. S. Government securities, 70% for NYSE traded stock, 65% for AMEX and 50% for all other common stocks, with the exception of control stocks which are not acceptable as collateral. Commercial loans for working capital can have a maximum loan-to-value ratio of 80% against eligible accounts if secured by receivables, a maximum of 50% if secured by inventory and a maximum of 80% if secured by equipment. Real estate loans can have a maximum loan-to-value ratio of 80% unless private mortgage insurance is provided for advances over 80%. Commercial real estate loans typically are funded at a lower loan-to value ratio and require the personal guarantee of the borrower(s). Home equity loans require a loan-to-value ratio of 80% of the appraised value less any debt.\nLoans made by subsidiary banks of the Corporation which are collateralized by real estate require an appraisal prior to funding of the loan. These loans are reappraised when management believes that the financial condition or resources of the borrower have deteriorated or when the collectibility of the loan is in question. Loans collateralized by real estate are not necessarily reappraised on an annual or quarterly basis by policy; however, all loans secured by real estate, with immaterial exceptions, are made in the local market area served by Pinnacle subsidiaries and each of these areas is closely monitored by management for economic changes. A new appraisal is required for any loan which undergoes foreclosure or is transferred into other real estate owned. Updated appraisals on other real estate owned are completed as required by regulatory authorities, or if management believes a material change in the value of a property has taken place.\nThe current loan policies in effect for collateral and appraisals are similar and consistent with the policies in place in prior years.\nRISK ELEMENTS\nNONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS. The following table represents information regarding the aggregate amount of nonaccrual, past due, and restructured loans in thousands:\nA discussion regarding the nonperforming assets listed above is contained within the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" under the subsection \"Provision for Loan Losses\" on pages 26 through 28 of the Corporation's 1995 Annual Report to Stockholders included as Exhibit 2.\nLOAN CONCENTRATIONS. Loan concentrations are defined as amounts loaned to a multiple number of borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions. Although the Corporation has a diversified loan portfolio, a substantial natural geographic concentration of credit risk exists within the Corporation's defined customer market areas. These geographic market areas include the Chicago metropolitan area and the Quad-Cities metropolitan area of Illinois and Iowa.\nADOPTION OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS \"SFAS\" NOS. 114 AND 118. Effective January 1, 1995, the Corporation adopted SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\", and its amendment No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure\". There was no effect on the financial position and results of operations of the Corporation as a result of adopting these statements. No changes were required to the Corporation's accounting policies to loans, charge-offs, and interest income as a result of adopting these statements. Loans considered impaired under these statements include nonaccrual loans, restructured loans, and loans classified as at least doubtful under the Corporation's credit risk classification system. All of the Corporation's impaired loans are included in the nonperforming category.\nNONACCRUAL LOAN POLICY. The Corporation follows banking regulatory guidelines with respect to classifying loans on a nonaccrual basis. Loans are placed on nonaccrual when the loan becomes past due over 90 days with no intervening activity or when the collection in full of interest and principal is doubtful. Thereafter, no interest is taken into income unless received in cash or until such time as the borrower demonstrates the ability to pay interest and principal.\nIV. SUMMARY OF LOAN LOSS EXPERIENCE\nInformation required in this table is incorporated herein by reference to the 1995 Annual Report to Stockholders included as Exhibit 2. The information required is contained in Table 3, \"Analysis of the Allowance for Loan Losses\" on page 27 of Exhibit 2, within the section titled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nALLOCATION OF ALLOWANCE FOR LOAN LOSSES\nThe Corporation's subsidiary banks do not allocate the allowance for loan losses by specific loan categories. However, bank disclosure guidelines issued by the Securities and Exchange Commission request management to allocate the total allowance for loan losses into certain categories. Accordingly, management has allocated the allowance for loan losses by loan category based on historical charge-off experience and management's evaluation of potential losses in the loan portfolio. The specific allocations are not intended to be indicative of future charge-offs. The unallocated portion of the\nallowance for loan losses represents that portion of the allowance which has not been specifically allocated by the analysis performed. The percent of loans in each category to total loans and the allocation of the allowance for loan losses at December 31 of each year, in thousands, is as follows:\nManagement believes that the portfolio is well diversified and, to a large extent, secured without undue concentrations in any specific risk area. Control of loan quality is continually monitored by management. Management's system of review of the loan portfolio and the attendant determination of the adequacy of the allowance for loan losses is made up of a number of factors. The most significant part of the system is the independent credit review system which reviews all commercial credits in excess of $100,000 and all commercial real estate credits in excess of $250,000 on an annual basis at a minimum, with problem credits reviewed more often as necessary. An informed, judgmental determination is made of the risk associated with loans which have received low grades under the credit review system. This estimated risk is taken into account in determining the allowance for loan losses. In addition, the allowance includes a substantial reserve for coverage of unidentified risks.\nIn addition to the credit review system, on a quarterly basis an internal report provides an analysis of the adequacy of the allowance for management and the Board of Directors. This analysis focuses on allocations based on loan review ratings and historical charge-off and recovery data. Management also reviews the status of all watch list credits on a monthly basis. The process and the amount of the allowance and of the provision have also been subject to the review of external auditors and banking regulatory authorities, and management believes that it has an effective system of credit review assessment demonstrated by the fact that the Corporation has not recorded a significant loss that had not been previously identified as a watch list credit by the loan review process.\nV. DEPOSITS\nReference is made to (I.) Distribution of Assets, Liabilities and Stockholders' Equity for data regarding average daily deposits and rates paid thereon for the years ended December 31, 1995, 1994 and 1993. The aggregate amount of certificates of deposit, in denominations of $100,000 or more, by maturity, as of December 31, 1995 are shown below, in thousands.\nVI. RETURN ON EQUITY AND ASSETS\nThe following table shows consolidated operating and capital ratios for years ended December 31, 1995, 1994 and 1993. The return on average assets and the return on average stockholders' equity is calculated by dividing net income for the period by average assets or average stockholders' equity, respectively. The dividend payout ratio is calculated by dividing total dividends paid by net income.\nVII. SHORT-TERM BORROWINGS\nThe following table shows the distribution of short-term borrowings and the weighted average interest rates thereon for the years ended December 31, 1995, 1994 and 1993. Also provided is the maximum amount of short-term borrowings as well as weighted average interest rates for the same periods. Dollars are 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 on March 19, 1996.\nPINNACLE BANC GROUP, INC.\nBy: \/s\/ John J. Gleason By: \/s\/ William P. Gleason ------------------------- --------------------------- John J. Gleason William P. Gleason Chairman President\nBy: \/s\/ John J. Gleason, Jr. By: \/s\/ Sara J. Mikuta ------------------------- --------------------------- John J. Gleason, Jr. Sara J. Mikuta Vice Chairman and Principal Financial and Chief Executive Officer Principal Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following Directors on behalf of the registrant on March 19, 1996.\n\/s\/ James L. Green ______________________________ ______________________________ Richard W. Burke James L. Greene\n\/s\/ Mark P. Burns \/s\/ Donald G. King ______________________________ ______________________________ Mark P. Burns Donald G. King\n\/s\/ William J. Finn, Jr. \/s\/ James A. Maddock ______________________________ ______________________________ William J. Finn, Jr. James A. Maddock\n\/s\/ James J. McDonough ______________________________ ______________________________ Samuel M. Gilman James J. McDonough\n______________________________ ______________________________ Albert Giusfredi William C. Nickels\n\/s\/ John J. Gleason \/s\/ John E. O'Neill ______________________________ ______________________________ John J. Gleason John E. O'Neill\n\/s\/ John J. Gleason, Jr. \/s\/ James R. Phillip, Jr. ______________________________ ______________________________ John J. Gleason, Jr. James R. Phillip, Jr.\n\/s\/ William P. Gleason \/s\/ Kenneth C. Whitener. Jr. ______________________________ ______________________________ William P. Gleason Kenneth C. Whitener, Jr.","section_15":""}
{"filename":"217165_1995.txt","cik":"217165","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Registrant, MRI Medical Diagnostics, Inc., a Colorado corporation (the \"Company\"), was incorporated on November 12, 1971 as Sierra Resources, Inc. The Company changed its name to Petro-Global, Inc. on May 27, 1987, and to MRI Medical Diagnostics, Inc. on February 12, 1992 when, pursuant to a change of control, the Company redirected its business purposes to medical diagnostic imaging services. In July 1993, the Company and its wholly owned subsidiaries each filed for bankruptcy in the Central District Court of California. On November 7, 1995, the Court approved and declared effective a reorganization plan for the Company, which went into effect on January 2, 1996.\nPursuant to the Reorganization Plan, Tri-National Development Corporation, a Wyoming corporation, obtained all of the stock of MRI Grand Terrace, Inc., the Company's wholly owned subsidiary, in partial exchange of which the bankruptcy estate is to receive 30% of the net proceeds on that portion of any resulting judgment issued to MRI Grand Terrace, Inc. out of litigation between Tri-National Development Corporation and MRI Grand Terrace, Inc. against Citizens Business Bank, then Chino Valley Bank. On June 3, 1998, the California Superior Court of San Bernardino County entered a gross judgment in favor of Tri-National Development Corporation and MRI Grand Terrace, Inc. in the approximate amount of $5,000,000. Approximately $4,411,911 of the gross judgment was awarded to MRI Grand Terrace, Inc. The judgment is currently under appeal and, due to the risk of reversal, the Company is unable to estimate the amount of proceeds, if any, that the bankruptcy estate may receive. See, \"LEGAL PROCEEDINGS\" below. In the event of recovery on the judgment, the amount received by the Company will be less the amounts due the claimants in the bankruptcy proceedings and fees paid to the bankruptcy trustee. The Company is unable to determine the extent of such claims and fees at this time.\nOn July 15, 1997, the Company approved the Agreement and Plan of Reorganization with Alpine Herbs & Nutrition International, Inc., a Nevada Corporation (\"Alpine\"). The Agreement provided for the acquisition of 100% of the common stock of Alpine for 4,000,000 post-split shares of the common stock of the Company. The Agreement was later rescinded by mutual agreement of the parties and the share certificates for 3,900,000 shares issued were canceled on the Company's books with the understanding that the original certificates would be returned to the Company.\nCurrent management has become aware that certificates for approximately 2,500,000 of the shares issued as part of the rescinded transaction with Alpine have not been submitted to the Company for cancellation. Management is in the process of trying to obtain these share certificates for cancellation. The Company has issued stop transfer instruction to its transfer agent to prohibit transfer of these shares. However, recent revisions to the Colorado Uniform Commercial Code may result in these instructions being treated as an adverse, third party claim, and the Company may be forced to obtain an injunction to prevent transfer of the shares. Should such an action be necessary, the holders of the certificates may be held liable to the Company for their bad faith retention of the certificates.\nThe Company has no current operations, and has retained the services of Intermountain Capital Corporation to seek possible merger candidates for the Company and to accomplish the sale, merger, exchange, capital investment, loan, joint venture or such other transaction as is deemed advisable subject to the approval of the Company's Board of Directors and shareholders.\nOn June 1, 2000, the Company received a Letter of Intent from a Delaware corporation, the terms of which would provide for the reverse acquisition of the Company through the acquisition of a majority interest in its common stock. The Letter of Intent has been signed on behalf of the Company; however, there can be no assurance as to if and when the contemplated transaction will be consummated. The parties are still in the due diligence phase of negotiations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nNot Applicable.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Bankruptcy Trustee continues to monitor application of the Company's reorganization plan, specifically with respect to the collection of the judgment rendered in favor of MRI Grand Terrace, Inc. and Tri-National Development Corporation against Citizens Business Bank. Pursuant to the Settlement Agreement approved by the Bankruptcy Court, the bankruptcy estate is entitled to recover 30% of the net proceeds of any judgment received by MRI Grand Terrace, Inc. rendered in the litigation. On August 17, 1998, Citizens Business Bank posted a $7.5 million bond and filed its appeal on June 16, 1999 with the California Court of Appeals, San Bernardino County. Due to the risk of reversal on appeal, the Company is unable to estimate the proceeds, if any, that the bankruptcy estate may recover on the judgment. Any amount recoverable by the bankruptcy estate will be less attorney fees and any fees paid to the trustee.\nCurrent management has become aware that certificates for approximately 2,500,000 of the shares issued as part of the rescinded transaction with Alpine have not been submitted to the Company for cancellation. Management is in the process of trying to obtain these share certificates for cancellation. The Company has issued stop transfer instruction to its transfer agent to prohibit transfer of these shares. However, recent revisions to the Colorado Uniform Commercial Code may result in these instructions being treated as an adverse, third party claim, and the Company may be forced to obtain an injunction to prevent transfer of the shares. Should such an action be necessary, the holders of the certificates may be held liable to the Company for their bad faith retention of the certificates.\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 fiscal year ended March 31, 2000.\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 currently traded on the Over-the-Counter Bulletin Board under the symbol \"MMDI.\" Following is a statement of the high and low bid information for each full quarter since the Company's stock began trading on the OTC in September 1997, including the incomplete period ending June 6, 2000.\nQUARTER HIGH LOW CLOSE 09\/30\/97 1\/2 3\/32 13\/64 12\/31\/97 5\/16 1\/8 5\/32 03\/31\/98 11\/64 3\/64 3\/64 06\/30\/98 5\/64 3\/64 3\/64 09\/30\/98 3\/32 3\/64 3\/64 12\/31\/98 3\/64 1\/32 1\/32 03\/31\/99 1\/16 1\/32 3\/64 06\/30\/98 3\/32 1\/32 1\/32 09\/30\/98 1\/16 1\/64 1\/64 12\/31\/99 3\/64 1\/64 1\/32 03\/31\/00 29\/64 1\/32 1\/4 06\/30\/00 21\/64 1\/8 11\/64\nAs of May 31, 2000, there were approximately 2,425 holders of record of the Common Stock.\nThe Company has not declared any cash dividends on its Common Stock since the Company's formation in November 1971.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected historical financial data set forth below have been derived from, and are qualified by reference to (i) the audited Consolidated Financial Statements of the Company for the fiscal year ended March 31, 2000 as compared to the fiscal year ended March 31, 1999. The audited financial statements referred to above are included elsewhere herein. The selected financial data set forth below should be read in conjunction with, and are qualified by reference to, Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Financial Statements and accompanying notes included elsewhere herein.\nFISCAL YEAR ENDED MARCH 31 1999 2000 ---- ---- Income Statement Data: Operating revenue (1) . . . . . . . . . . . $ 0 $ 0 Expenses. . . . . . . . . . . . . . . . . . Net Income. . . . . . . . . . . . . . . . . $ 0 $ 0 Accumulated deficit, beginning. . . . . . . $(1,563,343) $(1,582,079) Accumulated deficit, ending . . . . . . . . $(1,563,343) $(1,582,079) ----------- -----------\nEarnings per share. . . . . . . . . $ 0 $ 0\nBalance Sheet Data (at end of period): Total assets. . . . . . . . . . . . . . . . $ 0 $ 0 Total debt. . . . . . . . . . . . . . . . . $ 3,413 $ 22,149 Total Stockholders equity . . . . . . . . . $ (3,413) $ (22,149)\nOther Financial Data: Cash flows. . . . . . . . . . . . . . . . . $ 0 $ (18,736)\n(1) Currently, the Company has no operations and is evaluating its options in the acquisition by or merger with another Company.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nYEAR ENDED MARCH 31, 1999 COMPARED TO YEAR ENDED MARCH 31, 2000\nThe Company had no operation during the fiscal years ended March 31, 1999 and 2000.\nLIQUIDITY AND CAPITAL RESOURCES\nPursuant to the Reorganization Plan, Tri-National Development Corporation, a Wyoming corporation, obtained all of the stock of MRI Grand Terrace, Inc., the Company's wholly owned subsidiary, in partial exchange of which the bankruptcy estate is to receive 30% of the net proceeds of litigation between MRI Grand Terrace, Inc., Tri-National Development Corporation and Citizens Business Bank to which MRI Grand Terrace, Inc. would be entitled, pending in the California Superior Court, San Bernardino County. On June 3, 1998, the Superior Court entered judgment in favor of MRI Grand Terrace, Inc. and Tri-National Development Corporation in the approximate amount of $5,000,000. The judgment is currently under appeal. See, \"LEGAL PROCEEDINGS\" above. The Company continues to monitor the appeal, and hopes to use any resulting proceeds in its efforts to locate a potential purchaser or merger candidate. The Company has retained the services of Intermountain Capital Corporation to seek such possible merger candidates for the Company and to accomplish the sale, merger, exchange, capital investment, loan, joint venture or such other transaction as is deemed advisable subject to the approval of the Company's Board of Directors and shareholders.\nYEAR 2000\nThe Company has not experienced any negative effects as a result of the Year 2000 problem, and, because there are no current operations, does not anticipate related difficulties over the next few months. There is no assurance that any of the possible merger candidates that the Company has or will approach will be Year 2000 compliant or that such candidates will not experience Year 2000-related \"glitches\" over the next six months. As part of its due diligence in locating potential candidates, the Company will determine the Year 2000 compliance of each such candidate.\nFORWARD-LOOKING STATEMENTS\nExcept for the historical statements and discussions contained herein, statements contained in this report constitute \"forward-looking statements\" as defined in the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended. These forward-looking statements rely on a number of assumptions concerning future events, and are subject to a number of risks and uncertainties and other factors, many of which are outside the control of the Company, that could cause actual results to differ materially from such statements.\nReaders are cautioned not to put undue reliance on such forward-looking statements, each of which speaks only as of the date hereof. Factors and uncertainties that could affect the outcome of such forward-looking statements include, among others, market and industry conditions, increased competition, changes in governmental regulations, general economic conditions, pricing pressures, and the Company's ability to continue its growth and expand successfully into new markets and services. The Company disclaims any intention or obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDirectors of the Company are elected annually by its shareholders to serve during the ensuing year or until a successor is duly elected and qualified. Executive officers of the Company are duly elected by its Board of Directors to serve until their respective successors are elected and qualified. The following table sets forth certain information with respect to the directors and executive officers of the Company.\nNAME AGE POSITION OR OFFICE\nJacob J. Parker, M.D. 62 Director and Vice-President\nWilliam J. Piggott, M.D. 55 Director and Secretary\nJavaid I. Sheikh 46 Director, President and Treasurer\nJACOB J. PARKER, M.D. (62), Director and Vice-President of the Company since June 20, 2000. He held the office of President for the Company from March 4, 1998 until that date. Dr. Parker also serves as Vice-President of Medical Development for Tri-National Development Corporation, a reporting company, and has held that position he has held since 1996. Dr. Parker is currently Medical Director and Director of Radiology for several MRI centers and breast imaging centers in Northern California. He was previously Chief of Radiology and Nuclear Medicine at Ross General Hospital, Clinical Professor of Radiology at the University of California, Irvine, and Instructor of Radiology at the University of Southern California Medical Center from 1970 to 1988. Dr. Parker received his M.D. from the University of Manitoba, Canada in 1962.\nWILLIAM J. PIGGOTT, M.D. (55), Director and Secretary of the Company since March 24, 1998. Dr. Piggott currently operates an international medical technology consulting firm, I.M.T.E.C., as a sole proprietorship. In the past, he has served with or been a member of the American Society of anesthesiologists, the California Society of Anesthesiologists, the California Medical Association and the San Diego County Medical Association. Dr. Piggott obtained his M.D. from the University of California at San Diego in 1972.\nJAVAID IQBAL SHEIKH, M.D. (46), Director, President and Treasurer of the Company since June 20, 2000. He held the office of Vice-President from March 4, 1998 until appointed President on June 20, 2000. Dr. Sheikh is an associate professor of psychiatry at the Stanford University School of Medicine, a position he has held since 1993. At the University, Dr. Sheikh's research focuses on studying phenomenology, vulnerability factors, and psychiatric and medical comorbidity of panic disorder in old age, as well as treatment responses to medication in elders with panic disorder. Dr. Sheikh obtained his M.D. from King Edward Medical College in 1978.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNone of the executive officers listed in Item 10 received compensation for their services during the Company's fiscal year ended March 31, 2000. The Company is not bound by any employment agreement with past or present employees of the Company, and has no current employees other than the officers listed above.\nDIRECTOR COMPENSATION\nNone of the directors listed in Item 10 above have received any compensation for their services as directors of the Company for the Company's fiscal year ended March 31, 2000.\nOPTION PLANS\nThe Company does not currently maintain a stock option plan, employee stock purchase plan or any other employment compensation plan. Currently, there are no outstanding options to purchase MRI stock.\nCOMMITTEES\nThe Company does not currently have an executive compensation committee.\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 each class of the Company's capital stock beneficially owned as of May, 2000, by (i) each person known to the Company to be the beneficial owner of more than 5% of any class of the Company's equity securities, (ii) each of the Company's directors and nominees, and (iii) all directors and executive officers of the Company as a group.\nTITLE NAME AND ADDRESS AMOUNT AND NATURE PERCENTAGE OF CLASS OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP OF CLASS\nNo Par Value Jacob J. Parker 243,317 shares(2)(5) 0.178% Common Stock Director and Vice-President 333 Locust Ave. San Rafael, CA 94901\nNo Par Value William J. Piggott 151,785 shares(2) 0.1% Common Stock Director and Secretary 7833 Lower River Road Grants Pass, OR 97526\nNo Par Value Javaid I. Sheikh 160,068 shares(2) 0.12% Common Stock Director, President and Treasurer 988 St Joseph Ave, Los Altos, CA 94024\nNo Par Value Michael A. Sunstein 1,351,488 shares(1)(2) 9.86% Common Stock 480 Camino del Rio South Suite 140 San Diego, CA 92108\nNo Par Value Ronald C. Hibbard 1,720,000 shares(3)(4) 12.56% Common Stock 72-751 Jamie Way Rancho Mirage, CA 92270\nNo Par Value Jeanne M. Hibbard 1,560,000 shares(3)(4) 11.38% Common Stock 72-751 Jamie Way Rancho Mirage, CA 92270\nNo Par Value Rod Jones 1,000,000 shares(4) 7.3% 75-560 Mary Lane Indian Wells, CA 92210\nNo Par Value All directors and 555,170 shares 0.41% Common Stock officers as a group\n(1) Includes 15,616 shares held indirectly for Post Kirby Noonan & Sweat, LLP, 401,948 shares held by Tri-National Development Corporation, a company in which Mr. Sunstein is an officer, director and majority shareholder, and 140,000 issued on February 17, 2000 as repayment of a loan to the Company.\n(2) During its 1999 calendar year, the Company borrowed $7,000 each from Jacob J. Parker, William J. Piggott, Javaid J. Sheikh and Michael A. Suntein to pay expenses. Each of the lenders agreed that the Company could pay back the loans in shares of restricted common stock of the Company. On February 17, 2000, the Company issued 140,000 shares each to these persons as repayment of their loans to the Company. (3) Includes 1,520,000 shares held jointly by Ronald C. Hibbard and Jeanne M. Hibbard and 40,000 shares held in trusts for which Mrs. Hibbard acts as trustee. Mr. Hibbard is deceased and 200,000 of the 1,720,00 shares attributable to him are apparently being held by his estate. (4) These shares were issued pursuant to the Agreement and Plan of Reorganization with Alpine Herbs & Nutrition International, Inc., a Nevada Corporation (\"Alpine\") on July 15, 1997. Of the 4 million shares issued pursuant to this Plan, 3.9 million shares were cancelled and returned to treasury pursuant to the subsequent recission of the Plan. (5) Includes 85,067 shares held by Ross Radiology Medical Group, Inc., Dr. Parker's pension trust.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring its fiscal year ended March 31, 1999 and the nine-month interim period ended December 31, 1999, the Company borrowed funds from each of its officers and directors in an amount of $7,000 each, to be repaid with restricted shares of the Company's common stock. On February 17, 2000, the Company issued 140,000 shares each to its officers and directors in full payment of these loans. These funds, along with $14,000 borrowed from Michael A. Sunstein and Delanorte Investments, Inc., were borrowed in order to pay expenses incurred by the Company, including amounts due to the Company's transfer agent. In February 2000, the Company issued 140,000 shares to each of Palomar Investment, Inc., a company in which Michael A. Suntein, as community property with his spouse, maintains a majority ownership interest, and Delanorte Investments, Inc. in repayment of these loans.\nADVISORY SERVICES AGREEMENT\nThe Company has retained the services of Intermountain Capital Corporation to seek possible merger candidates for the Company and to accomplish the sale, merger, exchange, capital investment, loan, joint venture or such other transaction as is deemed advisable subject to the approval of the Company's Board of Directors and shareholders. Pursuant to the agreement, the Company issued 500,000 shares of its common stock to Intermountain in February 2000.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements. The following financial information for the Company for the fiscal years ended March 31, 1999 and 2000 is filed as part of this report.\nMRI Medical Diagnostics and Independent Auditors' Report. . . . . . . . . . . . . . . . . . . .F-1 Balance Sheets at March 31, 1999 and 2000 . . . . . . . . . . . . .F-2 Statements of Income & Retained Earnings for March 31, 1999 and 2000 . . . . . . . . . . . . . . . . . . . . . .F-3 Statements of Cash Flows for March 31, 1999 and 2000. . . . . . . .F-4 Notes to Financial Statements . . . . . . . . . . . . . . . . . . .F-5\n2. Financial Statement Schedules.\nNot Applicable.\n3. Exhibits\nExhibit No. - ------------ * 3.1 Articles of Incorporation of Registrant. * 3.2 By-Laws of Registrant. * 10.1 MRI\/Colorado agreement to acquire MRI\/California. * 10.2 MRI\/Colorado agreement to acquire Grand Terrace retirement hotel. * 10.3 MRI\/Colorado agreement to acquire Sierra Cardiac. ** 10.4 Agreement and Plan of Reorganization dated June 20, 1997 between Registrant and Alpine Herbs & Nutrition International, Inc. *** 10.5 Advisory Agreement between the Registrant and Intermountain Capital Corporation dated February 19, 1999. 27.1 Financial Data Schedule *** 99.1 Order Approving Application to Compromise Controversy entered on August 31, 1995 by Federal Bankruptcy Court.\n- ---------------- * Previously filed with Amended Form 10-K filed June 21, 1993.\n** Previously filed with Form 8-K filed July 15, 1997.\n*** Previously filed with Form 10-K filed February 4, 2000.\n(b) Reports on Form 8-K\nDuring the fiscal year ended March 31, 1999, no reports were filed 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.\nMRI MEDICAL DIAGNOSTICS, INC.\nDated: July 12, 2000 \/s\/ JACOB J. PARKER -------------------------------------- Jacob J. Parker, M.D. Executive Vice-President\nDated: July 12, 2000 \/s\/ WILLIAM J. PIGGOTT -------------------------------------- William J. Piggott, M.D. Secretary\nDated: July 12, 2000 \/s\/ JAVAID I. SHEIKH -------------------------------------- Javaid I. Sheikh, M.D. President\nMRI Medical Diagnostics and Independent Auditors' Report. . . . . . . . . . . . . . . . . . . .F-1 Balance Sheets at March 31, 1999 and 2000 . . . . . . . . . . . . .F-2 Statements of Income & Retained Earnings for March 31, 1999 and 2000. . . . . . . . . . . . . . . . . . . . . .F-3 Statements of Cash Flows for March 31, 1999 and 2000. . . . . . . .F-4 Notes to Financial Statements . . . . . . . . . . . . . . . . . . .F-5\nLUDLOW & HARRISON a CPA corporation\n3545 Camino Del Rio South, Suite D (619) 283-3333 San Diego, CA 92108 Fax: (619) 2837997\nINDEPENDENT AUDITOR'S REPORT ----------------------------\nWe have audited the accompanying balance sheets of MRI Medical Diagnostics, Inc. as of March 31, 1999 and 2000, and the related statements of income, retained earnings, cash flows and stockholders' equity for the years 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 on 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 of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as assessing the overall financial statements 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 MRI Medical Diagnostics, Inc. as of March 31, 1999 and 2000, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ LUDLOW & HARRISON\nLudlow & Harrison A CPA Corporation\nJune 19, 2000\nMRI MEDICAL DIAGNOSTICS, INC. Balance Sheets March 31,\n2000 1999 ---- ----\nTotal Assets $ - $ - =========== ===========\nAccounts Payable $ 22,149 $ 3,413 ----------- ----------- Total Current Liabilities 22,149 3,413 ----------- -----------\nStockholders' Equity Capital Stock Common, no par value Authorized 50,000,000 shares, outstanding 8,600,657 shares\nPreferred, no par value Authorized 10,000,000 shares, no shares issued 1,599,930 1,599,930\nAccumulated Deficit (1,582,079) (1,563,343) ----------- -----------\nTotal Stockholders' Equity ( 22,149) ( 3,413) ----------- -----------\nTotal Liabilities and Stockholders' Equity $ - $ - =========== ===========\nSee accountant's report and notes to financial statements.\nMRI MEDICAL DIAGNOSTICS, INC. Statements of Income and Retained Earnings March 31,\n2000 1999 ---- ----\nRevenues $ - $ -\nExpenses 18,736 - ----------- -----------\nNet Income ( 18,736) -\nAccumulated deficit, beginning (1,563,343) (1,563,343) ----------- -----------\nAccumulated deficit, ending $(1,563,343) $(1,563,343) ----------- -----------\nEarnings per share $( .0022) $ - =========== ===========\nSee accountant's report and notes to financial statements.\nMRI MEDICAL DIAGNOSTICS, INC. Statements of Cash Flows March 31,\n2000 1999 ---- ----\nCASH FLOWS FROM OPERATING ACTIVITIES Net Loss $( 18,736) $ - Adjustments to reconcile net loss to net cash provided by operating activities: Increase in accounts payable 18,736 - ----------- -----------\nNET CASH PROVIDED BY OPERATING ACTIVITIES - -\nCASH AT BEGINNING OF YEAR - - ----------- -----------\nCASH AT OF YEAR $ - $ - =========== ===========\nSee accountant's report and notes to financial statements.\nMRI MEDICAL DIAGNOSTICS, INC. NOTES TO FINANCIAL STATEMENTS MARCH 31, 1999 AND 2000\nNote A - Significant Accounting Policies\nNature of Business - ------------------\nThe business of the Company in the past has consisted of the acquisition, development and operation of outpatient medical diagnostic imaging facilities. Currently, the Company is not operating and is evaluating its options in the acquisition or merger with another company.\nTaxes - -----\nThe Company owes taxes to the Franchise Tax Board of the State of California. The minimum tax in the State of California for the privilege of doing business within the State of California is $800 per year.","section_15":""}
{"filename":"764587_1995.txt","cik":"764587","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAirship International Ltd. (the \"Company\") has operated lighter-than-air airships, also commonly known as blimps, which have been used to advertise and promote the products and services of the Company's clients. The Company's clients utilize its airships at major sporting and special events and over urban and beach locations as an informative advertising and promotional vehicle. The Company operated one airship during 1995.\nThe Company was incorporated in New York on June 9, 1982 and commenced operations in August 1985 following the completion of the Company's initial public offering in June 1985. The Company's principal executive offices are located at 7380 Sand Lake Road, Suite 350, Orlando, Florida 32819 and its telephone number is (407) 351-0011. The Company also maintains a small office in New York, New York.\nAIRSHIPS\nFor daytime advertising, each of the Airships and its ground support vehicles were generally painted with the name and logo of the respective client. In addition, the Company's operating personnel wore uniforms carrying the client's logo or name.\nThe Company's clients utilized its Airships as an aerial ambassador and network-television camera platform for numerous major events.\nEach of the Company's airships was operated by a team employed by the Company which included U.S. Federal Aviation Administration (\"FAA\") certified airship pilots, mechanics, technicians and crew. The team supervised and executed the flight schedule and activities which the client specified. The team was supported by specially equipped ground support vehicles owned by the Company, which were used in the operation and maintenance of the Airships. The flight schedule of an airship could have included flights over a several hundred mile geographical area. The Company could accommodate such requirements because an airship's mooring support facilities are mobile and will travel with the ground crew to each of the landing sites. The Company believes that this mobility provides the flexibility for the use of the airships and implementation of a client's promotional campaign. No specialized facility is required for use as a landing site.\nHistorically, substantially all of the Company's revenues were derived from the operation of the Airships pursuant to aerial advertising contracts with its clients. Fees were generally paid to the Company on a monthly basis and the respective Airships were flown according to a flight schedule provided by the client, subject to weather conditions, government regulations and maintenance requirements. In the absence of availability of suitable replacements and\/or rights of the Company to terminate outstanding advertising contracts, Termination of or substantial reduction in fees provided by the Company's operating Airships has had a material adverse impact on the Company's revenues. The Company continue to seek new aerial advertising contracts and clients.\nAERIAL ADVERTISING AND OTHER CONTRACTS\nSet forth below are descriptions of the Company's aerial advertising contracts which were in effect during the fiscal year ended December 31, 1995 (for further detail see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Comparison of Revenue and Operating Costs - -- 1995 to 1994\").\nBUD ONE CONTRACT. On March 12, 1992, the Company entered into an agreement (the \"Bud One Contract\") with Anheuser-Busch for the use of the Bud One Airship. In March 1994, the Company and Anheuser-Busch agreed to reduce flight time and monthly fees under the Bud One Contract by approximately 50%, effective February 1994 through July 1994 (the \"March Amendment\").\nOn July 8, 1994 the Bud One Contract was amended and restated, pursuant to which amendment the Bud One Airship was to be operated from September 1, 1994 through December 31, 1996. Thereafter, Anheuser-Busch had the option to extend the agreement for one year. The airship was to be operated, in all material respects, in the same manner as it had been operated in the past, with contract payments being substantially equivalent to those under the Bud One Contract prior to the March Amendment. The Bud One Contract contained restrictions on the Company's ability to operate airships for potential clients which are competitive with Anheuser-Busch. In June 1995 the Bud One Airship was sold to Trans Continental Leasing, Inc., an affiliate of the Company in a sale-leaseback transaction. See \"--Acquisitions, Leasing and Financings--Allstate Loan.\" In November 1995 the Bud One Airship was deemed to be in need of a new envelope and was taken out of service.\nARGENTINA AGREEMENTS. On December 15, 1994 the Company and AOI consummated the Argentina Lease Agreement and the Argentina Operations Agreement, respectively, with Mastellone, an Argentinean dairy company, for the promotion of the products of Mastellone.\nSubsequently, on May 24, 1995, prior to commencement of flight operations of the Argentina Airship and pursuant to the Purchase and Assignment Agreement, the Argentina Airship and related equipment were sold and the Argentina Lease Agreement was assigned to First Security. In consideration for such sale and assignment, First Security assumed the Company's obligations under the Argentina Lease Agreement. The initial terms of the Agreements were for a period of four months, and commenced in July 1995. Such initial terms were extended for a ten-month period by Mastellone pursuant to the provisions of the Agreements.\nIn addition, the Company had the option to repurchase the Airship for 120% of the out-of-pocket expenses and the assumption of all liabilities incurred by First Security and Aviation in connection with the Argentina Airship. Such option expired unexercised on January 15, 1996.\nConcurrently with the execution and delivery of the Purchase and Assumption Agreement, the Company sold to Aviation all of the issued and outstanding shares of the capital stock of AOI. Mr. Julian Benscher, who held, indirectly through designees, approximately 4.0% of the Company's common stock, is an officer and stockholder of Aviation. See \"Certain Relationships and Related Transactions\".\nThe Company's revenues were historically dependent on the Company's aerial advertising contracts. For the years ended December 31, 1995 and 1994, __% and __%, respectively, of the Company's revenues were derived from Anheuser-Busch. In addition, 19% of 1994 revenues were derived from Kingstreet Tours and --% were derived from Gulf Oil. The Company has been adversely affected during the period between the time that any particular aerial advertising agreement terminated and the time a new contract commenced.\nACQUISITIONS, LEASES AND FINANCINGS\nSet forth below is a description of the Company's financing arrangements in effect during the year ended December 31, 1995 and for the period from December 31, 1995 through September , 1997.\nORIX LEASE\nIn 1989 the Company executed, as lessee, an airship lease (the \"Orix Lease\") with Orix USA, Inc. then known as Orix Commercial Credit Corporation (\"Orix\") for the 600.05 Airship, which provided for an initial three year term with two three-year renewal options. Pursuant to the Orix Lease, the Company was obligated to pay a monthly lease payment of $121,000 (through November 1995), and $35,000 per month from December 1995 to November 1998. As a result of the termination of the Met Life Contract in October 1993, the Company and Orix entered into amendments to the Orix Lease in January and May 1994 to restructure the monthly payments. As a result of the reduced fees under the Bud One Contract and the suspension of operations of the Gulf Oil Airship, several required payments were not made. The Company again renegotiated its arrangement with Orix and in October, 1995, entered into an Amended and Restated Lease Agreement in the form of a Conditional Sales Contract effective as of June 2, 1995 (the \"Amended Lease\"). Pursuant to the Amended Lease, the payments to Orix are $20,000 per month for the first year, $40,000 plus interest per month for the next 6 months, $60,000 plus interest per month for the next 6 months and thereafter the greater of $80,000 per month or 50% of annual cash flow for the proceeding 12 month period. The Amended Lease expires June 2, 2002 at which time the Company can purchase the Airship for $1.00. The Airship which is the subject of the Amended Lease is not currently operational, as it requires a new envelope. To date, the envelope has not been replaced.\nAs security for the Company's obligations under the Orix Lease and the Amended Lease, Louis J. Pearlman, Chairman of the Board, President and Chief Executive and Operating Officer of the Company (\"Mr. Pearlman\"), has personally guaranteed the payment and performance of the obligations of the Company. In addition, the Company's obligations to Orix are guaranteed by Trans Continental Airlines, Inc., an affiliate of the Company, which received common stock of the Company in exchange for such guaranty. See \"Certain Relationships and Related Transactions.\"\nWDL LEASE\nPursuant to an agreement effective May 16, 1993 (the \"WDL Lease\"), the Company leased from Westdeutsche Luftwerbung Theodor Wullenkemper GMBH (\"Westdeutsche\") a used type WDL IB airship equipped with a NightSign(TM) system. The Company entered into the WDL Lease to procure an airship to fulfill its obligations under the Gulf Oil Contract when it became apparent that the proposed acquisition of the assets of Slingsby could not be completed in time to provide an additional airship to fulfill the Company's obligations under the Gulf Oil Contract. The Company began operating this airship as the Gulf Oil Airship on June 25, 1993. On September 11, 1994, the Gulf Oil Airship was damaged in an accident and its operations ended. As a result of the damage to the Gulf Oil Airship, the Company sustained a loss of $1,978,000, representing the cost of the airship less insurance proceeds and credits allowed, including salvage value, when the airship was returned to WDL in September 1994. At December 31, 1994, the Company owed WDL a total of $2,866,000 under the WDL Lease including the $1,978,000 described above plus lease and other operating costs through September 11, 1994. Pursuant to the WDL Lease, the Company was to maintain a security deposit of $2,500,000 in a cash account (the \"Cash Escrow Account\") with Trans Continental Airlines Inc., an affiliate of the Company (\"Trans Continental\") (see Note C to the Financial Statements included elsewhere herein). The Cash Escrow Account, from which the Company could withdraw its funds at any time upon demand, enabled the Company to maintain a lower amount of insurance coverage on the Gulf Oil Airship than otherwise would have been required under the WDL Lease. During the fiscal year ended December 31, 1995, the Company had withdrawn the funds from\nthe Cash Escrow Account to pay certain obligations owing to WDL. As a result of the payment to WDL of such funds, the Company is currently indebted to WDL in the approximate amount of $1,000,000. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nALLSTATE LOAN\nOn November 16, 1994, the Company entered into an Aircraft Collateral Funding Repayment Agreement (the \"Allstate Agreement\") with Allstate Financial Corporation (\"Allstate\"). Pursuant to the Allstate Agreement, on December 6, 1994, the Company borrowed $1,500,000, (the \"Allstate Loan\") and as of December 31, 1994, the Company owed Allstate $1,250,000 plus approximately $47,000 of accrued interest. The Allstate Loan bore interest at the rate of 37.5% annually and required a minimum payment of $75,000 each month, the first payment of $75,000 having been made on January 5, 1995. The Allstate Loan was guaranteed by both Mr. Pearlman and Trans Continental. See \"Certain Relationships and Related Transactions.\" The guarantors agreed to subordinate any payments due to them from the Company while the Allstate Loan is outstanding, and any payments that would otherwise be paid to the guarantors is to be paid to Allstate and applied against the Allstate Loan.\nSubsequently on June 22, 1995 the Allstate Loan was repaid when Trans Continental Leasing, Inc. (\"TLI\"), a wholly-owned subsidiary of Trans Continental Airlines, Inc., (\"Trans Continental\"), an affiliate of the Company, entered into a Sale-Leaseback Agreement the (\"S\/L Agreement\") with the Company pursuant to which the Company's last remaining airship was sold to TLI for the purchase price of $2,060,000, which in turn leased such airship back to the Company. TLI borrowed the purchase price for the airship (the \"Phoenixcor Loan\") from Phoenixcor, Inc. (\"Phoenixcor\"), which was granted a pledge of the lease and a lien on the Bud One Airship. In addition, the Phoenixcor Loan was guaranteed by the Company and Trans Continental. The lease payments to be made under the S\/L Agreement are equal to the payments to be made under the Phoenixcor Loan.\nThe Phoenixcor Loan was structured as a sale-leaseback for financing purposes only.\nThe Company entered into an arrangement with Senstar Capital Corporation, (\"Senstar\") pursuant to which the sale leaseback arrangement with TLI was reversed such that the Company reacquired such airship and the Company has borrowed a total of $3,500,000 from Senstar (the \"Senstar Loan\"), part of which has been used to repay the Phoenixcor Loan. The loan from Senstar is repayable over 5 years in sixty monthly payments of approximately $63,371.06 each, with a balance due at the end of the five year term of approximately $700,000, and is secured by a lien on the Airship and a guaranty by Trans Continental. The Senstar Loan provided approximately $1,337,207.31 to the Company after payment of the Phoenixcor Loan. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\".\nOn January 15, 1997 the Company entered into a sale agreement with TLI, an affiliated company, with respect to the Company's $500.04 airship (formerly the \"Bud One\" airship) whereby the Company sold to TLI the airship and related equipment. In consideration for said assets, TLI retired the Company's debt to Senstar Capital Corp. in the amount of $3,014,000. Additionally, TLI procured a new envelope from a third party and agreed to lease back the entire assembled and operational airship to the Company. Pursuant to the agreement, the Company provided that TLI would undertake to pay the operational costs or the $500.04 airship for a minimum of eight months. In addition, the Company anticipates.\nIn December 1995, the Company entered into an Envelope Purchase Contract with Hampstead Technologies Limited, an affiliate of Julian Benscher, for the purchase of a new envelope for the Bud One Airship. The Company made a nonrefundable deposit of $630,000. Because the transaction was never consummated, the amount was written off in 1995. See \"Management's Discussion and Analysis--Results of Operations.\"\nADDITIONAL AIRSHIPS; AIRSHIP ASSEMBLY\nIn addition to providing clients with aerial advertising and promotion with its airships, the Company also acquired assets enabling it to partially construct additional airships either to service existing or potential clients of the Company or for lease or purchase by other parties. The Company owns substantial airship replacement components and its experience in airship assembly includes the assembly of four airships. The airship components that the Company currently has in inventory, plus approximately $1,000,000 of additional capital per airship, would enable the Company to construct up to five additional airships. The Company believes that its inventory of spare airship components will significantly reduce its cost for initial airship assembly and future maintenance expenditures, should future clients be obtained. There can be no assurance, however, that the Company would be able to obtain the financing necessary to complete construction of any additional airships, or that it would be able to consummate aerial advertising agreements with respect to any such airships. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nOperation of the Company's airships is subject to suitable weather conditions and an absence of mechanical failures, either of which could damage or destroy an airship. During 1994, the 600.05 Airship was damaged in a storm while attached to its mast and the Gulf Oil Airship was damaged in an accident. Airships can be operated only in warm climates. Accordingly, during the winter months airships can only operate in the southern states and west coast states. Furthermore, maintenance of an airship requires that it cease operations for an aggregate of approximately one month each year, including approximately two weeks of in-hangar maintenance.\nMARKETING\nThe Company marketed its airship services directly to potential clients through a sales effort conducted by its management, including a Director of Marketing. During 1995, the Company continued pursuing potential new clients, both for aerial advertising contracts and for the purchase of new airships; none of such contracts or purchases was consummated.\nSUPPLIERS\nAirships are manufactured by a limited number of suppliers worldwide. The Company's Airships were manufactured by Airship UK, a United Kingdom supplier no longer doing business, and by Slingsby. Due to asset purchases and expertise described above in \"Additional Airships; Airship Assembly,\" the Company could be in a position to manufacture or assemble up to five additional airships, subject to financing requirements.\nCOMPETITION\nHistorically, the Company's direct competition was limited to those companies which had airships legally permitted to operate in the United States. The Company competed with Airship Management Service (AMS), the operator of the Fuji airship, and Icarus Aircraft, Inc. (\"IAI\"), a privately-held firm which operates lightships, which are small airships approximately 1\/3 the size of the Company's airships. Currently, IAI is operating for MetLife. The Lightship Group, Inc. (formerly Virgin Lightships Inc. and American Blimp Company) owns and operates the smaller airships on behalf of numerous advertising clients in the United States. MetLife is a former client of the Company which did not renew its agreement with the Company in 1993, at least in part due to these alternative airship providers.\nGOVERNMENTAL REGULATION\nOperation of airships in the United States is regulated by the Federal aviation laws of the United States. The Company currently holds all necessary Federal Aviation Administration (\"FAA\") and U.S. Department of Transportation authorizations to operate all of its existing airships, including a Standard airworthiness Certificate issued by the FAA with respect to each of the airships. In addition, the Company holds an FAA \"Type Certificate\" which certifies that the design for the Company's airships meets air-worthiness requirements of Federal aviation regulations, and an FAA facilities license which permits the Company to assemble, repair and maintain airships. However, there can be no assurance that the federal government will not impose additional requirements on the operation of airships in the future, which might require the Company to incur additional expense, or which might otherwise have a material adverse effect on the Company's operations.\nIn addition, the Argentina Airship is subject to regulation by the Argentinean equivalent of the FAA. The Company is currently in compliance with the requirements of such governmental authority, and anticipates that it will be able to maintain such compliance in the foreseeable future.\nEMPLOYEES\nAs of December 31, 1996, the Company had approximately 30 full-time employees, 11 of whom are administrative, 3 of whom are pilots and the balance of whom are field operating personnel including mechanics and others who have a high degree of knowledge and expertise in the airship industry as well as field workers who accompany and maintain the Airships. The number of employees fluctuates based in part on the number of Airships conducting flight operations.\nThe Company's employees are not represented by any union. The Company considers its employee relations to be good. The Company believes it can serve additional pilots and flight personnel as required if new contracts are served.\nINSURANCE\nThere are risks inherent in the ownership and operation of airships. The Company has maintained insurance in such amounts and for such coverage as management has determined to be appropriate and as has been required from time to time under its contracts with Orix and various financing companies and airship aerial advertisers. Currently, the Company maintains insurance for its spare parts, as well as property coverage and general liability insurance. The Company has also maintained Aircraft Hull All Risk Insurance for the periods when its Airships are operational.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company had leased its principal executive offices pursuant to the terms of a five-year lease, which commenced May 7, 1991 and ended May 6, 1996, for approximately 7,000 square feet in Orlando, Florida, the home base of the Company. The annual rent under such lease was approximately $132,000. Since May 7, 1996, the Company has subleased approximately 2,000 square feet of such facility from Trans Continental Airlines, Inc. on a month-to-month basis for monthly rental payments of approximately $1,800. The Company also maintains a small office in New York City for which it pays minimal rent. In December 1994, the Company renewed for one year a lease for a warehouse of approximately 5,000 square feet in Kissimmee, Florida for\napproximately $15,000 per year. The Company stores various spare parts for its existing airships at this warehouse and intends to do so for the foreseeable future.\nIn May 1991, the Company and Westinghouse entered into a contract for the Company to use Westinghouse's Weeksville, North Carolina hangar for repair, renovation, maintenance, and related uses. The Westinghouse facility was destroyed in a fire during the third quarter of 1995. The Company rents space as available in Lakehurst, New Jersey, if needed, to perform maintenance and related functions previously performed at the Westinghouse facility.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTenerten and Drake, Inc. On September 15, 1994, Tenerten and Drake, Inc. (\"TDI\") filed a complaint against the Company. The complaint alleges that the Company failed to pay certain sums of money due and owing to TDI under an agreement to perform advertising and related services for the Company. The Company filed its answer and raised its affirmative defenses to said complaint alleging that the services allegedly performed by TDI were defective in numerous respects. On June 13, 1995, the parties entered into a Settlement Stipulation whereby the Company agreed to make certain payments to Tenerten and Drake, Inc. On July 20, 1995, Tenerten and Drake, Inc. filed its Motion for Final Judgment alleging that the Company failed to make a payment under the Settlement Stipulation. A Final Judgment was entered against the Company on July 20, 1995. The Company filed its Notice of Appeal on September 19, 1995 and posted a cash bond in the amount of $24,190.76. The Company filed Appellant's Initial Brief on January 8, 1996, contending that the Company's payment was made in a timely manner as required by the Settlement Stipulation. The Circuit Court of the Eighteenth Judicial Circuit in and for Seminole County, Florida is reviewing the Briefs filed by the parties and no opinion has been received as of this date.\nWestinghouse. On September 14, 1994, Westinghouse Airships,Inc. filed a complaint against Airship International Ltd. (\"AIL\"). The Complaint alleges that AIL breached an agreement to purchase two Gondolas from WAI. Specifically, the complaint alleges that WAI delivered both Gondolas at issue and AIL failed to make certain installments to WAI under the Agreement. The complaint also alleges that AIL breached a sub-lease to occupy certain hangar space located at Elizabeth City, North Carolina. On October 31, 1994, WAI filed its Second Amended Complaint. On November 31, 1994, AIL filed its answer and raised its affirmative defenses to said complaint alleging payment, fraudulent concealment by WAI and estoppel. On June 19, 1995, the parties entered into Defendant's Consent to Entry of Judgment in the amount of $320,240.00. The Company has paid all sums of money due and owing under said Consent to Entry of Judgment. On July 27, 1995, a Satisfaction of Judgment was filed with the Court.\nWatermark. In January, 1993, a second amended complaint to a lawsuit, which was initially commenced in March 1991 and subsequently dismissed twice without prejudice, was filed in the Circuit Court of the State of Florida against the Company and its President by Watermark Group PLC and Von Tech Corporation, as general partners of Company Communications (collectively, the \"WNT Plaintiffs\") alleging breach of an alleged joint venture agreement involving Company Communications and Airship Enterprises Ltd. (a company that was owned by Mr. Pearlman and that was not in any way owned or controlled by the Company), breach of an alleged agreement by the Company regarding the lease and operation of a particular airship; and breach of an alleged oral commission agreement by the Company relating to the Company's acquisition of two airships it presently owns. The WNT Plaintiffs seek various legal and equitable remedies, including monetary damages against the Company and Mr. Pearlman in excess of $800,000 together with a claim for some portion of the advertising revenue the Company has received, and will continue to receive, from the operation of some of its airships. On October 3,\n1995, the parties entered into a Mutual Release and Joint Stipulation for Settlement whereby the Company agreed to make payments to Watermark in the total amount of $40,000. Such payments were made during 1995 and 1996.\nIn March 1993, the second amended complaint was dismissed without prejudice. Since the Company denies any involvement with any of the transactions set forth in the second amended complaint, the Company believes that its liability, if any, on the claims made by the WNT Plaintiffs will not be material.\nCapital Funding Group Ltd. In February 1992, Capital Funding Group Ltd. (\"CFG\") commenced an action against the Company and others in excess of $1,000,000 in damages based on the alleged failure by the Company to provide adequate collateral and security in connection with certain alleged financial agreements with CFG. The Company retained CFG in July 1991, paid a commitment fee (which was written off in 1991) and received a commitment from CFG which then failed to provide the funding. The Company and the other defendants answered the complaint in February 1992 by denying all of the substantive allegations and asserting several affirmative defenses. In addition, the Company asserted certain counterclaims against CFG and its two principals for breach of a commitment letter pursuant to which CFG was to arrange for a $9 million loan to the Company, breach of a compromise agreement accepted by CFG in January 1992, pursuant to which CFG was to provide funding to the Company in the amount of $7 million, breach of an escrow agreement, pursuant to which CFG was to return $200,000 of the commitment fee paid by the Company and various other counterclaims. In March 1993, the Company was awarded a default judgment of $8,000,000 against CFG and the complaint against the Company was dismissed. No balances have been returned to the Company as of December 31, 1995.\nDue to the weakening financial position of the Company at the time, the Company was unable to complete its audit for the year ended December 31, 1994 or to conduct audits for the years ended December 31, 1995 and 1996. Accordingly, the Company had not filed any periodic reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, for the quarterly and annual periods ended December 31, 1994 through March 31, 1997 or any Current Reports on Form 8-K during such periods until July 11, 1997, on which date the Company filed its Current Report on Form 8-K reporting a change of accountants. On July 18, 1997, the Company entered into a Consent and Undertaking with the Securities and Exchange Commission pursuant to which the Company agreed, among other things, to file this Annual Report on Form 10-K, an Annual Report on Form 10-K for the year ended December 31, 1996 and all reports due under Sections 13 and 15 of the Securities Exchange Act of 1934, as amended, for all subsequent periods. Judgement was entered on August 21, 1997.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company's annual meeting of stockholders for the year ended December 31, 1994 was held on April 11, 1995. In connection with such meeting, a proxy statement was sent to the Company's stockholders with respect to the following items: (1) election of the Company's Board of Directors (2) ratification of Grant Thornton, as independent accountants of the Company, for the fiscal year ended December 31, 1994. (3) approval of a reverse stock split pursuant to which 100 shares of the Company's Common Stock would be combined into one share of Common Stock and 100 shares of the Company's Preferred Stock would be combined into one share of Preferred Stock (the \"Reverse Stock Split\"); (4) adoption of an Employee Share Purchase Plan of the Company to be effective as of November 1, 1994 (the \"Share Purchase Plan\") and (5) approval of a proposal to issue options to purchase Common Stock to certain employees of the Company (the \"Employee Options\").\nAt the meeting, the Company's directors were elected. For Louis Pearlman 18,396,603 shares were voted for and 1,266,328 shares were withheld, for Roy Belotti 18,510,594 shares were voted for and 1,152,337 shares were withheld; for Marvin Palmquist 18,540,217 shares were voted for and 1,122,714 shares were withheld; for James Ryan 18,554,134 shares were voted for and 1,108,747 shares were withheld; and for Alan Siegel 18,556,117 shares were voted for and 1,106,814 shares were withheld. The appointment for Grant Thornton as the Company's independent accountants for the fiscal year was approved with 18,487,369 shares being cast for, 526,545 shares cast against and 648,908 shares abstaining. The Reverse Stock Split was defeated, with 11,517,471 shares being cast for, 7,487,272 shares cast against, and 498,213 shares abstaining. The Employee Share Purchase Plan was approved, with 16,677,446 shares being cast for, 2,487,272 shares cast against and 498,213 shares abstaining. The issuance of the Employee Options was approved, with 14,465,208 shares being cast for 4,653,011 shares cast against and 544,712 shares abstaining.\nThe Company has not held any meetings of shareholders since April 11, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock, Preferred Stock, and Class B Warrants had been listed on the Nasdaq SmallCap Market under the symbols BLMP, BLMPP and BLMPL, respectively, until Nasdaq's delisting of the Company's securities on July 5, 1995 (the \"Delisting\") as a result of the Company's failure to timely file this Annual Report on Form 10-K. Since the Delisting, the Company's Common Stock and Preferred Stock have traded on the over-the-counter market under the symbols \"BLMPE\" and \"BLMPPE,\" respectively. The price ranges presented below represent the highest and lowest quoted bid prices during each quarter reported by the Nasdaq SmallCap Market for periods prior to the Delisting and periods subsequent to the quarter of 1995, and as obtained from the National Quotation Bureau, Inc for the third quarter of 1995. The Nasdaq quotes represent prices between dealers and do not reflect mark-ups, markdowns or commissions and therefore may not necessarily represent actual transactions.\nCOMMON STOCK:\n1995 High Bid Low Bid -------- ------- 1st Quarter $.125 $.0625 2nd Quarter $.0625 $.03125 3rd Quarter* N\/A N\/A 4th Quarter $.125 $.03125\n1996 High Bid Low Bid -------- ------- 1st Quarter $.3125 $.03125 2nd Quarter $.3125 $.04 3rd Quarter* $.1 $.04 4th Quarter $.085 $.05\n- ------------------------\n* Prior to the Delisting. Price ranges during the third quarter of 1995 include quotations on NASDAQ SmallCap Market up to such date. The Common Stock and the Preferred Stock are currently traded on the Nasdaq OTC Electronic Bulletin Board.\nN\/A Not available.\n1997 High Bid Low Bid -------- ------- 1st Quarter $.19 $.08 2nd Quarter $.2 $.09\nPreferred Stock:\n1995 High Bid Low Bid -------- ------- 1st Quarter $.59375 $.40625 2nd Quarter $.46875 $.37 5 3rd Quarter* $.325 $.325 4th Quarter $.25 $.125\n1996 High Bid Low Bid -------- ------- 1st Quarter $.1875 $.1875 2nd Quarter $1.625 $.375 3rd Quarter* $.71875 $.385 4th Quarter $.59375 $.28125\n1997 High Bid Low Bid -------- ------- 1st Quarter $1.125 $.51 2nd Quarter $1.09375 $.53125\nCLASS B WARRANTS:\n1994 High Bid Low Bid -------- ------- 1st Quarter $1\/16 $1\/32 2nd Quarter. The Class B $1\/32 $1\/32 Warrants expired on February 6, 1995.\nAs reported by the Nasdaq OTC Bulletin Board, on September 5, 1997 the closing bid price of the Common Stock was $0.0825 per share and the closing bid price of the Preferred Stock was $0.4375.\nAs of September 5, 1997, there were 1,496 holders of record of the Company's Common Stock and 83 holders of record of the Preferred Stock, respectively.\nNo dividends were declared or paid on the Common Stock during the foregoing periods and the Company does not anticipate paying any dividends on its Common Stock in the foreseeable future.\nDividends on the Preferred Stock are payable quarterly on February 15, May 15, August 15 and November 15 of each year (each such date a \"Dividend Payment Date\") and accrue at the annual rate of $.48 per share, to the extent payable in cash and $.60 per share, to the extent payable in shares of Common Stock. The first four dividend payments were paid 50% in cash and 50% in registered shares of Common Stock computed on an annual basis, the last such dividend payment being made on February 15, 1994. The cash portion of such dividend payments was paid with a portion of the proceeds of the 1993 Offering, which had been reserved for such purposes. Beginning May 15, 1994, dividends were payable in cash from the available cash derived from the adjusted earnings of the Company for the fiscal quarter immediately preceding the Dividend Payment Date to the extent available, according to a formula based on adjusted earnings. Such formula provides that the available cash will be determined as one half of the difference between airship operating revenues and the sum of operating costs, interest and principal payments on debt, selling, general and administrative expenses (limited to a ceiling based on historical numbers with stated annual percentage increases thereafter) and airship related capital expenditures (limited to $2,000,000 in any given year). The components of the above formula are to be determined in accordance with generally accepted accounting principles as applied in the Company's financial statements as filed with the Securities and Exchange Commission (the \"Commission\"). At its option, the Company may pay cash dividends in excess of the available cash determined by the above formula. The May 15, 1994 dividend was paid in registered shares of Common Stock. The Company has deferred and accrued the cash dividend on the Preferred Stock due on August 15, 1994 and all subsequent quarterly dividends until a later payment date. The Company does not anticipate paying such dividends in the near future, and intends to continue to defer and accrue such dividends.\nConcern has been expressed by management and various shareholders of the Company over the dilutive effects of issuances of shares of Common Stock in payment of dividends accrued on the Preferred Stock. The Company is currently exploring possible alternatives to such issuances, including submitting to the Company's shareholders a proposal to amend the terms of the Preferred Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the Company's financial statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere herein.\nOPERATING STATEMENT DATA:\nBALANCE SHEET DATA:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGOING CONCERN AND MANAGEMENT'S PLANS\nAs shown in the accompanying financial statements, the Company has experienced significant operating losses and negative cash flow from operations in recent years and has an accumulated deficit of $46,569,000, at December 31, 1995. During the year ended December 31, 1995, the Company generated revenues from airship operations; however, it reported a net loss of $4,687,000 and has negative working capital of $7,538,000. These conditions raise substantial doubt about the Company's ability to continue as a going concern.\nManagement's plans to improve the financial position and operations with the goal of sustaining the Company's operations for the next twelve months and beyond include:\nArranging with Trans Continental Airlines, Inc. or other related parties common directorship and ownership, to provide funds on a monthly basis as a loan and acquiring assets and operations of one or more entities, with which the Company has been in negotiation. The expectation is that such business combination, if completed, would provide additional cash flow and net income to the Company.\nThough management believes the Company will secure additional capital and\/or attain one or more of the above goals, there can be no assurance that any acquisition, financing or other plan will be effected. Any\nacquisition or securities offering is subject to the Company's due diligence, the state of the general securities markets and of the specific market for the Company's securities, and any necessary regulatory review.\nWhile the Company believes that its plans for additional funding or possible business combination have the reasonable capability of improving the Company's financial situation and ensuring the continuation of its business, there can be no assurance that the Company will be successful in carrying out its plans and the failure to achieve them could have a material adverse effect on the Company.\nOVERALL FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n1995-1994:\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. For its year ended December 31, 1994, the Company incurred a loss of $20,645,000 and had negative cash flows of $2,144,000 from operations. For its year ended December 31, 1995, the Company incurred a loss of $4,867,000 and had negative cash flows of $4,887,000 from operations. The accompanying financial statements do not include any adjustments that might result from the Company's current liquidity shortage, including any adjustments relating to the values that would be realized from the Company's assets, with the exception of the effects of applying Statement of Financial Accounting Standards No. 121, \"Impairment of Long-Lived Assets to be Disposed Of,\" as described in Note A to the Financial Statements.\nThe Company's stockholders' deficit at December 31, 1995 was $9,607,000, a increase of from stockholders' deficit of $6,346,000 at December 31, 1994. The decrease was due primarily to the net loss of $4,867,000 in fiscal 1995. Accrual of dividends on Preferred Stock increased stockholders' deficit by $1,725,000. As a result of these deficit changes, during 1995 the Company's assets decreased $4,736,000 while liabilities increased $1,610,000. Compared to the year ended December 31, 1994, revenues, operating costs and selling, general and administrative costs decreased 34.2%, 76.9% and 21.4%, respectively. Interest expense less other income for 1995 was $1,045,000, an increase of $446,000 or 74.4%. In 1993 the Company incurred a nonrecurring cost of $741,000 in connection with the settlement of a lawsuit by a lender and related expenses and a $478,000 cost on disposition of airship components, while in 1994 the Company incurred losses of $3,443,000 when two airships were damaged. These changes in revenues and costs, as explained in more detail below, resulted in a net loss for fiscal 1994 of $20,645,000 compared to a net loss of $5,406,000 in fiscal 1993.\nThe Company continues to experience negative cash flows from operating activities. Cash flow was adversely affected in 1994 through the termination, at the end of 1993, of contracts relating to the Met Life and Sea World Airships, and through the temporary cessation of flights and fees under the Gulf Oil Contract and its subsequent termination in 1994, as well as by the modification in certain terms of the Bud One Contract pursuant to the March Amendment. Cash flows for 1995 were adversely affected by the termination of the Gulf Oil Contract as liabilities at December 31, 1994 related to its termination and the damage to the Gulf Oil Airship approximates $3,220,000.\nThe Company has made changes in its management, office and airship crew operations (the \"Restructuring\"). The Restructuring includes the reduction of salaries of certain of its management, office, and operations personnel (\"Personnel\"); the reduction of Personnel; the reduction of insurance costs and the reduction of recurring costs throughout its operations; (collectively, the \"Cost Savings\"). Certain of the Restructuring considerations were the result of the cessation of operations under both the 600.05 Aerial Advertising Agreement and the Sea World Passenger Contract. Additional Personnel reductions were made, and operating costs ceased, when the Gulf Oil Airship was destroyed in an accident on September 11, 1994.\n1994-1993: The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. For its year ended December 31, 1993, the Company incurred a loss of $5,406,000 and had negative cash flows of $2,956,000 from operations. For its year ended December 31, 1994, the Company incurred a loss of $20,645,000 and had negative cash-flows of $2,144,000 from operations. The accompanying financial statements do not include any adjustments that might result from the Company's current liquidity shortage, including any adjustments relating to the values that would be realized from the Company's assets.\nThe Company's stockholders' deficit at December 31, 1994 was $3,261,000, a decrease of $21,500,000 from stockholders' equity of $18,235,000 at December 31, 1993. The decrease was due primarily to the net loss of $20,645,000 in fiscal 1994. Issuance of Common Stock less the payment of cash dividends on Preferred Stock decreased equity by $852,000. As a result of these equity changes, during 1994 the Company's assets decreased $16,300,000 while liabilities increased $5,300,000. Compared to the year ended December 31, 1993, revenues, selling, general and administrative costs decreased 59.3% and 27.7%, respectively, while operating costs increased 75.2%. Interest expense less other income for 1994 was $599,000, an increase of $77,000 or 14.8%. In 1993 the Company incurred a nonrecurring cost of $741,000 in connection with the settlement of a lawsuit by a lender and related expenses and a $478,000 cost on disposition of airship components, while in 1994 the Company incurred losses of $3,443,000 when two airships were damaged. These changes in revenues and costs, as explained in more detail below, resulted in a net loss for fiscal 1994 of $20,645,000 compared to a net loss of $5,406,000 in fiscal 1993.\nThe Company continues to experience negative cash flows from operating activities. Cash flow was adversely affected in 1994 through the termination, at the end of 1993, of contracts relating to the Met Life and Sea World Airships, and through the temporary cessation of flights and fees under the Gulf Oil Contract and its subsequent termination in 1994, as well as by the modification in certain terms of the Bud One Contract pursuant to the March Amendment. Cash flows for 1995 will also be adversely affected by the termination of the Gulf Oil Contract as liabilities at December 31, 1994 related to its termination and the damage to the Gulf Oil Airship approximates $3,220,000.\nThe Company has made changes in its management, office and airship crew operations (the \"Restructuring\"). The Restructuring includes the reduction of salaries of certain of its management, office, and operations personnel (\"Personnel\"); the reduction of Personnel; the reduction of insurance costs and the reduction of recurring costs throughout its operations; (collectively, the \"Cost Savings\"). Certain of the Restructuring considerations were the result of the cessation of operations under both the 600.05 Aerial Advertising Agreement and the Sea World Passenger Contract. Additional Personnel reductions were made, and operating costs ceased, when the Gulf Oil Airship was destroyed in an accident on September 11, 1994.\nCOMPARISON OF REVENUE AND OPERATING COSTS 1995 TO 1994.\nAirship revenues for 1995 were $3,620,000, a decrease of $1,360,000 (or 34.2% compared to revenues of $3,980,000 for 1994, primarily due to $1,360,000 of decreased revenues from the Bud One Airship contract which terminated on December 31, 1993. In addition, monthly fees under the Bud One Contract were reduced for a period of six months effective February 1994. The 600.05 Airship, formerly the Met Life airship, operated for only three months during 1994, while the Met Life airship operated for six months during 1993, reducing revenues for 1994, as compared to 1993. These decreases were partially offset by approximately four months of revenues earned from operating the Gulf Oil Airship in 1994 compared to its operation for just over three months during 1993 when operations of that airship first began. The Bud One contract was amended in July 1994 and provided for operations at the full price from August 1994 through December 1996. However, during December 1995, it was determined that the envelope was in need of replacement. Therefore, the Company removed the airship from service.\nOperating costs for 1995 were $4,027,000, a decrease of $13,425,000 or 76.9% compared to 1994. This increase was primarily due to the discontinuance of its contract with Bud One. The Company also had a write down in its airships and airship components by $1,462,000 that offset the reduction in operating costs. See Note A to the financial statements \"Impairment of Long-Lived Assets.\" Costs to operate the 600.05 Airship until it was damaged on June 20, 1994, primarily in connection with the 600.05 Aerial Advertising Agreement, were $1,349,000 lower than costs to operate that airship during 1993 under the former Met Life contract. Costs to operate the Sea World Airship declined 61% or $1,471,000 compared to the 1993 fiscal year as it began limited operations under the Sea World Passenger Contract beginning January 1994. These cost reductions were offset in part by cost increases resulting primarily from operation and lease of the Gulf Oil Airship of $231,000, and secondarily due to increased warehouse costs of $69,000, related to depreciation on airship components purchased during 1993. In addition, increased depreciation charges of $1,156,000 related to changes in accounting estimates and writedowns of $479,000 related to construction in progress were taken during 1994.\nCOMPARISON OF REVENUE AND OPERATING COSTS 1994 TO 1993.\nAirship revenues for 1994 were $3,980,000, a decrease of $5,768,000 (or 59.2%) compared to revenues of $9,748,000 for 1993, primarily due to $3,454,000 of decreased revenues from the Sea World Airship contract which terminated on December 31, 1993. In addition, monthly fees under the Bud One Contract were reduced for a period of six months effective February 1994. The 600.05 Airship, formerly the Met Life airship, operated for only three months during 1994, while the Met Life airship operated for six months during 1993, reducing revenues for 1994, as compared to 1993. These decreases were partially offset by approximately four months of revenues earned from operating the Gulf Oil Airship in 1994 compared to its operation for just over three months during 1993 when operations of that airship first began.\nOperating costs for 1995 were $17,452,000, an increase of $7,488,000 or 75.2% compared to 1994. This increase was primarily due to a write down in its airships and airship components by $9,634,000. See Note A to the financial statements \"Impairment of Long-Lived Assets.\" Costs to operate the 600.05 Airship until it was damaged on June 20, 1994, primarily in connection with the 600.05 Aerial Advertising Agreement, were $1,349,000 lower than costs to operate that airship during 1993 under the former Met Life contract. The cost savings resulted primarily from a decrease in costs to operate the Bud One Airship of $710,000,or 34% compared to the 1993 fiscal year. Costs to operate the Sea World Airship declined 61% or $1,471,000 compared to the 1993 fiscal year as it began limited operations under the Sea World Passenger Contract beginning January 1994. These cost reductions were offset in part by cost increases resulting primarily from operation and lease of the Gulf Oil Airship of $231,000, and secondarily due to increased warehouse costs of $69,000, related to depreciation on airship components purchased during 1993. In addition, increased depreciation charges of $1,156,000 related to changes in accounting estimates and writedowns of $479,000 related to construction in progress were taken during 1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSE COMPARISON 1995 TO 1994.\nSelling, general and administrative costs were $1,393,000 for 1995, a decrease of $515,000 or 21.4% compared to 1994. The decrease related primarily to a reduction in outside services and professional and legal fees of $309,000 and late fees incurred with respect to the Orix Lease during 1994 in the amount of $138,898.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSE COMPARISON 1994 TO 1993.\nSelling, general and administrative costs were $2,408,000 for 1994, a decrease of $1,041,000 or 30.2% compared to 1993, primarily due to the non-recurrence of accounting, legal and other costs incurred in 1993 related to the Company's public offering of its Preferred Stock (the \"1993 Offering\") and the acquisition of the Slingsby Assets ($687,000). The Cost Savings reduced salaries and certain other costs by approximately $710,000. These savings were partially offset by restructuring costs of $135,000 and a net increase in other costs, primarily in connection with late fees incurred with respect to the Orix Lease plus costs incurred in connection with the Allstate Loan. Such costs resulted from the Company's liquidity shortage. See \"Liquidity and Capital Resources\", below.\nINTEREST EXPENSE COMPARISON 1995-1994.\nInterest expense in 1995 was $1,103,000, an increase of $295,000 or 37.0% compared to 1994. Interest costs related to the Senstar loan, the Orix Lease and Mr. Pearlman's loan to the Company were the primary reason for the increase in interest costs compared to 1994. Ongoing interest expense, at the end of 1994, relates to the Senstar loan, Orix Lease plus other loans payable and capital leases, mainly for vehicles and the loan from Mr. Pearlman.\nINTEREST EXPENSE COMPARISON 1994-1993.\nInterest expense in 1994 was $805,000, a decrease of $108,000 or 12.4% compared to 1993. Debt that was fully repaid in 1993 reduced interest costs by $102,000 in 1994 compared to 1993. Interest costs related to the Orix Lease and Mr. Pearlman's loan to the Company decreased $88,000 compared to 1993 as payments were made in both 1993 and 1994, (including the reduction of Mr. Pearlman's loan in connection with the June 1993 Loan. See \"Certain Relationships and Related Transactions\"). These decreases were partially offset by interest costs related to the Allstate Loan and the short term loans from private investors received and repaid in 1994 (See Note E to the Financial Statements included elsewhere herein). Ongoing interest expense, at the end of 1994, relates to the Orix Lease plus other loans payable and capital leases, mainly for vehicles, the loan from Mr. Pearlman and the Allstate Loan.\nOTHER INCOME (EXPENSE)\nInterest and other income in 1995 was $58,000, a decrease of $148,000 or 71.8% compared to 1994. In 1993, proceeds from the 1993 Offering were placed in certificates of deposit and utilized throughout 1993 and interest was earned in 1993 on a receivable related to a sale of airship components in 1992.\nINFLATION.\nSince the formation of the Company in August 1985, the rate of inflation has remained low and the cost of the Company's operations has not been significantly affected by inflationary trends in the economy. The Company has incorporated adjustments for inflation in its contract with Anheuser-Busch.\nLIQUIDITY AND CAPITAL RESOURCES.\nIn 1993 the Company completed the 1993 Offering, obtaining net proceeds of approximately $14,471,000. The 1993 Offering proceeds have been utilized to date: to repay short term debt ($3,600,000) and related interest ($120,000), for architectural and design services for Blimp Port USA'tm' ($479,000); to acquire parts for the assembly of an additional airship, including a Nightsign'tm' ($3,263,000); to acquire additional airship assets ($2,500,000); to fund a portion of dividend payments on the Preferred Stock ($600,000); and for working capital ($1,455,000). Of the 1993 Offering proceeds to be used for the purchase of land and a hangar for Blimp Port USA'tm' a significant portion had been used instead for working capital purposes due to net losses sustained by the Company.\nThe Company continues to experience negative cash flows from operating activities. During 1995, the Company sustained a net change in cash and cash equivalents of ($511,000), with a reduction of $4,887,000 from operating activities. At December 31, 1995, available cash balances were represented by the $26,000 in cash plus $1,809,000 in funds contained in the Cash Escrow Account. The balance of the funds in the Cash Escrow Account were subsequently used by the Company to repay certain obligations to its vendors. Cash flow has been adversely affected by the temporary cessation of flights and fees under all of its contracts.\nThe Gulf Oil Airship did not recommence operations until April 15, 1994, causing an approximate $650,000 negative cash flow. The accident involving the Gulf Oil Airship and its subsequent suspension of operations on September 11, 1994 resulted in a further negative operating cash flow for 1994 of approximately $400,000. The Gulf Oil Airship was returned to WDL in September 1994. Approximately $610,000 of the negative cash flow sustained in connection with the Gulf Oil Airship during 1994 resulted from rental and other costs due WDL. Including similar costs for 1993, the Company owed WDL $2,866,000 at December 31, 1994 including $1,978,000 representing the loss incurred when the Gulf Oil Airship was damaged. The Company will not incur additional operating cash costs relating to the Gulf Oil Airship. However, the Company's liability to WDL at December 31, 1994 was $2,866,000. Of such amount, approximately $1,800,000 was repaid to WDL from the Cash Escrow Account during 1995, leaving a balance owing from the Company to WDL of approximately $1,000,000.\nThe Sea World Airship commenced limited operations under the Sea World Passenger Contract, causing a $659,000 negative cash flow during 1994, including maintenance costs when it was disassembled for shipment\nto Argentina for use as the Argentina Airship. The 600.05 Airship was operated under an aerial advertising contract only during part of 1994, causing a $128,000 negative cash flow for 1994. The 600.05 Airship was disassembled in June 1994, and ongoing cash costs will be minimal for this airship.\nThe Company's negative cash flow for 1995 was $517,000. Operating activities utilized $4,687,000 principally as a result of the net loss for the period, which includes non-cash charges of approximately $3,047,000. In addition, the change in operating assets and liabilities increased the negative cash flow effect of the net loss by approximately $3,067,000. Liabilities at December 31, 1995 increased to approximately $14,680,000 as a result of new debt financing with Senstar Capital Corporation. Investing activities contributed $1,632,000 in the form of funds taken from the Cash Escrow Account. Financing activities contributed $2,739,000 principally from proceeds of the Senstar Loan, partially offset by repayment of loans.\nThe Company has not had existing bank lines of credit available to provide additional working capital due to the Company's negative cash flow and existing encumbrances on assets, and has previously received substantial financing from Mr. Pearlman in the form of loans and guarantees which supplement the funds available from the Company's operations. There can be no assurance that Mr. Pearlman will make additional cash advances or loans or give personal guarantees if the Company requires additional capital. At December 31, 1995, the Company owed Mr. Pearlman $1,040,000 net of unauthorized discount and after offsetting $785,000 with respect to a loan made by the Company and guaranteed by Mr. Pearlman. The entire unpaid principal balance of the loan from Mr. Pearlman, together with all accrued and unpaid interest, became due and payable on May 31, 1997.\nIn addition, Trans Continental has guaranteed the Company's obligations under the Allstate Loan and the Phoenixcor Loan. In consideration for these and other guarantees of the Company's obligations, Trans Continental has been granted 10% of the issued and outstanding common stock of the Company. See \"Certain Relationships and Related Transactions.\" There can be no assurance that Trans Continental will continue to guaranty the Company's obligations in connection with any future financings. During the year ended December 31, 1995, Trans Continental advanced the Company $549,000.\nThe Company has been taking steps to improve its liquidity. The Company renegotiated the Orix Lease, and completed refinancing of the Phoenixcor Loan. See \"Business-Acquisitions, Leases and Financings.\" Cost Savings in operations and administration were instituted in 1994. Management eliminated its hull insurance on certain airships and continues to attempt to renegotiate certain long term obligations. In addition, the Company experienced decreases in ongoing costs resulting from the acquisition in 1993 of certain airship assets and from the sale and retirement from service of its airships; however, to date the Company has failed to secure any new aerial advertising contracts to replace lost revenues from contracts which have terminated. The Company has continued to seek potential new contracts and customers, but there can be no assurance that any of these results will be achieved.\nTo date the Company has never paid a dividend on its Common Stock and does not anticipate paying one on its Common Stock in the foreseeable future.\nDividends on the Company's Preferred Stock are payable in cash to the extent of available cash derived from the adjusted earnings of the Company for the fiscal quarter immediately preceding the Dividend Payment Date (according to a formula based on adjusted earnings). The Company has deferred and accrued the cash\ndividend on the Preferred Stock due on August 15, 1994, and all subsequent quarterly dividend payment dates, until a later payment date.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SCHEDULES\nThe report of the Company's Independent Auditor, Financial Statements, Notes to Financial Statements and Financial Statement Schedules appear herein commencing on Page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company became delinquent in its financial filings subsequent to filing its Form 10-Q for the period ending September 30, 1994. In June 1997 the Company retained Charlie Meeks, C.P.A., P.A. as its independent auditor due to the added expense of continuing with a large audit firm such as Grant Thornton.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth information, as of August 21, 1997, relating to each director and executive officer of the Company.**\n- --------------------\n(1) Mr. Bobet resigned as Chief Financial Officer in June 1995. Mr. Pearlman now acts as Chief Financial Officer of the Company.\nThe following sets forth the business experience of each director, executive officer, including principal occupations, at present and for at least the past five years.\nLouis J. Pearlman has been Chairman of the Board, President, Chief Executive and Operating Officer and Treasurer of the Company since June 1982. Since November 1976, Mr. Pearlman has been President and Chief Operating Officer, a director and a 21% shareholder of Trans Continental. See \"Certain Relationships and Related Transactions.\" Mr. Pearlman currently devotes approximately 10% of his time to Trans Continental and the remainder of his time to the Company.\nMarvin Palmquist has been a director of the Company since November 1984. Since August 1967, Mr. Palmquist has been Chairman of the Board of Directors and President of Lloyd American Corporation (\"LAC\") and its subsidiaries, including Lloyd Communications Group, Inc. which develops, owns and operates local television stations and a satellite receiving center associated with the Independent Network System. LAC also owns and operates the Midway Theater, an historic theater located in Rockford, Illinois.\nSeth M. Bobet was appointed Vice President of Finance in February 1990. From June 1987 through February 1990, Mr. Bobet was the controller of the Company. Mr. Bobet graduated in June 1985 with a Bachelor of Science Degree in Accounting from the State University of New York.\nJames J. Ryan has been a director of the Company since July 1986. Until 1994 for more than 20 years he had been employed with Alexander and Alexander Inc., an international insurance brokerage firm and its predecessor firm, where he most recently held the title of Senior Vice President of the Aviation and Aerospace Division. Mr. Ryan is currently Executive Director of Sedgwick Aviation of North America, an international insurance brokerage firm.\nAlan A. Siegel has been a director of the Company since December 1991 and Secretary of the Company since October 1989. From 1985 to 1989, Mr. Siegel was Senior Account Manager of the Company and since 1989 has served as the Company's General Manager. Mr. Siegel has also been Senior Account Manager for Trans Continental since 1986.\n- -------- ** Mr. Roy Belotti, a director since November 1984, passed away in May, 1995. To date the Company's Board of Directors has not chosen a director to fill the vacancy on the Board created by Mr. Belotti's death.\nThe Company's directors are elected for a period of one year and until their successors are duly elected and qualified. Directors who are not employees of the Company are compensated at a rate of $500 for each meeting of the full Board of Directors which they attend in person, up to a maximum of $2,000 in any one year, plus expenses for attending such meetings. Officers are appointed annually by the Board of Directors and serve at the discretion of the Board.\nTo the knowledge of management of the Company, except as set forth above, no director of the Company holds any directorship in any other company with a class of securities registered pursuant to Section 12, or subject to the requirements of Section 15(d), of the Securities Exchange Act of 1934 or in any company registered as an investment company under the Investment Company Act of 1940.\nThere are currently four members of the Board of Directors. The Company and its principal shareholders have agreed to use their best efforts to elect two designees of the underwriters of the 1993 Offering to the Company's Board of Directors. Due to the Company's failure to pay a specified portion of dividends on the Preferred Stock in cash, the holders of the Preferred Stock, voting as a class, have the right to designate two additional members of the Company's Board of Directors.\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. Section 16(a) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), requires officers and directors of the Company and persons who own more than ten percent of the Common Stock or the Preferred Stock, to file initial statements of beneficial ownership (Form 3), and statements of changes in beneficial ownership (Forms 4 or 5), of the Common Stock and the Preferred Stock with the Securities and Exchange Commission (the \"SEC\"). Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all such forms they file.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table summarizes all compensation earned by or paid to the Company's Chief Executive Officer for services rendered in all capacities to the Company for the three years ended December 31, 1995. No other executive officer's annual salary and bonus exceeded $100,000 during the Company's past three fiscal years.\nSUMMARY COMPENSATION TABLE\n- ------------------\n(1) Mr. Siegel deferred $25,000 of his salary for each of 1995 and 1994.\n1994 EMPLOYEE SHARE PURCHASE PLAN\nThe Company has an employee share option plan (the \"Plan\") for employees of the Company and any present or future \"subsidiary corporations.\" The Company intends the Plan to be an \"employee stock purchase plan\" as defined in Section 423 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Plan, approved by the Company's shareholders on April 11, 1995, was effective November 1, 1994. All employees are eligible to participate in the Plan, except that the Company's appointed committee may exclude any or all of the following groups of employees from any offering: (i) employees who have been employed for less than 2 years; (ii) employees whose customary employment is 20 hours or less per week; (iii) employees whose customary employment is not more than 5 months in any calendar year; and (iv) highly compensated employees (within the meaning of Code Section 414(q). The shares issuable under the Plan shall be common shares of the Company subject to certain restrictions up to a maximum of 1,000,000 shares. The committee shall determine the length of each offering but no offering may exceed 27 months. The option price for options granted in each offering may not be less than the less of (i) 85% of the fair value of the shares on the day of the offering, or (ii) 85% of the fair market value of the shares at the time the option is exercised.\nOPTIONS\/SAR GRANTS IN LAST FISCAL YEAR\nThere were no options grants made in 1995.\nAGGREGATED OPTION EXERCISE IN 1995 AND 1995 FISCAL YEAR-END OPTION VALUES\nThere were no option exercises in 1995.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Board of Directors of the Company does not have a compensation committee. Messrs. Pearlman and Siegel determine executive compensation, based on corporate performance and market conditions. The compensation of Mr. Pearlman, the Chief Executive and Operating Officer of the Company, is based solely upon the terms of his employment agreement with the Company. Similarly, the compensation of Mr. Siegel, the Secretary of the Company, is fixed by the terms of his employment agreement with the Company. See \"Employment Agreements.\"\nEMPLOYMENT AGREEMENTS\nThe Company entered into an employment agreement as of February 15, 1993 with Louis J. Pearlman, superseding his prior agreement which was to expire December 31, 1994. Both agreements contemplate an annual salary to Mr. Pearlman of $200,000 during 1989 and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida 1967 - 100. The agreement also provided for an annual profit bonus payable to Mr. Pearlman in an amount equal to 4% of the first $1 million of the Company's net after-tax profits for such fiscal year. Pursuant to the agreement, Mr. Pearlman's annual compensation, including salary and bonus was limited to $340,000 per year. In addition, Mr. Pearlman agreed in 1993 not to receive a bonus for the 1993 fiscal year. Mr. Pearlman received a bonus of $254,000 (including $100,000 applied to exercise of options) for the 1994 fiscal year. See \"Option Grants in 1994.\" The Company is presently negotiating a new employment agreement with Mr. Pearlman.\nThe Company entered into an employment agreement as of December 31, 1992 with Alan A. Siegel. Mr. Siegel's agreement expires on January 1, 1998. Mr. Siegel's agreement provides for an annual salary of $75,000 for the first year of the agreement and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida 1967 -- 100. The agreement also provides for an annual bonus payable to Mr. Siegel in an amount equal to 1 1\/2% of the Company's net after-tax profits for such fiscal year plus an amount determined in the discretion of the Board.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the number and percentage of shares of Common Stock beneficially owned, as of the Record Date, by (i) all persons known by the Company to be the beneficial owner of more than 5% of\nthe outstanding Common Stock or Preferred Stock, (ii) each of the Company's directors, (iii) the Company's Chief Executive Officer and (iv) all executive officers and directors of the Company as a group (5 persons).\n- ---------- * Denotes less than 1%.\n(1) Mr. Pearlman has an address at: c\/o Airship International Ltd., 7380 Sand Lake Road, Suite 350, Orlando, Florida 32819.\n(2) Includes 50,000 options granted under the Company's Incentive Stock Option Plan.\n(3) Includes a warrant to purchase 67,000 shares of Common Stock which expired unexercised on April 7, 1995. See \"Certain Relationships and Related Transactions.\"\n(4) Such shares of Common Stock were granted to Trans Continental in consideration for its guaranty of the Company's obligations under the Allstate Loan, the Phoenixcor Loan, the Senstar Loan, the Argentina Lease Agreement and the Argentina Operations Agreement, and a corporate credit card issued for the Company's benefit. See \"Certain Relationships and Related Transactions\".\n(5) Includes the options described in footnotes (2) through (3), above.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs of January 1, 1993, the Company owed Mr. Pearlman an aggregate amount of approximately $1,900,000 which amount represented accrued and unpaid salary and bonus, and principal and accrued and unpaid interest on loans made to the Company by Mr. Pearlman for general operation purposes. On June 30,1993, the Company made a $789,000 loan (the \"June 1993 Loan\") to an individual who had previously facilitated financing for the Company. Mr. Pearlman has guaranteed repayment of the Loan and in addition, has agreed that the Company's obligation to repay principal and interest on Mr. Pearlman's loan to the Company shall be reduced proportionately to reflect the amount of the then outstanding Loan for so long as the Loan shall remain outstanding. The loan from Mr. Pearlman bears interest at the rate of 8.5%. In consideration for Mr. Pearlman's guaranteeing repayment of the Loan and agreeing that the Loan can be offset against his loan, the Company has treated the $789,000 as a reduction of the amount due to Mr. Pearlman.\nAs the result of further interest accruing on the amounts owing to Mr. Pearlman by the Company, at December 31, 1994, and after allowing for the offset described above with respect to the Loan, the Company owed Mr. Pearlman $950,000 net of unamortized discount. As of December 31, 1994 the Company owed Mr. Pearlman $950,000 net of unamortized discount.\nDuring the year ended December 31, 1994, the Company earned $164,000 of interest income on advances (the \"Trans Continental Account\") previously made to Trans Continental Airlines, Inc. (\"Trans Continental\"). Mr. Louis J. Pearlman owns 21% of Trans Continental and is the Company's Chairman of the Board, President and principal shareholder. The advances were made to obtain higher yields and, at December 31, 1994, totaled $1,809,000. Trans Continental has pledged a $2,500,000 money market account as collateral for this advance. This advance is returnable to the Company upon demand, and during the year ended December 31, 1994, an aggregate amount of $881,000 of the advances were returned to the Company including interest earned. The balance of the advances were returned to the Company during 1995 and were used by the Company to pay outstanding amounts owing to WDL.\nOn October 9, 1995 the Company granted to Transcontinental 3,666,862 shares of Common Stock representing 10% of the issued and outstanding Common Stock of the Company. Such grant was made in consideration of Transcontinental's guaranty of the Company's obligations under the Allstate Loan, the Phoenixcor Loan and the Senstar Loan and the Argentina Lease and Operations Agreements. In addition, Transcontinental has procured, for the Company's benefit, a corporate credit card.\nOn January 15, 1997 the Company entered into a sale agreement with TLI, an affiliated company, with respect to the Company's $500.04 airship (formerly the \"Bud One\" airship) whereby the Company sold to TLI the airship and related equipment. In consideration for said assets, TLI retired the Company's debt to Senstar Capital Corp. in the amount of $3,014,000. Additionally, TLI procured a new envelope from a third party and agreed to lease back the entire assembled and operational airship to the Company. Pursuant to the agreement, the Company provided that TLI would undertake to pay the operational costs or the $500.04 airship for a minimum of eight months. In addition, the Company anticipates.\nThe Company advanced Airship Airways, Inc. (\"AAI\") $137,500 in August 1994. At such time, Mr. Pearlman was a principal stockholder of AAI, owning approximately 44% of its stock. Subsequent to such transaction Mr. Pearlman has reduced his ownership interest in AAI to approximately 4%. The advance was made in connection with a proposed merger (the \"Merger\") transaction between the Company and AAI. At the present time the Company believes that it is unlikely that the Merger will be consummated. In connection with the advance, AAI issued to the Company its promissory note (the \"AAI Note\") in the amount of $137,500 in October 1994. The AAI Note is secured by certain aircraft and equipment owned by AAI. The AAI Note bore interest at the rate of 8% per annum, and was due and payable on or before February 23,1995. On February 8, 1995 AAI repaid the AAI Note in full by paying the Company $82,100 and cancelling two promissory notes that had been issued by the Company to AAI in the respective principal amounts of $25,000 and $30,400. These notes had been issued in connection with expenses incurred in connection with the Merger, and reductions in rental payments on office space obtained with the cooperation of AAI, and which were due and payable on February 23, 1995 and May 1, 1996, respectively.\nPursuant to an Agreement dated December 7, 1993, the Company made a $75,000 unsecured loan to Superbound Limited (\"Superbound\"), a United Kingdom corporation controlled by James Stuart Tucker, the former President of Slingsby. The loan bears interest at an annual rate of 10%. Principal is payable in two equal installments of $37,500 each on the first two anniversaries of the date the loan proceeds were paid to Superbound (within seven days of December 7, 1993). Mr. Tucker is a guarantor of this loan. During 1994 Mr. Tucker was able to procure, without cost to the Company, required maintenance service and parts which would otherwise have cost the Company over $100,000. In exchange for his services, $37,500 of the loan was cancelled as of December 3, 1994 and interest of $7,500 was received in February 1995. The remaining balance of the loan was subsequently repaid.\nOn December 31, 1991, Mr. Julian Benscher and the Company entered into a Line of Credit Agreement, pursuant to which Mr. Benscher loaned the Company $ 1,000,000 in 1992. As partial consideration for making these loans, the Company issued to Mr. Benscher warrants to purchase 775,000 shares of Common Stock and issued additional warrants to purchase 325,000 shares of Common Stock to certain parties designated by Mr. Benscher. The Company has granted Mr. Benscher registration rights with respect to all shares of Common Stock and warrants owned by him. These warrants were to expire on December 31, 1994; however, for continued assistance provided to the Company by Mr. Benscher, the Company extended the expiration date of these warrants to January 15, 1996, on which date the warrants expired unexercised.\nThe Company sold the Argentina Airship to First Security for the benefit of Aviation, in June, 1995 in consideration for First Security's assumption of the Company's liabilities under the Argentina Lease Agreement and AOI's obligations under the Argentina Operations Agreement. In connection with such sale, the Company assigned the Argentina Lease Agreement to First Security, and Aviation purchased all of the issued and outstanding Capital Stock of AOI. See \"Business-Aerial Advertising and Other Contracts-Argentina Airship.\"\nThe Company has purchased hull insurance for the Company's airships through Sedgwick Aviation of North America, an international insurance brokerage firm of which Mr. James J. Ryan is the Executive Director.\nItem 14","section_14":"Item 14 - Exhibits, Financial Statements, Schedules and Reports on Form 8-K\n*Filed herewith.\n(1) The Company's Registration Statement on Form S 18 Registration No. 2.96334 NY as filed with the Securities and Exchange Commission (the \"SEC\") on March 9, 1985. (2) The Company's Registration Statement on Form S-1 Registration No. 33-7830, as filed with the SEC on August 7, 1986. (3) The Company's Annual Report on Form 10-K for fiscal year ended December 31, 1988. (4) The Company's Annual Report on Form 10-K for fiscal year ended December 31, 1991. (5) The Company's Registration Statement on Form S-2, Registration No. 33-32619, as filed with the SEC on December 18, 1989. (6) The Company's Post-effective Amendment No. 1 on Form S-3 to Form S-2, Registration No. 33-38076, as filed with the SEC on May 14,1 992. (7) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. (8) The Company's Report on Form 8 dated August 14, 1991. (9) The Company's Report on Form 8-K dated February 27, 1990. (10) The Company's Registration Statement on Form S-2, Registration No. 33038076. as filed with the SEC on December 5. 1990.\n(11) The Company's Registration Statement on Form S-1, Registration No. 33-56382, as filed with the SEC on February 16, 1993. (12) The Company's Registration Statement on Form 8-A, as filed with SEC on March 16, 1993. (13) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (14) The Company's Report on Form 8-K dated July 9, 1993. (15) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (16) The Company's Report on Form 8-K, as filed with the SEC on July 11, 1997. (17) The Company's Report on Form 8-K\/A, as filed with the SEC on July 22, 1997. (18) The Company's Proxy Statement, as filed with the SEC on March 20, 1995. (19) The Company's Annnual Report on Form 10-K for the year ended December 31, 1994.\n(b) The Company had not filed any reports on form 8-K during the last quarter of the period covered by this report.\nSTATEMENT OF REFERENCES The copyright symbol shall be expressed as.............................`c' The registered trademark symbol shall be expressed as..................`r' The trademark symbol shall be expressed as.............................`tm' Characters normally expressed as superscript shall be preceded by.......`pp'\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nAIRSHIP INTERNATIONAL LTD.\nDated: September 8, 1997 By: \/s\/ Louis J. Pearlman ----------------------- Louis J. Pearlman Chairman of the Board of Directors, President and Treasurer (Principal Executive and Financial Officer)\nDated: September 8, 1997 By: \/s\/ Alan A. Siegel -------------------- Alan A. Siegel Secretary & Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDated: September 8, 1997 By: \/s\/ Marvin Palmquist --------------------- Marvin Palmquist Director\nDated: September 8, 1997 By: \/s\/ James J. Ryan ------------------- James J. Ryan Director\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT\nBoard of Directors and Stockholders Airship International Ltd.\nI have audited the accompanying balance sheets of Airship International Ltd. as of December 31, 1995 and 1994 and the related statement of operations, stockholders' equity (deficit) 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 audit. The December 31, 1993 financial statements were audited by other auditors whose report, dated March 24, 1994 on those statements included an explanatory paragraph describing conditions that raised substantial doubt about the Company's ability to continue as a going concern.\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 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 financial position of Airship International Ltd. at 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 described in Note B to the financial statements, the Company has experienced significant operating losses, an accumulated deficit and negative working capital at December 31, 1995 and 1994. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note B. The financial statements do not include any adjustments that might result from the outcome of this uncertainty, with the exception of the effects of applying Statement of Financial Accounting Standards No. 121, \"Impairment of Long-Lived Assets to be Disposed Of,\" as described in Note A.\nCHARLIE M. MEEKS, C.P.A., P.A.\nMaitland, Florida September 5, 1997\nAIRSHIP INTERNATIONAL LTD. BALANCE SHEETS DECEMBER 31,\nThe accompanying notes are an integral part of these statements. AIRSHIP INTERNATIONAL LTD.\nSTATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying notes are an integral part of these statements.\nAIRSHIP INTERNATIONAL LTD. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying notes are an integral part of these statements.\nAIRSHIP INTERNATIONAL LTD. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying notes are an integral part of these statements.\nAIRSHIP INTERNATIONAL LTD. STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31,\nIncrease (decrease) in cash and cash equivalents\nThe accompanying notes are an integral part of these statements.\nAIRSHIP INTERNATIONAL LTD. STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31,\nIncrease (decrease) in cash and cash equivalents\nThe accompanying notes are an integral part of these statements.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE A -- NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNature of Business -- The Company operates lighter-than-air airships used to advertise and promote the products and services of the Company's clients. At December 31, 1995, the Company had no airships in operation.\nCash and Equivalents -- The Company considers unrestricted short-term, highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.\nRevenue Recognition -- Airship revenues are being recognized during the period in which services are provided. Whenever significant flight time is owed to a customer, the incremental cost of providing services is accrued. No amounts are accrued at December 31, 1995 or 1994.\nFlight Crew Training Costs -- Significant flight crew training costs for new blimps are amortized over twelve months from the date related revenues commence.\nAirships and Related Equipment -- Property and Equipment are stated at cost. Depreciation is provided by the straight line method over the estimated useful lives of the assets - 10 to 20 years (airships), 4 to 8 years (vehicles), 3 to 5 years (parts and equipment) and 2 to 3 years (improvements). Airship components are not depreciated until placed in service.\nConstruction in Progress -- The Company has abandoned its plans to build a manufacturing complex and aviation hangar to be called Blimp Port USA'tm' which will be located at a site near its Orlando, Florida base of operations. The Company intended to use this facility to manufacture, assemble and maintain airships for commercial and governmental use and provide offices for technical and executive personnel. The Company has acquired a Federal Aviation Administration (FAA) license necessary for the assembly and maintenance of airships. Capitalized costs, including interest, relating to the facilities amounted to $479,000 were written off during the year ended December 31, 1994. Such costs included incremental costs directly identifiable with the facility, such as land lease rental, property taxes, insurance and other costs directly associated with the acquisition, development and construction of the project. To date costs capitalized represent consulting, architectural and design fees.\nDeferred Financing and Offering Costs -- Costs incurred to obtain debt financing are capitalized and amortized over the terms of the related loans. Such costs include incremental payments to consultants, lenders and other out of pocket expenses, as well as the fair value of options and warrants issued to persons other than lenders. The fair value of options and warrants issued to lenders are reported as debt discount and amortized over the term of the related loan. In determining the fair value of warrants issued, substantial discounts have been provided for the effects of restrictions on sale, the volume of shares involved and other factors.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Continued\nIncome Taxes -- The Company follows the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting For Income Taxes\", which requires the recognition of deferred tax liabilities and assets for expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect when these differences are expected to reverse. Valuation allowances are established when appropriate, to reduce deferred tax assets to the amount expected to be realized.\nImpairment of Long-Lived Assets -- In March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets to be Disposed Of (\"SFAS 121\"). SFAS 121 requires that long-lived assets held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this standard in the fourth quarter of the fiscal year ended December 31, 1994 resulted in an adjustment of $9,634,000 or $0.32 per share to the Company's financial statements. The Company obtained an independent appraisal on its airship components in August 1997, which reflects a range of values from $2,174,000 (on a liquidation sale value) to $5,096,000 (on a market value basis). Based on the fact that the Company had two airships in operation at December 31, 1994, the Company adjusted the carrying value to $3,635,000 or the midpoint of the above range. At December 31, 1995, the Company decided to write down the balance of the airship components to liquidation sale value, which resulted in an additional adjustment of $1,462,000 or $_____ per share. The Company reviews all of its long-lived assets for impairment in accordance with SFAS 121. Prior to the adoption of SFAS 121, all long-lived assets, were reviewed for impairment by comparing the carrying value of such assets to future expected net cash flows.\nChange in Accounting Estimate -- Effective April 1, 1994, the Company revised its estimate of useful lives of airships and airship components. Previously, airship envelopes and Nightsigns'tm' on operating airships were depreciated over 20 years. The Company has changed the useful lives to 4 1\/2 on airship envelopes years and 10 years for Nightsigns'tm' resulting in an additional charge to income of $774,000 or $.03 per share.\nNet Income (Loss) Per Share -- Net income (loss) per share is based on the weighted average number of shares outstanding during the periods. When losses have been incurred, warrants and options are not included since the effect would dilute loss per share, however, preferred stock dividends are included in the loss per share calculation. When net income is reported, warrants and options are included using the treasury stock method, provided exercise prices are less than the average market price; warrants convertible into common stock are included when such inclusion results in further dilution.\nRecently Issued Pronouncements -- In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", (\"SFAS 123\") which sets forth accounting and disclosure requirements for stock-based compensation arrangements. The new statement encourages, but does not require, companies to measure stock-based compensation cost using a fair-value method, rather than the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25 (\"APB Opinion 25\"). The Company will adopt the disclosure requirements of SFAS 123 in 1995 and will\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Continued\nelect to continue to record stock-based compensation expense using the intrinsic-value approach prescribed by APB Opinion 25.\nAccordingly, the Company computes compensation cost for each employee stock option granted as the amount by which the quoted market price of the Company's Common Stock on the date of grant exceeds the amount the employee must pay to acquire the stock. The amount of compensation costs, if any, will be charged to operations over the vesting period.\nIn February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, \"Earnings Per Share\" (\"SFAS 128\") and Statement of Financial Accounting Standards No. 129, \"Disclosure of Information about Capital Structure (\"SFAS 129\"). SFAS 128 specifies the computation of earnings per share, and SFAS 129 specifies the presentation and disclosure requirements about an entity's capital structure. Both SFAS 128 and 129 shall be adopted in the fourth quarter of 1997 with restatement back to January 1, 1997. The initial adoption of these standards are not expected to have a material effect on the Company's earnings per share as disclosed.\nNOTE B - SIGNIFICANT UNCERTAINTIES AND MANAGEMENT'S PLANS TO OVERCOME OPERATING DIFFICULTIES AND MEET CASH REQUIREMENTS\nAs shown in the accompanying financial statements, the Company has experienced significant operating losses and negative cash flow from operations in recent years and has an accumulated deficit of $46,569,000 at December 31, 1995. During the year ended December 31, 1995, the Company generated revenues from airship operations; however, it reported a net loss of $4,687,000 and has negative working capital of $7,538,000. These conditions raise substantial doubt about the Company's ability to continue as a going concern.\nManagement's plans to improve the financial position and operations with the goal of sustaining the Company's operations for the next twelve months and beyond include:\nArranging with Trans Continental Airlines, Inc., a company related through common directorship and ownership, to provide funds on a monthly basis as a loan and acquiring assets and operations of one or more entities, which the Company has been exploring. Management's hope is that such business combination, if completed, would provide additional cash flow and net income to the Company.\nThough management believes the Company will secure additional capital and\/or attain one or more of the above goals, there can be no assurance that any acquisition, financing or other plan will be effected. Any acquisition or securities offering is subject to the Company's due diligence, the state of the general securities markets and of the specific market for the Company's securities, and any necessary regulatory review.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE B - SIGNIFICANT UNCERTAINTIES AND MANAGEMENT'S PLANS TO OVERCOME OPERATING DIFFICULTIES AND MEET CASH REQUIREMENTS - Continued\nThough management believes the company will secure additional capital and\/or attain one or more of the above goals, there can be no assurance that any acquisition, financing or other plan will be effected. Any acquisition or securities offering is subject to the Company's due diligence, the state of the general securities markets and of the specific market for the Company's securities, and any necessary regulatory review.\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES AND OTHERS\nDue from Affiliate -- At December 31, 1995 and 1994, the Company made advances of $1,809,000 to Trans Continental Airlines, Inc. (\"Trans Continental\"), an affiliated aircraft leasing company and stockholder of the Company. Louis J. Pearlman (\"Mr. Pearlman\") owns 21% of Trans Continental and is the Company's Chairman of the Board, President and Principal Stockholder. Trans Continental pledged a $2,500,000 money market account as collateral for this advance. The deposit was returned to the Company during 1995. Interest earned on this deposit amounted to $23,467, $164,000 and $107,000 for years ended December 31, 1995, 1994 and 1993, respectively.\nPersonal Guarantees -- Mr. Pearlman and Trans Continental have guaranteed all capital leases and loans of the Company (see Note E).\nLoans from Principal Stockholder -- In May 1992, all amounts due to Mr. Pearlman, consisting of 10% notes payable, accrued salaries, bonuses and interest were consolidated into one single loan of $1,845,000. The loan was payable in equal quarterly installments of $135,000 per year including interest at 8 1\/2% per annum, and commenced in July 1992. This payment schedule continued until a loan payable to a bank for the SeaWorld airship was paid (with the preferred stock proceeds - see Note H), at which time the loan became payable at the discretion of the Company. All unpaid principal and interest is due in May 1997 and has been deferred by Mr. Pearlman for an indefinite period of time. Interest on the loan payable was $85,000, $105,000, and $144,000 for the years ended 1995, 1994, and 1993, respectively.\nOn June 30, 1993, the Company made a $789,000 loan (the \"Loan\") to an individual who had previously facilitated financing for the Company. Mr. Pearlman has guaranteed repayment of the Loan. The Loan is being repaid by Mr. Pearlman in equal monthly installments of $6,209 per month, including interest at the rate of 8.75%. The remaining unpaid principal balance of the Loan was due on June 30, 1995. It has been agreed that the Company's obligation to repay principal and interest on the loan to Mr. Pearlman shall be reduced to reflect the outstanding balance on this Loan for so long as it shall remain outstanding. Amounts due to Mr. Pearlman at December 31, 1995 and 1994 totaled $1,040,000 and $950,000, respectively, net of unamortized discount.\nDuring 1995, Trans Continental advanced the Company funds that were used for operations in the amount of $549,000. The balance owed to Trans Continental is accruing interest at the rate of 10% per annum and is due on demand.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES and OTHERS - Continued\nTransactions with Stockholder and His Affiliate -- Mr. Julian Benscher (\"Mr. Benscher\") beneficially owned 4.0% of the common stock of the Company at December 31, 1994. Mr. Benscher is also a stockholder and director of J&B Enterprises Limited (UK) Corp. (\"J&B\"). The Company and Mr. Benscher have been involved in certain transactions as follows:\nSale of Airship Components -- In December 1992, the Company entered into two agreements with J&B to sell for $2,790,000 ($2,721,000 net of imputed interest) an unassembled airship and its related components which had a cost basis to the Company of $355,000. The Company received a $500,000 initial payment in December 1992. The balance of the purchase price was paid in February and November 1993 and bore interest at the LIBOR rate. The unpaid balance of the purchase price was collateralized by the respective airship components and such other security as the parties were to mutually agree to be reasonable and guaranteed by Mr. Benscher. This transaction involves the sale of unassembled airship components acquired in the 1990 asset acquisition from Airship UK.\nIn addition, certain real property located in the United Kingdom and owned by a director of J&B who is a relative of Mr. Benscher was pledged and accepted by the Company in satisfaction of the unspecified collateral stated in the December 1992 agreement. Certain components at this time continue to remain in a warehouse leased by the Company in Florida. J&B reimburses the Company for occupancy costs for storage of the components.\nRental Arrangement and Travel Agency Service -- Trans Continental serves as the Company's travel agent for substantially all of its travel arrangements and the Company is its principal customer. In the opinion of management, the terms and prices received from the corporation are similar to those available from other travel agencies. The Company paid the agency $6,000 for travel expenses in 1993. During 1995, 1994 and 1993, the Company utilized the travel agency services for reservations, while primarily paying certain costs directly to the provider.\nHull and Liability Insurance -- The Company purchases hull and liability insurance with respect to the Company's airships through Alexander and Howden, Inc., an international insurance brokerage firm of which James J. Ryan is the Senior Vice President of its Aviation Aerospace Division. Mr. Ryan is also a director of the Company and, in 1990, was granted a five-year warrant to purchase 67,000 shares of common stock at $2.20 per share. Insurance expense for Alexander and Howden was $________, $72,000, and $1,319,000 in 1995, 1994, and 1993, respectively.\nWarrants -- Reference should be made to Note H for warrants issued in connection with certain of the above transactions.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES and OTHERS - Continued\nCorporate Offices -- The Company provides office space to affiliates free of charge. The Company is reimbursed by the affiliates for telephone charges.\nLoan Receivable -- During 1993 the Company made an unsecured loan of $75,000 to a company controlled by and guaranteed by the former president of Slingsby. This loan bears interest at 10%, payable quarterly. Principal payments of $37,500 were paid during 1995.\nNOTE D - INCOME TAXES\nAt December 31, 1995, the Company had net operating loss carryforwards for income taxes of approximately $35,117,000 available as offsets against future taxable income. During 1991, the Company experienced changes in the Company's ownership as defined in Section 382 of the Internal Revenue Code (\"IRC\"). The effect of these changes in ownership is to limit the utilization of certain existing net operating loss carryforwards for income tax purposes. Operating losses incurred after the ownership change are not limited. As a result, only approximately $20,436,000 of the operating losses which occurred after the ownership change are not limited. The operating losses incurred prior to the ownership change are limited to a certain dollar amount each year. The net operating loss carryforwards expire during the years 2000 to 2012. The company also has unused investment tax credits of $140,000 which expire principally in the year 2000.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE D-INCOME TAXES-Continued\nThe tax effect of temporary differences that give rise to significant positions of the deferred tax assets and deferred tax liabilities, consist of the following at December 31:\n1995 1994 - -------------------------------------------------------------------------------- Deferred tax assess: Net operating loss $ 10,595,000 $ 14,576,000 Accrued expenses 323,000 291,000 - -------------------------------------------------------------------------------- 10,918,000 14,867,000 Less: Valuation allowance 8,491,000 11,990,000 - -------------------------------------------------------------------------------- 2,427,000 2,877,000 Deferred tax liabilities: Airships and related equipment (2,427,000) (2,877,000) - -------------------------------------------------------------------------------- (2,427,000) (2,877,000) - -------------------------------------------------------------------------------- Net deferred tax asset $ -- $ -- - --------------------------------------------------------------------------------\nThe net change in the valuation allowance was approximately $450,000 relating to net operating losses from 1995.\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE\nCapital leases payable consist of the following:\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE - Continued\nThe following is a schedule by year of future minimum lease payments pursuant to the capital leases together with the present value of the net minimum lease payments as of December 31, 1995:\n1996 $ 400,000 1997 860,000 1998 960,000 1999 960,000 2000 960,000 Thereafter 28,000 ------------ Total minimum lease payments 4,168,000 Less amount representing interest 820,000 ------------ Present value of net minimum lease payments $ 3,348,000 ============\nCapital Leases - In October 1989, the Company purchased a new Skyship 600 Series airship (the \"MetLife airship\") from Airship UK. The MetLife airship and related equipment were financed primarily by net proceeds of $6,200,000 from a capital lease obtained through ORIX Commercial Credit Corp. (\"ORIX\"). The capital lease initially required monthly payments of $135,000 through November 1992. In December 1992, the lease was renewed for an additional three-year term at monthly payments of $121,000. At the end of the additional three year term the Company had the option to purchase this airship for $1,000,000 or renew the lease for another three year term at monthly payments of $35,000. At the completion of the third lease term, title is to be transferred to the Company upon payment of $1. On January 11, 1994 the Company renegotiated the lease to reduce the $121,000 payments. Even after the payment modifications the Company was unable to make the payments and went into default. Effective June 2, 1995, the lease was renegotiated calling for payments of principle only of $20,000 for twelve months. At the end of the initial twelve-month period, the Company will begin to make principle and interest payments at the rate of prime plus 1% of $40,000 for the next six months, followed by payments of $60,000 for an next six months and finally payments equaling the higher of $80,000 or 50% of the annual cash flows for the fiscal year immediately prior to the commencement of each applicable twelve-month period for the remaining term of the lease until the lease is fully amortized or a larger payment is made based upon the annual cash flow of the year. Based upon the revised payment schedule, the payments are not sufficient to cover the interest expense. Thus negative amortization results in 1994 and 1995 and the ending principal balance is increased.\nThe airship and related equipment financed by the capital leases had a cost of $6,687,000 and accumulated depreciation of $1,077,000 at December 31, 1993. During 1994 the leased airship was damaged and taken out of service. A cost of $2,699,000 and accumulated depreciation of $1,232,000 were written off due to the damage. The remaining cost basis of approximately $3,500,000 was transferred to spare parts and air ship components. The resulting net book value was later analyzed as part of the SEAS 121 writedown as described in Note A.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE - Continued\nLoan Payable to Senstar (Allstate) - The Company entered into an accounts receivable factoring security agreement on September 19, 1994 which was modified on November 16, 1994 and November 23, 1994. The maximum borrowing amount under the November 23rd agreement was $1,500,000. The loan balance was to be reduced by $75,000 per month beginning December 1, 1994. A fee of 0.125% per month is payable each month on the higher of funds outstanding or $1,500,000. The loan was used to pay off certain liabilities and provide a source of working capital. The balance due to Allstate as of December 31, 1994 amounted to $1,250,000. The loan was secured by accounts receivable, inventory, certain airships and equipment.\nOn June 22, 1995, the Allstate loan was repaid when Trans Continental Leasing, Inc. (\"TLI\"), a wholl-yowned subsidiary of Trans Continental, entered into a sale-leaseback agreement with the Company. Pursuant to which, the Bud One Airship was sold by the Company to TLI for the purchase price of $2,060,000, which in turn was leased back to the Company.\nOn November 30, 1995, the Company entered into an arrangement with Senstar Capital Corporation (\"Senstar\") pursuant to which the sale-leaseback arrangement with TLI was reversed. The Company borrowed a total of $3,500,000 from Senstar, part of which has been used to repay the loan from Phoenixcor, Inc., the lender for TLI's transaction. The loan from Senstar is repayable over 5 years in sixty monthly payments of approximately $63,000 each, with a balance due at the end of the five year term of approximately $700,000, and secured by a lien on the Airship and is guaranteed by Trans Continental. The balance due under this loan amounted to $3,463,000 at December 31, 1995.\nOther Long-Term Debt - The Company has other long-term debt in the amount of $215,000 maturing through December 31, 2001 at various annual interest rates.\nCurrent maturities of long-term are as follows: 1996 $ 601,000 1997 552,000 1998 572,000 1999 609,000 2000 663,000 Thereafter 679,000 --------- Total minimum lease payments 3,676,000 - ------------------------------------------------------------------- Warrants - Reference should be made to Note H for warrants issued in connection with certain of these transactions.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE F - LEGAL PROCEEDINGS\nCapital Funding Ltd. - In February 1992, Capital Funding Group Ltd. (\"CFG\") commenced an action against the Company and others seeking in excess of $1,000,000 in damages based on the alleged failure by the Company to provide adequate collateral and security in connection with certain alleged financial agreements with CFG. The Company retained CFG in July 1991, paid a commitment fee (which was written off in 1991) and received a commitment from CFG which then failed to provide the funding. The Company and the other defendants answered the complaint in February 1992 by denying all of the substantive allegations and asserting several affirmative defenses. In addition, the Company asserted certain counterclaims against CFG and its two principals for breach of a commitment letter pursuant to which CFG was to arrange for a $9 million loan to the Company, breach of a compromise agreement accepted by CFG in January 1992, pursuant to which CFG was to provide funding to the Company in the amount of $7 million, breach of an escrow agreement, pursuant to which CFG was to return $200,000 ofthe commitment fee paid by the Company and various other counterclaims. In March 1993, the Company was awarded a default judgment of $8,000,000 against CFG. No balances have been returned to the Company as of December 31, 1995.\nWatermark Group PLC and Von Tech Corporation - In January 1993, a second amended complaint to a lawsuit, which was initially commenced in March 1991 and subsequently dismissed twice without prejudice, was filed against the Company and Mr. Pearlman by Watermark Group PLC and Von Tech Corporation, a general partners of Company communications (collectively the \"W\/VT Plaintiffs\") alleging breach of an alleged joint venture agreement involving Company Communications and Airship Enterprises Ltd. (a company that was owned by Mr. Pearlman and that was not in any way owned or controlled by the Company); breach of an alleged agreement by the Company regarding the lease and operation of a particular airship; and breach of an alleged oral commission agreement by the Company relating to the Company's acquisition of two airships it presently owns. The W\/VT Plaintiffs seek various legal and equitable remedies, including monetary damages against the Company and Mr. Pearlman in excess of $80O,000 together with a claim for some portion of the advertising revenue the Company has received, and will continue to receive, from the operation of some of its airships. In March 1993, the second amended complaint filed against the Company and Mr. Pearlman by W\/VT Plaintiffs was dismissed without prejudice. Since the Company denies any involvement with any of the transactions set forth in the second amended complaint, the Company believes that its liability, if any, on the claims made by the W\/VT Plaintiffs will not be material. This case was settled on October 3, 1995 for $40,000.\nSequel Capital Corporation - In December 1992 a lawsuit was filed against the Company, Mr. Pearlman and an advertising customer of the Company by Sequel Capital Corporation (\"Sequel\"). The complaint (as amended) contains claims for default on an $800,000 loan from Sequel (the \"Sequel Loan\") as a result of an alleged failure to provide collateral consisting of monthly payments being made to the Company by a third party on an airship advertising agreement. The proceeds of the Sequel Loan, which was personally guaranteed by Mr. Pearlman, were applied by the Company towards the purchase of a new airship from the Seoul Olympic Sports Promotion Foundation. The amended complaint also includes a claim for breach of an alleged contract to enter into a sale leaseback agreement with respect to one of the company's airships and a claim for allegedly fraudulently inducing Sequel to make the Loan to the Company. This claim was settled by the Company in 1993 for approximately $741,000 including legal expenses.\nTenerten and Drake. Inc. - On September 15, 1994, Tenerten and Drake, Inc. (\"TDI\") filed a complaint against the Company. The complaint alleges that the Company failed to pay certain sums of money due to\nAirship International Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE F - LEGAL PROCEEDINGS - Continued\nTDI under an agreement to perform advertising and related services for the Company. The Company filed its answer and raised its affirmative defenses to said complaint alleging that the services allegedly performed by TDI were defective in numerous respects. A final judgment was entered against the Company on July 20, 1995 in the amount of $24,000, which has been placed in escrow pending appeal.\nWestinghouse Airships. Inc. - On September 14, 1994, Westinghouse Airships, Inc. (\"WAI\") filed a complaint against the Company alleging that the Company and Mr. Pearlman breached an agreement to purchase two gondolas from WAI. Specifically, the complaint alleges that WAI delivered both gondolas at issue and that the Company failed to make certain installments to WAI under the agreement. The complaint also alleges that the Company breached a sub-lease to occupy certain hangar space located in North Carolina. On June 19, 1995, the Company and WAI agreed to settle the case for $32,000.\nOther Proceedings - The Company is a defendant in a number of other legal proceedings, which occurred in the normal the course of business. Those cases in which the ultimate settlement is known or estimable have been accrued in the financial statements. It is not possible at this time to predict the outcome of the unsettled legal actions; however, in the opinion of management and informal advice of counsel, the disposition of these other lawsuits will not have a material effect on the financial statements.\nNOTE G - COMMITMENTS AND CONTINGENCIES\nPossible Future Tax Claims - Because blimp advertising services differ from many other forms of advertising, state and local tax authorities may assert claims based on interpretations of law which differ from interpretations by management. In the opinion of management, its positions are consistent with similar entities.\nEmployment Agreements - In 1993 the Company and Mr. Pearlman entered into an employment agreement which was amended to continue to December 199 . The agreement provides for an annual salary to Mr. Pearlman of $200,000 for the first year of the agreement and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida. The agreement also provides for an annual bonus payable to Mr. Pearlman in an amount equal to 4% profits for such fiscal year. Pursuant to this agreement, Mr. Pearlman's annual compensation, including salary and bonus is limited to $340,000 per year. Accrued and unpaid salaries through December 31, 1995 are $391,000 and are included in amounts due to related party.\nOn March 1, 1994 the Company agreed to reimburse Mr. Pearlman $4,000 per month in expenses, effective January 1, 1993, due to Mr. Pearlman's out-of-pocket expenses for the Company's business.\nThe Company entered into employment agreements as of January 1, 1993 with each of two officers and another employee. Each agreement expires on January 1, 1998 and provides for annual salaries of $75,000 for the first year ofthe agreement and annual increases thereafter in an amount equal to the greater of 5% of his previous years salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida. Each agreement also provides for an annual bonus payable in an amount equal to 1 1\/2% of the Company's net aftertax profits for such fiscal year plus an additional amount determined at the discretion ofthe Board of Directors.\nAirship International Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE G - COMMITMENTS AND CONTINGENCIES - Continued\nOperating Leases - The Company has various operating leases which will expire at various dates through May 1996 with unrelated parties for its executive offices, warehouse space, maintenance facility, and the Gulf airship discussed in Note I.\nFuture minimum payments under these operating leases at December 31, 1995 are as follows:\n1996 $ 95,000 1997 27,000 1998 4,000 1999 1,000 --------- $ 126,000 =========\nRent expense amounted to approximately $(18,000), $819,000 and $577,000 for the years ended 1995, 1994 and 1993, respectively.\nNOTE H - STOCKHOLDERS' EQUITY\nPreferred Stock - In February 1993, the Company completed a public offering (\"the Offering\") of 2,875,000 shares of its Class A 8% Cumulative Convertible Voting Preferred Stock (\"Preferred Stock\") at $6.00 per share.\nEach share of Preferred Stock is convertible, at any time after the earlier of February 16, 1994 or a date determined by the underwriters at their sole discretion (which date was not to be prior to April 19, 1993), into 6 shares of common stock, subject to future adjustment. Dividends on the Preferred Stock are payable quarterly and the first four dividends were paid, on an annualized basis, 50% in cash and 50% in shares of the Company's common stock. The Preferred Stock accrues dividends at the annual rate of $.60 per share for dividends paid in shares of common stock, and $.48 per share for dividends paid in cash. If available cash is not sufficient to pay any or all of the subsequent dividend payments, the balance of the dividend will be paid in shares of the common stock.\nThe Preferred Stock is redeemable at the option of the Company, in whole or in part, at $6.60, together with all accrued and unpaid dividends, at any time after February 16, 1996. The liquidation preference of the Preferred Stock is $6.00 per share.\nIn connection with the offering, the Company issued to the two representatives of the several underwriters, warrants to purchase an additional 10% of the Preferred Stock sold in the Offering. The Preferred Stock warrants are exercisable for four years commencing February 1994 at an exercise price equal to 165% of the initial offering price ofthe Preferred Stock, subject to certain anti-dilution provisions.\nPrivate Placement of Common Stock - During the first and second quarters of 1994, the Company sold common stock to certain investors pursuant to a share subscription agreement. The number of shares initially sold were 5,301,164 at an average purchase price of $.20 per share. These shares were not sold pursuant to a formal offering memorandum. Therefore, the Company offered a right of recession, which the majority of the purchasers of the common stock exercised.\nAirship International, Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE H - STOCKHOLDERS' EQUITY - Continued\nWarrants and Options - Outstanding warrants and options at December 31, 1995, all of which are currently exercisable, after giving effect to adjustments through such date for anti-dilution provisions and exercisable price reductions are as follows:\nThe Company has an incentive stock option plan (the \"Plan\") for key employees under which it may grant options to purchase the Company's common stock over a term of up to ten years at the fair market value at the time of the grant. Options granted to a ten percent or more shareholder, an officer, or a director, may not be for less than 110% of fair market value and must be exercised within five years. The Plan was amended in December 1991 increasing to 750,000 the number of shares reserved for issuance. The Plan terminated on October 31, 1994.\nOptions under the Plan are summarized as follows:\nAirship International, Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE H - STOCKHOLDERS' EQUITY - Continued\nSince inception, 24,000 options granted under the Plan have been exercised (none in 1995, 1994 or 1993). The Plan terminated on October 31, 1994.\nEmployee Share Purchase Plan - The Company has an employee share option plan (the \"Plan\") for employees of the Company and any present or future \"subsidiary corporations.\" The Company intends the Plan to be an \"employee stock purchase plan\" as defined in Section 423 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Plan was effective November 1, 1994. All employees are eligible to participate in the Plan, except that the Company's appointed committee may exclude any or all of the following groups of employees from any offering: (i) employees who have been employed for less than 2 years; (ii) employees whose customary employment is 20 hours or less per week; (iii) employees whose customary employment is not more that 5 months in any calendar year; and (iv) highly compensated employees (within the meaning of Code Section 414(q). The shares issuable under the Plan shall be common shares of the Company subject to certain restrictions up to a maximum of 1,000,000 shares. The committee shall determine the length of each offering but no offering may exceed 27 months. The option price for options granted in each offering may not be less than the less of (i) 85% of the fair value of the shares on the day of the offering, or (ii) 85% of the fair market value of the shares at the time the option is exercised.\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION\nMetropolitan Life - During 1993, the Company derived airship revenue from Metropolitan Life Insurance Company (\"MetLife\") pursuant to an amended aerial advertising agreement which expired in October 1993. The agreement provided for minimum monthly revenues plus travel expense reimbursements. The Company was responsible for all costs associated with the ownership, use or operation of the MetLife airship, including repairs, maintenance supplies, insurance and taxes.\nIn January 1994, the Company entered into an advertising agreement with Kingstreet Tours Limited (UK) for the use of the MetLife airship promoting Pink Floyd. The term of the agreement was originally for six months commencing January 18, 1994. The Company was responsible for all costs associated with the operations of the airship, including travel costs, repairs, maintenance, insurance and taxes. On June 20, 1994, the MetLife airship was damaged in a storm and the contract was cancelled (See Note E).\nAirship International, Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION-- Continued\nAnheuser-Busch\/Sea World - In April 1990, the Company entered into an aerial advertising agreement with Anheuser-Busch Companies, Inc. (\"Anheuser-Busch\") granting Anheuser-Busch the exclusive use of the Sea World airship to advertise and promote Anheuser-Busch's products and business. The agreement was replaced in April 1991 (retroactive to January 1, 1991) to include the payment of $540,000 to the Company in January 1991 as an advance against the fees for the next 18 months. The $540,000 advance was recognized as airship revenue at the rate of $30,000 per month over the period of January 1, 1991 to June 30, 1992. The agreement also provided for additional monthly revenues through the expiration of the agreement on June 30, 1993. The Company continued to operate the airship for a monthly fee through December 1993, after which the lease was terminated.\nThe Company was responsible for all costs associated with the ownership, use or operation of the airship, including repairs, maintenance supplies, insurance and taxes.\nThe Company is also entitled to receive royalties from Anheuser-Busch on monthly sales of merchandise shaped like or containing an image of the airship and bearing Anheuser-Busch's trademarks during the term of the Sea World Contract and for two years thereafter. The amount of royalties recognized as revenue amounted to $7,000 for the years ended December 31, 1993.\nOn January 2, 1994 the Company entered into an agreement with Anheuser-Busch, whereby the Company was permitted to provide passenger rides and to display advertising. The contract did not provide for usage fees or for a monthly operating fee, but permits the Company to use this airship while it still carries Sea World's logos\/markings. The term of this agreement was to expire on December 31, 1994. However, the Company exercised its right under the contract to voluntarily suspend operations of the airship in April 1994.\nAnheuser-Busch\/Bud One - In March 1992, the Company entered into an agreement similar to the above with Anheuser-Busch for the use of the Bud One airship. Pursuant to this agreement, the Company agreed to convert the Bud One airship (then being used as a passenger airship) into an airship operated to promote the goods and products of Anheuser-Busch. The agreement provides for an initial term of six months with renewals for additional terms totaling three years. Anheuser-Busch may terminate the agreement during the first or at the end of the second annual period by giving proper notice to the Company (see Note L). The Company had operated this airship to advertise and promote the Sea World theme park from September l991 to March 1992 under a prior agreement with Anheuser-Busch which enabled the Company to operate sightseeing tours for passengers on a fee basis at Kissimmee Airport.\nPursuant to an amendment dated March 4, 1994, monthly fees under the Bud One agreement were reduced by 50% effective February 1994 through July 1994 and the term of the contract ended in August 1994. The Bud One contract was amended in July 1994 and provided for operations at the full price from August 1994 through December 1996. However, during December 1995, it was determined that the envelope was in need of replacement. Therefore, the Company removed the airship from service.\nAirship International Ltd.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION -Continued\nCatamount Petroleum CorPoration\/Gulf Oil - In May 1993, the Company entered into an agreement with Catamount Petroleum Corporation for the use of the Gulf airship. The initial term of the agreement is for three years. Notwithstanding this term, the agreement may be terminated by either party upon proper written notice. During 1993, the airship was in operation from July through October upon which, at the request of Catamount, the agreement was suspended through April 1994 when the airship resumed operations through October 1994.\nThe Company is responsible for all costs associated with the operation of the Gulf airship, including repairs, maintenance, insurance and taxes.\nMastellone Hno's S.A. - On December 15, 1994, the Company and its wholly-owned subsidiary Airship Operations, Inc. consummated an Aircraft Lease Agreement (the \"Argentina Lease Agreement\") and an Airship Operations Agreement (the \"Argentina Operations Agreement\"), respectively, with Mastellone Hnos, S. A. (\"Mastellone\") for the promotion of the products of Mastellone (the \"Argentina Airship\"). The Company received a deposit from Mastellone in the amount of $500,000. The operations for the Argentina Airship were never commenced.\nOn May 24, 1995, prior to commencement of operations of the Argentina Airship and pursuant to an Aircraft Purchase and Lease Assignment and Assumption between the Company and First Security Bank of Utah, as trustee for the benefit of Aviation Support Group, Ltd. (\"Aviation\"), the Argentina Airship was sold and the Argentina Lease Agreement was assigned to First Security. In consideration for such sale and assignment, First Security assumed the Company's obligations under the Argentina Lease Agreement. The Company is entitled to receive, during a ten-month renewal term provided for in the Argentina Lease and Argentina Operations Agreements, a portion of the rental income generated should Mastellone exercise its right to extend the terms of such agreement.\nIn addition, by notifying First Security prior to December 15, 1995 (extended to January 15, 1996), the Company had the right to repurchase the airship for 120% of the out-of-pocket expenses and the assumption of all liabilities incurred by First Security and Aviation in connection with the Argentina Airship. The Company did not exercise the right to repurchase the airship.\nConcurrently with the execution and delivery of the Purchase and Assumption Agreement, the Company sold to Aviation all of the issued and outstanding shares of the capital stock of Airship Operations, Inc. Mr. Benscher, who holds indirectly through designees approximately 4% of the Company's common stock, is a principal stockholder of Aviation. See Note C - Transactions With Stockholders, Related Parties And Others.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE J - EMPLOYEE SAVINGS PLAN\nThe Company has an employee savings plan (the \"Savings Plan\") that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, participating employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit of 15% of the employees salary. The Company matches 25% of each employees contributions for 1993 and 5% for 1995 and 1994, depending on length of service, up to a maximum of 6% of the employee's earnings. The Company's matching contributions to the Savings Plan was $1,948, $11,000 and $25,000 for 1995 and 1994 and 1993, respectively.\nNOTE K - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nNOTE L - SUBSEQUENT EVENTS On December 24, 1996, Transcontinental Leasing, Inc. obtained a loan with Norwest Equipment Finance, Inc. in the amount of $4,709,000. The proceeds of this refinancing were used to repay the Company's debt to Senstar and to provide working capital to the Company. This financing did not close until January 1997.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOLINTANTS ON SCHEDULES\nBoard of Directors and Stockholders Airship International Ltd.\nIn connection with our audit of the financial statements of Airship International Ltd. referred to in our report dated August 22, 1997 (that contains an explanatory paragraph pertaining to a going concern and other uncertainties), which is included in the Annual Report on SEC Form 10-K for the year ended December 31, 1995 and 1994, we have also audited Schedules II, IV, V, VI, and IX for the year ended December 31, 1995 and 1994. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.\nCHARLIE M. MEEKS, C.P.A, P.A.\nMaitland, Florida September 5, 1997\nAIRSHIP INTERNATIONAL LTD.\nSCHEDULE II\nAMOUNTS RECEIVABLE FROM RELATED PARTIES\n* Includes $164,000 and $107,000 of interest income earned on advances for the years ended December 31, 1994 and 1993, respectively.\nAIRSHIP INTERNATIONAL LTD. SCHEDULE IV INDEBTEDNESS TO RELATED PARTIES\n(1) Includes amortization of debt discount of $5,000 per year. (2) Includes reduction for the loan paid to an individual which was treated as a reduction of the balance outstanding (See Note C).\nAirship International Ltd.\nSCHEDULE V\nAIRSHIPS AND RELATED EQUIPMENT\nAirship International Ltd.\nSCHEDULE VI\nACCUMULATED DEPRECIATION AND AMORTIZATION OF AIRSHIPS AND RELATED EQUIPMENT\nAirship International Ltd.\nSCHEDULE IX\nSHORT-TERM BORROWINGS\nSTATEMENT OF DIFFERENCES The trademark symbol shall be expressed as................'tm'","section_15":""}
{"filename":"28630_1995.txt","cik":"28630","year":"1995","section_1":"Item 1. Business\nGeneral\nDiagnostic\/Retrieval Systems, Inc. (the \"Company\" or \"DRS\") was incorporated in Delaware in 1968. The operating units of the Company conduct their business in both military and commercial markets; however, revenues are derived principally from contracts or subcontracts with domestic and foreign government agencies of which a significant portion is attributed to U.S. Navy (\"Navy\") procurements. The Company's principal products and services fall within five broad categories: signal processors and display systems, trainer and simulation systems, data storage and playback systems, optics and manufacturing and technical services. Products within these categories include advanced integrated display workstations, sonar trainer systems, simulators, data recording playback systems and aircraft boresight systems. Manufacturing and technical services are provided in both military and commercial environments and encompass a wide range of activities that include field service support for the Navy fleet, refurbishment of video recording products and the manufacture of complex cable and harness assemblies and consumable magnetic head products.\nThe Company's growth over the years has been enhanced through the technological development of its products and services, and, since 1984, by the acquisition of several companies. In May 1984, DRS made its first acquisition with the purchase of Precision Echo, Inc. (\"Precision Echo\"), a company located in Santa Clara, California, engaged in the design and manufacture of magnetic recording devices, including those used in antisubmarine warfare. In August 1988, the Company acquired Photronics Corp. (\"Photronics\"), located in Hauppauge, New York, a company principally engaged in the design and manufacture of optical components, assemblies and optical systems used in the targeting and fire-control instrumentation of a variety of advanced military weapons. During fiscal 1994, the Company added three new operations. In October 1993, the Company acquired Technology Applications & Service Company (\"TAS\"), located in Gaithersburg, Maryland. TAS applies state-of-the-art technology to produce inexpensive displays and computer peripheral emulators that can replace more expensive militarized display consoles and computer peripherals used by the military. TAS also produces simulators, stimulators and training products used primarily for testing and training at military land-based sites. The acquisition of TAS provides an enhancement to the Company's display and trainer systems product lines as well as broadens the Company's scope of technical services. In December 1993, through its subsidiary DRS Systems Management Corporation, the Company formed a partnership called Laurel Technologies (\"Laurel\") in which it has an 80% controlling interest. The partnership operates from a manufacturing facility in Johnstown, Pennsylvania and provides manufacturing services to a variety of customers including the Company's other operating units. Also in December 1993, DRS acquired certain assets of CMC Technology (\"CMC\"), located in Santa Clara, California, providing the Company with a customer base in the commercial video recording systems industry and an opportunity to diversify from its traditional military and industrial markets. The Company's commercial business base was further expanded in November 1994, with the acquisition of the net assets of Ahead Technology Corporation (\"Ahead\") located in Los Gatos, California. Ahead designs and manufactures a variety of consumable magnetic head products used in the production of computer disk drives.\nProducts\nSignal Processors and Display Systems\nThe Company's signal processor and display business has its roots in the area of underwater surveillance with products which were designed initially for the Navy's antisubmarine warfare (\"ASW\") program. Detection of subsurface targets is an extremely difficult technical task due to a variety of factors, which include wide variations in salinity, temperature, the generally unknown contour of the subsurface floor, and, in the case of submarines, their ability to operate quietly and take evasive actions to avoid detection.\nIn 1972, the Company pioneered passive sonar detection with its AN\/SQS-54 Spectrum Analyzer Set. This system was deployed on Navy surface combatants and was utilized to detect submarines. The Company then developed the AN\/SQR-17, the AN\/SQR-17A Sonar Signal Processor systems and the signal processor and\ndisplay generator of the AN\/SQR-18A Tactical Towed Array Sonar System, which totally integrated submarine detection, classification, display and recording capabilities by processing information from the most advanced helicopter-deployed and ship-launched sonobuoys, as well as passive sonar data from hull-mounted and towed array sonars. These systems remain a vital part of the Navy's core, reserve and international program capabilities. Using this technology, the Company produced AN\/SQR-17A(V)3 processors for Mobile In-shore Undersea Warfare (\"MIUW\") systems. The current MIUW systems are electronically equipped vans, which utilize standard issue deployable sonobuoys or anchored passive sonobuoys to conduct underwater surveillance for harbor defense, coastal defense and amphibious-operation surveillance. MIUW also is used to enhance drug interdiction and underwater sonar systems. The system includes radars, radar intercept systems, thermal and visual imaging systems and underwater sonar systems. The Company also provides AN\/SQR-17A(V)3 system upgrade units for sonar processing and display for the next generation MIUW system, the MIUW-SU (system upgrade). The AN\/SQR-17A(V)3 upgrade system, the seventh generation in the product line, provides improved underwater surveillance capabilities in detection, classification, localization and neutralization of military and paramilitary threats. This is an integrated system which, along with sonobuoys, utilizes retrievable, bottom-mounted acoustic arrays and omni-hydrophone barrier strings as the primary underwater sensors. The Company, through a subcontract with a sensor manufacturer, is responsible for designing and delivery of the underwater sensor for this program. The Company currently is planning delivery of an AN\/SQR-17A(V)3-SU for the new MIUW-SU vans in August 1995 and expects to produce an additional 22 systems.\nBacked by years of experience in display technology, DRS provides high-resolution display processing systems. Data are presented in enhanced formats, incorporating alphanumerics and graphics with human-factor considerations to aid military personnel in target analysis and tactical coordination. The Company, under contract with the Navy, has developed AN\/UYQ-65 Data Processing and Display Sets. These systems are high-resolution, dual-monitor, color raster display workstations. When deployed on Navy ships, they will support both tactical graphics and acoustic sensor display formats and have been designed to replace the tactical and acoustic sensor displays in the AN\/SQQ-89 Combat System. The AN\/UYQ-65 is a Commercial-Off-The-Shelf (\"COTS\")-based workstation that is compliant with the stringent environmental requirements specified for sheltered shipboard systems used on U.S. Navy vessels such as the DDG-51 Aegis ships. With the delivery and acceptance of three engineering development models in April 1995, the Company has transitioned to the production phase of the program. It is expected that up to 148 production units may be manufactured under this contract.\nThe Company, through its teammate, the Government Systems Group of Unisys Corporation, now called Loral Corporation Defense Systems-Eagan, was awarded a contract to provide a next-generation tactical workstation-the AN\/UYQ-70 Advanced Display System (\"ADS\"). The Company has developed significant portions of hardware and software for these workstations utilizing commercial and Navy standards and has delivered the first prototypes. The open-system architecture design of both the ADS and the AN\/UYQ-65 systems provide built-in growth capabilities for future upgrades and incorporate the latest in commercial processing, graphics, networking and data storage technologies.\nWith the acquisition of TAS, DRS expanded into the Military Display Emulator (\"MDE\") market. TAS applies commercial technology to design, develop and produce MDEs, which are low-cost, microprocessor-based information processing and display workstations that emulate existing military display consoles and computer peripherals. The Company produces a product line that provides plug-compatible emulation of Navy display equipment at a fraction of the military equipment cost. The MDE product line includes commercial grade equivalents of fully militarized tactical and acoustic display equipment, video signal simulator and communication systems. Many fully militarized units have been emulated with MDE products. Applications for emulation products include software development, software maintenance, system test and integration and operator training. Emulators support cost-effective replacement of land-based military display equipment without sacrificing operational requirements. Cost savings on these systems are typically 75% of their military equivalents.\nUnder contract with the Navy, the Company has produced display emulators and central data buffers for the Navy's Aegis program. The Company received a multiple year contract to produce complete units and\/or components of display emulators for various training facilities.\nUsing the MDE concept, the Company, under contract with the Navy, was engaged to demonstrate the feasibility of using MDE equipment in a shipboard environment. The study included a determination of the applicability of replacing fully militarized equipment with ruggedized COTS equipment, as well as the design, development and production of displays for shipboard applications. Three units were delivered in February 1994 and delivery of the remaining eight units and final software development were completed during fiscal 1995.\nRevenues during fiscal 1995, 1994 and 1993 for the Company's signal processors and display systems totalled $20,300,000, $22,800,000 and $17,300,000, respectively.\nTrainers and Simulation Systems\nFor many years, DRS has emphasized the need for \"on-board\" training to maintain operator proficiency. The Company's ASW acoustic stimulator systems were developed to train new military personnel as well as to maintain the highly perishable skills of veteran sensor operators. Through technological upgrades, these systems have been adapted for new sensors and a variety of training requirements.\nThe Company's AN\/SQQ-T1 On-Board Trainer (\"OBT\") is an acoustic trainer designed and built for the AN\/SQR-17A and AN\/SQR-18A systems, and has been used on Navy FF-1052 frigates. The OBT, a high-fidelity, modular, acoustic stimulator, is used to sharpen the skills of sonar operators through target identification, analysis and classification. It generates simulated high-fidelity acoustic signals closely resembling those of actual targets under various environmental conditions. As a result of the decommissioning of the FF-1052 frigates, DRS is currently under contract with the Navy to upgrade the three existing OBT units and deliver three additional units. These six units will be portable and will be used at 20 different MIUW van sites around the United States. The newly configured OBT, designated the AN\/SQQ-T1A, will be used for training in existing MIUW vans. The AN\/SQQ-T1A will furnish training for acoustic sensor operators and radar operators by providing simulated inputs to the AN\/SQR-17A and SPS-64, both part of the MIUW van's sensor signal processing equipment.\nAs part of the MIUW-SU program, the Company is providing an embedded readiness trainer system for the van. This system provides acoustic proficiency training, Graphical Data Fusion System proficiency training and overall coordinated team training for the operators and supervisors assigned to operate the new MIUW-SU surveillance vans.\nUnder a contract award received during fiscal 1994 from the Oceanic Division of Westinghouse Electric Company (\"Westinghouse\"), DRS has developed and delivered three Sonar Image Display Simulators (\"SIDS\"). SIDS is a major subsystem of the AN\/AQS-14 Mod 2 Side Looking Sonar (\"SLS\") Trainer. Using a COTS-oriented workstation approach, the high-fidelity software-based display simulator produces realistic, ready-to-display images of typical SLS returns. The SIDS workstation software generates various background textures, bottom features and objects of interest along a search plan as specified by a mission scenario. Integrated as part of the ground-based AN\/AQS-14 trainer system, the sonar image display simulators will be utilized to train operators in preparation for critical mine hunting missions.\nRevenues from the Company's trainers and simulation systems during fiscal 1995, 1994 and 1993 amounted to $8,400,000, $4,700,000 and $2,600,000, respectively.\nData Storage and Playback Systems\nThe positive feedback of multi-source, time-correlated mission data has become essential to crew operational effectiveness and training. Using magnetic tape recording systems with multiple signal acquisition interfaces, the crew can capture the mission context for verification of target contacts and validation of tactics employment. Using the mission tape during post-mission analysis and reconstruction, the crew can improve tactics and target acquisition\/recognition.\nDRS provides a variety of military and security-related recording products. A substantial portion of the military recorders has been related to the Navy's ASW program. The Company's ASW recording products are utilized in ships, aircraft and helicopters and, in some instances, incorporated with its other ASW products. These recorders are used to store processed data gathered during ASW missions. The recorders are more rugged in construction than those used commercially and are suited for application in environments where vibration, temperature or contamination are potential problems.\nThe Company's AN\/AQH-4A(V)2 recorders\/reproducers are used for ASW information gathering on board patrol aircraft, such as the Navy's P-3C. These recorder\/reproducer systems record data transmitted from sonobuoys regarding the location of submerged vessels. DRS also produces digital annotation kits, which consist of board sets that enhance post-mission analysis when installed in the AN\/AQH-4A(V)2 recorders. The Company is under contract to install digital annotation kits into U.S. Government-owned recorders.\nA variant of the AN\/AQH-4A(V)2 recorder\/reproducer system records side looking sonar data on board the MH-53E mine hunting helicopter. The Westinghouse AN\/AQS-14 mine detection system is used to detect mines in critical areas on the ocean floor, such as ship transit lanes and harbors. Under contract to Westinghouse, the Company is developing a digital cassette recorder, the AN\/AQH-12, as a follow-on to the current analog recorder. The new digital recorder, using a low-cost, half-inch tape format to record digitized sensor data, will replace the existing reel-to-reel machine in the mine hunting mission and also will be capable of reproducing the data. The basic design will have many general-purpose instrumentation applications where severe environments are encountered.\nThe Company produces the AN\/AQH-9 analog mission tape recording systems and the follow-on AN\/AQH-11 digital mission recorders. These two systems were developed with the weight and volume constraints of ASW helicopters in mind. Both systems utilize low-cost, VHS style half-inch tape cassettes. The digital technology used in the AN\/AQH-11 has improved throughput capacity up to five times that of the AN\/AQH-9. The AN\/AQH-9 system is employed on the Navy's SH-60F ASW helicopter and the Republic of China Navy's S-70(C)M helicopter. The AN\/AQH-11 system is used on the U.S. Navy's SH-2G helicopter.\nThe Company produces the AN\/GSH-65 mission data playback system to reconstruct mission tapes from both the AN\/AQH-9 and AN\/AQH-11 mission recorders. The AN\/GSH-65 has been configured to accept tapes from both airborne systems in one common ground replay system. The AN\/GSH-65 is a transportable and environmentally protected system for use in severe shipboard environments. The AN\/GSH-65 is now being deployed to operational squadrons and ships.\nUnder contract with the Naval Air Systems Command, DRS has developed the AN\/USH-42 Mission Recorder\/Reproducer System (\"MR\/RS\"). The AN\/USH-42 MR\/RS is a military-specification quality, multiple input data recorder using a half-inch, VHS style high-performance tape cassette. The AN\/USH-42 has completed flight testing on a Navy A-6E aircraft at the Naval Air Test Center at Patuxent River. The AN\/USH-42 can record multiple sensor video channels with full motion frame rates plus digital data and voice. The AN\/USH-42 incorporates many user enhancements, such as in-flight replay and freeze frame, and contains embedded digital video scan converters to record radar signals in VHS format.\nThe AN\/USH-42 architecture has been selected by the Naval Air Systems Command to replace wet film recording in the S-3B Viking carrier-based aircraft. The AN\/USH-42 embedded video scan converters will be used to transform the non-standard video formats in the S-3B weapons system into standard television format for rapid replay and radar and infrared dissemination. Several developmental options of the AN\/USH-42 architecture are being evaluated for product improvement upgrades.\nFor single-channel raster video recording applications, the Company sells the WRR-812 and WRR-818 8mm video cassette recorders. Both of these recorders employ the high band, color video format which yields 400-line horizontal resolution performance. The 8 mm recorders are used where environmental conditions are severe. Currently, these recorders are being installed onto the Canadian Light Armored Vehicle, the U.S. Army OH-58D Kiowa Warrier Scout helicopter and the U.S. Navy's F\/A-18 Hornet carrier-based aircraft. Both recorders feature high-performance recording, a flexible control interface and low weight for video recording applications in harsh environments.\nThe 8 mm video recording product line is being expanded to include a triple deck video recorder carrying the model designation WRR-833. The same high-performance video recording capability found in the single-channel models is available in a multiple-deck unit. Additionally, a system multiplexer has been designed which can digitally merge multiple video, analog and digital data streams onto one 8 mm tape cassette. With the flexibility of the new multiplex design, recording problems that previously could only be solved by multiple, asynchronous recorders can now be handled by a single recording system.\nRevenues from the Company's data storage and playback systems comprised $14,800,000, $15,900,000 and $18,200,000 of total revenues in fiscal 1995, 1994 and 1993, respectively.\nOptics\nThe Company's optical products include boresighting systems and missile components. Through the generic boresight technology developed by the Company, named Multiple Platform Boresight Equipment (\"MPBE\"), DRS produces boresight systems that are adaptable to multiple military platforms, including fixed-wing and rotary-wing aircraft, as well as armored vehicles. This equipment features the Triaxial Measurement System, which is a single beam instrument that simultaneously measures azimuth, elevation and roll. Through the use of airframe-specific mounting adapters, the MPBE can be tailored for boresighting virtually any aircraft's, naval vessel's and ground vehicle's navigation, sensor and weapons systems. By using an off-the-shelf configuration, these products have been designed to address the military's emphasis on cost-effective, expediently produced products that are more readily upgradable to accommodate future technology and military budget objectives.\nThe Company has designed and developed boresight support equipment for the U.S. Army's AH-64A Apache Helicopter--the Captive Boresight Harmonization Kit (\"CBHK\"). CBHK is a portable, ground-support system that aligns the aircraft's navigation, targeting and weapons systems with the pilot's optical gear to assure optimum accuracy in target acquisition.\nThe Company is currently under contract to produce 33 Rapid Armament Boresighting Systems (\"RABS\") for the Marine Corps' AH-1W Cobra helicopter. Similar in scope to the CBHK, RABS provides the ability to harmonize and align the Cobra's weapons, targeting and navigation systems to insure increased accuracy. The Company is also under contract to produce eight units for a boresighting system for Cobra helicopters used by Taiwan, Republic of China.\nSince the early 1970s, DRS has manufactured optical components utilized in the guidance systems of various heat seeking missiles, including the FIM-92 Stinger (\"Stinger\"), AIM-9 Sidewinder and the RIM-166 RAM missile systems. These missile optics are used to focus incoming infrared energy onto the missile's electronic detector, allowing it to accurately track and destroy its target. The Stinger is a man-portable, infrared homing missile designed to provide air defense coverage. DRS is the manufacturer of the primary assemblies for this missile and has produced over thirty thousand mirrors in support of the Stinger program. The Stinger currently is being produced in the United States and Germany. The AIM-9 Sidewinder is a short-range air-to-air missile in service in at least forty nations. DRS has been producing mirror assemblies in support of the AIM-9 program since 1965.\nThe Company also has been active in the development of mirror assemblies for the next generation of missile systems. These advanced new missile systems include the Brilliant Anti-Tank program, the AIM-9X advanced missile and the THAAD missile program.\nDRS also manufactures optical components and assemblies using specialized techniques, such as diamond turning and electron beam deposition coating. These components are utilized on such defense systems as the Avenger sighting system, the Nite-Hawk targeting system and the TOW\/Cobra weapon system.\nRevenues for the Company's optics products were $12,600,000, $10,100,000 and $8,800,000 during fiscal 1995, 1994 and 1993, respectively.\nManufacturing and Technical Services\nThrough a partnership formed during fiscal 1994 with Laurel Technologies, Inc., the Company has established a manufacturing facility in Johnstown, Pennsylvania to provide high-quality, cost-effective manufacturing services for military and industrial products. These services include manufacturing, integration and testing of military-quality electronic assemblies, complex cables and harnesses and circuit card assemblies. Laurel provides these services to aerospace and industrial companies, as well as to other operating units within the Company.\nDRS also provides a variety of technical services for its own products, as well as those manufactured by other companies. The Company maintains field service operations at locations near the principal Navy shipyards in Norfolk, Virginia and San Diego, California, which provide support services to the Navy and, to a lesser extent, commercial ship repair companies. The scope of technical services includes equipment installation, field changes, configuration audit, repair, testing and integrated logistics support and maintenance of combat system test procedures. The Company also engages in technical service support to foreign governments.\nWith the decommissioning of the FF-1052 class frigates, the Navy has started a program of leasing these ships to foreign navies, including the Republic of China, Egypt, Turkey and Greece. In support of this leasing program, DRS has been tasked to provide AN\/SQR-17A system grooms and repairs, as well as training for foreign military personnel in the maintenance of this equipment. The Company expects to continue to be involved in the Navy's support plan to provide spare parts and repair services to these foreign navies.\nThrough its acquisition of certain assets of CMC in fiscal 1994, and the more recent acquisition of the net assets of Ahead in fiscal 1995, the Company has taken steps toward diversifying beyond its traditional military and industrial product base by exploring opportunities in technologically-related commercial business areas. Through CMC, the Company refurbishes and rebuilds magnetic video recording rotary-head scanner assemblies for post-production facilities and television broadcast stations around the world and also provides upper drum refurbishment services for broadcast-quality video recording products. Through Ahead, the Company designs and manufactures a variety of consumable magnetic head products used in the production of computer disk drives. These include burnishing heads, glide heads and speciality test heads. As a result of these acquisitions, the Company's customer base has been expanded to include customers in the commercial video recording systems industry and several prominent manufacturers of computer disk drives.\nRevenues for manufacturing and technical services, as adjusted to eliminate intercompany transactions, were $13,800,000, $4,300,000 and $900,000 in fiscal 1995, 1994 and 1993, respectively.\nCustomers\nA significant portion of the Company's products are sold to agencies of the U.S. Government, primarily the Department of Defense, to foreign government agencies or to prime contractors or subcontractors thereof. Approximately 84%, 94% and 83% of total consolidated revenues for fiscal 1995, 1994 and 1993, respectively, were derived directly or indirectly from defense contracts for end use by the U.S. Government and its agencies.\nFor information concerning sales to foreign governments, see \"Export Sales\" below.\nBacklog\nThe following table sets forth the Company's backlog by major product group (including enhancements, modifications and related logistics support) at the dates indicated:\nMarch 31, March 31, March 31, 1995 1994 1993 --------- --------- --------- Government Products:\nU.S. Government ....... $115,200,000 $123,700,000 $123,900,000\nForeign Government .... 8,600,000 5,800,000 1,000,000 ------------ ------------ ------------ 123,800,000 129,500,000 124,900,000\nCommercial Products ... 2,200,000 5,100,000 1,200,000 ------------ ------------ ------------ $126,000,000 $134,600,000 $126,100,000 ============ ============ ============\n\"Backlog\" refers to the aggregate revenues remaining to be earned at the specified date under contracts held by the Company, including, for U.S. Government contracts, the extent of the funded amounts thereunder which have been appropriated by Congress and allotted to the contract by the procuring Government agency. Fluctuations in backlog amounts relate principally to the timing and amount of Government contract awards.\nApproximately 54% of the backlog at March 31, 1995 is expected to result in revenues during the fiscal year ending March 31, 1996.\nResearch and Development\nThe Company's technological expertise has been an important factor in its growth. A portion of its research and development activities has taken place in connection with customer-sponsored research and development contracts. All such customer-sponsored activities are the result of contracts directly or indirectly with the U.S. Government. The Company also invests in Company-sponsored research and development.\nRevenues recorded by the Company for customer-sponsored research and development and expenditures for Company-sponsored research and development are as follows during the fiscal years indicated:\nRevenues Expenditures -------- ------------ Fiscal Year Ended:\nMarch 31, 1995 ................. $18,800,000 $800,000\nMarch 31, 1994 ................. $27,500,000 $500,000\nMarch 31, 1993 ................. $19,200,000 $500,000\nThe military electronics industry is subject to rapid technological changes and the Company's future success will depend in large part upon its ability to improve existing product lines and to develop new products and technologies in the same or related fields.\nContracts\nThe Company's contracts are normally for production, service or development. Production and service contracts are typically of the fixed-price variety with development contracts currently of the cost-type variety. Because of their inherent uncertainties and consequent cost overruns, development contracts historically have been less profitable than production contracts.\nFixed-price contracts may provide for a firm-fixed price or they may be fixed-price-incentive contracts. Under the firm-fixed-price contracts, the Company agrees to perform for an agreed-upon price and, accordingly, derives benefits from cost savings, but bears the entire risk of cost overruns. Under the fixed-price-incentive contracts, if actual costs incurred in the performance of the contracts are less than estimated costs for the contracts, the savings are apportioned between the customer and the Company. However, if actual costs under such a contract exceed estimated costs, excess costs are apportioned between the customer and the Company up to a ceiling. The Company bears all costs that exceed the ceiling.\nCost-type contracts typically provide for reimbursement of allowable costs incurred plus a fee (profit). Unlike fixed-price contracts in which the Company is committed to deliver without regard to performance cost, cost-type contracts normally obligate the Company to use its best efforts to accomplish the scope of work within a specified time and a stated contract dollar limitation. In addition, Government procurement regulations mandate lower profits for cost-type contracts because of the Company's reduced risk. Under cost-plus-incentive-fee contracts, the incentive may be based on cost or performance. When the incentive is based on cost, the contract specifies that the Company is reimbursed for allowable incurred costs plus a fee adjusted by a formula based on the ratio of total allowable costs to target cost. Target cost, target fee, minimum and maximum fee and adjustment formula are agreed upon when the contract is negotiated. In the case of performance-based incentives, the Company is reimbursed for allowable incurred costs plus an incentive, contingent upon meeting or surpassing stated performance targets. The contract provides for increases in the fee to the extent that such targets are surpassed and for decreases to the extent that such targets are not met. In some instances, incentive contracts also may include a combination of both cost and performance incentives. Under cost-plus-\nfixed-fee contracts, the Company is reimbursed for costs and receives a fixed fee, which is negotiated and specified in the contract. Such fees have statutory limits.\nThe percentages of revenues during fiscal 1995, 1994 and 1993 attributable to the Company's contracts by contract type were as follows:\nYear Ended March 31, ------------------------ 1995 1994 1993 ---- ---- ----\nFirm-fixed-price ........... 74% 65% 88%\nFixed-price-incentive ...... -- 1% --\nCost-plus-incentive-fee .... 6% 17% 10%\nCost-plus-fixed-fee ........ 20% 17% 2%\nThe Company negotiates for and generally receives progress payments from its customers of between 80-100% of allowable costs incurred on the previously described contracts. Included in its reported revenues are certain amounts which the Company has not billed to customers. These amounts, approximately $7,900,000, $5,900,000 and $8,100,000 as of March 31, 1995, 1994 and 1993, respectively, consist of costs and related profits, if any, in excess of progress payments for contracts on which sales are recognized on a percentage-of-completion basis.\nUnder generally accepted accounting principles, all Government contract costs, including applicable general and administrative expenses, are charged to work-in-progress inventory and are written off to costs and expenses as revenues are recognized. The Federal Acquisition Regulations (\"FAR\"), incorporated by reference in Government contracts, provide that Company-sponsored research and development costs are allowable general and administrative expenses. To the extent that general and administrative expenses are included in inventory, research and development costs also are included. Unallowable costs, pursuant to the FAR, have been excluded from costs accumulated on Government contracts. General and administrative costs, which include Company-sponsored research and development costs, aggregating $6,600,000 and $3,800,000 at March 31, 1995 and 1994, respectively, are included in work-in-process inventory.\nAll domestic defense contracts and subcontracts to which the Company is a party are subject to audit, various profit and cost controls, and standard provisions for termination at the convenience of the customer. Multi-year Government contracts and related orders are subject to cancellation if funds for contract performance for any subsequent year become unavailable. In addition, if certain technical or other program requirements are not met in the developmental phases of the contract, then the follow-on production phase may not be realized. Upon termination other than for a contractor's default, the contractor normally is entitled to reimbursement for allowable costs, but not necessarily all costs, and to an allowance for the proportionate share of fees or earnings for the work completed. Foreign defense contracts generally contain comparable provisions relating to termination at the convenience of the foreign government.\nCompanies engaged primarily in supplying defense-related equipment to the Government are subject to certain business risks peculiar to the defense industry. These risks include the ability of the Government to unilaterally suspend the Company from receiving new contracts, pending resolution of alleged violations of procurement laws or regulations. In addition, all defense businesses are subject to risks associated with dependence on Government appropriations, changes in Government procurement policies, uncertain cost factors related to technologically scarce skills and exotic components, the frequent need to bid on programs in advance of design completion (which may result in unforeseen technological difficulties and\/or cost overruns), substantial time and effort required for relatively unproductive design and development, design complexity and rapid obsolescence, and the constant necessity for design improvement.\nGovernment expenditures for defense products are likely to be flat or reduced during the 1990s. These reductions may or may not have an effect on the Company's programs; however, in the event expenditures for products of the type manufactured by the Company are reduced and not offset by greater foreign sales, commercial sales or other new programs or products, there will be a reduction in the volume of contracts or subcontracts awarded to the Company. Unless offset, such reductions would have an adverse affect on the Company's earnings.\nMarketing\nThe Company's marketing activities are conducted by its own staff of marketing personnel and engineers. The Company's domestic marketing approach begins with the development of information concerning the present and future requirements of its current and potential customers for defense electronics, as well as those in the security and commercial communities serviced by the Company's products. Such information is gathered in the course of contract performance, research into the enhancement of existing systems and inquiries into advances being made in hardware and software development, and is then evaluated and exchanged among marketing, research and engineering groups within the Company to devise proposals responsive to the perceived needs of customers. The Company markets its products abroad through independent marketing representatives.\nCompetition\nThe Company's products are sold in markets containing a number of competitors which are substantially larger than the Company with greater financial resources. The extent of competition for any single project generally varies according to the complexity of the product and the dollar volume of the anticipated award. The Company believes that it competes on the basis of the performance of its products, its reputation for prompt and responsive contract performance, and its accumulated technical knowledge and expertise.\nPatents\nThe Company has patents on many of its recording and certain commercial products. The Company does not believe patent protection to be significant to its current operations; however, future programs may generate the need for patent protection.\nManufacturing and Suppliers\nThe Company's manufacturing process for its products, excluding optical products, consists primarily of the assembly of purchased components and testing of the product at various stages in the assembly process. Purchased components include integrated circuits, circuit boards, sheet metal fabricated into cabinets, resistors, capacitors, semiconductors and insulated wire and cables. In addition, many of the Company's products use machined castings and housings, motors and recording and reproducing heads. Many of the purchased components have been fabricated to Company designs and specifications. The manufacturing process for the Company's optics products includes the grinding, polishing and coating of various optical materials and the machining of metal components.\nAlthough materials and purchased components generally are available from a number of different suppliers, several suppliers are the Company's sole source of certain components. If a supplier should cease to deliver such components, other sources probably would be available; however, added cost and manufacturing delays might result. The Company has not experienced significant production delays attributable to supply shortages, but occasionally experiences procurement problems with respect to certain components, such as semiconductors and connectors. In addition, certain exotic materials, such as germanium, zinc sulfide and cobalt, may not always be readily available.\nThe Company believes that quality control and testing are essential for manufacturing reliable products. The Company's testing and quality control procedures for products manufactured pursuant to Government contracts follow military specifications and are designed to reduce the likelihood of product failure after delivery.\nExport Sales\nDRS currently sells several of its products and services in the international marketplace to countries such as Canada, Germany, Australia and the Republic of China. Foreign sales accounted for approximately 7%, 3% and 17% of the Company's revenues in fiscal 1995, 1994 and 1993, respectively. Foreign sales are derived under export licenses granted on a case-by-case basis by the United States Department of State. Foreign contracts at March 31, 1995 generally were payable in United States' dollars.\nExecutive Officers of the Registrant\nThe names of the executive officers of the Company, their positions and offices with the Company, and their ages are set forth below:\nNAME POSITIONS WITH THE COMPANY AGE - ---- -------------------------- ---\nLeonard Newman Chairman of the Board and Secretary of the Company 71\nMark S. Newman President, Chief Executive Officer and Director of 45 the Company\nNancy R. Pitek Controller and Treasurer of the Company 38\nPaul G. Casner, Jr. Vice President of the Company; President of DRS 57 Electronic Systems Group; President of Technology Applications & Service Company\nStuart F. Platt Vice President and Director of the Company; 61 President of Precision Echo, Inc.\nRichard Ross Vice President of the Company; President of 40 Photronics Corp.\nLeonard Newman has been a Director of the Company since 1968 and Chairman of the Board and Secretary of the Company since 1971. From 1971 until May 1994, Mr. Newman also served as the Company's Chief Executive Officer. Leonard Newman is the father of Mark S. Newman.\nMark S. Newman has been employed by the Company since 1973, was named Vice President, Finance, Chief Financial Officer and Treasurer in 1980 and Executive Vice President in 1987. Mr. Newman became a Director of the Company in 1988. In May 1994, Mr. Newman became the President and Chief Executive Officer of the Company. Mark Newman is the son of Leonard Newman.\nNancy R. Pitek joined the Company in 1984 as Manager of Accounting. She became Assistant Controller in 1985 and Director of Internal Audit in 1988. Ms. Pitek became Director of Corporate Finance in 1990 and has been the Controller since 1993. In May 1994, she also was appointed to the position of Treasurer.\nPaul G. Casner, Jr. joined the Company in 1993 as President of TAS. In 1994 he also became President of the DRS Electronic Systems Group and a Vice President of the Company. Mr. Casner has over 30 years of experience in the defense electronics industry and has held positions in engineering, marketing and general management. He was the president of TAS prior to its acquisition by the Company.\nStuart F. Platt has been a Director of the Company since 1991 and became the President of Precision Echo in July 1992. He was named Vice President of the Company in May 1994. Rear Admiral Platt was a co-founder and director of FPBSM Industries, Inc., a holding company and management consulting firm for defense, aerospace and other technology-based companies and the Chairman of Stuart Platt & Partners, a management consulting firm handling principally defense-related issues. He also serves as director for Harding Associates, Inc. None of these companies is a parent, subsidiary or affiliate of the Company. Rear Admiral Platt held various positions as a military officer in the Department of the Navy, retiring as Competition Advocate General of the Navy in 1986.\nRichard Ross was employed by the Company as Assistant Vice President and Director, Sales in 1986 and Assistant Vice President, Corporate Development in 1987. In 1988, he became Vice President of the Company, and in 1990, he became President of Photronics.\nEmployees\nAt March 31, 1995, the Company employed 565 employees. None of the Company's employees are represented by a labor union, and the Company has experienced no work stoppages.\nThere is a continuing demand for qualified technical personnel, and the Company believes that its future growth and success will depend upon its ability to attract, train and retain such personnel.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nDuring fiscal 1995, the Company leased administrative and engineering facilities in neighboring buildings at 16 Thornton Road (\"Thornton\") and 138 Bauer Drive (\"Bauer\"), Oakland, New Jersey. The Thornton and Bauer facilities contain approximately 45,000 and 25,000 square feet, respectively. Upon expiration of the Thornton lease in March 1995, the Company moved administrative and engineering personnel, excluding the corporate staff, from the Thornton building to the Bauer building. The Company leases the Bauer building from LDR Realty Co., a partnership wholly-owned by Leonard Newman and David E. Gross, the former President and Chief Technical Officer of the Company, under a lease which expires in fiscal 1999. The Company currently leases approximately 6,000 square feet of office space for its corporate headquarters in an office building at 5 Sylvan Way, Parsippany, New Jersey under a lease which expires in fiscal 2001.\nPrecision Echo's engineering and principal operations are located in a 55,000 square foot building at 3105 Patrick Henry Drive, Santa Clara, California, under a lease which expires in fiscal 1997. The operations of CMC and Ahead are conducted from leased facilities in Santa Clara, California and Los Gatos, California, respectively. These leased facilities, containing 71,000 square feet and 12,000 square feet, respectively, are covered by leases, which, with respect to the CMC facility, is on a month-to-month basis, and for the Ahead facility, expires in fiscal 1998.\nPhotronics' principal and manufacturing facilities are located in a 45,000 square foot building at 270 Motor Parkway, Hauppauge, New York. The building, which is owned by the Company, was built in 1983. See Note 6 of Notes to Consolidated Financial Statements.\nTAS leases 40,000 square feet in a building at 200 Professional Drive, Gaithersburg, Maryland that houses its executive offices and principal engineering and manufacturing facilities. It also conducts field service operations from locations in Virginia Beach and National City, California. These leased facilities, comprising 15,000 square feet and 6,000 square feet, respectively, are covered by leases, which, with respect to the Virginia location, expire in fiscal 1997, and for the California location, is on a month-to-month basis.\nLaurel's manufacturing facilities and administrative offices are located in a 29,000 square-foot building at 423 Walters Avenue in Johnstown, Pennsylvania. The lease for this facility expires in fiscal 1999.\nThe Company also leases approximately 2,000 square feet of office space in Arlington, Virginia under a lease which expires in fiscal 1998.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is a party to various legal actions and claims arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses for each of the actions and claims and believes that their ultimate disposition 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 a Vote of Security Holders\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended March 31, 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 with respect to the market prices for the Company's common equity securities is incorporated herein by reference to page 31 of the Diagnostic\/Retrieval Systems, Inc. 1995 Annual Report (for the fiscal year ended March 31, 1995).\nThe Company has not paid any cash dividends since 1976. The Company intends to retain future earnings for use in its business and does not expect to declare cash dividends in the foreseeable future. As of June 20, 1995, the Class A Common Stock and Class B Common Stock of the Company was held by 325 and 219 stockholders of record, respectively.\nIn July 1994, pursuant to a Stock Purchase Agreement (the \"Stock Purchase Agreement\") between the Company and David E. Gross, its former President and Chief Technical Officer, the Company purchased 659,220 shares of its Class A Common Stock and 45,179 shares of its Class B Common Stock owned by Mr. Gross, at a price of $4.125 and $4.00 per share, respectively, totaling approximately $2.9 million in cash (the \"Buy-back\"). On October 18, 1994, the Company filed a Registration Statement on Form S-2, and on November 10, 1994, the Company filed Amendment No. 1 to such Registration Statement (the \"Registration Statement\") with the Securities and Exchange Commission for the purpose of selling shares of its common stock purchased in the Buy-back. Pursuant to the Registration Statement, the Company sold 650,000 shares of its Class A Common Stock and 45,000 shares of its Class B Common Stock at prices of $4.125 and $4.00 per share, respectively, totaling approximately $2.9 million.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required by this item is incorporated herein by reference to page 13 of the Diagnostic\/Retrieval Systems, Inc. 1995 Annual Report (for the fiscal year ended March 31, 1995).\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 14 through 17 of the Diagnostic\/Retrieval Systems, Inc. 1995 Annual Report (for the fiscal year ended March 31, 1995).\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 18 through 31 of the Diagnostic\/Retrieval Systems, Inc. 1995 Annual Report (for fiscal year ended March 31, 1995). See Part IV Item 14 herein for additional information.\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 Part is incorporated herein by reference to the Definitive Proxy Statement of the Company, dated July 7, 1995, for the 1995 Annual Meeting of Stockholders. Reference also is made to the information under Executive Officers of the Registrant in Part I of this report.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements\nThe following financial statements of Diagnostic\/Retrieval Systems, Inc. and subsidiaries have been incorporated herein by reference to the Diagnostic\/Retrieval Systems, Inc. 1995 Annual Report (for the fiscal year ended March 31, 1995), pursuant to Item 8 of this report:\n1995 Annual Report Page(s) --------------\nIndependent Auditors' Report ....................... 31\nConsolidated Balance Sheets-- March 31, 1995 and 1994 ............................ 18\nConsolidated Statements of Earnings-- Years ended March 31, 1995, 1994 and 1993 .......... 19\nConsolidated Statements of Stockholders' Equity-- Years ended March 31, 1995, 1994 and 1993 .......... 19\nConsolidated Statements of Cash Flows-- Years ended March 31, 1995, 1994 and 1993 .......... 20\nNotes to Consolidated Financial Statements ......... 21-30\n2. Financial Statement Schedules See Appendix A hereto.\n3. Exhibits\nIncorporated by reference to the Exhibit Index at the end of this report.\n(b) Reports on Form 8-K\nThe Company did not file 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.\nDIAGNOSTIC\/RETRIEVAL SYSTEMS, INC.\nDated: June 28, 1995 \/s\/ MARK S. NEWMAN ------------------------------------- Mark S. Newman, 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\/ LEONARD NEWMAN Chairman of the Board, June 28, 1995 - ---------------------- Secretary and Director Leonard Newman\n\/s\/ MARK S. NEWMAN President, Chief Executive June 28, 1995 - ---------------------- Officer and Director Mark S. Newman\n\/s\/ NANCY R. PITEK Controller and Treasurer June 28, 1995 - ---------------------- Nancy R. Pitek\n\/s\/ STUART F. PLATT Vice President, President of June 28, 1995 - ---------------------- Precision Echo and Director Stuart F. Platt\n\/s\/ THEODORE COHN Director June 28, 1995 - ---------------------- Theodore Cohn\nDirector June , 1995 - ---------------------- Donald C. Fraser\n\/s\/ MARK N. KAPLAN Director June 28, 1995 - ---------------------- Mark N. Kaplan\n\/s\/ JACK RACHLEFF Director June 28, 1995 - ---------------------- Jack Rachleff\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDIAGNOSTIC\/RETRIEVAL SYSTEMS, INC.\nDated: June , 1995 ------------------------------------- Mark S. Newman, 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 - --------- ----- ----\nChairman of the Board, June , 1995 - ---------------------- Secretary and Director Leonard Newman\nPresident, Chief Executive June , 1995 - ---------------------- Officer and Director Mark S. Newman\nController and Treasurer June , 1995 - ---------------------- Nancy R. Pitek\nVice President, President of June , 1995 - ---------------------- Precision Echo and Director Stuart F. Platt\nDirector June , 1995 - ---------------------- Theodore Cohn\n\/s\/ DONALD C. FRASER Director June 28, 1995 - ---------------------- Donald C. Fraser\nDirector June , 1995 - ---------------------- Mark N. Kaplan\nDirector June , 1995 - ---------------------- Jack Rachleff\nAppendix A\nDIAGNOSTIC\/RETRIEVAL SYSTEMS, INC. AND SUBSIDIARIES INDEX\nIndependent Auditors' Report\nFinancial Statement Schedules\nSchedule II--Valuation and Qualifying Accounts\nAll other financial statement schedules have been omitted because they are not required, not applicable, or the required information is shown in the consolidated financial statements or notes thereto.\nIndependent Auditors' Report on Consolidated Financial Statement Schedule\nThe Board of Directors and Stockholders Diagnostic\/Retrieval Systems, Inc.:\nUnder date of May 18, 1995, we reported on the consolidated balance sheets of Diagnostic\/Retrieval Systems, Inc. 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 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 consolidated financial statement schedule as listed in the accompanying index. The 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, 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\/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP\nShort Hills, New Jersey May 18, 1995\n(a) Represents, on a full-year basis, net credits to reserve accounts.\n(b) Represents, on a full-year basis, net charges to reserve accounts.\n(c) Represents amounts reclassified.\n(d) Represents amounts credited to costs and expenses associated with the corresponding write-off of related inventory costs.\n(e) Includes $801,000 representing amounts credited to costs and expenses associated with the corresponding write-off of related inventory costs.\n(f) Includes $2,302,000 representing amounts credited to costs and expenses associated with the corresponding write-off of related inventory costs.\n(g) Includes an increase to reserves of $111,000 as a result of business combinations and a charge of $143,000 to revenues.\nEXHIBIT INDEX\nCertain of the following exhibits, designated with an asterisk (*), are filed herewith. Certain of the following exhibits, designated with a P, are being filed in paper, pursuant to a hardship exemption Rule 202 of Regulation S-T. The exhibits not so designated have been previously filed with the Commission and are incorporated herein by reference to the documents indicated in brackets following the descriptions of such exhibits.\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n3.1 - Restated Certificate of Incorporation of the Company [Registration Statement No. 2-70062-NY, Amendment No. 1, Exhibit 2(a)]\n3.2 - Certificate of Amendment of the Restated Certificate of Incorporation of the Company, as filed July 7, 1983 [Registration Statement on Form 8-A of the Company, dated July 13, 1983, Exhibit 2.2]\n3.3 - Composite copy of the Restated Certificate of Incorporation of the Company, as amended [Registration Statement No. 2-85238, Exhibit 3.3]\n*3.4 - By-laws of the Company, as amended to November 7, 1994\n*3.5 - Certificate of Amendment of the Certificate of Incorporation of Precision Echo Acquisition Corp., as filed March 10, 1995\n4.1 - Indenture, dated as of August 1, 1983, between the Company and Bankers Trust Company, as Trustee [Form 10-Q, quarter ended September 30, 1983, File No. 1-8533, Exhibit 4.2]\n4.2 - Indenture of Trust, dated December 1, 1991, among Suffolk County Industrial Development Agency, Manufacturers and Traders Trust Company, as Trustee and certain bondholders [Form 10-K, fiscal year ended March 31, 1992, File No. 1-8533, Exhibit 4.2]\n4.3 - Reimbursement Agreement, dated December 1, 1991, among Photronics Corp., the Company and Morgan Guaranty Trust Company of New York [Form 10-K, fiscal year ended March 31, 1992, File No. 1-8533, Exhibit 4.3]\n10.1 - Stock Purchase Agreement, dated as of August 6, 1993, among TAS Acquisition Corp., Technology Applications and Service Company, Paul G. Casner, Jr. and Terrence L. DeRosa [Form 10-Q, quarter ended December 31, 1993, File No. 1-8533, Exhibit 6(a)(1)]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n10.2 - Waiver Letter, dated as of September 30, 1993, among TAS Acquisition Corp., Technology Applications and Service Company, Paul G. Casner, Jr. and Terrence L. DeRosa [Form 10-Q, quarter ended December 31, 1993, File No. 1-8533, Exhibit 6(a)(2)]\n10.3 - Joint Venture Agreement, dated as of November 3, 1993, by and between DRS Systems Management Corporation and Laurel Technologies, Inc. [Form 10-Q, quarter ended December 31, 1993, File No. 1-8533, Exhibit 6(a)(3)]\n10.4 - Waiver Letter, dated as of December 13, 1993, by and between DRS Systems Management Corporation and Laurel Technologies, Inc. [Form 10-Q, quarter ended December 31, 1993, File No. 1-8533, Exhibit 6(a)(4)]\n10.5 - Partnership Agreement, dated December 13, 1993, by and between DRS Systems Management Corporation and Laurel Technologies, Inc. [Form 10-Q, quarter ended December 31, 1993, File No. 1-8533, Exhibit 6(a)(5)]\n10.6 - Lease, dated as of June 1, 1983, between LDR Realty Co. and the Company [Form 10-K, fiscal year ended March 31, 1984, File No. 1-8533, Exhibit 10.7]\n10.7 - Renegotiated Lease, dated June 1, 1988, between LDR Realty Co. and the Company [Form 10-K, fiscal year ended March 31, 1989, File No. 1-8533, Exhibit 10.8]\n10.8 - Lease, dated July 20, 1988, between Precision Echo, Inc. and Bay 511 Corporation [Form 10-K, fiscal year ended March 31, 1991, File No. 1-8533, Exhibit 10.9]\n10.9 - Amendment to Lease, dated July 1, 1993, between Precision Echo, Inc. and Bay 511 Corporation [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.12]\n10.10 - Lease Modification Agreement, dated February 22, 1994, between Technology Applications and Service Company and Atlantic Real Estate Partners II [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.13]\n*10.11 - Amendment to Lease Modification, dated June 1, 1994, between Technology Applications and Service Company and Atlantic Estate Partners II\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n10.12 - Triple Net Lease, dated October 22, 1991, between Technology Applications and Service Company and Marvin S. Friedberg [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.14]\n10.13 - Lease, dated May 21, 1991, between Technology Applications and Service Company and Collins Development Company [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.16]\n10.14 - Lease, dated November 10, 1993, between DRS Systems Management Corp. and Skateland Roller Rink, Inc. [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.17]\n*10.15 - Lease, dated March 23, 1992, between Ahead Technology Corporation and Vasona Business Park\nP10.16 - Amendment to Lease, dated May 21, 1992, between Ahead Technology Corporation and Vasona Business Park 1\nP10.17 - Revision to Lease Modification, dated August 25, 1992, between Ahead Technology Corporation and Vasona Business Park ........................................ 3\n*10.18 - Lease, dated January 13, 1995, between the Company and Sammis New Jersey Associates\n*10.19 - Memorandum of Understanding, dated March 23, 1995, between Laurel Technologies and West Virginia Air Center\n10.20 - 1991 Stock Option Plan of the Company [Registration Statement No. 33-42886, Exhibit 28.1]\n10.21 - Contract No. N00024-92-C-6102, dated September 28, 1992, between the Company and the Navy [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.45]\nP10.22 - Modification No. P00005, dated August 24, 1994, to Contract No. N00024-92-C-6102 ........................ 5\nP10.23 - Modification No. P00006, dated September 7, 1994, to Contract No. N00024-92-C-6102 ........................ 8\n10.24 - Contract No. N00024-92-C-6308, dated April 1, 1992, between the Company and the Navy [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.46]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n10.25 - Modification No. P00001, dated July 30, 1992, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.47]\n10.26 - Modification No. P00002, dated September 25, 1992, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.48]\n10.27 - Modification No. P00003, dated October 22, 1992, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.49]\n10.28 - Modification No. P00004, dated February 24, 1993, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.50]\n10.29 - Modification No. P00005, dated June 11, 1993, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.26]\n10.30 - Modification No. P00006, dated March 26, 1993, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.51]\n10.31 - Modification No. P00007, dated May 3, 1993, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.28]\n10.32 - Modification No. PZ0008, dated June 11, 1993, to Contract No. N00024-92-C-6308 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.29]\n10.33 - Contract No. N39998-94-C-2228, dated November 30, 1993, between the Company and the Navy [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.30]\n10.34 - Order No. 87KA-SG-51484, dated December 10, 1993, under Contract No. N00024-93-G-6336, between the Company and Westinghouse Electric Corporation Oceanic Division [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.31]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\nP10.35 - Purchase Order Change Notice Order No. 87KA-SX-51484-P, dated April 21, 1994, under Contract No. N00024-93-G-6336, between the Company and Westinghouse Electric Corporation Oceanic Division............................................. 10\n10.36 - Letter Subcontract No. 483901(L), dated February 18, 1994, under Contract No. N00024-94-D-5204, between the Company and Unisys Government Systems Group [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.32]\nP10.37 - Subcontract No. 483901(D), dated June 24, 1994, under Contract No. N00024-94-D-5204, between the Company and Unisys Corporation Government Systems Group................................................ 11\n10.38 - Contract No. N00019-89-G-0223-XR05, dated September 30, 1992, between Precision Echo and the Navy [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.53]\n10.39 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated March 3, 1994, between Precision Echo, Inc. and Westinghouse Electric Corporation [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.34]\nP10.40 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated April 5, 1994, between Precision Echo and Westinghouse Electric Corporation.................... 308\nP10.41 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated August 16, 1994, between Precision Echo and Westinghouse Electric Corporation.................... 309\nP10.42 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated September 13, 1994, between Precision Echo and Westinghouse Electric Corporation.................... 310\nP10.43 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated February 2, 1995, between Precision Echo and Westinghouse Electric Corporation.................... 311\nP10.44 - Purchase Order Change Notice Order No. 87KA-IX-58687, dated February 24, 1995, between Precision Echo and Westinghouse Electric Corporation..................... 312\n10.45 - Contract No. N00019-90-G-0051, dated March 1, 1990, between Precision Echo, Inc. and the Navy [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.35]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n10.46 - Amendment 1A, dated February 26, 1992, to Contract No. N00019-90-G-0051 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.36]\n10.47 - Amendment 1B, dated April 23, 1993, to Contract No. N00019-90-G-0051 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.37]\n10.48 - Contract No. N00019-93-C-0041, dated January 29, 1993, between Photronics Corp. and the Navy [Form 10-K, fiscal year ended March 31, 1993, File No. 1-8533, Exhibit 10.54]\n10.49 - Modification No. P00001, dated March 29, 1993, to Contract No. N00019-93-C-0041 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.39]\n10.50 - Modification No. PZ0002, dated November 12, 1993, to Contract No. N00019-93-C-0041 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.40]\n10.51 - Modification No. P00003, dated February 1, 1994, to Contract No. N00019-93-C-0041 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.41]\n10.52 - Contract No. N00019-93-C-0202, dated August 30, 1993, between Photronics Corp. and the Navy [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.42]\n10.53 - Modification No. P00001, dated March 30, 1994, to Contract No. N00019-93-C-0202 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.43]\n10.54 - Modification No. P00002, dated April 29, 1994, to Contract No. N00019-93-C-0202 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.44]\nP10.55 - Modification No. P00003, dated August 9, 1994, to Contract No. N00019-93-C-0202................... 313\nP10.56 - Modification No. P00004, dated March 30, 1994, to Contract No. N00019-93-C-0202................... 320\n10.57 - Contract No. DAAJ09-93-C-0684, dated September 28, 1993, between Photronics Corp. and the Army [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.45]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- --------------\n10.58 - Modification No. P00001, dated December 28, 1993, to Contract DAAJ09-93-C-0684 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.46]\n10.59 - Modification No. P00002, dated March 21, 1994, to Contract No. DAAJ09-93-C-0684[Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.47]\n10.60 - Modification No. P00003, dated March 23, 1994, to Contract No. DAAJ09-93-C-0684 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.48]\n10.61 - Purchase Order No. 2228, dated September 29, 1993, between Photronics Corporation and International Precision Products N.V. [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.49]\n10.62 - Amendment No. 1, dated December 30, 1993, to Purchase Order No. 2228 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.50]\n10.63 - Amendment No. 2, dated March 17, 1994, to Purchase Order No. 2228 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.51]\nP10.64 - Amendment No. 3, dated June 6, 1994, to Purchase Order No. 2228........................... 323\n10.65 - Contract No. N00024-93-C-5204, dated November 18, 1992, between Technology Applications and Service Company and the Navy [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.53]\n10.66 - Modification No. P00001, dated May 6, 1993, to Contract No. N00024-93-C-5204 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.54]\n10.67 - Modification No. P00002, dated August 24, 1993, to Contract No. N00024-93-C-5204 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.55]\n10.68 - Modification No. PZ0003, dated September 30, 1993, to Contract No. N00024-93-C-5204 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.56]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- ---------------\n10.69 - Contract No. N00174-94-D-0006, dated February 17, 1994, between Technology Applications & Service Company and the Navy [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.57]\n10.70 - Modification No. P00001, dated March 7, 1994, to Contract No. N00174-94-D-0006 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.58]\n10.71 - Modification No. P00003, dated May 19, 1994, to Contract No. N00174-94-D-0006 [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.59]\n10.72 - Purchase Order No. N538010, dated March 28, 1994, between Laurel Technologies, Inc. and Short Brothers PLC [Form 10-K, fiscal year ended March 31, 1994, File No. 1-8533, Exhibit 10.60]\nP10.73 - Purchase Order No. 2285, dated June 6, 1994, between Photronics Corporation and International Precision Products N.V. .......... 324\nP10.74 - Amendment No. 1, dated December 1, 1994, to Purchase Order No. 2285......................... 325\nP10.75 - Purchase Order No. 2286, dated June 6, 1994, between Photronics Corporation and International Precision Products N.V. .......... 326\nP10.76 - Purchase Order No. CN74325, dated December 14, 1994, between Precision Echo and Lockheed Aeronautical Systems Company.................... 327\nP10.77 - Contract No. N39998-94-C-2239, dated July 26, 1993, between the Company and the Navy.......... 331\nP10.78 - Contract No. N00019-95-C-0057, dated December 16, 1994, between Precision Echo, Inc. and Naval Air Systems Command....................... 369\n10.79 - Employment, Non-Competition and Termination Agreement, dated July 20, 1994, between Diagnostic\/Retrieval Systems, Inc. and David E. Gross [Form 10-Q, quarter ended June 30, 1994, File No. 1-8533, Exhibit 1]\n10.80 - Stock Purchase Agreement, dated as of July 20, 1994, between Diagnostic\/Retrieval Systems, Inc. and David E. Gross [Form 10-Q, quarter ended June 30, 1994, File No. 1-8533, Exhibit 2]\nPage No. Exhibit No. Description of Paper Filing - ----------- ----------- --------------\n10.81 - Asset Purchase Agreement, dated October 28, 1994, Acquisition by PE Acquisition Corp., a subsidiary of Precision Echo, Inc. Of All Of The Assets of Ahead Technology Corporation [Form 10-Q, quarter ended December 31, 1994, File No. 1-8533, Exhibit 1]\n* 11 - Computation of earnings per share\n* 13 - Portions of Diagnostic\/Retrieval Systems, Inc.'s 1995 Annual Report to Stockholders\n* 21 - List of subsidiaries of the Company\n* 23 - Consent of KPMG Peat Marwick LLP\n* 27 - Financial Data Schedule","section_15":""}
{"filename":"716791_1995.txt","cik":"716791","year":"1995","section_1":"ITEM 1. BUSINESS\nNorthbrook Life Insurance Company (hereinafter \"Northbrook Life\" or the \"Company\"), incorporated in 1978 as a stock life insurance company under the laws of the State of Illinois, has done business continuously since that time as \"Northbrook Life Insurance Company\". Northbrook Life's products, group and individual annuities and life insurance, have been approved by the states where offered.\nNorthbrook Life is a wholly owned subsidiary of Allstate Life Insurance Company (\"Allstate Life\"), a stock life insurance company incorporated under the laws of Illinois. Allstate Life is a wholly owned subsidiary of Allstate Insurance Company (\"Allstate\"), a stock property-liability insurance company incorporated under the laws of Illinois. With the exception of directors' qualifying shares, all of the outstanding capital stock of Allstate is owned by The Allstate Corporation (\"Corporation\"). The Corporation was capitalized in 1993 with the contribution of all of the outstanding common stock of Allstate. Sears, Roebuck and Co. (\"Sears\") had previously been the direct owner of all the common stock of Allstate. On June 9, 1993 the Corporation completed its initial public offering of 89,500,000 common shares. On June 30, 1995, Sears distributed its remaining 80.3% ownership in the Corporation to Sears common shareholders through a tax free dividend.\nNorthbrook Life's operations consist of one business segment which is the sale of life insurance and annuity products.\nNorthbrook Life and Allstate Life entered into reinsurance agreements, effective December 31, 1987, under which Northbrook Life automatically reinsures substantially all of its business with Allstate Life. Under the agreements, purchase payments under all general account contracts are automatically transferred to Allstate Life and become invested with the assets of Allstate Life, and Allstate Life accepts 100% of the liability under such contracts. However, the obligations of Allstate Life under the reinsurance agreement are to the Company. In addition, assets of the Company that relate to insurance in- force excluding separate account assets and, beginning in 1995, assets related to certain market value adjusted annuity contracts under employee benefit plans, are transferred to Allstate Life. Therefore, the funds necessary to support the operations of the Company are provided by Allstate Life and the Company is not required to obtain additional capital to support in-force or future business.\nUnder the Company's reinsurance agreements with Allstate Life, the Company reinsures all reserve liabilities with Allstate Life. The Company's variable contract assets and liabilities are held in legally-segregated, unitized separate accounts and are retained by the Company. The assets and liabilities related to certain market value adjusted annuity contracts under employee benefit plans will be held in the general account of the Company, however, the transactions related to such variable and market value adjusted contracts such as\npremiums, expenses and benefits are transferred to Allstate Life.\nNorthbrook Life's and Allstate Life's general account assets must be invested in accordance with applicable state laws. These laws govern the nature and quality of investments that may be made by life insurance companies and the percentage of their assets that may be committed to any particular type of investment. Of Allstate Life's consolidated invested assets of $27,256 million on December 31, 1995, 81.5% was invested in fixed income securities, 2.9% in equities, 11.8% in mortgage loans, and 3.8% in real estate, short-term investments and other assets.\nNorthbrook Life is engaged in a business that is highly competitive because of the large number of stock and mutual life insurance companies and other entities competing in the sale of insurance and annuities. There are approximately 2,000 stock, mutual and other types of insurers in business in the United States. Several independent rating agencies regularly evaluate life insurer's claims paying ability, quality of investments and overall stability. A.M. Best Company assigns A+(Superior) to Allstate Life which automatically reinsures all net business of Northbrook Life. A.M. Best Company also assigns Northbrook Life the rating of A+(r) because Northbrook Life automatically reinsures all business with Allstate Life. Standard & Poor's Insurance Rating Services assigned AA+ (Excellent) to the Company's claims-paying ability and Moody's Investors Service assigned an Aa3 (excellent) financial stability rating to the Company. Northbrook Life shares the same ratings of its parent, Allstate Life.\nAlthough the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed measures which may significantly affect the Company's insurance business relate to the taxation of insurance companies, the tax treatment of insurance products and the removal of barriers preventing banks from engaging in the insurance business.\nNorthbrook Life is regulated by the Securities and Exchange Commission (\"SEC\") as an issuer of registered products. The SEC also regulates certain Northbrook Life Separate Accounts through which the Company issues variable annuity contracts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nNorthbrook Life occupies office space provided by its parent, Allstate Life, in Northbrook, Illinois. Expenses associated with these offices are allocated on a direct and indirect basis to Northbrook Life.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its Board of Directors know of no material legal proceedings pending to which the Company is a party or which would materially affect the Company. The Company is involved in pending and threatened litigation in the normal course of its business in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate the ultimate liability arising from such pending or threatened litigation to have a material effect on the financial condition of the Company.\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the Company's outstanding shares are owned by its parent, Allstate Life. Allstate Life's outstanding shares are owned by Allstate. With the exception of director's qualifying shares, all of the outstanding capital stock of Allstate is owned by The Allstate Corporation (\"Corporation\"). The Corporation was capitalized in 1993 with the contribution of all of the outstanding common stock of Allstate. Sears, Roebuck and Co. (\"Sears\") had previously been the direct owner of all the common stock of Allstate. On June 9, 1993 the Corporation completed its initial public offering of 89,500,000 common shares. On June 30, 1995, Sears distributed its 80.2% ownership in the Corporation to Sears common shareholders through a tax free dividend.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nNORTHBROOK LIFE INSURANCE COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following highlights significant factors influencing results of operations and financial position.\nNorthbrook Life Insurance Company (\"the Company\"), which is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), issues single and flexible premium fixed annuity contracts and universal life insurance policies. In addition, the Company issues flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as the assets and liabilities of the Separate Accounts. Dean Witter Reynolds is the sole distributor of the Company's products and also manages the funds in which the assets of the Separate Accounts are invested.\nThe Company reinsures substantially all of its annuity deposits and life insurance in force with Allstate Life. Accordingly, the financial results reflected in the Company's statements of operations relate only to the investment of those assets of the Company that are not transferred to Allstate Life under the reinsurance treaties.\nVariable annuity assets and liabilities are carried at fair value in the statements of financial position. Investment income and realized gains and losses of the Separate Account investments accrue directly to the contractholders (net of fees) and, therefore, are not included in the Company's statements of operations.\nRESULTS OF OPERATIONS\nIn 1995, net investment income increased $1.9 million. This increase related to an increased level of investments which resulted from a $25 million capital contribution from Allstate Life during December 1994. Net investment income decreased in 1994 over 1993, primarily due to slightly lower portfolio yields, partially offset by the increase in investments during the year.\nRealized capital gains after tax were $44 thousand in 1995 compared to capital losses of $125 thousand in 1994. Overall, the market values of fixed income securities were higher in 1995 than in 1994, which resulted in gains in 1995 and losses in 1994 when certain fixed income securities were sold in response to changes in market conditions.\nNet income increased $1.4 million in 1995 reflecting the increase in net investment income and realized capital gains. The $0.8 million decrease in 1994 from 1993 is primarily attributable to increased realized capital losses and a higher effective income tax rate in 1994.\nFINANCIAL POSITION\n- --------\n(1) Unrealized net capital gains (losses) exclude the effect of deferred income taxes.\nFixed income securities are classified as available for sale and carried in the statements of financial position at fair value. Although the Company generally intends to hold its fixed income securities for the long-term, such classification affords the Company flexibility in managing the portfolio in response to changes in market conditions.\nAt December 31, 1995 unrealized capital gains were $4.1 million compared to an unrealized capital loss of $2.4 million at December 31, 1994. The significant change in the unrealized capital gain\/loss position is primarily attributable to declining interest rates.\nContractholder funds decreased by $453 million and reinsurance recoverable from Allstate Life under reinsurance treaties decreased by $449 million, reflecting policyholder transfers from fixed annuities to variable annuities and fixed annuity surrenders. Reinsurance recoverable from Allstate Life relates to policy benefit obligations ceded to Allstate Life.\nSeparate Accounts increased by $750 million attributable to sales of variable annuities, the favorable investment performance of the Separate Account funds, and the policyholder transfers previously described.\nLIQUIDITY AND CAPITAL RESOURCES\nIn December 1994, Allstate Life made a $25 million capital contribution to the Company.\nUnder the terms of intercompany reinsurance agreements, assets of the Company that relate to insurance in force, excluding Separate Account assets, are transferred to Allstate Life who maintains the investment portfolios which support the Company's products.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements\nIndex -----\nPage ----\nIndependent Auditors' Report 8\nFinancial Statements:\nStatements of Financial Position, December 31, 1995 and 1994 9\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 10\nStatements of Shareholder's Equity for the Years Ended December 31, 1995, 1994 and 1993 11\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 12\nNotes to Financial Statements 13\nSchedule IV - Reinsurance for the Years Ended December 31, 1995, 1994 and 1993 23\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND SHAREHOLDER OF NORTHBROOK LIFE INSURANCE COMPANY:\nWe have audited the accompanying Statements of Financial Position of Northbrook Life Insurance Company as of December 31, 1995 and 1994, and the related Statements of Operations, Shareholder's Equity and Cash Flows for each of the three years in the period ended December 31, 1995. Our audits also included Schedule IV--Reinsurance. 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 financial statements present fairly, in all material respects, the financial position of Northbrook Life Insurance 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. Also, in our opinion, Schedule IV--Reinsurance, 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 financial statements, in 1993 the Company changed its method of accounting for investment in fixed income securities.\n\/s\/ Deloitte & Touche LLP\nChicago, Illinois March 1, 1996\nNORTHBROOK LIFE INSURANCE COMPANY\nSTATEMENTS OF FINANCIAL POSITION\nSee notes to financial statements.\nNORTHBROOK LIFE INSURANCE COMPANY\nSTATEMENTS OF OPERATIONS\nSee notes to financial statements.\nNORTHBROOK LIFE INSURANCE COMPANY\nSTATEMENTS OF SHAREHOLDER'S EQUITY\nSee notes to financial statements.\nNORTHBROOK LIFE INSURANCE COMPANY\nSTATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n($ IN THOUSANDS)\n1. ORGANIZATION AND NATURE OF OPERATIONS\nNorthbrook Life Insurance Company (the \"Company\") is wholly owned by Allstate Life Insurance Company (\"Allstate Life\"), which is wholly owned by Allstate Insurance Company (\"Allstate\"), a wholly-owned subsidiary of The Allstate Corporation (the \"Corporation\"). On June 30, 1995, Sears, Roebuck and Co. (\"Sears\") distributed its 80.3% ownership in the Corporation to Sears common shareholders through a tax-free dividend (the \"Distribution\").\nThe Company develops and markets single and flexible premium annuities and flexible premium deferred and variable annuity contracts to individuals in the United States through Dean Witter Reynolds (\"Dean Witter\")(Note 4). Other products include universal life and single premium life insurance.\nAnnuity contracts issued by the Company are subject to discretionary withdrawal or surrender by the contractholder, subject to applicable surrender charges. These contracts are reinsured with Allstate Life (Note 4) which selects assets to meet the anticipated cash flow requirements of the assumed liabilities. Allstate Life utilizes various modeling techniques in managing the relationship between assets and liabilities and employs strategies to maintain investments which are sufficiently liquid to meet obligations to contractholders in various interest rate scenarios.\nThe Company monitors economic and regulatory developments which have the potential to impact its business. Currently there is proposed federal legislation which would permit banks greater participation in securities businesses, which could eventually present an increased level of competition for sales of the Company's annuity contracts. Furthermore, the federal government may enact changes which could possibly eliminate the tax-advantaged nature of annuities or eliminate consumers' need for tax deferral, thereby reducing the incentive for customers to purchase the Company's products. While it is not possible to predict the outcome of such issues with certainty, management evaluates the likelihood of various outcomes and develops strategies, as appropriate, to respond to such challenges.\nCertain reclassifications have been made to the prior year financial statements to conform to the presentation for the current year.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nLIFE INSURANCE ACCOUNTING\nThe Company writes long-duration insurance contracts with terms that are not fixed and guaranteed and single premium life insurance contracts, which are considered universal life-type contracts. The Company also sells long-duration contracts that do not involve significant risk of policyholder mortality or\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS) morbidity (principally single and flexible premium annuities, structured settlement annuities and supplemental contracts when sold without life contingencies) which are considered investment contracts. Limited payment contracts (policies with premiums paid over a period shorter than the contract period), primarily consist of structured settlement annuities and supplemental contracts when sold with life contingencies.\nTRADITIONAL LIFE\nThe reserve for life insurance policy benefits, which relates to structured settlement annuities and supplementary contracts when sold with life contingencies, is computed on the basis of assumptions as to future investment yields, mortality, morbidity, terminations and expenses. These assumptions, which for traditional life are applied using the net level premium method, include provisions for adverse deviation and generally vary by such characteristics as plan, year of issue and policy duration. Reserve interest rates ranged from 7.3% to 9.5% during 1995.\nUNIVERSAL LIFE-TYPE CONTRACTS\nReserves for universal life-type contracts are established using the retrospective deposit method. Under this method, liabilities are equal to the account balance that accrues to the benefit of the policyholder.\nCONTRACTHOLDER FUNDS\nContractholder funds arise from the issuance of individual contracts that include an investment component, including universal life-type contracts. Payments received are recorded as interest-bearing liabilities. Contractholder funds are equal to deposits received and interest accrued to the benefit of the contractholder less withdrawals, mortality charges and administrative expenses. During 1995, credited interest rates on contractholder funds ranged from 3.0% to 8.0% for those contracts with fixed interest rates and from 3.0% to 8.7% for those with flexible rates.\nSEPARATE ACCOUNTS\nThe Company issues flexible premium deferred variable annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying statements of financial position as assets and liabilities of the Separate Accounts. Assets and liabilities of the Separate Accounts represent funds of Northbrook Variable Annuity Account and Northbrook Variable Annuity Account II (\"Separate Accounts\"), unit investment trusts registered with the Securities and Exchange Commission. The assets of the Separate Accounts are carried at fair value. Investment income and realized gains and losses of the Separate Accounts accrue directly to the contractholders and, therefore, are not included in the accompanying statements of operations. Revenues to the Company from the Separate Accounts consist of contract maintenance fees, administrative fees and mortality and expense risk charges, which are entirely ceded to Allstate Life.\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS) REINSURANCE\nPremiums, contract charges, credited interest, and policy benefits are ceded and reflected net of such cessions in the statements of operations. Reinsurance recoverable and the related reserves for policy benefits and contractholder funds are reported separately in the statements of financial position.\nINVESTMENTS\nFixed income securities include bonds and mortgage-backed securities. Fixed income securities are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes, is reflected as a component of shareholder's equity. Provisions are made to write down the value of fixed income securities for declines in value that are other than temporary. Such writedowns are included in realized capital gains and losses.\nShort-term investments are carried at cost which approximates fair value.\nInvestment income consists primarily of interest, which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method, based on the estimated principal repayments. Realized capital gains and losses are determined on a specific identification basis.\nINCOME TAXES\nThe income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. Deferred income taxes also arise from unrealized capital gains or losses on fixed income securities carried at fair value.\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.\n3. ACCOUNTING CHANGE\nEffective December 31, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires that investments classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of amortized cost or fair value, determined in the aggregate. Unrealized holding gains and losses are reflected as a separate component of shareholder's equity, net of deferred income taxes. The net effect of adoption of this statement increased shareholder's equity at December 31, 1993 by $747, with no impact on net income.\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS) 4. RELATED PARTY TRANSACTIONS\nREINSURANCE\nThe Company reinsures substantially all business with Allstate Life. Premiums and contract charges ceded to Allstate Life were $2,284 and $52,348 in 1995, $1,886 and $38,306 in 1994, and $2,688 and $22,446 in 1993. Credited interest, policy benefits and other expenses ceded to Allstate Life amounted to $229,525, $243,326, and $525,467 in 1995, 1994, and 1993, respectively. Investment income earned on the assets which support contractholder funds was excluded from the Company's financial statements as those assets were transferred to Allstate Life under the terms of reinsurance treaties. Reinsurance ceded arrangements do not discharge the Company as the primary insurer.\nBUSINESS OPERATIONS\nThe Company utilizes services and business facilities owned or leased, and operated by Allstate in conducting its business activities. The Company reimburses Allstate for the operating expenses incurred by Allstate. The cost to the Company is determined by various allocation methods and is primarily related to the level of services provided. Operating expenses, including compensation and retirement and other benefit programs, allocated to the Company were $5,341, $5,483 and $5,301 in 1995, 1994 and 1993, respectively. Investment-related expenses are retained by the Company. All other costs are assumed by Allstate Life under reinsurance agreements.\nDEAN WITTER\nThe Company and Allstate Life have formed a strategic alliance with Dean Witter to develop, market and distribute proprietary annuity and life insurance products through Dean Witter account executives. Dean Witter provides a portion of the funding for these products through loans to an affiliate of the Company.\nUnder the terms of the strategic alliance, which is cancelable by either party, the Company has agreed to use Dean Witter as an exclusive distribution channel for the Company's products. Dean Witter is also the investment manager for the Dean Witter Variable Investment Series, the fund in which the assets of the Separate Accounts are invested.\n5. INCOME TAXES\nAllstate Life and its life insurance subsidiaries, including the Company, will file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective subsidiaries, whether or not such benefits generated by the subsidiaries would be available on a separate return basis. The Corporation and its domestic subsidiaries, including the Company (the \"Allstate Group\"), will be eligible to file a consolidated tax return beginning in the year 2000.\nPrior to the Distribution, the Allstate Group joined with Sears and its domestic business units (the \"Sears Group\") in the filing of a consolidated federal income tax return (the \"Sears Tax Group\") and were parties to a federal income tax allocation agreement (the \"Tax Sharing Agreement\"). As a member of the\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS)\nSears Tax Group, the Corporation was jointly and severally liable for the consolidated income tax liability of the Sears Tax Group. Under the Tax Sharing Agreement, the Company, through the Corporation, paid to or received from the Sears Group the amount, if any, by which the Sears Tax Group's federal income tax liability was affected by virtue of inclusion of the Allstate Group in the consolidated federal income tax return. Effectively, this resulted in the Company's annual income tax provision being computed as if the Company filed a separate return, except that items such as net operating losses, capital losses, foreign tax credits, or similar items which might not be immediately recognizable in a separate return, were allocated according to the Tax Sharing Agreement and reflected in the Company's provision to the extent that such items reduced the Sears Tax Group's federal tax liability.\nThe Allstate Group and Sears Group have entered into an agreement which governs their respective rights and obligations with respect to federal income taxes for all periods prior to the Distribution (\"Consolidated Tax Years\"). The agreement provides that all Consolidated Tax Years will continue to be governed by the Tax Sharing Agreement with respect to the Company's federal income tax liability and taxes payable to or recoverable from the Sears Group.\nThe components of the deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\nThe components of income tax expense are as follows:\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS)\nThe Company paid income taxes of $4,206, $4,219 and $1,175 in 1995, 1994 and 1993, respectively under the Tax Sharing Agreement. Included in these amounts are $2,651, $2,826 and $1,111 reimbursed to the Company by Allstate Life under the terms of reinsurance agreements for 1995, 1994 and 1993, respectively.\nThe Company had income taxes payable to Allstate Life of $233 and $4,634 at December 31, 1995 and 1994, respectively.\nA reconciliation of the statutory federal income tax rate to the effective federal income tax rate is as follows:\n6. INVESTMENTS\nFAIR VALUES\nThe amortized cost, fair value and gross unrealized gains and losses for fixed income securities are as follows:\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS)\nSCHEDULED MATURITIES\nThe scheduled maturities for fixed income securities at December 31, 1995 are as follows:\nActual maturities may differ from those scheduled as a result of prepayments by the issuers.\nUNREALIZED NET CAPITAL GAINS AND LOSSES\nUnrealized net capital gains and losses on fixed income securities included in shareholder's equity at December 31, 1995 are as follows:\nThe change in unrealized net capital gains and losses for fixed income securities is as follows:\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS)\nCOMPONENTS OF INVESTMENT INCOME\nInvestment income by type of investment is as follows:\nREALIZED CAPITAL GAINS AND LOSSES\nRealized capital gains and losses on investments are as follows:\nPROCEEDS FROM SALES OF FIXED INCOME SECURITIES\nThe proceeds from sales of investments in fixed income securities, excluding calls, and related gross realized gains and losses are as follows:\nSECURITIES ON DEPOSIT\nAt December 31, 1995, fixed income securities with a carrying value of $8,041 were on deposit with regulatory authorities as required by law.\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS)\n7. FINANCIAL INSTRUMENTS\nIn the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The assets and liabilities of the Separate Accounts are carried at the fair value of the funds in which the assets are invested. The fair value of all financial assets other than fixed income securities and all liabilities other than contractholder funds approximates their carrying value as they are short-term in nature.\nFair values for fixed income securities are based on quoted market prices. The December 31, 1995 and 1994 fair values and carrying values of fixed income securities are discussed in Note 6.\nThe fair value of contractholder funds related to investment contracts is based on the terms of the underlying contracts. Reserves on investment contracts with no stated maturities (single premium and flexible premium deferred annuities) are valued at the fund balance less surrender charge. The fair value of immediate annuities and annuities without life contingencies with fixed terms are estimated using discounted cash flow calculations based on interest rates currently offered for contracts with similar terms and duration. Contractholder funds on investment contracts had a carrying value of $2,294,536 at December 31, 1995 and a fair value of $2,274,053. The carrying value and fair value at December 31, 1994 were $2,738,823 and $2,685,448, respectively.\n8. STATUTORY FINANCIAL INFORMATION\nThe following tables reconcile net income and shareholder's equity as reported herein in conformity with generally accepted accounting principles with statutory net income and capital and surplus, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities:\nNORTHBROOK LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n($ IN THOUSANDS) PERMITTED STATUTORY ACCOUNTING PRACTICES\nThe Company prepares its statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the insurance department of the State of Illinois. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company does not follow any permitted statutory accounting practices that have a material effect on statutory surplus or risk-based capital.\nDIVIDENDS\nThe ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company and other relevant factors. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in accordance with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. The maximum amount of dividends that the Company can distribute during 1996 without prior approval of both the Illinois and California Departments of Insurance is $7,057.\nNORTHBROOK LIFE INSURANCE COMPANY\nSCHEDULE IV--REINSURANCE\n($ IN THOUSANDS)\nYEAR ENDED DECEMBER 31, 1995\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) The following documents are filed as part of this Report. The page number, if any, listed opposite a document indicates the page number in the sequential numbering system in the manually signed original of this Report where such document can be found.\n(1) The financial statements filed as part of this Report are listed in Item 8.\n(2) Financial Statement Schedules\nSchedule IV - Reinsurance page 23\n(3) 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.\nNORTHBROOK LIFE INSURANCE COMPANY\nBy \/s\/ Louis G. Lower, II -------------------------- Louis G. Lower, II Chief Executive Officer and Chairman (Principal 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 the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Louis G. Lower, II -------------------------- Louis G. Lower, II Chief Executive Officer and Chairman (Principal Executive Officer)\nDate March 29, 1996 ------------------------\nBy \/s\/ Barry S. Paul -------------------------- Barry S. Paul Assistant Vice President and Controller (Chief Accounting Officer)\nDate March 29, 1996 ------------------------","section_15":""}
{"filename":"316709_1995.txt","cik":"316709","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business. The Charles Schwab Corporation (CSC) is -------------------------------- a holding company engaged, through its subsidiaries, in securities brokerage and related investment services. CSC's principal operating subsidiary, Charles Schwab & Co., Inc. (Schwab), serves an estimated 51% of the discount brokerage market, up from 50% (a) in 1994. Another subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq securities, provides trade execution services to broker-dealers and institutional customers. During 1995, orders handled by M&S totaled over 7 billion shares, or approximately 7% of the total shares traded on Nasdaq. As used herein, the \"Company\" refers to CSC and its subsidiaries. Schwab was incorporated in California in 1971 and adopted the name Charles Schwab & Co., Inc. after Mr. Charles R. Schwab became its owner and President. In September 1987, the Company raised $123 million in its initial public offering. Since becoming a publicly-owned entity, the Company has experienced significant growth in revenues, net income and customer assets. This growth has been accomplished through investment in technology, product and service development, marketing programs and customer service delivery systems. In addition, the Company has broadened its service capability through the acquisition and development of additional businesses. In October 1989, Charles Schwab Investment Management, Inc. (CSIM) was formed as a subsidiary of CSC. In January 1990, CSIM became the general investment adviser (employing a sub-adviser to perform portfolio management for certain funds), as well as the administrator for three proprietary money market funds. Substantially all of the balances previously invested by Schwab customers in other money market funds having similar investment objectives were transferred to these proprietary money market funds in January 1990. Schwab subsequently introduced additional proprietary mutual funds. The Company refers to all funds for which CSIM is the investment adviser as the SchwabFunds (registered trademark). In response to the continued growth of customer trading activity in Nasdaq securities and a desire to secure a capability to execute customer trades in these and other securities, CSC acquired M&S in July 1991. Since the acquisition, M&S has executed substantially all the Nasdaq security trades originated by the customers of Schwab, which in 1995 accounted for approximately 21% of Schwab's total trading volume. During July 1992, Schwab introduced nationally its no-transaction-fee mutual fund service, known as the Mutual Fund OneSource (registered trademark) service, which at December 31, 1995, enabled customers to trade 370 mutual funds in 44 well-known fund families without incurring brokerage transaction fees. In March 1992, CSC opened The Charles Schwab Trust Company (CSTC), which provides custody services for independent investment managers and serves as trustee for employee benefit plans (primarily 401(k) plans). CSTC's primary focus is to provide services to fee-based independent investment managers and 401(k) plan record keepers and administrators.\nDevelopments During 1995\nDuring 1995, the Company experienced record revenues, net income and growth in customer assets. Net income for 1995 was $173 million, or $.97 per share, up from $135 million, or $.77 per share, in 1994, and $118 million, or $.66 per share, in 1993. The Company's strong performance was due in part to the $59.1 billion, or 48%, increase in assets held in Schwab customer accounts. The Company invested $166 million in various capital expenditures during 1995, including the expansion of each of its regional customer telephone service centers, and enhancements to its data processing and telecommunications systems. The Company also opened 19 branch offices and made improvements to certain existing office facilities. During 1995, the Company paid approximately $68 million, net of cash received, for businesses acquired, the largest of which was ShareLink Investment Services plc (ShareLink), a retail discount securities brokerage firm located in the United Kingdom. During 1995, the Company's Board of Directors declared two stock splits of the Company's common stock effected in the form of stock dividends: a three-for-two common stock split payable March 1995; and a two-for-one common stock split payable September 1995. Share information throughout this report has been restated to reflect these transactions. Also, the Board increased the Company's quarterly cash dividend 29% in January 1995 to $.03 per share payable February 1995, and 33% in July 1995 to $.04 per share payable August 1995. During 1995, Schwab introduced e.Schwab (trademark), which provides customers with online trading capability and significant discounts from Schwab's standard commission rates for equity trades, along with discounts on other security trades.\n(b) Financial Information About Industry Segments. The Company operates in a ---------------------------------------------- single industry segment: securities brokerage and related investment services. Fees received from the Company's proprietary mutual funds represented\n(a) The Securities Industry Association revised its definition of discount brokers in 1995. Schwab's share in 1994 was revised to 50% from 42% under this new definition.\n- 1 -\napproximately 12% of the Company's consolidated revenues in 1995. As of December 31, 1995, approximately 28% of Schwab's total customer accounts were located in California. The next highest geographic concentrations of total customer accounts were approximately 7% in each of New York and Florida.\n(c) Narrative Description of Business. Schwab provides securities brokerage ---------------------------------- and related investment services to more than 3.4 million active (b) investor accounts. These accounts held $181.7 billion in assets at December 31, 1995. Schwab's primary focus is serving retail clients who seek a wide selection of quality investment services at fees that, in most cases, are substantially lower than those of full-commission firms. The table on the following page sets forth on a comparative basis the Company's revenues for the three years ended December 31, 1995. These revenue figures reflect developments in, and the composition of, the Company's business. Schwab primarily serves investors who wish to conduct their own research and make their own investment decisions and do not wish to pay, through brokerage commissions, for research or portfolio management. To attract and accommodate investors who want research and portfolio management, however, Schwab offers a variety of fee-based (primarily third-party) research and portfolio management products and services. This segment of customers who want research and portfolio management has become increasingly significant to Schwab's growth in customer assets and accounts. During 1995, Schwab customer assets held in accounts managed by approximately 5,600 active independent investment managers increased $18.0 billion (55%) to a total of $50.6 billion. As a market maker in Nasdaq securities, M&S generally executes customer trades as principal. Revenues from M&S' market-making activities, along with revenues from Schwab's specialist operations on the Pacific Stock Exchange, comprise substantially all of the Company's principal transaction revenues. The Company, through M&S and Schwab, maintains inventories of securities and acts as principal in transactions with its customers primarily as a result of its market-making activities in Nasdaq and exchange-listed securities, as well as overnight positions in money market funds relating to the accommodation of customer liquidity needs. Schwab's customer service delivery systems reduce dependency on the need for personal relationships between Schwab's customers and employees to generate orders. Schwab does not generally assign customers to individual employees. Each customer-contact employee has immediate access to the customer account and market-related information necessary to respond to any customer's inquiries, and for most customer orders, can enter the order and confirm the transaction. Customer orders involving certain types of transactions, such as those in fixed income securities and mutual funds, are handled by separate groups of registered representatives that specialize in such transactions. As a result of this approach, the departure of a registered representative generally does not result in a loss of customers for the firm. The securities brokerage industry is directly affected by fluctuations in volumes and price levels of securities transactions generally, which are affected by many national and international economic and political factors that cannot be predicted, including broad trends in business and finance, the availability of credit and capital, legislation and regulation affecting the United States and international business and financial communities, currency values, and the level and volatility of interest rates. Sustained low volumes of investment activity or of securities transactions generally, particularly if accompanied by low securities prices, could substantially reduce the Company's transaction-based revenues and could lead to reduced margin account balances, thus reducing interest revenue as well. Shifts in customer investment vehicle preferences from individual equity securities to products that have lower commissions per transaction, such as mutual funds, could also reduce transaction-based revenues, which include commission and principal transaction revenues. In connection with its information processing systems, its branch office network, its regional customer telephone service centers and other aspects of its business, the Company incurs substantial expenses that do not vary directly, at least in the short term, with fluctuations in securities transaction volumes and revenues. In the event of a material reduction in revenues, the Company may not reduce such expenses quickly and, as a result, the Company could experience reduced profitability or losses. Conversely, sudden surges in transaction volumes can result in increased profit and profit margin. To ensure that it has the capacity to process projected increases in transaction volumes, the Company has historically made substantial capital and operating expenditures in advance of such projected increases, including during periods of low transaction volumes. In the event that such growth in transaction volumes does not occur, the expenses related to such investments could, as they have in the past, cause reduced profitability or losses. Additionally, during recent periods of high transaction volumes and increased revenues, the Company has also made substantial capital and operating expenditures to enhance future growth prospects.\n(b) Accounts with balances or activity within the preceding twelve months.\n- 2 -\nSources of Revenues (Dollar amounts in thousands)\nCompetition\nThe Company encounters rigorous competition from full-commission and discount brokerage firms, as well as from financial institutions, mutual fund sponsors, market makers in Nasdaq securities and other organizations. The general financial success within the securities industry over the past several years has strengthened existing competitors. Management believes that such success will continue to attract additional competitors such as banks, software development companies, insurance companies, providers of online financial and information services, and others as they expand their product lines. Some of these competitors are larger, more diversified, have greater capital resources, and offer a wider range of services and financial products than the Company. Particularly as financial services and products proliferate, to the extent such competitors are able to attract and retain customers on the basis of the convenience of one-stop shopping, the Company's business or its ability to grow could be adversely affected. In many instances, the Company is competing with such organizations for the same customers. Management believes that the main competitive factors are quality, convenience, price of services and products offered, and breadth of product line. Most discount brokerage firms charge commissions lower than Schwab. Full- commission brokerage firms also\n- 3 -\noffer discounted commissions to selected retail brokerage customers. Many brokerage firms employ substantial funds in advertising and direct solicitation of customers to increase their market share of commission dollars and other securities-related income. If the well-capitalized brokerage firms pursue these competitive strategies successfully, Schwab's customer asset growth, commission revenues and profit margin could be adversely affected.\nMarketing and Promotion\nAdvertising plays a crucial role in obtaining new customers, which have constituted an important source of revenue and revenue growth for the Company. The Company's advertising and market development expense for the years ended December 31, 1995, 1994 and 1993 was $53 million, $36 million and $41 million, respectively. For the same years, the numbers of new accounts opened were approximately 698,000, 688,000 and 644,000, respectively. Prior year amounts are restated to reflect the $1,000 minimum opening balance requirement for basic brokerage accounts implemented in July 1994. New account openings represent a significant portion of the growth in customer assets, which the Company believes is critical to growth in revenues. Accounts opened during 1995, 1994 and 1993 generated approximately 13%, 14% and 16% of total commission revenues during each of those years, respectively. The branch office network also plays a key role in building Schwab's business. Many customers prefer to open accounts in person in Schwab branch offices. With the customer service support of the regional customer telephone service centers, TeleBroker (registered trademark), StreetSmart (registered trademark) and e.Schwab (trademark), branch personnel are able to focus a significant portion of their time on business development. Schwab advertises regularly in financially-oriented newspapers and periodicals and occasionally in general circulation publications. Schwab advertisements appear regularly on national and local cable television and periodically on radio and independent television stations. Schwab also engages extensively in targeted direct mail advertising through monthly statement \"inserts\" and special mailings. Such efforts have increased Schwab's brand awareness among investors. In its advertising, as well as in promotional events such as press appearances, Schwab has aggressively promoted the name and likeness of its Chairman, Mr. Schwab. The Company believes there is a substantial benefit related to Mr. Schwab's association with the Company. The Company has an agreement with Mr. Schwab by which he, subject to certain limitations, has assigned to the Company and Schwab all service mark, trademark, and trade name rights in his name (and variations thereon) and likeness.\nProducts and Services\nAccounts and Features. Each Schwab customer has a brokerage account through ---------------------- which securities may be purchased or sold. These securities include Nasdaq and exchange-listed securities, options, mutual funds and fixed income investments, including U.S. Treasuries, zero-coupon bonds, listed and OTC corporate bonds, municipal bonds, GNMAs, unit investment trusts and CDs. If approved for margin transactions, a customer may borrow a portion of the price of certain securities purchased through Schwab, or may sell securities short. Customers must have specific approval to trade options; as of December 31, 1995, approximately 169,000 accounts were so approved. To write uncovered options, customers must go through an additional approval process and must maintain a significantly higher level of equity in their brokerage accounts. Because Schwab does not pay interest on cash balances in basic brokerage accounts, it provides customers with an option to have cash balances in their accounts automatically swept into certain SchwabFunds (registered trademark) money market funds. In July 1994, Schwab instituted a $1,000 cash and\/or securities minimum opening balance requirement for basic brokerage accounts. A customer may receive additional services by qualifying for and opening a Schwab One (registered trademark) brokerage account. A customer may remove available funds from his or her Schwab One account either with a personal check or a VISA debit card. When a Schwab One customer is approved for margin trading, the checks and debit card also provide access to margin cash available. For cash balances awaiting investment, Schwab pays interest to Schwab One customers at a discretionary rate of interest. Alternatively, Schwab One customers seeking tax-exempt income may elect to have cash balances swept into one of three tax-exempt SchwabFunds money market funds. During 1995, the number of active Schwab One accounts increased 19% and the customer assets in all Schwab One accounts increased 51%. Schwab acts as custodian, as well as broker, for Individual Retirement Accounts (IRAs). In Schwab IRAs, cash balances are swept daily into one of three SchwabFunds money market funds. During 1995, active IRAs increased 17% and customer assets in all IRAs increased 44%. Schwab also acts as custodian and broker for Keogh accounts. During 1995, Schwab continued to expand its Schwab 500 Brokerage (trademark) service to attract and retain customers who trade frequently. This service provides discounts from Schwab's standard commission rates, as well as customized services and information resources.\nCustomer Financing. Customers' securities transactions are effected on either ------------------- a cash or margin basis. Generally, a customer buying securities in a cash-only brokerage account is required to make payment by settlement date, usually three\n- 4 -\nbusiness days after the trade is executed. However, for purchases of certain types of securities, such as certain mutual fund shares, a customer must have a cash or money market fund balance in his or her account sufficient to pay for the trade prior to execution. When selling securities, a customer is required to deliver the securities, and is entitled to receive the proceeds, on settlement date. In an account authorized for margin trading, Schwab may lend its customer a portion of the market value of certain securities up to the limit imposed by the Federal Reserve Board, which for most equity securities is initially 50%. Such loans are collateralized by the securities in the customer's account. Short sales of securities represent sales of borrowed securities and create an obligation to purchase the securities at a later date. Customers may sell securities short in a margin account subject to minimum equity and applicable margin requirements and the availability of such securities to be borrowed and delivered. Interest on margin loans to customers provides an important source of revenue to Schwab. During the year ended December 31, 1995, Schwab's outstanding margin loans to its customers averaged approximately $3.2 billion, up from 1994's average of approximately $2.7 billion. In permitting a customer to engage in transactions, Schwab takes the risk of such customer's failure to meet his or her obligations in the event of adverse changes in the market value of the securities positions in his or her account. Under applicable rules and regulations for margin transactions, Schwab, in the event of such an adverse change, requires the customer to deposit additional securities or cash, so that the amount of the customer's obligation is not greater than specified percentages of the cash and market values of the securities in the account. As a matter of policy, Schwab generally requires its customers to maintain higher percentages of collateral values than the minimum percentages required under these regulations. Schwab may use cash balances in customer accounts to extend margin credit to other customers. Under SEC Rule 15c3-3, the portion of such cash balances not used to extend margin credit (increased or decreased by certain other customer- related balances) must be held in segregated investment accounts. The balances in these segregated investment accounts must be invested in qualified interest- bearing securities. To the extent customer cash balances are available for use by Schwab at interest costs lower than Schwab's costs of borrowing from alternative sources (e.g., balances in Schwab One (registered trademark) brokerage accounts) or at no interest cost (e.g., balances in other accounts and outstanding checks that have not yet cleared Schwab's bank), Schwab's cost of funds is reduced and its net income is enhanced. Such interest savings contribute substantially to Schwab's profitability and, if a significant reduction of customer cash balances were to occur, Schwab's borrowings from other sources would have to increase and such profitability would decline. To the extent Schwab's customers elect to have cash balances in their brokerage accounts swept into certain SchwabFunds (registered trademark) money market funds, the cash balances available to Schwab for investments or for financing margin loans are reduced. However, Schwab receives mutual fund service fees from such funds based on the daily average invested balances. See also \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1995 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and \"Regulation\" below.\nMutual Funds. CSIM provides investment advisory and administrative services ------------- to the SchwabFunds, which consisted of nine money market funds, six bond funds, three equity index funds and three asset allocation funds, containing stocks, bonds and cash equivalents, at December 31, 1995. Customer assets invested in the SchwabFunds totaled approximately $31.7 billion at December 31, 1995, a 36% increase over the prior year. The Company intends to offer additional proprietary mutual funds to its customers in the future. Through its Mutual Fund Marketplace (registered trademark) program, Schwab purchases and redeems for its customers shares of over 1000 mutual funds in over 200 fund families sponsored by third parties. At December 31, 1995, the Mutual Fund Marketplace totaled $50.0 billion in customer assets, including $23.9 billion in the Mutual Fund OneSource (registered trademark) service. The Mutual Fund Marketplace program provides Schwab's customers with the convenience of purchasing and redeeming mutual fund shares with a single telephone call and of using margin credit to purchase most mutual fund shares. Schwab charges a transaction fee on trades placed in the funds included in its Mutual Fund Marketplace (except as described below). Commissions from customer transactions in mutual fund shares comprised approximately 8% of Schwab's total commission revenues in 1995, compared to approximately 11% in 1994 and approximately 9% in 1993. At December 31, 1995, Schwab's Mutual Fund OneSource service enabled customers to trade 370 mutual funds in 44 well-known fund families without incurring brokerage transaction fees. The service is particularly attractive to investors who execute mutual fund trades directly with multiple mutual fund companies to avoid brokerage transaction fees and achieve investment diversity among fund families. While Schwab does not receive transaction fees (commissions) on customer transactions in the Mutual Fund OneSource program, it is compensated directly by the participating funds or their sponsors via fees received for providing record keeping and shareholder services. Such compensation is ongoing, based on daily balances of customer assets invested in the participating funds and held at Schwab.\n- 5 -\nMarket Making In Nasdaq and Exchange-Listed Securities. M&S provides trade ------------------------------------------------------- execution services in Nasdaq securities to broker-dealers, including Schwab, and institutional customers. In most instances, customer orders are routed directly to M&S' trading system and are executed automatically. M&S generally executes customer trades as principal. M&S business practices call for competitively- priced customer trade executions, generally defined as the highest bid price on a sell order and the lowest offer price on a buy order available through the National Association of Securities Dealers (NASD) member firms. Certain customer trades are executed on a negotiated basis. Substantially all Nasdaq security trades originated by the customers of Schwab are directed to M&S. In 1995's third quarter, the Company introduced a new service, Assurance Trading (trademark), which provides customers an opportunity for price improvement on certain trades in certain Nasdaq securities through the scanning of multiple computer systems for a price better than the current quoted Nasdaq inside price. During 1994, Schwab commenced operation of specialist posts on the Pacific Stock Exchange to make markets in exchange-listed securities and ended that year with five posts that collectively made markets in over 240 securities. At December 31, 1995, Schwab had fourteen specialist posts that collectively made markets in approximately 700 securities. The majority of trades originated by the customers of Schwab in exchange-listed securities for which Schwab makes a market are directed to these posts. In the normal course of its market making in Nasdaq and exchange-listed securities activities, M&S and Schwab maintain inventories in such securities on both a long and short basis. While long inventory positions represent M&S' and Schwab's ownership of securities, short inventory positions represent obligations of M&S and Schwab to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, long or short inventory positions may result in gains or losses as market values of such securities fluctuate.\nServices for Independent Investment Managers. To attract the business of --------------------------------------------- accounts managed by fee-based independent investment managers, Schwab has a dedicated group through which, among other things, it assigns specific, experienced registered representatives to individual managers and occasionally provides certain research materials for the benefit of the managed accounts. Independent investment managers participating in this program may use SchwabLink (trademark) to access information in their customers' accounts directly from Schwab's computer data bases and to enter their customers' trades online. During 1995, Schwab added approximately 800 independent investment managers to this program, which at December 31, 1995 totaled more than 5,600. Schwab's brokerage business generated by independent investment managers and other professional investors represented approximately 13% of Schwab's total commission revenues in 1995, 14% in 1994 and 11% in 1993.\nCustomer Service Delivery Systems\nBranch Office Network. Schwab believes that the existence of branch offices ---------------------- is important to increasing new account openings and maintaining high levels of customer satisfaction. At December 31, 1995, the Company maintained a network of over 225 branches throughout the United States, including a branch office in the Commonwealth of Puerto Rico and the United Kingdom. Schwab plans to continue its branch expansion program in 1996 by opening approximately 10 to 15 new branches. Customers can use branch offices to obtain market information, place orders, open accounts, deliver and receive checks and securities, and obtain related customer services in person, yet most branch activities are conducted by telephone and mail. Branch offices remain open during normal market hours to service customers in person and by telephone. Many branch offices offer extended office hours. Customer calls received during nonbranch hours are routed to regional customer telephone service centers.\nRegional Customer Telephone Service Centers. Schwab's four regional customer -------------------------------------------- telephone service centers, located in Indianapolis, Denver, Phoenix and Orlando, handle calls to many of Schwab's toll-free numbers, customer calls that otherwise would have to wait for available registered representatives at branches during business hours, and calls routed from branches after hours and on weekends. Through the service centers, customers may place orders twenty- four hours a day, seven days a week, except for certain holidays. Customer orders placed during nonmarket hours are routed to appropriate markets the following business day. The capacity of the service centers allows new branches to be opened and maintained at lower staffing levels.\nElectronic Delivery Services. Schwab provides automated brokerage services ----------------------------- through which investors may place orders, receive account information and obtain securities market information. These services are designed to provide added convenience for customers and minimize Schwab's costs of responding to and processing routine customer transactions. Schwab's TeleBroker Service (registered trademark) enables customers to place orders for stocks, options and certain mutual funds, including Mutual Fund OneSource (registered trademark) transactions, as well as obtain real-time securities quotes and account information electronically from any touchtone telephone. TeleBroker,\n- 6 -\nwhich provides customers with an additional 10% discount on commissions, has become increasingly important in providing customers access to Schwab, particularly during periods of heavy customer activity. In 1994, Schwab introduced TeleBroker (registered trademark) in Spanish, and in 1995 Mandarin and Cantonese languages were added. Online access to brokerage and investment information services is also available through Schwab's online trading software, StreetSmart (registered trademark) for Windows (registered trademark) and Macintosh (registered trademark), introduced in October 1993 and July 1994, respectively. In 1995, Schwab enhanced its electronic delivery services by introducing a new online trading software, e.Schwab (trademark), and upgrading StreetSmart to a more powerful version. During 1995, TeleBroker and other electronic brokerage services handled over 75% of Schwab's customer calls.\nInformation Systems\nSchwab's operations rely heavily on its information processing and communications systems. Schwab's system for processing a securities transaction is highly automated. Registered representatives equipped with online computer terminals can access customer account information, obtain securities prices and related information, and enter orders online. To support its customer service delivery systems, as well as other applications such as clearing functions, account administration, record keeping and direct customer access to investment information, Schwab maintains a sophisticated computer network connecting all of the branch offices and regional customer telephone service centers. Schwab's computers are also linked to the major registered United States securities exchanges, M&S, the National Securities Clearing Corporation and The Depository Trust Company. Failure of Schwab's information processing or communications systems for a significant period of time could limit Schwab's ability to process its large volume of transactions accurately and rapidly. This could cause Schwab to be unable to satisfy its obligations to customers and other securities firms, and could result in regulatory violations. External events, such as an earthquake or power failure, loss of external information feeds, such as security price information, as well as internal malfunctions, such as those that could occur during the implementation of system modifications, could render part of or all such systems inoperative. To enhance the reliability of the system and integrity of data, Schwab maintains carefully monitored backup and recovery functions. These include logging of all critical files intraday, duplication and storage of all critical data outside of its central computer site every 24 hours, and maintenance of facilities for backup and communications in San Francisco. They also include the maintenance and periodic testing of a disaster recovery plan that management believes would permit Schwab to recommence essential computer operations if its central computer site were to become inaccessible. To reduce the exposure to system failures caused by external factors, including earthquakes, the Company relocated its primary data center in 1993 from San Francisco to a newly constructed and owned site in Phoenix.\nClearing and Account Maintenance\nSchwab performs clearing services for all securities transactions in customer accounts. Schwab clears the vast majority of customer transactions through the facilities of the National Securities Clearing Corporation or the Options Clearing Corporation. Certain other transactions, such as mutual fund transactions and transactions in securities not eligible for settlement through a clearing corporation, are settled directly with the mutual funds or other financial institutions. Schwab is obligated to settle transactions with clearing corporations, mutual funds and other financial institutions even if Schwab's customer fails to meet his or her obligations to Schwab. In addition, for transactions that do not settle through a clearing corporation, Schwab takes the risk of the other party's failure to settle the trade. See \"Financial Instruments with Off-Balance-Sheet and Credit Risk\" in the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\nEmployees\nAs of December 31, 1995, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of approximately 9,200 full-time employees, including approximately 8,000 full-time employees and part-time equivalents. None of the employees are represented by a union, and the Company believes its relations with its employees are good.\nRegulation\nThe securities industry in the United States is subject to extensive regulation under both Federal and state laws. The SEC is the Federal agency charged with administration of the Federal securities laws. Schwab and M&S are registered as broker-dealers with the SEC. Schwab and CSIM are registered as investment advisers with the SEC. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the\n- 7 -\nNASD and the national securities exchanges such as the New York Stock Exchange, Inc. (NYSE), which has been designated by the SEC as Schwab's primary regulator with respect to its securities activities. The NASD has been designated by the SEC as M&S' primary regulator with respect to its securities activities. During 1995, the American Stock Exchange was Schwab's designated primary regulator with respect to options trading activities. The Chicago Board Options Exchange is Schwab's designated primary regulator with respect to options trading activities for 1996. These self-regulatory organizations adopt rules (subject to approval by the SEC) governing the industry and conduct periodic examinations of broker-dealers. Securities firms are also subject to regulation by state securities authorities in the states in which they do business. Schwab was registered as a broker-dealer in 50 states, the District of Columbia and Puerto Rico as of December 31, 1995. M&S was registered as a broker-dealer in 22 states as of December 31, 1995. The principal purpose of regulations and discipline of broker-dealers and investment advisers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of broker-dealers and investment advisers. The regulations to which broker-dealers and investment advisers are subject cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of customers' funds and securities, capital structure of securities firms, record keeping, fee arrangements, disclosure to clients, and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and by self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules may directly affect the method of operation and profitability of broker-dealers and investment advisers. The SEC, self-regulatory organizations and state securities authorities may conduct administrative proceedings which can result in censure, fine, cease and desist orders, or suspension or expulsion of a broker-dealer or an investment adviser, its officers, or employees. Schwab and M&S have been the subject of such administrative proceedings. M&S is a significant participant in the Nasdaq market. During 1994, the Department of Justice, the SEC and the NASD commenced a series of investigations and regulatory actions involving the activities of many market makers in Nasdaq securities. These investigations and regulatory actions have continued into 1996. Current and proposed rulemaking, regulatory actions, improvements in technology, such as those which permit the introduction of Assurance Trading (trademark) (see also \"Market Making in Nasdaq and Exchange-Listed Securities\" above), changes in market practices and new market systems, if approved, could significantly impact the manner in which business is currently conducted in the Nasdaq market. The above factors, individually or in the aggregate, have had and could continue to have a material adverse impact on M&S' revenues from principal transactions. As registered broker-dealers and NASD member organizations, Schwab and M&S are required by Federal law to belong to the Securities Investor Protection Corporation (SIPC), which provides, in the event of the liquidation of a broker- dealer, protection for securities held in customer accounts held by the firm of up to $500,000 per customer, subject to a limitation of $100,000 on claims for cash balances. SIPC is funded through assessments on registered broker-dealers. In addition, in 1995, Schwab has purchased from private insurers additional account protection of up to $49.5 million per customer, as defined, for customer securities positions only. Stocks, bonds, mutual funds and money market funds are considered securities and are protected on a share basis for the purposes of SIPC protection and the additional protection (i.e., protected securities may either be replaced or converted into an equivalent market value as of the date a SIPC trustee is appointed). Neither SIPC protection nor the additional protection applies to fluctuations in the market value of securities. Schwab is also authorized by the Municipal Securities Rulemaking Board to effect transactions in municipal securities on behalf of its customers and has obtained certain additional registrations with the SEC and state regulatory agencies necessary to permit it to engage in certain other activities incidental to its brokerage business. Margin lending by Schwab and M&S is subject to the margin rules of the Board of Governors of the Federal Reserve System and the NYSE. Under such rules, broker-dealers are limited in the amount they may lend in connection with certain purchases and short sales of securities and are also required to impose certain maintenance requirements on the amount of securities and cash held in margin accounts. In addition, those rules and rules of the Chicago Board Options Exchange govern the amount of margin customers must provide and maintain in writing uncovered options. As a California state-chartered trust company, CSTC is authorized to conduct business in California, and is primarily regulated by the California State Banking Department. Since it provides employee benefit plan trust services, CSTC is also required to comply with the Employee Retirement Income Security Act of 1974 (ERISA) and, consequently, is subject to oversight by both the Internal Revenue Service and Department of Labor. CSTC is required under ERISA to maintain a fidelity bond for the protection of employee benefit trusts for which it serves as trustee. Charles Schwab Limited, a subsidiary of Schwab, is registered as an arranger with the Securities and Futures Authority (SFA) in the United Kingdom, and engages in business development activities on behalf of Schwab. ShareLink Limited, a subsidiary of ShareLink, is registered as a broker-dealer with the SFA in the United Kingdom.\n- 8 -\nNet Capital Requirements\nAs registered broker-dealers, Schwab and M&S are subject to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC (the Net Capital Rule), which has also been adopted through incorporation by reference in NYSE Rule 325. Schwab is a member firm of the NYSE and the NASD, and M&S is a member firm of the NASD. The Net Capital Rule specifies minimum net capital requirements for all registered broker-dealers and is designed to measure financial integrity and liquidity. Failure to maintain the required net capital may subject a firm to suspension or expulsion by the NYSE and the NASD, certain punitive actions by the SEC and other regulatory bodies, and ultimately may require a firm's liquidation. Because CSC itself is not a registered broker-dealer, it is not subject to the Net Capital Rule. However, if Schwab failed to maintain specified levels of net capital, such failure would constitute a default by CSC under certain debt covenants. \"Net capital\" is essentially defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings, less certain deductions that result from excluding assets that are not readily convertible into cash and from conservatively valuing certain other assets. These deductions include charges that discount the value of firm security positions to reflect the possibility of adverse changes in market value prior to disposition. The Net Capital Rule requires notice of equity capital withdrawals to be provided to the SEC prior to and subsequent to withdrawals exceeding certain sizes. Such rule prohibits withdrawals that would reduce a broker-dealer's net capital to an amount less than 25% of its deductions required by the Net Capital Rule as to its security positions. The Net Capital Rule also allows the SEC, under limited circumstances, to restrict a broker-dealer from withdrawing equity capital for up to 20 business days. Schwab and M&S have elected the alternative method of calculation under paragraph (a)(1)(ii) of the Net Capital Rule, which requires a broker-dealer to maintain minimum net capital equal to 2% of its \"aggregate debit items,\" computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (SEC Rule 15c3-3). \"Aggregate debit items\" are assets that have as their source transactions with customers, primarily margin loans. Under the alternative method of the Net Capital Rule, a broker- dealer may not (a) pay, or permit the payment or withdrawal of, any subordinated borrowings or (b) pay cash dividends or permit equity capital to be removed if, after giving effect to such payment, withdrawal, or removal, its net capital would be less than 5% of its aggregate debit items. Under NYSE Rule 326, Schwab is required to reduce its business if its net capital is less than 4% of aggregate debit items for more than 15 consecutive business days; NYSE Rule 326 also prohibits the expansion of business if net capital is less than 5% of aggregate debit items for more than 15 consecutive business days. The provisions of NYSE Rule 326 also become operative if capital withdrawals (including scheduled maturities of subordinated borrowings during the following six months) would result in a reduction of a firm's net capital to the levels indicated. If compliance with applicable net capital rules were to limit Schwab's or M&S' operations and their ability to repay subordinated debt to CSC, this in turn could limit CSC's ability to repay debt, pay cash dividends and purchase shares of its outstanding stock. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1995 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. At December 31, 1995, Schwab was required to maintain minimum net capital under the Net Capital Rule of $82 million and had total regulatory net capital of $392 million. At December 31, 1995, the amounts in excess of 2%, 4% and 5% of aggregate debit items were $310 million, $229 million and $188 million, respectively. At December 31, 1995, M&S was required to maintain minimum net capital under the Net Capital Rule of $1 million and had total regulatory net capital of $6 million. At December 31, 1995, the amount in excess of 2% of aggregate debit items exceeded $5 million. CSTC's capital requirement is established by the California Superintendent of Banks under the California Financial Code (the Code). The Code requires that CSTC's ratio of contributed capital, as defined, to accumulated deficit shall exceed 2.5 to 1. At December 31, 1995, the ratio of contributed capital to accumulated deficit was 3.0 to 1. If CSTC's capital declines, or if the California Superintendent of Banks determines that additional capital is required for other reasons, CSC could be required to contribute additional capital to CSTC.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's corporate headquarters are located in a 28-story building at 101 Montgomery Street in San Francisco, California. The building contains approximately 296,000 square feet and is leased by Schwab under a term expiring in the year 2000. The current rental is approximately $8.7 million per year, subject to certain increases and obligations to pay certain operating expenses such as utilities, insurance and taxes. Schwab has three successive five-year options to renew the lease at the then market rental value. Schwab also leases space in other buildings for its San Francisco operations aggregating approximately 443,000 additional square feet at year-end 1995. M&S' headquarters are located in leased office space in Jersey City, New Jersey.\n- 9 -\nThe Company's primary data center is located in Phoenix, Arizona in a 105,000 square feet facility owned by the Company. All of Schwab's branch offices and three of its regional customer telephone service centers and M&S' branch offices are located in leased premises, generally with lease expiration dates five to ten years from inception. In September 1995, the Company entered into an agreement to purchase an office building containing approximately 330,000 square feet located in Phoenix, Arizona to be used for the expansion of its operations. The Company expects to close this transaction in April 1996 using general corporate resources or external financing.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information required to be furnished pursuant to this item is set forth under the caption \"Commitments and Contingent Liabilities\" in the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 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 Company's security holders during the fourth quarter of 1995.\nItem 4a. Executive Officers of the Registrant\nSee Item 10 in Part III of this report.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock is listed on the New York and Pacific Stock Exchanges under the ticker symbol SCH. The number of common stockholders of record as of February 9, 1996 was 2,486. The other information required to be furnished pursuant to this item is set forth under the caption \"Quarterly Financial Information (Unaudited)\" in the Company's 1995 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required to be furnished pursuant to this item is set forth under the captions \"Operating Results (for the year),\" \"Other (for the year)\" and \"Other (at year end)\" in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required to be furnished pursuant to this item is set forth under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1995 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Average balances and interest rates for the fourth quarters of 1995 and 1994 are summarized as follows (dollars in millions):\nThe increase in interest revenue, net of interest expense, from the fourth quarter of 1994 to the fourth quarter of 1995 was primarily due to higher levels of earning assets, partially\n- 10 -\noffset by increases in average interest rates on funding sources compared to earning assets.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required to be furnished pursuant to this item is set forth in the Consolidated Financial Statements and under the caption \"Quarterly Financial Information (Unaudited)\" in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 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 directors of the Company required to be furnished pursuant to this item is incorporated by reference from portions of the Company's definitive proxy statement for its annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after December 31, 1995 (the Proxy Statement) under the captions \"Election of Directors\" (excluding all information under the caption \"Information about the Board of Directors and Committees of the Board\") and \"Principal Stockholders.\"\nExecutive Officers of the Registrant\nThe following table provides certain information about each of the Company's current executive officers. Executive officers are elected by and serve at the discretion of the Company's Board of Directors. However, Mr. Schwab has an employment agreement with the Company through March 2000, which includes an automatic renewal feature that, as of each March 31 (beginning in 1996), extends the agreement for an additional year unless either party elects to not extend the agreement.\nExecutive Officers of the Registrant\n- 11 -\nMr. Schwab has been Chairman and Chief Executive Officer and a director of the Company since its incorporation in November 1986. Mr. Schwab was a founder of Schwab in 1971 and has been its Chairman since 1978. Mr. Schwab is currently a director of The Gap, Inc., Transamerica Corporation, AirTouch Communications and a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios, all registered investment companies.\nMr. Stupski has been Vice Chairman of the Company since July 1992 and a director of the Company since its incorporation in November 1986. Mr. Stupski was Chief Operating Officer of the Company from November 1986 to March 1994 and the Company's President from November 1986 to July 1992. He also served as Chief Executive Officer and Chief Operating Officer of Schwab from July 1988 to July 1992. He served as Vice Chairman of Schwab from July 1992 to August 1994.\nMr. Pottruck has been Chief Operating Officer and a director of the Company since March 1994, President of the Company and Chief Executive Officer of Schwab since July 1992, and President of Schwab since July 1988. Mr. Pottruck was Executive Vice President of the Company and Schwab from March 1987 to July 1992. Mr. Pottruck joined Schwab in March 1984.\nMr. Coghlan has been Executive Vice President of the Company and Schwab and General Manager of Schwab Institutional since July 1992. Mr. Coghlan joined Schwab in January 1986, became Vice President in 1988 and became Senior Vice President in 1990.\nMr. Gambs has been Executive Vice President - Finance, and Chief Financial Officer of the Company and Schwab since he joined the Company in March 1988.\nMr. Leemon has been Executive Vice President - Business Strategy of the Company and Schwab since September 1995. Before joining the Company in September 1995, Mr. Leemon held various positions with The Boston Consulting Group, Inc., a management consulting firm, from 1989 to 1995, including Vice President from 1990.\nMs. Lepore has been Executive Vice President and Chief Information Officer of the Company and Schwab since October 1993. Ms. Lepore joined Schwab in September 1983 and became Senior Vice President in 1989.\nMr. McCarthy has been Executive Vice President - Mutual Funds of the Company and Schwab and Chief Executive Officer of Charles Schwab Investment Management, Inc. since September 1995. Before joining the Company in September 1995, Mr. McCarthy was Chief Executive Officer of Jardine Fleming Unit Trusts Ltd., a mutual fund company, from 1994 to 1995. From 1987 to 1994, he held various executive positions with Fidelity Investments, including President of Fidelity Investments Advisor Group, President of National Financial Institutional Services and Executive Director of Fidelity Brokerage Group.\nMs. Sawi has been Executive Vice President - Electronic Brokerage of the Company and Schwab since May 1995. Ms. Sawi was President of Charles Schwab Investment Management, Inc. from April 1994 to September 1995. From April 1994 to May 1995, she was Executive Vice President - Mutual Funds of the Company and Schwab. Prior to that, Ms. Sawi was Executive Vice President - Marketing and Advertising of the Company and Schwab from January 1992 to April 1994. Ms. Sawi joined Schwab in November 1982.\nMr. Seip has been Executive Vice President - Retail Brokerage of the Company and Schwab since April 1994. He was President of Charles Schwab Investment Management, Inc. (CSIM) from July 1992 to April 1994 and Chief Operating Officer of CSIM from June 1991 to April 1994. From July 1992 to April 1994, Mr. Seip was Executive Vice President - Mutual Funds and Fixed Income Products of the Company and Schwab. He joined Schwab in January 1983. Prior to becoming Senior Vice President of Schwab and assuming his mutual fund responsibilities in June 1991, Mr. Seip was the divisional executive in charge of Schwab's retail branches east of the Mississippi.\nMr. Valencia has been Executive Vice President and Chief Administrative Officer of the Company and Schwab since February 1996. From March 1994 to February 1996, Mr. Valencia was Executive Vice President - Human Resources of the Company and Schwab. Before joining the Company in March 1994, he served as a Managing Director of Commercial Credit Corp., a subsidiary of the Travelers engaged in consumer finance for the Travelers, from January 1993 to February 1994. From 1975 to 1993, Mr. Valencia held various positions with Citicorp, including President and Chief Executive Officer of Transaction Technology, a subsidiary of Citicorp, from 1990 to 1993.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under the captions \"Executive Compensation\" (excluding all information under the caption \"Board Compensation Committee Report on Executive\n- 12 -\nCompensation\" and \"Performance Graph\") and \"Certain Transactions.\"\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under the caption \"Principal Stockholders.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required to be furnished pursuant to this item is incorporated by reference from a portion of the Proxy Statement under the caption \"Certain Transactions.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of this Report --------------------------------------\n1. Financial Statements\nThe financial statements and independent auditors' report are set forth in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report and are listed below:\nConsolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Stockholders' Equity Notes to Consolidated Financial Statements Independent Auditors' Report\n2. Financial Statement Schedules\nThe financial statement schedules required to be furnished pursuant to this item are listed in the accompanying index appearing on page.\n(b) Reports on Form 8-K -------------------\nNone filed during the last quarter of 1995.\n- 13 -\n(c) Exhibits --------\nThe exhibits listed below are filed as part of this annual report on Form 10-K.\n- 18 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 28, 1996.\nTHE CHARLES SCHWAB CORPORATION (Registrant)\nBY: \/s\/ CHARLES R. SCHWAB ----------------------- Charles R. Schwab Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on March 28, 1996.\n- 19 -\nTHE CHARLES SCHWAB CORPORATION\nIndex to Financial Statement Schedules\nPage ----\nIndependent Auditors' Report\nSchedule I - Condensed Financial Information of Registrant: Condensed Balance Sheet Condensed Statement of Income and Retained Earnings Condensed Statement of Cash Flows\nSchedule II - Valuation and Qualifying Accounts\nSchedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the Company's consolidated financial statements and notes in the Company's 1995 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\nINDEPENDENT AUDITORS' REPORT - ------------------------------\nTo the Stockholders and Board of Directors of The Charles Schwab Corporation:\nWe have audited the consolidated financial statements of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 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 21, 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 schedules of the Company and subsidiaries appearing on pages through. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP San Francisco, California February 21, 1996\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Balance Sheet (In thousands, except share data)\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Statement of Income and Retained Earnings (In thousands)\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Statement of Cash Flows (In thousands)\nSCHEDULE II\nTHE CHARLES SCHWAB CORPORATION\nValuation and Qualifying Accounts (In thousands)","section_15":""}
{"filename":"708819_1995.txt","cik":"708819","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nDue to the nature of its business, McDermott International is, from time to time, involved in litigation. It is management's opinion that none of this litigation will have a material adverse effect on the consolidated financial position of McDermott International.\nFor a discussion of McDermott International's potential liability for non-employee products liability asbestos claims see Item 1F and Note 1 to the consolidated financial statements.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.\nPART I I\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nInternational's Common Stock is traded on the New York Stock Exchange. High and low stock prices and dividends declared for the fiscal years ended March 31, 1995 and 1994 follow:\nFISCAL YEAR 1994 ----------------\nFISCAL YEAR 1995 ----------------\nAs of March 31, 1995, the approximate number of record holders of Common Stock was 6,673.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSee Note 1 to the consolidated financial statements regarding the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 112 in fiscal year 1995, Emerging Issues Task Force Issue No. 93-5 in fiscal year 1994 and SFAS No. 106 and SFAS No. 109 in fiscal year 1993. See Note 2 regarding the acquisition of OPI in fiscal year 1995 and the acquisitions of Northern Ocean Services Limited and DCC in fiscal year 1994. See Note 10 regarding the uncertainty as to the ultimate loss relating to products liability asbestos claims.\nIn fiscal year 1995, Income before Cumulative Effect of Accounting Change included after tax charges of $30,218,000 for provisions for the decontamination, decommissioning and closing of certain nuclear manufacturing facilities and the closing of a manufacturing facility, and $8,832,000 for the reduction of estimated products liability asbestos claims recoveries from insurers. Also, in fiscal year 1995, after tax income included $16,631,000 for a reduction in accrued interest expense due to the settlement of outstanding tax issues. In fiscal year 1993 and 1992, Income from Continuing Operations before Extraordinary Items and Cumulative Effect of Accounting Changes included after tax gains from the sale of McDermott International's interest in its two commercial nuclear joint ventures of $15,667,000 and $35,436,000, respectively.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nA significant portion of McDermott International's revenues and operating results are derived from its foreign operations. As a result, McDermott International's operations and financial results could be significantly affected by international factors, such as changes in foreign currency exchange rates. McDermott International's policy is to minimize its exposure to changes in foreign currency exchange rates by attempting to match foreign currency contract receipts with like foreign currency disbursements during contract negotiations. To the extent that it is unable to match the foreign currency receipts and disbursements related to its contracts, it enters into forward exchange contracts to hedge foreign currency transactions on a continuing basis for periods consistent with its committed exposures. This practice minimizes the impact of foreign exchange rate movements on McDermott International's operating results.\nFISCAL YEAR 1995 VS FISCAL YEAR 1994\nPower Generation Systems and Equipment's revenues increased $49,029,000 to $1,663,235,000. This was primarily due to higher revenues from fabrication and erection of fossil fuel steam and environmental control systems, nuclear fuel assemblies and reactor components for the U. S. Government, replacement nuclear steam generators, repair and alteration of existing fossil fuel steam systems, and operations and maintenance contracts for small power plants. These increases were partially offset by lower revenues from defense and space-related products (other than nuclear fuel assemblies and reactor components), extended scope of supply and fabrication of industrial boilers, and replacement parts.\nPower Generation Systems and Equipment's segment operating income decreased $29,131,000 to $20,810,000 due to provisions for the decontamination, decommissioning and closing of certain nuclear manufacturing facilities and the closing of a manufacturing facility ($46,489,000) and a favorable warranty reserve recorded in the prior year ($11,000,000). Operating income increased due to lower operating expenses (including favorable workers compensation adjustments) and administrative expenses (including cost reduction initiatives); higher volume and margins on operations and maintenance contracts; and improved margins on plant enhancement projects. These increases were partially offset by lower volume and margins on extended scope of supply and fabrication of industrial boilers, lower volume on replacement parts, and lower margins on nuclear fuel assemblies and reactor components for the U. S. Government.\nPower Generation Systems and Equipment's equity in income of investees decreased $3,668,000 to $8,364,000 primarily due to a provision for loss on discontinuing a domestic joint venture and lower operating results in a foreign joint venture.\nBacklog for this segment at March 31, 1995 was $2,058,215,000 compared to $2,398,285,000 at March 31, 1994. At March 31, 1995 this segment's backlog with the U.S. Government was $631,578,000 (of which $21,607,000 had not been funded). U.S\nGovernment budget reductions have negatively affected this segment's government operations, and backlog at March 31, 1995 and 1994 reflects the impact of Congressional budget reductions on the advanced solid rocket motor and super conducting super collider projects in prior years. The current competitive economic environment has also negatively affected demand for other industrial- related product lines and these markets are expected to remain very competitive.\nAs discussed (see Item 1F - Insurance), provisions for these estimated future costs for non-employee products liability asbestos claims have been recognized for financial reporting purposes during fiscal years 1995 and 1994 (see Note 1 to the consolidated financial statements and the discussion of Other-net expense and Liquidity below). Inherent in the estimate of these liabilities and recoveries are expected trends in claim severity and frequency and other factors, including recoverability from insurers, which may vary significantly as claims are filed and settled.\nThe current competitive economic environment for the electric power industry in the United States has intensified, as the Federal Energy Regulatory Commission has begun to implement the provisions of the Energy Policy Act of 1992, which deregulated the electric power generation industry by allowing independent power producers and other companies access to its transmission and distribution systems, and the Clean Air Act amendments of 1990 have caused U. S. utilities to defer ordering large new baseload power plants and to defer repairs and refurbishments on existing plants. Most electric utilities have already purchased equipment to comply with Phase I of the Clean Air Act, and many will defer purchases of new equipment to comply with Phase II deadlines until after the turn of the century. Electric utilities in Asia are active purchasers of large, new baseload generating units, due to the rapid growth of the Pacific Rim economies and to the small existing stock of electrical generating capacity in most developing countries.\nMarine Construction Services' revenues decreased $61,578,000 to $1,390,919,000, primarily due to lower volume in worldwide marine and domestic fabrication operations. These decreases were partially offset by the inclusion of revenues as a result of the acquisitions of Offshore Pipelines, Inc. (\"OPI\") ($44,439,000) on January 31, 1995 and Northern Ocean Services (\"NOS\") ($59,644,000 for the full fiscal year) in February 1994 (See Note 2 to the Consolidated Financial Statements), and higher volume in foreign fabrication and procured materials.\nMarine Construction Services' segment operating income increased slightly to $44,619,000 (including $4,993,000 from OPI) from $44,394,000 primarily due to improved margins in foreign marine operations, inclusion of the operating results of NOS for the full fiscal year; and higher volume of procured materials, domestic engineering operations, and foreign fabrication. These increases were mostly offset by higher operating expenses, lower operating results from DCC's operations, lower margins from shipyard operations, and start-up costs associated with new shipbuilding activities.\nMarine Construction Services' equity in income of investees decreased $82,340,000 to $25,488,000 primarily due to lower operating volume and margins of the McDermott ETPM-West, Inc. and HeereMac joint ventures.\nBacklog for this segment at March 31, 1995 and 1994 was $1,510,117,000 (including $46,396,000 from the acquisition of OPI) and $1,054,142,000, respectively. Not included in backlog at March 31, 1995 and 1994 was backlog relating to contracts to be performed by unconsolidated joint ventures of approximately $1,014,000,000 and $840,000,000, respectively.\nThe activity of McDermott International depends mainly on the capital expenditures of oil and gas companies which in turn are influenced by world oil and gas prices. World oil and gas prices are expected to remain weak in the near term resulting in a negative impact on new business awards. In addition, the continued overcapacity of marine equipment worldwide has resulted in a competitive environment and put pressure on operating profit margins worldwide. In fiscal year 1995, McDermott International's unconsolidated affiliates performed at significantly lower levels as several large contracts were completed in fiscal year 1994 and are expected to remain at low levels in fiscal 1996 and 1997.\nInterest income increased $13,989,000 to $52,740,000 primarily due to recognition of interest on a receivable from an equity investee, settlement of claims for interest relating to foreign tax refunds and contract claims, and higher interest rates on investments in government obligations and other investments.\nInterest expense decreased $6,860,000 to $57,115,000, primarily due to a reduction of accrued interest on proposed tax deficiencies, partially offset by changes in debt obligations and interest rates prevailing thereon.\nMinority interest expense decreased $3,084,000 to $12,167,000 primarily due to minority shareholder participation in increased losses of DCC and JRM's losses for the two months ended March 31, 1995. These decreases in expense were partially offset by an increase due to minority shareholder participation in the improved results of the McDermott-ETPM East joint venture.\nOther-net expense increased $28,926,000 to $33,291,000 primarily due to a loss related to the reduction of estimated products liability asbestos claim recoveries from insurers, a provision for the settlement of a lawsuit and losses on the sales of investment securities in the current period.\nThe provision for income taxes decreased $45,041,000 from a provision of $24,998,000 to a benefit of $20,043,000, while income before income taxes and cumulative effect of accounting changes decreased $124,121,000. The reduction in income taxes is primarily due to a decrease in income from operations along with a reduction in a provision for taxes due to a settlement of outstanding issues and higher non-taxable earnings. In addition, McDermott International operates in many different tax jurisdictions. Within these jurisdictions, tax provisions vary because of nominal rates, allowability of deductions, credits and other benefits, and even tax basis (for example, revenues versus income). These variances, along with variances in the mix of income within jurisdictions, are responsible for shifts in the effective tax rate. As a result of these factors, the benefit from income taxes was 219% of pretax loss in fiscal year 1995 compared to a provision for income taxes of 22% of pretax income in fiscal year 1994.\nNet lncome increased $19,905,000 from a loss of $10,794,000 to income of $9,111,000 reflecting the cumulative effect of the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" of $1,765,000 in the current year and the cumulative effect of accounting change for non-employee products liability asbestos claims of $100,750,000 in the prior year, in addition to other items described above.\nFISCAL YEAR 1994 VS FISCAL YEAR 1993\nPower Generation Systems and Equipment's revenues increased $90,730,000 to $1,614,206,000. This was primarily due to higher revenues from fabrication and erection of fossil fuel steam and environmental control systems, replacement nuclear steam generators, repair and alteration of existing fossil fuel steam systems, and nuclear fuel assemblies and reactor components for the U. S. Government. These increases were partially offset by lower revenues from extended scope of supply and fabrication of industrial boilers, defense and space-related products other than nuclear fuel assemblies and reactor components, and air cooled heat exchangers.\nPower Generation Systems and Equipment's segment operating income decreased $6,526,000 to $49,941,000. This was primarily due to lower volume and margins on extended scope of supply and fabrication of industrial boilers as well as defense and space-related products other than nuclear fuel assemblies and reactor components. There were also lower margins on plant enhancements, replacement parts, and repair and alteration of existing fossil fuel steam systems, as well as higher royalty income recorded in the prior year. These decreases were partially offset by higher volume and margins on replacement nuclear steam generators, nuclear fuel assemblies and reactor components for the U. S. Government and higher volume on fabrication and erection of fossil fuel steam and environmental control systems. There were also lower general and administrative expenses, and lower warranty expense primarily due to net favorable warranty reserve adjustments.\nPower Generation Systems and Equipment's equity in income of investees increased $3,341,000 to $12,032,000 primarily due to improved results in a foreign joint venture and in three domestic joint ventures which own and operate a cogeneration plant and two small power plants, partially offset by unfavorable results in another foreign joint venture.\nMarine Construction Services' revenues decreased $197,156,000 to $1,452,497,000, primarily due to lower volume in worldwide fabrication and engineering operations, foreign marine operations and procured materials. These decreases were partially offset by the acquisition of DCC.\nMarine Construction Services' segment operating income decreased $23,258,000 to $44,394,000, primarily due to lower volume in worldwide fabrication and engineering operations and lower volume in procured materials. These decreases were partially offset by the acquisition of DCC, higher margins in foreign marine operations, the accelerated depreciation and write-off of certain fabrication facilities and marine construction equipment in the prior year, and reduced operating costs.\nMarine Construction Services' equity in income of investees increased $22,461,000 to $107,828,000. This increase was principally due to improved operating results of the HeereMac joint venture.\nInterest income decreased $1,640,000 to $38,751,000. This decrease was primarily due to lower interest rates on investments in government securities and other long-term investments.\nInterest expense decreased $26,365,000 to $63,975,000, primarily due to changes in debt obligations and interest rates prevailing thereon. The decrease reflects the redemption of high coupon debt during April and June 1993, and a reduction in accrued interest on proposed tax deficiencies.\nMinority interest expense decreased $2,952,000 to $15,251,000 primarily due to minority shareholder participation in the losses of the McDermott-ETPM East joint venture in the current year and income in the prior year, partially offset by participation in the results of DCC since its acquisition in June 1993.\nOther-net decreased $14,562,000 to a loss of $4,365,000 from income of $10,197,000. This decrease was primarily due to gains on the sale of interests in two commercial nuclear joint ventures a foreign marine asset casualty gain and gains on the sale of nineteen tugboats, all in the prior period.\nProvision for income taxes decreased $15,101,000 to $24,998,000, while income from continuing operations before provision for income taxes, extraordinary items, and cumulative effect of accounting changes increased $7,532,000 to $114,954,000. The decrease in the provision for income taxes is primarily due to a reduction in a provision for taxes of $10,000,000 due to a settlement of outstanding issues and higher non-taxable earnings. In addition, McDermott International operates in many different tax jurisdictions. Within these jurisdictions, tax provisions vary because of nominal rates, allowability of deductions, credits and other benefits, and even tax basis (for example, revenues versus income). These variances, along with variances in the mix of income within jurisdictions, are responsible for shifts in the effective tax rate. During this period, these factors reduced the effective tax rate to 22% from 37%.\nNet loss decreased $177,938,000 to $10,794,000 reflecting the cumulative effect of the change in accounting for non-employee products liability asbestos claims of $100,750,000 in the current year and the cumulative effect of the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" of $249,351,000 in the prior year, in addition to other items described above.\nEffect of Inflation and Changing Prices\nMcDermott International's financial statements are prepared in accordance with generally accepted accounting principles, using historical dollar accounting (historical cost). Statements based on historical cost, however, do not adequately reflect the cumulative effect of increasing costs and changes in the purchasing power of the dollar, especially during times of significant and continued inflation.\nThe management of McDermott International is cognizant of the effects of inflation and, in order to minimize the negative impact of inflation on its operations, attempts to cover the increased cost of anticipated changes in labor, material and service costs, either through an estimation of such changes, which is reflected in an original price, or through price escalation clauses in its contracts.\nLiquidity and Capital Resources\nDuring fiscal year 1995, McDermott International's cash and cash equivalents decreased $47,900,000 to $85,909,000 and total debt increased $257,077,000 (including $120,200,000 assumed in the acquisition of OPI) to $986,687,000. During this period, McDermott International used cash of $97,890,000 for additions to property, plant and equipment; $61,827,000 for dividends on International's common and preferred stocks; $35,553,000 for repayment of long-term debt; $12,559,000 in operating activities; and $17,185,000 for the repurchase of a subsidiary's preferred stock to satisfy current and future sinking fund requirements.\nDecreases in accounts payable reflect settlement of charter obligations to the HeereMac joint venture and amounts owned to ETPM S.A. Higher payables due to increased volume at B&W's Canadian operations and activity on the Britoil contract for the Atlantic Frontier Programme Development of Foinaven Phase One Facility (\"Foinaven\") were offset by lower volume elsewhere. Increases in Net contracts in progress and advance billings were primarily due to the timing of billings on the Canadian and Foinaven contracts. Lower income taxes reflects payments made in Canada and changes in the domestic tax provision due to higher losses in the U.S., and accrued liabilities includes a reduction of accrued interest expense of $26,300,000 resulting from the settlement of outstanding tax issues with the IRS.\nPursuant to an agreement with the majority of its principal insurers, McDermott International negotiates and settles products liability asbestos claims from non-employees and bills these amounts to the appropriate insurers. As a result of collection delays inherent in the process, reimbursement is usually delayed for three months or more. The number of claims had declined moderately since fiscal year 1990, but have increased during the second half of fiscal year 1995. Management believes, based on information currently available, that the recent increase represents an acceleration in the timing of the receipt of these claims, but does not represent an increase in its total estimated liability. The average amount of these claims (historical average of approximately $4,800 per claim over the last three years) has continued to rise. Claims paid in fiscal year 1995 were $126,151,000, of which $111,163,000 has been recovered or is due from insurers. At March 31, 1995, Accounts receivable-other included receivables of $34,925,000 that are due from insurers for reimbursement of settled claims. During fiscal year 1995, McDermott International received notice that provisional liquidators have been appointed to a London-based products liability asbestos insurer and certain of its subsidiaries and as a result, a loss of $14,478,000 related to the reduction of estimated products liability asbestos claim recoveries was recognized. Estimated liabilities for pending and future non-employee products liability asbestos claims are derived from McDermott International's claims history and constitute management's best estimate of such future costs. Estimated insurance recoveries are based upon analysis of insurers providing coverage of the estimated liabilities. Inherent in the estimate of such liabilities and recoveries are expected trends in claim severity and frequency and other factors, including recoverability from insurers, which may vary significantly as claims are filed and\nsettled. Accordingly, the ultimate loss may differ materially from amounts provided in the consolidated financial statements. Settlement of the liability is expected to occur over approximately the next 25 years. The collection delays, and the amount of claims paid for which insurance recovery is not probable have not had a material adverse effect on McDermott International's liquidity, and management believes, based on information currently available, that they will not have a material adverse effect on liquidity in the future.\nMcDermott International's expenditures for property, plant and equipment increased $21,569,000 to $97,890,000 in fiscal year 1995. While the majority of these expenditures were incurred to maintain and replace existing facilities and equipment, $15,010,000 was expended for the purchase of a barge which was formerly leased by a subsidiary of International. McDermott International has committed to make capital expenditures of approximately $40,301,000 (including $9,457,000 for a new pipelay system on marine equipment and $14,286,000 for the conversion of a barge to a floating production unit) during fiscal 1996. The barge conversion is financed by a $16,700,000 note, payable in 30 monthly installments beginning with the completion of the conversion. Interest is at Libor plus 2%. There were no borrowings against this facility at March 31, 1995.\nAt March 31, 1995 and 1994, The Babcock & Wilcox Company had sold, with limited recourse, an undivided interest in a designated pool of qualified accounts receivable of approximately $175,000,000 and $170,000,000, respectively, under an agreement with a U. S. bank. The maximum sales limit available under the agreement, which expires on December 31, 1997 is $225,000,000. (See Note 7 to the consolidated financial statements).\nAt March 31, 1995 and 1994, International and its subsidiaries, had available to them various uncommitted short-term lines of credit from banks totaling $373,867,000 and $246,412,000, respectively. Borrowings against these lines of credit at March 31, 1995 and 1994 were $63,025,000 and $37,512,000, respectively. In addition, the Babcock & Wilcox Company had available to it a $128,000,000 unsecured and committed revolving line of credit facility. Loans outstanding under the revolving credit facility may not exceed the banks' commitments thereunder. In addition, it is a condition to borrowing under the revolving credit facility that the borrower's consolidated net tangible assets exceed a certain level. There were no borrowings against this facility at March 31, 1995 and 1994. DCC had available from a certain Canadian bank an unsecured and committed revolving credit facility of $14,184,000 which expires on May 31, 1997. Borrowings outstanding against this facility at March 31, 1995 were $7,420,000. There were no borrowings outstanding against this facility at March 31, 1994. In addition, JRM had available two secured and committed revolving credit facilities totaling $53,500,000 of which $24,500,000 was outstanding at March 31, 1995. Loans outstanding under these facilities were repaid and the facility terminated on May 10, 1995.\nIn consideration for the contribution of substantially all of McDermott International's marine construction services business, JRM issued 3,200,000 shares of Series A $2.25 Cumulative Convertible Preferred Stock, $231,000,000 9% Senior Subordinated Notes due 2001 and a $39,750,000 Floating Rate Note at 7.69% at the Merger Date (7.4375% at March 31, 1995) to International. The Floating Rate Note is due January 31, 1997 or earlier upon demand. JRM expects to pay this note during fiscal year 1996. In addition, a\nsubsidiary of JRM assumed all of OPI's $70,000,000 12-7\/8% Guaranteed Senior Notes due 2002. The Notes due 2002 are redeemable at the option of a subsidiary of JRM after June 1997. On June 7, 1995, JRM entered into an agreement with a group of banks to provide a $150,000,000 three year unsecured and committed line of credit to support the operating requirements of its domestic and international operations. JRM is restricted, as a result of covenants in these agreements, in its ability to transfer funds to International and its subsidiaries through cash dividends or through unsecured loans or investments. As approximately $40,000,000 of its net assets were not subject to these restrictions, they are not expected to impact JRM's ability to make preferred dividend payments.\nThe Delaware Company is restricted, as a result of covenants in credit agreements, in its ability to transfer funds to International and its subsidiaries through cash dividends or through unsecured loans or investments. Substantially all of the net assets of the Delaware Company is subject to such restrictions. It is not expected that these restrictions will have any significant effect on International's liquidity.\nMcDermott International maintains an investment portfolio of government obligations and other investments which is classified as available for sale under SFAS No. 115 (See Note 12 to the consolidated financial statements). The fair value of short-term investments and the long-term portfolio at March 31, 1995 was $715,093,000 (amortized cost $723,946,000). The net unrealized loss on the current and long-term investment portfolio, net of income tax effect, was $8,050,000 at March 31, 1995. At March 31, 1995, approximately $146,142,000 fair value (amortized cost of $148,422,000) of these obligations were pledged to secure a letter of credit in connection with a long-term loan and certain reinsurance agreements. In addition, McDermott International had obligations of $135,691,000 under short-term repurchase agreements which were secured by government obligations with a fair value of $134,673,000 at March 31, 1995.\nWorking capital decreased $106,442,000 to a deficit of $40,790,000 at March 31, 1995 from $65,652,000 at March 31, 1994. During 1996, McDermott International expects to obtain funds to meet capital expenditure, working capital and debt maturity requirements from operating activities, its short-term investment portfolio, and additional borrowings. On June 1, 1995, McDermott International repaid its 10.25% Notes of $150,000,000 from its short-term investment portfolio and additional borrowings from revolving lines of credit. Leasing agreements for equipment, which are short-term in nature, are not expected to impact McDermott International's liquidity or capital resources.\nInternational's quarterly dividends are $0.25 per share on its Common Stock and $0.71875 per share on its Series C Cumulative Convertible Preferred Stock. The Delaware Company's quarterly dividends are $0.55 per share on the Series A $2.20 Cumulative Convertible Preferred Stock and $0.65 per share on the Series B $2.60 Cumulative Preferred Stock. International's and the Delaware Company's quarterly dividends were at the same rates in 1995 and 1994. JRM's quarterly dividends on its Series A and Series B Preferred Stock are $0.5625 per share. At March 31, 1995, JRM paid dividends for a partial quarterly period of $900,000 on its Series A Preferred Stock and on April 17, 1995 paid $217,000 on its Series B Preferred Stock.\nAt March 31, 1995 the ratio of long-term debt to total stockholders' equity was 0.81 as compared with 1.23 at March 31, 1994.\nMcDermott International accounts for income taxes in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\". This standard requires, among other things, recognition of future tax benefits, measured by enacted tax rates, attributable to deductible temporary differences between the financial statement and income tax basis of assets and liabilities and to tax net operating loss and foreign tax credit carryforwards to the extent that realization of such benefits is more likely than not.\nMcDermott International has provided a valuation allowance ($34,943,000 at March 31, 1995) for deferred tax assets which can not be realized through carrybacks and future reversals of existing taxable temporary differences. Management believes that remaining deferred tax assets ($675,282,000 at March 31, 1995) in all other tax jurisdictions are realizable through carrybacks and future reversals of existing taxable temporary differences and, if necessary, the implementation of tax planning strategies involving sales and sale\/leasebacks of appreciated assets. A major uncertainty that affects the ultimate realization of deferred tax assets is the possibility of declines in value of appreciated assets involved in identified tax planning strategies. This factor has been considered in determining the valuation allowance. Management will continue to assess the adequacy of the valuation allowance on a quarterly basis.\nItem 8.","section_7A":"","section_8":"Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCOMPANY REPORT ON CONSOLIDATED FINANCIAL STATEMENTS\nInternational has prepared the consolidated financial statements and related financial information included in this report. International has the primary responsibility for the financial statements and other financial information and for ascertaining that the data fairly reflects the financial position and results of operations of McDermott International. The financial statements were prepared in accordance with generally accepted accounting principles, and necessarily reflect informed estimates and judgments by appropriate officers of McDermott International with appropriate consideration given to materiality.\nMcDermott International believes that it maintains an internal control structure designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and that the financial records are adequate and can be relied upon to produce financial statements in accordance with generally accepted accounting principles. The concept of reasonable assurance is based on the recognition that the cost of an internal control structure must not exceed the related benefits. Although internal control procedures are designed to achieve these objectives, it must be recognized that errors or irregularities may nevertheless occur. McDermott International seeks to assure the objectivity and integrity of its accounts by its selection of qualified personnel, by organizational arrangements that provide an appropriate division of responsibility and by the establishment and communication of sound business policies and procedures throughout the organization. McDermott International believes that its internal control structure provides reasonable assurance that errors or irregularities that could be material to the financial statements are prevented or would be detected.\nMcDermott International's accompanying consolidated financial statements have been audited by its independent auditors, who provide McDermott International with expert advice on the application of U. S. generally accepted accounting principles to McDermott International's business and also provide an objective assessment of the degree to which McDermott International meets its responsibility for the fairness of financial reporting. They regularly evaluate the internal control structure and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements. The report of the independent auditors appears elsewhere herein.\nThe Board of Directors pursues its responsibility for McDermott International's consolidated financial statements through its Audit Committee, which is composed solely of directors who are not officers or employees of McDermott International. The Audit Committee meets periodically with the independent auditors and management to review matters relating to the quality of financial reporting and internal control structure and the nature, extent and results of the audit effort. In addition, the Audit Committee is responsible for recommending the engagement of independent auditors for McDermott International to the Board of Directors, who in turn submit the engagement to the stockholders for their approval. The independent auditors have free access to the Audit Committee.\nMay 24, 1995\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders McDermott International, Inc.\nWe have audited the accompanying consolidated balance sheet of McDermott International, Inc. as of March 31, 1995 and 1994, and the related consolidated statements of income (loss), 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 McDermott International, Inc. at March 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 March 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Company has provided for estimated future costs for non-employee products liability asbestos claims. Inherent in the estimate of such future costs are assumptions which may vary significantly as claims are filed and settled. Accordingly, the ultimate loss may differ materially from amounts provided in the consolidated financial statements.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its methods of accounting for postemployment benefits and investment securities in 1995, recoveries of products liability claims in 1994 and income taxes and postretirement benefits other than pensions in 1993.\nERNST & YOUNG LLP\nNew Orleans, Louisiana May 24, 1995\nMcDERMOTT INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEET MARCH 31, 1995 and 1994\nASSETS\nSee accompanying notes to consolidated financial statements.\nLIABILITIES AND STOCKHOLDERS' EQUITY\nMcDERMOTT INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF INCOME (LOSS) FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1995\nCONTINUED\nSee accompanying notes to consolidated financial statements.\nMcDERMOTT INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1995 (In thousands, except for share amounts)\nSee accompanying notes to the consolidated financial statements.\nMcDERMOTT INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1995\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nCONTINUED\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nSee accompanying notes to consolidated financial statements.\nMcDERMOTT INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1995\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements are presented in U.S. Dollars in accordance with accounting principles generally accepted in the United States. The consolidated financial statements include the accounts of McDermott International, Inc. and all subsidiaries and controlled joint ventures. Investments in joint venture and other entities in which McDermott International, Inc. has a 20% to 50% interest are accounted for on the equity method. Differences between the cost of equity method investments and the amount of underlying equity in net assets of the investees are amortized systematically to income. All significant intercompany transactions and accounts have been eliminated. Certain amounts previously reported have been reclassified to conform with the presentation at March 31, 1995.\nUnless the context otherwise requires, hereinafter \"International\" will be used to mean McDermott International, Inc., a Panamanian corporation; \"JRM\" will be used to mean J. Ray McDermott, S.A., a Panamanian corporation, which is a majority owned subsidiary of International, and its consolidated subsidiaries; and the \"Delaware Company\" will be used to mean McDermott Incorporated, a Delaware corporation which is a subsidiary of International, and its consolidated subsidiaries (including Babcock & Wilcox Investment Company and its principal subsidiary, The Babcock & Wilcox Company); and \"McDermott International\" will be used to mean the consolidated enterprise.\nChanges in Accounting Policies\nProducts Liability - As a result of the consensus reached on Emerging Issues Task Force (\"EITF\") Issue No. 93-5, a company is no longer permitted to offset, for recognition purposes, reasonable possible recoveries against probable losses which until fiscal year 1994 had been McDermott International's practice with respect to estimated future costs for non-employee products liability asbestos claims. During the third quarter of fiscal year 1994, and effective April 1, 1993, McDermott International adopted this provision of EITF Issue No. 93-5 as a change in accounting principle and provided for estimated future costs to the extent that recovery from its insurers was not determined to be probable. The cumulative effect of the accounting change at April 1, 1993 was a charge of $100,750,000 (net of income taxes of $54,250,000), or $1.89 per share. The adoption of this provision of EITF Issue No. 93-5 resulted in an increase in pre-tax Income before Cumulative Effect of Accounting Change of $19,947,000 ($12,168,000 net of tax, or $0.23 per share) in fiscal year 1994, as costs in fiscal year 1994 that would have been recognized under McDermott International's prior practice were included in the cumulative effect of the accounting change. Prior to the adoption of EITF Issue No. 93-5, McDermott International had not made calculations in similar detail to those required to adopt EITF 93-5 and determined at the time of adoption of EITF Issue No. 93-5 that it was not practical to do so retroactively. Events giving rise to the liability for non- employee products liability asbestos claims occurred prior to 1987 and McDermott International had concluded in all\nearlier periods, based upon information then currently available, that it was adequately insured against future non-employee products liability claims. Therefore, because the amounts were not available and because of the inherent complexities in making reliable determinations at an earlier point in time consistent with the methods used in the April 1, 1993 determination, pro forma amounts reflecting the retroactive application of the accounting change for fiscal year 1993 are not presented.\nDuring the first quarter of fiscal year 1995, McDermott International adopted the provisions of Financial Accounting Standards Board (\"FASB\") Interpretation No. 39, which required McDermott International to present separately in the balance sheet its estimated liabilities for pending and future non-employee products liability asbestos claims and related estimated insurance recoveries. Accordingly, the accompanying consolidated balance sheet at March 31, 1994 and the consolidated statement of cash flows for the years ended March 31, 1994 and 1993 have been restated to conform to the March 31, 1995 presentation. The adoption of FASB Interpretation No. 39 did not have any effect on earnings.\nPostemployment Benefits - Effective April 1, 1994, McDermott International adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" in accounting for disability benefits and other types of benefits paid to employees, their beneficiaries and covered dependents after active employment, but before retirement. The cumulative effect as of April 1, 1994 of this change in accounting was to reduce net income by $1,765,000 (net of income taxes of $287,000) or $0.03 per share. Other than the cumulative effect, the accounting change had no material effect on the results of fiscal year 1995. Prior to April 1, 1994, McDermott International recognized the cost of providing most of these benefits on a cash basis. Under this new principle of accounting, the cost of these benefits is accrued when it becomes probable that such benefits will be paid and when sufficient information exists to make reasonable estimates of the amounts to be paid. In accordance with the Statement, prior period financial statements have not been restated to reflect this change in accounting principle.\nPostretirement Health Care Benefits - Effective April 1, 1992, McDermott International adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". In accordance with the Statement, McDermott International elected immediate recognition of its transition obligation and recorded $249,351,000 (net of income tax benefit of $136,228,000), or $4.79 per share, as the cumulative effect of an accounting change. In fiscal year 1993, other than the cumulative effect of the accounting change, the adoption of SFAS No. 106 resulted in a decrease in Income before Extraordinary Items and Cumulative Effect of Accounting Changes of $4,688,000, or $0.09 per share.\nInvestments - Effective April 1, 1994, McDermott International adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" for investments held as of or acquired after April 1, 1994. The adoption of SFAS No. 115 resulted in a decrease in the opening balance of stockholders' equity of $4,095,000 to reflect the net unrealized holding losses on McDermott International's investment securities which were previously carried at amortized cost. In accordance with the Statement, prior period financial statements have not been restated to reflect this change in accounting principle.\nAt March 31, 1995 McDermott International's investments, primarily government obligations and other debt securities, are classified as available-for-sale and are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. Management determines the appropriate classifications of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Investment securities available for current operations are classified in the balance sheet as current assets while securities held for long-term investment purposes are classified as non- current assets. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses are included in other income. The cost of securities sold is based on the specific identification method. Interest on securities is included in interest income.\nIncome Taxes - Income taxes have been provided using the liability method in accordance with SFAS No. 109, \"Accounting for Income Taxes\", which was adopted effective April 1, 1992. The cumulative effect of the accounting change on prior years at April 1, 1992 was a benefit of $3,727,000, or $0.07 a share. Other than the cumulative effect, the accounting change had no material effect on fiscal year 1993.\nForeign Currency Translation\nAssets and liabilities of foreign operations, other than operations in highly inflationary economies, are translated into U.S. Dollars at current exchange rates and income statement items are translated at average exchange rates for the year. Adjustments resulting from the translation of foreign currency financial statements are recorded in a separate component of equity. Foreign currency transaction adjustments are reported in income. Included in Other Income (Expense) are transaction losses of $1,057,000, $2,260,000, and $3,747,000 for fiscal years 1995, 1994 and 1993, respectively.\nContracts and Revenue Recognition\nContract revenues and related costs are principally recognized on a percentage of completion method for individual contracts or components thereof based upon work performed or a cost to cost method, as applicable to the product or activity involved. Revenues and related costs so recorded, plus accumulated contract costs that exceed amounts invoiced to customers under the terms of the contracts, are included in Contracts in Progress. Billings that exceed accumulated contract costs and revenues and costs recognized under percentage of completion are included in Advance Billings on Contracts. Most long-term contracts have provisions for progress payments. Contract price and cost estimates are reviewed periodically as the work progresses and adjustments proportionate to the percentage of completion are reflected in income in the period when such estimates are revised. There are no unbilled revenues which will not be billed. Provisions are made currently for all known or anticipated losses. Claims for extra work or changes in scope of work are included in contract revenues when collection is probable. Included in Accounts Receivable and Contracts in Progress are approximately $50,831,000 and $56,873,000 relating to commercial and U.S. Government contracts claims whose final settlement is\nsubject to future determination through negotiations or other procedures which had not been completed at March 31, 1995 and 1994, respectively.\nMcDermott International is usually entitled to financial settlements relative to the individual circumstances of deferrals or cancellations of Power Generation Systems and Equipment contracts. McDermott International does not recognize such settlements or claims for additional compensation until final settlement is reached.\nIncluded in accounts receivable - trade are amounts representing retainages on contracts as follows:\nOf its long-term retainages at March 31, 1995, McDermott International anticipates collection as follows: $23,790,000 in fiscal year 1997, $15,768,000 in fiscal year 1998, $284,000 in fiscal year 1999 and $1,513,000 in fiscal year 2000.\nInventories\nInventories are carried at the lower of cost or market. Cost is determined on an average cost basis except for certain materials inventories, for which the last-in first-out (LIFO) method is used. The cost of approximately 20% and 21% of total inventories was determined using the LIFO method at March 31, 1995 and 1994, respectively. Consolidated inventories at March 31, 1995 and 1994 are summarized below:\nWarranty Expense\nEstimated warranty expense which may be required to satisfy contractual requirements, primarily of the Power Generation Systems and Equipment segment, is accrued relative to revenue recognition on the respective contracts. In addition, specific provisions are made where the costs of warranty are expected to significantly exceed such accruals.\nEnvironmental Clean-up Costs\nMcDermott International accrues for future decommissioning and decontamination of its nuclear facilities that will permit the release of these facilities to unrestricted use at the end of each facility's life, which is a condition of its licenses from the Nuclear Regulatory Commission. Such accruals are based on the estimated cost of those activities over the economic useful life of each facility, which is estimated at 40 years.\nResearch and Development\nThe cost of research and development which is not performed on specific contracts is charged to operations as incurred. Such expense was approximately $19,905,000, $21,036,000 and $19,459,000 in fiscal years 1995, 1994 and 1993, respectively. In addition, expenditures on research and development activities of approximately $44,240,000, $48,112,000 and $42,082,000 in fiscal years 1995, 1994 and 1993, respectively, were paid for by customers of McDermott International.\nDepreciation, Maintenance and Repairs and Drydocking Expenses\nExcept for major marine vessels, property, plant and equipment is depreciated on the straight-line method, using estimated economic useful lives of 8 to 40 years for buildings and 2 to 28 years for machinery and equipment.\nMajor marine vessels are depreciated on the units-of-production method based on the utilization of each vessel. Depreciation expense calculated under the units-of-production method may be less than, equal to, or greater than depreciation expense calculated under the straight-line method in any period. The annual depreciation based on utilization of each vessel will not be less than the greater of 25% of annual straight-line depreciation, or 50% of cumulative straight-line depreciation.\nMaintenance, repairs and renewals which do not materially prolong the useful life of an asset are expensed as incurred except for drydocking costs for the marine fleet, which are estimated and accrued over the period of time between drydockings, and such accruals are charged to operations currently.\nAmortization of Excess of Cost Over Fair Value of Net Assets of Purchased Businesses\nExcess of the cost over fair value of net assets of purchased businesses pertains to the acquisition of The Babcock & Wilcox Company, which is being amortized on a straight-line basis over forty years and the acquisitions of Offshore Pipelines, Inc., Delta Catalytic Corporation and Northern Ocean Services Limited (See Note 2) which are being amortized on a straight-line basis over ten years. Management periodically reviews goodwill to assess recoverability, and impairments would be recognized in operating results if a permanent diminution in value were to occur.\nCapitalization of Interest Cost\nIn fiscal years 1995, 1994 and 1993, total interest cost incurred was $59,715,000, $65,296,000 and $92,111,000, respectively, of which $2,600,000, $1,321,000 and $1,771,000, respectively, was capitalized.\nEarnings Per Share\nPrimary earnings per share are based on the weighted average number of common and dilutive common equivalent shares outstanding during the year. For fiscal years 1995, 1994 and 1993, fully dilutive earnings per share, which includes the effects of stock options and appreciation rights, is considered to be the same as primary since the effect of these common stock equivalents would be antidilutive.\nCash Equivalents\nCash equivalents are highly liquid investments, with maturities of three months or less when purchased, which are not held as part of the investment portfolio.\nDerivative Financial Instruments\nDerivatives, primarily forward exchange contracts, are utilized by McDermott International to minimize exposure and reduce risk from foreign exchange fluctuations in the regular course of business. Gains and losses related to qualifying hedges of firm commitments are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transactions occur. Gains and losses on forward exchange contracts which hedge foreign currency assets or liabilities are recognized in income as incurred. Such amounts effectively offset gains and losses on the foreign currency assets or liabilities that are hedged.\nNOTE 2 - ACQUISITIONS\nOn January 31, 1995, McDermott International contributed substantially all of its marine construction services business to JRM and JRM acquired Offshore Pipelines, Inc. (\"OPI\"), a full-range provider of offshore marine construction and other related services on a worldwide basis to the oil and gas industry, pursuant to an Agreement and Plan of Merger dated as of June 2, 1994 as amended ( the \"Merger Agreement\"). Pursuant to the Merger Agreement, JRM issued 13,867,946 shares of Common Stock, 897,818 options to acquire shares of Common Stock and 458,632 shares of Series B $2.25 Cumulative Convertible Exchangeable Preferred Stock (liquidation preference $11,465,800) valued at $347,599,000 in exchange for all of the outstanding common stock, stock options and preferred stock of OPI. As a result of the acquisition of OPI, McDermott International's ownership interest in the common stock of JRM was reduced to approximately 64%. The acquisition was accounted for by the purchase method and, accordingly, the purchase price ($369,868,000, including direct costs of acquisition and non-compete agreements) has been allocated to the underlying assets and liabilities based upon preliminary fair values at the date of acquisition. The excess of cost over fair value of net assets acquired is being amortized over 10 years. The operating results have been included in the Consolidated Statement of Income (Loss) from the acquisition date. The preliminary purchase price allocation is subject to change when additional information concerning asset and liability valuations is obtained. Therefore, the final allocation may differ from the preliminary allocation summarized as follows:\nAt March 31, 1995, JRM's Series B $2.25 Cumulative Convertible Exchangeable Preferred Stock was convertible into 1,005,772 shares of JRM common stock and JRM had options outstanding under its stock option plans to purchase 1,078,242 shares of JRM stock at an average price of $9.46 per share (834,712 shares exercisable at an average price of $5.62 per share). In addition, at March 31, 1995, JRM had outstanding 3,200,000 shares of its voting Series A $2.25 Cumulative Convertible Preferred Stock (liquidation preference $160,000,000), all of which is owned by McDermott International.\nThe following unaudited pro forma results of operations assume the acquisition of OPI had occurred as of the beginning of the periods presented.\nThe pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition of OPI been completed as of April 1, 1993, nor is it necessarily indicative of future operating results. The pro forma information does not reflect estimates of cost savings that may be realized.\nOn February 28, 1994, McDermott International acquired Northern Ocean Services Limited (\"NOS\") for $57,645,000. NOS owns and operates 2 major marine construction vessels and specialized construction equipment for providing subsea and trenching services to industries worldwide; including oil, gas, marine construction and hydrocarbon processing. In addition, during June 1993, the Delaware Company acquired a controlling interest in Delta Catalytic Corporation (\"DCC\") of Calgary, Alberta, Canada for $28,249,000. The Delaware Company has reached an agreement to purchase the remaining portion of DCC in fiscal year 1996. DCC provides engineering, procurement, construction and maintenance services to industries worldwide; including oil, gas, marine construction and hydrocarbon processing.\nThe acquisitions of NOS and DCC were accounted for by the purchase method of accounting and, accordingly, the purchase price has been allocated to the underlying assets and liabilities based on fair values as of the dates of acquisition. The excess of cost over fair value of net assets acquired is being amortized over a period of 10 years. The operating results have been included in the Consolidated Statement of Income (Loss) from the acquisition dates. A summary of the purchase price allocation for DCC and NOS follows:\nThe following unaudited pro forma results of operations assume the acquisitions of NOS and DCC had occurred as of the beginning of the periods presented.\nThe pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisitions of NOS and DCC been completed as of April 1, 1992 nor is it necessarily indicative of future operating results.\nNOTE 3 - INVESTMENTS IN JOINT VENTURES AND OTHER ENTITIES\nInvestments in joint ventures and other entities, which are accounted for on the equity method, were $163,029,000 and $128,006,000 at March 31, 1995 and 1994, respectively. Transactions with entities for which investments are accounted for by the equity method included sales to ($152,517,000, $89,123,000 and $91,448,000 in fiscal years 1995, 1994 and 1993, respectively, including approximately $54,657,000, $49,121,000 and $47,535,000, respectively, attributable to leasing activities) and purchases from ($12,582,000, $137,942,000, and $76,396,000 in fiscal years 1995, 1994 and 1993, respectively) these entities. Included in non- current Other Assets at March 31, 1995 and 1994 are $12,996,000 and $1,395,000, respectively of accounts and note receivable from unconsolidated investees. Included in Accounts payable at March 31, 1995 and 1994 are $7,168,000 and $18,180,000, respectively, of payables to unconsolidated investees.\nIn fiscal year 1995, JRM contributed various marine construction barges (including the DB100 semi-submersible derrick barge) with a cost of $102,602,000 and accumulated depreciation of $76,763,000 and sold the DB51 derrick barge to the HeereMac joint venture for $9,101,000. In fiscal year 1994, McDermott International recognized revenues of $131,000,000 on work subcontracted to HeereMac.\nAt March 31, 1995 and 1994, property, plant and equipment included $402,479,000 and $409,952,000, and accumulated depreciation included $230,674,000 and $221,503,000, respectively, of marine equipment that is leased to unconsolidated investees. Dividends received from unconsolidated investees were $76,481,000, $65,214,000 and $33,202,000 (including a return of capital of $27,402,000) in fiscal years 1995, 1994 and 1993, respectively. Undistributed earnings in unconsolidated affiliates were $44,503,000 and $76,843,000, respectively, at March 31, 1995 and 1994.\nOn March 30, 1993, McDermott International sold its remaining interests in its B&W Fuel Company and B&W Nuclear Service Company for $10,150,000 and $32,440,000, respectively. Included in Other-net were gains on the sales of $23,968,000 in fiscal year 1993.\nSummarized combined balance sheet and income statement information based on the most recent financial information for equity investments in joint ventures and other entities (25% to 50% owned) are presented below:\nNOTE 4 - INCOME TAXES\nIncome taxes have been provided based upon the tax laws and rates in the countries in which operations are conducted. All income has been earned outside of Panama and McDermott International is not subject to income tax in Panama on income earned outside of Panama. Therefore, there is no expected relationship between the provision for, or benefit from, income taxes and income, or loss, before income taxes. The major reason for the variations in such relationships is that income is earned within and subject to the taxation laws of various countries, each of which has a regime of taxation which varies from that of any other country (not only with respect to nominal rate but also with respect to the allowability of deductions, credits and other benefits) and because the proportional extent to which income is earned in, and subject to tax by, any particular country or countries varies from year to year. International and certain of its subsidiaries keep books and file tax returns on the completed contract method of accounting.\nDeferred income taxes reflect the net tax effects of temporary differences between the financial and tax bases of assets and liabilities. Significant components of deferred tax assets and liabilities as of March 31, 1995 and 1994 were as follows:\nIncome (loss) before provision for (benefit from) income taxes, extraordinary items and cumulative effect of accounting changes was as follows:\nThe provision for (benefit from) income taxes consists of:\nThe current provision for other than U. S. income taxes in 1995, 1994 and 1993 includes a reduction of $1,323,000, $22,515,000 and $28,113,000, respectively, for the benefit of net operating loss carryforwards.\nDuring fiscal year 1995, a settlement was reached with the Internal Revenue Service (\"IRS\") concerning the Delaware Company's U. S. income tax liability for the fiscal years ended March 31, 1983 through March 31, 1986 disposing of all U.S. federal income tax issues for those years. A settlement was also reached for the fiscal years ended March 31, 1987 and March 31, 1988 disposing of all U.S. federal income tax issues for those years and is pending approval by the Joint Committee of Taxation. These settlements resulted in a reduction in accrued interest expense of $26,300,000. The IRS has issued notices for fiscal years March 31, 1989 and March 31, 1990 asserting deficiencies in the amount of taxes reported. The deficiencies are based on issues substantially similar to those of earlier years. The Delaware Company believes that any income taxes ultimately assessed will not exceed amounts already provided.\nPursuant to a stock purchase and sale agreement (the \"Intercompany Agreement\"), the Delaware Company has the right to sell to International and International has the right to buy from the Delaware Company, 100,000 units, each unit consisting of one share of International Common Stock and one share of International Series A Participating Preferred Stock, at a price based primarily upon the stockholders' equity of McDermott International at the close of the fiscal year preceding the date at which the right to sell or buy, as the case may be, is exercised, and, to a limited extent, upon the price-to-book value of the Dow Jones Industrial Average. At April 1, 1995, the current unit value was $2,649 and the aggregate current unit value for the Delaware Company's 100,000 units was $264,880,000. The net proceeds to the Delaware Company from the exercise of any rights under the Intercompany Agreement would be subject to U. S. federal, state and other applicable taxes. No tax provisions have been established, since there is no present intention by either party to exercise such rights.\nNOTE 5 - LONG-TERM DEBT AND NOTES PAYABLE\nNotes payable and current maturities of long-term debt consist of:\nThe Indenture for the 9.375% Notes due 2002 and the Series A and B Medium Term Notes, contain certain covenants which restrict the amount of funded indebtedness that the Delaware Company may incur, and place limitations on certain restricted payments, certain transactions between affiliates, the creation of certain liens and the amendment of the Intercompany Agreement.\nIn connection with the OPI acquisition, a subsidiary of JRM assumed OPI's $70,000,000 12-7\/8% Guaranteed Senior Notes (\"12.875% Notes\"). The 12.875% Notes are subject to mandatory sinking fund requirements beginning on July 15, 2000 calculated to retire 50% of the original principal amount prior to maturity in 2002. The 12.875% Notes are redeemable, for cash, at the option of the issuer, at any time on or after July 15, 1997, in whole or in part, at a price of 106.4% of the principal amount, and thereafter at prices declining annually to 100% of the principal amount on or after July 15, 2000.\nMcDermott International's 10.375% Note payable due 1998 is secured by a letter of credit issued by a U. S. bank. The letter of credit was secured by $83,363,000 market value of McDermott International's long-term portfolio at March 31, 1995. The outstanding principal is repayable in semi-annual payments with the final installment due June 20, 1998. The letter of credit and collateral amounts decline as the loan principal is repaid.\nMaturities of long-term debt during the five fiscal years subsequent to March 31, 1995 are as follows: 1996 - $176,950,000; 1997 - $25,913,000; 1998 - $74,483,000; 1999 - $50,643,000; 2000 - $546,000.\nThe Delaware Company and JRM are restricted, as a result of covenants in certain credit agreements, in their ability to transfer funds to International and its subsidiaries through cash dividends or through unsecured loans or investments. At March 31, 1995, substantially all of the net assets of the Delaware Company and JRM were subject to such restrictions.\nPursuant to its right of redemption, on March 31, 1993, the Delaware Company deposited cash into trusts for the purpose of redeeming its 9.625% Sinking Fund Debentures, 10% Subordinated Debentures, and 10.20% Sinking Fund Debentures. These redemptions resulted in an extraordinary loss of $2,429,000 (net of income tax benefit of $1,252,000), in fiscal year 1993. Also on March 31, 1993, pursuant to its redemption option, McDermott International provided for the loss associated with the redemption and extinguishment of its 12.25% Senior Subordinated Notes due in 1998 resulting in an extraordinary loss of $7,392,000 (net of income tax benefit of $3,808,000). Additionally, during October 1992, the Delaware Company repurchased $10,600,000 aggregate principal amount of its 12.25% Senior Subordinated Notes due 1998 resulting in an extraordinary loss of $610,000 (net of income tax benefit of $314,000).\nAt March 31, 1995 and 1994, International and its subsidiaries, had available to them various uncommitted short-term lines of credit from banks totaling $373,867,000 and $246,412,000, respectively. Borrowings against these lines of credit at March 31, 1995 and 1994 were $63,025,000 and $37,512,000, respectively. In addition, the Babcock & Wilcox Company had available to it a $128,000,000 unsecured and committed revolving line of credit facility. Loans outstanding under the revolving credit facility may not exceed the banks' commitments thereunder. In addition, it is a condition to borrowing under the revolving credit facility that the borrower's consolidated net tangible assets exceed a certain level. There were no borrowings against this facility at March 31, 1995 and 1994. DCC had available from a certain Canadian bank an unsecured and committed revolving credit facility of $14,184,000 which expires on May 31, 1997. Borrowings outstanding against this facility at March 31, 1995 were $7,420,000. There were no borrowings outstanding against this facility at March 31, 1994. In addition, JRM had available two secured and committed revolving credit facilities totaling $53,500,000 of which $24,500,000 was outstanding at March 31, 1995. Loans outstanding under these facilities were repaid and the facility terminated on May 10, 1995.\nMcDermott International's obligations under short-term repurchase agreements at March 31, 1995 were secured by government obligations with a fair value of $134,673,000.\nNOTE 6 - PENSION PLANS AND POSTRETIREMENT BENEFITS\nPension Plans - McDermott International provides retirement benefits, primarily through non-contributory pension plans, for substantially all of its regular full-time employees, except certain non-resident alien employees of foreign subsidiaries who are not citizens of a European Community country or who do not earn income in the United States, Canada, or the United Kingdom. Salaried plan benefits are based on final average compensation and years of service, while hourly plan benefits are based on a flat benefit rate and years of service. McDermott International's funding policy is to fund applicable pension plans to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and, generally, to fund other pension plans as recommended by the respective plan actuary and in accordance with applicable law. At January 1, 1995 and 1994, approximately one- half of total plan assets were invested in listed stocks and bonds. The remaining assets were held in foreign equity funds, U. S. Government securities and investments of a short-term nature.\nU. S. Pension Plans:\nThe net periodic pension benefit for fiscal years 1995, 1994 and 1993 included the following components:\nDue to the sale of a domestic entity, loss from operations before cumulative effect of accounting change in fiscal year 1995, includes a net after-tax gain of $732,000 resulting from the recognition of a curtailment of a related plan.\nThe following table sets forth the U. S. plans' funded status and amounts recognized in the consolidated financial statements:\nThe assumptions used in determining the funded status of the U. S. plans were:\nThe changes in the discount rate and the rate of increase in future compensation levels for the U. S. plans decreased the projected benefit obligation at March 31, 1995. This net decrease includes a decrease of $76,961,000 due to the change in discount rate and an increase of $12,458,000 due to the change in the rate of increase in future compensation levels.\nIn accordance with the provisions of SFAS No. 87, \"Employers' Accounting for Pensions,\" McDermott International recorded, during 1995 and 1994, an additional minimum liability for certain of its U. S. plans of $10,322,000 and $8,414,000, respectively. These liabilities resulted in recognition of intangible assets of $9,910,000 and $7,457,000 and reductions in stockholders' equity of $391,000 and $931,000, respectively, in fiscal years 1995 and 1994.\nThe two principal U. S. ERISA pension plans provide that, subject to certain limitations, any excess assets in such plans would be used to increase pension benefits if certain events occurred within a 60 month period following a change in control of International.\nNon-U. S. Pension Plans:\nThe net periodic pension benefit for fiscal years 1995, 1994 and 1993 included the following components:\nDue to a reduction in workforce at one foreign subsidiary, income before cumulative effect of accounting change in fiscal year 1994 includes a net after-tax loss of $1,456,000 resulting from the recognition of a curtailment of a related plan.\nThe following table sets forth the non-U. S. plans' funded status (assets exceed accumulated benefits) and amounts recognized in the consolidated financial statements:\nThe assumptions used in determining the funded status of the non-U. S. plans were:\nThe changes in the discount rate and the rate of increase in future compensation levels for the non-U. S. plans decreased the projected benefit obligation at March 31, 1995. This net decrease includes a decrease of $9,825,000 due to the change in discount rate and a decrease of $3,094,000 due to the change in the rate of increase in future compensation levels.\nMultiemployer Plans - One of McDermott International's subsidiaries contributes to various multiemployer plans. The plans generally provide defined benefits to substantially all unionized workers in this subsidiary. Amounts charged to pension cost and contributed to the plans were $9,838,000, $8,367,000 and $4,687,000 in fiscal years 1995, 1994 and 1993, respectively.\nPostretirement Health Care and Life Insurance Benefits - McDermott International offers postretirement health care and life insurance benefits to substantially all of its retired regular full-time employees, including those associated with discontinued operations, except certain non-resident alien retired employees who are not citizens of a European Community country or who, while employed, did not earn income in the United States, Canada or the United Kingdom. McDermott International shares the cost of providing these benefits with all affected retirees, except for certain life insurance plans. Postretirement health care and life insurance benefits are offered under separate defined benefit postretirement plans to union and non-union employees. The health care plans are contributory and contain cost-sharing provisions such as deductibles and coinsurance; the life insurance plans are contributory and non-contributory. McDermott International does not fund any of its plans.\nThe following table sets forth the amounts recognized in the consolidated financial statements at March 31:\nThe accumulated postretirement benefit obligation in the above table includes $358,543,000 and $408,675,000 for McDermott International's health care plans and $41,158,000 and $43,026,000 for McDermott International's life insurance plans at March 31, 1995 and 1994, respectively. The changes in the accumulated postretirement benefit obligation and the unrecognized net gain (loss) at March 31, 1995 were primarily attributable to the increase in the discount rate.\nNet periodic postretirement benefit cost for fiscal years 1995, 1994 and 1993 included the following components:\nFor measurement purposes, a weighted-average annual assumed rate of increase in the per capita cost of covered health care claims of 11-1\/2% was assumed for 1995, 12-1\/2% for 1994 and 13-1\/2% in 1993. For 1996, a rate of 10-3\/4% is assumed. In all years, the rate was assumed to decrease gradually to 5% in 2005 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of March 31, 1995 by $20,896,000 and the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for fiscal year 1995 by $2,638,000.\nNOTE 7 - SALE OF ACCOUNTS RECEIVABLE\nThe Babcock & Wilcox Company has an agreement with a U.S. bank, whereby it can sell, up to a maximum limit of $225,000,000, with limited recourse, an undivided interest in a designated pool of qualified accounts receivable. Under the terms of the agreement, new receivables are added to the pool as collections reduce previously sold accounts receivable. At March 31, 1995, approximately $175,000,000 of receivables had been sold for cash under this agreement. At March 31, 1994, approximately $170,000,000 had been sold. Receivables sold under this agreement are presented as a reduction of accounts receivable on the accompanying balance sheets. Included in Other-net income were expenses recorded on the sale of receivables which represent bank fees and discounts of $9,709,000, $8,699,000 and $7,851,000 for fiscal years 1995, 1994 and 1993, respectively. Discounts are based on the bank's cost of issuing commercial paper and bank fees are a fixed amount based on the maximum limit which may be sold.\nNOTE 8 - SUBSIDIARY'S REDEEMABLE PREFERRED STOCKS\nAt March 31, 1995 and 1994, 13,000,000 shares of Delaware Company Preferred Stock, with a par value of $1 per share, were authorized. Of the authorized shares, 2,818,780 shares of Series A Preferred Stock, and 2,917,236 and 3,474,652 shares of Series B Preferred Stock were outstanding (in each case, exclusive of shares owned by the Delaware Company) at March 31, 1995 and 1994, respectively. The outstanding shares are entitled to $31.25 per share in liquidation. Preferred dividends of $14,142,000, $15,719,000 and $15,885,000 are classified as minority interest in Other Income (Expense) in fiscal years 1995, 1994 and 1993, respectively. Both series of Preferred Stock are entitled to general voting rights of one-half vote for each share. The Board of Directors of the Delaware Company may authorize additional series of Preferred Stock, and may set terms of each new series except that the Delaware Company cannot create any series of stock senior to the existing Series A and Series B Preferred Stock without the consent of the holders of at least 50% of the shares of such Preferred Stock.\nEach share of the outstanding Series A Preferred Stock is convertible into one share of International's Common Stock plus $0.10 cash. Series A and Series B Preferred Stock are redeemable at the option of the Delaware Company at $31.25 per share plus accrued dividends. On March 31, 1996 and each subsequent year through March 31, 2008, the Delaware Company is obligated to redeem, at a redemption price of $31.25 plus accrued dividends, 313,878 shares of Series A Preferred Stock. On March 31 of fiscal years 1996 through 2006, and March 31 of fiscal years 2007 and 2008, the Delaware Company is obligated to redeem 252,702 and 189,526 shares, respectively, of Series B Preferred Stock. For the five fiscal years subsequent to March 31, 1995, the obligation to redeem the Series A and B Preferred Stock is $17,706,000 for each of the fiscal years 1996 through 2000. The Delaware Company may apply to the mandatory sinking fund obligations any Series A or B Preferred Stock reacquired, redeemed or surrendered for conversion which have not been previously credited against the mandatory sinking fund obligations. The Delaware Company applied 313,878 shares of Series A Preferred Stock and 315,877 shares of Series B Preferred Stock that it owned to satisfy the March 31, 1995 mandatory sinking fund obligations. During fiscal years 1995 and 1994, 557,416 and 114,800 shares, respectively, of Series B Preferred Stock were purchased on the open market. At March 31, 1995, 49,637 shares of Series A Preferred Stock have been converted to date and the Delaware Company owned 1,261,627 and 241,539 shares of Series A and Series B Preferred Stock, respectively.\nNOTE 9 - CAPITAL STOCK\nThe Panamanian regulations relating to acquisitions of securities of companies, such as International, registered with the National Securities Commission require, among other matters, that detailed disclosure concerning the offeror, which is subject to review by either the Panamanian National Securities Commission or the Board of Directors of the subject company, be finalized prior to the beneficial acquisition of more than 5 percent of the outstanding shares of any class of stock. Transfers of securities in violation of these regulations are invalid and cannot be registered for transfer.\nAt March 31, 1995 and 1994, 86,389,216 and 85,521,703 shares of Common Stock, respectively, were reserved for issuance in connection with the conversion and redemption\nof the Delaware Company's Series A Preferred Stock, the conversion of International's Series C Preferred Stock, the exercise of International Rights, the 1992 Officer Stock Program (and its predecessor programs), the 1992 Director Stock Program, the 1992 Senior Management Stock Program and contributions to the Thrift Plan.\nInternational Preferred Stock - At March 31, 1995 and 1994, 25,000,000 shares of Preferred Stock were authorized. Of the authorized shares, 100,000 shares of Series A Participating Preferred Stock (the \"Participating Preferred Stock\") and 70,000 and 80,000 shares of Series B Non-Voting Preferred Stock (the \"Non-Voting Preferred Stock\") were issued and owned by the Delaware Company at March 31, 1995 and 1994, respectively. The Non-Voting Preferred Stock is currently callable by International at $275 per share and 10,000 shares are to be redeemed each year by International at $250 per share. The annual per share dividend rates for the Participating Preferred Stock and the Non-Voting Preferred Stock are $10 (but no more than ten times the amount of the per share dividend on International Common Stock) and $20, respectively, payable quarterly, and dividends on such shares are cumulative to the extent not paid. In addition, shares of Participating Preferred Stock are entitled to receive additional dividends whenever dividends in excess of $3.00 per share on International Common Stock are declared (or deemed to have been declared) in any fiscal year. In 1987, the voting rights of the Participating Preferred Stock were eliminated.\nOf the authorized shares, International issued 2,875,000 shares of Series C Cumulative Convertible Preferred Stock in July 1993. Net cash proceeds to International were $140,066,000. The Series C shares have a par value of $1.00 per share, and a liquidation preference of $50.00 per share, plus an amount equal to accrued and unpaid dividends. Dividends on Series C shares are cumulative at the annual rate of 5.75% per share on the liquidation preference, equal to $2.875 per annum. International may not redeem Series C shares prior to July 1, 1997. On or after July 1, 1997, the Series C shares are redeemable, in whole or in part, at the option of International, either in cash, shares of International Common Stock, or a combination thereof. Holders of Series C shares may convert them, in whole or in part, at any time, into International Common Stock at a conversion price of $35.25 per share of Common Stock (equivalent to a conversion rate of 1.4184 shares of Common Stock for each share of Series C Preferred Stock), subject to adjustment.\nThe issuance of additional International Preferred Stock in the future and the specific terms thereof, such as the dividend rights, conversion rights, voting rights, redemption prices and similar matters, may be authorized by the Board of Directors of International without stockholder approval, except to the extent such approval may be required by applicable rules of the New York Stock Exchange or applicable law. If additional Preferred Stock is issued, such additional shares will rank senior to International Common Stock as to dividends and upon liquidation.\nInternational Rights - On December 30, 1985, each holder of Common Stock received a dividend distribution of one Right for each outstanding share of Common Stock. The Rights currently trade with the Common Stock and at March 31, 1995 and 1994, International had outstanding Rights to purchase 54,059,597 and 53,544,467 shares (including Rights to purchase 100,000 shares held by the Delaware Company at March 31,\n1995 and 1994), respectively, of its Common Stock at a price of $50 per share subject to anti-dilution adjustments. The Rights will become exercisable and will detach from the Common Stock 10 days after a person or a group either becomes the beneficial owner of 20 percent or more of the outstanding Common Stock, or commences or announces an intention to commence a tender or exchange offer for 30 percent or more of the outstanding Common Stock. If thereafter the acquiring person or group engages in certain self-dealing transactions, holders of Rights may purchase at the exercise price that number of shares of Common Stock having a market value equal to twice the exercise price. In the event International merges with or transfers 50 percent or more of its assets or earnings to any person after the Rights become exercisable, holders of Rights may purchase at the exercise price that number of shares of Common Stock of the acquiring entity having a market value equal to twice the exercise price. The Rights are redeemable by International and expire on December 30, 1995.\nInternational's Stock Plans - The following table summarizes activity for International's stock option plans:\nA total of 749,191 shares of Common Stock (including 230,811 of approved shares that were not awarded, and rights to shares that have not terminated or expired, under predecessor plans) are available for grants of options under the 1992 Officer Stock Program. Options become exercisable at such time or times as determined at the date of the grant, and expire ten years after the date of grant. Pursuant to the program, eligible employees may be granted rights to purchase shares of Common Stock at par value\n($1.00 per share) subject to restrictions on transfer which lapse at such times and circumstances as specified when granted. Substantially all of the shares of Common Stock available for award under the 1992 Officer Stock Program may be granted as rights under the program. A total of 847,525 rights have been granted to purchase shares at par value ($1.00 per share) under the 1992 Officer Stock Program (and its predecessor plans) and the 1992 Director Stock Program (described below) at March 31, 1995.\nA total of 18,575 shares of Common Stock are available for grants of options, and rights to purchase shares, to non-employee directors under the 1992 Director Stock Program. Options to purchase 900, 300 and 300 shares will be granted on the first, second, and third years, respectively, of a Director's term at not less than 100% of the fair market value on the date of grant. Options become exercisable, in full, six months after the date of the grant, and expire ten years and one day after the date of grant. Rights to purchase 450, 150 and 150 shares are granted on the first, second and third years, respectively, of a Director's term at par value ($1.00 per share) subject to restrictions on transfer, which lapse at the end of such term.\nUnder the 1992 Senior Management Stock Option plan, senior management employees may be granted options to purchase shares of Common Stock. The total number of shares available for grant is determined by the Board of Directors from time to time. Options to purchase shares are granted at no less that 100% of the fair market value on the date of grant, become exercisable at such time or times as determined when granted, and expire ten years after the date of the grant.\nIn the event of a change in control of McDermott International, all three programs have provisions that may cause restrictions to lapse and accelerate the exercisability of options outstanding.\nThrift Plan - On November 12, 1991, a maximum of 5,000,000 of the authorized and unissued shares of International's Common Stock was reserved for possible issuance to be used as the employer match for employee contributions to the Thrift Plan for Employees of McDermott Incorporated and Participating Subsidiary and Affiliated Companies. Such employer contributions equal 50% of the first 6% of compensation, as defined in the Plan, contributed by participants, and fully vest and are non-forfeitable after five years of service or upon retirement, death, lay-off or approved disability. During fiscal years 1995, 1994 and 1993, 312,883, 300,391 and 347,054 shares, respectively, were issued as employer contributions pursuant to the Plan. At March 31, 1995, 3,923,885 shares remained available for issuance.\nNOTE 10 - CONTINGENCIES AND COMMITMENTS\nLitigation - International and certain of its officers, directors and subsidiaries are defendants in numerous legal proceedings. Management believes that the outcome of these proceedings will not have a material adverse effect upon the consolidated financial position of McDermott International.\nProducts Liability - At March 31, 1995 and 1994, the estimated liability for pending and future non-employee products liability asbestos claims was $995,948,000 (of which less than $165,000,000 had been asserted) and $1,122,099,000 and estimated insurance recoveries were $861,407,000 and $987,046,000, respectively. During fiscal year 1995, McDermott International received notice that provisional liquidators had been appointed to a London-based products liability asbestos insurer and, as a result, a loss of $14,478,000 related to the reduction of estimated insurance recoveries was recognized. Estimated liabilities for pending and future non-employee products liability asbestos claims are derived from McDermott International's claims history and constitute management's best estimate of such future costs. Estimated insurance recoveries are based upon analysis of insurers providing coverage of the estimated liabilities. Inherent in the estimate of such liabilities and recoveries are expected trends in claim severity and frequency and other factors, including recoverability from insurers, which may vary significantly as claims are filed and settled. Accordingly, the ultimate loss may differ materially from amounts provided in the consolidated financial statements.\nEnvironmental Matters - During the March 1995 quarter, a decision was made to close certain of its nuclear manufacturing facilities, and a provision of $41,724,000 for the decontamination, decommissioning and the closing of these facilities was recognized immediately. Previously, decontamination and decommissioning costs were being accrued over the facilities' remaining expected life. Decontamination will proceed as permitted by the existing NRC license, while funding support will be sought and a decommissioning plan will be submitted for review and approval as required by the NRC. B&W expects to have reached agreement with the NRC in fiscal 1997 on the plan that will provide for the completion of facilities dismantlement and soil restoration by the end of fiscal year 2001. B&W expects to request approval from the NRC to release the site for unrestricted use at that time.\nAt March 31, 1995 and 1994, McDermott International had total environmental reserves of $51,721,000 (including the provision discussed above) and $13,513,000 respectively, of which $8,770,000 and $661,000 were included in current liabilities.\nMcDermott International has been identified as a potentially responsible party at various cleanup sites under the Comprehensive Environmental Response, Compensation and Liability Act, as amended. McDermott International has not been determined to be a major contributor of wastes to these sites. However, each potentially responsible party or contributor may face assertions of joint and several liability. Generally, however, a final allocation of costs is made based on its relative contribution of wastes to each site. Based on its relative contribution of waste to each site, McDermott International's share of the ultimate liability for the various sites is not expected to have a material effect on its consolidated financial position.\nThe Department of Environmental Resources of the Commonwealth of Pennsylvania, (\"PADER\"), by letter dated March 19, 1994, advised B&W that it will seek monetary sanctions, and remedial and monitoring relief, related to B&W's Parks Facilities in Parks Township, Armstrong County, Pennsylvania. The relief sought relates to potential groundwater contamination related to the previous operations of the facilities. B&W is currently negotiating with PADER and expects to reach a settlement without having to resort to litigation. Any sanctions ultimately assessed are not expected to have a material effect on the consolidated financial statements of McDermott International.\nOperating Leases - Future minimum payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year at March 31, 1995 are as follows: 1996 -$16,510,000; 1997 - $12,233,000; 1998 - $10,122,000; 1999 - $9,629,000; 2000 - $9,156,000; and thereafter - $44,347,000. Total rental expense for fiscal years 1995, 1994 and 1993 was $109,655,000, $120,515,000, and $131,014,000, respectively. These expense figures include contingent rentals and are net of sublease income, both of which are not material.\nOther - McDermott International performs significant amounts of work for the U.S. Government under both prime contracts and subcontracts and thus is subject to continuing reviews by governmental agencies.\nMcDermott International maintains liability and property insurance that it considers normal in the industry. However, certain risks are either not insurable or insurance is available only at rates which McDermott International considers uneconomical.\nCommitments for capital expenditures amounted to approximately $40,301,000 at March 31, 1995, all of which relates to fiscal year 1996.\nMcDermott International is contingently liable under standby letters of credit totaling $374,414,000 (including $47,864,000 issued on behalf of unconsolidated foreign joint ventures) at March 31, 1995, issued in the normal course of business. McDermott International has guaranteed $29,705,000 of loans to and $26,559,000 of standby letters of credit issued by unconsolidated foreign joint ventures at March 31, 1995. At March 31, 1995, McDermott International had pledged approximately $62,778,000 fair value of government obligations and corporate bonds to secure payments under and in connection with certain reinsurance agreements.\nRelated Party - In connection with the acquisition of OPI, two directors and two officers of JRM have entered into noncompetition agreements. As consideration, the directors and officers received a total of $10,117,000 (including 50,000 shares of JRM's common stock valued at $1,117,000) during fiscal year 1995. In addition, one director will receive additional payments of $1,500,000 per year over the next five years.\nA subsidiary of JRM has entered into an office sublease with an affiliate of two of JRM's directors. Under the sublease, which expires no later than March 1997, the affiliate is required to make monthly rental payments of approximately $18,000 to the subsidiary.\nUnder another agreement, the affiliate will manage and operate the subsidiary's offshore producing oil an gas property for a monthly fee of $48,000 and reimbursement of certain costs. In addition, a subsidiary of JRM sold an offshore jacket and deck to the affiliate for $1,100,000 during fiscal year 1995 and has a contract to refurbish and install the jacket and deck for approximately $1,300,000.\nA subsidiary of JRM entered into agreements with an affiliate of another director of JRM pursuant to which, the subsidiary acquired interests in certain offshore oil and gas property. During fiscal year 1995, the subsidiary paid $3,000,000 to the affiliate under the agreements in connection with the acquisition of its interests and the development of such property. In addition, a subsidiary of JRM owns 140,000 shares of this affiliate and 20,000 units in a limited partnership which is also an affiliate of this director.\nJRM maintains employment agreements with certain officers and employees which contain change in control provisions that would entitle each to receive two times his three-year average annual salary plus continuation of certain benefits if there is a change in control of JRM (as defined) and a termination of his employment within two years after a change in control. These agreements also provide medical and health insurance benefits for a two year period following the termination of employment.\nNOTE 11 - FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK\nMcDermott International's Power Generation Systems and Equipment customers are principally the electric power generation industry (including government-owned utilities and independent power producers), the U.S. Government (including its contractors), and the pulp and paper and other process industries, such as oil refineries and steel mills. The principal customers of the Marine Construction Services segment are the offshore oil, natural gas and hydrocarbon processing industries and other marine construction companies. These concentrations of customers may impact McDermott International's overall exposure to credit risk, either positively or negatively, in that the customers may be similarly affected by changes in economic or other conditions. However, McDermott International's management believes that the portfolio of receivables is well diversified and that such diversification minimizes any potential credit risk. Receivables are generally not collateralized.\nMcDermott International believes that its provision for possible losses on uncollectible accounts receivable is adequate for its credit loss exposure. At March 31, 1995 and 1994, the allowance for possible losses deducted from Accounts receivable-trade on the balance sheet was $8,526,000 and $7,289,000, respectively.\nNOTE 12 - INVESTMENTS\nThe following is a summary of available-for-sale securities at March 31, 1995:\nThe amortized cost and estimated fair value amounts above include $10,909,000 in other debt securities which are reported as cash equivalents in the balance sheet.\nProceeds, gross realized gains and losses on sales of available-for-sale securities were approximately $251,565,000, $88,000 and $2,666,000, respectively, for fiscal year 1995. The amortized cost and estimated fair value of available-for-sale debt and equity securities at March 31, 1995, by contractual maturity, are shown below:\nNOTE 13 - DERIVATIVE FINANCIAL INSTRUMENTS\nMcDermott International operates internationally giving rise to exposure to market risks from changes in foreign exchange rates. Derivative financial instruments, primarily forward exchange contracts, are utilized to reduce those risks. McDermott International does not hold or issue financial instruments for trading purposes.\nForward exchange contracts are entered into primarily as hedges of certain firm purchase and sale commitments denominated in foreign currencies. At March 31, 1995, McDermott International had forward exchange contracts to purchase $251,562,000 in foreign currencies (primarily Canadian Dollars, Japanese Yen, and Pound Sterling), and to sell $199,735,000 in foreign currencies (primarily Canadian Dollars, Dutch Guilders, Japanese Yen, Malaysian Ringgit, and Pound Sterling), at varying maturities from fiscal year 1996 through 2000. At March 31, 1994, McDermott International had forward exchange contracts to purchase $328,881,000 in foreign currencies (primarily Canadian Dollars and Dutch Guilders), and to sell $281,787,000 in foreign currencies (primarily Canadian Dollars, Japanese Yen, Dutch Guilders, British Pounds, and Saudi Riyals), at varying maturities from fiscal year 1995 through 1998.\nDeferred realized and unrealized gains and losses from hedging firm purchase and sale commitments are included on a net basis in the balance sheet as a component of either contracts in progress or advance billings on contracts or as a component of either other current assets or accrued liabilities. They are recognized in income as part of the purchase or sale transaction when it is recognized, or as other gains or losses when a hedged transaction is no longer expected to occur. At March 31, 1995, McDermott International had deferred gains of $2,231,000 and deferred losses of $10,865,000 related to forward exchange contracts which will principally be recognized in accordance with the percentage of completion method of accounting.\nIn management of its net interest costs (expense on debt and income on investments), McDermott International entered into interest rate swap agreements with certain banks which effectively change the fixed interest rates on certain long-term notes payable. Net amounts to be paid or received as a result of these agreements are accrued as adjustments to interest expense over the terms of these contracts. Gains realized as a result of terminating agreements in fiscal year 1993 were deferred and were recognized as reductions of interest expense over the original terms of the agreements. Interest rate swaps resulted in an increase in interest expense of $1,202,000 in fiscal year 1995 and a reduction of interest expense of $5,782,000 and $6,961,000 in fiscal years 1994 and 1993, respectively. At March 31, 1995 and 1994 McDermott International had an interest rate swap outstanding on the current notional principal of $73,800,000 and $90,400,000, respectively, of its 10.375% note payable due 1998.\nMcDermott International is exposed to credit-related losses in the event of nonperformance by counterparties to derivative financial instruments, but it does not anticipate nonperformance by any of these counterparties. The amount of such exposure is generally the unrealized gains in such contracts.\nNOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by McDermott International in estimating its fair value disclosures for financial instruments:\nCash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value.\nInvestment securities: The fair values of investments are estimated based on quoted market prices. For investments for which there are no quoted market prices, fair values are derived from available yield curves for investments of similar quality and terms.\nLong and short-term debt: The fair values of debt instruments are based on quoted market prices or where quoted prices are not available, on the present value of cash flows discounted at estimated borrowing rates for similar debt instruments or on estimated prices based on current yields for debt issues of similar quality and terms.\nRedeemable preferred stocks: The fair values of the redeemable preferred stocks of the Delaware Company are based on quoted market prices.\nForeign currency exchange contracts: The fair values of foreign currency forward exchange contracts are estimated by obtaining quotes from brokers. At March 31, 1995 and 1994, McDermott International had net forward exchange contracts outstanding to purchase foreign currencies with a notional value of $51,827,000 and $47,094,000 and a fair value of $41,237,000 and $35,288,000, respectively.\nInterest rate swap agreements: The fair values of interest rate swaps are the amounts at which they could be settled and are estimated by obtaining quotes from brokers. At March 31, 1995 and 1994, McDermott International had an interest rate swap outstanding on current notional principal of $73,800,000 with a fair value of ($2,541,000) and $90,400,000 with a fair value of ($1,853,000), respectively, which represents the estimated amount, McDermott International would have to pay to terminate the agreement.\nThe estimated fair values of McDermott International's financial instruments are as follows:\nNOTE 15 - SEGMENT REPORTING\nMcDermott International operates in two industry segments - Power Generation Systems and Equipment and Marine Construction Services.\nPower Generation Systems and Equipments' principal businesses are the supply of fossil-fuel and nuclear steam generating systems and equipment to the electric power generation industry, and nuclear reactor components to the U. S. Navy.\nMarine Construction Services supplies worldwide services for the offshore oil, natural gas and hydrocarbon processing industries, and to other marine construction companies, primarily through JRM. Principal activities include the design, engineering, fabrication and installation of marine pipelines and offshore structures and subsea production systems for development drilling and production, and onshore construction and maintenance services.\nIntersegment sales are accounted for at prices which are generally established by reference to similar transactions with unaffiliated customers. Identifiable assets by industry segment are those assets that are used in McDermott International's operations in each segment. Corporate assets are principally cash and cash equivalents, short-term investments, marketable securities and prepaid pension costs.\nIn the fiscal years 1995, 1994 and 1993, the U. S. Government accounted for approximately 12%, 13% and 13%, respectively, of McDermott International's total revenues. These revenues are principally included in the Power Generation Systems and Equipment segment.\nAt March 31, 1995, 1994 and 1993 receivables of $6,230,000, $1,142,000, and $10,524,000, respectively, were due from minority shareholders, primarily ETPM S.A., participating in McDermott International's majority-owned joint ventures. Sales to ETPM S.A. were $1,801,000, $3,358,000 and $31,234,000, respectively, for the fiscal years ended March 31, 1995, 1994 and 1993. In fiscal years 1995, 1994 and 1993 equipment charters and overhead expenses of $4,938,000, $6,330,000 and $6,046,000, respectively, were charged by ETPM S.A. to the McDermott-ETPM joint venture.\nThe provisions for the closing of certain facilities in fiscal year 1995 resulted in a decrease in the Power Generation Systems and Equipment segment operating income of $46,489,000. The adoption of EITF Issue No. 93-5 in fiscal year 1994 resulted in an increase in the Power Generation Systems and Equipment segment operating income of $19,947,000. The adoption of SFAS No. 106 in fiscal year 1993 resulted in a net decrease in segment operating income of $6,784,000. This included a decrease of $3,760,000 in the Power Generation Systems and Equipment segment and a decrease of $3,024,000 in the Marine Construction Services segment.\nSegment Information for the Three Fiscal Years Ended March 31, 1995.\n1. Information about McDermott International's Operations in Different Industry Segments.\n(1) Segment revenues include intersegment transfers as follows:\n(2) See Note 2 regarding the acquisition of OPI during fiscal year 1995 and the acquisitions of NOS and DCC during fiscal year 1994.\n(1) Includes property, plant and equipment of $173,134,000 and $79,233,000 of acquired companies in fiscal years 1995 and 1994, respectively, and the purchase of a fabrication yard financed by a note payable of $16,250,000 in fiscal year 1994.\n2 . Information about McDermott International's Operations in Different Geographic Areas.\n(1) Net of inter-geographic area revenues in fiscal years 1995 and 1994 as follows: United States- $69,432,000 and $38,666,000, Canada - $11,538,000 and $12,082,000, Europe and West Africa - $13,200,000 and $15,868,000, Far East - $18,414,000 and $474,000, Middle East - $37,303,000 and $2,686,000 and Other Foreign - $26,259,000 and $25,770,000, respectively.\n(2) Net of inter-geographic area revenues of $71,027,000 in fiscal year 1993.\nNOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following tables set forth selected unaudited quarterly financial information for the fiscal years ended March 31,1995 and 1994:\nPre-tax results for the quarter ended June 30, 1994 include a reduction in accrued interest expense of $5,700,000 due to settlement of an outstanding tax issue with the IRS. Results for the quarter ended September 30, 1994 include a loss related to the reduction of estimated products liability asbestos claim recoveries from insurers of $14,478,000 and a reduction in accrued interest expense of $5,600,000 due to the settlement of outstanding tax issues. Results for the quarter ended December 31, 1994 include a reduction in accrued interest expense of $5,000,000 due to the settlement of outstanding tax issues and favorable worker's compensation cost adjustments of $14,886,000. Results for the quarter ended March 31, 1995 include provisions of $46,489,000 for the decontamination, decommissioning, and closing of a nuclear facility and for the closing of a manufacturing facility, and a reduction in accrued interest expense and taxes of $10,000,000 and $5,200,000, respectively, due to the settlement of outstanding tax issues.\nPre-tax results for the quarter ended June 30, 1993 include a favorable warranty reserve adjustment of $11,000,000. Results for the quarter ended December 31, 1993 include a reduction in the provision for worker's compensation and general liability costs resulting from a change in actuarial estimate of $12,001,000. Results for the quarter ended March 31, 1994 include a provision of $8,807,000, including interest, resulting from an unfavorable ruling on a lawsuit relating to a warranty issue; and a reduction in accrued interest on proposed tax deficiencies of $9,400,000. Included in income before cumulative effect of accounting change and net income for the quarter ended March 31, 1994, is a reduction in the provision for taxes of $10,000,000 due to the settlement of outstanding issues.\nItem 9.","section_9":"Item 9. DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART I I I\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere are no family relationships between any of the executive officers, directors or persons nominated to be such, and no executive officer was elected to his position pursuant to any arrangements or understanding between himself and any other person.\nInformation required by this item with respect to directors and executive officers is incorporated by reference to the material appearing under the headings \"Election of Directors\" in the Proxy Statement for International's 1995 Annual Meeting of Stockholders.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Compensation of Executive Officers\" and \"Certain Transactions\" in the Proxy Statement for International's 1995 Annual Meeting of Stockholders.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is incorporated by reference to the material appearing under the headings \"Security Ownership of Directors and Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\" in International's Proxy Statement for the 1995 Annual Meeting of Stockholders.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Compensation of Executive Officers\" and \"Certain Transactions\" in International's Proxy Statement for the 1995 Annual Meeting of Stockholders.\nPART I V\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Annual Report or incorporated by reference:\n1. CONSOLIDATED FINANCIAL STATEMENTS\nReport of Independent Auditors\nConsolidated Balance Sheet March 31, 1995 and 1994\nConsolidated Statement of Income (Loss) For The Three Fiscal Years Ended March 31, 1995\nConsolidated Statement of Stockholders' Equity For The Three Fiscal Years Ended March 31, 1995\nConsolidated Statement of Cash Flows For the Three Fiscal Years Ended March 31, 1995\nNotes to Consolidated Financial Statements For the Three Fiscal Years Ended March 31, 1995\n2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nAll required schedules will be filed by amendment to this Form 10-K on Form 10-K\/A.\n3. EXHIBITS\n(a) CURRENT REPORTS ON FORM 8-K\nA Current Report on Form 8-K, Item 2, was filed by McDermott International, Inc. on February 15, 1995.\nA Current Report on Form 8-K\/A, Item 7, was filed by McDermott International, Inc. on March 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.\nMcDERMOTT INTERNATIONAL, INC.\ns\/ Robert E. Howson ------------------------------ June 16, 1995 By: Robert E. Howson 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 and on the date indicated.\nJune 16, 1995","section_15":""}
{"filename":"87086_1995.txt","cik":"87086","year":"1995","section_1":"ITEM 1 - BUSINESS\nScan-Optics, Inc. (the Company) was incorporated in Delaware in 1968 and has its principal office at 22 Prestige Park Circle, East Hartford, Connecticut 06108.\nThe Company designs, manufactures, markets and services information processing systems which are used for imaging, data capture, document processing and the management of information. The Company's Series 7000 Network Image Scanners and Series 9000 optical character recognition\/(OCR) and intelligent character recognition (ICR) scanners deliver cost-effective, high volume imaging solutions. Its UNIX and PC-based post-scanning systems offer verification, image storage and retrieval, and document management in an open-systems environment. The Company's professional services integrate scanning platforms and networked tools to deliver a turn-key system solutions.\nTARGET SOLUTIONS\nHEALTH CARE AND INSURANCE PROCESSING The Company has been providing health care related information systems since 1985. These applications include processing customer satisfaction forms, patient encounter forms, and Health Care Financing Administration (HCFA) Forms. To ease the implementation for customers, the systems are designed to utilize industry standard components wherever feasible, including processing on industry standard client\/server, open LAN-based systems designed specifically to improve the efficiency of health claim form reporting and processing. The Company's goal in providing this service is to minimize the customer investment involved with processing paper health claim forms.\nORDER PROCESSING The Company has been providing applications for order entry for at least 16 years. At one customer site, order entry software is processing over 800,000 orders on a daily basis. Order entry is a key operational requirement for any successful company. The Company's systems fulfill this requirement in an efficient, timely, and cost-effective manner. The Company enjoys the reputation as a leading supplier of high speed order entry software.\nTAX AND FINANCIAL SERVICES PROCESSING The Company has had significant experience in processing taxes at various state governments as well as at the Internal Revenue Service. The Company's Series 9000 systems recently processed the One Hundred Millionth (100,000,000th) tax document on the IRS SCRIPS System during this past calendar year. These Series 9000 systems use application programs developed and supported by the Company. The Company has 25 years of experience in tax processing.\nPRODUCTS\nThe Company designs, manufactures, markets and services information processing systems which use \"state of art\" technology for imaging, automated data capture, document processing and the management of information. These systems employ high speed paper movement, OCR\/ICR, high speed image capture, image storage and retrieval systems, image information processing, key-entry, microfilming, ink jet printing, high-speed paper handling with multi-pocket page and\/or document sorting, local area networking, client\/server PC processing, communications software and software\/hardware integration technologies to assure a complete approach to engineering solutions for data processing.\nThese key product disciplines translate integration skills that leverage the core competencies of the Company to provide broader solution alternatives. These core competencies include:\nDocument Scanning Character Recognition (OCR, ICR, Barcode, Marksense, etc.) High Speed Paper Handling Image Enhancement Algorithms and Image Quality Key-From-Image and Data Entry Customer Relations Value Added Engineering Services and Solutions\nCORE COMPETENCIES\nDOCUMENT SCANNING The Company has been addressing the high-speed, high-volume, page\/document processing market place since its inception in 1968. During 1992, the Company introduced the newest generation of scanners called the Series 9000 system. This system launched the Company into the full page image and recognition (ICR) market. Full page document processing includes front and back imaging, OCR reading, serialization and microfilming of a document in a single pass. During 1994, the Company introduced the Model 7800 scanner which is an image product which can be utilized to improve Customer Service, Order Processing, and Microfilm Replacement.\nCHARACTER RECOGNITION As with the scanners, the Company has been providing its own developed character recognition since 1968. This recognition has always included the basic in-line recognition of machine printed, handprinted, and mark sense. With the introduction of the Series 9000 system, the Company has expanded this recognition to include barcode, patch code, special educational score testing analysis, and special stamp recognition. In addition to these recognition processes, the Company has integrated and developed neural recognition technologies that support both in-line and post recognition.\nHIGH SPEED PAPER HANDLING The Company is a leader in patented high speed paper handling systems. The Series 9000 scanner which was introduced in 1992 has over 100 systems installed world wide. The Company has over 300 scanning systems installed world wide processing 15 million pieces of paper on a daily basis.\nIMAGE ENHANCEMENT ALGORITHMS AND IMAGE QUALITY Image enhancement algorithms and image quality are priority development activities for the Company. Image enhancement starts at the scanner capture system. The Company provides the fastest page capture and image system on the market today. This processing is carried forward into the Company's key-From-Image and Image Storage and Retrieval Systems. Management believes that the Company's image quality is among the best in the industry . Electronic image processing and storage are rapidly overtaking the use of microfilm and the Company is on the leading edge of this technology with its hardware and application software solutions.\nKEY-FROM-IMAGE AND DATA ENTRY The Company has been providing complete hardware and software solutions using Key-From-Image (KFI) and Data Entry since 1976. This KFI and Data Entry solution remains important today, using the latest open network and platform designs with Windows, UNIX, Novell, TCP\/IP, NT, and other industry standard components. By combining the high-speed scanning systems with the flexibility of KFI and Data Entry, customers are able to lower their overall data capture and document processing costs while improving the level of data accuracy.\nCUSTOMER RELATIONS 28 Years of Customized Software Solutions Customized software support has provided service to the Company's customers since 1968. The Company's scanners and assorted network system products provide the hardware platforms for delivering advanced high-volume forms processing, imaging, and document management system solutions, especially in Health Care, Order Entry, and Tax Processing. This customized software support enables the Company to provide full production-ready application systems tailored to the customer's specific needs.\nThis support is provided through professional services offered by the Company. These services offer a total package of Application Services including: specifications, design, development, installation, training, support and project management. The Company also provides individual, custom software services as requested by the customer. In this way, the Company can either provide the entire package of software support or simply provide those services that the customer desires.\n28 Years of Hardware Support The Company has been offering service and maintenance support to its broad customer base since 1968. This support is available with either leased or purchased systems in both the domestic and the international markets. Service is provided through a network of over 100 service centers in North America and the United Kingdom. The Company provides on-site and on-call service with response times of two hours or less. The Company focuses on comprehensive diagnostic routines, modular design and preventative maintenance procedures to assure its users of high system availability to perform mission critical applications.\nService revenue accounted for 34%, 36% and 37% of the Company's total revenue for 1995, 1994 and 1993, respectively.\nVALUE ENGINEERING SERVICES AND SOLUTIONS The Company has been supplying engineering services and solutions to meet customer needs since introducing its first fully integrated solution in 1976. The solutions include scanning, recognition, Key-From-Image, data entry, and communications. During 1993, the Company was selected to develop a prototype system to process medical claims for a health care agency in Japan. This system was designed with 36 stacker pockets for sorting forms; expanded paper handling capabilities for light-weight, flimsy forms; high resolution image cameras to permit recognition of complex Japanese kanji characters; and software forms recognition for up to 20,000 different form formats.\nThe Company has been involved in special recognition techniques to process order forms that contain stamps. These stamps are used as an entry into a sweepstake contest or to select ordered items for a record or book club. The stamps are of a multitude of colors and are successfully processed through the Company's special recognition features. In addition to stamp processing, the Company has been engaged in recognition analysis for educational test scoring. This process is accomplished in full duplex mode at a transport speed of 50 inches per second.\nSIGNIFICANT CUSTOMERS\nIn 1995, one customer accounted for approximately 31% of consolidated revenues. Two customers accounted for approximately 22% of consolidated revenues in 1994, each at 11%. No single customer accounted for more than 10% of consolidated revenues in 1993.\nCHANNELS OF DISTRIBUTION\nThe Company is augmenting its practice of selling directly to end-users and distributors to respond to new opportunities in the marketplace. The focus on providing more complete solutions to customers has stimulated the pooling of resources with selected system integration firms and specialized niche suppliers. The cooperative effort with system integrators and other vendors has introduced the Scan-Optics logo to new markets in 1995, both domestically and internationally.\nBACKLOG\nThe backlog for the Company's products and services as of December 31, 1995 and 1994 was approximately $12,483,000 and $19,775,000 respectively. The backlog consists of equipment, software and services to be sold and noncancelable rentals and maintenance due on existing rental and maintenance contracts. The Company normally delivers a system within 30 to 180 days after receiving an order, depending upon the degree of software customization required.\nMANUFACTURING\nManufacture of the Company's products requires the fabrication of sheet metal and mechanical parts, the subassembly of electronic and mechanical parts and components, and operational and quality control testing of components, assemblies and completed systems. The Company's products consist of both standard and Company-specified mechanical and electronic parts, sub- assemblies and major components, including microcomputers. Most parts are purchased, including many complex electronic and mechanical sub-assemblies. The Company also purchases major standard components, including magnetic tape and disk storage drives, display terminals, and microcomputers. An important aspect of the Company's manufacturing activities is its quality control program which uses computer-controlled testing equipment.\nThe Company has not experienced significant shortages of any components or subassemblies; however, alternate sources for such components and subassemblies have been developed.\nCOMPETITION\nThe Company competes with service providers utilizing multiple vendor architectures. The Company differentiates its solutions by offering a total system, including post installation of hardware and software services. The Company focuses on industry specific \"application\" areas with solutions utilizing image and data entry\/data capture systems provided by the Company.\nPATENTS\nThe Company currently has five United States patents in force which expire between 2003 and 2013. The patents are on mechanical systems, electronic circuits, electronic systems and software algorithms which are used throughout the product lines. The Company expects to continue to apply for patents on its new technological developments when it believes they are significant.\nEMPLOYEES\nAs of December 31, 1995 the Company employed 269 persons, including 20 with administrative and support responsibilities, 144 in marketing, sales, software and service activities and 105 in engineering and production capacities. The Company considers its employee relations to be good. The Company has not experienced any work stoppages.\nPRODUCT DEVELOPMENT\nIn June 1992, the Company introduced the Series 9000 Scanner. The Series 9000 integrates the latest in character recognition, image capture, and paper handling technology into a high speed scanner. During 1993, the Company introduced several options for this scanner. These options permit character recognition and image processing on the \"reverse side\" of documents; a special small document stacker module; and the ability to recognize several industry standard bar-codes.\nThe Series 9000 interfaces with other company products to provide multi-media data entry and image storage retrieval. During 1994, the Company developed and delivered a network-based scanning, recognition and data entry product - the Series 7000 - which addresses requirements for a distributed solution.\nIn April 1995, the Company introduced the Model 7800 Scanner. The Model 7800 is the world's fastest full-page image scanner, capable of capturing up to 200 full size pages per minute. It is based on Scan-Optics' high-end, industry proven Series 9000.\nThe Company considers product development to be a significant element in maintaining market share. During the years ended December 31, 1995, 1994 and 1993, the Company's research and development expenses were $4,574,000, $5,690,000, and $4,601,000, respectively. Some portion of these amounts were funded under the development agreements described above.\nThe Company intends to continue its program of development of additional options and capabilities for its existing products as well as the development of new products which exploit the Company's core competencies: document scanning, character recognition, high speed paper handling, image enhancement, key-from-image and data entry, customer relations and value engineering services and solutions.\nFUNDED DEVELOPMENT AGREEMENTS\nDuring 1990, the Company entered into two separate agreements for the development of new product technology, which provided a total funding of $3,645,000 over an eighteen month period. Revenues related to these development projects were recorded through 1992, which offset related costs incurred to successfully develop the products. The agreements provide the respective third party with exclusive rights to market the developed product in its geographic market area while the Company will manufacture the product and retain ownership and all other distribution rights. Royalties and other considerations, up to a maximum of 130% of the amount advanced to the Company, are required to be paid based on sales of the new product technology through the termination dates of the agreements, June 30, 1995 and December 31, 1996. As of December 31, 1995, the Company had repaid or accrued $4,432,000 or 90% of the maximum potential royalty.\nDuring 1993, the Company entered into a $1,160,000 product development agreement for a specific customer, which required various modifications and enhancements to the Company's Series 9000 product. The Company recorded revenue related to this development agreement of $370,000 in 1994 and $790,000 in 1993. These revenues offset related costs incurred to develop the modifications and enhancements. Two prototype systems were delivered in the first quarter of 1994 and successfully passed customer acceptance testing. An initial production contract was awarded for delivery in the fourth quarter of 1994. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement.\nDuring 1995, the Company entered into $700,000 of product development agreements with a specific customer, which required various modifications and enhancements to the Company's Series 9000 product. The Company recorded revenue related to these development agreements of $336,000 in 1995. These revenues offset related costs incurred to develop the modifications and enhancements. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement.\nEFFECTS OF ENVIRONMENTAL LAWS\nThe effect of federal and state environmental regulations on the Company's operations is insignificant.\nGEOGRAPHICAL SEGMENTS\nSales of equipment to customers in the international market represent an important source of the Company's revenues. The Company has international distributors located in 40 countries and covering six continents. The Company does not believe that there are any special additional risks attendant to sales in its present international markets.\nThe following table sets forth certain information relating to export sales for the three most recent fiscal years ended December 31:\nEXPORT SALES\nExport sales represented 57%, 39% and 24% of net sales for the three years ended December 31, 1995, 1994 and 1993, respectively.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company's executive offices and principal research and development and marketing activities are located in a one-story, thirty-five thousand square foot brick and cinder block building located in East Hartford, Connecticut, leased for a term expiring in December 1996. The Company has a eighty-four thousand square foot manufacturing facility in Manchester, Connecticut, whose lease expires in December 1996. The Company also operates two sales, support, and research and development facilities; one in Irvine, California of four thousand square feet expiring in December 1998 and one in Berkeley, California of two thousand square feet expiring in December 1996.\nThe Company leases office space throughout the United States for sales, service and administrative functions. Office space for administration and equipment demonstration is also leased by Scan-Optics, Ltd., in the United Kingdom and Scan-Optics (Canada), Ltd., both wholly-owned subsidiaries.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThere are certain claims pending against the Company which arose in the normal course of business. In the opinion of management, the ultimate outcome of these matters will not have a material 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\nThe Company did not submit any matter during the fourth quarter of 1995 to a vote of the stockholders.\nEXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT\nOfficers of the Company are set forth in the schedule below. Officer Name Age Principal Occupation: Since\nRichard I. Tanaka 67 Chairman, Chief Executive Officer and Director 1989\nJames C. Mavel 50 Chief Operating Officer and President 1996\nRobert L. Bell 44 Vice President - Business Development 1993\nWilliam H. Cuddy 60 Secretary 1984\nRichard C. Goyette 44 Vice President - 1996 Sales and Marketing\nClarence W. Rife 56 Vice President - Customer Relations 1975\nJohn B. Sayre 60 Vice President - Facilities and Manufacturing 1988\nMichael J. Villano 36 Chief Financial Officer and Vice President 1992\nDr. Tanaka joined the Company in September 1989 as Chairman of the Board and Chief Executive Officer. Prior to joining the Company, Dr. Tanaka was President of Lundy Electronics and Systems, Inc., a division of TransTechnology Corp. from 1987 to 1989 and from 1980 to 1986 he was President and CEO of Systonetics, Inc.\nMr. Mavel joined the Company in January 1996 as Chief Operating Officer and President. Prior to joining the Company, from 1992 through 1995, Mr. Mavel was Vice President and General Manager of the Imaging Systems Division of Unisys. From 1991 to 1992, he was Group Vice President of the Financial Information Systems Division of National Data Corporation.\nMr. Bell joined the Company in August 1993 as Vice President - Product Development. Prior to this date, he was a consultant for the design and development of information networks from 1991 to 1992 and from 1989 to 1991 he was President of Bluebonnet, a research organization for advanced telecommunications systems. From 1979 to 1989 he held various positions with Recognition International, Inc.\nMr. Cuddy has been a partner in the law firm of Day, Berry and Howard since 1968. He was elected to the position of Corporate Secretary in September 1984.\nMr. Goyette joined the Company in March 1996 as Vice President - Sales and Marketing. Prior to joining the Company, from 1993 through 1995, Mr. Goyette was Vice President of the Imaging Systems Group of Unisys. From 1992 to 1993, he was Vice President of the Software Products Group of Unisys. From 1990 to 1992 he was Vice President of Corporate Information Productivity Systems of Unisys.\nMr. Rife has been employed by the Company since 1969 and was elected to the position of Vice President in 1975. He is currently Vice President - Customer Relations.\nMr. Sayre joined the Company in December 1988 as Vice President - Facilities and Manufacturing. Prior to this date he held various management positions with Pratt and Whitney, Division of United Technologies Corporation, from 1985 to 1988 and previously with LTV\/Republic Steel from 1980 to 1985.\nMr. Villano joined the Company in 1986 and in 1988 was named Assistant Controller. In 1989 he was promoted to the position of Controller, in February 1992 was named Vice President and Controller and in March 1994 was named Chief Financial Officer and Vice President.\nThe executive officers are elected for a one year term at the Directors' meeting following the Annual Meeting of Stockholders each year. There are no family relationships between any of the listed officers and directors.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCOMMON STOCK MARKET PRICES AND DIVIDENDS\nThe following is a two year history of Common Stock prices for each quarter. The table sets forth the high and low closing quotations per share for the periods indicated of the Common Stock in the over-the-counter market based upon information provided by the National Association of Security Dealers, Inc. The closing quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not represent actual transactions. There were 1,419 Common stockholders of record at December 31, 1995.\nThe Company has not paid any dividends on its Common Stock and the Board of Directors of the Company has no present intention of declaring dividends in the foreseeable future. The declaration and payment of dividends in the future will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition, capital requirements and other factors.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA SCAN-OPTICS, INC. AND SUBSIDIARIES FIVE YEAR SUMMARY OF OPERATIONS SELECTED FINANCIAL DATA\nThe Company has not paid any dividends for the five year period ended December 31, 1995.\nThe above financial data should be read in conjunction with the related consolidated financial statements and notes thereto.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nCash and cash equivalents increased by $.1 million from 1994 to 1995.\nTotal Company borrowings decreased $2.0 million to $.3 million at December 31, 1995. The average borrowing level for 1995 was $5.3 million compared to $4.8 million for 1994. The change in borrowing level is due in part to the loss incurred in 1995 as well as the timing of cash flows throughout the year.\nOperating activities provided $2.4 million of cash in 1995 compared to $1.2 million in 1994. The increase is attributable to a significant customer deposit received in the last quarter of 1995, offset partially by increases in accounts receivable and inventory.\nNon-cash expenses recorded in 1995 were $2.5 million vs. $2.6 million in 1994. These expenses primarily relate to depreciation, amortization, provisions for losses on accounts receivable and provisions for inventory obsolescence.\nAccounts receivable increased $1.2 million from 1994 reflecting the increase in sales in the fourth quarter of 1995 compared to 1994.\nTotal inventories decreased $.5 million from 1994 levels. Manufacturing inventories decreased $3.1 million during the year due to transfers of product to the customer service inventory that are utilized in support of our maintenance contracts. The items transferred mainly represent non-current products with significant numbers of installed machines requiring this supply of parts. The transfer of $2.5 million accounted for the change in both manufacturing and customer service inventories.\nPlant and equipment increased $.3 million in 1995. The major components of this increase include assets acquired as a result of the Company's license of the Image EMC product, engineering development equipment and test equipment, and the upgrading of the Company's show booth.\nAccounts payable and accrued expenses increased $.9 million from 1994 levels. Accounts payable increased $.1 million due to timing of cash flows related to inventory purchases. Accrued expenses decreased $1.0 million due to the payment of the royalty accrual upon completion of a research and development agreement during June of 1995.\nCustomer deposits increased $3.7 million and relate primarily to deliveries of equipment in 1996 to a Japanese health agency.\nOn March 11, 1996, the Company received a commitment letter extending the maturity date of the Company's outstanding bank line of credit to May 29, 1997. Management believes that the line of credit provides the Company with sufficient financial resources to meet its working capital and capital expenditure requirements.\nRESULTS OF OPERATIONS -- 1995 VS. 1994\nTOTAL REVENUES decreased $1.8 million from 1994.\nNET SALES increased $.7 million from the prior year. North American sales decreased $4.6 million and international sales increased $5.3 million from 1994. The North American sales decreased due to the completion of the primary implementation of the IRS SCRIPS award in 1994. International sales in the Pacific Rim showed significant growth from 1994 to 1995. Sales to a Japanese health agency increased sales volume in this marketplace by 123% or $8.3 million. Sales to Latin America and South America decreased 76% or $1.2 million. Sales to Europe decreased 80% or $1.8 million over the prior year. These decreases are reflective of large non-recurring sales which occurred in the prior year.\nSERVICE REVENUES decreased $2.3 million from 1994 to 1995. Customer service revenue decreased $1.5 million due to the replacement of older product lines which included a significant maintenance surcharge with the Series 9000. Software service revenue decreased $.3 million due to the decrease in North American sales during the year. Engineering revenue decreased $.5 million from 1994 to 1995 due to the completion of a significant product development agreement.\nCOST OF SALES increased $1.9 million from 1994 to 1995. The gross margin percentage decreased 5.3% from 34.8% in 1994 to 29.5% in 1995. The decrease in gross margin is due to the shift in revenue mix from domestic sales to international sales, particularly to the Pacific Rim. Sales to a Japanese health agency, due to the volume of orders, carried a lower margin percentage. Additionally, unabsorbed manufacturing expenses increased in 1995 due to the fluctuations in production volume throughout the year.\nMARKETING AND SERVICE EXPENSES decreased by $.7 million in 1995 principally due to staffing reductions related to changes in the installed base of serviced equipment.\nRESEARCH AND DEVELOPMENT EXPENSES decreased $1.1 million from 1994 mainly due to the decrease in engineering staff resulting from the corporate reorganization as well as a decrease in the utilization of outside consultants.\nGENERAL AND ADMINISTRATIVE EXPENSES increased $.5 million compared to prior year mainly due to a $.2 million increase in legal expenses, and a $.1 million increase in the Company's contribution to the 401(k) plan. Additionally, outside recruiting firms were utilized in 1995 to fill open positions in upper management.\nRESULTS OF OPERATIONS -- 1994 VS. 1993\nTOTAL REVENUES increased $7.5 million from 1993.\nNET SALES increased $7.3 million from the prior year. North American sales increased $2.7 million and international sales increased $4.6 million from 1993. The North American sales increases are reflective of the continued acceptance of the Series 9000 product line as well as the fulfillment of the primary implementation of the IRS SCRIPS award. International sales showed significant growth from 1993 to 1994. The growth occurred in two of the three major international marketplaces for the Company's products. Sales to a Japanese health agency increased sales volume to the Pacific Rim by 191% or $4.4 million. Sales to Latin America and South America increased 272% or $1.2 million as the Company sold a major credit card system to a bank in Mexico. Sales to Europe increased 8% or $.2 million over the prior year.\nSERVICE REVENUES increased $.2 million from 1993 to 1994. Customer service revenue decreased $.2 million due to the replacement by the Series 9000 of older product lines which included a significant maintenance surcharge. Software service revenue increased $.5 million due to the increase in North American sales and the continued Company focus on software as a growth business line in the future. Engineering revenue decreased $.1 million from 1993 to 1994.\nCOST OF SALES increased $5.7 million from 1993 to 1994. The gross margin percentage decreased 4.8% from 39.6% in 1993 to 34.8% in 1994. The decrease in gross margin is due to the increase in royalty expense incurred from 1993 to 1994 of $1.2 million. The gross margin percentage remained consistent from 1993 to 1994 after adjusting for the change in royalty expense.\nMARKETING AND SERVICE EXPENSES decreased by $1.5 million in 1994. Customer service expenses decreased $.6 million from the prior year due to parts usage and amortization expense decreases related to customer service inventory. Customer service staffing adjustments relating to changes in the installed base of serviced equipment also accounted for a portion of the decrease. Software service expenses decreased $.2 million due to the reduction in travel expenses related to system acceptances in 1994. Marketing expenses decreased $.7 million from the prior year of which $.2 million was due to staffing reductions and the remaining $.5 million was due to the reduction in the requirement for an accounts receivable provision from 1993 to 1994.\nRESEARCH AND DEVELOPMENT EXPENSES increased $1.1 million from 1993 mainly due to the use of consultants to augment existing staffing.\nGENERAL AND ADMINISTRATIVE EXPENSES remained consistent with the prior year.\n(This page has been left intentionally blank.)\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Scan-Optics, Inc.\nWe have audited the accompanying consolidated balance sheets of Scan-Optics, 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. 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 Scan- Optics, 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 a whole, presents fairly in all material respects the information set forth therein.\nErnst & Young LLP\nHartford, Connecticut February 2, 1996, except for the second paragraph of Note C, as to which the date is March 11, 1996\nSCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nSCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes. SCAN-OPTICS, INC. AND SUBSIDIARIES\nSCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes.\nSCAN-OPTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- ACCOUNTING POLICIES\nORGANIZATION: The Company designs and manufactures information processing systems used for imaging, data capture, document processing and information management. The Company's systems, software and services are marketed world- wide to commercial and government organizations either directly by the Company sales organization or through distributors. The Company's business is vulnerable to a number of factors beyond its control. These include (1) the effect of a weakening in the domestic and international economies which potentially impacts capital investments by customers, (2) the cyclical nature of funding within federal and state government agencies, (3) competition from similar products, (4) the implementation of other technologies which may provide alternative solutions, and (5) the stability of our sole source suppliers.\nBASIS OF PRESENTATION: The consolidated financial statements include the accounts of Scan-Optics, Inc. and its subsidiaries, all wholly-owned. All intercompany accounts and transactions are eliminated in the consolidated financial statements. 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. While management believes that the estimates and related assumptions used in the preparation of these financial statements are appropriate, actual results could differ from those estimates.\nCASH EQUIVALENTS: Highly liquid investments purchased with maturities of three months or less are considered cash equivalents.\nINVENTORIES: Inventories are valued at the lower of cost (first-in, first-out method) or market.\nPLANT AND EQUIPMENT: Plant and equipment is stated on the basis of cost. Depreciation is computed principally using the straight-line method over periods of 3 to 10 years. Leasehold improvements are amortized over the useful life of the improvements or the life of the lease, whichever is shorter.\nREVENUE RECOGNITION: Revenues from maintenance and application software services are recognized as earned. Revenues relating to sales of certain equipment (principally optical character recognition equipment) are recognized upon acceptance of the related application software.\nINCOME TAXES: Deferred income taxes are provided for differences between the income tax and the financial reporting bases of assets and liabilities at the statutory tax rates that will be in effect when the differences are expected to reverse.\nSTOCK BASED COMPENSATION: The Company generally grants stock options to key employees and members of the board of directors with an exercise price equal to the fair value of the shares on the date of grant. The Company accounts for\nstock 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.\nEARNINGS (LOSS) PER SHARE: Earnings (loss) per share amounts are computed using weighted average common and common equivalent shares outstanding during the year assuming conversion of the common stock equivalents into common stock, if dilutive, at the weighted average market price of the stock for the year. All shares held by the Company's Employee Stock Ownership Plan (ESOP) are considered outstanding.\nFOREIGN CURRENCY TRANSLATION: The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with FASB Statement No. 52, Foreign Currency Translation. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the year. The gains and losses resulting from the changes in exchange rates from year to year have been reported separately as a component of stockholders' equity.\nRECLASSIFICATIONS: Certain 1994 and 1993 amounts have been reclassified to conform to current year presentation.\nNOTE B -- INVENTORIES\nThe components of inventories were as follows:\nNOTE C -- CREDIT ARRANGEMENTS\nThe Company has a line of credit agreement (Agreement) with a bank which expires on May 31, 1996. The Agreement has two components, a $4 million line (international) guaranteed by a third party bank which is collateralized by international accounts receivable and inventory, and which bears interest at prime (8 1\/2% at December 31, 1995); and a $4 million line (domestic) which is collateralized by domestic accounts receivable and inventory, and which bears interest at prime plus 1\/2% (9% at December 31, 1995). The weighted average interest rate on borrowings during 1995 and 1994 was 9.1% and 7.9% respectively. The unused portion of the $4 million domestic line is subject to a commitment fee of 3\/4% per annum. Borrowings under the Agreement are subject to various limitations based upon percentages of eligible receivables and inventories of the Company. The available balance on the total line of credit was $7,014,000 at December 31, 1995. In addition, the Agreement contains covenants which, among other things, require the maintenance of specified working capital, debt to equity ratios, net income levels and tangible net worth levels.\nOn March 11, 1996, the Company received a commitment letter from the bank extending the maturity date of the outstanding line of credit to May 29, 1997. The line of credit was reduced from $8 million to $6 million ($3 million each for the international and domestic lines) which is reflective of the Company's current cash availability and projected cash flow requirements for the next twelve months. The commitment letter is subject to the extension of the guarantee by the third party bank on the international line. The Company expects that the guarantee will be extended.\nThe carrying value of the Company's credit arrangement approximates its fair value.\nNOTE D -- CAPITAL STOCK\nThe Board of Directors is authorized to issue shares of the Company's preferred stock in series, to establish from time to time the number of shares to be included in each series and to fix the designation, powers, preferences and other terms and conditions with respect to such stock. No shares have been issued to date.\nClass A stock has the same rights as common stock, except that its holders may not vote for the election of directors, and it is convertible into common stock on a share for share basis. On September 2, 1994, all outstanding shares of Class A stock were converted to common stock.\nAt December 31, 1995, the Company had reserved 1,163,774 shares of common stock for the exercise of warrants (43,000) and the issuance or exercise of stock options (1,120,774).\nNOTE E -- COMMON STOCK WARRANTS\nWarrants outstanding generally have anti-dilution provisions and expire between 1996 and 1998.\nNOTE F -- STOCK OPTION PLANS\nThe Company has five stock option plans for key employees and board members. Options granted under the plans are for a period of ten years and at prices not less than the fair market value of the shares at date of grant except that the price for non-qualified options may not be less than the par value of the stock. Options for employees are not exercisable for one year following the date of grant and then are exercisable in such installments during the period prior to expiration as the Stock Option Committee shall determine. Options for Directors are not exercisable until six months after the grant thereof. Options may be exercised from time to time, in part or as a whole, on a cumulative basis as determined by the Stock Option Committee under all stock option plans.\nThe following schedule summarizes the changes in stock options for each of the three years in the period ended December 31, 1995:\nAt December 31, 1995 there were 334,059 options available for grant.\nNOTE G -- RESEARCH AND DEVELOPMENT AGREEMENTS\nDuring 1990, the Company entered into two separate agreements for the development of new product technology, which provided a total funding of $3,645,000 over an eighteen month period. Revenues related to these development projects were recorded through 1992, which offset related costs incurred to successfully develop the products. The agreements provide the respective third party with exclusive rights to market the developed product in its geographic market area while the Company will manufacture the product and retain ownership and all other distribution rights. Royalties and other considerations, up to a maximum of 130% of the amount advanced to the Company, are required to be paid based on sales of the new product technology through the termination dates of the agreements, June 30, 1995 and December 31, 1996. As of December 31, 1995, the Company had repaid or accrued $4,432,000 or 90% of the maximum potential royalty.\nDuring 1993, the Company entered into a $1,160,000 product development agreement for a specific customer, which required various modifications and enhancements to the Company's Series 9000 product. The Company recorded revenue related to this development agreement of $370,000 in 1994 and $790,000 in 1993. These revenues offset related costs incurred to develop the modifications and enhancements. Two prototype systems were delivered in the first quarter of 1994 and successfully passed customer acceptance testing. An initial production contract was awarded for delivery in the fourth quarter of 1994. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement.\nDuring 1995, the Company entered into $700,000 of product development agreements with a specific customer, which required various modifications and enhancements to the Company's Series 9000 product. The Company recorded revenue related to this development agreement of $336,000 in 1995. These revenues offset related costs incurred to develop the modifications and enhancements. The ownership of the technologies created as a result of this development agreement remains with the Company. No royalties or other considerations are required as a part of this agreement.\nNOTE H -- EMPLOYEE BENEFITS\nThe Company maintains a Retirement Savings Plan for United States employees. Under this plan, all employees may contribute up to 15% of their salary to a retirement account up to the maximum amount allowed by law. The Company contributed an amount equal to 50% of the first 4% contributed by the participant in 1995, and 25% of the first 4% in 1994 and 1993. The Company's contributions to this plan were $205,000, $107,000 and $99,000 for 1995, 1994 and 1993, respectively.\nThe Company sponsors an Employee Stock Ownership Plan (the Plan) covering substantially all full-time employees. The Plan, which is a tax qualified employee benefit plan, was adopted by the Board of Directors of the Company on January 29, 1988 to provide retirement benefits for employees. The Plan borrowed $1,325,000 to purchase 260,000 shares of the Company's stock to be allocated to participants ratably over a ten year period. The ESOP loan was guaranteed by the Company and the outstanding balance of the loan was repaid in 1991. At December 31, 1995, there were 52,000 unallocated shares. In 1995, 1994 and 1993 the expenses related to the Plan were $132,000 in each year.\nNOTE I -- INCOME TAXES\nThe Company has approximately $7,000,000 and $5,200,000 of net operating loss carryforwards for federal and state income tax purposes, respectively, which are scheduled to expire periodically between 1996 and 2010. For financial reporting purposes a valuation allowance has been recognized to offset the deferred tax assets related to those carryforwards and other temporary differences.\nSignificant components of the Company's deferred tax liabilities and assets were as follows:\nFor financial reporting purposes, income (loss) before income taxes is set forth in the following tabulation:\nIncome taxes (benefit) are summarized as follows:\nA reconciliation of the effective tax rate to the statutory rate is as follows:\nNOTE J -- LEASE COMMITMENTS\nThe Company's principal lease commitments are for its corporate offices and research and development facility in East Hartford, Connecticut, its manufacturing facility in Manchester, Connecticut and its research and development facilities in Irvine and Berkeley, California. The East Hartford and Manchester leases expire on December 31, 1996, the Irvine lease expires on December 31, 1998 and the Berkeley lease expires on December 20, 1996. Minimum rental payments for all noncancelable leases which are operating leases with terms equal to or in excess of one year as of December 31, 1995 are as follows: 1996 - $496,000, 1997 - $41,000 and 1998 - $42,000.\nRental expense for the years ended December 31, 1995, 1994 and 1993 was $887,000, $808,000, and $792,000, respectively.\nNOTE K -- CONTINGENCIES\nThere are certain claims pending against the Company which arose in the normal course of business. In the opinion of management, the ultimate outcome of these matters will not have a material impact on the Company's financial position, results of operations or liquidity.\nNOTE L -- SEGMENT INFORMATION\nExport sales by geographic area were as follows:\nIn 1995, one customer accounted for approximately 31% of consolidated revenues. Two customers accounted for approximately 22% of consolidated revenues in 1994, each at 11%. No single customer accounted for more than 10% of consolidated revenues in 1993.\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 pertaining to Directors and additional information pertaining to Executive Officers is included, under the caption \"Governance of the Company\", and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 15, 1996 and is incorporated herein by reference and made a part hereof.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThis information is included, under the caption \"Executive Compensation\", in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 15, 1996 and is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is included, under the caption \"Share Ownership of Management\", in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 15, 1996 and is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information is included, under the caption \"Certain Transactions\", in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 15, 1996 and is incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) The following consolidated financial statements and report of independent auditors of the Company and its subsidiaries are included in Item 8:\n(1) Report of Independent Auditors:\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 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 - \t\t December 31, 1995\n(2) The following consolidated 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 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\n*3.1(a) Certificate of Incorporation, including amendments thereto (filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, File No. 2-70277).\n*3.1(b) Amendments to Certificate of Incorporation adopted May 17, 1984, included in Exhibits A, B, C and D in the Company's proxy statement dated April 17, 1984 for the Annual Meeting of Stockholders held May 17, 1984.\n*3.1(c) Amendment to Article Tenth of the Certificate of Incorporation included as Exhibit A in the Company's proxy statement dated April 16, 1987 for the Annual Meeting of Stockholders held May 19, 1987\n*3.2(a) By-laws of the Company (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, File No. 2-70277).\n*3.2(b) Amendments to By-laws of the Company adopted May 17, 1984, included in Exhibits A and B in the Company's proxy statement dated April 17, 1984 for the Annual Meeting of Stockholders held May 17, 1984.\n*3.2(c) Amendment to By-laws of the Company adopted at the meeting of the Board of Directors on January 28, 1991, included as Exhibit 3.2(c) in the Company's Annual Report on Form 10K filed for the year ended December 31, 1991.\n*+10.1 The Scan-Optics, Inc. 1979 Incentive and Non-Qualified Stock Option Plan included in Exhibit B in the Company's Proxy statement dated June 8, 1979 for the Annual Meeting of Stockholders held on June 27, 1979.\n* +10.2 The Scan-Optics, Inc. 1984 Incentive and Non-Qualified Stock Option Plan included in Exhibit E in the Company's Proxy statement dated April 19, 1984 for the Annual Meeting of Stockholders held on May 17, 1984.\n* +10.3 The Scan-Optics, Inc. 1987 Incentive and Non-Qualified Stock Option Plan included in Exhibit B in the Company's Proxy statement dated April 16, 1987 for the Annual Meeting of Stockholders held on May 19, 1987.\n* +10.4 The Scan-Optics, Inc. 1990 Incentive and Non-Qualified Stock Option Plan included in Exhibit A in the Company's Proxy statement dated April 30, 1990 for the Annual Meeting of Stockholders held on June 12, 1990.\n* +10.5 The Scan-Optics, Inc. 1990 Stock Option Plan for Outside Directors included in Exhibit B in the Company's Proxy statement dated April 30, 1990 for the Annual Meeting of Stockholders held on June 12, 1990.\n* +10.6 Employment agreement between Richard I. Tanaka and Scan- Optics, Inc. effective September 5, 1989, included as Exhibit 10.7 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1991.\n* +10.7 Severance agreement between Clarence W. Rife and Scan- Optics, Inc.dated December 17, 1986, included as Exhibit 10.8 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1991.\n* +10.8 Executive severance agreement between certain officers and Scan-Optics, Inc. dated July 28, 1992, included as Exhibit 10.8 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1992.\n11. Computation of earnings per share for the last three fiscal years.\n* 22. List of subsidiaries of the Company, included as Exhibit 10.8 in the Company's Annual Report on Form 10-K filed for the year ended December 31, 1993.\n23. Consent of Independent Auditors.\n27. Financial Data Schedule.\n* Exhibits so marked have heretofore been filed by the Company with the Securities and Exchange Commission and are incorporated herein by reference.\n+ Management contract for 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 report on Form 8-K was filed for the quarter ended December 31, 1995.\n(c) Exhibits\nThe exhibits required by this item are included herein.\n(d) Financial Statement Schedule\nThe response to this portion of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. SCAN-OPTICS, INC. Registrant\nBy: \/ss\/ _________________ Richard I. Tanaka Chairman, Chief Executive Officer and Director Date: 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 in the capacities and on the dates indicated.\n\/ss\/ _________________ Richard I. Tanaka Chairman, Chief Executive Officer and Director (Principal Executive Officer) Date: March 25, 1996\n\/ss\/ ______________________ Michael J. Villano Chief Financial Officer and Vice President (Principal Financial and Accounting Officer) Date: March 25, 1996 \/ss\/ _______________________ Logan Clarke, Jr. Director March 25, 1996\n\/ss\/ _______________________ Richard J. Coburn Director March 25, 1996\n\/ss\/ _______________________ E. Bulkeley Griswold Director March 25, 1996\n\/ss\/ _______________________ Lyman C. Hamilton, Jr. Director March 25, 1996\n\/ss\/ _______________________ Robert H. Steele Director March 25, 1996\nA majority of the Directors\nSCHEDULE VIII SCAN-OPTICS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (thousands)\n(1) Uncollectible accounts written off, net of recoveries\nEXHIBIT 11.\nSCAN-OPTICS, INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE (thousands, except share data)\nEXHIBIT 23 -- CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-37253, Form S-8 No. 33-37829, Form S-8 No. 33-16362, Form S-8 No. 2-93268 and Form S-8 No. 2-65503) of Scan Optics, Inc. and in the related prospectuses of our report dated February 2, 1996, except for the second paragraph of Note C, as to which the date is March 11, 1996, with respect to the consolidated financial statements and schedule of Scan-Optics, Inc. and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 1995.\nErnst & Young LLP\nHartford, Connecticut March 25, 1996","section_15":""}
{"filename":"940170_1995.txt","cik":"940170","year":"1995","section_1":"ITEM 1. BUSINESS\nDescription of Business On December 6, 1995 San Diego Gas & Electric Company announced the formation of Enova Corporation as the parent company for itself and its subsidiaries. On January 1, 1996 Enova Corporation became the parent of SDG&E. SDG&E's outstanding common stock was converted on a share-for-share basis into Enova Corporation common stock. SDG&E's debt securities, preferred stock and preference stock were unaffected and remain with SDG&E. On January 31, 1996 SDG&E's ownership interests in its subsidiaries were transferred to Enova Corporation at book value, completing the organizational restructuring into the new parent company framework. Thus, the consolidated financial statements of SDG&E incorporated herein, which include SDG&E and its subsidiaries, also reflect what is now Enova Corporation and its subsidiaries. Beginning on January 1, 1996, SDG&E's financial statements for periods prior to 1996 will be restated to reflect the net results of nonutility subsidiaries as discontinued operations in accordance with Accounting Principles Board Opinion No. 30 \"Reporting the Effects of a Disposal of a Segment of Business.\"\nSDG&E is an operating public utility engaged in the electric and gas businesses. It generates and purchases electric energy and distributes it to 1.2 million customers in San Diego County and an adjacent portion of Orange County, California. It also purchases and distributes natural gas to 700,000 customers in San Diego County and also transports gas for others in SDG&E's service territory. Factors affecting SDG&E's utility operations include regulation, deregulation, competition, nonutility generation, customers' bypass of its electric and gas systems, population growth, changes in interest and inflation rates, and environmental and other laws.\nSDG&E has diversified into other businesses. Enova Financial, Inc. invests in limited partnerships representing approximately 800 affordable-housing projects located throughout the United States. Califia Company leases computer equipment. The investments in Enova Financial and Califia are expected to provide income tax benefits over the next several years. Enova Energy, Inc. is an energy management consulting firm offering services to utilities and large consumers. Pacific Diversified Capital Company is the parent company for non- utility subsidiaries, Phase One Development, Inc., which is engaged in real estate development, and Enova Technologies, Inc. Enova Technologies, whose ownership was transferred directly to Enova Corporation after December 31, 1995, is in the business of developing new technologies generally related to utilities and energy, including certain research transferred from the utility. Enova Technologies has entered into a joint venture with Philips Home Services to establish a new electronic consumer network using the Philips screen phone as the network platform. Enova International was formed after December 31, 1995 to develop and operate natural-gas and power projects outside the United States.\nAs a result of the formation of Enova Corporation and the subsequent restructuring, Enova and its subsidiaries have more flexibility to pursue non- regulated business opportunities than in the past. As new non-regulated businesses are undertaken, risks will increase. The intent is for rewards to increase correspondingly.\nAdditional information regarding SDG&E's subsidiaries is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 in the 1995 Annual Report to Shareholders and in Notes 1 and 3 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nGOVERNMENT REGULATION\nLocal Regulation SDG&E has separate electric and gas franchises with the two counties and the 25 cities in its service territory. These franchises allow SDG&E to locate facilities for the transmission and distribution of electricity and gas in the streets and other public places. The franchises do not have fixed terms, except for the electric and gas franchises with the cities of Chula Vista (expiring in 1997), Encinitas (2012), San Diego (2021), and Coronado (2028); and the gas franchises with the city of Escondido (2036) and the county of San Diego (2030).\nState Regulation The California Public Utilities Commission consists of five members appointed by the governor and confirmed by the senate for six-year terms. The commission regulates SDG&E's rates and conditions of service, sales of securities, rate of return, rates of depreciation, uniform systems of accounts, examination of records, and long-term resource procurement. The CPUC also conducts various reviews of utility performance and conducts investigations into various matters, such as deregulation, competition and the environment, to determine its future policies.\nThe California Energy Commission has discretion over electric-demand forecasts for the state and for specific service territories. Based upon these forecasts, the CEC determines the need for additional energy sources and for conservation programs. The CEC sponsors alternative-energy research and development projects, promotes energy conservation programs, and maintains a state-wide plan of action in case of energy shortages. In addition, the CEC certifies power-plant sites and related facilities within California.\nFederal Regulation The Federal Energy Regulatory Commission regulates transmission access, the uniform systems of accounts, rates of depreciation and electric rates involving sales for resale. The FERC also regulates the interstate sale and transportation of natural gas.\nThe Nuclear Regulatory Commission oversees the licensing, construction and operation of nuclear facilities. NRC regulations require extensive review of the safety, radiological and environmental aspects of these facilities. Periodically, the NRC requires that newly developed data and techniques be used to reanalyze the design of a nuclear power plant and, as a result, requires plant modifications as a condition of continued operation in some cases.\nLicenses and Permits SDG&E obtains a number of permits, authorizations and licenses in connection with the construction and operation of its generating plants. Discharge permits, San Diego Air Pollution Control District permits and NRC licenses are the most significant examples. The licenses and permits may be revoked or modified by the granting agency if facts develop or events occur that differ significantly from the facts and projections assumed in granting the approval. Furthermore, discharge permits and other approvals are granted for a term less than the expected life of the facility. They require periodic renewal, which results in continuing regulation by the granting agency.\nOther regulatory matters are described throughout this report.\nCOMPETITION\nThis topic is discussed in \"Electric Operations\" and \"Rate Regulation\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Note 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nSOURCES OF REVENUE\n(In Millions of Dollars) 1995 1994 1993 - ------------------------------------------------------------------- Utility revenue by type of customer:\nElectric- Residential $ 610 $ 612 $ 615 Commercial 589 600 572 Industrial 250 231 250 Other 55 67 77 ------ ------ ------ Total Electric 1,504 1,510 1,514 ------ ------ ------ Gas- Residential 189 204 195 Commercial 60 65 63 Industrial 25 31 40 Other 36 46 49 ------ ------ ------ Total Gas 310 346 347 ------ ------ ------ Total Utility 1,814 1,856 1,861 ------ ------ ------ Diversified Operations 57 56 36 ------ ------ ------ Total $1,871 $1,912 $1,897 ====== ====== ======\nIndustry segment information is contained in \"Statements of Consolidated Financial Information by Segments of Business\" on page 34 of the 1995 Annual Report to Shareholders.\nCONSTRUCTION EXPENDITURES\nConstruction expenditures, excluding nuclear fuel and the allowance for equity funds used during construction, were $221 million in 1995 and are estimated to be about $220 million in 1996.\nELECTRIC OPERATIONS\nIntroduction In December 1995 the CPUC issued its policy decision on the restructuring of California's electric utility industry to stimulate competition and reduce rates. These matters are discussed in \"Competition-California\" herein, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Note 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nResource Planning SDG&E's ability to provide energy at the lowest possible cost has been based on a combination of production from its own plants and purchases from other producers. The purchases have been a combination of short-term and long-term contracts and spot purchases. Most resource acquisitions are obtained through a competitive bidding process. In December 1994 the CPUC issued a decision ordering SDG&E, Pacific Gas & Electric and Southern California Edison to go forward with the Biennial Resource Plan Update proceeding, allowing qualified nonutility power producers that cogenerate or use renewable energy technologies to bid for a portion of SDG&E's future capacity needs. As a result of the decision, SDG&E would be required to enter into contracts (ranging in term from 17 to 30 years) to purchase 500 mw of power, including 341 mw from cogenerators, 94 mw from geothermal sources, and the remainder from wind and other sources. The present value of ratepayer payments beginning in 1997 over the life of these contracts was estimated to be $2.3 billion. Prices under these contracts could significantly exceed the future market price. In February 1995 the FERC issued an order declaring the BRPU auction procedures unlawful under federal law. In July 1995 the CPUC issued a ruling encouraging SDG&E, PG&E and Edison to reach settlements with the auction winners. SDG&E has reached settlement with two auction winners. Settlement discussions with the others are ongoing.\nIn 1995 SDG&E also negotiated contracts for 760 mw of short-term purchased power.\nThe CPUC has also ordered utilities in the state to implement pilot demonstration projects to allow others to bid to supply utilities' customers with energy-conservation services, which could reduce the need for generation capacity.\nAdditional information concerning resource planning is provided in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders and in Notes 10 and 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nElectric Resources Based on generating plants in service and purchased-power contracts in place as of January 31, 1996, the net megawatts of electric power expected to be available to SDG&E during the next summer (normally the time of highest demand) are as follows:\nSource Net Megawatts -------------------------------------------------- Gas\/oil generating plants 1,641 Combustion turbines 332 Nuclear generating plants 430 Long-term contracts with other utilities 675 Short-term contracts with other utilities 350 Contracts with others 510 ----- Total 3,938 =====\nSDG&E's 1995 system peak demand of 3,260 mw occurred on August 30, when the net system capability, including power purchases, was 3,857 mw. The all-time record is 3,335 mw which was reached on August 17, 1992.\nGas\/Oil Generating Plants: SDG&E's South Bay and Encina power plants are equipped to burn either natural gas or fuel oil. The four South Bay units went into operation between 1960 and 1971 and can generate 690 mw. The five Encina units began operation between 1954 and 1978 and can generate 951 mw. SDG&E sold and leased back Encina Unit 5 (330 mw) in 1978. The lease term is through 2004, with renewal options for up to 15 additional years.\nSDG&E has 19 combustion turbines that were placed in service from 1966 to 1979. They are located at various sites and are used only in times of peak demand.\nNuclear Generating Plants: SDG&E owns 20 percent of the three nuclear units at San Onofre Nuclear Generating Station. The cities of Riverside and Anaheim own a total of 5 percent of SONGS 2 and 3. Southern California Edison Company owns the remaining interests and operates the units.\nSDG&E is currently recovering its existing capital investment in SONGS 1 over a four-year period that began in November 1992, when the CPUC issued a decision to permanently shut down the unit. SDG&E and Edison filed a decommissioning plan in November 1994, although final decommissioning will not occur until SONGS 2 and 3 are also decommissioned. The unit's spent nuclear fuel has been removed from the reactor and stored on-site. In March 1993 the NRC issued a Possession-Only License for SONGS 1, and the unit was placed in a long-term storage condition in May 1994.\nSONGS 2 and 3 began commercial operation in August 1983 and April 1984, respectively. SDG&E's share of the capacity is 214 mw of SONGS 2 and 216 mw of SONGS 3.\nBetween 1993 and 1995, SDG&E spent $69 million on capital modifications and additions for all three units and expects to spend $16 million in 1996 on SONGS. SDG&E deposits funds in an external trust to provide for\nthe future dismantling and decontamination of the units. The shutdown of SONGS 1 does not affect contributions to the trust.\nIn 1983 the CPUC adopted performance-based incentive plans for SONGS that set a Target Capacity Factor range of 55 percent to 80 percent for Units 2 and 3. Energy costs or savings outside that range were shared equally by SDG&E and its customers. Since the TCF was adopted, these units have operated above 55 percent for each of their fuel cycles and have exceeded 80 percent a total of seven times in the fourteen completed cycles. However, there can be no assurance that they will continue to achieve a 55 percent capacity factor.\nIn January 1996 the CPUC approved the accelerated recovery of the existing capital costs of Units 2 and 3. The decision allows SDG&E to recover more than $750 million over an eight-year period beginning in 1996, rather than over the anticipated operational life of the units, which is expected to extend to 2013. During the eight-year period, the authorized rate of return on the equity portion of the investment will be 90 percent of SDG&E's embedded cost of debt and the return on the debt-financed component will be at 7.52 percent (SDG&E's 1995 authorized cost of debt). The decision includes a performance incentive plan that encourages continued, efficient operation of the plant during the eight-year period. During the eight-year period, customers will pay about four cents per kilowatt-hour. This pricing structure replaces the traditional method of recovering the units' operating expenses and capital improvements. This is intended to make the units more competitive with other sources.\nAdditional Information: Additional information concerning SDG&E's power plants, the SONGS units, nuclear decommissioning and the CPUC's industry restructuring proposal is presented under \"Environmental Matters,\" \"Electric Properties\" and \"Legal Proceedings\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Notes 6, 10 and 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nPurchased Power: The following table lists contracts with the various suppliers:\nMegawatt Supplier Period Commitment Source - ------------------------------------------------------------------------------ Long-Term Contracts with Other Utilities:\nBonneville Power May Through September 1996 300 Hydro Power Administration\nComision Federal de Through August 1996 150 Geothermal Electricidad (Mexico)\nPortland General Through December 1998 50 Hydro storage Electric Through December 2013 75 Coal\nPublic Service Company Through April 2001 100 System supply of New Mexico ----- Total summer availability (see page 7) 675 ===== Short-Term Contracts with Other Utilities:\nPortland General July Through September 1996 100 System Supply Electric October 1996 40*\nPublic Service Company January through May 1996 130* System Supply of New Mexico June through September 1996 110 October through December 1996 130*\nPuget Sound Power & June through September 1996 40 System Supply Light\nSalt River Project Through December 1996 100 System Supply ----- Total summer availability (see page 7) 350 ===== Contracts with Others:\nCities of Azusa, Banning Through December 1996 40 Coal and Colton\nElectric Clearinghouse Through December 1996 50 System Supply\nEnron Power Marketing Through December 1996 120 System Supply September 1996 150*\nGoal Line Limited Through December 2024 50 Cogeneration Partnership\nIllinova Power Marketing Through December 1996 70 System Supply\nSithe Energies USA Through December 2019 102 Cogeneration\nYuma Cogeneration Through June 2024 50 Cogeneration\nOther Various 28 Various ----- Total summer availability (see page 7) 510 ===== * Not included in total summer availability.\nThe commitments with CFE and BPA are for energy and capacity. All short-term contracts with other utilities and the commitments with Electric Clearinghouse and Enron are for firm energy only. All other contracts are for capacity only.\nCosts under contracts with qualifying facilities (identified above as sourced from cogeneration) represent SDG&E's avoided cost. Contracts with power marketers are at market value at the time the contracts were negotiated. Charges under contracts with other utilities are based on\nthe selling utility's costs, including a return on and depreciation of the utility's rate base (or lease payments in cases where the utility does not own the property), fuel expenses, operating and maintenance expenses, transmission expenses, administrative and general expenses, and state and local taxes.\nEnergy costs under the CFE contract are indexed to changes in Mayan crude oil prices and the dollar\/peso exchange rate.\nThe locations of the utilities which have long-term supply contracts with SDG&E and the primary transmission lines (and their capacities) used by SDG&E are shown on the following map of the Western United States. Where applicable, interconnection to the primary lines is provided by contract.\n[ MAP ]\nLong-Term Contracts with Other Utilities Bonneville Power Administration: In 1993 SDG&E and BPA entered into a four- year agreement for the exchange of capacity and energy. SDG&E provides BPA with off-peak, non-firm energy in exchange for firm summer capacity and associated energy. In addition, SDG&E makes energy available for BPA to purchase during the period of January through April of each year. To facilitate the exchange, SDG&E has agreements with Southern California Edison and the Los Angeles Department of Water and Power for 200 MW of firm transmission service from the Nevada-Oregon border to SONGS.\nComision Federal de Electricidad: The 10-year agreement under which SDG&E purchases firm energy and capacity of 150 MW from CFE will terminate on September 1, 1996.\nPortland General Electric: In 1985 SDG&E and PGE entered into an agreement for the purchase of 75 MW of capacity from PGE's Boardman Coal Plant from January 1989 through December 2013. SDG&E pays a monthly capacity charge plus a charge based upon the amount of energy received. In addition, SDG&E has 50 MW of available hydro storage service with PGE through December 1998. SDG&E has also purchased 75 MW of transmission service from PGE in the northern section of the Pacific Intertie through December 2013.\nPublic Service Company of New Mexico: In 1985 SDG&E and PNM entered into an agreement for the purchase of 100 MW of capacity from PNM's system from June 1988 through April 2001. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nShort-Term Contracts with Other Utilities Portland General Electric: In November 1995 SDG&E and PGE entered into agreements for the purchase of up to 100 MW of firm energy from July 1996 through September 1996 and 40 MW in October 1996. The energy charge is based on the amount of energy received.\nPublic Service Company of New Mexico: In November 1995 SDG&E and PNM entered into an agreement for the purchase of up to 130 MW of firm energy through 1996, of which 110 MW will be available during the summer peak. The energy charge is based on the amount of energy received.\nPuget Sound Power & Light: In November 1995 SDG&E and PSP&L entered into an agreement for the purchase of up to 40 MW of firm energy from June through September 1996. The energy charge is based on the amount of energy received.\nSalt River Project: In October 1995 SDG&E and SRP entered into an agreement for the purchase of up to 100 MW of firm energy through December 1996. The energy charge is based on the amount of energy received.\nContracts with Others Cities of Azusa, Banning and Colton: In 1993 SDG&E and the cities entered into an agreement for the purchase of 40 MW of capacity. The agreement was extended through December 1996. SDG&E pays a capacity charge plus a charge based on the amount of energy received.\nElectric Clearinghouse: In October 1995 SDG&E and EC entered into an agreement for the purchase of up to 50 MW of firm energy through December 1996. The energy charge is based on the amount of energy received.\nEnron Power Marketing: In October 1995 SDG&E and Enron entered into an agreement for the purchase of 120 MW of firm energy through December 1996 and an option on an additional 150 MW in September 1996. The energy charge is based on the amount of energy received.\nGoal Line Limited Partnership: In December 1990 SDG&E and Goal Line entered into a 30-year agreement for the purchase of 50 MW of firm\ncapacity, beginning in February 1995. SDG&E pays a firm capacity charge plus a charge based on the amount of energy received.\nIllinova Power Marketing: In November 1995 SDG&E and Illinova entered into an agreement for the purchase of up to 70 MW of capacity from January 1996 through December 1996. SDG&E pays a capacity charge for the months of June through September plus a charge based on the amount of energy received.\nSithe Energies USA: In April 1985 SDG&E entered into three 30-year agreements for the purchase of 102 MW of firm capacity from December 1989 through December 2019. SDG&E pays a firm capacity charge plus a charge based on the amount of energy received.\nYuma Cogeneration: In March 1990 SDG&E and Yuma Cogeneration entered into a 30-year agreement for the purchase of 50 MW of firm capacity which began in June 1994. SDG&E pays a firm capacity charge plus a charge based on the amount of energy received.\nOther: SDG&E currently purchases capacity and energy from 115 as-available Qualifying Facilities. SDG&E also has two 20-year agreements with Pacific Energy and two 22-year agreements with Landfill Generating Partners for the purchase of 5 MW of firm capacity through the years 2007-2011. SDG&E pays a capacity charge plus a charge based on the amount of energy received. These account for 28 MW of capacity annually.\nAdditional information concerning SDG&E's purchased-power contracts is described in \"Legal Proceedings\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Notes 10 and 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nPower Pools In 1964 SDG&E, PG&E, and Edison entered into the California Power Pool Agreement. It provides for the transfer of electrical capacity and energy by purchase, sale or exchange during emergencies and at other mutually determined times.\nSDG&E is a participant in the Western Systems Power Pool, which includes an electric power and transmission rate agreement with utilities and power agencies located throughout the United States and Canada. More than 100 investor-owned and municipal utilities, state and federal power agencies, energy brokers, and power marketers share power and information in order to increase efficiency and competition in the bulk power market. Participants are able to target and coordinate delivery of cost-effective sources of power from outside their service territories through a centralized exchange of information.\nTransmission Arrangements In addition to interconnections with other California utilities, SDG&E has firm transmission capabilities for purchased power from the Northwest, the Southwest and Mexico.\nPacific Intertie: The Pacific Intertie, consisting of AC and DC transmission lines, enables SDG&E to purchase and receive surplus coal and hydroelectric power from the Northwest. SDG&E, PG&E, Edison and others share transmission capacity on the Pacific Intertie under an agreement that expires in July 2007. SDG&E's share of the intertie is\n266 MW through July 2007, and SDG&E has obtained 200 MW of additional transfer capacity through 1996. (Repairs necessitated by damages caused by the January 17, 1994 Northridge earthquake and by a major fire at the DC terminal at Sylmar in October 1994 have been completed.)\nSouthwest Powerlink: SDG&E's 500-kilovolt Southwest Powerlink transmission line, which it shares with Arizona Public Service Company and Imperial Irrigation District, extends from Palo Verde, Arizona to San Diego and enables SDG&E to import power from the Southwest. SDG&E's share of the line is 914 MW, although it can be less, depending on specific system conditions.\nMexico Interconnection: Mexico's Baja California Norte system is connected to SDG&E's system via two 230-kilovolt interconnections with firm capability of 408 MW. SDG&E uses this interconnection for transactions with CFE.\nAdditional Transmission Capabilities: Various studies have been undertaken or are ongoing to determine the extent to which various path ratings may be increased. SDG&E expects to receive an allocation of approximately 64 MW East- of-the-Colorado-River and 94 MW West-of-the-Colorado-River as a result of these various studies.\nTransmission Access As a result of the enactment of the National Energy Policy Act of 1992, the FERC has established rules to implement the Act's transmission access provisions. These rules specify FERC-required procedures for others' requests for transmission service. Additional information regarding transmission access is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders.\nFuel and Purchased-Power Costs The following table shows the percentage of each electric fuel source used by SDG&E and compares the costs of the fuels with each other and with the total cost of purchased power:\nPercent of Kwhr Cents per Kwhr - ----------------------------------------------------------------------- 1995 1994 1993 1995 1994 1993 ----- ----- ----- ---- ---- ---- Natural gas 21.7% 22.4% 24.4% 2.3 3.1 3.4 Nuclear fuel 16.5 21.8 17.2 0.5 0.5 0.6 Fuel oil 0.1 1.4 3.7 2.1 2.6 2.5 ----- ----- ----- Total generation 38.3 45.6 45.3 Purchased power-net 61.7 54.4 54.7 3.3 3.7 3.5 ----- ----- ----- Total 100.0% 100.0% 100.0% ===== ===== =====\nThe cost of purchased power includes capacity costs as well as the costs of fuel. The cost of natural gas includes transportation costs. The costs of natural gas, nuclear fuel and fuel oil do not include SDG&E's capacity costs. While fuel costs are significantly less for nuclear units than for other units, capacity costs are higher.\nElectric Fuel Supply Natural Gas: Information concerning natural gas is provided in \"Natural Gas Operations\" herein.\nNuclear Fuel: The nuclear-fuel cycle includes services performed by others. These services and the dates through which they are under contract are as follows: \t\t\t\t\t\t\t\t\t Mining and milling of uranium concentrate(1) -- Conversion of uranium concentrate to uranium hexafluoride(1) -- Enrichment of uranium hexafluoride(2) 1998 Fabrication of fuel assemblies 2000 Storage and disposal of spent fuel(3) --\n(1) Competitive bids are currently being sought for a multi-year contract to supply uranium and conversion services beginning in mid-1996.\n(2) The United States Enrichment Corporation, a government-owned corporation, is committed to offer any required enrichment services through 2014.\n(3) Spent fuel is being stored at SONGS, where storage capacity will be adequate at least through 2003. If necessary, modifications in fuel-storage technology can be implemented to provide on-site storage capacity for operation through 2014, the expiration date of the NRC operating license. The DOE's plan is to provide a permanent storage site for the spent nuclear fuel by 2010.\nPursuant to the Nuclear Waste Policy Act of 1982, SDG&E entered into a contract with the DOE for spent-fuel disposal. Under the agreement, the DOE is responsible for the ultimate disposal of spent fuel. SDG&E is paying a disposal fee of $0.91 per megawatt-hour of net nuclear generation. Disposal fees average $2.7 million per year.\nTo the extent not currently provided by contract, the availability and the cost of the various components of the nuclear-fuel cycle for SDG&E's nuclear facilities cannot be estimated at this time.\nAdditional information concerning nuclear-fuel costs is discussed in Note 10 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nFuel Oil: SDG&E has no long-term commitments to purchase fuel oil. The use of fuel oil is dependent upon price differences between it and natural gas. During 1995 SDG&E burned 36,000 barrels of fuel oil.\nNATURAL-GAS OPERATIONS\nSDG&E purchases natural gas for resale to its customers and for fuel in its generating plants. All natural gas is delivered to SDG&E under a transportation and storage agreement with Southern California Gas Company through two transmission pipelines with a combined capacity of 430 million cubic feet per day.\nDuring 1995 SDG&E purchased approximately 89 billion cubic feet of natural gas. The majority of SDG&E's natural-gas requirements are met through contracts of less than one year. SDG&E purchases natural gas primarily from various spot-market suppliers and from suppliers under short-term contracts. These supplies originate in New Mexico, Oklahoma and Texas, and are transported to the SoCal Gas Company pipeline at the California border by El Paso Natural Gas Company and by Transwestern Pipeline Company. SDG&E also purchases natural gas under long-term\ncontracts with four Canadian suppliers. These contracts have varying terms through 2004. Two of these suppliers have suspended sales to SDG&E while contractual disputes are in litigation. Natural gas from Canada is transported to SDG&E's system over Alberta Natural Gas, Pacific Gas Transmission, and PG&E pipelines. The natural gas transportation contracts have varying terms through 2023.\nAdditional information concerning SDG&E's gas operations is provided under \"Legal Proceedings\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Note 10 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nRATE REGULATION\nCompetition-California\nIn December 1995 the CPUC issued its policy decision on the restructuring of California's electric utility industry to stimulate competition and reduce rates. The decision provides that, beginning in January 1998, customers can buy their electricity through a power exchange that will obtain power from the lowest-bidding suppliers. The exchange is a spot market with published pricing. An independent system operator (ISO) will schedule power transactions and access to the transmission system. Consumers also may to continue to purchase from their local utility under regulated tariffs. As a third option, a cross section of all customer groups (residential, industrial, commercial and agricultural) will be able to go directly to any energy supplier and enter into private contracts with generators, brokers or others (direct access). As the direct access mechanism has many technical issues to be resolved, a five- year phase-in is planned. All California electricity customers of investor- owned utilities will have the option to purchase generation services directly by 2003. The utilities will continue to provide transmission and distribution services to customers that choose to purchase their energy from other providers.\nUtilities will, within certain limits, be allowed recovery of generation- related regulatory assets and the excess carrying amount of existing generation-investment costs over fair-market value over a transition period that ends in 2005. Obligations under long-term purchased-power contracts in excess of fair-market value will be recoverable over the duration of the contracts. The CPUC is currently working on building a consensus on the new market structure with the California legislature, the governor, utilities and customers. In addition, plans to implement the exchange and the ISO must be presented by the utilities to both the CPUC and the FERC by May 1996 for review and approval. This decision will change significantly some of the existing ratemaking mechanisms that are described below.\nPerformance-based regulation will replace cost-of-service regulation for distribution services. SDG&E is currently participating in a performance-based ratemaking process on an experimental basis which commenced in 1993 and is expected to run through 1998.\nThese matters are discussed in \"Performance-Based Ratemaking\" herein, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Note 11 of the \"Notes to Consolidated Financial\nStatements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nCompetition-Federal\nIn March 1995 the FERC issued a proposed rule that, if adopted, would require all public utilities to offer wholesale \"open-access\" transmission service on a nondiscriminatory basis. In addition, public utilities would be required to functionally price their generation and transmission services separately from each other. The FERC also stated its belief that utilities should be allowed to recover the costs of assets and obligations made uneconomic by the changed regulatory environment. In October 1995 SDG&E filed for approval of its open- access tariffs for its service territory with the FERC in conjunction with its request for a marketing license for Enova Energy, a wholly-owned subsidiary which desires to transact business at market-based rates in the wholesale energy market. In December 1995 the FERC issued a draft order approving SDG&E's open-access tariff, but rejecting Enova Energy's filing. This limits Enova Energy to cost-based rates. All non-rate terms and conditions were accepted subject to the outcome of the FERC's restructuring rulemaking. Final approval of the FERC's rule and the CPUC's industry restructuring plan would result in the creation of a bid-based wholesale electricity spot market with open-access transmission. The FERC is expected to issue a final rule during the first half of 1996.\nBase Rates\nSDG&E files annually under its base-rates performance-based ratemaking mechanism formula to offset the effects of inflation. Base rates allow SDG&E to recover the cost of operating and maintaining the utility system, taxes, depreciation, and other non-fuel business costs. In addition, SDG&E files an annual application to establish its cost of capital (see \"Cost of Capital\" below), which reflects the cost of debt and equity. Additional information concerning PBR is described under \"Performance-Based Ratemaking\" herein.\nCost of Capital\nIn November 1995 the CPUC issued its decision on the 1996 Cost of Capital proceeding, adopting an 11.6 percent return on equity for 1996 for SDG&E, PG&E, Edison, SoCal Gas, and Sierra Pacific Power, resulting in an overall rate of return for SDG&E of 9.37 percent. SDG&E's 1995 authorized return on equity and rate of return were 12.05 percent and 9.76 percent, respectively.\nIn October 1995 SDG&E filed a proposal with the CPUC to implement a mechanism, in lieu of the existing, litigated proceeding, to establish its cost of capital beginning in January 1997. Under the mechanism, each October SDG&E's authorized rate of return would be adjusted if single-A bond rates change by one percent or more from a previously established benchmark rate. For example, a one-percent change in single-A bond rates would result in a one-half percent change in SDG&E's return on equity. In addition, SDG&E's embedded costs of debt and preferred stock would be adjusted to reflect SDG&E's outstanding long-term debt and preferred stock at each September 30 if the return on equity adjustment described above is triggered. The adjustments would be effective on January 1 of the following year. The proposal suggests a three- year trial period during which SDG&E's authorized capital structure would not change.\nBalancing Accounts\nThe CPUC requires balancing accounts for fuel and purchased energy costs and for sales volumes. The CPUC sets balancing account rates based on estimated costs and sales volumes. Revenues are adjusted upward or downward to reflect the differences between authorized and actual volumes and costs. These differences are accumulated in the balancing accounts and represent amounts to be either recovered from customers or returned to them. These balancing accounts were overcollected by $171 million at December 31, 1995 and by $112 million at December 31, 1994. The CPUC adjusts SDG&E's rates annually to amortize the accumulated balances. As a result, changes in SDG&E's fuel and purchased-power costs or changes in electric and natural-gas sales volumes normally have not affected SDG&E's net income. As described under \"Performance-Based Ratemaking,\" SDG&E can realize rewards or penalties depending on the achievement of certain benchmarks for operations and expenses.\nIt is uncertain whether the CPUC will continue to allow these or some other form of balancing accounts once its electric industry restructuring decision takes effect in 1998.\nElectric Fuel Costs and Sales Volumes\nRates to recover electric-fuel and purchased-power costs are determined in the Energy Cost Adjustment Clause proceeding. This proceeding normally takes place annually, in two phases. In the forecast phase, prices are set based on the estimated cost of fuel and purchased power for the following year and are adjusted to reflect any changes from the previous period. These adjustments are made by amortizing any accumulation in the balancing accounts described above. In the second phase, the reasonableness review, the CPUC evaluates the prudence of SDG&E's nuclear and natural-gas-storage operations. As described under \"Performance-Based Ratemaking,\" reviews of fuel and purchased-power transactions, electric operations and natural-gas transactions now are required only if SDG&E's fuel and energy expenses vary significantly from the established benchmarks. The Electric Revenue Adjustment Mechanism compensates for variations in sales volume compared to the estimates used for setting the non-fuel component of rates. ERAM is designed to stabilize revenues, which otherwise may vary due to changes in sales volumes resulting from weather fluctuations and other factors. Any accumulation in the ERAM balancing account is amortized when new rates are set in the ECAC proceeding.\nNatural-Gas Costs and Sales Volumes\nRates to recover the cost of purchasing and transporting natural gas to SDG&E are determined in the Biennial Cost Allocation Proceeding. The BCAP proceeding normally occurs every two years and is updated in the interim year for purposes of amortizing any accumulation in the balancing accounts. Balancing accounts for natural-gas costs and sales volumes are similar to those for electric fuel costs and sales volumes. The natural-gas balancing accounts include the Purchased Gas Account for natural-gas costs and the Gas Fixed Cost Account for sales volumes. Balancing account coverage includes both core customers (primarily residential and commercial customers) and noncore customers (primarily large industrial customers). However, SDG&E does not receive balancing account coverage on 25 percent of noncore GFCA overcollections and undercollections.\nPerformance-Based Ratemaking\nSDG&E implemented performance-based ratemaking in 1993 for natural-gas procurement and transportation, and for electric generation and purchased energy; and in 1994 for base rates.\nThe CPUC has authorized the first two mechanisms to remain in effect beyond their authorized July 31, 1995 expiration until the Division of Ratepayer Advocates and the Commission Advisory and Compliance Division file their final reports for the year ended July 31, 1995 (expected during the first quarter of 1996). Thereafter, SDG&E will be applying for an extension and modification in conjunction with the restructuring of California's electric utility industry, and the existing mechanisms are expected to remain in place until the CPUC acts on the application. These mechanisms measure SDG&E's ability to purchase and transport natural gas, and to generate or purchase energy at the lowest possible cost, by comparing SDG&E's performance against various market benchmarks. SDG&E's shareholders and customers share in any savings or excess costs within predetermined ranges.\nNatural Gas: Under the natural-gas procurement and transportation mechanism, if SDG&E's actual commodity cost exceeds the benchmark by more than two percent or falls below the benchmark, the excess costs or savings is shared equally between customers and shareholders. If the delivered cost of gas (including interstate transmission charges) falls below the index, 95 percent of the savings goes to customers and five percent of the savings goes to SDG&E's shareholders.\nElectric Generation & Dispatch: The benchmark to measure SDG&E's electric generation and purchased energy performance (\"generation and dispatch\") is based upon the difference between SDG&E's actual and authorized electric-fuel and short-term purchased-energy expenses. SDG&E shareholders will receive 30 percent to 50 percent of over- or under-expenditures in specified bands within six percent of the benchmark. SDG&E is allowed to recover expenses exceeding the six percent range, subject to a reasonableness review by the CPUC. SDG&E's customers will receive 100 percent of the additional savings should expenses fall below the benchmark by more than six percent.\nIn October 1995 SDG&E filed reports with the CPUC on the results of the generation and dispatch and the gas procurement mechanisms for the year ended July 31, 1995. SDG&E's fuel and purchased power expenses fell below the benchmarks for these mechanisms by a total of $27.9 million ($2.8 million for G&D and $25.1 million for gas). As a result, SDG&E's ECAC application (see above) and its current Biennial Cost Allocation Proceeding application request a total shareholder award of $3.4 million ($0.8 million for G&D and $2.6 million for gas) and that the remainder of these savings be given to customers through lower rates.\nBase Rates: The base-rate component of SDG&E's Performance-Based Ratemaking mechanism is expected to continue through 1998, replacing the traditional general rate case application. The base-rate mechanism has three segments. The first is a formula similar to the traditional attrition mechanism used to determine SDG&E's annual revenue requirement for operating, maintenance and capital costs. SDG&E's initial revenue requirements were based on SDG&E's 1993 General Rate Case decision. The second is a set of indicators which determine performance standards for customer rates, employee safety, electric system reliability and\ncustomer satisfaction. Each indicator specifies a range of possible shareholder benefits and risks. SDG&E can be penalized up to a total of $21 million should it fall significantly below these standards or earn up to $19 million if it exceeds all of the performance targets. The third segment sets limits on SDG&E's rate of return. If SDG&E realizes an actual rate of return that exceeds its authorized rate of return by one percent to one-and-one-half percent, it is required to return 25 percent of the excess over one percent to customers. If SDG&E's rate of return exceeds the authorized level by more than one-and-one-half percent, SDG&E also will return 50 percent of the excess over one-and-one-half percent to customers. SDG&E will be at risk if its rate of return falls below the authorized level. However, if SDG&E's rate of return is three percent or more below or above the authorized level, a rate case review would automatically occur. SDG&E may request a rate case review if at any time its rate of return drops one-and-one-half percent or more below the authorized level.\nSDG&E must file a report with the CPUC on the results of the 1995 PBR base- rates mechanism by May 15, 1996. SDG&E expects to determine the final 1995 PBR base-rate award or penalty in September 1996 when the Edison Electric Institute publishes its final report on 1995 national electric rates.\nSONGS: In 1983 the CPUC adopted performance incentive plans for SONGS that set a Target Capacity Factor range of 55 percent to 80 percent for Units 2 and 3. Energy costs or savings outside that range were shared equally by shareholders and customers. In January 1996 the CPUC approved the accelerated recovery of the units' existing capital costs. The decision includes a performance incentive plan. Additional information concerning the SONGS units, including its new incentive plan, is presented under \"Nuclear Generating Plants\" herein.\nEnergy Conservation Program\nOver the past several years, SDG&E has promoted conservation programs to encourage efficient use of energy. The programs are designed to conserve energy through the use of energy-efficiency measures that will reduce customers' energy costs and reduce the need to build additional power plants. The costs of these programs are recovered from customers. The programs contain an incentive mechanism that could increase or decrease SDG&E's earnings, depending upon the performance of the programs in meeting specified efficiency and expenditure targets. The CPUC has encouraged expansion of these programs, authorizing annual expenditures ranging from $54 million in 1993 to $60 million in 1996. However, the CPUC has also ordered utilities to conduct a test program to determine if unaffiliated suppliers could offer energy conservation services at a lower cost.\nLow-Emission Vehicle Programs\nSDG&E has conducted a CPUC-approved natural-gas-vehicle program since 1991. The program includes building refueling stations, demonstrating new technology, providing incentives and converting portions of SDG&E's fleet vehicles to natural gas. The cost of this program is being recovered in natural-gas rates. In November 1995 the CPUC issued its decision authorizing funding for limited electric-vehicle and natural-gas-vehicle programs through the year 2000 to allow recovery of costs for operation and maintenance of SDG&E's EV and NGV fleets and NGV fueling stations, and to allow recovery of transition costs to meet\nexisting commitments to customers. The decision requires the sale of SDG&E's NGV fueling stations located on customer property within six years. The CPUC approved a six-year program that provides a total of $5.3 million for SDG&E's electric-vehicle program and $6.7 million for its natural-gas-vehicle program over the six-year period.\nElectric Rates The average price per kilowatt-hour charged to electric customers was 9.8 cents in 1995 and 9.7 cents in 1994.\nNatural-Gas Rates The average price per therm of natural gas charged to customers was 55.7 cents in 1995 and 59.9 cents in 1994.\nAdditional information concerning rate regulation is provided in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders.\nENVIRONMENTAL MATTERS\nSDG&E's operations are guided by federal, state and local environmental laws and regulations governing air quality, water quality, hazardous substance handling and disposal, land use, and solid waste. Compliance programs to meet these laws and regulations increase the cost of electric and natural-gas service by requiring changes and\/or delays in the location, design, construction and operation of new facilities. SDG&E may also incur significant costs to operate its facilities in compliance with these laws and regulations and to clean up the environment as a result of prior operations of SDG&E or others. The costs of compliance with environmental laws and regulations are normally recovered in customer rates. However, the CPUC has issued a decision for restructuring the California electric utility industry to stimulate competition (see \"Rate Regulation\" herein). This decision will change the way utility rates are set and costs are recovered. Depending on the final outcome of industry restructuring and the impact of competition, the costs of compliance with environmental regulations may not be fully recoverable.\nElectric and Magnetic Fields Scientists are researching the possibility that exposure to low-frequency magnetic fields causes adverse health effects. This research, although often referred to as relating to electric and magnetic fields, or EMFs, focuses on magnetic fields. To date, some laboratory studies suggest that such exposure creates biological effects, but those effects have not been shown to be harmful.\nThe studies that have most concerned the public are certain epidemiological studies. Some of those studies reported a weak correlation between childhood leukemia and the proximity of homes to certain power lines and equipment. Other studies reported weak correlations between computer estimates of historic exposure and disease. Various wire-configuration categories and computer calculations were used as substitutes for historical exposure measurements, which were not available. However, some of the studies also measured actual field levels. When actual field levels were measured, no correlation was found with disease.\nOther epidemiological studies found no correlation between estimated exposure and any disease. No studies correlate measured fields with disease. Scientists cannot explain why some studies using estimates of past exposure report correlations between estimated fields and disease, while others do not.\nTo respond to public concern and scientific uncertainty, the CPUC created the California Consensus Group in 1991 and assigned this group the responsibility of reaching agreement on interim measures which could be implemented until science provides direction. In November 1993 the CPUC adopted an interim EMF policy, which implemented the Consensus Group's recommendations. Consistent with the more-than-twenty major scientific reviews of available research literature, the CPUC concluded that no health risk has been identified with exposure to low-frequency magnetic fields. The November 1993 decision created two utility-funded programs (a public education program and a research program) and directed utilities to adopt a low-cost EMF-reduction policy for new projects. This policy entails design changes to new projects to achieve a noticeable reduction of magnetic-field levels. The CPUC indicated that utilities should use four percent of the cost of new or upgraded facilities as a benchmark in developing low-cost measures which produce a noticeable reduction in field levels. In May 1994 SDG&E adopted design guidelines which implement the low-cost measures, subject to safety, reliability, efficiency and other operational criteria.\nLitigation concerning EMFs is discussed under \"Legal Proceedings\" herein.\nHazardous Substances In May 1994 the CPUC issued its decision on the Hazardous Waste Collaborative, approving a mechanism for utilities to recover their hazardous waste costs, including those related to Superfund sites or similar sites requiring cleanup. Basically, the decision allows utilities to recover 90 percent of their cleanup costs and related third-party litigation costs, and 70 percent of the related insurance-litigation expenses.\nSDG&E disposes of its hazardous wastes at facilities owned and operated by other entities. Operations at these facilities may result in actual or threatened risks to the environment or public health. Where the owner or operator of such a facility fails to complete any corrective action required by regulatory agencies to abate such risks, applicable environmental laws may impose an obligation on SDG&E and others who disposed of hazardous wastes at the facility to undertake corrective actions.\nRosens: The above-mentioned type of obligation has been imposed upon SDG&E with respect to the Rosen's Electrical Equipment Supply Company located in Pico Rivera, California. In December 1993, SDG&E and eight other entities were named as potentially responsible parties with respect to the Rosen's site. In December 1995 SDG&E and the other entities received an Imminent and Substantial Endangerment Determination and Remedial Action Order from the California Department of Toxic Substances Control requiring site assessment and remediation. Additional information concerning this site is described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders.\nUnderground Storage: California has enacted legislation to protect ground water from contamination by hazardous substances. Underground storage containers require permits, inspections and periodic reports, as well as specific requirements for new tanks, closure of old tanks and monitoring systems for all tanks. It is expected that cleanup of sites previously contaminated by underground tanks will occur for an unknown number of years. SDG&E cannot predict the cost of such cleanup. Specific known underground locations requiring assessment and\/or remediation are indicated below:\nIn May 1987 the San Diego Regional Water Quality Control Board issued SDG&E a cleanup and abatement order for gasoline contamination originating from an underground storage tank located at SDG&E's Mountain Empire Operation and Maintenance facility. SDG&E assessed the extent of the contamination and removed all contaminated soil and completed remediation of the site. SDG&E will continue to monitor the site to confirm its remediation. After such confirmation, SDG&E will apply for a site-closure letter from the Regional Board.\nIn January 1993 SDG&E was issued a Notice of Unauthorized Release order by the San Diego County Division of Environmental Health Services relative to soil contamination from used motor oil associated with an underground tank located at SDG&E's South Bay Operation and Maintenance facility. SDG&E removed the tank and the associated contaminated soil. No actionable levels of contamination remain on the site. SDG&E has applied for and is awaiting the issuance of a site-closure letter from the San Diego County Division of Environmental Health Services.\nIn 1993 SDG&E discovered a shallow underground tank-like structure while installing underground electric facilities under a public street immediately west of a former manufactured-gas plant. The past ownership, operation and use of the structure is unknown. Hydrocarbon contamination has been found in the vicinity of the structure, but it has not been established whether the structure was the source of the contamination. The San Diego County Division of Environmental Health Services has issued a Notice of Unauthorized Release order to SDG&E. The order requires SDG&E to conduct a site assessment to delineate the nature and scope of the contamination. SDG&E's duty to meet these requirements has been postponed pending the resolution of property ownership. SDG&E is unable to determine the extent of its responsibility, if any, or to estimate the nature and extent of the contamination or the potential remediation costs if SDG&E is found at all responsible.\nStation B: Station B is located in downtown San Diego and was operated as a steam and generating facility between 1911 and June 1993. During 1986, three 100,000-gallon underground diesel-fuel storage tanks were removed from an adjacent substation. Pursuant to a cleanup and abatement order, SDG&E remediated the existing hydrocarbon contamination. In the course of the remediation effort, detectable levels of PCBs were discovered. Further information regarding the PCB contamination in the area was submitted by SDG&E, evidencing that no further action is required. SDG&E has applied for and is awaiting the issuance of a site-closure letter from the San Diego County Division of Environmental Health Services.\nAsbestos was used in the construction of the Station B power plant. Renovation, reconditioning or demolition of the facility will require the removal of the asbestos in a manner complying with all applicable environmental, health and safety laws. Additionally, reuse of the\nfacility may require the removal or cleanup of PCBs, paints containing heavy metals, fuel oil or other substances. SDG&E has assessed the extent of any possible contamination by these or other hazardous materials at the facility. The estimated cost of this removal effort is estimated to be between $4 million and $5 million.\nEncina Power Plant: During 1993 SDG&E discovered the presence of hydrocarbon contamination in subsurface soil at its Encina power plant. This contamination was located near the fuel-storage facilities and believed to be fuel oil originating from a 1950s refueling spill. SDG&E believes that it has remediated the contamination to the extent required by the San Diego County Division of Environmental Health Services and has applied for and is awaiting the issuance of a site-closure letter.\nManufactured-Gas Plant Sites: During the early 1900s SDG&E and its predecessors manufactured gas from oil at its Station A facility and at small facilities in Escondido and Oceanside.\nIn 1995 SDG&E commenced an environmental assessment of Station A. Some significant amounts of residual by-products from the gas-manufacturing process have been discovered on portions of the facility during the assessment. However, the magnitude of such contamination has yet to be determined. The assessment will be completed in 1996 at which time the extent of any required remediation activities can be determined. Sufficient information is not currently available to estimate clean-up costs. SDG&E will be able to estimate a range of costs after completion of the site assessment.\nResidual by-products from the gas-manufacturing process at the Escondido facility were remediated at a cost of approximately $3 million during the period of 1990 through 1993. A site-closure letter for SDG&E's Escondido's facility was obtained from the San Diego County Department of Environmental Health Services. However, contaminants similar to the ones found on the Escondido site have been observed on adjacent parcels of property. SDG&E will assess these contaminants in 1996.\nSDG&E will also undertake an environmental assessment of its Oceanside facility in 1996. Some materials similar to residual by-products from the operation of town gas sites have been observed on an adjacent parcel of property. SDG&E's assessment of the Oceanside facility will include an evaluation of such materials.\nAir Quality The San Diego Air Pollution Control District (APCD) regulates air quality in San Diego County in conformance with the California and federal Clean Air Acts. California's standards are more restrictive than federal standards.\nAlthough SDG&E facilities comply with very strict emission limits and contribute only about three percent of the air emissions in San Diego County, the APCD is required by the California Clean Air Act to further reduce emissions from all San Diego industry. In January 1994 the APCD adopted Rule 69 to further reduce nitrogen dioxide (NOx) emissions from SDG&E's power plants. As adopted, the rule required the retrofit of each of the nine boilers at Encina and South Bay power plant generating units with catalytic converters to remove approximately 87 percent of current NOx emissions. In addition, the NOx emissions from all units were required to remain below a system-wide cap. The estimated capital cost to comply with Rule 69 was $110 million, with annual operating costs\nexpected to increase about $6 million after all units were retrofitted. In December 1995 the APCD adopted amendments to Rule 69 which eliminated the requirement that each unit be retrofitted with catalytic converters, but which retained the system-wide cap with further system-wide emission reductions to be achieved by 2005. The rule change provides SDG&E with greater flexibility to utilize effective and cost-efficient methods to achieve the required NOx emission reduction milestones. The estimated capital costs for compliance with the amended rule is approximately $60 million. The California Air Resources Board (ARB) expressed concern that the amendments to Rule 69 did not meet the requirements of the California Clean Air Act. However, the ARB withheld any formal objections pending its review of SDG&E's Rule 69 compliance plan to be submitted in 1996. The ARB may seek to overturn some or all of the Rule 69 amendments or otherwise impose more restrictive emissions limitations which would cause SDG&E's Rule 69 compliance costs to increase.\nIn 1990 the South Coast Air Quality Management District passed a rule which will require SDG&E's older natural-gas-compressor engines at its Moreno facility to either meet new, stringent nitrogen oxide emission levels or be converted to electric drive. In October 1993 the Air Quality District adopted a new program called RECLAIM, which replaced existing rules and requires SDG&E's natural-gas-compressor engines at its Moreno facility to reduce their nitrogen oxide emission levels by about 10 percent a year through 2003. This will be accomplished through the installation of new emission-monitoring equipment, operational changes to take advantage of low-emitting engines, and engine retrofits. SDG&E has concluded negotiations with the Air Quality District, reclassifying three of these engines and thus eliminating the need for certain expensive monitoring equipment for those engines. The cost of complying with RECLAIM may be as much as $3 million.\nWater Quality Discharge permits are required to enable SDG&E to discharge its cooling water and its treated in-plant waste water, and are, therefore, a prerequisite to the continued operation of SDG&E's power plants. The promulgation or modification of water-quality-control plans by state and federal agencies may impose increasingly stringent cooling-water and treated-waste-water-discharge requirements on SDG&E in the future.\nSDG&E is unable to predict the terms and conditions of any renewed permits or their effects on plant or unit availability, the cost of constructing new cooling-water-treatment facilities, or the cost of modifying the existing treatment facilities. However, any modifications required by such permits could involve substantial expenditures, and certain plants or units may be unavailable for electric generation during such modification. Additional information concerning discharge permits for the South Bay, Encina and SONGS plants is provided in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders.\nWood Pole Preservatives The Pacific Justice Center (Pacific), a for-profit law firm, and the Mateel Environmental Justice Foundation (Mateel), a nonprofit corporation, claim that SDG&E, other utilities and other parties have violated California's Safe Drinking Water and Toxic Enforcement Act (Proposition 65) by failing to warn persons who may come into contact with the preservatives used in treated wood utility poles and by allowing these preservatives to be released into sources of drinking\nwater. Some preservatives used in wood poles are included on California's list of chemicals known to cause cancer or reproductive harm. Proposition 65 requires that prior warning be given to individuals who may be exposed to such chemicals unless the exposure will not pose a significant risk and that these substances not be released into sources of drinking water in significant quantities or otherwise in violation of the law. Violations of the Proposition 65 warning requirement can result in penalties of up to $2,500 per violation. SDG&E believes, on the basis of studies and other information, that exposure to wood poles containing these preservatives does not give rise to a significant risk and, therefore, no warning is required, and that significant quantities of these preservatives are not released into any source of drinking water. SDG&E and others have responded to the claims by denying their validity. On June 20, 1995 Mateel, represented by Pacific, filed a complaint in San Francisco County Superior Court against Pacific Bell, PG&E and two wood-pole manufacturers alleging the violations noted above. Although SDG&E was not named in this lawsuit, it is anticipated that Mateel may file a separate lawsuit against SDG&E and other utilities on the same grounds. SDG&E is cooperating with PG&E, Pacific Bell and others to achieve an effective and favorable resolution of this matter.\nAdditional information concerning SDG&E's environmental matters is provided in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders and in Note 10 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nOTHER\nResearch, Development and Demonstration SDG&E conducts research and development in areas that provide value to SDG&E and its customers. Annual research, development and demonstration costs averaged $7 million over the past three years. The CPUC historically has permitted rate recovery of research, development and demonstration expenditures.\nWages SDG&E and Local 465, International Brotherhood of Electrical Workers have a labor agreement through February 29, 1996. Negotiations are ongoing.\nEmployees of Registrant As of December 31, 1995 SDG&E had 3,880 employees, compared to 3,998 at December 31, 1994. SDG&E's subsidiaries had 13 employees at December 31, 1995 compared to 550 at December 31, 1994 (of which 542 were employees of Wahlco Environmental Systems, Inc., which was sold on June 6, 1995).\nForeign Operations SDG&E foreign operations in 1995 included power purchases and sales with CFE in Mexico; purchases of power and natural gas from suppliers in Canada; and purchases of uranium from suppliers in Canada, Australia, France, Niger, People's Republic of China and South Africa.\nSDG&E's subsidiary Wahlco Environmental Systems, which it sold on June 6, 1995, operated in various foreign locations in 1995, including Great Britain, Australia and Italy, and sold products and services to customers in additional foreign countries.\nAdditional information concerning foreign operations is provided under \"Electric Operations\" and \"Natural Gas Operations\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Note 10 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSubstantially all utility plant is subject to the lien of the July 1, 1940 mortgage and deed of trust and its supplemental indentures between SDG&E and the First Trust of California N.A. as trustee, securing the outstanding first- mortgage bonds.\nInformation concerning SDG&E's properties is provided below. Additional information is provided under \"Electric Operations\" and \"Gas Operations\" herein, in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" beginning on page 18 of the 1995 Annual Report to Shareholders, and in Notes 1 through 3, 6, 10 and 11 of the \"Notes to Consolidated Financial Statements\" beginning on page 35 of the 1995 Annual Report to Shareholders.\nElectric Properties\nAs of December 31, 1995 SDG&E's installed generating capacity based on summer ratings, was as follows:\nPlant Location Net Megawatts - ----------------------------------------------------------------- Encina Carlsbad 951 South Bay Chula Vista 690 San Onofre South of San Clemente 430* Combustion Turbines (19) Various 332 - -----------------------------------------------------------------\n*SDG&E's 20 percent share.\nExcept for San Onofre and some of the combustion turbines, these plants are equipped to burn either oil or gas.\nThe 1995 system load factor was 58 percent and ranged from 56 percent to 64 percent for the past five years.\nSDG&E's electric transmission and distribution facilities include substations, and overhead and underground lines. Periodically various areas of the service territory require expansion to handle customer growth.\nSDG&E owns an approved nuclear power-plant site near Blythe, California.\nNatural-Gas Properties\nSDG&E's natural-gas facilities are located in San Diego and Riverside counties and consist of the Moreno and Rainbow compressor stations, various high- pressure transmission pipelines, high-pressure and low-pressure distribution mains, and service lines. SDG&E's natural-gas system is sufficient to meet customer demand and short-term growth. SDG&E is currently undergoing an expansion of its high-pressure transmission lines to accommodate expected long-term customer growth.\nGeneral Properties\nThe 21-story corporate office building at 101 Ash Street, San Diego is occupied pursuant to a capital lease through the year 2005. The lease has four separate five-year renewal options. SDG&E also occupies an office complex at Century Park Court in San Diego pursuant to an operating lease ending in the year 2007. The lease can be renewed for two five-year periods.\nIn addition, SDG&E occupies eight operating and maintenance centers, two business centers, six district offices, and five branch offices.\nSubsidiary Properties\nPhase One Development, a subsidiary of Pacific Diversified Capital, holds one property in San Diego County for future development and sale. Other, developed properties were sold during 1995. Wahlco Environmental Systems, sold on June 6, 1995, had manufacturing facilities in the continental United States, Puerto Rico, Great Britain and Australia, and a sales office in Italy.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe McCartin proceeding, described in SDG&E's 1994 Annual Report on Form 10-K, was concluded during the year ended December 31, 1995. Information concerning the conclusion of this proceeding is contained in SDG&E's Quarterly Report on Form 10-Q for the three-month period ended June 30, 1995.\nCentury Power\nThis FERC proceeding, arising from a rate dispute among Century Power Corporation, Tucson Electric Power Company, and SDG&E, has been resolved. On October 23, 1995 SDG&E filed with the FERC an offer of settlement which would result in the dismissal of all claims among SDG&E, Tucson and Century with prejudice. On January 18, 1996 FERC approved the settlement and all claims were dismissed.\nAmerican Trails\nPrior to Pacific Diversified Capital's purchase of Wahlco Environmental Systems, a complaint was filed in 1985 in the Superior Court of San Diego County against Wahlco and others by Michael Bessey and others who owned American Trails, a membership campground company, for, among other things, breach of contract, negligence and fraud. In 1993 the court found in favor of Wahlco for all claims and causes of action by the plaintiffs against Wahlco. Subsequently, the plaintiffs filed a notice of appeal from the court's judgment and the appeal is pending. Wahlco intends to continue defending this lawsuit vigorously.\nRobert R. Wahler, as Trustee of the Wahler Family Trust; John H. McDonald; and Westfore, a California limited partnership; agreed, subject to certain exceptions, to indemnify Pacific Diversified and its subsidiaries in connection with the American Trails litigation. Under a settlement agreement entered into on November 26, 1995, Wahlco agreed to continue to pay all attorneys' fees and costs incurred in the pending\nAmerican Trails appeal on behalf of all defendants, provided that all of the above parties are represented by the same counsel throughout. Costs at subsequent retrial, appeal and judgment, if any, would be borne by Wahlco subject to reimbursement by Wahler, McDonald and Westfore, under certain circumstances.\nOn June 6, 1995 Pacific Diversified sold its interest in Wahlco and, therefore, no longer retains any ownership or interest in Wahlco.\nPublic Service Company of New Mexico\nOn October 27, 1993 SDG&E filed a complaint with the FERC against Public Service Company of New Mexico, alleging that charges under a 1985 power- purchase agreement are unjust, unreasonable and discriminatory. SDG&E requested that the FERC investigate the rates charged under the agreement and establish December 26, 1993 as the effective refund date. The relief, if granted, would reduce annual demand charges paid by SDG&E to PNM by up to $11 million per year through April 2001. If approved, the proceeds would be refunded principally to SDG&E customers.\nOn December 8, 1993 PNM answered the complaint and moved that it be dismissed. PNM denied that the rates are unjust, unreasonable or discriminatory and asserted that SDG&E's claims were barred by certain orders issued by the FERC in 1988.\nThere have been no further developments in this case. SDG&E is unable to predict the ultimate outcome of this litigation.\nCanadian Natural Gas\nDuring early 1991 SDG&E signed four long-term natural-gas-supply contracts with Husky Oil Ltd., Canadian Hunter Ltd. and Noranda Inc., Bow Valley Energy Inc., and Summit Resources Ltd. Canadian-sourced natural gas began flowing to SDG&E under these contracts in 1993. Disputes have arisen with each of these producers with respect to events which are alleged by the producers to have occurred and to have justified a revision to the pricing terms of each contract, and possibly their termination. Consequently, during December 1993 SDG&E filed complaints in the United States Federal District Court, Southern District of California, seeking a declaration of SDG&E's contract rights. Specifically, SDG&E states that neither price revision nor contract termination is warranted.\nIn 1994 SDG&E voluntarily dismissed its complaint against Bow Valley without prejudice. In addition, the court denied the other defendants' motions to dismiss SDG&E's complaints. These motions were based on jurisdictional grounds. Two of the defendants, Bow Valley and Husky Oil, filed claims against SDG&E with the Queens Bench in Alberta, Canada, seeking a declaration that they are entitled to damages or, in the alternative, that they may terminate their respective natural-gas shipments to SDG&E. SDG&E has answered these claims. In March 1995 SDG&E and Husky Oil reached an agreement dismissing all of their respective claims with prejudice.\nBow Valley and Summit Resources gave SDG&E notice that their natural-gas- supply contracts with SDG&E were terminated pursuant to provisions in the contract that purportedly give them the right to do so. SDG&E has responded that the notices were inappropriate and that it will seek both contract and tort damages.\nIn July 1995 the United States Federal District Court, Southern District of California, dismissed SDG&E's lawsuit against Summit Resources. SDG&E's lawsuit in Federal District Court against Canadian Hunter is still proceeding.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nElectric and Magnetic Fields\nCovalt: On December 16, 1993 Martin and Joyce Covalt filed a complaint against SDG&E in Orange County Superior Court. The Covalt lawsuit involves the same lawyers and issues as the lawsuits brought by McCartin and Zuidema, in which SDG&E prevailed and which were reported in previous Annual Reports on Form 10- K. On April 13, 1994 SDG&E filed a demurrer to the Covalts' claims. On June 22, 1994 an Orange County Superior Court judge, different from the judge who presided over the McCartin case, denied SDG&E's demurrer. On July 15, 1994 SDG&E petitioned the California Court of Appeal to review the trial judge's decision on the grounds that the California Public Utilities Commission, not the courts, has exclusive jurisdiction over power-line health and safety issues. On February 28, 1995 the California Court of Appeal granted SDG&E's petition, completely dismissing the plaintiffs' lawsuit, ruling that the CPUC has exclusive jurisdiction over these claims. On March 30, 1995 the Court of Appeal denied the plaintiffs' petition for rehearing. On May 11, 1995 the California Supreme Court granted plaintiffs' request for review of the California Court of Appeal decision to dismiss the case. A decision is not expected before late 1996.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nNorth City West: On June 14, 1993 the Peninsula at Del Mar Highlands Homeowners Association filed a complaint with the Superior Court of San Diego County against the City of San Diego and SDG&E to prevent SDG&E from constructing and operating an electric substation in an area which is known as North City West. In the complaint, plaintiffs sought to have the city either revoke previously issued permits or reopen the hearing process to address alleged EMF concerns. In 1993 the court denied the plaintiffs' motion for a temporary restraining order and motion for a preliminary injunction. Subsequently, the plaintiffs withdrew their complaint and the court dismissed it without prejudice.\nOn August 18, 1993 the plaintiffs filed a complaint with the CPUC, requesting that the CPUC conduct an environmental assessment. This complaint is still pending.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nSONGS Personal Injury Litigation\nJames v. Southern California Edison Company, San Diego Gas & Electric Company and Combustion Engineering was tried and successfully defended in Federal District Court, Southern District of California. Mr. James, an employee of a SONGS contractor, was diagnosed with chronic myelogenous leukemia. He alleged his leukemia was caused by radiation exposure and from \"fuel fleas\" (radioactive fuel particles) from failed fuel rods. Plaintiffs sought $25 million in compensatory damages and $100 million in punitive damages. On October 12, 1995 the jury\ndetermined there was no scientific link between the plaintiff's illness and the amount of radiation he was exposed to while at SONGS. The case is currently on appeal to the Ninth Circuit Court of Appeal.\nThree wrongful death lawsuits have been filed against Southern California Edison, San Diego Gas & Electric Company, Combustion Engineering, and the Institute of Nuclear Power Operations in Federal District Court, Southern District of California, by the heirs of former SONGS employees: McLandrich filed February 6, 1995, Mettler filed July 5, 1995, and Knapp filed August 31, 1995. In McLandrich, the former employee allegedly developed leimyosarcoma, a rare form of cancer. In Mettler and Knapp, the former employees allegedly developed acute myelogenous leukemia. All plaintiffs attribute the illnesses to radiation exposure and \"fuel fleas\". Southern California Edison, co-owner and operator of SONGS, was dismissed from McLandrich based on the workers' compensation exclusive-remedy rule. SDG&E's motion on the same theory was denied. SDG&E has been granted permission to file a motion for summary judgment. The heirs of the plaintiffs in each case seek unspecified amounts in compensatory and punitive damages. SDG&E is defending the lawsuits on the basis that the workers' compensation exclusive-remedy rule should apply for SDG&E as co-owner of the plant and that there is no scientific link between the illnesses and the alleged radiation exposure. All the SONGS personal injury lawsuits, including the two listed below, have involved the same lawyers for the plaintiffs.\nTwo additional lawsuits have been filed wherein SDG&E was not named as a defendant. Kennedy v. Southern California Edison and Combustion Engineering, Inc., was filed in Federal District Court, Southern District of California on November 17, 1995. In this case, the wife of a current SONGS worker was diagnosed with chronic myelogenous leukemia (CML). She and her husband allege the CML was caused by exposure to radioactive particles that were transported home on the employee's clothing. In Rock v. Southern California Edison and Combustion Engineering, Inc. (filed November 28, 1995 in Federal District Court, Southern District of California), plaintiffs allege that the 18-year- old son of a former temporary SONGS employee developed acute myelogenous leukemia from exposure to radioactive material that was transported home on the worker's clothing. Plaintiffs seek unspecified amounts in compensatory and punitive damages in both cases.\nSDG&E is unable to predict the ultimate outcome of this litigation.\nEnvironmental and Regulatory Issues\nOther legal matters related to environmental and regulatory issues are described under \"Environmental Matters\" and \"Regulatory Matters\" herein.\nItem 4.","section_4":"Item 4. Submission of Matter to a Vote of Security Holders NONE. Item 4. Executive Officers of the Registrant\n*All positions are at SDG&E unless otherwise noted.\nPART II - Enova Corporation:\nPart II - San Diego Gas & Electric Company beginning on page 32 of this Annual Report on Form 10-K is incorporated herein by reference.\nPART II - San Diego Gas & Electric Company:\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nCommon stock is traded on the New York and Pacific stock exchanges. At December 31, 1995 there were 84,158 holders of common stock. The quarterly common stock information required by Item 5 is incorporated by reference from page 43 of the 1995 Annual Report to Shareholders.\nItem 6.","section_6":"Item 6. Selected Financial Data\n*Includes long-term debt redeemable within one year.\nThis summary should be read in conjunction with the consolidated financial statements and notes to consolidated financial statements contained in the 1995 Annual Report to Shareholders. Prior periods have been restated to reflect discontinued operations, as described in note 3\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required by Item 7 is incorporated by reference from pages 18 through 26 of the 1995 Annual Report to Shareholders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required by Item 8 is incorporated by reference from pages 28 through 43 of the 1995 Annual Report to Shareholders. See Item 14 herein for a listing of financial statements included in the 1995 Annual Report to Shareholders.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.\nPART III - Enova Corporation:\nPart III - San Diego Gas & Electric Company beginning on page 33 of this Annual Report on Form 10-K is incorporated herein by reference.\nPART III - San Diego Gas & Electric Company:\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information required on Identification of Directors is incorporated by reference from \"Election of Directors\" in the March 1996 Proxy Statement. The information required on executive officers is incorporated by reference from Item 4 herein.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by Item 11 is incorporated by reference from \"Executive Compensation and Transactions with Management and Others\" in the March 1996 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 is incorporated by reference from \"Security Ownership of Management and Certain Beneficial Holders\" in the March 1996 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions None.\nPART IV - Enova Corporation:\nPart IV - San Diego Gas & Electric Company beginning on page 34 of this Annual Report on Form 10-K is incorporated herein by reference.\nPART IV - San Diego Gas & Electric Company:\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n1. Financial statements Page in Annual Report*\nResponsibility Report for the Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . 27\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . 27\nStatements of Consolidated Income for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . 28\nConsolidated Balance Sheets at December 31, 1995 and 1994 . . 29\nStatements of Consolidated Cash Flows for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . 30\nStatements of Consolidated Changes in Capital Stock and Retained Earnings for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . 31\nStatements of Consolidated Capital Stock at December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . 32\nStatements of Consolidated Long-Term Debt at December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . 33\nStatements of Consolidated Financial Information by Segments of Business for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . 34\nNotes to Consolidated Financial Statements . . . . . . . . . . 35\nQuarterly Financial Data (Unaudited) . . . . . . . . . . . . . 43\n*Incorporated by reference from the indicated pages of the 1995 Annual Report to Shareholders.\n2. Financial statement schedules\nNone\n3. Exhibits\nThe Forms 8, 8-B\/A, 8-K, S-4, 10-K and 10-Q referred to herein were filed under Commission File Number 1-3779 (SDG&E) or Commission File Number 1-11439 (Enova Corporation).\nExhibit 3 -- Bylaws and Articles of Incorporation\nBylaws\n3.1 Restated Bylaws (Incorporated by reference from the Registration Statement on Form 8-B\/A of Enova Corporation (Exhibit 3.2)).\nArticles of Incorporation\n3.2 Restated Articles of Incorporation of Enova Corporation (Incorporated by reference from the Registration Statement on Form 8-B\/A of Enova Corporation (Exhibit 3.1)).\nExhibit 4 -- Instruments Defining the Rights of Security Holders, Including Indentures\n4.1 Mortgage and Deed of Trust dated July 1, 1940. (Incorporated by reference from SDG&E Registration No. 2-49810, Exhibit 2A.)\n4.2 Second Supplemental Indenture dated as of March 1, 1948. (Incorporated by reference from SDG&E Registration No. 2-49810, Exhibit 2C.)\n4.3 Ninth Supplemental Indenture dated as of August 1, 1968. (Incorporated by reference from SDG&E Registration No. 2-68420, Exhibit 2D.)\n4.4 Tenth Supplemental Indenture dated as of December 1, 1968. (Incorporated by reference from SDG&E Registration No. 2-36042, Exhibit 2K.)\n4.5 Sixteenth Supplemental Indenture dated August 28, 1975. (Incorporated by reference from SDG&E Registration No. 2-68420, Exhibit 2E.)\n4.6 Thirtieth Supplemental Indenture dated September 28, 1983. (Incorporated by reference from SDG&E Registration No. 33-34017, Exhibit 4.3.)\nExhibit 10 -- Material Contracts (Previously filed exhibits are incorporated by reference from Forms S-4, 10-K or 10-Q as referenced below).\nCompensation\n10.1 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1996 compensation, 1997 bonus).\n10.2 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #1 (1995 compensation, 1996 bonus)(1994 SDG&E Form 10-K Exhibit 10.2).\n10.3 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #3 (1996 compensation, 1997 bonus).\n10.4 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Officers #3 (1995 compensation, 1996 bonus)(1994 SDG&E Form 10-K Exhibit 10.1).\n10.5 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Nonemployee Directors (1996 compensation).\n10.6 Form of San Diego Gas & Electric Company Deferred Compensation Agreement for Nonemployee Directors (1995 compensation)(1994 SDG&E Form 10-K Exhibit 10.3).\n10.7 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1995 restricted stock award agreement.\n10.8 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan Special 1995 restricted stock award agreement.\n10.9 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1994 restricted stock award agreement two- year vesting.\n10.10 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1994 restricted stock award agreement (1994 SDG&E Form 10-K Exhibit 10.4).\n10.11 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1993 restricted stock award agreement (1993 SDG&E Form 10-K Exhibit 10.4).\n10.12 Form of San Diego Gas & Electric Company 1986 Long-Term Incentive Plan 1992 restricted stock award agreement (1992 SDG&E Form 10-K Exhibit 10.4).\n10.13 Amended 1986 Long-Term Incentive Plan, amended and restated effective April 25, 1995 (SDG&E's Amendment No. 2 to Form S-4 filed February 28, 1995).\n10.14 Amended 1986 Long-Term Incentive Plan, Restatement as of October 25, 1993 (1993 SDG&E Form 10-K Exhibit 10.6).\n10.15 San Diego Gas & Electric Company Retirement Plan for Directors, restated as of October 24, 1994 (1994 SDG&E Form 10-K Exhibit 10.5).\n10.16 Executive Incentive Plan dated April 23, 1985 (1991 SDG&E Form 10-K Exhibit 10.39).\n10.17 Employment agreement between San Diego Gas & Electric Company and Thomas A. Page, dated June 15, 1988 (1988 SDG&E Form 10-K Exhibit 10E).\n10.18 Supplemental Pension Agreement with Thomas A. Page, dated as of April 3, 1978 (1988 SDG&E Form 10-K Exhibit 10V).\n10.19 Supplemental Executive Retirement Plan restated as of July 1, 1994 (1994 SDG&E Form 10-K Exhibit 10.14).\nFinancing\n10.20 Loan agreement with the City of San Diego in connection with the issuance of $16.7 million of Industrial Development Bonds, dated as of June 1, 1995 (June 30, 1995 SDG&E Form 10-Q Exhibit 10.2).\n10.21 Loan agreement with the City of San Diego in connection with the issuance of $57.7 million of Industrial Development Bonds, dated as of June 1, 1995 (June 30, 1995 SDG&E Form 10-Q Exhibit 10.3).\n10.22 Loan agreement with the City of San Diego in connection with the issuance of $92.9 million of Industrial Development Bonds 1993 Series C dated as of July 1, 1993 (June 30, 1993 SDG&E Form 10-Q Exhibit 10.2).\n10.23 Loan agreement with the City of San Diego in connection with the issuance of $70.8 million of Industrial Development Bonds 1993 Series A dated as of April 1, 1993 (March 31, 1993 SDG&E Form 10-Q Exhibit 10.3).\n10.24 Loan agreement with the City of San Diego in connection with the issuance of $14.9 million of Industrial Development Bonds 1993 Series B dated as of April 1, 1993 (March 31, 1993 SDG&E Form 10-Q Exhibit 10.4).\n10.25 Loan agreement with the City of San Diego in connection with the issuance of $118.6 million of Industrial Development Bonds dated as of September 1, 1992 (Sept. 30, 1992 SDG&E Form 10-Q Exhibit 10.1).\n10.26 Loan agreement with the City of Chula Vista in connection with the issuance of $250 million of Industrial Development Bonds, dated as of December 1, 1992 (1992 SDG&E Form 10-K Exhibit 10.5).\n10.27 Loan agreement with the City of San Diego in connection with the issuance of $25 million of Industrial Development Bonds, dated as of September 1, 1987 (1992 SDG&E Form 10-K Exhibit 10.6).\n10.28 Loan agreement with the City of San Diego in connection with the issuance of $44.25 million of Industrial Development Bonds, dated as of July 1, 1986 (1991 SDG&E Form 10-K Exhibit 10.36).\n10.29 Loan agreement with the City of San Diego in connection with the issuance of $81.35 million of Industrial Development Bonds, dated as of December 1, 1986 (1991 SDG&E Form 10-K Exhibit 10.37).\n10.30 Loan agreement with the California Pollution Control Financing Authority in connection with the issuance of $60 million of Pollution Control Bonds dated as of June 1, 1993 (June 30, 1993 SDG&E Form 10-Q Exhibit 10.1).\n10.31 Loan agreement with the California Pollution Control Financing Authority, dated as of December 1, 1991, in connection with the issuance of $14.4 million of Pollution Control Bonds (1991 SDG&E Form 10-K Exhibit 10.11).\n10.32 Loan agreement with the California Pollution Control Financing Authority, dated as of December 1, 1985, in connection with the issuance of $35 million of Pollution Control Bonds (1991 SDG&E Form 10-K Exhibit 10.10).\n10.33 Loan agreement with the California Pollution Control Financing Authority dated as of December 1, 1984, in connection with the issuance of $27 million of Pollution Control Bonds (1991 SDG&E Form 10-K Exhibit 10.40).\n10.34 Loan agreement with the California Pollution Control Financing Authority dated as of May 1, 1984, in connection with the issuance of $53 million of Pollution Control Bonds (1991 SDG&E Form 10-K Exhibit 10.41).\nNatural Gas Commodity, Transportation and Storage\n10.35 Long-Term Natural Gas Storage Service Agreement dated January 12, 1994 between Southern California Gas Company and SDG&E (1994 SDG&E Form 10-K Exhibit 10.42).\n10.36 Amendment to San Diego Gas & Electric Company and Southern California Gas Company Restated Long-Term Wholesale Natural Gas Service Contract dated March 26, 1993 (1993 SDG&E Form 10-K Exhibit 10.53).\n10.37 San Diego Gas & Electric Company and Southern California Gas Company Restated Long-Term Wholesale Natural Gas Service Contract, dated September 1, 1990 (1990 SDG&E Form 10-K Exhibit 10.9).\n10.38 Gas Purchase Agreement, dated March 12, 1991 between Husky Oil Operations Limited and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.1).\n10.39 Gas Purchase Agreement, dated March 12, 1991 between Canadian Hunter Marketing Limited and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.2).\n10.40 Gas Purchase Agreement, dated March 12, 1991 between Bow Valley Industries Limited and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.3).\n10.41 Gas Purchase Agreement, dated March 12, 1991 between Summit Resources Limited and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.4).\n10.42 Service Agreement Applicable to Firm Transportation Service under Rate Schedule FS-1, dated May 31, 1991 between Alberta Natural Gas Company Ltd. and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.5).\n10.43 Firm Transportation Service Agreement, dated December 31, 1991 between Pacific Gas and Electric Company and San Diego Gas & Electric Company (1991 SDG&E Form 10-K Exhibit 10.7).\n10.44 Firm Transportation Service Agreement, dated April 25, 1991 between Pacific Gas Transmission Company and San Diego Gas & Electric Company (March 31, 1991 SDG&E Form 10-Q Exhibit 28.2).\nNuclear\n10.45 Uranium enrichment services contract between the U.S. Department of Energy (DOE assigned its rights to the U.S. Enrichment Corporation, a U.S. government-owned corporation, on July 1, 1993) and Southern California Edison Company, as agent for SDG&E and others; Contract DE-SC05-84UEO7541, dated November 5, 1984, effective June 1, 1984, as amended (1991 SDG&E Form 10-K Exhibit 10.9).\n10.46 Fuel Lease dated as of September 8, 1983 between SONGS Fuel Company, as Lessor and San Diego Gas & Electric Company, as Lessee, and Amendment No. 1 to Fuel Lease, dated September 14, 1984 and Amendment No. 2 to Fuel Lease, dated March 2, 1987 (1992 SDG&E Form 10-K Exhibit 10.11).\n10.47 Nuclear Facilities Qualified CPUC Decommissioning Master Trust Agreement for San Onofre Nuclear Generating Station, approved November 25, 1987 (1992 SDG&E Form 10-K Exhibit 10.7).\n10.48 Amendment No. 1 to the Qualified CPUC Decommissioning Master\nTrust Agreement dated September 22, 1994 (see Exhibit 10.47 herein).\n10.49 Second Amendment to the San Diego Gas & Electric Company Nuclear Facilities Qualified CPUC Decommissioning Master Trust Agreement for San Onofre Nuclear Generating Station (see Exhibit 10.47 herein).\n10.50 Nuclear Facilities Non-Qualified CPUC Decommissioning Master Trust Agreement for San Onofre Nuclear Generating Station, approved November 25, 1987 (1992 SDG&E Form 10-K Exhibit 10.8).\n10.51 Second Amended San Onofre Agreement among Southern California Edison Company, SDG&E, the City of Anaheim and the City of Riverside, dated February 26, 1987 (1990 SDG&E Form 10-K Exhibit 10.6).\n10.52 U. S. Department of Energy contract for disposal of spent nuclear fuel and\/or high-level radioactive waste, entered into between the DOE and Southern California Edison Company, as agent for SDG&E and others; Contract DE-CR01-83NE44418, dated June 10, 1983 (1988 SDG&E Form 10-K Exhibit 10N).\nPurchased Power\n10.53 Public Service Company of New Mexico and San Diego Gas & Electric Company 1988-2001 100 mw System Power Agreement dated November 4, 1985 and Letter of Agreement dated April 28, 1986, June 4, 1986 and June 18, 1986 (1988 SDG&E Form 10-K Exhibit 10H).\n10.54 San Diego Gas & Electric Company and Portland General Electric Company Long-Term Power Sale and Transmission Service agreements dated November 5, 1985 (1988 SDG&E Form 10-K Exhibit 10I).\n10.55 Comision Federal de Electricidad and San Diego Gas & Electric Company Contract for the Purchase and Sale of Electric Capacity and Energy dated November 20, 1980 and additional Agreement to the contract dated March 22, 1985 (1988 SDG&E Form 10-K Exhibit 10J).\n10.56 Agreement with Arizona Public Service Company for Arizona transmission system participation agreement - contract 790116 (1988 SDG&E Form 10-K Exhibit 10P).\nOther\n10.57 U. S. Navy contract for electric service, Contract N62474-70-C-1200-P00414, dated September 29, 1988 (1988 SDG&E Form 10-K Exhibit 10C).\n10.58 City of San Diego Electric Franchise (Ordinance No. 10466) (1988 SDG&E Form 10-K Exhibit 10Q).\n10.59 City of San Diego Gas Franchise (Ordinance No. 10465) (1988 SDG&E Form 10-K Exhibit 10R).\n10.60 County of San Diego Electric Franchise (Ordinance No. 3207) (1988 SDG&E Form 10-K Exhibit 10S).\n10.61 County of San Diego Gas Franchise (Ordinance No. 5669) (1988 SDG&E Form 10-K Exhibit 10T).\n10.62 Lease agreement dated as of March 25, 1992 with American National Insurance Company as lessor of an office complex at Century Park (1994 SDG&E Form 10-K Exhibit 10.70).\n10.63 Lease agreement dated as of June 15, 1978 with Lloyds Bank California, as owner-trustee and lessor - Exhibit B to financing agreement of SDG&E's Encina Unit 5 equipment trust (1988 SDG&E Form 10-K Exhibit 10W).\n10.64 Amendment to Lease agreement dated as of July 1, 1993 with Sanwa Bank California, as owner-trustee and lessor - Exhibit B to secured loan agreement of SDG&E's Encina Unit 5 equipment trust (See Exhibit 10.63 herein).\n10.65 Lease agreement dated as of July 14, 1975 with New England Mutual Life Insurance Company, as lessor (1991 SDG&E Form 10-K Exhibit 10.42).\n10.66 Assignment of Lease agreement dated as of November 19, 1993 to Shapery Developers as lessor by New England Mutual Life Insurance Company (See Exhibit 10.65 herein).\nExhibit 12 -- Statement re: computation of ratios\n12.1 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends for the years ended December 31, 1995, 1994, 1993, 1992 and 1991.\nExhibit 13 -- The financial statements and other documents listed under Part IV Item 14(a)1. and Management's Discussion and Analysis of Financial Condition and Results of Operations listed under Part II Item 7 of this Form 10-K are incorporated by reference from the 1995 Annual Report to Shareholders.\nExhibit 22 - Subsidiaries - See \"Part I, Item 1. Description of Business.\"\nExhibit 24 - Independent Auditors' Consent, page 41.\nExhibit 27 - Financial Data Schedules\n27.1 Financial Data Schedule for the year ended December 31, 1995.\n(b) Reports on Form 8-K:\nA Current Report on Form 8-K was filed on December 7, 1995 announcing the CPUC's approval of SDG&E's application to form a holding company, the January 1, 1996 effective date of the new parent company, and associated changes in officers' responsibilities.\nA Current Report on Form 8-K was filed on February 2, 1996 to report that on January 31, 1996 SDG&E's ownership interests in its subsidiaries were transferred to Enova Corporation at book value, completing the organizational restructuring into the new parent company framework.\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference of our report dated February 16, 1996 on San Diego Gas & Electric Company, appearing on page 27 of the 1995 Annual Report to Shareholders of Enova Corporation and San Diego Gas & Electric Company incorporated by reference in this Annual Report on Form 10-K for the year ended December 31, 1995.\nWe also consent to the incorporation by reference of the above-mentioned report in the Enova Corporation Post-Effective Amendment No. 1 to Registration Statement No. 33-59681 on Form S-3, Post-Effective Amendment No. 1 to Registration Statement No. 33-59683 on Form S-8 and Post-Effective Amendment No. 1 to Registration Statement No. 33-7108 on Form 8; and in the San Diego Gas & Electric Company Registration Statement No. 33-45599 on Form S-3, Registration Statement No. 33-52834 on Form S-3 and Registration Statement No. 33-49837 on Form S-3.\nDELOITTE & TOUCHE LLP\nSan Diego, California February 28, 1996\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, hereunto duly authorized. The signatures of the undersigned companies relate only to matters having reference to such companies and their respective subsidiaries.\nENOVA CORPORATION. SAN DIEGO GAS & ELECTRIC COMPANY\nBy: \/s\/ Stephen L. Baum By: \/s\/ Donald E. Felsinger _____________________ ________________________ Stephen L. Baum Donald E. Felsinger President and Chief President and Chief Executive Officer Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. The signatures of the undersigned companies relate only to matters having reference to such companies and their respective subsidiaries.\nSignature Title Date\nPrincipal Executive Officers:\n\/s\/ Stephen L. Baum _________________________________________________________________________ Stephen L. Baum President and Chief Executive February 26, 1996 Officer (Enova) and a Director (Enova and SDG&E) \/s\/ Donald E. Felsinger __________________________________________________________________________ Donald E. Felsinger President and Chief Executive February 26, 1996 Officer and a Director (SDG&E) Principal Financial Officer:\n\/s\/ David R. Kuzma __________________________________________________________________________ David R. Kuzma Senior Vice President Chief Financial February 26, 1996 Officer and Treasurer (Enova and SDG&E) Principal Accounting Officer:\n\/s\/ Frank H. Ault __________________________________________________________________________ Frank H. Ault Vice President and Controller (Enova and SDG&E)February 26, 1996\nDirectors (Enova and SDG&E):\n\/s\/ Thomas A. Page __________________________________________________________________________ Thomas A. Page Chairman February 26, 1996\n\/s\/ Ann L. Burr ___________________________________________________________________________ Ann L. Burr Director February 26, 1996\n\/s\/ Richard A. Collato ___________________________________________________________________________ Richard A. Collato Director February 26, 1996\n\/s\/ Daniel W. Derbes ____________________________________________________________________________ Daniel W. Derbes Director February 26, 1996\n\/s\/ Catherine T. Fitzgerald ____________________________________________________________________________ Catherine T. Fitzgerald Director February 26, 1996\n\/s\/ Robert H. Goldsmith ____________________________________________________________________________ Robert H. Goldsmith Director February 26, 1996\n\/s\/ William D. Jones ____________________________________________________________________________ William D. Jones Director February 26, 1996\n\/s\/ Ralph R. Ocampo ____________________________________________________________________________ Ralph R. Ocampo Director February 26, 1996\n\/s\/ Thomas C. Stickel _____________________________________________________________________________ Thomas C. Stickel Director February 26, 1996\nGLOSSARY\nAPCD Air Pollution Control District\nBCAP Biennial Cost Allocation Proceeding\nBPA Bonneville Power Administration\nBRPU Biennial Resource Plan Update\nCEC California Energy Commission\nCFE Comision Federal de Electricidad\nCPUC California Public Utilities Commission\nDOE Department of Energy\nEC Electric Clearinghouse\nECAC Energy Cost Adjustment Clause\nEdison Southern California Edison Company and\/or its parent, SCEcorp\nEMF Electric and magnetic fields\nEnron Enron Power Marketing\nERAM Electric Revenue Adjustment Mechanism\nEV Electric vehicle\nFERC Federal Energy Regulatory Commission\nG&D Electric Generation and Dispatch Mechanism\nGFCA Gas Fixed Cost Account\nGoal Line Goal Line Limited Partnership\nIID Imperial Irrigation District\nIllinova Illinova Power Marketing\nISO Independent System Operator\nkv Kilovolt\nkwhr Kilowatt hour\nmw Megawatt\nNGV Natural-Gas Vehicle\nNOx Nitrogen Dioxide\nNRC Nuclear Regulatory Commission\nPacific Intertie A transmission line connecting San Diego to the Pacific Northwest\nPBR Performance-Based Ratemaking\nPCB Polychlorinated Biphenyl\nPG&E Pacific Gas and Electric Company\nPGE Portland General Electric Company\nPNM Public Service Company of New Mexico\nPSP&L Puget Sound Power & Light\nRECLAIM Regional Clean Air Incentive Market\nSDG&E San Diego Gas & Electric Company\nSoCal Gas Southern California Gas Company\nSONGS\/San Onofre San Onofre Nuclear Generating Station\nSRP Salt River Project\nSouthwest Powerlink A transmission line connecting San Diego to Phoenix and intermediate points\nTCF Target Capacity Factor","section_15":""}
{"filename":"916863_1995.txt","cik":"916863","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":"721238_1995.txt","cik":"721238","year":"1995","section_1":"Item 1. Business\nAmerican Bancorp, Inc. (the Corporation) was incorporated under the laws of the State of Louisiana in 1982. On October 1, 1983, American Bank and Trust Company (the Bank) was reorganized as a subsidiary of the Corporation. Prior to October 1, 1983, the Corporation had no material activity. The Corporation is currently engaged, through its subsidiary, in banking and related business. The Bank is the Corporation's principal asset and primary source of revenue.\nThe Bank\nThe Bank, incorporated under the State Banking Laws on August 1, 1958 is in the business of gathering funds by accepting checking, savings, and other time-deposit accounts and reemploying these by making loans and investing in securities and other interest-bearing assets. The Bank is a full service commercial bank. Some of the major services which it provides include checking, NOW accounts, Money Market checking, savings, and other time deposits of various types, loans for business, agriculture, real estate, personal use, home improvement, automobile, and a variety of other types of loans and services including letters of credit, safe deposit boxes, bank money orders, wire transfer facilities, and electronic banking facilities.\nThe State of Louisiana, through its various departments and agencies, deposits public funds with the Bank. As of December 31, 1995, $297,000 in certificates of deposit were on deposit representing .53% of total deposits outstanding. The weighted average interest rates on these deposits was 6%. The maturity of these deposits is December 18, 1997.\nThe Bank's general market area is in St. Landry Parish, which has a population of approximately 80,300. Its primary market is Opelousas, which has a population of approximately 19,300, and has experienced little population growth over the past several years.\nThe commercial banking business in St. Landry Parish is highly competitive. The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982 have eliminated most, if not all, substantive distinctions between the services of commercial banks and thrift institutions. The Bank competes with three banks and two savings and loan institutions located in St. Landry Parish. The following is a list of banks and savings associations in this market with the total deposits and assets as of December 31, 1995.\n- 2 - Item 1. Business (continued)\nIn addition to the institutions listed above, further competition is provided by banks and other financial institutions located in Lafayette, Louisiana, which is 20 miles south of Opelousas and Baton Rouge, Louisiana, the state capital, which is 60 miles east of St. Landry Parish.\nLouisiana Banking Law provides that generally Louisiana banks having capital of one hundred thousand dollars or more may open one or more branch offices within the State or may acquire one or more banks or any or all branches thereof, or both. On July 2, 1986, Louisiana passed an interstate banking law affirmatively permitting Louisiana bank holding companies to immediately acquire out-of-state bank holding companies and banks. On July 1, 1987, bank holding companies located in a fifteen state region were permitted to acquire banks or bank holding companies in Louisiana, and beginning January 1, 1991, out-of-state bank holding companies may acquire banks or bank holding companies provided that the law of the state in which the out-of-state bank holding company has its principal place of business permits Louisiana bank holding companies to acquire banks and bank holding companies in that state.\nThe effect of the new liberalized branching laws and the Louisiana Interstate Banking Law on the Company cannot be predicted at this time, but increased competition is expected.\nEmployees\nDuring 1995, the average number of full-time equivalent employees at the Bank was 45. This includes the officers of the Corporation that are listed under Item 1 below.\nThere are no unions or bargaining units that represent the employees of the Bank. The relation between management and employees is considered to be good.\nExecutive Officers\nThe executive officers of the Corporation are as follows:\n- 3 - Item 1. Business (continued)\nNone of the directors and executive officers of the Corporation or the Bank holds a directorship in any company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, or subject to the requirements of Section 15(d) of that Act or in any company registered as an investment company under the Investment Company Act of 1940. Salvador L. Diesi, Sr. and Ronald J. Lashute are the nephews of J.C. Diesi. No other family relationships exist among the above named directors or executive officers of the Corporation.\nSupervision and Regulation\nThe Bank is subject to regulation and regular examinations by the Louisiana Commissioner of Financial Institutions and by the Federal Deposit Insurance Corporation. Applicable regulations relate to reserves, investments, loans, issuance of securities, establishment of branches, and other aspects of its operations.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") further expanded the regulatory and enforcement powers of bank regulatory agencies. Among the significant provisions of FDICIA is the requirement that bank regulatory agencies prescribe standards relating to internal controls, information systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits. FDICIA mandates annual examinations of banks by their primary regulators.\nThe Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the Act), and is thereby subject to the provisions of the Act and to regulation by the Board of Governors of the Federal Reserve System (the Board).\nThe Act requires the Corporation to file with the Board an annual report containing such information as the Board may require. The Board is authorized by the Act to examine the Corporation and all of its activities. The activities that may be engaged in by the Corporation and its subsidiary are limited by the Act to those so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is a proper incident to banking or managing or controlling banks, the Board must consider whether its performance by an affiliate of a holding company can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.\nThe Board has adopted regulations implementing the provisions of the Act with respect to the non-banking activities of bank holding companies. Such regulations reflect a determination by the Board that certain specified activities are permissible for a bank holding company. An activity not listed in the regulation may be engaged in if, upon application, the Board determines that the activity meets the criteria described in the preceding paragraph. In each case, a bank holding company must secure the approval of the Board prior to engaging in any of these activities.\nWhether or not a particular non-banking activity is permitted under the Act, the Board is authorized to require a holding company to terminate any activity, or divest itself of any non-banking subsidiary, if in its judgment the activity or subsidiaries would be unsound.\n- 4 - Item 1. Business (continued)\nUnder the 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 provision of any property or services.\nIn some cases, the Company must receive the prior approval of the Board in order to repurchase or redeem its outstanding equity securities.\nWith certain exceptions, the Subsidiary Bank is restricted by Sections 22 and 23A of the Federal Reserve Act from extending credit or making loans to or investments in the Company and certain other affiliates as defined in the Federal Reserve Act. Such transactions by the Subsidiary Bank with the Company or any such affiliate are limited in an amount to 10% of the Subsidiary Bank's capital and surplus. Furthermore, loans and extensions of credit are subject to various collateral requirements.\nThe Louisiana bank holding company law, as amended (the \"Louisiana Act\"), permits bank holding companies to own more than one bank. In addition, a bank holding company and its subsidiaries may not engage in any insurance activity in which a bank may not engage. The Louisiana Commissioner of Financial Institutions is authorized to administer the Louisiana Act and to issue orders and regulations.\nThe Board of Directors of the Corporation have no present plans or intentions to cause the Corporation to engage in any substantial business activity which would be permitted to it under the Act or the Louisiana Act but which is not permitted to the Bank; however, a significant reason for formation of the one-bank holding company is to take advantage of the additional flexibility afforded by that structure if the Board of Directors of the Corporation concludes that such action would be in the best interest of stockholders.\nStatistical Information\nThe following tables contain additional information concerning the business and operations of the Registrant and its subsidiary and should be read in conjunction with the Consolidated Financial Statements of the Registrant and Management's Discussion and Analysis of Financial Condition and Results of Operations. The 1995 Annual Report to Shareholders is incorporated herein by reference under Item 8.\nInvestment Portfolio\nThe following table sets forth the carrying amount of Investment Securities at the dates indicated (in thousands of dollars):\n- 5 - Item 1. Business (continued)\nThe following tables set forth the maturities of investment securities at December 31, 1995, 1994, and 1993 and the weighted average yields of such securities (in thousands of dollars):\n- 6 - Item 1. Business (continued)\n* Weighted average yields have been computed on a fully tax-equivalent basis assuming a rate of 34% for 1995, 1994 and 1993.\n- 7 - Item 1. Business (continued)\nLoan Portfolio\nThe amounts of loans outstanding at the indicated dates are shown in the following table according to type of loan (in thousands of dollars):\nThe following table presents information concerning the aggregate amount of nonperforming loans. Nonperforming loans comprise: (a) loans accounted for on a nonaccrual basis; (b) loans contractually past due ninety days or more as to interest or principal payments [but not included in the nonaccrual loans in (a) above]; (c) other loans whose terms have been restructured to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower [exclusive of loans in (a) or (b) above]; and (d) loans now current where there are serious doubts as to the ability of the borrower to comply with present loan requirement terms (in thousands of dollars):\n- 8 - Item 1. Business (continued)\nAs of January 1, 1995, the Company adopted SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" which, as it relates to in-substance foreclosures, requires that a creditor continue to classify these assets as loans in the balance sheet unless the creditor receives physical possession of the collateral. The Company had no in-substance foreclosures at the date of adoption of SFAS No. 114. At December 31, 1995, the recorded investment in loans that were considered to be impaired under SFAS No. 114 was $114,059, with the related allowance for loan losses of $5,901. These loans are included in nonaccrual loans.\nThe effect of nonperforming loans on interest income has not been substantial in the past three years. Had interest been accrued on the nonperforming loans, interest income would have been recorded in the amount of $13,732, $13,846 and $19,747, for the years 1995, 1994, and 1993, respectively. Interest income in the amount of $7,638, $6,707 and $7,558 on nonperforming loans during 1995, 1994 and 1993, respectively, was recorded.\nAt December 31, 1995, 1994 and 1993 there were no significant commitments to lend additional funds to debtors whose loans were considered to be nonperforming.\nThe Bank places loans on nonaccrual when the borrower is no longer able to make periodic interest payments due to a deterioration of the borrowers financial condition.\nAt December 31, 1995, the Bank has an insignificant amount of loans for which payments are current, but the borrowers are experiencing financial difficulties. These loans are subject to constant management attention, and their classification is reviewed on a monthly basis.\nSummary of Loan Loss Experience\nThe following table summarizes loan balances at the end of each period and average loans based on daily average balances for 1995, 1994, and 1993; 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 (in thousands of dollars):\n- 9 - Item 1. Business (continued)\nAllowance for Possible Loan Losses (In thousands of dollars)\nThe allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the date indicated:\nAllocation of Allowance for Possible Loan Losses (In thousands of dollars)\n- 10 - Item 1. Business (continued)\nAllocation of Allowance for Possible Loan Losses (continued) (In thousands of dollars)\nDeposits\nThe average amount of deposits, using daily average balances for 1995, 1994, and 1993, is summarized for the periods indicated in the following table (in thousands of dollars):\nReturn on equity and assets\nThe ratio of Net Income to Average Shareholders' Equity and to Average Total Assets, and certain other ratios, are as follows:\n- 11 - Item 1. Business (continued)\nShort-Term Borrowing\nThe Corporation's short-term borrowing and the average interest rate thereon at the end of the last three years, are as follows (in thousands of dollars):\nThe Corporation's short-term note payable was completely paid in 1992. The note was scheduled to mature in 1993.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe main office of the Corporation and the Bank are presently located at 328 East Landry Street, Opelousas, Louisiana, in the downtown business district. The Bank leases three branch sites. The building in which the main office is located is free of all mortgages.\nFor information with respect to the Corporation obligations under its lease commitments, see Note 11 to the Consolidated Financial Statements, which are incorporated herein by reference under Item 8.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Corporation is not involved in any legal actions; however, there are presently pending by the Bank a number of legal proceedings. It is the opinion of management that the resulting liability, if any, from these actions and other pending claims will not materially affect the consolidated financial statements.\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.\n- 12 - PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Security Holder Matters\nMARKET PRICE AND DIVIDENDS DECLARED\nNote: The primary market area for American Bancorp, Inc.'s common stock is the Opelousas, Louisiana area with American Bank and Trust Company acting as registrar and transfer agent. There were approximately 572 shareholders of record at December 31, 1995.\nSource of market price - American Bank & Trust Company acts as the transfer agent for the Company. The stock is thinly traded and the price ranges are based on stated sales price to the transfer agent, which does not represent all sales.\nRESTRICTIONS ON CASH DIVIDENDS PAYABLE BY THE REGISTRANT:\nThe only source of funds by the Company to pay dividends is dividends paid by the Subsidiary Bank, the payment of which is restricted by applicable federal and state statutes.\nFederal bank regulatory authorities have authority under the Financial Institutions Supervisory Act to prohibit a bank from engaging in an unsafe or unsound practice. The payment of a dividend by the Bank could, depending upon the financial condition of the Bank and other factors be deemed an unsafe or unsound practice.\nApplicable Louisiana law prohibits a state bank subsidiary from paying a dividend if its surplus remaining after payment of the dividend would be less than half the aggregate par value of its outstanding stock. In addition, a state bank subsidiary is required to obtain the prior approval of the Commissioner of Financial Institutions of Louisiana before declaring or paying a dividend in a given year if the total of all dividends declared or paid during that year would exceed the total of its net profits for that year combined with the net profits from the immediately preceding year.\n- 13 - Item 6.","section_6":"Item 6. Selected Financial Data\nThe information called for by Item 6 is included in Registrant's Annual Report on page 5 in the Section titled \"Summary of Operations for the Last Five Years\" 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 called for by Item 7 is included in the Registrant's Annual Report in the section titled \"Management's Discussion and Analysis of Operations\" and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of the Registrant and its subsidiary included on pages 28 through 55 in the Annual Report 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 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\nItem 9.","section_9":"Item 9. Disagreements in Accounting and Financial Disclosure\nThere have been no disagreements with an independent accountant on any matter of accounting principles or practice, financial disclosure, auditing scope or procedure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers\nWith the exception of identification of executive officers of the Corporation, the information called for by Item 10 is omitted pursuant to General Instruction G(3) and is included in Registrant's definitive Proxy Statement filed pursuant to Section 14(a). Executive officers of the Corporation are identified in Item 1, \"Executive Officer,\" included in Part I of this report.\nItem 11.","section_11":"Item 11. Management Remuneration and Transactions\nThe information called for by this item is included in Registrant's definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934 and is incorporated herein by reference.\n- 14 - Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information called for by this item is included in Registrant's definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934 and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information called for by this item is included in Registrant's definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934 and is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements\nThe following consolidated financial statements of American Bancorp, Inc. and Subsidiary, included in pages 28 through 55 of the Registrant's Annual Report are incorporated by reference in 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\n(a) 2. Financial Statement Schedules\nThe Schedules to the consolidated financial statements required by Article 9, and all other schedules to the financial statements of the Registrant required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n(a) 3. Exhibits\n(13) 1995 Annual Report to Shareholders (23) Proxy Statement for Annual Meeting of Shareholders to be held on April 10, 1996 (24) Consent of Independent Auditors\n- 15 - Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (continued)\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n- 16 - 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.\nAmerican Bancorp, Inc. (Registrant)\nBy: \/s\/ SALVADOR L. DIESI, SR. ------------------------------ Salvador L. Diesi, Sr., Chairman of the Board of the Corporation and the Bank; President of the Corporation and the Bank\nDated: 3\/28\/96 ------------------------------\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\/ SALVADOR L. DIESI, SR. \/s\/ JOSEPH J. ARTALL - ------------------------------------- -------------------------------- Salvador L. Diesi, Sr., Chairman of Joseph J. Artall, Director the Board of the Corporation and the Bank; President of the Corporation and the Bank\n\/s\/ RONALD J. LASHUTE \/s\/ WALTER J. CHAMPAGNE, JR. - ------------------------------------- -------------------------------- Ronald J. Lashute, Executive Vice- Walter J. Champagne, Jr., Director President and Chief Executive Officer of the Bank; Secretary\/Treasurer of the Corporation\n\/s\/ J.C. DIESI -------------------------------- J.C. Diesi, Director\n- 17 - EXHIBIT INDEX\n- 18 -","section_15":""}
{"filename":"802969_1995.txt","cik":"802969","year":"1995","section_1":"Item 1. Business.\nSoutheastern Income Properties Limited Partnership (the \"Registrant\") was organized under the Virginia Uniform Limited Partnership Act on November 21, 1985 for the purpose of acquiring, owning, operating, and ultimately selling existing residential apartment complexes located primarily in the southeastern United States. The general partner of the Registrant is Winthrop Southeast Limited Partnership, a Delaware limited partnership (\"WSLP\" or the \"Managing General Partner\"), whose general partner is Eight Winthrop Properties, Inc., a Delaware corporation (\"Eight Winthrop\") (See \"Item 1, Business Change in Control.\")\nThe Registrant was initially capitalized with contributions of $100 from the Original General Partner and $100 from SIP Assignor Corporation, a Virginia corporation (the \"Assignor Limited Partner\"). On September 26, 1986, the Registrant filed a Registration Statement on Form S-11 (Registration No. 33-9085, the \"Registration Statement\") with the Securities and Exchange Commission (the \"Commission\") with respect to the public offering of assignee units of limited partnership interest (\"Units\") in the Registrant. The Registration Statement, covering the offering of 50,000 Units at a purchase price of $500 per Unit (an aggregate of $25,000,000), was declared effective on January 7, 1987. The offering concluded on June 29, 1987, at which time all 50,000 Units had been sold to limited partners (the \"Limited Partners\").\nThe Registrant's only business is acquiring, owning, operating and ultimately selling residential apartment complexes. The Registrant's investment objectives and policies are described on pages 31-38 under the caption \"Investment Objective and Policies\" of the Registrant's Prospectus dated January 7, 1987 as filed pursuant to Rule 424(b) on January 12, 1987 (the \"Prospectus\"), which description is incorporated herein by this reference. WSLP does not intend to change the business or the investment objectives of the Registrant.\nThe Registrant invested $20,593,101 of the original offering proceeds (net of sales commissions and sales and organizational costs, but including acquisition fees and expenses) in four\nresidential properties. All four properties were acquired by the Registrant directly.\nThe following tables set forth certain information regarding the properties which the Registrant acquired. For a further description of the properties, see pages 14 through 18 of the 1991 Solicitation of Consents, which is incorporated herein by reference.\nSee \"Item 8, Financial Statements and Supplementary Data Note C\" for further information concerning the mortgages encumbering the properties.\nThe Registrant maintains property and liability insurance on it properties which the Registrant believes to be adequate.\nEmployees\nThe Registrant does not have any employees.\nUntil March 18, 1996, management services were performed for the Registrant at its properties by on-site personnel all of whom were employees of Winthrop Management, an affiliate of the Managing General Partner, which directly managed the Registrant's\nproperties. All payroll and associated expenses of such on-site personnel were fully reimbursed by the Registrant to Winthrop Management. Pursuant to a management agreement, Winthrop Management provided certain property management services to the Registrant in addition to providing on-site management. Winthrop Management is a Massachusetts general partnership whose managing general partner is First Winthrop Corporation, the parent of Eight Winthrop.\nOn March 18, 1996, Registrant appointed an unaffiliated management company to assume management of its properties. (See \"Item 3, Legal Proceedings.\") The provisions of the new management agreement are substantially similar to those of the Winthrop Management agreement. The term is for one year, renewable annually.\nCompetition\nThe real estate business is highly competitive and the Registrant's properties have active competition from similar properties in the vicinity including, in certain instances, properties owned by affiliates of the Registrant. Furthermore, various limited partnerships controlled by the Managing General Partner and\/or its affiliates are also engaged in business which may be competitive with the Registrant. The Registrant is also competing for potential buyers with respect to the ultimate sale of its properties. See \"Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation.\"\nChange in Control\nThe original general partner of the Registrant was K-A Southeastern Income Properties Limited Partnership, a Virginia Limited Partnership (the \"Original General Partner\"). The general partners of the Original General Partner were Glade M. Knight, Ben T. Austin, III and Southeast Real Properties Corporation.\nOn February 12, 1992, WSLP was admitted as the general partner of the Registrant, while the Original General Partner's interest in the Registrant was converted to a special limited partnership interest. The substitution of WSLP as the general partner, and the conversion of the status of the Original General Partner to that of a limited partner, was previously approved by the limited partners of Registrant pursuant to the 1991\nSolicitation of Consents. The general partner of WSLP is Eight Winthrop, which is wholly-owned by First Winthrop Corporation, a Delaware corporation, which in turn is wholly-owned by Winthrop Financial Associates, A Limited Partnership, a Maryland limited partnership (\"WFA\").\nUntil December 22, 1994, Arthur J. Halleran, Jr. was the sole general partner of Linnaeus Associates Limited Partnership (\"Linnaeus\"), the general partner of WFA. On December 22, 1994, pursuant to an Investment Agreement entered into among Nomura Asset Capital Corporation (\"NACC\"), 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\"). W.L. Realty is a Delaware limited partnership, the general partner of which was, until July 18, 1995, A.I. Realty Company, LLC (\"Realtyco\"). The equity securities of Realtyco were held by certain employees of NACC.\nOn July 18, 1995 Londonderry Acquisition II Limited Partnership, a Delaware limited partnership (\"Londonderry II\"), an affiliate of Apollo Real Estate Advisors, L.P. (\"Apollo\"), acquired, among other things, Realtyco's general partner interest in W.L. Realty and a sixty four percent (64%) limited partnership interest in W.L. Realty. WFA owns the remaining thirty-five percent (35%) limited partnership interest.\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, which in turn is the sole general partner of WFA. As a result of the foregoing, effective July 18, 1995, Londonderry II became the controlling entity of the Managing General Partner. In connection with the transfer of control, the officers and directors of WFA resigned and Londonderry II appointed new officers and directors. See \"Item 10, Directors and Executive Officers of the Registrant.\"\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nFor a discussion of the Registrant's properties, see \"Item 1, Business.\"\nItem 3.","section_3":"Item 3. Legal Proceedings.\nExcept as disclosed below, the Registrant is not a party, nor are any of its properties subject, to any material pending legal proceedings.\nRTC Commercial Loan Trust 1995 - NP1A, a Delaware business trust, Plaintiff v. Winthrop Management, a Massachusetts general partnership, Defendant, United States District Court for the Eastern District of Virginia; Case No. 3:96CV177.\nThis action arises in connection with the transfer of the general partnership interest in 1992 from the Original General Partner to WSLP at which time WLSP entered into certain agreements with Investors Savings Bank, F.S.B. (\"ISB\"), including the delivery of a promissory note to ISB, which was secured by an assignment of rights of Winthrop Management in the management agreements for the Registrant's properties, and the partnership interests acquired by WSLP. (See the 1991 Solicitation of Consents which is incorporated by reference herein.) The RTC Commercial Loan Trust 1995-NP1A (the \"RTC Loan Trust\") has succeeded to the rights of ISB. In February 1996, the RTC Loan Trust filed an action against Winthrop Management, alleging Winthrop Management was in default under its obligations set forth in the security agreement, and sought to have a receiver appointed to control Winthrop Management's management of the properties. On March 15, 1996, the Registrant terminated Winthrop Management as the managing agent for its properties effective March 18, 1996, and appointed an unaffiliated managing agent to assume management of the properties. On March 20, 1996, the court appointed a receiver to assume the rights of Winthrop Management under the management agreements, including the right to pursue the Registrant for breach of contract. On March 21, 1996, the court stayed its own order appointing the receiver pending a motion to dismiss for lack of jurisdiction. The Managing General Partner believes that any claim, if brought by the receiver, is without merit, and will vigorously defend any action.\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 Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters.\nThe Registrant is a partnership and thus has no common stock. There is currently no established public market in which the Units are traded, nor is it anticipated that a public market will develop. Trading in the Units is sporadic and occurs solely through private transactions.\nAs of March 15, 1996 there were 2,656 holders of Units.\nNo cash distributions were made to the holders of Units during the years ended December 31, 1994 and 1993. Cash distributions to holders of Units amounted to approximately $300,000 in the aggregate, or $6.00 per Unit through December 1995. An additional cash distribution of $150,000, or $3.00 per Unit, was made in January 1996. See \"Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations,\" for information relating to the Registrant's future distributions.\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.\n(1) The 1992 numbers in this year's financial statements have been revised from prior years' presentation to provide a more consistent presentation from year to year. Specifically, bad debt and rental concessions are now reflected as an offset to revenue rather than as an expense. There was no effect on 1991.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Registrant receives rental income from its properties and is responsible for operating expenses, administrative expenses, capital improvements and debt service payments. The Registrant's properties are leased to tenants who are subject to leases of up to one year.\nDuring the year ended December 31, 1995, rental revenue and other income from the properties, along with interest income from the Registrant's short-term investments, was sufficient to cover: (i) all operating expenses and debt service of the properties and all administrative expenses of the Registrant; as well as (ii) all capital improvements made to the properties during 1995. As of December 31, 1995 the Registrant's unrestricted cash balance had increased to $575,510 from $248,928 at the end of 1994.\nThe Registrant budgeted approximately $1.5 to $2.0 million to be spent on capital improvements between 1992 and 1995. In that time period, approximately $1,885,000 has been spent on capital improvements, of which approximately $571,000 was expended in 1995. A considerable amount of capital work was performed at each property during 1995. At Season's Chase, capital improvements consisted of landscaping, balcony repairs, kitchen upgrades including new appliances and renovation of the club house. A fire occurred at Season's Chase, damaging the rental office and 16 apartment units. Restoration of the office and apartment units is nearly complete with the majority of the costs associated with the restoration and lost revenue to be covered by the property's insurance. At Sterlingwood, 1995 improvements consisted mainly of roof replacements. Capital improvements completed at Pelham Ridge and Forestbrook in 1995 included exterior repairs and painting and roof replacement. Forestbrook also underwent paving repairs in 1995. While the renovation program has been substantially completed (with the exception of Forestbrook), additional capital improvements have been identified, along with recurring capital improvements, which will be performed in 1996. Implementation of Forestbrook's capital improvement program was delayed because management did not believe the improvements would sufficiently impact revenue due to a weak local economy. Since the local economy has\nimproved, improvements have begun at the property. In 1996, the Registrant plans to spend an additional $750,000 on capital improvements, which would include additional exterior painting and repairs at Forestbrook, exterior painting and repairs at Sterlingwood, balcony and exterior siding repairs at Seasons Chase, and paving repairs and carpet and appliance replacement at all four properties.\nIt is expected that future rental revenue and other income from the Registrant's properties will continue to be sufficient to cover all administrative expenses of the Registrant and all operating expenses and debt service of the properties, as well as the capital improvement program described on pages 14-18 in the 1991 Solicitation of Consents, which description is incorporated herein by reference. As a result of the Registrant's improved operating results, the Registrant resumed making cash distributions to limited partners in April 1995. The cash distributions amounted to approximately $300,000 in the aggregate, or $6.00 per investment Unit through December 31, 1995. The Registrant intends to continue to limit cash distributions to fund the capital improvement program. However, the performance of the Registrant's properties and its distribution policy will continue to be reviewed on a quarterly basis.\nIn addition, the ability of the Registrant's properties to improve operations may affect the liquidity of the Registrant. Inflation and changing economic conditions in the future could affect vacancy levels, rental payment defaults and operating expenses of the Registrant's properties, and thus, could affect the Registrant's revenue, net income and liquidity.\nAs of December 31, 1995 the Registrant has $575,510 in unrestricted cash. The Registrant has invested, and expects to continue to invest, such amounts in money market instruments until required for partnership purposes. In addition, the Registrant has replacement reserves of $460,161 held by the mortgage lenders for Forestbrook and Sterlingwood Apartments. These funds are restricted under the terms of the mortgage loans for those two properties. The Registrant's total cash balance, both restricted and unrestricted, as of December 31, 1995, was therefore $1,035,671, which is expected to be sufficient to satisfy working capital requirements set forth in the Registrant's partnership agreement. The Registrant's partnership\nagreement requires the Registrant to retain reserves in an amount equal to at least 1% of capital contributions of unit holders.\nResults of Operations\n1995 Compared to 1994: The Registrant's total revenue increased by 8.9% in 1995 to $4,208,409 from $3,863,083 in 1994, due primarily to an 8.9% increase in rental income to $3,958,054. Revenue increased at all four of the Registrant's properties, reflecting continued stabilization of the local apartment markets and the positive effects of the capital improvement programs. Average rental rates and occupancy were stable or higher at all properties. Overall, average rents for the Registrant's properties increased by 4.2%, to $444 in 1995 from $426 in 1994 and average occupancy increased to 94.0% in 1995 from 91.2% in 1994. The most significant increase in revenue occurred at Forestbrook, where average rents increased to $472 in 1995 from $453 in 1994 and average occupancy rose to 93.4% in 1995 from 87.3% in 1994.\nThe Registrant's operating expenses decreased by 4.1% in 1995, to $2,170,951 in 1995 from $2,264,757 in 1994, due primarily to a decrease in repairs and maintenance expense as well as leasing expenses. Other expenses of the Registrant (including depreciation and amortization expense, interest expenses and partnership administrative expenses) increased 7.8% in 1995 to $1,769,780 from $1,641,445 in 1994 due to a 19.6% increase depreciation expense, reflecting the Registrant's on-going investment in capital improvements. The Registrant's interest expense remained relatively constant from 1994 to 1995.\n1994 Compared to 1993: The Registrant's total revenue increased by 11.3% in 1994 compared to 1993, primarily due to a 12.0% increase in rental income to $3,633,607. Revenue at all four of the Registrant's properties increased reflecting the stabilization of the local apartment markets and the effects of the Registrant's renovation programs. Average rental rates and occupancies were higher at each property. Overall, average rents for the Registrant's properties increased by 2.4%, from $416 to $426, and average occupancy increased from 84.9% in 1993 to 91.2%. The most notable improvement occurred at Forestbrook, where average rents increased from $445 per apartment unit to $453, and average occupancy improved from 77.5% in 1993 to 87.3% in 1994. Interest and other income (including revenues from laundry, vending, late fees and corporate units) increased by 1.3% to $229,476.\nThe Registrant's expenses declined significantly (by 36.9%) in 1994 as a result of the investment property writedown taken in 1993. Excluding the writedown, the Registrant's expenses were 3.3% lower in 1994. Direct operating expenses increased by 4.3% to $2,264,757 as a result of a further increase in repair and maintenance costs as well as an increase in utilities and insurance. The Registrant's interest expense remained relatively constant, while depreciation and amortization expense declined by 24.3%, reflecting the writedown of the Registrant's assets taken in 1993.\nAs a result of higher income and lower expenses, the Registrant's net loss decreased significantly to $43,119.\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 is effective for financial statements issued for fiscal years beginning after December 15, 1995, with earlier application permitted. SFAS No. 21 addresses the intangibles to be held and used by an entity to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Registrant's will adopt SFAS No. 121 on January 1, 1996, as required. Adopting SFAS No. 121 is not expected to have a significant effect on the Registrant's consolidated financial statements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee the Financial Statements of the Partnership, listed in the Index on page 28, included as part of the Annual Report on Form 10-K.\nFINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT\nSOUTHEASTERN INCOME PROPERTIES LIMITED PARTNERSHIP\nFor the years ended December 31, 1995, 1994 and 1993\nINDEPENDENT AUDITORS' REPORTS\nFINANCIAL STATEMENTS\nBALANCE SHEETS\nSTATEMENTS OF OPERATIONS\nSTATEMENTS OF PARTNERS' CAPITAL\nSTATEMENTS OF CASH FLOWS\nNOTES TO FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS REPORT\nTo the Partners and Unit Holders of Southeastern Income Properties Limited Partnership\nWe have audited the accompanying balance sheets of Southeastern Income Properties Limited Partnership as of December 31, 1995 and 1994, and the related statements of operations, partners' capital, and cash flows for the years then ended. These financial statements are the responsibility of the partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Southeastern Income Properties Limited Partnership for the year ended December 31, 1993 were audited by other auditors whose report, dated February 4, 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 financial statements referred to above present fairly, in all material respects, the financial position of Southeastern Income Properties Limited Partnership 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.\n\/s\/ REZNICK FEDDER & SILVERMAN\nBethesda, Maryland January 19, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners and Unit Holders of Southeastern Income Properties Limited Partnership:\nWe have audited the statements of operations and cash flows for the year ended December 31, 1993 Southeastern Income Properties Limited Partnership (the \"Partnership\"). 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 audits provide 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 the Partnership for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\n\/s\/ COOPERS & LYBRAND L. L. P.\nBoston, Massachusetts February 4, 1994\nSoutheastern Income Properties Limited Partnership\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nLIABILITIES AND PARTNERS' CAPITAL\nSee notes to Financial Statements.\nSoutheastern Income Properties Limited Partnership\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\nSee notes to Financial Statements.\nSoutheastern Income Properties Limited Partnership\nSTATEMENTS OF PARTNERS' CAPITAL\nYears ended December 31, 1995, 1994, and 1993\nSee notes to Financial Statements.\nSoutheastern Income Properties Limited Partnership\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\nSee notes to Financial Statements.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nSoutheastern Income Properties Limited Partnership (the \"Partnership\") is a Virginia limited partnership formed in November 1985 for the purpose of acquiring, managing and ultimately selling existing apartment communities. At that time, K-A Southeastern Income Properties Limited Partnership (\"K-A SIP\") was the general partner. Glade M. Knight is the principal general partner of K-A SIP. Knight Austin Corporation (\"Knight Austin\"), a management firm controlled by Knight, served as the management agent for the Partnership's properties until August 1, 1991.\nThe Partnership Agreement provided for a public offering of up to 50,000 assignee units of limited partnership interest (\"Units\") at $500 per unit. Purchasers of Units (\"Unit Holders\") are assignees of the Limited Partner and are entitled to all the rights and economic benefits of a limited partner. During 1987, the Partnership sold all 50,000 Units.\nIn contemplation of this public offering, the Partnership acquired two apartment communities - Sterlingwood in Roanoke, Virginia in November 1985; and Forestbrook in Charlotte, North Carolina in August 1986- with borrowed funds. The Partnership used a portion of the proceeds of the public offering to repay all the mortgages payable related to Sterlingwood and Forestbrook and to pay for a portion of the cost of acquiring Seasons Chase in Greensboro, North Carolina and Pelham Ridge in Greenville, South Carolina (See Note B).\nThe Partnership Agreement provided that upon\/and after the initial closing of the public offering both taxable loss and taxable income would be allocated 15% to K-A SIP and 85% to the Unit Holders. Further, K-A SIP would be allocated 1% of the distributable cash from operations until the Unit Holders had received a noncompounded, noncumulative annual cash return equal to 10% of their capital contribution, as adjusted for certain capital transactions, and 15% of the distributable cash from operations thereafter. However, distributions to K-A SIP through any date could not exceed 10% of the total amount of cash distributed through such date.\nUpon liquidation of the Partnership, after payment of, or adequate provision for, the debts and obligations of the Partnership, the remaining assets of the Partnership would be distributed to all partners and Unit Holders with positive capital accounts in the proportion that the positive balance in each partner's or Unit Holder's capital account bore to the aggregate of such positive balances, after taking into account all capital account adjustments for the Partnership's taxable year during which such liquidation occurred.\nIn early 1992, the Unit Holders approved certain changes in (and amendments to) the Partnership Agreement, which converted K-A SIP to a special limited partner and admitted Winthrop Southeast Limited Partnership (\"WSLP\") as the sole general partner, effective February 12, 1992. K-A SIP retained its current capital account and adjusted capital contribution upon its conversion to special limited partner status. Under the revised Partnership Agreement, taxable income and loss was to be allocated 85% to Unit Holders, 14% to K-A SIP and 1% to WSLP. Federal tax regulations, however, limit allocations of net losses due to considerations as provided in Internal Revenue Section 704(b). As a result, the Partnership's 1993 federal tax return reflect a reallocation of losses only to the limited partners and WSLP. The revised Partnership Agreement also provides for K-A SIP and WSLP to receive .99% and .01%, respectively, of distributable cash from operations for the five-year period commencing February 12, 1992 and .88% and .12%, respectively, thereafter, until the Unit Holders have received their preferred return. After the Unit Holders have received a noncompounded, noncumulative annual cost return on their capital contributions, as adjusted for certain capital transactions, K-A SIP and WSLP will receive 14% and 1%, respectively, of distributable cash from operations for the five-year period commencing February 12, 1992 and 12.32% and 2.68%, respectively, thereafter. Winthrop Management (Winthrop), an affiliate of WSLP, has served as the management agent for the properties since August 1, 1991.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nInvestment in Rental Property\nThe investment in rental property is recorded at cost, not in excess of net realizable value, which includes acquisition fees paid to Knight Austin. Depreciation is determined by the straight-line method over the estimated useful lives of the various assets. Estimated useful lives are 30 years for buildings and building improvements and 5 years for personal property.\nLoan Costs\nLoan costs of $304,147, which were incurred in connection with obtaining financing on Forestbrook and Sterlingwood, are being amortized over 84 months.\nReplacement Reserves\nReplacement Reserves (included in other assets) are comprised of Partnership funds held by the Partnership's mortgage lenders, the use of which are limited to specific capital or other costs, which are included in other assets and total $460,161 in 1995, and $386,432 in 1994. The Partnership Agreement requires the General Partner to maintain cash and reserves in an amount equal to at least 1% of the capital contributions of the Unit Holders.\nRental Income\nRental income is recognized as rents become due. Rental payments received in advance are deferred until earned. All leases between the partnership and the tenants of the property are operating leases.\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.\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.\nNet Loss Allocated to Each Unit\nNet loss allocable to each Limited Partner's Unit is computed using the weighted average number of units outstanding in each year.\nReclassification of Certain Revenue and Expenses\nCertain revenue and expenses in the 1993 Statement of Operations were reclassified to conform to the presentation in 1995 and 1994.\nCash Equivalents\nFor purposes of the statement of cash flows, the partnership considers all highly liquid investments consisting of a money market fund to be cash equivalents. The carrying amount as of December 31, 1995 of $465,697 approximates fair value because of the short maturity of this instrument.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nRecent Accounting Statements Not Yet Adopted\nIn March, 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Live Assets and for Long-Lived Assets to be Disposed Of.\" SFAS No. 121 is effective for financial statements issued for fiscal years beginning after December 15, 1995, with earlier application permitted. SFAS No. 121 addresses the accounting for long-lived assets and certain identifiable intangibles to be held and used by an entity to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The partnership will adopt SFAS No. 121 on January 1, 1996, as required. Adopting SFAS No. 121 is not expected to have a significant effect on the partnership's financial statements.\nNOTE B - INVESTMENT IN RENTAL PROPERTY\nOn November 27, 1985, the Partnership acquired Sterlingwood, a 162-unit apartment complex in Roanoke, Virginia. The total cost of the acquisition was $4,227,000. The Partnership financed the acquisition and used a portion of the proceeds from the public offering of the Units to repay the outstanding debt.\nOn August 28, 1986, the Partnership acquired Forestbrook, a 262-unit apartment complex in Charlotte, North Carolina. The total cost of the acquisition was $5,894,000. The Partnership financed the acquisition and used a portion of the proceeds from the public offering of the Units to extinguish the outstanding debt.\nOn August 18, 1987, the Partnership acquired Seasons Chase, a 225-unit apartment complex in Greensboro, North Carolina. The total cost of the acquisition of $4,650,000, which included a rental guarantee agreement of $200,000, which was funded by a portion of the proceeds from the public offering of the Units.\nOn August 22, 1988, the Partnership acquired Pelham Ridge, a 184-unit apartment complex in Greenville, South Carolina. The total cost of the property of $4,100,000, which included a rental guarantee agreement of $100,000, which was funded by a portion of the proceeds from the public offering of the Units.\nNOTE C - MORTGAGES PAYABLE\nDuring 1989, the partnership financed Forestbrook by obtaining a $5,726,600 mortgage. The existing mortgage with a balance of $5,564,046 at December 31, 1995 and $5,598,280 at December 31, 1994 is collateralized by the apartment community in Charlotte, North Carolina and is payable in monthly installments totalling $47,050 of principal and interest at 9.50% per annum through January 1, 1997. The unpaid principal balance and interest is due and payable in full on January 1, 1997. Prepayment during the initial five years of the loan term carries a penalty based upon the yield rate on a 7.75% U.S. Treasury security due February, 1995. Prepayment after five years carries a penalty of 1% of the outstanding loan balance.\nDuring 1990, the partnership financed Sterlingwood by obtaining a $2,570,900 mortgage. The existing mortgage with a balance of $2,505,688 at December 31, 1995 and $2,519,947 at December 31, 1994 is collateralized by the apartment community in Roanoke, Virginia and is payable in monthly installments totalling $21,611 of principal and interest at 9.75% per annum through April 1, 1997. The unpaid principal balance, in the amount of $8,012,216, and interest is due and payable in full on April 1, 1997. Prepayment during the initial five years of the loan term carries a penalty based upon the yield rate on a 7.75% U.S. Treasury Security due February 1995. Prepayment after five years carries a penalty of 1% of the outstanding loan balance.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE C - MORTGAGES PAYABLE (Continued)\nBased on the interest rates of loans with similar maturities currently available to the partnership, the estimated fair value of the mortgages payable is $8,228,482.\nThe liability of the partnership under the mortgages is limited to the underlying value of the real estate collateral, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage notes payable for the years following December 31, 1995 are as follows:\n1996 $ 53,345 1997 8,016,389\nNOTE D - RELATED-PARTY TRANSACTIONS\nThe Partnership has incurred management fees, accounting fees and investor servicing fees resulting from transactions with WSLP and Winthrop Management. The investor servicing fees for 1993, 1994 and part of 1995 were paid to First Winthrop Corporation.\nAfter the approval of the amendments to the Partnership Agreement (see Note A), the Partnership entered into new management agreements with Winthrop which provide for a management fee of 5% of gross revenues, as defined. The accounting fees are included in general and administrative expenses and investor servicing fees are included in management fees on the Statements of Operations.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE E - INCOME TAXES AND PARTNERS' CAPITAL\nThe following is a reconciliation of the net loss and partners' capital for financial statement purposes with the net loss and partners' capital for income tax purposes:\nNOTE F - INVESTMENT PROPERTY WRITEDOWN\nAnnually, management of the Partnership reviews the carrying value of properties in order to determine if an impairment to the asset value has occurred. Properties are then written down to management's estimate of net realizable value if necessary. For the year ended December 31, 1993, a provision for investment property writedown of $1,350,000 for Seasons Chase and $800,000 for Pelham Ridge was recorded. The reserve is reflected as a component of accumulated depreciation in the accompanying balance sheets.\nNOTE G - CONCENTRATION OF CREDIT RISK\nAt December 31, 1995, the partnership has cash in the amount of $460,161 held by the mortgage lenders. The account is insured by the Federal Deposit Insurance Corporation up to $100,000. The uninsured portion of this balance at December 31, 1995 is $360,161.\nSoutheastern Income Properties Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nSCHEDULE\nINVESTMENT IN RENTAL PROPERTY\n(1) Depreciation of buildings for federal income tax purposes is determined over the following useful lives: Sterlingwood - 19 years; Forestbrook - 19 years; Seasons Chase - 27.5 years; and Pelham Ridge - 27.5 years.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nEffective November 21, 1994, the Registrant dismissed its former independent auditors, Coopers & Lybrand, for economic reasons and retained as its new independent auditors, Reznick, Fedder & Silverman. The Independent Auditor's Report for the calendar year ended 1993 did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change independent auditors was approved by the Registrant's Managing General Partner. During the calendar year 1993 and through November 21, 1994, there were no disagreements between the Registrant and the former accountants 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 disagreements in connection with its reports.\nEffective November 21, 1994, the Registrant engaged Reznick, Fedder & Silverman as its independent auditors. The Registrant did not consult Reznick, Fedder & Silverman regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K prior to November 21, 1994.\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 Registrant has no officers or directors. The Managing General Partner manages and controls substantially all of the Registrant's affairs and has general responsibility and ultimate authority in all matters affecting its business. As of March 1, 1996, the names of the directors and executive officers of Eight Winthrop, the general partner of the Managing General Partner, and the position held by each of them, are as follows:\nHas served as a Director and\/or Officer of the Managing Name Positions Held General Partner since\nMichael L. Ashner Chief Executive January 1996 Officer and Director\nRonald Kravit Director July 1995\nW. Edward Scheetz Director July 1995\nRichard J. McCready Chief Operating July 1995 Officer and President\nJeffrey Furber Executive Vice January 1996 President and Clerk\nAnthony R. Page Chief Financial August 1995 Officer, Vice President and Treasurer\nPeter Braverman Senior Vice January 1996 President\nEach director and officer of Eight Winthrop will hold office until the next annual meeting of the stockholders of Eight Winthrop and until his successor is elected and qualified.\n(c) Identification of Certain Significant Employees. None.\n(d) Family Relationships. None.\n(e) Business Experience. Eight Winthrop was incorporated in Delaware in August 1991. The background and experience of the executive officers and directors of Eight Winthrop, described above in Items 10(a) and (b), are as follows:\nMichael L. Ashner, age 44, has been the Chief Executive Officer of Winthrop Financial Associates, A Limited Partnership (\"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.\nW. Edward Scheetz, age 31, has been a Director of WFA since July 1995. Mr. Scheetz was a director of NPI from October 1994 until January 1996. Since May 1993, Mr. Scheetz has been a limited partner of Apollo Real Estate Advisors, L.P. (\"Apollo\"), the managing general partner of Apollo Real Estate Investment Fund, L.P., a private investment fund. Mr. Scheetz has also served as a Director of Roland International, Inc., a real estate investment company since January 1994, and as a Director of Capital Apartment Properties, Inc., a multi-family residential real estate investment trust, since January 1994. From 1989 to May 1993, Mr. Scheetz was a principal of Trammel Crow Ventures, a national real estate investment firm.\nRonald Kravit, age 39, has been a Director of WFA since July 1995. Mr. Kravit has been associated with Apollo since August 1995. From October 1993 to August 1995, Mr. Kravit was a Senior Vice President with G. Soros Realty Advisors\/Reichman International. Mr. Kravit was a Vice President and Chief Financial Officer of MAXXAM Property Company from July 1991 to October 1993.\nRichard J. McCready, age 37, is the 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 June 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.\nOne or more of the above persons are also directors or 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;\nSixty-Six Associates Limited Partnership; Springhill Lake Investors Limited Partnership; Twelve AMH Associates Limited Partnership; Winthrop California Investors Limited Partnership; Winthrop Growth Investors I Limited Partnership; Winthrop Interim Partners I, A Limited Partnership; Winthrop Financial Associates, A Limited Partnership; Southeastern Income Properties II Limited Partnership; Winthrop Miami Associates Limited Partnership and Winthrop Apartment Investors Limited Partnership.\n(f) Involvement in Certain Legal Proceedings. None.\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 Eight Winthrop. Eight Winthrop does not presently pay any compensation to any of its officers and directors (See \"Item 13, Certain Relationships and Related Transactions\").\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 Registrant to be the beneficial owner of more than 5% of the outstanding Units as of March 15, 1996. Under the Registrant's 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.\n(b) Security Ownership of Management.\nAs of March 15, 1996, no officers, directors or partners of WFA, WSLP or Eight Winthrop own any Units of the Registrant.\n(c) Changes in Control.\nAs of March 15, 1996, there exists no arrangement known to the Registrant the operation of which may at a subsequent date result in a change in control of the Registrant, other than the following:\nIn connection with the withdrawal of the Original General Partner and the substitution of WSLP as the Managing General Partner, WSLP entered into certain loan arrangements with ISB, including the pledge of its general partnership interest. (See the 1991 Solicitation of Consents which is hereby incorporated by reference, and \"Item 3, Legal Proceedings.\") In the event the RTC Loan Trust, successor in interest to ISB, was successful in enforcing its remedies under the security agreement, the RTC Loan Trust may claim an interest in the general partnership interest of the Registrant. WSLP disputes the validity of the security interest, and would vigorously defend any action, and raise, among other meritorious defenses, the fact that the transfer of the general partnership interest requires the consent of a majority of Unit holders.\nIn 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, among other things, the partnership interests in W.L. Realty acquired by Londonderry II and the W.L. Realty partnership interest in Linnaeus. Accordingly, if Londonderry II does not satisfy its obligations under the Purchase Money Note, NACC would have the right to foreclose upon this security and, as a result, would gain control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nUnder the Registrant's partnership agreement, the Managing 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 Registrant.\nThe following tables sets forth the amounts of the fees, commissions and cash distributions which the Registrant paid to or accrued for the account of the Managing General Partner and its affiliates for the years ended December 31, 1995, 1994 and 1993:\n- ---------------\n(1) Equal to .01% of cash flow distributed to all partners of the Registrant. (2) Equal to 5.0% of gross collected revenues of the Registrant's properties. (3) Equal to 1.0% of gross collected revenues of the Registrant's properties. (4) Equal to $2.50 per apartment unit per month.\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. Exhibits - The 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 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.\nSOUTHEASTERN INCOME PROPERTIES LIMITED PARTNERSHIP\nBy: Winthrop Southeastern Limited Partnership, Its General Partner\nBy: Eight Winthrop Properties, Inc., Its General Partner\nBy: \/s\/ Michael L. Ashner Michael L. Ashner 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 the Registrant and in the capacities and on the dates indicated.\nSignature\/Name Title Date\n\/s\/ Michael L. Ashner Chief Executive March 29, 1996 - --------------------- Michael L. Ashner Officer and Director\n\/s\/ Ronald Kravit Director March 29, 1996 Ronald Kravit\n\/s\/ Anthony R. Page Chief Financial Officer March 29, 1996 Anthony R. Page\nIndex to Exhibits\nExhibit Number Document\n2.1 Agreement and Addendum to Agreement by and among Glade M. Knight (\"Knight\"), Ben T. Austin, II (\"Austin\"), Winthrop Southeast Limited Partnership (\"WSLP\") and Investors Savings Bank, F.S.B. (\"ISB\") (the \"Agreement\") dated as of August 8, 1991 and effective as of August 16, 1991. [The exhibits to the Agreement have been omitted from the Agreement and are listed in the Agreement.] (Exhibit 2.1)(8)\n2.2 Supplemental Agreement by and among WSLP, Knight and ISB (the \"Knight Agreement\") dated as of August 8, 1991 and effective as of August 16, 1991. [The exhibits to the Knight Agreement have been omitted from the Knight Agreement and are listed in the Knight Agreement.] (Exhibit 2.2)(8)\n2.3 Supplemental Agreement and Addendum to Supplemental Agreement by and among WSLP, Austin and ISB dated as of August 8, 1991 and effective as of August 16, 1991. (Exhibit 2.3)(8)\n2.4 Employment Agreement by and between WSLP and Austin dated as of August 8, 1991 and effective as of August 16, 1991. (Exhibit 2.4)(8)\n2.5 Supplemental Agreement by and between WSLP and ISB dated as of August 8, 1991 and effective as of August 16, 1991. (Exhibit 2.5)(8)\n3.1 Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership. (Exhibit 4.1)(1)\n3.2 First Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of February 17, 1987. (Exhibit 4.2)(1)\n3.3 Second Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of March 16, 1987. (Exhibit 4.3)(1)\n3.4 Third Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of April 30, 1987. (Exhibit 4.4)(1)\n3.5 Fourth Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of May 28, 1987. (Exhibit 4.1)(2)\n3.6 Fifth Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of June 29, 1987. (Exhibit 4.2)(2)\n3.7 Sixth Amendment to Amended and Restated Certificate and Agreement of Limited Partnership of Southeastern Income Properties Limited Partnership dated as of February 12, 1992. (Exhibit 3.7)(9)\n3.8 Articles of Incorporation of SIP Assignor Corporation. (Exhibit 3.6)(3)\n3.9 Bylaws of SIP Assignor Corporation. (Exhibit 3.7)(3)\n10.1 Apartment Management Agreement (for the Sterlingwood Apartments). (Exhibit 28.1)(1)\n10.2 Apartment Management Agreement (for the Forestbrook Apartments). (Exhibit 28.2)(1)\n10.3 Apartment Management Agreement (for the Seasons Chase Apartments). (Exhibit 10.5)(4)\n10.4 Apartment Management Agreement (for the Pelham Ridge Apartments). (Exhibit 10.4)(5)\n10.5 Apartment Management Agreement, dated February 12, 1992 between the Registrant and Winthrop Management (for Pelham Ridge Apartments). (Exhibit 10.5) (9)\n10.6 Apartment Management Agreement, dated February 12, 1992 between the Registrant and Winthrop Management (for Forestbrook Apartments). (Exhibit 10.6)(9)\n10.7 Apartment Management Agreement, dated February 12, 1992 between the Registrant and Winthrop Management (for Seasons Chase Apartments). (Exhibit 10.7) (9)\n10.8 Apartment Management Agreement, dated February 12, 1992 between the Registrant and Winthrop Management (for Sterlingwood Apartments). (Exhibit 10.8) (9)\n10.9 Property Acquisition Agreement between Southeastern Income Properties Limited Partnership and Knight Austin Corporation. (Exhibit 28.3)(1)\n10.10 Real Estate Consulting Agreement between Southeastern Income Properties Limited Partnership and WFS Realty Corporation. (Exhibit 28.4)(1)\n10.11 Rent Guarantee and Escrow Agreement for the Seasons Chase Apartments. (Exhibit 29.2)(6)\n10.12 Novation to Rent Guarantee and Escrow Agreement for the Seasons Chase Apartments. (Exhibit 19.3)(6)\n10.13 Rent Guarantee Agreement for the Pelham Ridge Apartments. (Exhibit 10.3)(5)\n10.14 Repair Supervisory Contract. (Exhibit 10.10)(7)\n10.15 Supervisory Insurance Adjustment Contract. (Exhibit 10.11)(7)\n10.16 Mortgage Brokerage and Consulting Agreement. (Exhibit 10.12)(7) - ------------------------\n(1) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's quarterly report on Form 10-Q for the quarter ended March 30, 1987.\n(2) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's quarterly report on Form 10-Q for the quarter ended June 30, 1987.\n(3) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's registration statement on Form S-11 (Registration No. 33- 9085).\n(4) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's current report on Form 8-K dated September 2, 1987.\n(5) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's current report on Form 8-K dated September 6, 1988.\n(6) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 1987.\n(7) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's 1989 Annual Report.\n(8) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's current report on Form 8-K on September 3, 1991.\n(9) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's annual report on Form 10-K for the year ended December 31, 1991.\n(10) Incorporated by reference to the exhibit shown in parentheses filed with the Commission in the Registrant's annual report on Form 10-K for the year ended December 31, 1992.","section_15":""}
{"filename":"5016_1995.txt","cik":"5016","year":"1995","section_1":"ITEM 1\nBusiness\nIntroduction\nAmerican Financial Corporation (\"AFC\") was incorporated as an Ohio Corporation in 1955. Its address is One East Fourth Street, Cincinnati, Ohio, 45202; its phone number is (513) 579-2121. At December 31, 1995, American Financial Group, Inc. (\"AFG\") owned all of the outstanding Common Stock of AFC (See \"Mergers\" below).\nAFC is a holding company operating through wholly-owned and majority-owned subsidiaries and other companies in which it holds significant minority ownership interests. These companies operate in a variety of financial businesses, including property and casualty insurance, annuities, and portfolio investing. In non-financial areas, these companies have substantial operations in the food products industry and radio and television station operations.\nMergers\nOn April 3, 1995, AFC merged with a newly formed subsidiary of American Premier Group, Inc., a new company formed to own 100% of the common stock of both AFC and American Premier Underwriters, Inc. (\"American Premier\"). Subsequently, American Premier Group changed its name to American Financial Group, Inc. to reflect its core property and casualty insurance and annuity businesses. In the transaction, Carl H. Lindner and members of his family, who owned 100% of the Common Stock of AFC, exchanged their AFC Common Stock for approximately 55% of AFG voting common stock. Former shareholders of American Premier, including AFC and its subsidiaries, received shares of AFG stock on a one-for- one basis. AFC receives dividends paid on AFG common stock; however, its shares generally will not be eligible to be voted as long as AFC is owned by AFG. No gain or loss was recorded on the exchange of shares.\nAFC continues to be a separate SEC reporting company with publicly traded debentures and preferred stock. Holders of AFC Series F and G Preferred Stock were granted voting rights equal to approximately 21% of the total voting power of AFC shareholders immediately prior to the Mergers.\nGeneral\nGenerally, companies have been included in AFC's consolidated financial statements when AFC's ownership of voting securities has exceeded 50%; for investments below that level but above 20%, AFC has accounted for the investments as investees. (See Note F to AFC's financial statements.) The following table shows AFC's percentage ownership of voting securities of its significant affiliates over the past several years:\nThe following summarizes the more significant changes in ownership percentages shown in the above table.\nAmerican Annuity Group On December 31, 1992, American Annuity purchased Great American Life Insurance Company (\"GALIC\") from Great American Insurance Company (\"GAI\"). In connection with the acquisition, GAI purchased 5.1 million shares of American Annuity's common stock pursuant to a cash tender offer and 17.1 million additional shares directly from American Annuity.\nAmerican Premier Underwriters In 1993, American Financial Enterprises, Inc. (\"AFEI\") sold 4.5 million shares of American Premier common stock in a secondary public offering. In April 1995, American Premier became a subsidiary of AFG as a result of the Mergers.\nChiquita Brands International In 1995, AFC sold 3.2 million shares of Chiquita common stock to American Premier.\nCiticasters In December 1993, Great American Communications Company (\"GACC\") completed a prepackaged plan of reorganization. In the restructuring, AFC's previous holdings of GACC stock and debt were exchanged for 20% of the new common stock. GACC changed its name to Citicasters to reflect the nature of its business. In June 1994, AFEI purchased approximately 10% of Citicasters common stock. In the second half of 1994, Citicasters repurchased and retired approximately 21% of its common stock.\nIn February 1996, Citicasters entered into a merger agreement with Jacor Communications, Inc. Under the agreement, each Citicasters shareholder, including AFC and its subsidiaries, will receive cash and warrants to purchase Jacor common stock. Consummation of the transaction is subject to regulatory approvals, and certain adjustments to the price will be made if the transaction does not close by September 30, 1996.\nGeneral Cable In 1992, American Premier distributed to its shareholders approximately 88% of the stock of General Cable, which was formed to own certain of American Premier's manufacturing businesses. AFC and its subsidiaries received approximately 45% of General Cable in the spin-off. In 1994, an unaffiliated company acquired all of the common stock of General Cable including AFC's and the 12% which had been retained by American Premier.\nThe following discussion concerning AFC's businesses is organized along the lines of the major company investments as shown in the table above. Reference to the table and to AFC's consolidated financial statements is recommended for a better understanding of this section and Item 6 - \"Selected Financial Data\".\nGreat American Insurance Group\nAFC's primary insurance business is multi-line property and casualty insurance, headed by GAI. Hereafter, GAI and its property and casualty insurance subsidiaries will be referred to collectively as \"Great American\". They employ approximately 3,900 persons.\nAccording to the most recent ranking published in \"Best's Review\", Great American was the 37th largest among all property and casualty insurance groups operating in the United States on the basis of total net premiums written in 1994. GAI is rated \"A\" (Excellent) by A.M. Best Company, Inc. This rating is given to companies that \"have a strong ability to meet their obligations to policyholders over a long period of time\".\nGreat American manages and operates its property and casualty business in two major business segments: Specialty Lines and Commercial and Personal Lines. Each segment 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 property and casualty insurance operations is to achieve underwriting profitability. Underwriting profitability is measured by the combined ratio which is a sum of the ratios 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.\nManagement's focus on underwriting performance has resulted in a statutory combined ratio averaging 102.9% for the period 1991 to 1995, as compared to 109.3% for the property and casualty industry over the same period (Source: \"Best's Review - Property\/Casualty\" January 1996 Edition). Management's philosophy is to refrain from writing business that is not expected to produce an underwriting profit even if it is necessary to limit premium growth to do so.\nFor 1995, net written premiums were $1.6 billion, compared to $1.5 billion in 1994. The increase in net written premiums was due to increases in specialty niche lines, workers' compensation and commercial umbrella insurance.\nThe following table shows (in millions) the performance of Great American in various categories. While financial data is reported on a statutory basis for insurance regulatory purposes, it is reported in accordance with generally accepted accounting principles (\"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.\nUnless indicated otherwise, the financial information presented for Great American is presented on a GAAP basis.\nThe following table presents certain information with respect to Great American's property and casualty insurance operations (dollars in millions).\n1995 1994 1993\nNet written premiums $1,600 $1,489 $1,288\nNet earned premiums $1,535 $1,387 $1,243 Loss and LAE 1,066 987 877 Underwriting expenses 461 424 407 Policyholder dividends(a) 13 8 2 Underwriting loss ($ 5) ($ 32) ($ 43)\nGAAP ratios: Loss and LAE ratio 69.4% 71.2% 70.6% Underwriting expense ratio 30.0 30.6 32.8 Policyholder dividend ratio .8 .6 .1 Combined ratio 100.2% 102.4% 103.5%\nStatutory ratios: Loss and LAE ratio 69.7% 72.2% 70.8% Underwriting expense ratio 29.7 30.8 33.1 Policyholder dividend ratio .3 .6 - Combined ratio 99.7% 103.6% 103.9%\nIndustry statutory combined ratio(b) 107.2% 108.5% 106.9%\n(a) Policyholder dividends may be treated as a reduction of earned premiums elsewhere in this document. (b) Ratios are derived from \"Best's Review - Property\/Casualty\" (January 1996 Edition).\nAs shown in the table above, Great American's underwriting results have been significantly better than the industry's. Great American's results reflect an emphasis on writing commercial lines coverages of specialized niche products where company personnel are experts in particular lines of business.\nGreat American operates in a highly competitive industry that is affected by many factors which can cause significant fluctuations in their results of operations. The property and casualty insurance industry has historically been subject to pricing cycles characterized by periods of intense competition and lower premium rates (a \"downcycle\") followed by periods of reduced competition, reduced underwriting capacity due to lower policyholders' surplus and higher premium rates (an \"upcycle\"). The property and casualty insurance industry is currently in an extended downcycle, which has lasted approximately eight years. Great American's underwriting results have been adversely affected by this downcycle, particularly in unfavorable pricing in certain standard commercial lines of business.\nAs with other property and casualty insurers, Great American's operating results can be adversely affected by unpredictable catastrophe losses. Certain natural disasters (hurricanes, torna does, floods, forest fires, etc.) and other incidents of major loss (explosions, civil disorder, fires, etc.) are classified as catastrophes by industry associations. Losses from these incidents are usually tracked separately from other business of insurers because of their sizable effects on overall operations. Great American generally seeks to reduce its exposure to such events through individual risk selection and the purchase of reinsurance. Major catastrophes in recent years included the Texas hailstorms in 1995; the Northridge, California earthquake and winter storms in 1994; flooding in the Midwest in 1993; Hurricanes Andrew and Iniki, Chicago flooding, and Los Angeles civil disorder in 1992 and Oakland fires in 1991. Total net losses to AFC's insurance operations from catastrophes were $48 million in 1995; $51 million in 1994; $26 million in 1993; $42 million in 1992; and $22 million in 1991. These amounts are included in the tables herein.\nSpecialty Lines\nGeneral. The Specialty Lines segment emphasizes the writing of specialized insurance coverage where Great American personnel are experts in particular lines of business or customer groups including workers' compensation, executive liability, ocean and inland marine, agricultural-related coverages (allied lines), non-profit liability, umbrella and excess and surplus lines. The Specialty Lines workers' compensation operations write coverage for statutorily prescribed benefits payable to employees who are injured on the job. The executive and professional liability divisions market liability coverage for lawyers and corporate directors and officers. Ocean and inland marine businesses provide such coverage as marine cargo, boat dealers, marina operators\/dealers, excursion vessels, builder's risk, contractor's equipment, excess property and transportation cargo. The agricultural-related businesses provide multi-peril crop\ninsurance covering all weather and disease perils as well as coverage for full-time operating farms\/ranches and agribusiness operations on a nationwide basis through independent agents who specialize in the rural market. The non-profit liability business provides property, general\/professional liability, automobile, trustee liability, umbrella and crime coverage for a wide range of non-profit organizations. These operations also provide excess and surplus commercial property and casualty insurance in a variety of industries.\nSpecialization is the key element to the underwriting success of these business units. Each unit has independent management with significant operating autonomy to oversee the important operational functions of its business such as underwriting, pricing, marketing, policy processing and claims service. These specialty lines are opportunistic and their premium volume will vary based on current market conditions. Great American continually evaluates new specialty markets.\nThe U.S. geographic distribution of the Specialty Lines statutory direct written premiums in 1995 compared to 1991, was as follows:\nState 1995 1991 State 1995 1991 Texas(a) 19.7% 6.1% Oklahoma 3.7% 11.7% California 13.8 19.6 New Jersey 2.9 3.4 Pennsylvania 6.4 3.9 Ohio 2.3 3.3 New York 5.8 7.6 Michigan 2.2 3.1 Massachusetts 4.7 3.1 Kentucky * 2.6 Florida 4.2 3.3 Other 30.5 27.6 Illinois 3.8 4.7 100.0% 100.0%\n______________ * less than 2%\n(a) Approximately half of the Texas business in 1995 was ceded to the NSA Group in American Premier.\nThe following table sets forth a distribution of statutory net written premiums for Great American's Specialty Lines by NAIC annual statement line for 1995 compared to 1991:\n1995 1991 Other liability 25.3% 27.2% Auto liability 15.3 16.4 Commercial multi-peril 10.6 5.4 Allied lines 10.5 7.6 Inland marine 9.9 10.4 Ocean marine 5.6 5.6 Auto physical damage 5.2 5.1 Workers' compensation 4.5 8.9 Surety 3.7 4.8 Fire 3.1 2.7 Other 6.3 5.9 100.0% 100.0%\nThe following table presents certain information with respect to Great American's Specialty Lines insurance operations (dollars in millions):\n1995 1994 1993\nNet written premiums $882 $801 $616\nNet earned premiums $836 $724 $574 Loss and LAE 568 528 392 Underwriting expenses 245 211 167 Policyholder dividends 2 - - Underwriting profit (loss) $ 21 ($ 15) $ 15\nGAAP ratios: Loss and LAE ratio 67.9% 72.9% 68.2% Underwriting expense ratio 29.4 29.2 29.1 Policyholder dividend ratio .2 - - Combined ratio 97.5% 102.1% 97.3%\nStatutory ratios: Loss and LAE ratio 68.1% 73.5% 68.7% Underwriting expense ratio 29.4 29.5 29.8 Policyholder dividend ratio .1 .2 (.1) Combined ratio 97.6% 103.2% 98.4%\nIndustry statutory combined ratio (a) 107.2% 108.5% 106.9%\n(a) Ratios are derived from \"Best's Review - Property\/Casualty\" (January 1996 Edition).\nMarketing. The Specialty Lines operations direct their sales efforts primarily toward independent property and casualty insurance agents and brokers. These businesses write insurance through more than 7,500 agents and have more than 250,000 policies in force.\nCompetition. Because of the specialty nature of these coverages, competition is based primarily on service to policyholders and agents, specific characteristics of products offered and reputation for claims handling. Price, commissions and profit sharing terms are also important factors. Competitors include individual insurers and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. Management believes that sophisticated data analysis for refinement of risk profiles, extensive specialized knowledge and loss prevention service have helped these businesses compete successfully.\nCommercial and Personal Lines\nGeneral. Major commercial lines of business are workers' compensation, commercial multi-peril, umbrella (including primary and excess layers) and general liability insurance. The workers' compensation business has experienced solid growth and profitability due to improved rate structures and favorable trends in medical care costs and the success of its Drug-Free Workplace program.\nGreat American's Drug-Free Workplace program for workers' compensation customers assists insureds in setting up drug testing programs (as permitted by law), drug and alcohol education programs and work safety programs. At December 31, 1995, there were more than 650 insureds in 16 states with such programs producing approximately $55 million in annual net written premiums.\nCommercial business is written in 25 states where management believes adequate rates can be obtained and where assigned risk costs are not excessive. Great American's approach focuses on specific customer groups, such as fine restaurants, light manufacturers, high rise living units, hotels\/motels and insureds with large umbrella coverages. The approach also emphasizes site visits at prospective customers to ensure underwriter familiarity with risk factors relating to each insured and to avoid those risks which have unacceptable frequency or severity exposures.\nPersonal lines of business consist primarily of standard private passenger auto and homeowners' insurance and are written in 38 states. Great American's approach is to develop tailored rates for its personal automobile customers based on a wide variety of factors, including make and model of the insured automobile and the driving record of the insureds. The approach to homeowners business is to limit writings in locations with catastrophic exposures such as windstorms, earthquakes and hurricanes.\nThe U.S. geographic distribution of the Commercial and Personal Lines statutory direct written premiums in 1995 compared to 1991, was as follows:\nState 1995 1991 State 1995 1991 Connecticut 14.1% 12.0% Florida 3.2% 2.8% New York 11.9 7.7 California 2.3 9.1 North Carolina 10.6 11.7 Massachusetts 2.2 2.6 New Jersey 9.7 7.6 Illinois 2.2 3.2 Pennsylvania 6.5 2.5 Washington * 2.7 Texas 5.0 * Oregon * 2.5 Michigan 4.0 3.5 Virginia * 2.3 Maryland 3.8 3.5 Minnesota * 2.1 Ohio 3.8 4.5 Other 20.7 19.7 100.0% 100.0% ______________ * less than 2%\nThe following table sets forth a distribution of statutory net written premiums for Great American's Commercial and Personal Lines by NAIC annual statement line for 1995 compared to 1991:\n1995 1991 Auto liability 28.8% 23.9% Workers' compensation 18.0 13.3 Commercial multi-peril 17.2 24.7 Auto physical damage 12.3 12.0 Homeowners 11.1 12.1 Other liability 7.3 9.1 Inland marine 1.7 1.8 Other 3.6 3.1 100.0% 100.0%\nThe following table presents certain information with respect to Great American's Commercial and Personal Lines insurance operations (dollars in millions):\n1995 1994 1993\nNet written premiums $717 $683 $666\nNet earned premiums $698 $656 $664 Loss and LAE 468 430 430 Underwriting expenses 214 211 238 Policyholder dividends 11 8 2 Underwriting profit (loss) $ 5 $ 7 ($ 6)\nGAAP ratios: Loss and LAE ratio 66.9% 65.5% 64.8% Underwriting expense ratio 30.6 32.2 35.9 Policyholder dividend ratio 1.6 1.2 .3 Combined ratio 99.1% 98.9% 101.0%\nStatutory ratios: Loss and LAE ratio 67.2% 67.0% 65.0% Underwriting expense ratio 29.9 32.4 36.0 Policyholder dividend ratio .6 1.0 - Combined ratio 97.7% 100.4% 101.0%\nIndustry statutory combined ratio (a) 107.2% 108.5% 106.9%\n(a) Ratios are derived from \"Best's Review - Property\/Casualty\" (January 1996 Edition).\nMarketing. The Commercial and Personal Lines business units direct their sales efforts primarily toward independent agents and brokers. These businesses write insurance through more than 4,000 agents and have more than 515,000 policies in force.\nCompetition. These businesses compete with other insurers, primarily on the basis of price (including differentiation on policy limits, coverages offered and deductibles), agent commissions and profit sharing terms. Customer service, loss prevention and reputation for claims handling are also important factors. Competitors include individual insurers and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. Management believes that sophisticated data analysis for refinement of risk profiles, disciplined underwriting practices and aggressive loss prevention procedures have enabled these businesses to compete successfully on the basis of price without negatively affecting underwriting profitability.\nReinsurance\nConsistent with standard practice of most insurance companies, Great American reinsures a portion of its business with other reinsurance companies and assumes a relatively small amount of business from other insurers. Ceding reinsurance permits diversification of risks and limits the maximum loss arising from large or unusually hazardous risks or catastrophic events. AFC's insurance companies enter into separate reinsurance programs due to their differing exposures. The availability and cost of reinsurance are subject to prevailing market conditions which may affect the volume and profitability of business that is written. Although reinsurance does not legally discharge the original insurer from primary liability, risks that are reinsured are, in practice, treated as though they were transferred to the reinsurers.\nReinsurance is provided on one of two bases: the facultative basis or the treaty basis. Facultative reinsurance is generally provided on a risk by risk basis. Individual risks are ceded and assumed based on an offer and acceptance of risk by each party to the transaction. Treaty reinsurance provides for risks to be automatically ceded and assumed according to contract provisions.\nGAI currently has treaty reinsurance programs which generally provide reinsurance coverage above specified retention maximums. For workers' compensation policies, the retention maximum is $1 million per loss occurrence with reinsurance coverage for the next $49 million. For all other casualty policies, the retention maximum is $5 million per loss occurrence with reinsurance coverage for the next $15 million. For property coverages, a property per risk excess of loss treaty is maintained with a retention maximum of $5 million per risk and reinsurance coverage for the next $25 million; for catastrophe coverage on property risks, the retention is $20 million with reinsurance covering 95% of the next $130 million in losses with an additional layer of reinsurance providing coverage for 76% of the next $50 million for the peril of wind only. Contracts relating to reinsurance are subject to periodic renegotiation.\nIncluded in the balance sheet caption \"recoverables from reinsurers and prepaid reinsurance premiums\" were $82 million on paid losses and LAE and $709 million on unpaid losses and LAE at December 31, 1995. The collectibility of a reinsurance balance is based upon the financial condition of a reinsurer as well as individual claim considerations. Market conditions over the past few years have forced many reinsurers into financial difficulties or liquidation proceedings. At December 31, 1995, Great American had an allowance of approximately $79 million for doubtful collection of reinsurance recoverables. Great American regularly monitors the financial strength of its reinsurers. This process periodically results in the transfer of risks to more financially secure reinsurers. Great American's major reinsurers include American Re-Insurance Company, Employers Reinsurance Corporation, NAC Reinsurance Corporation, Mitsui Marine and Fire Insurance Company, Ltd. and Taisho Marine & Fire Insurance Company. Management believes that this present group of reinsurers is financially sound.\nPremiums written for reinsurance ceded and assumed are presented in the following table (in millions):\n1995 1994 1993 Reinsurance ceded to: Non-affiliates $466 $402 $333 Affiliates 144 161 89 Reinsurance assumed - including involuntary pools and associations 75 83 61\nLoss and Loss Adjustment Expense Reserves\nThe consolidated financial statements include the estimated liability for unpaid losses and LAE of Great American. 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 Great American's results at the amounts reported by those entities.\nSee Note S to the Financial Statements for an analysis of changes in Great American'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 Great American's liability for losses and LAE, net of reinsurance, on a GAAP basis for the last ten years. 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 deficiency (redundancy) which represents the aggregate percentage increase (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 reserve liability.\nThis table does not present accident or policy year development data. Furthermore, in evaluating the re-estimated liability and cumulative deficiency (redundancy), it should be noted that each percentage includes the effects of changes in amounts for prior periods. For example, a deficiency (redundancy) related to losses settled in 1995, but incurred in 1985, would be included in the re-estimated liability and cumulative deficiency (redundancy) percentage for each of the years 1985 through 1994. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.\nThe adverse development in earlier years in the table above was caused partially by the effect of higher than projected inflation on medical, hospitalization, material, repair and replacement costs. Additionally, changes in the legal environment have influenced the development patterns over the past ten years. Two significant changes in the early to mid- 1980s were the trend towards an adverse litigious climate and the change from contributory to comparative negligence.\nThe adverse litigious climate is evidenced by an increase in lawsuits and damage awards, changes in judicial interpretation of legal liability and of the scope of policy coverage, and a lengthening of time it takes to settle cases. In addition, a trend has developed in the manner and timeliness of first claim notices. Historically, the first notification of claim came directly from the claimant; in recent years, however, there has been a gradual increase in the number of notifications in the form of direct legal action. Not only has this notification been less timely, it has been more adversarial in nature.\nThe change in rules of negligence governing tort claims has also influenced the loss development trend. During the early to mid-1980s, most states changed from contributory to comparative negligence rules. Under contributory negligence rules, a plaintiff seeking damages is barred from recovering damages for a loss if it can be demonstrated that the plaintiff's own negligence contributed in any way to the cause of the injury. Under comparative negligence rules, a plaintiff's negligence is no longer a bar to recovery. Instead, the degree of plaintiff's negligence is compared to the negligence of any other party. Generally, if the plaintiff's negligence is 50% or less of the cause of the injury, the plaintiff can recover damages, but in an amount reduced by the portion of damage attributable to the plaintiff's own negligence. Many claims which would have been successfully defended under contributory negligence rules now result in an award of damages or a settlement during suit under the comparative negligence rules.\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 $2,278\nAdditional discounting of GAAP reserves in excess of the statutory limitation for SAP reserves (21) Reinsurance recoverables 709\nLiability reported on a GAAP basis $2,966\nAsbestos and Environmental Reserves The insurance industry typically includes only claims relating to polluted waste sites and asbestos in defining environmental exposures. Great American extends this definition to include claims relating to breast implants, repetitive stress on keyboards, DES (a drug used in pregnancies years ago alleged to cause cancer and birth defects) and other latent injuries (\"A&E\").\nEstablishing reserves for A&E claims is subject to uncertainties that are greater than those presented by other types of claims. Factors contributing to those uncertainties include a lack of sufficiently detailed historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when a loss is deemed to have occurred, what policies provide coverage, what claims are covered, whether there is an insured obligation to defend, how policy limits are determined and other policy provisions. Management believes these issues are not likely to be resolved in the near future.\nPrior to the fourth quarter of 1994, Great American maintained reserves only on its reported A&E claims; reserves for claims incurred but not reported (\"IBNR\") were not allocated to A&E claims. Following completion of a detailed analysis in the fourth quarter, Great American allocated a specific portion of its IBNR reserves to A&E claims. Based on known facts, current law, and current industry practices, management believes that its reserves for such claims are appropriate.\nThe following table (in millions) is a progression of reserves for A&E exposures for which Great American has been held liable under general liability policies written years ago where environmental coverage was not intended and, in many cases, was specifically excluded.\nSince the mid-1980's, Great American has also written certain environmental coverages (asbestos abatement and underground storage tank liability) in which the premium charged is intended to provide coverage for the specific environmental exposures inherent in these policies. The business has been profitable since its inception. To date, approximately $174 million of premiums has been written and reserves for unpaid losses and LAE aggregated $48 million at December 31, 1995 (not included in the above table).\nInvestment Results\nThe following table, prepared on a GAAP basis, shows the performance of Great American's investment portfolio, excluding equity investments in affiliates (dollars in millions):\n___________________________________\nAmerican Annuity Group and Great American Life Insurance Company\nData in this section relating to the period following the sale of GALIC to American Annuity generally has been derived from American Annuity's 1995 Form 10-K.\nGeneral\nAmerican Annuity Group (\"AAG\") is a holding company whose primary asset is the capital stock of GALIC which it acquired from GAI on December 31, 1992. GALIC sells annuities primarily to employees of qualified not-for-profit organizations. GALIC is currently rated \"A\" (Excellent) by A.M. Best. AAG and its subsidiaries employ approximately 850 persons.\nThe following table (in millions) presents information concerning GALIC.\n1995 1994 1993 Statutory Accounting Principles Basis Total Assets $5,414 $5,057 $4,758 Insurance Reserves: Annuities $4,974 $4,655 $4,299 Life 22 21 22 Accident and Health - 1 1 $4,996 $4,677 $4,322\nCapital and Surplus $ 273 $ 256 $ 251 Asset Valuation Reserve (a) 90 80 70 Interest Maintenance Reserve (a) 32 28 36\nAnnuity Receipts: Flexible Premium: First Year $ 42 $ 39 $ 47 Renewal 196 208 223 238 247 270 Single Premium 219 196 130 Total Annuity Receipts $ 457 $ 443 $ 400\nGenerally Accepted Accounting Principles Basis Total Assets $5,631 $5,044 $4,883 Annuity Benefits Accumulated 4,917 4,596 4,257 Stockholder's Equity 645 449 520\n(a) Allocation of surplus.\nAnnuity Products\nAnnuities are long-term retirement savings plans that benefit from interest accruing on a tax-deferred basis. Employees of qualified not-for-profit organizations are eligible to save for retirement through contributions made on a before tax basis. Contributions are made at the discretion of the participants through payroll deductions or through tax-free \"rollovers\" of funds. Federal income taxes are not payable on contributions or earnings until amounts are withdrawn.\nGALIC's principal products are \"FPDAs\" and \"SPDAs\". FPDAs are characterized by premium payments that are flexible in amount and timing as determined by the policyholder. SPDAs are issued in exchange for a one-time lump-sum premium payment. Over the last five years, approximately three-fourths of GALIC's SPDA receipts have resulted from rollovers of tax-deferred funds previously maintained by policyholders with other insurers.\nAll annuity products issued by GALIC itself have been fixed rate annuities. With a fixed rate annuity, an interest crediting rate is initially set by the issuer, and thereafter changed from time to time by the issuer based on market conditions, subject to any guaranteed interest crediting rates in the policy. At December 31, 1995, approximately 95% of GALIC's annuity policyholder benefit reserves consisted of fixed rate annuities which offered a minimum interest rate guarantee of 4%. The balance of the liabilities had a minimum guaranteed rate of 3%. In determining the frequency and extent of changes in the crediting rate, GALIC takes into account the profitability of its annuity business and the relative competitive position of its products.\nA GALIC subsidiary began marketing variable annuities in the fourth quarter of 1995. With a variable annuity, the earnings credited to the policy varies based on the investment results of the underlying investment options chosen by the policyholder. Policyholders may also choose to direct all or a portion of their premiums to various fixed rate options. For these annuity products, all premiums directed to the variable options are placed in funds managed by third party investment advisers.\nGALIC seeks to maintain a desired spread between the yield on its investment portfolio and the rate it credits to its policies. GALIC accomplishes this by (i) offering crediting rates which it has the option to change, (ii) designing annuity products that encourage persistency and (iii) maintaining an appropriate matching of assets and liabilities. GALIC imposes certain surrender charges and front-end fees during the first five to ten years of a policy to discourage customers from surrendering or withdrawing funds in those early years. Partly due to these features, annuity surrender payments have averaged approximately 8% of related statutory reserves over the past five years. At December 31, 1995, GALIC had over 250,000 annuity policies in force, nearly all of which were individual contracts.\nMarketing\nGALIC markets its tax-deferred annuities principally to employees of educational institutions in the kindergarten through high school segment. GALIC's management believes that this market segment is attractive because of its size and growth potential, and the persistency rate it has demonstrated. In 1995, written premiums from this market segment represented approximately three-fourths of GALIC's total tax-qualified premiums.\nGALIC distributes its annuity products through over 80 managing general agents (\"MGAs\") who, in turn, direct approximately 1,000 actively producing independent agents. GALIC has developed its business on the basis of its relationships with MGAs and independent agents primarily through a consistent marketing approach and responsive service.\nGALIC is licensed to sell its products in all states (except New York) and in the District of Columbia. The following table reflects the geographical distribution of GALIC's annuity premiums in 1995 compared to 1991:\nSales of annuities are affected by many factors, including: (i) competitive rates and products; (ii) the general level of interest rates; (iii) the favorable tax treatment of annuities; (iv) commissions paid to agents; (v) services offered; (vi) ratings from independent insurance rating agencies; (vii) alternative investment products and (viii) general economic conditions.\nAcquisition of Laurentian\nIn November 1995, AAG completed the acquisition of Laurentian Capital Corporation, a life insurance holding company, for $151 million. Laurentian's principal insurance subsidiaries are Loyal American Life Insurance Company and Prairie States Life Insurance Company.\nLoyal offers a variety of life and supplemental health insurance products through payroll deduction plans and credit unions. Loyal's products are marketed with the endorsement or consent of the employer or the credit union management. In 1995 and 1994, Loyal collected $41 million and $43 million, respectively, in life, accident and health premiums. At December 31, 1995, Loyal had total statutory assets of approximately $252 million, reserves for future policy benefits of approximately $201 million, and capital and surplus of approximately $35 million.\nPrairie offers a variety of life insurance and annuity products to finance pre-arranged funerals. Prairie markets its products with the sponsorship of state associations of funeral directors as well as individual funeral directors. At year-end 1995, Prairie had relationships with more than 2,000 funeral homes nationwide. In 1995 and 1994, Prairie collected $80 million and $53 million, respectively, in life and annuity premiums. At December 31, 1995, Prairie had total statutory assets of approximately $359 million, reserves for future policy benefits of approximately $320 million and capital and surplus of approximately $24 million. In March 1996, AAG changed Prairie's name to American Memorial Life Insurance Company.\nCompetition\nAAG's insurance companies operate in highly competitive markets. They compete with other insurers and financial institutions based on many factors, including (i) ratings, (ii) financial strength, (iii) reputation, (iv) service to policyholders, (v) product design (including interest rates credited), (vi) commissions and (vii) service to agents. Since policies are marketed and distributed primarily through independent agents, the insurance companies must also compete for agents. Management believes that consistently targeting the same market and emphasizing service to agents and policyholders provides a competitive advantage.\nMore than 100 insurance companies offer tax-deferred annuities. No single insurer dominates the marketplace. Competitors include (i) individual insurers and insurance groups, (ii) mutual funds and (iii) other financial institutions of varying sizes. Some of these are mutual insurance companies possessing competitive advantages in that all of their profits inure to their policyholders, and many of which possess financial resources substantially in excess of those available to AAG's insurance companies. In a broader sense, AAG's insurance companies compete for retirement savings with a variety of financial institutions offering a full range of financial services. Financial institutions have demonstrated a growing interest in marketing investment and savings products other than traditional deposit accounts. In addition, recent judicial and regulatory decisions have expanded powers of financial institutions in this regard. It is too early to predict what impact, if any, these developments will have on AAG's insurance companies.\nInvestment Results\nAAG's annuity products are structured to generate a stable flow of investable funds. AAG earns a spread by investing these funds at an investment earnings rate in excess of the crediting rate payable to its policyholders.\nInvestments comprise approximately 90% of AAG's assets and are the principal source of its income. The following table shows the performance of AAG's investment portfolio, excluding equity investments in affiliates (dollars in millions):\nEquity Investments in Affiliates\nAmerican Premier\nData in this section generally has been derived from American Premier's 1995 Form 10-K.\nAmerican Premier's principal operations are conducted by a group of insurance subsidiaries which write nonstandard automobile insurance and workers' compensation coverage. American Premier employs approximately 3,700 persons.\nInsurance\nAmerican Premier purchased Great American's nonstandard automobile insurance companies on December 31, 1990, and Leader National Insurance Company in May 1993. These companies (collectively the \"NSA Group\") write auto insurance coverage for physical damage and personal liability for (i) individuals perceived to be higher than normal risks due to factors such as age, prior driving record, occupation or type of vehicle driven, or (ii) those who have been cancelled or rejected by another insurance company. Premium rates for nonstandard risks are generally higher than for standard risks.\nAmerican Premier acquired Republic Indemnity Company of America in 1989. Republic sells workers' compensation and employer's liability insurance principally in California. 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. 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.\nIn November 1995, A.M. Best downgraded its rating of Republic and two of the NSA Group companies from \"A+\" (Superior) to \"A\" (Excellent) and affirmed its ratings for the remaining NSA Group companies (substantially all \"A\"). In announcing these ratings adjustments, A.M. Best expressed its opinion that each of these ratings reflects primarily the \"significant financial leverage\" of AFG. At the time of the Mergers, AFG's debt to total capital ratio was nearly 60%; at December 31, 1995, the ratio had improved to approximately 30%.\nUnless otherwise indicated, data in this section is presented on a GAAP basis.\nThe profitability of a property and casualty insurance company depends on both the underwriting of insurance and investment of assets. When the combined ratio is under 100%, underwriting results are generally considered profitable. The statutory ratios for the major classes of business written by American Premier's Insurance Group are as follows.\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 evaluations of individual risks, providing management greater flexibility in the ongoing assessment of the business. In addition, cost control measures have been implemented in the underwriting and claims handling areas.\nRepublic's workers' compensation insurance operations are highly regulated by California state authorities. In 1993, California enacted significant changes in the workers' compensation insurance system (the \"Reform Legislation\"). The 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. Management believes that Republic's record and reputation for paying relatively high policyholder dividends had enhanced its competitive position. With the Reform Legislation, 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 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.\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. geographical distribution of statutory written premiums in 1995 compared to 1991, is presented below. All business written in Texas and included in the table below was assumed from a subsidiary of GAI. In addition, the NSA Group writes approximately $50 million (4%) of its net premiums annually in the United Kingdom.\n1995 1991 Nonstandard Automobile(*) Texas 11.6% - % Florida 11.0 21.5 Georgia 9.9 20.5 California 8.1 - Connecticut 5.4 5.6 Arizona 4.4 2.7 Tennessee 4.1 5.6 Pennsylvania 3.8 - Oklahoma 3.8 1.7 Indiana 3.6 4.2 Mississippi 3.4 4.3 Alabama 3.1 4.0 Other 27.8 29.9 100.0% 100.0%\nWorkers' Compensation California 96.4% 100.0% Arizona 3.6 - 100.0% 100.0%\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. The nonstandard market has experienced growth in recent years as standard insurers have become more restrictive in the types of risks they will write.\nLoss and Loss Adjustment Expense Reserves\nThe following table presents the development of American Premier's liability for losses and LAE (in millions), net of reinsurance, on a GAAP basis since 1989 (the year American Premier acquired its first insurance subsidiary).\nOther\nIn 1994, American Premier sold its investment in General Cable common stock and notes for $177 million. During 1995, American Premier completed the divestiture of its last industrial subsidiary for approximately $13 million. In March 1996, American Premier sold its interest in an independent pipeline common carrier of refined petroleum products for approximately $63 million.\nChiquita Brands International\nChiquita is a leading international marketer, producer and distributor of bananas and other quality fresh and processed food products. In addition to bananas, these products include tropical fruit and other fresh produce; fruit and vegetable juices and beverages; processed fruits and vegetables; salads; and edible oil- based consumer products. Sales of bananas accounted for approximately 60% of Chiquita's net sales in each of the last three years. In 1995, Chiquita sold approximately one-half of its total banana volumes in Europe and over 40% of its banana volumes in North America. Chiquita has generally been able to obtain a premium price for its bananas due to its reputation for quality and its innovative marketing techniques.\nBanana marketing is highly competitive. Selling prices which importers receive for bananas depend on the available supplies of bananas and other fresh fruit in each market and on the relative quality and wholesaler and retailer acceptance of bananas offered by competing importers. Excess supplies may result in increased price competition. Although production of bananas tends to be relatively stable throughout the year, competition comes not only from bananas sold by others, but also from other fresh fruit which may be seasonal in nature. The resulting seasonal variations in demand cause banana pricing to be seasonal. As a result, quarterly results of Chiquita, and therefore AFG's equity in Chiquita's earnings, are subject to significant seasonal variations with stronger quarterly results occurring in the first six months of the calendar year.\nA significant portion of Chiquita's operations are conducted in foreign countries, and are subject to risks that are inherent in operating in such foreign countries, including government regulation, fluctuations in exchange rates, currency restrictions and other restraints, risks of expropriation and burdensome taxes.\nIn 1993, the European Union (\"EU\") implemented a new quota restricting the volume of Latin American bananas imported into the EU, which had the effect of decreasing Chiquita's volume and market share in Europe. The quota grants preferred status to producers and importers within the EU and its former colonies, while imposing quotas and tariffs on bananas imported from other sources, including Latin America, which is Chiquita's primary source of fruit. In March 1994, four of the countries which had previously filed actions against the EU banana policy (Costa Rica, Colombia, Nicaragua and Venezuela) reached a settlement with the EU by signing a \"Framework Agreement.\" The Framework Agreement authorizes the imposition of additional restrictive and discriminatory quotas and export licenses on U.S. banana marketing firms, while leaving EU firms exempt. Costa Rica and Colombia implemented this agreement in 1995, significantly increasing Chiquita's cost to export bananas from these sources.\nIn September 1995, based on a finding by the Office of the U.S. Trade Representative (\"USTR\") that the EU regime unfairly discriminates against U.S. banana marketing firms, the United States, joined by Guatemala, Honduras and Mexico (and, in February 1996, by Ecuador), commenced an international trade challenge against the EU regime using the procedures of the World Trade Organization. In January 1996, the USTR announced that it had found the Framework Agreement export policies of Costa Rica and Columbia to be unfair and further announced that it was not imposing sanctions at that time, pending further consultations with those countries to eliminate harm to U.S. commerce. There can be no assurance as to the outcome of these proceedings or their impact, if any, on the EU quota regime or the Framework Agreement.\nCiticasters\nCiticasters owns and operates two network-affiliated television stations, 14 FM radio stations and five AM radio stations. Substantially all of Citicasters' broadcast revenues come from the sale of advertising time to local and national advertisers. Local advertisements are sold by each stations' sales personnel and national spots are sold by independent national sales representatives.\nCiticasters' AM radio stations offer their listeners a wide range of programs including news, music, discussion, commentary and sports. Citicasters' FM radio stations offer programming more focused on music. Citicasters' television stations receive a significant portion of their programming from their respective networks; the networks sell commercial advertising time within such programming. The competitive position of the stations is directly affected by viewer acceptance of network programs. Citicasters currently has one CBS affiliated television station and one ABC affiliated station. The ABC affiliate is scheduled to switch its affiliation to CBS in June 1996. The non-network programs broadcast by the stations are either produced by the stations or acquired from other sources. Locally originated programs include a wide range of show types such as news, entertainment, sports, public affairs and religious programs.\nIn February 1996, AFG announced that it had entered into an agreement to sell its common stock investment in Citicasters to Jacor Communications, Inc. for $220 million in cash plus warrants to purchase Jacor common stock. ______________________________________\nOther Companies\nAFEI is a holding company with assets consisting primarily of investments in the common stock of American Financial Group, American Annuity and Citicasters.\nThrough subsidiaries, AFC is engaged in a variety of other businesses, including The Golf Center at Kings Island (golf and tennis facility) and Provident Travel Agency, both in the Greater Cincinnati area; commercial real estate operations in Cincinnati (office buildings and The Cincinnatian Hotel), Louisiana (Le Pavillon Hotel), Massachusetts (Chatham Bars Inn), Texas (Driskill Hotel) and apartments in Florida, Kentucky, Louisiana, Minnesota, Oklahoma, Pennsylvania, Texas and Wisconsin. These operations employ approximately 700 full-time employees.\nIn June 1994, AFC sold its investment in General Cable common stock to an unaffiliated company for $27.6 million in cash. General Cable was formed in 1992 to hold American Premier's wire and cable and heavy equipment manufacturing businesses.\nAFC was engaged in the distribution and production of filmed entertainment programming through Spelling Entertainment Group. In 1993, AFC sold its common stock investment in Spelling to Blockbuster Entertainment in exchange for $151 million in Blockbuster securities.\nIn 1993, AFC sold its insurance brokerage operation, American Business Insurance, Inc., to Acordia, Inc., an Indianapolis-based insurance broker for $82 million in cash and Acordia securities.\nInvestment Portfolio\nGeneral\nA breakdown of AFC's December 31, 1995, investment portfolio by business segment follows (excluding investment in equity securities of affiliates) (in millions).\nThe following tables present the percentage distribution and yields of AFC's investment portfolio (excluding investment in equity securities of affiliates) as reflected in its financial statements.\nFixed Maturity Investments\nUnlike most insurance groups which have portfolios that are invested heavily in tax-exempt bonds, AFC's bond portfolio is invested primarily in taxable bonds. The National Association of Insurance Commissioners (\"NAIC\") assigns quality ratings which range from Class 1 (highest quality) to Class 6 (lowest quality). The following table shows AFC'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):\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.\nAFC's primary investment objective for bonds and mandatory redeemable preferred stocks is to receive interest and dividend income rather than to realize capital gains. AFC invests in bonds and mandatory redeemable preferred stocks that have primarily short-term and intermediate-term maturities. This practice allows flexibility in reacting to fluctuations of interest rates.\nEquity Investments\nAFC's equity investment practice permits concentration of attention on a relatively limited number of companies. Some of the equity investments, because of their size, may not be as readily marketable as the typical small investment position. Alternatively, a large equity position may be attractive to persons seeking to control or influence the policies of a company and AFC's concentration in a relatively small number of companies may permit it to identify investments with above average potential to increase in value.\nRegulation\nAFC's insurance companies are regulated under the insurance and insurance holding company laws of their states of domicile and other states in which they operate. These laws, in general, require approval of the particular insurance regulators prior to certain actions by the insurance companies, such as the payment of dividends in excess of statutory limitations, continuing service arrangements with affiliates and certain other transactions. Regulation and supervision of each insurance subsidiary is administered by a state insurance commissioner who has broad statutory powers with respect to the granting and revoking of licenses, approvals of premium rates, forms of insurance contracts and types and amounts of business which may be conducted in light of the policyholders' surplus of the particular company. AFC's largest insurance subsidiaries, GAI and GALIC, are Ohio domiciled insurers. State insurance departments conduct periodic financial examinations of insurance companies, with GAI's and GALIC's most recent such examinations being as of December 31, 1993. Insurance departments also perform market conduct examinations to determine compliance with rate and form filings and to monitor treatment of policyholders and claimants. State insurance laws also regulate the character of each insurance company's investments, reinsurance and security deposits. The statutes of most states provide for the filing of premium rate schedules and other information with the insurance commissioner, either directly or through rating organizations, and the commissioner generally has powers to disapprove such filings or make changes to the rates if they are found to be excessive, inadequate or unfairly discriminatory. The determination of rates is based on various factors, including loss and loss adjustment expense experience. The failure to obtain, or delay in obtaining, the required approvals could have an adverse impact on the operations of AFC's insurance subsidiaries.\nThe NAIC is an organization which is comprised of the chief insurance regulator for each of the 50 states and the District of Columbia. In 1990, the NAIC began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over 15 regulatory areas to be considered for accreditation. The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of December 1995, the District of Columbia and 46 states were accredited including states which regulate AFC's largest insurance subsidiaries.\nThe NAIC model law for Risk Based Capital applies to both life and property and casualty companies. The risk-based capital formulas determine the amount of capital that an\ninsurance company needs to ensure that it has an acceptably low expectation of becoming financially impaired. The model law provides for increasing levels of regulatory intervention as the ratio of an insurer's total adjusted capital and surplus decreases relative to its risk-based capital, culminating with mandatory control of the operations of the insurer by the domiciliary insurance department at the so-called \"mandatory control level\". The risk-based capital formulas became effective in 1993 for life companies and in 1995 for property and casualty companies. Based on the 1995 results of AFC's insurance companies, all such companies are adequately capitalized.\nThe NAIC's state accreditation criteria require that a state adopt the NAIC model law governing extraordinary dividends or a law substantially similar to the model. In Ohio, the maximum amount of dividends which may be paid without (i) prior approval or (ii) expiration of a 30 day waiting period without disapproval is the greater of statutory net income or 10% of policyholders' surplus as of the preceding December 31, but only to the extent of earned surplus as of the preceding December 31. The Ohio Insurance Department has broad discretion to limit the payment of dividends by insurance companies domiciled in Ohio.\nThe NAIC has been considering the adoption of a model investment law for several years. The current projection for a new model investment law is 1996, at the earliest. It is not yet determined whether the model investment law would be added to the NAIC accreditation standards so that adoption of the model would be required for the achievement or continuation of any state's accreditation. It is not possible to predict the impact of these activities on AFC's insurance subsidiaries.\nIn 1994, the California Supreme Court upheld Proposition 103, an insurance reform measure passed by California voters in 1988. In addition to increasing rate regulation, Proposition 103 gives the California Insurance Commissioner power to mandate rate rollbacks for most lines of property and casualty insurance. By its terms, Proposition 103 does not affect workers' compensation insurance. During 1995, GAI finalized a settlement agreement setting its refund obligation at $19 million.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2\nProperties\nAFC and subsidiaries own several buildings in downtown Cincinnati. AFC and its affiliates occupy about three-fifths of the aggregate 580,000 square feet of commercial and office space.\nGAI, its subsidiaries, and American Premier's insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States, including GAI's and AAG's home offices in Cincinnati. Two of AAG's subsidiaries own home office buildings in Mobile, Alabama and Rapid City, South Dakota. These companies occupy approximately two-thirds of the 133,000 square feet and lease the remaining space to unaffiliated tenants.\nITEM 3","section_3":"ITEM 3\nLegal Proceedings\nAFC and its subsidiaries are involved in various litigation, most of which arose in the ordinary course of business. Except for the following, management believes that none of the litigation meets the threshold for disclosure under this Item.\nThe following information has been summarized from \"Legal Proceedings\" of American Premier's 1995 Form 10-K. In May 1994, lawsuits were filed against American Premier by USX Corporation (\"USX\") and its former subsidiary, Bessemer and Lake Erie Railroad Company (\"B&LE\"), seeking contribution by American Premier, as the successor to the railroad business conducted by Penn Central Transportation Company (\"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 payment was 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 American Premier, 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 12, 1995, the Court of Appeals reversed the U.S. District Court decision. In its opinion, the Court of Appeals only addressed American Premier'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 American Premier's defenses on the merits.\nOn January 8, 1996, American Premier 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, American Premier 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, American Premier and its outside counsel believe that American Premier has substantial defenses to these lawsuits and should not suffer a material loss as a result of this litigation.\nPART II\nITEM 5\nMarket for Registrant's Common Equity and Related Stockholder Matt ers\nNot applicable - Registrant's Common Stock is owned by American Financial Group, Inc. See the Consolidated Financial Statements for information regarding dividends.\nITEM 6\nSelected Financial Data\nThe following table sets forth certain data for the periods indicated (dollars in millions).\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 AFC's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page.\nAFC is organized as a holding company with almost all of its operations being conducted by subsidiaries and affiliates. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and dividends on AFC Preferred Stock. Therefore, certain analyses are best done on a parent only basis while others are best done on a total enterprise basis. In addition, since many of its businesses are financial in nature, AFC does not prepare its balance sheet using a current-concurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.\nAs discussed in Note A to the financial statements, on April 3, 1995, AFC merged with a newly formed subsidiary of American Financial Group, Inc., another new company formed to own both AFC and American Premier.\nLIQUIDITY AND CAPITAL RESOURCES\nRatios The following ratios may be considered relevant indicators of AFC's liquidity and are typically presented by AFC in its prospectuses and similar documents. Management believes that balance sheet ratios (debt to total capital) 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.\nAFC's ratio of debt to total capital at the holding company level (excluding amounts due to affiliates) was .31, .68 and .57 at December 31, 1995, 1994 and 1993, respectively. Including the note payable to American Premier, the ratio changes to .57. at December 31, 1995. Ratios of earnings to fixed charges, excluding and including preferred dividends, for the three years ended December 31, 1995, are shown below.\n1995 1994 1993 Earnings to fixed charges 2.23 1.69 2.62 Earnings to fixed charges plus preferred dividends 1.90 1.40 2.26\nThe National Association of Insurance Commissioners' model law for risk based capital (\"RBC\") applies to both life and property and casualty companies. RBC formulas determine 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 AFC insurance companies substantially exceeded the RBC requirements.\nSources of Funds Management believes AFC has sufficient resources to meet its liquidity requirements through operations in the short- term and long-term future. If funds generated from operations, including dividends from subsidiaries, are insufficient to meet fixed charges in any period, AFC would be required to generate cash through borrowings, sales of securities or other assets, or similar transactions.\nBank credit lines at several subsidiary holding companies provide ample liquidity which can be used to obtain funds for the operating subsidiaries or, if necessary, for the parent company. Agreements with the banks generally run for three to seven years and are renewed before maturity. While it is highly unlikely that all such amounts would ever be borrowed at one time, up to $395 million is available under these bank facilities.\nIn the past, funds have been borrowed under certain of these bank facilities and used for working capital, capital infusions into subsidiaries, and to retire other issues of short-term or high-rate debt. Also, while little was drawn on the bank lines at December 31, 1995, AFC believes it may be prudent and advisable to borrow up to $200 million of bank debt in the normal course and use the proceeds to retire additional amounts of public or privately held fixed rate debt over the next year or two.\nIn April 1995, AFC entered into a subordinated credit agreement with American Premier under which it can borrow up to $675 million. 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. During 1995, AFC borrowed $623 million under the agreement using the proceeds for debt retirements, capital contributions to subsidiaries and other corporate purposes. Borrowings, repayments and interest payments on the line are included in \"net advances from (to) affiliates\" in the following table.\nFunds to meet the parent company's expenditures have been provided from a variety of sources within the holding company, from subsidiaries and directly from outside sources, as detailed in the following table (in millions):\nGenerally, over 90% of the dividends (including non-cash dividends) received from subsidiaries have been from GAI. Payments of dividends by GAI are subject to various laws and regulations which limit the amount of dividends that can be paid without regulatory approval. Under Ohio law, the maximum amount of dividends which may be paid without (i) prior approval or (ii) expiration of a 30 day waiting period without disapproval\nis the greater of statutory net income or 10% of policyholders' surplus as of the preceding December 31, but only to the extent of earned surplus as of the preceding December 31. The maximum amount of dividends payable (without prior approval) in 1996 from GAI based on its 1995 statutory net income is approximately $129 million.\nFor statutory accounting purposes, equity securities are generally carried at market value. At December 31, 1995, AFC's insurance companies owned publicly traded equity securities with a market value of $1.2 billion, including equity securities of AFC affiliates (including subsidiaries) of $960 million. Since significant amounts of these are concentrated in a relatively small number of companies, decreases in the market prices could adversely affect the insurance group's capital, potentially impacting the amount of dividends available or necessitating a capital contribution. Conversely, increases in the market prices could have a favorable impact on the group's dividend- paying capability.\nUnder tax allocation agreements with AFC, its 80%-owned U.S. subsidiaries generally compute tax provisions as if filing separate returns based on book taxable income computed in accordance with generally accepted accounting principles. The resulting provision (or credit) is currently payable to (or receivable from) AFC. Following the Mergers, AFC and American Premier will each continue to file separate consolidated tax returns.\nUncertainties Great American's liability for unpaid losses and loss adjustment expenses includes amounts for various liability coverages related to environmental and hazardous product claims. The insurance industry typically includes only claims relating to polluted waste sites and asbestos in defining environmental exposures, whereas Great American extends this definition to include claims relating to breast implants, repetitive stress on keyboards, DES (a drug used in pregnancies years ago alleged to cause cancer and birth defects), and other latent injuries. At December 31, 1995, Great American had recorded $220 million (net of reinsurance recoverables of $164 million) for environmental pollution and hazardous products claims on policies written many years ago where, in most cases, coverage was never intended. Due to inconsistent court decisions on many coverage issues and the difficulty in determining standards acceptable for cleaning up pollution sites, significant uncertainties exist which are not likely to be resolved in the near future.\nIn exchange for $5 million, AFC has agreed to indemnify a former subsidiary for up to $35 million in excess of a threshold amount of $25 million of the costs it may incur in the 12 years beginning April 1, 1993 to resolve environmental matters, bankruptcy claims and certain other matters. Additionally, another AFC subsidiary has accrued $10.3 million at December 31, 1995 for environmental costs associated with the sales of former manufacturing properties.\nWhile 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 two-thirds of AFC's consolidated assets are invested in marketable securities. A diverse portfolio of bonds and redeemable preferred stocks accounts for over 95% of these securities. AFC attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. AFC's goal is to maximize return on an ongoing basis rather than focusing on short-term 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 AFC's bonds and redeemable preferred stocks was approximately 6 years.\nApproximately 94% of the bonds and redeemable preferred stocks held by AFC 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.\nInvestments in mortgage-backed securities (\"MBSs\") represented approximately 30% of AFC's bonds and redeemable preferred stocks at December 31, 1995. AFC invests primarily in MBSs which have a reduced risk of prepayment. Interest only (I\/Os), principal only (P\/Os) and other \"high risk\" MBSs represented approximately two percent of AFC's total mortgage-backed securities portfolio. In addition, the majority of MBSs held by AFC were purchased at a discount. Management believes that the structure and discounted nature of the MBSs will minimize the effect of prepayments on earnings over the anticipated life of the MBSs portfolio. More than 90% of AFC's MBSs are rated \"AAA\" with substantially all being of investment grade quality. The majority are collateralized 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, AFC does not believe a material risk (relative to earnings and liquidity) is inherent in holding such investments.\nBecause most income of the property and casualty insurance subsidiaries is currently sheltered from income taxes, non- taxable municipal bonds represent only a small portion (less than 1%) of the portfolio.\nAFC's equity securities are concentrated in a relatively limited number of major positions. This approach allows management to more closely monitor the companies and industries in which they operate.\nThe realization of capital gains, primarily through sales of equity securities, was an integral part of AFC's investment program. Individual securities are sold creating gains or losses as market opportunities exist. Pretax capital gains recognized upon disposition of securities, including affiliates, during the past five years have been: 1995 - $57 million; 1994 - - $50 million; 1993 - $165 million; 1992 - $104 million and 1991 - - $38 million. At December 31, 1995, the net unrealized gain on AFC's bonds and redeemable preferred stocks was $330 million; the net unrealized gain on equity securities was $115 million.\nRESULTS OF OPERATIONS - THREE YEARS ENDED DECEMBER 31, 1995\nGeneral AFC had accounted for American Premier as a subsidiary in 1992 and the first quarter of 1993 and as an investee from the second quarter of 1993 through the first quarter of 1995. AFC began accounting for American Financial Group as an investee in April 1995. As a result of these changes, current year income statement components are not comparable to prior years and are not indicative of future years.\nPretax earnings were $183 million in 1995 compared to $44 million in 1994 and $262 million in 1993.\nResults for 1995 include an improvement of $32 million in underwriting results of the property and casualty insurance segment, a $50 million increase in investment income and the absence of nonrecurring charges recorded in 1994. These items were partially offset by increases of $13 million in annuity benefits and $23 million in interest on borrowed money.\nResults for 1994 include AFC's share ($28 million) of American Premier's loss on the sale of General Cable securities, GAI's $19 million charge relating to a rate rollback liability in California and a $35 million charge related to payments under AFC's Book Value Incentive Plan. These items were partially offset by a $42 million decrease in interest expense.\nResults for 1993 include (i) $155 million in gains from the sales of AFC's insurance agency operations, Spelling Entertainment Group and 4.5 million shares of American Premier and additional proceeds received on the 1990 sale of the NSA Group to American Premier, and (ii) AFC's share ($52 million) of a tax benefit recorded by American Premier in the second, third and fourth quarters of 1993. These items were partially offset by a write-off of debt discount and expenses of $24 million.\nProperty and Casualty Insurance - Underwriting Great American (GAI and its property and casualty insurance subsidiaries) manages and operates its property and casualty business as two major sectors. The specialty lines are a diversified group of over twenty-five business lines that offer a wide variety of specialty insurance products. Some of the more significant areas are executive liability, inland and ocean marine, U.S.- based operations of Japanese companies, agricultural-related coverages, excess and surplus lines and fidelity and surety bonds. The commercial and personal lines provide coverages in commercial multi-peril, workers' compensation, umbrella and commercial automobile, standard private passenger automobile and homeowners insurance.\nTo understand the overall profitability of particular lines, timing of claims payments and the related impact of investment income must be considered. Certain \"short-tail\" lines of business (primarily property coverages) have quick loss payouts which reduce the time funds are held, thereby limiting investment income earned thereon. On the other hand, \"long- tail\" lines of business (primarily liability coverages and workers' compensation) have payouts that are either structured over many years or take many years to settle, thereby significantly increasing investment income earned on related premiums received.\nUnderwriting 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.\nWhile Great American desires and seeks to earn an underwriting profit on all of its business, it is not always possible to do so. As a result, the company attempts to expand in the most profitable areas and control growth or even reduce its involvement in the least profitable ones.\nResults for Great American's property and casualty insurance subsidiaries are as follows (dollars in millions):\n1995 1994 1993 Net Written Premiums (GAAP) Specialty Operations $ 882 $ 801 $ 616 Commercial and Personal Operations 717 683 666 Other Lines 1 5 6 Aggregate $1,600 $1,489 $1,288\nCombined Ratios (GAAP) Specialty Operations 97.5% 102.1% 97.3% Commercial and Personal Operations 99.1 98.9 101.0 Aggregate 100.2 102.4 103.5\nIn 1995, Great American's underwriting results significantly outperformed the industry average for the tenth consecutive year. Great American has been able to exceed the industry's results by focusing on highly specialized niche products, supplemented by commercial lines coverages and personal automobile products.\nSpecialty Operations Net written premiums for the specialty operations increased 10% during 1995 over 1994 due to increases in specialty niche lines (primarily crop hail, excess and surplus and executive liability). The combined ratio of the specialty operations in 1995 reflects improved results experienced in the crop hail and farm lines as well as coverages of U.S. operations of Japanese companies. The 1995 combined ratio also includes losses resulting from participation in a voluntary pool from which Great American withdrew in 1995.\nCommercial and Personal Operations Net written premiums for the commercial and personal operations increased 5% in 1995 due primarily to increased writing of workers' compensation and commercial umbrella insurance. The profitability of both of these lines improved in 1995. Workers' compensation improved due to favorable rate action by rating bureaus, health care cost containment programs, marketing emphasis on profitable states and implementation of a Drug-Free Workplace program. Commercial umbrella results improved due to a focus on low hazard risks and more favorable pricing in the higher umbrella layers. In addition, cost control measures reduced the underwriting expense ratio. These improved results were offset by an increase in the combined ratio of the personal lines operations due primarily to weather-related losses, start-up costs from its direct-to- consumer operation and deteriorating automobile loss experience for accident years 1994 and 1995.\nInvestment Income Changes in investment income reflect fluctuations in market rates and changes in average invested assets.\n1995 compared to 1994 Investment income increased $50 million (9%) in 1995 due to an increase in average investments held.\n1994 compared to 1993 Excluding American Premier, which was included as a subsidiary for the first three months of 1993, investment income increased $20 million (4%) due to an increase in average investments held.\nInvestee Corporations Equity in net earnings of investee corporations (companies in which AFC owns a significant portion of the voting stock) represents AFC's proportionate share of the investees' earnings and losses.\n1995 compared to 1994 AFC's equity in net earnings of investee corporations increased $53 million in 1995. Chiquita reported a $105 million improvement in operating income due primarily to the absence on certain nonrecurring charges, net gains from the sale of non-core assets, cost reductions in its core business and higher banana prices outside the European Union.\n1994 compared to 1993 AFC's equity in net earnings (losses) of investee corporations in 1994 includes its share ($28 million) of American Premier's loss on the sale of securities of General Cable and its share ($52 million) of American Premier's tax benefit in 1993. Chiquita's loss before extraordinary items was comparable in 1994 and 1993 as improvements in Meat Division operations and banana pricing were offset by charges and losses relating to farm closings and banana cultivation write-downs in Honduras and a substantial reduction of Chiquita's Japanese banana trading operations.\nGains (Losses) on Sales of Investees The loss on sale of investees in 1995 primarily represents a pretax loss on the sale of Chiquita to American Premier.\nThe gain on sale of investees in 1994 represents a pretax gain on the sale of General Cable common stock.\nThe gains on sales of investees in 1993 include (i) a pretax gain of $52 million on the sale of Spelling Entertainment and (ii) a pretax gain of $28 million on the public sale by AFEI of 4.5 million shares of American Premier common stock.\nGains on Sales of Subsidiaries The gains on sales of subsidiaries in 1993 include pretax gains of (i) $44 million from the sale of American Business Insurance, Inc. and (ii) $31 million representing an adjustment on AFC's 1990 sale of the nonstandard automobile insurance group to American Premier.\nSales of Other Products and Services Sales of other products and services represent American Premier's revenues from systems and software engineering services and the manufacture and supply of industrial products and services during the first quarter of 1993.\nAnnuity Benefits For GAAP financial reporting purposes, annuity receipts are generally accounted for as interest-bearing deposits (\"annuity benefits accumulated\") rather than as revenues. Under these contracts, policyholders' funds are credited with interest on a tax-deferred basis until withdrawn by the policyholder. Annuity benefits represent primarily interest related to annuity policyholders' funds held. The rate at which GALIC credits interest on annuity policyholders' funds is subject to change based on management's judgment of market conditions.\nAnnuity receipts totaled approximately $460 million in 1995, $440 million in 1994 and $400 million in 1993. Annuity receipts have increased in 1995, 1994 and 1993 due primarily to sales of newly introduced single premium products and, in 1995, the development of new single premium distribution channels. Annuity surrender payments have averaged approximately 8% of statutory reserves over the past three years.\nAnnuity benefits increased $13 million (5%) in 1995 and $13 million (6%) in 1994 due primarily to an increase in average annuity benefits accumulated.\nInterest on Borrowed Money Changes in interest expense result from fluctuations in market rates as well as changes in borrowings. AFC has generally financed its borrowings on a long- term basis which has resulted in higher current costs.\nInterest expense included in AFC's consolidated Statement of Earnings was comprised of (in millions):\n1995 1994 1993 AFC Parent $ 86.7 $ 56.9 $ 71.1 Great American Holding 20.2 24.7 23.4 American Annuity 17.3 20.9 21.2 Great American Insurance 13.0 11.9 14.0 American Premier - - 17.2 Other Companies 1.0 .8 10.3 $138.2 $115.2 $157.2\nAFC Parent's interest expense increased in 1995 due to an increase in average borrowings. In the second quarter of 1995, AFC borrowed $549 million under its new credit agreement with American Premier using the proceeds to retire $372 million of debt and for other corporate purposes. AFC Parent's interest expense decreased in 1994 due to (i) the issuance of $204 million of 9-3\/4% debentures in exchange for higher rate debt and (ii) the repurchase of $79 million principal amount of debentures. GAHC's interest expense decreased in 1995 due to a decrease in bank borrowings and the retirement of its floating rate notes and 11% notes in the third and fourth quarters, respectively. The decrease in other companies' interest expense in 1994 is due primarily to the repayments of borrowings in 1993.\nOther Operating and General Expenses Operating and general expenses included the following charges (in millions):\n1995 1994 1993 Minority interest $15 $ 9 $35 Proposition 103 - 19 - Allowance for bad debts - 18 10 Writeoff of debt discount and issue costs - - 24 Relocation expenses - - 8\nAllowance for bad debts includes charges for possible losses on agents' balances, reinsurance recoverables and other receivables. Relocation expenses represent the estimated costs of moving GALIC's operations from Los Angeles to Cincinnati.\nIncome Taxes See Note M to the Financial Statements for an analysis of items affecting AFC's effective tax rate.\nITEM 8\nFinancial Statements and Supplementary Data\nPage\nReports of Independent Auditors\nConsolidated Balance Sheet: December 31, 1995 and 1994\nConsolidated Statement of Earnings: Years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Changes in Capital Accounts: 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\"Selected Quarterly Financial Data\" has been included in Note Q to the Consolidated Financial Statements.\nITEM 9\nChanges in and Disagreements with Accountants on Accounting and Financial Disclosure\nAFC filed a report on Form 8-K on August 29, 1995, reporting a change in independent accountants of American Premier Underwriters, Inc., an AFC investee. The report is incorporated herein by reference.\nPART III\nThe information required by the following Items will be included in AFC'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 Directors and Executive Officers of the Registrant\nITEM 11 Executive Compensation\nITEM 12 Security Ownership of Certain Beneficial Owners and Management\nITEM 13 Certain Relationships and Related Transactions\nREPORTS OF INDEPENDENT AUDITORS\nBoard of Directors American Financial Corporation\nWe have audited the accompanying consolidated balance sheets of American Financial Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in capital accounts, 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 Corporation's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. The financial statements of American Premier Underwriters, Inc. (1994 and 1993) and General Cable Corporation (1993) have been audited by other auditors whose reports have been furnished to us; insofar as our opinion on the consolidated financial statements and schedules relates to data included for those corporations, it 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 American Financial 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.\nERNST & YOUNG LLP\nCincinnati, Ohio March 15, 1996\nREPORT OF AMERICAN PREMIER'S 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 American Premier's financial statements)\nREPORT OF GENERAL CABLE'S INDEPENDENT AUDITORS\nGeneral Cable Corporation:\nWe have audited the consolidated financial statements and related schedules of General Cable Corporation and subsidiaries listed in Item 14(a) of the Annual Report on Form 10-K of General Cable Corporation for the year ended December 31, 1993 (not presented separately herein). These consolidated financial statements and related schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and related schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 General Cable Corporation and subsidiaries at December 31, 1993 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information shown therein.\nDELOITTE & TOUCHE\nCincinnati, Ohio February 18, 1994\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL ACCOUNTS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n____________________________________________________________________________\nINDEX TO NOTES\nA. Mergers J. Capital Subject to Mandatory B. Accounting Policies Redemptions C. Acquisitions and Sales of Subsidiaries K. Other Preferred Stock and Investees L. Common Stock D. Segments of Operations M. Income Taxes E. Investments N. Extraordinary Items F. Investment in Investees O. Pending Legal Proceedings G. Cost in Excess of Net Assets Acquired P. Benefit Plans H. Payable to American Premier Q. Transactions with Affiliates Underwriters, Inc. R. Quarterly Operating Results I. Other Long-Term Debt S. Insurance T. Additional Information\n____________________________________________________________________________\nA. Mergers On April 3, 1995, American Financial Corporation (\"AFC\") merged with a newly formed subsidiary of American Premier Group, Inc., another new company formed to own 100% of the common stock of both AFC and American Premier Underwriters, Inc. (\"American Premier\"). Subsequently, American Premier Group changed its name to American Financial Group, Inc. In the transaction, Carl H. Lindner and members of his family, who owned 100% of the Common Stock of AFC, exchanged their AFC Common Stock for approximately 55% of American Financial Group voting common stock. Former shareholders of American Premier, including AFC and its subsidiaries, received shares of American Financial Group stock on a one-for-one basis. No gain or loss was recorded on the exchange of shares.\nAFC continues to be a separate SEC reporting company with publicly traded debentures and preferred stock. Holders of AFC Series F and G Preferred Stock were granted voting rights equal to approximately 21% of the total voting power of AFC shareholders immediately prior to the Mergers.\nB. Accounting Policies\nBasis of Presentation The consolidated financial statements include the accounts of AFC and its subsidiaries. Changes in ownership levels of subsidiaries and affiliates have resulted in certain differences in the financial statements and have affected comparability between years. 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 wi th 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.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAFC's ownership of subsidiaries and significant affiliates with publicly traded shares at December 31, was as follows:\nInvestments Debt securities are classified as \"held to maturity\" and reported at amortized cost if AFC 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, AFC reassessed the classifications of its investments and transferred fixed maturity securities with an amortized cost of approximately $2.0 billion to \"available for sale.\" This \"one-time\" reclassification resulted in an increase of $104 million in the carrying value of fixed maturity investments and an increase of $67 million in shareholders' equity. The transfer had no effect on net earnings.\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.\nShort-term investments are carried at cost; loans receivable are stated primarily at the aggregate unpaid balance.\nInvestment in Investees Investments in securities of 20%- to 50%-owned companies are carried at cost, adjusted for AFC's proportionate share of their undistributed earnings or losses. Investments in less than 20%-owned companies are accounted for by the equity method when, in the opinion of management, AFC can exercise significant influence over operating and financial policies of the investee.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nCost in Excess of Net Assets Acquired The excess of cost of subsidiaries and investees over AFC's equity in the underlying net assets (\"goodwill\") is being amortized over 40 years. The excess of AFC's equity in the net assets of other subsidiaries and investees over its cost of acquiring these companies (\"negative goodwill\") is allocated to AFC's basis in these companies' fixed assets, goodwill and other long-term assets and is amortized on a 10- to 40-year basis.\nInsurance As discussed under \"Reinsurance\" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance recoverable.\nReinsurance In the normal course of business, AFC'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, AFC'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. AFC'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. AFC's insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers.\nDeferred Acquisition Costs Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred (\"DPAC\"). For the property and casualty companies, the deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. DPAC is charged against income ratably over the terms of the related policies. For the annuity companies, DPAC is amortized, with interest, in relation to the present value of expected gross profits on the 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 written; (b) estimates received from ceding\nreinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience; (d) estimates based on experience of expenses for investigating and adjusting claims and (e) the current state of the law and coverage litigation. 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.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAnnuity Benefits Accumulated Annuity receipts and benefit payments are generally recorded as increases or decreases in \"annuity benefits accumulated\" rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income.\nLife, Accident and Health Benefits Reserves Liabilities for future policy benefits under traditional ordinary life, accident and health policies are computed using a net level premium method. Computations are based on anticipated investment yields (primarily 7%), mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves are modified as necessary to reflect actual experience and developing trends.\nAssets Held In and Liabilities Related to Separate Accounts Investment annuity deposits and related liabilities represent deposits maintained by several banks under a previously offered tax deferred annuity program. AAG receives an annual fee from each bank for sponsoring the program; depositors can elect to purchase an annuity from AAG with funds in their account.\nIncome Taxes AFC files consolidated federal income tax returns which include all 80%-owned U.S. subsidiaries, except for certain life insurance subsidiaries. Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a benefit will be realized.\nBenefit Plans AFC provides retirement benefits, through contributory and noncontributory defined contribution plans, to qualified employees of participating companies. Contributions to benefit plans are charged against earnings in the year for which they are declared. AFC's Employee Stock Ownership Retirement Plan (\"ESORP\") is a noncontributory, qualified plan which invests in securities of AFG and affiliates for the benefit of their employees.\nAFC and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. AFC also provides postemployment benefits to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. The projected future cost of providing these benefits is expensed over the period the employees qualify for such benefits.\nIn connection with the Mergers, full vesting was granted to holders of units under AFC's Book Value Incentive Plan and the plan was terminated. Cash payments, which were made in April to holders of the units, were accrued at December 31, 1994.\nDebt Discount Debt discount and expenses are being amortized over the lives of respective borrowings, generally on the interest method.\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. Annuity receipts, benefits and withdrawals are also reflected as financing\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nactivities. 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.\nFair Value of Financial Instruments Methods and assumptions used in estimating fair values are described in Note T to the financial statements. These fair values represent point-in- time estimates of value that might not be particularly relevant in predicting AFC's future earnings or cash flows.\nC. Acquisitions and Sales of Subsidiaries and Investees\nChiquita In April 1995, AFC sold 3.2 million shares of Chiquita common stock to American Premier for $43.7 million in cash. AFC realized a pretax loss of $442,000 on the sale.\nGeneral Cable In June 1994, AFC sold its investment in General Cable common stock to an unaffiliated company for $27.6 million in cash. AFC realized a $1.7 million pretax gain on the sale (excluding its share of American Premier's loss on its sale of General Cable securities).\nAmerican Business Insurance In 1993, AFC sold its insurance brokerage operation, American Business Insurance, Inc., to Acordia, Inc., an Indianapolis-based insurance broker, for cash and Acordia common stock and warrants. AFC recognized a pretax gain of approximately $44 million on the sale.\nAmerican Premier In 1993, AFEI, whose assets consisted primarily of investments in American Premier, General Cable and AAG, sold 4.5 million shares of American Premier common stock in a secondary public offering. AFC recognized a pretax gain of $28.3 million, before minority interest, on the sale, including recognition of a portion of previously deferred gains related to sales of assets to American Premier from AFC subsidiaries. In anticipation of the reduction of AFC's ownership of American Premier below 50%, AFC ceased accounting for it as a subsidiary and began accounting for it as an investee in April 1993.\nIn 1993, American Premier paid AFC $52.8 million (including $12.8 million in interest) representing an adjustment on the 1990 sale of AFC's non-standard automobile group to American Premier. AFC recorded an additional pretax gain of $31.4 million on this transaction after deferring $21.4 million based on its then current ownership of American Premier.\nCiticasters In December 1993, GACC completed a plan of reorganization under which AFC received approximately 20% of new common stock in exchange for its previous holdings of GACC stock and debt. In connection with the plan, AFC also invested an additional $7.5 million in GACC common stock and debt securities.\nIn June 1994, AFEI purchased approximately 10% of Citicasters common stock from a third party for $23.9 million in cash.\nIn February 1996, Citicasters entered into a merger agreement with Jacor Communications, Inc. providing for the acquisition of Citicasters by Jacor. Under the agreement, AFC and its subsidiaries would receive approximately $220 million in cash plus warrants to buy approximately 1.5 million shares of Jacor common stock at $28 per share. AFC expects to\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nrealize a pretax gain of approximately $150 million on the sale. Consummation of the transaction is subject to regulatory approvals, and certain adjustments to the price will be made if the transaction does not close by September 30, 1996.\nSpelling In 1993, AFC sold its common stock investment in Spelling to Blockbuster Entertainment in exchange for Blockbuster common stock and warrants. AFC realized a $52 million pretax gain on the sale.\nD. Segments of Operations AFC operates its property and casualty insurance business in two major segments: specialty lines and commercial and personal lines. AFC's annuity business sells tax-deferred annuities principally to employees of primary and secondary educational institutions and hospitals. These insurance businesses operate throughout the United States. AFC also owns significant portions of the voting equity securities of certain companies (investee corporations - see Note F).\nThe following tables (in thousands) show AFC's assets, revenues and operating profit (loss) by significant business segment. Capital expenditures, depreciation and amortization are not significant. Operating profit (loss) represents total revenues less operating expenses. Goodwill and its amortization have been allocated to the various segments to which they apply. General corporate assets and expenses have not been identified or allocated by segment.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nE. Investments Bonds, redeemable preferred stocks and other stocks at December 31, consisted of the following (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES 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 7 years at December 31, 1995.\nCertain risks are inherent in connection with fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.\nRealized gains (losses) and changes in unrealized appreciation (depreciation) on fixed maturity and equity security investments are summarized as follows (in thousands):\nTransactions in fixed maturity investments included in the Statement of Cash Flows consisted of the following (in millions):\nSecurities classified as \"held to maturity\" having an amortized cost of $14.7 million and $8.7 million were sold for a loss of $1.8 million and $712,000 in 1995 and 1994, respectively, due to significant deterioration in the issuers' creditworthiness.\nGross gains of $69.4 million and gross losses of $16.5 were realized on sales of fixed maturity investments during 1993.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nF. Investment in Investees Investment in investees represents AFC's ownership of securities of certain companies. All of the companies named in the following table are subject to the rules and regulations of the SEC. Market value of the investments was approximately $1.0 billion and $890 million at December 31, 1995 and 1994, respectively.\nAFC's investment (and common stock ownership percentage) and equity in net earnings and losses of investees are stated below (dollars in thousands):\nIn addition to owning the common stock of AFC, American Financial Group owns all the common stock of American Premier, a specialty property and casualty insurance company. Chiquita is a leading international marketer, processor and producer of quality food products. Citicasters owns and operates radio and television stations in major markets throughout the country.\nIncluded in AFC's consolidated retained earnings at December 31, 1995, was approximately $290 million applicable to equity in undistributed net earnings of investees. Unamortized goodwill in investees totaled $187 million at December 31, 1995.\nSummarized financial information for AFC's investees at December 31, 1995, is shown below (in millions). See \"Investee Corporations\" in Management's Discussion and Analysis.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nG. 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 $107 million and $100 million, respectively. Amortization expense was $6.2 million in 1995, $6.1 million in 1994 and $15.0 million in 1993.\nH. Payable to American Premier Underwriters, Inc. Following the Mergers, American Premier agreed to lend up to $675 million to AFC under a line of credit, and subsequently advanced funds which, along with other funds available, were used by AFC to redeem $279 million of its various debentures, repay $187 million of Great American Holding Corporation's (\"GAHC's\") bank debt, and redeem $200 million of GAHC's Notes. Borrowings under the credit line bear interest at 11- 5\/8% and convert to a four-year term loan in March 2005. At December 31, 1995, AFC had borrowed $623.2 million under the credit agreement. Accrued interest of $16.2 million at December 31, 1995, was paid in January 1996.\nI. Long-Term Debt Long-term debt consisted of the following at December 31, (in thousands):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAt December 31, 1995, sinking fund and other scheduled principal payments on debt for the subsequent five years were as follows (in thousands):\nDebentures purchased in excess of scheduled payments may be applied to satisfy any sinking fund requirement. The scheduled principal payments shown above assume that debentures purchased are applied to the earliest scheduled retirements.\nGAHC, a wholly-owned subsidiary of AFC, has a revolving loan agreement with groups of banks under which it can borrow up to $300 million. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized by stock of an operating subsidiary. The facility is guaranteed by AFC.\nAAG and AFEI have revolving credit agreements with banks under which they can borrow up to $75 million and $20 million, respectively. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized.\nDuring 1995, AFC sold an aggregate of $100 million of its 9- 3\/4% debentures due in 2004 for cash. In a 1994 exchange offer, AFC issued $204 million of its 9-3\/4% debentures for a like amount of its various other debenture issues. The related unamortized original issue discount and debt issue costs ($24.3 million) were written off in 1993. In connection with the offer, all of AFC's 13-1\/2% debentures not tendered for exchange were redeemed for $63.2 million in cash.\nIn connection with its acquisition of GALIC in 1992, AAG borrowed $230 million from several banks. In 1993, AAG sold $225 million of Notes to the public and repaid the bank loans. During 1994, AAG repurchased $77.1 million of the Notes in exchange for $69 million in cash plus 810,000 shares of its common stock. During 1995, AAG repurchased $4.9 million of the Notes for $5.0 million in cash.\nIn the first two months of 1996, AFC repurchased $48.3 million of its debentures for $52.4 million; and AAG repurchased $22.1 million of its Notes for $24.1 million.\nCash interest payments of $98 million, $115 million and $133 million were made on long-term debt in 1995, 1994 and 1993, respectively.\nJ. Capital Subject to Mandatory Redemption Capital subject to mandatory redemption includes AFC's Mandatory Redeemable Preferred Stock at December 31, 1994 and 1993 and, at December 31, 1993, capital subject to a put option.\nMandatory Redeemable Preferred Stock At December 31, 1994, there were 274,242 shares of $10.50 par value Series E Preferred Stock outstanding. These shares were retired, at par, in December 1995. During 1994, AFC redeemed all 150,212 outstanding shares of Series I Preferred Stock and 230,469 shares of Series E Preferred Stock for approximately $6.6 million. During 1993, AFC purchased 75,106 shares of Series I Preferred Stock for approximately $2.1 million.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nCapital Subject to Put Option Under a 1983 agreement, certain members of the Lindner family (the \"Group\") had the right to \"put\" to AFC their shares of AFC Common Stock or options at a defined value. In anticipation of the extinguishment of the Group's rights due to the Mergers, the allocation of capital equal to that value ($32.5 million) was reclassified to Retained Earnings at December 31, 1994.\nK. Other Preferred Stock Under provisions of both the Nonvoting (21.1 million shares authorized, including the Mandatory Redeemable Preferred Stock) and Voting (17.0 million shares authorized, 14.1 million shares outstanding) Cumulative Preferred Stock, the Board of Directors may divide the authorized stock into series and set specific terms and conditions of each series. The outstanding shares of preferred stock consisted of the following:\nSeries F, $1 par value - authorized 15,000,000 shares; annual dividends per share $1.80; 10% may be retired at AFC's option at $20 per share in 1996; 13,744,754 shares (stated value - $167.9 million) outstanding at December 31, 1995 and 1994.\nSeries G, $1 par value - authorized 2,000,000 shares; annual dividends per share $1.05; may be retired at AFC's option at $10.50 per share; 364,158 shares (stated value - $600,000) outstanding at December 31, 1995 and 1994.\nIn 1994, AFC purchased 8,500 shares of Series F Preferred Stock from a subsidiary's profit sharing plan for $159,000.\nL. Common Stock At December 31, 1994, there were 18,971,217 shares of AFC Common Stock outstanding. Prior to the Mergers discussed in Note A, AFC issued 762,500 common shares upon exercise of stock options. In connection with the Mergers, the number of authorized common shares was increased to 53.5 million and the number of outstanding shares was increased to 53.0 million. At December 31, 1995, American Financial Group owned all 53.0 million outstanding shares of AFC's Common Stock.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nM. Income Taxes The following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Earnings (in thousands):\nAdjusted earnings (loss) before income taxes consisted of the following (in thousands): 1995 1994 1993 Subject to tax in: United States $178,100 $ 28,422 $255,682 Foreign jurisdictions - (2,046) 1,744\n$178,100 $ 26,376 $257,426\nThe total income tax provision consists of (in thousands):\nFor income tax purposes, certain members of the AFC consolidated tax group had approximately $268 million of operating loss carryforwards available at December 31, 1995. The carryforwards are scheduled to expire as follows: $1 million in 1996, $21 million in 1997 through 2001, $143 million in 2002 through 2006 and $103 million in 2007 through 2010.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDeferred income taxes reflect the impact of temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities for AFC's tax group included in the Balance Sheet at December 31, were as follows (in millions):\nThe gross deferred tax asset has been reduced by a valuation allowance based on an analysis of the likelihood of realization. Factors considered in assessing the need for a valuation allowance include: (i) recent tax returns, which show neither a history of large amounts of taxable income nor cumulative losses in recent years, (ii) opportunities to generate taxable income from sales of appreciated assets, and (iii) the likelihood of generating larger amounts of taxable income in the future. The likelihood of realizing this asset will be reviewed periodically; any adjustments required to the valuation allowance will be made in the period in which the developments on which they are based become known.\nCash payments for income taxes, net of refunds, were $12.9 million, $30.0 million and $49.6 million for 1995, 1994 and 1993, respectively.\nN. Extraordinary Items Extraordinary items represent AFC's proportionate share of losses recorded by the following companies from their debt retirements. Amounts shown are net of minority interest and income tax benefits (in thousands):\nO. Pending Legal Proceedings Counsel has advised AFC that there is little likelihood of any substantial liability being incurred from any litigation pending against AFC and subsidiaries.\nP. Benefit Plans AFC expensed ESORP contributions of $11.0 million in 1995, $6.2 million in 1994 and $9.4 million in 1993. AFC expensed postretirement benefits of $2.9 million in 1995, $2.4 million in 1994 and $3.1 million in 1993.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nQ. Transactions With Affiliates In 1993, AFC sold stock of an affiliate to certain of its officers and employees for $1.8 million in cash and $270,000 in 5.25% unsecured notes due in five equal annual installments beginning in 1996. At December 31, 1993, an AFC real estate subsidiary owed $452,000 to The Provident Bank under a loan purchased by Provident in 1991 from an unrelated bank. The loan was repaid in 1994. Members of the Lindner family are majority owners of Provident's parent. In 1995, a subsidiary of AFC sold a house to its Chairman for $1.8 million. Also during 1995, AFC purchased from American Premier (i) certain properties for $15.9 million; (ii) a small reinsurance subsidiary for $13.7 million; and (iii) shares of AAG for $553,000. All of the above transactions have taken place at approximate market rates or values and, in the opinion of management, all amounts receivable are fully collectible.\nR. Quarterly Operating Results (Unaudited) The operations of certain of AFC's business segments are seasonal in nature. While insurance premiums are recognized on a relatively level basis, claim losses related to adverse weather (snow, hail, hurricanes, tornadoes, etc.) may be seasonal. Quarterly results necessarily rely heavily on estimates. These estimates and certain other factors, such as the nature of affiliates' operations and discretionary sales of assets, cause the quarterly results not to be necessarily indicative of results for longer periods of time. See Notes A and C for changes in ownership of companies whose revenues are included in the consolidated operating results and for the effects of gains on sales of subsidiaries and affiliates in individual quarters. The following are quarterly results of consolidated operations for the two years ended December 31, 1995 (in millions).\nResults for 1994 included credits of $3.9 million and $5.3 million in the second and third quarters and a fourth quarter charge of $43.9 million for units outstanding under AFC's Book Value Incentive Plan.\nRealized gains on sales of securities amounted to (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nS. Insurance Securities owned by insurance subsidiaries having a carrying value of approximately $808 million at December 31, 1995, were on deposit as required by regulatory authorities.\nOther income includes life, accident and health premiums of $15.7 million in 1995, $2.2 million in 1994 and $2.4 million in 1993.\nDuring the third quarter of 1994, the California Supreme Court upheld Proposition 103, an insurance reform measure passed by California voters in 1988. In addition to increasing rate regulation, Proposition 103 gives the California insurance commissioner power to mandate rate rollbacks for most lines of property and casualty insurance. GAI recorded a charge of $26 million (included in \"Other operating and general expenses\") in the third quarter of 1994 in response to the California court decision. This charge was revised at December 31, 1994 to reflect a settlement agreement signed in March 1995 setting GAI's refund obligation at $19 million. The agreement was finalized in 1995 following a required waiting period.\nSeveral proposals have been made in recent years to change the federal income tax system. Some proposals included changes in the method of treating investment income and tax deferred income. To the extent a new tax law reduces or eliminates the tax deferred status of AFC's annuity products, that segment could be materially affected.\nInsurance Reserves The liability for losses and loss adjustment expenses for certain long-term scheduled payments under workers' compensation, auto liability and other liability insurance has been discounted at rates ranging from 4% to 8%. As a result, the total liability for losses and loss adjustment expenses at December 31, 1995, has been reduced by $67 million.\nThe following table provides an analysis of changes in the liability for losses and loss adjustment expenses, net of reinsurance (and grossed up), over the past three years on a GAAP basis (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNet Investment Income The following table shows (in millions) investment income earned and investment expenses incurred by AFC's insurance companies.\nStatutory Information AFC's insurance subsidiaries are required to file financial statements with state insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Net earnings and policyholders' surplus on a statutory basis for the insurance subsidiaries were as follows (in millions):\nReinsurance In the normal course of business, AFC's insurance subsidiaries assume and cede reinsurance with other insurance companies. The following table shows (in millions) (i) amounts deducted from property and casualty premium income accounts in connection with reinsurance ceded, (ii) amounts included in income for reinsurance assumed and (iii) reinsurance recoveries deducted from losses and loss adjustment expenses.\nT. Additional Information Total rental expense for various leases of railroad rolling stock, office space and data processing equipment was $25 million, $22 million and $24 million for 1995, 1994 and 1993, respectively. Sublease rental income related to these leases totaled $6.2 million in 1995, $6.4 million in 1994 and $6.6 million in 1993.\nFuture minimum rentals, related principally to office space and railroad rolling stock, required under operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 1995, were as follows: 1996 - $32 million, 1997 - $25 million, 1998 - $18 million, 1999 - $11 million, 2000 - $5 million and $7 million thereafter. At December 31, 1995, minimum sublease rentals to be received through the expiration of the leases aggregated $27 million.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\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 - $18 million and 1993 - $10 million. The aggregate allowance for such losses amounted to approximately $125 million and $109 million at December 31, 1995 and 1994, respectively.\nFair Value of Financial Instruments The following table presents (in millions) the carrying value and estimated fair value of AFC's financial instruments at December 31.\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. The fair value of the liability for annuities in the payout phase is assumed to be the present value of the anticipated cash flows, discounted at current interest rates. Fair value of annuities in the accumulation phase is assumed to be the policyholders' cash surrender amount.\nFinancial Instruments with Off-Balance-Sheet Risk On occasion, AFC and its subsidiaries have entered into financial instrument transactions which may present off- balance-sheet risks of both credit and market risk nature. These transactions include commitments to fund loans, loan guarantees and commitments to purchase and sell securities or loans. At December 31, 1995, AFC and its subsidiaries had commitments to fund credit facilities and contribute limited partnership capital totaling $17 million.\nRestrictions on Transfer of Funds and Assets of Subsidiaries Payments of dividends, loans and advances by AFC's subsidiaries are subject to various state laws, federal regulations and debt covenants which limit the amount of dividends, loans and advances that can be paid. The maximum amount of dividends payable (without prior approval from state insurance regulators) in 1996 from GAI based on net income is approximately $129 million. Total \"restrictions\" on intercompany transfers from AFC's subsidiaries cannot be quantified due to the discretionary nature of the restrictions.\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 R to the Consolidated Financial Statements.\nB. Schedules filed herewith for 1995, 1994 and 1993: Page I - Condensed Financial Information of Registrant S-2\nV - Supplemental Information Concerning Property-Casualty Insurance Operations S-4\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 Reports Items Reported\nDecember 13, 1995 Court of Appeals Ruling - USX Litigation\nFebruary 14, 1996 Agreement to sell Citicasters Common Stock\nS-1\nAMERICAN FINANCIAL CORPORATION - PARENT ONLY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In Thousands)\nCondensed Balance Sheet\nCondensed Statement of Earnings\nS-2\nAMERICAN FINANCIAL CORPORATION - PARENT ONLY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED (In Thousands)\nCondensed Statement of Cash Flows\nS-3\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE V - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS THREE YEARS ENDED DECEMBER 31, 1995 (IN MILLIONS)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F (a) AFFILIATION DEFERRED RESERVES FOR WITH POLICY UNPAID CLAIMS (b) REGISTRANT ACQUISITION AND CLAIM DISCOUNT (c) COSTS ADJUSTMENT DEDUCTED IN UNEARNED EARNED EXPENSES COLUMN C PREMIUMS PREMIUMS\nCONSOLIDATED PROPERTY-CASUALTY ENTITIES\n1995 $181 $2,966 $67 $921 $1,535 1994 $166 $2,917 $71 $825 $1,379 1993(d) $1,495\nCOLUMN G COLUMN H COLUMN I COLUMN J COLUMN K CLAIMS AND CLAIM AMORTIZATION PAID NET ADJUSTMENT EXPENSES OF DEFERRED CLAIMS PREMIUMS INVESTMENT CURRENT PRIOR POLICY AND CLAIM WRITTEN INCOME YEAR YEARS ACQUISITION ADJUSTMENT COSTS EXPENSES\nCONSOLIDATED PROPERTY-CASUALTY ENTITIES\n1995 $197 $1,174 ($108) $356 $ 996 $1,600\n1994 $177 $1,027 ($ 40) $329 $ 913 $1,481\n1993(d) $206 $1,103 ($ 39) $345 $1,052 $1,587\n(a) Grossed up for reinsurance recoverables of $709 and $730 at December 31, 1995 and 1994, respectively. (b) Discounted at rates ranging from 4% to 8%. (c) Grossed up for prepaid reinsurance premiums of $201 and $172 at December 31, 1995 and 1994, respectively. (d) Includes American Premier's Insurance Group through March 31, 1993.\nAMERICAN FINANCIAL GROUP, INC.\nInformation for American Financial Group is not included since that company files such information with the Commission as a registrant in its own right.\nS-4\nINDEX TO EXHIBITS\nAMERICAN FINANCIAL CORPORATION\nE-1\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND FIXED CHARGES AND PREFERRED DIVIDENDS (Dollars in Thousands)\nE-2\nAMERICAN FINANCIAL CORPORATION\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of subsidiaries of AFC at December 31, 1995. All corporations are subsidiaries of AFC and, if indented, subsidiaries of the company under which they are listed.\nThe names of certain subsidiaries are omitted, as such subsidiaries in the aggregate would not constitute a significant subsidiary.\nSee Part I, Item 1 of this Report for a description of certain companies in which AFC owns a significant portion and accounts for under the equity method. E-3\nAMERICAN FINANCIAL CORPORATION\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 AFC's consolidated property and casualty subsidiaries. The following is a summary of Schedule P reserves (in millions):\nSchedule P - Part 1 Summary - col. 33 $1,912 - col. 34 366 Statutory Loss and Loss Adjustment Expense Reserves $2,278\nB. UNCONSOLIDATED SUBSIDIARIES None\nC. 50% OR LESS OWNED PROPERTY AND CASUALTY AFFILIATES Not Included\nInformation for American Financial Group, Inc. for 1995 is not included since that company files such information with the Commission as a registrant in its own right.\nE-4\nAMERICAN FINANCIAL CORPORATION\nEXHIBIT 23 - CONSENTS OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in Registration Statement No. 33-59989 on Form S-3 and Registration Statement No. 33- 63441 on Form S-3 of our report dated March 15, 1996, with respect to the consolidated financial statements and schedules of American Financial Corporation included in the Annual Report on Form 10-K for the year ended December 31, 1995.\nERNST & YOUNG LLP Cincinnati, Ohio March 27, 1996\n____________________________________________________________\nWe consent to the incorporation by reference in Registration Statement No. 33-59989 on Form S-3 and Registration Statement No. 33- 63441 on Form S-3 of our report dated February 15, 1996 (March 23, 1995 with respect to the acquisition of American Financial Corporation as discussed in Note B to the financial statements), appearing in the Annual Report on Form 10-K of American Financial Corporation for the year ended December 31, 1995.\nDELOITTE & TOUCHE LLP\nCincinnati, Ohio March 27, 1996\nE-5\nSignatures\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, American Financial Corporation has duly caused this Report to be signed on its behalf by the undersigned, duly authorized.\nAmerican Financial Corporation\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:","section_4":"","section_5":"ITEM 5\nMarket for Registrant's Common Equity and Related Stockholder Matt ers\nNot applicable - Registrant's Common Stock is owned by American Financial Group, Inc. See the Consolidated Financial Statements for information regarding dividends.\nITEM 6","section_6":"ITEM 6\nSelected Financial Data\nThe following table sets forth certain data for the periods indicated (dollars in millions).\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 AFC's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page.\nAFC is organized as a holding company with almost all of its operations being conducted by subsidiaries and affiliates. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and dividends on AFC Preferred Stock. Therefore, certain analyses are best done on a parent only basis while others are best done on a total enterprise basis. In addition, since many of its businesses are financial in nature, AFC does not prepare its balance sheet using a current-concurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.\nAs discussed in Note A to the financial statements, on April 3, 1995, AFC merged with a newly formed subsidiary of American Financial Group, Inc., another new company formed to own both AFC and American Premier.\nLIQUIDITY AND CAPITAL RESOURCES\nRatios The following ratios may be considered relevant indicators of AFC's liquidity and are typically presented by AFC in its prospectuses and similar documents. Management believes that balance sheet ratios (debt to total capital) 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.\nAFC's ratio of debt to total capital at the holding company level (excluding amounts due to affiliates) was .31, .68 and .57 at December 31, 1995, 1994 and 1993, respectively. Including the note payable to American Premier, the ratio changes to .57. at December 31, 1995. Ratios of earnings to fixed charges, excluding and including preferred dividends, for the three years ended December 31, 1995, are shown below.\n1995 1994 1993 Earnings to fixed charges 2.23 1.69 2.62 Earnings to fixed charges plus preferred dividends 1.90 1.40 2.26\nThe National Association of Insurance Commissioners' model law for risk based capital (\"RBC\") applies to both life and property and casualty companies. RBC formulas determine 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 AFC insurance companies substantially exceeded the RBC requirements.\nSources of Funds Management believes AFC has sufficient resources to meet its liquidity requirements through operations in the short- term and long-term future. If funds generated from operations, including dividends from subsidiaries, are insufficient to meet fixed charges in any period, AFC would be required to generate cash through borrowings, sales of securities or other assets, or similar transactions.\nBank credit lines at several subsidiary holding companies provide ample liquidity which can be used to obtain funds for the operating subsidiaries or, if necessary, for the parent company. Agreements with the banks generally run for three to seven years and are renewed before maturity. While it is highly unlikely that all such amounts would ever be borrowed at one time, up to $395 million is available under these bank facilities.\nIn the past, funds have been borrowed under certain of these bank facilities and used for working capital, capital infusions into subsidiaries, and to retire other issues of short-term or high-rate debt. Also, while little was drawn on the bank lines at December 31, 1995, AFC believes it may be prudent and advisable to borrow up to $200 million of bank debt in the normal course and use the proceeds to retire additional amounts of public or privately held fixed rate debt over the next year or two.\nIn April 1995, AFC entered into a subordinated credit agreement with American Premier under which it can borrow up to $675 million. 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. During 1995, AFC borrowed $623 million under the agreement using the proceeds for debt retirements, capital contributions to subsidiaries and other corporate purposes. Borrowings, repayments and interest payments on the line are included in \"net advances from (to) affiliates\" in the following table.\nFunds to meet the parent company's expenditures have been provided from a variety of sources within the holding company, from subsidiaries and directly from outside sources, as detailed in the following table (in millions):\nGenerally, over 90% of the dividends (including non-cash dividends) received from subsidiaries have been from GAI. Payments of dividends by GAI are subject to various laws and regulations which limit the amount of dividends that can be paid without regulatory approval. Under Ohio law, the maximum amount of dividends which may be paid without (i) prior approval or (ii) expiration of a 30 day waiting period without disapproval\nis the greater of statutory net income or 10% of policyholders' surplus as of the preceding December 31, but only to the extent of earned surplus as of the preceding December 31. The maximum amount of dividends payable (without prior approval) in 1996 from GAI based on its 1995 statutory net income is approximately $129 million.\nFor statutory accounting purposes, equity securities are generally carried at market value. At December 31, 1995, AFC's insurance companies owned publicly traded equity securities with a market value of $1.2 billion, including equity securities of AFC affiliates (including subsidiaries) of $960 million. Since significant amounts of these are concentrated in a relatively small number of companies, decreases in the market prices could adversely affect the insurance group's capital, potentially impacting the amount of dividends available or necessitating a capital contribution. Conversely, increases in the market prices could have a favorable impact on the group's dividend- paying capability.\nUnder tax allocation agreements with AFC, its 80%-owned U.S. subsidiaries generally compute tax provisions as if filing separate returns based on book taxable income computed in accordance with generally accepted accounting principles. The resulting provision (or credit) is currently payable to (or receivable from) AFC. Following the Mergers, AFC and American Premier will each continue to file separate consolidated tax returns.\nUncertainties Great American's liability for unpaid losses and loss adjustment expenses includes amounts for various liability coverages related to environmental and hazardous product claims. The insurance industry typically includes only claims relating to polluted waste sites and asbestos in defining environmental exposures, whereas Great American extends this definition to include claims relating to breast implants, repetitive stress on keyboards, DES (a drug used in pregnancies years ago alleged to cause cancer and birth defects), and other latent injuries. At December 31, 1995, Great American had recorded $220 million (net of reinsurance recoverables of $164 million) for environmental pollution and hazardous products claims on policies written many years ago where, in most cases, coverage was never intended. Due to inconsistent court decisions on many coverage issues and the difficulty in determining standards acceptable for cleaning up pollution sites, significant uncertainties exist which are not likely to be resolved in the near future.\nIn exchange for $5 million, AFC has agreed to indemnify a former subsidiary for up to $35 million in excess of a threshold amount of $25 million of the costs it may incur in the 12 years beginning April 1, 1993 to resolve environmental matters, bankruptcy claims and certain other matters. Additionally, another AFC subsidiary has accrued $10.3 million at December 31, 1995 for environmental costs associated with the sales of former manufacturing properties.\nWhile 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 two-thirds of AFC's consolidated assets are invested in marketable securities. A diverse portfolio of bonds and redeemable preferred stocks accounts for over 95% of these securities. AFC attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. AFC's goal is to maximize return on an ongoing basis rather than focusing on short-term 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 AFC's bonds and redeemable preferred stocks was approximately 6 years.\nApproximately 94% of the bonds and redeemable preferred stocks held by AFC 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.\nInvestments in mortgage-backed securities (\"MBSs\") represented approximately 30% of AFC's bonds and redeemable preferred stocks at December 31, 1995. AFC invests primarily in MBSs which have a reduced risk of prepayment. Interest only (I\/Os), principal only (P\/Os) and other \"high risk\" MBSs represented approximately two percent of AFC's total mortgage-backed securities portfolio. In addition, the majority of MBSs held by AFC were purchased at a discount. Management believes that the structure and discounted nature of the MBSs will minimize the effect of prepayments on earnings over the anticipated life of the MBSs portfolio. More than 90% of AFC's MBSs are rated \"AAA\" with substantially all being of investment grade quality. The majority are collateralized 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, AFC does not believe a material risk (relative to earnings and liquidity) is inherent in holding such investments.\nBecause most income of the property and casualty insurance subsidiaries is currently sheltered from income taxes, non- taxable municipal bonds represent only a small portion (less than 1%) of the portfolio.\nAFC's equity securities are concentrated in a relatively limited number of major positions. This approach allows management to more closely monitor the companies and industries in which they operate.\nThe realization of capital gains, primarily through sales of equity securities, was an integral part of AFC's investment program. Individual securities are sold creating gains or losses as market opportunities exist. Pretax capital gains recognized upon disposition of securities, including affiliates, during the past five years have been: 1995 - $57 million; 1994 - - $50 million; 1993 - $165 million; 1992 - $104 million and 1991 - - $38 million. At December 31, 1995, the net unrealized gain on AFC's bonds and redeemable preferred stocks was $330 million; the net unrealized gain on equity securities was $115 million.\nRESULTS OF OPERATIONS - THREE YEARS ENDED DECEMBER 31, 1995\nGeneral AFC had accounted for American Premier as a subsidiary in 1992 and the first quarter of 1993 and as an investee from the second quarter of 1993 through the first quarter of 1995. AFC began accounting for American Financial Group as an investee in April 1995. As a result of these changes, current year income statement components are not comparable to prior years and are not indicative of future years.\nPretax earnings were $183 million in 1995 compared to $44 million in 1994 and $262 million in 1993.\nResults for 1995 include an improvement of $32 million in underwriting results of the property and casualty insurance segment, a $50 million increase in investment income and the absence of nonrecurring charges recorded in 1994. These items were partially offset by increases of $13 million in annuity benefits and $23 million in interest on borrowed money.\nResults for 1994 include AFC's share ($28 million) of American Premier's loss on the sale of General Cable securities, GAI's $19 million charge relating to a rate rollback liability in California and a $35 million charge related to payments under AFC's Book Value Incentive Plan. These items were partially offset by a $42 million decrease in interest expense.\nResults for 1993 include (i) $155 million in gains from the sales of AFC's insurance agency operations, Spelling Entertainment Group and 4.5 million shares of American Premier and additional proceeds received on the 1990 sale of the NSA Group to American Premier, and (ii) AFC's share ($52 million) of a tax benefit recorded by American Premier in the second, third and fourth quarters of 1993. These items were partially offset by a write-off of debt discount and expenses of $24 million.\nProperty and Casualty Insurance - Underwriting Great American (GAI and its property and casualty insurance subsidiaries) manages and operates its property and casualty business as two major sectors. The specialty lines are a diversified group of over twenty-five business lines that offer a wide variety of specialty insurance products. Some of the more significant areas are executive liability, inland and ocean marine, U.S.- based operations of Japanese companies, agricultural-related coverages, excess and surplus lines and fidelity and surety bonds. The commercial and personal lines provide coverages in commercial multi-peril, workers' compensation, umbrella and commercial automobile, standard private passenger automobile and homeowners insurance.\nTo understand the overall profitability of particular lines, timing of claims payments and the related impact of investment income must be considered. Certain \"short-tail\" lines of business (primarily property coverages) have quick loss payouts which reduce the time funds are held, thereby limiting investment income earned thereon. On the other hand, \"long- tail\" lines of business (primarily liability coverages and workers' compensation) have payouts that are either structured over many years or take many years to settle, thereby significantly increasing investment income earned on related premiums received.\nUnderwriting 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.\nWhile Great American desires and seeks to earn an underwriting profit on all of its business, it is not always possible to do so. As a result, the company attempts to expand in the most profitable areas and control growth or even reduce its involvement in the least profitable ones.\nResults for Great American's property and casualty insurance subsidiaries are as follows (dollars in millions):\n1995 1994 1993 Net Written Premiums (GAAP) Specialty Operations $ 882 $ 801 $ 616 Commercial and Personal Operations 717 683 666 Other Lines 1 5 6 Aggregate $1,600 $1,489 $1,288\nCombined Ratios (GAAP) Specialty Operations 97.5% 102.1% 97.3% Commercial and Personal Operations 99.1 98.9 101.0 Aggregate 100.2 102.4 103.5\nIn 1995, Great American's underwriting results significantly outperformed the industry average for the tenth consecutive year. Great American has been able to exceed the industry's results by focusing on highly specialized niche products, supplemented by commercial lines coverages and personal automobile products.\nSpecialty Operations Net written premiums for the specialty operations increased 10% during 1995 over 1994 due to increases in specialty niche lines (primarily crop hail, excess and surplus and executive liability). The combined ratio of the specialty operations in 1995 reflects improved results experienced in the crop hail and farm lines as well as coverages of U.S. operations of Japanese companies. The 1995 combined ratio also includes losses resulting from participation in a voluntary pool from which Great American withdrew in 1995.\nCommercial and Personal Operations Net written premiums for the commercial and personal operations increased 5% in 1995 due primarily to increased writing of workers' compensation and commercial umbrella insurance. The profitability of both of these lines improved in 1995. Workers' compensation improved due to favorable rate action by rating bureaus, health care cost containment programs, marketing emphasis on profitable states and implementation of a Drug-Free Workplace program. Commercial umbrella results improved due to a focus on low hazard risks and more favorable pricing in the higher umbrella layers. In addition, cost control measures reduced the underwriting expense ratio. These improved results were offset by an increase in the combined ratio of the personal lines operations due primarily to weather-related losses, start-up costs from its direct-to- consumer operation and deteriorating automobile loss experience for accident years 1994 and 1995.\nInvestment Income Changes in investment income reflect fluctuations in market rates and changes in average invested assets.\n1995 compared to 1994 Investment income increased $50 million (9%) in 1995 due to an increase in average investments held.\n1994 compared to 1993 Excluding American Premier, which was included as a subsidiary for the first three months of 1993, investment income increased $20 million (4%) due to an increase in average investments held.\nInvestee Corporations Equity in net earnings of investee corporations (companies in which AFC owns a significant portion of the voting stock) represents AFC's proportionate share of the investees' earnings and losses.\n1995 compared to 1994 AFC's equity in net earnings of investee corporations increased $53 million in 1995. Chiquita reported a $105 million improvement in operating income due primarily to the absence on certain nonrecurring charges, net gains from the sale of non-core assets, cost reductions in its core business and higher banana prices outside the European Union.\n1994 compared to 1993 AFC's equity in net earnings (losses) of investee corporations in 1994 includes its share ($28 million) of American Premier's loss on the sale of securities of General Cable and its share ($52 million) of American Premier's tax benefit in 1993. Chiquita's loss before extraordinary items was comparable in 1994 and 1993 as improvements in Meat Division operations and banana pricing were offset by charges and losses relating to farm closings and banana cultivation write-downs in Honduras and a substantial reduction of Chiquita's Japanese banana trading operations.\nGains (Losses) on Sales of Investees The loss on sale of investees in 1995 primarily represents a pretax loss on the sale of Chiquita to American Premier.\nThe gain on sale of investees in 1994 represents a pretax gain on the sale of General Cable common stock.\nThe gains on sales of investees in 1993 include (i) a pretax gain of $52 million on the sale of Spelling Entertainment and (ii) a pretax gain of $28 million on the public sale by AFEI of 4.5 million shares of American Premier common stock.\nGains on Sales of Subsidiaries The gains on sales of subsidiaries in 1993 include pretax gains of (i) $44 million from the sale of American Business Insurance, Inc. and (ii) $31 million representing an adjustment on AFC's 1990 sale of the nonstandard automobile insurance group to American Premier.\nSales of Other Products and Services Sales of other products and services represent American Premier's revenues from systems and software engineering services and the manufacture and supply of industrial products and services during the first quarter of 1993.\nAnnuity Benefits For GAAP financial reporting purposes, annuity receipts are generally accounted for as interest-bearing deposits (\"annuity benefits accumulated\") rather than as revenues. Under these contracts, policyholders' funds are credited with interest on a tax-deferred basis until withdrawn by the policyholder. Annuity benefits represent primarily interest related to annuity policyholders' funds held. The rate at which GALIC credits interest on annuity policyholders' funds is subject to change based on management's judgment of market conditions.\nAnnuity receipts totaled approximately $460 million in 1995, $440 million in 1994 and $400 million in 1993. Annuity receipts have increased in 1995, 1994 and 1993 due primarily to sales of newly introduced single premium products and, in 1995, the development of new single premium distribution channels. Annuity surrender payments have averaged approximately 8% of statutory reserves over the past three years.\nAnnuity benefits increased $13 million (5%) in 1995 and $13 million (6%) in 1994 due primarily to an increase in average annuity benefits accumulated.\nInterest on Borrowed Money Changes in interest expense result from fluctuations in market rates as well as changes in borrowings. AFC has generally financed its borrowings on a long- term basis which has resulted in higher current costs.\nInterest expense included in AFC's consolidated Statement of Earnings was comprised of (in millions):\n1995 1994 1993 AFC Parent $ 86.7 $ 56.9 $ 71.1 Great American Holding 20.2 24.7 23.4 American Annuity 17.3 20.9 21.2 Great American Insurance 13.0 11.9 14.0 American Premier - - 17.2 Other Companies 1.0 .8 10.3 $138.2 $115.2 $157.2\nAFC Parent's interest expense increased in 1995 due to an increase in average borrowings. In the second quarter of 1995, AFC borrowed $549 million under its new credit agreement with American Premier using the proceeds to retire $372 million of debt and for other corporate purposes. AFC Parent's interest expense decreased in 1994 due to (i) the issuance of $204 million of 9-3\/4% debentures in exchange for higher rate debt and (ii) the repurchase of $79 million principal amount of debentures. GAHC's interest expense decreased in 1995 due to a decrease in bank borrowings and the retirement of its floating rate notes and 11% notes in the third and fourth quarters, respectively. The decrease in other companies' interest expense in 1994 is due primarily to the repayments of borrowings in 1993.\nOther Operating and General Expenses Operating and general expenses included the following charges (in millions):\n1995 1994 1993 Minority interest $15 $ 9 $35 Proposition 103 - 19 - Allowance for bad debts - 18 10 Writeoff of debt discount and issue costs - - 24 Relocation expenses - - 8\nAllowance for bad debts includes charges for possible losses on agents' balances, reinsurance recoverables and other receivables. Relocation expenses represent the estimated costs of moving GALIC's operations from Los Angeles to Cincinnati.\nIncome Taxes See Note M to the Financial Statements for an analysis of items affecting AFC's effective tax rate.\nITEM 8","section_7A":"","section_8":"ITEM 8\nFinancial Statements and Supplementary Data\nPage\nReports of Independent Auditors\nConsolidated Balance Sheet: December 31, 1995 and 1994\nConsolidated Statement of Earnings: Years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Changes in Capital Accounts: 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\"Selected Quarterly Financial Data\" has been included in Note Q to the Consolidated Financial Statements.\nITEM 9","section_9":"ITEM 9\nChanges in and Disagreements with Accountants on Accounting and Financial Disclosure\nAFC filed a report on Form 8-K on August 29, 1995, reporting a change in independent accountants of American Premier Underwriters, Inc., an AFC investee. The report is incorporated herein by reference.\nPART III\nThe information required by the following Items will be included in AFC'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\nREPORTS OF INDEPENDENT AUDITORS\nBoard of Directors American Financial Corporation\nWe have audited the accompanying consolidated balance sheets of American Financial Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in capital accounts, 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 Corporation's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. The financial statements of American Premier Underwriters, Inc. (1994 and 1993) and General Cable Corporation (1993) have been audited by other auditors whose reports have been furnished to us; insofar as our opinion on the consolidated financial statements and schedules relates to data included for those corporations, it 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 American Financial 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.\nERNST & YOUNG LLP\nCincinnati, Ohio March 15, 1996\nREPORT OF AMERICAN PREMIER'S 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 American Premier's financial statements)\nREPORT OF GENERAL CABLE'S INDEPENDENT AUDITORS\nGeneral Cable Corporation:\nWe have audited the consolidated financial statements and related schedules of General Cable Corporation and subsidiaries listed in Item 14(a) of the Annual Report on Form 10-K of General Cable Corporation for the year ended December 31, 1993 (not presented separately herein). These consolidated financial statements and related schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and related schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 General Cable Corporation and subsidiaries at December 31, 1993 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information shown therein.\nDELOITTE & TOUCHE\nCincinnati, Ohio February 18, 1994\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL ACCOUNTS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands)\nSee notes to consolidated financial statements.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n____________________________________________________________________________\nINDEX TO NOTES\nA. Mergers J. Capital Subject to Mandatory B. Accounting Policies Redemptions C. Acquisitions and Sales of Subsidiaries K. Other Preferred Stock and Investees L. Common Stock D. Segments of Operations M. Income Taxes E. Investments N. Extraordinary Items F. Investment in Investees O. Pending Legal Proceedings G. Cost in Excess of Net Assets Acquired P. Benefit Plans H. Payable to American Premier Q. Transactions with Affiliates Underwriters, Inc. R. Quarterly Operating Results I. Other Long-Term Debt S. Insurance T. Additional Information\n____________________________________________________________________________\nA. Mergers On April 3, 1995, American Financial Corporation (\"AFC\") merged with a newly formed subsidiary of American Premier Group, Inc., another new company formed to own 100% of the common stock of both AFC and American Premier Underwriters, Inc. (\"American Premier\"). Subsequently, American Premier Group changed its name to American Financial Group, Inc. In the transaction, Carl H. Lindner and members of his family, who owned 100% of the Common Stock of AFC, exchanged their AFC Common Stock for approximately 55% of American Financial Group voting common stock. Former shareholders of American Premier, including AFC and its subsidiaries, received shares of American Financial Group stock on a one-for-one basis. No gain or loss was recorded on the exchange of shares.\nAFC continues to be a separate SEC reporting company with publicly traded debentures and preferred stock. Holders of AFC Series F and G Preferred Stock were granted voting rights equal to approximately 21% of the total voting power of AFC shareholders immediately prior to the Mergers.\nB. Accounting Policies\nBasis of Presentation The consolidated financial statements include the accounts of AFC and its subsidiaries. Changes in ownership levels of subsidiaries and affiliates have resulted in certain differences in the financial statements and have affected comparability between years. 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 wi th 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.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAFC's ownership of subsidiaries and significant affiliates with publicly traded shares at December 31, was as follows:\nInvestments Debt securities are classified as \"held to maturity\" and reported at amortized cost if AFC 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, AFC reassessed the classifications of its investments and transferred fixed maturity securities with an amortized cost of approximately $2.0 billion to \"available for sale.\" This \"one-time\" reclassification resulted in an increase of $104 million in the carrying value of fixed maturity investments and an increase of $67 million in shareholders' equity. The transfer had no effect on net earnings.\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.\nShort-term investments are carried at cost; loans receivable are stated primarily at the aggregate unpaid balance.\nInvestment in Investees Investments in securities of 20%- to 50%-owned companies are carried at cost, adjusted for AFC's proportionate share of their undistributed earnings or losses. Investments in less than 20%-owned companies are accounted for by the equity method when, in the opinion of management, AFC can exercise significant influence over operating and financial policies of the investee.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nCost in Excess of Net Assets Acquired The excess of cost of subsidiaries and investees over AFC's equity in the underlying net assets (\"goodwill\") is being amortized over 40 years. The excess of AFC's equity in the net assets of other subsidiaries and investees over its cost of acquiring these companies (\"negative goodwill\") is allocated to AFC's basis in these companies' fixed assets, goodwill and other long-term assets and is amortized on a 10- to 40-year basis.\nInsurance As discussed under \"Reinsurance\" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance recoverable.\nReinsurance In the normal course of business, AFC'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, AFC'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. AFC'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. AFC's insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers.\nDeferred Acquisition Costs Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred (\"DPAC\"). For the property and casualty companies, the deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. DPAC is charged against income ratably over the terms of the related policies. For the annuity companies, DPAC is amortized, with interest, in relation to the present value of expected gross profits on the 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 written; (b) estimates received from ceding\nreinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience; (d) estimates based on experience of expenses for investigating and adjusting claims and (e) the current state of the law and coverage litigation. 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.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAnnuity Benefits Accumulated Annuity receipts and benefit payments are generally recorded as increases or decreases in \"annuity benefits accumulated\" rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income.\nLife, Accident and Health Benefits Reserves Liabilities for future policy benefits under traditional ordinary life, accident and health policies are computed using a net level premium method. Computations are based on anticipated investment yields (primarily 7%), mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves are modified as necessary to reflect actual experience and developing trends.\nAssets Held In and Liabilities Related to Separate Accounts Investment annuity deposits and related liabilities represent deposits maintained by several banks under a previously offered tax deferred annuity program. AAG receives an annual fee from each bank for sponsoring the program; depositors can elect to purchase an annuity from AAG with funds in their account.\nIncome Taxes AFC files consolidated federal income tax returns which include all 80%-owned U.S. subsidiaries, except for certain life insurance subsidiaries. Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a benefit will be realized.\nBenefit Plans AFC provides retirement benefits, through contributory and noncontributory defined contribution plans, to qualified employees of participating companies. Contributions to benefit plans are charged against earnings in the year for which they are declared. AFC's Employee Stock Ownership Retirement Plan (\"ESORP\") is a noncontributory, qualified plan which invests in securities of AFG and affiliates for the benefit of their employees.\nAFC and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. AFC also provides postemployment benefits to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. The projected future cost of providing these benefits is expensed over the period the employees qualify for such benefits.\nIn connection with the Mergers, full vesting was granted to holders of units under AFC's Book Value Incentive Plan and the plan was terminated. Cash payments, which were made in April to holders of the units, were accrued at December 31, 1994.\nDebt Discount Debt discount and expenses are being amortized over the lives of respective borrowings, generally on the interest method.\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. Annuity receipts, benefits and withdrawals are also reflected as financing\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nactivities. 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.\nFair Value of Financial Instruments Methods and assumptions used in estimating fair values are described in Note T to the financial statements. These fair values represent point-in- time estimates of value that might not be particularly relevant in predicting AFC's future earnings or cash flows.\nC. Acquisitions and Sales of Subsidiaries and Investees\nChiquita In April 1995, AFC sold 3.2 million shares of Chiquita common stock to American Premier for $43.7 million in cash. AFC realized a pretax loss of $442,000 on the sale.\nGeneral Cable In June 1994, AFC sold its investment in General Cable common stock to an unaffiliated company for $27.6 million in cash. AFC realized a $1.7 million pretax gain on the sale (excluding its share of American Premier's loss on its sale of General Cable securities).\nAmerican Business Insurance In 1993, AFC sold its insurance brokerage operation, American Business Insurance, Inc., to Acordia, Inc., an Indianapolis-based insurance broker, for cash and Acordia common stock and warrants. AFC recognized a pretax gain of approximately $44 million on the sale.\nAmerican Premier In 1993, AFEI, whose assets consisted primarily of investments in American Premier, General Cable and AAG, sold 4.5 million shares of American Premier common stock in a secondary public offering. AFC recognized a pretax gain of $28.3 million, before minority interest, on the sale, including recognition of a portion of previously deferred gains related to sales of assets to American Premier from AFC subsidiaries. In anticipation of the reduction of AFC's ownership of American Premier below 50%, AFC ceased accounting for it as a subsidiary and began accounting for it as an investee in April 1993.\nIn 1993, American Premier paid AFC $52.8 million (including $12.8 million in interest) representing an adjustment on the 1990 sale of AFC's non-standard automobile group to American Premier. AFC recorded an additional pretax gain of $31.4 million on this transaction after deferring $21.4 million based on its then current ownership of American Premier.\nCiticasters In December 1993, GACC completed a plan of reorganization under which AFC received approximately 20% of new common stock in exchange for its previous holdings of GACC stock and debt. In connection with the plan, AFC also invested an additional $7.5 million in GACC common stock and debt securities.\nIn June 1994, AFEI purchased approximately 10% of Citicasters common stock from a third party for $23.9 million in cash.\nIn February 1996, Citicasters entered into a merger agreement with Jacor Communications, Inc. providing for the acquisition of Citicasters by Jacor. Under the agreement, AFC and its subsidiaries would receive approximately $220 million in cash plus warrants to buy approximately 1.5 million shares of Jacor common stock at $28 per share. AFC expects to\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nrealize a pretax gain of approximately $150 million on the sale. Consummation of the transaction is subject to regulatory approvals, and certain adjustments to the price will be made if the transaction does not close by September 30, 1996.\nSpelling In 1993, AFC sold its common stock investment in Spelling to Blockbuster Entertainment in exchange for Blockbuster common stock and warrants. AFC realized a $52 million pretax gain on the sale.\nD. Segments of Operations AFC operates its property and casualty insurance business in two major segments: specialty lines and commercial and personal lines. AFC's annuity business sells tax-deferred annuities principally to employees of primary and secondary educational institutions and hospitals. These insurance businesses operate throughout the United States. AFC also owns significant portions of the voting equity securities of certain companies (investee corporations - see Note F).\nThe following tables (in thousands) show AFC's assets, revenues and operating profit (loss) by significant business segment. Capital expenditures, depreciation and amortization are not significant. Operating profit (loss) represents total revenues less operating expenses. Goodwill and its amortization have been allocated to the various segments to which they apply. General corporate assets and expenses have not been identified or allocated by segment.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nE. Investments Bonds, redeemable preferred stocks and other stocks at December 31, consisted of the following (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES 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 7 years at December 31, 1995.\nCertain risks are inherent in connection with fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.\nRealized gains (losses) and changes in unrealized appreciation (depreciation) on fixed maturity and equity security investments are summarized as follows (in thousands):\nTransactions in fixed maturity investments included in the Statement of Cash Flows consisted of the following (in millions):\nSecurities classified as \"held to maturity\" having an amortized cost of $14.7 million and $8.7 million were sold for a loss of $1.8 million and $712,000 in 1995 and 1994, respectively, due to significant deterioration in the issuers' creditworthiness.\nGross gains of $69.4 million and gross losses of $16.5 were realized on sales of fixed maturity investments during 1993.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nF. Investment in Investees Investment in investees represents AFC's ownership of securities of certain companies. All of the companies named in the following table are subject to the rules and regulations of the SEC. Market value of the investments was approximately $1.0 billion and $890 million at December 31, 1995 and 1994, respectively.\nAFC's investment (and common stock ownership percentage) and equity in net earnings and losses of investees are stated below (dollars in thousands):\nIn addition to owning the common stock of AFC, American Financial Group owns all the common stock of American Premier, a specialty property and casualty insurance company. Chiquita is a leading international marketer, processor and producer of quality food products. Citicasters owns and operates radio and television stations in major markets throughout the country.\nIncluded in AFC's consolidated retained earnings at December 31, 1995, was approximately $290 million applicable to equity in undistributed net earnings of investees. Unamortized goodwill in investees totaled $187 million at December 31, 1995.\nSummarized financial information for AFC's investees at December 31, 1995, is shown below (in millions). See \"Investee Corporations\" in Management's Discussion and Analysis.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nG. 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 $107 million and $100 million, respectively. Amortization expense was $6.2 million in 1995, $6.1 million in 1994 and $15.0 million in 1993.\nH. Payable to American Premier Underwriters, Inc. Following the Mergers, American Premier agreed to lend up to $675 million to AFC under a line of credit, and subsequently advanced funds which, along with other funds available, were used by AFC to redeem $279 million of its various debentures, repay $187 million of Great American Holding Corporation's (\"GAHC's\") bank debt, and redeem $200 million of GAHC's Notes. Borrowings under the credit line bear interest at 11- 5\/8% and convert to a four-year term loan in March 2005. At December 31, 1995, AFC had borrowed $623.2 million under the credit agreement. Accrued interest of $16.2 million at December 31, 1995, was paid in January 1996.\nI. Long-Term Debt Long-term debt consisted of the following at December 31, (in thousands):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nAt December 31, 1995, sinking fund and other scheduled principal payments on debt for the subsequent five years were as follows (in thousands):\nDebentures purchased in excess of scheduled payments may be applied to satisfy any sinking fund requirement. The scheduled principal payments shown above assume that debentures purchased are applied to the earliest scheduled retirements.\nGAHC, a wholly-owned subsidiary of AFC, has a revolving loan agreement with groups of banks under which it can borrow up to $300 million. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized by stock of an operating subsidiary. The facility is guaranteed by AFC.\nAAG and AFEI have revolving credit agreements with banks under which they can borrow up to $75 million and $20 million, respectively. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized.\nDuring 1995, AFC sold an aggregate of $100 million of its 9- 3\/4% debentures due in 2004 for cash. In a 1994 exchange offer, AFC issued $204 million of its 9-3\/4% debentures for a like amount of its various other debenture issues. The related unamortized original issue discount and debt issue costs ($24.3 million) were written off in 1993. In connection with the offer, all of AFC's 13-1\/2% debentures not tendered for exchange were redeemed for $63.2 million in cash.\nIn connection with its acquisition of GALIC in 1992, AAG borrowed $230 million from several banks. In 1993, AAG sold $225 million of Notes to the public and repaid the bank loans. During 1994, AAG repurchased $77.1 million of the Notes in exchange for $69 million in cash plus 810,000 shares of its common stock. During 1995, AAG repurchased $4.9 million of the Notes for $5.0 million in cash.\nIn the first two months of 1996, AFC repurchased $48.3 million of its debentures for $52.4 million; and AAG repurchased $22.1 million of its Notes for $24.1 million.\nCash interest payments of $98 million, $115 million and $133 million were made on long-term debt in 1995, 1994 and 1993, respectively.\nJ. Capital Subject to Mandatory Redemption Capital subject to mandatory redemption includes AFC's Mandatory Redeemable Preferred Stock at December 31, 1994 and 1993 and, at December 31, 1993, capital subject to a put option.\nMandatory Redeemable Preferred Stock At December 31, 1994, there were 274,242 shares of $10.50 par value Series E Preferred Stock outstanding. These shares were retired, at par, in December 1995. During 1994, AFC redeemed all 150,212 outstanding shares of Series I Preferred Stock and 230,469 shares of Series E Preferred Stock for approximately $6.6 million. During 1993, AFC purchased 75,106 shares of Series I Preferred Stock for approximately $2.1 million.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nCapital Subject to Put Option Under a 1983 agreement, certain members of the Lindner family (the \"Group\") had the right to \"put\" to AFC their shares of AFC Common Stock or options at a defined value. In anticipation of the extinguishment of the Group's rights due to the Mergers, the allocation of capital equal to that value ($32.5 million) was reclassified to Retained Earnings at December 31, 1994.\nK. Other Preferred Stock Under provisions of both the Nonvoting (21.1 million shares authorized, including the Mandatory Redeemable Preferred Stock) and Voting (17.0 million shares authorized, 14.1 million shares outstanding) Cumulative Preferred Stock, the Board of Directors may divide the authorized stock into series and set specific terms and conditions of each series. The outstanding shares of preferred stock consisted of the following:\nSeries F, $1 par value - authorized 15,000,000 shares; annual dividends per share $1.80; 10% may be retired at AFC's option at $20 per share in 1996; 13,744,754 shares (stated value - $167.9 million) outstanding at December 31, 1995 and 1994.\nSeries G, $1 par value - authorized 2,000,000 shares; annual dividends per share $1.05; may be retired at AFC's option at $10.50 per share; 364,158 shares (stated value - $600,000) outstanding at December 31, 1995 and 1994.\nIn 1994, AFC purchased 8,500 shares of Series F Preferred Stock from a subsidiary's profit sharing plan for $159,000.\nL. Common Stock At December 31, 1994, there were 18,971,217 shares of AFC Common Stock outstanding. Prior to the Mergers discussed in Note A, AFC issued 762,500 common shares upon exercise of stock options. In connection with the Mergers, the number of authorized common shares was increased to 53.5 million and the number of outstanding shares was increased to 53.0 million. At December 31, 1995, American Financial Group owned all 53.0 million outstanding shares of AFC's Common Stock.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nM. Income Taxes The following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Earnings (in thousands):\nAdjusted earnings (loss) before income taxes consisted of the following (in thousands): 1995 1994 1993 Subject to tax in: United States $178,100 $ 28,422 $255,682 Foreign jurisdictions - (2,046) 1,744\n$178,100 $ 26,376 $257,426\nThe total income tax provision consists of (in thousands):\nFor income tax purposes, certain members of the AFC consolidated tax group had approximately $268 million of operating loss carryforwards available at December 31, 1995. The carryforwards are scheduled to expire as follows: $1 million in 1996, $21 million in 1997 through 2001, $143 million in 2002 through 2006 and $103 million in 2007 through 2010.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDeferred income taxes reflect the impact of temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities for AFC's tax group included in the Balance Sheet at December 31, were as follows (in millions):\nThe gross deferred tax asset has been reduced by a valuation allowance based on an analysis of the likelihood of realization. Factors considered in assessing the need for a valuation allowance include: (i) recent tax returns, which show neither a history of large amounts of taxable income nor cumulative losses in recent years, (ii) opportunities to generate taxable income from sales of appreciated assets, and (iii) the likelihood of generating larger amounts of taxable income in the future. The likelihood of realizing this asset will be reviewed periodically; any adjustments required to the valuation allowance will be made in the period in which the developments on which they are based become known.\nCash payments for income taxes, net of refunds, were $12.9 million, $30.0 million and $49.6 million for 1995, 1994 and 1993, respectively.\nN. Extraordinary Items Extraordinary items represent AFC's proportionate share of losses recorded by the following companies from their debt retirements. Amounts shown are net of minority interest and income tax benefits (in thousands):\nO. Pending Legal Proceedings Counsel has advised AFC that there is little likelihood of any substantial liability being incurred from any litigation pending against AFC and subsidiaries.\nP. Benefit Plans AFC expensed ESORP contributions of $11.0 million in 1995, $6.2 million in 1994 and $9.4 million in 1993. AFC expensed postretirement benefits of $2.9 million in 1995, $2.4 million in 1994 and $3.1 million in 1993.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nQ. Transactions With Affiliates In 1993, AFC sold stock of an affiliate to certain of its officers and employees for $1.8 million in cash and $270,000 in 5.25% unsecured notes due in five equal annual installments beginning in 1996. At December 31, 1993, an AFC real estate subsidiary owed $452,000 to The Provident Bank under a loan purchased by Provident in 1991 from an unrelated bank. The loan was repaid in 1994. Members of the Lindner family are majority owners of Provident's parent. In 1995, a subsidiary of AFC sold a house to its Chairman for $1.8 million. Also during 1995, AFC purchased from American Premier (i) certain properties for $15.9 million; (ii) a small reinsurance subsidiary for $13.7 million; and (iii) shares of AAG for $553,000. All of the above transactions have taken place at approximate market rates or values and, in the opinion of management, all amounts receivable are fully collectible.\nR. Quarterly Operating Results (Unaudited) The operations of certain of AFC's business segments are seasonal in nature. While insurance premiums are recognized on a relatively level basis, claim losses related to adverse weather (snow, hail, hurricanes, tornadoes, etc.) may be seasonal. Quarterly results necessarily rely heavily on estimates. These estimates and certain other factors, such as the nature of affiliates' operations and discretionary sales of assets, cause the quarterly results not to be necessarily indicative of results for longer periods of time. See Notes A and C for changes in ownership of companies whose revenues are included in the consolidated operating results and for the effects of gains on sales of subsidiaries and affiliates in individual quarters. The following are quarterly results of consolidated operations for the two years ended December 31, 1995 (in millions).\nResults for 1994 included credits of $3.9 million and $5.3 million in the second and third quarters and a fourth quarter charge of $43.9 million for units outstanding under AFC's Book Value Incentive Plan.\nRealized gains on sales of securities amounted to (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nS. Insurance Securities owned by insurance subsidiaries having a carrying value of approximately $808 million at December 31, 1995, were on deposit as required by regulatory authorities.\nOther income includes life, accident and health premiums of $15.7 million in 1995, $2.2 million in 1994 and $2.4 million in 1993.\nDuring the third quarter of 1994, the California Supreme Court upheld Proposition 103, an insurance reform measure passed by California voters in 1988. In addition to increasing rate regulation, Proposition 103 gives the California insurance commissioner power to mandate rate rollbacks for most lines of property and casualty insurance. GAI recorded a charge of $26 million (included in \"Other operating and general expenses\") in the third quarter of 1994 in response to the California court decision. This charge was revised at December 31, 1994 to reflect a settlement agreement signed in March 1995 setting GAI's refund obligation at $19 million. The agreement was finalized in 1995 following a required waiting period.\nSeveral proposals have been made in recent years to change the federal income tax system. Some proposals included changes in the method of treating investment income and tax deferred income. To the extent a new tax law reduces or eliminates the tax deferred status of AFC's annuity products, that segment could be materially affected.\nInsurance Reserves The liability for losses and loss adjustment expenses for certain long-term scheduled payments under workers' compensation, auto liability and other liability insurance has been discounted at rates ranging from 4% to 8%. As a result, the total liability for losses and loss adjustment expenses at December 31, 1995, has been reduced by $67 million.\nThe following table provides an analysis of changes in the liability for losses and loss adjustment expenses, net of reinsurance (and grossed up), over the past three years on a GAAP basis (in millions):\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNet Investment Income The following table shows (in millions) investment income earned and investment expenses incurred by AFC's insurance companies.\nStatutory Information AFC's insurance subsidiaries are required to file financial statements with state insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Net earnings and policyholders' surplus on a statutory basis for the insurance subsidiaries were as follows (in millions):\nReinsurance In the normal course of business, AFC's insurance subsidiaries assume and cede reinsurance with other insurance companies. The following table shows (in millions) (i) amounts deducted from property and casualty premium income accounts in connection with reinsurance ceded, (ii) amounts included in income for reinsurance assumed and (iii) reinsurance recoveries deducted from losses and loss adjustment expenses.\nT. Additional Information Total rental expense for various leases of railroad rolling stock, office space and data processing equipment was $25 million, $22 million and $24 million for 1995, 1994 and 1993, respectively. Sublease rental income related to these leases totaled $6.2 million in 1995, $6.4 million in 1994 and $6.6 million in 1993.\nFuture minimum rentals, related principally to office space and railroad rolling stock, required under operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 1995, were as follows: 1996 - $32 million, 1997 - $25 million, 1998 - $18 million, 1999 - $11 million, 2000 - $5 million and $7 million thereafter. At December 31, 1995, minimum sublease rentals to be received through the expiration of the leases aggregated $27 million.\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\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 - $18 million and 1993 - $10 million. The aggregate allowance for such losses amounted to approximately $125 million and $109 million at December 31, 1995 and 1994, respectively.\nFair Value of Financial Instruments The following table presents (in millions) the carrying value and estimated fair value of AFC's financial instruments at December 31.\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. The fair value of the liability for annuities in the payout phase is assumed to be the present value of the anticipated cash flows, discounted at current interest rates. Fair value of annuities in the accumulation phase is assumed to be the policyholders' cash surrender amount.\nFinancial Instruments with Off-Balance-Sheet Risk On occasion, AFC and its subsidiaries have entered into financial instrument transactions which may present off- balance-sheet risks of both credit and market risk nature. These transactions include commitments to fund loans, loan guarantees and commitments to purchase and sell securities or loans. At December 31, 1995, AFC and its subsidiaries had commitments to fund credit facilities and contribute limited partnership capital totaling $17 million.\nRestrictions on Transfer of Funds and Assets of Subsidiaries Payments of dividends, loans and advances by AFC's subsidiaries are subject to various state laws, federal regulations and debt covenants which limit the amount of dividends, loans and advances that can be paid. The maximum amount of dividends payable (without prior approval from state insurance regulators) in 1996 from GAI based on net income is approximately $129 million. Total \"restrictions\" on intercompany transfers from AFC's subsidiaries cannot be quantified due to the discretionary nature of the restrictions.\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 R to the Consolidated Financial Statements.\nB. Schedules filed herewith for 1995, 1994 and 1993: Page I - Condensed Financial Information of Registrant S-2\nV - Supplemental Information Concerning Property-Casualty Insurance Operations S-4\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 Reports Items Reported\nDecember 13, 1995 Court of Appeals Ruling - USX Litigation\nFebruary 14, 1996 Agreement to sell Citicasters Common Stock\nS-1\nAMERICAN FINANCIAL CORPORATION - PARENT ONLY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In Thousands)\nCondensed Balance Sheet\nCondensed Statement of Earnings\nS-2\nAMERICAN FINANCIAL CORPORATION - PARENT ONLY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED (In Thousands)\nCondensed Statement of Cash Flows\nS-3\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE V - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS THREE YEARS ENDED DECEMBER 31, 1995 (IN MILLIONS)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F (a) AFFILIATION DEFERRED RESERVES FOR WITH POLICY UNPAID CLAIMS (b) REGISTRANT ACQUISITION AND CLAIM DISCOUNT (c) COSTS ADJUSTMENT DEDUCTED IN UNEARNED EARNED EXPENSES COLUMN C PREMIUMS PREMIUMS\nCONSOLIDATED PROPERTY-CASUALTY ENTITIES\n1995 $181 $2,966 $67 $921 $1,535 1994 $166 $2,917 $71 $825 $1,379 1993(d) $1,495\nCOLUMN G COLUMN H COLUMN I COLUMN J COLUMN K CLAIMS AND CLAIM AMORTIZATION PAID NET ADJUSTMENT EXPENSES OF DEFERRED CLAIMS PREMIUMS INVESTMENT CURRENT PRIOR POLICY AND CLAIM WRITTEN INCOME YEAR YEARS ACQUISITION ADJUSTMENT COSTS EXPENSES\nCONSOLIDATED PROPERTY-CASUALTY ENTITIES\n1995 $197 $1,174 ($108) $356 $ 996 $1,600\n1994 $177 $1,027 ($ 40) $329 $ 913 $1,481\n1993(d) $206 $1,103 ($ 39) $345 $1,052 $1,587\n(a) Grossed up for reinsurance recoverables of $709 and $730 at December 31, 1995 and 1994, respectively. (b) Discounted at rates ranging from 4% to 8%. (c) Grossed up for prepaid reinsurance premiums of $201 and $172 at December 31, 1995 and 1994, respectively. (d) Includes American Premier's Insurance Group through March 31, 1993.\nAMERICAN FINANCIAL GROUP, INC.\nInformation for American Financial Group is not included since that company files such information with the Commission as a registrant in its own right.\nS-4\nINDEX TO EXHIBITS\nAMERICAN FINANCIAL CORPORATION\nE-1\nAMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND FIXED CHARGES AND PREFERRED DIVIDENDS (Dollars in Thousands)\nE-2\nAMERICAN FINANCIAL CORPORATION\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of subsidiaries of AFC at December 31, 1995. All corporations are subsidiaries of AFC and, if indented, subsidiaries of the company under which they are listed.\nThe names of certain subsidiaries are omitted, as such subsidiaries in the aggregate would not constitute a significant subsidiary.\nSee Part I, Item 1 of this Report for a description of certain companies in which AFC owns a significant portion and accounts for under the equity method. E-3\nAMERICAN FINANCIAL CORPORATION\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 AFC's consolidated property and casualty subsidiaries. The following is a summary of Schedule P reserves (in millions):\nSchedule P - Part 1 Summary - col. 33 $1,912 - col. 34 366 Statutory Loss and Loss Adjustment Expense Reserves $2,278\nB. UNCONSOLIDATED SUBSIDIARIES None\nC. 50% OR LESS OWNED PROPERTY AND CASUALTY AFFILIATES Not Included\nInformation for American Financial Group, Inc. for 1995 is not included since that company files such information with the Commission as a registrant in its own right.\nE-4\nAMERICAN FINANCIAL CORPORATION\nEXHIBIT 23 - CONSENTS OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in Registration Statement No. 33-59989 on Form S-3 and Registration Statement No. 33- 63441 on Form S-3 of our report dated March 15, 1996, with respect to the consolidated financial statements and schedules of American Financial Corporation included in the Annual Report on Form 10-K for the year ended December 31, 1995.\nERNST & YOUNG LLP Cincinnati, Ohio March 27, 1996\n____________________________________________________________\nWe consent to the incorporation by reference in Registration Statement No. 33-59989 on Form S-3 and Registration Statement No. 33- 63441 on Form S-3 of our report dated February 15, 1996 (March 23, 1995 with respect to the acquisition of American Financial Corporation as discussed in Note B to the financial statements), appearing in the Annual Report on Form 10-K of American Financial Corporation for the year ended December 31, 1995.\nDELOITTE & TOUCHE LLP\nCincinnati, Ohio March 27, 1996\nE-5\nSignatures\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, American Financial Corporation has duly caused this Report to be signed on its behalf by the undersigned, duly authorized.\nAmerican Financial Corporation\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:","section_15":""}
{"filename":"788784_1995.txt","cik":"788784","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nEnterprise\nPublic Service Enterprise Group Incorporated (Enterprise), incorporated under the laws of the State of New Jersey with its principal executive offices located at 80 Park Plaza, Newark, New Jersey 07101, is a public utility holding company that neither owns nor operates any physical properties. Enterprise has two direct wholly-owned subsidiaries, Public Service Electric and Gas Company (PSE&G) and Enterprise Diversified Holdings Incorporated (EDHI). Enterprise's principal subsidiary, PSE&G, is an operating public utility providing electric and gas service in certain areas in the State of New Jersey. Enterprise has claimed an exemption from regulation by the Securities and Exchange Commission (SEC) as a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA), except for Section 9(a)(2) thereof which relates to the acquisition of voting securities of an electric or gas utility company. PSE&G is subject to direct regulation by the New Jersey Board of Public Utilities (BPU) and the Federal Energy Regulatory Commission (FERC). EDHI is the parent of Enterprise's nonutility businesses: Energy Development Corporation (EDC), an oil and gas exploration and production and marketing company; Community Energy Alternatives Incorporated (CEA), an investor in and developer and operator of cogeneration and independent power production facilities; Public Service Resources Corporation (PSRC), which makes primarily passive investments; Enterprise Group Development Corporation (EGDC), a diversified nonresidential real estate development and investment business; PSEG Capital Corporation (Capital), which provides debt financing on the basis of a minimum net worth maintenance agreement from Enterprise; and Enterprise Capital Funding Corporation (Funding), which provides privately placed debt financing on the basis of the consolidated financial position of EDHI without direct support from Enterprise. As of December 31, 1995 and 1994, PSE&G comprised 85% of Enterprise's assets. PSE&G's 1995, 1994 and 1993 revenues were 93% of Enterprise's revenues and PSE&G's earnings available to Enterprise for such years were 88%, 91% and 96%, respectively, of Enterprise's net income. Production of electricity and electric and gas distribution will continue as the principal business of Enterprise for the foreseeable future. Enterprise has announced that it intends to divest EDC in 1996. See EDHI - EDC and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A).\nFinancial information with respect to business segments of PSE&G and Enterprise is set forth in Note 15 -- Financial Information by Business Segments of Notes to Consolidated Financial Statements (Notes).\nPSE&G\nPSE&G, a New Jersey corporation with its principal executive offices at 80 Park Plaza, Newark, New Jersey 07101, is an operating public utility company engaged principally in the generation, transmission, distribution and sale of electric energy service and in the transmission, distribution and sale of gas service in New Jersey. PSE&G supplies electric and gas service in areas of New Jersey in which approximately 5,500,000 persons, about 70% of the State's population, reside. (See General -- Enterprise.)\nPSE&G's electric and gas service area is a corridor of approximately 2,600 square miles running diagonally across New Jersey from Bergen County in the northeast to an area below the City of Camden in the southwest. The greater portion of this area is served with both electricity and gas, but some parts are served with electricity only and other parts with gas only. This heavily populated, commercialized and industrialized territory encompasses most of New Jersey's largest municipalities, including its six largest cities -- Newark, Jersey City, Paterson, Elizabeth, Trenton and Camden -- in addition to approximately 300 suburban and rural communities. It contains a diversified mix of commerce and industry, including major facilities of many corporations of national prominence.\nUnder the general laws of New Jersey, PSE&G has the right to use the public highways, streets and alleys in New Jersey for erecting, laying and maintaining poles, conduits and wires necessary for its electric operations. PSE&G must, however, first obtain the consent in writing of the owners of the soil for the purpose of erecting poles. In incorporated cities and towns, PSE&G must obtain from the municipality a designation of the streets in which the poles are to be placed and the manner of placing them. PSE&G's rights are also subject to regulation by municipal authorities with respect to street openings and the use of streets for erecting poles in incorporated cities and towns.\nPSE&G, by virtue of a special charter granted by the State of New Jersey to one of its predecessors, has the right to use the roads, streets, highways and public grounds in New Jersey for pipes and conduits for distributing gas.\nPSE&G believes that it has all the franchises (including consents) necessary for its electric and gas operations in the territory it serves. Such franchises are non-exclusive.\nFor discussion of the significant changes which PSE&G's electric and gas utility businesses have been and are undergoing, see Competition and Regulation.\nIndustry Issues\nEnterprise and PSE&G are affected by many issues that are common to the electric and gas industries, such as: deregulation and the unbundling of energy supplies and services; an increasingly competitive energy marketplace, sales retention and growth potential in a mature service territory and a need to contain costs (see Competition, Regulation and MD&A - Competition); ability to operate nuclear plants in a cost effective way (see PSE&G - Nuclear Operations); ability to obtain adequate and timely rate relief, cost recovery, including the potential impact of stranded assets, and other necessary regulatory approvals (see PSE&G -- Rate Matters; Regulation and Item 7. MD&A - Competition); costs of construction (see Construction and Capital Requirements); operating restrictions, increased costs and construction delays attributable to environmental regulations (see Environmental Controls); controversies regarding electric and magnetic fields (EMF) (see Environmental Controls); nuclear decommissioning and the availability of reprocessing and storage facilities for spent nuclear fuel (see Electric Fuel Supply and Disposal); and credit market concerns with these issues.\nCompetition\nOverview\nThe energy utility industry is in transition. Changes in Federal and state law and regulation are encouraging new entrants to the traditional markets of electric and gas utilities. New technologies are creating opportunities for new energy services. Customers, more aware and sophisticated about their choices and dissatisfied with prices and the often limited range of options available from the local utility, are increasingly turning elsewhere for energy supplies and services. As a consequence of competition, the traditional utility structure -- consisting of a vertically integrated system and functioning as a natural monopoly -- is being dramatically altered. Further, PSE&G's ability to meet competition and change prices to meet customer's needs is impacted by state regulation, including the historic utility mandate to serve all customers. (See MD&A -- Competition.) For a discussion of PSE&G's alternative plan of rate regulation, \"New Jersey Partners in Power\" (Alternative Rate Plan) as a response to these demands, see MD&A and Note 2 -- Rate Matters of Notes.\nNon health and safety related Federal energy laws and regulations are designed to make more efficient use of all energy, introduce price competition, encourage the use of nonconventional energy sources and\nlimit oil imports by increasing production of domestic energy resources. Among other things, these actions (1) encourage development of alternative energy generation, (2) require wheeling of power for wholesale transactions, (3) require state regulatory authorities to consider certain standards on rate design and certain other utility practices, (4) encourage conservation of energy through certain financial incentives, including incentives by individual utilities to customers to help them to conserve energy and (5) deregulate prices on natural gas.\nAlso, Federal and State laws designed to reduce air and water pollution and control hazardous substances have had the effect of increasing the costs of operation and replacement of existing utility plants and other facilities. (See Environmental Controls.)\nCompetition from nonutility generators (NUGs), such as cogenerators, independent power producers (IPP) and exempt wholesale generators (EWGs), as permitted by the Public Utility Regulatory Policies Act of 1978 (PURPA) and the National Energy Policy Act of 1992 (EPAct), continues to impact PSE&G. As a result of changes brought about by EPAct, along with proposals in some states to authorize retail wheeling, discussed below, electric customers and suppliers, including PSE&G and its customers, have increased opportunities for purchase and sale of electricity from and to sellers and buyers outside of traditional franchised territories. Retention of existing customers and potential sales growth will depend upon the ability of PSE&G to contain costs, meet customer expectations and respond to changing economic conditions and energy regulation. As a result of such competitive forces, Enterprise Ventures & Services Corporation (Ventures) has been established as a subsidiary of PSE&G to develop and market new energy-related products and services beyond traditional geographic and\/or industry boundaries. Competition may also adversely impact upon the economics of certain regulatory-created incentives, such as Demand Side Management (DSM) and conservation. For additional information, including a discussion of the potential effects of competition upon rates, cost recovery and assets, see MD&A -- Competition. For information relating to the Alternative Rate Plan see MD&A and Note 1--Organization and Summary of Significant Accounting Policies, Note 2--Rate Matters and Note 5--Deferred Items of Notes.\nElectric\nIn the electric utility industry, competitive pressures began with the enactment of PURPA. This law, together with subsequent changes in Federal regulation, has increasingly opened the electric utility industry to competition. PURPA created a class of generating facilities exempt from Federal and State public utility regulation -- cogeneration and small power producers known as \"qualifying facilities\" (QFs) -- and created an instant market for them by requiring regulated utilities to purchase their excess power production. EPAct, by facilitating the development of the wholesale power market, has led to even stronger competition. The increasing competitiveness of the electric wholesale markets, along with consideration of retail wheeling or \"direct retail access\" within utility franchise areas in several states, has brought to the forefront the issue of potential stranded costs within the electric utility industry (see MD&A - Competition).\nEPAct provides FERC with increased authority to order \"wheeling\" of wholesale, but not retail, electric power on the transmission systems of electric utilities, provided that certain requirements are met. In order to facilitate the transition to increased competition in wholesale power markets made possible by EPAct, in March 1995, FERC issued a Notice of Proposed Rulemaking (NOPR) which, if adopted, would require electric utilities, including PSE&G, to provide open access to the interstate transmission network pursuant to non-discriminatory tariffs available to all wholesale sellers and buyers of electric energy. Utilities would be required to offer transmission to eligible customers comparable to the service they provide themselves and to take service under the tariffs for their own wholesale sales and purchases. Further, transmission and ancillary service components would be unbundled and, when buying or selling power, utilities would have to rely on the same network for transmission system information as their customers.\nThe NOPR states FERC's general principle that utilities should be entitled to full recovery of legitimate and verifiable stranded costs at the Federal and State levels and reiterates its prior proposal that such costs be directly assigned to departing customers. The NOPR further provides that stranded costs due to retail wheeling are a state matter, while stranded costs due to wholesale wheeling, municipalization or a change from retail to wholesale customer class are within FERC's jurisdiction. PSE&G cannot predict the impact of any regulations that may be adopted. See MD&A -- Competition. For discussion of the Pennsylvania, New Jersey and Maryland Interconnection (PJM) proposal in response to the FERC NOPR, see Pennsylvania--New Jersey--Maryland Interconnection. For a discussion of PSE&G's actions and comments related to the potential environmental impact of the NOPR, see Environmental Controls - Air Pollution Control.\nEPAct also amended PUHCA to create a new category of generation owners known as EWGs, which are not subject to PUHCA regulation. EPAct permits both independent companies and utility affiliates to participate in the development of EWG projects regardless of the location and ownership of other generating resources. The transmission access provisions apply to wholesale, but not retail, \"wheeling\" of power, subject to FERC review. See PSE&G -- Integrated Resource Plan, Construction and Capital Requirements, Financing Activities and PSE&G - -- Customers. For information concerning the activities of CEA, which is an owner-developer of QFs and EWGs, see EDHI -- CEA.\nAnother key factor in determining how competition will affect PSE&G's electric business is the extent to which New Jersey public utility regulation may be modified to be reflective of these new competitive realities. The BPU presented the first phase of the New Jersey Energy Master Plan to Governor Whitman on March 8, 1995. This Phase I Plan acknowledged the need for regulatory flexibility as competition unfolds and called for legislation that would allow New Jersey utilities to propose, subject to BPU approval, alternatives to existing rate base\/rate of return pricing, allow for pricing flexibility under certain standards for customers with competitive options and equalize the impact of tax policies, such as New Jersey Gross Receipts and Franchise Tax (NJGRT) which is currently assessed only on utility retail energy sales. On July 20, 1995, Governor Whitman signed into law legislation which provides utilities the flexibility to propose alternative regulatory pricing and to offer negotiated off-tariff agreements (See PSE&G - Customers). On January 16, 1996, PSE&G filed a petition with the BPU for its Alternative Rate Plan designed to fulfill the objectives of this new regulatory reform legislation. This Alternative Rate Plan represents a regulatory transition designed to provide PSE&G with the mechanisms and incentives to compete more effectively on several fronts, including the ability to develop revenue from non-regulated products and services, accelerate or modify depreciation schedules to help mitigate any potential stranded asset issue and more aggressively manage costs. For more information regarding the Alternative Rate Plan see MD&A and Note 1 -- Organization and Summary of Significant Accounting Policies, Note 2 -- Rate Matters and Note 5 -- Deferred Items of Notes.\nOn June 1, 1995, the BPU issued its Order initiating a formal Phase II proceeding to the New Jersey Energy Master Plan. This proceeding is intended to investigate and consider the future long term structure of the electric power industry in New Jersey. The proceeding will address wholesale and retail competition, ownership of generation, transmission and distribution facilities, operation of the transmission system and stranded investments. A Phase II report proposing policy restructuring is expected by March 1996. PSE&G cannot predict what impact, if any, the Phase II report will have.\nGas\nOver the last decade the natural gas industry has experienced a dramatic transformation as several FERC initiatives have subjected the industry to competitive market forces. On the interstate level, the pipeline suppliers that serve PSE&G have unbundled gas supply and service and now offer transportation services that move gas purchased from numerous natural gas producers and marketers to PSE&G's service territory.\nThis unbundling effort has moved to the local level and, in late 1994, the BPU approved unbundled transport tariffs for PSE&G. These tariffs allow any non-residential customer, regardless of size, to purchase its own gas, transport it to PSE&G and require PSE&G to deliver such gas to the customer's facility. To date, over 5,000 commercial and industrial customers out of a potential of 180,000 customers have decided to utilize this service. It is expected that this number will continue to grow as marketers become more active in New Jersey and encourage customers to convert from sales service. The transportation rate schedules produce the same non-fuel revenue per therm as existing sales service rate schedules. Thus, PSE&G's earnings are unaffected whether the customers remain on sales service or convert to transportation service. See Gas Operations and Supply. In meeting the challenges and opportunities presented by this unbundling of gas supply and service, Enterprise initiated a gas marketing company, U.S. Energy Partners (USEP). For more information see EDHI - PSRC.\nConstruction and Capital Requirements\nFor information concerning investments, construction and capital requirements see MD&A, Note 6 -- Schedule of Consolidated Debt, Note 7 -- Long-Term Investments and Note 12 -- Commitments and Contingent Liabilities -- Construction and Fuel Supplies of Notes.\nFinancing Activities\nFor a discussion of issuance, book value and market value of Enterprise's Common Stock and external financing activities of Enterprise, PSE&G and EDHI for the year 1995, see MD&A -- Liquidity and Capital Resources and Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nFor a discussion of Capital and Funding, see EDHI -- Capital and EDHI - Funding. For further discussion of long-term debt and short-term debt, see Note 6 -- Schedule of Consolidated Debt of Notes.\nFederal Income Taxes\nFor information regarding Federal income taxes, see Note 1 -- Organization and Summary of Significant Accounting Policies, Note 2 -- Rate Matters and Note 10 -- Federal Income Taxes of Notes.\nCredit Ratings\nThe current ratings of securities of Enterprise's subsidiaries set forth below reflect the respective views of the rating agency furnishing the same, from whom an explanation of the significance of such ratings may be obtained. There is no assurance that such ratings will continue for any given period of time or that they will not be revised downward or withdrawn entirely by such rating agencies, if, in their respective judgments, circumstances so warrant. Any such downward revision or withdrawal of any of such ratings may have an adverse effect on the market price of Enterprise's Common Stock and PSE&G's securities and serve to increase the cost of capital of PSE&G and EDHI.\n(A) Supported by commercial bank letter of credit (see MD&A -- Liquidity and Capital Resources and Note 6-- Schedule of Consolidated Debt -- Short-Term of Notes.)\nPSE&G\nRate Matters\nFor information concerning PSE&G's Alternative Rate Plan, rate matters, and environmental remediation and fuel adjustment clauses see Note 1 -- Organization and Summary of Significant Accounting Policies and Note 2 -- Rate Matters of Notes. For information concerning PSE&G's Under (Over) recovered Electric Energy and Gas Fuel Costs, see Note 5 -- Deferred Items of Notes.\nNuclear Performance Standard\nThe BPU has established a nuclear performance standard (NPS) for nuclear generating stations owned by New Jersey electric utilities, including the five nuclear units in which PSE&G has an ownership interest: Salem Nuclear Generating Station, Units 1 and 2 (Salem 1 and 2) -- 42.59%; Hope Creek Nuclear Generating Station (Hope Creek) -- 95%; and Peach Bottom Atomic Power Station, Units 2 and 3 (Peach Bottom 2 and 3) -- 42.49%. PSE&G operates Salem and Hope Creek, while Peach Bottom is operated by PECO Energy, Inc. (PECO). The following table sets forth the capacity factor in accordance with the NPS of each of PSE&G's nuclear units for the years indicated:\nFor information concerning the NPS, see Nuclear Operations and Note 12 -- Commitments and Contingent Liabilities of Notes.\nCustomers\nAs of December 31, 1995, PSE&G provided service to approximately 1,900,000 electric customers and 1,500,000 gas customers. PSE&G is not dependent on a single customer or a few customers for its electric or gas sales. For the year ended December 31, 1995, PSE&G's operating revenues aggregated $5.7 billion, of which 70% was from its electric operations and 30% from its gas operations. PSE&G's business is seasonal in that sales of electricity are higher during the summer months because of air conditioning requirements and sales of gas are greater in the winter months due to the use of gas for space-heating purposes.\nThese revenues were derived as follows:\nCustomers of PSE&G, as well as those of other New Jersey electric and gas utilities, pay the NJGRT which, in effect, adds approximately 13% to their bills. The NJGRT is a unit tax based on electric kilowatthour and gas therm sales. This tax differential provides an incentive to large-volume electric and gas customers to seek to obtain their energy supplies from nonutility sources not subject to NJGRT. To the extent PSE&G experiences a loss of customers seeking to avoid this cost, it could result in a significant decrease in PSE&G's revenues and earnings.\nOn November 17, 1995, the BPU issued an order approving a Stipulation regarding PSE&G's proposed Experimental Hourly Energy Pricing Tariff and the first service agreement thereunder with its second largest customer. Under the agreement, the tariff will result in a bill reduction for the customer of approximately $7 million or about 27%. This reduction in revenues will be partially offset by a decrease of $1.25 million in PSE&G's NJGRT liability. Under the agreement between the customer and PSE&G, the customer will forego an opportunity to relocate to another state and remain a PSE&G customer for ten years. On January 2, 1996, an appeal seeking to overturn the BPU's November 17, 1995 Decision and Order was filed by a third party in the Appellate Division of the Superior Court of New Jersey. PSE&G cannot predict the outcome of this matter.\nPSE&G has signed each of its three existing wholesale electric customers, aggregating 40 mw of load, to 5-year full service agreements with mid-term extension options. In addition, under the terms of a previously negotiated 10-year wholesale power transaction, PSE&G receives $12.5 million in annual revenues from an out of state electric cooperative. For further information on the impact of competition on PSE&G's customer and revenue base - See Competition and MD&A - Competition.\nIntegrated Resource Plan\nPSE&G's construction program focuses on upgrading electric and gas transmission and distribution systems and constructing new transmission and distribution facilities to serve new load.\nPursuant to its Integrated Resource Plan (IRP), PSE&G periodically reevaluates its forecasted customer load and peak growth and the sources of electric generating capacity and DSM to meet such projected growth (see Demand Side Management below). The IRP takes into account assumptions concerning future customer demand, future cost trends, especially fuel and purchased power expenses, the effectiveness of conservation and load management activities, the long-term condition of and projected additions to PSE&G's plants and capacity available from other electric utilities and nonutility suppliers. PSE&G's IRP consists principally of plant additions, power purchases through PJM and from NUGs and DSM.\nPennsylvania -- New Jersey -- Maryland Interconnection\nPSE&G is a member of the PJM which integrates the bulk power generation and transmission supply operations of 11 utilities in Pennsylvania, New Jersey, Delaware, Maryland, Virginia and the District of Columbia, and, in turn, is interconnected with other major electric utility companies in the northeastern part of the United States. The PJM is operated as one system and provides for the purchase and sale of power among members on the basis of reliability of service and operating economy. As a result, the most economical mix of generating capability available is used to meet PJM daily load requirements. PSE&G's output, as shown under Electric Fuel Supply and Disposal, reflects significant amounts of purchased power because at times it is more economical for PSE&G to purchase power from PJM and others than to produce it. As of December 31, 1995, the aggregate installed generating capacity of the PJM companies was 56,098 megawatts (MW). The all time record peak one-hour demand experienced by the PJM power pool was 48,524 MW which occurred on August 2, 1995. The 1995 peak was 2,532 MW higher than the record-setting 1994 summer peak of 45,992 MW which occurred on July 8, 1994. PSE&G's capacity obligations to the PJM system vary from year to year due to changes in system characteristics. PSE&G expects to have sufficient installed capacity to meet its obligations during the 1996-2000 period.\nPJM has developed a comprehensive proposal intended to meet or exceed the goals expressed by FERC in its open access NOPR, including a number of innovations that were designed to harmonize the requirements of the NOPR with the benefits of power pooling. In this proposal, PJM intends to satisfy the NOPR's goals by building upon the foundation of PJM's power pooling operations. The member companies of PJM intend to file this proposal with FERC by May 1996 and implement a restructured pool by year-end 1996.\nUnder this proposal, the current members of PJM and other load- serving entities in the PJM control area will purchase regional \"network\" transmission rights that are intended to enable them to reliably and economically integrate generation and load. For deliveries to retail customers, this service will remain part of the bundled rates for retail electric service, subject to state jurisdiction, but with terms and conditions comparable to the service provided for wholesale users. Because this service will cover all deliveries to loads located in the pool, generators selling power to serve pool load will not have to purchase transmission service independently. This is intended to create a regional wholesale power market in which all sellers and buyers operate on a level playing field.\nUnder the proposal, transmission service will be provided under a regional point-to-point transmission service tariff. This tariff will apply a uniform ratemaking methodology to all wholesale transactions involving deliveries outside the pool, including off- system sales by the current members of PJM and other load-serving entities in the pool. Accordingly, all transmission service associated with sales outside the pool will be provided on a comparable basis.\nIn order to meet the requirements to functionally unbundle transmission, PJM has proposed to reorganize into an independent System Operator (ISO) with responsibility for operating the bulk power system, administering the regional transmission service tariffs and managing\nthe pool's competitive energy market. The ISO will be governed by a Board of Directors that is not controlled by the transmission-owning members of PJM or their affiliates, and its responsibilities will be set forth in contracts filed with the FERC. The ISO will contract with the various pool participants to supply control area services, administer the transmission service tariffs and be responsible for maintaining the reliable operation of the system throughout each day.\nOne of the key elements of PJM's restructuring proposal is the creation of an expanded regional market for energy transactions. PJM will replace the existing system of cost-based centralized dispatch with an expanded, hourly bid\/price pool in which all sellers will be able to bid their energy into the pool and all load-serving entities will be able to buy energy from the pool. The energy market will \"clear\" in each hour at the highest bid price for energy that must be dispatched to serve load.\nFurther, under the proposal, PJM will retain most of the existing pool procedures for ensuring reliable electric service, but will create new contractual mechanisms to ensure participation by all entities responsible for serving load in decisions affecting reliability. Each load-serving entity that chooses to operate in the PJM control area will be required to execute an agreement to maintain adequate generation reserves and to share those reserves on a reciprocal basis. PJM will establish an enhanced regional planning process, under the supervision of the ISO, to meet Mid-Atlantic Area Reliability Council (MAAC) reliability requirements applicable to both generation and transmission. In short, all load-serving entities in the pool will be subject to the same reliability standards and will participate in decisions relating to the establishment of regional reliability requirements.\nPower Purchases\nA component of PSE&G's IRP consists of expected capacity additions from NUGs. These additions are projected to aggregate 46 MW and are scheduled for service by 1998. NUG projects are expected to comprise approximately 6.5% of energy resources by 2004. This availability of NUG generation will reduce the need for PSE&G to build or acquire additional generation.\nPSE&G is also a party to the MAAC which provides for review and evaluation of plans for generation and transmission facilities and other matters relevant to reliability of the bulk electric supply systems in the Mid-Atlantic area.\nPSE&G expects to be able to continue to meet the demand for electricity on its system through operation of available equipment and by power purchases. However, if periods of unusual demand should coincide with outages of equipment, PSE&G could find it necessary at times to reduce voltage or curtail load in order to safeguard the continued operation of its system.\nDemand Side Management\nIntegrated resource planning brings together demand-side and supply-side strategies. In order to encourage DSM, the BPU adopted rules in 1991 providing special incentives to encourage utilities to offer these load management conservation services. The rules are designed to place DSM on an equal regulatory footing with supply side or energy production investments. Both EPAct and Phase I of the Energy Master Plan call for conservation to play a significant role in meeting New Jersey's energy needs over the coming decade. PSE&G's DSM Plan has been approved by the BPU. The IRP calls for PSE&G to utilize conservation and DSM to meet most of the incremental resource needs for the next decade (see Competition).\nPSE&G's DSM Plan is designed to encourage investment in energy-saving DSM activities in New Jersey. These activities involve new techniques and technologies, such as high-efficiency lighting and motors, that help reduce customer demand for energy. The DSM Plan consists of two major program areas for both electric and gas: (1) a core program which includes many specialized programs such as energy audits, seal-ups and rebates for high efficiency heating and cooling equipment; and (2) a standard offer program which is performance based and provides payment for measurable energy savings resulting from the installation of qualified measures that improve the energy efficiency of end-uses. PSE&G's most recent IRP includes a demand forecast average compound annual rate of growth through the year 2004 of electric system peak demand of 1.3%. PSE&G's IRP projects 597 MW of passive DSM and 815 MW of active DSM by the year 2004.\nPSE&G has established a wholly owned subsidiary, Public Service Conservation Resources Corporation (PSCRC), to offer DSM services. PSCRC has its principal office at 9 Campus Drive, Parsippany, N.J. 07054. PSCRC finances, markets and develops energy conservation projects, mostly within the PSE&G service territory. At December 31, 1995, its assets totaled $110 million, of which $88.2 million were project assets and work in progress.\nElectric Generating Capacity\nThe following table sets forth certain information as to PSE&G's installed generating capacity as of December 31, 1995:\nFor additional information, see Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPSE&G\nThe statements under this Item as to ownership of properties are made without regard to leases, tax and assessment liens, judgments, easements, rights of way, contracts, reservations, exceptions, conditions, immaterial liens and encumbrances and other outstanding rights affecting such properties, none of which is considered to be significant in the operations of PSE&G, except that PSE&G's First and Refunding Mortgage (Mortgage), securing the bonds issued thereunder, constitutes a direct first mortgage lien on substantially all of such property.\nPSE&G maintains insurance coverage against loss or damage to its principal plants and properties, subject to certain exceptions, to the extent such property is usually insured and insurance is available at a reasonable cost. For a discussion of nuclear insurance, see Note 12 - -- Commitments and Contingent Liabilities of Notes to Consolidated Financial Statements.\nThe electric lines and gas mains of PSE&G are located over or under public highways, streets, alleys or lands, except where they are located over or under property owned by PSE&G or occupied by it under easements or other rights. These easements and rights are deemed by PSE&G to be adequate for the purposes for which they are being used. Generally, where payments are minor in amount, no examinations of underlying titles as to the rights of way for transmission or distribution lines or mains have been made.\nElectric Properties\nAs of December 31, 1995, PSE&G's share of installed generating capacity was 10,400 MW, as shown in the following table:\nAs of December 31, 1995, PSE&G owned and operated approximately 15,467 miles of gas mains, owned 12 gas distribution headquarters and one subheadquarters and leased one other subheadquarters all in two operating regions located in New Jersey and owned one meter shop in New Jersey serving all such areas. In addition, PSE&G operated 61 natural gas metering or regulating stations, all located in New Jersey, of which 28 were located on land owned by customers or natural gas pipeline companies supplying PSE&G with natural gas and were operated under lease, easement or other similar arrangement. In some instances, portions of the metering and regulating facilities were owned by the pipeline companies.\nOffice Buildings and Facilities\nPSE&G leases substantially all of a 26-story office tower for its corporate headquarters at 80 Park Plaza, Newark, New Jersey, together with an adjoining three-story building. PSE&G also leases other office space at various locations throughout New Jersey for district offices and offices for various corporate groups and services. PSE&G also owns various other sites for training, testing, parking, records storage, research, repair and maintenance, warehouse facilities and for other purposes related to its business.\nEDHI owns no real property. EDHI leases its corporate headquarters at One Riverfront Plaza, Newark, New Jersey 07102. For a brief general description of the properties of the subsidiaries of EDHI, see Item 1. Business -- EDHI.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn October 1995, Enterprise received a letter from a representative of a purported shareholder demanding that it commence legal action against certain of its officers and directors with regard to nuclear operations and the current shutdown of the Salem generating station. In January, 1996, Enterprise and each of its directors except Forrest J. Remick were served with a civil complaint in a shareholder derivative action by such purported shareholder on behalf of Enterprise shareholders (Public Service Enterprise Group Incorporated by G.E. Stricklin, derivatively vs. E. James Ferland, et al., Docket No. L1068395, Superior Court of New Jersey, Law Division, Camden County filed December 27, 1995). The complaint seeks removal of certain executive officers of PSE&G and Enterprise, certain changes in the composition of Enterprise's Board of Directors, recovery of damages and certain other relief for alleged losses purportedly arising out of PSE&G's operation of the Salem and Hope Creek generating stations. The Board of Directors has commenced an investigation of the matters raised in the October demand letter, and that investigation has not yet been completed. Following conclusion of the investigation, the Board will meet to determine what action, if any, should be taken with respect to the complaint filed in the shareholder derivative action.\nIn addition, see the following, at the pages indicated:\n(1) Page 5. Proceedings before FERC relating to competition and electric wholesale power markets. (Inquiry Concerning the Pricing Policy for Transmission Services Provided by Utilities Under the Federal Power Act, Docket No. RM93-19.)\n(2) Page 11. Proceedings before the BPU relating to PSE&G's Second Largest Customer, filed January 6, 1995, in Docket No. ER95010005.\n(3) Page 44. Requests filed in 1974 and later supplemented, to EPA and NJDEP to establish thermal discharges and intake structures for PSE&G's electric generating stations (Sewaren Generating Station, NJ 0000680; Hudson Generating Station, NJ 0000647; Kearny Generating Station, NJ 0000655; Salem Generating Station, NJ 0005622; Linden Generating Station, NJ 0000663).\n(4) Page 46. Notice of Violation issued by EPA against Eagle Point Cogeneration Partnership regarding alleged violations of air permit.\n(5) Pages 48 through 53. Various administrative actions, claims, litigation and requests for information by federal and\/or state agencies, and\/or private parties, under CERCLA, RCRA, and state environmental laws to compel PRPs, which may include PSE&G, to provide information with respect to transportation and disposal of hazardous substances and wastes, and\/or to undertake or contribute to the costs of investigative and\/or cleanup actions at various locations because of actual or threatened releases of one or more potentially hazardous substances and\/or wastes.\n(6) Page 74. Proceedings before The BPU relating to New Jersey Partners in Power Plan filed January 16, 1996, in Docket No. E096010028.\n(7) Page 115. Proceedings before the BPU relating to PSE&G's LGAC, filed October 2, 1995, in Docket No. GR9510456.\n(8) Page 116. Proceedings before the BPU relating to recovery of replacement power costs in connection with the Salem 1 shutdown, May 5, 1995, Docket No. ER94070293.\n(9) Page 116. Proceedings before the BPU relating to PSE&G's LEAC Remediation Program Costs (RAC), filed July 21, 1995, in Docket No. GR95070344.\n(10) Page 117. Generic proceeding before the BPU relating to recovery of capacity costs associated with power purchases from cogenerators, September 16, 1994, in Docket No. EX93060255.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nEnterprise and PSE&G, inapplicable.\nITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANTS\nEnterprise and PSE&G. Information regarding executive officers required by this Item is set forth in Part III, Item 10 hereof.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nEnterprise's Common Stock is listed on the New York Stock Exchange, Inc. and the Philadelphia Stock Exchange, Inc. All of PSE&G's common stock is owned by Enterprise, its corporate parent. As of December 31, 1995, there were 175,831 holders of record of Enterprise Common Stock.\nThe following table indicates the high and low sale prices for Enterprise's Common Stock, as reported in The Wall Street Journal as Composite Transactions and dividends paid for the periods indicated:\nSince 1986, PSE&G has made regular cash payments to Enterprise in the form of dividends on outstanding shares of PSE&G's Common Stock. PSE&G has paid quarterly dividends on its common stock in each year commencing in 1948, the year of the distribution of PSE&G's common stock by Public Service Corporation of New Jersey, the former parent of PSE&G. Since 1992, EDHI has made regular cash payments to Enterprise in the form of dividends on outstanding shares of EDHI's common stock. Enterprise has paid quarterly dividends in each year commencing with the corporate restructuring of PSE&G when Enterprise became the owner of all the outstanding common stock of PSE&G. While the Board of Directors of Enterprise intends to continue the practice of paying dividends quarterly, amounts and dates of such dividends as may be declared will necessarily be dependent upon Enterprise's future earnings, financial requirements and other factors. See MD&A -- Dividends.\nThe ability of Enterprise to declare and to pay dividends is contingent upon its receipt of dividend payments from its subsidiaries. PSE&G has restrictions on the payments of dividends which are contained in its Restated Certificate of Incorporation, as amended, certain of the indentures supplemental to its Mortgage and certain debenture bond indentures. Under these restrictions, dividends on PSE&G's common stock may be paid only out of PSE&G's earned surplus and may not reduce PSE&G's earned surplus to less than $10 million. PSE&G dividends on common stock would be limited to 75% of Earnings Available for Public Service Enterprise Group Incorporated if payment thereof would reduce PSE&G's Stock Equity to less than 33 1\/3% of PSE&G's Total Capitalization and would be limited to 50% of Earnings Available for Public Service Enterprise Group Incorporated if payment thereof would reduce Stock Equity to less than 25% of PSE&G's Total Capitalization, as each of said terms is defined in said PSE&G's debenture bond indentures. Further, under an indenture relating to the loan to PSE&G of the proceeds of the Monthly Income Preferred Securities of Public Service Electric and Gas Capital, L.P. (see Note 4. -- Schedule of Consolidated Capital Stock and Other Securities of Notes), dividends may not be paid on PSE&G's capital stock as long as any payments on PSE&G's deferrable interest subordinated debentures issued under said indenture have been deferred or there is a default under said indenture or PSE&G's guarantee relating to the Monthly Income Preferred Securities. None of these restrictions presently limits the payment of dividends out of current earnings. The amount of Enterprise's and PSE&G's consolidated retained earnings not subject to these restrictions at December 31, 1995 was $1.6 billion and $1.4 billion, respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nEnterprise\nPSE&G\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nENTERPRISE\nSignificant factors affecting the consolidated financial condition and the results of operations of Public Service Enterprise Group Incorporated (Enterprise) and its subsidiaries are described below. This discussion refers to the Consolidated Financial Statements and related Notes of Enterprise and should be read in conjunction with such statements and notes.\nOverview\nEnterprise has two direct wholly owned subsidiaries, Public Service Electric and Gas Company (PSE&G) and Enterprise Diversified Holdings Incorporated (EDHI). Enterprise's principal subsidiary, PSE&G, is an operating public utility providing electric and gas service in certain areas in the State of New Jersey.\nEDHI is the parent of Enterprise's nonutility businesses: Energy Development Corporation (EDC), an oil and gas exploration and production and marketing company; Community Energy Alternatives Incorporated (CEA), an investor in and developer and operator of cogeneration and independent power production (IPP) facilities and exempt wholesale generators (EWGs); Public Service Resources Corporation (PSRC), which has made primarily passive investments; and Enterprise Group Development Corporation (EGDC), a diversified nonresidential real estate development and investment business. EDHI also has two finance subsidiaries: PSEG Capital Corporation (Capital), which provides privately placed debt financing on the basis of a minimum net worth maintenance agreement from Enterprise and Enterprise Capital Funding Corporation (Funding), which provides privately placed debt financing guaranteed by EDHI but without direct support from Enterprise. Enterprise has been conducting a controlled exit from the real estate business since 1993 and, in December 1995, announced that it intends to divest EDC.\nAs of December 31, 1995 and December 31, 1994, PSE&G comprised 85% of Enterprise assets. For each of the years 1995, 1994 and 1993, PSE&G revenues were 93% of Enterprise's revenues and PSE&G's earnings available to Enterprise for such years were 88%, 91% and 96%, respectively, of Enterprise's net income.\nThe major factors which will affect Enterprise's future results include general and regional economic conditions, PSE&G's customer retention and growth, the ability of PSE&G and EDHI to meet competitive pressures and to contain costs, the ability to respond to and take advantage of opportunities arising from increasing competition in the\nutility business, the adequacy and timeliness of rate relief, cost recovery and necessary regulatory approvals, the ability to continue to operate and maintain nuclear programs in accordance with Nuclear Regulatory Commission (NRC) and New Jersey Board of Public Utilities (BPU) requirements, the impact of environmental regulations, continued access to the capital markets and continued favorable regulatory treatment of consolidated tax benefits. (See Note 2 -- Rate Matters, Note 10 -- Federal Income Taxes and Note 12 -- Commitments and Contingent Liabilities of Notes to Consolidated Financial Statements (\"Notes\").)\nCompetition\nThe regulatory structure which has historically embraced the electric and gas industry is in the process of transition. Legislative and regulatory initiatives, at both the federal and state levels, are designed to promote competition and will continue to impose additional pressures on PSE&G's ability to retain customers. In addition, new technology and interest in self generation and cogeneration have provided customers with alternative sources of energy.\nOver the last several years, the gas industry has been transformed. Today, commercial and industrial customers can negotiate their own gas purchases directly with producers or brokers, while PSE&G is required to provide intrastate transportation of such purchased gas to the customers' facilities. Although PSE&G is not providing gas sales service to certain commercial and industrial customers, to date there has been no negative impact on earnings since sales service and transportation service tariffs result in the same non-fuel revenue per therm. Additionally, as a result of this restructuring, PSE&G has been able to negotiate lower cost gas supplies for those customers who continue to be part of its bundled rate schedules. A potential significant competitive challenge could emerge if interstate pipeline companies are permitted to expand their facilities into PSE&G territory and provide intrastate transportation to customers. However, this type of expansion would require federal and state regulatory approvals not currently in existence.\nThe restructuring of the electric industry is more complex and evolving at a slower pace than that of the gas industry. Federal legislation, such as the National Energy Policy Act (EPAct) has eased restrictions on independent power producers (IPP) in an effort to increase competition in the wholesale electric generation market. As the barriers to entry in the power production business have been lowered, the construction of cogeneration facilities and independent\npower production facilities has been growing, with the result of creating lower cost alternatives for large commercial and industrial customers. Presently, PSE&G is in the process of assessing the potential for individual arrangements with commercial and industrial customers which have such competitive alternatives, but PSE&G believes that it does not currently have a material exposure with respect to such customers.\nFurther, EPAct authorized the Federal Energy Regulatory Commission (FERC) to mandate utilities to transport and deliver or \"wheel\" energy for the supply of bulk power to wholesale customers. In March 1995, FERC issued a Notice of Proposed Rulemaking (NOPR) that would require utilities to (1) establish open access to all wholesale sellers and buyers, (2) offer transmission service comparable to service they provide themselves and (3) take transmission service under the same tariffs offered to other buyers and sellers. FERC's stated position is that it will ensure that utilities have a fair opportunity to recover prudently incurred investments that could become stranded costs as a result of the NOPR.\nIn the wholesale electric market, other competitive pressures, such as municipalization, may also have an impact on utilities in the evolving electric power industry. Municipalization involves the acquisition and operation of existing investor-owned facilities by a municipal utility (MUNI) through condemnation, purchase or lease or the construction and operation of duplicate, parallel facilities within a municipal boundary. As a result, utilities, such as PSE&G, could lose customers (residential, commercial and industrial) in the municipality that is served by the MUNI, as well as lose the municipal entity itself as a customer.\nEPAct granted the states sole authority to mandate retail wheeling. New Jersey regulators have been reviewing existing regulations in an effort to develop a revised regulatory structure that would afford public utilities, such as PSE&G, increased flexibility to meet the competitive challenges of the future. Phase I of the New Jersey Energy Master Plan (Phase I), a two-phase plan to better manage the future energy needs of the State, has been completed. Phase I called for legislation that would allow New Jersey utilities to propose, subject to BPU approval, alternatives to rate base\/rate of return pricing, allow for pricing flexibility under certain standards for customers with competitive options and equalize the impact of tax policies, such as the New Jersey Gross Receipts and Franchise Tax (NJGRT) currently assessed on retail energy utility sales, upon all energy producers. On July 20, 1995, Governor Whitman signed into law legislation which provides utilities the flexibility\nto propose, subject to BPU approval, alternatives to existing rate base\/rate of return pricing and offer negotiated off-tariff agreements to customers with competitive options. On June 1, 1995, the BPU issued its order initiating a formal Phase II proceeding of the Master Plan. The proceeding will address wholesale and retail competition in New Jersey.\nRecoverability of stranded costs is largely dependent on the transition rules established by regulators, including FERC and the BPU. Stranded costs that could result as the industry moves to a more competitive environment include investments in generating facilities, transmission assets, purchase power agreements where the price being paid under such an agreement exceeds the market price for electricity and regulatory assets for which recovery is based solely on continued cost based regulation. At this time, management cannot predict the level of stranded costs, if any, or the extent to which regulators will allow recovery of such costs.\nIncreased competition and the shift of risks and opportunities between rate payers and PSE&G resulting from PSE&G's filing of its proposed Alternative Rate Plan (discussed below) will increase the emphasis upon electric operational reliability, efficiency and cost. While the incremental cost of nuclear production is less expensive than PSE&G's other sources of generation, comparatively high embedded costs for nuclear plants increase the need for PSE&G to optimize the utilization of its nuclear generating capacity in order to make its actual generation output cost competitive.\nIn order to succeed in this increasingly competitive environment, Enterprise and its subsidiaries have taken the following steps designed to retain customers, reduce costs, improve operations and strategically position itself for future operation:\n1) On January 16, 1996, PSE&G filed its proposed alternative rate plan, the \"New Jersey Partners in Power\" Plan (Alternative Rate Plan). This seven-year proposed Alternative Rate Plan allows for a transition to a competitive energy marketplace while substantially shifting the business and financial risks and opportunities involved in such transition away from customers to PSE&G. Some of the key features of the proposal are: (a) an indexed or price-capped approach to replace the rate base\/rate of return form of regulation including the discontinuance of the electric Levelized Energy Adjustment Clause (LEAC) and the BPU's Nuclear Performance Standard (NPS), (b) a productivity gains sharing mechanism with electric and gas customers, (c) continued recovery of costs associated with activities mandated by state or federal agencies and (d) a program of rewards and penalties based on the performance of certain key overall service indicators, such as the\nduration of customer power outages compared to a five year average. For a full discussion of the Alternative Rate Plan, see Note 2 -- Rate Matters of Notes.\n2) PSE&G reorganized its senior nuclear leadership team to address operation and performance issues at PSE&G operated nuclear facilities and completed a thorough work scope assessment of Salem 1 and Salem 2 in order to return these units to safe, reliable operation over the long-term.\n3) PSE&G reorganized to reflect the evolution toward stand-alone energy and energy services businesses designed to compete successfully in the future. The reorganization \"unbundled\" the services previously provided by the electric and gas businesses. The focus is now on areas of business: Generation, Transmission and Distribution and Customer Services.\n4) Also as part of the corporate reorganization, a new business was created, Enterprise Ventures & Services Corporation, to pursue products and services which can be marketed beyond traditional geographic and industry boundaries. Among these are: natural gas marketing in the wake of deregulation of that industry, conservation and energy management services and a product development venture with AT&T Corp. to pilot and eventually market two-way customer communications systems and services.\n5) PSE&G developed initiatives, including the announced closure of five older, less efficient generating units, to reduce annual fossil generation operating and maintenance expenses, as well as to reduce annual fossil capital expenditures.\n6) PSE&G has established a deleveraging plan to retire more than $1 billion of outstanding debt over the next five years and to fund its current five-year construction program entirely through internally generated cash.\n7) PSE&G became the first utility in the Northeast to implement a service guarantee program. It covers nine key service areas and provides direct bill credits to customers should PSE&G fail to live up to its promises.\n8) The Strategic Account Marketing Organization was created within PSE&G to provide more individualized service to its 200 largest customers.\n9) PSE&G received BPU approval for its proposed Experimental Hourly Energy Pricing Tariff and the first service agreement thereunder with its second largest customer. This type of agreement serves as an incentive to retain customers with other energy alternatives in PSE&G's customer base, as well as in New Jersey.\n10) Also in 1995, PSE&G completed the Bergen Repowering Project which improved the efficiency and environmental effectiveness of the facility. Fuel costs for the facility will be reduced by approximately $30 million annually.\n11) CEA pursued business opportunities in certain international markets. During 1995, CEA closed on three projects and a strategic alliance in China and South America.\n12) Enterprise announced that EDHI will pursue the divestiture of EDC. The decision to divest EDC stems from Enterprise's conclusion that ownership of large oil and natural gas reserves is no longer necessary to provide efficient energy solutions to customers and that the true market value of EDC is not reflected in the price of Enterprise Common Stock.\nEnterprise and its subsidiaries remain committed to the pursuit of initiatives to contain costs and retain customers.\nAccounting for the Effects of Regulation\nCurrently, PSE&G accounts for the effects of regulation in accordance with Statement of Financial Accounting Standards No. 71 \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). In accordance with the provisions of SFAS 71, PSE&G defers certain expenses (regulatory assets) on the basis that they will be recovered from customers as part of the ratemaking process. PSE&G believes that if its proposed Alternative Rate Plan is approved essentially as proposed, it would continue to meet the criteria to account for certain utility revenues and expenses in accordance with SFAS 71. However, if future events or regulatory changes limit PSE&G's ability to establish prices to recover its costs, PSE&G might conclude that it no longer meets the application criteria to defer certain expenses in accordance with SFAS 71. If PSE&G were to discontinue the application of SFAS 71, the accounting impact would be an extraordinary, non-cash charge to operations that could be material to the financial position and results of operations of Enterprise and PSE&G.\nPSE&G has certain regulatory assets resulting from the use of a level of depreciation expense in the rate making process that is less than the amount that would be recorded under Generally Accepted Accounting Principles (GAAP) for non-regulated companies. PSE&G cannot presently quantify what the financial statement impact may be if depreciation expense were required to be determined absent regulation, but the impact on the financial position and results of operations of PSE&G and Enterprise could be material.\nStatement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets\" (SFAS 121) effective for 1996, establishes accounting standards for the impairment of long-lived assets. SFAS 121 also requires that regulatory assets which are no longer probable of recovery through future revenues be charged to earnings. The adoption of SFAS 121 is not expected to have a material impact on the financial position or results of operations of PSE&G and Enterprise.\nPSE&G Energy and Fuel Adjustment Clauses\nUnder the existing regulatory framework, PSE&G has fuel and energy tariff rate adjustment clauses, the Levelized Gas Adjustment Charge (LGAC) and the LEAC, which are designed to permit adjustments for changes in electric energy and gas supply costs and certain other costs as approved by the BPU, when compared to cost recovery included in base rates. Presently, charges under the clauses are primarily based on energy and gas supply costs which are normally projected over twelve-month periods except for large gas commercial and industrial customers for which commencing January 1, 1996, gas supply costs are projected monthly. The changes in the clauses do not directly affect earnings because such costs are adjusted monthly to match amounts recovered through revenues except for the financing costs of carrying underrecovered balances and required interest payments on net overrecovered balances. Under the clauses, if actual costs differ from the costs recovered, the amount of the underrecovery or overrecovery is deferred. Actual costs otherwise includable in the LEAC are subject to adjustment by the BPU in accordance with the NPS. (See Note 2 -- Rate Matters and Note 12 -- Commitments and Contingent Liabilities of Notes.) The Alternative Rate Plan proposes discontinuing LEAC and NPS and would substantially shift the risks and opportunities involved in managing changes in fuel and replacement power costs from customers to PSE&G.\nAccounting for Stock Compensation\nStatement of Financial Accounting Standards No. 123 \"Accounting for Stock-Based Compensation\" (SFAS 123) is effective for fiscal years that begin after December 15, 1995. SFAS 123 establishes financial accounting and reporting standards for stock based compensation plans and includes all arrangements by which employees receive shares of stock or other equity instruments of the employer or by which the employer incurs liabilities to employees in amounts based on the price of the employer's stock. The adoption of SFAS 123 is not expected to have a material impact on the financial position or results of operations of PSE&G and Enterprise.\nCorporate Policy for the Use of Derivatives\nEnterprise and its subsidiaries have established a policy to use derivatives only for the purpose of managing financial risk and not for speculative purposes. EDHI currently uses derivatives to manage financial risk for EDC and PSRC, including its subsidiary United States Energy Partners (USEP). The derivatives are used to mitigate the impact on earnings of volatile gas prices for EDC and USEP and volatile security prices for PSRC's investing activities. For details, see Note 8 -- Financial Instruments and Risk Management of Notes. Although PSE&G does not currently use derivatives, if the Alternative Rate Plan is approved as proposed, PSE&G could find derivatives to be a useful and appropriate tool in managing the volatility of fuel prices, among other things.\nNuclear Operations\nOperation of the Salem units has continued to present challenges to PSE&G. The units have experienced equipment failures which, combined with personnel errors, have precipitated or contributed to plant events or trips which have led to a number of outages over the lifetime of the units.\nBoth of the Salem units are currently out of service and their return dates are subject to completion of testing, analysis, repair activity and NRC concurrence that they are prepared to restart. Restart of Salem 1, which had originally been scheduled for the second quarter of 1996, will be delayed for a substantial period as a result of the ongoing steam generator inspection and analysis. Salem 2, which is also undergoing steam generator inspection and analysis is still scheduled to return to service in the third quarter of 1996. The inability to successfully return these units to continuous, safe operation could have a material effect on the financial position, results of operation and net cash flows of Enterprise and PSE&G.\nResults of Operations\nEarnings per share of Enterprise Common Stock were $2.71 in 1995, $2.78 in 1994 and $2.50 in 1993.\nIn 1995, Enterprise earnings decreased principally due to increased operating expenses and lower gas sales from PSE&G. These decreases in earnings were partially offset by improved electric sales, EDC revenues resulting from the settlement of litigation related to a take or pay sales contract and from gains realized on sales of properties by EDC.\nIn 1994, the increase in Enterprise earnings was driven primarily by increased weather related electric and gas sales. Enterprise earnings also benefited from higher investment income from PSRC.\nPSE&G - Earnings Available to Enterprise\nDuring 1995, electric revenues were impacted by higher residential and commercial sales resulting from a recovering economy, warm summer weather and a modest increase in customer base. In addition, other electric revenues increased principally due to higher miscellaneous revenues from increased capacity sales to unaffiliated utilities and to wholesale customers, service reconnections, temporary services and revenues from Public Service Conservation Resources Corporation (PSCRC), PSE&G's energy services subsidiary. Capacity sales are sales for the reservation of a specified quantity of PSE&G system generating capacity and must be paid even when the energy is not taken.\nIn 1995, gas revenues decreased due to the mild winter weather, partially offset by revenues resulting from the rapidly growing off system sales and higher gas service contract revenues. Off system sales are sales of excess gas to brokers and other utilities which are not part of PSE&G's firm customer base. Earnings on these sales are shared between the firm customer and PSE&G on an 80\/20 split, respectively.\nIn 1994, electric and gas revenues benefited from weather related sales which primarily impacted electric commercial sales and all firm gas rate schedules. Other electric revenues increased principally due to increased capacity sales to unaffiliated utilities and increased miscellaneous revenues, partially offset by lower energy sales to the unaffiliated utilities. Other gas revenues were significantly impacted by a one time $10 million legal settlement of a gas contract.\nPSE&G - Expenses\nFuel Expenses\nAs discussed in the PSE&G Energy and Fuel Adjustment Clauses section, variances in fuel expenses do not directly affect earnings because of the adjustment clause mechanism. However, if the proposed Alternative Rate Plan is adopted as filed, future changes in electric fuel and replacement power costs could impact earnings.\nOther Operation Expenses\nDuring 1995, other operation expenses decreased $10 million from 1994 levels. PSE&G had lower nuclear and miscellaneous production expenses. Nuclear production expenses decreased during 1995 due in part to the extended outage of Salem Units 1 and 2. PSE&G also secured savings in miscellaneous expenditures, such as clerical and office supplies in its steam production area. These savings were partially offset by increased marketing expenditures for customer related programs initiated in 1995.\nDuring 1994, other operation expenses increased $77 million when compared to 1993 principally due to increased nuclear production expenses which were higher than 1993 levels when Salem had a refueling outage, increased transmission and distribution expenses incurred during the bitter 1994 winter and increased administrative and general expenses primarily due to a rise in personal and property damage claim expenses. The increase in personal and property damage claims was directly related to storm damage and other weather related occurrences.\nMaintenance Expenses\nMaintenance expense increased $4 million in 1995 in comparison to 1994 due to the extended outage at Salem Units 1 and 2, partially offset by decreased expenses for electric and gas distribution facilities. Maintenance expense for 1994 was $4 million higher than in 1993 primarily due to the 1994 Hope Creek refueling outage and increased expenses for gas distribution facilities which resulted from the extremely cold weather during January and February 1994.\nDepreciation and Amortization Expenses\nDepreciation and Amortization expenses increased $39 million in 1995 when compared to 1994 and $41 million in 1994 when compared to 1993. The increases in 1995 and 1994 are attributable to increased depreciation expenses directly related to increases in plant in service.\nFederal Income Taxes\nIn 1995, Federal Income Taxes increased $27 million from 1994 and 1994 Federal Income Taxes decreased $14 million from 1993. The 1995 taxes were higher than 1994 principally due to the receipt of a non- taxable insurance benefit in 1994 and to higher pre-tax operating income. Federal Income Taxes decreased in 1994 due to the receipt of a non-taxable insurance benefit, partially offset by higher pre-tax operating income.\nInterest Charges\nIn 1995, interest charges were $11 million higher than in 1994 and, in 1994, interest charges were $6 million higher than in 1993. The primary reason for the 1995 increase was higher interest charges on miscellaneous liabilities, while the driving force behind the 1994 increase was a higher average daily balance of short-term debt outstanding at higher interest rates.\nAllowance for Funds Used During Construction\nIn 1995, there was a $2 million decrease in AFDC income principally due to a decrease in construction expenditures. In 1994, AFDC income was $11 million higher than the 1993 level due to increased construction resulting from the repowering of the Bergen Generating Station.\nPreferred Securities\nDividend requirements on preferred securities increased $8 million in 1995 compared to 1994 and $4 million in 1994 compared to 1993. The increases are the result of the issuance of higher rate Monthly Income Preferred Securities used to redeem certain issues of PSE&G Preferred Stock.\nEDHI - Net Income\nThe net income of EDHI was $80 million in 1995, a $20 million increase over 1994. EDC's income increased $23 million primarily due to the realization of a settlement related to a take-or-pay sales contract. EDC's gains from property sales, higher oil prices and volumes and reduced depreciation, depletion and amortization (DD&A) expenses also contributed to higher earnings but were substantially offset by lower gas prices and volumes. CEA's earnings decreased $4 million compared to 1994 due to higher interest and development expenses.\nThe net income of EDHI was $60 million in 1994. Excluding the impact of an impairment of assets of $51 million, after tax, by EGDC in 1993, EDHI's earnings in 1994 decreased $15 million in comparison to 1993. Increased income from PSRC (higher investment income, lower income taxes compared to 1993 which included the effects of a Federal income tax increase and lower interest charges) and CEA (higher income from operating plants) was offset by lower EDC earnings (lower gas volumes and prices and higher exploration and development expenditures due to increased drilling activities).\nDividends\nThe ability of Enterprise to declare and pay dividends is contingent upon its receipt of dividend payments from its subsidiaries. PSE&G has made regular payments to Enterprise in the form of dividends on outstanding shares of its common stock since Enterprise was formed in 1986. In addition, commencing in 1992, EDHI has also made payments to Enterprise in the form of dividends on its outstanding common stock. Since 1992, Enterprise has maintained a constant rate of common stock dividends. Management believes that gradually reducing the common stock dividend payout ratio is a prudent policy.\nDividends paid to holders of Enterprise Common Stock increased $.5 million during 1995 compared to 1994 and increased $6 million during 1994 compared to 1993. Such increases were due to the issuance of additional shares of Enterprise Common Stock.\nDividends paid to holders of PSE&G's Preferred Stock decreased $6.7 million during 1995 compared to 1994 and increased $2 million during 1994 compared to 1993. The 1995 decrease in such dividends was due to the redemption of certain series of Preferred Stock. The increase in 1994 was due to the issuance of additional shares of Preferred Stock. (See Liquidity and Capital Resources.)\nDividends paid to holders of Monthly Income Preferred Securities of Public Service Electric and Gas Capital, L.P. (Partnership), a limited partnership of which PSE&G is the general partner, increased $14 million during 1995 compared to 1994. The Partnership's Monthly Income Preferred Securities were first issued in 1994 and were not outstanding for the entire year. The increase in 1995 was due to the issuance of additional securities coupled with the fact that Monthly Income Preferred Securities were outstanding for the entire year. (See Note 4 -- Schedule of Consolidated Capital Stock and Other Securities of Notes.)\nLiquidity and Capital Resources\nEnterprise's liquidity is affected by maturing debt, investment and acquisition activities, the capital requirements of PSE&G's and EDHI's construction and investment programs, permitted regulatory recovery of expenses and collection of revenues. Capital resources available to meet such requirements depend upon general and regional economic conditions, PSE&G's customer retention and growth, the ability of PSE&G and EDHI to meet competitive pressures and to contain costs, the adequacy and timeliness of rate relief, cost recovery and necessary regulatory approvals, the ability to continue to operate and maintain nuclear programs in accordance with NRC and BPU requirements, the impact of environmental regulations, continued access to the capital markets and continued favorable regulatory treatment of consolidated tax benefits. (For additional information see the discussion of Competition above and Note 12, Commitments and Contingencies of the Notes.)\nPSE&G\nPSE&G had utility plant additions of $686 million, $887 million and $890 million, for 1995, 1994 and 1993, respectively, including AFDC of $36 million, $38 million and $27 million, respectively. Construction expenditures were related to improvements in PSE&G's existing power plants, transmission and distribution system, gas system and common facilities. PSE&G also expended $30 million, $34 million and $48 million for the cost of plant removal (net of salvage) in 1995, 1994 and 1993, respectively. Construction expenditures from 1996 through 2000 are expected to aggregate $2.8 billion, including AFDC. Forecasted construction expenditures are related to improvements in PSE&G's existing power plants (including nuclear fuel), transmission and distribution system, gas system and common facilities. (See Construction, Investments and Other Capital Requirements Forecast below.)\nPSE&G expects that it will be able to internally generate all of its capital requirements, including construction expenditures, over the next five years and reduce its debt outstanding by approximately $1 billion, assuming adequate and timely recovery of costs, as to which no assurances can be given. (See Note 2 -- Rate Matters and Note 12 -- Commitments and Contingent Liabilities of Notes.)\nEDHI\nDuring the next five years, a majority of EDHI's capital requirements are expected to be provided from operational cash flows. (See Construction, Investments and Other Capital Requirements Forecast below.) CEA is expected to be the primary vehicle for EDHI's business growth. A significant portion of CEA's growth is expected to occur in the international arena due to the current and anticipated growth in electric capacity required in certain regions of the world. EDC will continue to pursue a program to grow its reserve base through a combination of strategic acquisitions, high potential exploration activities and exploitation of its acquired properties and new discoveries. EDC's worldwide 1995 production totaled 99 BCFE and, at year end, EDC had proved reserves of 920 BCFE. EDC expended approximately $153 million, $188 million and $109 million in 1995, 1994 and 1993, respectively, to acquire, discover or develop domestic and international reserves. Of these expenditures, $132 million, $160 million and $92 million in 1995, 1994 and 1993, respectively, were capitalized. These amounts included capitalized interest of $4 million, $4 million and $3 million, respectively. For discussion regarding the potential divestiture of EDC, see Competition.\nPSRC will continue to limit new investments to those related to the energy businesses, while EGDC will exit the real estate business in a prudent manner. Over the next several years, EDHI and its subsidiaries will also be required to refinance a portion of their maturing debt in order to meet their capital requirements. In addition, any divestiture of EDC will require the renegotiation of existing loan agreements of Funding. Any inability to extend or replace maturing debt and or existing agreements at current levels and interest rates may affect future earnings and result in an increase in EDHI's cost of capital.\nPSRC is a limited partner in various limited partnerships and is committed to make investments from time to time, upon the request of the respective general partners. At December 31, 1995, $58 million remained as PSRC's unfunded commitment subject to call.\nEDHI and each of its subsidiaries are subject to restrictive business and financial covenants contained in existing debt agreements and are required to not exceed various debt to equity ratios which vary from 3:1 to 1.75:1. EDHI is also required to maintain a twelve-months earnings before interest and taxes to interest (EBIT) coverage ratio of at least 1.35:1. As of December 31, 1995 and 1994, EDHI had a consolidated debt to equity ratio of 1.15:1 and, for the years ended December 31, 1995, 1994 and 1993, EBIT coverage ratios, as defined to exclude the effects of EGDC, of 2.47:1, 1.94:1 and 2.13:1, respectively. Compliance with applicable financial covenants will depend upon future financial position and levels of earnings, as to which no assurance can be given. (See Note 6 -- Schedule of Consolidated Debt and Note 16 -- Property Impairment of Enterprise Group Development Corporation of Notes.)\nLong-Term Investments and Real Estate\nLong-term investments and real estate increased $82 million in 1995 and decreased $58 million and $67 million in 1994 and 1993, respectively. The increase in 1995 was primarily due to an increase in PSCRC's long-term investments of $49 million, PSRC's increase in investments in partnerships and leases of $52 million and CEA's increase in partnership investments of $27 million, partially offset by EGDC's property sales of $53 million. The decrease in 1994 was primarily due to a $73 million net decrease in PSE&G's investment in an insurance contract, partially offset by an increase in long-term investments of $23 million. The decrease in 1993 was due primarily to EDHI's decrease in long-term investments of $63 million. (For more details, see Note 7 -- long-term investments and Note 11 -- Leasing Activities - As Lessor of Notes.)\nConstruction, Investments and Other Capital Requirements Forecast\nWhile the above forecast includes capital costs to comply with revised Federal Clean Air Act (CAA) requirements through 2000, it does not include additional requirements being developed under the CAA by Federal and State agencies. Such additional costs cannot be reasonably estimated at this time. PSE&G believes that such CAA costs would be recoverable from electric customers. In accordance with the proposed Alternative Rate Plan, separate mechanisms would be established to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies or otherwise out of PSE&G's control.\nInternal Generation of Cash from Operations\nEnterprise's cash from operations is generated primarily from the operating activities of PSE&G.\nEnterprise's cash provided by operations for 1995 increased $261 million to $1.493 billion from 1994. This increase was primarily due to the increase in PSE&G s revenues (partially offset by an increase in accounts receivable and unbilled revenues), an increase in the recovery of electric energy and gas costs through PSE&G's LEAC and LGAC and a decrease in PSE&G s gross receipts taxes. For additional information see Results of Operations.\nEnterprise's cash provided by operations for 1994 increased $200 million to $1.232 billion from 1993. This increase was primarily due to the increase in PSE&G's revenues (plus a decrease in accounts receivable and unbilled revenues) and an increase in the recovery of electric energy and gas costs through PSE&G's LEAC and LGAC. For additional information see Results of Operations.\nExternal Financings - PSE&G\nIn 1995, PSE&G issued $156 million of its First and Refunding Mortgage Bonds (Bonds)\/Medium-Term Notes (MTNs) for the purpose of redeeming $56 million of its higher cost Bonds and to pay a portion of its maturing bonds.\nIn 1995, Partnership issued $60 million of Monthly Income Preferred Securities, the proceeds of which were used to redeem $60 million of PSE&G's Preferred Stock.\nThe BPU has authorized PSE&G to issue approximately $4.375 billion aggregate amount of additional Bonds\/MTNs\/Preferred Stock\/Monthly Income Preferred Securities through 1997 for refunding purposes. Under its Mortgage, PSE&G may issue new Bonds against retired Bonds and as of December 31, 1995, up to $2.840 billion aggregate amount of new Bonds against previous additions and improvements to utility plant, provided that the ratio of earnings to fixed charges is at least 2:1. At December 31, 1995 the ratio was 2.77:1.\nIn January 1996, PSE&G issued $350 million of Bonds. In February 1996, the net proceeds from the sale were deposited in an escrow account for the purpose of refunding certain higher cost bonds at their respective first optional redemption dates in November 1996 and February 1997.\nThe BPU has authorized PSE&G to issue and have outstanding at any one time not more than $1 billion of its short-term obligations, consisting of commercial paper and other unsecured borrowings from banks and other lenders through January 1, 1997. On December 31, 1995, PSE&G had $449 million of short-term debt outstanding.\nTo provide liquidity for its commercial paper program, PSE&G has a $500 million one year revolving credit agreement expiring in August 1996 and a $500 million five year revolving credit agreement expiring in August 2000 with a group of commercial banks, which provides for borrowing up to one year. On December 31, 1995, there were no borrowings outstanding under these credit agreements. PSE&G expects to be able to renew the credit agreement expiring in 1996.\nPSCRC has a $30 million revolving credit facility supported by a PSE&G subscription agreement in an aggregate amount of $30 million which terminates on March 7, 1996. PSCRC is presently in the process of negotiating a one year extension for this facility. As of December 31, 1995, PSCRC had $30 million outstanding under this facility.\nPSE&G Fuel Corporation (Fuelco) has a $150 million commercial paper program to finance a 42.49% share of Peach Bottom nuclear fuel, supported by a $150 million revolving credit facility with a group of banks, which expires on June 28, 1996. PSE&G has guaranteed repayment of Fuelco's respective obligations. As of December 31, 1995, Fuelco had commercial paper of $88 million outstanding under such program.\nExternal Financings - EDHI\nFunding has a commercial paper program, supported by a commercial bank letter of credit and credit facility, in the amount of $225 million expiring in March 1998. As of December 31, 1995, Funding had $182 million of borrowings outstanding under this commercial paper program.\nAdditionally, Funding has a $225 million revolving credit facility expiring in March 1998. As of December 31, 1995, Funding had $100 million of borrowings outstanding under this facility.\nCapital's MTN program has previously provided for an aggregate principal amount of up to $750 million of MTNs so that its total debt outstanding at any time, including MTNs, would not exceed such amount. Effective January 31, 1995, Capital will not have more than $650 million of debt outstanding at any time. In 1995, Capital repaid $112 million of its MTNs. At December 31, 1995, Capital had total debt outstanding of $478 million, including $355 million of MTNs.\nPSE&G\nThe information required by this item is incorporated herein by reference to the following portions of Enterprise's Management's Discussion and Analysis of Financial Condition and Results of Operations, insofar as they relate to PSE&G and its subsidiaries: Overview; Competition; PSE&G Energy and Fuel Adjustment Clauses; Accounting for Stock Compensation; Corporate Policy for the Use of Derivatives; Nuclear Operations; Results of Operations; Dividends; Liquidity and Capital Resources; Long-Term Investments and Real Estate; Construction; Investments and Other Capital Requirements Forecast; and External Financings.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFINANCIAL STATEMENT RESPONSIBILITY - ENTERPRISE\nManagement of Enterprise is responsible for the preparation, integrity and objectivity of the consolidated financial statements and related notes of Enterprise. The consolidated financial statements and related notes are prepared in accordance with generally accepted accounting principles. The financial statements reflect estimates based upon the judgment of management where appropriate. Management believes that the consolidated financial statements and related notes present fairly Enterprise's financial position and results of operations. Information in other parts of this Annual Report is also the responsibility of management and is consistent with these consolidated financial statements and related notes.\nThe firm of Deloitte & Touche LLP, independent auditors, is engaged to audit Enterprise's consolidated financial statements and related notes and issue a report thereon. Deloitte & Touche's audit is conducted in accordance with generally accepted auditing standards. Management has made available to Deloitte & Touche, all the corporation's financial records and related data, as well as the minutes of directors' meetings. Furthermore, management believes that all representations made to Deloitte & Touche, during its audit were valid and appropriate.\nManagement has established and maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded, and that transactions are executed in accordance with management's authorization and recorded properly for the prevention and detection of fraudulent financial reporting, so as to maintain the integrity and reliability of the financial statements. The system is designed to permit preparation of consolidated financial statements and related notes in accordance with generally accepted accounting principles. The concept of reasonable assurance recognizes that the costs of a system of internal accounting controls should not exceed the related benefits. Management believes the effectiveness of this system is enhanced by an ongoing program of continuous and selective training of employees. In addition, management has communicated to all employees its policies on business conduct, safeguarding assets and internal controls.\nThe Internal Auditing Department of PSE&G conducts audits and appraisals of accounting and other operations of Enterprise and its subsidiaries and evaluates the effectiveness of cost and other controls and recommends to management, where appropriate, improvements thereto.\nManagement has considered the internal auditors' and Deloitte & Touche's recommendations concerning the corporation's system of internal accounting controls and has taken actions that, in its opinion, are cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that, as of December 31, 1995, the corporation's system of internal accounting controls is adequate to accomplish the objectives discussed herein.\nThe Board of Directors of Enterprise carries out its responsibility of financial overview through its Audit Committee, which presently consists of six directors who are not employees of Enterprise or any of its affiliates. The Audit Committee meets periodically with management as well as with representatives of the internal auditors and Deloitte & Touche. The Audit Committee reviews the work of each to ensure that its respective responsibilities are being carried out and discusses related matters. Both the internal auditors and Deloitte & Touche periodically meet alone with the Audit Committee and have free access to the Audit Committee, and its individual members, at any time.\nFINANCIAL STATEMENT RESPONSIBILITY - PSE&G\nManagement of PSE&G is responsible for the preparation, integrity and objectivity of the consolidated financial statements and related notes of PSE&G. The consolidated financial statements and related notes are prepared in accordance with generally accepted accounting principles. The financial statements reflect estimates based upon the judgment of management where appropriate. Management believes that the consolidated financial statements and related notes present fairly PSE&G's financial position and results of operations. Information in other parts of this Annual Report is also the responsibility of management and is consistent with these consolidated financial statements and related notes.\nThe firm of Deloitte & Touche LLP, independent auditors, is engaged to audit PSE&G's consolidated financial statements and related notes and issue a report thereon. Deloitte & Touche's audit is conducted in accordance with generally accepted auditing standards. Management has made available to Deloitte & Touche, all the corporation's financial records and related data, as well as the minutes of directors' meetings. Furthermore, management believes that all representations made to Deloitte & Touche, during its audit were valid and appropriate.\nManagement has established and maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded, and that transactions are executed in accordance with management's authorization and recorded properly for the prevention and detection of fraudulent financial reporting, so as to maintain the integrity and reliability of the financial statements. The system is designed to permit preparation of consolidated financial statements and related notes in accordance with generally accepted accounting principles. The concept of reasonable assurance recognizes that the costs of a system of internal accounting controls should not exceed the related benefits. Management believes the effectiveness of this system is enhanced by an ongoing program of continuous and selective training of employees. In addition, management has communicated to all employees its policies on business conduct, safeguarding assets and internal controls.\nThe Internal Auditing Department conducts audits and appraisals of accounting and other operations and evaluates the effectiveness of cost and other controls and recommends to management, where appropriate, improvements thereto. Management has considered the internal auditors' and Deloitte & Touche's recommendations concerning the corporation's system of internal accounting controls and has taken actions that are cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that, as of December 31, 1995, the corporation's system of internal accounting controls is adequate to accomplish the objectives discussed herein.\nThe Board of Directors carries out its responsibility of financial overview through the Audit Committee of Enterprise, which presently consists of six directors who are not employees of Enterprise or any of its affiliates. The Enterprise Audit Committee meets periodically with management as well as with representatives of the internal auditors and Deloitte & Touche. The Audit Committee reviews the work of each to ensure that their respective responsibilities are being carried out and discusses related matters. Both the internal auditors and Deloitte & Touche, periodically meet alone with the Audit Committee and have free access to the Audit Committee, and its individual members, at any time.\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Board of Directors of Public Service Enterprise Group Incorporated:\nWe have audited the consolidated balance sheets of Public Service Enterprise Group Incorporated and its subsidiaries (the \"Company\") 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 consolidated financial statement schedules listed in the Index in Item 14(b)(1). These consolidated financial statements and the consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 consolidated financial statements present fairly, in all material respects, the financial position of Public Service Enterprise Group Incorporated 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 consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets 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 consolidated 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 for the Company, presented in Item 6, is fairly stated in all material respects, in relation to the consolidated financial statements from which it has been derived.\nDELOITTE & TOUCHE LLP\nFebruary 14, 1996 Parsippany, New Jersey\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors of Public Service Electric and Gas Company:\nWe have audited the consolidated balance sheets of Public Service Electric & Gas Company and its subsidiaries (the \"Company\") 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 consolidated financial statement schedules listed in the Index in Item 14(b)(2). These consolidated financial statements and the consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 consolidated financial statements present fairly, in all material respects, the financial position of Public Service Electric & Gas 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. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets 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 consolidated 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 for the Company, presented in Item 6, is fairly stated in all material respects, in relation to the consolidated financial statements from which it has been derived.\nDELOITTE & TOUCHE LLP\nFebruary 14, 1996 Parsippany, New Jersey\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nCONSOLIDATED STATEMENTS OF INCOME\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nCONSOLIDATED BALANCE SHEETS\nCAPITALIZATION AND LIABILITIES\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nCONSOLIDATED STATEMENTS OF INCOME\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nCONSOLIDATED BALANCE SHEETS\nCAPITALIZATION AND LIABILITIES\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nSee Notes to Consolidated Financial Statements.\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nPublic Service Enterprise Group (Enterprise) has two direct wholly owned subsidiaries, Public Service Electric and Gas Company (PSE&G) and Enterprise Diversified Holdings Incorporated (EDHI). Enterprise's principal subsidiary, PSE&G, is an operating public utility providing electric and gas service to customers in certain areas in the State of New Jersey. As of December 31, 1995, PSE&G comprised 85% of Enterprise's assets and for the year ending on that date, 93% of its revenues. Of the 150,000,000 authorized shares of PSE&G common stock at December 31, 1995, there were 132,450,344 shares outstanding, with an aggregate book value of $2.6 billion.\nPSE&G has a finance subsidiary, PSE&G Fuel Corporation (Fuelco), providing financing, unconditionally guaranteed by PSE&G, of up to $150 million aggregate principal amount at any one time of a 42.49% interest in the nuclear fuel acquired for Peach Bottom Atomic Power Station Units 2 and 3 (Peach Bottom). PSE&G also has a subsidiary, Public Service Conservation Resources Corporation (PSCRC) which offers demand side management (DSM) services to utility customers. In 1994, Public Service Electric and Gas Capital, L.P. (Partnership), a limited partnership in which PSE&G is the general partner, was formed for the purpose of issuing Monthly Income Preferred Securities. (See Note 4 -- Schedule of Consolidated Capital Stock and Other Securities.) In 1995, PSE&G created a new subsidiary, Enterprise Ventures and Services, to pursue products and services beyond traditional geographic and industry boundaries.\nEDHI is the parent of Enterprise's nonutility businesses: Energy Development Corporation (EDC), an oil and gas exploration and production and marketing company; Community Energy Alternatives Incorporated (CEA), an investor in and developer and operator of cogeneration and independent power production facilities; Public Service Resources Corporation (PSRC), which makes primarily passive investments; and Enterprise Group Development Corporation (EGDC), a nonresidential real estate development and investment business. EDHI also has two finance subsidiaries: PSEG Capital Corporation (Capital) and Enterprise Capital Funding Corporation (Funding).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nConsolidation Policy\nThe consolidated financial statements include the accounts of Enterprise and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications of prior years' data have been made to conform with the current presentation.\nRegulation -- PSE&G\nThe accounting and rates of PSE&G are subject, in certain respects, to the requirements of the New Jersey Board of Public Utilities (BPU) and the Federal Energy Regulatory Commission (FERC). As a result, PSE&G maintains its accounts in accordance with their prescribed Uniform Systems of Accounts, which are the same. The applications of Generally Accepted Accounting Principles (GAAP) by PSE&G differ in certain respects from applications by non-regulated businesses. PSE&G prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards No. 71 -- \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). In general, SFAS 71 recognizes that accounting for rate-regulated enterprises should reflect the relationship of costs and revenues. As a result, a regulated utility may defer recognition of cost (a regulatory asset) or recognize an obligation (a regulatory liability) if it is probable that, through the rate-making process, there will be a corresponding increase or decrease in revenues. Accordingly, PSE&G has deferred certain costs, which will be amortized over various periods. To the extent that collection of such costs or payment of liabilities is no longer probable as a result of changes in regulation and\/or PSE&G's competitive position, the associated regulatory asset or liability will be reversed with a charge or credit to income. (See Note 5 -- Deferred Items.) If PSE&G were to discontinue the application of SFAS 71, the accounting impact would be an extraordinary, non-cash charge to operations that could be material to the financial position and results of operations of Enterprise and PSE&G.\nAmounts charged to operations for depreciation expense reflect estimated useful lives and methods, which include estimates of cost of removal and salvage, prescribed and approved by regulators rather than those that might otherwise apply to non-regulated enterprises. PSE&G cannot presently quantify what the financial statement impact may be if depreciation expense were to be determined absent regulation.\nUtility Plant and Related Depreciation -- PSE&G\nAdditions to utility plant and replacements of units of property are capitalized at original cost. The cost of maintenance, repairs and replacements of minor items of property is charged to appropriate expense accounts. At the time units of depreciable property are retired or otherwise disposed of, the original cost less net salvage value is charged to accumulated depreciation.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDepreciation is computed under the straight-line method. Depreciation is based on estimated average remaining lives of the several classes of depreciable property. These estimates are reviewed on a periodic basis and necessary adjustments are made as approved by the BPU. Depreciation provisions stated in percentages of original cost of depreciable property were 3.52% in 1995, 3.51% in 1994 and 3.46% in 1993.\nUse of Estimates\nThe process of preparing financial statements in conformity with GAAP requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts.\nDecontamination and Decommissioning -- PSE&G\nIn 1993, FERC issued Order No. 557 on the accounting and rate- making treatment of special assessments levied under the National Energy Policy Act of 1992 (EPAct). Order No. 557 provides that special assessments are a necessary and reasonable current cost of fuel and shall be fully recoverable in rates in the same manner as other fuel costs. In accordance with its filed Alternative Rate Plan, PSE&G has requested to have separate mechanisms to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies, but no assurances can be given that the BPU will authorize such recovery from customers. (See Note 2 -- Rate Matters and Note 3 -- PSE&G Nuclear Decommissioning and Amortization of Nuclear Fuel - Uranium, Decontamination and Decommissioning Fund.)\nAmortization of Nuclear Fuel -- PSE&G\nNuclear energy burnup costs are charged to fuel expense on a units-of-production basis over the estimated life of the fuel. Rates for the recovery of fuel used at all nuclear units include a provision of one mill per kilowatthour (KWH) of nuclear generation for spent fuel disposal costs. (See Note 3 -- PSE&G Nuclear Decommissioning and Amortization of Nuclear Fuel.)\nRevenues and Fuel Costs -- PSE&G\nRevenues are recorded based on services rendered to customers during each accounting period. PSE&G records unbilled revenues representing the estimated amount customers will be billed for services\nrendered from the time meters were last read to the end of the respective accounting period. Rates include projected fuel costs for electric generation, purchased and interchanged power, gas purchased and materials used for gas production. Any under or overrecoveries, together with interest (in the case of net overrecoveries), are deferred and included in operations in the period in which they are reflected in rates.\nLong-Term Investments\nPSRC has invested in securities and limited partnerships investing in securities, which are recorded at fair value, and various leases and other limited partnerships. EGDC is a participant in the nonresidential real estate markets. CEA is an investor in and developer and operator of cogeneration and power production facilities. (See Note 7 -- Long-Term Investments.)\nDerivatives\nGains and losses on hedges of existing assets or liabilities are included in the carrying amounts of those assets and liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to qualifying hedges of firm commitments or anticipated transactions also are deferred and recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. (See Note 8 -- Financial Instruments and Risk Management.)\nOil and Gas Accounting -- EDC\nEDC uses the successful efforts method of accounting under which proved leasehold costs are capitalized and amortized over the proved developed and undeveloped reserves on a unit-of-production basis. Drilling and equipping costs, except exploratory dry holes, are capitalized and depreciated over the proved developed reserves on a unit-of-production basis. Estimated future abandonment costs of offshore proved properties are depreciated on a unit-of-production basis over the proved developed reserves. Estimated future abandonment costs of onshore properties are estimated to be offset by the salvage value of the tangible equipment. Unproved leasehold costs are capitalized and not amortized, pending an evaluation of the exploration results. Unproved leasehold and producing properties costs are assessed periodically to determine if an impairment of the cost of significant individual properties has occurred. The cost of an impairment is charged to expense. Costs incurred for exploratory dry holes, exploratory geological and geophysical work and delay rentals are charged to expense as incurred.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncome Taxes\nEnterprise and its subsidiaries file a consolidated Federal income tax return and income taxes are allocated to Enterprise's subsidiaries based on taxable income or loss of each. Investment tax credits are deferred and amortized over the useful lives of the related property, including nuclear fuel.\nEffective January 1, 1993, Enterprise and its subsidiaries adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS 109). Under SFAS 109, deferred income taxes are provided for all temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities irrespective of the treatment for rate-making purposes. For periods prior to January 1, 1993, PSE&G provided deferred income taxes to the extent permitted for rate-making purposes. (See Note 10 -- Federal Income Taxes.)\nAllowance for Funds Used During Construction (AFDC) and Capitalized Interest\nPSE&G -- AFDC represents the cost of debt and equity funds used to finance the construction of new utility facilities. The amount of AFDC capitalized is reported in the Consolidated Statements of Income as a reduction of interest charges for the borrowed funds component and as other income for the equity funds component. The rates used for calculating AFDC in 1995, 1994 and 1993 were 6.98%, 6.48% and 6.96%, respectively. These rates were within the limits set by FERC.\nEDHI -- The operating subsidiaries of EDHI capitalize interest costs allocable to construction expenditures at the average cost of borrowed funds.\nPension Plan and Other Postretirement Benefits\nThe employees of PSE&G, other than non represented employees commencing service after January 1, 1996, as well as those of participating affiliates, are covered by a noncontributory trusteed pension plan (Pension Plan) from the date of hire. New represented employees of PSE&G who commence service after January 1, 1996 are covered by a Cash Balance Pension Plan. The policy is to fund pension costs accrued. PSE&G also provides certain health care and life insurance benefits to active and retired employees. The portion of such costs pertaining to retirees amounted to $33 million, $29 million, and $28 million in 1995, 1994 and 1993, respectively. The current cost of these benefits is charged to expense when paid and is currently being recovered from ratepayers.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn January 1, 1993, Enterprise and PSE&G adopted Statement of Financial Accounting Standards No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" (SFAS 106), which requires that the expected cost of employees' postretirement health care benefits be charged to expense during the years in which employees render service. Prior to 1993, Enterprise and PSE&G recognized postretirement health care costs in the year in which the benefits were paid. PSE&G elected to amortize over 20 years its unfunded obligation at January 1, 1993. (See Note 13 -- Postretirement Benefits Other Than Pensions and Note 14 -- Pension Plan.)\nNOTE 2. RATE MATTERS\nAlternative Rate Plan\nOn January 16, 1996, PSE&G proposed to the BPU major changes in utility regulation that include an immediate $50 million rate reduction for its electric customers, various types of rate freezes, assurances that future price increases related to controllable costs will be lower than the rate of inflation and funding of up to an aggregate of $55 million in two economic development initiatives.\nThe seven-year \"New Jersey Partners in Power\" Plan (Plan), if approved, would give PSE&G the mechanisms and incentives to compete more effectively on several fronts, including the ability to develop revenue from non-regulated products and services, accelerate or modify depreciation schedules to help mitigate any potential stranded asset issue and more aggressively manage the control of costs. In addition, the Plan would provide the foundation for ongoing price flexibility without the need for prolonged, adversarial regulatory proceedings.\nThe Plan begins the process for a transition to a more competitive energy marketplace while substantially shifting the business and financial risks and opportunities involved in this transition away from customers to PSE&G and enhancing PSE&G's ability to make the necessary human, intellectual and financial investments required to stimulate innovation and productivity.\nKey energy pricing features of the proposed Plan are as follows:\nUpon the BPU's approval of the Plan, PSE&G will reduce electric rates across the board by $50 million annually as an upfront guaranteed share of the productivity improvements that it expects to achieve over the life of the Plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNew rates for all PSE&G electric customers reflecting the reduction would be established through a merger of existing base tariffs and the electric Levelized Energy Adjustment Clause (LEAC) and would be frozen at these levels through December 31, 1996. In addition, the Plan proposes the elimination of the BPU's existing Nuclear Performance Standard (NPS). This discontinuance of the LEAC and NPS would result in substantially shifting the risks and opportunities involved in managing changes in fuel and replacement power costs from customers to PSE&G. Gas fuel costs will continue to be recovered on a dollar for dollar basis from customers under the existing Levelized Gas Adjustment Charge (LGAC).\nIn order to create incentives to lower costs and improve efficiency and productivity, the Plan would rely on a comprehensive external price cap index based upon changes in the Gross Domestic Product Price Index (GDPPI) and a separate fuel price index mechanism, reduced by a fixed productivity offset of 0.30% to establish optional annual price changes each January 1st for electricity. In addition, the Plan would rely on an index for non-fuel gas prices calculated on the basis of changes in the GDPPI, reduced by a fixed productivity offset of 0.35%, to establish optional annual price changes each January 1st. The price cap mechanisms would become effective on January 1, 1997 and would assure that any rate increase related to controllable costs would be below the rate of inflation, guaranteeing that these costs would decline in real terms.\nUnder the Plan, PSE&G would establish an initial service block equal to the first 150 kilowatthours (KWH) of usage for residential electric customers who would be protected from price cap index increases through December 31, 2002, the proposed expiration date of the Plan. Similarly, an initial service block equal to 40 therms would be set for residential gas customers and protected from index increases over the same period of time. In addition, public street lighting prices would not be subject to index increases for the life of the Plan.\nThe Plan includes a productivity gains sharing mechanism. This mechanism has been designed to provide incentives to maximize efficiency and productivity improvements and ensure that electric and gas customers receive an increasing share of productivity gains using returns on equity as a proxy for these gains. The gains, which would be awarded through bill credits, would be based on a threshold earnings level defined as PSE&G's established return on equity of 12% plus a 100 basis points neutral zone above that level. Customers would receive a 10% share of the gains from the first 50 basis points above the threshold level. Their share would increase by an additional 10% for each subsequent increase of 50 basis points up to a maximum of 50%.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSeparate mechanisms also would be established to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies or otherwise out of PSE&G's control. These costs include demand side management programs, environmental remediation, costs associated with non-utility electric generators, nuclear decommissioning funding and nuclear fuel assessment costs. These mechanisms would assure that PSE&G recovers only actual costs related to these activities.\nThe Plan would allow for electric and non-fuel gas prices to be changed to reflect exogenous events beyond the control of PSE&G and would be subject to modification for industry restructuring.\nThe Plan calls for an increase of $50 million in annual depreciation expenses for PSE&G's Hope Creek nuclear generating station -- $25 million effective January 1, 1997, and an additional $25 million effective January 1, 1998. In addition, the Plan proposes a transfer of depreciation reserves totaling $253 million from transmission and distribution to fossil steam electric generating accounts. The Plan would permit depreciation to be changed annually following BPU review and approval.\nIn addition to the pricing features, the Plan guarantees enhanced quality of customer services through PSE&G's recently established service guarantee program for electric and gas customers and specific incentive and penalty mechanisms based on various service indicators.\nThe Plan would establish a program of rewards and penalties in key overall service indicators such as duration of customer power outages compared to a historic five-year average.\nIn addition to these service quality incentives, the Plan would establish rewards and penalties based on the movement of PSE&G's average electric residential rate measured against the national average of residential electric rates. Rewards or penalties of up to $5 million would be implemented if comparisons indicate that PSE&G's residential rates decreased or increased by more than one-half of one percent relative to the national average.\nA major component of the Plan is a proposed economic and market development and retention assurance program. This would allow flexible pricing and promote special economic development activities designed to enhance the economic vitality of the State of New Jersey. One aspect of the program would give PSE&G the ability to quickly establish new optional electric or gas rates or individual customer contracts to serve new markets and retain or attract individual customers.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAlso under the Plan, PSE&G would fund two economic development initiatives. The first is a private sector leadership investment of $5 million in the New Jersey Fund for Community Economic Development. The second new initiative is the establishment of the PSE&G Economic Development Fund in which PSE&G would commit to investing up to $50 million for financing significant economic development projects within PSE&G's service territory over the seven years of the Plan.\nIn addition, the Plan calls for establishment of a State Emissions Trading Bank (Bank) for economic development and environmental improvement. PSE&G would donate 1,000 tons of nitrogen oxide emissions credits to the Bank for use in economic development. This is intended as a key step to linking economic development with sound environmental policy and building on New Jersey's leadership role in seeking a regional solution to air pollution problems.\nUnder the Plan, price levels associated with the recovery of Gross Receipts and Franchise Tax (GRFT) or successor taxes will be directly adjusted in such a manner as to insure their full and timely recovery from ratepayers.\nPSE&G cannot predict what action, if any, may be taken by the BPU with respect to the Plan.\nLevelized Gas Adjustment Charge\nOn October 2, 1995, PSE&G petitioned the BPU for modifications to its LGAC, requesting that:\n(a) The LGAC be renamed to the Levelized Gas Incentive Clause (LGIC);\n(b) A benchmark be established for certain gas delivered from the Gulf Coast, and any difference between PSE&G's actual gas purchase costs and the benchmark price, either positive or negative, be shared 50\/50 between customers and PSE&G;\n(c) The current annual LGAC rate be converted to a monthly rate for firm commercial and industrial customers; and\n(d) A fixed annual margin would be credited to LGAC for certain interruptible rate schedules, while actual margins from such sales will be retained by PSE&G. Any differences, positive or negative, will be absorbed by PSE&G.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn December 20, 1995, the BPU approved an interim Stipulation to include the implementation of monthly pricing on the commodity portion of the LGAC rate for firm commercial and industrial customers effective January 1, 1996. The incentive proposal relating to interruptible sales (request (d)) above was withdrawn. The remaining aspects of PSE&G's October 2, 1995 petition remain the subject of continued investigation and litigation.\nElectric Levelized Energy Adjustment Clause\nBy Order dated May 5, 1995, the BPU approved PSE&G's LEAC. Such Order also required that a hearing be convened regarding the April 1994 Salem 1 shutdown, to determine whether PSE&G should be allowed to recover replacement power costs of approximately $8 million which have been deferred. On October 18, 1995, this matter was ordered to be transmitted to the Office of Administrative Law (OAL) for hearing. PSE&G cannot predict the outcome of this proceeding.\nRemediation Adjustment Charge\nOn July 21, 1995, PSE&G petitioned the BPU to recover Remediation Program costs incurred during the period August 1, 1994 through July 31, 1995. In accordance with a BPU Order dated November 4, 1994, the petition proposes to recover, effective October 1, 1995, $2.5 million from gas customers and $1.6 million from electric customers.\nConsolidated Tax Benefits\nIn a case affecting another utility in which neither Enterprise nor PSE&G were parties, the BPU considered the extent to which tax savings generated by nonutility affiliates included in the consolidated tax return of that utility's holding company should be considered in setting that utility's rates. In September, 1992, the BPU approved an order in such case treating certain consolidated tax savings generated after June 30, 1990 by that utility's nonutility affiliates as a reduction of its rate base. In December, 1992, the BPU issued an order approving a stipulation in PSE&G's 1992 base rate proceeding which resolved the case without separate quantification of the consolidated tax issue. The stipulation did not provide final resolution of the consolidated tax issue for any subsequent base rate filing. While Enterprise continues to account for its two wholly-owned subsidiaries on a stand-alone basis, resulting in a realization of the tax benefits by the entity generating the benefit, an ultimate unfavorable resolution of the consolidated tax issue could reduce PSE&G's and Enterprise's future revenue and net income. In addition, an unfavorable resolution\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nmay adversely impact Enterprise's nonutility investment strategy. Enterprise believes that PSE&G's taxes should be treated on a stand-alone basis for rate-making purposes, based on the separate nature of the utility and nonutility businesses. However, neither Enterprise nor PSE&G is able to predict what action, if any, the BPU may take concerning consolidation of tax benefits in future rate proceedings. (See Note 10 -- Federal Income Taxes.)\nOther Rate Matters\nOn July 21, 1995, the BPU initiated a generic proceeding to expeditiously adopt specific standards to guide utility \"off-tariff\" negotiated rate agreement programs, which proceeding would consider minimum prices, confidentiality, maximum contract duration, filing requirements and such other standards as necessary for compliance with the law. A Written Summary Decision and Order was issued on October 27, 1995, which ordered each New Jersey electric utility, including PSE&G, to file initial minimum tariffs, consistent with the terms of such Order, and further, indicated that such Order will be supplemented by a Final Decision and Order to fully discuss and explain the rationale for the BPU's overall decision. On November 13, 1995 PSE&G filed its compliance filing. PSE&G cannot predict what impact, if any, the generic tariff may have on its electric revenues and earnings.\nIn September 1994, the BPU initiated a generic proceeding regarding recovery of capacity costs associated with electric utility power purchases from cogeneration and small power procedures. The initial phase of the proceeding, which has been transmitted to the Office of Administrative Law, seeks to determine whether there was any such overrecovery and, if so, the amount overrecovered.\nThe New Jersey Division of Ratepayer Advocate has intervened in the proceeding and alleges, among other things, that PSE&G has overrecovered such costs ranging from $250 to $300 million during the period from August 1991 to December 1994. PSE&G denies such overrecovery because its capacity cost recovery mechanisms were approved by the BPU as to each of its cogeneration contracts and as to its base rates. Additionally, PSE&G contends that a review of any individual cost item is inappropriate and that the BPU has previously found that, during the period under review, PSE&G did not overearn compared to its established return. Moreover, PSE&G contends that the Ratepayer Advocate's assertion is proscribed as retroactive ratemaking.\nWhile PSE&G cannot predict the outcome of this proceeding, the final resolution of this issue may impact the financial position, results from operations or net cash flows of Enterprise and PSE&G on a prospective basis.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 3. PSE&G NUCLEAR DECOMMISSIONING AND AMORTIZATION OF NUCLEAR FUEL\nThe BPU decision in PSE&G's 1992 base rate case utilized studies based on the prompt removal\/dismantlement method of decommissioning for all of PSE&G's nuclear generating stations. This method consists of removing all fuel, source material and all other radioactive materials with activity levels above accepted release limits from the nuclear sites. PSE&G has an ownership interest in five nuclear units: Salem 1 and Salem 2 -- 42.59% each, Hope Creek -- 95% and Peach Bottom 2 and 3 -- 42.49% each. In accordance with rate orders received from the BPU, PSE&G has established an external master nuclear decommissioning trust for all of its nuclear units. The Internal Revenue Service (IRS) has ruled that payments to the trust are tax deductible. PSE&G's total estimated cost of decommissioning its share of these 5 nuclear units is estimated at $681 million in year-end 1990 dollars (the year that the site specific estimate was prepared), excluding contingencies. The 1992 base rate decision provided that $15.6 million of such costs are to be collected through base rates and an additional annual amount of $7.0 million in 1993 and $14 million each year thereafter are to be recovered through PSE&G's LEAC. In accordance with the filed Alternative Rate Plan, PSE&G has requested to have separate mechanisms to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies, but no assurances can be given that the BPU will authorize such recovery from customers (see Note 2 -- Rate Matters). At December 31, 1995 and 1994, the accumulated provision for depreciation and amortization included reserves for nuclear decommissioning for PSE&G's units of $292 million and $249 million, respectively. As of December 31, 1995 and 1994, PSE&G had contributed $220 million and $190 million, respectively, into independent external qualified and nonqualified nuclear decommissioning trust funds.\nOn January 3, 1996, PSE&G filed with the BPU its 1995 nuclear plant decommissioning cost update. The filing includes decommissioning cost updates for PSE&G's respective ownership share of Salem, Hope Creek and Peach Bottom. PSE&G's filing was based on the existing Nuclear Regulatory Commission (NRC) generic formula(s). PSE&G does not believe that the NRC generic estimates provide an accurate estimate of the cost of decommissioning because the NRC formula does not factor into its cost estimates the cost of removal of nonradiological structures and equipment and interim spent fuel storage installations. PSE&G is currently completing site specific studies in order to update its filing with the BPU during 1996.\nThe Staff of the Securities and Exchange Commission (SEC) has questioned certain of the current accounting practices of the electric utility industry, including PSE&G, 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 Financial Accounting Standards Board (FASB) has agreed to review the accounting for removal costs,\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nincluding decommissioning. If current electric utility industry accounting practices for such decommissioning are changed: (1) annual provisions for decommissioning could increase, (2) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation and (3) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nUranium Enrichment Decontamination and Decommissioning Fund\nIn accordance with EPAct, domestic utilities that own nuclear generating stations are required to pay a cumulative total of $150 million each year (adjusted for inflation) into a decontamination and decommissioning fund, based on their past purchases of enrichment services from the United States Department of Energy (DOE) Uranium Enrichment Enterprise (now a federal government corporation known as the United States Enrichment Corporation (USEC)). These amounts are being collected over a period of 15 years or until $2.25 billion (adjusted for inflation) has been collected. Under this legislation, PSE&G's obligation for the nuclear generating stations in which it has an interest is $67 million (adjusted for inflation). Since 1993, PSE&G has paid $17 million, resulting in a balance due of $50 million. PSE&G has deferred the expenditures incurred to date as part of deferred underrecovered electric energy costs and expects to recover its costs in the next LEAC. In accordance with the filed Alternative Rate Plan, PSE&G has requested to have separate mechanisms to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies, but no assurances can be given that the BPU will authorize such recovery from customers (see Note 2 -- Rate Matters).\nSpent Nuclear Fuel Disposal Costs\nIn accordance with the Nuclear Waste Policy Act (NWPA), PSE&G has entered into contracts with the DOE for the disposal of spent nuclear fuel. Payments made to the DOE for disposal costs are based on nuclear generation and are included in Fuel for Electric Generation and Interchanged Power in the Statements of Income. These costs are recovered through the LEAC. In accordance with the filed Alternative Rate Plan, PSE&G has requested to have separate mechanisms to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies, but no assurances can be given that the BPU will authorize such recovery from customers (see Note 2 -- Rate Matters).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 4. SCHEDULE OF CONSOLIDATED CAPITAL STOCK AND OTHER SECURITIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 5. DEFERRED ITEMS\nProperty Abandonments\nUnder (Over) Recovered Electric Energy and Gas Costs -- net\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nUnrecovered Plant and Regulatory Study Costs\nAmounts shown in the consolidated balance sheets consist of costs associated with developing, consolidating and documenting the specific design basis of PSE&G's jointly owned nuclear generating stations, as well as PSE&G's share of costs associated with the cancellation of the Hydrogen Water Chemistry System Project (HWCS Project) at Peach Bottom. PSE&G has received both BPU and FERC approval to defer and amortize, over the remaining life of the Salem and Hope Creek nuclear units, costs associated with configuration baseline documentation and the canceled HWCS Project. PSE&G has received FERC approval to defer and amortize over the remaining life of the applicable Peach Bottom units, costs associated with the configuration baseline documentation and the canceled HWCS Project. In accordance with the filed Alternative Rate Plan, PSE&G has requested to have separate mechanisms to ensure continued recovery of costs associated with activities mandated or approved by state or federal agencies or otherwise out of PSE&G's control (see Note 2 -- Rate Matters).\nUnamortized Debt Expense\nGains and losses and the costs of issuing and redeeming long-term debt for PSE&G are deferred and amortized over the life of the applicable debt.\nOil and Gas Property Write-Down\nOn December 31, 1992, the BPU approved the recovery of PSE&G's deferral of an EDC write-down through PSE&G's LGAC over a ten-year period beginning January 1, 1993. At December 31, 1995 and 1994, the remaining balance to be amortized was $36.1 million and $41.2, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 6. SCHEDULE OF CONSOLIDATED DEBT\nLONG-TERM\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTES:\n(A) PSE&G's Mortgage, securing the Bonds, constitutes a direct first mortgage lien on substantially all PSE&G'S property and franchises.\n(B) The aggregate principal amounts of mandatory requirements for sinking funds and maturities for each of the five years following December 31, 1995 are as follows:\nSHORT-TERM (Commercial Paper and Loans)\nCommercial paper represents unsecured bearer promissory notes sold through dealers at a discount with a term of nine months or less.\nBank loans represent PSE&G's unsecured promissory notes issued under informal credit arrangements with various banks and have a term of eleven months or less.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 9. CASH AND CASH EQUIVALENTS\nThe December 31, 1995 and 1994 balances consist primarily of working funds and highly liquid marketable securities (commercial paper) with a maturity of three months or less.\nNOTE 10. FEDERAL INCOME TAXES\nA reconciliation of reported Net Income with pretax income and of Federal income tax expense with the amount computed by multiplying pretax income by the statutory Federal income tax rate of 35% is as follows:\nReconciliation between total Federal income tax provisions and tax computed at the statutory tax rate on pretax income:\n(A) The provision for deferred income taxes represents the tax effects of the following items:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nBetween the years 1987 and 1994, Enterprise's Federal alternative minimum tax (AMT) liability exceeded its regular Federal income tax liability. This excess can be carried forward indefinitely to offset regular income tax liability in future years. Enterprise commenced using these AMT credits in 1995 and expects to continue using them in future years as regular tax liability exceeds AMT. As of December 31, 1995, 1994 and 1993, Enterprise had AMT credits of $203 million, $256 million and $247 million, respectively.\nSince 1986, Enterprise has filed a consolidated Federal income tax return on behalf of itself and its subsidiaries. Prior to 1986, PSE&G filed consolidated tax returns. In March, 1992, the Internal Revenue Service (IRS) issued a Revenue Agent's Report (RAR) following completion of examination of PSE&G's consolidated tax return for 1985 and Enterprise's consolidated tax returns for 1986 and 1987, proposing various adjustments for such years which would increase Enterprise's consolidated Federal income tax liability by approximately $121 million, exclusive of interest and penalties, of which approximately $118 million is attributable to PSE&G. Interest after taxes on these proposed adjustments is currently estimated to be approximately $119 million as of December 31, 1995 and will continue to accrue at the Federal rate for large corporate underpayments, currently 11% annually.\nThe most significant of these proposed adjustments relates to the IRS contention that PSE&G's Hope Creek nuclear unit is a partnership with a short 1986 taxable year. In addition, the IRS contends that the tax in-service date of that unit is four months later than the date claimed by PSE&G. In June 1992, Enterprise and PSE&G filed a protest with the IRS disagreeing with certain of the proposed adjustments (including those related to Hope Creek) contained in the RAR for taxable years 1985 through 1987 and continue to contest these issues. Any tax adjustments resulting from the RAR would reduce Enterprise's and PSE&G's respective deferred credits for accumulated deferred income taxes. While PSE&G believes that assessments attributable to it are generally recoverable from its customers in rates, no assurances can be given as to what regulatory treatment may be afforded by the BPU.\nOn January 1, 1993, Enterprise adopted SFAS 109 without restating prior years' financial statements which resulted in Enterprise recording a $5.4 million cumulative effect increase in its net income. Under SFAS 109, deferred taxes are provided at the enacted statutory tax rate for all temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities irrespective of the treatment for rate-making purposes. Since management believes that it is probable that the effects of SFAS 109 on PSE&G, principally the accumulated tax benefits that previously have been treated as a flow-through item to customers, will be recovered from utility customers in the future, an offsetting regulatory asset was established. As of December 31, 1995, PSE&G had recorded a deferred tax liability and an offsetting regulatory asset of $769 million representing the future revenue expected to be recovered through rates based upon established regulatory practices which permit recovery of current taxes payable. This amount was determined using the 1995 Federal income tax rate of 35%.\nSFAS 109\nThe following is an analysis of accumulated deferred income taxes:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 11. LEASING ACTIVITIES\nAs Lessee\nThe Consolidated Balance Sheets include assets and related obligations applicable to capital leases under which PSE&G is a lessee. The total amortization of the leased assets and interest on the lease obligations equals the net minimum lease payments included in rent expense for capital leases.\nCapital leases of PSE&G relate primarily to its corporate headquarters and other capital equipment. Certain of the leases contain renewal and purchase options and also contain escalation clauses.\nEnterprise and its other subsidiaries are not lessees in any capitalized leases.\nUtility plant includes the following amounts for capital leases at December 31:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAs Lessor\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 12. COMMITMENTS AND CONTINGENT LIABILITIES\nNuclear Performance Standard\nThe BPU has established its NPS for nuclear generating stations owned by New Jersey electric utilities, including the five nuclear units in which PSE&G has an ownership interest: Salem Units 1 and 2 - -- 42.59%; Hope Creek -- 95%; and Peach Bottom Units 2 and 3 -- 42.49%. PSE&G operates Salem and Hope Creek, while Peach Bottom is operated by PECO Energy, Inc. (PECO).\nThe penalty\/reward under the NPS is a percentage of replacement power costs. (See table below.)\nUnder the NPS, the capacity factor is calculated annually using maximum dependable capability of the five nuclear units in which PSE&G owns an interest. This method takes into account actual operating conditions of the units.\nWhile the NPS does not specifically have a gross negligence provision, the BPU has indicated that it would consider allegations of gross negligence brought upon a sufficient factual basis. A finding of gross negligence could result in penalties other than those prescribed under the NPS. During 1995, the five nuclear units in which PSE&G has an ownership interest aggregated a 62% combined capacity factor which resulted in a penalty for 1995 of approximately $3.5 million. On January 16, 1996, PSE&G filed its Alternative Rate Plan with the BPU which proposes the elimination of the NPS. See Note 2.\nBased upon current projections and assumptions regarding PSE&G's five nuclear units during 1996, including the return of Hope Creek to service in early March, the return of Salem 2 in the third quarter and\nthe continued outage of Salem 1 for the remainder of the year, the 1996 aggregate capacity factor would be approximately 57%, which would result in a penalty ranging from $11 to $12 million. Both of the Salem units are currently out of service and their return dates are subject to completion of testing, analysis, repair activity and NRC concurrence that they are prepared to restart. Restart of Salem 1, which had originally been scheduled for the second quarter of 1996, will be delayed for a substantial period as a result of the ongoing steam generator inspection and analysis. Salem 2, which is also undergoing steam generator inspection and analysis is still scheduled to return to service in the third quarter of 1996. The inability to successfully return these units to continuous, safe operation could have a material effect on the financial position, results of operation and net cash flows of Enterprise and PSE&G.\nCertain of the owners of Salem have indicated that they may seek to hold PSE&G responsible for their share of costs of the current outage. PSE&G cannot predict what actions, if any, may be taken.\nNuclear Insurance Coverages and Assessments\nPSE&G's insurance coverages and maximum retrospective assessments for its nuclear operations are as follows:\n(A) Retrospective premium program under the Price-Anderson liability provisions of the Atomic Energy Act of 1954, as amended (Price- Anderson). Subject to retrospective assessment with respect to loss from an incident at any licensed nuclear reactor in the United States. Assessment adjusted for inflation effective August 20, 1993.\n(B) Limit of liability for each nuclear incident under Price- Anderson.\n(C) Industry aggregate limit representing the potential liability from workers claiming exposure to the hazard of nuclear radiation. This policy includes automatic reinstatements up to an aggregate of $200 million, thereby providing total coverage of $400 million. This policy does not increase PSE&G's obligation under Price- Anderson.\n(D) In the event of a second industry loss triggering NEIL II - coverage, the maximum retrospective premium assessment can increase to $18.5 million.\n(E) Represents limit of coverage available to co-owners of Salem and Hope Creek, for each plant. Each co-owner purchases its own policy. PSE&G is currently covered for its percent ownership interest of this limit for each plant.\nPrice-Anderson sets the \"limit of liability\" for claims that could arise from an incident involving any licensed nuclear facility in the nation. The \"limit of liability\" is based on the number of licensed nuclear reactors and is adjusted at least every five years based on the Consumer Price Index. The current \"limit of liability\" is $8.9 billion. All utilities owning a nuclear reactor, including PSE&G, have provided for this exposure through a combination of private insurance and mandatory participation in a financial protection pool as established by Price-Anderson. Under Price- Anderson, each party with an ownership interest in a nuclear reactor can be assessed its share of $79.3 million per reactor per incident, payable at $10 million per reactor per incident per year. If the damages exceed the \"limit of liability,\" the President is to submit to Congress a plan for providing additional compensation to the injured parties. Congress could impose further revenue raising measures on the nuclear industry to pay claims. PSE&G's maximum aggregate assessment per incident is $210.2 million (based on PSE&G's ownership interests in Hope Creek, Peach Bottom and Salem) and its maximum aggregate annual assessment per incident is $26.5 million.\nFurther, a recent decision by the U.S. Court of Appeals for the Third Circuit, not involving PSE&G, held that the Price Anderson Act did not preclude awards based on state law claims for punitive damage.\nPSE&G is a member of two industry mutual insurance companies; Nuclear Mutual Limited (NML), and Nuclear Electric Insurance Limited (NEIL). NML provides the primary property insurance at Salem and Hope Creek. NEIL provides excess property insurance through its NEIL II and NEIL III policies and replacement power coverage through its NEIL I policy. Both companies may make retrospective premium assessments in case of adverse loss experience. PSE&G's maximum potential liabilities\nunder these assessments are included in the table and notes above. Certain of the policies also provide that the insurer may suspend coverage with respect to all nuclear units on a site without notice if the NRC suspends or revokes the operating license for any unit on a site, issues a shutdown order with respect to such unit or issues a confirmatory order keeping such unit down. All coverages at Salem and Hope Creek remain fully in effect.\nConstruction and Fuel Supplies\nPSE&G has substantial commitments as part of its ongoing construction program which include capital requirements for nuclear fuel. PSE&G's construction program is continuously reviewed and periodically revised as a result of changes in economic conditions, revised load forecasts, changes in the scheduled retirement dates of existing facilities, changes in business strategies, site changes, cost escalations under construction contracts, requirements of regulatory authorities and laws, the timing of and amount of electric and gas rate changes and the ability of PSE&G to raise necessary capital. Pursuant to an electric integrated resource plan (IRP), PSE&G periodically reevaluates its forecasts of future customers, load and peak growth, sources of electric generating capacity and demand side management (DSM) to meet such projected growth, including the need to construct new electric generating capacity. The IRP takes into account assumptions concerning future demands of customers, effectiveness of conservation and load management activities, the long-term condition of PSE&G's plants, capacity available from electric utilities and other suppliers and the amounts of co-generation and other non-utility capacity projected to be available.\nBased on PSE&G's construction program, construction expenditures are expected to aggregate approximately $2.8 billion, which includes $428 million for nuclear fuel and $84 million of Allowance for Funds used During Construction (AFDC) during the years 1996 through 2000. The estimate of construction requirements is based on expected project completion dates and includes anticipated escalation due to inflation of approximately 3%, annually. Therefore, construction delays or higher inflation levels could cause significant increases in these amounts. PSE&G expects to generate internally the funds necessary to satisfy its construction expenditures over the next five years, assuming adequate and timely recovery of costs, as to which no assurances can be given. In addition, PSE&G does not presently anticipate any difficulties in obtaining sufficient sources of fuel for electric generation or adequate gas supplies during the years 1996 through 2000.\nHazardous Waste\nCertain Federal and State laws authorize the United States Environmental Protection Agency (EPA) and the New Jersey Department of Environmental Protection (NJDEP), among other agencies, to issue orders and bring enforcement actions to compel responsible parties to take investigative and remedial actions at any site that is determined to present an imminent and substantial danger to the public or the environment because of an actual or threatened release of one or more hazardous substances. Because of the nature of PSE&G's business, including the production of electricity, the distribution of gas and, formerly, the manufacture of gas, various by-products and substances are or were produced or handled which contain constituents classified as hazardous. PSE&G generally provides for the disposal or processing of such substances through licensed independent contractors. However, these statutory provisions impose joint and several responsibility without regard to fault on all responsible parties, including the generators of the hazardous substances, for certain investigative and remediation costs at sites where these substances were disposed of or processed. PSE&G has been notified with respect to a number of such sites and the remediation of these potentially hazardous sites is receiving greater attention from the government agencies involved. Generally, actions directed at funding such site investigations and remediation include all suspected or known responsible parties. PSE&G does not expect its expenditures for any such site to have a material effect on its financial position, results of operations or net cash flows.\nPSE&G Manufactured Gas Plant Remediation Program\nIn 1988, NJDEP notified PSE&G that it had identified the need for PSE&G, pursuant to a formal arrangement, to systematically investigate and, if necessary, resolve environmental concerns extant at PSE&G's former manufactured gas plant sites. To date, NJDEP and PSE&G have identified 38 former gas plant sites. PSE&G is currently working with NJDEP under a program to assess, investigate and, if necessary, remediate environmental concerns at these sites (Remediation Program). The Remediation Program is periodically reviewed and revised by PSE&G based on regulatory requirements, experience with the Remediation Program and available technologies. The cost of the Remediation Program cannot be reasonably estimated, but experience to date indicates that costs of at least $20 million per year could be incurred over a period of more than 30 years and that the overall cost could be material to PSE&G's financial position, results of operations or net cash flows.\nCosts incurred through December 31, 1995 for the Remediation Program amounted to $64.6 million, net of certain insurance proceeds. In addition, at December 31, 1995, PSE&G's estimated liability for remediation costs through 1998 aggregated $96.3 million.\nIn accordance with a Stipulation approved by the BPU in 1992, PSE&G is recovering through its LEAC over a six-year period $32 million of its actual remediation costs to reflect costs incurred through September 30, 1992. As of December 31, 1995, PSE&G has recovered $27.8 million of the $32 million of such costs. PSE&G is expected to recover the balance of $4.2 million in its currently filed LGAC period ending in 1996.\nNOTE 13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nOn January 1, 1993, Enterprise and PSE&G adopted SFAS 106 which requires that the expected cost of employees' postretirement health care and insurance benefits be charged to expense during the years in which employees render service. PSE&G elected to amortize, over 20 years, its unfunded obligation of $609.3 million at January 1, 1993. The following table discloses the significant components of the net periodic postretirement benefit obligation:\n(a) Reflects change in Plan Assumptions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe discount rate used in determining the PSE&G net periodic postretirement benefit cost was 8.50% and 7.25% for 1995 and 1994, respectively.\nA one-percentage-point increase in the assumed health care cost trend rate for each year would increase the aggregate of the service and interest cost components of net periodic postretirement health care cost by approximately $2.6 million, or 5.6%, and increase the accumulated postretirement benefit obligation as of December 31, 1995 by $34.8 million, or 5.9%.\nThe assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation in 1995 were: medical costs for pre-age sixty-five retirees -- 13.0%, medical costs for post-age sixty-five retirees -- 9.0% and dental costs -- 7.0%; such rates are assumed to gradually decline to 5.0%, 5.0% and 5.0%, respectively, in 2011. The medical costs above include a provision for prescription drugs.\nIn its 1992 base rate case, PSE&G requested full recovery of the costs associated with postretirement benefits other than pensions (OPEB) on an accrual basis, in accordance with SFAS 106. The BPU's December 31, 1992 base rate order provided that (1) PSE&G's pay-as-you-go basis OPEB costs will continue to be included in cost of service and will be recoverable in base rates on a pay-as-you-go basis; (2) prudently incurred OPEB costs, that are accounted for on an accrual basis in accordance with SFAS 106, will be recoverable in future rates; (3) PSE&G should account for the differences between its OPEB costs on an accrual basis and the pay-as-you-go basis being recovered in rates as a regulatory asset; and (4) the issue of cash versus accrual accounting will be revisited and in the event that FASB or the SEC requires the use of accrual accounting for OPEB costs for rate-making purposes, the regulatory asset will be recoverable, through rates, over an appropriate amortization period.\nAccordingly, PSE&G is accounting for the differences between its SFAS 106 accrual cost and the cash cost currently recovered through rates as a regulatory asset. OPEB costs charged to expenses during 1995 were $32.6 million and accrued OPEB costs deferred were $50.7 million. The amount of the unfunded liability, at December 31, 1995, as shown below, is $717.9 million and funding options are currently being explored. The primary effect of adopting SFAS 106 on Enterprise's and PSE&G's financial reporting is on the presentation of their financial positions with minimal effect on their results of operations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDuring January 1993 and subsequent to the receipt of the Order, the FASB's Emerging Issues Task Force (EITF) concluded that deferral of such costs is acceptable, provided regulators allow SFAS 106 costs in rates within approximately five years of the adoption of SFAS 106 for financial reporting purposes, with any cost deferrals recovered in approximately twenty years. In accordance with the Alternative Rate Plan filed, PSE&G expects full SFAS 106 recovery in accordance with the EITF's view of such standard and believes that it is probable that any deferred costs will be recovered from utility customers within such twenty-year time period. As of December 31, 1995, PSE&G has deferred $167.2 million of such costs. However, if recovery of SFAS 106 costs is not approved by the BPU , the impact on the financial position and results of operations would be material.\nIn accordance with SFAS 106 disclosure requirements, a reconciliation of the funded status of the plan is as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 14. PENSION PLAN\nThe discount rates, expected long-term rates of return on assets and average compensation growth rates used in determining the Pension Plan's funded status and net pension cost as of December 31, 1995 and 1994 were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following table shows the Pension Plan's funded status:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 15. FINANCIAL INFORMATION BY BUSINESS SEGMENTS\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\nNOTE 16. PROPERTY IMPAIRMENT OF ENTERPRISE GROUP DEVELOPMENT CORPORATION\nAs a result of a management review of each property's current value and the potential for increasing such value through operating and other improvements, EGDC recorded an impairment in 1993 related to certain of its properties, including properties upon which EDHI's management revised its intent from a long-term investment strategy to a hold for sale status, reflecting such properties on its books at their net realizable value. This impairment reduced the estimated value of EGDC's properties by $77.6 million and 1993 net income by $50.5 million, after tax, or 21 cents per share of Enterprise Common Stock.\nNOTE 17. JOINTLY OWNED FACILITIES -- UTILITY PLANT\nPSE&G has ownership interests in and is responsible for providing its share of the necessary financing for the following jointly owned facilities. All amounts reflect the share of PSE&G's jointly owned projects and the corresponding direct expenses are included in Consolidated Statements of Income as operating expenses. (See Note 1 -- Organization and Summary of Significant Accounting Policies.)\nNOTE 18. SELECTED QUARTERLY DATA (UNAUDITED)\nThe information shown below, in the opinion of Enterprise, includes all adjustments, consisting only of normal recurring accruals, necessary to a fair presentation of such amounts. Due to the seasonal nature of the utility business, quarterly amounts vary significantly during the year.\nPUBLIC SERVICE ELECTRIC AND GAS COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPSE&G\nExcept as modified below, the Notes to Consolidated Financial Statements of Enterprise are incorporated herein by reference insofar as they relate to PSE&G and its subsidiaries:\nNote 1. - Organization and Summary of Significant Accounting Policies Note 2. - Rate Matters Note 3. - PSE&G Nuclear Decommissioning and Amortization of Nuclear Fuel Note 4.- Schedule of Consolidated Capital Stock and Other Securities Note 5. - Deferred Items Note 6. - Schedule of Consolidated Debt Note 7. - Long-Term Investments Note 8. - Financial Instruments and Risk Management Note 11.- Leasing Activities -- As Lessee Note 12.- Commitments and Contingent Liabilities Note 13.- Postretirement Benefits Other Than Pensions Note 14.- Pension Plan Note 15.- Financial Information by Business Segments Note 17.- Jointly Owned Facilities -- Utility Plant\nNOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation Policy\nThe consolidated financial statements include the accounts of PSE&G and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications of prior years' data have been made to conform with the current presentation.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 9. CASH AND CASH EQUIVALENTS\nThe December 31, 1995 and 1994 balances consist primarily of working funds.\nNOTE 10. FEDERAL INCOME TAXES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSFAS 109\nThe following is an analysis of accumulated deferred income taxes:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\nNOTE 18. SELECTED QUARTERLY DATA (UNAUDITED)\nThe information shown below, in the opinion of PSE&G, includes all adjustments, consisting only of normal recurring accruals, necessary to a fair presentation of such amounts. Due to the seasonal nature of the utility business, quarterly amounts vary significantly during the year.\nNOTE 19. ACCOUNTS PAYABLE TO ASSOCIATED COMPANIES -- NET\nThe balance at December 31, 1995 and 1994 consisted of the following:\nPART III\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nEnterprise and PSE&G, none.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nDIRECTORS OF THE REGISTRANTS\nEnterprise\nThe information required by Item 10 of Form 10-K with respect to present directors who are nominees for election as directors at Enterprise's Annual Meeting of Stockholders to be held on April 16, 1996, and directors whose terms will continue beyond the meeting, is set forth under the heading \"Election of Directors\" in Enterprise's definitive Proxy Statement for such Annual Meeting of Stockholders, which definitive Proxy Statement is expected to be filed with the Securities and Exchange Commission on or about March 1, 1996 and which information set forth under said heading is incorporated herein by this reference thereto.\nPSE&G\nThere is shown as to each present director information as to the period of service as a director of PSE&G, age as of April 16, 1996, present committee memberships, business experience during the last five years and other present directorships. For discussion of certain litigation involving the directors of PSE&G, except Forrest J. Remick, see Part I - Business, Item 3 - Legal Proceedings.\nLAWRENCE R. CODEY has been a director since 1988. Age 51. Member of Executive Committee. Has been President and Chief Operating Officer of PSE&G since September 1991. Was Senior Vice President - Electric of PSE&G from January 1989 to September 1991. Director of Enterprise. Director of Sealed Air Corporation, The Trust Company of New Jersey, United Water Resources Inc. and Blue Cross & Blue Shield of New Jersey.\nE. JAMES FERLAND has been a director since 1986. Age 54. Chairman of Executive Committee. Chairman of the Board, President and Chief Executive Officer of Enterprise since July 1986, Chairman of the Board and Chief Executive Officer of PSE&G since September 1991 and Chairman of the Board and Chief Executive Officer of EDHI since June 1989. President of PSE&G from July 1986 to September 1991. Director of Enterprise and of EDHI and its principal subsidiaries. Director of Foster Wheeler Corporation and The Hartford Steam Boiler Inspection and Insurance Company.\nRAYMOND V. GILMARTIN has been a director since 1993. Age 55. Director of Enterprise. Has been Chairman of the Board, President and Chief Executive Officer of Merck & Co., Inc., Whitehouse Station, New Jersey (discovers, develops, produces and markets human and animal health products) since November 1994. Was President and Chief Executive Officer from June 1994 to November 1994. Was Chairman of the Board, President and Chief Executive Officer of Becton Dickinson and Company from November 1992 to June 1994 and President and Chief Executive Officer from February 1989 to November 1992. Director of Merck & Co., Inc. and Providian Corporation.\nIRWIN LERNER has been a director since 1993. Age 65. Was previously a director from 1981 to February 1988. Director of Enterprise. Was Chairman, Board of Directors and Executive Committee from January 1993 to September 1993 and President and Chief Executive Officer from 1980 to December 1992 of Hoffmann-La Roche Inc., Nutley, New Jersey (prescription pharmaceuticals, vitamins and fine chemicals, and diagnostic products and services). Director of Humana Inc., Sequana Therapeutics, Inc. and Medarex, Inc.\nJAMES C. PITNEY has been a director since 1993. Age 69. Was previously a director from 1979 to February 1988. Member of Executive Committee. Director of Enterprise. Has been a partner in the law firm of Pitney, Hardin, Kipp & Szuch, Morristown, New Jersey, since 1958. Director of Tri-Continental Corporation, sixteen funds of the Seligman family of funds and Seligman Quality, Inc.\nFORREST J. REMICK has been a director since May 1995. Age 65. Director of Enterprise. Has been an engineering consultant since July 1994. Was Commissioner, United States Nuclear Regulatory Commission, from December 1989 to June 1994. Was Associate Vice President - Research and Professor of Nuclear Engineering at Pennsylvania State University, from 1985 to 1989.\nExecutive Officers of the Registrants\nThe following table sets forth certain information concerning the executive officers of Enterprise and PSE&G, respectively.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nENTERPRISE\nThe information required by Item 11 of Form 10-K is set forth under the heading \"Executive Compensation\" in Enterprise's definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 16, 1996, which definitive Proxy Statement is expected to be filed with the Securities and Exchange Commission on or about March 1, 1996 and such information set forth under such heading is incorporated herein by this reference thereto.\nPSE&G\nInformation regarding the compensation of the Chief Executive Officer and the four most highly compensated executive officers of PSE&G as of December 31, 1995 is set forth below. Amounts shown were paid or awarded for all services rendered to Enterprise and its subsidiaries and affiliates including PSE&G.\nSUMMARY COMPENSATION TABLE\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR (1995) AND FISCAL YEAR-END OPTION VALUES (12\/31\/95)\nCompensation Pursuant to Pension Plans\nPENSION PLAN TABLE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPUBLIC SERVICE ENTERPRISE GROUP INCORPORATED\nBy E. JAMES FERLAND ------------------------------- E. James Ferland Chairman of the Board, President Date: February 22, 1996 and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 ELECTRIC AND GAS COMPANY\nBy E. JAMES FERLAND ------------------------------- E. James Ferland Chairman of the Board and Chief Executive Officer Date: February 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.\nEXHIBIT INDEX\nCertain Exhibits previously filed with the Commission and the appropriate securities exchanges are indicated as set forth below. Such Exhibits are not being refiled, but are included because inclusion is desirable for convenient reference.\n(a) Filed by PSE&G with Form 8-A under the Securities Exchange Act of 1934, on the respective dates indicated, File No. 1-973.\n(b) Filed by PSE&G with Form 8-K under the Securities Exchange Act of 1934, on the respective dates indicated, File No. 1-973.\n(c) Filed by PSE&G with Form 10-K under the Securities Exchange Act of 1934, on the respective dates indicated, File No. 1-973.\n(d) Filed by PSE&G with Form 10-Q under the Securities Exchange Act of 1934, on the respective dates indicated, File No. 1-973.\n(e) Filed by Enterprise with Form 10-K under the Securities Exchange Act of 1934, on the respective dates indicated, File No. 1-9120.\n(f) Filed with registration statement of PSE&G under the Securities Exchange Act of 1934, File No. 1-973, effective July 1, 1935, relating to the registration of various issues of securities.\n(g) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-4995, effective May 20, 1942, relating to the issuance of $15,000,000 First and Refunding Mortgage Bonds, 3% Series due 1972.\n(h) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-7568, effective July 1, 1948, relating to the proposed issuance of 200,000 shares of Cumulative Preferred Stock.\n(i) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-8381, effective April 18, 1950, relating to the issuance of $26,000,000 First and Refunding Mortgage Bonds, 2 3\/4% Series due 1980.\n(j) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-12906, effective December 4, 1956, relating to the issuance of 1,000,000 shares of Common Stock.\n(k) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-59675, effective September 1, 1977, relating to the issuance of $60,000,000 First and Refunding Mortgage Bonds, 8 1\/8% Series I due 2007.\n(l) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-60925, effective March 30, 1978, relating to the issuance of 750,000 shares of Common Stock through an Employee Stock Purchase Plan.\n(m) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-65521, effective October 10, 1979, relating to the issuance of 3,000,000 shares of Common Stock.\n(n) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 2-74018, filed on June 16, 1982, relating to the Thrift Plan of PSE&G.\n(o) Filed with registration statement of Public Service Enterprise Group Incorporated under the Securities Act of 1933, No. 33-2935 filed January 28, 1986, relating to PSE&G's plan to form a holding company as part of a corporate restructuring.\n(p) Filed with registration statement of PSE&G under the Securities Act of 1933, No. 33-13209 filed April 9, 1987, relating to the registration of $575,000,000 First and Refunding Mortgage Bonds pursuant to Rule 415.\nENTERPRISE\nPSE&G","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"821218_1995.txt","cik":"821218","year":"1995","section_1":"Item 1. Business --------\nLeastec Income Fund V, a California limited partnership (the \"Partnership\"), is engaged in the business of owning and leasing equipment. The Partnership's original general partners were Leastec Corporation (\"Leastec\") and CAI Partners Management Company, both of whom were affiliates of Capital Associates, Inc. (\"CAI\"). During 1988, CAI acquired all the outstanding stock of Leastec. In June 1990, CAI sold all of the stock of Leastec back to its original owners and, effective December 1990, Leastec resigned as a general partner. As a result, CAI Partners Management Company is currently the sole general partner of the Partnership.\nCapital Associates International, Inc. (\"CAII\"), the parent of the general partner, is the sole Class B limited partner of the Partnership. The Class B limited partner has contributed $2,501,890 in cash and equipment to the Partnership, which represented 10% of the net offering proceeds from sales of Class A limited partner units after September 1, 1988. CAII is the largest single investor in the Partnership.\nSince its formation in 1987, the Partnership has acquired equipment of various types under lease to third parties on short-term leases (generally five years or less). All of the equipment was purchased by CAII directly from manufacturers or from other independent third parties and sold to the Partnership. The equipment generally consisted of, but was not limited to, office technology and manufacturing equipment. The Partnership entered its liquidation period, as defined in the Partnership Agreement, during 1994. Accordingly, the Partnership did not purchase any equipment during 1995 and it is not anticipated that the Partnership will acquire any material amount of equipment in future periods.\nThe Partnership may assign the rentals from leases to financial institutions, or acquire leases subject to such assignments, at fixed interest rates on a non-recourse basis. The financial institution has a first lien on the assigned rents and the underlying leased equipment, with no recourse against the Partnership or any other Partnership assets in the event of default by a lessee. Cash proceeds from such financings, or the assumption of such assignments incurred in connection with the acquisition of leases, are recorded on the balance sheet as discounted lease rentals. As lessees make payments to financial institutions, leasing revenue and interest expense are recorded.\nThe Partnership leases equipment to investment grade and noninvestment grade lessees. Pursuant to the Partnership Agreement, an investment grade lessee is a company (1) with a credit rating of not less than Baa, as determined by Moody's Investor Services, Inc., or (2) that has comparable credit ratings as determined by other recognized credit rating services or (3) which, if not rated by a recognized credit rating service, then in the opinion of the general partner, is of comparable credit quality. The Partnership may choose to manage its credit risk through selective use of non-recourse debt financing of future lease rentals, as described above. Approximately 49% of the Partnership's equipment under lease was leased to investment grade lessees or equivalent as of December 31, 1995.\nThe Partnership only acquired equipment that was on lease at the time of acquisition. After the initial term of its lease, each item of equipment will be expected to provide additional investment income from its re-lease or ultimate sale. Upon expiration of an initial lease, the Partnership attempts to re-lease or sell the equipment to the existing lessee. If a re-lease or sale to the lessee cannot be negotiated, the Partnership will attempt to lease or sell the equipment to a third party.\nItem 1. Business, continued --------\nAlthough not subject to seasonal variations, the Partnership's business is directly affected by the national economy and the new and used equipment markets. As discussed in the Prospectus, the Partnership initially emphasized the acquisition of office technology equipment. Increased competition, particularly from large leasing companies, including IBM Credit Corporation (\"ICC\") has resulted in decreased profit margins in this segment of the equipment leasing industry. The IBM market segment in particular has recently been returning significantly reduced yields on equipment leases due to increased industry competition. IBM has encountered significant competition from Amdahl, Hitachi and EMC in the mainframe related market. IBM has also seen their market share erode due to the movement away from mainframes to client-server networks. The Partnership purchased a higher volume of low technology equipment during 1993 and 1992 to offset the market conditions described.\nThese same factors, described above, have also created a more competitive market for most used equipment and, as a result, the Partnership is devoting substantial effort to remarketing the equipment in its maturing initial lease portfolio. The IBM and other high technology secondary markets have produced a lower return due to the more rapid technological obsolescence and resulting shorter useful life of equipment. This has resulted in a more rapid turnover of equipment by lessees that has made the realization of equipment residual values extremely difficult.\nThe ultimate rate of return on leases depends, in part, on the general level of interest rates at the time the leases are originated. Because leasing is an alternative to financing equipment purchases with debt, lease rates tend to rise and fall with interest rates (although lease rate movements generally lag interest rate changes in the capital markets). Interest rates declined from 1990 until the early part of 1994. The lease rates on equipment purchased by the Partnership during this period reflect this low interest rate environment. This will result in corresponding reductions in the ultimate overall yields to partners.\nThe Partnership has no employees. The officers, directors and employees of the general partner and its affiliates perform services on behalf of the Partnership. The general partner is entitled to receive certain fees and expense reimbursements in connection with the performance of these services. See Item 10 of this Report, \"Directors and Executive Officers of the Partnership\" and Item 13 of this Report, \"Certain Relationships and Related Transactions\".\nThe Partnership competes in the leasing remarketing marketplaces as a lessor\/seller with a significant number of other companies, including equipment manufacturers, leasing companies and financial institutions. The Partnership is in its liquidation period. Therefore, the Partnership currently competes mainly on the basis of the expertise of its general partner in remarketing equipment. Although the Partnership does not account for a significant percentage of the leasing market, the general partner believes that the Partnership's remarketing strategies will enable it to continue to compete effectively in the remarketing markets.\nThe Partnership leases equipment to a significant number of lessees. No single lessee and its affiliates accounted for more than 10% of total rental revenue of the Partnership during 1995.\nThe Partnership is required to dissolve and distribute all of its assets no later than December 31, 1998. However, the general partner anticipates that all equipment will be sold prior to that date and that the Partnership will be liquidated earlier.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------\nThe Partnership does not own or lease any physical properties other than the equipment discussed in Item 1 of this Report, \"Business\".\nItem 3.","section_3":"Item 3. Legal Proceedings -----------------\nNeither the Partnership nor any of the Partnership's equipment 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 matters were submitted to a vote of the limited partners of the Partnership, through the solicitation of proxies or otherwise, during the fourth quarter of 1995.\nItem 5.","section_5":"Item 5. Market for the Partnership's Common Equity and Related Stockholder ---------------------------------------------------------------------- Matters -------\n(a) The Partnership's Class A limited partner units and Class B interest are not publicly traded. There is no established public trading market for such units and interest, and none is expected to develop.\n(b) As of February 13, 1996 the number of Class A limited partners was 3,860.\n(c) During 1995, the Partnership made four (4) quarterly and twelve (12) monthly distributions (all of which constituted a return of capital) to Class A limited partners (note that investors may elect to receive distributions either monthly or quarterly), as follows:\nDistributions Per $250 Class A limited partner unit (computed on weighted average) For the Payment ----------------------- Total Month Ended Made During Monthly Quarterly Distributions ------------------ -------------- -------- --------- -------------\nDecember 31, 1994 January 1995 $ 1.25 $ 3.75 $ 401,879 January 31, 1995 February 1995 1.25 177,054 February 28, 1995 March 1995 1.25 160,157 March 31, 1995 April 1995 1.25 3.75 397,447 April 30, 1995 May 1995 0.63 85,650 May 31, 1995 June 1995 0.63 88,505 June 30, 1995 July 1995 0.63 1.89 196,964 July 31, 1995 August 1995 0.63 88,506 August 31, 1995 September 1995 0.63 88,506 September 30, 1995 October 1995 0.63 1.89 198,187 October 31, 1995 November 1995 0.15 21,002 November 30, 1995 December 1995 0.26 35,003 ------ ------- ----------- $ 9.19 $ 11.28 $ 1,938,860 ====== ======= ===========\nItem 5. Market for the Partnership's Common Equity and Related Stockholder ---------------------------------------------------------------------- Matters, continued -------\nDistributions may be characterized for tax, accounting and economic purposes as a return of capital, a return on capital or both. The total return on capital over a leasing partnership's life can only be determined at the termination of the Partnership after all residual cash flows (which include proceeds from the re-leasing and sale of equipment after initial lease terms expire) have been realized. However, as the general partner has represented for the last several years, all distributions to the partners are expected to be a return of capital.\nDistributions for the month and quarter ended December 31, 1995, totaling $173,995, were paid to the Class A limited partners during January 1996. Distributions to the general partner and the Class B limited partner during 1995 are discussed in Item 13 of the Report, \"Certain Relationships and Related Transactions\".\nThe general partner currently anticipates that the Partnership will generate cash flow from rentals and equipment sales during 1996 which, when added to cash and cash equivalents on hand, should provide sufficient cash to enable the Partnership to meet its current operating requirements and to fund distributions to the Class A limited partners. The general partner currently anticipates that 1996 distributions to the Class A limited partners are expected to be in the range of an annualized rate of 1% to 3% of their capital contributions (all of which is expected to be a return of capital). Because the Partnership is in liquidation, as defined in the Partnership Agreement, cash distributions to the Class A limited partners will be based upon cash availability and will vary in 1996.\nThe Class B distributions of cash from operations are subordinated to the Class A limited partners receiving distributions of cash from operations, as scheduled in the Partnership Agreement (i.e., 15%). Therefore, because of the decrease in the distributions to the Class A limited partners effective as of June 1994, CAII, the sole Class B limited partner, ceased receiving distributions of cash from operations as of March 1994 and the general partner currently anticipates that CAII will not receive any future Class B distributions as a result of this subordination.\nDuring 1994, the Partnership made four (4) quarterly and twelve (12) monthly distributions (all of which constituted a return of capital) to Class A limited partners, as follows:\nItem 5. Market for the Partnership's Common Equity and Related Stockholder ---------------------------------------------------------------------- Matters, continued -------\nDistributions Per $250 Class A limited partner unit (computed on weighted average) For the Payment ----------------------- Total Month Ended Made During Monthly Quarterly Distributions ------------------ -------------- -------- --------- -------------\nDecember 31, 1993 January 1994 $ 3.13 $ 9.39 $ 1,006,127 January 31, 1994 February 1994 3.13 445,329 February 28, 1994 March 1994 3.13 402,597 March 31, 1994 April 1994 3.13 9.39 993,685 April 30, 1994 May 1994 3.13 430,903 May 31, 1994 June 1994 3.13 445,266 June 30, 1994 July 1994 1.25 9.39 985,415 July 31, 1994 August 1994 1.25 178,107 August 31, 1994 September 1994 1.25 178,106 September 30, 1994 October 1994 1.25 3.75 396,604 October 31, 1994 November 1994 1.25 177,444 November 30, 1994 December 1994 1.25 171,720 ------- ------- ----------- $ 26.28 $ 31.92 $ 5,811,303 ======= ======= ===========\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nThe following selected financial data relates to 1995 through 1991. The data 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 notes thereto appearing elsewhere herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations -------------\nResults of Operations - ---------------------\nPresented below are schedules (prepared solely to facilitate the discussion of results of operations that follows) showing condensed income statement categories and analyses of changes in those condensed categories derived from the Statements of Operations.\nThe Partnership is in its liquidation period, as defined in the Partnership Agreement, and as expected, the Partnership is not purchasing equipment, initial leases are expiring and the equipment is being remarketed (i.e., re-leased, renewed or sold). As a result, the size of the Partnership's leasing portfolio and the amount of leasing revenue is declining (referred to in this discussion as \"portfolio run-off\").\nLEASING MARGIN\nLeasing margin consists of the following:\nItem 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued -------------\nResults of Operations, continued - ---------------------\nAll components of leasing margin have declined and are expected to decline further, due to portfolio run-off. However, leasing margin increased during 1995 compared to 1994 primarily due to remarketing activities, which include the rental proceeds from renewing, extending or re-leasing equipment before and after the end of the initial lease term. Leasing margin decreased during 1994 compared to 1993 primarily due to portfolio run-off.\nLeasing margin ratio increased primarily because of (a) remarketing activities, and (b) a portion of the Partnership's portfolio consists of operating leases financed with non-recourse debt. Leasing margin and leasing margin ratio for an operating lease financed with non-recourse debt increases during the term of the lease since rents and depreciation are typically fixed while interest expense declines as the related non-recourse debt is repaid.\nThe ultimate rate of return on leases depends, in part, on the general level of interest rates at the time the leases are originated. Because leasing is an alternative to financing equipment purchases with debt, lease rates tend to rise and fall with interest rates (although lease rate movements generally lag interest rate movements in the capital market). Interest rates declined from 1990 until the early part of 1994. The lease rates on equipment purchased by the Partnership during that period reflect that low interest rate environment. This will result in corresponding reductions in the ultimate overall yields to partners.\nEQUIPMENT SALES MARGIN\nEquipment sales margin consists of the following:\nYears Ended December 31, ----------------------------------------- 1995 1994 1993 ----------- ----------- -----------\nEquipment sales revenue $ 378,905 $ 1,747,881 $ 1,972,733 Cost of equipment sales (195,245) (1,103,730) (1,601,471) ----------- ----------- -----------\nEquipment sales margin $ 183,660 $ 644,151 $ 371,262 =========== =========== ===========\nThe Partnership is in its liquidation. During the liquidation period, as initial leases terminate, equipment is being remarketed (i.e., re-leased or sold to either the original lessee or a third party) and, accordingly the timing and amount of equipment sales are difficult to project.\nINTEREST INCOME\nThe decline in interest income is due to decreases in cash available for investment.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued -------------\nResults of Operations, continued - ---------------------\nPROVISION FOR LOSSES\nThe remarketing of equipment for an amount greater than its book value is reported as equipment sales margin (if the equipment is sold) or leasing margin (if the equipment is re-leased). The realization of less than the carrying value of equipment (which is typically not known until remarketing subsequent to the initial lease termination has occurred) is recorded as provision for losses.\nResidual values are established equal to the estimated value to be received from the equipment following termination of the lease. In estimating such values, the Partnership considers all relevant facts regarding the equipment and the lessee, including, for example, the likelihood that the lessee will re-lease the equipment. The nature of the Partnership's leasing activities is that it has credit exposure and residual value exposure and, accordingly, in the ordinary course of business, it will incur losses from those exposures. The Partnership performs ongoing quarterly assessments of its assets to identify any other-than-temporary losses in value.\nNo provision for loss was recorded in 1995 because no other-than-temporary losses in the value of equipment were identified in the quarterly assessments of the Partnership's asset.\nThe provisions for losses for 1994 and 1993 related to identified other-than-temporary losses in value of off-lease equipment, principally telecommunications equipment and semiconductor manufacturing equipment.\nEXPENSES\nManagement fees paid to the general partner and direct services from the general partner decreased primarily as a result of portfolio run-off. General and administrative expenses decreased in 1995 as compared to 1994, due to higher third-party professional fees incurred for remarketing the Partnership's equipment in 1994.\nLiquidity and Capital Resources - -------------------------------\nThe Partnership funds its activities principally with cash from rents, interest income and sales of off-lease equipment. Available cash and cash reserves of the Partnership are invested in interest bearing accounts and short-term U.S. Government securities pending distributions to the partners.\nThe Partnership entered its liquidation period during 1994. Accordingly, the Partnership did not purchase any equipment during 1995.\nDuring 1995, 1994 and 1993, the Partnership declared distributions to the partners of $1,801,042, $5,624,247 and $8,152,711, respectively, all of which constituted a return of capital. Distributions may be characterized for tax, accounting and economic purposes as a return of capital, a return on capital or both. The total return on capital over a leasing partnership's life can only be determined at the termination of the Partnership after all residual cash flows (which include proceeds from the re-leasing and sale of equipment after initial lease terms expire) have been realized. However, as the general partner has represented for the last several years, all distributions to the partners are expected to be a return of capital.\nLiquidity and Capital Resources, continued - -------------------------------\nThe general partner currently anticipates that the Partnership will generate cash flow from rentals and equipment sales during 1996 which, when added to cash and cash equivalents on hand, should provide sufficient cash to enable the Partnership to meet its current operating requirements and to fund distributions to the Class A limited partners. The general partner currently anticipates that 1996 distributions to the Class A limited partners are expected to be in the range of an annualized rate of 1% to 3% of their capital contributions (all of which is expected to be a return of capital). Because the Partnership is in liquidation, as defined in the Partnership Agreement, cash distributions to the Class A limited partners will be based upon cash availability and will vary in 1996.\nThe Class B distributions of cash from operations are subordinated to the Class A limited partners receiving distributions of cash from operations, as scheduled in the Partnership Agreement (i.e., 15%). Therefore, because of the decrease in the distributions to the Class A limited partners effective as of June 1994, CAII, the sole Class B limited partner, ceased receiving distributions of cash from operations as of March 1994 and the general partner currently anticipates that CAII will not receive any future Class B distributions as a result of this subordination.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nIndex to Financial Statements and Financial Statement Schedules\nPage Financial Statements Number --------------------\nIndependent Auditors' Report 12\nBalance Sheets at December 31, 1995 and 1994 13\nStatements of Income for the years ended December 31, 1995, 1994 and 1993 14\nStatements of Partners' Capital for the years ended December 31, 1995, 1994 and 1993 15\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 16\nNotes to Financial Statements 17-27\nFinancial Statement Schedules -----------------------------\nIndependent Auditors' Report 28\nSchedule II - Valuation and Qualifying Accounts 29\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTHE PARTNERS LEASTEC INCOME FUND V, A CALIFORNIA LIMITED PARTNERSHIP:\nWe have audited the accompanying balance sheets of Leastec Income Fund V, a California Limited Partnership, as of December 31, 1995 and 1994, and the related statements of income, partners' capital, 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 Leastec Income Fund V, 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 years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/KPMG Peat Marwick LLP ------------------------ KPMG Peat Marwick LLP\nDenver, Colorado February 2, 1996\nLEASTEC INCOME FUND V A California Limited Partnership\nBALANCE SHEETS\nASSETS\nSee accompanying notes to financial statements.\nLEASTEC INCOME FUND V A California Limited Partnership\nSTATEMENTS OF INCOME\nSee accompanying notes to financial statements.\nSee accompanying notes to financial statements.\nLEASTEC INCOME FUND V A California Limited Partnership\nSTATEMENTS OF CASH FLOWS\nSee accompanying notes to financial statements\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS\n1. Organization and Summary of Significant Accounting Policies -----------------------------------------------------------\nOrganization\nLeastec Income Fund V, a California Limited Partnership (the \"Partnership\"), was organized on August 28, 1987 as a limited partnership under the laws of the State of California pursuant to an Agreement of Limited Partnership (the \"Partnership Agreement\"). The Partnership was formed for the purpose of acquiring and leasing a portfolio of equipment to unaffiliated third parties. The Partnership's lease portfolio initially consisted principally of computer peripherals, data communication devices, office systems, workstations and other high technology equipment. The Partnership will continue until December 31, 1998 unless terminated earlier in accordance with the terms of the Partnership Agreement. The general partner began liquidating the Partnership's portfolio in 1994.\nThe general partner of the Partnership is CAI Partners Management Company, a wholly owned subsidiary of Capital Associates International, Inc. (\"CAII\"). The general partner manages the Partnership, including investment of funds, purchase and sale of equipment, lease negotiation and other administrative duties.\nCAII is the Class B limited partner. The Class B limited partner has contributed $2,501,890 of cash and equipment to the Partnership, an amount equal to 10% of net offering proceeds generated from sales of Class A limited partner units after September 1, 1988. The Class B limited partner has no remaining obligation to contribute cash and\/or equipment to 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 revenue and expenses during the reporting period. For leasing entities, this includes the estimate of residual values, as described below. Actual results could differ from those estimates.\nPartnership Cash Distributions and Allocations of Profit and Loss\nCash Distributions ------------------\nDuring the Distribution Period, as defined in the Partnership Agreement, cash distributions are to be made as follows:\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\nPartnership Cash Distributions and Allocations of Profit and Loss, continued\nCash Distributions, continued ------------------\nFirst, 95% to the Class A limited partners and 5% to the general partner until such time as all Class A limited partners have received, on a cumulative, noncompounded basis, distributions equal to (1) 12% on their contributed capital during the first three years after the initial closing date (November 16, 1987), (2) 13% on their contributed capital during the fourth year after the initial closing date, (3) 14% on their contributed capital during the fifth year after the initial closing date and (4) 15% thereafter.\nSecond, 95% to the Class B limited partner and 5% to the general partner until such time as the Class B limited partner has received distributions equal to 11% per annum, cumulative, noncompounded, on its subordinated capital contribution.\nThird, any remaining available cash is to be reinvested or distributed to the partners as specified in the Partnership Agreement.\nDuring the Liquidation Phase, as defined in the Partnership Agreement, cash distributions are to be made as follows:\nFirst, in accordance with the first and second cash distribution provisions during the Distribution Period as described above.\nSecond, 95% to the Class A limited partners and 5% to the general partner until the Class A limited partners have received aggregate distributions from all sources equal to their capital contributions plus their Priority Return as defined in the Partnership Agreement.\nThird, 85.5% to the Class B limited partner, 9.5% to the Class A limited partners and 5% to the general partner until the Class B limited partner has received aggregate distributions from all sources equal to its subordinated capital contribution plus its Subordinated Priority Return as defined in the Partnership Agreement.\nFourth, thereafter 90% to the Class A limited partners and the Class B limited partner (and among them in proportion to their respective capital contributions as of the first day of the calendar quarter for which the amount of such distribution is being determined), and 10% to the general partner.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\nFederal Income Tax Basis Profits and Losses -------------------------------------------\nProfits for any period are allocated according to the following provisions:\nFirst, profit is allocated to the partners in proportion to, and to the extent of, any losses allocated to the partners as described in the Partnership Agreement.\nSecond, any remaining profit is allocated 5% to the general partner and 95% to the limited partners, on a pari passu basis as described in the Partnership Agreement.\nThird, any remaining profit is allocated 90% to the limited partners (and among them in proportion to their respective capital contributions) and 10% to the general partner.\nNotwithstanding anything in the Partnership Agreement to the contrary, and before any other allocation is made, profits shall be allocated to the general partner until the aggregate profits so allocated in the current period and all prior periods are equal to the amount necessary to restore the general partner's capital account to zero. All such allocations shall be credited against any other allocations of profit to the general partner.\nLosses for any period are allocated according to the following priorities:\nFirst, to the partners in proportion to, and to the extent of, any profits allocated to them in reverse chronological order.\nSecond, 99% to the limited partners (and among them in proportion to their respective capital contributions) and 1% to the general partner.\nOn October 21, 1988, the partners amended the Partnership Agreement to admit CAII, as the Class B limited partner. CAII made its first required capital contribution in 1989. The amendment provided for the distribution of a share of available cash and liquidation proceeds to the Class B limited partner, but did not provide for the allocation of a corresponding share of profits or losses to the Class B limited partner. In the years ended December 31, 1987 and 1988, the Partnership allocated profits and losses to the general partner and the Class A limited partners in accordance with the then applicable provisions of the Partnership Agreement. In the years ended December 31, 1989 and 1990, the Partnership treated the Class B limited partner as a Class A limited partner for purposes of allocations of profits and losses. In the years ended December 31, 1991 and 1992, the Partnership allocated profits and losses among the\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\npartners in the manner provided for in an amendment adopted by the Partnership in the first quarter of 1992, discussed in the following paragraph, which allocation methodology approximates the allocation methodology employed in 1989 and 1990.\nPursuant to Section 15.2.11(iv) of the Partnership Agreement, the general partner amended the Partnership Agreement during the first quarter of 1992 (1) to allocate a share of profits and losses to the Class B limited partner, and (2) to correct an ambiguity in the allocation and distribution provisions with respect to the Class A limited partners. With respect to the Class B limited partner, the amendment provides for the allocation of a share of profits and losses to the Class B limited partner commensurate with its right to receive subordinated distributions of available cash. With respect to the Class A limited partners, the amendment provides that profits and losses allocated, and available cash distributed, will be shared by the individual Class A limited partners in proportion to their capital contributions and the number of days that each such Class A limited partner is a partner during each period. The amendment reflects (1) the actual method of allocations and distributions to the Class B limited partner that the Partnership has used since the admission of the Class B limited partner to the Partnership, (2) allocations of profits and losses among the individual Class A limited partners, consistent with such allocations in 1990 and 1991, and (3) distributions of available cash among the individual Class A limited partners consistent with the Partnership's calculation and payment of such distributions since its inception.\nReclassifications\nCertain reclassifications have been made to prior years' financial statements to conform to the current year's presentation.\nLease Accounting\nStatement of Financial Accounting Standards No. 13 requires that a lessor account for each lease by the direct finance, sales-type or operating lease method. The Partnership currently utilizes the direct finance and operating methods for substantially all of the Partnership's equipment under lease. Direct finance leases are defined as those leases which transfer substantially all of the benefits and risks of ownership of the equipment to the lessee. For all types of leases, the determination of profit considers the estimated value of the equipment at lease termination, referred to as the residual value. After the inception of a lease, the Partnership may engage in financing of lease receivables on a non-recourse basis and\/or equipment sale transactions to reduce or recover its investment in the equipment.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\nThe Partnership's accounting methods and their financial reporting effects are described below.\nNet Investment in Direct Financing Leases (\"DFLs\")\nLeasing revenue, which is recognized over the term of the lease, consists of the excess of lease payments plus the estimated residual value over the equipment's cost. Earned income is recognized monthly to provide a constant yield over the term of the lease. The cost of the equipment includes acquisition fees paid to the general partner and carrying costs on the lease until transferred to the Partnership, reduced by rents received prior to transferring the lease to the Partnership. Residual values are estimated at lease inception equal to the estimated value to be received from the equipment following termination of the lease (which in certain circumstances includes anticipated re-lease proceeds), as determined by the general partner. In estimating such values, the general partner considers all relevant information regarding the equipment and the lessee.\nEquipment on Operating Leases (\"OLs\")\nLeasing revenue consists principally of monthly rentals. The cost of equipment includes acquisition fees paid to the general partner and carrying costs on the equipment until transferred to the Partnership, reduced by rents received prior to transferring the equipment to the Partnership and is depreciated on a straight-line basis over the lease term to an amount equal to the estimated residual value at the lease termination date. Residual values are established at lease inception equal to the estimated value to be received from the equipment following termination of the initial lease (which in certain circumstances includes anticipated re-lease proceeds), as determined by the general partner. In estimating such values, the general partner considers all relevant information and circumstances regarding the equipment and the lessee. Because revenue, depreciation expense and the resultant profit margin before interest expense are recorded on a straight-line basis, and interest expense on discounted lease rentals is incurred on the interest method, profit is skewed toward lower returns in the early years of the term of an OL and higher returns in later years.\nNon-recourse Discounting of Rentals\nThe Partnership may assign the rentals from leases to financial institutions, or acquire leases subject to such assignments, at fixed interest rates on a non-recourse basis. In return for such future lease payments, the Partnership receives the discounted value of the payments in cash. The financial institution has a first lien on the assigned rents and the underlying leased equipment, with no recourse against the Partnership or any other Partnership assets in the event of default by a lessee. Cash proceeds from such financings are recorded on the balance sheet as discounted lease rentals. As lessees make payments to financial institutions, leasing revenue and interest expense are recorded.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\nAllowance for Losses\nAn allowance for losses is maintained at levels determined by the general partner to adequately provide for any other-than-temporary declines in asset values. In determining losses, economic conditions, the activity in the used equipment markets, the effect of actions by equipment manufacturers, the financial condition of lessees, the expected courses of action by lessees with regard to leased equipment at termination of the initial lease term, and other factors which the general partner believes are relevant, are considered. Assets are reviewed quarterly to determine the adequacy of the allowance for losses.\nTransactions Subsequent to Initial Lease Termination\nAfter the initial lease term of equipment on lease expires, the equipment is either sold or re-leased to the existing lessee or another third party. The remaining net book value of equipment sold is removed and gain or loss recorded when equipment is sold. The accounting for re-leased equipment is consistent with the accounting described under \"Net Investment in Direct Finance Leases\" and \"Equipment on Operating Leases\" above.\nIncome Taxes\nNo provision for income taxes has been made in the financial statements since taxable income or loss is recorded in the tax returns of the individual partners.\nCash Equivalents\nThe Partnership considers short-term, highly liquid investments that are readily convertible to known amounts of cash to be cash equivalents.\nCash equivalents of $440,000 and $675,000 at December 31, 1995 and 1994, respectively, are comprised of an investment in a money market fund which invests solely in U.S. Government securities having maturities of 90 days or less.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n1. Organization and Summary of Significant Accounting Policies, continued -----------------------------------------------------------\nNet Income Per Class A Limited Partner Unit\nNet income per Class A limited partner unit is computed by dividing the net income allocated to the Class A limited partners by the weighted average number of Class A limited partner units outstanding during the period.\n2. Net Investment in Direct Finance Leases ---------------------------------------\nThe components of the net investment in direct finance leases as of December 31, 1995 and 1994 were:\n1995 1994 ----------- -----------\nMinimum lease payments receivable $ 1,500,213 $ 2,412,506 Estimated residual values 609,902 567,517 Less unearned income (286,658) (512,506) ----------- ----------- $ 1,823,457 $ 2,467,517 =========== ===========\n3. Leased Equipment\nThe Partnership's investment in equipment on operating leases by major classes as of December 31, 1995 and 1994 were:\n1995 1994 ------------ ------------\nTransportation and industrial equipment $ 6,282,988 $ 6,349,416 Office furniture and equipment 2,681,979 2,908,549 Computers and peripherals 1,535,014 3,231,985 Other 1,925,030 3,327,676 ------------ ------------ 12,425,011 15,817,626 Less: Accumulated depreciation (8,674,997) (9,721,555) Allowance for losses (678,636) (671,937) ------------ ------------ $ 3,071,378 $ 5,424,134 ============ ============\nDepreciation expense for 1995, 1994 and 1993 was $2,090,097, $4,026,511 and $6,778,448, respectively.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n4. Future Minimum Lease Payments -----------------------------\nFuture minimum lease receivable from noncancelable leases as of December 31, 1995 are as follows:\nYear Ending December 31 DFLs OLs ----------------------- ----------- ----------- 1996 $ 708,389 $ 1,628,306 1997 495,734 53,684 1998 296,090 - ----------- ----------- Total $ 1,500,213 $ 1,681,990 =========== ===========\n5. Discounted Lease Rentals ------------------------\nDiscounted lease rentals outstanding at December 31, 1995 bear interest at rates primarily ranging between 5% and 12%. Aggregate maturities of such non-recourse obligations are as follows:\nYear Ending December 31 ----------------------- 1996 $ 1,346,447 1997 477,113 1998 237,774 -----------\nTotal $ 2,061,334 ===========\n6. Transactions With the General Partner and Affiliates ----------------------------------------------------\nAcquisition Fees ----------------\nThe general partner receives a fee equal to 5.0% of the sales price of equipment sold to the Partnership as compensation for evaluating, selecting, negotiating and consummating the acquisition of the equipment subject to the maximum discussed below and as permitted under terms of the Partnership Agreement. There is no acquisition fee payable with respect to the equipment contributed by the Class B limited partner. No acquisition fees were paid in 1995, 1994 and 1993.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n6. Transactions With the General Partner and Affiliates, continued ----------------------------------------------------\nMaximum Front-end Fee ---------------------\nPursuant to the Partnership Agreement, the total of all front-end fees (sales commissions, organization and offering costs and acquisition fees) may not exceed an amount which would cause the Partnership's investment in equipment (total cost of equipment excluding front-end fees) to be less than the greater of (1) a percentage amount of total Class A and Class B limited partners' capital contributions equal to 80% minus .0625% for each 1% of the aggregate purchase price of equipment that is borrowed by the Partnership (determined by dividing the principal amount of all such indebtedness incurred by the Partnership by the aggregate purchase price of the equipment) or (2) 75% of the total Class A and Class B limited partners capital contributions. The total of all acquisition fees also may not exceed 17% of total Class A and Class B capital contributions. The maximum fee was reached during 1991. Equipment purchases after the maximum front-end fee was reached have not (and will not in the future) included any acquisition fees to the general partner.\nManagement Fees ---------------\nThe general partner receives management fees as compensation for services performed in connection with managing the Partnership's equipment equal to the lesser of (a) 5% of gross rentals received (limited to 2% of gross rentals received in the case of full payout leases) or (b) the fee which the general partner reasonably believes to be competitive with that which would be charged by a non-affiliate for rendering comparable services as permitted under the Partnership Agreement. Such fees totaled $212,268, $325,641 and $467,926 in 1995, 1994 and 1993, respectively.\nDirect Services ---------------\nThe general partner and its affiliates provide accounting, investor relations, billing, collecting, asset management, and other administrative services to the Partnership. The Partnership reimburses the general partner for these services performed on its behalf as permitted under the terms of the Partnership Agreement. Such reimbursements totaled $73,966 in 1995, $91,975 in 1994 and $102,141 in 1993.\nEquipment Purchases -------------------\nThere were no equipment purchases in 1995 or 1994. The Partnership purchased equipment from CAII with a total purchase price of $3,848,152 (including $1,897,325 of discounted lease rentals) during 1993.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n6. Transactions With the General Partner and Affiliates, continued ----------------------------------------------------\nPayable to Affiliates ---------------------\nPayable to affiliates consists primarily of direct services and management fees payable to the general partner.\nDisposition Fee ---------------\nThe general partner is entitled to a subordinated fee with respect to each sale of equipment in an amount not to exceed the lesser of (a) 50% of the fee that would be charged by an unaffiliated party or (b) 2% of the gross equipment sales price. The disposition fee has not and will not be paid to the general partner until the Class A limited partners have received cash distributions in an amount equal to their capital contributions plus an 8% annual, cumulative return compounded daily on their adjusted capital contributions, calculated from and after the first day of the month following the month that each Class A limited partner is admitted to the Partnership. The Partnership has not accrued any disposition fees since inception as it is anticipated that the limited partners will not receive the minimum distributions described above.\n7. Tax Information (Unaudited) ---------------\nThe following reconciles net income for financial reporting purposes to income (loss) for federal income tax purposes for the years ended December 31,:\nAs of December 31, 1995, the partners' capital accounts per the financial statements totaled $2,867,516 compared to partners' capital accounts for federal income tax purposes of $7,625,319 (unaudited). The difference arises primarily from commissions reported as a reduction in partners' capital for financial reporting purposes but not for federal income tax purposes, and temporary differences related to direct finance leases, depreciation, and provisions for losses.\nLEASTEC INCOME FUND V A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS, continued\n8. Concentration of Credit Risk ----------------------------\nApproximately 49% of the Partnership's equipment under lease was leased to investment grade lessees. Pursuant to the Partnership Agreement, an investment grade lessee is a company (1) with a credit rating of not less than Baa, as determined by Moody's Investor Services, Inc. or (2) that has comparable credit ratings, as determined by other recognized credit rating services, or (3) which, if not rated by a recognized credit rating service, then in the opinion of the general partner, is of comparable credit quality.\nThe Partnership's cash balance is maintained with a high credit quality financial institution. At times such balances may exceed the FDIC insurance limit due to the receipt of lockbox amounts that have not cleared the presentment bank (generally for less than two days). As funds become available, they are invested in a money market mutual fund.\n9. Disclosures about Fair Value of Financial Instruments -----------------------------------------------------\nStatement of Financial Standards No. 107 (\"SFAS No. 107\"), Disclosures about Fair Value of Financial Instruments specifically excludes certain items from its disclosure requirements such as the Company's investment in leased assets. The carrying amounts at December 31, 1995 for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, payable to affiliates, rents and sale proceeds received in advance and distributions payable to partners approximate their fair values due to the short maturity of these instruments.\nAs of December 31, 1995, discounted lease rentals of $2,061,334 had fair values of $1,973,594. The fair values were estimated utilizing market rates of comparable debt having similar maturities and credit quality as of December 31, 1995.\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTHE PARTNERS LEASTEC INCOME FUND V A CALIFORNIA LIMITED PARTNERSHIP:\nUnder date of February 2, 1996, we reported on the balance sheets of Leastec Income Fund V, a California Limited Partnership, as of December 31, 1995 and 1994, and the related statements of income, partners' capital, and cash flows for each of the years in the three-year period ended December 31, 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 have also audited the related financial statement Schedule II, 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, 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\/KPMG Peat Marwick LLP ------------------------ KPMG Peat Marwick LLP\nDenver, Colorado February 2, 1996\nLEASTEC INCOME FUND V A California Limited Partnership\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nSee accompanying independent auditors' report.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosures -----------------------------------------------------\nNone\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership ---------------------------------------------------\nThe Partnership has no officers and directors. The general partner manages and controls the affairs of the Partnership and has general responsibility and authority in all matters affecting its business. Information concerning the directors and executive officers of the general partner is as follows:\nCAI Partners Management Company\nName Positions Held ---- --------------\nJohn F. Olmstead President and Director\nDennis J. Lacey Senior Vice President and Director\nJohn E. Christensen Senior Vice President, Principal Financial and Chief Administrative Officer and Director\nAnthony M. DiPaolo Senior Vice President, Assistant Secretary and Director\nDaniel J. Waller Vice President and Director\nRichard H. Abernethy Vice President and Director\nJohn A. Reed Vice President, Assistant Secretary and Director\nDavid J. Anderson Chief Accounting Officer and Secretary\nJohn F. Olmstead, age 51 joined CAII as Vice President in December, 1988, is a Senior Vice President of CAI ad CAII and is head of CAII's Public Equity division. He has served as Chairman of the Board for Neo-kam Industries, Inc., Matchless Metal Polish Company, Inc. and ACL, Inc. for more than 5 years. He has over 20 years of experience holding various positions of responsibility in the leasing industry. Mr. Olmstead holds a Bachelor of Science degree from Indiana University and a Juris Doctorate degree from Indiana Law School.\nItem 10. Directors and Executive Officers of the Partnership, continued ---------------------------------------------------\nDennis J. Lacey, age 42, joined CAI as Vice President, Operations, in October 1989. Mr. Lacey was appointed Treasurer on January 1, 1991, Chief Financial Officer on April 11, 1991, a director on July 19, 1991, and President and Chief Executive Officer on September 6, 1991. Prior to joining CAI, Mr. Lacey was an audit partner for the public accounting firm of Coopers & Lybrand. Mr. Lacey is also a director and senior officer of CAII, CAI Equipment Leasing I Corp., CAI Equipment Leasing II Corp., CAI Equipment Leasing III Corp., CAI Equipment Leasing IV Corp., CAI Leasing Canada, Ltd., CAI Partners Management Company, CAI Securities Corporation, CAI Lease Securitization I Corp. and Capital Equipment Corporation (collectively referred to herein as the \"CAI Affiliates\"), all of which are first- or second-tier wholly-owned subsidiaries of the CAI.\nJohn E. Christensen, age 48, joined CAII as Vice President and Treasurer in November 1988. He now serves as Senior Vice President, Finance and Chief Financial Officer of CAI and CAII. Mr. Christensen previously held senior management positions at Maxicare Health Plans, Inc., Global Marine, Inc. and Santa Fe International, Inc. Mr. Christensen obtained his MBA in Finance from the University of Michigan and his Bachelor of Arts degree from Michigan State University.\nAnthony M. DiPaolo, age 36, joined CAII in July 1990 as an Assistant Treasurer and is currently Senior Vice President-Business Development. He has also held the positions of Senior Vice President-Controller and Assistant Vice President-Credit Administration for the Company. Mr. DiPaolo has held financial management positions as Chief Financial Officer for Mile High Kennel Club, Inc. from 1988 to 1990 and was Vice President\/Controller for VICORP Restaurants, Inc. from 1986 through 1988. Mr. DiPaolo holds a Bachelor of Science degree in Accounting from the University of Denver.\nDaniel J. Waller, age 37, joined CAII in July 1990, as a manager of Investor Relations. Mr. Waller assumed the responsibility for the asset management department a short time later, and is currently Vice President, Capital Markets Group. Prior to joining CAII, Mr. Waller was an audit manager with Coopers & Lybrand for over three years and gained considerable experience in the leasing industry. While at Coopers & Lybrand, Mr. Waller held positions with the International Accounting and Auditing Committee as well as the national Auditing Directorate. Mr. Waller holds a Bachelor of Arts degree in accounting from the University of Northern Iowa.\nRichard H. Abernethy, age 41, joined CAII in April 1992 as Equipment Valuation Manager and currently serves as Vice President of Asset Management. Mr. Abernethy has thirteen years experience in the leasing industry, including prior positions with Barclays Leasing Inc., from November 1986 to February 1992, and Budd Leasing Corporation, from January 1981 to November 1986. Mr. Abernethy holds a Bachelor of Arts in Business Administration from the University of North Carolina at Charlotte.\nJohn A. Reed, age 40, joined CAII in January 1990 as the Tax Director and Assistant Secretary. Mr. Reed is currently the Vice President of Marketing and is responsible for all lease documentation and management of transaction structuring and processing. Prior to joining the Marketing Department, Mr. Reed was Vice President of Credit and Debt Administration. He spent seven and one half years with Coopers & Lybrand in the Tax Department and served on CAII's tax consulting engagement during that time. Mr. Reed holds a Bachelor of Arts degree in Social Sciences and Masters of Science in Accounting, from Colorado State University.\nItem 10. Directors and Executive Officers of the Partnership, continued ---------------------------------------------------\nDavid J. Anderson, age 42, joined CAII in August 1990 as Manager of Billing & Collections and currently serves as Assistant Vice-President\/Chief Accounting Officer. Prior to joining CAII, Mr. Anderson was Vice- President\/Controller for Systems Marketing, Inc., from 1985 to 1990, and previous to that working in several senior staff positions at the Los Alamos National Laboratory and with Ernst & Whinney. Mr. Anderson holds a Bachelor of Business Administration degree in Accounting from the University of Wisconsin.\nItem 11.","section_11":"Item 11. Executive Compensation ----------------------\nNo compensation was paid by the Partnership to the officers and directors of the general partner. See Item 13 of this Report, \"Certain Relationships and Related Transactions\", for a description of the compensation and fees paid to the general partner and its affiliates by the Partnership 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 Partnership to be the beneficial owner of more than 5% of the Class A limited partner units of the Partnership. The Partnership has no directors or officers, and neither the general partner nor the Class B limited partner of the Partnership owns any Class A limited partner units.\nCAII, the parent of the general partner, owns 100% of the Partnership's Class B limited partner interest.\nCAI Partners Management Company owns 100% of the Partnership's general partner interest.\nThe names and addresses of the general partner and the Class B limited partner are as follows:\nGeneral Partner ---------------\nCAI Partners Management Company 7175 West Jefferson Avenue Suite 4000 Lakewood, Colorado 80235\nClass B Limited Partner -----------------------\nCapital Associates International, Inc. 7175 West Jefferson Avenue Suite 4000 Lakewood, Colorado 80235\nItem 12. Security Ownership of Certain Beneficial Owners and Management, -------------------------------------------------------------- continued\n(b) No directors or officers of the general partner or the Class B limited partner owned any Class A limited partner units as of February 1, 1996.\n(c) The Partnership knows of no arrangements, 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 partner and its affiliates receive certain types of compensation, fees or other distributions in connection with the operations of the Partnership.\nFollowing is a summary of the amounts paid or payable to the general partner and its affiliates during 1994.\nManagement Fee - --------------\nThe general partner receives a monthly fee as compensation for services rendered in connection with the management of the Partnership's equipment in an amount equal to the lesser of (i) 5.0% of gross rentals received by the Partnership (but limited to 2.0% of gross rentals received in the case of full payout leases), or (ii) the fee which the general partner reasonably believes to be competitive with that which would be charged by a non-affiliate for rendering comparable services. The general partner earned $212,268 of management fees during 1995.\nDisposition Fee - ---------------\nThe general partner earns a subordinated fee with respect to each sale of equipment in an amount equal to the lesser of (i) 50% of the fee that would be charged by an unaffiliated party, or (ii) 2% of the gross equipment sale price. The disposition fee has not and will not be paid to the general partner until the Class A Limited Partners have received cash distributions in an amount equal to their capital contributions plus 8% annual cumulative return compounded daily on their adjusted capital contributions, calculated from and after the first day of the month following the month that each Class A Limited Partner is admitted to the Partnership. The Partnership did not accrue any disposition fees in 1995 as it is anticipated that the limited partners will not recover the aforementioned amounts.\nAccountable General and Administrative Expenses - -----------------------------------------------\nThe general partner is entitled to reimbursement of certain expenses paid on behalf of the Partnership which are incurred in connection with the Partnership's operations. The general partner received $73,966 of expense reimbursements during 1995.\nItem 13. Certain Relationships and Related Transactions, continued ----------------------------------------------\nThe general partner receives 5.0% of Partnership cash distributions and is allocated certain Partnership income or loss relating to its general partner interest in the Partnership. Distributions paid and income allocated to the general partner totaled $90,066 and $90,066, respectively, for 1995.\nThe Class B Limited Partner did not receive any distributions during 1995 but was allocated net income of $37,180 for 1995.\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\n2. Financial Statement Schedule\n(b) There were no reports on Form 8-K filed during the three months ended December 31, 1995.\n(c) Exhibits required to be filed.\nExhibit Exhibit Number Name ------- -------\n3* Leastec Income Fund V Limited Partnership Agreement (Filed as Exhibit A on Form S-1 in September 1987)\n4.1* Subscription Agreement and Power of Attorney (Filed as Exhibit B on Form S-1 in September 1987)\n4.2* First Amendment to Limited Partnership Agreement dated October 14, 1987 (Filed on October 14, 1987)\n4.3* Second Amendment to Limited Partnership Agreement dated March 31, 1992 (Filed on May 15, 1992)\n4.4* Third Amendment to Limited Partnership Agreement dated June 30, 1992\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.\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.\nDated: March 19, 1996 Leastec Income Fund V, A California Limited Partnership By: CAI Partners Management Company\nBy: \/s\/John F. Olmstead -------------------------- John F. Olmstead 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 general partner of the Partnership and in the capacities indicated on March 18, 1996.\nSignature Title - ---------------------- -----\n\/s\/John F. Olmstead - ---------------------- John F. Olmstead President and Director\n\/s\/Dennis J. Lacey - ---------------------- Dennis J. Lacey Senior Vice President and Director\n\/s\/John E. Christensen - ---------------------- John E. Christensen Senior Vice President, Principal Financial and Chief Administrative Officer and Director\n\/s\/Anthony M. DiPaolo - ---------------------- Anthony M. DiPaolo Senior Vice President, Assistant Secretary and Director\n\/s\/Daniel J. Waller - ---------------------- Daniel J. Waller Vice President and Director\n\/s\/John A. Reed - ---------------------- John A. Reed Vice President, Assistant Secretary and Director\n\/s\/David J. Anderson - ---------------------- David J. Anderson Chief Accounting Officer and Secretary","section_15":""}
{"filename":"805297_1995.txt","cik":"805297","year":"1995","section_1":"ITEM 1. BUSINESS\nKrupp Insured Plus-II Limited Partnership (the \"Partnership\") is a Massachusetts limited partnership which was formed on October 29, 1986. The Partnership raised approximately $292 million through a public offering of limited partner interests evidenced by units of depositary receipts (\"Units\") and used the investable proceeds primarily to acquire participating insured mortgages (\"PIMs\") and mortgage-backed securities (\"MBS\"). The Partnership considers itself to be engaged only in the industry segment of 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. These insured mortgages were issued or originated under or in connection with the housing programs of the Federal National Mortgage Association (\"FNMA\"), the Government National Mortgage Association (\"GNMA\") or the Department of Housing and Urban Development (\"HUD\"). PIMs provide the Partnership with monthly payments of principal and interest and also provide for Partnership participation in the current revenue stream and in residual value, if any, from a sale or other realization of the underlying property. The borrower conveys these rights to the Partnership through a subordinated promissory note and mortgage. The participation features are neither insured nor guaranteed.\nThe Partnership also acquired MBS and insured mortgages collateralized by single-family or multi-family mortgage loans issued or originated by GNMA, FNMA, HUD or the Federal Home Loan Mortgage Corporation (\"FHLMC\"). FNMA and FHLMC guarantee the principal and basic interest of the FNMA and FHLMC MBS, respectively. GNMA guarantees the timely payment of principal and interest on its MBS, and HUD insures the pooled mortgage loans underlying the GNMA MBS and its own direct mortgage loans.\nAlthough the Partnership will terminate no later than December 31, 2026 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, 2026.\nThe Partnership's investments are not expected to be subject to seasonal fluctuations. Any ultimate realization of the participation features of the PIMs are 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 properties and provide adequate insurance coverage; adverse changes in general economic conditions, adverse local conditions, and changes in governmental 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 is 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.\nPART 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 15,000. One of the objectives of the Partnership is to provide quarterly distributions of cash flows generated by its investments in mortgages. The Partnership anticipates that future operations will continue to generate cash available for distribution. Adjustments may be made to the distribution rate in the future due to realization and payout of the existing mortgages.\nThe Partnership made the following distributions, in quarterly installments, and special distributions, 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 Supplementary Data, 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 demands on the Partnership's liquidity are regular quarterly distributions paid to investors of approximately $4.1 million. Funds used for investor distributions are generated from interest income received on the PIMs, MBS, cash and short-term investments, and the principal collections received on the PIMs and MBS. The Partnership funds a portion of the distribution from principal collections, as a result the capital resources of the Partnership will continually decrease. As a result of this decrease, the total cash inflows to the Partnership will also decrease, which will result in periodic adjustments to the 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.\nBased on current projections, the General Partners believe the Partnership can maintain the current distribution rate for the foreseeable future. However, in the event of PIM prepayments the Partnership would be required to distribute any proceeds from the prepayments as a special distribution which may cause an adjustment to the distribution rate to reflect the anticipated future cash inflows from the remaining mortgage investments.\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 GNMA, FNMA, FHLMC 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 timely payment of principal and basic interest on the securities it issues, which represents interest 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 to 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. (Amounts in thousands, except per Unit amounts)\n(a) Represents all distributions paid in 1995 except the February 1995 distribution and includes an estimate of the distribution to be paid in February 1996. (b) Includes an estimate of the distribution to be paid in February 1996.\n(c) Limited Partners average per Unit return of capital as of February 1996 is $4.13 [$13.76 - $9.63] Return of capital represents that 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 decreased approximately $1,492,000 during 1995 as compared to 1994 due primarily to lower interest income that resulted from a reduction in the invested assets in the Partnership. The reduction in assets was a result of a payoff of the Mediterranean Village PIM during September 1994. Subsequently, a special distribution was made from the Partnership using the payoff proceeds and a portion of the available cash. The decline in net income from 1994 to 1995 is also related to participation income recognized in 1994 from the payoff of the Mediterranean Village PIM and the payment of participation income related to the Longwood Villas PIM which together totalled approximately $1.1 million. Interest income on MBS decreased in 1995 versus 1994 and will continue to decline as principal collections decrease the Partnership's MBS portfolio. The Partnership will continue to see a decline in base interest income on its PIMs based on the amortization of the underlying mortgages. Expenses decreased approximately $1,017,000 in 1995 versus 1994 primarily resulting from reduced amortization expense. As a result of the repayment of the Mediterranean Village PIM, the Partnership fully amortized its associated prepaid fees and expenses which increased amortization expense in 1994 as compared to 1995. During 1995, the Partnership experienced a decrease in expense reimbursements to affiliates and a decrease in the asset management fee due to declining asset base as compared to 1994.\nThe Partnership's net income for 1994 declined as compared to 1993, primarily because net income in 1993 included a $377,000 gain on the sale of MBS. Overall, total interest income did not change significantly from 1993 to 1994. However, payoffs of the Fox Valley and Pinecrest PIMs in 1993 and the Mediterranean Village PIM in 1994 resulted in lower interest income on PIMs in 1994 as compared to 1993. Participation income increased significantly in 1994 as compared to 1993 due primarily to the participation income provided from the Mediterranean Village PIM payoff and the payment of participation income from the Longwood Villas PIM. The Partnership saw an increase in interest income on MBS in 1994 versus 1993 due primarily to the reinvestment of the proceeds from the payoff of the Fox Valley PIM in MBS. The Partnership's expenses did not change significantly from 1993 to 1994, because the Partnership fully amortized certain prepaid fees and expenses associated with the PIMs that paid off during each of these years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A to this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. PART 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) Vice President and Treasurer\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 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 also 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 14,655,412 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 Notes To 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, page to this report.\n2. Financial Statement Schedule - see Index to Financial Statements and Schedule included under Item 8, Appendix A, page to this report. All other schedules are omitted as they are not applicable, not required or the information is provided in the Financial Statements or the Notes thereto.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable Exhibits required under Item 601 of Regulation S-K:\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended and Restated Agreement of Limited Partnership dated as of May 29, 1987 [Exhibit A to Prospectus included in Post Effective Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 18, 1987 (File No. 33- 9889)].*\n(4.2) Second Amendment to Agreement of Limited Partnership dated as of June 17, 1987 [Exhibit 4.6 in Post Effective Amendment No. l of Registrant's Registration Statement on Form S-11 dated June 18, 1987 (File No. 33-9889)].*\n(4.3) Subscription Agreement whereby a subscriber agrees to purchase Units and adopts the provisions of the Amended and Restated Agreement of Limited Partnership [Exhibit D to Prospectus included in Post Effective Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 18, 1987 (File No. 33-9889)].*\n(4.4) Copy of Amended Certificate of Limited Partnership filed with the Massachusetts Secretary of State on April 28, 1987. [Exhibit 4.4 in Amendment No. 1 of Registrant's Registration Statement on Form S- 11 dated May 14, 1987 (File No. 33-9889)].*\n(10) Material Contracts:\n(10.1) Form of agreement between the Partnership and Krupp Mortgage Corporation. [Exhibit 10.3 in Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated May 14, 1987 (File No. 33-9889)].*\nColonial Park Apartments\n(10.2) Prospectus for GNMA Pool No. 248521 (PL). [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0- 16817)].*\n(10.3) Subordinated Open-End Multi-Family Mortgage (including Subordinated Promissory Note) dated March 30, 1988 between Euclid Creek Company, and York Associates, Inc. [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\n(10.4) Assignment of Subordinated Mortgage dated March 30, 1988 between York Associates, Inc. and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.3 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\nWestbrook Manor Apartments\n(10.5) Prospectus for GNMA Pool No. 256059 (PL). [Exhibit 19.6 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0- 16817)].*\n(10.6) Subordinated Multi-Family Deed of Trust (including Subordinated Promissory Note) dated April 19, 1988 between Wiston XXIII Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.7 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\nLakeside Apartments\n(10.7) Prospectus for GNMA Pool No. 255955. [Exhibit 19.8 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\n(10.8) Subordinated Multi-Family Deed of Trust (including Subordinated Promissory Note) dated May 5, 1988 between Lakeside Apartments Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.9 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\nLe Coeur du Monde Apartments\n(10.9) Prospectus for GNMA Pools No. 257721 (CS) and 257722 (PN). [Exhibit 19.10 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 File No. 0-16817)].*\n(10.10) Subordinated Multi-Family Open-End Deed of Trust (including Subordinated Promissory Note) dated May 11, 1988 between Le Coeur du Monde Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.11 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\nHarbor House Apartments\n(10.11) Prospectus for GNMA Pools No. 257723 (CS) and 257724 (PN). [Exhibit 19.12 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\n(10.12) Subordinated Multi-family Mortgage (including Subordinated Promissory Note) dated May 11, 1988 between Harbor House Apartment Homes Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.13 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1988 (File No. 0-16817)].*\nFallwood Apartments\n(10.13) Prospectus for GNMA Pool No. 260300 (PL). [Exhibit 19.14 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0-16817)].*\n(10.14) Multifamily Mortgage (including Subordinated Promissory Note) dated June 23, 1988 between Wiston XVIII Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.15 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0-16817)].*\nGreenbrier Apartments\n(10.15) Prospectus for GNMA Pool No. 260301 (PL). [Exhibit 19.16 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0-16817)].*\n(10.16) Multifamily Mortgage (including Subordinated Promissory Note) dated August 16, 1988 between Wiston XVI Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.17 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0- 16817)].*\nCountry Meadows Apartments\n(10.17) Prospectus for GNMA Pools No. 260733 (CL) and 260734 (PN). [Exhibit 19.18 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0-16817)].*\n(10.18) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated June 15, 1988 between Country Meadows Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.19 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1988 (File No. 0-16817)].*\nPine Ridge Apartments\n(10.19) Prospectus for GNMA Pool No. 259436(PL). [Exhibit 10.27 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 0-16817)]*\n(10.20) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated October 18, 1988 between LaSalle National Bank and Krupp Insured Plus-II Limited Partnership. [Exhibit 10.28 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 0-16817)]*\nDenrich Apartments\n(10.21) Prospectus for GNMA Pool No. 267075 (PL). [Exhibit 10.29 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 0- 16817)].*\n(10.22) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated November 3, 1988 between Arthur J. Stagnaro and Krupp Insured Plus-II Limited Partnership. [Exhibit 10.30 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 0-16817)].*\n(10.23) Modification Agreement dated June 28, 1995 between Arthur J. Stagnaro and Krupp Insured Plus-II Limited Partnership [Exhibit 10.1 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995 (File No. 0-16817)].*\nThe Greenhouse\n(10.24) Prospectus for GNMA Pools No. 259233(CS) and 259234(PN) [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16817)].*\n(10.25) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated January 5, 1989 between Farnam Associates Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0- 16817)].*\nWalden Village Apartments\n(10.26) Subordinated Multifamily Open-End Mortgage (including Subordinated Promissory Note) dated February 23, 1989 between The Walden Village Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.3 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16817)].*\n(10.27) Participation Agreement dated February 23, 1989 between The Centralbanc Mortgage Company and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.4 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16817)].*\nLongwood Villas Apartments\n(10.28) Prospectus for GNMA Pool No. 272539(PL). [Exhibit 19.7 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1989 (File No. 0-16817)].*\n(10.29) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated March 29, 1989 between Daniel Properties XI Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.8 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1989 (File No. 0- 16817)].*\n(10.30) Guaranty Agreement dated April 19, 1994 between SCA-Florida Holdings (I) Incorporated and Krupp Insured Plus-II Limited Partnership. [Exhibit 10.29 to Registrant's Report on Form 10-K for the year ended December 31, 1994 (File No. 0-16317)]*\n(10.31) Agreement of Release, Assumption and Modification of Subordinated Promissory Note and Subordinated Mortgage by and among Daniel Properties XI Limited Partnership, SCA-Florida Holdings (I) Incorporated and Krupp Insured Plus-II Limited Partnership. [Exhibit 10.30 to Registrant's Report on Form 10-K for the year ended December 31, 1994 (File No. 0- 16817)].*\nLily Flagg Station\n(10.32) Prospectus for GNMA Pool No 272540(PL). [Exhibit 19.9 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1989 (File No. 0-16817)].*\n(10.33) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) date March 29, 1989 between Daniel Properties I Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.10 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1989 (File No. 0- 16817)].*\nRichmond Park Apartments\n(10.34) Prospectus for GNMA Pool No. 260865 (PL) [Exhibit 1 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)].*\n(10.35) Subordinated Multifamily Open-Ended Mortgage (including Subordinated Promissory Note) dated July 14, 1989 between Carl Milstein, Trustee, Irwin Obstgarten, Al Simon and Krupp Insured Plus- II Limited Partnership. [Exhibit 2 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)]*\n(10.36) Participation Agreement dated July 31, 1989 between Krupp Insured Mortgage Limited Partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 3 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)].*\nSaratoga Apartments\n(10.37) Prospectus for GNMA Pool No. 280643 (Pl) [Exhibit 4 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)].*\n(10.38) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated July 27, 1989 between American National Bank and Trust Company of Chicago, as Trustee and Krupp Insured Mortgage Limited Partnership. [Exhibit 5 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)].*\n(10.39) Participation Agreement dated July 31, 1989 between Krupp Insured Plus-II Limited Partnership and Krupp Insured Mortgage Limited Partnership. [Exhibit 6 to Registrant's Report on Form 8-K dated August 30, 1989 (File No. 0-16817)].*\nCarlyle Court\n(10.40) Prospectus for FNMA Pool No. MX-073004 [Exhibit 10.50 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-16817)].*\n(10.41) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 26, 1989 between Carlyle-XI, L.P. an Indiana limited partnership and Krupp Insured Plus-II Limited Partnership [Exhibit 10.51 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-16817)].*\nHillside Court\n(10.42) Prospectus for FNMA Pool No. MX-073003 [Exhibit 10.52 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-16817)].*\n(10.43) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 16, 1989 between Hillside Limited Partnership-IX, an Indiana limited partnership and Krupp Insured Plus-II Limited Partnership [Exhibit 10.53 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0- 16817)].*\nStanford Court\n(10.44) Prospectus for FNMA Pool No. MX-073002 [Exhibit 10.54 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-16817)].*\n(10.45) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 26, 1989 between Hillside Limited Partnership-IX, an Indiana limited partnership and Krupp Insured Plus-II Limited Partnership [Exhibit 10.55 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0- 16817)].*\nWaterford Court\n(10.46) Prospectus for FNMA Pool No. MX-073005 [Exhibit 10.56 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-16817)].*\n(10.47) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 26, 1989 between Waterford-VIII, an Indiana limited partnership and Krupp Insured Plus-II Limited Partnership [Exhibit 10.57 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-16817)].*\n* Incorporated by reference.\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-II 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 Douglas Krupp Officer) and Director of Krupp Plus Corporation, a General Partner\n\/s\/ George Krupp Co-Chairman (Principal Executive George Krupp Officer) and Director of Krupp Plus Corporation, a General Partner\n\/s\/ Laurence Gerber President of Krupp Plus Laurence Gerber Corporation, a General Partner\n\/s\/ Peter F. Donovan Senior Vice President of Krupp Peter F. Donovan Plus Corporation, a General Partner\n\/s\/ Robert A. Barrows Treasurer and Chief Accounting Robert A. Barrows Officer of Krupp Plus Corporation, a G e n e r a l Partner\nAPPENDIX A\nKRUPP INSURED PLUS-II 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-II 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-II Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Krupp Insured Plus-II Limited Partnership (the \"Partnership\") listed in the index on page of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partners of the Partnership, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Krupp Insured Plus-II 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-II LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-II LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-II LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-II LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS A. Organization\nKrupp Insured Plus-II Limited Partnership (the \"Partnership\") was formed on October 29, 1986 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, 2026, 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 May 29, 1987 and completed its public offering having sold 14,655,412 Units for $292,176,381 net of purchase volume discounts of $931,859 as of May 27, 1988.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (Note G).\nPIMs\nPIMs are carried at amortized cost as the Partnership has the ability and intention to hold them. Basic interest is recognized based on the stated rate of the Federal Housing Administration (\"FHA\") first mortgage loan (less the servicer's fee) or the stated coupon rate or reduced rate of the Government National Mortgage Association (\"GNMA\") or Federal National Mortgage Association (\"FNMA\") MBS. To the extent interest rate reductions provide for payment of unpaid base interest from surplus cash or the net proceeds from a sale or refinancing, the Partnership will recognize such interest payments as income when received. 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\nShort-term investments represent investments with maturities of three months or less at 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 any loss to date on its invested cash.\nShort-term Investment\nShort-term investment consists of a banker's acceptance with an original maturity greater than three months. The Partnership carries the short-term investment at amortized cost, which approximates fair value, due to the short period of time to maturity. The Partnership intends to hold its short-term investment until maturity.\nPrepaid Expenses and Fees\nPrepaid expenses and fees consist of acquisition fees and expenses and participation servicing fees paid for the acquisition and servicing of PIMs. The Partnership amortizes 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.\nThe 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\") 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 twenty PIMs. Of the twenty PIMs, seven funded the construction of multi-family housing. 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 promissory note and 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 first mortgage loan.\nThe borrower usually cannot 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 the rates 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 the value of the underlying property in excess of a specified base. Payment of Minimum Additional Interest and Shared Income Interest will be from the operations of the property and is limited to 50% of net revenue or surplus cash as defined by FNMA or HUD, respectively.\nThe total amount of Minimum Additional Interest, Shared Income Interest and Shared Appreciation interest payable by the underlying borrower usually can not exceed 50% of any increase in Value of the property. However, generally any net proceeds from a sale or refinancing 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.\nOn September 30, 1994, the Partnership received a repayment on the Mediterranean Village PIM totaling $12,581,806. The repayment consisted of outstanding principal of $11,125,765, a prepayment penalty of $861,319 and accrued and delinquent base interest of $594,722. The prepayment penalty received by the Partnership was in excess of what the Partnership would have received if the Shared Appreciation calculation had been performed. Under that calculation, the Partnership would have received approximately $525,000 in Shared Appreciation and $215,000 of accrued Shared Income or Minimum Additional Interest.\nIn April 1994, the Partnership received $240,022 of participation income on the Longwood Villas PIM resulting from the sale of the property by the borrower. Of the total participation income received $126,231 represented Shared Appreciation Income with the remaining $113,791 representing Shared Interest Income and Minimum Additional Interest. The buyer acquired the property by assuming the insured mortgage from the borrower, so the Partnership will continue to receive principal and interest payments on the insured mortgage. The buyer also entered into an agreement with the Partnership modifying the participation features.\nUnder the agreement with the buyer, the Partnership will be entitled to additional interest calculated monthly and payable semiannually at the rate of .5% per annum on the unpaid principal balance of the insured mortgage. An affiliate of the buyer guarantees the semiannual payment of additional interest. The Partnership will not receive either Shared Appreciation or Shared Income or Minimum Additional interest from the buyer in the future.\nListed in the chart is a summary of the Partnership's PIM investments. The Partnership's PIMs consisted of the following at December 31, 1995 and 1994:\n(a) Includes two PIMs - Richmond Park and Saratoga - in which the Partnership holds a 62% and 50% interest, respectively, and the remaining portion is held by an affiliate of the Partnership. (b) The Partnership agreed to temporarily reduce the interest rate on the Harbor House PIM effective on March 1, 1992, for a period of thirty months at rates ranging from 6.75% to 7.75% per annum and thereafter is 8.25% per annum. As consideration for this reduction, the Partnership increased its Minimum Additional Interest from .5% to .75% as well as reduced the Shared Appreciation Interest Base to $13,000,000 from $13,750,000.\n(c) In May 1993, the Partnership agreed to temporarily reduce the interest rate of the Le Couer du Monde PIM, retroactive to October 1, 1992. The reduction lasted for thirty six months and ranged from 6.375% to 8.125% per annum. The current interest rate is 8.25% per annum. Any unpaid interest is payable from the net proceeds from a sale or refinancing of the property. As consideration for this reduction, the Partnership increased its Shared Appreciation Interest rate from 30% to 35% and decreased the base value used for this calculation from $10,795,260 to $9,814,200. (d) On June 28, 1995, the Partnership entered into a temporary interest rate reduction agreement on the Denrich Apartments PIM. Beginning July 1, 1995, the interest rate decreased from 8% per annum to 6.25% per annum for thirty months, then increase to 6.75% per annum for the following thirty-six month period and then increase to the original interest rate of 8% per annum. The difference between interest at the original interest rate and the reduced interest rates will accumulate and be payable from surplus cash or from the net proceeds of a sale or refinancing. These accumulated amounts will be due and payable prior to any distributions to the borrower or payment of participation interest to the Partnership. Also under the agreement, the base level for calculating Shared Appreciation Interest decreased from $4,025,000 to $3,500,000.\nThe underlying mortgages of the PIMs are collateralized by multi-family apartment complexes located in 11 states. The apartment complexes range in size from 80 to 736 units.\nD. MBS\nAt December 31, 1995, the Partnership's MBS portfolio has an amortized cost of approximately $43,316,000 and unrealized gains and losses of approximately $1,285,000 and $4,000, respectively. At December 31, 1994, the Partnership's MBS portfolio had a market value of approximately $44,236,000 and unrealized gains and losses of approximately $475,000 and $1,738,000, respectively. The Partnership's MBS have maturities ranging from 2007 to 2033.\nE. Partners' Equity\nProfits and losses 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 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.\nProfits arising from a capital transaction, will be allocated in the same manner as related cash distributions. Losses from a capital transaction will be allocated 97% to the Limited Partners and 3% to the General Partners.\nDuring 1995, the Partnership made quarterly distributions totaling $1.12 per unit. During 1994 and 1993 the Partnership made quarterly distributions totaling $1.48 and $1.60 per Unit and special distributions of $1.18 and $.18 per Unit, respectively.\nAs of December 31, 1995, the following cumulative partner contributions and allocations have been made since the inception of the Partnership:\nF. Related Party Transactions\nUnder the terms of the Partnership Agreement, the General Partners or their affiliates are entitled to an asset management fee for the management of the Partnership's business, 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 an amount equal to .3% per annum on the Partnership's total invested assets provided the Unitholders have received their specified non-cumulative annual return on their Invested Capital. Total fees payable to the General Partners for management services shall not exceed 10% of cash available for distribution over the life of the Partnership.\nAdditionally, the Partnership reimburses affiliates of the General Partners for certain costs 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 investors.\nG. Federal Income Taxes\nThe reconciliation of the income reported in the accompanying financial statements with the income reported in the Partnership's 1995 federal income tax return is as follows:\nNet income per statement of income $12,656,200\nAdd: Book to tax difference for amortization of prepaid expenses and fees 75,532\nNet income for federal income tax purposes $12,731,732\nThe allocation of the 1995 net income for federal income tax purposes is as follows:\nPortfolio Income\nUnitholders $12,349,696 Corporate Limited Partner 84 General Partners 381,952\n$12,731,732\nFor the years ended December 31, 1995, 1994 and 1993 the average per unit income to the Unitholders for federal income tax purposes was $.84, $1.05 and $.96, 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 instruments:\nCash and Cash Equivalents and Short-term Investment\nThe carrying amount approximates fair value because of the short maturity of those instruments.\nMBS\nThe Partnership estimates the fair value and 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 Trust's investments in PIMs had gross unrealized gains of $5,606,000 at December 31, 1995 and gross unrealized losses of $9,073,000 at December 31, 1994.\nAt December 31, 1995 and 1994, the estimated fair values of the Partnership's financial instruments are as follows:\n1995 1994 Cash and cash equivalents and short-term investment $ 6,454 $ 5,453 MBS 44,597 44,236 PIMs 158,535 144,970\n$209,586 $194,659\nKRUPP INSURED PLUS-II LIMITED PARTNERSHIP\nSCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE December 31, 1995\n(a) The Participating Insured Mortgages (\"PIMs\") consist of either a mortgage-backed security guaranteed by the Federal National Mortgage Association ( FNMA ) or the Government National Mortgage Association ( GNMA ), or a direct 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 direct mortgage. In addition, the Partnership receives 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. (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. (e) Shared income interest is based on 25% of monthly gross rental income over a specified base amount. (f) Shared income interest is based on 30% of monthly gross rental income over a specified base amount. (g) Shared income interest is based on 35% of monthly gross rental income over a specified base amount. (h) Shared appreciation interest is based on 25% of any increase in the value of the project over the specified base value. (i) Shared appreciation interest is based on 30% of any increase in the value of the project over the specified base value. (j) Shared appreciation interest is based on 35% of any increase in the value of the project over the specified base value. (k) The Partnership's GNMA MBS and HUD direct mortgages have call provisions, which allow the Partnership to accelerate their respective maturity date. (l) 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 GNMA MBS, FNMA MBS and HUD-insured first mortgage loan generally may not be prepaid during the first five years and may 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. The normal monthly payment consisting of principal and interest for FNMA MBS is payable at level amounts based on a 35-year amortization. All unpaid principal and accrued interest is due at the end of year ten. (m) The Partnership agreed to temporarily reduce the interest rate on the Harbor House PIM. The reduction, which was effective on March 1, 1992, lasted for a period of thirty months and ranged from 6.75% to 7.75% per annum and thereafter is 8.25% per annum. As consideration for this reduction, the Partnership increased its Minimum Additional Interest from .5% to .75% as well as reduced the Shared Appreciation Interest Base from $13,750,000 to $13,000,000.\n(n) The Partnership agreed to temporarily reduce the interest rate on the Le Couer du Monde PIM. The reduction is retroactive to October 1, 1992, and ranged from 6.375% to 8.125% per annum through October 1, 1995 and thereafter is at 8.25% per annum. As consideration for this reduction, the Partnership increased its Shared Appreciation Interest rate from 30% to 35% and decreased the base value used for this calculation from $10,795,620 to $9,814,200. (o) The approximate principal balance due at maturity for each PIM, respectively, is as follows:\nPIM Amount\nCarlyle Court $7,620,000 Hillside Court $4,224,000 Stanford Court $6,543,000 Waterford Court $9,308,000\n(p) The Partnership permitted the borrower to sell the property and allowed the buyer to assume the first mortgage loan. In addition, this buyer entered into an agreement with the Partnership to pay additional interest calculated monthly and payable semiannually at a rate of .5% per annum on the unpaid principal balance of the insured mortgage loan.\n(q) On June 28, 1995, the Partnership entered into a temporary interest rate reduction agreement on the Denrich Apartments PIM. Beginning July 1, 1995, the interest rate decreased from 8% per annum to 6.25% per annum for thirty months, then increases to 6.75% per annum for the following thirty-six month period and then increases to the original interest rate of 8% per annum. The difference between interest at the original interest rate and the reduced interest rates will accumulate and be payable from surplus cash or from the net proceeds of a sale or refinancing. These accumulated amounts will be due and payable prior to any distributions to the borrower or payment of participation interest to the Partnership. Also under the agreement, the base level for calculating Shared Appreciation Interest decreased from $4,025,000 to $3,500,000. (r) The aggregate cost of PIMs for federal income tax purposes is $152,929,361.\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":"815556_1995.txt","cik":"815556","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nFastenal Company (\"Fastenal Company\" and, together with its wholly owned subsidiary, Fastenal Canada Company, collectively, the \"Company\") began as a partnership in 1967, and was incorporated under the laws of Minnesota in 1968. As of December 31, 1995, the Company sold approximately 41,000 different types of threaded fasteners and other industrial and construction supplies through 366 stores located in 45 states and in Canada which were operated by the Company under the Fastenal(R) name\/1\/, and approximately 8,000 different types of tools and safety supplies through 37 stores located in 18 states which were operated by the Company under the FastTool(R) name. As of December 31, 1995, the Company also operated nine combined Fastenal\/FastTool stores in smaller communities located in nine states, all nine of which stores were opened in 1995. The Company maintains seven distribution centers from which the Company distributes products to its stores, and operates a facility in Memphis, Tennessee to receive and package goods coming from suppliers outside of the United States.\nThrough 1995 the Company counted as a new store the addition of two employees at a site dedicated to the sale of a new product line. By way of example, each FastTool store is located in a store site housing an existing Fastenal store, but has been counted as a separate store because of the addition of two people at the site to sell the FastTool product line. The Company plans to begin adding product lines to some existing sites with only one additional employee or, in some cases, no additional employees. In the future, therefore, the Company's reports relating to growth will include data about total store sites, average sales at these sites, total employment at these sites, and average sales per marketing employee. The Company will also report total Company sales by major product classification, but will not report sales or profits by product class for individual sites. As of January 1, 1996, the Company had 375 store sites and 1,310 people employed at these sites.\nDEVELOPMENT OF THE BUSINESS\nFastenal Company began in 1967 with a marketing strategy of supplying threaded fasteners to customers in small to medium-sized cities. The Company believes its success can be attributed to its ability to offer such customers a full line of products at convenient locations, and to the high quality of the Company's employees.\nThe Company opened its first store in Winona, Minnesota, a city with a population of approximately 25,000. The following table shows the growth in the number of Company stores during the last ten years, and the related increases in the Company's consolidated net sales during that period:\n- ----------------------- \/1\/ Fastenal(R), FastTool(R), SharpCut(TM) and PowerFlow(TM) are trademarks and\/or service marks of the Company.\nAs of December 31, 1995, the Company operated 412 stores located in Minnesota (11 stores), Wisconsin (22 stores), Iowa (16 stores), Illinois (23 stores), Indiana (18 stores), Ohio (31 stores), Michigan (18 stores), Kentucky (7 stores), Pennsylvania (16 stores), New York (14 stores), Nebraska (4 stores), Missouri (10 stores), Kansas (8 stores), South Dakota (4 stores), West Virginia (6 stores), Arkansas (5 stores), Maryland (4 stores), North Dakota (3 stores), North Carolina (16 stores), Oklahoma (5 stores), Tennessee (11 stores), Texas (33 stores), South Carolina (5 stores), Colorado (7 stores), Virginia (8 stores), Louisiana (3 stores), Georgia (12 stores), Alabama (11 stores), Utah (3 stores), Washington (10 stores), Oregon (6 stores), Mississippi (5 stores), California (12 stores), Idaho (4 stores), Massachusetts (7 stores), Florida (5 stores), Connecticut (4 stores), Arizona (2 stores), Montana (4 stores), Nevada (1 store), New Hampshire (4 stores), New Mexico (2 stores), Maine (2 stores), Delaware (1 store), Vermont (1 store) and Canada (8 stores). The Company has closed only three stores in its history.\nThe Company selects new locations for its stores based on their proximity to the Company's distribution network, population statistics, and employment data for manufacturing and construction. The Company currently intends to continue opening new stores at the rate experienced over the last several years, subject to market and general economic conditions. The Company believes that approximately 135 additional markets in the United States have sufficient potential to justify a stand-alone Fastenal store.\nSince 1993 the Company has developed a new store concept, opening 37 FastTool stores which sell tools and safety supplies. Each such store is located in a store site housing an existing Fastenal store, but has been counted as a separate store because of the addition of two employees at the site dedicated to the sale of the FastTool product line. The Company plans to open between 25 and 35 additional FastTool stores in 1996. The Company believes that most cities with Fastenal stores have sufficient market potential for a FastTool store. However, in the aggregate, the existing FastTool stores currently operate at a loss.\nIn 1995 the Company opened nine experimental stores in communities which are smaller (populations of approximately 8,000 to 25,000) than those in which regular Fastenal stores are located. These stores, each of which starts operations with two full-time employees, combine the Fastenal and FastTool product lines in single stores. The Company plans to open between 25 and 40 of these combination stores in 1996. Although the Company cannot be sure of the success of these stores, the Company believes that their success potentially could lead to 500 more store sites in the United States.\nIn 1995 the Company announced plans to begin marketing an expanded line of metal cutting blades and new lines of fluid flow products and materials handling equipment and systems. The Company started selling the expanded line of cutting blades from certain existing Fastenal locations in January 1996, and plans to begin adding each of the other new product lines later in 1996.\nIn 1994 the Company began to sell products into Mexico from its existing McAllen, Texas store. In 1995 similar operations were begun from stores in El Paso and Brownsville, Texas. The Company opened two Fastenal stores in\nCanada in 1994 and six in 1995, and plans to open between five and ten additional Canadian stores in 1996.\nNo assurance can be given that any of the expansion plans described above will be achieved, or that new stores, once opened, will be profitable.\nIt has been the Company's experience that near-term profitability has been adversely affected by new store openings, due to the related start-up costs and the time necessary to generate a customer base. A new store generates its sales from direct sales calls, a slow process involving repeated contacts. As a result of this process, sales volume builds slowly and it typically requires nine to 15 months for a new stand-alone Fastenal store to achieve its first profitable month. Of the 15 Fastenal stores, five FastTool stores and two combination stores opened in the first quarter of 1995, 12 Fastenal stores, one FastTool store and two combination stores were profitable in the fourth quarter of 1995.\nFor 1995 annual sales volumes of stores operating at least five years ranged between approximately $398,000 and $3,386,000, with 75% of these stores having annual sales volumes within the range of approximately $630,000 to $1,495,000. The data in the following table shows the growth in the average sales of the Company's stores from 1994 to 1995 based on each store's age. The stores opened in 1995 contributed $8.6 million (or approximately 3.9%) of the Company's consolidated sales in 1995, with the remainder coming from existing stores.\n- --------------------\n\/(1)\/ Average sales includes sales of stores open for less than the full fiscal year.\nThe Company currently maintains distribution centers in or near Winona, Minnesota; Indianapolis, Indiana; Dallas, Texas; Atlanta, Georgia; Scranton, Pennsylvania; Fresno, California; and Kent, Washington. Distribution centers are located so as to permit twice-a-week delivery to Company stores using Company trucks and overnight delivery by surface common carrier. As the number of stores increases, the Company intends to add new distribution centers. The Company plans to open a distribution center in Ohio in 1996.\nIn December 1994 the Company opened a packaging facility in Memphis, Tennessee. This facility receives freight containers from foreign suppliers and repackages the items in standard packages using high speed equipment. This packaging facility serves five of the Company's distribution centers.\nThe Company operates a UNIX\/terminal-based computer system allowing automatic data exchange between the stores and the distribution centers during regular business hours. The use of client\/server technology allows the Company's network of UNIX-based machines to serve networked personal computers and workstations. During 1995 the Company continued to improve its point of sale hardware and software.\nPRODUCTS\nFastenal Stores ---------------\nThe Company distributes approximately 41,000 different items through its Fastenal stores which may be divided into two broad categories: threaded fasteners, such as bolts, nuts, screws, studs and related washers; and other industrial and construction supplies, such as cutting tools, paints, chains, various pins and machinery keys, concrete anchors, masonry drills, flashlights and batteries, sealants, metal framing systems, wire rope and related accessories.\nThreaded fasteners are used in most manufactured products and building projects, and in the maintenance and repair of machines and structures. Although some aspects of the threaded fastener market are common to all cities, the Company feels that each city's market is to some extent unique. Therefore, the Company opens each Fastenal store with minimal base stocks of inventory, and then tailors the growing inventory to the local market demand as it develops. Threaded fasteners accounted for approximately 68% of the Company's consolidated sales in 1993 and 1994, and approximately 65% of consolidated sales in 1995.\nThe remainder of the Company's products sold through the Fastenal stores consists primarily of other supplies used in construction and industrial maintenance. Many of the same marketing methods used with regard to threaded fasteners also apply to the marketing of these items. The Company currently believes that it will continue to add to the number of supply items it distributes. With the exception of limited lines of chemical anchors, paints and sealants, the Company does not distribute chemical supplies. The Company also avoids selling supplies that have limited shelf lives.\nThe Company has added certain supplies, such as cutting tools, paints, brass fittings, flashlights and batteries, chains and various pins and machinery keys, to its product line to improve a marketing strategy targeted toward industrial maintenance accounts. These accounts improve their buying efficiency by purchasing large orders of maintenance items from a single source.\nConcrete anchors make up the largest portion of supply items used in construction. Most concrete anchors use threaded fasteners as part of the completed anchor assembly. Most of the other supplies distributed by the Company through the Fastenal stores to construction firms are items that are consumed as construction takes place, such as cutting tools and blades.\nFastTool Stores ---------------\nIn 1993 the Company began a new FastTool division which sells power and hand tools and safety supplies to the same customer base serviced by its existing Fastenal stores. The inventory of tools and safety supplies in the FastTool stores is comprised of approximately 8,000 different items. The Company opened three FastTool stores in 1993, six FastTool stores in 1994, and 28 FastTool stores in 1995. The Company uses its current distribution system\nfor the FastTool division, but store personnel are specialists in tool marketing. FastTool stores are located in store sites housing existing Fastenal stores.\nSmaller Community Combination Stores ------------------------------------\nIn 1995 the Company opened nine experimental stores in communities which are smaller (populations of approximately 8,000 to 25,000) than those in which current Fastenal stores are located. These stores, each of which started operations with two full-time employees, combine the Fastenal and FastTool product lines in single stores. Although the Company cannot be sure of the success of these stores, the Company believes that their success potentially could lead to 500 more store sites in the United States.\nAdditional Product Lines ------------------------\nIn 1995 the Company announced plans to begin selling an expanded line of metal cutting blades and blade regrinding services under the SharpCut(TM) name, to begin selling fluid transmission products under the PowerFlow(TM) name, and to begin selling materials handling products and systems. The Company began the regrinding service in September 1995, started selling the expanded line of cutting blades from select Fastenal sites in January 1996, and plans to begin adding the other new products later in 1996.\nINVENTORY CONTROL\nThe Company controls inventory by using computer systems to preset desired stock levels. The data used for this purpose are derived from reports showing sales activity by item for the previous three years. Computers then convert this data to typical store maximum-minimum inventory levels for each item. Stores can deviate from preset inventory levels as deemed appropriate by their district managers. Inventories in distribution centers are established from computerized sales data for the stores served by the respective centers.\nMANUFACTURING OPERATIONS\nIn 1995 approximately 95.9% of the Company's consolidated sales were attributable to products manufactured by other companies to industry standards. The remaining approximately 4.1% of the Company's consolidated sales for 1995 related to products manufactured by, or modified in, the Company's machining shop. These manufactured products consist primarily of non-standard sizes of threaded fasteners made to customers' specifications. The Company engages in manufacturing activity primarily as a service to its customers and does not expect any significant growth in the foreseeable future in the proportion of the Company's consolidated sales attributable to manufacturing.\nSOURCES OF SUPPLY\nThe Company uses a large number of suppliers for the approximately 49,000 standard items it distributes. Most items distributed by the Company can be purchased from several sources, although preferred sourcing is used for some items to facilitate quality control. No single supplier accounted for more than 5.0% of the Company's purchases in 1995.\nCUSTOMERS AND MARKETING\nThe Company believes its success can be attributed to its ability to offer customers in small to medium-sized cities a full line of products at convenient locations, and to the high quality of the Company's employees. Most of the Company's customers are in the construction and manufacturing markets. The construction market includes general, electrical, plumbing, sheet metal and road contractors. The manufacturing market includes both original equipment manufacturers and maintenance and repair operations. Other users of the Company's products include farmers, truckers, railroads, mining companies, municipalities, schools and certain retail trades. As of December 31, 1995, the Company's total number of active customer accounts (defined as accounts having purchase activity within the last 90 days) was approximately 53,000.\nDuring each of the three years ended December 31, 1995, no one customer accounted for a significant portion of the Company's sales. The Company believes that the large number of its customers together with the varied markets that they represent provide some protection to the Company from economic downturns in a particular market.\nA significant portion of the Company's sales are generated through direct calls on customers by store personnel. Because of the nature of the Company's business, the Company does not use the more expensive forms of mass media advertising such as television, radio and newspapers. Forms of advertising used by the Company include signs and catalogs.\nCOMPETITION\nThe Company's business is highly competitive. Competitors include both large distributors located primarily in large cities and smaller distributors located in many of the same cities in which the Company has stores. The Company believes that the principal competitive factors affecting the markets for the Company's products are customer service and convenience.\nSome competitors use vans to sell their products in communities away from their main warehouses. The Company, however, believes that the convenience provided to customers by actually operating a number of stores in smaller markets, each carrying a full line of products, is a competitive selling advantage and that the large number of stores in a given area, taken together with the Company's ability to provide frequent deliveries to such stores from centrally located distribution centers, makes possible the prompt and efficient distribution of products. Having trained personnel at each store also enhances the Company's ability to compete (see \"Employees\" below).\nEMPLOYEES\nAs of January 1, 1996, the Company employed a total of 2,045 full and part- time employees, 1,310 being store managers and store employees, and the balance being employed in the Company's distribution centers, packaging facility, manufacturing operations and home office.\nThe Company believes that the quality of its employees is critical to its ability to compete successfully in the markets it currently serves and to its ability to open new stores in new markets. The Company fosters the growth and education of skilled employees throughout the organization by operating training programs and by decentralizing decision making. Wherever possible, promotions are from within the Company. For example, most new store managers are promoted from an assistant manager's position at another store and\ndistrict managers (who supervise a number of stores) are usually former store managers.\nThe Company's sales personnel participate in incentive bonus arrangements which place emphasis on achieving increased sales on a store and regional basis, while still attaining targeted levels of gross profit. As a result, a significant portion of the Company's total employment cost varies with sales volume. The Company also pays incentive bonuses to other personnel for achieving pre-determined cost containment goals.\nNone of the Company's employees is subject to a collective bargaining agreement and the Company has experienced no work stoppages. The Company believes its employee relations are excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe Company owns three facilities in Winona, Minnesota: a 98,000 square foot distribution center and home office building, a 50,000 square foot manufacturing facility, and a 23,000 square foot building that houses both the Company's Winona store and some operations departments. In 1995 the Company began construction of a 75,000 square foot addition to its distribution center and office building in Winona. The Company expects to occupy this facility in July 1996. The Company also owns a 60,000 square foot distribution center in Indianapolis, Indiana, a 54,000 square foot distribution center in Atlanta, Georgia, a 50,000 square foot distribution center in Dallas, Texas and a 50,000 square foot distribution center near Scranton, Pennsylvania. The buildings that house the Fastenal and FastTool stores in Waterloo and Mason City, Iowa; St. Joseph, Missouri; Wichita Falls and Texarkana, Texas; Topeka, Kansas; and Kokomo, Indiana are also owned by the Company.\nAll other buildings occupied by the Company are leased. Leased stores range from approximately 1,200 to 8,000 square feet, with lease terms of up to 48 months. The Company's leased distribution center in Kent, Washington, which opened in February 1994, is approximately 16,400 square feet. The term of the lease of the Washington facility expires on January 31, 1997, provided that the lease may be renewed at the Company's option for two additional one year periods. The Company's leased distribution center in Fresno, California, which opened in March 1995, is approximately 11,200 square feet. The term of the lease of the California facility expires on February 28, 1998. The Company's leased packaging facility in Memphis, Tennessee, which opened in December 1994, is approximately 37,500 square feet. The term of the lease of the Memphis facility expires on November 15, 1997.\nIf economic conditions are suitable, the Company will, in the future, consider purchasing store sites to house its older stores. All sites for new stores (other than new FastTool stores, which are located in sites housing existing Fastenal stores, some of which are or may be owned) will continue to be leased. It is the Company's policy to negotiate relatively short lease terms to facilitate relocation of particular store operations if deemed desirable by management. It has been the Company's experience that space suitable for its needs and available for leasing is more than sufficient.\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.\nITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT - ---------------------------------------------\nThe executive officers of Fastenal Company are:\nMr. Kierlin has been the Chairman of the Board and President of Fastenal Company and has served as a director since Fastenal Company's incorporation in 1968.\nMr. Slaggie has been the Secretary and Treasurer of Fastenal Company and has served as a director since 1970. He became a full-time employee of Fastenal Company in December 1987, at which time he assumed the additional duties of Shareholder Relations Director and Insurance Risk Manager.\nNeither of the above executive officers is related to the other or to any other director of Fastenal Company.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------\nIncorporated herein by reference is Fastenal Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995, Common Stock Data on page 7.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nIncorporated herein by reference is Fastenal Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995, page 2.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - -------------\nIncorporated herein by reference is Fastenal Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995, pages 5-6.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nIncorporated herein by reference is Fastenal Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995, Selected Quarterly Financial Data (Unaudited) on page 7 and Consolidated Financial Statements, Notes to Consolidated Financial Statements and Independent Auditors' Report on pages 8-16.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE - --------------------\nNone.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nIncorporated herein by reference is the information appearing under the headings \"Election of Directors - Nominees and Required Vote\", pages 4-5, and \"General\", page 9, in Fastenal Company's Proxy Statement dated March 19, 1996. See also Part I hereof under the heading \"Item X. Executive Officers of the Registrant\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nIncorporated herein by reference is the information appearing under the headings \"Election of Directors - Board and Committee Meetings\", page 5, \"Election of Directors - Executive Compensation - Summary of Compensation\", page 5, and \"Election of Directors - Executive Compensation - Compensation Committee Interlocks and Insider Participation\", pages 5-6, in Fastenal Company's Proxy Statement dated March 19, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nIncorporated herein by reference is the information appearing under the heading \"Security Ownership of Principal Shareholders and Management\", pages 2- 3, in Fastenal Company's Proxy Statement dated March 19, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nIncorporated herein by reference is the information appearing under the heading \"Election of Directors - Executive Compensation - Compensation Committee Interlocks and Insider Participation\", pages 5-6, in Fastenal Company's Proxy Statement dated March 19, 1996.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------\na) 1. Financial Statements:\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Earnings 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\nIndependent Auditors' Report\n(Incorporated by reference to pages 8-16 of Fastenal Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995)\n2. Financial Statement Schedules:\nSchedule VIII - Valuation and Qualifying Accounts\n3. Exhibits:\n3.1 Restated Articles of Incorporation of Fastenal Company, as amended (incorporated by reference to Exhibit 3.1 to Fastenal Company's Form 10-Q for the quarter ended September 30, 1993)\n3.2 Restated By-Laws of Fastenal Company (incorporated by reference to Exhibit 3.2 to Registration Statement No. 33-14923)\n13 Annual Report to Shareholders for the fiscal year ended December 31, 1995 (only those portions specifically incorporated by reference herein shall be deemed filed with the Commission)\n21 List of Subsidiaries (incorporated by reference to Exhibit 21 to Fastenal Company's Form 10-K for the fiscal year ended December 31, 1994)\n27 Financial Data Schedule\nCopies of Exhibits will be furnished upon request and payment of the Company's reasonable expenses in furnishing the Exhibits.\nb) Reports on Form 8-K\nNo report on Form 8-K was filed by Fastenal Company during the fourth quarter of the fiscal year ended December 31, 1995.\n[LETTERHEAD OF KPMG PEAT MARWICK LLP]\nIndependent Auditors' Report on Schedule ----------------------------------------\nThe Board of Directors and Stockholders Fastenal Company:\nUnder date of January 29, 1996, we reported on the consolidated balance sheets of Fastenal Company 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 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 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 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 29, 1996\nFASTENAL COMPANY\nSchedule VIII Valuation and Qualifying Accounts Years Ended December 31, 1995, 1994 and 1993 --------------------------------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 18, 1996\nFASTENAL COMPANY\nBy \/s\/Robert A. Kierlin -------------------------------- Robert A. Kierlin, 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 18, 1996 \/s\/Robert A. Kierlin ------------------------------------ Robert A. Kierlin, President (Principal Executive Officer) and Director\nDate: March 18, 1996 \/s\/Stephen M. Slaggie ------------------------------------ Stephen M. Slaggie, Treasurer (Principal Financial Officer) and Director\nDate: March 18, 1996 \/s\/Patrick J. Rice ------------------------------------ Patrick J. Rice, Controller (Principal Accounting Officer)\nDate: March 18, 1996 \/s\/Michael M. Gostomski ------------------------------------ Michael M. Gostomski, Director\nDate: March 18, 1996 \/s\/Henry K. McConnon ------------------------------------ Henry K. McConnon, Director\nDate: March 18, 1996 \/s\/John D. Remick ------------------------------------ John D. Remick, Director\nINDEX TO EXHIBITS\n3.1 Restated Articles of Incorporation of Fastenal Company, as amended (incorporated by reference to Exhibit 3.1 to Fastenal Company's Form 10-Q for the quarter ended September 30, 1993).\n3.2 Restated By-Laws of Fastenal Company (incorporated by reference to Exhibit 3.2 to Registration Statement No. 33-14923).\n13 Annual Report to Shareholders for the fiscal year ended December 31, 1995 (only those portions specifically incorporated by reference herein shall be deemed filed with the Commission)........................................Electronically Filed\n21 List of Subsidiaries (incorporated by reference to Exhibit 21 to Fastenal Company's Form 10-K for the fiscal year ended December 31, 1994).\n27 Financial Data Schedule ...........................Electronically Filed","section_15":""}
{"filename":"740156_1995.txt","cik":"740156","year":"1995","section_1":"Item 1. Business.\nCentury Properties Growth Fund XXII (the \"Registrant\") was organized in January 1984, as a California limited partnership under the Uniform Limited Partnership Act of the California Corporations Code. Fox Partners IV, a California general partnership, is the general partner of the Registrant. The general partners of Fox Partners IV are Fox Capital Management Corporation (the \"Managing General Partner\") a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership, and Fox Associates 84, a California general partnership.\nThe Registrant's Registration Statement, filed pursuant to the Securities Act of 1933 (No. 2-89285), was declared effective by the Securities and Exchange Commission (\"Commission\") on September 25, 1984. The Registrant marketed its securities pursuant to its Prospectus dated September 25, 1984, and thereafter supplemented (hereinafter the \"Prospectus\"). The Prospectus was filed with the 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 Management\" and \"Investment Objectives and Policies\" of the Prospectus.\nBeginning in September 1984 through June 1986, the Registrant offered $120,000,000 in Limited Partnership Units. Limited Partnership Units having an original purchase price of $82,848,000 were sold. The net proceeds of this offering were used to purchase eleven income-producing real properties. The Registrant's property portfolio is geographically diversified with properties acquired in eight states. Leaseback agreements which covered ten of the properties, whereby the seller assumed the risks of operating each property in its initial operating phase, have now expired. The Registrant's acquisition activities were completed in September 1986 and since then the principal activity of the Registrant has been managing its portfolio. One property was acquired by the lender through foreclosure in 1992. The Registrant sold its Monterey Village Apartments property in 1995. See \"Property Matters\" below. See \"Item 2, Properties\" for a description of the Registrant's properties.\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\nalways be reflected in rental 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 properties. Even under the most favorable market conditions, there is no guarantee that any property owned by the Registrant can be sold 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 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 general partner's strategy as set forth herein 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, some or all of the remaining properties will be 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.\nProperty Matters\nCooper's Pointe - On September 1, 1994, the Registrant completed a debt modification agreement with the Cooper's Pointe Apartments mortgagee. As modified, the loan required monthly debt service payments of approximately $46,000, bearing interest at 8.25% per annum and was amortized over 20 years. The loan matured on August 31, 1999, with a balloon payment of $4,746,000. As specified in the loan documents, the Registrant was required to make monthly deposits of $7,000 to a replacement reserve for future capital improvements. The Registrant incurred costs and extension fees in connection with this modification of approximately $57,000.\nOn December 29, 1995, the first mortgage encumbering Cooper's Pointe Apartments was refinanced. The principal amount of the refinanced mortgage was $4,250,000. The loan bears interest at 7.88% per annum, has a 30 year amortization and matures in January 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nCopper Mill - On September 1, 1994, the Registrant completed a debt modification agreement with the Copper Mill Apartments mortgagee. As modified, the loan required monthly debt service payments of approximately $31,000, bearing interest at 8.25% per annum and was amortized over 20 years. The loan matured on August 31, 1999, with a balloon payment of $3,240,000. As specified in the loan documents, the Registrant was required to make monthly deposits of $5,000 to a replacement reserve for future capital improvements. The Registrant incurred costs and extension fees in connection with this modification of approximately $131,000.\nOn December 29, 1995, the first mortgage encumbering Copper Mill Apartments was refinanced. The principal amount of the refinanced mortgage was $6,100,000. The loan bears interest at 7.88% per annum, has a 30 year amortization and matures in January 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nHampton Greens - On December 29, 1995, the first mortgage encumbering Hampton Greens Apartments was refinanced. The principal amount of the refinanced mortgage is $5,800,000. The loan bears interest at 7.88% per annum, has a 30 year amortization and matures in January 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nStoney Creek - On December 29, 1995, the first mortgage encumbering Stoney Creek Apartments was refinanced. The principal amount of the refinanced mortgage is $7,050,000. The loan bears interest at 7.88% per annum, has a 30 year amortization and matures in January 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nFour Winds - On January 17, 1996, the first mortgage encumbering Four Winds Apartments was refinanced. The principal amount of the refinanced mortgage is $9,675,000. The loan bears interest at 7.93% per annum, has a 30 year amortization and matures in February 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Notes 5 and 9\" for additional information with respect to this loan.\nPlantation Creek - On January 17, 1996, the first mortgage encumbering Plantation Creek Apartments was refinanced. The principal amount of the refinanced mortgage is $15,900,000. The loan bears interest at 7.93% per annum, has a 30 year amortization and matures in February 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Notes 5 and 9\" for additional information with respect to this loan.\nWood Creek - On January 17, 1996, the first mortgage encumbering Wood\nCreek Apartments was refinanced. The principal amount of the refinanced mortgage is $12,900,000. The loan bears interest at 7.93% per annum, has a 30 year amortization and matures in February 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Notes 5 and 9\" for additional information with respect to this loan.\nIn connection with the refinancings of Cooper's Pointe, Copper Mill, Hampton Greens, Stoney Creek, Four Winds, Plantation Crossing and Wood Creek, the lender required the Registrant to transfer each property into a separate single asset entity. As a result, the Registrant transferred each of these properties into limited partnerships in which the Registrant holds a 99% limited partnership interest. The general partners of these partnerships are corporations in which the Registrant is the sole stockholder. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Notes 5 and 9\" for additional information with respect to these loans.\nMonterey Village - The Registrant modified the existing debt encumbering Monterey Village Apartments in January 1994. The terms of the modified loan included a seven year extension with a reduction in the interest rate from 10.50 percent to 8.25 percent per annum and a 30 year amortization period. In addition, the Registrant made a principal payment of $799,000 on the loan. In connection with the modification, the Registrant incurred extension fees and costs totaling approximately $78,000.\nOn August 18, 1995, the Registrant sold Monterey Village Apartments to an unaffiliated third party for $10,609,000. The buyer assumed the existing mortgage on the property (approximately $7,359,000) and paid to the Registrant approximately $2,926,000. The sale resulted in a gain of approximately $2,033,000. On January 11, 1996, the Registrant distributed $2,548,000 to the limited partners and $52,000 to the general partner from the proceeds received from this sale.\nHampton Greens, Promontory Point, Stoney Creek and Wood Creek Apartments - On December 28, 1994, the Registrant refinanced its existing loans on these properties. The refinanced loan was in the principal amount of $30,000,000, bears interest at 90 day LIBOR plus 3.75% and matures on December 26, 1999. The Registrant is required to make monthly debt service payments in an amount equal to the greater of (i) the interest due on the loan or (ii) $218,750 per month through December 31, 1996, $225,000 per month from January 1, 1997 through December 31, 1997, or $231,250 per month from January 1, 1998 through maturity. To the extent the Registrant is required to make payments in the amounts set forth in clause (ii), the difference between such amount and the amount which would otherwise have been paid pursuant to clause (i) will be applied to the loan principal. In addition, the Registrant is required to maintain a $500,000 working capital reserve. In connection with this refinancing, the Registrant transferred ownership to Wood Creek Apartments to Century Stoney Greens, L.P., a wholly-owned subsidiary of the Registrant which had already held title to the other three properties. The portion of this loan attributable to Hampton Greens, Stoney Creek and Wood Creek was refinanced as described above. The portion of the loan attributable to Promontory Point was not refinanced.\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\nto sell to IFGP Corporation, a Delaware corporation, an affiliate of Insignia Financial Group, Inc. (\"Insignia\"), a Delaware corporation, 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 eleven 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 17,022.5 limited partnership units or approximately 21% 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. In addition, each of the Registrant's properties competes in an area which normally contains numerous other 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 or had an ownership interest is as follows. All of the Registrant's properties are owned in fee.\nDate of Name and Location Purchase Size\nWood Creek Apartments 05\/84 432 units 1710 S. Gilbert Road Mesa, Arizona\nPlantation Creek Apartments(1) 06\/84 484 units 6925 Roswell Road Atlanta, Georgia\nStoney Creek Apartments 06\/85 364 units 11333 Amanda Lane Dallas, Texas\nFour Winds Apartments 09\/85 350 units SEC of 79th Street & Switzer Road Overland Park, Kansas\nPromontory Point Apartments 10\/85 252 units 2250 Ridgepoint Austin, Texas\nDate of Name and Location Purchase Size\nCooper's Pointe Apartments 11\/85 192 units 2225 Greenridge Road Charleston, South Carolina\nHampton Greens Apartments 12\/85 309 units 10911 Woodmeadow Parkway Dallas, Texas\nAutumn Run Apartments 06\/86 320 units 1627 Country Lakes Drive Naperville, Illinois\nCopper Mill Apartments 09\/86 192 units 3400 Copper Mill Trace Richmond, Virginia\n(1) Formerly Post Creek Apartments.\nSee, \"Item 8, Consolidated Financial Statements and Supplementary Data\", for information regarding any encumbrances to which properties of the Registrant are subject.\nThe following chart sets forth the average occupancy at the Registrant's remaining properties for the years ended December 31, 1995, 1994, 1993, 1992, and 1991:\nCENTURY PROPERTIES GROWTH FUND XXII OCCUPANCY SUMMARY\nOCCUPANCY SUMMARY\nAverage Occupancy Rate(%) for the Year Ended December 31, -------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Wood Creek Apartments 97 97 93 93 88 Plantation Creek Apartments 95 97 92 89 89 Stoney Creek Apartments 94 93 91 91 93 Four Winds Apartments 97 95 96 96 94 Promontory Point Apartments 97 96 96 95 93 Cooper's Pointe Apartments 95 94 91 92 92 Hampton Greens Apartments 97 95 95 94 92 Autumn Run Apartments 95 96 91 93 94 Copper Mill Apartments 96 97 95 94 92\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\nalleged, 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) a breach of the fiduciary duty owed by the Managing General Partner to the limited partners 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 actions 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. Through December 1995, cash distributions of $15 for each $1,000 of original investment have been made. No market for Limited Partnership Units exists nor is expected to develop.\nNo distributions from operations were made during the years ended December 31, 1995 and 1994. On January 11, 1996, the Registrant distributed $2,548,000 to the limited partners and $52,000 to the general partners from the proceeds from the sale of the Monterey Village. 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 5,837.\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 consolidated financial statements included elsewhere herein. This data is not covered by the independent auditors' report.\n(1) $1,000 original contribution per unit, based on units outstanding during the period after giving effect to the allocation of net 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 holds investments in and operates residential real estate properties. The properties are located in Arizona, Georgia, Texas, Kansas, South Carolina, Illinois and Virginia. The Registrant receives rental income from its properties and is responsible for operating expenses, administrative expenses, capital improvements and debt service payments. As of March 1, 1996, two of the eleven properties originally purchased by the Registrant were sold or otherwise disposed. On August 18, 1995, the Registrant's Monterey Village Apartments was sold to an unaffiliated third party for $10,609,000. After assumption of the mortgage balance of $7,359,000, and closing costs of $324,000, the Registrant received net proceeds of $2,926,000. The sale resulted in a gain of $2,033,000. In connection with the sale of the property and the assumption of the related outstanding debt, the Registrant recognized an extraordinary loss on extinguishment of debt of $217,000. All of the Registrant's remaining properties, except its Cooper's Pointe Apartments, generated positive cash flow from operations during the year ended December 31, 1995. Cooper's Pointe Apartments experienced negative cash flow due to significant non-recurring exterior painting and repairs during this period.\nThe Registrant uses working capital reserves from any undistributed cash flow from operations and refinancing proceeds as its primary source of liquidity. On January 11, 1996, the Registrant distributed $2,548,000 ($30.76 per unit) to the limited partners and $52,000 to the general partners from the proceeds received from the sale of Monterey Village Apartments in August 1995. On January 17, 1996, the Registrant refinanced the mortgages that secured their Wood Creek, Plantation Creek and Four Winds Apartments properties.\nLiquidity based upon cash and cash equivalents experienced a $4,242,000 increase at December 31, 1995, as compared to 1994. The Registrant's increase in cash was provided by $2,496,000 of cash from investing activities and $1,934,000 of cash from operating activities, which was partially offset by $188,000 of cash used in financing activities. Cash from investing activities included $2,926,000 of net proceeds from the sale of the Registrant's Monterey Village Apartments property which was partially offset by $430,000 of improvements to real estate. Cash used in financing activities included $23,200,000 of notes payable proceeds which was more than offset by $20,582,000 of cash used for the repayment of notes payable, $2,037,000 of notes payable principal payments, $506,000 of deferred financing costs paid and $263,000 of prepayment premiums paid to extinguish debt. Cash from operating activities increased due to improved operations. The Managing General Partner is currently evaluating the Registrant's capital improvement requirements. 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 being invested in a money market account or in repurchase agreements secured by United States Treasury obligations. The Managing General Partner believes that, if market conditions remain\nrelatively stable, cash flow from operations, when combined with working capital reserves, will be sufficient to fund required capital improvements and debt service payments (excluding balloon payments beginning in December 1999) during 1996 and the foreseeable future. The Registrant has a balloon payment of $10,575,000 on Autumn Run Apartments complex due June 1996. The Registrant will attempt to extend the due date of this loan or find replacement financing. If, however, this loan is not refinanced or extended, or the property is not sold, the Registrant could lose this property through foreclosure. If the Registrant's Autumn Run Apartments were lost through foreclosure, the Registrant would recognize a loss of approximately $700,000.\nOn December 29, 1995, the Registrant refinanced the mortgage that encumbered its Hampton Greens Apartments property with a new first mortgage in the amount of $5,800,000. The loan requires monthly payments of approximately $42,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $5,175,000. The loan may not be prepaid without penalty.\nOn December 29, 1995, the Registrant refinanced the mortgage that encumbered its Stoney Creek Apartments property with a new first mortgage in the amount of $7,050,000. The loan requires monthly payments of approximately $51,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $6,291,000. The loan may not be prepaid without penalty.\nOn December 29, 1995, the Registrant refinanced the mortgage that encumbered its Cooper's Pointe Apartments property with a new first mortgage in the amount of $4,250,000. The loan requires monthly payments of approximately $31,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $3,792,000. The loan may not be prepaid without penalty.\nOn December 29, 1995, the Registrant refinanced the mortgage that encumbered its Copper Mill Apartments property with a new first mortgage in the amount of $6,100,000. The loan requires monthly payments of approximately $44,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $5,443,000. The loan may not be prepaid without penalty.\nIn 1995, in connection with the above refinanced mortgages, the Registrant recognized an extraordinary loss on extinguishment of debt of $494,000, consisting of the write-off of unamortized deferred loan costs and prepayment premiums.\nOn January 17, 1996, the Registrant refinanced the mortgage that encumbered its Wood Creek Apartments property with a new first mortgage in the amount of $12,900,000. The loan requires monthly payments of approximately $94,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of approximately $11,524,000. The loan may not be prepaid without penalty.\nOn January 17, 1996, the Registrant refinanced the mortgage that encumbered its Plantation Creek Apartments property with a new first\nmortgage in the amount of $15,900,000. The loan requires monthly payments of approximately $116,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of approximately $14,204,000. The loan may not be prepaid without penalty.\nOn January 17, 1996, the Registrant refinanced the mortgage that encumbered its Four Winds Apartments property with a new first mortgage in the amount of $9,675,000. The loan requires monthly payments of approximately $71,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of approximately $8,643,000. The loan may not be prepaid without penalty.\nIn connection with the above refinancings the Registrant was required to transfer all the assets and liabilities of each of the properties to its own newly formed, wholly-owned subsidiary.\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 Registrant. Pursuant to the Second Tender Offer, DeForest I acquired an additional 2,391 units of the Registrant which, when added to the units acquired during the First Tender Offer, represents approximately 20% of the total number of outstanding units of the Registrant. Also 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. The Registrant has no outstanding amounts due under this line of credit. Based on present plans, the Managing General Partner 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 to be elected. 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 original investment objective of capital growth from inception of the Registrant 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 remaining properties and the markets in which such properties are located and on the sales price of the remaining properties. In this regard, all of 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\nrefinancing 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, before the extraordinary loss on extinguishment of debt, improved by $2,798,000 for the year ended December 31, 1995, as compared to 1994, due to an increase in revenues of $2,526,000 and a decrease in expenses of $272,000. Operating results improved due to the $2,033,000 gain on sale of the Registrant's Monterey Village Apartments and improved property operations.\nWith respect to the remaining properties, rental revenues increased by $1,050,000 due to increases in rental rates at all of the Registrant's properties. Occupancy remained relatively constant at all of the Registrant's properties. In addition, interest and other income decreased by $27,000 due to the receipt of $100,000 for the release of a restrictive covenant on land adjacent to the Four Winds Apartments complex during the year ended December 31, 1994, which was partially offset by an increase in average working capital reserves available for investment coupled with an increase in interest rates.\nWith respect to the remaining properties, expenses increased due to an increase in operating expenses of $478,000 which was slightly offset by a decrease in interest expense of $31,000. Operating expenses increased due to increases in maintenance expenses at the Registrant's Cooper's Pointe, Four Winds, Promontory Point, Wood Creek and Plantation Creek properties, which were partially offset by a decrease in maintenance expenses at the Registrant's Autumn Run, Copper Mill and Stoney Creek properties. Interest expense decreased primarily due to mortgage principal amortization. Depreciation expense remained relatively constant. In addition, general and administrative expense decreased by $158,000 due to the reduction in asset management costs effective July 1, 1994.\n1994 Compared 1993\nOperating results, before the extraordinary loss on extinguishment of debt, improved by $631,000 for the year ended December 31, 1994, as compared to 1993, due to increases in revenues of $1,170,000 and in expenses of\n$539,000.\nRevenues increased by $1,170,000 for the year ended December 31, 1994, as compared to 1993, due to increases of $1,081,000 in rental revenue and of $89,000 in interest and other income. Rental revenues increased at all of the Registrant's properties except for Monterey Village. The increase was primarily due to increases in rental rates at all the Registrant's properties except for Monterey Village and improved occupancy at the Registrant's Autumn Run, Cooper's Pointe, Copper Mill, Plantation Creek, Wood Creek and Stoney Creek properties. Interest and other income increased due to the receipt of $100,000 relating to the release of a restrictive covenant on land adjacent to the Four Winds Apartment complex which was slightly offset by a decrease in interest income due to a decline in average working capital reserves available for investment.\nExpenses increased by $539,000 for the year ended December 31, 1994, as compared to 1993, due to increases of $1,171,000 in operating expenses which was partially offset by decreases of $288,000 in interest expense, $46,000 in depreciation expense and $298,000 in general and administrative expenses. Operating expenses increased due to general repair and maintenance expenditures associated with the various mortgage refinancings and rent up expenses at all of the Registrant's properties. Interest expense decreased due to the partial repayment of mortgage principal and a lower interest rate resulting from the debt modification on the mortgage encumbering the Registrant's Monterey Village Apartments. Depreciation expense decreased due to the effect of assets becoming fully depreciated. General and administrative expenses decreased due to bad debt expenses recognized in 1993 relating to revenue bonds acquired when the Registrant's Fox Hollow property was purchased, partially offset by increased costs associated with the management transition.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nCONSOLIDATED FINANCIAL STATEMENTS\nYEAR ENDED DECEMBER 31, 1995\nINDEX\nPage\nIndependentt Auditors' Reports............................................. Consolidated Financial Statements: Balance Sheets at December 31, 1995 and 1994............................. Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993...................................... Statements of Partners' Equity 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 Consolidated Financial Statements............................... Financial Statement Schedule: Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995................................................. F - 17\nConsolidated financial statements and financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in the consolidated financial statements.\nTo the Partners Century Properties Growth Fund XXII Greenville, South Carolina\nIndependent Auditors' Report\nWe have audited the accompanying consolidated balance sheets of Century Properties Growth Fund XXII (a limited partnership) (the \"Partnership\") and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated 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 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 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.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Century Properties Growth Fund XXII and its subsidiaries 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. 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.\nImowitz Koenig & Co., LLP\nCertified Public Accountants\nNew York, N.Y. January 23, 1996\nIndependent Auditors' Report by Deloitte & Touche\nINDEPENDENT AUDITORS' REPORT\nCentury Properties Fund XXII: We have audited the accompanying consolidated statements of operations, partners' equity and cash flows of Century Properties Fund XXII (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. 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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. In 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. The accompanying 1993 consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in the first paragraph of Note 8 to the financial statements, the Partnership has balloon payments totaling $11,869,000 and $27,511,000 due in 1994 and 1995, respectively, which raises substantial doubt about the Partnership's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 8. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, ------------------------------ 1995 1994 ----------- ----------- ASSETS\nCash and cash equivalents $ 4,717,000 $ 475,000 Restricted cash 500,000 500,000 Other assets 1,186,000 862,000\nReal Estate:\nReal estate 128,394,000 139,861,000 Accumulated depreciation (44,342,000) (43,985,000) ----------- ----------- Real estate, net 84,052,000 95,876,000\nDeferred financing costs, net 893,000 734,000 ----------- ----------- Total assets $91,348,000 $98,447,000 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY\nNotes payable $74,111,000 $80,889,000 Accrued expenses and other liabilities (including $116,000 to a related party in 1995). 1,465,000 1,361,000 ----------- ----------- Total liabilities 75,576,000 82,250,000 ----------- ----------- Partners' Equity (Deficit):\nGeneral partner (7,173,000) (7,173,000) Limited partners (82,848 units outstanding at December 31, 1995 and 1994) 22,945,000 23,370,000 ----------- ----------- Total partners' equity 15,772,000 16,197,000 ----------- ----------- Total liabilities and partners' equity $91,348,000 $98,447,000 =========== ===========\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, ------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Revenues: Rental $20,123,000 $19,603,000 $18,522,000 Interest and other income 156,000 183,000 94,000 Gain on property disposition 2,033,000 -- -- ----------- ----------- ----------- Total revenues 22,312,000 19,786,000 18,616,000 ----------- ----------- ----------- Expenses (including $1,802,000 and $1,003,000 paid to the general partner and affiliates in 1995 and 1994): Operating 10,567,000 10,353,000 9,182,000 Interest 7,192,000 7,397,000 7,685,000 Depreciation 4,002,000 4,125,000 4,171,000 General and administrative 265,000 423,000 721,000 ----------- ----------- ----------- Total expenses 22,026,000 22,298,000 21,759,000 ----------- ----------- ----------- Income (loss) before extraordinary item 286,000 (2,512,000) (3,143,000)\nExtraordinary item: Loss on extinguishment of debt (711,000) (530,000) -- ----------- ----------- ----------- Net loss $(425,000) $(3,042,000) $(3,143,000) =========== =========== =========== Net income (loss) per limited partnership unit:\nIncome (loss) before extraordinary item $ 2.44 $ (26.74) $ (33.46)\nExtraordinary item (7.57) (5.64) -- ----------- ----------- ----------- Net loss $ (5.13) $ (32.38) $ (33.46) =========== =========== ===========\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nGeneral Limited Total partner's partners' partners' (deficit) equity equity ----------- ------------ ------------\nBalance - January 1, 1993 $(6,443,000) $28,825,000 $22,382,000\nNet loss (371,000) (2,772,000) (3,143,000) ----------- ------------ ------------\nBalance - December 31, 1993 (6,814,000) 26,053,000 19,239,000\nNet loss before extraordinary item (296,000) (2,216,000) (2,512,000)\nExtraordinary item (63,000) (467,000) (530,000) ----------- ------------ ------------\nBalance - December 31, 1994 (7,173,000) 23,370,000 16,197,000\nNet income before extraordinary item 84,000 202,000 286,000\nExtraordinary item (84,000) (627,000) (711,000) ----------- ------------ ------------\nBalance - December 31, 1995 $(7,173,000) $(22,945,000) $(15,772,000) =========== ============ ============\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, ------------------------------------------ 1995 1994 1993 ------------- ------------- ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (425,000) $ (3,042,000) $(3,143,000) ------------- ------------- ------------ Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization 4,152,000 4,179,000 4,528,000 Extraordinary item - extinguishment of debt 711,000 530,000 -- Gain on property disposition (2,033,000) -- -- Changes in operating assets and liabilities: Other assets (324,000) (342,000) (203,000) Accrued expenses and other liabilities (147,000) (674,000) 70,000 ------------- ------------- ------------ Net cash provided by operating activities 1,934,000 651,000 1,252,000 ------------- ------------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Additions to real estate (430,000) (621,000) (1,305,000) Purchase of cash investments -- -- (1,782,000) Proceeds from maturity of cash investments -- 1,187,000 595,000 Restricted cash decrease (increase) -- 275,000 11,000 Net proceeds on sale of property 2,926,000 -- -- ------------- ------------- ------------ Net cash provided by (used in) investing activities 2,496,000 841,000 (2,481,000) ------------- ------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Notes payable proceeds 23,200,000 30,000,000 -- Notes payable principal payments (2,037,000) (703,000) (605,000) Repayment of notes payable (20,582,000) (30,256,000) -- Deferred financing costs paid (506,000) (399,000) (94,000) Deferred financing costs refunded -- -- 33,000 Costs paid to extinguish debt (263,000) -- -- ------------- ------------- ------------ Net cash (used in) financing activities (188,000) (1,358,000) (666,000) ------------- ------------- ------------ Increase (Decrease) in Cash and Cash Equivalents 4,242,000 134,000 (1,895,000)\nCash and Cash Equivalents at Beginning of year 475,000 341,000 2,236,000 ------------- ------------- ------------\nCash and Cash Equivalents at End of Year $ 4,717,000 $ 475,000 $ 341,000 ============= ============= ============\nSupplemental Disclosure of Cash Flow Information: Interest paid in cash during the year $ 7,142,000 $ 7,513,000 $ 7,284,000 ============= ============= ============ Supplemental Disclosure of Non-cash Investing and Financing Activities:\nMortgage assumed on property sale (see Note 6) $7,359,000 $ -- $ -- ============= ============= ============ Refinancing of notes payable (see Note 5)\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nCentury Properties Growth Fund XXII (the \"Partnership\") is a limited partnership organized in 1984 under the laws of the State of California to acquire, hold for investment, and ultimately sell income-producing real estate. The Partnership currently owns nine residential apartment complexes, located in Arizona, Georgia, Texas, Kansas, South Carolina, Illinois and Virginia. The general partner of the Partnership is Fox Partners IV, a California general partnership. The general partners of Fox Partners IV are Fox Capital Management Corporation (\"FCMC\"), a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership, Fox Partners 85, a California general partnership and Fox Associates 84, a California general partnership. The capital contributions of $82,848,000 ($1,000 per unit) were made by the limited partners.\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 20% of total limited partnership units of the Partnership (see Note 9).\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 Financial 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 9).\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nConsolidation\nThe consolidated financial statements include the statements of the Partnership, a wholly-owned subsidiary, which was formed in 1991 and four wholly-owned subsidiaries which were formed in 1995 (see Note 5) All significant intercompany transactions and balances have been eliminated.\nDistributions\nOn January 11, 1996, the Partnership distributed $2,548,000 ($30.76 per unit) to the limited partners and $52,000 to the general partners from the proceeds received from the sale of the Partnership's Monterey Village Apartments property.\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.\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.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year. At December 31, 1995, the Partnership had approximately $4,450,000 invested in overnight repurchase agreements, secured by United States Treasury obligations, which are included in cash and cash equivalents.\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 amouThe adoption of the SFAS had no effect on the Partnership's financial statements.\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 as interest expense 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 $322,000 and $679,000, respectively.\nNet Loss Per Limited Partnership Unit\nThe net loss per limited partnership unit is computed by dividing the net loss allocated to the limited partners by 82,848 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.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nReclassifications\nCertain amounts in 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 partner, 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 partner 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, the Managing General Partner 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 (see Notes 1 and 9). Related party fees and expenses for the years ended December 31, 1995, 1994, and 1993 were as follows:\n1995 1994 1993 ---------- ---------- -----------\nFinancing fees $ 116,000 $ -- $ -- Property management fees 1,011,000 825,000 -- Real estate tax reduction fees 43,000 -- -- Reimbursement of expenses: Partnership accounting and investor services 174,000 158,000 -- Professional services -- 20,000 -- ---------- ----------- -----------\nTotal $1,344,000 $ 1,003,000 $ -- ========== =========== ===========\nProperty management fees and real estate tax reduction fees are included in\noperating expenses. Reimbursed expenses are primarily included in general and administrative expenses. Financing fees have been capitalized and are being amortized over the life of the loans. In addition, approximately $574,000 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.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES (Continued)\nIn accordance with the partnership agreement, the general partner received a Partnership management incentive allocation equal to ten percent of net and taxable losses and cash distributions. The general partner was also allocated its two percent continuing interest in the Partnership's net and taxable losses and cash distributions after the above allocation of the Partnership management incentive. Gains from the disposition of Partnership properties were allocated first to the general partner to the extent of distributions received or they are entitled to receive, then 12% of the remainder until any deficit in their capital account is eliminated.\n3. RESTRICTED CASH\nRestricted cash of $500,000 at December 31, 1995 and 1994, consists of required reserves maintained in accordance with Partnership financing agreements.\n4. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\n1995 1994 ------------- ------------ Land $ 14,396,000 $ 15,829,000 Buildings and improvements 103,304,000 112,257,000 Furnishings 10,694,000 11,775,000 ------------ ------------\nTotal 128,394,000 139,861,000 Accumulated depreciation (44,342,000) (43,985,000) ------------ ------------\nReal estate, net $ 84,052,000 $ 95,876,000 ============ ============\n5. NOTES PAYABLE\nIndividual rental properties are pledged as collateral for the related notes payable. At December 31, 1995, the notes, which are payable monthly, bear interest at rates ranging from 7.4 to 9.4 percent.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. NOTES PAYABLE (Continued)\nOn December 29, 1995, the Partnership refinanced the mortgage that encumbered its Hampton Greens Apartments property with a new first mortgage in the amount of $5,800,000. The loan requires monthly payments of approximately $42,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $5,175,000. The loan may not be prepaid without penalty. The Partnership incurred closing costs and fees of $170,000 in connection with the refinancing, of which $129,000 was paid in 1995. In connection with the refinancing, the Partnership was required to transfer all the assets and liabilities of Hampton Greens Apartments to a newly formed, wholly-owned subsidiary, Hampton Greens CPGF 22, L.P.\nOn December 29, 1995, the Partnership refinanced the mortgage that encumbered its Stoney Creek Apartments property with a new first mortgage in the amount of $7,050,000. The loan requires monthly payments of approximately $51,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $6,291,000. The loan may not be prepaid without penalty. The Partnership incurred closing costs and fees of $230,000 in connection with the refinancing, of which $151,000 was paid in 1995. In connection with the refinancing, the Partnership was required to transfer all the assets and liabilities of Stoney Creek Apartments to a newly formed, wholly-owned subsidiary, Stoney Creek CPGF 22, L.P.\nOn December 29, 1995, the Partnership refinanced the mortgage that encumbered its Cooper's Pointe Apartments property with a new first mortgage in the amount of $4,250,000. The loan requires monthly payments of approximately $31,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $3,792,000. The loan may not be prepaid without penalty. The Partnership incurred closing costs and fees of $135,000 in connection with the refinancing, of which $78,000 was paid in 1995. In connection with the refinancing, the Partnership was required to transfer all the assets and liabilities of Cooper's Pointe Apartments to a newly formed, wholly-owned subsidiary, Cooper's Pointe CPGF 22, L.P.\nOn December 29, 1995, the Partnership refinanced the mortgage that encumbered its Copper Mill Apartments property with a new first mortgage in the amount of $6,100,000. The loan requires monthly payments of approximately $44,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $5,443,000. The loan may not be prepaid without penalty. The Partnership incurred closing costs and fees of $210,000 in connection with the refinancing, of which $135,000 was paid in 1995. In connection with the refinancing, the Partnership was required to transfer all the assets and liabilities of Copper Mill Apartments to a newly formed, wholly-owned subsidiary, Copper Mill CPGF 22, L.P.\nIn 1995 and 1994, in connection with the refinancing of mortgages, the Partnership recognized an extraordinary loss on extinguishment of debt of $494,000 and $530,000, respectively, consisting of the write-off of unamortized deferred loan costs and prepayment premiums.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. NOTES PAYABLE (Continued)\nThe mortgage encumbering the Partnership's Autumn Run Apartments property matures on June 1, 1996, with a balloon payment of approximately $10,575,000. The Partnership will attempt to extend the due date of this loan or find replacement financing. If, however, this loan is not refinanced or extended, or the property is not sold, the Partnership could lose this property through foreclosure.\nThe note payable on Four Winds Apartments with a balloon payment of $10,452,000 was due in September 1995. The Partnership extended the due date of the note to April 1996. In connection with the loan extension, the Partnership incurred fees of $13,000. On January 17, 1996, the Partnership replaced the mortgage encumbering Four Winds Apartments with a new first mortgage in the amount of $9,675,000 (see Note 9).\nThe notes payable on the Partnership's Plantation Creek and Wood Creek properties, which were due to mature in July 1996 and December 1999, respectively, were refinanced on January 17, 1996 (see Note 9).\nPrincipal payments at December 31, 1995 are required as follows:\n1996 $ 11,006,000 1997 487,000 1998 528,000 1999 4,911,000 2000 618,000 Thereafter 59,080,000 ------------ 76,630,000 Less: Additional proceeds received from January 17, 1996 refinancings (2,519,000) ------------ Total $ 74,111,000 ============\nPrincipal payments reflect the refinancings that occurred on January 17, 1996, regardless of their original due date. Approximately $2,500,000 of additional proceeds were received from the January 17, 1996 refinancings.\nAmortization of deferred financing costs totaled $150,000, $54,000 and $357,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n6. DISPOSITION OF RENTAL PROPERTY\nOn August 18, 1995, the Partnership sold its Monterey Village Apartments to an unaffiliated third party for $10,609,000. After assumption of the mortgage balance of $7,359,000, and closing costs of $324,000, the partnership received net proceeds of $2,926,000. For financial reporting purposes the sale resulted in a gain of $2,033,000.\nIn connection with the write-off of unamortized deferred loan costs and the assumption of debt, the Partnership recognized an extraordinary loss on extinguishment of debt of $217,000 in 1995.\n7. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING\nThe difference between the accrual method of accounting for income tax reporting and the accrual method of accounting used in the consolidated financial statements are as follows: 1995 1994 1993 ------------- ----------- ------------ Net loss - financial statements $ (425,000) $ (3,042,000) $(3,143,000) Differences resulted from: Gain on property disposition 582,000 -- -- Depreciation (1,085,000) (1,286,000) (1,505,000) Interest expense -- 110,000 131,000 Construction period interest amortization (187,000) (315,000) (374,000) Other 48,000 32,000 5,000 ------------ ----------- ------------\nNet loss - income tax method $ (1,067,000) $ (4,501,000) $(4,886,000) ============ =========== ============\nTaxable loss per limited partnership unit after giving effect to the allocation to the general partner $ (12) $ (48) $ (52) ============ =========== ============\nPartners' equity - financial statements $ 15,772,000 $ 16,197,000 $ 19,239,000 Differences resulted from: Sales commissions and organization expenses 12,427,000 12,427,000 12,427,000 Depreciation (28,279,000) (27,562,000) (26,273,000) Payments credited to rental properties 2,014,000 2,056,000 2,056,000 Interest expense 287,000 287,000 177,000\nConstruction period interest amortization (3,498,000) (3,567,000) (3,252,000) Other 53,000 5,000 (27,000) ------------ ----------- ------------ Partners' (deficit) equity - income tax method $ (1,224,000) $ (157,000) $ 4,347,000 ============ =========== ============\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n8. BASIS OF PRESENTATION AND OPERATING STRATEGY FOR THE YEAR ENDED DECEMBER 31,\nThe accompanying consolidated financial statements for the year ended December 31, 1993, have been prepared on a going concern basis which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As of December 31, 1993, the Partnership had balloon payments totaling $11,869,000 due on two properties, Monterey Village and Copper Mill in August and December of 1994, respectively. In addition, balloon payments totaling $27,511,000 were due in 1995 on Four Winds, Woodcreek and Cooper's Pointe. The Partnership believed that its current strategy, combined with cash generated from the Partnership's properties with positive operations would allow the Partnership to meet its capital and operating requirements. The outcome of this uncertainty could not be determined. The consolidated financial statements do not include any adjustments that might result from the ultimate outcome of this uncertainty.\nThe Partnership sold Monterey Village and has refinanced the other properties as of January 17, 1996 (see Notes 5 and 6).\n9. SUBSEQUENT EVENTS\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.\nOn January 17, 1996, the Partnership refinanced the mortgage that encumbered its Wood Creek Apartments property with a new first mortgage in the amount of $12,900,000. The loan requires monthly payments of approximately $94,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of approximately $11,524,000. The loan may not be prepaid without penalty.\nOn January 17, 1996, the Partnership refinanced the mortgage that encumbered its Plantation Creek Apartments property with a new first mortgage in the amount of $15,900,000. The loan requires monthly payments of approximately $116,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of approximately $14,204,000. The loan may not be prepaid without penalty.\nOn January 17, 1996, the Partnership refinanced the mortgage that encumbered its Four Winds Apartments property with a new first mortgage in the amount of $9,675,000. The loan requires monthly payments of approximately $71,000 at 7.93% interest and matures on February 1, 2006, with a balloon payment of\napproximately $8,643,000. The loan may not be prepaid without penalty.\nIn connection with the above refinancings the Partnership was required to transfer all the assets and liabilities of each of the properties to its own newly formed, wholly-owned subsidiary.\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nSCHEDULE III\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSee accompanying notes.\nSCHEDULE III\nCENTURY PROPERTIES GROWTH FUND XXII (A Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $127,398,000.\n(2) Balance, January 1, 1993 $ 137,935,000 Improvements capitalized subsequent to acquisition 1,305,000 -------------\nBalance, December 31, 1993 139,240,000 Improvements capitalized subsequent to acquisition 621,000 -------------\nBalance, December 31, 1994 139,861,000 Improvements capitalized subsequent to acquisition 430,000 Cost of rental property sold (11,897,000) -------------\nBalance, December 31, 1995 $ 128,394,000 =============\n(3) Balance, January 1, 1993 $ 35,689,000 Additions charged to expense 4,171,000 -------------\nBalance, December 31, 1993 39,860,000 Additions charged to expense 4,125,000 -------------\nBalance, December 31, 1994 43,985,000 Additions charged to expense 4,002,000 Accumulated depreciation on rental property sold (3,645,000) -------------\nBalance, December 31, 1995 $ 44,342,000 =============\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 uncertainty, audit scope or accounting principles. However, Deloitte's Independent Auditor's Report for the calendar year December 31, 1993 was modified due to the uncertainty regarding the Registrant's ability to continue as a going concern since the Registrant has substantial balloon payments due on Notes in 1994 and 1995; the financial statements did not include any adjustments that might result from the outcome of this uncertainty. 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 IV (\"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 Insignia (See \"Item 1, Business - Change in Control\"). Insignia is a full service real estate service organization performing property management, commercial and retail leasing, 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:\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 the Assistant Secretary of the Managing General Partner since January 1996 and Assistant Secretary of\nInsignia 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.\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) 17,022.5(2) 21 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.\n(2) Based upon information supplied to the Registrant by Insignia NPI, L.L.C.\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 Registrant's partnership agreement, the Registrant may be charged by the general partner and affiliates for services provided to the Registrant. On January 1, 1993, Metric Management, Inc. (\"MMI\"), a company which is not affiliated with the general partner, 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 partner 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, the Managing General Partner 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 II commenced providing certain property management services. Related party fees and expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 ---------- ----------- ----------- Financing fees $ 116,000 $ - $ - Property management fees 1,011,000 825,000 - Real estate tax reduction fees 43,000 - - Reimbursement of expenses: Partnership accounting and investor services 174,000 158,000 - Professional services - 20,000 - ---------- ----------- ----------- Total $1,344,000 $ 1,003,000 $ - =====================================\nProperty management fees and real estate tax reduction fees are included in operating expenses. Reimbursed expenses are primarily included in general and administrative expenses. Financing fees have been capitalized and are being amortized over the life of the loans. In addition, approximately $574,000 of insurance premiums which were paid to an affiliate of NPI 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 Registrant's partnership agreement, the general partner received a partnership management incentive allocation equal to ten percent of net and taxable losses and cash distributions. The general partner was also allocated its two percent continuing interest in the Registrant's net and taxable losses and cash distributions after the above allocation of the partnership management incentive. Gains from the disposition of the Registrant's properties were allocated first to the general partner to the extent of distributions received or they are entitled to receive, then 12% of the remainder until any deficit in their capital account is eliminated.\nAs a result of its ownership of 17,022.5 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\nmatters, 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) Consolidated Financial Statements and Financial Statement Schedules:\nSee \"Item 8\" of this Form 10-K for Consolidated Financial Statements of the Registrant, Notes thereto, and Financial Statement Schedules. (A Table of Contents to Consolidated 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 on September 25, 1984, and thereafter supplemented contained in the Registrant's Registration Statement on Form S-11 (Reg. No. 2-89285).\n10(a) Promissory Note dated December 27, 1994 from Century Stoney Greens, L.P. to USL Capital Corporation (\"USL\") in the principal amount of $30,000,000 incorporated by reference to the Registrant's Form 10-K for the year\nended December 31, 1994.\n10(b) Form of Deed of Trust, Security Agreement, Assignment of Leases and Rents, Fixture Filing and Financing Statement by CSG to Howard E. Schreiber, Trustee for the benefit of USL incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1994.\n10(c) Form of Promissory Note from the Registrant to Secore Financial Corporation (\"Secore\") relating to the refinancing of each of Cooper's Pointe, Copper Mill, Four Winds, Hampton Greens, Plantation Creek, Stoney Creek, and Wood Creek.\n10(d) Form of Mortgage\/Deed of Trust and Security Agreement from the Registrant to Secore relating to the refinancing of each of Cooper's Pointe, Copper Mill, Four Winds, Hampton Greens, Plantation Creek, Stoney Creek and Wood Creek.\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 has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on this 28th day of March, 1996.\nCENTURY PROPERTIES GROWTH FUND XXII\nBy: FOX PARTNERS IV Its General Partner\nBy: FOX CAPITAL MANAGEMENT CORPORATION A 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 - -------------- ----- ---- \/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\n2.1 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 (6)\n10.1 Promissory Note dated December 27, 1994, from Century (7) Stoney Greens, L.P. to USL Capital Corporation (\"USL\") in the principal amount of $30,000.00\n10.2 Form of Deed of Trust, Security Agreement, (7) Assignment and Rents, Fixture Filing and Financing Statement by CSG to Howard E. Schreiber, Trustee for the benefit of USL\n10.3 Form of Promissory Note from the Registrant to Secore Financial Corporation (\"Secore\") relating to the refinancing of each of Cooper's Pointe, Copper Mill, Four Winds, Hampton Greens, Plantation Creek, Stoney Creek, and Wood Creek.\n10.4 Form of Mortgage\/Deed of Trust and Security Agreement from the Registrant to Secore relating to the refinancing of each of Cooper's Pointe, Copper Mill, Four Winds, Hampton Greens, Plantation Creek, Stoney Creek and Wood Creek.\n16 Letter dated April 27, 1994, from the Registrant's (8) Former Independent Auditors\n___________________\n(1) Incorporated by reference 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 September 25, 1984, and thereafter supplemented, included in Registration Statement on Form S-11 (Reg No. 2-89285).\n(7) Incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1994.\n(8) Incorporated by reference to the Registrant's Current Report on Form 8-K dated April 22, 1994.","section_15":""}
{"filename":"8960_1995.txt","cik":"8960","year":"1995","section_1":"Item 1. BUSINESS.\nGeneral\nBeneficial Corporation (Beneficial or Company) was organized under the laws of the State of Delaware on May 9, 1929, through the consolidation of three companies which had been operated under the same management. The Company traces its origin to 1914 when its first consumer loan office was opened. The Company is a holding company, subsidiaries of which are engaged principally in the consumer finance and credit-related insurance businesses. Operations conducted by the subsidiaries consist principally of a 1,130-office consumer finance network located in the United States, Canada, Germany, and the United Kingdom; Personal Mortgage Corporation, a direct response mortgage lending unit, which originates second mortgage loans chiefly in the Northeast and Middle Atlantic regions; Beneficial National Bank USA, a specialized privatelabel credit card bank located in Delaware; Beneficial Credit Services, which is engaged in sales finance activities; Beneficial National Bank, a full service commercial bank located in Delaware, which is also engaged in making income tax refund anticipation loans; The Central National Life Insurance Company of Omaha and its subsidiary, First Central National Life Insurance Company of New York, which underwrite life and disability consumer credit insurance; Wesco Insurance Company, which provides credit property insurance; BFC Insurance Limited which is located in Ireland and underwrites life, accident and health insurance; and Harbour Island Inc. and subsidiaries, which are engaged in real estate development in Florida. Beneficial and its subsidiaries employed approximately 9,000 people at December 31, 1995.\nFor information concerning various factors that affected operations during 1995, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" under Item 7.","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":"736994_1995.txt","cik":"736994","year":"1995","section_1":"ITEM 1. BUSINESS\nAlliance Pharmaceutical Corp. (the \"Company\" or \"Alliance\") is a pharmaceutical research and development company that focuses on the application of scientific discoveries which can be developed into innovative drug products. Based on its perfluorochemical (\"PFC\") technologies, the Company has two drug products in clinical trials: Oxygent(TM), an intravascular agent for use as a temporary oxygen carrier (\"blood substitute\") to reduce or eliminate the requirement for allogeneic (donor) blood transfusions during elective surgery; and LiquiVent(R), an intrapulmonary drug for use in treating patients with acute respiratory failure to reduce the morbidity associated with conventional mechanical ventilation therapy. In addition, Imagent(R) US, a PFC-based contrast agent for enhancement of ultrasound images of blood flow abnormalities (perfusion defects) is in the preclinical phase. The Company is also in early research and development of antigenized antibody technology for potential use in producing novel vaccines directed against infectious diseases and for use in regulating autoimmune disorders.\nOver the past several years, the health care industry has experienced significant and rapid change. One of these changes is the rapid pace at which scientific discoveries are being made. These discoveries often occur in the universities and medical centers where the researchers and clinicians work toward identifying the basic causes of disease and potential targets for new therapies. The Company believes that research and development companies such as Alliance are in a position to collaborate with inventors to develop innovative pharmaceutical products based on the intellectual property arising from these discoveries. Alliance has developed significant experience defining pharmaceutical formulations, designing manufacturing processes, conducting preclinical pharmacology and toxicology studies, and conducting early-phase human testing in accordance with regulatory guidelines. The final phase of drug development requires greater resources and involves the completion of late- phase human testing, obtaining worldwide regulatory approvals, building large- scale manufacturing capacity, and implementing marketing strategies. Multinational pharmaceutical companies with established capabilities and expertise are in a stronger position to perform these tasks.\nAlliance has entered into agreements with institutions and inventors for the rights to their discoveries and is adding value to these discoveries by defining the product, market and regulatory strategies prior to seeking collaborative relationships with multinational pharmaceutical companies for the delivery of these products to the market. Alliance intends to seek additional similar agreements and, through this approach, Alliance believes it can play an important role in the development of innovative pharmaceutical products.\nThe Company was incorporated in New York in 1983. Its principal executive offices are located at 3040 Science Park Road, San Diego, California 92121.\nPRODUCTS\nThree of the products currently under development by Alliance are based upon PFC technologies. PFCs are clear, colorless and non-flammable liquids, are twice as dense as water, and are biochemically inert. Alliance's primary drug substance is perflubron (perfluorooctyl bromide), an eight-carbon brominated PFC that, along with other attributes, produces a stable emulsion.\nOXYGENT. Oxygent (an emulsion containing perflubron) is an intravascular oxygen carrier for use as a temporary \"blood substitute\" to provide oxygen to tissues during elective surgeries where substantial blood\nloss is anticipated. Oxygent has several potential advantages over the use of allogeneic (donor) blood: it does not transmit infectious disease, is compatible with all blood types, and has a shelf life exceeding one year.\nAccording to the 1994 estimates of The National Institutes of Health, the risks per unit of blood transfused in the U.S. are 1:2,500 for bacterial infections; 1:3,000 for hepatitis; 1:100,000 for fatal hemolytic reactions (clerical error); and 1:250,000 for HIV infections (AIDS). To avoid these risks, certain techniques can be employed that allow use of the patient's own (autologous) blood. These techniques include (1) predonation, in which patients donate several units of their blood in the six weeks leading up to surgery, (2) perioperative hemodilution, in which several units of their blood are removed just prior to surgery and are replaced with a plasma expander, and (3) salvage, where a \"cell saver\" is used to collect blood lost during the surgical procedure. In the future, drugs such as erythropoietin, serine protease inhibitors, and oxygen-carrying drugs may increase the utilization of these techniques by improving both their safety and effectiveness. Oxygent is intended for use with any of the above-mentioned autologous blood collection techniques. During surgery, when a blood transfusion is indicated, Oxygent would be given instead to maintain an adequate level of oxygen delivery despite a lower red blood cell concentration, thereby delaying the need for transfusion. This delay allows the majority of the previously removed autologous blood to be reinfused at the end of the procedure, providing a safe red blood cell concentration level for recovery while avoiding donor blood.\nThe Oxygent dose for surgical applications is expected to provide the equivalent oxygen delivery of approximately two units of red blood cells. It is estimated that approximately three million patients are at risk of receiving one or more units of blood during elective surgeries annually in the United States.\nIn August 1994, the Company entered into a license agreement (the \"License Agreement\") with Ortho Biotech, Inc. and The R.W. Johnson Pharmaceutical Research Institute, a division of Ortho Pharmaceutical Corporation, subsidiaries of Johnson & Johnson (collectively referred to as \"Ortho\"), which provides Ortho with worldwide marketing rights to the Company's injectable PFC emulsions capable of transporting oxygen for therapeutic use, including Oxygent. The product is being developed jointly by Alliance and Ortho, with Ortho being responsible for substantially all of the remaining costs of development.\nIn April 1995, the Company completed two clinical studies with healthy volunteers using Oxygent. The purpose of these studies was to obtain supplemental safety information and pharmacokinetic data regarding the administration, distribution, metabolism and excretion (ADME study) of the product. The results of these studies indicate that both the incidence and the magnitude of certain transient side effects seen previously in some patients have been diminished.\nLIQUIVENT. LiquiVent (sterile perflubron) is in clinical development for use as an intrapulmonary agent to treat acute respiratory failure, a disorder that can result from many causes, including serious infections, traumatic shock, severe burns, or inhalation of toxic substances. Acute respiratory failure is generally characterized by an excessive inflammatory response, which leads to blockage of the small airways and collapse of alveoli, resulting in inadequate gas exchange and impairment of normal lung function.\nApproximately 700,000 patients in the United States are placed on mechanical gas ventilators each year for treatment of lung dysfunction due to acute injuries or exacerbations of chronic lung diseases. The most urgent need for these patients is to improve their blood oxygenation; however, the prolonged use of high ventilatory pressures or high concentrations of inspired oxygen can be damaging to the lungs. Each year, approximately 150,000 patients in the United States suffering from respiratory failure progress to the most severe form, referred to as acute respiratory distress syndrome (\"ARDS\"), where the risk of death is 40-60%.\nLiquiVent is intended to be used in a technique called partial liquid ventilation (\"PLV\"). In this procedure, the drug is administered through an endotracheal tube into the lungs of a patient being supported by a mechanical ventilator. The initial goal of LiquiVent\/PLV therapy is to open collapsed alveoli to improve pulmonary function and gas exchange. Once this has been accomplished, ventilator pressure and oxygen concentration may be lowered to minimize ventilator-induced lung trauma. In clinical studies, LiquiVent has also been observed to encourage the migration of mucus and alveolar debris to the central airways, where suctioning is easier. In conjunction with a possible direct LiquiVent anti-inflammatory effect, the ability to remove such debris may significantly reduce the excessive inflammatory response associated with acute respiratory failure and enhance the effectiveness of other therapeutic interventions, all serving to potentially reduce patient recovery time.\nIn May 1995, the Company completed Phase I\/II clinical trials in which adults, children and premature infants with ARDS who were treated with LiquiVent showed improvement in both respiratory gas exchange and lung mechanics. In July 1995, the Company commenced a Phase II clinical trial with adult patients for LiquiVent in several academic medical centers throughout the United States. The U.S. Food and Drug Administration (\"FDA\") has granted the Company Subpart E status (expedited review) for the product in connection with the treatment of ARDS.\nIMAGENT US. Imagent US is a contrast agent that is an aqueous dispersion of PFC vapor-containing microbubbles. The gas bubbles are highly echogenic and, when delivered intravenously, generate signals that enhance ultrasonic images. Imagent US is intended to be used to enhance ultrasound images of blood flow abnormalities (perfusion defects), which can occur as a result of myocardial infarctions, blood clots or solid tumors. Approximately 18 million scans of the heart, vasculature, and abdominal organs are performed annually in the United States. More than 50% of these procedures may potentially benefit from a cost- effective contrast agent. In preclinical studies, Imagent US has been found to enhance the ultrasound signal from perfused tissues and blood vessels using both gray-scale and color Doppler imaging techniques.\nTo be successful in the marketplace, ultrasound contrast agents should provide enhanced diagnostic images during several minutes of scanning, be easy to use, and have a shelf life exceeding one year. Imagent US is being developed to meet these requirements. It has the potential for assessing general vascular disease, cardiac (ventricular) function and, most importantly, myocardial perfusion. The agent may also be useful in detecting space-occupying lesions (such as solid tumors) in organs such as the liver.\nThe Company has evaluated multiple formulations for Imagent US, each of which has advantages for certain applications. Imagent US is in the preclinical phase.\nIMAGENT GI. In August 1993, the Company received FDA approval to market Imagent GI, an oral contrast agent for use with magnetic resonance (\"MR\") imaging. In September 1994, the Company discontinued promotion of Imagent GI. The emphasis on cost containment in the delivery of health care services has contributed to a reduction in the use of many medical products and diagnostic procedures. MR imaging procedures, in particular, have come under increased pricing pressure. Capitated MR procedure reimbursement and the lack of specific reimbursement for oral contrast agents have limited the market acceptance of Imagent GI.\nIMAGENT LN AND IMAGENT BP. The formulations for Imagent LN, the Company's contrast agent for imaging lymph nodes with computed tomography (\"CT\"), and Imagent BP, an intravenous blood pool contrast agent for use with CT, are similar to Oxygent. Because of the similarities, these products fall within the scope of the License Agreement. Following discussions with Ortho, it was determined in September\n1994, that development activities would focus on the oxygen-carrying uses of the PFC emulsions and that development efforts on Imagent LN and Imagent BP would be suspended.\nSAT PAD(R). Sat Pad (MR imaging accessory) is a re-usable product developed and marketed by Alliance that improves the quality of images obtained by certain MR imaging techniques. Sat Pad kits contain conformable, PFC-filled pads that are positioned externally over musculoskeletal areas, such as the neck or ankle. Current MR imaging technology is, at times, limited in its ability to detail musculoskeletal anatomy in the presence of fatty tissues. Sat Pad can be used in conjunction with the approximately 2,200 MR scanners which have \"fat saturation\" software in operation in the United States. When used with such software, Sat Pad improves the ability of MR to suppress signals generated by fat and, as a result, can improve the quality of MR images. Sat Pad is distributed by dealers specializing in radiology products. Sales of Sat Pad were approximately $176,000 for fiscal 1995. The Company expects that the sales volume of Sat Pad will be limited and does not anticipate significant revenue from the product.\nThe Company's products require substantial development efforts. The Company may encounter unforeseen technical problems which may force abandonment or substantial change in the development of a specific product or process, or technological change or product development by others, any of which may have a material adverse effect on the Company. The Company expends substantial amounts of money on research and development and expects to do so for the foreseeable future. In fiscal 1995, 1994, and 1993 the Company incurred research and development expenses of $35,063,000, $31,605,000, and $24,767,000, respectively.\nCOLLABORATIVE RELATIONSHIPS\nIn August 1994, the Company entered into the License Agreement, which provides Ortho with worldwide marketing rights to the Company's injectable PFC emulsions capable of transporting oxygen for therapeutic use, including Oxygent. The product is being developed jointly by Alliance and Ortho, with Ortho being responsible for substantially all of the remaining costs of development. Ortho paid Alliance an initial license fee of $4.0 million and will make other payments upon the achievement of certain milestones. In addition, Ortho will pay to Alliance a royalty based upon its sales of the product after commercialization. In conjunction with the License Agreement, Johnson & Johnson Development Corporation purchased 1.5 million shares of Alliance convertible preferred stock for $15.0 million and obtained a three year warrant to purchase 300,000 shares of Common Stock at $15 per share.\nIn November 1994, the Company entered into a license agreement with Glaxo for the use of the Company's fluorinated surfactants in certain metered dose inhalers (\"MDIs\") which deliver Glaxo's respiratory drug formulations. Glaxo is responsible for the development and marketing of MDI products incorporating the Company's surfactant. The agreement provides for an initial license fee and milestone payments to Alliance, which are not expected to exceed $2.5 million in the aggregate, with royalties to Alliance following commercialization.\nThe Company is seeking collaborative relationships for the marketing of LiquiVent and Imagent US on terms conceptually similar to those contained in the License Agreement.\nThere can be no assurances that the Company will be able to enter into future collaborative relationships on acceptable terms. The termination of any collaborative relationship or failure to enter into such relationships may limit the ability of the Company to develop its technology and may have a material adverse effect on the Company's business.\nMARKETING\nSat Pad is currently distributed through certain distributors of MR equipment and imaging products. Under the terms of the License Agreement, Ortho has exclusive worldwide marketing rights to Oxygent and any other injectable PFC emulsion products capable of transporting oxygen for therapeutic use. The Company has not yet selected its marketing partners for LiquiVent or Imagent US.\nMANUFACTURING\nThe Company manufactures all of its products for preclinical and clinical trials. Oxygent is produced in Alliance's San Diego facility, which includes both pilot-scale (18 liter) and intermediate-scale (250 liter) production capability. The Company believes that, if and when approved by the FDA, the intermediate scale-up facility will provide sufficient production capacity for future clinical trials and market launch. A larger commercial-scale facility will be required for products in the future. Under the terms of the License Agreement, Ortho has the right to elect to manufacture Oxygent itself or have the Company continue to do so, which election must be made at or prior to the filing of a new drug application. If Alliance manufactures Oxygent for Ortho, the transfer price will be determined by Ortho's net sales price for the product, provided that Alliance will not transfer it for less than Alliance's burdened cost. The Company has not selected a commercial-scale site or obtained any regulatory approvals. Construction of such a facility will depend upon regulatory approvals, product development, and capital resources, among other things.\nLiquiVent is manufactured for clinical trials at the Company's Otisville, New York facility. It is the same drug substance for which Alliance obtained FDA approval in August 1993 as an oral contrast agent for MR imaging (Imagent GI). As a result, certain chemistry, manufacturing, and control requirements for perflubron have been accepted by the FDA, which may benefit the Company in the regulatory review process for certain other products.\nImagent US is manufactured for preclinical studies at the San Diego facility, using a proprietary process to form PFC vapor-containing dry microbubbles, which are reconstituted with sterile water just prior to use. The existing process is satisfactory for production of quantities of Imagent US for clinical trials and to support introductory marketing after commercialization.\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nThe Company has obtained perflubron, the principal raw material utilized in Oxygent and LiquiVent, from several large chemical suppliers, and believes that it has sufficient inventory of the drug substance for clinical trials.\nSUBSIDIARY ACTIVITIES\nAntigenized antibodies utilize human immunoglobulin as a platform to carry specific peptides to modulate the immune system. The presentation of the peptide is accomplished by use of genetic engineering techniques to make a substitution in the complementarity determining regions (CDR) of the antibody. Depending on the disease and the antigen, antigenized antibodies may be used to either stimulate antibody production (as in a vaccine) to prevent disease or to down-regulate antibody production (as in a tolerogen) to treat certain autoimmune disorders. Antigenized antibodies provide for a delivery system with advantages over the free peptide, including its half-life in blood circulation and the ability of the peptide to stimulate both a cellular and a humoral antibody response. In this manner a cost-effective combination vaccine or vaccine\/tolerogen therapy may be engineered by using a common platform and a common manufacturing\nprocess. Further chemical modification of these molecules may obviate the requirement for adjuvants during immunization or tolerization. The Company, through its Astral, Inc. (\"Astral\") subsidiary, is developing a prototype vaccine for an infectious disease and a prototype tolerogen for an autoimmune disease.\nFor strategic business reasons, in January 1995 Astral terminated licensing and research agreements which it initiated with the University of Pennsylvania in September 1993.\nIn June 1995, the Company formed a subsidiary, Talco Pharmaceutical, Inc. (\"Talco\"), which entered into licensing and research agreements with Temple University, whereby Talco agreed to make payments to Temple in exchange for certain technology rights, and Temple and others received an initial seven percent ownership interest in Talco.\nThe Company intends to consider other technologies that may be available for licensing and research agreements with other institutions or inventors. Alliance intends, where appropriate, to seek outside sources of funding for the operation of its subsidiaries. There can be no assurance that such funding will be available on terms favorable to the subsidiaries, if at all. If new license and research agreements are added and the Company is not able to obtain outside sources of funding for its subsidiaries, research support by the Company to its subsidiaries is expected to increase significantly.\nCOMPETITION\nThe biotechnology and pharmaceutical industries are highly competitive. There are many pharmaceutical companies, biotechnology companies, public and private universities and research organizations actively engaged in research and development of products which may be similar to Alliance's products. Many of the Company's existing or potential competitors have substantially greater financial, technical and human resources than the Company and may be better equipped to develop, manufacture and market products. These companies may develop and introduce products and processes competitive with or superior to those of the Company. There can be no assurance that the Company will be able to compete successfully.\nWell-publicized side effects associated with the transfusion of human donor blood have spurred efforts to develop a blood substitute. Two primary approaches have shown promise as temporary oxygen carriers: PFC emulsions and hemoglobin solutions. Hemoglobin development efforts include: stroma-free, chemically modified hemoglobin from human or bovine red blood cells, and the use of genetic engineering to produce recombinant hemoglobin. There are several companies working on hemoglobin solutions as a blood substitute, some of which have entered clinical trials. One major U.S. pharmaceutical company is collaborating with a company developing a recombinant hemoglobin-based blood substitute. Alliance is aware of two other companies developing PFC-based temporary oxygen carriers, one of which has entered clinical trials.\nAlthough liquid ventilation therapy has been in the research phase for the last two decades, the Company is unaware of any potential competition which has reached the clinical trial stage. However, other companies may be evaluating compounds with the possibility of entering this field. If major manufacturers of PFCs entered the field, the Company could face competition from companies with substantially greater resources. The Company believes that its patent position and stage of research and development give it an advantage over these potential competitors.\nA number of larger companies currently market a broad range of contrast agents. One U.S. pharmaceutical company has recently gained FDA approval to market an ultrasound contrast agent and other\ncompanies are known to be developing similar products. One of these companies is believed to have a product in Phase III clinical trials, another has reported that it has completed a Phase II clinical trial, and a third is believed to be in Phase II clinical trials.\nGOVERNMENT REGULATIONS\nThe Company's products require governmental approval before production and marketing can commence. The regulatory approval process is administered in the United States by the FDA and by similar agencies in foreign countries. The process of obtaining regulatory clearances or approvals is costly and time consuming. The Company cannot predict how long the necessary clearances or approvals will take or whether it will be successful in obtaining them.\nGenerally, all potential pharmaceutical products must successfully complete two major stages of development (preclinical and clinical testing) prior to receiving marketing approval by the governing regulatory agency. In preclinical testing, potential compounds are tested both in vitro and in animals to gain safety information prior to administration in humans. Knowledge is obtained regarding the effects of the compound on bodily functions as well as its absorption, distribution, metabolism and elimination.\nIn clinical testing, a three-phase progression of studies includes:\nFollowing completion of these studies, a new drug application must be submitted to and approved by the FDA in order to market the product in the United States. Similar applications are required in foreign countries. There can be no assurance that, upon completion of the foregoing trials, the results will be considered adequate for government approval. If and when approval is obtained to market a product, the FDA's (or applicable foreign agency's) regulations will govern manufacturing and marketing activities.\nThe FDA has established a designation to speed the availability of new therapies for life-threatening or severely debilitating diseases. This designation, defined in Subpart E of the FDA's investigational new drug regulations, may expedite clinical evaluation and regulatory review of some new drugs.\nPerflubron is an eight-carbon halogenated fluorocarbon liquid. Certain halogenated fluorocarbons (primarily the gaseous chlorofluorocarbons) have been implicated in stratospheric ozone depletion. The FDA issued a Finding of No Significant Impact under the National Environmental Protection Act in connection\nwith the approval for marketing Imagent GI, a perflubron-based drug; however, perflubron remains subject to regulation by governmental agencies.\nIn addition to FDA regulation, the Company is subject to regulation by various governmental agencies including, without limitation, the Drug Enforcement Administration, the United States Department of Agriculture, the Environmental Protection Agency, the Occupational Safety and Health Administration, and the California State Department of Health Services, Food and Drug Branch. Such regulation, by governmental authorities in the United States and other countries, may impede or limit the Company's ability to develop and market its products.\nPATENTS AND PROPRIETARY RIGHTS\nThe Company is diligent in seeking protection for its products, processes, technologies, and ongoing improvements. The Company is pursuing patent protection in the United States and in foreign countries that it regards as important for future endeavors. Numerous patent applications have been filed in the European Patent Office, Australia, Canada, Ireland, Israel, Japan, Norway, and South Africa, and patents have been granted in some of these countries.\nThe Company has six issued U.S. patents related to or covering PFC emulsions which are the basis for its Oxygent product. The issued patents and other pending patent applications cover specific details of emulsified PFCs which are covered by product-by-process claims, method claims describing their manufacture, and some composition claims. These broadly cover high concentration PFC emulsions, typically 40-125% weight per volume (although some are limited to 75-125% weight per volume), and manufacturing methods.\nIn September 1994, Alliance received a United States patent for its preferred method of using blood substitutes to facilitate oxygen delivery. The patent is pending in Europe, Japan, and other countries. The issued claims cover a method for facilitating autologous blood use in conjunction with administering oxygen enriched gas and oxygen carriers that contain fluorochemicals, as well as those derived from human, plant, or recombinant hemoglobin, in order to reduce or eliminate the need for allogeneic blood transfusions during surgery.\nThe Company has filed U.S. and foreign patent applications on its method of using oxygen-carrying PFCs to enhance respiratory gas exchange utilizing conventional gas ventilators. In August 1995, Alliance received a U.S. patent covering its method of administering LiquiVent to patients. The Company has patent applications pending which cover the use of PFCs to deliver drugs to the lungs and to wash debris from, and open, collapsed lungs. The Company also has patent applications pending which cover apparatus for liquid ventilation using PFCs.\nThe Company has filed four patent applications concerning the composition, manufacture and use of novel stabilized microbubble compositions, which are based on its discovery that PFC gases, in combination with appropriate surfactants, can stabilize microbubbles that are effective for ultrasonic imaging.\nThe Company has patents that have issued in the U.S. and abroad, and additional pending patents, covering its novel fluorinated surfactants. These compounds may be useful in oxygen-carrying or drug-transport compositions, and in liposomal formulations that have therapeutic and diagnostic applications. Additional fluorinated compounds disclosed in pending applications may be employed in cosmetics, protective creams, and lubricating agents. Compositions that can be structured as emulsions, microemulsions, and gels\nmay be useful as contrast enhancement agents for radiography and scintigraphy. The Company also has pending applications relating to microstructures (tubules, helixes, fibers) that may have uses in the fields of medicine, biomolecular engineering, microelectronics, and electro-optics.\nAside from the issued patents and allowed applications referred to above, however, no assurance can be given that any of these applications will result in issued U.S. or foreign patents. Although patents are issued with a presumption of validity and require a challenge with a high degree of proof to establish invalidity, no assurance can be given that any issued patents would survive such a challenge and would be enforceable.\nThe Company also attempts to protect its proprietary products, processes, and other information by relying on trade secret laws and non-disclosure and confidentiality agreements with its employees, consultants and certain other persons who have access to such products, processes, and information. The agreements affirm that all inventions conceived by employees are the exclusive property of the Company, with the exception of inventions unrelated to the Company's business and developed entirely on the employee's own time. Nevertheless, there can be no assurance that these agreements will afford significant protection against or adequate compensation for misappropriation or unauthorized disclosure of the Company's trade secrets.\nPRODUCT LIABILITY CLAIMS AND UNINSURED RISKS\nThe sale or use of the Company's present products and any other products or processes that may be developed or sold by the Company may expose the Company to potential liability from claims by end-users of such products or by manufacturers or others selling such products, either directly or as a component of other products. While the Company has product liability insurance, there can be no assurance that the Company will continue to maintain such insurance or that it will provide adequate coverage. If the Company is held responsible for damages in a product liability suit, the Company's financial condition could be materially and adversely affected.\nEMPLOYEES\nAs of August 31, 1995, the Company had 186 full-time employees, of whom 150 were engaged in research and development, production and associated support, five in business development, sales and marketing, and 31 in general administration. There can be no assurance that the Company will be able to continue attracting and retaining sufficient qualified personnel in order to meet its needs. None of the Company's employees is represented by a labor union. The Company believes that its employee relations are satisfactory.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following are the executive officers of the Company:\nDUANE J. ROTH. Mr. Roth, who is 45, has been President and Chief Executive Officer since 1985 and Chairman since October 1989. Prior to joining Alliance, Mr. Roth served as President of Analytab Products, Inc., an American Home Products company involved in manufacturing and marketing medical diagnostics, pharmaceuticals and devices. For the previous ten years, he was employed in various sales, marketing and general management capacities by Ortho Diagnostic Systems, Inc., a Johnson & Johnson company, which is a manufacturer of diagnostic and pharmaceutical products. Mr. Roth's brother, Theodore D. Roth, is an Executive Vice President of the Company.\nHAROLD W. DELONG. Mr. DeLong, who is 47, has been Executive Vice President - Business Development and Marketing for the Company since February 1989. Mr. DeLong has been employed for more than 20 years in the medical diagnostics and pharmaceutical industry in various sales, marketing and management positions. Prior to joining Alliance, Mr. DeLong was Vice President, Sales and Marketing for Murex Corporation, a company participating in the infectious disease diagnostics market. He previously served as Director, Sales and Marketing for Becton Dickinson's Immunocytometry Systems division. Mr. DeLong was also previously employed by Ortho Diagnostic Systems, Inc., for over ten years, where his last position was Director of the Hemostasis and Chemistry Products business units.\nTHEODORE D. ROTH. Mr. Roth, who is 44, has been Executive Vice President and Chief Financial Officer of the Company since November 1987 and Secretary since 1990. For more than ten years prior to joining the Company, he was General Counsel of SAI Corporation, a company in the business of operating manufacturing concerns, and General Manager of Holland Industries, Inc., a manufacturing company. Mr. Roth received his J.D. from Washburn University and an LL.M. in Corporate and Commercial Law from the University of Missouri in Kansas City. He is the brother of Mr. Duane J. Roth, the Chairman of the Company.\nB. JACK DEFRANCO. Mr. DeFranco, who is 50, has been Vice President - Marketing for Alliance since January 1991. He has more than 20 years experience in sales and marketing in the medical products industry. He was President of Orthoconcept Inc., a private firm marketing orthopedic and urological devices from 1986 through 1990. Prior to 1986, he was Director of Marketing and New Business Development for Smith and Nephew Inc., which markets orthopedic and general wound-care products and he served in various sales and marketing positions with Ortho Diagnostic Systems, Inc. Mr. DeFranco received an M.B.A. from Fairleigh Dickinson University.\nN. SIMON FAITHFULL, M.D., PH.D. Dr. Faithfull, who is 55, has been Vice President - Medical Research for the Company since September 1990. Dr. Faithfull joined Alliance after serving as Director of Medical Research for Delta Biotechnology Ltd. from 1989 to 1990. He has also served as Senior Lecturer in Anesthesia at the University of Manchester (UK), and has held various academic appointments and clinical anesthesia positions at Erasmus University (Netherlands), Tulane University and the University of Alabama (Birmingham) for more than 15 years. He has served as Secretary of the International Society on Oxygen Transport to Tissue. He received his Ph.D. from Erasmus University, Rotterdam and his M.D. from London University.\nHENRY A. GRAHAM, PH.D. Dr. Graham, who is 52, has been Vice President - Technology Development since January 1990. In his more than 20 years in industrial research, he has directed groups involved in the development of biological and immunodiagnostic products. Prior to joining Alliance, he worked for Johnson & Johnson for 17 years on a broad range of projects including injectable human biologicals, immunohematology reagents, immunoassay reagents and instrument systems. Dr. Graham was Director of Product Development for Ortho Diagnostic Systems, Inc. for at least five years prior to 1990. During his tenure at Johnson & Johnson, he was the recipient of several awards, including the Corporate Medal for Outstanding Research. Dr. Graham received a Ph.D. in immunology from Rutgers University.\nRONALD M. HOPKINS, PH.D. Dr. Hopkins, who is 53, has been Vice President - Research and Development since May 1990. Prior to joining Alliance, Dr. Hopkins spent 20 years with Mallinckrodt Medical, Inc. As Vice President at Mallinckrodt his responsibilities primarily involved identification and development of various diagnostic x-ray, magnetic resonance, ultrasound and radiopharmaceutical imaging agents as well as angiographic catheters. In addition to product and business development experience, Dr.\nHopkins has an extensive background in cardiovascular pharmacology and toxicology research, as well as sterile pharmaceutical formulation and production. Dr. Hopkins received a Ph.D. in pharmacology from the University of Maryland.\nGORDON L. SCHOOLEY, PH.D. Dr. Schooley, who is 48, has been Vice President - Clinical Research and Regulatory Affairs since January 1989. Dr. Schooley has been employed for over 20 years in research and development in the pharmaceutical industry. Prior to joining Alliance in 1989, Dr. Schooley was Vice President of Clinical Research and Regulatory Affairs for Newport Pharmaceuticals, a company developing antiviral drugs. For the previous eight years, he was Director of Clinical Research and Biostatistics for Allergan Pharmaceuticals, a division of SmithKline Beecham, developing ophthalmologic and dermatologic drugs and devices. He was also employed by McGaw Laboratories as Manger of Biostatistics for parenteral products and by The Upjohn Company as a senior biostatistician for analgesic and CNS drugs. Dr. Schooley received a Ph.D. from the University of Michigan School of Public Health.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFACILITIES\nThe Company has facilities in two locations: Otisville, New York and San Diego, California. The Otisville site, where the Company has established the Imagent GI and Sat Pad production facility, includes laboratories and administrative offices. In San Diego, California, where the Company maintains its principal executive offices, performs research and development on its PFC- based products and has its emulsion products manufacturing facility, the Company has approximately 70,000 square feet of laboratory, manufacturing and office space in two leased facilities. The Company believes its existing facilities will be adequate to meet its needs for the next twelve months.\nThe Company purchased the Otisville site from the New York City Public Development Corporation (\"PDC\") in June 1983. In connection with the acquisition, the Company entered into a land use agreement (\"Land Use Agreement\") with New York City and the PDC. The Company estimates that the cost of complying with the Land Use Agreement for fiscal 1995 was approximately $100,000. The provisions of the Land Use Agreement are \"covenants running with the land,\" which may bind the Company and subsequent owners of the Otisville site for a substantial period of time.\nWhile the Company believes that it can produce materials for clinical trials and initial market launch for its emulsion products at its existing San Diego facility and for LiquiVent at its Otisville, New York facility, it may need to expand its commercial manufacturing capabilities for its products in the future. This expansion may occur in stages, each of which would require regulatory approval, and product demand could at times exceed supply capacity. The Company has not selected a site or obtained any regulatory approvals for construction of a commercial production facility for its products. The projected location and completion date of any production facility will depend upon regulatory and development activities and other factors. The Company cannot predict the amount that it will expend for the construction of such production facility, and there can be no assurance as to when or whether the FDA will determine that such facility conforms with Good Manufacturing Practices. The License Agreement grants an option to Ortho to elect to manufacture the emulsion products referred to therein, or to require the Company to manufacture such products at a negotiated price.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring September 1992, the Company and certain of its officers and directors were named as defendants in several lawsuits filed in the U.S. District Court for the Southern District of California by certain shareholders. The actions were consolidated into one class action lawsuit titled \"In re Alliance Pharmaceutical Securities Litigation.\" The complaint claimed, among other things, that the defendants failed to disclose certain problems with two of the Company's products under development, which conduct is alleged to have portrayed falsely the Company's financial condition. On May 25, 1995, summary judgment was granted in favor of the Company and its officers and directors. Attorneys for the plaintiffs have filed a notice of appeal. The Company believes the eventual outcome of the litigation will not have a material adverse effect on the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's stockholders during the last quarter of Alliance's fiscal year ended June 30, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock is traded in the over-the-counter market, and prices therefor are quoted on the NASDAQ National Market System under the symbol ALLP.\nThe following table sets forth, for the periods indicated, the high and low sale prices of the common stock as reported on NASDAQ, without retail mark- up, markdown or commission.\nOn August 31, 1995, the closing price of the Company's common stock was $8.50.\nThe Company has not paid dividends on its common stock and the Board of Directors does not anticipate paying cash dividends in the foreseeable future.\nOn August 31, 1995, the approximate number of record holders of the Company's common stock was 2,200. The Company believes that, in addition, there are in excess of 20,000 beneficial owners of its common stock whose shares are held in street name and, consequently, the Company is unable to determine the actual number of beneficial holders thereof.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following information has been summarized from the financial statements included elsewhere herein and should be read in conjunction with such financial statements and the related notes thereto (in thousands except per share amounts):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n(References to years are to the Company's fiscal years ended June 30.)\nAlliance has devoted substantial resources to research and development related to its pharmaceutical products based upon PFC and emulsion technologies. The Company has been unprofitable since inception and expects to incur operating losses for at least the next several years due to continued requirements for research and development, preclinical testing and clinical trials, regulatory activities, and commercial manufacturing start-up. The amount of net losses and the time required by the Company to achieve profitability are highly uncertain. There can be no assurance that the Company will be able to achieve profitability at all or on a sustained basis.\nLIQUIDITY AND CAPITAL RESOURCES\nThrough June 1995, the Company financed its activities primarily from public and private sales of equity and funding from collaborations with corporate partners. In April 1995, the Company completed offerings of 3.2 million shares of newly issued common stock, resulting in net proceeds to the Company of approximately $14.3 million. In August 1994, the Company and Ortho entered into the License Agreement for injectable PFC emulsions capable of transporting oxygen for therapeutic use, including Oxygent. Under the License Agreement, Ortho paid to Alliance an initial fee of $4.0 million and will make other payments upon the achievement of certain milestones. Ortho is responsible for substantially all the remaining costs of developing the products and will pay Alliance a royalty based upon sales of products after commercialization. As of June 30, 1995, the Company had received research revenue payments of $5.1 million from Ortho, and had recorded a receivable of $2.0 million, representing funding due from Ortho for development costs incurred. In conjunction with the License Agreement, Johnson & Johnson Development Corp. (\"J&JDC\") purchased 1.5 million shares of Alliance convertible preferred stock for $15.0 million and obtained a three-year warrant to purchase 300,000 shares of Alliance common stock at $15 per share.\nIn August 1995, the Company entered into a loan and security agreement under which the Company received $2.2 million, and the Company may borrow up to an additional $800,000 if certain conditions are met. Amounts borrowed under the agreement are secured by fixed assets, and are to be repaid over three years commencing in September 1995. If certain financial covenants are not satisfied, the note or notes may become due and payable. The Company has financed substantially all of its office and research facilities and related leasehold improvements under operating lease arrangements.\nThe Company had net working capital of $22.3 million at June 30, 1995 compared to $19.4 million at June 30, 1994. The Company's cash, cash equivalents, and short-term investments increased to $23.5 million at June 30, 1995 from $21.1 million at June 30, 1994. The increase resulted primarily from $15.0 million received from the sale of convertible preferred stock to J&JDC, $14.3 million received from the April 1995 offerings, and from receipts of $4.5 million of license revenue and $5.1 million of research revenue. These cash receipts were offset by cash used for operating expenses of $35.4 million and from property, plant, and equipment additions of $1.3 million. Capital expenditures for 1996 are expected to increase compared to 1995. The Company's operations to date have consumed substantial amounts of cash, and are expected to continue to do so over the foreseeable future.\nThe Company continually reviews its product development activities in an effort to allocate its resources to those product candidates that the Company believes have the greatest commercial potential. Factors considered by the Company in determining the products to pursue include projected markets and need, potential for regulatory approval and reimbursement under the existing health care system, technical feasibility, expected and known product attributes, and estimated costs to bring the product to market. Based on these and other factors, the Company may from time to time reallocate its resources among its product development activities. Additions to products under development or changes in products being pursued can substantially and rapidly change the Company's funding requirements.\nIn December 1993, in order to obtain a commitment for a long-term supply of raw material for both clinical trials and anticipated future production requirements, the Company entered into an agreement with a supplier under which the Company was obligated to make payments to the vendor through May 1997 based, in part, upon the achievement of certain milestones. Some or all of the payments may be reimbursed to the Company by existing and future collaborative partners.\nThe Company expects to incur substantial additional expenditures associated with product development. The Company will seek additional collaborative research and development relationships with suitable corporate partners for its non-licensed products. There can be no assurance that such relationships, if any, will successfully reduce the Company's funding requirements. Additional equity or debt financing may be required, and there can be no assurance that funds from these sources will be available on favorable terms, if at all. If adequate funds are not available, the Company may be required to delay, scale back, or eliminate one or more of its product development programs, or obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates, or products that the Company would not otherwise relinquish.\nAlliance anticipates that its current capital resources, expected revenues from the License Agreement, cash proceeds from the loan and security agreement, its investments, and product sales, will be adequate to satisfy its capital requirements and fund current and planned operations for approximately one year. The Company's future capital requirements will depend on many factors, including continued scientific progress in its research and development programs, progress with preclinical testing and clinical trials, the time and cost involved in obtaining regulatory approvals, patent costs, competing technological and market developments, changes in existing collaborative relationships, the ability of the Company to establish additional collaborative relationships, and the cost of manufacturing scale-up.\nWhile the Company believes that it can produce materials for clinical trials and the initial market launch for its emulsion products at its existing San Diego facility and for LiquiVent at its Otisville facility, it may need to expand its commercial manufacturing capabilities for its products in the future. This expansion may occur in stages, each of which would require regulatory approval, and product demand could at times exceed supply capacity. The Company has not selected a site or obtained any regulatory approvals for construction of a commercial production facility for its products. The projected location and completion date of any production facility will depend upon regulatory and development activities and other factors. The Company cannot predict the amount that it will expend for the construction of such a production facility, and there can be no assurance as to when or whether the FDA will determine that such facility conforms with Good Manufacturing Practices. The License Agreement provides an option to Ortho to elect to manufacture the emulsion products referred to therein, or to require the Company to manufacture such products at a negotiated price.\nThe Company's business is subject to significant risks, including the uncertainties associated with the lengthy regulatory approval process and with obtaining and enforcing patents important to the Company's business and possible competition from other products. Even if the Company's products appear promising at an early stage of development, they may not reach the market for a number of reasons. Such reasons include, but are not limited to, the possibilities that the potential products will be found ineffective during clinical trials, failure to receive necessary regulatory approvals, difficulties in manufacturing on a large scale, failure to obtain market acceptance, and the inability to commercialize because of proprietary rights of third parties. The research, development, and market introduction of new products will require the application of considerable technical and financial resources by Alliance, while revenues generated from such products, assuming they are developed successfully, may not be realized for several years. Other material and unpredictable factors which could affect operating results include, without limitation, the uncertainty of the timing of product approvals and introductions and of sales growth; the ability to obtain necessary raw materials at cost effective prices or at all; the effect of possible technology and\/or other business acquisitions or transactions; and the increasing emphasis on controlling health care costs and potential legislation or regulation of health care pricing.\nDuring September 1992, the Company and certain of its officers and directors were named as defendants in several lawsuits filed in the U.S. District Court for the Southern District of California by certain shareholders. The actions were consolidated into one class action lawsuit titled \"In re Alliance Pharmaceutical Securities Litigation.\" The complaint claimed, among other things, that the defendants failed to disclose certain problems with two of the Company's products under development, which conduct is alleged to have portrayed falsely the Company's financial condition. On May 25, 1995, summary judgment was granted in favor of the Company and its officers and directors. Attorneys for the plaintiffs have filed a notice of appeal. The Company believes the eventual outcome of the litigation will not have a material adverse effect on the Company's financial condition.\nRESULTS OF OPERATIONS\n1995 AS COMPARED WITH 1994 --------------------------\nThe Company's license and research revenue increased to $11.6 million in 1995 compared to $163,000 in 1994. The increase was primarily due to $4.0 million of license revenue and $7.1 million of research revenue derived from the License Agreement.\nThe Company incurred total operating expenses of $42.1 million for 1995. Operating expenses include $5.0 million for purchases of raw material for certain products currently being developed, $1.8 million for Oxygent costs incurred prior to execution of the License Agreement, $545,000 for products no longer promoted or developed by Alliance, and a $1.7 million non-cash charge related to the license of previously capitalized product rights. The $5.0 million charge for the purchase of raw materials arises from a December 1993 agreement the Company entered into with a supplier. In 1996, charges under the agreement will be substantially less than in 1995. In January 1994, the Company regained from Boehringer Ingelheim International GmbH (\"BII\") all marketing and manufacturing rights to Imagent, diagnostic imaging agents, and Oxygent products outside of North America. In conjunction with the acquisition of the marketing and manufacturing rights from BII, the Company recorded product rights of $1.8 million, based on the value of warrants issued to acquire the rights. The unamortized portion ($1.7 million) of these product rights was charged to research and development expense when the Company licensed these product rights to Ortho.\nResearch and development expenses increased by 11% to $35.1 million for 1995 compared to $31.6 million for 1994. The growth in expenses is primarily a result of increased raw material costs and the product rights charge discussed above and increased salary costs. These expenses were partially offset by a reduction in payments to universities and outside consultants.\nGeneral and administrative expenses decreased by 3% to $7.1 million for 1995 compared to $7.3 million for 1994. During the fourth quarter of 1995, the Company was successful in recovering $1.6 million from its insurance carrier to offset professional fees incurred in connection with the defense of its lawsuit.\nInvestment and other income was $1.2 million for 1995 compared to $1.6 million for 1994. The decline in investment revenue was primarily a result of lower average cash balances.\nAlliance expects to incur substantial operating losses over the next several years due to continuing and increasing expenses associated with its research and development programs. Operating losses may fluctuate from quarter to quarter as a result of the differences in the timing of revenues earned and expenses incurred and such fluctuations may be substantial. The Company's historical results are not necessarily indicative of future results.\n1994 AS COMPARED WITH 1993 --------------------------\nThe Company had net product revenue of $246,000 for 1994 compared to $50,000 for 1993. In August 1993, the Company received FDA approval to market Imagent GI. The increase in net product revenue from 1993 to 1994 was primarily attributable to sales of Imagent GI and Sat Pad. Sales of Imagent GI and Sat Pad were not expected to provide significant revenue to the Company. In September 1994, the Company discontinued promotional activities for Imagent GI. The majority of the Company's products are in the development stage and there can be no assurance as to whether or when it will be able to increase its revenues significantly.\nLicense and research revenue decreased to $163,000 for 1994 compared to $2.3 million for 1993. The Company's 1993 license and research revenue was primarily derived from the BII agreements. In July 1993, the BII agreements were modified, which resulted in BII discontinuing all contract payments.\nResearch and development expenses increased by 28% to $31.6 million for 1994 compared to $24.8 million for 1993. The growth in expenses reflects increases in staffing, costs of preclinical testing and clinical trials, and additional laboratory supplies and equipment associated with the growth of the Company's research and development efforts. Due to the discontinuance of Imagent GI promotional activities, the Company reduced its perflubron inventories to the estimated net realizable value from sales of Imagent GI, resulting in a charge of $2.1 million.\nGeneral and administrative expenses increased by 14% to $7.3 million for 1994 compared to $6.4 million for 1993. The increases were principally due to increases in staffing to support the growth of product research and development efforts, and professional fees incurred in connection with the defense of the lawsuit.\nInvestment and other income was $1.6 million for 1994 compared to $2.4 million for 1993. The decline in investment revenue was primarily a result of lower average cash and short-term investment balances.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Table of Contents to Consolidated Financial Statements on page below for a list of the Financial Statements being filed 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 concerning the executive officers of the Company is contained in Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant.\" Information concerning the directors of the Company is incorporated by reference to the section entitled \"Election of Directors\" that the Company intends to include in its definitive proxy statement for Alliance's November 1995 Annual Meeting of Shareholders (the \"Proxy Statement\"). Copies of the Proxy Statement will be duly filed with the commission\npursuant to Rule 14a-6(c) promulgated under the Securities Exchange Act of 1934, as amended, not later than 120 days after the end of the fiscal year covered by its Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe sections labeled \"Executive Compensation\" and \"Election of Directors\" to appear in the Company's Proxy Statement are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section labeled \"Ownership of Voting Securities by Certain Beneficial Owners and Management\" to appear in the Company's Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe sections labeled \"Election of Directors\" and \"Executive Compensation\" to appear in the Company's Proxy Statement are incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents Filed as Part of the Report. --------------------------------------\n1. See Table of Contents to Consolidated Financial Statements on Page for a list of Financial Statements being filed herein.\n2. See Pages and for the Independent Auditors' Reports being filed herein.\n3. See Exhibits below for a list of all Exhibits being filed or incorporated by reference herein.\n(b) None\n(c) Exhibits. ---------\n(3) (a) Restated Certificate of Incorporation of the Company, as amended through August 31, 1994. (Incorporated by reference to Exhibit 3(a) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994 (the \"1994 10-K\").)\n(b) By-Laws of the Company, 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, 1989 (the \"1989 10-K\").)\n(10) (a) Lease Agreement, as amended, between the Company and Hartford Accident and Indemnity Company relating to the Company's San Diego, California facilities. (Incorporated by reference to Exhibit 10(x) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993.)\n(b) Loan Modification Agreement between the Company and Theodore Roth, dated May 24, 1994 - Management contract or compensatory plan or arrangement required to be filed. (Incorporated by reference to Exhibit 10(d) to the 1994 10-K.)\n(c) Formula Award of Stock Options for Non-employee members of the Board of Directors as approved by shareholders of the Company - Management contract or compensatory plan or arrangement required to be filed. (Incorporated by reference to Exhibit 10(e) to the 1994 10-K.)\n(d) License Agreement dated August 16, 1994 among the Company, Ortho Biotech, Inc. and The R.W. Johnson Pharmaceutical Research Institute. (Incorporated by reference to Exhibit 10(f) to the 1994 10-K.)\n(e) Stock and Warrant Purchase Agreement dated August 16, 1994 between the Company and Johnson & Johnson Development Corporation. (Incorporated by reference to Exhibit 10(g) to the 1994 10-K.)\n(23.1) Consent of Independent Auditor - Ernst & Young LLP\n(23.2) Consent of Independent Auditor - Deloitte & Touche LLP\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nALLIANCE PHARMACEUTICAL CORP. (Registrant)\nDate: September 19, 1995 By: \/s\/ Duane J. Roth ------------------- Duane J. Roth 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\/ Duane J. Roth President, Chief Executive September 19, 1995 ---------------------------- Officer and a Director Duane J. Roth\n\/s\/ Theodore D. Roth Executive Vice President September 19, 1995 ---------------------------- and Chief Financial Officer Theodore D. Roth\n\/s\/ Tim T. Hart Controller, Chief Accounting September 19, 1995 ---------------------------- Officer Tim T. Hart\n\/s\/ Carroll O. Johnson Director September 19, 1995 ---------------------------- Carroll O. Johnson\n\/s\/ Stephen M. McGrath Director September 19, 1995 ---------------------------- Stephen M. McGrath\n\/s\/ Helen M. Ranney, M.D. Director September 19, 1995 ---------------------------- Helen M. Ranney, M.D.\n\/s\/ Donald E. O'Neill Director September 19, 1995 ---------------------------- Donald E. O'Neill\n\/s\/ Jean G. Riess, Ph.D. Director September 19, 1995 ---------------------------- Dr. Jean Riess\n\/s\/ Thomas F. Zuck. M.D. Director September 19, 1995 ---------------------------- Thomas F. Zuck, M.D.\nEXHIBIT INDEX ------------- Certain exhibits to this Report on Form 10-K have been incorporated by reference. For a list of exhibits, see Item 14 hereof.\nThe following exhibits are being filed herewith:\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ----------------------------------------------\nTABLE OF CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------\nNo consolidated financial statement schedules are filed herewith because they are not required or not applicable, or because the required information is included in the financial statements or notes thereto.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Alliance Pharmaceutical Corp.\nWe have audited the accompanying consolidated balance sheets of Alliance Pharmaceutical Corp. 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 two 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. The consolidated financial statements of Alliance Pharmaceutical Corp. and subsidiaries for the year ended June 30, 1993, were audited by other auditors whose report, dated July 27, 1993, expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the 1995 and 1994 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alliance Pharmaceutical Corp. and subsidiaries at June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the two years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Ernst & Young LLP Ernst & Young LLP\nSan Diego, California July 26, 1995\nIndependent Auditors' Report ----------------------------\nThe Board of Directors of Alliance Pharmaceutical Corp.:\nWe have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows of Alliance Pharmaceutical Corp. and Subsidiaries (the \"Company\") for the year ended June 30, 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 misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the results of the Company's operations and its cash flows for the year ended June 30, 1993 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nNew York, New York July 27, 1993\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ---------------------------------------------- CONSOLIDATED BALANCE SHEETS ---------------------------\nSee Notes to Consolidated Financial Statements.\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ---------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nSee Notes to Consolidated Financial Statements.\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ---------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -----------------------------------------------\nSee Notes to Consolidated Financial Statements.\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ---------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\nSee Notes to Consolidated Financial Statements.\nALLIANCE PHARMACEUTICAL CORP. AND SUBSIDIARIES ---------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION ------------\nAlliance Pharmaceutical Corp. (\"Alliance\") and its subsidiaries (collectively, the \"Company\") are engaged in identifying, designing, and developing novel medical and pharmaceutical products.\nPRINCIPLES OF CONSOLIDATION ---------------------------\nThe consolidated financial statements include the accounts of Alliance, its wholly owned subsidiaries, BioPulmonics, Inc. (\"BioPulmonics\") and Rosanin Corporation, and its majority-owned subsidiaries, Astral, Inc. and Applications et Transferts de Technologies Avancees. All significant intercompany accounts and transactions have been eliminated. Certain amounts in 1994 and 1993 have been reclassified to conform to the current year's presentation.\nCASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS --------------------------------------------------\nEffective July 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"FAS No. 115\"), Accounting for Certain Investments in Debt and Equity Securities. Cash, cash equivalents, and short- term investments consist of highly liquid debt instruments. The Company considers instruments purchased with an original maturity of three months or less to be cash equivalents. Management has classified the Company's cash equivalents and short-term investments as available-for-sale securities in the accompanying financial statements. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity.\nINVENTORIES -----------\nInventories, which consist primarily of raw materials, are stated at the lower of cost (first-in, first-out basis) or market.\nCONCENTRATION OF CREDIT RISK ----------------------------\nCash, cash equivalents, and short-term investments are financial instruments which potentially subject the Company to concentration of credit risk. The Company invests its excess cash primarily in U.S. government securities and marketable debt securities of financial institutions and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturities to maintain safety and liquidity. These guidelines are reviewed periodically and modified to take advantage of trends in yields and interest rates. The Company has not experienced any material losses on its investments.\nPROPERTY, PLANT, EQUIPMENT, AND OTHER ASSETS --------------------------------------------\nBuildings, furniture, and equipment are stated at cost and depreciation is computed using the straight-line method over the estimated useful lives of 4 to 25 years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term. Technology and patent rights are amortized using the straight-line method over 5 to 20 years.\nPURCHASED TECHNOLOGY --------------------\nThe purchased technology was primarily acquired by virtue of the merger of Fluoromed Pharmaceutical, Inc. into a subsidiary of the Company in fiscal 1989. The technology acquired is the Company's core perfluorochemical (\"PFC\") technology and was valued based on an analysis of the present value of future earnings anticipated from this technology at that time. The Company identified alternative future uses for the PFC technology, including the Oxygent(TM) (temporary blood substitute) and LiquiVent(R) (intrapulmonary oxygen carrier) products.\nThe PFC technology is the basis for the Company's main drug development programs and is being amortized over a 20-year life. Amortization of purchased technology is included in research and development expense. Accumulated amortization was $7,355,000 and $6,193,000 at June 30, 1995 and 1994, respectively.\nThe carrying value of purchased technology is reviewed periodically based on the projected cash flows to be received from license fees, milestone payments, royalties and other product revenues. If such cash flows are less than the carrying value of the purchased technology, the difference will be charged to expense.\nRESEARCH AND DEVELOPMENT EXPENSES ---------------------------------\nResearch and development expenditures are charged to expense as incurred.\nNET LOSS PER SHARE ------------------\nNet loss per share is based on the weighted average number of shares outstanding during the respective years and does not include common stock equivalents since their effect on the net loss per share would be anti- dilutive.\n2. FINANCIAL STATEMENT DETAILS\nPROPERTY, PLANT, AND EQUIPMENT - NET ------------------------------------\nProperty, plant, and equipment consist of the following:\nINVENTORIES AND OTHER CURRENT ASSETS ------------------------------------\nInventories and other current assets consist of the following:\nInventories include amounts related to certain raw materials reimbursable under a license agreement.\nOTHER ASSETS - NET ------------------\nOther assets consist of the following:\nACCRUED EXPENSES ----------------\nAccrued expenses consist of the following:\n3. INVESTMENTS\nIn July 1994, the Company adopted FAS No. 115. The Company's management has classified its investment securities as available-for-sale and records holding gains or losses as a separate component of stockholders' equity. The cumulative effect of the change resulted in a decrease to stockholders' equity of $127,000 at July 1, 1994.\nThe following is a summary of available-for-sale securities at June 30, 1995:\nThe gross realized losses on sales of available-for-sale securities totaled $104,000 in 1995. The net unrealized losses of $145,000 in 1995 are recorded as a component of additional paid-in capital. The unrealized losses had no cash effect and therefore are not reflected in the consolidated statement of cash flows.\nThe amortized cost and estimated fair value of available-for-sale debt securities at June 30, 1995, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations.\nAs of June 30, 1995, $1,969,000 of the available-for-sale securities were classified as cash equivalents.\n4. STOCKHOLDERS' EQUITY\nIn April 1995, the Company completed offerings of 3.2 million shares of newly issued common stock. Net proceeds to the Company from such offerings were approximately $14.3 million.\nSTOCK OPTION PLANS ------------------\nThe Company has a 1983 Incentive Stock Option Plan (the \"1983 Plan\"), a 1983 Non-Qualified Stock Option Program (the \"1983 Program\"), and a 1991 Stock Option Plan which provides for both incentive and non-qualified stock options (the \"1991 Plan\"). These plans provide for the granting of options to purchase shares of the Company's common stock (up to an aggregate of 500,000, 2,500,000, and 2,000,000 shares under the 1983 Plan, 1983 Program, and 1991 Plan, respectively) to directors, officers, employees, and consultants. The optionees, date of grant, option price (which cannot be less than 100% and 80% of the fair market value of the common stock on the date of grant for incentive stock options and non-qualified stock options, respectively), vesting schedule, and term of options, which cannot exceed ten years (five years under the 1983 Plan), are determined by the Stock Option Committee of the Board of Directors. The 1983 Plan has expired and no additional options may be granted under such plan. In September 1995, the Board of Directors amended the 1991 Plan, subject to stockholders' approval, to increase the number of shares available by 1,200,000 (to 3,200,000).\nThe following table summarizes stock option activity through June 30, 1995:\nAt June 30, 1995, 1,773,902 options were vested and exercisable.\nWARRANTS --------\nIn December 1993, the Company issued a warrant to purchase 500,000 shares of the Company's common stock through December 2000 at $12 per share. The warrant was issued to a former corporate partner in exchange for certain marketing and manufacturing rights. In August 1994, the Company issued a warrant to purchase 300,000 shares of common stock through August 1997 at an exercise price of $15 per share. The warrant was issued in conjunction with the license agreement discussed in Note 5. At June 30, 1995, the Company had warrants outstanding to purchase 982,289 shares of common stock at prices ranging from $6.95 to $15.96 per share. The warrants expire on various dates from July 1997 through December 2000.\nPREFERRED STOCK ---------------\nIn fiscal 1995, in conjunction with a license agreement (see Note 5), Johnson & Johnson Development Corp. purchased 1.5 million shares of Alliance convertible preferred stock for $15.0 million. On or before June 30, 1998, each share of the preferred stock will be converted into a number of common shares based upon the lower of the average price of Alliance common stock at the time of conversion or $20 per share. Prior to conversion, each share of preferred stock is entitled to one-half vote on matters on which shareholders are entitled to vote. The preferred stock carries a cumulative annual cash dividend of $0.50 per share.\nACQUISITION OF BIOPULMONICS, INC. ---------------------------------\nIn December 1991, the Company purchased all the outstanding stock of BioPulmonics in a transaction recorded using the purchase method of accounting. The total purchase price was $3,055,000, payable in four installments.\nIn June 1995, the Company made the final $1,000,000 payment to the former BioPulmonics' stockholders to complete the acquisition, with substantially all of which was made in the Company's common stock. Since the acquisition of BioPulmonics, an alternative future use of the acquired technology has been pursued by the Company. An intrapulmonary drug delivery system using the PFC- based liquid as a carrier (or dispersing agent) is being developed by Alliance from the liquid ventilation technology. Accordingly, the Company has recorded purchased technology of $1,000,000.\n5. LICENSE AGREEMENT\nIn August 1994, the Company executed a license agreement with Ortho Biotech, Inc. and The R.W. Johnson Pharmaceutical Research Institute, a division of Ortho Pharmaceutical Corporation (collectively referred to as \"Ortho\"), which provides Ortho with worldwide marketing and, at its election, manufacturing rights to the Company's injectable perfluorochemical emulsions capable of transporting oxygen for therapeutic use. Ortho will pay to Alliance a royalty based upon its sales of the products after commercialization. In addition, Ortho paid to Alliance an initial license fee of $4.0 million and will make other payments based on the achievement of certain milestones. Ortho will also be responsible for substantially all the remaining costs of developing the products. Through June 30, 1995, the Company earned research revenue of $7.1 million from Ortho, of which $2.0 million was included in accounts receivable. In conjunction with the license agreement, Johnson & Johnson Development Corp. purchased 1.5 million shares of Alliance convertible preferred stock for $15.0 million and obtained a warrant to purchase 300,000 shares of Alliance common stock at $15 per share during the next three years.\n6. INCOME TAXES\nSignificant components of the Company's deferred tax assets as of June 30, 1995 are shown below. A valuation allowance of $70,601,000, of which $12,428,000 is related to 1995, has been recognized to offset the deferred tax assets as realization of such assets is uncertain.\nApproximately $1,740,000 of the valuation allowance for deferred tax assets relates to stock option deductions which, when recognized, will be allocated to contributed capital.\nAt June 30, 1995, the Company had federal and various state net operating loss carryforwards of approximately $156,000,000 and $33,517,000, respectively. The difference between the federal and state tax loss carryforwards is primarily attributable to the capitalization of research and development expenses for California tax purposes and the fifty percent limitation on California loss carryforwards. The federal and various state tax loss carryforwards will begin expiring in fiscal\n1998 and 1996, respectively, unless previously utilized. The Company also has federal and state research and development tax credit carryforwards of $6,996,000 and $1,748,000, respectively, which will begin expiring in fiscal 1998 unless previously utilized.\nFederal and California tax laws limit the utilization of income tax net operating loss and credit carryforwards that arise prior to a change of control of the Company. However, the Company believes that such limitations will not have an impact on the utilization of the carryforwards.\n7. COMMITMENTS AND CONTINGENCIES\nThe Company leases certain office and research facilities in San Diego and certain equipment under operating leases. Provisions of the facilities lease provide for abatement of rent during certain periods and escalating rent payments during the lease terms based on changes in the Consumer Price Index. Rent expense is recognized on a straight-line basis over the term of the leases.\nMinimum annual commitments related to operating lease payments at June 30, 1995 are as follows:\nRent expense for fiscal 1995, 1994, and 1993 was $2,043,000, $2,286,000, and $1,886,000, respectively.\nIn December 1993, in order to obtain a commitment for a long-term supply of raw material for both clinical trials and anticipated future commercial production requirements, the Company entered into an agreement with a supplier under which the Company was obligated to make payments to the vendor through May 1997 based, in part, upon the achievement of certain milestones. The Company's total minimum future commitment is approximately $3.0 million, some or all of which may be reimbursed to the Company by existing and future collaborative partners.\nDuring September 1992, the Company and certain of its officers and directors were named as defendants in several lawsuits filed by certain shareholders. The actions were consolidated into one class action lawsuit. The complaint claims, among other things, that the defendants failed to disclose certain problems with two of the Company's products under development, which conduct is alleged to have falsely portrayed the Company's financial condition. In May 1995, the U.S. District Court for the Southern District of California granted summary judgment in favor of the Company, dismissing the lawsuit in its entirety. The plaintiffs have filed a notice of intent to appeal the dismissal. The Company believes the eventual outcome of the litigation will not have a material adverse effect on the Company's financial condition.","section_15":""}
{"filename":"32258_1995.txt","cik":"32258","year":"1995","section_1":"Item 1. Business\nGeneral Development and Description of Business\nThe Titan Corporation (\"Titan\" or the \"Company\") is an innovative high technology company which groups its businesses in four industry segments: Communications Systems, Software Systems, Defense Systems, and Emerging Technologies. The Communications Systems segment contains two start-up business units, both targeting rapidly growing commercial markets. The first business unit, secure television, specializes in providing complete turnkey security for television delivery systems. The second business unit is satellite communications, which develops, manufactures, and sells satellite earth station networks and related components. The Software Systems segment provides custom and semi-custom software development services to assist customers in moving from older mainframe systems to distributed computing systems utilizing client\/server software. The Defense Systems segment, serving primarily the U.S. Government, includes satellite communications products; test and evaluation of complex systems; management and technical consulting; training and simulation support; and other consulting and engineering services. The Defense Systems segment also provides militarized computers. The Emerging Technologies segment contains a group of diverse businesses including the start-up medical product sterilization services and systems and environmental consulting services businesses, as well as several established businesses generally involved in broad-based technology development primarily for the U.S. Government and pulse power products.\nThe Company has significantly changed its customer mix over the last five years. In 1991 a minimal amount of the Company's revenues was generated from commercial business with the bulk of revenues generated by business with the Department of Defense (DoD) and other Government agencies. For 1995, 1994, and 1993, the Company's revenues generated by business other than DoD or other U.S. Government agencies represented 39%, 32% and 25% of total Company revenues, respectively. For the past several years, the Company has pursued a strategy to use the technology and experience gained in its defense business to build commercial business. At the same time, the Company has continued to focus on growing its defense business in key market areas.\nCOMMUNICATIONS SYSTEMS SEGMENT\nThe Communications Systems segment contains two start-up business units, both targeting rapidly growing commercial markets. The first business, secure television, specializes in providing complete turnkey security for television delivery systems, with applications for delivery of television programming via satellite, coaxial cable, fiber optics and wireless distribution. In January 1995, the Company signed an equipment purchase agreement to provide analog equipment and software for use in a wireless television service in New York City. It is currently making significant investments in developing a digital conditional access system in order to address the direct-to-home satellite and wireless television markets. The Company is making enhancements to its existing analog system. The Company is actively marketing its system in domestic and international markets.\nThe second business unit is satellite communications, which develops, manufactures and sells bandwidth-efficient, cost-effective satellite earth station networks and related subsystems. The Company believes that these systems are particularly suited for commercial applications in developing nations for rural communications. These systems are being marketed in Asia and Latin America. In the third quarter of 1995, the Company received a $10 million fixed price contract to develop a rural telephony system in Indonesia.\nSOFTWARE SYSTEMS SEGMENT\nThe Software Systems segment provides custom and semi-custom software development services to clients desiring to upgrade their information systems. These services assist customers in moving from older mainframe systems to distributed computing systems utilizing client\/server software so that they can respond to market changes, meet competitive demands and improve their responsiveness to customer needs. Applications include enhancement of customer service centers for telecommunications companies and improved trouble reporting for telecommunications systems. The Company provides its products and services using its detailed knowledge of the telecommunications and other customers' operations and business needs, expert and responsive project teams, senior management experience, and a protocycling approach to software development. The Software Systems segment is substantially dependent on business from a major telecommunications customer. Revenues in 1995 from this customer were approximately $24.5 million. The Company has been actively working to diversify its software customer base.\nDEFENSE SYSTEMS SEGMENT\nThe Defense Systems segment includes two business units, communications and information systems. These units provide their products and information systems solutions primarily to U.S. and allied government and defense customers. The defense communications business develops and produces advanced satellite terminals and associated voice\/data processing modems. These products are specifically tailored to meet defense requirements, provide highly secure communications and are produced in relatively small amounts. Generally, the Company is initially involved in a product development stage which is subsequently followed by production orders. In some situations, the government is shifting to a nondevelopment approach to procurement wherein companies are encouraged to perform their own research and development for products identified for procurement. During 1995, the Company completed major portions of research and development on four new technology applications in the defense communications area. By the end of 1995, all four developments had been converted into deliverable products and were under contract.\nThe defense information systems business supports high priority government programs by providing information systems engineering services as well as development and integration of systems and specialized products. The systems engineering services business applies key technologies to the large-scale and complex problems of major government programs. The systems development and integration business provides systems and related software design and development, as well as the integration of complex government information systems.\nThe segment also includes the Company's Electronics division, which designs and manufactures processing and control electronics for use in severe environmental conditions.\nMarketing for the Defense Systems segment involves identifying the requirements of the U.S. Government and other potential customers for the types of products and services provided by the Company. The information is then evaluated to determine if the Company can prepare a responsive proposal to the customer. This business is highly dependent upon continued funding of certain U.S. Government contracts.\nEMERGING TECHNOLOGIES SEGMENT\nThe Emerging Technologies segment contains a group of mature businesses generally involved in Department of Defense (DoD) funded research and development contracts and start-up commercial businesses, including medical product sterilization services and systems and environmental consulting services. The Company's strategy is to use the research and development activities as a source of additional DoD and commercial products, systems or services.\nThe research and development activity is primarily composed of defense cost reimbursable contracts. These research and development activities involve a number of technologies including those necessary to develop and manufacture particle accelerators and high powered microwave tubes.\nThe Company's medical product sterilization business is based upon advanced linear accelerator technology developed from the Company's research and development activities. The Company owns and operates two medical sterilization facilities - one in Denver, Colorado and one in San Diego, California. These facilities provide electron beam sterilization services using Titan's SureBeamR process to producers of disposable medical products. The facility in Denver has been operational since July 1993 and the facility in San Diego became operational in January 1996. In 1995, the Company also sold a turnkey electron beam sterilization system to a customer in Austria.\nThe environmental consulting and services business provides a range of professional environmental consulting and engineering services to commercial customers.\nSEGMENT PRO FORMA DATA\nThe following unaudited pro forma data should be read in conjunction with the audited historical financial statements and related management discussion and analysis beginning on page 9. Such financial statements reflect the actual historical operating performance of Titan for the period 1993 through 1995. The following additional information is provided to assist the reader in understanding the segment data contained in this document taking into account all those businesses divested during 1993 through 1995 which are not a part of ongoing business. Revenues and operating profit are reflected as if all divested businesses as of December 31, 1995 had been divested as of January 1, 1993. Also excluded from the pro forma data is the effect of restructuring.\nThe pro forma data does not purport to represent results of operations for any future date or period.\nGovernment Contracts\nSales to the United States Government, including both defense and non-defense agencies, and sales as a subcontractor as well as direct sales, aggregated $81,632 in 1995, $93,107 in 1994 and $112,001 in 1993. These amounts represent 61%, 68% and 75% of total revenues in 1995, 1994, and 1993, respectively.\nTitan's Government customers include the Army, the Air Force, the Navy and other Government agencies, including the Federal Emergency Management Agency, the Department of Commerce, the National Aeronautics and Space Administration, the Federal Aviation Administration, the Defense Nuclear Agency and others. The Company's business is dependent to a large extent upon continued funding from these and other government agencies.\nThe Company's contracts with the Government and subcontracts to prime contractors are subject to termination for the convenience of the Government; termination, reduction, or modification in the event of change in the Government's requirements or budgetary constraints; and, when the Company participates as a subcontractor, the failure or inability of the prime contractor to perform its prime contract. In addition, the Company's contract costs and fees, including allocated indirect costs, are subject to audits and adjustments by negotiation between the Company and the Government.\nIn addition to the right to terminate, Government contracts are conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds on a fiscal year basis even though contract performance may take several years. Consequently, at the outset of a major program, the contract is usually incrementally funded and additional funds are normally committed to the contract by the procuring agency as appropriations are made by Congress for future fiscal years.\nThe Company's business with the Government and prime contractors is generally performed under cost reimbursement, time and materials or fixed price contracts. Cost reimbursement contracts for the Government provide for reimbursement of costs plus the payment of a fee. Under time and materials contracts, the Company is reimbursed for labor hours at negotiated hourly billing rates and is reimbursed for travel and other direct expenses at actual costs plus applied general and administrative expense. Under fixed price contracts, the Company agrees to perform certain work for a fixed price.\nThe following table gives the percentage of revenues realized by the Company from the three primary types of Government contracts during the years indicated.\nContract Type 1995 1994 1993 Cost Reimbursement.............. 54.7% 59.9% 35.5% Time and Materials.............. 5.1 3.3 1.8 Fixed Price..................... 40.2 36.8 62.7 100.0% 100.0% 100.0%\nIndustry Segments, Significant Customers and Export Revenues\nReference is made to Note 4 to the accompanying consolidated financial statements.\nRaw Materials\nThe Company operates both fabrication and assembly facilities and also purchases certain components and assemblies from other suppliers. No one supplier accounts for a significant portion of total purchases.\nPatents, Trademarks and Trade Secrets\nThe policy of the Company is to apply for patents and other appropriate statutory protection when it develops new or improved technology. The Company presently holds over 50 U.S. patents, as well as a number of trademarks and copyrights. However, it does not rely solely on such statutory protection to protect its technology and intellectual property. In addition to seeking patent protection for its inventions, the Company relies on the laws of unfair competition and trade secrets to protect its unpatented proprietary rights. The Company attempts to protect its trade secrets and other unpatented proprietary information through agreements with customers, vendors, employees and consultants. In addition, various names used by the Company for its products and services have been registered with the U.S. Patent and Trademark Office.\nBacklog\nContracts undertaken by the Company may extend beyond one year, and accordingly, portions are carried forward from one year to the next as part of backlog. Because many factors affect the scheduling of projects, no assurances can be given as to when revenue will be realized on projects included in the Company's backlog. Although backlog represents only business which is considered to be firm, there can be no assurance that cancellations or scope adjustments will not occur. The majority of backlog represents contracts under the terms of which cancellation by the customer would entitle the Company to all or a portion of its costs incurred and potential fees.\nThe Company's commercial backlog represents contracts primarily for services. By segment, the commercial backlog is approximately $11 million, $5 million, and $9 million for Communications Systems, Software Systems and Emerging Technologies, respectively.\nMany of the Company's contracts with the U.S. Government are funded by the procuring agency from year to year, primarily based on its fiscal requirements. This results in two different categories of U.S. Government backlog: funded and unfunded backlog. \"Funded backlog\" consists of the aggregate contract revenues remaining to be earned by the Company at a given time, but only to the extent such amounts have been appropriated by Congress and allocated to the contract by the procuring Government agency. \"Unfunded backlog\" consists of (i) the aggregate contract revenues which are expected to be earned as the Company's customers incrementally allot funding to existing contracts, whether the Company is acting as a prime contractor or subcontractor, and (ii) the aggregate contract revenues which remain to be funded on contracts which have been newly awarded to the Company. \"Backlog\" is the total of the commercial and government funded and unfunded backlog.\nThe Company's backlog consists of the following approximate amounts as of December 31:\nIn addition to the backlog described above, at December 31, 1995 the Company had priced options of approximately $70 million from the U.S. Navy for full- scale production of its Mini-DAMA satellite communications terminal. The Company expects that a substantial number of these options will be exercised in the future.\nManagement believes that year-to-year comparisons of backlog are difficult and not necessarily indicative of future revenues. The Company's backlog is typically subject to large variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, all U.S. Government contracts included in backlog, whether or not funded, may be terminated at the convenience of the U.S. Government.\nThe Company expects to realize approximately 92% of its 1995 backlog by the end of 1996.\nResearch and Development\nThe Company maintains a staff of engineers, other scientific professionals and support personnel engaged in development of new applications of technology and improvement of existing products. These programs' costs are expensed as incurred. Total expenditures for research and development were $16,667,000, $12,699,000, and $8,935,000 in 1995, 1994, and 1993, respectively. These expenditures included company funded research and development of $5,904,000, $5,339,000, and $2,257,000 and customer sponsored research and development of $10,763,000, $7,360,000, and $6,678,000 in 1995, 1994, and 1993, respectively. The majority of the Company's customer sponsored research and development activity is funded under contract to the U.S. Government.\nCompetitive Conditions\nThe Company is one of many companies providing satellite earth station networks and related subsystems in commercial markets. The products compete based primarily on quality, reliability, service and price. Competition is intense, and many competitors have greater financial and personnel resources than does the Company.\nThe Company is one of many developers producing custom software for high technology clients. The custom software industry is rapidly changing and is subject to technological obsolescence. Many of the Company's customers in this business have their own in-house capabilities to perform certain types of services that might otherwise be performed by the Company. The primary factors of competition in the business in which the Company is engaged include technical skills, knowledge of specific industry operations for which the software is being developed, management and marketing expertise and price.\nThe Company is one of a few companies in the secure distribution of television business. These products compete based primarily on quality, reliability, service and price. The Company's major competitors are General Instruments Corporation and Scientific Atlanta, Inc., both of whom have significantly greater resources than the Company.\nThe Company designs, manufactures and sells earth stations and related subsystems for use in military satellite communications systems. Although the Company has significant market share in certain segments of the military satellite communications systems market, some competitors have greater financial and personnel resources than the Company.\nThe Company is one of a few companies involved in the sterilization of disposable medical products prior to their use. This service competes primarily on quality, reliability, service, safety, environmental acceptability and price. The Company's major competitors are Isomedix, Inc. and Sterigenics International, Inc.\nThe Company is one of many involved in providing sophisticated systems engineering for a variety of programs for agencies of the United States Government and prime contractors for these agencies. Most activities in which the Company engages are very competitive and require highly skilled and experienced technical personnel. Numerous companies compete in the service areas in which the Company is engaged, many of which have significantly greater financial and personnel resources than does the Company. As is customary in the business, the Company expends time and effort in preparing competitive proposals, only a portion of which may result in the award of contracts.\nThe Government's own in-house capabilities and federally-funded (non-profit) research and development centers are also, in effect, competitors of the Company in that they perform certain types of services that might otherwise be performed by the Company. The primary factors of competition in the business in which the Company is engaged include technical skills, management and marketing expertise and price.\nThe Company is also one of many manufacturers offering computer-related products and systems in the United States. These products are part of the even larger data processing industry, in which the Company is not a significant factor. Digital systems and microcomputers are subject to technological obsolescence that could result from improvements in technology or from the development of more advanced products.\nEmployees\nAt the end of fiscal 1995, the Company employed approximately 895 employees, predominantly located in the United States.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's operations occupy approximately 636,120 square feet of space located throughout the United States. The large majority of the space is office space. All of the Company's facilities are leased. For lease commitment information, reference is made to Note 7 to the accompanying financial statements.\nIt is management's policy to maintain the Company's facilities and equipment in good condition and at a high level of efficiency. Existing facilities are considered to be generally suitable and adequate for the Company's present needs. Substantially all of the machinery and equipment employed by Titan in its business is owned by the Company.\nThe locations of the principal operating facilities of the Company and its consolidated subsidiaries at the end of 1995 were as follows:\nCommunications Systems Software Systems San Diego, California San Diego, California Reston, Virginia Colorado Springs, Colorado Tampa, Florida Dallas, Texas Boston, Massachusetts\nDefense Systems Emerging Technologies San Diego, California San Diego, California Reston, Virginia San Leandro, California Orlando, Florida Dublin, California Denver, Colorado Chatsworth, California Colorado Springs, Colorado Albuquerque, New Mexico Boston, Massachusetts Denver, Colorado Dayton, Ohio Bozeman, Montana Huntsville, Alabama Princeton, New Jersey\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn the ordinary course of business, the Company's defense business is subject to many levels of audit and investigation by various government agencies. Further, the Company and its subsidiaries are subject to claims and from time- to-time are named as defendants in legal proceedings. In the opinion of management, the amount of ultimate liability with respect to these pending actions will not materially affect the financial position or results of operations of the Company.\nThe Company is a party to three separate lawsuits in the United States District Court for the Eastern District of Virginia, Alexandria Division filed by three female former Company employees. Each action arises from the course of the plaintiff's employment with and termination from the Company, and seeks monetary damages due to alleged gender discrimination, constructive discharge and\/or wrongful termination and related claims. The cases are scheduled for trial in March and April of 1996. The Company intends to continue to defend the cases vigorously. While it is not feasible to predict the outcome of these cases, management believes that their ultimate disposition will not have a material adverse effect on the financial position or results of operations of the Company. A fourth lawsuit was settled in March 1996 through an offer of judgment and did not have a material effect on the financial position or results of the operation of the Company.\nThe Company is also a party to a lawsuit filed by a male former Company employee seeking monetary damages due to alleged wrongful termination and intentional infliction of emotional distress arising out of his termination of employment in March 1994. The case was originally filed in the Circuit Court of Fairfax County Virginia and in March 1996 was removed to the United States District Court of the Eastern District of Virginia, Alexandria Division. The case is scheduled for trial in June 1996. The Company intends to defend the case vigorously. While it is not feasible to predict the outcome of this case, management believes that its ultimate disposition will not have a material adverse effect on the financial position or results of operations of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock and preferred stock are traded on the New York Stock Exchange (\"NYSE\") and the Chicago Stock Exchange. As of March 1, 1996, there were approximately 3,475 holders of record of the Company's common stock and 959 holders of record of the Company's preferred stock, excluding beneficial owners of shares held in the names of brokers or other nominees. The closing prices for the common and preferred stock on the New York Stock Exchange as of March 1, 1996, were $7.00 and $12.38, respectively. The quarterly market price ranges for the Company's common and preferred stock on the New York Stock Exchange in 1995 and 1994 were as follows:\nCommon Stock 1995 1994 Fiscal Quarter High Low High Low\nFirst $ 7.13 $5.63 $8.00 $2.88 Second 9.38 6.25 6.88 4.75 Third 10.38 8.50 5.88 4.50 Fourth 9.63 6.63 6.38 4.50\nPreferred Stock 1995 1994 Fiscal Quarter High Low High Low\nFirst $11.88 $10.88 $13.00 $11.00 Second 12.25 11.63 12.13 11.50 Third 13.25 11.75 11.63 10.88 Fourth 12.88 11.88 11.13 10.50\nNo dividends were paid on the Company's common stock in 1995 or 1994. Regular quarterly dividends of $.25 per share were paid on preferred stock in both years.\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 (The following should be read in conjunction with the consolidated financial statements and related notes. Dollar amounts are expressed in thousands.)\nCOMPANY OVERVIEW\nThroughout 1995, Titan pursued its strategy of investing in its emerging commercial businesses. Investment dollars were provided primarily by drawing upon the Company's bank line of credit and through internally generated funds. The investments included, among other things, the construction of the Titan Scan medical device sterilization facility in San Diego, California, hardware and software development related to the secure television business and increased selling, marketing and research and development expenditures. Significant accomplishments achieved by Titan's emerging commercial businesses this year included the award of a $10 million fixed price rural telephony development contract in Indonesia, the completion of a $2 million contract in Thailand to integrate a satellite network, delivery of the first products in the secure television business and the sale of a turnkey medical device sterilization system in Austria. These accomplishments marked significant progress for Titan. However, the need to speed up product development and the commercialization process heightened the challenge of internally funding these start-up activities. As such, management continued the process of critically examining Titan's long-term operating and financing strategy.\nIn response, the Board of Directors adopted a strategy to reshape the Company in order to make it more attractive to external funding sources within the capital marketplace. A formal plan of restructuring was adopted which redefined Titan's businesses into four business segments: Communications Systems, Software Systems, Defense Systems, and Emerging Technologies. As part of this strategy, management has determined that the restructuring would require dispositions of certain of Titan's businesses as well as significant reorganizations of its Software Systems segment and sterilization business, reductions of personnel, and other actions associated with reorganizing the structure of the Company. A charge of approximately $5.4 million was recorded in 1995 to reflect these restructuring activities. Titan's strategic plan now focuses on the pursuit of various financing alternatives including, but not limited to, public and private offerings of minority interests in certain of its subsidiaries and the sale of non-core businesses, in order to provide additional funding for the development and commercialization of new products and services.\nThe Company is currently involved in a number of start-up ventures, most notably secure television, commercial satellite communications, and medical device sterilization. Certain investments made in these start-up ventures have been capitalized and are included in the balance sheet, primarily within the captions of Property and Equipment and Other Assets which includes capitalized software costs. At December 31, 1995, these capitalized investments aggregate approximately $12.5 million. These start-up ventures are in various growth stages and have not yet generated sufficient revenues to achieve profitability. Management plans to continue to invest, primarily in the Communications Systems segment, while at the same time carefully monitoring its return on investment from all of its start-up ventures.\nAn essential element of the Company's long-term operating plan is the growth associated with its well established Defense Systems segment. This segment offers a variety of opportunities for Titan. Management intends to grow this segment's businesses relying on Titan's proven technological capabilities and reputation for performance. During 1995, achievements in this segment included a $12 million award for low rate initial production for Mini-DAMA satellite communications terminals, a $5.2 million contract with the U.S. Navy for engineering services in the C3I area, and a $2.8 million production order for satellite communication modems to be installed in Motorola's LST-5 tactical radios.\nOPERATING RESULTS\nThe table below sets forth Titan's consolidated revenues, operating profit (loss), net interest expense, provision for income taxes (benefit) and net income (loss) for each of the three years ended December 31, 1995:\n1995 1994 1993\nRevenues $ 133,967 $ 136,206 $ 149,414 Operating profit (loss) (3,955) 9,635 (14,647) Interest expense, net 1,059 632 1,506 Income tax provision (benefit) (1,207) 3,050 (6,547) Net income (loss) (3,807) 5,953 (7,906)\nTitan's consolidated revenues were $133,967, $136,206 and $149,414 in 1995, 1994 and 1993, respectively. Excluding revenues from Titan's Applications Group, which was sold in April 1994, Titan's pro forma 1995-1993 revenues were $133,967, $124,293 and $117,714 reflecting a compound annual growth rate of 6.6%. This revenue growth was achieved primarily in the Communications Systems and Software Systems segments, while the Defense Systems segment, excluding the Applications Group, and Emerging Technologies segment revenues were relatively stable over the three year period.\nTitan's consolidated operating profit (loss) has been significantly impacted by a number of factors in each of the three years shown above. Combined selling, marketing, and research and development expenses were $12,008, $9,686 and $7,557 in 1995, 1994 and 1993, respectively, reflecting Titan's efforts to expand commercial applications of its technologies and to continue developing certain defense communication technologies. General and administrative expenses decreased from $18,164 in 1994 to $17,434 in 1995 after having been reduced significantly from the 1993 level of $21,930. The decrease in 1994 resulted from specific actions taken to reduce headcount as well as more selective bid and proposal activity primarily in Titan's Defense Systems segment. Restructuring charges were recorded in both 1995 and 1994 reflecting management's efforts to adapt to both internal and external forces impacting Titan's long-term operating strategy. The 1994 charge was offset by a $12,700 pre-tax gain resulting from the sale of Titan's Applications Group. Lastly, in 1993, operating profit was significantly impacted by the recording of an increase in estimated cost at completion of approximately $9,950 on the Company's Mini-DAMA fixed price development contract with the U.S. Navy.\nNet interest expense has fluctuated significantly over the three year period ended December 31, 1995. Generally, the principal component of interest expense is the Company's borrowings under its bank line of credit. Borrowings from this source averaged $6,400, $4,180 and $14,200 at weighted average interest rates of 8.8%, 7.6% and 5.5% during 1995, 1994 and 1993, respectively. Also affecting interest expense is interest on the Company's deferred compensation and retiree medical obligations. Interest expense related to these items was $726, $529 and $441 for 1995, 1994 and 1993, respectively. Interest on the deferred compensation obligation will continue to increase as the total obligation increases, while interest on the retiree medical obligation is expected to decrease.\nIncome taxes reflect a benefit of $1,207 in 1995 or a 24% effective tax rate. The difference between the actual provision and the expected provision (based on the United States statutory tax rates applicable each year) is due to the alternative minimum tax and to permanent differences between financial statement income and taxable income. The provision for taxes in 1994 was $3,050, or a 34% effective tax rate, while the benefit for taxes in 1993 was $6,547 or a 41% effective rate. The differences between the actual effective rate and the expected rate in both these years was largely due to the effects of research credits and operating loss carryforwards. Also with respect to taxes, in 1993 Titan recorded a $1,700 benefit representing the cumulative effect of a change in accounting principal as a result of the Company's adoption of SFAS No. 109 \"Accounting for Income Taxes\".\nBusiness Segments\nCommunications Systems: The Communications Systems segment contains two business units, both targeting rapidly growing commercial markets. The first business unit, secure television, specializes in providing complete turnkey security for television delivery systems. The second business unit is satellite communications, which develops, manufactures and sells satellite earth station networks and related subsystems.\nRevenues in this segment were $7,490, $6,319 and $6,492 in 1995, 1994 and 1993, respectively. The composition of the revenues was significantly different over the three year period. Revenues in 1995 included approximately $2,400 of secure television revenues from the Company's first contract in this business area. There were no secure television revenues in 1994 or 1993. Revenues in the satellite communications business unit were approximately $5,100 in 1995, $6,000 in 1994 and $6,400 in 1993. However, in early 1995, Titan sold its transceiver manufacturing division which was part of this business unit. On a pro forma basis, excluding the sold division, this segment's revenues were approximately $7,000, $2,500 and $1,300 in 1995, 1994 and 1993, respectively. The increase in pro forma revenues from 1994 to 1995 resulted from obtaining and performing on a contract to develop and integrate a satellite communications network in Thailand as well as from the addition of secure television revenues previously mentioned. The change from 1993 to 1994 was primarily due to increased sales of voice digitizing cards.\nThe segment's operating loss was $4,488 in 1995 compared to $7,927 in 1994 and $7,413 in 1993. The loss in 1995 reflects the start-up nature of this segment's businesses which require significant selling, marketing and research and development activities disproportionate to the level of revenues generated to date. Management intends to continue investing in these businesses and, as a result, expects that significant losses will also be experienced in 1996. The loss in 1994 includes approximately $5,400 of losses and restructuring charges associated with Titan exiting its transceiver manufacturing business which was primarily responsible for this segment's 1993 operating loss.\nSoftware Systems: The Software Systems segment provides custom and semi- custom software development services to assist customers in moving from older mainframe systems to distributed computing systems utilizing client\/server software.\nRevenues in this segment were $33,175 for 1995, $28,868 in 1994 and $13,713 in 1993. One customer accounted for approximately $24,000 of this segment's revenue in both 1995 and 1994, and $9,700 in 1993. In the second half of 1995, this segment experienced reduced demand from this customer and management expects this trend to continue in 1996. The 1995 revenue increase was generated from new customers. As shown above, the increase from 1993 to 1994 resulted from increased business with the one significant customer.\nSegment income margin (segment operating income as a percentage of segment revenues) was 11.5% in 1995 and 21.6% in 1994. The 1995 decrease was principally due to the effect of restructuring charges for severance and other reorganization costs and the impact of reduced sales volume from the one previously mentioned customer. Segment income margin was 6.7% in 1993. The results for 1993 included losses on certain now completed fixed price contracts which significantly lowered overall segment profitability.\nDefense Systems: The Defense Systems segment includes two business units, communications and information systems, which provide information systems solutions primarily to U.S. and allied government and defense customers. The defense communications business develops and produces advanced satellite terminals and associated voice\/data processing modems. These products are specifically tailored to meet defense requirements, provide highly secure communications and are produced in relatively small amounts. The defense information systems business supports high priority government programs by providing information systems engineering services as well as development and integration of systems and specialized products.\nRevenues in this segment were $67,948, $78,780 and $103,071 for 1995, 1994 and 1993, respectively. However, excluding revenues attributable to the Company's Applications Group, pro forma segment revenues were $67,948, $66,867 and $71,371 for 1995, 1994 and 1993, respectively. The decrease from 1993 to 1994 was due to reduced shipments in the Electronics division. Revenues in 1995 and 1994 included approximately $18,300 and $9,700, respectively, for work subcontracted to the buyer of the Applications Group. There was no operating profit associated with these revenues. This contract is expected to conclude in mid-1996. Furthermore, 1995 revenues and operating profit included approximately $1,400 recovered from a termination for convenience claim with the U.S. Government for work performed in prior years.\nSegment income margin for 1995 was 6.6%, compared with 6.0% in 1994. In 1993 there was an operating loss of $2,804. Operating results for 1994 include $2,500 of profit resulting from a favorable settlement and from improved contract performance on the Company's Mini-DAMA fixed price development contract. This profit was offset by a charge of approximately $3,200 for restructuring this segment's Electronics division. The loss in 1993 was primarily the result of recording an increase in estimated costs to complete the Company's Mini-DAMA fixed price development contract which was the subject of a contract dispute with the customer, the U.S. Navy.\nEmerging Technologies: Emerging Technologies contains a group of mature businesses generally involved in Department of Defense (DoD) funded research and development contracts and start-up commercial businesses, including medical product sterilization services and systems and environmental consulting services. The Company's strategy is to use the research and development activities as a source of additional DoD and commercial products, systems and services.\nRevenues in this segment were $25,354, $22,239 and $26,138 in 1995, 1994 and 1993, respectively. Approximately $7,400 of 1995 revenue was generated by the segment's start-up businesses. Substantially all remaining revenue for all periods presented was derived from the various established business lines. This segment's operating profit (loss) has not been material in relation to Titan's consolidated operating results. Generally losses experienced by the start-up operations have offset profits contributed by the segment's other lines of business.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995, the Company used cash for increased operating requirements, investing in its emerging businesses which included significant capital expenditures as well as investments in capitalized software costs, and payment of dividends. The operating cash requirements resulted primarily from an increase in accounts receivable and inventories along with payment of certain compensation obligations and funding of restructuring activities. Cash was provided from a variety of sources. The Company utilized $9,200 of its bank line of credit, obtained $4,600 as a result of secured debt financing for the San Diego Scan facility, received $2,325 through a private placement of common stock and $1,835 from the sale of businesses. In January 1996, the Company obtained $1,784 in cash as a result of the replacement of a maturing secured obligation with a new secured financing transaction.\nCash requirements in 1996 are expected to continue to be significant. Cash generation varies from quarter to quarter and in most years the Company has experienced higher cash requirements in the first quarter than in other quarters. Management expects this pattern to continue in the first quarter of 1996. During 1996, the Company expects to invest up to $11 million primarily in the further development of business ventures within the Communications Systems segment. Funding is planned to be from operations, the bank line of credit, and the sale of non-core businesses. Titan's line of credit agreement requires the Company to have annual net income, as defined, prohibits two consecutive quarterly losses and contains other financial covenants which require the Company to maintain stipulated levels of tangible net worth, a minimum debt service coverage ratio and a specified quick ratio. The Company has obtained a waiver from the bank for the 1995 net loss. In order to provide additional funding for further and\/or accelerated growth, the Company continues to explore various other financing alternatives. Should the Company be unable to successfully obtain outside financing, the investment in these start-up ventures could change.\nFORWARD LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS\nCertain statements contained in this Management's Discussion and Analysis of Results of Operations and Financial Condition that are not related to historical results are forward looking statements. Actual results may differ materially from those stated or implied in the forward looking statements. Further, certain forward looking statements are based upon assumptions of future events which may not prove to be accurate. These forward looking statements involve risks and uncertainties including but not limited to those referred to below.\nEntry Into Commercial Business. Prior to 1992, the Company's revenues had been derived principally from business with the Department of Defense and other government agencies. Since that time, the Company has pursued a strategy of using the technology from its defense business to build commercial businesses. This strategy presents both significant opportunities and significant risks for the Company. Many of the Company's commercial businesses, such as secure television, satellite communications and medical sterilization, remain in an early stage. As such, the Company is subject to all the risks inherent in the operation of a start-up venture, including the need to develop and maintain marketing, sales and customer support capabilities, to secure appropriate third party manufacturing arrangements, to respond to the rapid technological advances inherent in these markets and to secure the necessary financing to support these activities. In addition, many of the opportunities in the secure television and satellite communications businesses are large, international projects which require long lead times in the contract process. The Company's efforts to address these risks have required, and will continue to require, significant expenditures and dedicated management time and other resources. There can be no assurance that the Company will be successful in addressing these risks.\nReliance on Major Software Customer. The Company's Software Systems business is substantially dependent on business from a major telecommunications company to develop and support access carrier client\/server software applications. Revenues from this customer totalled approximately $24.5 million, $24.3 million and $9.7 million, or 18%, 18% and 7% of total Company revenues in 1995, 1994 and 1993, respectively. In the second half of 1995, the Company experienced reduced demand from this customer and management expects this trend to continue in 1996. The loss of this customer, or a substantial delay or decrease in the amount of its business, could have a material adverse effect on the Company's results of operations and financial condition.\nDependence on Defense Spending. The Company's Defense Systems segment is dependent upon continued funding of U.S. Department of Defense programs. Titan, like other companies doing business with the U.S. Department of Defense, has been affected by declining defense budgets and has experienced increased competition in certain of its defense business areas. The size and scope of any reductions in future defense budgets is uncertain, and management anticipates that competition in most defense-related areas will continue to be intense.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIndex to Consolidated Financial Statements and Financial Statement Schedules\nPage Report of Independent Public Accountants....................................... 15 Financial Statements Consolidated Statements of Operations....................................... 16 Consolidated Balance Sheets................................................. 17 Consolidated Statements of Cash Flows....................................... 18 Consolidated Statements of Stockholders' Equity............................. 19 Notes to Consolidated Financial Statements.................................. 20-30\nSupporting Financial Statement Schedule Covered by the Foregoing Report of Independent Accountants:\nSchedule II - Valuation and Qualifying Accounts................................. 35\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of The Titan Corporation: We have audited the accompanying consolidated balance sheets of The Titan 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 and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Titan 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 5 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The 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\nSan Diego, California February 28, 1996\nThe Titan Corporation Consolidated Statements of Operations (in thousands of dollars, except per share data)\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe Titan Corporation Consolidated Statements of Cash Flows (in thousands of dollars)\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe Titan Corporation Consolidated Statements of Stockholders' Equity For the years ended December 31, 1995, 1994 and 1993 (in thousands of dollars, except per share data)\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe Titan Corporation Notes to Consolidated Financial Statements (in thousands of dollars, except per share data)\nNote 1. Summary of Significant Accounting Policies\nNature of Operations. The Titan Corporation provides engineering, technical, management and consulting services in the areas of national security, software systems, communication systems, advanced research and development, sterilization and the environment. The Company also develops, designs, manufactures and markets satellite communications subsystems, secure television security systems, pulse power products including linear accelerators, and hardened electronic subsystems.\nPrinciples of Consolidation. The consolidated financial statements include the accounts of The Titan Corporation (\"Titan\" or \"the Company\") and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Also, certain prior year amounts 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.\nStart-up Activities. The Company is involved in a number of start-up ventures, most notably secure television, commercial satellite communications and medical device sterilization. Certain investments made in these start-up ventures are reflected in the balance sheet, primarily within the captions of Property and Equipment and Other Assets, which includes capitalized software costs. These capitalized investments aggregate approximately $12,500 at December 31, 1995. These start-up ventures are in various early growth stages and have not yet generated sufficient revenues to achieve profitability. At this time, management plans to continue to invest in these ventures and will review and evaluate the realizability of the related assets.\nRevenue Recognition. A majority of the Company's revenue, both commercial and government, is derived from products manufactured and services performed under cost-reimbursement and fixed-price contracts wherein revenues are generally recognized using the percentage-of-completion method. Certain other revenues are recognized as units are delivered. Estimated contract losses are fully charged to operations when identified.\nCash Equivalents. All highly liquid investments purchased with a maturity of three months or less are classified as cash equivalents.\nInventories. Inventories include the cost of material, labor and overhead, and are stated at the lower of cost, determined on the first-in, first-out (FIFO) and weighted average methods, or market.\nProperty and Equipment. Property and equipment are stated at cost. Depreciation is provided using the straight-line method, with estimated useful lives of 2 to 15 years for leasehold improvements and 3 to 7 years for machinery and equipment and furniture and fixtures. Certain machinery and equipment in the Company's medical sterilization business is depreciated based on units of production.\nGoodwill. The excess of the cost over the fair value of net assets of purchased businesses (\"goodwill\") is amortized on a straight-line basis over varying lives ranging from 5 to 20 years. The Company periodically re- evaluates the original assumptions and rationale utilized in the establishment of the carrying value and estimated lives of these assets. The criteria used for these evaluations include management's estimate of the asset's continuing ability to generate positive income from operations and positive cash flow in future periods as well as the strategic significance of the intangible asset to the Company's business objectives.\nCapitalized Software Costs. The Company's policy is to amortize capitalized software costs over the greater of (a) the ratio that current gross revenues for a product bears to the total of current and amortized future gross revenues for that product, or (b) the straight-line method over the remaining estimated economic life of the product including the period being reported on. Notwithstanding the above, the maximum amortization period is four years. It is reasonably possible that those estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both, could be reduced in the future which could significantly impact the carrying amount of the capitalized software costs.\nIncome Taxes. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. 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.\nPer Share Information. Per share information is based on the weighted average number of common shares and all dilutive common share equivalents outstanding (13,445,000 in 1995, 13,288,000 in 1994, and 11,739,000 in 1993). Common stock equivalents consist primarily of shares issuable upon the exercise of stock options. Conversion of preferred stock has not been assumed as the effect of the conversion would not be dilutive in any of the periods presented.\nRecent Accounting Pronouncements. The Financial Accounting Standards Board (\"FASB\") has 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 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. The FASB has also issued SFAS No. 123 \"Accounting for Stock-Based Compensation\". This Statement (No. 123) provides companies the option to account for employee stock compensation awards based on their estimated fair value at the date of grant, resulting in a charge to income in the period the awards are granted, or to present pro forma footnote disclosure describing the effect to the Company's net income and net income per share data as if the Company had adopted SFAS 123. SFAS 121 and SFAS 123 are effective for companies with fiscal years beginning after December 15, 1995. The Company has not yet determined what impact, if any, the adoption of SFAS 121 or SFAS 123 will have on the Company's financial statements or related disclosures thereto.\nNote 2. Restructuring\nIn early 1994, Titan sold its Applications Group (its Army training and simulation service business) as part of a formal plan of restructuring adopted at that time. The sale resulted in a pre-tax gain of approximately $12,700 and generated net cash proceeds of approximately $17,000. The gain on sale was substantially offset by provisions made for the estimated costs of planned disposals and\/or consolidations of certain operations deemed not compatible with the Company's long range strategy at that time. Such strategy was primarily reliant upon Titan internally funding the product development efforts and commercialization activities relating to its start-up ventures.\nThe Board of Directors adopted a new formal plan of restructuring for 1995 that redefined Titan's businesses into four business segments: Communications Systems, Software Systems, Defense Systems, and Emerging Technologies. Implementation of this restructuring plan provides for further disposition of businesses not central to the Company's long-term strategy as currently defined. Management believes these actions will better position the Company for growth and strategic transactions designed to increase shareholder value. The restructuring charge of $5,431 also provides for significant reorganization of the Software Systems segment and the sterilization business, reductions of personnel, and other actions associated with reorganizing the structure of the Company.\nAs explained above, Titan has historically funded growth for new business areas with internally generated funds, its bank line of credit and certain secured long-term debt. Presently, the Company intends to pursue various financing alternatives in order to provide additional funding for the development and commercialization of its emerging business areas. In management's opinion, the need for and the timing of these further restructuring activities were largely driven by management's plan to gain access to capital markets as a significant source of continued development funding. Should the Company be unable to successfully obtain outside funding, the level of investment in these emerging businesses could change.\nThe restructuring charge of $5,431 includes approximately $2,000 for severance which provides for the termination of a total of 84 employees throughout the Company. As of December 31, 1995, 12 employees had been terminated and a total of $318 had been charged against the accrual. The restructuring charge also includes approximately $3,400 for the exiting of businesses, which is net of a $1,450 pre-tax gain on the sale in September 1995 of the Company's shaped-charge munitions business. The charge includes estimates for direct costs of the planned disposals, termination of certain agreements, and other costs associated with selling or closing certain businesses. A total of $461 had been charged against the accrual as of December 31, 1995. This group of businesses had revenues of $19,384 and an operating loss of $298 in 1995.\nNote 3. Other Financial Data Following are details concerning certain balance sheet accounts:\n1995 1994 Accounts Receivable: U.S. Government - billed $ 14,449 $ 20,176 U.S. Government - unbilled 10,758 9,224 Trade 14,447 7,176 Less allowance for doubtful accounts (294) (412) $ 39,360 $ 36,164\nUnbilled receivables include approximately $5,000 at December 31, 1995 and 1994 representing work-in-process which will be billed in accordance with contract terms and delivery schedules. Also included in unbilled receivables are amounts billable upon final execution of contracts, contract completion, milestones or completion of rate negotiations. Generally, unbilled receivables are expected to be collected within one year. Payments to the Company for performance on certain U.S. Government contracts are subject to audit by the Defense Contract Audit Agency. Revenues have been recorded at amounts expected to be realized upon final settlement.\n1995 1994 Inventories: Materials $ 3,152 $ 2,921 Work-in-process 4,159 1,287 Finished goods 3,088 2,947 $ 10,399 $ 7,155\nProperty and Equipment: Machinery and equipment $ 23,429 $ 21,619 Furniture and fixtures 3,207 3,307 Leasehold improvements 3,503 2,818 Construction in progress 6,041 1,968 36,180 29,712\nLess accumulated depreciation and amortization (17,885) (16,780)\n$ 18,295 $ 12,932\nDeferred income taxes of $5,904 and $5,501 and capitalized software costs of $3,088 and $1,345 are included in Other Assets at December 31, 1995 and 1994, respectively. At December 31, 1995 and 1994, respectively, other liabilities, current and non-current, include $958 and $2,185 related to estimated losses on contracts. In addition, these captions include liabilities for post- retirement benefits for employees of previously discontinued operations of $3,016 and $3,134 at December 31, 1995 and 1994, respectively. Also included in other accrued liabilities are customer advance payments of approximately $1,653 and $1,503 at December 31, 1995 and 1994, respectively, and $4,914 and $3,814 related to restructuring activities at December 31, 1995 and 1994, respectively.\nNote 4. Segment Information\nIn 1995, Titan classified its businesses in four industry segments, Communications Systems, Software Systems, Defense Systems, and Emerging Technologies. This change from prior years more clearly reflects the nature of the Company's operations after restructuring. All prior year segment data have been restated to conform to the 1995 presentation. The Communications Systems segment contains two start-up business units, both targeting rapidly growing commercial markets. The first business unit, secure television, specializes in providing complete turnkey security for television delivery systems. The second business unit is satellite communications, which develops, manufactures and sells satellite earth station networks and related subsystems. The Software Systems segment provides custom and semi-custom software development services to assist customers in moving from older mainframe systems to distributed computing systems utilizing client\/server software. The Defense Systems segment, serving primarily the U.S. Government, includes satellite communications products; test and evaluation of complex systems; management and technical consulting; training and simulation support; and other consulting and engineering services. The Defense Systems segment also provides militarized computers. The Emerging Technologies segment contains a group of businesses including the start-up medical product sterilization services and systems and environmental consulting services businesses as well as several established businesses generally involved in broad-based technology development primarily for the U.S. Government. Substantially all operations are located in the United States. Export revenues amounted to approximately $14,240, $8,498, and $16,289 in 1995, 1994 and 1993, respectively, primarily to countries in Western Europe and the Far East.\nThe following tables summarize industry segment data for 1995, 1994 and 1993.\n1995 1994 1993 Revenues: Communications Systems $ 7,490 $ 6,319 $ 6,492 Software Systems 33,175 28,868 13,713 Defense Systems 67,948 78,780 103,071 Emerging Technologies 25,354 22,239 26,138\n$133,967 $136,206 $149,414\nSales to the United States Government, including both defense and non-defense agencies, and sales as a subcontractor as well as direct sales, aggregated approximately $81,632 in 1995, $93,107 in 1994, and $112,001 in 1993. In the Defense Systems segment, revenues in 1995 and 1994 included approximately $18,300 and $9,700, respectively, for work subcontracted to the buyer of the Applications Group which was sold in April 1994. There was no operating profit associated with these revenues. This contract is expected to conclude in mid-1996. Furthermore, 1995 Defense Systems revenues and operating profit included approximately $1,400 recovered from a termination for convenience claim with the U.S. Government for work performed in prior years. Within the Software Systems segment, sales to one customer, a telephone company, totalled $24,451, $24,323, and $9,712, in 1995, 1994 and 1993, respectively. No other single customer accounted for 10% or more of the consolidated revenues for these years. Intersegment sales were not significant in any year.\n1995 1994 1993 Operating Profit (Loss): Communications Systems $ (4,488) $ (7,927) $ (7,413) Software Systems 3,803 6,237 915 Defense Systems 4,456 4,725 (2,804) Emerging Technologies 14 (305) 947 Corporate (7,740) 6,905 (6,292)\n$(3,955) $ 9,635 $(14,647)\nThe Defense Systems segment includes Applications Group revenue of $11,913 and $31,700 and operating profit of $919 and $3,300 in 1994 through the date of sale and in the full year 1993, respectively.\nCorporate includes corporate general and administrative expenses, certain Corporate restructuring charges, and gains or losses from the sale of businesses. Corporate general and administrative expenses are generally recoverable from contract revenues by allocation to operations.\n1995 1994 1993 Identifiable Assets: Communications Systems $ 8,287 $ 4,813 $ 3,649 Software Systems 8,945 6,084 3,458 Defense Systems 39,587 38,859 58,625 Emerging Technologies 19,191 12,165 9,866 General corporate assets 19,160 19,982 17,616\n$95,170 $81,903 $93,214\nGeneral corporate assets are principally cash, prepaid expenses, deferred income taxes, and other assets.\n1995 1994 1993 Depreciation and Amortization of Property and Equipment, Goodwill, and Other Assets: Communications Systems $ 366 $ 387 $ 177 Software Systems 1,044 533 715 Defense Systems 1,744 1,838 2,813 Emerging Technologies 712 630 756 Corporate 251 36 34\n$ 4,117 $ 3,424 $ 4,495\nCapital Expenditures: Communications Systems $ 697 $ 397 $ 56 Software Systems 1,709 1,784 562 Defense Systems 1,431 2,003 1,598 Emerging Technologies 5,007 1,963 4,046 Corporate 144 97 39\n$ 8,988 $ 6,244 $ 6,301 Note 5. Income Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). This statement changed the criteria for the recognition and measurement of deferred tax assets and liabilities, including net operating loss carryforwards. Prior years' financial statements were not restated to apply the provisions of SFAS 109. The cumulative effect of the adoption of the accounting change was an increase in 1993 net income of $1,700 ($0.14 per share) relating to the recognition of additional net deferred tax assets.\nThe components of the income tax provision (benefit) are as follows:\n1995 1994 1993 Current: Federal $(2,232) $1,377 $(2,334) State (220) 203 --\n(2,452) 1,580 (2,334)\nDeferred 1,245 1,470 (4,213)\n$(1,207) $3,050 $(6,547)\nFollowing is a reconciliation of the income tax provision (benefit) expected (based on the United States federal income tax rate applicable in each year) to the actual tax provision (benefit) on income (loss):\n1995 1994 1993 Expected Federal tax provision (benefit) $(1,705) $3,061 $(5,492) State income taxes, net of Federal income tax benefits (44) 450 (540) Loss carryforwards\/carrybacks -- (216) -- Research credit -- (338) (570) Goodwill amortization 160 149 15 Alternative minimum tax 100 -- -- Keyman life insurance 75 83 60 Other 207 (139) (20) Actual tax provision (benefit) $(1,207) $ 3,050 $(6,547)\nDuring 1993, the Revenue Reconciliation Act of 1993 was signed into law which reinstated research tax credits retroactive to July 1, 1992. The retroactive application of the law increased the Company's 1992 research credit by $570 which is reflected in the income tax provision for the year ended December 31, 1993.\nThe deferred tax assets as of December 31, 1995 and 1994, result from the following temporary differences:\n1995 1994 Inventory and contract loss reserves $ 3,005 $ 4,102 Employee benefits 4,289 4,518 Restructuring 2,786 2,534 Tax credit carryforwards 815 1,315 Depreciation (1,875) (1,664) Loss carryforward 1,680 429 Other 1,213 236 11,913 11,470 Valuation allowance (1,200) (1,200)\nNet deferred tax assets $10,713 $10,270\nRealization of certain components of the net deferred tax asset is dependent on Titan generating sufficient taxable income prior to expiration of loss and credit carryforwards. Although realization is not assured, management believes 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 changed. Also, under Federal tax law, certain potential changes in ownership of the Company which may not be within the Company's control may limit annual future utilization of these carryforwards.\nNet tax refunds in 1995 were $828. Cash paid for income taxes was $1,252 and $309 in 1994 and 1993, respectively.\nNote 6. Debt\nAt December 31, 1995, the Company had debt outstanding of $9,200 under an unsecured bank line of credit at a weighted average interest rate of 8.13%. The Company also had commitments under letters of credit at December 31, 1995 of $1,070 which reduced availability of the line of credit. In May 1995, this bank line of credit was increased to $17,000 from $10,000 and the maturity date was extended from May 1996 to May 1997. The Company has the option to borrow at prime or at LIBOR plus 2 percent. The line of credit agreement requires Titan to have annual net income, as defined, prohibits two consecutive quarterly losses and contains other financial covenants which require the Company to maintain stipulated levels of tangible net worth, a minimum debt service coverage ratio and a specified quick ratio. A waiver was received relating to the 1995 net loss. No borrowings were outstanding under this agreement at December 31, 1994. Borrowings under the Company's lines of credit averaged $6,400, $4,180, and $14,200 at weighted average interest rates of 8.8%, 7.6% and 5.5% during 1995, 1994 and 1993, respectively.\nAt December 31, 1995 and 1994 the Company had $5,300 and $1,321, respectively, outstanding under two promissory notes, secured by certain machinery and equipment. The interest rates of the notes are 8.5% and 8.56%. In January 1996, the Company entered into another loan agreement for $2,500 at an interest rate of 7.42%, also secured by machinery and equipment. Part of the proceeds from this agreement were used to repay one of the promissory notes outstanding at December 31, 1995 with a principal balance of $765.\nCash paid for interest, primarily on these borrowings, was $572, $578, and $1,274 in 1995, 1994 and 1993, respectively.\nNote 7. Commitments and Contingencies\nTitan is obligated for aggregate rentals of $41,609 under operating lease agreements, principally for facilities. These leases generally include renewal options and require minimum payments of $5,426 in 1996, $4,936 in 1997, $4,452 in 1998, $3,810 in 1999, $3,475 in 2000 and $19,510 for the years thereafter. Rental expense under these leases was $7,496 in 1995, $7,367 in 1994 and $6,294 in 1993. The Company has entered into a long-term lease agreement for facilities which are owned by an entity in which the Company has a minority ownership interest. Rental expense in 1995, 1994 and 1993 includes $868, $838, and $824, respectively, paid under this agreement.\nThe Company is a party to four separate lawsuits filed by former employees claiming, among other things, wrongful termination and discrimination. The cases are scheduled for trial in March, April and June of 1996. The Company intends to continue to defend the cases vigorously. While it is not feasible to predict the outcome of these cases, management believes that their ultimate disposition will not have a material adverse effect on the financial position or results of operations of the Company.\nIn the ordinary course of business, defense contractors are subject to many levels of audit and investigation by various government agencies. Further, the Company and its subsidiaries are subject to claims and from time to time are named as defendants in 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.\nNote 8. Preferred Stock\nEach share of $1.00 cumulative convertible preferred stock is entitled to 1\/3 vote, annual dividends of $1 per share and is convertible at any time into 2\/3 share of the Company's common stock. Common stock of 463,248 shares has been reserved for this purpose. Upon liquidation, the $1.00 cumulative convertible preferred stockholders are entitled to receive $20 per share, plus cumulative dividends in arrears, before any distribution is made to the common stockholders.\nNote 9. Common Stock\nAt December 31, 1995, aggregate common shares reserved for future issuance for conversion of preferred stock, all stock incentive plans and warrants were 2,792,568.\nOn August 17, 1995, the Board of Directors adopted a Shareholder Rights Agreement and subsequently distributed one preferred stock purchase right (\"Right\") for each outstanding share of the Company's common stock. Each Right entitles the registered holder to purchase from the Company one one- hundredth of a share of Series A Junior Participating Preferred Stock, par value $1.00 per share (the \"Preferred Shares\") at a price of $42.00 per one one-hundredth of a Preferred Share, subject to adjustment. The Rights become exercisable if a person or group acquires, in a transaction not approved by the Company's Board of Directors (\"Board\"), 15% or more of the Company's common stock or announces a tender offer for 15% or more of the stock.\nIf a person or group acquires 15% or more of the Company's common stock, each Right (other than Rights held by the acquiring person or group which become void) will entitle the holder to receive upon exercise a number of shares of Company common stock having a market value of twice the Right's exercise price. If the Company is acquired in a transaction not approved by the Board, each Right may be exercised for common shares of the acquiring company having a market value of twice the Right's exercise price. The Company may redeem the Rights at $.01 per Right, subject to certain conditions. The Rights expire on August 17, 2005.\nIn September 1995, the Company completed a private placement of 300,000 shares of its common stock, receiving net proceeds of $2,325. Treasury shares were used for the issuance. The Company's shares were placed with offshore institutional investors pursuant to Regulation S under the Securities Act of 1933, as amended.\nNote 10. Stock Incentive Plans\nAt December 31, 1995, 1,218,811 shares of common stock were reserved for options granted under Titan's stock option plans for officers, directors and key employees. Options vest ratably over 4 years and expire up to 10 years from the date granted. The option price must not be less than the fair market value on the date of grant, and the provisions covering exercise are established at the date of grant by the option committee.\nA summary of changes in the shares under option is shown below:\nShares Issuable Under Options Outstanding Price Range\nBalance at December 31, 1992 1,837,014 $ 1.63 - 4.25 Options granted 536,500 2.63 - 3.50 Options exercised (129,716) 1.63 - 3.25 Options terminated (223,436) 1.63 - 4.25\nBalance at December 31, 1993 2,020,362 1.63 - 4.25 Options granted 369,000 2.63 - 6.63 Options exercised (855,212) 1.63 - 4.25 Options terminated (104,694) 1.63 - 4.25\nBalance at December 31, 1994 1,429,456 1.63 - 6.63 Options granted 429,000 5.75 - 9.50 Options exercised (454,629) 1.63 - 7.13 Options terminated (185,016) 1.63 - 6.63\nBalance at December 31, 1995 1,218,811 2.13 - 9.50\nAt December 31, 1995, and 1994, respectively, options for 451,521 and 568,816 shares were exercisable, and 509,944 and 814,706 shares were reserved for the granting of additional options in the future.\nNote 11. Benefit Plans\nThe Company has various defined contribution benefit plans covering certain employees. The Company's contributions to these plans were $2,514, $2,291, and $2,713 in 1995, 1994 and 1993, respectively. The Company's discretionary contributions to its Employee Stock Ownership Plan were $339 and $487 in 1994 and 1993, respectively. There were no discretionary contributions for 1995. During 1995, 1994 and 1993, the Company utilized treasury stock of $871, $1,267, and $1,551, respectively, for benefit plan contributions.\nThe Company has a non-qualified executive deferred compensation plan for certain officers and key employees. The Company's expense for this plan was $970, $668, and $680 in 1995, 1994, and 1993, respectively. At December 31, 1995 and 1994, respectively, Other Non-current Liabilities include $2,975 and $2,466 for obligations under this plan. Interest expense for the years ended December 31, 1995, 1994, and 1993 includes $486, $229, and $191, respectively, related to the plan. The Company also has performance bonus plans for certain of its employees. Related expense amounted to approximately $2,679, $5,220 and $1,708 in 1995, 1994 and 1993, respectively.\nThe Company has previously provided for post-retirement benefit obligations of operations discontinued in prior years. The Company has no post-retirement benefit obligations for any of its continuing operations.\nNote 12. Quarterly Financial Data (Unaudited)\nFirst Second Third Fourth Total 1995 Quarter Quarter Quarter Quarter(b) Year . Revenues $ 30,165 $ 34,307 $ 34,983 $ 34,512 $133,967 Gross profit 8,464 9,222 7,346 6,704 31,736 Net income (loss) 535 719 470 (5,531) (3,807) Net income (loss) per common share .03 .04 .02 (.41) (.33)\nFirst Second Third Fourth Total 1994 Quarter Quarter(a) Quarter Quarter Year . Revenues $ 39,689 $ 28,804 $ 29,541 $ 38,172 $ 136,206 Gross profit 8,249 7,400 9,382 11,254 36,285 Net income 751 1,773 1,514 1,915 5,953 Net income per common share .05 .12 .10 .13 .40\n(a) Net income in the second quarter of 1994 includes a net restructuring credit of $1,200.\n(b) Net loss in the fourth quarter of 1995 includes a net restructuring charge (see Note 2 of Notes to Consolidated Financial Statements).\nThe above financial information for each quarter reflects all normal and recurring adjustments.\nItem 9.","section_9":"Item 9. Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information required by Item 10 with respect to the directors and the executive officers of the Company is incorporated herein by this reference to such information in the definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by Item 11 is incorporated herein by this reference to such information in the definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 is incorporated herein by this reference to such information in the definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by Item 13 is incorporated herein by this reference to such information in the definitive 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 and 2. Financial statements being filed as part of this report are listed in the index in Item 8 on page 14.\n(b) The Company filed a current report on Form 8-K dated October 19, 1995 to report an amendment to the Company's bylaws.\n3. Exhibits\n3.1 Titan's Restated Certificate of Incorporation dated as of November 6, 1986 which was Exhibit 3.1 to Registrant's 1987 Annual Report on Form 10-K is incorporated herein by this reference. Titan's Certificate of Amendment of Restated Certificate of Incorporation dated as of June 30, 1987 which was Exhibit 3.2 to Registrant's 1987 Annual Report on Form 10-K is incorporated herein by this reference.\n3.2 Titan's by-laws, as amended, which was Exhibit 6(a)(3) to Registrant's Quarterly Report on Form 10-Q dated November 13, 1995 is incorporated herein by this reference.\n4.1 Warrant to Purchase Common Stock of Registrant issued to Corporate Property Associates 9, L.P., a Delaware limited partnership, which was Exhibit 4.1 to Registrant's Form 8-K dated July 11, 1991 is incorporated herein by this reference.\n4.2 Warrant to Purchase Common Stock of Registrant issued to Corporate Property Associates 10 Incorporated, a Maryland corporation, which was Exhibit 4.2 to Registrant's Form 8-K dated July 11, 1991 is incorporated herein by this reference.\n4.3 Rights Amendment, dated as of August 21, 1995, between The Titan Corporation and American Stock Transfer and Trust Company, which was Exhibit 1 to Registrant's Form 8-A dated September 5, 1995, is incorporated herein by this reference.\n10.1 Stock Option Plan of 1983, as amended though January 1, 1987, which was Exhibit 10.2 to Registrant's 1987 Annual Report on Form 10-K is incorporated herein by this reference.\n10.2 Stock Option Plan of 1986, as amended through January 1, 1987, which was Exhibit 10.3 to Registrant's 1987 Annual Report on Form 10-K is incorporated herein by this reference.\n10.3 Stock Option Plan of 1990, which was filed in the 1990 definitive proxy statement and was Exhibit 10.11 to Registrant's 1989 Annual Report on Form 10-K is incorporated herein by this reference.\n10.4 Stock Option Plan of 1994, which was filed in the 1994 definitive proxy statement and was Exhibit 10.17 to Registrant's 1993 Annual Report on Form 10-K is incorporated herein by this reference.\n10.5 1989 Directors' Stock Option Plan which was filed in the 1990 definitive proxy statement and was Exhibit 10.12 to Registrant's 1989 Annual Report on Form 10-K is incorporated herein by this reference.\n10.6 1992 Directors' Stock Option Plan which was filed in the 1993 definitive proxy statement and was Exhibit 10.14 to Registrant's 1992 Annual Report on Form 10-K is incorporated herein by this reference.\n10.7 1996 Directors' Stock Option and Equity Participation Plan.\n10.8 Supplemental Retirement Plan for Key Executives which was filed in the 1990 definitive proxy statement and was Exhibit 10.13 to Registrant's 1989 Annual Report on Form 10-K is incorporated herein by this reference.\n10.9 1995 Employee Stock Purchase Plan, which was Exhibit 4 to Registrant's Form S-8 dated December 18, 1995, is incorporated herein by this reference.\n10.10 Lease Agreement dated as of July 9, 1991 by and between Torrey Pines Limited Partnership, a California limited partnership, as landlord, and Registrant, as tenant, which was Exhibit 10.1 to Registrant's Form 8-K dated July 11, 1991 is incorporated herein by this reference.\n10.11 Secured Promissory Note and Security Agreement dated as of April 14, 1993 by and between Fleet Credit Corporation and Registrant, which was Exhibit 10.16 to Registrant's 1993 Annual Report on Form 10-K, is incorporated herein by this reference.\n10.12 Asset Purchase Agreement as of March 5, 1994, by and between Registrant and Cubic Corporation which was Exhibit 2 to Registrant's Form 8-K dated March 5, 1994 is incorporated herein by this reference.\n10.13 Line of Credit Agreement dated as of August 8, 1994, by and between Sumitomo Bank of California and Registrant, which was Exhibit 10.16 to Registrant's 1994 Annual Report on Form 10-K, is incorporated herein by this reference.\n10.14 Executive Severance Plan entered into by the Company with Gene W. Ray, John E. Koehler, Ronald B. Gorda, David A. Hahn, Roger Hay, Cornelius L. Hensel, Frederick L. Judge and Stephen P. Meyer, which was Exhibit 6(a)(10) to Registrant's Quarterly Report on Form 10-Q dated November 13, 1995, is incorporated herein by this reference.\n10.15 First Amendment to Commercial Loan Agreement dated May 25, 1995 by and between Registrant and Sumitomo Bank of California.\n10.16 Second Amendment to Commercial Loan Agreement dated December 29, 1995 by and between Registrant and Sumitomo Bank of California.\n10.17 Loan and Security Agreement, dated December 29, 1995 by and between Registrant and Capital Associates International, Inc.\n10.18 Loan and Security Agreement dated January 31, 1996 by and between Registrant and Sanwa General Equipment Leasing, a division of Sanwa Business Credit Corporation.\n21. Titan Subsidiaries as of December 31, 1995.\n23. Consent of Independent Public Accountants.\n27. Financial Data Schedule\nTHE TITAN CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the years ended December 31, 1995, 1994 and 1993 (in thousands of dollars)\nBalance Balance at at beginning end of year Additions Deductions of year\n1995: Allowance for doubtful accounts $ 412 $ 193 $ 311 $\n1994: Allowance for doubtful accounts 764 1 353\n1993: Allowance for doubtful accounts 555 561 352\nEXHIBIT 21\nSUBSIDIARIES OF THE TITAN CORPORATION\nState or Jurisdiction Name of Incorporation\nFederal Services, Inc.......................................... California Pulse Sciences, Inc............................................ California Titan Environmental Corporation................................ Delaware Titan Information Systems Corporation.......................... Delaware Titan Beam International Group................................. Delaware Tomotherapeutics, Inc.......................................... Delaware\nEXHIBIT 23\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report, dated February 28, 1996, into the Company's previously filed Registration Statements (as amended, as applicable) File Numbers 33-4830, 33- 4041, 33-9570, 33-12119, 33-15680, 33-15892, 33-37827, 33-56762, 33-65123, and 33-83402.\nARTHUR ANDERSEN LLP\nSan Diego, California March 29, 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.\nTHE TITAN CORPORATION\nBy \/s\/ Gene W. Ray President and Chief Executive Officer\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.\nSignature Title Date\n\/s\/ Chairman of the March 29, 1996 J.S. Webb Board of Directors\n\/s\/ President, Chief March 29, 1996 Gene W. Ray Executive Officer and Director\n\/s\/ Senior Vice President and March 29, 1996 Roger Hay Chief Financial Officer (Principal Financial Officer)\n\/s\/ Vice President and March 29, 1996 Jane E. Judd Corporate Controller (Principal Accounting Officer)\n\/s\/ Director March 29, 1996 Charles R. Allen\n\/s\/ Director March 29, 1996 Joseph F. Caligiuri\n\/s\/ Director March 29, 1996 Daniel J. Fink\n\/s\/ Director March 29, 1996 Robert E. La Blanc\n\/s\/ Director March 29, 1996 Thomas G. Pownall\nLOAN AND SECURITY AGREEMENT\nTHIS LOAN AND SECURITY AGREEMENT (the \"Agreement\") is made as of the 31st day of January, 1996, by and between SANWA GENERAL EQUIPMENT LEASING, A DIVISION OF SANWA BUSINESS CREDIT CORPORATION, its successors and assigns (\"Lender\"), and THE TITAN CORPORATION (\"Borrower\").\nBorrower is desirous of obtaining a loan from Lender and Lender is willing to make the loan to Borrower upon the terms and conditions set forth herein.\nNOW, THEREFORE, in consideration of the sum of Ten Dollars ($10.00) in hand paid and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties do hereby agree as follows:\n1. Advance of Loan.\n(a) On the terms and conditions hereinafter set forth, the parties agree that Lender shall lend to Borrower certain sums (the \"Loan\") on the terms specified pursuant to that certain commitment letter dated January 3 , 1996 (the \"Commitment Letter\"; which is incorporated herein by reference). Time is of the essence.\n(b) The obligation to repay the Loan hereunder shall be evidenced by one or more promissory notes payable by Borrower to the order of Lender in substantially the form attached hereto as Exhibit No. 1 (hereinafter collectively referred to as the \"Promissory Note\"). The Promissory Note shall bear interest, be payable and mature as set forth in Exhibit No. 1.\n(c) The commitment of Lender to make the Loan herein shall expire on the date specified in the Commitment Letter, provided, however, that such commitment shall terminate (at Lender's option) upon the occurrence of any Default (as such term is hereinafter defined) or of any event which, with the giving of notice or lapse of time, or both, would become a Default hereunder.\n2. Security. As security for the payment as and when due of the indebtedness of Borrower to Lender hereunder and under Borrower's Promissory Note (and any renewals, extensions and modifications thereof) and under any other agreement or instrument, both now in existence and hereafter created related to the transaction described in this Agreement (as the same may be renewed, extended or modified), and the performance as and when due of all other obligations of Borrower to Lender, both now in existence and hereafter created related to the transaction described in this Agreement (as the same may be renewed, extended or modified) (the \"Obligations\"), Borrower hereby grants to Lender a purchase money security interest in the items of equipment (the \"Equipment\") described on the collateral schedule(s) in substantially the form attached hereto as Exhibit No. 2 (hereinafter collectively referred to as the \"Collateral Schedule\") now or hereafter executed in connection with the Promissory Note, and all replacements, substitutions and alternatives therefor and thereof and accessions thereto and all proceeds (cash and non-cash), including the proceeds of all insurance policies, thereof (the \"Collateral\"). Borrower agrees that with respect to the Collateral Lender shall have all of the rights and remedies of a secured party under the Maryland Uniform Commercial Code (the \"UCC\"). Borrower may not dispose of any of the Collateral without the prior written consent of Lender, notwithstanding the fact that proceeds constitute a part of the Collateral.\n3. Conditions Precedent to Lender's Obligation. The obligation of lender to make the Loan as set forth in Section 1 hereof is expressly conditioned upon compliance by Borrower, to the reasonable satisfaction of Lender and its counsel, of the following conditions precedent:\n(a) Concurrently with the execution hereof, or on or prior to the date on which Lender is to advance the Loan hereunder, Borrower shall cause to be provided to Lender the following:\n(1) Resolutions of the Board of Directors or validly authorized Executive Committee of Borrower, certified by the Secretary or an Assistant Secretary of Borrower, duly authorizing the borrowing of funds hereunder and the execution, delivery and performance of this Agreement and all related instruments and documents.\n(2) An opinion of counsel for Borrower satisfactory as to form and substance to Lender, as to each of the matters set forth in sub-parts (a) through (e) of Section 4 hereof and as to such other matters as Lender may reasonably request.\n(3) Uniform Commercial Code Financing Statements duly executed on behalf of Borrower.\n(b) On each date on which Lender is to advance funds hereunder,\n(1) Borrower shall cause to be provided to Lender the following:\na. A certificate executed by the Secretary or an Assistant Secretary of Borrower, certifying that the representations and warranties of Borrower contained herein remain true and correct as of such date, and that no Default or event which, with the giving of notice or the lapse of time, or both, would become a Default hereunder, has then occurred.\nb. Evidence satisfactory to Lender as to due compliance with the insurance provisions of Section 5(f) hereof.\nc. A Promissory Note in the amount of the Loan to be advanced on such date, duly executed on behalf of Borrower, pursuant to Section 1 hereof.\nd. Photocopies of the invoice(s) or other evidence reasonably satisfactory to Lender and its counsel, related to the acquisition cost of the Collateral to which such advance of the Loan relates.\ne. A Collateral Schedule describing the Collateral to which such advance of the Loan relates.\n(2) Such filings shall have been made and other actions taken as reasonably may be required by Lender and its counsel to perfect a valid, first priority security interest granted by Borrower to Lender with respect to the Collateral.\n(3) No Default or event which, with the giving of notice or lapse of time, or both, would become a Default hereunder, shall have occurred.\n4. Representations and Warranties. Borrower hereby represents and warrants that:\n(a) Borrower is a corporation duly organized, and validly existing in good standing under the laws of the state of its incorporation; and is duly qualified and authorized to transact business as a foreign corporation in good standing in each state in which the Collateral is to be located.\n(b) Borrower has the corporate power and authority to own or hold under lease its properties and to enter into and perform its obligations hereunder; and the borrowing hereunder by Borrower from Lender, the execution, delivery and performance of this Agreement and all related instruments and documents, (1) have been duly authorized by all necessary corporate action on the part of Borrower; (2) do not require any stockholder approval or approval or consent of any trustee or holders of any indebtedness or obligations of Borrower except such as have been duly obtained; and (3) do not and will not contravene any law, governmental rule, regulation or order now binding on Borrower, or the certificate of incorporation or by-laws of Borrower, or contravene the provisions of, or constitute a default under, or result in the creation of any lien or encumbrance upon the property of Borrower under any agreement to which Borrower is a party or by which it or its property is bound.\n(c) Neither the execution and delivery by Borrower of this Agreement and all related instruments and documents, nor the consummation of any of the transactions by Borrower contemplated hereby or thereby, requires the consent or approval of, the giving of notice to, the registration with, or the taking of any other action in respect of, any Federal, state or foreign governmental authority or agency, except as provided herein.\n(d) This Agreement constitutes, and all related instruments and documents when entered into will constitute, the legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with the terms hereof and thereof, except as limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws or equitable principles relating to or affecting the enforcement of creditors' rights generally, and by applicable laws (including any applicable common law and equity) and judicial decisions which may affect the remedies provided herein and therein.\n(e) Other than as set forth in Schedule 4(e) hereto, there are no pending or threatened actions or proceedings to which Borrower is a party, and there are no other pending or threatened actions or proceedings of which Borrower has knowledge, before any court, arbitrator or administrative agency, which, either individually or in the aggregate, would materially adversely affect the financial condition of Borrower, or the ability of Borrower to perform its obligations hereunder. Further, Borrower is not in default under any material obligation for the payment of borrowed money, for the deferred purchase price of property or for the payment of any rent which, either individually or in the aggregate, would have the same such effect.\n(f) Under the laws of the state(s) in which the Equipment is to be located, the Equipment consists solely of personal property and not fixtures (with the exception of the cell).\n(g) Upon payment in full of the acquisition cost of the Equipment, Borrower will have good and marketable title to the Equipment, free and clear of all liens and encumbrances (excepting only the lien of Lender). Upon the last to occur of: (1) delivery of an item of Equipment, (2) payment to the vendor of the acquisition cost of such item of the Equipment, (3) advance by Lender to Borrower of the Loan relating to such item of the Equipment, and (4) filing in the appropriate public offices of Uniform Commercial Code financing statements or statements of amendment naming Borrower as debtor, and Lender as secured party, and describing such item of the Equipment, Lender will have a valid, perfected, first priority security interest in such item of the Equipment.\n(h) The financial statements of Borrower (copies of which have been furnished to Lender) have been prepared in accordance with generally accepted accounting principles consistently applied (\"GAAP\"), and fairly present Borrower's financial condition and the results of Borrower's operations as of the date of and for the period covered by such statements, and since the date of such statements there has been no material adverse change in such conditions.\n(i) Borrower has filed or has caused to have been filed all federal, state and local tax returns which, to the knowledge of Borrower, are required to be filed, and has paid or caused to have been paid all taxes as shown on such returns or on any assessment received by it, to the extent that such taxes have become due, unless and to the extent only that such taxes, assessments and governmental charges are currently contested in good faith and by appropriate proceedings by Borrower and adequate reserves therefor have been established as required under GAAP. To the extent Borrower believes it advisable to do so, Borrower has set up reserves which are believed by Borrower to be adequate for the payment of additional taxes for years which have not been audited by the respective tax authorities.\n(j) Borrower is not in violation of any law, ordinance, governmental rule or regulation to which it is subject and the violation of which would have a material adverse effect on the conduct of its business, and Borrower has obtained any and all licenses, permits, franchises or other governmental authorizations necessary for the ownership of its properties and the conduct of its business, the violation of which would have a material adverse effect on the conduct of its business.\n(k) None of the proceeds of the Loan will be used, directly or indirectly, by Borrower for the purpose of purchasing or carrying, or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase or carry, any \"margin security\" within the meaning of Regulation G (12 CFR Part 207), or \"margin stock\" within the meaning of Regulation U (12 CFR Part 221), of the Board of Governors of the Federal Reserve System (herein called \"margin security\" and \"margin stock\") or for any other purpose which might make the transactions contemplated herein a \"purpose credit\" within the meaning of Regulation G or Regulation U, or cause this Agreement to violate any other regulation of the Board of Governors of the Federal Reserve System or the Securities Exchange Act of 1934 or the Small Business Investment Act of 1958, as amended, or any rules or regulations promulgated under any of such statutes.\n(l) The address stated below the signature of Borrower is the chief place of business and chief executive office of Borrower.\n5. Covenants of Borrower. Borrower covenants and agrees as follows:\n(a) The proceeds of the Loan will be used exclusively for business or commercial purposes and to refinance the indebtedness secured by the Equipment.\n(b) Borrower shall use the Collateral solely in the conduct of its business and in a careful and proper manner; and shall not change the location of any item of the Collateral, as specified on the applicable Collateral Schedule, without the prior written consent of Lender, which shall not unreasonably be withheld.\n(c) Borrower shall not dispose of or further encumber its interest in the Collateral without the prior written consent of Lender.\n(d) Borrower, at its own expense, will pay or cause to be paid all taxes and fees relating to the ownership and use of the Equipment and will keep and maintain, or cause to be kept and maintained, the Equipment in accordance with the manufacturer's recommended specifications, and in as good operating condition as on the date of execution hereof (or on the date on which acquired, if such date is subsequent to the date of execution hereof), ordinary wear and tear resulting from proper use thereof alone excepted, and will provide all maintenance and service and make all repairs necessary for such purpose. In addition, if any parts or accessories forming part of the Equipment shall from time to time become worn out, lost, destroyed, damaged beyond repair or otherwise permanently rendered unfit for use, Borrower, at its own expense, will within a reasonable time replace such parts or accessories or cause the same to be replaced, with replacement parts or accessories which are free and clear of all liens, encumbrances or rights of others and have a value and utility at least equal to the parts or accessories replaced. All accessories, parts and replacements for or which are added to or become attached to the Equipment shall immediately be deemed incorporated in the Equipment and subject to the security interest granted by Borrower herein. Upon reasonable advance notice, Lender shall have the right to inspect the Equipment and all maintenance records thereto, if any, at any reasonable time.\n(e) The parties intend that the Equipment shall remain personal property, notwithstanding the manner in which it may be affixed to any real property, and Borrower shall obtain and deliver to Lender (to be recorded at Borrower's expense) from the landlord and any mortgagee having an encumbrance or lien on the property (the \"Premises\") where the Equipment is to be located, waivers of any lien, encumbrance or interest which such person might have or hereafter obtain or claim with respect to the Equipment. Borrower shall maintain the Equipment free from all claims, liens and legal processes of creditors of Borrower other than liens (1) for fees, taxes, or other governmental charges of any kind which are not yet delinquent or are being contested in good faith by appropriate proceedings which suspend the collection thereof (provided, however, that such proceedings do not involve any substantial danger of the sale, forfeiture or loss of the Equipment or any interest therein); (2) liens of mechanics, materialmen, laborers, employees or suppliers and similar liens arising by operation of law incurred by Borrower in the ordinary course of business for sums that are not yet delinquent or are being contested in good faith by negotiations or by appropriate proceedings which suspend the collection thereof (provided, however, that such contest does not involve any substantial danger of the sale, forfeiture or loss of the Equipment or any interest therein); and (3) liens arising out of any judgments or awards against Borrower which have been adequately bonded to protect Lender's interests or with respect to which a stay of execution has been obtained pending an appeal or a proceeding for review. Borrower shall notify Lender immediately upon receipt of notice of any lien, attachment or judicial proceeding affecting the Equipment in whole or in part.\n(f) At its own expense, Borrower shall keep the Equipment or cause it to be kept insured against loss or damage due to fire and the risks normally included in extended coverage, malicious mischief and vandalism, for the full replacement value thereof. All insurance for loss or damage shall provide that losses, if any, shall be payable to Lender. The proceeds of such insurance payable as a result of loss of or damage to the Equipment shall be applied, at Lender's reasonable option, (x) toward the replacement, restoration or repair of the Equipment which may be lost, stolen, destroyed or damaged, or (y) toward payment of the balance outstanding on the Promissory Note or the Obligations. In addition, Borrower shall also carry public liability insurance, both personal injury and property damage. All insurance required hereunder shall be in form and amount and with companies reasonably satisfactory to Lender. Borrower shall pay or cause to be paid the premiums therefor and deliver to Lender evidence satisfactory to Lender of such insurance coverage. Borrower shall cause to be provided to Lender, not less than fifteen (15) days prior to the scheduled expiration or lapse of such insurance coverage, evidence satisfactory to Lender of renewal or replacement coverage. Each insurer shall agree, by endorsement upon the policy or policies issued by it, or by independent instrument furnished to Lender, that (1) it will give Lender thirty (30) days' (10 days notice for non-payment of premium) prior written notice of the effective date of any material alteration or cancellation of such policy; and (2) insurance as to the interest of any named loss payee other than Borrower shall not be invalidated by any actions, inactions, breach of warranty or conditions or negligence of Borrower with respect to such policy or policies.\n(g) Borrower shall promptly and duly execute and deliver to Lender such further documents, instruments and assurances and take such further action as Lender may from time to time reasonably request in order to carry out the intent and purpose of this Agreement and to establish and protect the rights and remedies created or intended to be created in favor of Lender hereunder; including, without limitation, the execution and delivery of any Uniform Commercial Code Financing Statement or other document reasonably required, and payment of all necessary costs to record such documents (including payment of any documentary or stamp tax), to perfect and maintain perfected the security interest granted under this Agreement.\n(h) Borrower shall provide written notice to Lender (1) thirty (30) days prior to any contemplated change in the name or address of Borrower or of Borrower's corporate structure such that a filed financing statement would become seriously misleading (within the meaning of the UCC); and (2) promptly upon the occurrence of any event which constitutes a Default (as hereinafter defined) hereunder or which, with the giving of notice, lapse of time or both, would constitute a Default hereunder.\n(i) Borrower shall furnish Lender (1) within one hundred twenty (120) days after the end of each fiscal year of Borrower, its 10-K Report and balance sheet as at the end of such year, and the related statement of income and statement of changes in financial position for such fiscal year, prepared in accordance with GAAP, all in reasonable detail and certified by independent certified public accountants of recognized standing selected by Borrower (which shall be a \"Big 6\" accounting firm); (2) within ninety (90) days after the end of each quarter of Borrower's fiscal year, its 10-Q Report and balance sheet as at the end of such quarter and the related statement of income and statement of changes in financial position for such quarter, prepared in accordance with GAAP; and (3) within thirty (30) days after the date on which they are filed, all reports, forms and other filings required to be made by Borrower to the Securities and Exchange Commission, if any.\n(j) Borrower shall at all times maintain its corporate existence except as expressly permitted herein. Borrower shall not consolidate with, merge into, or convey, transfer or lease substantially all of its assets as an entirety to (such actions being referred to as an \"Event\"), any Person (which term, for the purposes of this paragraph means any individual, corporation, partnership, joint venture, association, joint-stock company, trust, unincorporated organization, or government or any agency or political subdivision thereof), unless (not less than sixty (60) days before the Event):\n(1) such Person shall be an entity organized and existing under the laws of the United States of America or any state or the District of Columbia, and shall execute and deliver to Lender an agreement containing an effective assumption by such Person of the due and punctual performance and observance of each covenant and condition of this Agreement to be performed or observed by Borrower; and\n(2) Lender is reasonably satisfied as to the creditworthiness of such Person.\n(k) Borrower shall provide written notice to Lender of the commencement of proceedings under the Federal bankruptcy laws or other insolvency laws (as now or hereafter in effect) involving Borrower as a debtor.\n(l) Borrower shall indemnify and defend Lender, its successors and assigns, and their respective directors, officers and employees, from and against any and all claims, actions and suits (including, without limitation, related attorneys' fees) of any kind, nature or description whatsoever arising, directly or indirectly, in connection with any of the Collateral, including (without limitation) any rent paid to the landlord of the Premises, and all costs of repair or restoration of the Premises (in each case, (other than such as may result from the gross negligence or willful misconduct of Lender, its successors and assigns, and their respective directors, officers and employees).\n(m) Borrower has conducted, and will continue to conduct its business operations, and so long as any Obligations remains outstanding will use the Collateral, so as to comply with all Environmental Laws in all material respects; as of the date hereof, and as of the date of execution of each Collateral Schedule, except as have been previously disclosed in writing by Borrower to Lender, there are no Hazardous Substances generated, treated, handled, stored, transported, discharged, emitted, released or otherwise disposed of in connection with Borrower's use of the Collateral resulting in any material liability or obligations; and Borrower has, and so long as any Obligations remains outstanding will continue to have in full force and effect all federal, state and local licenses, permits, orders and approvals required to operate the Collateral in compliance with all Environmental Laws in all material respects.\nAs used herein, the following terms shall have the following meaning:\n(A) \"Adverse Environmental Condition\" shall mean (i) the existence or the continuation of the existence of an Environmental Contamination (including, without limitation, a sudden or non-sudden accidental or non-accidental Environmental Contamination), or exposure to any substance, chemical, material, pollutant, Hazardous Substance, odor or audible noise or other release or emission in, into or onto the environment (including without limitation, the air, ground, water or any surface) at, in, by, from or related to any Collateral, (ii) the environmental aspect of the transportation, storage, treatment or disposal of materials in connection with the operation of any Collateral, or (iii) the violation, or alleged violation, of any Environmental Law, permits or licenses of, by or from any governmental authority, agency or court relating to environmental matters connected with any of the Collateral.\n(B) \"Environmental Claim\" shall mean any accusation, allegation, notice of violation, claim, demand, abatement or other order on direction (conditional or otherwise) by any governmental authority or any Person for personal injury (including sickness, disease or death), tangible or intangible property damage, damage to the environment or other adverse affects on the environment, or for fines, penalties or restrictions, resulting from or based upon any Adverse Environmental Condition.\n(C) \"Environmental Contamination\" shall mean any actual or threatened release, spill, emission, leaking, pumping, injection, presence, deposit, abandonment, disposal, discharge, dispersal, leaching or migration into the indoor or outdoor environment, or into or out of any of the Collateral, including, without limitation, the movement of any Hazardous Substance or other substance through or in the air, soil, surface water, groundwater or property which is not in compliance with applicable Environmental Laws.\n(D) \"Environmental Law\" shall mean any present or future federal, foreign, state or local law, ordinance, order, rule or regulation and all judicial, administrative and regulatory decrees, judgments and orders, pertaining to health, industrial hygiene, the use, disposal or transportation of Hazardous Substances, Environmental Contamination, or pertaining to the protection of the environment, including, but not limited to, the Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\") (42 U.S.C. 9601 et seq.), the Hazardous Material Transportation Act (49 U.S.C. 1801 et seq.), the Federal Water Pollution Control Act (33 U.S.C. Section 1251 et seq.), the Resource Conservation and Recovery Act (42 U.S.C. 6901 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 Federal Insecticide, Fungicide, and Rodenticide Act (7 U.S.C. 1361 et seq.), the Occupational Safety and Health Act (19 U.S.C. 651 et seq.), the Hazardous and Solid Waste Amendments (42 U.S.C. 2601 et seq.),\nas these laws have been or may be amended or supplemented, and any successor thereto, and any analogous foreign, state or local statutes, and the rules, regulations and orders promulgated pursuant thereto.\n(E) \"Environmental Loss\" shall mean any loss, cost, damage, liability, deficiency, fine, penalty or expense (including, without limitation, reasonable attorneys' fees, engineering and other professional or expert fees), investigation, removal, cleanup and remedial costs (voluntarily or involuntarily incurred) and damages to, loss of the use of or decrease in value of the Collateral arising out of or related to any Adverse Environmental Condition.\n(F) \"Hazardous Substances\" shall mean and include hazardous substances as defined in CERCLA; oil of any kind, petroleum products and their by- products, including, but not limited to, sludge or residue; asbestos containing materials; polychlorinated biphenyls; any and all other hazardous or toxic substances; hazardous waste, as defined in CERCLA; medical waste; infectious waste; those substances listed in the United States Department of Transportation Table (49 C.F.R. 172.101); explosives; radioactive materials; and all other pollutants, contaminants and other substances regulated or controlled by the Environmental Laws and any other substance that requires special handling in its collection, storage, treatment or disposal under the Environmental Laws.\n(G) \"Person\" shall mean any individual, partnership, corporation, trust, unincorporated organization, government or department or agency thereof and any other entity.\n6. Default. Borrower shall be deemed to be in default hereunder (\"Default\") if (a) Borrower shall fail to make any payment of the Obligations as and when due, and such failure shall continue unremedied for a period of ten (10) days after the same shall have become due; or (b) Borrower shall fail to provide the insurance required pursuant to Section 5(f) hereof; or (c) Borrower's Net Worth shall not be equal to or exceed Thirty-Five Million Dollars ($35,000,000.00) as of the end of each of Borrower's fiscal quarters (i.e. March 31, June 30, September 30 and December 31) during the term of this Agreement; or (d) Borrower shall fail to perform or observe in timely fashion any other covenant, condition or agreement to be performed or observed by it hereunder or under the Promissory Note and such failure shall continue unremedied for a period of thirty (30) days after written notice thereof to Borrower by Lender; or (e) Borrower shall (1) be generally not paying its debts as they become due, (2) take action for the purpose of invoking the protection of any bankruptcy or insolvency law, or any such law is invoked against or with respect to Borrower or its property, and any such petition filed against Borrower is not dismissed within sixty (60) days; or (f) any certificate, statement, representation, warranty or audit contained herein or heretofore or hereafter furnished with respect hereto by or on behalf of Borrower proving to have been false in any material respect at the time as of which the facts therein set forth were stated or certified, or having omitted any substantial contingent or unliquidated liability or claim against Borrower; or (g) Borrower shall be in default under any obligation for the payment of borrowed money, for the deferred purchase price of property or for the payment of any rent, and the applicable grace period with respect thereto shall have expired; or (h) an individual, group of individuals or entity, who did not own fifty (50) percent or more of Borrower's capital stock as of the date hereof, becomes the owner of fifty (50) percent or more of Borrower's capital stock and at such time Borrower's Debt to Tangible Net Worth equals or exceeds twice the ratio of Borrower's Debt to Tangible Net Worth as of the date of this Agreement, without the prior written consent of Lender. As used herein, \"Debt\" shall mean Borrower's total liabilities which, in accordance with GAAP, would be included in the liability side of a balance sheet; and \"Tangible Net Worth\" shall mean Borrower's tangible net worth including the sum of the par or stated value of all outstanding capital stock, surplus and undivided profits, less any amounts attributable to goodwill, patents, copyrights, mailing lists, catalogs, trademarks, bond discount and underwriting expenses, organization expense and other intangibles. Accounting terms used herein shall be as defined, and all calculations hereunder shall be made, in accordance with GAAP.\nThe occurrence of a Default with respect to any Promissory Note shall, at the sole discretion of Lender (as set forth in a written declaration to Borrower), constitute a Default with respect to any or all of the other Promissory Notes. Notwithstanding anything to the contrary set forth herein, Lender or its assignee(s) (as applicable) may exercise all rights and remedies hereunder or under a Promissory Note independently with respect to each Promissory Note and\/or with respect to the Collateral collateralizing such Promissory Note.\n7. Remedies. Upon the occurrence of a Default hereunder, Lender may, at its option, declare this Agreement to be in default with respect to any or all of the Promissory Notes, and at any time thereafter may do any one or more of the following, all of which are hereby authorized by Borrower:\n(a) Exercise any and all rights and remedies of a secured party under the UCC in effect in the State of Maryland at the date of this Agreement and in addition to those rights, at its sole discretion, may require Borrower (at Borrower's sole expense) to forward promptly any or all of the Collateral to Lender at such location as shall reasonably be required by Lender, or enter upon the premises where any such Collateral is located (without obligation for rent) and take immediate possession of and remove the Collateral by summary proceedings or otherwise, all without liability from Lender to Borrower for or by reason of such entry or taking of possession, whether for the restoration of damage to property caused by such taking or otherwise (other than liability caused by the gross negligence or willful misconduct of Lender or its agents).\n(b) Subject to any right of Borrower to redeem the Collateral, sell, lease or otherwise dispose of any or all of the Collateral in a commercially reasonable manner at public or private sale with notice to Borrower (the parties agreeing that ten (10) days' prior written notice shall constitute adequate notice of such sale) at such price as it may deem best, for cash, credit, or otherwise, with the right of Lender to purchase and apply the proceeds:\nFirst, to the payment of all reasonable expenses and charges, including the expenses of any sale, lease or other disposition, the reasonable expenses of any taking, attorneys' fees, court costs and any other reasonable expenses incurred or advances made by Lender in the protection of its rights or the pursuance of its remedies, and to provide adequate indemnity to Lender against all taxes and liens which by law have, or may have, priority over the rights of Lender to the monies so received by Lender;\nSecond, to the payment of the Obligations; and\nThird, to the payment of any surplus thereafter remaining to Borrower or to whosoever may be entitled thereto;\nand in the event that the proceeds are insufficient to pay the amounts specified in clauses \"First\" and \"Second\" above, Lender may collect such deficiency from Borrower.\n(c) Lender may exercise any other right or remedy available to it under this Agreement, the Promissory Note, or applicable law, or proceed by appropriate court action to enforce the terms hereof or to recover damages for the breach hereof or to rescind this Agreement in whole or in part.\nIn addition, Borrower shall be liable for any and all unpaid additional sums due hereunder or under the Promissory Note, before, after or during the exercise of any of the foregoing remedies; for all reasonable legal fees and other reasonable costs and expenses incurred by reason of any default or of the exercise of Lender's remedies with respect thereto. No remedy referred to in this Section is intended to be exclusive, but each shall be cumulative, and shall be in addition to any other remedy referred to above or otherwise available at law or in equity, and may be exercised concurrently or separately from time to time. Borrower hereby waives any and all existing or future claims to any offset against the sums due hereunder or under the Promissory Note and agrees to make the payments regardless of any offset or claim which may be asserted by Borrower or on its behalf in connection with this Agreement.\nThe failure of Lender to exercise, or delay in the exercise of, the rights granted hereunder upon any Default by Borrower shall not constitute a waiver of any such right upon the continuation or recurrence of any such Default. Lender may take or release other security; may release any party primarily or secondarily liable for the Obligations; may grant extensions, renewals or indulgences with respect to the Obligations and may apply any other security therefor held by it to the satisfaction of the Obligations without prejudice to any of its rights hereunder.\n8. Notices. All notices (excluding billings and communications in the ordinary course of business) hereunder shall be in writing, personally delivered, sent by overnight courier service, sent by facsimile telecopier, or sent by certified mail, return receipt requested, addressed to the other party at its respective address stated below the signature of such parties or at such other addresses as such parties shall from time to time designate in writing to the other parties; and shall be effective from the date of receipt.\n9. Lender's Right to Perform for Borrower. If Borrower fails to perform or comply with any of its agreements contained herein, Lender shall have the right, but shall not be obligated, to effect such performance or compliance, and the amount of any reasonable out-of-pocket expenses (including reasonable outside attorney's fees) thereby incurred, together with interest thereon at the Late Charge Rate (as defined in the Promissory Note), shall be due and payable by Borrower upon demand.\nBorrower hereby irrevocably appoints Lender as Borrower's attorney-in-fact (which power shall be deemed coupled with an interest) to execute, endorse and deliver any deed, conveyance, assignment or other instrument in writing as may be required to vest in Lender any right, title or power which by the terms hereof are expressed to be conveyed to or conferred upon Lender, including, without limitation, Uniform Commercial Code financing statements (including continuation statements), real property waivers, and documents and checks or drafts relating to or received in payment for any loss or damage under the policies of insurance required by the provisions of Section 5(f) hereof, but only to the extent that the same relates to the Collateral.\n10. Successors and Assigns. This Agreement shall inure to the benefit of Lender, its successors and assigns, and shall be binding upon the successors of Borrower. This Agreement may not be assigned by Borrower without the consent of Lender, which consent shall not be unreasonably withheld; provided however, that Borrower may assign this Agreement to any subsidiary which succeeds to the operations of the business utilizing the Collateral provided that the Borrower shall remain primarily liable for all obligations hereunder and such subsidiary shall execute an agreement evidencing such assignment in form and content reasonably satisfactory to the Lender. Lender reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Lender's rights and obligations hereunder, in the Promissory Notes, in the Collateral and\/or the Obligations held by it to others at any time and from time to time, provided, however, that Lender cannot assign to a direct competitor of Borrower; and Lender may disclose to any such purchaser, assignee, transferee or participant (the \"Participant\"), or potential Participant, this Agreement and all information, reports, financial statements and documents executed or obtained in connection with this Agreement which Lender now or hereafter may have relating to the Loan, Borrower, or the business of Borrower. Borrower hereby grants to any Participant all liens, rights and remedies of Lender under the provisions of this Agreement or any other documents relating hereto or under applicable laws. Borrower agrees that any Participant may enforce such liens and exercise such rights and remedies in the same manner as if such Participant were Lender and a direct creditor of Borrower.\n11. MARYLAND LAW GOVERNS. THIS AGREEMENT AND ALL OTHER RELATED INSTRUMENTS AND DOCUMENTS AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER AND THEREUNDER SHALL, IN ALL RESPECTS, BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF MARYLAND (WITHOUT REGARD TO THE CONFLICT OF LAWS PRINCIPLES OF SUCH STATE), INCLUDING ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE, REGARDLESS OF THE LOCATION OF THE COLLATERAL.\nThe parties agree that any action or proceeding arising out of or relating to this Agreement may be commenced in any state or Federal court of competent jurisdiction in the State of Maryland, and each party submits to the jurisdiction of such court and agrees that a summons and complaint commencing an action or proceeding in any such court shall be properly served and shall confer personal jurisdiction if served personally or by certified mail to it at its address designated pursuant hereto, or as otherwise provided under the laws of the State of Maryland.\nBORROWER HEREBY WAIVES TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO WHICH BORROWER AND LENDER MAY BE PARTIES, ARISING OUT OF OR IN ANY WAY PERTAINING TO THIS AGREEMENT OR THE PROMISSORY NOTE. BORROWER AUTHORIZES LENDER TO FILE THIS PROVISION WITH THE CLERK OR JUDGE OF ANY COURT HEARING SUCH CLAIM. IT IS HEREBY AGREED AND UNDERSTOOD THAT THIS WAIVER CONSTITUTES A WAIVER OF TRIAL BY JURY OF ALL CLAIMS AGAINST PARTIES TO SUCH ACTIONS OR PROCEEDINGS, INCLUDING CLAIMS AGAINST PARTIES WHO ARE NOT PARTIES TO THIS AGREEMENT. THIS WAIVER IS KNOWINGLY, WILLINGLY AND VOLUNTARILY MADE BY BORROWER AND BORROWER HEREBY ACKNOWLEDGES THAT NO REPRESENTATIONS OF FACT OR OPINION HAVE BEEN MADE BY ANY INDIVIDUAL TO INDUCE THIS WAIVER OF TRIAL BY JURY OR IN ANY WAY TO MODIFY OR NULLIFY ITS EFFECT. BORROWER FURTHER ACKNOWLEDGES THAT IT HAS BEEN REPRESENTED IN THE SIGNING OF THIS AGREEMENT AND THE PROMISSORY NOTE AND IN THE MAKING OF THIS WAIVER BY LEGAL COUNSEL, SELECTED OF ITS OWN FREE WILL, AND THAT IT HAS HAD THE OPPORTUNITY TO DISCUSS THIS WAIVER WITH COUNSEL.\n12. Miscellaneous. This Agreement, the Promissory Note all other related instruments and documents executed pursuant hereto, and the Commitment Letter, constitute the entire agreement between the parties with respect to the subject matter hereof and shall not be amended or altered in any manner except by a document in writing executed by both parties.\nAll representations, warranties, and covenants of Borrower contained herein or made pursuant hereto shall survive closing and continue throughout the term hereof and until the Obligations are satisfied in full.\nAny provision of this Agreement or of any instrument or document executed pursuant hereto which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or thereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, Borrower hereby waives any provision of law which renders any provision hereof or thereof prohibited or unenforceable in any respect. The captions in this Agreement are for convenience of reference only and shall not define or limit any of the terms or provisions hereof.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, under seal, as of the day and year first above written.\nSANWA GENERAL EQUIPMENT LEASING, THE TITAN CORPORATION A DIVISION OF SANWA BUSINESS Borrower CREDIT CORPORATION Lender\nBy: \/S\/ (SEAL) By: \/S\/ (SEAL) Name: H. Duane Steelberg Name: Roger Hay Title: Senior Vice President Title:Sr. V.P. & CFO\n502 Washington Avenue 3033 Science Park Road Suite 800 San Diego, California 92121 Towson, Maryland 21204 Facsimile: 619-552-9471 Facsimile: 410-821-8775\nFIRST AMENDMENT TO COMMERCIAL LOAN AGREEMENT\nThis First Amendment to the Commercial Loan Agreement (\"Amendment\") is entered into as of this 25th day of May, 1995 by and between SUMITOMO BANK OF CALIFORNIA (\"Bank\") and THE TITAN CORPORATION, a Delaware Corporation (\"Borrower\"), with reference to the following:\nRECITALS\nA. Borrower and Bank entered into that certain Commercial Loan Agreement dated August 8, 1994 (\"Agreement\") pursuant to which Bank has agreed to lend up to Ten Million Dollars ($10,000,000) to Borrower.\nB. Borrower and Bank desire to amend the Agreement on the terms and conditions set forth herein.\nAMENDMENT\nNOW THEREFORE, in consideration of the foregoing, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Borrower and Bank hereby agree as follows:\n1. Defined Terms. Capitalized terms used in this Amendment and not otherwise defined herein shall have the meanings given such terms in the Agreement.\n2. Amendments. The Agreement is hereby amended as follows:\nA. 1.1 Line of Credit Amount. Section 1.1 is hereby amended in its entirety and replaced with the following:\n(a) Unsecured Line of Credit. During the Availability Period, Bank will provide an unsecured line of credit (the \"Revolving Line of Credit\") to Borrower. The maximum amount of this Revolving Line of Credit (the \"Commitment\") is Seventeen Million Dollars ($17,000,000). Borrower's obligation to repay this Revolving Line of Credit is evidenced by a promissory note substantially in the form of Exhibit A attached hereto (the \"Unsecured Line Note\").\n(b) Revolving\/Subline Facilities. This is a revolving line of credit with a subline facility for letters of credit. The subline is not to exceed Five Million Dollars ($5,000,000). During the Availability Period, Borrower may repay principal amounts and reborrow them.\n(c) Maximum Loan Balance. Borrower agrees not to permit the outstanding principal balance of the Revolving Line of Credit plus the outstanding amounts of any letters of credit, including any amounts drawn on letters of credit and not yet reimbursed (such sum is the \"Loan Balance\") to exceed the Commitment.\nB. SECTION 1.2 is hereby amended in its entirety and replaced with the following:\n1.2 Availability Period\nThe period under which Borrower may draw on the Revolving Line of Credit (\"Availability Period\") is between the date of this Agreement and May 31, 1997 (the \"Maturity Date\") unless Borrower is in default, in which event Bank need not make any advances.\n1.5 Letter of Credit Line\nC. SECTION 1.5 (a) is hereby amended in its entirety and replaced with the following:\n(a) The amount of outstanding letters of credit, including amounts drawn on letters of credit and not yet reimbursed, may not exceed at any one time Five Million Dollars ($5,000,000) in the aggregate.\n6.2 Financial Information\nD. SECTION 6.2 (d) is hereby amended in its entirety and replaced with the following:\n(d) Borrower will submit a 2 year operating plan for the new fiscal year within 60 days of the end of the old fiscal year. Such plan will detail, on a quarterly basis for the then current fiscal year and on an annual basis for the subsequent year, management's best estimate of revenue, expenses and balance sheet categories and will be presented in the customary form of Balance Sheets, Income Statements, and Cash Flow Statements.\n6.3 Quick Ratio\nE. SECTION 6.3 is hereby amended as follows:\nQuick Ratio. To maintain on a consolidated basis as of the last day of each quarter, a ratio of quick assets to current liabilities of at least .85:1.00. Facility direct advances to be defined as a current liability.\n6.4 Current Ratio\nF. SECTION 6.4 Current Ratio. This covenant has been eliminated in its entirety and replaced with the following:\nMinimum Debt Service Coverage Ratio To maintain on a consolidated basis as of the last day of each quarter a Minimum Debt Service Coverage Ratio of 1.50:1.00, increasing to 2.50:1.00 as of December 31, 1996.\n\"Debt Service Coverage Ratio\" to be defined as EBIT* for the previous four fiscal quarters to the sum of Cash Interest Expense for the previous four fiscal quarters, plus the Current Portion of Long Term Debt, plus 20% of Facility cash advances as of the date of calculation.\n*Defined as earnings before interest and taxes.\n6.5 Tangible Net Worth\nG. SECTION 6.5, Tangible Net Worth is hereby amended as follows:\nTangible Net Worth To maintain on a consolidated basis as of the last day of each quarter, Tangible Net Worth equal to at least Twenty Eight Million Dollars ($28,000,000) plus 50% of Net Income realized after December 31, 1994.\n6.10 Capital Expenditures\nH. SECTION 6.10, Capital Expenditures, is hereby amended in its entirety and replaced with the following:\nCapital Expenditures Borrower to limit capital expenditures to Twelve Million Dollars ($12,000,000) during each fiscal year. If Borrower's capital expenditures are less than Twelve Million Dollars ($12,000,000) in any fiscal year, the difference between actual capital expenditures and the Twelve Million Dollar ($12,000,000) covenant will be added to the following year's covenant level, to a maximum covenant level of Fifteen Million Dollars ($15,000,000).\n\"BORROWER\" \"BANK\" THE TITAN CORPORATION SUMITOMO BANK OF CALIFORNIA A Delaware Corporation\nBy: \/S\/ By: \/S\/ .\nGene Ray, President & CEO Johanna L. Dragner, V.P.\nBy: \/S\/ .\nRoger Hay, Sr. V.P. & CFO\nLOAN AND SECURITY AGREEMENT Number: 2566 ______________________________________________________________________________ _________________ Name of Debtor The Titan Corporation d\/b\/a Titan Scan Systems Name of Secured Party: Capital Associates Address : 3033 Science\nPark Road\nInternational, Inc. San Diego, CA 92121 Address\n: 7175 West Jefferson Ave\nLakewood, CO 80235.\n______________________________________________________________________________ _________________ Quantity DESCRIPTION OF PERSONAL PROPERTY (Show: Manufacturer, Model No., Serial No., Other Identification) ______________________________________________________________________________ _________________ All of Debtor s nowowned, or hereafter acquired, machinery, equipment, furniture, fixtures and vehicles, at the location referenced belowwheresoever the same may be situated, together with all acccessories, atttachments, substitutions, replacements, renewals, additions, alterations, betterments, repairs and proceeds (including, without limitation, insurance proceeds) of the foregoing; including but not limited to Titan Beta TB10\/15 E-Beam Medical Device Sterilization System consisting of a 10MEV\/15KW S\/N 2927 Conveyor System SN:1Y5537564 Control System SN:22B65600. ______________________________________________________________________________ _________________ Location of Equipment: Titan Scan Systems 9020 Activity Road, Suite D San Diego, CA 92121 ______________________________________________________________________________ _________________ SCHEDULE OF OBLIGATIONS ______________________________________________________________________________ _________________\nLoan Amount ( Unpaid Cash Price Balance ) $ 4,600,000.00 Documentation Fees $ 1,500.00 Interest ( Finance Charge ) $ 1,600,308.00 Time Balance $ 6,200,308.00 Term of Loan 85 Months Number of Payments 85 Payments Payable Monthly in Advance Amount of Each Payment 1-84: $68,337.00 EACH 85th: $460,000.00\nDebtor agrees to pay the Time Balance to Secured Party in eighty-five (85) installments commencing on January 1, 1996 and continuing on the 1st of each month thereafter until and including January 1, 2003. The first installment shall be in the amount of $68,337.00 the next eighty-three (84) installments shall each be in the amount of $68,337.00, and the last payment shall be in the amount of $460,000.00. ______________________________________________________________________________ _________________\nADDITIONAL TERMS AND CONDITIONS ______________________________________________________________________________ _________________\n1. Grant of Security Interest. Debtor hereby grants to Secured Party a security interest in the personal property described above (hereinafter with all renewals, substitutions and replacements and all parts, repairs, improvements, additions and accessories incorporated therein or affixed thereto referred to as the Equipment ), together with any and all proceeds thereof and any and all insurance policies and proceeds with respect thereto.\n2. Obligations Secured. The aforesaid security interest is granted by Debtor as security for (a) the payment of the Time Balance (as set forth in the Schedule of Obligations) and the payment and performance of all other indebtedness and obligations now or hereafter owing by Debtor to Secured Party, of any and every kind of description, arising hereunder or in connection herewith, howsoever evidenced, and any and all renewals and extensions of the foregoing, and all interest, fees, charges, expenses and attorneys fees accruing or incurred in connection with any of the foregoing (all of which Time Balance, indebtedness and obligations are hereinafter referred to as the Liabilities ) and (b) the payment and performance of all other indebtedness and obligations now or hereafter owing by Debtor to any assignee of Secured Party, of any and every kind and description, howsoever arising or evidenced (all of which indebtedness and obligations are hereinafter referred to as the Other Liabilities ). Subject to Paragraph 15, any nonpayment of installment or other amounts due hereunder shall result in the obligation on the part of Debtor promptly to pay also an amount equal to five per cent (5%), (or the maximum rate permitted by law, whichever is less) of the installment or other amounts overdue. 3. Warranties. DEBTOR ACKNOWLEDGES THAT SECURED PARTY MAKES NO WARRANTIES, EXPRESS OR IMPLIED, IN RESPECT OF THE EQUIPMENT, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE. EXCEPT AS MAY BE SET FORTH IN A WARRANTY RIDER ANNEXED TO THIS AGREEMENT. Secured Party shall not be liable to Debtor for any loss, damage or expense of any kind or nature caused, directly or indirectly, by any Equipment secured hereunder or the use or maintenance thereof or the failure of operation thereof, or the repair, service or adjustment thereof, or by any delay or failure to provide any such maintenance, repairs, service or adjustment, or by any interruption of service or loss of use thereof or for any loss of business howsoever caused. The Equipment shall be shipped directly to Debtor by the supplier thereof and Debtor agrees to accept such delivery. No defect or unfitness of the Equipment, nor any failure or delay on the part of the manufacturer or the shipper of the Equipment to deliver the Equipment or any part thereof to Debtor, shall relieve Debtor of the obligation to pay the Time Balance or any other obligation under this Agreement. Secured Party shall have no obligation under this Agreement in respect of the Equipment and shall have no obligation to install, erect, test, adjust or service the Equipment. Secured Party agrees, so long as they shall not have occurred or be continuing any Event of Default hereunder or event which with lapse of time or notice, or both, might become an Event of Default hereunder, that Secured Party will permit Debtor to enforce in Debtor's own name at Debtor's sole expense any supplier's or manufacturer's warranty or agreement in respect of the Equipment to the extent that such warranty or agreement is assignable.\n4. Assignment. This Agreement shall be assignable by Secured Party, and by its assigns. without the consent of Debtor, but Debtor shall not be obligated to any assignee except upon written notice of such assignment from Secured Party or such assignee. The obligation of Debtor to pay and perform the Liabilities to such assignee shall be absolute and unconditional and shall not be affected by any circumstance whatsoever, and such payments shall be made without interruption or abatement notwithstanding any event or circumstance whatsoever, including, without limitation, the late delivery, non-delivery, destruction or damage of or to the Equipment, the deprivation or limitation of the use of the Equipment, the bankruptcy or insolvency of Secured Party or Debtor or any disaffirmance of this Agreement by or on behalf of Debtor and notwithstanding any defense, set-off, recoupment or counterclaim or any other right whatsoever, whether by reason of breach of this Agreement or of any warranty in respect of the Equipment or otherwise which Debtor may now or hereafter have against Secured Party, and whether any such event shall be by reason of any act or omission of Secured Party (including, without limitation, any negligence of Secured Party) or otherwise; provided, however, that nothing herein contained shall affect any right of Debtor to enforce against Secured Party any claim which Debtor may have against Secured Party in any manner other than by abatement, attachment or recoupment of, interference with, or set-off, counterclaim or defense against, the aforementioned payments to be made to such assignee. Debtor s undertaking herein to pay and perform the Liabilities to an assignee of Secured Party shall constitute a direct, independent and unconditional obligation of Debtor to said assignee. Said assignee shall have no obligations under this Agreement or in respect of the Equipment and shall have no obligation to install, erect, test, adjust or service the Equipment. Debtor also acknowledges and agrees that any assignee of Secured Party s interest in this Agreement shall have the right to exercise all rights, privileges and remedies (either in its own name or in the name of Secured Party) which by the terms of this Agreement are permitted to be exercised by Secured Party.\n5. Damage to or Loss of the Equipment; Requisition. Debtor assumes and shall bear the entire risk of loss or damage to the Equipment from any and every cause, whatsoever. No loss or damage to the Equipment or any part thereof shall affect any obligation of Debtor with respect to the Liabilities and this Agreement, which shall continue in full force and effect. Debtor shall advise Secured Party in writing promptly of any item of Equipment lost or damaged and of the circumstances and extent of such damage. If the Equipment is totally destroyed, irreparably damaged, lost, stolen or title thereto shall be requisitioned or taken by any governmental authority under the power of eminent domain or otherwise, Debtor shall, at the option of Secured Party, replace the same with like equipment in good repair, condition and working order, or pay to Secured Party all Liabilities due and to become due, less the net amount of the recovery, if any, actually received by Secured Party from insurance or otherwise for such destruction, damage, loss, theft, requisition or taking. Whenever the Equipment is destroyed or damaged and, in the sole discretion of Secured Party, such destruction or damage can be repaired, Debtor shall, at its expense, promptly effect such repairs as Secured Party shall deem necessary for compliance with clause (a) of paragraph 7 below. Any proceeds of insurance received by Secured Party with respect to such reparable damage to the Equipment shall, at the election of Secured Party, be applied either to the repair of the Equipment by payment by Secured Party directly to the party completing the repairs, or to the reimbursement of Debtor for the cost of such repairs; provided, however, that Secured Party shall have no obligation to make such payment or any part thereof until receipt of such evidence as Secured Party shall deem satisfactory that such repairs have been completed and further provided that Secured Party may apply such proceeds to the payment of any of the Liabilities or the Other Liabilities due if at the time such proceeds are received by Secured Party there shall have occurred and be continuing any Event of Default hereunder or any event which with lapse of time or notice, or both, would become an Event of Default. Debtor shall, when and as requested by Secured Party, undertake, by litigation or otherwise, in Debtor's name, the collection of any claim against any person for such destruction, damage, loss, theft, requisition or taking, but Secured Party shall not be obligated to undertake, by litigation or otherwise, the collection of any claim against any person for such destruction, damage, loss, theft, requisition or taking.\n6. Representations and Warranties of Debtor. Debtor represents and warrants that: it has the right, power and authority to enter into and carry out the terms and provisions of this Agreement; this Agreement constitutes a valid obligation of the Debtor and is enforceable in accordance with its terms; and entering into this Agreement and carrying out its terms and provisions will not violate the terms or constitute a breach of any other agreement to which Debtor is a party.\n7. Affirmative Covenants of Debtor. Debtor shall (a) cause the Equipment to be kept in good condition and use the Equipment only in the manner for which it was designed and intended so as to subject it only to ordinary wear and tear and cause to be made all needed and proper repairs, renewals and replacements thereto; (b) maintain at all times property damage, fire, theft and comprehensive insurance for the full replacement value of the Equipment, with loss payable provisions in favor of Secured Party and any assignee of Secured Party as their interests may appear, and maintain public liability insurance in amounts satisfactory to Secured Party, naming Secured Party and any assignee of Secured Party as insureds with all of said insurance and loss payable provisions to be in form, substance and amount and written by companies approved by Secured Party, and deliver the policies therefor, or duplicates thereof, to Secured Party; (c) pay or reimburse Secured Party for any and all taxes, assessments and other governmental charges of whatever kind or character, however designated (together with any penalties, fines or interest thereon) levied or based upon or with respect to the Equipment, the Liabilities or this Agreement or upon the manufacture, purchase, ownership, delivery, possession, use, storage, operation, maintenance, repair, return or other disposition of the Equipment, or upon any receipts or earnings arising therefrom, or for titling or registering the Equipment, or upon the income or other proceeds received with respect to the Equipment or this Agreement provided, however, that Debtor shall pay taxes on or measured by the net income of Secured Party and franchise taxes of Secured Party only to the extent that such net income taxes or franchise taxes are levied or assessed in lieu of any other taxes, assessments or other governmental charges hereinabove described; (d) pay all shipping and delivery charges and other expenses incurred in connection with the Equipment and pay all lawful claims, whether for labor, materials, supplies, rents or services, which might or could if unpaid become a lien on the Equipment; (e) comply with all governmental laws, regulations, requirements and rules, all instructions and warranty requirements of Secured Party or the manufacturer of the Equipment, and with the conditions and requirements of all policies of insurance with respect to the Equipment and this Agreement; (f) mark and identify the Equipment with all information and in such manner as Secured Party may request from time to time and replace promptly any such marking or identification which are removed, defaced or destroyed; (g) at any and all times during business hours, grant to Secured Party free access to enter upon the premises wherein the Equipment shall be located and permit Secured Party to inspect the Equipment; (h) reimburse Secured Party for all charges, costs and expenses (including attorneys' fees) incurred by Secured Party in defending or protecting its interests in the Equipment, in the attempted enforcement or enforcement of the provisions of this Agreement or in the attempted collection or collection of any of the Liabilities; (i) indemnify and hold any assignee of Secured Party, and Secured Party, harmless from and against all claims, losses, liabilities, damages, judgments, suits, and all legal proceedings, and any and all costs and expenses in connection therewith (including attorneys' fees) arising out of or in any manner connected with the manufacture, purchase, ownership, delivery, possession, use, storage, operation, maintenance, repair, return or other disposition of the Equipment or with this Agreement, including, without limitation, claims for injury to or death of persons and for damage to property, and give Secured Party prompt notice of any such claim or liability, provided, however, that the foregoing shall not affect or impair any warranty made by Secured Party; and (j) maintain a system of accounts established and administered in accordance with generally accepted accounting principles and practices consistently applied, and, within thirty (30) days after the end of each fiscal quarter, deliver to Secured Party a balance sheet as at the end of such quarter and statement of operations for such quarter, and, within one hundred and twenty (120) days after the end of each fiscal year, deliver to Secured Party a balance sheet as at the end of such year and statement of operations for such year, in each case prepared in accordance with generally accepted accounting principles and practices consistently applied and certified by Debtor's chief financial officer as fairly presenting the financial position and results of operation of Debtor, and, in the case of year end financial statements, certified by an independent accounting firm acceptable to Secured Party.\n8. Negative Covenants of Debtor. Debtor shall not (a) create, incur, assume or suffer to exist any mortgage, lien, pledge or other encumbrance or attachment of any kind whatsoever upon, affecting or with respect to the Equipment or this Agreement or any of Debtor s interests hereunder; (b) make any changes or alterations in or to the Equipment except as necessary for compliance with clause (a) of paragraph 7 above; (c) permit the name of any person, association or corporation other than Secured Party to be placed on the Equipment as a designation that might be interpreted as a claim of interest in the Equipment; (d) part with possession or control of or suffer or allow to pass out of its possession or control any of the Equipment or change the location of the Equipment or any part thereof from the location shown above; (e) assign or in any way dispose of all or any part of its rights or obligations under this Agreement or enter into any lease of all or any part of the Equipment; or (f) change its name or address from that set forth above unless it shall have given Secured Party no less than thirty (30) days prior written notice thereof.\n9. Equipment Personalty. The Equipment is, and shall at all times be and remain, personal property notwithstanding that the Equipment or any part thereof may now be, or hereafter become, in any manner affixed or attached to, or imbedded in, or permanently resting upon, real property or attached in any manner to real property by cement, plaster, nails, bolts, screws or otherwise. If requested by Secured Party with respect to any item of Equipment, Debtor will obtain and deliver to Secured Party waivers of interest or liens in recordable form, satisfactory to Secured Party, from all persons claiming any interest in the real property on which such item of Equipment is installed or located.\n10. Events of Default and Remedies. If any one or more of the following events ( Events of Default ) shall occur:\n(a) Debtor shall fail to make any payment in respect of the Liabilities when due; or\n(b) any certification, statement, representation, warranty or financial report or statement heretofore or hereafter furnished by or on behalf of Debtor or any guarantor of any or all of the Liabilities proves to have been false in any material respect at the time as of which the facts therein set forth were stated or certified or has omitted any material contingent or unliquidated liability or claim against Debtor or any such guarantor; or\n(c) Debtor or any guarantor of any or all of the Liabilities shall fail to perform or observe any covenant, condition or agreement to be performed or observed by it hereunder or under any guaranty agreement; or\n(d) Debtor or any guarantor of any or all of the Liabilities shall be in breach of or in default in the payment and performance of any obligation relating to any of the Other Liabilities; or\n(e) Debtor or any guarantor of any or all of the Liabilities shall cease doing business as a going concern, make an assignment for the benefit of creditors, admit in writing its inability to pay its debts as they become due, file a petition commencing a voluntary case under any chapter of Title 11 of the United States Code entitled Bankruptcy (the Bankruptcy Code ), be adjudicated an insolvent, file a petition seeking for itself any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar arrangement under any present or future statute, law, rule or regulation or file an answer admitting the material allegations of a petition filed against it in any such proceeding, consent to the filing of such a petition or acquiescence in the appointment of a trustee, receiver or liquidator of it or of all or any part of its assets or properties, or take any action looking to its dissolution or liquidation; or\n(f) an order for relief against Debtor or any guarantor of any or all of the Liabilities shall have been entered under any chapter of the Bankruptcy Code or a decree or order by a court having jurisdiction in the premises shall have been entered approving as properly filed a petition seeking reorganization, arrangement, readjustment, liquidation, dissolution or similar relief against Debtor or any guarantor of any or all of the Liabilities under any present or future statute, law, rule or regulation, or within thirty (30) days after the appointment without Debtor's or such guarantor's consent or acquiescence of any trustee, receiver or liquidator of it or such guarantor or of all or any part of its or such guarantor s assets and properties, such appointment shall not be vacated, or an order, judgment or decree shall be entered against Debtor or such guarantor by a court of competent jurisdiction and shall continue in effect for any period of ten (10) consecutive days without a stay of execution, or any execution or writ or process shall be issued under any action or proceeding against Debtor whereby the Equipment or its use may be taken or restrained; or\n(g) Debtor or any guarantor of any or all of the Liabilities shall suffer an adverse material change in its financial condition as compared to such condition as at the date hereof, and as a result of such change in condition Lessor deems itself or any of the Equipment to be insecure; then and in any such event, Secured Party may, at the sole discretion of Secured Party, without notice or demand and without limitation of any rights and remedies of Secured Party under the Uniform Commercial Code, take any one or more of the following steps:\n(1) Declare all of the Time Balance to be due and payable, whereupon the same shall forthwith mature and become due and payable less the credit for unearned interest provided for in paragraph 15 below, provided, however, upon the occurence of any of the events specified in subparagraphs (e) and (f) above, all sums as specified in this clause (1) shall immediately be due and payable without notice to Debtor (the date on which Secured Party declares all of the Time Balance to be due and payable is hereinafter referred to as the Declaration Date );\n(2) proceed to protect and enforce its rights by suit in equity, action at law or other appropriate proceedings, whether for the specific performance of any agreement contained herein, or for an injunction against a violation of any of the terms hereof, or in aid of the exercise of any other right, power or remedy granted hereby or by law, equity or otherwise; and\n(3) at any time and from time to time, with or without judicial process and the aid or assistance of others, enter upon any premises wherein any of the Equipment may be located and, without resistance or interference by Debtor, take possession of the Equipment on any such premises, and require Debtor to assemble and make available to Secured Party at the expense of Debtor any part or all of the Equipment at any place or time designated by Secured Party; and remove any part or all of the Equipment from any premises wherein the same may be located for the purpose of effecting the sale or other disposition thereof; and sell, resell, lease, assign and deliver, grant options for or otherwise dispose of any or all of the Equipment in its then condition or following any commercially reasonable preparation or processing, at public or private sale or proceedings, by one or more contracts, in one or more parcels, at the same or different times, with or without having the Equipment at the place of sale or other disposition, for cash and\/or credit, and upon any terms, at such place(s) and time(s) and to such persons, firms or corporations as Secured Party shall deem best, all without demand for performance or any notice or advertisement whatsoever, except that Debtor shall be given five (5) business days' written notice of the place and time of any public sale or of the time after which any private sale or other intended disposition is to be made, which notice Debtor hereby agrees shall be deemed reasonable notice thereof. If any of the Equipment is sold by Secured Party upon credit or for future delivery, Secured Party shall not be liable for the failure of the purchaser to pay for same and in such event Secured Party may resell such Equipment. Secured Party may buy any part or all of the Equipment at any public sale and if any part or all of the Equipment is of a type customarily sold in a recognized market or which is the subject of widely distributed standard price quotations Secured Party may buy at private sale and may make payment therefor by application of all or a part of the Liabilities (after giving effect to any credit for unearned interest pursuant to clause (1) above) and of all or a part of any Other Liabilities. Any personalty in or attached to the Equipment when repossessed may be held by Secured Party without any liability arising with respect thereto, and any and all claims in connection with such personalty shall be deemed to have been waived unless notice of such claim is made by certified or registered mail upon Secured Party within three business days after repossession.\nSecured Party shall apply the cash proceeds from any sale or other disposition of the Equipment first, to the reasonable expenses of re-taking, holding, preparing for sale, selling, leasing and the like, and to reasonable attorneys' fees and other expenses which are to be paid or reimbursed to Secured Party pursuant hereto, and second, to all outstanding portions of the Liabilities (after giving effect to any credit for unearned interest pursuant to clause (1) above) and to any Other Liabilities in such order as Secured Party may elect, and third, any surplus to Debtor, subject to any duty of Secured Party imposed by law to the holder of any subordinate security interest in the Equipment known to Secured Party; provided however, that Debtor shall remain liable with respect to unpaid portions of the Liabilities owing by it and will pay Secured Party on demand any deficiency remaining with interest as provided for in paragraph 15 below.\n11. Secured Party's Right to Perform for Debtor. If Debtor fails to perform or comply with any of its agreements contained herein Secured Party may perform or comply with such agreement and the amount of any payments and expenses incurred by Secured Party in connection with such performance or compliance, together with interest thereon at the rate provided for in paragraph 15 below, shall be deemed a part of the Liabilities and shall be payable by Debtor upon demand.\n12. Further Assurances. Debtor will cooperate with Secured Party for the purpose of protecting the interests of Secured Party in the Equipment, including, without limitation, the execution of all Uniform Commercial Code financing statements requested by Secured Party. Secured Party and any assignee of Secured Party are each authorized to the extent permitted by applicable law to file one or more Uniform Commercial Code financing statements disclosing any security interest in the Equipment without the signature of Debtor or signed by Secured Party or any assignee of Secured Party as attorney-in-fact for Debtor. Debtor will pay all costs of filing any financing, continuation or termination statements with respect to this Agreement, including, without limitation, any documentary stamp taxes relating thereto. Debtor will do whatever may be necessary to have a statement of the interest of Secured Party and of any assignee of Secured Party in the Equipment noted on any certificate of title relating to the Equipment and will deposit said certificate with Secured Party or such assignee. Debtor shall execute and deliver to Secured Party, upon request, such other instruments and assurances as Secured Party deems necessary or advisable for the im- plementation, effectuation, confirmation or perfection of this Agreement and any rights of Secured Party hereunder.\n13. Non-Waiver; Etc. No course of dealing by Secured Party or Debtor or any delay or omission on the part of Secured Party in exercising any rights hereunder shall operate as a waiver of any rights of Secured Party. No waiver or consent shall be binding upon Secured Party unless it is in writing and signed by Secured Party. A waiver on any one occasion shall not be construed as a bar to or a waiver of any right and\/or remedy on any future occasion. To the extent permitted by applicable law, Debtor hereby waives the benefit and advantage of, and covenants not to assert against Secured Party, any valuation, inquisition, stay, appraisement, extension or redemption laws now existing or which may hereafter exist which, but for this provision, might be applicable to any sale or other disposition made under the judgment, order or decree of any court or under the powers of sale and other disposition conferred by this Agreement or otherwise. Debtor hereby waives any right to a jury trial with respect to any matter arising under or in connection with this Agreement.\n14. Entire Agreement; Severability; Etc. This Agreement constitutes the entire agreement between Secured Party and Debtor and all conversations, agreements and representations relating to this Agreement or to the Equipment are integrated herein. If any provision hereof or any remedy herein provided for shall be invalid under any applicable law, such provision or remedy shall be inapplicable and deemed omitted, but the remaining provisions and remedies hereunder shall be given effect in accordance with the intent hereof. Neither this Agreement nor any term hereof may be changed, discharged, terminated or waived except in an instrument in writing signed by the party against which enforcement of the change, discharge, termination or waiver is sought. This Agreement shall in all respects be governed by and construed in accordance with the internal laws of the State of New York, including all matters of construction, validity and performance, and shall be deemed a purchase money security agreement within the meaning of the Uniform Commercial Code. The captions in this Agreement are for convenience of reference only and shall not define or limit any of the terms or provisions hereof. This Agreement shall inure to the benefit of and be binding upon Secured Party and Debtor and their respective successors and assigns, subject, however, to the limitations set forth in this Agreement with respect to Debtor's assignment hereof. No right or remedy referred to in this Agreement is intended to be exclusive but each shall be cumulative and in addition to any other right or remedy referred to in this Agreement or otherwise available to Secured Party at law or in equity, and shall be in addition to the provisions contained in any instrument referred to herein and any instrument supplemental hereto. Debtor shall be liable for all costs and expenses, including attorneys fees and disbursements, incurred by reason of the occurrence of any Event of Default or the exercise of Secured Party's remedies with respect thereto. Time is of the essence with respect to this Agreement and all of its provision.\n15. Prepayment; Rebate; Interest. Except for the installment payments of the Time Balance as set forth in the Schedule of Obligations, the Debtor may not prepay the Time Balance, in whole or in part, at any time. In the event Secured Party declares all of the Time Balance to be due and payable pursuant to clause (1) of paragraph 10 above, Debtor shall be entitled to a credit against such Time Balance of an amount equal to (a) that portion of the Finance Charge (as shown in the Schedule of Obligations) unearned by Secured Party as of the Declaration Date computed in accordance with the Rule of 78's, less (b) a sum equal to 7.5% of the Unpaid Cash Price Balance, provided that the amount of the Finance Charge earned by Secured Party computed as aforesaid shall not exceed the highest amount permitted by applicable law. The Time Balance as reduced in accordance with the preceding sentence shall bear interest from and after the Declaration Date, and all other Liabilities due and payable under the Agreement (including past due installments) shall bear interest from and after their respective due dates, at the lesser of 1% per month or the highest rate permitted by applicable law, provided, however, that Debtor shall have no obligation to pay any interest on interest except to the extent permitted by applicable law.\n16. Consent to Jurisdiction. Debtor hereby irrevocably consents to the jurisdiction of the courts of the State of New York and of any federal court located in such state in connection with any action or proceeding arising out of or relating to this Agreement or the transactions contemplated hereby. Any such action or proceeding will be maintained in the United States District Court for the Southern District of New York or in any court of the State of New York located in the County of New York and Debtor waives any objections based upon venue or forum non conveniens in connection with any such action or proceeding. Debtor consents that process in any such action or proceeding may be served upon it by registered mail directed to Debtor at its address set forth at the head of this Agreement or in any other manner permitted by applicable law or rules of court. Debtor hereby irrevocably appoints Secretary of State of the State of New York as its agent to receive service of process in any such action or proceeding.\n17. Notices. Notice hereunder shall be deemed given if served personally or by certified or registered mail, return receipt requested, to Secured Party and Debtor at their respective addresses set forth at the head of this Agreement. Any party hereto may from to time by written notice to the other change the address to which notices are to be sent to such party. A copy of any notice sent by Debtor to Secured Party shall be concurrently sent by Debtor to any assignee of Secured Party of which Debtor his notice.\nThe Debtor agrees to all the provisions set forth above. This Agreement is executed pursuant to due authorization. DEBTOR ACKNOWLEDGES RECEIPT OF A SIGNED TRUE COPY OF THIS AGREEMENT.\nAccepted on December 29, 1995 Date December 29 , 1 995\nCAPITAL ASSOCIATES INTERNATIONAL, INC. THE TITAN CORPORATION d\/b\/a TITAN SCAN SYSTEMS (Debtor) (Secured Party) (Signature of Proprietor or name of Corporation or Partnership)\nBy_______________\/S\/_____________________ By____________\/S\/________________ ______ Its_______John A. Reed______________ ____ Its_____V.P.\/Corporate Controller_________________ (Title of Officer) (if Corporation, President or Vice President should sign and give official title; if Partnership, state partner)\nBH:l-share-dd-titan.agr\nRIDER TO LOAN AND SECURITY AGREEMENT NO. 2566 DATED 12\/29\/95 ( AGREEMENT ) BETWEEN THE TITAN CORPORATION d\/b\/a TITAN SCAN SYSTEMS AS DEBTOR AND CAPITAL ASSOCIATES INTERNATIONAL, INC. AS SECURED PARTY\nIn addition to the terms and conditions set forth in the printed portion of the Loan and Security Agreement, Debtor and Secured Party agree as follows:\n1. In the seventh (7th) line of Section two (2) of the Agreement, after the words every kind and description , add the words arising hereunder or in connection herewith , .\n2. In the eighth (8th) line of Section two (2) of the Agreement, after the words or other amounts , add the words within five (5) days of when .\n3. In the ninth (9th) line of Section five (5) of the Agreement, after the words in the sole , add the word reasonable .\n4. In the seventeenth (17th) line of Section five (5) of the Agreement, after the words when and as , add the word reasonably .\n5. In the seventh (7th) line of Section seven (7) of the Agreement , after the initial word companies , add the word reasonably .\n6. In the twentieth (20th) line of Section seven of the Agreement preceding the words at any and all times , add the words upon forty-eight (48) hours prior notice to Debtor, .\n7. In the thirtieth (30th) line of Section seven (7) of the Agreement , change thirty (30) to fifty-five (55) .\n8. In clause (a) of Section ten (10) of the Agreement, after the words of the Liabilities , add the words within five (5) days of .\n9. In second (2nd) line of clause (c) of Section ten (10) of the Agreement, after the words or under any guaranty agreement , add the words and such failure continues for ten (10) or more days after Debtor is given notice thereof .\n10. In the second (2nd) line of clause (g) of Section ten (10) of the Agreement , change the word Lessor to Secured Party .\n11. In the second (2nd) line of Section fifteen (15) of the Agreement, after the words at any time , add the words except as otherwise provided in the Prepayment Agreement of even date herewith executed by Secured Party and Debtor .\nTHE TITAN CORPORATION CAPITAL ASSOCIATES INTERNATIONAL, INC. d\/b\/a TITAN SCAN SYSTEMS\nBy: \/S\/ By \/S\/\nTitle: V.P. Title: V.P.\/Corporate Controller\nDate: December 29, 1995 Date: December 29,\nDESCRIPTION\nAll of Debtor s now owned, or hereafter acquired, machinery, equipment, furniture, fixtures and vehicles at the location referenced below, wheresoever the same may be situated, together with all accessories, attachments, substitutions, replacements, renewals, additions, alterations, betterments, repairs and proceeds (including, without limitation, insurance proceeds) of the foregoing; including but not limited to Titan Beta TB10\/15 E-Beam Medical Device Sterilization System consisting of a 10MEV\/15KW S\/N 2727 Conveyor System SN: 1Y5537564 Control System SN: 22B65600.\nLOCATION OF EQUIPMENT: TITAN SCAN SYSTEMS 9020 ACTIVITY ROAD SAN DIEGO, CALIFORNIA 92126\nTHE TITAN CORPORATION d\/b\/a TITAN SCAN SYSTEMS\nBY:\nSECOND AMENDMENT TO COMMERCIAL LOAN AGREEMENT\nThis Second Amendment to the Commercial Loan Agreement (\"Amendment\") is entered into as of this 29th day of December, 1995 by and between SUMITOMO BANK OF CALIFORNIA (\"Bank\") and THE TITAN CORPORATION, a Delaware Corporation (\"Borrower\"), with reference to the following:\nRECITALS\nA. Borrower and Bank entered into that certain Commercial Loan Agreement (\"Agreement\") dated August 8, 1994 and subsequently amended on May 25, 1995 pursuant to which Bank has agreed to lend up to Seventeen Million Dollars ($17,000,000) to Borrower.\nB. Borrower and Bank desire to amend the Agreement on the terms and conditions set forth herein.\nAMENDMENT\nNOW THEREFORE, in consideration of the foregoing, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Borrower and Bank agree as follows:\n1. Defined Terms Capitalized terms used in this Amendment and not otherwise defined herein shall have the meanings given such terms in the Agreement.\n2. Amendments This Agreement is hereby amended as follows:\nA. 1.5 Letter of Credit Line Section 1.5 of the Agreement is hereby amended and replaced with the following:\nLetter of Credit Line This Revolving Line of Credit may be used for financing (a) commercial letters of credit with a maximum maturity of two years but not to extend more than 365 days beyond the Maturity Date. Each commercial letter of credit will require drafts payable at sight; or (b) standby letters of credit with a maximum maturity of two years but not to extend more than 365 days beyond the Maturity Date.\nB. 6.4 Minimum Debt Service Coverage Ratio Section 6.4 of the Agreement is hereby amended and replaced with the following:\nDebt Service Coverage Ratio. To maintain on a consolidated basis as of the last day of each quarter beginning December 31, 1996 a Debt Service Coverage Ratio of at least 1.50:1.\n\"Debt Service Coverage Ratio\" to be defined as Earnings before Interest and Taxes for the previous four fiscal quarters to the sum of Cash Interest Expense for the previous four fiscal quarters, plus the Current Portion of Long Term Debt, plus 20% of Facility cash advances as of the date of calculation.\nC. 6.24 Interest Coverage Ratio Section 6.24, Interest Coverage Ratio is hereby added to the Agreement as follows:\nInterest Coverage Ratio To maintain on a consolidated basis as of the last day of each quarter an Interest Coverage Ratio of at least the following:\nQuarter Ending 3\/31\/96 1.25:1.00 Quarter Ending 6\/30\/96 1.25:1.00 Quarter Ending 9\/30\/96 3.50:1.00\n\"Interest Coverage Ratio\" to be defined as Earnings Before Interest and Taxes to Cash Interest Expense for the applicable year-to-date period.\n\"BORROWER\" \"BANK\" THE TITAN CORPORATION SUMITOMO BANK OF CALIFORNIA\nBY: \/S\/ BY: \/S\/ .\nRoger Hay, Sr.V.P.\/CFO Johanna L. Dragner, V.P. .\nTHE TITAN CORPORATION 1996 DIRECTORS' STOCK OPTION AND EQUITY PARTICIPATION PLAN\n1. Purpose of the Plan. Under this 1996 Directors' Stock Option and Equity Participation Plan (the \"Plan\") of The Titan Corporation (the \"Company\"), (i) options shall be granted to directors who are not Employees of the Company to purchase shares of the Company's capital stock, and (ii) directors who are not Employees of the Company may elect to receive shares of the Company's Common Stock in lieu of cash payment of Director Fees. The Plan is designed to enable the Company to attract and retain outside directors of the highest caliber and experience. Certain capitalized terms used in this Plan are defined in Section 12 hereof. 2. Stock Subject to Plan. The maximum number of shares of stock for which options granted hereunder may be exercised or which may be issued under stock grants in lieu of Director Fees shall be 125,000 shares of the Company's Common Stock, par value $.01 per share (\"Common Stock\"), subject to the adjustments provided in Section 6. The shares of Common Stock to be issued under the Plan may be either previously authorized but unissued shares or treasury shares. Shares of stock subject to the unexercised portions of any options granted under this Plan which expire or terminate or are canceled may again be subject to options or stock grants under the Plan. 3. Participating Directors. The directors of the Company who shall participate in this Plan are those directors who are not, at the time they receive options or stock grants hereunder, Employees of the Company or any of its subsidiaries. 4. Grant of Options. Each participating director shall be granted the following options, the date of each of which being a \"date of grant\": (a) 5,000 shares of stock (subject to the adjustments provided in Section 6) on the later to occur (the \"date of initial grant\") of (i) the date on which he or she first takes office as a director of the Company, or (ii) the date on which this Plan was adopted by the Board of Directors of the Company; (b) 5,000 shares of stock (subject to adjustments provided in Section 6) on the date that is one year after the date of initial grant; and (c) 5,000 shares of stock (subject to the adjustments provided in Section 6) on the date that is two years after the date of initial grant. Notwithstanding any other provision of this Plan, no option hereunder shall be granted unless sufficient shares (subject to said adjustments) are then available therefor under Sections 2 and 7. In consideration of the granting of the options, the option holder shall be deemed to have agreed to remain as a director of the Company for a period of at least one year after each date of grant. Nothing in this Plan shall, however, confer upon any option holder any right to continue as a director of the Company or shall interfere with or restrict in any way the rights of the Company or the Company's shareholders, which are hereby expressly reserved, to remove any option holder at any time for any reason whatsoever, with or without cause, to the extent permitted by the Company's bylaws and applicable law. 5. Option Provisions. Each option granted under the Plan shall contain such terms and provisions as the President of the Company may authorize, including in any event the following: (a) The exercise price of each option shall be equal to the aggregate Fair Market Value of the shares of stock optioned on the date of grant of such option. Fair Market Value means the closing price of stock of the same class on the day in question (or, if such day is not a trading day in the U.S. securities markets or if no sales of stock of that class were made on such day, on the nearest preceding trading day on which sales of stock of that class were made), as reported with respect to the market (or the composite of the markets, if more than one) in which such stock is then traded; or if no such closing prices are reported the lowest independent offer quotation reported, for such day in Level 2 of NASDAQ; or if no such quotations are reported, it means the value established by what the Board of Directors of the Company in its judgment then deems to be the most nearly comparable valuation method. (b) Payment for stock purchased upon any exercise of the option shall be made in full in cash concurrently with such exercise. (c) The option shall become exercisable in installments as follows: It may be exercised as to up to but no more than 25% of the total number of shares optioned on the first anniversary of the date of grant; up to but no more than 50% of the total number of shares optioned on the second anniversary of the date of grant; up to but no more than 75% of the total number of shares optioned on the third anniversary of the date of grant; and up to 100% of the total number of shares optioned on the fourth anniversary of the date of grant; in each case to the nearest whole share. (d) When the option holder ceases to be a director of the Company, whether because of death, resignation, removal, expiration of his or her term of office or any other reason, the option shall terminate ninety (90) days after the date such option holder ceases to be a director of the company and may thereafter no longer be exercised; except that (i) upon the option holder's death his or her legal representative(s) or the person(s) entitled to do so under the option holder's last will and testament or under applicable intestate laws shall have the right to exercise the option within one year after the date of death (but not after the expiration date of the option), but only for the number of shares as to which the option holder was entitled to exercise the option on the date of his or her death and (ii) upon the option holder's ceasing to be a director by reason of disability her or she (or his or her guardian) shall have the right to exercise the option within one year after the date of the option holder ceased to be a director (but not after the expiration date of the option), but only for the number of shares as to which the option holder was entitled to exercise the option on the date of his or her ceasing to be a director. (e) Notwithstanding any other provision herein, such option may not be exercised prior to shareholder approval of this Plan at an annual meeting of shareholders by a majority of the shares represented at such meeting; nor prior to the admission of the shares of stock issuable on exercise of the option to listing on notice of issuance on any stock exchange on which shares of the same class are then listed; nor unless and until, in the opinion of counsel for the Company, such securities may be issued and delivered without causing the Company to be in violation of or incur any liability under any federal, state or other securities law, any requirement of any securities exchange listing agreement to which the Company may be a party, or any other requirement of law or of any regulatory body having jurisdiction over the Company. (f) The option shall not be transferable by the option holder other than by will or the laws of descent and distribution, or pursuant to a qualified domestic relations order as defined by the Internal Revenue Code of 1986, as amended (the \"Code\"), or Title I of the Employee Retirement Income Security Act (\"ERISA\") or the rules thereunder; may not be pledged or hypothecated; and shall be exercisable during the option holder's lifetime only by the option holder or by his or her guardian or legal representative. 6. Adjustments. If the outstanding shares of the Company's Common Stock are increased or decreased, or are changed into or exchanged for a different number or kind of shares or securities of the Company, as a result of one or more reorganizations, recapitalizations, stock splits, reverse stock splits, stock dividends or the like, appropriate adjustments shall be made in the number and\/or kind of shares or securities as to which options may thereafter be granted under this Plan and for which options then outstanding under this Plan may thereafter be exercised. Any such adjustment in outstanding options shall be made without change in the aggregate purchase price applicable to the unexercised portion of such options, but with a corresponding adjustment in the purchase price for each share or other unit of any security covered by the option. No fractional shares of stock shall be issuable under any option granted under this Plan or as a result of any such adjustment.\n7. Corporate Reorganizations. Upon the dissolution or liquidation of the Company, or upon a reorganization, merger or consolidation of the Company as a result of which the outstanding shares of the Company's Common Stock are changed or exchanged for cash or property or securities not of the Company's issue, or upon a sale of substantially all the property of the Company to another corporation or person, the Plan shall terminate, and all options thereto granted hereunder shall terminate, unless provisions shall be made in writing in connection with such transaction for the continuance of the Plan and\/or for the assumption of options theretofore granted, or the substitution for such options of options covering the stock of a successor corporation, or a parent or subsidiary thereof, with appropriate adjustments as to the number and kind of shares and prices, in which event the Plan and options theretofore granted shall continue in the manner and under the terms so provided. If the Plan and unexercised options shall terminate pursuant to the foregoing sentence, all persons entitled to exercise any unexercised portions of options then outstanding shall have the right, at such time prior to the consummation of the transaction causing such termination as the Company shall designate, to exercise the unexercised portions of their options, including the portions thereof which would, but for this section entitled \"Corporation Reorganizations,\" not yet be exercisable. 8. Change in Control. Notwithstanding any other provisions of this Plan, upon any Change in Control (as defined herein below) all then outstanding options will become fully vested and exercisable. The term \"Change in Control\" shall mean (a) any \"person\" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Securities Exchange Act of 1934) becomes the beneficial owner (as such term is used in Section 13(d)(1) of the Securities Exchange Act of 1934), directly or indirectly, of securities of the Company representing at least 25% of the combined voting power of the then outstanding securities of the Company in a transaction which was not approved by the Company's Board of Directors prior to its occurrence; or (b) during any period of twenty-four (24) consecutive months, individuals who at the beginning of such period constituted the Company's Board of Directors cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. 9. Granting of Stock. (a) Each participating Director may elect to forego cash payment of all or any portion of his or her Director Fees (the fees subject to such election are hereinafter referred to as \"Elected Fees\") and receive, subject to provisions of subsection (c) hereof, on the date such Elected Fees otherwise would be paid, or such other date specified by the Board, shares of Common Stock. If the participating director elects to receive shares of Common Stock, the number of shares issuable shall equal the amount of the Elected Fees divided by the Fair Market Value per share of Common Stock as of the issue date. No fractional shares of Common Stock shall be issued and the value of such fractional share shall be paid to each participating director in cash. An election pursuant to this Section 9 shall be made prior to the commencement of any period of Board service to which the grant relates, but in any event at least six months prior to the scheduled payment of the Elected Fees, and such election shall be irrevocable. (b) This Plan will be submitted for the approval of the Company's stockholders within twelve months after the date of the Board's initial adoption of this Plan. No grant of Common Stock pursuant to Section 9 hereof shall be made prior to approval of this Plan by the Company's stockholders. (c) The Company shall be entitled to require payment in cash or deduction from other compensation payable to each participating director of any sums required by federal, state or local tax law to be withheld with respect to the issuance of Common Stock under the Plan. (d) This Plan and the issuance and delivery of shares of Common Stock hereunder are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Company, be necessary or advisable in connection therewith. Any securities delivered under this Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Company, provide such assurances and representations to the Company as the Company may deem necessary or desirable to assure compliance with all applicable legal requirements. To the extent permitted by applicable law, the Plan shall be deemed amended to the extent necessary to conform to such laws, rules and regulations. 10. Duration, Termination and Amendment of the Plan. This Plan shall become effective upon its adoption by the Board of Directors of the Company and shall expire on February 22, 2001, so that no option may be granted hereunder after that date although any option outstanding on that date may thereafter be exercised in accordance with its terms. The Board of Directors of the Company may alter, amend, suspend or terminate this Plan, provided that no such action shall deprive an option holder, without his or her consent, of any option previously granted pursuant to this Plan or of any of the option holder's rights under such option. Except as herein provided, no such action of the Board, unless taken with the approval of the stockholders of the Company, may make any amendment to the Plan as to which approval by stockholders is necessary for continued applicability of Rule 16b-3 of the Securities and Exchange Commission. Notwithstanding the foregoing, the Plan shall not be amended more than once every six months other than to comport with changes in the Code, ERISA or the rules thereunder.\n11. Administration. (a) It shall be the duty of the Board to conduct the general administration of this Plan in accordance with its provisions. The Board shall have the power to interpret this Plan and to adopt such rules for the administration, interpretation, and application of this Plan as are consistent therewith and to interpret, amend or revoke any such rules. (b) All expenses and liabilities which members of the Board incur in connection with the administration of this Plan shall be borne by the Company. The Board may employ attorneys, consultants, accountants, appraisers, brokers, or other persons. The Board, the Company and the Company's officers and Directors shall be entitled to rely upon the advice, opinions or valuations of any such persons. All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding upon the Company and all other interested persons. No members of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to this Plan, and all members of the Board shall be fully protected by the Company in respect of any such action, determination or interpretation. 12. Certain Definitions. Wherever the following terms are used in this Plan they shall have the meaning specified below, unless the context clearly indicates otherwise. (a) Director Fees. \"Director Fees\" shall mean the annual retainer fee and regular meeting fees, including committee fees, if any, paid by the Company to a participating director. (b) Employee. \"Employee\" shall mean any officer or other employee (as defined in accordance with Section 3401(c) of the Code) of the Company, or of any corporation which is a Subsidiary. (c) Fair Market Value. Fair Market Value is defined in Section 5(a) hereof.","section_15":""}
{"filename":"51644_1995.txt","cik":"51644","year":"1995","section_1":"Item 1. Business\nThe Interpublic Group of Companies, Inc. was incorporated in Delaware in September 1930 under the name of McCann-Erickson Incorporated as the successor to the advertising agency businesses founded in 1902 by A.W. Erickson and in 1911 by Harrison K. McCann. It has operated under the Interpublic name since January 1961. As used in this Annual Report, the \"Registrant\" or \"Interpublic\" refers to The Interpublic Group of Companies, Inc. while the \"Company\" refers to Interpublic and its subsidiaries.\nThe advertising agency business is the primary business of the Company. This business is conducted throughout the world through three advertising agency systems, McCann-Erickson Worldwide, Ammirati Puris Lintas and The Lowe Group. The Company also offers advertising agency services through association arrangements with local agencies in various parts of the world. Other activities conducted by the Company within the area of \"marketing communications\" include market research, sales promotion, product development, product design, direct marketing, telemarketing and other related services.\nThe principal functions of an advertising agency are to plan and create advertising programs for its clients and to place advertising in various media such as television, cable, radio, magazines, newspapers, transit, direct response media and outdoor. The planning function involves analysis of the market for the particular product or service, evaluation of alternative methods of distribution and choice of the appropriate media to reach the desired market most efficiently. The advertising agency then creates an advertising program, within the limits imposed by the client's advertising budget, and places orders for space or time with the media that have been selected. Interpublic also carries on a media buying business through its ownership of Western International Media and its affiliates.\nThe principal advertising agency subsidiaries of Interpublic operating within the United States directly or through subsidiaries and the locations of their respective corporate headquarters are: PAGE\nMcCann-Erickson USA, Inc.......... New York, New York\nCampbell-Ewald Company.......................... Detroit (Warren), Michigan\nAmmirati Puris Lintas Inc......... New York, New York\nDailey & Associates............... Los Angeles, California\nLowe & Partners Inc............... New York, New York\nCampbell Mithun Esty LLC.......... Minneapolis, Minnesota\nIn addition to domestic operations, the Company provides advertising services for clients whose business is international in scope as well as for clients whose business is restricted to a single country or a small number of countries. It has offices in Canada as well as in one or more cities in each of the following countries:\nEUROPE, AFRICA AND THE MIDDLE EAST\nAustria Germany Namibia South Africa Belgium Greece Netherlands Spain Croatia Hungary Norway Sweden Czech Republic Ireland Poland Switzerland Denmark Italy Portugal Turkey Finland Ivory Coast Romania United Arab Emirates France Kenya Russia United Kingdom Malawi Slovak Zimbabwe Republic\nLATIN AMERICA AND THE CARIBBEAN\nArgentina Costa Rica Honduras Peru Barbados Dominican Republic Jamaica Puerto Rico Bermuda Ecuador Mexico Trinidad Brazil El Salvador Panama Uruguay Chile Guatemala Paraguay Venezuela Colombia\nPAGE\nASIA AND THE PACIFIC\nAustralia Japan People's Republic South Korea Hong Kong Malaysia of China Taiwan India Nepal Philippines Thailand New Zealand Singapore\nOperations in the foregoing countries are carried on by one or more operating companies, at least one of which is either wholly owned by Interpublic or a subsidiary or is a company in which Interpublic or a subsidiary owns a 51% interest or more, except in Malawi and Nepal, where Interpublic or a subsidiary holds a minority interest.\nThe Company also offers advertising agency services in Aruba, the Bahamas, Bahrain, Belize, Bolivia, Bulgaria, Cambodia, Cameroon, Egypt, Gabon, Ghana, Grand Cayman, Guadeloupe, Guam, Guyana, Haiti, Reunion, Indonesia, Iran, Israel, Ivory Coast, Jordan, Kuwait, Lebanon, Martinique, Mauritius, Morocco, Nicaragua, Nigeria, Oman, Pakistan, Paraguay, Saudi Arabia, Senegal, Sri Lanka, Surinam, Tunisia, Uganda, United Arab Emirates (Dubai), Vietnam and Zaire through association arrangements with local agencies operating in those countries.\nFor information concerning revenues, operating profits and identifiable assets on a geographical basis for each of the last three years, reference is made to Note 13: Geographic Areas of the Notes to the Consolidated Financial Statements in the Company's Annual Report to Stockholders for the year ended December 31, 1995, which Note is hereby incorporated by reference.\nDevelopments in 1995\nThe Company completed several acquisitions within the United States and abroad in 1995.\nEffective November 10, 1995, Anderson & Lembke,Inc. was acquired. Anderson & Lembke, Inc. is an advertising agency with headquarters in New York City and San Francisco.\nAs of June 29, 1995, the Company acquired a 50% interest in a limited liability company, Campbell Mithun Esty LLC. The other 50% is owned by former employees of Campbell Mithun Esty Inc. which are employed by the LLC. PAGE\nIn 1995, the Company completed its integration of Ammirati & Puris (acquired in 1994) with its Lintas Agency System. In 1995, Ammirati & Puris Holdings, Inc. and Ammirati & Puris Inc. were merged into Lintas, Inc. and the name of the surviving corporation has been changed to Ammirati Puris Lintas Inc. Ammirati Puris Lintas Inc. continues to be headquartered in New York City. The Company also is in the process of changing the names of the corporations comprising the Lintas Worldwide Agency System to reflect the \"Ammirati Puris Lintas\" name.\nSee Note 3 to the Consolidated Financial Statements incorporated by reference in this Report on Form 10-K for discussion of additional acquisitions.\nIncome from Commissions, Fees and Publications\nThe Company generates income from planning, creating and placing advertising in various media. Historically, the commission customary in the industry was 15% of the gross charge (\"billings\") for advertising space or time; more recently lower commissions have been negotiated, but often with additional incentives for better performance. For example, an incentive component is frequently included in arrangements with clients based on increases in a client's sales of the products or services being advertised. Under commission arrangements, media bill the Company at their gross rates. The Company bills these amounts to its clients, remits the net charges to the media and retains the balance as its commission. Some clients, however, prefer to compensate the Company on a fee basis, under which the Company bills its client for the net charges billed by the media plus an agreed-upon fee. These fees usually are calculated to reflect the Company's salary costs and out-of-pocket expenses incurred on the client's behalf, plus proportional overhead and a profit mark-up.\nNormally, the Company, like other advertising agencies, is primarily responsible for paying the media with respect to firm contracts for advertising time or space. This is a problem only if the client is unable to pay the Company because of insolvency or bankruptcy. The Company makes serious efforts to reduce the risk from a client's insolvency, including (1) carrying out credit clearances, (2) requiring in some cases payment of media in advance, or (3) agreeing with the media that the Company will be solely liable to pay the media only after the client has paid the Company for the media charges. PAGE\nThe Company also receives commissions from clients for planning and supervising work done by outside contractors in the physical preparation of finished print advertisements and the production of television and radio commercials and infomercials. This commission is customarily 17.65% of the outside contractor's net charge, which is the same as 15% of the outside contractor's total charges including commission. With the spread of negotiated fees, the terms on which outstanding contractors' charges are billed are subject to wide variations and even include in some instances the elimination of commissions entirely provided that there are adequate negotiated fees.\nThe Company derives income in many other ways, including the planning and placement in media of advertising produced by unrelated advertising agencies; the maintenance of specialized media placement facilities; the creation and publication of brochures, billboards, point of sale materials and direct marketing pieces for clients; the planning and carrying out of specialized marketing research; managing special events at which clients' products are featured; and designing and carrying out interactive programs for special uses.\nThe five clients of the Company that made the largest contribution in 1995 to income from commissions and fees accounted individually for 2% to 11% of such income and in the aggregate accounted for over 31% of such income. Twenty clients of the Company accounted for approximately 45% of such income. Based on income from commissions and fees, the three largest clients of the Company are General Motors Corporation, Unilever and The Coca-Cola Company. General Motors Corporation first became a client of one of the Company's agencies in 1916 in the United States. Predecessors of several of the Lintas agencies have supplied advertising services to Unilever since 1893. The client relationship with The Coca-Cola Company began in 1942 in Brazil and in 1955 in the United States. While the loss of the entire business of one of the Company's three largest clients might have a material adverse effect upon the business of the Company, the Company believes that it is very unlikely that the entire business of any of these clients would be lost at the same time, because it represents several different brands or divisions of each of these clients in a number of geographical markets - in each case through more than one of the Company's agency systems.\nRepresentation of a client rarely means that the Company handles advertising for all brands or product lines of the client in all geographical locations. Any client may transfer its\nPAGE\nbusiness from an advertising agency within the Company to a competing agency, and a client may reduce its advertising budget at any time. The Company's advertising agencies in many instances have written contracts with their clients.\nAs is customary in the industry, these contracts provide for termination by either party on relatively short notice, usually 90 days but sometimes shorter or longer. In 1995, however, 42% of income from commissions and fees was derived from clients that had been associated with one or more of the Company's agencies or their predecessors for 20 or more years.\nPersonnel\nAs of January 1, 1996, the Company employed approximately 19,700 persons, of whom approximately 5,900 were employed in the United States. Because of the personal service character of the marketing communications business, the quality of personnel is of crucial importance to continuing success. There is keen competition for qualified employees. Interpublic considers its employee relations to be satisfactory.\nThe Company has an active program for training personnel. The program includes meetings and seminars throughout the world. It also involves training personnel in its offices in New York and in its larger offices worldwide.\nCompetition and Other Factors\nThe advertising agency and other marketing communications businesses are highly competitive. The Company's agencies and media services must compete with other agencies, both large and small, and also with other providers of creative or media services which are not themselves advertising agencies, in order to maintain existing client relationships and to obtain new clients. Competition in the advertising agency business depends to a large extent on the client's perception of the quality of an agency's \"creative product\". An agency's ability to serve clients, particularly large international clients, on a broad geographic basis is also an important competitive consideration. On the other hand, because an advertising agency's principal asset is its people, freedom of entry into the business is almost unlimited and quite small agencies are, on occasion, able to take all or some portion of a client's account from a much larger competitor. PAGE\nMoreover, increasing size brings limitations to an agency's potential for securing new business, because many clients prefer not to be represented by an agency that represents a competitor. Also, clients frequently wish to have different products represented by different agencies. The fact that the Company owns three separate worldwide agency systems and interests in other advertising agencies gives it additional competitive opportunities.\nThe advertising business is subject to government regulation, both domestic and foreign. There has been an increasing tendency in the United States on the part of advertisers to resort to the courts to challenge comparative advertising on the grounds that the advertising is false and deceptive. Through the years, there has been a continuing expansion of specific rules, prohibitions, media restrictions, labeling disclosures and warning requirements with respect to the advertising for certain products. Representatives within state governments and the federal government as well as foreign governments continue to initiate proposals to ban the advertising of specific products and to impose taxes on or deny deductions for advertising which, if successful, may have an adverse effect on advertising expenditures.\nSome countries are relaxing commercial restrictions as part of their efforts to attract foreign investment. However, with respect to other nations, the international operations of the Company still remain exposed to certain risks which affect foreign operations of all kinds, such as local legislation, monetary devaluation, exchange control restrictions and unstable political conditions. In addition, international advertising agencies are from time to time exposed to the threat of forced divestment in favor of local investors because they are considered an integral factor in the communications process. A provision of the present constitution in the Philippines is an example.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nMost of the advertising operations of the Company are conducted in leased premises, and its physical property consists primarily of leasehold improvements, furniture, fixtures and equipment. These facilities are located in various cities in\nPAGE\nwhich the Company does business throughout the world. However, subsidiaries of the Company own office buildings in Louisville, Kentucky; Warren, Michigan; Frankfurt, Germany; Sao Paulo, Brazil; Lima, Peru; and Brussels, Belgium and own office condominiums in Buenos Aires, Argentina; Bogota, Colombia; Manila, the Philippines; in England, subsidiaries of the Company own office buildings in London, Manchester, Birmingham and Stoke-on-Trent.\nThe Company's ownership of the office building in Frankfurt is subject to three mortgages which became effective on or about February 1993. These mortgages terminate at different dates, with the last to expire in February 2003. Reference is made to Note 15: Commitments and Contingent Liabilities - of the Notes to the Consolidated Financial Statements in the Company's Annual Report to Stockholders for the year ended December 31, 1995, which Note is hereby incorporated by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Company nor any of its subsidiaries are subject to any pending material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nExecutive Officers of the Registrant\nThere follows the information disclosed in accordance with Item 401 of Regulation S-K of the Securities and Exchange Commission (the \"Commission\") as required by Item 10 of Form 10-K with respect to executive officers of the Registrant.\nName Age Office\nPhilip H. Geier, Jr. (1) 61 Chairman of the Board, President and Chief Executive Officer\nEugene P. Beard (1) 60 Vice Chairman-Finance and Operations, Chief Financial Officer PAGE\nJohn J. Dooner, Jr. (1) 47 Chairman of McCann-Erickson Worldwide, Inc.\nNicholas J. Camera 49 Vice President, Secretary and General Counsel\nFrank B. Lowe (1) 54 Chairman of The Lowe Group\nC. Kent Kroeber 57 Senior Vice President-Human Resources\nMartin F. Puris (1) 57 Chairman, Chief Executive Officer and Chief Creative Officer of Ammirati Puris Lintas Worldwide\nThomas J. Volpe 60 Senior Vice President-Financial Operations\nJoseph M. Studley 43 Vice President and Controller\n(1) Also a Director\nThere is no family relationship among any of the executive officers.\nThe employment histories for the past five years of Messrs. Geier, Beard, Dooner, Puris and Lowe are incorporated by reference to the Proxy Statement for Interpublic's 1996 Annual Meeting of Stockholders.\nMr. Camera joined Interpublic on May 17, 1993. He was elected Vice President, Assistant General Counsel and Assistant Secretary on June 1, 1994 and Vice President, General Counsel and Secretary on December 15, 1995.\nMr. Kroeber joined Interpublic in January 1966 as Manager of Compensation and Training. He was elected a Vice President in 1970 and Senior Vice President in May 1980.\nMr. Volpe joined Interpublic on March 3, 1986. He was appointed Senior Vice President-Financial Operations on March 18, 1986. He served as Treasurer from January 1, 1987 through May 17, 1988 and the Treasurer's office continues to report to him. He was Vice President and Treasurer of Colgate-Palmolive Company\nPAGE\nfrom February 1981 to February 1986 and Assistant Corporate Controller prior thereto.\nMr. Studley was elected as Vice President and Controller of Interpublic effective as of April 1, 1994, formerly he was Senior Vice President and Chief Financial Officer of E.C. Television, a division of Interpublic, since January 1, 1990. He was a Vice President of Lintas New York, a division of one of Interpublic's subsidiaries, from August 1, 1987 until December 31, 1989.\nPAGE\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe response to this Item is incorporated by reference to the Registrant's Annual Report to Stockholders for the year ended December 31, 1995. See Note 12: Results by Quarter (Unaudited), of the Notes to the Consolidated Financial Statements and information under the heading Transfer Agent and Registrar for Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe response to this Item is incorporated by reference to the Registrant's Annual Report to Stockholders for the year ended December 31, 1995 under the heading Selected Financial Data for Five Years.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe response to this Item is incorporated by reference to the Registrant's Annual Report to Stockholders for the year ended December 31, 1995 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 response to this Item is incorporated in part by reference to the Registrant's Annual Report to Stockholders for the year ended December 31, 1995 under the headings Financial Statements and Notes to the Consolidated Financial Statements. Reference is also made to the Financial Statement Schedules listed under Item 14(a) of this Report on Form 10-K.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable. PAGE\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information required by this Item is incorporated by reference to the Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders (the \"Proxy Statement\"), to be filed not later than 120 days after the end of the 1995 calendar year, except for the description of Interpublic's Executive Officers which appears in Part I of this Report on Form 10-K under the heading Executive Officers of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item is incorporated by reference to the Proxy Statement. Such incorporation by reference shall not be deemed to incorporate specifically 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\nThe information required by this Item is incorporated by reference to the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated by reference to the Proxy Statement. Such incorporation by reference shall not be deemed to incorporate specifically by reference the information referred to in Item 402(a)(8) of Regulation S-K.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nPAGE\n(a) Listed below are all financial statements, financial statement schedules and exhibits filed as part of this Report on Form 10-K.\n1. Financial Statements:\nSee the Index to Financial Statements on page.\n2. Financial Statement Schedules:\nSee the Index to Financial Statement Schedules on page.\n3. Exhibits:\n(Numbers used are the numbers assigned in Item 601 of Regulation S-K and the EDGAR Filer Manual. An additional copy of this exhibit index immediately precedes the exhibits filed with this Report on Form 10-K and the exhibits transmitted to the Commission as part of the electronic filing of the Report.)\nExhibit No. Description\n3 (i) The Restated Certificate of Incorporation of the Registrant, as amended is incorporated by reference to its Report on Form 10-Q for the quarter ended June 30, 1995. See Commission file number 1-6686.\n(ii) The By-Laws of the Registrant, amended as of February 19, 1991, are incorporated by reference to its Report on Form 10-K for the year ended December 31, 1990. See Commission file number 1-6686.\n4 Instruments Defining the Rights of Security Holders.\n(i) Indenture, dated as of April 1, 1992, between Interpublic and Morgan Guaranty Trust Company of New York is not included as an Exhibit to this Report but will be furnished to the Commission upon its request.\n(ii) The Preferred Share Purchase Rights Plan as adopted on July 18, 1989 is incorporated by reference to Registrant's Registration Statement on Form 8-A dated August 1, 1989 (No. 00017904) and, as amended, by reference to Registrant's Registration Statement on Form 8 dated October 3, 1989 (No. 00106686).\nPAGE\n10 Material Contracts.\n(a) Underwriting Agreement, dated March 30, 1992, by and between Interpublic and Goldman Sachs International Limited is incorporated by reference to Registrant's Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(b) Employment, Consultancy and other Compensatory Arrangements with Management.\nEmployment and Consultancy Agreements and any amendments or supplements thereto and other compensatory arrangements filed with the Registrant's Reports on Form 10-K for the years ended December 31, 1980 through December 31, 1994, inclusive, or filed with the Registrant's Reports on Form 10-Q for the periods ended March 31, 1995, June 30, 1995 and September 30, 1995 are incorporated by reference in this Report on Form 10-K. See Commission file number 1-6686. Listed below are agreements or amendments to agreements between the Registrant and its executive officers which remain in effect on and after the date hereof or were executed during the year ended December 31, 1995 and thereafter, unless previously submitted, which are filed as exhibits to this Report on Form 10-K.\n(i) John J. Dooner, Jr.\n(a) Employment Agreement made as of August 1, 1984.\n(b) Supplemental Agreement made as of June 1, 1985 to an Employment Agreement made as of August 1, 1984.\n(c) Supplemental Agreement made as of December 1, 1985 to an Employment Agreement made as of August 1, 1984.\n(d) Supplemental Agreement made as of June 1, 1986 to an Employment Agreement made as of August 1, 1984. PAGE\n(e) Executive Special Benefit Agreement made as of July 1, 1986.\n(f) Deferred Bonus Agreement made as of November 12, 1986.\n(g) Supplemental Agreement made as of June 1, 1987 to an Employment Agreement made as of August 1, 1984.\n(h) Executive Severance Agreement made as of August 10, 1987.\n(i) Supplemental Agreement made as of April 1, 1988 to an Employment Agreement made as of August 1, 1984.\n(j) Supplemental Agreement made as of November 1, 1988 to an Employment Agreement made as of August 1, 1984.\n(k) Supplemental Agreement made as of July 1, 1989 to an Employment Agreement made as of August 1, 1984.\n(l) Supplemental Agreement made as of May 23, 1990 to an Executive Special Benefit Agreement made as of July 1, 1986.\n(m) Supplemental Agreement made as of July 1, 1990 to an Employment Agreement made as of August 1, 1984.\n(n) Supplemental Agreement made as of October 1, 1991 to an Employment Agreement made as of August 1, 1984.\n(o) Supplemental Agreement made as of May 1, 1992 to an Employment Agreement made as of August 1, 1984.\n(p) Supplemental Agreement made as of August 10, 1992 to an Executive Severance Agreement made as of August 10, 1987.\nPAGE\n(q) Executive Special Benefit Agreement made as of July 1, 1992.\n(r) Employment Agreement made as of January 1, 1994.\n(s) Executive Special Benefit Agreement made as of June 1, 1994.\n(t) Supplemental Agreement made as of July 1, 1995 to an Employment Agreement made as of January 1, 1994.\n(ii) Frank B. Lowe\n(a) Employment Agreement made as of January 1,1996.\n(b) Executive Special Benefit Agreement made as of January 1, 1996.\n(iii) Martin F. Puris\nEmployment Agreement made as of August 11, 1994.\n(c) Executive Compensation Plans.\n(i) Trust Agreement, dated as of June 1, 1990 between The Interpublic Group of Companies, Inc., Lintas Campbell-Ewald Company, McCann-Erickson USA, Inc., McCann-Erickson Marketing, Inc., Lintas, Inc. and Chemical Bank, as Trustee, is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. See Commission file number 1-6686.\n(ii) The Stock Option Plan (1988) and the Achievement Stock Award Plan of the Registrant are incorporated by reference to Appendices C and D of the Prospectus dated May 4, 1989 forming part of its Registration Statement on Form S-8 (No. 33-28143).\nPAGE\n(iii) The Management Incentive Compensation Plan of the Registrant is incorporated by reference to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1995. See Commission file number 1-6686.\n(iv) The 1986 Stock Incentive Plan of the Registrant is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. See Commission file number 1-6686.\n(v) The 1986 United Kingdom Stock Option Plan of the Registrant is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(vi) The Employee Stock Purchase Plan (1985) of the Registrant, as amended, is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. See Commission file number 1-6686.\n(vii) The Long-Term Performance Incentive Plan of the Registrant is incorporated by reference to Appendix A of the Prospectus dated December 12, 1988 forming part of its Registration Statement on Form S-8 (No. 33-25555).\n(viii) Resolution of the Board of Directors adopted on February 16, 1993, amending the Long-Term Performance Incentive Plan is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(ix) Resolution of the Board of Directors adopted on May 16, 1989 amending the Long-Term Performance Incentive Plan is incorporated by reference to Registrant's Report on Form 10-K for the year ended December 31, 1989. See Commission file number 1-6686.\nPAGE\n(d) Loan Agreements.\n(i) Credit Agreement dated as of July 3, 1995, between Interpublic and Lloyds Bank Plc.\n(ii) Credit Agreement dated and effective December 21, 1995 between Interpublic and NBD Bank.\n(iii)Note dated as of December 21, 1995 between Interpublic and NBD Bank pursuant to the Credit Agreement dated and effective as of December 21, 1995.\n(iv) Other Loan and Guaranty Agreements filed with the Registrant's Annual Report on Form 10-K for the years ended December 31, 1988 and December 31, 1986 are incorporated by reference in this Report on Form 10-K. Other Credit Agreements, amendments to various Credit Agreements, Supplemental Agreements, Termination Agreements, Loan Agreements, a Note Purchase Agreement, dated August 20, 1991, Guarantee, dated December 17, 1991, Notification dated March 14, 1991 by Registrant and Intercreditor Agreements filed with the Registrant's Report on Form 10-K for the years ended December 31, 1989 through December 31, 1994, inclusive and filed with Registrant's Reports on Form 10-Q for the periods ended March 31, 1995, June 30, 1995 and September 30, 1995 are incorporated by reference into this Report on Form 10-K. See Commission file number 1-6686.\n(e) Leases.\nMaterial leases of premises are incorporated by reference to the Registrant's Annual Report on Form 10-K for the years ended December 31, 1980 and December 31, 1988. See Commission file number 1-6686. PAGE\n(f) Acquisition Agreement for Purchase of Real Estate.\n(i) Acquisition Agreement (in German) between Treuhandelsgesellschaft Aktiengesellschaft & Co. Grundbesitz OHG and McCann-Erickson Deutschland GmbH & Co. Management Property KG (\"McCann-Erickson Deutschland\") and the English translation of the Acquisition Agreement are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(g) Mortgage Agreements and Encumbrances.\n(i) Summaries In German and English of Mortgage Agreements between McCann-Erickson Deutschland and Frankfurter Hypothekenbank Aktiengesellschaft (\"Frankfurter Hypothekenbank\"), Mortgage Agreement, dated January 22, 1993, between McCann-Erickson Deutschland and Frankfurter Hypothekenbank, Mortgage Agreement, dated January 22, 1993, between McCann-Erickson Deutschland and Hypothekenbank are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. See Commission file number 1-6686. Summaries In German and English of Mortgage Agreement, between McCann-Erickson Deutschland and Frankfurter Sparkasse and Mortgage Agreement, dated January 7, 1993, between McCann-Erickson Deutschland and Frankfurter Sparkasse are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(ii) Summaries In German and English of Documents Creating Encumbrances In Favor of Frankfurter Hypothekenbank and Frankfurter Sparkasse In Connection With the Aforementioned Mortgage Agreements, Encumbrance, dated January 15, 1993, In Favor Of Frankfurter Hypothekenbank, and Encumbrance, dated January 15, 1993, In Favor of Frankfurter Sparkasse are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\nPAGE\n(iii) Loan Agreement (in English and German), dated January 29, 1993 between Lintas Deutschland GmbH and McCann-Erickson Deutschland is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n11 Computation of Earnings Per Share.\n13 This Exhibit includes: (a) those portions of the Annual Report to Stockholders for the year ended December 31, 1995 which are included therein under the following headings: Financial Highlights; Management's Discussion and Analysis of Financial Condition and Results Of Operations; Consolidated Balance Sheet; Consolidated Statement of Income; Consolidated Statement of Cash Flows; Consolidated Statement of Stockholders' Equity; Notes to Consolidated Financial Statements (the aforementioned consolidated financial statements together with the Notes to Consolidated Financial Statements hereinafter shall be referred to as the \"Consolidated Financial Statements\"); Report of Independent Accountants; Selected Financial Data For Five Years; Report of Management; and Stockholders' Information; and (b) Appendix to Exhibit 13.\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n24 Power of Attorney to sign Form 10-K and resolution of Board of Directors re Power of Attorney.\n27 Financial Data Schedules\n99 No reports on Form 8-K were filed during the quarter ended December 31, 1995. PAGE\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.\nTHE INTERPUBLIC GROUP OF COMPANIES, INC. (Registrant)\nMarch 28, 1996 BY: Philip H. Geier, Jr. Philip H. Geier, Jr., 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.\nName Title Date\nFrank J. Borelli Director March 28, 1996 Frank J. Borelli\nPhilip H. Geier, Jr. Chairman of the Board, March 28, 1996 Philip H. Geier, Jr. President and Chief Executive Officer (Principal Executive Officer) and Director\nEugene P. Beard Vice Chairman March 28, 1996 Eugene P. Beard -Finance and Operations (Principal Financial Officer) and Director\nJohn J. Dooner, Jr. Director March 28, 1996 John J. Dooner, Jr\nFrank B. Lowe Director March 28, 1996 Frank B. Lowe\nPAGE\nLeif H. Olsen Director March 28, 1996 Leif H. Olsen\nMartin F. Puris Director March 28, 1996 Martin F. Puris\nJ. Phillip Samper Director March 28, 1996 J. Phillip Samper\nJoseph J. Sisco Director March 28, 1996 Joseph J. Sisco\nJoseph M. Studley Vice President and March 28, 1996 Joseph M. Studley Controller (Principal Accounting Officer)\nAllen Questrom Director March 28, 1996 Allen Questrom\nBy Philip H. Geier, Jr. Philip H. Geier, Jr. Attorney-in-fact\nPAGE\nThe Financial Statements appearing under the headings: Financial Highlights, Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements, Notes to Consolidated Financial Statements, Report of Independent Accountants, Selected Financial Data for Five Years and Report of Management accompanying Annual Report to Stockholders for the year ended December 31, 1995, together with the report thereon of Price Waterhouse LLP dated February 13, 1996 appearing on page 40 thereof, are incorporated by reference in this report on Form 10-K. With the exception of the aforementioned information and the information incorporated in Items 5, 6 and 7, no other data appearing in the Annual Report to Stockholders for the year ended December 31, 1995 is deemed to be filed as part of this report on Form 10-K.\nThe following financial statement schedule should be read in conjunction with the financial statements in such Annual Report to Stockholders for the year ended December 31, 1995. Financial statement schedules not included in this report on Form 10-K have been omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\nSeparate financial statements for the companies which are 50% or less owned and accounted for by the equity method have been omitted because, considered in the aggregate as a single subsidiary, they do not constitute a significant subsidiary.\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPage Report of Independent Accountants on Financial Statement Schedules\nConsent of Independent Accountants\nFinancial Statement Schedules Required to be filed by Item 8 of this form:\nVIII Valuation and Qualifying Accounts\nPAGE\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of The Interpublic Group of Companies, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 13, 1996 appearing in the 1995 Annual Report to Stockholders of The Interpublic Group of Companies, 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 New York, New York February 13, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 of The Interpublic Group of Companies, Inc. (the \"Company\"), of our report dated February 13, 1996, appearing in the 1995 Annual Report to Stockholders which is incorporated in this Annual Report on Form 10-K: Registration Statements No. 2-79071; No. 2-43811; No. 2-56269; No. 2-61346; No. 2-64338; No. 2-67560; No. 2-72093; No. 2-88165; No. 2-90878, No. 2-97440 and No. 33-28143, relating variously to the Stock Option Plan (1971), the Stock Option Plan (1981), the Stock Option Plan (1988) and the Achievement Stock Award Plan of the Company; Registration Statements No. 2-53544; No. 2-91564, No. 2-98324, No. 33-22008, No. 33-64062 and No. 33-61371, relating variously to the Employee Stock Purchase Plan (1975), the Employee Stock Purchase Plan (1985) and the Employee Stock Purchase Plan of the Company (1995); Registration Statements No. 33-20291 and No. 33-2830 relating to the Management Incentive Compensation Plan of the Company; Registration Statement No. 33-5352 and No. 33-21605 relating to the 1986 Stock Incentive Plan and 1986 United Kingdom Stock Option Plan of the Company; and Registration Statement No. 33-10087 and No. 33-25555 relating to the Long-Term Performance Incentive Plan of the Company. We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 33-37346) of the Interpublic Group of Companies, Inc. of our report dated February 13, 1996, appearing in the 1995 Annual Report to Stockholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules, which appears above.\nPRICE WATERHOUSE LLP New York, New York March 28, 1996\nPAGE\nPAGE\nINDEX TO DOCUMENTS\nExhibit No. Description\n3 (i) The Restated Certificate of Incorporation of the Registrant, as amended is incorporated by reference to its Report on Form 10-Q for the quarter ended June 30, 1995. See Commission file number 1-6686.\n(ii) The By-Laws of the Registrant, amended as of February 19, 1991, are incorporated by reference to its Report on Form 10-K for the year ended December 31, 1990. See Commission file number 1-6686.\n4 Instruments Defining the Rights of Security Holders.\n(i) Indenture, dated as of April 1, 1992, between Interpublic and Morgan Guaranty Trust Company of New York is not included as an Exhibit to this Report but will be furnished to the Commission upon its request.\n(ii) The Preferred Share Purchase Rights Plan as adopted on July 18, 1989 is incorporated by reference to Registrant's Registration Statement on Form 8-A dated August 1, 1989 (No. 00017904) and, as amended, by reference to Registrant's Registration Statement on Form 8 dated October 3, 1989 (No. 00106686).\n10 Material Contracts.\n(a) Underwriting Agreement, dated March 30, 1992, by and between Interpublic and Goldman Sachs International Limited is incorporated by reference to Registrant's Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(b) Employment, Consultancy and other Compensatory Arrangements with Management.\nPAGE\nEmployment and Consultancy Agreements and any amendments or supplements thereto and other compensatory arrangements filed with the Registrant's Reports on Form 10-K for the years ended December 31, 1980 through December 31, 1994, inclusive, or filed with the Registrant's Reports on Form 10-Q for the periods ended March 31, 1995, June 30, 1995 and September 30, 1995 are incorporated by reference in this Report on Form 10-K. See Commission file number 1-6686. Listed below are agreements or amendments to agreements between the Registrant and its executive officers which remain in effect on and after the date hereof or were executed during the year ended December 31, 1995 and thereafter, unless previously submitted, which are filed as exhibits to this Report on Form 10-K.\n(i) John J. Dooner, Jr.\n(a) Employment Agreement made as of August 1, 1984.\n(b) Supplemental Agreement made as of June 1, 1985 to an Employment Agreement made as of August 1, 1984.\n(c) Supplemental Agreement made as of December 1, 1985 to an Employment Agreement made as of August 1, 1984.\n(d) Supplemental Agreement made as of June 1, 1986 to an Employment Agreement made as of August 1, 1984.\n(e) Executive Special Benefit Agreement made as of July 1, 1986.\n(f) Deferred Bonus Agreement made as of November 12, 1986.\n(g) Supplemental Agreement made as of June 1, 1987 to an Employment Agreement made as of August 1, 1984.\n(h) Executive Severance Agreement made as of August 10, 1987.\nPAGE\n(i) Supplemental Agreement made as of April 1, 1988 to an Employment Agreement made as of August 1, 1984.\n(j) Supplemental Agreement made as of November 1, 1988 to an Employment Agreement made as of August 1, 1984.\n(k) Supplemental Agreement made as of July 1, 1989 to an Employment Agreement made as of August 1, 1984.\n(l) Supplemental Agreement made as of May 23, 1990 to an Executive Special Benefit Agreement made as of July 1, 1986.\n(m) Supplemental Agreement made as of July 1, 1990 to an Employment Agreement made as of August 1, 1984.\n(n) Supplemental Agreement made as of October 1, 1991 to an Employment Agreement made as of August 1, 1984.\n(o) Supplemental Agreement made as of May 1, 1992 to an Employment Agreement made as of August 1, 1984.\n(p) Supplemental Agreement made as of August 10, 1992 to an Executive Severance Agreement made as of August 10, 1987.\n(q) Executive Special Benefit Agreement made as of July 1, 1992.\n(r) Employment Agreement made as of January 1, 1994.\n(s) Executive Special Benefit Agreement made as of June 1, 1994.\n(t) Supplemental Agreement made as of July 1, 1995 to an Employment Agreement made as of January 1, 1994. PAGE\n(ii) Frank B. Lowe\n(a) Employment Agreement made as of January 1,1996.\n(b) Executive Special Benefit Agreement made as of January 1, 1996.\n(iii) Martin F. Puris\nEmployment Agreement made as of August 11, 1994.\n(c) Executive Compensation Plans.\n(i) Trust Agreement, dated as of June 1, 1990 between The Interpublic Group of Companies, Inc., Lintas Campbell-Ewald Company, McCann-Erickson USA, Inc., McCann-Erickson Marketing, Inc., Lintas, Inc. and Chemical Bank, as Trustee, is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. See Commission file number 1-6686.\n(ii) The Stock Option Plan (1988) and the Achievement Stock Award Plan of the Registrant are incorporated by reference to Appendices C and D of the Prospectus dated May 4, 1989 forming part of its Registration Statement on Form S-8 (No. 33-28143).\n(iii) The Management Incentive Compensation Plan of the Registrant is incorporated by reference to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1995. See Commission file number 1-6686.\n(iv) The 1986 Stock Incentive Plan of the Registrant is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. See Commission file number 1-6686.\n(v) The 1986 United Kingdom Stock Option Plan of the Registrant is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686. PAGE\n(vi) The Employee Stock Purchase Plan (1985) of the Registrant, as amended, is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. See Commission file number 1-6686.\n(vii) The Long-Term Performance Incentive Plan of the Registrant is incorporated by reference to Appendix A of the Prospectus dated December 12, 1988 forming part of its Registration Statement on Form S-8 (No. 33-25555).\n(viii) Resolution of the Board of Directors adopted on February 16, 1993, amending the Long-Term Performance Incentive Plan is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(ix) Resolution of the Board of Directors adopted on May 16, 1989 amending the Long-Term Performance Incentive Plan is incorporated by reference to Registrant's Report on Form 10-K for the year ended December 31, 1989. See Commission file number 1-6686.\n(d) Loan Agreements.\n(i) Credit Agreement dated as of July 3, 1995 between Interpublic and Lloyds Bank Plc.\n(ii) Credit Agreement dated and effective December 21, 1995 between Interpublic and NBD Bank.\n(iii) Note dated as of December 21, 1995 between Interpublic and NBD Bank pursuant to the Credit Agreement dated and effective as of December 21, 1995.\n(iv) Other Loan and Guaranty Agreements filed with the Registrant's Annual Report on Form 10-K for the years ended December 31, 1988 and December 31, 1986 are incorporated by reference in this Report on Form 10-K. Other Credit Agreements, amendments to various Credit Agreements, Supplemental Agreements, Termination Agreements, Loan PAGE\nAgreements, a Note Purchase Agreement, dated August 20, 1991, Guarantee, dated December 17, 1991, Notification dated March 14, 1991 by Registrant and Intercreditor Agreements filed with the Registrant's Report on Form 10-K for the years ended December 31, 1989 through December 31, 1994, inclusive and filed with Registrant's Reports on Form 10-Q for the periods ended March 31, 1995, June 30, 1995 and September 30, 1995 are incorporated by reference into this Report on Form 10-K. See Commission file number 1-6686.\n(e) Leases.\nMaterial leases of premises are incorporated by reference to the Registrant's Annual Report on Form 10-K for the years ended December 31, 1980 and December 31, 1988. See Commission file number 1-6686.\n(f) Acquisition Agreement for Purchase of Real Estate.\nAcquisition Agreement (in German) between Treuhandelsgesellschaft Aktiengesellschaft & Co. Grundbesitz OHG and McCann-Erickson Deutschland GmbH & Co. Management Property KG (\"McCann-Erickson Deutschland\") and the English translation of the Acquisition Agreement are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(g) Mortgage Agreements and Encumbrances.\n(i) Summaries In German and English of Mortgage Agreements between McCann-Erickson Deutschland and Frankfurter Hypothekenbank Aktiengesellschaft (\"Frankfurter Hypothekenbank\"), Mortgage Agreement, dated January 22, 1993, between McCann-Erickson Deutschland and Frankfurter Hypothekenbank, Mortgage Agreement, dated January 22, 1993, between McCann-Erickson Deutschland and Hypothekenbank are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\nPAGE\nSee Commission file number 1-6686. Summaries In German and English of Mortgage Agreement, between McCann-Erickson Deutschland and Frankfurter Sparkasse and Mortgage Agreement, dated January 7, 1993, between McCann-Erickson Deutschland and Frankfurter Sparkasse are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(ii) Summaries In German and English of Documents Creating Encumbrances In Favor of Frankfurter Hypothekenbank and Frankfurter Sparkasse In Connection With the Aforementioned Mortgage Agreements, Encumbrance, dated January 15, 1993, In Favor Of Frankfurter Hypothekenbank, and Encumbrance, dated January 15, 1993, In Favor of Frankfurter Sparkasse are incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n(iii) Loan Agreement (in English and German), dated January 29, 1993 between Lintas Deutschland GmbH and McCann-Erickson Deutschland is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. See Commission file number 1-6686.\n11 Computation of Earnings Per Share.\n13 This Exhibit includes: (a) those portions of the Annual Report to Stockholders for the year ended December 31, 1995 which are included therein under the following headings: Financial Highlights; Management's Discussion and Analysis of Financial Condition and Results Of Operations; Consolidated Balance Sheet; Consolidated Statement of Income; Consolidated Statement of Cash Flows; Consolidated Statement of Stockholders' Equity; Notes to Consolidated Financial Statements (the aforementioned consolidated financial Statements together with the Notes to Consolidated Financial Statements hereinafter shall be referred to as the \"Consolidated Financial Statements\"); Report of Independent Accountants; Selected Financial Data For Five Years; Report of Management; and Stockholders' Information; and (b) Appendix to Exhibit 13. PAGE\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n24 Power of Attorney to sign Form 10-K and resolution of Board of Directors re Power of Attorney.\n27 Financial Data Schedules\n99 No reports on Form 8-K were filed during the quarter ended December 31, 1995.","section_15":""}
{"filename":"318526_1995.txt","cik":"318526","year":"1995","section_1":"ITEM 1. BUSINESS\nKrupp Associates 1980-1(\"KRLP-I\") is a limited partnership formed on July 31, 1980, pursuant to the provisions of the Massachusetts Uniform Limited Partnership Act. The Krupp Company and The Krupp Corporation serve as the General Partners of KRLP-I. Chivas Square Associates serves as the Original Limited Partner of KRLP-I. On November 10, 1980, KRLP-I commenced an offering of $4,000,000 of Class A Limited Partner Interests in Units of $1,000 each, which was successfully completed on April 30, 1981. (For further details see Note A of Notes to Consolidated Financial Statements included in Item 8 (Appendix A) of this report). The primary business of KRLP-I has been to invest in, operate, refinance, and ultimately dispose of fully developed, income producing residential properties and related assets. KRLP-I considers itself to be engaged in the industry segment of investment in real estate.\nOn January 20, 1988, the General Partners formed Krupp Associates Riverside Limited Partnership (\"Realty-I\") as a prerequisite for the refinancing of Riverside Apartments. At the same time, the General Partners transferred ownership of the property to Realty-I. The General Partner of Realty-I is The Krupp Corporation (\"Krupp Corp.\"). The Limited Partner of Realty-I is KRLP-I. Krupp Corp. has beneficially assigned its interest in Realty-I to KRLP-I. KRLP-I and Realty-I are collectively known as Krupp Realty Limited Partnership-I (collectively the \"Partnership\").\nThe Partnership's remaining real estate investment, Riverside I Apartments (\"Riverside\"), is a 140-unit apartment complex with approximately 30,000 square feet of commercial retail space located in Evansville, Indiana. Riverside is subject to some seasonal fluctuations due to changes in utility consumption and seasonal maintenance expenditures. However, the future performance of the Partnership will depend upon factors which cannot be predicted. Such factors include general economic and real estate market conditions, both on a national basis and in those areas where the Partnership's investments are located, real estate tax rates, operating expenses, energy costs, government regulations, and federal and state income tax laws. The requirements for compliance with federal, state and local regulations to date have not had an adverse effect on the Partnership's operations, and no adverse effect is anticipated in the future.\nRiverside is also subject to such risks as (i) competition from existing and future projects held by other owners in the area in which the Partnership's property operates, (ii) possible reduction in rental income due to an inability to maintain high occupancy levels and rental rates, (iii) possible adverse changes in general economic and local conditions such as competitive over-building, increased unemployment, adverse changes in real estate zoning laws and the possible future adoption of rent control legislation which would not permit the full amount of increased costs to be passed on to tenants in the form of rent increases, and (iv) other circumstances over which the Partnership may have little or no control.\nAs of December 31, 1995, there were 8 full or part-time on-site project personnel employed by the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nA summary of the Partnership's real estate investments is presented below. Schedule III included in Appendix A to this report contains additional detailed information with respect to the property.\nTotal Units\/\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe transfer of Units is subject to certain limitations contained in the Partnership Agreement. There is no public market for the Units and it is not anticipated that any such public market will develop.\nThe number of Class A Limited Partners as of December 31, 1995 was approximately 400.\nOne of the objectives of the Partnership is to generate cash available for distribution. However, there is no assurance that future operations will generate cash available for distribution. The Partnership has not made distributions since 1988 due to insufficient operating cash flow. The Partnership does not anticipate resuming distributions until the property generates sufficient operating cash flow.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial information regarding the Partnership's consolidated financial position and operating results. The information is comparable and should be read in conjunction with Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations and the Financial Statements, which are included in Items 7 and 8 of this report, respectively.\n(1) Includes demand notes payable, since the General Partners expect they will be long-term obligations.\nPrior performance of the Partnership is not necessarily indicative of future operations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe Partnership's ability to generate cash adequate to meet its needs is dependent primarily upon the operating performance of Riverside. Such ability is also dependent upon the future sale of the asset. These sources of liquidity could be used by the Partnership for payment of expenses related to real estate operations, debt service and expenses. Cash Flow and Capital Transaction Proceeds, if any, as calculated under Section 8.2(a) (\"Cash Flow\") and 8.3(a) of the Partnership Agreement would then be available for distribution to the Partners. The Partnership has discontinued distributions due to insufficient operating cash flow.\nThe Partnership has experienced cash flow deficiencies for several years and currently has very limited liquidity. Expenditures are being monitored closely and capital improvements are made on an as-needed basis. To date, the General Partners have been able to arrange financing through borrowings, from an affiliate of the General Partners, to cover a substantial portion of these cash flow deficiencies. Also, one of the General Partners, The Krupp Company Limited Partnership (\"The Krupp Company\"), contributed an additional\n$100,000 to the Partnership during 1991. In January 1993, The Krupp Company loaned an additional $135,000 to the Partnership in the form of a demand note to payoff a demand note from an unaffiliated bank. In addition, the affiliate lender has been willing to defer interest payments on the borrowings since late 1990. Furthermore, the General Partners, through annual negotiations, have continued to arrange for the waiver of property management fees and expense reimbursements payable to the management agent, also an affiliate of the General Partners.\nThe General Partners anticipate operating deficits to continue and cannot guarantee that they will be able to take actions that will cover any future deficits. If the property is unable to generate funds sufficient to cover these deficits, the Partnership could default on its mortgage payments and become subject to foreclosure proceedings. However, the Partnership is current on its mortgage payments.\nIn January 1996, the General Partners entered into a purchase and sale agreement for the sale of Riverside to an unaffiliated buyer scheduled in the second quarter of 1996 for the selling price of $4,500,000. In the event the property is ultimately sold, the Partnership would be liquidated. It is anticipated that all sale proceeds would be used to satisfy Partnership obligations and no funds would be available to investors for distribution.\nCash Flow (Deficit)\nShown below, as required by the Partnership Agreement, is the calculation of Cash Flow (Deficit) of the Partnership for the year ended 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, Cash Flow (Deficit) should not be considered by the reader as a substitute to net income\/loss, as an indicator of the Partnership's operating performance or to cash flows as a measure of liquidity.\nOperations\n1995 compared to 1994\nIn comparing 1995 to 1994, increase in cash deficit is attributable to increased capital expenditures. Net income improved by $30,000, as increases in rental revenue more than offset the increase in expenses. Riverside showed a 7% increase in rental revenue due to increased occupancy and management's successful effort in leasing 100% of the commercial space in the fourth quarter of 1995.\nOverall total expenses increased approximately 4%, with a decrease in operating expense offset by increases in maintenance and interest expenses. Operating expense decreased due to lower leasing costs resulting from higher occupancy levels, decreased utilities expense because of the warmer winter season and a reduction in insurance expense due to a favorable claim history. Maintenance expense increased as a result of painting interior stairways and pavement repairs made to the sidewalks. The increase in interest expense is attributable to a rise in the prime rate from an average 7.1% in 1994 to 8.8% in 1995.\n1994 compared to 1993\nIn comparing 1994 to 1993, cash deficits decreased approximately $61,000 primarily as a result of lower capital expenditures and improvements in operating cash flow. The improvements in operating cash flow can be attributed to increases in revenue due to residential rental increases and the acquisition of three new commercial tenants during the fourth quarter of 1993.\nOverall, total expenses increased 5% with increases in operating costs primarily due to increases in utility rates and leasing expenses. This is offset by a decrease in maintenance expense as a result of the commercial unit improvement program completed in 1993. Additionally, interest expense increased as a result of a rise in prime rate in 1994.\nRiverside Apartments residential occupancy averaged 97%, 96% and 97% for the years ended December 31, 1995, 1994, and 1993, respectively. For the years ended December 31, 1995, 1994 and 1993, occupancy of the commercial space averaged 90%, 87% and 83%, respectively.\nGeneral\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate asset.\nThe investment in the property is carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down investment in property to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are significantly impaired.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A to this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership has no directors or executive officers. Information as to the directors and executive officers of The Krupp Corporation, which is both a General Partner of KRLP-I and The Krupp Company, the other General Partner of KRLP-I, is as follows:\nPosition with Name and Age The Krupp Corporation\nDouglas Krupp (49) Co-Chairman of the Board\nGeorge Krupp (51) Co-Chairman of the Board\nLaurence Gerber (39) President\nRobert A. Barrows (38) Senior Vice President and Corporate Controller\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, healthcare facility ownership and the management of the Company. 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 approximately 3,400 are responsible for the more than $4 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 is Chairman of the Board and a Director of Berkshire Realty Company, Inc. (NYSE-BRI). George Krupp is Douglas Krupp's brother.\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 approximately 3,400 are responsible for more than $4 billion under management for institutional and individual clients. Mr. Krupp attended the University of Pennsylvania and Harvard University. Mr. Krupp also serves as Chairman of the Board and Trustee of Krupp Government Income Trust and as Chairman of the Board and Trustee of 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 Director of Berkshire Realty Company, Inc. (NYSE-BRI) and President and Trustee of Krupp Government Income Trust and President and Trustee of Krupp Government Income Trust II.\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 4,000 outstanding Units. On that date, the General Partners or their affiliates owned 80 Units (2% of the total outstanding) of the Partnership in addition to their General Partner interests and a portion of the Original Limited Partner interest.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership does not have any directors, executive officers or nominees for election as director. Additionally, as of December 31, 1995 no person of record owned or was known by the General Partners to own beneficially more than 5% of the Partnership's outstanding Units.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Consolidated Financial Statements - See Index to Consolidated Financial Statements included under Item 8 (Appendix A) on page\nto this report.\n2. Consolidated Financial Statement Schedule III is included under Item 8 (Appendix A) on page . Certain other schedules are omitted as they are not applicable, not required or the information is provided in the consolidated financial statements or the notes thereto.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable exhibits required by Item 601 of Regulation S-K.\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended Agreement of Limited Partnership dated as of May 15, 1981 [Exhibit 4.1 to Registrant's Report on Form 10-K for 1982 (File 2-68727)].*\n(4.2) Fourth Amendment to Certificate of Limited Partnership filed with the Massachusetts Secretary of State on October 19, 1981 [Exhibit 4.2 to Registrant's Report on Form 10-K for 1982 (File 2-68727)].*\n(10) Material contracts:\nRiverside I Apartments\n(10.1) Contract and Certificate of Limited Partnership of Krupp Associates Riverside Limited Partnership dated January 20, 1988 between The Krupp Corporation (the \"General Partner\") and Krupp Associates 1980-1 (the \"Limited Partner\")[Exhibit 10.1 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.2) Assignment dated January 20, 1988 between Krupp Associates 1980-1(\"Assignee\") and The Krupp Corporation (\"Assignor\") [Exhibit 10.2 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.3) Bill of Sale dated January 20, 1988 between Krupp Associates 1980-1 (as \"Seller\") and Krupp Associates Riverside Limited Partnership (as \"Buyer\")[Exhibit 10.3 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.4) Special Warranty Deed dated January 20, 1988 between Krupp Associates 1980-1 (\"Grantor\") and Krupp Associates Riverside Limited Partnership (\"Grantee\")[Exhibit 10.4 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.5) Assignment dated January 20, 1988 between Krupp Associates 1980-1 (\"Assignor\") and\nKrupp Associates Riverside Limited Partnership (\"Assignee\")[Exhibit 10.5 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2- 68727)].*\n(10.6) Management Agreement dated January 28, 1988 between Krupp Associates Riverside Limited Partnership, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management, as Agent. [Exhibit 10.6 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.7) Regulatory Agreement for Multifamily Housing Projects Co-insured by HUD dated January 21, 1988 between Krupp Associates Riverside Limited Partnership (the \"Owner\") and DRG Funding Corporation (the \"Mortgagee\") [Exhibit 10.7 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2-68727)].*\n(10.8) Mortgage Note dated January 21, 1988, from Krupp Associates Riverside Limited Partnership, an Indiana limited partnership, to DRG Funding Corporation, a Delaware corporation. [Exhibit 10.6 to Registrant's Report on Form 10-K for the year ended December 31, 1987 (File No. 2- 68727)].*\n(10.9) Mortgage dated January 21, 1988, from Krupp Associates Riverside Limited Partnership, an Indiana limited partnership, to DRG Funding Corporation, a Delaware corporation. [Exhibit 10.7 to Registrant's Report on Form 10-K for the year ended December 31, 1987 (File No. 2- 68727)].*\n(10.10) Security Agreement dated January 21, 1988 between Krupp Associates Riverside Limited Partnership (\"Debtor\") and DRG Funding Corporation (\"Creditor\") [Exhibit 10.10 to Registrant's Report on Form 10-K for the year ended December 31, 1988 (File No. 2- 68727)].*\n(10.11) Escrow Deposit Agreement dated January 21, 1988, between Krupp Associates Riverside Limited Partnership, an Indiana limited partnership, and DRG Funding Corporation, a Delaware corporation. [Exhibit 10.8 to Registrant's Report on Form 10-K for the year ended December 31, 1987 (File No. 2-\n68727)].*\n(10.12) Purchase and Sale Agreement dated January 22, 1996, between Krupp Associates Riverside Limited Partnership, an Indiana Limited Partnership (\"Seller\") and BluSky, Inc., an Indiana Corporation (\"Buyer\"). (File No. 2-68727).+\n* Incorporated by reference + Incorporated 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 21st day of March, 1996.\nKRUPP ASSOCIATES 1980-1\nBy: The Krupp Corporation, a General Partner\nBy: \/s\/Douglas Krupp Douglas Krupp, Co-Chairman (Principal Executive Officer) and Director of The Krupp Corporation\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the 21st day of March, 1996.\nSignatures Titles\n\/s\/Douglas Krupp Co-Chairman (Principal Executive Officer) and Douglas Krupp Director of The Krupp Corporation, a General Partner.\n\/s\/George Krupp Co-Chairman (Principal Executive Officer) George Krupp and Director of The Krupp Corporation, a General Partner.\n\/s\/Laurence Gerber President of The Krupp Corporation, a Laurence Gerber General Partner.\n\/s\/Robert A. Barrows Senior Vice President and Corporate Robert A. Barrows Controller of The Krupp Corporation, a General Partner.\nAPPENDIX A\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nCONSOLIDATED FINANCIAL STATEMENTS ITEM 8 OF FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1995 KRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\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 Partners' Deficit 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 III - Real Estate and Accumulated Depreciation\nAll other schedules are omitted as they are not applicable or not required, or the information is provided in the consolidated financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Krupp Associates 1980-1 and Subsidiary:\nWe have audited the consolidated financial statements and consolidated financial statement schedule of Krupp Associates 1980-1 and subsidiary (the \"Partnership\") listed in the index on page of this Form 10-K. These consolidated financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these 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 consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management of the Partnership, 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 Krupp Associates 1980-1 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 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 incurred therein.\nThe accompanying consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note K to the consolidated financial statements, the Partnership has experienced cash flow deficiencies in the past. In connection therewith the General Partners, to date, have been able to arrange financing to cover these deficits, and effective January 1, 1991 the General Partners obtained a waiver of management fees and expense reimbursements due to the affiliated management agent. The General Partners cannot guarantee that they will be able to continue to arrange for financing to cover deficits as they arise or that the arrangement with the management agent will continue. In addition, as disclosed in Note L, the Partnership's subsidiary entered into a purchase and sale agreement for the sale of the sole remaining property to an unaffiliated buyer for $4,500,000. In the event the property is ultimately sold, the Partnership would be liquidated. These factors raise substantial doubt about the ability of the Partnership to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. February 1, 1996\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nASSETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nCONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Organization\nKRLP-I was formed on July 31, 1980 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. KRLP- I issued all of the General Partner Interests to two General Partners (The Krupp Company and The Krupp Corporation) in exchange for capital contributions totalling $5,000.\nThe Class B Limited Partner Interests were issued to Chivas Square Associates (the \"Original Limited Partner\"), in connection with the transfer by the Original Limited Partner to KRLP-I of the real estate property which it formerly owned, subject to the related mortgage note payable.\nThe purchasers of 4,000 Units of Class A Investor Limited Partner Interests at a price of $1,000 per Unit are the Investor Limited Partners.\nOn January 20, 1988, the General Partners formed Krupp Associates Riverside Limited Partnership (\"Realty-I\") as a prerequisite for the refinancing of Riverside Apartments. At the same time, the General Partners transferred ownership of the property to Realty-I. The General Partner of Realty-I is The Krupp Corporation (\"Krupp Corp.\"). The Limited Partner of Realty-I is KRLP-I. Krupp Corp. has beneficially assigned its interest in Realty-I to KRLP-I. KRLP-I and Realty-I are collectively known as Krupp Realty Limited Partnership-I (collectively the \"Partnership\"). B. 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 (See Note J):\nBasis of Presentation\nThe consolidated financial statements present the consolidated assets, liabilities and operations of the Partnership. All intercompany balances and transactions have been eliminated.\nRisks and Uncertainties\nThe Partnership invests its cash primarily in deposits and money market funds with commercial banks. The Partnership has not experienced any losses to date on its invested cash.\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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\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 cash equivalents are recorded at cost, which approximates current market values.\nRental Revenues\nLeases require the payment of base rent monthly in advance. Rental revenues are recorded on the accrual basis. Leases generally contain provisions for additional rent based on a percentage of tenant sales and other provisions which are also recorded on the accrual basis, but are billed in arrears.\nDepreciation\nDepreciation is provided for by the use of the straight-line method over the estimated useful life of the related asset as follows:\nBuildings and improvements 5-35 years Appliances, carpeting and equipment 3-5 years\nImpairment of Long-Lived Asset\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate asset.\nThe investment in the property is carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down the investment in property to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are significantly impaired.\nDeferred Expenses\nThe Partnership is amortizing the costs associated with refinancing the property over the term of the related mortgage using the straight-line method.\nIncome Taxes\nThe Partnership is not liable for federal or state income\ntaxes as Partnership income or loss is allocated to the partners for income tax purposes. In the event that the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and the examination results in a change in the Partnership's taxable income or loss, such change will be reported to the partners.\nReclassifications\nCertain prior year balances have been reclassified to conform with current year consolidated financial statement presentation.\nC. Property\nThe Partnership purchased Riverside I Apartments (\"Riverside\"), a 140-unit apartment complex with approximately 30,000 square feet of commercial space located in Evansville, Indiana, on February 13, 1981. The total purchase price for Riverside was $3,518,000, of which $1,842,200 was paid in cash and $1,675,800 was financed with a 40-year non-recourse mortgage payable to the Department of Housing and Urban Development (\"HUD\").\nOn January 21, 1988, the Partnership refinanced Riverside under a $2,310,000 non-recourse first mortgage note payable between Realty-I (in which KRLP-I has a 100% beneficial interest) and HUD. (See below for additional information.) The note is collateralized by Riverside. The Partnership paid off the prior mortgage with a portion of the proceeds.\nD. Mortgage Note Payable\nThe non-recourse first mortgage note is payable in equal monthly installments of $20,747 at an interest rate of 10.5% per annum based on a thirty-five year amortization schedule. The note matures on February 1, 2023, when the remaining principal and any accrued interest will be due and payable. Under the regulatory agreement with HUD, monthly deposits of $4,036 must be contributed to a reserve for replacements. The reserve for replacements is to be used to fund property improvements. In addition, the regulatory agreement requires HUD approval for any additional encumbrances or for transfer of title to the project, and limits distributions based on the project's operations to the extent of \"surplus cash\" as defined in the regulatory agreement.\nBased on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities, the fair value of long-term debt is approximately $4,000,000.\nPrincipal payments due on the mortgage note payable are $15,302, $16,988, $18,860, $20,939 and $23,246 for the five years 1996 through 2000, respectively.\nDuring 1995, 1994 and 1993, the Partnership paid $235,059, $236,169, and $238,090, respectively, of interest on its mortgage note payable.\nE. Notes Payable\nThe Partnership had demand notes outstanding with both the General Partners and an affiliate of the General Partners at December 31, 1995 and 1994, respectively, in the amount of $1,257,385. Interest accrues monthly at the prime rate of an unaffiliated bank (8.5% at December 31, 1995) plus one percent per annum. During 1995, 1994 and 1993, no interest was paid on these notes. The carrying value of the notes approximate fair value.\nF. Accrued Expenses and Other Liabilities\nAccrued expenses and other liabilities at December 31, 1995 and 1994 consisted of the following: 1995 1994\nAccrued real estate taxes $133,334 $130,956 Tenant security deposits 32,004 33,191 Deferred income 4,230 7,102 Accrued expenses, other 60,731 56,678\n$230,299 $227,927\nG. Partners' Deficit\nUnder the terms of the Partnership Agreement, profits and losses from operations are allocated 90% to the Class A Limited Partners, 9% to the Original Limited Partner and 1% to the General Partners until such time that the Class A Limited Partners have received a return of their total invested capital. Thereafter, 40% shall be allocated to the Class A Limited Partners, 20% to the Original Limited Partner and 40% to the General Partners.\nUnder the terms of the Partnership Agreement, capital transactions are allocated 90% to the Class A Limited Partners, 9% to the Original Limited Partner and 1% to the General Partners, until such time that the Class A Limited Partners have received a return of their total invested capital and thereafter, allocated 40% to the Class A Limited Partners, 20% to the Original Limited Partner and 40% to the General Partners.\nIn general, the allocation of profits and losses are calculated based on the terms of the Partnership Agreement, as described above. However, the Internal Revenue Code contains rules which govern the allocation of tax losses among partners. For the years 1992 through 1995, the allocation of tax losses were calculated based on these rules. Under this code, tax losses are not allocated to a limited partner if a general partner bears the economic risk for that loss. Due to operating losses incurred during these years, the General Partners undertook additional liabilities on behalf of the Partnership. As a result, the Partnership allocated additional tax losses to the General Partners. In conjunction with the tax election referred to above, the financial statements presented herein reflect the allocation of net loss in accordance with the rules of the Internal Revenue Code.\nAs of December 31, 1995, the following cumulative partner contributions and allocations have been made since inception of the Partnership:\nH. Related Party Transactions\nCommencing with the date of acquisition of the Partnership's property, the Partnership entered into an agreement under which property management fees are paid to an affiliate of the General Partners for services as management agent. Such agreement provides for management fees payable monthly at a rate of 5% of the gross receipts from the property under management. The Partnership also reimburses affiliates of the General Partners for certain expenses incurred in connection with the operation of the Partnership and its property including accounting, computer, insurance, travel, legal and payroll costs relating to the preparation and mailing of reports and other communications to the Limited Partners. Since January 1, 1991, the General Partners arranged with the management agent for the annual waivers of management fees and expense reimbursements.\nDuring 1995, 1994 and 1993, interest on borrowings accrued to the General Partners or affiliates of the General Partners were $125,279, $103,839 and $88,872, respectively.\nDuring 1995, 1994 and 1993, amounts paid to the General Partners or their affiliates relating to disposition activities were $1,095, $8,711 and $0, respectively.\nI. Future Base Rents Due Under Commercial Operating Leases\nFuture base rents due under commercial operating leases for the years 1996 through 2000 and thereafter are as follows:\n1996 $260,677 1997 $266,328 1998 $269,608 1999 $272,252\n2000 $272,710 Thereafter $ 0\nJ. Federal Income Taxes\nFor federal income tax purposes, the Partnership is depreciating its property using the accelerated cost recovery system (\"ACRS\") and the modified accelerated cost recovery system (\"MACRS\") depending on which is applicable.\nThe reconciliation of the net loss reported in the accompanying Consolidated Statement of Operations with the net loss reported in the Partnership's federal income tax return follows:\nJ. Federal Income Taxes - Continued\nThe allocation of net loss for federal income tax purposes for 1995 is as follows:\nFor the years ended December 31, 1995, 1994 and 1993, the per Unit net loss for the Class A Limited Partners for federal income tax purposes was $3.08, $19.75, and $10.87, respectively.\nK. Operating Deficits\nThe Partnership has experienced cash flow deficiencies for several years. In connection therewith, the General Partners, to date, have been able to arrange financing through short-term borrowings from affiliates to cover a substantial portion of these deficits. Also, one of the General Partners, The Krupp Company, contributed an additional $100,000 to the Partnership during 1991, and the General Partners have arranged for the waiver of property management fees and expense reimbursements payable to the management agent. In January 1993, The Krupp Company loaned\n$135,000 in the form of a demand note to the Partnership to payoff a demand note from an unaffiliated bank. The operating deficits could continue and the General Partners cannot guarantee that they will be able to take actions that will cover any future deficits. In that event, the Partnership could default on its mortgage payments and become subject to foreclosure proceedings. This would have a significant impact on the financial position and operations of the Partnership. However, the Partnership is current on its mortgage payments, and it cannot presently be determined if a foreclosure will occur in the future. Accordingly, the financial statements do not include any adjustments that might result from the outcome of these uncertainties, all of which raise substantial doubt about the ability of the Partnership to continue as a going concern.\nIn the event of the sale of Riverside, the Partnership would be liquidated. As a result of the liquidation, the partners would receive allocations of taxable income equivalent to any negative account balance they may have. In addition, there would be no cash available in connection with such income. Therefore, in the event that the partner does not have items which could offset such income, the partner would have to pay taxes with funds from other sources.\nL. Subsequent Event\nIn January 1996, the General Partners entered into a purchase and sale agreement for the sale of Riverside to an unaffiliated buyer scheduled in the second quarter of 1996 for the selling price of $4,500,000. In the event the property is ultimately sold, the Partnership would be liquidated. It is anticipated that all sale proceeds would be used to satisfy Partnership obligations and no funds would be available to investors for distribution.\nKRUPP ASSOCIATES 1980-1 AND SUBSIDIARY\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nGross Amounts Carried at End of Year\nReconciliation of Real Estate and Accumulated Depreciation for each of the three years in the period ended December 31, 1995:\nThe Partnership uses the cost basis for property valuation for both income tax and financial statement purposes. The aggregate cost for income tax purposes at December 31, 1995 is $4,730,796.","section_15":""}
{"filename":"837757_1995.txt","cik":"837757","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nSee Exhibits 1(a) and 1(b): Annual Statements as to Compliance\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.\nPage 2 of 16\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\na. There is no established public trading market for Registrant's Senior Certificates.\nb. As to Registrant's Class A-1 Senior Certificates, there are four holders of record; as to Registrant's Class A-2 Senior Certificates, there is one holder of record.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nNot applicable pursuant to the SEC No-Action Letter.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nNot applicable pursuant to the SEC No-Action Letter.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee Exhibit 2: Independent Accountant's Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPage 3 of 16\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nNot applicable pursuant to the SEC No-Action Letter.\nItem 11.","section_11":"Item 11. Executive Compensation.\nNot applicable pursuant to the SEC No-Action Letter.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\na. Holder of record of more than five percent of Registrant's Class A-1 Senior Certificates:\nCEDE & CO. c\/o Depository Trust Company Attn: Dividend Announcements 7 Hanover Square, 22nd Floor New York, New York 10004\nPercent of class owned: 99.9%\nb. Holder of record of more than five percent of Registrant's Class A-2 Senior Certificates:\nCEDE & CO. c\/o Depository Trust Company Attn: Dividend Announcements 7 Hanover Square, 22nd Floor New York, New York 10004\nPercent of class owned: 100%\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNot applicable pursuant to the SEC No-Action Letter.\nPage 4 of 16\nPart IV\nItem. 14. Exhibits, Financial Statement Schedules, and Reports on Form 10-K.\nExhibit 1(a): Annual Statement of Compliance sent to Bankers Trust Company.\nExhibit 1(b): Annual Statement of Compliance sent to Financial Security Assurance, Inc. 1\nExhibit 2: Independent Accountant's Annual Report.1\nExhibit 3: Powers of Attorney:\nThomas J. Cusack 5 Kent L. Colwell John A. Fibiger Richard H. Finn 3 David E. Gooding 2 Edgar H. Grubb 2 Frank C. Herringer 2 Richard N. Latzer 2 Charles E. LeDoyen 2 Karen MacDonald 1 Gary U. Rolle' 2 James B. Roszak 2 William E. Simms 2 Nooruddin S. Veerjee Robert A. Watson 1\nPage 5 of 16\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTRANSAMERICA OCCIDENTAL LIFE INSURANCE COMPANY\nDated: March ____, 1996 By: Alan T. Cunningham Vice President\nPage 6 of 16\nSignature Title Date\n* Investment Officer March 15, 1996 Kent L. Colwell and Director\n* President, March 15, 1996 Thomas J. Cusack Chief Executive Officer and Director\nExecutive Vice President, March 15, 1996 James W. Dederer General Counsel, Corporate Secretary and Director\n* Chairman March 15, 1996 John A. Fibiger and Director\n* Director March 15, 1996 Richard H. Finn\n* Executive Vice President, March 15, 1996 David E. Gooding Chief Information Officer and Director\n* Director March 15, 1996 Edgar H. Grubb\n* Director March 15, 1996 Frank C. Herringer\n* Chief Investment Officer March 15, 1996 Richard N. Latzer and Director\n* President, Structured March 15, 1996 Charles E. LeDoyen Settlements Division and Director\n* Senior Vice President, March 15, 1996 Karen MacDonald Corporate Actuary and Director\nPage 7 of 16\n* Chief Investment Officer March 15, 1996 Gary U. Rolle' and Director\n* President, Life Insurance March 15, 1996 James B. Roszak Division, Chief Marketing Office and Director\n* President, Reinsurance March 15, 1996 William E. Simms Division, and Director\n* President, Group Pension March 15, 1996 Nooruddin S. Veerjee Division, and Director\n* Director March 15, 1996 Robert A. Watson\n* By James W. Dederer Attorney-in-Fact\nPage 8 of 16\nSupplemental Information To Be Furnished With Reports Filed Pursuant To Section 15 (d) Of The Securities Exchange Act Of 1934 By Registrants Which Have Not Registered Securities Pursuant To Section 12 Of The Act\nNo annual report or proxy material has been sent to the holders of Registrant's Senior Certificates.\nPage 9 of 16\nExhibit Index\nExhibit 1(a) Annual Statement of Compliance sent to Bankers Trust Company Page 11\nExhibit 1(b) Annual Statement of Compliance sent to Financial Security Assurance, Inc. Page 12\nExhibit 2 Independent Accountant's Annual Report Page 13\nExhibit 3 Power of Attorney of Robert A. Watson Page 15\nExhibit 4 Power of Attorney of Karen MacDonald Page 16\nPage 10 of 16\nFebruary 1, 1996\nVIA FEDERAL EXPRESS\nMr. Steve Hessler Assistant Vice President Bankers Trust Company Four Albany Street, 7th Floor New York, New York 10006\nRe: Commercial Mortgage Pass-Through Certificate Trust Created by Transamerica Occidental Life Insurance Company Under a Pooling and Servicing Agreement dated as of May 22, 1989; Annual Statement of Compliance of Transamerica Occidental Life Insurance Company\nWe, the undersigned, are duly appointed servicing officers of Transamerica Occidental Life Insurance Company (\"TOLIC\"), the servicer of the above referenced Commercial Mortgage Pass-Through Certificate Trust (the \"Trust\"), and we each hereby certify as follows:\n1.) A review of the activities of TOLIC as servicer of the Trust during the period beginning January 1, 1995 and continuing to and including December 31, 1995, and of TOLIC's performance under the Pooling and Servicing Agreement, dated as of May 22, 1989, between TOLIC and Security Pacific National Trust Company (New York) (the \"Agreement\"), as related to the Trust, has been made under our supervision; and\n2. To the best of our knowledge, based on our review, TOLIC has fulfilled all of its obligations under the Agreement during the period beginning January 1, 1995 and continuing to and including December 31, 1995, and there has not been any default on TOLIC's part in the fulfillment of such obligations.\nSincerely,\nTRANSAMERICA OCCIDENTAL LIFE INSURANCE COMPANY\nBy:_______________________\nSally S. Yamada Servicing Officer\nBy:_______________________\nWayne K. Nakano Servicing Officer\nExhibit 1(a) Page 11 of 16\nFebruary 1, 1996\nVIA FEDERAL EXPRESS\nMr. Joshua Brain Managing Director Surveillance Department Financial Security Assurance, Inc. 350 Park Avenue, 12th Floor New York, New York 10022\nRe: Commercial Mortgage Pass-Through Certificate Trust Created by Transamerica Occidental Life Insurance Company Under a Pooling and Servicing Agreement dated as of May 22, 1989; Annual Statement of Compliance of Transamerica Occidental Life Insurance Company\nDear Mr. Brain:\nWe, the undersigned, are duly appointed servicing officers of Transamerica Occidental Life Insurance Company (\"TOLIC\"), the servicer of the above referenced Commercial Mortgage Pass-Through Certificate Trust (the \"Trust\"), and we each hereby certify as follows:\n1.) A review of the activities of TOLIC as servicer of the Trust during the period beginning January 1, 1995 and continuing to and including December 31, 1995, and of TOLIC's performance under the Pooling and Servicing Agreement, dated as of May 22, 1989, between TOLIC and Security Pacific National Trust Company (New York) (the \"Agreement\"), as related to the Trust, has been made under our supervision; and\n2.) To the best of our knowledge, based on our review, TOLIC has fulfilled all of its obligations under the Agreement during the period beginning January 1, 1995 and continuing to and including December 31, 1995, and there has not been any default on TOLIC's part in the fulfillment of such obligations.\nSincerely,\nTRANSAMERICA OCCIDENTAL LIFE INSURANCE COMPANY\nBy:____________________ Sally S. Yamada Servicing Officer\nBy:_____________________ Wayne K. Nakano Servicing Officer\nExhibit 1(b) Page 12 of 16\nFebruary 14, 1996\nTransamerica Occidental Life Insurance Company Los Angeles, California\nBankers Trust Company New York, New York\nFinancial Security Assurance, Inc. New York, New York\nWe have audited the combined balance sheet of Transamerica Life Companies as of December 31, 1995, and the related statements of income, changes in shareholder s equity, and cash flows for the year then ended, and have issued our report thereon dated February 14, 1996. Our audit was made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances.\nIn addition to the audit referred to above and pursuant to Section 3.18 of the Pooling and Servicing Agreement (the Agreement ) dated May 22, 1989 between Transamerica Occidental Life Insurance Company (the Seller and Servicer ) and Bankers Trust Company (the successor to Bank America National Trust Company) (the Trustee ), we have performed specific procedures as described herein. We have not performed any procedures, except those described below, related to those Mortgage Loans serviced by sub-servicers which, since January 1, 1995, has been all of the mortgage loans subject to the Agreement. The specific procedures performed by us are described below.\nTerms used but not defined herein shall have the meaning given to them in the Agreement or in Amendment No. 3 to Form S-11 Registration Statement under the Securities Act of 1933, dated June 6, 1989, related to the Seller s Senior Commercial Mortgage Pass-Through Certificates, Series 1989-1.\n1. With respect to the eight full prepayments received during the period from January 1, 1995 to December 31, 1995, we determined that:\na. The full prepayment was accurately calculated as to principal and interest by recalculating the loan s amortization schedule included in the mortgage loan contract.\nb. The full prepayment was remitted to the Trustee on a timely basis.\n2. We observed the Servicer s procedures for monitoring delinquent monthly payments, identifying defaults, and arranging for substitutions of other qualifying mortgage loans or eligible investments as required by the Agreement.\n3. Except for the calculations in the Mortgage Payments Reports, included in the Distribution Date Statements, we tested, without exception, the calculations made by the Servicer in connection with the preparation of the March 31, June 30, and December 31, 1994 Distribution Date Statements.\nExhibit 2 Page 13 of 16\nIn connection with our audit referred to in the first paragraph of this letter and the specific procedures described above, nothing came to our attention that, in our opinion, would be required to be reported pursuant to Section 3.18 of the Agreement.\nIt should be understood that we make no representations regarding questions of legal interpretation or the sufficiency for your purposes of the foregoing procedures.\nThis letter is solely for the information of the addressees and it is not to be used, circulated, quoted or otherwise referred to for any other purpose, including but not limited to, the registration, purchase or sale of securities, nor is it to be referred to in whole or in part in any document without our prior written consent.\nLos Angeles, California\nPage 14 of 16\nPOWER OF ATTORNEY\nThe undersigned director of Transamerica Occidental Life Insurance Company, a California corporation (the \"Company\"), hereby constitutes and appoints Aldo Davanzo, James Dederer, Charles E. LeDoyen and David E. Gooding and each of the (with full power to each of them to act alone), his or her true and lawful attorney-in-fact and agent, with full power of substitution to each, for him or her and on his or her behalf and in his or her name, place and stead, to execute and file the annual report on Form 10-K, pursuant to Section 13 of the Securities and Exchange Act of 1934, with respect to the Senior Commercial Mortgage Pass-Through Certificates, Series 1989-1, File no. 33-23781, created by Transamerica Occidental Life Insurance Company under a Pooling and Servicing Agreement dated as of May 22, 1989, with all exhibits and all instruments necessary or appropriate in connection therewith, each of said 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 attorney-in-fact and agents, or any of them, may do or cause to be done by virtue thereof.\nIN WITNESS WHEREOF, the undersigned has hereunto set his or her hand, this ______ day of January, 1996.\n----------------------------- Robert A. Watson Exhibit 3 Page 15 of 16\nPOWER OF ATTORNEY\nThe undersigned director of Transamerica Occidental Life Insurance Company, a California corporation (the \"Company\"), hereby constitutes and appoints Aldo Davanzo, James Dederer, Charles E. LeDoyen and David E. Gooding and each of the (with full power to each of them to act alone), his or her true and lawful attorney-in-fact and agent, with full power of substitution to each, for him or her and on his or her behalf and in his or her name, place and stead, to execute and file the annual report on Form 10-K, pursuant to Section 13 of the Securities and Exchange Act of 1934, with respect to the Senior Commercial Mortgage Pass-Through Certificates, Series 1989-1, File no. 33-23781, created by Transamerica Occidental Life Insurance Company under a Pooling and Servicing Agreement dated as of May 22, 1989, with all exhibits and all instruments necessary or appropriate in connection therewith, each of said 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 attorney-in-fact and agents, or any of them, may do or cause to be done by virtue thereof.\nIN WITNESS WHEREOF, the undersigned has hereunto set his or her hand, this ______ day of January, 1996.\n----------------------------- Karen MacDonald\nExhibit 4 Page 16 of 16","section_14":"","section_15":""}
{"filename":"910224_1995.txt","cik":"910224","year":"1995","section_1":"Item 1. Business\nNot applicable.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nMMCA Auto Owner Trust 1995-1 (the \"Trust\") was formed on November 21, 1995 pursuant to a Trust Agreement (the \"Trust Agreement\"), dated as of November 21, 1995, between MMCA Auto Receivables Inc., as depositor, and Chemical Bank Delaware, as owner trustee. Pursuant to the Trust Agreement, the Trust issued asset-backed certificates evidencing an interest in the trust property (the \"Certificates\") and a separate certificate evidencing an interest in the trust property (the \"Final Payment Certificate\"). The Certificates were privately placed and the Final Payment Certificate is held by MMCA Auto Receivables Inc.\nPursuant to an Indenture, dated as of December 1, 1995, between the Trust, as issuer and Mitsubishi Bank Trust Company of New York, as indenture trustee, the Trust issued a single class of asset-backed notes (the \"Notes\").The Notes were registered and publicly offered and sold.\nThe assets of the Trust primarily include a pool of motor vehicle retail installments sale contracts originated by Mitsubishi Motors Credit of America, Inc. and secured by new and used vehicles and light- and medium-duty trucks. The Trust's business activities include acquiring and holding the assets of the Trust, issuing the Notes, the Certificates and the Final Payment Certificate and distributing payments on the Notes, the Certificates and the Final Payment Certificate.\nItem 2. Properties (continued)\nThe following tables set forth the delinquency experience with respect to the level payments due each month on the Trust's motor vehicle retail installment sale contracts but does not include the delinquency experience with respect to balloon payments due at the end of the term of the Trust's contracts which provide for such payments. The period of delinquency is based on the number of days more than 10% of a level payment is contractually past due, and the delinquency rate as a percentage of the balance outstanding represents delinquent dollars as a percentage of dollars outstanding.\nDecember 31, 1995 ------------------------------------- Balances Contracts of Receivables --------------- ----------------- Delinquent Contracts: (i) 30-59 Days............... 2,592 $28,333,538.83 (ii) 60-89 Days.............. 739 $8,303,239.00 (iii) 90 Days or More........ 249 $2,790,579.87\nDecember 31, 1995 ------------------------------------- % of Contracts % of Balance Outstanding Outstanding --------------- ----------------- Delinquency Rates: (i) 30-59 Days Delinquent.... 6.24% 6.03% (ii) 60-89 Days Delinquent... 1.78% 1.77% (iii) 90 Days or More Delinquent............... 0.60% 0.59%\nThe following table sets forth the net loss experience with respect to the payments due each month on the Trust's motor vehicle retail installment sale contracts, including contracts which provide for balloon payments at the end of the terms of such contracts.\nDecember 31, 1995 --------------------------------- Contracts Amount --------------- ------------- Aggregate Net Losses............... 22 $390,270.48\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere is nothing to report with regard to this item.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere is nothing to report with regard to this item.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe holder of record of all the Notes as of December 31, 1995 was Cede & Co., the nominee of The Depository Trust Company (\"DTC\") in the United States. An investor holding Notes is not entitled to receive a certificate representing such Notes except in limited circumstances. Accordingly, Cede & Co. is the sole holder of record of the Notes, which it holds on behalf of brokers, dealers, banks and other participants in the DTC system. Such participants may hold Notes for their own accounts or for the accounts of their customers. The address of Cede & Co. is:\nCede & Co. c\/o The Depository Trust Company Seven Hanover Square New York, New York 10004\nThe holders of record of all of the Certificates as of December 31, 1995 were Hare & Co., CS First Boston Corporation and MMCA Auto Receivables Inc. The holder of record of the Final Payment Certificate as of December 31, 1995 was MMCA Auto Receivables Inc.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNot applicable.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nNot applicable.\nItem 7A.","section_7A":"Item 7A. Quantitative and Qualitative Disclosures About Market Risk\nNot applicable.\nItem 8.","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\nThere is nothing to report with regard to this item.\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\nThere is nothing to report with regard to this item.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere is nothing to report with regard to this item.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Not applicable. 2. Not applicable. 3. Exhibits: 99.1 Annual Statement as to Compliance.\n(b) Reports on Form 8-K.\nThe Registrant has filed a Current Report on Form 8-K with the Securities and Exchange Commission dated December 14, 1995.\n(c) See (a) 3 above.\n(d) Not applicable.\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.\nMMCA AUTO OWNER TRUST 1995-1\nBY: MMCA AUTO RECEIVABLES, INC.\nDate: January 5, 1999 By: \/s\/ Hideyuki Kitamura ---------------------------- Hideyuki Kitamura Secretary and Treasurer\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 soliciting material has been sent to holders of the Notes during the period covered by this report and the registrant does not intend to furnish such materials to holders of the Notes subsequent to the filing of this report.","section_15":""}
{"filename":"75252_1995.txt","cik":"75252","year":"1995","section_1":"Item 1.Business\nOwens & Minor, Inc. (the \"Company\" or \"O&M\") is one of the two largest distributors of medical\/surgical supplies in the United States. The Company distributes approximately 300,000 finished medical\/surgical products produced by approximately 3,000 manufacturers to over 4,000 customers from 49 distribution centers nationwide. The Company's customers are primarily hospitals and also include alternate care facilities such as physicians' offices, clinics, nursing homes and surgery centers. The majority of the Company's sales consists of dressings, endoscopic products, intravenous products, needles and syringes, sterile procedure trays, surgical products and gowns, sutures and urological products. The Company was incorporated in Virginia on December 7, 1926 as a successor to a partnership founded in Richmond, Virginia in 1882.\nThe Company has significantly expanded its national presence over the last five years. This expansion resulted from both internal growth and acquisitions, including the May 1994 acquisition of Stuart Medical, Inc. (\"Stuart\"), then the third largest distributor of medical\/surgical supplies in the United States with 1993 net sales of approximately $890.5 million. Since 1991, the Company has grown from 27 medical distribution centers serving 37 states to 49 distribution centers serving 50 states currently. Over the same period, the Company's net sales increased at a 30.7% compound annual rate, almost tripling from approximately $1.0 billion in 1991 to approximately $3.0 billion in 1995.\nThe Company believes that in 1995 sales of medical\/surgical supplies in the United States approximated $30.0 billion and that approximately half of these sales were made through distributors, with the balance having been sold directly by manufacturers. In recent years, the medical\/surgical supply distribution industry has grown due to the rising consumption of medical supplies and the increasing reliance by manufacturers and customers on distributors. This increasing reliance is driven by customers seeking to take advantage of cost savings achievable through the use of distributors. In addition, the healthcare industry has been characterized by the consolidation of healthcare providers into larger and more sophisticated entities that are increasingly seeking lower delivered product costs and incremental services through a broad distribution network capable of supplying their inventory management needs. These pressures have in turn driven significant and continuing consolidation within the medical\/surgical supply distribution industry.\nThe Company is committed to providing its customers and suppliers with the most responsive, efficient and cost effective distribution system for the delivery of medical\/surgical supplies and services. In order to meet this commitment, the Company has implemented the following strategy: (i) maintain market leadership and leverage the benefits of its national distribution capabilities; (ii) continue to be a low-cost provider of distribution services; (iii) increase sales to existing customers and obtain new customers by providing responsive customer service and offering a broad range of inventory management services; and (iv) enhance relationships with major medical\/surgical supply manufacturers.\nIndustry Overview\nDistributors of medical\/surgical supplies provide a wide variety of disposable medical and surgical products to healthcare providers, including hospitals, integrated healthcare systems (\"IHSs\") and alternate care providers. Medical\/surgical supplies do not include pharmaceuticals. In 1995, hospital and alternate care facilities purchased approximately $23.0 billion and $7.0 billion, respectively, of medical\/surgical supplies. Sales of medical\/surgical supplies are estimated to have grown at a compound annual growth rate of approximately 7% over the last three years. Factors contributing to this growth include an aging population, the availability of new healthcare procedures and new product introductions.\nThe healthcare industry has been characterized by the consolidation of healthcare providers into larger and more sophisticated entities that are increasingly seeking lower delivered product costs and incremental services through a broad distribution network capable of supplying their inventory management needs. The economies of scale that a distributor can generate by servicing a number of facilities should allow it to perform this service at a lower cost than an individual healthcare provider or manufacturer. Customers also benefit from a complete range of enhanced inventory management services developed by medical\/surgical supply distributors that include continuous inventory replenishment process (\"CRP\"), asset management consulting and stockless and just-in-time inventory programs.\nThe above trends have driven significant and continuing consolidation in the medical\/surgical supply distribution industry since the mid-1980s. The Company believes that large distributors with national geographic capabilities and broad product offerings are capturing market share from regional and local distributors. As the industry continues to consolidate, large distributors are selectively acquiring regional and local distributors whose facilities can provide access to new metropolitan areas or expand geographic coverage to serve existing national accounts more effectively.\nThe traditional role of a distributor involves warehousing and delivering medical\/surgical supplies to a customer's loading dock. Increasingly, distributors have assumed the additional roles of asset managers and information managers. Larger distributors are offering a wide array of customized asset management services that many smaller distributors are unable to provide. In addition, as the ability of medical\/surgical supply distributors to manage information becomes an increasingly important factor, the larger, national distributors will have a distinct advantage. The quality of information generated by a national distributor, in terms of its ability to discern utilization patterns across a broad spectrum of products, customers and locations, will be more useful to both manufacturers and customers than that of a local or regional distributor.\nCustomers\nThe Company currently markets its distribution services to several types of healthcare providers, including hospitals, IHSs and alternate care providers. O&M contracts with these providers directly and through national healthcare networks (\"Networks\") and group purchasing organizations (\"GPOs\").\nNational Healthcare Networks and Group Purchasing Organizations. Networks and GPOs are entities that act on behalf of a group of healthcare providers to obtain pricing and other benefits that the individual members may not be able to obtain. Hospitals, physicians and other types of healthcare providers have joined Networks and GPOs to obtain services from medical\/surgical supply distributors ranging from discounted product pricing to logistical and clinical support in exchange for a fee. Networks and GPOs negotiate directly with both medical\/surgical supply manufacturers and distributors on behalf of their members, establishing exclusive or multi-vendor relationships.\nBecause the combined purchasing volumes of their member institutions are very large, Networks and GPOs have the buying power to negotiate price discounts for the most commonly used medical\/surgical products and logistical services. Accordingly, O&M believes that successful relationships with Networks and GPOs are central to the Company's ability to maintain market share. Sales to the Company's top ten Network or GPO customers represented approximately 70% of its net sales in 1995.\nNetworks and GPOs do not issue purchase orders or collect funds on behalf of their members and they cannot ensure that members will purchase their supplies from a given vendor. However, the buying power of Networks and GPOs is such that they are able to negotiate price discounts without having to guarantee minimum purchasing volumes. Members may belong to more than one Network or GPO, and they are also free to negotiate directly with distributors and manufacturers. As a result, healthcare providers often select the best pricing and other benefits from among those offered through several Networks and GPOs. Despite the inability of most Networks and GPOs to compel members to use O&M when it is the Network's or the GPO's primary distributor, O&M believes that, in such circumstances, the incentives for Network or GPO members to buy supplies through the Network's or GPO's contract with the Company are strong, and that these contracts yield significant sales volumes. The Company plans to continue to maintain and strengthen its relationships with selected Networks and GPOs as a means of securing its leading market position. The Company's Network or GPO customers include VHA Inc. (\"VHA\"), AmeriNet, Inc. (\"AmeriNet\"), AmHS\/Premier\/Sun Health (\"Premier\") and University Health System Consortium (\"UHC\").\nSince 1985, the Company has been a distributor for VHA, the nation's second largest network for not-for-profit hospitals, representing over 1,200 healthcare organizations. In November 1994, VHA added Baxter International Inc. (\"Baxter\") as its fourth authorized VHA distributor and initiated a policy permitting the other three authorized VHA distributors, including the Company, to distribute certain Baxter-manufactured products. During 1995, members of VHA were given the opportunity to select one of four medical\/surgical supply distributors as their authorized VHA distributor. The Company retained over 85% of its previous sales volume to VHA members. The loss of volume to VHA members has been partially offset by the gain in distributing Baxter's self-manufactured products to VHA members and by increasing market share within VHA facilities. Sales through VHA and AmeriNet represented approximately 39.6% and 5.6%, respectively, of the Company's net sales in 1995.\nIntegrated Healthcare Systems. An IHS is an organization which is composed of several healthcare facilities that jointly offer a variety of healthcare services in a given market. These providers may be individual not-for-profit or investor-owned entities that are joined by a formal business arrangement, or they may all be part of the same legal entity. An IHS is distinguished by the fact that it is typically a network of different types of healthcare providers that are strategically located within a defined service area, and seek to offer a broad spectrum of healthcare services and comprehensive geographic coverage to a particular local market. Although an IHS may include alternate care facilities, hospitals remain the key component of any IHS.\nO&M believes that IHSs will become increasingly important because of their expanding role in healthcare delivery and cost containment and their reliance upon the hospital, O&M's traditional customer, as a key component of their organizations. Individual healthcare providers within a multiple-entity IHS may be able to contract individually for distribution services; however, O&M believes that the providers' shared economic interests create strong incentives for participation in distribution contracts which are established at the system level. Additionally, single-entity IHSs are usually committed to using the primary distributor designated at the corporate level because they are all part of the same legal entity. Because the IHSs frequently rely on cost containment as a competitive advantage, IHSs have become an important source of demand for O&M's enhanced inventory management and other value-added services.\nIn February 1994, the Company was selected by Columbia\/HCA Healthcare Corporation (\"Columbia\/HCA\"), an investor-owned system of hospitals and alternate care facilities, as its primary distributor of medical\/surgical supplies. Pursuant to its agreement with Columbia\/HCA, the Company provides distribution and other inventory management process services to Columbia\/HCA hospitals and other healthcare facilities. Columbia\/HCA is the Company's largest customer owning over 300 hospitals and IHSs throughout the United States. Sales to Columbia\/HCA represented approximately 8.4% of the Company's net sales in 1995. Other than VHA, AmeriNet and Columbia\/HCA, no Network, GPO or individual customer accounted for as much as 5% of the Company's net sales during such year.\nIndividual Providers. In addition to contracting with healthcare providers at the IHS level and indirectly through Networks and GPOs, O&M contracts directly with healthcare providers. In 1995, hospitals represented approximately 90% of the Company's net sales. Not-for-profit hospitals represented a majority of these facilities. The Company targets high-volume independent hospitals and those which are part of larger healthcare systems such as IHSs. The Company also markets to alternate care providers that are primarily owned by, or members of, an IHS. Sales to such alternate care customers comprised the balance of the Company's net sales in 1995. The Company's hospital customers include Brigham & Women's Hospital, The Hospital of the University of Pennsylvania, Johns Hopkins Health System, Massachusetts General Hospital, Ohio State University Hospital, Shands Hospital at the University of Florida, Stanford Health Services, University of California, Los Angeles Medical Center (\"UCLA\"), University of Nebraska Medical Center, University of Texas-M.D. Anderson Cancer Center and Yale-New Haven Hospital.\nContracts and Pricing\nIndustry practice is for the healthcare providers to negotiate product pricing directly with manufacturers and then negotiate distribution pricing terms with distributors. Contracts in the medical\/surgical supply distribution industry set forth the price at which products will be distributed, but generally do not require minimum volume purchases by customers and are terminable by the customer upon short notice. Accordingly, most of the Company's contracts with customers do not guarantee minimum sales volumes.\nThe majority of the Company's contracts compensate the Company on a fixed cost-plus percentage basis under which a negotiated percentage distributor fee is added to the product cost agreed to by the customer and the manufacturer. In April 1994, however, the Company began to sell products to VHA-member hospitals and affiliates on a variable cost-plus percentage basis that varies according to the services rendered, the dollar volume of purchases and the percentage of the institution's total purchase volume that is directed to the Company. The Company has since entered into this type of pricing arrangement with other Networks and GPOs. As the Company's sales to a Network or GPO member institution grow, the cost-plus pricing charged to such customers decreases. The Company has recently negotiated contracts that charge incremental fees for additional distribution and enhanced inventory management services, such as frequent deliveries and distribution of products in small units of measure. Although the Company's marketing and sales personnel based in the distribution centers negotiate local contracts and pricing levels with customers, management has established minimum pricing levels.\nServices\nThe Company's core competency is the timely and accurate delivery of bulk medical\/surgical supplies at low cost. In addition to these core distribution services, the Company offers flexible delivery alternatives supported by inventory management services to meet the varying needs of its customers.\nElectronic data interchange (\"EDI\") is an integral component of the Company's business strategy. EDI includes computer-to-computer electronic data interchange for business transactions, such as purchasing, invoicing, funds transfer and contract pricing. The Company encourages all customers to use EDI for product orders and, in some cases, imposes additional charges on customers who do not use EDI for purchasing. Approximately 75% of items ordered by the Company's customers are made through EDI. By expediting communication between the Company and its customers and manufacturers and reducing the use of paper for purchasing and invoicing, EDI enhances efficiencies and generates cost savings.\nEDI and the Company's information technology (\"IT\") systems enable the Company to offer its customers the following services to minimize their inventory holding requirements:\n(BULLET) PANDAC(R) Since 1968, the Company has offered the PANDAC(R) wound closure management system that provides customers with an accurate evaluation of their current wound closure inventories and usage levels in order to reduce costs for wound closure products. The Company guarantees that PANDAC(R) will generate a minimum of 5% savings in total wound closure inventory expenditures during its first year of use.\n(BULLET) Interactive Value Model(TM) The Interactive Value Model(TM) is a software program that uses an interactive question and answer format to calculate potential cost savings achievable through the use of O&M's distribution services.\n(BULLET) Stockpoint(TM) Stockpoint(TM) is a just-in-time inventory management program designed to provide customers with delivery of products in a cost-efficient combination of bulk and lowest unit of measure.\n(BULLET) Pallet Architecture Location System. The Pallet Architecture Location System provides a customized approach to the delivery of products by expediting the \"put-away\" functions at customer's stockrooms.\n(BULLET) TracePak(TM) The Company, in partnership with DeRoyal Industries, Inc., packages medical\/surgical supplies under the TracePak(TM) name for use by healthcare providers for specific medical\/surgical procedures. TracePak(TM) reduces the time spent by healthcare personnel assembling medical\/surgical supplies for such procedures.\n(BULLET) Net\/GAIN(SM) The Company and Henry Schein, Inc. are developing a program called Net\/GAIN(SM) to permit physician practices associated with an IHS to order medical and other supplies from the customized Net\/GAIN(SM) product selection or from Henry Schein, Inc.'s extensive catalogue of products.\n(BULLET) Cost Trak(SM) Cost Trak(SM) is an activity-based costing program utilized to price value-added services accurately. By identifying costs associated with activities, Cost Trak(SM) enables customers to select the most cost-effective services.\nSales and Marketing\nThe Company's sales and marketing force is organized on a decentralized basis in order to provide individualized services to customers by giving the local sales force at each distribution center the discretion to respond to customers' needs quickly and efficiently. The sales and marketing force, which is divided into three tiers, consists of approximately 300 locally based sales personnel. In order to ensure that all of the Company's customers receive high levels of customer service, each tier of the sales force is dedicated to specific functions, including: developing relationships with large hospitals and IHS customers; targeting increased penetration of existing accounts; and providing daily support services. Corporate personnel and IT employees work closely with the local sales force to support the marketing of O&M's inventory management capabilities and the strengthening of customer relationships.\nAll sales and marketing personnel receive performance based compensation aligned with customer satisfaction and O&M's expectations. In addition, the Company, with the support of its suppliers, emphasizes quality and IT in comprehensive training programs for its sales and marketing force to sharpen customer service skills. In order to respond rapidly to its customers needs, all marketing and sales personnel are equipped with laptop computers that provide access to (i) order, inventory and payment status, (ii) customized reporting and data analysis and (iii) computer programs, such as the Interactive Value Model(TM) and PANDAC(R).\nSuppliers\nThe Company is the only national distributor that does not manufacture or sell products under its own label, and believes that this independence has enabled it to develop strong and mutually beneficial relationships with its suppliers. The Company believes that its size, strong, long-standing relationships and independence enable it to obtain attractive terms from manufacturers, including discounts for prompt payment, volume incentives and fees for customer sales information. These terms contribute significantly to the Company's gross margin.\nThe Company has relationships with virtually all major manufacturers of medical\/surgical supplies and has long-standing relationships with manufacturers, such as C.R. Bard, Inc., Becton Dickinson and Company (\"Becton Dickinson\"), Johnson & Johnson Hospital Services, Inc. (\"Johnson & Johnson\"), Kendall Healthcare Products (\"Kendall\"), Kimberly Clark Professional Health Care (\"Kimberly Clark\"), and 3M Health Care (\"3M\"). O&M is the largest distributor of these manufacturers' medical\/surgical products. Approximately 18.3% and 5.3% of the Company's net sales in 1995 were sales of Johnson & Johnson and Becton Dickinson products, respectively. In 1995, no other manufacturer accounted for more than 5% of the Company's net sales.\nAsset Management\nInventory\nDue to the Company's significant investment in inventory to meet the rapid delivery requirements of its customers, efficient asset management is essential to the Company's profitability. O&M maintains inventories of approximately 300,000 finished medical\/surgical products (up from less than 100,000 in 1992) produced by approximately 3,000 manufacturers. The significant increase in the number of stock keeping units (\"SKUs\") has challenged distributors and healthcare providers to create more efficient inventory management systems.\nThe Company has responded to the significant increase in the number of SKUs by improving warehousing techniques, including the use of radio-frequency hand-held computers and bar-coded labels that identify location, routing and inventory picking and replacement, which allow the Company to monitor inventory throughout its distribution systems. The Company is implementing additional programs to manage inventory including a state-of-the-art inventory forecasting system, warehouse slotting and reconfiguration techniques, CRP, FOCUS(SM) and vendor certification programs. The forecasting system uses historical information for the three prior years to predict the future demand for particular items thereby reducing the cost of carrying unnecessary inventory and increasing inventory turnover. As of December 31, 1995, 20 of the Company's distribution centers utilized the inventory forecasting system and the remaining distribution centers are expected to be utilizing it by mid-1996. CRP, which utilizes computer-to-computer interfaces, allows manufacturers to monitor daily sales and inventory levels so that they can automatically and accurately replenish the Company's inventory. The Company has initiated a vendor certification program that will require \"preferred manufacturers\" to satisfy minimum requirements, such as purchasing by EDI, exceeding minimum fill rates and offering a flexible returned goods policy. O&M believes the increased efficiency resulting from vendor certification will reduce SG&A expenses.\nAccounts Receivable\nThe Company's average days sales outstanding have been significantly less than the industry average as determined by the National Health Care Credit Group. The Company actively manages its accounts receivable to minimize credit risk and does not believe that credit risk associated with accounts receivable poses a risk to its results from operations.\nCompetition\nThe medical\/surgical supply distribution industry in the United States is highly competitive and consists of (i) three major, nationwide distributors, the Company, Baxter and General Medical Corporation (\"General Medical\"), (ii) a few smaller, nationwide distributors and (iii) a number of regional and local distributors. Competition within the medical\/surgical supply distribution industry exists with respect to total delivered product cost, product availability and the ability to fill orders accurately, delivery time, efficient computer communication capabilities, services provided, breadth of product line and the ability to meet special requirements of customers.\nRegional and local distributors often provide high levels of customer service but are constrained by relatively high operating costs which are passed on to customers. The Company believes that the higher costs associated with purchasing through regional and local distributors will result in opportunities for the Company to augment its market share as customers continue to seek to lower costs.\nBaxter manufactures medical\/surgical supplies and distributes its own products as well as the products of other manufacturers primarily to the hospital and IHS market. General Medical distributes medical\/surgical products under its own label as well as the products of other manufacturers. General Medical services alternate care facilities, such as physicians' offices, clinics, nursing homes and surgery centers, in addition to serving hospital customers and the wholesale hospital market.\nIn November 1995, Baxter announced its intention to distribute to its shareholders the stock of its subsidiary that conducts cost management, United States distribution and surgical products operations. The Company does not believe the Baxter restructuring will have a significant effect on the Company's competitive position in the industry.\nDistribution\nThe Company employs a decentralized approach to sales and customer service, operating 49 distribution centers throughout the United States. The Company's distribution centers currently provide products and services to customers in 50 states and the District of Columbia. The range of products and customer and administrative services provided by a particular distribution facility are determined by the characteristics of the market it serves. Most distribution centers are managed as separate profit centers. Most functions, including purchasing, customer service, warehousing, sales, delivery and basic financial tasks, are conducted at the distribution center and are monitored by corporate personnel. The Company believes that the decentralized nature of its distribution system provides customers with flexible and individualized service and contributes to overall cost reductions.\nThe Company delivers most medical\/surgical supplies with a leased fleet of trucks. Parcel services are used to transport all other medical\/surgical supplies. Distribution centers generally service hospitals and other customers within a 100 to 150 mile radius. The frequency of deliveries from distribution centers to principal accounts varies by customer account.\nInformation Technology\nO&M continuously invests in advanced IT, which includes automated warehousing technology and EDI, to increase efficiencies and facilitate the exchange of information with its customers and suppliers and thereby reduce costs to the Company, its suppliers and customers. Following its acquisition of Stuart, the Company expended significant resources to integrate Stuart's systems with those of the Company, including incorporating certain aspects of Stuart's IT, and to outsource the operation of the Company's mainframe computer system to Integrated Systems Solutions Corporation, an affiliate of International Business Machines Corporation. In 1994, the Company began a major initiative to convert its mainframe computer system to a client\/server, local area network system.\nThe conversion to client\/server technology will be completed over the next several years. The client\/server technology will have several applications, including inventory forecasting, procurement, warehousing, order processing, accounts receivable, accounts payable and contract management. The Company began to implement the first of these applications, the inventory forecasting application, in the fourth quarter of 1995 and 20 distribution centers utilized this application as of December 31, 1995. The remaining distribution centers are expected to be utilizing this inventory forecasting application by mid-1996. Through client\/server technology, the Company expects to improve significantly the efficiency of each distribution center. The Company's commitment to IT will enable it to serve profitably larger volumes of business and more complex contracts.\nRegulation\nThe medical\/surgical supply distribution industry is subject to regulation by federal, state and local governmental agencies. Each of the Company's distribution centers is licensed to distribute medical\/surgical supply products as well as certain pharmaceutical and related products. The Company must comply with regulations, including operating and security standards for each of its distribution centers, of the Food and Drug Administration, the Drug Enforcement Agency, the Occupational Safety and Health Administration, state boards of pharmacy and, in certain areas, state boards of health. The Company believes that it is in material compliance with all statutes and regulations applicable to distributors of medical\/surgical supply products and pharmaceutical and related products, as well as other general employee health and safety laws and regulations.\nThe current government focus on healthcare reform and the escalating cost of medical care has increased pressures on all participants in the healthcare industry to reduce the costs of products and services. The Company does not believe that the continuation of these trends will have a significant effect on the Company's results of operations or financial condition.\nEmployees\nAs of December 31, 1995, the Company employed approximately 3,200 full and 150 part-time employees. Approximately 40 employees are currently covered by a collective bargaining agreement at one of the Company's distribution centers. The Company believes that its relations with its employees are good.\nO&M believes that on-going employee training is critical to employee performance. The Company emphasizes quality and technology in training programs designed to increase employee efficiency by sharpening overall customer service skills and by focusing on functional best practices.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe corporate headquarters of the Company is located in western Henrico County, a suburb of Richmond, Virginia, in leased facilities. The Company owns two undeveloped parcels of land which are adjacent to the Company's corporate headquarters. In addition, the Company owns its warehouse facilities in Youngstown, Ohio and Greensburg, Pennsylvania as well as a former office\/warehouse facility in Sanford, Florida which is fully leased. All three of these facilities are currently being offered for sale. Greensburg is under contract. In 1995, the Company sold its La Mirada, California facility and has leased it back for a one year period.\nO&M continuously reevaluates the efficiency of its distribution system. Over the past two years, the Company has realigned its distribution operations through the closure or consolidation of 12 distribution centers and the opening or expansion of 22 distribution centers. The Company anticipates further reduction of distribution center costs through the closure of two and the downsizing of five distribution centers in 1996. Also in 1996 and early 1997, new facilities are planned for five locations including Houston, Boston, Los Angeles, Baltimore and Cincinnati and expansions are planned for three more facilities.\nO&M believes that its facilities are adequate to carry on its business as currently conducted. Except for the Greensburg, Pennsylvania and Youngstown, Ohio facilities, which are owned by the Company and held for sale and leaseback, all of the Company's distribution centers are leased from unaffiliated third parties. A number of the leases relating to the above properties are scheduled to terminate within the next several years. The Company believes that, if necessary, it could find facilities to replace such leased premises without suffering a material adverse effect on its business.\nItem 3.","section_3":"Item 3. Legal Proceedings\nStuart has been named as a defendant along with manufacturers, healthcare providers and others in a number of lawsuits based on alleged injuries attributable to the implantation of internal spinal fixation devices distributed by a specialty products division of Stuart from the early 1980s to December 1992 and prior to O&M's acquisition of Stuart in 1994. Stuart did not manufacture the devices. The Company believes that Stuart is entitled to indemnification by the manufacturers of the devices with respect to claims alleging defects in the products. The Company and Stuart are also entitled to indemnification by the former shareholders of Stuart for any liabilities and related expenses incurred by the Company or Stuart in connection with the foregoing litigation. Although the Company believes it is unlikely that Stuart will be held liable as a result of such lawsuits, the Company believes that Stuart's available insurance coverage together with the indemnification rights discussed above are adequate to cover any losses should they occur. The Company is not aware of any uncertainty as to the availability and adequacy of such insurance or indemnification.\nThe Company is party to various other legal actions that are ordinary and incidental to its business. While the outcome of legal actions cannot be predicted with certainty, management believes the outcome of these proceedings will not 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 fourth quarter of 1995.\nExecutive and Other Officers of the Registrant\nIdentification of Executive and Other Officers\nFollowing are the names and ages, as of December 31, 1995, of the executive and other officers of Owens & Minor, their positions and summaries of their backgrounds and business experience. During 1995, new officers were elected at the Board of Directors meetings including Charlie C. Colpo, elected and effective February 27, 1995, Wayne B. Luck, elected and effective on May 2, 1995, Paul J. Julian and Bruce J. MacAllister elected on July 24, 1995, effective August 10, 1995, and Ann Greer Rector elected and effective August 7, 1995. All of the other officers were elected at the annual meeting of the Board of Directors held May 2, 1995. All officers are elected to serve until the 1996 Annual Meeting of Shareholders, or such time as their successors are elected.\nG. Gilmer Minor, III, age 55, has been employed by the Company for 33 years since 1963 and has served as President since 1981 and Chief Executive Officer since 1984. In May 1994, he was elected Chairman of the Board. Mr. Minor also serves as a member of the Boards of Directors of Crestar Financial Corporation and Richfood Holdings, Inc.\nCraig R. Smith, age 44, has been employed by the Company and National Healthcare and Hospital Supply Corporation, which was acquired by the Company in 1989, for 13 years. From 1990 to 1992, Mr. Smith served as Group Vice President for the western region. In January 1993, Mr. Smith assumed responsibilities of Senior Vice President, Distribution. Later in 1993, Mr. Smith assumed the new role of Senior Vice President, Distribution and Information Systems, and in 1994, he was elected Executive Vice President, Distribution and Information Systems. In February 1995, Mr. Smith was promoted to Chief Operating Officer.\nRobert E. Anderson, III, age 61, has been employed by the Company for 29 years since 1967. Mr. Anderson was employed by the Company in the Medical\/Surgical Division in sales and marketing and was elected Vice President in 1981. In October 1987, he was elected Senior Vice President, Corporate Development. In April 1991, Mr. Anderson was elected Senior Vice President, Marketing and Planning. In 1992, Mr. Anderson assumed a new role as Senior Vice President, Planning and Development and in 1994, he was elected Executive Vice President, Planning and Development. In May 1995, Mr. Anderson was elected Executive Vice President, Planning and Business Development.\nHenry A. Berling, age 53, has been employed by the Company for 30 years since 1966. Mr. Berling was employed by the Company in the Medical\/Surgical Division and was elected Vice President in 1981 and Senior Vice President, Sales and Marketing, in 1987. In 1989, he was elected Senior Vice President and Chief Operating Officer. In 1991, Mr. Berling assumed a new role as Senior Vice President, Sales and Distribution. In 1992, Mr. Berling assumed the role of Senior Vice President, Sales and Marketing and in 1994, he was elected Executive Vice President, Sales and Customer Development. In May 1995, Mr. Berling was elected Executive Vice President, Partnership Development.\nDrew St. J. Carneal, age 57, has been employed by the Company for seven years since 1989 when he joined the Company as Vice President and Corporate Counsel. From 1985 to 1988, he served as the Richmond City Attorney and, prior to that date, he was a partner in the law firm of Cabell, Moncure and Carneal. In 1989, he was elected Secretary, and in March 1990, Senior Vice President, Corporate Counsel and Secretary. In May 1995, the title Corporate Counsel was changed to General Counsel.\nGlenn J. Dozier, age 45, has been employed by the Company for six years since 1990 in the position of Senior Vice President, Finance, Chief Financial Officer. In April 1991, he assumed the additional responsibility of Senior Vice President, Operations and Systems. In 1992, Mr. Dozier assumed a new role of Senior Vice President, Finance and Information Systems and Chief Financial Officer. In 1993, Mr. Dozier assumed the role of Senior Vice President, Finance, Chief Financial Officer. Prior to joining the Company, Mr. Dozier had been Chief Financial Officer and Vice President of Administration and Control since 1987 for AMF Bowling, Inc.\nDick F. Bozard, age 49, has been employed by the Company for eight years since 1988. In 1991, Mr. Bozard was elected Vice President, Treasurer. Prior to joining the Company, he served as an officer for CIT\/Manufacturers Hanover Bank and Trust. From 1984 to 1986, he was with Williams Furniture where his last position was President.\nCharles C. Colpo, age 38, has been employed by the Company for 15 years since 1981 when he joined the Company as Manager, Internal Audit. In April 1984, Mr. Colpo was promoted to Division Vice President (DVP) and served as DVP for three divisions from 1987 to 1994. In 1994, he served as Director, Business Process Redesign. In 1995, Mr. Colpo was promoted to Vice President, Inventory Management.\nHugh F. Gouldthorpe, age 57, has been employed by the Company for ten years since 1986 when he joined the Company as Director of Hospital Sales for the Wholesale Drug Division. In 1987, Mr. Gouldthorpe was promoted to Vice President and in 1989, he was promoted to Vice President, General Manager. In 1991, he was elected Vice President, Corporate Communications and in 1993, Vice President, Quality and Communications. Prior to joining the Company, Mr. Gouldthorpe was employed by E.R. Squibb and Sons serving in a variety of positions.\nPaul C. Julian, age 40, has been employed by the Company and Stuart, which was acquired by the Company, for ten years since 1986. With the Company's acquisition of Stuart in 1994, he became Group Vice President. From 1986 to 1994, Mr. Julian had been employed by Stuart and Eastern Hospital Supply, which was acquired by Stuart, serving in various positions and most recently, Executive Vice President, Chief Operating Officer. In 1995, he was elected to Corporate Vice President, Group Vice President, Northern and Central Regions.\nWayne B. Luck, age 39, has been employed by the Company for four years since 1992. Prior to joining the Company, Mr. Luck had been employed by Best Products Co. Inc. working on various management systems. In 1992, he served as Manager of Electronic Data Interchange (EDI) and subsequently Manager, Applications and Director, Application Services. In 1995, he was elected Vice President, Information Technology.\nBruce J. MacAllister, age 44, has been employed by the Company for three years since 1993 when he joined the Company as Division Vice President. Prior to joining the Company, Mr. MacAllister was employed by Proctor & Gamble in a variety of sales and marketing positions. In 1995, he was elected Corporate Vice President, Group Vice President, Southern and Western Regions.\nAnn Greer Rector, age 38, joined the Company in August 1995 as Vice President, Controller. Prior to joining the Company, Ms. Rector was employed by USAir Group, Inc. from 1983 to 1995 serving in various financial positions and from 1992 through July 1995, Vice President and Controller.\nMichael L. Roane, age 41, has been employed by the Company for four years since 1992 when he joined the Company as Vice President, Human Resources. Prior to joining the Company, Mr. Roane was employed by Philip Morris Co. from 1980 to 1992 where his last position was Manager, Employee Relations Operations. Prior to that he was employed by Gulf Western Industries in a variety of human resources positions.\nThomas J. Sherry, age 47, has been employed by the Company and Stuart, which was acquired by the Company, for 20 years. With the Company's acquisition of Stuart in 1994, he became Vice President, Sales and Marketing. From 1976 to 1994, Mr. Sherry had been employed by Stuart, serving in various sales and management positions and most recently, Executive Vice President.\nF. Thomas Smiley, age 40, has been employed by the Company for 17 years since 1979 when he joined the Company as Manager of Internal Audit. In 1981, he became Assistant Controller and in 1985, he became Controller. In 1986, Mr. Smiley was elected Assistant Vice President, Controller and from 1989 to 1995, he served as Vice President, Controller. In 1995, he was elected Vice President, Operations and Cost Management.\nHue Thomas, III, 57, has been employed by the Company for 26 years since 1970. In 1984, Mr. Thomas served as Assistant General Manager, Medical\/Surgical Division. In 1985, he served as Assistant Corporate Vice President, and in 1987 he was elected Vice President. In 1989, he was elected Vice President, General Manager, Medical\/Surgical Division. In 1991, he was elected Vice President, Corporate Relations.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInformation regarding the market price of the Company's Common Stock and related stockholder matters is set forth in the 1995 Annual Report under the heading \"Stock Market and Dividend Information\" on page 35 and is incorporated by reference herein.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required under this item is contained in the 1995 Annual Report under the heading \"Selected Financial Data\" on pages 12 and 13 and is incorporated by reference herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required under this item is contained in the 1995 Annual Report under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 14 through 17 and is incorporated by reference herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements and notes as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995, together with the independent auditors' report of KPMG Peat Marwick LLP dated February 2, 1996 except as to Note 7, which is as of March 1, 1996, appearing on pages 18 through 33 of the 1995 Annual Report are incorporated by reference herein.\nThe information required under Item 302 of Regulation S-K is set forth in the 1995 Annual Report in Note 13 - \"Quarterly Financial Data (Unaudited)\" in the Notes to Consolidated Financial Statements on page 32 and is incorporated by reference herein.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no changes in or disagreements with accountants on accounting and financial disclosures during the two-year period ended December 31, 1995.\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 contained in Part I of this Form 10-K and in the 1996 Proxy Statement under the heading \"Proposal 1: Election of Directors\" and is incorporated by reference herein.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required under this item is contained in the 1996 Proxy Statement under the heading \"Proposal 1: Election of Directors - Executive Compensation\" and is incorporated by reference herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required under this item is contained in the 1996 Proxy Statement under the heading \"Proposal 1: Election of Directors - Capital Stock Owned by Principal Shareholders and Management\" and is incorporated by reference herein.\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 Numbers 1995 Annual Form Report * 10-K\n(a) The following documents are filed as part of this report:\n1. Consolidated Financial Statements:\nIndependent Auditors' Report of KPMG Peat Marwick LLP 33\nConsolidated Balance Sheets at December 31, 1995 and 1994 19\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 18\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 20\nNotes to Consolidated Financial Statements 21-32\n2. Financial Statement Schedules:\nIndependent Auditors' Report of KPMG Peat Marwick LLP 22\nSchedule - Valuation and Qualifying Accounts 23\n* Incorporated by reference from the indicated pages of the 1995 Annual Report.\nAll other schedules are omitted because the related information is included in the Consolidated Financial Statements or notes thereto or because they are not applicable.\n3. Exhibits\n(2) Agreement of Exchange dated December 22, 1993, as amended and restated on March 31, 1994, by and among Stuart Medical, Inc., the Company and certain shareholders of Stuart Medical, Inc. (incorporated herein by reference to the Company's Proxy Statement\/Prospectus dated April 6, 1994, Annex III)**\n(3) (a) Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 3(a), for the year ended December 31, 1994)\n(b) Amended and Restated Bylaws of the Company (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 3(b), for the year ended December 31, 1994)\n(4) (a) Owens & Minor, Inc. $11.5 million, 0% Subordinated Note dated May 31, 1989, due May 31, 1997, between the Company and Hygeia Ltd. (incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990)\n(b) Amendment to Owens & Minor, Inc. 0% Subordinated Note due May 31, 1997 (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 4(b), for the year ended December 31, 1994)\n(c) Owens & Minor, Inc. $3,332,912, 9.10% Convertible Subordinated Note dated May 10, 1994, due May 31, 1996, between the Company and Hygeia Ltd. (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 4(c), for the year ended December 31, 1994)\n(d) Amended and Restated Rights Agreement dated as of May 10, 1994 between the Company and Wachovia Bank of North Carolina, N.A., Rights Agent (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q, Exhibit 4, for the quarter ended June 30, 1995)\n(e) Credit Agreement dated as of April 29, 1994 among the Company, as borrower, certain of the Company's subsidiaries, as guarantors, NationsBank of North Carolina, N.A., as Agent, Chemical Bank and Crestar Bank, as Co-Agents, and the Banks identified therein (\"Credit Agreement\") (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 4(d), for the year ended December 31, 1994)\n(f) First Amendment to Credit Agreement dated February 28, 1995 (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 4(e), for the year ended December 31, 1994)\n(g) Second Amendment to Credit Agreement dated October 20, 1995 (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q, Exhibit (4), for the quarter ended September 30, 1995)\n(h) Third Amendment to Credit Agreement dated March 1, 1996\n(10) (a) Owens & Minor, Inc. Annual Incentive Plan (incorporated herein by reference to the Company's definitive Proxy Statement dated March 25, 1991)*\n(b) 1985 Stock Option Plan as amended on January 27, 1987 (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 10(f), for the year ended December 31, 1987)*\n(c) Owens & Minor, Inc. Pension Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 10(h), for the year ended December 31, 1990)*\n(d) Supplemental Executive Retirement Plan dated July 1, 1991 (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 10(i), for the year ended December 31, 1991)*\n(e) Owens & Minor, Inc. Executive Severance Agreements (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 10(i), for the year ended December 31, 1991)*\n(f) Owens & Minor, Inc. Directors' Stock Option Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K, Exhibit 10(i), for the year ended December 31, 1991)*\n(g) Agreement dated December 31, 1985 by and between Owens & Minor, Inc. and Philip M. Minor (incorporated herein by reference to the Company's Annual Report on Form 10-K, exhibit 10(1), for the year ended December 31, 1992)*\n(h) Agreement dated May 1, 1991 by and between Owens & Minor, Inc. and W. Frank Fife (incorporated herein by reference to the Company's Annual Report on Form 10-K, exhibit 10(m), for the year ended December 31, 1992)*\n(i) Owens & Minor, Inc. 1993 Stock Option Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K, exhibit 10(k), for the year ended December 31, 1993)*\n(j) Owens & Minor, Inc. Directors' Compensation Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K, exhibit 10(1), for the year ended December 31, 1993)*\n(k) Form of Enhanced Authorized Distribution Agency Agreement (\"ADA Agreement\") dated as of November 16, 1993 by and between VHA, Inc. (formerly Voluntary Hospitals of America, Inc.) and Owens & Minor, Inc. (incorporated herein by reference to Form 10-K\/A to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)***\n(l) Form of Amendments to ADA Agreement dated as of August 9, 1994, September 15, 1994 and November 15, 1994, respectively (incorporated herein by reference to the Company's Annual Report on Form 10-K, exhibit 10(n), for the year ended December 31, 1994)\n(m) Form of Amendment to ADA Agreement dated as of November 10, 1995***\n(n) Purchase and Sale Agreement dated as of December 28, 1995 among Owens & Minor Medical, Inc. (\"O&M Medical\"), the Company and O&M Funding Corp. (\"O&M Funding\")\n(o) Receivables Purchase Agreement dated as of December 28, 1995 among O&M Funding, O&M Medical, the Company, Receivables Capital Corporation and Bank of America National Trust and Savings Association, as Administrator\n(p) Parallel Asset Purchase Agreement dated as of December 28, 1995 among O&M Funding, O&M Medical, the Company, the Parallel Purchasers from time to time party thereto and Bank of America National Trust and Savings Association, as Administrative Agent\n(11) Calculation of Net Income (Loss) Per Common Share\n(13) Owens & Minor, Inc. 1995 Annual Report to Shareholders\n(21) Subsidiaries of Registrant\n(23) Consent of KPMG Peat Marwick LLP, independent auditors\n* A management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K.\n** The schedules to this Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company hereby undertakes to file supplementally with the Commission upon request a copy of the omitted schedules.\n*** The Company has requested confidential treatment by the Commission of certain portions of this Agreement, which portions have been omitted and filed separately with the Commission.\n(b) Reports on Form 8-K\nThere were no reports filed on Form 8-K during the fourth quarter of 1995.\nNote 1. With the exception of the information incorporated in this Form 10-K by reference thereto, the 1995 Annual Report shall not be deemed \"filed\" as a part 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.\nOWENS & MINOR, INC.\nby \/s\/ G. Gilmer Minor, III G. Gilmer Minor, III 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 dated indicated:\n\/s\/ G. Gilmer Minor, III \/s\/ C. G. Grefenstette\nG. Gilmer Minor, III C. G. Grefenstette Chairman, President and Chief Executive Director Officer and Director (Principal Executive Officer)\n\/s\/ Glenn J. Dozier \/s\/ Vernard W. Henley\nGlenn J. Dozier Vernard W. Henley Senior Vice President, Finance and Chief Director Finance Officer (Principal Financial Officer)\n\/s\/ Ann Greer Rector \/s\/ E. Morgan Massey Ann Greer Rector E. Morgan Massey Vice President, Controller Director (Principal Accounting Officer)\n\/s\/ Josiah Bunting, III \/s\/ James E. Rogers Josiah Bunting, III James E. Rogers Director Director\n\/s\/ R. E. Cabell, Jr. \/s\/ James E. Ukrop R. E. Cabell, Jr. James E. Ukrop Director Director\n\/s\/ James B. Farinholt, Jr. \/s\/ Anne Marie Whittemore James B. Farinholt, Jr. Anne Marie Whittemore Director Director\n\/s\/ William F. Fife William F. Fife Director\nEach of the above signatures is affixed as of March 13, 1996.\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE\nThe Board of Directors Owens & Minor, Inc.:\nOver date of February 2, 1996, except as to Note 7, which is as of March 1, 1996, we reported on the consolidated balance sheets of Owens & Minor, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations 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 December 31, 1995 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule included on page 23 of this annual report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, 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 Richmond, Virginia February 2, 1996\nSchedule\nOWENS & MINOR, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts (In thousands)\nAdditions Balance at Charged to Beginning Costs Additions Balance Year-End of and Charged to at End Description Year Expenses Other** Deductions* of Year\nAllowance for doubtful accounts deducted from accounts and notes receivable in the Consolidated Balance Sheets\n1995 $5,340 $ 827 - $157 $6,010\n1994 $4,678 $1,149 $40 $527 $5,340\n1993 $4,442 $ 497 - $261 $4,678\n* Uncollectible accounts written off. ** Adjusted for the allowance reserve acquired with the Emery acquisition.\nForm 10-k Exhibit Index\nExhibit #\n4 (h) Third Amendment to Credit Agreement dated March 1, 1996\n10 (m) Form of Amendment to ADA Agreement dated as of November 10, 1995\n10 (n) Purchase and Sale Agreement dated as of December 28, 1995 among Owens & Minor Medical, Inc (\"O&M Medical\"), the Company and O&M Funding Corp. (\"O&M Funding\")\n10 (o) Receivables Purchase Agreement dated as of December 28, 1995 among O&M Funding, O&M Medical, the Company, Receivables Capital Corporation and Bank of America National Trust and Savings Association, as Administrator\n10 (p) Parallel Asset Purchase Agreement dated as of December 28, 1995 among O&M Funding, O&M Medical, the Company, the Parallel Purchasers from time to time party thereto and Bank of America National Trust and Savings Association, as Administrative Agent\n11 Calculation of Net Income (Loss) per Common Share\n13 Owens & Minor, Inc. 1995 Annual Report to Shareholders\n21 Subsidiaries of Registrant\n23 Consent of KPMG Peat Marwick LLP, independent auditors","section_15":""}
{"filename":"772124_1995.txt","cik":"772124","year":"1995","section_1":"Item 1. Business\nPaineWebber Development Partners Four, Ltd. (the ``Partnership') is a limited partnership formed in June 1985 under the Uniform Limited Partnership Act of the State of Texas to invest either directly or through the acquisition of joint venture interests in a diversified portfolio of newly-constructed and to-be-constructed income-producing properties. On September 9, 1986, the Partnership elected to extend the offering period to the public through September 10, 1987 and reduced the maximum offering amount to 42,000 Partnership Units (at $1,000 per Unit) from 100,000 Units. At the conclusion of the offering period 41,644 Units had been issued representing capital contributions of $41,644,000. Limited Partners will not be required to make any additional capital contributions.\nAs of March 31, 1995, the Partnership has investments, through joint ventures and limited partnerships, in three residential apartment complexes referred to below:\nName of Joint Venture or Limited Partnership Date of Name and Type of Property Acquisition Type of Location Size of Interest Ownership (1)\nThe Lakes Joint Venture 770 units 11\/1\/85 Fee ownership of land and The Lakes at South improvements (through Coast Apartments joint venture partnership) Costa Mesa, California\nLincoln Garden Apartments 200 units 11\/15\/85 Fee ownership of land and Joint Venture improvements (through Lincoln Garden Apartments joint venture partnership) Tucson, Arizona\n71st Street Housing Partners, Ltd. 234 units 12\/16\/85 Fee ownership of land and Harbour Pointe Apartments improvements (through Bradenton, Florida limited partnership) [FN] (1)See Notes to the financial statements filed with this Annual Report for a description of the long-term mortgage indebtedness secured by the Partnership's operating property investments and for a description of the agreements through which the Partnership has acquired these real estate investments.\nThe Partnership originally had investments in six operating investment properties. Through March 31, 1995, three of these properties had been forfeited through foreclosure proceedings. During the fourth quarter of fiscal 1991, due to a default by the Quinten's Crossing Joint Venture under the terms of its mortgage loan, the lender was granted, by Court order, the right to foreclose on the venture's operating property. As a result, on April 1, 1991, the Partnership's co-venturer filed an involuntary petition under Chapter 11 of the United States Bankruptcy Code on behalf of the venture. The bankruptcy petition prevented an immediate foreclosure action. However, the venture partners and the lender were unable to reach an agreement on an acceptable modification of the mortgage obligation. Accordingly, on August 27, 1992, the Partnership and its co-venturer forfeited their interests in Quinten's Crossing to the mortgage lender. The Parrot's Landing Joint Venture had not made required debt service payments since February 1, 1990. Because of the defaults, the mortgage lender had the right to accelerate payment on the entire balance ofthe mortgage note. The mortgage lender had given the joint venture formal notice of default and had filed for foreclosure. On October 16, 1992, the Partnership and the co-venturer forfeited their interests in Parrot's Landing to the mortgage holder in settlement of the foreclosure proceedings, after protracted negotiations failed to produce an acceptable loan modification agreement. The Partnership also originally had an investment, through a limited partnership, in a sixth apartment complex, the Clipper Cove Apartments, located in Boynton Beach, Florida. On March 5, 1990, the Clipper Cove Apartments, owned by The Landing Apartments, Ltd., was foreclosed on by the mortgage lender. The lender was entitled to foreclose on the property because of the inability of the venture to make the required debt service payments due on the mortgage loan. Negotiations to modify the loan terms and efforts by the Partnership to locate a buyer for the property were unsuccessful. As a result of these transactions, the Partnership no longer owns any interest in these three properties.\nThe Partnership's original investment objectives were:\n(1)to preserve and protect the original capital invested in the Partnership; (2)to achieve long-term capital appreciation through potential appreciation in the values of Partnership properties; (3)to obtain tax losses during the early years of operations from deductions generated by investments; (4)to provide annual distributions of cash flow from operations of the Partnership; (5)to achieve accumulation of equity through reduction of mortgage loans on Partnership properties.\nThe Partnership's operating investment properties have been adversely affected by an oversupply of competing rental apartment properties in the markets in which the properties are located. The effects of the resulting competition, combined with high debt service costs and weakened local economies, resulted in the inability of all of the joint ventures to meet their original debt service obligations without contributions from the venture owners. This situation has caused the Partnership to lose its investments in the Clipper Cove Apartments, Quinten's Crossing Apartments and Parrot's Landing Apartments through foreclosure proceedings, as discussed above. These three properties comprised approximately 38% of the Partnership's original investment portfolio. Furthermore, while the three remaining ventures have obtained more favorable financing terms, additional relief from debt service obligations and continued financial support from the venture partners may be required if the properties' operations do not improve. The Managing General Partner, along with the Partnership's co-venture partners, has pursued workout negotiations with the mortgage holders on all of the operating investment properties in efforts to obtain relief from debt service obligations, in order to protect the Partnership's invested capital. Despite such efforts, which have been partially successful, the Partnership will be unable to achieve most of its original objectives due to the foreclosure losses of a substantial portion of the original investment portfolio.\nThe Managing General Partner's strategy has been, and continues to be, to marshall the Partnership's resources for use in protecting the investment properties with the best long-term financial prospects in order to return as much of the invested capital as possible. The portion of the Partnership's original invested capital which may be returned to the Limited Partners will depend upon the ultimate selling prices obtained for the three remaining investment properties, which cannot presently be determined. At the present time, all three remaining properties have estimated market values which are below the balances of their outstanding debt obligations. The Partnership has generated tax losses since inception. However, the benefits of such losses to investors have been significantly reduced by changes in the federal income tax laws subsequent to the organization of the Partnership. Furthermore, the Partnership's investment properties have not produced sufficient cash flow from operations to provide the Limited Partners with cash distributions to date.\nAll of the Partnership's investment properties are located in real estate markets in which they face significant competition for the revenues they generate. The apartment complexes compete with numerous projects of similar type generally on the basis of price and amenities. Apartment properties in all markets also compete with the local single family home market for prospective tenants. 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 begin to be absorbed, with the result being a gradual improvement in occupancy levels and effective rental rates and a corresponding increase in property values. Management of the Partnership expects to continue to see improvement in this sector of the real estate market in the near-term.\nThe Partnership has no real property investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser''), which is responsible for the day-to-day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated ('PWI''), a wholly-owned subsidiary of PaineWebber Group Inc. (`PaineWebber'').\nThe general partners of the Partnership (the ``General Partners') are Fourth Development Fund Inc., and Property Associates 1985, L.P. Fourth Development Fund Inc. (the `Managing General Partner''), a wholly-owned subsidiary of PaineWebber, is the managing general partner of the Partneship. The associate general partner is Properties Associates 1985, L.P. (the ``Associate General Partner'), a Virginia limited partnership, certain limited 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\nAs of March 31,1995, the Partnership owns interests in three operating properties through joint ventures and limited partnerships. These joint ventures and limited partnerships and the related properties are referred to under Item 1 above to which reference is made for the name, location and description of each property.\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\nThe Lakes 94% 96% 93% 94% 94%\nLincoln Garden Apartments 98% 94% 93% 95% 95%\nHarbour Pointe Apartments 94% 91% 95% 97% 94%\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 Fourth Development Fund Inc. and Properties Associates 1985, L.P. (`PA1985''), 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 PaineWebber Development Partners Four, Ltd., PaineWebber, Fourth Development Fund Inc. and PA1985 (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 Development Partners Four, Ltd., also allege that following the sale of the partnership interests, PaineWebber, Fourth Development Fund Inc. and PA1985 misrepresented financial information about the Partnership's value and performance. The amended complaint alleges that PaineWebber, Fourth Development Fund Inc. and PA1985 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 Fourth Development Fund Inc., PA1985 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 3,153 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 the resale of Units will develop. The Managing General Partner will not redeem or repurchase Units.\nItem 6.","section_6":"Item 6. Selected Financial Data [CAPTION] PAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD. FOR THE YEARS ENDED MARCH 31, 1995, 1994, 1993, 1992 AND 1991 (IN THOUSANDS EXCEPT FOR PER UNIT DATA)\nYears ended March 31, 1995 1994 1993 1992 (1) 1991 [S] [C] [C] [C] [C] [C] Revenues $ 10,275 $ 10,481 $ 10,359 $ 10,542 $ 1,590\nOperating loss $ (2,047) $ (1,503)$ (2,141)$ (7,582) $ (650)\nPartnership's share of unconsolidated ventures' losses $ (35) $ (101) $(1,032) $ (1,788) $ (8,793)\nPartnership's share of gain on transfer of assets at foreclosure - - $ 821 - - Loss before extraordinary items $ (2,082) $ (1,604)$ (2,350)$ (5,535)$ (9,385)\nExtraordinary loss - - - $ (1,338) -\nPartnership's share of extraordinary gains on settlement of debt obligations - - $ 6,968 - -\nNet income (loss) $ (2,082) $ (1,604)$ 4,618 $ (6,873) $ (9,385)\nPer Limited Partnership Unit: Loss before extraordinary items $ (47.48)$ (36.59)$ (54.64) $ (126.27) $(219.88)\nExtraordinary loss - - - $ (30.52) -\nExtraordinary gains - - $ 150.23 - -\nNet income (loss) $ (47.48) $ (36.59) $ 95.59 $ (156.79)$ (219.88)\nTotal assets $ 77,924 $ 80,500 $ 83,600 $ 86,988 $ 11,510\nMortgage loans payable $ 92,870 $ 93,518 $ 95,083 $ 97,375 $ 9,125 [FN] (1)During fiscal 1992, as further discussed in Note 4 to the accompanying financial statements, the Partnership assumed complete control of the joint venture which owns and operates The Lakes at South Coast Apartments. Accordingly, the joint venture, which had been accounted for under the equity method in prior periods, has been consolidated in the Partnership's financial statements for years subsequent to fiscal 1991.\nThe above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\nThe above per Limited Partnership Unit information is based upon the 41,644 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 September 11, 1985 to September 5, 1987 pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933. Gross proceeds of $41,644,000 were received by the Partnership and, after deducting selling expenses and offering costs, approximately $32,751,000 was originally invested in joint venture interests in six residential apartment properties. The performance of the Partnership's investment properties has been adversely impacted by an oversupply of competing apartment units throughout the country and in the six local markets in which the properties are located. Through March 31, 1995, these conditions have resulted in the loss of three of the properties to foreclosure: Clipper Cove Apartments in March 1990, Quinten's Crossing Apartments in August 1992 and Parrot's Landing Apartments in October 1992. The foreclosures of these three properties represent a loss of approximately 38% of the original investment portfolio. The operations of the three remaining assets, The Lakes at South Coast Apartments, the Harbour Pointe Apartments and the Lincoln Garden Apartments,have been stabilized as a result of successful debt restructurings, and the properties do not currently require the use of the Partnership's cash reserves to support operations. Nonetheless, the properties would not operate at or above breakeven under conventional financing terms based on the current outstanding principal amounts owed. All three of these properties have been financed with tax-exempt bonds issued by local housing authorities. The interest rates on all three of these restructured debt obligations are now variable rates which are based on comparable rates on similar tax-exempt obligations. Such rates rose during fiscal 1995 along with the general increase in market interest rates, but remained 3 to 4 percent per annum below comparable conventional rates. As previously reported, the debt modification agreement for The Lakes was structured with certain debt service reserves and accrual features intended to help absorb interest rate fluctuations. The Lakes Joint Venture still has significant reserves in place to help absorb possible future increases in the mortgage interest rate. The Harbour Pointe and Lincoln Garden joint ventures would require advances from the venture partners, principally the Partnership in the case of Harbour Pointe, if future cash flows are insufficient to cover any increases in debt service payments.\nDespite a general strengthening in the real estate market for multi-family residential properties over the past three years, based on current cash flows generated from operations, all three of the Partnership's remaining properties have estimated current market values which are below the balances of their outstanding debt obligations. It remains to be seen whether further improvement in market conditions will occur as rapidly or to the extent necessary to enable the Partnership to recover any meaningful portion of its original investment in these three remaining properties. In addition, the Reimbursement Agreement which governs the secured debt obligations of The Lakes Joint Venture contains certain restrictive covenants, including a provision that required the venture to provide the lender, in September 1994, with an independent appraisal of the operating property showing the value of the property to be equal to or greater than $92 million. Failure to provide such an appraisal is defined as an event of default under the Reimbursement Agreement. Based on current cash flow levels and the prevailing market conditions, the value of the property could be expected to be considerably less than $92 million. The Managing General Partner has had preliminary discussions with the lender regarding possible changes to the 1994 appraisal requirement. Preliminary indications have been that the lender might consider waiving or modifying the minimum appraised value requirement for September 1994 in exchange for a rearrangement of the timing and amounts of certain payment priorities, as specified in the Reimbursement Agreement. However, to date the venture has not provided the lender with an appraisal which meets the $92 million requirement, and the lender has not waived or modified the minimum appraised value requirement. Accordingly, the venture is technically in default under the Reimbursement Agreement. Management does not expect the lender to take any actions as long as progress continues to be made in negotiations for modification to the terms of the Reimbursement Agreement. However, there can be no assurances that the lender will grant any relief in connection with this appraisal covenant.\nIn the event that management is successful in negotiating a waiver or modification of the minimum appraised value requirement described above for The Lakes Joint Venture, which represents approximately 49% of the Partnership's original investment portfolio, the Partnership will continue to direct the management of the remaining operating properties in order to generate sufficient cash flow to sustain operations in the near-term while attempting to maximize their long-term values. As discussed above, even under these circumstances, it remains to be seen whether such a strategy would result in the return of any significant amount of invested capital to the Limited Partners. If management cannot reach an agreement with The Lakes' mortgage lender regarding the appraisal covenant, the lender could choose to initiate foreclosure proceedings. The Partnership is prepared to exercise all available legal remedies in the event that the lender takes such actions. If the Partnership were not successful with such legal defenses and the result was a foreclosure of the operating property, the Partnership would have to weigh the costs of continued operations against the realistic hopes for any future recovery of capital from the other two investments. Under such circumstances, the Managing General Partner might determine that it would be in the best interests of the Limited Partners to liquidate the remaining investments and terminate the Partnership. In light of these circumstances, the independent auditors' report on the Partnership's financial statements as of and for the year ended March 31, 1995 includes qualifying language which expresses uncertainty regarding the Partnership's ability to continue as a going concern. Management will reassess its future operating strategy once the appraisal covenant compliance issue on The Lakes is resolved.\nAs a result of the lower tax-exempt interest rates on their respective loan obligations, each of the remaining joint ventures is generating cash flow in excess of their current debt service requirements. For The Lakes Joint Venture, such excess cash flow continues to be applied toward the reduction of the venture's outstanding indebtedness. Additional principal paydowns during fiscal 1995 totalled approximately $648,000. In the near term, barring a significant further increase in tax-exempt interest rates, excess cash flow from Harbour Pointe should be sufficient to cover the Partnership's operating expenses. Excess cash flow from the Lincoln Garden joint venture has been minimal and is primarily payable to the co-venturer for the repayment of prior advances. To the extent that the Partnership's operating properties continue to generate excess cash flow after current debt service, a substantial portion of such amounts will be reinvested in the properties to make certain repairs and improvements aimed at maximizing long-term value. At The Lakes, planned capital improvements for the next fiscal year include the completion of a major capital program begun during fiscal 1995. Such improvements include upgrading the hallways, elevator landings and lobbies and painting. Improvements planned at Lincoln Garden for fiscal 1996 include resurfacing the pool deck, replacing the roofs on several buildings, repairing the sidewalks and upgrading the unit interiors on a turnover basis. Management completed an improvement program at Harbour Pointe during the first quarter of calendar 1994 which included exterior painting and the installation of new window awnings. Future improvements at this property are expected to include new pool furniture, additional exterior lighting and the installation of individual water meters in all units. The amount and timing of the funds to be spent on property improvements at all three of the remaining ventures will depend upon the availability of cash flow from the respective property's operations.\nAt March 31, 1995 the Partnership and its consolidated joint ventures had available cash and cash equivalents of approximately $1,292,000. Such cash and cash equivalents will be used for the working capital requirements of the Partnership and the consolidated ventures and, to the extent necessary and economically justified, to fund the Partnership's share of capital improvements and operating deficits of its remaining joint venture investments. The source of future liquidity and distributions to the partners is expected to be through proceeds received from the sale, refinancing or other disposition of the remaining investment properties and, to a lesser extent, from cash generated from the operations of such properties.\nRESULTS OF OPERATIONS 1995 Compared to 1994\nThe Partnership's net loss increased by $478,000 during fiscal 1995 as compared to the prior year. The primary reasons for this increase in net loss were increases in property operating expenses, an increase in interest expense and a decrease in other income. Property operating expenses increased by $183,000 primarily due to an increase in repairs and maintenance expenses at The Lakes at South Coast Apartments. Repairs and maintenance expenses increased as a result of the start of a major capital improvement and deferred maintenance program at the property, particularly to upgrade common areas, elevator landings and lobbies. Interest expense increased by $87,000 primarily due to an increase in the variable interest rates on the mortgage loans secured by the Partnership's consolidated joint ventures, The Lakes at South Coast Apartments and the Harbour Point Apartments. In addition, the interest cap on The Lakes debt which fixed the interest rate on the mortgage loan at less than 4% per annum expired at the end of calendar 1993. Other income decreased by $313,000 primarily due to the receipt of real estate tax refunds by The Lakes Joint Venture during the prior year. Rental revenues at the two consolidated investment properties were fairly flat compared to the prior year, which reflects the competitive local market conditions facing The Lakes and Harbour Pointe Apartments. At The Lakes, a combination of a still depressed Southern California economy and some newly constructed competing projects have forced management to offer substantial concessions to maintain average occupancy levels in the mid-90% range. At Harbour Pointe, rental rate increases implemented in calendar 1993 had pushed rents at the property to the top of its local market. Competition from some newly constructed projects during calendar 1994 made it impossible to continue the pace of these rental rate increases. The market had stabilized somewhat by the end of the year and management expects to be able to increase rents further in calendar 1995. In addition, management expects to improve net cash flow at Harbour Pointe upon the completion of the individual water meter installation referred to above, which will transfer water usage costs to the tenants. The increases in property operating expenses and interest expense and the decrease in other income were partially offset by an increase of $64,000 in interest income earned on short-term investments and a decrease of $66,000 in the Partnership's share of the unconsolidated venture's loss. The increase in interest income earned on short term investments is a result of a steady increase in interest rates earned on such investments throughout the year. The decrease in the Partnership's share of the unconsolidated venture's loss, which represents the operating results of the Lincoln Garden joint venture, was mainly the result of an increase in rental rates at the Lincoln Garden Apartments. Although average property occupancy levels fell slightly from the high to low 90% range during the middle two quarters of the year, rental rates increased by approximately 6% over the prior year.\n1994 Compared to 1993\nThe Partnership had a net loss of approximately $1,604,000 for the year ended March 31, 1994 as compared to net income of approximately $4,618,000 in the prior year. The primary reason for this significant change in reported net operating results is the impact of the foreclosures of the Quinten's Crossing and Parrot's Landing properties during fiscal year 1993. The effects of the foreclosures were partially offset by the continued improvement in the net operating results of The Lakes Joint Venture, as discussed further below. During the prior year, the foreclosures of the Quinten's Crossing Apartments and Parrot's Landing Apartments generated extraordinary gains on settlement of debt obligations of approximately $9,322,000. The Partnership's share of such gains was approximately $6,969,000. The transfers of Quinten Crossing's and Parrot's Landing to the lenders through foreclosure proceedings were accounted for as troubled debt restructurings in accordance with Statement of Financial Accounting Standards No. 15, `Accounting by Debtors and Creditors for Troubled Debt Restructurings.'' The extraordinary gains arise due to the fact that the balance of the mortgage loans and related accrued interest exceeded the estimated fair value of the respective joint ventures' investment properties and certain other assets transferred to the lenders at the time of the foreclosure. The Partnership also recognized a net gain during the prior year on the transfers of assets at foreclosure in the amount of approximately $821,000. In accordance with SFAS No. 15, a gain or loss on transfer of assets is calculated as the difference between the net carrying value of the operating investment property and its fair value at the time of foreclosure. Quinten's Crossing had a loss on transfer of assets of approximately $4,897,000, of which approximately $3,065,000 was allocated to the Partnership. Parrot's Landing had a gain on transfer of assets of approximately $3,764,000 of which approximately $3,886,000 was allocated to the Partnership. The Partnership's share of the Parrot's Landing ordinary gain was greater than the gain recognized by the joint venture due to the method of allocating the gain as called for in the joint venture agreement.\nThe Partnership's operating loss decreased by approximately $637,000 during fiscal 1994 as compared to the prior year primarily as a result of the continued reduction in the net operating loss of the consolidated Lakes Joint Venture. The net loss of the Lakes Joint Venture decreased by approximately $652,000 mainly as a result of a decrease in interest expense on the venture's variable rate long-term debt of approximately $716,000. Interest expense decreased due to the venture's purchase of a one-year interest rate cap, which fixed the interest rate on the mortgage loan at less than 4% per annum for calendar 1993. In addition, the variable interest rate on the venture's long-term debt fell below the rate specified by the cap during portions of calendar 1993. The operating results of the consolidated Harbour Pointe joint venture improved by approximately $29,000 during calendar 1993. The operating results of Harbour Pointe also improved as a result of a decrease in interest expense of approximately $49,000 on the venture's variable rate debt. The decrease in interest expense was a result of a lower average rate on the variable rate debt during calendar 1993 as compared to the prior year.\nThe Partnership's share of unconsolidated ventures' losses decreased by approximately $931,000 during fiscal 1994 as compared to the prior year. The Partnership's share of unconsolidated ventures' losses for fiscal 1993 included the operating losses of the Quinten's Crossing and Parrot's Landing properties prior to their foreclosures during fiscal 1993. The operating loss of the Partnership's remaining unconsolidated venture, the Lincoln Garden Apartments, decreased by approximately $50,000 as a result of an increase in rental income and a decrease in interest expense on the venture's variable rate mortgage. Rental income at Lincoln Garden increased by approximately 9%, almost entirely due to an increase in rental rates. Property occupancy remained stable, in the low 90's, throughout both calendar 1992 and 1993.\n1993 Compared to 1992\nThe Partnership had net income of approximately $4,618,000 for the year ended March 31, 1993, as compared to a net loss of approximately $6,873,000 in the prior year. The primary reasons for this significant change in reported net operating results were a substantial improvement in the net operating results of the Partnership's consolidated joint ventures and the impact of the foreclosures of the Quinten's Crossing and Parrot's Landing properties. The net operating losses of The Lakes Joint Venture declined significantly in fiscal 1993 and contributed an additional amount of approximately $1,446,000 to the Partnership's net operating results as compared to the prior year, primarily due to substantial decreases in interest expense and real estate taxes. The decrease in interest expense was a result of the successful restructuring of the venture's long-term debt, which had been in default. As noted above, the interest rate on the restructured debt is a variable rate which was at its lowest level in many years during calendar 1992. Interest was accruing on the debt at a default rate for a portion of the prior year. In addition, the venture's real estate tax expense declined by approximately $766,000 as a result of certain refunds and abatements received. The Partnership also realized a decrease in the operating loss of the consolidated Harbour Pointe joint venture of approximately $272,000 primarily due to a decrease in interest expense of approximately $173,000. This decrease was a result of the refinancing of the loan secured by the Harbour Pointe Apartments in fiscal 1991. The variable interest rate on the new loan continued to decline with general market rates during calendar 1992.\nThe Partnership's net operating results were also favorably impacted by the foreclosures of the Quinten's Crossing Apartments and Parrot's Landing Apartments, which, as discussed further above, generated extraordinary gains on settlement of debt obligations of approximately $9,322,000. The Partnership's share of such gains was approximately $6,969,000. Quinten's Crossing had a loss on transfer of assets of approximately $4,897,000, of which approximately $3,065,000 was allocated to the Partnership. Parrot's Landing had a gain on transfer of assets of approximately $3,764,000 of which approximately $3,886,000 was allocated to the Partnership.\nA decrease in the Partnership's share of unconsolidated ventures' losses of approximately $756,000 also contributed to the change in the Partnership's net operating results and could be primarily attributed to the foreclosures of Quinten's Crossing and Parrot's Landing, which had generated net operating losses prior to their foreclosures. The operations of the Partnership's remaining unconsolidated venture, Lincoln Garden, did not change significantly as compared to the prior year. However, the Partnership's share of the venture's net loss increased by approximately $103,000 in fiscal 1993 due to the method of allocating such losses between the venture partners as required by the joint venture agreement.\nInflation\nThe Partnership commenced operations in 1985 and completed its ninth full year of operations in the current fiscal year. The effects of inflation and changes in prices on the Partnership's operating results to date have not been significant.\nInflation in future periods may increase revenues as well as operating expenses at the Partnership's operating investment properties. Tenants at the Partnership's apartment properties have short-term leases, generally of one year or less in duration. Rental rates at these properties can be adjusted to keep pace with inflation, to the extent market conditions allow, as the leases are renewed or turned over. Such increases in rental income would be expected to at least partially offset the corresponding increases in Partnership and property operating expenses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership\nThe General Partners of the Partnership are Fourth Development Fund Inc. (the `Managing General Partner''), a Texas corporation, which is a wholly-owned subsidiary of PaineWebber, and Properties Associates 1985, L.P. (the `Associate General Partner'), a Virginia limited partnership, certain limited partners of which are officers and employees of the Managing General Partner.\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 Cohen President and Chief Executive Officer 41 5\/1\/91 Albert Pratt Director 84 6\/24\/85 * J. Richard Sipes Director 48 6\/9\/94 Walter V. Arnold Senior Vice President and Chief Financial Officer 47 10\/29\/85 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 6\/24\/85 * Timothy J. Medlock Vice President and Treasurer 33 6\/1\/88 Thomas W. Boland Vice President 32 12\/1\/91\n* The date of incorporation of the Managing General Partner.\n(c) There are no other significant employees in addition to the directors and executive officers mentioned above.\n(d) There is no family relationship among any of the foregoing directors or executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and 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 PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber. They are also officers and employees of PaineWebber Properties Incorporated (\"PWPI\"), a wholly-owned subsidiary of 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. John B. Watts III is a Senior Vice President of the Managing General Partner and a Senior Vice President of PWPI 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 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 the Adviser. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.\nThomas W. Boland is a Vice President of the Managing General Partner and a Vice President and Manager of Financial Reporting of the Adviser which he joined in 1988. From 1984 to 1987, Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.\n(f) None of the directors and officers was involved in legal proceedings which are material to an evaluation of his or her ability or integrity as a director or officer. (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 renumeration from the Partnership.\nThe General Partners are entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described in Item 13.\nThe Partnership has never paid regular quarterly distributions of excess cash flow. Furthermore, the Partnership's Limited Partnership Units are not actively traded on any organized exchange, and no efficient secondary market exists. Accordingly, no accurate price information is available for these Units. Therefore, a presentation of historical unitholder total returns would not be meaningful.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management (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, Fourth Development Fund Inc., is owned by PaineWebber. Properties Associates 1985, L.P. the Associate General Partner, is a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\n(b) Neither directors nor officers of the Managing General Partner nor the limited 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 limited partner of the Associate General Partner, possesses a right to acquire beneficial ownership of Units of limited partnership interest of the Partnership.\n(c) There exists no arrangement, known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partners of the Partnership are Fourth Development Fund Inc. (the `Managing General Partner''), a wholly-owned subsidiary of PaineWebber Group Inc. (`PaineWebber'') and Properties Associates 1985, L.P. (the `Associate General Partner''), a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated (`PWPI''), a wholly-owned subsidiary of PaineWebber Incorporated (`PWI''). PWI, a wholly-owned subsidiary of PaineWebber, acted as the selling agent for the Limited Partnership Units. The General Partners, PWPI and PWI 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, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments. 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 operation of the Partnership's real property investments.\nAll distributable cash, as defined, for each fiscal year shall be distributed annually in the ratio of 95% to the Limited Partners and 5% to the General Partners. All sale or refinancing proceeds shall 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, net income or loss of the Partnership, other than net gains resulting from Capital Transactions, as defined, will generally be allocated 95% to the Limited Partners and 5% to the General Partners.\nAdditionally, the Partnership Agreement provides for the allocation of net gains resulting from Capital Transactions, as defined, first, to those partners whose capital accounts reflect a deficit balance (after all distributions for the year and all allocations of net income and losses from operations have been made) in the ratio of such deficits and up to an amount equal to the sum of such deficits; second, to the General and Limited Partners in such amounts as are necessary to bring the General Partners' capital account balance in the ratio of 5 to 95 to the Limited Partners' capital account balances; then, 95% to the Limited Partners and 5% to the General Partners. Selling commissions incurred by the Partnership and paid to PWI for the sale of Partnership interests were approximately $3,540,000 through the completion of the offering period which expired in September of 1987.\nIn connection with the acquisition of properties, PWPI was entitled to receive acquisition fees in an amount not greater than 5% of the gross proceeds from the sale of the Partnership units. Total acquisition fees incurred by the Partnership and paid to PWPI aggregated $2,077,000.\nThe Partnership recorded as income a total of $5,000 of investor servicing fees from certain of its joint ventures for the year ended March 31, 1995.\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 March 31, 1995 is $84,000, 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 $4,000 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 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 the Adviser. PART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this Report:\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 Schedule 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 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 Schedule at page.\nIV-1\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 DEVELOPMENT PARTNERS FOUR, LTD.\nBy: Fourth Development 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 Dated: 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 Partnership and in the capacities and on the dates indicated.\nBy:\/s\/ Albert Pratt Date: June 28, 1995 Albert Pratt Director\nBy: \/s\/ J. Richard Sipes Date: June 28, 1995 J. Richard Sipes Director\nIV-2\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(3)\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\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 September 11, 1985, as pursuant to Rule 424(c) and supplemented, with particular incorporated herein reference to the Amended and by reference. Restated Agreement and Certificate 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 Icorporated such contracts filed as exhibigs of 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 1 of this Report pages I-1 and I-2, to which reference is hereby made.\nIV-3\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(1) AND (2) AND ITEM 14(D)\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReference PAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.:\nReports of independent auditors Consolidated 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' 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\nOther financial statement schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners PaineWebber Development Partners Four, Ltd.:\nWe have audited the accompanying consolidated balance sheets of PaineWebber Development Partners Four, Ltd. as of March 31, 1995 and 1994, and the related consolidated statements of operations, changes in partners' deficit and cash flows for each of the three years in the period ended March 31, 1995. We have also audited 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 71st Street Housing Partners, Ltd. for the years ended December 31, 1994 and 1993, which statements reflect 10% of the Partnership's consolidated total assets as of March 31, 1995 and 1994, and 1% of the Partnership's consolidated net loss for the years ended March 31, 1995 and 1994. 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 71st Street Housing Partners, Ltd., 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 the other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PaineWebber Development Partners Four, Ltd. at March 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 March 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 7 to the financial statements, the ability of The Lakes Joint Venture (a consolidated joint venture investee) to continue as a going concern is dependent upon future events, including the waiver or modification of a restrictive covenant on its existing non-recourse debt requiring The Lakes to provide, by September 1994, a certified independent appraisal of The Lakes' operating investment property for an amount equal to or greater than $92,000,000. Failure to provide such an appraisal constitutes an event of default under The Lakes' loan agreement. These conditions raise substantial doubt about the Partnership's ability to continue as a going concern. Management's plans as to these matters are also described in Note 7 and include negotiating with the lender regarding a possible waiver or modification of this appraisal requirement. However, there are no assurances that the lender will grant any relief. The accompanying financial statements do not include any adjustments that might result form the outcome of this uncertainty.\n\/s\/ Ernst & Young ERNST & YOUNG LLP\nBoston, Massachusetts June 23, 1995\nReznick Fedder & Silverman Certified Public Accountants 217 East Redwood Street, Suite 1900 Baltimore, MD 21202\nINDEPENDENT AUDITORS' REPORT\nTo the Partners 71st Street Housing Partners, Ltd.\nWe have audited the accompanying balance sheets of 71st Street Housing Partners, Ltd. as of December 31, 1994 and 1993, and the related statements of operations, changes in partners' 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. The financial statements of 71st Street Housing Partners, Ltd. for the year ended December 31, 1992, were audited by other auditors whose report, dated January 28, 1993, expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 1994 and 1993 financial statements referred to above present fairly, in all material respects, the financial position of 71st Street Housing Partners, Ltd. as of December 31, 1994 and 1993, and the results of its operations, changes in partners' deficit and its cash flows for each of the two years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\n\/S\/ Reznick Fedder & Silverman Reznick Fedder & Silverman\nBaltimore, Maryland January 11, 1995\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\nCONSOLIDATED BALANCE SHEETS\nMarch 31, 1995 and 1994 (In Thousands, except for per Unit data)\nASSETS\n1995 1994 Operating investment properties: Land $ 18,190 $ 18,190 Building and improvements 76,825 76,400 95,015 94,590 Less accumulated depreciation (22,386) (19,339) 72,629 75,251\nCash and cash equivalents 1,292 1,252 Restricted cash 3,045 2,900 Accounts receivable - affiliates 11 39 Prepaid and other assets 67 67 Deferred expenses, net of accumulated amortization of $514 ($508 in 1994) 880 991 $ 77,924 $ 80,500\nLIABILITIES AND PARTNERS' DEFICIT\nLong-term debt in technical default $ 83,745 $ - Accounts payable and accrued expenses 390 311 Accrued interest and fees 3,156 2,716 Advances from consolidated ventures - 100 Tenant security deposits 441 398 Minority interest in net assets of consolidated ventures 1,221 1,221 Equity in losses of unconsolidated joint venture in excess of investments and advances 2,099 2,064 Deferred gain on forgiveness of debt 4,087 4,430 Long-term debt 9,125 93,518 Total liabilities 104,264 104,758 Partners' deficit: General Partners: Capital contributions 1 1 Cumulative net loss (2,501) (2,397)\nLimited Partners ($1,000 per unit; 41,644 Units issued): Capital contributions, net of offering costs 36,641 36,641 Cumulative net loss (60,481) (58,503) Total partners' deficit (26,340) (24,258) $ 77,924 $ 80,500\nSee accompanying notes.\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\nCONSOLIDATED STATEMENTS OF OPERATIONS For the years ended March 31, 1995, 1994 and 1993 (In thousands, except for per unit data)\n1995 1994 1993 REVENUES: Rental income $ 9,894 $ 9,851 $ 9,759 Interest income 163 99 171 Other income 218 531 429 10,275 10,481 10,359 EXPENSES: Interest expense 4,207 4,120 4,723 Property operating expenses 3,744 3,561 3,606 Depreciation and amortization 3,053 3,010 3,008 Real estate taxes 1,033 1,007 942 General and administrative 285 286 221 12,322 11,984 12,500 Operating loss (2,047) (1,503) (2,141)\nCo-venturers' share of consolidated ventures' losses - - 2\nPartnership's share of unconsolidated ventures' losses (35) (101) (1,032)\nPartnership's share of net gain on transfers of assets at foreclosure - - 821 Loss before extraordinary items (2,082) (1,604) (2,350)\nPartnership's share of extraordinary gains on settlement of debt obligations - - 6,968\nNET INCOME (LOSS) $ (2,082) $ (1,604) $ 4,618\nPer Limited Partnership Unit: Loss before extraordinary items $ (47.48) $ (36.59) $ (54.64)\nPartnership's share of extraordinary gains on settlement of debt obligations - - 150.23\nNet income (loss) $ (47.48) $ (36.59) $ 95.59\nThe above per Limited Partnership Unit information is based upon the 41,644 Limited Partnership Units outstanding for each year.\nSee accompanying notes.\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' DEFICIT\nFor the years ended March 31, 1995, 1994 and 1993 (In Thousands)\nGeneral Limited Partners Partners Total\nBalance at March 31, 1992 $ (2,954) $ (24,318) $ (27,272)\nNet income 638 3,980 4,618\nBALANCE AT MARCH 31, 1993 (2,316) (20,338) (22,654)\nNet loss (80) (1,524) (1,604)\nBALANCE AT MARCH 31, 1994 (2,396) (21,862) (24,258)\nNet loss (104) (1,978) (2,082)\nBALANCE AT MARCH 31, 1995 $ (2,500) $ (23,840) $ (26,340) See accompanying notes.\nPAINEWEBBER DEVELOPMENT PARTNERS FOUR, LTD.\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 Cash flows from operating activities: Net income (loss) $ (2,082) $ (1,604) $ 4,618 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Co-venturers' share of consolidated ventures' losses - - (2) Partnership's share of unconsolidated ventures' losses 35 101 1,032 Depreciation and amortization 3,053 3,010 3,008 Amortization of deferred expenses 105 294 121 Amortization of deferred gain on forgiveness of debt (343) (343) (346) Partnership's share of net gain on transfers of assets at foreclosure - - (821) Partnership's share of extraordinary gains from settlement of debt obligations - - (6,968) Changes in assets and liabilities: Accounts receivable - - 2 Accounts receivable - affiliates 28 (30) 4 Deferred expenses - - (126) Accounts payable and accrued expenses 79 (133) 6 Accrued interest and fees 440 397 1,329 Tenant security deposits 43 41 18 Accounts payable - affiliates - (14) 10 Advances from consolidated ventures (100) 18 38 Total adjustments 3,340 3,341 (2,695) Net cash provided by operating activities 1,258 1,737 1,923\nCash flows from investing activities: Additional investments in joint ventures - - (10) Additions to operating investment properties (425) (155) (129) Net cash used for investing activities (425) (155) (139)\nCash flows from financing activities: Decrease (increase) in restricted cash (145) 14 323 Repayment of long-term debt (648) (1,565) (2,292) Net cash used for financing activities (793) (1,551) (1,969)\nNet increase (decrease) in cash and cash equivalents 40 31 (185) Cash and cash equivalents, beginning of year 1,252 1,221 1,406\nCash and cash equivalents, end of year $ 1,292 $ 1,252 $ 1,221\nCash paid for interest $ 3,965 $ 3,786 $ 3,589\nSee accompanying notes.\n1. Organization\nPaineWebber Development Partners Four, Ltd. (the ``Partnership'') is a limited partnership organized pursuant to the laws of the State of Texas on June 24, 1985 for the purpose of investing in a diversified portfolio of newly-constructed and to-be-constructed income-producing real properties. On September 9, 1986 the Partnership elected to extend the offering period to the public through September 10, 1987 (beyond its original termination date of September 10, 1986) and reduced the maximum offering amount to 42,000 Partnership Units (at $1,000 per Unit) from 100,000 Units. Through the conclusion of the offering period, 41,644 Units were issued representing capital contributions of $41,644,000.\nThe Partnership originally invested the net proceeds of the offering, through joint venture partnerships, in six rental apartment properties. As further discussed in Notes 4 and 5, the Partnership's operating properties have encountered major adverse business developments which, to date, have resulted in the loss of three of the original investments to foreclosure. As of March 31, 1995, the remaining three joint ventures, which had obtained more favorable financing terms, were generating net cash flow sufficient to satisfy their current debt service requirements. However, as discussed further in Note 7, one of these ventures is in technical default of the terms of its debt agreement.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements include the Partnership's investments in three joint venture partnerships which own operating properties. The joint ventures in which the Partnership has invested are\nrequired to maintain their accounting records on a calendar year basis for income tax purposes. As a result, the Partnership records its share of ventures' income or losses based on financial information of the ventures which is three months in arrears to that of the Partnership.\nThe Partnership accounts for one of its three remaining investments in joint venture partnerships using the equity method because the Partnership does not have majority voting control. Under the equity method the investment is carried at cost adjusted for the Partnership's share of the ventures' earnings and losses and distributions. See Note 5 for a description of the unconsolidated joint venture partnerships. As further discussed in Note 4, the Partnership acquired complete control of 71st Street Housing Partners, Ltd., which owns the Harbour Pointe Apartments, in fiscal 1990. In addition, the Partnership acquired complete control of The Lakes Joint Venture, which owns The Lakes at South Coast Apartments, in fiscal 1992. As a result, the accompanying financial statements present the financial position and results of operations of these joint ventures on a consolidated basis. As discussed above, the joint ventures have December 31 year-ends and operations of the consolidated ventures continue to be reported on a three-month lag. All material transactions between the Partnership and the joint ventures have been eliminated in consolidation, except for lag-period cash transfers. Such lag period cash transfers are accounted for as advances from consolidated ventures on the accompanying balance sheets.\nThe consolidated joint ventures' 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 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 market value. Both of the consolidated ventures' operating investment properties were 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 estimated useful lives of five-to-thirty years. Interest and taxes incurred during the construction period, along with acquisition fees paid to PaineWebber Properties Incorporated and costs of identifiable improvements, have been capitalized and are included in the cost of the operating investment properties. Maintenance and repairs are charged to expense when incurred.\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 consolidated joint ventures lease apartment units under leases with terms generally of one year or less. Rental income is recorded monthly as earned.\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. In connection with the restructuring of the debt of The Lakes Joint Venture, $191,338 of accrued interest payable and $190,755 of accrued legal fees incurred in 1990 were forgiven in fiscal 1993 pursuant to the debt restructuring. Such forgiveness of debt has been treated as a noncash transaction.\nDeferred expenses on the balance sheet at March 31, 1995 and 1994 consist of joint venture modification expense and deferred loan costs. Joint venture modification expense represents a payment by the Partnership to the co-venturer in 71st Street Housing Partners, Ltd. during fiscal 1990, in return for the relinquishment of the general partner's rights to control the operations of the joint venture, and is being amortized on a straight-line basis over the term of the joint venture's mortgage note payable. Deferred loans costs are being amortized using the straight-line method over the term of the related debt. Amortization of deferred loan costs is included in interest expense on the accompanying statements of operations.\nNo provision for income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership. Upon the sale or disposition of the Partnership's investments, the taxable gain or loss incurred will be allocated among the partners. In the case where a taxable gain would be incurred, gain would first be allocated to the General Partners in an amount at least sufficient to eliminate their deficit capital balance. Any remaining gain would then be allocated to the Limited Partners. In certain cases, the Limited Partners could be allocated taxable income in excess of any liquidation proceeds that they may receive. Additionally, in cases where the disposition of an investment involves a foreclosure by, or voluntary conveyance to, the mortgage lender, taxable income could occur without distribution of cash. Income from the sale or disposition of the Partnership's investments would represent passive income to the partners which could be offset by each partner's existing passive losses, including any carryovers from prior years.\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 Fourth Development Fund Inc. (the ``Managing General Partner'', a wholly-owned subsidiary of PaineWebber Group Inc. (``PaineWebber') and Properties Associates 1985, L.P. (the ``Associate General Partner'', a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated (``PWPI'', a wholly-owned subsidiary of PaineWebber Incorporated (``PWI'). PWI, a wholly-owned subsidiary of PaineWebber, acted as the selling agent for the Limited Partnership Units. The General Partners, PWPI and PWI 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, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments. 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 operation of the Partnership's real property investments.\nAll distributable cash, as defined, for each fiscal year shall be distributed annually in the ratio of 95% to the Limited Partners and 5% to the General Partners. All sale or refinancing proceeds shall 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, net income or loss of the Partnership, other than net gains resulting from Capital Transactions, as defined, will generally be allocated 95% to the Limited Partners and 5% to the General Partners.\nAdditionally, the Partnership Agreement provides for the allocation of net gains resulting from Capital Transactions, as defined, first, to those partners whose capital accounts reflect a deficit balance (after all distributions for the year and all allocations of net income and losses from operations have been made) in the ratio of such deficits and up to an amount equal to the sum of such deficits; second, to the General and Limited Partners in such amounts as are necessary to bring the General Partners' capital account balance in the ratio of 5 to 95 to the Limited Partners' capital account balances; then, 95% to the Limited Partners and 5% to the General Partners.\nSelling commissions incurred by the Partnership and paid to PWI for the sale of Partnership interests were approximately $3,540,000 through the completion of the offering period which expired in September of 1987.\nIn connection with the acquisition of properties, PWPI was entitled to receive acquisition fees in an amount not greater than 5% of the gross proceeds from the sale of the Partnership units. Total acquisition fees incurred by the Partnership and paid to PWPI aggregated $2,077,000.\nThe Partnership recorded as income a total of $5,000, $83,000 and $48,000 of investor servicing fees from certain of its joint ventures for the years ended March 31, 1995, 1994 and 1993, respectively.\nIncluded in general and administrative expenses for the years ended March 31, 1995, 1994 and 1993 is $84,000, $93,000 and $82,000, 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 $4,000, $2,000 and $3,000 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 1995, 1994 and 1993, respectively.\n4. Operating Investment Properties\nAs of March 31, 1995 and 1994, the Partnership owns majority and controlling interests in two joint venture partnerships which own operating investment properties as described below. As discussed in Note 2, the Partnership's policy is to report the operations of the joint ventures on a three-month lag.\n71st Street Housing Partners, Ltd.\nOn December 16, 1985, the Partnership acquired an interest in 71st Street Housing Partners, Ltd., a joint venture formed to develop, own and operate the Harbour Pointe Apartments, a 234-unit two-story garden apartment complex located in Bradenton, Florida. Construction of this complex was completed in January, 1987. The Partnership's co-venture partners are affiliates of The Lieberman Corporation. The Partnership made a capital investment of $2,658,000 (including an acquisition fee of $150,000 paid to PWPI) for a 60% interest in the Joint Venture. The property was acquired subject to a nonrecourse mortgage note in the amount of $9,200,000. On May 1, 1990, the joint venture refinanced its mortgage note under more favorable terms, as further discussed in Note 7. Pursuant to an Amended and Restated Agreement of the Limited Partnership dated August 4, 1989, the general partner interests of the co-venturers were converted to limited partnership interests. The co-venturers received a payment of $125,000 from the Partnership in return for their agreement to relinquish their general partner rights and the property management contract. As a result of the amendment, the Partnership, as the sole general partner, assumed full control of the operations of the property and hired a third-party property manager to manage the day-to-day operations of the apartment complex.\nPer the terms of the amended joint venture agreement, income is allocated to the Partnership until such time as the Partnership's capital account balance equals 250% of all capital contributions theretofore made by the Partnership. Thereafter, income is allocated 60% to the Partnership and 40% to the co-venturers. Net losses are generally allocated 95% to the Partnership and 5% to the co-venturers.\nAllocations of gains and losses from capital transactions will be allocated according to the formulas provided in the joint venture agreement.\nDistributions of cash from a sale or operations of the operating property will be made in the following order of priority: first, to repay accrued interest and principal on optional loans (none outstanding as of March 31, 1995 and 1994); second, to the Partnership until the Partnership has received an amount equal to 250% of all capital contributions theretofore made by the Partnership; and third, any remainder, will be distributed 60% to the Partnership and 40% to the co-venturers. Distributions of cash from a refinancing of the operating property shall be distributed 60% to the Partnership and 40% to the co-venturers.\nThe Lakes Joint Venture\nThe Lakes Joint Venture (\"Venture\") was formed May 30, 1985 (inception) in accordance with the provisions of the laws of the State of California for the purpose of developing, owning and operating a 770-unit apartment complex (operating investment property) in Costa Mesa, California. On November 1, 1985 the Partnership acquired a 65% general partnership interest in the joint venture. The Partnership's original co-venture partner was The Lakes Development Company (\"Developer\"), a California general partnership and an affiliate of Regis Homes Corporation. Construction of the operating investment property was completed in December 1987. The initial aggregate cash investment made by the Partnership for its interest was approximately $16,226,000 (including an acquisition fee of $1,130,000 paid to PWPI). Construction of the property was financed from the proceeds of a nonrecourse $76,000,000 mortgage loan. On September 26, 1991, in conjunction with a refinancing and modification of the Venture's long-term indebtedness, the Developer transferred its interest in the Venture to Development Partners, Inc. (\"DPI\"), a Delaware corporation and a wholly-owned subsidiary of Paine Webber Group, Inc., and withdrew from the Venture. As a result of the original co-venturer's withdrawal, the Partnership assumed full control over the operations of the Venture. The debt secured by the The Lakes at South Coast Apartments is in technical default as of March 31, 1995 due to the failure of the Venture to satisfy a covenant of the loan agreement. See Note 7 for a further discussion.\nConcurrent with the Developer's withdrawal from the Venture and the admission of DPI as a Venturer, the Venture Agreement was amended and restated effective September 26, 1991. The Venture Agreement between the Partnership and DPI provides that, if the Venture's operating revenues are insufficient to pay its operating expenses, the Venturers shall have the right, but not the obligation, to arrange third-party loans to the Venture. Alternatively, the Venturers may choose to make Optional Loans to the Venture. If both Venturers desire to make such loans, the loans shall be made in the ratio of 99.98% from the Partnership and .02% from DPI.\nDistributable Funds and Net Proceeds of the Venture are to be allocated first to the Partnership until the Partnership shall have received cumulative distributions equal to any Additional Capital Contributions, as defined. Thereafter, any remaining Distributable Funds or Net Proceeds are to be distributed next to repay accrued interest and principal on any Optional Loans and then to the Partnership until the Partnership shall have received cumulative distributions equal to $17,250,000. Any remainder is to be distributed 99.98% to the Partnership and .02% to DPI.\nNet losses are to be allocated 99.98% to the Partnership and .02% to DPI. Net income shall be allocated to Venturers to the extent of and in the ratio of the distribution of Distributable Funds, with any remainder allocated 99.98% to the Partnership and .02% to DPI. In the event that there are no Distributable Funds, net income would be allocated 99.98% to the Partnership and .02% to DPI. Allocations of gain or losses from sales or other dispositions of the operating investment property are set forth in the Venture Agreement.\nThe following is a summary of combined property operating expenses for Harbour Pointe Apartments and for The Lakes at South Coast Apartments for the years ended December 31, 1994, 1993 and 1992:\n1994 1993 1992 (in thousands) Property operating expenses: Repairs and maintenance $ 915 $ 768 $ 776 Salaries and related expenses 672 635 663 Utilities 504 547 541 Administrative and other 1,062 1,032 1,036 Management fee 349 354 350 Leasing commissions and fees 124 112 126 Insurance 118 113 114 $ 3,744 $ 3,561 $ 3,606\n5. Investments in Unconsolidated Joint Ventures\nThe Partnership has an investment in one unconsolidated joint venture at March 31, 1995 and 1994. During fiscal 1993, two of the Partnership's joint venture investment properties were transferred to the respective mortgage lenders through foreclosure proceedings. The unconsolidated joint ventures are accounted for on the equity method in the Partnership's financial statements. As discussed in Note 2, these joint ventures report their operations on a calendar year basis.\nThe two unconsolidated joint ventures (Quinten's Crossing and Parrot's Landing) that lost their operating properties to foreclosure in fiscal 1993 had been in violation of their mortgage loan agreements for extended periods of time and had incurred significant cash flow deficits. In both of these cases, management determined that the expense of continuing to contest the lenders' foreclosure actions was not in the best interests of the Partnership because the joint venture interests had no current or potential future value without substantial concessions that the lenders were ultimately unwilling or unable to give. The Partnership forfeited its interest in Quinten's Crossing to the mortgage lender on August 27, 1992. This transaction resulted in a net gain to the Partnership of approximately $1,024,000, comprised of an extraordinary gain of approximately $4,089,000 and an ordinary loss of approximately $3,065,000. The Parrot's Landing joint venture had filed for bankruptcy in fiscal 1992 in order to forestall the lender's foreclosure actions. Under generally accepted accounting principles, entities in reorganization under a Chapter 11 bankruptcy proceeding generally recognize interest expense on a nonrecourse debt obligation only to the extent that such interest is paid in cash. This accounting treatment resulted in the non-recognition of contractual interest expense in the amount of approximately $510,000 for calendar 1992. On October 16, 1992, the Partnership and its co-venture partner forfeited their interests in the Parrot's Landing Apartments to the mortgage lender in settlement of the foreclosure litigation. This transaction resulted in a net gain to the Partnership of approximately $6,765,000, comprised of an extraordinary gain of approximately $2,879,000 and an ordinary gain of approximately $3,886,000. The transfer of each joint venture's operating property to the lender 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\". As a result, each joint venture's extraordinary gain from settlement of debt obligation arose due to the fact that the balance of the mortgage loan and related accrued interest exceeded the estimated fair market value of each joint venture's operating property and other assets transferred to the lender at the time of the foreclosure. In accordance with SFAS No. 15, an ordinary gain or loss on transfer of assets is calculated as the difference between the net carrying value of each joint venture's net operating investment property and its estimated fair value at the time of the foreclosure.\nCondensed combined financial statements of the unconsolidated joint ventures, for the periods indicated, follow. The operating results reflected in the condensed combined summary of operations for 1992 include the results of the Quinten's Crossing and Parrot's Landing apartment complexes up through the date that the operating properties were transferred to the lenders.\nCONDENSED COMBINED BALANCE SHEETS December 31, 1994 and 1993 Assets (in thousands)\n1994 1993\nCurrent assets $ 126 $ 17 Operating investment property, net 4,996 5,082 Other assets 375 447 $ 5,497 $ 5,546\nLiabilities and Partners' Deficit\nCurrent liabilities $ 427 $ 363 Loans payable to affiliates 537 537 Long-term debt 6,900 6,964 Partnership's share of combined deficit (2,239) (2,208) Co-venturer's share of combined deficit (128) (110) $ 5,497 $ 5,546\nCondensed Combined Summary of Operations For the years ended December 31, 1994, 1993 and 1992 (in thousands)\n1994 1993 1992\nRental revenues $ 1,102 $ 1,038 $ 3,897 Interest and other income 109 51 190 1,211 1,089 4,087\nProperty operating expenses 636 656 2,273 Depreciation and amortization 212 282 866 Interest expense (contractual interest of $2,566,000 in 1992) 411 301 2,056 1,259 1,239 5,195 Net loss from operations (48) (150) (1,108)\nNet loss on transfer of assets at foreclosure - - (1,133) Loss before extraordinary gains (48) (150) (2,241) Extraordinary gains on settlement of debt obligations - - 9,323 Net income (loss) $ (48) $ (150) $ 7,082\nNet income (loss): Partnership's share of income (loss) $ (31) $ (97) $ 6,761 Co-venturers' share of income (loss) (17) (53) 321\n$ (48) $ (150) $ 7,082\nReconciliation of Partnership's Investment March 31, 1995 and 1994 (in thousands)\n1995 1994 Partnership's share of combined deficit as shown above at December 31 $ (2,239) $ (2,208) Partnership's share of current liabilities 60 60 Excess basis due to investment in joint venture, net (1) 80 84 Equity in losses of unconsolidated joint venture in excess of investment and advances at March 31 (2) $ (2,099) $ (2,064)\n(1) At March 31, 1995 and 1994, the Partnership's investment exceeds its share of the combined joint venture's deficit account by approximately $80,000 and $84,000, respectively. These amounts, which relate to certain expenses incurred by the Partnership in connection with acquiring its remaining unconsolidated joint venture investment, are being amortized using the straight-line method over the estimated useful life of the related operating investment property.\n(2) Investments in unconsolidated joint venture, at equity at March 31, 1995 and 1994 represents the Partnership's net investment in the Lincoln Garden joint venture partnership. This 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.\nReconciliation of Partnership's Share of Operations For the years ended March 31, 1995, 1994 and 1993 (in thousands)\n1995 1994 1993 Partnership's share of operations, as shown above $ (31) $ (97) $ 6,761 Amortization of excess basis (4) (4) (4) Partnership's share of unconsolidated ventures' net income (loss) $ (35) $ (101) $ 6,757\nThe Partnership's share of unconsolidated ventures' net income (loss) is presented as follows on the accompanying statement of operations:\n1994 1993 1992 Partnership's share of unconsolidated ventures' losses $ (35) $(101) $(1,032) Partnership's share of net gain on transfers of assets at foreclosure - - 821 Partnership's share of extraordinary gains on settlement of debt obligations - - 6,968 Partnership's share of unconsolidated ventures' net income (loss) $ (35) $(101) $6,757\nA description of the property owned by the remaining unconsolidated joint venture and certain other matters are summarized below:\nLincoln Garden Apartments Joint Venture\nOn November 15, 1985, the Partnership acquired an interest in a joint venture which developed, owns and operates Lincoln Garden Apartments, a 200- unit complex located on an 8.1-acre tract of land in Tucson, Arizona. Construction of this complex was completed in June, 1986. The Partnership's co-venture partner is an affiliate of Lincoln Property Company. The Partnership made a cash investment of approximately $1,762,000 (including an acquisition fee of $103,125 paid to PWPI) for a 65% interest in the Joint Venture. The property was acquired subject to a nonrecourse mortgage note in the amount of $7,700,000.\nDuring fiscal 1989, the joint venture ceased to meet the debt service requirements of its mortgage financing and, technically, was in default of the loan agreements. In March 1989, the Partnership refinanced its loan and obtained a lower interest rate which reduced the venture's debt service requirements. Interest rates on the previous financing arrangement ranged from 7.2% to 8.8% per annum. The new financing arrangement bore interest at varying rates ranging from 2.26% to 3.77% and 2.515% to 3.112% during calendar 1994 and 1993, respectively. The venture has remained current on its debt service payments since the date of the refinancing. The mortgage note has a remaining principal balance of $6,900,000 as of December 31, 1994 and is scheduled to mature on May 1, 1997. To improve the credit rating of the outstanding debt and provide a more favorable variable interest rate, in 1993 the lender provided to the joint venture a confirming letter of credit for $7,109,500. The confirming letter of credit requires annual fees equal to 0.3% of the letter of credit amount and expires on June 4, 1996.\nThe co-venturer guaranteed to fund negative cash flow, as defined, of the Joint Venture during the guarantee period, which ended September 30, 1988. Operating expenses and debt service, if any, in excess of the amounts available for expenditure were to be funded by the co-venturer during the guarantee period. The co-venturer's obligation to fund cash pursuant to these guarantees was in the form of nonreturnable capital contributions through September 30, 1987, and mandatory additional capital contributions, as defined, through September 30, 1988. From October 1, 1988 until July 2, 1990, the co-venturer was required to make mandatory loans, as defined, to the Joint Venture to the extent operating revenues were insufficient to pay the operating expenses. Thereafter, if operating revenues are insufficient to pay operating expenses, either the co-venturer or the Partnership may make optional loans, as defined, to the Joint Venture, but there is no assurance that any will be made. All mandatory and optional loans bear interest at prime (8.5% at December 31, 1994) plus 1% per annum and are to be repaid from distributable funds, as defined. At December 31, 1994, mandatory and optional loans payable to the co-venturer amounted to $522,000. Unpaid interest on mandatory and optional loans at December 31, 1994, amounted to $284,000. Loans payable to the Partnership at December 31, 1994, amounted to $14,000 and are being accounted for as optional loans similar to those made by the co-venturer.\nThe joint venture agreement provides that distributable funds, as defined, and net proceeds arising from the sale, refinancing, or other disposition of the Operating Investment Property of the Joint Venture, as defined, will be distributed as follows: 1) for repayment of accrued interest and principal on optional loans, 2) for repayment of accrued interest and principal on mandatory loans, 3) to the Partnership until the Partnership has received cumulative distributions equal to $1,897,500, 4) to the co-venturer until the co-venturer has received a cumulative distribution equal to, first, a preferred return on mandatory additional capital contributions of prime plus 1% per annum and, second, any mandatory additional capital contributions, and 5) the balance, 65% to the Partnership and 35% to the co-venturer. The obligation to distribute distributable funds is cumulative.\nLosses of the joint venture, other than losses resulting from the sale of the Operating Investment Property, were allocated 100% to the Partnership through December 31, 1990, and thereafter, are allocated 65% to the Partnership and 35% to the co-venturer unless the allocation of additional losses to the Partnership would result in the Partnership's capital account having a deficit balance while the co-venturer's capital account has a credit balance. In such cases, the co-venturer will be allocated losses until the capital account of the co-venturer is reduced to zero. Income of the Joint Venture, other than gains resulting from the sale or other disposition of the Operating Investment Property, will be allocated 65% to the Partnership and 35% to the co-venturer if there are no distributable funds. If there are distributable funds, income will be allocated as follows: 1) to the Partnership to the extent of its preferred distributions, 2) to the co-venturer to the extent of its preferred distributions, and 3) the balance, 65% to the Partnership and 35% to the co- venturer.\nGains arising from the sale, refinancing, or other disposition of the Operating Investment Property are to be allocated in accordance with specific formulas set forth in the joint venture agreement.\n6. Restricted Cash\nIn September 1991, The Lakes Joint Venture entered into an agreement with its mortgage lender whereby restricted cash accounts were established for the purpose of making specific disbursements for debt service, property taxes and insurance, security deposit refunds, and funding operating deficits. These accounts are controlled by the bank in which all disbursements and transfers are dictated by the related Reimbursement Agreement (see Note 7). These cash accounts are included in Restricted Cash on the accompanying balance sheet.\n7. Long-term debt\nLong-term debt on the Partnership's balance sheet at March 31, 1995 and 1994 consists of the following:\n1995 1994 (in thousands) Nonrecourse mortgage note payable which secures Manatee County Housing Finance Authority Revenue Refunding Bonds. The mortgage loan is secured by a deed to secure debt and a security agreement covering the real and personal property of the Harbour Pointe Apartments. $ 9,125 $ 9,125\nDeveloper loan payable which secures County of Orange, California Tax-Exempt\nApartment Development Revenue Bonds. The mortgage loan is nonrecourse and is secured by a first deed of trust plus all future rents and income generated by The Lakes at South Coast Apartments. 75,600 75,600\nNonrecourse loan payable to bank secured by a third deed of trust plus all future rents and income generated by The Lakes at South Coast Apartments. 4,584 5,232\nPrior indebtedness principal payable to bank. This obligation is related to The Lakes Joint Venture and is nonrecourse. 3,561 3,561 92,870 93,518\nLess: Long-term debt in technical default (see discussion below) (83,745) - $ 9,125 $ 93,518\nMortgage loan secured by the Harbour Pointe Apartments\nOriginal financing for construction of the Harbour Pointe Apartments was provided through $9,200,000 of Multi-Family Housing Mortgage Revenue Bonds, Series 1985 E due December 1, 2007 (the original Bonds) issued by the Manatee County Housing Finance Authority which bore interest at 8.25% plus a 1.25% letter of credit fee. An amount of $75,000 was paid on the original bonds prior to the refinancing. The original bond issue was refinanced on May 1, 1990 with $9,125,000 Weekly Adjustable\/Fixed Rate Multi-Family Housing Revenue Refunding Bonds, Series 1990A, due December 1, 2007 (the Bonds).\nThe interest rate on the Bonds is adjusted weekly to a minimum rate that would be necessary to remarket the Bonds in a secondary market as determined by a bank remarketing agent. During calendar 1994, the interest rate averaged 3.36% (3.03% in 1993). The Bonds are secured by the Harbour Pointe Apartments.\nInterest on the underlying bonds is intended to be exempt from federal income tax pursuant to Section 103 of the Internal Revenue Code. In connection with obtaining the mortgage, the partnership executed a Land Use Restriction Agreement with the Manatee County Housing Finance Authority which provides, among other things, that substantially all of the proceeds of the Bonds issued be utilized to finance multi-family housing of which 20% or more of the units are to be leased to low and moderate income families as established by the United States Department of Housing and Urban Development. In the event that the underlying Bonds do not maintain their tax-exempt status, whether by a change in law or by noncompliance with the rules and regulations related thereto, repayment of the note may be accelerated.\nPursuant to the financing agreement, a bank has issued an irrevocable letter of credit to the Bond trustee in the joint venture's name for $9,247,500. An annual fee equal to 1% of the letter of credit balance is payable monthly to the extent of net cash operating income available to pay such fees. Accrued letter of credit fees currently due as of December 31, 1994 were $12,072.\nDebt secured by The Lakes at South Coast Apartments\nOriginal financing for construction of The Lakes at South Coast Apartments was provided from a developer loan in the amount of $76,000,000 funded by the proceeds of a public offering of tax-exempt apartment development revenue bonds. The Venture had been in default of the developer loan since December 1989 for failure to make full and timely payments on the loan. As a result of the Venture's default, the required semi-annual interest and principal payments due to the bond holders through June of 1991 were made by the bank which had issued an irrevocable letter of credit securing the bonds. Under the terms of the loan agreement, the Venture was responsible for reimbursing the letter of credit issuer for any draws made against the letter of credit which totalled $7,748,000.\nThe original bond issue was refinanced during 1991 and the original developer loan was extinguished. The new developer loan (1991 Developer Loan), in the amount of $75,600,000, is payable to the County of Orange and was funded by the proceeds of a public offering of tax-exempt apartment development revenues bonds issued, at par, by the County of Orange, California in September 1991. Principal is payable upon maturity, December 1, 2006. Interest on the bonds is variable, with the rate determined weekly by a remarketing agent (ranging from 1.7% to 6.8% during calendar 1994), and is payable in arrears on the first of each month. In November 1992, the Venture entered into an interest rate cap agreement for an amount which covered the $75,600,000 Developer's loan. The cap agreement, which cost the Venture $208,000, provided an interest rate ceiling of 3.49% and was effective from November 30, 1992 to December 15, 1993. The cost of the interest rate cap was amortized on a straight-line basis over the 13-month period covered by the agreement.\nThe loan is secured by a first deed of trust plus all future rents and income generated by the operating investment property. Bond principal and interest payments are secured by and payable from an irrevocable letter of credit issued by a bank in the amount of $76,569,000, expiring December 15, 1998. The Venture pays an annual letter of credit fee equal to 1.0% of the outstanding amount, payable 60% monthly with the remaining 40% (Unpaid Accrued Letter of Credit Fees) deferred and paid in accordance with the Reimbursement Agreement (see below). Such Unpaid Accrued Letter of Credit Fees were $999,000 and $693,000 at December 31, 1994 and 1993, respectively. The bank letter of credit is secured by a second deed of trust on the operating investment property and future rents and income from the operating investment property.\nIn conjunction with the 1991 Developer Loan, the Venture entered into a Reimbursement Agreement with the letter of credit issuer regarding the unreimbursed letter of credit draws referred to above. The letter of credit issuer agreed to forgive all outstanding accrued interest through September 26, 1991, aggregating $1,132,000, along with a portion of the outstanding principal in the amount of $300,000. In return, the Venture made a principal payment of $926,000, leaving an unpaid balance of $6,523,000 (Prior Indebtedness). Such amount bears interest payable to the letter of credit issuer at the rate of 11% per annum. Interest accrued on the Prior Indebtedness from the date of closing through June 1992 was forgiven by the letter of credit issuer. At the time of the refinancing the Venture also owed the letter of credit issuer of credit fees totalling $2,184,000. The letter of credit issuer agreed to forgive $1,259,000 of such unpaid fees, leaving an unpaid balance of $925,000 (Deferred Prior Letter of Credit Fees). The Venture has a limited right to defer payment of interest and principal on the Prior Indebtedness and the Unpaid Accrued Letter of Credit Fees to the extent that the net cash flow from operations is not sufficient after the payment of debt service on the 1991 Developer Loan and the funding of certain required reserves. In addition, upon a sale or other disposition of the operating property, the Reimbursement Agreement allows for the payment to the Venture of an amount of $5,500,000, plus accrued interest at the rate of 8% per annum, prior to the repayment to the letter of credit issuer of the accrued interest on the Prior Indebtedness and the Deferred Prior Letter of Credit Fees.\nThe 1991 Developer Loan required the establishment of a $2,000,000 deficit reserve account, funded from the Venturers' 1991 contributions. The loan also requires the funding of an additional reserve account on a monthly basis from available cash flow (as defined) to the extent that the interest rate on the bonds is below 6%, until the balance in this reserve account totals $1,000,000. The requirement for this additional reserve account may be eliminated if the operating property generates a certain minimum level of net operating income. The $2,000,000 deficit reserve account and the additional reserve account funded by operations may be used under certain circumstances to fund the Venture's debt service obligations to the extent that net operating income is insufficient. In the event that such reserves no longer become necessary under the terms of the Reimbursement Agreement, any remaining balances in the reserve accounts are to be paid to the letter of credit issuer to be applied against certain of the Venture's outstanding obligations. In November 1992, the bank and the Venture agreed to release $1,764,000 from the deficit reserve account to pay down the Prior Indebtedness. As of December 31, 1994, the balances in the deficit reserve account and the additional reserve account totalled $150,000 and $1,051,000, respectively, ($150,000 and $1,017,000 in 1993, respectively), and are included in restricted cash on the accompanying balance sheets. The remaining balance in restricted cash relates to operating cash accounts of the Venture in which disbursements are restricted by the bank.\nThe 1991 Developer Loan contains several restrictive covenants, including, among others, a requirement that the Venture furnish the letter of credit issuer in September 1994 and September 1996 with certified independent appraisals of the fair market value of the operating investment property for an amount equal to or greater than $92,000,000 and $100,000,000, respectively. Failure to provide such appraisals constitute events of default under the Reimbursement Agreement. To date, the Lakes Joint Venture has not provided the lender with an appraisal which meets the $92,000,000 requirement, and the lender has not waived or modified the minimum appraised value requirement. Accordingly, the Venture is technically in default under the Reimbursement Agreement. The Managing General Partner has had preliminary discussions with the lender regarding possible changes to the 1994 appraisal requirement. Preliminary indications have been that the lender might consider waiving or modifying the minimum appraised value requirement for September 1994 in exchange for a rearrangement of the timing and amounts of certain priorities, as specified in the Reimbursement Agreement. Management does not expect the lender to take any actions as long as progress continues to be made in negotiations for modification to the terms of the Reimbursement Agreement. However, there can be no assurances that the lender will grant any relief in connection with this appraisal covenant and, accordingly, the principal amount of the debt related to The Lakes Joint Venture has been classified as long-term debt in technical default on the balance sheet as of March 31, 1995. These conditions raise substantial doubt about the Venture's and the Partnership's ability to continue as going concerns. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. The total assets, total liabilities, gross revenues and total expenses of The Lakes Joint Venture included in the 1995 consolidated financial statements total $67,718,000, $91,578,000, $8,713,000 and $10,511,000, respectively.\nIn November 1988, a borrowing arrangement with a bank was entered into to provide funds for The Lakes. The Venture obtained a line of credit secured by a third trust deed on the subleasehold interest, buildings and improvements, and rents and income in the amount of $6,300,000. Interest on the line of credit was originally payable monthly at 1-1\/2% over the Citibank, N.A. prime rate. However, because of the default status of this obligation during 1990, interest had accrued at a rate of prime plus 4% through September 26, 1991. Accrued interest on the line of credit, which is payable to the same bank which issued the letter of credit in connection with the bonds, totalled $1,841,000 at September 26, 1991. In conjunction with the refinancing of the developer loan described above, the lender agreed to forgive all of the outstanding accrued interest at the date of the refinancing. Interest accrues on the outstanding principal balance at the rate of 11% per annum beginning September 27, 1991. Payment of interest and principal on the line of credit borrowings, prior to a sale or other disposition of the operating property, is limited to the extent of available cash flow after the payment of debt service on the developer loan and the funding of certain required reserves. In addition, as with the Prior Indebtedness principal and interest described above, upon a sale or other disposition of the operating property, the payment of accrued interest on the line of credit borrowings is subordinated to the receipt by the Venture of $5,500,000 plus a simple return thereon of 8% per annum.\nThe restructuring of the Prior Indebtedness, the Deferred Letter of Credit Fees and the line of credit borrowings, as described above, have been accounted for in accordance with Statement of Financial Accounting Standards No. 15, \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\". Accordingly, the forgiveness of debt, aggregating $5,279,000, has been deferred and is being amortized as a reduction of interest expense prospectively using a method approximating the effective interest method over the estimated remaining term of the Venture's indebtedness. At December 31, 1994 and 1993, $4,087,000 and $4,430,000, respectively of such forgiven debt (net of accumulated amortization) has been reflected in the accompanying balance sheet and $343,000, $343,000 and $346,000 for the years ended December 31, 1994, 1993 and 1992, respectively, has been amortized as a reduction of interest expense in the accompanying statements of operations.\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.\nSchedule III - Real Estate and Accumulated Depreciation PAINEWEBBER DEVELOPMENT PARTNERS FOUR LTD. SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION\nMarch 31, 1995 (In Thousands)","section_15":""}
{"filename":"65984_1995.txt","cik":"65984","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":"867961_1995.txt","cik":"867961","year":"1995","section_1":"Item 1. Business\nThe Navistar Financial Dealer Note Trust 1990 (the \"1990 Trust\") was formed pursuant to a Pooling and Servicing Agreement dated as of December 1, 1990 among Navistar Financial Securities Corporation, as seller (the \"Seller\"), Navistar Financial Corporation, as servicer (the \"Servicer\"), and Chemical Bank (Successor to Manufacturers Hanover Trust Company), as 1990 Trust Trustee. Wholesale dealer notes (the \"Dealer Notes\") and security interests in the vehicles financed thereby were transferred to the 1990 Trust in exchange for three classes of floating rate pass-through certificates (the \"Investor Certificates\") which were remarketed to the public. The Seller's undivided fractional interest in the 1990 Trust (the \"Seller Interest\") is evidenced by a Seller Certificate.\nAdditional Dealer Notes are sold on a daily basis by the Seller to the 1990 Trust to replace those Dealer Notes which have been liquidated or charged off as uncollectible. Accordingly, the aggregate amount of Dealer Notes in the 1990 Trust will fluctuate from day to day as new Dealer Notes are generated and as existing Dealer Notes are removed.\nUnder the terms of the Pooling and Servicing Agreement, the Seller is required to maintain a minimum investment in the 1990 Trust (the \"Minimum Seller Interest\"), a portion of which is subordinated to the Investor Certificates. If the amount of Dealer Notes in the 1990 Trust is less than the combined ownership interest evidenced by the Investor Certificates and Minimum Seller Interest, the Seller must transfer additional funds (the \"Investment Securities\") to the 1990 Trust to maintain the Seller Interest at an amount not less than the Minimum Seller Interest.\nOn June 8, 1995, the Navistar Financial Dealer Note Master Trust (the \"Master Trust\") was formed pursuant to a Pooling and Servicing Agreement among Navistar Financial Securities Corporation, as seller, Navistar Financial Corporation, as servicer, Chemical Bank (Successor to Manufacturers Hanover Trust Company), as 1990 Trust Trustee and The Bank of New York, as Master Trust Trustee. On June 8, 1995, the 1990 Trust issued Class A-4 Certificates in the amount of $207.9 million to the Master Trust which, in turn, issued Series 1995-1 Certificates in the amount of $200.0 million to the public.\nThe 1990 Trust is the active trust and will hold the Dealer Notes and certain related assets until the termination of the 1990 Trust. The termination of the 1990 Trust will occur upon the repayment of the three classes of Investor Certificates issued in 1990 (Class A-1, Class A-2 and Class A-3) at which time the Master Trust will become the active trust.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nNot applicable.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe registrant knows of no material pending legal proceedings involving either the Dealer Notes or the trustees, or the Seller or Servicer in respect of the trusts.\nPART I\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring October 1994, holders of the Class A-1, Class A-2 and Class A-3 Certificates were solicited to amend the 1990 Pooling and Servicing Agreement for the following matters:\n1. Allow Navistar Financial Securities Corporation to sell to the 1990 Trust Dealer Notes originated by Navistar Financial Corporation that finance new vehicles manufactured by an entity other than Navistar International Transportation Corp.\n2. Modify the limit for Investor Certificateholders' exposure to individual dealers by allowing an individual dealer's Dealer Note principal balance to reach the greater of up to 2.0% of the aggregate principal balance of Dealer Notes and Investment Securities in the 1990 Trust or the present $4.0 million.\n3. Allow the proceeds from the issuance of a new class of certificates to be invested in Investment Securities rather than Dealer Notes until such time as additional Dealer Notes become available.\nNavistar Financial Securities Corporation received consent on each of the above matters from 67.7% of the Certificateholders resulting in an amendment of the 1990 Pooling and Servicing Agreement effective March 23, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nNot applicable.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNot applicable.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nAs of October 31, 1995, the combined aggregate principal balance of Dealer Notes and Investment Securities was $847.1 million. Reference is made to Exhibit 13 for additional information regarding principal and interest payments in respect of the Investor Certificates and information regarding servicing compensation and other fees paid by the trusts during the fiscal year.\nAs of October 31, 1995, the combined aggregate principal balance of Dealer Notes and Investment Securities allocated by the 1990 Trust to Investor Certificates and the Seller Certificate were $507.9 million and $339.2 million, respectively.\nPART II\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\nNot applicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot applicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Exhibits\n3 Articles of Incorporation and By-Laws\n10 Material Contracts\nAn Annual Summary of the Certificateholders' Statement, the Servicer Certificate and the Servicer and Settlement Certificate listed below is an annualized version of the monthly Servicer Certificates prepared by the Servicer.\n13 - Report of Independent Certified Public Accountants\n13 - Annual Summary of Servicer and Settlement Certificates\n13 - Annual Summary of Servicer Certificates\n13 - Annual Summary of Certificateholders' Statements\n27 - Financial Data Schedule\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(b) Reports on Form 8-K:\nThe Registrant filed the following reports on Form 8-K during the three months ended October 31, 1995:\n(i) Form 8-K dated September 25, 1995\n(ii) Form 8-K dated October 25, 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.\nNAVISTAR FINANCIAL SECURITIES CORPORATION on behalf of NAVISTAR FINANCIAL DEALER NOTE TRUST 1990 and NAVISTAR FINANCIAL DEALER NOTE MASTER TRUST (Exact name of Registrant as specified in its charter)\nBy: \/s\/PHYLLIS E. COCHRAN January 29, 1996 Phyllis E. Cochran Vice President and Controller\nEXHIBIT INDEX","section_15":""}
{"filename":"812563_1995.txt","cik":"812563","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nIDS Life Account RE (the Account) was established by a resolution of the Board of Directors of IDS Life Insurance Company (IDS Life) as a separate asset account, pursuant to Minnesota law. The Account was formed to make real estate related investments in connection with the sale of individual deferred variable annuity contracts (Contracts) offered by IDS Life. The Account commenced operations on August 7, 1987 when the annuity contracts were first offered for sale to the public. Effective May 1, 1995, the Account discontinued new contract sales. The Account holds assets that are segregated from all of IDS Life's other assets and are not chargeable with liabilities arising out of any other business of IDS Life.\nThe Account is not registered as an investment management company under the Investment Company Act of 1940. The Account is under the control and management of the Board of Directors of IDS Life and its officers. The owners of the Contracts have no voting rights with respect to the Account.\nIDS Life does not guarantee the investment performance of the Account and is not responsible for the liabilities of the Account. However, IDS Life is responsible for the fulfillment of the terms of each Contract, including payment of death benefits and the guarantees of the minimum annuity purchase rates contained in the Contracts.\nInvestment Objective\nThe investment objectives of the Account previously were to provide for payment of retirement income under the Contracts by seeking to: (i) preserve and protect the Account's assets in real (i.e., inflation-adjusted) terms; (ii) provide for compounding of income through reinvestment of cash flow from investments; and (iii) provide for increases in income through capital appreciation of real property investments and, to the extent available, through participation in the capital appreciation, gross revenues or income of the real properties subject to mortgage loans or land sale- leasebacks. There is no guarantee that the investment objectives of the Account will be attained. The assets of the Account have been invested primarily in real estate related investments in accordance with the diversification requirements regarding variable annuities contained in Section 817(h) of the Internal Revenue Code (the \"Code\").\nThe Account previously sought to have approximately 50 to 70 percent of the Account's assets invested in income-producing real property investments such as office buildings, shopping centers, apartment complexes and other real properties, with approximately 15 to 40 percent of the Account's assets invested in mortgage loans and land sale-leaseback investments, which could include participation in the appreciation or the gross revenues or income of the real properties that are subject to the mortgage loans or land sale- leaseback investments. The remaining portion of the Account's assets generally were to be invested in short-term debt instruments and intermediate term bonds with maturities of up to five years.\nThe Account has experienced substantial net contract terminations over the past several years, which have adversely affected its liquidity and ability to acquire additional real estate related investments. As a result, the Account does not intend to acquire additional real estate related investments. Further, the Account intends to liquidate the real estate related investments that it currently holds when it becomes advantageous or necessary to do so.\nIDS Life has purchased and expects to continue to purchase accumulation units in order to maintain the Account's liquidity. IDS Life makes these payments so that no contract holder is disadvantaged because sales of new contracts have been discontinued. These payments for accumulation units have been made to enable the Account to pay off amounts borrowed under its line of credit with IDS Life and as needed in order to fund all of the Account's obligations under the contracts such as paying surrenders. By purchasing accumulation units, IDS Life has an ownership interest in the Account and participates in the increase or decrease in value of the Account's investments just as other owners of accumulation units do. IDS Life may realize a gain or loss on its accumulation units when redeemed.\nIDS Life currently expects to hold the accumulation units it purchases until the surrender of all outstanding contracts or until the Account's liquidity improves (through, for example, one or more sales of real estate related investments) thereby permitting the Account to satisfy its anticipated contract obligations. Because IDS Life may purchase a significant amount of accumulation units, IDS Life may be subject to certain conflicts of interest it would not otherwise have if it had not purchased such accumulation units, including, among other things, a conflict in approving periodic valuations of real estate related investments made by the Investment Adviser, JMB Annuity Advisers.\nCompetition\nAs of December 31, 1995, IDS Life was aware of 3 other real estate variable annuity products that have been registered with the Securities and Exchange Commission and that are being offered for sale by competitors. These products differed from the Account in various features although their structure and investment objectives were similar to the Account's prior to its termination of new contract sales. In addition, the Account competed against other real estate investment funds and registered investment companies including limited partnerships, real estate investment trusts, unit investment trusts, pension and profit sharing trusts, corporations, etc., all of which may or may not be offered for sale by commercial and investment banks, realty corporations, insurance companies, savings and loan associations, diversified financial service companies, and other financial service intermediaries. The Account had been in competition for real property investments, mortgage loans and land sale-leasebacks with numerous other entities, as well as with individuals, corporations, real estate investment trusts, real estate partnerships and other entities engaged in real estate investment activities, including certain affiliates of the JMB Annuity Advisers (the Investment Adviser) and IDS Life. The real properties that are the subject of the Account's real estate related investments are in competition with other real properties (including those in which the Investment Adviser, IDS Life or their affiliates may have an interest) in the areas in which they are located, particularly with respect to obtaining new tenants and the retention of existing tenants. Such competition is based upon, among other things, effective rents charged, services to tenants and the facilities available.\nEmployees\nIDS Life Account RE does not directly employ any persons. The business of the Account is under the control and management of IDS Life's Board of Directors, its principal officers, and its investment committee to the Account. The Investment Adviser, an affiliate of JMB Realty Corporation, provides investment selection, management, disposition, and consulting services with respect to the real estate related investments of the Account pursuant to an investment advisory agreement.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nDescription of the Account's real estate related investments is hereby incorporated herein by reference to pages 21 to 44 of the Registrant's prospectus included in Form S-1 (as amended), File number 33-13375 to be filed April 1, 1996, which pages are filed herewith as Exhibit 99.2 to this report.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material current or pending legal proceedings to which the Registrant is a party, or to which the Registrant's assets are subject.\nItem 4.","section_4":"Item 4. SUBMISSIONS OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot applicable. PART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDERS MATTERS\nThe Contracts were offered for sale through the registered representatives of IDS Life. There is no established public trading market for the Contracts. In addition, the Contracts were not bid for, but were sold at the Account's current accumulation unit value. A contract owner may elect to surrender all or part of the Contract while the Contract is in force prior to the earlier of the retirement date or the death of the first to die of the annuitant or owner. A description of surrenders, withdrawals and transfers is hereby incorporated herein by reference to pages 62 to 63 under the heading \"Contract Surrender\" and 67 to 68 under the headings \"Suspension and Delay of Payments\" and \"Transfer of Ownership\" in the Registrant's prospectus included in Form S-1 (as amended), File Number 33-13375, to be filed April 1, 1996, which pages are filed herewith as Exhibit 99.1 to this report. For the year ended December 31, 1995, the high and low accumulation unit values were $1.10 and $.99 per unit, respectively. The number of contract owners at December 31, 1995 was 1,260.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY\nDecember 31, 1995\nNOTES TO FINANCIAL STATEMENTS\n1. Organization\nIDS Life Account RE (the Account) is a segregated asset account of IDS Life Insurance Company (IDS Life) under Minnesota law. A registration statement under the Securities Act of 1933 relative to the deferred variable annuity contracts (the Contracts) issued by the Account became effective on August 6, 1987. Effective May 1, 1995, the Account discontinued new contract sales. The assets of the Account are held for the exclusive benefit of contract owners and are not chargeable with liabilities arising out of any other business conducted by IDS Life.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements have been prepared on the accrual basis of accounting. Significant accounting policies followed by the Account are summarized below.\nInvestments in Securities Investments in short-term securities maturing more than 60 days from the valuation date are valued at the market price or approximate fair value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. The Account also may invest in intermediate-term bonds with maturities of up to five years which are valued at fair value as determined by reference to market quotations, market indices, matrices and data from independent brokers.\nSecurity transactions are accounted for on the date securities are purchased or sold. Interest income, including amortization of premium and discount, is accrued daily.\nConsolidation and Unconsolidated Joint Ventures The Account's policy is to consolidate the underlying assets, liabilities and operations of property investments where 50 percent or greater ownership position is maintained. Investments in unconsolidated joint ventures with less than 50 percent ownership interest are accounted for on the equity method of accounting.\nInvestments in Real Property, Mortgage Loans and Land\/Sale-Leasebacks The Account initially values real estate related investments at their cost (including acquisition or mortgage placement fees and other acquisition or placement expenses) unless circumstances otherwise indicate that a different value should be used. Subsequently, the value of these investments will be periodically determined by JMB Annuity Advisers (the Investment Adviser). Procedures utilized to determine the estimated value include the following: (i) at the time of purchase and once every two years thereafter, each real property investment and each real property underlying a participating mortgage loan or land sale-leaseback investment will be appraised by an independent appraiser or an existing appraisal will be updated, (ii) various assumptions including, but not limited to, occupancy and rental rates, expense levels, net operating income, average capital costs and capitalization rates upon sale will be used in determining the discounted present value of an investment's estimated cash flow and its estimated sale proceeds or its asset value under a direct capitalization methodology, and (iii) for fixed interest rate mortgage loans and fixed rental rate land sale-leaseback investments, estimated values will be determined by comparison to current interest rates on U.S. Treasury debt as adjusted for a risk differential of the Account's investments. The relative weight to be given to a particular methodology or other relevant factors in determining the estimated asset value of a particular real property will depend upon an assessment of the existing and anticipated market conditions and property specific factors relevant to such real property. There is no assurance that the assumptions, estimates and methodologies used in valuing the Account's real estate related investments will in fact prove accurate or that such values would in fact be realized. Such estimates involve subjective judgments as the actual price of real estate can only be determined between independent third parties in sales transactions. In addition, any expenses that may be borne by the Account in connection with the disposition of a real estate related investment are not deducted in determining its estimated value.\nBecause the Account values its real property investments at estimated fair values, no provision for depreciation expense is recorded.\nEach day the Account will record estimated income and expenses attributable to real estate related assets. Periodically, adjustments to reflect the difference between estimated and actual income and expenses will be made.\nFederal Income Taxes IDS Life is taxed as a life insurance company. The Account is treated as part of IDS Life for federal income tax purposes. Under existing federal income tax law, no income taxes are payable with respect to any income of the Account.\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 results of operations during the period. Actual results could differ from those estimates. 3. Fees and Expenses\nThe Account pays a mortality and expense risk fee to IDS Life which is accrued daily and is equal, on an annual basis, to 1.00 percent of the average daily asset value, as defined, of the Account. The mortality risk is IDS Life's guarantee to make retirement payments according to the terms of the Contract, no matter how long annuitants live. The expense risk portion of the fee is paid to IDS Life for its guarantee that the various fees paid by the Account to IDS Life will not be increased in the future. For the years ended December 31, 1995, 1994 and 1993, the Account paid IDS Life a mortality and expense risk fee of $482,896, $502,607 and $549,250, respectively.\nThe Account also pays IDS Life an asset management fee equal, on an annual basis, to 1.25 percent of the average daily asset value, as defined, of the Account. A portion of this fee, equal to 0.95 percent of the average daily asset value, is paid by IDS Life to the Investment Adviser. The total fee may be adjusted upward to a maximum of 1.50 percent depending upon the performance of the Account's real property investments as measured against the FRC Property Index. The performance-related portion of the fee is calculated and recorded on an annual basis when the FRC Property Index is released each year for the preceding calendar year. No performance fee was paid by the Account in 1995 for 1994. The performance fee paid by the Account in 1994 for 1993 was $137,299. The performance fee paid by the Account in 1993 for 1992 was $87,287. Any performance fee adjustment will be paid to the Investment Adviser. For the years ended December 31, 1995, 1994 and 1993, the Account paid total asset management fees of $603,620, $765,557 and $773,849, respectively.\nIDS Life receives from the Account an acquisition and mortgage placement fee equal to 3.75 percent of the total cash to be paid or advanced by the Account (net of any borrowings in the case of real property investments) in connection with each real property investment, mortgage loan or land sale-leaseback investment made by the Account. A portion of this fee, equal to 3.50 percent, is paid to the Investment Adviser in consideration for its services in connection with the acquisition or placement of real estate related investments of the Account. No acquisition and mortgage placement fees were paid in 1995, 1994 or 1993.\nThe Account pays for all operational expenses incurred on its behalf. For the years ended December 31, 1995, 1994 and 1993, IDS Life was reimbursed $56,102, $51,223 and $83,122, respectively, for personnel-related expenses incurred in the administration of the Account.\n4. Investments in Unconsolidated Joint Venture Partnerships and Participation in Mortgage Loan\nJoint Venture Partnership - N\/S Associates\nIDS Life, on behalf of the Account, entered into a joint venture partnership called N\/S Associates, which on April 4, 1988 acquired interests in two enclosed super regional shopping malls that are described below.\nThe terms of N\/S Associates' partnership agreement provide that its annual net cash flows and net sales or refinancing proceeds generally will be distributed among all of the partners in accordance with their respective percentage ownership interests in N\/S Associates.\nThe Account contributed approximately $12,008,000 to N\/S Associates as its capital contribution. The percentage interest of the Account in N\/S Associates is 5.92 percent. In connection with the purchase of the shopping malls, the Account paid to IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to approximately $450,000.\nSummary of Real Estate Investments Made Through N\/S Associates\nMilwaukee, Wisconsin - Northridge Mall\nThe Account, through N\/S Associates, owns an interest in an existing enclosed super regional shopping center in Milwaukee, Wisconsin, known as Northridge Mall. The mall shops and four adjacent department stores comprising the shopping center contain approximately 1,053,000 square feet of gross leasable area, of which N\/S Associates owns approximately 399,000 square feet consisting of mall shops (approximately 388,000 square feet) and storage space (approximately 11,000 square feet). The remaining 654,000 square feet of gross leasable area are occupied by four department stores, three of which own their own stores and a portion of the parking area. The fourth department store leases its space from an unaffiliated third party.\nN\/S Associates acquired its interest in the shopping center in April 1988 for a purchase price of approximately $108,107,000, of which $89,653,000 was paid in cash at closing, subject to the existing mortgage loans with a then outstanding aggregate balance of approximately $18,454,000. In addition to the purchase price, a reserve of $8,900,000 was established, all of which had been used to pay for certain capital improvements made at the shopping center. In February 1995, the two mortgage loans secured by the property were repaid with a portion of the proceeds from the refinancing of the Southridge Mall mortgage loan.\nThe shopping center is being managed by an affiliate of the Investment Adviser under a management agreement. The affiliate of the Investment Adviser receives an annual fee equal to 3.75 percent of the gross receipts of the property plus reimbursement of certain direct expenses in connection with the property management.\nGreendale, Wisconsin - Southridge Mall\nThe Account, through N\/S Associates, owns an interest in an existing enclosed super regional shopping center in Greendale, Wisconsin, known as Southridge Mall. The mall shops and five adjacent department stores comprising the shopping center contain approximately 1,297,000 square feet of gross leasable area, of which N\/S Associates owns approximately 437,000 square feet, including the space leased to one of the department stores. The remaining 860,000 square feet of gross leasable area are occupied by four other department stores, three of which own their own stores and a portion of the parking area. The fourth department store leases its space from an unaffiliated third party.\nN\/S Associates acquired its interest in the shopping center for a purchase price of approximately $115,401,000, of which $96,865,000 was paid in cash at closing. In addition to the purchase price, a reserve of approximately $7,250,000 was established for capital improvements, all of which had been used to pay for certain capital improvements made at the shopping center. In February 1995, the mortgage loan secured by the property was repaid with a portion of the proceeds from a new mortgage loan in the principal amount of $35,000,000. The new mortgage loan has a term of seven years, bears interest at 8.35 percent per annum and requires monthly payments of interest only prior to maturity. Proceeds from the new mortgage loan were also used to repay the two mortgage loans secured by Northridge Mall. The remaining net proceeds from the new loan were used to pay approximately $2,900,000 of tenant improvement and other capital costs incurred for Northridge and Southridge Malls.\nThe shopping center is being managed by an affiliate of the Investment Adviser under a management agreement. The affiliate of the Investment Adviser receives an annual fee equal to 3.75 percent of the gross receipts of the property plus reimbursement of certain direct expenses in connection with the property management.\nJoint Venture Partnership - Monmouth Associates\nIDS Life, on behalf of the Account, entered into a joint venture partnership called Monmouth Associates, which on October 27, 1988 (i) acquired certain land underlying a super regional shopping center in Eatontown, New Jersey known as Monmouth Mall, (ii) leased the land to the owner of the shopping center pursuant to a long-term ground lease, and (iii) executed a first leasehold mortgage loan to the owner of the shopping center secured by the leasehold real estate and the improvements thereon as more fully described below. The owner of the shopping center (the Borrower\/Lessee) is a partnership whose partners are not affiliated with Monmouth Associates.\nThe terms of Monmouth Associates' partnership agreement provide that its annual net cash flows and net sales or refinancing proceeds generally will be distributed among all of the partners in accordance with their respective percentage interests in Monmouth Associates. The Account contributed approximately $10,000,000 to Monmouth Associates as its initial capital contribution. The Account has made additional capital contributions of approximately $685,000. The percentage interest of the Account in Monmouth Associates is 6.97 percent. In connection with the investment, the Account paid to IDS Life and the Investment Adviser their respective portions of the acquisition and mortgage placement fee amounting to approximately $375,000.\nSummary of Real Estate Investment Made Through Monmouth Associates\nEatontown, New Jersey - Monmouth Mall\nThe Account, through Monmouth Associates, acquired an interest in the land underlying a shopping center in Eatontown, New Jersey known as Monmouth Mall. The mall is located on approximately 90 acres of land, of which Monmouth Associates owns approximately 88.5 acres, subject to the rights of one of the department store tenants to acquire the land underlying its store and the improvements thereon for nominal consideration. The remaining acres are owned by 2 department stores. Monmouth Associates acquired its interest in the land for a purchase price of approximately $13,000,000.\nMonmouth Associates entered into an agreement whereby the land underlying the mall is leased back to the Borrower\/Lessee under a long-term ground lease. The long-term ground lease, which has a term of 75 years, provides for monthly base rent aggregating $1,170,000 annually with minimum payments of $650,000. The long-term ground lease also provides for contingent rent, payable quarterly out of the excess, if any, of substantially all of the gross receipts from the shopping center received by the Borrower\/Lessee over certain base amounts, equal to the sum of (x) a specified annual amount (commencing in the fourth lease year at $390,000 per annum and increasing in the sixth lease year to $520,000 per annum), increased until paid at the \"applicable rate\" of interest payable under the first leasehold mortgage loan described below (such amount as so increased herein called the \"rent shortfall amount\"), plus (y) 15 percent of the balance of such excess gross receipts remaining after deducting the aggregate amount paid at such time of the rent shortfall amount under the long-term ground lease and the \"interest shortfall amount\" under the first leasehold mortgage loan as described below.\nIn addition, Monmouth Associates made a first leasehold participating mortgage loan in the original principal amount of $128,920,000 to the Borrower\/Lessee which is secured by the leasehold real estate and the improvements thereon. The current loan amount is $127,670,000. The loan has a term of 15 years, which may be extended from time to time at the option of Monmouth Associates for up to an additional 20 years. The loan provides for monthly payments of base interest at a base rate of approximately 5.98 percent per annum for the first two loan years, approximately 7.97 percent per annum for the third loan year and approximately 5.00 percent per annum for each loan year thereafter. The first leasehold mortgage also provides for quarterly payments of contingent interest, payable out of the excess, if any, of substantially all of the gross receipts from the shopping center received by the Borrower\/Lessee over certain base amounts, equal to the sum of (x) the difference between the amount of interest payable on the loan at the \"applicable rate\" and that payable at the base rate described above, increased until paid at the applicable rate (such amount as so increased herein called the \"interest shortfall amount\"), plus (y) 45 percent of the balance of such excess gross receipts remaining after deducting the aggregate amount paid at such time of the rent shortfall amount under the ground lease and the interest shortfall amount under the first leasehold mortgage loan. The \"applicable rate\" under the loan is 5.98 percent per annum for the first two loan years, 7.97 percent per annum for the next three loan years and 8.97 percent per annum for each loan year thereafter. In addition, upon a joint sale or refinancing of the land and improvements or at maturity of the leasehold mortgage loan, Monmouth Associates is entitled to receive certain participations in the proceeds from such sale or refinancing after payment of its investment in the land and\/or repayment of the principal amount of the leasehold mortgage loan. For financial reporting purposes, Monmouth Associates discontinued the accrual of contingent interest on the leasehold mortgage loan in April 1992 as a result of uncertainty as to the collectibility of such contingent interest in light of the previous decrease in the estimated value of Monmouth Mall. In addition, for financial reporting purposes, no contingent rent was accrued under the ground lease for 1995, 1994 or 1993. In 1995, Monmouth Associates wrote off the receivable balance of $3,576,000 primarily related to the accrued interest resulting from the difference between the accrual and pay rates (\"contingent interest\") recorded prior to 1992, due to the uncertainty as to the collectibility of these amounts.\nMonmouth Associates is obligated to make certain additional loans to the Borrower\/Lessee under certain circumstances to finance the cost of 60 percent of tenant improvements or other ordinary capital expenditures. In addition, in May 1994, Monmouth Associates made a loan to finance the cost of a renovation of the shopping center, which commenced during the third quarter of 1994. The renovation consists of, among other things, the addition of a food court and cinema and the re-merchandising of approximately 300,000 square feet of gross leasable area. The renovation loan from Monmouth Associates bears interest at a fixed interest rate of 10.5 percent per annum. In addition, Monmouth Associates' participation in certain levels of sale or refinancing proceeds from the property will be increased until Monmouth Associates has received aggregate payments equal to an internal rate of return of 11 percent per annum on its investments in the land and\/or the first leasehold mortgage loan. The maximum amount of the renovation loan is $29,100,000, and the cost of the renovation is currently estimated to be $28,500,000. As of December 31, 1995, Monmouth Associates had funded approximately $21,476,000, using its cash reserves, cash flow and additional capital contributions made pro rata based upon the respective interests of the joint venture partners in Monmouth Associates. The renovation loan requires monthly payments of interest only until maturity when the entire principal amount and any accrued and unpaid interest will be due. The renovation loan will mature contemporaneously with the first leasehold mortgage loan in October 2003, subject to acceleration or extension of the loan by Monmouth Associates under certain circumstances.\nJoint Venture - 1225 Connecticut Avenue, N.W.\nWashington, D.C. - 1225 Connecticut Avenue, N.W.\nIn May 1990, IDS Life, on behalf of the Account, acquired an interest in a newly formed Delaware corporation, 1225 Investment Corporation (the Corporation) owned jointly with certain other persons described below. The Corporation acquired an office building located in Washington, D.C. known as 1225 Connecticut Avenue, N.W. (1225 Connecticut).\nThe office building, which was completed in 1968, is an eight-story reinforced concrete frame building containing 184,432 square feet of rentable office space, 18,498 square feet of rentable retail space, 6,416 square feet of below grade storage space and 100,024 square feet of subsurface parking space for over 300 automobiles.\nThe Corporation has elected to qualify as a real estate investment trust (REIT) pursuant to sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the Code). For each taxable year that the Corporation qualifies as a REIT, the Corporation in general will not be subject to federal corporate income tax or the District of Columbia corporate franchise tax on its regular taxable income and will not be taxed on long-term capital gain income to the extent its income is distributed as dividends. If the Corporation were to fail to qualify as a REIT, it would be taxed at rates applicable to a corporation on its taxable income, whether or not distributed.\nThe Account owns approximately 16.3 percent of the outstanding shares of common stock of the Corporation. Certain of the outstanding shares of common stock of the Corporation not owned by the Account are owned by an affiliate of the Investment Adviser.\nThe Corporation purchased 1225 Connecticut from the seller for a purchase price of approximately $54,125,000 (net of prorations and miscellaneous closing costs), consisting of $51,425,000 paid in cash and assumption of approximately $2,700,000 of mortgage indebtedness then encumbering the property. The Corporation paid approximately $2,130,000 for real estate brokerage commissions to an independent third party and certain closing costs. The Account contributed $9,000,000 for its interest in the Corporation. The Account has also paid acquisition fees amounting to $337,500.\nIn January 1994, the Corporation refinanced its mortgage loan with a first mortgage loan in the principal amount of $7,000,000 bearing interest at 6.98 percent per annum. The new loan requires monthly payments of interest only aggregating $488,600 per annum until maturity in February 2001 when the principal amount together with accrued interest will be due and payable. Under certain circumstances, the principal amount of the loan may be prepaid in whole (but not in part), subject to a prepayment premium. Pursuant to the deed of trust securing the mortgage loan, the Corporation is prohibited from modifying Ernst & Young's primary lease or from entering into certain other tenant leases without the lender's consent. Prior to selling the property or encumbering the property with any additional debt, the Corporation must obtain the consent of the lender, which may be arbitrarily withheld. However, subject to certain restrictions, the Corporation has a one-time right to transfer title to the property together with an assumption of the mortgage loan.\nThe property is being managed under an agreement pursuant to which the manager is obligated to manage 1225 Connecticut, collect all of the receipts from operations and, to the extent available from such receipts, pay all of the expenses of 1225 Connecticut. The manager is paid a fee equal to 2.5 percent of the gross revenues of 1225 Connecticut, plus reimbursement for certain direct expenses of the manager. The property had previously been managed by JMB Properties Company, an affiliate of the Investment Adviser. In December 1994, JMB Properties Company sold substantially all of its assets to an unaffiliated third party, and certain management personnel of JMB Properties Company became management personnel of the third party. As a result of the sale, the successor to JMB Properties Company's assets became the property manager of the 1225 Connecticut office building on the same terms that existed prior to the sale.\n1225 Connecticut leases approximately 80 percent of the available space of the property to one tenant under leases, all with terms of 12 years. For the year ended December 31, 1995, such tenant represented approximately 77 percent of total revenues.\nPursuant to a lease currently in effect, an unaffiliated third party leases and operates the entire parking garage (subject to certain parking rights provided for tenants of the property) until November 1997. The lease provides for a fixed rent payment of $485,000 a year (which reflects an increase at the end of 1993 from $430,000 a year), provides that the lessee shall pay the operating expenses of the parking garage and does not provide such lessee with an option to extend the term of the lease. Unconsolidated Joint Ventures - Summary Information\nSummary information for the Account of its investments in Unconsolidated Joint Ventures as of and for the years ended December 31, 1995 and 1994 is as follows:\nParticipation in Mortgage Loan - Riverpoint Associates\nChicago, Illinois - Riverpoint Center\nIn August 1989, IDS Life, on behalf of the Account, participated in the initial funding of a non-recourse participation first mortgage loan in the principal amount of $26,000,000. The Account's share of the initial funding was $2,666,660 or 10.26 percent of this loan. The remaining portion of the loan is funded by affiliates of the Investment Adviser (herein, the Account and said affiliates are collectively called the Lenders). The Loan is secured by a first mortgage on a shopping center known as Riverpoint Center in Chicago, Illinois. The shopping center is owned by a partnership (the Borrower) whose general partners are not affiliated with any of the Lenders. In connection with the loan, the Account paid to the Investment Adviser a mortgage placement fee amounting to approximately $108,000, less $37,500 in loan origination fees paid to the Investment Adviser by the Borrower, for a net fee paid of approximately $70,500 paid by the Account.\nAdditional amounts aggregating approximately $2,040,000 (of which the Account's share was approximately $209,000) have been funded since the Initial Funding. The Borrower did not qualify for any additional fundings above the $28,040,000 which has been funded to date, and no additional fundings will be made by the Lenders.\nThe ten-year loan requires periodic payments of interest only and bears basic interest at the rate of 8.84 percent per annum in the first loan year, 8.75 percent per annum during the second loan year, increasing 0.50 percent per annum in the fourth and 0.25 percent per annum in the seventh loan year to a maximum rate of 9.50 percent per annum, payable monthly in advance. The loan also provides for additional annual simple accrual of interest at the rate of 2.00 percent per annum payable upon prepayment or maturity. For financial reporting purposes, commencing in August of 1991, the Account suspended recognition of income related to the simple accrual interest receivable (deferred until maturity).The loan also provides for additional interest in an amount equal to a percentage of annual gross income from the underlying property (exclusive of tenant reimbursement of expenses) in excess of a base amount and, on sale or repayment of the loan, an amount equal to a percentage of the subsequent increase in the value of the underlying property in excess of a specified amount. Such amounts of additional interest payments made by the Borrower will be used to offset, on a dollar-for-dollar basis, the amount of accrued interest payable. The loan is generally non-recourse to the Borrower and its partners.\nThe shopping center, completed in 1989, is located on approximately 17 acres and consists of approximately 200,800 square feet of gross leasable area.\n5. Investments in Wholly-owned Real Estate Property\nFairfax County, Virginia - West Springfield Terrace Apartments\nIn August 1989, IDS Life, on behalf of the Account, acquired a 244-unit garden apartment complex known as West Springfield Terrace Apartments, which is located in Fairfax County, Virginia.\nThe apartment complex, which was completed in 1978, consists of 17 separate three and four-story buildings of wood frame with brick veneer construction containing 52 one-bedroom units, 22 one-bedroom and den units, 118 two-bedroom units, 22 two-bedroom and den units, and 30 three-bedroom units. The complex contains a swimming pool, tennis court, clubhouse and approximately 380 parking spaces.\nThe Account paid $15,222,278 for the apartment complex in cash at closing, excluding closing costs and prorations. In connection with the acquisition of the property, the Account paid a prepayment charge at closing of $92,221 to the lender that held the mortgage loan on the property. The Account also paid to IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to $274,834. At the time of the acquisition it was anticipated that an additional amount of approximately $1,450,000 would be used by the Account to pay the cost of upgrading kitchens and bathrooms and certain other upgrades and capital improvements at the complex. The renovation project was subsequently increased to include replacing certain carpets in units as they were renovated and to increase the number of units that received certain upgrades. The renovation project was completed during 1992 at an aggregate cost of approximately $1,900,000. To date the Account has paid IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to $18,000 in connection with the renovation project. In November 1989, the Account obtained a loan from an institutional lender in the principal amount of $8,000,000 secured by a first mortgage on the property. At December 31, 1995, the current balance of the mortgage loan encumbering the property was approximately $7,770,000. The loan has a term of seven years and bears interest at a rate of 9.50 percent per annum. The loan required monthly payments of interest only during the first three loan years and thereafter is amortizable over a 27-year schedule through monthly payments of principal and interest aggregating $824,400 per annum until November 1996, when the remaining principal balance and any accrued and unpaid interest of approximately $7,704,000 is due and payable.\nThe apartment complex is being managed for a fee equal to 5.00 percent of the gross revenues from the property, plus reimbursement of certain direct expenses of the manager. The property had previously been managed by JMB Properties Company, an affiliate of the Investment Adviser, but since December 1994 has been managed on the same terms by an unaffiliated third party that purchased substantially all of JMB Properties Company's assets, as discussed in Note 4 in connection with the 1225 Connecticut office building.\n6. Liquidity Arrangements with IDS Life\nThe Account has experienced substantial net contract terminations over the past several years, which have adversely affected its liquidity. In March 1994, the Account obtained a short-term revolving line of credit for up to $10 million from IDS Life to pay for contract surrenders and other obligations under the Contracts. On June 2, 1995, the line of credit was terminated and the Account repaid the outstanding balance under the line of credit with the proceeds from accumulation units purchased by IDS Life. For the year ended December 31, 1995, IDS Life cumulatively contributed $24,700,000 toward the purchase of accumulation units. IDS Life expects to continue to make additional payments into the Account for accumulation units in order to maintain the Account and its liquidity. As of December 31, 1995, IDS Life's portion of the Contract Owners' Equity was $22,644,467, which represents 63% of total Contract Owners' Equity.\nSchedule III\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY\nParticipation in Mortgage Loan on Real Estate and Interest Earned on Participation in Mortgage\nDecember 31, 1995\nIDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements\nYears ended December 31, 1995, 1994, and 1993\n(1) Organization and Basis of Accounting\nThe accompanying combined financial statements have been prepared for the purpose of complying with Rule 3.09 of Regulation S-X of the Securities and Exchange Commission. The combined financial statements include the accounts of the unconsolidated joint ventures in which IDS Life Account RE of IDS Life Insurance Company owns an equity interest. The unconsolidated joint ventures are N\/S Associates, Monmouth Associates and 1225 Investment Corporation.\nThe accompanying combined financial statements have been prepared on the market value accrual basis of accounting.\nThe preparation of the combined 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 ventures have implemented Statement of Accounting Standards No. 95 \"Statement of Cash Flows\" which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The ventures records amounts held in U.S. Government obligations at cost, which approximates market. For the purposes of these statements, the ventures' policy is to consider all such amounts held with original maturities of three months or less ($2,200,000 and $5,989,000 at December 31, 1995 and 1994, respectively) as cash equivalents with any remaining amounts reflected as short-term investments.\nInvestments in real estate are stated at estimated fair value. A description of the valuation process is contained in Note 2 of Notes to Financial Statements of the Account. Such note is incorporated herein by reference.\nMarket values have been estimated by the Investment Adviser. Such market values involve subjective judgments and the actual values can only be determined by negotiations with independent third parties.\nNo provision for State or Federal income taxes has been made for N\/S Associates or Monmouth Associates as the liability for such taxes, if any, is expected to be that of the venture partners rather than the venture. 1225 Investment Corporation has elected and qualifies to be treated as a real estate investment trust for Federal income tax purposes. The Corporation had no Federal income tax liabilities for taxable years ended December 31, 1995, 1994 and 1993. IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\nMaintenance and repair expenses are charged to operations as incurred. Significant costs of physical improvements are capitalized as part of investments in real estate.\nFixed rental income is recorded when the obligation for the payment of rent is incurred according to the terms of the lease agreements.\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires entities with total assets exceeding $150 million at December 31, 1994 to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The ventures believe the carrying amount of its assets and liabilities (excluding current portion of long-term debt) approximates SFAS 107 value due to the relatively short maturity of these instruments. There is no quoted market value available for any of the ventures' other instruments. Based upon estimates of current market rates for debt with similar terms, the ventures discounted the scheduled loan payments to maturity. Based upon this calculation, the ventures believe that the carrying value of the mortgage notes payable approximate market value at December 31, 1995 and 1994.\n(2) Venture Agreements\nA description of the venture agreements are contained in Note 4 of Notes to Financial Statements of the Account for the year ended December 31, 1995. Such note is incorporated herein by reference. IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\n(3) Mortgage Notes Payable\n(a) Mortgage notes payable consist of the following at December 31, 1995 and 1994:\n(b) Refinancing - Southridge\nOn February 1, 1995, the Partnership refinanced the existing mortgage note on Southridge Mall in the amount of $35,000,000. Proceeds, net of transaction costs, were used to repay the existing mortgage notes at Southridge and Northridge Malls (including prepayment penalties of $155,000 and $240,000, respectively). The remaining proceeds which were reserved for future leasing costs, capital improvements and other related costs, have been expended.\nFive year maturities of mortgage notes payable are as follows:\n1996 . . . . . . . . . . $ -- 1997 . . . . . . . . . . -- 1998 . . . . . . . . . . -- 1999 . . . . . . . . . . -- 2000 . . . . . . . . . . --\n(4) Leases - As Property Lessor\nThe venture has determined that all leases relating to the two retail properties and the office building are properly classified as operating leases; therefore, rental income is reported when earned. Leases with tenants range in term from one to thirty-two years and provide for fixed minimum rent and partial to full reimbursement of operating costs. In addition, substantially all retail leases provide for additional rent based upon percentage of tenants' sale volumes over certain specified amounts. IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\nMinimum lease payments to be received in the future under the above operating lease agreements, are as follows: 1996 . . . . . . . . . . $ 21,306,282 1997 . . . . . . . . . . 20,488,269 1998 . . . . . . . . . . 18,517,784 1999 . . . . . . . . . . 16,734,147 2000 . . . . . . . . . . 14,709,466 Thereafter . . . . . . . 56,125,989 $147,881,937\nContingent rent (based on sales by property tenants) from the retail investments included in rental income is $1,058,000, $1,010,000 and $1,000,000 in 1995, 1994 and 1993, respectively.\nMonmouth Associates entered into an agreement whereby the land underlying the Monmouth shopping center is leased under a long-term ground lease. The long-term ground lease, which has a term of 75 years, provides for accrual of annual base rent of $1,170,000 with minimum payments of $650,000 per annum.\n(5) Related Party Transactions\nNS Associates has entered into a management agreement with Urban Retail Properties Company, (the \"Retail Manager\"). The Retail Manager is entitled to receive a fee of 3.75% of gross receipts from the operations of the Malls. Management fees earned by the Retail Manager are included in property operating expenses and aggregated approximately $1,174,000 and $1,266,000 for the periods ended December 31, 1995 and 1994, respectively.\n1225 Investment Corporation had entered into a management agreement with JMB Properties Company. During December 1994, JMB Properties Company assigned the management agreement to Heitman Washington D.C. Properties, Ltd. (\"Office Manager\"). The Office Manager is entitled to receive a fee of 2.5% of gross receipts from the operations of the Property. Management fees earned by the Office Manager are included in property operating expenses and aggregated approximately $175,000 and $196,000 for the years ended December 31, 1995 and 1994, respectively. IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\n(6) Subsequent Events\n(a) NS Associates\nIn February 1996, the Investment Adviser authorized and paid a cash distribution to the partners aggregating $2,125,000. Each partner received its proportionate share based on its respective ownership percentage.\n(b) 1225 Investment Corporation\nIn February 1996, 1225 Investment Corporation paid a dividend of $1,250,000 ($22.67 per share) to the shareholders of record as of December 31, 1995. Schedule III\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY Monmouth Associates Unconsolidated Joint Venture of IDS Life Account RE Participation in Mortgage Loan on Real Estate and Interest Earned on Participation in Mortgage\nDecember 31, 1995\nPart 1 - Participation in Mortgage Part 2 - Interest Earned on Loan on Real Estate at Close of Year on Participation in Mortgage\nLiens on Shopping Center: Principal unpaid Amount of Interest due Monmouth Mall Carrying at close mortgage being & accrued at Interest Eatontown, New Jersey Amount (A) of period foreclosed end of period Income Earned\n1995 $ 108,000,000 $ 158,373,000 $ -- $ 742,000 $ 6,994,000\n1994 $ 119,154,000 $ 141,056,000 $ -- $ 3,960,000 $ 7,641,000\n1993 $ 119,650,000 $ 132,338,000 $ -- $ 3,437,000 $ 7,166,000\n(A) - Reconciliation of the carrying value of the participation in the mortgage loan:\n1995 1994 1993\nBalance at the beginning of year........... $ 119,154,000 $ 119,650,000 $ 119,650,000\nChanges during year: Additional fundings...................... 17,317,000 9,318,000 -- Unrealized depreciation.................. (28,471,000) (9,814,000) --\nBalance at end of year..................... $ 108,000,000 $ 119,154,000 $ 119,650,000\nSchedule IV IDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nCombined Real Estate Owned and Rental Income\nDecember 31, 1995\nPart 1 - Real Estate Owned at End of Year (C) Amount at Cost of Unrealized which carried Amount of improvements, Appreciation at close of encumbrances Initial Cost etc. (Depreciation) period (A)(B) Retail properties: Northridge Mall, Milwaukee, WI $ -- $108,107,000 $ 14,560,000 $(74,667,000) $ 48,000,000 Southridge Mall, Greendale, WI $ 35,000,000 $115,401,000 $ 15,375,000 $(25,776,000) $105,000,000 Office Building: 1225 Connecticut Ave., Washington, D.C. $ 7,000,000 $ 54,775,000 $ 7,566,000 $ (8,071,000) $ 54,270,000 Ground Lease: Monmouth Mall, Eatontown, NJ $ -- $ 13,000,000 $ -- $ -- $ 13,000,000 $ 42,000,000 $291,283,000 $ 37,501,000 $(108,514,000) $220,270,000\nPart 2 - Rental Income\nRents due and accrued at end of period Retail Properties: Northridge Mall, Milwaukee, WI $ 93,000 Southridge Mall, Greendale, WI $ 264,000 Office Building: 1225 Connecticut Ave., Washington, D.C. $ 19,000 Ground Lease: Monmouth Mall, Eatontown, NJ $ -- $ 376,000\n(A) The aggregate cost of real estate owned at December 31, 1995 for Federal Income tax purposes was approximately $465,315,000.\n(B) Reconciliation of real estate owned: 1995 1994 1993\nBalance at the beginning of period.......... $254,500,000 $272,660,000 $279,726,000\nAdditions (deductions), including unrealized depreciation................... (34,230,000) (18,160,000) (7,066,000)\nBalance at end of year...................... $220,270,000 $254,500,000 $272,660,000\n(C) - Reconciliation for depreciation is not applicable as real estate owned is stated at estimated market value. \/TABLE Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Account has no directors or officers. The directors and principal executive officers of IDS Life Insurance Company are listed below.\nDavid R. Hubers, 53: Director, IDS Life, since September 1989; President and Chief Executive Officer, American Express Financial Corporation (AEFC), since August 1993, and Director since January 1984. Senior Vice President, Finance and Chief Financial Officer, AEFC, from January 1984 to August 1993.\nRichard W. Kling, 55: Director, IDS Life, since February 1984; President, IDS Life, since March 1994; Executive Vice President, Marketing and Products, from January 1988 to March 1994. Senior Vice President, AEFC, since May 1994. Director of IDS Life Series Fund, Inc. and manager of IDS Life Variable Annuity Funds A & B.\nPaul F. Kolkman, 49: Director, IDS Life, since May 1984; Executive Vice President, IDS Life, since March 1994; Vice President, Finance, IDS Life from May 1984 to March 1994; Vice President, AEFC, since January 1987.\nJanis E. Miller, 44: Director and Executive Vice President, Variable Assets since March 1994; Vice President, AEFC, since June 1990; Director, Mutual Funds Product Development and Marketing, AEFC, from May 1987 to May 1990. Director of IDS Life Series Fund, Inc. and manager of IDS Life Variable Annuity Funds A and B.\nJames A. Mitchell, 54: Chairman of the Board since March 1994; Chief Executive Officer since November 1986; President from July 1984 to March 1994; Executive Vice President, AEFC, since March 1994; Director, AEFC, since July 1984; Senior Vice President, AEFC, from July 1984 to March 1994.\nBarry J. Murphy, 44: Director and Executive Vice President, Client Service since March 1994; Senior Vice President, Operations, Travel Related Services (TRS) a subsidiary of American Express Company, since July 1992; Vice President, TRS, from November 1989 to July 1992; Chief Operating Officer, TRS, from March 1988 to November 1989. Stuart A. Sedlacek, 38: Director and Executive Vice President, Assured Assets since March 1994; Vice President, AEFC, since September 1988.\nMelinda S. Urion, 42: Director and Controller, IDS Life, since September 1991; Executive Vice President since March 1994; Vice President and Treasurer from September 1991 to March 1994; Senior Vice President and Chief Financial Officer, AEFC, since November 1995; Corporate Controller, AEFC, from April 1994 to November 1995; Vice President, AEFC, from September 1991 to November 1995; Chief Accounting Officer, AEFC, from July 1988 to September 1991.\nMorris Goodwin Jr., 44: Vice President and Treasurer since March 1994; Vice President and Corporate Treasurer, AEFC, since July 1989; Chief Financial Officer and Treasurer, American Express Trust Company, from January 1988 to July 1989.\nWilliam A. Stoltzmann, 47: Vice President, General Counsel and Secretary since 1985.\nThe directors, executive officers and certain other officers of JMB Realty Corporation (JMB), the managing partner of the Investment Adviser, are listed below. Many of such persons are also officers and\/or directors of numerous affiliated companies of JMB and\/or partners of certain partnerships (herein collectively referred to as the Associate Partnerships) which are partners, directly or indirectly, in publicly offered real estate limited partnerships sponsored by JMB.\nJudd D. Malkin, 58, Chairman and Director of JMB, is a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, an officer and\/or director of various other JMB affiliates and a partner of the Associate Partnerships. Until December 1994, he was also a Trustee of JMB Group Trust I, JMB Group Trust II, JMB Group Trust III, JMB Group Trust IV and JMB Group Trust V, which until that time had been advised by an affiliate of the Investment Adviser. Mr. Malkin has been associated with JMB since October 1969. He is a Certified Public Accountant.\nNeil G. Bluhm, 58, President and Director of JMB, is a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, an officer and\/or director of various other JMB affiliates and a partner of the Associate Partnerships. Until December 1994, he was also a Trustee of JMB Group Trust I, JMB Group Trust II, JMB Group Trust III, JMB Group Trust IV and JMB Group Trust V, which until that time has been advised by an affiliate of the Investment Adviser. Mr. Bluhm has been associated with JMB since August 1970. He is a member of the Bar of the State of Illinois and is a Certified Public Accountant. Burton E. Glazov, 57, Director of JMB, was until December 1990 also Executive Vice President of JMB. Mr. Glazov has been associated with JMB since June 1971. He is member of the Bar of the State of Illinois and is a Certified Public Accountant.\nStuart C. Nathan, 54, Executive Vice President and Director of JMB, is an officer and\/or director of various JMB affiliates and a partner of the Associate Partnerships. Mr. Nathan has been associated with JMB since July 1972. He is also a director of Sportmart Inc., a retailer of sporting goods. He is member of the Bar of the State of Illinois.\nJohn G. Schreiber, 49, Director of JMB, is also a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, and was, until December 1990, Executive Vice President of JMB. Mr. Schreiber has been associated with JMB since December 1970. Mr. Schreiber is President of Schreiber Investments, Inc., a company which is engaged in the real estate investing business. He is also a senior advisor and partner of Blackstone Real Estate Partners, an affiliate of the Blackstone Group, L.P. Mr. Schreiber also serves as a Trustee of Amli Residential Property Trust, a publicly-traded real estate investment trust that invests in multi-family properties. He is also a director of a number of investment companies advised or managed by T. Rowe Price Associates and its affiliates. He holds a master's degree in business administration from the Harvard University Graduate School of Business.\nA. Lee Sacks, 62, Director of JMB, is President and Director of JMB Insurance Agency, Inc. and a partner of various Associate Partnerships. Mr. Sacks has been associated with JMB since December 1972.\nH. Rigel Barber, 47, Chief Executive Officer and Executive Vice President of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Barber has been associated with JMB since March 1982. He holds a law degree from the Northwestern University Law School and is a member of the Bar of the State of Illinois.\nIra J. Schulman, 44, Executive Vice President of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Schulman has been associated with JMB since February 1983. He holds a master's degree in business administration from the University of Pittsburgh.\nGary Nickele, 43, Executive Vice President and General Counsel of JMB, is an officer and\/or director of various JMB affiliates and a partner of various Associate Partnerships. Mr. Nickele has been associated with JMB since February 1984. He holds a law degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nGlenn E. Emig, age 48, Executive Vice President and Chief Operating Officer of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Emig has been associated with JMB since December 1979. He holds a master's degree in business administration from the Harvard University Graduate School of Business.Item 11. EXECUTIVE COMPENSATION\nNot applicable.\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIDS Life has purchased and expects to continue to purchase accumulation units in order to maintain the Account's liquidity. By purchasing accumulation units, IDS Life has an ownership interest in the Account and participates in the increase or decrease in value of the Account's investments just as other owners of accumulation units do. As of March 19, 1996, IDS Life owned 23,967,444 accumulation units.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Account incurred asset management fees for the year ended December 31, 1995 of $603,620 of which $458,751 was paid to the Investment Adviser and the remainder to IDS Life. Asset management fees incurred for the year ended December 31, 1994 were $765,557, of which $614,775 was paid to the Investment Adviser and the remainder to IDS Life.\nFor the years ended December 31, 1995 and 1994, IDS Life was paid or reimbursed $482,896 and $502,607, respectively, for mortality and expense risk fee and $56,102 and $51,225, respectively, for personnel-related expenses incurred in the administration of the Account.\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A.1) See Item 8","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"317187_1995.txt","cik":"317187","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND\n\tPP&L is an operating electric utility, incorporated under the laws of the Commonwealth of Pennsylvania in 1920.\n\tTo take advantage of new business opportunities, both domestically and in foreign countries, PP&L formed a holding company structure, effective April 27, 1995, after receiving all necessary regulatory approvals and shareowner approval at PP&L's 1995 annual meeting. As a result of this restructuring, PP&L became a direct subsidiary of Resources.\n\tIn 1995, Resources also became the parent holding company of a new subsidiary, PMDC, which engages in unregulated business activities through investments in world-wide power markets. During 1995, PMDC invested $10.6 million as part of a consortium that is part owner of an electric generating company in Bolivia and committed to invest up to $10 million as a partner in a fund which will invest in Latin American generation, transmission and distribution businesses. PMDC also committed to invest up to $24 million as part of a consortium to develop an integrated gas, power and transmission facility in Peru. This project will be funded during 1996 and 1997.\n\tIn July 1995, Resources formed another unregulated subsidiary, Spectrum, to pursue opportunities to offer energy-related products and services to PP&L's existing customers and to others outside of PP&L's service territory. Other subsidiaries may be formed to take advantage of new business opportunities.\n\tPP&L remains Resources' principal subsidiary (approximately 97% of consolidated assets as of December 31, 1995), and the financial condition and results of operation of PP&L are currently the principal factors affecting the financial condition and results of operations of Resources.\n\tThe electric utility industry, including PP&L, has experienced and will continue to experience a significant increase in the level of competition in the energy supply market. The Energy Act amended the PUHCA to create a new class of independent power producers, and amended the Federal Power Act to provide open access to electric transmission systems for wholesale transactions. In response to this increased competition, several strategic initiatives have been put in place to improve financial performance and enhance PP&L's competitive position. See \"Financial Condition\" below for a discussion of these initiatives. PP&L has announced its support for full customer choice of their energy supplier for all customer classes. See \"Increasing Competition\" on page 41 for a discussion of pending PUC and FERC proceedings on industry competition and PP&L's involvement in those proceedings.\n\tPP&L is subject to regulation as a public utility by the PUC and is subject in certain of its activities to the jurisdiction of the FERC under Parts I, II and III of the Federal Power Act. Resources and PP&L have been exempted by the SEC from the provisions of PUHCA applicable to them as holding companies.\n\tPP&L is subject to the jurisdiction of the NRC in connection with the operation of the two nuclear-fueled generating units at PP&L's Susquehanna station. PP&L owns a 90% undivided interest in each of the Susquehanna units and Allegheny Electric Cooperative, Inc. owns a 10% undivided interest in each of those units.\n\tPP&L is also subject to the jurisdiction of certain federal, regional, state and local regulatory agencies with respect to air and water quality, land use and other environmental matters. The operations of PP&L are subject to the Occupational Safety and Health Act of 1970 and the coal cleaning and loading operations of a PP&L subsidiary are subject to the Federal Mine Safety and Health Act of 1977.\n\tPP&L serves approximately 1.2 million customers in a 10,000 square mile territory in 29 counties of central eastern Pennsylvania (see Map on page 16), with a population of approximately 2.6 million persons. This service area has 129 communities with populations over 5,000, the largest cities of which are Allentown, Bethlehem, Harrisburg, Hazleton, Lancaster, Scranton, Wilkes-Barre and Williamsport.\n\tDuring 1995, about 98% of total operating revenue was derived from electric energy sales, with 34% coming from residential customers, 29% from commercial customers, 20% from industrial customers, 12% from contractual sales to other major utilities, 2% from energy sales to members of the PJM and 3% from others.\n\tWholly-owned subsidiary companies of PP&L principally are engaged in oil pipeline operations and passive financial investing.\n\tPP&L operates its generation and transmission facilities as part of the PJM. The PJM, one of the world's largest power pools, includes 11 companies serving about 21 million people in a 50,000 square mile territory covering all or part of Pennsylvania, New Jersey, Maryland, Delaware, Virginia and Washington, D.C.\n\tIn November 1995, all but one PJM company supported the plan that PJM presented to the FERC to increase competition in the region. The other company presented a separate plan. The PJM plan would offer to all generators and wholesale buyers of electricity a PJM Pool-wide energy market and open access to Pool-wide high-voltage transmission lines.\n\tThe PJM plan contains a number of key components, including: 1) new Pool-wide transmission tariffs to provide open access, comparable service to all wholesale customers; 2) implementation of a regional energy market with price-based dispatch, open to all wholesale bulk power buyers and sellers; and 3) an Independent System Operator to administer Pool operations and transmission service, and to operate the regional energy market.\n\tThe PJM plan is designed to further develop a truly competitive wholesale market with broader participation. The PJM companies propose to submit a comprehensive filing to the FERC for approval in May 1996, with implementation of the new structure by the end of 1996.\nFINANCIAL CONDITION\n\tEarnings per share of Resources' common stock were $2.05 in 1995, $1.41 in 1994 and $2.07 in 1993. The following table highlights the major items that impacted earnings for each of the years:\n1995 1994 1993\nEarnings per share - excluding workforce reduction programs and one-time adjustments $1.79 $2.02 $2.19\nWorkforce reduction programs: VERP 0.24 (0.28) Other (0.12)\nOne-time adjustments: Postretirement benefits other than pensions 0.10 (0.04) Disallowance-Susquehanna Unit No. 1 deferred costs (0.13) ECR purchased power costs 0.04 (0.06) Gain\/(loss) on subsidiary coal reserves 0.12 (0.26) ECR settlement (0.06) Rate reduction - FERC (0.04) Other 0.01 0.03 (0.02)\nEarnings per share - reported $2.05 $1.41 $2.07\n\tThe decline in earnings excluding workforce reduction programs and one-time adjustments for 1995 was primarily due to increases in other operating costs, depreciation for the Susquehanna station and costs associated with the review of PECO's proposals to acquire Resources. The decline in earnings excluding workforce reduction programs and one-time adjustments for 1994 was primarily due to the increase in depreciation for the Susquehanna station and for postretirement benefits other than pensions.\n\tResources earned a 12.81% return on average common equity during 1995, an increase from the 8.73% earned in 1994. The ratio of Resources' pre-tax income to interest charges increased from 2.7 in 1994 to 3.6 in 1995. The annual per share dividend rate on Resources' common stock remained unchanged at $1.67 per share. The book value per share of Resources' common stock increased 3.2% from $15.79 at the end of 1994 to $16.29 at the end of 1995. The ratio of the market price to book value of Resources' common stock was 153% at the end of 1995 compared with 120% at the end of 1994.\n\tPP&L system, or service area, sales were 32.7 billion kwh in 1995, an increase of 357 million kwh, or 1.1%, over 1994. This increase was primarily due to increased economic activity in central eastern Pennsylvania in 1995. If normal weather had been experienced in both 1995 and 1994, system sales for 1995 would have increased by about 529 million kwh, or 1.7%, over 1994.\n\tActual sales to residential customers in 1995 decreased 144 million kwh, or 1.3%, from 1994, while actual sales to residential customers in 1994 increased 401 million kwh, or 3.6%, from 1993. The change in residential sales for both periods was primarily due to the extreme cold weather in early 1994. Under normal weather conditions in both 1995 and 1994, residential sales would have remained essentially unchanged.\n\tFor the period 1992-1995, industrial sales have increased in each quarter as compared to the same quarter in the prior year. Industrial sales are an important indicator of the economic health of PP&L's service area.\n\tOn September 27, 1995, the PUC issued a final order with respect to the base rate case filed by PP&L on December 30, 1994. PP&L's request sought to increase PUC-jurisdictional revenues by $261.6 million, or about 11.7%. The PUC Decision in the rate case granted PP&L a $107 million increase based on test year conditions. At the same time, PP&L's ECR was reduced by $22 million related to capacity credit sales resulting in a net increase of $85 million, or about 3.8%, in PUC-jurisdictional revenues effective September 28, 1995. A detailed discussion of the PUC Decision, along with other rate matters, is presented in Financial Note 3.\n\tWith the completion of PP&L's base rate case, several key initiatives have been put in place to improve Resources' financial performance. These initiatives include:\n\to A $671 million reduction in PP&L's construction expenditures over the five-year period 1996-2000, including reductions of $93 million and $220 million for 1996 and 1997, respectively. These reductions reflect, among other things, a decision to not install FGD at PP&L's Montour station; \to A planned $50-$60 million (about 8%) reduction in PP&L's operation and maintenance costs from previously budgeted amounts by the year 2000; \to Marketing and economic development activities to achieve an average compound annual growth rate of about 2% in sales to PP&L's service area customers through the year 2000; and \to Except for common equity capital to be provided through sales of Resources' common stock under the DRIP and ESOP, Resources expects to meet all of PP&L's construction expenditures and debt maturities through internally generated funds during the five-year period 1996-2000.\n\tResources believes that the PUC Decision, the above initiatives and the expected financial performance of PMDC and Spectrum will permit Resources to increase shareowner value, including growth in earnings per share and the dividend rate on Resources' common stock over the long term. Actual sales growth and improvement in earnings and financial performance will depend upon economic conditions, energy consumption, the impact of increasing competition in the electric utility industry, the effects of regulation, investment opportunities and performance and other factors. Additionally, PP&L remains committed to a corporate objective of keeping its prices as stable as possible and maintaining customer rates that compare favorably with those of neighboring utilities.\nCAPITAL EXPENDITURE REQUIREMENTS AND FINANCING\n\tSee \"Financial Condition - Reduction in Capital Expenditure Requirements-PP&L\" on page 35 for information concerning PP&L's estimated capital expenditure requirements for the years 1996-2000. See \"Environmental Matters\" on page 37 and Note 15 to Financial Statements for information concerning PP&L's estimate of the cost to comply with the federal clean air legislation enacted in 1990, to address groundwater degradation and waste water control at PP&L facilities and to comply with solid waste disposal regulations adopted by the DEP.\n\tPP&L anticipates the issuance of $116 million of unsecured notes in early 1996 in order to redeem higher-cost bonds through the maintenance and replacement fund provisions of PP&L's Mortgage.\n\tResources will continue to obtain common equity capital through the DRIP and PP&L's ESOP. It is expected that the DRIP will be continued during the years 1996 and 1997, resulting in proceeds of about $70 million annually, and that the ESOP will be continued through 2000, with expected proceeds of about $8 million annually.\n\tExcept for funds derived from sales of Resources' common stock, Resources expects that internally generated funds (after provision for dividends and capital lease payments) will be adequate to meet PP&L's capital requirements and $415 million of debt maturities for the years 1996-2000. PP&L has no preferred stock sinking fund requirements during 1996-2000.\n\tAdditional outside financing, in amounts not currently determinable, or the liquidation of certain financial investments may be required over the next five years to finance investment opportunities in worldwide power projects by PMDC.\n\tNeither Resources' nor PP&L's ability to issue securities during the next three years is expected to be limited by earnings or other issuance tests.\nPOWER SUPPLY\n\tPP&L's system capacity (winter rating) at December 31, 1995 was as follows: Net Kilowatt Plant Capacity Nuclear-fueled steam station Susquehanna 1,995,000 (a) Coal-fired steam stations Montour 1,525,000 Brunner Island 1,469,000 Sunbury 389,000 Martins Creek 300,000 Keystone 210,000 (b) Conemaugh 194,000 (c) Holtwood 73,000 Total coal-fired 4,160,000 Oil-fired steam station Martins Creek 1,592,000 Combustion turbines and diesels 508,000 Hydroelectric 146,000 Total generating capacity 8,401,000 Firm purchases Hydroelectric 139,000 (d) Qualifying facilities 474,000 (e) Total firm purchases 613,000 Total system capacity 9,014,000 _____________________________ (a) PP&L's 90% undivided interest. (b) PP&L's 12.34% undivided interest. (c) PP&L's 11.39% undivided interest. (d) From Safe Harbor Water Power Corporation. (e) From non-utility generating companies.\n\tThe system capacity shown in the preceding tabulation does not reflect: (i) sales of capacity and energy to Atlantic through March 1998; (ii) sales of capacity and energy to BG&E through 2001; (iii) sales of capacity and energy to JCP&L through 1999; or (iv) sales of capacity credits to GPU Service Corporation and BG&E for PJM installed capacity accounting purposes only, which capacity credit sales aggregated 454,000 kilowatts at December 31, 1995. Giving effect to the sales to Atlantic (129,000 kilowatts), BG&E (132,000 kilowatts) and JCP&L (945,000 kilowatts), PP&L's net system capacity at December 31, 1995 was 7,354,000 kilowatts.\n\tThe capacity of generating units is based upon a number of factors, including the operating experience and physical condition of the units, and may be revised from time to time to reflect changed circumstances.\n\tDuring 1995, PP&L produced about 39.1 billion kwh in plants it owned. PP&L purchased 5.5 billion kwh under purchase agreements and received 0.9 billion kwh as power pool interchange. During the year, PP&L delivered about 2.4 billion kwh as pool interchange and about 1.7 billion kwh under purchase agreements.\n\tDuring 1995, 59.1% of the energy generated by PP&L's plants came from coal-fired stations, 35.9% from nuclear operations at the Susquehanna station, 2.7% from the Martins Creek oil-fired steam station and 2.3% from hydroelectric stations.\n\tThe maximum one-hour demand recorded on PP&L's system is 6,607,000 kilowatts, which occurred on February 6, 1996. The maximum recorded one-hour summer demand is 6,021,000 kilowatts, which occurred on August 2, 1995. The peak demands do not include energy sold to Atlantic, BG&E or JCP&L.\n\tPP&L purchases energy from other utilities and FERC-certified power marketers (marketers) when it is economically desirable to do so. From time-to-time, PP&L purchases energy from systems outside the PJM on a daily, weekly or monthly basis, at advantageous prices. The amount of energy purchased depends on a number of factors, including cost and the import capability of the transmission network. When it has been economical to do so, PP&L has sold portions of its entitlement to use the bulk power transmission system to import energy from utilities outside the PJM.\n\tIn 1995, the FERC accepted a PP&L wholesale generating services tariff (tariff). This tariff enables PP&L to sell to other utilities and marketers reservations of output from PP&L's generating units during certain periods, with the option to purchase energy from these units. As of the end of 1995, about 30 utilities and marketers have signed service agreements under the tariff. Typically, a reciprocal agreement will enable PP&L to purchase energy from these same utilities and marketers. Transactions under these agreements will continue to allow PP&L to make more efficient use of its generating resources, and provide benefits to customers of both PP&L and the other utilities.\n\tSee Note 4 to Financial Statements for additional information concerning the sale of capacity and energy to Atlantic, BG&E and JCP&L, the sale of capacity credits (but not energy) to other electric utilities in the PJM and the sale of transmission entitlements and the reservation of output from the Martins Creek units. See \"Rate Matters\" on page 30 and Note 3 to Financial Statements for information concerning a settlement agreement between PP&L and ECR complainants with respect to capacity-related transactions.\n\tIn addition to the 474,000 kilowatts of non-utility generation shown in the preceding tabulation, PP&L is purchasing about 3,000 kilowatts of output from various other non-utility generating companies. The payments made to non-utility generating companies, all of whose facilities are located in PP&L's service area, are recovered from customers through the ECR applicable to PUC- jurisdictional customers and base rate charges applicable to FERC- jurisdictional customers.\n\tThe PJM companies had 56.5 million kilowatts of installed generating capacity at December 31, 1995, and transmission line connections with neighboring power pools have the capability of transferring an additional 4 to 5 million kilowatts between the PJM and neighboring power pools. Through December 31, 1995, the maximum one-hour demand recorded on the PJM was approximately 48.5 million kilowatts, which occurred on August 2, 1995. PP&L is also a party to the Mid-Atlantic Area Coordination Agreement, which provides for the coordinated planning of generation and transmission facilities by the companies included in the PJM.\n\tPP&L has begun converting the two oil-fired generating units at its Martins Creek steam electric station to burn both oil and natural gas. The DEP has approved a change to the station's air permit to allow the burning of either or both fuels. The current schedule is to complete conversion construction work and begin dual fuel operation by June 1996. Interstate Energy Company (IEC), a PP&L subsidiary, has received approval from the PUC to also transport natural gas through the existing oil pipeline to Martins Creek. Conversion of IEC's facilities has begun and the pipeline should be able to transport natural gas by June 1996. Another party, who opposed IEC's PUC application on the grounds that it had the sole authority to provide such gas service to PP&L, has appealed the PUC approval to the Commonwealth Court of PA. PP&L cannot predict the outcome of this proceeding.\nFUEL SUPPLY\n\tCoal\n\tDuring 1995, PP&L's generating stations burned about 8.6 million tons of bituminous coal and about 1.0 million tons of anthracite and petroleum coke.\n\tDuring 1995, 75% of the coal delivered to PP&L's generating stations was purchased under contracts and 25% was obtained through open market purchases.\n\tThe amount of bituminous coal carried in inventory at PP&L's generating stations varies from time to time depending on market conditions and plant operations. As of December 31, 1995, PP&L's bituminous coal supply was sufficient for about 26 days of operations.\n\tContracts with non-affiliated coal producers provided PP&L with about 4.7 million tons of bituminous coal in 1995 and are expected to provide PP&L with about 5.0 million tons in both 1996 and 1997.\n\tThe coal burned in PP&L's generating stations contains both organic and pyritic sulfur. Mechanical cleaning processes are utilized to reduce the pyritic sulfur content of the coal. The reduction of the pyritic sulfur content by either mechanical cleaning or blending has lowered the total sulfur content of the coal burned to levels which permit compliance with current sulfur dioxide emission regulations established by the DEP. For information concerning PP&L's plans to achieve compliance with the federal clean air legislation enacted in 1990, see \"Environmental Matters\" on page 37 and Note 15 to Financial Statements.\n\tPP&L owns a 12.34% undivided interest in the Keystone station and an 11.39% undivided interest in the Conemaugh station, both of which are generating stations located in western Pennsylvania. The owners of the Keystone station have a long-term contract with a coal supplier to provide at least two-thirds of that station's requirements through 1999 and declining amounts thereafter until the contract expires at the end of 2004. The balance of the Keystone station requirements are purchased in the open market. The coal supply requirements for the Conemaugh station are being met from several sources through a blend of long-term and short-term contracts and spot market purchases.\n\tAt December 31, 1995, PP&L's inventory of anthracite was about 4.3 million tons. PP&L's requirements for petroleum coke and any additional anthracite that may be required over the remainder of the expected useful lives of PP&L's anthracite-fired generating stations are expected to be obtained by contract and market purchases.\n\tNuclear\n\tThe nuclear fuel cycle consists of the mining of uranium ore and its milling to produce uranium concentrates; the conversion of uranium concentrates to uranium hexafluoride; the enrichment of uranium hexafluoride; the fabrication of fuel assemblies; the utilization of the fuel assemblies in the reactor; the temporary storage of spent fuel; and the permanent disposal of spent fuel.\n\tPP&L has entered into uranium supply agreements that, together with options to extend, satisfy 100% of the uranium concentrate requirements for the Susquehanna units through 1997 and approximately 60% of the requirements for the period 1998-1999. Deliveries under these agreements are expected to provide sufficient quantities of uranium concentrates to permit Unit 1 to operate into the first quarter of 2000 and Unit 2 to operate into the first quarter of 1999.\n\tPP&L has entered into agreements that satisfy approximately 80% of its conversion requirements through 1997 and approximately 25% of the conversion requirements for the period 1998-1999.\n\tPP&L also has entered into agreements for other segments of the nuclear fuel cycle. Based upon the current operating plans for each of the Susquehanna units, the following tabulation shows the years through which contracts, including options to extend, could provide the indicated segments of the nuclear fuel cycle:\nEnrichment 2014 Fabrication 2006\n\tPP&L has elected to cancel all or a portion of deliveries under its existing enrichment contract during the period 1999 through 2002, and plans to competitively bid those requirements on the open market. Additional arrangements will be necessary to satisfy the remaining fuel requirements of the Susquehanna units over their anticipated useful lives.\n\tPP&L estimates that there is sufficient storage capability in the spent fuel pools at Susquehanna to accommodate the fuel that is expected to be discharged through the year 1997. Federal law requires the federal government to provide for the permanent disposal of commercial spent nuclear fuel. Pursuant to the requirements of that law, DOE has initiated an analysis of a site in Nevada for a permanent nuclear waste repository. Progress on characterization of a proposed disposal facility has been slow, and the repository is not expected to be operational before 2010. Congress is considering new legislation designed to re-establish a schedule for the spent fuel disposal program. This legislation would authorize an above-ground interim storage facility, along with the permanent disposal facility, as part of an integrated disposal program. Even if this legislation is enacted and DOE is successful in building and operating the interim storage facility, it is unlikely that any spent fuel will be shipped from Susquehanna until well after the year 2000 because of the large volume of other utilities' spent fuel that is scheduled to be shipped before PP&L's spent fuel. Therefore, expansion of Susquehanna's spent fuel storage capability is necessary. To support this expansion, a contract was recently signed providing for the design and construction of a new spent fuel storage facility employing dry fuel storage technology at the Susquehanna plant. The facility will be modular so that additional storage capacity can be added as needed. PP&L currently estimates that construction of the facility will be completed in the spring of 1997.\n\tFederal law also provides that the costs of spent nuclear fuel disposal are the responsibility of the generators of such wastes. PP&L includes in customer rates the fees charged by the DOE to fund the permanent disposal of spent nuclear fuel.\n\tFor a discussion of the assessment on PP&L pursuant to the Energy Act for the Uranium Enrichment Decontamination and Decommissioning Fund, see the discussion under that caption on page 40.\n\tOil\n\tPP&L has agreements with two suppliers under which it can purchase its expected oil requirements for the Martins Creek units. However, if there are price advantages to be realized from purchasing oil in the spot market, these contracts permit PP&L to acquire up to one-half of its expected oil requirements for the Martins Creek units in that manner. One oil purchase agreement expired in mid-1995 and was replaced with a similar two-year agreement which will expire in mid-1997. The other agreement expires in mid-1996.\n\tDuring 1995, approximately 71% of the oil requirements for the Martins Creek units was purchased under PP&L's oil contracts and the balance was purchased on the spot market.\n\tSee \"POWER SUPPLY\" on page 6 for information concerning the ongoing conversion of the two oil-fired generating units at the Martins Creek station to burn both oil and natural gas.\nENVIRONMENTAL MATTERS\n\tPP&L is subject to certain present and developing federal, regional, state and local laws and regulations with respect to air and water quality, land use and other environmental matters. See \"Financial Condition - Reduction in Capital Expenditure Requirements- PP&L\" on page 35 for information concerning environmental expenditures during 1995 and PP&L's estimate of those expenditures during the years 1996-2000. PP&L believes that it is presently in substantial compliance with applicable environmental laws and regulations.\n\tSee \"Environmental Matters\" on page 37 and Note 15 to Financial Statements for information concerning federal clean air legislation enacted in 1990, groundwater degradation and waste water control at PP&L facilities, DEP's solid waste disposal regulations, PP&L's agreement with the DEP concerning remediation at certain sites of past operations, the issue of electric and magnetic fields and DEP's order that a PP&L subsidiary abate seepage from a former mine. Other environmental laws, regulations and developments that may have a substantial impact on PP&L are discussed below.\n\tAir\n\tThe Clean Air Act includes, among other things, provisions that: (a) require the prevention of significant deterioration of existing air quality in regions where air quality is better than applicable ambient standards; (b) restrict the construction of and revise the performance standards for new coal-fired and oil-fired generating stations; and (c) authorize the EPA to impose substantial noncompliance penalties of up to $25,000 per day of violation for each facility found to be in violation of the requirements of an applicable state implementation plan. The DEP administers the EPA's air quality regulations through the Pennsylvania State Implementation Plan and has concurrent authority to impose penalties for noncompliance. At this time, PP&L is meeting all requirements of Phase I of the Clean Air Act.\n\tAs a result of computer dispersion modeling of the effects of PP&L's Martins Creek station (located in Pennsylvania) on ambient air quality in New Jersey, the EPA redesignated Warren County, New Jersey to non-attainment status for sulfur dioxide, effective February 1, 1988. However, the EPA withheld further regulatory action until PP&L, the EPA, the DEP and the New Jersey Department of Environmental Protection (NJDEP) could agree upon and apply a computer model that will more accurately predict the actual ambient air quality of the area. PP&L negotiated with the EPA, the DEP and the NJDEP on a study to allow the use of a more accurate model. This study began in May 1992 and is expected to be concluded in 1996. In addition, the regulatory agencies have required PP&L to expand the study area beyond the designated sulfur dioxide non-attainment area to include any predicted \"areas of concern\" in the vicinity of the plant. PP&L is developing a study to address this expanded area. If it is determined that the Martins Creek operations are causing ambient air violations, PP&L may be required to make changes to reduce sulfur dioxide emissions. However, it is currently expected that the reductions planned to meet the requirements of the Clean Air Act acid rain provisions should be adequate to meet any reduction that may be required as a result of these studies. See \"Environmental Matters\" on page 37 and Note 15 to Financial Statements.\n\tWater\n\tTo implement the requirements established by the Federal Water Pollution Control Act of 1972, as amended by the Clean Water Act of 1977 and the Water Quality Act of 1987, the EPA has adopted regulations including effluent standards for steam electric stations. The DEP administers the EPA's effluent standards through state laws and regulations relating, among other things, to effluent discharges and water quality. The standards adopted by the EPA pursuant to the Clean Water Act may have a significant impact on PP&L's existing facilities depending on the DEP's interpretation and future amendments to its regulations.\n\tThe EPA and DEP limitations, standards and guidelines for the discharge of pollutants from point sources into surface waters are enforced through the issuance of NPDES permits. PP&L has NPDES permits necessary for the operation of its facilities.\n\tPursuant to the Surface Mining and Reclamation Act of 1977 (Reclamation Act), the United States Office of Surface Mining (OSM) has adopted effluent guidelines which are applicable to PP&L subsidiaries as a result of their past coal mining and continued coal processing activities. The EPA and the OSM limitations, guidelines and standards also are enforced through the issuance of NPDES permits. In accordance with the provisions of the Clean Water Act and the Reclamation Act, the EPA and the OSM have authorized the DEP to implement the NPDES program for Pennsylvania sources. Compliance with applicable water quality standards is assured by DEP review of NPDES permit conditions. PP&L's subsidiaries have received NPDES permits for their mines and related facilities.\n\tSolid and Hazardous Waste\n\tThe 1976 Resource Conservation and Recovery Act (RCRA) regulates the generation, transportation, treatment, storage and disposal of hazardous wastes. RCRA also imposes joint and several liability on generators of solid or hazardous waste for clean-up costs. A revision of RCRA in late 1984 lowered the threshold for the amount of on-site hazardous waste generation requiring regulation and incorporated underground tanks used for the storage of petroleum and petroleum products as regulated units. Based upon the results of a survey of its solid waste practices, PP&L in the past has filed notices with the EPA indicating that hazardous waste is occasionally generated at all of its steam electric generating stations and service centers. PP&L has established specific operating procedures for handling this hazardous waste. Therefore, at this time RCRA and related DEP regulations are not expected to have a significant additional impact on PP&L.\n\tThe provisions of Superfund authorize the EPA to require past and present owners of contaminated sites and generators of any hazardous substance found at a site to clean up the site or pay the EPA or the state for the costs of clean-up. The generators and past owners can be liable even if the generator contributed only a minute portion of the hazardous substances at the site. Present owners can be liable even if they contributed no hazardous substances to the site.\n\tThe Pennsylvania Superfund law also gives the DEP broad authority to identify hazardous or contaminated sites in Pennsylvania and to order owners or responsible parties to clean up the sites. If responsible parties cannot or will not perform the clean-up, the DEP can hire contractors to clean up the sites and then require reimbursement from the responsible parties after the clean-up is completed. To date, PP&L has principally been involved in federal, rather than state, Superfund sites.\n\tIn 1981, PP&L was notified by the EPA that PP&L could be liable for the cost of removing coal tar deposits discovered at a former coal gasification plant site owned by PP&L along Brodhead Creek in Monroe County, Pennsylvania, and on adjacent property owned by a company unrelated to PP&L. The EPA used Superfund monies to construct a slurry wall which was paid for by the adjacent property owner. PP&L removed approximately 8,000 gallons of coal tar from its property. To determine whether additional work needed to be done, a Remedial Investigation and a Risk Assessment were conducted by PP&L and the adjacent property owner and submitted to the EPA and the DEP. Although the Risk Assessment showed acceptable risk levels, the EPA and the DEP required a Feasibility Study to identify whether additional remedial action was required.\n\tBased on the results of that Feasibility Study and other investigations, PP&L and the adjacent property owner signed a consent decree with the EPA in November 1991. Under the terms of that consent decree, PP&L and the adjacent property owner have paid EPA's past costs and are undertaking removal of two subsurface coal tar accumulations. PP&L and the adjacent property owner also will monitor the site for up to 30 years, as well as pay all future EPA oversight costs. PP&L's share of the costs associated with the consent decree is estimated to be about $2 million, all of which has been spent or accrued.\n\tIn May 1992, PP&L and the adjacent property owner signed a consent order from the EPA directing that an additional Remedial Investigation and Feasibility Study be performed to address groundwater contamination at the site. This investigation is now complete and has determined that further action is not feasible. Accordingly, a notice has been submitted to EPA stating that all actions required by the consent order to address groundwater contamination have been completed and requesting that the order be terminated.\n\tThe EPA has placed the site of a former PP&L gas plant in Columbia, Pennsylvania on the national Superfund list. PP&L and another potentially responsible party (PRP) had previously conducted a detailed investigation of the site, and PP&L removed a substantial amount of coal tar from a pedestrian tunnel at the rear of the property. However, coal tar remains in two brick pits on the site. There also is coal tar contamination of the soil and groundwater at the site and of river sediment adjacent to the site. PP&L is negotiating a consent order with the DEP to remediate the brick pits and conduct additional investigations. The costs of investigation and remediation of the areas of the site where the agencies have required action are estimated at $1.2 million, all of which has been spent or is accrued. Further remediation of other areas of the site may be required, the costs of which are not now determinable but could be material.\n\tPP&L at one time also owned and operated several other gas plants in its service area. None of these sites is presently on the Superfund list. However, a few of them may be possible candidates for listing at a future date. PP&L expects to continue to investigate and, if necessary, remediate these sites. The cost of this work is not now determinable but could be material.\n\tSee \"LEGAL PROCEEDINGS\" on page 17 for information concerning an EPA order and a complaint filed by the EPA in federal district court against PP&L and 35 unrelated parties for remediation of a Superfund site in Berks County, Pennsylvania; a complaint filed by PP&L and 16 unrelated parties in federal district court against other parties for contribution under Superfund relating to a landfill site in Lehigh County, Pennsylvania; an EPA complaint in federal district court against PP&L and 10 unrelated parties to recover all past and future EPA costs of investigating and remediating the Heleva landfill site in Lehigh County, Pennsylvania; and action by the EPA for reimbursement of the EPA's past response costs and remediation at the site of a former metal salvaging operation in Montour County, Pennsylvania.\n\tPP&L is involved in several other sites where it may be required, along with other parties, to contribute to investigation and remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for listing at a future date. Future investigation or remediation work at sites currently under review, or at sites currently unknown, may result in material additional operating costs which PP&L cannot estimate at this time. In addition, certain federal and state statutes, including Superfund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DEP, to seek compensation from the responsible parties for the lost value of damaged natural resources. The EPA and the DEP may file such compensation claims against the parties, including PP&L, held responsible for cleanup of such sites. Such natural resource damage claims against PP&L could result in material additional liabilities.\n\tLow-Level Radioactive Waste\n\tUnder federal law, each state is responsible for the disposal of low-level radioactive waste generated in that state. States may join in regional compacts to jointly fulfill their responsibilities. The states of Pennsylvania, Maryland, Delaware and West Virginia are members of the Appalachian States Low-Level Radioactive Waste Compact. Efforts to develop a regional disposal facility in Pennsylvania are currently underway. Low-level radioactive wastes resulting from the operation of Susquehanna are currently being sent to Barnwell, South Carolina for disposal. In the event that this disposal option becomes unavailable or no longer cost effective, the low-level radioactive waste will be stored onsite at Susquehanna. PP&L cannot predict the future availability of low-level waste disposal facilities or the cost of such disposal.\n\tGeneral\n\tIn addition to the matters described above, PP&L and its subsidiaries have been cited from time to time for temporary violations of the DEP and EPA regulations with respect to air and water quality and solid waste disposal in connection with the operation of their facilities and may be cited for such violations in the future. As a result, PP&L and its subsidiaries may be subject to certain penalties which are not expected to be material in amount.\n\tPP&L is unable to predict the ultimate effect of evolving environmental laws and regulations upon its existing and proposed facilities and operations. In complying with statutes, regulations and actions by regulatory bodies involving environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances, PP&L may be required to modify, replace or cease operating certain of its facilities. PP&L may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nFRANCHISES AND LICENSES\n\tPP&L has authority to provide electric public utility service throughout its entire service area as a result of grants by the Commonwealth of Pennsylvania in corporate charters to PP&L and companies to which it has succeeded and as a result of certification thereof by the PUC. PP&L has been granted the right to enter the streets and highways by the Commonwealth subject to certain conditions. In general, such conditions have been met by ordinance, resolution, permit, acquiescence or other action by an appropriate local political subdivision or agency of the Commonwealth.\n\tPP&L operates Susquehanna Unit 1 and Unit 2 pursuant to NRC operating licenses which expire in 2022 and 2024, respectively. PP&L operates two hydroelectric projects pursuant to licenses which were renewed by the FERC in 1980: Wallenpaupack (44,000 kilowatts capacity) and Holtwood (102,000 kilowatts capacity). The Wallenpaupack license expires in 2004 and the Holtwood license expires in 2014.\n\tPP&L also owns one-third of the capital stock of Safe Harbor Water Power Corporation, which holds a project license which extends until 2030 for the operation of its hydroelectric plant. The total capability of the Safe Harbor plant is 417,500 kilowatts, and PP&L is entitled by contract to one-third of the total capacity (139,000 kilowatts).\nEMPLOYEE RELATIONS\n\tAs of December 31, 1995, approximately 4,228 of PP&L's 6,661 full-time employees were represented by the IBEW under a three-year agreement which expires in May 1997.\nPage 16 contains a map of PP&L's service territory which shows its location, the location of each of PP&L's coal-fired, oil-fired, hydro and nuclear-fueled generating stations and the location of major population centers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n\tThe accompanying Map shows the location of PP&L's service area and generating stations.\n\tReference is made to Exhibit 99 - Schedule of Property, Plant and Equipment for information concerning PP&L's investment in property, plant and equipment. Substantially all electric utility plant is subject to the lien of PP&L's first mortgage. Additional information concerning capital leases is set forth in Note 8 to Financial Statements.\n\tFor additional information concerning the properties of PP&L see Item 1, \"BUSINESS - Power Supply\" and \"BUSINESS - Fuel Supply\".\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n\tReference is made to Notes to Financial Statements for information concerning rate matters.\n\tReference is made to Notes to Financial Statements for information concerning a complaint filed against PP&L by fuel oil dealers alleging that PP&L's promotion of electric heat pumps and off-peak storage systems had violated and continues to violate the federal antitrust laws.\n\tReference is made to Notes to Financial Statements for information concerning a DEP order that a PP&L subsidiary abate seepage from a former mine.\n\tIn October 1995, a shareowner of Resources sent a letter to the Board of Directors (Demand Letter) which, among other things, requested that Resources \"commence legal proceedings\" against each of the directors \"for failing to prudently exercise [their] fiduciary duties to Resources and its shareholders\" in regard to the Board's rejection of an unsolicited proposal by PECO to acquire Resources. The Board considered the Demand Letter at meetings held in October and November 1995, and determined unanimously in the exercise of its business judgment that commencement by Resources of legal proceedings against the directors as requested in the letter would not be in the best interests of Resources. Resources filed an action for declaratory judgment in the Court of Common Pleas for Lehigh County, Pennsylvania against this shareowner. This action sought, among other things, a judgment that the Board's determination to refuse the shareowner's demand was a valid exercise of its business judgment.\n\tIn December 1995, Resources dismissed this action without prejudice on the basis of a letter in which the shareowner, through his attorney, represented that he had no plans to pursue any type of claim against Resources such as the one referred to in the Demand Letter and that all shares beneficially owned by the shareowner had been sold.\n\tIn August 1995, Schuylkill Energy Resources, Inc. (SER), one of the non-utility generating companies from which PP&L purchases power under PURPA, brought suit against PP&L in the District Court of PA. SER alleges that, since July 1994, PP&L has improperly curtailed power purchases from SER under the power purchase agreement between the parties. SER claims that such activity breached the power purchase agreement and violated the federal antitrust laws, among other counts. SER alleges that PP&L's actions resulted in loss of revenue from power sales of $1.6 million and an unquantified increase in its costs of operation. SER is requesting compensatory and punitive damages, as well as treble damages and attorneys' fees for alleged antitrust violations. In November 1995, PP&L filed a motion to dismiss the complaint. In January 1996, the District Court stayed the SER action pending consideration by the PUC. After PUC consideration, the stay will be lifted and the federal proceedings will resume. PP&L cannot predict the outcome of this proceeding.\n\tIn addition, in September 1995 PP&L's Corporate Audit Services Department released an audit of SER which raised questions regarding SER's compliance with the pricing provisions of the power purchase agreement between SER and PP&L. The principal issue is whether SER and an affiliate of SER properly used the steam generated by the plant in accordance with the terms of the contract. Under the contract, if the steam was used properly, SER is entitled to a rate of 6.6 cents\/KWH; if not, it is entitled to a rate of only 5.0 cents\/KWH. The total annual difference in payment under the two rates is about $9 million. SER has refused to provide any of the documentation requested by PP&L based on its claim that the information is in the possession of its affiliate, not SER. The information that PP&L has been able to develop without access to internal SER documentation tends to support a conclusion that SER was not in compliance with the terms of the contract and is not entitled to the higher contract rate. Accordingly, in November 1995, PP&L instituted a separate civil action in the Lehigh County, Pennsylvania Court of Common Pleas seeking a judgment against SER in an amount to be determined.\n\tIn April 1991, the U.S. Department of Labor through its Mine Safety and Health Administration (MSHA) issued citations to one of PP&L's coal-mining subsidiaries for alleged coal-dust sample tampering at one of the subsidiary's mines. The MSHA at the same time issued similar citations to more than 500 other coal-mine operators. Based on a review of its dust sampling procedures, the subsidiary is contesting all of the citations. It is believed at this time, based on the information available, that the MSHA allegations are without merit. Citations were also issued against the independent operator of another subsidiary mine, who is also contesting the citations issued with respect to that mine. The Administrative Law Judge (Judge) assigned to the proceedings ordered that one case be tried against a single mine operator unrelated to PP&L to determine whether the MSHA could prove its general allegations regarding sample tampering. In April 1994, the Judge ruled in favor of the mine operator and vacated the 75 citations against it. The MSHA appealed the Judge's decision to the Mine Safety and Health Review Commission. In November 1995, the Commission affirmed the Judge's rulings in favor of the operator. The Secretary of Labor has not yet made a final decision on whether to appeal. The other cases, including those involving PP&L's subsidiaries, have been stayed pending the outcome of the appeal.\n\tOn July 25, 1994, Mon Valley Steel Company, Inc. (Mon Valley) filed suit in the Court of Common Pleas of Fayette County, Pennsylvania, against PP&L and two of its subsidiaries, claiming that PP&L and those subsidiaries made fraudulent misrepresentations during negotiations for the 1992 sale to Mon Valley of Tunnelton Mining Company (Tunnelton). Tunnelton was a coal-mining operation formerly owned by PP&L's subsidiary, Pennsylvania Mines Corporation. Specifically, Mon Valley alleges that PP&L and those subsidiaries misrepresented Tunnelton's capability to produce coal, as well as the amount of funding Tunnelton would receive for mine closing costs. Mon Valley is claiming about $6 million to cover mine closing costs as well as punitive damages in an unspecified amount. In July 1994, PP&L and those subsidiaries filed a legal action in the Court of Common Pleas of Allegheny County, Pennsylvania, requesting a judicial determination that they had not breached any of their contractual obligations to Mon Valley. PP&L cannot predict the outcome of these proceedings.\n\tIn August 1991, PP&L and 35 other unrelated parties received an EPA order under Section 106 of Superfund, requiring that certain remedial actions be taken at a former oil recovery site in Berks County, Pennsylvania, which has been included on the federal Superfund list. PP&L had been identified by the EPA as a potentially responsible party, along with over 100 other parties. The EPA order required remediation by the 36 named parties of four specific areas of the site. Remedial action under this order has been completed at a cost of approximately $2 million, of which PP&L's interim share was approximately $50,000.\n\tThe EPA at the same time filed a complaint under Section 107 of Superfund in the United States District Court for the Eastern District of Pennsylvania (District Court) against PP&L and the same 35 unrelated parties. The complaint asks the District Court to hold the parties jointly and severally liable for all EPA's past costs at the site and future costs of remediating some of the remaining areas of the site. The EPA claims it has spent approximately $21 million to date. PP&L and a group of the other named parties have sued in District Court approximately 460 other parties that have contributed waste to the site, demanding that these companies contribute to the clean-up costs.\n\tIn July 1993, PP&L and 33 of the 35 unrelated parties received an EPA order under Section 106 of Superfund requiring remediation of the remaining areas of the site identified by EPA. Current estimates of remediating the remainder of the site range from $50 million to $200 million. These costs would be shared among the responsible parties. PP&L is negotiating with the federal government to settle both the Section 107 and Section 106 actions, for an amount which currently is not expected to be material.\n\tIn October 1993, DEP moved to intervene in the EPA suit, seeking to hold 16 of the original named parties, including PP&L, liable for all past and future DEP costs of remediating the site and for any natural resource damages at the site. The DEP has recently informed PP&L that it does not presently intend to pursue the natural resource damage claim. PP&L's share of DEP's past-cost claim is not expected to be material.\n\tIn December 1991, PP&L and 16 unrelated parties filed complaints against 64 other parties in District Court seeking reimbursement under Superfund for costs the plaintiffs have incurred and will incur to investigate and remediate the Novak landfill site in Lehigh County, Pennsylvania. The complaints allege that the 64 defendants generated or transported substances disposed of at the Superfund site. A Remedial Investigation and Draft Feasibility Study for the site has been completed at a cost of approximately $3 million of which PP&L's share was approximately $200,000. EPA's selected remedy is currently estimated to cost approximately $20 million. EPA has issued a 106 Order against PP&L and several other parties to implement this remedy. PP&L currently does not expect its share of these costs to be material.\n\tIn March 1993, the EPA filed a complaint under Section 107 of Superfund in District Court against PP&L and 10 unrelated parties to recover all past and future EPA costs of investigating and remediating the Heleva landfill site in Lehigh County, Pennsylvania. The EPA alleges it has spent approximately $10 million to date at this site. PP&L has filed an answer to the complaint denying liability based on the absence of evidence that PP&L sent any hazardous substances to the site. PP&L expects to settle this matter for a sum which currently is not expected to be material.\n\tIn April 1993, PP&L received an order under Section 106 of Superfund requiring that actions be taken at the site of a former metal salvaging operation in Montour County, Pennsylvania. The EPA has taken similar action with two other potentially responsible parties at the site. The cost of compliance with the order is currently estimated to be approximately $37 million. The EPA currently estimates that additional remediation work not covered by the order will cost an additional $36 million. In addition, the EPA has already incurred clean-up costs of approximately $5 million to date. The EPA had indicated that it will seek to recover these additional costs at a later date. PP&L's records indicate that scrap metal, wire and transformers were sold to the salvage operator between 1969 and 1971. Current information indicates that PP&L's contribution to the site, if any, is de minimis.\n\tAs a result of its ongoing re-engineering and cost reduction efforts, PP&L expects further reductions in the number of full- time employees. In this regard, PP&L and Local Union No. 1600 -- which represents approximately 4,000 PP&L employees -- have agreed to submit to arbitration under their collective bargaining agreement the issue of whether PP&L can eliminate bargaining unit positions while utilizing outside contractors for certain functions. A decision from the arbitrator is expected by mid- year. PP&L cannot predict the outcome of this proceeding or the effect it may have on the continuing workforce reduction effort.\n\tPP&L has been notified by the NRC that it is proposing a $100,000 fine for an incident in which a security officer at the Susquehanna nuclear plant was subjected to adverse action after he reported personnel concerns to the NRC. The NRC proposed the fine for violation of a commission regulation forbidding adverse employment action against an employee who raises such concerns. PP&L is not contesting the NRC decision and will pay the fine. PP&L also has taken significant measures to prevent reoccurrence of the problem.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n\tNeither Resources nor PP&L submitted any matter to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANTS\n\tOfficers of Resources and PP&L are elected annually by their Boards of Directors to serve at the pleasure of the respective Boards. There are no family relationships among any of the executive officers, or any arrangement or understanding between any executive officer and any other person pursuant to which the officer was selected.\n\tThere have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any executive officer during the past five years.\n\tListed below are the executive officers of:\nPP&L Resources, Inc. Effective Date of Election to Name Age Position Present Position\nWilliam F. Hecht 52 Chairman, President and Chief Executive February 24, 1995 Officer\nFrancis A. Long 55 Executive Vice President February 24, 1995\nRobert G. Byram* 50 Senior Vice President- Nuclear - PP&L December 20, 1995\nRonald E. Hill 53 Senior Vice President- Financial & Treasurer April 10, 1995\nRobert D. Fagan* 50 President - Power Markets Development Company December 20, 1995\nRobert J. Grey** 45 Vice President, General Counsel and Secretary April 10, 1995\nJoseph J. McCabe 45 Vice President and Controller August 1, 1995\nPennsylvania Power & Light Company:\nEffective Date of Election to Name Age Position Present Position\nWilliam F. Hecht 52 Chairman, President and Chief Executive Officer January 1, 1993\nFrancis A. Long 55 Executive Vice President and Chief Operating Officer January 1, 1993\nRobert G. Byram 50 Senior Vice President- Nuclear March 26, 1993\nRonald E. Hill 53 Senior Vice President- Financial January 1, 1994\nJohn R. Biggar 51 Vice President- Finance & Treasurer August 1, 1995\nRobert J. Grey** 45 Vice President, General Counsel and Secretary March 6, 1995\nJoseph J. McCabe 45 Vice President and Controller August 1, 1995\n*\tMr. Byram and Mr. Fagan have been designated executive officers of Resources by virtue of their respective positions at Resources subsidiaries.\n**\tMr. Grey has been elected Senior Vice President, General Counsel and Secretary of Resources and PP&L, effective March 1, 1996.\n\tEach of the above officers, with the exception of Mr. Fagan, Mr. Grey, and Mr. McCabe, have been employed by PP&L for more than five years as of December 31, 1995. Mr. Fagan joined PMDC - then a PP&L subsidiary - in November 1994. Prior to that time, he was Vice President and General Manager at Mission Energy Company. Mr. McCabe joined PP&L in May 1994 and was previously employed by Deloitte & Touche LLP as a partner. Mr. Grey joined PP&L in March 1995. He had been General Counsel of Long Island Lighting Company since 1992. Prior to that time, he held the position of partner at the law firm of Preston Gates & Ellis.\n\tPrior to election to the positions shown above, the following executive officers held other positions with PP&L since January 1, 1991: Mr. Hecht was Senior Vice President-System Power and Engineering, Executive Vice President-Operations and President and Chief Operating Officer; Mr. Long was Vice President-Power Supply and Senior Vice President - System Power & Engineering; Mr. Byram was Vice President - Nuclear Operations and Senior Vice President - System Power & Engineering; Mr. Hill was Vice President and Comptroller; and Mr. Biggar was Vice President - Finance.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n\tAdditional information for this item is set forth in the section entitled \"Shareowner and Investor Information\" on pages 87 through 89 of this report, and the number of common shareowners is set forth in the section entitled \"Selected Financial and Operating Data\" on page 85.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\tInformation for this item is set forth in the section entitled \"Selected Financial and Operating Data\" on pages 85 and 86 of this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n\tInformation for this item is set forth in the section entitled \"Review of the Financial Condition and Results of Operations of PP&L Resources, Inc. and Pennsylvania Power & Light Company\" on pages 28 through 43 of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\tFinancial statements and supplementary data are set forth on the pages indicated below. Page\nIndependent Auditors' Reports 45\nManagement's Report on Responsibility for Financial Statements 47\nFinancial Statements:\nPP&L Resources, Inc.\n\tConsolidated Statement of Income for the Three Years \t Ended December 31, 1995 49 \tConsolidated Statement of Cash Flows for the Three \t Years Ended December 31, 1995 50 \tConsolidated Balance Sheet at December 31, 1995 and \t 1994 51 \tConsolidated Statement of Shareowners' Common Equity \t for the Three Years Ended December 31, 1995 53 \tConsolidated Statement of Preferred and Preference \t Stock at December 31, 1995 and 1994 53\nPennsylvania Power & Light Company\n\tConsolidated Statement of Income for the Three Years \t Ended December 31, 1995 55 \tConsolidated Statement of Cash Flows for the Three \t Years Ended December 31, 1995 56 \tConsolidated Balance Sheet at December 31, 1995 and \t 1994 57 \tConsolidated Statement of Shareowner's Common Equity \t for the Three Years Ended December 31, 1995 59 \tConsolidated Statement of Preferred and Preference \t Stock at December 31, 1995 and 1994 59 \tConsolidated Statement of Long-Term Debt at \t December 31, 1995 and 1994 61\nNotes to Financial Statements 62\nSupplemental Financial Statement Schedule:\n\tII - Valuation and Qualifying Accounts and \t Reserves for the Three Years Ended \t December 31, 1995 92\nSelected Financial and Operating Data for the Five Years Ended December 31, 1995 85\nQuarterly Financial, Common Stock Price and Dividend Data 90 ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\n\tBased upon a recommendation of its Audit Committee, PP&L's Board of Directors decided on January 25, 1995 that Deloitte & Touche LLP (Deloitte) would not be retained as the independent auditors for 1995. On February 22, 1995, PP&L's Board of Directors, based upon a recommendation of PP&L's Audit Committee, appointed Price Waterhouse LLP as PP&L's new independent auditors.\n\tThe auditors' report of Deloitte on PP&L's financial statements for each of the two fiscal years ending December 31, 1993 and 1994, did not contain any adverse opinion or disclaimer of opinion, nor were the reports modified or qualified in any manner.\n\tDuring the period of such two fiscal years and the period from December 31, 1994 through January 25, 1995, there were no disagreements with Deloitte on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. During such periods, there were no \"reportable events\" as that term is defined in Item 304(a)(1)(v) of Regulation S-K.\n\tDeloitte provided a letter to PP&L regarding this matter, dated February 1, 1995, indicating that they agreed with the statements in the two preceding paragraphs.\n\t\nGlossary of Terms and Abbreviations\nAFUDC (Allowance for Funds Used During Construction) - the cost of equity and debt funds used to finance construction projects that is capitalized as part of construction cost.\nAtlantic - Atlantic City Electric Company\nBankruptcy Court - United States Bankruptcy Court for the Middle District of Pennsylvania\nBG&E - Baltimore Gas & Electric Company\nClean Air Act (Federal Clean Air Act Amendments of 1990) - legislation passed by Congress to address environmental issues including acid rain, ozone and toxic air emissions.\nContinental - Continental Energy Associates\nD&D Fund - a fund established by the Energy Act for the decontamination and decommissioning of DOE's uranium enrichment facilities.\nDEP - Pennsylvania Department of Environmental Protection\nDOE - Department of Energy\nDRIP (Dividend Reinvestment Plan) - program available to shareowners of Resources' common stock and PP&L preferred stock to reinvest dividends in Resources' common stock instead of receiving dividend checks.\nECR (Energy Cost Rate) - a tariff applied to PUC-jurisdictional customers to recover fuel and other energy costs. Differences between actual and estimated amounts are collected or refunded to customers.\nEMF - Electric and Magnetic Fields\nEnergy Act (Energy Policy Act of 1992) - legislation passed by Congress to promote competition in the electric energy market for bulk power.\nEPA - Environmental Protection Agency\nESOP - Employee Stock Ownership Plan\nFASB (Financial Accounting Standards Board) - a rulemaking organization that establishes financial accounting and reporting standards.\nFGD - Flue gas desulfurization equipment installed at coal-fired power plants to reduce sulfur dioxide emissions.\nFERC (Federal Energy Regulatory Commission) - government agency that regulates interstate transmission and sale of electricity and related matters.\nIBEW - International Brotherhood of Electrical Workers\nJCP&L - Jersey Central Power & Light Company\nMajor utilities - Atlantic, BG&E and JCP&L\nNOPR (Notice of Proposed Rulemaking) - proposed rules and regulations issued by FERC for comment by interested parties.\nNPDES - National Pollutant Discharge Elimination System\nNRC - Nuclear Regulatory Commission\nNUG (Non-Utility Generator) - generating plants not owned by regulated utilities. If the NUG meets certain criteria, its electrical output must be purchased by public utilities as required by PURPA.\nOCA - Pennsylvania Office of Consumer Advocate\nOTS - PUC Office of Trial Staff\nPa. CNI - Pennsylvania Corporate Net Income Tax\nPCB (Polychlorinated Biphenyl) - additive to oil used in certain electrical equipment up to the late 1970s. Now classified as a hazardous chemical.\nPECO - PECO Energy Company (the former Philadelphia Electric Company)\nPJM (Pennsylvania - New Jersey - Maryland Interconnection Association) - Mid-Atlantic power pool consisting of 11 operating electric utilities, including PP&L.\nPlan - PP&L's noncontributory defined benefit pension plan.\nPMDC (Power Markets Development Company) - Resources' unregulated subsidiary formed to invest in and develop world-wide power markets.\nPP&L - Pennsylvania Power & Light Company\nPSE&G - Public Service Electric & Gas Company\nPUC (Pennsylvania Public Utility Commission) - agency that regulates certain ratemaking, accounting, and operations of Pennsylvania utilities.\nPUC Decision - final order issued by the PUC on September 27, 1995 pertaining to PP&L's base rate case filed in December 1994.\nPUHCA - Public Utility Holding Company Act of 1935\nPURPA (Public Utility Regulatory Policies Act of 1978) - legislation passed by Congress to encourage energy conservation, efficient use of resources, and equitable rates.\nResources (PP&L Resources, Inc.) - parent holding company of PP&L, PMDC and Spectrum.\nSBRCA - Special Base Rate Credit Adjustment\nSEC - Securities and Exchange Commission\nSFAS (Statement of Financial Accounting Standards) - accounting and financial reporting rules issued by the FASB.\nSmall utilities - utilities subject to FERC jurisdiction whose billings include base rate charges and a supplemental charge or credit for fuel costs over or under the levels included in base rates.\nSpectrum (Spectrum Energy Services Corporation) - Resources' unregulated subsidiary formed to offer energy related products and services.\nSTAS (State Tax Adjustment Surcharge) - rate adjustment mechanism to customer bills for changes in certain state taxes.\nSuperfund - Federal and state legislation that addresses remediation of contaminated sites.\nUGI - UGI Corporation\nVEBA (Voluntary Employee Benefit Association Trust) - trust accounts for health and welfare plans for future payments to employees, retirees or their beneficiaries.\nVERP - Voluntary Early Retirement Program\nWheeling - transmitting power from one system to another over the transmission facilities of a system not party to the transaction.\nREVIEW OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF PP&L RESOURCES, INC. AND PENNSYLVANIA POWER & LIGHT COMPANY\n\tIn 1995, Resources became the parent holding company of PP&L, PMDC and Spectrum. Resources' principal subsidiary, PP&L, is an operating public utility providing electric service in central eastern Pennsylva- nia. PMDC was formed to engage in unregulated business activities through investments in world-wide power markets. Spectrum, another un- regulated subsidiary, was formed to pursue opportunities to offer energy- related products and services to PP&L's existing customers and to others beyond PP&L's service territory.\n\tThe financial condition and results of operations of PP&L are cur- rently the principal factors affecting the financial condition and re- sults of operations of Resources. All nonutility operating transactions are included in \"Other Income and Deductions -- Other-net\" on the Con- solidated Statement of Income.\n\tTerms and abbreviations appearing in the Review of the Financial Condition and Results of Operations are explained in the glossary on page 27.\nResults of Operations\nEarnings - Resources \tEarnings per share of common stock were $2.05 in 1995, $1.41 in 1994 and $2.07 in 1993. The following table highlights the major items that impacted earnings for each of the years: 1995 1994 1993\nEarnings per share - excluding costs of workforce reduction programs and one-time adjustments $1.79 $2.02 $2.19\nWorkforce reduction programs: Voluntary early retirement program 0.24 (0.28) Other (0.12)\nOne-time adjustments: Postretirement benefits other than pensions 0.10 (0.04) Disallowance-Susquehanna Unit No. 1 deferred costs (0.13) ECR purchased power costs 0.04 (0.06) Gain\/(loss) on subsidiary coal reserves 0.12 (0.26) ECR settlement (0.06) Rate reduction - FERC (0.04) Other 0.01 0.03 (0.02)\nEarnings per share - reported $2.05 $1.41 $2.07\n\tThe decline in earnings excluding the cost of workforce reduction programs and one-time adjustments for 1995 was primarily due to increases in other operating costs, depreciation for the Susquehanna station and costs associated with the review of PECO's proposals to acquire Re- sources. The decline in earnings excluding workforce reduction programs and one-time adjustments for 1994 was primarily due to the increase in depreciation for the Susquehanna station and for postretirement benefits other than pensions.\n\tSeveral key initiatives have been put in place to improve financial performance. These initiatives include:\no\tA $671 million reduction in PP&L's construction expenditures over the five-year period 1996-2000, including reductions of $93 million and $220 million for 1996 and 1997, respectively. These reductions reflect, among other things, a decision to not install FGD at PP&L's Montour station;\no\tA planned $50-$60 million (about 8%) reduction in PP&L's operation and maintenance costs from previously budgeted amounts by the year 2000;\no\tMarketing and economic development activities to achieve an average compound annual growth rate of about 2% in sales to PP&L's service area customers through the year 2000; and\no\tExcept for common equity capital to be provided through sales of common stock under the DRIP and PP&L's ESOP, Resources expects to meet all of PP&L's construction expenditures and debt maturities through internally generated funds during the five-year period 1996- 2000.\n\tResources believes that the PUC Decision, the above initiatives and the expected financial performance of PMDC and Spectrum will permit Re- sources to increase shareowner value, including growth in earnings per share and the dividend rate on common stock over the long term. Actual sales growth and improvement in earnings and financial performance will depend upon economic conditions, energy consumption, the impact of in- creasing competition in the electric utility industry, the effects of regulation, investment opportunities and other factors. Additionally, PP&L remains committed to a corporate objective of keeping its prices as stable as possible and maintaining customer rates that compare favorably with those of neighboring utilities.\nElectric Energy Sales - PP&L\n\tChanges in PP&L's electric energy sales were as follows:\n1995 1994 vs vs 1994 1993 (Millions of KWH) Electric energy sales Residential (144) 401 Commercial 232 342 Industrial 309 437 Other (including UGI) (40) 84 System sales 357 1,264 Sales to other major utilities 1,368 (835) PJM energy sales (800) (983)\n925 (554)\n\tSystem, or service area, sales were 32.7 billion kwh in 1995, an in- crease of 357 million kwh, or 1.1%, over 1994. This increase was primar- ily due to increased economic activity in central eastern Pennsylvania in 1995. If normal weather had been experienced in both 1995 and 1994, sys- tem sales for 1995 would have increased by about 529 million kwh, or 1.7%, over 1994.\n\tActual sales to residential customers in 1995 decreased 144 million kwh, or 1.3%, from 1994, while actual sales to residential customers in 1994 increased 401 million kwh, or 3.6%, from 1993. The change in resi- dential sales for both periods was primarily due to the extreme cold weather in early 1994. Under normal weather conditions in both 1995 and 1994, residential sales would have remained essentially unchanged.\n\tFor the period 1992-1995, industrial sales have increased in each quarter as compared to the same quarter in the prior year. Industrial sales are an important indicator of the economic health of PP&L's service area.\n\tSee \"Operating Revenues\" for more information.\nRate Matters - PP&L\n\tBase Rate Filing with the PUC\n\tOn September 27, 1995, the PUC issued a final order with respect to the base rate case filed by PP&L on December 30, 1994.\n\tPP&L's request sought to increase PUC-jurisdictional revenues by $261.6 million, or about 11.7%. The PUC Decision in the rate case granted PP&L a $107 million increase in base rates based on test year conditions. At the same time, PP&L's ECR was reduced by $22 million re- lated to capacity credit sales resulting in a net increase of $85 mil- lion, or about 3.8%, in PUC-jurisdictional revenues effective September 28, 1995. A detailed discussion of the PUC Decision is presented in Fi- nancial Note 3.\n\tEnergy Cost Rate Issues\n\tAs a result of the PUC Decision, a new ECR, which reflects the roll- in of all test year energy costs into base rates, became effective as of September 28, 1995.\n\tIn April 1994, the PUC reduced PP&L's 1994-95 ECR claim by approxi- mately $15.7 million to reflect costs associated with replacement power during a portion of the time that Unit 1 of the PP&L Susquehanna station was out of service for refueling and repairs. As a result of the PUC's action, PP&L recorded a charge against income in the first quarter of 1994 for the $15.7 million of unrecovered replacement power costs. This charge adversely affected net income by about $9.0 million or 6 cents per share of common stock.\n\tPP&L filed a complaint with the PUC objecting to the decision to ex- clude these replacement power costs from the 1994-95 ECR and subsequently reached a settlement with the OTS and other parties to the proceeding on this matter which reduced the disallowed costs by $9.7 million.\n\tThe PUC approved the settlement agreement and in the first quarter of 1995, PP&L recorded a credit to income of $9.7 million which increased earnings by 4 cents per share of common stock.\n\tProposed Buyout of Power Purchase Contract\n\tIn February 1996, PP&L signed agreements with Continental Energy As- sociates (Continental) to terminate the 1985 power purchase contract un- der which PP&L purchases up to 100 MW of power from Continental's cogen- eration project. The Continental project is a qualifying facility from which PP&L has been required to purchase power under PURPA. In 1985, the PUC approved ECR recovery of the amounts paid to Continental under the power purchase contract. In 1994, Continental filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code. Under the Febru- ary agreements, PP&L would pay Continental $91.2 million over five years to cancel the power purchase contract. Also, Continental agrees to waive its rights under PURPA or similar legislation or regulations to require PP&L to purchase power from the plant in the future.\n\tThe agreements are conditioned upon PUC approval of full recovery of the buyout cost through the ECR and approval of the agreements by the United States Bankruptcy Court for the Middle District of Pennsylvania (Bankruptcy Court). PP&L will file a petition with the PUC seeking such ECR recovery of the $91.2 million buyout cost over a five-year period. PP&L's request for recovery will state that the buyout would save retail customers approximately $113.6 million over the next 13 years by elimi- nating the need to buy this power from Continental. At the same time, Continental will file with the Bankruptcy Court for approval of the agreements.\n\tFERC-Major Utilities' Rates\n\tIn October 1995, the FERC approved PP&L's request to recover postre- tirement benefits other than pensions through its contractual agreements with other major electric utilities, subject to refund after FERC review. PP&L is billing these utilities their share of postretirement costs other than pensions incurred since January 1993. See Financial Notes 3 and 4 for more details on these contracts.\n\tIn an October 1995 order, the FERC also ordered hearings to evaluate the justness and reasonableness of PP&L's rates in its contractual agree- ments with JCP&L, Atlantic, BG&E and UGI.\n\tIn January 1996, PP&L filed a request with the FERC to incorporate a change in the method of calculating decommissioning in several of its contractual agreements with other major utilities. PP&L also requested to increase its decommissioning rate to reflect the projected cost of de- commissioning the Susquehanna station and fossil plants.\n\tPP&L cannot predict the outcome of these proceedings.\nOperating Revenues - PP&L\n\tChanges in PP&L's total operating revenues were attributable to the following:\n1995 1994 vs vs 1994 1993 (Millions of Dollars) Sales volume & sales mix $ 34.5 $ 31.3 Weather (8.4) 10.8 Energy revenues 3.6 1.4 Rate increase 21.0 Reduction in Pa. CNI rate (11.9) (13.6) Sales to other major utilities & PJM (5.0) (34.4) Other (7.1) 2.6 $ 26.7 $ (1.9)\n\tEnergy revenues increased $3.6 million in 1995. This increase is the net effect of lower energy revenues of $21.8 million and the effects of regulatory action regarding recovery of certain replacement power costs during 1994 and 1995. See \"Rate Matters - Energy Cost Rate Issues\" for more details.\n\tThe decrease in 1995 revenues from sales to other major utilities and PJM was due to declining market prices resulting from improved avail- ability of lower cost PJM generation.\n\tOther revenues in 1995 were lower than 1994 due to the expiration of a long-term contract for capacity credit sales.\n\tThe increase in energy revenues of $1.4 million in 1994 was the net effect of higher energy revenues partially offset by unrecovered replace- ment power costs. See \"Rate Matters - Energy Cost Rate Issues\" for more details.\n\tThe decrease in 1994 revenues from sales to other major utilities and PJM was primarily due to lower availability of PP&L's coal-fired units in 1994.\n\tTariffs subject to PUC jurisdiction accounted for approximately 84% of PP&L's revenues from energy sales in 1995. The remaining 16% of such revenues resulted from sales regulated by the FERC and PP&L's PJM energy sales.\nFuel Expense - PP&L \tFuel expense for 1995 and 1994 decreased by $24.3 million and $33.3 million, respectively, from the prior year. These decreases exclude the write-off of $11 million of deferred retired miners' health care benefits in 1993 and a related credit to expense of $3.6 million in 1994. The de- creases in fuel expense were due to:\n1995 1994 vs vs 1994 1993 (Millions of Dollars)\nDecrease due to change in fuel prices $(19.7) $ (4.8) Decrease due to fuel mix (4.6) (28.5)\n$(24.3) $(33.3)\n\tThe decrease in 1995 was attributable to lower use of oil-fired gen- eration due to increased nuclear and coal-fired generation and lower unit fuel costs for nuclear generation. Fuel costs decreased in 1994 due to a 3.5% decrease in total generation primarily due to lower availability of coal-fired generation which resulted in lower sales to PJM and other utilities. Lower fuel costs for off-system sales were partially offset by higher cost oil-fired generation for base load during the first quar- ter of 1994.\nTaxes - Resources\/PP&L\n\tIncome tax expense increased $106 million, or 59%, from 1994. This was primarily due to an increase in pre-tax book income of $212 million and a charge of $12 million applicable to the disallowance of Susquehanna Unit No. 1 deferred operating and capital costs. Partially offsetting these increases was an $8.1 million decrease resulting from the reduction of the Pa. CNI rate from 11.99% for 1994 to 9.99% for 1995. See Finan- cial Note 3 - \"Refund of State Tax Decrease\".\nOther Operation, Maintenance and Depreciation - PP&L\n\tOther operating costs increased $30.0 million in 1995 and $26.9 mil- lion in 1994. Both periods were impacted by the regulatory effects of accounting for postretirement benefits costs. Excluding these effects, other operating expenses increased $73.8 and $6.6 million, respectively, for 1995 and 1994.\n\tThe increase in 1995 was primarily due to: $31.3 million for PP&L's workforce reductions; $18.4 million for increased efforts for computer support that will increase productivity; $7.9 million due to an increase in the reserve for uncollectible accounts; and $6.2 million of increased leasing costs. See Financial Note 12 - \"Workforce Reductions\" for fur- ther information.\n\tMaintenance expense increased $5.6 million in 1995 and decreased $13.2 million in 1994. In 1995, PP&L incurred a charge of $19.2 million for obsolete and excess inventory at its fossil-fueled and nuclear gener- ating stations. Excluding this write-off, maintenance expense decreased $13.6 million in 1995. The decrease in maintenance expense for 1995 was primarily due to PP&L's continued efforts to reduce costs and achieve longer operating cycles at its generating stations. The decrease in 1994 was the net result of lower costs associated with maintaining PP&L's gen- erating stations in 1994 and a $6.9 million write-off of obsolete and ex- cess inventory at its fossil-fueled generating stations in 1993.\n\tDepreciation expense increased $34.2 million in 1995 and $29.4 mil- lion in 1994. Higher depreciation expense reflected increases associated with the Susquehanna station and the depreciation of new property, plant and equipment placed in service. As a result of the PUC Decision, Sus- quehanna depreciation applicable to property placed in service prior to January 1, 1989, will be recorded at an annual level of $173 million through 1998 at which time depreciation is scheduled to decline by about $71 million.\n\tPP&L is continuing its ongoing re-engineering and cost reduction ef- forts, which are expected to impact the size of its workforce. As a re- sult of these efforts, PP&L announced in the fourth quarter of 1995 that about 300 bargaining unit positions will be eliminated. Although no spe- cific targets have been set, PP&L currently expects that the year-end 1995 level of 6,661 full-time employees will decline to 6,000 or fewer employees over the next few years. As the workforce declines, additional costs may be incurred due to the reductions, in amounts that are not cur- rently determinable.\nVoluntary Early Retirement Program - PP&L\n\tAs part of its continuing efforts to reduce costs, PP&L offered a VERP to 851 employees who were age 55 or older by December 31, 1994. A total of 640 employees elected to retire under the program, at a total cost of $75.9 million. The VERP provided for a lump sum payment based on an employee's years of service, no reduction in retirement benefits for age, and supplemental monthly payments. PP&L recorded the cost of the program as a charge against income in the fourth quarter of 1994, which reduced net income by $43.4 million, or 28 cents per share of common stock.\n\tAs a result of the PUC Decision, PP&L was allowed to recover through customer rates the PUC-jurisdictional amount, $65.7 million, of the cost of its VERP over a period of five years. Consequently, PP&L recorded a $37.8 million after-tax credit to income, or 24 cents per share of common stock, in the third quarter of 1995 to reverse the PUC-jurisdictional portion of the charge for this program that was recorded in the fourth quarter of 1994. The estimated annual savings of $35 million from the program also are included in rates.\nSubsidiary Coal Reserves - PP&L\n\tIn connection with a 1994 review by PP&L of its non-core business assets, a subsidiary of PP&L initiated an evaluation of the carrying value of its $83.5 million investment in undeveloped coal reserves in western Pennsylvania. Outside appraisal firms completed the evaluation and indicated that due to changing market conditions an impairment of these assets had occurred. Accordingly, the carrying value of this in- vestment was written down to its estimated net realizable value of $9.8 million. This write-down resulted in an after-tax charge to income of $40 million in 1994, which reduced 1994 earnings by approximately 26 cents per share of common stock.\n\tThese reserves were acquired in 1974 with the intention of supplying future coal-fired generating stations. PP&L concluded that it would not develop these reserves. In November 1995, the coal reserves were sold for $52 million, which resulted in a $41.7 million gain, or $20.3 million after-tax, and increased 1995 earnings by approximately 12 cents per share of common stock.\nOther Income and Deductions - Other-Net - Resources\n\t\"Other - net\" decreased $19.1 million in 1995 and $8.9 million in 1994. The decrease in 1995 was primarily due to $14.5 million of costs associated with evaluating and responding to PECO's unsolicited proposals to acquire Resources and an $8.9 million write-off of the Susquehanna Unit No. 1 deferred operating and capital costs that were disallowed in the PUC Decision. The decrease in 1994 was primarily due to a decrease in the income from passive financial investments.\nFinancing Costs - Resources\/PP&L\n\tIn 1995, PP&L continued to take advantage of opportunities to reduce its financing costs by retiring long-term debt with the proceeds from the sales of securities at a lower cost. Interest on long-term debt and dividends on preferred and preference stock decreased from $281 million in 1992 to $241 million in 1995, for a total decrease of $40 million.\nFinancial Condition\nReduction in Capital Expenditure Requirements - PP&L\n\tThe following schedule shows PP&L's current capital expenditure pro- jections for the years 1996-2000 and reflects a $671 million reduction in capital expenditures from previously budgeted amounts over the period 1996 through 2000.\nPP&L's Capital Expenditure Requirements (a)\nActual -------------Projected---------------- 1995 1996 1997 1998 1999 2000 (Millions of Dollars) Construction expenditures Generating facilities $100 $ 80 $ 63 $ 68 $ 56 $ 61 Transmission and distribution facilities 166 146 140 142 145 150 Environmental 34 33 25 33 25 3 Other 55 49 30 22 18 17 355 308 258 265 244 231 Nuclear fuel owned and leased 46 88 62 62 63 64 Other leased property 28 7 7 7 8 8 Total $429 $403 $327 $334 $315 $303\n(a)\tConstruction expenditures include AFUDC which is expected to be less than $20 million in each of the years 1996-2000.\n\tA significant portion of the reduction in construction expenditures from the amounts projected in 1995 reflects PP&L's decision to not in- stall FGD -- at an estimated capital cost of $413 million -- on the two generating units at the Montour station. Instead of relying on the FGD to achieve compliance with the Phase II requirements of the Clean Air Act, PP&L plans to purchase low sulfur coal, utilize banked emission al- lowances and purchase additional emission allowances.\n\tPP&L also has reduced its projected construction expenditures for transmission and distribution facilities during this period by about $120 million and reduced its expenditures for capital improvements at fossil- fueled and hydro generating stations by $78 million from the previous es- timate.\nFinancing and Liquidity - Resources\/PP&L\n\tNet cash provided by operating activities for 1995 was essentially unchanged and decreased $58.7 million in 1994. The decrease in 1994 was primarily due to lower earnings, increases in income tax payments, higher fuel inventories and a reduction in accounts payable.\n\tNet cash used in investing activities was $183.5 million lower in 1995 than 1994. This decrease was due primarily to lower construction expenditures and the proceeds from the sale of coal reserves. Net cash used in investing activities was $78.7 million higher in 1994 than 1993 due to higher construction expenditures and an increase in financial in- vestments by a Resources' subsidiary.\n\tFor the years 1993-1995, PP&L issued $1.8 billion of long-term debt and $380 million of preferred stock. For the same period, PP&L and Re- sources issued a total of $157 million of common stock. Proceeds from security sales were used to retire $1.6 billion of long-term debt and $463 million of preferred and preference stock to lower PP&L's financing costs, reduce short-term debt and finance construction expenditures. During the years 1993-1995, PP&L also incurred $220 million of obliga- tions under capital leases (primarily nuclear fuel). In 1995, PP&L sold $55 million principal amount of first mortgage bonds while Resources is- sued $81 million of common stock of which $74 million was issued through its DRIP and the remaining $7 million issued to PP&L's ESOP. During the year, PP&L retired $140 million of long-term debt.\n\tPP&L anticipates the issuance of $116 million of unsecured notes in early 1996 in order to redeem higher-cost bonds through the maintenance and replacement fund provisions of PP&L's Mortgage.\n\tResources will continue to obtain common equity capital through the DRIP and PP&L's ESOP. It is expected that the DRIP will be continued during the years 1996 and 1997, resulting in proceeds of about $70 mil- lion annually, and that PP&L's ESOP will be continued through 2000, with expected proceeds of about $8 million annually.\n\tExcept for funds derived from sales of common stock, Resources ex- pects that internally generated funds (after provision for dividends and capital lease payments) will be adequate to meet PP&L's capital require- ments and $415 million of debt maturities for the years 1996-2000. PP&L has no preferred stock sinking fund requirements during 1996-2000.\n\tAdditional outside financing, in amounts not currently determinable, or the liquidation of certain financial investments may be required over the next five years to finance investment opportunities in world-wide power projects by PMDC.\n\tTo enhance financing flexibility, a $250 million revolving credit arrangement is maintained with a group of banks and is used principally as a back-up for PP&L's commercial paper. In addition, $45 million in credit arrangements are maintained with a group of banks to provide back- up for PP&L's commercial paper and short-term borrowings of certain of its subsidiaries. No borrowings were outstanding at December 31, 1995 under these arrangements. See Financial Note 10 for further information.\nFinancial Indicators - Resources\n\tResources earned a 12.81% return on average common equity during 1995, an increase from the 8.73% earned in 1994. The ratio of Resources' pre-tax income to interest charges increased from 2.7 in 1994 to 3.6 in 1995. The annual per share dividend rate on common stock remained un- changed at $1.67 per share. The book value per share of common stock in- creased 3.2% from $15.79 at the end of 1994 to $16.29 at the end of 1995. The ratio of the market price to book value of common stock was 153% at the end of 1995 compared with 120% at the end of 1994.\nEnvironmental Matters - PP&L\n\tAir\n\tThe Clean Air Act deals, in part, with acid rain under Title IV, at- tainment of federal ambient ozone standards under Title I, and toxic air emissions under Title III. The acid rain provisions specified Phase I sulfur dioxide emission limits for about 55% of PP&L's coal-fired gener- ating capacity by January 1995, and more stringent Phase II sulfur diox- ide emission limits for all of PP&L's fossil-fueled generating units by January 2000. PP&L has complied with the Phase I acid rain provisions under Title IV. To meet the Phase II limits, PP&L plans to purchase lower sulfur coal, utilize banked emission allowances and purchase addi- tional emission allowances instead of relying on FGD. PP&L's decision not to install FGD, with an estimated capital cost of $413 million, on the two generating units at the Montour station represents a significant reduction in previously planned capital expenditures. PP&L filed appli- cations for Phase II permits for its fossil-fuel fired plants in December 1995. The permit applications state that PP&L will comply with applica- ble requirements and obtain emission allowances for each ton of sulfur dioxide emitted.\n\tPP&L has met the initial requirements under Title I to install rea- sonably available control technology to reduce nitrogen oxide emissions. An additional two-phase reduction in nitrogen oxides from pre-Clean Air Act levels has been proposed for the area where PP&L's plants are lo- cated, a 55% reduction by May 1999 and a 75% reduction by 2003, unless scientific studies expected to be completed by 1997 indicate a different reduction is appropriate. The reductions would be required during a five-month ozone season from May through September. Expenditures to meet the 1999 requirements are included in the table of projected construction expenditures in \"Financial Condition - Reduction in Capital Expenditure Requirements\".\n\tIn addition to acid rain and ambient ozone attainment provisions, the clean air legislation requires the EPA to conduct a study of hazard- ous air emissions from power plants. EPA is also studying the health ef- fects of fine particulates which are emitted from power plants and other sources. Adverse findings from either study could cause the EPA to man- date additional ultra high efficiency particulate removal baghouses or specialized flue gas scrubbing to remove certain vaporous trace metals and certain gaseous emissions.\n\tPP&L currently estimates that additional capital expenditures and operating costs for environmental compliance under the Clean Air Act will be incurred beyond 2000 in amounts which are not now determinable but could be material.\n\tThe Pennsylvania Air Pollution Control Act implements the Clean Air Act. The state legislation essentially requires that new state air emis- sion standards be no more stringent than federal standards. This legis- lation is not expected to significantly affect PP&L's plans for compli- ance with the Clean Air Act.\n\tThe PUC's policy regarding the trading and usage of, and the rate- making treatment for, emission allowances by Pennsylvania electric utili- ties provides, among other things, that the PUC will not require approval of specific transactions and that the cost of allowances will be recog- nized as energy-related power production expenses and recoverable through the ECR.\n\tWater and Residual Waste\n\tThe DEP regulations governing the handling and disposal of indus- trial (or residual) solid waste require PP&L to upgrade and repermit ex- isting ash basins at all of its coal-fired generating stations by apply- ing updated standards for waste disposal. Ash basins that cannot be repermitted are required to close by July 1997. Any groundwater contami- nation caused by the basins must also be addressed. Any new ash disposal facility must meet the rigid siting and design standards set forth in the regulations. In addition, the siting of future facilities could be af- fected.\n\tTo address the DEP regulations, PP&L is moving forward with its plan to install dry fly ash handling systems at the Brunner Island, Sunbury and Holtwood stations similar to Montour's facilities. Dry fly ash han- dling provides new opportunities for its beneficial use as opposed to disposing of it on-site.\n\tGroundwater degradation related to fuel oil leakage from underground facilities and seepage from coal refuse disposal areas and coal storage piles has been identified at several PP&L generating stations. Many re- quirements of the DEP regulations address these groundwater degradation issues. PP&L has reviewed its remedial action plans with the DEP. Reme- dial work is substantially completed at two generating stations. At this time, there is no indication that remedial work will be required at other PP&L generating stations.\n\tThe DEP regulations to implement the toxic control provisions of the Federal Water Quality Act of 1987 and to advance Pennsylvania's toxic control program authorize the DEP to use both biomonitoring and a water quality-based chemical-specific approach in the NPDES permits to control toxics. The current Montour station NPDES permit contains stringent lim- its for certain toxic metals and increased monitoring requirements. Toxic reduction studies are being conducted at the Montour station before the permit limits become effective. Depending on the results of the studies, additional water treatment facilities may be needed at the Mon- tour station. Improvements and upgrades are being planned for the Sun- bury, Brunner Island and Holtwood stations' waste water treatment systems to meet the anticipated NPDES permit requirements.\n\tCapital expenditures through 2000 to comply with the residual waste regulations, correct groundwater degradation at fossil-fueled generating stations and address waste water control at PP&L facilities, are included in the table of construction expenditures in \"Financial Condition - Re- duction in Capital Expenditure Requirements\". PP&L currently estimates that about $68 million of additional capital expenditures could be re- quired in 2000 and beyond. Actions taken to correct groundwater degrada- tion, to comply with the DEP's regulations and to address waste water control are also expected to result in increased operating costs in amounts which are not now determinable but could be material.\n\tSuperfund and Other Remediation\n\tPP&L has signed a consent order with the DEP to address a number of sites where PP&L may be liable for remediation of contamination. This may include potential PCB contamination at certain of PP&L's substations and pole sites; potential contamination at a number of coal gas manufac- turing facilities formerly owned and operated by PP&L; and oil or other contamination which may exist at some of PP&L's former generating facili- ties. As a current or past owner or operator of these sites, PP&L may be liable under Superfund or other laws for the costs associated with ad- dressing any hazardous substances at these sites.\n\tThese sites have been prioritized based upon a number of factors, including any potential human health or environmental risk posed by the site, the public's interest in the site, and PP&L's plans for the site. Under the consent order, PP&L will not be required to spend more than $5 million per year on investigation and remediation at those sites covered by the consent order. PP&L will not be required to spend additional money under the consent order in any year that its total remediation costs for sites both within and outside the scope of the consent order exceeds $5 million.\n\tAt December 31, 1995, PP&L had accrued $11.2 million, representing the amount PP&L can reasonably estimate it will have to spend to remedi- ate sites involving the removal of hazardous or toxic substances includ- ing those covered by the consent order mentioned above. PP&L is involved in several other sites where it may be required, along with other par- ties, to contribute to such remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for list- ing at a future date. Future cleanup or remediation work at sites cur- rently under review, or at sites not currently identified, may result in material additional operating costs which PP&L cannot estimate at this time. In addition, certain federal and state statutes, including Super- fund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DEP, to seek compensation from the responsible parties for the lost value of damaged natural re- sources. The EPA and the DEP may file such compensation claims against the parties, including PP&L, held responsible for cleanup of such sites. Such natural resource damage claims against PP&L could result in material additional liabilities.\n\tElectric and Magnetic Fields\n\tConcerns have been expressed by some members of the scientific com- munity and others regarding the potential health effects of EMFs. These fields are emitted by all devices carrying electricity, including elec- tric transmission and distribution lines and substation equipment. Fed- eral, state and local officials are focusing increased attention on this issue. PP&L is actively participating in the current research effort to determine whether EMFs cause any human health problems and is taking steps to reduce EMFs, where practical, in the design of new transmission and distribution facilities. PP&L is unable to predict what effect the EMF issue might have on PP&L operations and facilities and the associated cost.\n\tSubsidiary Issues\n\tIn June 1995, the DEP ordered a PP&L subsidiary to abate seepage al- legedly discharged from a mine formerly operated by that subsidiary. The subsidiary currently does not believe that it is responsible for this seepage and has appealed the order to DEP's Environmental Hearing Board, which has scheduled evidentiary hearings on the matter. A consultant has been hired to perform additional testing to determine the source of the seepage. If no connection exists between the mine water and the seepage, no abatement is required. However, if abatement ultimately is required, the PP&L subsidiary may be responsible for an extensive and protracted program to pump water from the mine at a cost which could be material.\n\tOther Environmental Matters\n\tIn addition to the issues discussed above, PP&L may be required to modify, replace or cease operating certain of its facilities to comply with other statutes, regulations and actions by regulatory bodies involv- ing environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances. As a result, PP&L may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nUranium Enrichment Decontamination and Decommissioning Fund - PP&L\n\tThe Energy Act established the D&D Fund and provides for an assess- ment on domestic utilities with nuclear power operations, including PP&L. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the Energy Act and the assessments are expected to be paid to the D&D Fund by such utilities over a 15-year period. Amounts paid to the D&D Fund are to be used for the ultimate de- contamination and decommissioning of the DOE's uranium enrichment facili- ties. The Energy Act states that the assessment shall be deemed a neces- sary and reasonable current cost of fuel and shall be fully recoverable in rates in all jurisdictions in the same manner as the utility's other fuel costs.\n\tAs of December 31, 1995, PP&L's recorded liability for its total as- sessment amounted to about $29.7 million. The liability is subject to adjustment for inflation. The corresponding charge to expense was de- ferred because PP&L includes its annual payments to the D&D Fund in the ECR which is in PP&L's PUC tariffs and in the fuel adjustment clause which is in PP&L's FERC tariffs. As a result, the assessment does not affect net income.\nNew Accounting Standards - Resources\n\tEffective January 1, 1996, Resources adopted SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" SFAS 121 requires a company to review certain assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an asset is deter- mined to be impaired, an impairment loss is recognized. Resources does not anticipate any impairment as a result of adopting SFAS 121.\n\tAlso effective January 1, 1996, Resources adopted SFAS 123, \"Accounting for Stock-Based Compensation.\" SFAS 123 addresses the recom- mended accounting and required disclosures for stock-based employee com- pensation plans, which include all arrangements by which employees re- ceive shares of stock or other equity instruments of the employer or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. Resources' current accounting for restricted stock awards conforms to the requirements as defined in SFAS 123.\n\tThe adoption of SFAS 121 and 123 will not have a significant impact on net income.\nIncreasing Competition - Resources\/PP&L\n\tThe electric utility industry, including PP&L, has experienced and will continue to experience a significant increase in the level of compe- tition in the energy supply market. The Energy Act amended the Public Utility Holding Company Act of 1935 to create a new class of independent power producers, and amended the Federal Power Act to provide open access to electric transmission systems for wholesale transactions. In response to this increased competition, PP&L has undertaken strategic initiatives to improve financial performance and enhance its competitive position. See \"Earnings\" for a discussion of these initiatives.\n\tPUC Investigation on Competition - PP&L\n\tIn May 1994, the PUC ordered a generic investigation to examine the role of competition in Pennsylvania's electric utility industry. The purpose of the investigation is to solicit input regarding the potential impact of competition on the state's electric utilities and their custom- ers. The first phase of the investigation gathered and analyzed data at both the wholesale and retail levels of the electric utility industry. Interested parties filed written comments addressing the following spe- cific topics: issues and impact of wheeling, consumer issues, safety and reliability, the impact of market structure changes and legal issues. PP&L submitted comments in response to the PUC order.\n\tThe second phase of the investigation involves hearings to accept testimony from interested parties. These hearings, which began in Decem- ber 1995, are presided over by the PUC Commissioners and an Administra- tive Law Judge. In January 1996, PP&L testified before this panel to ex- press support for full customer choice of their energy supplier for all customer classes. PP&L will be involved in efforts to encourage a smooth transition to full competition. PP&L believes that this transition to full competition should allow for the recovery of a utility's stranded investments, which are those costs incurred by a utility because of fed- eral or state regulatory requirements and, also, any portion of prudent investments made in generating facilities which would not be recoverable in a competitive market.\n\tOpen Access and Stranded Costs - PP&L\n\tIn March 1995, the FERC issued a NOPR, primarily dealing with open access to transmission lines and recovery of stranded costs. If adopted as proposed, the NOPR would require all utilities to file open access tariffs available to all wholesale sellers and buyers of electricity. The tariffs must offer point-to-point and network services, as well as ancillary services. A utility would have to offer these services to all eligible wholesale customers on a basis comparable to the services the utility provides to itself. A utility must take service under its trans- mission access tariff for its own wholesale sales and purchases. The NOPR would not affect existing transmission agreements.\n\tThe NOPR also provides that utilities are entitled to recover all \"legitimate, prudent and verifiable stranded costs\" incurred as a result of rendering transmission services pursuant to their tariffs. The FERC proposes to provide recovery mechanisms for wholesale stranded costs, in- cluding stranded costs resulting from municipalization. The NOPR con- tains filing requirements for utilities to seek recovery of wholesale stranded costs. Wholesale contracts signed after July 11, 1994 must con- tain explicit provisions authorizing recovery of stranded costs. For contracts signed before this date, a utility may seek recovery if it can show that it had a reasonable expectation of continuing to serve the cus- tomer after the contract term and that it has made reasonable efforts to mitigate any stranded costs. PP&L's contracts with its 18 FERC wholesale customers were signed before July 11, 1994.\n\tThe states have responsibility for adopting policies concerning re- covery of stranded costs resulting from retail wheeling transactions. Under the NOPR, the FERC will assert jurisdiction over such costs only if the states lack authority to deal with stranded costs.\n\tInitial comments on the open access and stranded cost recovery por- tions of the NOPR were due in August 1995. PP&L filed comments on the NOPR. The FERC is expected to issue a final ruling on the NOPR in 1996.\n\tNew Markets - Resources\n\tOne of Resources' strategic initiatives is to invest in power- related businesses outside of PP&L's service territory, both domestically and in foreign countries. To take advantage of these new business oppor- tunities, PP&L formed a holding company structure, effective April 27, 1995, after receiving all necessary regulatory approvals and shareowner approval at PP&L's 1995 annual meeting. As a result of this restructur- ing, PP&L became a direct subsidiary of Resources.\n\tIn March 1994, a new subsidiary, PMDC, was incorporated and received an initial capital contribution of $50 million. PMDC engages in unregu- lated business activities through investments in world-wide power mar- kets. In 1995, PMDC invested $10.6 million as part of a consortium that is part owner of an electric generating company in Bolivia and committed to invest up to $10 million as a partner in a fund which will invest in Latin American generation, transmission and distribution businesses. PMDC also committed to invest up to $24 million as part of a consortium to develop an integrated gas, power and transmission facility in Peru. This project will be funded during 1996 and 1997.\n\tIn July 1995, Resources formed another unregulated subsidiary, Spec- trum, to pursue opportunities to offer energy-related products and serv- ices to PP&L's existing customers and to others beyond PP&L's service territory. Other subsidiaries may be formed to take advantage of new business opportunities.\n\tPJM Proposed Restructuring Plan - PP&L\n\tIn November 1995, all but one PJM company supported the plan that PJM presented to the FERC to increase competition in the region. The other company presented a separate plan. The PJM plan would offer to all generators and wholesale buyers of electricity a PJM Pool-wide energy market and open access to Pool-wide high-voltage transmission lines.\n\tThe PJM plan contains a number of key components, including: 1) new Pool-wide transmission tariffs to provide open access, comparable service to all wholesale customers; 2) implementation of a regional energy market with price-based dispatch, open to all wholesale bulk power buyers and sellers; and 3) an Independent System Operator to administer Pool opera- tions and transmission service, and to operate the regional energy mar- ket.\n\tThe PJM plan is designed to further develop a truly competitive wholesale market with broader participation. The PJM companies propose to submit a comprehensive filing to the FERC for approval in May 1996, with implementation of the new structure by the end of 1996.\nProposed Acquisition by PECO Energy Company - Resources\n\tIn August 1995, PECO publicly announced a proposal to acquire Re- sources. Under this proposal, each share of Resources' common stock would have been converted into 0.865 of a share of PECO's common stock.\n\tIn September 1995, Resources' Board of Directors, after due consid- eration and review of the proposal, unanimously voted to reject the pro- posal. The Board concluded that the proposal was not in the best inter- ests of Resources, its shareowners, customers, employees or the communities it serves.\n\tIn October 1995, PECO made a revised acquisition proposal for con- sideration by Resources' Board. Under the revised proposal, Resources' shareowners would have received 0.921 shares of PECO's common stock for each share of Resources' common stock which they owned. PECO stated that the revised proposal was its \"final offer.\" On November 1, 1995, Re- sources' Board, after a comprehensive analysis, unanimously voted to re- ject the revised proposal. The Board concluded that the revised proposal was not in the best interests of Resources and its shareowners, custom- ers, employees or the communities it serves. Later that same day, PECO withdrew its proposal to acquire Resources and stated that it would take no further action to pursue such a transaction.\n(Address and phone number appears here) Thirty South Seventeenth Street Philadelphia, PA 19103-4094 Telephone 215 575 5000\n(Price Waterhouse LLP logo appears here)\nIndependent Auditors' Report\nFebruary 1, 1996\nTo the Shareowners and Board of Directors of PP&L Resources, Inc. and to the Shareowners and Board of Directors of Pennsylvania Power & Light Company\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 8 on page 25 and the supplemental financial statement schedule appearing under the Exhibit Index on page 107 as Exhibit 99, present fairly, in all material respects, the consolidated financial position of PP&L Resources, Inc. and its subsidiaries (Resources) at December 31, 1995 and their consolidated results of operations and their cash flows for the year then ended and the consolidated financial position of Pennsylvania Power & Light Company and its subsidiaries (PP&L) at December 31, 1995 and their consolidated results of operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. These financial statements and the financial statement schedule are the responsibility of management; our responsibility is to express an opinion on these financial statements and financial statement schedule 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. The consolidated financial statements of PP&L for the years ended December 31, 1994 and 1993, prior to restatement (not presented separately herein), were audited by other independent accountants whose report dated February 3, 1995 expressed an unqualified opinion on those financial statements.\nAs discussed in Note 1 to the consolidated financial statements, effective April 27, 1995, Resources, which had been a wholly-owned subsidiary of PP&L, became the parent holding company of PP&L. The accompanying consolidated financial statements reflect this reorganization on a retroactive basis. We have audited the adjustments that were applied to restate the 1994 and 1993 PP&L consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied to the 1994 and 1993 PP&L consolidated financial statements.\n(Signed) Price Waterhouse LLP\n(Deloitte & Touche LLP Logo appears here) (Address and phone number appear here) Two Hilton Court P.O. Box 319 Parsippany, New Jersey 07054-0319 Telephone: (201) 631-7000 Facsimile: (201) 631-7459\nINDEPENDENT AUDITORS' REPORT\nPennsylvania Power & Light Company:\nWe have audited the consolidated balance sheet and statements of preferred and preference stock and long-term debt of Pennsylvania Power & Light Company and its subsidiaries as of December 31, 1994, and the related consolidated statements of income, shareowners' common equity, and cash flows for each of the two years in the period ended December 31, 1994, prior to restatement and not presented separately herein. Our audits also included the financial statement schedules for the years ended December 31, 1994 and 1993 listed in the Index at Item 8 and in the Exhibit Index as Exhibit 99. These financial statements and the financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements, prior to restatement and not presented separately herein, present fairly, in all material respects, the financial position of the Pennsylvania Power & Light Company 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. Also, in our opinion, the financial statement schedules for the years ended December 31, 1994 and 1993, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 7 to the consolidated 1994 financial statements, prior to restatement and not presented separately herein, in 1994 the Company changed its method of accounting for certain investments in debt and equity securities to conform with Statement of Financial Accounting Standards Number 115.\n(Signed) Deloitte & Touche LLP\nFebruary 3, 1995\n(Deloitte Touche Tohmatsu International logo appears here)\nPP&L Resources, Inc. Management's Report on Responsibility for Financial Statements\n\tThe management of PP&L Resources, 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 were prepared in accordance with generally accepted accounting principles and the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission. In preparing the financial statements, management makes informed estimates and judgments of the expected effects of events and transactions based upon currently available facts and circumstances. Management believes that the financial statements are free of material misstatement and present fairly the financial position, results of operations and cash flows of Resources.\n\tResources' consolidated financial statements have been audited by Price Waterhouse LLP (Price Waterhouse), independent certified public accountants, whose report with respect to the financial statements appears on page 45. Price Waterhouse's appointment as auditors was previously ratified by the shareowners. Management has made available to Price Waterhouse all Resources' financial records and related data, as well as the minutes of shareowners' and directors' meetings. Management believes that all representations made to Price Waterhouse during its audit were valid and appropriate.\n\tResources maintains a system of internal control designed to provide reasonable, but not absolute, assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. The concept of reasonable assurance recognizes that the cost of a system of internal control should not exceed the benefits derived and that there are inherent limitations in the effectiveness of any system of internal control.\n\tFundamental to the control system is the selection and training of qualified personnel, an organizational structure that provides appropriate segregation of duties, the utilization of written policies and procedures and the continual monitoring of the system for compliance. In addition, Resources maintains an internal auditing program to evaluate Resources' system of internal control for adequacy, application and compliance. Management considers the internal auditors' and Price Waterhouse's recommendations concerning its system of internal control and has taken actions which are believed to be cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that Resources' system of internal control is adequate to accomplish the objectives discussed in this report.\n\tThe Board of Directors, acting through its Audit Committee, oversees management's responsibilities in the preparation of the financial statements. In performing this function, the Audit Committee, which is composed of four independent directors, meets periodically with management, the internal auditors and the independent certified public accountants to review the work of each. The independent certified public accountants and the internal auditors have free access to the Audit Committee and to the Board of Directors, without management present, to discuss internal accounting control, auditing and financial reporting matters.\n\tManagement also recognizes its responsibility for fostering a strong ethical climate so that Resources' affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in Resources' Standards of Integrity, which is publicized throughout Resources. The Standards of Integrity addresses: the necessity of ensuring open communication within Resources; potential conflicts of interest; proper procurement activities; compliance with all applicable laws, including those relating to financial disclosure; and the confidentiality of proprietary information. Resources maintains a systematic program to assess compliance with these policies.\n(Signed) William F. Hecht William F. Hecht Chairman, President and Chief Executive Officer\n(Signed) R. E. Hill R. E. Hill Senior Vice President - Financial and Treasurer\nPennsylvania Power & Light Company Management's Report on Responsibility for Financial Statements\n\tThe management of Pennsylvania Power & Light Company is responsible for the preparation, integrity and objectivity of the consolidated financial statements and all other sections of this annual report. The financial statements were prepared in accordance with generally accepted accounting principles and the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission. In preparing the financial statements, management makes informed estimates and judgments of the expected effects of events and transactions based upon currently available facts and circumstances. Management believes that the financial statements are free of material misstatement and present fairly the financial position, results of operations and cash flows of PP&L.\n\tPP&L's consolidated financial statements have been audited by Price Waterhouse LLP (Price Waterhouse), independent certified public accountants, whose report with respect to the financial statements appears on page 45. Price Waterhouse's appointment as auditors was previously ratified by the shareowners. Management has made available to Price Waterhouse all PP&L's financial records and related data, as well as the minutes of shareowners' and directors' meetings. Management believes that all representations made to Price Waterhouse during its audit were valid and appropriate.\n\tPP&L maintains a system of internal control designed to provide reasonable, but not absolute, assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. The concept of reasonable assurance recognizes that the cost of a system of internal control should not exceed the benefits derived and that there are inherent limitations in the effectiveness of any system of internal control.\n\tFundamental to the control system is the selection and training of qualified personnel, an organizational structure that provides appropriate segregation of duties, the utilization of written policies and procedures and the continual monitoring of the system for compliance. In addition, PP&L maintains an internal auditing program to evaluate PP&L's system of internal control for adequacy, application and compliance. Management considers the internal auditors' and Price Waterhouse's recommendations concerning its system of internal control and has taken actions which are believed to be cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that PP&L's system of internal control is adequate to accomplish the objectives discussed in this report.\n\tThe Board of Directors, acting through Resources' Audit Committee, oversees management's responsibilities in the preparation of the financial statements. In performing this function, the Audit Committee, which is composed of four independent directors, meets periodically with management, the internal auditors and the independent certified public accountants to review the work of each. The independent certified public accountants and the internal auditors have free access to Resources'Audit Committee and to the Board of Directors, without management present, to discuss internal accounting control, auditing and financial reporting matters.\n\tManagement also recognizes its responsibility for fostering a strong ethical climate so that PP&L's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in PP&L's Standards of Integrity, which is publicized throughout PP&L. The Standards of Integrity addresses: the necessity of ensuring open communication within PP&L; potential conflicts of interest; proper procurement activities; compliance with all applicable laws, including those relating to financial disclosure; and the confidentiality of proprietary information. PP&L maintains a systematic program to assess compliance with these policies.\n(Signed) William F. Hecht William F. Hecht Chairman, President and Chief Executive Officer\n(Signed) R. E. Hill R. E. Hill Senior Vice President - Financial\nNOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies - Resources\/PP&L\nGlossary of Terms\n\tTerms and abbreviations appearing in Notes to Financial Statements are explained in the glossary on page 27.\nBusiness and Consolidation\n\tIn 1995, Resources became the parent holding company of PP&L, PMDC and Spectrum. These consolidated financial statements have been restated to reflect the formation of the holding company on a retroactive basis.\n\tPP&L's financial condition and results of operation are currently the principal factors affecting Resources' financial condition and re- sults of operations. All nonutility operating transactions are included in \"Other Income and Deductions -- Other-net\" on the Consolidated State- ment of Income.\n\tThe consolidated financial statements include the accounts of Re- sources and its direct and indirect wholly owned subsidiaries. All sig- nificant intercompany transactions have been eliminated.\n\tLess than 50% owned subsidiaries are accounted for using the equity method. These subsidiaries consist principally of Safe Harbor Water Power Corporation and investments held by PMDC.\nReclassification\n\tCertain amounts from prior years' financial statements have been re- classified to conform to the current year presentation.\nManagement's Estimates\n\tThese financial statements have been prepared using information available to Resources including certain information which represents management's best estimates of existing conditions.\nAccounting Records\n\tThe accounting records for PP&L, the principal subsidiary of Re- sources, are maintained in accordance with the Uniform System of Accounts prescribed by the FERC and adopted by the PUC.\nRegulation\n\tPP&L prepares its financial statements in accordance with the provi- sions of SFAS 71, \"Accounting for the Effects of Certain Types of Regula- tion.\" SFAS 71 requires a rate-regulated entity to reflect the effects of regulatory decisions in its financial statements. In accordance with SFAS 71, PP&L has deferred certain costs pursuant to the rate actions of the PUC and the FERC and is recovering or expects to recover such costs in electric rates charged to customers. These deferred costs or \"regulatory assets\" are enumerated and discussed in Note 9.\n\tTo the extent that PP&L concludes that recovery of a regulatory as- set is no longer probable due to regulatory treatment, the effects of competition or other factors, the amount would have to be written off against income.\nUtility Plant\n\tAdditions to utility plant and replacement of units of property are capitalized at cost. As provided in the Uniform System of Accounts, the cost of funds used to finance construction projects or AFUDC is capital- ized as part of construction cost.\n\tThe cost of units of property retired or replaced is charged to ac- cumulated depreciation. Expenditures for maintenance and repairs of property and the cost of replacing items determined to be less than an entire unit of property are charged to operating expense.\n\tFor financial statement purposes, depreciation is being provided over the estimated useful lives of property using a straight-line method for all property except for certain property at the Susquehanna steam station. Prior to October 1995, PUC and FERC rate orders provided for increasing amounts of annual depreciation for certain property at the Susquehanna station. As a result of the PUC Decision, Susquehanna depre- ciation applicable to property placed in service prior to January 1, 1989, will be recorded at an annual level of $173 million through 1998 at which time depreciation is scheduled to decline by about $71 million to the level that would have been recorded if the straight-line method had been used since the Susquehanna units were placed in service.\n\tDeferred depreciation shown on the Consolidated Balance Sheet is the accumulated difference between the straight-line depreciation that would have been recorded on property placed in service at the Susquehanna sta- tion prior to January 1, 1989 and the amount of depreciation on such property provided for financial reporting purposes and included in rates. The annual difference is shown as amortized depreciation on the Consoli- dated Statement of Income. Provisions for depreciation, as a percent of average depreciable property, approximated 3.7% in 1995, 3.5% in 1994 and 3.3% in 1993.\nNuclear Decommissioning and Fuel Disposal\n\tAn annual provision for PP&L's share of the future cost to decommis- sion the Susquehanna station, equal to the amount allowed for ratemaking purposes, is charged to operating expense. Such amounts are invested in external trust funds which can be used only for future decommissioning costs. See Notes 3 and 6.\n\tThe DOE is responsible for the permanent storage and disposal of spent nuclear fuel removed from nuclear reactors. PP&L currently pays DOE a fee for future disposal services and recovers such costs in cus- tomer rates.\nFinancial Investments\n\tIn January 1994, Resources adopted SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS 115 addresses the ac- counting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securi- ties.\n\tSecurities subject to the requirements of SFAS 115 are carried at fair value, determined at the balance sheet date. Net unrealized gains on available-for-sale securities are included in common equity and to- taled, after applicable income taxes, $3.4 million and $0.3 million at December 31, 1995 and 1994, respectively. Net unrealized gains and losses on trading securities are included in income and amounted to $0.6 million and $(0.2) million for 1995 and 1994, respectively. Net unreal- ized gains and losses on securities that are not available for unre- stricted use by Resources due to regulatory or legal reasons are re- flected in the related asset and liability accounts. Realized gains and losses on the sale of securities are recognized utilizing the specific cost identification method. The adoption of SFAS 115 did not have a ma- terial effect on Resources' net income. Investments in financial limited partnerships are accounted for under the equity method of accounting and venture capital investments are recorded at cost. See Note 7.\nPremium on Reacquired Long-Term Debt\n\tAs provided in the Uniform System of Accounts, the premium paid and expenses incurred by PP&L to redeem long-term debt are deferred and amor- tized over the life of the new debt issue or the remaining life of the retired debt when the redemption is not financed by a new issue.\nCapital Leases\n\tLeased property of PP&L capitalized on the Consolidated Balance Sheet is recorded at the present value of future lease payments and is amortized so that the total of interest on the lease obligation and amor- tization of the leased property equals the rental expense allowed for ratemaking purposes. See Note 8.\nRevenues\n\tElectric revenues are recorded based on the amounts of electricity delivered to customers through the end of each accounting period. This includes amounts customers will be billed for electricity delivered from the time meters were last read to the end of the respective period. For information on the ECR, SBRCA and STAS, see Note 3.\n\tPP&L's PUC tariffs contain an ECR under which customers are billed an estimated amount for fuel and other energy costs. Any difference be- tween the actual and estimated amount for such costs is collected from, or refunded to, customers in a subsequent period. Revenues applicable to ECR billings are recorded at the level of actual energy costs and the difference between amounts billed to customers and the cost of fuel is recorded as payable to, or receivable from, customers.\nIncome Taxes\n\tResources and its wholly owned subsidiaries file a consolidated fed- eral income tax return. Income taxes are allocated to operating expenses and other income and deductions on the Consolidated Statement of Income.\n\tThe provision for PP&L's deferred income taxes included on the Con- solidated Statement of Income is based upon the ratemaking principles re- flected in rates established by the PUC and FERC. The difference in the provision for deferred income taxes and the amount that otherwise would be recorded under generally accepted accounting principles is deferred and included in taxes recoverable through future rates on the Consoli- dated Balance Sheet. See Note 5.\n\tInvestment tax credits were deferred when utilized and are amortized over the average lives of the related property.\nPension Plan and Other Postretirement and Postemployment Benefits\n\tPP&L has a noncontributory pension plan covering substantially all employees, and subsidiary companies of PP&L formerly engaged in coal min- ing have a noncontributory pension plan for substantially all non- bargaining, full-time employees. Funding is based upon actuarially de- termined computations that take into account the amount deductible for income tax purposes and the minimum contribution required under the Em- ployee Retirement Income Security Act of 1974.\n\tFor information on other postretirement and postemployment benefits see Note 11.\nCash Equivalents\n\tResources considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.\nNew Accounting Standards\n\tEffective January 1, 1996, Resources adopted SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" SFAS 121 requires a company to review certain assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an asset is deter- mined to be impaired, an impairment loss is recognized. Resources does not anticipate any impairment as a result of adopting SFAS 121.\n\tAlso effective January 1, 1996, Resources adopted SFAS 123, \"Accounting for Stock-Based Compensation.\" SFAS 123 addresses the recom- mended accounting and required disclosures for stock-based employee com- pensation plans, which include all arrangements by which employees re- ceive shares of stock or other equity instruments of the employer or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. Resources' current accounting for restricted stock awards conforms to requirements as defined in SFAS 123.\n\tThe adoption of SFAS 121 and 123 will not have a significant impact on net income.\n2. Sources of Revenues - PP&L\n\tPP&L is an operating electric utility serving about 1.2 million cus- tomers in a 10,000 square-mile territory of central eastern Pennsylvania with a population of approximately 2.6 million persons. Substantially all of PP&L's operating revenues are derived from the sale of electric energy subject to PUC and FERC regulation.\n\tDuring 1995, about 98% of total operating revenues were derived from electric energy sales, with 34% coming from residential customers, 29% from commercial customers, 20% from industrial customers, 12% from con- tractual sales to other major utilities, 2% from energy sales to members of the PJM and 3% from others.\n3. Rate Matters - PP&L\nBase Rate Filing with the PUC\n\tOn September 27, 1995, the PUC issued a final order with respect to the base rate case filed by PP&L on December 30, 1994.\n\tPP&L's request to increase base rates, which was its first in ten years, sought to increase annual PUC-jurisdictional revenues by $261.6 million, or about 11.7%. The PUC's decision granted PP&L a $107 million increase in base rates based on test year conditions. At the same time, PP&L's ECR was reduced by $22 million related to capacity credit sales resulting in a net increase of $85 million, or about 3.8%, in PUC- jurisdictional revenues effective September 28, 1995.\n\tThe PUC Decision allowed PP&L to levelize the annual amount of de- preciation on pre-1989 property for its Susquehanna station at $173 mil- lion for the period October 1, 1995 through December 31, 1998. This lev- elization eliminates the previously scheduled annual increase in depreciation expense resulting from use of the modified sinking fund method of depreciation.\n\tThe PUC determined that all of PP&L's generating capacity is neces- sary to meet customer needs, rejecting the arguments of some intervenors that an excess capacity adjustment should be imposed on PP&L. As a re- sult of the PUC's action in this regard, PP&L's base rates include a full return on all of its generating facilities used to serve retail custom- ers, as well as all operating expenses associated with those facilities.\n\tAlso, the PUC Decision permitted recovery of the PUC-jurisdictional amount of retiree health care costs resulting from the adoption of SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pen- sions\". In addition, the PUC Decision permitted PP&L to recover, over a period of about 17 years, the amount of SFAS 106 costs that would have been deferred from January 1, 1993, through September 30, 1995, pursuant to a PUC order but for a Commonwealth Court decision that PP&L could not recover these deferred costs. As a result of the PUC Decision, which provided for recovery of $27 million of previously expensed SFAS 106 costs, PP&L recorded a $15.7 million after-tax credit to income, or 10 cents per share of common stock, in the third quarter of 1995.\n\tIn addition, the PUC Decision permitted PP&L to recover through cus- tomer rates the PUC-jurisdictional amount, $65.7 million, of the cost of its 1994 VERP over a period of five years. As a result, PP&L recorded a $37.8 million after-tax credit to expense, or 24 cents per share of com- mon stock, in the third quarter of 1995 to reverse the charge for this program that was recorded in the fourth quarter of 1994. The estimated annual savings of $35 million from the program also are reflected in the allowed rates.\n\tThe PUC Decision also permitted recovery over a 10-year period of certain deferred operating and capital costs, net of energy savings, in- curred from the time Susquehanna Unit No. 2 was placed in commercial op- eration until the effective date of base rate recognition for that Unit, but the PUC denied recovery of similar costs for Susquehanna Unit No. 1. As a result of the PUC Decision with respect to Susquehanna Unit No. 1, PP&L recorded a one-time charge in the third quarter of 1995 which, after taxes, reduced net income by $20.4 million, or 13 cents per share of com- mon stock.\n\tThe PUC Decision made adjustments to the amount requested by PP&L for the currently estimated cost of decommissioning the Susquehanna sta- tion. These adjustments include the elimination of the $106.6 million contingency amount included in the decommissioning cost estimate, an in- crease in the earnings assumption on the decommissioning fund from 5.5% to 7.5% and a reflection of post-shutdown earnings on the fund in calcu- lating the total amount necessary to decommission the Susquehanna sta- tion. After giving effect to these adjustments, the total amount of the Susquehanna station decommissioning costs included in PUC-jurisdictional rates is $9.5 million annually.\n\tThe PUC Decision granted PP&L a return on common equity of 11.5%.\n\tIn its decision, the PUC ruled that PP&L cannot include in its ECR the cost of capacity, currently being billed to other utilities pursuant to contractual arrangements, as those contracts terminate and the capac- ity returns to PP&L. The PUC did rule that PP&L was not required to flow back to PUC-jurisdictional customers through the ECR the revenues re- ceived for off-system sales of capacity and energy attributable to such returning capacity. Accordingly, the PUC Decision permitted the benefits that can be achieved from sales of the returning capacity to accrue to shareowners.\n\tThe OCA has appealed certain aspects of the PUC Decision to the Com- monwealth Court. PP&L cannot predict the final outcome of this matter.\nEnergy Cost Rate Issues\n\tAs a result of the PUC Decision, PP&L adopted a new ECR effective as of September 28, 1995 that reflects the roll-in of all test year energy costs into base rates.\n\tIn April 1994, the PUC reduced PP&L's 1994-95 ECR claim by approxi- mately $15.7 million to reflect costs associated with replacement power during a portion of the period that Susquehanna Unit 1 was out of service for refueling and repairs. As a result of the PUC's action, PP&L re- corded a charge against income in the first quarter of 1994 for the $15.7 million of unrecovered replacement power costs which reduced earnings by 6 cents per share of common stock.\n\tPP&L filed a complaint with the PUC objecting to the decision to ex- clude these replacement power costs from the 1994-95 ECR, and subse- quently reached a settlement with the OTS and other parties to the pro- ceeding reducing the amount of disallowed costs.\n\tThe PUC approved the settlement agreement and in the first quarter of 1995, PP&L recorded a credit to income of $9.7 million which increased earnings by 4 cents per share of common stock.\nSpecial Base Rate Credit Adjustment\n\tThe SBRCA, which has been in effect since April 1, 1991, reduces PUC-jurisdictional customers' bills for the effects of two nonrecurring items. The first item is the annual amortization over a five-year period of a credit to income associated with PP&L's use of an inventory method of accounting for power plant spare parts. This credit will expire March 31, 1996.\n\tThe second relates to the proceeds from the settlement of outstand- ing contract claims arising from construction of the Susquehanna station. In accordance with approval of the settlement by the PUC, PP&L began, on April 1, 1992, to return the settlement proceeds to PUC customers through the SBRCA. This credit will expire March 31, 1997.\n\tA third nonrecurring item ended with the implementation of the new PUC rates and related to costs that were being recovered from Atlantic pursuant to the sale of 125,000 kilowatts of capacity (summer rating) and related energy from PP&L's wholly owned coal-fired stations beginning Oc- tober 1, 1991. As a result of the PUC Decision, PP&L's SBRCA was changed to exclude that portion of the credit associated with the Atlantic con- tract, since the costs recovered from Atlantic were excluded from PUC- jurisdictional base rates.\nRefund of State Tax Decrease\n\tIn accordance with PP&L's tariffs, PUC-jurisdictional rates are ad- justed for changes in certain state taxes.\n\tDue to the two state legislation changes decreasing the Pa. CNI rate as described in Note 5, and the PUC Decision which reflected a 10.99% Pa. CNI rate in base rates, PP&L filed three changes to its STAS in 1995. The final STAS filing, which was approved on October 26, 1995, is ex- pected to reduce customer rates by about $12.9 million through March 1996. This change has no effect on net income.\nFERC-Major Utilities' Rates\n\tIn October 1995, the FERC approved PP&L's request to recover postre- tirement benefits other than pensions through its contractual agreements with other major electric utilities, subject to refund after FERC review. PP&L is billing these utilities their share of postretirement costs other than pensions incurred since January 1993. See Note 4 for more details on these contracts.\n\tIn an October 1995 order, the FERC also ordered hearings to evaluate the justness and reasonableness of PP&L's rates in its contractual agree- ments with JCP&L, Atlantic, BG&E and UGI.\n\tIn January 1996, PP&L filed a request with the FERC to incorporate a change in the method of calculating decommissioning in several of its contractual agreements with other major utilities. PP&L also requested to increase its decommissioning rate to reflect the projected cost of de- commissioning the Susquehanna station and fossil plants.\n\tPP&L cannot predict the outcome of these proceedings.\nUranium Enrichment Decontamination and Decommissioning Fund\n\tThe Energy Act established the D&D Fund and provides for an assess- ment on domestic utilities with nuclear power operations, including PP&L. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the Energy Act and the assessments are expected to be paid to the D&D Fund by such utilities over a 15-year period. Amounts paid to the D&D Fund are to be used for the ultimate de- contamination and decommissioning of the DOE's uranium enrichment facili- ties. The Energy Act states that the assessment shall be deemed a neces- sary and reasonable current cost of fuel and shall be fully recoverable in rates in all jurisdictions in the same manner as the utility's other fuel costs.\n\tAs of December 31, 1995, PP&L's recorded liability for its total as- sessment amounted to about $29.7 million. The liability is subject to adjustment for inflation. The corresponding charge to expense was de- ferred because PP&L includes its annual payments to the D&D Fund in the ECR which is in PP&L's PUC tariffs and in the fuel adjustment clause which is in PP&L's FERC tariffs. As a result, the assessment does not affect net income.\n4. Sales to Other Major Electric Utilities - PP&L\n\tPP&L provides Atlantic with 125,000 kilowatts of capacity (summer rating) and related energy from its wholly owned coal-fired stations. The agreement with Atlantic originally provided for sales to continue through September 2000.\n\tOn March 20, 1995, Atlantic notified PP&L that it will terminate the agreement on March 20, 1998, pursuant to termination provisions in the agreement. PP&L expects to be able to resell the capacity and energy at market prices.\n\tPP&L provided JCP&L with 945,000 kilowatts of capacity and related energy from all of its generating units. Sales to JCP&L were at the 945,000 kilowatt level in 1995, and the amount will decline uniformly each year beginning January 1996 (189,000 kilowatts per year) until the end of the agreement on December 31, 1999.\n\tIn August 1995, JCP&L filed a complaint against PP&L with the FERC regarding billings under the agreement. In its complaint, JCP&L alleges that PP&L inappropriately allocated certain costs to JCP&L that should not have been billed and seeks other adjustments. JCP&L is seeking both refunds (with interest) in an unspecified amount and an amendment to the agreement. PP&L has denied JCP&L's allegations and requested that FERC dismiss the complaint. PP&L cannot predict the final outcome of this proceeding.\n\tIn April 1995, PP&L entered into a new agreement with JCP&L whereby PP&L would provide JCP&L increasing amounts of capacity credits and en- ergy from all of its generating units. Sales to JCP&L under this agree- ment begin in June 1997 and continue through May 2004. Under this agree- ment, PP&L would provide JCP&L 150,000 kilowatts of capacity credits and energy from June 1997 through May 1998, 200,000 kilowatts from June 1998 through May 1999 and 300,000 kilowatts from June 1999 through May 2004. Sales under the new agreement are priced based on a predetermined demand rate that escalates over time, plus an energy component based on PP&L's actual fuel-related costs. This agreement with JCP&L must be approved by the FERC and the New Jersey Board of Public Utilities.\n\tPP&L provides BG&E with 129,000 kilowatts or 6.6 percent of its share of capacity and related energy from the Susquehanna station. Sales to BG&E will continue through May 2001.\n\tSee Note 3 for more information about these contracts.\n\tIn December 1995, PP&L entered into a one year agreement with PSE&G, which provides PSE&G with 245,000 kilowatts of delivered output from Mar- tins Creek Units 1 & 2. PP&L will continue to seek additional opportuni- ties to market its capacity and energy in the bulk power markets that will produce revenues in excess of the amount that would be realized through economy energy sales on the PJM. 5. Taxes - Resources\/PP&L \tThe corporate federal income tax rate from 1993 to 1995 was 35%. \tIn June 1994, state legislation was enacted that decreased the Pa. CNI rate from 12.25% to 11.99% retroactive to January 1, 1994, with fur- ther reductions to 10.99%, 10.75% and 9.99% in 1995, 1996 and 1997, re- spectively. In June 1995, state legislation was enacted that accelerated the tax decrease to 9.99% retroactive to January 1, 1995. For 1995 and 1994, Resources recorded a decrease in income tax expense of $8.1 million and $0.8 million respectively, substantially all of which was reflected in lower customer rates through the STAS. For 1995 and 1994 Resources also recorded a decrease in deferred income tax liabilities and taxes re- coverable through future rates of $1.1 million and $124.0 million respec- tively to reflect the new tax rates.\n\tThe tax effects of significant temporary differences comprising Re- sources' net deferred income tax liability were as follows (thousands of dollars): 1995 1994\nDeferred tax assets Deferred investment tax credits $90,101 $ 94,650 Accrued pension costs 53,859 67,327 Other 87,122 107,830 Valuation allowance (5,920) (8,183) 225,162 261,624 Deferred tax liabilities Electric utility plant - net 1,787,975 1,790,378 Other property - net 11,728 13,829 Taxes recoverable through future rates 416,110 409,417 Reacquired debt costs 48,301 46,934 Other 25,722 20,355 2,289,836 2,280,913 Net deferred tax liability $2,064,674 $2,019,289\n\tDetails of the components of income tax expense, a reconciliation of federal income taxes derived from statutory tax rates applied to income from continuing operations for accounting purposes and details of taxes, other than income are as follows (thousands of dollars):\nIncome Tax Expense 1995 1994 1993 Included in operating expenses Provision - Federal $195,028 $198,777 $162,795 State 62,388 76,903 63,508 257,416 275,680 226,303 Deferred - Federal 9,020 (34,177) 22,491 State 5,998 (11,021) (124) 15,018 (45,198) 22,367 Investment tax credit, net - Federal (10,814) (12,253) (13,506) 261,620 218,229 235,164 Included in other income and deductions Provision (credit) - Federal 8,127 (18,453) (5,134) State 4,203 (7,309) 486 12,330 (25,762) (4,648) Deferred - Federal 9,450 (8,688) 4,047 State 2,111 (4,197) (679) 11,561 (12,885) 3,368 23,891 (38,647) (1,280)\nTotal income tax expense - Federal 210,811 125,206 170,693 State 74,700 54,376 63,191 $285,511 $179,582 $233,884\nReconciliation of Income Tax Expense Indicated federal income tax on pre-tax income at statutory tax rate - 35% $222,576 $148,373 $203,704 Increase (decrease) due to: State income taxes 50,141 35,017 41,829 Flow through of depreciation differences not previously normalized 16,479 14,883 8,470 Amortization of investment tax credit (10,814) (12,253) (13,506) Other 7,129 (6,438) (6,613) 62,935 31,209 30,180 Total income tax expense $285,511 $179,582 $233,884 Effective income tax rate 44.9% 42.4% 40.2%\nTaxes, Other Than Income State gross receipts $101,783 $ 99,311 $ 98,280 State utility realty 45,940 46,556 45,292 State capital stock 32,545 34,739 35,943 Social security and other 20,366 20,555 24,452 $200,634 $201,161 $203,967\n6. Nuclear Decommissioning Costs - PP&L\n\tPP&L's most recent estimate of the cost to decommission the Susque- hanna station was completed in 1993 and was a site-specific study, based on immediate dismantlement and decommissioning of each unit following fi- nal shutdown. The study indicates that PP&L's 90% share of the total es- timated cost of decommissioning the Susquehanna station is approximately $724 million in 1993 dollars. The estimated cost includes decommissioning the radiological portions of the station and the cost of removal of non- radiological structures and materials. The operating licenses for Units 1 and 2 expire in 2022 and 2024, respectively.\n\tDecommissioning costs charged to operating expense were $8.5 million in 1995, $7.2 million in 1994 and $6.9 million in 1993 and are based upon amounts included in customer rates. The increase in 1995 is a result of the PUC Decision in which recovery of decommissioning costs was based on the cost estimates in the 1993 site-specific study. Rates charged to other small FERC wholesale customers reflect the estimated cost of decom- missioning in the 1993 study. In January 1996, PP&L filed with the FERC to increase its decommissioning rate to reflect the projected cost of de- commissioning the Susquehanna station. See Note 3 for further informa- tion.\n\tAmounts collected from customers for decommissioning, less applica- ble taxes, are deposited in external trust funds for investment and can be used only for future decommissioning costs. The market value of secu- rities held and accrued income in the trust funds at December 31, 1995 and 1994 aggregated approximately $109.4 million, including $7.0 million of net unrealized gains, and $87.5 million, including $0.7 million of net unrealized losses, respectively. The trust funds experienced, on a fair market value basis, a $14.0 million net gain in 1995, which includes net unrealized appreciation of $7.7 million, and a net loss in 1994 of $2.3 million, which includes net unrealized depreciation of $6.7 million. The trust fund activity is reflected in the nuclear plant decommissioning trust fund and in other noncurrent liabilities on the Consolidated Bal- ance Sheet. Accrued nuclear decommissioning costs were $112.2 million and $89.7 million at December 31, 1995 and 1994, respectively.\n\tThe FASB issued an exposure draft on the accounting for liabilities related to closure and removal of long-lived assets, including decommis- sioning of nuclear power plants. As a result, current electric utility industry accounting practices for decommissioning may change, including the possibility that the estimated cost for decommissioning could be re- corded as a liability on a basis other than an accrual over the estimated life of the power plant.\n7. Financial Instruments - Resources\n\tThe carrying amount shown on the Consolidated Balance Sheet and the estimated fair value of Resources' financial instruments are as follows (thousands of dollars):\nDecember 31, 1995 December 31, 1994 \t Carrying Fair Carrying Fair \t Amount Value Amount Value \tAssets \t Nuclear plant decommis- \t sioning trust fund (a) $109,400 $109,400 $ 87,490 $ 87,490 \t Financial investments (a) 237,985 236,069 220,169 219,038 \t Other investments 20,742 20,742 8,654 8,654 \t Cash and cash equivalents 19,883 19,883 10,079 10,079 \t Other financial instru- \t ments included in \t other current assets 3,163 3,163 2,435 2,435\n\tLiabilities \t Preferred stock with \t sinking fund require- \t ments (b) 295,000 294,825 295,000 265,275 \t Long-term debt (b) 2,858,728 3,032,742 2,940,789 2,756,131 \t Commercial paper and \t bank loans 89,145 89,145 74,168 74,168\n\t(a) The carrying value of financial instruments generally is based on established market prices and approximates fair value. \t(b) The fair value generally is based on quoted market prices for the securities where available and estimates based on current rates offered to Resources where quoted market prices are not available.\n8. Leases - PP&L\n\tPP&L has entered into capital leases consisting of the following (thousands of dollars):\nDecember 31 1995 1994 \tNuclear fuel, (net of \t accumulated amortization \t 1995, $147,587; 1994, \t $196,617) $135,066 $144,380 \tVehicles, oil storage tanks \t and other property, \t (net of accumulated amortization \t 1995, $91,914; 1994, $84,330) 84,575 80,385\n\tNet property under capital leases $219,641 $224,765\n\tCapital lease obligations incurred for the acquisition of nuclear fuel and other property were (millions of dollars): 1995, $74.0; 1994, $62.0 and 1993, $84.0.\n\tNuclear fuel lease payments, which are charged to expense as the fuel is used for the generation of electricity, were (millions of dol- lars): 1995, $63.2; 1994, $71.8 and 1993, $67.6. Future nuclear fuel lease payments are based on the quantity of electricity produced by the Susquehanna station. The maximum amount of unamortized nuclear fuel available for lease under current arrangements is $200 million.\n\tFuture minimum lease payments under capital leases in effect at De- cember 31, 1995 (excluding nuclear fuel) aggregate $99.7 million, includ- ing $15.2 million in imputed interest. During the five years ending 2000, such payments decrease from $31.3 million per year to $7.1 million per year.\n\tInterest on capital lease obligations was recorded as operating ex- penses on the Consolidated Statement of Income in the following amounts (millions of dollars): 1995, $14.4; 1994, $11.1 and 1993, $9.1.\n\tGenerally, capital leases obligate PP&L to pay maintenance, insur- ance and other related costs and contain renewal options. Various oper- ating leases have also been entered into which are not material with re- spect to PP&L's financial position.\n9. Regulatory Assets - PP&L\n\tThe following regulatory assets were reflected in the Consolidated Balance Sheet (thousands of dollars):\n1995 1994 \tDeferred depreciation $ 209,330 $ 256,021 \tDeferred operating and carrying \t costs - Susquehanna 18,390 39,215 \tReacquired debt costs 116,954 113,466 \tTaxes recoverable through future \t rates 1,002,902 986,292 \tAssessment for decommissioning \t uranium enrichment facilities 31,686 33,492 \tPostretirement benefits other \t than pensions 31,406 \tVoluntary early retirement program 62,377 \tOther 56,632 52,307 \t $1,529,677 $1,480,793\n\tAs of December 31, 1995, all of PP&L's regulatory assets are being recovered through rates charged to customers over periods ranging from 3 to 29 years.\n\tFor a discussion of taxes recoverable through future rates, postre- tirement benefits other than pensions, assessment for decommissioning uranium enrichment facilities, VERP, and additional information on the PUC Decision, see Notes 3, 5, 11, and 12.\n10. Credit Arrangements - PP&L\n\tPP&L issues commercial paper and, from time to time, borrows from banks to provide short-term funds required for general corporate pur- poses. In addition, certain subsidiaries also borrow from banks to ob- tain short-term funds. Bank borrowings generally bear interest at rates negotiated at the time of the borrowing. PP&L's weighted average inter- est rate on short-term borrowings was 6.0% and 6.1% at December 31, 1995 and 1994, respectively.\n\tPP&L has entered into a $250 million revolving credit arrangement with a group of banks. Any loans made under this credit arrangement would mature in September 1999 and, at the option of PP&L, interest rates would be based upon certificate of deposit rates, Eurodollar deposit rates or the prime rate. PP&L has additional credit arrangements with another group of banks. The banks have committed to lend PP&L up to $45 million under these credit arrangements, which mature in November 1996, at interest rates based upon Eurodollar deposit rates or the prime rate. These credit arrangements produce a total of $295 million of lines of credit to provide back-up for PP&L's commercial paper and short-term bor- rowings of certain subsidiaries. No borrowings were outstanding at De- cember 31, 1995 under these credit arrangements.\n\tPP&L leases its nuclear fuel from a trust. The maximum financing capacity of the trust under existing credit arrangements is $200 million.\n11.\tPension Plan and Other Postretirement and \tPostemployment Benefits - PP&L\nPension Plan\n\tPP&L has a funded noncontributory defined benefit pension plan cov- ering substantially all employees. Benefits are based upon a partici- pant's earnings and length of participation in the Plan, subject to meet- ing certain minimum requirements.\n\tPP&L also has two unfunded supplemental retirement plans for certain management employees and directors. Benefit payments pursuant to these supplemental plans are made directly by PP&L. At December 31, 1995, the projected benefit obligation of these supplemental plans was approxi- mately $19.2 million. Effective December 1, 1994, PMDC has a non- qualified retirement plan for its corporate officers. The cost of the plan was immaterial in 1995.\n\tThe components of PP&L's net periodic pension cost for the three plans were (thousands of dollars):\n1995 1994 1993\nService cost-benefits earned during the period $ 27,549 $ 33,527 $ 31,381 Interest cost 57,711 51,330 48,266 Actual return on plan assets (241,075) 28,680 (92,085) Net amortization and deferral 166,758 (96,413) 29,696\nNet periodic pension cost $ 10,943 $ 17,124 $ 17,258\n\tThe net periodic pension cost charged to operating expenses was $6.4 million in 1995, $9.9 million in 1994 and $10.1 million in 1993. The balance was charged to construction and other accounts. The funded status of PP&L's Plan was (thousands of dollars):\nDecember 31 1995 1994\nFair value of plan assets $1,086,236 $ 888,214 Actuarial present value of benefit obligations: Vested benefits 673,264 573,564 Nonvested benefits 1,343 1,396 Accumulated benefit obligation 674,607 574,960 Effect of projected future compensation 194,203 173,311 Projected benefit obligation 868,810 748,271 Plan assets in excess of projected benefit obligation 217,426 139,943 Unrecognized transition assets (being amortized over 23 years) (63,277) (67,796) Unrecognized prior service cost 58,598 61,941 Unrecognized net gain (394,105) (288,105)\nAccrued expense $(181,358) $(154,017)\n\tThe weighted average discount rate used in determining the actuarial present value of projected benefit obligations was 6.75% and 7.5% on De- cember 31, 1995 and 1994, respectively. The rate of increase in future compensation used in determining the actuarial present value of projected benefit obligations was 5.0% and 5.7% on December 31, 1995 and 1994, re- spectively. The assumed long-term rates of return on assets used in de- termining pension cost in 1995 and 1994 was 8.0%. Plan assets consist primarily of common stocks, government and corporate bonds and temporary cash investments.\n\tPP&L's subsidiaries formerly engaged in coal mining have a noncon- tributory defined benefit pension plan covering substantially all non- bargaining unit, full-time employees which is fully funded, primarily by group annuity contracts with insurance companies. In addition, the com- panies are liable under federal and state laws to pay black lung benefits to claimants and dependents with respect to approved claims, and are mem- bers of a trust which was established to facilitate payment of such li- abilities. Such costs were not material in 1995, 1994 and 1993.\nPostretirement Benefits Other Than Pensions\n\tSubstantially all employees of PP&L and its subsidiaries will become eligible for certain health care and life insurance benefits upon retire- ment. PP&L sponsors four health and welfare benefit plans that cover substantially all management and bargaining unit employees upon retire- ment. One plan provides for retiree health care benefits to certain man- agement employees, another plan provides retiree health care benefits to bargaining unit employees, a third plan provides retiree life insurance benefits to certain management employees up to a specified amount and a fourth plan provides retiree life insurance benefits to bargaining unit employees.\n\tDollar limits have been established for the amount PP&L will con- tribute annually toward the cost of retiree health care for employees re- tiring after March 1993.\n\tIn January 1993, PP&L adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires PP&L to ac- crue, during the years that the employees render the necessary service, the expected cost of providing retiree health care and life insurance benefits. The adoption of SFAS 106 did not have a material effect on PP&L's net income. In accordance with a PUC order, PP&L had deferred the PUC-jurisdictional accrued cost of retiree health and life insurance benefits in excess of actual claims paid pending recovery of the in- creased cost in retail rates. As a result of a decision of the Common- wealth Court, in 1994 PP&L started to expense the increased costs appli- cable to operations that were previously being deferred and wrote off such costs deferred in 1993.\n\tThe PUC Decision permitted recovery of the PUC-jurisdictional amount of retiree health care costs resulting from the adoption of SFAS 106. In addition, the PUC Decision permitted PP&L to recover, over a period of about 17 years, the amount of SFAS 106 costs that would have been de- ferred from January 1, 1993 through September 30, 1995, pursuant to a PUC order but for a Commonwealth Court decision that PP&L could not recover these deferred costs. As a result of the PUC Decision, which provided for recovery of $27 million of previously expensed SFAS 106 costs, PP&L recorded a $15.7 million after-tax credit to income, or 10 cents per share of common stock, in the third quarter of 1995.\n\tIn December 1993, PP&L established a separate VEBA for each of the four health and welfare benefit plans for retirees. After making initial contributions, additional funding of the trusts was deferred pending resolution of PP&L's ability to recover the costs of the plans in rates. In December 1995, as a result of the PUC Decision, PP&L resumed funding of these trusts.\n\tThe following table sets forth the plans' combined funded status reconciled with the amount shown on Resources' Consolidated Balance Sheet as of December 31 (thousands of dollars):\n1995 1994 Accumulated postretirement benefit obligation: Retirees $127,926 $124,484 Fully eligible active plan participants 18,184 13,604 Other active plan participants 78,790 68,828 224,900 206,916 Plan assets at fair value, primarily temporary cash investments 29,208 23,506 Accumulated postretirement benefit obligation in excess of plan assets 195,692 183,410 Unrecognized prior service costs (5,208) Unrecognized net loss (18,275) (13,770) Unrecognized transition obligation (being amortized over 20 years) (147,750) (156,448)\nAccrued postretirement benefit cost $ 24,452 $ 13,192\n\tThe net periodic postretirement benefit cost included the following components (thousands of dollars):\n1995 1994 1993\nService cost - benefits attributed to service during the period $ 3,711 $ 4,286 $ 3,699 Interest cost on accumulated postretirement benefit obligation 15,339 14,189 13,008 Actual return on plan assets (1,737) (435) Net amortization and deferral 8,544 7,645 8,691\nNet periodic postretirement benefit cost $ 25,857 $ 25,685 $25,398\n\tRetiree health and benefits costs charged to operating expenses were a net credit of approximately $16.5 million in 1995, reflecting a $32.1 million credit due to the PUC Decision and costs applicable to contrac- tual agreements with other major utilities, $27.2 million in 1994 (which includes $10.8 million of retiree health and benefits costs previously deferred in 1993) and $6.9 million in 1993. Costs in excess of the amount charged to expense were charged to construction and other ac- counts.\n\tFor measurement purposes, a 9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1996; the rate was assumed to decrease gradually to 6% by 2006 and remain at that level thereafter. Increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit ob- ligation as of December 31, 1995, by about $10.4 million and the aggre- gate of the service and interest cost components of net periodic postre- tirement benefit cost for the year then ended by about $1.0 million.\n\tIn determining the accumulated postretirement benefit obligation, the weighted average discount rate used was 6.75% and 7.5% on December 31, 1995 and 1994, respectively. The trusts that are holding the plan assets, except for retiree health care benefits to certain management em- ployees, are tax-exempt. The expected long-term rate of return on plan assets for the tax-exempt trusts was 6.5% on December 31, 1995 and 1994.\n\tIn 1992, as a result of the Energy Act, PP&L's subsidiaries formerly engaged in coal mining accrued an additional liability for the cost of health care of retired miners previously employed by them. The new li- ability, based on the present value of future benefits, was estimated at $58 million. As of December 31, 1995, this estimate remains unchanged.\nPostemployment Benefits\n\tPP&L provides health and life insurance benefits to disabled employ- ees and income benefits to eligible spouses of deceased employees. In December 1993, the Company adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" which requires a company to accrue, during the years that the employees render the necessary service, the expected cost of providing benefits to former or inactive employees after employment but before retirement. The adoption of SFAS 112 did not have a material effect on PP&L's net income. Postemployment benefits charged to operat- ing expenses were $0.2 million, $2.1 million and $6.5 million for 1995, 1994 and 1993, respectively. Postemployment benefits charged to operat- ing expenses decreased in 1995 from 1994 due to a change in assumptions used in the 1995 actuarial study.\n12. Workforce Reductions - PP&L\n\tPP&L continued to reduce the size of its workforce in 1995 as part of ongoing efforts to reduce costs. During 1995, PP&L offered a volun- tary severance program to employees who are members of the IBEW Local 1600 and continued re-engineering efforts that reduced the management workforce. Total employment declined in 1995 by approximately 225 due to these two initiatives. In addition, PP&L expects, and has accrued costs for, additional management workforce reductions in the first half of 1996. The costs of the workforce reductions in 1995 amounted to about $18.6 million after-tax, or 12 cents per share of common stock.\n\tDuring 1994, PP&L offered a voluntary early retirement program to 851 employees who were age 55 or older by December 31, 1994. A total of 640 employees elected to retire under the program, at a total cost of $75.9 million. PP&L recorded the cost of the program as a charge against income in the fourth quarter of 1994, which reduced net income by $43.4 million, or 28 cents per share of common stock. As a result of the PUC Decision, which permitted recovery of the PUC-jurisdictional amount through customer rates, PP&L recorded in 1995 a $37.8 million after-tax credit to expense, or 24 cents per share of common stock, to reverse the charge for this program that was recorded in 1994. PP&L estimates annual savings of $35 million from this program which were included in the re- cently decided rate case.\n13. Jointly Owned Facilities - PP&L\n\tAt December 31, 1995, PP&L or a subsidiary owned undivided interests in the following facilities (millions of dollars):\nMerrill -----Generating Stations------ Creek Susquehanna Keystone Conemaugh Reservoir Ownership interest 90.00% 12.34% 11.39% 8.37% Electric utility plant in service $4,068 $64 $101 Other property $22 Accumulated depreciation 851 32 32 7 Construction work in progress 35 1 1\n\tEach participant in these facilities provides its own financing. PP&L receives a portion of the total output of the generating stations equal to its percentage ownership. PP&L's share of fuel and other oper- ating costs associated with the stations is reflected on the Consolidated Statement of Income. The Merrill Creek Reservoir provides water during periods of low river flow to replace water from the Delaware River used by PP&L and other utilities in the production of electricity.\n14. Subsidiary Coal Reserves - PP&L\n\tIn connection with a review by PP&L of its non-core business assets performed in 1994, a subsidiary of PP&L initiated an evaluation of the carrying value of its $83.5 million investment in undeveloped coal re- serves in western Pennsylvania. Outside appraisal firms completed the evaluation and indicated that due to changing market conditions an im- pairment had occurred. Accordingly, the carrying value of this invest- ment was written down to its estimated net realizable value of $9.8 mil- lion, resulting in a $73.7 million pre-tax charge to income. This write down resulted in an after-tax charge to income of $40 million in 1994, which reduced 1994 earnings by approximately 26 cents per share of common stock.\n\tThese reserves were acquired in 1974 with the intention of supplying future coal-fired generating stations. PP&L concluded that it would not develop these reserves. In November 1995, the coal reserves were sold for $52 million, which resulted in a $41.7 million gain, or $20.3 million after-tax, and increased 1995 earnings by approximately 12 cents per share of common stock.\n15. Commitments and Contingent Liabilities - PP&L\nConstruction Expenditures\n\tPP&L's construction expenditures are estimated to aggregate $308 million in 1996, $258 million in 1997 and $265 million in 1998, including AFUDC. For discussion pertaining to construction expenditures, see Re- view of Resources' Financial Condition and Results of Operations under the caption \"Financial Condition -- Reduction in Capital Expenditure Re- quirements\" on page 35.\nNuclear Operations\n\tPP&L is a member of certain insurance programs which provide cover- age for property damage to members' nuclear generating stations. Facili- ties at the Susquehanna station are insured against property damage losses up to $2.75 billion under these programs. PP&L is also a member of an insurance program which provides insurance coverage for the cost of replacement power during prolonged outages of nuclear units caused by certain specified conditions. Under the property and replacement power insurance programs, PP&L could be assessed retrospective premiums in the event of the insurers' adverse loss experience. The maximum amount PP&L could be assessed under these programs at December 31, 1995 was about $40.0 million.\n\tNRC regulations require that in the event of an accident, where the estimated cost of stabilization and decontamination exceeds $100 million, proceeds of property damage insurance be segregated and used, first, to place and maintain the reactor in a safe and stable condition and, sec- ond, to complete required decontamination operations before any insurance proceeds would be made available to PP&L or the trustee under the Mort- gage. PP&L's on-site property damage insurance policies for the Susque- hanna station conform to these regulations.\n\tPP&L's public liability for claims resulting from a nuclear incident at the Susquehanna station is limited to about $8.9 billion under provi- sions of The Price Anderson Amendments Act of 1988. PP&L is protected against this liability by a combination of commercial insurance and an industry assessment program. A utility's liability under the assessment program will be indexed not less than once during each five-year period for inflation and will be subject to an additional surcharge of 5% in the event the total amount of public claims and costs exceeds the basic as- sessment. In the event of a nuclear incident at any of the reactors cov- ered by The Price Anderson Amendments Act of 1988, PP&L could be assessed up to $151 million per incident, payable at a rate of $20 million per year, plus the additional 5% surcharge, if applicable.\nFuel Oil Dealers' Litigation\n\tIn August 1991, a group of fuel oil dealers in PP&L's service area filed a complaint against PP&L in District Court alleging that PP&L's promotion of electric heat pumps and off-peak thermal storage systems had violated, and continues to violate, the federal antitrust laws. Specifi- cally, the complaint alleged that PP&L's use of its PUC-filed tariff to provide a lower electric rate for newly constructed residences equipped with thermal storage systems, combined with PP&L's program of providing cash grants to developers and contractors for the installation of high efficiency heat pumps in these residences allowed PP&L to illegally cap- ture at least 70% of the market for heating in new residential construc- tion within its service area.\n\tThe complaint requests judgment against PP&L for a sum in excess of $10 million for the alleged antitrust violations, treble the damages al- leged to have been sustained by the plaintiffs over the past four years. The complaint also requests a permanent injunction against all activities found to be illegal, including the cash grant program.\n\tPP&L filed a motion for summary judgment seeking to dispose of plaintiffs' claims in this case, and in September 1992, the judge ruled on this motion and dismissed all counts against PP&L. The plaintiffs ap- pealed to the Court of Appeals for the Third Circuit. In April 1994, the Court of Appeals issued a decision which in part affirmed the lower court's grant of summary judgment for PP&L, but reversed the grant of summary judgment as to PP&L's payment of cash grants to developers based upon all-electric builder agreements.\n\tThe district court judge has reacquired jurisdiction over this case, and a trial date has been set for September 1996. PP&L cannot predict the outcome of this litigation.\nEnvironmental Matters\n\tAir\n\tThe Clean Air Act deals, in part, with acid rain under Title IV, at- tainment of federal ambient ozone standards under Title I, and toxic air emissions under Title III. The acid rain provisions specified Phase I sulfur dioxide emission limits for about 55% of PP&L's coal-fired gener- ating capacity by January 1995, and more stringent Phase II sulfur diox- ide emission limits for all of PP&L's fossil-fueled generating units by January 2000. PP&L has complied with the Phase I acid rain provisions under Title IV. To meet the Phase II limits, PP&L plans to purchase lower sulfur coal, utilize banked emission allowances and purchase addi- tional emission allowances instead of relying on FGD. PP&L's decision not to install FGD, with an estimated capital cost of $413 million, on the two generating units at the Montour station represents a significant reduction in previously planned capital expenditures. PP&L filed appli- cations for Phase II permits for its fossil-fuel fired plants in December 1995. The permit applications state that PP&L will comply with applica- ble requirements and obtain emission allowances for each ton of sulfur dioxide emitted.\n\tPP&L has met the initial requirements under Title I to install rea- sonably available control technology to reduce nitrogen oxide emissions. An additional two-phase reduction in nitrogen oxides from pre-Clean Air Act levels has been proposed for the area where PP&L's plants are lo- cated, a 55% reduction by May 1999 and a 75% reduction by 2003, unless scientific studies expected to be completed by 1997 indicate a different reduction is appropriate. The reductions would be required during a five-month ozone season from May through September. Expenditures to meet the 1999 requirements are included in the table of projected construction expenditures in \"Financial Condition - Reduction in Capital Expenditure Requirements\" on page 35.\n\tIn addition to acid rain and ambient ozone attainment provisions, the clean air legislation requires the EPA to conduct a study of hazard- ous air emissions from power plants. EPA is also studying the health ef- fects of fine particulates which are emitted from power plants and other sources. Adverse findings from either study could cause the EPA to man- date additional ultra high efficiency particulate removal baghouses or specialized flue gas scrubbing to remove certain vaporous trace metals and certain gaseous emissions.\n\tPP&L currently estimates that additional capital expenditures and operating costs for environmental compliance under the Clean Air Act will be incurred beyond 2000 in amounts which are not now determinable but could be material.\n\tThe Pennsylvania Air Pollution Control Act implements the Clean Air Act. The state legislation essentially requires that new state air emis- sion standards be no more stringent than federal standards. This legis- lation is not expected to significantly affect PP&L's plans for compli- ance with the Clean Air Act.\n\tThe PUC's policy regarding the trading and usage of, and the rate- making treatment for, emission allowances by Pennsylvania electric utili- ties provides, among other things, that the PUC will not require approval of specific transactions and that the cost of allowances will be recog- nized as energy-related power production expenses and recoverable through the ECR.\n\tWater and Residual Waste\n\tThe DEP regulations governing the handling and disposal of indus- trial (or residual) solid waste require PP&L to upgrade and repermit ex- isting ash basins at all of its coal-fired generating stations by apply- ing updated standards for waste disposal. Ash basins that cannot be repermitted are required to close by July 1997. Any groundwater contami- nation caused by the basins must also be addressed. Any new ash disposal facility must meet the rigid siting and design standards set forth in the regulations. In addition, the siting of future facilities could be af- fected.\n\tTo address the DEP regulations, PP&L is moving forward with its plan to install dry fly ash handling systems at the Brunner Island, Sunbury and Holtwood stations similar to Montour's facilities. Dry fly ash han- dling provides new opportunities for its beneficial use as opposed to disposing of it on-site.\n\tGroundwater degradation related to fuel oil leakage from underground facilities and seepage from coal refuse disposal areas and coal storage piles has been identified at several PP&L generating stations. Many re- quirements of the DEP regulations address these groundwater degradation issues. PP&L has reviewed its remedial action plans with the DEP. Reme- dial work is substantially completed at two generating stations. At this time, there is no indication that remedial work will be required at other PP&L generating stations.\n\tThe DEP regulations to implement the toxic control provisions of the Federal Water Quality Act of 1987 and to advance Pennsylvania's toxic control program authorize the DEP to use both biomonitoring and a water quality-based chemical-specific approach in the NPDES permits to control toxics. The current Montour station NPDES permit contains stringent lim- its for certain toxic metals and increased monitoring requirements. Toxic reduction studies are being conducted at the Montour station before the permit limits become effective. Depending on the results of the studies, additional water treatment facilities may be needed at the Mon- tour station. Improvements and upgrades are being planned for the Sun- bury, Brunner Island and Holtwood stations' waste water treatment systems to meet the anticipated NPDES permit requirements.\n\tCapital expenditures through 2000 to comply with the residual waste regulations, correct groundwater degradation at fossil-fueled generating stations and address waste water control at PP&L facilities, are included in the table of construction expenditures in \"Financial Condition - Re- duction in Capital Expenditure Requirements\" on page 35. PP&L currently estimates that about $68 million of additional capital expenditures could be required in 2000 and beyond. Actions taken to correct groundwater degradation, to comply with the DEP's regulations and to address waste water control are also expected to result in increased operating costs in amounts which are not now determinable but could be material.\n\tSuperfund and Other Remediation\n\tPP&L has signed a consent order with the DEP to address a number of sites where PP&L may be liable for remediation of contamination. This may include potential PCB contamination at certain of PP&L's substations and pole sites; potential contamination at a number of coal gas manufac- turing facilities formerly owned and operated by PP&L; and oil or other contamination which may exist at some of PP&L's former generating facili- ties. As a current or past owner or operator of these sites, PP&L may be liable under Superfund or other laws for the costs associated with ad- dressing any hazardous substances at these sites.\n\tThese sites have been prioritized based upon a number of factors, including any potential human health or environmental risk posed by the site, the public's interest in the site, and PP&L's plans for the site. Under the consent order, PP&L will not be required to spend more than $5 million per year on investigation and remediation at those sites covered by the consent order. PP&L will not be required to spend additional money under the consent order in any year that its total remediation costs for sites both within and outside the scope of the consent order exceeds $5 million.\n\tAt December 31, 1995, PP&L had accrued $11.2 million, representing the amount PP&L can reasonably estimate it will have to spend to remedi- ate sites involving the removal of hazardous or toxic substances includ- ing those covered by the consent order mentioned above. PP&L is involved in several other sites where it may be required, along with other par- ties, to contribute to such remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for list- ing at a future date. Future cleanup or remediation work at sites cur- rently under review, or at sites not currently identified, may result in material additional operating costs which PP&L cannot estimate at this time. In addition, certain federal and state statutes, including Super- fund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DEP, to seek compensation from the responsible parties for the lost value of damaged natural re- sources. The EPA and the DEP may file such compensation claims against the parties, including PP&L, held responsible for cleanup of such sites. Such natural resource damage claims against PP&L could result in material additional liabilities.\n\tElectric and Magnetic Fields\n\tConcerns have been expressed by some members of the scientific com- munity and others regarding the potential health effects of EMFs. These fields are emitted by all devices carrying electricity, including elec- tric transmission and distribution lines and substation equipment. Fed- eral, state and local officials are focusing increased attention on this issue. PP&L is actively participating in the current research effort to determine whether EMFs cause any human health problems and is taking steps to reduce EMFs, where practical, in the design of new transmission and distribution facilities. PP&L is unable to predict what effect the EMF issue might have on PP&L operations and facilities and the associated cost.\n\tSubsidiary Issues\n\tIn June 1995, the DEP ordered a PP&L subsidiary to abate seepage al- legedly discharged from a mine formerly operated by that subsidiary. The subsidiary currently does not believe that it is responsible for this seepage and has appealed the order to DEP's Environmental Hearing Board, which has scheduled evidentiary hearings on the matter. A consultant has been hired to perform additional testing to determine the source of the seepage. If no connection exists between the mine water and the seepage, no abatement is required. However, if abatement ultimately is required, the PP&L subsidiary may be responsible for an extensive and protracted program to pump water from the mine at a cost which could be material.\n\tOther Environmental Matters\n\tIn addition to the issues discussed above, PP&L may be required to modify, replace or cease operating certain of its facilities to comply with other statutes, regulations and actions by regulatory bodies involv- ing environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances. As a result, PP&L may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nSHAREOWNER AND INVESTOR INFORMATION\nThe following information is provided as a service to shareowners and other investors. For any questions you may have or additional information you may require about PP&L Resources and its subsidiaries, please feel free to call the toll-free number listed below, or write to:\nGeorge I. Kline, Manager Investor Services Department Pennsylvania Power & Light Co. Two North Ninth Street Allentown, PA 18101-1179\nToll-Free Phone Number: For information regarding your investor account, or other inquiries, call toll-free: 1-800-345-3085.\nAnnual Meeting: The annual meetings of shareowners are held each year on the fourth Wednesday of April. The 1996 annual meetings will be held on Wednesday, April 24, 1996, at Lehigh University's Stabler Arena, Lower Saucon Valley Goodman Campus Complex, Bethlehem, PA. A reservation card for meeting attendance is included with shareowners' proxy material.\nProxy Material: A proxy statement, a proxy and a reservation card for Resources' and PP&L's annual meetings are mailed to all shareowners of record as of February 28, 1996.\nDividends: For 1996, the dates on which the declaration of dividends will be considered by the board or its executive committee are: February 28, May 22, August 28, and November 27, for payment on April 1, July 1 and October 1, 1996, and January 1, 1997, respectively. Dividend checks are mailed ahead of those dates with the intention they arrive as close as possible to the payment dates.\nRecord Dates: The 1996 record dates for dividends are March 9, June 10, September 10 and December 10.\nDirect Deposit of Dividends: Shareowners may choose to have their dividend checks deposited directly into their checking or savings account. Quarterly dividend payments are electronically credited on the dividend date, or the first business day thereafter.\nDividend Reinvestment Plan: Shareowners may choose to have dividends on their Resources' common stock or PP&L preferred stock reinvested in Resources' common stock instead of receiving the dividend by check.\nCertificate Safekeeping: Shareowners participating in the Dividend Reinvestment Plan may choose to have their common stock certificates forwarded to PP&L for safekeeping. These shares will be registered in the name of PP&L as agent for plan participants and will be credited to the participants' accounts.\nLost Dividend or Interest Checks: Dividend or interest checks lost by investors, or those that may be lost in the mail, will be replaced if the check has not been located by the 10th business day following the payment date.\nTransfer of Stock or Bonds: Stock or bonds may be transferred from one name to another or to a new account in the name of another person. Please call or write regarding transfer instructions.\nBondholder Information: Much of the information and many of the procedures detailed here for shareowners also apply to bondholders. Questions related to bondholder accounts should be directed to Investor Services.\nLost Stock or Bond Certificates: Please call or write to Investor Services for an explanation of the procedure to replace lost stock or bond certificates.\nPublications: Several publications are prepared each year and sent to all investors of record and to others who request their names be placed on our mailing lists. These publications are:\nPP&L Resources Annual Report -- published and mailed to all shareowners of record of Resources in mid-March.\nShareowners' Newsletter -- an easy-to-read newsletter containing current items of interest to shareowners -- published and mailed at the beginning of each quarter. Additionally, a special year-end edition containing unaudited results of the year's operations is mailed in early February.\nQuarterly Review -- published in May, July and October to provide quarterly financial information to investors.\nPeriodic Mailings: Letters regarding new investor programs, special items of interest, or other pertinent information are mailed on a non-scheduled basis as necessary.\nDuplicate Mailings: Annual reports and other investor publications are mailed to each investor account. If you have more than one account, or if there is more than one investor in your household, you may call or write to request that only one publication be delivered to your address. Please provide account numbers for all duplicate mailings.\nForm 10-K: Resources' annual report, filed with the Securities and Exchange Commission on Form 10-K, is available about mid-March. Investors may obtain a copy, at no cost, by calling or writing to Investor Services.\nListed Securities: Fiscal Agents: New York Stock Exchange Stock Transfer Agents and Registrars PP&L Resources, Inc.: Norwest Bank Minnesota, N.A. Common Stock (Code: PPL) Shareowner Services 161 North Concord Exchange Pennsylvania Power & Light Co.: South St. Paul, MN 55075 4-1\/2% Preferred Stock (Code: PPLPRB) Pennsylvania Power & Light Co. 4.40% Series Preferred Stock Investor Services Department (Code: PPLPRA) Dividend Disbursing Office and Dividend Reinvestment Plan Agent Philadelphia Stock Exchange Pennsylvania Power & Light Co. PP&L Resources, Inc.: Investor Services Department Common Stock Mortgage Bond Trustee Bankers Trust Co. Pennsylvania Power & Light Co.: Attn: Security Transfer Unit 4-1\/2% Preferred Stock P.O. Box 291569 3.35% Series Preferred Stock Nashville, TN 37229 4.40% Series Preferred Stock Bond Interest Paying Agent 4.60% Series Preferred Stock Pennsylvania Power & Light Co. Investor Services Department\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\tInformation for this item concerning directors of Resources will be set forth in the sections entitled \"Nominees for Directors\" and \"Directors Continuing in Office\" in Resources' 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with the SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference. Information required by this item concerning the executive officers of Resources is set forth on page 22 through 23 of this report.\n\tInformation for this item concerning directors of PP&L will be set forth in the sections entitled \"Nominees for Directors\" and \"Directors Continuing in Office\" in PP&L's 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with the SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference. Information required by this item concerning the executive officers of PP&L is set forth on page 22 through 23 of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n\tInformation for this item for Resources will be set forth in the sections entitled \"Compensation of Directors,\" \"Summary Compensation Table\" and \"Retirement Plans for Executive Officers\" in Resources' 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference.\n\tInformation for this item for PP&L will be set forth in the sections entitled \"Compensation of Directors,\" \"Summary Compensation Table\" and \"Retirement Plans for Executive Officers\" in PP&L's 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n\tInformation for this item for Resources will be set forth in the section entitled \"Stock Ownership\" in Resources' 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with the SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference.\n\tInformation for this item for PP&L will be set forth in the section entitled \"Stock Ownership\" in PP&L's 1996 Notice of Annual Meeting and Proxy Statement, which will be filed with the SEC not later than 120 days after December 31, 1995, and which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\tNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n1. Financial Statements - included in response to Item 8.\nPP&L Resources, Inc. Independent Auditors' Reports Consolidated Statements of Income for the Three Years Ended December 31, 1995 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995 Consolidated Balance Sheet at December 31, 1995 and 1994 Consolidated Statement of Shareowners' Common Equity for the Three Years Ended December 31, 1995 Consolidated Statement of Preferred and Preference Stock at December 31, 1995 and 1994 Notes to Financial Statements\nPennsylvania Power & Light Company Independent Auditors' Reports Consolidated Statements of Income for the Three Years Ended December 31, 1995 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995 Consolidated Balance Sheet at December 31, 1995 and 1994 Consolidated Statement of Shareowner's Common Equity for the Three Years Ended December 31, 1995 Consolidated Statement of Preferred and Preference Stock at December 31, 1995 and 1994 Consolidated Statement of Long-Term Debt at December 31, 1995 and 1994 Notes to Financial Statements\n2. Supplementary Data and Supplemental Financial Statement Schedule - included in response to Item 8.\nSchedule II - Valuation and Qualifying Accounts and Reserves for the Three Years Ended December 31, 1995\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto.\n3. Exhibits\nExhibit Index on page 97.\n(b) Reports on Form 8-K:\nNone.\n\t\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.\nPP&L Resources, Inc. (Registrant)\nPennsylvania Power & Light Company (Registrant)\nBy (Signed) William F. Hecht William F. Hecht - Chairman, President and Chief Executive Officer(PP&L Resources, Inc. and Pennsylvania Power & Light Company)\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 date indicated.\nTITLE By (Signed) William F. Hecht Principal Executive William F. Hecht - Chairman, President Officer and Director and Chief Executive Officer (PP&L Resources, Inc. and Pennsylvania Power & Light Company)\nBy (Signed) R. E. Hill Principal Financial R. E. Hill - Senior Vice President- Officer Financial and Treasurer (PP&L Resources, Inc.) Senior Vice President- Financial (Pennsylvania Power & Light Company)\nBy (Signed) J. J. McCabe Chief Accounting J. J. McCabe - Vice President and Officer Controller(PP&L Resources, Inc. and Pennsylvania Power & Light\nE. Allen Deaver Clifford L. Jones Nance K. Dicciani John T. Kauffman William J. Flood Robert Y. Kaufman Daniel G. Gambet Francis A. Long Directors Elmer D. Gates Norman Robertson Derek C. Hathaway David L. Tressler Stuart Heydt\nBy (Signed) William F. Hecht William F. Hecht, Attorney-in-fact Date: March 1, 1996\nEXHIBIT INDEX\n\tThe following Exhibits indicated by an asterisk preceding the Exhibit number are filed herewith. The balance of the Exhibits have heretofore been filed with the Commission and pursuant to Rule 12(b)-32 are incorporated herein by reference. Exhibits indicated by a # are filed or listed pursuant to Item 601(b)(10)(iii) of Regulation S-K.\n\t3(i)-1\t-\tArticles of Incorporation of Resources (Exhibit B to Proxy Statement of PP&L and Prospectus of Resources, dated March 9, 1995)\n\t3(i)-2\t-\tRestated Articles of Incorporation of PP&L (Exhibit A to the Proxy Statement of PP&L and Prospectus of Resources dated March 9, 1995)\n\t3(ii)-1\t-\tBy-laws of Resources (Exhibit 3.2 to Registration Statement No. 33-57949)\n\t3(ii)-2\t-\tBy-laws of PP&L (Exhibit 3(ii) to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n\t4(a)-1\t-\tAmended and Restated Employee Stock Ownership Plan, dated October 26, 1988 (Exhibit 4(b) to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1988)\n\t4(a)-2\t-\tAmendment No. 1 to said Employee Stock Ownership Plan, effective January 1, 1989 (Exhibit 4(b)-2 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t4(a)-3\t-\tAmendment No. 2 to said Employee Stock Ownership Plan, effective January 1, 1990 (Exhibit 4(b)-3 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t4(a)-4\t-\tAmendment No. 3 to said Employee Stock Ownership Plan, effective January 1, 1991 (Exhibit 4(b)-4 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n\t4(a)-5\t-\tAmendment No. 4 to said Employee Stock Ownership Plan, effective January 1, 1991 (Exhibit 4(a)-5 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n\t4(a)-6\t-\tAmendment No. 5 to said Employee Stock Ownership Plan, effective October 23, 1991 (Exhibit 4(a)-6 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n\t4(a)-7\t-\tAmendment No. 6 to said Employee Stock Ownership Plan, effective January 1, 1990 and January 1, 1992 (Exhibit 4(a)-7 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n4(a)-8\t-\tAmendment No. 7 to said Employee Stock Ownership Plan, effective January 1, 1992 (Exhibit 4(a)-8 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n4(a)-9\t-\tAmendment No. 8 to said Employee Stock Ownership Plan, effective July 1, 1992 (Exhibit 4(a)-9 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1992)\n4(a)-10\t-\tAmendment No. 9 to said Employee Stock Ownership Plan, effective January 1, 1993 (Exhibit 4(a)-10 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1992)\n4(a)-11\t-\tAmendment No. 10 to said Employee Stock Ownership Plan, effective January 1, 1993 (Exhibit 4(a)-11 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n4(a)-12\t-\tAmendment No. 11 to said Employee Stock Ownership Plan, effective January 1, 1994 (Exhibit 4(a)-12 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1994)\n4(a)-13\t-\tAmendment No. 12 to said Employee Stock Ownership Plan, effective January 1, 1994 (Exhibit 4(a)-13 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1994)\n*4(a)-14\t-\tAmendment No. 13 to said Employee Stock Ownership Plan, effective April 27, 1995\n4(a)-15\t-\tAmendment No. 14 to said Employee Stock Ownership Plan, effective January 1, 1989 and January 1, 1995 (Exhibit 4(a)-14 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1994)\n*4(a)-16\t-\tAmendment No. 15 to said Employee Stock Ownership Plan, effective October 25, 1995\n\t 4(b)-l\t-\tMortgage and Deed of Trust, dated as of October l, 1945, between PP&L and Guaranty Trust Company of New York (now Morgan Guaranty Trust Company of New York), as Trustee (Exhibit 2(a)-4 to Registration Statement No. 2-60291)\n\t 4(b)-2\t-\tSupplement, dated as of July 1, 1954, to said Mortgage and Deed of Trust (Exhibit 2(b)-5 to Registration Statement No. 219255)\n\t 4(b)-3\t-\tSupplement, dated as of June l, 1966, to said Mortgage and Deed of Trust (Exhibit 2(a)-l3 to Registration Statement No. 2-60291)\n\t4(b)-4\t-\tSupplement, dated as of November 1, 1967, to said Mortgage and Deed of Trust (Exhibit 2(a)-14 to Registration Statement No. 2- 60291)\n\t4(b)-5\t-\tSupplement, dated as of January 1, 1969, to said Mortgage and Deed of Trust (Exhibit 2(a)-16 to Registration Statement No. 2- 60291)\n\t4(b)-6\t-\tSupplement, dated as of June 1, 1969, to said Mortgage and Deed of Trust (Exhibit 2(a)-17 to Registration Statement No. 2-60291)\n\t4(b)-7\t-\tSupplement, dated as of February 1, 1971, to said Mortgage and Deed of Trust (Exhibit 2(a)-19 to Registration Statement No. 2- 60291)\n\t4(b)-8\t-\tSupplement, dated as of February 1, 1972, to said Mortgage and Deed of Trust (Exhibit 2(a)-20 to Registration Statement No. 2- 60291)\n\t4(b)-9\t-\tSupplement, dated as of January 1, 1973, to said Mortgage and Deed of Trust (Exhibit 2(a)-21 to Registration Statement No. 2- 60291)\n\t4(b)-10\t-\tSupplement, dated as of October 1, 1989, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated November 6, 1989)\n\t4(b)-11\t-\tSupplement, dated as of July 1, 1991, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1-905) dated July 29, 1991)\n\t4(b)-12\t-\tSupplement, dated as of May 1, 1992, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated June 1, 1992)\n\t4(b)-13\t-\tSupplement, dated as of November 1, 1992, to said Mortgage and Deed of Trust (Exhibit 4(b)-29 to PP&L's Form 10-K Report (File 1- 905) for the year ended December 31, 1992)\n\t4(b)-14\t-\tSupplement, dated as of February 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated February 16, 1993)\n\t4(b)-15\t-\tSupplement, dated as of April 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated April 30, 1993\n\t4(b)-16\t-\tSupplement, dated as of June 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated July 7, 1993)\n\t4(b)-17\t-\tSupplement, dated as of October 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated October 29, 1993)\n4(b)-18\t-\tSupplement, dated as of February 15, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated March 11, 1994)\n4(b)-19\t-\tSupplement, dated as of March 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(b) to PP&L's Form 8-K Report (File No. 1- 905) dated March 11, 1994)\n4(b)-20\t-\tSupplement, dated as of March 15, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated March 30, 1994)\n4(b)-21\t-\tSupplement, dated as of September 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K (File No. 1-905) dated October 3, 1994)\n4(b)-22\t-\tSupplement, dated as of October 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to PP&L's Form 8-K Report (File No. 1- 905) dated October 3, 1994)\n4(b)-23\t-\tSupplement, dated as of August 1, 1995, to said Mortgage and Deed of Trust (Exhibit 6(a) to PP&L's Form 10-Q Report (File No. 1-905) dated November 14, 1995)\n\t l0(a)-1\t-\tRevolving Credit Agreement, dated as of August 30, 1994, between PP&L and the Banks named therein\n\t l0(b)\t-\tPollution Control Facilities Agreement, dated as of May 1, 1973, between PP&L and the Lehigh County Industrial Development Authority (Exhibit 5(z) to Registration Statement No. 2-60834)\n\t l0(c)-l\t-\tInterconnection Agreement, dated September 26, 1956, among Public Service Electric & Gas Company, Philadelphia Electric Company, PP&L, Baltimore Gas & Electric Company, Pennsylvania Electric Company, Metropolitan Edison Company, New Jersey Power & Light Company and Jersey Central Power & Light Company (Exhibit 5(e) to Registration Statement No. 2-60291)\n\t l0(c)-2\t-\tSupplemental Agreement, dated April 1, 1974, to said Interconnection Agreement (Exhibit 5(f)-4 to Registration Statement No. 2-51312)\n\t l0(c)-3\t-\tSupplemental Agreement, dated June 15, 1977, to said Interconnection Agreement (Exhibit 5(e)-5 to Registration Statement No. 2-60291)\n\t l0(c)-4\t-\tAgreement of Settlement and Compromise, dated July 25, 1980, among the parties to said Interconnection Agreement (Exhibit 20(b)-8 to PP&L's Form l0-Q Report (File No. l-905) for the quarter ended September 30, 1980)\n\t l0(c)-5\t-\tSupplemental Agreement, dated March 26, 1981, to said Interconnection Agreement (Exhibit l0(b)-l0 to PP&L's Form l0-K Report (File No. 1-905) for the year ended December 31, 1981)\n\t l0(c)-6\t-\tRevisions to Schedules 4.02, 7.01, and 9.01, all effective August 9, 1982, to said Interconnection Agreement (Exhibit 10(e)-11 to PP&L's Form l0-K Report (File No. l-905) for the year ended December 31, 1982)\n\t l0(c)-7\t-\tSchedules 4.02, 5.01, 5.02, 5.04, 5.05, 6.01, 6.03, 6.04, 7.01, 7.02 7.03; all effective February 6, 1984, to said Interconnection Agreement (Exhibit 10(e)-8 to PP&L's Form l0-K Report (File No. 1-905) for the year ended December 31, 1985)\n\t l0(c)-8\t-\tSchedule 5.03, Revision l, Exhibit A, revised May 31, 1985, to said Intercon- nection Agreement (Exhibit 10(e)-10 to PP&L's Form l0-K Report (File No. 1-905) for the year ended December 31, 1985)\n\t 10(c)-9\t-\tSchedule 4.02, Revision No. 2, effective December 4, 1989, to said Interconnection Agreement (Exhibit 10(d)-13 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t 10(c)-10\t-\tSchedule 5.06, Revision No. 1, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-14 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n\t10(c)-11\t-\tSchedule 2.21, Revision No. 1, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-15 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n\t10(c)-12\t-\tSchedule 2.212, Revision No. 2, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-16 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n\t10(c)-13\t-\tSchedule 9.01, Revision No. 4, effective June 1, 1992, to said Interconnection Agreement (Exhibit 10(d)-18 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n\t10(c)-14\t-\tSchedule 3.01, Revision No. 3, effective June 1, 1992, to said Interconnection Agreement (Exhibit 10(c)-15 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n\t10(c)-15\t-\tSchedule 4.01, Revision No. 13, effective June 1, 1993, to said Interconnection Agreement (Exhibit 10(c)-15 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n\tl0(d)\t-\tCapacity and Energy Sales Agreement, dated June 29, 1983, between PP&L and Atlantic City Electric Company (Exhibit 10(f)-2 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1983)\n\t10(e)-1\t-\tCapacity and Energy Sales Agreement, dated March 9, 1984, between PP&L and Jersey Central Power & Light Company (Exhibit l0(f)-3 to PP&L's Form l0-K Report (File No. 1-905) for the year ended December 31, 1984)\n\t10(e)-2\t-\tFirst Supplement, effective February 28, 1986, to said Capacity and Energy Sales Agreement (Exhibit 10(e)-4 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1986)\n\t10(e)-3\t-\tSecond Supplement, effective January 1, 1987, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-3 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(e)-4\t-\tAmendments to Exhibit A, effective October 1, 1987, to said Capacity and Energy Sales Agreement (Exhibit 10(e)-6 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n\t10(e)-5\t-\tThird Supplement, effective December 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-5 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(e)-6\t-\tFourth Supplement, effective December 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-6 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(f)-1\t-\tCapacity and Energy Sales Agreement, dated December 21, 1989, between PP&L and GPU Service Corporation (Exhibit 10(h) to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(f)-2 \t-\tFirst Supplement, effective June 1, 1991, to said Capacity and Energy Sales Agreement (Exhibit 10(f)-2 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n\t10(g)-1\t-\tCapacity and Energy Sales Agreement, dated January 28, 1988, between PP&L and Baltimore Gas and Electric Company (Exhibit 10(e)-7 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n\t10(g)-2\t-\tFirst Supplement, effective November 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(i)-2 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(g)-3\t-\tSecond Supplement, effective June 1, 1989, to said Capacity and Energy Sales Agreement (Exhibit 10(i)-3 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n\t10(g)-4\t-\tThird Supplement, effective June 1, 1991, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-4 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n\t#10(h)-1\t-\tAmended and Restated Directors Deferred Compensation Plan, effective July 1, 1995 (Exhibit C to Proxy Statement of PP&L and Prospectus of Resources, dated March 9, 1995)\n*#10(i)-1\t-\tAmended and Restated Directors Retirement Plan, effective April 27, 1995\n#10(j)-1\t-\tAmended and Restated Deferred Compensation Plan for Executive Officers, effective January 1, 1990 (Exhibit 10(s) to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(j)-2\t-\tAmendment No. 1 to said Officers Deferred Compensation Plan, effective January 1, 1991 (Exhibit 10(j)-2 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-3\t-\tAmendment No. 2 to said Officers Deferred Compensation Plan, effective October 23, 1991 (Exhibit 10(j)-3 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-4\t-\tAmendment No. 3 to said Officers Deferred Compensation Plan, effective January 1, 1992 and April 1, 1992 (Exhibit 10(j)-4 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-5\t-\tAmendment No. 4 to said Officers Deferred Compensation Plan, effective January 1, 1995 (Exhibit 10(j)-5 to PP&L's Form 10-K Report (File No. 1-905) for the year ended December 31, 1994)\n*#l0(k)\t-\tAmended and Restated Supplemental Executive Retirement Plan, effective August 31, 1995\n*#10(l)\t-\tAmended and Restated Executive Retirement Security Plan, effective August 31, 1995\n#10(m)-1\t-\tAmended and Restated Incentive Compensation Plan, effective January 1, 1995 (Exhibit D to Proxy Statement of PP&L and Prospectus of PP&L Resources, Inc., dated March 9, 1995)\n*#10(m)-2\t-\tAmendment No. 1 to said Amended and Restated Incentive Compensation Plan, effective April 27, 1995\n*#10(n)\t-\tDescription of Executive Compensation Incentive Award Program 1\/\nFootnote 1\/ \tThis description is provided pursuant to 17 C.F.R. Subsection 229.601(b)(10)(iii)(A).\n10(o)\t-\tConformed Nuclear Fuel Lease, dated as of February 1, 1982, between PP&L, as lessee, and Newton I. Waldman, not in his individual capacity, but solely as Cotrustee of the Pennsylvania Power & Light Energy Trust, as lessor (Exhibit 10(g) to PP&L's Form l0-K Report (File No. 1-905) for the year ended December 31, 1981)\n*12(a)\t-\tResources' Computation of Ratio of Earnings to Fixed Charges\n*12(b)\t-\tPP&L's Computation of Ratio of Earnings to Fixed Charges\n*23(a)\t-\tConsent of Price Waterhouse LLP\n*23(b)\t-\tConsent of Deloitte & Touche LLP\n*24\t-\tPower of Attorney\n*27\t-\tFinancial Data Schedule\n*99\t-\tSchedule of Property, Plant and Equipment\n________________________\n\tCertain long-term debt instruments of PP&L's consolidated subsidiaries have been omitted from this filing pursuant to 17 C.F.R. Subsection 229.601(b)(4)(iii)(A). PP&L will furnish a copy of any such instrument to the Commission upon request.\n(PP&L LOGO APPEARS HERE)\n\tPP&L Resources, Inc. \tTwo North Ninth Street * Allentown, PA 18101\nBulk Rate U.S. Postage PAID Allentown, PA. Permit No. 104","section_15":""}
{"filename":"70412_1995.txt","cik":"70412","year":"1995","section_1":"ITEM 1: BUSINESS\nGENERAL\nNational Media Corporation (\"the Company\" or \"National Media\") is one of the leaders in the use of direct response transactional television programming, known as infomercials, to sell consumer products. The Company is engaged in this form of direct marketing of consumer products in the United States and Canada through its domestic subsidiary, Media Arts International, and overseas through the programming of its wholly-owned subsidiary, Quantum International Ltd. (\"Quantum\") which reaches over 40 countries in Europe, the Middle East, South America and the Pacific Rim. Through its programming, the Company introduced 13 new products in fiscal 1995, 8 of which were successfully introduced and are currently airing. The Company plans to introduce approximately 25 new products worldwide during fiscal 1996. In addition to these products, the Company markets products of independent third parties who provide programs to National Media. The Company currently has working relationships with three of the industry's leading infomercial production companies (Positive Response Television, Inc., Guthy-Renker Corporation and Inphomation, Inc.) to air their shows and distribute their products in the international marketplace. To capitalize on the consumer awareness and familiarity that National Media's infomercials create for its products, the Company, along with its strategic partners, also markets and sells its products through non-infomercial distribution channels, including retail stores and television home shopping programs.\nInfomercials are advertisements for consumer products, typically 30 minutes in length, which provide in-depth demonstrations and explanations of a product. In some cases, advertisements ranging from 1 to 2 minutes may be used. The Company attempts to present the product in an entertaining and informative fashion utilizing a variety of program formats, including talk shows and live paid studio audience programs. The product is made available for purchase by viewers through toll-free telephone numbers in the United States and Canada and through pay telephone numbers in other countries. These telephone numbers are provided on-screen during the broadcast.\nThe Company's product line is concentrated in eight principal categories: health and fitness, automotive, kitchen and household goods, beauty and personal care, outdoor, music, self-improvement and crafts. For the majority of the products marketed by National Media, the Company manages all phases of the marketing of a product in both the United States and international markets, including the selection of the product, the manufacture of the product by third parties, the production and airing of the infomercial, and the delivery of the product to the customer. Orders are taken by independent telemarketing companies and are electronically transmitted to the Company's fulfillment centers where the product is packaged and shipped. The Company has an in-house customer service unit in North America and provides customer service for its international operations through independent fulfillment centers.\nIn general, the Company airs each infomercial domestically for four to ten months or more, after which the potential exists for additional international airings which may range from twelve to twenty-four months. The Company's recent entrance into the Asian market provides it with an opportunity to further extend an infomercial's airing life. The Company's marketing efforts frequently include a second phase of distribution through non-infomercial marketing programs. Non-infomercial distribution includes sales through television home shopping programs; direct mail marketing through catalogs, credit card statement inserts, magazines and newspapers; and retail distribution.\nTHE INFOMERCIAL INDUSTRY\nThe infomercial industry developed after the Federal Communications Commission (\"FCC\") rescinded its limitations on advertising minutes per hour in 1984, thereby permitting 30-minute blocks of television advertising. The deregulation of the cable television industry and the resulting proliferation of cable channels led to the growth of the infomercial industry by increasing the available media time in the United States, particularly during the hours between midnight and 9:00 a.m. Producers of infomercials, combining direct response marketing and retailing in a television talk show format, took advantage of the new opportunity to purchase the \"dark time\" from cable channels. After the initial growth period, the industry consolidated through the end of the 1980s. At the same time, increased attention from the Federal Trade Commission (\"FTC\") and consumer protection agencies led to increased\nregulation of the reliability of the advertisements. By the early 1990s, infomercials, and home shopping cable channels, had become more accepted by television viewers as a forum for obtaining information about products and services and making purchases from home.\nCOMPANY HISTORY\nNational Media is the successor to National Paragon Corporation, a company engaged in the needlecraft business for more than 60 years, which filed for bankruptcy in 1985. Emerging from bankruptcy in 1986, the Company acquired an infomercial business, Media Arts International (\"Media Arts\"), as part of its plan of reorganization. In September 1990, the Company was approved for listing on the New York Stock Exchange. In April 1991, the Company sold National Syndications, Inc. (\"NSI\"), its specialty catalog\/mail order business, and focused on developing its infomercial business. In June 1991, the Company acquired out of bankruptcy the business and assets of Quantum Marketing International (\"Old Quantum\"), a competitor in the infomercial business, which had a European operation. Since the beginning of fiscal 1992, the Company implemented a strategy involving the recruitment of management personnel with experience in the direct-response industry, the improvement of its product development and product sourcing practices, the acquisition of in-house product fulfillment and customer service capabilities, the expansion of current operations into the international marketplace and the development of other distribution outlets particularly through its strategic partners and retail stores.\nPRODUCT AND INFOMERCIAL DEVELOPMENT\nThe Company maintains a product development department which researches and develops new products that may be suited for direct response television marketing and subsequent marketing through non-infomercial distribution channels. Typically these products are selected based on their suitability for television demonstration and explanation.\nThe Company's product development staff, consisting of nine employees, develops new product ideas from a variety of sources, including inventors, suppliers, trade shows, industry conferences, strategic alliances with manufacturing and consumer product companies and the Company's ongoing review of new developments within its eight targeted product categories. As a result of the Company's prominence in the infomercial industry, National Media receives unsolicited new product proposals from independent third parties. The Company currently reviews in excess of 100 new product proposals per month. In early calendar year 1994, the Company became a target of an acquisition bid by ValueVision International, Inc. (\"ValueVision\") which ultimately was never consummated. Management's and the Company's attention was directed from the production of infomercials. As a result of the foregoing and the Company's limited cash position, only 13 new products were introduced on a global basis during fiscal year 1995. The Company, revitalized by its capital infusion and improved operating results, expects to bring approximately 25 new products to market worldwide during fiscal 1996.\nThe evaluation phase of the product development process generally takes approximately two to eight weeks, depending upon the product being reviewed. During this phase, the product development department evaluates the marketability of the product, determines whether adequate and timely supplies of the product can be obtained and analyzes whether the projected profitability of the product satisfies the Company's criteria. If the Company determines that a product idea that is owned by a third party is worth pursuing, the Company generally seeks to license exclusive worldwide rights to the product. With regard to certain of its products, however, the Company does not possess exclusive worldwide rights for all marketing venues. See -- \"Licensing Arrangements.\"\nOnce the Company decides to bring a product to market, it arranges for the production of a 30-minute infomercial for the product at a cost that generally ranges from $100,000 to $200,000. In addition, producers, hosts and spokespersons generally receive fees based upon the success of the product. The Company's infomercials are produced by independent production companies with experience in the Company's product categories in the United States and other countries. The production of an infomercial generally takes approximately eight to sixteen weeks to complete. The program is then tested in specific time slots on both national cable networks and targeted broadcast stations. If a show achieves successful results in the market test, it is aired on a rapidly increasing schedule on cable networks and broadcast stations. During this initial phase, the Company may modify the creative presentation of the infomercial and the retail pricing, depending upon viewer response. After the initial marketing phase, the Company may adjust the frequency of a program's airings to achieve a schedule of programs that it believes maximizes the profitability of all of the Company's products being marketed through infomercial programming at a given time.\nPRODUCTS\nNational Media markets consumer products in a variety of categories, including automotive, beauty and personal care, kitchen and household, health and fitness, outdoor, music, crafts and self-improvement. In fiscal 1995, National Media offered approximately 85 products to consumers in the global marketplace. Of these products, 46 were products sold through National Media's infomercials and 39 were products sold through infomercials produced by other companies. Of the 46 products sold through National Media's infomercials, 13 were products first introduced by National Media in fiscal 1995 and 33 were products that were previously offered by National Media. The following table sets forth examples of some of the products marketed and sold through the Company's infomercials, their respective product categories and the fiscal year in which each infomercial was first aired.\nThe Company's five most successful products in each of the fiscal years ended March 31, 1995, 1994, and 1993 accounted for 54%, 67% and 47%, respectively, of the Company's net revenues for such periods. The Company continues to be dependent, in part, upon its ability to introduce and sell new products. The Company's expansion into international markets has reduced\nits dependency on new shows by giving new life to programs that comprise the Company's show library. Historically, the majority of the Company's products generated their most significant domestic revenue in their introductory year, while foreign revenues have tended to be generated more evenly over a longer period.\nLICENSING ARRANGEMENTS\nNational Media obtains the rights to new products generated by third parties through various licensing arrangements generally involving royalties related to the success of the product. The amount of the royalty is negotiated and generally depends upon the level of involvement of the third party in the development and marketing of the product. The Company generally pays the smallest royalty to a third party that only provides a product concept. A somewhat higher royalty is paid to a third party that has developed and manufactured a product. National Media also obtains the rights to sell products which have already been developed, manufactured and marketed through infomercials produced by other companies. In such cases, the Company generally pays a higher royalty rate to the third party because of the relatively small amount of the Company's resources required to develop the product. The Company generally seeks exclusive worldwide rights to all products, which includes global infomercial and non-infomercial rights. In some cases, the Company does not obtain all marketing and distribution rights, but seeks to receive a royalty on sales made by the licensor pursuant to the rights retained by the licensor.\nMEDIA ACCESS\nAt present, the Company utilizes approximately 450 to 550 hours of cable and broadcast television time per week in the United States and in excess of 325 hours per week internationally to air its infomercials. The Company believes that a large and productive inventory of media time is necessary to maintain a competitive advantage as well as allowing the Company to maximize the revenue producing potential from its portfolio of shows (i.e. rollout or support of retail). Approximately one-half of the Company's cable air time in the United States and over two-thirds of the Company's satellite and terrestrial air time internationally has been purchased under long-term contracts that provide for specific time slots on television over the life of the respective contracts.\nDomestically, the Company purchases most of its cable television time directly from cable networks and their respective media representatives, and at present has commitments for cable television time slots for periods ranging from one month to five years. These cable networks presently include The Nashville Network, USA Network, The Learning Channel, Lifetime Television, Discovery, The Family Channel, BET, Home Team Sports, CNBC, America's Talking, FX, The New Inspirational Network, TV Food Network, SCIFI, E!, ESPN2, and Product Information Network. The Company believes that at least one of the above networks is carried on every local cable system carrier throughout the country. The Company has an exclusive contract with Group W Satellite Communication on behalf of The Nashville Network which expires in December 1997.\nIn addition to domestic air time purchased on cable networks, the Company also purchases broadcast television time from network affiliates and independent stations. Broadcast television time segments are purchased primarily in 30-minute spots. The Company also purchases 60 and 120-second spots where economically feasible. The time segments on broadcast television are purchased primarily on a quarterly basis based on the availability of programming time. The Company intends to continue to pursue opportunities in new television markets through other cable channels and with additional broadcast television stations in existing television markets. The Company believes that there is currently more than an adequate supply of broadcast television time available from these sources in the United States. Recently, larger multiple system operators (MSO's) have elected to change their operations by selling dark time. The Company believes that this may create an opportunity to lower its cost of airtime as well as obtain additional airtime in desired markets. The Company generally has the right to sell any excess media times it may have to others, if necessary. During fiscal 1995, the Company maintained a broker relationship with several companies, to which it sold excess air time. In addition to generating additional revenues, this practice reduces some of the risk associated with large purchases of media time and provides an additional source of product for its international operations.\nIn fiscal 1995 in the United States, approximately 49% of the media time purchased by the Company came from cable television and 51% came from network affiliates and independent television. The Company's infomercials generally run in the United States between the hours of 3:00 a.m. to 2:00 p.m., Eastern time, seven days a week.\nThe Company, through its international subsidiary Quantum, has several exclusive contracts with European satellite networks that enable the Company to broadcast its programming throughout Europe and the Middle East. See \"International.\" Through these contracts, Quantum is generally entitled to broadcast programming continuously for a specified period of time. Under some of these arrangements, the Company has a right of first refusal for any additional air time that may become available for direct marketing during the term of the respective contract. This gives the Company the right to air its infomercials on a given network exclusive of any other competing infomercials.\nThe Company purchases its media time in Japan exclusively through its partner Mitsui & Co., Ltd..\nAs discussed above, the Company purchases a significant amount of its media time from cable television and satellite networks. These cable television and satellite networks assemble programming for transmission to multiple and local cable system operators. These operators may not be required to carry all the network's programming. The Company currently does not pay and is not paid for the \"privilege\" of being broadcast by these operators. It is possible that, if demand for air time grows, and because of recently enacted cable legislation, these operators will begin to charge the Company to continue broadcasting the Company's infomercials or limit the amount of time available to the Company. The Company is dependent on having access to media time to televise its infomercials on cable networks, satellite networks, network affiliates and local stations. There can be no assurance that the Company will be able to purchase or renew media time on a long-term basis or at favorable price levels. Significant increases in the cost of media time or significant decreases in the Company's access to media time could have a material adverse effect on the Company's results of operations.\nINTERNATIONAL\nFor fiscal years 1995, 1994 and 1993, the Company's international operations generated net revenues of $80.4 million, $46.0 million and $37.6 million, respectively. See Note 16 to the consolidated financial statements for information related to foreign operating income (loss) and identifiable assets for fiscal years 1995, 1994 and 1993. National Media entered the international market for direct response television marketing as a result of its June 1991 acquisition of the assets of Old Quantum. The Company believes that it is the leader in direct response transactional television programming in Europe and Asia. Quantum's infomercials are aired in its market territories by satellite transmission direct to homes (\"DTH\") with satellite reception dishes, by cable operators who retransmit satellite broadcasts to cable ready homes and by terrestrial broadcast television. Quantum's satellite air time is obtained through long term agreements with companies that own or lease satellite transponder time. While Quantum's programs presently reach consumers in countries all over the world, including the United Kingdom, Germany, France, the Benelux countries, Denmark, Austria, Switzerland, Italy, Sweden, Finland, Norway, former Eastern Bloc countries, the Middle East, Turkey, Spain, Portugal, Ireland, Australia, New Zealand, Peru, Mexico, Brazil, Greece, Argentina, Singapore, Taiwan, and Japan, approximately 60% of international revenue is currently generated in the European market. The Company made significant penetration of the Asian market in fiscal 1995 with its airing of infomercials in Japan beginning in late July 1994. The Company has recently entered into a two year agreement with its partner Mitsui & Co., Ltd. to provide media time and fulfillment service in support of the Japanese operations. Approximately 37% of fiscal 1995 international revenue was generated in the Asian market, primarily in Japan.\nThe products offered through Quantum's programs are licensed on an exclusive basis for televised marketing in its broadcast areas, and consist of consumer products concentrated in the following categories: health and fitness, sports, automotive, kitchen and household, beauty and personal care, self improvement, crafts and music. The majority of Quantum's programs have historically come from Media Arts; however, Quantum also has available programming from other independent domestic infomercial companies, including three industry leaders with which the Company has working relationships. In addition, Quantum has continued to devote additional attention to the sourcing of product and corresponding production of its own locally developed infomercials. During fiscal year 1995, the Company introduced 7 new products from locally developed infomercials and has plans to introduce approximately 11 new products in fiscal 1996. These products along with products supplied by Media Arts and independent infomercial companies should provide a steady stream of new product offerings to the international marketplace.\nThrough Quantum's programming, the Company has brought to the international marketplace many of its products that had been successfully marketed in the United States, including, for example, Auri car polish, the\nBedazzler Plus craft kit, Perfect Smile, the Flying Lure fishing lure, Bruce Jenner's Super Step stair climber and Minimax Exercise System, Tony Little's Target Training System video tapes and Royal Diamond Cookware. As a key component of the Company's strategy to extend the life cycle of each of its products, management identifies products that had wide consumer appeal in the United States which it believes can be duplicated internationally. The selected infomercial programs are dubbed into the appropriate foreign languages, and re-broadcast in other countries. During fiscal 1995, Quantum successfully aired locally produced infomercials in the music category, including Hits of the 60's and 70's and Shades of Country.\nThroughout most of Europe, Singapore, and Japan, the Company operates the inbound telemarketing, warehousing, fulfillment, distribution and customer service functions of its business through independent agents, each of which is responsible for a particular territory. Orders are processed and shipped directly to customers by these agents who are later paid by the Company, generally on a per unit basis. Outside Europe and Japan, Quantum contracts with independent licensees who buy Quantum's products outright and then sell to consumers, both through infomercials and through other local distribution channels, under conditions and standards prescribed and monitored by Quantum.\nSince 1991, the Company has entered into a number of long-term, exclusive contracts with Pan European satellite channels such as Eurosport, NBC Super Channel, and Flextech (Starstream). During the term of these contracts, the Company is guaranteed a specified amount of satellite television hours per month, and has rights of first refusal for any additional infomercial air time that becomes available. In Japan, the Company has a two year contract with Mitsui & Co., Ltd., for terrestrial broadcast television time. As a result of these relationships, the Company's transactional television programming can be seen in virtually every country in Europe and the Middle East and in Japan, although at the present time the Company's products are only available for purchase in the countries set forth above. The Company's long-term media contracts in Europe expire at various dates from August 1996 through 1999. Presently, the Company broadcasts in excess of 325 hours per week internationally. The Company intends to pursue marketing relationships in additional Asian and Latin American markets.\nThe Company believes that it is currently the dominant direct response television marketing Company in Europe and Japan, due to its established distribution systems, its market penetration, its broadcast reach and the frequency of its infomercial broadcasts in these markets. Furthermore, the Company believes that it is well positioned to take advantage of the potential growth in the international transactional television marketplace, which the Company believes is in its early stages of development. The Company believes that its purchase of additional airtime in Europe, Japan and the Middle East will enable it to increase revenues without incurring a proportional increase in operating costs.\nSOURCING AND MANUFACTURING\nThe Company uses sources in the United States and several countries in Europe and Asia to manufacture its infomercial products. The Company has entered into strategic partnerships with several manufacturers in various product categories in an effort to reduce its dependence on third party manufacturers. The Company believes that its strategic partnership strategy reduces the risk of supply problems, such as delays in receiving shipments, which could have a material adverse effect on the success of a product. The Company closely monitors the availability of supplies of products and promptly adjusts the air time of an infomercial for a product which cannot be adequately supplied. Additionally, the Company employs a technical\/engineering firm in Hong Kong to coordinate and direct the Company's manufacturing sources in Asia and to monitor the quality of the products manufactured in such countries.\nBefore the Company takes a major inventory position, the Company test markets the product. The Company then purchases additional product units which generally take four to six weeks to deliver.\nINBOUND TELEMARKETING\nA necessary element of infomercial marketing is the order-taking function known as inbound telemarketing. Customers may order products marketed through infomercials during or after the infomercial by calling a number (toll-free in the United States) which is shown periodically on the television screen during the broadcast. The majority of customer payments in the United States\nfor such products are made through credit cards over the telephone with the remainder paid by check. National Media subcontracts the telemarketing function to one of several companies that provide this service for a fixed fee based on the number of telephone calls answered. This service includes order processing. The inbound telemarketers, in certain cases, also promote additional Company product sales at the time of purchase.\nStarting in fiscal 1996 (September 1995) and continuing through fiscal 1998, the Company has positioned itself to reduce its telemarketing costs as a result of its tentative settlement of litigation with ValueVision, as described in Note 13 to the Consolidated Financial Statements. This settlement includes an agreement by ValueVision to provide telemarketing services to the Company for a minimum of one million telephone calls a year over a three year period at rates significantly below those currently being paid by the Company for similar services. This covers a significant portion of the Company's current domestic telemarketing expenditures.\nFULFILLMENT AND CUSTOMER SERVICE\nThe Company's North American fulfillment center is located in Phoenix, Arizona. Product fulfillment consists of the assembly, as required, packaging and shipping of products, and processing of customer returns. The Company's fulfillment center in Phoenix, Arizona, a 190,000 square foot facility, processes substantially all orders for the Company's products for sales in North America. National Media primarily uses CTC, a bulk shipper to deliver products to customers in the United States. During the fourth quarter of fiscal year 1994, the Company replaced United Parcel Service with CTC as its primary deliverer of domestic product. This change resulted in reduced freight costs during fiscal year 1995. In certain instances, the manufacturer of the product ships directly to the customer.\nIn markets outside North America, the Company uses various firms in different countries for fulfillment services. European products are shipped to independent warehouses in Rotterdam, The Netherlands and Middlesex, England. Products are then shipped to nine independent fulfillment centers throughout Europe that process the Company's European sales orders. In Europe, products are generally delivered to consumers on a \"cash on delivery\" basis through local postal systems. In Asia, products are primarily shipped to warehouses in Japan controlled by the Company's partner, Mitsui & Co., Ltd., from where the orders are fulfilled and shipped. In Japan, products are generally delivered to consumers on a \"cash on delivery\" basis.\nAn important aspect of the Company's marketing strategy is to maintain and improve quality customer service. The Company operates toll-free customer service telephone numbers and maintains its own customer service department in Phoenix, Arizona to respond to customer inquiries, provide product information to customers and process product returns for its United States operations. Outside of the United States and Canada, the Company provides customer service through third parties on a contract basis.\nThe Company generally offers a 30-day money back return policy to purchasers of any of its products. In addition, products are also covered by the warranty offered by manufacturers for defective products. The terms of such warranties vary depending upon the product and the manufacturer. The average return rate of the Company's products for the fiscal years ended March 31, 1995 and 1994 was 14.3% and 11.7%, respectively. Management believes that the increase in the average return rate percentage is due to a change in the domestic product mix to higher priced products (which historically carry a higher return rate), as well as an increase in international revenues as a percentage of total revenues. International revenues carry a higher average return rate due to the \"cash on delivery\" terms of the business.\nMANAGEMENT INFORMATION SYSTEMS\nThe Company's computer system, located in its Philadelphia headquarters features programs which allow the Company to manage its media time purchases and program scheduling, to manage the flow of product order information among its telemarketers, its fulfillment center and its credit card clearing house and to manage the flow of shipping, billing and payments information. The Company's primary computer system located in its Phoenix, Arizona fulfillment facility allows the Company to manage the functions related to fulfillment and customer service. The Company believes that its management information systems are currently adequate. However, in order to facilitate growth and to\nintegrate fully its international operations, the Company is in the process of enhancing its computer systems related to all phases of its operations. The Company has earmarked approximately $2 million of the capital budget for fiscal year 1996 for this project.\nNON-INFOMERCIAL MARKETING\nBased on the success of certain products in retail markets and the evolution of the nature of its business, the Company believes that its transactional television programming can be highly effective in building consumer awareness of its products as well as positioning the Company to act as the media marketing partner for manufacturers of consumer products. The Company intends to capitalize on this product awareness and ability to act as a media marketing partner and extend the sales life of its products by shifting products from traditional infomercial programming to non-infomercial marketing channels such as retail distribution; catalogs; direct mail; direct response print ads; television home shopping programs; credit card statement inserts and the development of strategic partnerships. The Company realized that infomercials provided a legitimate vehicle for established manufacturers to showcase certain products. Many products, due to their complex nature or simply economics, cannot be effectively marketed through traditional 30 or 60 second spots. Additionally, manufacturers have come to realize that the aforementioned showcasing of a product through an infomercial on television is a powerful means to create and build brand awareness and generate follow-up product sales through traditional retail outlets. The Company continues to work closely with (i) Regal Ware, Inc. to develop products in the housewares segment, (ii) CSA, Inc. in the fitness product segment, and (iii) Blue Coral, Inc. in the car wax and auto care segment. A clear advantage of these relationships is that typically the Company's manufacturing partner will provide research and development support and assume the inventory risk, thereby reducing the Company's financial risk as well as its working capital requirements. National Media's marketing programs are structured to strengthen and protect its products through patents, product positioning and brand identification.\nPrior to fiscal 1992, a limited amount of the Company's sales had been through non-infomercial distribution channels that did not include retail distribution. In fiscal 1992, the Company began selling products through traditional retail channels, such as mass merchandisers (e.g., Venture, Caldor, Target, Sears, Montgomery Ward and Kmart), specialty retailers (e.g., Bass Pro Shops), and wholesale clubs (e.g., BJ's Wholesale Club and PACE). During fiscal year 1994, the Company entered into agreements with strategic partners who handle the retail marketing and pay a royalty to the Company on retail sales in consideration of the television advertising for the product funded by the Company. As a result of these agreements being in effect for the entire year during fiscal 1995, the Company's net revenues from non-infomercial sales were $11.0 million in fiscal 1995 as compared with $16.6 million in 1994, a decrease of 34%; however, the Company realized approximately $1.0 million of additional gross profit from these revenues in the current year.\nThe Company intends to pursue further expansion of its retail operations in order to capitalize on the consumer brand awareness created by the Company's transactional television programming and reinforced by the \"As Seen On TV\" in-store signage. The Company believes that the product exposure created by the Company's transactional television programming enables the Company and its strategic partners to utilize traditional retail distribution channels without incurring any of the additional advertisement costs that other consumer product companies may incur. In this manner, the Company believes that it will be able to market products to consumers who view its programming, but do not traditionally purchase products through direct response marketing.\nBACKLOG\nThe timing of orders is largely influenced by the degree of consumer response to product offerings, inventory levels, marketing strategies, seasonality and overall economic conditions. Backlog orders for the Company at May 31, 1995 and 1994 were approximately $4.6 million and $6.6 million, respectively. The Company's average backlog during fiscal year 1995 was between $3 million to $6 million representing two to four weeks' processing. The consumer is notified upon placement of an order that normal shipping time is four to six weeks. Orders in excess of anticipated production capacity are included in backlog figures. However, product shortages, cancellations, returns and allowances may reduce the amount of sales realized from the fulfillment of backlog orders.\nGOVERNMENT REGULATION\nVarious aspects of the Company's business are subject to regulation and ongoing review by a variety of federal, state, and local agencies, including the Federal Trade Commission (FTC), the United States Post Office, the Consumer Product Safety Commission (CPSC), the Federal Communications Commission, the Food and Drug Administration, States' Attorneys General and other state and local consumer protection and health agencies. The statutes, rules and regulations applicable to the Company's operations, and to various products marketed by it, are numerous, complex and subject to change.\nAs a result of prior settlements with the FTC, the Company has agreed to two consent orders which among other things require the Company to submit compliance reports to the FTC staff. The Company has submitted the compliance reports as well as additional information requested by the FTC staff. In connection with one of these orders, the Company recently received a request from the FTC for certain information regarding the Company's infomercials in order to determine whether the Company is in compliance with such order. The Company is cooperating with such request and as of the current date believes itself to be in compliance with the consent orders and other FTC requirements.\nOn February 24, 1994, the staff of the CPSC notified the Company that it had made a preliminary determination that a particular model of the Company's Juice Tiger product presents a \"substantial product hazard\" under the provisions of the Consumer Product Safety Act. The Company has disputed this preliminary determination and is presently in negotiation with the CPSC staff to resolve this issue. See \"Legal Proceedings\" for further discussion of this matter.\nQuantum's business is subject to the laws and regulations of England and of the European Union and various consumer and health protection laws and regulations in other countries in which the programming is broadcast, where applicable. If any significant actions were brought against Quantum in connection with a breach of such laws or regulations, including the imposition of fines or other penalties, or against one of the entities through which Quantum obtains a significant portion of its media access, Quantum's results of operations could be materially adversely affected. At this time, Quantum's European business is operating under licenses issued in the United Kingdom. There can be no assurance that changes in the laws and regulations of any territory which forms a significant portion of Quantum's market will not adversely affect the Company's business.\nThe Company collects and remits sales tax in the states in which it has a physical presence. Certain states in which the Company's only activity is direct marketing have attempted to require direct marketers, such as the Company, to collect and remit sales tax on sales to customers residing in such states. A recent decision of the U.S. Supreme Court held that Congress can enable the states to impose a sales tax although Congress has taken no action to that effect. The Company is prepared to collect sales taxes for other states if laws are passed requiring such collection. The Company does not believe that a change in the tax laws requiring the collecting of sales tax will have a material adverse effect on the Company's results of operations.\nCOMPETITION\nThe Company competes directly with several companies which generate sales from infomercials. The Company also competes with a large number of consumer product companies and retailers which have substantially greater financial, marketing and other resources than the Company, some of which have indicated their intent to conduct direct response marketing. The Company also competes with companies that make imitations of the Company's products at substantially lower prices. Products similar to the Company's products may be sold in department stores, pharmacies, general merchandise stores and through magazines, newspapers, direct mail advertising and catalogs. Other companies with substantially greater financial resources may be entering the infomercial market creating additional competition.\nEMPLOYEES\nAs of May 31, 1995, the Company and its subsidiaries had 178 full time employees. The Company also utilizes contract laborers at its fulfillment center in Phoenix, Arizona. None of the Company's employees are covered by collective bargaining agreements, and management considers relations with its employees to be good.\nTRADEMARKS\nThe Company has a number of registered trademarks and other common law trademark rights for certain of its products and marketing programs. It is the Company's policy that it will seek to fully protect its trademark rights in its future products and programs and will vigorously defend its trademark rights.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases office space for its principal executive offices in Philadelphia, Pennsylvania. The lease, which commenced in November 1992, provides for the Company to rent office space of approximately 30,000 square feet. The annual rent is $14.75 per square foot. In April 1995, the Company exercised its option to terminate the lease at the end of the initial 5 year term, effective October 31, 1997 and in connection therewith, as called for by the lease, paid a termination fee of $220,000. This building is owned by Mergren Associates, a real estate company owned by John J. Turchi, Jr., the Company's former Chairman of the Board and Chief Executive Officer and a significant stockholder of the Company. The building is managed by an independent real estate firm. An independent real estate firm engaged by the Company determined that the lease was based on fair market conditions at the time of inception. The Company believes that the terms of the lease are fair to the Company.\nA subsidiary of the Company leases approximately 190,000 square feet in Phoenix, Arizona for warehousing, fulfillment and customer service operations. The Company currently has approximately 30,000 square feet of office space available for subletting or expansion. The annual lease payments for this lease range from $452,000 for fiscal year 1996 to $1,084,000 for fiscal years 2010 through 2014.\nQuantum leases approximately 6,800 square feet of office space in London, England. The lease expires in March 1996. The lease requires annual rent payment of pounds sterling183,700 ($298,000 as of March 31, 1995).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSHAREHOLDERS' FEDERAL CLASS ACTIONS\nIn June 1993, a class action complaint was filed in the United States District Court for the Eastern District of Pennsylvania against the Company and certain of its former executive officers. Five similar lawsuits subsequently were filed in the same court. The six actions were consolidated, and an amended consolidated class action complaint was filed in October, 1993. The complaint involved allegations concerning disclosure by the Company of its ongoing relationship with Positive Response Television, Inc., an infomercial producer and Ronic, S.A., a supplier of the Company. The parties have reached a settlement of this action, calling for cash payments by the Company's insurer of $2.175 million and the issuance, subject to adjustment, of 145,000 shares of the Company's common stock.\nSHAREHOLDERS' DELAWARE CLASS ACTIONS\nIn January 1994 four class action complaints were filed against the Company and certain of its present and former officers and directors in the Court of Chancery of the State of Delaware in connection with a proposed merger transaction with ValueVision International, Inc. (\"ValueVision\"). On April 17, 1995, the Company and the other parties to the litigation reached an agreement in principle to settle these actions, as well as the Lachance and Efron and Cohen Class Action Litigation described below, providing for cash payments of $1.5 million, 75% of which will be paid by the Company's insurer. The Company recorded a charge of $375,000 in the fourth quarter of fiscal year 1995 for its portion of the settlement.\nLACHANCE AND EFRON AND COHEN CLASS ACTIONS\nIn July and December, 1994, stockholders filed purported class action lawsuits in federal court against the Company and certain of its former officers and directors in connection with the aborted ValueVision tender offer. The parties have reached an agreement in principle to settle the matter as discussed in Shareholders' Delaware Class Actions above.\nCONSUMER PRODUCT SAFETY COMMISSION INVESTIGATION\nOn February 24, 1994, the staff of the Consumer Product Safety Commission (CPSC) notified the Company that it had made a preliminary determination that a particular model of the Company's Juice Tiger(R) product presents a \"substantial product hazard,\" under the Consumer Product Safety Act. The CPSC staff requested the Company to take voluntary corrective action to ameliorate such alleged product hazard. While the Company has disputed that the model in question presents a substantial product hazard, the Company and the CPSC staff are presently discussing the form and nature of voluntary action proposed by the Company to assuage the CPSC staff's concerns. The CPSC staff has also indicated that, upon agreement on and implementation of a corrective action plan, it may investigate and assess whether the Company failed to comply with reporting requirements under the Consumer Product Safety Act such as to warrant imposition of a civil penalty. Given the current status of the proceedings before the CPSC staff, it is not yet possible to determine whether the costs of implementing any such corrective action plan and the amount of any such civil penalty, alone or together, would have a material adverse effect on the Company's results of operation and financial position.\nTERMINATED TENDER OFFER AND MERGER AGREEMENT WITH VALUEVISION INTERNATIONAL, INC.\nOn April 22, 1994, the Company filed suit in federal court against ValueVision alleging that ValueVision had wrongfully terminated its amended tender offer. In May 1994 ValueVision answered the Company's complaint and set forth various counterclaims. The Company and ValueVision have agreed to settle this action and have, in connection with such settlement, executed a Telemarketing, Production and Post-Production Agreement and an International Joint Venture Agreement as more fully described in Note 13 to the Consolidated Financial Statements. All of such matters are subject to the approval of the Company's shareholders on or before August 31, 1995. There can be no assurance that such approval will be obtained.\nWILLIAM H. CAMPBELL\nIn July, 1994, a former officer of the Company filed a complaint in federal court against the Company and Mr.Turchi, the Company's former Chairman and CEO, alleging that the defendants fraudulently induced him to purchase the Company's common stock through the exercise of stock options and to forebear from selling his shares of common stock. Mr. Campbell seeks to recover compensatory damages in excess of $1.3 million as well as punitive damages and to rescind all alleged debts owed to the Company by Mr. Campbell (approximately $238,000). The parties have informally reached a confidential settlement of the action, and on December 9, 1994, the court dismissed the case with prejudice. The court has retained jurisdiction of the case in the event that any party seeks to have the dismissal vacated, modified or stricken should the parties fail to execute and deliver a definitive settlement agreement. Although the Company has no reason to expect that such a definitive settlement agreement will not be executed by all parties, there can be no assurance that the settlement will be so finalized. Management of the Company believes that the definitive settlement, if implemented on substantially the terms of the informal settlement, would not be likely to have a material adverse effect on the financial position or results of operations of the Company.\nOTHER MATTERS\nThe Company in the normal course of its business is a party to litigation relating to trademark and copyright infringement, product liability, contract-related disputes and other actions. It is the Company's policy to vigorously defend all such claims and enforce its rights in these areas. Except as disclosed herein, the Company does not believe any of these actions either individually or in the aggregate, will have a material adverse effect on the Company's results of operations or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company held an annual meeting of its stockholders on February 22, 1995. The meeting was held to elect a board of eight directors; to consider and approve (a) the adoption of the Director's Stock Grant Plan, (b) the amendment of the 1991 Stock Option Plan, to include an increase in the number of shares of common stock available for issuance by 565,000 shares and the grant of options for such shares, and (c) the adoption of the 1995 Management Incentive Plan; and to ratify the Board of Directors' appointment of the Company's independent certified public accountants as auditors for the Company\nfor the fiscal years ending March 31, 1995 and 1996. All proposals were approved as follows:\n- ------ * The holders of the Company's Series B Convertible Preferred Stock have the right to elect two members of the Company's Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is listed on the New York Stock Exchange and the Philadelphia Stock Exchange under the symbol \"NM\".\nThe following table sets forth the quarterly high and low closing stock prices and dividends declared for the last two fiscal years. The Company's common stock has been traded on the New York Stock Exchange since September 14, 1990.\nThe number of record holders of the Company's common stock on May 31, 1995 was approximately 866. The Company is currently restricted in its ability to pay dividends under the terms of its Note and Warrant Purchase agreement as more fully described in Note 4 to the consolidated financial statement.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\n- ------ (1) The information herein relates only to continuing operations and has been restated to reflect the discontinued operations resulting from the sale of the Company's wholly-owned subsidiary, National Syndications, Inc. subsequent to March 31, 1991.\n(2) Net of loan discount of $1,650.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company is engaged in the direct marketing of consumer products primarily through the use of infomercials in both the domestic and international marketplace. The Company's operating results continue to\ndepend upon its ability to introduce and sell new products. The Company is generally dependent on its most successful products to generate a significant portion of its net revenue. The Company continues to take actions designed to reduce the risk associated with relying on a limited number of successful products for a disproportionate amount of its revenues by expanding its presence in the international marketplace, thereby creating new markets for its products, and joining forces with strategic partners to increase its product base. International expansion has resulted in a greater percentage of the Company's revenues being generated from the international infomercial market. As the Company enters new markets overseas, it is able to air shows from its existing library, thus reducing its dependence on new show productions. The Company is taking advantage of the product awareness created by its infomercials by extending the sales life of its infomercial products through non-infomercial distribution channels, such as retail arrangements and entering into agreements with manufacturers of consumer products in which the Company's strategic partner will supply new products and retail distribution channels for product sales. The Company's fiscal year end is March 31. All references herein to fiscal 1995 refer to the fiscal year ended March 31, 1995. Similar references are made for prior fiscal years.\nRESULTS OF OPERATIONS\nThe following table sets forth operating data of the Company as a percentage of net revenues for the periods indicated below.\nFISCAL 1995 COMPARED TO FISCAL 1994\nNET REVENUES\nNet revenues were $176.2 million in fiscal 1995 as compared to $172.6 million in fiscal 1994, an increase of $3.6 million or 2.1%.\nDomestic net revenues. Domestic net revenues were $95.8 million in fiscal 1995 as compared to $126.6 million in fiscal 1994, a decrease of $30.8 million or 24.3%. Domestic infomercial and non-infomercial net revenues decreased by $25.2 million and $5.6 million, respectively. The decrease in infomercial revenues was primarily due to a reduction in the number of shows available for airing during 1995. New show production was adversely effected by the events of the early part of 1995 relating to the ValueVision Tender Offer as described in Note 13 to the Consolidated Financial Statements. The Company introduced 6 new shows in fiscal 1995 as compared to 17 in fiscal 1994. Domestic revenues were also unfavorably impacted by a change in the Company's sales mix toward higher priced products, which have historically experienced a higher return rate. As expected, based on the current year product mix, returns as a percentage of gross revenues increased from 8.5% in fiscal 1994 to 11.8% in fiscal 1995. The decline in non-infomercial net revenues was primarily a result of the Company's decision to receive royalties for certain products in lieu of full sales participation in retail distribution. Despite the $5.6 million decline in non-infomercial net revenue, the Company realized approximately $1.0 million of additional gross profit from these revenues during the current year. In addition, as a result of its decision to shift away from owning inventory for retail sales in favor\nof royalty arrangements with manufacturers, the Company believes it has provided itself with a more stable and steady stream of royalty revenue with limited associated inventory risk. Approximately 54% and 15% of the Company's current year domestic net revenues were generated from sales of its Powerwalk Plus product and Regal Ware Royal Diamond Cookware product, respectively.\nThe Company recently entered into separate agreements with Inphomation, Inc., and Positive Response Television, Inc., infomercial companies, which provide for the worldwide marketing of new products via infomercials. This development, coupled with recent additions to its marketing staff, should allow the Company to compete more effectively in the area of product and infomercial development in fiscal 1996.\nForeign net revenues. Foreign net revenues were $80.4 million in fiscal 1995 as compared to $46.0 million in fiscal 1994, an increase of $34.4 million or 74.8%. On a local currency basis, foreign net revenues for the year increased 67.7% over the prior year. The increase in net revenues from foreign sales was primarily due to the Company's successful entrance into the Japanese market which began in late July 1994. Japanese net revenues were $25.7 million for the period ended March 31, 1995. The remaining $8.7 million increase in foreign net revenues was due to the continued expansion of the Company's foreign operations from 30 countries at the end of fiscal 1994 to over 40 countries in Europe and the Middle East at the end of fiscal 1995. Revenue growth is supported by the Company's ability to capitalize on its large library of infomercials, many of which are five or more years old, but which are entirely new to the international market. In addition, foreign net revenues are not dependent on any single product due to the Company's existing show library.\nOPERATING COSTS\nTotal operating costs and expenses were $176.5 million for fiscal 1995 as compared to $181.3 million in fiscal 1994, a decrease of $4.8 million or 2.6%.\nMedia purchases. Media purchases were $52.0 million (net of $13.5 million in media sales) in fiscal 1995 as compared to $56.2 million (net of $5.6 million in media sales) in fiscal 1994, a decrease of $4.2 million or 7.5%, principally as a result of a decrease in domestic show airings. The ratio of media purchases to net revenues decreased from 32.5% in fiscal year 1994 to 29.5% in fiscal year 1995 as a result of a higher proportion of current year net revenues being generated in international markets characterized by more effective media costs. Internationally, the ratio of media purchases to net revenues further benefited from increased availability of lower cost time while the domestic ratio was favorably impacted by an effective mix of media time utilized to air Company products and media time sold.\nDirect costs. Direct costs consist of the cost of materials, freight, infomercial production, commissions and royalties, fulfillment, inbound telemarketing, credit card authorization, and warehousing. Direct costs were $97.6 million in fiscal 1995 as compared to $95.0 million in fiscal 1994, an increase of $2.6 million or 2.7%. This increase was a result of the 2.1% increase in net revenues during the year. As a percentage of net revenues, direct costs remained stable at 55.4% in fiscal year 1995 and 55.1% in fiscal year 1994. Domestically, direct costs as a percentage of net revenues decreased by 1.9 percentage points as a result of a reduction in non-infomercial direct costs. Higher infomercial product costs due to a change in product mix were offset by a reduction in freight, telemarketing and commission costs. The reduction in non-infomercial direct costs was due to the Company's decision to receive royalties for certain products in lieu of full sales participation in retail. The Company believes that its tentative settlement of litigation with ValueVision as described in Note 13 to the Consolidated Financial Statements, which includes an agreement by ValueVision to provide telemarketing services to the Company for a minimum of one million telephone calls a year over a three year period at rates significantly below the rates currently being paid by the Company for similar services, represents an excellent opportunity for cost reduction in fiscal years 1996, 1997 and 1998.\nInternationally, direct costs as a percentage of net revenues increased approximately 4.2 percentage points primarily due to increased freight, fulfillment and processing costs as a result of the Company's expansion into new countries, especially Japan. These costs are typically higher upon initial entrance into a market. Management anticipates future reductions in fulfillment and telemarketing costs in connection with new agreements recently entered into covering the Japanese market.\nSELLING, GENERAL AND ADMINISTRATIVE\nSelling, general and administrative expenses were $20.8 million in fiscal 1995 as compared to $20.7 million in fiscal 1994, a decrease of $.1 million or .5%. Selling, general and administrative expenses as a percentage of net revenues decreased in fiscal 1995 to 11.8% from 12.0% in fiscal 1994. The reduction in selling, general and administrative expenses as a percentage of net revenues in fiscal year 1995 was accomplished despite costs associated with the Company's entrance into the Japanese market and an increased provision for bad debt expense of $750,000 primarily related to royalties due from a single customer. As a result of staff reductions made in late fiscal year 1994 and early fiscal year 1995, the Company reduced its domestic personnel costs by $1.8 million.\nSEVERANCE EXPENSE FOR FORMER CHAIRMAN AND CHIEF EXECUTIVE OFFICER\nDuring fiscal year 1995, the Company incurred severance expense of $2.65 million relating to the resignation of the Company's former Chairman and Chief Executive Officer. See Note 7 to the Consolidated Financial Statements herein for further discussion.\nUNUSUAL CHARGES\nThe Company's results of operations for the year ended March 31, 1995 included unusual charges of $2,868,000 relating to settlement of ongoing litigation and associated legal fees. Such matters are discussed in Note 17 to the Consolidated Financial Statements. $1,100,000 of such unusual charges were incurred in the fourth quarter of fiscal 1995.\nIncluded in the unusual charges of $9,049,000 for the year ended March 31, 1994 was $4,127,000 for certain legal settlements. In addition, the Company recognized additional expenses during the period including $1,138,000 in legal fees associated with the aforementioned settlements and class action lawsuits, $1,000,000 related to the relocation of its fulfillment center to Phoenix, Arizona; $1,268,000 in costs associated with the terminated tender offer and agreement of merger with ValueVision; $725,000 in severance related to personnel reductions; $591,000 in costs associated with two aborted stock offerings; and $200,000 in other costs.\nINTEREST EXPENSE\nInterest expense was $689,000 in fiscal 1995 as compared to $300,000 in fiscal 1994, an increase of $389,000. This increase reflects interest at 9.5% as well as amortization of the loan discount ($150,000) and loan origination fees associated with the Company's $5.0 million term loan obtained October 1994 and higher interest rates during the current year.\nNET INCOME (LOSS)\nThe Company had a net loss of $672,000 in fiscal 1995 as compared to a net loss of $8,699,000 million in fiscal 1994, an improvement of $8,027,000.\nFISCAL 1994 COMPARED TO FISCAL 1993\nNET REVENUES\nNet revenues were $172.6 million in fiscal 1994 as compared to $142.0 million in fiscal 1993, an increase of $30.6 million or 21.6%.\nDomestic net revenues. Domestic net revenues were $126.6 million in fiscal 1994 as compared to $104.4 million in fiscal 1993, an increase of $22.2 million or 21.3%. Domestic infomercial net revenues increased by $31.2 million while non- infomercial revenues decreased by $9.0 million. The success of the TONY LITTLE TARGET TRAINING SYSTEM(R) coupled with the increase in show airings were the major reasons for the increase in infomercial revenues in fiscal year 1994. The decline in non-infomercial net revenues was primarily due to fiscal year 1993 reflecting strong sales of JUICE TIGER(R) as well as the Company's decision to receive royalties for certain products in lieu of full sales participation in retail distribution.\nForeign net revenues. Foreign net revenues were $46.0 million in fiscal 1994 as compared to $37.6 million in fiscal 1993, an increase of $8.4 million or 22.3%. On a local currency basis, foreign net revenues for fiscal year 1994 increased 34.5% over fiscal year 1993. The increase in net revenues from foreign sales was primarily due to the expansion of the Company's European operations from 17 countries at the end of fiscal 1993 to 30 countries in Europe and the Middle East at the end of fiscal 1994, coupled with an increased average unit selling price in fiscal 1994.\nOPERATING COSTS\nTotal operating costs and expenses were $181.3 million for fiscal 1994 as compared to $135.7 million in fiscal 1993, an increase of $45.6 million or 33.6%.\nMedia purchases. Media purchases were $56.2 million (net of $5.6 million in media sales) in fiscal 1994 as compared to $38.5 million in fiscal 1993, an increase of $17.7 million or 46.0%, principally as a result of increased show airings to support domestic and international revenue growth, higher media rates and the Company's decision to enter the media brokerage business during fiscal year 1994. The Company's ratio of media purchases to net revenue for fiscal year 1993 was favorably impacted by the renegotiation of one of its European cable contracts. Results of operations in fiscal year 1994 reflected decreases in consumer response to product offerings, higher media rates, and the decline in domestic non- infomercial net revenues which incur no media costs. The result was an increase in the ratio of media purchases to net revenues from 27.1% in fiscal year 1993 to 32.5% during fiscal year 1994.\nDirect costs. Direct costs were $95.1 million in fiscal 1994 as compared to $74.8 million in fiscal 1993, an increase of $20.3 million or 27.1%. This increase was attributable primarily to increased product sales in fiscal 1994. During fiscal year 1994, the Company experienced a favorable trend in the cost of materials. Material cost reductions in the domestic operations more than offset increased material costs internationally. Significant sales of the lower cost TONY LITTLE TARGET TRAINING TAPE product was a major factor in the domestic material cost reduction. Offsetting a portion of the material cost reduction was an increase in commission expense, especially with the aforementioned Tony Little tapes, of approximately $4.5 million. As a percentage of sales, direct costs increased to 55.1% in fiscal year 1994 from 52.6% in fiscal year 1993. A significant factor was increased production cost of approximately $5.1 million in fiscal 1994 versus fiscal 1993. This increase was due to a reduced success rate on newly introduced shows and an increase in the average production cost of infomercials aired in fiscal year 1994. In addition, the international operation incurred increased dubbing cost as a result of its expansion into new countries during fiscal 1994.\nSELLING, GENERAL AND ADMINISTRATIVE\nSelling, general and administrative expenses were $20.7 million in fiscal 1994 as compared to $21.3 million in fiscal 1993, a decrease of $.6 million or 2.8%. Selling, general and administrative expenses as a percentage of net revenues decreased in fiscal 1994 to 12.0% from 15.1% in fiscal 1993. This decrease was a direct result of the growth in the Company's net revenues. In addition, the Company took action in 1994 to further reduce selling, general and administrative expenses in the future by enacting management and staff reductions. The Company recorded associated severance costs of $725,000 in fiscal year 1994 which are included in the unusual charges described below.\nUNUSUAL CHARGES\nUnusual charges of $9,049,000 for the year ended March 31, 1994 included $4,127,000 for certain legal settlements. In addition, the Company recognized additional expenses during fiscal year 1994 including $1,138,000 in legal fees associated with the aforementioned settlements and class action lawsuits, $1,000,000 related to the relocation of its fulfillment center to Phoenix, Arizona; $1,268,000 in costs associated with anti- takeover defenses and the terminated tender offer and agreement of merger with ValueVision; $725,000 in severance related to personnel reductions; $591,000 in costs associated with two aborted stock offerings; and $200,000 in other costs.\nUnusual charges for the fiscal year ended March 31, 1993 were $725,000 and included $425,000 for severance expense and $300,000 for settlements of litigation and related legal fees.\nINTEREST EXPENSE\nInterest expense was $300,000 in fiscal 1994 as compared to $371,000 in fiscal 1993, a decrease of 19.1%. This decrease reflected lower interest rates and a reduction in the Company's average outstanding short-term borrowings.\nNET INCOME (LOSS)\nThe Company had a net loss of $8.7 million in fiscal 1994 as compared to net income of $6.3 million in fiscal 1993, a decrease of $15.0 million. This was primarily due to the unusual charges and the increase in the Company's media purchases as a percentage of net revenues as described above.\nLIQUIDITY AND CAPITAL RESOURCES\nCash provided by operations and outstanding cash and cash equivalents will provide the primary support for funding current operations. Cash and cash equivalents increased $11.9 million from $1.6 million at March 31, 1994 to $13.5 million at March 31, 1995. The Company's working capital increased by $20.7 million during the same period from $1.4 million to $22.1 million. The increases were primarily a result of the Company's current year financing activities which generated approximately $10.4 million in cash. An additional benefit was realized from an increase of $4.1 million in cash provided by operations which changed from a use of cash of $2.2 million in fiscal year 1994 to a source of cash of $1.9 million in fiscal year 1995. The primary reason for the increase was a reduction of in excess of $8.0 million in the Company's net loss. The increase in inventories during the year was primarily attributable to the Company's need to support its continued global expansion, especially into Japan, as is evidenced by the 74.8% growth in foreign net revenues during fiscal year 1995. The Company achieved a turnaround in cash provided from operations during 1995 despite cash payments in excess of $5.1 million for litigation related settlements and legal fees.\nIn October and December 1994, the Company received proceeds of $9,415,000 (net of offering costs of $872,000) from the sale of 255,796 investment units (\"Units\") in private placement transactions described in Note 11 to the Consolidated Financial Statements.\nPrior to the December 1994 private placement, the Board carefully evaluated the current and projected financial position of the Company, including its liquidity needs. The Audit Committee of the Board expressly authorized the Company to make an application to the New York Stock Exchange to consummate the transactions without seeking shareholder approval because, in the Audit committee's opinion, the delay necessary in securing shareholder approval would have seriously jeopardized the Company's financial viability. Without such authorization from the New York Stock Exchange, under the New York Stock Exchange rules (but not under Delaware state corporate law), shareholder approval of such transactions would have otherwise been required. In reaching this conclusion, the Audit Committee noted that the report of the Company's independent auditors included in the Company's 10-K for the fiscal year ended March 31, 1994 makes reference to the need for additional liquidity to ensure the Company's viability. The New York Stock Exchange accepted this application.\nIn October 1994, the Company entered into a Note and Warrant Purchase Agreement (the \"Note Agreement\") pursuant to which it obtained a $5 million five year interest only term loan bearing interest at a rate equal to the prime rate plus .5%. Approximately $3.1 million of the proceeds were used to repay the Company's pre-existing bank debt. The loan is secured by a lien on substantially all of the assets of the Company and its subsidiaries. The terms of the Note Agreement, among other things, restrict the Company's ability to make acquisitions, pay dividends and incur additional indebtedness except for a maximum of $1.0 million in borrowing from a foreign bank. The lenders received a warrant to purchase 2,250,000 shares (subject to adjustment) of the Company's common stock at $4.80 per share at any time from and after September 30, 1995 until September 30, 2004 as part of the Note Agreement. In April 1995, the term loan was acquired by a bank with all material terms remaining unchanged.\nThe remainder of the proceeds from the term loan and sale of Units are being used for working capital purposes.\nThe Company's international revenues are subject to foreign exchange risk. To the extent that the Company incurs local currency expenses that are based on local denominated sales volume (fulfillment and media costs), this exposure is reduced significantly. The Company closely monitors exchange rate movements and will protect short term cash flows through the use of options and\/or future contracts when appropriate. In the long term the Company has the ability to change prices at any time in order to react to major currency fluctuations; thus reducing the risk associated with local currency movements.\nFiscal year 1995 saw the Company achieve significant improvement in its financial position and operating results, including its return to profitability in its two most recent fiscal quarters and its settlement or tentative settlement of the bulk of the Company's outstanding litigation. The Company's financial statements for the year ended March 31, 1995 contain an unqualified opinion from its independent auditors.\nThe Company settled or tentatively settled significant outstanding litigation during fiscal years 1995 and 1994 and, in connection therewith, incurred costs resulting in a reduction of earnings of $2.8 million and $5.3 million, respectively. While it is not possible to give assurance as to the effects of any potential future litigation against the Company or settlements in excess of current accruals, management believes it has taken a major step in positioning the Company against these types of unusual litigation charges in the future.\nThe Company has additional capital resource and liquidity requirements related to its issuance, subject to adjustment, of 145,000 shares of the Company's common stock in connection with the Federal Class Action settlement described in Note 13 to the Consolidated Financial Statements and the payment of $375,000 upon final approval of the ValueVision Class Action Litigation settlement described in Note 13 to the Consolidated Financial Statements. Management believes that the ValueVision settlement, if approved on substantially the same terms as the tentative settlement, would not be likely to have a material adverse effect on the financial position of the Company.\nIn connection with its financing activities during fiscal year 1995, the Company issued preferred stock convertible into and warrants to acquire shares of common stock in a total amount of 7,897,512 which represents 55.6% of common stock outstanding at March 31, 1995. The Company also has 2,908,096 options outstanding under its stock option plans. While having a dilutive effect on future earnings per share, the exercise of all of these warrants and options would provide the Company with approximately $40.1 million in additional capital.\nThe Company's capital expenditures for the past two years have been limited partially due to its financial condition. The Company expects to spend in excess of $2.0 million to update its worldwide management information system in fiscal 1996.\nManagement believes that cash generated from operations, its current capital structure and the other sources of capital described above are adequate to support the Company's long term growth needs including continued international expansion, required capital expenditures and potential future acquisitions.\nQUARTERLY RESULTS OF OPERATIONS\nThe following table sets forth operating data of the Company, including such data as a percentage of net revenues, for the last two fiscal years.\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. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers and directors of the Company are:\n- ------ (1) Member of the Executive Committee.\n(2) Member of the Audit Committee.\n(3) Member of the Compensation Committee.\n(4) Member of the Nominating Committee.\n(5) Member of the Shareholder Committee.\nDavid J. Carman served as President and Chief Operating Officer of the Company's Quantum International, Ltd. (\"Quantum\") subsidiary since joining the Company in December 1991 until April 1995, has been President and Chief Executive Officer of Quantum since April 1995, and has been Executive Vice President of the Company since September 1994. From June 1991 to August 1994, Mr. Carman served as Vice President of the Company. From October 1989 to June 1991, Mr. Carman had been Vice President in charge of European, Central Pacific, Australian and New Zealand operations of The Franklin Mint. Between 1986 and 1989, he had been President of various international subsidiaries of The Franklin Mint. Prior to that time, Mr. Carman held a Teaching Fellowship at an Australian university and was President of his own strategic consulting company. He has served as a Director of the Company since April 1993.\nJames A. Jernigan has served as Executive Vice President of the Company and Chief Operating Officer for North American Operations since September 1994. From June 1994 until September 1994, he served as Senior Vice President and Chief Operating Officer of the Company. From January 1992 until June 1994, Mr. Jernigan was Vice President, Manufacturing, Sourcing and International Operations of the Company. He was Vice President of Sourcing and International Operations at The Franklin Mint from December 1987 to January 1992.\nJohn J. Sullivan has served as Senior Vice President, Administration, Planning and Investor Relations of the Company since April 1995 and as Vice President, Treasurer and Chief Financial Officer of the Company from\nSeptember 1991 to April 1995. From 1989 to 1991, Mr. Sullivan was Chief Financial Officer of Gold Medal Sporting Goods. Prior to that time, Mr. Sullivan was employed by The Franklin Mint for more than 18 years in various capacities, most recently as Corporate Controller.\nConstantinos I. Costalas has been the Vice Chairman of the Company since September 1994 and the Senior Financial Officer since April 1995. Until February 11, 1994, he served as Chairman of the Board, President and Chief Executive Officer of Glendale Bancorporation and as Chairman of the Board, President and Chief Executive Officer of Glendale National Bank of New Jersey, which positions were held since 1985 and 1976, respectively. He has served as a Director of the Company since May 1993.\nMichael J. Emmi has served as Chairman of the Board, Chief Executive Officer and President of Systems & Computer Technology Corporation, a provider of computer software and services, since May 1985. Mr. Emmi is also a Director of CompuCom Systems, Inc., Crusader Savings and Loan Association, and The Franklin Institute and is the Chairman of the Pennsylvania Chapter of the American Electronics Association. Prior to such time, Mr. Emmi held various positions with General Electric Information Services Company (GEISCO), a unit of General Electric Company and other subsidiaries of General Electric Company, most recently as Senior Vice President, Marketing and U.S. Sales of GEISCO, from February 1982 to May 1985. He has served as a Director of the Company since April 1995.\nBrian McAdams has served as Chairman of the Board and Chairman of the Executive Committee of the Company since September 1994 and was Chief Executive Officer of the Company from September 1994 to April 1995. Mr. McAdams has served as President, Chief Executive Officer and a Director of McAdams, Richman & Ong, Inc., an advertising and marketing company, since 1976. He is also a Director of Crusader Savings and Loan Association. Mr. McAdams serves on the board of the Council of Better Business Bureau and serves on the Marketing and Advertising Review Committee. He has served as a Director of the Company since June 1990.\nMark P. Hershhorn has served as President of the Company since August 1994, has been Chief Executive Officer of the Company and Chairman of Quantum since April 1995 and served as Chief Operating Officer of the Company from August 1994 until April 1995. From June 1993 to August 1994, Mr. Hershhorn served as President and Chief Operating Officer of Buckeye Communications, Inc. From December 1991 to April 1993, Mr. Hershhorn was President and Chief Operating Officer of the Company. From April 1990 until December 1991, Mr. Hershhorn was Senior Vice President of Food Operations and Joint Ventures for Nutri\/System, Inc. Prior to assuming the position with Nutri\/System, Inc., he acted as a consultant for J. Crew, Inc. from January through April 1990. From 1985 to January 1990, Mr. Hershhorn was an executive with The Franklin Mint in Philadelphia, Pennsylvania, serving as Vice President and Chief Financial Officer, as well as a Director. He has served as a Director of the Company since September 1994.\nFrederick S. Hammer has been Vice Chairman of Tri-Arc Financial Services, Inc., a provider of specialized insurance products to the financial services industry, since June 1994. From February 1993 to June 1994, Mr. Hammer was Chairman of Mutual of America Capital Management Corporation. From 1989 until 1993, Mr. Hammer was President of the SEI Asset Management Group in Wayne, Pennsylvania. From 1989 until 1991, Mr. Hammer was Mazur Fellow at the Wharton School of the University of Pennsylvania. Mr. Hammer presently serves on the Board of Directors of Alco Standard Corporation and was previously a director of Meritor Savings Bank. He has served as a Director of the Company since October 1994.\nIra M. Lubert has served as Managing Director of Radnor Venture Management Company and of Technology Leaders Management,Inc., both of which are venture capital management companies, since 1988. Mr. Lubert is a Director of CompuCom Systems, Inc. He has served as a Director of the Company since December 1994.\nCharles L. Andes has served as Chief Executive Officer of Interactive Marketing Ventures since January 1995 and as Chief Executive Officer and President of the Eastern Technology Council, an affiliation of industry leaders in technology fields who collaborate and cooperate on a broad range of technology related matters, since 1991. From 1986 until 1991, Mr. Andes was President and Chief Executive Officer of The Franklin Institute in Philadelphia, a world-renowned science museum and research center. From 1973 until 1985, Mr. Andes was Chairman of The Franklin Mint. Mr. Andes is a Director of Information Systems Acquisition Corporation and First Fidelity Bank, N.A., Chairman of the Pennsylvania Academy of the Fine Arts and is Vice Chairman of the Pennsylvania Intergovernmental Corporation Authority, a board created by the Commonwealth of Pennsylvania to oversee the operating and capital budgets of the City of Philadelphia. He has served as a Director of the Company since October 1994.\nJon W. Yoskin II has served as Chairman, Chief Executive Officer and a Director of Tri-Arc Financial Services Inc., a provider of specialized insurance products to the financial services industry, since 1986. Prior to that time, he worked in the insurance and banking industries with companies such as Meritor, TransAtlantic Life Insurance Assurance Company and Royal Oak Insurance Company. Mr. Yoskin has served as a Director of the Company since June 1994.\nBOARD COMMITTEES\nThe Board of Directors has an Executive Committee which exercises such management functions as may be delegated by the Board of Directors from time to time, an Audit Committee which reviews the results and scope of the audit and other services provided by the Company's independent public accountants, a Compensation Committee which makes recommendations regarding salaries and incentive compensation for officers of, and consultants to, the Company, and a Nominating Committee which is responsible for reviewing candidates, and recommending to the Board nominees for membership on the Board of Directors. The Executive Committee is currently comprised of Messrs. Carman, Costalas, Hammer, Hershhorn and McAdams, the Audit Committee is currently comprised of Messrs. Emmi, Hammer and Yoskin, the Compensation Committee is currently comprised of Messrs. Hammer and Yoskin and the Nominating Committee is currently comprised of Messrs. Hammer and Andes. The Shareholder's Committee is currently comprised of Messrs. Hammer, Lubert, Andes and Yoskin.\nSECTION 16(A) DISCLOSURE\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors and persons who own more than ten percent of the Company's Common Stock to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the New York and Philadelphia Stock Exchanges. Officers, directors and greater than ten-percent owners are required by Securities and Exchange Commission regulations to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on the Company's review of the copies of such forms received by it, the Company believes that, during the fiscal year ended March 31, 1995, it was in compliance with all filing requirements applicable to its officers, directors, and greater than ten-percent owners, except the Company recently discovered that certain filings which were made on a timely basis with the Securities and Exchange Commission may not have been made with the New York Stock Exchange and\/or the Philadelphia Stock Exchange.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information will be set forth in the Registrant's definitive proxy statement for its 1995 annual meeting of stockholders and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information will be set forth in the Registrant's definitive proxy statement for its 1995 annual meeting of stockholders and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS\nThis information will be set forth in the Registrant's definitive proxy statement for its 1995 annual meeting of stockholders and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial Statements and Schedules\nThe following is a list of the consolidated financial statements of the Company and its subsidiaries and supplementary data submitted in a separate section of this report.\n-- Report of Independent Auditors.\n-- Consolidated Balance Sheets -- March 31, 1995 and 1994.\n-- Consolidated Statements of Operations -- Years ended March 31, 1995, 1994, and 1993.\n-- Consolidated Statements of Shareholders Equity -- Years ended March 31, 1995, 1994, and 1993.\n-- Consolidated Statements of Cash Flows -- Years ended March 31, 1995, 1994, and 1993.\n-- Notes to Consolidated Financial Statements\nThe following is a list of the schedules filed as part of this Form 10-K.\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(b) Reports on Form 8-K filed in the fourth quarter of 1995:\nForm 8-K dated January 13, 1995 Item 5. Other Events -- Announcement of the Company's consummation of several transactions with Buckeye Communications, Inc. (\"Buckeye\") in accordance with an August 1994 agreement by and among the Company, Buckeye and Mark Hershhorn as a result of the Company's success in consummating private sales of its equity securities in the aggregate amount of approximately $10,260,000.\nForm 8-K dated March 20, 1995 Item 5. Other Events -- Announcement by the Company of the following: tentative settlement of ValueVision litigation, and in connection with settlement, the entrance of a Telemarketing and Joint Venture Agreement with ValueVision and the tentative settlement of the related Class Action lawsuits.\nForm 8-K dated April 13, 1995 Item 5. Other Events -- Announcement by the Company of the following: execution of a settlement agreement concerning all claims involved in the Company's Federal Shareholders' Class Action litigation pending since October 1993 and notification of the Company being served with a copyright infringement suit.\nc) Index to Exhibits\n- ------ * Incorporated by reference to Registrant's Registration Statement on Form S-1 (Reg. No. 33-26778) filed January 31, 1989.\n** Incorporated by reference to Registrant's Registration Statement on Form S-3 (Reg. No. 33-35301) filed June 8, 1990.\n*** Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1992 filed June 26, 1992.\n**** Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1991 filed June 20, 1991.\n++ Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1994 filed July 14, 1994.\n+ Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c).\n+ Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1993 filed June 29, 1993.\n++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1993 filed November 12, 1993.\n+++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 1993 filed February 14, 1994.\n++++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 1994 filed February 14, 1995.\n|B| Incorporated by reference to Registrant's Report on Form 8-K dated October 5, 1994.\n|B%|B| Incorporated by reference to Registrant's Report on Form 8-K dated December 8, 1994.\n|B||B||B| Incorporated by reference to Registrant's Report on Form 8-K dated January 13, 1995.\n& Incorporated by reference to Registrant's Report on Form 8-K dated April 13, 1995.\n&& Incorporated by reference to Registrant's Report on Form 8-K dated September 12, 1994.\n&&& Incorporated by reference to Registrant's Report on Form 8-K dated August 26, 1994.\n&&&& Incorporated by reference to Registrant's Report on Form 8-K dated July 19, 1994.\n## Incorporated by reference to Registrant's Proxy Statement in connection with annual meeting of Stockholders to be held on February 22, 1995.\n# Incorporated by reference to Registrant's Schedule 14 D-9 filed on February 18, 1994.\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(A)(1) AND (2), (C) AND (D)\nCONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLIST OF CONSOLIDATED FINANCIAL STATEMENTS\nAND FINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED MARCH 31, 1995\nNATIONAL MEDIA CORPORATION\nPHILADELPHIA, PA\nNATIONAL MEDIA CORPORATION\nCONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED MARCH 31, 1995 AND 1994\nCONTENTS\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors National Media Corporation\nWe have audited the accompanying consolidated balance sheets of National Media Corporation as of March 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 March 31, 1995. Our audits also included the financial statement schedule included 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 National Media Corporation at March 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 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.\nERNST & YOUNG LLP\nMay 12, 1995\nNATIONAL MEDIA CORPORATION\nCONSOLIDATED BALANCE SHEETS\n(IN THOUSANDS, EXCEPT NUMBER OF SHARES\nAND PER SHARE AMOUNTS)\nSee accompanying notes.\nNATIONAL MEDIA CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(IN THOUSANDS, EXCEPT NUMBER OF SHARES\nAND PER SHARE AMOUNTS)\nSee accompanying notes.\nNATIONAL MEDIA CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT NUMBER OF SHARES)\nSee accompanying notes.\nNATIONAL MEDIA CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nSee accompanying notes.\nNATIONAL MEDIA CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMARCH 31, 1995\n1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. DESCRIPTION OF BUSINESS\nNational Media Corporation is engaged in the direct marketing of consumer products principally through television media, by its wholly-owned subsidiaries, Media Arts International, Ltd. and Quantum International Limited (\"Quantum\").\nB. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of National Media Corporation and its wholly- owned subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated.\nREVENUE RECOGNITION AND RESERVE FOR RETURNED MERCHANDISE\nProduct sales and retail royalty revenue is recognized when the product is shipped. Commission revenue is recognized when an order is received and the appropriate credit investigation is completed. Generally, it is the Company's policy to refund unconditionally the total price of merchandise returned within 30 days. The Company provides an allowance, based upon experience, for returned merchandise.\nCASH AND CASH EQUIVALENTS\nFor the purposes of the 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.\nCASH FLOW--NONCASH FINANCING ACTIVITIES\nDuring the year ended March 31, 1995, the Company engaged in certain noncash financing activities which resulted in the reduction of the Company's current liabilities in the approximate amount of $3,400,000. Approximately $1,700,000 related to the issuance of 500,000 shares of the Company's common stock in connection with the settlement of the Salaman litigation discussed in Note 13. The value of the shares was based on the stock's fair market value at the date of settlement. The remaining $1,700,000 represents an offset of severance expense payable to the Company's former Chairman and Chief Executive Officer (\"CEO\") as described more fully in Note 7, by amounts due the Company by the former Chairman and CEO which were previously included in Notes Receivable in the shareholders' equity section of the balance sheet.\nACCOUNTS RECEIVABLE\nThe allowance for doubtful accounts was $1,954,360 and $906,400 at March 31, 1995 and 1994, respectively.\nINVENTORIES\nInventories consist principally of products purchased for resale, and are stated at the lower of cost (determined by the first-in, first-out method) or market.\nPROPERTY AND EQUIPMENT AND DEPRECIATION AND AMORTIZATION\nProperty and equipment are stated at cost. Depreciation and amortization are provided using the straight- line method based on the estimated useful lives of the assets or lease terms.\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n1. Description of Business and Summary of Significant Accounting Policies - (Continued)\nEXCESS OF COST OVER NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS\nExcess of cost over net assets of acquired businesses (\"goodwill\") is being amortized by the straight-line method over 20 to 40 years. Other intangible assets are being amortized by the straight-line method over 2 to 5 years. Amortization expense for excess of cost over net assets acquired and other intangible assets was $336,200, $415,200, and $702,100 for the years ended March 31, 1995, 1994, and 1993, respectively.\nSHOW PRODUCTION COSTS\nCosts related to the production of the Company's direct response televised advertising programs are capitalized and amortized over the estimated useful life of the production. Show production expense was $6,077,000, $6,833,000, and $1,765,000 for the years ended March 31, 1995, 1994, and 1993, respectively. Production expense for 1995, 1994, and 1993 included $1,100,000, $2,600,000, and $200,000, respectively, for amounts written down related to unsuccessful shows.\nDEFERRED REVENUE AND COSTS\nDeferred revenue consists of funds received by the Company for items ordered, but not shipped. The related costs are deferred and expensed as orders are shipped. The Company also defers direct costs on product orders for which the funds are not yet received and expenses these costs as orders are shipped.\nPER SHARE AMOUNTS\nIncome (loss) per share amounts have been computed based upon the weighted average number of common shares and dilutive common equivalent shares (stock options, warrants, and preferred stock) outstanding using the \"if converted method\" in 1995 and the \"treasury stock\" method in 1994 and 1993. For 1995 and 1994, the effect of the exercise of stock options and warrants and the conversion of convertible preferred stock was not assumed in the calculation of loss per share because the effect was anti-dilutive.\nFOREIGN CURRENCY TRANSLATION\nResults of operations for the Company's foreign subsidiary are translated using the average exchange rates during the period, while assets and liabilities are translated into U.S. dollars using the rate at the balance sheet date. Resulting translation adjustments are recorded as a component of shareholders' equity.\nRECLASSIFICATIONS\nCertain prior-year amounts have been reclassified to conform to the current presentation.\nINCOME TAXES\nThe Company uses the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n2. ACCRUED EXPENSES\nAccrued expenses include the following (in thousands):\n3. PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following (in thousands):\nDepreciation and amortization expense for property and equipment, including equipment under capital lease, was $1,314,374, $1,212,800, and $1,319,900 for the years ended March 31, 1995, 1994, and 1993, respectively.\n4. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS\nLong-term debt and capital lease obligations consist of the following (in thousands):\nThe Company obtained a $5,000,000 five-year secured term loan with an independent investor pursuant to a Note and Warrant Purchase Agreement, dated October 19, 1994 (Note Agreement). Approximately $3.1 million of the proceeds of the loan were used to repay the Company's pre-existing bank credit facility. The balance of the proceeds is being utilized for working capital purposes. The Company also issued to the investor a warrant (the \"Loan Warrants\") to purchase 2,250,000 shares (subject to adjustment) of common stock. The Loan Warrants are exercisable at a price of $4.80 per share of common stock at any time from and after September 30, 1995 until September 30, 2004. Based on an independent valuation analysis, the Company has valued the Loan Warrants at $1.8 million. The corresponding loan discount is being\nNational Media Corporation Notes to Consolidated Financial Statements - (Continued)\n4. Long-Term Debt and Capital Lease Obligations - (Continued)\namortized over the life of the loan (60 months) and is included in interest expense. On April 20, 1995, the term loan was purchased by a bank. All material terms of the loan remained unchanged. The loan is guaranteed by the original investor.\nThe term loan bears interest on the unpaid principal amount at a floating rate equal to the prime rate plus .5%, and is payable, monthly in arrears, on the first day of each month. The entire principal amount of the term loan is payable on September 30, 1999. The term loan is secured by a lien on all of the inventory, receivables, trademarks, tradenames, service marks, copyright and all other assets of the Company and its subsidiaries. Such lien on certain nondomestic assets of the Company is subordinate to a lien held by Barclays Bank PLC. At present, the Company has an overdraft line with Barclays Bank PLC in the amount of pounds sterling200,000 pounds (approximately $300,000). Under the Note Agreement, the Company is subject to certain restrictions, including the payment of dividends, and must comply with covenants including the maintenance of specific ratios.\nLong-term debt maturities and payments due under capital lease obligations are as follows (in thousands):\n5. SERIES B CONVERTIBLE PREFERRED STOCK\nIn October 1994, the Company authorized the issuance of a series of preferred stock designated \"Series B Convertible Preferred Stock,\" par value $.01 per share, consisting of 400,000 shares, of which a total of 255,796 shares have been issued in connection with the private placements, as described above in Note 11.\nEach share of preferred stock is valued at $40.00 per share for conversion purposes and is presently convertible at the option of the holder into shares of common stock at a price of $4.00 per share of common stock (subject to adjustment). The holders of shares of preferred stock shall be entitled to receive dividends declared on the common stock as if the shares of preferred stock had been converted into shares of common stock. Except as to the election of directors, each share of preferred stock has voting rights equivalent to the total number of shares of common stock into which the share of the preferred stock is convertible. The holders of the preferred stock, voting as a class, have the right to elect two directors; the holders of the common stock, voting as a class, have the right to elect the remaining directors. The preferred stockholders' right to elect two directors terminates under certain circumstances.\nAt March 31, 1995, there were 11,750,000 shares of common stock reserved for conversion of preferred stock, for exercise of stock options and warrants, for issuance under the 1995 Management Incentive Plan, and for issuance in connection with the tentative settlement of the Shareholders' Federal Class Action litigation. The Company would receive proceeds in excess of $40 million upon exercise of all options and warrants currently outstanding.\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n6. INCOME TAXES\nThe components of income tax expense are as follows (in thousands):\nIncome (loss) before income taxes consisted of the following (in thousands):\nSignificant components of the Company's deferred tax liabilities and assets are as follows (in thousands):\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n6. Income Taxes - (Continued)\nThe increase in the valuation allowance recorded against deferred tax assets is allocable to the increase in net U.S. operating loss carryforwards generated in the fiscal year ended March 31, 1995.\nA reconciliation of the Company's provision for income taxes to the provision for income taxes at the U.S. federal statutory rate of 34% is as follows:\nAt March 31, 1995, the Company has the following loss and credit carryforwards for tax purposes (in thousands):\nThe U.S. net operating loss carryforward includes approximately $14.2 million related to the exercise of employee stock options. For financial reporting purposes, a valuation allowance has been recognized to offset the deferred tax assets related to the entire U.S. net operating loss carryforward.\nUndistributed earnings of the Company's foreign subsidiary amounted to approximately $3,377,000 million at March 31, 1995. Those earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Distribution of those earnings in the form of dividends or otherwise would be subject to U.S. income taxes, reduced by foreign tax credits.\n7. SEVERANCE TO FORMER CHAIRMAN\nIn September 1994, the Chairman of the Board and Chief Executive Officer of the Company resigned. In connection with his resignation, he and the Company executed a letter agreement. The Company recorded severance expense of $2,650,000, pursuant to the terms of the letter agreement and the terms of his employment agreement. In connection with the former Chairman's resignation as a member of the Company's Board of Directors and the Company's settlement of the ValueVision litigation as discussed in Note 13, the Company and the former Chairman entered into further agreements in part amending the earlier agreements. Pursuant to such agreements, the Company (i) paid the former Chairman $50,000 per month through March 31, 1995, (ii) forgave two notes made by the former Chairman, in the principal amount of $1,646,189, (iii) accelerated the vesting of 750,000 options to acquire shares of the Company's common stock in accordance with the terms of his employment agreement, and (iv) retained the former Chairman as a consultant for a term of 36 months for which he will be paid $300,000. He will continue to be eligible to participate in the 1991 Option Plan and stock options granted to him under such plan, but yet unexercised, will terminate 90 days after the termination of his services as a consultant.\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n8. STOCK OPTIONS\nThe Company has stock option plans under which, as amended, a maximum of 5,065,000 shares of common stock may be issued upon exercise of incentive or nonincentive stock options, special options, or stock appreciation rights granted pursuant to such plans. To date, the exercise price of options issued under the Plans has been market or related to market. All employees of the Company, as well as directors, officers, and third parties providing services to the Company are eligible to participate in the Plans.\nPursuant to employment agreements with various officers of the Company, who entered into employment agreements after August 31, 1991, as well as certain other agreements, the Board of Directors has authorized the grant of options to purchase up to 1,042,000 shares of common stock at exercise prices equal to the market price at the time of grant. In each case, the grant of option was an inducement to the execution of an employment or other agreement.\nOptions granted vest over a period ranging from the date of grant up to a maximum of three years. Options may be exercised up to a maximum of 10 years from date of grant.\n9. NOTES RECEIVABLE, DIRECTORS, OFFICERS, EMPLOYEES, CONSULTANTS, AND OTHERS\nNotes outstanding in an aggregate principal amount of $1,868,000 were received in connection with the issuance of 995,000 shares of common stock upon exercise of stock options with exercise prices ranging from $1.625 to $5.125 per share. Approximately $504,000 of these notes are repayable upon the earlier of the sale of the underlying stock or in equal quarterly installments over a three-year period commencing on the 90th day or first anniversary of the individual ceasing to be employed by the Company. A note in the amount of $1,364,000 is due September 30, 1996 with minimum quarterly repayments of $270,000 effective September 30, 1995. This note is secured by certain of the Company's common stock. The notes carry interest rates ranging from 3.79% to 4.00%.\n10. STOCK PURCHASE RIGHTS\nOn January 13, 1994, the Company distributed one preferred share purchase right on each outstanding share of its common stock. The rights will become exercisable only if, without the Company's consent or waiver a person or group acquires 15 percent or more of the Company's outstanding common stock or announces a tender offer the consummation of which would result in\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n10. Stock Purchase Rights - (Continued)\nownership by a person or group of 15 percent or more of the Company's outstanding common stock. Each right will entitle shareholders to buy one one-hundredth of a share of a new series of junior participating preferred stock at an exercise price of $40. In addition, upon the occurrence of certain events, the holders of rights will thereafter have the right to receive, upon exercise at the then-current exercise price, 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. In the event that the Company is acquired in a merger or other business combination, or 50% or more of the Company's assets or earning power is sold, proper provision will be made so that each holder of a right will thereafter have the right to receive, upon exercise at the then-current exercise price of the right, common stock of the acquiring or surviving company having a value equal to two times the exercise price of the right. Any rights that are, or were, under certain circumstances, beneficially owned by such a 15% owner will immediately become null and void.\nThe holders of rights, as such, have no rights as stockholders of the Company. The Company has the ability to redeem the rights at $.001 per right until the occurrence of certain specified events.\n11. EQUITY INVESTMENT\nDuring the year ended March 31, 1995, the Company raised a total of $9,415,000 (net of $872,000 of offering costs) through the sale, in privately negotiated transactions, of a total of 255,796 investment units (\"Units\"). Each Unit consists of one share of preferred stock, par value $.01 per share, of the Company and a warrant (the \"Warrants\") to purchase twelve (12) shares (subject to adjustment) of common stock, par value $.01 per share, of the Company. Each share of preferred stock is valued at $40 per share for conversion purposes, is convertible into common stock at a price of $4.00 per common share (subject to adjustment) and carries no preferred dividend right. The Warrants are exercisable at a price of $4.80 per share of common stock, except for those applicable to 3,546 Units which are exercisable at a price of $5.74 per share of common stock. The warrants are exercisable as follows:\nCertain executive officers and directors of the Company participated in the aforementioned private placement acquiring 17,921 Units. The purchase price of these Units was at the same prices as offered to other investors. Holders of the aforementioned preferred stock and Warrants and Loan Warrants (see Note 4) have certain demand registration rights and piggy-back registration rights with respect to the shares of common stock issuable thereunder. The preferred stock issued (on a common stock equivalent basis) represents approximately 15% of the Company's current outstanding shares of common stock (after giving effect to the issuance of such shares).\n12. COMMITMENTS AND CONTINGENCIES\nThe Company rents warehouse and office space under various operating leases which expire through December 2013 including a lease with a related party as described in Note 14. Future minimum lease payments (exclusive of real estate taxes and other operating expenditures) as of March 31, 1995 under noncancelable operating leases with initial or remaining terms of one year or more are as follows for the years ended March 31 (in thousands):\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n12. Commitments and Contingencies - (Continued)\nRent expense under various operating leases aggregated $2,119,100, $2,483,500, and $930,200 in 1995, 1994, and 1993, respectively. Subleased building space rental income aggregated $140,500, $148,600, and $67,300, for 1995, 1994, and 1993, respectively.\nDuring fiscal year 1995, the Company expended $51,961,000 on media purchases, a portion of which were made under long-term agreements. According to the terms of one such agreement between the Company and a cable television network which extends through December 1997, the Company is obligated to purchase a specific number of television hours per calendar year. The agreement is cancelable by the cable television network with six months' written notice, only in the event that it decides to telecast its own programming on a 24-hours-per-day basis. In addition, the Company has agreements with certain Pan European satellite channels to purchase a specific number of television hours per week at a minimum guaranteed amount. These contracts expire at various dates from August 1996 to December 1999. Total commitments under these media contracts are: $22,700,000 in 1996; $21,800,000 in 1997; $18,300,000 in 1998; $1,000,000 in 1999; and $750,000 in 2000.\n13. LITIGATION AND REGULATORY MATTERS\nSHAREHOLDERS' FEDERAL CLASS ACTIONS\nIn June 1993, a class action complaint was filed in federal court against the Company and certain of its former executive officers. Five similar lawsuits subsequently were filed in the same court. The six actions were consolidated and an amended and consolidated complaint (the \"complaint\") was filed in October 1993. The complaint involved allegations concerning disclosure by the Company of its ongoing relationship with Positive Response Television, Inc., an infomercial producer, and Ronic, S.A., a supplier of the Company.\nThe parties have reached a settlement of this action, calling for cash payments by the Company's insurer of $2.175 million and the issuance, subject to adjustment, of 145,000 shares of common stock. In connection with the settlement, the Company recorded a charge of approximately $725,000.\nTERMINATED TENDER OFFER AND MERGER AGREEMENT WITH VALUEVISION INTERNATIONAL, INC.\nOn April 22, 1994, the Company filed suit in federal court against ValueVision International, Inc. (\"ValueVision\") alleging that ValueVision had wrongfully terminated its amended tender offer. In May 1994, ValueVision answered the Company's complaint and set forth various counterclaims. On April 17, 1995, the Company, ValueVision, and all other parties to this litigation entered into a settlement agreement, pursuant to which the parties agreed to dismiss with prejudice all claims and counterclaims. In connection with the settlement agreement, the Company and ValueVision executed a Telemarketing, Production and Post-Production Agreement (the \"Telemarketing Agreement\") and a Joint Venture Agreement. The settlement agreement shall become effective upon the earlier to occur of (i) the date upon which the shareholder approval required by the applicable New York Stock Exchange rules and regulations in order to consummate the Telemarketing Agreement has been obtained or (ii) the date the Telemarketing Agreement becomes effective. In the event the settlement agreement is not effective by August 31, 1995, the settlement agreement shall become null and void in its entirety.\nPursuant to the Telemarketing Agreement, ValueVision is obligated to provide to the Company over a three-year period inbound telephone call-taking services at rates more favorable than those currently being paid by the Company. ValueVision is also obligated to provide to the Company certain production and post- production services.\nAs additional consideration for the services to be provided by ValueVision under the Telemarketing Agreement, the Company is obligated to grant to ValueVision, on the effective date, warrants (the \"Warrants\") to purchase up to 500,000 shares of the Company's common stock at a price of $8.865 per share (subject to adjustment pursuant to the antidilution provisions of the Warrants). This price was based on a premium over the average 20-day market\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n13. Litigation and Regulatory Matters - (Continued)\nTERMINATED TENDER OFFER AND MERGER AGREEMENT WITH VALUEVISION INTERNATIONAL, INC. -- (CONTINUED)\nvalue prior to the date of settlement. The Warrants will vest with respect to an equal number of shares on each of the thirteen-month, 2-year and 3-year anniversaries of the effective date provided that ValueVision satisfies certain conditions. The Warrants will expire on the tenth anniversary of the effective date.\nThe Telemarketing Agreement shall become effective upon the later to occur of the stockholder approval date and the certification date. In the event the stockholder approval date does not occur on or prior to August 31, 1995, either the Company or ValueVision may terminate the Telemarketing Agreement. Upon such a termination, the settlement agreement shall become null and void. In the event the certification date has not occurred by the sixtieth day following the stockholder approval date, the Company may terminate the Telemarketing Agreement. Upon such a termination, the Company will be entitled to receive liquidated damages in the amount of $3,000,000. The Company will also be entitled to liquidated damages at a lesser amount for certain other material breaches under the Telemarketing Agreement.\nAs part of the settlement, the Company and ValueVision also entered into a Joint Venture Agreement. Pursuant to the Joint Venture Agreement, the Company is required, subject to certain exceptions, to negotiate in good faith with ValueVision to form a joint venture to pursue home shopping opportunities outside of the United States and Canada before pursuing such opportunities by itself or with certain third parties. ValueVision granted the Company similar rights with respect to infomercial opportunities ValueVision may have outside the United States and Canada.\nIn connection with the matters discussed above, the Company agreed to reimburse its former Chairman $50,000 for certain legal fees and associated costs he incurred in connection with the litigation with ValueVision and certain other legal matters to which the Company is a party and to accelerate a substantial portion of the payments payable to the former Chairman under that certain Consulting Agreement as described in Note 7. In addition, the Company exercised its option to terminate, effective October 31, 1997, that certain Lease dated February 25, 1992 as discussed more fully in Note 15. Pursuant to the terms of the Lease, the Company was required to pay the sum of $220,000 in connection with the exercise of its right of early termination.\nThe issuance of the Warrants to ValueVision required the prior consent of the holders of the promissory notes issued pursuant to the Note Agreement as discussed in Note 4. As an inducement to the Noteholders to permit the issuance of the Warrants, the Company has agreed to issue the Noteholders warrants (the \"Waiver Warrants\") to purchase 500,000 shares of the Company's common stock at a price of $10.00 per share. These warrants expire on the earlier of 12 months after the notes are paid in full or upon the Noteholders no longer being guarantors of the notes. The issuance of the Waiver Warrants is subject to the approval of the Company's stockholders.\nSHAREHOLDERS' DELAWARE CLASS ACTIONS\nIn January 1994, four class action complaints were filed in Delaware Chancery Court against the Company and certain of its present and former officers and directors in connection with a proposed merger transaction with ValueVision. On April 17, 1995, the Company and other parties to the litigation entered into agreements in principle to settle these actions as well as the Lachance and Efron and Cohen Class Action litigation described below. These agreements provide for cash payments of $1.5 million, 75% of which will be paid by the Company's insurer. The Company recorded a charge of $375,000 for its portion of the settlement.\nLACHANCE AND EFRON AND COHEN CLASS ACTIONS\nIn 1994, stockholders filed purported class action lawsuits in federal court against the Company and certain of its former officers and directors in connection with the aborted ValueVision tender offer. The parties have reached an agreement in principle to settle the matter as discussed in Shareholders' Delaware Class Actions above.\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n13. Litigation and Regulatory Matters - (Continued)\nCONSUMER PRODUCT SAFETY COMMISSION INVESTIGATION\nOn February 24, 1994, the staff of the Consumer Product Safety Commission (CPSC) notified the Company that it had made a preliminary determination that a particular model of the Company's Juice Tiger(R) product presents a \"substantial product hazard,\" under the Consumer Product Safety Act. The CPSC staff requested the Company to take voluntary corrective action to ameliorate such alleged product hazard. While the Company has disputed that the model in question presents a substantial product hazard, the Company and the CPSC staff are presently discussing the form and nature of voluntary action proposed by the Company to assuage the CPSC staff's concerns. The CPSC staff has also indicated that, upon agreement on the implementation of a corrective action plan, it may investigate and assess whether the Company failed to comply with reporting requirements under the Consumer Product Safety Act such as to warrant imposition of a civil penalty. Given the current status of the proceedings before the CPSC staff, it is not yet possible to determine whether the cost of implementing any such corrective action plan and the amount of any such civil penalty, alone or together, would have a material adverse effect on the Company's results of operations and financial condition.\nCAMPBELL V. NATIONAL MEDIA CORPORATION\nOn July 28, 1994, a former officer of the Company filed a complaint in federal court against the Company and the former Chairman and Chief Executive Officer containing various allegations including a claim that the Company and the former Chairman fraudulently induced him to purchase the Company's common stock through the exercise of stock options and to forebear from selling his shares of common stock. The former officer seeks to recover compensatory damages in excess of $1.3 million as well as punitive damages and to rescind all alleged debts owed to the Company by him (approximately $238,000). The Company and its former Chairman filed motions to dismiss and\/or for summary judgment, which motions were denied by the Court on November 3, 1994. The parties have informally reached a confidential settlement of the action, and on December 9, 1994, the court dismissed the case with prejudice. The court has retained jurisdiction of the case, however, in the event that any party seeks to have the dismissal vacated, modified, or stricken should the parties fail to execute and deliver a definitive settlement agreement. Although the Company has no reason to expect that such a definitive settlement agreement will not be executed by all parties, there can be no assurance that the settlement will be so finalized. Management of the Company believes that the definitive settlement, if implemented on substantially the terms of the informal settlement, would not be likely to have a material adverse effect on the financial position or results of operations of the Company.\nSALAMAN V. NATIONAL MEDIA\nOn August 1, 1994, the Company entered into an agreement which settled a judgment entered against the Company related to litigation brought by a former director against the Company. Pursuant to the agreement, the Company paid the former director $500,000 and issued to him 500,000 newly issued shares of the Company's common stock (the \"Shares\"). On February 10, 1995, the Company registered the Shares under the Securities Act of 1933, as amended, for resale by the former director. Upon the declaration of effectiveness of the registration statement, the parties caused the action to be dismissed with prejudice.\nRONIC, S.A. V. NATIONAL MEDIA\nIn October 1993, the Company entered into a settlement agreement with Ronic, S.A., a supplier of one of the Company's products, related to litigation involving its claim for payment of merchandise ordered and received, and damages for Ronic's entry into receivership among other things. The remaining terms of the settlement agreement (i) require Ronic to make available during the period October 1, 1994 to September 30, 1997 (or until the Company has purchased a total of $25,000,000 of product from Ronic) certain manufacturing capacity for the Company in return for payment by the Company annually on September 30 of between $0 and $250,000, on a sliding-scale\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n13. Litigation and Regulatory Matters - (Continued)\nRONIC, S.A. V. NATIONAL MEDIA -- (CONTINUED)\nformula, depending upon the amount of goods purchased from Ronic, (ii) designate Ronic as the preferred manufacturer of all of the Company's small electrical and mechanical appliances for the next three years, and (iii) grant Ronic a twenty-year license to market and manufacture electronic juice extractors under the Company's Juice Tiger(R) trademark.\nOTHER MATTERS\nThe Company, in the normal course of its business, is a party to litigation relating to trademark and copyright infringement, product liability, contract-related disputes, and other actions. It is the Company's policy to vigorously defend all such claims and enforce its rights in these areas. Except as disclosed herein, the Company does not believe any of these actions either individually or in the aggregate, will have a material adverse effect on the Company's results of operations or financial condition.\n14. RETIREMENT PLAN\nThe Company adopted a 401(k) defined contribution plan effective August 1, 1992. All of the Company's U.S. full-time employees may participate in the plan. The Company matches employee contributions. The level of the matching contributions depends on the return on equity of the Company each year. Expense recognized for the plan was $40,000 and $12,500 for the years ended March 31, 1995 and 1994, respectively.\n15. RELATED PARTY TRANSACTIONS\nIn February 1992, the Company entered into a lease agreement for office space in a building owned by Mergren Associates, a real estate company owned by the Company's former Chairman of the Board and CEO. The lease provided for the Company to rent approximately 29,795 square feet of office space for a ten-year term ending October 31, 2002. Pursuant to the terms of the lease and in connection with the ValueVision settlement as more fully discussed in Note 13 the Company exercised its option to terminate the lease, effective October 31, 1997. The rent for the remaining term will be $14.75 per square foot. To assess the fairness of this lease, an independent real estate firm was engaged to determine that the lease was based on fair market conditions at the time of inception. The Company took possession of the property in February 1993. Rental expense is $37,000 per month.\n16. SEGMENT AND GEOGRAPHIC INFORMATION\nThe Company operates in one industry segment and is engaged in the direct marketing of products principally through television. Information as to the Company's foreign operations, which are principally in Europe and Asia (commencing in July 1994) is set forth below (in thousands):\nNational Media Corporation\nNotes to Consolidated Financial Statements - (Continued)\n16. Segment and Geographic Information - (Continued)\nOperating income is net income before interest and income taxes. U.S. and Canada includes unallocated corporate expenses.\n17. UNUSUAL CHARGES\nThe year ended March 31, 1995 includes unusual charges of $2,868,000 consisting of settlement costs and related legal fees of $831,000 for the tentative settlement of the Shareholders' Federal Class Action litigation and $345,000 for settlement of a dispute with Direct Records, a former business partner; $914,000 in costs associated with the tentative settlement of the ValueVision litigation and related shareholder class action litigation; $198,000 in costs connected with the Salaman litigation; and $580,000 representing the present value of future purchase commitments required as part of the Ronic Settlement (see Note 13).\nIncluded in the unusual charges of $9,049,000 for the year ended March 31, 1994 is $4,127,000 for certain legal settlements, including $1,852,000 ($1,550,000 of which represents punitive damages) for Salaman v. National Media, $1,625,000 for Ronic, S.A. v. National Media, $550,000 for Positive Response Marketing, Inc. and Michael Levey v. National Media Corporation and Media Arts International, Ltd., and $100,000 for other settlements. Also included is $1,138,000 in legal fees associated with the aforementioned settlements, as well as the shareholders' federal class action lawsuits, $1,000,000 related to the relocation of its fulfillment center to Phoenix, Arizona; $1,268,000 in costs associated with anti-takeover defenses and the terminated tender offer and agreement of merger; $725,000 in severance related to personnel reductions; $591,000 in costs associated with two aborted stock offerings; and $200,000 of other charges.\nUnusual charges for the fiscal year ended March 31, 1993 were $725,000 and include $425,000 in severance expense and $300,000 in legal settlements and related legal fees.\n18. SUBSEQUENT EVENT\nIn June 1995, the Company signed a letter of intent to purchase the stock of two companies which own the rights to the Flying Lure, a line of fishing lure products. This transaction is contingent upon the Company's satisfactory completion of a due diligence review of the two companies. The contemplated transaction calls for a basic purchase price of $4 million payable over a three-year period with an additional amount up to a maximum of $3 million payable if worldwide sales of the product exceed targeted levels over a three- to six-year period. A portion of the basic purchase price would consist of a debenture convertible by the seller into the Company's common stock at a premium over the stock price at the closing date. In addition, the Company would pay $1.2 million under the terms of a noncompetition agreement with the inventor.\nSCHEDULE VIII\nNATIONAL MEDIA CORPORATION AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)\n- ------ (1) Uncollectible accounts written off, net of recoveries.\n(2) Refunds on products sold.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 MEDIA CORPORATION\nDate: June 29, 1995 \/s\/ MARK P. HERSHHORN --------------------------------------------------- Mark P. Hershhorn President, Chief Executive Officer, and Director\nDate: June 29, 1995 \/s\/ JOHN J. SULLIVAN ---------------------------------------------------- John J. Sullivan Senior Vice President, Administration, Planning and Investor Relations and Principal Accounting Officer\nDate: June 29, 1995 \/s\/ CONSTANTINOS I. COSTALAS ---------------------------------------------------- Constantinos I. Costalas Vice Chairman of the Board, Principal Financial Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: June 29, 1995 \/s\/ BRIAN MCADAMS --------------------------------------------------- Brian McAdams Chairman of the Board, Chairman of the Executive Committee and Director\nDate: June 29, 1995 \/s\/ DAVID J. CARMAN ---------------------------------------------------- David J. Carman Executive Vice President of the Company, President and Chief Executive Officer of Quantum International, Ltd. and Director\nDate: June 29, 1995 \/s\/ CHARLES L. ANDES ---------------------------------------------------- Charles L. Andes Director\nDate: June 29, 1995 \/s\/ MICHAEL J. EMMI ---------------------------------------------------- Michael J. Emmi Director\nDate: June 29, 1995 \/s\/ FREDERICK S. HAMMER ---------------------------------------------------- Frederick S. Hammer Director\nDate: June 29, 1995 \/s\/ JON W. YOSKIN II ---------------------------------------------------- Jon W. Yoskin II Director\nDate: June 29, 1995 \/s\/ IRA M. LUBERT ---------------------------------------------------- Ira M. Lubert Director\nINDEX TO EXHIBITS\n- ------ * Incorporated by reference to Registrant's Registration Statement on Form S-1 (Reg. No. 33-26778) filed January 31, 1989.\n** Incorporated by reference to Registrant's Registration Statement on Form S-3 (Reg. No. 33-35301) filed June 8, 1990.\n*** Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1992 filed June 26, 1992.\n**** Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1991 filed June 20, 1991.\n++ Incorporated by reference to Registrant's Annual Report on Form 10-K for fiscal year ended March 31, 1994 filed July 14, 1994.\n+ Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c).\n+ Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1993 filed June 29, 1993.\n++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1993 filed November 12, 1993.\n+++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 1993 filed February 14, 1994.\n++++ Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 1994 filed February 14, 1995.\n|B| Incorporated by reference to Registrant's Report on Form 8-K dated October 5, 1994.\n|B||B| Incorporated by reference to Registrant's Report on Form 8-K dated December 8, 1994.\n|B||B||B| Incorporated by reference to Registrant's Report on Form 8-K dated January 13, 1995.\n& Incorporated by reference to Registrant's Report on Form 8-K dated April 13, 1995.\n&& Incorporated by reference to Registrant's Report on Form 8-K dated September 12, 1994.\n&&& Incorporated by reference to Registrant's Report on Form 8-K dated August 26, 1994.\n&&&& Incorporated by reference to Registrant's Report on Form 8-K dated July 19, 1994.\n## Incorporated by reference to Registrant's Proxy Statement in connection with annual meeting of Stockholders to be held on February 22, 1995.\n# Incorporated by reference to Registrant's Schedule 14 D-9 filed on February 18, 1994.","section_15":""}
{"filename":"721683_1995.txt","cik":"721683","year":"1995","section_1":"Item 1. Business.\nBusiness. Established in 1983 as an outgrowth of an on-line accounting and bankcard data processing system developed for Columbus Bank and Trust Company(R), Total System Services, Inc.(sm) (\"TSYS(R)\") is now one of the world's largest credit, debit and private-label card processing companies. Based in Columbus, Georgia, and traded on the New York Stock Exchange under the symbol \"TSS,\" TSYS provides a comprehensive on-line system of data processing services marketed as THE TOTAL SYSTEM(sm), servicing issuing and acquiring institutions throughout the United States, Puerto Rico, Canada and Mexico, representing more than 63 million cardholder and over 600,000 merchant accounts. TSYS provides card production, domestic and international clearing, statement preparation, customer service support, merchant accounting, merchant services and management support. Synovus Financial Corp.(R), a $7.9 billion asset, multi-financial services company, owns 80.8 percent of TSYS.\nTSYS has four wholly-owned subsidiaries: (1) Columbus Depot Equipment Company(sm) (\"CDEC(sm)\"), which sells and leases computer related equipment associated with TSYS' bankcard data processing services and bank data processing services provided by an affiliate; (2) Mailtek, Inc.(sm) (\"Mailtek\"), which provides full-service direct mail production services and offers data processing, list management, laser printing, computer output microfiche, card embossing, encoding and mailing services; (3) Lincoln Marketing, Inc.(sm) (\"LMI\"), which provides correspondence, fulfillment, telemarketing, data processing and mailing services; and (4) Columbus Productions, Inc.(sm) (\"CPI\"), which provides full-service commercial printing and related services. TSYS also holds a 49% equity interest in a Mexican company named Total System Services de Mexico, S.A. de C.V.(\"TSM\"), which provides credit card related processing services to Mexican banks.\nService Marks. TSYS owns a family of service marks containing the name Total System, and the federally registered service marks TSYS and TS2, to which TSYS believes strong customer identification attaches. TSYS also owns service marks associated with its subsidiaries. Management does not believe the loss of such marks would have a material impact on the business of TSYS.\nMajor Customers. A significant amount of TSYS' revenues are derived from certain major customers who are processed under long-term contracts. For the year ended December 31, 1995, AT&T Universal Card Services Corp. and NationsBank accounted for 21.4% and 12.4%, respectively, of TSYS' total revenues. As a result, the loss of one of TSYS' major customers could have a material adverse effect on TSYS' results of operations.\n- ------------------------------------ Synovus Financial Corp., Synovus, Columbus Bank and Trust Company and CB&T are federally registered service marks of Synovus Financial Corp. Total System Services, Inc., \"THE TOTAL SYSTEM,\" Columbus Depot Equipment Company, CDEC, Lincoln Marketing, Inc., Mailtek, Inc. and Columbus Productions, Inc. are service marks of Total System Services, Inc. TSYS and TS2 are federally registered service marks of Total System Services, Inc.\nCompetition. TSYS encounters vigorous competition in providing bankcard data processing services from several different sources. The national market in third party bankcard data processors is presently being provided by approximately five vendors. TSYS believes that it is the second largest third party bankcard processor in the United States. In addition, TSYS competes against software vendors which provide their products to institutions which process in-house. TSYS is presently encountering, and in the future anticipates continuing to encounter, substantial competition from bankcard associations, data processing and bankcard computer service firms and other such third party vendors located throughout the United States.\nTSYS' major competitor in the bankcard data processing industry is First Data Resources, Inc., a wholly-owned subsidiary of First Data Corporation, which is headquartered in Omaha, Nebraska, and provides bankcard data processing services, including authorization and data entry services. The principal methods of competition between TSYS and First Data Resources are price and the type and quality of services provided. In addition, there are a number of other companies which have the necessary financial resources and the technological ability to develop or acquire products and, in the future, to provide services similar to those being offered by TSYS.\nRegulation and Examination. TSYS is subject to being examined, and is indirectly regulated, by the Office of the Comptroller of the Currency, the Federal Reserve Board (\"Board\"), the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the National Credit Union Administration, and the various state financial regulatory agencies which supervise and regulate the banks, savings institutions and credit unions for which TSYS provides bankcard data processing services. Matters reviewed and examined by these federal and state financial institution regulatory agencies have included TSYS' internal controls in connection with its present performance of bankcard data processing services, and the agreements pursuant to which TSYS provides such services.\nOn January 4, 1990, the Federal Reserve Bank of Atlanta approved Synovus' indirect retention of its ownership of TSYS through Columbus Bank and Trust Company (\"CB&T\") and TSYS is now subject to direct regulation by the Board. TSYS was formed with the prior written approval of, and is subject to regulation and examination by, the Department of Banking and Finance of the State of Georgia as a subsidiary of CB&T and is authorized to engage in only those activities which CB&T itself is authorized to engage in directly, which includes the bankcard and other data processing services presently being provided by TSYS. As TSYS and its subsidiaries operate as subsidiaries of CB&T, they are subject to regulation by the Federal Deposit Insurance Corporation.\nEmployees. On December 31, 1995, TSYS had 2,269 full-time employees.\nSee the \"Financial Review\" Section on pages 18 through 25 and Note 1, Note 4 and Note 9 of Notes to Consolidated Financial Statements on pages 30 through 32, 33 and 34, and 37 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nTSYS owns its 73,000 square foot South Center located at 1000 Fifth Avenue, Columbus, Georgia 31901, and owns its 60,000 square foot Annex Building located at 420 10th Street, Columbus, Georgia 31901. TSYS also owns a warehouse facility, various other tracts of real estate located near or adjacent to its South Center and Annex Building which are used for parking and\/or future expansion needs, and leases additional office space in Columbus, Georgia, Atlanta, Georgia, and Jacksonville, Florida.\nThe approximately 32,000 square foot Columbus Depot, located at 1200 Sixth Avenue, Columbus, Georgia 31901, which is owned by TSYS and is on the National Register of Historic Places, houses TSYS' executive offices and several corporate divisions.\nTSYS also owns a 210,000 square foot production center which is located on a 40.4 acre tract of land in north Columbus, Georgia. Primarily a production center, this facility houses TSYS' primary data processing computer operations, statement preparation, mail handling, microfiche production and purchasing, as well as other related operations.\nTSM owns a 52,000 square foot structure in Toluca, Mexico which has offices, a communication node and facilities for statement production, report printing and card embossing.\nDuring 1995, TSYS purchased a 110,000 square foot building on a 23-acre site in Columbus, Georgia, to accommodate current and future office space needs.\nOn March 7, 1996, TSYS announced its plans to purchase approximately 50 acres in downtown Columbus, Georgia, on which it will begin building a campus-like complex for its corporate headquarters in early 1997.\nAll properties owned and leased by TSYS are in good repair and suitable condition for the purposes for which they are used.\nIn addition to its real property, TSYS owns and\/or leases a substantial amount of computer equipment.\nSee Note 1, Note 2, Note 3, Note 5 and Note 9 of Notes to Consolidated Financial Statements on pages 30 through 32, pages 33 and 34, and page 37 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nSee Note 9 of Notes to Consolidated Financial Statements on page 37 of TSYS' Annual Report to Shareholders which is specifically incorporated herein by reference.\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 \"Quarterly Financial Data, Stock Price, Dividend Information\" Section which is set forth on page 39 of TSYS' 1995 Annual Report to Shareholders is specifically incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe \"Selected Financial Data\" Section which is set forth on page 17 of TSYS' 1995 Annual Report to Shareholders is specifically 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\" Section which is set forth on pages 18 through 25 of TSYS' 1995 Annual Report to Shareholders, which includes the information encompassed within \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" is specifically incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe \"Quarterly Financial Data, Stock Price, Dividend Information\" Section, which is set forth on page 39, and the \"Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Shareholders' Equity, Consolidated Statements of Cash Flows, Notes to Consolidated Financial Statements and Report of Independent Auditors\" Sections, which are set forth on pages 26 through 38 of TSYS' 1995 Annual Report to Shareholders are specifically 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 \"ELECTION OF DIRECTORS - Information Concerning Number and Classification of Directors and Nominees\" Section which is set forth on pages 2 and 3, the \"ELECTION OF DIRECTORS - Information Concerning Directors and Nominees for Class I Directors - General Information\" Section which is set forth on pages 3 and 4, the \"ELECTION OF DIRECTORS - Executive Officers\" Section which is set forth on pages 6 and 7, and the \"COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT\" Section which is set forth on pages 19 and 20 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held\non April 15, 1996 are specifically incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe \"EXECUTIVE COMPENSATION - Summary Compensation Table; Stock Option Exercises and Grants; Compensation of Directors; Change in Control Arrangements; and Compensation Committee Interlocks and Insider Participation\" Sections which are set forth on pages 9 through 12, and page 15 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe \"ELECTION OF DIRECTORS - Information Concerning Directors and Nominees for Class I Directors - TSYS Common Stock Ownership of Directors and Management\" Section which is set forth on page 5, the \"RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Beneficial Ownership of TSYS Common Stock by CB&T\" Section which is set forth on page 16, and the \"RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - - Synovus Common Stock Ownership of Directors and Management\" Section which is set forth on pages 16 and 17 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe \"EXECUTIVE COMPENSATION - Compensation Committee Interlocks and Insider Participation\" Section which is set forth on page 15, \"EXECUTIVE COMPENSATION - Transactions with Management\" Section which is set forth on pages 15 and 16, the \"RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Beneficial Ownership of TSYS Common Stock by CB&T\" Section which is set forth on page 16, the \"RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T AND CERTAIN OF SYNOVUS' SUBSIDIARIES Interlocking Directorates of TSYS, Synovus and CB&T\" Section which is set forth on page 16, and the \"RELATIONSHIPS BETWEEN TSYS, SYNOVUS, CB&T, AND CERTAIN OF SYNOVUS' SUBSIDIARIES - Bankcard Data Processing Services Provided to CB&T and Certain of Synovus' Subsidiaries; Other Agreements Between TSYS, Synovus, CB&T and Certain of Synovus' Subsidiaries\" Section which is set forth on pages 18 and 19 of TSYS' Proxy Statement in connection with the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996 are specifically incorporated herein by reference.\nSee also Note 2 and Note 5 of Notes to Consolidated Financial Statements on pages 32, and 33 and 34 of TSYS' 1995 Annual Report to Shareholders which are specifically incorporated herein by reference.\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 TSYS are specifically incorporated by reference from pages 26 through 38 of TSYS' 1995 Annual Report to Shareholders to Item 8, Part II, Financial Statements and Supplementary Data.\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.\nReport of Independent Auditors.\n2. Index to Financial Statement Schedules\nThe following report of independent auditors and consolidated financial statement schedule of Total System Services, Inc. are included:\nReport of Independent Auditors.\nSchedule II - Valuation and Qualifying Accounts - Years Ended December 31, 1995, 1994 and 1993.\nAll other schedules are omitted because they are inapplicable or the required information is included in the Notes to Consolidated Financial Statements.\n3. Exhibits\nExhibit Number Description\n3.1 Articles of Incorporation of Total System Services, Inc. (\"TSYS\"), as amended, incorporated by reference to Exhibit 3.1 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1990, as filed with the Commission on March 19, 1991.\n3.2 Bylaws of TSYS.\n10. EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\n10.1 Director Stock Purchase Plan of TSYS, incorporated by reference to Exhibit 10.1 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.2 Group \"Y\" Key Executive Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.2 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.3 1985 Key Employee Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.3 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.4 1990 Key Employee Restricted Stock Bonus Plan of TSYS, incorporated by reference to Exhibit 10.4 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.5 Total System Services, Inc. 1992 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.5 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.6 Excess Benefit Agreement of TSYS, incorporated by reference to Exhibit 10.6 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.7 Wage Continuation Agreement of TSYS, incorporated by reference to Exhibit 10.7 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.8 Incentive Bonus Plan of Synovus Financial Corp. in which executive officers of TSYS participate, incorporated by reference to Exhibit 10.8 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.9 Agreement in connection with use of aircraft, incorporated\nby reference to Exhibit 10.9 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 18, 1993.\n10.10 Split Dollar Insurance Agreement of TSYS, incorporated by reference to Exhibit 10.10 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1993, as filed with the Commission on March 22, 1994.\n10.11 Synovus Financial Corp. 1994 Long-Term Incentive Plan in which executive officers of TSYS participate, incorporated by reference to Exhibit 10.11 of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as filed with the Commission on March 9, 1995.\n10.12 Synovus Financial Corp. Executive Bonus Plan in which executive officers of TSYS participate.\n10.13 Change of Control Agreements for executive officers of TSYS.\n11.1 Statement re Computation of Per Share Earnings.\n13.1 Certain specified pages of TSYS' 1995 Annual Report to Shareholders, which are specifically incorporated herein by reference.\n20.1 Proxy Statement for the Annual Meeting of Shareholders of TSYS to be held on April 15, 1996, certain pages of which are specifically incorporated herein by reference.\n21.1 Subsidiaries of Total System Services, Inc.\n23.1 Independent Auditors' Consent.\n24.1 Powers of Attorney contained on the signature pages of the 1995 Annual Report on Form 10-K.\n27.1 Financial Data Schedule (for SEC use only).\n99.1 Annual Report on Form 11-K for the Total System Services, Inc. Employee Stock Purchase Plan for the year ended December 31, 1995 (to be filed as an amendment hereto within 120 days of the end of the period covered by this report.)\n99.2 Annual Report on Form 11-K for the Total System Services,\nInc. Director Stock Purchase Plan for the year ended December 31, 1995 (to be filed as an amendment hereto within 120 days of the end of the period covered by this report.)\n(b) Reports on Form 8-K\nOn October 20, 1995, TSYS filed a Form 8-K with the Commission in connection with the renewal of a long-term credit card processing contract with NationsBank.\nfilings\\TSYS\\TSYS96.10K\nReport of Independent Auditors\nThe Board of Directors Total System Services, Inc.\nUnder date of January 26, 1996, we reported on the consolidated balance sheets of Total System Services, 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 years in the three-year period ended December 31, 1995, as contained in the Total System Services, Inc. 1995 Annual Report to Shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the Total System Services, Inc. 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 in 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, such financial 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\nAtlanta, Georgia January 26, 1996\nTotal System Services, Inc. Schedule II Valuation and Qualifying Accounts\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, Total System Services, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTOTAL SYSTEM SERVICES, INC. (Registrant)\nMarch 19, 1996 By:\/s\/ Richard W. Ussery --------------------- Richard W. Ussery, Chairman and Principal Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James H. Blanchard, Richard W. Ussery and Philip W. Tomlinson each of them, his true and lawful attorney(s)-in-fact and agent(s), 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 report and to file the same, with all exhibits and schedules thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney(s)-in-fact and agent(s) 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(s)-in-fact and agent(s), or their substitute(s), may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated.\n\/s\/James H. Blanchard Date: March 19, 1996 - ----------------------------------------------- James H. Blanchard, Director and Chairman of the Executive Committee\n\/s\/Richard W. Ussery Date: March 19, 1996 - ----------------------------------------------- Richard W. Ussery, Chairman of the Board and Principal Executive Officer\n\/s\/Philip W. Tomlinson Date: March 19, 1996 - ----------------------------------------------- Philip W. Tomlinson, President and Director\n\/s\/James B. Lipham Date: March 19, 1996 - ----------------------------------------------- James B. Lipham, Executive Vice President, Treasurer, Principal Accounting and Financial Officer\n\/s\/William A. Pruett Date: March 19, 1996 - ----------------------------------------------- William A. Pruett, Exective Vice President\n\/s\/M. Troy Woods Date: March 19, 1996 - ----------------------------------------------- M. Troy Woods, Executive Vice President\n\/s\/G. Sanders Griffith, III Date: March 19, 1996 - ----------------------------------------------- G. Sanders Griffith, III, General Counsel and Secretary\n\/s\/Griffin B. Bell Date: March 19, 1996 - ----------------------------------------------- Griffin B. Bell, Director\n\/s\/ Richard Y. Bradley Date: March 19, 1996 - ----------------------------------------------- Richard Y. Bradley, Director\n\/s\/Salvador Diaz-Verson, Jr. Date: March 19, 1996 - ----------------------------------------------- Salvador Diaz-Verson, Jr., Director\n\/s\/Kenneth E. Evans Date: March 19, 1996 - ----------------------------------------------- Kenneth E. Evans, Director\n\/s\/Gardiner W. Garrard, Jr. Date: March 19, 1996 - ----------------------------------------------- Gardiner W. Garrard, Jr., Director\n\/s\/ John P. Illges Date: March 19, 1996 - ----------------------------------------------- John P. Illges, III, Director\n\/s\/Mason H. Lampton Date: March 19, 1996 - ----------------------------------------------- Mason H. Lampton, Director\n\/s\/W. Walter Miller, Jr. Date: March 19, 1996 - ----------------------------------------------- W. Walter Miller, Jr., Director\n\/s\/H. Lynn Page Date: March 19, 1996 - ----------------------------------------------- H. Lynn Page, Director\n\/s\/William B. Turner Date: March 19, 1996 - ----------------------------------------------- William B. Turner, Director\n\/s\/George C. Woodruff, Jr. Date: March 19, 1996 - ----------------------------------------------- George C. Woodruff, Jr., Director\n\/s\/James D. Yancey Date: March 19, 1996 - ----------------------------------------------- James D. Yancey, Director","section_15":""}
{"filename":"742103_1995.txt","cik":"742103","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business\nAMERICAN INCOME 3 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 the \"Manager\") a Massachusetts partnership. On December 17, 1985, the Partnership issued 80,885 limited partnership units (the \"Units\") to 1,663 investors, including four Units purchased by the Initial Limited Partner. The General Partner contributed $50,000 in consideration of its general partner interest.\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 equal or 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 has the additional objective of providing certain federal income tax benefits.\nThe Closing Date of the Offering of Units of the Partnership was December 17, 1985. The initial purchase of equipment and the associated lease commitments occurred on December 17, 1985. The Partnership completed the disposition of its equipment portfolio in 1994 and dissolution of the Partnership occurred on December 29, 1995.\nThe Partnership had 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, technological obsolescence and defaults by lessees. 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.\nThere are no material pending legal proceedings to which the Partnership is a party or which involve any of its equipment or leases.\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 payable at December 31, 1994 were $204,255. 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 Date. The Partnership has distributed $21,002,832 to the Limited Partners and $212,150 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. The General Partner transferred $100,000 on September 29, 1995, representing a liquidating distribution, into a non-interest bearing custodian account (the \"Account\") of the Trust. The remainder of the Partnership's operating cash of $65,590 was transferred into the Trust Account on December 29, 1995. The transferred amount included $27,723 of accrued expenses which were paid in 1996. Amounts held in the Trust 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 the balance of the Trust Account exceeds the ultimate liabilities of the Partnership, the General Partner will distribute such remaining balance to the beneficiaries of the Trust Account, 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.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated herein by reference to the financial statements and supplementary data included in 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 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:\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.\n(c) Other Compensation\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 services 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 of 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(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.\nInterest 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 3 Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to Partners of American Income 3 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":"20405_1995.txt","cik":"20405","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":"893739_1995.txt","cik":"893739","year":"1995","section_1":"Item 1. Business\nHarris & Harris Group, Inc. (the \"Registrant\" or \"Company\") is a venture capital investment company, operating as a Business Development Company (\"BDC\") under the Investment Company Act of 1940 (the \"1940 Act\"). The Company's objective is to achieve long-term capital appreciation, rather than current income, from its investments. The Company has invested, and expects to continue to invest, a substantial portion of its assets in private, development stage or start-up companies, and in the development of new technologies in a broad range of industry segments. These private businesses tend to be thinly capitalized, unproven, small companies that lack management depth and have not attained profitability or have no history of operations. The Company may also invest, to the extent permitted under the 1940 Act, in publicly-traded securities, including high risk securities as well as investment grade securities. The Company may participate in expansion financing and leveraged buy-out financing of more mature operating companies as well as other investments. As a venture capital company, the Company invests in, and provides managerial assistance to, its private investees which, in its opinion, have significant potential for growth. There is no assurance that the Company's investment objective will be achieved.\nThe Registrant was incorporated under the laws of the State of New York in August 1981. Prior to September 30, 1992, the Company was registered and filed under the reporting requirements of the Securities and Exchange Act of 1934 as an operating company. On that date the Company commenced operations as a closed end, non-diversified investment company under the 1940 Act. On July 26, 1995, the Company elected to become a business development company subject to the provision of Sections 55 through 65 of the 1940 Act, as amended by the Small Business Incentive Act of 1980. As a BDC, the Company operates as an internally managed investment company whereby its officers and employees, under the general supervision of its Board of Directors, conduct its operations.\nVenture Capital Investments\nThe Company has invested, and expects to continue to invest, a substantial portion of its assets in private, development stage or start-up companies. The Company may initially own 100 percent of the securities of a start-up investment for a period of time and may control such company for a substantial period. In connection with its venture capital investments, the Company may be involved in recruiting management, formulating operating strategies, product development, marketing and advertising, assisting in financial plans, as well as providing management in the initial, start-up stages and establishing corporate goals. The Company may assist in raising additional capital for such companies from other potential investors and may subordinate its own investment to that of other investors. The Company may also find it necessary or appropriate to provide additional capital of its own. The Company may introduce such companies to potential joint venture partners, suppliers and customers. In addition, the Company may assist in establishing relationships with investment bankers and other professionals. The Company may also assist with mergers and acquisitions. The Company may derive income from such companies for the performance of any of the above services. Because of the speculative nature of these investments and the lack of any market for such securities, there is significantly greater risk of loss than is the case with traditional investment securities. The Company expects that some of its venture capital investments will be a complete loss or will be unprofitable and that some will appear likely to become successful, but never realize their potential. The Company has been and will continue to be risk seeking rather than risk averse in its approach to its venture capital and other investments.\nThe Company may control a company for which it has provided venture capital, or it may be represented on the company's board of directors by one or more of its officers or directors, who may also serve as officers of such a company. Particularly during the early stages of an investment, the Company may in effect be conducting the operations of the company. As a venture company emerges from the developmental stage with greater management depth and experience, the Company expects that its role in the company's operations will diminish. The Company seeks to assist each company in establishing its own independent capitalization, management and board of directors. The Company expects to be able to reduce its active involvement in the management of its investment in those start-up companies that become successful by a liquidity event, such as a public offering or sale of a company.\nThe Company has invested and expects to continue to invest a substantial portion of its assets in securities that do not pay interest or dividends and that are subject to legal or contractual restrictions on resale that may adversely affect the liquidity and marketability of such securities.\nThe Company expects to make speculative investments that have limited marketability and a greater risk of investment loss than less speculative issues. The Company does not seek to invest in any particular industries or categories of investments.\nIntellectual Property\nThe Company believes there is a role for organizations that can assist in technology transfer. Scientists and institutions that develop and patent intellectual property increasingly seek the rewards of entrepreneurial commercialization of their inventions, particularly as governmental, philanthropic and industrial funding for research has become harder to obtain. The Company believes that several factors combine to give it a high value-added role to play in the commercialization of technology: its experience in organizing and developing successful new companies; its willingness to invest its own capital at the highest risk, seed stage; its access to high-grade institutional sources of intellectual property; its experience in mergers, acquisitions and divestitures; its access to and knowledge of the capital markets; and its willingness to do as much of the early work as it is qualified to do.\nThe Company's form of investment may include: 1) funding of research and development in the development of a technology; 2) obtaining licensing rights to intellectual property or patents; 3) outright acquisition of intellectual property or patents; and 4) formation and funding of companies or joint ventures to commercialize intellectual property. Income from the Company's investments in intellectual property or its development may take the form of participation in licensing or royalty income, fee income, or some other form of remuneration. At some point during the commercialization of a technology, the Company's investment may be transformed into ownership of securities of a development stage or start-up company as discussed above. Investing in intellectual property is highly risky.\nIlliquidity of Investments\nMany of the Company's investments consist of securities acquired directly from the issuer in private transactions. They may be subject to restrictions on resale or otherwise be illiquid. The Company does not anticipate that there will be any established trading market for such securities. Additionally, many of the securities that the Company may invest in will not be eligible for sale to the public without registration under the Securities Act of 1933, as amended, which could prevent or delay any sale by the Company of such investments or reduce the amount of proceeds that might otherwise be realized therefrom. Restricted securities generally sell at a price lower than similar securities not subject to restrictions on resale. Further, even if a portfolio company or investee registers its securities and becomes a reporting company under the Securities and Exchange Act of 1934, the Company may be considered an insider by virtue of its board representation and would be restricted in sales of such company's securities.\nManagerial Assistance\nThe Registrant believes that providing managerial assistance to its investees is critical to its business development activities. \"Making available significant managerial assistance\" as defined in the 1940 Act with respect to a business development company such as the Registrant means (a) any arrangement whereby a business development company, through its directors, officers, employees or general partners, offers to provide, and if accepted, does so provide, significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company; or (b) the exercise by a business development company of a controlling influence over the management or policies of a portfolio company by a business development company acting individually or as a part of a group acting together which controls such portfolio company. The Registrant is required by the 1940 Act to make significant managerial assistance available at least with respect to investee companies that the Registrant treats as qualifying assets for purposes of the 70% test (see \"Regulation\"). The nature, timing, and amount of managerial assistance provided by the Registrant vary depending upon the particular requirements of each investee company.\nThe Registrant may be involved with its investees in recruiting management, product planning, marketing and advertising and the development of financial plans, operating strategies and corporate goals. In this connection, the Registrant may assist clients in developing and utilizing accounting procedures to efficiently and accurately record transactions in books of account which will facilitate asset and cost control and the ready determination of results of operations. The Registrant also seeks capital for its investees from other potential investors and occasionally subordinates its own investment to those of other investors. The Registrant introduces its investees to potential suppliers, customers and joint venture partners and assists its investees in establishing relationships with commercial and investment bankers and other professionals, including management consultants, recruiters, legal counsel and independent accountants. The Registrant also assists with joint ventures, acquisitions and mergers.\nIn connection with its managerial assistance, the Registrant may be represented by one or more of its officers or directors on the board of directors of an investee. As an investment matures and the investee develops management depth and experience, the Registrant's role will become progressively less active. However, when the Registrant owns or on a pro forma basis could acquire a substantial proportion of a more mature investee company's equity, the Registrant remains active in and will frequently initiate planning of major transactions by the investee. The Registrant's goal is to assist each investee company in establishing its own independent and effective board of directors and management.\nNeed for Follow-On Investments\nFollowing its initial investment in investees, the Company has made and anticipates that it will continue to make additional investments in such investees as \"follow-on\" investments, in order to increase its investment in an investee, and may exercise warrants, options or convertible securities that were acquired in the original financing. Such follow-on investments may be made for a variety of reasons including: 1) to increase the Company's exposure to an investee, 2) to acquire securities issued as a result of exercising convertible securities that were purchased in the original financing, 3) to preserve the Company's proportionate ownership in a subsequent financing, or 4) in an attempt to preserve or enhance the value of the Company's investment. There can be no assurance that the Company will make follow-on investments or have sufficient funds to make such investments; the Company will have the discretion to make any follow-on investments as it determines, subject to the availability of capital resources. The failure to make such follow-on investments may, in certain circumstances, jeopardize the continued viability of an investee and the Company's initial investment, or may result in a missed opportunity for the Company to increase its participation in a successful operation.\nCompetition\nNumerous companies and individuals are engaged in the venture capital business and such business is intensely competitive. Most of the competitors have significantly greater experience, resources and managerial capabilities than the Company and are therefore in a better position than the Company to obtain access to attractive venture capital investments.\nRegulation\nThe Small Business Investment Incentive Act of 1980 modified the provisions of the 1940 Act that are applicable to a BDC. After filing its election to be treated as a BDC, a company may not withdraw its election without first obtaining the approval of holders of a majority of its outstanding voting securities. The following is a brief description of the 1940 Act, as modified by the Small Business Investment Incentive Act of 1980, and as qualified in its entirety by the reference to the full text of the 1940 Act and the rules thereunder by the Securities and Exchange Commission (the \"SEC\").\nGenerally, to be eligible to elect BDC status, a company must primarily engage in the business of furnishing capital and managerial expertise to companies which do not have ready access to capital through conventional financial channels. Such portfolio companies are termed \"eligible portfolio companies.\" More specifically, in order to qualify as a BDC, a company must (i) be a domestic company, (ii) have registered a class of its securities or have filed a registration statement with the SEC pursuant to Section 12 of the Exchange Act of 1934; (iii) operate for the purpose of investing in the securities of certain types of portfolio companies, namely, immature or emerging companies and businesses suffering or just recovering from financial distress (see following paragraph); (iv) extend significant managerial assistance to such portfolio companies; (v) have a majority of \"disinterested\" directors (as defined in the 1940 Act); and (vi) file (or, under certain circumstances, intend to file) a proper notice of election with the SEC.\nAn eligible portfolio company generally is a domestic company that is not an investment company and that (i) does not have a class of securities registered on an exchange or included in the Federal Reserve Board's over-the- counter margin list; (ii) is actively controlled by a BDC and has an affiliate of a BDC on its board of directors; or (iii) meets such other criteria as may be established by the SEC. Control under the 1940 Act is presumed to exist where a BDC owns 25% of the outstanding securities of the investee.\nThe 1940 Act prohibits or restricts companies subject to the 1940 Act from investing in certain types of companies, such as brokerage firms, insurance companies, investment banking firms and investment companies. Moreover, the 1940 Act limits the type of certain assets necessary for its operations (such as office furniture, equipment and facilities) if, at the time of acquisition, less than 70% of the value of the Company's assets consist of qualifying assets. Qualifying assets include: (i) securities of companies that were eligible portfolio companies at the time such company acquired their securities; (ii) securities of bankrupt or insolvent companies that were eligible at the time of such company's initial investment in those companies: (iii) securities received in exchange for or distributed in or with respect to any of the foregoing; and (iv) cash items, government securities and high-quality short-term debt. The 1940 Act also places restrictions on the nature of the transactions in which, and the persons for whom, securities can be purchased in order for the securities to be considered qualifying assets. Such restrictions include limiting purchases to transactions not involving a public offering and acquiring securities from either the portfolio company or their officers, directors or affiliates.\nThe Company is permitted by the 1940 Act, under specified conditions, to issue multiple classes of senior debt and a single class of preferred stock if its asset coverage, as defined in the 1940 Act, is at least 200% after the issuance of the debt or the preferred stock (i.e., such senior securities may not be in excess of 50% of its net assets). If the value of the Company's assets, as defined, were to increase through the issuance of additional capital stock or otherwise, the Company would be permitted under the 1940 Act to issue senior securities.\nThe Company may sell its securities at a price that is below the prevailing net asset value per share only after a majority of its disinterested directors has determined that such sale would be in the best interests of the Company and its stockholders and upon the approval by the holders of a majority of its outstanding voting securities, including a majority of the voting securities held by non-affiliated persons. If the offering of the securities is underwritten, a majority of the disinterested directors must determine in good faith that the price of the securities being sold is not less than a price which closely approximates market value of the securities, less any distribution discount or commission. As defined by the 1940 Act, the term \"majority of the Company's outstanding voting securities\" means the vote of (i) 67% or more of the Company's Common Stock present at the meeting, if the holders of more than 50% of the outstanding Common Stock are present or represented by proxy, or (ii) more than 50% of the Company's outstanding Common Stock, whichever is less.\nMost of the transactions involving the Company and its affiliates (as well as affiliates of those affiliates) which were prohibited without the prior approval of the Commission under the 1940 Act prior to its amendment by the Small Business Investment Incentive Act are now permissible upon the prior approval of a majority of the Company's independent directors and a majority of the directors having no financial interest in the transactions. However, certain transactions involving certain closely affiliated persons of the Company, including its directors, officers, and employees, may still require the prior approval of the Commission. In general, (i) any person who owns, controls or holds power to vote, more than 5% of the Company's outstanding Common Stock; (ii) any director, executive officer or general partner of that person; and (iii) any person who directly or indirectly controls, is controlled by, or is under common control with, that person, must obtain the prior approval of a majority of the Company's independent directors and, in some situations, the prior approval of the Commission, before engaging in certain transactions involving the Company or any company controlled by the Company. The 1940 Act generally does not restrict transactions between the Company and its portfolio companies. While a BDC may change the nature of its business so as to cease being a BDC (and in connection therewith withdraw its election to be treated as a BDC) only if authorized to do so by a majority vote (as defined in the 1940 Act) of its outstanding voting securities, stockholder approval of changes in other fundamental investment policies of a BDC is not required (in contrast to the general 1940 Act requirement, which requires stockholder approval for a change in any fundamental investment policy). The Company is entitled to change its diversification status without stockholder approval.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company maintains its offices at One Rockefeller Plaza, Suite 1430, New York, New York 10020, where it leases approximately 3,400 square feet of office space pursuant to a lease agreement expiring in 2003.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn Friday, October 20, 1995, Registrant held its Annual Meeting of Shareholders, for the following purposes: 1) to elect directors of the Company; 2) to consider and act upon a proposal to authorize options to be automatically granted to non-employee Directors under the 1988 Stock Option Plan; 3) to ratify, confirm and approve the Board of Directors' selection of Arthur Andersen LLP as the Company's independent public accountant for its fiscal year ending December 31, 1995. All of the nominees at the October 20, 1995 annual meeting were elected directors by an affirmative vote of at least 89% of the total shares outstanding. With respect to purpose number two, described as proposal \"to consider and act upon a proposal to authorize options to be automatically granted to non-employee Directors under the 1988 Stock Option Plan\" in the Registrant's 1995 Proxy Statement, the affirmative votes cast were 8,528,138, the negative votes cast were 514,787 and those abstaining were 109,405, effecting passage. With respect to purpose number three, described as proposal \"to ratify, confirm and approve the Board of Directors' selection of Arthur Andersen LLP\" as the Company's independent public accountant for its fiscal year ending December 31, 1995, the affirmative votes cast were 9,140,065, the negative votes cast were 31,050 and those abstaining were 55,050, effecting passage.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe information set forth under the caption \"Shareholder Information- Shareholders and Market Prices\" on page 36 of the 1995 Annual Report is herein incorporated by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nPages 31 through 35 of the Company's 1995 Annual Report are herein incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPages 12 through 30 of the Company's 1995 Annual Report are herein incorporated by reference. See also Item 14 of the Form 10K - \"Exhibits, Financial Statement Schedules and Reports of Form 8K\"\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants of 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\" on page 3 and \"Executive Officers\" on page 8 in the Company's definitive Proxy Statement for Annual Meeting of Shareholders to be held April 11, 1996, filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, on or about March 4, 1996 (the \"1996 Proxy Statement\") is herein incorporated by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the caption \"Summary Compensation Table\" on page 11 in the 1996 Proxy Statement is herein incorporated 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 Directors, Nominees, and Officers and other principal holders of the Corporations's voting securities\" on page 7 in the 1996 Proxy Statement is herein incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere were no relationships or transactions within the meaning of this item during the year ended December 31, 1995.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K\n(a) (1)The following financial statements included on pages 12 through 30 of the Company's 1995 Annual Report are herein incorporated by reference:\n(A) Statement of Assets and Liabilities as of December 31, 1995 and 1994 Statement of Operations for the years ended December 31, 1995, 1994 and 1993 Statement of Changes in Net Assets for the years ended December 31, 1995, 1994, and 1993 Statement of Cash Flows for the years ended December 31, 1995, 1994, and 1993\n(B) Notes to Financial Statements\n(C) Financial Highlights (selected per share data and ratio)\n(a)(2)The following financial statement schedules are submitted herewith:\nSchedule I - Marketable Securities - Other Investments\nThe information set forth under the captions \"Schedule of Investments\" and \"Footnote to Schedule of Investments\" on pages 16 through 23 of the 1995 Annual Report are herein incorporated by reference.\nSchedules other than those listed above have been omitted because they are not applicable or the required information is presented in the financial statements and\/or related notes.\n(a)(3)Exhibits. The exhibits which are filed with this Form 10-K or incorporated herein by reference are set forth in the Exhibit Index on page 13.\n(b) Reports on Form 8-K. The Registrant did not file any reports of Form 8-K 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.\nHARRIS & HARRIS GROUP, INC.\nDate: March 28, 1996 By: \/s\/___________________ Charles E. Harris 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.\nEXHIBIT INDEX\nThe following exhibits are filed with this report or are incorporated herein by reference to a prior filing, in accordance with Rule 12b-32 under the Securities Exchange Act of 1934. (Asterisk denotes exhibits filed with this report.)\nExhibit No. Description - ----------- -----------\n3.1(a) * Restated Certificate of Incorporation of the Registrant, as amended, incorporated by reference to Exhibit 3 (a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n3.1(b) * Restated By-laws of the Registrant.\n4.1 Specimen certificate of common stock certificate, incorporated by reference to Exhibit 4 to Company's Registration Statement on Form N-2 filed October 29, 1992.\n8.1 * Harris & Harris Group, Inc. 1988 Stock Option Plan, as amended and restated.\n9.1 * Harris & Harris Group, Inc. Custodian Agreement with JP Morgan\n10.1 Employment Agreement by and between the Registrant and Charles E. Harris dated August 15, 1990, incorporated by reference to Exhibit 10 (r) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.2 Amendment No.1 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of June 30, 1992, incorporated by reference to Exhibit 10.2 to the Company's Registration Statement in Form N-2 filed on October 29, 1992.\n10.3 Amendment No.2 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of January 6, 1993, incorporated by reference to Exhibit 10.22 to the Company's Registration Statement in Form N-2 filed on December 3, 1993.\n10.4 * Amendment No.3 to the Employment Agreement dated as of August 15, 1990 between the Registrant and Charles E. Harris dated as of June 30, 1994.\n10.5 Severance Compensation Agreement by and between the Registrant and Charles E. Harris dated August 15, 1990, incorporated by reference to exhibit 10 (s) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.6 Employment Agreement by and between the Registrant and C. Richard Childress dated August 15, 1990, incorporated by reference to exhibit 10 (t) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.7 Amendment No. 1 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of June 30, 1992 incorporated by reference to Exhibit 10.2 to the Company's Registration Statement in Form N-2 filed on October 29, 1992.\n10.8 Amendment No.2 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of January 6, 1993, incorporated by reference to Exhibit 10.22 to the Company's Registration Statement in Form N-2 filed on December 3, 1993.\n10.9 * Amendment No.3 to the Employment Agreement dated as of August 15, 1990 between the Registrant and C. Richard Childress dated as of June 30, 1994.\n10.10 Severance Compensation Agreement by and between the Registrant and C. Richard Childress dated August 15, 1990, incorporated by reference to Exhibit 10 (u) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.11 Warrant issued by the Registrant to Charles E. Harris dated September 23, 1985 as clarified and restated on May 1, 1989, incorporated by reference to Exhibit 10 (n) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10.12 Warrant issued by the Registrant to C. Richard Childress dated September 23, 1985 as clarified and restated on May 1, 1989, incorporated by reference to Exhibit 10 (o) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10.13 * Stock Purchase Agreement, Standstill Agreement and Termination and Release by and among Harris & Harris Group, Inc. and American Bankers Life Assurance Company of Florida dated May 18, 1995.\n10.14 * Form of Indemnification Agreement which has been established with all directors and executive officers of the Company.\n10.15 * Definitive Proxy Statment for the Annual Meeting of Shareholders to be held on April 11, 1996\n13 * Annual Report to shareholders for year ended December 31, 1995\n24 * Consent of Arthur Andersen LLP","section_15":""}
{"filename":"824410_1995.txt","cik":"824410","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSandy Spring Bancorp, Inc. (\"Bancorp\") is a one-bank holding company for Sandy Spring National Bank of Maryland (the \"Bank\"). Bancorp is registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the \"Holding Company Act\"). As such, Bancorp is subject to the supervision of and regulation by the Board of Governors of the Federal Reserve System (the \"FRB\"). Bancorp commenced operations in 1988. The Bank traces its origin to 1868 and is the oldest banking business based in Montgomery County, Maryland. The Bank is independent, community oriented, and conducts a full- service commercial banking business through 17 community offices located in Montgomery and Howard counties in Maryland. The Bank is subject to the supervision of and regulation by the Office of the Comptroller of the Currency (the \"OCC\"). The Bank's savings and deposit accounts are insured by the Bank Insurance Fund administered by the Federal Deposit Insurance Corporation (the \"FDIC\") to the maximum permitted by law.\nThe Bank experiences substantial competition both in attracting and retaining savings deposits and in the making of mortgage and other loans. Direct competition for savings deposits comes from savings institutions, other commercial banks and credit unions located in the Bank's primary market area of Montgomery and Howard Counties in Maryland. Additional significant competition for savings deposits comes from mutual funds and corporate and government debt securities. As an alternative to traditional deposit accounts, annuities are offered through Sandy Spring Insurance Corporation, a wholly owned subsidiary of the Bank. The primary factors in competing for loans are interest rates and loan origination fees and the range of services offered by the various financial institutions. Competition for origination of real estate and other loans normally comes from thrift institutions, other commercial banks, mortgage bankers, mortgage brokers and insurance companies. Management believes the Bank is able to compete effectively in its primary market area.\nBancorp's and the Bank's principal executive office is at 17801 Georgia Avenue, Olney, Maryland 20832, and its telephone number is (301) 774-6400.\nREGULATION, SUPERVISION AND GOVERNMENTAL POLICY\nThe following is a brief summary of certain statutes, rules and regulations affecting Bancorp and the Bank. A number of other statutes and regulations have an impact on their operations. The following summary of applicable statutes and regulations does not purport to be complete and is qualified in its entirety by reference to such statutes and regulations.\nBank Holding Company Regulation. Bancorp is registered as a bank holding ------------------------------- company under the Holding Company Act and, as such, is subject to supervision and regulation by the FRB. As a bank holding company, Bancorp is required to furnish to the FRB annual and quarterly reports of its operations at the end of each period and to furnish such additional information as the FRB may require pursuant to the Holding Company Act. Bancorp is also subject to regular examination by the FRB.\nUnder the Holding Company Act, a bank holding company must obtain the prior approval of the FRB before (i) acquiring direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company would directly or indirectly own or control more than 5% of such shares; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company.\nThe Holding Company Act, as amended by the Riegle-Neal Act, however, permits the FRB, effective September 29, 1995, to approve interstate bank acquisitions by bank holding companies. See \"Competition.\"\nUnder the Holding Company Act, any company must obtain approval of the FRB prior to acquiring control of Bancorp or the Bank. For purposes of the Holding Company Act, \"control\" is defined as ownership of more than 25% of any class of voting securities of Bancorp or the Bank, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of Bancorp or the Bank.\nThe Change in Bank Control Act and the regulations of the FRB thereunder require any person or persons acting in concert (except for companies required to make application under the Holding Company Act), to file a written notice with the FRB before such person or persons may acquire control of Bancorp or the Bank. The Change in Bank Control Act defines \"control\" as the power, directly or indirectly, to vote 25% or more of any voting securities or to direct the management or policies of a bank holding company or an insured bank.\nThe Holding Company Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The activities of Bancorp are subject to these legal and regulatory limitations under the Holding Company Act and the FRB's regulations thereunder. Notwithstanding the FRB's prior approval of specific nonbanking activities, the FRB has the power to order a holding company or its subsidiaries to terminate any activity, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that holding company.\nThe FRB has adopted guidelines regarding the capital adequacy of bank holding companies, which require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See \"Regulatory Capital Requirements.\"\nThe FRB has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality, and overall financial condition.\nAs a bank holding company, Bancorp is required to give the FRB notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of Bancorp's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would violate any law, regulation, FRB order, directive, or any condition imposed by, or written agreement with, the FRB.\nBank Regulation. As a national bank, the Bank is subject to the primary --------------- supervision of the OCC under the National Bank Act. The prior approval of the OCC is required for a national bank to establish or relocate an additional branch office or to engage in any merger, consolidation or significant purchase or sale of assets.\nThe OCC regularly examines the operations of the Bank, including but not limited to capital adequacy, reserves, loans, investments and management practices. These examinations are for the protection of the Bank's depositors and not its shareholders. In addition, the Bank is required to furnish quarterly and annual reports to the OCC. The OCC's enforcement authority includes the power to remove officers and directors and the authority to\nissue cease-and-desist orders to prevent a bank from engaging in unsafe or unsound practices or violating laws or regulations governing its business.\nThe OCC has adopted regulations regarding the capital adequacy of national banks, which require national banks to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See \"Regulatory Capital Requirements.\"\nPursuant to the National Bank Act, no national bank may pay dividends from its paid-in capital. All dividends must be paid out of current or retained net profits, after deducting reserves for losses and bad debts. The National Bank Act further restricts the payment of dividends out of net profits by prohibiting a national bank from declaring a dividend on its shares of common stock until the surplus fund equals the amount of capital stock or, if the surplus fund does not equal the amount of capital stock, until one-tenth of a bank's net profits for the preceding half year in the case of quarterly or semi-annual dividends, or the preceding two half-year periods in the case of annual dividends, are transferred to the surplus fund.\nThe approval of the OCC is required prior to the payment of a dividend if the total of all dividends declared by a national bank in any calendar year would exceed the total of its net profits for that year combined with its net profits for the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock. In addition, the Bank is prohibited by federal statute from paying dividends or making any other capital distribution that would cause the Bank to fail to meet its regulatory capital requirements. Further, the OCC also has authority to prohibit the payment of dividends by a national bank when it determines such payment to be an unsafe and unsound banking practice.\nThe Bank is a member of the Federal Reserve System and its deposits are insured by the FDIC to the legal maximum of $100,000 for each insured depositor. Some of the aspects of the lending and deposit business of the Bank that are subject to regulation by the FRB and the FDIC include reserve requirements and disclosure requirements in connection with personal and mortgage loans and savings deposit accounts. In addition, the Bank is subject to numerous federal and state laws and regulations which set forth specific restrictions and procedural requirements with respect to the establishment of branches, investments, interest rates on loans, credit practices, the disclosure of credit terms and discrimination in credit transactions.\nThe Bank is subject to restrictions imposed by federal law on extensions of credit to, and certain other transactions with, Bancorp and other affiliates, and on investments in the stock or other securities thereof. Such restrictions prevent Bancorp and such other affiliates from borrowing from the Bank unless the loans are secured by specified collateral, and require such transactions to have terms comparable to terms of arms-length transactions with third persons. Further, such secured loans and other transactions and investments by the Bank are generally limited in amount as to Bancorp and as to any other affiliate to 10% of the Bank's capital and surplus and as to Bancorp and all other affiliates to an aggregate of 20% of the Bank's capital and surplus. These regulations and restrictions may limit Bancorp's ability to obtain funds from the Bank for its cash needs, including funds for acquisitions and for payment of dividends, interest and operating expenses.\nUnder an OCC regulation that became effective March 19, 1993, national banks must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits, that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. A bank's real estate lending policy must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the \"Interagency Guidelines\") that have been adopted by the federal bank regulators. The Interagency Guidelines, among other things, call upon depository institutions to establish internal loan-to-value limits for real estate loans that are not in excess of the loan-to-value limits specified in the Guidelines for the various types of real estate loans. The Interagency Guidelines state, however, that it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits.\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 effective corrective action is taken. For the semi-annual period beginning June 30, 1995, the assessment rate for institutions, such as the Bank, with deposits insured by the Bank Insurance Fund of the FDIC 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 the $1,000 statutory minimum.\nSupervision, regulation and examination of the Bank and Bancorp by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of Bank or Bancorp stock.\nRegulatory Capital Requirements. The FRB and the OCC have established ------------------------------- guidelines with respect to the maintenance of appropriate levels of capital by bank holding companies and national banks, respectively. The regulations impose two sets of capital adequacy requirements: minimum leverage rules, which require bank holding companies and banks to maintain a specified minimum ratio of capital to total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to \"risk-weighted\" assets.\nThe regulations of the FRB and the OCC require bank holding companies and national banks, respectively, to maintain a minimum leverage ratio of \"Tier 1 capital\" (as defined in the risk-based capital guidelines discussed in the following paragraphs) to total assets of 3.0%. Although setting a minimum 3.0% leverage ratio, the capital regulations state that only the strongest bank holding companies and banks, with composite examination ratings of 1 under the rating system used by the federal bank regulators, would be permitted to operate at or near such minimum level of capital. All other bank holding companies and banks are expected to maintain a leverage ratio of at least 1% to 2% above the minimum ratio, depending on the assessment of an individual organization's capital adequacy by its primary regulator. Any bank or bank holding company experiencing or anticipating significant growth would be expected to maintain capital well above the minimum levels. In addition, the FRB has indicated that whenever appropriate, and in particular when a bank holding company is undertaking expansion, seeking to engage in new activities or otherwise facing unusual or abnormal risks, it will consider, on a case-by-case basis, the level of an organization's ratio of tangible Tier 1 capital (after deducting all intangibles) to total assets in making an overall assessment of capital.\nThe risk-based capital rules of the FRB and the OCC require bank holding companies and state member banks to maintain minimum regulatory capital levels based upon a weighting of their assets and off-balance sheet obligations according to risk. The risk-based capital rules have two basic components: a core capital (Tier 1) requirement and a supplementary capital (Tier 2) requirement. Core capital consists primarily of common\nstockholders' equity, certain perpetual preferred stock (which must be noncumulative with respect to banks), and minority interests in the equity accounts of consolidated subsidiaries; less all intangible assets, except for certain purchased mortgage servicing rights and purchased credit card relationships. Supplementary capital elements include, subject to certain limitations, the allowance for losses on loans and leases; perpetual preferred stock that does not qualify as Tier 1 capital and long-term preferred stock with an original maturity of at least 20 years from issuance; hybrid capital instruments, including perpetual debt and mandatory convertible securities; and subordinated debt and intermediate-term preferred stock.\nThe risk-based capital regulations assign balance sheet assets and credit equivalent amounts of off-balance sheet obligations to one of four broad risk categories based principally on the degree of credit risk associated with the obligor. The assets and off-balance sheet items in the four risk categories are weighted at 0%, 20%, 50% and 100%. These computations result in the total risk- weighted assets.\nThe risk-based capital regulations require all banks and bank holding companies to maintain a minimum ratio of total capital to total risk-weighted assets of 8%, with at least 4% as core capital. For the purpose of calculating these ratios: (i) supplementary capital will be limited to no more than 100% of core capital; and (ii) the aggregate amount of certain types of supplementary capital will be limited. In addition, the risk-based capital regulations limit the allowance for loan losses includable as capital to 1.25% of total risk- weighted assets.\nThe federal bank regulatory agencies, including the OCC, have proposed to revise their risk-based capital requirements to ensure that such requirements provide for explicit consideration by commercial banks of interest rate risk. Under the proposed rule, a bank's interest rate risk exposure would be quantified using either the measurement system set forth in the proposal or the bank's internal model for measuring such exposure, if such model is determined to be adequate by the bank's examiner. If the dollar amount of a bank's interest rate risk exposure, as measured under either measurement system, exceeds 1% of the bank's total assets, the bank would be required under the proposed rule to hold additional capital equal to the dollar amount of the excess. Management of the Bank does not believe that adoption of the proposed rule would have a material adverse effect on the required levels of capital. The proposed interest rate risk component rule would not apply to bank holding companies on a consolidated basis.\nThe OCC has issued final regulations which classify national banks by capital levels and which provide for the OCC to take various prompt corrective actions to resolve the problems of any bank that fails to satisfy the capital standards. Under such regulations, a well-capitalized bank is one that is not subject to any regulatory order or directive to meet any specific capital level and that has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An adequately capitalized bank is one that does not qualify as well- capitalized but meets or exceeds the following capital requirements: a total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i) 4% or (ii) 3% if the bank has the highest composite examination rating. A bank not meeting these criteria is treated as undercapitalized, significantly undercapitalized, or critically undercapitalized depending on the extent to which the bank's capital levels are below these standards. A national bank that falls within any of the three undercapitalized categories established by the prompt corrective action regulation will be subject to severe regulatory sanctions. As of December 31, 1995, the Bank was well-capitalized as defined by the OCC's regulations.\nFor information regarding Bancorp's and the Bank's compliance with their respective regulatory capital requirements, see \"Management's Discussion and Analysis -- Capital and Capital Ratios\" in the Annual Report.\nCOMPETITION\nIn order to compete effectively, the Bank relies substantially on local commercial 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. ' The Holding Company 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, effective September 29, 1995, 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 from 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.\nEMPLOYEES\nAs of February 29, 1996, Bancorp and the Bank employed 327 persons, including executive officers, loan and other banking and trust officers, branch personnel, and others. None of Bancorp's or the Bank's employees is presently represented by a union or covered under a collective bargaining agreement. Management of Bancorp and the Bank consider their employee relations to be excellent.\nEXECUTIVE OFFICERS\nThe following table sets forth information regarding the executive officers of Bancorp and the Bank who are not directors.\n(1) At March 25, 1996\nThe principal occupation(s) and business experience of each executive officer who is not a director for the last five years are set forth below.\nJAMES H. LANGMEAD became Vice President and Treasurer of Bancorp and Senior Vice President and Chief Financial Officer of the Bank on May 6, 1995. Prior to that, Mr. Langmead was a Senior Vice President of the Bank from January 1994, Vice President and Controller of the Bank from March 1992 and Executive Vice President of the Bank of Baltimore from 1987.\nSTANLEY L. MERSON has been a Senior Vice President of the Bank since 1991 and was Vice President of the Commercial Loan Department prior to becoming Senior Vice President. Mr. Merson has been employed by the Bank since 1982.\nJAMES R. FARMER became a Senior Vice President of the Bank on January 1, 1994. Prior to that, Mr. Farmer was Vice President of the Bank. Mr. Farmer has been employed by the Bank since 1979.\nFRANK H. SMALL became a Senior Vice President of the Bank on January 1, 1994. Mr. Small was Vice President of the Bank (1990-1993) and prior to that, was Vice President in charge of branch operations at Equitable Bank, N.A.\nLAWRENCE T. LEWIS began his employment with the Bank on January 22, 1996 as Senior Vice President. From January 1984 to December 1995, Mr. Lewis was a managing director of Clark Melvin Securities Corporation.\nTABULAR FINANCIAL INFORMATION\nRate Volume Table. The following table sets forth information regarding the effect of volume and rate changes on net interest income (dollars in thousands and tax-equivalent basis).\n- -------------------- (1) Variances are computed on a line-by-line basis and are non-additive. (2) Combined rate\/volume variances, a third element of the calculation, are allocated to the volume and rate variances based on their relative size.\nLoan Maturity Table. The following table sets forth information as of December 31, 1995, regarding the loan maturities and interest rate sensitivity for the real estate-construction, commercial and tax exempt categories (dollars in thousands).\nCredit Loss Allowance Table. The following table presents the allocation of the allowance for credit losses for the past five years, along with the percentage of total loans in each category (dollars in thousands).\nThe tabular financial information set forth on pages 14 through 25 of the Annual Report is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nThe outside back cover page of the Annual Report (listing executive and community offices) is hereby incorporated by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNote 17 on page 39 of the Annual Report (\"Litigation\") is hereby incorporated by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the fourth quarter of 1995, through solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe sections entitled \"Recent Stock Prices and Dividends\" and \"Quarterly Stock Information\" on page 13 of the Annual Report is hereby incorporated by reference.\nFor information regarding regulatory restrictions on the Bank's and, therefore, Bancorp's payment of dividends, see Note 10 -- \"Stockholders' Equity\" on page 35 of the Annual Report, which is hereby incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe table entitled \"Historical Trends in Financial Data 1991 - 1995\" on page 15 of the Annual Report is hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPages 14 through 25 of the Annual Report are hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 26 through 43 of the Annual Report are hereby incorporated by reference. The remaining information appearing in the Annual Report to Shareholders is not deemed to be filed as part of this Report, except as expressly provided herein.\nITEM 9.","section_9":"ITEM 9. CHANGES 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 and nominees for directors of Bancorp and compliance with Section 16(a) of the Securities Exchange Act of 1934 is included under the captions entitled \"Election of Directors -- Information as to Nominees and Continuing Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on pages 3 through 5 and page 17 of the Proxy Statement and is hereby incorporated by reference.\nInformation concerning the executive officers of Bancorp is included under the caption entitled \"Item 1. Business -- Executive Officers\" of this report and is hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding compensation of Bancorp's directors and executive officers is included under the caption \"Executive Compensation\" on pages 6 through 14 of the Proxy Statement and is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding beneficial ownership of Bancorp's common stock by certain beneficial owners and management of Bancorp is included under the caption \"Stock Ownership of Management\" on page 2 of the Proxy Statement and is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions with management is included under the caption \"Transactions and Relationships with Management\" on page 15 of the Proxy Statement 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) The following consolidated financial statements of Bancorp included in the Annual Report to Stockholders for the year ended December 31, 1995, are incorporated herein by reference in Item 8 of this Report. The remaining information appearing in the Annual Report to Shareholders is not deemed to be filed as part of this Report, except as expressly provided herein.\nThe following financial statements are filed as a part of this report:\nReport of Independent Auditors\nConsolidated Balance Sheets at December 31, 1994 and 1995\nConsolidated Statements of Income 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\nConsolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1993, 1994 and 1995\nNotes to the Consolidated Financial Statements\nAll financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes.\nThe following exhibits are filed as a part of this report:\n(b) No Current Reports on Form 8-K were filed during the three month period ended December 31, 1995.\n(c) Exhibits to this Form 10-K are attached or incorporated by reference as stated above.\n(d) None.\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.\nSANDY SPRING BANCORP, INC. (Registrant)\nBy: \/s\/ Hunter R. Hollar -------------------- Hunter R. Hollar President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 22, 1996.\nPrincipal Executive Officer and Director: Principal Financial and Accounting Officer:\n\/s\/ Hunter R. Hollar \/s\/ James H. Langmead - -------------------- --------------------- Hunter R. Hollar James H. Langmead President and Chief Executive Officer Vice President and Treasurer\nA majority of the directors of Bancorp executed a power of attorney appointing Marjorie S. Cook as their attorney-in-fact, empowering her to sign this report on their behalf. This power of attorney has been filed with the Securities and Exchange Commission under Part IV, Exhibit 24 of this Form 10-K for the year ended December 31, 1995. This report has been signed below by such attorney-in-fact as of March 22, 1996.\nBy: \/s\/ Marjorie S. Cook -------------------- Marjorie S. Cook Attorney-in-Fact for Majority of the Directors of Bancorp\nINDEX TO EXHIBITS","section_15":""}
{"filename":"705453_1995.txt","cik":"705453","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings.\nThe Company is a defendant in certain legal proceedings that have resulted from the ordinary conduct of its business. In the opinion of the Company's management, none of these proceedings will have a material adverse effect on the Company's financial condition or operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted to the Company's stockholders 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 Company's common stock trades on The Nasdaq Stock Market under the symbol \"TIDE.\" At March 15, 1996, there were approximately 1,000 stockholders of record. The Company has not declared or paid any dividends on its common stock since the Draco Transaction and does not presently intend to pay cash dividends in the foreseeable future. The Company currently is restricted from paying cash dividends, in excess of 30% of cash flow, on its common stock under its existing bank credit facility. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Financing Arrangements.\"\nThe following table sets forth, for the periods indicated, the high and low sales prices of the Company's common stock on The Nasdaq Stock Market:\nItem 6.","section_6":"Item 6. Selected Financial Data\nSee \"Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following discussion should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto and other financial information included in this Form 10-K.\nRecent Developments\nOn February 25, 1996, the Company entered into the Merger Agreement with HS Resources, whereby the Company is to be merged with and into a subsidiary of HS Resources, with the Company's stockholders receiving $8.75 of cash and .6295 of a share of HS Resources common stock for each share of the Company's common stock (\"Common Stock\"), subject to adjustments in certain events. Certain stockholders of the Company (holding, in the aggregate, more than 50% of the outstanding shares of Common Stock) have agreed with HS Resources to, among other things, vote shares representing a majority of the outstanding Common Stock in favor of the Merger. See \"Items 1 and 2. Business and Properties - Recent Developments - Merger Agreement.\"\nResults of Operations\nGeneral\nThe factors that most significantly affect the Company's operating results are (i) the sales prices of oil and natural gas; (ii) the amount of oil and gas sold; (iii) the amount of operating expenses; and (iv) the interest rates on, and amount of, borrowing. Sales of oil and gas are significantly affected by the Company's ability to complete producing property acquisitions and to maintain or increase production from existing properties through developmental drilling and production enhancement activities.\nThe comparability of results during the periods presented is impacted by the fact that, during the period from October 1989 through December 1995, the Company completed 58 property acquisitions involving total acquisition and development costs of $140 million that added substantial proved oil and gas reserves and increased production levels. As a result, the Company's equivalent reserves increased 63% in 1993, 22% in 1994, and 40% in 1995, while production and revenues also increased.\nPrices received by the Company for sales of oil and natural gas fluctuate significantly from period to period. Relatively modest changes in either oil or gas prices can significantly impact the Company's results of operations and cash flows. The prices of natural gas are influenced by weather conditions and supply imbalances, particularly in the domestic market, and by world-wide oil price levels. Declines in natural gas or oil prices could adversely effect the semi-annual borrowing base determination under the Company's current credit agreement.\nIn October 1992, the Company began marketing natural gas. Through its wholly-owned subsidiary, Tide West Trading, the Company actively markets its own natural gas production as well as that of third parties. During 1995, the Company marketed, on average, 174.6 MMcf of gas per day. The Company believes that this activity gives it more control over the marketing of its product and, thus, affords the Company a higher sales price than it would otherwise receive if its gas were marketed by a third party. The revenues and the associated expenses of this activity are recognized under the heading \"Trading and transportation\" in the Company's financial statements. Tide West Trading strives to provide all of the functions of a large marketing company, but with the better service of a smaller company. Its primary\nmission is to find the best markets for the Company's gas at no net cost to the Company while generating additional profit by marketing third party supply.\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994\nOil and gas revenues increased from 1994 to 1995 by $7 million, or 24%. This increase was primarily due to a 58% increase in crude oil sales volumes, a 28% increase in natural gas sales volumes, and an increase in the average sales prices received for crude oil of $1.16 per Bbl, or 8%, although the average sales prices received for natural gas decreased by $.22 per Mcf, or 13%. Excluding the effects of the consolidation of Horizon into the Company's financial statements in 1995, crude oil sales volumes increased 40% and natural gas sales volumes increased 13% due to oil and gas property acquisitions and increased drilling activity in 1995. The consolidation of Horizon, in 1995, resulted in an additional 16% increase in oil and gas revenues. Excluding the effects of such consolidation, the increase in crude oil and natural gas sales volumes and oil prices, partially offset by a decrease in natural gas prices, increased oil and gas revenues 8% in 1995, compared to 1994.\nTrading and transportation net margins increased by $441,000 in 1995 compared to 1994. The quantity of gas marketed in 1995 increased to 63.7 Bcf, up from 58.0 Bcf in 1994. Net margins per Mcf were slightly lower at 3.2 cents per Mcf in 1995, compared to 4.0 cents per Mcf for the same period in 1994, partially offsetting the increased quantity of gas marketed. Natural gas marketed on the Company's behalf amounted to 19% of the total gas sold by Tide West Trading in 1995, as compared to 16% in 1994.\nIn order to reduce price fluctuation risk, Tide West Trading hedges its position throughout each trading month. This hedging activity impacts the trading and transportation revenue reported. In 1995, Tide West Trading's hedging activity yielded a gain of $253,000, however it yielded a loss of $272,000 in 1994.\nLease operating expenses increased $2.8 million, or 58%, in 1995 compared to 1994. Such increase was due to property acquisitions, the developmental wells drilled, and the consolidation of Horizon. Such consolidation increased lease operating expenses by $1.5 million, or 31%. Excluding the effects of the consolidation of Horizon, lease operating expenses increased $1.3 million, or 27%, from 1994.\nSeverance taxes increased $509,000, or 25%, as a result of a 24% increase in oil and gas revenues.\nGeneral and administrative expenses, excluding compensation expense - stock options, increased $755,000, or 24%, in 1995 compared to 1994, due primarily to the consolidation of Horizon. Such consolidation of Horizon increased general and administrative expenses $383,000, or 12%.\nDepreciation, depletion and amortization increased $916,000, or 9%, primarily as a result of the consolidation of Horizon, partially offset by a decrease due to the revision of reserve estimates and a change in the method of calculating depletion. The consolidation of Horizon increased depreciation, depletion and amortization by $1.2 million, or 11%. Excluding the consolidation of Horizon, depreciation, depletion and amortization decreased $229,000, or 2%.\nInterest expense increased by $1.3 million, or 72%, as a result of the increase in the average outstanding advances under the Company's revolving credit facility and an increase in interest rates.\nInterest income increased $216,000, or 243%, due to interest earned on short- term investments and due to the consolidation of Horizon. Horizon increased interest income $136,000, or 153%, in 1995.\nIn 1995, a net gain on commodity transactions was recorded in the amount $1.4 million, before income tax, of which $615,000 has been realized. These commodity transactions do not qualify as hedges. The Company did not have any comparable commodity transactions in 1994. Since 1991, the Company has engaged in limited hedging activities through commodity swaps and futures contracts in order to reduce the effect of the volatility of oil and gas prices. At December 31, 1995, the Company had covered all of its significant hedged oil and gas commodity transactions with offsetting contracts.\nOther expenses increased $75,000, or 16%, in 1995 compared to 1994. Other expenses in 1995 consisted primarily of merger expenses in the amount of $355,000 for costs associated with the merger of Killgore Investments, Inc. with and into the Company and the proposed Merger with HS Resources.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nThe Company's oil and gas revenues increased 24% from 1993 to 1994 primarily because of increased sales of oil and gas volumes. Total revenues increased by $21.7 million in 1994 compared to 1993, which consisted of a $5.7 million increase in oil and gas revenues and a $16.0 million increase in trading and transportation revenues.\nOil and gas production increased 37% in 1994 compared to 1993, on a BOE basis. This increase was due to a 22% increase in crude oil sales volumes and a 40% increase in natural gas sales volumes. The increase in production was primarily related to the acquisition of certain oil and gas properties from Pennzoil Petroleum Company and Pennzoil Exploration and Production Company in December 1993 (\"the Pennzoil Properties\"), and three acquisitions completed in the third quarter of 1994, partially offset by the contributions of oil and gas properties to Horizon during 1994.\nIn 1994 as compared to 1993, average sales prices received for crude oil decreased by $.40 per Bbl, or 3%, and average sales prices received for natural gas decreased by $.29 per Mcf, or 15%. The decrease in the price of oil was due to an overall market decline and the acquisition of the Pennzoil Properties which consisted, in part, of oil properties containing lower-priced heavy and sour crude. The decrease in the price of gas was due to an overall market decline.\nLease operating expenses increased $225,000, or 5%, in 1994 compared to 1993. The relatively modest change in lease operating expenses was due to the property acquisitions in the last half of 1993 and in 1994, which have relatively low lease operating expenses, further reduced by the oil and gas property contributions to Horizon and overall improvements in operating efficiencies.\nSeverance taxes increased $329,000, or 20%, in 1994 as a result of a 24% increase in oil and gas revenues.\nGeneral and administrative expenses increased $891,000 or 39%, in 1994 compared to 1993, due primarily to the acquisition of oil and gas properties and the expansion of the Company's developmental drilling and workover activities.\nDepreciation, depletion and amortization increased $1.6 million, or 18%, as a result of increased sales volumes stemming from the acquisition of the Pennzoil Properties and other oil and gas properties acquired in the third quarter of 1994, and which was partially offset by high depletion charges on the Company's Austin Chalk wells which were contributed to Horizon in 1994.\nInterest expense increased by $969,000, or 109%, in 1994 as a result of the increase in the average outstanding advances under the Company's revolving credit facility and increases in interest rates.\nOther expenses increased $321,000, or 228%, in 1994 primarily as a result of $150,000 in expenses associated with a merger agreement with Parker & Parsley Petroleum Company, which agreement was mutually terminated in 1995, and a $200,000 provision for litigation expense.\nRecent Accounting Pronouncements\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.\" Effective for fiscal years beginning after December 15, 1995, FAS 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to such assets. The Company will adopt FAS 121 in 1996. Management believes that the impact of this pronouncement on the Company's consolidated financial statements will not be material.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"FAS 123\"), \"Accounting for Stock-Based Compensation.\" FAS 123 establishes a fair value method and disclosure standards for stock-based employee compensation arrangements, such as stock purchase plans and stock options. As allowed by FAS 123, the Company will continue to follow the provisions of Accounting Principles Board Opinion No. 25 for such stock- based compensation arrangements and will disclose the pro forma effects of applying FAS 123 for 1995 and 1996 in its 1996 financial statements.\nCapital Resources and Liquidity\nSubject to change in the event the proposed Merger with HS Resources is consummated, the Company intends to continue expanding its reserve base through acquisitions of producing oil and gas properties, developmental drilling and workover programs. Sources of capital for such expansion include internally- generated cash flow from operations and borrowing capacity under the Company's revolving credit facility. At December 31, 1995, the Company had positive working capital of $4.4 million, long-term debt of $40.8 million, and stockholders' equity of $74.5 million. The Company's principal source of cash flow is the production and sale of its crude oil and natural gas reserves, which are depleting assets. Cash flow from oil and gas sales depends upon the quantity of production and the price obtained for such production. An increase in prices permits the Company to finance its operations to a greater extent with internally-generated funds. A decline in prices reduces the cash flow generated by operations, which in turn reduces the funds available for servicing debt, acquiring additional properties and exploring for and developing new reserves. At December 31, 1994, the Company had positive working capital, long-term debt, and stockholders' equity of $3.0 million, $32.3 million, and $70.5 million, respectively.\nNet cash provided by operating activities was $11.9 million, $17.7 million and $24.1 million for the years ended December 31, 1993, 1994, and 1995, respectively. The increase in 1995 was primarily due to an increase in operating income.\nCapital Expenditures\nThe Company's ability to finance its oil and gas acquisitions is determined by its cash flow from operations and sources of debt financing. Subject to change in the event the proposed Merger is consummated, the Company presently budgets capital expenditures in 1996 of approximately $10.0 million for oil and gas property acquisitions and approximately $17.0 million for drilling and enhancement activities. The timing of most capital expenditures is discretionary because the Company has no material long-term commitments. Thus, the Company has the flexibility to adjust expenditure levels as conditions warrant. The Company uses internally-generated cash flow to fund capital expenditures associated with the development and enhancement of existing properties. In the event the Company's internally-generated cash flow should be otherwise insufficient to meet its debt service or other obligations, the Company may reduce the level of discretionary capital expenditures in order to meet such obligations. The level of the Company's capital expenditures can vary, depending on energy market conditions, potential return on investment, and other related economic factors. The Company believes that its cash flow and available credit capacity will be sufficient to fund the budgeted capital expenditures and debt service for 1996.\nNet cash used in investing activities was $40.0 million, $27.8 million and $26.6 million for the years ended December 31, 1993, 1994, and 1995, respectively. The decrease in net cash used in investing activities in 1995 was primarily due to a $2.3 million increase in the amount of proceeds from the sale of assets offset by a $2.5 million increase in capital expenditures and a $1.3 million decrease in contributions to Horizon. Of the $29.9 million in capital expenditures for 1995, $13.4 million was spent on developmental drilling and enhancement activities, $16.0 million on producing property acquisitions, and $500,000 on other assets.\nFinancing Arrangements\nCertain banks have provided the Company with a revolving credit facility, which is secured by substantially all of the Company's oil and gas assets, and is renewable on July 1 of each year. At December 31, 1995, the outstanding principal balance under the facility was $40.8 million. On a semi-annual basis, the banks redetermine the Company's borrowing base based upon their review of the Company's reserves. In the event of non-renewal, the outstanding advances will be convertible into a three-year term loan. The unused and available portion of the revolving commitment under the Company's bank credit facility was $39.2 million at December 31, 1995 and $43.0 million on March 15, 1996. The unused portion of the Company's revolving credit facility provides liquidity to finance future acquisitions. The Company expects that cash flow from operations which is not utilized for capital expenditures will be used to reduce indebtedness.\nAt December 31, 1995, the borrowing base under the revolving facility was $80.0 million. Advances under the revolving credit facility bear interest, payable monthly, at a floating rate based on the prime rate or, at the Company's option, at a fixed rate for up to six months based on the Eurodollar market rate (\"LIBOR\"). The Company's interest rate increments above LIBOR vary based on the level of outstanding advances and the borrowing base at the time. In addition, the Company must pay a quarterly standby\ncommitment fee of .25% to .375%, depending upon the relationship of outstanding borrowing to the borrowing base.\nThe Company has a total of $40 million notional amount hedged through interest rate swaps for five years beginning in 1995 and continuing through 1999. The effective interest rates to be paid by the Company on its interest rate swaps are 7.9% for 1995, 8.7% for 1996, and 8.8% for 1997 through 1999.\nOn December 20, 1993, the Company's wholly-owned subsidiary, Tide West Trading, completed a $5.0 million letter of credit facility, all of which was available on December 31, 1995.\nNet cash provided by financing activities was $27.4 million, $10.0 million, and $5.9 million for the years ended December 31, 1993, 1994, and 1995, respectively. The cash provided by financing activities for the year ended December 31, 1993, consisted primarily of $31.9 million in proceeds from the Company's Common Stock offering offset by a $4.4 million reduction in long-term debt, compared with a $10.0 million net increase in long-term debt in 1994, and for 1995, an $8.5 million net increase in long-term debt offset by Common Stock repurchases of $2.7 million.\nThe Company's existing debt and credit agreements contain covenants which limit the amount of additional indebtedness the Company may incur, restrict acquisitions and sales of oil and gas properties above a certain amount, and restrict dividends to 30% of cash flow.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee \"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\"\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nSet forth below is certain information with respect to each director and executive officer of the Company. Each director is elected for a one-year term. Executive officers are elected by the Board of Directors and serve at its discretion.\nName Age Position - ---- --- --------\nPhilip B. Smith.............. 44 Director, President and Chief Executive Officer\nRobert H. Mase............... 42 Director and Vice President-Acquisitions\nDouglas J. Flint............. 39 Director and Vice President-Operations\nR. Gamble Baldwin............ 73 Director\nDavid R. Albin............... 36 Director\nKenneth A. Hersh............. 33 Director\nRobert A. Curry.............. 48 Director\nPeggy E. Gwartney............ 37 Chief Financial Officer, Controller, Treasurer and Secretary\nThe following is a brief description of the business background of each of the directors and executive officers of the Company.\nMr. Philip B. Smith has been President, Chief Executive Officer and a Director of the Company since November 20, 1992. He has been President and a director of Draco Petroleum, a wholly-owned subsidiary of the Company, since April 1991 and of Tide West Trading, formerly Draco Production Company, a wholly-owned subsidiary of the Company, since July 1989. From May 1986 until April 1991, Mr. Smith was a Senior Vice President of Mega Natural Gas Company, a natural gas gathering company and the former parent company of Tide West Trading and its predecessor companies (\"Mega\"). Prior to that time, he held various technical and management positions at other independent and major oil and gas companies.\nMr. Robert H. Mase has been a Vice President and a Director of the Company since November 20, 1992. He has been a Vice President and a director of Draco Petroleum and a director of Tide West Trading since April 1991. He has been a Vice President of Tide West Trading since June 1990. From March 1990 until June 1990, Mr. Mase was employed by Tide West Trading as manager of acquisitions and land. From July 1981 until March 1990, he was a Vice President and land manager at Oakland Petroleum, an independent oil and gas company.\nMr. Douglas J. Flint has been a Vice President and a Director of the Company since November 20, 1992. He served as Secretary of the Company from November 1992 until September 1994. From February 1986 until November 1992, he was President and a director of Old Tide West. From September 1986 until February 1988, Mr. Flint was President, and from February 1981 until September 1986, he was Vice President, of Square D Drilling & Production, Inc., a former wholly- owned subsidiary of Old Tide West.\nMr. R. Gamble Baldwin has been a Director of the Company since November 20, 1992. Since November 1988, he has been the general partner of G.F.W. Energy, L.P. (\"GFW\"), the general partner of NGP, an investment fund organized to make equity-related investments in the North American oil and gas industry. Mr. Baldwin is also a member\/manager of two limited liability companies which are the general partners of the general partners of Natural Gas Partners II, L.P. (formed in June 1994) (\"NGP II\") and Natural Gas Partners III, L.P. (formed in May 1995) (\"NGP III\"), limited partnerships which similarly invest in the North American oil and gas industry, and is active in the management of NGP II and NGP III. From 1974 until November 1988, Mr. Baldwin was a Managing Director of The First Boston Corporation, an investment banking firm, specializing in all aspects of the natural gas business. Mr. Baldwin has been a member of the International Advisory Board of Creditanstalt Bankverein, of Vienna, Austria, since 1984, and a director of Coflexip Stena Offshore, a provider of advanced technology oilfield equipment and service, since 1993.\nMr. David R. Albin has been a Director of the Company since November 20, 1992. Since November 1988, he has been a limited partner of GFW and has been responsible for the management of NGP's portfolio. Mr Albin is also a member\/manager of the two limited liability companies which are the general partners of the general partners of NGP II and NGP III and co-manages the portfolios of NGP II and NGP III. From December 1984 until November 1988, Mr. Albin was employed by Bass Investment Limited Partnership, an investment partnership, where he was also responsible for portfolio management.\nMr. Kenneth A. Hersh has been a Director of the Company since November 20, 1992. Since March 1989, he has been a limited partner of GFW and has co-managed NGP's portfolio. Mr. Hersh is also a member\/manager of the two limited liability companies which are the general partners of the general partners of NGP II and NGP III and co-manages the portfolios of NGP II and NGP III. During 1988, he was a consultant with McKinsey & Co., a management consulting firm. From August 1985 until August 1987, Mr. Hersh was employed by the investment banking division of Morgan Stanley & Co., where he was a member of that firm's energy group, specializing in oil and gas financing and acquisition transactions. Mr. Hersh currently serves as a director of HS Resources, an independent oil and gas company.\nMr. Robert A. Curry has been a Director of the Company since November 20, 1992. He has been a shareholder and a director of the law firm of Conner & Winters, A Professional Corporation, in Tulsa, Oklahoma since February 1992. From 1975 until February 1992, he was employed by the law firm of Hall, Estill, Hardwick, Gable, Golden & Nelson, P.C., in Tulsa, Oklahoma.\nMs. Peggy E. Gwartney was named Chief Financial Officer of the Company, in conjunction with her positions as Controller, Secretary and Treasurer, in January 1995. She has been Treasurer and Controller of the Company since the closing of the Draco Transaction in November 1992 and Secretary beginning September 1994. She has been Controller of Draco Petroleum and Tide West Trading since April 1991. From May 1981 until April 1991, she was employed by Mega as a senior accountant. Ms. Gwartney is a Certified Public Accountant.\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 ten percent of the Company's Common Stock to report their initial ownership of Common Stock and any subsequent changes in that ownership to the Securities and Exchange Commission (\"SEC\") and to furnish the Company with a copy of each such report. SEC regulations impose specific due dates for such reports, and the Company is required to disclose any failure to file such reports by their due dates during and for fiscal year 1995.\nTo the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required, all Section 16(a) filing requirements applicable to its officers, directors and more than ten percent stockholders were complied with during and for fiscal year 1995.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe following tables set forth information relating to compensation paid by the Company during the fiscal years ended December 31, 1993, 1994 and 1995, to its chief executive officer and to its other executive officers who earned, in salary and bonuses, more than $100,000 for services rendered during 1995.\nSummary Compensation Table\n(1) Other annual compensation paid or distributed did not exceed the lesser of $50,000 or 10% of the executive's annual salary and bonus.\n(2) Represents the Company's contribution to such officer's account under its 401(k) Plan.\nAggregated Option\/SAR Exercises in Last Fiscal Year and FY-End Option\/SAR Values\n- ------------------- (1) The product of (a) the difference between (i) the per share Option exercise price, and (ii) the per share market price of Common Stock on December 29, 1995 ($13.375); and (b) the number of shares of Common Stock underlying the unexercised in-the-money Options outstanding at December 31, 1995.\nCompensation of Directors\nEmployee directors receive no additional compensation for serving on the Board of Directors or any committee thereof. Non-employee directors receive an annual retainer of $10,000 and are reimbursed for expenses they incur to attend meetings of the Board of Directors and committees thereof. The Company's Certificate of Incorporation and By-laws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Delaware law. The Company also has entered into indemnification agreements with, and carries liability insurance on behalf of, all of its directors and officers.\nCompensation Committee Interlocks and Insider Participation\nMr. Smith, President and Chief Executive Officer of the Company, is a member of the Compensation Committee and participates in deliberations concerning executive officer compensation. The other two members of the Compensation Committee, Messrs. Albin and Curry, are outside directors of the Company. No executive officer of the Company served on the Stock Option Committee during 1995 or is currently serving on such Committee.\nIn January 1993, the Company and NGP entered into a financial advisory services contract whereby NGP provides financial advisory services to the Company for a quarterly fee of $12,500. The Company has also indicated that it will pay NGP a completion bonus of $150,000 upon the completion of a sale of the Company. Messrs. Albin and Hersh are limited partners of GFW, the general partner of NGP, and co-manage NGP's portfolio. For details of these transactions, see \"Item 13. Certain Relationships and Related Party Transactions.\" The law firm of Conner & Winters, A Professional Corporation, of which Mr. Curry is a shareholder and director, has regularly performed legal services as counsel to the Company since November 20, 1992.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth certain information, as of March 15, 1996, regarding ownership of the Company's Common Stock by (a) all persons known by the Company to be beneficial owners of more than five percent of such stock, (b) each director of the Company, (c) each of the executive officers of the Company named in the Summary Compensation Table above, and (d) all executive\nofficers and directors of the Company as a group. Unless otherwise noted, the persons named below have sole voting and investment power with respect to such shares:\n- --------------- (1) Excludes 340,500 shares owned by Douglas J. Flint which have been pledged to NGP in connection with a loan by NGP to Mr. Flint. NGP disclaims beneficial ownership of such shares. NGP's address is 777 Main Street, Suite 2700, Fort Worth, Texas 76102.\n(2) The stockholder has sole dispositive power with respect to the indicated shares, but shares voting power with HS Resources (only as to 344,000 shares, for Mr. Smith) pursuant to an irrevocable proxy as to certain matters granted by the stockholder in connection with the proposed Merger of the Company with a subsidiary of HS Resources. See \"Items 1 and 2. Business and Properties-Recent Developments.\" The address of HS Resources is One Maritime Plaza, 15th Floor, San Francisco, California 94111.\n(3) Includes (i) 150,000 shares subject to stock options which are currently exercisable at an average exercise price of $7.80 per share, and (ii) 85,000 shares held by Mr. Smith, as trustee of two trusts for benefit of his children, and as to which he has sole dispositive and voting power.\n(4) Includes 10,000 shares owned by Mr. Flint that are subject to a currently exercisable purchase option granted to a former executive officer and director of Old Tide West and 157,875 shares subject to stock options which are currently exercisable at an average exercise price of $7.82 per share, and excludes 8,000 shares held by Mr. Flint's wife, as custodian for their children, as to which he disclaims beneficial ownership.\n(5) Includes 180,000 shares subject to stock options which are currently exercisable at an average exercise price of $7.67 per share.\n(6) Mr. Baldwin is the sole general partner of GFW, the sole general partner of NGP. Therefore, Mr. Baldwin and GFW are deemed to be the beneficial owners of all shares beneficially owned by NGP. GFW's address is 777 Main Street, Suite 2700, Fort Worth, Texas 76102. Mr. Baldwin's address is 115 East Putnam Avenue, Greenwich, Connecticut 06830.\n(7) Includes 499,858 shares subject to stock options which are currently exercisable at an average exercise price of $7.79 per share. Excludes 8,000 shares held by Mr. Flint's wife, as custodian for their children, as to which he disclaims beneficial ownership.\nChanges in Control\nOn February 25, 1996, the Company entered into the Merger Agreement with HS Resources, whereby the Company is to be merged with and into a subsidiary of HS Resources, with the Company's stockholders receiving $8.75 of cash and .6295 of a share of HS Resources common stock for each share of the Company's Common Stock, subject to adjustments in certain events. Certain stockholders of the Company (holding, in the aggregate, more than 50% of the outstanding shares of Common Stock) have agreed with HS Resources to, among other things, vote shares representing a majority of the outstanding Common Stock in favor of the Merger. See \"Items 1 and 2. Business and Properties - Recent Developments - Merger Agreement\" for more details of the proposed Merger.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Party Transactions.\nEffective December 1, 1992, the Company acquired (a) from NGP, the limited partner interest in Draco in exchange for 4,550,000 shares of Common Stock (approximately 76% of the Company's then outstanding Common Stock), and (b) from Messrs. Smith and Mase, all of the issued and outstanding stock of Draco Petroleum, the sole general partner of Draco, in exchange for 489,558 and 122,389 shares of Common Stock, respectively. The stock of Draco Petroleum was acquired by Messrs. Smith and Mase in April 1991. Mr. Smith's interest in Draco Petroleum was acquired in exchange for shares of common stock of Mega owned by Mr. Smith. Mr. Mase acquired his interest in Draco Petroleum using $97,500 borrowed from Draco. Such loan was secured by the Draco Petroleum stock purchased by Mr. Mase. On November 20, 1992, the loan was assigned by Draco to the Company as part of a distribution in liquidation of Draco. The loan, which bears interest, payable quarterly, at a rate equal to the base lending rate of the Company's bank, is now secured by 20,000 shares of Common Stock owned by Mr. Mase. The largest amount outstanding under the loan during fiscal year 1995 was $65,250 on January 1, 1995. The outstanding principal balance of Mr. Mase's loan at December 31, 1995, was $50,000. The loan is repayable in 20 equal quarterly installments which commenced on June 1, 1993.\nEffective January 1, 1993, the Company and NGP entered into a financial advisory services contract whereby NGP provides financial advisory services to the Company for a quarterly fee of $12,500. In addition, NGP is reimbursed for its out-of-pocket expenses incurred in performing such services. The agreement is renewable annually and can be terminated by NGP or the Company at the end of any fiscal quarter. Under the agreement, NGP assists the Company in managing its public and private financing activities, its public financial reporting obligations, its budget planning processes, and its investor relations program, as well as providing ongoing strategic advice. NGP has not received any other transaction-related compensation for its advisory assistance to the Company. However, at the time the Company's Board of Directors determined and publicly announced that the Company would be sold, the Board of Directors decided to pay NGP a completion bonus of $150,000 upon the completion of the sale of the Company, in recognition of the extra effort required by NGP to prepare the Company for sale.\nThe law firm of Conner & Winters, A Professional Corporation, has regularly performed legal services as counsel to the Company since November 20, 1992. Robert A. Curry, a Director of the Company, is a shareholder and director of Conner & Winters.\nSandia Energy Corporation (\"Sandia\"), a drilling contractor which Old Tide West utilized to drill wells operated by Old Tide West, filed for reorganization under Chapter 11 of the United States Bankruptcy Code on March 2, 1992. Sandia is wholly-owned by Donald J. Flint, the brother of Douglas J. Flint, who was then the President and a director of Old Tide West. A second bankruptcy petition with respect to Sandia was filed and approved on October 26, 1994. Under the second bankruptcy plan, the Company elected to receive the amount of its unsecured claim from revenues from Sandia's royalty interest in an oil and gas property. At the time of the second bankruptcy filing, Sandia owed the Company $141,000 in receivables from operating and prepaid drilling costs. The Company expects to receive periodic payments in satisfaction of its claim beginning in 1996.\nThe Company's By-laws currently provide that, in the event the Company enters into a transaction or loan involving more than $10,000 in consideration or value with or involving any of its officers, directors, affiliates or stockholders in the future, such transaction or loan must be undertaken on terms no less favorable to the Company than those generally available from unaffiliated third parties, and that such transaction or loan must be approved by a majority of the members of the Board of Directors not having any interest in the transaction.\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 are listed in the accompanying Index to Financial Statements and are filed as a part of this Form 10-K.\n(2) Financial Statement Schedules:\nAll schedules are omitted as inapplicable or because the required information is included in the Consolidated Financial Statements or notes thereto.\n(3) Exhibits:\nThe following documents are included as exhibits to this Form 10-K. Those exhibits below incorporated by reference herein are indicated as such by the information supplied in the parenthetical thereafter. If no parenthetical appears after an exhibit, such exhibit is filed herewith.\n2.1 Agreement and Plan of Merger dated February 25, 1996, between H.S. Resources, Inc., HSR Acquisition, Inc. and the Company.\n3.1 Certificate of Incorporation of the Company (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated November 20, 1992 (the \"1992 Form 8-K\")).\n3.2 Amendment to Certificate of Incorporation dated January 29, 1993 (effective February 1, 1993) (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, No. 33-57058 (the \"S-1 Registration Statement\")).\n3.3 Restated By-laws of the Company (filed as Exhibit 3.3 to the S-1 Registration Statement).\n4.1 Form of stock certificate for the Company's Common Stock, par value $.01 per share (filed as Exhibit 4.1 to the S-1 Registration Statement).\n10.1 Second Amended and Restated Credit Agreement dated June 15, 1995, between the Company, as borrower, and Union Bank, Colorado National Bank, Texas Commerce Bank, National Association, and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q dated August 11, 1995 (the \"Second Quarter 1995 Form 10-Q\")).\n10.2 First Amendment to Second Amended and Restated Credit Agreement dated December 21, 1995, between the Company, as borrower, and Union Bank, Colorado National Bank, Texas Commerce Bank, National Association, and Den norske Bank AS, as lenders, and Union Bank, as agent.\n10.3 Credit Agreement dated December 23, 1993, between Tide West Trading & Transport Company, as borrower, and Union Bank, Colorado National Bank and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q dated August 12, 1994).\n10.4 First Amendment to Credit Agreement dated December 19, 1994, between Tide West Trading & Transport Company, as borrower, and Union Bank, Colorado National Bank and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K dated March 30, 1995 (the \"1994 Form 10-K\")).\n10.5 Second Amendment to Credit Agreement dated February 17, 1995, between Tide West Trading & Transport Company, as borrower, and Union Bank, Colorado National Bank, and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.10 to the 1994 Form 10-K).\n10.6 Third Amendment to Credit Agreement dated March 17, 1995, among Tide West Trading & Transport Company, as borrower, Union Bank, Den norske Bank AS and Colorado National Bank, as lenders, and Union Bank, as agent (filed as Exhibit 10.3 to the Second Quarter 1995 Form 10-Q).\n10.7 Fourth Amendment to Credit Agreement dated April 17, 1995, among Tide West Trading & Transport Company, as borrower, Union Bank, Den norske Bank AS and Colorado National Bank, as lenders, and Union Bank, as agent (filed as Exhibit 10.2 to the Second Quarter 1995 Form 10-Q).\n10.8 Limited Partnership Agreement dated December 28, 1993, between the Company and Horizon Natural Resources, Inc. (filed as Exhibit 10.7 to Company's Annual Report on Form 10-K dated March 30, 1994 (the \"1993 Form 10-K\")).\n10.9* Registration Rights Agreement dated November 20, 1992, among the Company, Natural Gas Partners, L.P. (\"NGP\"), Philip B. Smith and Robert H. Mase (filed as Exhibit 10.2 to the S-1 Registration Statement).\n10.10* Shareholders' Agreement dated November 19, 1992, among NGP, Philip B. Smith, Robert H. Mase and Douglas J. Flint (filed as Exhibit 28 to the 1992 Form 8-K).\n10.11* Promissory Note dated May 31, 1991, between Draco Gas Partners, L.P. (\"Draco\"), as lender, and Robert H. Mase, as borrower, and Assignment thereof by Draco to the Company, dated November 20, 1992 (filed as Exhibit 10.6 to the S-1 Registration Statement).\n10.12* Security Agreement dated November 20, 1992, between the Company, as secured party, and Robert H. Mase (filed as Exhibit 10.7 to the S-1 Registration Statement).\n10.13 Financial Advisory Services Contract dated January 1, 1993, between the Company and NGP (filed as Exhibit 10.8 to the S-1 Registration Statement).\n10.14 First Amendment to Financial Advisory Services Contract dated January 1, 1994, between the Company and NGP (filed as Exhibit 10.13 to the 1993 Form 10-K).\n10.15* Form of Indemnification Agreement dated as of November 20, 1992, between the Company and each of its officers and directors (filed as Exhibit 10.9 to the S-1 Registration Statement).\n10.16* The Company's 1991 Stock Option Plan and Amendment No. 1 thereto (filed as Exhibit 10.10 to the S-1 Registration Statement).\n10.17* Amendment No. 2 to the Company's 1991 Stock Option Plan (filed as Exhibit 4(e) to the Company's Registration Statement on Form S-8, No. 33-73020).\n10.18* Amendment No. 3 to the Company's 1991 Stock Option Plan (filed as Exhibit 10.17 to the 1993 Form 10-K).\n10.19* Form of Stock Option Agreement under the Tide West Oil Company 1991 Stock Option Plan (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q dated November 11, 1994).\n10.20 Form of Warrant Agreement between the Company and American Securities Transfer, Incorporated, dated June 21, 1991 (filed as Exhibit 10.11 to the S-1 Registration Statement).\n10.21 First Supplement and Amendment to Warrant Agreement between the Company and The First National Bank of Boston dated March 14, 1994 (filed as Exhibit 10.20 to the 1993 Form 10-K).\n10.22 Form of Purchase Warrant dated June 21, 1991, issued to Paulson Investment Company, Inc. and affiliates (filed as Exhibit 10.12 to the S-1 Registration Statement).\n21. Subsidiaries of the Company.\n23.1 Consent of Deloitte & Touche LLP.\n23.2 Consent of Netherland, Sewell & Associates, Inc.\n27. Financial Data Schedule.\n----------- * Management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the fourth quarter of the fiscal year ended December 31, 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.\nTIDE WEST OIL COMPANY\nDate: March 25, 1996 By: \/s\/ Philip B. Smith --------------------------- Philip B. Smith 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\/ Philip B. Smith Director and President March 25, 1996 - -------------------------- (Principal Executive Officer) Philip B. Smith\n\/s\/ Robert H. Mase Director and Vice President March 25, 1996 - -------------------------- Robert H. Mase\n\/s\/ Douglas J. Flint Director and Vice President March 25, 1996 - --------------------------- Douglas J. Flint\n\/s\/ Peggy E. Gwartney Chief Financial Officer, March 25, 1996 - --------------------------- Controller and Treasurer Peggy E. Gwartney (Principal Financial Officer and Principal Accounting Officer)\n\/s\/ R. Gamble Baldwin Director March 25, 1996 - --------------------------- R. Gamble Baldwin\n\/s\/ David R. Albin Director March 25, 1996 - --------------------------- David R. Albin\n\/s\/ Kenneth A. Hersh Director March 25, 1996 - --------------------------- Kenneth A. Hersh\n\/s\/ Robert A. Curry Director March 25, 1996 - --------------------------- Robert A. Curry\nTIDE WEST OIL COMPANY\nPage ---- Independent Auditors' Report.........................................\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 1995....................................\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1994, and 1995....................................\nNotes to Consolidated Financial Statements........................... -\nIndependent Auditors' Report\nTo the Stockholders of Tide West Oil Company\nWe have audited the accompanying consolidated balance sheets of Tide West Oil Company and subsidiaries (the \"Company\") as of December 31, 1994 and 1995, 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, 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 discussed in Note 2 to the 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.\nDeloitte & Touche LLP Tulsa, Oklahoma February 26, 1996\nTIDE WEST OIL COMPANY\nConsolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nTIDE WEST OIL COMPANY\nConsolidated Statements of Income\nSee accompanying notes to consolidated financial statements.\nTIDE WEST OIL COMPANY\nConsolidated Statements of Stockholders' Equity Years ended December 31, 1993, 1994 and 1995\nSee accompanying notes to consolidated financial statements.\nTIDE WEST OIL COMPANY\nConsolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nTIDE WEST OIL COMPANY\nNotes to Consolidated Financial Statements Years ended December 31, 1993, 1994 and 1995\n1. Organization, Business Combinations, and Stockholders' Equity\nOrganization Tide West Oil Company (the \"Company\") is an independent oil and gas company focused on the acquisition and enhancement of producing oil and gas properties. The Company's principal operations are conducted in the Anadarko Basin, Arkoma Basin, the Southern Oklahoma Region, and the Texas\/New Mexico Region. The Company also has a natural gas marketing subsidiary.\nPrices received by the Company for sales of oil and natural gas fluctuate significantly from period to period. Relatively modest changes in either oil or gas prices can significantly impact the Company's results of operations and cash flow. The prices of natural gas are influenced by weather conditions and supply imbalances, particularly in the domestic market, and by world-wide oil price levels. Declines in natural gas or oil prices could adversely affect the semi- annual borrowing base determination under the Company's current credit agreement.\nBusiness Combinations On April 10, 1995, Killgore Investments, Inc. (\"Killgore\") was merged with and into the Company, and 149,538 shares of the Company's common stock were issued in exchange for all of the outstanding common stock of Killgore. The merger was accounted for as a pooling of interests. Financial statements for prior periods were not restated because the effect of this business combination was not material.\nStockholders' Equity On January 28, 1993, the Company completed a 1-for-10 reverse common stock split. All common stock and per share amounts in the accompanying consolidated financial statements have been restated to reflect this reverse split.\nIn March 1993, the Company completed a stock offering of 3.45 million shares of common stock which yielded net proceeds of $31.9 million.\nDuring 1995, the Company purchased 266,000 shares of its common stock for $2.7 million. The shares were retired at December 31, 1995.\n2. Summary of Significant Accounting Policies\nPrinciples of Consolidation The financial statements include the accounts of the Company's majority-owned subsidiaries, Tide West Trading & Transport Company (\"Tide West Trading\"), Draco Petroleum, Inc., and, for 1995, Horizon Gas Partners, L.P. (\"Horizon\"), after elimination of all material inter-company transactions and balances.\nManagement 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 Cash and cash equivalents include cash and interest bearing time deposits with original maturities of three months or less.\nCommodity Transactions From time to time, the Company hedges the price of a portion of its future oil and gas production with commodity price swap contracts and futures contracts. Gains and losses on contracts which effectively hedge the sales price of future production are deferred and included in income\nTIDE WEST OIL COMPANY\nin the period that was hedged. Other commodity contracts that do not qualify as hedges are recorded at market value and gains or losses are recognized currently. Margin deposits on futures are recorded as other current assets. At December 31, 1995, the Company had covered all of its significant commodity transactions with offsetting contracts.\nInterest Rate Swaps Interest rate swaps are entered into primarily as a hedge against interest rate fluctuations on variable rate debt. The amounts to be paid or received on swaps are included in interest expense as payments are made or received.\nMarketing Natural gas is sold primarily on the spot market to a variety of purchasers, including intrastate and interstate pipelines, their marketing affiliates and other independent marketing companies. Based on actual pipeline deliveries and receipts, pipeline imbalance positions occur in the normal course of business. These positions are reflected as natural gas inventories or liabilities depending on the net position. The revenues and the associated expenses of Tide West Trading are presented under the heading \"trading and transportation.\"\nGas Imbalances Gas imbalances are accounted for under the sales method whereby revenues are recognized based on actual production sold. The proved reserves are adjusted for any significant volume imbalances existing on the property for purposes of determining depletion and any required valuation allowances. At December 31, 1995, the Company's gas balancing position was approximately 840,000 Mcf overproduced.\nProperty and Equipment The Company follows the successful efforts method of accounting for oil and gas producing activities. Under this method, property acquisition costs, costs of productive exploratory wells and all development costs (including lease acquisition, tangible, and intangible costs) are capitalized. These costs are amortized on a physical unit-of-production basis at the field level using proved oil and gas reserves estimates. All costs associated with unsuccessful exploratory wells, geological and geophysical costs, and delay rentals are expensed as incurred.\nValuation allowances are provided if the net capitalized costs of oil and gas properties at the field level exceed their estimated realizable values based on the undiscounted future net revenues. Unproved oil and gas properties are periodically assessed for impairment of value at the field level and, if necessary, a loss is recognized by providing an allowance.\nOther property and equipment is recorded at cost and depreciated on the straight-line method based on the estimated useful lives of the assets ranging from three to eight years.\nDuring the third quarter of 1995, the Company changed from the property-by- property basis to the field basis of applying the unit-of-production method to calculate depreciation, depletion and amortization (\"DD&A\") on producing oil and gas property. The field basis provides a better matching of expenses with revenues over the productive life of the properties, and, therefore, the Company believes the new method is preferable to the property-by-property basis. The effect of the accounting change was not material and prior interim periods were not restated. There was no material cumulative effect related to this change in computing DD&A at January 1, 1995.\nDD&A per equivalent barrel of production from the Company's oil and gas properties for the years ended December 31, 1993, 1994 and 1995 was $4.50, $3.86 and $3.17, respectively.\nInvestments Effective January 1, 1995, the Company began consolidating Horizon into its financial statements. Horizon was accounted for under the equity method during 1994 (its first year of operations). The Company's remaining unconsolidated investment, at December 31, 1995, consists of a\nTIDE WEST OIL COMPANY\n17.9 percent limited partnership interest in an oil and gas partnership accounted for under the cost method.\nIncome Taxes The Company adopted Statement of Financial Accounting Standards (\"FAS 109\"), Accounting for Income Taxes on a prospective basis effective January 1, 1993. Prior to January 1, 1993, the Company accounted for income taxes under the provisions of Accounting Principles Board Opinion No. 11.\nUnder FAS 109, the Company accounts for income taxes on an asset and liability method which requires the recognition of deferred tax liabilities and assets for the tax effects of (a) temporary differences between tax bases and financial reporting bases of assets and liabilities, (b) operating loss carryforwards and (c) tax credit carryforwards.\nSupplemental Disclosures of Cash Flow Information During the years ended December 31, 1993, 1994 and 1995, cash payments for interest totaled $880,000, $1.8 million, and $3.4 million, respectively, of which $230,000 was capitalized for the year ended December 31, 1995. No interest was capitalized during 1993 or 1994. Cash payments for income taxes totaled $2.2 million, $1.8 million, and $38,000 for the years ended December 31, 1993, 1994 and 1995, respectively. The Company received an income tax refund in the amount of $1.6 million in 1995.\nEffective January 1, 1995, the Company began consolidating the accounts and operations of Horizon in the consolidated financial statements. On April 10, 1995, Killgore was merged with and into the Company, and 149,538 shares of the Company's common stock were issued in exchange for all the outstanding common stock of Killgore.\nThe following table presents the balance sheet accounts that were combined in the Company's consolidated balance sheet at the dates indicated:\nEarnings Per Common Share Earnings per common share for the periods presented have been computed using the weighted average number of common shares outstanding. Outstanding stock options and warrants are included in the weighted average shares outstanding for all periods in which their effect on earnings per share is dilutive.\nReclassifications Certain reclassifications were made to the 1993 and 1994 financial statements to conform to the presentation used in 1995.\nTIDE WEST OIL COMPANY\n3. Fair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107 \"Disclosures About Fair Value of Financial Instruments,\" requires disclosure of the fair value of certain financial instruments. The carrying value of short-term investments, accounts receivable, short-term borrowing, accounts payable and accrued liabilities approximates fair value. The carrying value of long-term debt is also considered to approximate fair value based on its current interest rate and terms. The estimated fair value amounts of the Company's off-balance sheet financial instruments have been determined by the Company, using appropriate market information and valuation methodologies. Considerable judgment is required to develop the estimates of fair value, thus, the estimates provided herein are not necessarily indicative of the amounts that could be realized in a current market exchange. At December 31, 1995, the Company had interest rate swaps which, if terminated on that date, would result in a loss of approximately $2.0 million.\n4. Property and Equipment\nProperty and equipment consists of the following:\nCosts incurred in oil and gas property acquisitions and development activities are as follows:\nThe Company did not incur any exploration costs during the three years ended December 31, 1995.\nTIDE WEST OIL COMPANY\n5. Long-Term Debt\nLong-term debt consists of the following:\nThe revolving credit facility is secured by substantially all of the Company's oil and gas assets.\nIn June and December of each year, the borrowing base, as defined under the revolving credit facility, is redetermined by the banks based upon their review of the Company's oil and gas reserves. The amount of the revolving commitment and borrowing base was $80.0 million at December 31, 1995. The Company must pay a quarterly standby commitment fee of 0.25% to 0.375%, depending upon the relationship of borrowings to the borrowing base. The revolving credit facility is renewable on July 1 of each year. In the event the facility is not renewed, the balance outstanding, not to exceed the borrowing base, will be converted to a three-year term note. Advances under the revolving credit facility bear interest, payable monthly, at a floating rate based on the prime rate or, at the Company's option, at a fixed rate for up to six months based on the Eurodollar market rate (\"LIBOR\"). The Company's interest rate increments above LIBOR vary based on the level of outstanding advances and the borrowing base at the time of the fixed rate election.\nOn December 20, 1993, the Company's wholly-owned subsidiary, Tide West Trading, obtained a $5.0 million letter of credit facility. No amounts were outstanding under this facility at December 31, 1994 or 1995.\nThe Company fixed the interest rate on $40 million notional amount of debt through interest rate swaps for five years beginning in 1995 and continuing through 1999. The effective interest rates to be paid by the Company on its interest rate swaps were 7.9% for 1995, and are 8.7% for 1996, and 8.8% for 1997 through 1999.\nThe Company's credit agreement contains covenants which limit the amount of additional indebtedness the Company may incur, restrict acquisitions and sales of oil and gas properties above a certain amount, and restrict dividends to 30% of cash flow. The Company was in compliance with all such covenants at December 31, 1995.\nTIDE WEST OIL COMPANY\n6. Income Taxes\nThe Company's income tax expense consists of:\nDeferred tax liabilities and assets at December 31, 1994 and 1995 are composed of the following:\nThe effect of adopting FAS 109 was to decrease net income by $946,000 ($0.10 per share) in 1993, not including the cumulative effect of $300,000.\nThe Company's income tax expense, for the years ended December 31, 1993, 1994 and 1995, differs from the amount computed by applying the statutory federal income tax rate for the following reasons:\nThe Company had net operating loss carryforwards at December 31, 1995, totaling approximately $3.4 million for federal income tax purposes. The tax loss carryforwards will be available to offset future federal income tax that would be otherwise payable. These carryforwards expire during the years 2000 through 2006. Substantially all of these carryforwards relate to operations prior to December 1, 1992. The Company's ability to use the carryforwards to offset future income is subject to certain restrictions resulting from the change in stock ownership which occurred in November 1992. These net operating loss carryforwards may be further limited as a result of the proposed merger as described in Note 15.\nTIDE WEST OIL COMPANY\n7. Stock Purchase Warrants\nEffective June 28, 1991, the Company completed an offering to the public of common stock. The Company sold 1,400,000 units at $4.25 per unit, each unit consisting of two shares of common stock (or two-tenths of a share after adjustment for the one-for-ten reverse stock split) and two warrants, with each warrant exercisable to purchase one share of common stock (or one-tenth of a share on a post-split basis). Each warrant represents the right to purchase one- tenth of a share of common stock for $3.00. The warrants expire on June 21, 1996. In addition, the Company issued warrants to the underwriter. These warrants are exercisable at anytime during the four-year period commencing June 21, 1992, to purchase up to 140,000 units for $5.10 per unit, each unit consisting of two-tenths of a share of common stock and two stock purchase warrants, each exercisable to purchase one-tenth of a share of common stock for $3.00. Substantially all of the above-noted warrants were outstanding at December 31, 1995. Upon the exercise of any of these warrants after June 21, 1992, the Company has agreed to pay broker-dealers responsible for the exercise of warrants a fee of up to, but not in excess of, five percent of the aggregate exercise price of such warrants, if certain conditions are met.\n8. Stock Option Plan\nEffective May 31, 1991, the Company established the Tide West Oil Company 1991 Stock Option Plan (as amended, the \"Plan\"). The Plan provides for the granting of stock options (\"Options\"), including incentive stock options (\"ISO Options\"), with or without stock appreciation rights (\"SARs\"), and nonincentive stock options (\"NSO Options\"), with or without SARs, to employees and consultants of the Company, including employees who also serve as directors of the Company. The Plan will terminate on May 31, 2001. The total amount of common stock authorized and reserved for issuance under the Plan is 1,000,000 shares.\nOptions granted under the Plan are exercisable in such amounts, at such intervals and upon such terms as the option grant provides. The option price of the common stock may not be less than 85% (100% for ISO Options) of the fair market value of the shares on the date of grant of the option. However, if a participant owns more than 10% of the total combined voting power of all classes of capital stock of the Company, the exercise price of ISO Options may not be less than 110% of the fair market value of the common stock on the date of the grant, and such ISO Options expire five years after the date of grant.\nInformation with respect to options under the Plan follows:\nTIDE WEST OIL COMPANY\nAt December 31, 1995, 754,589 shares were exercisable.\nNSO Options were granted on December 11, 1992, September 16, 1993, November 16, 1993, January 19, 1995, and August 30, 1995, and vest over a three-year period at the rate of one-third per year. The difference between the exercise price of the December 11, 1992 options and the market value at date of grant ($1.125 per share) is being recognized as compensation expense ratably over the vesting period. The Options granted on December 11, 1992, vest over a four-year period at the rate of one-fourth per year. The options granted on September 16, 1993, November 16, 1993, January 19, 1995, and August 30, 1995, vest over a three-year period at a rate of one-third per year. All of the NSO and ISO Options expire on May 31, 2001.\nAt December 31, 1995, 62,160 shares were available for future grants under the Plan.\n9. Commitments and Contingencies\nThe Company is a defendant in certain legal proceedings during the normal course of business. Management believes the disposition of these matters will not have a material adverse effect on the consolidated financial position or results of operations of the Company.\nThe Company leases office space under an operating lease expiring in October 1997. Rent expense was $81,705, $115,224 and $173,000 in 1993, 1994 and 1995, respectively. Minimum annual rental commitments at December 31, 1995, are $162,000 in 1996, and $152,000 in 1997, for an aggregate commitment of $314,000.\n10. Significant Customers and Credit Risk\nThere were no purchasers in 1993 or 1995 representing more than 10% of total revenues. There was one natural gas purchaser in 1994 which represented 11% of the Company's total revenues. Financial instruments which potentially subject the Company to credit risk are primarily accounts receivable. Historically, the Company has not experienced significant losses related to receivables from individual purchasers or groups of purchasers.\n11. Related Party Transactions\nIn 1994, the Company contributed certain minor oil and gas properties and the Company's interest in two limited partnerships, with a net book value and estimated fair market value totaling $9.7 million, to Horizon in return for a 95% limited partnership interest.\nOn July 6, 1994, the Company acquired from Merit Energy Partners II, L.P. (\"Merit\") certain oil and gas properties for $8.2 million. Natural Gas Partners, L.P., the Company's largest stockholder and who has three representatives on the Company's Board of Directors, was the majority limited partner of Merit.\n12. Accounting Standards to be Adopted\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.\" Effective for fiscal years beginning after December 15, 1995, FAS 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to such assets. The Company will adopt FAS 121 in 1996. Management believes that the effect of this pronouncement on the Company's consolidated financial statements will not be material.\nTIDE WEST OIL COMPANY\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"FAS 123\"), \"Accounting for Stock- Based Compensation.\" FAS 123 establishes a fair value method and disclosure standards for stock-based employee compensation arrangements, such as stock purchase plans and stock options. As allowed by FAS 123, the Company will continue to follow the provisions of Accounting Principles Board Opinion No. 25 for such stock-based compensation arrangements, and disclose the pro forma effects of applying FAS 123 for 1995 and 1996 in its 1996 financial statements.\n13. Business Segments\nThe Company's operations include oil and gas exploration and production and gas marketing. Intersegment sales are generally made at prevailing market prices. The following table sets forth information with respect to the industry segments of the Company:\nTIDE WEST OIL COMPANY\n14. Quarterly Financial Data (Unaudited)\nThe following is a summary of the unaudited quarterly financial information for the years ended December 31, 1994 and 1995:\n15. Subsequent Event\nOn February 25, 1996, the Company entered into an agreement with HS Resources, Inc., a Delaware corporation (\"HS Resources\"), whereby the Company is to be merged with and into a subsidiary of HS Resources (the \"Merger\"). In the Merger, each share of the Company's common stock will be converted into .6295 of a share of HS Resources common stock and the right to receive a cash payment of $8.75 less 3% of the amount by which the average per share closing sales price of HS Resources common stock for the 10 trading days preceding the closing of the Merger exceeds $10.50, subject to adjustments in certain events. The Merger is subject to approval by the stockholders of the Company, and the issuance of HS Resources common stock pursuant to the Merger is subject to approval of the stockholders of HS Resources. Certain stockholders of the Company (holding, in the aggregate, more than 50% of the outstanding shares of common stock of the Company) have agreed with HS Resources to vote their shares representing a majority of the outstanding common stock in favor of the Merger.\nAt the time the Company's Board of Directors (the \"Board\") determined and publicly announced that the Company would be sold, the Board decided, and it was announced to the employees of the Company, that the Company would pay to each employee who is still employed by the Company at the closing date a completion bonus, payable immediately prior to the closing date (whether or not the employee is employed by the surviving corporation), in order to provide such employees with an incentive to remain in the employ of the Company and to help prepare the Company for sale. The amounts of such bonuses are, in the case of certain employees, measured in part by the market price of HS Resources common stock. The Board also decided to pay to Natural Gas Partners, L.P. (\"NGP\") (which acts as financial advisor to the Company) a fixed completion bonus in recognition of the extra effort required of NGP to prepare the Company for sale. The amount of all completion bonuses to be paid at closing, treating February 26, 1996 (the date of the public announcement of the execution of the Merger agreement), as the closing date, would be approximately $2.8 million.\nTIDE WEST OIL COMPANY\n16. Supplemental Information about Oil and Gas Producing Activities (Unaudited)\nThe following information summarizes the Company's net proved reserves of oil and gas and the present values thereof for the years ended December 31, 1993, 1994 and 1995. The information presented for 1993 and 1994 is based upon estimates prepared by Netherland, Sewell & Associates, Inc., which was engaged to perform an evaluation of approximately 80% of the present value of estimated future net cash flows before income tax (discounted at 10%), with the balance being estimated by the Company for those years. All of the reserve estimates for 1995 were prepared by the Company's engineers. The information was prepared in accordance with Statement of Financial Accounting Standards No. 69.\nPrices of crude oil, condensate, and gas were those prices in effect at the respective dates. Estimated future production costs, which include lease operating costs and severance taxes (estimated assuming existing economic conditions will continue over the lives of the individual leases, with no adjustment for inflation), have been deducted in arriving at the estimated future net revenues. The present value amounts should not necessarily be equated with fair market value of the Company's oil and gas reserves. All reserves are located in the United States.\nThe reliability of any reserve estimate is a function of the quality of available information and of engineering interpretation and judgment. These reserves should be accepted with the understanding that subsequent drilling activities or additional information might require their revision.\nTIDE WEST OIL COMPANY\nThe following schedules present certain data pertaining to the Company's proved reserves at December 31, 1993, 1994 and 1995:\nEstimated Quantities of Proved Reserves:\nStandardized Measure of Estimated Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:\nEstimated discounted future net cash flows before income taxes were $157.8 million at December 31, 1993, $132.6 million at December 31, 1994 (which includes the Company's proportionate share of equity method investee), and $231.7 million at December 31, 1995.\nChanges in the Standardized Measure of Estimated Discounted Future Net Cash Flows from Proved Oil and Gas Reserves:\nINDEX TO EXHIBITS\nThe following documents are included as exhibits to this Form 10-K. Those exhibits below incorporated by reference herein are indicated as such by the information supplied in the parenthetical thereafter. If no parenthetical appears after an exhibit, such exhibit is filed herewith.\nSequentially Exhibit Numbered Number Description Page\n2.1 Agreement and Plan of Merger dated February 25, 1996, between H.S. Resources, Inc., HSR Acquisition, Inc. and the Company.\n3.1 Certificate of Incorporation of the Company (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated November 20, 1992 (the \"1992 Form 8-K\")).\n3.2 Amendment to Certificate of Incorporation dated January 29, 1993 (effective February 1, 1993) (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, No. 33-57058 (the \"S-1 Registration Statement\")).\n3.3 Restated By-laws of the Company (filed as Exhibit 3.3 to the S-1 Registration Statement).\n4.1 Form of stock certificate for the Company's Common Stock, par value $.01 per share (filed as Exhibit 4.1 to the S-1 Registration Statement).\n10.1 Second Amended and Restated Credit Agreement dated June 15, 1995, between the Company, as borrower, and Union Bank, Colorado National Bank, Texas Commerce Bank, National Association, and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q dated August 11, 1995 (the \"Second Quarter 1995 Form 10-Q\")).\n10.2 First Amendment to Second Amended and Restated Credit Agreement dated December 21, 1995, between the Company, as borrower, and Union Bank, Colorado National Bank, Texas Commerce Bank, National Association, and Den norske Bank AS, as lenders, and Union Bank, as agent.\n10.3 Credit Agreement dated December 23, 1993, between Tide West Trading & Transport Company, as borrower, and Union Bank, Colorado National Bank and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q dated August 12, 1994).\n10.4 First Amendment to Credit Agreement dated December 19, 1994, between Tide West Trading & Transport Company, as borrower, and Union Bank, Colorado National Bank and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K dated March 30, 1995 (the \"1994 Form 10-K\")).\n10.5 Second Amendment to Credit Agreement dated February 17, 1995, between Tide West Trading & Transport Company, as borrower, and\nUnion Bank, Colorado National Bank, and Den norske Bank AS, as lenders, and Union Bank, as agent (filed as Exhibit 10.10 to the 1994 Form 10-K).\n10.6 Third Amendment to Credit Agreement dated March 17, 1995, among Tide West Trading & Transport Company, as borrower, Union Bank, Den norske Bank AS and Colorado National Bank, as lenders, and Union Bank, as agent (filed as Exhibit 10.3 to the Second Quarter 1995 Form 10-Q).\n10.7 Fourth Amendment to Credit Agreement dated April 17, 1995, among Tide West Trading & Transport Company, as borrower, Union Bank, Den norske Bank AS and Colorado National Bank, as lenders, and Union Bank, as agent (filed as Exhibit 10.2 to the Second Quarter 1995 Form 10-Q).\n10.8 Limited Partnership Agreement dated December 28, 1993, between the Company and Horizon Natural Resources, Inc. (filed as Exhibit 10.7 to Company's Annual Report on Form 10-K dated March 30, 1994 (the \"1993 Form 10-K\")).\n10.9* Registration Rights Agreement dated November 20, 1992, among the Company, Natural Gas Partners, L.P. (\"NGP\"), Philip B. Smith and Robert H. Mase (filed as Exhibit 10.2 to the S-1 Registration Statement).\n10.10* Shareholders' Agreement dated November 19, 1992, among NGP, Philip B. Smith, Robert H. Mase and Douglas J. Flint (filed as Exhibit 28 to the 1992 Form 8-K).\n10.11* Promissory Note dated May 31, 1991, between Draco Gas Partners, L.P. (\"Draco\"), as lender, and Robert H. Mase, as borrower, and Assignment thereof by Draco to the Company, dated November 20, 1992 (filed as Exhibit 10.6 to the S-1 Registration Statement).\n10.12* Security Agreement dated November 20, 1992, between the Company, as secured party, and Robert H. Mase (filed as Exhibit 10.7 to the S-1 Registration Statement).\n10.13 Financial Advisory Services Contract dated January 1, 1993, between the Company and NGP (filed as Exhibit 10.8 to the S-1 Registration Statement).\n10.14 First Amendment to Financial Advisory Services Contract dated January 1, 1994, between the Company and NGP (filed as Exhibit 10.13 to the 1993 Form 10-K).\n10.15* Form of Indemnification Agreement dated as of November 20, 1992, between the Company and each of its officers and directors (filed as Exhibit 10.9 to the S-1 Registration Statement).\n10.16* The Company's 1991 Stock Option Plan and Amendment No. 1 thereto (filed as Exhibit 10.10 to the S-1 Registration Statement).\n10.17* Amendment No. 2 to the Company's 1991 Stock Option Plan (filed as Exhibit 4(e) to the Company's Registration Statement on Form\nS-8, No. 33-73020).\n10.18* Amendment No. 3 to the Company's 1991 Stock Option Plan (filed as Exhibit 10.17 to the 1993 Form 10-K).\n10.19* Form of Stock Option Agreement under the Tide West Oil Company 1991 Stock Option Plan (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q dated November 11, 1994).\n10.20 Form of Warrant Agreement between the Company and American Securities Transfer, Incorporated, dated June 21, 1991 (filed as Exhibit 10.11 to the S-1 Registration Statement).\n10.21 First Supplement and Amendment to Warrant Agreement between the Company and The First National Bank of Boston dated March 14, 1994 (filed as Exhibit 10.20 to the 1993 Form 10-K).\n10.22 Form of Purchase Warrant dated June 21, 1991, issued to Paulson Investment Company, Inc. and affiliates (filed as Exhibit 10.12 to the S-1 Registration Statement).\n21. Subsidiaries of the Company.\n23.1 Consent of Deloitte & Touche LLP.\n23.2 Consent of Netherland, Sewell & Associates, Inc.\n27.1 Financial Data Schedule.\n____________________ * Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"66004_1995.txt","cik":"66004","year":"1995","section_1":"Item 1. Business\nGeneral\nMiddlesex Water Company (Middlesex or Company), has operated as a water utility in New Jersey since its organization in 1897 and is in the business of collecting, treating and distributing water for domestic, commercial, industrial and fire protection purposes in the State and, since 1992, in the State of Delaware through its acquisition of Tidewater Utilities, Inc. (Tidewater), as a wholly-owned subsidiary. In April 1995, Middlesex completed the purchase of the assets of a 2,200 customer water utility and a 2,200 customer wastewater utility in Burlington County, New Jersey. The systems were acquired through the Company's wholly-owned subsidiaries of Pinelands Water Company and Pinelands Wastewater Company (jointly Pinelands). All water system's are completely metered, including contract sales, except for fire hydrant service. The rates charged for water services must be approved by regulatory authorities. In May 1995, Middlesex and its wholly-owned subsidiary, Utility Service Affiliates, Inc., jointly entered into a five-year contract with the City of South Amboy to operate and maintain the City's 2,600 customer water system. The contract is subject to renewal for three future five-year periods.\nRetail Sales\nMiddlesex provides water services to retail customers primarily in eastern Middlesex County, New Jersey. Water services are now furnished to approximately 53,000 retail customers located in an area of approximately 55 square miles of New Jersey in Woodbridge Township, the Boroughs of Metuchen and Carteret, portions of Edison Township and the Borough of South Plainfield in Middlesex County and, to a minor extent, a portion of the Township of Clark in Union County. The retail customers include a mix of residential customers, large industrial concerns and commercial and light industrial facilities. These retail customers are located in generally well developed areas of central New Jersey.\nTidewater provides water services to almost 6,000 retail customers for domestic, commercial and fire protection purposes in over 75 community water systems located in Kent, Sussex and New Castle Counties in Delaware.\nPinelands provides water and wastewater services to approximately 2,200 retail customers in Burlington County, New Jersey.\nContract Sales\nMiddlesex also provides water on a wholesale basis in New Jersey to the Township of Edison (Edison), the Borough of Highland Park (Highland Park), the City of South Amboy (South Amboy), the Old Bridge Municipal Utilities Authority (Old Bridge), the Borough of Sayreville (Sayreville) and the Marlboro Township Municipal Utilities Authority (Marlboro). Under special contract, the Company also provides water treatment and pumping services to the Township of East Brunswick (East Brunswick). East Brunswick, South Amboy, Old Bridge, Sayreville and Marlboro are within an area designated as the South River Basin Study Area.\n- 1 -\nThe South River Basin Study Area refers to parts of southern Middlesex and northern Monmouth Counties addressed by a 1980's study conducted by the New Jersey Department of Environmental Protection (DEP). According to that study, ninety-five percent of the area's water supply was derived from groundwater sources that were being overpumped at that time and projected growth of the region would further over stress these groundwater resources. These conditions prompted the DEP to create Water Supply Critical Area No. 1 (Critical Area) covering portions of Middlesex, Monmouth and Ocean Counties and to promulgate mandatory reductions in groundwater withdrawals within the Critical Area. During the same mid-1980's time period, East Brunswick entered into a special contract with the Company and in 1986 began receiving water treatment and pumping services under that contract.\nIn 1986, as part of the State's South River Basin Feasibility Study, the Company outlined to the DEP and other interested parties a plan to construct facilities to ensure potable water supplies into this area through the year 2020. In connection with this project, the Company entered into long-term water supply agreements with Old Bridge, Marlboro and Sayreville, and the DEP approved these agreements.\nAs an interim measure to address the immediate needs of this region, an agreement was reached between the Company and the City of Perth Amboy for the lease of a large diameter pipeline which extends from the northern shore of the Raritan River to central Old Bridge. This pipeline was rehabilitated, isolated from the Perth Amboy system and connected to the Middlesex system, and now provides a supply of the Company's water to substantial portions of the Critical Area (Old Bridge, Sayreville, Marlboro and South Amboy).\nThe South River Basin Transmission Main was scheduled to be constructed in three stages, designated Sections C, B, and A, to meet the increasing demands of the customers in the Critical Area. Section C, which was connected to Marlboro in 1991, comprises a 6.5 mile main extending the Middlesex system from the southern end of the Perth Amboy line to Marlboro Township in Monmouth County. The Company completed construction of Section B, a 5 mile extension northwest through Old Bridge to East Brunswick, that was operational in 1993. In 1993, an interconnecting pipeline was constructed by East Brunswick thereby providing for an alternative means of transporting water from the Carl J. Olsen Water Treatment Plant (CJO Plant) to the South River Basin customers. The Company currently anticipates that Section A may be constructed later this decade, when demands in the region grow, and will directly connect Sections B and C to the Company's CJO Plant in Edison.\nFinancial Information\nConsolidated operating revenues and operating income relating primarily to operating water utilities are as follows:\n(000's) Years Ended December 31, --------------------------------------- 1995 1994 1993 ------- ------- ------- Operating Revenues $37,847 $36,122 $35,479 ------- ------- ------- Operating Income $ 8,912 $ 8,477 $ 8,156 ------- ------- -------\n- 2 -\nOperating revenues were derived from the following sources:\nYears Ended December 31, ------------------------------------ 1995 1994 1993 ------ ------ ------\nResidential 40.2% 39.6% 39.6% Commercial 11.6 11.9 11.8 Industrial 17.6 18.3 18.3 Fire Protection 12.0 12.1 12.2 Contract Sales 17.6 17.5 17.6 Miscellaneous 1.0 0.6 0.5 ----- ----- -----\nTOTAL 100.0% 100.0% 100.0% ===== ===== =====\nWater Supplies and Contracts\nThe Company's water utility plant consists of source of supply, pumping, water treatment, transmission, distribution and general facilities located in New Jersey and Delaware. The New Jersey and Delaware water supply systems are physically separate and are not interconnected. The newely acquired Pinelands system is not interconnected to the Middlesex system.\nMiddlesex obtains water from both surface and groundwater sources. In 1995, surface sources of water provided approximately 65% of the Company's water supply, groundwater from wells provided approximately 30% and the balance of 5% was purchased from Elizabethtown Water Company (Elizabethtown), a nonaffiliated water utility. The Company's distribution storage facilities are used to supply water at times of peak demand and for outages and emergencies.\nThe principal source of surface supply in New Jersey is the Delaware and Raritan Canal (D&R Canal), owned by the State of New Jersey and operated as a water resource by the New Jersey Water Supply Authority (NJWSA). The Company has contracts with the NJWSA to divert a maximum of 20 million gallons per day (mgd) of untreated water from the D&R Canal as augmented by the Round Valley\/Spruce Run Reservoir System. In addition, the Company has a one-year agreement for an additional 5 mgd renewed through April 30, 1996. The Company also has an agreement with Elizabethtown, effective through December 31, 2005, which provides for the minimum purchase of 3 mgd of treated water with provisions for additional purchases.\nWater is also derived from groundwater sources equipped with electric motor-driven deep-well turbine type pumps. Middlesex has 32 wells, which provide a pumpage capacity of approximately 23 mgd. These include the wells of the Park Avenue and Sprague Avenue Well Fields (with a pumpage capacity of over 12 mgd) which during 1993 were provided with treatment, refurbished and retrofitted to insure compliance with water quality standards. See \"Regulation - Water Quality and Environmental Regulations.\"\n- 3 -\nThe Company's New Jersey groundwater sources are:\nWater supply to Delaware customers is derived from Tidewater's 77 wells, which provided overall system delivery of 350 mg during 1995. Tidewater does not have a central treatment facility. Several of the water systems in Sussex County have an interconnected transmission system. Construction to link several water systems in New Castle County was completed during 1995. Tidewater currently has applications before the Delaware regulatory authorities for the approval of additional wells. Treatment is by chlorination and, in some cases, pH correction and filtration. Water supply to Pinelands Water customers is through four (4) wells drilled into the Mt. Laurel aquifer. Treatment (disinfection only) is done at individual well sites.\nThe Pinelands sewer system discharges into the south branch of the Rancoccos Creek through a tertiary treatment plant. The total capacity of the plant is 0.5 mgd. Current average flow is 0.3 mgd. Pinelands has a current valid NJPDES permit issued by the DEP.\nIn the opinion of management, the Company has adequate sources of water supply and other facilities to meet current and anticipated future service requirements in New Jersey, and each of the Tidewater community water systems has adequate sources of water supply and other facilities to meet current and anticipated future service requirements within that water system area.\nCompetition\nThe business of the Company is substantially free from direct competition with other public utilities, municipalities and other public agencies. Although Tidewater has been granted an exclusive franchise for each of its existing community water systems, its ability to expand service areas can be affected by the Delaware Department of Natural Resources and Environmental Control (DNREC) awarding franchises to other regulated water purveyors.\n- 4 -\nRegulation\nThe Company is subject to regulation as to its rates, services and other matters by the States of New Jersey and Delaware with respect to utility service within those states and with respect to environmental and water quality matters. The Company is also subject to regulation as to environmental and water quality matters by the United States Environmental Protection Agency (EPA).\nRegulation of Rates and Services\nThe Company and its Pinelands subsidiaries are subject to regulation by the New Jersey Board of Public Utilities (BPU), and Tidewater is similarly subject to regulation by the Delaware Public Service Commission (PSC). These regulatory authorities have jurisdiction with respect to rates, service, accounting procedures, the issuance of securities and other matters of utility companies operating within the States of New Jersey and Delaware, respectively. The Company and Tidewater, for ratemaking purposes, account separately for operations in New Jersey and in Delaware so as to facilitate independent ratemaking by the BPU for New Jersey operations and the PSC for Delaware operations.\nWater Quality and Environmental Regulations\nBoth the EPA and the DEP regulate the Company's operation in New Jersey with respect to water supply, treatment and distribution systems and the quality of the water, as do the EPA and the DNREC with respect to operations in Delaware.\nFederal, Delaware and New Jersey regulations adopted over the past five years relating to water quality require expanded types of testing by the Company to insure that its water meets State and Federal water quality requirements. In addition, the environmental regulatory agencies are reviewing current regulations governing the limits of certain organic compounds found in the water as by-products of treatment. The Company, as with many other water companies, participates in industry-related research to identify the various types of technology that might reduce the level of organic, inorganic and synthetic compounds found in the water. The cost to water companies of complying with the proposed water quality standards depends in part on the limits set in the regulation and on the method selected to implement such reduction; however, the cost to the Company of complying with proposed regulations promulgated in light of some of the standards being discussed might, depending upon the treatment process selected, be as high as $10 million, based upon current estimates. The Company has already begun studies to evaluate alternative treatment processes for upgrading the CJO Plant. The regular testing by the Company of the water it supplies shows that the Company is in compliance with existing Federal, New Jersey and Delaware water quality requirements.\nAs required by the Federal Safe Drinking Water Act (FSDWA), the EPA has established maximum contaminant levels (MCLs) for various substances found in drinking water. As authorized by similar state legislation, the DEP has set MCLs for certain substances which are more restrictive than the MCLs set by the EPA. In certain cases, the EPA and the DEP have also mandated that certain treatment procedures be followed in addition to satisfying MCLs established for specific contaminants. The DEP and the DNREC have assumed primacy for\n- 5 -\nenforcing the FSDWA in New Jersey and Delaware, respectively, and, in that capacity, monitor the activities of the Company and review the results of water quality tests performed by the Company for adherence to applicable regulations.\nOther regulations applicable to water utilities generally, including the Company, include the Lead and Copper Rule (LCR), the MCLs established for various volatile organic compounds (VOCs), the Federal Surface Water Treatment Rule, and the Total Coliform Rule.\nThe LCR requires the Company to test on a sample basis 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, initiate a public information campaign advising customers how to minimize exposure to lead and copper, add corrosion inhibitors to water to minimize leaching of lead from piping, faucets and soldered joints into water consumed at the tap, and implement applicable source water treatment requirements. Tests taken within the Company's system yielded results well below the Action Levels.\nVOCs, including primarily petro-chemicals, may percolate into groundwater aquifers from surface sources. The Company has found VOCs in excess of the applicable MCLs in certain of the Middlesex system wells and has constructed air stripping facilities which remove such contaminants from the water by venting them into the atmosphere. In 1990 the air stripping facility was complete at the Spring Lake Well Field. Construction of a similar facility was completed in 1993 and is operational to treat water from the Park Avenue and Sprague Avenue Well Fields, along with a 2 mg storage reservoir. To the extent that contamination in excess of applicable MCLs occurs at wells lacking air stripping and related facilities, the Company will consider building such facilities if feasible and cost effective. VOCs have not been identified in the Delaware wells.\nFederal and State regulations and controls concerning water quality, pollution and the effluent from treatment facilities are still in the process of being developed, and it is not possible to predict the scope or enforceability of regulations or standards which may be established in the future, or the cost and effect of existing and potential regulations and legislation upon any of the existing and proposed facilities and operations of the Company. Further, recent and possible future developments with respect to the identification and measurement of various elements in water supplies and concern with respect to the impact of one or more of such elements on public health may in the future require the Company to replace or modify all or portions of their various water supplies, to develop replacement supplies and\/or to implement new treatment techniques. In addition, the Company anticipates that threatened and actual contamination of water sources may become an increasing problem in the future. The Company has expended and may in the future be required to expend substantial amounts to prevent or remove said contamination or to develop alternative water supplies. Any such developments may increase operating costs and capital requirements. Since the rate regulation methodology of both the BPU and the PSC permits a utility to recover through rates prudently incurred expenses and investments in plant, based upon past BPU and PSC practice, the Company expects that all such expenditures and costs should ultimately be recoverable through rates for water service.\nEmployees\nAs of December 31, 1995, the Company had a total of 140 employees in New Jersey, and Tidewater had a total of 17 employees in Delaware. None of these employees is represented\n- 6 -\nby a union. Management considers its relations with its employees to be satisfactory. Wages and benefits are reviewed annually and are considered competitive within the industry.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's water utility plant consists of source of supply, pumping, water treatment, transmission and distribution and general facilities.\nThe Company's principal source of supply is the D&R Canal owned by the State of New Jersey and operated as a water resource by the NJWSA.\nWater is withdrawn from the D&R Canal at New Brunswick and processed for distribution by the Company. Its facilities consist of an intake and pumping station located on State-owned land bordering the Canal, a water treatment plant in Edison Township (CJO Plant) on property owned by the Company, 4,901 feet of 54-inch reinforced concrete water main connecting the CJO Plant and the intake and pumping station, 23,168 feet of 48-inch reinforced concrete transmission main connecting the water treatment plant to the Company's distribution pipe network, and related storage, pumping, control, laboratory and other facilities. The CJO Plant was placed into service in 1969.\nThe design capacity of the intake and pumping station in New Brunswick, New Jersey, and the raw water main is 80 mgd. The four electric motor-driven vertical turbine pumps presently installed have an aggregate design capacity of 65 mgd. The station is designed to permit its pumping capacity to be increased to 80 mgd by the installation of additional pumping units without structural changes. The station has an emergency power supply provided by a diesel-driven generator which, in the event of a power failure, will automatically become the power source to provide uninterrupted water service.\nThe CJO Plant includes chemical storage and chemical feed equipment, dual-rapid mixing basins, four reinforced concrete mechanical flocculation compartments, four underground reinforced concrete settling basins, eight rapid filters containing gravel, sand and anthracite for water treatment and a steel wash-water tank. The nominal design capacity of the CJO Plant is 30 mgd (45 mgd maximum capacity). Provision has been made to increase the nominal design capacity to 60 mgd (90 mgd maximum capacity) by the future construction of additional treatment facilities. The Company is currently studying treatment technologies prior to making a decision on the expansion of this facility.\nThe main pumping station at the CJO Plant has a design capacity of 90 mgd. The four electric motor-driven vertical turbine pumps presently installed have an aggregate capacity of 65 mgd. The station is constructed so that an additional pumping unit can be installed without structural change.\nIn addition to the main pumping station at the CJO Plant, there is a l5 mgd auxiliary pumping station located in a separate building. It has a dedicated substation and emergency power supply provided by a diesel-driven generator. It pumps from the l0 mg reservoir directly into the distribution system.\n- 7 -\nThe Company also owns property and other facilities located at the Robinson's Branch of the Rahway River. The storage facilities, consisting of an impounding reservoir, have been classified as nonutility plant. They are located in Clark Township, near the north central part of the territory served. The reservoir has a capacity of 232 mg and a tributary drainage area of approximately 25 square miles. There are no treatment facilities at this site.\nThe Company owns the properties on which its 32 wells are located. The Company owns its two-building headquarters complex at 1500 Ronson Road, Iselin, New Jersey, consisting of a 27,000 square foot, two-story office building and a 16,500 square foot maintenance facility. The Company's Delaware operations are managed from Tidewater's newly leased offices in Odessa, Delaware. The property, owned by White Marsh Environmental Systems, Inc., a wholly-owned subsidiary of Tidewater consists of a newly renovated 1,600 square foot building situated on a one (1) acre lot with ample room for expansion. The area is commercially zoned. Pinelands Water owns the well site properties which are located in Southampton Township, New Jersey. The 12 acre wastewater plant site is owned by Pinelands Wastewater.\nMiddlesex storage facilities consist of a 10 mg reservoir at the CJO Plant, 5 mg and 2 mg reservoirs in Edison (Grandview), 5 mg reservoir in Carteret (Eborn) and 2 mg reservoir at the Park Avenue Well Field. Pinelands Water storage facility is a 1.2 mg standpipe. Tidewater's systems include 18 ground level storage tanks with the following capacities; 11 - 30,000 gallons, 4 - 25,000 gallons, 2 - 120,000 gallons and 1 - 82,000 gallons.\nItem 3.","section_3":"Item 3. Legal Proceedings\nA local entity and its owner have filed a negligence claim against the Company, for which the Company is insured, with a claim for punitive damages which may not be insured. Their action alleges financial losses arising out of improper water pressure and service. An amendment to the claim alleges damages resulting from some poor quality water. Other parties who dealt with the claimants have joined the matter. Without taking a position on the negligence claim, the Company does not believe that the claim for punitive damages will prevail. While the outcome of this case is not presently determinable, management believes that the final resolution will not have a significant effect on the Company's financial position or results of operations or cash flows.\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\nPrice Range of Common Stock\n- 8 -\nThe following table shows the range of closing prices for the Common Stock on the NASDAQ Stock Market for the calendar quarter indicated.\n1995 High Low Dividend ---- ---- --- --------\nFirst Quarter $17.00 $15.25 $0.27 Second Quarter 16.50 15.25 0.27 Third Quarter 17.75 15.75 0.27 Fourth Quarter 18.75 16.75 0.27 1\/2\n1994 High Low Dividend ---- ---- --- -------- First Quarter $21.25 $19.25 $0.26 1\/4 Second Quarter 20.00 16.00 0.26 1\/4 Third Quarter 18.25 15.75 0.26 1\/4 Fourth Quarter 18.50 16.25 0.27\nApproximate Number of Equity Security Holders As of December 31, 1995\nNumber of Title of Class Record Holders -------------- --------------\nCommon Stock, No par Value 2,353 Cumulative Preferred Stock, No par Value: $7 Series 33 $4.75 Series 1 Cumulative Convertible Preferred Stock, No par Value: $7 Series 4\nDividends\nThe Company has paid dividends on its Common Stock each year since 1912. Although it is the present intention of the Board of Directors of the Company to continue to pay regular quarterly cash dividends on its Common Stock, the payment of future dividends is contingent upon the future earnings of the Company, its financial condition and other factors deemed relevant by the Board of Directors at its discretion.\nThe Common Stock of the Company is traded on the NASDAQ Stock Market under the symbol MSEX.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThis information is incorporated herein by reference to the attached Exhibit 13, 1995 Annual Report to Shareholders, Page 21.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis information is incorporated herein by reference to the attached Exhibit 13, 1995 Annual Report to Shareholders, Pages 8 and 9.\n- 9 -\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements and Independent Auditors' Report are incorporated herein by reference to the attached Exhibit 13, 1995 Annual Report to Shareholders, Pages 10 through 20. The supplementary data is included as indicated under Part IV, Item 14.\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 following information is provided with respect to each Director and Executive Officer of the Company.\nWalter J. Brady, who joined the Company in 1962, was elected Assistant Secretary-Assistant Treasurer in 1979, Assistant Vice President in 1982, Vice President-Human Resources in 1987, and Vice President-Administration in 1989. He had served in the capacity of Manager of Accounting from 1977 to 1985. He is a Director of White Marsh Environmental Systems, Inc., Pinelands Water Company, Pinelands Wastewater Company and Utility Service Affiliates, Inc.\nErnest C. Gere, who had been Vice President & Controller of the Company since 1978 was promoted to Senior Vice President & Controller in 1986 and is responsible for rate cases, cash management, financings and pension benefit plans. He was employed by the Company from 1964 to 1970 and from 1976 to present. On January 1, 1992 he assumed the designated title of Senior Vice President & Chief Financial Officer. He is Treasurer and Director of Tidewater Utilities,\n- 10 -\nInc., Vice President and Director of Pinelands Water Company and Pinelands Wastewater Company. Mr. Gere will retire from active employment with Middlesex and its subsidiaries, effective March 31, 1996.\nStephen H. Mundy until his retirement in 1995, was Vice President of A. Stanley Mundy, Inc., public utility contractors, Virginia Beach, Virginia, since 1985 and was a Partner of A. Stanley Mundy & Co.\nA. Bruce O'Connor who joined the Company in 1990 as Assistant Controller was elected Controller in 1992 and Vice President in 1995. He was formerly employed by Deloitte & Touche LLP, a certified public accounting firm from 1984 to 1990. He is Controller of Tidewater Utilities, Inc., and Treasurer of White Marsh Environmental Systems, Inc., and Utility Service Affiliates, Inc.\nPhilip H. Reardon has been President and Chief Executive Officer of Essex County Gas Company, Amesbury, Massachusetts, since December 1992, and prior to that date was President and Chief Executive Officer of New Jersey Natural Gas Company, Wall, New Jersey since 1987. He is a Director of Essex County Gas Company, New England Gas Association and First Ocean National Bank, Newberry Port, MA.\nMarion F. Reynolds who had been Secretary-Treasurer since 1987 was elected Vice President, Secretary and Treasurer in 1993. Prior to her election she had been employed by Public Service Electric and Gas Company, Newark, New Jersey since 1958, and was elected Assistant Corporate Secretary in 1976. She is Secretary of Tidewater Utilities, Inc., and Secretary\/Treasurer of Pinelands Water Company and Pinelands Wastewater Company and a Director of Utility Service Affiliates, Inc.\nRichard A. Russo who had been Vice President-Operations since 1989 was elected Executive Vice President in 1995 and is responsible for engineering, water production, water treatment, and distribution maintenance. He was formerly employed by Trenton Water Works as General Superintendent and Chief Engineer since 1979. He is President and Director of Tidewater Utilities, Inc., White Marsh Environmental Systems, Inc., Pinelands Water Company and Pinelands Wastewater Company. He is also Executive Vice President and Director of Utility Service Affiliates, Inc.\nCarolina M. Schneider, until her retirement in 1987, was Secretary-Treasurer of the Company since 1948.\nWilliam E. Scott, until his retirement in 1985, was Senior Executive Vice President of Public Service Electric and Gas Company (PSE&G), Newark, New Jersey since 1984 and had been Executive Vice President-Finance of PSE&G for over five years. He is a Trustee of Delta Dental Plan of New Jersey, Inc.\nJeffries Shein is a Partner in the firm of Jacobson, Goldfarb & Tanzman Associates, a large industrial and commercial brokerage firm in New Jersey. He is a Director of First Savings Bank\/SLA of Perth Amboy, New Jersey.\n- 11 -\nDennis G. Sullivan was hired in 1984 as Corporate Attorney, responsible for general corporate internal legal matters. He was elected Assistant Secretary-Assistant Treasurer in 1988 and Vice President and General Counsel in 1990. He was employed in a private law practice from 1981 to 1984 as a staff attorney. He is Assistant Secretary and Assistant Treasurer and a Director of Tidewater Utilities, Inc., Vice President, Secretary and Director of White Marsh Environmental Systems, Inc.; a Director of Pinelands Water Company and Pinelands Wastewater Company and a Director and Secretary of Utility Service Affiliates, Inc.\nRonald F. Williams, was hired in March 1995 as Assistant Vice President-Operations, responsible for the Company's Engineering and Distribution Departments. He was elected Vice President-Operations in October 1995. He was formerly employed with the Garden State Water Company as President and Chief Executive Officer since 1991.\nJ. Richard Tompkins was elected President of the Company in 1981 and was elected Chairman of the Board in 1990. In 1979 he was employed by Associated Utility Services, an independent utility consulting firm in New Jersey, as Vice President. From 1962 to 1979 he was employed by Buck, Seifert & Jost, Incorporated, consulting engineers in New Jersey and was appointed Vice President in 1973. He is Chairman and Director of Tidewater Utilities, Inc., White Marsh Environmental Systems, Inc., Pinelands Water Company, Pinelands Wastewater Company and Utility Service Affiliates, Inc. He is also a Director of Raritan Bay Healthcare Foundation.\nJoseph S. Yewaisis is Chairman of the Board and President of First Savings Bank\/SLA of Perth Amboy, New Jersey and a Director. He is also a Director of Financial Institutions Retirement Fund, Raritan Bay Healthcare Foundation, Chairman of the Board of Regents of St. Peter's College and Chairman of the Board of Raritan Bay Medical Center.\n- 12 -\nItem 11.","section_11":"Item 11. Executive Compensation\nThere is shown below information concerning the annual and long-term compensation for services in all capacities to the Company for the years 1995, 1994 and 1993 of the Chief Executive Officer and the other four most highly compensated officers.\nSUMMARY COMPENSATION TABLE\n(1) Includes Auto Allowance and Group Life Insurance for all officers and Directors Fees for Messrs. Tompkins, Gere and Russo.\n(2) The number and value of Restricted Stock held in escrow as of December 31, 1995 were as follows: Mr. Tompkins - 10,900\/$166,893; Mr. Gere - 4,500\/$68,063; Mr. Russo - 5,300\/$81,138; Mr. Brady - 4,100\/$61,423; and Mr. Sullivan - 4,800\/$72,720. Generally, the restrictions lapse on these awards five years from the date of grant. The restrictions on Mr. Gere's awards will lapse on March 31, 1996, Mr. Gere's retirement date. The restrictions also lapse in the event of a change in control of the Company. All dividends on these shares are paid to the awardees.\n(3) Employer contribution to the Company's Defined Contribution Plan.\n- 13 -\nCOMPENSATION PURSUANT TO PENSION PLANS Annual Benefit based on Compensation and Years of Service\nAll employees who receive pay for 1,000 hours during the year are included in the Plan. Under the noncontributory trusteed defined benefit plan current service costs are funded annually. The Company's annual contribution is determined on an actuarial basis. Benefits are measured from the member's entry date and accrue to normal retirement date or date of early retirement. Benefits are calculated, at normal retirement, at 1.25% of pay up to the Executive's benefit integration level, plus 1.9% of such excess pay, multiplied by service to normal retirement date, capped at 35 years of such excess pay, multiplied by service to normal retirement date of age 65. Average pay is the highest annual average of total pay during any 5 consecutive years within the 10 calendar-year period prior to normal retirement date. The benefit integration level is based on the 1995 Summary Compensation Table. The benefit amounts are not subject to any deduction for Social Security benefits or other offset amounts.\nDuring the year 1995, the Company made a contribution to the Pension Plan in the amount of $372,000. The range of the permissible Plan contribution was $351,000 to $385,000. Remuneration covered under the Pension Plan includes base wages only and not Directors' fees.\nThe estimated credited years of service based on normal retirement at age 65 includes 22 years, 21 years, 20 years, 44 years and 22 years for Messrs. Tompkins, Gere, Russo, Brady and Sullivan, respectively.\nSupplemental Executive Retirement Plan - All executive officers are eligible to participate in the Deferred Compensation Plan known as the Supplemental Executive Retirement Plan at the direction of the Board of Directors.\nA participant who retires on his normal retirement date is entitled to an annual retirement benefit equal to 75% of his compensation reduced by his primary Social Security benefit and further reduced by any benefit payable from the Qualified Pension Plan. In certain cases further reductions are made for benefits from other employment.\nVesting provisions start at 50% for 5 years of service and increases 10% for each year of service for a maximum of 100% vesting at 10 years of service. Annual retirement benefits are payable for 15 years either to the participant or his beneficiary.\n- 14 -\nRetirement benefits may be in the form of single life annuity, joint and 50% survivors annuity, joint and 100% survivors annuity, single life annuity with a 10-year certain period and single life annuity with a 15-year certain period paid on an actuarial equivalent basis.\nThe Company is not obligated to set aside or earmark any monies or other assets specifically for the purpose of funding the Plan. The benefits are in the form of an unfunded obligation of the Company. The Company has elected to purchase Corporate-owned life insurance as a means of satisfying its obligation under this Plan. The Company reserves the right to terminate any plan of life insurance at any time, however, a participant is entitled to any benefits he would have been entitled to under the Plan provisions. For the year 1995 the Company paid life insurance premiums totaling $131,767, for Messrs. Tompkins, Gere, Russo, Brady and Sullivan, which provides a preretirement net death benefit of 1-1\/2 times base salary at date of death.\nDefined Contribution Plan - The Company matches 100% of that portion of the contribution which does not exceed 1% of basic pay plus an additional 50% of that portion from 2% to 6% of basic pay. Distributions under the Plan are made upon normal retirement, total and permanent disability or death and are subject to certain vesting provisions as to Company contributions. During 1995, this Plan was converted from an after tax plan to a 401(k) pre tax plan.\nCompensation of Directors\nA director who is not an officer of the Company or its subsidiary is paid an annual retainer of $6,000, increased from $5,400 and a fee of $500 for attendance at Board of Directors (Board) meetings, a fee of $250 for attendance at special meetings of the Board, and a fee of $150 for attendance at special Board committee meetings by means of communications facilities, and a fee of $350, increased from $300 for each committee meeting attended. Committee chairmen receive an additional $200 for each committee meeting chaired. Directors who are officers of the Company are paid a fee of $250 for each meeting of the Board attended. Directors of all subsidiaries, except USA receive $50 for attendance at Board meetings. All fee increases were effective February 1, 1996.\nCompensation Committee Interlocks and Insider Participation\nDuring 1995, the members of the Executive Development and Compensation Committee were William E. Scott, Stephen H. Mundy, and Jeffries Shein. During 1995 no member of the Executive Development and Compensation Committee was an officer or employee of the Company or a subsidiary. Mr. Stephen H. Mundy has a financial interest in a construction company that was awarded a contract in the amount of $0.9 million in 1995.\nReport of the Executive Development and Compensation Committee\nThe compensation program for executive officers of the Company is administered by the Executive Development and Compensation Committee of the Board of Directors. The 1995 Committee was composed of three independent directors: William E. Scott, Stephen H. Mundy and Jeffries Shein. The Committee is responsible for setting and administering the policies which govern annual compensation and Restricted Stock awards. Policies and plans developed by the Committee are approved by the full Board of Directors.\n- 15 -\nThe Committee's compensation policies and plans applicable to the executive officers seek to enhance the profitability of the Company and shareholder value, as well as control costs and maintain reasonable rates for the customers. The Committee's practices reflect policies that compensation should (1) attract and retain well-qualified executives, (2) support short- and long-term goals and objectives of the Company, (3) reward individuals for outstanding contributions to the Company's success, (4) be meaningfully related to the value created for shareholders, and (5) relate to maintenance of good customer relations and reasonable rates.\nThe Committee meets with Mr. Tompkins to evaluate the performance of the other executive officers and meets in the absence of Mr. Tompkins to evaluate his performance. The Committee reports on all executive evaluations to the full Board of Directors.\nBase salary levels are reviewed annually using compensation data produced by an outside compensation expert for similar positions and comparable companies. Base salaries for satisfactory performance are targeted at the median of the competitive market. Individual performance of the executive is determined and taken into account when setting salaries against the competitive market data. The Committee reviews, as well, the individual's efforts on cost control and his or her contributions to the results of the year. The Committee also reviews the Company's financial results compared with prior years and compared with other companies. It compares salaries with both water and general industry salaries.\nThe factors and criteria upon which Mr. Tompkins' compensation was based generally include those discussed with respect to all the executive officers. Specifically, however, his salary is based on his overall performance and that of the Company. His salary was set at a rate which was approximately the median of the utility market and below that of the general industry. In addition, in evaluating the performance of the CEO, the Committee has taken particular note of management's success with respect to the growth of the Company.\nThe Company maintains a restricted stock plan for the purpose of attracting and retaining certain key employees of the Company who have contributed, or are likely to contribute, significantly to the long-term performance and growth of the Company. This plan is designed to enhance financial performance, customer service and corporate efficiency through a performance-based stock award. Annual stock awards are based upon several factors including the participant's ability to contribute to the overall success of the Company.\nThe level of awards and the value of the performance are reviewed annually by the Committee. The Committee submits reports on all executive evaluations and restricted stock awards to the full Board of Directors for approval.\n1996 Executive Development and Compensation Committee Jeffries Shein, Chairman Stephen H. Mundy William E. Scott\n- 16 -\nPerformance Graph\nSet forth below is a line graph comparing the yearly change in the cumulative total return (which includes reinvestment of dividends) of a $100 investment for the Company's Common Stock, the NASDAQ and a peer group of investor-owned water utilities for the period of five years commencing December 31, 1990. The peer group includes Aquarion Company, California Water Service Company, Connecticut Water Service, Inc., Consumers Water Company, E'town Corporation, IWC Resources Corporation, Philadelphia Suburban Corporation, SJW Corporation, Southern California Water Company, United Water Resources and the Company.\n[GRAPHIC]\nIn the printed document there is a line graph depicting the following:\n- -------------------------------------------------------------------------------- 12\/31\/90 12\/31\/91 12\/31\/92 12\/31\/93 12\/31\/94 12\/31\/95 - -------------------------------------------------------------------------------- MSEX $100 $130 $171 $226 $183 $219 - -------------------------------------------------------------------------------- NASDAQ 100 161 187 215 210 296 - -------------------------------------------------------------------------------- Peer Group 100 130 146 166 155 177 - --------------------------------------------------------------------------------\n- 17 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth information made known to the Company as of December 31, 1995 of any person or group to be a beneficial owner of more than five percent of the Company's Common Stock.\nNumber of Shares Beneficially Owned and Nature of Percent Name and Address Beneficial Ownership(1) of Class ---------------- -------------------- --------\nPNC Bank Corp. 299,602 7.24 One PNC Plaza Pittsburgh, PA 15265\n(1) Beneficial owner has sole power to vote and dispose of shares.\nThe following information pertains to the Common Stock of the Company beneficially owned, directly or indirectly, by all Directors and Officers of the Company as a group, as of December 31, 1995.\nCommon Stock ------------ Number Percent of of Shares Class ------ -----\nWalter J. Brady 7,022 .17 Ernest C. Gere 6,490 .16 Stephen H. Mundy 30,154 .73 A. Bruce O'Connor 1,632 .04 Philip H. Reardon 4,487 .10 Marion F. Reynolds 7,562 .18 Richard A. Russo 6,702 .16 Carolina M. Schneider 7,920 .19 William E. Scott 5,071 .12 Jeffries Shein 53,534 1.29 Dennis G. Sullivan 6,568 .16 J. Richard Tompkins 16,958 .41 Ronald F. Williams 48 - Joseph S. Yewaisis 1,871 .05 ------- ---- Totals 156,019 3.76 ======= ====\nNo Preferred Stock is beneficially owned, directly or indirectly by any Officer or Director.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nDuring 1995, 1994 and 1993, the Company had transactions with a construction company in which a Director has a financial interest. Major construction transactions were awarded on the basis of negotiated bids approved by the Board of Directors (with the interested\n- 18 -\nDirector abstaining) and amounted to $0.9 million, $0.6 million and $0.6 million for the years 1995, 1994 and 1993, respectively. These amounts included less than $0.1 million due the construction company at December 31, 1995, 1994 and 1993.\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 information is incorporated herein by reference to the attached Exhibit 13, 1995, Annual Report to Shareholders, pages 8 through 21:\nManagement's Discussion and Analysis, Pages 8-9\nConsolidated Balance Sheets at December 31, 1995, and 1994, Pages 10-11\nConsolidated Statements of Income for each of the three years in the period ended December 31, 1995, Page 12\nConsolidated Statements of Capital Stock and Long-term Debt at December 31, 1995, and 1994 Page 13\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995, Page 14\nConsolidated Statements of Retained Earnings for each of the three years in the period ended December 31, 1995, Page 15\nNotes to Consolidated Financial Statements, Pages 15-20\nIndependent Auditors' Report, Page 20\n(a) 2. Financial Statement Schedules\nAll Schedules are omitted because of the absence of the conditions under which they are required or because the required information is shown in the financial statements or notes thereto.\n(a) 3. Exhibits\nSee Exhibit listing on Pages 21-23.\n(b) Reports on Form 8-K None\n- 19 -\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.\nChairman of the Board and President and Director \/J. Richard Tompkins\/ 3\/28\/96 ------------------------------------ J. Richard Tompkins Date\nSenior Vice President & Chief Financial Officer and Director \/Ernest C. Gere\/ 3\/28\/96 ------------------------------------ Ernest C. Gere Date\nVice President and Controller \/A. Bruce O'Connor\/ 3\/28\/96 Principal Accounting Officer ------------------------------------ A. Bruce O'Connor Date\nExecutive Vice President and \/Richard A. Russo\/ 3\/28\/96 Director ------------------------------------ Richard A. Russo Date\nDirector \/Stephen H. Mundy\/ 3\/28\/96 ------------------------------------ Stephen H. Mundy Date\nDirector \/Philip H. Reardon\/ 3\/28\/96 ------------------------------------ Philip H. Reardon Date\nDirector \/Carolina M. Schneider\/ 3\/28\/96 ------------------------------------ Carolina M. Schneider Date\nDirector \/William E. Scott\/ 3\/28\/96 ------------------------------------ William E. Scott Date\nDirector \/Jeffries Shein\/ 3\/28\/96 ------------------------------------ Jeffries Shein Date\nDirector \/Joseph S. Yewaisis\/ 3\/28\/96 ------------------------------------ Joseph S. Yewaisis Date\n- 20 -\nEXHIBIT INDEX\nExhibits 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 the previous filing columns following the description of such exhibits.\nPrevious Filing's Exhibit Registration Exhibit No. Document Description No. No. - ------- ----------------------------- ------------ ------- 3.1 Certificate of Incorporation of the Company, as amended, filed as Exhibit 3.1 of 1993 Form 10-K.\n3.2 Bylaws of the Company, as amended. 33-54922 3.2\n4.1 Form of Common Stock Certificate. 2-55058 2(a)\n4.2 Registration Statement, Form S-3, under Securities Act of 1933 filed February 3, 1987, relating to the Dividend Reinvestment and Common Stock Purchase Plan. 33-11717\n4.3 Post Effective Amendments No. 3 and No. 4, Form S-3, under Securities Act of 1933 filed May 28, 1993, relating to the Dividend Reinvestment and Common Stock Purchase Plan. 33-11717\n10.1 Agreement, dated December 4, 1990, between the Company and Elizabethtown Water Company. 33-54922 10.1\n10.2 Copy of Mortgage, dated April 1, 1927, between the Company and Union County Trust Company, as Trustee, as supplemented by Supplemental Indentures, dated as of October 1, 1939, April 1, 1946, April 1, 1949, February 1, 1955 and December 1, 1959. 2-15795 4(a)-4(f)\n10.3 Copy of Supplemental Indenture, dated as of January 15, 1963, between the Company and Union County Trust Company, as Trustee. 2-21470 4(b)\n10.4 Copy of Supplemental Indentures, dated as of July 1, 1964, June 1, 1965, February 1, 1968, December 1, 1968, December 1, 1970, December 1, 1972 and June 15, 1991, between the Company and 10.4 - 10.9 Union County Trust Company, as Trustee 33-54922 and 10.16\n- 21 -\nEXHIBIT INDEX\nPrevious Filing's Exhibit Registration Exhibit No. Document Description No. No. - ------- ----------------------------- ------------ ------- 10.5 Copy of Supplemental Indenture, dated as of April 1, 1979, between the Company and United Counties Trust Company, as successor Trustee. 2-64770 5.9\n10.6 Copy of Supplemental Indenture, dated as of April 1, 1983, between the Company and United Counties Trust Company, as successor Trustee. 2-94106 10.12\n10.7 Copy of Supplemental Indenture, dated as of August 15, 1988, between the Company and United Counties Trust Company, as Trustee. 33-31476 4.3\n10.8 Copy of Trust Indenture, dated as of June 15, 1991, between the New Jersey Economic Development Authority and Midlantic National Bank, as Trustee. 33-54922 10.17\n10.9 Copy of Supply Agreement, dated as of November 17, 1986, between the Company and the Old Bridge Municipal Utilities Authority. 33-31476 10.12\n10.10 Copy of Supply Agreement, dated as of July 14, 1987, between the Company and the Marlboro Township Municipal Utilities Authority, as amended. 33-31476 10.13\n10.11 Copy of Supply Agreement, dated as of February 11, 1988, with modifications dated February 25, 1992, and April 20, 1994, between the Company and the Borough of Sayreville filed as Exhibit No. 10.11 of 1994 First Quarter Form 10-Q.\n10.12 Copy of Water Purchase Contract and Supple- mental Agreement, dated as of May 12, 1993, between the Company and the New Jersey Water Supply Authority filed as Exhibit No. 10.12 of 1993 Form 10-K.\n10.13 Copy of Treating and Pumping Agreement, dated April 9, 1984, between the Company and the Township of East Brunswick. 33-31476 10.17\n10.14 Copy of Supply Agreement, dated June 4, 1990, between the Company and Edison Township. 33-54922 10.24\n- 22 -\nPrevious Filing's Exhibit Registration Exhibit No. Document Description No. No. - ------- ----------------------------- ------------ ------- 10.15 Copy of Supply Agreement, dated as of December 5, 1991, between the Company and the Borough of Highland Park. 33-54922 10.25\n10.16 Copy of Pipeline Lease Agreement, dated as of January 9, 1987, between the Company and the City of Perth Amboy. 33-31476 10.20\n10.17 Copy of Supplemental Executive Retirement Plan, effective January 1, 1984, as amended. 33-31476 10.21\n10.18 Copy of 1989 Restricted Stock Plan, filed as Appendix A to the Company's Definitive Proxy Statement, dated April 19, 1989, and filed April 5, 1989. 33-31476 10.22\n10.19 Amendment to Supplemental Executive Retirement Plan, dated May 23, 1990, filed as Exhibit No. 10.23 of 1991 Form 10-K.\n10.20 Copy of Transmission Agreement, dated October 16, 1992, between the Company and the Township of East Brunswick. 33-54922 10.23\n10.21 Copy of Agreement and Plan of Merger, dated January 7, 1992, between the Company, Midwater Utilities, Inc. and Tidewater Utilities, Inc. 33-54922 10.29\n10.22 Copy of Supplemental Indentures, dated March 1, 1993 (Series P-1), September 1, 1993, (Series S & T) and January 1, 1994, (Series U & V), between the Company and United Counties Trust Company, as Trustee, filed as Exhibit No. 10.22 of 1993 Form 10-K.\n10.23 Copy of Trust Indentures, dated September 1, 1993, (Series S & T) and January 1, 1994, (Series V), between the New Jersey Economic Development Authority and First Fidelity Bank (Series S & T), as Trustee, and Midlantic National Bank (Series V), as Trustee, filed as Exhibit No. 10.23 of 1993 Form 10-K.\n*13 Annual Report to Shareholders for the year ended December 31, 1995, pages 8 through 21.\n*23 Independent Auditors' Consent.\n*27 Financial Data Schedule\n- 23 -","section_15":""}
{"filename":"21665_1995.txt","cik":"21665","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of the Business\nColgate-Palmolive Company (the \"Company\") is a corporation which was organized under the laws of the State of Delaware in 1923. The Company manufactures and markets a wide variety of products throughout the world for use by consumers. For recent business developments, refer to the information set forth in Part II, Item 7 of this report.\n(b) Financial Information About Industry Segments\nFor information about industry segments refer to the information set forth in Part II, Item 7 of this report.\n(c) Narrative Description of the Business\nFor information regarding description of the business refer to Note 1 to the Consolidated Financial Statements included herein; \"Average number of employees\" appearing under \"Historical Financial Summary\" included herein; and \"Research and development\" expenses appearing in Note 12 to the Consolidated Financial Statements included herein.\nCompliance with environmental rules and regulations has not significantly affected the Company's capital expenditures, earnings or competitive position. Capital expenditures for environmental control facilities totaled $12.7 million in 1995 and are budgeted at $18.3 million for 1996. For future years, expenditures are expected to be in the same range. The Company has programs that are designed to ensure that its operations and facilities meet or exceed all applicable environmental rules and regulations.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nFor information concerning geographic area financial data refer to the information set forth in Part II, Item 7 of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns and leases a total of 338 manufacturing, distribution, research and office facilities worldwide. Corporate headquarters is housed in leased facilities at 300 Park Avenue, New York, New York.\nIn the United States, the Company operates 57 facilities, of which 26 are owned. Major U.S. manufacturing and warehousing facilities used by the Oral, Personal and Household Care segment are located in Kansas City, Kansas; Morristown, New Jersey; Jeffersonville, Indiana; and Cambridge, Ohio. The Company is transforming its former facilities in Jersey City, New Jersey into a mixed-use complex with the assistance of developers and other investors. Hill's Pet Nutrition has major facilities in Bowling Green, Kentucky; Topeka, Kansas; and Richmond, Indiana. Research facilities are located throughout the world with the primary research center for Oral, Personal and Household Care products located in Piscataway, New Jersey.\nOverseas, the Company operates 281 facilities, of which 113 are owned, in over 70 countries. Major overseas facilities used by the Oral, Personal and Household Care segment are located in Australia, Brazil, Canada, China, Colombia, France, Italy, Mexico, Thailand, the United Kingdom and elsewhere throughout the world. In some areas outside the United States, products are either manufactured by independent contractors under Company specifications or are imported from the United States or elsewhere.\nAll facilities operated by the Company are, in general, well maintained and adequate for the purpose for which they are intended. The Company conducts continuing reviews of its facilities with the view to modernization and cost reduction.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFor information regarding legal matters see Note 14 to the Consolidated Financial Statements included herein.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of executive officers as of March 25, 1996:\nEach of the executive officers listed above has served the registrant or its subsidiaries in various executive capacities for the past five years.\nThe Company By-Laws, paragraph 38, states: The officers of the corporation shall hold office until their respective successors are chosen and qualified in their stead, or until they have resigned, retired or been removed in the manner hereinafter provided. Any officer elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the whole Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nRefer to the information regarding the market for the Company's Common Stock and the quarterly market price information appearing under \"Market and Dividend Information\" in Note 15 to the Consolidated Financial Statements included herein; the information under \"Capital Stock and Stock Compensation Plans\" in Note 6 to the Consolidated Financial Statements included herein; and the \"Number of shareholders of record\" and \"Cash dividends declared per common share\" under the caption \"Historical Financial Summary\" included herein.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nRefer to the information set forth under the caption \"Historical Financial Summary\" included herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS) - --------------------------------------------------------------------------------\n1995 1994 1993 -------- -------- -------- WORLDWIDE NET SALES BY BUSINESS SEGMENT Oral, Personal and Household Care...... $7,565.7 $6,735.8 $6,306.4 Pet Nutrition and Other................ 792.5 852.1 834.9 -------- -------- -------- Total Net Sales............................ $8,358.2 $7,587.9 $7,141.3 -------- -------- -------- -------- -------- --------\nSEGMENT NET SALES BY GEOGRAPHIC REGION North America* Oral, Personal and Household Care...... $1,784.7 $1,623.1 $1,762.5 Pet Nutrition and Other................ 689.9 776.9 774.8 -------- -------- -------- Total North America........................ 2,474.6 2,400.0 2,537.3\nEurope Oral, Personal and Household Care...... 2,159.7 1,968.2 1,843.6 Pet Nutrition and Other................ 102.6 75.2 60.1 -------- -------- -------- Total Europe............................... 2,262.3 2,043.4 1,903.7\nLatin America**............................ 1,977.2 1,736.5 1,525.8 Asia\/Africa**.............................. 1,644.1 1,408.0 1,174.5 -------- -------- -------- Total Net Sales............................ $8,358.2 $7,587.9 $7,141.3 -------- -------- -------- -------- -------- --------\n- --------------------------------------------------------------------------------\n* Sales from the U.S., Canada and Puerto Rico are combined and presented as North America.\n** Sales in Latin America and Asia\/Africa relate to the Oral, Personal and Household Care segment only. Sales of Pet Nutrition and Other products to these regions are primarily exported to local distributors and therefore are included in North America.\nNET SALES\nWorldwide net sales in 1995 increased 10% to $8,358.2 reflecting growth among all divisions. Excluding the acquisition of Kolynos in January of 1995 and the sale of non-core businesses in 1994, net sales increased 8% as the Company's worldwide brand presence led to overall sales gains, overcoming the effects of a maxi-devaluation and economic recession in Mexico and the effects of a strategic realignment at Hill's Pet Nutrition. Sales in the Oral, Personal and Household Care segment were up 12% to $7,565.7 in 1995 benefiting from acquisitions, new product introductions and further geographic expansion.\nSales in the Asia\/Africa region were up 17% overall, led by strong volume gains in India, Malaysia, Thailand and China, as well as the favorable effects of the Cibaca acquisition in India and the consolidation, for a portion of the year, of a new subsidiary in Turkiye. The success of Colgate Total toothpaste, Palmolive Optims shampoo and Protex personal care products in Asia as well as strong positioning of laundry bar soaps in Africa have fueled 1995 growth in this region.\nSales in Europe were up 10% on flat volumes, primarily reflecting the positive effects of stronger European currencies. Trade consolidation and the lack of current economic growth continued to affect results throughout Western Europe, while Central Europe experienced overall growth on volume gains. The roll-out of Ajax Ultra cleaning products, the strength of Colgate Total and Colgate Baking Soda toothpastes and the relaunch of Palmolive personal care products are maintaining the Company's competitive position in the West, while Colgate toothpastes and Mennen personal care products made significant contributions to growth in Eastern Europe.\nLatin America was up 14% overall, benefiting from the acquisition of the Kolynos oral care brand, a market leader in this region. Excluding Kolynos, Latin American results were flat as strong results from most countries offset the significant decline in Mexico caused by that country's economic downturn. Sales in Latin America, excluding both Mexico and the impact of the Kolynos acquisition, grew 24% on a 19% increase in volume. Continued leadership in oral care throughout the region as well as geographic expansion of Mennen Speed Stick and Lady Speedstick, development of the dishwashing market under the Axion brand and continued strength of fabric care led to growth in the region and helped maintain market shares in Mexico.\nNorth America posted overall sales increases in 1995 of 10% on 9% volume growth. Contributing to the growth was the introduction of Colgate Baking Soda & Peroxide toothpaste and increased sales of Irish Spring Waterfall Clean soap and Palmolive dishwashing liquid & antibacterial hand soap. Year-on-year reported sales for the Pet Nutrition and Other segment declined, reflecting the sale of non-core businesses during 1994, partially offset by a modest sales increase of 2% at Hill's Pet Nutrition. Hill's growth for the full year was restrained by the temporary impact of inventory liquidation by discontinued outside distributors in the U.S. Business pace at the retail level remains strong, and growth in Europe continues as the Company's nutritionally balanced Science Diet and Prescription Diet products gain brand recognition and market penetration.\nWorldwide net sales for 1994 were up 6% to $7,587.9 from the prior year and were up 8% on volume growth of 7% adjusted for the sale of non-core businesses in 1994. Asia\/Africa, with sales growth of 20% on 17% higher volume, and Latin America, with 14% sales growth on 11% higher volume, led the way on the strength of Colgate Total toothpaste and personal care product sales. Europe improved 7% on 6% volume growth, including 4% from acquisitions. North America was negatively impacted by trade downstocking as sales were down 8% on volume declines of 4%. Pet Nutrition and Other experienced rapid growth. Hill's increased sales 16% on 14% volume growth, offset slightly by the sale of non-core businesses in July 1994.\nGROSS PROFIT\nGross profit margin was 47.9%, below the 1994 level of 48.4% but higher than the 1993 gross profit margin of 47.8%. The 1995 decline is after a long-term trend of increases achieved by focusing on cost reduction and shifting the product mix towards high-margin oral care and personal care products.\nFactors influencing 1995 include higher raw material and packaging costs, lower volume at Hill's, as a result of the strategic realignment of the business, and the effects of the Mexican recession.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses as a percent of sales were 34% in 1995, 35% in 1994 and 34% in 1993. The Company continues to focus on expense-containment strategies including its announced restructuring, discussed below, and the consolidation in 1996 of worldwide media billings to one agency utilizing a cost-and-performance-based compensation structure. It is anticipated that these initiatives will provide incremental funds to further increase investments in research and development as well as media advertising to support growth.\nPROVISION FOR RESTRUCTURED OPERATIONS\nIn September 1995, the Company announced a major worldwide restructuring of its manufacturing and administrative operations designed to further enhance profitable growth over the next several years by generating significant efficiencies and improving competitiveness. As a result of this rationalization, 24 of the 112 factories worldwide will be closed or significantly reconfigured. The worldwide work force will be reduced by approximately 3,000 employees, or 8.5%, of which a reduction of approximately 150 occurred during 1995.\nThe changes, primarily in North America and Europe, are expected to be substantially completed during 1997 in facilities around the world. Hill's Pet Nutrition and Colgate locations in Asia\/Africa and certain Latin American countries, including Mexico, are also affected. The charge includes employee termination costs and expenses associated with the realignment of the Company's global manufacturing operations, as well as settlement of contractual obligations. The worldwide restructuring program resulted in a 1995 third quarter pretax charge of $460.5 ($369.2 net of tax) or $2.54 per share for the year.\nOTHER EXPENSE, NET\nOther expense, net of other income consists principally of amortization of goodwill and other intangible assets, minority interest in earnings of less-than-100% owned consolidated subsidiaries, earnings from equity investments and asset sales. Amortization expense increased in each of the three years ended 1995 due to higher levels of intangible assets stemming from the Company's recent acquisitions, most notably Kolynos in 1995, and Cibaca in India and certain brands acquired from S.C. Johnson in 1994. Loss on disposition of non-core businesses in 1994 and gains on sale of miscellaneous assets make up the remainder of other expense, net in 1995 and 1994.\n* Earnings from the U.S., Canada and Puerto Rico are combined and presented as North America.\n** Earnings in Latin America and Asia\/Africa relate to the Oral, Personal and Household Care segment only. Earnings of Pet Nutrition and Other products are included in North America as sales to these regions are primarily exported to local distributors.\nEARNINGS BEFORE INTEREST AND TAXES\nEarnings before interest and taxes (EBIT) was impacted by the provision for restructured operations of $460.5 recorded during 1995. Excluding this charge, EBIT for the Oral Personal and Household Care segment was up 13%, with North America, Asia\/Africa and Latin America posting gains of 20%, 14% and 15%, respectively. Results in Europe showed modest improvement in 1995, and overall EBIT was tempered by the 27% decline in the Pet Nutrition and Other segment, principally due to the realignment of the sales force at Hill's as well as the sale of non-core businesses in 1994.\nEBIT increased 9% in 1994 to $966.6 compared with $883.0 in the prior year. EBIT for the Oral, Personal and Household Care segment was up 9%, with strong gains across all of the Company's developing markets and mixed results in the developed world. Lower returns were experienced in the developed world due principally to a decline in North America, as a result of trade downstocking and increased spending on advertising and research and development to position that region for future growth. EBIT for Europe increased 19%, primarily reflecting sales growth and higher gross profit margins. Asia\/Africa and Latin America each increased EBIT by 20% on an already healthy base business. Pet Nutrition and Other also contributed to the overall EBIT growth led by improvement at Hill's, which increased EBIT while investing in developing markets to expand its international reach.\nINTEREST EXPENSE, NET\nInterest expense, net of interest income, was $205.4 in 1995 compared with $86.7 in 1994 and $46.8 in 1993. The increase in net interest expense in 1995 versus the prior two years results from higher\ndebt for the full year, incurred primarily to finance Kolynos and other acquisitions, and slightly higher effective interest rates in 1995. The increase in interest expense in 1994 from 1993 reflects higher debt from year to year due to acquisitions and share repurchases.\nINCOME TAXES\nThe effective tax rate on income was 52.7% in 1995 versus 34.1% in 1994 and 34.5% in 1993. The overall effective rate in 1995 was impacted by the provision for restructuring, the tax benefit of which was 20% due to the effect of tax benefits in certain jurisdictions not expected to be realized. Excluding the charge, the effective income tax rate was 34.3% in 1995. Global tax planning strategies benefited the rate in all three years presented.\nNET INCOME\nNet income was $172.0 in 1995 or $1.04 per share including the provision for restructured operations of $369.2 or $2.54 per share. Excluding the special charge, earnings were $541.2 or $3.58 per share compared to $580.2 or $3.82 per share in 1994. The 1995 results were also impacted by the expected first-year dilution caused by the acquisition of Kolynos, the recession and currency devaluation in Mexico and the effect of the strategic realignment at Hill's. Included in 1993 net income and per share amounts is the cumulative one-time impact on prior years of adopting new mandated accounting standards effective January 1, 1993 for income taxes, other postretirement benefits and postemployment benefits.\n- -------------------------------------------------------------------------------- 1995 1994 1993 -------- -------- -------- IDENTIFIABLE ASSETS North America* Oral, Personal and Household Care........ $2,497.7 $2,416.0 $2,420.3 Pet Nutrition and Other.................. 496.0 473.9 446.4 -------- -------- -------- Total North America.......................... 2,993.7 2,889.9 2,866.7\nEurope Oral, Personal and Household Care........ 1,271.0 1,293.8 1,169.3 Pet Nutrition and Other.................. 49.5 35.7 27.8 -------- -------- -------- Total Europe................................. 1,320.5 1,329.5 1,197.1\nLatin America**.............................. 2,158.3 845.2 804.4 Asia\/Africa**................................ 967.2 889.0 692.7 -------- -------- -------- 7,439.7 5,953.6 5,560.9\nCorporate Assets............................. 202.6 188.8 200.3 -------- -------- -------- Total Assets................................. $7,642.3 $6,142.4 $5,761.2 -------- -------- -------- -------- -------- -------- - --------------------------------------------------------------------------------\n* Assets from the U.S., Canada and Puerto Rico are combined and presented as North America.\n** Assets in Latin America and Asia\/Africa relate to the Oral, Personal and Household Care segment only.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operations decreased 2% to $810.2 in 1995 compared with $829.4 in 1994 and $710.4 in 1993. The decrease in cash generated by operating activities in 1995 reflects the previously discussed lower earnings in Mexico and at Hill's. Cash generated from operations was used to fund acquisitions, capital spending and an increased dividend level.\nDuring 1995, long-term debt increased from $1,777.5 to $3,029.0. The higher debt levels were primarily incurred to finance acquisitions including Kolynos. Initially, the acquisition was funded by a bridge loan from commercial banks which was rolled into various financial instruments during 1995.\nIn April of 1995, the Company obtained a $75.0 term loan and filed a shelf registration for $700.0 of debt securities. No notes have been issued under this registration. In June, the Company issued $89.2 of Swiss franc bonds and $71.7 of Luxembourg franc bonds, both of which were immediately swapped into U.S. dollar floating rate debt. During May and June, $220.0 of medium-term notes were issued under the shelf registration filed in May 1994.\nDuring 1995, the Company entered into $950.0 notional amount of interest rate swaps converting floating rate debt to fixed rate debt and $50.0 of swaps converting fixed rate debt to floating. In the fourth quarter of 1995, the Company finalized a European commercial paper facility. As of December 31, 1995, $1,143.0 of U.S. and European commercial paper was outstanding. These borrowings carry a Standard & Poor's rating of A1 and a Moody's rating of P1. The commercial paper as well as $235.2 of other short-term borrowings are classified as long-term debt at December 31, 1995, as it is the Company's intent and ability to refinance such obligations on a long-term basis. The Company has additional sources of liquidity available in the form of lines of credit maintained with various banks. At December 31, 1995 such unused lines of credit amounted to $2,093.4.\nDuring the third quarter of 1994, the remaining outstanding principal ($32.0) of the 9.625% debentures due July 15, 2017 was retired. Also during the third quarter, the Company obtained a $50.0 term loan. In May 1994, the Company filed a shelf registration for $500.0 of debt securities. During the second quarter of 1994, $208.0 of medium-term notes were issued under this registration and $72.8 was available as of December 31, 1995.\nDuring 1993, the Company participated in the formation of a business that purchases receivables, including Company receivables. Outside institutions invested $30.5 in this entity in 1995, $15.2 in 1994 and $60.0 in 1993. The Company consolidates this entity and the amounts invested by the outside institutions are classified as a minority interest. In the fourth quarter of 1993, $230.0 of medium-term notes were issued under an existing registration. These notes are currently rated A1\/A by Moody's and Standard & Poor's, respectively.\n- ------------------------------------------------------------------------------ 1995 1994 1993 ------ ------ ------ CAPITAL EXPENDITURES Oral, Personal and Household Care.............. $354.9 $343.1 $341.1 Pet Nutrition and Other........................ 76.9 57.7 23.2 ------ ------ ------ Total Capital Expenditures....................... $431.8 $400.8 $364.3 ------ ------ ------ ------ ------ ------\nDEPRECIATION AND AMORTIZATION Oral, Personal and Household Care............ $273.8 $213.0 $188.7 Pet Nutrition and Other...................... 26.5 22.1 20.9 ------ ------ ------ Total Depreciation and Amortization.............. $300.3 $235.1 $209.6 ------ ------ ------ ------ ------ ------ - ------------------------------------------------------------------------------\nCapital expenditures in 1995 of $431.8 were 5.2% of sales compared with 5.3% of sales in 1994 and 5.1% of sales in 1993. Capital spending continues to be focused primarily on projects that yield high aftertax returns, thereby reducing the Company's cost structure. Capital expenditures for 1996 are expected to continue at the current rate of approximately 5% of sales.\nOther investing activities in 1995, 1994 and 1993 included strategic acquisitions and equity investments worldwide. During 1995, the Company acquired the Kolynos oral care brand in Latin America and Odol oral care products in Argentina and made other regional investments. The aggregate purchase price of all 1995 acquisitions was $1,321.9. During 1994, the Company acquired the Cibaca toothbrush and toothpaste business in India, the NSOA laundry soap business in Senegal and several other regional brands across the Oral, Personal and Household Care segment. In October 1993, the Company acquired the liquid hand and body soap brands of S.C. Johnson in Europe, the South Pacific and other international locations. Also in 1993, the Company acquired the Cristasol glass cleaner business in Spain, increased ownership of its Indian operation to majority control and made other\ninvestments. The aggregate purchase price of all 1994 and 1993 acquisitions was $149.8 and $222.5, respectively.\nDuring 1994, the Company repurchased common shares in the open market and private transactions to provide for employee benefit plans and to maintain its targeted capital structure. Aggregate repurchases for the year approximated 6.9 million shares with a total purchase price of $411.1. During 1993, 12.6 million shares were acquired with a total purchase price of $698.1.\nThe ratio of net debt to total capitalization (defined as the ratio of the book values of debt less cash and marketable securities ['net debt'] to net debt plus equity) increased to 64% during 1995 from 49% in 1994. The increase in 1995 is primarily the result of the Kolynos acquisition and the restructuring charge. The ratio of market debt to market capitalization (defined as above using fair market values) increased to 23% during 1995 from 16% in 1994. The Company primarily uses market value analyses to evaluate its optimal capitalization.\nDividend payments were $284.8 in 1995 ($276.5 aftertax), up from $255.6 ($246.9 aftertax) in 1994. Common dividend payments increased to $1.76 per share in 1995 from $1.54 per share in 1994 reflecting a 15% increase in the dividend effective in the third quarter of 1995. The Series B Preference Stock dividends were declared and paid at the stated rate of $4.88 per share in 1995 and 1994. The increase in dividend payments in 1994 over 1993 reflects a 14% increase in the common dividend effective in the third quarter of 1994.\nThe Company utilizes interest rate agreements and foreign exchange contracts to manage interest rate and foreign currency exposures. The principal objective of such financial derivative contracts is to manage rather than attempt to eliminate fluctuations in interest rate and foreign currency movements. The Company, as a matter of policy, does not speculate in financial markets and therefore does not hold these contracts for trading purposes. The Company utilizes what are considered straightforward instruments, such as forward foreign exchange contracts and non-leveraged interest rate swaps, to accomplish its objectives.\nInternally generated cash flows appear to be adequate to support currently planned business operations, acquisitions and capital expenditures. Significant acquisitions, such as the acquisition of Kolynos discussed previously, require external financing.\nThe Company is a party to various superfund and other environmental matters and is contingently liable with respect to lawsuits, taxes and other matters arising out of the normal course of business. Management proactively reviews and manages its exposure to, and the impact of, environmental matters. While it is possible that the Company's cash flows and results of operations in particular quarterly or annual periods could be affected by the one-time impacts of the resolution of such contingencies, it is the opinion of management that the ultimate disposition of these matters, to the extent not previously provided for, will not have a material impact on the Company's financial condition or ongoing cash flows and results of operations.\nOUTLOOK\nLooking forward into 1996, the Company is well positioned for strong growth in developing markets, particularly Asia and Latin America. However, economic uncertainty in Mexico and Venezuela may continue to impact overall results from Latin America, and its growth may be tempered until these economies become more stable. In addition, the acquisition of Kolynos is currently under review by antitrust authorities in Brazil, which is discussed further in Note 14 - -Commitments and Contingencies. Competitive pressures in Western European markets are expected to persist as business in this region will continue to be affected by low economic growth, high unemployment and retail trade consolidation. Movements in foreign currency exchange rates can also impact future operating results as measured in U.S. dollars. Hill's Pet Nutrition is expected to benefit from the strategic focus of its in-house sales force. Savings from the worldwide restructuring announced during 1995 are anticipated to begin in the latter half of 1996 and are expected to reach $100 annually by 1998. The Company expects\nthe worldwide roll-out of Colgate Baking Soda and Colgate Baking Soda & Peroxide, and the continued success of Colgate Total using patented proprietary technology to bolster worldwide oral care leadership and expects new products in all other categories to add potential for further growth. Overall, the global economic situation for 1996 is not expected to be materially different from that experienced in 1995 and the Company expects its positive momentum to continue. Historically, the consumer products industry has been less susceptible to changes in economic growth than many other industries, and therefore the Company constantly evaluates projects which will focus operations on opportunities for enhanced growth potential. Over the long term, Colgate's continued focus on its consumer products business and the strength of its global brand names, its broad international presence in both developed and developing markets, and its strong capital base all position the Company to take advantage of growth opportunities and to continue to increase profitability and shareholder value.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee the \"Index to Financial Statements\" which is located on page 14 of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding directors and executive officers of the registrant set forth in the Proxy Statement for the 1996 Annual Meeting is incorporated herein by reference, as is the text in Part I of this report under the caption \"Executive Officers of the Registrant\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the Proxy Statement for the 1996 Annual Meeting is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security ownership of management set forth in the Proxy Statement for the 1996 Annual Meeting is incorporated herein by reference.\n(b) There are no arrangements known to the registrant that 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\nThe information set forth in the Proxy Statement for the 1996 Annual Meeting 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\nSee the \"Index to Financial Statements\" which is located on page 14 of this report.\n(b) Exhibits. See the exhibit index begins on page 42.\n(c) 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.\nCOLGATE-PALMOLIVE COMPANY (Registrant)\nDate March 25, 1996 By \/s\/ REUBEN MARK ................................. 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(a) Principal Executive Officer (c) Principal Accounting Officer\n\/s\/ REUBEN MARK \/s\/ STEPHEN C. PATRICK ................................... ................................. Reuben Mark Stephen C. Patrick Chairman of the Board Vice President and Chief Executive Officer Corporate Controller\nDate March 25, 1996 Date March 25, 1996\n(b) Principal Financial Officer (d) Directors:\n\/s\/ ROBERT M. AGATE Vernon R. Alden, Jill K. Conway, .................................. Ronald E. Ferguson, Ellen M. Hancock, Robert M. Agate David W. Johnson, John P. Kendall, Senior Executive Vice President Richard J. Kogan, Delano E. Lewis, and Chief Financial Officer Reuben Mark, Howard B. Wentz, Jr.\nDate March 25, 1996 By \/s\/ ANDREW D. HENDRY ................................ Andrew D. Hendry as Attorney-in-Fact\nDate March 25, 1996\nUNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\nFORM 10-K\nFINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\nCOLGATE-PALMOLIVE COMPANY\nNEW YORK, NEW YORK 10022\nAll other financial statements and 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.\nCOLGATE-PALMOLIVE COMPANY CONSOLIDATED STATEMENTS OF INCOME Dollars in Millions Except Per Share Amounts\nSee Notes to Consolidated Financial Statements.\nCOLGATE-PALMOLIVE COMPANY CONSOLIDATED BALANCE SHEETS Dollars in Millions Except Per Share Amounts\nSee Notes to Consolidated Financial Statements.\nCOLGATE-PALMOLIVE COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Dollars in Millions\nCONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL ACCOUNTS Dollars in Millions\nSee Notes to Consolidated Financial Statements.\nCOLGATE-PALMOLIVE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS Dollars in Millions\nSee Notes to Consolidated Financial Statements.\nCOLGATE-PALMOLIVE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dollars in Millions Except Per Share Amounts\n1. NATURE OF OPERATIONS\nThe Company manufactures and markets a wide variety of products in the U.S. and around the world in two distinct business segments: Oral, Personal and Household Care, and Pet Nutrition. Oral, Personal and Household Care products include toothpastes, oral rinses and toothbrushes, bar and liquid soaps, shampoos, conditioners, deodorants and antiperspirants, baby and shave products, laundry and dishwashing detergents, fabric softeners, cleansers and cleaners, bleaches, and other similar items. These products are sold primarily to wholesale and retail distributors worldwide. Pet Nutrition products include pet food products manufactured and marketed by Hill's Pet Nutrition. The principal customers for Pet Nutrition products are veterinarians and large-format specialty pet retailers. Principal global trademarks include Colgate, Palmolive, Mennen, Kolynos, Ajax, Soupline\/Suavitel, Fab, Science Diet and Prescription Diet in addition to various regional trademarks.\nThe Company's principal classes of products accounted for the following percentages of worldwide sales for the past three years:\n1995 1994 1993 ---- ---- ---- Oral Care................................. 30% 26% 25% Personal Care............................. 22% 24% 24% Household Surface Care.................... 16% 17% 17% Fabric Care............................... 18% 18% 19% Pet Nutrition............................. 9% 11% 11%\nCompany products are marketed under highly competitive conditions. Products similar to those produced and sold by the Company are available from competitors in the U.S. and overseas. Product quality, brand recognition and acceptance, and marketing capability largely determine success in the Company's business segments. The financial and descriptive information on the Company's geographic area and industry segment data, appearing in the tables contained in management's discussion, is an integral part of these financial statements. More than half of the Company's net sales, operating profit and identifiable assets are attributable to overseas operations. Transfers between geographic areas are not significant.\nThe Company's products are generally marketed by a sales force employed by each individual subsidiary or business unit. In some instances outside jobbers and brokers are used. Most raw materials used worldwide are purchased from others, are available from several sources and are generally available in adequate supply. Products and commodities such as tallow and essential oils are subject to wide price variations. No one of the Company's raw materials represents a significant portion of total material requirements.\nTrademarks are considered to be of material importance to the Company's business; consequently the practice is followed of seeking trademark protection by all available means. Although the Company owns a number of patents, no one patent is considered significant to the business taken as a whole.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe Consolidated Financial Statements include the accounts of Colgate-Palmolive Company and its majority-owned subsidiaries. Intercompany transactions and balances have been eliminated. Investments in companies in which the Company's interest is between 20% and 50% are accounted for using the equity method. The Company's share of the net income from such investments is recorded as equity earnings and is classified as other expense, net in the Consolidated Statements of Income.\nREVENUE RECOGNITION\nSales are recorded at the time products are shipped to trade customers. Net sales reflect units shipped at selling list prices reduced by promotion allowances.\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 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 reporting period. Actual results could differ from those estimates.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. Investments in short-term securities that do not meet the definition of cash equivalents are classified as marketable securities. Marketable securities are reported at cost, which equals market.\nINVENTORIES\nInventories are valued at the lower of cost or market. The last-in, first-out (LIFO) method is used to value substantially all inventories in the U.S. as well as in certain overseas locations. The remaining inventories are valued using the first-in, first-out (FIFO) method.\nPROPERTY, PLANT AND EQUIPMENT\nLand, buildings, and machinery and equipment are stated at cost. Depreciation is provided, primarily using the straight-line method, over estimated useful lives ranging from 3 to 40 years.\nGOODWILL AND OTHER INTANGIBLES\nGoodwill represents the excess of purchase price over the fair value of identifiable tangible and intangible net assets of businesses acquired. Goodwill and other intangibles are amortized on a straight-line basis over periods not exceeding 40 years. The recoverability of carrying values of intangible assets is evaluated on a recurring basis. The primary indicators of recoverability are current and forecasted profitability of a related acquired business. For the three-year period ended December 31, 1995, there\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) were no material adjustments to the carrying values of intangible assets resulting from these evaluations.\nINCOME TAXES\nDeferred taxes are recognized for the expected future tax consequences of temporary differences between the amounts carried for financial reporting and tax purposes. Provision is made currently for taxes payable on remittances of overseas earnings; no provision is made for taxes on overseas retained earnings that are deemed to be permanently reinvested.\nPOSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nThe cost of postretirement health care and other benefits is actuarially determined and accrued over the service period of covered employees.\nTRANSLATION OF OVERSEAS CURRENCIES\nThe assets and liabilities of subsidiaries, other than those operating in highly inflationary environments, are translated into U.S. dollars at year-end exchange rates, with resulting translation gains and losses accumulated in a separate component of shareholders' equity. Income and expense items are converted into U.S. dollars at average rates of exchange prevailing during the year.\nFor subsidiaries operating in highly inflationary environments, inventories, goodwill and property, plant and equipment are translated at the rate of exchange on the date the assets were acquired, while other assets and liabilities are translated at year-end exchange rates. Translation adjustments for these operations are included in net income.\nGEOGRAPHIC AREAS AND INDUSTRY SEGMENTS\nThe financial and descriptive information on the Company's geographic area and industry segment data, appearing in the tables contained in management's discussion of this report, is an integral part of these financial statements.\n3. ACQUISITIONS\nOn January 10, 1995, the Company acquired the worldwide Kolynos oral care business (\"Kolynos\") from American Home Products Corporation for $1,040.0 in cash. Kolynos is a multinational oral care business operating primarily in South America and having a presence in Greece, Taiwan and Hungary. The acquired assets of the Kolynos business, located principally in Argentina, Brazil, Colombia, Ecuador, Peru and Uruguay, include trademarks and other intellectual property, accounts receivable, inventories, and property, plant and equipment that is utilized in the production of toothpaste, toothbrushes, dental floss and oral rinses.\nThe transaction was structured as a multinational acquisition of assets and stock and was accounted for under the purchase method of accounting, with the results of operations of Kolynos included with the results of the Company from January 10, 1995.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n3. ACQUISITIONS--(CONTINUED)\nThe acquisition is currently being reviewed by antitrust regulatory authorities in Brazil. The financing used to acquire the Kolynos business was provided by commercial banks and refinanced during the year with long-term obligations.\nThe net book value of Kolynos assets was approximately $50.0. The purchase price was allocated to the acquired assets based upon preliminary determination of their respective fair values and is subject to adjustment. The cost in excess of the fair value of acquired assets is being amortized over 40 years.\nThe following unaudited pro forma summary combines the results of the operations of the Company and Kolynos as if the acquisition had occurred as of the beginning of 1994 after giving effect to certain adjustments, including amortization of goodwill, increased interest expense on the acquisition debt incurred and the related income tax effects.\nSUMMARIZED PRO FORMA COMBINED RESULTS OF OPERATIONS\nFOR THE YEAR ENDED DECEMBER 31, 1994 ------------------------------------ Net sales............................... $7,864.0 Income before income taxes.............. 835.4 Net income.............................. 550.9 Primary earnings per common share....... 3.62 Fully diluted earnings per common share. 3.38\nThe pro forma financial information is not necessarily indicative of either the results of operations that would have occurred had the Company and Kolynos actually been combined during the year ended December 31, 1994, or the future results of operations of the combined companies. Although the Company intends to operate Kolynos in Brazil as a separate operation, there are certain other benefits that are anticipated to be realized from the implementation of the Company's integration plans which are not included in the pro forma information. The Company believes that future growth opportunities, as well as the benefits of such integration plans when fully implemented, will reduce and eventually more than offset any dilutive impact on earnings per share.\nIn addition, during 1995, the Company acquired the Odol oral care business in Argentina, the Barbados Cosmetic Products business in the Caribbean as well as other regional brands in the Oral, Personal and Household Care Segment. The aggregate purchase price of all 1995 acquisitions was $1,321.9.\nDuring 1994, the Company acquired the Cibaca toothpaste and toothbrush business in India, the NSOA laundry soap business in Senegal, Nevex non-chlorine bleach in Venezuela, and Na Pancha laundry soap in Peru as well as several other regional brands in the Oral, Personal and Household Care segment. The aggregate purchase price of all 1994 acquisitions was $149.8.\nIn October 1993, the Company acquired the liquid hand and body soap brands of S.C. Johnson in Europe, the South Pacific and other international locations. During that year, the Company also acquired the Cristasol glass cleaner business in Spain, increased ownership of its Indian operation to majority control and made other investments. The aggregate purchase price of all 1993 acquisitions was $222.5.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n3. ACQUISITIONS--(CONTINUED) All of these acquisitions have been accounted for as purchases, and, accordingly, the purchase prices were allocated to the net tangible and intangible assets acquired based on estimated fair values at the dates of the respective acquisitions. The results of operations have been included in the Consolidated Financial Statements since the respective acquisition dates. The inclusion of pro forma financial data for all acquisitions except Kolynos prior to the dates of acquisition would not have materially affected reported results.\n4. RESTRUCTURED OPERATIONS\nIn September 1995, the Company announced a major worldwide restructuring of its manufacturing and administrative operations designed to further enhance profitable growth over the next several years by generating significant efficiencies and improving competitiveness. As a result of this rationalization, 24 of the 112 factories worldwide will be closed or significantly reconfigured. The worldwide workforce will be reduced by approximately 3,000 employees or 8.5%, of which a reduction of approximately 150 occurred during 1995.\nThe changes are expected to be substantially completed during 1997 in facilities around the world, but primarily in North America and Europe. Hill's Pet Nutrition and locations in Asia\/Africa and certain Latin American countries, including Mexico, are also affected. The charge includes employee termination costs, expenses associated with the realignment of the Company's global manufacturing operations as well as settlement of contractual obligations.\nThe worldwide restructuring program resulted in a 1995 pretax charge of $460.5 ($369.2 net of tax) or $2.54 per share for the year.\nA summary of the restructuring reserve established in 1995 is as follows:\nORIGINAL UTILIZED BALANCE AT RESERVE IN 1995 END OF YEAR -------- -------- ----------- Workforce.................................. $ 210.0 $ 4.2 $ 205.8 Manufacturing plants....................... 204.1 7.2 196.9 Settlement of contractual obligations...... 46.4 13.5 32.9 -------- -------- ----------- Total...................................... $ 460.5 $ 24.9 $ 435.6 -------- -------- ----------- -------- -------- -----------\nOf the restructuring reserve remaining as of December 31, 1995, $100.0 is classified as a current liability, $175.9 as a noncurrent liability and $159.7 as a reduction of fixed assets.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n5. LONG-TERM DEBT AND CREDIT FACILITIES\nLong-term debt consists of the following at December 31:\n- ------------\n* These bonds have been swapped into U.S. dollar floating rate liabilities.\nOther debt consists of capitalized leases and individual fixed and floating rate issues of less than $30.0 with various maturities. Commercial paper and certain other short-term borrowings are classified as long-term debt in accordance with the Company's intent and ability to refinance such obligations on a long-term basis. The Company has swapped the majority of these liabilities into long-term fixed rates ranging from 5.3% to 8.2%. Scheduled maturities of debt outstanding at December 31, 1995, excluding short-term borrowings reclassified, are as follows: 1996--$37.0; 1997--$142.2; 1998--$179.9; 1999-- $166.5; 2000--$231.6, and $893.6 thereafter.\nAt December 31, 1995, the Company had unused credit facilities amounting to $2,093.4. Commitment fees related to credit facilities are not material. The weighted average interest rate on all short-term borrowings as of December 31, 1995 and 1994 was 7.8% and 7.9%, respectively.\n6. CAPITAL STOCK AND STOCK COMPENSATION PLANS\nPREFERRED STOCK\nPreferred Stock consists of 250,000 authorized shares without par value. It is issuable in series, of which one series of 125,000 shares, designated $4.25 Preferred Stock, with a stated and redeemable value of $100 per share, has been issued and is outstanding. The $4.25 Preferred Stock is redeemable only at the option of the Company.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n6. CAPITAL STOCK AND STOCK COMPENSATION PLANS--(CONTINUED)\nPREFERENCE STOCK\nIn 1988, the Company authorized the issuance of 50,000,000 shares of Preference Stock, without par value. The Series B Convertible Preference Stock, which is convertible into two shares of common stock, ranks junior to all series of the Preferred Stock. At December 31, 1995 and 1994, 6,014,615 and 6,091,375 shares of Series B Convertible Preference Stock, respectively, were outstanding and issued to the Company's ESOP.\nSHAREHOLDER RIGHTS PLAN\nUnder the Company's Shareholder Rights Plan, each share of the Company's common stock carries with it one Preference Share Purchase Right. The Rights themselves will at no time have voting power or pay dividends. The Rights become exercisable only if a person or group acquires 20% 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 20% or more of the common stock. When exercisable, each Right entitles a holder to buy one two-hundredth of a share of a new series of preference stock at an exercise price of $87.50.\nIf the Company is acquired in a merger or other business combination, each Right will entitle a holder to buy, at the Right's then current exercise price, a number of the acquiring company's common shares having a market value of twice such price. In addition, if a person or group acquires 30% or more of the Company's common stock, other than pursuant to a cash tender offer for all shares in which such person or group increases its stake from below 20% to 80% or more of the outstanding shares, 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 shares of the Company's common stock having a market value of twice the Right's exercise price.\nFurther, at any time after a person or group acquires 30% or more (but less than 50%) of the Company's common stock, the Board of Directors may, at its option, exchange part or all of the Rights (other than Rights held by the acquiring person or group) for shares of the Company's common stock on a one-for-one basis.\nThe Company, at the option of its Board of Directors, may redeem the Rights for $.005 at any time before the acquisition by a person or group of beneficial ownership of 20% or more of its common stock. The Board of Directors is also authorized to reduce the 20% and 30% thresholds to not less than 15%. Unless redeemed earlier, the Rights will expire on October 24, 1998.\nINCENTIVE STOCK PLAN\nThe Company has a plan which provides for grants of restricted stock awards for officers and other executives of the Company and its major subsidiaries. A committee of non-employee members of the Board of Directors administers the plan. During 1995 and 1994, 155,094 and 80,249 shares, respectively were awarded to employees in accordance with the provisions of the plan.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n6. CAPITAL STOCK AND STOCK COMPENSATION PLANS--(CONTINUED)\nSTOCK OPTION PLAN\nThe Company's 1987 Stock Option Plan provides for the issuance of non-qualified stock options to officers and key employees. Options are granted at prices not less than the fair market value on the date of grant. At December 31, 1995, 1,779,497 shares of common stock were available for future grants.\nDuring 1992, an Accelerated Ownership feature was added to the 1987 Stock Option Plan. The Accelerated Ownership feature provides for the grant of new options when previously owned shares of Company stock are used to exercise existing options. The number of new options granted under this feature is equal to the number of shares of previously owned Company stock used to exercise the original options and to pay the related required U.S. income tax. The new options are granted at a price equal to the fair market value on the date of the new grant and have the same expiration date as the original options exercised.\nStock option plan activity is summarized below:\n1995 1994 ---------------- ---------------- Options outstanding, January 1.......... 10,261,408 9,626,394 Granted................................. 2,581,173 2,528,109 Exercised............................... (2,252,955) (1,803,574) Canceled or expired..................... (93,731) (89,521) ---------------- ---------------- Options outstanding, December 31........ 10,495,895 10,261,408 ---------------- ---------------- ---------------- ---------------- Options exercisable, December 31........ 6,770,039 6,402,658 ---------------- ---------------- ---------------- ---------------- Option price range at exercise.......... $13.28 to $64.88 $11.88 to $57.94 ---------------- ---------------- ---------------- ---------------- Option price range, December 31......... $19.53 to $99.79 $13.28 to $99.79 ---------------- ---------------- ---------------- ----------------\nIn October 1995, the Financial Accounting Standards Board issued Statement No. 123, \"Accounting for Stock-Based Compensation\" (SFAS 123). This Statement is effective beginning in 1996, with earlier application permitted. Although the statement encourages entities to adopt the fair value based method of accounting for employee stock options, the Company intends to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\". Adoption of SFAS 123 will require the Company to disclose additional information relating to the stock option plan and the Company's pro forma net income and earnings per share, as if the options granted were expensed at their estimated fair value at the time of grant.\n7. EMPLOYEE STOCK OWNERSHIP PLAN\nIn 1989, the Company expanded its employee stock ownership plan (ESOP) through the introduction of a leveraged ESOP covering certain employees who have met certain eligibility requirements. The ESOP issued $410.0 of long-term notes due through 2009 bearing an average interest rate of 8.6%. The long-term notes, which are guaranteed by the Company, are recorded on the accompanying Consolidated Balance Sheets. The ESOP used the proceeds of the notes to purchase 6.3 million shares of Series B Convertible Preference Stock from the Company. The Stock has a minimum redemption price of $65 per share and pays semiannual dividends equal to the higher of $2.44 or the current dividend paid on\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n7. EMPLOYEE STOCK OWNERSHIP PLAN--(CONTINUED)\ntwo common shares for the comparable six-month period. Each share may be converted by the Trustee into two shares of common stock.\nDividends on these preferred shares, as well as common shares also held by the ESOP, are paid to the ESOP trust and, together with Company contributions, are used by the ESOP to repay principal and interest on the outstanding notes. Preferred shares are released for allocation to participants based upon the ratio of the current year's debt service to the sum of total principal and interest payments over the life of the loan. At December 31, 1995, 1,190,498 shares were allocated to participant accounts.\nDividends on these preferred shares are deductible for income tax purposes and, accordingly, are reflected net of their tax benefit in the Consolidated Statements of Retained Earnings.\nAnnual expense related to the leveraged ESOP, determined as interest incurred on the notes, less dividends received on the shares held by the ESOP, plus the higher of either principal repayments on the notes or the cost of shares allocated, was $8.3 in 1995, $8.0 in 1994 and $7.9 in 1993. Similarly, unearned compensation, shown as a reduction in shareholders' equity, is reduced by the higher of principal payments or the cost of shares allocated.\nInterest incurred on the ESOP's notes amounted to $33.9 in 1995, $34.2 in 1994 and $34.5 in 1993. The Company paid dividends on the stock held by the ESOP of $31.7 in 1995, $32.3 in 1994 and $32.7 in 1993. Company contributions to the ESOP were $6.4 in 1995 and $5.7 in 1994 and 1993.\n8. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS\nRETIREMENT PLANS\nThe Company, its U.S. subsidiaries and a majority of its overseas subsidiaries maintain pension plans covering substantially all of their employees. Most plans provide pension benefits that are based primarily on years of service and employees' career earnings. In the Company's principal U.S. plans, funds are contributed to trustees in accordance with regulatory limits to provide for current service and for any unfunded projected benefit obligation over a reasonable period. To the extent these requirements are exceeded by plan assets, a contribution may not be made in a particular year. Plan assets consist principally of common stocks, guaranteed investment contracts with insurance companies, investments in real estate funds and U.S. Government obligations.\nNet periodic pension expense of the plans includes the following components:\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n8. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)\nThe following table sets forth the funded status of the plans at December 31:\nThe actuarial assumptions used to determine the projected benefit obligation of the plans were as follows:\nWhen remeasuring the pension obligation, the Company reassesses each actuarial assumption. In accordance with generally accepted accounting principles, the settlement rate assumption is pegged to long-term bond rates to reflect the cost to satisfy the pension obligation currently, while the other assumptions reflect the long-term outlook of rates of compensation increases and return on assets.\nOTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nThe Company and certain of its subsidiaries provide health care and life insurance benefits for retired employees to the extent not provided by government-sponsored plans.\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 required the Company to change its method of accounting for its postretirement life and health care benefits provided to retirees from the \"pay-as-you-go\" basis to accruing such costs over the working lives of the employees. The Company utilizes a portion of its leveraged ESOP, in the form of\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n8. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)\nfuture retiree contributions, to reduce its obligation to provide these postretirement benefits. Postretirement benefits currently are not funded. The Company also adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS 112 requires accrual accounting for the estimated cost of benefits provided to former or inactive employees after employment but before retirement.\nThe cumulative effect on prior years of adopting SFAS 106 and 112 as of January 1, 1993 resulted in a pretax charge during 1993 of $195.7 ($129.2 aftertax or $.83 per share), of which $189.5 related to SFAS 106 and $6.2 related to SFAS 112. This non-cash charge represented the accumulated benefit obligation net of related accruals previously recorded by the Company as of January 1, 1993.\nPostretirement benefits expense includes the following components:\nThe actuarial present value of postretirement benefit obligations included in Other liabilities in the Consolidated Balance Sheets is comprised of the following components, at December 31:\n1995 1994 ------ ------ Retirees.................................................. $145.2 $144.9 Active participants eligible for retirement............... 2.0 2.9 Other active participants................................. 9.2 17.0 ------ ------ Accumulated postretirement benefit obligation............. 156.4 164.8 Unrecognized net gain..................................... 44.4 38.5 ------ ------ Accrued postretirement benefit liability.................. $200.8 $203.3 ------ ------ ------ ------\nThe principal actuarial assumptions used in the measurement of the accumulated benefit obligation were as follows:\nWhen remeasuring the accumulated benefit obligation, the Company reassesses each actuarial assumption.\nThe cost of these postretirement medical benefits is dependent upon a number of factors, the most significant of which is the rate at which medical costs increase in the future. The effect of a 1% increase\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n8. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)\nin the assumed medical cost trend rate would increase the accumulated postretirement benefit obligation by approximately $12.5; annual expense would not be materially affected.\n9. INCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). The one-time non-cash charge for the recalculation of income taxes was $229.0 ($1.47 per share), which was recorded in 1993.\nThe provision for income taxes on income before changes in accounting consists of the following for the years ended December 31:\n1995 1994 1993 ------ ------ ------ United States................................. $ 18.0 $ 43.3 $ 75.9 Overseas...................................... 173.5 256.4 212.2 ------ ------ ------ $191.5 $299.7 $288.1 ------ ------ ------ ------ ------ ------\nDifferences between accounting for financial statement purposes and accounting for tax purposes result in taxes currently payable (lower) higher than the total provision for income taxes as follows:\n1995 1994 1993 ------ ------ ------ Excess of tax over book depreciation......... $(18.9) $(32.8) $(18.7) Net restructuring accrual (spending)......... 70.5 (19.0) (24.2) Other, net................................... (5.3) 5.6 (13.8) ------ ------ ------ $ 46.3 $(46.2) $(56.7) ------ ------ ------ ------ ------ ------\nThe components of income before income taxes are as follows for the three years ended December 31:\n1995 1994 1993 ------- ------ ------ United States............................... $(121.1) $181.8 $256.9 Overseas.................................... 484.6 698.1 579.3 ------- ------ ------ $ 363.5 $879.9 $836.2 ------- ------ ------ ------- ------ ------\nThe difference between the statutory United States federal income tax rate and the Company's global effective tax rate as reflected in the Consolidated Statements of Income is as follows:\n% OF INCOME BEFORE TAX 1995 1994 1993 ---------------------- ---- ---- ---- Tax at U.S. statutory rate.......................... 35.0% 35.0% 35.0% State income taxes, net of federal benefit.......... .6 .6 .7 Earnings taxed at other than U.S. statutory rate.... (.4) (.3) (.2) Restructured operations............................. 18.4 -- -- Other, net.......................................... (.9) (1.2) (1.0) ---- ---- ---- Effective tax rate.................................. 52.7% 34.1% 34.5% ---- ---- ---- ---- ---- ----\nCOLGATE-PALMOLIVE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Dollars in Millions Except Per Share Amounts\n9. INCOME TAXES--(CONTINUED) In addition, net tax benefits of $6.8 in 1995 and $16.0 in 1994 were recorded directly through equity.\nThe components of deferred taxes are as follows at December 31:\n1995 1994 ------- ------- Deferred Taxes--Current: Accrued liabilities, not deductible until paid..... $ 64.1 $ 68.6 Restructuring...................................... 20.0 -- Other, net......................................... 13.9 8.1 ------- ------- Total deferred taxes current....................... 98.0 76.7 ------- ------- Deferred Taxes--Long-term: Intangible assets, not amortized for tax purposes............................................. (212.2) (211.4) Property, plant and equipment, principally due to differences in depreciation.......................... (215.9) (196.6) Postretirement and postemployment benefits, past service cost......................................... 73.1 71.1 Restructuring...................................... 141.1 14.1 Tax loss and tax credit carryforwards.............. 124.8 81.5 Other, net......................................... (30.0) (21.7) Valuation allowance................................ (118.2) (32.4) ------- ------- Total deferred taxes long-term..................... (237.3) (295.4) ------- ------- Net deferred taxes--(liabilities)................ $(139.3) $(218.7) ------- ------- ------- -------\nThe major component of the 1995 and 1994 valuation allowance relates to tax benefits in certain jurisdictions not expected to be realized.\n10. FOREIGN CURRENCY TRANSLATION\nCumulative translation adjustments, which represent the effect of translating assets and liabilities of the Company's non-U.S. entities, except those in highly inflationary economies, were as follows:\n1995 1994 1993 ------- ------- ------- Balance, January 1............................. $(439.3) $(372.9) $(308.5) Effect of balance sheet translations........... (73.7) (66.4) (64.4) ------- ------- ------- Balance, December 31........................... $(513.0) $(439.3) $(372.9) ------- ------- ------- ------- ------- -------\nForeign currency charges, resulting from the translation of balance sheets of subsidiaries operating in highly inflationary environments and from foreign currency transactions, were not material in the years presented.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n11. EARNINGS PER SHARE\nPrimary earnings per share are determined by dividing net income, after deducting preferred stock dividends net of related tax benefits ($21.6 in 1995, 1994 and 1993) by the weighted average number of common shares outstanding (145.2 million in 1995, 146.2 million in 1994 and 155.9 million in 1993).\nEarnings per common share assuming full dilution, are calculated assuming the conversion of all potentially dilutive securities, including convertible preferred stock and outstanding options, unless the effect of such conversion is antidilutive. This calculation also assumes, if applicable, reduction of available income by pro forma ESOP replacement funding, net of income taxes.\n12. INCOME STATEMENT INFORMATION\nOther expense, net consists of the following for the years ended December 31:\n1995 1994 1993 ------ ------ ------ Amortization of intangibles....................... $ 87.7 $ 56.3 $ 51.2 Earnings from equity investments.................. (7.3) (1.3) (7.4) Minority interest................................. 37.1 37.8 27.5 Other............................................. (21.4) (10.0) -- ------ ------ ------ $ 96.1 $ 82.8 $ 71.3 ------ ------ ------ ------ ------ ------\nThe following is a comparative summary of certain expense information for the years ended December 31:\n1995 1994 1993 ------ ------ ------ Interest incurred................................. $250.7 $130.6 $ 81.3 Interest capitalized.............................. 14.7 9.7 11.8 ------ ------ ------ Interest expense.................................. $236.0 $120.9 $ 69.5 ------ ------ ------ ------ ------ ------\nResearch and development.......................... $156.7 $147.1 $139.9 Maintenance and repairs........................... $108.2 $110.1 $107.8 Media advertising................................. $561.3 $543.2 $508.3\n13. BALANCE SHEET INFORMATION\nSupplemental balance sheet information is as follows:\nINVENTORIES 1995 1994 - ---------------------------------------------------------- ------ ------ [S] [C] [C] Raw materials and supplies................................ $313.8 $280.3 Work-in-process........................................... 38.3 38.4 Finished goods............................................ 422.7 395.2 ------ ------ $774.8 $713.9 ------ ------ ------ ------\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n13. BALANCE SHEET INFORMATION--(CONTINUED)\nInventories valued under LIFO amounted to $207.2 at December 31, 1995 and $163.6 at December 31, 1994. The excess of current cost over LIFO cost at the end of each year was $42.9 and $39.6, respectively. In 1995 and 1994, certain inventory quantities were reduced, which resulted in liquidations of LIFO inventory quantities. The effect was to increase income by $1.4 and $2.8 in 1995 and 1994, respectively.\nPROPERTY, PLANT AND EQUIPMENT, NET 1995 1994 ------------------------------------ ----- ----- Land.............................................. $ 126.0 $ 94.9 Buildings......................................... 623.1 549.3 Machinery and equipment........................... 2,850.3 2,459.2 --------- --------- 3,599.4 3,103.4 Accumulated depreciation.......................... (1,444.2) (1,115.3) --------- --------- $ 2,155.2 $ 1,988.1 --------- --------- --------- ---------\nGOODWILL AND OTHER INTANGIBLE ASSETS, NET 1995 1994 ----------------------------------------- ----- ------ Goodwill and other intangibles.................... $ 3,037.0 $ 1,879.4 Accumulated amortization.......................... (295.3) (207.6) -------- -------- $2,741.7 $1,671.8 -------- -------- -------- --------\nOTHER ACCRUALS 1995 1994 -------------- ------ ------ [S] [C] [C] Accrued payroll and employee benefits............... $271.0 $233.0 Accrued advertising................................. 117.6 105.4 Accrued interest.................................... 46.0 38.6 Accrued taxes other than income taxes............... 51.1 42.4 Restructuring accrual............................... 100.0 -- Other............................................... 110.6 121.9 ------ ------ $696.3 $541.3 ------ ------ ------ ------\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nIn assessing the fair value of financial instruments at December 31, 1995 and 1994, the Company has used available market information and other valuation methodologies. Some judgment is necessarily required in interpreting market data to develop the estimates of fair value, and, accordingly the estimates are not necessarily indicative of the amounts that the Company could realize in a current market exchange.\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n13. BALANCE SHEET INFORMATION--(CONTINUED)\nThe estimated fair value of the Company's financial instruments at December 31, are summarized as follows:\nFINANCIAL INSTRUMENTS AND RATE RISK MANAGEMENT\nThe Company utilizes interest rate agreements and foreign exchange contracts to manage interest rate and foreign currency exposures. The principal objective of such contracts is to manage rather than attempt to eliminate fluctuations in interest rate and foreign currency movements. The Company, as a matter of policy, does not speculate in financial markets and therefore does not hold these contracts for trading purposes. The Company utilizes what it considers straightforward instruments, such as forward foreign exchange contracts and non-leveraged interest rate swaps, to accomplish its objectives.\nThe Company primarily uses interest rate swap agreements to effectively convert a portion of its floating rate debt to fixed rate debt in order to manage interest rate exposures in a manner consistent with achieving a targeted fixed to variable interest rate ratio. The net effective cash payment of these financial derivative instruments combined with the related interest payments on the debt that they hedge are accounted for as interest expense. Those interest rate instruments that do not qualify as hedge instruments for accounting purposes are marked to market and carried on the balance sheets at fair value. As of December 31, 1995 and 1994, the Company had agreements outstanding with an aggregate notional amount of $1,142.2 and $222.0, respectively, with maturities through 2025.\nThe Company uses forward exchange contracts principally to hedge foreign currency exposures associated with its net investment in foreign operations and overseas debt. This hedging minimizes the impact of foreign exchange rate movements on the Company's financial position. The terms of these contracts are generally less than five years.\nAs of December 31, 1995 and 1994, the Company had approximately $972.0 and $397.6, respectively, of outstanding foreign exchange contracts. At December 31, 1995 approximately 10% of outstanding foreign exchange contracts served to hedge net investments in foreign subsidiaries, 50% hedged intercompany loans, 30% hedged third-party firm commitments, and the remaining 10% hedged\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n13. BALANCE SHEET INFORMATION--(CONTINUED)\ncertain transactions that are anticipated to settle in accordance with their identified terms. The Company makes net settlements for foreign exchange contracts at maturity, based on rates agreed to at inception of the contracts.\nGains and losses from contracts that hedge the Company's investments in its foreign subsidiaries are shown in the cumulative translation adjustments account included in shareholders' equity. Gains and losses from contracts that hedge firm commitments (including intercompany loans) are recorded in the balance sheets as a component of the related receivable or payable until realized, at which time they are recognized in the statements of income.\nThe contracts that hedge anticipated sales and purchases do not qualify as hedges for accounting purposes. Accordingly, the related gains and losses are calculated using the current forward foreign exchange rates and are recorded in the statements of income as other expense, net. These contracts mature within eighteen months.\nThe Company is exposed to credit loss in the event of nonperformance by counterparties on interest rate agreements and foreign exchange contracts; however, nonperformance by these counterparties is considered remote as it is the Company's policy to contract only with counterparties that have a long-term debt rating of A or higher. The amount of any such exposure is generally the unrealized gain on such contracts, which at December 31, 1995 was not significant.\n14. COMMITMENTS AND CONTINGENCIES\nMinimum rental commitments under noncancellable operating leases, primarily for office and warehouse facilities, are $68.6 in 1996, $52.7 in 1997, $44.1 in 1998, $38.7 in 1999, $38.9 in 2000 and $213.4 for years thereafter. Rental expense amounted to $91.8 in 1995, $83.4 in 1994 and $91.5 in 1993. Contingent rentals, sublease income and capital leases, which are included in fixed assets, are not significant.\nThe Company has various contractual commitments to purchase raw materials, products and services totaling $165.6 that expire through 1998.\nThe Company is a party to various superfund and other environmental matters and is contingently liable with respect to lawsuits, taxes and other matters arising out of the normal course of business. Management proactively reviews and manages its exposure to, and the impact of, environmental matters. While it is possible that the Company's cash flows and results of operations in particular quarterly or annual periods could be affected by the one-time impacts of the resolution of such contingencies, it is the opinion of management that the ultimate disposition of these matters, to the extent not previously provided for, will not have a material impact on the Company's financial condition or ongoing cash flows and results of operations.\nAs discussed in Note 3, the acquisition of Kolynos is subject to review by antitrust regulatory authorities in Brazil. While it is not yet possible to definitively determine whether or not approval will be obtained, management believes the acquisition, or some variation thereof, will eventually be approved.\n15. MARKET AND DIVIDEND INFORMATION\nThe Company's common stock and $4.25 Preferred Stock are listed on the New York Stock Exchange. The trading symbol for the common stock is CL. Dividends on the common stock have been\nCOLGATE-PALMOLIVE COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDollars in Millions Except Per Share Amounts\n15. MARKET AND DIVIDEND INFORMATION--(CONTINUED)\npaid every year since 1895, and the amount of dividends paid per share has increased for 33 consecutive years.\nMARKET PRICE\n16. QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------\n(1) The third quarter of 1995 includes a provision for restructured operations of $460.5 ($369.2 aftertax) or $2.54 per share on a primary basis and $2.50 per share on a fully diluted basis.\n(2) The sum of the quarterly fully diluted earnings (loss) per share amounts in 1995 is not equal to the full year because the computations of the weighted average number of shares outstanding and the potential impact of dilutive securities for each quarter and for the full year are made independently.\nSCHEDULE II\nCOLGATE-PALMOLIVE COMPANY\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1995\n(DOLLARS IN MILLIONS)\n- ------------\nNOTES:\n(1) Uncollectible accounts written off and cash discounts allowed.\n(2) Increase\/decrease in allowance for tax loss and tax credit carryforward benefits which more likely than not will not be utilized in the future.\n(3) Allowance for tax benefits from restructured operations in certain jurisdictions not expected to be realized.\n(4) Other adjustments.\nSCHEDULE II\nCOLGATE-PALMOLIVE COMPANY\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1994\n(DOLLARS IN MILLIONS)\n- ------------\nNOTES:\n(1) Uncollectible accounts written off and cash discounts allowed.\n(2) Allowance for tax loss and tax credit carryforward benefits which more likely than not will not be utilized in the future.\n(3) Other adjustments.\nCOLGATE-PALMOLIVE COMPANY\nSCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEAR ENDED DECEMBER 31, 1993\n(DOLLARS IN MILLIONS)\n- ------------\nNOTES:\n(1) Adjustments arising from translation of reserve balances at year-end exchange rates.\n(2) Uncollectible accounts written off and cash discounts allowed.\n(3) Allowance for tax loss and tax credit carryforward benefits which more likely than not will not be utilized in the future. The $22.0 charged to costs and expenses was included in the 1993 one-time charge for the adoption of SFAS 109, \"Accounting for Income Taxes.\"\n(4) Other adjustments.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Colgate-Palmolive Company:\nWe have audited the accompanying consolidated balance sheets of Colgate-Palmolive Company (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings, changes in capital accounts and cash flows 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 Colgate-Palmolive Company 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 the accompanying notes to the consolidated financial statements, in 1993, the Company adopted three new accounting standards promulgated by the Financial Accounting Standards Board, changing its methods of accounting for income taxes, postretirement benefits other than pensions, and postemployment benefits.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index to 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 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\nNew York, New York February 7, 1996\nCOLGATE-PALMOLIVE COMPANY\nHISTORICAL FINANCIAL SUMMARY(1)\nDollars in Millions Except Per Share Amounts\n- ------------ (1) All share and per share amounts have been restated to reflect the 1991 two-for-one stock split. (2) Income in 1995 includes a net provision for restructured operations of $369.2 ($2.54 per share on a primary basis or $2.50 per share on a fully diluted basis). (3) Income in 1994 includes a one-time charge of $5.2 for the sale of a non-core business, Princess House. (4) Income in 1993 includes a one-time impact of adopting new mandated accounting standards, effective in the first quarter of 1993, of $358.2 ($2.30 per share on a primary basis or $2.10 on a fully diluted basis). (5) Income in 1991 includes a net provision for restructured operations of $243.0 ($1.80 per share on a primary basis or $1.75 per share on a fully diluted basis). (6) Income in 1988 includes Hill's service agreement renegotiation net charge of $42.0 ($.30 per share on both a primary and fully diluted basis). (7) Due to timing differences, 1988 includes three dividend declarations while all other years include four dividend declarations. (8) Income in 1987 includes a net provision for restructured operations of $144.8 ($1.06 per share on a primary basis or $1.05 per share on a fully diluted basis).\nCOLGATE-PALMOLIVE COMPANY\nEXHIBITS TO FORM 10-K\nYEAR ENDED DECEMBER 31,1995\nCOMMISSION FILE NO. 1-644\n- ------------\n* Registrant hereby undertakes upon request to furnish the Commission with a copy of any instrument with respect to long-term debt 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.\nThe exhibits indicated above which are not included with the Form 10-K are available upon request and payment of a reasonable fee approximating the registrant's cost of providing and mailing the exhibits. Inquiries should be directed to:\nColgate-Palmolive Company Office of the Secretary (10-K Exhibits) 300 Park Avenue New York, New York 10022-7499","section_15":""}
{"filename":"80966_1995.txt","cik":"80966","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nPRINCIPAL BUSINESSES\nThe principal businesses of PS Group, Inc. (the \"Company\") are aircraft leasing (conducted directly), fuel sales and distribution, and oil and gas production and development.\nSTATE OF INCORPORATION AND EXECUTIVE OFFICES\nThe Company was incorporated in Delaware in 1972 (under the original name PSA, Inc.) as the successor to a California corporation originally incorporated in 1945. The Company has its principal executive offices at 4370 La Jolla Village Drive, Suite 1050, San Diego, California, 92122; telephone number (619) 642-2999.\nITEMS INCORPORATED BY REFERENCE\nCertain information required by \"Item 1. - Business\" is incorporated by reference from pages 8 through 16 of the Company's 1995 Annual Report to Shareholders. This incorporated information includes financial information about the Company's business segments. Additional disclosure is made in this Form 10-K.\nCORPORATE EMPLOYEES\nAs of December 31, 1995 the Company's corporate staff (excluding employees of subsidiaries) consisted of 7 full-time employees who manage the aircraft leasing operations and furnish administrative services to the Company. The staff also provides some administrative services for its subsidiaries for which it is reimbursed. None of the employees of the Company or its subsidiaries are covered by union contracts.\nPROPOSED HOLDING COMPANY REORGANIZATION\nThe Board of Directors of the Company has proposed for submission to shareholders at the 1996 Annual Meeting of Shareholders (the \"1996 Annual Meeting\") a holding company reorganization pursuant to which the Company would become a wholly-owned subsidiary of PS Group Holdings, Inc. (\"Holdings\"), a newly-formed company organized under the laws of the State of Delaware which is currently a wholly-owned subsidiary of the Company (the \"Reorganization\"). If the Reorganization is consummated, each outstanding share of the Company's Common Stock will be converted into one share of Holdings Common Stock (to be listed on the New York and Pacific Stock Exchanges) and the Company will be a wholly-owned subsidiary of Holdings. The sole purpose of the Reorganization is to help preserve the Company's substantial net operating loss carryforwards, investment tax credit carryforwards and other tax benefits (the \"Tax Benefits\") for use in offsetting future taxable income. The Reorganization is intended to accomplish this objective by imposing certain transfer restrictions (the \"Transfer Restrictions\") on the shares of Holdings Common Stock in order to help decrease the risk of certain transfers of shares of the Company's Common Stock that could result in the occurrence of an \"ownership change\" for income tax purposes, which would limit the ability of the Company to use these tax benefits.\nOn February 9, 1996, Holdings filed with the Securities and Exchange Commission a Registration Statement on Form S-4 (Registration No. 333-00821) covering the shares of its\nCommon Stock to be issued in the Reorganization (the prospectus contained in such Registration Statement, in its final form, will also constitute the Company's proxy statement for the 1996 Annual Meeting). Reference is made to such Registration Statement for further information with respect to the proposed Reorganization. As of the date of this Form 10-K, such Registration Statement has not been declared effective by the Securities and Exchange Commission. The shares of Holdings Common Stock covered by such Registration Statement will be offered in connection with the Reorganization, and forms of proxy for use by shareholders of the Company in voting on the Reorganization at the 1996 Annual Meeting will be disseminated, only pursuant to the definitive version of such prospectus\/proxy statement.\nFORWARD-LOOKING STATEMENTS.\nThe Private Securities Litigation Reform Act of 1995 provides a \"safe harbor\" for forward-looking statements. Certain information included in this Form 10-K or incorporated by reference from the Company's 1995 Annual Report to Shareholders is forward looking, such as information relating to the future prospects of the Company's aircraft leases, the consequences of any unscheduled return of aircraft under lease, PS Trading's potential for growth, plans for expansion of Statex Petroleum, the availability of the Tax Benefits, the amount of otherwise-taxable income against which such benefits may be offset, and the effect of the proposed Transfer Restrictions in reducing the risk of a loss of the Tax Benefits. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including, but not limited to, the impact of economic conditions on each of the Company's business segments, the impact of competition, the impact of governmental legislation and regulation, and other risks detailed in this Form 10-K, in the Company's 1995 Annual Report to Shareholders and in other Securities and Exchange Commission filings of the Company.\nCERTAIN ADDITIONAL INFORMATION\nPS TRADING, INC. (PST) -- FUEL SALES AND DISTRIBUTION\nRISKS. PST's operations are subject to all risks inherent in the business of fuel sales and distribution including fuel spillage and distribution accidents, which could result in damage to or destruction of property, or could result in personal injury or loss of life. Such an event could result in substantial cost to PST. PST carries substantial insurance coverage but may not be fully insured against all such risks.\nECONOMIC AND COMPETITIVE FACTORS AFFECTING PST. Virtually every refiner and reseller of refined petroleum products who sell in PST's market areas (including other large distributors and major oil companies) is a competitor or potential competitor of PST for the sale of its products. Many of these companies have greater financial resources and broader marketing capabilities than PST. In some instances competitors, especially refiners, may have lower costs for the refined petroleum products they sell and may thus be in a favorable position to offer product prices to PST's customers lower than those PST can offer.\nENVIRONMENTAL ISSUES. Since PST owns or leases fuel storage facilities or pipelines at several locations and contracts with independent companies to deliver fuel on its behalf, it is possible that future claims may be made against PST regarding potential soil and groundwater pollution. Currently no claim has been asserted. However, see \"Legal Proceedings\" for discussion of an order filed by the California Regional Water Quality Control Board, San Francisco Region. Typically PST operates at locations served by other companies including major airlines, oil companies and airports, most of which have greater financial resources and higher levels of operations at the locations served than PST.\nSTATEX PETROLEUM, INC. (STATEX) - OIL AND GAS PRODUCTION AND DEVELOPMENT\nACREAGE. The following table sets forth, by states, Statex well ownership and producing acreage as of December 31, 1995:\nThe following table sets forth, by states, undeveloped acreage ownership as of December 31, 1995:\nRISKS. Statex's operations are subject to all risks inherent in the exploration for and production of oil and gas, including blowouts, cratering and fires, which could result in damage to or destruction of oil and gas wells or formations, producing facilities or property, or could result in personal injury or loss of life. Such an event could result in substantial cost to Statex and could have a material adverse effect upon its financial condition if Statex is not fully insured against such risk. Statex carries substantial insurance coverage but may not be fully insured against all such risks.\nGOVERNMENTAL REGULATION AND ENVIRONMENTAL ISSUES. Statex's operations are affected from time to time in varying degrees by political developments and federal and state laws and regulations. In particular, oil and gas production operations and returns are affected by tax and other laws relating to the petroleum industry, changes in such laws and constantly changing administrative regulations. In addition, oil and gas operations are subject to regulation, interruption and termination by governmental authorities for environmental issues and other considerations. Additionally, in most, if not all, areas where Statex conducts activities, there are statutory provisions regulating the production of oil and gas. These provisions allow administrative agencies to promulgate rules in connection with the operation and production of both oil and gas wells, including the method of developing new fields, spacing of wells and the maximum daily production allowable for both oil and gas wells and various environmental issues.\nECONOMIC AND COMPETITIVE FACTORS AFFECTING STATEX. Statex is engaged primarily in the production and sale of crude oil and natural gas. Statex has literally hundreds of competitors, most of which are larger and have greater resources than Statex. Oil and natural gas are fungible commodities and, as such, the prices Statex receives for its products are directly related to the open market price for such products at the time of sale. These prices generally fluctuate and are for the most part controlled by the laws of supply and demand. The price for oil is particularly driven by worldwide production and demand. Statex has virtually no control over the establishment of prices\nfor its products. To the extent there should be an oversupply of product and resulting lower prices, Statex's revenues would be negatively impacted.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nEXECUTIVE OFFICES AND OTHER GROUND FACILITIES\nThe Company's executive offices and principal administrative offices are located at 4370 La Jolla Village Drive, Suite 1050, San Diego, California. At December 31, 1995 the Company leased approximately 7,000 square feet for executive offices. During early 1996 the Company renegotiated a new lease to reduce its space to approximately 3,000 square feet. The new lease is expected to become effective in mid-1996 and will run for a five-year period ending in 2001. Base rent for the first 22 months of the lease totals approximately $512,000, and base rent for the remaining 38 months totals approximately $211,000.\nPST owns an 8,000 square foot building located at 17742 Preston Road, Dallas, Texas which is used as its administrative offices. In addition, PST's wholesale operations leases 1,560 square feet for administrative offices at 5620 Birdcage Street, Suite 130, Citrus Heights, California for an annual rent of $23,000.\nStatex leases approximately 5,000 square feet for executive offices at 1801 Royal Lane, Suite 110, Dallas, Texas at an annual rental of $34,000, for a period ending in mid-1998 with a 2-year renewal option at 95% of current market rates. For information regarding Statex oil and gas properties see \"Business - Oil and Gas Production and Development.\"\nThe Company believes that its present properties are adequate for its business in light of its current operations.\nFLIGHT EQUIPMENT\nThe aircraft owned by the Company as of February 29, 1996 are listed in the following table.\nNotes: (a) Six MD-80s are leased to USAir for terms expiring from 1998 to 2004. One is leased to Continental for a term expiring at the beginning of 2008. (b) These aircraft are all leased to USAir for terms expiring in 2000. (c) The Company owns a one-third interest in each of these aircraft. United States Airlease and Airlease, Ltd. each also own a one-third interest. All six aircraft are leased to Continental for terms expiring in 1996. (d) One aircraft is leased to Continental for a term expiring at the beginning of 2008. One aircraft is leased to America West for a term expiring in 2006.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1992 three related lawsuits were filed against the Company, certain of its directors and officers by stockholders in the United States District Court for the Southern District of California and a fourth lawsuit was filed in the United States District Court for the Central District of Illinois (the Illinois Case). All of the Southern District of California cases were consolidated into a single case (the California Case). Both the California Case and the Illinois Case were purported class actions alleging that the defendants made materially false and misleading statements in public statements in filings with the Securities and Exchange Commission and other reports, or omitted in such materials information necessary to make them not misleading, and that the defendants are therefore liable to the plaintiff class for declines in the price of the Company's common stock during a defined class period.\nIn the fall of 1992 the Company obtained dismissals of both the California Case and Illinois Case. In each instance, however, the court granted the plaintiffs leave to file an amended petition. In December 1992 the California case and the Illinois Case were consolidated in the Southern District of Illinois (the Consolidated Case). In March 1995 the Company reached an agreement in principle to settle with all defendants for $5 million all pending class action litigation. In October 1995 the United States District Court approved the settlement. While the $5 million settlement liability was recorded as of December 31, 1994, the actual cash payment was made by the Company in July 1995.\nThe Company, along with numerous other companies including major airlines, major oil companies and the owner of the San Francisco International Airport (most of which have greater financial resources than the Company), is under an order by the California Regional Water Quality Control Board, San Francisco Bay Region, to participate in the investigation, remediation and monitoring of actual or alleged soil and groundwater pollution at San Francisco International Airport. The Company and other potentially responsible parties have undertaken a joint compliance effort. No litigation is currently pending concerning this matter. The Company will vigorously defend against future claims, if any, in this matter.\nThe Company is a defendant in several other lawsuits related to the ordinary course of business, none of which are expected to have a materially adverse effect on the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone during the year ended December 31, 1995.\nADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth the names, ages and certain additional information concerning the executive officers of the Company.\nThere are no family relationships between any of the Company's executive officers. Each of the Company's executive officers are elected annually and serve at the pleasure of the Board of Directors.\nPART II\nThe information required by Items 5, 6, 7 and 8 of this Part II are hereby incorporated by reference from page 1 and pages 17 through 40 of the Company's 1995 Annual Report to Shareholders.\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nThe information called for by Part III, Items 10 through 13, is incorporated by reference from the Company's definitive Proxy Statement which will be filed with the Securities and Exchange Commission on or prior to April 30, 1996. Certain information concerning the Executive Officers of the Company is included in Part I, supra. See \"Additional Item. Executive Officers of the Company.\"\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. FINANCIAL STATEMENTS, EXHIBITS AND REPORTS ON FORM 8-K\n(a) Financial Statements and Exhibits\n1. Financial Statements: See Index to Financial Statements, Page. 2. Exhibits: See Index to Exhibits following Page.\n(b) Reports on Form 8-K\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned thereunto duly authorized.\nDATED: March 26, 1996.\nPS GROUP, INC. (Registrant)\nBy: \/s\/ Lawrence A. Guske --------------------------------------- LAWRENCE A. GUSKE Vice President - Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes Lawrence A. Guske and Johanna Unger, and each of them, as attorneys-in-fact, on his or her behalf, individually and in each capacity stated below, to sign and file any amendment to this Form 10-K Annual Report.\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ C. E. Rickershauser, Jr. Chairman of the Board, March 26, 1996 - ----------------------------- Chief Executive Officer (C. E. Rickershauser, Jr.)\n\/s\/ Lawrence A. Guske Vice President - March 26, 1996 - ----------------------------- Finance and Chief (Lawrence A. Guske) Financial Officer (principal financial officer)\n\/s\/ Johanna Unger Vice President, Controller March 26, 1996 - ----------------------------- and Secretary (principal (Johanna Unger) accounting officer)\n\/s\/ Robert M. Fomon Director March 26, 1996 - ----------------------------- (Robert M. Fomon)\n\/s\/ J. P. Guerin Director March 26, 1996 - ----------------------------- (J. P. Guerin)\n\/s\/ Donald W. Killian, Jr. Director March 26, 1996 - ----------------------------- (Donald W. Killian, Jr.)\n\/s\/ Gordon C. Luce Director March 26, 1996 - ----------------------------- (Gordon C. Luce)\nPS GROUP, INC. [ITEM 14(A)]\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.\nThe consolidated statements of financial position of PS Group, Inc. at December 31, 1995 and 1994 and the related statements of operations, cash flows and stockholders' equity and the report of Ernst & Young LLP, independent auditors, are set forth on the pages indicated above in the Annual Report to Stockholders of PS Group, Inc. for the year ended December 31, 1995 and are incorporated herein by reference.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of PS Group, Inc. of our report dated February 9, 1996, included in the 1995 Annual Report to Stockholders of PS Group, Inc.\nWe also consent to the incorporation by reference in ( i) the Registration Statement (Form S-8 No. 2-97926) pertaining to the Employee Incentive Stock Option Program and the Incentive Stock Option Plan of PS Group, Inc. and (ii) the Registration Statement (Form S-8, No. 33-45608) pertaining to the Recontek, Inc. 1987 Employment Stock Option Plan of our report referred to above, with respect to the consolidated financial statements of PS Group, Inc. incorporated herein by reference.\nERNST & YOUNG LLP\nSan Diego, California March 26, 1996\nINDEX TO EXHIBITS\n(3)(i) Articles of Incorporation.\n(a) Restated Certificate of Incorporation. (Incorporated by reference to Exhibit (3)(a) to the Company's Current Report on Form 8-K dated November 18, 1986.) (b) Certificate of Amendment of Certificate of Incorporation. (Incorporated by reference to Exhibit (3)(b) to the Company's Current Report on Form 8-K dated November 18, 1986.) (c) Certificate of Amendment to Certificate of Incorporation dated May 24, 1990. (Incorporated by reference to Exhibit 3(c) to the Company's 1990 Annual Report on Form 10-K.) (d) Certificate of Amendment to Certificate of Incorporation dated June 12, 1992. (Incorporated by reference to Exhibit 3(d) to the Company's 1992 Annual Report on Form 10-K.)\n(3)(ii) Bylaws as amended through March 24, 1995. (Incorporated by reference to Exhibit 3(ii) to the Company's 1994 Annual Report on Form 10-K.)\n(4) Instruments defining the rights of security holders, including indentures:\n(a) Amended and Restated Rights Agreement dated as of June 30, 1986 between the Company and Chemical Bank (Successor Rights Agent to Bank of America, N.T. & S.A.) (Incorporated by reference to the Company's Current Report on Form 8-K dated February 16, 1996.) (b) Amendment dated September 15, 1988 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated September 12, 1988.) (c) Amendment dated September 16, 1990 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated September 16, 1990.) (d) Amendment dated December 14, 1990 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated December 14, 1990.)\n(10) Material contracts:\n(a) 1984 Stock Incentive Plan of PS Group, Inc. (Incorporated by reference to Exhibit (19)(a) to the Company's report on Form 10-Q for the quarter ended June 30, 1985.) (b) Amendment to 1984 Stock Incentive Plan for PS Group, Inc., as approved by the Stockholders May 21, 1987. (Incorporated by reference to Exhibit (10)(g) to the Company's 1987 Annual Report on Form 10-K.) (c) Form 1, Form 2, Form 3, and Form 4 of Option Agreement effective November 17, 1984. (Incorporated by reference to Exhibit (19)(h) to the Company's report on Form 10-Q for the quarter ended June 30, 1985.)\nIndex-1\n(d) Retirement Plan for Corporate Officers of PSA, Inc. (now PS Group, Inc.) and Participating Subsidiaries effective March 12, 1984, amending and restating the Retirement Plan for Corporate Officers of Pacific Southwest Airlines. (Incorporated by reference to Exhibit 10(d) to the Company's 1994 Annual Report on Form 10-K.) (e) Employment Agreement dated January 15, 1988 between the Company and Lawrence A. Guske. (Incorporated by reference to Exhibit 10(q) to the Company's 1988 Annual Report on Form 10-K.) This Agreement is substantially identical in all material respects to the Employment Agreement between the Company and Johanna Unger. (f) Amendment dated April 1, 1989 to Employment Agreement between the Company and Lawrence A. Guske. (Incorporated by reference to Exhibit 10(q) to the Company's 1989 Annual Report on Form 10-K.) This Amendment is substantially identical in all material respects to Amendment to Employment Agreement between the Company and Johanna Unger. (g) Agreement dated December 14, 1990 between Berkshire Hathaway Inc. (\"Berkshire\") and the Company relating to Berkshire's acquisition of the Company's Common Stock. (Incorporated by reference to Exhibit 10(v) to the Company's 1990 Annual Report on Form 10-K.) (h) Form of Indemnification Agreement. (Incorporated by reference to Exhibit 10(w) to the Company's 1990 Annual Report on Form 10-K as filed on Form 8 Amendment thereto dated May 29, 1991.) (i) Arrangement for Pension benefit for Chairman of the Board of the Company. (Incorporated by reference to Exhibit 10(u) to the Company's 1992 Annual Report on Form 10-K.) (j) Amended and Restated Credit Agreement dated October 3, 1995 between the Company and Bank of America National Trust and Savings Association. (Incorporated by reference to Exhibit (10)(a) to the Company's report on Form 10-Q for the quarter ended September 30, 1995.) (k) Agreement and Plan of Reorganization dated as of January 30, 1996 by and among the Company, PS Group Holdings, Inc. and PSG Merger Subsidiary, Inc. (Incorporated by reference to the Company's current report on Form 8-K dated February 16, 1996.)\n(12) Computation of Ratios. (13) Inside front cover, page 1 and pages 8 to 40 from the 1995 Annual Report to Stockholders. (21) Subsidiaries. (23) Consent of Independent Auditors (see page of Item 14(a) of this Form 10-K). (27) Financial Data Schedule.\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nMatters relating to executive compensation plans and arrangements can be found within the index to exhibits as follows: (10)(a), (10)(b), (10)(c), (10)(d), (10)(e), (10)(f), (10)(h) and (10)(i).\nALL EXHIBITS INCORPORATED BY REFERENCE ARE FILED IN PS GROUP, INC. DOCUMENTS COMMISSION FILE NUMBER 1-7141.\nIndex-2","section_15":""}
{"filename":"9801_1995.txt","cik":"9801","year":"1995","section_1":"Item 1. Business.\nGeneral.\nBanta Corporation (the \"Corporation\"), together with its subsidiaries, is one of the larger printing organizations in the United States, providing a broad range of printing and graphic arts services. The Corporation was incorporated in Wisconsin in 1901. Its principal executive offices are located at 225 Main Street, Box 8003, Menasha, Wisconsin, 54952-8003. The Corporation had a total of 5,700 employees at the end of fiscal 1995.\nThe Corporation operates in one business segment-Printing Services. Market classifications of the Corporation's sales are commercial (catalogs, direct mail and single-use products); books (educational, general, trade, data manuals and project management services); magazines; and other (digital imaging services, production of point-of-purchase displays and security products). At the end of fiscal 1995, the Corporation's operations were conducted at 30 production facilities in the United States located in Wisconsin, Minnesota, California, Colorado, Connecticut, Illinois, Massachusetts, Missouri, North Carolina, Utah, Virginia and Washington and at five European production facilities located in Ireland, Scotland, and The Netherlands.\nThe following table sets forth the approximate percentage of consolidated net sales contributed by each class of similar products and services which accounted for ten percent or more of consolidated net sales for any of the last three fiscal years.\n1995 1994 1993 Commercial 47% 46% 44% Books 34 32 34 Magazines 11 12 12 Other 8 10 10 ----- ----- ----- TOTAL 100% 100% 100% ----- ----- -----\nIn October 1995, the Corporation acquired B.G. Turnkey Services Limited (\"B.G. Turnkey\"). B.G. Turnkey, which has been included in the book market classification since the acquisition date, reported sales for 1994 of approximately $160 million. The purchase price consisted of 236,765 shares of the Corporation's common stock and approximately $21 million of the Corporation's debentures which were called and prepaid in December 1995. The Corporation also paid $3.2 million to former shareholders of B.G. Turnkey in exchange for a covenant not to compete.\nDuring 1995, the Corporation purchased Applied Technology Corporation, which serves the single-use health care market, and New Frontiers Information Corporation, which provides customers with online solutions for distributing catalogs and direct marketing materials via the Internet's World Wide Web. The combined purchase price for these two acquisitions was approximately $9.0 million.\nIn August 1994, the Corporation completed its acquisition of United Graphics Inc. (\"UGI\") for approximately $9.5 million in cash and a $1.5 million note. The Corporation also paid $4 million to former shareholders of UGI in exchange for a covenant not to compete. UGI, which has been included in the book market classification since the acquisition date, reported sales for its fiscal year prior to acquisition of approximately $28 million.\nIn March 1994, the Corporation purchased substantially all of the assets of Danbury Printing & Litho, Inc. (\"Danbury\"). The purchase price consisted of $16.3 million in cash plus the assumption of selected liabilities. Danbury, which has been included in the commercial market classification since the acquisition date, reported sales of approximately $35 million in 1993.\nCustomers.\nThe Corporation sells its products and services to a large number of customers and ordinarily does not have long-term contracts with its customers. Production agreements covering one to three years are, however, more frequent for magazine and catalog production. Substantially all sales are made to customers through employees of the Corporation and its subsidiaries based on customer specifications. The fifteen largest customers accounted for approximately 25%, 23% and 25% of net sales during 1995, 1994 and 1993, respectively. No customer accounted for more than 10% of the Corporation's net sales in 1995, 1994 or 1993. In the opinion of management, the loss of any single customer would not have a material long-term adverse effect on the Corporation.\nBacklog.\nThe Corporation is primarily a manufacturing services company and provides its customers with printing, converting and other services. Lead time for services varies, depending upon the type of customer, the industry being serviced and seasonal factors. Backlogs would be expressed in terms of time scheduled on equipment and not dollar value. Consequently, the dollar value of backlog is not readily available.\nMarkets Served.\nBelow is a description of the primary markets the Corporation serves:\n- Commercial\nThe Corporation produces catalogs primarily for the consumer, industrial and retail catalog markets. Bindery services provide ink-jet labeling and demographic binding (which allows several different versions of the same catalog to be bound simultaneously). Distribution services provided by various Banta operating units, including computerized mail distribution planning systems which assist the Corporation's customers in minimizing postage costs, are an integral part of catalog printing services.\nPrinted materials for direct marketing customers are provided by three Banta units. These products vary in format and size and include magazine and catalog inserts, bill stuffers, brochures, booklets, cards and target market products designed to sell a product or solicit a response. Over the past two years, the Corporation has invested in imaging equipment which personalizes direct mail pieces at press speeds. This capability is becoming increasingly important to customers and the Corporation expects to make additional investments in this important technology. The Corporation's acquisition of Danbury in 1994 improved its ability to provide direct marketing materials to customers in the Northeastern United States. These three units experienced higher levels of utilization in 1995 than in 1994, which contributed to increased sales in this market.\nCatalog and direct marketing materials are primarily distributed through the United States Postal Service (\"USPS\") as third class or bulk rate mail. The substantial escalation in postage rates, which increased by in excess of 14% effective January 1, 1995, significantly impacted the cost of doing business for the Corporation's customers, particularly when combined with the increases in paper prices (see Raw Materials section below).\nOne of the Corporation's subsidiaries, Ling Products, Inc., provides printed products to the fast-food industry and converts poly film and paper into single-use products for the food service industry and health care industry. In addition, Ling Products extrudes films, using both cast and blown extruders, for use in its manufacturing processes and for sale to external customers. Its health care products include plastic garment covers, examination gowns, stretcher sheets, examination table paper, pillow covers, and gloves for personnel who come into contact with patients having highly communicable diseases. The acquisition of Applied Technology Corporation in 1995 expanded the health care product offerings to include disposable thermometer sheaths, dental camera covers, cotton- tipped applicators and tongue depressors.\n- Books\nThe Corporation prints consumable elementary and high school workbooks and other products for publishers of educational and general book markets including textbooks (primarily soft cover), testing materials and paperbound books. Print opportunities in the consumable educational workbook market have decreased during the last several years. Publisher consolidations have resulted in fewer companies offering educational products which has reduced the number of projects printed. Additionally, the effort to improve the nation's educational system has prompted schools to try alternate teaching methods. Some of these efforts have replaced consumable workbooks with other instructional materials.\nTo reduce its concentration in the elementary and high school markets, the Corporation has increased its marketing efforts relating to other softcover books including college texts, general books, data manuals and software documentation for the computer industry. The Corporation's operating units serving the computer equipment and software industries print manuals, using both offset printing and high speed photocopying, and offer complete turnkey services including computer disk replication, product packaging and distribution. The acquisition of B.G. Turnkey in 1995 increased the Corporation's product offerings to include project management, procurement, packaging, assembly and fulfillment services for computer software and hardware manufacturers primarily in Europe. This acquisition will also enable the Corporation to help meet customers' international distribution needs. The Corporation's acquisition of UGI in 1994 enhanced its ability to service software publishers in the Northwestern United States.\nThe Corporation's book units also produce multimedia products for educational publishers, industry and professional and trade associations.\nOther customers include publishers of trade books, calendars, religious books, cookbooks and manuals.\n- Magazines\nThe Corporation's two plants serving the magazine market print, sort and mail magazines representing more than 500 different titles. These magazines include primarily short-to-medium run publications (usually less than 350,000 copies) which are generally distributed to subscribers by mail. The Corporation's magazine customers are primarily publishers of specialty magazines, including religious, business and professional journals and hobby, craft and sporting publications. The Corporation began provides its customers with computerized mailing list and distribution services.\nThe January 1, 1995 postage rate increase and increasing paper prices (see Raw Materials section below) also increased operating costs for the Corporation's magazine customers.\n- Other\nPrepress services are provided by five of the Corporation's operating units to publishers, printers and advertising agencies. Such services include the conversion of full-color photographs, art and text into color separated film for use in the production of printing plates. These units also provide electronic graphic design, digital photography and on-demand print services. During the last several years these units have diversified their customer base to include packaging customers and increased their ability to maximize plant utilization by connecting their facilities through an extensive network of high-speed T-1 telecommunication lines.\nDuring the past several years, the Corporation has expanded its service offerings to include CD-ROM production, CD Interactive programming and developing interactive online products for the World Wide Web. These services are primarily provided by three of the Corporation's subsidiaries - KnowledgeSet Corporation, The DI Group, Inc. And New Frontiers Information Corporation, which was acquired in 1995.\nKCS Industries Inc., a subsidiary of the Corporation, produces point- of-purchase products such as custom designed signs, displays, labels and decals for a variety of customers including those in the brewing, cosmetic, food, appliance, automotive and home entertainment industries. KCS Industries also produces, through a joint venture, postage stamps in booklet, coil and sheet format for the USPS.\nCompetitive Conditions.\nThe Corporation is subject to competition from a large number of companies, some of which have greater resources and capacity than the Corporation. The graphic arts industry has undergone a period of consolidation for a number of years. This trend has resulted in the emergence of several additional competitors which are similar to the Corporation in size and product offerings. The major competitive factors in the Corporation's business are price, quality of finished products, distribution capabilities, ongoing customer service and availability of time on equipment which is appropriate in size and function for a given project. The consolidation of customers within certain of the Corporation's markets provides both greater competitive pricing pressures and opportunities for increased volume solicitation. In recent years, excess capacity in the printing industry has resulted in lower unit prices. Despite the unit price reductions, the Corporation has been able to improve its earnings in part because it is financially able to invest in modern technologically advanced equipment, which helps reduce unit costs, and because of productivity gains resulting from Continuous Improvement programs.\nThere are seasonal fluctuations in the usage of printing equipment which in times of low demand and excess capacity can give rise to increased pricing pressure. In the educational market, for instance, activity is greater in the first half of the year, and in the catalog and direct marketing markets, activity is greater in the second half of the year. Computer software and hardware products are also typically in greater demand during the second half of the year, although the release of a new product by a major customer can increase activity on an \"event\" basis at any time during the year.\nRaw Materials.\nThe principal raw material used by the Corporation is paper. Most of the Corporation's production facilities are located in heavily concentrated papermaking areas, and the Corporation can generally obtain quality paper at competitive prices. The Corporation is not dependent upon any one source for its paper or other raw materials.\nIn the fourth quarter of 1994 and throughout 1995, there was a dramatic increase in paper prices and a tightening of availability, with nearly all grades on allocation and delivery times extending up to six weeks or more. During the fourth quarter of 1995 paper prices stabilized somewhat, and it is anticipated that allocation restrictions may be reduced or eliminated in 1996 due to the softening demand for paper. The solid relationships the Corporation has built with paper suppliers over the years has been beneficial during periods of limited paper availability as the Corporation is able to meet its customers needs and was able to accommodate its added production capacity in 1995. It is customary for printers to adjust sales prices to reflect market fluctuations in paper prices. The average cost of paper to the Corporation's customers was about 33% higher in 1995 than in 1994, 3% lower in 1994 than in 1993 and 2% higher in 1993 than in 1992.\nThe Corporation uses a number of other raw materials including ink, resins, solvents, adhesives, wire, packaging materials and subcontracted components. Costs for many of these materials increased significantly during the second half of 1994 and throughout 1995.\nDevelopment.\nIn the graphic arts industry, most research and development is done by equipment and material suppliers. The Corporation generally does not engage in long-range research and development relating to equipment and has not spent significant amounts of money for such purposes. One of the purposes of the Corporation's technical research and development effort is to establish a competitive advantage in existing markets by focusing on improving operating procedures, increasing machine speeds and improving monitoring of paper usage, as well as working on the development of proprietary inks, coatings, adhesives and machine modifications. The Corporation has also increased its emphasis on the development of new products and services using digital technology which includes video tape, CD-ROM and data base management products. During the last several years, eleven professional and technical employees have worked primarily on research and development activities. Additionally, approximately fifty persons from quality control and engineering devoted a portion of their time to research and development.\nThe Corporation has environmental compliance programs primarily for control of internal and external air quality, ground water quality, disposal of waste material and all aspects of the work environment concerning employee health. Capital expenditures for air quality equipment have approximated 1% to 3% of total capital expenditures in each of the last three years. Planned capital expenditures for environmental control equipment are expected to be in the same range for 1996. The Corporation also incurs ongoing costs in monitoring compliance with environmental laws, in connection with disposal of waste materials and in connection with laws governing the remediation of sites at which the Corporation has previously disposed of waste materials. Requirements of the U.S. Environmental Protection Agency and state officials nationwide, relating to disposal of wastes in landfill sites, are increasing and result in higher costs for the Corporation and its competitors. Costs for environmental compliance and waste disposal have not been material to the Corporation in the past, but the Corporation presently believes that expenditures for these purposes will have a negative impact on its earnings and those of its competition in the future. These increased costs should not have a material impact on the Corporation's competitive position, assuming similar expenditures are required to be made by competitors. The Corporation does not believe at the present time that any costs, claims or penalties that may be incurred or assessed under environmental laws, in connection with known environmental assessment and remediation matters, beyond any reserves already provided, will have a material adverse effect upon the operations or consolidated financial position of the Corporation.\nForeign Operations.\nFootnote 11 to the Corporation's Consolidated Financial Statements in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995 includes information on the Corporation's foreign operations. The disclosures contained in such footnote is hereby incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE CORPORATION\nName, Age, Position Business Experience During Last Five Years\nDonald D. Belcher; 57; . . . Chairman of the Board of the Corporation Chairman, President and since May 1995: President and Chief Chief Executive Officer Executive Officer of the Corporation since January 1995; President and Chief Operating Officer of the Corporation from September 1994 to January 1995; Senior Group Vice President of Avery Dennison Corporation (diversified manufacturing company) from 1990 until joining the Corporation.\nGerald A. Henseler; 55; . . . Executive Vice President and Chief Financial Executive Vice President Officer of the Corporation since 1992; and Chief Financial Officer Senior Vice President, Chief Financial Officer and Treasurer of the Corporation prior thereto.\nRonald D. Kneezel; 39; . . . Secretary of the Corporation since December Vice President, General 1991; Vice President and General Counsel of Counsel and Secretary the Corporation since 1988.\nRobert A. Kreider; 41; . . . Treasurer of the Corporation since November Treasurer and Corporate 1992; Corporate Controller since July 1989; Controller Assistant Treasurer from April 1991 to October 1992.\nDennis J. Meyer; 40; . . . . Vice President of the Corporation since Vice President Marketing January 1994; Vice President, Quebecor Printing (manufacturer of printed materials) from 1990 to December 1993.\nJohn E. Tiffany; 57; . . . . Vice President of the Corporation. Vice President Manufacturing\nAllan J. Williamson; 64; . . President of Banta Book Group President of Banta Book Group\nThere are no family relationships between the executive officers of the Corporation.\nAll of the executive officers are elected or appointed annually. Each officer holds office until his successor has been elected or appointed or until his death, resignation or removal.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Corporation and its subsidiaries own operating plants located in Wisconsin, Connecticut, Minnesota, Missouri, North Carolina, Utah and Virginia, as well as several warehouse facilities for storage of materials. As of the end of fiscal 1995, these owned facilities include approximately 2,971,000 square feet of space utilized as follows: office space 313,000, manufacturing 1,634,000 and warehouse 1,024,000. The Corporation leases its headquarters office located in Menasha, Wisconsin. The Corporation leases production facilities in Wisconsin, California, Colorado, Illinois, Massachusetts, Minnesota, Utah and Washington, as well as warehouse space in numerous locations. European production facilities located in Ireland, Scotland and The Netherlands are also leased. The total of all leased facilities contain approximately 1,497,000 square feet of space. The buildings owned and leased by the Corporation are primarily of steel and brick construction.\nOne plant owned by the Corporation and certain equipment are pledged to secure issues of industrial revenue bonds in the principal amount of $2,660,000 as of December 30, 1995.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Corporation is not involved in any material pending legal proceedings, as defined by this item.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nAs of March 8, 1996 there were approximately 1,811 holders of record of the Corporation's Common Stock.\nUnder long-term debt agreements to which the Corporation is a party, payment of cash dividends is restricted. As of December 30, 1995, approximately $94,398,000 of retained earnings was not restricted under these agreements.\nThe information set forth under the caption \"Dividend Record and Market Prices\" (but excluding the graphs related thereto) in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995, is hereby incorporated herein by reference in response to this Item.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth under the caption \"Five-Year Summary of Selected Financial Data\" (but excluding the graphs related thereto) in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995, 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 under the caption \"Management's Discussion and Analysis of Financial Position and Operations\" in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995, 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 Balance Sheets of the Corporation and subsidiaries as of December 30, 1995 and December 31, 1994, and the related Consolidated Statements of Earnings, Cash Flows and Shareholders' Investment for the fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994, together with the related notes thereto and the Report of Independent Public Accountants thereon set forth in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995, are hereby incorporated herein by reference in response to a portion of this Item.\nThe information set forth under the caption \"Unaudited Quarterly Financial Information\" in the Corporation's Annual Report to Shareholders for the fiscal year ended December 30, 1995, is hereby incorporated herein by reference in response to a portion of this item.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information under the captions \"Election of Directors\" and \"Other Matters\" contained in the Corporation's definitive proxy statement for the annual meeting of shareholders to be held on April 23, 1996, as filed with the Securities Exchange Commission, is hereby incorporated herein by reference in response to a portion of this item. Reference is also made to the information under the heading \"Executive Officers of the Corporation\" included under Item 1 of Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information under the captions \"Board of Directors\" and \"Executive Compensation\" (other than the information under the subheading \"Board Compensation Committee Report on Executive Compensation\") contained in the Corporation's definitive proxy statement for the annual meeting of shareholders to be held on April 23, 1996, as filed with the Securities and Exchange Commission, is hereby 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 under the caption \"Stock Ownership of Management\" contained in the Corporation's definitive proxy statement for the annual meeting of shareholders to be held on April 23, 1996, as filed with the Securities and Exchange Commission, is hereby incorporated herein by reference in response to this Item.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information under the of Director caption \"Executive Compensation - Compensation Committee Interlocks and Insider Participation\" contained in the Corporation's definitive proxy statement for the annual meeting of shareholders to be held on April 23, 1996, as filed with the Securities and Exchange Commission, is hereby incorporated herein by reference in response to this Item.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) The following documents are filed as part of this report:\nPAGE REFERENCE\nANNUAL REPORT FORM 10-K TO SHAREHOLDERS\n1. Financial Statements: Consolidated Balance Sheets December 30, 1995, and December 31, 1994 24 For the fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994: Consolidated Statements of Earnings 25 Consolidated Statements of Cash Flows 26 Consolidated Statements of Shareholders' Investment 27 Notes to Consolidated Financial Statements 28-34 Report of Independent Public Accountants 35\n2. Financial Statement Schedule: Report of Independent Public Accountants 14 Schedule II - Valuation and Qualifying Accounts 15\nAll other schedules have been omitted since the required information is included in the consolidated financial statements or notes thereto, or because the information is not required or applicable.\n3. Exhibits:\n3.(a) Articles of Incorporation, as amended (1) (b) Amendment to Bylaws (c) Bylaws, as amended\n4.(a) Note Purchase Agreements dated December 9, 1986 (2) (b) Amendment to Note Purchase Agreements dated December 9, 1986 (3) (c) Note Purchase Agreement dated June 24, 1988 (4) (d) Amendment to Note Purchase Agreements dated December 9, 1986 (5) (e) Promissory Note Agreement dated July 17, 1990 (6) (f) Rights Agreement dated October 29, 1991 (7) (g) Note Purchase and Private Shelf Agreement dated May 12, 1994 (8) (h) Amendment to Note Purchase Agreements dated December 9, 1986 (9) (I) Amendment to Promissory Note Agreement dated July 17, 1990 (10) (j) Note Purchase and Medium-term Note Agreement Dated November 2, 1995 (11)\n[Note: The registrant has outstanding certain issues of industrial revenue bonds, none of which authorize the issuance of securities in an amount exceeding 10% of the registrant's consolidated assets. The registrant hereby agrees to furnish to the Commission upon request a copy of any instrument with respect to long-term debt not being registered under which the total amount of securities authorized does not exceed 10% of the registrant's consolidated assets.]\n*10. (a) Amended and Restated Supplemental Retirement Plan for Key Employees (b) Management Incentive Award Plan (12) (c) Amendment to Management Incentive Award Plan (13) (d) Form of Agreements with Gerald A. Henseler and Allan J. Williamson (14) (e) Form of Agreement with Ronald D. Kneezel (15) (f) Form of Agreements with Robert A. Kreider, Dennis J. Meyer and John E. Tiffany (16) (g) Agreement with Donald D. Belcher (17) (h) 1985 Deferred Compensation Plan for Key Employees, as amended and restated (18) (i) 1988 Deferred Compensation Plan for Key Employees, as amended and restated (19) (j) Basic Form of Deferred Compensation Agreements under (pre- January 1994) 1985 and 1988 Deferred Compensation Plans for Key Employees (20) (k) Basic Form of Deferred Compensation under (post-December 1993) 1988 Deferred Compensation plan for Key Employees (21) (l) Deferred Compensation Plan for Directors (22) (m) Form of Deferred Compensation Agreements for Directors (23) (n) Revised Form of Indemnity Agreements with Directors and Certain Officers (24) (o) 1987 Incentive Stock Option Plan; 1987 Nonstatutory Stock Option Plan (25) (p) Amendment to 1987 Nonstatutory Stock Option Plan (26) (q) Executive Trust Agreement (27) (r) Amendment to Executive Trust Agreement (28) (s) Long-term Incentive Plan (29) (t) Amendment to Long-term Incentive Plan (u) Amendment to Long-term Incentive Plan (30) (v) 1991 Stock Option Plan as amended (31) (w) Agreement with Allan J. Williamson (32) (x) Description of Supplemental Long-term Disability Plan (33) (y) Letter Agreement with Donald D. Belcher (34) (z) Letter Agreement with Dennis J. Meyer (35) (aa) Agreement with Gerald A. Henseler (36) (bb) Outside Directors' Retirement Plan (37) (cc) Banta Corporation 1995 Equity Incentive Plan (38)\n* Exhibits 10(a) through 10(cc) are management contracts or compensatory plans or arrangements.\n13. Portions of Annual Report to Shareholders for fiscal year ended December 30, 1995 that are incorporated by reference herein.\n21. List of Subsidiaries.\n23. Consent of Arthur Andersen LLP.\n27. Financial Data Schedule [EDGAR version only].\n(1) Exhibit No. 19(b) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(2) Exhibit No. 4(c) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(3) Exhibit No. 4(b) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(4) Exhibit No. 4(a) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(5) Exhibit No. 4(d) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(6) Exhibit No. 4 to Form 10-Q for the quarter ended September 29, 1990 is hereby incorporated herein by reference.\n(7) Exhibit No. 4.1 to the Form 8-K dated October 29, 1991 is hereby incorporated herein by reference.\n(8) Exhibit No. 4(a) to Form 10-Q for the quarter ended July 2, 1994 is hereby incorporated herein by reference.\n(9) Exhibit No. 4(b) to Form 10-Q for the quarter ended July 2, 1994 is hereby incorporated herein by reference.\n(10) Exhibit No. 4(c) to Form 10-Q for the quarter ended July 2, 1994 is hereby incorporated herein by reference.\n(11) Exhibit No. 4(a) to Form 10-Q for the quarter ended September 30, 1995 is hereby incorporated herein by reference.\n(12) Exhibit No. 10(e) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(13) Exhibit No. 19(e) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(14) Exhibit No. 10 to Form 10-K for the year ended January 1, 1983 is hereby incorporated herein by reference.\n(15) Exhibit No. 10(k) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(16) Exhibit No. 10(g) to Form 10-K for the year ended December 28, 1991 is hereby incorporated herein by reference.\n(17) Exhibit No. 10(b) to Form 10-Q for the quarter ended October 1, 1994 is hereby incorporated herein by reference.\n(18) Exhibit No. 10(j) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(19) Exhibit No. 10(a) to Form 10-Q for the quarter ended April 2, 1994 is hereby incorporated herein by reference.\n(20) Exhibit No. 10(l) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(21) Exhibit No. 10(b) to Form 10-Q for the quarter ended April 2, 1994 is hereby incorporated herein by reference.\n(22) Exhibit No. 10(q) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(23) Exhibit No. 10(p) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(24) Exhibit No. 10(a) to Form 10-Q for the quarter ended March 28, 1992 is hereby incorporated herein by reference.\n(25) Exhibit No. 6(a) to Form 10-Q for the quarter ended July 4, 1987 is hereby incorporated herein by reference.\n(26) Exhibit No. 19(a) to Form 10-Q for the quarter ended October 3, 1987 is hereby incorporated herein by reference.\n(27) Exhibit No. 10(r) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(28) Exhibit No. 10(s) to Form 10-K for the year ended January 1, 1994 is hereby incorporated herein by reference.\n(29) Exhibit No. 10(t) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(30) Exhibit No. 19(f) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(31) Exhibit No. 10(b) to Form 10-Q for the quarter ended July 1, 1995 is hereby incorporated herein by reference.\n(32) Exhibit No. 10(v) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(33) Exhibit No. 10(a) to Form 10-Q for the quarter ended October 2, 1993 is hereby incorporated herein by reference.\n(34) Exhibit No. 10(a) to Form 10-Q for the quarter ended October 1, 1994 is hereby incorporated herein by reference.\n(35) Exhibit No. 10(bb) to Form 10-K for the year ended December 31, 1994 is hereby incorporated herein by reference.\n(36) Exhibit No. 10(dd) to Form 10-K for the year ended December 31, 1994 is hereby incorporated herein by reference.\n(37) Exhibit No. 10(ee) to Form 10-K for the year ended December 31, 1994 is hereby incorporated herein by reference.\n(38) Exhibit No. 10(a) to Form 10-Q for the quarter ended July 1, 1995 is hereby incorporated herein by reference.\nAll documents incorporated herein by reference are filed with the Commission under File No. 0-6187.\n(b) Reports on Form 8-K. No Current Reports on Form 8-K were filed by the Corporation during the quarter ended December 30, 1995.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in the Banta Corporation annual report to shareholders and incorporated by reference in this Form 10-K, and have issued our report thereon dated January 30, 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 in item 14(a) (2) is the responsibility of the Corporation'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 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, January 30, 1996.\nSIGNATURES\nPursuant to the requirements Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBANTA CORPORATION\nDATE: March 23, 1996 BY: \/s\/ DONALD D. BELCHER Donald D. Belcher Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ DONALD D. BELCHER March 23, 1996 Donald D. Belcher, Chairman, President and Chief Executive Officer\n\/s\/ GERALD A. HENSELER March 23, 1996 Gerald A. Henseler, Executive Vice President, Chief Financial Officer, and Director\n\/s\/ ROBERT A. KREIDER March 23, 1996 Robert A. Kreider, Treasurer\n\/s\/ BERNARD S. KUBALE March 23, 1996 Bernard S. Kubale, Director\n\/s\/ DONALD TAYLOR March 23, 1996 Donald Taylor, Director\n\/s\/ ALLAN J. WILLIAMSON March 23, 1996 Allan J. Williamson, Director\nBANTA CORPORATION - File No. 0-6187 Form 10-K, Year Ended December 30, 1995\nEXHIBIT INDEX\nPage Numbering In Sequential Exhibit Number Numbering System\n3. (b) Amendment to Bylaws ----- (c) Bylaws, as amended -----\n10. (a) Amended and Restated Supplemental Retirement Plan for Key Employees ----- (t) Amendment to Long-term Incentive Plan -----\n13. Portions of Annual Report to Shareholders for fiscal year ended December 30, 1995 that are incorporated by reference herein. -----\n21. List of Subsidiaries. -----\n23. Consent of Arthur Andersen LLP. -----\n27. Financial Data Schedule [EDGAR version only].","section_15":""}
{"filename":"37996_1995.txt","cik":"37996","year":"1995","section_1":"Item 1. Business - -----------------\nFord Motor Company (referred to herein as \"Ford\", the \"Company\" or the \"Registrant\") was incorporated in Delaware in 1919 and acquired the business of a Michigan company, also known as Ford Motor Company, incorporated in 1903 to produce automobiles designed and engineered by Henry Ford. Ford is the second-largest producer of cars and trucks in the world, and ranks among the largest providers of financial services in the United States.\nGeneral -------\nThe Company's two principal business segments are Automotive and Financial Services. The activities of the Automotive segment consist of the design, manufacture, assembly and sale of cars and trucks and related parts and accessories. Substantially all of Ford's automotive products are marketed through retail dealerships, most of which are privately owned and financed.\nThe primary activities of the Financial Services segment consist of financing operations, vehicle and equipment leasing and insurance operations. These activities are conducted through the Company's subsidiaries, Ford FSG, Inc. (\"FFSGI\"), Ford Holdings, Inc. (\"Ford Holdings\"), The Hertz Corporation (\"Hertz\") and Granite Management Corporation (\"Granite\"). FFSGI is a holding company that owns primarily Ford Motor Credit Company (\"Ford Credit\"), a majority of Ford Credit Europe plc (\"Ford Credit Europe\"), and Associates First Capital Corporation (\"The Associates\"). Ford Holdings is a holding company that owns primarily a portion of FFSGI and all of USL Capital Corporation (\"USL Capital\") and The American Road Insurance Company (\"American Road\").\nSee Note 17 of Notes to Financial Statements and Item 6. \"Selected Financial Data\" for information relating to revenue, operating income\/(loss) and assets attributable to Ford's industry segments. Also see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for information with respect to revenue, net income and other matters.\nAutomotive Operations ---------------------\nThe worldwide automotive industry is affected significantly by a number of factors over which the industry has little control, including general economic conditions.\nIn the United States, the automotive industry is a highly- competitive, cyclical business characterized by a wide variety of product offerings. The level of industry demand (retail deliveries of cars and trucks) can vary substantially from year to year and, in any year, is dependent to a large extent on general economic conditions, the cost of purchasing and operating cars and trucks and the availability and cost of credit and of fuel, and reflects the fact that cars and trucks are durable items, the replacement of which can be postponed.\nThe automotive industry outside of the United States consists of many producers, with no single dominant producer. Certain manufacturers, however, account for the major percentage of total sales within particular countries, especially their respective countries of origin. Most of the factors that affect the U.S. automotive industry and its sales volumes and profitability are equally relevant outside the United States.\nItem 1. Business (Continued) - ---------------------------\nThe worldwide automotive industry also is affected significantly by a substantial amount of government regulation. In the United States and Europe, for example, government regulation has arisen primarily out of concern for the environment, for greater vehicle safety and for improved fuel economy. Many governments also regulate local content and\/or impose import requirements as a means of creating jobs, protecting domestic producers or influencing their balance of payments.\nUnit sales of Ford vehicles vary with the level of total industry demand and Ford's share of industry sales. Ford's share is influenced by the quality, price, design, driveability, safety, reliability, economy and utility of its products compared with those offered by other manufacturers, as well as by the timing of new model introductions and capacity limitations. Ford's ability to satisfy changing consumer preferences with respect to type or size of vehicle and its design and performance characteristics can affect Ford's sales and earnings significantly.\nThe profitability of vehicle sales is affected by many factors, including unit sales volume, the mix of vehicles and options sold, the level of \"incentives\" (price discounts) and other marketing costs, the costs for customer warranty claims and other customer satisfaction actions, the costs for government-mandated safety, emission and fuel economy technology and equipment, the ability to control costs and the ability to recover cost increases through higher prices. Further, because the automotive industry is capital intensive, it operates with a relatively high percentage of fixed costs which can result in large changes in earnings with relatively small changes in unit volume.\nFord has operations in over 30 countries and sells vehicles in over 200 markets. These businesses frequently have foreign currency exposures when they buy, sell, and finance in currencies other than their local currencies. Ford's primary foreign currency exposures, in terms of net corporate exposure, are in the German Mark, Japanese Yen, Italian Lira and French Franc. The effect of changes in exchange rates on income depends largely on the relationship between revenues and costs incurred in the local currency versus other currencies. Historically, the effect of changes in exchange rates on Ford's earnings generally has been small relative to other factors that also affect earnings (such as unit sales).\nUnited States - -------------\nSales Data. The following table shows U.S. industry demand for the years indicated:\nItem 1. Business (Continued) - ---------------------------\nFord classifies cars by small, middle, large and luxury segments and trucks by compact pickup, compact van\/utility, full- size pickup, full-size van\/utility and medium\/heavy segments. The large and luxury car segments and the compact van\/utility, full- size pickup and full-size van\/utility truck segments include the industry's most profitable vehicle lines. The following tables show the proportion of retail car and truck sales by segment for the industry (including Japanese and other foreign-based manufacturers) and Ford for the years indicated:\nAs shown in the tables above, since 1991 there has been a significant shift from cars to trucks for both industry sales and Ford sales. Most of the shift reflects fewer sales of cars in the middle and large segments for the industry and in the middle, large and luxury segments for Ford and increased sales of trucks in the compact van\/utility (e.g., Windstar and Explorer) and full-size pickup segments for both the industry and Ford. The increased sales of full-size pickups reflects the increased use of such vehicles for personal (rather than commercial) purposes.\nItem 1. Business (Continued) - ---------------------------\nMarket Share Data. The following tables show changes in car and truck market shares of United States and foreign-based manufacturers for the years indicated:\n__________________________ * All U.S. retail sales data are based on publicly available information from the American Automobile Manufacturers Association, the media and trade publications. ** Share data include cars and trucks assembled and sold in the U.S. by Japanese-based manufacturers selling through their own dealers as well as vehicles imported by them into the U.S. \"All Other\" includes primarily companies based in various European countries and in Korea.\nItem 1. Business (Continued) - ---------------------------\nJapanese Competition. The market share of Ford and other domestic manufacturers in the U.S. is affected by sales from Japanese manufacturers. As shown in the table above, the share of the U.S. combined car and truck industry held by the Japanese manufacturers decreased from 25.5% in 1991 to 22.6% in 1995, reflecting in part the effects of the strengthening of the Japanese yen on the prices of vehicles produced by the Japanese manufacturers, the overall market shift from cars to trucks and improvements in the vehicles produced by U.S. manufacturers.\nIn the 1980s and continuing in the 1990s, Japanese manufacturers added assembly capacity in North America (frequently referred to as \"transplants\") in response to a variety of factors, including export restraints, the significant growth of Japanese car sales in the U.S. and international trade considerations. In response to the strengthening of the Japanese yen to the U.S. dollar, Japanese manufacturers are continuing to add production capacity (particularly in the profitable truck segments) in the United States. Production in the U.S. by Japanese transplants reached about 2.3 million units in 1995 and is expected to increase gradually over the next several years.\nMarketing Incentives and Fleet Sales. As a result of intense competition from new product offerings (from both domestic and foreign manufacturers) and the desire to maintain economic production levels, automotive manufacturers that sell vehicles in the U.S. have provided marketing incentives (price discounts) to retail and fleet customers (i.e., daily rental companies, commercial fleets, leasing companies and governments). Marketing incentives are particularly prevalent during periods of economic downturns, when excess capacity in the industry tends to exist.\nFord's marketing costs in North America as a percentage of gross sales revenue for each of 1995, 1994, and 1993 were: 7.5%, 7.3%, and 8.7%, respectively. During the 1983-1988 period, such costs as a percentage of sales revenue were in the 3% to 5% range. In 1991, marketing costs peaked at 12% of gross revenues. \"Marketing costs\" include (i) marketing incentives such as retail rebates and special financing rates, (ii) reserves for residual guaranties on retail vehicle leases, (iii) reserves for costs and\/or losses associated with obligatory repurchases of certain vehicles sold to daily rental companies and (iv) costs for advertising and sales promotions.\nSales by Ford to fleet customers were as follows for the years indicated:\nFleet sales generally are less profitable than retail sales, and sales to daily rental companies generally are less profitable than sales to other fleet purchasers. The mix between sales to daily rental companies and other fleet sales has been about evenly split in recent years.\nWarranty Coverages. In recent years, due to competitive pressures, vehicle manufacturers have both expanded the coverages and extended the terms of warranties on vehicles sold in the U.S. Ford presently provides warranty coverage for defects in factory- supplied materials and workmanship on all vehicles sold by it in the U.S. that extends for at least 36 months or 36,000 miles (whichever occurs first) and covers all components of the vehicle, other than tires which are warranted by the tire manufacturers. Different warranty coverages are provided on vehicles sold outside the U.S. In addition, as discussed below under \"Governmental Standards - Mobile Source Emissions Control\", the Federal Clean Air Act requires a useful life of 10 years or 100,000 miles (whichever occurs first) for emissions equipment on vehicles sold in the U.S. As a result of these coverages and the increased concern for customer satisfaction, costs for warranty repairs, emissions equipment repairs and customer satisfaction actions (\"warranty costs\") can be substantial. Estimated warranty costs for each vehicle sold by Ford are accrued at the time of sale. Such accruals, however, are subject to adjustment from time to time depending on actual experience.\nItem 1. Business (Continued) - ---------------------------\nEurope - ------\nEurope is the largest market for the sale of Ford cars and trucks outside the United States. The automotive industry in Europe is intensely competitive; for the past 12 years, the top six manufacturers have each achieved a car market share in about the 10% to 16% range. (Manufacturers' shares, however, vary considerably by country.) This competitive environment is expected to intensify further as Japanese manufacturers, which together had a European car market share of 10.9% for 1995, increase their production capacity in Europe and import restrictions on Japanese built-up vehicles gradually are removed in total by December 31, 1999.\nIn 1995, European car industry sales were 11.8 million cars, equal to 1994 levels. Truck sales were 1.6 million units, up 7% from 1994 levels. Ford's European car share for 1995 was 11.9%, the same as 1994, and its European truck share for 1995 was a record 14.8%, compared with 14.7% for 1994.\nFor Ford, Great Britain and Germany are the most important markets within Europe, although the Southern European countries are becoming increasingly significant. Any adverse change in the British or German market has a significant effect on total automotive profits. For 1995 compared with 1994, total industry sales were up 1% in Great Britain and up 3% in Germany.\nOther Foreign Markets - ---------------------\nMexico and Canada. Mexico and Canada also are important markets for Ford. Generally, industry conditions in Canada closely follow conditions in the U.S. market. In 1995, industry sales of cars and trucks in Canada were down 7% from 1994 levels, somewhat worse than the decrease of 2% in the U.S. over the same period. Mexico had been a growing market until late 1994. However, substantial devaluation of the Mexican Peso in late 1994 created a high level of uncertainty regarding economic activity in Mexico. Although the long-term outlook remains positive, industry volume was down 62% in 1995. Ongoing financial effects on Ford of the devaluation are expected to be unfavorable; the magnitude of these effects will be dependent in large part upon overall economic conditions.\nSouth America. Brazil and Argentina are the principal markets for Ford in South America. The economic environment in those countries has been volatile in recent years, leading to large variations in profitability. Results also have been influenced by government actions to reduce inflation and public deficits, and improve the balance of payments. In 1995 , Ford's results in the region declined compared with 1994. The decrease reflected primarily losses for operations in Brazil, where higher import duties and a market shift to small cars resulted in excess dealer inventories and higher marketing costs. The lower results are expected to continue into 1996. The Company is reestablishing manufacturing capacity in Brazil for small cars, which should assist in improving the Company's competitiveness in this region longer term. Industry sales in 1995, compared with 1994, were up 19% in Brazil but down 35% in Argentina. Ford's future results in the region largely will be dependent on the political and economic environments in Brazil and Argentina, which historically have been unpredictable and are expected to continue to be volatile and subject to rapid change.\nIn November 1995, Ford and Volkswagen AG dissolved their Autolatina joint venture in Brazil and Argentina. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for more information concerning the effects of this dissolution.\nItem 1. Business (Continued) - ---------------------------\nAsia Pacific. In the Asia Pacific region, Australia, Taiwan and Japan are the principal markets for Ford products. In 1995, Ford was the market share leader in Australia with a 21.5% combined car and truck market share. In Taiwan (where sales of built-up vehicles manufactured in Japan are prohibited), Ford was the market share leader with a combined car and truck market share in 1995 of 18.9%. Ford's principal competition in the Asia Pacific region has been the Japanese manufacturers. It is anticipated that the continuing relaxation of import restrictions (including duty reductions) in Australia and Taiwan will intensify competition in those markets.\nThe Asia Pacific region offers many important opportunities for the future. Ford believes that China is strategically important to its long-term success in the Asia Pacific region. In 1995, Ford purchased a 20% equity interest in a Chinese light truck manufacturer, Jiangling Motors Corporation, Ltd.; established a wholly owned holding company in Beijing; and invested in an aluminum radiator joint venture in China, in addition to the previously established automotive component manufacturing joint ventures in China (automotive interior trim, automotive glass and automotive electronic\/audio components). In late 1995, Ford established a joint venture in Thailand with Mazda Motor Corporation (\"Mazda\") to manufacture pickup trucks designed by Mazda. In 1994, Ford purchased a 6.5% equity interest in Mahindra and Mahindra Limited (\"Mahindra\"), an automotive and tractor manufacturer in India. In 1995, Ford received governmental approval to invest in an automobile manufacturing joint venture in India with Mahindra. Ford is continuing to investigate additional automotive component manufacturing and vehicle assembly opportunities in those markets as well as others. In addition, Ford is expanding the number of right-hand-drive vehicles it will offer in Japan, including the Explorer and Taurus models.\nAfrica. In late 1994, Ford re-entered the South African market by acquiring a 45% equity interest in South African Motor Corporation (Pty.) Limited (\"SAMCOR\"). SAMCOR is an assembler of Ford and other manufacturers' vehicles in South Africa.\nFinancial Services Operations -----------------------------\nFord Holdings, Inc. and Ford FSG, Inc. - --------------------------------------\nFord Holdings was incorporated in 1989 for the principal purpose of acquiring, owning and managing certain assets of Ford. In December 1995, Ford Holdings merged with Ford Holdings Capital Corporation, a wholly owned subsidiary of Ford Holdings, which resulted in the cancellation of all of the voting preferred stock of Ford Holdings. All of the outstanding common stock of Ford Holdings, representing 100% of the voting power in Ford Holdings, is owned beneficially by Ford.\nIn late 1995, Ford began a reorganization of its Financial Services group in order to align more closely under a single subsidiary legal ownership of the Financial Services affiliates with management responsibility for such affiliates. As part of the reorganization, Ford Holdings formed FFSGI to own primarily all of the Financial Services affiliates. At the time, 55% of the common stock of Ford Holdings was owned by Ford and 45% was owned by Ford Credit.\nAfter the formation of FFSGI, Ford Holdings contributed its interest in The Associates to FFSGI in exchange for 100% of the common stock of FFSGI and the assumption by FFSGI of certain debt of Ford Holdings. Thereafter, Ford contributed to FFSGI all of its interest in Ford Credit Europe. In exchange for this contribution, Ford received a class of common stock in FFSGI that has controlling voting power of FFSGI but otherwise is equal to all other common stock of FFSGI as to the payment of dividends, etc. (the \"Class F Stock\"). In February 1996, substantially all of the shares of Ford Holdings common stock owned by Ford Credit were repurchased by Ford Holdings in exchange for the issuance of a promissory note by Ford Holdings. Thereafter, Ford contributed to FFSGI all of its interest in Ford Credit in exchange for additional shares of Class F Stock of FFSGI. In addition, Ford will contribute to FFSGI certain of its international Financial Services affiliates managed by Ford Credit in exchange for additional stock in FFSGI.\nItem 1. Business (Continued) - ---------------------------\nIt is also expected that Ford Holdings will contribute American Road to FFSGI, which in turn is expected to contribute it to Ford Credit. The percentages of economic interests of FFSGI held by Ford and Ford Holdings are based on the relative value of the entities contributed to FFSGI by Ford and Ford Holdings. Currently, those percentages are approximately 78% for Ford and 22% for Ford Holdings.\nOn February 9, 1996, The Associates filed a registration statement with the Securities and Exchange Commission for an initial public offering of its common stock representing up to a 19.8% economic interest in The Associates (the \"IPO\"). Substantially all of the net proceeds from the IPO are expected to be used to repay indebtedness of The Associates, which will be incurred to repay an intercompany debt owed to FFSGI in the amount of $1.75 billion. Prior to completion of the IPO, Ford expects to contribute to The Associates certain international affiliates owned by Ford but managed by The Associates. Also, as announced by Ford in the fourth quarter of 1995, Ford is investigating the sale of all or a part of USL Capital.\nFord Motor Credit Company - -------------------------\nFord Credit is a wholly owned subsidiary of FFSGI. It provides wholesale financing and capital loans to franchised Ford dealers and other dealers associated with such franchisees and purchases retail installment sale contracts and retail leases from them. Ford Credit also makes loans to vehicle leasing companies, the majority of which are affiliated with such dealers. In addition, a wholly owned subsidiary of Ford Credit provides these financing services in the U.S. and Canada to other vehicle dealers. More than 80% of all new vehicles financed by Ford Credit are manufactured by Ford or its affiliates. In addition to vehicle financing, Ford Credit makes loans to affiliates of Ford, finances certain receivables of Ford and its subsidiaries and offers diversified financing services which are managed by USL Capital, a wholly owned subsidiary of Ford Holdings. Ford Credit also manages the activities of a number of international credit affiliates of Ford and FFSGI. In addition, it is expected that Ford Credit will become the owner of American Road, an insurance company discussed further below. Currently, Ford Credit manages the activities of American Road.\nFord Credit financed the following percentages of new Ford cars and trucks sold or leased at retail and sold at wholesale in the United States during each of the past five years:\n___________________ * As a percentage of total sales and leases, including cash sales.\nItem 1. Business (Continued) - ---------------------------\nFord Credit's finance receivables and investments in operating leases were as follows at the dates indicated (in millions):\nInstallments on finance receivables, including interest, past-due 60 days or more and the aggregate receivable balances related to such past-due installments were as follows at the dates indicated (in millions):\nThe following table sets forth information concerning Ford Credit's credit loss experience with respect to the various categories of financing during the years indicated (dollar amounts in millions):\nItem 1. Business (Continued) - ---------------------------\nAn analysis of Ford Credit's allowance for credit losses on finance receivables and operating leases is as follows for the years indicated (in millions):\nFord Credit relies heavily on its ability to raise substantial amounts of funds. These funds are obtained primarily by sales of commercial paper and issuance of term debt. Funds also are provided by retained earnings and sales of receivables. The level of funds can be affected by certain transactions with Ford, such as capital contributions and dividend payments, interest supplements and other support from Ford for vehicles financed by Ford Credit under Ford-sponsored special financing or leasing programs, and the timing of payments for the financing of dealers' wholesale inventories and for income taxes. Ford Credit's ability to obtain funds is affected by its debt ratings, which are closely related to the financial condition of and the outlook for Ford, and the nature and availability of support facilities, such as revolving credit agreements and receivables-backed facilities.\nThe long-term senior debt of Ford and Ford Credit is rated \"A1\" and \"A+\" and Ford Credit's commercial paper is rated \"Prime-1\" and \"A-1\" by Moody's Investors Service, Inc. and Standard & Poor's Ratings Group, respectively.\nFord and Ford Credit have a profit maintenance agreement which provides for payments by Ford to the extent required to maintain Ford Credit's earnings at specified minimum levels. No payments were required under the agreement during the period 1988 through 1995.\nFord Credit Europe plc - ----------------------\nIn 1993, most of the European credit operations of Ford, which generally had been organized as subsidiaries of the respective automotive affiliates of Ford throughout Europe, were consolidated into a single company, Ford Credit Europe. Ford Credit Europe, which was originally incorporated in 1963 in England as a private limited company, is now owned by FFSGI and Ford Werke AG. Ford Credit Europe's primary business is to support the sale of Ford vehicles in Europe through the Ford dealer network. A variety of retail, leasing and wholesale finance plans is provided in most countries in which it operates. The business of Ford Credit Europe is substantially dependent upon Ford's automotive operations in Europe. Ford Credit Europe issues commercial paper, certificates of deposit and term debt to fund its credit operations. One of the purposes of the consolidation described above is to facilitate Ford Credit Europe's access to public debt markets. Ford Credit Europe's ability to obtain funds in these markets is affected by its credit ratings, which are closely related to the financial condition of and outlook for Ford.\nItem 1. Business (Continued) - ---------------------------\nFord Credit Europe's finance receivables and investments in operating leases were as follows at the dates indicated (in millions):\nAn analysis of Ford Credit Europe's allowance for credit losses in finance receivables and operating leases is as follows for the years indicated (in millions): ==== ==== ==== ___________________________ * The reported amounts reflect primarily foreign currency translation adjustments.\nAssociates First Capital Corporation - ------------------------------------\nThe Associates conducts its operations primarily through its principal operating subsidiary, Associates Corporation of North America. The Associates' primary business activities are consumer finance and commercial finance. The consumer finance operation invests in home equity, personal lending and sales finance receivables, and credit card receivables primarily through a wholly owned credit card bank, in addition to providing financing in the foregoing areas and in manufactured housing. The commercial finance operation is principally engaged in financing and leasing transportation and industrial equipment, and providing other services, including automobile fleet leasing and management, relocation services and automobile club and roadside assistance services. The Associates has an insurance operation which underwrites credit life, credit accident and health, property, casualty and accidental death and dismemberment insurance, principally for customers of the finance operations. Such insurance activity is conducted by The Associates' licensed insurance agents and is managed as a separate activity. Insurance sales are dependent on the business activities and volumes of the consumer and commercial business. As mentioned above, The Associates has filed a registration statement with the Securities and Exchange Commission for an initial public offering of its common stock representing up to a 19.8% economic interest in The Associates.\nItem 1. Business (Continued) - ---------------------------\nThe Associates' net finance receivables were as follows at the dates indicated (in millions):\nCredit loss experience, net of recoveries, of The Associates' finance business was as follows for the years indicated (dollar amounts in millions):\nThe following table shows total gross balances contractually delinquent sixty days and more by type of business at the dates indicated (dollar amounts in millions):\nItem 1. Business (Continued) - ---------------------------\nAn analysis of The Associates' allowance for losses on finance receivables is as follows for the years indicated (in millions):\nUSL Capital Corporation - ------------------------\nUSL Capital, a diversified commercial leasing and financing organization, originally incorporated in 1956, was acquired by Ford in 1987 and was transferred to Ford Holdings in 1989. The primary operations of USL Capital include the leasing, financing, and management of office, manufacturing and other general-purpose business equipment; commercial fleets of automobiles, vans, and trucks; large-balance transportation equipment (principally commercial aircraft, rail, and marine equipment); industrial and energy facilities; and essential-use equipment for state and local governments. It also provides intermediate-term, first-mortgage loans on commercial properties and invests in corporate preferred stock and senior and subordinated debt instruments. Certain of these financing transactions are underwritten by Ford Credit. As mentioned above, Ford is considering the sale of all or a part of USL Capital.\nThe following table sets forth certain information regarding USL Capital's earning assets, credit losses, and delinquent accounts at the dates indicated (dollar amounts in millions):\nThe American Road Insurance Company - -----------------------------------\nAmerican Road was incorporated by Ford in 1959, became a wholly owned subsidiary of Ford Credit in 1966, and was transferred to Ford Holdings in 1989. It is expected that American Road will be transferred back to Ford Credit as part of the reorganization of the Financial Services group. The operations of American Road consist primarily of underwriting floor plan insurance related to substantially all new vehicle inventories of dealers financed at wholesale by Ford Credit in the United States and Canada, credit life and disability insurance in connection with retail vehicle financing, and insurance related to retail contracts sold by automobile dealers to cover vehicle repairs. In late 1995, American Road agreed to sell all of its interest in Ford Life Insurance Company (\"Ford Life\"), a wholly owned subsidiary of American Road, to SunAmerica Inc. At the time of the sale, Ford\nItem 1. Business (Continued) - --------------------------- Life's business consisted of offering deferred annuities sold primarily through banks and brokerage firms; the non-annuities portion of the business was transferred to another subsidiary of American Road prior to the sale of Ford Life.\nThe following table summarizes the revenues and net income of American Road (in millions):\nThe detail of premiums earned by American Road was as follows (in millions):\nThe Hertz Corporation - ---------------------\nHertz was incorporated in 1967 and is a successor to corporations which were engaged in the automobile and truck leasing and rental business since 1924. During 1994, Ford entered into various transactions which resulted in Hertz becoming a wholly owned subsidiary of Ford. Hertz, its affiliates and independent licensees are engaged principally in the business of renting automobiles and renting and leasing trucks, without drivers, in the U.S. and in approximately 150 foreign countries. Collectively, they operate what Hertz believes is the largest car rental business in the world and one of the largest one-way truck rental businesses in the U.S. In addition, through its wholly owned subsidiary, Hertz Equipment Rental Corporation, Hertz operates what it believes to be the largest business in the U.S. involving the rental, lease and sale of construction and materials handling equipment. 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 telecommunications services in the U.S.\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.\nItem 1. Business (Continued) - ---------------------------\nThe cost and accumulated depreciation of revenue earning equipment were as follows for the nine months ended December 31, 1994 and the year ended December 31, 1995 (in millions):\nGranite Management Corporation - ------------------------------\nGranite, a savings and loan holding company organized in Delaware in 1959, was acquired by Ford in December 1985. Until September 30, 1994, the principal asset of Granite was the capital stock of First Nationwide Bank, A Federal Savings Bank, since known as Granite Savings Bank (the \"Bank\"). On September 30, 1994, substantially all of the assets of the Bank were sold to, and substantially all of the liabilities of the Bank were assumed by, First Madison Bank, FSB (\"First Madison\").\nAt the time of the sale, Ford retained, through Granite, approximately $1.2 billion of commercial real estate and other assets formerly owned by the Bank. These retained assets generally were of lower quality than those included in the sale and will be liquidated over time as market conditions permit. In addition, for the three-year period ending in November 1996, First Madison has the option of requiring Granite to repurchase up to $500 million of the assets included in the sale that become nonperforming. This repurchase obligation is guaranteed by Ford. Through December 31, 1995, approximately $387 million of such assets had been repurchased by Granite. At December 31, 1995, approximately $875 million of Granite's assets remained unsold.\nGovernmental Standards ----------------------\nA number of governmental standards and regulations relating to safety, corporate average fuel economy (\"CAFE\"), emissions control, noise control, damageability and theft prevention are applicable to new motor vehicles, engines, and equipment manufactured for sale in the United States, Europe and elsewhere. In addition, manufacturing and assembly facilities in the United States, Europe and elsewhere are subject to stringent standards regulating air emissions, water discharges and the handling and disposal of hazardous substances. Such facilities in the United States also are subject to a comprehensive federal-state permit program relating to air emissions.\nMobile Source Emissions Control - United States Requirements. As amended in November 1990, the Federal Clean Air Act (the \"Clean Air Act\" or the \"Act\") imposes stringent limits on the amount of regulated pollutants that lawfully may be emitted by new motor vehicles and engines produced for sale in the United States. In addition, the Act requires that emissions equipment for vehicles sold in the U.S. have a minimum \"useful life\" during which compliance with the applicable standards must be achieved. Passenger cars, for example, must comply for 10 years or 100,000 miles, whichever first occurs. The Act prohibits, among other things, the sale in or importation into the U.S. of any new motor vehicle or engine which is not covered by a certificate of conformity issued by the United States Environmental Protection Agency (the \"EPA\").\nThe Act also may require production of certain new cars and trucks capable of operating on clean alternative fuels under a\nItem 1. Business (Continued) - ---------------------------\npilot test program to be conducted in California beginning in the 1996 model year. Under this pilot program, each manufacturer will be required to sell its pro rata share of 150,000 alternative fuel vehicles in each of the 1996, 1997 and 1998 model years and its pro rata share of 300,000 alternative fuel vehicles in each model year thereafter. The Act also authorizes certain states to establish programs to encourage the purchase of such vehicles. Since the Act considers California's already adopted reformulated (i.e., cleaner burning) gasoline to be an alternative fuel, most manufacturers will be able to comply with this requirement in California by selling vehicles certified to California standards.\nMotor vehicle emissions standards even more stringent than those presently in effect will become effective as early as the 2004 model year, unless the EPA determines that such standards are not necessary, technologically feasible or cost-effective.\nThe Act authorizes California to establish unique emissions control standards that, in the aggregate, are at least as stringent as the federal standards if it secures the requisite waiver of federal preemption from the EPA. The Health and Safety Code of the State of California prohibits, among other things, the sale to an ultimate purchaser who is a resident of or doing business in California of a new motor vehicle or engine which is intended for use or registration in that state which has not been certified by the California Air Resources Board (the \"CARB\"). The CARB received a waiver from the EPA for a series of passenger car and light truck emissions standards (the \"low emission vehicle\", or \"LEV\", standards), effective beginning between the 1994 and 2003 model years, that are significantly more stringent than those prescribed by the Act for the corresponding periods of time. These California standards are intended to promote the development of various classes of low emission vehicles. California also requires that a specified percentage of each manufacturer's vehicles produced for sale in California, beginning at 2% in 1998 and increasing to 10% in 2003, must be \"zero-emission vehicles\" (\"ZEVs\"), which produce no emissions of regulated pollutants. In February 1996, CARB issued a notice for eliminating the ZEV mandate applicable before the 2003 model year. Final action on the proposed rule change is expected at the March 1996 board meeting. If CARB eliminates the mandate, manufacturers have volunteered to provide air quality benefits for California equivalent to a 49 state program (i.e., providing vehicles certified to California LEV emissions standards nationwide beginning with the 2001 model year), to continue research and development of EV technology and to provide specific numbers of advanced technology battery vehicles through demonstration programs in California.\nElectric vehicles are the only presently known type of zero- emission vehicles. However, despite intensive research activities, technologies have not been identified that would allow manufacturers to produce an electric vehicle that either meets customer expectations or is commercially viable. Such vehicles likely will run on lead-acid batteries with a limited range (well under 100 miles per recharge in optimal conditions), have a long recharge time (up to 8 hours), lack substantial infrastructure support (home and public facilities for recharging) and have a significant cost premium over conventional vehicles. The proposed elimination of the ZEV mandate and the manufacturers' voluntary program will better allow market forces to guide the introduction of ZEVs into the market. If the mandate is not changed, compliance may require manufacturers to offer substantial discounts on electric vehicles, selling them well below cost, or increase the price or curtail the sale of nonelectric vehicles.\nThe California LEV standards present significant technological challenges to manufacturers and compliance may require costly actions that would have a substantial adverse effect on Ford's sales volume and profits.\nThe Act also permits other states which do not meet national ambient air quality standards to adopt new motor vehicle emissions standards identical to those adopted by California, if such states lawfully adopt such standards two years before commencement of the affected model year. Twelve northeastern states and the District of Columbia organized under provisions of the Act into a group known as the Ozone Transport Commission (the \"OTC\") and petitioned the EPA to require California LEV standards in that region. There are major problems with transferring California standards to the Northeast - many dealers sell vehicles in neighboring states and the range of present ZEVs is greatly diminished (by more than 50 percent) in cold weather. Also, the Northeast states have refused to adopt the California reformulated gasoline requirement - the absence of which makes the task of meeting standards even more difficult. California LEV standards (including the ZEV requirements) already have been adopted in New York and Massachusetts. Connecticut also has adopted such standards, but without the ZEV requirements.\nItem 1. Business (Continued) - ---------------------------\nTo mitigate these problems, the automobile industry proposed to voluntarily meet emissions standards nationwide that are more stringent than those required by the Act. The proposal was based on using technology developed to meet the California LEV standards, but adjusting for the absence of the California reformulated gasoline and ZEV requirements. While there was a general receptivity to the industry's proposal, some of the states are insisting on either a ZEV mandate or a guarantee that \"advanced technology\" vehicles will be sold in their states.\nIn December 1994, the EPA granted the OTC petition to impose California LEV standards, while at the same time urging states and manufacturers to agree on a national approach which the EPA described as \"environmentally superior\" to the California standards. The states will have until early 1996 to include in their State Implementation Plans a California LEV program or an acceptable alternative.\nUnder the Act, if the EPA determines that a substantial number of any class or category of vehicles, although properly maintained and used, do not conform to applicable emissions standards, a manufacturer may be required to recall and remedy such nonconformity at its expense. Further, if the EPA determines through testing of production vehicles that emission control performance requirements are not met, it can halt shipment of motor vehicles of the configuration tested. California has similar, and in some respects greater, authority to order manufacturers to recall vehicles. Ford may be required to recall vehicles for such purposes from time to time. In addition, as it has from time to time in the past, Ford may voluntarily recall vehicles to fix emissions-related concerns. The costs of related repairs or inspections associated with such recalls can be substantial.\nThe Act generally prohibits the introduction of new fuel additives unless a waiver is granted by the EPA. In 1995, the U.S. Court of Appeals for the District of Columbia ordered the EPA to grant such a waiver to Ethyl Corporation for the additive MMT, over the objections of the EPA and U.S. automobile manufacturers, including Ford. Ethyl Corporation can now market MMT for use in unleaded gasoline. Ford and other manufacturers believe that the use of MMT will impair the performance of current emissions systems and onboard diagnostics systems. The introduction of MMT could increase Ford's future warranty costs and necessitate changes in the Company's warranties for emission control devices.\nEuropean Requirements. Council Directive 70\/220\/EEC (as amended through Council Directive 94\/12\/EEC) and related European legislation impose limits on the amount of regulated pollutants that may be emitted by new motor vehicles and engines sold in the European Union. Standards for vehicles homologated before January 1, 1996 are of generally equivalent stringency to 1983 model year U.S. standards for gasoline powered vehicles and to 1987 model year U.S. standards for diesel powered vehicles. All passenger cars homologated from January 1, 1996 and all new passenger cars registered from January 1, 1997 must comply with more stringent standards that are of generally equivalent stringency to 1994 model year U.S. standards. Similarly, new more stringent standards for light duty trucks (\"LDTs\") have been proposed but not yet finally enacted by the European Union. These would apply to passenger-car derived LDTs from January 1, 1997 for new homologations and October 1, 1997 for new registrations and would apply to other classes of LDTs from January 1, 1998 for new homologations and October 1, 1998 for new registrations. The European Commission is presently preparing proposals for even more stringent emissions standards and for new enforcement procedures for both passenger cars and trucks (the \"Stage III Directive\"). It is proposed that the Stage III Directive would become effective beginning in 2000 for new vehicle homologations and 2001 for new vehicle registrations.\nCertain European countries are conducting in-use emissions testing to ascertain compliance of motor vehicles with applicable emission standards. These actions could lead to recalls of vehicles; the future costs of related inspection or repairs could be substantial.\nItem 1. Business (Continued) - ---------------------------\nMotor Vehicle Safety - Under the National Traffic and Motor Vehicle Safety Act of 1966, as amended (the \"Safety Act\"), the National Highway Traffic Safety Administration (the \"Safety Administration\") is required to establish appropriate federal motor vehicle safety standards that are practicable, meet the need for motor vehicle safety and are stated in objective terms. The Safety Act prohibits the sale in the United States of any new motor vehicle or item of motor vehicle equipment that does not conform to applicable federal motor vehicle safety standards. Compliance with many safety standards is costly because doing so tends to conflict with the need to reduce vehicle weight in order to meet stringent emissions and fuel economy standards. The Safety Administration also is required to make a determination on the basis of its investigation whether motor vehicles or equipment contain defects related to motor vehicle safety or fail to comply with applicable safety standards and, generally, to require the manufacturer to remedy any such condition at its own expense. The same obligation is imposed on a manufacturer which learns that motor vehicles manufactured by it contain a defect which the manufacturer decides in good faith is related to motor vehicle safety. There currently are pending before the Safety Administration a number of major investigations relating to alleged safety defects or alleged noncompliance with applicable safety standards in vehicles built, imported or sold by Ford. The cost of recall programs to remedy safety defects or noncompliance, should any be determined to exist as a result of certain of such investigations, could be substantial.\nCanada, the European Union, individual member countries within the European Union and other countries in Europe, Latin America and the Asia-Pacific markets also have safety standards applicable to motor vehicles and are likely to adopt additional or more stringent standards in the future. The cost of complying with these standards, as well as the cost of any recall programs to remedy safety defects or noncompliance, could be substantial.\nMotor Vehicle Fuel Economy - Passenger cars and trucks rated at less than 8,500 pounds gross vehicle weight are required by regulations issued by the Safety Administration pursuant to the Motor Vehicle Information and Cost Savings Act (the \"Cost Savings Act\") to meet separate minimum CAFE standards. Failure to meet the CAFE standard in any model year, after taking into account all available credits, would subject a manufacturer to the imposition of a civil penalty of $5 for each one-tenth of a mile per gallon (\"mpg\") under the applicable standard multiplied by the number of vehicles in the class (i.e., trucks, domestic cars, or imported cars) produced in that model year. Each such class of vehicle may earn credits either as a result of exceeding the standard in one or more of the preceding three model years (\"carryforward credits\") or pursuant to a plan, approved by the Safety Administration, under which a manufacturer expects to exceed the standard in one or more of the three succeeding model years (\"carryback credits\"), but credits earned by a class may not be applied to any other class of vehicles.\nThe Cost Savings Act established a passenger car CAFE standard of 27.5 mpg for the 1985 and later model years, which the Safety Administration asserts it has the authority to amend to a level it determines to be the \"maximum feasible\" level (considering the following factors: technological feasibility, economic practicality, the effect of other federal motor vehicle standards on fuel economy, and the need of the nation to conserve energy). Pursuant to the Cost Savings Act, the Safety Administration has established a 20.7 mpg CAFE standard applicable to light trucks (under 8,500 pounds gross vehicle weight on a combined two-wheel drive\/four-wheel drive basis) for model years 1996 and 1997 and has proposed the same for 1998.\nThe EPA issued proposed regulations pursuant to the Clean Air Act that would change the test procedures for measuring motor vehicle emissions and fuel economy. If adopted without adequate adjustments, these regulations may require costly measures to reduce tailpipe emissions and to increase fuel economy.\nAlthough Ford expects to be able to comply with the foregoing CAFE standards, there are factors that could jeopardize its ability to comply. These factors include the possibility of changes in market conditions, including a shift in demand for larger vehicles and a decline in demand for small and middle-size vehicles; or\nItem 1. Business (Continued) - ---------------------------\nconversely, a shortage of reasonably priced gasoline resulting in a decreased demand for more profitable vehicles and a corresponding increase in demand for relatively less profitable vehicles.\nIt is anticipated that efforts may be made to raise the CAFE standard because of concerns for carbon dioxide (\"CO2\") emissions, energy security or other reasons. President Clinton's Climate Change Action Plan (\"CCAP\") sets a goal to improve new vehicle fuel efficiency in an amount equivalent to at least 2% per year over a 10 to 15 year period, using a combination of regulatory and nonregulatory measures. The Safety Administration is considering significant increases in the truck CAFE standard for the 1999 - 2006 model years that could be as high as 28 mpg by the 2006 model year. If the CCAP goals are partially or fully implemented through increases in the CAFE standard, or if significant increases in car or light truck CAFE standards for subsequent model years otherwise are imposed, Ford would find it necessary to take various costly actions that would have substantial adverse effects on its sales volume and profits. For example, Ford could find it necessary to curtail or eliminate production of larger family-size and luxury passenger cars and full-size light trucks, restrict offerings of engines and popular options, and continue or increase market support programs for its most fuel-efficient passenger cars and light trucks.\nInternational concerns over global warming due to the emission of \"greenhouse gasses\" have given rise to strong pressures to increase fuel economy of motor vehicles as a means of limiting their emission of CO2. For example, the United Nations Climate Change Convention held in Brazil in 1992 (the \"U.N. Climate Change Convention\") sought to stabilize greenhouse gas emissions at 1990 levels by the year 2000. A subsequent meeting of the parties to the U.N. Climate Change Convention in Berlin in March 1995 resulted in an agreement to establish goals by 1997 for reductions in greenhouse gas emissions after the year 2000.\nIn December 1994, the European Union Council of Environmental Ministers directed the European Commission to develop proposals for reducing CO2 emissions from passenger cars to 120 grams per kilometer by 2005 (which equates to 5 liters consumed per 100 kilometers for gasoline engines and 4.5 liters consumed per 100 kilometers for diesel engines). Similar proposals have been made within the European Parliament. In December 1995, the European Commission issued a communication to the Council and the Parliament proposing a package of potential measures for reducing CO2 emissions from passenger cars. These include fiscal measures (taxes and incentives), fuel economy labeling, increased research and development efforts, and a negotiated agreement with industry for reduction in CO2 emissions from new cars of 25% from 1990 levels by 2005. The proposed agreement may also include incremental targets and monitoring provisions for the years before 2005. Some of these proposals, if adopted, could require costly actions that could have substantial adverse effects on Ford's sales volumes and profits in Europe.\nOn March 23, 1995, the German Automobile Manufacturers Association (of which Ford Werke A.G. is a member) undertook an industry-wide voluntary agreement with the German government to reduce the average fuel consumption of new cars sold in Germany by 25% from 1990 levels by 2005, to review before the year 2000 the need for and feasibility of further reductions in average fuel consumption, to make regular reports on fuel consumption, and to increase industry research and development efforts. At the same time, the German government undertook to improve traffic management systems, eliminate infrastructure bottlenecks, integrate transport modes, promote alternative fuels and improved drive systems, and introduce an emission-based road tax system.\nOn January 26, 1996, French vehicle manufacturers made a voluntary pledge to reduce the average fuel consumption of new vehicles to a sales-weighted average of 150 grams of CO2 per kilometer by 2005, to offer at least one vehicle that emits less than 120 grams of CO2 per kilometer by 2005, to propose an objective by 2000 for further reducing CO2 emissions by 2010, and to promote alternative fuel technologies that result in reduced CO2 emissions. This pledge assumes a 50\/50 mix of gasoline and diesel engined vehicles, no change in the mix of vehicles by weight and engine size class, no new regulatory requirement beyond those forecast in 1995 for the year 2000, and that oil companies and tire\nItem 1. Business (Continued) - ---------------------------\nproducers will contribute to reduction in vehicle fuel consumption. The pledge of the French vehicle manufacturers may create pressure for similar pledges from automobile importers (such as Ford France S.A.).\nOther initiatives for reducing CO2 emissions from motor vehicles may be proposed by other European countries. Taken together such proposals could have substantial adverse effects on Ford's sales volumes and profits in Europe.\nJapan has adopted automobile fuel consumption goals that manufacturers must attempt to achieve by the 2000 model year. The consumption levels apply only to gasoline-powered vehicles, vary by vehicle weight, and range from 5.8 km\/I to 19.2 km\/l. To achieve these target fuel consumption levels for the vehicles Ford exports to Japan may require costly actions that could have substantial adverse effects on Ford's sales volume and profits in Japan.\nThe U.S. Energy Tax Act of 1978, as amended, imposes a federal excise tax on automobiles which do not achieve prescribed fuel economy levels. Additional legislative proposals could be introduced that, if enacted, would increase excise taxes or create economic disincentives to purchase any except the least fuel consuming vehicles. Because of the uncertainties and variables inherent in testing for fuel economy and the uncertain effect on fuel economy of other government requirements, it is not possible to predict the amount of excise tax, if any, which may be incurred.\nStationary Source Air Pollution Control - Pursuant to the Clean Air Act the states are required to amend their implementation plans to require more stringent limitations on the quantity of pollutants which may be emitted into the atmosphere, and other controls, to achieve national ambient air quality standards established by the EPA. In addition, the Act requires reduced emissions of substances that are classified as hazardous 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 Act requires the EPA and the states to adopt regulations, and allows states to adopt standards more stringent than those required by the Act. The costs to comply with these provisions of the Act cannot presently be quantified but could be substantial. In addition, the enormous complexity and time-consuming nature of the comprehensive federal- state permit program provided for by the Act may reduce operational flexibility and may delay or prevent future competitive upgrading of Ford's production facilities in the United States.\nWater Pollution Control - Pursuant to the Federal Clean Water Act (the \"Clean Water Act\"), Ford has been issued National Pollutant Discharge Elimination System permits which establish certain pollution control standards for its manufacturing facilities that discharge wastewater into public waters. Ford, among many other companies, also is required to comply with certain standards and obtain permits relating to discharges into municipal sewerage systems. The EPA also requires management standards and, in some cases, permits for the discharge of storm water. The standards under the Clean Water Act are established by the EPA and by the state where a facility is located. Many states have requirements that go beyond those established under the Clean Water Act. These various requirements may necessitate the addition of costly control equipment.\nThe EPA recently adopted regulations, pursuant to the Great Lakes Critical Programs Act of 1990, that require more restrictive standards for discharges into waters that impact the Great Lakes. These regulations may require the addition of costly control equipment.\nHazardous Waste Control - Pursuant to the Federal Resource Conservation and Recovery Act (\"RCRA\"), the EPA has issued regulations establishing certain procedures and standards for persons who generate, transport, treat, store, or dispose of hazardous wastes. These regulations also require permits for treatment, storage, and disposal facilities and corrective action for prior releases at sites where permits are issued. The EPA has delegated permit authority to states with programs equivalent to\nItem 1. Business (Continued) - ---------------------------\nRCRA, and states may adopt even more extensive requirements. The Federal Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (the \"Superfund Act\"), requires disclosure of certain releases from Ford facilities into the environment, creates potential liability for remediation costs at sites where Ford waste was disposed and for damage to natural resources resulting from a release, and provides for citizens' suits for failure to comply with final requirements of orders or regulations. A number of states have enacted separate state laws of this type. In addition, under the Federal Toxic Substances Control Act (\"TSCA\"), the EPA evaluates environmental and health effects of existing chemicals and new substances. Pursuant to TSCA, the EPA has banned production of polychlorinated biphenyls and regulates their use in transformers, capacitors and other equipment that may be located at Ford's facilities.\nEuropean Stationary Source Environmental Control - The European Union by directives and regulations, and individual member countries by legislation and regulations, impose requirements on waste and hazardous wastes, incineration, packaging, landfill, soil pollution, integrated pollution control, air emissions standards, import\/export and use of dangerous substances, air and water quality standards, noise, environmental management systems, energy efficiency, emissions reporting, and planning and permitting. Additional or more stringent requirements (including tax measures and civil liability schemes for cleaning polluted sites) are likely to be adopted in the future. The cost of complying with these standards could be substantial.\nClimate Change Convention - In response to the requirements of the U.N. Climate Change Convention, national governments are examining ways to reduce potential global warming risks. These actions may restrict the use of certain chemicals that are used as refrigerants (in vehicles and buildings), such as R-134a, and cleaning solvents.\nWorldwide Regulatory Compatibility - Ford's efforts to develop new markets and increase imports are impeded by incompatible automotive safety, environmental and other product regulatory standards. At present, differing standards either restrict the vehicles Ford can export to serve new markets or increase the cost and complexity to do so. Also, vehicle safety is a priority with customers in North America, Europe and key Asia-Pacific markets and better global understanding of real-world accidents and injuries is a competitive necessity.\nThe \"traditional\" and developed automotive markets have developed their own bodies of regulation. Two sets of European vehicle regulations overlay those of individual European countries: 1) European Union directives and regulations, which member countries are obliged to implement; and 2) United Nations Economic Commission for Europe (ECE) regulations, which member countries have the option to implement. Although European Union directives and regulations and ECE regulations generally are aligned (the European Union directives cover about half of the 99 ECE regulations), some variations exist in the manner in which they are interpreted and enforced by each member country. The United States and Canada use a substantially different regulatory system, and Japan and Australia use a hybrid of the ECE system.\nThe ECE regulations are generally recognized outside the above markets. Countries in the process of defining motor vehicle regulations, such as China, India, Malaysia and Russia, are adopting ECE (versus U.S.) regulations. As a result, U.S.-built vehicles have to be modified for these markets.\nThe U.S. and Europe have so far shown limited willingness to accept each other's regulations, and negotiations for acceptance of U.S. regulations as being functionally equivalent to the ECE standards in emerging markets have had limited success.\nPollution Control Costs - During the period 1996 through 2000, Ford expects that approximately $700 million will be spent on its North American and European facilities to comply with air and water pollution and hazardous waste control standards which now are in effect or are scheduled to come into effect. Of this total, Ford estimates that approximately $200 million will be spent in 1996 and $150 million will be spent in 1997.\nItem 1. Business (Continued) - ---------------------------\nEmployment Data ---------------\nIn 1995, Ford's worldwide average employment increased to 346,990 from 337,728 in 1994. The increase in average employment for 1995 resulted primarily from the full-year (versus partial- year) inclusion of Hertz as a consolidated subsidiary. Worldwide payrolls were $16.6 billion in 1995, an increase of $719 million from 1994.\nAverage employment by geographic area in 1995 compared with 1994 levels was as follows:\nItem 4A. Executive Officers of the Registrant (Continued) - --------------------------------------------------------\nItem 4A. Executive Officers of the Registrant (Continued) - --------------------------------------------------------\nItem 4A. Executive Officers of the Registrant (Continued) - --------------------------------------------------------\n__________________ (1) Also Chairman of the Organization Review and Nominating Committee of the Board of Directors. (2) Also a member of the Finance Committee of the Board of Directors.\nSome of the officers listed above also are members of one or more additional committees of the Registrant that are not committees of the Board of Directors.\nAll of the above officers, other than Mr. Ross, have been employed by the Registrant or its subsidiaries in one or more capacities during the past five years. Before joining Ford, Mr. Ross had been a partner in the New York law firm of Davis, Polk & Wardwell since 1989.\nUnder the By-Laws of the Registrant the executive officers are elected by the Board of Directors at the Annual Meeting of the Board of Directors held for this purpose, each to hold office until his or her successor shall have been chosen and shall have qualified or as otherwise provided in the By-Laws.\nItem 5.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters - ------------------------------------------------------------\nPART II\nThe Common Stock of Ford presently is listed on the New York and Pacific Coast Stock Exchanges in the United States and on certain stock exchanges in Belgium, France, Germany, Switzerland and the United Kingdom. Ford is considering, however, the withdrawal of its Common Stock from listing and registration on certain of these foreign stock exchanges.\nThe high and low sales prices for Ford Common Stock and the dividends paid per share of Common and Class B Stock for each full quarterly period in the years indicated were as follows (in each case, adjusted to reflect a 2-for-1 stock split in the form of a 100% stock dividend on Ford's Common and Class B Stock effective June 6, 1994):\n___________________________ * Prices reflect New York Stock Exchange Composite Transactions.\nAs of February 1, 1996, stockholders of record of Ford included 280,738 holders of Common Stock and 110 holders of Class B Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data - ---------------------------------\nThe following tables set forth selected financial data and other data concerning Ford for each of the last ten years (dollar amounts in millions except per share amounts):\n_________________\nd\/ The cumulative effects of changes in accounting principles reduced equity by $6,883 million in 1992. e\/ Per hour worked (in dollars). Excludes data for subsidiary companies.\nItem 7.","section_7":"Item 7. Managments's Discussion and Analysis of Financial Condition and Results of Operations - -------------------------------------------------------------------\nOVERVIEW\nThe Company's worldwide net income in 1995 was $4,139 million, or $3.58 per share of Common and Class B stock, compared with $5,308 million, or $4.97 per share in 1994. Fully diluted earnings per share were $3.33 in 1995, compared with $4.44 a year ago. The Company's worldwide sales and revenues were $137.1 billion in 1995, up $8.7 billion, or 7% from 1994. Vehicle unit sales of cars and trucks were 6,606,000, down 247,000 units, or 3.6%. Stockholders' equity was $24.5 billion at December 31, 1995, up $2.9 billion from December 31, 1994.\nThe Company's earnings in 1995 were down from 1994, a record year, and reflected the effects of lower volumes in the U.S., costs associated with introducing new products and lower earnings at operations outside the U.S., primarily in Latin America. Earnings from Financial Services operations were up $688 million compared with 1994. The improvement reflected record earnings at Ford Credit, The Associates, USL Capital and Hertz and the nonrecurrence of a $440 million charge to net income in the first quarter of 1994 for the disposition of First Nationwide Bank.\nIn 1995, Automotive capital expenditures for new products and facilities totaled $8.7 billion, up $366 million from 1994. Cash and marketable securities of the Company's Automotive operations were $12.4 billion at December 31, 1995, up $323 million from December 31, 1994. Automotive debt at December 31, 1995 totaled $7.3 billion, up $49 million from a year ago.\nIn 1994, the Company announced a reorganization of its Automotive operations, called \"Ford 2000.\" The reorganization is a fundamental change intended to provide customers with a wider array of vehicles in more markets, assure full competitiveness in vehicle design, quality and value, and substantially reduce the cost of operating Ford's automotive business. The new structure reduces duplication of effort and facilitates best practices around the world by merging Ford's North American Automotive Operations, European Automotive Operations, and Automotive Components Group into a single global organization, Ford Automotive Operations. The new organization was implemented during 1995. The major operations in Latin America and Asia Pacific will be integrated into Ford Automotive Operations during 1996.\nFord is expanding its efforts in many new markets, particularly in the Asia Pacific region including China, India and Thailand. New market development encompasses a variety of business arrangements to establish component manufacturing and vehicle assembly capabilities. Entry into new markets is an integral part of the Company's long-term strategy to improve its global competitive position.\nThe Company's Financial Statements and Notes to Financial Statements on pages FS-1 through FS-31, including the Report of Independent Accountants, should be read as an integral part of this review.\nFourth Quarter of 1995 - ----------------------\nIn the fourth quarter of 1995, the Company's worldwide net income was $660 million, or $0.49 per share of Common and Class B stock, compared with $1,569 million, or $1.47 per share in the fourth quarter of 1994. Fully diluted earnings per share were $0.48 in the fourth quarter of 1995, compared with $1.31 a year ago.\nWorldwide Automotive operations earned $16 million in the fourth quarter of 1995, compared with $1,119 million a year ago. U.S. Automotive operations earned $168 million in the fourth quarter of 1995, compared with $745 million a year ago. The lower results for U.S. Automotive operations reflected lower unit volume and costs associated with introducing new products. Automotive operations outside the U.S. incurred a loss of $152 million in the fourth quarter of 1995, compared with earnings of $374 million a year ago, reflecting primarily losses in Latin America and the nonrecurrence of a one-time favorable effect from devaluation of the Mexican Peso in 1994. Ford's European Automotive operations incurred a loss of $48 million in the fourth quarter of 1995, compared with a loss of $55 million a year ago.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - -------------------------------------------------------------------\nFinancial Services operations earned a record $644 million in the fourth quarter of 1995, compared with $450 million a year ago. The improvement reflected primarily record earnings at Ford Credit, The Associates, USL Capital and Hertz.\nRESULTS OF OPERATIONS: 1995 COMPARED WITH 1994\nAutomotive Operations - ---------------------\nFord's worldwide Automotive operations earned $2,056 million in 1995 on sales of $110.5 billion, compared with $3,913 million in 1994 on sales of $107.1 billion.\nIn the U.S., Ford's Automotive operations earned $1,843 million on sales of $73.9 billion, compared with $3,002 million in 1994 on sales of $73.7 billion. The decline in earnings reflected primarily lower unit volume (reflecting nonrecurrence of a dealer inventory increase in 1994 and lower industry sales) and costs associated with introducing new products (mainly the all-new Taurus, Sable and pickup truck). U.S. Automotive after-tax return on sales was 2.5% in 1995, down 1.6 points from a year ago. It is expected that results in the first half of 1996 will continue to be affected adversely by costs associated with introducing new products (the pickup truck, Escort and Tracer).\nThe U.S. economy grew at a moderate rate in 1995 with interest rates and inflation at comparatively low levels. U.S. car and truck industry volumes, however, decreased from 15.4 million units in 1994 to 15.1 million units in 1995. Most of the decrease in industry sales was attributable to cars. Ford's share of the U.S. car market was 20.9%, down 9\/10 of a point from 1994. Ford's U.S. truck share was 31.9%, up 1.8 points from 1994. Ford's combined U.S. car and truck share was 25.6%, up 4\/10 of a point from 1994. The increase in share reflected primarily higher sales of the Explorer and F-Series trucks, offset partially by lower sales of specialty vehicles and lower availability of the Taurus and Sable due to model changeover.\nOutside the U.S., Automotive operations earned $213 million in 1995 on sales of $36.6 billion, compared with $911 million in 1994 on sales of $33.4 billion. The decline reflected primarily lower results in Latin America.\nFord's European Automotive operations earned $116 million in 1995, compared with $128 million in 1994. The decline reflected primarily costs associated with introducing new products (the all- new Galaxy minivan and Fiesta) and the unfavorable effect of foreign exchange rate changes.\nCar and truck industry sales in Europe were 13.4 million units in 1995, compared with 13.3 million units in 1994. Ford's share of the European car market was 11.9%, equal to a year ago. Ford's European truck share was 14.8%, up 1\/10 of a point from 1994. Ford's combined European car and truck share was 12.3%, up 1\/10 of a point from 1994.\nOutside the U.S. and Europe, Ford earned $97 million in 1995, compared with $783 million in 1994. About half of the decrease reflected primarily unfavorable results for operations in Brazil, where higher import duties and a market shift to small cars resulted in excess dealer inventories and higher marketing costs. These conditions are expected to continue into 1996; business conditions have been and are expected to continue to be volatile and subject to rapid change, which can affect Ford's future earnings. These factors were offset partially in 1995 by a one- time gain from the dissolution of Ford's Autolatina joint venture (discussed below). The decline in earnings outside the U.S. and Europe also reflected the nonrecurrence of a one-time favorable effect for devaluation of the Mexican Peso in 1994 and lower results in Argentina.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) - -------------------------------------------------------------------\nDuring the fourth quarter of 1995, the Company's Autolatina joint venture in Brazil and Argentina with Volkswagen AG was dissolved. The dissolution resulted in a gain of $230 million, primarily from a one-time cash compensation payment to Ford. Historically, earnings in Brazil and Argentina have represented a significant portion of Ford's Automotive earnings outside the U.S. and Europe. The long-term effect, if any, of the dissolution of Autolatina on the Company's future results will depend on Ford's ability to compete on its own in these markets. The Company is reestablishing manufacturing capacity in Brazil for small cars, which should assist in improving Ford's competitiveness.\nFinancial Services Operations - -----------------------------\nThe Company's Financial Services operations earned a record $2,083 million in 1995, up $688 million from 1994. The improvement reflected record earnings at Ford Credit, The Associates, USL Capital and Hertz and the nonrecurrence of a $440 million charge to net income in the first quarter of 1994 for the disposition of First Nationwide Bank.\nFord Credit's consolidated net income was a record $1,395 million in 1995, up $82 million from 1994. The improvement reflected primarily higher levels of earning assets, favorable tax adjustments and improved cost performance, offset partially by lower net interest margins and higher credit losses. Depreciation costs increased as a result of continued growth in operating leases; the related lease revenues more than offset the increased depreciation. Ford Credit's results for 1995 included $255 million from equity in the net income of affiliated companies, primarily Ford Holdings, compared with $233 million a year ago. Ford Holdings is a holding company which, through December 1995, owned primarily The Associates, USL Capital and American Road. The international operations managed by Ford Credit, but not included in its consolidated results, earned $265 million in 1995, up $24 million from 1994, reflecting primarily higher levels of earning assets, offset partially by lower net interest margins.\nThe Associates earned a record $632 million in the U.S. in 1995, up $84 million from 1994. The increase reflected higher levels of earning assets and improved net interest margins. The international operations managed by The Associates, but not included in its consolidated results, earned $114 million in 1995, up $38 million from 1994.\nUSL Capital earned a record $135 million in 1995, up $26 million from 1994. The improvement resulted primarily from higher levels of earning assets, higher gains on asset sales and lower operating costs. Hertz earned a record $105 million in 1995, up $13 million from 1994. The increase reflected primarily higher volume in construction equipment rentals and sales, offset partially by increased depreciation and borrowing costs. American Road earned $28 million in 1995, down $30 million from 1994. The decline reflected primarily the nonrecurrence of prior year tax adjustments and a loss on disposition of the annuity business.\nIn December 1995, Ford Holdings merged with Ford Holdings Capital Corporation, a subsidiary of Ford Holdings, which resulted in the cancellation of the voting preferred stock of Ford Holdings in exchange for payment by Ford Holdings of the liquidation preference of the stock plus accrued dividends (totaling about $2 billion). Ford Holdings funded the payment to the holders of the preferred stock, which occurred in January 1996, primarily with bank loans.\nIn late 1995, Ford began a reorganization of its Financial Services group in order to align management responsibility more closely with the legal ownership of the Financial Services affiliates. As part of this reorganization, substantially all of the common stock of Ford Holdings owned by Ford Credit was repurchased by Ford Holdings in exchange for a promissory note.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) - -------------------------------------------------------------------\nAlso, in February 1996, The Associates filed a registration statement with the Securities and Exchange Commission for an initial public offering of its common stock representing up to a 19.8% economic interest in The Associates. As previously announced, Ford is investigating the sale of all or a part of USL Capital. A fuller description of the reorganization is provided in Item 1. \"Business - Financial Services Operations - Ford Holdings, Inc. and Ford FSG, Inc.\"\nHISTORICAL REFERENCE: 1994 COMPARED WITH 1993\nThe Company's worldwide net income in 1994 was a record $5,308 million, or $4.97 per share of Common and Class B stock, compared with $2,529 million, or $2.27 per share in 1993. Fully diluted earnings per share were $4.44, compared with $2.10 a year ago. Sales and revenues totaled $128.4 billion in 1994, up 18% from 1993. Vehicle unit sales of cars and trucks were 6,853,000, up 669,000 units, or 11%.\nOn June 6, 1994, a 2-for-1 stock split in the form of a 100% stock dividend on the Company's outstanding Common and Class B stock became effective. Earnings per share for prior periods were restated to reflect the stock split.\nThe Company's financial results in 1994 showed substantial improvement compared with 1993. Improvements in U.S. Automotive operations included the favorable effects of higher industry volume and improved margins. Automotive operations outside the U.S. also improved. The improvement reflected primarily higher unit volume, lower manufacturing costs and improved margins in Europe. Earnings from Financial Services operations were down $126 million compared with 1993, which was more than explained by a $440 million write- off for the disposition of First Nationwide Bank (discussed below). The write-off was offset largely by substantially improved earnings at the other operations.\nAutomotive Operations - ---------------------\nNet income from Ford's worldwide Automotive operations was $3,913 million in 1994 on sales of $107.1 billion, compared with $1,008 million in 1993 on sales of $91.6 billion.\nIn the U.S., Ford's Automotive operations earned $3,002 million on sales of $73.7 billion, compared with $1,442 million in 1993 on sales of $62.1 billion. Higher vehicle production, reflecting increased industry sales, accounted for most of the improvement. Improved margins, reflecting mainly favorable material costs, manufacturing efficiencies, and lower marketing costs, were offset partially by higher costs for new products and related facilities. Results in 1993 included the one-time favorable effect of tax legislation ($171 million) for the restatement of U.S. deferred tax balances, and the gain on the sale of Ford's North American automotive seating and seat trim business ($73 million).\nThe U.S. economy grew at an above-trend rate in 1994, and interest rates and inflation remained at comparatively low levels. U.S. car and truck industry volumes increased from 14.2 million units in 1993 to 15.4 million units in 1994. Over 70% of the increase in industry sales was attributable to trucks (including minivans, compact utility vehicles, full-size pickups and compact pickups). Ford's share of the U.S. car market was 21.8%, down half of a point from 1993, reflecting lower shares for the Tempo and Topaz, which were discontinued in 1994. The Company's U.S. truck share was 30.1%, down 4\/10 of a point from 1993, reflecting capacity constraints on the Explorer.\nOutside the U.S., Ford's Automotive operations earned $911 million in 1994 on sales of $33.4 billion, compared with a loss of $434 million in 1993 on sales of $29.5 billion. The improvement reflected primarily higher unit volumes, lower manufacturing costs and improved margins in Europe. Ford's European Automotive operations earned $128 million in 1994, compared with a loss of $873 million in 1993. Results outside the U.S. in 1993 included restructuring charges at Jaguar ($174 million) and at Ford of Australia ($57 million), offset partially by the favorable one-time effect of a reduction in German tax rates ($59 million).\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) - -------------------------------------------------------------------\nCar and truck industry sales in Europe were 13.3 million units in 1994, compared with 12.6 million units in 1993. Ford's European car market share was 11.9% in 1994, up 3\/10 of a point from 1993. Ford's European truck share improved 2\/10 of a point to 14.7%.\nFinancial Services Operations - -----------------------------\nThe Company's Financial Services operations earned $1,395 million in 1994, down $126 million from 1993. The decline was more than explained by the charge to net income of $440 million in 1994 related to the disposition of First Nationwide Bank. This charge, however, was offset largely by record earnings at Ford Credit, The Associates and USL Capital, and the consolidation of results for Hertz. Results in 1993 included an unfavorable one- time effect of $31 million from tax legislation in the U.S.\nFord Credit's consolidated net income was a record $1,313 million in 1994, up $119 million from 1993. The improvement reflected primarily higher levels of earning assets, the one-time effect of the gain on sale of an interest in Manheim Auctions, Inc. (an auto auction company), the nonrecurrence of the one-time tax adjustment in 1993 for increased U.S. tax rates, and improved cost performance; partial offsets included lower net interest margins and lower gains from the sale of receivables. Ford Credit's results in 1994 included $233 million from equity in the net income of affiliated companies, primarily Ford Holdings, compared with $198 million a year ago. Depreciation costs increased as a result of continued growth in operating leases; the related lease revenues more than offset the increased depreciation. The international operations managed by Ford Credit, but not included in its consolidated results, earned $241 million in 1994, up $42 million from 1993, reflecting primarily higher levels of earning assets and lower credit losses.\nThe Associates earned a record $548 million in the U.S. in 1994, up $78 million from 1993. The increase reflected higher levels of earning assets and improved net interest margins. The international operations managed by The Associates, but not included in its consolidated results, earned $76 million in 1994, up $38 million from 1993, reflecting primarily higher levels of earning assets.\nUSL Capital earned a record $109 million in 1994, up $32 million from 1993. The increase reflected higher earning assets, lower operating costs and the nonrecurrence of the one-time tax adjustment in 1993 for increased U.S. tax rates. American Road earned $58 million in 1994, compared with $79 million in 1993. The decline reflected primarily reduced investment income from capital gains.\nIn April 1994, Hertz became a wholly owned subsidiary of Ford. In 1994, Financial Services net income included $92 million for Hertz. In 1993, Automotive net income included $26 million for Hertz (reflecting Ford's prior equity interest).\nOn September 30, 1994, substantially all of the assets of First Nationwide Bank, since known as Granite Savings Bank (the \"Bank\"), were sold to, and substantially all of the Bank's liabilities were assumed by, First Madison Bank, FSB. The Bank is a wholly owned subsidiary of Granite Management Corporation (formerly First Nationwide Financial Corporation) (\"Granite\"), which in turn is a wholly owned subsidiary of Ford. In 1994, Granite incurred a loss of $484 million including a charge of $440 million related to the disposition of the Bank, reflecting the nonrecovery of goodwill and reserves for estimated losses on assets not included in the sale. Granite incurred a loss of $55 million in 1993.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) - -------------------------------------------------------------------\nLIQUIDITY AND CAPITAL RESOURCES\nAutomotive Operations - ---------------------\nCash and marketable securities of the Company's Automotive operations were $12.4 billion at December 31, 1995, up $323 million from December 31, 1994. The Company paid $1.6 billion in cash dividends on its Common Stock, Class B Stock and Preferred Stock during 1995.\nAutomotive capital expenditures were $8.7 billion in 1995, up $366 million from 1994. During the next several years, Ford's spending for product change is expected to be at similar levels; however, as a percent of sales, such spending is expected to be at lower levels.\nAt December 31, 1995, Automotive debt totaled $7.3 billion, which was 22% of total capitalization (stockholders' equity and Automotive debt), compared with $7.3 billion, or 25% of total capitalization, at December 31, 1994.\nAt December 31, 1995, Ford had long-term contractually committed global credit agreements under which $8.4 billion is available from various banks at least through June 30, 2000. The entire $8.4 billion may be used, at Ford's option, by any affiliate of Ford; however, any borrowing by an affiliate will be guaranteed by Ford. In addition, Ford has the ability to transfer on a nonguaranteed basis the entire $8.4 billion in varying portions to Ford Credit and Ford Credit Europe. These facilities were unused at December 31, 1995.\nIn addition, at December 31, 1995, Ford Brasil Ltda. had $276 million of contractually committed credit facilities with various banks ranging in maturity from June 1996 to December 1996. None of these facilities were in use at December 31, 1995.\nFinancial Services Operations - -----------------------------\nThe Financial Services operations rely heavily on their ability to raise substantial amounts of funds in the capital markets in addition to collections on loans and retained earnings. The levels of funds for certain Financial Services operations are affected by certain transactions with Ford, such as capital contributions, dividend payments and the timing of payments for income taxes. Their ability to obtain funds also is affected by their debt ratings which, for certain operations, are closely related to the financial condition and outlook for Ford and the nature and availability of support facilities, such as revolving credit and receivables sales agreements.\nFord Credit's outstanding commercial paper totaled $35 billion at December 31, 1995 with an average remaining maturity of 29 days. Support facilities represent additional sources of funds, if required.\nAt December 31, 1995, Financial Services had a total of $48.5 billion of contractually committed support facilities. Of these facilities, $23.8 billion (excluding the $8.4 billion of Ford credit facilities) are contractually committed global credit agreements under which $19.8 billion and $4 billion are available to Ford Credit and Ford Credit Europe, respectively, from various banks; 62% and 75%, respectively, of such facilities are available through June 30, 2000. The entire $19.8 billion may be used, at Ford Credit's option, by any subsidiary of Ford Credit, and the entire $4 billion may be used, at Ford Credit Europe's option, by any subsidiary of Ford Credit Europe. Any borrowings by such subsidiaries will be guaranteed by Ford Credit or Ford Credit Europe, as the case may be. At December 31, 1995, none of the Ford Credit global facilities were in use; $742 million of the Ford Credit Europe global facilities were in use. In addition to the Ford, Ford Credit and Ford Credit Europe global credit agreements, at December 31, 1995, international subsidiaries and other credit operations managed by Ford Credit had $1.1 billion of contractually committed support facilities available outside the U.S. At December 31, 1995, approximately 29% of these facilities were in use.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) - -------------------------------------------------------------------\nAt December 31, 1995, Ford Holdings had outstanding long-term debt of $1.9 billion, of which $205 million matures in 1996. All of the Ford Holdings debt held by nonaffiliated persons is guaranteed by Ford. Ford Holdings has a $1.5 billion term loan agreement available through December 13, 1996, none of which was in use at December 31, 1995, but all of which has since been used to fund the payment to the holders of Ford Holdings' preferred stock discussed above.\nAt December 31, 1995, The Associates had contractually committed lines of credit with banks of $3.9 billion, with various maturities ranging from January 31, 1996 to December 30, 1996, none of which were utilized at December 31, 1995. Also, at December 31, 1995, The Associates had $5.1 billion of contractually committed revolving credit facilities with banks, with maturity dates ranging from January 1, 1996 through April 1, 2001, and $1.3 billion of contractually committed receivables sale facilities, $275 million of which are available through April 24, 1996, $500 million of which are available through April 15, 1997, and $500 million of which are available through April 30, 1998; none of these facilities were in use at December 31, 1995. At December 31, 1995, international operations managed by The Associates, but not included in its support facilities, had about $270 million of contractually committed support facilities available outside the U.S., of which $50 million were in use at December 31, 1995.\nAt December 31, 1995, USL Capital had $1.7 billion of contractually committed credit facilities, of which 71% are available through September 2000. These facilities included $46 million of contractually committed receivables sale facilities, of which 100% were in use at December 31, 1995. At December 31, 1995, international operations managed by USL Capital, but not included in its support facilities, had about $3 million of contractually committed support facilities available outside the U.S., of which 50% were in use at December 31, 1995.\nAmerican Road's principal sources of funds are insurance premiums and investment income. American Road had no debt and none of its own credit lines at December 31, 1995.\nAt December 31, 1995, Hertz had $2 billion of contractually committed credit facilities in the U.S., none of which were utilized at December 31, 1995. These facilities included $751 million and $1 billion of agreements with banks which mature June 27, 1996 and June 30, 2000, respectively, and a $250 million revolving credit facility with Ford which matures June 30, 1999. In addition, at December 31, 1995, international operations of Hertz had about $317 million of contractually committed support facilities available outside the U.S., of which about 53% were in use at December 31, 1995.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------\nThe Financial Statements and Notes to Financial Statements of the Registrant and the Report of Independent Accountants that are filed as part of this Report are listed under Item 14. \"Exhibits, Financial Statement Schedules, and Reports on Form 8-K\" and are set forth on pages FS-1 through FS-31 immediately following the signature pages of this Report.\nSelected quarterly financial data of Ford and its consolidated subsidiaries for 1995 and 1994 are set forth in Note 18 of Notes to Financial Statements.\nItem 9.","section_9":"Item 9. Disagreements With Accountants on Accounting and Financial Disclosure - ----------------------------------------------------------\nNot required.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------\nThe information called for by Item 10 is incorporated by reference from the information under the caption \"Election of Directors\" in the Proxy Statement, except that the information called for by Item 10 with respect to executive officers of the Registrant appears as Item 4A under Part I of this Report.\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nThe information called for by Item 11 is incorporated by reference from the information under the captions \"Compensation of Directors\", \"Compensation and Option Committee Report on Executive Compensation\" and \"Compensation of Executive Officers\" in the 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 from the information on page 1 of, and under the caption \"Election of Directors\" in, the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nThe information called for by Item 13 is incorporated by reference from the information under the caption \"Certain Relationships and Related Transactions\" 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 - Ford Motor Company and Subsidiaries\nConsolidated Statement of Income 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.\nConsolidated Statement of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nNotes to Financial Statements\nReport of Independent Accountants\nThe Financial Statements, the Notes to Financial Statements and the Report of Independent Accountants listed above are filed as part of this Report and are set forth on pages FS-1 through FS-31 immediately following the signatures pages of this Report.\n(a) 2. Financial Statement Schedules\nDesignation Description - ----------- ----------- Supplemental Schedule Condensed Financial Information of Subsidiary\nThe Financial Statement Schedule listed above is filed as part of this Report and is set forth on page FSS-1 immediately following page FS-31. The schedules not filed are omitted because the information required to be contained therein is disclosed elsewhere in the Financial Statements or the amounts involved are not sufficient to require submission.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) - ----------------------------------------------------------------\n(a) 3. Exhibits\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) - -------------------------------------------------------------\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) - -----------------------------------------------------------------\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) - ----------------------------------------------------------------\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) - ----------------------------------------------------------------\nInstruments defining the rights of holders of certain issues of long-term debt of the Registrant and of certain consolidated subsidiaries and of any unconsolidated subsidiary, for which financial statements are required to be filed with this Report, have not been filed as exhibits to this Report because the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of each of such instruments to the Commission upon request.\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1995, the Registrant filed the following Current Reports on Form 8-K:\n1. Current Report on Form 8-K dated October 12, 1995 that included information regarding possible strategic actions with respect to the Registrant's Financial Services group.\n2. Current Report on Form 8-K dated October 18, 1995 that included information regarding the consolidated results of operations and financial condition of the Registrant and its subsidiaries for the three and nine-month periods ended or at September 30, 1995.\n3. Current Report on Form 8-K dated November 9, 1995 that included information regarding the Registrant's 7-1\/8% Debentures due November 15, 2025.\n4. Current Report on Form 8-K dated December 11, 1995 that included information regarding extension of an exchange offer for the Registrant's Series B Cumulative Preferred Stock.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFORD MOTOR COMPANY\nBy: John M. Devine* --------------- (John M. Devine) Group Vice President and Chief Financial Officer\nDate: March 19, 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.\n- - - - - - *Includes a loss of $440 million related to the disposition of Granite Savings Bank (formerly First Nationwide Bank)\nSegment results for 1994 have been adjusted to reflect reclassification of certain tax amounts to conform with the 1995 presentation.\nFS-1\nVehicle unit sales are reported worldwide on a \"where sold\" basis and include sales of all Ford-badged units, as well as units manufactured by Ford and sold to other manufacturers.\nFourth Quarter and Full Year 1994 unit sales have been restated to reflect the country where sold and to include sales of all Ford-badged units. Previously, factory unit sales were reported in North America on a \"where sold\" basis and overseas on a \"where produced\" basis. Also, Ford-badged unit sales of certain unconsolidated subsidiaries (primarily Autolatina -- Brazil and Argentina) were not previously reported.\nFS-2\nThe accompanying notes are part of the financial statements.\nFS-3\n- - - - - - *Less than $1 million The accompanying notes are part of the financial statements.\nFS-4\nThe accompanying notes are part of the financial statements.\nFS-5\n- - - - - - *The balances at the beginning and end of each period were less than $1 million.\nThe accompanying notes are part of the financial statements.\nFS-6\nFord Motor Company and Subsidiaries\nNotes to Financial Statements\nNOTE 1. Accounting Policies - ----------------------------\nPrinciples of Consolidation - --------------------------- The consolidated financial statements include all significant majority owned subsidiaries and reflect the operating results, assets, liabilities and cash flows for two business segments: Automotive and Financial Services. The assets and liabilities of the Automotive segment are classified as current or noncurrent, and those of the Financial Services segment are unclassified. Affiliates that are 20% to 50% owned, principally Mazda Motor Corporation and AutoAlliance International Inc., and subsidiaries where control is expected to be temporary, principally investments in certain dealerships, are generally accounted for on an equity basis. For purposes of Notes to Financial Statements, \"Ford\" or \"the company\" means Ford Motor Company and its majority owned consolidated subsidiaries unless the context requires otherwise.\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.\nNature of Operations - --------------------\nThe company operates in two principal business segments: Automotive and Financial Services. The Automotive segment consists of the design, manufacture, assembly and sale of cars, trucks and related parts and accessories. The Financial Services segment consists primarily of financing operations, insurance operations, and vehicle and equipment leasing operations.\nIntersegment transactions represent principally transactions occurring in the ordinary course of business, borrowings and related transactions between entities in the Financial Services and Automotive segments, and interest and other support under special vehicle financing programs. These arrangements are reflected in the respective business segments.\nRevenue Recognition - Automotive - --------------------------------\nSales are recorded by the company when products are shipped to dealers, except as described below. Estimated costs for approved sales incentive programs normally are recognized as sales reductions at the time of revenue recognition. Estimated costs for sales incentive programs approved subsequent to the time that related sales were recorded are recognized when the programs are approved.\nBeginning December 1, 1995, sales through dealers to certain daily rental companies where the daily rental company has an option to require the company to repurchase vehicles, subject to certain conditions, are recognized over the period of daily rental service in a manner similar to lease accounting. This change in accounting principle was made as a result of the consensus reached on November 15, 1995 by the Emerging Issues Task Force of the Financial Accounting Standards Board on Issue 95-1 concerning the timing of revenue recognition when a manufacturer conditionally guarantees the resale value of a product or agrees to repurchase the product at a fixed price. The company elected to recognize this change in accounting principle on a prospective basis. The effect on the company's 1995 consolidated results of operations was not material, nor is it expected to have a material effect in future years. Implementation of this change will not affect the company's cash flow. Previously, the company recognized revenue for these vehicles when shipped.\nFS-7\nNOTE 1. Accounting Policies (Cont'd) - ----------------------------\nRevenue Recognition - Financial Services - ----------------------------------------\nRevenue from finance receivables is recognized over the term of the receivable using the interest method. Certain loan origination costs are deferred and amortized over the term of the related receivable as a reduction in financing revenue. Revenue from operating leases is recognized as scheduled payments become due. Agreements between Automotive operations and certain Financial Services operations provide for interest supplements and other support costs to be paid by Automotive operations on certain financing and leasing transactions. Financial Services operations recognize this revenue in income over the period that the related receivables and leases are outstanding; the estimated costs of interest supplements and other support costs are recorded as sales incentives by Automotive operations.\nOther Costs - -----------\nAdvertising and sales promotion costs are expensed as incurred. Advertising costs were $2,024 million in 1995, $1,823 million in 1994 and $1,610 million in 1993.\nEstimated costs related to product warranty are accrued at the time of sale.\nResearch and development costs are expensed as incurred and were $6,509 million in 1995, $5,811 million in 1994, and $5,618 million in 1993.\nIncome Per Share of Common and Class B Stock - --------------------------------------------\nIncome per share of Common and Class B Stock is calculated by dividing the income attributable to Common and Class B Stock by the average number of shares of Common Stock and Class B Stock outstanding during the applicable period.\nThe company has outstanding securities, primarily Series A Preferred Stock, that could be converted to Common Stock. Other obligations, such as stock options, are considered to be common stock equivalents. The calculation of income per share of Common and Class B Stock assuming full dilution takes into account the effect of these convertible securities and common stock equivalents when the effect is material and dilutive.\nIncome attributable to Common and Class B Stock was as follows (in millions):\n- - - - - * Represents a one-time reduction of $0.06 per share of Common and Class B Stock related to the exchange of Series B Preferred Stock for company-obligated mandatorily redeemable preferred securities of a subsidiary trust; this adjustment equals the excess of the fair value of company-obligated mandatorily redeemable preferred securities at the date of issuance over the carrying amount of exchanged Series B Preferred Stock\nFS-8\nNOTE 1. Accounting Policies (Cont'd) - ----------------------------\nDerivative Financial Instruments - --------------------------------\nThe company and many of its subsidiaries have entered into agreements to manage certain exposures to fluctuations in foreign exchange and interest rates. All derivative financial instruments are classified as \"held for purposes other than trading;\" company policy specifically prohibits the use of derivatives for speculative purposes.\nFord has operations in many countries outside the U.S., and purchases and sales of finished vehicles and production parts, debt and other payables, subsidiary dividends, and investments in subsidiaries are frequently denominated in foreign currencies. Agreements to manage foreign exchange exposures include foreign currency forward contracts, currency swaps and, to a lesser extent, foreign currency options. Gains and losses on the various agreements are recognized in income during the period of the related transactions, included in the bases of the related transactions, or, in the case of hedges of net investments in foreign subsidiaries, recognized as an adjustment to the foreign currency translation component of stockholders' equity.\nFinancial Services operations issue debt and other payables for which the maturity and interest rate structure differs from the invested assets to ensure continued access to capital markets and to minimize overall borrowing costs. Agreements to manage interest rate exposures include primarily interest rate swap agreements. The differential paid or received on interest rate swap agreements is recognized as an adjustment to interest expense in the period.\nForeign Currency Translation - -----------------------------\nRevenues, costs and expenses of foreign subsidiaries are translated to U.S. dollars at average-period exchange rates. The effect of changes in foreign exchange rates on revenues and costs was generally unfavorable in 1995, 1994 and 1993.\nAssets and liabilities of foreign subsidiaries are translated to U.S. dollars at end-of-period exchange rates. The effects of this translation for most foreign subsidiaries and certain other foreign currency transactions are reported in a separate component of stockholders' equity. Translation gains and losses for foreign subsidiaries that are located in highly inflationary countries or conduct a major portion of their business with the company's U.S. operations are included in income. Also included in income are gains and losses arising from transactions denominated in a currency other than the functional currency of the subsidiary involved.\nThe effect of changes in foreign exchange rates on assets and liabilities, as described above, increased net income by $13 million in 1995, $376 million in 1994, and $419 million in 1993. These amounts included net transaction and translation gains before taxes of $37 million in 1995, $574 million in 1994 and $988 million in 1993. These gains were offset by higher costs of sales that resulted from the use of historical exchange rates for inventories sold during the period in countries with high inflation rates.\nImpairment of Long-Lived Assets and Certain Identifiable Intangibles - --------------------------------------------------------\nThe company 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 company also considers projected future operating results, trends and other circumstances in making such estimates and evaluations.\nStatement 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,\" was issued in March 1995. SFAS 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 SFAS 121 is not expected to be material.\nFS-9\nNOTE 1. Accounting Policies (Cont'd) - ----------------------------\nGoodwill - --------\nGoodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies and is amortized using the straight-line method principally over 40 years. Total goodwill included in Automotive and Financial Services other assets at December 31, 1995 was $2.3 billion and $3.2 billion, respectively.\nCompany-Obligated Mandatorily Redeemable Preferred Securities of a Subsidiary Trust - ----------------------------------------------------------------\nOn December 21, 1995, Ford Motor Company Capital Trust I (the \"Trust\") issued $632 million of its 9% Trust Originated Preferred Securities (the \"Preferred Securities\") in a one-for-one exchange for 25,273,537 shares of the company's outstanding Series B Depositary Shares (\"Depositary Shares\"), each representing 1\/2,000 of a share of Series B Preferred Stock of Ford. Concurrent with the issuance of the Preferred Securities in exchange for Depositary Shares and the related purchase by Ford of the Trust's common securities (the \"Common Securities\"), the company issued to the Trust $651 million aggregate principal amount of its 9% Junior Subordinated Debentures due December 2025 (the \"Debentures\"). The sole assets of the Trust are and will be the Debentures. The interest and other payment dates on the Debentures correspond to the distribution and other payment dates on the Preferred Securities and Common Securities. The Debentures are redeemable, in whole or in part, at the company's option on or after December 1, 2002, at a redemption price of $25 per Debenture plus accrued and unpaid interest. If the company redeems the Debentures, or upon maturity of the Debentures, the Trust is required to redeem the Preferred Securities and Common Securities at $25 per share plus accrued and unpaid distributions.\nFord guarantees to pay in full to the holders of the Preferred Securities all distributions and other payments on the Preferred Securities to the extent not paid by the Trust only if and to the extent that Ford has made a payment of interest or principal on the Debentures. This guarantee, when taken together with Ford's obligations under the Debentures and the Indenture relating thereto and its obligations under the Declaration of Trust of the Trust, including its obligation to pay certain costs and expenses of the Trust, constitutes a full and unconditional guarantee by Ford of the Trust's obligations under the Preferred Securities.\nPreferred Stockholders' Equity in a Subsidiary Company - ------------------------------------------------------\nDuring Fourth Quarter 1995, Ford Holdings, Inc. (\"Ford Holdings\"), a subsidiary of Ford, merged with Ford Holdings Capital Corporation, a subsidiary of Ford Holdings, which resulted in the cancellation of the voting preferred stock of Ford Holdings in exchange for payment by Ford Holdings of the liquidation preference of the stock plus accrued and unpaid dividends. Ford Holdings funded the payment to the holders of the preferred stock primarily with bank loans.\nFS-10\nNOTE 2. Marketable and Other Securities - ----------------------------------------\nTrading securities are recorded at fair value with unrealized gains and losses included in income. Available-for-sale securities are recorded at fair value with unrealized gains and losses excluded from income and reported, net of tax, in a separate component of stockholders' equity. Held-to-maturity securities are recorded at amortized cost. Equity securities which do not have readily determinable fair values are recorded at cost. The bases of cost used in determining realized gains and losses are specific identification for Automotive operations and first-in, first-out for Financial Services operations.\nThe fair value of most securities was estimated based on quoted market prices. For those securities for which there were no quoted market prices, the estimate of fair value was based on similar types of securities that are traded in the market.\nExpected maturities of debt securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty.\nAutomotive - ----------\nInvestments in securities at December 31, 1995 were as follows (in millions):\nInvestments in securities at December 31, 1994 were as follows (in millions):\nAll debt securities classified as available-for-sale or held-to-maturity had contractual maturities of one year or less.\nIncluded in stockholders' equity at December 31, 1995 and 1994 was $146 million and $188 million, respectively, which represented principally the company's equity interest in the unrealized gains on securities owned by certain unconsolidated subsidiaries.\nFS-11\nNOTE 2. Marketable and Other Securities (Cont'd) - ----------------------------------------\nFinancial Services - ------------------\nInvestments in securities at December 31, 1995 were as follows (in millions):\nInvestments in securities at December 31, 1994 were as follows (in millions):\nFS-12\nNOTE 2. Marketable and Other Securities (Cont'd) - ----------------------------------------\nFinancial Services (Cont'd) - ------------------\nThe amortized cost and fair value of investments in available-for-sale securities and held-to-maturity securities at December 31, 1995, by contractual maturity, were as follows (in millions):\nThe amortized cost and fair value of investments in available-for-sale securities and held-to-maturity securities at December 31, 1994, by contractual maturity, were as follows (in millions):\nProceeds from sales of available-for-sale securities were $2.4 billion in 1995 and $9.1 billion in 1994; gross gains of $39 million and gross losses of $18 million were realized on those sales in 1995, and gross gains of $24 million and gross losses of $56 million were realized on those sales in 1994. Stockholders' equity included, net of tax, a net unrealized gain of $56 million at December 31, 1995 and a net unrealized loss of $155 million at December 31, 1994. Proceeds from sales of investments in debt securities were $11.2 billion in 1993; gross gains of $113 million and gross losses of $20 million were realized on those sales.\nFS-13\nNOTE 3. Receivables - Financial Services - -----------------------------------------\nIncluded in net receivables and lease investments at December 31 were net finance receivables, investments in direct financing leases and investments in operating leases. The investments in direct financing and operating leases relate to the leasing of vehicles, various types of transportation and other equipment, and facilities.\nNet finance receivables at December 31 were as follows (in millions):\nIncluded in finance receivables at December 31, 1995 and 1994 were a total of $1.3 billion owed by three customers with the largest receivable balances. Other finance receivables consisted primarily of commercial and consumer loans, collateralized loans, credit card receivables, general corporate obligations and accrued interest. Also included in other finance receivables at December 31, 1995 and 1994 were $3.5 billion and $3.4 billion, respectively, of accounts receivable purchased by certain Financial Services operations from Automotive operations.\nContractual maturities of automotive and other finance receivables are as follows (in millions): 1996 - $53,718; 1997 - $20,569; 1998 - $14,160; thereafter - $17,447. Experience indicates that a substantial portion of the portfolio generally is repaid before the contractual maturity dates.\nThe fair value of most receivables was estimated by discounting future cash flows using an estimated discount rate that reflected the credit, interest rate and prepayment risks associated with similar types of instruments. For receivables with short maturities, the book value approximated fair value.\nSales of finance receivables increased net income by $69 million in 1995, $15 million in 1994 and $60 million in 1993.\nInvestments in direct financing leases at December 31 were as follows (in millions):\nMinimum direct financing lease rentals (including executory costs of $31 million) are contractually due as follows (in millions): 1996 - $3,093; 1997 - $2,346; 1998 - $1,489; 1999 - $893; thereafter - $1,595.\nFS-14\nNOTE 3. Receivables - Financial Services (Cont'd) - -----------------------------------------\nInvestments in operating leases at December 31 were as follows (in millions):\nMinimum rentals on operating leases are contractually due as follows (in millions): 1996 - $6,364; 1997 - $2,694; 1998 - $431; 1999 - $131; thereafter - $222.\nDepreciation expense for assets subject to operating leases is provided primarily on the straight-line method over the term of the lease in amounts necessary to reduce the carrying amount of the asset to its estimated residual value. Gains and losses upon disposal of the asset also are included in depreciation expense. Depreciation expense was as follows (in millions): 1995 - $5,508; 1994 - $4,231; 1993 - $2,984.\nAllowances for credit losses are estimated and established as required based on historical experience. Other factors that affect collectibility also are evaluated, and additional amounts may be provided. Finance receivables and lease investments are charged to the allowances for credit losses when an account is deemed to be uncollectible, taking into consideration the financial condition of the borrower, the value of the collateral, recourse to guarantors and other factors. Recoveries on finance receivables and lease investments previously charged off as uncollectible are credited to the allowances for credit losses.\nChanges in the allowances for credit losses were as follows (in millions):\nStatement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan,\" was issued in May 1993 and amended in October 1994 by Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" The Standards require that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. The company adopted these standards as of January 1, 1995, and the effect was not material.\nNOTE 4. Inventories - Automotive - ---------------------------------\nInventories at December 31 were as follows (in millions):\nInventories are stated at the lower of cost or market. The cost of most U.S. inventories is determined by the last-in, first-out (\"LIFO\") method. The cost of the remaining inventories is determined primarily by the first-in, first-out (\"FIFO\") method.\nIf the FIFO method had been used instead of the LIFO method, inventories would have been higher by $1,406 million and $1,383 million at December 31, 1995 and 1994, respectively.\nFS-15\nNOTE 5. Net Property, Depreciation and Amortization - Automotive - -----------------------------------------------------------------\nNet property at December 31 was as follows (in millions):\nProperty, equipment and special tools are stated at cost, less accumulated depreciation and amortization. Property and equipment placed in service before January 1, 1993 are depreciated using an accelerated method that results in accumulated depreciation of approximately two-thirds of asset cost during the first half of the estimated useful life of the asset. Property and equipment placed in service after December 31, 1992 are depreciated using the straight-line method of depreciation over the estimated useful life of the asset. On average, buildings and land improvements are depreciated based on a 30-year life; machinery and equipment are depreciated based on a 14-year life. Special tools are amortized using an accelerated method over periods of time representing the estimated productive life of those tools.\nDepreciation and amortization expenses were as follows (in millions):\n1995 1994 1993 ------ ------ ------ Depreciation $2,454 $2,297 $2,392 Amortization 2,765 2,129 2,012 ------ ------ ------ Total $5,219 $4,426 $4,404 ====== ====== ======\nWhen property and equipment are retired, the general policy is to charge the cost of those assets, reduced by net salvage proceeds, to accumulated depreciation. Maintenance, repairs, and rearrangement costs are expensed as incurred and were $2,529 million in 1995, $2,377 million in 1994, and $1,934 million in 1993. Expenditures that increase the value or productive capacity of assets are capitalized. Preproduction costs related to new facilities are expensed as incurred.\nNOTE 6. Income Taxes - ---------------------\nIncome\/(loss) before income taxes for U.S. and foreign operations, excluding equity in net (loss)\/income of affiliated companies, was as follows (in millions):\nThe provision for income taxes was estimated as follows (in millions):\nFS-16\nNOTE 6. Income Taxes (Cont'd) - ---------------------\nThe provision includes estimated taxes payable on that portion of retained earnings of subsidiaries expected to be received by the company. No provision was made with respect to $2.6 billion of retained earnings at December 31, 1995 that have been invested by foreign subsidiaries. It is not practicable to estimate the amount of unrecognized deferred tax liability for the undistributed foreign earnings.\nA reconciliation of the provision for income taxes compared with the amounts at the U.S. statutory tax rate is shown below (in millions):\nDeferred income taxes reflect the estimated tax effect of temporary differences between assets and liabilities for financial reporting purposes and those amounts as measured by tax laws and regulations and net operating losses of subsidiaries. The components of deferred income tax assets and liabilities at December 31 were as follows (in millions):\nForeign net operating loss carryforwards for tax purposes were $2.4 billion at December 31, 1995. A substantial portion of these losses has an indefinite carryforward period; the remaining losses have expiration dates beginning in 1996. For financial statement purposes, the tax benefit of operating losses is recognized as a deferred tax asset, subject to appropriate valuation allowances. The company evaluates the tax benefits of operating loss carryforwards on an ongoing basis. Such evaluations include a review of historical and consideration of projected future operating results, the eligible carryforward period and other circumstances.\nFS-17\nNOTE 7. Liabilities - Automotive - ---------------------------------\nCurrent Liabilities - -------------------\nIncluded in accrued liabilities at December 31 were the following (in millions):\nNoncurrent Liabilities - ----------------------\nIncluded in other liabilities at December 31 were the following (in millions):\nNOTE 8. Employee Retirement Benefits - -------------------------------------\nEmployee Retirement Plans - -------------------------\nThe company has two principal retirement plans in the U.S. The Ford-UAW Retirement Plan covers hourly employees represented by the UAW, and the General Retirement Plan covers substantially all other employees of the company and several finance subsidiaries in the U.S. The hourly plan provides noncontributory benefits related to employee service. The salaried plan provides similar noncontributory benefits and contributory benefits related to pay and service. Other U.S. and non-U.S. subsidiaries have separate plans that generally provide similar types of benefits covering their employees. The company and its subsidiaries also have defined benefit plans applicable to certain executives which are not funded.\nThe company's policy for funded plans is to contribute annually, at a minimum, amounts required by applicable law, regulations and union agreements. Plan assets consist principally of investments in stocks, government and other fixed income securities and real estate. The various plans generally are funded, except in Germany, where this has not been the custom, and as noted above; in those cases, an unfunded liability is recorded.\nThe company's pension expense, including Financial Services, was as follows (in millions):\nFS-18\nNOTE 8. Employee Retirement Benefits (Cont'd) - -------------------------------------\nPension expense in 1995 decreased for U.S. plans primarily as a result of higher discount rates, and increased for non-U.S. plans primarily as a result of benefit improvements and unfavorable exchange rates. Pension expense increased in 1994 as a result of lower discount rates for both U.S. and non-U.S. plans. In addition, amendments made in September 1993 to the Ford-UAW Retirement Plan and the General Retirement Plan provided benefit improvements that increased U.S. expense in 1995 and 1994.\nThe status of these plans at December 31 was as follows (in millions):\na\/ The balance of the initial difference between assets and obligation deferred for recognition over a 15-year period. b\/ The prior service effect of plan amendments deferred for recognition over remaining service. c\/ The deferred gain or loss resulting from investments, other experience and changes in assumptions. d\/ An adjustment to reflect the unfunded accumulated benefit obligation in the balance sheet for plans whose benefits exceed the assets -- at year-end 1995, the unfunded liability in excess of $448 million is recorded net of deferred taxes as a $108 million reduction in stockholders' equity, and at year-end 1994, the unfunded liability was offset by an intangible asset.\nFS-19\nNOTE 8. Employee Retirement Benefits (Cont'd) - -------------------------------------\nPostretirement Health Care and Life Insurance Benefits - ------------------------------------------------------\nThe company and certain of its subsidiaries sponsor unfunded plans to provide selected health care and life insurance benefits for retired employees. The company's U.S. and Canadian employees may become eligible for these benefits if they retire while working for the company; however, benefits and eligibility rules may be modified from time to time. The estimated cost for postretirement health care benefits is accrued over periods of employee service on an actuarially determined basis.\nNet postretirement benefit expense, including Financial Services, was as follows (in millions):\nThe status of these plans at December 31 was as follows (in millions):\n- - - - - - a\/ The prior service effect of plan amendments deferred for recognition over remaining service to retirement eligibility. b\/ The deferred gain or loss resulting from experience and changes in assumptions deferred for recognition over remaining service to retirement.\nChanging the assumed health care cost trend rates by one percentage point is estimated to change the aggregate service and interest cost components of net postretirement benefit expense for 1995 by about $245 million and the accumulated postretirement benefit obligation at December 31, 1995 by about $2 billion. Health care trend rates, together with other assumptions, are subject to review annually in the first quarter. Based on estimates of recent experience and the general health care cost trend outlook, it is expected that these rates will be lowered.\nFS-20\nNOTE 9. Debt - -------------\nThe fair value of debt was estimated based on quoted market prices or current rates for similar debt with the same remaining maturities.\nAutomotive - ----------\nDebt at December 31 was as follows (in millions):\n*Excludes the effect of interest rate swap agreements\nLong-term debt at December 31, 1995 included maturities as follows (in millions): 1996 - $960 (included in current liabilities); 1997 - $580; 1998 - $351; 1999 - $53; 2000 - $1,003; thereafter - $3,488.\nIncluded in long-term debt at December 31, 1995 and 1994 were obligations of $5,031 million and $6,567 million, respectively, with fixed interest rates and $444 million and $536 million, respectively, with variable interest rates (generally based on LIBOR or other short-term rates). Obligations payable in foreign currencies at December 31, 1995 and 1994 were $968 million and $994 million, respectively.\nAgreements to manage exposures to fluctuations in interest rates, which include primarily interest rate swap agreements and futures contracts, did not materially change the overall weighted-average rate on long-term debt and effectively decreased the obligations subject to variable interest rates to $287 million at December 31, 1995 and $465 million at December 31, 1994.\nFinancial Services - ------------------\n*Excludes the effect of interest rate swap agreements\nFS-21\nNOTE 9. Debt (Cont'd) - -------------\nFinancial Services (Cont'd) - ------------------\nInformation concerning short-term borrowings (excluding long-term debt payable within one year) is as follows (in millions):\nLong-term debt at December 31, 1995 included maturities as follows (in millions): 1996 - $12,097; 1997 - $14,326; 1998 - $13,696; 1999 - $11,485; 2000 - $12,306; thereafter - $16,446.\nIncluded in long-term debt at December 31, 1995 and 1994 were obligations of $53.2 billion and $45.9 billion, respectively, with fixed interest rates and $15.1 billion and $12.2 billion, respectively, with variable interest rates (generally based on LIBOR or other short-term rates). Obligations payable in foreign currencies at December 31, 1995 and 1994 were $21 billion and $12.2 billion, respectively. These obligations were issued primarily to fund foreign business operations.\nAgreements to manage exposures to fluctuations in interest rates include primarily interest rate swap agreements. At December 31, 1995, these agreements did not change the overall weighted-average rate on long-term debt of 7% excluding these agreements, and effectively decreased the obligations subject to variable interest rates to $11.9 billion. At December 31, 1995, the weighted- average interest rate on short-term debt increased to 5.8%, compared with 5.7% excluding these agreements. At December 31, 1994, these agreements decreased the overall weighted-average rate on long-term debt to 7.1%, compared with 7.2% excluding these agreements, and effectively decreased the obligations subject to variable rates to $7.2 billion. At December 31, 1994, the weighted-average interest rate on short- term debt decreased to 5.6%, compared with 5.9% excluding these agreements.\nSupport Facilities - ------------------\nAt December 31, 1995, Ford had long-term contractually committed global credit agreements under which $8.4 billion is available from various banks at least through June 30, 2000. The entire $8.4 billion may be used, at Ford's option, by any affiliate of Ford; however, any borrowing by an affiliate will be guaranteed by Ford. In addition, Ford has the ability to transfer on a nonguaranteed basis the entire $8.4 billion in varying portions to Ford Credit and Ford Credit Europe. These facilities were unused at December 31, 1995.\nAt December 31, 1995, Financial Services had a total of $48.5 billion of contractually committed support facilities. Of these facilities, $23.8 billion (excluding the $8.4 billion of Ford credit facilities) are contractually committed global credit agreements under which $19.8 billion and $4 billion are available to Ford Credit and Ford Credit Europe, respectively, from various banks; 62% and 75%, respectively, of such facilities are available through June 30, 2000. The entire $19.8 billion may be used, at Ford Credit's option, by any subsidiary of Ford Credit, and the entire $4 billion may be used, at Ford Credit Europe's option, by any subsidiary of Ford Credit Europe. Any borrowings by such subsidiaries will be guaranteed by Ford Credit or Ford Credit Europe, as the case may be. At December 31, 1995, none of the Ford Credit global facilities were in use; $742 million of the Ford Credit Europe global facilities were in use. Other than the global credit agreements, the remaining portion of the Financial Services support facilities at December 31, 1995 consisted of $22 billion of contractually committed support facilities available to various affiliates in the U.S. and $2.7 billion of contractually committed support facilities available to various affiliates outside the U.S.; at December 31, 1995, about $1 billion of these facilities were in use.\nFS-22\nNOTE 10. Capital Stock - ------------------------\nAt December 31, 1995, all general voting power was vested in the holders of Common Stock and the holders of Class B Stock, voting together without regard to class. At that date, the holders of Common Stock were entitled to one vote per share and, in the aggregate, had 60% of the general voting power; the holders of Class B Stock were entitled to such number of votes per share as would give them, in the aggregate, the remaining 40% of the general voting power, as provided in the company's Certificate of Incorporation.\nThe Certificate provides that all shares of Common Stock and Class B Stock share equally in dividends (other than dividends declared with respect to any outstanding Preferred Stock), except that any stock dividends are payable in shares of Common Stock to holders of that class and in Class B Stock to holders of that class. Upon liquidation, all shares of Common Stock and Class B Stock are entitled to share equally in the assets of the company available for distribution to the holders of such shares.\nOn April 14, 1994, the company's Board of Directors declared a 2- for-1 stock split in the form of a 100% stock dividend on the company's Common Stock and Class B Stock effective June 6, 1994. Share data were restated to reflect the split, where appropriate.\nInformation concerning the Preferred Stock of the company is as follows:\nThe Series A and Series B Preferred Stock rank (and any other outstanding Preferred Stock of the company would rank) senior to the Common Stock and Class B Stock in respect of dividends and liquidation rights.\nFS-23\nNOTE 11. Stock Options - -----------------------\nThe company has stock options outstanding under the 1985 Stock Option Plan and the 1990 Long-Term Incentive Plan. These plans were approved by the stockholders.\nInformation concerning stock options is as follows (shares in millions):\n- - - - - - a\/ Fair market value of Common Stock at dates of grant. b\/ At option prices ranging from $9.09 to $29.06 during 1995, $9.09 to $28.84 during 1994, and $9.09 to $25.84 during 1993. c\/ Including 7.6 million and 40.9 million shares under the 1985 and 1990 Plans, respectively, at option prices ranging from $13.42 to $32.00 per share. d\/ In addition, up to 1% of the issued Common Stock as of December 31 of any year may be made available for stock options and other plan awards in the next succeeding calendar year. That limit may be increased up to 2% in any year, with a corresponding reduction in shares available for grants in future years. At December 31, 1995, this reduction aggregated 2.4 million shares.\nNo further grants may be made under the 1985 Plan. Grants may be made under the 1990 Plan through April 2000. In general, options granted under the 1985 Plan and options granted to date under the 1990 Plan become exercisable 25% after one year from the date of grant, 50% after two years, 75% after three years and in full after four years. Options under both Plans expire after 10 years. Certain options outstanding under the Plans were granted with an equal number of accompanying stock appreciation rights that may be exercised in lieu of the options. Under the Plans, a stock appreciation right entitles the holder to receive, without payment, the excess of the fair market value of the Common Stock on the date of exercise over the option price, either in Common Stock or cash or a combination. In addition, grants of Contingent Stock Rights were made with respect to 884,500 shares in 1995, 709,800 shares in 1994, and 2,327,200 shares in 1993 under the 1990 Long-Term Incentive Plan (not included in the table above). The number of shares ultimately awarded will depend on the extent to which the Performance Target specified in each Right is achieved, the individual performance of the recipients and other factors, as determined by the Compensation and Option Committee of the Board of Directors.\nStatement of Financial Accounting Standards No. 123 (\"SFAS 123\"), \"Accounting for Stock-Based Compensation\", was issued in October 1995. SFAS 123 permits entities to record expense for employee stock compensation plans based on fair value at date of grant. The company, however, plans to continue to measure compensation cost using the intrinsic value method, in accordance with APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\"\nFS-24\nNOTE 12. Litigation and Claims - -------------------------------\nVarious legal actions, governmental investigations and proceedings and claims are pending or may be instituted or asserted in the future against the company and its subsidiaries, including those arising out of alleged defects in the company's products; governmental regulations relating to safety, emissions and fuel economy; financial services; employment related matters; intellectual property rights; product warranties; and environmental matters. Certain of the pending legal actions are, or purport to be, class actions. Some of the foregoing matters involve or may involve compensatory, punitive, or antitrust or other treble damage claims in very large amounts, or demands for recall campaigns, environmental remediation programs, sanctions, or other relief which, if granted, would require very large expenditures.\nLitigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Reserves have been established by the company for certain of the matters discussed in the foregoing paragraph where losses are deemed probable. It is reasonably possible, however, that some of the matters discussed in the foregoing paragraph for which reserves have not been established could be decided unfavorably to the company or the subsidiary involved and could require the company or such subsidiary to pay damages or make other expenditures in amounts or a range of amounts that cannot reasonably be at December 31, 1995. The company does not reasonably expect, based on its analysis, that any adverse outcome from such matters would have a material effect on future consolidated financial statements for a particular year, although such an outcome is possible.\nNOTE 13. Commitments and Contingencies - ---------------------------------------\nAt December 31, 1995, the company had the following minimum rental commitments under non-cancelable operating leases (in millions): 1996 - $740; 1997 - $689; 1998 - $363; 1999 - $310; 2000 - $251; thereafter - $456. These amounts include rental commitments related to the sales and leasebacks of certain Automotive machinery and equipment.\nThe company and certain of its subsidiaries have entered into agreements with various banks to provide credit card programs that offer rebates that can be applied against the purchase or lease of Ford cars or trucks. The maximum amount of rebates available to qualified cardholders at December 31, 1995 and 1994 was $3.1 billion and $2.3 billion, respectively. The company has provided for the estimated net cost of these programs as a sales incentive based on the estimated number of participants who ultimately will purchase vehicles.\nCertain Financial Services subsidiaries make credit lines available to holders of their credit cards. At December 31, 1995 and 1994, the unused portion of available credit was approximately $19.3 billion and $10.3 billion, respectively, and is revocable under specified conditions. The fair value of unused credit lines and the potential risk of loss were not considered to be material.\nFS-25\nNOTE 14. Financial Instruments - -------------------------------\nEstimated fair value amounts have been determined using available market information and various valuation methods depending on the type of instrument. In evaluating the fair value information, considerable judgment is required to interpret the market data used to develop the estimates. The use of different market assumptions and\/or different valuation techniques may have a material effect on the estimated fair value amounts. Accordingly, the estimates of fair value presented herein may not be indicative of the amounts that could be realized in a current market exchange.\nBalance Sheet Financial Instruments - -----------------------------------\nInformation about specific valuation techniques and related estimated fair value detail is provided throughout the footnotes. The table below provides book value and estimated fair value amounts (in millions) and a cross reference to the applicable Note.\nForeign Currency Instruments - ----------------------------\nThe fair value of foreign currency instruments generally was estimated using current market prices provided by outside quotation services. At December 31, 1995 and 1994, the fair value of net receivable contracts was $373 million and $298 million, respectively, and the fair value of net payable contracts was $316 million and $108 million, respectively. At December 31, 1995 and 1994, foreign currency instruments had a net deferred loss of $111 million and a net deferred gain of $59 million, respectively. In the unlikely event that a counterparty fails to meet the terms of a foreign currency agreement, the company's market risk is limited to the exchange rate differential. In the case of currency swaps, the company's market risk also may include an interest rate differential. At December 31, 1995 and 1994, the total amount of the company's foreign currency forward contracts (contracts purchased and sold) and currency swaps and options outstanding was $24.5 billion and $12.6 billion, respectively, maturing primarily through 1996.\nInterest Rate Instruments - -------------------------\nThe fair value of interest rate instruments is the estimated amount the company would receive or pay to terminate the agreement. Fair value is calculated using information provided by outside quotation services, taking into account current interest rates and the current credit-worthiness of the swap parties. At December 31, 1995 and 1994, the fair value of net receivable contracts was $739 million and $452 million, respectively, and the fair value of net payable contracts was $430 million and $596 million, respectively. In the unlikely event that a counterparty fails to meet the terms of an interest rate agreement, the company's exposure is limited to the interest rate differential. At December 31, 1995 and 1994, the underlying principal amounts on which the company has interest rate swap agreements outstanding aggregated $66.3 billion and $52.7 billion, respectively, maturing primarily through 2001.\nOther Financial Agreements - --------------------------\nAt December 31, 1995, the company had guaranteed $1.2 billion of debt of unconsolidated subsidiaries, affiliates and others. The potential risk of loss under other financial agreements was not material.\nFS-26\nNOTE 15. Acquisitions and Dispositions - ---------------------------------------\nDissolution of Autolatina Joint Venture - ---------------------------------------\nDuring 1995, the company's joint venture with Volkswagen AG in Brazil and Argentina was dissolved. The dissolution resulted in a gain of $230 million, primarily from a one-time cash compensation payment to Ford. Prior to dissolution, the company held a 49% interest in Autolatina and accounted for it on an equity basis. The company's income statement for 1995 included Ford's equity share in the net loss of the Autolatina joint venture through the dissolution date together with the gain on dissolution. The assets and liabilities of the new entities in Brazil and Argentina were consolidated in the company's balance sheet at December 31, 1995.\nHistorically, earnings in Brazil and Argentina have represented a significant portion of Ford's Automotive earnings outside the U.S. and Europe. The long-term effect, if any, of the dissolution of Autolatina on the company's future results will depend on Ford's ability to compete on its own in these markets.\nSale of Annuity Business - ------------------------\nDuring 1995, the company agreed to sell its annuity business to SunAmerica, Inc. for $173 million. The sale is expected to be completed in early 1996. The company recognized a one-time charge related to the sale that was not material. The company's income statement included the results of operations of the annuity business through December 31, 1995. Net assets of the annuity business at December 31, 1995 were included in the balance sheet under Financial Services - Other Assets; at December 31, 1994, the assets and liabilities were consolidated as part of the Financial Services segment.\nSale of First Nationwide Bank - -----------------------------\nOn September 30, 1994, substantially all of the assets of First Nationwide Bank, since known as Granite Savings Bank (the \"Bank\"), were sold to, and substantially all of the Bank's liabilities were assumed by, First Madison Bank. The Bank is a wholly owned subsidiary of Granite Management Corporation (formerly First Nationwide Financial Corporation) (\"Granite\"), which in turn is a wholly owned subsidiary of Ford.\nThe company recognized in First Quarter 1994 earnings a pre-tax charge of $475 million ($440 million after taxes) related to the disposition of the Bank, reflecting the non-recovery of goodwill and reserves for estimated losses on assets not included in the sale. The company's income statement included the results of operations of Granite through March 31, 1994. The remaining net assets of Granite at December 31, 1995 and 1994 were included in the balance sheet under Financial Services - Other Assets.\nAcquisition of The Hertz Corporation - ------------------------------------\nIn April 1994, The Hertz Corporation (\"Hertz\") became a wholly owned subsidiary of Ford. In 1993 and First Quarter 1994, Hertz was accounted for on an equity basis as part of the Automotive segment. In the balance of 1994 and in 1995, the operating results, assets, liabilities and cash flows of Hertz were consolidated as part of the Financial Services segment.\nFS-27\nNOTE 16. Cash Flows - --------------------\nThe reconciliation of net income to cash flows from operating activities is as follows (in millions):\n- - - - - - * Intercompany sales among geographic areas consist primarily of vehicles, parts and components manufactured by the company and various subsidiaries and sold to different entities within the consolidated group; transfer prices for these transactions are established by agreement between the affected entities\n- - - - - - ** Financial Services activities do not report operating income; income before income taxes is representative of operating income\nFS-29\nNOTE 17. Segment Information (Cont'd) - -----------------------------\nFinancial Services (Cont'd) - ------------------\nNOTE 18. Summary Quarterly Financial Data (Unaudited) - ------------------------------------------------------ (in millions, except amounts per share)\n- - - - - - a\/ Includes a loss of $440 million related to the disposition of Granite Savings Bank (formerly First Nationwide Bank). b\/ The sum of the per share amounts in 1995 and 1994 is different than the amounts reported for the full year because of the effect that issuances of the company's stock had on average shares for those periods.\nFS-30\nCoopers & Lybrand L.L.P.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders Ford Motor Company\nWe have audited the consolidated financial statements and the supplemental schedule of condensed financial information of selected subsidiaries of Ford Motor Company and Subsidiaries listed in Items 14(a)1 and 14(a)2 of this Form 10-K. These financial statements and the supplemental schedule are the responsibility of the Company's managment. Our responsibility is to express an opinion on these financial statements and supplemental schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures inthe financial statemetnts. An audit also includes assessing the accounting pirnciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Ford Motor 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. In addition, in our opinion, the supplemental 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 presented therein.\n\/s\/Coopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P.\n400 Renaissance Center Detroit, Michigan 48243 313-446-7100 January 26, 1996\nFS-31\nSupplemental Schedule\nFord Capital B.V., a wholly-owned subsidiary of Ford Motor Company, was established primarily for the purpose of raising funds through the issuance of commercial paper and debt securities. Ford Capital B.V. also holds shares of the capital stock of Ford Nederland B.V., Ford Motor Company (Belgium) B.V., and Ford Motor Company A\/S (Denmark). Substantially all of the assets of Ford Capital B.V., other than its ownership interests in subsidiaries, represent receivables from Ford Motor Company or its consolidated subsidiaries.\nFSS-1\nEXHIBIT INDEX","section_15":""}
{"filename":"855433_1995.txt","cik":"855433","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral\nBHC Communications, Inc. (\"BHC\"), the majority owned (74.4% at Feb- ruary 29, 1996) television broadcasting subsidiary of Chris-Craft Industries, Inc. (\"Chris-Craft\"), was organized in Delaware in 1977 under the name \"BHC, Inc.\" and changed its name to BHC Communications, Inc. on August 4, 1989. BHC's principal business is television broadcasting, conducted through its wholly owned subsidiaries, Chris-Craft Television, Inc. (\"CCTV\") and Pine- lands, Inc. (\"Pinelands\"), and its majority owned (57.1% at February 29, 1996) subsidiary, United Television, Inc. (\"UTV\").\nAt February 29, 1996, BHC, solely through subsidiaries, had 1,028 full-time employees and 108 part-time employees.\nIn July, 1994, BHC, along with Viacom Inc.'s Paramount Television Group (\"Paramount\"), formed the United Paramount Network (\"UPN\"), a fifth broadcast television network which premiered in January 1995.\nTelevision Broadcasting\nBHC operates six very high frequency (\"VHF\") television stations and two ultra high frequency (\"UHF\") television stations, together constituting Chris-Craft's Television Division. Commercial television broadcasting in the United States is conducted on 68 channels numbered 2 through 69. Channels 2 through 13 are in the VHF band, and channels 14 through 69 are in the UHF band. In general, UHF stations are at a disadvantage relative to VHF stations, because UHF frequencies are more difficult for households to receive. This disadvantage is eliminated when a viewer receives the UHF station through a cable system.\nCommercial broadcast television stations may be either affiliated with one of the three major national networks (ABC, NBC and CBS); three more recently established national networks (Fox Broadcasting Company (\"Fox\"), UPN, and The WB Network (\"WB\")), which provide substantially fewer hours of programming; or may be independent. UPN, formed by BHC, along with Paramount, began broadcasting a total of four hours of original prime time programming over two nights per week in January 1995 and expanded to a third night in March 1996. UPN currently has 151 affiliates in markets reaching 91% of all U.S. house- holds, including all of BHC's and Paramount's previously independent stations, and UPN continues to seek additional affiliates to expand its household reach. UPN is still in its infancy, and because of the intense competition that characterizes the broadcast television network business, the cost of develop- ing UPN is expected to remain significant for several years.\nThe following table sets forth certain information with respect to BHC stations and their respective markets:\n_______________\n(a) KCOP and KPTV are owned by CCTV; WWOR is owned by Pinelands; the remaining stations are owned by UTV. All stations are UPN affiliates, except for KTVX, an ABC affiliate, and KMOL, an NBC affiliate.\n(b) Designated Market Area (\"DMA\") is an exclusive geographic area consisting of all counties in which the home-market commercial stations received a preponderance of total viewing hours. The ranking shown is the nationwide rank, in terms of television households in DMA, of the market served by the station. Source: Nielsen Media Research television households uni- verse estimates.\n(c) Additional channels have been allocated by the Federal Communications Commission (\"FCC\") for activation as commercial television stations in certain of these markets. Also, additional stations may be located within the respective DMAs of BHC stations but outside the greater metropolitan television markets in which BHC stations operate.\n(d) Cable penetration refers to the percentage of DMA television viewing households receiving cable television service, as estimated by Nielsen Media Research.\n(e) WWOR broadcasts across a tri-state area including the entire New York City metropolitan area. Its broadcast signal is also carried as a \"superstation\" on numerous cable television systems throughout the United States.\nTelevision stations derive their revenues primarily from selling advertising time. The television advertising sales market consists primarily of national network advertising, national spot advertising and local spot advertising. An advertiser wishing to reach a nationwide audience usually purchases advertising time directly from the national networks, \"superstations\" (i.e., broadcast stations carried by cable operators in areas outside their broadcast coverage area), barter program syndicators, national basic cable networks, or \"unwired\" networks (groups of otherwise unrelated stations whose advertising time is combined for national sale). A national advertiser wishing to reach a particular regional or local audience usually buys advertising time from local stations through national advertising sales representative firms having contractual arrangements with local stations to solicit such advertising. Local businesses generally purchase advertising from the stations' local sales staffs.\nTelevision stations compete for television advertising revenue primarily with other television stations serving the same DMA. There are 211 DMAs in the United States. DMAs are ranked annually by the estimated number of households owning a television set within the DMA. Advertising rates that a television station can command vary in part with the size, in terms of television households, of the DMA served by the station.\nWithin a DMA, the advertising rates charged by competing stations depend primarily on three factors: the stations' program ratings, the time of day the advertising will run, and the demographic qualities of a program's viewers (primarily age and sex). Ratings data for television markets are measured by A.C. Nielsen Co. (\"Nielsen\"). This rating service uses two terms to quantify a station's audience: rating points and share points. A rating point represents one percent of all television households in the entire DMA tuned to a particular station, and a share point represents one percent of all television households within the DMA actually using at least one tele- vision set at the time of measurement and tuned to the station in question.\nBecause the major networks regularly provide first-run programming during prime time viewing hours (in general, 8:00 P.M. to 11:00 P.M. Eastern\/ Pacific time), their affiliates generally (but do not always) achieve higher audience shares, but have substantially less advertising time (\"inventory\") to sell, during those hours, than affiliates of the newer networks or independent stations, since the major networks use almost all of their affiliates' prime time inventory for network shows. Although the newer networks generally use the same amount of their affiliates' inventory during network broadcasts, the newer networks provide less programming; accordingly, their affiliates, as well as non-affiliated stations, generally have substantially more inventory for sale than the major-network affiliates. The newer network affiliates' and independent stations' smaller audiences and greater inventory during prime time hours generally result in lower advertising rates charged and more advertising time sold during those hours, as compared with major affiliates' larger audiences and limited inventory, which generally allow the major-network affiliates to charge higher advertising rates for prime time programming. By selling more advertising time, the new-network or independent station typically achieves a share of advertising revenues in its market greater than its audience ratings. On the other hand, total programming costs for such a station, because it broadcasts more syndicated programming than a major-network affiliate, are generally higher than those of a major- network affiliate in the same market. These differences have been reduced by the growth of the Fox network, which currently provides 15 weekly hours of programming during prime time and additional programming in other periods, and would be reduced further if the other newer networks should be successful in providing expanded schedules of programming.\nIn July 1995, the FCC repealed, effective August 30, 1996, its prime time access rule, which limited broadcasts, by major-network affiliates in the 50 largest markets, of \"off network\" entertainment programming. Among other effects, elimination of this rule is expected to increase the competition faced by new-network affiliates and independent stations in bidding for the rights to popular \"off network\" shows.\nProgramming\nBHC's UPN stations depend heavily on independent third parties for programming, as do KTVX and KMOL for their non-network broadcasts. Recog- nizing the need to have a more direct influence on the quality of programming available to its stations, and desiring to participate in potential profits through national syndication of programming, BHC has joined in the formation of UPN, and, additionally, has begun to invest directly in the development of original programming. The aggregate amount invested in original programming through December 31, 1995 was not significant to BHC's financial posi- tion. BHC television stations also produce programming directed to meet the needs and interests of the area served, such as local news and events, public affairs programming, children's programming and sports.\nPrograms obtained from independent sources consist principally of syndicated television shows, many of which have been shown previously on a major network, and syndicated feature films, which were either made for net- work television or have been exhibited previously in motion picture theaters (most of which films have been shown previously on network or cable tele- vision). Syndicated programs are sold to individual stations to be broadcast one or more times. Television stations not affiliated with a major network generally have large numbers of syndication contracts; each contract is a license for a particular series or program that usually prohibits licensing the same programming to other television stations in the same market. A single syndication source may provide a number of different series or programs.\nLicenses for syndicated programs are often offered for cash sale (i.e., without any barter element) to stations; however, some are offered on a barter or cash plus barter basis. In the case of a cash sale, the station purchases the right to broadcast the program, or a series of programs, and sells advertising time during the broadcast. The cash price of such program- ming varies, depending on the perceived desirability of the program and whether it comes with commercials that must be broadcast (i.e., on a cash plus barter basis). Barter programming is offered to stations for no cash consideration, but comes with a greater number of commercials that must be broadcast, and therefore, with less inventory.\nIn recent years, the amount of barter and cash plus barter program- ming broadcast both industry-wide and by BHC stations has increased sub- stantially. Barter and cash plus barter programming reduce both the amount of cash required for program purchases and the amount of time available for sale. Although the direct impact on broadcasters' operating income generally is believed to be neutral, program distributors that acquire barter air time compete with television stations and broadcasting networks for sales of air time. BHC believes that the effect of barter on its television stations is not significantly different from its impact on the industry as a whole.\nBHC television stations are frequently required to make substantial financial commitments to obtain syndicated programming while such programming is still being broadcast by another network and before it is available for broadcast by BHC stations or even before it has been produced. Generally, syndication contracts require the station to acquire an entire program series, before the number of episodes of original showings that will be produced has been determined. While analyses of network audiences are used in estimating the value and potential profitability of such programming, there is no assur- ance that a successful network program will continue to be successful or profitable when broadcast after initial network airing. FCC rules limiting the ability of major networks to acquire financial interests in independently produced programming or prohibiting such networks from syndicating programs terminated in 1995. Elimination of the restraints is expected to result in increased competition by the major networks for production and syndication of first-run programming.\nPursuant to generally accepted accounting principles, commitments for programming not available for broadcast are not recorded as liabilities until the programming becomes available for broadcast, at which time the related contract right is also recorded as an asset. BHC television stations had prepaid broadcast rights, unamortized film contract rights for programming available for telecasting, and deposits on film contracts for programming not available for telecasting aggregating $145,902,000 as of December 31, 1995. The stations were committed for film and sports rights contracts aggregating $166,200,000 for programming not available for broadcasting as of that date.\nLicense periods for particular programs or films generally run from one to five years. Long-term contracts for the broadcast of syndicated television series generally provide for an initial telecast and subsequent reruns for a period of years, with full payment to be made by the station over a period of time shorter than the rerun period. See Notes 1(C) and 8 of Notes to Consolidated Financial Statements.\nKTVX and KMOL are primary affiliates of their respective networks. Network programs are produced either by the networks themselves or by independent production companies and are transmitted by the networks to their affiliated stations for broadcast.\nGenerally, in the past, major network primary affiliation agreements were automatically renewed for two-year periods (unless advance written notice of termination was given by either the affiliate or the network). More recently, however, most networks have begun to enter into affiliation agree- ments for terms as long as ten years. BHC is discussing long-term affiliation agreements for KTVX and KMOL. Current FCC rules do not limit the duration of such agreements.\nAn affiliation agreement gives the affiliate the right to broadcast all programs transmitted by the network. The affiliate must run in its entirety, together with all network commercials, any network programming the affiliate elects or is required to broadcast, and is allowed to broadcast a limited number of commercials it has sold. For each hour of programming broad- cast by the affiliate, the major networks generally have paid their affiliates a fee, specified in the agreement (although subject to change by the network), which varies in amount depending on the time of day during which the program is broadcast and other factors. Prime time programming generally earns the highest fee. A network may, and sometimes does, designate certain programs to be broadcast with no compensation to the station.\nSubject to certain limitations contained in the affiliation agreement, an affiliate may accept or reject a program offered by the network and instead broadcast programming from another source. Rejection of a program gives the network the right to offer that program to another station in the area.\nUnited Paramount Network\nIn January 1995, UPN began broadcasting four hours of original prime time programming per week, of which one hour consists of Star Trek: Voyager, a science fiction adventure. In March 1996, UPN increased its weekly prime time programming to six hours. The network also broadcasts two hours of previously exhibited movies on Saturday afternoons and one hour of original children's programming on Sunday mornings, which it plans to increase to two hours commencing in September 1996. UPN intends, over the next several years, to expand its prime time programming to five nights per week, as well as to begin broadcasting in other day parts.\nUPN licenses most of its current programming on the same bases as are customary in the industry. UPN seeks license or ownership rights for all other programming from all available sources on arms-length terms.\nUPN's primary affiliate station agreements have three year terms and provide commercial time to the stations as consideration for broadcasting the network's programming.\nBHC currently owns 100% of UPN, and Paramount has an option exer- cisable through January 15, 1997 to acquire an interest in the network equal to that of BHC. The option price is equivalent to approximately one-half of BHC's aggregate cash contributions to UPN through the exercise date, plus interest. Payment may be deferred through the option expiration date. BHC expenditures for UPN have been substantial, and UPN funding requirements are expected to continue to be significant for the next several years. See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 2 of Notes to Consolidated Financial Statements.\nSources of Revenue\nThe principal source of revenues for BHC stations is the sale of advertising time to national and local advertisers. Such time sales are represented by spot announcements purchased to run between programs and program segments and by program sponsorship. The relative contributions of national and local advertising to BHC's gross cash advertising revenues vary from time to time. During the year ended December 31, 1995, national advertising contributed 37%, and local advertising contributed 63%, of total gross cash advertising revenues. Most advertising contracts are short-term. Like that of the television broadcasting business generally, BHC's television business is seasonal. In terms of revenues, generally the fourth quarter is strongest, followed by the second, third and first.\nAdvertising is generally placed with BHC stations through advertising agencies, which are allowed a commission generally equal to 15% of the price of advertising placed. National advertising time is usually sold through a national sales representative, which also receives a commission, while local advertising time is sold by each station's sales staff. In July 1995, UTV established a national sales representative organization, United Television Sales, Inc. (\"UTS\"), to represent, initially, all BHC stations. Practices with respect to sale of advertising time do not differ markedly between BHC's major network and UPN stations, although the major-network affiliated stations have less inventory to sell.\nGovernment Regulation\nTelevision broadcasting operations are subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended (the \"Communications Act\"). The Communications Act empowers the FCC, among other things, to issue, revoke or modify broadcast licenses, to assign frequencies, to determine the locations of stations, to regulate the broadcasting equipment used by stations, to establish areas to be served, to adopt such regulations as may be necessary to carry out the provisions of the Communications Act and to impose certain penalties for violation of its regulations. BHC television stations are sub- ject to a wide range of technical, reporting and operational requirements imposed by the Communications Act or by FCC rules and policies. The Communi- cations Act was recently and substantially amended by the Telecommunications Act of 1996 (the \"Telecom Act\"), some provisions of which have been incorp- orated into the FCC's rules and regulations during the past month, and other provisions of which will be incorporated over the next several months.\nThe Communications Act provides that a license may be granted to any applicant if the public interest, convenience and necessity will be served thereby, subject to certain limitations, including the requirement that the FCC allocate licenses, frequencies, hours of operation and power in a manner that will provide a fair, efficient and equitable distribution of service throughout the United States. Television licenses generally have been issued for five- year terms, but the Telecom Act permits the FCC to issue such licenses and their renewals for up to eight years. Upon application, and in the absence of adverse questions as to the licensee's qualifications or operations, tele- vision licenses have usually been renewed for additional terms without a hearing by the FCC. An existing license automatically continues in effect once a timely renewal application has been filed until a final FCC decision is issued.\nKMSP's license renewal was granted on April 15, 1993, and is due to expire on April 1, 1998. KTVX's license renewal was granted on September 29, 1993, and is due to expire on October 1, 1998. KUTP's license renewal was granted on March 28, 1994, and is due to expire on October 1, 1998. KCOP's license renewal was granted on April 18, 1994, and is due to expire on December 1, 1998. KBHK's license renewal was granted on October 2, 1995, and is due to expire on December 1, 1998. KPTV's license renewal was granted on August 9, 1995, and is due to expire on February 1, 1999. KMOL's license renewal was granted on August 18, 1995, and is due to expire on August 1, 1998. In September 1995, an administrative appeal of the grant of KMOL's renewal was filed, challenging the FCC staff's determination that KMOL had complied with FCC requirements concerning equal employment opportunity. KMOL has vigorously opposed this appeal, which BHC believes is without merit.\nWWOR's latest license renewal was granted on January 22, 1992. The current license renewal of WWOR has been opposed by a petition challenging its compliance with FCC requirements concerning equal employment opportunity. The station has vigorously opposed the petition, and BHC believes that the petition is without merit. WWOR's license remains in effect pending the resolution of the petition.\nUnder existing FCC regulations governing multiple ownership of broad- cast stations, a license to operate a television station generally will not be granted to any party (or parties under common control), if such party directly or indirectly owns, operates, controls or has an attributable interest in another television or radio station serving the same market or area. The FCC, however, is favorably disposed to grant waivers of this rule for radio station- television station ownership combinations in the top 25 television markets, in which there will be at least 30 separately owned, operated and controlled broadcast stations, and in certain other circumstances. The Telecom Act di- rects the FCC to extend this waiver policy to the top 50 markets, consistent with the public interest, and to conduct a rule-making proceeding to determine whether to retain or modify the current restriction on same-market multiple television station ownership.\nFCC regulations further provide that a broadcast license will not be granted if that grant would result in a concentration of control of radio and television broadcasting in a manner inconsistent with the public interest, convenience or necessity. Prior to adoption of the Telecom Act, FCC rules had deemed such concentration of control to exist if any party, or any of its officers, directors or stockholders, directly or indirectly, owned, operated, controlled or had an attributable interest in more than 12 television stations, or in television stations capable of reaching, in the aggregate, a maximum of 25% of the national audience. This percentage is determined by the DMA market rankings of the percentage of the nation's television households considered within each market. Because of certain limitations of the UHF signal, however, the FCC will attribute only 50% of a market's DMA reach to owners of UHF sta- tions for the purpose of calculating the audience reach limits. Applying the 50% reach attribution rule to UHF stations KBHK and KUTP, the eight BHC sta- tions are deemed to reach approximately 18% of the nation's television house- holds. The Telecom Act directed the FCC to eliminate the numerical limita- tion on television station ownership and to increase the maximum national audience reach limit to 35%, and the FCC has adopted such changes. The FCC is also considering whether to eliminate the 50% attribution reduction under this rule for UHF stations.\nThe FCC's multiple ownership rules require the attribution of the licenses held by a broadcasting company to its officers, directors and certain of its stockholders, so there would ordinarily be a violation of FCC regulations where an officer, director or such a stockholder and a television broadcasting company together hold interests in more than the permitted number of stations or more than one station that serves the same area. In the case of a corpora- tion controlling or operating television stations, such as BHC, there is attribution only to stockholders who own 5% or more of the voting stock, except for institutional investors, including mutual funds, insurance companies and banks acting in a fiduciary capacity, which may own up to 10% of the voting stock without being subject to such attribution, provided that such entities exercise no control over the management or policies of the broadcasting company.\nThe FCC has begun a proceeding to consider modification of the various TV ownership restrictions described above, as well as changes in the rules for attributing the licenses held by an enterprise to various parties. BHC cannot predict the outcome of the FCC proceedings.\nFCC regulations currently prevent a national sales representative organization, such as UTS, which is commonly owned with a national network such as UPN, from representing affiliates of that network other than affiliates that are also under common ownership with the network. FCC regulations also place restrictions on provisions of agreements between networks and their affiliates relating to network exclusivity, territorial exclusivity, time optioning, and pre-emption rights. The FCC is conducting rule-making proceedings to consider whether to retain, modify, or eliminate these regulations. BHC is unable to predict the outcome of these proceedings.\nAs required by the Telecom Act, the FCC recently amended another of its regulations, the dual network rule, which generally had prohibited common ownership or control of two television broadcast networks. Ownership and control of two or more such networks will now be permitted, except for common ownership or control between two of ABC, NBC, CBS, and Fox, or any one of those four networks and either UPN or WB.\nThe Telecom Act directs the FCC to conduct a rule-making proceeding to require the inclusion, in all television sets 13 inches or larger, of a feature (commonly referred to as the V-chip) designed to enable viewers to block display of programs carrying a common rating and authorizes the FCC to establish an advisory committee to recommend a system for rating video programming that contains sexual, violent, or other indecent material about which parents should be informed, before it is displayed to children, if the television industry does not establish a satisfactory voluntary rating system of its own. Industry leaders have announced their intention to establish a voluntary rating system by the end of 1996. The Telecom Act also directs the FCC to adopt regulations requiring increased closed-captioning of video pro- gramming and to conduct an inquiry into the use of audio-narrated descriptions of video programming that could increase the accessibility of such programming to persons with visual impairments.\nFCC regulations prohibit the holder of an attributable interest in a television station from having an attributable interest in a cable television system located within the predicted coverage area of that station. FCC regu- lations also prohibit the holder of an attributable interest in a television station from having an attributable interest in a daily newspaper located within the predicted coverage area of that station. The FCC intends to conduct a rule-making proceeding to consider possible modification of this latter regulation.\nThe Communications Act limits the amount of capital stock that aliens (including their representatives, foreign governments, their representatives, and entities organized under the laws of a foreign country) may own in a tele- vision station licensee or any corporation directly or indirectly controlling such licensee. No more than 20% of a licensee's capital stock and, if the FCC so determines, no more than 25% of the capital stock of a company controlling a licensee, may be owned, directly or indirectly, or voted by aliens or their representatives. Should alien ownership exceed this limit, the FCC may revoke or refuse to grant or renew a television station license or approve the assignment or transfer of such license. BHC believes the ownership by aliens of its stock and that of UTV to be below the applicable limit.\nThe Communications Act prohibits the assignment of a broadcast license or the transfer of control of a licensee without the prior approval of the FCC. Legislation was introduced in the past that would impose a transfer fee on sales of broadcast properties. Although that legislation was not adopted, similar proposals, or a general spectrum licensing fee, may be advanced and adopted in the future. Recent legislation has imposed annual regulatory fees applicable to BHC stations, currently ranging as high as $22,400 per station.\nThe foregoing does not purport to be a complete summary of all the provisions of the Communications Act or regulations and policies of the FCC thereunder. Reference is made to the Communications Act, such regulations and the public notices promulgated by the FCC for further information.\nOther Federal agencies, including principally the Federal Trade Com- mission, also impose a variety of requirements that affect the business and operations of broadcast stations. Proposals for additional or revised require- ments are considered by the FCC, other Federal agencies or Congress from time to time. BHC cannot predict what new or revised Federal requirements may result from such consideration or what impact, if any, such requirements might have upon the operation of BHC television stations.\nCompetition\nBHC television stations compete for advertising revenue in their respective markets, primarily with other broadcast television stations and cable television channels, and compete with other advertising media as well. Such competition is intense.\nIn addition to programming, management ability and experience, tech- nical factors and television network affiliations are important in determining competitive position. Competitive success of a television station depends primarily on public response to the programs broadcast by the station in rela- tion to competing entertainment, and the results of this competition affect the advertising revenues earned by the station from the sale of advertising time.\nAudience ratings provided by Nielsen have a direct bearing on the competitive position of television stations. In general, major network pro- grams achieve higher ratings than programs of other stations.\nThere are at least five other commercial television stations in each market served by a BHC station. BHC believes that the three VHF major- network affiliates and the two other VHF stations in New York City generally attract a larger viewing audience than does WWOR, and that WWOR generally at- tracts a viewing audience larger than the audiences attracted by the UHF sta- tions in the New York City market. In Los Angeles, the three VHF major- network affiliates and two other VHF stations generally attract a larger view- ing audience than does KCOP, and KCOP generally attracts a viewing audience larger than one other VHF station and the ten UHF stations in Los Angeles. In Portland, the three VHF major-network affiliated stations generally attract a larger audience than does KPTV, which generally attracts a larger audience than the other independent stations, both of which are UHF stations. BHC believes that, in Minneapolis\/St. Paul, KMSP generally attracts a smaller viewing audience than the three major VHF network-affiliated stations, but a larger viewing audience than the other three stations, all of which are UHF stations. In Salt Lake City, KTVX generally ranks first of the six tele- vision stations in terms of audience share. In San Antonio, KMOL generally ranks first of the six stations in terms of audience share. Of the 14 com- mercial television stations in San Francisco, KBHK generally ranks fifth in terms of audience share, behind the three major network-affiliated VHF television stations, and the VHF Fox affiliate. KUTP generally ranks sixth in terms of audience share, of the eight commercial stations in the Phoenix market.\nIn late 1995, KCOP received two Civil Investigative Demands ( \"CIDs\") from the Antitrust Division of the U.S. Department of Justice seeking production of documents in connection with a civil investigation by the Division of the television advertising business in the Los Angeles market. KCOP has responded to both CIDs, and several KCOP employees have given deposition testimony in the matter. All of the VHF television stations in the Los Angeles market have received similar CIDs seeking document production and deposition testimony. It is not known at this time what further pro- ceedings, if any, may occur.\nBHC stations may face increased competition in the future from additional television stations that may enter their respective markets. See note (c) to the table under Television Broadcasting.\nCable television has become a major competitor of television broad- casting stations. Because cable television systems operate in each market served by a BHC station, the stations are affected by rules governing cable operations. If a station is not widely accessible by cable in those markets having strong cable penetration, it may lose effective access to a significant portion of the local audience. Even if a television station is carried on a local cable system, an unfavorable channel position on the cable system may adversely affect the station's audience ratings and, in some circumstances, a television set's ability to receive the station being carried on an unfavorable channel position. Some cable system operators may be inclined to place broad- cast stations in unfavorable channel locations. Similar competitive effects may be expected from video delivery systems offered by local telephone companies, as permitted by the provisions of the Telecom Act.\nFCC regulations requiring cable television stations to carry or re- serve channels for retransmission of local broadcast signals have twice been invalidated in Federal court. In October 1992, Congress enacted legislation\ndesigned to provide television broadcast stations the right to be carried on cable television stations (and to be carried on specific cable channel positions), or (at the broadcaster's election) to prohibit cable carriage of the television broadcast station without its consent. This law is currently being challenged in the Federal courts, and BHC cannot predict the outcome. The Telecom Act extends the must-carry requirements to the video delivery systems of local telephone companies, and these extended requirements may also be affected by the pending court challenge. While Federal law has until re- cently generally prohibited local telephone companies from providing video programming to subscribers in their service areas, this restriction has been held constitutionally invalid by eight federal district courts. Two such rulings have been affirmed by the United States Court of Appeals, one by the Fourth Circuit and one by the Ninth Circuit, and the Supreme Court has heard oral argument with respect to the Fourth Circuit case. This prohibition has been substantially eliminated by the Telecom Act, and the Supreme Court has consequently remanded the case to the Circuit Court for further consideration. The FCC has also initiated a rule-making proceeding to consider rules for \"Open Video Systems\" -- a new structure of video delivery system authorized by the Telecom Act for provision by local telephone companies and, if permitted by the FCC, others. BHC is unable to predict the outcome or effect of these developments.\n\"Syndicated exclusivity\" rules allow television stations to prevent local cable operators from importing distant television programming that duplicates syndicated programming in which local stations have acquired ex- clusive rights. In conjunction with these rules, network nonduplication rules protect the exclusivity of major-network broadcast programming within the local video marketplace. The FCC is also reviewing its \"territorial exclusivity\" rule, which limits the area in which a broadcaster can obtain exclusive rights to video programming. BHC believes that the competitive position of BHC stations would likely be enhanced by an expansion of broadcasters' permitted zones of exclusivity.\nAlternative technologies could increase competition in the areas served by BHC stations and, consequently, could adversely affect their profitability. Two direct broadcast satellite (\"DBS\") systems currently provide service, and others are expected to begin service later in 1996. The number of subscribers to DBS services more than doubled during 1995, from approximately 600,000 at the end of 1994, to approximately 1.7 million. An additional challenge is now posed by wireless cable systems, including multichannel distribution services (\"MDS\"). At the end of 1994, wireless cable systems served about 800,000 subscribers. Two four-channel MDS licenses have been granted in most television markets. MDS operation can provide commercial pro- gramming on a paid basis. A similar service can also be offered using the instructional television fixed service (\"ITFS\"). The FCC now allows the educational entities that hold ITFS licenses to lease their \"excess\" capacity for commercial purposes. The multichannel capacity of ITFS could be combined with either an existing single channel MDS or a newer multichannel multi-point distribution service to increase the number of available channels offered by an individual operator. The emergence of home satellite dish antennas has also made it possible for individuals to receive a host of video programming options via satellite transmission.\nTechnological developments in television transmission have created the possibility that one or more of the broadcast and nonbroadcast television media will provide enhanced or \"high definition\" pictures and sound to the public of a quality that is technically superior to that of the pictures and sound currently available. It is not yet clear when and to what extent technology of this kind will be available to the various television media; whether and how television broadcast stations will be able to avail themselves of these improvements; whether all television broadcast stations will be afforded sufficient spectrum to do so; what channels will be assigned to each of them to permit them to do so; whether viewing audiences will make choices among services upon the basis of such differences; or, if they would, whether significant additional expense would be required for television sta- tions to provide such services. Many segments of the television industry are intensively studying enhanced and \"high definition\" television tech- nology. A proceeding is under way at the FCC regarding policies concerning advanced television service, including \"high definition\" service. The Tele- com Act, as well as proposed federal legislation, addresses several of these issues, and some members of Congress support auctioning or otherwise charging broadcasters for use of spectrum designated for \"high definition\" television use. The Telecom Act, in particular, authorizes the FCC, if it chooses, to issue the initial licenses for new advanced television broad- cast stations exclusively to existing television station licensees and per- mittees, provided that they are required to surrender either their old or new\nlicenses after a period of time to be specified by the FCC. The Telecom Act also directs the FCC to adopt regulations regarding ancillary uses of such new licenses and the collection of fees for certain ancillary uses. BHC is unable to predict the outcome of these legislative proposals or rule-making proceedings.\nThe broadcasting industry is continuously faced with technological changes, competing entertainment and communications media and governmental restrictions or actions of Federal regulatory bodies, including the FCC. These technological changes may include the introduction of digital compression by cable systems that would significantly increase the number and availability of cable program services with which BHC stations compete for audience and revenue, the establishment of interactive video services, and the offering of multimedia services that include data networks and other computer technologies. Such factors have affected, and will continue to affect, the revenue growth and profitability of BHC.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nKCOP owns its studios and offices in two buildings in Los Angeles containing a total of approximately 54,000 square feet located on adjacent sites having a total area of approximately 1.93 acres. KCOP's transmitter is located atop Mt. Wilson on property utilized pursuant to a permit issued by the United States Forest Service.\nKPTV owns its studios and offices in a building in Portland, Oregon, containing approximately 45,252 square feet located on a site of approximately 2.0 acres. Its transmitter is located on its own property at a separate site containing approximately 16.18 acres.\nWWOR owns office and studio facilities in Secaucus, New Jersey, containing approximately 110,000 square feet on approximately 3.5 acres and leases additional office space in New York City. Along with almost all of the television stations licensed to the New York market, WWOR's transmitter is located on top of the World Trade Center in New York City pursuant to a lease agreement which expires in 2004, unless terminated by WWOR in 1999.\nPhysical facilities consisting of offices and studio facilities are owned by UTV in Minneapolis, San Antonio and Phoenix and are leased in Salt Lake City and San Francisco. The Salt Lake City lease agreement expires in 1999 and is renewable, at an increased rental, for two five-year periods. The San Francisco lease expires in 2007.\nThe Minneapolis facility includes approximately 49,700 square feet of space on a 5.63-acre site. The Salt Lake City facility is approximately 30,400 square feet on a 2.53-acre site. The San Antonio facility is approx- imately 41,000 square feet on a .92-acre site. The San Francisco facility is approximately 27,700 square feet in downtown San Francisco. The Phoenix facility is approximately 26,400 square feet on a 3.03-acre site. Smaller buildings containing transmission equipment are owned by UTV at sites separate from the studio facilities.\nUTV owns a 55-acre tract in Shoreview, Minnesota, of which 40 acres are used by KMSP for transmitter facilities and tower.\nKTVX's transmitter facilities and tower are located at a site on Mt. Nelson, close to Salt Lake City, under a lease that expires in 2004. KTVX also maintains back-up transmitter facilities and tower at a site on nearby Mt. Vision under a lease that expires in 2002 and is renewable, at no increase in rental, for a 50-year period.\nKMOL's transmitter facilities are located at a site near San Antonio on land and on a tower owned by Texas Tall Tower Corporation, a corporation owned in equal shares by UTV and another television station that also transmits from the same tower.\nKBHK's transmitter is located on Mt. Sutro, as part of the Sutro Tower complex, which also houses equipment for other San Francisco television sta- tions and many of its FM radio stations. The lease for the Mt. Sutro facili- ties expires in February 2005 and is renewable for two five-year periods.\nKUTP's transmitter facilities and tower are located on a site within South Mountain Park, a communications park owned by the City of Phoenix, which also contains transmitter facilities and towers for the other television sta- tions in Phoenix as well as facilities for several FM radio stations. The license for this space expires in 2012.\nBHC believes its properties are adequate for their present uses.\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 executive officers of BHC, as of February 29, 1996, are as follows:\nHas served Positions with BHC; principal occupation; as officer Name and age as of February 29, 1996 since ---- ----------------------------------------- ---------- Herbert J. Siegel Chairman of the Board and President; Chairman of the Board and President, Chris- Craft; 67 1977\nJohn C. Siegel Senior Vice President; Senior Vice President, Chris-Craft; 43 1981\nWilliam D. Siegel Senior Vice President; Senior Vice President, Chris-Craft; 41 1981\nJoelen K. Merkel Vice President and Treasurer; Vice President and Treasurer, Chris-Craft; 44 1980\nBrian C. Kelly General Counsel and Secretary; General Counsel and Secretary, Chris-Craft; 44 1992\nChris-Craft, through its majority ownership of BHC, is principally engaged in television broadcasting. The principal occupation of each of the individuals for the past five years is stated in the foregoing table, except that prior to being elected General Counsel and Secretary of BHC on December 14, 1992, Brian C. Kelly served as President of Finevest Foods, Inc. (\"Finevest\") from July 1992 through December 13, 1992, served as Executive Vice President, General Counsel and Secretary of Finevest from March 1992 until July 1992 and served as Vice President, General Counsel and Secretary of Finevest until February 1992. Finevest filed a Chapter 11 bankruptcy petition on February 11, 1991, and emerged from bankruptcy on July 9, 1992 pursuant to a confirmed reorganization plan. All officers hold office until the meeting of the Board following the next annual meeting of stockholders or until removed by the Board.\nEvan C Thompson, age 53, is Executive Vice President of Chris-Craft. Although not an officer of BHC, as President of UTV and Chris-Craft's Television Division for more than the past five years, Mr. Thompson may be considered an executive officer of BHC within the Securities and Exchange Commission definition of the term.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information appearing in the Annual Report under the caption STOCK PRICE, DIVIDEND AND RELATED INFORMATION is incorporated herein by this reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information appearing in the Annual Report under the caption SELECTED FINANCIAL DATA is incorporated herein by this reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information appearing in the Annual Report under the caption MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS is incorporated herein by this reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Consolidated Financial Statements, Notes thereto, Report of Independent Accountants thereon and Quarterly Financial Information (unaudited) appearing in the Annual Report are incorporated herein by this reference. Except as specifically set forth herein and elsewhere in this Form 10-K, no information appearing in the Annual Report is incorporated by reference into this report nor is the Annual Report deemed to be filed, as part of this report or otherwise, pursuant to the Securities Exchange Act of 1934.\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 in the Proxy Statement under the caption ELECTION OF DIRECTORS--Nominees of the Board of Directors is incorporated herein by this reference. Information relating to BHC's executive officers is set forth in Part I under the caption EXECUTIVE OFFICERS OF THE REGISTRANT.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information appearing in the Proxy Statement under the caption ELECTION OF DIRECTORS--Executive Compensation is incorporated herein by this reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information appearing in the Proxy Statement under the caption ELECTION OF DIRECTORS--Voting Securities of Certain Beneficial Owners and Management is incorporated herein by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information appearing in the Proxy Statement under the caption ELECTION OF DIRECTORS--Certain Relationships and Related Transactions is incorporated herein by this reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this report:\n1. The financial statements and quarterly financial information incorporated by reference from the Annual Report pursuant to Item 8.\n2. The financial statements of UPN and report thereon listed under the caption Schedules in the Index to Consolidated Financial Statements and Schedules.\n3. Exhibits listed in the Exhibit Index, including the com- pensatory plans listed below:\nChris-Craft's Benefit Equalization Plan Employment Agreement dated as of January 1, 1994 between Herbert J. Siegel and Chris-Craft Employment Agreement dated as of January 1, 1994 between Evan C Thompson and Chris-Craft\n(b) No reports on Form 8-K were filed by the registrant during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 29, 1996\nBHC COMMUNICATIONS, INC. ------------------------ (Registrant)\nBy: WILLIAM D. SIEGEL ----------------- William D. Siegel Senior 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 and Title Date\nHERBERT J. SIEGEL March 29, 1996 ----------------- Herbert J. Siegel Chairman, President and Director (principal executive officer)\nWILLIAM D. SIEGEL March 29, 1996 ----------------- William D. Siegel Senior Vice President and Director (principal financial officer)\nJOELEN K. MERKEL March 29, 1996 ---------------- Joelen K. Merkel Vice President, Treasurer and Director (principal accounting officer)\nJOHN L. EASTMAN March 29, 1996 --------------- John L. Eastman Director\nBARRY S. GREENE March 29, 1996 --------------- Barry S. Greene Director\nLAURENCE M. KASHDIN March 29, 1996 ------------------- Laurence M. Kashdin Director\nMORGAN L. MILLER March 29, 1996 ---------------- Morgan L. Miller Director\nJOHN C. SIEGEL March 29, 1996 -------------- John C. Siegel Director\nBHC COMMUNICATIONS, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nCONSOLIDATED FINANCIAL STATEMENTS:\nReport of Independent Accountants\nConsolidated Balance Sheets - 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' Investment - For the Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nSCHEDULES:\nUPN Financial Statements --\nReport of Independent Accountants\nBalance Sheet - December 31, 1995\nStatement of Operations and Statement of Changes in Partners' Capital (Deficit) - For the Year Ended December 31, 1995\nStatement of Cash Flows - For the Year Ended December 31, 1995\nNotes to Financial Statements\nReport of Independent Accountants\nFebruary 14, 1996\nTo the Partners of United Paramount Network\nIn our opinion, the accompanying balance sheet and the related statements of operations, of changes in Partners' capital (deficit) and of cash flows present fairly, in all material respects, the financial position of United Paramount Network (a partnership between BHC Network Partner, Inc. and BHC Network Partner II, Inc.) at December 31, 1995, and the results of its operations and its cash flows for the year ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of United Paramount Network's manage- ment; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit 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 ac- counting 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.\nPrice Waterhouse LLP Century City\nUnited Paramount Network Balance Sheet December 31, 1995 - ---------------------------------------------------------------\n(in thousands) Assets Current assets: Cash and cash equivalents $ 74 Accounts receivable (net of allowance for doubtful accounts of $178) 9,040 Program rights and development costs (net of reserve for abandonment of $4,631) 12,893 Other current assets 609 ------ Total current assets 22,616\nRestricted cash 974 Property and equipment, at cost: Furniture, fixtures and computer equipment 1,082 Leasehold improvements and other 341 ------ 1,423 Less accumulated depreciation 198 ------ 1,225 Intangible asset (net of accumulated amortization of $54) 217 Investment in joint venture 2,750 ----- Total assets $ 27,782 ========\nLiabilities and Partners' Capital (Deficit)\nCurrent liabilities: Accounts payable $ 3,224 Accrued program costs 10,587 Accrued expenses and other liabilities 11,850 ------- Total current liabilities 25,661\nDue to related party 109,935 -------- Total liabilities 135,596\nCommitments and contingencies (Note 6)\nPartners' capital (deficit): Network Partner (8,942) Network Partner II (98,872) -------- Total partners' deficit (107,814) Total liabilities and partners' capital $ 27,782 =========\nThe accompanying notes are an integral part of these financial statements.\nUnited Paramount Network Statement of Operations and Statement of Changes in Partners' Capital (Deficit) For the Year Ended December 31, 1995 - ----------------------------------------------------------------\nStatement of Operations (in thousands)\nNet revenues $ 30,376\nOperating costs and expenses: Operating expenses 99,940 Selling, general and administrative expenses 58,924 Depreciation and amortization 252 -------- 159,116\nOperating loss (128,740)\nOther income (expense): Interest expense to related parties (4,535) Interest and other income 62 Net loss on investment in joint venture (625) --------- (5,098) Net loss $(133,838) =========\nStatement of Changes in Partners' Capital (Deficit) (in thousands) Network Network Partner Partner II Total ------- ---------- ----- Balance at December 31, 1994 $ 1,500 $ 1,338 $ 2,838\nCapital contributions - 23,186 23,186 Capital transfers between partners (3,977) 3,977 -\nAllocation of 1995 net loss (6,465) (127,373) (133,838) -------- --------- ---------\nBalance at December 31, 1995 $ (8,942) $ (98,872) $(107,814) ======= ======== =========\nThe accompanying notes are an integral part of these financial statements.\nUnited Paramount Network Statement of Cash Flows For the Year Ended December 31, 1995 - ----------------------------------------------------------------\n(in thousands)\nCash flows from operating activities: Net loss $(133,838) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of program costs 91,744 Payments for programming (98,420) Depreciation and amortization 252 Abandonment reserve 4,631 Changes in assets and liabilities: Increase in accounts receivable, net (9,025) Increase in accounts payable, accrued expenses and other current liabilities 12,546 Decrease in other assets 3,052 --------\nNet cash used in operating activities (129,058) --------\nCash flows from investing activities: Additions to property and equipment (1,113) Cash placed in restricted account (974) Increase in intangible asset (271) Net investment in joint venture (2,750) --------\nNet cash used in investing activities (5,108) -------- Cash flows from financing activities: Advances from related party 109,935 Capital contributions 23,186 ------- Net cash provided by financing activities 133,121 ------- Net decrease in cash and cash equivalents (1,045)\nCash and cash equivalents: Beginning of period 1,119 ------- End of period $ 74 ========\nSupplemental Cash Flow Information:\nCash paid for interest $ 4,530 ========\nThe accompanying notes are an integral part of these financial statements.\nUnited Paramount Network Notes to Financial Statements For the Year Ended December 31, 1995 - ----------------------------------------------------------------\nNote 1 - Organization\nIn July 1994, BHC Network Partner, Inc. (\"Network Partner\"), a wholly owned subsidiary of Chris-Craft Industries, Inc.'s majority owned subsidiary, BHC Communications, Inc. (\"BHC\"), along with PCI Network Partner, Inc. (\"PCI\/NP\"), a wholly owned indirect subsidiary of Viacom Inc.'s Paramount Television Group, formed the United Paramount Network (\"UPN\" or the \"Network\"), a fifth broad- cast television network.\nUPN was organized as a partnership in December 1994 between Network Partner and BHC Network Partner II, Inc., a wholly owned indirect subsidiary of BHC, (\"Network Partner II\", collectively referred to as the \"Partners\"). PCI\/NP has an option exercisable through January 15, 1997 to acquire an interest in UPN equal to that of the Partners. The option price is equivalent to approxi- mately one-half of the Partners' aggregate cash contributions to UPN through the exercise date, plus interest; payment may be deferred through the option expiration date.\nUPN began providing programming for broadcast in January 1995. At December 31, 1995, the Network had 150 affiliates reaching over 90% of U.S. television house- holds. The Network's revenues are derived entirely from providing television programming and are, therefore, subject to the vagaries of the advertising industry.\nOperating costs of the Network are funded through capital contributions and loans made by the Partners. Profits or losses are allocated between the Partners in accordance with the partnership agreement. During the year ended December 31, 1995, UPN incurred operating losses of $128,740,000 and negative cash flows from operations of $129,058,000. UPN is still in its infancy and the cost of developing and expanding its programming is expected to remain significant for several years. The Partners intend to continue funding UPN through capital contributions and loans, as UPN incurs obligations arising through the normal course of its business.\nNote 2 - Accounting Policies\nFinancial Instruments\nRestricted cash consists of cash and marketable securities having maturities at time of purchase not exceeding one year, all of which are U.S. government securities. In accordance with Statement of Financial Accounting Standards No. 115 (SFAS 115), \"Accounting for Certain Investments in Debt and Equity Securities,\" marketable securities have been classified as held-to-maturity. The fair value of restricted cash approximates its amortized cost, reflecting the short maturities. Restricted cash has been placed in an account as a security deposit, is not available for current operations of the Network and, therefore, has been classified as non-current in the accompanying balance sheet.\nProperty and Equipment\nProperty and equipment is recorded at cost. Depreciation of furniture, fix- tures and computer equipment is computed on the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is computed on a straight-line basis over the life of the lease.\nNOTE 2 (continued)\nProgram Rights and Development Costs\nCosts for program production are capitalized as incurred. Other Network programming rights and related liabilities are recorded at the contractual amounts when the programming becomes available for telecasting. Capitalized program costs are amortized over the estimated number of showings, using accelerated methods based on management's estimate of the flow of revenues. The estimated costs of recorded program rights to be charged to income within one year are included in current assets; payments on such program rights due within one year are included in current liabilities.\nCosts incurred for the development of programs are capitalized and included in the accompanying balance sheet, net of reserves established for projects which may be terminated prior to being placed into production.\nRevenue Recognition\nThe Network sells advertising time for broadcast on UPN programs through Premier Advertising Sales (\"Premier\") a wholly owned subsidiary of Paramount Communications, Inc. (Note 6). Revenues are recognized substantially as adver- tisements are aired, at contractual rates as reported to UPN by Premier. With respect to certain of its programming, UPN derives no revenue and incurs no programming expense.\nUse of Estimates in Preparation of Financial Statements\nPreparation of financial statements in accordance with generally accepted accounting principles requires the use of management estimates.\nIncome Taxes\nAs a general partnership, the Network's losses are allocated to, and reported by, the individual Partners. Therefore, no credit for income tax benefit is included in the accompanying financial statements.\nNOTE 3 - Accrued Expenses and Other Liabilities\nAccrued expenses and other liabilities consist of the following: (in thousands)\nAccrued advertising cost $ 6,215 Accrued compensation 2,388 Accrued sales commission 1,395 Other accrued expenses 1,852 ------ $11,850 ======\nNOTE 4 - Investment in Joint Venture\nIn January 1995, UPN entered into a joint venture (the \"Venture\") with Saban Entertainment for the purpose of developing, producing and distributing children's television programming. Under terms of the Venture agreement, UPN funds certain programming costs in return for certain distribution rights to such programming and a share of aggregate revenue. UPN accounts for its interest in the Venture using the equity method.\nNOTE 5 - Due to Related Party\nDuring 1995 the Partners made loans to UPN totalling $109,935,000 at December 31, 1995. The loans bear interest at the prime rate (8.5% at December 31, 1995), payable annually. The loans are to be repaid from cash provided by the Network's operations, as available.\nNOTE 6 - Commitments and Contingencies\nThe aggregate amount payable by UPN under contracts for programming not cur- rently available for telecasting and, accordingly, not included in accrued program costs in the accompanying balance sheet totalled approximately $62,000,000 at December 31, 1995.\nAt December 31, 1995 UPN was obligated under a five year lease for its office space. The lease is noncancellable for three years and calls for certain penalty payments upon cancellation thereafter. Rental expense for the year ended December 31, 1995 was $427,000. Aggregate future minimum lease payments at December 31, 1995 are $3,523,000, with amounts of $755,000 due in each of the years 1996 through 1999 and $503,000 due in 2000. Additionally, as re- quired by the lease agreement, UPN obtained an irrevocable letter of credit in the amount of $1,220,000 on behalf of the lessor. The obligation under the letter of credit is required to be reduced annually over the lease term.\nEXHIBIT INDEX\nIncorporated by Exhibit Reference to: No. Exhibit\nExhibit 3(a) [1] 3.1 Restated Certificate of Incorporation\nExhibit 3(b) [1] 3.2 Restated By-laws\nExhibit 10(c) [1] 10.1 Management Agreement between registrant and Chris-Craft dated July 21, 1989\nExhibit 19 [4] 10.2 Amendment No. 1 thereto dated October 31, 1991\nExhibit 10(H)(2) [5] 10.3 Amendment No. 2 thereto dated March 24, 1994\nExhibit 10(E) [2] 10.4 Form of Agreement under Chris-Craft's Executive Deferred Income Plan\nExhibit 10(B) [5] 10.5 Employment Agreement dated January 1, 1994 between Chris- Craft and Herbert J. Siegel\nExhibit 10(C) [5] 10.6 Split-Dollar Agreement dated January 6, 1994 between registrant and William D. Siegel\nExhibit 10(D) [5] 10.7 Split-Dollar Agreement dated January 6, 1994 between registrant and John C. Siegel\nExhibit 10(F) [5] 10.8 Employment Agreement dated January 1, 1994 between Chris- Craft and Evan C Thompson\nExhibit 11(H) [3] 10.9 Chris-Craft's Exhibit 10(B)(1) [6] Benefit Exhibit 10.3 [8] Equalization Plan, as amended\nExhibit 10.10[7] 10.10 Option Agreement dated July 19, 1994 between BHC Network Partner, Inc. and PCI Network Partner, Inc.\n* 13 Portions of the Annual Report incorporated by reference\n* 21 Subsidiaries of registrant\n* 27 Financial Data Schedule\n_______________________\n* Filed herewith.\n[1] Registrant's Registration Statement on Form S-1 (Regis. No. 33- 31091).\n[2] Chris-Craft's Annual Report on Form 10-K for the year ended August 31, 1983 (File No. 1-2999).\n[3] Chris-Craft's Registration Statement on Form S-1 (Regis. No. 2- 65906).\n[4] Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1991.\n[5] Chris-Craft's Annual Report on Form 10-K for the year ended December 31, 1993.\n[6] Chris-Craft's Annual Report on Form 10-K for the year ended December 31, 1989.\n[7] Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n[8] Chris-Craft's Annual Report on Form 10-K for the year ended December 31, 1994.","section_15":""}
{"filename":"75043_1995.txt","cik":"75043","year":"1995","section_1":"ITEM 1. BUSINESS. DEVELOPMENT OF BUSINESS\nOshman's Sporting Goods, Inc. (\"Oshman's\" or the \"Company\"), which operates a chain of retail sporting goods specialty stores, primarily in the Sun Belt, was incorporated in 1946 as the successor to a proprietorship founded by J. S. Oshman in 1931. Unless the context otherwise requires, the terms \"Oshman's\" and the \"Company\" as used herein include the Company and its subsidiaries, whether operating under the name \"Oshman's,\" \"SuperSports USA\" or \"Honsport.\"\nOshman's offers a full line of sporting goods equipment, sportswear and athletic footwear in medium to higher price ranges. Nationally advertised brand name products are featured, along with the Company's own labels in certain categories. Sales of sportswear represented approximately 29-32% and footwear accounted for approximately 17-19% of net retail sales during the last three fiscal years. The remaining approximately 51-52% of the net retail sales during these years was attributable to sporting goods equipment. Net retail sales contributed 97% of the Company's total net sales for the fiscal year ended January 28, 1995. The Company has determined, pursuant to the provisions of Statement 14 of the Financial Accounting Standards Board, that its business constitutes a single reportable industry segment.\nOshman's retail stores are located primarily in major regional or suburban shopping centers, shopping malls and suburban shopping districts. The Company believes that its extensive promotional policies enable it to operate stores successfully in a variety of shopping environments. The Company's Texas stores and California stores accounted for approximately 42% and 23%, respectively, of consolidated net sales for the fiscal year ended January 28, 1995.\nThe Company operates two types of stores: traditional stores, which range from approximately 3,600 to 32,000 square feet, and SuperSports USA megastores, which range from approximately 41,000 to 85,000 square feet.\nThrough the establishment of new stores and the acquisition of existing stores, Oshman's expanded from 11 retail sporting goods stores in 1970 to 193 stores at February 3, 1990. As reflected in the following table, the Company has reduced the number of stores open since that time, and in December 1993 announced a restructuring plan that included closing 34 underperforming traditional stores to redeploy its assets to its more profitable megastore strategy. As of January 28, 1995, Oshman's was operating 141 stores, 124 of which were Oshman's stores, 12 of which were SuperSports USA megastores and five of which were Honsport stores. Changes in the number of stores and square footage during the last five fiscal years are summarized below:\n- --------------------- *Includes a traditional store which was expanded and converted to a megastore.\nThe Company opened its first SuperSports USA Megastore in March 1990. Customer response to the first megastore was excellent and sales exceeded the Company's expectations. In subsequent years, a total of eleven additional megastores have been opened. In 1993, the Board of Directors approved plans designating the megastore as the Company's principal growth vehicle. Oshman's megastores cost more to build and fixture and more to operate than those of its large-store competitors, however the Company believes that the Oshman's megastores are more profitable. A significant amount of the capital differential has been funded by developers who consider these stores an attraction for shopping centers attempting to differentiate themselves from their competition. The slightly higher operating costs have been more than offset by the higher gross margins that these stores are able to deliver. Although the twelve megastores represent only 8.5% of Oshman's total stores, they were responsible for 31.6% of store sales and 39.2% of total direct store contributions during the fiscal year ended January 28, 1995.\nThe following table is included to highlight the current contribution of SuperSports USA megastores relative to Oshman's traditional stores and to demonstrate the significance of Oshman's plans for opening 62 megastores in the five years, 1995-1999.\nFIVE-YEAR SUMMARY OF DIRECT STORE CONTRIBUTIONS* (Unaudited)\n- --------------------- * Direct store contributions are presented for comparative purposes and do not include any charges for warehousing, buying or administrative expenses. Direct store contributions include all direct revenues and expenses incurred within the respective stores and allocated charges for advertising, insurance, accrual of shrinkage and merchandise markdowns and certain other expenses.\nCOMPETITION\nOshman's competes with a number of other specialty sporting goods chains, including large-format retailers that provide a broad selection of inventory at every-day low prices, but believes that, in terms of sales and number of stores, it is one of the largest specialty retailers of sporting goods in the United States. Oshman's also competes with diversified retail establishments, such as department, discount, drug and other stores carrying sporting goods and equipment or sports and leisure apparel. Many of these non-specialty retailers are part of organizations considerably larger than Oshman's in terms of overall sales and financial resources, and some of these organizations have larger sporting goods volume as well. Competition is based on a number of factors, including price, quality and variety of goods offered, location of stores and quality of service.\nIn recent years, competition has intensified in the Company's key market areas, particularly with the opening of a number of new sporting goods stores offering large quantities and broad selections of sporting goods equipment and related merchandise at competitive prices. These large-format retailers are reshaping the retail sporting goods market, and Oshman's expects them to continue to expand aggressively and seek to increase their market share, while competition from traditional chain-store operations may diminish. Where appropriate, Oshman's will continue to operate traditional stores, but, as noted above, the predominant number of new\nstore openings will be SuperSports USA megastores. Oshman's experienced 8.5% same store sales increases in megastores and .5% same store sales decreases in traditional stores during the fiscal year ended January 28, 1995.\nSEASONAL FACTORS\nOshman's business is highly seasonal. Retail sales reach their peak in December due to holiday shopping and the purchase of ski equipment. Retail sales also increase in May in connection with Oshman's annual Once-A-Year Sale, while institutional sales are at their heaviest in August and September with the commencement of the traditional school year and football season. Weather conditions add to the seasonal nature of the business, particularly with regard to sales of snow ski equipment and cold weather apparel.\nSUPPLIERS AND INVENTORY; CUSTOMERS\nOshman's purchases most of its merchandise on a centralized basis from its Houston, Texas offices directly from manufacturers and their representatives, both in the United States and overseas (principally the Far East). Inventory is stored at its warehouses in Houston, Texas and Santa Ana, California. Oshman's has no significant long-term contract with any supplier; the merchandise sold by the Company is available from several manufacturers, and no single supplier accounted for more than 11% of the Company's total purchases during the fiscal year ended January 28, 1995.\nTRADEMARKS AND SERVICE MARKS; OTHER BUSINESS\nAs of January 28, 1995, Oshman's owned approximately 33 trademarks and service marks that were employed in its advertising and operations. The Company believes that its marks are, in the aggregate, materially important in its business and that the \"Oshman's\" marks are individually material. The Company anticipates that it will continue to own each of its trademarks and service marks for so long as it finds it beneficial to use them in connection with its operations.\nOshman's sells sporting goods and equipment to certain institutional customers, including scholastic, industrial, amateur and professional teams and has limited export sales which are made through written request. Neither area is material to its business. Oshman's has also entered into a licensing arrangement relating to the use of its name and trademarks in Japan, but this arrangement is not material to the Company's business.\nMISCELLANEOUS\nOshman's typically satisfies its working capital needs out of internally generated funds from current operations and its credit facilities as addressed in Management's Discussion and Analysis of Financial Condition and Results of Operations, below.\nInasmuch as Oshman's is a retailer, backlog is not relevant to its business. Oshman's does not have contracts subject to renegotiation or termination and does not carry on any material amount of research and development activities.\nFederal, state, and local environmental regulations have not had, and are not expected to have, any material effect upon the expenditures, earnings or competitive position of the Company.\nAs of January 28, 1995, Oshman's employed approximately 3,300 people including part-time employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nOshman's general and executive offices are located at 2302 Maxwell Lane, Houston, Texas and consist of approximately 79,000 square feet of leased space in a well maintained brick and steel building. A Houston warehouse and distribution center occupies approximately 257,000 square feet of leased space in the same building complex. The Company rents an office\/warehouse in Santa Ana, California, in which approximately 7,000 square feet are devoted to office space and 151,000 square feet are used as warehouse space.\nOshman's owns the following properties: an 83,000 square foot building on approximately six acres in Houston, Texas housing a second distribution center; a 56,500 square foot building on 2.7 acres in Millbrae, California, of which 14,900 square feet are utilized for a retail store and the remaining 41,600 square feet are leased to an unrelated party; a 10,000 square foot building on approximately one acre in Los Angeles, California which is utilized for a retail store; a 27,500 square foot building on 1.8 acres in San Antonio, Texas of which 20,000 square feet are utilized for a retail store and the remaining 7,500 square feet are leased to an unrelated party; and approximately 5.9 acres in Houston, Texas which the Company anticipates selling in conjunction with a sale\/leaseback\/construction of a 65,000 square foot megastore.\nSubstantially all of Oshman's retail stores occupy leased space in modern structures. As of the end of the last fiscal year, these retail stores occupied an aggregate of approximately 2,200,000 square feet of floor space under leases expiring at various dates from 1995 to 2017 (exclusive of renewal options). Traditional stores on average are comprised of approximately 11,300 square feet, while the average megastore occupies approximately 65,000 square feet. The three traditional stores in locations owned by Oshman's aggregate approximately 39,000 square feet of floor space.\nAggregate rentals paid by the Company under all its leases amounted to approximately $15,591,000 during the fiscal year ended January 28, 1995. Most store leases provide for rentals which are the greater of a fixed minimum or a specified percentage of sales. Oshman's owns the fixtures in its retail stores and considers all property owned or leased to be well maintained, adequately insured and suitable for its purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is subject to certain pending legal proceedings, most of which are ordinary and routine litigation incidental to its business. None of such legal proceedings, in the opinion of the Company, is material to its business or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOshman's did not submit any matters to a vote of security holders during the fourth quarter of the fiscal year ended January 28, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the name and age of each executive officer of the Company, all positions and offices with the Company held by each person named, and the period during which each person named has served as an officer of the Company:\n- ---------------- (1) Unless otherwise stated below, each person has held such positions and offices for the last five years. The term of office of each officer is until the next annual meeting of directors or until his or her successor has been elected and qualified.\n(2) Ms. Oshman was elected Chairman of the Board in April 1993 and has been a director of the Company since 1979. Prior to becoming an employee of the Company in 1990, Ms. Oshman was involved in civic and charitable activities and management of her personal investments.\n(3) Mr. Anderson was elected President, Chief Operating Officer and Director in June 1994. Prior to that time Mr. Anderson served as Senior Vice President, General Manager of Ames Department Stores, Inc. (1992-1994), Chief Executive Officer of Reality Technologies, Ltd., a computer software developer in the financial planning\/services sector (1991-1992) and President and Chief Operating Officer of Domain, Inc., a specialty home furnishings retailer (1985-1991).\n(4) Prior to being elected Executive Vice President in March 1991, Mr. Rice served as California Division Vice President (1988-1991) and Divisional Merchandise Manager (1986-1988).\n(5) Mr. Bockart was elected Treasurer in June 1990.\n(6) Prior to becoming Vice President of the Company, Mr. Clark served as a Divisional Vice President in the warehousing and human resource functions (1990-1992), and store operations (1989-1990). Before joining the Company, Mr. Clark was Vice President and General Manager of The Outdoorsman Group, a retailer and manufacturer of sporting goods apparel and equipment.\n(7) Mr. Dennis was elected Vice President in June 1994. Mr. Dennis also served as General Counsel of the Company since 1993; Managing Attorney, Banc One New Hampshire Asset Management Company (1992-1993) and Associate Attorney, Weil, Gotshal & Manges (1986-1992).\n(8) Prior to becoming Vice President of the Company, Mr. Rath served as a Divisional Vice President for corporate development (1990-1992), and Director of Corporate Development (1988-1989).\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nOshman's Common Stock is traded on The Nasdaq Stock Market (\"Nasdaq\") under the symbol OSHM. The high and low closing sales prices of the Common Stock, as reported by Nasdaq, were as follows for the quarterly periods indicated:\nAs of March 31, 1995, there were 371 holders of record of the Common Stock. The Board of Directors suspended the payment of dividends in March 1991 and does not anticipate paying dividends in the foreseeable future. The Company's credit facility restricts the payment of dividends on the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table provides selected consolidated financial information for the Company's last five fiscal years.\n- -------------------------- * Does not include a net gain of $2,150,000 arising from a non-recurring change in accounting principle reflected in the Company's Statement of Operations for the year ended February 1, 1992.\nThe three years ended January 30, 1993 were restated from originally issued results to reflect a change in inventory valuation methods from the last- in, first-out (LIFO) to the first-in, first-out (FIFO) method during the third quarter of 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOVERVIEW\nFor the year ended January 28, 1995 (\"fiscal 1994\"), Oshman's earned its first profit in six years as it continued to reposition itself within the competitive sporting goods market with the goal of becoming primarily a megastore sporting goods operator. During the year, the Company opened four additional SuperSports USA megastores, including the conversion of one of its traditional stores into a megastore, and closed 23 traditional stores. In fiscal 1994, the Company's SuperSports USA megastores (12 in operation as of the end of the fiscal year) contributed 31.6% of total retail sales and 39.2% of direct store contributions. Of the 23 stores closed in fiscal 1994, 14 were stores included in a restructuring plan announced in the fourth quarter of 1993.\nOshman's business is subject to normal seasonal variations and may be further impacted by regional and national economic conditions. Additionally, weather may have a significant effect on the Company's snow ski business, particularly in its California stores. Favorable snow ski conditions during fiscal 1994 and the year ended January 30, 1993 (fiscal 1992), for instance, benefitted the Company, while unfavorable ski conditions negatively impacted results during fiscal 1993. In addition, results of operations in recent years have been influenced by certain non-recurring items which affect the comparison of one year's results to another.\nNON-RECURRING ITEMS\nIn the fourth quarter of fiscal 1993, the Company implemented a restructuring plan to accelerate the closing of 34 underperforming traditional stores during 1994 and 1995 and recorded a $15,000,000 pretax restructuring charge. The significant components of the charge, which negatively affect cash flows of the Company, were (i) estimated operating losses totaling approximately $3,360,000, before depreciation, (ii) $3,650,000 for estimated lease termination costs, (iii) $3,050,000 for markdowns related to the liquidation of merchandise inventories and (iv) approximately $1,100,000 for severance pay and various other store closing costs. In addition, the Company expected non-cash flow charges of approximately $3,500,000 in connection with disposition of fixed assets. Management believed the Company would be better served by redeploying the assets invested in these stores towards the more profitable megastore strategy, thereby accelerating the Company's transformation into a megastore sporting goods operator. At the end of fiscal 1994, the Company had closed 16 of the 34 stores, obtained rent concessions on two stores and expects to close six additional stores prior to the end of April 1995.\nDuring fiscal 1994, the stores included in the restructure group used cash of approximately $4,745,000 to cover losses before depreciation and amortization and writeoff of fixed assets. Approximately $481,000 of this amount was used for lease terminations related to stores closed during the year. Sales from all stores included in the restructure group were\n$21,286,000 in fiscal 1994 compared to $33,726,000 in fiscal 1993. In fiscal 1994, these stores as a group incurred direct store losses of approximately $6,962,000, including accelerated depreciation of approximately $2,238,000 and estimated liquidation markdowns in excess of \"normal\" markdowns totaling approximately $2,959,000, compared to a loss of $2,982,000 during the previous year. During fiscal 1994, the Company charged its restructuring reserve $7,663,000 for the operating losses, liquidation markdowns, lease termination costs and write-off of fixed assets for the stores included in the restructure group. Management believes that the closure of these stores is proceeding in accordance with expectations and that the restructure reserve remaining at the end of fiscal 1994 is adequate to provide for the costs associated with closing the remaining restructure stores.\nIn the third quarter of fiscal 1993, the Company changed its method of valuing its merchandise inventories from the last-in, first-out method (LIFO) to the first-in, first-out method (FIFO) in order to better measure the current value of such merchandise inventories and the financial position of the Company. This change was applied retroactively and at the beginning of the fiscal year 1993 had the effect of increasing merchandise inventories by $10,896,000 and retained earnings by $6,911,000, net of income taxes. Accordingly, all prior year amounts effected by this accounting change have been restated-primarily earnings, inventories, income tax liabilities and expense, retained earnings and costs of goods sold.\nLIQUIDITY AND CAPITAL RESOURCES\nIn fiscal 1994, operating activities provided cash of $2,396,000. The primary sources of the cash provided were pretax earnings before depreciation, amortization and real estate gains of $4,432,000 and a $12,820,000 increase in trade accounts payable. These amounts were offset by a $9,595,000 increase in merchandise inventories and by $4,745,000 used by stores included in the restructure group. Investing activities used $3,964,000, primarily for the purchase of property, plant and equipment totaling $7,905,000 offset by developer provided funds of $1,931,000 in excess of such amounts applied to new store construction costs and by proceeds from the sale of real estate and leasehold interest of $1,923,000. Financing activities provided net cash of $1,778,000 as a result of increased utilization of the Company's credit facility at the end of fiscal 1994. Cash of $859,000 was used for payment of scheduled long-term debt and the prepayment of mortgage debt in relation to a sale of real estate.\nDuring fiscal 1993, net cash of $4,462,000 was used in operating activities. The primary causes for the net use of cash were (i) a pretax loss of $4,587,000 before depreciation, amortization and the $15,000,000 restructuring charge and (ii) a $2,622,000 decrease in accounts payable, offset by cash provided by a reduction in merchandise inventories of $4,634,000. Cash used by investing activities was $2,979,000, which related primarily to the net purchase of property, plant and equipment of $4,497,000, after reduction for landlord- provided construction funds of $1,576,000, offset by proceeds of $1,284,000 from the sale of real estate and leasehold interests. Financing activities provided net cash of $2,042,000 due to the Company's utilization of its credit facility at the end of the year in the amount of $1,985,000 and the addition of a five-\nyear mortgage note for $855,000 in the second quarter of 1993 in connection with the purchase of real estate where one of the Company's stores was under lease. Cash of $765,000 was used for payment of scheduled long-term debt and the prepayment of mortgage debt in relation to a sale of real estate.\nIn fiscal 1992, operating activities provided a net cash increase of $3,906,000. The primary sources of the net cash increase from operating activities were pretax profits before depreciation and amortization of $5,011,000 and a decrease in prepaid expenses and other of $2,900,000, related primarily to the realization of a Federal income tax refund. These items were offset by an increase in merchandise inventories of $7,200,000 reduced by a related increase in trade accounts payable of $3,643,000. Cash used by investing activities was $2,021,000, including net purchase of property, plant and equipment totaling $2,876,000 after reduction for landlord-provided construction funds of $2,817,000. Financing activities used cash of $7,724,000 for payment of scheduled long-term debt installments, costs associated with the acquisition of a new revolving credit facility and prepayment of certain long- term debt obligations, discussed below.\nFiscal year-end inventories were $98,294,000 for 1994, $88,699,000 for 1993 and $93,333,000 for 1992. In fiscal 1993, as a result of the Company's efforts to continue to improve its inventory management and in consideration of declining sales trends, inventories were reduced. Inventory levels and trade accounts payable increased at the end of fiscal 1994 primarily as a result of early receipts of footwear and certain direct import categories of merchandise in anticipation of additional promotions planned for February 1995. In addition, selected categories of merchandise were increased from relatively low, end-of-fiscal-1993 levels in order to improve early 1995 spring season sales compared to the prior year.\nAdditions to property, plant and equipment in fiscal 1994, fiscal 1993 and fiscal 1992 were $7,905,000, $4,497,000 and $2,876,000, respectively. In fiscal 1994, the Company opened three new SuperSports USA megastores and converted an existing traditional store to a SuperSports USA megastore at a net cost of $3,170,000 over and above developer funding. In addition, the Company spent $1,381,000 to purchase a tract of land in Houston, Texas where it will open a SuperSports USA megastore in 1995. In 1994, the Company began a two-year program to upgrade its point of sale information systems. The total cost is expected to be approximately $2,600,000, of which $750,000 was expended in fiscal 1994. Additionally, the Company spent approximately $850,000 to upgrade its merchandise planning and advertising systems, $860,000 for other hardware and software and $894,000 for renovation and refurbishment of existing locations. In fiscal 1993, the Company opened three new stores, two of which were SuperSports USA megastores and converted an existing traditional store to a megastore at a net expenditure, over and above developer funding, of approximately $1,067,000. Approximately $1,736,000 was spent to renovate and refurbish existing locations, and $953,000 was used for the purchase of real estate where one of the Company's retail stores was under lease. Five stores, including three new SuperSports USA megastores, were opened during fiscal 1992, the construction of and appointments for which were substantially funded by developers. Approximately $1,676,000 was spent to renovate and refurbish existing locations and $750,000\nwas used in the exercise of an advantageous option to purchase real estate where one of the Company's stores was under lease. Additions of approximately $687,000 in fiscal 1993 and $450,000 in fiscal 1992 were related to the acquisition of computer hardware and software.\nThe Company's policy regarding developer funding of new stores is to offset the respective construction cost of real property improvements by the amount, if any, of funding provided by developers. In fiscal 1994, developer funding of stores opened exceeded the respective real property construction costs by $1,931,000 in the aggregate. This amount will be amortized over the life of the respective leases to which they apply as a reduction of rental expense. At the end of fiscal 1994, the non-current portion of this developer funding is presented on the Company's balance sheet as Deferred Rental Allowances in the amount of $1,738,000. The remaining portion is included in accrued liabilities. In previous years, developer funding in excess of real property construction costs has been immaterial.\nOn August 31, 1992, the Company entered into an agreement providing for a three-year, $32,500,000 revolving credit facility with The CIT Group\/Business Credit, Inc. Advances under the facility are based on a borrowing base formula, and subject to certain loan reserves. The facility is secured primarily by inventory, accounts receivable and real estate. The credit agreement includes various restrictions, requirements and financial covenants.\nThe Company's financing agreement was amended in December 1993 to increase the revolving line of credit from $32,500,000 to $40,000,000. In November 1994, the financing agreement was amended to extend the term of the agreement for two additional years until August 31, 1997, and to immediately reduce the interest rate. Additionally, in August 1995, the revolving line of credit will increase from $40,000,000 to $50,000,000, with a further seasonal increase to $65,000,000 during the period from mid-October through mid-December each year. Other terms of the financing agreement such as the formula for calculating the Company's borrowing base and certain requirements regarding the Company's loan reserves remain unchanged. The agreement has been amended several other times as well, primarily to modify the financial covenants contained therein. The Company is in compliance with all covenants of the agreement.\nThe Company's primary source of liquidity in the fiscal years 1994, 1993 and 1992 was the use of its credit facility and lines of credit, under which average borrowings were $13,776,000, $13,781,000 and $7,884,000, respectively. In fiscal 1994 and fiscal 1992, operating activities provided cash of $2,396,000 and $3,906,000, respectively, as additional sources of liquidity. Average borrowings increased in fiscal 1993 primarily as a result of the Company's inability to provide sufficient levels of cash from operations. Because of the seasonal nature of its business and the build up in inventory for the holiday season, the amount of outstanding borrowings and letters of credit under the Company's credit facility and lines of credit typically is highest in November and was $27,440,000 at November 14, 1994, $30,489,000 at November 12, 1993 and $25,652,000 at November 13, 1992.\nAt the end of fiscal 1994, borrowings outstanding against the Company's credit facility were $4,610,000 compared to $1,985,000 at the end of fiscal 1993. There were no borrowings outstanding against the company's credit facilities at the end of fiscal 1992. The Company had outstanding letters of credit (used primarily to purchase certain of the Company's imported inventory) totaling $2,786,000 at the end of fiscal 1994, $3,439,000 at the end of fiscal 1993 and $3,092,000 at the end of fiscal 1992.\nCapital expenditures in fiscal 1995 are expected to be approximately $16,400,000. The Company plans to open approximately six SuperSports USA megastores in fiscal 1995, at a capital cost of about $10,600,000, of which approximately $9,000,000 will be funded by a capital lease related to a sale\/leaseback and by funds provided by real estate developers. Approximately $3,700,000 will be used for computer hardware and software (primarily point-of- sale related) and $2,100,000 will be allocated to existing stores, warehouses and administrative areas. During fiscal 1994, the Company closed 23 of its traditional stores, 14 of which were part of the restructure discussed above, thereby eliminating their working capital requirements and overhead costs. In fiscal 1995, the Company expects to close approximately 21 traditional stores, including the 16 remaining restructure stores, the costs of which will be charged against the restructure reserve provided in fiscal 1993. In fiscal 1995, the Company estimates that the stores included in the restructure will require cash of approximately $6,400,000 to cover operating losses, lease termination costs, liquidation markdowns and other closing costs. The remainder of the closures in fiscal 1995 are expected to occur in the normal course of business as leases expire and the Company does not anticipate any unusual material costs or capital requirements in connection with these closures. The Company anticipates being able to satisfy its capital needs during fiscal 1995 from the capital lease arrangement and developer funding mentioned above, in addition to the use of its credit facility and internally generated funds.\nRESULTS OF OPERATIONS\nSales for fiscal 1994 increased 1.1% to $311,419,000 from $307,935,000 in fiscal 1993. Sales for fiscal 1993 decreased 1.7% to $307,935,000 from $313,253,000 in fiscal 1992. Same store sales increases (decreases) for the last three fiscal years were 1.7% in fiscal 1994, (4.2%) in fiscal 1993 and 1.7% in fiscal 1992.\nThe $3,484,000 net increase in sales during fiscal 1994 reflects an increase in sales of $29,439,000 contributed by new and ongoing stores offset by lost sales of $25,955,000 in traditional stores closed during the year and in the remaining restructure stores. During the last three fiscal years, the Company has closed a total of 53 of its traditional stores, including 16 stores included in the restructure group. Sales from these 53 closed stores were $14,370,000, $36,563,000 and $54,792,000, respectively, in fiscal 1994, fiscal 1993 and fiscal 1992. Same store sales in the Company's SuperSports USA megastores, including sales of a traditional store which was converted to a megastore in October, 1994, increased 8.5% for the fiscal year, while total sales from all SuperSports USA megastores open at the end of the year reached\n$95,711,000 compared to $64,616,000 at the end of fiscal 1993. At the end of fiscal 1994, sales from the SuperSports USA megastores represented 31.6% of total retail sales compared to 21.6% in the previous year.\nIn fiscal 1993, sales declined largely as a result of lost sales in California resulting primarily from the declining economic environment, poor snow-ski conditions and disruptions caused by the natural disasters which occurred in the state. Sales also declined in the state of Florida as a result of a substantial reduction in advertising expenditures that had been increased to combat large-format competitors during fiscal 1992. A substantial number of the Company's Florida stores are included in the group of stores to be closed pursuant to the restructure plan.\nDuring the quarter ended July 31, 1993, the Company changed its method of determining same store sales results. Previously, a store's sales had been included in same store sales after its twelfth full month of operation. To prevent distortions of same store sales results caused by the relatively high sales levels associated with the grand opening promotions of its SuperSports USA megastores, the Company has redefined same store sales to include only those stores that have been open for a full 12 months as of the beginning of the current fiscal year.\nEven though the Company experienced an overall same store sales decrease in fiscal 1993, the SuperSports USA megastores experienced a same store sales increase of 13.2% while total sales from all megastores (including two new stores) open at the end of the year increased 57.5% to $64,616,000. Same store sales from stores to be closed pursuant to the restructure plan declined 10.9% from fiscal 1992.\nCost of goods sold as a percentage of sales for fiscal years 1994, 1993 and 1992 was 64.9%, 66.7% and 64.0%, respectively. The reduction in cost of goods sold as a percentage of sales in fiscal 1994 was due primarily to reduced promotional markdowns resulting from the Company's strategy to discontinue competitive pricing which did not prove to be productive, and to improve gross profit margins as a percentage of sales.\nIn fiscal 1993, cost of goods sold as a percentage of sales increased primarily because of increased price reductions and promotional markdowns. The Company aggressively pursued competitive pricing, which did not produce sufficient sales increases to cover the increased cost of goods sold as a percentage of sales.\nSelling and administrative expenses as a percentage of sales was 35.5%, 36.7% and 36.3% for the fiscal years 1994, 1993 and 1992, respectively. Selling and administrative expenses in fiscal 1994 included a net credit of $1,766,000 related to operating results of the 34 stores included in the restructure group. Excluding this adjustment, selling and administrative expenses, as a percentage of sales, was 36.0% in fiscal 1994. The decrease, in fiscal 1994, of selling and administrative expenses, as a percentage of sales, was related primarily to lower occupancy costs, as a percentage of sales, which decreased to 8.0% in fiscal 1994, compared to 8.6% and 8.3%, respectively, in fiscal 1993 and fiscal 1992. The reduced rate in fiscal 1994 is largely attributable to lower occupancy costs, as a percentage of sales, in the SuperSports\nUSA megastores as a group, compared to the traditional stores, and to the Company's continued closing of higher cost, marginally performing, traditional stores. In addition, advertising costs decreased slightly, both in dollars spent and as a percentage of sales to 5.0% from 5.2% in each of the two previous fiscal years during which the Company conducted a more aggressive promotional program.\nThe slightly increased rate of selling and administrative expenses as a percentage of sales in fiscal 1993 was primarily related to reduced same store sales and the resulting effect on relatively fixed costs. However, payroll and related taxes and benefit costs decreased .4% as a percentage of sales from the prior year levels. This decrease of approximately $2,100,000 from fiscal 1992 levels resulted primarily from a net reduction of sales related payrolls in existing and closed stores, offset by payrolls in new stores.\nInterest expense for fiscal years 1994, 1993 and 1992 was $1,498,000, $1,427,000 and $1,085,000, respectively. The increased expense in fiscal 1994 and fiscal 1993 resulted from the Company's increased average borrowing during those years compared to fiscal 1992.\nThe major components of miscellaneous (income) expense are set out in the table below:\nThe income tax (benefit) rates for fiscal years 1994, 1993 and 1992 were 31.3%, (24.2%) and (40.0%), respectively. The tax rate in fiscal 1994 is related primarily to state income taxes. The decreased benefit rate in fiscal 1993, compared to fiscal 1992, was the result of the Company's inability to fully recognize the tax benefits of net operating losses and future deductible temporary differences in the calculation of its tax expense under SFAS 109. However, these amounts will be available to reduce future tax liabilities in years in which the Company has taxable earnings.\nPretax income in fiscal 1994 was $422,000 compared to a $10,731,000 pretax loss before the $15,000,000 restructuring charge in fiscal 1993. The improved results were primarily due to (i) a $6,624,000 increase in gross profit caused by both increased sales and a decrease in the rate of cost of goods sold as a percentage of sales, (ii) the non-recurrence of direct store losses of approximately $2,982,000 by the restructure group of stores and (iii) an increase in miscellaneous income as shown above.\nIn fiscal 1993, the Company's net loss was $19,494,000. Before income tax benefit and the $15,000,000 charge related to the Company's restructure (discussed above), the Company incurred a loss of $10,731,000 compared to a pretax loss of $1,131,000 in fiscal 1992. The increase in the loss before income tax benefit and the restructuring charge was primarily attributable to a $10,220,000 decrease in gross profit which was somewhat offset by a slight reduction in selling and administrative expenses. The reduction of gross profit was caused by a sales decline of $5,318,000 compared to fiscal 1992 and the increased rate of cost of goods sold as a percentage of sales in fiscal 1993 as discussed above. The Company also recorded a charge of $500,000 for damages suffered during the California earthquake in January 1994.\nRevenues will continue to be influenced by economic conditions and the competitive environment, however, in fiscal 1995 the Company expects a significant sales increase from its SuperSports USA megastores as it accelerates its store opening program with the opening of an additional five to seven megastores. The Company believes that the increasing sales and profit contributions from these more profitable megastores will enable it to provide increased operating cash flows and also to overcome the effects of any future inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item appears on pages 25 through 45 of this report.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere is no incident required to be disclosed herein.\nPART III\nIn accordance with paragraph (3) of General Instruction G to Form 10-K, Part III of this Report is omitted because the Company will file with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended January 28, 1995 a definitive proxy statement pursuant to Regulation 14A involving the election of directors, which proxy statement is incorporated herein by reference.\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.\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 financial statements or the notes thereto.\n- ------------------- * Management contract or compensatory plan or arrangement.\nThe Registrant will furnish to stockholders a copy of any exhibit upon payment of $.20 per page to cover the expense of furnishing such copies. Requests should be directed to Richard L. Bockart, Vice President, Oshman's Sporting Goods, Inc., P.O. Box 230234, Houston, Texas 77223-0234.\n(b) Reports on Form 8-K. The Company filed no reports on Form 8-K during the last quarter of the fiscal year 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 report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOSHMAN'S SPORTING GOODS, INC.\nBy:\/s\/ A. LYNN BOERNER ------------------------------ A. Lynn Boerner Vice President and Chief Accounting Officer\nDate: April 21, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on April 21, 1995 by the following persons on behalf of the Registrant and in the capacities indicated.\n\/s\/ MARILYN OSHMAN \/s\/ ALVIN N. LUBETKIN - ------------------------ --------------------------------- Marilyn Oshman Alvin N. Lubetkin Chairman of the Board of Vice Chairman of the Board of Directors, Directors Chief Executive Officer (Principal Executive Officer) and Director\n\/s\/ WILLIAM N. ANDERSON \/s\/ MARVIN ARONOWITZ - ------------------------- -------------------------------- William N. Anderson Marvin Aronowitz President, Chief Operating Director Officer and Director\n\/s\/ FRED M. GERSON \/s\/ STEWART ORTON - ------------------------- --------------------------------- Fred M. Gerson Stewart Orton Director Director\n\/s\/ DOLPH B.H. SIMON - ------------------------- Dolph B.H. Simon Director\nFINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS FOR INCLUSION IN FORM 10-K\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nJANUARY 28, 1995, JANUARY 29, 1994 AND JANUARY 30, 1993\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS --------------------------------------------------\nBoard of Directors and Stockholders Oshman's Sporting Goods, Inc.\nWe have audited the accompanying consolidated balance sheets of Oshman's Sporting Goods, Inc. (a Delaware 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 three years in the period ended January 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 our 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 Oshman's Sporting Goods, Inc. and Subsidiaries as of January 28, 1995 and January 29, 1994, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended January 28, 1995, in conformity with generally accepted accounting principles.\nWe have also audited Schedule II of Oshmans Sporting Goods, Inc. and Subsidiaries for each of the three years in the period ended January 28, 1995. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nHouston, Texas March 15, 1995\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS January 28, 1995 and January 29, 1994 (In thousands)\nSee notes to consolidated financial statements.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS Years ended January 28, 1995, January 29, 1994 and January 30, 1993 (In thousands except per share amounts)\nSee notes to consolidated financial statements.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended January 30, 1993, January 29, 1994 and January 28, 1995 (In thousands)\nSee notes to consolidated financial statements.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended January 28, 1995, January 29, 1994 and January 30, 1993 (In thousands)\nSee notes to consolidated financial statements.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE A - BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES\nGENERAL BUSINESS ----------------\nOshman's Sporting Goods, Inc. (the Company) operates a chain of retail sporting goods specialty stores, primarily in the Southwestern, Western, and Southern United States. The Texas and California stores accounted for approximately 41% and 23%, respectively, of sales for the year ended January 28, 1995. The majority of the Company's sales are either cash or through major national credit cards.\n1. FISCAL YEAR -----------\nThe Company's fiscal year ends on the Saturday closest to the end of January. Fiscal years 1994 (52 weeks), 1993 (52 weeks), and 1992 (52 weeks) ended on January 28, 1995, January 29, 1994, and January 30, 1993, respectively.\n2. PRINCIPLES OF CONSOLIDATION ---------------------------\nThe consolidated financial statements include the accounts of Oshman's Sporting Goods, Inc. and its subsidiaries, all wholly-owned. In consolidation, all significant intercompany transactions have been eliminated.\n3. CASH AND CASH EQUIVALENTS -------------------------\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\n4. MERCHANDISE INVENTORIES -----------------------\nMerchandise inventories are valued principally by the retail method and are stated at the lower of cost, determined on a first-in, first-out (FIFO) basis, or market. During the year ended January 29, 1994, the Company changed its method of valuing its inventory to the FIFO method from the last-in, first-out (LIFO) method in order to better measure the current value of such inventories and the financial position of the Company.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE A - BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES-Continued\n5. PROPERTY, PLANT AND EQUIPMENT -----------------------------\nDepreciation and amortization are provided principally by the straight-line method based upon estimated useful lives of 3 to 10 years for furniture, fixtures and equipment, 3 to 30 years for leasehold improvements and 20 to 40 years for buildings. Estimated useful lives of leasehold improvements represent the remaining term of the lease in effect at the time the improvements are made.\n6. AMORTIZATION OF OTHER ASSETS ----------------------------\nAmortization is computed using the straight-line method. Excess of cost over net assets of a business acquired is being amortized over 40 years. Loan acquisition costs are being amortized over the term of the related debt.\n7. DEFERRED RENTAL ALLOWANCES --------------------------\nThe Company may receive payments from landlords as inducements to sign new store leases. The construction costs of real property improvements are offset by this landlord funding. Deferred rental allowances represent payments in excess of the costs of the real property improvements and are recognized as a reduction of rent expense over the life of each applicable lease.\n8. INCOME TAXES ------------\nProvision has been made for deferred income taxes applicable to the temporary differences between earnings for financial reporting purposes and taxable income. Principal temporary differences include differences in accounting for depreciation and capitalization of certain inventory costs.\n9. PRE-OPENING COSTS -----------------\nCosts (other than property, plant and equipment) associated with the opening of new stores under 25,000 square feet are charged to expense as incurred. Pre- opening costs of stores larger than 25,000 square feet are deferred and amortized over a one-year period subsequent to the store opening.\n10. RECLASSIFICATIONS -----------------\nCertain amounts in prior financial statements have been reclassified to conform to the 1994 financial statement presentation.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE B - PROPERTY, PLANT AND EQUIPMENT\nThe cost of property, plant and equipment at the end of the year consists of the following:\nNOTE C - NOTE RECEIVABLE\nThe Company has a non-interest bearing note receivable from the Company's chief executive officer. At the end of 1994 and 1993, the balance of the note was $511,000 and $556,000, respectively. The note is payable in 228 bi-weekly installments of approximately $2,000 beginning April 1, 1991, with the remainder due September 2000. The note is collateralized by life insurance and Company stock options.\nNOTE D - LONG-TERM OBLIGATIONS\nLong-term obligations at the end of the year consist of the following:\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE D - LONG-TERM OBLIGATIONS - CONTINUED\nFollowing are maturities of long-term obligations for each of the next five years and thereafter:\nOn August 31, 1992, the Company entered into an agreement providing for a revolving credit facility. Currently, available credit under the facility is $40,000,000. Effective August 1, 1995, available credit under the facility will be $50,000,000, except for the mid-October to mid-December period when the available amount is $65,000,000. Advances under the facility are based on a borrowing base formula and subject to certain loan reserves, and the facility is secured primarily by inventory, accounts receivable and real estate. The credit agreement includes various requirements, financial covenants and restrictions, including a restriction on the payment of dividends. Such covenants have been modified several times, most recently in January 1995. Advances under the credit facility bear interest at the prime rate (8.5% at January 28, 1995) plus .5% and any unused borrowing capacity is subject to a line of credit fee of .5%. The Company may, under certain circumstances, elect to have interest computed at a rate of the London Interbank Offered Rate (LIBOR, 6% at January 28, 1995) plus 3%. Additionally, the Companys performance, as measured by a defined ratio, will cause both the prime and LIBOR based rates to be reduced or increased by one-quarter of one percent. Advances outstanding at January 28, 1995 amounted to $4,610,000. The credit facility expires August 31, 1997.\nAt the end of 1994 and 1993, outstanding letters of credit were $2,786,000 and $3,439,000, respectively.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE E - INCOME TAXES\nThe Company's tax expense (benefit) consisted of the following:\nA reconciliation of income tax expenses (benefits) on net earnings (losses) before cumulative effect of change in accounting principle computed at the statutory federal income tax rate and income taxes reported in the consolidated statements of operations is as follows:\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE E - INCOME TAXES - CONTINUED\nDeferred tax assets and liabilities consist of the following:\nDeferred income taxes of $80,000 and $54,000 were included in current liabilities at the end of 1994 and 1993. The change in the method of accounting for inventory which was made in the first quarter of 1993 resulted in a $3,596,000 increase in the deferred federal tax liability and a $388,000 increase in deferred state tax liability.\nDeferred tax assets were reduced by valuation allowances of $2,911,000 and $2,950,000 at January 28, 1995 and January 29, 1994, respectively. Based upon the criterion of SFAS No. 109, recognition of a deferred tax asset is prohibited if the Company cannot show that it is more likely than not that the deferred tax asset will be realized in future years. Based upon financial income and tax credits earned but not utilized during 1994, the valuation allowance was reduced by $39,000.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE E - INCOME TAXES - CONTINUED\nThe Company has net operating loss carryforwards of approximately $10,985,000. The carryforwards expire as follows: $641,000 in 2008, $6,680,000 in 2009, and $3,664,000 in 2010. Additionally, the Company has foreign tax credit carryforwards of $265,000 expiring from 1997 to 2000, job tax credit carryforwards of $278,000 expiring from 2008 to 2010 and alternative minimum tax credit carryforwards of $61,000.\nNOTE F - COMMITMENTS AND CONTINGENCIES\nOPERATING LEASES ----------------\nThe Company conducts certain of its operations in owned facilities with its remaining operations being conducted in facilities leased under noncancelable operating leases. Rentals of the retail locations are based on minimum required rentals and\/or, in certain instances, contingent rentals based on a percentage of sales. Some leases contain renewal options with provision for increased rentals during the renewal term.\nFuture minimum rental payments under operating leases at the end of 1994 are as follows:\nMinimum payments have not been reduced by minimum sublease rental income of $18,057,000 due in the future under noncancelable subleases.\nTotal rental expense entering into the determination of net earnings (loss) is as follows:\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE F - COMMITMENTS AND CONTINGENCIES - Continued\nCertain leases between the Company and two trusts, which are for the benefit of two shareholders, provide for total minimum annual rentals of $363,000 through 1998.\nCAPITAL LEASES --------------\nFuture minimum lease payments for assets under capital leases at the end of 1994, and the present value of such payments, are as follows:\nPROFIT SHARING PLAN -------------------\nThe Company and its subsidiaries participate in a discretionary employee profit sharing plan. No contributions were made in 1994, 1993 or 1992.\nEMPLOYEE MEDICAL PLAN ---------------------\nThe Company has an employee medical plan available to all full-time regular employees. The plan provides for payment of various medical expenses and is funded by participating employees and the Company. The provision for the Company's contribution to the plan amounted to $1,088,000, $691,000 and $484,000 for 1994, 1993 and 1992, respectively.\nSEVERANCE PAY BONUS AGREEMENTS ------------------------------\nThe Company has employment agreements with certain executive officers that become operative only upon a change in control of the Company. Compensation which may be payable under these agreements has not been accrued in the consolidated financial statements as a change in control, as defined, has not occurred.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE F - COMMITMENTS AND CONTINGENCIES - Continued\nDEFERRED COMPENSATION AGREEMENT -------------------------------\nThe Company has a deferred compensation agreement with an executive officer under which the officer will receive an estimated annual retirement benefit of $152,000 after he attains age 65. Upon the executives death, such payments will be made to his designated beneficiary.\nLITIGATION ----------\nVarious legal claims have arisen in the normal course of business, which, in the opinion of management, will not have a material adverse effect on the Company's financial statements.\nNOTE G - STOCKHOLDERS' EQUITY\nCAPITAL STOCK -------------\nAuthorized capital stock consists of 500,000 shares of $1 par value preferred stock and 15,000,000 shares of $1 par value common stock. No preferred stock has been issued. At the end of 1994, common stock shares issued and outstanding were 5,811,000 and 5,808,000, respectively. Common stock shares issued and outstanding at the end of 1993 and 1992 were 5,805,000.\nCOMMON STOCK OPTION PLANS -------------------------\nThe Company's 1994 Omnibus Plan authorizes the grant of Incentive Awards for up to 500,000 shares of common stock to key employees of the Company. Awards may be in the form of stock options, stock appreciation rights, restricted stock, performance units, performance shares or other stock based awards and certain additional payments in the amount of federal income taxes payable by a grantee and relating to an award, and are to be determined by a committee of the Board of Directors.\nStock options granted may be either nonqualified options or incentive stock options and may include reload options. Exercise price will be determined by the committee; however, in the case of incentive stock options, the exercise price shall not be less than 100% of the market value of the shares at the time the options are granted. No option is exercisable after the expiration of ten years from the date of grant.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE G - STOCKHOLDERS' EQUITY - Continued\nThe 1994 Omnibus Plan replaces the Company's 1991 Stock Option Plan, 1986 Stock Option Plan and 1986 Stock Bonus Plan. However, currently outstanding options and grants under those plans and the Company's 1982 Incentive Stock Option Plan will continue to exist until they vest and are exercised or expire. No awards are outstanding under the 1986 Stock Bonus Plan at year end.\nAdditionally, the Company's 1993 Non-Employee Director Stock Option Plan provides for the issuance of options to non-employee directors of the Company at an option price equal to the average of the closing prices of the last five trading days preceding and including the date of grant. Unexercised options expire no later than ten years from date of grant or three months after the termination of the directorship, extended to one year if the termination of directorship is caused by death or disability.\nThe Company records an expense based on the difference between the option price and fair market value of the stock at date of grant, amortized over the vesting period of the option. Selling and administrative expenses related to the grant of stock options were not material in 1994, 1993 or 1992. Upon the exercise of options, the proceeds are credited to the common stock account to the extent of the par value of the shares issued, and the proceeds in excess of the par value are credited to additional capital.\nThe following table reflects the activity under the Company's various plans during the three-year period ended January 29, 1995:\nAt January 28, 1995, options to purchase 358,950 shares of Common Stock under the stock option plans were exercisable and options available for grant under the plans were 360,000 shares.\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued January 28, 1995, January 29, 1994 and January 30, 1993\nNOTE G - STOCKHOLDERS' EQUITY - Continued\nRESTRICTED STOCK AWARD ----------------------\nThe Company granted 100,000 restricted shares of the Company's common stock to the Company's current Chief Executive Officer in 1994 pursuant to the 1994 Omnibus Plan. The grantee has no rights as a stockholder with respect to the restricted shares, including no right to transfer or receive dividends in most circumstances. Grantee becomes 100% vested in restricted shares if retirement occurs at or after age 65, in the event of death or disability of the grantee, termination by grantee following a change in control of the Company, termination of grantee by the company without cause and termination by grantee for good reason. Partial vesting occurs at the rate of 25% of the grant per year if retirement occurs at or after the grantee reaches the age of 62. Restrictions on the stock end on the vesting date. Additionally, the grant provides that the Company will pay the grantee the federal tax benefit (if any) realized by the Company from the tax deduction for compensation resulting from the restricted stock grant. Expense recorded in 1994 for the grant was approximately $187,000.\nNOTE H - EARNINGS (LOSS) PER SHARE\nEarnings (loss) per common and dilutive common equivalent share are based upon the weighted average number of common shares outstanding during each year. Outstanding options and bonus grants are included in periods where they have a dilutive effect.\nNOTE I - CORPORATE RESTRUCTURING\nDuring the fourth quarter of 1993, as a result of the Company's review of its operating strategies to become primarily a megastore sporting goods operator, and in order to more aggressively redeploy its assets, the Company implemented a restructuring plan to close 34 underperforming traditional stores. A restructuring charge of $15,000,000 before taxes was recorded which includes provisions for anticipated operating losses, liquidation markdowns on inventory, leasehold improvement abandonments, lease termination costs and other anticipated costs necessary to close the stores. At the end of 1994, 16 stores remain to be closed.\nSUPPLEMENTAL INFORMATION\nOSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nSELECTED QUARTERLY FINANCIAL DATA (Unaudited) Years ended January 28, 1995 and January 29, 1994 (In thousands except per share amounts)\nSchedule II OSHMAN'S SPORTING GOODS, INC. AND SUBSIDIARIES\nALLOWANCE FOR DOUBTFUL RECEIVABLES Years ended January 28, 1995, January 29, 1994 and January 30, 1993 (In thousands)\n- -------------- (A) Receivables charged off, net of recoveries.\nColumn C(2) - None.\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\n- ------------------- * Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"764065_1995.txt","cik":"764065","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nArrowhead. - ---------\nCMC, which has a 15 percent ownership interest in and acts as Managing Agent for Hibbing Taconite Company, a joint venture, has been included as a named defendant in a suit captioned United States of America v. Arrowhead Refining Company, et al., which was filed on or about September 29, 1989 in the United States District Court for the District of Minnesota, Fifth Division. In that suit, the United States seeks declaratory relief and recovery of costs incurred in connection with the study and remedial plan conducted or to be conducted by the U.S. EPA at the Arrowhead Refinery Superfund Site near Duluth, St. Louis County, Minnesota. In that suit, the United States has alleged that CMC and the other 14 named defendants, including former and present owners of the Arrowhead site, are jointly and severally liable for $1.9 million, plus interest, representing the amount incurred for actions already taken by or on behalf of the U.S. EPA at the Arrowhead site, and are jointly and severally liable for the cost attributable to implementation of a remedial plan adopted by the U.S. EPA with respect to the Arrowhead site, which remedial action is estimated by the U.S. EPA to cost $30 million. CMC has filed an answer to the suit denying liability. Since January 31, 1991, CMC and 13 of the other named defendants have filed a counter claim against the United States and further complaints naming additional parties as third party defendants. The counter claim and third party complaints allege that the parties named therein are jointly and severally liable for such costs. In 1995, a Consent Decree among the parties, including 224 third-party defendants named in the lawsuit, was entered into by the United States District Court. The Decree provides for funding for remediation of the Site, with a substantial portion of the funding to be provided by the U.S. EPA and the State of Minnesota. It is estimated that Hibbing Taconite's share of the funding will be approximately $230,000, of which CMC's share is 15 percent.\nRio Tinto. - ---------\nOn July 21, 1993, CCIC and Cliffs Copper Corp, a subsidiary of the Company, each received Findings of Alleged Violation and Order from the Department of Conservation and Natural Resources, Division of Environmental Protection, State of Nevada. The Findings allege that tailings materials left at the Rio Tinto Mine, located near Mountain City, Nevada, are entering State waters which the State considers to be in violation of State water quality laws. The Rio Tinto Mine was operated by Cliffs Copper Corp from 1971 to 1975 and by other companies prior to 1971. The Order requires remedial action to eliminate water quality impacts. The Company does not believe the potential liability, if any, to be material. The Company believes that it has substantial defenses to claims of liability.\nSummitville. - -----------\nOn January 12, 1993, CCIC received from the United States Environmental Protection Agency a Notice of Potential Liability at the Summitville mine site, located at Summitville, Colorado, where CCIC, as one of three joint venturers, conducted an unsuccessful copper ore exploration activity from 1966 through 1969. On June 25, 1993, CCIC received from the U.S. EPA a Notice of Potential Involvement in certain portions of the Summitville mine site. The mine site has been listed on the National Priorities List under the Comprehensive Environmental Response Compensation and Liability Act. The Company does not believe the potential liability, if any, to be material. The Company has substantial defenses to these claims of liability. The Company conducted no production activities at the Summitville mine site.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThere is no family relationship between any of the executive officers of the Company, or between any of such executive officers and any of the Directors of the Company. Officers are elected to serve until successors have been elected. All of the above-named executive officers of the Company were elected effective on the effective dates listed below for each such officer.\nThe business experience of the persons named above for the last five years is as follows:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required by this item is incorporated herein by reference and made a part hereof from that portion of the Company's Annual Report to Security Holders for the year ended December 31, 1995 contained in the material under the headings, \"Common Share Price Performance and Dividends\", \"Investor and Corporate Information\" and \"Summary of Financial and Other Statistical Data\", such information filed as a part hereof as Exhibits 13(h), 13(i) and 13(j), respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item is incorporated herein by reference and made a part hereof from that portion of the Company's Annual Report to Security Holders for the year ended December 31, 1995 contained in the material under the headings, \"Summary of Financial and Other Statistical Data\" and \"Notes to Consolidated Financial Statements\", such information filed as a part hereof as Exhibits 13(j) and 13(g), 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 incorporated herein by reference and made a part hereof from that portion of the Company's Annual Report to Security Holders for the year ended December 31, 1995 contained in the material under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", which such Management's Discussion and Analysis of Financial Condition and Results of Operations was subsequently amended by this Annual Form 10-K to reflect events occurring on March 15, 1996 with respect to McLouth Steel Products Company, such information, as amended, filed as a part hereof as Exhibit 13(a).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item is incorporated herein by reference and made a part hereof from that portion of the Company's Annual Report to Security Holders for the year ended December 31, 1995 contained in the material under the headings \"Statement of Consolidated Financial Position\", \"Statement of Consolidated Income\", \"Statement of Consolidated Cash Flows\", \"Statement of Consolidated Shareholders' Equity\", \"Notes to Consolidated Financial Statements\" and \"Quarterly Results of Operations\", such information filed as a part hereof as Exhibits 13(c), 13(d), 13(e), 13(f), 13(g) and 13(h), respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information regarding Directors required by this Item is incorporated herein by reference and made a part hereof from the Company's Proxy Statement to Security Holders, dated March 25, 1996, from the material under the heading \"Election of Directors\". The information regarding executive officers required by this item is set forth in Part I hereof under the heading \"Executive Officers of the Registrant\", which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is incorporated herein by reference and made a part hereof from the Company's Proxy Statement to Security Holders, dated March 25, 1996 from the material under the headings \"Executive Compensation (excluding the Compensation Committee Report on Executive Compensation)\", \"Pension Benefits\", and the first five paragraphs under \"Agreements and Transactions\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this Item is incorporated herein by reference and made a part hereof from the Company's Proxy Statement to Security Holders, dated March 25, 1996, from the material under the heading \"Securities Ownership of Management and Certain Other Persons\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item is incorporated herein by reference and made a part hereof from the Company's Proxy Statement to Security Holders, dated March 25, 1996, from the material under the last paragraph of the heading \"Directors' Compensation\".\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)\n(1) and (2)-List of Financial Statements and Financial Statement Schedules.\nThe following consolidated financial statements of the Company, included in the Annual Report to Security Holders for the year ended December 31, 1995, are incorporated herein by reference from Item 8 and made a part hereof:\nStatement of Consolidated Financial Position - December 31, 1995 and 1994 Statement of Consolidated Income - Years ended December 31, 1995, 1994 and 1993 Statement of Consolidated Cash Flows - Years ended December 31, 1995, 1994 and 1993 Statement of Consolidated Shareholders' Equity - Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\nThe following consolidated financial statement schedule of the Company is included herein in Item 14(d) and attached as Exhibit 99(a).\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(3) List of Exhibits - Refer to Exhibit Index on pages 20-26 which is incorporated herein by reference.\n(b) There were no reports on Form 8-K filed during the three months ended December 31, 1995.\n(c) Exhibits listed in Item 14(a)(3) above are included herein.\n(d) Financial Statements and Schedule listed above in Item 14(a)(1) and (2) are incorporated herein by reference.\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.\nCLEVELAND-CLIFFS INC\nBy: \/s\/ John E. Lenhard --------------------------------------- John E. Lenhard, Secretary and Assistant General Counsel\nDate: March 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.\nOriginal powers of attorney authorizing Messrs. M. Thomas Moore, John S. Brinzo, Frank L. Hartman, and John E. Lenhard and each of them, to sign this Annual Report on Form 10-K and amendments thereto on behalf of the above-named officers and Directors of the Registrant have been filed with the Securities and Exchange Commission.\nEXHIBIT INDEX","section_15":""}
{"filename":"51124_1995.txt","cik":"51124","year":"1995","section_1":"ITEM 1. Business\nGENERAL\nAmerican Banknote Corporation is a holding company whose subsidiaries operate the largest private-sector security printing business in North and South America and the world's leading security hologram manufacturer.\nAmerican Bank Note Company (\"ABN\"), the Company's United States security printing subsidiary, produces counterfeit-resistant documents of value using special paper, ink, elaborate steel-engraved designs and intaglio printing. ABN also uses special lithographic printing techniques for document security. ABN's manufacturing, storage and distribution facilities employ high levels of plant security through the use of guards, alarms, monitoring activities and extensive accountability controls. ABN is a major producer of government security documents including food coupons, social security cards and treasury checks for the United States government, currency and passports for foreign governments and motor vehicle titles and birth certificates for state and local governments. ABN's commercial products include travelers cheques, stock and bond certificates, gift certificates, certificates of deposit and bank checks. ABN and its predecessors have printed security documents for over 150 years.\nAmerican Bank Note Company Grafica e Servicos Ltda. (\"ABNB\") is the Company's 77.5% owned Brazilian subsidiary. ABNB is the largest private-sector security printer in Brazil. In addition to government and commercial security documents, ABNB produces personalized checks, financial cards, such as MasterCardTM, VISATM, and American Express cards, and drivers licenses. ABNB is a leading supplier of pre-paid telephone stored-value cards for Telebras, Brazil's national telephone company. ABNB was acquired June 23, 1993 and was a wholly-owned subsidiary until July 1, 1995 when ABNB acquired the printing business and operations of Grafica Bradesco Ltda. (\"GB\"), from Banco Bradesco, S.A., Brazil's largest private bank.\nAmerican Bank Note Holographics, Inc. (\"ABNH\") produces holograms primarily for security and anti-counterfeiting purposes. A hologram is a laser generated, three-dimensional image that can be permanently applied to a product, such as a credit card or identification document. ABNH's holograms are used on credit cards, identification cards, videocassette packages, computer\nsoftware packages, clothing tags, tickets and other products. ABNH is the principal producer of holograms for MasterCardTM, VISATM, EuroPay and Discover financial cards and ABNH's holograms have been used for national identification cards and drivers licenses.\nThe Company continues to focus its efforts on international expansion through joint ventures, acquisitions and foreign agent representations and on new product introductions. In 1995, 1994, and 1993 the Company's sales in foreign markets (principally South America) accounted for approximately 55%, 40% and 26%, respectively, of consolidated sales.\nThe Company was incorporated in 1993 in Delaware as United States Banknote Corporation and changed its name on July 1, 1995 to American Banknote Corporation. During 1993, 1994 and 1995 the Company undertook a series of consolidation and restructuring actions affecting the former Jeffries Banknote facility in Los Angeles, California and the Bedford Park, Illinois facility. The Company also has significantly downsized its New York corporate headquarters after a reorganization of its operating subsidiaries to establish greater autonomy for each subsidiary. The Company's domestic workforce is expected to be reduced by approximately 27% from prior levels. The Company's principal executive offices are located at 200 Park Avenue, New York, New York 10166, and its telephone number is (212) 557-9100.\nProduct Lines\nThe following table presents the Company's sales and the percentage of sales by product line for each of the three years ended December 31, 1995, 1994 and 1993, respectively (dollars in millions). 1995(2) 1994 1993(1)\nCorporate and Commercial Products . . . . . . $129.8 63.0% $121.1 58.2% $ 93.0 46.5% Government Products . 48.5 23.5 65.0 31.2 82.5 41.2 Holographic Products. 27.9 13.5 22.0 10.6 24.6 12.3 $206.2 100.0% $208.1 100.0% $200.1 100.0%\n(1) Includes sales of ABNB from June 23, 1993. (2) Includes sales of Grafica Bradesco S.A. from July 1, 1995.\nCORPORATE AND COMMERCIAL PRODUCTS\nThe Company produces a variety of security documents for corporate and commercial (non-government) customers including travelers cheques, domestic and foreign stock and bond certificates, pre-paid telephone cards, personalized checks and direct mail and fulfillment services.\nTravelers Cheques\nABN believes that it is one of the largest printers and distributors of travelers cheques in the world, whose customer's include American Express, Citicorp, MasterCardTM, VISATM and their issuing banks.\nStock and Bond Certificates\nStock and bond printing accounted for in excess of 10% of the Company's consolidated sales in 1995, 1994 and 1993. Stock and bond certificate sales is a function of the volume of trading activity, the number and size of public offerings, the mix of debt and equity security issuances and regulatory considerations. Although the number of new issues may vary substantially from year to year, reprints of existing publicly traded securities provide the Company with a continuing base of revenues. The New York Stock Exchange (the \"NYSE\") requires certificates of listed companies to be intaglio printed with unique border designs and vignettes. The Company's library of engravings includes the plates containing the border designs and vignettes for substantially all NYSE listed companies.\nThe Company's sales of stock and bond certificates declined in 1995 primarily as a result of reduced sales in foreign markets. The elimination of printed certificates continues to be advocated by various banking and securities firms who favor the use of book-entry systems for recording security ownership. The complete elimination of or substantial reduction in the domestic use of certificates would have a material adverse effect on the sales and earnings of the Company. The growth of institutional investors and shortened settlement periods has reduced demand for printed certificates.\nTelephone Cards and Payment Cards\nThe Company is one of the largest producers of pre-paid telephone cards in Brazil. Through its contracts with Telebras, Brazil's national telephone company, the Company's Brazil subsidiary has supplied embedded circuitry stored-value' cards to the Brazilian market since 1993 while Telebras continues converting the public telephones in Brazil from coin to card operation. ABNB is currently supplying cards under a $105 million contract over a 15 month period which commenced October 1995 and ABNB has added substantial new production capacity. Sales to Telebras were in excess of 10% of consolidated sales during 1995.\nABNB is one of the largest producers of financial payment cards supplying approximately 30 customers in Brazil and several other South American countries. These cards include ATM, credit and debit cards for financial institutions, including those issued for American Express, VISATM and MasterCardTM. The Company believes that the continuing progress of Brazil's Real Economic Plan could lead to expansion of consumer credit and increasing demand for financial payment cards in Brazil.\nDuring early 1996 the Company acquired a 25% interest in Ordacard HiTech Industries (1995) Ltd., a financial payment and identification card company which produces both traditional financial cards and smart cards.\nPersonalized Checks and Other Products\nABNB is the leading private sector supplier of personalized checks in Brazil, serving major banks as customers, some of which are among the largest in Brazil. ABNB's acquisition of the in-house printing operations of Brazil's largest (non-government) private bank, Banco Bradesco, S.A.,in exchange for 22.5% of ABNB has resulted in ABNB becoming the print supplier to Brazil's largest private bank under a multi-year contract for checks, check personalization, continuous forms, deposit slips, financial cards, insurance policies, and a wide array of additional printed products. As a result of this combination, ABNB has acquired the assets and taken over the operations and facilities of Banco Bradesco's printing plant in Osasco, Sao Paulo, Brazil. Management of the Company believes that Brazilian banks will continue to seek to outsource their check printing requirements and additional opportunities to expand ABNB's business in this manner are expected to continue.\nSecure Commercial Products\nRecent technological advancements in color copying, desktop publishing and laser scanning and printing have resulted in more companies requiring security in documents such as commercial paper, certificates of deposit, bank checks and other financial instruments, gift certificates and redemption coupons. The Company believes that the intaglio printing process and other secure printing methods greatly reduce the risk of copying and counterfeiting of such documents. ABN believes it is the largest producer of intaglio printed secure gift certificates in the United States including those for K-mart, Bloomingdale's and Saks Fifth Avenue. The Company has recently begun to sell and market gift certificates in foreign countries and has increased its sales efforts for non-intaglio printed commercial products and processing, packaging and distribution services.\nGOVERNMENT PRODUCTS\nGovernment Products include a variety of security documents printed for the United States government, numerous state and local governments and foreign governments, including food coupons, treasury checks, passports and currency.\nFood Coupons\nThe United States Department of Agriculture (\"USDA\") is ABN's largest government customer. Through 1995, the Company and its predecessors had collectively printed the food coupon requirements for the USDA since the printing of food coupons was fully privatized more than 20 years ago. Food coupons are intaglio printed documents that are accepted by food stores in lieu of currency for the purchase of food. Sales of food coupons were in excess of 10% of consolidated sales and were approximately $23.8 million, $46.0 million, and $40.6 million in 1995, 1994 and 1993, respectively.\nIn September 1995, the food coupon production contract under which the Company has produced food coupons expired and bids for food coupon production have been solicited under a competitive bid which is presently pending. The food coupon contract is expected to be awarded during the second quarter of 1996 and the Company believes the award will be for substantially lower volumes than prior awards. See \"Business - Competition\". In June 1995 ABN was awarded a three-year contract with USDA to store and distribute food coupons to state and local government agencies that administer the food coupon program.\nFood coupon production and distribution constitutes a significant component of the Company's consolidated sales and earnings. Although the Company's food coupon production has increased during recent years, implementation of electronic card-based systems, proposed benefit reforms and high levels of food coupon inventory are expected to reduce the Company's volume of food coupon production for 1996 and in future years. Card-based programs have had a negative impact on the Company's printing of food coupons and are expected to continue to have a negative effect.\nThe USDA is promoting the issuance of electronic card-based food coupon benefits and nationwide implementation is being pursued and by 1996, eight states had begun implementation (although only Maryland, Texas and South Carolina are statewide). The Company believes that twenty-one additional states recently awarded or are in the process of awarding contracts to perform similar services. The elimination or a substantial reduction in the use of paper food coupons or changes in federal benefit programs could have a material adverse effect on the sales and earnings of the Company. See \"Management's Discussion and Analysis - Liquidity and Capital Resources.\"\nDuring 1994 and 1993, the Company believes that increases in the number of eligible recipients as well as the USDA's increasing inventory of food coupons, increased food coupon sales. Neither of these factors are continuing.\nOther Government Products\nABN prints all official United States government checks under a contract with the United States Government Printing Office and Social Security cards under a contract through January 1996. From time to time, ABN has manufactured visas, currency, passports, gas rationing coupons and similar products for government and similar customers, such as NATO. ABN also manufactures motor vehicle title certificates, as well as birth certificates and other vital documents for various state and local governments. The Company believes it is the largest supplier of such intaglio documents in the United States.\nABN presently prints American Commemorative Postage Stamp Panels for the United States Postal Service (\"USPS\") under a three-year contract with two one-year options. ABN's sales to the USPS declined in 1994 following an award of a competitively bid contract to print postage stamps. ABN's sales to the USPS were approximately $1.3 million, $2.5 million and $23.5 million in 1995, 1994 and 1993, respectively.\nSales of Government Products, particularly to the United States government and state and local governments, is principally dependent on successful competitive bids. Competitive bids are generally awarded on the basis of price, but may also consider other factors. Multiple awards and requirements contract provisions can affect the level of Government sales. Many of the Company's contracts are re-bid annually or on a multiple year basis. There can be no assurance that any particular bid by the Company will be successful. Government sales are generally subject to provisions which allow termination for the convenience of the Government, and upon such termination, to reduce payment to the contractor.\nABN competes directly with foreign security printing companies and certain government-owned printing operations. Highly specialized equipment is necessary for much of ABN's printing and ABN believes that it is the only private sector company in the United States with a Super Giori intaglio printing press. Special equipment, such as a Giori intaglio press, is necessary for the efficient printing of certain currencies.\nABNB produces a wide variety of lithographic and intaglio documents for governmental customers in Brazil including motor vehicle registrations, drivers licenses, fiscal stamps, identity cards and transportation passes.\nHOLOGRAPHIC PRODUCTS\nHolographic Products include holograms with security and anticounterfeiting features for products such as credit cards and identification cards and product authentication labels. ABNH's security hologram sales are made primarily to the credit card industry. To date, ABNH has produced and sold over 4 billion holograms for use on bank credit cards. ABNH is the principal producer of holograms for MasterCard , VISA , Europay and Discover credit cards in use around the world. Holograms manufactured by ABNH have been used as security labels to authenticate computer equipment, computer software, video cassettes, transit passes and auto parts with many leading brand-name products. The Company's see-through holographic laminates have been used for national identification cards and for drivers licenses in the United States and abroad.\nPart of ABNH's growth strategy focuses attention on markets in the Pacific Rim and ABNH has entered into various third-party distribution arrangements in Japan, Hong Kong, Taiwan, Malaysia, Indonesia, Korea and Thailand.\nOTHER ACTIVITIES\nIn 1992, the Company and Thomson-CSF (\"Thomson\"), a leading French electronics and defense company, concluded a joint venture agreement to combine their respective identification systems businesses. In 1995, Thomson purchased the Company's interest in the joint venture for approximately $4.7 million. Revenues generated were not material in relation to the Company's total revenues.\nFOREIGN OPERATIONS AND EXPORT SALES\nInformation with respect to the Company's foreign operations and export sales is disclosed in Note A to \"Notes to Consolidated Financial Statements.\"\nCOMPETITION\nCompetition in the Company's product markets is based upon price, service, quality, and reliability. Each of the Company's subsidiaries conduct their businesses in highly competitive markets. In certain markets, the Company's competitors have greater financial resources than the Company. In the United States, ABN competes with other printers as well as companies engaged in businesses unrelated to printing that provide goods or\nservices which could replace or substantially reduce demand for certain of the Company's printed products, including food coupons. The market for holographic products is highly fragmented with no dominant competitor to ABNH. ABNH believes it is the largest producer of secure holographic products in the United States and that it competes with various smaller, less technologically advanced holographers and with companies producing non-holographic optical devices. ABNB competes in Brazil with other printers who offer various secure alternatives to ABNB's secure printed products. Internationally, ABN and ABNB primarily compete with private security printers located in the United Kingdom, Germany, France and Canada, as well as various government printers.\nPATENTS\nABN and ABNH presently hold, or are licensed under, numerous United States and foreign patents. The Company continues to pursue patent protection when patent protection can be obtained or expanded in strategic markets. Patents held by the Company will expire over the next several years and may be challenged or ultimately declared invalid whenever the Company seeks to enforce its patents in judicial proceedings. The Company has also granted licenses to third parties for certain patents. Licensing and the loss of patent protection may allow additional competition to develop, particularly with respect to the business of ABNH. The Company believes, however, that its patent rights are of less significance to sales in the holography industry than factors such as innovation and technological expertise. In addition, there can be no assurance that others will not independently develop substantially equivalent technology or obtain access to the Company's trade secrets or technology.\nBACKLOG\nAt December 31, 1995 and 1994, the Company had an overall backlog of approximately $138 million and $81 million, respectively.\n1994 backlog included $23 million of firm orders for food coupons and distribution with the USDA and 1995 includes none.\n1995 backlog principally consists of orders relating to Telebras pre-paid telephone cards, personal checks, travelers checks and financial payment cards. The Company believes that substantially all of its backlog will be produced and shipped in 1996.\nRAW MATERIALS\nThe Company is not materially dependent upon any one supplier for raw materials used in its businesses. Certain raw materials used are available from a limited number or only a single source supplier and certain other products, particularly for national governments, require domestic content which limits potential suppliers. The Company regards its relationships with its primary suppliers as reliable.\nENVIRONMENT\nIn connection with the Company's business, the Company engages in the use or disposal of substances that may be considered to be toxic or hazardous substances under applicable environmental laws. The Company believes that its compliance with such laws has not had and will not have a material effect on the capital expenditures, earnings or competitive position of the Company.\nEMPLOYEES\nAt December 31, 1995, the Company had approximately 2,380 employees consisting of 2,120 employees engaged in manufacturing, 230 engaged in plant administration and sales and 30 in executive, corporate and administrative functions. Approximately 66% of the Company's domestic employees and all of ABNB's employees are represented by labor unions. The Company has multi-year contracts with labor unions covering a substantial number of employees of ABN, several of which were renegotiated during 1995. The Company's future profitability will be dependent, in part, upon its ability to maintain satisfactory relationships with labor unions and employees and in avoiding strikes and work stoppages.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe following table describes the Company's facilities:\nSize (in Location square feet) Owned or Leased Operations\nCorporate Headquarters 200 Park Avenue 12,500 Lease expiring Executive, administration New York, New York in 1998 and sales offices (1)\nPrinting\/Engraving Operations Bedford Park, 156,000 Lease expiring Printing (2) Illinois in 2009, with purchase option\nColumbia, 50,000 Leasing expiring Printing Tennessee in 1999, with purchase option\nElmsford, 59,000 Lease expiring Administration and New York in 2007, with sales offices, renewal option research and development and hologram production\nHorsham, 111,000 Owned Administration and Pennsylvania sales offices; printing\nHuntingdon Valley, 30,000 Lease expiring Hologram production Pennsylvania in 1996, with renewal option\nBarueri, Sao Paulo 290,000 Leased, under Future consolidation of Brazil construction Osasco, Brazil facility with purchase option\nOsasco, Sao Paulo 280,000 Leased Checks, financial cards Brazil bank forms and publications\nRio de Janeiro, RJ 140,000 Owned Checks, financial and Brazil telephone cards, intaglio documents and vouchers\nAlphaville, Sao Paulo 27,000 Owned Personalization of Brazil checks\nSize (in Location square feet) Owned or Leased Operations\nOther Facilities Forest Park, 60,000 Lease expiring Storage Illinois in 1997, with renewal and purchase option\nLos Angeles, 148,000 Lease expiring Facility closed (3) California in 2000\nNew York, 30,000 Lease expiring (1) New York in 1997\nPhiladelphia, 104,000 Owned Product distribution Pennsylvania (Caroline Road) and storage(4)\nPhiladelphia, 95,000 Owned Ink manufacturing and Pennsylvania (55th Street) storage(4) _____________________ (1) In connection with a new long-term lease for 22,000 square feet for corporate offices entered in 1993, the landlord assumed the cost of maintaining the Company's former headquarters lease through its expiration in 1997. In 1996, as part of the Company's restructuring, the Company terminated the 1993 lease and vacated those facilities in March 1996 to move to smaller corporate offices. Notwithstanding termination of the 1993 lease, the landlord will continue to make the payments required under the old lease through expiration of its term. (2) The plant is to cease production in 1996 and the facility will be closed. (3) In 1994 the Company decided to completely vacate its Los Angeles facility and is seeking to sublease or otherwise terminate this lease. (4) These former production or administration facilities are currently used for storage of files, excess equipment and materials.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nIn January 1994, Vladimir v. United States Banknote Corporation, et al., and in February 1994, Sinay v. United States Banknote Corporation, et al. were filed in the United States District Court for the Southern District of New York on behalf of a purported class of purchasers of Common Stock between April 1, 1993 and January 6, 1994. Also, in January 1994, Atencio v. Morris Weissman, et al. was filed in the Court of Chancery for the State of Delaware, New Castle County, against various directors and\/or officers of the Company, on behalf of a purported class and also derivatively on behalf of the Company which was named as a nominal defendant. In February 1994, Rosenberg v. Morris Weissman, et al. was filed in the same court as Atencio, alleging similar claims to Atencio, but not on behalf of a class of plaintiffs.\nThe complaints in these four actions allege, among other things, that the Company and the individual defendants knowingly or recklessly caused the market price of its Common Stock to be inflated artificially by making misleading statements and\/or omissions of material fact concerning the risk of loss of the Company's stamp printing contracts with the USPS. The Vladimir and Sinay actions seek unspecified damages. The Atencio and Rosenberg actions also assert claims for breach of fiduciary duty by the individual defendants, and allege that certain of the defendants sold Common Stock while in possession of material non-public information and seek recapture of the profits earned by the defendants who purportedly traded, the repayment by the defendants of their 1993 salaries, damages for the costs to the Company of defending the Vladimir and Sinay actions and the annulment of the 1993 election of directors.\nOn June 16, 1995, the court granted plaintiff's motion for class certification in Vladmir and defined the class to include persons (other than defendants and related persons) who purchased the Company's stock from April 1, 1993 through January 6, 1994. On February 28, 1996, the Sinay action was voluntarily dismissed. The Atencio and Rosenberg actions have been stayed pending the outcome of the Vladimir action.\nOn November 1, 1994, the Company filed an action against De La Rue, AG (\"DLR\")and its parent, De La Rue Plc in New York State Supreme Court. The complaint alleges breach of contract in connection with the 1993 purchase of the Company's Brazilian subsidiary from DLR and seeks in excess of $1.5 million in damages. In December 1994, the action was removed by the defendants to the United States District Court for the Southern District of New York. Defendants have filed an answer denying liability and asserting counterclaims. Discovery is presently underway. On November 2, 1994, an action was commenced against the Company and certain of its directors and officers entitled Thomas De La Rue AG v. United States Banknote Corporation, et al. in the United States District Court for the Southern District of New York. The complaint, as amended, alleges, among other things, breach of contract by the Company in connection with the Brazil purchase agreement and common law fraud based on the alleged failure to disclose the risk of loss of the Company's stamp printing contracts with the USPS and the alleged failure to register the Common Stock paid to DLR expeditiously with the SEC. The complaint seeks unspecified damages as well as $6.8 million for the Common Stock received by DLR in the transaction. On November 20, 1995, plaintiff amended its complaint and eliminated all of its federal securities law\nclaims and the individual defendants following dismissal of certain of DLR's securities law claims by the court. Discovery is presently underway.\nThe adverse determination of the above-described litigations could have a material adverse effect on the financial condition or results of operations of the Company in the event that the Company's insurance was not available to cover such claims or an award materially in excess of insurance coverage was made. The Company believes, however, that it has good and meritorious defenses to the litigations and intends to vigorously defend against such actions. The Company maintains insurance coverage which presently covers a majority of the expenses of defense of the class action suits and, until November 1995, the DLR suit. In addition to the foregoing, the Company is party to legal proceedings that are considered to be either ordinary, routine litigation incidental to its business or not material to the Company's 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 in the fourth quarter of 1995.\nITEM 10. Directors and Executive Officers of the Company\nThe following table sets forth certain information regarding the current executive officers of the Company.\nPositions and Offices Office Held Name Age With the Company Since\nMorris Weissman* . . . . . 54 Chairman of the Board and (1) Chief Executive Officer Bette B. Anderson . . . . 67 Director June 1994 Dr. Oscar Arias. . . . . . 56 Director July 1995 C. Gerald Goldsmith . . . 67 Director July 1990 Ira J. Hechler. . . . . . 76 Director February 1990 David S. Rowe-Beddoe. . . 57 Director July 1990 John T. Gorman*. . . . . . 51 Executive Vice President (1) and Chief Financial Officer Harvey J. Kesner*. . . . . 38 Senior Vice President, June 1991(1) General Counsel and Secretary Robert K. Wilcox*. . . . . 49 Senior Vice President - (1) Manufacturing, General Manager ABN Sidney Levy. . . . . . . . 39 Managing Director of February 1994 ABNB Paul Amatucci. . . . . . . 49 Executive Vice President, (1) ABN Josh Cantor. . . . . . . . 36 Executive Vice President, (1) General Manager ABNH Sheldon Cantor . . . . . . 62 Vice President - Corporate (1) Services and Assistant Secretary Patrick D. Reddy . . . . . 54 Vice President and Assistant (1) Secretary Ward A.W. Urban. . . . . . 35 Vice President, Treasurer and Assistant Secretary (1) Patrick J. Gentile . . . . 37 Vice President and Corporate (1) Comptroller ___________________ * \"Executive Officer\" under the Securities Exchange Act of 1934, as amended. (1) See below.\nMorris Weissman. Mr. Weissman has served as Chairman of the Board and Chief Executive Officer of the Company since July 1990 and as a Director of the Company since February 1990. Mr. Weissman assumed the additional duties of Chief Operating Officer in July 1995. Mr. Weissman was Chairman and Chief Executive Officer of United States Banknote Company, L.P. (\"USBC\") a predecessor of the Company, from April 1986 to July 1990 and Vice Chairman and Director of USBC's predecessor from 1976 to 1986. Mr. Weissman is a Director of the Convenience and Safety Corporation and a Trustee of the Jackie Robinson Foundation and the Business Council for the United Nations.\nBette B. Anderson. Ms. Anderson has served as a Director of the Company since June 1994. She has served as President of Kelly, Anderson, Pethick & Associates, Inc., financial and corporate\nconsultants, since 1989. Ms. Anderson served as Undersecretary of the Treasury from 1977 to 1981 and held various Washington, D.C. consulting posts from 1981 to 1991. Ms. Anderson is a Director and Chairperson of the Compensation Committee of Manville Corporation, a Director of ITT Corporation, a Director of ITT Financial Corporation, a Director and Chairperson of the Compensation Committee of Riverwood International Corporation, Chairperson of the U.S. Treasury Historical Association, a member of the Council for the Miller Foundation, University of Virginia, and a member of the Advisory Council of the Girl Scouts of America.\nC. Gerald Goldsmith. Mr. Goldsmith is a private investor. He has served as a Director of the Company since July 1990. He is a Director of Palm Beach National Bank and Trust, and since June 1993, a Director of Nine West Group, Inc.\nIra J. Hechler. Mr. Hechler is a private investor. He has served as a Director of the Company since February 1990. He is a Director of Leslie Fay Companies, Inc. and Concord Camera Corp.\nDavid S. Rowe-Beddoe. Mr. Rowe-Beddoe has served as a Director of the Company since July 1990. He has been Chairman of the Board of Welsh Development Agency since 1993 and Chairman of the Development Board of Rural Wales since 1994. Mr. Rowe-Beddoe is also a Director of Cavendish Services Ltd. and Development Securities plc. Mr. Rowe-Beddoe previously held various senior management positions, including at Revlon Inc. and De La Rue plc, where he was an Executive Director.\nJohn T. Gorman. Mr. Gorman has served as Executive Vice President and Chief Financial Officer of the Company since July 1990 and as Vice President of the Company from February 1990 to July 1990. Mr. Gorman was Executive Vice President and Chief Financial Officer of USBC from January 1983 to July 1990 and Senior Vice President of Finance of USBC's predecessor from 1978 to 1983.\nHarvey J. Kesner, Esq. Mr. Kesner has served as Senior Vice President, General Counsel and Secretary of the Company since June 1994 and as Vice President, General Counsel and Secretary of the Company from 1991 to 1994. Mr. Kesner was an attorney in private practice for more than five years prior thereto.\nRobert K. Wilcox. Mr. Wilcox has served as Senior Vice President Manufacturing of the Company since August 1995 and as Executive Vice President - Operations and General Manager of ABN since\nNovember 1995. Mr. Wilcox was Vice President of US Operations for Transcontinental Printing and previously held senior positions at the Bureau of Engraving and Printing as well as Gowe Printing, Arcata Graphics and C.P.Y. Jeffries Banknote Co.\nSidney Levy. Mr. Levy has served as Managing Director of ABNB since February 1994. Prior to joining ABNB, Mr. Levy was employed as Managing Director of De La Rue Lerchundi in Spain since 1991 and prior thereto was employed by Thomas De La Rue Grafica e Servicos Ltda. in Brazil, serving in various management capacities.\nPaul Amatucci. Mr. Amatucci has served as Executive Vice President of ABN since September 1994. Mr. Amatucci was Vice President - Sales of ABN for more than five years prior thereto.\nJosh Cantor. Mr. Cantor has served as Executive Vice President and General Manager of ABNH since November 1995 and Executive Vice President of ABN since September 1994. Mr. Cantor was Vice President - Sales of ABN for more than five years prior thereto.\nSheldon Cantor. Mr. Cantor has served as Vice President-Corporate Services of the Company since August 1993. Mr. Cantor was Treasurer of the Company from July 1990 to August 1993, and Vice President and Assistant Secretary from February 1990. Mr. Cantor was Treasurer of USBC and its predecessor from January 1983 to July 1990.\nPatrick D. Reddy. Mr. Reddy has served as Vice President and Assistant Secretary of the Company since July 1990 and as Vice President, Treasurer and Secretary from February 1990 to July 1990. Mr. Reddy had been a continuous employee of the Company's predecessors since 1969 and has held many positions during that period, including Comptroller, Secretary and Treasurer.\nWard A.W. Urban. Mr. Urban has served as Treasurer of the Company since August 1993 and as Vice President and Assistant Secretary since June 1995. Mr. Urban was employed as an Assistant Vice President in the leveraged finance department of Citibank, N.A. since August 1988.\nPatrick J. Gentile. Mr. Gentile has served as Vice President of the Company since June 1995 and as Comptroller since 1989 and has been a continuous employee of the Company's predecessors since 1986.\nPART II\nITEM 5.","section_5":"ITEM 5. Market Price for the Company's Common Stock and Related Matters\nThe Company's Common Stock is traded on the New York Stock Exchange. The following table sets forth, for the periods indicated, the high and low sales price per share of the Company's Common Stock. 1995 1994 High Low High Low First Quarter $2 1\/2 $1 1\/2 $6 1\/2 $3 1\/4 Second Quarter $2 1\/2 $1 3\/4 $4 $3 Third Quarter $2 3\/8 $1 5\/8 $3 5\/8 $2 1\/2 Fourth Quarter $2 1\/8 $1 1\/4 $2 7\/8 $1 3\/4\nDuring the first quarter of 1996 through March 25, 1996 the high and low sales prices of the Company's stock was $2 and $1 1\/4, respectively.\nNo cash dividends have been paid during the two most recent fiscal years on the Common Stock. The Company is restricted from paying cash dividends on the Common Stock by the terms of the Company's 10-3\/8% Senior Notes due June 1, 2002 (the\"10-3\/8% Senior Notes\"), the 11-5\/8% Senior Notes due August 1, 2002 (the\"11-5\/8% Senior Notes\") and the credit agreement with Chemical Bank. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -Liquidity and Capital Resources.\" The Company does not expect to pay cash dividends on the Common Stock in the foreseeable future.\nThere were 2,976 holders of record of the Company's Common Stock at the close of business on March 26, 1996.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe selected financial data presented below is derived from the Company's consolidated financial statements, and should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, appearing elsewhere herein.\nThe historical financial data presented below reflects the results of operations of ABNB from June 23, 1993, the date of its acquisition by the Company and the acquisition of Grafica Bradesco since July 1, 1995.\nAt December 31\nNotes to Selected Financial Data\n(1) Restructuring costs represent provisions principally for the consolidation during 1995 of ABN's Chicago plant and its Los Angeles plant in 1994 and 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" (2) Consists primarily of charges for leases and equipment that will not be utilized in the Company's business. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" (3) Results from the Company's translation of Brazilian local currency into dollars in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 52, \"Foreign Currency Translation.\" See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" (4) 1995 includes a $2.8 million benefit and 1993 includes a $1.5 million charge for adjustment of deferred tax assets and liabilities pursuant to SFAS No. 109 for changes in enacted tax rates. The 1995 amount pertained to decreases in ABNB local tax rates and the 1993 amount pertained to increases in the US federal corporate tax rate.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nOverview\nThe Company's growth during the past three years has been generated principally by the acquisition of ABNB in June 1993, increases in ABNB's major product lines and the acquisition of Grafica Bradesco in July 1995. Operating income and operating margins before restructuring charges were lower in 1995 due to decreased domestic sales by ABN and changes in product mix and start-up of new production capacity in Brazil for telephone cards during the first half of 1995.\nThe Company has been consolidating its domestic facilities to improve its competitive position. During 1994, the Company closed its Los Angeles facility and consolidated its operations in its remaining two domestic facilities. During 1995 and 1996, the Company further consolidated domestic activities in ABN's Horsham, Pennsylvania facility, and significantly downsized the its corporate offices. The Company's domestic workforce is expected to be reduced by approximately 27% from prior levels.\nDuring the consolidation and downsizing, the Company expects a short-term negative impact on operating margins, cash flow and cash position while redundancies in fixed and other costs are eliminated through 1996. The Company, in the fourth quarter of 1995, established a reserve for charges in connection with the downsizing, consolidation and restructuring activities. See, \"Liquidity and Capital Resources.\" As a result of the consolidation program described above, the Company believes it has increased the overall productivity and efficiency of ABN's operations which should begin to benefit the Company by the second half of 1996 and thereafter.\nThe Company has experienced increasing competition in many of the markets in which it competes. ABN and ABNB compete with other printers, as well as companies engaged in businesses unrelated to printing that provide goods or services which could replace or substantially reduce demand for certain of the Company's printed products. In addition, certain of ABN's domestic product lines are mature.\nThe Company's business strategy includes continuing its growth by increasing its presence in selected foreign markets, particularly Latin America and Asia, through strategic alliances, selective acquisitions and expanded selling efforts. These activities, particularly the Company's acquisitions, could require the Company to commit portions of its cash balances in order to consummate a transaction and to commit a portion, or all, of the cash flow of any acquisition or similar transaction for an indefinite period to debt service for such acquisition. As part of this strategic plan, the Company acquired ABNB in June 1993 and in July 1995 ABNB acquired the printing operations and business of Grafica Bradesco. Prior to the acquisition of ABNB, the Company did not have any substantial foreign manufacturing operations. The Company's financial condition could be adversely affected if the Company cannot successfully integrate any acquired business into its existing operations or if the Company is required to materially increase the amount of its financial commitment to such acquisitions, investments or joint ventures. ABNB currently operates in a changing economic environment which may cause volatility in the Company's financial results from time to time. In addition, cash dividends from ABNB to the Company have historically been subject to a 15% Brazilian withholding tax and could be subject to government restrictions in the future, including restrictions or prohibitions on the repatriation of funds. As a result of recent legislation enacted by the Brazilian government, effective for tax years beginning in 1996, the 15% withholding tax on post-1995 repatriated earnings was eliminated. In 1994, the Brazilian government introduced an economic stabilization program designed to reduce the country's hyperinflation. See \"Impact of Inflation\" for additional information.\nRecent Developments\nIn connection with the consolidation and restructuring, the Company announced plans to close its Bedford Park, Illinois facilities. The Company expects a substantial downsizing in its domestic workforce to be completed during the first half of 1996 as the Company reduces operations, closes its Bedford Park, Illinois facility and downsizes its corporate headquarters.\nDuring February 1996, ABN leased a 50,000 square foot facility in Columbia, Tennessee and expects to be operational in this new facility during the second quarter of 1996. The Company expects the additional costs associated with start-up of this facility to negatively affect operating margins and operating income during 1996.\nResults of Operations\nGeneral\nOn June 23, 1993, the Company acquired all of the outstanding shares of ABNB and as of July 1, 1995, ABNB acquired Grafica Bradesco in exchange for a 22.5% minority interest in ABNB. The acquisitions were accounted for as a purchase transactions and operations of the companies have been included in the consolidated operations since the acquisition dates. The acquisitions of ABNB in the third quarter of 1993 and Grafica Bradesco in the third quarter of 1995, have had a significant impact on the operations of the Company.\nComparison of Results of Operations 1995 with 1994\nSales in 1995 decreased by $2.0 million (1.0%) from 1994. Corporate and Commercial and Holographic sales increased $8.7 million and $5.9 million, respectively. Government sales decreased $16.5 million. The increase in Corporate and Commercial sales is primarily due to increases in sales as a result of the Grafica Bradesco acquisition ($25.4 million) and increases in prepaid telephone cards ($19.0 million) offset by decreases in sales of stocks and bonds ($5.7 million), foreign security products ($15.1 million), personalized checks ($6.9 million), commercial products ($4.8 million), and other products ($3.2 million). The increase in holographic sales is primarily attributable to holograms for credit cards. The decrease in Government sales is primarily due to a decrease in food coupons ($22.5 million) and US Postal ($1.2 million) sales, partially offset by increases in currency ($2.4 million) and automobile vouchers, driver licenses and other product sales ($4.8 million). The reduction in food coupon sales reflects a trend resulting in a present level of sales that is not expected to increase and which may experience further declines. See \"Liquidity and Capital Resources.\" The change in various components of sales may be affected by the timing of contract awards and delivery requirements of customers.\nCost of goods sold increased $18.1 million (13.9%) from 1994 and as a percentage of sales was 72.3% in 1995 as compared to 62.9% in 1994. Cost of goods sold increased as a result of the Grafica Bradesco acquisition in the third quarter of 1995, which resulted in a change in product mix and, in the second quarter of 1995, the write-off of inventory related to work for an overseas customer that went out of business and manufacturing losses on certain other orders. The Company does not expect to incur additional charges from these inventory and manufacturing losses in the future. Manufacturing margins are expected to be negatively affected while the Company continues to consolidate ABN's operations and downsize, particularly in connection with the closure of the Bedford Park, Illinois plant and the start-up of the new Columbia, Tennessee facility. The cost of sales percentage also was impacted by reduced margins in Brazil since margins in the prior year were higher as sales included inflationary price adjustments which have now been eliminated as part of the Brazil economic stabilization program. While margins were lower due to this stabilization program, earnings were favorably impacted by the virtual elimination of translation losses. The Company expects ABNB's margins to continue to be affected by these factors. New prepaid telephone card production lines in Brazil increased fixed manufacturing costs which was offset, in part, by lower domestic fixed manufacturing cost. The product mix in any given period is not indicative of the expected product mix which can be expected in future periods.\nSelling and administrative expenses increased by $0.9 million from 1994 (2.3%) primarily as a result of the settlement of an executive severance agreement and increased selling and administrative expenses in Brazil due principally to the Grafica Bradesco acquisition and increased sales. As a percentage of sales, selling and administrative expenses increased to 19.3% from 18.7% in 1994.\nDepreciation expense increased $1.7 million in 1995, as a result of the Grafica Bradesco acquisition ($0.7 million) and other fixed asset additions.\nInterest expense increased $2.1 million in 1995 primarily due to the issuance in May 1994 of the $65 million 11-5\/8% Senior Notes at a higher rate of interest than the $40 million of bank debt it replaced. In addition, under its interest rate swap agreements, the Company incurred net interest expense ($0.3 million) in 1995 versus income ($0.3 million) in 1994.\nForeign exchange losses, net, is a result of the Company's translation of Brazilian local currency financial statements into dollars in accordance with SFAS No. 52 \"Foreign Currency Translation.\" As a result, the translation adjustment is recorded as a period item. Improving economic conditions in Brazil stemming from the country's July 1994 economic stabilization program resulted in a $7.0 million reduction in foreign exchange loss. See \"Impact of Inflation.\"\nOther income, net, increased $1.0 million principally due to an unrealized gain in marketable securities.\nIncome taxes reflect a benefit in 1995 as a result of losses. The benefit rate was lower than the 1994 effective tax rate, principally due to limitations on deducting certain expenses for state tax purposes. As a result of changes in enacted tax rates in 1995 ABNB realized a reduction in the net deferred tax liability of $2.8 million.\nThe minority interest represents Banco Bradesco's 22.5% interest in ABNB's operations since the July 1, 1995 acquisition of Grafica Bradesco by ABNB.\nComparison of Results of Operations 1994 with 1993\nSales in 1994 increased by $8.0 million (4.0%) from 1993. The inclusion of ABNB for an entire year in 1994 represented $24.5 million of increased sales. Corporate and Commercial Products sales increased ($28.1 million), offset by decreased Government Products sales ($17.5 million), and Holographic Products sales ($2.6 million). The increase in Corporate and Commercial Product sales is primarily due to the inclusion of ABNB sales for an entire year ($20.4 million) and other sales, principally stock and bonds ($7.7 million). The net decrease in Government Product sales of $17.5 million is primarily due to the loss of USPS postage stamp business ($21.0 million) and decreased currency sales ($7.5 million) offset by ABNB government sales ($4.1 million) and increased food coupon and other government sales ($6.9 million). The decrease in Holographic Product sales ($2.6 million) was due to lower commercial and product authentication sales ($4.2 million) offset in part by increased credit card sales ($1.6 million). The change in various components of sales, particularly Government Product sales is affected by the timing of contract awards and delivery requirements of customers. Increased sales of food coupons, a\nmajor component of Government Product sales during 1994 was due to an increase in the number of eligible recipients receiving food coupon benefits and increased USDA inventory of food coupons. ABNB's sales volume for the second half of 1994 was reduced due to discontinuation of inflationary price increases resulting from the country's economic stabilization plan begun in July 1994 and the reduction in price increases reduced sales. In addition, many contracts required re-negotiation and in certain instances, selling prices were lowered due to the re-negotiations.\nCost of goods sold for 1994 increased $13.7 million (11.7%) from 1993 and as a percentage of sales was 62.9% in 1994 as compared to 58.6% in 1993. The increase in cost of goods sold in absolute dollars and as a percentage of sales is due to several factors. First, higher sales and product mix contributed to the increase. Second, ABNB experienced lower margins in the second half of the year due to a change in product mix and manufacturing difficulties encountered in manufacturing the pre-paid telephone card for Telebras. Third, fixed expenses were not immediately reduced in line with the reduction in postage stamp business. The product mix in any given period is not indicative of the expected product mix for future periods.\nSelling and administrative expenses in 1994 increased by $5.0 million from 1993 (14.7%). As a percentage of sales, selling and administrative expenses increased to 18.7% from 17.0%. The inclusion of ABNB for an entire year in 1994 represented $5.6 million of the increase. This increase was offset by a decrease of $0.6 million in domestic costs, primarily due to reduced sales volume in certain product areas.\nIn the fourth quarter of 1994, the Company made a decision to completely vacate ABN's leased facility in Los Angeles and is currently negotiating a final settlement with the landlord which, if consummated, would eliminate any further liability for rental and other payments under the lease. Accordingly, the Company incurred an additional restructuring charge of $5 million in 1994, which included a provision for the remaining termination or exit costs.\nIn prior years, the Company made investments in capital equipment intended for use in connection with the products and services supplied to the USPS. As a result of the loss of this business, the Company re-evaluated the net carrying value of\ncapitalized equipment and the cost of operating leases used for postage stamp production and recorded in the fourth quarter of 1994 a $2 million provision for the write-down of idle postal equipment.\nDepreciation and amortization expense increased by $1.9 million in 1994, primarily as a result of the inclusion of ABNB's operations for a full year ($2.3 million). This increase was partially offset by a $0.4 million reduction in domestic depreciation as a result of the Los Angeles plant closing.\nInterest expense increased $6.4 million in 1994 primarily due to increased borrowings resulting from the $65 million 11-5\/8% Senior Note private placement on May 5, 1994 at a higher rate of interest than the $40 million of bank debt it replaced. The bank debt was incurred to acquire ABNB in June 1993. In addition, as a result of an increase in interest rates, the Company incurred a net expense ($0.1 million) from its interest rate swap agreements, which is included in interest expense.\nThe foreign exchange loss is a result of the Company's translation of Brazilian local currency financial statements into dollars in accordance with SFAS No. 52 \"Foreign Currency Translation.\" As a result, the translation adjustment is recorded as a period item. During 1994, the Company experienced a greater translation loss than anticipated due to the higher inflation rate prior to the change in the monetary system in Brazil. See \"Impact of Inflation.\"\nOther income increased by a net $1.6 million principally due to increased interest income resulting from higher invested cash balances and the inclusion of ABNB for a full year.\nIncome taxes reflect a benefit in 1994 as a result of losses. The benefit rate was lower than the 1993 effective tax rate, principally due to limitations on deducting certain expenses for state tax purposes.\nThe 1994 extraordinary item of $0.1 million represents the write off of deferred debt expenses, net of tax benefits (approximately $0.1 million) related to the early extinguishment of the Company's $40.0 million bank indebtedness.\nRestructuring\nIn 1993, the Company decided to cease manufacturing operations at ABN's Los Angeles plant after considering its high manufacturing and overhead costs. The Company incurred a $12 million restructuring charge which anticipated subleasing a portion of the facility and retaining a portion for use by the Company. The Company, in 1994, re-evaluated the Los Angeles real estate market and decided that it would vacate the entire facility, which resulted in an additional provision of $5.0 million. The net annual pre-tax cash flow savings were estimated to be $3.9 million after allowing for the carrying cost of the plant. This estimate was based on assumptions and estimates which are subject to uncertainties and unforeseen events and may not be indicative of the actual savings realized. However, during the first year following the plant closure, the cash flow benefit was approximately $2.5 million after allowing for moving costs, leasehold improvements required at other plants to accommodate increased volume and certain other non-recurring closing costs. The remaining obligations under this restructuring relate to lease commitments.\nIn 1995, the Company recorded a pre-tax restructuring charge of approximately $14.3 million pursuant to a restructuring plan developed by management for the Company's domestic security printing operations and the relocation and downsizing of its corporate offices. The plan is expected to be substantially completed by the second quarter of 1996.\nThe 1995 restructuring charge provided for those reasonably estimable costs resulting from the plan including costs that are: (i) associated with and will not benefit activities that will continue or generate future revenue and are incremental as a result of the plan (ii) incurred under contractual agreements (i.e. leases and employment agreements) that existed prior to the commitment date that provide no future economic benefit; or (iii) related to asset impairments and writedowns resulting directly from the plan. The Company has estimated that the pre-tax annual cost savings would be approximately $6.5 million, of which approximately $5.3 million are manufacturing related fixed costs. The realization of the cost savings is expected to commence during the second quarter of 1996. Under the plan, the Company plans to reduce the domestic workforce by approximately 27 percent from prior levels and has provided a $2.9 million reserve for severance and related costs.\nAsset re-valuations and writedowns accounted for $5.0 million of the charge which reduced certain assets to their net realizable value and primarily relates to leasehold improvements.\nLease and other facility obligations accounted for $6.4 million of the charge for the facilities to be closed in 1996.\nLiquidity and Capital Resources\nFor the year ended December 31, 1995, the Company's net cash used by operating activities totaled approximately $4.5 million. The net loss of $22.4 million was adjusted by $17.9 million net to reconcile to the cash used by operating activities. The adjustments consisted primarily of adding back $17.7 million of depreciation and amortization, $1.6 million of minority interest and $14.2 of restructuring costs and by subtracting $16.7 million of deferred taxes and $1.1 million in unrealized gain in marketable securities. In addition, the decrease in accounts and other receivables of $5.5 million, inventory of $1.7 million and other net of $2.4 million provided cash during the year. The increase in prepaid expenses of $2.5 million, marketable securities of $1.3 million and the decrease in accounts payable and accrued expenses of $3.8 million required the use of cash during the year.\nSignificant increases in certain balance sheet amounts at December 31, 1995 compared to December 31, 1994 were due principally to the acquisition of the business and certain operating assets of Grafica Bradesco in 1995 by ABNB in exchange for a 22.5% minority interest in ABNB. As a result of the acquisition, the following balance sheet accounts increased: inventories $5.2 million, prepaid expenses and other current assets $1.6 million, property plant and equipment $17.7 million, net excess cost of investment in subsidiaries over net assets acquired $2.3 million, accounts payable and accrued expenses $2.0 million, deferred income tax liabilities $7.7 million and minority interest $17.2 million.\nNet cash used in investing activities totaled $6.1 million, as a result of $10.4 million of capital expenditures for new equipment, primarily at ABNB and an investment in an affiliate of $0.6 million, offset by the proceeds from the sale of a joint venture of $4.7 million and sale of assets $0.2 million.\nDuring the same period, consolidated net cash provided from financing activities amounted to $3.0 million primarily on proceeds from borrowings $3.4 million, offset by other payments $0.4 million.\nThe Company's cash interest obligations under the 11-5\/8% Senior Notes and the 10-3\/8% Senior Notes are approximately $7.6 million and $13.1 million per year, respectively. The Company invests in short term investment grade obligations which currently bear interest at approximately 5.25% and certain marketable securities.\nAt December 31, 1995, the Company had approximately $23.5 million in cash and cash equivalents, $3.0 in marketable securities, $126.5 million of 10-3\/8% Senior Notes outstanding, $65.0 million principal amount of 11-5\/8% Senior Notes outstanding, and approximately $3.3 million for outstanding letters of credit.\nOn January 26, 1996, the Company's subsidiaries, ABN and ABNH (the \"Borrowers\") as co-borrowers, entered into a three-year, $20 million revolving credit facility with Chemical Bank (the \"Credit Agreement\"). The Credit Agreement is a committed facility and replaces the former Citibank agreement. The Credit Agreement is available for general working capital purposes and letters of credit and expires on October 30, 1998.\nUnder the Credit Agreement: (i) interest is based upon the lender's Alternate Base Loan Rate (as defined) plus 1.00%, or at the Company's option, LIBOR plus 2.50% (these margins will automatically reduce to 0.50% and 2.00% respectively once the Borrowers (ABN and ABNH) demonstrate compliance with the financial covenants); and (ii) certain covenants apply to ABN and ABNH's borrowings, including, but not limited to, interest coverage ratios for both the consolidated Company and Borrowers, EBITDA minimums for both ABN and ABNH, limitations on indebtedness, capital expenditures, sales of assets and acquisitions and restrictions on the payment of cash dividends. The Credit Agreement is an asset-based facility secured by accounts receivable and inventory of the Borrowers. Borrowings under the Credit Agreement are restricted to a permissible amount relating to the receivables and inventory borrowing base. At December 31, 1995, the Borrowers would have had available approximately $10 million under the Credit Agreement.\nIn 1994, the Company amended its 10-3\/8% Senior Notes to: (i) permit the sale or issuance of up to 35% of the equity interests of ABNB in certain circumstances; (ii) permit the release of up to 35% of the voting interests of ABNB from their pledge as security for the obligations of the Company under the 10-3\/8% Senior Notes; and (iii) exclude from the definition of Major Asset Sales any permitted issuances by ABNB of its capital stock. In 1995, 35% of the equity interest of ABNB was released from the pledge.\nFor the year ended December 31, 1995, the Company had made all required interest payments and was in compliance with the covenants of the 10-3\/8% Senior Notes and the 11-5\/8% Senior Notes. Pursuant to the indentures, the Company and its subsidiaries are restricted from incurring additional indebtedness without consent, except for borrowings under certain bank borrowing agreements, lease financings in the normal course of business, intercompany indebtedness and other obligations entered into in the ordinary course of business. Additionally, the Company and its subsidiaries are restricted from declaring or paying a cash dividend or making any distributions on its capital stock, purchasing or redeeming any equity interests or making investments, with certain exceptions.\nThe Company and its subsidiaries are highly leveraged. At December 31, 1995, total consolidated long-term debt, excluding the current portion, was approximately $194.2 million (representing approximately 83% of total capitalization) and the Company had approximately $23.5 million in cash and cash equivalents and $3.0 million in marketable securities.\nThe high level of the Company's indebtedness, as well as any acquisition debt permitted to be incurred in connection with any of the Company's permitted acquisitions, poses certain risks to holders of the Company's senior indebtedness, including the risk that the Company might not generate sufficient cash flow to service the Company's obligations and the risk that the Company's capacity to respond to market conditions, extraordinary capital needs and other factors could be adversely affected. The Company's ability to service its debt depends upon the future performance of the Company's subsidiaries, which will be subject to prevailing economic and competitive conditions and to other factors, including the continued ability to generate cash at the Company's operating subsidiaries, to distribute that cash to the\nCompany for debt service and to repatriate funds from foreign subsidiaries, particularly ABNB. Other future acquisitions and joint ventures in which the Company does not maintain 100% ownership, foreign legal and tax requirements and the terms of any acquisition debt incurred may further restrict the ability of newly acquired subsidiaries and joint venture investments to declare and pay dividends or make distributions.\nThe Company expects to seek to refinance the 11-5\/8% Senior Notes and the 10-3\/8% Senior Notes at or before their respective maturities; however, no assurance can be given as to the Company's ability to refinance such obligations, that the Company's revolving credit facility will be available when required or that prevailing interest rates will be advantageous to the Company. In the event that the Company is unable to refinance its indebtedness as it matures or raise funds through asset sales, sales of equity or otherwise, its ability to pay principal of or interest on the 10-3\/8% Senior Notes, the 11-5\/8% Senior Notes and other long-term indebtedness of the Company would be adversely affected.\nIn December 1995, the existing interest rate swap and interest rate cap agreements based upon a $60 million notional amount were terminated at an approximate break-even cost. The Company has no contingent liability under these agreements.\nCertain states have adopted electronic programs which replace the traditional methods of distribution of public assistance benefits to recipients, including replacing food coupons with debit-type cards. Several state-wide programs have been implemented, while others have recently awarded contracts. Other states are evaluating such programs. While sales of food coupons have increased in recent years, proposed benefit reforms as well as electronic programs will reduce the Company's volume of food coupon production in 1996 and future years. It is not anticipated that the USDA will maintain past levels of orders.\nDuring the next two years, the Company may make aggregate capital expenditures, including maintenance of existing equipment and capital expenditures for new business, of up to $25 million, principally to acquire modernized printing equipment and to increase production capacity for pre-paid telephone cards in Brazil. Such capital expenditures include amounts that will be financed through equipment leasing and other financing arrangements. The portion of capital expenditures not financed through such leases will be financed with working capital.\nManagement of the Company believes that cash flows from operations of the Company, together with its existing cash balances and available borrowings and leasing arrangements, will be sufficient to service its working capital and debt service requirements for the foreseeable future and to fund the capital expenditures referred to above.\nThe future cash outlays for the remaining restructuring reserve of $12.0 million (principally related to leases) at December 31, 1995 are anticipated to be $5.1 million in 1996, $2.1 million in 1997, $1.3 million in 1998 and $3.5 million thereafter to 2009.\nTax Law Changes\nAs a result of Brazilian tax legislation, beginning in 1996 income tax rates have been reduced from approximately 48% to 31%. Effective for tax years beginning in 1996, the 15% withholding tax on post-1995 repatriated earnings was eliminated.\nNew Accounting Standards\nIn March 1995, SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\", was issued. Management estimates that the adoption will not have a material effect on the Company's financial statements and will be adopted in 1996.\nIn November 1995, SFAS No. 123 \"Stock Based Compensation\" was issued. Management is evaluating the effect of the adoption of this Standard on the Company's financial statements which Standard will be adopted in 1996.\nImpact of Inflation\nOn July 1, 1994 the Brazilian government introduced a new currency, the \"Real\" as part of the government's economic stabilization program designed to reduce the country's hyperinflation. Prior to the introduction of the Real, the Brazilian government created a new monetary unit (the \"URV\") as a transition mechanism. During this period prices were re-negotiated in URV's. From April 1 to June 30, 1994 inflation increased over pre-URV levels resulting in higher than anticipated translation losses. However, the annual inflation\nrate has decreased substantially to approximately 23% for 1995 as compared to 941% for 1994. The Company cannot predict what impact, if any, such initiatives will have on the Brazilian economy or on ABNB's consolidated results of operations\nThe Company's domestic operations are not significantly affected by inflation. ABNB sales for 1995 contributed a significant portion of consolidated sales of the Company (48%). The Company's foreign exchange exposure policy generally calls for selling its domestic manufactured product in US dollars and, in the case of ABNB, selling in Brazilian national currency, in order to minimize transactions occurring in currencies other than those of the originating country. The Company has not engaged in material hedging activities. In addition, the Company's accounting policies require translation of local currency into US dollars in accordance with SFAS No. 52, which provides for appropriate accounting treatment where exchange rates are most volatile. Any translation adjustments resulting from converting ABNB's balance sheet and income statements into US dollars are recorded as period costs in accordance with SFAS No. 52. Currently, repatriation of earnings from ABNB is permitted, subject to certain regulatory approvals. As a result of tax legislation in Brazil in 1995, cash dividends from ABNB to the Company from earnings after 1996 are not subject to the dividend withholding tax. Dividends or distributions from Brazil could be subject to government restrictions in the future. The Company has not received any dividends from ABNB to date and the Company may reinvest excess cash from ABNB and other activities outside the United States.\nEarnings on foreign investments, including operations and earnings of foreign companies in which the Company may invest or rely upon for sales, are generally subject to a number of risks, including high rates of inflation, currency exchange rate fluctuations, trade barriers, exchange controls, government expropriation and political instability and other risks. These factors may affect the results of operations of companies in selected markets included in the Company's growth strategy, such as in Latin America (including ABNB) and Asia. The Company's financial performance on a dollar-denominated basis can be significantly affected by changes in currency exchange rates and inflation. The Company's cash balances and borrowings in foreign currency can mitigate the effect of fluctuating currency exchange rates; however, borrowings and investments in foreign currency and markets may not be available or practical and may face local\ninterest rate and principal risks. In addition, adverse changes in foreign interest and exchange rates could adversely affect the Company's ability to meet its interest and principal obligations as well as applicable financial covenants with respect to its dollar-denominated debt, including the 10-3\/8% Senior Notes, the 11-5\/8% Senior Notes and other indebtedness of the Company.\nPrior to the acquisition of ABNB, the Company did not have any substantial foreign domicile operations. See Note A of \"Notes to Consolidated Financial Statements\" for the disclosure of certain financial information relating to foreign operations.\nEarnings of foreign subsidiaries are subject to foreign income taxes that reduce cash flow available to meet required debt service and other obligations of the Company. The ability to utilize foreign taxes paid, as credits against US tax liability, is based upon the determination of foreign source income. In computing allowable foreign source income, certain consolidated expenses are allocated which limit the utilization of foreign tax credits.\nThe Company has from time to time reorganized and restructured, and may in the future reorganize and restructure, its foreign operations based on certain assumptions about the various tax laws (including capital gains and withholding tax), foreign currency exchange and capital repatriation laws and other relevant laws of a variety of foreign jurisdictions. While management believes that such assumptions are correct, there can be no assurance that foreign taxing or other authorities will reach the same conclusion. If such assumptions are incorrect, or if such foreign jurisdictions were to change or modify such laws, the Company may suffer adverse tax and other financial consequences which could impair the Company's ability to meet its payment obligations on the 10-3\/8% Senior Notes, 11-5\/8% Senior Notes and other indebtedness of the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of the Company and its subsidiaries for the year ended December 31, 1995 are set forth herein:\nIndependent Auditors' Report\nConsolidated Statements of Operations - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statement of Stockholders' Equity - Three Years Ended December 31, 1995\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995 1994 and 1993\nNotes to Consolidated Financial Statements\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of American Banknote Corporation New York, New York\nWe have audited the accompanying consolidated balance sheets of American Banknote Corporation (formerly named United States Banknote 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 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 American Banknote 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.\nDELOITTE & TOUCHE LLP February 21, 1996 New York, New York\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)\nYear Ended December 31 1995 1994 1993\nSales . . . . . . . . . . . . . . . . $206,164 $208,133 $200,079\nCosts and expenses: Cost of goods sold. . . . . . . . . . 149,035 130,889 117,200 Selling and administrative. . . . . . 39,851 38,974 34,011 Restructuring costs. 14,304 5,000 12,000 Provision for idle equipment. . . . . - 2,000 - Depreciation and amortization . . . . 14,824 13,094 11,180 218,014 189,957 174,391\n(11,850) 18,176 25,688\nOther (expense) income: Interest expense. . . . . . . . . . . (23,147) (21,057) (14,605) Foreign exchange losses, net . . . . (38) (7,037) (5,161) Other, net 2,824 1,816 222 (20,361) (26,278) (19,544) Income (loss) before provision for income taxes and minority interest. . . . . . . . (32,211) (8,102) 6,144\nProvision for income taxes: Taxes (benefits) based on income. . . . (8,522) (2,401) 2,789 Effect of changes in income tax rates (2,837) - 1,500 (11,359) (2,401) 4,289\nIncome (loss) before minority interest. . . . . . . . . (20,852) (5,701) 1,855\nMinority interest. . . . . . . . . . 1,563 - 262\nIncome (loss) before extraordinary item . . . . . . (22,415) (5,701) 1,593\nExtraordinary item . . . . . . . . . . - (114) -\nNet income (loss) . . . . . . . . . $(22,415) $ (5,815) $1,593\nIncome (loss) per share: Operations. . . . . . . . . . . . . $ (1.17) $ (.30) $ .08 Extraordinary item. . . . . . . . . . - (.01) - Net income (loss) per share . . . $ (1.17) $ (.31) $ .08\nSee Notes to Consolidated Financial Statements.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except for per share data) December 31 1995 1994 ASSETS Current assets Cash and cash equivalents $ 23,525 $ 31,658 Marketable securities - at market 2,952 637 Accounts receivable, net of allowance for doubtful accounts of $816 and $471 32,058 43,783 Other receivables 7,772 4,767 Inventories 23,243 20,497 Deferred income tax benefits 5,983 5,685 Prepaid expenses 4,755 2,334 Total current assets 100,288 109,361\nProperty, plant and equipment, at cost, net of accumulated depreciation and amortization 225,974 215,859\nOther assets 18,342 23,985\nExcess of cost of investment in subsidiaries over net assets acquired, net of accumulated amortization of $3,119 and $1,851 34,798 33,745 $379,402 $382,950 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portions of long-term debt $ 332 $ 359 Accounts payable and accrued expenses 44,983 43,115 Total current liabilities 45,315 43,474\nLong-term debt, net of unamortized discount of $1,120 and $1,221 194,156 191,192\nOther liabilities 20,181 16,188\nDeferred income taxes 60,579 69,319\nMinority interest 18,818 - 339,049 320,173 Commitments and Contingencies\nStockholders' equity Preferred Stock, authorized 5,000,000 shares, no shares issued or outstanding - - Common Stock, par value $.01 per share, authorized 50,000,000 shares; issued 19,391,763 shares and 19,289,888 shares 194 193 Capital surplus 67,091 66,883 Retained-earnings (deficit) (25,461) (3,046) Treasury stock, at cost (281,000 shares in both years) (1,253) (1,253) Pension liability adjustment (218) - Total stockholders' equity 40,353 62,777 $379,402 $382,950\nSee Notes to Consolidated Financial Statements.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995\nSee Notes to Consolidated Financial Statements.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31 (Dollars in thousands)\nSee Notes to Consolidated Financial Statements.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote A - Basis of Presentation and Summary of Significant Accounting Policies\nAmerican Banknote Corporation is a holding company whose subsidiaries operate the largest private-sector security printing business in North and South America and the world's leading security hologram manufacturer.\nOn June 23, 1993, American Banknote Corporation (the \"Company\") acquired 100% of the outstanding shares of Thomas De La Rue Grafica e Servicos Ltda. (renamed American Bank Note Company Grafica e Servicos Ltda.(\"ABNB\"), a company engaged in the manufacturing and printing of security documents, prepaid telephone cards and credit cards in Brazil, for approximately $45 million. The purchase price consisted of approximately $38.1 million in cash and 944,538 shares of the Company's Common Stock, valued at approximately $6.9 million. The acquisition was accounted for as a purchase transaction in accordance with Accounting Principles Board Opinion (\"APB\") No. 16, \"Business Combinations,\" and the Company recorded approximately $26 million as the cost in excess of the fair value of the underlying net assets, which cost is being amortized over 30 years. The fair value of the assets acquired net of cash was approximately $34 million and the fair value of the liabilities assumed was approximately $15 million.\nThe Company acquired the remaining 20% minority interest in its subsidiary, American Bank Note Holographics, Inc. (\"ABNH\") for a net cash payment of $15 million. The acquisition has been accounted for as a purchase transaction in accordance with APB No. 16. At the June 23, 1993 acquisition date, the excess of cost of the investment exceeded the fair value of the underlying net assets acquired by approximately $10 million. Such amount is being amortized over 30 years. Included in this transaction was the sale by the Company of its 20% interest in a holography affiliate, which was carried and sold at a nominal amount. The sale of this interest had no impact on the Company's cash flows or operations.\nAs of July 1, 1995, ABNB acquired the printing business and operations of Grafica Bradesco Ltda. (\"Grafica Bradesco\") from Banco Bradesco S.A. (Brazil) (\"Banco Bradesco\"). Under the terms of the acquisition agreement Banco Bradesco became a holder of 22.5% of ABNB in exchange for the business and certain operating assets of Grafica Bradesco valued at approximately $17 million.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nGrafica Bradesco's business includes check printing, and other forms for financial institutions. The acquisition was accounted for as a purchase and approximately $2.3 million was recorded as the cost in excess of the fair market value of the underlying net assets acquired, which cost is being amortized over 20 years.\nThe following summary, prepared on a pro forma basis, combines the consolidated results of operations as if Grafica Bradesco had been acquired as of the beginning of the periods presented, after including the impact of certain adjustments, such as amortization of intangibles, increased minority interest and the related income tax effects (dollars in thousands, except per share amounts):\n1995 1994 (Unaudited)\nSales $224,662 $242,803 Net income (loss) (20,177) 1,171 Net income (loss) per share ($1.06) $0.06\nThe unaudited pro forma financial information is presented for informational purposes only and does not purport to represent what the Company's result of operations would have been had the transaction described actually occurred at the beginning of the periods indicated or to project the Company's results of operations for any future date or period. The pro forma adjustments are based upon available information which the Company believes is reasonable in the circumstances.\n1. Principles of Consolidation: The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries all of which are wholly-owned, except ABNB which is 77.5% owned. Certain reclassifications have been made to the 1994 balances in order to conform to 1995 presentation. All significant intercompany items have been eliminated.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. Pervasiveness 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 form those estimates.\n3. Inventories and Profit Recognition on Long-Term Contracts: Inventories are stated at the lower of cost or market with cost being determined on the first-in, first-out (FIFO) method. Profit is generally recognized when goods are shipped. However, pursuant to contract terms with certain customers, completed items are sometimes stored at the Company's premises and, in those instances, profit is recognized when the goods are transferred to the on-site storage location.\n4. Depreciation and Amortization: Depreciation and amortization of property, plant and equipment is computed principally on the straight-line method over the estimated useful life of the asset as follows: Buildings 25 to 40 years Rolls and dies 40 years Machinery, equipment and fixtures 5 to 22 years\nAmortization of improvements to leased properties is computed using the straight-line method based upon the remaining term of the applicable lease or the estimated useful life of the asset, whichever is shorter.\n5. Intangible Assets: Patents and other intangibles are amortized over their useful lives. The excess cost of investment in subsidiaries acquired is being amortized over a 30 year period with the exception of Grafica Bradesco which is being amortized over 20 years. These costs are amortized using the straight-line method.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. Income (Loss) Per Share: Income (loss) per share has been computed based on the weighted average number of common shares and common equivalent shares (in 1993) outstanding during the year (approximately 19.1 million in 1995, 19.0 million in 1994 and 19.2 million in 1993). Primary and fully diluted income (loss) per share are the same.\n7. Research and Development: Research and development costs are expensed as incurred (1995 - $0.4 million, 1994 - $1.6 million and 1993 - $0.9 million).\n8. Deferred Debt Costs: Expenses incurred in connection with debt financings are capitalized and amortized over the respective loan terms ($6.3 million and $6.9 million at December 31, 1995 and December 31, 1994, respectively, included in other assets). In connection with certain early extinguishments of indebtedness in 1994, the Company wrote off related deferred debt expense and unamortized discounts as a net extraordinary charge to income of $0.1 million\n9. Industry Information: The Company's principal business activity consists of financial payments and prepaid telephone cards, holograms, and engraving and printing of corporate and government securities and other secure documents. Sales to the United States government were 15%, 26% and 34% of consolidated sales for the years ended December 31, 1995, 1994 and 1993, respectively. Sales to a customer in Brazil (national telephone company) were 13% of consolidated sales for the year ended December 31, 1995.\n10. Supplemental Cash Flow Information: Cash tax payments, for the year ended December 31, 1995, 1994 and 1993 amounted to approximately $3.7 million, $1.6 million and $3.5 million,, respectively. Cash interest payments for the years ended December 31, 1995, 1994 and 1993, amounted to approximately $21.9 million, $16.2 million and $13.8 million, respectively. As a result of the beneficial effects of an interest rate swap agreement that was entered into in July 1992, net cash interest payments of $0.9 million and $1.3 million were received, in the years ended December 31, 1994 and 1993, respectively, however, in 1995 net cash payments of $0.6 million were made. The interest rate swap agreements were\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nterminated in December 1995 at an approximately break-even cost to the Company.\n11. Cash and Cash Equivalents: All highly liquid investments with a maturity of three months or less, when purchased, are considered to be cash equivalents.\n12. Marketable Securities: Such current investments are held for trading purposes and changes in the market value are reflected in earnings.\n13. Foreign Exchange Losses, Net: ABNB's financial statements are translated into dollars from the local currency. The foreign exchange translation loss represents the Company's translation of local currency into U.S. dollars in accordance with SFAS No. 52, \"Foreign Currency Translation,\" which provides for appropriate accounting treatment of ABNB's exchange rate volatility in a hyper-inflationary economy. As a result, the translation adjustment is recorded as a period cost in accordance with SFAS No. 52.\n14. Condensed Financial Information and Geographic Area Data: The 10-3\/8% Senior Notes are secured by a pledge of all issued capital stock of its wholly-owned subsidiaries ABN and ABNH, and by a pledge of 65% of ABNB. ABN, ABNH and the 77.5% interest owned in ABNB constitutes substantially all the assets of the Company (see Note F - Long-Term Debt). ABNB is domiciled in Brazil, and all other subsidiaries of the Company are domiciled in the United States.\nThe following condensed consolidating financial information illustrates the composition of the pledged subsidiaries and provides additional material information which is useful in assessing the financial composition of the pledged subsidiaries. Investments in subsidiaries are accounted for by the parent on the equity method for purposes of the condensed consolidating financial information. Earnings of subsidiaries are therefore reflected in the parent's investment accounts and earnings. Intercompany investments and transactions are eliminated in consolidations.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following are the condensed financial statements (amounts in millions):\nCondensed Balance Sheets Domestic Foreign Elim. Consol.\nAs at December 31, 1995 Cash and cash equivalents $16.5 $7.0 $23.5 Marketable securities 3.0 3.0 Accounts receivable, net 18.0 14.0 32.0 Other receivables 6.6 1.2 7.8 Inventories 12.3 10.9 23.2 Deferred income tax benefits 5.7 0.3 6.0 Prepaid expenses 3.3 1.5 4.8 Property, plant and equipment, net 176.6 49.4 226.0 Other assets 72.9 8.8 ($63.4) 18.3 Goodwill 9.5 25.3 . 34.8 Total assets $324.4 $118.4 ($63.4) $379.4\nTotal current liabilities $24.5 $20.8 $45.3 Senior debt, net of discounts 191.1 3.0 194.1 Other non-current liabilities 14.5 5.7 20.2 Deferred income taxes 53.9 6.7 60.6 Minority interest 18.8 18.8 Total stockholders' equity 40.4 63.4 ($63.4) 40.4 Total liabilities and stockholders' equity $324.4 $118.4 ($63.4) $379.4\nAs at December 31, 1994 Cash and cash equivalents $29.7 $2.0 $31.7 Marketable securities 0.6 0.6 Accounts receivable, net 37.2 6.6 43.8 Other receivables 3.9 0.9 4.8 Inventories 13.1 7.4 20.5 Deferred income tax benefits 5.3 0.4 5.7 Prepaid expenses 2.3 0.1 2.4 Property, plant and equipment, net 188.9 26.9 215.8 Other assets 73.8 7.2 ($57.0) 24.0 Goodwill 9.8 23.9 . 33.7 Total assets $364.6 $75.4 ($57.0) $383.0\nTotal current liabilities $32.1 $11.4 $43.5 Senior debt, net of discounts 191.2 191.2 Other non-current liabilities 11.3 4.9 16.2 Deferred income taxes 67.2 2.1 69.3 Total stockholders' equity 62.8 57.0 ($57.0) 62.8 Total liabilities and stockholders' equity $364.6 $75.4 ($57.0) $383.0\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCondensed Statements of Operations Domestic Foreign Elim's Consol. Year Ended December 31, 1995 Sales * $108.1 $ 98.1 $206.2 Cost of goods sold 76.5 72.5 149.0 Selling and administrative 30.0 9.9 39.9 Restructuring costs 14.3 14.3 Depreciation and amortization 9.3 5.6 14.9 130.1 88.0 218.1\n(22.0) 10.1 (11.9)\nInterest expense (23.1) (23.1) Foreign exchange gain (loss), net - - Other income (expense), net 8.5 .2 $(5.9) 2.8 Income (loss) before provision for income taxes and minority interest (36.6) 10.3 (5.9) (32.2) Provision for income taxes (14.2) 2.8 . (11.4) Income (loss) before minority interest (22.4) 7.5 (5.9) (20.8) Minority interest . 1.6 . 1.6 Net income (loss) $(22.4) $ 5.9 $(5.9) $(22.4)\nYear Ended December 31, 1994 Sales * $150.0 $ 58.1 $208.1 Cost of goods sold 94.9 36.0 130.9 Selling and administrative 29.8 9.2 39.0 Restructuring costs and other costs 7.0 7.0 Depreciation and amortization 9.3 3.8 13.1 141.0 49.0 190.0\n9.0 9.1 18.1\nInterest expense (21.0) (21.0) Foreign exchange (loss), net (7.0) (7.0) Other income (expense), net 3.9 .2 $ (2.3) 1.8 Income (loss) before provision for income taxes and extraordinary item (8.1) 2.3 (2.3) (8.1) Provision for income taxes (2.4) . . (2.4) Income (loss) before extraordinary item (5.7) 2.3 (2.3) (5.7) Extraordinary item (.1) . . (.1) Net income (loss) $ (5.8) $ 2.3 $ (2.3) $ (5.8)\nYear Ended December 31, 1993 Sales * $166.5 $ 33.6 $200.1 Cost of goods sold 103.6 13.6 117.2 Selling and administrative 29.5 4.5 34.0 Restructuring costs 12.0 12.0 Depreciation and amortization 9.6 1.6 11.2 154.7 19.7 174.4\n11.8 13.9 25.7\nInterest expense (14.6) (14.6) Foreign exchange loss, net (5.2) (5.2) Other income (expense), net 6.6 .2 $ (6.6) .2 Income before provision for income taxes and minority interest 3.8 8.9 (6.6) 6.1 Provision for income taxes 2.0 2.3 . 4.3 Income before minority interest 1.8 6.6 (6.6) 1.8 Minority interest .2 . . .2 Net income $ 1.6 $ 6.6 $ (6.6) $ 1.6\n* Represents sales to unaffiliated customers. Foreign subsidiaries sales are to customers in South America.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCondensed Statements of Cash Flows Domestic Foreign Elim's Consol.\nYear Ended December 31, 1995 Net cash- operating activities $ (15.9) $ 11.4 $ . $ (4.5) Investing activities Investment in affiliates (.6) (.6) Proceeds from sales of assets 4.9 4.9 Capital expenditures (1.2) (9.2) . (10.4) Net cash - investing activities 3.1 (9.2) . (6.1) Financing activities Proceeds from bank financings 3.4 3.4 Other (0.4) . . (0.4) Net cash - financing activities (0.4) 3.4 . 3.0 Effect of foreign currency exchange rate changes on cash and cash equivalents . (0.6) . (0.6) Net increase (decrease) (13.2) 5.0 (8.2) Cash and cash equivalents: Beginning of period 29.7 2.0 . 31.7 End of period $ 16.5 $ 7.0 $ . $ 23.5\nYear Ended December 31, 1994 Net cash - operating activities $ (3.5) $ 5.8 $ . $ 2.3 Investing activities Proceeds from sale of assets 1.7 1.7 Capital expenditures (3.2) (6.9) . (10.1) Net cash - investing activities (1.5) (6.9) . (8.4) Financing activities Proceeds from 11 5\/8% Senior Notes 63.7 63.7 (Repayment) proceeds from bank financings (40.0) (40.0) Other (0.8) . . (0.8) Net cash - financing activities 22.9 . . 22.9 Effect of foreign currency exchange rate changes on cash and cash equivalents . (0.5) . (0.5) Net increase (decrease) 17.9 (1.6) 16.3 Cash and cash equivalents: Beginning of period 11.8 3.6 . 15.4 End of period $ 29.7 $ 2.0 $ . $31.7\nYear Ended December 31, 1993 Net cash - operating activities $ 9.8 $ 2.7 $ . $12.5 Investing activities Acquisition of subsidiary (38.1) (38.1) Investment in subsidiary (40.0) 40.0 Repurchase of minority interest (15.0) (15.0) Capital expenditures (3.0) (1.2) (4.2) Repayment of loans and other 0.7 . . 0.7 Net cash - investing activities (57.3) (1.2) 1.9 (56.6) Financing activities Proceeds from bank financings 40.0 40.0 Other (2.0) (0.1) . (2.1) Net cash - financing activities 38.0 (0.1) . 37.9 Effect of foreign currency exchange rate changes on cash and cash equivalents . 0.3 . 0.3 Net increase (decrease) (9.5) 1.7 1.9 (5.9) Cash and cash equivalents: Beginning of period 21.3 1.9 (1.9) 21.3 End of period $ 11.8 $ 3.6 $ . $15.4\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n15. Export Sales: US Export sales were 7%, 12% and 10% of consolidated sales for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote B - Inventories\nInventories consist of the following (in thousands): December 31 1995 1994\nWork in process $ 15,874 $ 12,963 Raw materials and supplies 7,369 7,534 $ 23,243 $ 20,497\nNote C - Property, Plant and Equipment\nProperty, plant and equipment consist of the following (in thousands): December 31 1995 1994\nLand $ 2,727 $ 2,727 Buildings and improvements 20,858 19,090 Rolls and dies 177,154 177,300 Machinery, equipment and fixtures 70,368 54,196 Leasehold improvements 1,522 3,335 Construction in progress 260 3,728 272,889 260,376 Accumulated depreciation and amortization 46,915 44,517 $225,974 $215,859\nNote D - Accounts Payable and Accrued Expenses\nAccounts payable and accrued expenses consist of the following (in thousands): December 31 1995 1994\nAccounts payable - trade $ 11,335 $ 10,633 Accrued expenses 2,893 9,924 Customers' advances 7,026 6,656 Salaries and wages 5,666 5,645 Restructuring and merger- related accruals 8,838 4,202 Interest payable 4,291 3,550 Other 4,934 2,505 $ 44,983 $ 43,115\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote E - Income Taxes\nThe Company complies with SFAS No. 109 \"Accounting for Income Taxes\" which requires the asset and liability approach to accounting for income taxes and that deferred tax liabilities and assets be adjusted in the period of enactment for the effect of a change in tax laws or rates. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities, and their reported amounts in the financial statements.\nIn 1995 and 1993 the Company adjusted its deferred tax assets and liabilities for the estimated effect of a decrease in Brazil's tax rates enacted in the fourth quarter of 1995 and an increase in the US federal corporate tax rates enacted in the third quarter of 1993. The effect of these non-cash items was to decrease deferred income taxes in 1995 and increase deferred income taxes in 1993. Accordingly, the net loss decreased by $2.8 million or $.15 per share in 1995 and net income decreased by $1.5 million or $.08 per share in 1993.\nAs a result of Brazilian tax legislation, effective for tax years after 1995, the 15% dividend withholding tax on post 1995 earnings was eliminated. The unrepatriated earnings of ABNB at December 31, 1995 is approximately $16.7 million. Approximately $11.2 million of such earnings have already been subject to US tax. The remainder is subject to US tax when repatriated and may be partially offset by US foreign tax credits when repatriated.\nPre-tax income from foreign operations in 1995, 1994 and 1993 was $10.3 million, $2.3 million and $8.9 million, respectively.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Company files a US corporate consolidated federal income tax return which includes its subsidiaries. The provision for income taxes, for the years ended December 31, follows (in thousands): 1995 1994 1993 Current Federal $ - $ - $ 748 Foreign 4,755 - 2,131 State and local 536 656 1,324 Total current portion 5,291 656 4,203\nDeferred Federal (14,209) (2,892) (833) Adjustments due to rate changes (2,837) - 1,500 Foreign 844 (31) 124 State and local (448) (134) (705) Total deferred portion (16,650) (3,057) 86 Total provision for income taxes $(11,359) $(2,401) $ 4,289\nA reconciliation of the provisions for income taxes recorded and the amount computed by applying the federal income tax statutory rate follows (in thousands): 1995 1994 1993\nPre-tax income (loss) $(32,211) $ (8,102) $ 6,144\nStatutory tax on pre-tax income $(10,952) $ (2,755) $ 2,089 Adjustments due to rate changes (2,837) - 1,500 Difference between federal and Brazilian statutory rates 1,390 - - Non-deductible goodwill 601 State and local income taxes, net of federal benefit 58 345 409 Other 381 9 291 Income tax provision $(11,359) $ (2,401) $ 4,289\nThe Company generated approximately $2.1 million of foreign tax credits in 1993, of which $1.3 million was utilized in 1993. A valuation allowance of $0.8 million was established for the remaining amount. In 1995 and 1994, there were no foreign taxes creditable against federal taxes. In 1993, the Company was taxed under the alternative minimum tax method. The Company has an alternative minimum tax credit carry forward of approximately $0.8 million, which is available to offset future taxable income pursuant to the US federal tax laws. In addition, in 1995 and 1994, the Company generated net operating loss carry forwards of approximately $21.4 million and $2.8 million, respectively which are scheduled to expire in the years 2010 and 2009 respectively.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe tax effects of the items comprising the Company's deferred income tax assets and liabilities are as follows (in thousands):\nDecember 31 1995 1994 Current deferred tax assets: Accrued expenses deductible when paid $ 2,945 $ 1,753 Tax benefit of operating loss carry forwards and tax credits - 2,930 Other temporary differences 3,038 1,002 Total current deferred tax assets $ 5,983 $ 5,685\nNon-current deferred tax assets $16,176 $ 5,680\nDeferred tax liabilities: Difference between book and tax basis of assets acquired in acquisitions and mergers $ 68,837 $66,535 Excess tax over book depreciation 5,882 5,185 Other temporary differences 2,036 3,279 Total deferred tax liabilities 76,755 74,999\nNon-current deferred tax assets: Tax benefit of operating loss carry forwards and tax credits (8,929) - Restructuring expenses deductible when paid (3,205) - Other temporary differences (4,042) (5,680) Total non-current deferred tax assets 16,176) (5,680) Net deferred tax liabilities $ 60,579 $69,319\nNote F - Long-Term Debt Long-term debt consists of the following (in thousands): December 31 1995 1994 Senior Debt: 10-3\/8% Senior Notes, due June 1, 2002 $126,500 $126,500 11-5\/8% Senior Notes, due August 1, 2002, net of unamortized original issue discount of $1,120 and $1,221 63,880 63,779 Other long-term obligations 4,108 1,272 Less current portions (332) (359) Net long-term debt $194,156 $191,192\nThe 10-3\/8% Senior Notes due June 1, 2002 (the \"10 3\/8 Senior Notes\") are redeemable at the option of the Company, in whole or in part, at any time on or after June 1, 1997, at stated redemption prices. Equal mandatory sinking fund payments on June 1, 2000 and June 1, 2001 are calculated to retire an aggregate of 50% of the original principal amount of the 10-3\/8% Senior Notes.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe 10-3\/8% Senior Notes are senior indebtedness of the Company and rank equally in right of payment, on a pari passu basis, with all existing and future senior indebtedness of the Company. The 10-3\/8% Senior Notes are secured by a pledge on all the issued and outstanding shares of capital stock of the Company's wholly-owned subsidiaries, ABN and ABNH, and by a pledge of 65% of the shares of ABNB. ABN, ABNH and the 77.5% interest owned in ABNB constitute substantially all of the assets of the Company. The 10-3\/8% Senior Notes' covenants restrict, among other things, incurrence of additional debt by the Company and its subsidiaries, cash dividends on and redemptions of capital stock of the Company and its subsidiaries, mergers, sales of assets, sale and leaseback transactions, liens, transactions with affiliates and issuance of preferred stock by subsidiaries and prohibit certain limitations on distributions from subsidiaries of the Company.\nTo allow the Company greater flexibility in tax planning strategies, the Company amended its 10 3\/8% Senior Notes in 1994 to allow the release of 35% of ABNB's capital stock from the pledge. In 1995, these shares were released from the pledge.\nIn May, 1994, the Company completed a private placement of $65 million principal amount of 11-5\/8% Senior Notes due August 1, 2002 (the \"11-5\/8% Senior Notes\"). A portion of the proceeds was used to prepay all outstanding bank borrowings.\nThe 11-5\/8% Senior Notes were issued at 98.028% of par and are redeemable at the Company's option, in whole or in part, on and after August 1, 1998, at stated redemption prices with accrued interest. The 11-5\/8% Senior Notes are unsecured senior indebtedness of the Company and rank equally in right of payment, on a pari passu basis, with all existing and future senior indebtedness of the Company. The 11-5\/8% Senior Notes restrict, among other things, incurrence of additional debt, cash dividends on and redemptions of capital stock, mergers, sales of assets, sale and leaseback transactions, liens, and transactions with affiliates, and prohibit certain limitations on distributions from subsidiaries of the Company.\nIn connection with the above 1994 prepayment of all outstanding bank borrowings, the Company wrote off as an extraordinary charge to income, $0.1 million of existing deferred debt expense and unamortized discounts net of associated tax benefits.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe 11-5\/8% Senior Notes are effectively subordinated to the 10-3\/8% Senior Notes to the extent of the value of the above collateral pledged to secure the 10-3\/8% Senior Notes, which constitutes substantially all the assets of the Company.\nAt December 31, 1995, the Company had made all required interest payments and was in compliance with the covenants of the 10-3\/8% Senior Notes and the 11-5\/8% Senior Notes.\nThe fair value of the 10-3\/8% Senior Notes and the 11-5\/8% Senior Notes based on market quotes at December 31, 1995 was approximately $84.8 million and $39.0 million, respectively and at December 31, 1994 was approximately $107.5 million and $57.2 million, respectively. The fair value of all other debt approximates its carrying value. The market values are not necessarily indicative of the price at which the Company could acquire this indebtedness.\nOn January 26, 1996, the Company's subsidiaries, ABN and ABNH (\"Borrowers\"), entered into a three-year $20 million revolving credit facility with Chemical Bank, N.A. (the \"Credit Agreement\") as co-borrowers. The Credit Agreement is a committed facility and replaces a credit facility which expired in October 1995. The Credit Agreement is available for general working capital purposes and letters of credit and expires on October 30, 1998.\nUnder the Credit Agreement interest is based upon the lenders Alternate Base Loan Rate (as defined) plus 1.00%, or at the Company's option, LIBOR plus 2.50% and certain covenants apply which include but are not limited to, interest coverage ratios, EBITDA minimums, limitations on indebtedness, capital expenditures, sales of assets and acquisitions and restrictions on the payment of cash dividends. The Credit Agreement is an asset-based facility secured by accounts receivable and inventory of the Borrowers and the borrowings are subject to a borrowing base. At December 31, 1995, the Company would have had available approximately $10.0 million under the Credit Agreement.\nPrincipal maturities of long-term debt follow: 1996 - $0.3 million, 1997 - $1.7 million, 1998 - $1.4 million, 1999 - $0.1 million, 2000 - - $48.0 million, 2001 and thereafter - $144.1 million.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn December 1995, the existing interest rate swap and interest rate cap agreements based upon a $60 million notional amount were terminated at no cost to the Company. The Company has no contingent liability under these agreements. The effect of these agreements increased interest expense in 1995 and 1994 by approximately $0.3 million and $0.1 million, respectively, and reduced 1993 interest expense by approximately $1.3 million. The Company does not expect to enter into any new agreements.\nNote G - Capital Stock\nThe Company is authorized to issue 5,000,000 shares of Preferred Stock, with such terms as the Board of Directors may determine.\nIn 1994, the Board of Directors adopted a Preferred Stock Purchase Rights Plan pursuant to which it declared a dividend of one Preferred Stock Purchase Right (the \"Rights\") for each outstanding share of Common Stock on March 24, 1994. Each Right entitles the registered holder to purchase from the Company one one-hundredth (1\/100) of a share of preferred stock of the Company, designated as Series A Junior Preferred Stock, at a price of $15.50. The rights will become exercisable only in the event, with certain exceptions, an acquiring party accumulates 15 percent or more of the Company's voting stock or if a party announces an offer to acquire 30 percent or more of the voting stock. The Rights will expire on March 24, 2004. Upon the occurrence of certain events, holders of the Rights will be entitled to purchase either the Company's stock or shares in an \"acquiring entity\" at half of market value. The Company will generally be entitled to redeem the Rights at $.01 per right at any time until the tenth day following the acquisition of 15 percent of its voting stock by an acquirer. The Rights are not exercisable if redeemed by the Board of Directors.\nIn 1993, the Company issued to the operating management of the Company warrants expiring in 2000 (\"Performance Warrants\") for the purchase of 250,000 shares of Common Stock. In 1994 and 1993, Performance Warrants for 43,000 and 30,500 common shares were exercised at $.011 per share. At December 31, 1995, Performance Warrants for 176,500 common shares are outstanding and exercisable.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn 1995, the Board of Directors issued warrants to purchase 200,000 shares of Common Stock over a three year period at an exercise price of $2.213 which was the market price at the date of grant. At December 31, 1995, the warrants for 200,000 common shares are outstanding and exercisable.\nIn 1993, all outstanding shares of Convertible Preference Stock (the \"Preference Stock\") were redeemed and in 1993 prior to redemption, 29,557 shares were converted into approximately 13,700 shares of Common Stock and cash.\nIn 1994 and 1993, pursuant to a Common Stock repurchase program, the Company purchased 143,500 shares and 87,500 shares, respectively.\nAt December 31, 1995, approximately 4,755,000 shares of Common Stock were reserved for warrants, performance plans, deferred stock and compensation plans and stock options.\nNote H - Stock Option Plans\nUnder the Company's Long-Term Performance Plan for officers and other key employees (the \"LTP Plan\"), the Compensation Committee (the \"Committee\") may grant to key employees awards up to a maximum of 1,500,000 shares of Common Stock, as stock options, stock appreciation rights, restricted stock, performance shares, or other stock based awards. The maximum grant to any one participant is limited to no more than 250,000 shares. Options are granted at not less than the market price on the date of grant and become exercisable in equal amounts over a three year period from the date of grant. In 1994, the Committee authorized the issuance of 90,000 shares of restricted stock under the LTP Plan that become fully vested to the employees after three years. The market value of the shares on its date of grant was approximately $2.87 per share and the cost of the grant based on the market price is being amortized evenly over the vesting period. At December 31, 1995, 993,500 shares were available for awards under the LTP Plan.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA summary of changes in options issued pursuant to the above plan is as follows:\nOutstanding at December 31, 1993 - - - Granted in 1994 144,500 $2.94 Canceled (4,000) $2.94 Outstanding at December 31, 1994 140,500 $2.94 Granted in 1995 285,000 $2.19 - $2.25 Canceled (9,000) $2.94 Outstanding at December 31, 1995 416,500 $2.19 - $2.94\nAt December 31, 1995, options for 43,839 shares were exercisable.\nUnder the Company's Executive Incentive Plan, for Executive Officers (the \"Executive Incentive Plan\") the Committee may grant awards up to a maximum of 900,000 shares of Common Stock. In 1995, an award for 91,875 shares was issued in lieu of a cash bonus and the shares vest evenly over a three year period. At December 31, 1995, approximately 808,125 shares were available for the granting of awards and no shares were vested at December 31, 1995.\nUnder the Deferred Stock and Compensation Plan for Non-Employee Directors (the \"Directors Plan\") 200,000 shares of Common Stock may be issued. Under the Directors Plan, each director is to receive rights to the equivalent of 1,300 shares of Common Stock annually following election to the Board of Directors. In 1995 and 1994, an aggregate of 5,850 and 5,200 common share equivalents, respectively, were granted. The market values of the equivalent shares on the date of grant was approximately $2.19 and $3.69, respectively, per share. The aggregate cost is charged to income. At December 31, 1995, 188,950 shares were available under the plan.\nThe 1990 Employee Stock Option Plan (the \"Plan\") provides that options to purchase shares of Common Stock may be granted at a price determined by the Stock Option Committee of the Board of Directors (the \"Option Committee\"); the exercise period may be fixed by the Option Committee, but not to exceed ten years; and only employees of the Company and its subsidiaries may be granted options under the Plan. The options generally become exercisable in equal amounts over three years from the date of grant.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe maximum number of shares available for grant pursuant to the Plan, as amended, is 11% of the number of shares of the Company's Common Stock authorized and issued or approximately 2,116,000 shares. At December 31, 1995, approximately 675,000 shares were available for the granting of options under the Plan.\nA summary of changes in options issued pursuant to the above plan is as follows:\nOutstanding at December 31, 1992 1,380,750 $1.81 - 6.19 Granted in 1993 312,500 $6.31 - 6.63 Canceled (3,000) $6.00 Exercised (84,967) $1.81 - 3.94 Outstanding at December 31, 1993 1,605,283 $1.81 - 6.63 Granted in 1994 275,000 $3.38 - 8.44 Canceled (233,000) $4.38 - 6.31 Exercised (61,000) $1.88 - 2.11 Outstanding at December 31, 1994 1,586,283 $1.81 - 8.44 Canceled in 1995 (336,000) $1.88 - 8.44 Exercised (10,000) $1.81 Outstanding at December 31, 1995 1,240,283 $1.81 - 6.63\nAt December 31, 1995, options for 1,140,784 shares were exercisable.\nDuring 1993 and 1992 options were granted under the Non-Employee Directors Plan to purchase 20,000 and 40,000 shares at a per share exercise price of $7.44 and $6.13, respectively, and are exercisable in equal amounts over three years from the date of grant. In 1994, options for 15,000 shares at an exercise price of $7.44 were canceled. At December 31, 1995, options for 43,334 shares were exercisable. No further options may be granted pursuant to the Non-Employee Directors Plan.\nNote I - Employee Benefits Plans\nPostretirement Health Care and Life Insurance Plans. The Company provides certain health care and life insurance benefits for eligible retired employees. The Company's employees, including employees subject to certain collective bargaining agreements, may become eligible for these benefits if they reach normal retirement age, with certain service requirements, while working for the Company.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn 1993, the Company adopted SFAS No. 106. This Statement requires the accrual of the estimated cost of retiree benefit payments other than pensions during the years an employee provides services. The cost of these benefits, which are principally health care and life insurance, were previously expensed as incurred, although approximately $3.6 million was recorded in connection with the acquisition of ABN in 1990. The plan is not being funded; thus there are no assets or expected return on assets. The Company has elected to record the previously unrecognized obligation of approximately $4.2 million over a twenty year period. Benefits for active and retired employees are provided for through insured and self-funded plans.\nThe following table sets forth the status of this obligation:\nDecember 31 1995 1994\nAccumulated postretirement benefit obligation (in thousands): Retirees $ 7,329 $ 6,295 Eligible active plan participants 419 568 Other active plan participants 1,812 2,054 Accumulated postretirement benefit obligation 9,560 8,917 Unrecognized transition obligation (3,119) (3,758) Unrecognized net loss (1,018) (627) Accrued postretirement benefit obligation $ 5,423 $ 4,532\nNet postretirement benefit cost consisted of the following components (in thousands):\n1995 1994\nService cost-benefits earned $ 154 $ 190 Interest cost on accumulated postretirement benefit obligation 715 627 Partial plan termination (1) 430 - Amortization of transition obligation 209 209 Net postretirement benefit cost $ 1,508 $ 1,026\n(1) In connection with the 1995 restructuring, a portion of the previously unrecognized transition obligation was charged to the restructuring reserve.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation, as of January 1, 1995, was 12.00% for 1995 decreasing each successive year until it reaches 6.0%, after which it remains constant. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase service cost plus interest on the accumulated postretirement benefit obligation by approximately 14.1%. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.5% at December 31, 1995 and 8.5% at December 31, 1994.\nPostretirement Plans. The Company is obligated to make regular defined contributions to several multi-employer plans and contributions to one single employer defined benefit pension fund, under the terms of various union contracts. The aggregate contribution to such multi-employer plans for retirement and welfare benefits was approximately $1.7 million, $1.8 million, and $1.9 million for the years ended December 31, 1995, 1994 and 1993, respectively. Retirement benefits are also provided by the Company, to eligible union and nonunion employees, through defined contributions to an employees' retirement plan; the aggregate contribution to such plan and charged to operations was $1.2 million, $1.5 million, and $1.7 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company has a trusteed, noncontributory defined benefit pension plan which covered substantially all employees of a company acquired in 1990. As of December 31, 1990, the plan was frozen for the nonunion employees and in 1992 for union employees who became participants in the Company's defined contribution employees' retirement plan. Benefits under the noncontributory defined benefit plan were based on years of service and average final compensation. The funding policy is to pay at least the minimum amounts required by the Employee Retirement Income Security Act of 1974. The net pension expense for the Company's defined benefit pension plan was approximately $0.2 million, $0.1 million, and $0.1 million in 1995, 1994 and 1993, respectively.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following table sets forth the 1995 and 1994 funded status and amounts recognized for the Company's defined benefit pension plan in the consolidated balance sheet (in thousands): 1995 1994 Actuarial present value of accumulated plan benefits, including vested benefits of $8,798 and $7,058 $ 8,862 $ 7,157\nProjected benefit obligation for service rendered to date $ 8,862 $ 7,157 Plan assets at fair value, primarily equity securities . 7,612 6,113 Accrued pension liability $ 1,250 $ 1,044\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.0% and 8.5% as of December 31, 1995 and 1994. The expected long-term rate of return was 8.5% in 1995 and in 1994.\nThe Company adopted, as of April 1, 1994, a noncontributory supplemental executive retirement plan (\"SERP\") for certain senior management employees. Benefits under the noncontributory plan are based on years of service and average final compensation. The plan is unfunded and benefits will be paid from the assets of the Company.\nThe following table sets forth at the status of this obligation at: December 31 1995 1994\nAccumulated benefit $ 1,501 $ 1,072\nProjected benefit obligation (equals funded $ 2,706 $2,249 Prior service cost (1,558) (1,689) Unrecognized net loss (362) (253) Preliminary accrued pension costs 786 307 Additional minimum liability* 1,116 765 Accrued pension cost for financial statements $ 1,902 $ 1,072\n*There is an intangible asset equal to the additional minimum liability reported.\nNet periodic pension cost consisted of the following components (in thousands): 1995 1994\nService cost-benefits earned $ 185 $ 124 Interest cost on projected benefit obligation 191 106 Amortization of prior service cost 103 77 Net periodic pension cost $ 479 $ 307\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7% and 8.5% as of December 31, 1995 and 1994. The expected long-term rate of return is not applicable as benefits are not funded. The above is from the adoption date.\nNote J - Restructuring Costs\nIn 1995, the Company recorded a pre-tax restructuring charge of approximately $14.3 million pursuant to a restructuring plan developed by management for the Company's domestic security printing operations, including the relocation and downsizing of its corporate offices.\nThe restructuring charge provided for those reasonably estimable costs resulting from the plan including costs that are: (i) associated with and will not benefit activities that will continue or generate future revenue and are incremental as a result of the plan (ii) incurred under contractual agreements (i.e. leases and employment agreements) that existed prior to the commitment date that provide no future economic benefit; or (iii) related to asset impairments and writedowns resulting directly from the plan. The plan is expected to be substantially completed in the second quarter of 1996.\nUnder the plan, the Company will reduce the domestic workforce by 27 percent and has provided a $2.9 million reserve for severance and related costs.\nAsset valuations and writedowns accounted for $5.0 million of the charge which reduced certain assets to their net realizable value and primarily relates to equipment not being relocated and leasehold improvements.\nLease and other facility obligations accounted for $6.4 million of the charge for the facilities to be closed in 1996.\nRestructuring activities in 1994 and 1993 relate primarily to the closing of ABN's Los Angeles plant. Remaining obligations under this restructuring relate to lease commitments.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following represents the Company's restructuring activities for the periods indicated (in millions):\nSeverance Asset Leases and Related Revaluations and other Costs and Writedowns Obligations Total\nRestructuring charge 1993 $ 2.4 $ 2.7 $ 6.9 $12.0 Noncash items (1.0) (1.0) Cash payments (2.1) (1.7) (2.8) (6.6) Balance at December 31, 1993 0.3 - 4.1 4.4 Restructuring charge - - 5.0 5.0 Imputed interest 0.3 0.3 Cash payments (0.3) -. (3.7) (4.0) Balance at December 31, 1994 - - 5.7 5.7 Restructuring charge 2.9 5.0 6.4 14.3 Imputed interest 0.3 0.3 Noncash items (1.8) (5.0) - (6.8) Cash payments (0.1) -. (1.4) (1.5) Balance at December 31, 1995 $ 1.0 $ -. $11.0 $12.0\nFuture cash outlays for the remaining restructuring reserve of $12.0 million at December 31, 1995 are anticipated to be $5.1 million in 1996, $2.1 million in 1997, $1.3 million in 1998 and $3.5 million thereafter to 2009.\nNote K - Provision for Idle Equipment\nIn January 1994, the Company was notified that it was not awarded any portion of a contract by the United States Postal Service (\"USPS\") in response to a competitive bid for postage stamp production. In prior years, the Company made investments in capital equipment intended for use in connection with the products and services supplied to the USPS. As a result of the loss of the business, the Company re-evaluated the net carrying value of capitalized equipment and the cost of operating leases used for postage stamp production and recorded a $2 million provision for the write-down of idle postal equipment.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote L - Commitments and Contingencies\nIn January 1994, Vladimir v. United States Banknote Corporation, et al., and in February 1994, Sinay v. United States Banknote Corporation, et al. were filed in the United States District Court for the Southern District of New York on behalf of a purported class of purchasers of Common Stock between April 1, 1993 and January 6, 1994. Also, in January 1994, Atencio v. Morris Weissman, et al. was filed in the Court of Chancery for the State of Delaware, New Castle County, against various directors and\/or officers of the Company, on behalf of a purported class and also derivatively on behalf of the Company which was named as a nominal defendant. In February 1994, Rosenberg v. Morris Weissman, et al. was filed in the same court as Atencio, alleging similar claims to Atencio, but not on behalf of a class of plaintiffs.\nThe complaints in these four actions allege, among other things, that the Company and the individual defendants knowingly or recklessly caused the market price of its Common Stock to be inflated artificially by making misleading statements and\/or omissions of material fact concerning the risk of loss of the Company's stamp printing contracts with the USPS. The Vladimir and Sinay actions seek unspecified damages. The Atencio and Rosenberg actions also assert claims for breach of fiduciary duty by the individual defendants, and allege that certain of the defendants sold Common Stock while in possession of material non-public information and seek recapture of the profits earned by the defendants who purportedly traded, the repayment by the defendants of their 1993 sala7.0% and 8.5% as of December 31, 1995 and 1994. The expected long-term rate of return was 8.5% in 1995 and in 1994.\nThe Company adopted, as of April 1, 1994, a noncontributory supplemental executive retirement plan (\"SERP\") for certain senior management employees. Benefits under the noncontributory plan are ated persons) who purchased the Company's stock from April 1, 1993 through January 6, 1994. On February 28, 1996, the Sinay action was voluntarily dismissed. The Atencio and Rosenberg actions have been stayed pending the outcome of the Vladimir action.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nOn November 1, 1994, the Company filed an action against De La Rue, and its parent, De La Rue Plc in New York State Supreme Court. The complaint alleges breach of contract in connection with the 1993 purchase of the Company's Brazilian subsidiary from DLR and seeks in excess of $1.5 million in damages. In December 1994, the action was removed by the defendants to the United States District Court for the Southern District of New York. Defendants have filed an answer denying liability and asserting counterclaims. Discovery is presently underway.\nOn November 2, 1994, an action was commenced against the Company and certain of its directors and officers entitled Thomas De La Rue AG v. United States Banknote Corporation, et al. in the United States District Court for the Southern District of New York. The complaint, as amended, alleges, among other things, breach of contract by the Company in connection with the Brazil purchase agreement and common law fraud based on the alleged failure to disclose the risk of loss of the Company's stamp printing contracts with the USPS and the alleged failure to register the Common Stock paid to DLR expeditiously with the SEC. The complaint seeks unspecified damages as well as $6.8 million for the Common Stock received by DLR in the transaction. On November 20, 1995, plaintiff amended its complaint and eliminated all of its federal securities law claims and the individual defendants following dismissal of certain of DLR's securities law claims by the court. Discovery is presently underway.\nThe adverse determination of the above-described litigations could have a material adverse effect on the financial condition or results of operations of the Company in the event that the Company's insurance was not available to cover such claims or an award materially in excess of insurance coverage was made. The Company believes, however, that it has good and meritorious defenses to the litigations and intends to vigorously defend against such actions. The Company maintains insurance coverage which presently covers a majority of the expenses of defense of the class action suits and, until November 1995, the DLR suit. In addition to the foregoing, the Company is party to legal proceedings that are considered to be either ordinary, routine litigation incidental to its business or not material to the Company's consolidated financial position.\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAs of December 31, 1995, the Company had approximately $3.3 million of outstanding letters of credit cash collateralized.\nThe Company has long-term operating leases for offices, manufacturing facilities and equipment which expire through 2013. The Company has renewal options on some locations, which provide for renewal rents based upon increases tied to the consumer price index.\nAt December 31, 1995, future minimum lease payments under noncancelable operating leases are as follows: $6.6 million in 1996; $7.0 million in 1997; $6.6 million in 1998; $5.7 million in 1999; $5.7 million in 2000; and $10.0 million thereafter.\nNet rental expense was $8.0 million, $8.1 million, and $7.0 million for the years ended December 31, 1995, 1994 and 1993, respectively\nAMERICAN BANKNOTE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote M - Quarterly Results of Operations - unaudited\nThe following is a summary of the quarterly results of operations for the years ended December 31, 1995 and 1994 (in thousands, except per share data):\n1995 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr (1)\nSales $49,068 $47,591 $56,783 $ 52,722 Cost of sales 31,949 38,149 39,414 39,523 Net income (loss) $ (797) $(9,608) $ 53 $(12,063)\nPer share net income (loss) $(.04) $(.50) $ .00 $(.63)\n(1) In the fourth quarter pre-tax income was charged an aggregate of $14.3 million of restructuring charges (See Note J). The after-tax charge was approximately $11.1 million.\n1994 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr (2) Sales $43,614 $52,688 $52,890 $58,941 Cost of sales 24,967 32,174 33,517 40,231 Income (loss) from operations (969) (465) 561 (4,828) Extraordinary item (1) - (114) - - Net income (loss) $ (969) $ (579) $ 561 $(4,828)\nPer share net income (loss) Operations $ (.05) $ (.02) $ .03 $ (.25) Extraordinary item - (.01) - - Net Income (loss) $ (.05) $(.03) $ .03 $ (.25)\n(1) In connection with the early extinguishment of indebtedness. (See Note A 8) (2) In the fourth quarter, pre-tax income was charged $7.0 million of restructuring charges (See Note J) and $2.0 million for idle equipment (See Note K). The after-tax charge was approximately $5.2 million.\nITEM 9.","section_9":"ITEM 9. Disagreements on Accounting and Financial Disclosure\nNone. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Company\nSee Item 13\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nSee Item 13\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\nInformation required for Items 10, 11, 12 and 13 will be set forth either (I) in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders, or (ii) in an amendment to this Report on Form 10-K\/A, which in either case will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1995, and which information is incorporated herein by reference. In addition, reference is made to Item 10 in Part I of this Report.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K\n(a)(1) List of Financial Statements.\nThe following consolidated financial statements of American Banknote Corporation and subsidiaries are included in Item 8:\nConsolidated Statements of Operations - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statement of Stockholders' Equity - Three Years Ended December 31, 1995\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(a)(2) List of Financial Statement Schedules.\nThe following schedules of American Banknote Corporation and subsidiaries are included in Item 14(d): None\nAll schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(a)(3) List of Executive Compensation Plans and Arrangements.\nSecond Amended and Restated Employment Agreement dated as of October 1, 1993, between the Company, American Bank Note Company and Morris Weissman is hereby incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K (as amended) for the year ended December 31, 1993 (the\"1993 10-K\").\nSeverance Agreement effective as of July 19, 1995 is hereby incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 (the \"June 30, 1995 10-Q\").\nEmployment Agreement dated July 24, 1990 between the Company and John T. Gorman is hereby incorporated by reference to Exhibit (c)(32) to Amendment No. 3 to the Company's Rule 13E-3 Transaction Statement on Schedule 13E-3 dated July 31, 1990 (the \"Schedule 13E-3\").\nAmendment dated August 31, 1992 to Employment Agreement dated July 24, 1990, between the Company and John T. Gorman is hereby incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (the \"1992 10-K\").\nEmployment Letter effective August 18, 1995 between Robert Wilcox and the Company is hereby incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 (the \"September 30, 1995 10-Q\").\nForm of Performance Warrants dated July 25, 1990, issued to Morris Weissman, John T. Gorman and Sheldon Cantor is hereby incorporated by reference to Exhibit (c)(29) to the Company's Rule 13E-3 Transaction Statement on Schedule 13E-3 dated April 18, 1990.\nAmended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (the \"1991 10-K\").\nAmendment dated September 23, 1993 to Amended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.13 to the 1993 10-K.\n1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.38 to the 1991 10-K.\nAmendment dated as of June 11, 1992 to the 1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.16 to the 1992 10-K.\nSupplemental Executive Retirement Plan of the Company effective as of April 1, 1994, is hereby incorporated by reference to Exhibit 10.22 to Amendment No. 2 to the Company's Registration Statement on Form S-4 (File No. 33-79726) filed July 18, 1994.\nAmendments to SERP effective April 1, 1994.*\nForm of severance agreement for designated officers is hereby incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (the \"1994 10-K\").\nLong-Term Performance Plan for key employees is hereby incorporated by reference to Exhibit 10.26 to the 1994 10-K.\nExecutive Incentive Plan for executive officers, as amended, is hereby incorporated by reference to Exhibit 10.27 to the 1994 10-K.\nDeferred Stock and Compensation Plan for Non-employee Directors is hereby incorporated by reference to Exhibit 10.28 of the 1994 10-K.\n(b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of the period covered by this Report.\n(c) Exhibits.\n2.1 Agreement of Plan of Merger and Certificate of Merger of United States Banknote Corporation (a New York corporation) (\"USBN-NY\") and United States Banknote Corporation (a Delaware corporation) dated as of June 29, 1993 are hereby incorporated by reference to Exhibits 2.1 and 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (the \"June 30, 1993 10-Q\").\n2.2 Certificate of Ownership and Merger of USBN-NY into the Company dated as of July 14, 1994 is hereby incorporated by reference to Exhibit 3.1 to the Company's Registration of Successor Issuer on Form 8-B filed September 30, 1993 (the \"Form 8-B\").\n2.3 Certificate of Merger of USBN-NY into the Company dated as of July 14, 1994 is hereby incorporated by reference to Exhibit 3.2 to the Form 8-B.\n2.4 Certificate of merger of USBC Acquisition, Inc. with and into USBN-NY is hereby incorporated by reference to Exhibit 4(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990.\n3.1 Certificate of Incorporation of the Company including Amendment No. 1 thereto is hereby incorporated by reference to Exhibit 3.1 to the June 30, 1995 10-Q.\n3.2 Certificate of Designation of the Company authorizing Preferred Stock as Series A is hereby incorporated by reference to Exhibit 4 to the Company's Report on Form 8-A filed April 6, 1994.\n3.3 By-Laws of the Company including amendments thereto are hereby incorporated by reference to Exhibit 3.2 to the June 30, 1995 10-Q.\n4.1 Indenture dated as of May 15, 1992 between the Company and Chemical Bank, as Trustee, relating to the 10-3\/8% Senior Notes due June 1, 2002 is hereby incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated May 26, 1992 (the \"May 26, 1992 8-K\").\n4.2 Pledge Agreement, as amended, dated as of May 26, 1992 between the Company and Chemical Bank, as Trustee, relating to the Company's 10-3\/8% Senior Notes due June 1, 2002 is hereby incorporated by reference to Exhibit 4.3 to the May 26, 1992 8-K.\n4.3 First Amendment to the Pledge Agreement dated as of May 26, 1992 between the Company and Chemical Bank, N.A., dated as of May 23, 1994 is hereby incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 (the \"June 30, 1994 10-Q\").\n4.4 First Supplemental Indenture relating to 10-3\/8% Senior Notes due June 1, 2002 between the Company and Chemical Bank, N.A., dated as of May 23, 1994 is hereby incorporated by reference to the June 30, 1994 10-Q.\n4.5 Pledged Share Amendment dated as of July 31, 1995 between the Company and Chemical Bank, as Trustee, relating to the 10-3\/8% Senior Notes due June 1, 2002.*\n4.6 Indenture dated as of May 1, 1994 between the Company and The First National Bank of Boston as Trustee, relating to the 11-5\/8% Senior Notes Due August 1, 1002, Series B, of the Company and Form of Series B Note, is hereby incorporated by reference to Exhibit 4.1 and 4.3 to the Company's Registration Statement on Form S-4 dated August 5, 1994.\n4.7 Rights Agreement dated as of March 24, 1994 between the Company and Chemical Bank as Rights Agent including the form of Rights Certificate and form of Certificate of Designation is hereby incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated March 24, 1994.\n4.8 Credit Agreement dated as of January 29, 1996, among American Bank Note Company and American Bank Note Holographics, Inc., American Banknote Corporation and Chemical Bank, as Agent.*\n4.9 Security Agreement dated as of January 29, 1996, among American Bank Note Company and American Bank Note Holographics, Inc. and Chemical Bank, as Agent.*\n10.1 Second Amended and Restated Employment Agreement dated as of October 1, 1993, between the Company, American Bank Note Company and Morris Weissman is hereby incorporated by reference to Exhibit 10.1 to the 1993 10-K.\n10.2 Severance Agreement effective July 19, 1995 is hereby incorporated by reference to Exhibit 10.1 to the June 30, 1995 10-Q.\n10.3 Employment Agreement dated July 24, 1990 between the Company and John T. Gorman is hereby incorporated by reference to Exhibit (c)(32) to the Schedule 13E-3.\n10.4 Amendment dated August 31, 1992 to Employment Agreement dated July 24, 1990, between the Company and John T. Gorman is hereby incorporated by reference to Exhibit 10.3 to the 1992 10-K.\n10.5 Employment Letter effective August 18, 1995 between Robert Wilcox and the Company is hereby incorporated by reference to the September 30, 1995 10-Q.\n10.6 Form of Performance Warrants dated July 25, 1990, issued to Morris Weissman, John T. Gorman and Sheldon Cantor is hereby incorporated by reference to Exhibit (c)(29) to the Company's Rule 13E-3 Transaction Statement on Schedule 13E-3 dated April 18, 1990.\n10.7 Amended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.37 to the 1991 10-K.\n10.8 Amendment dated September 23, 1993 to Amended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992, is hereby incorporated by reference to Exhibit 10.13 to the 1993 10-K.\n10.9 1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.38 to the 1991 10-K.\n10.10 Amendment dated as of June 11, 1992 to the 1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.16 to the 1992 10-K.\n10.11 Supplemental Executive Retirement Plan (\"SERP\") of the Company effective as of April 1, 1994, is hereby incorporated by reference to Exhibit 10.22 to Amendment No. 2 to the Company's Registration Statement on Form S-4 (File No. 33-79726) filed July 18, 1994.\n10.12 Amendments to SERP effective April 1, 1994.*\n10.13 Form of severance agreement for designated officers is hereby incorporated by reference to Exhibit 10.25 to the 1994 10-K.\n10.14 Long-Term Performance Plan for Key employees is hereby incorporated by reference to Exhibit 10.26 to the 1994 10-K.\n10.15 Executive Incentive Plan for executive officers, as amended, is hereby incorporated by reference to Exhibit 10.27 to the 1994 10-K.\n10.16 Deferred Stock and Compensation Plan for Non-employee Directors is hereby incorporated by reference to Exhibit 10.26 to the 1994 10-K.\n10.17 Sublease dated January 31, 1996 between Grow Group, Inc. and the Company for the Company's headquarters at 200 Park Avenue, New York.*\n10.18 Real Estate Rental Agreement, dated February 29, 1996, between Walter Torre Junior LTDA. And American Bank Note Company Grafica E Servicos Ltda for property located in Barueri, Sao Paulo, Brazil.*\n10.19 Agreement of Lease, dated as of July 23, 1992, between Robert Martin Company and American Banknote Holographics, Inc. is hereby incorporated by reference to Exhibit 10.17 to the 1992 10-K.\n10.20 Stock Purchase Agreement dated as of June 7, 1993, between the Company and Thomas De La Rue AG, relating to the acquisition of Thomas De La Rue Grafica e Servicos Ltda is hereby incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated June 23, 1993 (the \"June 23, 1993 8-K\").\n10.21 Stock Purchase Agreement dated as of June 7, 1993, by and among American Bank Note Holographics, Inc., the Company and Thomas De La Rue, Inc. is hereby incorporated by reference to Exhibit 10.2 to the June 23, 1993 8-K.\n10.22 Stock Purchase Agreement dated as of June 7, 1993, by and among De La Rue Holographics Limited (Amblehurst Limited), De La Rue plc and the Company is hereby incorporate by reference to Exhibit 10.3 to the June 23, 1993 8-K.\n10.23 Non-Exclusive Patent License Agreement between American Bank Note Holographics, Inc. and De La Rue Holographics Limited dated June 23, 1993, is hereby incorporated by reference to Exhibit 10.4 to the June 23, 1993 8-K.\n10.24 Subscription Agreement dated June 2, 1995 regarding Grafica Bradesco Ltda. and ABN-Brazil is hereby incorporated by reference to the Company's Current Report on Form 8-K\/A (Amendment No. 1) dated July 10, 1995 (the \"July 10, 1995 8-K\").\n10.25 By-Laws of ABN-Brazil, as amended, are hereby incorporated by reference to the July 10, 1995 8-K.\n10.26 Contract dated September 4, 1995 with Telecomunicacoes Brasileiras S\/A - Telebras for production of telephone cards.*\n10.27 Agreement for Services, effective October 1, 1995 between Kelly, Anderson, Pethick & Associates, Inc. and the Company is hereby incorporated by reference to Exhibit 10.2 to the September 30, 1995 10-Q.\n11 Computation of per share income (loss).*\n21 Subsidiaries of the Registrant.*\n23 Independent Auditors' Consent.*\n* Filed herewith\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICAN BANKNOTE CORPORATION Registrant\nBy: s\/ Morris Weissman Morris Weissman Chairman and Chief Executive Officer March 29, 1996\nBy: s\/ John T. Gorman John T. Gorman Executive Vice President, Chief Financial Officer and Chief Accounting Officer 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 and in the capacities and on the dates indicated:\ns\/ Morris Weissman s\/ C. Gerald Goldsmith Morris Weissman C. Gerald Goldsmith Director, Chairman and Director Chief Executive Officer March 29, 1996 March 29, 1996\ns\/ Bette B. Anderson s\/ Ira J. Hechler Bette B. Anderson Ira J. Hechler Director Director March 29, 1996 March 29, 1996\ns\/ David S. Rowe-Beddoe Dr. Oscar Arias S David S. Rowe-Beddoe Director Director March , 1996 March 29, 1996\nEXHIBIT INDEX Page No. in Manually Exhibit No. Signed Report\n2.1 Agreement of Plan of Merger and Certificate of Merger of United States Banknote Corporation (a New York corporation) (\"USBN-NY\") and United States Banknote Corporation (a Delaware corporation) dated as of June 29, 1993 are hereby incorporated by reference to Exhibits 2.1 and 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (the \"June 30, 1993 10-Q\").\n2.2 Certificate of Ownership and Merger of USBN-NY into the Company dated as of July 14, 1994 is hereby incorporated by reference to Exhibit 3.1 to the Company's Registration of Successor Issuer on Form 8-B filed September 30, 1993 (the \"Form 8-B\").\n2.3 Certificate of Merger of USBN-NY into the Company dated as of July 14, 1994 is hereby incorporated by reference to Exhibit 3.2 to the Form 8-B.\n2.4 Certificate of merger of USBC Acquisition, Inc. with and into USBN-NY is hereby incorporated by reference to Exhibit 4(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990.\n3.1 Certificate of Incorporation of the Company including Amendment No. 1 thereto is hereby incorporated by reference to Exhibit 3.1 to the June 30, 1995 10-Q.\n3.2 Certificate of Designation of the Company authorizing Preferred Stock as Series A is hereby incorporated by reference to Exhibit 4 to the Company's Report on Form 8-A filed April 6, 1994.\n3.3 By-Laws of the Company including amendments thereto are hereby incorporated by reference to Exhibit 3.2 to the June 30, 1995 10-Q.\n4.1 Indenture dated as of May 15, 1992 between the Company and Chemical Bank, as Trustee, relating to the 10-3\/8% Senior Notes due June 1, 2002 is hereby incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated May 26, 1992 (the \"May 26, 1992 8-K\").\n4.2 Pledge Agreement, as amended, dated as of May 26, 1992 between the Company and Chemical Bank, as Trustee, relating to the Company's 10-3\/8% Senior Notes due June 1, 2002 is hereby incorporated by reference to Exhibit 4.3 to the May 26, 1992 8-K.\n4.3 First Amendment to the Pledge Agreement dated as of May 26, 1992 between the Company and Chemical Bank, N.A., dated as of May 23, 1994 is hereby incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 (the \"June 30, 1994 10-Q\").\n4.4 First Supplemental Indenture relating to 10-3\/8% Senior Notes due June 1, 2002 between the Company and Chemical Bank, N.A., dated as of May 23, 1994 is hereby incorporated by reference to the June 30, 1994 10-Q.\n4.5 Pledged Share Amendment dated as of July 31, 1995 between the Company and Chemical Bank, as Trustee, relating to the 10-3\/8% Senior Notes due June 1, 2002.*\n4.6 Indenture dated as of May 1, 1994 between the Company and The First National Bank of Boston as Trustee, relating to the 11-5\/8% Senior Notes Due August 1, 1002, Series B, of the Company and Form of Series B Note, is hereby incorporated by reference to Exhibit 4.1 and 4.3 to the Company's Registration Statement on Form S-4 dated August 5, 1994.\n4.7 Rights Agreement dated as of March 24, 1994 between the Company and Chemical Bank as Rights Agent including the form of Rights Certificate and form of Certificate of Designation is hereby incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated March 24, 1994.\n4.8 Credit Agreement dated as of January 29, 1996, among American Bank Note Company and American Bank Note Holographics, Inc., American Banknote Corporation and Chemical Bank, as Agent.*\n4.9 Security Agreement dated as of January 29, 1996, among American Bank Note Company and American Bank Note Holographics, Inc. and Chemical Bank, as Agent.*\n10.1 Second Amended and Restated Employment Agreement dated as of October 1, 1993, between the Company, American Bank Note Company and Morris Weissman is hereby incorporated by reference to Exhibit 10.1 to the 1993 10-K.\n10.2 Severance Agreement effective July 19, 1995 is hereby incorporated by reference to Exhibit 10.1 to the June 30, 1995 10-Q.\n10.3 Employment Agreement dated July 24, 1990 between the Company and John T. Gorman is hereby incorporated by reference to Exhibit (c)(32) to the Schedule 13E-3.\n10.4 Amendment dated August 31, 1992 to Employment Agreement dated July 24, 1990, between the Company and John T. Gorman is hereby incorporated by reference to Exhibit 10.3 to the 1992 10-K.\n10.5 Employment Letter effective August 18, 1995 between Robert Wilcox and the Company is hereby incorporated by reference to the September 30, 1995 10-Q.\n10.6 Form of Performance Warrants dated July 25, 1990, issued to Morris Weissman, John T. Gorman and Sheldon Cantor is hereby incorporated by reference to Exhibit (c)(29) to the Company's Rule 13E-3 Transaction Statement on Schedule 13E-3 dated April 18, 1990.\n10.7 Amended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.37 to the 1991 10-K.\n10.8 Amendment dated September 23, 1993 to Amended and Restated 1990 Employee Stock Option Plan dated as of February 19, 1992, is hereby incorporated by reference to Exhibit 10.13 to the 1993 10-K.\n10.9 1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.38 to the 1991 10-K.\n10.10 Amendment dated as of June 11, 1992 to the 1992 Non-Employee Directors Stock Option Plan dated as of February 19, 1992 is hereby incorporated by reference to Exhibit 10.16 to the 1992 10-K.\n10.11 Supplemental Executive Retirement Plan (\"SERP\") of the Company effective as of April 1, 1994, is hereby incorporated by reference to Exhibit 10.22 to Amendment No. 2 to the Company's Registration Statement on Form S-4 (File No. 33-79726) filed July 18, 1994.\n10.12 Amendments to SERP effective April 1, 1994.*\n10.13 Form of severance agreement for designated officers is hereby incorporated by reference to Exhibit 10.25 to the 1994 10-K.\n10.14 Long-Term Performance Plan for Key employees is hereby incorporated by reference to Exhibit 10.26 to the 1994 10-K.\n10.15 Executive Incentive Plan for executive officers, as amended, is hereby incorporated by reference to Exhibit 10.27 to the 1994 10-K.\n10.16 Deferred Stock and Compensation Plan for Non-employee Directors is hereby incorporated by reference to Exhibit 10.26 to the 1994 10-K.\n10.17 Sublease dated January 31, 1996 between Grow Group, Inc. and the Company for the Company's headquarters at 200 Park Avenue, New York.*\n10.18 Real Estate Rental Agreement, dated February 29, 1996, between Walter Torre Junior LTDA. And American Bank Note Company Grafica E Servicos Ltda for property located in Barueri, Sao Paulo, Brazil.*\n10.19 Agreement of Lease, dated as of July 23, 1992, between Robert Martin Company and American Banknote Holographics, Inc. is hereby incorporated by reference to Exhibit 10.17 to the 1992 10-K.\n10.20 Stock Purchase Agreement dated as of June 7, 1993, between the Company and Thomas De La Rue AG, relating to the acquisition of Thomas De La Rue Grafica e Servicos Ltda is hereby incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated June 23, 1993 (the \"June 23, 1993 8-K\").\n10.21 Stock Purchase Agreement dated as of June 7, 1993, by and among American Bank Note Holographics, Inc., the Company and Thomas De La Rue, Inc. is hereby incorporated by reference to Exhibit 10.2 to the June 23, 1993 8-K.\n10.22 Stock Purchase Agreement dated as of June 7, 1993, by and among De La Rue Holographics Limited (Amblehurst Limited), De La Rue plc and the Company is hereby incorporate by reference to Exhibit 10.3 to the June 23, 1993 8-K.\n10.23 Non-Exclusive Patent License Agreement between American Bank Note Holographics, Inc. and De La Rue Holographics Limited dated June 23, 1993, is hereby incorporated by reference to Exhibit 10.4 to the June 23, 1993 8-K.\n10.24 Subscription Agreement dated June 2, 1995 regarding Grafica Bradesco Ltda. and ABN-Brazil is hereby incorporated by reference to the Company's Current Report on Form 8-K\/A (Amendment No. 1) dated July 10, 1995 (the \"July 10, 1995 8-K\").\n10.25 By-Laws of ABN-Brazil, as amended, are hereby incorporated by reference to the July 10, 1995 8-K.\n10.26 Contract dated September 4, 1995 with Telecomunicacoes Brasileiras S\/A - Telebras for production of telephone cards.*\n10.27 Agreement for Services, effective October 1, 1995 between Kelly, Anderson, Pethick & Associates, Inc. and the Company is hereby incorporated by reference to Exhibit 10.2 to the September 30, 1995 10-Q.\n11 Computation of per share income (loss).*\n21 Subsidiaries of the Registrant.*\n23 Independent Auditors' Consent.*\n* Filed herewith","section_15":""}
{"filename":"805019_1995.txt","cik":"805019","year":"1995","section_1":"ITEM 1. Business.\nTenneco Credit Corporation (the \"Company\") was incorporated in 1981 under the laws of the State of Delaware and commenced operations on October 1, 1984. All of the issued and outstanding capital stock of the Company is owned by Tenneco Inc. The business of the Company relates primarily to financing, on a nonrecourse basis, receivables of Tenneco Inc. and its subsidiaries (\"Tenneco\").\nThe Company's headquarters are located at 1010 Milam, Houston, Texas 77002. The Company has no employees, and employees of Tenneco Management Company, a subsidiary of Tenneco Inc., render all services to the Company that are necessary for the conduct of its operations.\nPurchase of Receivables\nThe Company has entered into an agreement (the \"Operating Agreement\") with subsidiaries of Tenneco Inc. (\"Tenneco Subsidiaries\") pursuant to which it buys trade receivables generated by the Tenneco Subsidiaries from the sale of goods or services. Each Tenneco Subsidiary, as the Company's agent, makes collections of, and otherwise services, receivables sold by it to the Company. Tenneco Inc., the parent of the Company, has entered into a Performance Agreement for the benefit of the Company in which it agreed to cause the Tenneco Subsidiaries to perform their obligations under the Operating Agreement. Additionally, pursuant to an Investment Agreement between the Company and Tenneco Inc., Tenneco Inc. agreed to provide financial support to the Company if the Company does not satisfy certain financial tests. For additional information concerning these agreements, see \"Relationship with Tenneco Inc.--Performance Agreement\" and \"--Investment Agreement.\" Because a significant amount of the long- term debt owed by the Company will mature after the maturity of a significant amount of the long-term receivables held by the Company, the Company believes that it will be necessary for Tenneco Inc. to provide financial support, under the provisions of the contractual agreements, in future periods.\nThe Company has also purchased from time to time receivables and other assets from subsidiaries of Tenneco Inc. on terms different from those set forth in the Operating Agreement.\nPrior to June 1994, Case Corporation (\"Case\") sold all of its domestic retail receivables to the Company. Those receivables arose from sales by stores owned by Case and sales through independent dealers. As an incentive to dealers to assist in assuring the collectibility of their receivables, the purchase price discount included an amount for possible losses that may arise from their receivables. This portion of the discount became payable to the dealers as their receivables were collected and was recorded by the Company as a dealers' reserve. Any loss arising from the uncollectibility of a dealer's receivables was charged against this dealer's reserve to the extent of the reserve; any losses in excess of the dealer's reserve are recorded as a loss by the Company. During the years 1991 through 1995, there were no credit losses recorded by the Company in excess of the dealer's reserve.\nPrior to June 1994, Case and its subsidiaries were wholly-owned subsidiaries of Tenneco Inc. On June 23, 1994, pursuant to a Reorganization Agreement dated as of that date, Case acquired the business and assets of the farm and construction equipment business of Tenneco (the \"Reorganization\") and Tenneco Inc. and certain of its subsidiaries acquired all of the outstanding common stock of Case and (subject to a legally binding commitment to sell) 100% of Case's Series A Cumulative Convertible Preferred Stock. Subsequent to the Reorganization, Tenneco Inc. and its subsidiaries sold an aggregate of approximately 79% of the outstanding shares of Case in an initial public offering and two secondary public offerings. Also, in June 1994, the subsidiaries of Tenneco Inc. that owned the Series A Cumulative Convertible Preferred Stock sold such shares to unaffiliated investors in a private offering. In March 1996, Tenneco Inc. and its subsidiaries sold all their remaining Case shares.\nAs part of the Reorganization, the Company retained ownership of approximately $1.2 billion of Case's United States retail receivables and related debt existing at the time of the Reorganization that is not redeemable prior to maturity. Since the Reorganization, United States retail finance activity has been conducted by Case's United States finance subsidiary. Case services the retail receivables retained by the Company, for which it receives a monthly servicing fee based on the amount of net receivables outstanding at the beginning of each month. At December 31, 1995, approximately $509 million of the retail receivables related to Case remained outstanding.\nUnder the Operating Agreement, the Company purchases trade receivables at prices agreed to by it and the Tenneco Subsidiaries at the time of sale. The purchase prices have historically been primarily as follows:\nCase. The purchase prices for Case retail receivables were set at levels intended to provide an appropriate market yield to the Company above the Company's cost of funds. The average yield for 1995 on retail receivables purchased from Case was 10.4%, up from 10.1% in 1994.\nOther Tenneco Subsidiaries. The face amount of the trade receivables purchased less a discount based upon the prime rate plus 25 basis points. The discount rate charged on short-term trade receivables purchased from Tenneco ranged from 8.75% to 9.25% during 1995 and from 5.75% to 8.75% during 1994.\nMaturities of receivables purchased by the Company, which are not restricted by the Operating Agreement, are primarily as follows:\nCase. Retail receivables purchased from Case generally had original maturities ranging from 24 months to 60 months. As of December 31, 1995, the weighted average remaining life to maturity of retail receivables purchased from Case was approximately 28 months. The Case receivables retained by the Company will be substantially liquidated by 1999.\nOther Tenneco Subsidiaries. Most trade accounts receivable purchased from other Tenneco Subsidiaries mature in 30 to 60 days.\nAs stated above, the Company believes that it will be necessary for Tenneco Inc. to provide financial support, under the provisions of the contractual agreements, in future periods.\nSales of receivables to the Company under the Operating Agreement are without recourse to the selling Tenneco Subsidiaries. Reference is made to the caption \"Tenneco Subsidiaries and Case\" for a discussion of the businesses which generate the trade receivables purchased by the Company.\nAs of December 31, 1995, and December 31, 1994, the Company held the following trade notes and accounts receivable generated by (i) Case and (ii) Tenneco business segments:\nSee Note 4 to the Financial Statements of Tenneco Credit Corporation and Consolidated Subsidiaries for an analysis of the maturities of the trade notes and accounts receivable held by the Company on December 31, 1995. See also the \"Outlook\" section of Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" for a discussion of the Company's assessment of its viability following the liquidation of substantially all of the Case retail receivables in 1999.\nIn addition to purchasing trade receivables under the Operating Agreement, the Company has acquired, and may acquire in the future, various long-term receivables from non-affiliated companies. Purchases of these long-term receivables are negotiated on an arm's length basis by the Company and the seller at the time of purchase.\nTenneco Subsidiaries and Case\nAs of December 31, 1995, the Company held trade notes and accounts receivable purchased under the Operating Agreement from eleven Tenneco Subsidiaries, including subsidiaries in Tenneco's Energy, Automotive and Packaging divisions. The information below is provided with respect to those Tenneco Subsidiaries from which the Company has purchased or expects to purchase a substantial amount of accounts and notes receivable.\nThe principal business operations of Tenneco's Automotive division are Walker Manufacturing Company and Monroe Auto Equipment Company. Walker Manufacturing Company and its affiliates (\"Walker\") manufacture a variety of automotive exhaust systems and emission control products. Walker's products are sold to automotive manufacturers for use as original equipment and to wholesalers and retailers for sale as replacement equipment. Monroe Auto Equipment Company and its affiliates are engaged principally in the design, manufacture and distribution of original equipment and replacement ride control products.\nTenneco's Energy division principally consists of Tennessee Gas Pipeline Company (\"Tennessee\") and other subsidiaries who transport gas for, or sell gas to, primarily transmission and distribution companies. Its multiple-line interstate natural gas transmission system begins in the gas-producing areas of Texas and Louisiana, including the continental shelf of the Gulf of Mexico, and extends into the northeastern section of the United States, including the New York City and Boston metropolitan areas.\nTenneco's Packaging division is involved in the manufacture and sale of containerboard, paperboard, corrugated shipping containers, folding cartons, disposable plastic and aluminum containers, molded fiber products and other related products. Its shipping container products are used in the packaging of food, paper products, metal products, rubber and plastics, automotive products and point of purchase displays. Its folding cartons are used in the packaging of soap and detergent, food products and a wide range of other consumer goods. Uses for its molded fiber products include produce and egg packaging, food service items and institutional and consumer disposable dinnerware, as well as a wide range of other consumer and industrial goods. Its disposable plastic and aluminum containers are sold to the food service, food processing and related industries.\nDuring 1995, Tenneco's Packaging division acquired the plastics division of Mobil Corporation. The plastics business is the largest North American producer of polyethylene and polystyrene consumer and food service packaging products. Subsequent to the acquisition, certain receivables of the plastics business have been purchased by the Company under the terms of the Operating Agreement.\nCase and its subsidiaries, which are no longer subsidiaries of the Company, manufacture a full line of farm equipment and light- and medium- sized construction equipment. Prior to June 30, 1994, Case and its subsidiaries were wholly-owned subsidiaries of Tenneco Inc. See \"Purchase of Receivables\" above. As part of the Reorganization, the Company retained ownership of approximately $1.2 billion of Case's United States retail receivables and related debt existing at the time of the Reorganization that is not redeemable prior to maturity. Since the Reorganization, United States retail finance activity has been conducted by Case's United States finance subsidiary.\nOther Investments\nThe Company owns a 95% limited partner interest in a partnership that owns a multifuel boiler that is leased to Tenneco Packaging for use in its paper mill at Counce, Tennessee, pursuant to an agreement designed to return to the Company its investment and a return on investment during the term of the lease. The remaining 5% interest in this partnership is owned by Tenneco InterAmerica Inc., an indirect wholly-owned subsidiary of Tenneco Inc., which is also the general partner of this partnership.\nRelationship with Tenneco Inc.\nThe Company's business is substantially dependent upon the level of operations conducted by the Tenneco Subsidiaries. Accordingly, lower levels of sales from such operations could result in a reduction in the level of finance operations of the Company. See \"Purchase of Receivables\" above.\nThe agreements described below have been entered into by or among Tenneco Inc., the Company and the Tenneco Subsidiaries and relate to the operations of the Company. These agreements, which are governed by New York law, are enforceable by holders of the Unaffiliated Debt (as defined in the Investment Agreement described below). The following are summaries of certain provisions contained in such agreements, copies of which are filed as exhibits to this annual report. Such summaries do not purport to be complete descriptions of all the terms and provisions of such agreements, and reference is made to such agreements for the complete terms and provisions thereof.\nOperating Agreement\nThe Operating Agreement, as amended and restated as of June 15, 1988, provides that purchases from the Tenneco Subsidiaries of notes and accounts receivable owed to the Tenneco Subsidiaries by third parties will be made by the Company at a purchase price equal to the amount of such receivables less a discount determined by the parties at the time of the sale. Historically, the discount rate has been based on the prevailing prime rate at the time of sale plus 25 basis points. Under the Operating Agreement, the selling Tenneco Subsidiaries are required to collect the receivables on behalf of the Company and remit the proceeds to it promptly after collection. From time to time, additional subsidiaries of Tenneco Inc. may become parties to the Operating Agreement and begin selling receivables to the Company.\nThe Operating Agreement contains representations and warranties of the Tenneco Subsidiaries to the effect that (i) the amount of receivables purchased will be true and correct at the time of purchase; (ii) at the time of assignment, each receivable will be recorded on the books of\nthe selling Tenneco Subsidiary as an account receivable and will represent a valid and legally enforceable obligation incurred in connection with the sale or lease of a product or service; (iii) each assignment of receivables to the Company will vest in the Company the right, title and interest in and to such receivables and the proceeds of collection therefrom free and clear from claims of third persons; (iv) at the time of assignment, beneficial ownership of such assigned receivable will not have been conveyed to any other person; (v) the receivables assigned to the Company will be free and clear of all liens and encumbrances and will not be subject to any setoff or counterclaim, except as provided by law; (vi) each receivable assigned to the Company will conform with any and all applicable laws and governmental rules and regulations; and (vii) all obligations to be performed by or on behalf of the selling Tenneco Subsidiary in connection with such receivables will have been or will be promptly fulfilled. Each Tenneco Subsidiary has agreed to indemnify the Company for any loss that it sustains as a result of any breach of a representation or warranty. Although each Tenneco Subsidiary has made the foregoing representations, it has not warranted the ultimate collectibility of receivables that it sells to the Company. These representations and warranties do not apply to sales of receivables by Tenneco Subsidiaries that are sold outside of the Operating Agreement.\nPerformance Agreement\nTenneco Inc. has agreed, pursuant to a Performance Agreement dated as of June 15, 1988 (the \"Performance Agreement\"), to guarantee to the Company the due and punctual performance of the obligations of each of the Tenneco Subsidiaries under the Operating Agreement when and as the same shall become due and payable or performable. The obligations of Tenneco Inc. under the Performance Agreement are continuing, absolute and unconditional and are not subject to any defense that might otherwise be available to the selling Tenneco Subsidiary.\nInvestment Agreement\nTenneco Inc. and the Company have entered into an Investment Agreement dated as of June 15, 1988, pursuant to which Tenneco Inc. agreed to own, directly or indirectly, all of the capital stock of the Company having the right to vote for directors so long as the Company has any debt outstanding that is held by persons other than Tenneco Inc. or any of its affiliates (\"Unaffiliated Debt\"). Tenneco Inc. has also agreed to maintain an investment in the Company (either in the form of subordinated debt or stockholder's equity) at least equal to 20% of the sum of the Company's debt and stockholder's equity and to pay with respect to each month a fee to the Company equal to the amount, if any, by which the cumulative earnings of the Company and its consolidated subsidiaries for the period from the beginning of the calendar year to the end of such month, before deduction of interest, other fixed charges and income taxes are less than 25% of interest and other fixed charges. Under the Investment Agreement, the Company will not sell or otherwise dispose of its assets (other than in the ordinary course of business) or incur any Unaffiliated Debt unless after such disposition or incurrence the Company will own assets in an amount at least equal to 125% of the Unaffiliated Debt (other than debt that is expressly subordinated). Furthermore, the Company will not declare or pay any dividends or make any distribution with respect to its capital stock if the Company would thereafter be unable to pay the principle of, or interest or premium, if any, on the Unaffiliated Debt.\nA service charge of $234,000 was paid by Tenneco Inc. for the month of January 1994. No service charge was required for any months prior to or following January 1994.\nAmendments\nThe Operating Agreement, Performance Agreement and Investment Agreement may each be amended or modified at any time by the parties thereto; provided, that (i) no amendment or modification which adversely affects the rights of holders of Senior Debt or Subordinated Debt, other than Affiliated Debt, outstanding at the time of execution thereof shall be binding on or in any manner become effective with respect to such Senior Debt or Subordinated Debt at the time outstanding except with the prior written consent of (a) the holders of not less than 66 2\/3% in principal\namount of the Senior Debt at the time outstanding if such holders would be adversely affected thereby and (b) the holders of not less than 66 2\/3% in principal amount of the Subordinated Debt, other than Affiliated Debt, at the time outstanding if such holders would be adversely affected thereby.\nRelationship with Tennessee\nTennessee is a party to a Performance Agreement and an Investment Agreement that are substantially identical to the Performance Agreement and Investment Agreement of Tenneco Inc. These agreements were originally entered into in 1984 at the time the Company commenced operations (at which time Tennessee was the parent of the Company). The original Performance Agreement of Tennessee has been modified so that Tennessee's obligations only relate to the Tenneco Subsidiaries that are also subsidiaries of Tennessee, and the original Investment Agreement was amended so that it enured to the benefit of holders of Unaffiliated Debt outstanding on January 14, 1987. The Company, Tenneco Inc. and Tennessee are also parties to an Investment Agreement that enures to the benefit of holders of Unaffiliated Debt issued after January 14, 1987, and prior to June 14, 1988, and certain holders of Unaffiliated Debt outstanding on January 14, 1987. The principal differences between the two Investment Agreements to which Tennessee is a party relate to technical differences in the definitions of debt and fixed charges.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nThe Company believes that the multifuel boiler leased to Tenneco Packaging Inc. is well maintained and in good operating condition. This boiler is subject to a mortgage and other security interests that secure indebtedness assumed by a subsidiary of the Company in connection with the acquisition of the boiler.\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.\nItem 4, \"Submission of Matters to a Vote of Security Holders\", has been omitted from this report pursuant to the reduced disclosure format permitted by General Instruction J to Form 10-K.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nAll of the capital stock of the Company is owned by Tenneco Inc. and, therefore, there is no trading market for such securities. See Note 1 to the Financial Statements of Tenneco Credit Corporation and Consolidated Subsidiaries. During 1995, the Company declared and paid $300 million in dividends. The Company paid no dividends in 1994 and 1993. The Company may pay additional dividends to Tenneco Inc. from time to time depending upon the profitability, liquidity and capital and contractual requirements of the Company. See \"Relationship with Tenneco Inc.--Investment Agreement\" under Item 1 for information concerning restrictions on the Company's ability to pay dividends.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nItem 6, \"Selected Financial Data\", has been omitted from this report pursuant to the reduced disclosure format permitted by General Instruction J to Form 10-K.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nPursuant to paragraph (2)(a) of General Instruction J to Form 10-K, the following analysis explains the reasons for material changes in the amount of revenue and expense items between 1995 and 1994.\nRevenues\nTenneco Credit Corporation and its consolidated subsidiaries (the \"Company\") reported total revenues of $134.1 million for 1995, down $25.8 million or 16% from 1994. The decrease is primarily attributable to the continuing liquidation of retail receivables related to Case.\nPresented below are the percentages of revenues from the various sources for the years ended December 31:\nThe average yield on Case Corporation (\"Case\") retail receivables for 1995 was 10.4% compared to 10.1% for 1994. The discount rate charged on short-term trade receivables purchased from subsidiaries of Tenneco Inc. ranged from 8.75% to 9.25% during 1995 compared to ranges of 5.75% to 8.75% in 1994.\nThe Company's only leasing activity is the multifuel boiler facility leased to Tenneco Packaging Inc., an affiliate of the Company. Leasing activities provided $5.7 million of revenues in each of the years 1995 and 1994.\nInterest income from notes receivable increased $9.4 million during 1995 compared to 1994 primarily due to the purchase of the Case Corporation subordinated note receivable from Tenneco Inc. in July 1995. The note was subsequently sold to Tenneco Equipment Corporation, a subsidiary of Tenneco Inc., in December 1995. See Note 4 in Notes to Financial Statements for additional information.\nUnder an Investment Agreement dated June 15, 1988, between the Company and Tenneco Inc. (the \"Investment Agreement\"), the Company is to receive a service charge from Tenneco Inc. for each month equal to the amount, if any, by which the cumulative earnings of the Company for the period from the beginning of the calendar year to the end of such month, before deduction of fixed charges and federal income taxes, are less than 125% of the Company's fixed charges, as defined therein. A service charge of $234,000 was paid by Tenneco Inc. for the month of January 1994. No service charge was required for any months prior or subsequent to January 1994.\nSubsequent to the Case reorganization in June 1994, the Case retail financing activities have been conducted by Case's United States finance subsidiary. As the Company no longer purchases Case retail receivables, future revenues and income will continue to decline as the remaining retail receivables balance is collected. See Note 2 in Notes to Financial Statements for additional information.\nExpenses\nInterest expense of $86.3 million for 1995 represented a decrease of 26% or $31.0 million from 1994. This decrease resulted from lower levels of long-term and short-term debt. The average interest rate was 10.1% and 9.8% for 1995 and 1994, respectively. Operating and administrative expenses increased $1.1 million primarily due to fees paid to Case to service Case retail receivables retained by the Company (See Note 2 in Notes to Financial Statements for additional information).\nOther Income (Loss)\nOther income (loss) for 1995 principally consists of a $1.3 million loss, recorded in December 1995, to reserve for a doubtful note receivable from a third party. During 1994, the Company received net proceeds of $555 million from the sale of certain retail farm and construction equipment receivables to limited purpose business trusts, which utilized the receivables as collateral for the issuance of asset-backed securities to the public. The net book value of the receivables sold was $530 million and accordingly, the Company recognized a pre-tax gain of $25 million in February 1994 due to the sale. In addition, the Company recognized a gain on the sale of dealer owned rental yard receivables to Case in 1994.\nNet Income\nNet income for 1995 was $21.5 million, a decrease of $19.9 million or 48% compared with 1994. The decrease is primarily attributable to lower revenues from Case retail receivables and lower income from sale of receivables offset by decreased interest expense and income taxes.\nAssets\nThe Company had total assets of $1,000.3 million at December 31, 1995, compared to $1,516.1 million at December 31, 1994. The 34% decrease from year-end 1994 was due primarily to the continuing liquidation of the Case retail receivables (See Notes 2 and 4 in Notes to Financial Statements for additional information).\nAs of December 31, 1995, the Company held net trade notes and accounts receivable purchased from affiliates totaling $702.8 million, which accounted for 70% of the Company's total assets. This compares to $1,379.5 million, or 91%, of assets as of December 31, 1994. Details of these receivables are shown as follows:\nCase net trade notes and accounts receivable are $300 million lower at December 31, 1995, compared to December 31, 1994, primarily due to the continuing liquidation of the Case retail receivables.\nNet notes receivable from non-affiliated companies was zero at December 31, 1995, down from $67.2 million at December 31, 1994. The decrease from 1994 was primarily due to the pre-payment of a long-term note from a third party. In addition, the Company established a loss provision for its remaining $1.3 million in notes receivable from non-affiliated companies. Notes receivable from affiliated companies was $25 million at December 31, 1995, which was attributable to borrowings under a credit facility provided by the Company to an affiliate. See Note 4 in the Financial Statements for additional information.\nAt December 31, 1995, the Company had a $49 million net investment in a multifuel boiler leased to Tenneco Packaging Inc., an indirect, wholly- owned subsidiary of Tenneco Inc. The leased facility represented 5% of the Company's total assets at December 31, 1995.\nCapitalization and Capital Resources\nPursuant to the Investment Agreement, Tenneco Inc. is required to maintain an investment in the Company as necessary to assure that at all times the sum of the Company's subordinated debt plus stockholder's equity will be at least equal to 20% of the Company's total debt plus stockholder's equity.\nSubsequent to December 31, 1995, substantially all of the proceeds from the maturity of the Company's temporary cash investments at year-end 1995 was loaned to its parent, Tenneco Inc.\nThe Company's capital requirements have been financed through the issuance of commercial paper, short-term bank loans and advances and equity capital from Tenneco Inc. plus earnings retained in the business.\nThe Company's total capitalization was $956.8 million at December 31, 1995, and $1,469.3 million at December 31, 1994. The components of capitalization at such dates are set forth in the following table:\nOutlook\nAs previously discussed, the Case retail receivables have a weighted average remaining life to maturity of approximately 28 months and will be substantially liquidated by 1999. However, a significant portion of the Company's Senior Debt matures in the year 2001. Following is an analysis of the maturities of the Company's trade receivable portfolio (including rentals receivable under the operating leases) compared to the maturities of its total debt portfolio:\nPursuant to the Investment Agreement, Tenneco Inc. is required to cause the Company's consolidated assets to be at least equal to 125% of all its consolidated Senior Debt outstanding. Further, Tenneco Inc. is required to pay the Company a monthly service charge equal to the amount by which pre-interest, pre-tax earnings are less than 125% of fixed charges, as defined. Because a significant amount of the long-term debt owed by the Company will mature after the maturity of a significant amount of the long-term trade receivables held by the Company, the Company believes that it will be necessary for Tenneco Inc. to provide financial support, under the provisions of this contractual agreement, in future periods. The Company also is contractually restricted from declaring or paying dividends or making any other capital distributions if such action would render the Company unable to meet its debt service obligations on unaffiliated debt. As a result, the Company believes that the continuing liquidation of the Case retail receivable portfolio will not impact the Company's ability to meet the maturities of its debt portfolio which are due after these receivables are substantially liquidated.\nOn an ongoing basis, the Company expects that the scope of its operations will be substantially reduced as the Case retail receivables are liquidated. As a result, earnings, assets and total capitalization are expected to continue to decrease throughout the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nINDEX TO FINANCIAL STATEMENTS OF TENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Tenneco Credit Corporation:\nWe have audited the accompanying balance sheets of Tenneco Credit Corporation (a Delaware corporation and a wholly-owned subsidiary of Tenneco Inc.) and consolidated subsidiaries as of December 31, 1995 and 1994, and the related statements of income, cash flows and changes in stockholder's equity for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of Tenneco Credit Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Tenneco Credit Corporation and consolidated subsidiaries as of December 31, 1995 and 1994, and the results of their operations, cash flows and changes in stockholder's equity for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHouston, Texas February 8, 1996\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nBALANCE SHEETS\n(Thousands Except Share Amounts)\n(The accompanying notes to financial statements are an integral part of these balance sheets.)\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSTATEMENTS OF INCOME\n(Thousands)\n(The accompanying notes to financial statements are an integral part of these statements of income.)\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSTATEMENTS OF CASH FLOWS\n(Thousands)\nNote: Cash and cash equivalents include highly liquid investments with a maturity of three months or less at date of purchase.\n(The accompanying notes to financial statements are an integral part of these statements of cash flows.)\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSTATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY\n(Thousands)\n(The accompanying notes to financial statements are an integral part of these statements of changes in stockholder's equity.)\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n(1) CONTROL AND SUMMARY OF ACCOUNTING POLICIES\nControl\nAll of the outstanding common stock of Tenneco Credit Corporation is owned by Tenneco Inc. Tenneco Credit Corporation and consolidated subsidiaries (\"TCC\" or the \"Company\") are thus members of an operating group under the control of Tenneco Inc. As such, TCC engages in transactions characteristic of group administration and operation with other members of the group. The primary purpose of TCC is to finance, on a nonrecourse basis, receivables of Tenneco Inc. and its subsidiaries.\nConsolidation\nThe consolidated financial statements include the accounts of Tenneco Credit Corporation, its majority-owned subsidiaries, Counce Limited Partnership and subsidiary, and its wholly-owned subsidiary, TenFac Corporation. Counce Limited Partnership was organized to construct a multifuel steam boiler and turbine generator facility for lease to Tenneco Packaging Inc., an indirect wholly-owned subsidiary of Tenneco Inc.\nAll significant intercompany items have been eliminated in consolidation.\nRevenue Recognition\nFinance charges are recognized as income on the accrual method in the period in which they are earned. Finance charges earned on purchased trade and other receivables in 1995, 1994 and 1993 were approximately $128 million, $154 million and $227 million, respectively. Finance charges on the trade receivables purchased from affiliates are charged by TCC to these affiliates at mutually agreed amounts. Historically, the discount rate has been based upon the prevailing prime rate plus 25 basis points. Rates charged on short-term trade receivables purchased from subsidiaries of Tenneco Inc. ranged from 8.75% to 9.25% during 1995 as compared to ranges of 5.75% to 8.75% and 5.75% to 6.50% for 1994 and 1993, respectively. The average yield on Case Corporation (\"Case\") retail receivables for 1995 was 10.4%, up from 10.1% in 1994 and down from 11.4% in 1993.\nRevenue from the operating lease covering the boiler facility is recognized monthly on a pro rata basis over the terms of the related contract.\nRelated Party Transactions\nThe Company has entered into an agreement (the \"Operating Agreement\") with several subsidiaries of Tenneco Inc. (\"Tenneco Subsidiaries\") pursuant to which the Company buys trade receivables generated by the Tenneco Subsidiaries from the sale of goods and services. Each Tenneco Subsidiary, as the Company's agent, makes all collections and services the receivables sold by it to the Company. The Company also may purchase receivables and other assets from Tenneco Subsidiaries on terms different from those set forth in the Operating Agreement. Gross receivables purchased from affiliates at December 31, 1995 and 1994, totaled $.8 billion and $1.5 billion, respectively.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in determining the reported amounts of the Company's assets, liabilities, revenues and expenses. The Company's financial statements include estimates regarding the collectibility of its accounts and notes receivable and the useful life of its equipment under operating lease. These estimates could change in future periods depending upon new facts or circumstances.\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nReclassification\nCertain reclassifications have been made to prior year amounts to conform with the current year's presentation.\n(2) REORGANIZATION OF CASE FINANCING ACTIVITIES\nPrior to June 1994, Case sold all of its domestic retail receivables to the Company. Those receivables arose from sales by stores owned by Case and sales through independent dealers. As an incentive to dealers to assist in assuring the collectibility of their receivables, the purchase price discount included an amount for possible losses that may arise from their receivables. This portion of the discount became payable to the dealers as their receivables were collected and was recorded by the Company as a dealers' reserve. Any loss arising from the uncollectibility of a dealer's receivables was charged against this dealer's reserve to the extent of the reserve; any losses in excess of the dealer's reserve are recorded as a loss by the Company. During the years 1991 through 1995, there were no credit losses recorded by the Company in excess of the dealer's reserve.\nOn June 23, 1994, pursuant to a reorganization agreement dated as of that date, Case acquired the business and assets of the farm and construction equipment business of Tenneco Inc. and subsidiaries (the \"Reorganization\") and Tenneco Inc. and certain of its subsidiaries acquired all of the outstanding common stock of Case. Subsequent to the Reorganization, Tenneco Inc. and certain of its subsidiaries have sold an aggregate of approximately 79% of the outstanding shares of Case in an initial public offering and two secondary public offerings. As part of the Reorganization, the Company retained ownership of approximately $1.2 billion of Case's United States retail receivables and related debt existing at the time of the Reorganization that is not redeemable prior to maturity. The Company also sold Case-related notes and accounts receivable of approximately $395 million back to Case. Since the Reorganization, United States retail finance activity has been conducted by Case's United States finance subsidiary. Case continues to service the retail receivables retained by the Company, for which it receives a monthly servicing fee based on the amount of net receivables outstanding at the beginning of each month. At December 31, 1995, approximately $509 million of the Case retail receivables remained outstanding. It is estimated that the Case receivables retained by the Company will be substantially liquidated by 1999 (See Note 4).\nAs a result of the Reorganization and subsequent initial public offering of Case common stock, the applicable dealers' reserve was transferred to Case. In addition, due to Case's use of its finance subsidiary to conduct retail finance activity, the Company no longer purchases Case receivables. Consequently, the Company's revenues and interest expense will decline as the existing Case receivables are collected and the associated debt is retired. The reduction in receivables and debt will also reduce the Company's future net income.\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n(3) INCOME TAXES\nTCC and Tenneco Inc., together with certain of their respective subsidiaries which are owned 80% or more, have entered into an agreement to file a consolidated U.S. federal income tax return. Such agreement provides, among other things, that (i) each company in a taxable income position will be currently charged with an amount equivalent to its federal income tax computed on a separate return basis and (ii) each company in a tax loss position will be currently reimbursed to the extent its deductions and tax credits are utilized in the consolidated return.\nThe Company utilizes the liability method of accounting for income taxes whereby it recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. The Company's pre-tax income is principally domestic and subject to taxation under U.S. federal and applicable state jurisdictions.\nThe components of total income tax expense are as follows:\nThe difference between income tax expense and the amount computed by applying the statutory federal income tax rate to income before income taxes is primarily due to state income taxes of $1 million, $1 million and $6 million in 1995, 1994 and 1993, respectively, net of federal income tax benefit. In addition, 1995 income tax expense was reduced by a revision to estimated federal income taxes provided in 1994.\nThe components of net deferred tax liability at December 31, 1995 and 1994, were as follows:\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n(4) NOTES AND ACCOUNTS RECEIVABLE\nContractual maturities of notes and accounts receivable purchased from affiliates as of December 31, 1995, are as follows:\nDuring 1994 and 1993, TCC received net proceeds of $555 million and $877 million, respectively, from the sale of certain retail farm and construction equipment receivables to limited purpose business trusts, which utilized the notes as collateral for the issuance of asset-backed securities to the public. The net book value of the receivables sold was $530 million and $834 million for 1994 and 1993, respectively, and accordingly, TCC recognized pre-tax gains on the transactions of $25 million and $43 million for 1994 and 1993, respectively. In addition, the Company recognized a gain of $1 million and $6 million from the sale of trade receivables to Asset Securitization Cooperative Corporation in 1994 and 1993, respectively. These receivables originated with Tenneco Inc.'s packaging, automotive parts and energy subsidiaries. The gains on sale of receivables were recorded in \"Other income (loss)\" in the Statements of Income.\nIn July 1995, the Company purchased the Case Corporation 10 1\/2% Subordinated Note (the \"Subordinated Note\") at fair market value from Tenneco Inc., its parent, for $310.8 million in cash. The Company recorded this receivable at Tenneco Inc.'s historical cost of $279.7 million. The $31.1 million premium paid on the note is included in the Statement of Changes in Stockholder's Equity caption \"Capital contribution from (distribution to) affiliate, net.\" In December 1995, the Company sold the Subordinated Note to a subsidiary of Tenneco Inc. for $326 million in cash. At the date of sale, the Company's carrying value for the Subordinated Note was $292 million, and the difference between the cash proceeds and carrying value is also included in the Statement of Changes in Stockholder's Equity caption \"Capital contribution from (distribution to) affiliate, net.\"\nDuring 1995, gross notes receivable from non-affiliated companies decreased $66 million, principally due to the pre-payment of a long-term note by a third party.\nTenneco International Holding Corp. (\"TIHC\"), an indirect subsidiary of Tenneco Inc., has arranged a $50 million committed line of credit with the Company to provide short-term financing which provides for borrowings at various market rates. At December 31, 1995, the Company had made loans of $25 million to TIHC related to this line of credit.\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n(5) COMMERCIAL PAPER AND LINES OF CREDIT\nTCC sells commercial paper on a short-term unsecured basis. Information regarding commercial paper as of and for the years ended December 31, 1995 and 1994 follows:\nTCC also has available total lines of credit of $400 million with various banks which are committed through November 1999. Borrowings are available as either domestic loans or as Eurodollar loans. The agreements provide for facility fees of 0.1875% on the entire amount of the commitment. At December 31, 1995, TCC had no amounts outstanding under these lines of credit.\n(6) SENIOR AND SUBORDINATED DEBT\nA summary of Senior and Subordinated Debt outstanding is set forth in the following tabulation (in thousands):\nAt December 31, 1995, approximately $49 million net book value of equipment under lease was pledged as collateral to secure $28 million of senior notes.\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe aggregate maturities applicable to the notes outstanding at December 31, 1995, are $158 million, $176 million, $73 million, $4 million and $5 million for 1996, 1997, 1998, 1999 and 2000, respectively.\n(7) EQUIPMENT UNDER OPERATING LEASE TO AFFILIATES\nAt December 31, 1995, Counce Limited Partnership had a long-term operating lease with Tenneco Packaging Inc., covering equipment with a net book value of $49 million. The lease requires Tenneco Packaging Inc. to pay all operating, maintenance and insurance costs. The aggregate minimum future annual rentals receivable under the operating lease at December 31, 1995, are as follows:\nDepreciation of the equipment under lease is provided on a straight-line basis in amounts which, in the opinion of management, are adequate to allocate the cost of the property over its estimated useful life.\n(8) FINANCIAL INSTRUMENTS\nThe estimated fair values of TCC's financial instruments at December 31, 1995 and 1994, were estimated as follows:\nThe following methods and assumptions were used to estimate the fair value of financial instruments:\nCash and Cash Equivalents--The fair value of cash and other cash investments was considered to be the same as or was not determined to be materially different from the carrying amount.\nReceivables--TCC believes that in the aggregate, the carrying amount of its trade receivables, purchased from Tenneco Subsidiaries, was not materially different from the fair value of those receivables. Fair value of the long-term receivables was based on the market value of receivables with similar maturities and interest rates. Customer notes and accounts receivable purchased from affiliates are concentrated 62% in the farm and construction business, 17% in energy businesses, 11% in automotive parts businesses and 10% in packaging businesses.\nSenior and Subordinated Notes--The fair value of fixed-rate long-term debt was based on the market value of debt with similar maturities and interest rates.\nTENNECO CREDIT CORPORATION AND CONSOLIDATED SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\n(9) INVESTMENT AGREEMENT\nUnder the terms of the Investment Agreement between TCC and Tenneco Inc., the companies have agreed, among other terms, that:\n(a) Tenneco Inc. will own, directly or indirectly, all the outstanding shares of TCC stock.\n(b) TCC's consolidated assets must equal at least 125% of all consolidated \"senior debt\" (commercial paper and senior notes) outstanding.\n(c) TCC will not declare or pay any dividends or make any capital distributions if such action would render TCC unable to meet any of its requirements for the payment of principal of, or interest or premium, if any, on unaffiliated debt.\n(d) Tenneco Inc.'s investment in TCC (either directly or through its subsidiary companies) and subordinated debt must equal at least 20% of TCC's total consolidated debt plus stockholder's equity.\n(e) Tenneco Inc. will pay to TCC a service charge for each month during the term of the Investment Agreement equal to the amount, if any, by which the cumulative consolidated earnings of TCC and its consolidated subsidiaries for the period from the beginning of the calendar year to the end of such month, before deduction of fixed charges (interest expense) and income taxes (but including in earnings all such service charges previously paid by Tenneco Inc. for such year) are less than 125% of the fixed charges. A service charge of $234,000 was paid by Tenneco Inc. for the month of January 1994. No service charge was required for any months prior to or following January 1994.\nBecause a significant amount of the long-term debt owed by the Company will mature after the maturity of a significant amount of the long-term trade receivables held by the Company, the Company believes that it will be necessary for Tenneco Inc. to provide financial support, under the provisions of the Investment Agreement, in future periods. The Company was in compliance with these covenants during the years ended and as of December 31, 1995, 1994 and 1993.\n(10) QUARTERLY FINANCIAL DATA (UNAUDITED)\n____________\nNote: See Notes 2 and 4 for items affecting comparability between the quarters presented above.\n(The above notes are an integral part of the foregoing financial statements.)\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nThere has been no change in accountants during 1995 or 1994, nor has there been any disagreement on any matter of accounting principles or practices or financial disclosure which in either case is required to be reported pursuant to this Item 9.\nPART III\nItem 10, \"Directors and Executive Officers of the Registrant\", Item 11, \"Executive Compensation\", Item 12, \"Security Ownership of Certain Beneficial Owners and Management\", and Item 13, \"Certain Relationships and Related Transactions\", have been omitted from this report pursuant to the reduced disclosure format permitted by General Instruction J 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.\nFINANCIAL STATEMENTS INCLUDED IN ITEM 8\nSee \"Index to Financial Statements of Tenneco Credit Corporation and Consolidated Subsidiaries\" set forth in Item 8, \"Financial Statements and Supplementary Data.\"\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES INCLUDED IN ITEM 14\nSCHEDULES OMITTED AS NOT REQUIRED OR INAPPLICABLE Schedule I -- Condensed financial information of registrant Schedule II -- Valuation and qualifying accounts--three years ended December 31, 1995 Schedule III -- Real estate and accumulated depreciation Schedule IV -- Mortgage loans on real estate Schedule V -- Supplemental information concerning property--casualty insurance operations\nREPORTS ON FORM 8-K\nDuring the fourth quarter of the fiscal year ended December 31, 1995, the Company did not file with the Securities and Exchange Commission any Current Reports on Form 8-K.\nEXHIBITS\nExhibits 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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTENNECO CREDIT CORPORATION\nBy Robert T. Blakely Robert T. Blakely President\nDate: 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 capacities and on the dates indicated.\nEXHIBIT INDEX\nExhibits 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.\nEXHIBIT NUMBER DESCRIPTION OF EXHIBITS ------- ------------------------\n3(a) -- Certificate of Incorporation of Tenneco Credit Corporation dated August 6, 1981 (Exhibit 3(a) to Form 10 Registration Statement of Tenneco Credit Corporation, File No. 0-15095). 3(b) -- By-Laws of Tenneco Credit Corporation, amended as of March 1, 1987 (Exhibit 3(b) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1989, File No. 0-15095). 4(a) -- Included in Exhibits 3(a) and 3(b). 4(b)(1) -- Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of January 15, 1987 (Exhibit 4(b) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1986, File No. 0-15095). 4(b)(2) -- First Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of January 16, 1987 (Exhibit 4(c) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1986, File No. 0-15095). 4(b)(3) -- Second Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of February 1, 1987 (Exhibit 4(d) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1986, File No. 0-15095). 4(b)(4) -- Third Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of August 1, 1987 (Exhibit 4(e) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1987, File No. 0-15095). 4(b)(5) -- Fourth Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of June 15, 1988 (Exhibit 4(b)(5) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 4(b)(6) -- Fifth Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of June 28, 1988 (Exhibit 4(c) to Form 8-K of Tenneco Credit Corporation dated June 28, 1988, File No. 0-15095). 4(b)(7) -- Sixth Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of July 15, 1989 (Exhibit 4(b)(7) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1989, File No. 0-15095). 4(b)(8) -- Seventh Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of August 16, 1989 (Exhibit 4(b)(8) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1989, File No. 0-15095). 4(b)(9) -- Eighth Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of November 1, 1989 (Exhibit 4(b)(9) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1989, File No. 0-15095). \/TABLE\nEXHIBIT NUMBER DESCRIPTION OF EXHIBITS ------- -----------------------\n4(b)(10) -- Ninth Supplemental Indenture between Tenneco Credit Corporation and The Chase Manhattan Bank (National Association) dated as of December 1, 1990 (Exhibit 4(b) to Form 8-K of Tenneco Credit Corporation dated December 4, 1990, File No. 0-15095). 4(c)(1) -- Indenture between Tenneco Credit Corporation and The First National Bank of Boston dated as of June 15, 1988 (Exhibit 4(c)(1) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 4(c)(2) -- First Supplemental Indenture between Tenneco Credit Corporation and The First National Bank of Boston dated as of June 15, 1988 (Exhibit 4(d) to Form 8-K of Tenneco Credit Corporation dated June 28, 1988, File No. 0-15095). 9 -- None. 10(a) -- Operating Agreement between Tenneco Credit Corporation and various subsidiaries of Tenneco Inc. as amended and restated as of June 15, 1988 (Exhibit 10(a) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 10(b) -- Investment Agreement among Tenneco Credit Corporation, Tennessee Gas Pipeline Company and Tenneco Inc. amended and restated as of November 1, 1988 (Exhibit 10(b) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 10(c) -- Performance Agreement of Tennessee Gas Pipeline Company as amended and restated as of June 14, 1988 (Exhibit 10(c) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 10(d) -- Investment Agreement between Tenneco Credit Corporation and Tennessee Gas Pipeline Company (formerly Tenneco Inc.) dated as of October 15, 1984; together with an amendment thereto dated January 14, 1987 (Exhibit 10(d) to Form 8 of Tenneco Credit Corporation dated January 14, 1987, File No. 0-15095). 10(e) -- Investment Agreement between Tenneco Credit Corporation and Tenneco Inc. dated as of June 15, 1988 (Exhibit 10(e) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 10(f) -- Performance Agreement dated as of June 15, 1988 from Tenneco Inc. (Exhibit 10(f) to Form 10-K of Tenneco Credit Corporation for the fiscal year ended December 31, 1988, File No. 0-15095). 11 -- None. *12 -- Statement re computation of ratio of earnings to fixed charges. 13 -- None. 16 -- None. 18 -- None. 21 -- Omitted pursuant to the reduced disclosure format permitted by General Instruction J to Form 10-K. 22 -- None. 23 -- None. 24 -- None. *27 -- Financial data schedule. 28 -- None. 99 -- None.\n\/TABLE","section_15":""}
{"filename":"745142_1995.txt","cik":"745142","year":"1995","section_1":"Item 1. Business\nGeneral\nHelene Curtis Industries, Inc. (together with its subsidiaries, the \"Company\") is a holding company incorporated in Delaware on April 16, 1984, whose principal subsidiary, Helene Curtis, Inc., has been operating since January 1928.\nThe Company develops, manufactures and markets personal care products consisting primarily of consumer brand name hair and skin care products and antiperspirants and deodorants. The Company is one of the largest sellers of hair care products in the United States, mainly with its Suave, Finesse, Salon Selectives and Vibrance hair care brands.\nThe Company is also the fourth leading seller in the United States of antiperspirant\/deodorant products through its Degree and Suave brands, and the third leading seller of hand and body lotion products with its Suave brand.\nThe Company also develops, manufactures and markets professional hair care products for use and resale by licensed cosmetologists. The Company's Quantum permanent wave is the leading permanent wave brand sold to licensed cosmetologists in the United States.\nThe Company's products, particularly its Finesse and Salon Selectives brands, are among the market leaders in most countries where the Company has an operating subsidiary and have been introduced through licensees and others in over 100 countries throughout the world. Sales of the Company's products outside the U.S. account for approximately 36 percent of annual volume.\nProducts\nU.S. Consumer Products\nThe Company markets a wide variety of hair care products to consumers under the Suave, Finesse, Salon Selectives and Vibrance brand names. It markets antiperspirants\/deodorants under the Suave and Degree brand names and skin care and baby care products under the Suave brand name.\nThe Company targets its Suave products to consumers who desire a high quality product priced considerably below premium-priced lines. This positioning has proven successful as Suave is both the best-selling shampoo and the best-selling conditioner in the United States in terms of units sold. The Company sells Suave shampoo, Suave conditioner and Suave styling aids for this price-value segment of the market.\nFinesse, the sixth largest hair care brand in the United States on a dollar-sales basis, is marketed as a premium-priced line of products. Finesse conditioner, relying on a unique patented formulation, was launched in 1982 and Finesse shampoo was introduced in 1983. The Company also sells Finesse styling aids, including hair spray, gel and mousse.\nThe Company's Salon Selectives line of consumer shampoos, conditioners and styling aids is marketed to consumers who are interested in purchasing products which were traditionally available only in beauty salons and which can be customized to their hair and lifestyle needs. Salon Selectives, introduced in 1987, is the third largest hair care brand on a dollar-sales basis, in the United States.\nThe Company also markets Vibrance hair care products, which were introduced in 1991 and targeted toward consumers who desire strong, healthy looking hair. The line was repositioned at the start of the fiscal year commencing March 1, 1995.\nThe Company's Degree antiperspirant\/deodorant products were introduced in 1990. Degree antiperspirant products provide consumers with additional odor and wetness protection in response to rising body heat. The Company's Suave antiperspirant\/deodorant products are targeted to the price-value segment of the market. With its Degree and Suave brands, the Company ranks fourth in antiperspirant\/deodorant sales in the United States.\nThe Company ranks third in the category of hand and body lotion products in the U.S. in units sold. The Company sells these products under its Suave brand. The Company also markets a line of Suave facial care products and a line of Suave baby care products, which build on Suave's brand equity and reputation of offering quality products at a value price.\nU.S. Professional Products\nThe Company develops and markets a wide range of permanent waves and other hair care products to licensed cosmetologists for use in beauty salons and for resale to consumers through salons. Since its founding, the Company has been a technological leader in this industry, pioneering, among other things, the \"cold\" permanent wave, which is safer and more effective than prior methods of waving hair. Its Quantum permanent wave is applicable for all hair types and is the best-selling permanent wave brand for professional use in the United States.\nThe Company markets numerous professional product lines, including the following: Quantum, Naturelle and Hair Specifics hair care products; ISO, Catio Therm, Post Impressions, One Better, Impact, Even Heat, Fine Solutions and Luxuriance permanent waves.\nInternational Products\nThe Company sells its products in over 100 countries through wholly-owned operating subsidiaries in Australia, Canada, Italy, Japan, New Zealand, Sweden (serving Scandinavia) and the United Kingdom and through licensees and authorized distributors in other countries, and export sales from the United States. The Company is among the market leaders in the consumer hair care business in each market in which it has a subsidiary, except Italy, where the business has focused on the sale of professional products.\nThe Company has introduced Degree antiperspirant\/deodorant in Canada, Australia, New Zealand and Scandinavia.\nAdditionally, in some markets, the Company's subsidiaries have developed and introduced their own brands. For example, the Company's Japanese subsidiary markets Program, a hair care line targeted to women with damaged hair.\nThe Company's international business is subject to all the risks inherent in operations in foreign countries. The sales, operating profit and identifiable assets attributable to each geographic area for the fiscal years ended in February 1995, 1994 and 1993 are set forth in Note (12) of the Notes to the Consolidated Financial Statements, which Note is incorporated herein by reference.\nCompetition\nThe markets for the Company's products are intensely competitive and sensitive to changing consumer preferences and demands. They are characterized by frequent introductions of competitive products, often accompanied by major advertising and promotional programs which can significantly affect sales and earnings of the product sponsor and its competitors. The Company competes primarily on the basis of product quality, price and brand-name recognition built by advertising and promotion.\nAt least 10 domestic manufacturers, some of which are highly diversified and have significantly greater financial resources than the Company, can be regarded as major competitors in the United States and throughout the world. The Company is a significant competitor in its industry.\nMarketing\nThe Company competes in businesses where growth is achieved largely by gaining market share at the expense of competitors. Accordingly, the Company maintains an aggressive strategy utilizing substantial television advertising, consumer promotion and merchandising support of existing brands, coupled with periodic major investments in new products and line extensions of established brand names. During the fiscal years ended in February 1995, 1994 and 1993, the Company's advertising and media expenses were approximately $150.5 million, $152.3 and $147.6 million, respectively.\nThe Company believes there is substantial consumer recognition for its major brands and that this recognition is a meaningful contributor to its sales. Significant and repeated advertising and promotion serve to build and retain a brand's position in the marketplace. In order for a brand's position to be sustained for many years, as in the case of the Suave brand which has been marketed for nearly 60 years, product formulas and packaging must continue to be improved. In addition, major advertising expenditures are necessary from time to time to maintain the brand's market share. Although these expenditures may impact the Company's earnings in the year in which they are made, to the extent that they sustain a brand's position, they support the Company's growth.\nNew product development also plays a significant role in the Company's marketing strategy. The Company relies on its market research and new product development groups to identify consumer needs, to foresee shifts in consumer preferences and to assess the competitive marketplace. The successful introduction of any new product is largely dependent on product positioning, product quality and innovation, packaging, advertising and promotional support and the level of competitive activity. In view of the intensely competitive industry in which the Company competes, new product introductions require substantial advertising and promotional expenditures which are made at a proportionally higher rate relative to sales than expenditures for well-established products. Although these expenditures materially impact earnings in the particular period in which they are made, they foster the Company's growth well beyond that period if the new product is ultimately successful.\nCustomers and Distribution\nIn the United States, the Company's products are distributed through wholesalers and directly to major drug chains, mass merchandisers and food outlets and major chains of beauty salons. In international markets, the Company's products are manufactured and marketed through a network of subsidiaries, licensees and distributors.\nApproximately 15% of the Company's net sales for the fiscal year ended February 28, 1995 were to one customer. None of the Company's customers has any continuing contractual obligations to make purchases from the Company.\nTrademarks and Patents\nThe Company markets its products under a number of trademarks and trade names (e.g., Helene Curtis, Suave, Finesse, Salon Selectives, Degree, Vibrance and Quantum) which are registered in the United States and many foreign countries. The Company's position in the marketplace is dependent upon the goodwill engendered in these trademarks as well as in the individual performance and price of products using them. The Company considers trademark protection to be of material importance to its business.\nThe Company is not materially dependent on any patent, license, franchise or concession, whether owned by or licensed to the Company. Although the Company owns certain patents, the loss of any patent would not have a materially adverse effect on the Company's operations as a whole. During the fiscal year ended February 28, 1995, the Company successfully prevented the continued sale of several products that infringed the Company's patent on its ISO permanent wave.\nResearch and Development\nThe Company is continuously engaged in the development of new products and maintains an extensive laboratory facility for such purpose. The Company relies principally on its experience in the personal care business in formulating new products and maintains a staff of approximately 230 people for research and development. The Company expended $26.8 million, $22.5 million and $22.0 million during the fiscal years ended in February 1995, 1994 and 1993, respectively, on research activities relating to the development of new products and the improvement of existing personal care products.\nRegulation\nGovernment regulation has not materially restricted or impeded the Company's operations. Certain of the Company's products are subject to regulation under the Federal Food, Drug and Cosmetic Act and the Fair Packaging and Labeling Act. The Company is also subject to regulation by the Federal Trade Commission with respect to the content of its advertising, its trade practices and other matters.\nEmployees\nThe Company currently employs approximately 3,400 employees. Virtually all of the Company's employees are non-union. The Company considers its relationship with its employees to be good.\nManufacturing and Supplies\nMost of the Company's products are manufactured, filled and packaged by the Company at its facilities in Chicago, Illinois and the City of Industry, California, as well as at its subsidiary operation in New Zealand. See \"Properties.\" Some of the Company's products sold in the United States or by its international subsidiaries are manufactured by outside contractors, none of which manufactures a significant portion of the Company's output.\nRaw materials used in the Company's products are available from several sources. If any single supplier should be unable to furnish materials, the Company believes that other sources could be obtained without material disruption to or other adverse effect upon its business.\nBacklog\nAs the Company manufactures and ships its products against orders received in a relatively short period of time thereafter, the dollar amount of backlog orders at any given date, or from year to year, is not a material element in the Company's business.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal office of the Company is located at 325 North Wells Street in Chicago, Illinois. The office building, which has approximately 120,000 square feet of space used by the Company, was purchased in 1981 and rehabilitated by the Company.\nThe Company owns its principal manufacturing plant, which comprises approximately 315,000 square feet, and is located at 4401 West North Avenue, Chicago, Illinois. The Company owns a connecting building and land of approximately 60,500 square feet. An additional 238,000 square feet of land and building adjacent to said plant is leased until 1996. This lease contains five renewal options of five years each, giving the Company the right to extend the term to 2021.\nThe Company owns approximately 12 acres of property in Chicago adjacent to its principal manufacturing facility. This property includes a building of approximately 587,000 square feet, which is used for offices, manufacturing and warehousing. Approximately one-third of the building has been leased to its former owner for a ten-year period ending in 2001.\nThe Company owns its principal warehouse and distribution facility, comprising approximately 376,000 square feet of building on 32.5 acres of land, located in Chicago, Illinois. This facility became fully operational in 1989. The Company also owns a warehouse facility comprising approximately 475,000 square feet of building space on 10.5 acres of land at 1657 N. Kilpatrick Avenue, Chicago, Illinois. Additional warehouse and shipping facilities are located at the Company's principal manufacturing plant.\nThe Company owns a 128,000 square foot manufacturing and warehousing facility in the City of Industry, California, which was constructed in 1982. In addition, in 1989, the Company purchased 8.36 acres of property, including an industrial building of approximately 150,000 square feet, adjacent to the facility.\nIn March 1995, the Company relocated its research and development operations to an approximately 151,000 square foot facility located in Rolling Meadows, Illinois which is leased until 2012. The building includes offices and laboratories. The relocation will allow for the expansion of the Company's principal manufacturing and operations facility. The lease contains ten (10) renewal options of five (5) years each, giving the Company the right to extend the term until 2062.\nThe Company also leases or owns other smaller properties and facilities in various locations in the United States and in foreign countries.\nAlthough some of the Company's manufacturing plants were constructed a number of years ago, such plants, together with newer additions, are, in the opinion of management, deemed to be in good condition and sufficient for the Company's current needs.\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\nThere were no matters submitted during the fourth quarter of fiscal 1995 to a vote of security holders.\nExecutive Officers of the Registrant:\nTitle Name Age\nChairman of the Board Gerald S. Gidwitz 88 Vice Chairman of the Board Joseph L. Gidwitz 90 President and Chief Executive Officer Ronald J. Gidwitz 50 Executive Vice President and Chief Operating Officer Michael Goldman 58 Executive Vice President Gilbert P. Smith 58 Senior Vice President Charles G. Cooper 67 Senior Vice President Colin J. Morgan 59 Senior Vice President Eugene Zeffren 53 Vice President and Chief Information Officer Thomas J. Gildea 51 Vice President and Chief Financial Officer Lawrence A. Gyenes 44 Vice President V. James Marino 45 Vice President Robert K. Niles 50 Vice President and Corporate Controller Mary J. Oyer 46 Vice President Robert Sack 58 Vice President, Secretary and General Counsel Roy A. Wentz 45 Treasurer Arthur A. Schneider 48\nForeign-Based Officers:\nPresident and Managing Director, Helene Curtis United Kingdom and Vice President of the Company Robert G. Kelly 51\nPresident, Helene Curtis Ltd. (Canada) and Vice President of the Company Jack D. Pogue 62\nRonald J. Gidwitz is the son of Gerald S. Gidwitz; Joseph L. Gidwitz and Gerald S. Gidwitz are brothers.\nAll executives have served in the capacities shown for the last five years except as follows: Charles G. Cooper, Michael Goldman, Robert G. Kelly, V. James Marino, Colin J. Morgan, Mary J. Oyer, Jack D. Pogue, Arthur A. Schneider, Gilbert P. Smith, Roy A. Wentz and Eugene Zeffren, all of whom have been employed by the Company in other executive capacities for at least five years and were elected to the positions shown during this five-year period. Prior to joining the Company in 1991, Robert K. Niles served in various capacities for The Quaker Oats Company, most recently as Vice President, Human Resources for its Breakfast Division. Prior to joining the Company in 1994, Lawrence A. Gyenes served in various capacities for G. D. Searle & Co., most recently as Corporate Vice President of Finance.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nIncorporated by reference to the Company's Annual Report to Stockholders for the fiscal year ended February 28, 1995, under the caption \"Common Stock Data,\" page 31.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated by reference to the Company's Annual Report to Stockholders for the fiscal year ended February 28, 1995, under the caption \"Ten-Year Summary,\" page 31.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nIncorporated by reference to the Company's Annual Report to Stockholders for the fiscal year ended February 28, 1995, under the caption \"Management's Discussion and Analysis,\" pages 22-23.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIncorporated by reference to the Company's Annual Report to Stockholders for the fiscal year ended February 28, 1995, see index in Part IV, 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 Officers of the Registrant\nInformation with respect to directors is incorporated by reference to the Company's Proxy Statement for the Company's Annual Meeting of Stockholders to be held June 27, 1995, under the captions \"Nominees for Directors,\" \"Continuing Directors\" and \"Compliance with Section 16(a),\" pages 6-7 and 21. Information with respect to Executive Officers is set forth in Part I, under the caption \"Executive Officers of the Registrant.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on June 27, 1995, under the caption \"Executive Officer Compensation\" but excluding information contained under \"Compensation Committee Report on Executive Compensation,\" pages 9-12.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on June 27, 1995, under the captions \"Principal Security Holders\" and \"Security Ownership of Management,\" pages 2-5.\nChanges 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\nIncorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on June 27, 1995, under the caption \"Compensation Committee Interlocks and Insider Participation\" and \"Transactions with Affiliated Persons\" on pages 16 and 18, respectively.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nPage in Annual Report to Stockholders --------------- (a) 1. Financial Statements:\nIndependent Accountants' Report 21\nConsolidated Statements of Earnings for the years ended February 28, 1995, 1994 and 1993 24\nConsolidated Statements of Stockholders' Equity for the years ended February 28, 1995, 1994 and 1993 24\nConsolidated Balance Sheets as of February 28, 1995 and 1994 25\nConsolidated Statements of Cash Flows for the years ended February 28, 1995, 1994 and 1993 26\nNotes to Consolidated Financial Statements 27-30\n(b) Reports on Form 8-K During the last quarter of the fiscal year ended February 28, 1995, the Company did not file any reports on Form 8-K.\n(c) Exhibits\n3 (i) The Certificate of Incorporation of Helene Curtis Industries, Inc., as amended, incorporated by reference to the Company's Annual Report listed on Form 10-K for the fiscal year ended February 29, 1992, Exhibit 3(a).\n(ii) The bylaws of the Company, as amended, effective April 24, 1991. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 28, 1991, Exhibit 3(b).\n4 (a) Letter of Credit Agreement dated as of October 1, 1986, between Helene Curtis, Inc. and Harris Trust and Savings Bank, relating to an Industrial Revenue bond refinancing. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 28, 1987, Exhibit 4(a).\n(b) Revolving Credit Agreement dated as of September 13, 1990, between Helene Curtis, Inc. and the Harris Trust and Savings Bank; The First National Bank of Chicago; Bank of America National Trust & Savings Association; NBD Bank, N.A.; Mellon Bank, N.A.; Chemical Bank; The Industrial Bank of Japan, Limited; and The Mitsubishi Bank, Limited. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 28, 1991, Exhibit 4(c).\n(c) Note Purchase Agreement dated as of January 31, 1992, between Helene Curtis, Inc. and Nationwide Life Insurance Company, West Coast Life Insurance Company, Financial Horizons Life Insurance Company, Farmland Life Insurance Company and Wisconsin Health Care Liability Insurance Plan. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 29, 1992, Exhibit 4(d).\n(d) Note Agreement dated as of March 1, 1994, between Helene Curtis, Inc. and Connecticut Mutual Life Insurance Company, Connecticut General Life Insurance Company, Life Insurance Company of North America, Great-West Life and Annuity Insurance Company, Nationwide Life Insurance Company, Financial Horizons Life Insurance Company and Employers Life Insurance Company of Wausau. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 28, 1994, Exhibit 4(d).\n10 Executive Compensation Plans and Arrangements\n(a) Executive Pension Agreement. Incorporated by reference to the Helene Curtis, Inc. Annual Report filed on Form 10-K for the fiscal year ended February 28, 1981, Exhibit 10(a).\n(b) 1983 Stock Option Plan, as amended. Incorporated by reference to the Company's Annual Report filed on Form 10-K for the fiscal year ended February 28, 1989, Exhibit 3(d).\n(c) Death Benefit Agreement. Incorporated by reference to the Helene Curtis, Inc. Annual Report filed on Form 10-K for the fiscal year ended February 28, 1982, Exhibit 10(c).\n(d) Supplemental Profit Sharing and Retirement Savings Plan.\n(e) Directors Stock Option Plan. Incorporated by reference to the Proxy Statement for the Helene Curtis Industries, Inc. Annual Meeting of Stockholders held June 21, 1988.\n(f) 1992 Stock Option Plan. Incorporated by reference to the Proxy Statement for the Helene Curtis Industries, Inc. Annual Meeting of Stockholders held June 16, 1992.\n(g) 1994 Stock Appreciation Right Plan. Incorporated by reference to the Proxy Statement for the Helene Curtis Industries, Inc. Annual Meeting of Stockholders held June 28, 1994.\n(h) Executive Management Incentive Plan. Incorporated by reference to the Proxy Statement for the Helene Curtis Industries, Inc. Annual Meeting of Stockholders held June 28, 1994.\n(i) Executive Incentive Plan.\n11 Computation of Earnings Per Share.\n13 Annual Report to Stockholders, for the fiscal year ended February 28, 1995 (only those portions incorporated by reference in this document are deemed \"filed.\")\n21 List of Subsidiaries.\n23 Consent of Coopers & Lybrand L.L.P.\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) HELENE CURTIS INDUSTRIES, INC.\nBY (SIGNATURE) s\/Ronald J. Gidwitz (NAME AND TITLE) Ronald J. Gidwitz, President and Chief Executive Officer DATE May 25, 1995\nBY (SIGNATURE) s\/Lawrence A. Gyenes (NAME AND TITLE) Lawrence A. Gyenes, Vice President and Chief Financial Officer DATE May 25, 1995\nBY (SIGNATURE) s\/Mary J. Oyer (NAME AND TITLE) Mary J. Oyer, Vice President and Corporate Controller 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.\nBY (SIGNATURE) s\/Marshall L. Burman (NAME AND TITLE) Marshall L. Burman, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Frank W. Considine (NAME AND TITLE) Frank W. Considine, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Charles G. Cooper (NAME AND TITLE) Charles G. Cooper, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Gerald S. Gidwitz (NAME AND TITLE) Gerald S. Gidwitz, Chairman of the Board; Director DATE May 25, 1995\nBY (SIGNATURE) s\/Michael Goldman (NAME AND TITLE) Michael Goldman, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Joseph L. Gidwitz (NAME AND TITLE) Joseph L. Gidwitz, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Ronald J. Gidwitz (NAME AND TITLE) Ronald J. Gidwitz, President; Principal Executive Officer; Director DATE May 25, 1995\nBY (SIGNATURE) s\/John C. Stetson (NAME AND TITLE) John C. Stetson, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Abbie J. Smith (NAME AND TITLE) Abbie J. Smith, Director DATE May 25, 1995\nBY (SIGNATURE) s\/Gilbert P. Smith (NAME AND TITLE) Gilbert P. Smith, Director DATE May 25, 1995","section_15":""}
{"filename":"3133_1995.txt","cik":"3133","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAmSouth Bancorporation (AmSouth) is a bank holding company which was organized in 1970 as a corporation under the laws of Delaware and commenced doing business in 1972. At December 31, 1995, AmSouth had total consolidated assets of approximately $17.7 billion. AmSouth offers a broad range of bank and bank-related services through its subsidiaries. AmSouth's principal banking subsidiaries are AmSouth Bank of Alabama, AmSouth Bank of Florida, and AmSouth Bank of Tennessee.\nAmSouth Bank of Alabama (AmSouth Alabama), headquartered in Birmingham, Alabama, is the largest subsidiary of AmSouth. As of December 31, 1995, AmSouth Alabama had total consolidated assets of approximately $9.8 billion and total consolidated deposits of approximately $7.0 billion. AmSouth Alabama is a full service bank with 125 banking offices located throughout Alabama at December 31, 1995. Based upon total consolidated assets as of December 31, 1995, AmSouth Alabama was the third largest bank headquartered in Alabama. It offers complete consumer and commercial banking and trust services to businesses and individuals. The Commercial Banking Group of AmSouth Alabama offers a variety of products and services, including commercial lending, international banking, and cash management sales and operations. Consumer Banking encompasses a wide variety of transaction, credit, and investment services to meet the needs of a diverse consumer customer base. AmSouth Alabama's network of automated teller machines is linked with shared automated tellers in all 50 states. The Trust Division of AmSouth Alabama is the largest in Alabama with more assets under management than any other bank in Alabama. It offers a complete array of trust services including estate and trust planning, investment management for individuals and corporations, land and natural resources management, employee benefit administration, and administration of debt issues and provision of transfer agent services for equity issues for corporations. AmSouth Alabama also provides additional services through several subsidiaries. AmSouth Leasing Corporation is a specialized lender providing equipment leasing. Brokerage services and investment sales are provided by AmSouth Investment Services, Inc., a registered broker-dealer.\nAmSouth Bank of Florida (AmSouth Florida) is headquartered in Tampa, Florida. At December 31, 1995, AmSouth Florida had total consolidated assets of approximately $6.8 billion and total consolidated deposits of approximately $5.2 billion and was the fifth largest bank headquartered in Florida. It is a full-service bank that offers services similar to those offered by AmSouth Alabama. At December 31, 1995, AmSouth Florida operated 116 banking offices in Florida.\nAmSouth Bank of Tennessee (AmSouth Tennessee) is headquartered in Chattanooga, Tennessee. At December 31, 1995, AmSouth Tennessee had total assets of approximately $1.1 billion and total deposits of approximately $829 million and was the ninth largest bank headquartered in Tennessee. AmSouth Tennessee offers banking services similar to those of AmSouth Alabama. At December 31, 1995, AmSouth Tennessee operated 22 offices in Tennessee. AmSouth also owns two other smaller banking subsidiaries: AmSouth Bank of Walker County, located in Jasper, Alabama, and AmSouth Bank of Georgia, headquartered in Rome, Georgia. All of AmSouth's banking subsidiaries are state-chartered banks that are members of the Federal Reserve System.\nAs of February 29, 1996, AmSouth and its subsidiaries had 5,182 full-time employees and 1,074 part-time employees.\nCOMPETITION\nAmSouth's subsidiaries compete aggressively with banks located in Alabama, Florida, Tennessee, and Georgia, as well as large banks in major financial centers and with other financial institutions, such as savings and loan associations, credit unions, consumer finance companies, brokerage firms, insurance companies, investment companies, mortgage companies, and financial service operations of major retailers. Areas of\nof competition include prices, interest rates, services, and availability of products. AmSouth also competes with the other bank holding companies headquartered in Alabama, Florida, Tennessee, Georgia, and other states for the acquisition of financial institutions.\nAt December 31, 1995, of the bank holding companies headquartered in Alabama, AmSouth was the second largest in terms of equity capital and total assets. However, in some geographic areas of Alabama, AmSouth's market share is smaller than that of other banks and financial institutions competing in those areas. Also, AmSouth is significantly smaller than many of the financial institutions competing in Florida, Tennessee, and Georgia.\nVarious regulatory developments and existing laws have allowed financial institutions to conduct significant activities on an interstate basis for a number of years. During recent years, a number of financial institutions expanded their out-of-state activities, and various states enacted legislation intended to allow certain interstate banking combinations which otherwise would be prohibited by federal law. For a number of years, the Bank Holding Company Act of 1956, as amended (the BHCA), generally provided that no company which owned or controlled a commercial bank in the United States could acquire ownership or control of a commercial bank in a state other than the state in which the company's banking subsidiaries were principally located unless the acquisition was specifically authorized by the laws of the state in which the bank being acquired was located.\nFor a number of years Alabama had a reciprocal interstate banking law that allowed banks in several other states (primarily in the Southeast) and the District of Columbia to acquire banks in Alabama provided there was reciprocal legislation in the other jurisdictions. Alabama bank holding companies were thereby permitted to acquire banks in the jurisdictions specified in the law which had adopted such reciprocal legislation. These laws resulted in a significant increase in competition for banking services in Alabama, Florida, Tennessee, Georgia, and the other affected areas.\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the IBBEA) authorized interstate acquisitions of banks and bank holding companies without geographic limitation beginning September 29, 1995. In addition, beginning June 1, 1997, the IBBEA authorizes a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching by May 31, 1997. A bank may establish and operate a de novo branch in a state in which the bank does not maintain a branch if that state expressly permits de novo branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or de novo. Although the management of AmSouth cannot predict with certainty the effect of the IBBEA on AmSouth, it is probable that the IBBEA will result in greater consolidation within the banking industry.\nBUSINESS COMBINATIONS\nAmSouth continually evaluates business combination opportunities and from time to time conducts due diligence activities in connection with them. As a result, business combination discussions and, in some cases, negotiations may take place, and transactions involving cash, debt or equity securities may be expected. Any future business combination or series of business combinations that AmSouth might undertake may be material, in terms of assets acquired or liabilities assumed, to AmSouth's financial condition. Recent business combinations in the banking industry have typically involved the payment of a premium over book and market values. This practice may result in dilution of book value and net income per share for the acquirers.\nSUPERVISION AND REGULATION\nThe following discussion addresses the regulatory framework applicable to bank holding companies and their subsidiaries, and provides certain specific information relevant to AmSouth. Regulation of financial institutions such as AmSouth and its subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation (the FDIC) and the banking system as a whole, and generally is not intended for the protection of stockholders or other investors.\nThe following is a summary of certain statutes and regulations that apply to the operation of banking institutions. Changes in the applicable laws, and in their application by regulatory agencies, cannot necessarily be predicted, but they may have a material effect on the business and results of banking organizations, including AmSouth.\nGENERAL\nAs a bank holding company, AmSouth is subject to the regulation and supervision of the Federal Reserve Board under the BHCA. Under the BHCA, bank holding companies may not in general directly or indirectly acquire the ownership or control of more than 5 percent 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 BHCA from engaging in nonbanking activities, subject to certain exceptions.\nAmSouth's subsidiary banks (the Subsidiary Banks) are subject to supervision and examination by applicable federal and state banking agencies. As state banks that are members of the Federal Reserve System, they are generally subject to regulation by the Federal Reserve Board and the banking agencies of the states in which they are located. Each of the Subsidiary Banks is also an insured depository institution, and, therefore, also subject to regulation by the FDIC. The Subsidiary Banks are also subject to various 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 the Subsidiary Banks. 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.\nVarious legislative proposals have been made that would affect the operations of bank holding companies and their subsidiaries, including proposals to revise the bank regulatory system and to allow affiliations between bank holding companies and non-bank entities that are restricted under current law. AmSouth is unable to predict whether any of these proposals will be adopted and, if so, what their effect on AmSouth would be.\nPAYMENT OF DIVIDENDS\nAmSouth is a legal entity separate and distinct from its banking and other subsidiaries. The principal source of cash flow for AmSouth, including cash flow to pay dividends on AmSouth's capital stock and to pay interest and principal on any debt of AmSouth, is dividends from the Subsidiary Banks. There are statutory and regulatory limitations on the payment of dividends by the Subsidiary Banks to AmSouth as well as by AmSouth to its shareholders. The payment of dividends by AmSouth and the Subsidiary Banks also may be affected by other factors, such as the requirement to maintain capital at or above regulatory guidelines.\nUnder Alabama law, a bank may not pay a dividend in excess of 90 percent of its net earnings until the bank's surplus is equal to at least 20 percent of capital. AmSouth Alabama is also required by Alabama law to obtain the prior approval of the superintendent of the Alabama Banking Department for the payment of\ndividends if the total of all dividends declared by the bank in any calendar year will exceed the total of (a) the bank's net earnings (as defined by statute) for that year plus (b) its retained net earnings for the preceding two years, less any required transfers to surplus. Also, no dividends may be paid from AmSouth Alabama's surplus without the prior written approval of the superintendent.\nThe other Subsidiary Banks are also subject to varying restrictions on the payment of dividends under applicable state laws. Under Florida law, before declaring a dividend, a bank must (a) have transferred 20 percent of its net profits for the period covered by the dividend to its surplus fund until the fund is at least equal to the amount of common and preferred stock outstanding, and (b) have charged off bad debts, depreciation and other worthless assets and made provision for reasonably anticipated future losses on loans and other assets. A bank may then declare a dividend equal to the net profits for the period covered by the dividend plus its retained net profits for the preceding two years. A bank may not declare a dividend from retained net profits that accrued prior to the preceding two years without the approval of the Florida Department of Banking and Finance. A bank may not declare a dividend if its net income from the current year combined with net income from the preceding two years is a loss or would cause the capital of the bank to fall below the minimum amount required by law or regulation.\nUnder Tennessee law, AmSouth Tennessee may declare dividends not more than once in each calendar quarter from undivided profits if (a) the bank's undivided profits account has been maintained as required by law and (b) the required reserve against deposits is not and will not thereby be impaired. Before any net profits are credited to the undivided profits account, deductions for various expenses are required to be made. No transfers may be made from the surplus account to the undivided profits account or to any part of the capital stock account without the consent of the Tennessee Commissioner of Banking. In addition, prior to determining that undivided profits are available for the declaration of dividends, (a) any net loss must be deducted from the undivided profits account and (b) transfers must be made from the undivided profits account to the surplus account (i) in an amount required to raise the surplus to 50 percent of the capital stock and (ii) in an amount not less than 10 percent of net profits until the surplus equals the capital stock.\nIn addition, as banks that are members of the Federal Reserve System, each Subsidiary Bank is required by federal law to obtain regulatory approval for the payment of dividends if the total of all dividends declared by the Board of Directors of such bank in any year will exceed the total of (a) the bank's net profits (as defined and interpreted by regulation) for that year plus (b) the retained net profits (as defined and interpreted by regulation) for the preceding two years, less any required transfers to surplus. Each Subsidiary Bank also can pay dividends only to the extent that retained net profits (including the portion transferred to surplus) exceed its losses and bad debts.\nFurthermore, if, in the opinion of the applicable federal bank regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and a hearing, that such bank cease and desist from such practice. The Federal Reserve Board has indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Act (the FDI Act), an insured bank may not pay any dividend if it is undercapitalized or if payment would cause it to become undercapitalized. Moreover, the Federal Reserve Board has issued a policy statement which provides that bank holding companies and state member banks should generally only pay dividends out of current operating earnings.\nAt December 31, 1995, under dividend restrictions imposed under federal and state laws, including those described above, the Subsidiary Banks, without obtaining government approvals, could declare aggregate dividends of approximately $197.9 million.\nCAPITAL ADEQUACY AND RELATED MATTERS\nCapital Guidelines\nThe Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies. The minimum guideline for the ratio of total regulatory capital (Total Capital) to risk-weighted assets (including\ncertain off-balance-sheet items, such as standby letters of credit) is 8 percent. At least half of the Total Capital must be composed of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (Tier 1 Capital). The remainder may consist of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. At December 31, 1995, AmSouth's consolidated Tier 1 Capital and Total Capital ratios were 7.87 percent and 11.74 percent, respectively.\nIn addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. The guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and certain other intangible assets (the Leverage Ratio), of 3 percent for bank holding companies that meet certain specific criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3 percent, plus an additional cushion of 100 to 200 basis points. AmSouth's Leverage Ratio at December 31, 1995 was 6.38 percent. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve Board has indicated that it will consider a \"tangible Tier 1 Capital Leverage Ratio\" (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.\nEach of the Subsidiary Banks itself is subject to risk-based and leverage capital requirements, similar to those described above. Each of the Subsidiary Banks was in compliance with applicable minimum capital requirements as of December 31, 1995. Neither AmSouth nor any of the Subsidiary Banks has been advised by any federal banking agency of any specific minimum Leverage Ratio requirement applicable to it.\nAll of the federal banking agencies have proposed regulations that would add an additional risk-based capital requirement based upon the amount of an institution's exposure to interest rate risk. In addition, bank regulators have the ability to raise capital requirements applicable to banking organizations beyond current levels. However, the management of AmSouth is unable to predict whether and when higher capital requirements would be imposed, and, if so, at what levels and on what schedule.\nPrompt Corrective Action\nThe FDI Act requires the federal banking regulators to take prompt corrective action in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. The FDI Act establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized,\" and \"critically undercapitalized.\" Under applicable regulations, an FDIC-insured depository institution is defined to be well capitalized if it maintains a Leverage Ratio of at least 5 percent, a risk- adjusted Tier 1 Capital Ratio of at least 6 percent, and a Total Capital Ratio of at least 10 percent and is not subject to any order or written directive to maintain any specific capital level. An FDIC-insured depository institution is defined to be adequately capitalized if it maintains a Leverage Ratio of at least 4 percent, a risk-adjusted Tier 1 Capital Ratio of at least 4 percent, and a Total Capital Ratio of at least 8 percent. In addition, an FDIC-insured depository institution will be considered: (a) undercapitalized if it fails to meet any minimum required measure; (b) significantly undercapitalized if it is significantly below such measure; and (c) critically undercapitalized if it fails to maintain a level of tangible equity equal to not less than 2 percent of total assets. An FDIC-insured depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it is operating in an unsafe or unsound manner or receives an unsatisfactory examination rating. AmSouth believes that at December 31, 1995, all of the Subsidiary Banks had capital ratios sufficient to qualify as \"well capitalized.\"\nThe capital-based prompt corrective action provisions of the FDI Act and the implementing regulations apply to FDIC- insured depository institutions and are not directly applicable to holding companies that control such institutions. However, the Federal Reserve Board has indicated that, in regulating bank holding companies, it will take appropriate action at the holding company level based on an assessment of the\neffectiveness of supervisory actions imposed upon subsidiary depository institutions pursuant to such provisions and regulations. Although the capital categories defined under the prompt corrective action regulations are not directly applicable to AmSouth under existing law and regulations, if AmSouth were placed in a capital category it would qualify as well capitalized as of December 31, 1995.\nThe FDI Act 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 insured 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. An insured depository institution's holding company must guarantee the capital plan, up to an amount equal to the lesser of 5 percent 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. 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 an insured depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.\nSignificantly undercapitalized insured 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 insured depository institutions are subject to appointment of a receiver or conservator.\nBrokered Deposits\nThe FDIC has adopted regulations under the FDI Act governing the receipt of brokered deposits. Under the regulations, an FDIC-insured depository institution cannot accept, rollover or renew brokered deposits unless (a) it is well capitalized or (b) it is adequately capitalized and receives a waiver from the FDIC. A depository institution 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 depository institution 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 depository institution that is well capitalized.\nHOLDING COMPANY STRUCTURE\nThere are various legal restrictions on the extent to which AmSouth and its nonbank subsidiaries may borrow or otherwise obtain funding from its Subsidiary Banks. Each Subsidiary Bank (and its subsidiaries) is limited in engaging in borrowing and other \"covered transactions\" with nonbank and non-savings bank affiliates to the following amounts: (a) in the case of any such affiliate, the aggregate amount of covered transactions of the Subsidiary Bank and its subsidiaries may not exceed 10 percent of the capital stock and surplus of such Subsidiary Bank; and (b) in the case of all affiliates, the aggregate amount of covered transactions of the Subsidiary Bank and its subsidiaries may not exceed 20 percent of the capital stock and surplus of such Subsidiary Bank. Covered transactions also are subject to certain collateralization requirements. \"Covered transactions\" are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve Board), the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate.\nUnder Federal Reserve Board policy, AmSouth is expected to act as a source of financial strength to, and to commit resources to support, each of the Subsidiary Banks. This support may be required at times when, absent such Federal Reserve Board policy, AmSouth may not be inclined to provide it. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of\npayment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.\nThe FDI Act provides that, in the event of the \"liquidation or other resolution\" of an insured depository institution, the claims of depositors of such institution (including claims by the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as receiver would be afforded a priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will be placed ahead of unsecured, nondeposit creditors, including a parent holding company such as AmSouth, in order of priority of payment.\nUnder the FDI Act, a depository institution insured by the FDIC, such as each of the Subsidiary Banks, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (a) the default of a commonly controlled FDIC-insured depository institution or (b) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution \"in danger of default.\" \"Default\" is defined generally as the appointment of a conservator or receiver and \"in danger of default\" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance.\nFDIC DEPOSIT INSURANCE ASSESSMENTS\nThe Subsidiary Banks are subject to FDIC deposit insurance assessments. On August 8, 1995, the FDIC amended its regulations on insurance assessments to establish a new assessment rate schedule of 4 to 31 cents per $100 of deposits in replacement of the previous schedule of 23 to 31 cents per $100 of deposits for institutions whose deposits are subject to assessment by the Bank Insurance Fund (BIF). The FDIC has maintained the current assessment rate schedule of 23 to 31 cents per $100 of deposits for the institutions whose deposits are subject to assessment by the Savings Association Insurance Fund (SAIF). The new BIF schedule became effective on June 1, 1995. Assessments collected under the previous assessment schedule in excess of the amount due under the new schedule were refunded, with interest, from the effective date of the new schedule, and AmSouth received a refund of approximately $5.0 million. On November 14, 1995, the Board of Directors of the FDIC approved a further reduction in the assessment schedule for BIF deposits. Effective January 1, 1996, the assessment schedule ranges from 0 to 27 cents per $100 of deposits subject to BIF assessments, based on each institution's risk classification. At December 31, 1995, AmSouth had a BIF deposit assessment base of $8.4 billion and a SAIF deposit assessment base of $4.5 billion. Various legislative proposals regarding the future of BIF and SAIF have been reported recently. Several of these proposals include a one-time special assessment for SAIF deposits (which could under certain proposals be as high as 0.85% of each insured institution's SAIF deposit assessment base) and a subsequent reduced level of annual premiums for SAIF deposits comparable to the rate for BIF deposits. AmSouth does not currently know when or if any such proposal or any other related proposal may be adopted. See \"Noninterest Expenses\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" of this Form 10-K.\nThe FDIC is authorized to change the calculation and rates of insurance premiums in certain circumstances. Any change in premiums would have an effect on AmSouth's earnings.\nUnder the FDI Act, 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 the FDIC.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of AmSouth are located in the 30-story AmSouth-Sonat Tower in downtown Birmingham, Alabama. An undivided one-half interest in this building is owned by AmSouth Alabama through an unincorporated joint venture. AmSouth Alabama is a principal tenant of this building. AmSouth\nAlabama is also a principal tenant of the AmSouth\/Harbert Plaza, a 32-story office building also located in downtown Birmingham, Alabama, and of a recently constructed office complex in the Birmingham area. AmSouth Alabama's headquarters and most of its operations are located in these facilities. Other bank subsidiaries of AmSouth also have headquarters, banking and operational offices located in Alabama, Florida, Tennessee and Georgia.\nAt December 31, 1995, AmSouth and its subsidiaries had 277 offices (principally bank buildings) of which 194 were owned and 83 were either leased or subject to a ground lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSeveral of AmSouth's subsidiaries are defendants in legal proceedings arising in the ordinary course of business. Some of these proceedings seek relief or damages that are substantial. The actions relate to AmSouth's lending, collections, servicing, investment, trust and other activities.\nAmong the actions which are pending against AmSouth subsidiaries are actions filed as class actions in the State of Alabama. The actions are similar to others that have been brought in recent years in Alabama against financial institutions in that they seek punitive damages in transactions involving relatively small amounts of actual damages. In recent years, juries in Alabama state courts have made large punitive damage awards in such cases. Legislation which would limit these lawsuits has been introduced in the Alabama legislature but has not been enacted into law. AmSouth cannot predict whether any such legislation will be enacted.\nIt may take a number of years to finally resolve some of these legal proceedings pending against AmSouth subsidiaries, due to their complexity and other reasons. It is not possible to determine with any certainty at this time the potential exposure from the proceedings. However, based upon the advice of legal counsel, AmSouth's management is of the opinion that the ultimate resolution of these legal proceedings will not have a material adverse effect on AmSouth's 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 brought to a vote of security holders during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of AmSouth, their ages, the positions held by them with AmSouth and certain of its subsidiaries, and their principal occupations for the last five years are as follows:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAmSouth's common stock, par value $1.00 per share, is listed for trading on the New York Stock Exchange under the symbol ASO. The following table sets forth certain common stock data for the last five years.\nQuarterly high and low sales prices of and cash dividends declared on AmSouth common stock are set forth in Note U of the Notes to Consolidated Financial Statements, which are incorporated by reference into Item 8 of this Form 10-K.\nAs of March 8, 1996, there were approximately 13,819 holders of record of AmSouth's common stock.\nRestrictions on AmSouth's Subsidiary Banks to transfer funds to the holding company at December 31, 1995 are set forth in Note P of the Notes to Consolidated Financial Statements, which are incorporated by reference into Item 8 of this Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data for the last five years.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of AmSouth's 1995 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 AmSouth and Subsidiaries, the accompanying Notes to Consolidated Financial Statements, Management's Statement on Responsibility for Financial Reporting, and the Report of Independent Auditors contained in AmSouth's 1995 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 on the directors and director nominees of AmSouth included at pages 6, 8, and 10 of AmSouth's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 1996 (the Proxy Statement) is hereby incorporated herein by reference. Information on AmSouth's executive officers is included in Part I of this report. As of April 18, 1996, three directors of AmSouth will leave the Board. Information about them follows.\n- -------- (1) These are directorships with corporations subject to the registration or reporting requirements of the Securities Exchange Act of 1934 or registered under the Investment Company Act of 1940.\nInformation regarding late filings under Section 16(a) of the Securities Exchange Act of 1934 included at page 12 of the Proxy Statement is hereby incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding compensation of directors and executive officers included at pages 13 through 22 of the Proxy Statement is hereby incorporated herein by reference. Provided, however, the information provided under the headings \"Executive Compensation and Benefits Committee Report on Executive Compensation\" and \"Performance Graph\" shall not be deemed to be \"soliciting material\" or to be \"filed\" with the Securities and Exchange Commission, or subject to Regulation 14A or 14C, other than as provided in Item 402 of Regulation S-K, or to liabilities of Section 18 of the Securities Exchange Act of 1934.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the caption \"Voting Securities and Principal Holders Thereof\" at pages 1 through 5 of the Proxy Statement is hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth in the Proxy Statement under the caption \"Certain Transactions\" at pages 12 and 13 and the second paragraph under the caption \"Information with Respect to Executive Compensation and Benefits Committee Interlocks and Insider Participation in Compensation Decisions\" at page 18 is hereby incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENTS\nThe following management's statement on responsibility for financial reporting, report of independent auditors and consolidated financial statements of AmSouth and its subsidiaries included in AmSouth's 1995 Annual Report to Shareholders are incorporated by reference in Item 8.\nManagement's Statement on Responsibility for Financial Reporting Report of Ernst & Young LLP, Independent Auditors Consolidated Statement of Condition--December 31, 1995 and 1994 Consolidated Statement of Earnings--Years ended December 31, 1995, 1994 and Consolidated Statement of Shareholders' Equity - Years ended December 31, 1995, 1994, and 1993 Consolidated Statement of Cash Flows--Years ended December 31, 1995, 1994, and 1993 Notes to Consolidated Financial Statements\nFINANCIAL STATEMENT SCHEDULES\nAll schedules to the consolidated financial statements required by Article 9 of Regulation S-X and all other schedules to the financial statements of AmSouth required by Article 5 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n(B) REPORTS ON FORM 8-K\nThe following reports on Form 8-K were filed during the fourth quarter of 1995:\na) Report on Form 8-K filed November 2, 1995 to report AmSouth's preliminary results of operations for the third quarter of 1995.\nb) Report on Form 8-K filed December 21, 1995 to report that C. Dowd Ritter had been elected Chief Executive Officer of AmSouth effective January 1, 1996.\n(C) EXHIBITS\nThe exhibits listed in the Exhibit Index at page 18 of this Form 10-K are filed herewith or are incorporated herein by reference.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nAmSouth Bancorporation\n\/s\/ C. Dowd Ritter By: _________________________________ C. DOWD RITTER President and Chief Executive Officer Date: March 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.\n\/s\/ C. Dowd Ritter \/s\/ Dennis J. Dill By: _________________________________ By: _________________________________ C. DOWD RITTER DENNIS J. DILL President, Chief Executive Officer Executive Vice President and a Director Chief Accounting Officer (Principal Executive Officer) (Principal Accounting Officer) Date: March 26, 1996 Date: March 26, 1996\n\/s\/ Kristen M. Hudak By: _________________________________ KRISTEN M. HUDAK Senior Executive Vice President and Chief Financial Officer (Principal Financial Officer) Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ BARNEY B. BURKS, JR. JAMES R. MALONE A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ J. HAROLD CHANDLER CLAUDE B. NIELSEN A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ JOSEPH M. FARLEY Z. CARTTER PATTEN, III A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ RODNEY C. GILBERT BENJAMIN F. PAYTON, PH.D. A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ ELMER B. HARRIS HERBERT A. SKLENAR A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* * By: _________________________________ By: _________________________________ DONALD E. HESS JOHN W. WOODS A Director A Director Date: March 26, 1996 Date: March 26, 1996\n* By: _________________________________ RONALD L. KUEHN, JR. A Director Date: March 26, 1996\n*Carl L. Gorday, by signing his name hereto, does sign this document on behalf of each of the persons indicated above pursuant to powers of attorney executed by such persons and filed with the Securities and Exchange Commission.\n\/s\/ Carl L. Gorday By: _________________________________ CARL L. GORDAY Attorney in Fact\nEXHIBIT INDEX\nThe following is a list of exhibits including items incorporated by reference. Compensatory plans and arrangements are identified by an asterisk.\nNOTES TO EXHIBITS\n(1)Filed as Exhibit 2(a) to AmSouth's Report on Form 8-K filed on September 16, 1993, as amended by a Form 8-K\/A filed on September 23, 1993, and Annex A to the Supplement to the Proxy Statement\/Prospectus dated May 12, 1994 and filed pursuant to Rule 424(b)(3), incorporated herein by reference\n(2)Filed as Exhibit 2(a) to AmSouth's Registration Statement on Form S-4 (Registration Statement No. 33-49865), incorporated herein by reference\n(3)Filed as Exhibit 2(a) to AmSouth's Registration Statement on Form S-4 (Registration Statement No. 33-50605), incorporated herein by reference\n(4)Filed as Exhibit 2(a) to AmSouth's Registration Statement on Form S-4 (Registration Statement No. 33-50727), incorporated herein by reference\n(5)Filed as Exhibit 2(a) to AmSouth's Registration Statement on Form S-4 (Registration Statement No. 33-51767), incorporated herein by reference\n(6)Filed as Exhibit 2(a) to AmSouth's Registration Statement on Form S-4 (Registration Statement No. 33-50865), incorporated herein by reference\n(7)Filed as Exhibit 3-b to AmSouth's Form 10-Q Quarterly Report for the quarter ended March 31, 1993, incorporated herein by reference\n(8)Filed as Exhibit 3-c to AmSouth's Form 10-Q Quarterly Report for the quarter ended September 30, 1995, incorporated herein by reference\n(9)Instruments defining the rights of holders of long-term debt of AmSouth are not filed herewith pursuant to Item 601(b)(4)(iii) of Regulation S-K, and AmSouth hereby agrees to furnish a copy of said instruments to the SEC upon request\n(10)Filed as Exhibit 4-a to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1989, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1-7476, former File No. 0-6907)\n(11)Filed as Exhibit 4-c to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1989, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1-7476, former File No. 0-6907)\n(12)Filed as Exhibit 10-a to AmSouth's Form 10-Q Quarterly Report for the quarter ended March 31, 1995 incorporated herein by reference\n(13)Filed as Exhibit 10-b to AmSouth's Form 10-K Annual Report for the year ended December 31, 1993, incorporated herein by reference\n(14)Filed as part of Exhibit 23 to AmSouth's Form 10-Q Quarterly Report for the quarter ended March 31, 1984, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1-7476, former File No. 0-6907)\n(15)Filed as Exhibit 10-e to AmSouth's Form 10-K Annual Report for the year ended December 31, 1985, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1- 7476, former File No. 0-6907)\n(16)Filed as Exhibit 10-b to AmSouth's Form 10-Q Quarterly Report for the quarter ended March 31, 1987, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1- 7476, former File No. 0-6907)\n(17)Filed as Exhibit 10(b) to AmSouth's Form 10-Q Quarterly Report for the quarter ended September 30, 1988, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1-7476, former File No. 0-6907)\n(18)Filed as Exhibit 10-i to AmSouth's Form 10-K Annual Report for the year ended December 31, 1988, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1- 7476, former File No. 0-6907)\n(19)Filed as Exhibit 10-i to AmSouth's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference\n(20)Filed as Exhibit 10-b to AmSouth's Form 10-Q Quarterly Report for the quarter ended September 30, 1995, incorporated herein by reference\n(21)Filed as Exhibit 10 to AmSouth's Form 10-Q Quarterly Report for the quarter ended March 31, 1993, incorporated herein by reference\n(22)Filed as Exhibit 10-k to AmSouth's Form 10-K Annual Report for the year ended December 31, 1994, incorporated herein by reference\n(23)Filed as Exhibit 10-a to AmSouth's Form 10-Q Quarterly Report for the quarter ended September 30, 1995, incorporated herein by reference\n(24)Filed as Exhibit 10-k to AmSouth's Form 10-K Annual Report for the year ended December 31, 1992, incorporated herein by reference; agreement in this form is with John W. Woods\n(25)Filed as Exhibit 10-a to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1986, incorporated herein by reference (filed with the Securities and Exchange Commission in Washington D.C., SEC File No. 1-7476, former File No. 0-6907)\n(26)Filed as Exhibit 10-p to AmSouth's Form 10-Q Quarterly Report for the quarter ended September 30, 1994, incorporated herein by reference\n(27)Filed as Exhibit 10-a to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1995, incorporated herein by reference\n(28)Filed as Exhibit 10-b to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1995, incorporated herein by reference; agreements in this form have been entered into with the following Executive Officers: Michael C. Baker, David B. Edmonds, Sloan D. Gibson, IV, Kristen M. Hudak, W. Charles Mayer, III, Candice W. Rogers, E.W. Stephenson, Jr., Alfred W. Swan, Jr., and Stephen A. Yoder\n(29)Filed as Exhibit 10-c to AmSouth's Form 10-Q Quarterly Report for the quarter ended June 30, 1995, incorporated herein by reference","section_15":""}
{"filename":"795968_1995.txt","cik":"795968","year":"1995","section_1":"ITEM 1. Business\nEdison Control Corporation (the \"Company\") was incorporated under the laws of the State of New Jersey on June 18, 1986 to succeed a limited partnership organized on October 31, 1979. The Company operates in one business segment: the design, development, manufacture and sale of electronic fault indicators. The indicators detect electrical transmission and distribution line breakdowns and locate faults (or breaks) in power lines, enabling a more rapid restoration of power.\nFault Indicators-General\nA major problem faced by electric utilities is the disruption of service caused by transmission and distribution line faults. These disruptions (which are one cause of \"blackouts\") represent millions of dollars in lost revenues to electric utilities. Additionally, significant losses may be suffered by both business and residential users of electricity due to such disruptions.\nElectricity is transported by electric utilities across high voltage power lines located overhead on poles or under the ground. In recent years, there has been a growing trend to place power lines underground due to consumer and environmentalist demands. The voltage in these underground power lines ranges from 4,000 to 34,500 volts. Transformers are placed along these lines in order to reduce the high voltage to the 120 volt current which is delivered to users. Generally, one transformer is used for every four to ten homes.\nWhen a fault occurs in a line, high voltage electricity passes directly to the ground, causing enormous amounts of electrical current from the damaged power line and other lines connected to it to rush to the ground, burning out any protective fuses or equipment which may have been in series with the line. Since most lines are interconnected, adjacent lines may discharge their currents into the same fault, causing a large power outage or \"blackout.\"\nWithout the use of fault indicators, in order to detect the location of the fault in a blacked-out area, a lineman selects a transformer at a point midway along the dead power line for testing. The transformer is disconnected and power is reapplied. If the line fails again, it can be determined that the fault must be closer to the generator. This process is repeated until the shorted section has been located. This method is extremely time consuming, costly, requires skilled personnel and causes additional damage to equipment by the repeated short circuits involved in the testing process. When lines are located underground, this process is further complicated due to the fact that broken lines cannot be readily seen.\nFault locating using an automatic fault indicator such as that manufactured and marketed by the Company is considerably easier and faster than the method described above. The use of fault indicators eliminates the need for the reapplication of damaging power and the need to disconnect and reconnect transformers, thereby making more rapid restoration of power possible, effecting substantial savings in manpower, increasing safety and decreasing power outage losses and claims. Fault indicators are permanently attached to power lines, generally at transformers. Many systems using fault indicators locate such indicators at every third or fourth transformer.\nThe Company's fault indicators generally consist of three parts: a current transformer for sensing the electrical current conditions of the line, a circuit to instruct the fault display to operate, and a meter display. If a power line faults to the ground, a surge of current will flow through the line exceeding the limit set by the utility for that particular line. This surge causes the fault indicator display to indicate a \"fault.\" To detect the source of a fault, the lineman drives or walks along the line looking at each indicator. The fault will be between the last indicator displaying a fault signal and the first indicator displaying a normal condition. All of the Company's fault indicators on the line will return to a normal setting automatically once the fault has been repaired, eliminating the need for a lineman to manually reset all the indicators effected in series on the line.\nFault Indicators-Product Specifications\nIt is common practice in the electric utility industry for each company to establish its own standard specifications for capital equipment to be purchased. These specifications, in many cases, are strongly influenced, if not entirely controlled, by the standards developed by the power section of the Institute of Electrical and Electronics Engineers (\"IEEE\"). The Company believes its fault indicators meet or exceed IEEE specifications.\nDue to the fact that fault indicators are often exposed to the elements, they must be capable of operation within specifications in extreme environmental conditions. The Company's units are hermetically sealed and submersible and operate in temperatures ranging from -40 degrees to 85 degrees centigrade.\nThe Company's products are capable of being installed on both live and de-energized lines. Installation on live lines is accomplished by means of an insulated pole referred to as a \"hot stick.\" This ability to be installed on live lines is a key requirement for retrofitting existing power systems which cannot be de-energized in order to install fault indicators. The Company also produces fault indicators which are installed on de-energized lines for a slightly lower cost.\nThe Company offers to its customers fault indicators which work on both single and three phase lines of any voltage, with output displays that can be read visually or heard. The automatic fault indicators manufactured by the Company can be set to various limits and are sensitive to small fluctuations in levels of current. The Company believes its fault indicators are the most accurate in tripping at the line current level set by the user.\nAccuracy in trip level setting, speed of response to faults and adaptability to various line protection devices are important characteristics of the Company's fault indicators. The Company believes that it offers a wider range of features and equipment than any other company offering similar devices.\nMarketing\nThe Company currently markets its products, systems and services in the United States and internationally through a network of distributors and independent sales representatives. The Company's customers are comprised primarily of electric utilities and electric equipment distributors.\nThere are a total of approximately 3,000 electric utilities in the United States. In the year ended December 31, 1995, the Company sold product to 99 domestic customers. Additionally, the Company received orders from 4 export distributors totaling $36,451.80 or 5% of 1995 sales. The decline in export sales was due in part to the devaluation of the peso in Mexico.\nIn fiscal year 1995 three customers accounted for more than 10% of the Company's sales: Gulf States Utilities Company accounted for 20%, Horrey Electric Cooperative, Inc. accounted for 15% and Florida Power And Light Company accounted for 13%. The loss of these customers, if not replaced with other business, would have a material adverse affect on the manufacturing portion of the Company.\nManufacturing\nThe Company's manufacturing activities consist primarily of the assembly and soldering of discrete electronic components to printed circuit boards, plastic encapsulation of the circuitry, cable stripping, ultrasonic sealing and final testing.\nAssembly of components such as resistors, transistors and diodes is performed manually. After inspection, the assembled boards are dipsoldered automatically by machine. Leads extending from soldered boards are automatically removed by machine and certain connections between major equipment components are made by machine. The final assembly testing of the Company's fault indicators is performed manually.\nThe Company's fault indicators are all enclosed in polycarbonate cases. Sealing of the fault indicator circuits and mechanism in a case is accomplished by means of an ultrasonic sealing machine. Final test sets are capable of producing constant currents of up to 1,500 amperes in order to simulate line fault conditions and accurately set the current trip level for each fault indicator. The Company does not subcontract any of its production because of its desire to maintain a high level of quality control and product reliability.\nRaw Materials\nIn general, the electronic components utilized by the Company are standard and readily available. The Company generally does not maintain finished goods inventories but instead usually produces inventory to fill specific orders.\nThe Company's supply of raw materials consists of electronic components such as diodes, transistors, resistors, capacitors and potentiometers, as well as various types of printed circuit boards, cables, ferrite cores, meter movements, lexan cups, bezels and potting material.\nPatents and Licenses\nThe Company is not dependent upon patents in its business. The Company believes that its success is more dependent upon hardware reliability and performance than upon patentability of its products. It is the policy of the Company to seek to protect trade secrets and other material proprietary information regarding the design and manufacture of its products. The Company intends to rely upon internal non-disclosure safeguards as well as upon patent and copyright protection for new products in the future.\nProduct Enhancement and New Product Development\nAlthough most power distribution systems share a considerable degree of commonality, particularly in the components and apparatus which make up the systems, there is, nonetheless, a considerable diversity from system to system in the methods of circuit protection and distribution. Growth in electric power grids has led to increasing complexity, making it difficult for a single fault indicator to work on all systems universally. In particular, some systems are protected by fuses which burn out at varying rates when a line shorts to the ground, while others are protected by mechanical reclosures which open when they sense a large current flow caused by a ground fault. Some lines have a combination of both fuses and mechanical reclosures, which are set to trip at various speeds and levels of current according to the system specifications. Consequently, an ideal fault indicator should be able to sense when a true fault condition occurs and to not falsely trigger in the presence of unusual conditions of current caused by the action of various protective devices employed on the line.\nThe Company has developed a line of fault indicators which trip at different current levels depending on power company requirements. These units are more complex than the Company's original units. The Company simplified construction of these products by reducing the number of components and printed circuit boards.\nIn April, 1993, the Company entered into a research contract with the Electric Power Research Institute (\"EPRI\") for the development of a second generation underground residential distribution (URD) cable fault locator based on an EPRI patent and technology. This project has as its ultimate objective the design and production of a device capable of locating and estimating the distance to a fault on a URD cable system quickly and easily, without the need for skilled personnel to interpret the results of the readings. The device is intended to be used either as an on-line monitor or as an after-the-fault location tool. The cost of the development and test phase of this project is approximately $290,000, of which EPRI is responsible for 64% and the Company is responsible for 36%. During 1995 the Company incurred $43,475 of development costs (excluding internal engineering salaries) on this project and $101,634 cumulatively through December 31, 1995. The initial field testing of this product was completed in December, 1994. A redesign was necessary due to low frequency noise interference. This problem has been resolved and prototypes will be shipped in April of 1996.\nIn September, 1993, the Company entered into a 15 year licensing agreement with EPRI to manufacture and sell the cable locating device discussed above based on EPRI's patent and technology. The licensing agreement provides for a percentage royalty based on total device sales over the term of the agreement.\nCompetition\nThere are a number of other companies which supply fault indicators to the electric utility industry. The Company knows of four direct competitors: RTE Corp., McGraw-Edison Company, Horstmann Inc. and Fisher-Pierce, Inc. These companies have greater financial, technical and personnel resources as well as more diversified product lines than the Company. Accordingly, there can be no assurance that the Company will be able to maintain a competitive position.\nEmployees and Labor Relations\nAs of December 31, 1995, the Company employed 16 persons, of whom 6 were engaged in engineering, research, marketing and general administration and 10 were engaged in manufacturing. None of the Company's employees is represented by a labor union. The Company has never had a work stoppage and the Company considers its employee relations to be excellent.\nManagement Change\nFrom fiscal year 1988 through fiscal year 1991, the Company lost a total of ($864,561), or ($0.41) per share. Present management (see Part III, Item 10) took control of the Company in 1991 shortly after the death of the Company's founder, chief executive officer and largest shareholder. New management has operated the Company with the intention of returning the Company to profitability. The Company was profitable in fiscal years 1992, 1993 and increased its profitability in fiscal years 1994 and 1995. Such profitability resulted from improved returns from the investment of the Company's funds. New management continues to seek acquisitions for the investment of the Company's liquid assets (see Part II, Item 7). On February 1, 1995, Mary E. McCormack was appointed President and Chief Executive Officer of the Company, for the purpose of locating and evaluating potential acquisition candidates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Company's executive offices and manufacturing facilities consist of 6,800 square feet of leased space in an industrial park in Piscataway, New Jersey. The current annual base rent is $36,700, and is subject to adjustment for increases in taxes, insurance and ground rent in an amount proportionate to the Company's share thereof. The Company has recently entered into a one year lease extension beginning April 1, 1996 in the same industrial park for 6,800 square feet of executive office, manufacturing and warehouse space. The 1996 annual ase rent is $35,700 subject to adjustment as noted above. On February 18, 1995, the Company entered into a one year lease for office space in New York City at an annual cost of $17,400 for the President. In 1996, the lease was extended beginning March 1, 1996 for one year at an annual cost of $17,922.\nITEM 3.","section_3":"ITEM 3. Submission of Matters to a Vote of Security Holders\nThe Company held its Annual Meeting of Shareholders on October 17, 1995. At the Annual Meeting the shareholders elected members to the Company's Board of Directors and approved an Amendment to the Company's 1986 Stock Option Plan to increase by 200,000 the number of shares of Common Stock authorized for issuance thereunder to a total of 350,000 shares (see Part III, Item 11).\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stock Holder Matters\nThe Company's Common Stock trades in the over-the-counter-market (NASDAQ Symbol:EDCO). The following table sets forth the high and low bid quotation for the quarter shown. The prices quoted represent prices between dealers in securities without adjustment for mark-ups, mark-downs or commissions and do not necessarily reflect actual transactions.\nPRICE RANGE HIGH LOW 1st Quarter 8 5 2nd Quarter 7 1\/4 3 3\/4 3rd Quarter 5 1\/4 4 4th Quarter 5 3 5\/8\nPRICE RANGE HIGH LOW 1st Quarter 5 1\/4 4 3\/4 2nd Quarter 5 3\/4 4 3\/4 3rd Quarter 5 1\/2 4 3\/4 4th Quarter 5 1\/4 4 1\/2\nOn March 14, 1996 the high bid and low asked prices of the Company's Common Stock, as reported by the National Quotation Bureau, were $4 and $4.75, respectively.\nApproximate Number of Holders of Common Stock\nApproximate Number of Record Title of Class Holders (as of March 14, 1996)\nCommon Stock, $.01 par value 36\nDividends\nThe Company has not previously paid any dividends on its Common Stock. The Company intends to follow a policy of retaining all of its earnings, if any, to finance its business and for general corporate purposes, including investing in an acquisition.\nITEM 7.","section_6":"","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n1995 versus 1994\nNet sales for the fiscal year ended December 31, 1995 totaled $791,502, a decrease of $652,502, or 45.2%, compared with fiscal year 1994. While sales prices remained stable in 1995, the sales decrease was due in part to a decline in the sale of the Company's products for export. Sales in Mexico in 1994 were $229,219 versus $36,093 in 1995, a 84% decrease. Sales domestically decreased as well, primarily due to sales to Jacksonville Electric Authority from $261,648 in 1994 and decreasing to $0 in 1995. This decline was partly attributable to an excess inventory condition at Jacksonville Electric Authority. Management also believes the decreased 1995 unit volume was a result of decreased spending by the Company's electric utility customers for products such as faulted circuit indicators which are not essential for the generation and distribution of electric power. Management feels this trend will continue, but does not have any indication at this time when faulted circuit indicators, which enhance efficiency, will again be purchased in substantial quantities.\nGross profit margin decreased to 16.5% in fiscal 1995 from 30.4% in fiscal 1994. The decrease was due to reduced unit volume and the allocation of overhead cost over the unit volume.\nSelling, general and administrative expenses were $729,267 in fiscal year 1995, an increase of $52,410, or 7.2% from 1994. Management believes selling, general and administrative expenses will remain constant for 1996. As a percentage of sales, selling, general and administrative expenses increased to 92% of sales in 1995, from 47% of sales in 1994. This increase is a result of increased salary, rent and other administrative expenses related to the hiring of a President and Chief Executive Officer in February, 1995. Selling expenses remained constant at 14% of sales.\nThe operating loss before interest and dividends, realized gains and unrealized gains\/losses on trading securities was $598,622 in fiscal year 1995 compared to $238,179 in fiscal year 1994, an increase in the loss of $360,443. The increase in the operating loss was due to decreased sales volume, decreased gross profit margin and increased selling, general and administrative expenses.\nInterest and dividends, net of security fees and commissions, for fiscal year 1995 was $39,598 compared to $187,818 in fiscal year 1994, a decrease of $148,220 or 78.9%. This decrease is due to fewer dividend generating securities. Realized gains on the sale of trading securities for 1995 was $2,214,145 as compared to $712,530 for 1994. The increase of $1,501,615 or 210.7% was due to increased trading activities. In addition, 1995 included unrealized gains on trading securities of $1,842,902 as compared to losses of $193,830 in 1994. The increase in unrealized gains is mainly attributable to an upward-market trend. The Company has no debt.\nThe effective tax rate increased to 40% in 1995 as compared to 18% in 1994 due to the remaining tax-loss carry forward being utilized in fiscal 1994.\nNet income of $2,082,582 or $0.95 per share for fiscal year 1995 increased from $1,830,347, or $0.85 per share in fiscal year 1994 for a difference of $252,235.\nCash increased $1,199,095, from $821,901 in fiscal 1994 to $2,020,996 in 1995. This increase is significantly a result of cash provided by operations of $1,122,000 which was generated from the sale of trading securities and proceeds from the exercise of $117,000 of stock options.\nManagement continues to analyze the possible discontinuance of the Company's sale of electronic fault indicators in light of operating losses in this business. No decision regarding said discontinuance has been made. If the Company discontinued the manufacture and sale of electronic fault indicators, the Company would be left with assets consisting of cash and cash equivalents, investments and trading securities. Management continues to actively seek opportunities for the investment of its liquid assets in areas which may not be related to its present operations.\n1994 versus 1993\nNet sales for the fiscal year ended December 31, 1994 totaled $1,444,004, an increase of $248,197, or 20.8%, compared with fiscal year 1993. The increase in ales in 1994 was caused mainly by an increase in unit volume and an increase in sales of 3 phase units verses single phase units. Management believes the increased 1994 unit volume was a result of increased spending by the Company's electric utility customers for products such as faulted circuit indicators which are not essential for the generation and distribution of electric power and increased export shipping. Management does not know whether this trend will continue or whether products such as faulted circuit indicators which enhance efficiency will again be purchased in substantial quantities. Product prices on single phase units were increased by 4% in the last quarter to offset material cost increases. Management does not believe that significant increases are probable given the competitive nature of the market.\nGross profit margin improved to 30.4% in fiscal 1994 from 28.8% in fiscal 1993. The improvement was due to improved operating efficiency, due in part by improved absorption of manufacturing overhead caused by higher unit volume. Management believes these margins will be maintained at or near present levels in fiscal 1995.\nSelling, general and administrative expenses were $676,857 in fiscal year 1994, an increase of $25,590, or 3.9% from 1993. Management believes SG&A expenses will increase as a percentage of net sales due to the hiring of the new President and Chief Operating Officer and the related increased cost of an additional office.\nThe operating loss before interest and dividends, realized gains and unrealized losses on trading securities was $238,179 in fiscal year 1994 compared to $307,161 in fiscal year 1993, an improvement of $68,982. This improvement was due to increased sales and a reduction of selling, general and administrative expenses as a percentage of net sales.\nInterest and dividends for fiscal year 1994 was $187,818 compared to $305,390 in fiscal year 1993, a decrease of $117,572 or 38.5%. This decrease is due to fewer dividend generating securities. Realized gains on the sale of trading securities for 1994 was $712,530 as compared to realized gains on the sale of marketable securities for 1993 of $545,742. The increase of $166,788 or 30.6% was due to increased trading activities. In addition, 1994 included unrealized losses on trading securities of $193,830 as a result of the Company adopting the provision of Statement of Financial Accounting Standards No. 115 as of January 1, 1994. The Company has no debt.\nThe provision for taxes in fiscal year 1993 was offset by the federal and state benefits arising from the carryforward of prior years' net operating losses. The remaining tax-loss carryforward was utilized during fiscal year 1994, resulting in an effective tax rate of 18% for 1994.\nNet income of $1,830,347, or $0.85 per share, for fiscal year 1994 increased from $543,971, or $0.25 per share, in fiscal year 1993. This increase is entirely due to the $1,447,567 cumulative effect of change in accounting principle as a result of the adoption of FAS 115 effective January 1, 1994.\nThe Company generated cash from operating activities of $590,374 in fiscal year 1994, compared to $2,497 in cash generated in fiscal year 1993, an increase of $587,877. The Company generated net cash of $79,869 in its investing activities in fiscal year 1994 compared to a cash usage of $162,613 in fiscal year 1993, for a net increase in cash and cash equivalents of $670,243 in fiscal 1994. The increase in cash and cash equivalents at the end of fiscal year 1994 is a result of the cash generated by the Company's operating activities.\nLiquidity and Capital Resources\nThe Company believes that it can fund its capital expenditures and its operational requirements from operations and its currently available cash, cash equivalents and short-term investments. Proposed capital expenditures for fiscal year 1996 are expected to total approximately $35,000 compared to actual capital expenditures of $39,905 in fiscal year 1995.\nThe Company has no long-term debt and does not anticipate a long-term need for capital to fund its present business. The Company may, however, need additional capital to fund an acquisition in the event such acquisition requires funding greater than the Company's currently available liquid capital assets, comprised of cash and cash equivalents, investments and trading securities. The Company has not sought to obtain such capital and will do so only in the event it is required to fund an acquisition. The source or terms of such funding, if any, is unknown at this time.\nAdditionally, at December 31, 1995 the working capital ratio (i.e., the ratio o ftotal current assets to total current liabilities) was 5.7:1. At December 31, 1994, the working capital ratio was 8.1:1.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nTo: The Stockholders and The Board of Directors of Edison Control Corporation\nWe have audited the financial statements of Edison Control Corporation listed in the accompanying index to the financial statements (Item 14(a)). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements listed in the accompanying index to financial statements (Item 14(a)) present fairly, in all material respects, the financial position of Edison Control Corporation 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 discussed in Note 1 to the financial statements, in 1994 the Company changed its method of accounting for equity and debt securities.\nMetroPark, New Jersey ERNST & YOUNG LLP February 14, 1996\nEDISON CONTROL CORPORATION BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee Accompanying Notes.\nEDISON CONTROL CORPORATION STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee Accompanying Notes.\nEDISON CONTROL CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY\nSee Accompanying Notes.\nEDISON CONTROL CORPORATION STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee Accompanying Notes.\nEDISON CONTROL CORPORATION RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee Accompanying Notes.\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 1. Summary of significant accounting policies\nOrganization\nEdison Control Corporation (the \"Company\") was incorporated under the laws of the State of New Jersey on June 18, 1986 to succeed a limited partnership organized on October 31, 1979. The Company designs, develops, manufactures and sells electronic fault indicators to the utility industry in North America. The indicators detect electrical transmission and distribution line breakdowns and locate faults (or breaks) in power lines, enabling a more rapid restoration of power.\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 in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCash and cash equivalents\nCash and cash equivalents consist primarily of investments in money market funds. For purposes of the Statement of Cash Flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.\nInvestments\nInvestments consist of certificates of deposit with maturities in excess of three months and are recorded at cost which approximates market. The Company intends to hold these certificates until maturity.\nAccounts receivable-trade\nAccounts receivable-trade are net of an allowance for doubtful accounts of $0 in 1995, $10,000 in 1994 and $0 in 1993.\nInventories\nInventories are stated at the lower of cost or market and are valued by the first-in, first-out method.\nEquipment and leasehold improvements\nEquipment is carried at cost. Depreciation is computed using straight line methods over the estimated useful lives of the assets from 5 to 10 years. Amortization of leasehold improvements is over the lesser of the asset's useful life or the term of the lease agreement.\nIncome taxes\nThe Company uses the liability method to account 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\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 1. Summary of significant account policies (cont'd)\ndifferences are expected to reverse.\nEarnings per common share\nEarnings per common share is based on the weighted average number of common shares and common share equivalents outstanding during each year.\nCommon share equivalents from dilutive stock options were calculated using the treasury stock method.\nAccounting change for equity and debt securities\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The Company adopted the provisions of the new standard for securities 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 as of January 1, 1994 of adopting Statement 115 increased net income by $1,447,567 (net of $962,635 in deferred income taxes), or $ .67 per share.\nAs required by Statement 115, equity and debt securities purchased 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. Prior to January 1, 1994 these marketable securities were valued at the aggregate of the lower of cost or market. The cost of securities sold is based on the first-in, first-out method.\nRevenue recognition\nRevenue is recognized when finished product is shipped.\nResearch and development\nAmounts expended for research and development for the years 1995, 1994 and 1993 totaled $43,475, $32,082 and $26,077 respectively, and are expensed as incurred.\nStock Based Compensation\nThe Company accounts for its stock compensation arrangements under the provisions of APB Opinion No. 25, \"Accounting for Stock Issued to Employees\", and intends to continue to do so. Since the stock options are granted by the Company at the fair value of the shares at the date of grant, no compensation expense is recognized in the accompanying financial statements.\nReclassification\nCertain reclassifications of prior years information were made to conform with current year presentation.\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\n5. License agreement\nIn April, 1993, the Company entered into a research contract with the Electric Power Research Institute (\"EPRI\") for the development of a second generation underground residential distribution (URD) cable fault locator based on an EPRI patent and technology. The cost of the development and test phase of this project is approximately $290,000, of which EPRI is responsible for 64% and the Company is responsible for 36%. During 1995, 1994 and 1993 the Company incurred $43,475, $32,082 and $26,077, respectively, of development costs (excluding internal engineering salaries) on the project.\nIn September, 1993, the Company acquired a licensing agreement from EPRI to manufacture a device based on the above-mentioned project. The license is for a term of 15 years, during the first two years of which the Company has the exclusive right to utilize EPRI's patent and technology. Under the terms of the agreement, EPRI is entitled to percentage royalties based on net sales of the device. No sales have been made or royalties paid to date.\n6. 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 and liabilities as of December 31, 1995 and December 31, 1994 are as follows:\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nSignificant components of the provision (benefits) for income taxes for the years ended December 31, 1995 and 1994 are as follows:\n1995 1994\nCurrent: Federal $ 506,616 $ 128,924 State 185,974 46,250 --------- -------- $ 692,590 $ 175,174 ========= ========\nDeferred: Federal $ 556,595 $( 69,127) State 166,256 ( 20,488) --------- -------- $ 722,851 $( 89,615) ========= ========\nTotal $1,415,441 $ 85,559 ========= ========\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994, and 1993\n7. Stock options\nThe Company adopted a 1986 Stock Option Plan (the \"Plan\") for the benefit of directors, officers and key employees of the Company. Pursuant to the Plan these persons may be granted options to purchase up to an aggregate of 150,000 shares of Common Stock. The Board of Directors may authorize the granting of options under the Plan, and may determine to whom the options may be granted, the number thereof, the option price and the exercise period. The price for incentive stock options, which may be granted under the Plan and which meet the requirements of Section 422A of the Internal Revenue Code, as amended, will not be less than the fair market value of the Common Stock on the date the option is granted (110% of such fair market value for an optionee who holds more than 10% of the outstanding shares of the capital stock of the Company). The price for non-statutory options shall be fixed in the discretion of the Board of Directors and in no event will the option price for any non-statutory option granted be less than 85% of the fair market value of the Common Stock on the date of grant. The maximum exercise period for any option under the Plan is ten years from the date the option is granted (five years for any optionee who holds more than 10% of the outstanding shares of the capital stock of the Company).In November 1987, the Board of Directors issued non-statutory options to purchase an aggregate of 90,000 shares at an exercise price of $2.50 per share (\"2.50 options\"). In 1989 the Company issued non-statutory options to purchase an additional 60,000 shares at an exercise price of $1.22 per share.\nIn June 1993, the Board of Directors granted non-statutory options to purchase 18,000 shares each to Clarke H. Bailey, Gerald B. Cramer, John J. Delucca and Jay J. Miller, and 35,000 shares to William B. Finneran, Directors of the Company, at an exercise price of $2.50 per share, vesting 50% at June 5, 1994 and 50% at June 5, 1995 (\"vesting $2.50 options\"). In June 1995, Clarke H. Bailey exercised his option and purchased 18,000 shares.\nIn July 1993, the Board of Directors granted non-statutory options to purchase 18,000 shares to John M. Sanzo, a Director of the Company, at an exercise price of $4.00 per share, vesting 50% at July 15, 1994 and 50% at July 15, 1995 (\"vesting $4.00 options\"). In October, 1994, the Board of Directors resolved that the stock option, heretofore, granted to Mr. John M. Sanzo to be fully vested notwithstanding any term of said option to the contrary and that said option would expire 120 days following the effectiveness of a Registration Statement on Form S-8 under the Securities Act of 1993, as amended. In June 1995, John M. Sanzo exercised his option and purchased 18,000 shares.\nIn October 1995, the 1986 Stock Option Plan was amended to increase by 200,000 the number of shares of common stock authorized for issuance, thereunder to a total of 350,000 shares.\nIn February 1995, the Board of Directors authorized a grant, subject to and effective upon the date of approval by the Company's stockholders, to the Company's President and Chief Executive Officer of options to purchase up to 200,000 shares of common stock pursuant to the 1986 Option Plan at an exercise price of $4.00 per share vesting 33% each at date of grant, on February 1, 1996, and on February 1, 1997, respectively. At the Annual Meeting on October 17, 1995, the shareholders approved this grant.\nEDISON CONTROL CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994, AND 1993\n8. Major customers\nGulf States Utilities Company accounted for 20%, 13% and 19% of net sales, Jacksonville Electric Authority accounted for 0%, 17% and 9% of net sales, Horry Electric Cooperative, Inc. accounted for 15%, 3% and 3% of net sales and Florida Power And Light Company accounted for 13%, 5%, and .10% of net sales in 1995, 1994 and 1993, respectively. In addition, the Company's export sales accounted for 5%, 16% and 12% of net sales in 1995, 1994 and 1993, respectively.\n9. Commitments and contingencies\nSubsequent to December 31, 1995, the Company entered into a one year lease extension beginning April 1, 1996 for 6,800 square feet of administrative, production and warehouse space. Annual payments under this lease are $35,700, exclusive of joint tenant maintenance fees. The Company incurred rent expense in the amount of $49,382, $44,800 and $25,790 in 1995, 1994 and 1993, respectively (including joint tenant maintenance fees). Also subsequent to December 31, 1995 the Company entered into a one year lease extension beginning February 18, 1996 for office space in New York City at an annual cost of $17,922.\nIn August 1992, the Company became subject to a wrongful discharge lawsuit in the amount of $200,000 filed by a former employee in the United States District Court for the Eastern District of New York. This suit was dismissed in a summary judgment in July, 1993. In December 1993, the Company became subject to a wrongful discharge lawsuit in the amount of $550,000 filed by the same employee in the Superior Court of New Jersey. The Company believes that although this lawsuit is without merit, the cost to continue through trial would have exceeded $25,000. As a result, a settlement of $10,000 was reached in a court conference on January 25, 1995, accrued for in the accompanying financial statements as of December 31, 1994 and paid in March 1995.\nIn February 1995, the Company entered into an employment agreement with one of its executives. The agreement's term is for a three year period and stipulates that the executive's annual base salary shall be $150,000.\n10. Related party transactions\nAt December 31, 1995, Edison Control Corporation held in its investment portfolio 65,000 shares of common stock of Glenayre Technologies, Inc. which were purchased during 1992, 1993 and 1995 at a cost of $1,355,175 and have a market value at December 31, 1995 of $4,046,250. The Chairman of the Board of Glenayre Technologies, Inc. is a member of the Board of Directors of Edison Control Corporation.\n* * * * *\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. * * * * *\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nDirector Name Company Office(s) Since Age\nWilliam B. Finneran Chairman of the Board 1991 54 and Director\nJay J. Miller Secretary and Director (1) 1991 63\nGerald B. Cramer Director (1) (2) 1992 65\nJohn J. Delucca Director (2) 1991 52\nMary E. McCormack President, Chief Executive 1995 42 Officer and Director (3)\nJack V. Miller Vice President, Treasurer and - 57 Chief Financial Officer - ----------\n(1) Member of the Compensation Committee.\n(2) Member of the Audit Committee.\n(3) Hired as President and Chief Executive Officer on February 1, 1995.\nWilliam B. Finneran is a Managing Director of Oppenheimer & Co., Inc., an investment banking firm, with which he has been associated since 1972. Mr. Finneran is a Director of Champion Beverage, Inc., a beverage manufacturer and retailer; Keystone Communications, Inc., a software development company; National Planning Association, a non-profit advisory board; and Covenant House, a non-profit charitable institution. Mr. Finneran was elected Chairman of the Board and Chief Executive Officer of the Company in November, 1991.\nJay J. Miller has been a practicing attorney in the State of New York for more than thirty years. Mr. Miller is a director of Total-Tel U.S.A. Communication, Inc., a provider of long-distance telephone service; Vestro Natural Foods, Inc., a specialty food manufacturer and distributor; and Gulf Resources LTD., a New Zealand Real Estate Company.\nGerald B. Cramer has been Chairman of the Board of Glenayre Technologies, Inc. and its predecessor since 1986. Glenayre Technologies, Inc. is a leading manufacturer of equipment for the wireless telecommunications industry. Mr. ramer has also been Chairman and Chief Executive Officer of Cramer Rosenthal McGlynn, Inc., an investment management firm, since 1973, and also serves as a director of OSHAP Technologies, Ltd, a computer aided design\/manufacturing technology company, and Express America Holdings Corporation, a mortgage banking and servicing company.\nJohn J. Delucca is Senior Vice President and Treasurer of RJR Nabisco. Mr. Delucca was Chief Financial Officer of the Hascoe Association, a private investment company from January, 1991 to September, 1993, President and Chief Financial Officer for The Lexington Group from October, 1990 to January, 1991, Senior Vice President of Finance and Managing Director of the Trump Group from May, 1988 to October, 1990, and Senior Vice President of Finance for International Controls Corporation from April, 1986 to May, 1988. Mr. Delucca is a director of Enzo Biochem, Inc., a genetic research and laboratory company, and Nature Food Centers, Inc.,a specialty retailer.\nMary E. McCormack was appointed President and Chief Executive Officer of the Company on February 1, 1995. Prior to joining the Company, Ms. McCormack was a Managing Director of Beechtree Capital Partners, Inc., a boutique merchant banking firm which she co-founded in 1989. From 1983 to 1989, she served in a variety of capacities for the investment banking and brokerage firm of Advest, Inc., most recently as Vice President-Corporate Finance. Ms. McCormack is a Director of Star International Holdings, Inc., a manufacturer of commercial cooking appliances, and the Junior League of Central Westchester, a non-profit charitable institution.\nJack V. Miller has been with the Company since July, 1991 and has served as Material Manager and General Operation Manager. Mr. Miller was appointed Chief Financial Officer on August 10, 1994 and Treasurer on November 15, 1994. Mr. Miller was appointed Vice President of the Company on October 17, 1995. Prior to joining the Company, Mr. Miller was an independent consultant.\n(1) Value is the difference between the market value of the Company's Common Stock on December 31, 1995 and the exercise price.\nLong-Term Incentive Plan-Awards in the Last Fiscal Year\nThere were no long-term incentive plan awards made by the Company in the year ended December 31, 1995.\nPension Plan\nThe Company has no pension plan for employees or directors.\nStock Option Plan\nThe Company adopted a 1986 Stock Option Plan (the \"Plan\") for the benefit of directors, officers and key employees of the Company. Pursuant to the Plan these persons may be granted options to purchase up to an aggregate of 150,000 shares of Common Stock. The Board of Directors may authorize the granting of options under the Plan and may determine to whom the options may be granted, the number thereof, the option price and the exercise period. The price for incentive stock options which may be granted under the Plan and meet the requirements of Section 422A of the Internal Revenue Code, as amended, will not be less than the fair market value of the Common Stock on the date the option is granted (110% of such fair market value for an optionee who holds more than 10% of the outstanding shares of the capital stock of the Company). The price for non-statutory options shall be fixed in the discretion of the Board of Directors and in no event will the option price for any non-statutory option granted be less than 85% of the fair market value of the Common Stock on the ate of grant. The maximum exercise period for any option under the Plan is ten years from the date the option is granted (five years for any optionee who holds more than 10% of the outstanding shares of the capital stock of the Company). In November, 1987, the Board of Directors issued non-statutory options to purchase an aggregate of 90,000 shares at an exercise price of $2.50 per share (\"$2.50 options\"). In 1989 the Company issued non-statutory options to purchase an additional 60,000 shares at an exercise price of $1.22 per share.\nIn June 1993, the Board of Directors granted non-statutory options to purchase 18,000 shares each to Clarke H. Bailey, Gerald B. Cramer, John J. Delucca and Jay J. Miller, and 35,000 shares to William B. Finneran, Directors of the Company, at an exercise price of $2.50 per share, vesting 50% at June 5, 1994 and 50% at June 5, 1995 (\"vesting $2.50 options\"). In June 1995, Clarke H. Bailey exercised his 18,000 option shares.\nIn July 1993, the Board of Directors granted non-statutory options to purchase 18,000 shares to John M. Sanzo, Director of the Company, at an exercise price of $4.00 per share, vesting 50% at July 15, 1994 and 50% at July 15, 1995 (\"vesting $4.00 options\"). In October, 1994, the Board of Directors resolved that the stock option, heretofore, granted Mr. John M. Sanzo to be fully vested notwithstanding any term of said option to the contrary and that said option expire 120 days following the effectiveness of a Registration Statement on Form S-8 under the Securities Act of 1993, as amended. In June 1995, John M. Sanzo exercised said option in full.\nIn October 1995, the 1986 Stock Option Plan was amended to increase by 200,000 the number of shares of common stock authorized for issuance, thereunder to a total of350,00 shares.\nIn February 1995, the Company entered into a 3 year Employment Agreement with Mary McCormack which includes the grant of a stock option referenced to in Note 7 of the Notes to Financial Statements on page 25 of this report.\nITEM 12.","section_11":"","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nSecurity Ownership of Certain Beneficial Owners\nSet forth below is certain information concerning persons who are known by the Company to own beneficially more than 5% of the Company's outstanding Common Stock on March 1, 1996:\nName and Address Number of Shares Percentage Of Beneficial Owner Owned of Class\nWilliam B. Finneran 765,785 (1,2) 33.0% World Financial Center 34th Floor New York, NY 10281\nEdco Partners, Ltd. 182,053 7.9% 950 17th Street, Suite 1600 Denver, CO 80202\nJohn M. Sanzo 152,000 7.1% 140 Ethel Road West Piscataway, NJ 08854\n- ------------\n(1) Includes 60,000 currently exercisable stock options.\n(2) Does not include 4,740 shares owned by two Uniform Gifts to Minors Act accounts, each account for the benefit of one of Mr. Finneran's children; Mr. Finneran disclaims beneficial ownership of these shares for purposes of section 16 of the Securities Exchange Act of 1934, as amended, or otherwise.\nSecurity Ownership of Management\nThe following table sets forth as of March 1, 1996 information concerning the beneficial ownership of Common Stock by each director of the Company and all directors and officers of the Company as a group:\nName of Number of Shares Percentage Beneficial Owner Owned of Class\nGerald B. Cramer 88,000 (3) 3.8%\nJohn J. Delucca 28,000 (3) 1.2%\nWilliam B.Finneran 765,785 (1,2) 33.0% (1,2)\nMary E. McCormack 66,666 (4) 2.9%\nJay J. Miller 18,000 (3) 0.8%\nAll Directors and Officers as a group (5 in number) 966,451 45.2%\n(1) Includes 60,000 currently exercisable stock options.\n(2) Includes 4,740 shares owned by two Uniform Gifts to Minors Act accounts, each account for the benefit of Mr. Finneran's children; Mr. Finneran disclaims beneficial ownership of these shares for purposes of Section 16 of the Securities Exchange Act of 1934, as amended, or otherwise.\n(3) Includes 18,000 currently exercisable stock options.\n(4) Includes 66,666 currently exercisable stock options.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nMr. Gerald B. Cramer is Chairman of the Board of Glenayre Technologies, Inc. At December 31, 1995, the Company held in its investment portfolio 65,000 common shares of stock in Glenayre Technologies, Inc., acquired in 1992, 1993 and 1995 at a cost of $1,355,175 and has a market value at December 31, 1995 of $4,046,250.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) There are filed as part of this Form 10-K the following:\n1. Report of Independent Auditors\nFinancial Statements\nBalance Sheets as of 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\n2. Financial Statement Schedules\nAll schedules to the financial statements are omitted since the required information is either inapplicable or the information is presented in the financial statements or related notes.\n(b) Employment Agreement between the Company and Mary E. McCormack\n3. Listing of Exhibits\nIncorporation by Reference Exhibit Number Description of Documents Designation\n(3) (i) * Certificate of Incorporation (3) (i) filed June 18, 1986 (ii) * By-laws of the Company (3) (ii)\n(4) (i) ** Copy of Specimen Stock (4) (i) Certificate (ii) * Form of Warrant sold to (4) (ii) McKinley Allsopp, Inc. (iii) * 1986 Stock Option Plan of (4) (iii) Company\n(10) (i) * Employment Agreement (10) (i) between Company and Taft B. Russell\n(ii) * License Agreement, dated (10) (iii) September 7, 1979, between Company and Hershel Toomim\n(iii) *** Employment Agreements dated November 1, 1987 between Company and George Powers, Anthony Gagliardi and Marilyn Salko\n(iv) * Employment Agreement dated February 1, 1995 between the Company and Mary E. McCormack\n* Previously filed as Exhibits to Registration Statements on Forms S-18 (File No. 33-6736-NY), filed with the Securities and Exchange Commission on June 24, 1986, and incorporated herein by reference\n** Previously filed as Exhibits to Amendment No. 1 to Registration Statement on Form S-18 (File No. 33-6736-NY), filed with the Securities and Exchange Commission on July 23, 1986, and incorporated herein by reference\n*** Previously filed as exhibits to Form 10-K for year ended December 31, 1988\n(c) No reports on Form 8-K have been filed during the last quarter of the period covered by this Annual 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.\nEDISON CONTROL CORPORATION\n\/s\/ Mary E. McCormack By: Mary E. McCormack President, Chief Executive Officer and Director\n\/s\/ Jack V. Miller By: Jack V. Miller Vice President, Treasurer 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 and in the capacities and on the dates indicated:\nSignature Title Date\n\/s\/ William B. Finneran 3\/27\/96\nWilliam B. Finneran Chairman of the Board and Director\n\/s\/ Mary E. McCormack 3\/27\/96\nMary E. McCormack President, Chief Executive Officer and Director\n\/s\/ Jack V. Miller 3\/27\/96\nJack V. Miller Vice President, Treasurer and Chief Financial Officer\n\/s\/ Jay J. Miller 3\/27\/96\nJay J. Miller Secretary and Director\n\/s\/ Gerald B. Cramer 3\/27\/96\nGerald B. Cramer Director\n\/s\/ John J. Delucca 3\/27\/96\nJohn J. Delucca Director","section_15":""}
{"filename":"45012_1995.txt","cik":"45012","year":"1995","section_1":"Item 1. Business.\nGeneral Development of Business. Halliburton Company (the Company) was established in 1919 and incorporated under the laws of the state of Delaware in 1924. The Company provides energy services and engineering and construction services. Information related to acquisitions and dispositions is set forth in Note 13 to the financial statements of this Annual Report. Financial Information About Business Segments. The Company is comprised of two business segments. See Note 9 to the financial statements of this Annual Report for financial information about these two business segments. Description of Services and Products. The following is a summary which briefly describes the Company's services and products for each business segment. Halliburton Energy Services (Energy Services) provides a wide range of services and products to provide integrated solutions to customers in the exploration, development and production of oil and natural gas. Energy Services operates worldwide serving major oil companies, independent operators and national oil companies. The services and products provided by Energy Services include cementing, casing equipment and water control services; completion and production products; directional drilling systems, measurement while drilling, logging while drilling and mud logging services; open and cased hole logging and perforating services and logging and perforating products; well testing, reservoir description and evaluation services, tubing conveyed well completion systems and reservoir engineering services; stimulation, sand control services and coiled tubing services; and wellhead pressure control equipment, well control, hydraulic workover and downhole video services. Engineering and Construction Services (Brown & Root) includes services for both land and marine activities. Included are technical and economic feasibility studies, site evaluation, licensing, conceptual design, process design, detailed engineering, procurement, project and construction management, construction and start-up assistance of electric utility plants, chemical and petrochemical plants, refineries, pulp and paper mills, metal processing plants, highways and bridges, subsea construction, fabrication and installation of subsea pipelines, offshore platforms, production platform facilities, marine engineering and other marine related projects, contract maintenance and operations and maintenance services for both industry and government, engineering and environmental consulting and waste management services for industry, utilities and government, and remedial engineering and construction services for hazardous waste sites. Markets and Competition. The Company is one of the world's largest diversified energy services and engineering and construction services companies. The Company's services and products are sold in highly competitive markets throughout the world. Competition in both services and products is based upon a combination of price, service (including the ability to deliver services and products on an \"as needed where needed\" basis), product quality, warranty and technical proficiency. Some Energy Services' and Engineering and Construction Services' customers have indicated a preference for integrated services and solutions. These integrated solutions, in the case of Energy Services, relate to all phases of exploration and production of oil and gas, and, in the case of Engineering and Construction Services, relate to all phases of design, procurement, construction, project management and maintenance of a facility. Demand for these types of integrated solutions is based primarily upon quality of service, technical proficiency and overall price. The Company conducts business worldwide in over 100 countries. Since the market for the Company's services and products is so large and crosses many geographic lines, a meaningful estimate of the number of competitors cannot be made. The markets are, however, highly competitive with many substantial companies operating in each market. Generally, the Company's services and products are marketed through its own servicing and sales organizations. A small percentage of sales of Energy Services' products is made by supply stores and third-party representatives. Operations in some countries may be affected by unsettled political conditions, expropriation or other governmental actions, and exchange control and currency problems. The Company believes the geographic diversification of its business activities reduces the risk that loss of its operations in any one country would be material to the conduct of its operations taken as a whole. Information regarding the Company's exposures to foreign currency fluctuations, risk concentration and financial instruments used to minimize risk is included in Note 11 to the financial statements of this Annual Report.\nCustomers and Backlog. Substantially all of the Company's Energy Services and a significant portion of Engineering and Construction Services are related to the energy industry. In 1995, 1994, and 1993, respectively, 78%, 78% and 79% of the Company's revenues were derived from the sale of products and services to, including construction for, the energy industry. The following schedule summarizes the backlog of engineering and construction projects at December 31, 1995 and 1994:\nIt is estimated that nearly 65% of the backlog existing at December 31, 1995 will be completed during 1996. The Company does not believe that engineering and construction backlog should necessarily be relied on as an indication of future operating results since such backlog figures are subject to substantial fluctuations. Arrangements included in backlog are in many instances extremely complex, nonrepetitive in nature and may fluctuate in contract value. Many contracts do not provide for a fixed amount and are subject to modification or termination by the customer. Due to the size of certain contracts, the termination or modification of any one or more contracts or the addition of other contracts may have a substantial and immediate effect on backlog. Orders for Energy Services are generally placed by customers on the basis of current need. Therefore, backlog of orders for these services and products are not material. Raw Materials. Raw materials essential to the Company's business are normally readily available. Where the Company is dependent on a single supplier for any materials essential to its business, the Company is confident that it could make satisfactory alternative arrangements in the event of interruption in the supply of such materials. Research, Development and Patents. The Company maintains an active research and development program to assist in the improvement of existing products and processes, the development of new products and processes and the improvement of engineering standards and practices that serve the changing needs of its customers. Information relating to expenditures for research and development is included in Note 1 to the financial statements of this Annual Report. The Company owns a large number of patents and has pending a substantial number of patent applications covering various products and processes. It is also licensed under patents owned by others. The Company does not consider a particular patent or group of patents to be material to the Company's business. Seasonality. Weather and natural phenomena can temporarily affect the performance of the Company's services. Winter months in the Northern Hemisphere tend to affect operations negatively, but the widespread geographical locations of the Company's services serve to mitigate the seasonal nature of the Company's business. Employees. At December 31, 1995 the Company employed approximately 57,300 people of which 23,300 were located outside the United States. Regulation. The Company is subject to various environmental laws and regulations. Compliance with such requirements has neither substantially increased capital expenditures or adversely affected the Company's competitive position, nor materially affected the Company's earnings. The Company does not anticipate any such material adverse effects in the foreseeable future as a result of such existing laws and regulations. Note 10 to the financial statements of this Annual Report discusses the Company's involvement as a potentially responsible party in remedial activities to clean up various \"Superfund\" sites.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nInformation relating to lease payments is included in Note 10 to the financial statements of this Annual Report. The Company's owned and leased facilities, as described below, are suitable and adequate for their intended use. Energy Services owns manufacturing facilities covering approximately 3,400,000 square feet. Principal locations of these manufacturing facilities are Davis and Duncan, Oklahoma; Alvarado, Amarillo, Carrollton, Fort Worth, Garland, Houston and Mansfield, Texas; Arbroath, Scotland; Reynosa, Mexico; and Jurong, Singapore. The manufacturing facilities at Davis, Amarillo, and one of four locations in Houston were idle at the end of 1995. The manufacturing facility in Cisco, Texas was sold in 1995. The manufacturing facility in Mansfield, Texas is leased to another company. Energy Services also leases manufacturing facilities covering approximately 96,000 square feet. Principal locations of these facilities are Jurong, Singapore; Basingstoke, England; and Kilwinning, Scotland. Research, development and engineering activities are carried out in owned facilities covering approximately 440,000 square feet in Duncan, Oklahoma; Houston and Carrollton, Texas; and Aberdeen, Scotland; and leased facilities covering approximately 41,000 square feet in Bedford, England; and Leiderdorp,\nHolland. One of two facilities in Houston was idle at the end of 1995. In addition, service centers, sales offices and field warehouses are operated at approximately 200 locations in the United States, almost all of which are owned, and at approximately 270 locations outside the United States in both the Eastern and Western Hemispheres. Engineering and Construction Services owns manufacturing facilities covering approximately 441,000 square feet in Houston, Texas, and Edmonton, Canada of which 388,000 square feet in Houston is leased to another Company. Engineering and Construction Services also owns marine fabrication facilities covering approximately 640 acres in Belle Chasse, Louisiana; Greens Bayou, Texas; Sunda Strait, Indonesia (35% owned); and Nigg and Wick, Scotland. The Belle Chasse, Louisiana facility consisting of approximately 165 acres is idle. Engineering and design, project management and procurement services activities are carried out in owned facilities covering approximately 4,800,000 square feet in Houston, Texas; Edmonton, Canada; Leatherhead, England; and Aberdeen, Scotland. Approximately 1,000,000 square feet of the Aberdeen facility was leased to another company and 400,000 square feet was idle at the end of 1995. These activities are also carried out at leased facilities covering approximately 2,000,000 square feet in Mobile, Alabama; Alhambra, California; Gaithersburg, Maryland; Aiken, South Carolina; Eastleigh and London, England; Kuala Lumpur, Malaysia; Stavanger, Norway; Singapore; Aberdeen, Scotland; Plzen, Czech Republic; Al Khobar, Saudi Arabia; and Bahrain. In addition, laboratories, service centers, and sales offices are operated at approximately 30 locations in the United States, almost all of which are leased by the Company, and at approximately 10 foreign locations in both the Eastern and Western Hemispheres.\nGeneral Corporate operates from leased facilities in Dallas, Texas covering approximately 55,000 square feet. The Company also leases approximately 5,500 square feet of space in Washington, D.C. In connection with outsourcing of the computer and data processing services, the 85,000 square foot mainframe processing center in Arlington, Texas has been leased to another company which has the exclusive right to purchase the facility until April, 1996.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nInformation relating to various commitments and contingencies is described in Note 10 to the financial statements of this Annual Report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1995.\nItem 4(A). Executive Officers of the Registrant.\nThe following table indicates the names and ages of the executive officers of the registrant along with a listing of all offices held by each during the past five years:\nName and Age Offices Held and Term of Office\n* Richard B. Cheney Director of Registrant, since October 1995. (Age 55) Chairman of the Board, since January 1996 President and Chief Executive Officer, since October 1995 Senior Fellow, American Enterprise Institute, 1993 to October 1995 Secretary, U.S. Department of Defense, 1989 to 1992\nLester L. Coleman Executive Vice President and General Counsel, (Age 53) since May 1993 President of Energy Services Group, September 1991 to May 1993 Executive Vice President of Finance and Corporate Development, January 1988 to September 1991\n* Dale P. Jones Director of Registrant, since December 1988 (Age 59) Vice Chairman, since October 1995 President, June 1989 to October 1995\n* Tommy E. Knight President and Chief Executive Officer of (Age 57) Brown & Root, Inc., since May 1992 Executive Vice President - Operations of Brown & Root, Inc, January 1990 to May 1992\n* David J. Lesar Executive Vice President and Chief Financial (Age 42) Officer, since August 1995 Executive Vice President of Finance and Administration of Halliburton Energy Services, November 1993 to August 1995 Partner, Arthur Andersen LLP, 1988 to November 1993\n* Kenneth R. LeSuer President and Chief Executive Officer of Halliburton (Age 60) Energy Services, since March 1994 President and Chief Operating Officer of Halliburton Energy Services, May 1993 to March 1994 President and Chief Executive Officer of Halliburton Services, December 1989 to May 1993\n* Members of the Executive Committee of the registrant. There are no family relationships between the executive officers of the registrant.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nThe Company's common stock is traded on the New York Stock Exchange, the Stock Exchange of London, and the Swiss Stock Exchanges at Zurich, Geneva, Basel and Lausanne. Information relating to market prices of common stock and quarterly dividend payments is included under the caption \"Quarterly Data and Market Price Information\" on page 30 of this Annual Report. At December 31, 1995, there were approximately 16,200 shareholders of record. In calculating the number of shareholders, the Company considers clearing agencies and security position listings as one shareholder for each agency or listing.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nInformation relating to selected financial data is included on page 31 of this Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nInformation relating to management's discussion and analysis of financial condition and results of operations is included on pages 7 to 9 of this Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. Page No. Responsibility for Financial Reporting............................ 10 Report of Arthur Andersen LLP, Independent Public Accountants..... 11 Consolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993............................. 12 Consolidated Balance Sheets at December 31, 1995 and 1994......... 13 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993............................. 14 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993................. 15\nNotes to Financial Statements..................................... 16 to 29\nQuarterly Data and Market Price Information....................... 30\nThe related financial statement schedules are included under Part IV, Item 14 of this Annual Report.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nBUSINESS ENVIRONMENT AND OUTLOOK Approximately 80% of the Company's revenues are derived from services and products delivered to the energy industry. The Company operates in over 100 countries around the world to provide a variety of energy services and engineering and construction services. Operations in some countries may be affected by unsettled political conditions, expropriation or other governmental actions, and exchange control and currency problems. The Company believes the geographic diversification of its business activities reduces the risk that loss of its operations in any one country would be material to the conduct of its operations as a whole. The energy industry. The energy industry has experienced declining selling prices per barrel of oil equivalent, adjusted for inflation, during the past ten years. Per barrel costs of finding, developing and producing hydrocarbons have also declined. This is the result of several factors. Energy companies have restructured to reduce costs. Technological advances such as horizontal drilling, geosteering, logging while drilling, multi-lateral completions, 3-D seismic and coiled tubing applications are decreasing costs, improving well productivity and optimizing the ultimate recovery of hydrocarbon reserves. In addition, there is a trend toward incentive contracts between energy companies and their suppliers, alliances, contracts to produce, outsourcing arrangements and integrated solution approaches in order to reduce costs and share risks and gains from efficiencies. Although in early stages of development, the Company expects that the integrated solutions approach will be a major future growth area. The current outlook based upon published sources is that demand for oil and natural gas will increase with economic growth and that prices for oil and natural gas will be stable near term and increase moderately longer term. One major uncertainty is the potential negative impact on oil prices should Iraq reenter the market. Significant market areas with increasing exploration and development activities include international and the Gulf of Mexico. Services to the energy industry. The operations of the Company devoted to the energy industry are impacted by changes in oil and natural gas development activities in major producing areas throughout the world. These activities are sensitive to government actions in major producing countries, oil and natural gas prices and capital spending for hydrocarbon exploration, development, production, processing and pipeline delivery networks. In response to customer efforts to reduce costs and increase production, the Company has reorganized its operations to reduce its overall service and product delivery costs through increased productivity and cost efficiencies. The Company has the capability to provide a wide range of services needed to operate an existing oil and natural gas field or a new field and to handle all phases of bringing energy to market, including drilling and completing wells, building pipelines and other means of transportation and building refineries. The Company provides project management, development planning, well construction, production enhancement and production maintenance services to the energy industry through its Energy Services and Engineering and Construction Services segments. Based upon the outlook for the energy industry, the Company expects revenue growth in 1996 with some improvement in operating margins. Other industries served. The remaining 20% of the Company's revenues are derived from engineering, construction, maintenance, environmental services and logistical support services to governmental and industrial customers worldwide. According to published sources, these markets are expected to grow 15% to 20% in 1996. These markets are sensitive to changes in the economies of the world, government actions in the major economies and capital spending by industries and governments throughout the world. The Company's outlook. The Company's outlook could be negatively impacted by any of the factors noted above including significant changes in oil and gas prices, world economic and political conditions, and new or modified embargoes against oil and gas producing countries such as Iran, Iraq, Libya and Nigeria.\nRESULTS OF OPERATIONS Revenues in 1995 were $5,698.7 million, an increase of 3% over 1994 revenues of $5,510.2 million but a 6% decrease from 1993 revenues of $6,094.1 million. Excluding the revenues of businesses sold in 1994, revenues in 1995 increased by 5% over 1994 revenues and by 1% over 1993 revenues. Approximately 51% of the Company's consolidated revenues were derived from international activities in 1995 compared to 45% in 1994 and 43% in 1993. Consolidated international revenues increased 17% in 1995 over 1994 and 19% over 1993. Energy Services 1995 revenues increased by 4% to $2,623.4 million in 1995 compared to 1994 but declined by 11% from 1993 revenues. Excluding the revenues of businesses sold in 1994, Energy Services 1995 revenues increased by 7% over 1994 and 6% over 1993 primarily due to higher international activity levels, partially offset by a decline in the United States. Energy Services revenues per rotary rig, excluding the revenues of businesses sold in 1994, were up by 11% in 1995 over 1994 and up by 6% over 1993. The increases in revenues per rotary rig were accomplished at the same time the rotary rig count declined by 3% in 1995 compared to 1994 and was the same as 1993. International revenues per rotary rig increased 15% in 1995 over 1994 and 10% over 1993. United States revenues per rotary rig increased 5% in 1995 over 1994 but was down about 1% from 1993. Engineering and Construction Services 1995 revenues increased by 3% to $3,075.3 million in 1995 compared to 1994, but decreased by 2% compared to 1993.\nOperating income was $383.2 million in 1995 compared to $236.1 million in 1994 and an operating loss of $91.5 million in 1993. Excluding the special items and businesses sold in 1994 as described below, 1995 operating income increased by 54% over 1994 operating income of $248.4 million and by 68% over 1993 operating income of $227.7 million. Approximately 63% of the Company's consolidated operating income was derived from international activities in 1995 compared to 46% in 1994 and 60% in 1993. Consolidated international operating margins were 8% in 1995 compared to 5% in 1994 and 6% in 1993. Energy Services operating income in 1995 was $313.7 million, compared to $191.8 million in 1994 and a loss of $148.4 million in 1993. Excluding the special items and businesses sold in 1994 as described below, operating income in 1995 increased 54% over 1994 and 84% over 1993. Operating income increased in all geographic regions worldwide. Operating margins during 1995, 1994 and 1993 were 12%, 8% and 7%, respectively. The increase in 1995 margins was due to lower indirect costs and international revenue growth. Lower margins in 1994 were due primarily to decreased activities in the North Sea, Middle East and Asia Pacific, market disturbances in Nigeria and Yemen, unsettled economic, political and business conditions in the CIS and pricing pressures in the United States. Engineering and Construction Services operating income in 1995 increased 53% over 1994 and 31% over 1993 to $103.0 million. The increase in 1995 operating income is primarily due to improved performance in international marine construction activities and petrochemical engineering and construction activities in the Middle East. Operating income in 1994 includes a $5.0 million gain on the sale of an environmental remediation subsidiary.\nBusinesses sold in 1994 were the geophysical products and services business, natural gas compression business and the workover platform business. Special items recognized in 1994 and 1993 are as follows: In 1994, the Company sold its natural gas compression business and recognized a $102.0 million gain in other nonoperating income ($64.3 million net of income taxes). In addition, the Company recognized a $42.6 million charge against Energy Services operating income ($27.7 million net of income taxes) to recognize severance costs for the termination of about 2,700 employees. The terminations mostly impacted middle and senior management levels and various product line support and general and administrative employees. In 1993, the Company recognized a $301.8 million charge against Energy Services operating income ($263.8 million net of income taxes) to reflect the net realizable value of the Company's geophysical operations which were disposed of in January 1994. The Company also provided a $20.0 million charge in 1993 ($13.0 million net of income taxes) related to Energy Services non-geophysical employee severance costs. The provision for income taxes in 1993 was reduced by $40.4 million due to a settlement with the Internal Revenue Service relating to tax assessments for the 1980 - 1987 years and also reduced by $6.4 million due to changes in Federal income tax laws. See Note 5 to the financial statements. Interest income increased in 1995 to $27.8 million from $16.1 million in 1994 and $14.0 million in 1993 due primarily to higher levels of invested cash. Foreign currency gains (losses) netted to a gain of $1.5 million in 1995 compared to losses of $16.0 million in 1994 and $20.8 million in 1993. Included in the 1995 results were gains from devaluations of the Nigerian Naira and the Venezuelan Bolivar offset by losses in other currencies, particularly the Mexican Peso. Losses in 1994 and 1993 related primarily to Brazil and Venezuela. Losses in 1993 also included losses from certain African currency exposures. The Company routinely hedges its exposures to currency fluctuations using simple currency derivative instruments. See Note 11 to the financial statements for a description of such exposures and derivative instruments. Provision for income taxes was higher in 1995 than in 1994 and 1993 due to increased income. The effective income tax rates, excluding the businesses sold in 1994 and the special items outlined above, declined to 36% in 1995 from 42% in 1994 and 47% in 1993. The declines in the effective income tax rate were due primarily to the decrease in losses not currently benefited and increased realization of available net operating losses.\nDISCONTINUED OPERATIONS consists of the Company's Insurance Services Group. The Company declared a dividend on December 26, 1995 and subsequently distributed its property and casualty insurance subsidiary, Highlands Insurance Group, Inc. (HIGI), to its shareholders in a tax-free spin-off on January 23, 1996. The operations of the Insurance Services Group have been classified as discontinued operations. During 1995, HIGI increased its reserves for claim losses and related expenses and provisions for certain legal matters which together with certain other provisions associated with the Company's complete exit from the insurance industry resulted in a $67.2 million charge against net earnings. See Note 14 to the financial statements for further information.\nLIQUIDITY AND CAPITAL RESOURCES The Company ended the year 1995 with cash and equivalents of $174.9 million compared with $375.3 million in 1994 and $7.5 million in 1993. The decrease in cash and equivalents is primarily due to the prepayment of debt of $432.7 million, partially offset by increased cash flows from operating activities. The Company's cash return on gross invested capital, consistent with the Company's Cash Value Added performance measurement, adopted in 1994, was 13% in 1995 compared to 9% in 1994 and 5% in 1993. This is due to improved operating cash flows, dispositions of businesses and unproductive assets, the prepayment of debt and the spin-off of HIGI. CASH FLOWS FROM OPERATING ACTIVITIES were $632.0 million in 1995 compared to $415.4 million in 1994 and $269.6 million in 1993. The increases are attributable primarily to increased income and, in 1995, reductions in working capital. CASH FLOWS FROM INVESTING ACTIVITIES used $238.3 million in 1995 compared to $210.9 million in cash provided in 1994 and $323.4 million of cash used in 1993. Capital expenditures increased in 1995 by 24% over 1994 and 18% over 1993 mostly representing investments in new technologies such as logging while drilling and multi-lateral completions. The Company's capital expenditures are expected to continue to increase in 1996 as new technologies will continue to be developed and deployed. In 1994, the Company sold substantially all of the assets of its geophysical services and products business for $190.0 million and its natural gas compression business for $205.0 million. CASH FLOWS USED FOR FINANCING ACTIVITIES were $591.3 million in 1995 compared to $252.7 million in 1994 and $81.0 million in 1993. The increase in outflows is due to higher payments of long-term indebtedness. In 1995, the entire outstanding principal amounts of the zero coupon convertible subordinated debentures of $390.7 million and the $42.0 million term loan were redeemed with available cash resources. See Note 6 to the financial statements. In 1994, the Company redeemed the remaining $23.8 million of its 10.2% debentures and made $48.8 million in installments on the $73.8 million note issued by the Company to the buyer of the geophysical business. In 1993, the Company redeemed $56.5 million principal amount of its debentures. Total debt was 11%, 26% and 27% of total capitalization at the end of 1995, 1994 and 1993, respectively. The Company has the ability to borrow additional short-term and long-term funds if necessary. See Note 6 to the financial statements regarding the Company's various short-term lines of credit. In 1993, in connection with the acquisition of the drilling systems business, the Company issued 6,857,000 shares of Common Stock previously held as treasury stock valued at approximately $247 million.\nENVIRONMENTAL MATTERS The Company is involved as a potentially responsible party in remedial activities to clean up various \"Superfund\" sites under applicable Federal law which imposes joint and several liability, if the harm is indivisible, on certain persons without regard to fault, the legality of the original disposal, or ownership of the site. Although it is very difficult to quantify the potential impact of compliance with environmental protection laws, management of the Company believes that any liability of the Company with respect to all but one of such sites will not have a material adverse effect on the results of operations of the Company. See Note 10 to the financial statements for additional information on the one site.\nRESPONSIBILITY FOR FINANCIAL REPORTING\nHalliburton Company is responsible for the preparation and integrity of its published financial statements. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and, as such, include amounts based on judgments and estimates made by management. The Company also prepared the other information included in the annual report and is responsible for its accuracy and consistency with the financial statements. The financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of stockholders, the board of directors and committees of the board. The Company maintains a system of internal control over financial reporting, which is intended to provide reasonable assurance to the Company's management and board of directors regarding the preparation of financial statements. The system includes a documented organizational structure and division of responsibility, established policies and procedures including codes of conduct to foster a strong ethical climate, which are communicated throughout the Company, and the careful selection, training and development of our people. Internal auditors monitor the operation of the internal control system and report findings and recommendations to management and the board of directors, and corrective actions are taken to address control deficiencies and other opportunities for improving the system as they are identified. The board, operating through its audit committee, which is composed entirely of directors who are not officers or employees of the Company, provides oversight to the financial reporting process. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Furthermore, the effectiveness of an internal control system may change over time. The Company assessed its internal control system in relation to criteria for effective internal control over financial reporting described in \"Internal Control-Integrated Framework\" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon that assessment, the Company believes that, as of December 31, 1995, its system of internal control over financial reporting met those criteria.\nHALLIBURTON COMPANY\nby (Dick Cheney) by (David J. Lesar) Dick Cheney David J. Lesar Chairman of the Board, President Executive Vice President and Chief Executive Officer and Chief Financial Officer\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors, Halliburton Company:\nWe have audited the accompanying consolidated balance sheets of Halliburton Company (a Delaware corporation) and subsidiary companies 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. These financial statements are the responsibility of Halliburton Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Halliburton Company 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.\nARTHUR ANDERSEN LLP Dallas, Texas January 23, 1996\nNOTES TO FINANCIAL STATEMENTS\nNote 1. Significant Accounting Policies The Company employs accounting policies that are in accordance with generally accepted accounting principles in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires Company 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. Ultimate results could differ from those estimates. Principles of Consolidation. The consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries. All material intercompany accounts and transactions are eliminated. Investments in other affiliated companies in which the Company has at least 20% ownership and does not have management control are accounted for on the equity method. In connection with the discontinuance of the Company's insurance segment, the Company has adopted a classified balance sheet format. Certain prior year amounts have been reclassified to conform with current year presentation. Revenues and Income Recognition. The Company recognizes revenues as services are rendered or products are shipped. The distinction between services and product sales is based upon the overall business intent of the particular business operation. Revenues from construction contracts are reported on the percentage of completion method of accounting using measurements of progress toward completion appropriate for the work performed. All known or anticipated losses on any contracts are provided for currently. Claims for additional compensation are recognized during the period such claims are resolved. Research and Development. Research and development expenses are charged to income as incurred. Such charges were $88.5 million in 1995, $109.5 million in 1994 and $126.5 million in 1993. In addition, the Company capitalized software development costs related primarily to integrated information technologies and project management of $3.9 million in 1995, $6.4 million in 1994 and $39.8 million in 1993. Income Per Share. Income per share is based on the weighted average number of common shares and common share equivalents outstanding during each year. Common share equivalents included in the computation represent shares issuable upon assumed exercise of stock options which have a dilutive effect. Cash Equivalents. The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Receivables. The Company's receivables are generally not collateralized. Notes and accounts receivable at December 31, 1995 include $22.3 million ($30.1 million at December 31, 1994) due from customers in accordance with applicable retainage provisions of engineering and construction contracts, which will become billable upon future deliveries or completion of such contracts. Of the December 31, 1995 amount, approximately $17.8 million is expected to be collected during 1996 and the remainder is due in subsequent years. Unbilled work on uncompleted contracts generally represents work currently billable and such work is usually billed during normal billing processes in the next month. Inventories. Inventories are stated at cost which is not in excess of market. Cost represents invoice or production cost for new items and original cost less allowance for condition for used material returned to stock. Production cost includes material, labor and manufacturing overhead. About one-third of all sales items (including related work in process and raw materials) are valued on a last-in, first-out (LIFO) basis. Inventories of sales items owned by foreign subsidiaries and inventories of operating supplies and parts are generally valued at average cost. Depreciation, Amortization and Maintenance. Depreciation and amortization for financial reporting purposes is provided primarily on the straight-line method over the estimated useful lives of the assets not exceeding 40 years. Expenditures for maintenance and repairs are expensed; expenditures for renewals and improvements are generally capitalized. Upon sale or retirement of an asset, the related cost and accumulated depreciation or amortization are removed from the accounts and any gain or loss is recognized. In the event that facts and circumstances indicate that assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. Income Taxes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefit, or that future deductibility is prohibited or uncertain. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been realized in the financial statements or tax returns. Derivative Instruments. The Company enters into derivative financial transactions to hedge existing or projected exposures to changing foreign exchange rates, interest rates, security prices, or commodity prices. The Company does not enter into derivative transactions for speculative purposes. Hedges of derivative financial transactions are generally carried at fair value with the resulting gains and losses reflected in the results of operations.\nForeign Currency Translation. Foreign entities whose functional currency is the U.S. dollar translate monetary assets and liabilities at year-end exchange rates and 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 and cost of product sales which are translated at historical rates. Gains or losses from changes in exchange rates are recognized in consolidated income in the year of occurrence. Foreign entities whose functional currency is the local currency translate net assets at year-end rates and income and expense accounts at average exchange rates. Adjustments resulting from these translations are reflected in the Shareholders' Equity section titled \"Cumulative translation adjustment\".\nNote 2. Inventories About one-third of all sales items (including related work in process and raw materials) are valued using the LIFO method. If the average cost method had been in use for inventories on the LIFO basis, total inventories would have been about $18.3 million and $21.9 million higher than reported at December 31, 1995 and 1994, respectively.\nNote 3. Property, Plant and Equipment\nNote 4. Related Companies The Company conducts some of its operations through various joint venture and other partnership forms which are principally accounted for using the equity method. Included in the Company's revenues for 1995, 1994 and 1993 are equity in income of related companies of $88.4 million, $93.0 million and $76.3 million, respectively. When the Company sells or transfers assets to an affiliated company that is accounted for using the equity method and the affiliated company records the assets at fair value, the excess of the fair value of the assets over the Company's net book value is deferred and amortized over the expected lives of the assets. Deferred gains included in the Company's other liabilities were $10.1 million and $19.4 million at December 31, 1995 and 1994, respectively. Summarized financial statements for European Marine Contractors, Limited, a 50% owned company which specializes in engineering, procurement and construction of marine pipelines, and for the remaining combined jointly owned operations which are not consolidated are as follows:\nNote 5. Income Taxes The components of the (provision) benefit for income taxes are:\nIncluded in deferred income taxes are foreign tax credits of $31.6 million in 1995 and $18.4 million in 1994. The U.S. and foreign components of income (loss) from continuing operations before income taxes and minority interests are as follows:\nThe primary components of the Company's deferred tax assets and liabilities and the related valuation allowances are as follows:\nThe Company has foreign tax credits which expire in 2000 of $11.5 million. The Company has net operating loss carryforwards which expire as follows: 1996, $11.5 million; 1997, $19.3 million; 1998, $27.0 million; 1999, $30.2 million; 2000 through 2010, $108.7 million; and indefinite, $64.6 million. Reconciliations between the actual benefit (provision) for income taxes and that computed by applying the U.S. statutory rate to income or loss from continuing operations before income taxes and minority interests are as follows:\nThe Company has received statutory notices of deficiency for the 1989, 1990 and 1991 tax years from the Internal Revenue Service (IRS) of $51.8 million, $92.9 million and $16.8 million, respectively, excluding any penalties or interest. The Company believes it has meritorious defenses and does not expect that any liability resulting from the 1989, 1990 or 1991 tax years will result in a material adverse effect on its results of operations or financial position. In 1993, the Company reached a settlement with the IRS for the 1980-1987 taxable years. As a result of the settlement, as well as significant prepayments of\ntaxes in prior years, the Company received a refund and net income was increased by $40.4 million in 1993.\nNote 6. Lines of Credit and Long-Term Debt\nThe Company has short-term lines of credit totaling $125.0 million with several U.S. banks. No borrowings were outstanding at December 31, 1995 under these credit facilities. At December 31, 1995, $4.8 million of other short-term debt was outstanding. The Company's 8.75% debentures due February 15, 2021 do not have sinking fund requirements and are not redeemable prior to maturity. In September 1995, the Company redeemed all of the zero coupon convertible subordinated debentures due March 13, 2006 for $390.7 million in cash, which represents the original issue price plus accrued original issue discount to the redemption date. In addition, in December 1995, the Company redeemed all of the $42.0 million term loan. The remaining $23.8 million of the 10.2% sinking fund debentures were redeemed in 1994. Long-term debt of $5.2 million matures during 1996 and there are no maturities due for the succeeding four years.\nNote 7. Common Stock The Company's 1993 Stock and Long-Term Incentive Plan (1993 Plan) provides for the grant of any or all of the following types of awards: (1) stock options, including incentive stock options and non-qualified stock options; (2) stock appreciation rights, in tandem with stock options or freestanding; (3) restricted stock; (4) performance share awards; and (5) stock value equivalent awards. Under the terms of the 1993 Plan, 5.5 million shares of the Company's Common Stock were reserved for issuance to key employees. At December 31, 1995, 2.0 million shares were available for future grants. Stock option transactions are summarized as follows:\nAll stock options are granted at fair market value of the Common Stock at the grant date. The weighted average fair value of the stock options granted during 1995 was $13.20. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1995: risk-free interest rate of 6.22%; expected dividend yield of 2.38%; expected life of five years; and expected volatility of 32.11%. Stock options generally expire ten years from the grant date or three years after date of retirement, if earlier. Stock options vest over a three year period, with one-third of the shares becoming exercisable on each of the first three anniversaries of the grant date. The outstanding stock options at December 31, 1995 have a weighted average contractual life of 8.92 years. The number of stock option shares exercisable at December 31, 1995 was 745,744. These stock options have a weighted average exercise price of $34.31 per share. The Company accounts for the 1993 Plan in accordance with Accounting Principles Board Opinion No. 25, under which no compensation cost has been\nrecognized for stock option awards. Had compensation cost for the 1993 Plan been determined consistent with Statement of Financial Accounting Standards No. 123, \"Accounting for Stock - Based Compensation\" (SFAS 123), the Company's pro forma net income and earnings per share for 1995 would have been $164.5 million and $1.44, respectively. Because the SFAS 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Restricted shares awarded under the 1993 Plan for 1995, 1994 and 1993 were 206,350, 80,600 and 107,000, respectively. The shares awarded are net of forfeitures of 4,900 and 5,000 shares in 1995 and 1994, respectively. The weighted average fair market value per share at the date of grant of shares granted in 1995 was $40.88. The Company's Restricted Stock Plan for Non-Employee Directors (Restricted Stock Plan) allows for each non-employee director to receive an annual award of 200 restricted shares of Common Stock as a part of compensation. The Company reserved 50,000 shares of Common Stock for issuance to non-employee directors. The Company issued 1,600 restricted shares in 1995 and 1,800 restricted shares in both 1994 and 1993 under this plan. The weighted average fair market value per share at the date of grant of shares granted in 1995 was $40.75. The Company's Employees' Restricted Stock Plan was established for employees who are not officers, for which 100,000 shares of Common Stock have been reserved. The Company awarded 1,750 and 96,750 restricted shares in 1995 and 1994, respectively, and 900 restricted shares were forfeited in 1995. The weighted average fair market value per share at the date of grant of shares granted in 1995 was $35.00. Under the terms of the Company's career executive incentive stock plan, 7.5 million shares of the Company's Common Stock were reserved for issuance to officers and key employees at a purchase price not to exceed par value of $2.50 per share. At December 31, 1995, 5.9 million shares (net of 1.0 million shares forfeited) have been issued under the plan. No further grants will be made under the career executive incentive stock plan. Restricted shares issued under the 1993 Plan, Restricted Stock Plan, Employees' Restricted Stock Plan and the career executive incentive stock plan are limited as to sale or disposition with such restrictions lapsing periodically over an extended period of time. The fair market value of the stock, on the date of issuance, is being amortized and charged to income (with similar credits to paid-in capital in excess of par value) generally over the average period during which the restrictions lapse. Compensation costs recognized in income for 1995 was $7.0 million. At December 31, 1995, the unamortized amount is $23.9 million.\nNote 8. Series A Junior Participating Preferred Stock In 1986, the Company declared a dividend of one preferred stock purchase right (a Right) on each outstanding share of common stock, terms of which were subsequently modified as of February 15, 1990 and December 15, 1995 (the Amended Rights Agreement). Pursuant to the Amended Rights Agreement, each Right will entitle the holder thereof to buy one one-hundredth of a share of the Company's Series A Junior Participating Preferred Stock, without par value, at an exercise price of $150, subject to certain antidilution adjustments. The Rights do not have any voting rights and are not entitled to dividends. The Rights become exercisable in certain limited circumstances involving a potential business combination. Following certain other events after the Rights become exercisable, each Right will entitle its holder to an amount of common stock of the Company, or, in certain circumstances, securities of the acquiror, having a then-current market value of two times the exercise price of the Right. The Rights are redeemable at the Company's option at any time before they become exercisable. The Rights expire on December 15, 2005. No event during 1995 made the Rights exercisable.\nNote 9. Business Segment Information The Company operates in two segments - Energy Services and Engineering and Construction Services. Energy Services' products and services include drilling systems and services, pressure pumping equipment and services, logging and perforating, specialized completion and production equipment and services, and well control. Engineering and Construction Services provides engineering, construction, project management, facilities operation and maintenance, and environmental services for industrial and governmental customers. The Company's equity in income or losses of related companies is included in revenues and operating income of each applicable segment. Intersegment revenues included in the revenues of the other business segments are immaterial. Sales between geographic areas and export sales are also immaterial. General and administrative expenses were $157.8 million, $182.0 million and $195.9 million for the years ended December 31, 1995, 1994 and 1993, respectively. Depreciation and amortization expenses were increased in 1993 by the loss for the sale of the geophysical business in 1994 discussed in Note 13 by $128.9 million. General corporate assets are primarily comprised of cash and equivalents and certain other investments.\nNote 10. Commitments and Contingencies Leases. At December 31, 1995, the Company was obligated under noncancelable operating leases, expiring on various dates to 2108, principally for the use of land, offices, equipment and field facilities. Aggregate rentals charged to operations for such leases totaled $70.4 million in 1995, $105.3 million in 1994, and $130.8 million in 1993. Future aggregate rentals on noncancelable operating leases are as follows: 1996, $50.3 million; 1997, $41.8 million; 1998, $31.7 million; 1999, $23.0 million; 2000, $14.0 million; and thereafter, $94.2 million.\nEnvironmental. The Company is involved as a potentially responsible party (PRP) in remedial activities to clean up various \"Superfund\" sites under applicable Federal law which imposes joint and several liability, if the harm is indivisible, on certain persons without regard to fault, the legality of the original disposal, or ownership of the site. Although it is very difficult to quantify the potential impact of compliance with environmental protection laws, management of the Company believes that any liability of the Company with respect to all but one of such sites will not have a material adverse effect on the results of operations of the Company. With respect to a site in Jasper County, Missouri (Jasper County Superfund Site), sufficient information has not been developed to permit management to make such a determination and management believes the process of determining the nature and extent of remediation at this site and the total costs thereof will be lengthy. Brown & Root, Inc. (Brown & Root), a subsidiary of the Company, has been named as a PRP with respect to the Jasper County Superfund Site by the Environmental Protection Agency (EPA). The Jasper County Superfund Site includes areas of mining activity that occurred from the 1800's through the mid 1950's in the southwestern portion of Missouri. The site contains lead and zinc mine tailings produced from mining activity. Brown & Root is one of nine participating PRPs which have agreed to perform a Remedial Investigation\/Feasibility Study (RI\/FS), which is not expected to be completed until the third quarter of 1996. Although the entire Jasper County Superfund Site comprises 237 square miles as listed on the National Priorities List, in the RI\/FS scope of work, the EPA has only identified seven areas, or subsites, within this area that need to be studied and then possibly remediated by the PRPs. Additionally, the Administrative Order on Consent for the RI\/FS only requires Brown & Root to perform RI\/FS work at one of the subsites within the site, the Neck\/Alba subsite, which only comprises 3.95 square miles. Brown & Root's share of the cost of such a study is not expected to be material. At the present time Brown & Root cannot determine the extent of its liability, if any, for remediation costs on any reasonably practicable basis. Other. The Company and its subsidiaries are parties to various other legal proceedings. Although the ultimate dispositions of such proceedings are not presently determinable, in the opinion of the Company any liability that may ensue will not be material in relation to the consolidated financial position and results of operations of the Company.\nNote 11. Financial Instruments and Risk Concentration Foreign Exchange Risk. The Company operates in over 100 countries around the world and has exposures to currency fluctuations in approximately 80 foreign currencies. These exposures subject the Company to the risk that the eventual dollar net cash flows from sales to customers and purchases from suppliers could be adversely affected by changes in exchange rates. Some currencies have established markets that facilitate the active exchange of one currency for another (traded currencies), but most currencies are not widely traded and are actively controlled by their respective governments (non-traded currencies). It is the Company's policy to hedge significant exposures to potential foreign exchange losses considering current market conditions, future operating activities and the cost of hedging the exposure in relation to the perceived risk of loss. Techniques in managing foreign exchange risk include, but are not limited to, foreign currency borrowing, investing, and the use of currency derivative instruments. Foreign currency transactions for speculative purposes are not permitted. Market Risk. As part of the Company's efforts to minimize market risk associated with foreign currency exchange rate volatility, the Company hedges its exposure in traded currencies through the use of currency derivative instruments, specifically, forward exchange contracts and foreign exchange option contracts. Such contracts generally have an expiration date of one year or less. Forward exchange contracts (commitments to buy or sell a specified amount of a foreign currency at a specified price and time) are generally used to hedge identifiable foreign currency commitments. Gains or losses on such contracts are deferred and recognized when the offsetting gains and losses are recognized on the related hedged items. Foreign exchange option contracts (which convey the right, but not the obligation, to sell or buy a specified amount of foreign currency at a specified price) are generally used to hedge foreign currency commitments with an indeterminable maturity date. The use of some contracts may limit the Company's ability to benefit from favorable fluctuations in foreign exchange rates. Forward and option contracts associated with foreign currency commitments having indeterminable maturity dates are marked to market monthly with the resulting gains or losses included in current period income. While hedging instruments are subject to fluctuations in value, such fluctuations are generally offset by the value of the underlying exposures being hedged. The forward or option contracts utilized are all purchased from a selected group of highly rated banks. None of the forward or option contracts are exchange traded. At December 31, 1995, the Company held foreign currency forward contracts with net notional amounts totaling $12.4 million, in which the Company was the buyer of $3.4 million and the seller of $15.8 million of foreign currencies, and foreign currency option contracts with net notional amounts totaling $54.1 million in which the Company was the buyer of $18.1 million and the seller of $72.2 million of foreign currencies. At December 31, 1994, the Company held foreign currency forward contracts with net notional amounts totaling $11.8 million, in which the Company was the buyer of $5.1 million and the seller of $16.9 million of foreign currencies, and foreign currency option contracts with net notional amounts totaling $12.2 million, in which the Company was the buyer of $26.0 million and the seller of $38.2 million of foreign currencies. The Company actively monitors its foreign currency exposure (net\nposition) and adjusts the amounts hedged as appropriate. The table below summarizes the Company's net assets (liabilities) exposed to currency fluctuations at December 31, 1995, in traded (other than U.S. dollar) and non-traded foreign currencies as well as the net notional amounts of the related hedging contracts held.\nExposures to non-traded currencies are generally not hedged due primarily to lack of available markets or cost considerations. The Company attempts to manage its working capital position to minimize foreign currency commitments in non-traded currencies and recognizes that pricing for the services and products offered in such countries should cover the cost of exchange rate devaluations. The Company has historically incurred transaction losses in non-traded currencies. The risk of loss is primarily due to the magnitude of currency devaluations experienced in those currencies rather than the size of the foreign currency exposures. Net assets subject to currency exposure resulting from the use of functional currencies other than the U.S. dollar in which exchange movements affect shareholders' equity were $143.0 million in 1995. Credit Risk. Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash equivalents, investments and trade receivables. It is the Company's practice to place its cash equivalents and investments in high quality securities with various investment institutions. The Company derives the majority of its revenues from sales and services to, including engineering and construction for, the energy industry. Within the energy industry, trade receivables are generated from a broad and diverse group of customers. There are concentrations of receivables in the United States and the United Kingdom. The Company maintains an allowance for losses based upon the expected collectibility of all trade accounts receivable. The notional amounts of the Company's foreign exchange contracts do not generally represent amounts exchanged by the parties, and thus, are not a measure of the exposure of the Company or of the cash requirements relating to these contracts. The credit exposure of the Company on foreign exchange contracts is represented by the carrying amount of such contracts. Counterparties are selected by the Company based on creditworthiness, which the Company continually monitors, and on the counterparties' ability to perform their obligations under the terms of the transactions. There are no significant concentrations of credit risk with any individual counterparty or groups of counterparties related to the Company's derivative contracts. The Company does not expect any counterparties to fail to meet their obligations under these contracts given their high credit ratings and, as such, considers the credit risk associated with its derivative contracts to be minimal. Fair Value of Financial Instruments. The estimated fair value of long-term debt at December 31, 1995 and 1994 was $247.9 million and $626.1 million, respectively, as compared to the carrying amount of $200.0 million and $643.1 million at December 31, 1995 and 1994, respectively. The fair value of long-term debt is based on quoted market prices for those or similar instruments. The carrying amount of short-term financial instruments (cash and equivalents, receivables, and certain other liabilities) as reflected in the consolidated balance sheets approximates fair value due to the short maturities of these instruments. The fair value of currency derivative instruments, which generally approximates the carrying amount, was less than $2.5 million at December 31, 1995 and 1994.\nNote 12. Retirement Plans Retirement Plans. The Company has various retirement plans which cover a significant number of its employees. The major pension plans are defined contribution plans, which provide pension benefits in return for services rendered, provide an individual account for each participant, and have terms that specify how contributions to the participant's account are to be determined rather than the amount of pension benefits the participant is to receive. Contributions to these plans are based on pre-tax income and\/or discretionary amounts determined on an annual basis. The Company's expense for the defined contribution plans totaled $94.2 million, $98.0 million and $54.6 million in 1995, 1994 and 1993, respectively. Other pension plans include defined benefit plans, which define an amount of pension benefit to be provided, usually as a function of one or more factors such as age, years of service, or compensation. As a result of the sizable reduction in the number of employees, curtailment gains of $1.3 million and $8.9 million are reflected in the net amortization and deferral component of net periodic pension cost for 1995 and 1994, respectively.\nThese plans are funded to operate on an actuarially sound basis. Assumed long-term rates of return on plan assets, discount rates in estimating benefit obligations and rates of compensation increases vary for the different plans according to the local economic conditions. Plan assets are primarily invested in equity and fixed income securities of entities domiciled in the country of the plan's operation. The rates used are as follows:\nThe net periodic pension cost for defined benefit plans is as follows:\nThe reconciliation of the funded status for defined benefit plans where assets exceed accumulated benefits is as follows:\nThe reconciliation of the funded status for defined benefit plans where accumulated benefits exceed assets is as follows:\nPostretirement Medical Plan. The Company offers a postretirement medical plan to certain employees that qualify for retirement and, on the last day of active employment, are enrolled as participants in the Company's active employee medical plan. The Company's liability is limited to a fixed contribution amount for each participant or dependent. Effective in September 1993, coverage under this plan ceases when the participant reaches age 65. However, those participants aged 65 or over on January 1, 1994, have the option to participate in an expanded prescription drug program in lieu of the medical coverage. The plan participants share the total cost for all benefits provided above the fixed Company contribution and participants' contributions are adjusted as required to cover benefit payments. The Company has made no commitment to adjust the amount of its contributions; therefore, the computed accumulated postretirement benefit obligation amount is not affected by the expected future healthcare cost inflation rate. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7% in 1995, 8% in 1994 and 7% in 1993.\nNet periodic postretirement benefit cost included the following components:\nNon-pension postretirement benefits are funded by the Company when incurred. The Company's postretirement medical plan's funded status reconciled with the amounts included in the Company's Consolidated Balance Sheets at December 31, 1995 and 1994 is as follows:\nNote 13. Acquisitions and Dispositions See Note 14 as to the disposition of the Company's insurance segment. The Company sold its natural gas compression business unit in November 1994 for $205.0 million in cash. The sale resulted in a pretax gain of $102.0\nmillion, or 56 cents per share after tax. The business unit sold owns and operates a large natural gas compressor rental fleet in the United States and Canada. The compressors are used to assist in the production, transportation and storage of natural gas. In January 1994, the Company sold substantially all of the assets of its geophysical services and products business to Western Atlas International Inc. for $190.0 million in cash and notes subject to certain adjustments. The notes of $90.0 million were sold for cash in the first quarter of 1994. In addition, the Company issued $73.8 million in notes to Western Atlas to cover some of the costs of reducing certain geophysical operations, including the cost of personnel reductions, leases of geophysical marine vessels and the closing of duplicate facilities. The Company's notes to Western Atlas are payable over two years at a rate of interest of 4%. An initial installment of $33.8 million was made in February 1994, and quarterly installments of $5.0 million have been made thereafter. The Company recognized a $301.8 million charge ($263.8 million after tax) in 1993 related to the sale of its geophysical business. This charge includes $120.7 million for the write-down to the net realizable value of equipment and other assets; $54.0 million for anticipated operating and contract losses through the dates of disposition or completion; $43.4 million for marine vessel leases and mobilization; $35.1 million for facility leases and closures; $34.4 million for personnel and severance; and $14.2 million for transition costs and other related matters. Services and products provided through the geophysical business include seismic data collection and data processing services for both land and marine seismic exploration activities and manufacturing and sales of seismic equipment. The revenues, operating loss and net loss of the geophysical operations, excluding the charge in 1993, were $404.4 million, $20.1 million, and $20.3 million, respectively. In March 1993, the Company acquired the assets of Smith International, Inc.'s Directional Drilling Systems and Services business for 6,857,000 shares of Halliburton Company Common Stock previously held as treasury stock, valued at approximately $247 million. The Company recorded $135.8 million as excess of cost over net assets acquired. The excess of cost over net assets acquired will be amortized over 40 years.\nNote 14. Discontinued Operations On January 23, 1996, the Company spun-off its property and casualty insurance subsidiary, Highlands Insurance Group, Inc. (HIGI), in a tax-free distribution to holders of Halliburton Company common stock. Each common shareholder of the Company received one share of common stock of HIGI for every ten shares of Halliburton Company common stock. Approximately 11.4 million common shares of HIGI were issued in conjunction with the spin-off. After the spin-off transaction, HIGI issued $62.9 million of convertible subordinated debentures due December 31, 2005 with detachable Series A and B Common Stock Purchase Warrants to Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda), L.P. (IP) and to certain members of HIGI management. The convertible subordinated debentures issued are convertible into common stock of HIGI after one year from issuance at the option of the holders. HIGI can redeem the debentures at any time after December 31, 2002. The holders would receive approximately 3.9 million shares of HIGI, or approximately 25% ownership interest in HIGI, if all of the debentures are converted into common stock of HIGI at a conversion price of $16.16 per share. Interest on the debentures is payable semiannually in cash at 10% per annum. The detachable Series A Common Stock Purchase Warrants (Series A Warrants) enable the holders to purchase HIGI common stock at an exercise price of $14.69 per share, equal to an additional ownership interest of approximately 21% after giving effect to the assumed conversion of the debentures and the exercise of the Series A Warrants. If all of the Series A Warrants were exercised, IP would receive approximately 4.0 million shares of HIGI. The exercise price and the number of shares of HIGI common stock into which the Series A Warrants are exercisable will be subject to adjustment in certain circumstances. These warrants expire on December 31, 2005. The detachable Series B Common Stock Purchase Warrants (Series B Warrants) enable the holders to purchase shares of HIGI common stock at an exercise price of $14.69, equal to an additional ownership interest of 5% after giving effect to the assumed conversion of the debentures and the exercise of the Series A and B Warrants. The Series B Warrants become exercisable by the holders in the event that the average closing market price of HIGI common stock exceeds 1.61 times the exercise price for any 30 consecutive trading days prior to December 31, 2000 but after December 31, 1998. If all of the Series B Warrants were exercised, the holders would receive approximately 1.0 million additional shares of HIGI. The exercise price and the number of shares of HIGI common stock into which the Series A Warrants are exercisable will be subject to adjustment in certain circumstances. The detachable Series B Warrants expire on December 31, 2005. If the debentures are converted into common stock of HIGI and the Series A and B Warrants are utilized by the holders to purchase common stock of HIGI, the holders will own approximately 44% of HIGI.\nThe following summarizes the results of operations and consolidated balance sheets of the discontinued operations. Such amounts are summarized as follows:\nIn the third quarter of 1995, HIGI conducted an extensive review of its loss and loss adjustment expense reserves to assess HIGI's reserve position. The review process consisted of gathering new information and refining prior estimates and primarily focused on assumed reinsurance and overall environmental and asbestos exposure. As a result of such review, HIGI increased its reserves for loss and loss adjustment expenses and certain legal matters and the Company also recognized the estimated expenses related to the spin-off transaction and additional compensation costs and other regulatory and legal provisions directly associated with discontinuing the insurance services business segment as follows:\nThe review of the insurance policies and reinsurance agreements was based upon a recent actuarial study and HIGI management's best estimates using facts and trends currently known, taking into consideration the current legislative and legal environment. Developed case law and adequate claim history do not exist for such claims. Estimates of the liability are reviewed and updated\ncontinually. Due to the significant uncertainties related to these types of claims, past claim experience may not be representative of future claim experience. The Company also realized a valuation allowance for deferred tax assets primarily related to HIGI's insurance claim loss reserves. The Company had provided a valuation allowance for all temporary differences related to HIGI based upon its intent announced in 1992 that it was pursuing the sale of HIGI. A taxable transaction would have made it more likely than not that the related benefit or future deductibility would not be realized. The spin-off transaction was tax-free and allows HIGI to retain its tax basis and the value of its deferred tax asset.\nEUROPEAN MARINE CONTRACTORS LIMITED\nCOMBINED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nThese financial statements are presented in pounds sterling. The exchange rate was 1.54 U.S. dollars to the pound sterling at the balance sheet date of December 31, 1995.\nEUROPEAN MARINE CONTRACTORS LIMITED - --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nTo the Board of Directors European Marine Contractors Limited\nWe have audited the accompanying consolidated balance sheets of European Marine Contractors Limited as of December 31, 1995 and 1994, and the related consolidated statements of income, total recognised gains and losses and cashflows 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 audit.\nWe conducted our audits in accordance with United Kingdom auditing standards which do not differ in any significant respect from United States generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurances about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, 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 management, as 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 European Marine Contractors Limited 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 accounting principles generally accepted in the United Kingdom\nERNST & YOUNG Chartered Accountants Registered Auditor London, England\n15 February 1996\nEUROPEAN MARINE CONTRACTORS LIMITED GROUP PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nEUROPEAN MARINE CONTRACTORS LIMITED GROUP STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES FOR THE YEAR ENDED 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nEUROPEAN MARINE CONTRACTORS LIMITED BALANCE SHEETS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nEUROPEAN MARINE CONTRACTORS LIMITED GROUP STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n1 ACCOUNTING POLICIES\nAccounting Convention\nThe financial statements are prepared under the historical cost convention as modified to include the revaluation of certain fixed assets and in accordance with applicable United Kingdom accounting standards.\nBasis of Consolidation\nThe group financial statements consolidate the financial statements of European Marine Contractors Limited and EMC Nederland BV drawn up to 31 December each year.\nJoint Ventures\nThe company's share of the results of unincorporated joint ventures is proportionally consolidated in the group profit and loss account and balance sheet.\nGoodwill\nPurchased goodwill is amortised through the profit and loss account over the directors' original estimate of its useful life.\nDepreciation\nDepreciation is provided at rates calculated to write off the cost less the expected residual value of each fixed asset over its expected useful life as follows:\nMarine floating equipment - at 25% per annum on a reducing balance basis Buildings and leasehold improvements - over 3-15 years on a straight line basis Plant & Machinery:- Other marine equipment - over 2-5 years on a straight line basis Office equipment - over 4-5 years on a straight line basis\nDepreciation on assets under construction is provided when assets are partially brought into use during the year, at the appropriate rate above.\nEquipment Maintenance\nThe marine floating equipment is dry-docked for major repairs in accordance with statutory requirements. Other maintenance works are carried out on a yearly basis. Provisions towards meeting both these costs are being made each year based on an estimate of costs to be incurred and the future utilisation programmes.\nStocks\nStocks are valued at the lower of cost and net realisable value.\nForeign Currency\nThe financial statements of consolidated undertakings are translated at the rate of exchange prevailing at the balance sheet date.\nThe exchange adjustments arising on re-translating the opening net assets are taken directly to reserves.\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nOperating Leases\nRentals paid in respect of operating leases are charged to the profit and loss account on a straight line basis over the term of the lease.\nPensions\nPension scheme contributions are made in accordance with actuarial advice and are charged to the profit and loss account so as to spread the pension cost over the anticipated period of service of scheme members.\nGovernment Grants\nGovernment Grants on capital expenditure are credited to a deferral account and are released to revenue over the expected useful life of the relevant asset by equal annual amounts.\nLong Term Contracts\nProfit on long term contracts is taken as the work is carried out if the final outcome can be assessed with reasonable certainty. The profit included is calculated on a basis to reflect the proportion of the work carried out at the year end, by recording turnover and related costs as contract activity progresses. Turnover is calculated on that proportion of total contract value which costs incurred to date bear to total expected costs for that contract. Revenues derived from variations on contracts are recognised only when they have been accepted by the customer. Full provision is made for losses on all contracts in the year in which they are first foreseen.\nDeferred Taxation\nDeferred taxation is provided under the liability method on all timing differences which are expected to reverse in the future without being replaced, calculated at the rate at which it is estimated that tax will be payable. Deferred tax assets are recognised only where recovery is reasonably certain.\n2 TURNOVER\nTurnover comprises that part of each contract value represented by work completed at the balance sheet date. Turnover excludes applicable VAT.\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\nIncluded in turnover is (pound)1,722,000 (1994: (pound)14,407,000, 1993: (pound)29,346,000) in respect of sales to related undertakings which constitute the shareholders of European Marine Contractors Limited and their group undertakings.\nTurnover by destination is not materially different.\nThe net assets of the group are substantially located in the North Sea and temporarily in the Middle East.\nThe profit analysis for prior years has been restated on the basis of operating profit.\n4 a) OPERATING PROFIT\nOperating profit is stated after charging\/(crediting):\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n4 b) RECONCILIATION OF OPERATING PROFIT TO NET CASH INFLOW FROM OPERATING ACTIVITIES\n5 INTEREST PAYABLE AND SIMILAR CHARGES\n6 TAX ON PROFIT ON ORDINARY ACTIVITIES\nThe tax charge is made up as follows:-\nIf full provision had been made for deferred taxation for the year, the taxation charge would have been reduced \/(increased) by (pound)2m (1994: (pound)(0.3)m, 1993: Nil), as follows:\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n7 EMOLUMENTS OF DIRECTORS\nThe emoluments (excluding pension contributions) of the directors of the company are detailed as follows:-\n8 STAFF COSTS\nThe average number of persons employed by the group (and their costs) during the year, including directors, was as follows:-\nIn addition the group has used the services on average of 519 (1994: 601, 1993: 568) persons who were directly employed by the shareholders of European Marine Contractors Limited, their group undertakings and third party agencies.\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n9 TANGIBLE FIXED ASSETS\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n9 Tangible Fixed Assets (continued)\nThe assets under construction mainly consist of barge enhancements in progress at the year end.\nThe historical cost of the vessels included in marine floating equipment is as follows:\nThe vessels will be revalued in three years' time, unless market conditions change to an extent that necessitates an earlier revaluation.\nThe increase in the depreciation charge in the year as a result of revaluation is (pound)7.25m (1994: (pound)10.3m).\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n10 INVESTMENTS\nJoint Venture\nThe company has a 50% interest in Saipem SpA\/EMC Ltd J.V., an unincorporated joint venture, which is based in Bangkok, Thailand.\nThe remaining interest in the above joint venture is held by the other joint venture partner, Saipem SpA, which is a fellow group undertaking of Saipem UK Limited, a shareholder of the company.\nThis undertaking is managed jointly through management committees comprised of a representative from each joint venturer.\n11 STOCKS\nIn the directors' opinion the replacement value of stocks is approximately (pound)13.1m ((pound)15.7m in 1994).\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n12 DEBTORS\nIncluded in prepayments and accrued income is a deferred tax asset of (pound)8,431,000 (1994: (pound)5,615,000) due after more than one year. Further details are disclosed in note 16.\n13 CASH\nAnalysis of balances as shown in the group balance sheet and changes during the current and previous years:\n14 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR\nThe amounts shown under Accruals and deferred income as at 31 December 1994 have been restated in accordance with the provision restatement in note 15.\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n15 PROVISIONS FOR LIABILITIES AND CHARGES\nProvision is made for the periodic dry-docking and major planned maintenance expenditure of marine floating equipment. The provision shown as at 31 December 1994 has been restated to include amounts shown under Creditors in the 1994 Accounts due to a change in the planned maintenance schedule.\n16 DEFERRED TAXATION\nThe deferred tax asset included under debtors represents:\nThe deferred tax amounts not provided are as follows:\nThe potential tax charge of (pound)7.6m (1994: (pound)10.2m) which would arise on the sale of the revalued vessels has not been provided for as it is not the intention of the directors to dispose of these assets.\n17 SHARE CAPITAL\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n18 RESERVES\n19 PENSIONS\nOne hundred and thirty eight (1994: 122, 1993: 92) of the group's UK employees are members of a pension scheme operated by Brown & Root Limited, which controls the overall administration of the scheme. This scheme is of the defined benefit type. Contributions amounting to (pound)352,461 (1994: (pound)315,524, 1993: (pound)248,698) were charged to the profit and loss account during the year. The scheme includes employee contributions at a percentage of pensionable salaries. The pension cost is assessed in accordance with the advice of independent qualified actuaries and the latest actuarial assessment of the scheme was 1 January 1993. Further details of the Brown & Root scheme are included in the Brown & Root Limited accounts.\nEight (1994: 8, 1993: 7) other UK employees are members of the Merchant Navy Officers' Pension Fund, which was set up in July 1992. Contributions to this fund amounting to (pound)24,551 (1994: (pound)15,932, 1993: (pound)12,129) were made during the year.\nA further twenty three (1994: 21, 1993: 21) of the group's employees are members of the EMC Nederland BV pension scheme. The charge to the profit and loss account of (pound)102,451 (1994: (pound)74,550, 1993: (pound)52,195), in respect of this scheme has been determined in accordance with best local practice.\n20 CAPITAL COMMITMENTS\nThe board of directors has authorised capital expenditure of (pound)3,626,000 (1994: (pound)12,816,000) mainly in connection with the modification of vessels. Approximately (pound)1,321,000 (1994: (pound)172,000) of this authorised expenditure has already been contracted.\n21 CONTINGENT LIABILITIES\nThere are no contingent liabilities in existence as at the date on which the financial statements are approved that would have a material impact upon the financial position of the company other than those disclosed below.\nPerformance bonds have been issued in the ordinary course of business by bankers and supported by the shareholders to the value of (pound)96.6 million (1994: (pound)85.9 million). No liabilities are expected to arise from these other than those provided for in the financial statements.\nEUROPEAN MARINE CONTRACTORS LIMITED NOTES TO THE FINANCIAL STATEMENTS AT 31 DECEMBER 1995 - --------------------------------------------------------------------------------\n22 LEASING COMMITMENTS\nAmounts payable in the following year on operating leases which expire:\nOther leases relate primarily to the charter of support vessels.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of Registrant.\nThe information required for the directors of the Registrant is incorporated by reference to the Halliburton Company Proxy Statement dated March 26, 1996, under the caption \"Election of Directors.\" The information required for the executive officers of the Registrant is included under Part I, Item 4(A), page 5 of this Annual Report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThis information is incorporated by reference to the Halliburton Company Proxy Statement dated March 26, 1996, under the captions \"Compensation Committee Report on Executive Compensation,\" \"Comparison of Five Year and Three Year Cumulative Total Return,\" \"Summary Compensation Table,\" \"Option Grants in Last Fiscal Year,\" \"Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values,\" \"Retirement Plan\" and \"Directors' Compensation, Restricted Stock Plan and Retirement Plan.\"\nItem 12(a). Security Ownership of Certain Beneficial Owners.\nThis information is incorporated by reference to the Halliburton Company Proxy Statement dated March 26, 1996, under the caption \"Stock Ownership of Certain Beneficial Owners and Management.\"\nItem 12(b). Security Ownership of Management.\nThis information is incorporated by reference to the Halliburton Company Proxy Statement dated March 26, 1996, under the caption \"Stock Ownership of Certain Beneficial Owners and Management.\"\nItem 12(c). Changes in Control.\nNot applicable.\nItem 13.","section_12":"","section_13":"Item 13. Certain Relationships and Related Transactions.\nThis information is incorporated by reference to the Halliburton Company Proxy Statement dated March 26, 1996, 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. Financial Statements:\nThe report of Arthur Andersen LLP, Independent Public Accountants, and the financial statements of the Company as required by Part II, Item 8, are included on pages 11 through 29 of this Annual Report. See index on page 6.\n2. Financial Statement Schedules:\nThe financial statements of European Marine Contractors, Limited (EMC), the investment in which is accounted for on the equity method, follow the Five Year Financial Record. The EMC financial statements were prepared in accordance with accounting principles generally accepted in the United Kingdom. Certain parent company adjustments were included in the selected financial data presented in Note 4 to the Company's financial statements in order to conform with generally accepted accounting principles in the United States.\nNote: All schedules not filed herein for which provision is made under rules of Regulation S-X have been omitted as not applicable or not required or the information required therein has been included in the notes to financial statements.\n3. Exhibits:\nExhibit Number Exhibits\n3* By-laws of the Company, as amended through February 15, 1996.\n4(a) Resolutions of the Board of Directors of the registrant adopted at a meeting held on February 11, 1991 and of the special pricing committee of the Board of Directors of the registrant adopted at a meeting held on March 6, 1991 incorporated by reference to Exhibit 4(c) to the Company's Form 8-K dated as of March 13, 1991.\n4(b) Subordinated Indenture dated as of January 2, 1991 between the Company and Texas Commerce Bank National Association, as Trustee, incorporated by reference to Exhibit 4(b) to the Company's Form 8-K dated as of March 13, 1991.\n4(c) Form of debt security of 8.75% Debentures due February 15, 2021 incorporated by reference to Exhibit 4(a) to the Company's Form 8-K dated as of February 20, 1991.\n4(d) Senior Indenture dated as of January 2, 1991 between the Company and Texas Commerce Bank National Association, as Trustee, incorporated by reference to Exhibit 4(b) to the Company's Form 8-K dated as of February 20, 1991.\n4(e) Resolutions of the Company's Board of Directors adopted at a meeting held on February 11, 1991 and of the special pricing committee of the Board of Directors of the Registrant adopted at a meeting held on February 11, 1991 and the special pricing committee's consent in lieu of meeting dated February 12, 1991, incorporated by reference to Exhibit 4(c) to the Company's Form 8-K dated as of February 20, 1991.\n4(f) Composite Certificate of Incorporation filed May 26, 1987 with the Secretary of State of Delaware and that certain Certificate of Designation, Rights and Preferences related to the authorization of the Company's Junior Participating Preferred Stock, Series A, incorporated by reference to Exhibit 4(d) to the Company's Registration Statement on Form S-3 dated as of December 21, 1990.\n4(g) Copies of instruments which define the rights of holders of miscellaneous long-term notes of the Registrant and its subsidiaries, totaling $0.2 million in the aggregate at December 31, 1995, have not been filed with the Commission. The Registrant agrees herewith to furnish copies of such instruments upon request.\n4(h) Copies of the instruments which define the rights of the holder of the 4.0% notes payable totaling $5.0 million at December 31, 1995, have not been filed with the Commission. The Registrant agrees herewith to furnish copies of such instruments upon request.\n4(i) Amended and Restated Rights Agreement dated as of December 15, 1995, between the Company and Chemical Mellon Shareholders, L.L.C., as Rights Agent, which includes the form of Right Certificate as Exhibit A, incorporated by reference to Exhibit 2.1 to the Company's Form 8-A\/A dated January 16, 1996.\n10(a) Halliburton Company Career Executive Incentive Stock Plan as amended November 15, 1990, incorporated by reference to Exhibit 10(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10(b) Retirement Plan for the Directors of Halliburton Company adopted and effective January 1, 1990, incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\nExhibit Number Exhibits\n10(c) Halliburton Company Directors' Deferred Compensation Plan as amended and restated effective May 15, 1990, incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10(d) Summary Plan Description of the Executive Split-Dollar Life Insurance Plan, incorporated by reference to Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10(e) Halliburton Company 1993 Stock and Long-Term Incentive Plan incorporated by reference to Appendix A of the Company's proxy statement dated March 23, 1993.\n10(f) Asset acquisition agreement between Smith and the Company dated as of January 14, 1993 incorporated by reference to the Second Amendment of the Company's Registration Statement on Form S-3 dated as of March 29, 1993.\n10(g) Halliburton Company Restricted Stock Plan for Non-Employee Directors, incorporated by reference to Appendix B of the Company's proxy statement dated March 23, 1993.\n10(h) Halliburton Elective Deferral Plan effective January 1, 1995, incorporated by reference to Exhibit 10(k) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10(i) Employment agreement, incorporated by reference to Exhibit 10 to the Company's Form 10-Q for the quarterly period ended September 30, 1995.\n10(j)* Halliburton Company Senior Executives' Deferred Compensation Plan as amended and restated effective January 1, 1995.\n10(k)* Halliburton Company Annual Reward Plan\n10(l)* First Amendment to the Senior Executives' Deferred Compensation Plan, effective January 1, 1996.\n10(m)* Second Amendment to the Senior Executives' Deferred Compensation Plan, effective January 1, 1996.\n10(n)* Employment agreement\n10(o)* First Amendment to the Halliburton Elective Deferral Plan, effective November 1, 1995.\n10(p)* Second Amendment to the Halliburton Elective Deferral Plan, effective January 1, 1996.\n10(q)* Third Amendment to the Halliburton Elective Deferral Plan, effective January 1, 1996.\n11* Computation of Earnings per share.\n21* Subsidiaries of the Registrant.\nExhibit Number Exhibits\n24* Form of power of attorney signed in February 1996, for the following directors:\nAnne L. Armstrong Richard B. Cheney Lord Clitheroe Robert L. Crandall W. R. Howell Dale P. Jones C. J. Silas Roger T. Staubach Richard J. Stegemeier E. L. Williamson\n27* Financial data schedules for the Registrant (filed electronically).\n* Filed with this Annual Report - --------------------------------------------------------------------------------\n(b) Reports on Form 8-K:\nA Current Report was filed on Form 8-K dated October 12, 1995, reporting on Item 5. Other Events, regarding a press release dated October 11, 1995 announcing the spin-off of Highlands Insurance Group, Inc.\nA Current Report was filed on Form 8-K dated October 27, 1995, reporting on Item 5. Other Events, regarding a press release dated October 24, 1995 announcing third quarter results.\nA Current Report was filed on Form 8-K dated November 8, 1995, reporting on Item 5. Other Events, regarding a press release dated November 8, 1995 announcing the fourth quarter dividend.\nA Current Report was filed on Form 8-K dated December 8, 1995, reporting on Item 5. Other Events, regarding a press release dated December 7, 1995 announcing the renewal and ten-year extension of the Shareholders Rights Plan.\nA Current Report was filed on Form 8-K dated December 28, 1995, reporting on Item 5. Other Events, regarding a press release dated December 26, 1995 announcing the record and distribution dates for the distribution of Highlands Insurance Group, Inc. common stock.\nDuring the first quarter of 1996 to the date hereof:\nA Current Report was filed on Form 8-K dated January 24, 1996, reporting on Item 5. Other Events, regarding press releases dated January 23, 1996 announcing the completion of the spin-off of Highlands Insurance Group, Inc. and fourth quarter 1995 earnings.\nA Current Report was filed in Form 8-K dated February 16, 1996, reporting on Item 5. Other Events, regarding a press release dated February 15, 1996 announcing the first quarter 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 this 8th day of March, 1996.\nHALLIBURTON COMPANY\nBy *Richard B. Cheney Richard B. Cheney, 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 in the capacities indicated on this 8th day of March, 1996.\nSignature Title\nRichard B. Cheney Chairman of the Board, President Richard B. Cheney and Chief Executive Officer and Director\nDavid J. Lesar Executive Vice President and David J. Lesar Chief Financial Officer\nScott R. Willis Controller and Principal Scott R. Willis Accounting Officer\nSignature Title\n*ANNE L. ARMSTRONG Director Anne L. Armstrong\n*LORD CLITHEROE Director Lord Clitheroe\n*ROBERT L. CRANDALL Director Robert L. Crandall\n*W. R. HOWELL Director W. R. Howell\n*DALE P. JONES Vice Chairman and Director Dale P. Jones\n*C. J. SILAS Director C. J. Silas\n*ROGER T. STAUBACH Director Roger T. Staubach\n*RICHARD J. STEGEMEIER Director Richard J. Stegemeier\n*E. L. WILLIAMSON Director E. L. Williamson\n*SUSAN S. KEITH Susan S. Keith, Attorney-in-fact","section_15":""}
{"filename":"797465_1995.txt","cik":"797465","year":"1995","section_1":"Item 1. Business\nGeneral\nStanley Furniture Company, Inc. (\"Stanley\" or the \"Company\") is a leading designer and manufacturer of furniture exclusively targeted at the upper-medium price range of the residential market. The Company is ranked among the top 25 furniture manufacturers in North America, based on sales, according to Furniture Today, a trade publication. During 1994, the Company expanded it's product line offerings to include upholstered furniture. See \"Products and Styles\".\nThe original predecessor of the Company was founded in 1924. The Company was incorporated in Delaware in 1984 and was acquired by Stanley Holding Corporation, a Delaware corporation, in a leveraged buy out in January 1989.\nIn November 1992, the Company completed a comprehensive financial restructuring. As a result, the Company was the sole surviving corporation and the only outstanding class of the Company's capital stock was common stock.\nIn July 1993, the Company completed a public offering of 1,725,000 shares of its common stock at $8.50 per share. The net proceeds of $13.1 million were used to reduce debt. Approximately 61% of the Company's common stock was owned by the ML - Lee Acquisition Fund, L.P., certain affiliates of the Thomas H. Lee Company, and management after the public offering.\nIn connection with the financial restructuring, the Company closed its Waynesboro, Virginia facility in 1992 to eliminate excess capacity, and initiated the sale of the Norman's of Salisbury fabric division (\"Norman's\"). In June 1994, the Company ceased operations at Norman's.\nStrategy\nThe Company's marketing strategy is to penetrate all available distribution channels compatible with its price niche and to be a single-source provider by offering a broad range of product lines and styles. Product lines include bedroom, dining room, youth, occasional and upholstered furniture. The Company's product styling mix reflects current consumer preferences and covers all major design categories within its price niche. The Company's operating strategy is to provide superior quality, quick delivery, style and value. The Company believes its strategy of penetrating all available distribution channels compatible with its price niche provides it with flexibility to adapt to market changes.\nThe Company believes its operating strategy provides its customers with a competitive advantage. In order to respond to demand for shorter lead times and improved quality, the Company's manufacturing process focuses on producing smaller, more frequent and cost effective production runs. As a result, the Company achieved its goal of shipping customer orders within three weeks on average during 1995, with average finished goods inventory turns of 5.2 times. In addition, management believes this operating strategy has helped to improve product quality. Quick delivery and high quality reduce the retailer's inventory investment while minimizing the retailer's re-delivery costs and price markdowns. The Company uses the marketing theme, \"We Just Look Expensive,\" because it believes that the design, quality, and style of its furniture compare favorably with more premium-priced products.\nProducts and Style\nThe Company's broad range of product lines and styles provide retailers a single source for the purchase of upper-medium priced furniture. The range of product lines and number of designs for wood products currently marketed by the Company is set forth in the following table.\nNumber of Designs\nBedroom 32 Dining room 28 Youth bedroom 19 Occasional: Living room tables 24 Wall systems 13 Home Office 3\nThe Company's product styling mix reflects current consumer preferences and covers all major design categories within its upper-medium price niche including European traditional, contemporary, transitional, 18th century, country and nostalgia designs.\nUpholstered furniture products were initially introduced in the Fall of 1994, and consist mainly of stationary sofas, sleepers, love seats and chairs. The Company expanded its upholstered products in 1995 and now offers a variety of frame and fabric selections.\nMarketing and Sales\nThe Company has developed a diverse and extensive nationwide customer base which the Company believes provides it with flexibility to adapt to market changes. The Company sells its furniture products through approximately 60 independent sales representatives to independent furniture retailers; national accounts such as Sears and J.C. Penney; national and regional chain stores such as Homestead House, Huffman-Koos, Robb & Stucky, R C Willey and Rhodes; and major department stores such as Federated Department Stores. Products are also distributed internationally with approximately 7% of the Company's sales from international customers. The Company currently has approximately 3,600 active customers.\nIn marketing its products to independent retailers, the Company utilizes a promotional incentive sales program, the \"Stanley Preferred Retailer\". This program is designed to encourage the independent retailer to commit retail floor space to the Company's products. The program is designed to be flexible and is adapted into the marketing plans of retailers by accommodating geographic, style and promotional preferences. To participate, a retailer must commit a specified amount of floor space to the Company's products and achieve a specified sales volume.\nThe general marketing practice followed in the furniture industry is to exhibit products at international and regional furniture markets. In the Spring and Fall of each year, an eight- day furniture market is held in High Point, North Carolina, which is regarded by the industry as the international market, attracting buyers from the United States and abroad. The Company maintains showroom space at the High Point market and in the San Francisco regional market.\nNo single customer accounted for more than 10% of the Company's sales in 1995. No material part of the Company's business is dependent upon a single customer, the loss of which would have a material effect on the business of the Company. The loss of several of the Company's major customers could have a material impact on the business of the Company. There are no significant seasonal aspects to the Company's business.\nProduct Design and Development\nThe Company's marketing personnel begin the design process by identifying marketing needs to be fulfilled and conceptualizing product ideas, generally consisting of a group of related furniture pieces. A variety of sketches are produced, usually by Company designers, from which prototype furniture pieces are prepared in consultation with marketing personnel, selected dealers and sales representatives. The Company's engineering department then processes the prototype in preparation for actual full-scale production. Consistent with industry practice, the Company designs and develops new product groups each year, replacing discontinued items or collections.\nManufacturing\nThe Company's manufacturing operations complement its marketing strategy by emphasizing superior quality and quick delivery. The Company's manufacturing process produces smaller, more frequent and cost effective runs by identifying and eliminating manufacturing bottlenecks and waste, employing statistical process control, establishing cellular manufacturing and improving relationships with suppliers. In addition, a key element of the Company's manufacturing process is to involve all Company personnel, from hourly associates to management, in the improvement of the manufacturing process by encouraging and responding to suggested methods to improve quality and to reduce manufacturing lead times.\nThe Company operates manufacturing facilities in North Carolina and Virginia consisting of an aggregate of approximately 3 million square feet. The Company considers its present equipment to be generally modern, adequate and well maintained.\nRaw Materials\nThe principal materials used by the Company in manufacturing its products include lumber, veneers, plywood, particle board, hardware, glue, finishing materials, glass products, laminates, fabrics, metals; and frames, filling and cushioning materials for upholstered products. The Company uses a variety of species of lumber, including cherry, oak, ash, poplar, pine, maple, and mahogany. The Company's five largest suppliers accounted for approximately 22% of its purchases in 1995. The Company believes that its sources of supply for these materials are adequate and that it is not dependent on any one supplier. The furniture industry has experienced increased prices for lumber during the past several years, which is the most significant raw material used by the Company, although there was a moderation in lumber price increases during 1995. While the industry has historically increased prices to reflect such increased costs, there can be no assurance that, if raw material prices increase, market and competitive pressures will permit the Company or its competitors to increase the prices for their products.\nBacklog\nThe Company schedules production of its various groups based upon actual or anticipated orders. The Company, and the furniture industry, generally honor cancellation of orders prior to shipment, although cancellations generally decrease as demand increases. The Company's backlog of unshipped orders was $21.5 million, $17.4 million, and $26.6 million at December 31, 1995, 1994 and 1993, respectively. The Company's manufacturing process is intended to reduce backlog and to fill orders through manufacturing rather than inventory. Therefore, management believes that the size of its backlog is not necessarily indicative of its operations.\nCompetition\nThe furniture market is highly competitive and includes a large number of foreign and domestic manufacturers. The markets in which the Company competes include a large number of relatively small manufacturers; however, certain competitors of the Company have greater sales volumes and greater financial resources than the Company. While competition occurs principally in the areas of style, quality, service, design and price, the Company believes that its operating strategy, its long-standing relationships with its customers, its consistent support of existing product lines over time and its management experience are competitive advantages.\nAssociates\nAt December 31, 1995, the Company employed approximately 2,700 associates. None of the Company's associates are represented by a labor union. The Company considers its relations with its associates to be good.\nPatents and Trademarks\nThe trade names of the Company represent many years of continued business, and the Company believes such names are well recognized and associated with quality in the furniture industry. The Company owns a number of patents, trademarks, and licenses, none of which are considered to be material to the Company.\nEnvironmental Regulation\nThe Company is regulated under several federal, state and local environmental laws and regulations concerning air emissions, water discharges and management of solid and hazardous waste. Management believes that the Company is 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 earnings, capital expenditures or competitive position; however, the effect of such compliance in the future cannot be determined.\nRegulations issued in December 1995 under the Clean Air Act Amendments of 1990 may require the Company to reformulate certain furniture finishes or institute process changes to reduce emissions of hazardous volatile organic compounds. The furniture industry and its suppliers are attempting to develop water-based and other forms of compliant finishing materials to replace commonly-used organic-based finishes which are a major source of regulated emissions. The Company cannot at this time estimate the impact of these new standards on the Company's operations and future capital expenditure requirements, or the cost of compliance.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSet forth below is certain information with respect to the Company's principal properties. The Company believes that all these properties are well maintained and in good condition. The Company believes its manufacturing facilities are being efficiently utilized and that it could increase production at its facilities if required by customer demand. Each facility is focused on specific product lines to optimize efficiency. The Company estimates that its facilities are presently operating at approximately 85% of capacity, principally on a one-shift basis. All Company plants are equipped with automatic sprinkler systems and modern fire protection equipment, which management believes are adequate. All facilities set forth below are active and operational, except as noted.\nApproximate Owned Lease Facility Size or Expiration Location Primary Use (Square Feet) Leased Date\nStanleytown, VA Manufacturing 1,660,000 Owned(1) Corporate Headquarters 61,000 West End, NC Manufacturing 470,000 Owned(1) West End, NC Lumber Yard Leased May 31, 2007 Lexington, NC Manufacturing 635,000 Owned Robbinsville, NC Manufacturing 540,000 Owned Salisbury, NC Idle 109,000 Leased(2) April 30, 2000\n(1) These facilities were leased through June 1995 at which time the Company purchased these facilities. See Note 2 of the Notes to Financial Statements. (2) This facility was subleased through August 1995 and is currently idle. This was the principal facility of Norman's. The Company has the right to purchase the property at any time at its fair market value.\nThe Company also leases and maintains approximately 60,000 square feet (8,000 square feet is subleased) of showroom space in High Point, North Carolina and 7,000 square feet of showroom space in San Francisco, California.\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\nThe executive officers of the Company are:\nName Age Position\nAlbert L. Prillaman 50 Chairman, President, Chief Executive Officer and Director\nC. William Cubberley, Jr. 55 Senior Vice President- Sales and Marketing\nDouglas I. Payne 38 Vice President of Finance, Treasurer and Secretary\nBobby I. Hodges 58 Senior Vice President- Manufacturing\nWilliam A. Sibbick 39 Vice President-Product Development and Merchandising\nJoe G. Bost 49 Vice President-Upholstery\nAlbert L. Prillaman has been a Director of the Company since March 1986, President and Chief Executive Officer of the Company since December 1985 and Chairman of the Board of Directors since September 1988. Prior thereto, Mr. Prillaman had served as a Vice President of the Company and President of the Stanley Furniture division of the Company's predecessor since 1983, and in various executive and other capacities with predecessors of the Stanley Furniture division of the Company since 1969.\nC. William Cubberley, Jr. has been Senior Vice President-Sales and Marketing of the Company since April 1995. He has been a Vice President of the Company since December 1990 and Senior Vice President-Sales and Marketing of the Stanley Furniture division since October 1988. Mr. Cubberley was Senior Vice President-Sales of the Stanley Furniture division from January 1986 to October 1988, when he became Senior Vice President - Sales and Marketing of the Stanley Furniture division.\nDouglas I. Payne has been Vice President of Finance and Treasurer of the Company since September 1993, was Vice President- Treasurer of the Company from December 1989 to September 1993, was Treasurer of the Company from June 1986 to December 1989 and was Assistant Treasurer of the Company from August 1985 to June 1986. Mr. Payne has been Secretary of the Company since September 1988.\nBobby I. Hodges has been Senior Vice President-Manufacturing of the Company since April 1995. He has been a Vice President since June 1993. He was Senior Vice President-Manufacturing of the Stanley Furniture division from January 1986 until June 1993. He was Vice President-Manufacturing of the Stanley Furniture division from December 1983 until January 1986. Prior to that time, Mr. Hodges was employed by the Company in various positions related to manufacturing management.\nWilliam A. Sibbick has been Vice President-Product Development and Merchandising since April 1995. He was Vice President - Product Development from June 1993 until April 1995. He was Vice President-Senior Product Manager of the Stanley Furniture division from January 1992 until June 1993. Prior to that time, he had been Vice President-Product Manager since his employment in March 1989.\nJoe G. Bost has been Vice President-Upholstery since April 1995. He was President of Norman's of Salisbury since his employment in January 1993 until April 1995. Prior to joining the Company, Mr. Bost was Senior Vice-President of Sales, Marketing, Administration and Manufacturing of Hickorycraft, Inc., a manufacturer of upholstery and occasional tables, a position he held since 1987.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholders Matters\nThe Company's common stock is traded on the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market under the symbol STLY. The table below sets forth the high and low sales prices per share as reported by the NASDAQ National Market.\nHigh Low\nFirst Quarter.......................... 9 1\/2 7 Second Quarter......................... 8 3\/8 7 Third Quarter.......................... 8 3\/4 7 Fourth Quarter......................... 9 7 3\/4\nFirst Quarter.......................... 16 13 Second Quarter......................... 15 11 Third Quarter.......................... 12 1\/2 9 Fourth Quarter......................... 10 3\/4 9 3\/4\nThe quotations reflect interdealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. As of January 26, 1996, there were approximately 1,500 beneficial shareholders. The Company has not paid any cash dividends and is prohibited from doing so under its bank credit facility.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe selected financial data for the five years in the period ended December 31, 1995 are derived from the Company's financial statements, which have been audited by Coopers & Lybrand L.L.P. The selected financial data should be read in conjunction with the Financial Statements including the Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere herein.\nStanley Furniture Company, Inc. Selected Financial Data (In thousands, except per share data)\nSelected Financial Data (continued)\n(1) In 1993, the Company recorded $5.0 million of business interruption insurance replacing the gross profit on lost sales due to the fire which occurred in February 1993 at its Stanleytown, Virginia facility. See Note 8 of the Notes to Financial Statements.\n(2) In 1995, the Company recognized a pretax credit of $1.1 million after it was released from a lease obligation at its previously closed Waynesboro, Virginia manufacturing facility. Also included is a pretax charge for a severance accrual. See Note 4 of the Notes to Financial Statements.\n(3) In 1991, the Company recorded pretax charges of $14.1 million in anticipation of the closing of the Waynesboro, Virginia facility to eliminate excess capacity and the transfer of certain product lines to other manufacturing facilities. Operating income for 1992 includes a restructuring credit of $2.1 million from lower than anticipated costs of closing the Waynesboro facility.\n(4) In 1994, the Company recorded a pretax gain of $2.4 million as part of the final insurance settlement. Also, in 1993 a $2.2 million pretax gain was recorded since proceeds exceeded the book value of leasehold improvements and equipment destroyed in the fire. See Note 8 of the Notes to Financial Statements.\n(5) Income from continuing operations before insurance related gains was $3.7 million (77 cents per share) in 1994 and $4.3 million (90 cents per share) on a proforma basis in 1993.\n(6) In 1992, the Company completed a financial restructuring which resulted in the exchange of certain long-term debt and preferred stock for common stock.\n(7) In July 1993, the Company completed a public offering of 1,725,000 shares of common stock at $8.50 per share. The net proceeds of $13.1 million were used to reduce debt.\n(8) No dividends have been paid on common stock during any of the years presented.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion should be read in conjunction with the Selected Financial Data and the Financial Statements and Notes thereto contained elsewhere herein.\nResults of Operations\n1995 Compared to 1994 Net sales decreased $10.2 million, or 5.5%, from 1994 levels due principally to lower unit volume, partially offset by the additional volume from the upholstered products and higher average selling prices.\nGross profit margin increased to 21.0% from 19.5% in 1994. The higher gross profit margin was due principally to increased prices, a moderation in lumber cost increases, a more favorable product mix and the favorable impact from the purchase of the previously leased manufacturing facilities discussed in Note 2 of the Notes to Financial Statements. The increase in gross profit was slightly offset by an increased overhead absorption rate resulting from lower output levels in 1995.\nSelling, general and administrative expenses were approximately the same for both years. However, as a percentage of net sales these expenses increased to 15.2% in 1995 from 14.4% in 1994. The higher percentage was due principally to lower net sales and increased selling cost associated with new products.\nDuring the second quarter of 1995, the Company was released from a lease obligation at its previously closed Waynesboro, Virginia manufacturing facility. Accordingly, the Company recognized a pretax credit of $1.1 million related to the reversal of an accrual set up in 1991 for the closing of the facility. Unusual items also included a pretax charge for severance resulting from the resignation of the Company's Chief Operating Officer.\nAs a result of the above, operating income increased to $10.2 million, or 5.9%, of net sales from $9.4 million, or 5.1%, of net sales in 1994. The Company estimates that upholstery operations reduced operating income by approximately $1.0 million for both 1995 and 1994.\nInterest expense for 1995 increased due principally to higher debt levels, resulting from the purchase of two previously leased manufacturing facilities in June 1995 and also due to slightly higher interest rates.\nThe Company's effective tax rate in 1995 decreased to 38.0% from 38.9% in 1994. The lower tax rate in 1995 is principally due to an increase in non-taxable income and increased benefits from export sales.\n1994 Compared to 1993 Net sales increased $17.3 million, or 10.3%, from 1993 levels due principally to higher average selling prices and higher unit volume. Lower unit volume in the 1993 period was due principally to the disruption in production caused by the 1993 fire at the Stanleytown, Virginia facility.\nGross profit margin decreased to 19.5% from 22.2% in 1993. The higher gross profit percentage for 1993 was due principally to the recognition of $5.0 million of business interruption insurance without the related sales revenue. This $5.0 million represented the estimated settlement proceeds for gross profits lost and other direct costs related to lost sales from the Stanleytown fire.\nSelling, general and administrative expenses as a percentage of net sales was 14.4% and 15.5% for 1994 and 1993, respectively. The lower percentage was due principally to an increase in net sales and containment of cost.\nAs a result of the above, operating income for 1994 decreased to $9.4 million, or 5.1%, of net sales from $11.2 million, or 6.7%, of net sales in 1993. Operating income was reduced by upholstery startup costs of approximately $1.0 million, in 1994.\nIn 1994, the Company reached a final insurance settlement on the 1993 fire and recorded a pretax gain of $2.4 million.\nInterest expense approximated the 1993 period due principally to lower average debt levels, which was offset by higher interest rates.\nThe Company's effective income tax rate decreased to 38.9% from 41.1% in 1993. The higher 1993 rate was due principally to the effect of the 1% federal statutory rate increase on the prior years' deferred tax balances.\nFinancial Condition, Liquidity and Capital Resources\nDuring August 1995, the Company amended its $25.0 million revolving credit facility which extended its maturity date to August 1998. The interest rate under the facility was reduced to prime (8.5% on December 31, 1995) or, at the Company's option, equal to reserve adjusted LIBOR plus 1.0% per annum. In June 1995, the Company issued a $10.0 million 7.57% senior note due 2005 in a private placement of debt and the proceeds were used to purchase two previously leased manufacturing facilities. In February 1994, the Company completed the private placement of $30.0 million of 7.28% senior notes due 2004. The proceeds from the senior notes were used to repay an existing term note and a portion of the revolving credit facility.\nLong-term debt outstanding at December 31, 1995 was $40.4 million. Aggregate maturities of long-term debt for the next five years are as follows: 1996 - $650,000; 1997 - $878,000; 1998 - $6.0 million; 1999 - $5.1 million; 2000 - $5.2 million. As of December 31, 1995, approximately $21.9 million of additional borrowings were available under the revolving credit facility. The Company believes that its financial resources are adequate to support its capital needs and debt service requirements.\nDuring 1995, cash generated from operations of $6.6 million was used to reduce borrowings under the revolving credit facility and to fund capital expenditures in the normal course of business. The increase in cash generated from operations was due principally to lower tax payments of $1.0 million compared to $4.5 million in 1994. Tax payments were higher in 1994 principally due to the timing of installment payments for 1993, resulting from the utilization of net operating losses carried forward from 1992. Also, refunds attributed to 1994 reduced tax payments for 1995. Cash generated from operations, also increased as a result of less cash paid to suppliers and employees due to reduced production levels. During 1994, cash provided by operations of $4.1 million and net borrowings of $1.2 million were used to fund capital expenditures. Cash generated from operations in 1993 of $6.5 million was used to fund capital expenditures and to reduce borrowings under the senior credit facility.\nOperating cash flows in both 1994 and 1993 include proceeds of $4.6 and $23.2 million, respectively, received from insurance in connection with the fire. Cash paid to suppliers in 1994 and 1993 included costs of $2.7 million and $25.2 million, respectively, incurred in connection with the fire. Excluding the effect of the fire, cash was required in the 1994 period to support higher accounts receivable requirements reflecting higher sales levels, higher payments to suppliers and employees as a result of higher production levels and higher tax payments as discussed above. These higher payments in the 1994 period were partially offset by lower interest payments due principally to lower debt levels. Excluding the cash flow impact from the fire, cash provided by operating activities improved $12.1 million in 1993 principally from higher customer receipts, lower payments for the restructuring program and lower interest payments.\nNet cash used by investing activities was $14.7 million in 1995 compared to $5.2 million and $4.3 million in 1994 and 1993, respectively. As noted above, proceeds of $10.0 million from the senior note and additional borrowings from the revolving credit facility were used to purchase $10.5 million of previously leased manufacturing facilities. Expenditures in the 1994 period include the purchase of equipment and other capital expenditures for the new upholstery operation of approximately $727,000. Except for fire related expenditures in 1993, which were reimbursed by insurance, and the manufacturing facilities purchased in 1995, expenditures in each year were primarily for plant and equipment, and other assets in the normal course of business.\nNet cash provided by financing activities was $8.1 million in 1995 compared to net cash provided by financing activities of $1.2 million in 1994 and cash used by financing activities of $2.7 million in 1993. Cash provided by financing activities in the 1994 period was used to fund capital expenditures. In 1993, cash provided by the public offering ($13.1 million) and from operations enabled the Company to redeem $3.1 million of outstanding senior subordinated debentures and to reduce borrowings under the senior credit facility by $12.8 million.\nDiscontinued Operations\nBeginning in 1991, the Norman's of Salisbury fabric division (\"Norman's\") was reflected as a discontinued operation. In 1994, the Company ceased operations at Norman's and liquidated the division resulting in a $2.8 million ($4.5 million pretax) additional loss provision.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and schedule listed in Items 14(a)(1) and (a)(2) hereof are incorporated herein by reference and are filed as part of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nIn accordance with general instruction G(3) of Form 10-K, the information called for by items 10, 11, 12, and 13 of Part III is incorporated by reference to the registrant's definitive Proxy Statement for its Annual Meeting of Shareholders scheduled for April 25, 1996, except for information concerning the executive officers of the registrant which is included in Part I of this report 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 Schedule and Reports on Form 8-K\n(a) Documents filed as a part of this Report:\n(1) The following financial statements are included in this report on Form 10-K:\nReport of Independent Accountants\nBalance Sheets - as of December 31, 1995 and 1994\nStatements of Income - for each of the three years in the period ended December 31, 1995\nStatements of Changes in 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 Financial Statements\n(2) Financial Statement Schedule:\nSchedule II - Valuation of Qualifying Accounts - for each of the three years in the period ended December 31, 1995\n(b) The following reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report:\nNone.\n(c) Exhibits:\n2.1 Agreement and Plan of Merger dated as of July 24, 1992 by and among the Registrant, Stanley Holding Corporation, Stanley Acquisition Corporation, the ML-Lee Acquisition Fund (Retirement Accounts) II, L.P., and the persons listed on Schedules I and II thereto (incorporated by reference to Exhibit 2.1 to the Registrant's Registration Statement on Form S-4 No. 33-50050).\n3.1 The Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1, No. 33- 7300).\n3.2 The By-laws of the Registrant (incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-1, No. 33-7300).\n3.3 Amendment adopted March 21, 1988 to the By-laws of the Registrant (incorporated by reference to Exhibit 3.3 to the Registrant's Form 10-K (Commission File No. 0-14938) for the year ended December 31, 1987).\n3.4 Amendments adopted February 8, 1993 to the By-laws of the Registrant (incorporated by reference to Exhibit 3.4 to the Registrant's Registration Statement on Form S-1 No. 33-57432).\n3.5 Certificate of Stock Designation dated May 1, 1991 of the Registrant as modified by an Amendment to Certificate of Designation dated May 31, 1991 (incorporated by reference to Exhibit 3.6 to the Registrant's Form 10-K for the year ended December 31, 1991).\n3.6 Certificate of Merger dated as of November 9, 1992 (incorporated by reference to Exhibit 3.6 to the Registrant's Statement on Form S-1 No. 33-57432).\n3.7 Certificate of Amendment dated June 30, 1993. (incorporated by reference to Exhibit 3.7 to the Registrant's Form 10-K for the year ended December 31, 1994).\n4.1 The Certificate of Incorporation and By-laws of the Registrant as currently in effect incorporated by reference as Exhibits 3.1 through 3.7 (incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-1 No. 33-57432).\n4.2 Registration Rights Agreement dated as of November 9, 1992 by and among the Registrant, ML-Lee Acquisition Fund, L.P., ML - Lee Acquisition Fund II, L.P., ML-Lee Acquisition Fund (Retirement Accounts) II, L.P., Lee Stockholders (as defined therein) and Management Stockholders (as defined therein) (incorporated by reference to Exhibit 4.3 to the Registrant's Statement on Form S-1 No. 33-57432).\n4.3 Form of Indenture (including the Form of the Debenture) (incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on Form S-1, No. 33- 12746).\n4.4 First Supplemental Indenture dated as of January 17, 1989 (incorporated by reference to Exhibit 4.2 to the Registrant's Form 10-K for the year ended December 31, 1988).\n4.5 Second Supplemental Indenture dated as of November 9, 1992 (incorporated by reference to Exhibit 4.5 to the Registrant's Form 10-K for the year ended December 31, 1993).\n4.6 Note Agreement dated February 15, 1994 between the Registrant and the Prudential Insurance Company of America. (incorporated by reference to Exhibit 4.6 to the Registrant's Form 10-K for the year ended December 31, 1993).\nPursuant to Regulation S-K, Item 601(b)(4)(iii), instruments evidencing long term debt less than 10% of the Registrant's total assets have been omitted and will be furnished to the Securities and Exchange Commission upon request.\n10.1 Employment Agreement made as of January 1, 1991 between Albert L. Prillaman and the Company (incorporated by\nreference to Exhibit 10.1 to the Registrant's Form 10-K for the year ended December 31, 1991).(2)\n10.2 Lease dated February 23, 1987 between SIC Corporation and Southern Furniture Exposition Building, Inc. d\/b\/a Southern Furniture Market Center (incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-K for the year ended December 31, 1987).\n10.3 Lease dated June 30, 1987 between A. Allan McDonald, Virginia Cary McDonald, C. R. McDonald, Dorothy V. McDonald, and Lillian S. McDonald, as lessor, and SIC, as lessee (incorporated by reference to Exhibit 10.14 to the Registrant's Form 10-K for the year ended December 31, 1987).\n10.4 The Stanley Retirement Plan, as restated effective January 1, 1989, adopted April 20, 1995.(1)(2)\n10.5 Amendment No. 1, the Stanley Retirement Plan, effective December 31, 1995, adopted December 15, 1995.(1)(2)\n10.6 Supplemental Retirement Plan of Stanley Furniture Company, Inc. as restated effective January 1, 1993. (incorporated by reference to Exhibit 10.8 to the Registrant's Form 10-K for the year ended December 31, 1993).(2)\n10.7 First Amendment to Supplemental Retirement Plan of Stanley Furniture Company, Inc., effective December 31, 1995, adopted December 15, 1995.(1)(2)\n(1) Filed herewith (2) Management contract or compensatory plan\n10.8 Stanley Interiors Corporation Deferred Compensation Capital Enhancement Plan effective January 1, 1986 (incorporated by reference to Exhibit 10.12 to the Registrant's Registration Statement on Form S-1, No. 33- 7300).(2)\n10.9 Stanley 401(k) Retirement Savings Plan, as amended and restated effective January 1, 1996.(1)(2)\n10.10 Management Agreement with Thomas H. Lee Company entered into September 29, 1988 by and among the Registrant, as successor to Interiors Acquisition Corporation, Stanley Holding Corporation, Stanley Acquisition Corporation and Thomas H. Lee Company (incorporated by reference to Exhibit (c)(9) to the Registrant's Rule 13e-3 Transaction Statement filed October 14, 1988).\n10.11 Employment Agreement made as of January 1, 1991 between William Cubberley, Jr. and the Registrant (incorporated by reference to Exhibit 10.42 to the Registrant's Form 10-K for the year ended December 31, 1991).(2)\n10.12 Split Dollar Insurance Agreement dated as of March 21, 1991 between Albert L. Prillaman and the Registrant (incorporated by reference to Exhibit 10.43 to the Registrant's Form 10-K for the year ended December 31, 1991).(2)\n10.13 Second Amended and Restated Revolving Credit Facility and Term Loan Agreement dated February 15, 1994 (the \"Second Amended and Restated Credit Facility\") between the Registrant, National Canada Finance Corp., and the National Bank of Canada.\n10.14 First Amendment to Second Amended and Restated Credit Facility dated as of August 21, 1995.(1)\n10.15 1992 Stock Option Plan (incorporated by reference to Registrant's Registration Statement on Form S-8, No. 33- 58396).(2)\n10.16 1994 Stock Option Plan. (incorporated by reference to Exhibit 10.18 to the Registrant's Form 10-K for the year ended December 31, 1994).(2)\n(1) Filed herewith (2) Management contract or compensatory plan\n10.17 1994 Executive Loan Plan. (incorporated by reference to Exhibit 10.19 to the Registrant's Form 10-K for the year ended December 31, 1994).(2)\n10.18 Loan and Stock Purchase Agreement dated as of December 2, 1994 by Albert L. Prillaman. (incorporated by reference to Exhibit 10.20 to the Registrant's Form 10-K for the year ended December 31, 1994).(2)\n11 Schedule of Computation of Earnings Per Share.(1)\n21 Listing of Subsidiaries:\nCharter Stanley Foreign Sales Corporation, a United States Virgin Islands Corporation.\n23 Consent of Coopers & Lybrand L.L.P.(1)\n27 Financial Data Schedule.(1)\n(1) Filed herewith (2) 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.\nSTANLEY FURNITURE COMPANY, INC.\nFebruary 14, 1996 By: \/s\/ Albert L. Prillaman Albert L. Prillaman President, Chief Executive Officer, 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 and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Albert L. Prillaman President, Chief February 14, 1996 (Albert L. Prillaman) Executive Officer, Chairman of the Board, and Director (Principal Executive Officer)\n\/s\/ Douglas I. Payne Vice President of February 14, 1996 (Douglas I. Payne) Finance, Treasurer and Secretary (Principal Financial and Accounting Officer)\n\/s\/ David V. Harkins Director February 14, 1996 (David V. Harkins)\n\/s\/ C. Hunter Boll Director February 14, 1996 (C. Hunter Boll)\n\/s\/ Edward J. Mack Director February 14, 1996 (Edward J. Mack)\nSTANLEY FURNITURE COMPANY, INC. ANNUAL REPORT ON FORM 10-K INDEX TO FINANCIAL STATEMENTS AND SCHEDULE FOR THE YEAR ENDED DECEMBER 31, 1995\nFinancial Statements Page\nReport of Independent Accountants......................... F- 2\nBalance Sheets as of December 31, 1995 and 1994........... F- 3\nStatements of Income for each of the three years in the period ended December 31, 1995................... F- 4\nStatements of Changes in Stockholders' Equity for each of the three years in the period ended December 31, 1995...................................... F- 5\nStatements of Cash Flows for each of the three years in the period ended December 31, 1995................... F- 6\nNotes to Financial Statements............................. F- 7\nFinancial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 1995....................................... S- 1\nTo The Board of Directors and Shareholders Of Stanley Furniture Company, Inc.\nWe have audited the financial statements and financial statement schedule of Stanley Furniture Company, Inc. listed in the index on page. 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 Stanley Furniture Company, 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 Note 7 of the Notes to Financial Statements, effective as of the beginning of 1993, the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106.\nRichmond, Virginia January 26, 1996\nSTANLEY FURNITURE COMPANY, INC. BALANCE SHEETS (In thousands, except share data)\nDecember 31,\nThe accompanying notes are an integral part of the financial statements.\nSTANLEY FURNITURE COMPANY, INC. STATEMENTS OF INCOME (In thousands, except per share data)\nThe accompanying notes are an integral part of the financial statements.\nSTANLEY FURNITURE COMPANY, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For each of the three years in the period ended December 31, 1995 (In thousands)\nThe accompanying notes are an integral part of the financial statements.\nSTANLEY FURNITURE COMPANY, INC. STATEMENTS OF CASH FLOWS (In thousands)\nThe accompanying notes are an integral part of the financial statements.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nOrganization and Basis of Presentation Stanley Furniture Company, Inc. (the \"Company\") is a leading designer and manufacturer of furniture exclusively targeted at the upper-medium price range of the residential market.\nThe Company operates predominantly in one business segment. Substantially all revenues result from the sale of home furnishings, primarily residential furniture products. Substantially all of the Company's trade accounts receivable are due from retailers in this market, which consist of a large number of entities with a broad geographical dispersion.\nInventories Inventories are valued at the lower of cost or market. Cost for all inventories is determined using the first-in, first-out (FIFO) method.\nProperty, Plant and Equipment Depreciation of property, plant and equipment is computed using the straight-line method based upon the estimated useful lives of the assets and amounted to $4.5 million, $4.0 million and $3.7 million for 1995, 1994 and 1993, respectively. Depreciable lives are as follows: Years Buildings................................. 40 to 50 Machinery and equipment................... 5 to 12 Leasehold improvements.................... 3 to 20 Furniture, fixtures and office equipment.. 3 to 10\nGains and losses related to dispositions and retirements are included in income. Maintenance and repairs are charged to income as incurred; renewals and betterments are capitalized.\nCapitalized Software Cost The Company amortizes certain purchased computer software costs using the straight-line method over the economic lives of the related products not to exceed five years. Unamortized cost at December 31, 1995 and 1994 was $473,000 and $39,000, respectively.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n1. Summary of Significant Accounting Policies (continued)\nGoodwill and Long-lived Assets Goodwill is being amortized on a straight-line basis over 40 years. The Company continually evaluates the existence of impairment of long-lived assets, including goodwill, on the basis of whether it is fully recoverable from projected, undiscounted net cash flows.\nIncome Taxes Deferred income taxes are determined based on the difference between the financial statement and income 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 expense represents the change in the deferred tax asset\/liability balance. Income tax credits are reported as a reduction of federal income tax expense in the year in which the credits are generated.\nFair Value of Financial Instruments The fair value of the Company's long-term debt is estimated using discounted cash flow analysis based on the incremental borrowing rates currently available to the Company for loans with similar terms and maturities, and at December 31, 1995, the fair value approximated the carrying amount. The fair value of trade receivables, trade payables and letters of credit approximate the carrying amount because of the short maturity of these instruments.\nPension Plans The Company's funding policy is to contribute to all qualified plans annually an amount equal to the normal cost and a portion of the unfunded liability but not to exceed the maximum amount that can be deducted for federal income tax purposes.\nEarnings Per Common Share Earnings per common share are based upon the weighted average number of shares outstanding. All share and per share data have been restated to reflect the one-for-two reverse stock split, effective July 1993.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n1. Summary of Significant Accounting Policies (continued)\nSupplementary earnings per common share are presented below. Income from continuing operations for the 1994 and 1993 periods reflect a non-recurring gain from insurance proceeds. The 1993 period reflects the effect of proforma adjustments for the 1993 public offering. It is assumed that the transaction took effect at the beginning of the year. The 1995 and 1994 per share information is included for comparison purposes.\n1995 1994 1993 Continuing operations: Before non-recurring gain........... $ .82 $ .77 $ .90 Non-recurring gain on insurance..... .31 .29 As reported....................... .82 1.08 1.19 Discontinued operations............... (.58) Net income.......................... $ .82 $ .50 $ 1.19\n2. Property, Plant and Equipment at December 31\n(in thousands) 1995 1994\nLand and buildings.................... $33,594 $17,853 Machinery and equipment............... 43,127 41,059 Leasehold improvements................ 153 3,986 Furniture, fixtures and office equipment........................... 1,387 1,289 Construction in progress.............. 138 640 $78,399 $64,827\nIn June 1995, the Company purchased the manufacturing facilities at its Stanleytown, Virginia and West End, North Carolina locations, which it previously leased. The total purchase price was $10.5 million for both facilities. As a result of the purchase, the Company also reclassified related leasehold improvements with a net book value of $3.3 million to land and buildings.\n3. Long-Term Debt at December 31 (in thousands) 1995 1994\n7.28% Senior notes due March 15, 2004......... $30,000 $30,000 7.57% Senior note due June 30, 2005........... 10,000 Revolving credit facility..................... 914 3,234 7% Convertible subordinated debentures due April 1, 2012........................... 153 161 Total..................................... 41,067 33,395 Less current maturities....................... 650 $40,417 $33,395\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n3. Long-term debt at December 31 (continued)\nDuring August 1995, the Company amended its $25.0 million revolving credit facility which extended its maturity date to August 1998. The interest rate under the facility was reduced to prime (8.5% on December 31, 1995) or, at the Company's option, equal to reserve adjusted LIBOR plus 1.0% per annum. As of December 31, 1995, approximately $21.9 million of additional borrowings were available under the revolving credit facility. In June 1995, the Company issued a $10.0 million 7.57% senior note due 2005 in a private placement of debt and the proceeds were used to purchase two plant facilities, as discussed in Note 2. In February 1994, the Company completed the private placement of $30.0 million of 7.28% senior notes due in 2004. The proceeds were used to repay a term note and a portion of the revolving credit facility.\nThe Company utilizes letters of credit to collateralize certain insurance policies and inventory purchases. Outstanding letters of credit at December 31, 1995 and 1994 were $2.2 million and $1.8 million, respectively.\nThe above loan agreements require the Company to maintain certain financial covenants and prohibit the Company from paying dividends and acquiring or retiring it's common stock.\nAggregate maturities of long-term debt for the next five years are as follows: 1996 - $650,000; 1997 - $878,000; 1998 - $6.0 million; 1999 - $5.1 million; 2000 - $5.2 million.\n4. Unusual Items\nDuring the second quarter of 1995, the Company was released from a lease obligation at its previously closed Waynesboro, Virginia manufacturing facility. Accordingly, the Company recognized a pretax credit of $1.1 million related to the reversal of an accrual set up in 1991 for the closing of the facility. Unusual items also included a pretax charge for severance resulting from the resignation of the Company's Chief Operating Officer.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n5. Income Taxes\nThe provision for income taxes on income from continuing operations consists of (in thousands):\nA reconciliation of the difference between the federal statutory income tax rate and the effective income tax rate on income from continuing operations at December 31 follows:\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n5. Income Taxes (continued)\nThe income tax effects of temporary differences that comprise deferred tax assets and liabilities at December 31 follow (in thousands):\nAt December 31, 1994, the Company had alternative minimum tax credit carryforwards of $519,000 which were utilized in 1995. The Company's federal income tax returns have been examined and closed by the Internal Revenue Service through 1992.\n6. Stock Options and Loan Plan\nIn December 1994, the Company adopted the Stanley Furniture Company, Inc. 1994 Stock Option Plan (the \"1994 Plan\"). The 1994 Plan and the Company's 1992 Stock Option Plan provide for the granting of stock options for up to an aggregate of 700,000 shares of common stock to certain key employees. Options granted may be either nonqualified or qualified stock options and the exercise price may not be less than 100% of the fair market value of the Company's common stock on the date the options are granted. Granted options vest 20% annually.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n6. Stock Options and Loan Plan (continued)\nAt December 31, 1995 and 1994, options to purchase 229,023 and 182,297 shares, respectively, were exercisable and 16,935 were available for grant at December 31, 1995. Activity for the two years ended December 31, 1995 follows: Number Option price of shares per share\nOutstanding at December 31, 1993... 668,317 $ 8.50 to $12.86 Exercised.......................... (5,112) 8.50 to 12.86 Cancelled.......................... (602,834) 12.86 Granted............................ 609,629 10.00 Outstanding at December 31, 1994. 670,000 8.50 to 10.00\nLapsed............................. (5,327) 8.50 to 10.00 Cancelled.......................... (156,720) 8.50 to 10.00 Granted............................ 170,000 8.75\nOutstanding at December 31, 1995. 677,953 $ 8.50 to $10.00\nDuring 1994, the Company established the Executive Loan Plan. Under the Executive Loan Plan, the Company has entered into a contractual agreement to issue 50,000 shares of common stock to the Chief Executive Officer at $10 per share (the market price per share on the date of the agreement) in exchange for a non-recourse 7.6% note receivable payable in five annual installments with the balance due January 2, 1999. The Company has also agreed to forgive interest plus one half of the contractual purchase price over the next five years, if the Chief Executive Officer remains employed by the Company. The contractual agreement under the Executive Loan Plan with the former Chief Operating Officer was cancelled in July 1995. Accordingly, net compensation expense including interest and income taxes was $98,000 and $160,000 for 1995 and 1994, respectively.\n7. Employee Benefit Plans\nPension Plans The Company maintains a non-contributory defined benefit pension plan (the \"Stanley Retirement Plan\"), covering substantially all employees. The benefits provided by the plan are based on an employee's years of service and average compensation. Plan assets are invested principally in fixed income and equity instruments. The Company also maintains a supplemental retirement plan covering certain key employees (the \"Supplemental Plan\").\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. Employee Benefit Plans (continued)\nA Supplemental Plan participant who retires under any provision of the Stanley Retirement Plan will receive a supplemental retirement allowance equal to the excess, if any, of an eligible employee's benefit under the Stanley Retirement Plan in effect on January 1, 1987, over his benefit actually received at retirement. The Supplemental Plan is unfunded and benefit payments are made directly from Company assets.\nEffective December 31, 1995, the Company amended both the Stanley Retirement Plan and the Supplemental Plan to cease future benefit accruals under the plans. Accordingly, the Company recognized a pretax loss on curtailment of $31,000. The following table sets forth the plans' financial status at December 31 (in thousands):\nComponents of net periodic pension cost follow (in thousands):\n1995 1994 1993\nService cost.................... $ 774 $ 904 $ 799 Interest cost................... 1,256 1,315 1,333 Actual return on assets......... (1,320) (109) (382) Net amortization and deferral... 965 (589) (444) Loss on curtailment............. 31 $1,706 $1,521 $1,306\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. Employee Benefit Plans (continued)\nThe assumptions used as of December 31 to determine the plans' funded status, pension cost and loss on curtailment were:\n1995 1994 1993 Discount rate for funded status..... 7.67% 9.00% 7.75% Discount rate for pension cost...... 9.00% 7.75% 8.25% Salary progression.................. 5.00% 5.00% 4.00% Return on assets.................... 7.75% 8.00% 8.25%\nA reduction in the discount rate of 0.25% would create an additional minimum pension liability of $3.9 million and would result in a charge to stockholders' equity of $2.3 million, net of deferred taxes.\n401(k) Plan The Company also maintains the Stanley 401(k) Retirement Savings Plan (\"401(k) Plan\") for all of its eligible employees. Through December 31, 1995, the plan allowed for contributions by employees up to 20% of their salaries and also permitted discre- tionary contributions by the Company, although no discretionary contributions have been made to the plan by the Company. In connection with the curtailment of benefits in the Stanley Retirement Plan and Supplemental Plan, the Company amended its 401(k) Plan and expects to begin making discretionary matching and profit sharing contributions in 1996.\nPostretirement Benefits Other Than Pensions The Company provides certain health care benefits to eligible retired employees between the ages of 55 and 65 and provides certain life insurance benefits to eligible retired employees from age 55 until death. Substantially all of the Company's employees are eligible for these benefits after attaining specified years of service and age provisions. Employees who elect benefits at retirement contribute to the cost of coverage. The plan is unfunded. Prior to 1993, the Company expensed the cost of these benefits when paid. Effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Accordingly, the expected cost of retiree benefits, other than pensions, are charged to expense during the years the employees render service.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. Employee Benefit Plans (continued)\nThe Company elected to recognize the January 1, 1993, obligation of $8.1 million through charges to earnings over 20 years. On March 3, 1993, the Company also adopted plan design changes which reduced the January 1, 1993, obligation to $2.9 million. The following table sets forth the plan's financial status at December 31 (in thousands):\n1995 1994\nRetirees.................................... $(4,875) $(4,769) Fully eligible active plan participants..... (232) (333) Other active plan participants.............. (714) (634) Total accumulated postretirement benefit obligation...................... (5,821) (5,736) Unrecognized net loss....................... 2,752 2,927 Unrecognized transition obligation.......... 2,272 2,406 Net accrued postretirement benefit cost... $ (797) $ (403)\nComponents of net periodic postretirement benefit cost were (in thousands): 1995 1994 1993\nService cost................................ $ 93 $ 74 $ 72 Interest cost............................... 510 242 239 Amortization of transition obligation, after reduction for plan design changes... 134 359 146 Amortization and deferral................... 182 21\n$ 919 $ 696 $457\nThe weighted average discount rates used in determining the actuarial present value of the projected benefit obligation were 7.67%, 9.00% and 7.75% for 1995, 1994 and 1993, respectively. The rate of increase in future health care benefit cost used in determining the obligation for 1995 was 12% gradually decreasing to 6% beginning in 2002; for 1994 was 15% gradually decreasing to 7% beginning in 2005; and, for 1993 was 17% gradually decreasing to 5.75% beginning in 2007.\nIncreasing the assumed health care cost trend rate by one percentage point in each future year would increase the accumulated postretirement benefit obligation at December 31, 1995 by $307,000 and the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1995 by $31,000.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. Employee Benefit Plans (continued)\nDeferred Compensation The Company has a deferred compensation plan which permits certain management employees to defer portions of their compensation. The employees earn a fixed rate of interest on the deferred amounts. The plan is funded through the purchase of whole life insurance contracts on the employees, and the Company borrows against the cash surrender value of these policies to fund any benefit payments. The accrued liabilities relating to this plan of $1.4 million and $1.3 million at December 31, 1995 and 1994, respectively, are included in accrued salaries, wages and benefits and other long-term liabilities. The cash surrender value, net of policy loans, is included in other assets.\n8. Insurance Claim Accounting\nIn February 1993, a fire at the Stanleytown, Virginia facility damaged approximately 12% of the Company's total manufacturing facilities. The Company's insurance coverage provided for the complete replacement of the damaged building (which was leased), equipment and inventory, and reimbursement for business interruption losses.\nThe Company recorded business interruption insurance in 1993 based on estimated profits attributed to lost sales since the fire. The amount recognized represents the estimated gross profit that would have been realized on lost sales. Accordingly, $5.0 million of estimated income from business interruption insurance is included in gross profit in 1993. Also, a $2.2 million pretax gain was recorded in 1993 since proceeds from insurance exceeded the book value of leasehold improvements and equipment destroyed in the fire. In 1994, the Company reached a final insurance settlement and recorded a gain of $2.4 million.\n9. Discontinued Operations\nBeginning in 1991, Norman's was reflected as a discontinued operation. In 1994, the Company ceased operations at Norman's and liquidated the division resulting in a $2.8 million ($4.5 million pretax) additional loss provision. Net sales applicable to Norman's were $4.1 million and $12.1 million for 1994 and 1993, respectively.\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n10. Leases\nThe Company leased a substantial portion of its facilities under operating leases through June 1995, at which time the Company purchased these facilities, as described in Note 2. Rental expenses charged to operations were $1.4 million, $1.9 million and $2.0 million in 1995, 1994 and 1993, respectively. The Company continues to lease two showrooms and certain other equipment. Future minimum lease payments, net of subleases, are approximately as follows: 1996 - $769,000; 1997 - $801,000; 1998 -$534,000; 1999 - -$354,000; and thereafter - $12,000.\n11. Related Party Transactions\nApproximately 58% of the Company's common stock is owned by the ML-Lee Acquisition Fund, L.P. (the \"Majority Stockholder\") and certain affiliates of the Thomas H. Lee Company. The Company has entered into a management agreement with an affiliate of its Majority Stockholder. Fees paid pursuant to this agreement amounted to $250,000 annually in 1995, 1994 and 1993.\n12. Supplemental Cash Flow Information\nSTANLEY FURNITURE COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n13. Quarterly Results of Operations (Unaudited)\nThe Company's unaudited quarterly results of operations were as follows (in thousands, except per share data):\n(a) Uncollectible receivables written off, net of recoveries. (b) Represents net increase (decrease) in required reserve.\nS-1","section_15":""}
{"filename":"705752_1995.txt","cik":"705752","year":"1995","section_1":"Item 1. Business.\nCentury Properties Fund XIX (the \"Registrant\") was organized in August 1982 as a California limited partnership under the Uniform Limited Partnership Act of the California Corporations Code. Fox Partners II, a California general partnership, is the general partner of the Registrant. The general partners of Fox Partners II are Fox Capital Management Corporation (the \"Managing General Partner\"), a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership, and Fox Partners 83, a California general partnership.\nThe Registrant's Registration Statement, filed pursuant to the Securities Act of 1933 (No. 2-79007), was declared effective by the Securities and Exchange Commission on September 20, 1983. The Registrant marketed its securities pursuant to its Prospectus dated September 20, 1983, which was amended on June 13, 1984, and 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 multi-family residential properties. The Registrant is a \"closed\" limited partnership real estate syndicate formed to acquire multi-family residential properties.\nBeginning in September 1983 through October 1984, the Registrant offered $90,000,000 in Limited Partnership Units and sold units having an initial cost of $89,292,000. The net proceeds of this offering were used to acquire thirteen income-producing real properties. The Registrant's original property portfolio was geographically diversified with properties acquired in seven states. The Registrant's acquisition activities were completed in June 1985 and since then the principal activity of the Registrant has been managing its portfolio. One property was sold in each of the years, 1988, 1992 and 1993 and in February 1994. In addition one property was foreclosed on in 1993. 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 miscellaneous management expenses, are subject to change and cannot always be reflected in rental increases due to market conditions or existing leases. The profitability and marketability of developed real property may be adversely\naffected 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 legislation and 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 investment objective of capital growth will not be attained and that a significant portion of invested capital will not be returned to investors. 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, it is anticipated that some of the remaining properties will be held longer than originally expected. The ability to hold and operate these properties is dependent on the Registrant's ability to obtain additional financing, refinancing, or debt restructuring as required.\nProperty Matters\nMisty Woods - As of June 1, 1994, the lender holding the mortgage at Misty Woods Apartments was permitted to draw on the two letters of credit, each in the amount of $300,000, which were held in connection with the note payable encumbering this property. In accordance with the loan agreement, the Registrant applied the $594,000 net proceeds of the draw to the note, reducing the mortgage balance to $5,183,000. Commencing July 1, 1994, the monthly debt service payment was reduced to approximately $46,000. See, \"Item 8, Consolidated Financial Statements and Supplementary Data - Note 5.\"\nOn December 29, 1995, the first mortgage encumbering Misty Woods Apartments was refinanced. The principal amount of the refinanced mortgage was $5,450,000. The loan bears interest at 7.88% per annum, has a 30 year amortization and matures in January 2006. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with\nrespect to this loan.\nIn connection with this refinancing, the lender required the Registrant to transfer Misty Woods into a single asset entity. As a result, title to Misty Woods is held in a limited partnership in which the Registrant holds a 99% limited partnership interest. The general partner of the partnership is a corporation in which the Registrant is the sole stockholder.\nWood Lake, Wood Ridge and Plantation Crossing - On December 15, 1995, the Partnership refinanced the mortgage loan encumbering each of Wood Lake Apartments located in Atlanta, Georgia, Wood Ridge Apartments located in Atlanta, Georgia and Plantation Crossing located in Marietta, Georgia. In connection with this refinancing, each of these properties was conveyed from the sub-partnership which held these properties to the Registrant. The aggregate amount of the loan was $22,000,000, which was allocated $7,750,000 to Wood Lake, $9,000,000 to Wood Ridge and $5,250,000 to Plantation Crossing. The loan bears interest at a rate of 7.5% per annum, matures January 1, 2003 and has monthly payments of principal and interest of 163,000. In addition, the Registrant is required to make monthly tax escrow payments to the lender. Net proceeds from this refinancing to the Registrant were approximately $750,000. [Were net proceeds distributed?] See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nGreenspoint Apartments - On June 29, 1995, the Registrant replaced its maturing mortgage encumbering Greenspoint Apartments with a new first mortgage in the amount of $9,000,000. The loan bears interest at 8.33% per annum, is being amortized over 30 years and matures on May 15, 2005 with a balloon payment of approximately $7,974,00. As specified in the loan agreement, the Registrant was obligated to undertake additional improvements at the property in the amount of approximately $30,000 prior to December 31, 1995. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nSandspoint Apartments - On June 29, 1995, the Registrant replaced its maturing mortgage encumbering Sandspoint Apartments with a new first mortgage in the amount of $10,000,000. The loan bears interest at 8.33% per annum, is being amortized over 30 years and matures on May 15, 2005 with a balloon payment of approximately $8,859,00. As specified in the loan agreement, the Registrant was obligated to undertake additional improvements at the property in the amount of approximately $74,000 prior to March 31, 1996. See \"Item 8, Consolidated Financial Statements and Supplementary Data, Note 5\" for additional information with respect to this loan.\nPlantation Forest Apartments - On February 8, 1994, the Registrant sold this property for $2,450,000 to an unaffiliated third party. After payment of the existing loan of $1,965,000 and expenses of the sale, the proceeds to the Registrant were approximately $482,000. The tax loss on the sale was $149,000. Net proceeds realized from the sale were in part used to fully repay $370,000 of the demand notes, plus accrued interest, held by NPI Realty. The balance was added to working capital. See, \"Item 8, Consolidated Financial Statements and Supplementary Data - Note 8.\"\nMcMillan Place Apartments - On September 1, 1994, the Registrant\nobtained a modification of the existing mortgage encumbering McMillan Place Apartments in the amount of $12,939,000 (including accrued interest of $2,139,000). The loan was split into a first mortgage note of $10,800,000 and a second mortgage note of $2,139,000. The first mortgage requires monthly payments of approximately $89,000, bears interest at 8.25% per annum and is being amortized over a twenty-two year period. Under the terms of the second mortgage, interest accrues at 8.25% (with monthly compounding) per annum. Monthly payments of interest or principal are not required on the second mortgage. However, quarterly payments of all excess cash flow, as defined in the cash management agreement, are required to be made to the lender to reduce the second mortgage. In addition, pursuant to the terms of the loan documents the Registrant is prohibited from making any distributions from operations to its partners. Both loans mature on August 31, 1999 with a balloon payment of approximately $9,767,000 on the first mortgage plus the outstanding balance on the second mortgage note. As specified in the modification, the Registrant was required to deposit $80,000 in a reserve account for future capital improvements and is required to make monthly payments of $10,000 to the reserve account for the term of the loan. See, \"Item 8, Consolidated Financial Statements and Supplementary Data - Note 5.\"\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\ninterests 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 an affiliate of Insignia 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 eleven 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 24,811.66 limited partnership units or approximately 28% 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 dependent 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\nwhich 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 or has had an ownership interest is as follows. All of the Registrant's properties are owned in fee.\nDate of Name and Location Purchase Size - ----------------- -------- ---- Wood Lake Apartments 12\/83 220 units 100 Pinhurst Drive Atlanta, Georgia\nGreenspoint Apartments 02\/84 336 units NE Corner, 42nd Street Phoenix, Arizona\nSandspoint Apartments 02\/84 432 units SW Corner, Butler Drive and 19th Avenue Phoenix, Arizona\nWood Ridge Apartments 04\/84 280 units 100 Wood Ridge Drive Atlanta, Georgia\nPlantation Crossing Apartments 06\/84 180 units 2703 Delk Road Atlanta, Georgia\nSunrunner Apartments 07\/84 200 units 11400 4th Street North St. Petersburg, Florida\nMcMillan Place Apartments 06\/85 402 units 12610 Jupiter Place Dallas, Texas\nMisty Woods Apartments 06\/85 228 units 4642 Central Avenue Charlotte, North Carolina\nSee, \"Item 8, Consolidated 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 rate 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 ---- ---- ---- ---- ---- Wood Lake Apartments 97 96 91 92 89 Greenspoint Apartments 96 98 97 94 93 Sandspoint Apartments 96 95 90 91 91 Wood Ridge Apartments 95 97 94 92 90 Plantation Crossing Apartments 96 96 97 97 96 Sunrunner Apartments 95 97 91 92 92 McMillan Place Apartments 97 96 93 93 93 Misty Woods Apartments 97 95 93 95 93\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 partners 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\nWhiteside 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. No market for Limited Partnership Units exists, nor is expected to develop. As of March 1, 1996, distributions from operations to date to unitholders have been approximately $25 for each $1,000 of original investment.\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 6,710.\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 consolidated financial statements included elsewhere herein. This data is not covered by the independent auditors' report.\n- ---------------- (1) $1,000 original contribution per unit, based on units outstanding during the year, after giving effect to the allocation of net loss to the general partner.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial\nCondition and Results of Operations.\nLiquidity and Capital Resources\nThe Registrant holds investments in and operates eight apartment complexes. The properties are located in Georgia, Arizona, Florida, Texas, and North Carolina. The Registrant receives rental income from its properties and is responsible for operating expenses, administrative expenses, capital improvements and debt service payments. As of March 1, 1996, five of the thirteen properties originally purchased by the Registrant were sold or otherwise disposed. All of the Registrant's remaining properties, except for McMillan Place and Sunrunner Apartments, generated positive cash flow from operations during the year ended December 31, 1995. The Registrant's Sunrunner Apartments generated negative cash flow from operations due to significant capital improvements incurred during the year ended December 31, 1995.\nThe Registrant uses working capital reserves provided from any undistributed cash flow from operations, sales and refinancing proceeds as its primary sources of liquidity. For the long term, cash from operations will be the Registrant's primary source of liquidity. There have been no distributions since 1987. The Registrant is prohibited from making any distributions from operations until the mortgages encumbering McMillan Place Apartments are satisfied. Future distributions from sales or refinancings are permitted and will be evaluated at such time.\nThe level of liquidity based upon cash and cash equivalents experienced a $2,650,000 increase at December 31, 1995, as compared to 1994. The Registrant had an increase in cash of $1,159,000 from financing activities and $465,000 from investing activities and $1,026,000 from operating activities. The Registrant's cash provided by financing activities consists of $46,450,000 of proceeds received from the refinancing, at lower interest rates, of the mortgages encumbering the Registrant's Misty Woods, Plantation Crossing, Wood Lake, Wood Ridge, Greenspoint and Sandspoint Apartments properties, which was significantly offset by $42,807,000 of cash used for the repayment of the prior first mortgages and $364,000 of cash used for notes payable principal payments. The Registrant's net cash provided by investing activities consists of $787,000 of cash from the release of restricted cash, which was slightly offset by $322,000 of improvements to real estate. Cash from operating activities declined primarily due to significant refinancing fees, prepayment premiums and exit fees totaling $1,391,000. The Managing General Partner is currently evaluating the Registrant's capital improvement requirements. 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. The Registrant has substantial balloon payments on Sunrunner and McMillan Place Apartments due in January 1997 and August 1999 in the amounts of $3,169,000 and $12,971,000, respectively. Although management 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\nforeclosure. If the Registrant's Sunrunner Apartments were lost through foreclosure, the Registrant would recognize a loss of approximately $600,000. If the Registrant's McMillan Place Apartments were lost through foreclosure, the Registrant would not recognize a loss for financial reporting purposes.\nOn December 29, 1995, the Registrant refinanced the mortgage that encumbered its Misty Woods Apartments property with a new first mortgage in the amount of $5,450,000. The loan requires monthly payments of approximately $40,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $4,863,000. The loan may not be prepaid without penalty.\nOn December 15, 1995, the Registrant refinanced the mortgages that encumbered their Wood Ridge, Wood Lake and Plantation Crossing Apartments properties. The new $22,000,000 loan (allocated $9,000,000, $7,750,000 and $5,250,000, respectively) requires total monthly payments of approximately $163,000 at 7.5% interest and is being amortized over 25 years. The loan matures on January 1, 2003 with a balloon payment of approximately $19,283,000. The loan may not be prepaid without penalty.\nOn June 29, 1995, the Registrant replaced its maturing mortgage encumbering Greenspoint Apartments with a new first mortgage in the amount of $9,000,000. The loan requires monthly payments of approximately $68,000 at 8.33% interest and is being amortized over 30 years. The loan matures on May 15, 2005 with a balloon payment of approximately $7,974,000. The loan may not be prepaid without penalty.\nOn June 29, 1995, the Registrant replaced its maturing mortgage encumbering Sandspoint Apartment with a new first mortgage in the amount of $10,000,000. The loan requires monthly payments of approximately $76,000 at 8.33% interest and is being amortized over 30 years. The loan matures on May 15, 2005 with a balloon payment of approximately $8,859,000. The loan may not be prepaid without penalty.\nIn connection with the above refinanced mortgages, the Registrant recognized an extraordinary loss on extinguishment of debt of $1,636,000, consisting of the write-off of unamortized deferred loan costs, prepayment premiums and exit fees.\nIn connection with the refinancing of the Registrant's Misty Woods Apartments, the Registrant was required to transfer all the assets and liabilities of Misty Woods to a newly formed, wholly-owned subsidiary. In connection with the remaining refinancings that occurred in 1995, the Registrant was required to convey the properties from the respective wholly-owned subsidiaries back to the Partnership.\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 Registrant. Pursuant to the Second Tender Offer, DeForest I acquired an additional 4,234 units of the Registrant which, when added to the units acquired during the First Tender Offer, represents approximately 28% of the total number\nof outstanding units of the Registrant. The Managing General Partner believes that the tender will not have a significant impact on future operations or liquidity of the Registrant. Also 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. 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 to be elected. 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, it is anticipated at this time that the remaining properties will be 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, before the extraordinary loss on extinguishment of debt, improved by $1,058,000 for the year ended December 31, 1995, as compared to 1994, due to an increase in revenues of $963,000 and a decrease in expenses of $95,000. Operating results improved due to improved operations, the gain on sale of property of Plantation Forest Apartments and a provision for impairment of value on Sunrunner Apartments which were recorded in 1994.\nWith respect to the remaining properties, rental revenues increased by\n$977,000 primarily due to an increase in rental rates at all of the Registrant's properties. Occupancy remained relatively constant at all of the Registrant's properties. In addition, interest income increased by $42,000 due to an increase in average working capital reserves available for investment, coupled with an increase in interest rates.\nWith respect to the remaining properties, expenses increased due to increases in operating expenses of $596,000 and interest expense of $73,000, which was partially offset by decreases in depreciation expense of $11,000 and the provision for impairment of value of $500,000 which was recorded during 1994. Operating expenses increased primarily due to an increase in repairs and maintenance expenses at all of the Registrant's properties except for Sandspoint Apartments. The increase in interest expense is attributable to an increase in the variable interest rates on mortgages that had encumbered the the Registrant's Wood Lake, Wood Ridge, Plantation Crossing, Greenspoint and Sandspoint Apartments. Depreciation expense remained relatively constant. In addition, general and administrative expenses decreased by $32,000 due to a decrease in asset management costs, effective July 1, 1994.\n1994 Compared to 1993\nOperating results declined by $419,000 for the year ended December 31, 1994, as compared to 1993, due to the provision for impairment of value of $500,000 on the Sunrunner Apartments and the loss on the sale of Plantation Apartments of $149,000. Parkside Village Apartments and Plantation Forest Apartments were sold in May 1993 and February 1994, respectively, and the Cove Apartments was foreclosed in July 1993. With respect to the remaining properties, operating results improved by $194,000 due to increases in revenues of $826,000 and in expenses of $632,000.\nRevenues declined by $922,000 for the year ended December 31, 1994, as compared to 1993, due to the disposition of the Registrant's Parkside Village Apartments (May 1993), The Cove Apartments (July 1993) and Plantation Forest Apartments (February 1994). With respect to the remaining properties, rental revenues increased by $829,000 primarily due to increased rates and occupancy at all of the the Registrant's properties, except for Plantation Crossing, where rates and occupancy remained relatively constant. Reduced concessions at McMillan and Misty Woods Apartments also contributed to the increase in rental revenues. In addition, interest income decreased by $3,000.\nCosts and expenses declined by $503,000 for the year ended December 31, 1994, as compared to 1993, due to the disposition of the Registrant's Parkside Village, The Cove and Plantation Forest Apartments. With respect to the remaining properties, expenses increased due to increases in operating expenses of $892,000, depreciation expense of $15,000 and provision for impairment of $500,000, which were only partially offset by a decrease in interest expense of $396,000.\nOperating expenses increased primarily due to increased spending on deferred maintenance at the Registrant's Sandspoint, Greenspoint, Sunrunner and Wood Lake Apartments. Depreciation expense increased due to the effect of fixed asset additions. Interest expense declined partially due to a $594,000 reduction of the principal balance on the mortgage encumbering the Registrant's Misty Woods property. This was only partially offset by an increase in interest\nexpense on the Registrant's Greenspoint and Sandspoint properties due to an increase in interest rates on the variable rate mortgages. In addition, general and administrative expenses declined by $454,000 due to a decrease in asset management costs.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data.\nCENTURY PROPERTIES FUND XIX\nCONSOLIDATED FINANCIAL STATEMENTS\nYEAR ENDED DECEMBER 31, 1995\nINDEX\nIndependent Auditors' Reports.............................................F - 2 Consolidated Financial Statements: Balance Sheets at December 31, 1995 and 1994.........................F - 4 Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993...............................................F - 5 Statements of Partners' Equity for the Years Ended December 31, 1995, 1994 and 1993..................................F - 6 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993...............................................F - 7 Notes to Consolidated Financial Statements...........................F - 8 Financial Statement Schedule: Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995..........................F - 18\nConsolidated financial statements and financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in the consolidated financial statements.\nTo the Partners Century Properties Fund XIX Greenville, South Carolina\nIndependent Auditors' Report\nWe have audited the accompanying consolidated balance sheets of Century Properties Fund XIX (a limited partnership) (the \"Partnership\") and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated 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 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 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.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Century Properties Fund XIX and its subsidiaries 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. 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.\nIMOWITZ KOENIG & CO., LLP\nCertified Public Accountants\nNew York, N.Y. February 20, 1996\nINDEPENDENT AUDITORS' REPORT\nCentury Properties Fund XIX:\nWe have audited the accompanying consolidated statements of operations, partners' equity and cash flows of Century Properties Fund XIX (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.\nThe accompanying 1993 consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in the first paragraph of Note 10 to the financial statements, the Partnership has balloon payments totaling $10,800,000 due in December 1994, which raises substantial doubt about the Partnership's ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 10. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, --------------------------- 1995 1994 ------------ ------------ ASSETS\nCash and cash equivalents $ 2,868,000 $ 218,000 Restricted cash -- 787,000 Other assets and deferred costs 1,977,000 1,643,000\nReal Estate:\nReal estate 94,428,000 94,106,000 Accumulated depreciation (34,394,000 (31,650,000) Allowance for impairment of value (500,000) (500,000) ------------ ------------ Real estate, net 59,534,000 61,956,000 ------------ ------------ Total assets $ 64,379,000 $ 64,604,000 ============ ============\nLIABILITIES AND PARTNERS' EQUITY\nAccrued expenses and other liabilities (including $ 1,374,000 $ 1,195,000 $27,000 to a related party in 1995) Notes payable 62,342,000 59,063,000 ------------ ------------ Total liabilities 63,716,000 60,258,000 ------------ ------------\nPartners' Equity (Deficit):\nGeneral partner (8,992,000) (8,558,000) Limited partners (89,292 units outstanding at December 31, 1995 and 1994) 9,655,000 12,904,000 ------------ ------------ Total partners' equity 663,000 4,346,000 ------------ ------------ Total liabilities and partners' equity $ 64,379,000 $ 64,604,000 ============ ============\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, ------------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Revenues: Rental $14,630,000 $13,709,000 $14,052,000 Interest income 101,000 59,000 62,000 Gain on sale of property - - 576,000 ----------- ----------- ----------- Total revenues 14,731,000 13,768,000 14,690,000 ----------- ----------- ----------- Expenses (including $1,401,000, $690,000 and $57,000 paid to the general partner and affiliates in 1995,1994 and 1993): Interest 6,001,000 5,959,000 6,807,000 Operating 7,826,000 7,260,000 6,992,000 Depreciation 2,744,000 2,766,000 2,840,000 General and administrative 207,000 239,000 693,000 Loss on sale of property - 149,000 44,000 Provision for impairment of value - 500,000 - ----------- ----------- ----------- Total expenses 16,778,000 16,873,000 17,376,000 ----------- ----------- ----------- Loss before extraordinary item (2,047,000) (3,105,000) (2,686,000)\nExtraordinary item: Loss on extinguishment of debt (1,636,000) - - ----------- ----------- -----------\nNet loss $(3,683,000) $(3,105,000) $(2,686,000) =========== =========== =========== Net loss per limited partnership unit:\nLoss before extraordinary item $ (20.23) $ (30.67) $ (26.53)\nExtraordinary item (16.16) - - ----------- ----------- ----------- Net loss $ (36.39) $ (30.67) $ (26.53) =========== =========== ===========\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nGeneral Limited Total Partners' Partners' Partners' (Deficit) Equity Equity ----------- ----------- -----------\nBalance - January 1, 1993 $(7,875,000) $18,012,000 $10,137,000\nNet loss (317,000) (2,369,000) (2,686,000) ----------- ----------- -----------\nBalance - December 31, 1993 (8,192,000) 15,643,000 7,451,000\nNet loss (366,000) (2,739,000) (3,105,000) ----------- ----------- -----------\nBalance - December 31, 1994 (8,558,000) 12,904,000 4,346,000\nLoss before extraordinary item (241,000) (1,806,000) (2,047,000)\nExtraordinary item (193,000) (1,443,000) (1,636,000) ----------- ----------- ----------- Balance - December 31, 1995 $(8,992,000) $ 9,655,000 $ 663,000 =========== =========== ===========\nSee notes to consolidated financial statements.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nCentury Properties Fund XIX (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 estate. The Partnership currently owns three residential apartment complexes in Atlanta, Georgia, two residential apartment complexes in Phoenix, Arizona and one residential apartment complex in St. Petersburg, Florida, Dallas, Texas and Charlotte, North Carolina. The general partner of the Partnership is Fox Partners II, a California general partnership. The general partners of Fox Partners II are Fox Capital Management Corporation (\"FCMC\"), a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership, and Fox Partners 83, a California general partnership. The capital contributions of $89,292,000 ($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 28% of total limited partnership units of the Partnership (see Note 11).\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 Financial Group, Inc. (\"Insignia\"). In addition, an affiliate of Insignia acquired the limited partnership interests of the Partnership\nheld by DeForest I and certain of its affiliates (see Note 11).\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nConsolidation\nThe consolidated financial statements include the statements of the Partnership and its wholly-owned subsidiaries, one of which was formed in May 1993 into which Sunrunner Apartments was transferred and another which was formed in December 1995 into which Misty Woods Apartments was transferred. During 1995, two wholly-owned subsidiaries of the Partnership were terminated and the properties were conveyed back to the Partnership (see Note 5). All significant intercompany transactions and balances 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nDistributions\nCash distributions have been suspended since 1987. As specified in the modification of the existing mortgage encumbering McMillan Place Apartments, the Partnership is prohibited from making any distributions except from sales or refinancing of its properties, until the mortgage encumbering McMillan Place Apartments is satisfied.\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\npayments to maturity, approximates its carrying balance (see Note 5).\nCash and Cash Equivalents\nThe Partnership considers all highly liquid investments with an original maturity date of three months or less at the time of purchase to be cash equivalents.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year. At December 31, 1995, the Partnership had approximately $1,900,000 invested in overnight repurchase agreements, secured by United States Treasury obligations, which are included in cash and cash equivalents.\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 adoption of the SFAS had no effect on the Partnership's financial statements.\nDepreciation\nDepreciation is computed by the straight-line method over estimated useful lives ranging from 27.5 to 30 years for buildings and improvements and five to seven years for furnishings.\nDeferred Financing Costs\nFinancing costs are deferred and amortized over the lives of the related loans as interest expense or expensed if financing is not obtained. At December 31, 1995 and 1994, accumulated amortization of deferred financing costs totaled $114,000 and $974,000, respectively. Net deferred costs of $872,000 and $610,000 for the years ended December 31, 1995 and 1994, respectively, are included in other assets and deferred costs.\nNet Loss Per Limited Partnership Unit\nThe net loss per limited partnership unit is computed by dividing the net loss allocated to the limited partners by 89,292 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.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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 partners 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, the Managing General Partner 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 (see Notes 1 and 11). Related party fees and expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\nProperty management fees and real estate tax reduction fees are included in operating expenses. Reimbursed expenses are primarily included in general and administrative expenses. Financing fees have been capitalized and are being amortized over the life of the loan. Approximately $449,000 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.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES (Continued)\nIn accordance with the partnership agreement, the general partner received a partnership management incentive allocation equal to ten percent of net and taxable income (loss) before gains on property dispositions. The general partner was also allocated its two percent continuing interest in the Partnership's net and taxable income (loss) after the preceding allocation. The general partner is also allocated gain on property dispositions to the extent it is entitled to receive distributions and then 12 percent of remaining gain.\n3. RESTRICTED CASH\nRestricted cash at December 31, 1994, consists of required reserves maintained in accordance with financing arrangements on the Wood Lake, Wood Ridge, Plantation Crossing, Greenspoint and Sandspoint Apartments in order to meet future capital requirements. During 1995, these properties were refinanced and, as a result of these refinancings, restricted cash reserves were released.\n4. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\n1995 1994 ----------- -----------\nLand $11,681,000 $11,681,000 Buildings and improvements 75,225,000 75,029,000 Furnishings 7,522,000 7,396,000 ----------- -----------\nTotal 94,428,000 94,106,000 Accumulated depreciation (34,394,000) (31,650,000) Allowance for impairment of value (500,000) (500,000) ----------- -----------\nReal estate, net $59,534,000 $61,956,000 =========== ===========\n5. NOTES PAYABLE\nThe Partnership's properties are pledged as collateral for the related notes payable. The Partnership's Wood Lake, Wood Ridge and Plantation Crossing Apartments are cross-collateralized. The notes currently bear interest at rates ranging from 7.5% to 10.06%, and are payable monthly except for the second note on McMillan Apartments whose interest is compounded monthly and is payable at maturity, August 31, 1999.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. NOTES PAYABLE (Continued)\nOn December 29, 1995, the Partnership refinanced the mortgage that encumbered its Misty Woods Apartments property with a new first mortgage in the amount of $5,450,000. The loan requires monthly payments of approximately $40,000 at 7.88% interest and matures on January 1, 2006, with a balloon payment of approximately $4,863,000. The loan may not be prepaid without penalty. The Partnership incurred closing costs and fees of $177,000 in connection with the refinancing, of which $95,000 was paid in 1995. In connection with the refinancing, the Partnership was required to transfer all the assets and liabilities of Misty Woods Apartments to a newly formed, wholly-owned subsidiary, Misty Woods CPF 19, L.P.\nOn December 15, 1995, the partnership refinanced the mortgages that encumbered their Wood Ridge, Wood Lake and Plantation Crossing Apartments properties. The new $22,000,000 loan (allocated $9,000,000, $7,750,000 and $5,250,000, respectively) requires total monthly payments of approximately $163,000 at 7.5% interest and is being amortized over 25\nyears. The loan matures on January 1, 2003 with a balloon payment of approximately $19,283,000. A premium is to be calculated under the terms of the mortgage if the loan is prepaid. In connection with the refinancings, each of these properties was conveyed from a wholly-owned subsidiary, Century Woods 19, L.P., back to the Partnership. The Partnership incurred closing costs and fees of $346,000 in connection with this refinancing.\nOn June 29, 1995, the Partnership replaced its maturing mortgage encumbering Greenspoint Apartments with a new first mortgage in the amount of $9,000,000. The loan requires monthly payments of approximately $68,000 at 8.33% interest and is being amortized over 30 years. The loan matures on May 15, 2005 with a balloon payment of approximately $7,974,000. A premium is to be calculated under the terms of the mortgage if the loan is prepaid. In connection with the refinancing, the property was conveyed from a wholly-owned subsidiary, SGP Properties, L.P., back to the partnership. The partnership incurred closing costs of $138,000 in connection with the refinancing.\nOn June 29, 1995, the Partnership replaced its maturing mortgage encumbering Sandspoint Apartment with a new first mortgage in the amount of $10,000,000. The loan requires monthly payments of approximately $76,000 at 8.33% interest and is being amortized over 30 years. The loan matures on May 15, 2005 with a balloon payment of approximately $8,859,000. A premium is to be calculated under the terms of the mortgage if the loan is prepaid. In connection with the refinancing, the property was conveyed from a wholly-owned subsidiary, SGP Properties, L.P., back to the partnership. The Partnership incurred closing costs of $150,000 in connection with the refinancing.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. NOTES PAYABLE (Continued)\nIn connection with the above refinancings, the Partnership recognized an extraordinary loss on extinguishment of debt of $1,636,000, consisting of the write-off of unamortized deferred financing costs, prepayment premiums and exit fees.\nOn September 1, 1994, the Partnership obtained a modification of the existing mortgage encumbering McMillan Place Apartments in the amount of $12,939,000 (including accrued interest of $2,139,000). The loan was split into a first mortgage note of $10,800,000 and a second mortgage note of $2,139,000. The first mortgage requires monthly payments of approximately $89,000 at 8.25% interest and is being amortized over a twenty-two year period. Under the terms of the second mortgage, interest accrues at 8.25% (with monthly compounding). Quarterly payments, of all excess cash flow, as defined in the cash management agreement, are\nrequired to be made to the lender. No excess cash flow payments were made in 1995 or 1994. In addition, the Partnership is prohibited from making any distributions from operations to its partners. The notes mature on August 31, 1999, with a balloon payment of approximately $9,767,000 on the first mortgage plus the outstanding balance and accrued interest on the second mortgage note. As specified in the modification, the Partnership is required to make monthly payments of $10,000 to a reserve account for the term of the loan, which will be used to fund capital improvements.\nThe mortgage encumbering the Partnership's Sunrunner Apartments property matures on January 1, 1997, with a balloon payment of approximately $3,169,000. Based upon the operations of the property, the Managing General Partner anticipates that the maturing mortgage can be replaced.\nPrincipal payments at December 31, 1995 are required as follows:\n1996 $ 763,000 1997 3,933,000 1998 826,000 1999 12,691,000 2000 689,000 Thereafter 43,440,000 ------------- Total $ 62,342,000 =============\nAmortization of deferred financing costs totaled $304,000, $416,000 and $349,000 for 1995, 1994 and 1993, respectively.\n6. NOTES PAYABLE TO AFFILIATE OF THE GENERAL PARTNER\nThe Partnership repaid $370,000 in principal and $3,000 in interest to an affiliate of the general partner in 1994.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n7. ALLOWANCE FOR IMPAIRMENT OF VALUE\nIn 1994, the Partnership determined that, based upon current economic conditions and projected future operational cash flow, the decline in value of Sunrunner Apartments located in St. Petersburg, Florida was other than temporary and that recovery of its carrying value was not likely. Accordingly, a provision for impairment of value of $500,000 was recognized by the Partnership to reduce the property's carrying value to its estimated fair value.\n8. DISPOSITION OF RENTAL PROPERTIES\nIn February 1994, the Partnership sold Plantation Forest Apartments, located in Atlanta, Georgia for $2,450,000. After assumption of the existing loan of $1,965,000 and costs of sale of $3,000, the proceeds to the Partnership were $482,000. The carrying value of the property at the time of the sale was $2,590,000 and $6,000 in unamortized financing costs. The net loss on the sale was $149,000.\nIn May 1993, the Partnership sold Parkside Village Apartments, located in Aurora, Colorado for $11,259,000. After payment of the existing loan of $7,667,000 and costs of the sale of $728,000 (including $281,000 real estate commission paid to an outside broker and $400,000 prepayment premium on the existing loan), the net proceeds to the Partnership were $2,864,000. The carrying value of the property at the time of sale, net of the $1,895,000 provision for impairment of value recognized in 1992, was $9,955,000. The net gain on the sale was $576,000.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n9. 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 consolidated financial statements are as follows:\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n10. BASIS OF PRESENTATION AND OPERATING STRATEGY FOR THE YEAR ENDED DECEMBER 31, 1993\nThe accompanying consolidated financial statements for the year ended December 31, 1993, have been prepared on a going concern basis which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Partnership, after taking into account accrued but unpaid interest on certain notes payable for which the Partnership had suspended debt service payments, has experienced cash flow deficiencies during recent years. At December 31, 1993, the Partnership had borrowed a total of $370,000 from affiliates of the general partner for working capital needs. The Partnership holds investments in and operates properties in real estate markets that are or were experiencing unfavorable economic conditions. Many of the Partnership's properties are or were located in oil industry related and other weakened markets and have experienced operating difficulties. In addition, markets in some areas remained depressed due in part to overbuilding which continued to depress residential rental rates. The level of sales of existing properties have been affected by the limited availability of financing in real estate markets. The Partnership had a balloon payment of $10,800,000 on McMillan Place Apartments due in December 1994. The Partnership's ability to hold and operate its remaining properties was dependent on obtaining refinancing or debt restructuring as required. If the Partnership was unable to obtain debt modification or refinancing, it was likely that dispositions of properties operating at a deficit or with significant balloon payments would have occurred through sale, foreclosure or transfer to the lenders. The Partnership sold Plantation Forest in February 1994 and with the proceeds from the sale paid off the remaining loans from an affiliate of the general partner. The Partnership believed this strategy, combined with cash generated from the Partnership's properties with positive operations would allow the Partnership to meet its capital and operating requirements. The outcome of these uncertainties could not be determined. The consolidated financial statements do not include any adjustments that might have resulted from the ultimate outcome of these uncertainties.\nThe Partnership obtained a modification of the McMillan Place debt during 1994 and refinanced numerous properties during 1995, which resulted in significant net proceeds to the Partnership. Cash flow from operations improved in 1994 and 1995, as compared to 1993 (see Note 5).\n11. 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.\nCENTURY PROPERTIES FUND XIX (A Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSee accompanying notes.\nSCHEDULE III\nCENTURY PROPERTIES FUND XIX (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 was not qualified or modified as to audit scope or accounting principles. However, Deloitte's Independent Auditors' Report for the calendar year December 31, 1993 was modified due to the uncertainty regarding the Registrant's ability to continue as a going concern since the Registrant had substantial balloon payments due on Notes in 1994; the financial statements did not include any adjustments that might result from the outcome of this uncertainty. 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 II (\"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 affiliated Insignia (See \"Item 1, Business - Change in Control\"). Insignia is a full service real estate service organization performing property management, commercial and retail leasing, 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 Officer 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. From January 1983 until March 1991, Mr. Shuler was President of the Management Division of Hall Financial Group, Inc., a property management organization located in Dallas, Texas.\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\nInsignia NPI, LLC(1) 24,811.66(2) 27.8 All directors and executive officers as a group (5 persons) - - - ----------- (1) The business address for Insignia NPI, L.L.C. is One Insignia Financial Plaza, Greenville, South Carolina 29602. (2) Based upon information supplied to the Registrant by Insignia NPI, L.L.C.\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 Registrant's partnership agreement, the Partnership may be charged by the general partners and affiliates for services provided to the Partnership. On 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 II\nbegan directly providing cash management and other Partnership services on various dates commencing December 23, 1993. On March 1, 1994, an affiliate of NPI Equity II commenced providing certain property management services (see Notes 1 and 11). Related party expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 -------- -------- --------\nProperty management fees $738,000 $557,000 $ - Real estate tax reduction fees 66,000 - - Reimbursement of operational expenses: Partnership accounting and investor services 148,000 100,000 - Professional services - 30,000 - -------- -------- --------\nTotal $952,000 $687,000 $ - ======== ======== ========\nInterest expense $ - $ 3,000 $ 57,000 ======== ======== ========\nProperty management fees and real estate tax reduction fees are included in operating expenses. Reimbursed expenses are primarily included in general and administrative expenses. Approximately $449,000 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. In addition, a $27,000 fee was accrued to an affiliate of Insignia during 1995 in connection with the refinancing of the Partnership's Misty Woods Apartments property.\nIn accordance with the Registrant's partnership agreement, the general partner received a partnership management incentive allocation equal to ten percent of net and taxable income (loss) before gains on property dispositions. The general partner was also allocated its two percent continuing interest in the Partnership's net and taxable income (loss) after the preceding allocation. The general partner is also allocated gain on property dispositions to the extent it is entitled to receive distributions and then 12 percent of remaining gain.\nAs a result of its ownership of 24,811.66 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\naffiliates, 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) Consolidated Financial Statements and Financial Statement Schedules:\nSee \"Item 8\" of this Form 10-K for Consolidated Financial Statements of the Registrant, Notes thereto, and Financial Statement Schedules. (A Table of Contents to Consolidated 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 September 20, 1983, as amended or June 13, 1989, and as thereafter supplemented contained in the Registrant's Registration\nStatement on Form S-11 (Reg. No. 2-79007)\n10(a) Amended and Restated Note A, made as of September 1, 1994, by the Registrant in favor of The Travelers Insurance Company (\"Travelers\") in the principal amount of $10,800,000, incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1994.\n(b) Amended and Restated Note B, made as of September 1, 1994, by the Registrant in favor of Travelers in the principal amount of $2,138,673.53, incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1994.\n(c) Amended and Restated Deed of Trust, dated as of September 1, 1994, between the Registrant and Travelers, incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1994.\n(d) Amended and Restated Note B, made as of September 1, 1994, between the Registrant and Travelers, incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1994.\n(e) Promissory Note made December 15, 1995, by the Registrant in favor of Connecticut General Life Insurance Company (\"CIGNA\") in the principal amount of $22,000,000 relating to the refinancing of Wood Lake, Wood Ridge and Plantation Crossing.\n(f) Form of Deed to Secure Debt and Security Agreement from the Registrant to CIGNA relating to the refinancing of Wood Lake, Wood Ridge and Plantation Crossing.\n(g) First Mortgage Note from the Registrant to Secore Financial Corporation (\"Secore\") relating to the refinancing of Misty Woods Apartments.\n(h) First Mortgage and Security Agreement dated as of December 29, 1995, from the Registrant to Secure relating to the refinancing of Misty Woods Apartments.\n16. Letter from the Registrant's former Independent Auditor dated April 27, 1994, incorporated by reference to exhibit 10 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 26th of March, 1996.\nCENTURY PROPERTIES FUND XIX\nBy: FOX PARTNERS II Its General Partner\nBy: FOX CAPITAL MANAGEMENT CORPORATION, a General Partner\nBy:\/s\/ William H. Jarrard, Jr. William H. Jarrard, Jr. 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 date indicated.\nSignature\/Name Title Date\n\/s\/ William H. Jarrard, Jr. President and March 26, 1996 - --------------------------- Director William H. Jarrard, Jr.\n\/s\/ Ronald Uretta Principal Financial March 26, 1996 - --------------------------- Officer and Principal Ronald Uretta Accounting Officer\n\/s\/ John K. Lines Director March 26, 1996 - --------------------------- John K. Lines\nExhibit Index\nExhibit Page\n2.1 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 (6)\n10.1 Amended and Restated Note A, made as of September 1, (7) September 1, 1994, by the Registrant in favor of The Travelers Insurance Company (\"Travelers\") in the principal amount of $10,800,000\n10.2 Amended and Restated Note A, made as of September 1, (7) September 1, 1994, by the Registrant in favor of Travelers in the principal amount of $2,138,673.53\n10.3 Amended and Restated Deed of Trust, dated as of September (7) 1, 1994, between the Registrant and Travelers\n10.4 Amended and Restated Note B, made as of September 1, 1994 (7) between the Registrant and Travelers\n10.5 Promissory Note made December 15, 1995, by the Registrant in favor of Connecticut General Life Insurance Company (\"CIGNA\") in the principal amount of $22,000,000\n10.6 Deed to Secure Debt and Security Agreement from the Registrant to CIGNA\n10.7 First Mortgage Note from the Registrant to Secore Financial Corporation (\"Secore\")\n10.8 First Mortgage and Security Agreement dated as of December 29, 1995, from the Registrant to Secore\n16 Letter from the Registrant's former Independent Auditor dated April 27, 1994 (8)\n- -------------------\n(1) Incorporated by reference to the Registrant's Current Report on Form 8-K dated August 7, 1995\n(2) Incorporated by reference to Exhibt 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 September 20, 1983, as amended or June 13, 1989 and as thereafter supplemented contained in the Registrant's Registration Statement on Form S-11 (Reg. No. 2-79007)\n(7) Incorporated by reference to the Registrant's Form 10-Q for the quarter ended September 30, 1994.\n(8) Incorporated by reference to exhibit 10 to the Registrant's Current Report on Form 8-K dated April 22, 1994.","section_15":""}
{"filename":"742279_1995.txt","cik":"742279","year":"1995","section_1":"Item 1. Business\nGENERAL\nCOMMUNITY BANKSHARES INCORPORATED (CBI) AND THE COMMUNITY BANK. CBI's sole business is to serve as a holding company for The Community Bank. CBI was incorporated as a Virginia corporation on January 24, 1985, and on January 1, 1985, it acquired all of the issued and outstanding shares of The Community Bank's capital stock.\nThe Community Bank was incorporated in 1973 under the laws of the Commonwealth of Virginia. Since The Community Bank opened for business on June 10, 1974, its main banking and administrative office has been located at 200 North Sycamore Street, Petersburg, Virginia. The Community Bank opened a branch office in Colonial Heights, Virginia, during 1984. In 1985, The Community Bank opened its newest branch in the village of Chester in Chesterfield County, Virginia.\nPRINCIPAL MARKET AREA. The Community Bank concentrates its marketing efforts in the cities of Petersburg, and Colonial Heights, Virginia, and in the adjacent counties of Prince George, Dinwiddie and Chesterfield, including the village of Chester in Chesterfield County. As of December 31, 1995, The Community Bank had approximately $42.9 million of deposits in the City of Petersburg; $14.9 million of deposits in the City of Colonial Heights; and $19.3 million of deposits in the village of Chester. CBI's present intention is to continue concentrating its banking activities in its current market.\nBANKING SERVICES. Through its network of banking facilities, The Community Bank provides a wide range of commercial banking services to individuals and small and medium-sized businesses. The Community Bank conducts substantially all of the business operations of a typical independent, commercial bank, including the acceptance of checking and savings deposits, and the making of commercial real estate, personal, home improvement, automobile and other installment and term loans. The Community Bank also offers other related services, such as travelers' checks, safe deposit, lock box, depositor transfer, customer note payment, collection, notary public, escrow, drive-in facility and other customary banking services. Trust services are not offered by The Community Bank.\nThe accounts of The Community Bank's depositors are insured up to $100,000 for each account holder by the Federal Deposit Insurance Corporation, an instrumentality of the United States Government. Insurance of The Community Bank's accounts is subject to the statutes and regulations governing insured banks, to examination by the Federal Deposit Insurance Corporation, and to certain limitations and restriction imposed by that agency.\nLENDING ACTIVITIES\nLOAN PORTFOLIOS. CBI is a residential mortgage and residential construction lender and also extends commercial loans to small and medium-sized businesses within its primary service area. Consistent with its focus on providing community-based financial services, CBI does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside its primary service area.\nThe principal economic risk associated with each of the categories of loans in CBI's portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased depending on prevailing economic conditions. In an effort to manage the risk, CBI's policy gives loan amount approval limits to individual loan officers based on their level of experience. The risk associated with real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations and value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial loans varies based upon the strength and activity of the local economy of CBI's market area. The risk associated with real estate construction loans varies based upon the supply and demand for the type of real estate under construction. Most of CBI's residential real estate construction loans are for pre-sold and contract homes.\nRESIDENTIAL MORTGAGE LENDING. CBI originates conventional fixed rate and adjustable rate residential mortgage loans. All fixed rate loans are for a term of three years or less, unless the loan is to be fully amortized in 60 equal monthly payments. CBI does not originate residential mortgage loans for resale in the secondary market. Many of CBI's residential mortgage loan customers do not satisfy secondary mortgage market criteria. Such customers can qualify for a loan by providing larger down payments or third-party guarantors.\nRESIDENTIAL CONSTRUCTION LENDING. Because of the attractive adjustable rates available, CBI makes construction loans for residential purposes. These include both construction loans to experienced builders and loans to consumers for owner-occupied residences. CBI does not actively solicit loans to builders for homes that are not pre-sold. Construction lending entails significant additional risk as compared with residential mortgage lending. Construction loans to builders can involve larger loan balances concentrated with single borrowers or groups of related borrowers. Also, with construction loans, funds are advanced upon the security of the home under construction, which is of uncertain value prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. Residential construction loans to customers, for which a permanent loan commitment from another lender approved prior to loan closing is required, are subject to the additional risk of the permanent lender failing to provide the necessary funds at closing, either due to the borrower's inability to fulfill the terms of his commitment or due to the permanent lender's inability to meet its funding commitments. In addition to its unusual credit analysis of the borrowers, CBI seeks to obtain a first lien on the property as security for its construction loans.\nCOMMERCIAL REAL ESTATE LENDING. CBI provides permanent mortgage financing for a variety of commercial projects. In the normal course of business, CBI will provide financing for owner-occupied properties and for income producing, non-owner occupied projects which meet all the guidelines established by loan policy. These loans generally do not exceed 65% of current appraised or market value, whichever is lower, for unimproved land and 75% for improved commercial real estate. Such loans are written on terms which provide for a maturity provision of from one to three years.\nConstruction loans for the purpose of constructing commercial projects are provided for periods of not greater than one year, at floating rates of interest and are convertible to permanent financing consistent with terms outlined in CBI loan policy. When a construction loan agreement is entered into, particular care is taken to govern the process of the loan and, both initial project review and periodic inspections are conducted by competent personnel who are independent of CBI. Advance ratios are closely monitored and appropriate construction reserves are established.\nCONSUMER LENDING. CBI currently offers most types of consumer demand, time and installment loans, including automobile loans.\nCOMMERCIAL BUSINESS LENDING. As a full-service community bank, CBI makes commercial loans to qualified small businesses in CBI's market area. Commercial business loans generally have a higher degree of risk than residential mortgage loans but have commensurately higher yields. To manage these risks, CBI generally secures appropriate collateral and carefully monitors the financial condition of its business borrowers and the concentration of such loans in CBI's portfolio. Most of CBI's commercial loans are secured by real estate, which is viewed by CBI as the principal collateral securing such loans. Residential mortgage loans generally are made on the basis of the borrower's ability to make repayment from his employment and other income and are secured by real estate or real estate whose value tends to be easily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower's ability to make repayment from cash flow from its business and are either unsecured or secured by business assets, such as real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral for secured commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate.\nCOLLECTION PRACTICES. Often, CBI will not immediately proceed to foreclose on real estate loans that become more than 90 days past due. Instead, CBI will permit the borrower to market and sell the collateral in any orderly manner. If the borrower does not sell the collateral within a reasonable time, CBI will foreclose and sell the collateral. CBI's experience has been that losses on well collateralized real estate loans are minimized when it works with borrowers in this manner, although its practice of working with borrowers at times results in relatively high balances of past due loans. CBI also has found that its loan collection practices enable it to compete with larger and less flexible financial institutions that are not based in the community. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Nonperforming Assets\".\nCOMPETITION\nThe Community Bank encounters strong competition for its banking services within its primary market area. There are seven commercial banks actively engaged in business in the cities of Petersburg and Colonial Heights, Virginia, including approximately five major statewide banking organizations. Finance companies, mortgage companies, credit unions and savings and loan associations also compete with The Community Bank for loans and deposits. In addition, in some instances, The Community Bank must compete for deposits with money market mutual funds that are marketed nationally. Many of The Community Bank's competitors have substantially greater resources than The Community Bank.\nEMPLOYEES\nAs of December 31, 1995, The Community Bank had 33 full-time and 11 part-time employees. Management of The Community Bank considers its relations with employees to be excellent. No employees are represented by a union or any similar group, and The Community Bank has never experienced any strike or labor dispute.\nSUPERVISION AND REGULATION\nBanks and their holding companies are extensively regulated entities. CBI is currently a holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve). CBI's sole subsidiary is The Community Bank, a Virginia chartered bank which is subject to supervision and regulation by the Federal Reserve and the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia (the SCC).\nThe regulatory discussion is divided into two major subject areas. First, the discussion addresses the general regulatory considerations governing bank holding companies. This focuses on the primary regulatory considerations applicable to CBI as a bank holding company. Second, the discussion addresses the general regulatory provisions governing depository institutions. This focuses on the regulatory considerations of The Community Bank.\nThe discussion below is only a summary of the principal laws and regulations that comprise the regulatory framework. The descriptions of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, do not purport to be complete and are qualified in their entirety by reference to applicable laws and regulations.\nBANK HOLDING COMPANIES\nThe BHC Act generally limits the activities of the bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity which is so closely related to banking or to managing or controlling banks as to be a proper incident thereto.\nFormerly the BHC Act prohibited the Federal Reserve from approving an application from a bank holding company to acquire shares of a bank located outside the state in which the operations of the holding company's banking subsidiaries are principally conducted, unless such an acquisition was authorized by statute of the state where the bank whose shares were to be acquired was located. However, under federal legislation enacted in 1994, the restriction on interstate acquisitions was abolished, effective September 1995. A bank holding company from any state now may acquire banks and bank holding companies located in any other state, subject to certain conditions, including nationwide and state imposed concentration limits. Banks also will be able to branch across state lines by acquisition, merger or de novo, effective June 1, 1997 (unless state law would permit such interstate branching at an earlier date), provided certain conditions are met, including that applicable state law must expressly permit such interstate branching.\nThere are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries that are designed to reduce potential loss exposure to the depositors of the depository institutions and to the FDIC insurance fund. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the \"cross-guarantee\" provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the Bank Insurance Fund (BIF). The FDIC's claim for damages is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.\nBanking laws also provide that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder. This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the assets of any bank subsidiaries.\nCERTAIN REGULATORY CONSIDERATIONS\nREGULATORY CAPITAL REQUIREMENTS. All financial institutions are required to maintain minimum levels of regulatory capital. The federal bank regulatory agencies have established substantially similar risked based and leverage capital standards for financial institutions they regulate. These regulatory agencies also may impose capital requirements in excess of these standards on a case-by-case basis for various reasons, including financial condition or actual or anticipated growth. Under the risk-based capital requirements of these regulatory agencies, The Community Bank is required to maintain a minimum ratio of total capital to risk-weighted assets of at least 8%. At least half of the total capital is required to be \"Tier 1 capital\", which consists principally of common and certain qualifying preferred shareholders' equity, less certain intangibles and other adjustments. The remainder (\"Tier 2 capital\") consists of a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of The Community Bank as of December 31, 1995 are 14.94% and 16.10%, exceeding the minimums required. Based upon the applicable Federal Reserve regulations, at December 31, 1995, CBI and The Community Bank would be considered \"well capitalized\".\nIn addition, the federal regulatory agencies have established a minimum leverage capital ratio (Tier 1 capital to tangible assets). These guidelines provide for a minimum leverage capital ratio of 3% for banks and their respective holding companies that meet certain specified criteria, including that they have the highest regulatory examination rating and are not contemplating significant growth or expansion. All other institutions are expected to maintain a leverage ratio of at least 100 to 200 basis points above that minimum. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The leverage ratio of CBI as of December 31, 1995, was 11.49%, which is well above the minimum requirements.\nEach federal regulatory agency is required to revise its risk-capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. The Federal Reserve and the FDIC have jointly solicited comments on a proposed framework for implementing the interest rate risk component of the risk-based capital guidelines. Under the proposal, an institution's assets, liabilities, and off-balance sheet positions would be weighed by risk factors that approximate the instruments' price sensitivity to a 100 basis point change in interest rates. Institutions with interest rate risk exposure in excess of a threshold level would be required to hold additional capital proportional to that risk. In 1994, the federal bank regulatory agencies solicited comments on a proposed revision to the risk-based capital guidelines to take account of concentration of credit risk and the risk of nontraditional activities. The revision proposed to amend each agency's risk-based capital standards by explicitly identifying concentration of credit risk and the risk arising from nontraditional activities, as well as an institution's ability to manage those risks, as important factors to be taken into account by the agency in assessing an institution's overall capital adequacy. The proposal was adopted as a final rule by the federal bank regulatory agencies and subsequently became effective on January 17, 1995. CBI does not expect the final rule to have a material impact on their capital requirements; however, the Federal regulatory agencies may, as an integral part of their examination process, require CBI to provide additional capital based on such agency's judgments of information available at the time of examination.\nThe following table summarizes the minimum regulatory and current capital ratios for CBI on a consolidated basis, at December 31, 1995.\nCapital Ratios\nRegulatory CBI Minimum Current ----- ------ Risk-based capital Tier 1 (2) ..................................... 4.00% 14.94% Total (2) ...................................... 8.00% 16.10% Leverage (1) (2) ................................... 3.00% 11.49% Total shareholders' equity to total assets ......... N\/A 11.10%\n- ---------------- (1) Leverage ratio is calculated by Tier 1 capital as a percentage of quarterly period end assets\n(2) Calculated in accordance with the Federal Reserve's capital rules, with adjustment for net unrealized depreciation on securities available for sale.\nLIMITS ON DIVIDENDS AND OTHER PAYMENTS. Certain state law restrictions are imposed on distributions of dividends to shareholders of CBI. CBI shareholders are entitled to receive dividends as declared by the CBI Board of Directors. However, no such distribution may be made if, after giving effect to the distribution, it would not be able to pay its debts as they become due in the usual course of business or its total assets would be less than its total liabilities. There are similar restrictions with respect to stock repurchases and redemptions.\nThe Community Bank is subject to legal limitations on capital distributions including the payment of dividends, if, after making such distribution, the institution would become \"undercapitalized\" (as such term is used in the statute). For all state member banks of the Federal Reserve seeking to pay dividends, the prior approval of the applicable Federal Reserve Bank is required if the total of all dividends declared in any calendar year will exceed the sum of the bank's net profits for that year and its retained net profits for the preceding two calendar years. Federal law also generally prohibits a depository institution from making any capital distribution (including payment of a dividend or payment of a management fee to its holding company) if the depository institution would thereafter fail to maintain capital above regulatory minimums. Federal Reserve Banks are also authorized to limit the payment of dividends by any state member bank if such payment may be deemed to constitute an unsafe or unsound practice. In addition, under Virginia law no dividend may be declared or paid that would impair a Virginia chartered bank's paid-in capital. The Virginia SCC has general authority to prohibit payment of dividends by a Virginia chartered bank if it determines that the limitation is in the public interest and is necessary to ensure the bank's financial soundness.\nMost of the revenues of CBI and CBI's ability to pay dividends to its shareholders will depend on dividends paid to it by The Community Bank. Based on The Community Bank's current financial condition, CBI expects that the above-described provisions will have no impact on CBI's ability to obtain dividends from The Community Bank or on CBI's ability to pay dividends to its shareholders. At December 31, 1995, the Bank had $3.567 million of retained earnings legally available for the payment of dividends to CBI.\nIn addition to the regulatory provisions regarding holding companies addressed above, The Community Bank is subject to extensive regulation as well. The following discussion addresses certain primary regulatory considerations affecting The Community Bank.\nThe Community Bank is regulated extensively under both federal and state law. The Community Bank is organized a Virginia chartered banking corporation and is regulated and supervised by the Bureau of Financial Institutions of the Virginia SCC. As a member of the Federal Reserve System as well, The Community Bank is regulated and supervised by the Federal Reserve Bank in Richmond. The Virginia SCC and the Federal Reserve Bank of Richmond conduct regular examinations of The Community Bank, reviewing such matters as the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other aspects of their operations. In addition to these regular examinations, The Community Bank must furnish the Virginia SCC and the Federal Reserve with periodic reports containing a full and accurate statement of its affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.\nINSURANCE OF ACCOUNTS, ASSESSMENTS AND REGULATION BY THE FDIC. The Community Bank's deposits are insured up to $100,000 per insured depositor (as defined by law and regulation) through the BIF. The BIF is administered and managed by the FDIC. As insurer, the FDIC is authorized to conduct examinations of and to require reporting by BIF-insured institutions. The actual assessment to be paid by each BIF member is based on the institution's assessment risk classification and whether the institution is considered by its supervisory agency to be financially sound or to have supervisory concerns.\nThe FDIC is authorized to prohibit any BIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution's primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution, including The Community Bank, if it 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 the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of The Community Bank's deposit insurance.\nOTHER SAFETY AND SOUNDNESS REGULATIONS. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are \"well capitalized\", \"adequately capitalized\", \"undercapitalized\", \"significantly undercapitalized\" or \"critically undercapitalized\", as such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies.\nIn addition, FDIC regulations require that management report on the institution's responsibility to prepare financial statements, and to establish and to maintain an internal control structure and procedures for financial reporting and compliance with designated laws and regulations concerning safety and soundness; and that independent auditors attest to and report separately on assertions in management's reports concerning compliance with such laws and regulations, using FDIC-approved audit procedures.\nEach of the federal banking agencies also must develop regulations addressing certain safety and soundness standards for insured depository institutions and depository institution holding companies, including compensation standards, operational and managerial standards, asset quality, earnings and stock valuation. The federal banking agencies have issued a joint notice of proposed rulemaking, which requested comment on the implementation of these standards. The proposed rule sets forth general operational and management standards in the areas of internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. The proposed contemplates that each federal agency would determine compliance with these standards through the examination process, and if necessary to correct weaknesses, require an institution to file a written safety and soundness compliance plan. CBI has not yet determined the effect that the proposed rule would have on its operations and the operations of its depository institution subsidiary if it is enacted substantially as proposed.\nCOMMUNITY REINVESTMENT. The requirements of the Community Reinvestment Act (CRA) affect The Community Bank. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution's efforts in meeting community credit needs currently are evaluated as part of the examination process pursuant to twelve assessment factors. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility. To the best knowledge of The Community Bank, it is meeting its obligations under the CRA.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nCBI's offices and The Community Bank's main office are located in two 3,500 square feet condominiums in a seven-story masonry building located at 200 North Sycamore Street, Petersburg, Virginia. The first floor includes a drive-in facility, which is serviced by tellers located inside The Community Bank through a closed circuit TV\/pneumatic tube system. The Community Bank's branch office at 2618 South Crater Road in Petersburg was opened in 1979. The South Crater Road office occupies a one and one-half story 2,100 square foot brick building of Colonial design. In 1984, the Community Bank opened a branch office in Colonial Heights, located at 2000 Snead Avenue in a 640 square foot office of contemporary design. In 1985, The Community Bank opened its newest branch in Chester, located at 4203 West Hundred Road in a 1,600 square foot brick office of contemporary design. The Community Bank owns the land and the building in which the South Crater Road and Chester branches operate, and leases the Colonial Heights facility.\nCBI's facilities and equipment are considered adequate for its immediate needs and for foreseeable expansion.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to Vote of Security Holders.\nNone.\nItem 5.","section_5":"Item 5. Market for Company's Common Stock and Related Stockholder Matters.\nAs of December 31, 1995, the Company had 724 shareholders of record of its Common Stock.\nExcept for one share issued for organizational purposes in 1984, the Company did not issue any shares of its Common Stock until January 1, 1985, at which time each share of common stock outstanding of the Bank was automatically converted into the right to receive one-third share of the Company's Common Stock.\nThe following table sets forth, for the quarters indicated, the high and low sale prices for CBI Common Stock on the OTC Bulletin Board since May 1994 and the high and low bid prices of trades known to CBI on the over-the-counter market for stock prices reported locally through the regional quotation system before May 1994 and per share dividends paid during the respective periods.\nCBI Market Price and Dividends\n- ------------- (1) All prices and dividends are adjusted for a 100% stock dividend paid on August 31, 1995.\nDIVIDENDS\nThe Company declared annual dividends of $201,250 and $171,000 on its Common Stock during 1995 and 1994, respectively. The Company's management presently intends to continue the Bank's policy of paying out 11.5% to 17.5% of the previous year's earnings as dividends.\nLIMITS ON DIVIDENDS AND OTHER PAYMENTS\nAs noted in Item 1. Business, the Bank is limited in the amount of dividends it may pay to the Company in any given year. At December 31, 1995, the Bank had $3.567 million of retained earnings legally available for the payment of dividends to the Company.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nCOMPARATIVE SUMMARY OF EARNINGS\nThe following table presents a Comparative Summary of Earnings of the Company for the five years ended December 31, 1995. These statements should be read in conjunction with the Consolidated Financial Statements and related Notes appearing elsewhere in this filing.\n- -------------------------- (1) All per share information has been restated to reflect a 2 for 1 stock split effected in the form of a 100% stock dividend paid August 31, 1995.\n(2) Net interest margin is calculated as tax-equivalent net interest income divided by average earning assets and represents the Bank's net yield on its earning assets.\nCertain selected financial information required by Item 6. is included in Management's Discussion and Analysis.\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 contained in the Company's Annual Report to Stockholders 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.\nThe consolidated financial statements, together with the report thereon of Mitchell, Wiggins & Company LLP, is contained in the Company's 1995 Annual Report to Stockholders and is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure.\nNone.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company.\nWith respect to the directors and executive officers of the Company, the information required by Item 10 of Form 10-K appears in the Company's Proxy Statement for the 1996 Annual Meeting and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by Item 11 of Form 10-K appears in the Company's Proxy Statement for the 1996 Annual Meeting and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by Item 12 of Form 10-K appears in the Company's Proxy Statement for the 1996 Annual Meeting and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required by Item 13 of Form 10-K appears in the Company's Proxy Statement for the 1996 Annual Meeting and is incorporated herein by reference.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) (1) The following documents are contained in the Company's 1995 Annual Report and are incorporated herein by reference.\nFinancial Statements: Independent Auditors' Report on the Consolidated Financial Statements\nConsolidated Statements of Condition at December 31, 1995 and\nConsolidated Statements of Income for the three years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\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 included herein: 2 - Agreement And Plan Of Reorganization\n3 - Articles of Incorporation and By-laws (filed as an Exhibit to Registrant's Registration Statement of Form S-14 and amendment No. 1 thereto, filed with the Commission on March 14, 1984 and July 10, 1984, respectively, and incorporated herein by reference)\n13 - Community Bankshares Incorporated 1995 Annual Report to Stockholders\n21 - Subsidiaries of the Registrant\n23 - Consent of Mitchell, Wiggins & Company LLP\n(b) Reports on Form 8-K No reports on Form 8-K were filed for the year ended December 31, 1995.\nEXHIBITS\nANNUAL REPORT ON FORM 10-K\nPURSUANT TO SECTION 13 or 15(d) OF\nTHE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nCOMMUNITY BANKSHARES INCORPORATED\nCOMMISSION FILE NUMBER 0-13100\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, COMMUNITY BANKSHARES INCORPORATED has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:\nCOMMUNITY BANKSHARES INCORPORATED\n\/s\/ NATHAN S. JONES, 3RD. Nathan S. Jones, 3rd. President and Chief Executive Officer\nDate: 3-19-96\n\/s\/ LILLIAN UMPLHLETT Lilliam Umphlett Principal Financial Officer\nDate: 3-19-96\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\/s\/BOBBY G. HOLDEN Date: 3-19-96 Director\n\/s\/PHILLIP H. KIRKPATRICK Date: 3-19-96 Director\n\/s\/ELINOR B. MARSHALL Date: 3-19-96 Director\n\/s\/JAMES A. BOYD Date: 3-19-96 Director\n\/s\/A. L. SHEFFIELD Date: 3-19-96 Director\n\/s\/LOUIS C. SHELL Date: 3-19-96 Director\nExhibit Index\n2 - Agreement And Plan Of Reorganization\n13 - Community Bankshares Incorporated 1995 Annual Report to Stockholders\n21 - Subsidiaries of the Registrant\n23 - Consent of Mitchell, Wiggins & Company LLP","section_15":""}
{"filename":"721371_1995.txt","cik":"721371","year":"1995","section_1":"ITEM 1: BUSINESS\nGENERAL\nCardinal Health, Inc. (the \"Company\") is a national, full-service wholesaler distributing a broad line of pharmaceuticals, surgical and hospital supplies, therapeutic plasma and other specialty pharmaceutical products, health and beauty care products, and other items typically sold by hospitals, retail drug stores, and other health care providers. An important component of the Company's distribution activities is the broad range of support services it offers to its customers, which are designed to assist the Company's customers in maintaining and improving their market positions. These support services foster strong relationships between the Company and its customers by positioning the Company as a valuable resource capable of offering the centralized services which are increasingly important in today's competitive marketplace. The Company believes that in most instances it would not be economically feasible for its customers to develop and maintain these services independently.\nThe Company is structured as a holding company operating through a number of separate operating subsidiaries. These separate operating subsidiaries are sometimes collectively referred to as the \"Cardinal Health\" companies. As used in this report, the \"Registrant\" and the \"Company\" refers to Cardinal Health, Inc. and subsidiaries, unless the context requires otherwise. Prior to February 7, 1994, the Company was known as Cardinal Distribution, Inc.\nSUPPORT SERVICES\nAs a full-service wholesale distributor, the Company complements its distribution activities by offering a broad range of value-added support services to assist customers and suppliers in maintaining and improving their market positions and to strengthen the Company's role in the channel of distribution. These support services include computerized order entry and order confirmation systems, customized invoicing, generic sourcing programs, product movement and management reports, consultation on store operation and merchandising, and customer training. Most customers transmit merchandise orders directly to the Company's data processing system through computerized order entry devices. The Company's proprietary software systems feature customized databases specially designed to help its customers order more efficiently, contain costs, and monitor their purchases which are covered by group contract purchasing arrangements.\nSPECIALTY WHOLESALING\nIn addition to its core wholesaling activities, the Company operates several specialty health care businesses which offer value-added services to its customers and suppliers while providing the Company with additional opportunities for growth and profitability. For example, the Company's National PharmPak Services, Inc. subsidiary operates a pharmaceutical repackaging program for both independent and chain customers. In January 1992, the Company formed National Specialty Services, Inc. (\"NSS\"), which distributes therapeutic plasma products and other specialty pharmaceuticals to hospitals, clinics and other managed care facilities on a nationwide basis through the utilization of telemarketing and direct mail programs. In December 1993, the Company expanded its specialty wholesaling business through a merger with PRN Services, Inc., (\"PRN\"), a distributor of oncology and other specialty products to clinics and physician groups across the United States. PRN operations were merged into NSS on December 31, 1994. These specialty distribution activities are part of the Company's overall strategy of developing diversified products and services to enhance the profitability of its business and that of its customers and suppliers.\nCUSTOMERS AND SUPPLIERS\nThe Company regularly supplies pharmaceuticals, surgical and hospital supplies, health and beauty care products, and other items to hospitals, independent and chain drug stores, alternate care centers, and pharmacy departments of supermarkets and mass merchandisers located throughout the continental United States. In fiscal 1995, the Company's largest customer, K-Mart Corporation, accounted for approximately 11% of net sales (by dollar volume). Based upon dollar volume, in fiscal 1995, approximately 47% of the\nCompany's net sales were to hospitals and managed care facilities, approximately 28% of the Company's net sales were to chain drug stores and the pharmacy departments of supermarkets and mass merchandisers, approximately 20% of the Company's net sales were to independently owned drug stores, and approximately 5% of the Company's net sales were to other customers.\nThe Company obtains its products from many different suppliers, the largest of which accounted for approximately 5.9% (by dollar volume) of its net sales in fiscal 1995. The Company's five largest suppliers accounted for approximately 22% (by dollar volume) of its net sales during fiscal 1995, and the Company's relationships with its suppliers are generally good. The Company's arrangements with its suppliers typically may be canceled by either the Company or the supplier upon 30 to 90 days prior notice although many of these arrangements are not governed by formal agreements. The loss of certain suppliers could adversely affect the Company's business if alternative sources of supply were unavailable.\nCOMPETITION\nThe Company's markets are highly competitive. The Company competes directly with other national and regional wholesalers, direct selling manufacturers, mail-order houses, and specialty distributors on the basis of price, breadth of product lines, marketing programs, and support services. The Company's businesses have narrow profit margins and, accordingly, the Company's earnings depend significantly on its ability to distribute a large volume and variety of products efficiently and to provide quality support services.\nACQUISITIONS\nThe Company has grown during the past five years as a result of both internal growth and business acquisitions. In June 1990, the Company purchased Ohio Valley-Clarksburg, Inc. of Wheeling, West Virginia, for $27,125,000 in a cash transaction expanding the Company's presence in southern Pennsylvania, Maryland, Virginia, and Washington, D.C. The Company expanded into the mid-south market in October 1991, by acquiring Chapman Drug Company, based in Knoxville, Tennessee for $16,800,000 in a cash transaction. In May 1993, the Company purchased Solomons Company, a Savannah, Georgia based drug wholesaler serving customers located primarily in the southeastern region of the United States. In December 1993, a subsidiary of the Company merged with PRN (see \"Specialty Wholesaling\" above).\nIn February 1994, the Company completed its largest business combination to date when it combined with Whitmire Distribution Corporation (\"Whitmire\"), a Folsom, California based drug wholesaler (the \"Whitmire Merger\"). The majority of Whitmire's sales were concentrated in the western and central United States, complementing the Company's former concentration of sales in the eastern United States and positioning the combined company to service both customers and suppliers on a national basis. As a result of the Whitmire Merger, the Company now maintains a network of distribution centers enabling it to routinely serve the entire population of the continental U.S. on a next day basis.\nThe Company has completed two additional business combinations since the Whitmire Merger. On July 1, 1994, the Company completed a business combination with Humiston-Keeling, Inc., a Calumet City, Illinois based drug wholesaler serving customers located primarily in the upper midwest region of the United States. On July 18, 1994, the Company completed a merger with Behrens Inc., a Waco, Texas based drug wholesaler serving customers located primarily in Texas and adjoining states.\nThe Company recently signed a definitive merger agreement providing for the combination of Medicine Shoppe International, Inc. (\"Medicine Shoppe\"), a franchisor of independent retail pharmacies, with the Company. Under the terms of the transaction, shareholders of Medicine Shoppe will receive a fraction of a Common Share in exchange for each common share of Medicine Shoppe. The Company will issue between approximately 6.0 million and 6.8 million Common Shares in the transaction, depending in part upon the average closing price of the Common Shares over a specified period; under certain circumstances the Company could issue up to approximately 7.2 million Common Shares in the transaction. The Company has also agreed to convert existing Medicine Shoppe stock options (approximately 160,000 shares) into Company options at the same exchange rate as described above. If the transaction is completed, Medicine Shoppe will become a wholly-owned subsidiary of the Company. The transaction is subject to certain conditions, including approval by the Medicine Shoppe shareholders.\nThe Company continually evaluates possible candidates for acquisition and intends to continue to seek opportunities to expand its healthcare distribution operations and services. For additional information concerning the acquisitions described above, see Note 3 of \"Notes to Consolidated Financial Statements.\"\nEMPLOYEES\nAt September 1, 1995, the Company had approximately 4,000 employees, of which approximately 300 are subject to collective bargaining agreements. The Company considers its employee relations to be good.\nREGULATORY MATTERS\nThe Company, as a distributor of prescription drugs, including certain controlled substances, is required to register for permits and\/or licenses with, and comply with certain operating and security standards of, the United States Drug Enforcement Administration, the Food and Drug Administration and various state boards of pharmacy or comparable agencies. In addition, the Company is subject to requirements of the Controlled Substance Act and the Prescription Drug Marketing Act of 1987, an amendment to the Food, Drug and Cosmetic Act (the \"FDCA\") which requires each state to regulate the purchase and distribution of prescription drugs under prescribed minimum standards. National PharmPak Services, Inc., the Company's repackaging subsidiary, must comply with certain Good Manufacturing Practices as provided under the FDCA. The Company believes that it is in substantial compliance with all Federal and state statutes and regulations applicable to its activities.\nINDUSTRY CONSIDERATIONS\nAn aging population, new product introductions, and a higher concentration of distribution through wholesalers are all factors which have created favorable growth patterns for the drug wholesaling industry. At the same time, it is also a very competitive industry undergoing rapid change and consolidation. A number of factors have in the recent past affected and are expected to continue to affect the business equation for the Company, including: (a) a greater mix of higher volume customers, where the lower cost of distribution and better asset management and cash flow enable the Company to offer lower pricing to the customer; (b) reduced inventory gains associated with lower drug price inflation, which are partially offset by corresponding decreases in last-in, first-out (LIFO) earnings charges and inventory carrying costs; (c) increased merchandising funding from manufacturers, particularly related to the growth in generic pharmaceuticals; (d) improved selling, general and administrative cost absorption due to significant productivity investments and the operating leverage associated with sales growth and acquisitions; and (e) increased sales and earnings from specialty distribution services.\nIn response to cost containment pressure from private and governmental payers and the current focus on healthcare reform in the United States, customers are consolidating into super-regional and national affiliations while manufacturers are under increased pressure to slow the rate of drug price inflation and to seek more cost-effective methods of marketing and distributing their products. In this regard, drug wholesalers, including the Company, will be challenged to service customers over a wider geographic base, offer manufacturers more innovative marketing and distribution services, and provide both manufacturers and customers with the common system and reporting links necessary to streamline the efficient flow of product and information among distribution partners.\nOTHER\nDuring fiscal 1993, the Company recorded restructuring charges of $13.7 million, primarily related to the closing of certain non-core operations and the rationalization, standardization, and improvement of selected distribution operations, information systems and support functions. See Note 2 of \"Notes to Consolidated Financial Statements\" for further discussion. At June 30, 1995, the initiatives contemplated have been substantially completed in accordance with the original plan and all related funds have been expended.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nBecause of the nature of the Company's business, office and warehousing facilities are operated in widely dispersed locations across the United States. At September 1, 1995, the Company distributed products from thirty-six principal operating facilities located in twenty-three states, nine of which are owned by the Company and the balance of which are leased. The Company's principal executive offices currently consist of leased office space located at 655 Metro Place South, Dublin, Ohio. The Company has executed a lease to relocate its principal executive offices to another location in Dublin, Ohio before the end of calendar year 1995. The Company considers its operating properties to be in satisfactory condition and adequate to meet its present needs. However, the Company expects to make further additions, improvements, and consolidations to its properties as the Company's business continues to expand.\nFor certain financial information regarding the Company's office and warehousing facilities, see Notes 5 and 9 of \"Notes to Consolidated Financial Statements.\"\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nIn November 1993, Cardinal and Whitmire were each named as defendants in a series of purported class action antitrust lawsuits which were later consolidated and transferred by the Judicial Panel for Multi-District Litigation to the United States District Court for the Northern District of Illinois (the \"Brand Name Prescription Drug Litigation\"). Subsequent to the consolidation, a new consolidated complaint (\"amended complaint\") was filed which included allegations that the wholesaler defendants, including Cardinal and Whitmire, conspired with manufacturers to inflate prices by using a chargeback pricing system. Cardinal and Whitmire have filed an answer denying the allegations in the amended complaint. In addition to the Federal court case described above, Whitmire has been named as a defendant in a series of state court cases alleging similar claims under various state laws regarding the sale of brand name prescription drugs.\nEffective October 26, 1994, the Company entered into a Judgment Sharing Agreement in the Brand Name Prescription Drug Litigation with other wholesaler and pharmaceutical manufacturer defendants. Under the Judgment 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 judgment is entered 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 judgment or one million dollars. In addition, the Company has released any claims which it might have had against the manufacturers for the claims presented by the plaintiffs in the Brand Name Prescription Drug Litigation. The Judgment Sharing Agreement covers the Federal court litigation as well as the cases which have been filed in various state courts. On December 15, 1994, the plaintiffs filed a motion to declare the Judgment Sharing Agreement unenforceable. On April 10, 1995, the court denied that motion and ruled that the Judgment Sharing Agreement is valid and enforceable. The plaintiffs filed a motion for reconsideration of the court's April 10, 1995 ruling, and the court denied that motion and reaffirmed its earlier decision on April 24, 1995.\nThe Company believes that both Federal and state allegations against Cardinal and Whitmire are without merit, and it intends to contest such allegations vigorously. The Company does not believe that the outcome of these lawsuits will have a material adverse effect on the Company's financial condition or results of operations.\nThe Company also becomes involved from time to time in ordinary routine litigation incidental to its business, none of which is expected to have any 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\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are as follows (information provided as of September 1, 1995):\nUnless indicated to the contrary, the business experience summaries provided below for the Company's executive officers describe positions held by the named individuals during the last five years but may exclude other positions held with subsidiaries of the Company.\nRobert D. Walter has been a Director, Chairman of the Board and Chief Executive Officer of the Company since its formation in 1979 and has served as a director and officer of certain of the Company's subsidiaries since their formation or acquisition by the Company. Mr. Walter also serves as a director of Banc One Corporation, Columbia\/HCA Healthcare Corporation and Westinghouse Electric Corporation.\nMelburn G. Whitmire has been a Director of the Company since January 1994 and was elected Vice Chairman of the Company in February 1994. Prior to that, Mr. Whitmire was Chairman of the Board, Chief Executive Officer and President of Whitmire Distribution Corporation, and he has continued to serve in those capacities for Whitmire following the Whitmire Merger.\nJohn C. Kane has been a Director of the Company since August 1993 and has been the Company's President and Chief Operating Officer since joining the Company in February 1993. Prior to that, Mr. Kane was employed by Abbott Laboratories (a pharmaceutical and healthcare manufacturer), where he served most recently as President of the Ross Laboratories Division.\nDavid Bearman has been an Executive Vice President of the Company since February 1994 and, prior to that, served as a Region President from May 1991 to February 1994 and as a Senior Vice President from October 1989. Mr. Bearman has also served as the Company's Chief Financial and Accounting Officer since joining the Company in October 1989 and serves in similar capacities for subsidiaries of the Company. Prior to joining the Company, Mr. Bearman served as the Chief Finance Executive of the Medical Systems Division of General Electric Company.\nGeorge H. Bennett, Jr. has been Secretary of the Company since July 1994 and an Executive Vice President of the Company since February 1994. Prior to that, Mr. Bennett was a Senior Vice President and Chief Administrative Officer of the Company from May 1991. Mr. Bennett has also served as General Counsel of the Company since joining the Company in January 1984, and serves in a similar capacity for subsidiaries of the Company.\nAnthony J. Campanaro has been the Company's Executive Vice President -- Central Group since April 1995. Prior to that, Mr. Campanaro was the Company's Senior Vice President -- Retail Sales and Vice President -- Retail Sales.\nJames E. Clare has been the Company's Executive Vice President -- Southern Group since February 1994. Prior to that, Mr. Clare served as the Vice President -- Eastern Region of Whitmire Distribution Corporation and has continued to serve as an officer of Whitmire following the Whitmire Merger.\nGary E. Close has been the Company's Executive Vice President -- Western Group since February 1994. Prior to that, Mr. Close served as the Executive Vice President -- Operations of Whitmire Distribution Corporation and has continued to serve as an officer of Whitmire following the Whitmire Merger.\nDaniel P. Finkelman has been the Company's Executive Vice President -- Marketing since joining the Company in May 1994. Prior to that, Mr. Finkelman was a principal with McKinsey and Company, Inc. (an international management consulting firm).\nPhillip A. Greth has been the Company's Executive Vice President -- Chief Information Officer since joining the Company in May 1995. Prior to that, Mr. Greth was the Director of Management Information Services, Ross Products Division, Abbott Laboratories.\nJames F. Millar has been the Company's Executive Vice President -- Northern Group since February 1994. Prior to that, Mr. Millar served as a Region President from May 1991, a Senior Vice President of the Company from November 1992, and President of the Company's Cardinal Syracuse, Inc. subsidiary.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS\nThe Company's common shares, without par value (the \"Common Shares\") are quoted on the New York Stock Exchange under the symbol \"CAH.\" Prior to listing on the New York Stock Exchange, the Common Shares were quoted on the Nasdaq National Market under the symbol \"CDIC.\"\nThe following table reflects the range of the reported high and low last sale prices of the Common Shares as reported on the New York Stock Exchange Composite Tape from September 7, 1994 through September 15, 1995 and on the Nasdaq National Market for all periods prior to September 7, 1994, and the per share dividends declared thereon. The information in the table has been adjusted to reflect all stock splits and stock dividends.\nAt September 15, 1995, there were approximately 1,121 shareholders of record of the Company's Common Shares.\nThe Company paid a 25% stock dividend on June 30, 1994, to effect a five-for-four stock split of the Company's Common Shares. The Company anticipates that it will continue to pay quarterly cash dividends in the future. However, the payment and amount of future dividends remain within the discretion of the\nCompany's Board of Directors and will depend upon the Company's future earnings, financial condition, capital requirements, and other factors.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nThe following selected consolidated financial data of the Company was prepared giving retroactive effect to the business combination with Whitmire Distribution Corporation (\"Whitmire\") on February 7, 1994 (the \"Whitmire Merger\"), which was accounted for as a pooling-of-interests transaction. The term \"Cardinal,\" as used herein, refers to Cardinal Health, Inc. and its subsidiaries prior to the Whitmire Merger. Cardinal's fiscal year had historically ended on March 31, while Whitmire's fiscal year had ended on the Saturday closest to the end of June. On March 1, 1994, the Company changed its fiscal year end from March 31 to June 30. As a result, for the fiscal year ended March 31, 1993, and prior years, the information presented is derived from consolidated financial statements which combine data from Cardinal for the fiscal years ended March 31, 1993, March 31, 1992 and March 31, 1991, with data from Whitmire for fiscal years ended July 3, 1993, June 27, 1992, and June 29, 1991, respectively. For the fiscal years ended June 30, 1995 and 1994, and the twelve months ended June 30, 1993, the information presented is derived from consolidated financial statements which combine data from Cardinal for the fiscal years ended June 30, 1995 and 1994, and the twelve months ended June 30, 1993, with data from Whitmire for the fiscal years ended June 30, 1995 and 1994, and July 3, 1993. Due to the different fiscal year ends of the merged companies, Whitmire's results of operations for the three months ended July 3, 1993, have been included in both the twelve months ended June 30, 1993, and the fiscal year ended March 31, 1993. The selected consolidated financial data below 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.\"\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nSELECTED CONSOLIDATED FINANCIAL DATA\n(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nNet earnings and cash dividends per Common Share have been adjusted to reflect all stock dividends and stock splits.\nAmounts reflect business combinations in fiscal 1995, 1994, the twelve months ended June 30, 1993, fiscal 1992 and 1991.\nFiscal 1994, the twelve months ended June 30, 1993, and fiscal 1993 amounts reflect the impact of Unusual Items (See Note 2 of \"Notes to Consolidated Financial Statements\").\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's discussion and analysis has been prepared giving retroactive effect to the pooling-of-interests business combination with Whitmire on February 7, 1994 (see Note 3 of \"Notes to Consolidated Financial Statements\"). See \"Item 6: Selected Financial Data\" for a discussion regarding the terms used herein, the periods used to combine Cardinal and Whitmire, and the change in the Company's fiscal year. The discussion and analysis presented below should be read in conjunction with the consolidated financial statements and related notes appearing in this report.\nRESULTS OF OPERATIONS\nNet Sales. Net sales in fiscal 1995 increased 35% compared with fiscal 1994 due to internal business growth of 25%, the acquisition of Humiston-Keeling, Inc. in July 1994, and the merger transaction with Behrens, Inc. in July 1994 (see Note 3 of \"Notes to Consolidated Financial Statements\"). The 25% increase in net sales in fiscal 1994 compared to fiscal 1993 was due to internal business growth of 20%, sales resulting from the acquisition of Solomons Company in May 1993 and the merger transaction with PRN Services, Inc. in December 1993 (see Note 3 of \"Notes to Consolidated Financial Statements\"). The internal business growth in both fiscal 1995 and fiscal 1994 resulted primarily from the addition of new customers (partially as a result of expanded sales territories), increased sales to existing customers, and price increases.\nGross Margin. As a percentage of net sales, gross margin declined to 5.95% in fiscal 1995 from 6.13% in fiscal 1994 and 6.42% in fiscal 1993. The decreases in the gross margin percentages were due to lower selling margins, reflecting a more competitive market and a greater mix of higher volume customers, where a lower cost of distribution and better asset management and cash flow enable the Company to offer lower selling margins, offset in 1995 by a slight increase in purchasing gains associated with drug price inflation. The decline in the gross margin rate has moderated in 1995 from prior fiscal years to the point that the gross margin percentage for the fourth quarter of fiscal 1995 approximated that of the comparable quarter of fiscal 1994. This moderation is due primarily to a stabilization in the customer mix and growth in the higher margin specialty business units.\nSelling, General, and Administrative Expenses. Selling, general, and administrative expenses as a percentage of net sales have improved consistently from 4.40% in fiscal 1993 to 4.03% in fiscal 1994 and 3.85% in fiscal 1995. The improvements are due primarily to economies associated with the Company's significant sales growth, particularly with major customers where support costs are generally lower, consolidating distribution centers and administrative functions, and selectively automating facilities.\nUnusual Items. In February 1994, the Company recorded a charge to reflect estimated Whitmire Merger costs of approximately $35.9 million ($28.2 million net of tax), including (a) fees and other transaction costs related to the combination, and (b) other costs expected to be incurred in connection with the integration of Cardinal's and Whitmire's business operations. These estimated costs included approximately $7 million for investment banking, legal, accounting, and other related transaction fees and costs associated with the combination; $13 million for corporate integration and distribution rationalization; $6 million for integration of information systems; and $2 million for restructuring Whitmire's revolving credit agreement. Of these estimated costs, approximately $7 million pertained to the revaluation of certain operating assets and $2 million pertained to employee relocation, retraining and termination costs. At June 30, 1995, the Company had incurred actual costs aggregating approximately $26.9 million relative to the Whitmire Merger. The Company anticipates that the remainder of these costs will be expended in fiscal 1996. The current estimates of merger costs ultimately to be incurred are not materially different than the amounts originally recorded.\nDuring fiscal 1993, the Company received a termination fee of approximately $13.5 million resulting from the termination by Durr-Fillauer Medical, Inc. of its agreement to merge with the Company. Also during fiscal 1993, the Company recorded charges totaling approximately $13.7 million, primarily related to the closing of certain non-core operations and the rationalization, standardization and improvement of selected distribution operations, information systems and support functions. The charges included the write-down of certain assets, moving costs and other costs associated with the affected operations, and modification costs necessary to centralize and standardize certain information systems and support functions. At June 30, 1995,\nthe initiatives contemplated have been substantially completed in accordance with the original plan and all related funds have been expended.\nThe modification of the terms of certain Whitmire stock options in fiscal 1993 resulted in a one-time stock option compensation charge of approximately $5.2 million (see Note 11 of \"Notes to Consolidated Financial Statements\").\nInterest Expense. The increase in interest expense in fiscal 1995 is due to higher average short-term borrowings resulting from increased working capital requirements associated with the Company's growth. A portion of the funds used for the increased working capital requirements were provided by the proceeds from the issuance of approximately 1,867,000 of the Company's Common Shares (\"Common Shares Offering\") pursuant to a public offering completed on September 26, 1994 (see Note 11 of \"Notes to Consolidated Financial Statements\"). The decrease in interest expense in fiscal 1994 compared to fiscal 1993 is due primarily to the conversion in June 1993 of debt to equity of the Company's $75 million, 7.25% Convertible Debentures (see Note 11 of \"Notes to Consolidated Financial Statements\") and reduced borrowings under Whitmire's revolving credit agreements. The reduction in interest expense in fiscal 1994 as discussed above was partially offset by increased interest expense resulting from the sale by the Company of $100 million of 6.5% Notes on February 23, 1994 (see Note 5 of \"Notes to Consolidated Financial Statements\").\nThe Company has entered into various interest rate swap agreements, which serve to reduce the Company's aggregate interest cost on its $100 million 8% Notes (the \"8% Notes\"), in response to falling interest rates subsequent to the issuance of the 8% Notes (see Note 5 of \"Notes to Consolidated Financial Statements\"). The net effect of the swap agreements is that the Company exchanged its fixed rate position on the 8% Notes for a fixed rate of 5.1% for the period July 15, 1992, through March 1, 1993, a fixed rate of 6.5% for the period March 2, 1993, through March 1, 1994, and, thereafter, a fixed rate of 8.1% through March 1, 1997 (the maturity date of the 8% Notes). In May 1993, two of the offsetting swap agreements were canceled at no gain or loss to the Company.\nProvision for Income Taxes. The Company's provision for income taxes relative to pretax earnings decreased significantly in fiscal 1995 compared with fiscal 1994 due primarily to certain nondeductible costs associated with the Whitmire Merger recorded in the third quarter of fiscal 1994 (see Note 2 of \"Notes to Consolidated Financial Statements\").\nCumulative Effect of Change in Accounting Principle. Effective at the beginning of fiscal 1993, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS No. 109). The cumulative effect of adopting SFAS No. 109 ($10 million) has been reported as a change in accounting principle retroactive to the beginning of fiscal 1993. The $10 million cumulative effect resulted primarily from the fact that SFAS No. 109 modifies the accounting for business combinations recorded using the purchase method.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking capital increased $130.2 million to $601.3 million at June 30, 1995, from $471.1 million at June 30, 1994, and included increased investments in merchandise inventories and trade receivables of $203.6 million and $175.4 million, respectively, increased holdings of cash and equivalents and marketable securities of $8.3 million and a decrease in notes payable-banks of $22.0 million, offset primarily by an increase in accounts payable of $253.6 million and an increase in accrued liabilities of $26.5 million. The increases in merchandise inventories and accounts payable reflect the timing of seasonal purchases and related payments, the Company's internal growth, and current year business combinations (see Note 3 of \"Notes to Consolidated Financial Statements\"). The increase in cash and equivalents, as well as the decrease in the notes payable-banks, reflect the timing of seasonal purchases and payments noted above and partial use of proceeds from the Common Shares Offering (see \"Interest Expense,\" above). The increase in trade receivables was due primarily to increased sales (see \"Net Sales\", above) and current year business combinations completed in fiscal 1995 (see Note 3 of \"Notes to Consolidated Financial Statements\"). The increase in accrued liabilities is primarily due to the income tax liability arising from the current year net earnings.\nProperty and equipment, net of accumulated depreciation and amortization, increased by $35.2 million. This increase reflects the Company's continuing investment in management information systems, including customer support systems, and upgrade and automation of distribution facilities.\nShareholders' equity increased to $548.2 million at June 30, 1995 from $368.5 million at June 30, 1994 due primarily to (a) the Common Shares Offering ($70.5 million), (b) net earnings of the Company of approximately $85.0 million, (c) the recording of tax benefits related to restricted stock and the exercise of stock options of approximately $18.1 million, and (d) the addition of Behrens Inc. shareholders' equity of approximately $9.8 million (see Note 3 of \"Notes to Consolidated Financial Statements\"), offset primarily by dividends paid by the Company of approximately $4.9 million.\nThe Company has line-of-credit agreements with various bank sources aggregating $325 million, of which $100 million is represented by committed line-of-credit agreements and the balance is uncommitted. The Company had drawn upon $3.0 million of the available lines-of-credit at June 30, 1995, leaving $322 million available under the Company's existing line-of-credit agreements.\nAs of June 30, 1995, the Company has the capacity to offer to the public debt securities of up to $200 million pursuant to Shelf Registrations filed with the Securities and Exchange Commission.\nThe Company believes that it has adequate capital resources at its disposal to meet currently anticipated capital expenditures, routine business growth and expansion, and current and projected debt service.\nOTHER\nOn August 26, 1995, the Company signed a definitive agreement with Medicine Shoppe International, Inc. (\"Medicine Shoppe\"), a franchisor of independent retail pharmacies. Under the terms of the transaction, shareholders of Medicine Shoppe will receive Company Common Shares in exchange for common shares of Medicine Shoppe. The Company will issue between approximately 6.0 million and 6.8 million Common Shares in the transaction, depending in part upon the average closing price of the Company Common Shares over a specified period. Under certain circumstances, the Company could issue up to approximately 7.2 million Company Common Shares in the transaction. The transaction is subject to certain conditions including approval of the Medicine Shoppe shareholders and is expected to be accounted for as a pooling-of-interests.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndependent Auditors' Reports\nFinancial Statements:\nConsolidated Statements of Earnings for the Fiscal Years Ended June 30, 1995, June 30, 1994, Twelve Months Ended June 30, 1993, and Fiscal Year Ended March 31, 1993\nConsolidated Balance Sheets at June 30, 1995, and June 30, 1994\nConsolidated Statements of Shareholders' Equity for the Fiscal Years Ended June 30, 1995, June 30, 1994, and March 31, 1993\nConsolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 1995, June 30, 1994, and March 31, 1993\nNotes to Consolidated Financial Statements\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Directors of Cardinal Health, Inc.:\nWe have audited the accompanying consolidated balance sheets of Cardinal Health, Inc. and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of earnings, shareholders' equity, and cash flows for the years ended June 30, 1995 and 1994 and March 31, 1993. 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 these financial statements and financial statement schedule based on our audits. The consolidated financial statements and financial statement schedule give retroactive effect to the pooling-of-interests business combination of Cardinal Health, Inc. and Whitmire Distribution Corporation on February 7, 1994, as described in Note 1 to the consolidated financial statements. We did not audit the statements of earnings, shareholders' equity, and cash flows of Whitmire Distribution Corporation for the year ended July 3, 1993, which statements reflect shareholders' equity of $2,223,000 as of July 3, 1993; net sales of $2,666,829,000 and net earnings available for common shares before cumulative effect of change in accounting principle of $4,039,000 for the year ended July 3, 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 Whitmire Distribution Corporation in the March 31, 1993 financial statements, is based solely on the report of such other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the 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 the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cardinal Health, Inc. and subsidiaries at June 30, 1995 and 1994, and the results of their operations and their cash flows for the years ended June 30, 1995 and 1994 and March 31, 1993 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 7 to the consolidated financial statements, the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109 by applying it retroactively effective April 1, 1992.\nDELOITTE & TOUCHE LLP\nColumbus, Ohio August 14, 1995, except for Note 16, as to which the date is August 26, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Whitmire Distribution Corporation:\nWe have audited the statement of operations of Whitmire Distribution Corporation (a Delaware corporation), for the year ended July 3, 1993, and the related statements of stockholders' equity and cash flows for the year ended July 3, 1993 (not presented herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 Whitmire Distribution Corporation for the year ended July 3, 1993, in conformity with generally accepted accounting principles.\nArthur Andersen & Co.\nSacramento, California September 3, 1993 (Except with respect to the matter discussed in Note 10, as to which date is October 11, 1993.)\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF EARNINGS\n(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these statements.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCARDINAL HEALTH INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCardinal Health, Inc. and subsidiaries (the \"Company\") is a full service wholesaler distributing a broad line of pharmaceuticals, surgical and hospital supplies, therapeutic plasma and other specialty pharmaceutical products, health and beauty care products, and other items typically sold by hospitals, retail drug stores, and other health care providers. The Company is currently operating in only one business segment.\nBASIS OF PRESENTATION\nThe consolidated financial statements of the Company include the accounts of all majority-owned subsidiaries and all significant intercompany amounts have been eliminated. The consolidated financial statements give retroactive effect to the pooling-of-interests business combination with Whitmire Distribution Corporation (the \"Whitmire Merger\") on February 7, 1994 (see Note 3). The term \"Cardinal,\" as used herein, refers to Cardinal Health, Inc. and its subsidiaries prior to the Whitmire Merger. Cardinal's fiscal year had historically ended on March 31, while Whitmire's fiscal year had ended on the Saturday closest to the end of June. On March 1, 1994, the Company changed its fiscal year end from March 31 to June 30. Accordingly, the accompanying consolidated financial statements for the fiscal years ended June 30, 1995 and June 30, 1994, and for the twelve months ended June 30, 1993, combine the information for Cardinal and Whitmire as of June 30, 1995, and for each of the three years then ended. The accompanying consolidated financial statements for the fiscal year ended March 31, 1993 combine information for Cardinal's fiscal year ended March 31, 1993 with Whitmire's fiscal year ended July 3, 1993. The consolidated statement of earnings for the twelve months ended June 30, 1993, is unaudited and is presented for the purpose of supplemental analysis.\nDue to the different fiscal period ends of the merged companies, the results of Whitmire for the three months ended July 3, 1993, have been included in the consolidated statements of earnings for both the periods ended June 30, 1993, and March 31, 1993. Cardinal's results of operations (exclusive of Whitmire) for the three months ended June 30, 1993, are not included in the consolidated statement of earnings but have been included as an adjustment in the consolidated statement of shareholders' equity. For the three months ended June 30, 1993, Cardinal's net sales and net earnings were $550,034,000 and $7,771,000, respectively. The cash provided by operating activities was $53,752,000, while the cash used in investing and financing activities was $36,521,000 and $22,760,000, respectively. Cardinal paid dividends of $478,000 during the three months ended June 30, 1993.\nCASH EQUIVALENTS\nThe Company considers all liquid investments purchased with a maturity of three months or less to be cash equivalents. The carrying value of cash equivalents approximates their fair value.\nMARKETABLE SECURITIES AVAILABLE FOR SALE\nEffective July 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 No. 115). Pursuant to SFAS No. 115, the Company has classified its investment in short-term municipal bonds as available-for-sale. The fair value of the bonds at June 30, 1995 approximates the original cost determined on a specific identification basis and, accordingly, no net unrealized gain or loss has been recorded as a separate component of shareholders' equity. Gross unrealized gains and losses are not significant at June 30, 1995. These bonds mature on various dates in fiscal 1996.\nPrior to the adoption of SFAS No. 115, the Company accounted for debt securities that were held for sale using the lower-of-cost or market rule. The adoption of SFAS No. 115 did not have a material effect on the Company's financial statements.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nTRADE RECEIVABLES\nTrade receivables are presented net of the related allowance for doubtful accounts of approximately $28,275,000 and $21,594,000 at June 30, 1995, and June 30, 1994, respectively.\nMERCHANDISE INVENTORIES\nSubstantially all merchandise inventories are stated at lower of cost, last-in, first-out (LIFO) method, or market. If the Company had used the first-in, first-out (FIFO) method of inventory valuation, which approximates current replacement cost, inventories would have been higher than reported at June 30, 1995, by $79,365,000 and at June 30, 1994, by $61,852,000. The June 30, 1994 difference between replacement costs and LIFO values, restated to reflect the pooling-of-interests combination with Behrens, Inc. (see Note 3), was $77,465,000. The impact of partial inventory liquidations in certain LIFO pools reduced the LIFO provision by approximately $2,500,000 in fiscal 1993.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation and amortization for financial reporting purposes are computed using the straight-line method over the estimated useful lives of the assets which range from three to forty years, including capital lease assets which are amortized over the terms of their respective leases. Amortization of capital lease assets is included in depreciation and amortization expense. Certain software costs related to internally developed or purchased software are capitalized and amortized using the straight-line method over the useful lives not exceeding three years.\nOTHER ASSETS\nOther assets primarily represent intangible assets related to the excess of cost over net assets of subsidiaries acquired and noncurrent deferred tax assets (see Note 7). Intangible assets are being amortized using the straight-line method over lives which range from ten to forty years. Accumulated amortization was $18,670,000 and $16,571,000 at June 30, 1995, and June 30, 1994, respectively. At each balance sheet date, a determination is made by management to ascertain whether the intangible assets have been impaired based on several criteria, including, but not limited to, sales trends, undiscounted operating cash flows, and other operating factors.\nSALES RECOGNITION\nThe Company records sales when merchandise is shipped to its customers and the Company has no further obligation to provide services related to such merchandise. The Company also arranges for direct deliveries to be made to customer warehouses which are excluded from net sales and totaled $1,779,000,000, $562,000,000 and $467,000,000 in fiscal 1995, 1994 and 1993, respectively. The service fees related to direct deliveries are included in net sales and were not significant in fiscal 1995, 1994 or 1993.\nINCOME TAXES\nEffective as of the beginning of fiscal 1993, Cardinal began accounting for income taxes under the liability method by adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). The cumulative effect of adopting this statement ($10,000,000) has been reported as a change in accounting principle retroactive to the beginning of fiscal 1993. Prior to the adoption of SFAS No. 109, income taxes were accounted for in accordance with Accounting Principles Board Opinion No. 11.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nEARNINGS PER COMMON SHARE\nPrimary earnings per Common Share are based on the weighted average number of Common Shares outstanding during each period and the dilutive effect of stock options and warrants from the date of grant computed using the treasury stock method.\nFully diluted earnings per Common Share reflect: (a) the dilutive effect of stock options and warrants from the date of grant computed using the treasury stock method; and (b) the full conversion of the 7.25% Convertible Subordinated Debentures due 2015 through their conversion and redemption in July 1993 (see Note 11).\nCash dividends paid per Common Share were $0.12, $0.09 and $0.07 for the fiscal years ended June 30, 1995 and 1994 and March 31, 1993, respectively.\nSTOCK SPLIT\nThe Company paid a 25% stock dividend on June 30, 1994, to effect a five-for-four stock split of the Company's Common Shares. All share and per share amounts included in the Consolidated Financial Statements, except the Consolidated Statements of Shareholders' Equity, have been adjusted to reflect this stock split.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior years' amounts to conform with the classifications used for 1995.\n2. UNUSUAL ITEMS\nIn February 1994, the Company recorded a charge to reflect estimated Whitmire Merger costs of approximately $35.9 million ($28.2 million net of tax), including (a) fees and other transaction costs related to the combination, and (b) other costs expected to be incurred in connection with the integration of Cardinal's and Whitmire's business operations. These estimated costs included approximately $7 million for investment banking, legal, accounting, and other related transaction fees and costs associated with the combination; $13 million for corporate integration and distribution rationalization; $6 million for integration of information systems; and $2 million for restructuring Whitmire's revolving credit agreement. Of these estimated costs, approximately $7 million pertained to the revaluation of certain operating assets and $2 million pertained to employee relocation, retraining and termination costs. At June 30, 1995, the Company had incurred actual costs aggregating approximately $26.9 million relating to the Whitmire Merger. The Company anticipates that the remainder of these costs will be expended in fiscal 1996. The current estimates of merger costs ultimately to be incurred are not materially different than the amounts originally recorded.\nDuring fiscal 1993, the Company received a termination fee of approximately $13.5 million, resulting from the termination by Durr-Fillauer Medical, Inc. of its agreement to merge with the Company.\nAlso during fiscal 1993, the Company recorded charges totaling approximately $13.7 million, primarily related to the closing of certain non-core operations and the rationalization, standardization and improvement of selected distribution operations, information systems and support functions. The charges included the write-down of certain assets, moving costs and other costs associated with the affected operations, and modification costs necessary to centralize and standardize certain information systems and support functions. At June 30, 1995, the initiatives contemplated have been substantially completed in accordance with the original plan and all related funds have been expended.\nThe modification of the terms of certain Whitmire stock options in fiscal 1993 also resulted in a one-time stock option compensation charge of approximately $5.2 million (see Note 11).\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe following supplemental information, presented for purposes of facilitating meaningful comparisons to ongoing operations and to other companies in the drug distribution industry, summarizes the results of operations of the Company, adjusted on a pro forma basis to reflect (a) the elimination of the effect of the unusual items discussed above, and (b) the redemption of Whitmire's preferred stock pursuant to the terms of the Reorganization Agreement (see Note 3). Solely for purposes of the summary presented below, such redemption is assumed to have been funded from the liquidation of investments in tax-exempt marketable securities. Although not anticipated, unusual items of a similar nature could occur in the future.\nOperating earnings and net earnings as reported in the Company's historical financial statements are reconciled to the respective amounts in the preceding table as follows:\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n3. BUSINESS COMBINATIONS\nOn July 18, 1994, the Company issued approximately 944,000 Common Shares in a merger transaction for all of the common shares of Behrens Inc., a drug wholesaler based in Waco, Texas. The transaction was accounted for as a pooling-of-interests business combination. The impact of the Behrens merger, on both an historical and pro forma basis, is not significant. Accordingly, prior periods have not been restated for the Behrens merger.\nOn July 1, 1994, the Company acquired all of the outstanding stock of Humiston-Keeling, Inc., a drug wholesaler based in Calumet City, Illinois, for cash of $33,334,000 in a transaction accounted for by the purchase method. Had the purchase occurred at the beginning of fiscal 1994, operating results on a pro forma basis would not have been significantly different.\nOn January 27, 1994, shareholders of Cardinal and Whitmire approved and adopted the Agreement and Plan of Reorganization dated October 11, 1993 (the \"Reorganization Agreement\"), pursuant to which a wholly owned subsidiary of Cardinal was merged with and into Whitmire effective February 7, 1994. In the Whitmire merger, which was accounted for as a pooling-of-interests business combination, holders of outstanding Whitmire common stock received an aggregate of approximately 6,802,000 Common Shares and approximately 1,861,000 Class B common shares in exchange for all of the previously outstanding common stock of Whitmire. In addition, Whitmire's outstanding stock options were converted into options to purchase an aggregate of approximately 1,721,000 additional Common Shares pursuant to the terms of such options and the Reorganization Agreement.\nOn December 17, 1993, the Company issued approximately 296,000 Common Shares in a merger transaction for all of the capital stock of PRN Services, Inc., a distributor of pharmaceuticals and medical supplies to oncologists and oncology clinics. The transaction was accounted for as a pooling-of-interests business combination. The impact of the PRN merger, on both an historical and pro forma basis, is not significant. Accordingly, prior periods have not been restated for the PRN merger.\nOn May 4, 1993, the Company acquired all of the outstanding capital stock of Solomons Company, a wholesale drug distributor based in Savannah, Georgia, in exchange for approximately 1,062,000 Common Shares. The transaction was accounted for by the purchase method. Had the acquisition occurred at the beginning of fiscal 1993, operating results on a pro forma basis would not have been significantly different.\n4. NOTES PAYABLE -- BANKS\nThe Company has entered into various uncommitted line-of-credit arrangements which allow for borrowings up to $225,000,000 and $221,000,000 at June 30, 1995 and 1994, respectively, at various money market rates. The amount outstanding under such arrangements was $3,000,000 and $25,000,000, at weighted average interest rates of 6.89% and 4.28%, at June 30, 1995 and 1994, respectively.\nIn addition to the aforementioned credit arrangements, at June 30, 1995, the Company has revolving credit agreements with eight banks which have a maturity of less than one year, are renewable on a quarterly basis, and allow the Company to borrow up to $100,000,000 (none of which was in use at either June 30, 1995 or 1994). The Company is required to pay a commitment fee at the annual rate of .125% on the average daily unused amounts of the total credit allowed under the revolving credit agreements.\nTotal available but unused lines of credit at June 30, 1995 and June 30, 1994 were $322,000,000 and $296,000,000, respectively.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n5. LONG-TERM OBLIGATIONS\nLong-term obligations consist of the following (in thousands):\nOn February 23, 1994, the Company sold $100,000,000 of 6.5% Notes due 2004 (the \"6.5% Notes\") in a public offering. The 6.5% Notes represent unsecured obligations of the Company, are not redeemable prior to maturity and are not subject to a sinking fund. Issuance costs of approximately $860,000 incurred in connection with the offering are being amortized on a straight-line basis over the period the 6.5% Notes will be outstanding. The Company used the proceeds of this sale for general corporate purposes, including the repayment of bank lines of credit incurred as part of the Whitmire Merger (see Note 3). In anticipation of the sale of the 6.5% Notes, the Company entered into an interest rate hedge agreement, which was terminated at the approximate time of the issuance of the 6.5% Notes, resulting in a deferred gain of approximately $1.3 million which is being amortized as a reduction of interest expense over the period the 6.5% Notes are outstanding.\nOn March 11, 1992, the Company sold $100,000,000 of 8% Notes due 1997 (the \"8% Notes\") in a public offering. The 8% Notes represent unsecured obligations of the Company, are not redeemable prior to maturity and are not subject to a sinking fund. Issuance costs of approximately $718,000 incurred in connection with the offering, are being amortized on a straight-line basis over the period the 8% Notes will be outstanding.\nThe Company has entered into various interest rate swap agreements which serve to hedge the Company's aggregate interest cost on the 8% Notes, in response to falling interest rates subsequent to the issuance of the 8% Notes. The net effect of the swap agreements is that the Company exchanged its fixed rate position on the 8% Notes for a fixed rate of 5.1% for the period July 15, 1992, through March 1, 1993, a fixed rate of 6.5% for the period March 2, 1993, through March 1, 1994, and, thereafter, a fixed rate of 8.1% through March 1, 1997 (the maturity date of the 8% Notes). In May 1993, two of the offsetting swap agreements were canceled at no gain or loss to the Company. The notional principal in each of the four swap agreements outstanding at June 30, 1995 is $100 million. Due to the offsetting nature of the swaps, the market value of those in a net receivable position approximates the market value of those in a net payable position. The risk of accounting loss, based on a discounted cash flow assumption, in the event of nonperformance by counterparties with whom the Company is in a net receivable position is approximately $3 million as of June 30, 1995; however, based on the credit quality of the counterparties, the Company believes the likelihood of such a credit loss to be remote. The Company recognizes in income the periodic net cash settlements under the matched swap agreements as they accrue.\nCertain long-term obligations are collateralized by property and equipment of the Company with an aggregate book value of approximately $11,480,000 at June 30, 1995.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nMaturities of long-term obligations for future fiscal years are as follows (in thousands):\n6. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts of cash and equivalents, marketable securities, notes payable -- banks and other accrued liabilities at June 30, 1995, and June 30, 1994, approximate their fair value because of the short-term maturities of these items.\nThe estimated fair value of the Company's long-term obligations was $211,208,000 and $206,116,000 as compared to the carrying amounts of $211,333,000 and $213,015,000 at June 30, 1995, and June 30, 1994, respectively. The fair value of the Company's long-term obligations is estimated based on the quoted market prices for the same or similar issues and the current interest rates offered for debt of the same remaining maturities.\n7. INCOME TAXES\nEffective the beginning of fiscal 1993, Cardinal adopted SFAS No. 109. Under the provisions of SFAS No. 109, income taxes are recorded under the liability method. SFAS No. 109 results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and liabilities (temporary differences), and operating loss and tax credit carryforwards for tax purposes. The cumulative effect of adopting SFAS No. 109 ($10,000,000) has been reported as a change in accounting principle retroactive to the beginning of fiscal 1993.\nThe provision (credit) for income taxes consists of the following (in thousands):\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nA reconciliation of the Company's income tax provision and the provision based on the Federal statutory income tax rate follows:\nThe components of the Company's deferred income tax assets (liabilities), the current portion (a liability of $15,095,000 and an asset of $4,990,000 at June 30, 1995, and June 30, 1994, respectively) is included in the Consolidated Balance Sheets captions \"Other accrued liabilities\" and \"Prepaid expenses and other,\" and the noncurrent portion (a liability of $10,987,000 and an asset of $467,000 at June 30, 1995, and June 30, 1994, respectively) is included in the Consolidated Balance Sheets captions \"Other liabilities\" and \"Other assets,\" are as follows (in thousands):\n8. EMPLOYEE RETIREMENT BENEFIT PLANS\nSubstantially all of the Company's non-union employees are enrolled in Company-sponsored contributory profit sharing and retirement savings plans which include features under Section 401(k) of the Internal Revenue Code, and provide for matching Company contributions. The Company's contributions to the plans are determined by the Board of Directors subject to certain minimum requirements as specified in the plans.\nQualified union employees are covered by Company-sponsored and multiemployer defined benefit pension plans under the provisions of collective bargaining agreements. Benefits under these plans are generally based on the employee's years of service and average compensation at retirement.\nThe effect of the Company-sponsored defined benefit plans on the Company's consolidated financial statements is not material.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nEmployee retirement benefit plans expense was as follows (in thousands):\nThe adoption of Financial Accounting Standards Board Statement No. 112 \"Employer's Accounting for Postemployment Benefits\" in 1995 had no material effect on the consolidated financial statements of the Company.\n9. COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company leases certain warehouse and office facilities, vehicles, and data processing equipment under operating leases. The leases expire at various dates over the next twelve years. Certain of these leases provide for renewal options and\/or contingent rentals based on various factors.\nThe future minimum rental payments for operating leases having initial or remaining non-cancelable lease terms in excess of one year at June 30, 1995, are as follows (in thousands):\nThe minimum rental payments above have been reduced by sublease rentals of approximately $438,000 in 1996 and $353,000 in 1997. Rental expense (net of sublease rental income) relating to operating leases and short-term cancelable leases was approximately $12,631,000, $11,189,000 and $10,316,000 in fiscal 1995, 1994, and 1993, respectively.\nIn connection with its supplier relationship with various customers, the Company has guaranteed certain indebtedness and lease payments. As of June 30, 1995, these guarantees total approximately $1,633,000.\nDuring fiscal 1994, the Company began a program whereby certain customer notes receivables were sold, with full recourse, to a commercial bank. As of June 30, 1995, amounts outstanding on customer notes receivables sold to the commercial bank under this program totaled approximately $6,860,000.\nThe Company becomes involved from time-to-time in litigation arising out of its normal business activities. In addition, in November 1993, Cardinal, Whitmire, five other pharmaceutical wholesalers, 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. The Company believes that the allegations set forth against Cardinal and Whitmire in these lawsuits are without merit. In the opinion of management, the Company's liability, if any, under any pending litigation would not have a material adverse effect on the Company's financial condition or results of operations.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n10. REDEEMABLE PREFERRED STOCK\nThe Company had authorized 360,000 shares of redeemable preferred $.01 par value stock in Whitmire. The redeemable preferred stock was divided into two series: 350,000 shares designated as Senior Preferred Stock and 10,000 shares designated as Series A Preferred Stock.\nThe holders of the Whitmire redeemable preferred stock were entitled to cumulative annual dividends of $10.00 per share for Senior Preferred Stock and $10.125 for Series A Preferred Stock when and as declared by Whitmire's board of directors. In lieu of paying cash dividends to the holders of Senior Preferred Stock and Series A Preferred Stock, Whitmire could, at its election, pay scheduled dividends with additional shares of Senior Preferred Stock or Series A Preferred Stock, as appropriate.\nWhitmire would have been required to redeem, at $100.00 per share plus accrued but unpaid dividends, all shares of its Senior and Series A Preferred Stock commencing in October 1994 through July 1996. Stockholders' equity was charged $840,000 in fiscal 1993 for accretion relative to this mandatory redemption obligation. As of March 31, 1993, a total of $4,200,000 had been credited to redeemable preferred stock through accretion. Pursuant to the terms of the Reorganization Agreement between Cardinal and Whitmire (see Note 3), all of the outstanding shares of Whitmire Senior and Series A Preferred Stock were redeemed as of February 7, 1994, the date of the Whitmire Merger.\n11. SHAREHOLDERS' EQUITY\nThe Company's authorized capital shares consist of (a) 60,000,000 Class A common shares, without par value, of which 41,945,472 and 34,862,835 were outstanding and 193,292 and 179,878 were held in treasury at cost at June 30, 1995, and June 30, 1994, respectively: (b) 5,000,000 Class B common shares, without par value, of which none and 2,971,375 were outstanding at June 30, 1995 and June 30, 1994, respectively; and (c) 500,000 non-voting preferred shares without par value, none of which have been issued. The Class A common shares and Class B common shares are collectively referred to as common shares.\nThe Class B common shares were issued to a former Whitmire stockholder in February 1994 in connection with the Whitmire Merger. All of the Class B common shares outstanding at June 30, 1994 were converted to Class A common shares during the year ended June 30, 1995. Prior to the conversion of Class B common shares, all holders of Class A common shares and Class B common shares participated equally in dividends when and as declared by the Company's Board of Directors. Holders of Class A common shares were entitled to one vote per share for the election of Directors and upon all matters on which shareholders were entitled to vote. Holders of Class B common shares were entitled to one-fifth of one vote per share in the election of Directors and upon all matters which shareholders were entitled to vote.\nOn September 26, 1994, 8,050,000 of the Company's Common Shares were sold pursuant to a public offering. Approximately 1,867,000 Common Shares (the \"New Shares\") were sold by the Company, and approximately 6,183,000 Common Shares (the \"Existing Shares\") were sold by certain shareholders of the Company. The Existing Shares included all of the issued and outstanding Class B common shares, which were converted to Class A common shares prior to their sale to the public. Net proceeds received by the Company of approximately $70 million from the sale of the New Shares were used to finance working capital growth and for other general corporate purposes. The Company did not receive any of the proceeds from the sale of the Existing Shares.\nOn June 11, 1993, the Company called its 7.25% convertible Subordinated Debentures due 2015 (the \"Subordinated Debentures\") for redemption, effective as of July 2, 1993. Following this call, $74,920,000 of Subordinated Debentures were converted into Common Shares of the Company. The remaining $80,000 of Subordinated Debentures outstanding were redeemed for cash. The amount credited to shareholders' equity as a result of the conversion of the Subordinated Debentures was reduced by unamortized offering costs of approximately $1,767,000 and costs directly related to the conversion of approximately $13,000.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nDuring fiscal 1993, Whitmire canceled adjustment share rights, previously granted to outside investors, representing rights to purchase shares of Whitmire common stock (a defined percentage of the adjustment share rights were cancelable annually up to 100% based upon the achievement of certain financial targets). Additionally, certain conditions relative to the exercise of Whitmire options were eliminated. For financial reporting purposes, the modification of the terms of these options previously granted to key employees has been treated as if the options were issued on the date that the terms were modified. Accordingly, a compensation charge totaling approximately $5.2 million was recorded relative to these changes. The compensation charge is equal to the fair value (as determined by an independent appraisal) of the options on the date that the terms of the options were modified.\nPursuant to the terms of the Reorganization Agreement (see Note 3), warrants to purchase shares of Whitmire common stock which, upon exercise became convertible into approximately 2,831,000 Common Shares at an average price of $.08 per share, were exercised prior to the consummation of the pooling-of- interests business combination of Cardinal and Whitmire.\nOn Aril 14, 1993, the Company repurchased all of the Common Shares (approximately 725,000) owned by subsidiaries of North American National Corporation, the former Chairman of which is also a Director of the Company, at a price of $21.20 per share. Nearly all of these shares were subject to certain restrictions contained in a Shareholders Agreement among North American National Corporation and other individual shareholders, which restrictions were released as part of the repurchase transaction.\n12. STOCK OPTIONS AND RESTRICTED SHARES\nThe Company maintains stock incentive plans (the \"Plans\") for the benefit of certain officers, directors and key employees. Under the Plans, at June 30, 1995, the Company was authorized to issue up to an aggregate of 3,875,000 Common Shares in the form of incentive stock options, nonqualified stock options, and restricted shares. Options granted are generally exercisable for periods up to ten years from the date of grant at a price which equals fair market value at the date of grant.\nThe following summarizes all stock option transactions under the Plans from March 31, 1992, through June 30, 1995, giving retroactive effect to stock dividends and stock splits (in thousands, except per share amounts):\nAt June 30, 1995, approximately 476,000 option shares under the Plans were exercisable and approximately 2,723,000 Common Shares were reserved for issuance under the Plans.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nIn connection with the Whitmire Merger, outstanding Whitmire stock options granted to current or former Whitmire officers or employees were automatically converted into options (\"Cardinal Exchange Options\") to purchase an aggregate of approximately 1,721,000 additional Common Shares pursuant to the terms of such options and the Reorganization Agreement (see Note 3). Under the terms of their original issuance and as reflected in the Reorganization Agreement, the exercise price for substantially all of the Cardinal Exchange Options is remitted to certain former investors of Whitmire. Cardinal Exchange Options to purchase 1,250,000 and 271,000 Common Shares, with an average option price of $1.52 and $1.60, were exercised in fiscal 1995 and 1994, respectively. At June 30, 1995, Cardinal Exchange Options to purchase approximately 200,000 shares were outstanding with an average exercise price of $2.08 per share. Substantially all of the Cardinal Exchange Options outstanding at June 30, 1995, are 100% vested and are exercisable through October 25, 1995.\nThe market value of restricted shares awarded by the Company is recorded as unamortized restricted stock awards and shown as a separate component of shareholders' equity. The compensation awards are amortized to expense over the period in which participants perform services, generally one to six years. As of June 30, 1995, approximately 416,000 restricted shares have been issued, of which approximately 148,000 shares remain restricted and subject to forfeiture and approximately 16,000 shares have been forfeited.\n13. SUPPLEMENTAL INFORMATION REGARDING NONCASH INVESTING AND FINANCING ACTIVITIES\nIn conjunction with the acquisitions of Humiston-Keeling and Solomons (see Note 3), liabilities were assumed as follows (in thousands):\nTotal debt assumed by the Company as a result of these acquisitions was $1,670,000 and $4,315,000 in fiscal 1995 and for the three months ended June 30, 1993, respectively, and is included as part of the amount of liabilities assumed.\nIn conjunction with the pooling-of-interests combination with Behrens (see Note 3) in fiscal 1995, the historical cost of Behrens assets combined was approximately $25,396,000, and the total Behrens liabilities assumed (including total debt of approximately $1,336,000) were approximately $15,617,000.\nIn conjunction with the pooling-of-interests combination with PRN (see Note 3) in fiscal 1994, the historical cost of PRN assets combined was approximately $16,946,000, and the total PRN liabilities assumed (including total debt of approximately $5,847,000) were approximately $16,564,000.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following selected quarterly financial data for fiscal 1995 and 1994 reflects the amounts reported in previously filed quarterly reports:\nThe following supplemental information for fiscal 1994 excludes the impact of unusual items (see Note 2 for discussion of presentation) and assumes the redemption of Whitmire's preferred stock. Solely for the purposes of the supplemental information presented below, such redemption is assumed to have been funded from the liquidation of investments in tax-exempt marketable securities.\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nOperating earnings and net earnings as reported in the Company's quarterly financial data for fiscal 1994 are reconciled to the respective amounts in the preceding table as follows:\n15. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS\nThe Company's trade receivables are exposed to a concentration of credit risk with customers in the retail and health care sectors. However, the credit risk is limited due to the diversity of the customer base and its wide geographic dispersion. The Company performs ongoing credit evaluations of its customers' financial conditions and maintains reserves for credit losses. Such losses historically have been within the Company's expectations.\nDuring fiscal 1995, the Company's two largest customers accounted for 11% of net sales and 82% of direct deliveries, respectively. Trade receivables due from these two customers aggregated approximately 25% of total trade receivables at June 30, 1995.\n16. SUBSEQUENT EVENT\nOn August 26, 1995, the Company signed a definitive merger agreement with Medicine Shoppe International, Inc. (\"Medicine Shoppe\"), a franchisor of independent retail pharmacies. Under the terms of the transaction, shareholders of Medicine Shoppe will receive the Company's Common Shares in exchange for common shares of Medicine Shoppe. The Company will issue between approximately 6.0 million and 6.8 million Common Shares in the transaction, depending in part upon the average closing price of the Company's Common Shares over a specified period. Under certain circumstances, the Company could issue up to approximately 7.2 million Common Shares in the transaction. The transaction is subject to certain conditions including approval by Medicine Shoppe shareholders and is expected to be accounted for as a pooling-of-interests.\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.\nIn accordance with General Instruction G(3) to Form 10-K, the information called for in this Item 10 relating to Directors is incorporated herein by reference to the Company's Definitive Proxy Statement, to be filed with the Securities and Exchange Commission (the \"SEC\"), pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934 (the \"Exchange Act\"), relating to the Company's Annual Meeting of Shareholders (the \"Annual Meeting\") under the caption \"ELECTION OF DIRECTORS\". Certain information relating to Executive Officers of the Company appears at pages 5 and 6 of this Form 10-K, which is hereby incorporated by reference.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION.\nIn accordance with General Instruction G(3) to Form 10-K, the information called for by this Item 11 is incorporated herein by reference to the Company's Definitive Proxy Statement, to be filed with the SEC pursuant to Regulation 14A of the General Rules and Regulations under the Exchange Act, relating to the Company's Annual Meeting under the caption \"EXECUTIVE COMPENSATION\" (other than information set forth under the caption \"Compensation Committee Report\").\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nIn accordance with General Instruction G(3) to Form 10-K, the information called for by this Item 12 is incorporated herein by reference to the Company's Definitive Proxy Statement, to be filed with the SEC pursuant to Regulation 14A of the General Rules and Regulations under the Exchange Act, relating to the Company's Annual Meeting under the caption \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\".\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIn accordance with General Instruction G(3) to Form 10-K, the information called for by this Item 13 is incorporated herein by reference to the Company's Definitive Proxy Statement, to be filed with the SEC pursuant to Regulation 14A of the General Rules and Regulations under the Exchange Act, relating to the Company's Annual Meeting under the caption \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\" and \"EXECUTIVE COMPENSATION -- Compensation Committee Interlocks and Insider Participation\".\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) The following financial statements are included in Item 8 of this report:\n(a)(2) The following Supplemental Schedule is included in this report:\nAll other schedules not listed above have been omitted as not applicable or because the required information is included in the Consolidated Financial Statements or in notes thereto.\n(a)(3) Exhibits required by S-K item 601:\nOther long-term debt agreements of the Registrant are not filed pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K and the Registrant agrees to furnish copies of such agreements to the Securities and Exchange Commission upon its request.\n---------------\n(1) Included as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 (No. 0-12591) and incorporated herein by reference.\n(2) Included as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1992 (No. 0-12591) and incorporated herein by reference.\n(3) Included as an exhibit to the Registrant's Statement on Form S-8 (No. 33-52535) and incorporated herein by reference.\n(4) Included as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1993 (No. 0-12591) and incorporated herein by reference.\n(5) Included as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended March 29, 1986 (No. 0-12591) and incorporated herein by reference.\n(6) Included as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended March 28, 1987 (No. 0-12591) and incorporated herein by reference.\n(7) Included as an exhibit to the Registrant's Registration Statement on Form S-1 (No. 2-84444) and incorporated herein by reference.\n(8) Included as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1993 (No. 0-12592) and incorporated herein by reference.\n(9) Included as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994 (No. 0-12591) and incorporated herein by reference.\n(10) Included as an exhibit to the Registrant's Schedule 13D reporting Registrant's beneficial ownership of shares of Medicine Shoppe International, Inc. (No. 0-13008) and incorporated herein by reference.\n* Management contract or compensation plan or arrangement.\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.\nCARDINAL HEALTH, INC. September 19, 1995 By: \/s\/ ROBERT D. WALTER Robert D. Walter, Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nCARDINAL HEALTH, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR FISCAL YEARS ENDED JUNE 30, 1995 AND JUNE 30, 1994, THREE MONTHS ENDED JUNE 30, 1993, AND THE FISCAL YEAR ENDED MARCH 31, 1993 (IN THOUSANDS)\n---------------\n(1) Recovery of amounts provided for or written off in prior years.\n(2) Current year write-off of uncollectible accounts.\n(3) Amount arises from the acquisition of a subsidiary.\n(4) See Note 1 of \"Notes to Consolidated Financial Statements\" regarding basis of presentation.","section_15":""}
{"filename":"829374_1995.txt","cik":"829374","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nVictory Tax Exempt Realty Income Fund Limited Partnership (the \"Partnership\") was organized January 15, 1988 under the Delaware Revised Uniform Limited Partnership Act and will continue until December 31, 2018, unless dissolved earlier in accordance with the Agreement of Limited Partnership (the \"Partnership Agreement\"). The Partnership was formed for the purpose of acquiring tax-exempt mortgage revenue bonds issued by one or more states or local governments or their agencies or authorities, the proceeds of which are used to make participating first mortgage loans on multifamily residential rental developments and to make, in limited circumstances, taxable working capital loans to owners of such developments.\nThe general partner of the Partnership is CA Victory Inc. (the \"General Partner\"), formerly Shearson\/Victory Inc., a Delaware corporation and an affiliate of Lehman Brothers Inc. (\"Lehman\"), formerly Shearson Lehman Brothers Inc. (see section entitled \"Certain Matters Involving Affiliates contained in \"Item 10. \"Directors and Executive Officers of the Registrant\"). The assignor limited partner is CA Victory Assignor Corp. (the \"Assignor Limited Partner\"), formerly Shearson\/Victory Assignor Corp. (see section entitled \"Certain Matters Involving Affiliates contained in \"Item 10. \"Directors and Executive Officers of the Registrant\"), which is an affiliate of Lehman.\nThe Assignor Limited Partner has assigned certain of the ownership attributes of its limited partnership interests, including rights to a percentage of the income, gains, losses, deductions and distributions of the Partnership to the BAC Holders on the basis of one unit of limited partnership for one BAC.\nThe business objectives of the Partnership are:\n(1) to preserve and protect the Partnership's capital;\n(2) to provide quarterly cash distributions from payments of base interest on the mortgage revenue bond, which has been acquired by the Partnership, that are excludable from gross income for federal income tax purposes, and in certain instances, nontaxable distributions from the Partnership's Interest Reserve Account;\n(3) to provide additional cash distributions from payments of contingent interest on the mortgage revenue bond that are excludable from gross income for federal income tax purposes which are derived to the extent allocable from participation in project cash flow and sale or repayment proceeds; and\n(4) to provide additional cash distributions from payments of taxable interest pursuant to working capital loans, which will constitute no more than 10% of the Partnership's invested assets.\nOn April 28, 1989, the Partnership acquired a mortgage revenue bond (the \"Bond\") issued by the city of Fresno, California in the principal amount of $15,515,000. The Bond is secured by a first mortgage loan on Camelot Lakes Apartments (the \"Property\") located in Fresno. In conjunction with the investment in the Bond, the Partnership also made a working capital loan on the Property in the amount of $420,000 (the \"Working Capital Loan\"). The original owner of the Property was Camelot Lakes Associates (\"Camelot Lakes\"), an unaffiliated California Limited Partnership. On February 1, 1994, the General Partner finalized a restructuring with Camelot Lakes, which consisted of changing the ownership of the Property, entering into a Forbearance Agreement with a new borrower, amending the second mortgage, and replacing the original property management company. The new owner and borrower under the mortgage loan is ConCam Associates (the \"ConCam Owner\" or the \"New Borrower\"), an unaffiliated C alifornia limited partnership, which replaced the original borrower. The new property manager is ConAm Management Corporation (\"ConAm\"), an affiliate of the ConCam Owner. In conjunction with this restructuring, the Partnership also made a capital improvements loan (the \"Capital Improvements Loan\") of $500,000 during 1994, which was secured by a second mortgage on the Property. Additional information regarding the Bond, the Working Capital Loan and the Capital Improvements Loan is incorporated by reference to Note 4 \"Mortgage Revenue Bond\" and Note 5 \"Working Capital and Capital Improvements Loan\" of the Notes to the Financial Statements contained in the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit under Item 14.\n(b) Employees\nThe Partnership does not have any employees. Services are performed for the Partnership by affiliates of the General Partner and agents retained by them.\n(c) Competition\nIncorporated by reference to the section entitled Message to Investors contained in the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit under Item 14.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership does not own any property. The Partnership has, however, invested in the Bond for which an underlying first mortgage on the Property has been assigned to the Partnership as collateral and has made the initial Working Capital Loan and the Capital Improvements Loan to the Borrower. Additional information regarding the Bond, Working Capital Loan, the Capital Improvements Loan and the Property is incorporated by reference to Note 4 \"Mortgage Revenue Bond\" and Note 5 \"Working Capital and Capital Improvements Loan\" of the Notes to the Financial Statements contained in the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit under Item 14.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not the subject of any material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to the BAC Holders to be voted on during the fourth quarter of the year for which this report was filed.\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Limited Partnership Units and Related Unitholder Matters\n(a) Market Information.\nThere is no established public market in which the BACs are currently traded.\n(b) Approximate Number of Security Holders.\nAs of December 31, 1995, there were 1,066 BAC Holders.\n(c) Dividend History and Restrictions.\nInformation on the Partnership's cash distributions is incorporated by reference to Note 7 \"Distributions Payable\" of the Notes to the Financial Statements and the section entitled Message to Investors in the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit under Item 14.\nAs set forth in the Partnership's Agreement of Limited Partnership, the Partnership has maintained an Interest Reserve Account which has been used to supplement distributions to the Limited Partners. The Interest Reserve Account was established to supplement such payments until the end of the period in which base interest on the Bond has been deferred (the \"Deferral Period\"). Following the Deferral Period (April 28, 1989 to April 30, 1992), the funds from the Interest Reserve Account were transferred in mid-1993 to a Working Capital Reserve Account (The Working Capital Reserve Account and Interest Reserve Account are hereinafter referred to collectively as the \"Working Capital Reserve Account.\").\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected Partnership financial data for the years ended December 31, 1995, 1994, 1993, 1992 and 1991 are shown below. This data should be read in conjunction with the Partnership's financial statements and the related notes included herein, filed as an exhibit under Item 14.\n1995 1994 1993 1992 1991 - ------------------------------------------------------------------------------- Total Revenues $ 71,044 $ 406,502 $ 631,711 $ 802,387 $ 955,190\nNet Income (Loss) (30,145) 211,582 441,297 646,365 815,024\nNet Income (Loss) per BAC (1) (0.01) 0.10 0.20 0.30 0.38\nTotal Assets as of December 31 14,044,167 15,168,426 16,038,628 16,942,937 17,918,010\nTotal Cash Distributions declared per BAC (1) 0.500 0.500 0.562 0.750 0.750 - -------------------------------------------------------------------------------\n(1) 2,140,000 BACs outstanding.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Partnership's operating income is derived from its investment in a mortgage revenue bond (the \"Bond\") in the principal amount of $15,515,000 secured by a first deed of trust on Camelot Lakes Apartments (the \"Property\").\nOperating difficulties at the Property resulted in Camelot Lakes Associates, an unaffiliated limited partnership (\"Camelot Lakes\" or the \"Original Borrower\"), defaulting on the November 1993 through January 1994 Bond payments. Consequently, on February 1, 1994, the General Partner reached a restructuring agreement with the Original Borrower, whereby the ownership of the Property was transferred to ConCam Associates (the \"ConCam Owner or the \"New Borrower\"), and property management was transferred to the ConAm Management Corporation (\"ConAm\"), a major property management company. In addition to ownership, the ConCam Owner, an affiliate of ConAm, assumed the obligations under the Bond and loan documents on a nonrecourse basis. Pursuant to the restructuring, the Partnership entered into a Forbearance Agreement (the \"Forbearance Agreement\") with the ConCam Owner, which modified the terms of the Bond and amended the second mortgage. The Forbearance Agreement will expire on December 31, 1996 and is subject to renewal at the Partnership's sole option. Pursuant to the Forbearance Agreement, the minimum interest payment on the Bond increased to 7.0% on February 1, 1996 from the previous rate of 6.5%. Given the difficulties confronting multifamily property owners in Fresno, ConCam indicated that it was unlikely that the Property's operations could support debt service payments at the increased rate in 1996. Although the ConCam Owner provided debt service at the 7% minimum pay rate (partially from its cash reserves) on February 1, 1996, it was only able to provide for debt service at a 5% annualized pay rate on the Bond on March 1, 1996. In view of these circumstances, the General Partner is currently engaged in discussions with ConCam to negotiate a modification of the Forbearance Agreement. There can be no assurance that the ConCam Owner will be able to satisfy increased future payments.\nAt December 31, 1995, the Partnership had cash and cash equivalents, which are invested in tax-exempt money market accounts, of $679,620, compared with $802,222 at December 31, 1994. The decrease is due to net cash used to fund cash distributions exceeding net cash provided by operating activities.\nDue to the Property's operating difficulties, the General Partner reduced the cash distribution paid to the partners from an annual return of 7.5% to 5.0%, effective with the second quarter of 1993. Total cash distributions declared for 1995 were $1,080,808, which included $1,070,000, or $.50 per Beneficial Assignee Certificate, declared payable to the Limited Partners. As of December 31, 1995, total cash distributions paid to the Limited Partners since inception have been funded 77% from operating cash flow and 23% from the Partnership's cash reserves. The sources of the Partnership's future cash flows are expected to be from payments of Base Interest on the Bond, interest earned on cash and cash equivalents. Although the ConCam Owner has been able to meet its debt service obligations to date, its ability to service the new pay rate of 7.0% may be impeded should the adverse market conditions in Fresno continue. Depending on the outcome of negotiations with the ConCam Owner, it ma y be necessary to reduce the level of cash distributions during 1996.\nOn February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. \"Change of Control\" means any purchase or offer to purchase more than 10% of the BACs that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a Form 8-K disclosing this resolution on February 29, 1996.\nResults of Operations\n1995 versus 1994\nThe Partnership accounts for its investment in the Bond using the equity method of accounting. Accordingly, the Partnership reports as income its share of the Property's results of operations.\nFor the year ended December 31, 1995, the Partnership generated a net loss of $30,145, on total revenues of $71,044, compared with net income of $211,582 on total revenues of $406,502 for the year ended December 31, 1994. The change from net income to net loss primarily is due to a decrease in the Partnership's share of earnings from its investment in the Bond, which was partially offset by a decrease in general and administrative expenses.\nThe Partnership's share of earnings from investment in the Bond is based on the Property's earnings before debt service, which increased for the year ended December 31, 1995 relative to the same period in 1994. The Partnership's equity interest in the Property's earnings for the year ended December 31, 1995 was $43,158, compared with $377,211 for the year ended December 31, 1994. The decrease primarily is due to higher expenses at the Property in the first quarter of 1995. Total income at Camelot Lakes Apartments was $2,109,518 for the year ended December 31, 1995, compared with $1,806,488 for the year ended December 31, 1994. The increase largely is due to higher average occupancy in 1995. Total expenses at Camelot Lakes Apartments, net of debt service, were $1,657,939 for the year ended December 31, 1995, compared to $1,138,498 for the year ended December 31, 1994. The increase primarily is due to higher repairs and maintenance expense partially offset by lower advertising and promotion expenses and other expenses.\nTotal expenses for the year ended December 31, 1995 were $101,189, compared to $194,920 for the year ended December 31, 1994. The decrease largely is attributable to higher general and administrative expenses in 1994, primarily as a result of increased legal expenses and closing costs incurred related to the restructuring and higher amortization of organization costs in 1994. These costs were fully amortized in 1994.\nNet cash provided by the Partnership's operating activities for the year ended December 31, 1995 was $958,206, compared with $729,103 for the corresponding period in 1994. The increase primarily is attributable to an increase in interest received from the Property on the mortgage revenue bond. Interest received on the mortgage revenue bond increased to $1,002,015 for the year ended December 31, 1995, from $833,850 for the year ended December 31, 1994. The increase for the 1995 period is largely due to the increase in the minimum pay rate effective with the January 1995 payment. The lower interest received for the 1994 period was also due to the January 1994 default on debt service by Camelot Lakes.\nAs of December 31, 1995, occupancy at the Property increased to 89%, compared with 83% as of December 31, 1994.\n1994 versus 1993\nFor the year ended December 31, 1994, the Partnership earned net income of $211,582, on total revenue of $406,502, compared with net income of $441,297 on total revenue of $631,711 for the year ended December 31, 1993. The decrease in net income is primarily due to a reduction in the Partnership's share of earnings from its investment in the Bond. The change is also due to the decline in interest on the Working Capital Loan in 1994, which is no longer being accrued, since the collectibility of such interest is unlikely.\nThe Partnership's equity interest in the Property's earnings for the year ended December 31, 1994 was $377,211 compared with $527,857 for the year ended December 31, 1993. The Partnership's share of earnings from investment in the Bond is based on the Property's earnings before debt service, which decreased for the year ended December 31, 1994 relative to the same period in 1993. Total income at Camelot Lakes Apartments was $1,806,488 for the year ended December 31, 1994 compared to $1,846,989 for the year ended December 31, 1993. Property operating expenses were $1,138,498 for the year ended December 31, 1994 compared to $891,292 for the year ended December 31, 1993. Increased property operating expenses consist primarily of higher safety and security expenses, repair and maintenance expenses and advertising and promotion expenses.\nOther interest declined to $29,291 for the year ended December 31, 1994 from $32,479 for the year ended December 31, 1993, due to lower cash balances maintained by the Partnership. Interest on the Working Capital Loan for the year ended December 31, 1994 decreased to $0, compared with $53,025 for the year ended December 31, 1993. Interest is no longer being accrued, since the collectibility of such interest is unlikely. Effective February 1, 1994, the rate of interest on the Working Capital Loan was reduced from 12.625% to 6%, simple, non-compounding interest.\nTotal expenses for the year ended December 31, 1994 totaled $194,920 compared with $190,414 for the year ended December 31, 1993. The change is primarily due to higher general and administrative expenses in 1994, largely as a result of increased legal expenses and closing costs incurred related to the restructuring, which were partially offset by a decrease in amortization of organization costs, which were fully amortized in 1994.\nNet cash provided by the Partnership's operating activities for the year ended December 31, 1994 was $729,103 compared with $1,159,989 for the year ended December 31, 1993. The decrease is primarily attributable to a reduction in interest received from $1,172,899 to $833,850 on the mortgage revenue bond as a result of the Forbearance Agreement and the January 1994 default in debt service by Camelot Lakes Associates. Approximately $232,780 of the $1,172,899 was funded from the Borrower Operating Reserve.\nAs of December 31, 1994, occupancy at the Property increased to 83%, compared with 71% at December 31, 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIncorporated by reference to the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit 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\n(a), (b) and (c)\nThe Partnership has no directors, executive officers or employees of its own.\n(a), (b), (c) and (e)\nThe names, ages and business experience for the directors and executive officers of the General Partner as of December 31, 1995 are as follows:\nName Office\nPaul L. Abbott Director, President and Chief Financial Officer Gregory M. Mayer 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.\nGregory M. Mayer, 30, is a Vice President of Lehman Brothers Inc. in the Diversified Asset Group. Mr. Mayer is responsible for investment management of residential and commercial real estate. Prior to joining a predecessor of Lehman in 1988, Mr. Mayer worked in the investment banking division of Smith Barney, Harris Upham and Company. Mr. Mayer received a B.A. degree in computer science from Iona College in 1986 and an MBA degree from Cornell University in 1992.\n(d) There is no family relationship between any of the foregoing directors and executive officers.\n(e) Involvement in certain legal proceedings.\nCertain officers and directors of CA Victory Inc., formerly Shearson\/Victory, Inc. (see below) are now serving as officers or directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The Partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which that real estate is located and, consequently, the Partnerships sought the protection of the bankruptcy laws to protect the Partnerships' assets from loss through foreclosure.\n(g) Promoters and control persons.\nNone.\nCertain Matters Involving Affiliates\nOn July 31, 1993, Shearson sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the Partnership's General Partner. However, the assets acquired by Smith Barney included the name \"Shearson.\" Consequently, the General Partner changed its name to CA Victory Inc. and Shearson\/Victory Assignor Corp. changed its name to CA Victory Assignor Corp. to delete any reference to \"Shearson.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither the General Partner nor any of its directors and officers received any compensation from the Registrant. See Item 13 below with respect to a description of certain transactions of the General Partner and its affiliates with the Registrant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security ownership of certain beneficial owners\nTo the knowledge of the General Partner, no person or group owns more than 5% of the outstanding BACs.\n(b) Security ownership of management\nAs of December 31, 1995 none of the officers and directors of the General Partner owned any BACs.\n(c) Changes in control\nNone.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated by reference to Note 6 \"Transactions with General Partner and Affiliates\" of the Notes to Financial Statements contained in the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, filed as an exhibit under Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) Financial Statements: Page Number\nReport of Independent Auditors\nReport of KPMG Peat Marwick LLP (1)\nBalance Sheets - As of December 31, 1995 and 1994 (1)\nStatements of Operations - For the years ended December 31, 1995, 1994 and 1993 (1)\nStatements of Partners' Capital (Deficit) - For the years ended December 31, 1995, 1994 and 1993 (1)\nStatements of Cash Flows - For the years ended December 31, 1995, 1994 and 1993 (1)\nNotes to Financial Statements (1)\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(1) Incorporated by reference to the Partnership's Annual Report to BAC Holders for the year ended December 31, 1995, which is filed as an exhibit under Item 14.\n(a) (2) Financial Statement Schedules:\nConCam Associates, L.P.\nIndependent Auditors' Report A-1 Financial Statements: Balance Sheets at December 31, 1995 and 1994 A-2 Statements of Operations and Partners' Capital (Deficit) for the year ended December 31, 1995 and the period from January 28, 1994 (inception) through December 31, 1994 A-3 Statements of Cash Flows for the year ended December 31, 1995 and the period from January 28, 1994 (inception) through December 31, 1994 A-4 Notes to Financial Statements A-5\n(a) (3) Exhibits:\n3.1 Certificate of Limited Partnership of Victory Tax Exempt Realty Income Fund Limited Partnership. (Incorporated by reference from Exhibit 3 to the Registrant's Post-Effective Amendment No. 2, dated February 14, 1989, to the Registration Statement on Form S-11.)\n3.2 Agreement of Limited Partnership of Victory Tax Exempt Realty Income Fund Limited Partnership. (Incorporated by reference from Exhibit 3 to the Registrant's Post-Effective Amendment No. 2, dated February 14, 1989, to the Registration Statement on Form S-11.)\n3.3 Beneficial Assignee Certificate. (Incorporated by reference from Exhibit 3 to the Registrant's Registration Statement on Form S-11.)\n10.1 Forbearance Agreement between Victory Tax Exempt Realty Income Fund Limited Partnership and ConCam Associates, L.P. dated January 31, 1994. (Incorporated by reference from Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10.2 First Amendment to Working Capital Loan Agreement between Victory Tax Exempt Realty Income Fund Limited Partnership and ConCam Associates, L.P. dated February 1, 1994. (Incorporated by reference from Exhibit 10.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10.3 Property Management Agreement between ConCam Associates, L.P. and ConAm Management Corporation dated January 31, 1994. (Incorporated by reference from Exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10.4 Termination and Release Agreement between Victory Tax Exempt Realty Income Fund Limited Partnership, Camelot Lakes Associates and James Hendricks and Associates, Inc. dated February 1, 1994. (Incorporated by reference from Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n13.1 Annual Report to BAC Holders for the year ended December 31, 1995.\n27.1 Financial Data Schedule.\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 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.\nVICTORY TAX EXEMPT REALTY INCOME FUND LIMITED PARTNERSHIP\nBY: CA Victory Inc., General Partner\nDate: March 29, 1996 BY: s\/Paul L. Abbott\/ Name: Paul L. Abbott Title: Director, President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report to be signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nCA VICTORY INC. General Partner\nDate: March 29, 1996 BY: s\/Paul L. Abbott\/ Name: Paul L. Abbott Title: Director, President and Chief Financial Officer\nDate: March 29, 1996 BY: s\/Gregory M. Mayer\/ Name: Gregory M. Mayer Title: Vice President","section_15":""}
{"filename":"741742_1995.txt","cik":"741742","year":"1995","section_1":"Item 1. Business\nGeneral\nTseng Labs, Inc. (\"Tseng\" or the \"Company\") is one of the foremost designers and suppliers of high performance video graphic controller chips in the world. The Company's accelerators are designed to enhance the personal computer's (PC(TM)) performance by reassigning the graphic function from the Central Processing Unit (CPU) to the accelerator. By working in conjunction with the personal computer's CPU, the graphic accelerator can offer significant improvement to the quality of the graphics and also improve the system's overall performance.\nIncorporated in 1983, Tseng has built a long-standing reputation as an innovative company offering technological advancements and reliable products to the graphics market. This reputation has resulted in Original Equipment Manufacturers (OEM) agreements with some of the most respected names in the computer industry. These OEMs, as well as many other customers, believe that Tseng products provide the capabilities and reliability that are needed for PC video solutions.\nTseng has long been considered a pioneer in the graphics market. The Company successfully introduced the ET4000(TM) chip set in 1989. The ET4000 has the distinction of being the most successful SVGA controller in history. Following the debut of the ET4000, the Company offered a series of products designed to accentuate its video capabilities and performance. The result was the systematic introduction of the W32(TM), W32i(TM), W32p(TM) and the Video Image Processor (VIPeR(TM)), respectively. As the demand for greater multimedia capabilities, 3D, and teleconferencing takes hold in the consumer marketplace, Tseng is focused on offering solutions to meet and exceed those expectations. The Company is currently in the process of bringing to market the ET6000(TM), the first in a family of next generation graphics controller products.\nMarkets and Products\nPC Graphics Since VGA\nFollowing the advent of the IBM PS\/2(TM) series of personal computers in 1987, the era of video graphics array (VGA(TM)) arrived. Tseng Labs, on the strength of its fast response to VGA with its ET3000(TM) controller, quickly became recognized as a leader in the market of VGA-compatible video graphics products. Operating at 640x480 screen resolution with 16 to 256 colors and a refresh rate of 60Hz, VGA greatly improved the productivity of the PC user. Microsoft had recently introduced Windows(R) 3.0 which utilized a graphical user interface (GUI). GUI interfaces provide a more user-friendly environment while allowing the user to use a mouse or pointing device to select particular applications or documents. Graphics became extremely important following the Windows introduction. With graphics, however, came the desire for greater speed and higher screen resolutions. Unfortunately, higher speed and resolution placed a heavy burden upon the resources of the CPU. Subsequently, graphic chips represented a way to utilize the new interface while maintaining the speed and power of the system. While the VGA standard represented a quantum leap ahead of its predecessors, it had its own set of limitations, which drove graphic companies in search of a higher standard. The VGA standard became the building block for the next generation of graphic controllers, the Super VGA (SVGA(TM)).\nThe Company was influential as a pioneer of SVGA. Introduced as a solution to limited screen resolution and colors, SVGA was later ratified by the Video Electronics Standards Association (VESA) as the standard for the graphic industry. Operating originally at 800x600 screen resolution while maintaining the 16 to 256 color palette and between 60Hz and 72Hz refresh, SVGA was widely accepted by third-party developers of standards and accelerated chip sets. During this period, Tseng Labs reinforced its position as a leader in design and engineering with the ET4000 chip set targeting the SVGA standard.\nThe advent of Microsoft Windows 3.0(TM) and 3.1(TM) allowed for GUI interfaces for applications running on the PC. Unfortunately, Windows noticeably diminished the processing power of the computer due to its highly graphical operating environment. The Company, along with other graphics companies, realized that high speed, high resolution graphical interfaces needed to be provided. The graphics industry saw an opportunity in providing high resolution and color while improving performance by reassigning video responsibilities to the graphics card, thereby accelerating the entire system.\nIn 1989, the Company introduced the ET4000 controller. The ET4000 grew to become one of the single highest volume SVGA-compatible devices ever produced, permitting 1024x768 resolution at 256 colors, while using low cost DRAM. In addition, the low cost ET4000-based adapters were capable of displaying 16.8 million colors simultaneously, allowing for \"true color\" imaging on a low cost adapter. The ET4000 was the first SVGA class device to be connected to the CPU directly, which is now referred to as a \"local bus\" implementation. With a properly designed graphics chip, local bus provides the CPU with far greater access to the graphics memory, increasing the performance of the entire display subsystem. The ET4000 was noticeably faster than other SVGA chips, allowing the CPU to write to the video card without losing access time to the video memory, known as \"wait states,\" typical in previous technology.\nThe next advance in GUI software required better acceleration than that available from zero wait state and local bus operation. The Company answered with the ET4000\/W32, which retained full compatibility with the ET4000 software, but increased it from a 16-bit to a 32-bit local bus which was more appropriate for 486 CPU designs. The W32 allowed the CPU to write to the video memory at the same or faster rates than to its own system memory, and included an ability to power Windows and other applications between four and ten times faster than the acceleration of the original ET4000. Because of its price\/performance value, the W32 was integrated onto the system motherboards of a number of leading OEMs.\nWindows Acceleration for 2D and Developing 3D\nThe market demand for performance graphics increased substantially after the release of Microsoft's Windows 3.0 and follow-up Windows 3.1. Many manufacturers of PCs chose to bundle Windows, or other GUI software package such as OS\/2(R), with every system. An explosion of high-resolution and high-color applications authored for Windows occurred. By the end of 1992, the best selling DOS applications in word processing, spreadsheets, graphics and desktop publishing among others, had migrated to the Windows GUI application interface. This additional layer of software hampered the performance of many applications by increasing software execution time.\nWindows demanded more power from the graphic accelerator hence, the W32i and the W32p were introduced to provide additional performance, resolution and color, and higher levels of integration to reduce system chip count and cost. The W32i was the direct replacement for the W32 on OEM designs. The W32p delivered the memory interface of the W32i with the direct connection of PCI local bus architecture, an emerging industry standard. Both the W32i and the W32p enhanced graphic systems performance by using an approach known as memory interleaving that doubled the graphics processing power of the device. The original W32 chip provided a 32-bit path between the graphics controller and its memory. The W32i and W32p used interleaving to effectively double the path to 64-bits, with only a minimum incremental cost to deliver the enhanced performance. In addition, the W32i and W32p could process 64-bits of graphic data in the same time that the original W32 could process 32-bits of graphic data.\nBy 1992, many of the most popular applications which specified hardware sets such as EGA(TM), or VGA\/SVGA had been re-written to support the GUI environment. PC users benefited from this trend by having a multitude of applications that now run in higher resolution and\/or higher color modes on their non-IBM hardware. However, as the graphical environment has become more important, so has the need for increasingly powerful graphics hardware to maintain the users' expectation for GUI application performance.\nThe Company has always sought to further enhance video technologies through additional advancements regarding their products. Additionally, the Company has played an important role in the development and sanctioning of industry standards. In 1995, Windows 95(TM) was introduced by Microsoft. The Windows 95 operating system offered software developers the capability of drastically improving graphics and video performance over Windows 3.x. Game and entertainment titles depend on quick screen updates driven by real-time input from a mouse, joystick, or other device to maintain the illusion of realism. These title developers largely avoided porting their products from DOS to Windows, unable to accept the performance penalty Windows 3.x GDI (Graphics Device Interface) presented. By accessing the PC graphics hardware directly under DOS, interactive titles achieve the performance they need but lost the hardware independence that Windows applications enjoy. Windows 95 offered the best of both worlds, and represented an innovative departure from the traditional GUI as a \"layer\" between user and the operating system.\nWindows 95 offers application developers access to a set of programming interfaces that provide a thin layer of abstraction over graphics and multimedia hardware acceleration features. Writing to this set of interfaces, known as DirectX(TM), gives applications high performance and hardware independence as well as access to other Windows 95 features. This performance boost allows Windows 95 to be positioned as a compelling multimedia operating system for home as well as professional use. In late 1995, game developers began releasing the first wave of titles to take advantage of DirectX. As this list of software\ncontinues to grow, the Company believes that the demand for graphics solutions that are optimized for Windows 95 performance will continue to increase.\nIn November 1995, the Company responded with the introduction of the ET6000 during Fall Comdex, and was awarded the Best of Comdex in the Sound and Display category. The ET6000 is a state-of-the-art 128 bit graphics and multimedia engine that integrates a high quality video processor, a revolutionary interface to Multibank(TM) DRAM (MDRAM) and PCI bus interface. Optimized for Windows 95 graphics performance, the ET6000 was designed to offer high resolution and color without system degradation. As has characterized the PC industry, users continue to require greater video performance, speed, higher resolution, and greater bandwidth between the graphics chip and graphics memory. The Company responded with a 128-bit graphics and multimedia engine using MDRAM which resulted in a high quality video processor. The ET6000 will also continue the Company's trend of integrating technology by bringing two important circuits, the RAMDAC and clock generator, inside one single chip, positioning the Company to more effectively compete with a number of its competitors who currently offer this level of integration.\nTo complement the ET6000 chip's internal video processing engine and to reduce the required components for multimedia video applications, the Company introduced two multimedia processors, the VPR6000(TM), a video image processor, and the MPG9920(TM), and MPEG decoder with built-in scaling capabilities. The VPR6000 processes video, enables live video input, and allows ISA and other multimedia devices to reside on the Company's proprietary Image Memory Access (IMA) multimedia bus. The MPG9920 allows glueless attachment to the ET6000 for hardware playback of MPEG video. The MPG9920 also features an internal video scaler and input for live video. Both devices were designed to allow OEMs to create feature-rich, highly integrated, PCI compliant, low cost multimedia solutions. The Company is currently working to bring the ET6000, VPR6000 and the MPG9920 to commercial production.\nVideo, Multimedia, and Entertainment\nAdvancing technologies including faster microprocessors and higher performance memory have allowed microcomputers to perform more than traditional data processing applications. Multimedia is the mixing of entertainment, communications, and data processing capabilities. The Company views multimedia as an opportunity for growth in a rapidly emerging video market. The majority of multimedia titles are based upon communications, productivity, information, education and entertainment applications. Multimedia is a developing technology that places increased burdens on system hardware due to full-motion video requirements. An integral component of a multimedia computer is the display of live and stored motion video, and audio at the highest resolution and refresh rates.\nBroadcast video displays at relatively low resolution, but high color. The perceived quality of the display is created by rapid (30 times per second) changes in the motion video. With the W32-family of graphic controllers, the Company introduced a method to display color and resolution beyond the television color standard. By bringing the motion data into memory, a PC can digitally store or modify the motion data. In both engineering and market opportunity, Multimedia represents a challenge and an opportunity for growth for the Company.\nOther Multimedia video solutions, including live video stored using the Motion Picture Experts Group (MPEG) standard, have been introduced into the market. MPEG compression enables feature film motion pictures to be compressed onto standard CD-ROMs. Applications for MPEG technology include home entertainment, education, information kiosks, and others. The Company's graphics and multimedia products have been combined with MPEG-specific chips from other parties to form solutions addressing this market. The Company believes that the demand of the market for higher quality display will favor the currently emerging MPEG-2 standard. The new standard provides for greater throughput of the data resulting in a smoother, more realistic picture, without losing any picture frames. To accomplish this standard, MPEG-2 requires more performance from the graphics chip. The Company believes the ET6000 is ideally suited for MPEG-2 applications due to its increased bandwidth capacity, high resolution display capability, 128 bit GUI accelerator, use of MDRAM and advanced high quality multiple scaled window display capability. The Company is also currently developing additional products and evaluating technology from other parties to attempt to develop solutions for this emerging market.\nThe Company has developed technology that responds to the trend toward more feature oriented computer systems. All of the members of the W32- family of graphic controllers include two input paths to the display memory. The first path is for CPU bus data, and is standard on most SVGA and GUI accelerator chips. The second path is proprietary to the Company and is called Image Memory Access (IMA(TM)). IMA architecture allows video input from a live TV source or multimedia coprocessor directly into the display memory. In 1994, the Company provided the VIPeR chip as an IMA bus device to handle display and capture of live motion video, and to accelerate replay of motion video playback from\ninexpensive and popular software decompression products like Intel's Indeo. The VIPeR allows motion data to be dynamically sized in a window in real time, requiring no recalculation time by the system CPU, meaning that proportional resizing of the video image window is virtually instantaneous. The video image window can be adjusted for brightness, contrast, and saturation, and also coexist on-screen with traditional data processing applications. The VIPeR, when introduced, was found to be a cost-effective product for displaying broadcast television in a digital window on the personal computer. The high quality image processing of VIPeR allowed MPEG images to be enlarged without creating a blocky, unrealistic image often found in other MPEG products. In 1995, the Company introduced the VIPeR f\/x which gave the user higher resolution video display and other enhancements.\nComputer purchasing trends in the US have leaned towards multimedia machines since 1994. These PCs included a CD-ROM, speakers and a sound card, allowing the user to access a host of information with high quality speed and sound. Moreover, a greater percentage of computers began to ship to the home market as opposed to the workplace. As a result, the computer industry now offers hardware and software for home entertainment, education, on line accesses and searches, and productivity.\nThe largest growth segments in home entertainment is internet access and gaming applications, using home multimedia computers. Game applications have become the testing grounds for today's processors, graphic cards, and audio. Historically, the games applications were somewhat limited in terms of speed (if the application was developed in Windows) or graphics (if the application was developed in DOS). In 1995, Microsoft provided the interface and performance necessary for the development of high quality video games for the PC with the development of Windows 95, allowing all the performance of the DOS based applications with the interface of a Windows application (see \"DirectX\" in the previous section).\nThrough the use of DirectX, Windows 95 addresses the issues of performance and graphics necessary in gaming and teleconferencing applications. DirectX allows for a clear and direct path to real-time, real-motion video and the development of true 3D applications. The ET6000 was designed to allow the user to take advantage of the additional capabilities available in Windows 95. The ET6000 also included the capabilities of the entire W32-family of chip sets as well as the integration of portions of the multimedia features currently available in the VIPeR chip set series. The ET6000 and its emerging family of products is being designed to produce high-performance graphics at the resolution and color depths previously available on very high-end, more costly video solutions.\nET2000, ET3000, ET4000, W32, W32i, W32p, ET4000\/W32, ET6000, VPR6000 and MPG9920 are trademarks of Tseng Labs, Inc., Indeo, Peripheral Component Interconnect (PCI) and Pentium are trademarks of Intel Corporation, Video for Windows, Windows 3.0, Windows 3.1, Windows 95 and DirectX are trademarks of Microsoft Corporation, Personal Computer, PS\/2, Enhanced Graphics Adapter (EGA), Video Graphics Array (VGA) are trademarks of IBM Corporation, Motion Pictures Experts Group (MPEG-1 and MPEG-2, respectively) are trademarks of Motion Pictures Expert Group, Multibank is a trademark of Mosys Corporation. Other brands and names are properties of their respective companies.\nFactors Which May Affect Results\nThe Company cautions readers that it operates in a highly competitive and rapidly changing technology marketplace and that there are many factors, including those discussed below that, in some cases have, and may in the future, affect the Company's operating results and could cause the Company's actual consolidated results for one or more future periods to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the Company. Statements in this section and other sections of this Form 10-K which are not historical statements constitute forward looking statements.\nThe competition in the markets which the Company competes is intense. The market is characterized by rapid technological change, short product lives (typically less than 18 months) and severe price competition. The Company is continually attempting to develop new products to address market requirements. If new products are not brought to the market in a timely manner or do not address the market performance and price requirements, then sales and operating results in future periods could be adversely affected. In addition, if the Company is not able to effect a smooth transition from one product to another, competitive forces in the market, including pricing and margin pressures, could result in substantial fluctuations in quarterly operating results and adversely impact sales and operating results in future periods. Competitive factors to be considered include but are not limited to, the timing of new products, performance, features, price, product availability, breadth of product line and customer support.\nThe Company's historical operating results have been, and its future operating results may be, subject to fluctuations, including quarterly fluctuations due to a variety of factors including, but not limited to, changes in pricing policies by the Company or its competitors, including anticipated and unanticipated decreases in average unit selling prices, concentration of a high percentage of\ntotal sales in a few significant customers, gain or loss of significant customers, cancellations or rescheduling of orders by customers, changes in product or customer mix, new product introductions and acceptance by the Company or its competitors, market acceptance of new or enhanced versions of the Company's or competitors' products, strengths or weaknesses in the overall markets in which the Company competes and sensational demand. In addition, because the Company must order product and build inventory substantially in advance of customer orders and product shipments and because the markets for the Company's products are volatile and subject to rapid technological and price changes, there is a risk that the Company will forecast incorrectly and produce excess or insufficient inventories of particular products which could adversely impact operating results.\nThe semiconductor industry as a whole is characterized by a high percentage of a total sales in a quarter occurring in the third month of a quarter. Historically, based upon customer demand, the Company has shipped more product in the third month of each quarter than in either of the first two months. In addition, shipments in the third month are often higher at the end of the month. Accordingly, a disruption at the end of a quarter of either production or shipping could materially impact operating results in that quarter. In addition, such concentration can cause difficulties in both forecasting production requirements for a product and\/or forecasting operating results for a quarter.\nThe Company currently relies on outside foundries, packaging houses and test houses for the manufacturing of its semiconductor devices. The use of third parties involves many significant risks including, but not limited to, the absence of adequate capacity to produce the Company's products, unavailability of, or interruptions in access to the process technologies necessary to manufacture the Company's products, the absence of guaranteed manufacturing capacity, reduced control over delivery schedules, manufacturing yields and costs. The Company is currently attempting to qualify a number of additional foundries to provide additional production capacities for the Company's new products. However, the qualification process and production ramp-up is a complex process and could take longer than anticipated and there can be no assurance that such foundries will be able or willing to produce parts in quantities, in the time frames and at the price necessary to satisfy both the Company and customer requirements. In addition, customers may be unable or unwilling to qualify parts from multiple sources. The inability to meet customer requirements and price points for delivery of products could adversely impact future operating results.\nIn addition to the risks associated with delivery of the Company's products, the PC and the graphics subsystem rely on a number of component parts produced by third parties. In addition, the Company's ET6000 has been designed to attempt to optimize the additional memory bandwidth of Multibank DRAM (MDRAM) by Mosys, Inc. Mosys, Inc. is also a \"fabless\" semiconductor supplier and may be subject to risks similar to the Company with respect to many of the business risks discussed above including, but not limited to, reliance on outside foundries. Any shortage of components used in the PC or graphics subsystem could affect the Company's operating results.\nSales and Marketing\nThe Company employs traditional OEM channels to market its products. The Company utilizes an internal sales and marketing team responsible for all aspects of both domestic as well as international sales. Additionally, the Company uses a series of independent manufacturers representatives and regional distributors, to provide marketing and technical support for its customers. The Company maintains close working relationships with its customers and potential customers and periodically exchanges advance technical information with them under nondisclosure agreements. The Company has initiated on-going programs for continuous improvement geared towards customer satisfaction and fulfillment.\nIn North America, the Company uses a combination of a direct sales force operating from the Company's main headquarters in Newtown, Pennsylvania and independent manufacturers representatives. The manufacturers representatives are located in Massachusetts, Alabama, Pennsylvania, North Carolina, Georgia, California, Texas, Washington, and Oregon.\nInternationally, the Company also operates an Asian sales and support office located in Taipei, Taiwan with local distributors located in Hong Kong, Japan, Korea, Singapore, as well as Taiwan. The European customers are serviced using a direct sales labor force based at the Company's headquarters and manufacturers representatives located in Belgium, Germany, and the United Kingdom.\nAs the Company's customer base has largely become OEM and add-in board manufacturers, it has discontinued sales through distribution of its own brand name products. The Company promotes the acceptance and use of its products through direct contact with potential customers, coverage in trade and press articles, and participation in industry trade shows.\nDuring 1995, 1994, and 1993, sales to the Company's two largest customers accounted for 37%, 51%, and 42% respectively, of the Company's revenues. One customer represented 42% of revenues in 1994. This customer did not contribute significantly to revenues in 1995. In addition, sales to unaffiliated distributors, primarily in the Far East, accounted for 12%, 9% and 8% of total revenues for 1995, 1994, and 1993, respectively. (See Note 7 to the Company's consolidated financial statements). The Company expects a significant portion of its future sales to remain concentrated within a limited number of strategic customers. Sales to these customers can fluctuate significantly from quarter to quarter. In addition, orders from these customers may be subject to cancellation or rescheduling. There can be no assurance that loss or significant fluctuations in quarterly sales to the Company's significant customers (including but not limited to canceling and\/or rescheduling orders) may not adversely impact the Company's operating results in the future.\nForeign sales, including those to the Far East distributors, represented approximately 59%, 43% and 41% of revenues during 1995, 1994, and 1993, respectively. As a significant portion of the Company's sales are export sales, the Company is subject to the risks of conducting business internationally, including unexpected changes in regulatory requirements, fluctuations in the US dollar which could increase the sales price in local currencies of the Company's products in foreign markets, tariffs, and other barriers and restrictions and the burden of complying with a wide variety of foreign laws.\nProduct Support and Service\nThe Company believes that customer service and technical support are of paramount importance in obtaining and preserving a competitive advantage in the graphic accelerator market. To that end, the Company provides technical support to its OEM and add-in board manufacturers through support staffs located in its Newtown headquarters and in its Taiwan office. Additional support for the Company's products is provided by manufacturers representatives and distributors. Tseng also offers support via an electronic bulletin board service, evaluation boards, product design support, demonstration software, and a soon to be completed world wide web site on the internet. Additionally, the Company provides application design support and upgrading of customer software. By providing the latest enhancements for its products through software upgrades, the Company can extend the life and value of its products to the customer.\nThe Company will periodically provide product road maps, under non-disclosure agreements, to OEMs and add-in board manufacturers. The Company believes that such communication will improve customer satisfaction while enhancing the Company's corporate image. Additionally, the Company believes it can better understand current and future system requirements through a consistent dialog with its customers. It is the Company's belief that customer satisfaction is improved through open communication. Furthermore, the Company believes it can identify important trends and concerns which assist in defining future products and services.\nManufacturing\nHistorically, the Company has purchased all of its product from one foundry. The Company has developed and is implementing a strategy for major new products of utilizing a number of qualified foundries that it believes provide the technology, capacity, quality and cost required to support production of that product. The Company's products are manufactured utilizing CMOS processes with line geometrics as small as 0.6 micron. Most of the Company's new products are manufactured using advanced triple metal processes. The Company has an on-going program of evaluating foundries with even smaller geometries for future products. While the Company's strategy is to develop multiple sources for its major new products to reduce its dependency on any single foundry, improve its flexibility to respond to customer requirements, increase the Company's ability to fulfill customer requirements, and gain greater control over its production costs, the Company has not qualified second sources for certain of its products. In addition, new products (including the ET6000) are typically produced initially by a single foundry until alternate sources can be qualified. The Company currently does not have long-term contractual supply agreements with its foundries. Historically, the Company has conducted its business with its foundries by written purchase orders which cover a period or range of periods. Should a foundry terminate its relationship with the Company, or its supply from a foundry be interrupted for any other reason, the Company may not be able to replace, on a timely basis, the production loss from this foundry.\nThe Company is working with existing foundries to obtain additional production for its new products (including the ET6000) and is working to qualify new foundries to provide additional manufacturing capacity for its products (including the ET6000). The Company has commenced product development with additional foundries and has agreed to pay for certain non-recurring engineering costs and initial production and, subject to qualification of these foundries, has made certain purchase commitments. If there are significant delays in qualifying new foundries, shipments of products could be delayed, which could adversely affect operating results.\nPrior to 1995, the Company's foundry also performed the packaging and testing functions necessary to deliver finished, tested parts to the Company. The Company paid only for finished, tested parts meeting predetermined specifications. In 1995, the Company began purchasing product in wafer and \"known good die\" forms and managed the subcontracting by third parties of the assembly and test process. In 1996, the Company anticipates the majority of its product will be purchased in wafer or \"known good die\" form. In the assembly process, wafers are tested in accordance with predetermined specifications established by the Company and assembled into packaged parts. The packaged parts are again tested to the Company's specifications. Product returns to date have not been significant.\nThe Company's reliance on third party foundries involves a number of risks including, but not limited to, the absence of adequate capacity, the unavailability of, or interruptions in access to the process technologies utilized by the Company's products, the absence of guaranteed capacity, reduced control over delivery schedules, manufacturing yields and costs. Inability to obtain adequate, timely supply sources, whether due to capacity constraints, disruption at foundry, assembly or test, delays in qualification of new foundries or other reasons, could adversely affect the Company's operating results.\nIn order to obtain an adequate supply of wafers, especially wafers manufactured using advanced process technologies, the Company has considered and will continue to consider various possible transactions, including the use of \"take or pay\" contracts which commit the Company to purchase specified quantities of wafers over specified periods or the use of standby letters of credit to secure future capacity on a \"take or pay\" basis. In addition, a number of the Company's competitors have entered into various transactions to secure wafer capacity including equity investments in or advances to wafer foundries in exchange for guaranteed production, or the formation of joint ventures to own, construct or operate a wafer fabrication facility. The Company, to date, has not participated in advance funding or joint ventures and will continue to work to secure adequate capacity without such arrangements. Should the Company be required to enter into any of the above manufacturing arrangements to secure foundry capacity, such arrangements may require substantial capital investment, which may require the Company to seek additional equity or debt financing, and there can be no assurance that such additional financing, if required, will be available when needed or, if available, will be on satisfactory terms. In addition, the Company may, from time to time, as business conditions warrants, invest in or acquire businesses, technology or products that complement the business of the Company. No such investments or acquisitions are being negotiated as of the date of this document.\nThe Company's current foundries and the additional foundries that it is working to qualify are primarily located in the Far East, Europe and the Mid-East. Fluctuations in the value of the US dollar against local currencies could impact the price paid by the Company for its products.\nIn addition to adequate supply of the Company's products, PCs and graphics subsystems rely on a number of other components, produced by third parties. Any shortage of such components could adversely affect the Company's business and operating results.\nResearch and Development\nThe Company believes that a continued investment in engineering personnel and resources is critical to its ability to timely develop and introduce new products and allow it to become or to remain a leader in the markets in which it competes. This investment in the engineering personnel is viewed as critical to this effort and competition for attracting and retaining qualified personnel is intense. The Company conducts most of its product development in-house with an engineering staff of 50 personnel. The Company is currently working to further leverage its design resources by both jointly developing products with technology partners (the MPG9920 is an example of this joint development) and\/or utilizing outside, third party contractors to assist in the development of new products and the portation of existing products to additional foundries.\nThe Company uses advanced workstations, dedicated simulators, and a variety of modeling and layout tools to design products. The engineers also use a high level design language in the development of products. The Company is committed to continuing to invest in state-of-the-art computer aided engineering (CAE) and computer aided design (CAD) tools, to enable its engineers to effectively and efficiently develop new products which are tested using a variety of hardware and software modeling simulations. Additional support related to software driver development and firmware are also located on-site to further enhance Tseng's ability to bring product to market in the quickest, most cost-efficient manner.\nOnce developed, the Company offers development kits to customers and potential customers to assist them in developing products based upon Tseng's technology.\nThe efforts of the Company resulted in the development of the ET6000 and its family of products along with its predecessor W32 and ET4000 product families. During 1995, 1994, and 1993 the Company spent approximately $3,440,000, $1,922,000 and $1,011,000, respectively, on research and development activities.\nCompetition\nThe Company competes in a highly competitive marketplace numbering some 50+ participants. The principal competitive factors in the market for PC enhancement products are price, performance, brand recognition, product quality, availability, breadth of product line, service and OEM support, the timing of new product introductions by the Company and its competitors and the emergence of new standards for graphics, multimedia and PCs. Price competition in the industry is intense and may increase.\nThe Company's principle competitors include S3, Inc., Cirrus Logic, Inc., ATI Technologies, Inc., Trident Microsystems, Inc. and Matrox, Inc. Many of the Company's competitors have greater financial resources, more extensive business experience and greater design, development, manufacturing, marketing and service capabilities than the Company. The rapid pace of technological change in the computer and computer enhancement market places a premium on such factors as the knowledge and experience of the Company's management and personnel and their ability to develop and improve products. For these reasons, the Company believes its future success to be directly linked to the development and introduction of new products that are responsive to market needs. There can be no assurance that the Company will be able to successfully develop or market such products in a timely manner.\nLicenses, Patents and Trademarks\nHistorically, the Company principally relied upon its advanced technological innovations to enable it to compete in the graphics accelerator market. The Company has recently applied for its first ever patent for certain proprietary functions included in the newly developed ET6000 series. No patents have been issued to the Company to date. The Company has attempted to protect its technologies and proprietary information through non-disclosure agreements with its customers, suppliers, employees, and consultants. The Company intends to attempt to aggressively protect its intellectual property.\nThe Company has been issued trademarks for UltraPak and EVA (an application of the ET2000 chip) and its ET3000, ET4000, ET4000\/W32, W32i, and W32p-based chip and board products. The Company has also filed trademark registrations for its upcoming ET6000, VPR6000, and MPG9920 products. The Company believes that an active trademark program is important to developing and maintaining recognition in the market for its products.\nBacklog\nThe Company's business, and to a large extent that of the entire semiconductor industry, is characterized by short lead-time orders and frequent cancellation, rescheduling and price negotiation of orders. Sales of the Company's products have been historically made pursuant to purchase orders that are cancelable, at the customers' option, without significant penalties. Because of the above factors, the Company does not believe that backlog is a meaningful indicator of sales in any future period.\nEmployees\nAs of March 1, 1996, the Company had 95 full-time employees. Of these, 9 were engaged in operations; 50 in product and software development; 17 in marketing, customer service and support; and 19 in management, administrative and financial positions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns a building with 34,000 square feet in an industrial and office park in Newtown, Pennsylvania which is used as its advanced research and product development facility, as well as its principal executive office. The Company occupied this facility on February 1, 1992.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn May 1993, two purported shareholders of the Company brought an action against the Company and certain of its executive officers in the United States District Court for the Eastern District of Pennsylvania, alleging that the defendants had issued false and misleading statements concerning the Company and thus had violated the federal securities laws and committed common law fraud and negligent misrepresentation. Subsequently, several other purported shareholders filed similar actions in the same forum against the Company and certain of its executive officers. The actions have been consolidated. On July 8, 1994, pursuant to stipulation, the Court certified a class for the federal securities law claims and dismissed the state law claims, without prejudice. Discovery had been completed and on August 21, 1995, the Company filed a motion for summary judgment seeking to dismiss the action in its entirety. On March 19, 1996, the Court ruled on the Company's motion and dismissed the action in its entirety. The Company had recorded the expense in defending these complaints on an as incurred basis.\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 Stockholders Matters\nThe Company's Common Stock is traded over-the counter under the symbol \"TSNG\" There were approximately 1,361 holders of record of the Company's Common Stock as of February 29, 1996. The following table sets forth, for the periods indicated, the high and low bid quotations for the Common Stock, as reported by the National Quotation Bureau.\nBid Prices --------------------------\nHigh Low\n1994:\nFirst Quarter $11.88 $8.88 Second Quarter 9.38 6.63 Third Quarter 8.25 6.38 Fourth Quarter 7.63 5.88\n1995:\nFirst Quarter $ 7.00 $5.63 Second Quarter 9.50 6.25 Third Quarter 10.75 6.75 Fourth Quarter 10.63 7.50\nOn March 22, 1996, the closing bid price in the over-the-counter market of the Company's Common Stock, as reported by the National Quotation Bureau was $9.63. The high and low closing bid prices of the Company's Common Stock between January 1, 1996 and March 22, 1996 were $8.63 and $10.63 respectively.\nIn August 1995, the Company's Board of Directors voted to suspend the Company's quarterly cash dividend which had commenced in August 1993. Two dividends of $.05 per share were paid to holders of the Company's Common Stock in 1995 and four dividends of $.05 per share were paid in 1994. The Company does not anticipate paying cash dividends in the foreseeable future and currently intends, as most of its competitors currently do, to retain its cash and earnings for the development of its business.\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\nStatements in this section other than historical statements constitute forward looking statements and actual results could materially differ from those expressed in any forward looking statements by the Company. See \"Factors That May Impact Results.\"\nResults of Operations\nRevenues for 1995 were $39,277,000 a 51% decrease from 1994 levels. The decrease in revenues was due primarily to significantly lower shipments of the Company's W32i-based products as these products reached maturation in a rapidly evolving personal computer marketplace. Sales of W32i-based products to one customer accounted for 42% of revenues in 1994. This entity discontinued its W32i-based computer systems in the first quarter of 1995. Higher sales of W32p-based products were not sufficient to offset lower unit shipments of the W32i and lower selling prices on all of the Company's graphics accelerator products. The Company introduced the first product of its third generation graphics and multimedia family, the ET6000, at Comdex in November 1995. This product family is not yet in full volume production. Due to short product design cycles in the computer industry as a whole, announced and anticipated new product introductions by competitors of the Company, and anticipated design changes from major customers, the Company expects pricing and competitive market pressures on existing products will continue to intensify and revenues and earnings will continue to be lower than 1995 levels unless and until the ET6000 becomes a commercially successful product. In addition, because of the risks in bringing new technologies to market and market acceptance of new products, in the production process of semiconductor devices, in the availability and cost of materials from the Company's suppliers and due to the competitive nature of the graphics and PC market, there can be no assurance that revenues and earnings from the ET6000 will be sufficient to return the Company's operating results to historic levels.\nRevenues for 1994 and 1993 were $80,659,000 and $75,526,000, respectively. While sales only increased 6.8% between periods, the product mix comprising the sales changed significantly between years. The Company began a product transition late in the first quarter of 1993 when sales of the Company's first generation graphics accelerator product (the W32) began to contribute significantly to the Company's revenues. The W32 was the first in a family of products introduced by the Company to enhance video performance, especially in Microsoft Windows and other Graphical User Interface (GUI) applications. The Company also introduced its second generation accelerator products in 1993 and sales of the W32i and W32p contributed significantly to revenues late in the third and fourth quarters of 1993, respectively, and continued into 1994. For the years ended December 31, 1994 and 1993, sales of products of the full W32 family represented approximately 90% and 71% of total revenues, respectively. In 1994 alone, sales of the second generation accelerator products (W32i and W32p) represented approximately 85% of total revenues. Also contributing to revenues in 1994 was the Company's new video accelerator, VIPeR. Revenues based upon the newer technologies substantially replaced revenues based upon the Company's older ET4000-and W32-based technology. In addition to a change in the technology underlying the Company's products, there was a change in product mix between years. Unit shipments of the Company's VLSI graphics chips increased slightly in 1994. Sales of board level enhancement products continue to decrease primarily due to lower cost alternatives available in other markets including the Far Eastern markets. Average selling price on VLSI graphics chips also increased slightly in 1994 as lower average selling prices on the ET4000-and W32-based technology in 1994 were offset by higher selling prices for the Company's W32i - -and W32p based family of products as well as the new VIPeR. The Company expects selling prices on existing technologies to continue to decrease as a result of the competitive nature of the graphics marketplace and the PC market as a whole.\nCost of sales as a percentage of revenues was 74% for 1995, 71% for 1994 and 69% for 1993. The increase in cost of sales in 1995 and 1994 is due to the fact that the impact of cost reduction programs on the W32i and W32p graphics accelerator products has not been sufficient to offset lower selling prices on all of the Company's products. Also contributing to the increase in 1995 was a one-time reserve of $735,000 recorded by the Company in the fourth quarter related to establishing a reserve for certain of its older technology-based inventory. In addition, because of the price competitive nature of the market, anticipated pricing pressures on mature products and the current volatility in the yen\/dollar exchange rate, the Company expects increased pricing pressures impacting margins on its existing W32 product line.\nIn the future, the Company's gross margin percentages may be affected by factors including but not limited to increased competition and related decreases in unit average selling price (particularly with respect to mature products), timing of\nvolume shipments of new products, the introduction of new products by competitors, the availability and cost of products from the Company's suppliers and changes in the mix of products sold and customers.\nResearch and development expense in 1995 was $3,440,000, a 79% increase from 1994. Research and development expense in 1994 was $1,922,000, a 90% increase from 1993. The increase in both periods is due primarily to increased personnel and outside consulting costs to support development of its third generation graphics products, including the ET6000, and due to the pursuit of new opportunities to expand the Company's product line to address multimedia applications. The Company expects that its research and development expenditures will continue to increase in 1996 as the Company attempts to develop products which respond to emerging markets in desktop PCs, home PCs and interactive communication markets.\nSelling, general and administrative expenses were 16%, 8% and 8% of revenues in 1995, 1994 and 1993, respectively. The increase in 1995 is due primarily to both the fixed nature of certain of the Company's operating expenses and increased legal costs associated with the class action lawsuit referred to in Note 6 of the consolidated financial statements.\nThe Company's effective income tax rates were 17.6%, 35.8% and 34.2% for 1995, 1994 and 1993, respectively. The decrease in the effective tax rate in 1995 is primarily due to estimated research and development credits representing a higher percentage of pretax income. The increase in the effective tax rate in 1994 was primarily due to a higher effective state income tax.\nInflation is not expected to have an adverse significant impact on the Company's operations.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's ability to generate cash adequate to meet its requirements results primarily from cash on hand, operating cash flow and the availability of bank borrowing. The Company believes that these sources are sufficient to fund the Company's 1996 working capital requirements.\nTotal working capital was $47,155,000 and $50,431,000 at December 31, 1995 and 1994, respectively. The Company's cash and short-term investments increased to $39,214,000 at December 1995 from $38,542,000 at December 31, 1994. The increase is due primarily to the excess of cash generated from operations over that required to fund its capital requirements, stock repurchases, and dividend program. The Company also has a bank line of credit providing total availability of $2,500,000. There were no borrowings on this line in 1995 or 1994.\nThe Company had capital expenditures of approximately $2,211,000 during 1995, related primarily to the purchase of equipment and software utilized in the Company's research and development activities. The Company expects its existing sources of liquidity to be sufficient to fund its 1996 working capital and capital expenditure requirements.\nIn order to obtain an adequate supply of wafers, especially wafers manufactured using advanced process technologies, the Company has considered and will continue to consider various possible transactions, including the use of \"take or pay\" contracts which commit the Company to purchase specified quantities of wafers over specified periods or the use of standby letters of credit to secure future capacity on a \"take or pay\" basis. In addition, a number of the Company's competitors have entered into various transactions to secure wafer capacity including equity investments in or advances to wafer foundries in exchange for guaranteed production, or the formation of joint ventures to own, construct or operate a wafer fabrication facility. The Company, to date, has not participated in advance funding or joint ventures and will continue to work to secure adequate capacity without such arrangements. Should the Company be required to enter into any of the above manufacturing arrangements to secure foundry capacity, such arrangements may require substantial capital investment, which may require the Company to seek additional equity or debt financing, and there can be no assurance that such additional financing, if required, will be available when needed or, if available, will be on satisfactory terms. In addition, the Company may, from time to time, as business conditions warrant, invest in or acquire businesses, technologies or products that complement the business of the Company. No such investments or acquisitions are being negotiated as of the date of this Form 10K.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nThe index to the consolidated financial statements and financial statement schedule is listed in Item 14 on page 21.\nItem 9.","section_9":"Item 9. Disagreements with Accountants\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 as of March 28, 1996 are set forth below:\nJack Tseng has been President (and, as such, serves as the Company's chief executive officer) and a Director of the Company since December 9, 1983. He also was Treasurer of the Company until December 1, 1986. He holds a Bachelor's Degree in Electrical Engineering.\nJohn A. Vigna joined the Company as Executive Vice President and Chief Operating Officer in November 1995. Prior to joining the Company, Mr. Vigna served as Senior Vice President, Operations and Finance of Polygram Group Distribution from 1993 to 1995. From 1988 to 1992, Mr. Vigna held various management positions at Unisys Corporation, where he most recently served as Vice President of Business Development.\nDavid Kwok Ping Hui has been Executive Vice President and Technology Officer since December 1995. Mr. Hui joined the Company in 1983 and had been an Executive Vice President of the Company from May 1991 to December 1995, prior to which time he was Senior Vice President responsible for Operations. Mr. Hui also serves on the board of Directors of Telan Corporation.\nMark H. Karsch has been Senior Vice President and Chief Financial Officer since December 1995. Mr. Karsch joined the Company in May 1991 as Senior Vice President, Finance and Administration. Prior to joining the Company, Mr. Karsch was a senior manager at Arthur Anderson LLP. Mr. Karsch had been with Arthur Anderson LLP since 1978.\nJames E. Bauer joined the Company in February 1996 as Senior Vice President, Sales and Marketing. From 1987 to January 1996, Mr. Bauer held several management positions at Swan Technologies, Inc., where he most recently served as Senior Vice President, Sales and Marketing.\nRaymond Cheng has been Vice President, Engineering and Product Development since December 1995. Mr. Cheng joined the Company as Director of Engineering in September 1995. Prior to joining the Company, Mr. Cheng founded in 1992 a wholesale PC business which he operated through August 1995. Mr. Cheng served as the Engineering Design Manager of the ASIC Design Group for Digital Equipment Corp from 1987 to 1992.\nRichard K. McDowell joined the Company in February 1996 as Vice President, Production and Operations. Mr. McDowell was Director of Operations of Hughes Network Systems from December 1994 to January 1996. From 1975 to 1995, Mr. McDowell held various management positions with Unisys Corporation, where he most recently served as a Director of Operations.\nBarbara J. Hawkins has been Vice President and Chief Administrative Officer of the Company since December 1995. Ms. Hawkins had been Treasurer of the Company since December 1986.\nJohn J. Gibbons has been a Director of the Company since December 1983, and served the Company as Chief Financial Officer from January 1989 to May 1991 and thereafter as Vice Chairman. Mr. Gibbons is a CPA and his prior background includes service as a Vice President of Industrial Valley Bank and as a senior audit manager with Arthur Andersen LLP.\nMark Dorfman is President of Mark Dorfman & Company, which is engaged in consulting and acquisition related activities. Mr. Dorfman was President of Quantum Development Corporation from February to September 1994. Prior to joining Quantum Development Corporation, Mr. Dorfman had been the Chief Operating Officer and Chief Financial Officer of Robec, Inc., a publicly-trade corporation, since January 1993, and has been the Vice President-Finance since December 1987. Mr. Dorfman was also a director of Robec.\nChristopher F. Sutphin is President of C B Associates which is engaged in consulting, venture capital and real estate activities. Mr. Sutphin was Vice President of General Instrument from June 1987 to June 1990, and President of its Power Semiconductor Division from June 1987 to September 1990. Prior to that time, Mr. Sutphin was Senior Vice President of General Instrument's Components Group.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table summarizes all compensation paid to the Company's Chief Executive Officer and to each of the Company's four most highly compensated executive officers other than the Chief Executive Officer for services rendered in all capacities to the Company during the fiscal 1995.\nSUMMARY COMPENSATION TABLE\n(1) Represents amounts contributed by the Company for such executives under the Company's 401(k) Profit Sharing Plan.\n(2) There were no stock options granted to the named executive officers during 1994 and 1993.\n(3) Pursuant to a study undertook by the Executive Compensation Committee completed during 1995, the base salary of Mr. Tseng was increased retroactive to January 1, 1994 to $250,000 and an additional bonus of $71,005 was awarded for 1994.\nSTOCK OPTIONS\nThe following tables summarize options grant to, and exercises by, the Company's Chief Executive Officer and to each of the Company's four most highly compensated executive officers other than the Chief Executive Officer during fiscal 1995, and the value of the options held by each such person at the end of fiscal 1995.\nOPTIONS GRANTED IN LAST FISCAL YEAR\n(1) Options granted in fiscal 1995 vest one-year from the date of grant and become exercisable upon vesting.\n(2) The exercise price on the date of grant was equal to 100% of the fair market value on the date of grant.\n(3) The options have a term of 10 years, subject to earlier termination in certain events related to termination of employment.\n(4) The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the future Common Stock price.\nAGGREGATED OPTION EXERCISES IN 1995\nAND YEAR-END OPTION VALUES\n(1) Calculated on the basis of the fair market value of the underlying securities at the exercise date or year-end, as the case may be, minus the exercise price.\nCompensation Pursuant to Plans\nThe Company has adopted three Stock Option Plans (the 1984, 1991 and 1995 Stock Option Plans) (the \"Plans\") The 1995 Plan, subject to shareholder approval, provides for the grant of stock options to purchase up to 3,000,000 shares of the Company's Common Stock. The 1991 and 1984 Stock Option Plans provide for the grant of stock options to purchase an aggregate of 3,000,000 shares of the Company's Common Stock. Eligible participants under the Plans include officers and other key employees and consultants, as defined in the Plans.\nEffective with the approval of the 1995 Plan, all three plans are administered by a Committee composed of non-employee directors. The 1991 and 1984 Plans had been administered by two Stock Option Committees. One Committee was composed of non-employee directors with respect to principal officers of the Company (as the term \"officer\" is defined in Rule 166-1(f) under the Securities Exchange Act of 1934, as amended), while the Committee with respect to non-principal officers was comprised of three directors who are also officers of the Company.\nUnder the 1995 and 1991 Stock Option Plans, the Company may grant non-qualified stock options, incentive stock options or a combination thereof. The 1984 Stock Option Plan provides only for the granting of non-qualified stock options. The option exercise price for both incentive and non-qualified stock options granted under the Plans may not be less than the fair market value of the Common Stock on the date the stock option is granted. To date, all grants under the Plans have been non-qualified stock options. Participants who receive non-qualified stock options will be deemed to receive taxable income at ordinary income rates upon exercise for the difference between the exercise price and the fair market value of the Company's Common Stock at the date of exercise.\nAt December 31, 1995, the Company had outstanding options to purchase an aggregate of 1,659,300 shares of Common Stock at exercise prices ranging from $3.00 to $13.75 per share, with a weighted average price per share exercise price of $7.89. A total of 2,676,493 shares of Common Stock are available for future issuance under the Plans.\nNon-Employee Director Compensation\nDirectors who are not employees receive an annual retainer of $20,000 plus reimbursement for out-of-pocket expenses. The Company also has a stock option plan for non-employee directors (\"Directors Plan\") under which the outside directors are granted options at fair market value to purchase Common Stock. Directors receive options to purchase 20,000 shares of Common Stock upon their initial election to the Board and additional options for every two years of service on the Board. The options vest 50% at grant and 50% on the first anniversary of grant. At December 31, 1995, a maximum of 80,000 additional options may be granted under the plan. At December 31, 1995, 87,500 options were outstanding under the plan at an average exercise price of $10.59 per share. The outside directors exercised 2,500 options to acquire shares of the Company's Common Stock in 1993. There were no options exercised by outside directors in 1995 and 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table lists as of February 29, 1996 the number of shares of the Company's Common Stock beneficially owned by all persons known to the Company to be beneficial owners of more than 5% of the Company's Common Stock, by all directors and key personnel of the Company as a group, and the percentage of all outstanding shares held by such persons:\n(1) The address of all persons listed in this table is c\/o 6 Terry Drive, Newtown, Pennsylvania 18940.\n(2) Shares are owned by Mr. and Mrs. Tseng as joint tenants.\n(3) Includes 1,140,000 shares owned by Mr. and Mrs. Tseng's minor children as to which they disclaim beneficial ownership.\n(4) Includes 502,500 shares subject to stock options exercisable on or within 60 days after March 31, 1996, respectively.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Company has participated in a round of financing and has invested $818,000 in a minority interest in preferred stock of a start-up multimedia product company. The Company has also advanced this entity approximately $541,000 in the form of a secured interest bearing note and advance funded approximately $75,000 of customer receivables for this entity. The Company is carrying this investment at cost. This entity is in the start-up stage and is incurring operating losses. Sales to this entity were $180,000 in 1995.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n- ---------------\n* Exhibit incorporated by reference to Exhibit of the same number filed with the Registrant's. Registration Statement on Form 10.\n** Exhibit incorporated by reference to Exhibit of the same number filed with Registrant's Form 10-K for year ended December 31, 1986.\n*** Exhibit incorporated by reference to Exhibit of the same number filed with Registrant's Form 10-K for year ended December 31, 1991.\nReports 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.\nTSENG LABS, INC.\nBy:___________________________ Jack Tseng, President\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.\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Tseng Labs, Inc:\nWe have audited the accompanying consolidated balances sheets of Tseng Labs, Inc. (a Utah 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 and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Tseng Labs, 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 at Item 14 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\nPhiladelphia, Pa. February 8, 1996 (Except with respect to the matter discussed in Note 6, as to which the date is March 19, 1996)\nTSENG LABS INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(In thousands, except share amounts)\nDecember 31 -------------------\nASSETS 1995 1994 ------ ------ ------\nCURRENT ASSETS:\nCash and cash equivalents $ 9,004 $37,142 Short-term investments 30,210 1,400\nAccounts receivable,net of allowance for doubtful accounts of $678 and $861 respectively 5,924 10,591 Inventories 3,408 3,786\nPrepaid expense and other 2,574 1,223 ------ ------ Total current assets 51,120 54,142 ------ ------\nPLANT AND EQUIPMENT: Land and buildings 2,715 2,552 Equipment 8,721 6,708 Furniture and fixtures 586 551 ------ ------ 12,022 9,811\nLess accumulated depreciation (4,326) (3,246) ------ ------ Net plant and equipment 7,696 6,565 ------ ------\nDEFERRED COSTS, net 3,817 3,644 ------ ------\nOTHER ASSETS 2,038 1,468 ------ ------\n$64,671 $65,819 ====== ======\nDecember 31 --------------------\nLIABILITIES AND SHAREHOLDERS' EQUITY 1995 1994 ------ ------- CURRENT LIABILITIES: Accounts payable $ 2,834 $ 3,138 Accrued expenses 1,131 573 ------ ------- Total current liabilities 3,965 3,711 ------ -------\nDEFERRED INCOME TAXES 2,311 2,247 ------ ------- COMMITMENTS AND CONTINGENCIES (Note 6)\nSHAREHOLDERS' EQUITY: Common stock, $.005 par value authorized 50,000,000 shares; issued and outstanding 19,483,487 shares in 1995 and 19,435,987 shares in 1994 97 97 Additional paid-in-capital 10,316 9,997 Retained earnings 52,625 54,039 ------ ------- 63,038 64,133\nLess-Treasury stock at cost, 519,250 and 459,250 shares, respectively (4,643) (4,272) ------ ------- Total shareholders' equity 58,395 59,861 ------ ------- $64,671 $65,819 ======= =======\nThe accompanying notes are an integral part of these statements.\nTSENG LABS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(In thousands, except per share amounts)\nYear Ended December 31 ----------------------------------- 1995 1994 1993 ------- ------- -------\nNET SALES $39,277 $80,659 $75,526 COST OF SALES 28,930 57,541 52,309 ------- ------- ------- Gross Profit 10,347 23,118 23,217\nRESEARCH AND DEVELOPMENT 3,440 1,922 1,011\nSELLING,GENERAL AND ADMINISTRATIVE 6,328 6,761 5,824 ------- ------- -------\nIncome before income taxes 579 14,435 16,382\nINCOME TAXES 102 5,163 5,600 ------- ------- -------\nNET INCOME $ 477 $ 9,272 $10,782 ======= ======= =======\nNET INCOME PER SHARE $ .03 $ .49 $ .56 ======= ======= =======\nWEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 18,983 19,090 19,417 ======= ======= =======\nThe accompanying notes are an integral part of these statements.\nTSENG LABS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(In thousands, except share amounts)\nTSENG LABS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(In thousands)\nThe accompanying notes are an integral part of these statements\nTSENG LABS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. BACKGROUND:\nTseng Labs, Inc. is a developer of custom semiconductor devices and board level enhancement products that expand the graphics capabilities and performance of IBM and IBM-compatible personal computers.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Tseng Labs, Inc. and its wholly owned subsidiaries (the Company). All significant intercompany transactions and balances have been eliminated. 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, liabilities, contingent liabilities, revenues and expenses during a reporting period. The Company operates in very competitive and rapidly changing markets. Actual results could differ from management estimates.\nInventories\nInventories, which consist of materials, labor and overhead, are stated at the lower of weighted average cost or market and consist of the following (in thousands):\nDecember 31 ----------------------------------- 1995 1994 ---- ---- Purchased parts $ 662 $ 3,379 Finished goods 2,746 407 -------- --------- $ 3,408 $ 3,786 ======= =======\nThe Company recorded a charge to cost of sales in the fourth quarter of 1995 of approximately $735,000 related to a potential decline in value of certain older technology-based inventory.\nPlant and Equipment\nPlant and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives:\nBuilding 25 years Equipment 5-7 years Furniture and Fixtures 10 years\nDepreciation expense was $1,080,000, $862,000 and $523,000 in 1995, 1994, and 1993, respectively.\nDeferred Costs\nResearch and development costs incurred in developing the Company's proprietary chips are charged to expense until technological feasibility has been established. Thereafter, all costs incurred in refining and testing the chips are capitalized. These deferred costs are amortized on a product-by-product basis over the estimated revenue stream of the related product. Management periodically evaluates whether factors indicate that there is an impairment of the deferred costs and, accordingly, the carrying value is adjusted to reflect such impairment, if any. During 1995, the Company wrote-off approximately $307,000 of deferred costs which were identified as not recoverable over the revenue stream of future generation products. Approximately $1,284,000 of the unamortized deferred costs at December 31, 1995, relate to products for which development has been completed and sales have commenced. Amortization was $1,451,000 in 1995, $1,238,000 in 1994, and $825,000 in 1993.\nNet Income Per Share\nNet income per share is computed using the treasury stock method based on the weighted average number of common stock and common stock equivalents outstanding during each year.\nCash and Short-Term Investments\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents for the purpose of determining cash flows.\nThe Company adopted Statement of Financial Accounting Standard No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115) effective January 1, 1994. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. As of December 31, 1995, all of the Company's short-term investments were U.S. Government securities which have been classified as hold to maturity and reflected at amortized cost in the accompanying balance sheet. The estimated fair value of each investment approximated cost at December 31, 1995. There was no cumulative effect as a result of adopting SFAS No. 115 in 1994.\nConcentration of Credit Risk\nFinancial instruments which potentially subject the Company to concentration of credit risk consist primarily of cash equivalents, short-term investments and accounts receivable. By policy, the Company places its investments only with high-quality financial institutions and, other than U.S. government Treasury instruments, limits the amounts invested in any one institution or type of investment. Substantially all of the Company's accounts receivable are derived from sales to manufacturers of computer systems, subsystems and value-added resellers. The Company performs ongoing credit evaluations of its customers' financial condition. Approximately 59%, 43% and 41% of the Company's sales in 1995, 1994 and 1993, respectively, were export sales. To date, substantially all such sales have been in U.S. dollars. To reduce credit risk, the Company generally requires international customers to furnish letters of credit. Historically, the Company has not incurred material credit-related losses.\nRevenue Recognition\nRevenue is recognized upon product shipment. Accruals for estimated sales returns and allowances are recorded at the time of sale. Also included in revenues is interest income of $2,113,000, $1,241,000 and $881,000 for 1995, 1994 and 1993, respectively.\nIncome Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standard No. 109. \"Accounting for Income Taxes\" (SFAS No. 109). Under SFAS No. 109, the Company provides a deferred tax expense or benefit equal to the change in the deferred tax liability or asset during the year. 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, as well as operating loss and tax credit carry forward, if any.\nRecently Issued Financial Standards\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 which establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used for long-lived assets and certain intangibles to be disposed of. The Company is required to adopt SFAS No. 121 effective January 1, 1996. The adoption of SFAS No. 121 is not expected to have a material effect on the Company's financial condition or results of operation.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No.123, \"Accounting for Stock-Based Compensation.\" The Company's adoption of SFAS 123 in 1996 is not expected to have a material effect on the Company's financial position or results of operations, as the Company intends to continue to measure the compensation cost of stock option plans using the intrinsic value-based method.\nReclassifications\nCertain prior year balances have been reclassified to conform to the current year presentation.\n3. LINE OF CREDIT:\nThe Company has an unsecured $2,500,000 demand line of credit with a bank. The line bears interest at prime and places limits on, among other things, additional long-term debt, payment of dividends and capital expenditures. There were no borrowings under the line in 1995 and 1994.\n4. INCOME TAXES:\nAs discussed in Note 2, the Company adopted SFAS No. 109 as of January 1, 1993. The cumulative effect of the adoption was not material and, therefore, is not reported separately in the statement of income.\nIncome taxes are comprised of the following (in thousands):\nFederal- 1995 1994 1993 ---- ----- ---- Current $ 12 $ 4,167 $ 4,806 Deferred 64 388 519 ------- ------- ------- 76 4,555 5,325 ------- ------- -------\nState- Current 26 536 150 Deferred - 72 125 ------- ------- ------- 26 608 275 ------- ------- ------- $ 102 $ 5,163 $ 5,600 ======= ======= =======\nIncome tax expense differs from the amount currently payable because certain revenues and expenses are reported in different periods for financial reporting and tax purposes. The principal differences involve the timing of deducting software development costs and different methods used in computing financial statement and tax depreciation.\nA reconciliation of the statutory federal income tax rate to the Company's effective tax rate follows:\n1995 1994 1993 ---- ---- ----\nFederal statutory rate 34.0% 35.0% 35.0% State income taxes, net of federal benefit 3.0 2.7 1.1 Tax credits utilized (23.0) (1.8) (1.7) Other 3.6 ( .1) ( .2) ----- ---- ---- 17.6% 35.8% 34.2% ===== ==== ====\nThe Company's deferred tax assets, both individually and in the aggregate, are not material at December 31, 1995 and 1994.\n5. STOCK OPTION PLANS:\nDuring 1995, the Company adopted, subject to stockholder approval, the 1995 stock option plan which permits the issuance of either incentive or nonqualified stock options to employees and nonqualified options to key consultants. A maximum of 3,000,000 shares of common stock has been reserved for issuance under this plan. The Company also has two additional nonqualified stock option plans (the 1991 and 1984 stock option plans) under which a maximum of 3,000,000 shares of common stock have been reserved for issuance. Options under all three plans must be granted at a price not less than 100% of the fair market value of the common stock on the date of grant. Options granted under the plans become exercisable as determined by the Stock Option Committees of the Board of Directors at the time of the grant and may have terms extending to 10 years.\nA summary of stock options activity related to these plans is as follows:\nAggregate Outstanding Options Number Price Range Price --------- -------------- ----------- Balance, January 1, 1993 700,725 $ 2.66 - 14.00 $ 6,629,763 Granted 133,400 12.25 - 18.13 2,020,613 Exercised (116,000) 3.00 - 14.50 (898,623) Canceled (125) 3.00 - 3.19 (922) --------- ------ ----- ----------- Balance, December 31, 1993 718,000 2.66 - 18.13 7,750,831 --------- ------ ----- ----------- Granted 64,400 6.63 - 10.75 526,743 Exercised (2,500) 7.38 - 11.88 (17,413) Canceled (29,000) 10.63 - 14.50 (371,010) --------- ------ ----- ----------- Balance, December 31, 1994 750,900 2.66 - 18.13 7,889,151 --------- ------ ----- ----------- Granted 1,231,200 5.63 - 9.13 8,783,000 Exercised (47,500) 3.00 - 5.63 (261,937) Canceled (275,000) 5.63 - 18.13 (3,312,092) --------- ------ ----- ----------- Balance, December 31, 1995 1,659,300 $ 3.00 - 13.75 $13,098,122 --------- ------ ----- -----------\nAs of December 31, 1995, a maximum of 2,464,000 and 212,493 additional options may be granted under the 1995 and 1991 plans, respectively. No additional options may be granted under the 1984 plan. There were 832,400 options with an average exercise price of $7.65 per share exercisable at December 31, 1995. The options expire on various dates through 2005. In January 1995, the Company canceled and reissued 273,000 options which had been outstanding under the plans. These options had an average exercise price of $12.09 per share and represented all outstanding options under the 1991 plan held by non-officers of the Company. The re-issue price of the options was $5.625 per share.\nIn July 1991, the Board of Directors adopted the Special Directors Stock Option Plan, under which outside directors are granted options at fair market value to purchase common stock. Directors receive options upon their initial election to the Board and additional options for every two years of service on the Board. The options vest 50% at grant and 50% on the first anniversary of grant. A maximum of 200,000 shares have been reserved for grant under the plan. As of December 31, 1995, a maximum of 80,000 additional options may be granted under this plan. At December 31, 1995, 87,500 options were outstanding under the plan at an average exercise price of $10.59 per share. During 1993, the outside directors exercised options to acquire 2,500 shares of common stock at $6.875 per share. There were no options exercised in 1995 and 1994 by outside directors.\n6. COMMITMENTS AND CONTINGENCIES:\nDuring the three-year period ended December 31, 1995, the Company purchased all of its video graphics chips from one foundry. The Company is currently working to expand the number of foundries from which it purchases its video chips. The use of third parties to manufacture, package and test the Company's products involves a number of significant risks including, but not limited to, the absence of adequate capacity to produce the Company's products, unavailability of, or interruptions in access to the process technologies necessary to manufacture the Company's products, the absence of guaranteed manufacturing capacity and reduced control over delivery schedules, manufacturing yields and costs. The Company has various purchase commitments, including commitments to its foundries, at current market prices for materials and supplies used in the ordinary course of business.\nIn May 1993, two purported shareholders of the Company brought an action against the Company and certain of its executive officers in the United States District Court for the Eastern District of Pennsylvania, alleging that the defendants had issued false and misleading statements concerning the Company, and thus had violated the federal securities laws and committed common law fraud and negligent misrepresentation. Subsequently, several other purported shareholders filed similar actions in the same forum against the Company and certain of its executive officers. The actions have been consolidated. On July 8, 1994, pursuant to stipulation, the Court certified a class for the federal securities law claims and dismissed the state law claims, without prejudice. Discovery has been completed and on August 21, 1995, the Company filed a motion for summary judgment seeking to dismiss the action in its entirety. On March 19, 1996, the Court ruled on the Company's motion and dismissed the action in its entirety. The Company had recorded the expense of defending these claims on an as incurred basis.\nIn addition to the complaints discussed above, the Company is involved in certain legal actions and claims arising in the ordinary course of business. Management, after discussion with legal counsel, believes that the outcome of such litigation and claims will not have a material adverse effect on the Company's financial position.\n7. EXPORT SALES AND MAJOR CUSTOMERS:\nThe Company's primary operations are located in the United States. The Company sells its products primarily into the personal computer market in the United States, Europe and Asia. Sales into the Asian market are primarily through six unaffiliated distributors. Total export sales, including sales to the distributors discussed above, were 59%, 43% and 41% of the Company's sales in 1995, 1994 and 1993, respectively. Two customers accounted for 37% and 30% of revenues in 1995 and 1993, respectively. One customer accounted for 42% of revenue in 1994.\n8. RELATED-PARTY TRANSACTIONS:\nThe Company has participated in a round of financing and has invested $818,000 in a minority interest in preferred stock of a start-up multimedia product company. The Company has also advanced this entity $541,000 in the form of a secured interest bearing note and advance funded approximately $75,000 of customer receivables for this entity. The Company is carrying this investment at cost. This entity is in the start-up stage and is incurring operating losses. Sales to this entity were approximately $180,000 in 1995.\n9. QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data for 1995 and 1994 are as follows:\nQuarter ----------------------------------------\nFirst Second Third Fourth ----- ------ ----- ------\n(In thousands, except per share amounts)\n---- Net sales $ 11,980 $ 10,068 $ 9,433 $ 7,796 Cost of sales 8,036 7,309 6,973 6,612 Net income 1,056 304 100 (983) Net income per .06 .02 .01 (.05) share\n---- Net sales $ 21,944 $ 21,793 $ 19,270 $ 17,652 Cost of sales 16,438 15,596 14,018 11,489 Net income 2,277 2,616 2,002 2,377 Net income per .12 .14 .11 .13 share\nSCHEDULE II\nTSENG LABS,INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n(In thousands)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Tseng Labs, Inc.:\nAs independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statements, file numbers 33-44112 and 33-44113, both dated November 18, 1991.\nARTHUR ANDERSEN LLP\nPhiladelphia, Pa. March 28, 1996","section_15":""}
{"filename":"734380_1995.txt","cik":"734380","year":"1995","section_1":"ITEM 1. BUSINESS\nRio Hotel & Casino, Inc. (the \"Company\") owns and operates the country's only all-suite hotel-casino, the Rio Suite Hotel & Casino (the \"Rio\") in Las Vegas, Nevada. Situated on a 45-acre elevated site adjacent to the Flamingo Road exit from Interstate 15, the freeway linking Las Vegas with Southern California, the Rio is strategically positioned to attract travelers along Interstate 15, tourists visiting the Las Vegas Strip and local Las Vegas residents. The Company markets to both local residents and Las Vegas visitors. Management believes that the Rio's unique all-suite concept, diverse high quality dining, easy access and ample parking provide an attractive alternative to the Strip and a fun and comfortable environment in which to enjoy gaming, dining and entertainment.\nDecorated throughout in a fun-filled Brazilian Carnival and rain forest theme, the Rio is currently comprised of an 89,000 square foot casino, three 21-story hotel towers containing 1,551 suites, eight restaurants, seven bars, a 430-seat entertainment complex, meeting and banquet space, a 59,000 square foot outdoor entertainment area featuring a landscaped sand beach and two swimming pools and parking for over 3,200 cars. The Rio's casino offers approximately 2,000 slot machines, 76 table games, a poker room, keno and a race and sports book.\nThe Rio originally opened in 1990 with 424 suites and 44,000 square feet of casino space. Within the past three years the Rio has been expanded to its present configuration in phases in accordance with its original master plan. In the fall of 1993, the Company added a second hotel tower with 437 suites, a new restaurant and meeting rooms through a $37 million expansion (the \"Phase II Expansion\" or \"Tower Expansion\"). In April 1994, the Company completed a $25 million expansion (the \"Eastside Expansion\") which included a 25,000 square foot addition to the casino, a two-story parking garage, a new restaurant and the Copacabana showroom. In March 1995, the Rio completed a $75 million expansion (the \"Phase III Expansion\") which encompassed a third hotel tower with 549 suites, 10,000 square feet of casino space, a new three-level parking garage and a 50% expansion to its award winning Carnival World Buffet. In December 1995, the Company completed a $20 million expansion (the \"Phase IV Expansion\") which added 141 suites, approximately 5,400 square feet of meeting room space, doubled the size of the existing Buzios seafood restaurant, added a new health club and salon facility and included a variety of back-of-the-house improvements. Completion of the Phase IV Expansion brought the Rio's total number of hotel suites to 1,551.\nIn June 1995, the Company announced a three-phased expansion and development plan intended to be implemented over the next several years. The three-phased expansion and development plan consists of an approximately $185 million expansion at the Rio (the \"Phase V Expansion\"), acquisition of approximately 22 acres of land adjacent to the Rio to be master-planned for the development of another hotel-casino and the purchase of approximately 64 acres southeast of Las Vegas (the \"Old Vegas Site\") for possible future hotel-casino development. Of the 22 acres of land adjacent to the Rio, approximately 5 acres were purchased in 1995 and acquisition agreements have been entered into for the remaining 17 acres. The Company expects to finalize the purchase of all 17 acres during 1996.\nThe Company was incorporated in California in 1981 and reincorporated in Nevada in 1988. The Company changed its name from MarCor Resorts, Inc. to Rio Hotel & Casino, Inc. in February 1992. Its executive offices are located at 3700 West Flamingo Road, Las Vegas, Nevada 89103, and its telephone number is (702) 252-7733.\nPHASE V EXPANSION\nThe Phase V Expansion, for which construction commenced in September 1995, will center around a 41-story curved tower containing approximately 1,000 new suites located immediately southeast of the existing towers. The Phase V Expansion is planned to include 120,000 square feet of public space containing a casino expansion with capacity for approximately 600 slot machines and 30 table games, new retail and entertainment space, 6 additional restaurants, including one restaurant at the top of the tower overlooking the Strip, as well as an expanded pool and beach area and additional parking facilities. The new suites will be similar in size and decor to the existing suites.\nAs currently contemplated, the public area expansion will be based upon a Brazilian Carnival Mardi Gras theme. The new casino area will provide regular entertainment, as periodically a themed overhead entertainment attraction will provide an interactive show with patrons. The attraction will feature performers dressed in festive attire who will sing and dance. The attraction may change to celebrate different holidays and special events.\nManagement believes the Phase V Expansion will increase the number of tour and travel customers while enhancing the amenities available to local patrons. Given the Rio's high average occupancies and significant room turnaways, management believes that the additional room inventory will be successfully absorbed. Opening of the Phase V Expansion is expected to occur in the spring of 1997.\nBUSINESS STRATEGY\nThe Company's business strategy focuses on attracting and fostering repeat business from customers in the local resident and tourist markets in the middle to upper-middle income segments. To implement its business strategy, the Company capitalizes on its unique all-suite concept, strategic location, Brazilian Carnival theme, diverse product offering and friendly service. The Company strives to provide a quality, affordable gaming and entertainment experience in order to generate high customer satisfaction and loyalty. The Rio's value-priced suites and restaurants provide an attractive alternative to conventional Las Vegas properties for visitors who desire to avoid the crowds and congestion of the Strip. The Interstate 15 and Flamingo Road location is also ideal for attracting local residents.\nTo encourage repeat visits, the Company attempts to ensure that each customer has an enjoyable, high quality and high value experience. Management believes that it must offer consistent quality, a comfortable and fun atmosphere and, most importantly, friendly service at affordable prices to provide a high value experience to its customers. Accordingly, the Rio's suites offer guests approximately 50% more space than comparably priced Las Vegas hotel rooms. Similarly, the Company's restaurants have won awards year after year for their quality dining. All of the Rio's\nrestaurants offer generous portions of high quality food at reasonable prices which management believes is a major factor in attracting the value-conscious local customer.\nManagement believes that friendly service combined with a quality facility are integral to generating repeat business from locals as well as tourists. As a result, management continually seeks to instill in each employee a sense of service excellence designed to exceed guest expectations. To motivate its employees, management also strives to instill a sense of \"Team Rio\" in all of the Company's employees. Management strongly believes that its employees are one of the Company's biggest assets.\nThe Company has created an identifiable and innovative marketing presence and continues to build on its \"signature\" Rio theme. The Rio's Brazilian Carnival and rain forest theme incorporates bright colors, creative interior designs, festive employee costumes and other exotic touches to contribute to its tropical ambiance. The Rio's message of a fun-filled, colorful atmosphere is constantly emphasized. The Rio has developed the Rio Rita(TM) character as a promotional ambassador to the Rio's hotel-casino guests and as a focal point upon which many promotional activities have been built, such as Rio Rita's(TM) Paycheck Poker Wheel, Carnival Dice(TM), the Jackpot Jungle(TM), Rio Rita's(TM) Lotto Bucks, Carnival Days(TM), Copacabana(TM) Dinner Show, Conga Mania(TM) and Brazilia Days(TM). The Company advertises extensively in the Las Vegas area print, television and radio media, and periodically in Southern California, Phoenix and other regional markets.\nThe success of the Company's business strategy is evidenced by the large number of awards the Rio has received. In March 1995, the Rio won recognition through 10 \"Best of Las Vegas\" awards in an annual readers' survey published by Nevada's largest daily newspaper. Among others, these distinctions included: \"Best Buffet,\" \"Best Italian Restaurant,\" \"Best Coffee Shop,\" \"Best Steakhouse,\" \"Friendliest Employees\" and \"Most Efficient Service.\" In addition, the Rio received recognition in the 1995 ZAGAT U.S. HOTELS, RESORTS & SPAS SURVEY for \"Best Rooms,\" \"Best Dining,\" \"Best Service\" and \"Best Overall\" in Las Vegas. Since these awards, however, are based upon subjective criteria, undue significance should not be attributed to these awards. Management believes that these awards exemplify the Company's reputation for quality and value.\nMARKETING STRATEGY\nThe Company's marketing efforts are targeted at both the local patron and the tourist market. To market to local patrons, the Rio relies on its convenient location, its ample parking, its value-priced food and its slot machine variety. Management believes that its restaurants, in particular the Carnival World Buffet, are some of the Rio's greatest attractions for local patrons. The Carnival World Buffet is one of the most popular buffets in Las Vegas due to its extensive selections, its high quality food and the entertainment provided by the live-action cooking stations. During 1995, the Carnival World Buffet served an average of approximately 7,500 people per day. In addition to its emphasis on food and beverage, the Rio also has an aggressive marketing program which encompasses frequent radio, television and newspaper advertising, a variety of promotions directed at the local customer and other programs such as check cashing promotions.\nTo attract visitors and fill the Rio's hotel rooms, the Company markets primarily to three segments of the tourist market: independent travel, wholesale and special casino customers. The\nindependent travel segment consists of those travelers not affiliated with groups who make their reservations directly with the Rio or through independent travel agents. To attract the independent traveler, the Rio periodically utilizes print media, radio and direct mail to advertise in Southern California, Phoenix and other regional travel markets. In addition, the Company's sales force frequently attends trade shows in order to establish relationships with and promote the Rio to travel agents nationwide. The wholesale segment comprises those patrons participating in travel packages offered by air tour operators. To capture this segment of the market, the Rio has developed specialized marketing programs for, and cultivated relationships with, these operators. Finally, special casino customers are those frequent gaming customers who are in regular communication with Rio casino marketing personnel. The Rio utilizes a variety of promotions and special events and other amenities in marketing to this segment.\nRIO LOCATION\nThe Rio is strategically located to take advantage of the dynamic residential and commercial growth of the western portion of metropolitan Las Vegas, while offering proximity and easy access to the \"Old Four Corners\" (Flamingo Road and the Strip) and the \"New Four Corners\" (Tropicana Avenue and the Strip) areas of the Las Vegas Strip.\nTHE RIO\nSince 1992, the Company has consistently expanded the Rio under its master plan. Upon the completion of the Phase V Expansion, the Rio will have approximately 2,550 suites, 2,600 slot machines and 92 table games.\nGAMING. The Rio has 89,000 square feet of casino space. The casino currently has approximately 2,000 slot machines; 76 table games, including \"21,\" craps, roulette, pai gow poker, Caribbean stud poker and mini-baccarat; other casino games such as keno and poker; and a race and sports book.\nGaming operations at the Rio are continually being monitored and modified to respond to both changing market conditions and customer demand in an effort to attract new customers while retaining its existing customer base. New and innovative slot and table games have been introduced based on\ncustomer feedback and demand from both local customers and Las Vegas visitors. Management has introduced such games as Rio Rita's(TM) Royals, Rio Rita's(TM) Bonus Poker, Sneaky Queens(TM), Mambo Bucks(TM) and Rio Rita's(TM) Paycheck Poker Wheel. Management devotes substantial time and attention to the type, location and player activity of all gaming devices.\nHOTEL. The Rio's 21-story hotel towers contain a total of 1,551 suites, comprised of 1,504 standard Rio suites, 16 \"super\" suites, 18 \"cariocas\" suites, 6 two-story penthouse suites, and 7 executive suites that combine a conference room and an adjoining suite. The Company has progressively added new hotel suites since 1993 to meet its consistently strong demand. Despite such expansion, the Rio has maintained average occupancy rates of 95.9% and 94.5% for 1994 and 1995, respectively. During 1994 and 1995, management believes that approximately two potential room night bookings were turned away for each room night booking accepted. The Phase V Expansion will add another approximately 1,000 suites in the spring of 1997.\nThe standard Rio suite measures approximately 600 square feet, compared to approximately 400 square feet for the typical Las Vegas hotel room. The Brazilian Carnival and rain forest theme is carried throughout the guest suites in wall coverings, art work and other designer accents. Suite amenities include carved wood finishes, cut glass, polished granite surfaces, marble tile in the bath areas, room safes and refrigerators.\nRESTAURANTS. While important to attracting Las Vegas visitor gaming customers, the high quality, value and variety of food services are critical to consistently attracting the local resident gaming customer to the Rio. To provide such variety, seven bars and eight restaurants are located in the Rio's main floor area. The Rio currently serves an average of approximately 13,000 meals per day, including banquets and room service. The following table sets forth, for each restaurant, the type of service provided and the current seating capacity:\nENTERTAINMENT AND OTHER ATTRACTIONS. The Rio's Copacabana Showroom is a unique, circular 430-seat video, entertainment and restaurant complex which features two 12-foot by 90-foot video screens, an exhibition cooking area, multiple tiers of dining room seating and a stage. The Copacabana Showroom features the Copacabana Dinner Show, a musical review designed around the Rio's theme. After the dinner show the Copacabana Showroom is converted into Club Rio, a late-night dance club. The showroom is also used for casino-hosted events, concerts, viewing of sporting events on the large video screens, and corporate meetings that capitalize on the unique audio visual qualities of the room.\nThe Ipanema Lounge and Mambo's Lounge each offer live entertainment in separate casino cocktail settings. The Rio also houses a gift shop, a Rio logo shop, a spa, a hair and beauty salon, and an exercise room, as well as approximately 13,250 square feet of public meeting and banquet room facilities.\nThe Rio's pool\/outdoor entertainment area is approximately 59,000 square feet and includes a landscaped sand beach, an 11- foot waterfall, two swimming pools, a multi-level spa, and a terrace bar and food service facility. The Company hosts beach parties, volleyball games, outdoor concerts with name performers and other special events, including professional sporting events.\nEXPANSION STRATEGY\nRIO MASTER PLAN. The Rio's conceptual master plan was originally designed to accommodate multiple expansions without significantly interrupting normal business operations. This design included construction of a reinforced foundation for the hotel tower and a elevator core to support and facilitate additional room construction. The Company has also assembled ample acreage to allow future expansions. Starting from its original 30 acres, the Company acquired additional acreage in 1989 and 1991, bringing the current Rio site to 45 acres, exclusive of the additional 22 acres currently under acquisition as described elsewhere herein.\nManagement believes that a high quality, well-maintained property offering innovative entertainment is integral to success in the highly competitive Las Vegas gaming market. This belief has driven the Company's master plan development strategy. The Company has added substantial new facilities at the Rio every year since 1992.\nTo date, the Company has invested in excess of $250 million in the development, expansion and renovation of the Rio. The Phase V Expansion will continue the Rio's commitment to continued development and provide new, innovative entertainment attractions.\nADDITIONAL GAMING OPPORTUNITIES. The Company has also entered into commitments to acquire approximately 22 acres of land adjacent to the Rio site, bringing the total Rio acreage to approximately 67 acres. The entire Rio site is now being master- planned for the development of another hotel-casino, the size and timing of which has not yet been determined.\nAs the third step in its strategic plan to provide further growth for the Company, in 1995 the Company purchased the approximately 64 acre Old Vegas Site southeast of Las Vegas in Henderson, Nevada. The Old Vegas Site, already zoned for a hotel- casino, is situated where the Boulder Highway enters the Las Vegas valley from Phoenix and Laughlin along U.S. Highway 93-95. The timing and scale of the proposed development has not yet been determined. Moreover, the Company may pursue additional opportunities that management believes to be in the best interests of the Company.\nCOMPETITION\nThe gaming industry includes land-based casinos, dockside casinos, riverboat casinos, casinos located on Native American land and other forms of legalized gaming. There is intense competition among companies in the gaming industry, some of which have significantly greater resources than the Company.\nThe Rio faces competition from all other casinos and hotels in the Las Vegas area, including competitors located on the Las Vegas Strip, on the Boulder Highway and in downtown Las Vegas. Such competition includes a number of hotel-casinos targeted primarily toward local residents, as well as numerous non-hotel gaming facilities targeted toward local residents. In recent months, several of the Company's direct competitors have opened new hotel-casinos or have commenced or completed major expansion projects, and other expansions are in progress or are planned. As of December 31, 1995, there were 37 major gaming properties located on or near the Las Vegas Strip, 14 located in the downtown area, 4 located on the Boulder Highway and 11 located in other areas in or near Las Vegas. According to the Las Vegas Convention and Visitors Authority, the Las Vegas hotel-motel room inventory was 90,046 as of December 31, 1995. Seven new hotel- casinos and 7 hotel-casino expansions are under construction or have been announced, which will add approximately 19,000 rooms to the Las Vegas area over approximately the next two years. Four of the new hotel-casinos are major resorts with a theme and an attraction which are expected to draw significant numbers of visitors. Major expansions or enhancements of existing properties or the construction of new properties by competitors, could have a material adverse effect on the Company's business.\nTo a lesser extent, the Rio competes with hotel-casinos located in the Mesquite, Laughlin and Reno-Lake Tahoe areas of Nevada and in Atlantic City, New Jersey. The Company also competes with state-sponsored lotteries, on- and off-track wagering, card parlors, riverboat and Native American gaming ventures and other forms of legalized gaming in the United States, as well as with gaming on cruise ships and international gaming operations. In addition, many states have legalized, and additional other states are currently considering legalizing, casino gaming within those states. The Company believes that the growth in the legalization of gaming is fueled by a combination of increasing popularity and acceptability of gaming activities and the desire and need for states and local communities to generate revenues without increasing general taxation. The Company believes that the legalization of unlimited land-based casino gaming in or near any major metropolitan area, such as Chicago or Los Angeles, could have a material adverse effect on its current hotel-casino business. According to the Attorney General of California, as of January 1996, there were approximately 9,000 slot machines illegally located in approximately 30 casinos on Native American land throughout California, including four casinos in the Palm Springs area. In November 1995, a proposed initiative for the approval of gaming on Native American land in California was submitted to the California Attorney General's office but is facing opposition from certain government, law enforcement and religious leaders. The development of casinos, lotteries and other forms of gaming in other states, particularly in areas close to Nevada, such as California, could adversely affect the Company's operations.\nAs its principal methods of competition, the Company utilizes what management believes to be its unique all-suite concept based upon a Brazilian Carnival and rain forest theme, diverse high quality dining, friendly service and ample parking, which management believes provide an attractive alternative\nto the closest source of the Company's competition, the Las Vegas Strip, and a fun and comfortable environment in which to enjoy gaming, dining and entertainment.\nREGULATION AND LICENSING\nThe ownership and operation of casino gaming facilities in Nevada are subject to: (i) the Nevada Gaming Control Act and the regulations promulgated thereunder (collectively, \"Nevada Act\"); and (ii) various local regulations. The Company's gaming operations are subject to the licensing and regulatory control of the Nevada Commission, the Nevada State Gaming Control Board (the \"Nevada Board\"), and the Clark County Liquor and Gaming Licensing Board (the \"Clark County Board\"). The Nevada Commission, the Nevada Board, and the Clark County Board are collectively referred to as the \"Nevada Gaming Authorities.\"\nThe laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy which are concerned with, among other things: (i) the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity; (ii) the establishment and maintenance of responsible accounting practices and procedures; (iii) the maintenance of effective controls over the financial practices of licensees, including the establishment of minimum procedures for internal fiscal affairs and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Nevada Gaming Authorities; (iv) the prevention of cheating and fraudulent practices; and (v) providing a source of state and local revenues through taxation and licensing fees. Changes in such laws, regulations and procedures could have an adverse effect on the Company's gaming operations.\nThe Company, which operates the casino, is required to be licensed by the Nevada Gaming Authorities. The gaming license requires the periodic payment of fees and taxes and is not transferable. The Company is registered by the Nevada Commission as a publicly traded corporation (\"Registered Corporation\") and as such, it is required periodically to submit detailed financial and operating reports to the Nevada Commission and furnish any other information which the Nevada Commission may require. The Company has obtained from the Nevada Gaming Authorities the various registrations, approvals, permits and licenses required in order to engage in gaming activities in Nevada.\nThe Nevada Gaming Authorities may investigate any individual who has a material relationship to, or material involvement with, the Company in order to determine whether such individual is suitable or should be licensed as a business associate of a gaming licensee. Officers, directors and certain key employees of the Company must file applications with the Nevada Gaming Authorities and may be required to be licensed or found suitable by the Nevada Gaming Authorities. Officers, directors and key employees of the Company who are actively and directly involved in gaming activities of the Company may be required to be licensed or found suitable by the Nevada Gaming Authorities. The Nevada Gaming Authorities may deny an application for licensing for any cause which they deem reasonable. A finding of suitability is comparable to licensing, and both require submission of detailed personal and financial information followed by a thorough investigation. The applicant for licensing or a finding of suitability must pay all the costs of the investigation. Changes in licensed positions must be reported to the Nevada Gaming Authorities and in addition to their authority to deny an application for a finding of suitability or licensure, the Nevada Gaming Authorities have jurisdiction to disapprove a change in a corporate position.\nIf the Nevada Gaming Authorities were to find an officer, director or key employee unsuitable for licensing or unsuitable to continue having a relationship with the Company, the Company would have to sever all relationships with such person. In addition, the Nevada Commission may require the Company to terminate the employment of any person who refuses to file appropriate applications. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Nevada.\nThe Company is required to submit detailed financial and operating reports to the Nevada Commission. Substantially all material loans, leases, sales of securities and similar financing transactions by the Company must be reported to, or approved by, the Nevada Commission.\nIf it were determined that the Nevada Act was violated by the Company, the gaming licenses it holds could be limited, conditioned, suspended or revoked, subject to compliance with certain statutory and regulatory procedures. In addition, the Company and the persons involved could be subject to substantial fines for each separate violation of the Nevada Act at the discretion of the Nevada Commission. Further, a supervisor could be appointed by the Nevada Commission to operate the Company's gaming properties and, under certain circumstances, earnings generated during the supervisor's appointment (except for the reasonable rental value of the Company's gaming properties) could be forfeited to the State of Nevada. Limitation, conditioning or suspension of any gaming license or the appointment of a supervisor could (and revocation of any gaming license would) materially adversely affect the Company's gaming operations.\nAny beneficial holder of the Company's voting securities, regardless of the number of shares owned, may be required to file an application, be investigated, and have such holder's suitability as a beneficial holder of the Company's voting securities determined, if the Nevada Commission has reason to believe that such ownership would otherwise be inconsistent with the declared policies of the State of Nevada. The applicant must pay all costs of investigation incurred by the Nevada Gaming Authorities in conducting any such investigation.\nThe Nevada Act requires any person who acquires more than 5% of the Company's voting securities to report the acquisition to the Nevada Commission. The Nevada Act requires that beneficial owners of more than 10% of the Company's voting securities apply to the Nevada Commission for a finding of suitability within 30 days after the Chairman of the Nevada Board mails the written notice requiring such filing. Under certain circumstances, an \"institutional investor,\" as defined in the Nevada Act, which acquires more than 10%, but not more than 15%, of the Company's voting securities may apply to the Nevada Commission for a waiver of such finding of suitability if such institutional investor holds the voting securities for investment purposes only. An institutional investor shall not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as an institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of the board of directors of the Company, any change in the Company's corporate charter, bylaws, management, policies or operations of the Company, or any of its gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding the Company's voting securities for investment purposes only. Activities which are not deemed to be inconsistent with holding voting securities for investment purposes only include: (i) voting on all matters voted on by stockholders; (ii) making financial and other inquiries of management of the type normally made by securities analysts for informational\npurposes and not to cause a change in its management, policies or operations; and (iii) such other activities as the Nevada Commission may determine to be consistent with such investment intent. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all costs of investigation.\nAny person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Commission or the Chairman of the Nevada Board, may be found unsuitable. The same restrictions apply to a record owner if the record owner, after request, fails to identify the beneficial owner. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the common stock of a Registered Corporation beyond such period of time as may be prescribed by the Nevada Commission may be guilty of a criminal offense. The Company is subject to disciplinary action if, after it receives notice that a person is unsuitable to be a stockholder or to have any other relationship with the Company, the Company (i) pays that person any dividend or interest upon voting securities of the Company, (ii) allows that person to exercise, directly or indirectly, any voting right conferred through securities held by that person, (iii) pays remuneration in any form to that person for services rendered or otherwise, or (iv) fails to pursue all lawful efforts to require such unsuitable person to relinquish his voting securities for cash at fair market value.\nThe Nevada Commission may, in its discretion, require the holder of any debt security of a Registered Corporation to file applications, be investigated and be found suitable to own the debt security of a Registered Corporation. If the Nevada Commission determines that a person is unsuitable to own such security, then pursuant to the Nevada Act, the Registered Corporation can be sanctioned, including the loss of its approvals, if without the prior approval of the Nevada Commission, it: (i) pays to the unsuitable person any dividend, interest, or any distribution whatsoever; (ii) recognizes any voting right by such unsuitable person in connection with such securities; (iii) pays the unsuitable person remuneration in any form; or (iv) makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction.\nThe Company is required to maintain a current stock ledger in Nevada which may be examined by the Nevada Gaming Authorities at any time. If any securities are held in trust by an agent or by a nominee, the record holder may be required to disclose the identity of the beneficial owner to the Nevada Gaming Authorities. A failure to make such disclosure may be grounds for finding the record holder unsuitable. The Company is also required to render maximum assistance in determining the identity of the beneficial owner. The Nevada Commission has the power to require the Company's stock certificates to bear a legend indicating that the securities are subject to the Nevada Act.\nThe Company may not make a public offering of its securities without the prior approval of the Nevada Commission if the securities or proceeds therefrom are intended to be used to construct, acquire or finance gaming facilities in Nevada, or to retire or extend obligations incurred for such purposes. On July 27, 1995, the Nevada Commission granted the Company prior approval to make public offerings for a period of one year, subject to certain conditions (\"Shelf Approval\"). However, the Shelf Approval may be rescinded for good cause without prior notice upon the issuance of an interlocutory stop order by the Chairman of the Nevada Board. Such approval does not constitute a finding, recommendation or approval by the Nevada Commission or the Nevada Board as to the\naccuracy or adequacy of the prospectus or the investment merits of the securities. Any representation to the contrary is unlawful.\nChanges in control of the Company through merger, consolidation, stock or asset acquisitions, management or consulting agreements, or any act or conduct by a person whereby such person obtains control, may not occur without the prior approval of the Nevada Commission. Entities seeking to acquire control of a Registered Corporation must satisfy the Nevada Board and Nevada Commission in a variety of stringent standards prior to assuming control of such Registered Corporation. The Nevada Commission may also require controlling stockholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process relating to the transaction.\nThe Nevada legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and corporate defense tactics affecting Nevada gaming licensees, and Registered Corporations that are affiliated with those operations, may be injurious to stable and productive corporate gaming. The Nevada Commission has established a regulatory scheme to ameliorate the potentially adverse effects of these business practices upon Nevada's gaming industry and to further Nevada's policy to: (i) assure the financial stability of corporate gaming operators and their affiliates; (ii) preserve the beneficial aspects of conducting business in the corporate form; and (iii) promote a neutral environment for the orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the Nevada Commission before the Company can make exceptional repurchases of voting securities above the current market price thereof and before a corporate acquisition opposed by management can be consummated. The Nevada Act also requires prior approval of a plan of recapitalization proposed by the Company's Board of Directors in response to a tender offer made directly to the Registered Corporation's stockholders for the purposes of acquiring control of the Registered Corporation.\nLicensee fees and taxes, computed in various ways depending on the type of gaming or activity involved, are payable to the State of Nevada and to the counties and cities in which the Nevada licensee's respective operations are conducted. Depending upon the particular fee or tax involved, these fees and taxes are payable either monthly, quarterly or annually and are based upon either (i) a percentage of the gross revenues received, (ii) the number of gaming devices operated or (iii) the number of table games operated. A casino entertainment tax is also paid by casino operations where entertainment is furnished in connection with the selling of food or refreshments. Nevada licensees that hold a license as an operator of a slot route, or a manufacturer's or distributor's license, also pay certain fees and taxes to the State of Nevada.\nAny person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such persons (collectively, \"Licensees\"), and who proposes to become involved in a gaming venture outside of Nevada is required to deposit with the Nevada Board, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation of the Nevada Board of their participation in such foreign gaming. The revolving fund is subject to increase or decrease at the discretion of the Nevada Commission. Thereafter, Licensees are required to comply with certain reporting requirements imposed by the Nevada Act. Licensees are also subject to disciplinary action by the Nevada Commission if they knowingly violate any laws of the foreign jurisdiction pertaining to the foreign gaming operation, fail to conduct the foreign gaming operation in\naccordance with the standards of honesty and integrity required of Nevada gaming operations, engage in activities that are harmful to the State of Nevada or its ability to collect gaming taxes and fees, or employ a person in the foreign operation who has been denied a license or finding of suitability in Nevada on the ground of personal unsuitability.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 3,074 employees. None of the Company's employees is covered by collective bargaining agreements. The Company believes that its relationship with its employees is good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns the 45-acre site in Las Vegas on which the Rio is located. The Rio site is subject to a deed of trust securing the Company's $175 million revolving credit facility (the \"Rio Bank Loan\"), of which $125 million and $10 million were outstanding at December 31, 1994 and 1995, respectively. The Company is in the process of accumulating 22 acres of land adjacent to the current Rio site. In 1995 the Company purchased approximately five of such acres of improved land (the \"Warehouse Site\"). The purchase of the remaining approximately 17 additional acres of land is currently in escrow, which upon closing will bring the total Rio acreage to approximately 67 acres. The entire Rio site, including the Warehouse Site and the additional property the Company is acquiring, is now being master- planned for the development of another hotel-casino, the size and timing of which has not yet been determined. In 1995 the Company purchased the approximately 64 acre Old Vegas Site on Boulder Highway southeast of Las Vegas. The Company is presently considering various development options for the property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWilliam H. Ahern v. Caesars World, Inc., et al., Case No. 94- 532-Civ-Orl-22, instituted on May 10, 1994 (the \"Ahern Complaint\") and William Poulos v. Caesars World, Inc., et al., Case No. 94-478-Civ-Orl-22, instituted on April 26, 1994 (the \"Poulos Complaint\") (collectively, the Ahern Complaint and the Poulos Complaint are referred to as the \"Complaints\"). Two individuals, each purportedly representing a class, filed the Complaints in the United States District Court, Middle District of Florida, against 41 manufacturers, distributors and casino operators of video poker and electronic slot machines, including the Company. The Complaints allege that the defendants have engaged in a course of conduct intended to induce persons to play such games based on a false belief concerning how the gaming machines operate, as well as the extent to which there is an opportunity to win on a given play. The Complaints allege violations of the Racketeer Influenced and Corrupt Organizations Act (the \"RICO Act\"), as well as claims of common law fraud, unjust enrichment and negligent misrepresentation, and seek damages in excess of $1 billion without any substantiation of that amount. The Complaints were consolidated and transferred to the United States District Court for the District of Nevada. Management believes that the Complaints are without merit and intends vigorously to defend the allegations.\nLarry Schreier v. Caesars World, Inc., et al., Case No. 95- 923-LDG (RJJ), instituted on September 26, 1995, in the United States District Court for the District of Nevada, Southern District. An individual, purportedly representing a class, filed a complaint against four manufacturers, three distributors and 38 casino operators, including the Company, that manufacture, distribute or offer for play video poker and electronic slot machines. The individual allegedly intends to seek class certification of the interests he claims to represent. The complaint alleges that the defendants have engaged in a course of conduct intended to induce persons to play such games based on a false belief concerning how the gaming machines operate, as well as the extent to which there is an opportunity to win on a given play. The complaint alleges violations of the RICO Act, as well as claims of common law fraud, unjust enrichment and negligent misrepresentation, and seeks damages in excess of $1 billion. The complaint is similar to the Poulos Complaint and the Ahern Complaint. The Company filed a motion to dismiss the complaint. The court has not yet ruled on the motion. Plaintiff's attempts to consolidate this action with the Ahern Complaint and Poulos Complaint were not successful. Management believes that the complaint is without merit and intends vigorously to defend the allegations.\nHyland, et al. v. Griffin Investigations, et al., Case No. 95-CV-2236 (JEI) instituted on May 5, 1995 in the United States District Court for the District of New Jersey (Camden Division). The Company, together with 76 other casino operators and others, is named as a defendant in the action. The action, purportedly brought on behalf of \"card counters,\" alleges that the casino operators exclude \"card counters\" from play and share information about \"card counters.\" The action is based on alleged violations of federal antitrust law, the Fair Credit Reporting Act, and various state consumer protection laws. The amount of damages sought by the plaintiffs in the action is unspecified. The Company has made a motion to dismiss the complaint. The court has not yet ruled on the motion. Management believes that the complaint is without merit and the Company intends vigorously to defend the allegations.\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) Price Range of Common Stock\nThe Company's common stock, $.01 par value (\"Common Stock\"), began trading on the New York Stock Exchange (the \"NYSE\") under the symbol \"RHC\" on January 11, 1996. Prior to this date, the Company's Common Stock was traded on the Nasdaq National Market under the symbol \"RIOH\". The following table sets forth the high and low closing sale prices of the Company's Common Stock, as reported by the NYSE and the Nasdaq National Market, during the periods indicated.\nThe last reported sale price of the Common Stock on the NYSE on February 29, 1996 was $13.75 per share. There were approximately 1,607 holders of record of the Company's Common Stock as of February 29, 1996.\n(b) Dividend Policy\nThe Company has never declared or paid cash dividends on its Common Stock. The Company presently intends to retain earnings to finance the operation and expansion of its business and does not anticipate declaring cash dividends in the foreseeable future. Under the terms of the covenants in the Rio Bank Loan (as defined below), the Company's wholly owned subsidiary, Rio Properties, Inc. (\"Rio Properties\") cannot pay dividends to the Company without the consent of the lenders. Under the terms of the Indenture (as defined below), governing the Subordinated Notes (as defined below), the payout of dividends and other distributions is subject to specified restrictions.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nThe Rio's revenues and profits are derived largely from its gaming activities, although the Company also seeks to maximize revenues from food and beverage, lodging, entertainment and retail sales. The Rio generally views its non-casino related operations as complementary to its core casino operations. The Rio utilizes entertainment primarily as a casino marketing tool. The Rio expects to maintain a food and beverage pricing structure designed to maximize casino customer foot traffic.\nThe Company's sole business is the operation of the Rio, which opened in January 1990. The Rio was originally owned and operated by a limited partnership (the \"Rio Partnership\") formed by the Company in 1988. Through a series of transactions involving an exchange of preferred stock for partnership interests and later a merger of Rio Partnership into Rio Properties, the Company increased its ownership of the Rio from 34.4% in 1988 to 100% in 1992. Prior to 1990, the Company's operations consisted of real estate development and management. In December 1991, the Company sold all real estate assets and operations not used or held for the operation or expansion of the Rio. In 1995, as part of the Company's three-phased expansion and development plan, the Company entered into agreements for the purchase of approximately 22 acres adjacent to the Rio and approximately 64 acres southeast of Las Vegas, both of which may be developed into future hotel-casino projects.\nThe Rio was designed to permit multiple expansions in accordance with a conceptual master plan and has received necessary governmental approvals for the Phase V Expansion. An $8 million buffet-casino expansion was completed in December 1992; the $37 million Tower Expansion was completed in September 1993; and the $25 million Eastside Expansion was completed in April 1994. In May 1994, the Company commenced its Phase III Expansion, an expansion which contained a total of 549 additional suites (365 new suites were placed into service in February 1995 and the remaining suites were placed into service in March 1995), approximately 10,000 square feet of new casino area that accommodated approximately 300 additional slot machines (opened November 1994), an expansion of the Carnival World Buffet by approximately 50% (opened November 1994), a 527-space, three- level parking garage (opened August 1994), and associated back-of- the-house enhancements. The Phase III Expansion was completed in phases from August 1994 through March 1995. In April 1995, the Company commenced its $20 million Phase IV Expansion. The project added 141 suites to the existing 1,410 suites, added approximately 5,400 square feet of meeting room space, increased the size of the existing Buzios seafood restaurant to approximately 160 seats, added a new health club and salon facility and included a variety of back-of-the-house improvements. Completion of the Phase IV Expansion occurred in stages through the end of 1995. See \"Item l. Business-Expansion Strategy\".\nYEARS ENDED DECEMBER 31, 1995 AND 1994\nOperating profit for the Company increased to $37.1 million for 1995 from $25.8 million for 1994, an increase of $11.3 million or 44%. Management believes that the improvement in operating results was due to the additional 365 new hotel suites placed into service in February 1995, the additional 184 new hotel suites placed into service in March 1995, the additional 141 new hotel suites placed into service in December 1995, an average monthly increase from 1994 levels of approximately 174 slot machines and 19 table games, additional restaurant capacity and improved operating efficiencies in the hotel department.\nNet revenues for the Company increased to $192.5 million for 1995 from $146.3 for 1994, an increase of $46.2 million or 32%. Casino revenues increased to $105.5 million for 1995 from $87.2 million for 1994, an increase of $18.3 million or 21%. The increase in casino revenues was due primarily to an increase in slot machine revenues of $8.5 million or 16% to $63.0 million for 1995 from $54.5 million for 1994 and an increase in table games revenues of $10.3 million or 40% to $36.1 million for 1995 from $25.8 million for 1994, resulting from the additional slot machines and table games discussed above, as well as an increase in the per unit win of both slots and table games.\nRoom revenues increased by $14.5 million or 76% to $33.8 million for 1995 from $19.3 million for 1994. The increase in room revenue resulted primarily from the addition of 365 new hotel suites placed into service in February 1995, 184 new hotel suites placed into service in March 1995, and 141 new hotel suites placed into service in December 1995. The additional 690 suites placed into service in 1995 increased the Rio's total to 1,551 suites compared to 861 suites for 1994. Demand for the Rio's suites remained high during 1995 with a 94% average daily occupancy compared to a 96% average daily occupancy during 1994. The average number of suites available during 1995 was 1,354 compared to 861 during 1994. The average daily room rate during 1995 was $72.18 compared to $63.80 during 1994.\nFood and beverage revenues increased to $60.0 million for 1995 from $47.6 million for 1994, an increase of $12.4 million or 26%. The successful opening in February 1994 of the Copacabana Showroom, a 430-seat video, entertainment and restaurant complex; the successful opening in April 1994 of Fiore, a 186-seat fine dining restaurant; the successful opening in June 1994 of Club Rio, a late-night dance club; the successful completion in November 1994 of a 50% expansion of the Carnival World Buffet to 980 seats; and increased beverage sales as a result of increased gaming customers all contributed to the increase in food and beverage revenues.\nOther revenues for 1995 were $12.0 million, which included entertainment admission revenues of $4.1 million, retail sales of $4.1 million and miscellaneous other operating revenues, primarily telephone revenues, of $3.8 million. This represented an increase in other revenues of $4.9 million, or 68%, compared to the $7.1 million in other revenues generated during 1994. The increase in other revenues resulted primarily from increased entertainment admission revenues, retail sales and telephone revenues resulting from increased business levels.\nThe Company's operating margins were relatively consistent during 1995 compared to 1994. Operating profit as a percentage of net revenues was 19% during 1995 compared to 18% during 1994. Casino operating profit was relatively constant at 55% during 1995 compared to 56% during 1994. Food and beverage operating profit remained relatively constant at 20% during 1995 compared to 19% during 1994. Hotel operating profit increased to 69% during 1995 compared to 66% during 1994 due to efficiencies resulting from increased customer volume, effective cost controls and a higher average room rate during 1995 compared to 1994. Selling, general and administrative expenses were 14% of net revenues in both 1995 and 1994.\nDuring 1995, promotional allowances were $18.8 million, or 9% of gross revenues, which represented the retail value of rooms, food, beverage and other services provided to customers without charge. The estimated cost of providing such promotional allowances was $11.1 million. This compares to 1994 when promotional allowances were $14.9 million, or 9% of gross revenues, and the estimated cost of providing such promotional allowances was $9.1 million.\nDepreciation and amortization increased by $3.3 million or 31% to $14.2 million for 1995 compared to $10.9 million for 1994. This increase is attributable to depreciation expense from various completed expansion projects such as the Company's Eastside Expansion and the Phase III Expansion.\nOther expenses of the Company increased primarily because of higher interest expense. Borrowing levels increased in 1995 compared to 1994 due to funding costs of the various expansion projects. Also, in July 1995, in anticipation of the funding requirements for the Phase V Expansion, the Company issued $100 million in 10 5\/8% Senior Subordinated Notes. (See \"Item 7. Liquidity and Capital Resources\"). The fixed coupon rate of 10 5\/8% was higher than the floating rate that the Company was paying under the Rio Bank Loan. Consequently, the issuance of these notes resulted in an increase in interest expense. Interest expense for 1995 was reduced by $949,423 because of interest capitalized on amounts expended on the Phase III Expansion, the Phase IV Expansion and the Phase V Expansion. Interest expense for 1994 was reduced by $619,887 because of interest capitalized on amounts expended on the Eastside Expansion and the Phase III Expansion. Other income for 1994 was a one-time gain of $1.1 million related to the resale of two real estate parcels previously owned by the Company. A one-time gain of $966,510 related to the sale of real estate which was sold by the Company to a related party in December 1991. In April 1994, the real estate was resold to a non-related party. Pursuant to the terms of the sales agreement between the Company and the related party, the Company was entitled to a portion of the resale proceeds, which equaled $966,510, net of expenses. Another one-time gain of $173,500 related to the sale of a second piece of real property owned by the Company until May 1991, when it was sold to a non-related party. Pursuant to the terms of the sales agreement, the Company was entitled to a portion of the resale proceeds or refinancing amount, which equaled $173,500, net of expenses.\nNet income for 1995 increased 17% to $18.7 million or $0.87 per share (fully diluted) from $16.0 million or $0.74 per share (fully diluted) for 1994 as a result of the factors discussed above.\nYEARS ENDED DECEMBER 31, 1994 AND 1993\nOperating profit for the Company increased to $25.8 million for 1994 from $20.2 million for 1993, an increase of $5.6 million or 27.5%. Management believes that the improvement in operating results was due to increased business levels in 1994 as a result of having an additional 437 hotel suites for nine months of the year, an addition of approximately 800 slot machines (approximately 500 slot machines were added in December 1993 and approximately 300 slot machines were added in November 1994), an addition of approximately 13 table games and additional restaurant capacity compared to 1993.\nNet revenues for the Company increased to $146.3 million for 1994 from $110.0 million for 1993, an increase of $36.3 million or 33%. Casino revenues increased to $87.2 million for 1994 from $71.3 million for 1993, an increase of $15.9 million or 22%. The increase in casino revenues was due primarily to an increase in slot machine revenues of $9.3 million or 20% to $54.5 million for 1994, from $45.2 million for 1993, and an increase in table games revenues of $6.0 million or 30% to $25.8 million for 1994, from $19.8 million for 1993, resulting from the additional slot machines and table games discussed above.\nRoom revenues increased to $19.3 million for 1994 from $12.3 million for 1993, an increase of $6.9 million or 56%. The increase in room revenues resulted primarily from the addition of 437 suites during the fourth quarter of 1993 (375 new suites were placed in service in September 1993 and 62 suites were placed in service in October 1993), bringing the Company's total to 861 suites available during 1994. Demand for the Rio's suites remained high during 1994, at a 96% average daily occupancy compared to a 97% average daily occupancy during 1993. The average daily room rate during 1994 was $63.80 compared to $62.60 during 1993.\nFood and beverage revenues increased to $47.6 million for 1994 from $32.6 million for 1993, an increase of $15.1 million or 46%. The increase was principally due to the successful opening in February 1994 of a new 430-seat video, entertainment and restaurant complex, the successful opening in April 1994 of a new 186-seat fine dining restaurant, the successful completion in November 1994 of a 50% expansion of the Carnival World Buffet to 980 seats, an increase in the number of patrons served in other Rio restaurants and an increase in the average food check.\nOther revenues for the year ended December 31, 1994 were $7.1 million, which included entertainment admission revenues of $1.9 million, retail sales of $2.6 million and miscellaneous other operating revenues, primarily telephone revenues of $2.6 million. This represented an increase in other revenues of $2.9 million, or 69%, compared to the $4.2 million in other revenues generated during the twelve months ended December 31, 1993. The increase of $2.9 million was attributable to increases of approximately $0.9 million in each of admission revenues, retail sales, and miscellaneous other revenues.\nThe Company's operating margins were relatively consistent during 1994 compared to 1993. Operating profit as a percentage of net revenues was 18% in both 1994 and 1993. Casino operating profit was 56% in both 1994 and 1993. Food and beverage operating profit improved to\n19% during 1994 compared to 15% during 1993 as a result of an increase in volume, price increases and effective cost control measures. Hotel operating profit improved to 66% during 1994 compared to 64% during 1993 as a result of a higher average room rate and effective cost control measures. Selling, general and administrative expenses were 14% of net revenues during 1994, of which $421,367 were expenses related to gaming development. This compares favorably to 1993 when selling, general and administrative expenses were 15% of net revenues, which did not include any material expenditures related to gaming development.\nDuring 1994, promotional allowances were $14.9 million, or 9% of gross revenues, which represented the retail value of rooms, food, beverage and other services provided to customers without charge. The estimated cost of providing such promotional allowances was $9.1 million. This compares to 1993 when promotional allowances were $10.4 million, or 9% of gross revenues, and the estimated cost of providing such promotional allowances was $6.9 million.\nDepreciation and amortization increased to $10.9 million for 1994 from $7.5 million for 1993, an increase of $3.3 million or 44%. This increase is attributable to a full year of depreciation on the Phase II Expansion which was completed in September 1993, depreciation on the Eastside Expansion which was completed in phases by April 1994 and depreciation on the Phase III Expansion projects completed during 1994.\nOther income for 1994 was a one-time gain of $1.1 million related to the resale of certain real estate previously owned by the Company. A one-time gain of $966,510 related to the sale of real estate which was sold by the Company to a related party in December 1991. In April 1994, the real estate was resold to a non-related party. Pursuant to the terms of the sales agreement between the Company and the related party, the Company was entitled to a portion of the resale proceeds, which equaled $966,510, net of expenses. A one-time gain of $173,500 related to the sale of real estate owned by the Company until May 1991, when it was sold to a non-related party. Pursuant to the terms of the sales agreement, the Company was entitled to a portion of the resale proceeds or refinancing amount, which equaled $173,500, net of expenses.\nIncome before extraordinary items and cumulative effect of a change in accounting principle increased 37% to $16.0 million or $0.74 per share (fully diluted) for 1994, from $11.7 million or $0.60 per share (fully diluted) for 1993. The results for 1993 were impacted by the cumulative effect of a change in accounting principle resulting from the adoption of Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). Adoption of SFAS 109 resulted in a one-time, non- cash charge in the amount of $776,888 or ($0.04) per share (fully diluted). The results for 1993 were also adversely affected by the extraordinary loss on early extinguishment of debt, net of income tax benefit, of $253,711 or ($0.01) per share (fully diluted).\nNet income for 1994 increased 50% to $16.0 million or $0.74 per share (fully diluted) from $10.6 million or $0.55 per share (fully diluted) for 1993 as a result of the factors discussed above.\nIMPACT OF INFLATION\nAbsent changes in competitive and economic conditions or in specific prices affecting the industry, the Company believes that the hotel-casino industry may be able to maintain its real operating profit margins in periods of general inflation by increasing minimum wagering limits for its games and increasing the prices of its hotel rooms, food and beverage and other items, and by taking action designed to increase the number of patrons. The industry may be able to maintain growth in gaming revenues by the tendency of customer gaming budgets to increase with inflation. Changes in specific prices (such as fuel and transportation prices) relative to the general rate of inflation may have a material effect on the hotel-casino industry.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Company had working capital of $5.8 million compared with $50.2 million at December 31, 1994. Cash and cash equivalents were $20.0 million at December 31, 1995 compared with $76.4 million at December 31, 1994. At December 31, 1995, the Company had $165.0 million available under its bank facility while the bank facility was fully utilized at December 31, 1994. The decrease in both working capital and cash is primarily due to the use of cash and cash equivalents during 1995 to repay principal under the Rio Bank Loan and the decision of the Company not to draw down the full amount of the available Rio Bank Loan at the end of 1995, as well as the use of cash and cash equivalents to make capital expenditures for the Company's $75 million Phase III Expansion, the $20 million Phase IV Expansion, the $185 million Phase V Expansion, the purchase of land adjacent to the Rio and the purchase of the approximately 64 acre Old Vegas Site, both of which may be developed into future hotel casino projects.\nDuring 1995, cash provided by operating activities was $42.4 million. Investing activities used $76.1 million of the Company's cash during 1995. Approximately $27.2 million of such expenditures was related to the Phase III Expansion, approximately $18.1 million was related to the Phase IV Expansion and approximately $7.9 million was related to the Phase V Expansion. During the first quarter of 1995, the Company acquired an approximately 5-acre site adjacent to the Rio site, on which a former commercial warehouse is located, at a purchase price of $3.2 million (net of credit for profit participation from the seller to which the Company was entitled and net of rental proceeds during the term of the escrow). During the second quarter of 1995, the Company acquired the Old Vegas Site at a purchase price of $5.7 million (net of credit for profit participation from the seller to which the Company was entitled). The Old Vegas Site and additional land acquisitions are part of the Company's recently announced three phase expansion and development plan. During 1995, the Company spent approximately $11.7 million toward the acquisition of certain real property adjacent to the Rio. The balance of cash used in investing activities was expended on other capital projects.\nDuring the fourth quarter of 1994, the Board of Directors authorized the Company to make discretionary repurchases of up to 2 million shares of its Common Stock from time to time in the open market or otherwise. During 1995, the Company repurchased 430,500 shares of Common Stock at a total cost of $5.4 million. The repurchased shares of Common Stock were retired.\nUnder the Rio Bank Loan, the Company is subject to annual capital expenditure limits of $7.5 million plus the amount available of unused capital expenditures from the prior fiscal year, but not to exceed $12.5 million annually in any event. However, the Company received a written waiver to allow the Company to construct the Phase III Expansion, the Phase IV Expansion and the Phase V Expansion. Because of the annual restrictions on capital expenditures by the Company contained in the Rio Bank Loan, any other significant new capital improvements to the Rio will also require the consent of the lenders.\nAs of January 1, 1996 the Company's capital commitments include approximately $2.0 million for the remainder of the Phase III Expansion, $1.9 million for the Phase IV Expansion, $177.1 million for the Phase V Expansion and $8.6 million under commitments for the purchase of real estate. Based upon cash on hand, cash available through borrowings under the Rio Bank Loan and cash from operations, the Company believes that it has adequate cash available to fund the remaining cost of the Phase III Expansion, the Phase IV Expansion, the Phase V Expansion and the real estate purchase commitments.\nIn July 1993, the Company obtained a secured reducing revolving credit facility (\"the Rio Bank Loan\") in the original principal amount of $65 million with a syndicate of banks consisting of Bank of America National Trust Savings and Association (\"B of A\"), Bank of America Nevada, Societe Generale, NBD Bank, N.A., First Security Bank of Idaho, N.A., First Interstate Bank of Nevada, N.A. and U. S. Bank of Nevada. As a result of certain amendments, in December 1994, the Rio Bank Loan was increased to $125 million and in September 1995, the Rio Bank Loan was increased to $175 million. As amended, the Rio Bank Loan is a secured reducing revolving credit facility to be used (a) to refinance the pre-amendment Rio Bank Loan, (b) to finance the Phase V Expansion, (c) to finance acquisition of land adjacent to the Rio for up to $30 million, (d) for Common Stock repurchases up to $10 million, and (e) for general corporate purposes.\nAs amended, the Rio Bank Loan matures on June 30, 2001 and bears interest based upon a \"LIBOR Spread\" of from 1% to 3%, or a \"Base Rate Spread\" of from 0% to 2% based upon a schedule determined with reference to the \"Funded Debt to EBITDA Ratio\" of Rio Properties. The \"LIBOR Spread\" is the amount in excess of the applicable LIBOR rate which is the London interbank offer rate established in the London interbank market. The \"Base Rate Spread\" is the amount in excess of the applicable base rate, which is the rate per annum equal to the higher of the reference rate as it is publicly announced from time to time by Bank of America in San Francisco or 0.50% per annum above the latest Federal Funds rate. The Rio Bank Loan also provides for an unused facility fee ranging from 31.25 basis points (one one- hundredth of one percent) to 50.0 basis points depending upon the same Funded Debt to EBITDA ratio schedule utilized for the interest rate. The Rio Bank Loan requires monthly payments of interest and requires scheduled reductions of the maximum amount available under the Rio Bank Loan commencing with a $10 million reduction at December 31, 1997, a $7.5 million reduction at the end of each quarter during 1998 and 1999, a $10.0 million reduction at the end of each quarter during 2000, a $32.5 million reduction at March 31, 2001 and maturity at June 30, 2001.\nTo reduce the risks from interest rate fluctuations, the Company has previously entered into interest rate swap agreements in the amount of $20 million from September 30, 1994 through December 29, 1995 and $15 million from December 29, 1995 through June 28, 1996. In August 1994, the Company purchased a $40 million interest rate cap, effective September 30, 1994, for a three-year term, which provides for quarterly payments to the Company in the event that three-month LIBOR exceeds 7% on any quarterly reset date. The Company is exposed to credit risks in the event of non-performance by the counterparty. However, the Company does not anticipate non-performance by the counterparty. The counterparty under these agreements is B of A, the lead bank in the syndicate participating in the Rio Bank Loan. Management believes that the financial resources of B of A and its competitive position within the national banking industry significantly reduce the chances of non-performance under the interest rate swap and cap agreements.\nThe Rio Bank Loan is secured by a first deed of trust on the Rio, a security interest in substantially all of Rio Properties other real and personal property, and a guaranty by Rio Hotel & Casino, Inc., including a pledge of the Company's stock in Rio Properties. The Rio Bank Loan provides that Rio Hotel & Casino, Inc. will be permitted to accumulate and hold up to $5 million in assets which are not to be pledged for the benefit of the Rio Bank Loan lenders.\nThe Rio Bank Loan contains certain customary financial covenants to which the Company is subject. Those covenants include a requirement that Rio Properties maintain a maximum ratio of Total Debt (as defined in the Rio Bank Loan) to EBITDA (as defined in the Rio Bank Loan) ranging from 3.0 to 1 at December 31, 1995, increasing to 4.25 to 1 for the six month period ending March 31, 1997 and decreasing to 3.0 to 1 at December 31, 1997 and thereafter. Rio Properties must meet a maximum ratio of Senior Debt (as defined in the Rio Bank Loan) to EBITDA from 1.75 to 1 through December 31, 1995 up to 3.0 to 1 for the six months ended March 31, 1997 and reducing to 1.75 to 1 at December 31, 1997 and thereafter. Rio Properties must maintain a maximum Interest Coverage Ratio (as defined in the Rio Bank Loan) of 2.0 to 1 through the fiscal quarter ending December 31, 1996, reducing to 1.5 to 1 for the fiscal quarter ending March 31, 1997 and increasing to 3.0 to 1 for the fiscal quarter ending December 31, 1998 and thereafter. Minimum Consolidated Tangible Net Worth (as defined in the Rio Bank Loan) requirements of $125 million, plus 75% of accumulated net income after December 31, 1994 (not reduced by any consolidated net losses) plus 100% of the net proceeds of any equity offering by Rio Properties or the Company must be maintained. A maximum annual capital expenditure permitted under the Rio Bank Loan is $7.5 million annually, plus the amount available of unused capital expenditures from the prior fiscal year, but not to exceed $12.5 million, annually in any event. A specific carve- out of $200 million for the Phase V Expansion and $30 million for the identified adjacent Rio land acquisition is incorporated in the Rio Bank Loan. The Rio Bank Loan also provides for a basket for $10 million for the repurchase of equity shares of the Company through open market purchases over the life of the Rio Bank Loan.\nOn July 18, 1995, the Company entered into an agreement with Salomon Brothers Inc. and Montgomery Securities (the \"Initial Purchasers\") for the sale by the Company of $100 million in principal amount of the Company's 10 5\/8% Senior Subordinated Notes Due\n2005 (the \"Old Notes\"). The Old Notes were purchased by the Initial Purchasers for resale to qualified institutional investors. The net proceeds from the sale of the Old Notes (approximately $96.7 million after the deduction of a 2.75% discount to the Initial Purchasers and offering expenses of approximately $0.5 million), borrowings under the Rio Bank Loan, cash on hand and cash from operations will be used to finance the Company's approximately $185 million Phase V Expansion. Pending such use, the net proceeds were used to reduce amounts outstanding under the Rio Bank Loan. Pursuant to a registration agreement between the Company and the Initial Purchasers, the Company registered on Form S-4 under the Securities Act of 1933 $100 million principal amount of 10 5\/8% Senior Subordinated Notes Due 2005 (the \"New Notes\") which were exchanged for the Old Notes (the Old Notes and the New Notes are collectively referred to as the \"Subordinated Notes\").\nThe Subordinated Notes were issued under an indenture (the \"Indenture\") dated July 21, 1995 among the Company, Rio Properties and IBJ Schroder Bank & Trust Company, as trustee. The following summary of certain provisions of the Indenture does not purport to be complete and is subject to the provisions of the Indenture and the Subordinated Notes. Capitalized terms not otherwise defined have the same meanings assigned to them in the Indenture.\nThe Subordinated Notes mature on July 15, 2005. Interest payment dates under the Subordinated Notes are January 15 and July 15, commencing January 15, 1996. The Subordinated Notes are fully and unconditionally guaranteed (the \"Rio Guarantee\") on a senior subordinated basis by Rio Properties. The Subordinated Notes are subordinated in right of payment to all existing and future Senior Indebtedness of the Company and are structurally subordinated to all existing and future indebtedness and other liabilities (including trade payables) of the Company's subsidiaries. The Rio Guarantee is subordinated in right of payment to all existing and future Senior Indebtedness (as defined in the Indenture) of Rio Properties and is structurally subordinated to all existing and future indebtedness and other liabilities (including trade payables) of Rio Properties' subsidiaries.\nThe Subordinated Notes may be redeemed at the option of the Company, in whole or in part, at any time on or after July 15, 2000, at the redemption prices set forth in the Indenture, plus accrued and unpaid interest, if any, through the redemption date. The Subordinated Notes will be redeemed from any holder or beneficial owner of the Subordinated Notes which is required to be found suitable and is not found suitable by the Nevada Gaming Commission.\nUpon a Change of Control of the Company (as defined in the Indenture), each holder of Subordinated Notes will have the right to require the Company to repurchase all or part of such holder's Subordinated Notes at a price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase. The Company's obligation to repurchase the Subordinated Notes is guaranteed on a senior subordinated basis by Rio Properties. The Indenture contains certain covenants that, among other things, limit the ability of the Company and its Restricted Subsidiaries (as defined in the Indenture) to incur additional indebtedness, pay dividends or make other distributions, make investments, repurchase subordinated obligations or capital stock, create certain liens (except, among others, liens\nsecuring Senior Indebtedness), enter into certain transactions with affiliates, sell assets of the Company or its subsidiaries, issue or sell subsidiary stock, create or permit to exist restrictions on distributions from subsidiaries, or enter into certain mergers and consolidations.\nOn May 2, 1995, the Company announced a three-phase expansion and development plan to grow the Company over the next several years. The plan includes the Phase V Expansion on the existing Rio site, acquisition of approximately 22 acres of land adjacent to the Rio site to be master-planned for another hotel- casino property and the purchase of the Old Vegas Site for possible future hotel-casino development.\nThe Company cannot accurately state the timing for the funding requirements of the approximately $185 million Phase V Expansion costs. Construction commenced in September 1995 and opening is expected to occur in the spring of 1997. The Company spent approximately $7.9 million on the Phase V Expansion in 1995 and management anticipates that the bulk of the funds will be applied in 1996 and the balance of the funds will be applied in 1997. The $185 million Phase V Expansion will be financed with the proceeds from the Subordinated Notes, funds available under the Rio Bank Loan, cash on hand and cash from operations.\nAs described above, the Company has acquired approximately five acres of land adjacent to the Rio and has entered into agreements to acquire an additional approximately 17 acres of land adjacent to the Rio site. The combined cost of the approximately 22 acres is approximately $20.3 million, which the Company will fund through cash on hand, cash available through borrowings under the Rio Bank Loan and cash from operations. The entire Rio site is now being master-planned for the development of another hotel-casino, the size and timing of which has not yet been determined.\nAs the third step in its expansion and development plan to provide further growth for the Company, the Company acquired the Old Vegas Site southeast of Las Vegas. The cost of the Old Vegas Site was approximately $5.7 million (net of a credit for profit participation from the seller to which the Company was entitled) which the Company funded through cash on hand and cash available through borrowings under the Rio Bank Loan. The timing of the proposed development on the Old Vegas Site has not yet been determined.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Rio Hotel & Casino, Inc.:\nWe have audited the accompanying consolidated balance sheets of RIO HOTEL & CASINO, INC. (a Nevada 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 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 Rio Hotel & Casino, 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.\nAs discussed in Note 7 to the consolidated financial statements, effective January l, 1993, the Company changed its method of accounting for income taxes.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedules listed in Item 14 are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nLas Vegas, Nevada January 26, 1996\nRIO HOTEL & CASINO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES AND RELATED MATTERS PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Rio Hotel & Casino, Inc. and its wholly owned subsidiaries Rio Properties, Inc. (\"Rio Properties,\" which owns and operates the Rio Suite Hotel & Casino (the \"Rio\") in Las Vegas, Nevada); Rio Development Company, Inc. (formerly MarCor Development Company, Inc.); Rio Resort Properties, Inc. (formerly MarCor Resort Properties, Inc.); and Rio Properties' wholly owned subsidiary, Cinderlane, Inc.\nAll significant intercompany balances and transactions have been eliminated in consolidation.\nRECLASSIFICATIONS\nThe financial statements for prior periods reflect certain reclassifications, which have no effect on net income, to conform with classifications adopted in the current 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 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.\nCAPITALIZATION OF INTEREST\nThe Company capitalizes interest on funds disbursed during the active construction phases of real estate development and other major projects. Interest capitalized during the years ended December 31, 1995, 1994, and 1993 was $949,423, $619,887 and $467,798, respectively.\nPROPERTY AND EQUIPMENT\nLand and improvements, building and improvements, and equipment, furniture and improvements are stated at cost.\nDepreciation and amortization of property and equipment is computed using the straight-line method predominantly over the following estimated useful lives:\nBuilding and improvements 7 to 45 years Equipment, furniture and improvements 3 to 15 years\nCosts of major improvements are capitalized, while costs of normal repairs and maintenance are charged to expense as incurred.\nIMPAIRMENT\nManagement reviews existing information and analyses of the Company and its operations as well as indicators of impairment (such as dramatic changes in the manner in which an asset is used or forecasts showing lack of long-term profitability) to determine whether an impairment may exist. The Company considers relevant cash flow and profitability information, including estimated future operating results, trends and other available information, in assessing whether the carrying value of its fixed assets can be recovered. Upon a determination that the carrying value of an asset will not be recovered from its future undiscounted cash flows, the carrying value of that asset would be considered impaired and will be reduced by a charge to operations in the amount of the impairment. Impairment is measured as any deficiency in estimated undiscounted future cash flows of the fixed assets to recover the carrying value related to those assets.\nINVENTORIES\nInventories are stated at the lower of cost or market. Cost is determined by using the first-in, first-out method.\nREVENUE AND PROMOTIONAL ALLOWANCES\nCasino revenues represent the net win from gaming wins and losses. The retail value of rooms, 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 allowances are included in casino costs and expenses as follows:\nEARNINGS PER SHARE\nEarnings per common share are computed on the basis of the weighted average number of common shares and common stock equivalents outstanding during the period.\nHEDGING TRANSACTION\nThe Company is a party to an interest rate swap agreement and has purchased an interest rate cap (Note 6). Any net payments made or received by the Company in connection with this interest rate swap agreement or interest rate cap, or any other hedging transaction that the Company may enter into, will be classified as cash flows from operating activities.\nPremiums paid for the interest rate cap agreements are amortized to interest expense over the shorter of the original life of the debt or the term of the cap. Unamortized premiums are included in other assets in the statement of financial position. Accounts receivable under the agreements are accrued as a reduction of interest expense. Amounts payable under the interest rate swap agreements are included in interest expense.\nINCOME TAXES\nEffective January 1, 1993, the Company implemented the provisions of SFAS 109. SFAS 109 utilizes the liability method and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws.\n2. CASH AND CASH EQUIVALENTS\nCash and cash equivalents at December 31, 1995 and 1994 include $10 million and $68 million, respectively, in overnight repurchase agreements with a bank. These items are recorded at cost which approximates market value and are considered cash equivalents for purposes of the Consolidated Statements of Cash Flows.\n3. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe following supplemental disclosures are provided as part of the Consolidated Statements of Cash Flows:\nNon-cash financing and investing activities:\nDECEMBER 31, 1995\nPurchase of property and equipment financed through payables totaled $6,556,126.\nPurchase of land financed through long-term debt totaled $62,042.\nAccounts receivable increased by $85,380. This was financed through payables and will be reimbursed to the Company.\nTax benefit arising from the exercise of stock options granted under the Company's Non-Statutory Stock Option Plan (\"NSOP\") totaled $632,601.\nDECEMBER 31, 1994\nPurchase of property and equipment financed through payables totaled $10,026,210.\nTax benefit arising from the exercise of stock options granted under NSOP totaled $886,132.\nDECEMBER 31, 1993\nPurchase of property and equipment financed through payables totaled $8,442,660.\nPurchase of property and equipment financed through long- term debt totaled $183,586.\nAdditional costs of issuing Common Stock totaled $12,194.\nCosts of issuing Common Stock financed through payables totaled $163,801.\nTax benefit arising from the exercise of stock options granted under the NSOP totaled $1,120,823.\nReduction in paid-in capital as a result of the implementation of SFAS 109 totaled $823,152. This amount was charged directly against equity because it reflects the tax effect of SFAS 109 as it related to the gain on sale of assets to affiliates of the Company's largest stockholder in December 1991, which was also recorded directly to equity.\n4. ACCOUNTS RECEIVABLE\nComponents of receivables are as follows:\n5. ACCRUED EXPENSES\nComponents of accrued expenses are as follows:\n6. LONG-TERM DEBT\nLong-term debt consists of the following:\nThe prime interest rate quoted by the Company's primary lenders at December 31, 1995 and 1994 was 8.50%.\nAt December 31, 1995, the three month Eurodollar Rate was 5.625%. The margin on the Company's Eurodollar Rate borrowings at December 31, 1995 was 2.00%.\nThe Rio Bank Loan was originally entered into on July 15, 1993 in the amount of $65 million with a syndicate of banks consisting of Bank of America National Trust Savings and Association, Bank of America Nevada, Societe Generale, NBD Bank, N.A., First Security Bank of Idaho, N.A., First Interstate Bank of Nevada, N.A. and U. S. Bank of Nevada. As a result of certain amendments, in December 1994, the Rio Bank Loan was increased to $125 million and in September 1995, the Rio Bank Loan was increased to $175 million. As amended, the Rio Bank Loan is a secured reducing revolving credit facility to be used (a) to refinance the pre- amendment Rio Bank Loan, (b) to finance the\nPhase V Expansion, (c) to finance acquisition of land adjacent to the Rio for up to $30 million, and (d) for general corporate purposes.\nThe Rio Bank Loan matures on June 30, 2001 and will bear interest based upon a \"LIBOR Spread\" of from 1% to 3%, or a \"Base Rate Spread\" of from 0% to 2.0% based upon a schedule determined with reference to Rio Properties' \"Funded Debt to EBITDA Ratio\". The \"LIBOR Spread\" is the amount in excess of the applicable LIBOR rate which is the London interbank offer rate established in the London interbank market. The \"Base Rate Spread\" is the amount in excess of the applicable base rate, which is the rate per annum equal to the higher of the reference rate as it is publicly announced from time to time by Bank of America in San Francisco or 0.50% per annum above the latest Federal Funds rate. The Rio Bank Loan provides for an unused facility fee ranging from 31.25 basis points to 50.0 basis points depending upon the same Funded Debt to EBITDA ratio schedule utilized for the interest rate. (A basis point is one one-hundredth of one percent.) The Rio Bank Loan requires monthly payments of interest and will require scheduled reductions of the maximum amount available under the Rio Bank Loan commencing with a $10 million reduction at December 31, 1997, a $7.5 million reduction at the end of each quarter during 1998 and 1999, a $10.0 million reduction at the end of each quarter during 2000, a $32.5 million reduction at March 31, 2001 and maturity at June 30, 2001.\nTo reduce the risks from interest rate fluctuations, the Company entered into interest rate swap agreements in the amount of $20 million from September 30, 1994 through December 29, 1995 and $15 million from December 29, 1995 through June 28, 1996. In August 1994, the Company purchased a $40 million interest rate cap, effective September 30, 1994, for a three-year term, which provides for quarterly payments to the Company in the event that three-month LIBOR exceeds 7% on any quarterly reset date. The Company is exposed to credit risks in the event of non- performance by the counterparty. At December 31, 1995, the potential maximum credit risk amounted to $464,333, which is the carrying value of the unamortized premium. However, the Company does not anticipate non-performance by the counterparty. The counterparty under these agreements is Bank of America National Trust and Savings Association (\"B of A\"), the lead bank in the syndicate participating in the Rio Bank Loan. Management believes that the financial resources of B of A and its competitive position within the national banking industry significantly reduce the chances of non-performance under the interest rate swap and cap agreements.\nThe following table discloses (i) the aggregate amount of interest rate swaps categorized by annual maturity and (ii) the related weighted average interest rate paid and received assuming current market conditions:\nAt December 31, 1995 the interest rate swap and interest rate cap agreements had fair market values of $39,774 and $28,356, respectively (carrying values of $0 and $464,333, respectively). Management is of the opinion that the fair values of all other financial instruments are not materially different from their carrying values.\nAs a result of entering into interest rate swap agreements and cap agreements, the Company has recognized interest expense of $18,638, $83,833, and $187,875 for the years ended December 31, 1995, 1994 and 1993, respectively. The impact of these hedging activities on the Company's weighted average borrowing rate was an increase of approximately 0.03%, 0.26% and 0.44% for the years ended December 31, 1995, 1994 and 1993, respectively.\nAs of the years ended December 31, 1995 and 1994, there were no deferred gains and losses relating to terminated interest rate swap and interest rate cap agreements.\nThe revolving credit feature of the Rio Bank Loan allows the Company to pay down and reborrow principal under the line of credit as the Company deems appropriate. The Company utilized this ability by reborrowing $69 million on December 30, 1994 and repaying $69 million on January 3, 1995. The Company also reborrowed $10 million on December 29, 1995 and repaid $9 million on January 2, 1996 under the terms of the Rio Bank Loan. During the third quarter of 1995, the Company used the net proceeds from the Subordinated Notes (defined below) to reduce amounts outstanding under the Rio Bank Loan. The Company had $165 million available under the Rio Bank Loan at December 31, 1995, while the Company's borrowing capacity under the Rio Bank Loan was fully utilized at December 31, 1994.\nAs of December 31, 1995, annual maturities of total notes and loans payable are as follows:\nBased upon the present operations of the Rio, internal projections of revenues and expenses, and other anticipated cash requirements of Rio Properties during 1996, the Company anticipates meeting required principal and interest payments under the Rio Bank Loan during 1996.\nThe carrying values of assets included in the consolidated financial statements, which collateralize bank loans payable, are as follows:\nDecember 31, 1995 1994\nBuilding and improvements $192,818,896 $137,005,432 Equipment, furniture and improvements 68,500,267 43,108,873 Land and improvements 37,509,960 24,666,679 Construction in progress 17,173,483 38,521,773 $316,002,606 $243,302,757\nOn July 18, 1995, the Company entered into an agreement with Salomon Brothers Inc. and Montgomery Securities (the \"Initial Purchasers\") for the sale by the Company of $100 million in principal amount of the Company's 10 5\/8% Senior Subordinated Notes Due 2005 (the \"Old Notes\"). The Old Notes were purchased by the Initial Purchasers for resale to qualified institutional investors. The net proceeds from the sale of the Old Notes (approximately $96.7 million after the deduction of a 2.75% discount to the Initial Purchasers and offering expenses of approximately $0.5 million), borrowings under the Rio Bank Loan, cash on hand and cash from operations will be used to finance the Company's approximately $185 million Phase V Expansion. Pending such use, the net proceeds were used to reduce amounts outstanding under the Rio Bank Loan. Pursuant to a registration agreement between the Company and the Initial Purchasers, the Company registered on Form S-4 under the Securities Act of 1933 $100 million principal amount of 10 5\/8% Senior Subordinated Notes Due 2005 (the \"New Notes\") which were exchanged for the Old Notes (the Old Notes and the New Notes are collectively referred to as the \"Subordinated Notes\").\nThe Subordinated Notes were issued under an indenture (the \"Indenture\") dated July 21, 1995 among the Company, Rio Properties and IBJ Schroder Bank & Trust Company, as trustee. The following summary of certain provisions of the Indenture does not purport to be complete and is subject to the provisions of the Indenture and the Subordinated Notes. Capitalized terms not otherwise defined have the same meanings assigned to them in the Indenture.\nThe Subordinated Notes mature on July 15, 2005. Interest payment dates under the Subordinated Notes are January 15 and July 15, commencing January 15, 1996. The Subordinated Notes are unconditionally guaranteed (the \"Rio Guarantee\") on a senior subordinated basis by Rio Properties. The Subordinated Notes are subordinated in right of payment to all existing and future Senior Indebtedness (as defined in the Indenture) of the Company and are structurally subordinated to all existing and future indebtedness and other liabilities (including trade payables) of the Company's subsidiaries. The Rio Guarantee is subordinated in right of payment to all existing and future Senior Indebtedness (as defined in the Indenture) of Rio Properties and is structurally subordinated to all existing and future indebtedness and other liabilities (including trade payables) of Rio Properties' subsidiaries.\nThe Subordinated Notes may be redeemed at the option of the Company, in whole or in part, at any time on or after July 15, 2000, at the redemption prices set forth in the Indenture, plus accrued and unpaid interest, if any, through the redemption date. The Subordinated Notes will be redeemed from any holder or beneficial owner of the Subordinated Notes which is required to be found suitable and is not found suitable by the Nevada Commission.\nUpon a Change of Control of the Company (as defined in the Indenture), each holder of Subordinated Notes will have the right to require the Company to repurchase all or part of such holder's Subordinated Notes at a price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase. The Company's obligation to repurchase the Subordinated Notes is guaranteed on a senior subordinated basis by Rio Properties. The Indenture contains certain covenants that, among other things, limit the ability of the Company and its Restricted Subsidiaries (as defined in the Indenture) to incur additional indebtedness, pay dividends or make other distributions, make investments, repurchase subordinated obligations or capital stock, create certain liens (except, among others, liens securing Senior Indebtedness), enter into certain transactions with affiliates, sell assets of the Company or its subsidiaries, issue or sell subsidiary stock, create or permit to exist restrictions on distributions from subsidiaries, or enter into certain mergers and consolidations.\n7. INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued SFAS 109 which supersedes previous pronouncements on accounting for income taxes and is effective for fiscal years commencing after December 15, 1992. The Company adopted SFAS 109 in the first quarter of 1993 by reporting the effect of SFAS 109 as a cumulative effect of a change in accounting principle and not restating prior periods. The effect of SFAS 109 recorded in January 1993 decreased net income as a non-cash, non-recurring cumulative effect of a change in accounting principle by an amount totaling $776,888. It also reduced paid-in capital by an amount totaling $823,152. This amount was charged directly against equity because it reflects the tax effect of SFAS 109 as it related to the gain on sale of assets to affiliates of the Company's largest stockholder in December 1991, which was also recorded directly to equity.\nThe federal income tax provisions for the years ended December 31, 1995, 1994 and 1993 consist of the following:\nThe Revenue Reconciliation Act of 1993 raised the corporate income tax rate from 34% to 35%, retroactively to January 1, 1993. In accordance with the requirements of SFAS 109, the deferred income tax assets and liabilities were adjusted accordingly, resulting in a charge against income in the amount of $113,433.\nThe following schedule reconciles the Company's effective tax rate to the statutory rate:\nDuring 1994, the Company utilized all remaining alternative minimum tax credit carryforwards.\nThe Company's deferred tax assets (liabilities) at December 31, 1995 consisted of the following:\nThe Company's deferred tax assets (liabilities) at December 31, 1994 consisted of the following:\nThe current portion of the Company's net deferred tax assets is included on the Consolidated Balance Sheets under the heading \"Prepaid Expenses and Other Current Assets.\"\nThe Company has determined that it is probable that the full amount of the tax benefit from the deferred tax assets will be realized and therefore, has not recorded a valuation allowance to reduce the carrying value of the deferred tax assets.\n8. COMMITMENTS AND CONTINGENCIES\nIn connection with the bank loan agreements, the Company has entered into agreements with certain key stockholders, directors and executive officers to facilitate borrowings by the Company. These individuals personally guaranteed the previous bank loan made to Rio Properties in exchange for compensation of $1,250,000 upon the satisfaction of certain terms and conditions. The first potential payment obligation of the Company of $250,000 commenced with the fiscal year ended December 31, 1990 and continued to December 31, 1994, with a two-year extension provision. No amounts were due or paid arising out of the years ended December 31, 1990 or 1991. The Company made $250,000 payments in each of the four years ended December 31, 1995, 1994, 1993, and 1992. The Company anticipates paying the entire balance on or before December 31, 1996.\nEffective January 1, 1991, Rio Properties maintains an employee profit sharing plan for all employees who have accredited service. Contributions to the plan are discretionary and cannot exceed amounts permitted under the Internal Revenue Code. Contributions of $278,835, $215,039, and $109,701 have been authorized and charged to income for the years ended December 31, 1995, 1994, and 1993, respectively.\nIn the normal course of business, the Company is involved with various negotiations and legal matters. In addition, Rio Properties is a potential defendant in various personal injury allegations. Management is of the opinion that the effect of these matters is not material to the consolidated financial statements.\n9. STOCKHOLDERS' EQUITY\nCOMMON STOCK\nDuring 1995, the Company issued 198,300 shares of Common Stock at exercise prices ranging from $3.00 per share to $14.25 per share pursuant to options previously granted under the Company's Non-Statutory Stock Option Plan (\"NSOP\").\nDuring 1995, the Company repurchased 430,500 shares of Common Stock from time to time in the open market at a total cost of $5.4 million. The repurchased shares of Common Stock were retired.\nDuring 1994, the Company issued 223,550 shares of Common Stock at exercise prices ranging from $3.00 per share to $15.625 per share pursuant to options previously granted under the Company's NSOP.\nOn November 24, 1993, the Company sold in a public offering 2,300,000 shares of Common Stock at a net price per share of $13.60. The proceeds from the sale were received in November 1993.\nDuring 1993, the Company issued 247,000 shares of Common Stock at exercise prices ranging from $3.00 per share to $6.00 per share pursuant to options previously granted under the Company's NSOP.\nSTOCK OPTIONS\nKey officers and employees are eligible to participate in the Company's NSOP. The Company has granted 2,856,500 options at exercise prices ranging from $3.00 to $15.625 per share. As of December 31, 1995, 704,250 options had been exercised and 364,400 option had been forfeited, resulting in 1,787,850 options outstanding and 145,400 options available to be granted under the NSOP.\nThe NSOP will terminate July 8, 1997, subject to the right of the Board of Directors to terminate the NSOP prior thereto.\nOn September 5, 1991, the Company's Board of Directors adopted the 1991 Directors' Stock Option Plan, which was ratified by the Company's stockholders on May 16, 1992. On March 28, 1995, the Company's Board of Directors amended the 1991 Directors' Stock Option Plan, which was ratified by the Company's Stockholders on May 16, 1995, under which options to purchase up to 200,000 shares of Common Stock may be granted to non-employee directors. The option exercise price is 100% of the fair market value of the Common Stock on the date of grant. As of December 31, 1995, 108,000 options had been granted at exercise prices ranging from $3.00 per share to $16.625 per share. As of December 31, 1995, 20,000 options had been exercised and 22,000 options had been forfeited, resulting in 66,000 options outstanding and 114,000 options available to be granted under the Directors' Stock Option Plan.\n10. RELATED PARTY TRANSACTIONS\nThe Company contracted with two affiliates of the Company's largest stockholder for the design and construction of a 41- story hotel tower containing approximately 1,000 suites (the \"Phase V Expansion\") for a total of $177,109,805. As of December 31, 1995, the Company had capitalized $6,256,458 in connection with these contracts. As of December 31, 1995, $4,151,712 has been accrued in connection with these construction and design contracts.\nThe Company contracted with two affiliates of the Company's largest stockholder for the design and construction of an addition to an existing 21-story hotel tower of 141 additional suites (the \"Phase IV Expansion\") for a total of $18,848,258. As of December 31, 1995, the Company had capitalized $16,565,576 in connection with these contracts. As of December 31, 1995, $1,663,182 had been accrued in connection with these construction and design contracts.\nThe Company contracted with two affiliates of the Company's largest stockholder for the design and construction of a 21- story hotel tower containing 549 suites (the \"Phase III\nExpansion\") for a total of $64,166,368. As of December 31, 1995 and 1994, the Company had capitalized $62,026,368 and $37,241,468 in connection with these contracts. As of December 31, 1995 and 1994, $372,370 and $10,026,210 had been accrued in connection with these contracts.\nIn 1993, the Company contracted with two affiliates of the Company's largest stockholder for the design and construction of a 21-story hotel tower containing 437 suites (the \"Tower Expansion\") and an expansion of the Rio's public area (the \"Eastside Expansion\"). The two contracts were in amounts not to exceed $57,557,093. As of December 31, 1994, all amounts due in connection with these contracts had been capitalized and paid.\nIn December 1991, the Company sold non-Rio real estate to an affiliate of the Company's largest stockholder. In April 1994, the affiliated entity sold the real estate to a non- related party. Pursuant to the terms of the sales agreement, the Company was entitled to a portion of the sales proceeds which equaled $966,510, net of expenses.\nThe Company reimbursed an affiliate of the Company's largest stockholder for certain expenses advanced on behalf of or supplied to the Company during the years ended December 31, 1995 and December 31, 1993 of approximately $878,428 and $162,425, respectively. Nominal amounts were paid by the Company to the affiliate for similar purposes during 1994. Such amounts were generally billed to the Company at the affiliate's cost.\nTwo director\/officers of the Company are associated with affiliated entities which render various architectural and construction services for the Company. The Company paid these entities, in the aggregate, approximately $51,018,430, $50,416,348, and $44,567,088 during the years ended December 31, 1995, 1994, and 1993, respectively, for their services.\nEntities in which a director of the Company is the principal stockholder and the executive officer received commissions from the Company totaling approximately $158,789, $124,912 and $90,325 for the years ended December 31, 1995, 1994, and 1993, respectively, arising out of the acquisition of various insurance coverages by the Company.\nThe Company believes that the transactions described above are on terms at least as favorable as would have been obtained from non-related parties.\n11. DEBT GUARANTEE\nSummarized financial information is provided below for Rio Properties, the Company's principal wholly-owned operating subsidiary, as sole guarantor to the Company's $100,000,000 10 5\/8% Senior Subordinated Notes Due 2005. The Subordinated Notes are fully and unconditionally guaranteed by Rio Properties and are subordinated to all existing and future indebtedness and other liabilities (including trade payables) of the Company's subsidiaries.\nSummarized financial statements of Rio Properties have been prepared since the assets, pre-tax income and parents' net investment in the non-guarantor subsidiaries on an individual and combined basis are inconsequential. In addition, the Company's operations or assets other than its investment in its subsidiaries are inconsequential. The difference in net equity between the Company and Rio Properties is principally a result of the Company's purchase in 1990 and 1992 of minority interests in a subsidiary, resulting in the payment of premiums of approximately $13.7 million and $1.3 million, respectively. The premiums were allocated by the Company, based on fair market values, among land, building and equipment, furniture and improvements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThis information is incorporated by reference from the Company's Proxy Statement to be filed with the Commission in connection with the Company's annual meeting of stockholders on May 23, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information is incorporated by reference from the Company's Proxy Statement to be filed with the Commission in connection with the Company's annual meeting of stockholders on May 23, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is incorporated by reference from the Company's Proxy Statement to be filed with the Commission in connection with the Company's annual meeting of stockholders on May 23, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information is incorporated by reference from the Company's Proxy Statement to be filed with the Commission in connection with the Company's annual meeting of stockholders on May 23, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nIncluded in Part II of this report:\nConsolidated Balance Sheets at December 31, 1995 and December 31, 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\n2. Financial Statement Schedules\nIncluded in Part IV of this report:\nSchedule III - Condensed Financial Information of Registrant\nSchedule VIII - 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 financial statements or notes thereto.\n3. Exhibits\nNumber Exhibit Description\n3.01 Amended and Restated Articles of Incorporation of Rio Hotel & Casino, Inc. filed July 19, 1994, are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-Q for the Quarter Ended June 30, 1994, Part II, Item 6(a), Exhibit 4.01.\n3.02 Amended and Restated Bylaws of Rio Hotel & Casino, Inc., certified March 3, 1993, are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1992, Part IV, Item 14, Exhibit 4.02.\n4.01 Specimen common stock certificate for the common stock of Rio Hotel & Casino, Inc. is incorporated herein by reference from the Company's (SEC File No. 333-869) Registration Statement on Form S-3, filed on February 12, 1996, Part II, Item 15, Exhibit 4.03.\n4.02 Agreement and Plan of Exchange by and between Rio Hotel & Casino, Inc., a Nevada corporation, and Rio Properties, Inc., a Nevada corporation, dated August 14, 1992, is incorporated herein by reference from the Company's (SEC File No. 33-51092) Registration Statement on Form S-3 filed on August 24, 1992, Part II, Item 16, Exhibit 2.01.\n4.03 Form of Subscription and Exchange Agreement between Rio Properties, Inc., MarCor Resorts, Inc., and subscriber is incorporated herein by reference from the Company's (SEC File No. 33-51092) Registration Statement on Form S-3 filed on August 24, 1992, Part II, Item 16, Exhibit 2.02.\n4.04 Rio Hotel & Casino, Inc. Non-Statutory Stock Option Plan, as amended September 5, 1991, as amended February 28, 1992 (to reflect change in Company name) and as amended June 22, 1993, is incorporated herein by reference from the Company's (SEC File No. 33-38752) Registration Statement on Form S-8 filed on October 5, 1993, Part II, Item 8, Exhibit 4.04.\n4.05 Rio Hotel & Casino, Inc. Directors' Stock Option Plan As Amended February 28, 1992 (to reflect change in Company name only) is incorporated herein by reference from the Company's (SEC File No. 2-88147) Report on Form 10-K for the Year Ended December 31, 1991, Part IV, Item 14(c), Exhibit 4.07.\n4.06 Rio Suite Hotel & Casino Employee Retirement Savings Plan Trust Agreement dated February 11, 1991; First Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated March 20, 1992, effective April 1, 1992; Second Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated March 20, 1992, effective April 1, 1992; Third Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated December 14, 1992, effective August 15, 1992, and Rio Suite Hotel & Casino Employee Retirement Savings Plan, Participant Loan Program dated March 19, 1992 are incorporated herein by reference from the Company's (SEC File No. 33-56860) Registration Statement on Form S-8 filed January 8, 1993, Part II, Item 8, Exhibit 4.11; Rio Suite Hotel & Casino Employment Retirement Savings Plan dated February 21, 1991 is incorporated herein by reference from the Company's (SEC File No. 33-56860) Registration Statement on Form S-8 filed February 3, 1993, Part II, Item 8, Exhibit 4.11; Fourth Amendment to the Rio Suite Hotel & Casino Employee\nRetirement Savings Plan dated April 30, 1993, effective July 1, 1993; Fifth Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated August 17, 1993, effective July 1, 1993; Sixth Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated October 27, 1993, effective October 25, 1993; Seventh Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan Trust Agreement dated and effective December 16, 1993; and Eighth Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated May 3, 1994, effective May 1, 1994 are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-Q for the Quarter Ended June 30, 1994, Part II, Item 6(a), Exhibit 4.03; Ninth Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated August 26, 1994, effective August 25, 1994; Tenth Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated and effective January 1, 1995; and Eleventh Amendment to the Rio Suite Hotel & Casino Employee Retirement Savings Plan dated and effective January 12, 1995 are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 4.08.\n4.07 Rio Hotel & Casino, Inc. 1995 Long-Term Incentive Plan, as adopted January 16, 1995 is incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 4.09.\n4.08 Credit Agreement among Bank of America National Trust and Savings Association, as agent for itself and other financial institutions, as Lenders, and Rio Properties, Inc., as Borrower, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America National Trust and Savings Association, in the amount of $9,692,307.70 dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America Nevada, in the amount of $3,230,769.23, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of Societe Generale, in the amount of $6,461,538.46, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of NBD Bank, N.A., in the amount of $6,461,538.46, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of First Security Bank of Idaho, N.A., in the amount of $6,461,538.46, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of First Interstate Bank of Nevada, N.A., in the amount of $6,461,538.46, dated July 15, 1993; Line A Note executed by Rio Properties, Inc., as Borrower, in favor of U.S. Bank of Nevada, in the amount of $3,230,769.23, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America National Trust and Savings Association, in the amount of $5,307,692.30 dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America Nevada, in the amount of\n$1,769,230.77, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of First Interstate Bank of Nevada, N.A., in the amount of $3,538,461.54, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of First Security Bank of Idaho, N.A., in the amount of $3,538,461.54, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of NBD Bank, N.A., in the amount of $3,538,461.54, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of Societe Generale, in the amount of $3,538,461.54, dated July 15, 1993; Line B Note executed by Rio Properties, Inc., as Borrower, in favor of U.S. Bank of Nevada, in the amount of $1,769,230.77, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America National Trust and Savings Association, in the amount of $15,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of Bank of America Nevada, in the amount of $5,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of First Interstate Bank of Nevada, N.A., in the amount of $10,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of First Interstate Bank of Idaho, N.A., in the amount of $10,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of NBD Bank, N.A., in the amount of $10,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of Societe Generale, in the amount of $10,000,000, dated July 15, 1993; Revolving Note executed by Rio Properties, Inc., as Borrower, in favor of U.S. Bank of Nevada, in the amount of $5,000,000, dated July 15, 1993; Security Agreement executed by Rio Properties, Inc., as Debtor, in favor of Bank of America National Trust and Savings Association, as agent for itself and other financial institutions, as Secured Party, dated July 15, 1993; Construction Deed of Trust With Assignment of Rents and Fixture Filing among Rio Properties, Inc., as Trustor, Equitable Deed Company, as Trustee, and Bank of America National Trust and Savings Association, as agent for itself and the other financial institutions, as Beneficiary, dated July 15, 1993; Unsecured Indemnity Agreement executed by Rio Properties, Inc., as Indemnitor, in favor of Bank of America National Trust and Savings Association, as agent for itself and other financial institutions, dated July 15, 1993; Guaranty executed by Rio Hotel & Casino, Inc., as Guarantor, in favor of Bank of America National Trust and Savings Association, as agent for itself and other financial institutions, as Guaranteed Parties, dated July 15, 1993; and, Parent Guarantor Security Agreement by Rio Hotel & Casino, Inc., as Debtor, in favor of Bank of America National Trust and Savings Association, as agent for itself and other financial institutions, as Secured Party, dated July 15, 1993 are incorporated by reference from the Company's (SEC File No. 2-88147) Report on Form 8-K dated July 15, 1993, Item 7(c), Exhibit 28.01; First Amendment to Credit Agreement dated as of October 25, 1993 and Second Amendment and Waiver to Credit Agreement dated as of November 8, 1993 among Rio Properties, Inc., Bank of America National Trust and Savings Association, Bank of America Nevada, First Interstate Bank\nof Nevada, First Security Bank of Idaho, N.A., NBD Bank, N.A., Societe Generale, and U.S. Bank of Nevada are incorporated by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1993, Part IV, Item 14(c), Exhibit 4.09; Third Amendment to Credit Agreement dated as of April 15, 1994 among Rio Properties, Inc., Bank of America National Trust and Savings Association, as Agent and as a Bank, Bank of America, Nevada, First Interstate Bank of Nevada, First Security Bank of Idaho, N.A, NBD Bank, N.A., Societe Generale, and U.S. Bank of Nevada; Memorandum of Amendments to Credit Agreement and Amendment to Construction Deed of Trust with Assignment of Rents and Fixture Filing dated as of May 9, 1994 by Rio Properties, Inc. and Bank of America National Trust and Savings Association are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-Q for the Quarter Ended June 30, 1994, Part II, Item 6(a), Exhibit No. 4.02; and Fourth Amendment to Credit Agreement among Rio Properties, Inc., as Borrower, and Bank of America National Trust and Savings Association, First Interstate Bank of Nevada, First Security Bank of Idaho, N.A., NBD Bank, N.A., Societe Generale, Bank of America, Nevada, U.S. Bank of Nevada, Bank of Scotland and Midlantic Bank, N.A., as Lenders; and Second Memorandum of Amendment to Credit Agreement and Amendment to Construction Deed of Trust with Assignment of Rents and Fixture Filing between Borrower and Bank of America National Trust and Savings Association, as agent for Lenders, dated December 16, 1994 are incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 8-K dated December 16, 1994, Item 7(c), Exhibit 10.01; Fifth Amendment to Credit Agreement dated as of March 20, 1995, among Rio Properties, Inc., Bank of America National Trust and Savings Association, as Agent and as a Bank, First Interstate Bank of Nevada, First Security Bank of Idaho, N.A., NBD Bank, N.A., Societe Generale, Bank of America Nevada, U.S. Bank of Nevada, Bank of Scotland and Midlantic Bank, N.A., as Banks, is incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.09; Sixth Amendment to Credit Agreement dated as of July 31, 1995 among Rio Properties, Inc., Bank of America National Trust and Savings Association, as Agent and as a Bank, and First Interstate Bank of Nevada, First Security Bank of Idaho, N.A., NBD Bank, N.A., Societe Generale, Bank of America Nevada, U.S. Bank of Nevada, Bank of Scotland, Midlantic Bank, N.A., and Bank of Hawaii, as Banks is incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 8-K dated September 15, 1995, Item 7(c), Exhibit 4.01; and Seventh Amendment to Credit Agreement dated as of January 17, 1996 among Rio Properties, Inc., Bank of America National Trust and Savings Association, as Agent and as a Bank, and First Interstate Bank of Nevada, First Security Bank of Idaho, N.A., Societe Generale, Bank of America Nevada, U.S. Bank of Nevada, Bank of Scotland, Midlantic Bank, N.A., and Bank of Hawaii, as Banks.\n4.09 Indenture dated as of July 21, 1995, among Rio Hotel & Casino, Inc., Rio Properties,\nInc. and IBJ Schroder Bank & Trust Company for the Company's 105\/8% Senior Subordinated Notes Due 2005 is incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 8-K dated July 18, 1995, Item 7(c), Exhibit 4.3.\n4.10 Registration Agreement dated July 18, 1995 by Rio Hotel & Casino, Inc. and accepted July 18, 1995 by Salomon Brothers Inc. and Montgomery Securities is incorporated herein by reference from the Company's (SEC File No. 0- 13760) Report on Form 8-K dated July 18, 1995, Item 7(c), Exhibit 4.2.\n4.11 Form of Letter of Transmittal to IBJ Schroder Bank & Trust Company as Exchange Agent for exchange of 105\/8% Senior Subordinated Notes Due 2005 is incorporated herein by reference from the Company's (SEC File No. 33- 62163) Registration Statement on Form S-4 filed August 28, 1995, Part II, Item 21(a), Exhibit 4.14.\n10.01 Agreement by and among MarCor Resorts Inc., Marnell Corrao, Inc., Marnell Corrao Associates, Inc., MarCor Partnership, The Anthony A. Marnell II Revocable Living Trust dated June 16, 1982, Anthony A. Marnell II, Sandra J. Marnell, Barrett Family Revocable Living Trust dated December 18, 1981, James A. Barrett, Jr. and Maureen M. Barrett dated February 22, 1989, is incorporated herein by reference from the Company's (SEC File No. 0-13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.01; First Amendment to Agreement dated October 25, 1993 by and among Rio Hotel & Casino, Inc., and Marnell Corrao, Inc., Marnell Corrao Associates, Inc., MarCor Partnership, Anthony A. Marnell II, Barrett Family Revocable Living Trust dated December 18, 1981, James A. Barrett, Jr. and Maureen M. Barrett incorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1993, Part IV, Item 14(c), Exhibit 10.01.\n10.02 Interest Rate Swap Agreement dated as of July 28, 1993 between Rio Properties, Inc. and Bank of America National Trust and Savings Association is incorporated herein by reference from the Company's (SEC File No. 0- 13760) Report on Form 10-K for the Year Ended December 31, 1993, Part IV, Item 14(c), Exhibit 10.11.\n10.03 Architectural Agreement entered into as of February 25, 1994 between Rio Hotel & Casino, Inc., as Owner, and Anthony A. Marnell II, Chartered, as Architect, is incorporated herein by reference from the Company's (SEC File No. 0-13760), Report on Form 10-K for the Year Ended December 31, 1993, Part IV, Item 14(c), Exhibit 10.12.\n10.04 Building Contract entered into as of February 25, 1994 between Marnell Corrao Associates, Inc., as General Contractor, and Rio Properties, Inc., as Owner, is\nincorporated herein by reference from the Company's (SEC File No. 0-13760) Report on Form 10-K for the Year Ended December 31, 1993, Part IV, Item 14(c), Exhibit 10.13.\n10.05 Architectural Agreement entered into as of February 9, 1995 between Rio Hotel & Casino, Inc., as Owner, and Anthony A. Marnell, Chartered, as Architect, is incorporated herein by reference from the Company's (SEC File No. 0-13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.08.\n10.06 Building Contract entered into as of February 27, 1995 between Marnell Corrao Associates, Inc., as General Contractor, and Rio Properties, Inc., as Owner, is incorporated herein by reference from the Company's (SEC File No. 0-13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.09.\n10.07 Real Estate Purchase and Sale Agreement entered into as of January 25, 1995 between Focus 2000, Inc., as Seller, and Rio Properties, Inc., as Buyer, is incorporated herein by reference from the Company's (SEC File No. 0- 13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.10.\n10.08 Exchange Agreement entered into as of January 6, 1995 between Allied Building Materials, Cinderlane, Inc., and Rio Hotel & Casino, Inc. is incorporated herein by reference from the Company's (SEC File No. 0-13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.11.\n10.09 Letter Agreement regarding Rate Cap Transaction dated August 11, 1994 between Bank of America National Trust and Savings Association and Rio Properties, Inc. is incorporated herein by reference from the Company's (SEC File No. 0-13760) Annual Report on Form 10-K for the Year Ended December 31, 1994, Part IV, Item 14(c), Exhibit 10.12.\n10.10 Architectural Agreement entered into as of July 27, 1995 between Rio Hotel & Casino, Inc., as Owner, and Anthony A. Marnell II, Chtd., as Architect, is incorporated herein by reference from the Company's (SEC File No. 333-869) Registration Statement on Form S-3, filed on February 12, 1996, Part II, Item 16, Exhibit 10.10.\n10.11 Building Contract entered into as of August 14, 1995 by and between Marnell Corrao Associates, Inc., as General Contractor, and Rio Properties, Inc., as Owner, is incorporated herein by reference from the Company's (SEC File No. 333-869) Registration Statement on Form S-3, filed on February 12, 1996, Part II, Item 16, Exhibit 10.11.\n21.01 List of the Company's subsidiaries.\n23.01 Consent of Arthur Andersen LLP.\n27.01 Financial Data Schedule.\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.\nDECEMBER 31, 1995\nTax benefit arising from the exercise of stock options granted under the NSOP totaled $632,601.\nDECEMBER 31, 1994\nTax benefit arising from the exercise of stock options granted under the NSOP totaled $886,132.\nDECEMBER 31, 1993\nAdditional costs of issuing Common Stock financed through payables totaled $12,194.\nCosts of issuing Common Stock financed through payables totaled $163,801.\nTax benefit arising from the exercise of stock options granted under the Company's NSOP totaled $1,120,823.\nReduction of paid-in capital as a result of the implementation of SFAS 109 totaled $832,152. This amount was charged directly against equity because it reflects the tax effect of SFAS 109 as it related to the gain on sale of assets to affiliates of the Company's largest stockholder in December 1991, which was also recorded directly to equity (Note 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.\nRIO HOTEL & CASINO, INC.\nMarch 15, 1996 By: \/S\/ ROGER M. SZEPELAK Roger M. Szepelak, 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.","section_15":""}
{"filename":"105076_1995.txt","cik":"105076","year":"1995","section_1":"ITEM 1. BUSINESS.\nNATURE OF THE BUSINESS\nThe company, incorporated under the laws of the State of Wisconsin in 1899, manufactures and sells paper. The company is organized into a small corporate staff consisting of principal executive officers and two operating divisions: the Printing and Writing Division consisting of a paper and pulp mill in Brokaw, Wisconsin and Wausau Papers of New Hampshire, Inc., a wholly-owned subsidiary which operates a paper mill in Groveton, New Hampshire; and the Rhinelander Division which consists of Rhinelander Paper Company, Inc., a wholly-owned subsidiary operating a paper mill in Rhinelander, Wisconsin. The company's executive offices are located in Wausau, Wisconsin.\nThe company's export sales are administered through Wausau Papers International, Inc., a wholly-owned subsidiary which acts as a foreign sales corporation (FSC).\nUnless stated otherwise, the terms \"company\" and \"Wausau Papers\" mean the company and its subsidiaries.\nSEGMENT INFORMATION\nPaper manufacturing is the company's only line of business.\nPRINTING AND WRITING DIVISION\nThe Printing and Writing Division manufactures fine printing, writing and specialty papers at the Brokaw, Wisconsin and Groveton, New Hampshire mills. The division's product lines include recycled products made with 20% of the total fiber content from post-consumer waste. These papers are sold to paper distributors and converters throughout the United States and Canada. Typical end uses for these fine papers include printed advertising, corporate external reports, office papers and converted products such as announcements and greeting card envelopes.\nThe Printing and Writing Division was formed in 1993 by combining the operations of the company's Brokaw Division and the manufacturing facilities at Groveton, New Hampshire. The Groveton facilities were purchased from James River Corporation on April 1, 1993, by the company's wholly-owned subsidiary, Wausau Papers of New Hampshire, Inc.\nRHINELANDER DIVISION\nThe Rhinelander Division, located in Rhinelander, Wisconsin, manufactures lightweight, dense, technical specialty papers which are sold directly to converters and end users throughout the United States. International markets for Rhinelander's products include Canada, the Pacific Rim, Europe, Mexico, Central and South America. Typical end uses for these papers are pressure sensitive products, silicone coated products, medical packaging, food packaging and multiple laminated products. Small volumes of yeast and lignosulfonates are also manufactured. These products are sold for use as food additives, pet food ingredients and for other end uses.\nEXPORT SALES\nWausau Papers International, Inc. has been the commissioned sales agent for the export sales of the company since September 1, 1992. Wausau Papers International, Inc. has elected to be treated as a FSC for federal income tax purposes.\nRAW MATERIALS\nPulp is the basic raw material for paper production. Approximately 60% of the pulp consumed by the Brokaw mill is manufactured internally from aspen, which is in abundant supply. The remaining 40% of required pulp at Brokaw and all of the required pulp at the Rhinelander and Groveton mills is purchased from pulp mills throughout the United States and Canada. Although pulp prices increased approximately 70% in 1995 due to strong demand, purchased pulp is in adequate supply and readily obtained from both domestic and foreign sources.\nRecycled, de-inked fiber with a high content of post-consumer waste is also purchased from domestic suppliers as part of the fiber requirements for the Printing and Writing Division's recycled products. Recycled fiber is also in adequate supply and readily obtained.\nVarious chemicals are used in the pulping and papermaking processes. These industrial chemicals are all available from a number of suppliers and are purchased at current market prices.\nENERGY\nThe company's paper mills require large amounts of electrical energy and steam which are adequately supplied by public utilities or generated at company operated facilities. The Brokaw mill operates a power plant which provides all of the mill's steam requirements. The power plant is fueled by natural gas, which is in adequate supply, with fuel oil being an alternate energy source. The Brokaw mill purchases 100% of its electrical requirements from a public utility company. The Groveton mill operates a power plant which provides 100% of the mill's steam requirements and a portion of its electrical needs. The primary fuels burned at Groveton are wood chips and fuel oil. The Rhinelander Division maintains a coal burning plant capable of generating the mill's steam needs and nearly half of its electrical needs. The Groveton and Rhinelander mills purchase nearly 85% and 60% of their electrical needs, respectively, from public utility companies. The fuels used at each mill are all available on a contract basis at prevailing market prices.\nOn July 21, 1995, Rhinelander Paper Company and Wisconsin Public Service Corporation (WPS) issued a joint press release announcing cancellation of plans to build the Rhinelander Energy Center cogeneration power plant in the City of Rhinelander. The two companies were unable to agree upon several fundamental issues arising during the regulatory approval process. As stated in the joint announcement, \"following an in-depth financial analysis and a lengthy negotiation process, Rhinelander Paper Company decided it was not feasible to continue and decided to terminate the negotiations.\" The company has purchased a 200,000 pound per hour natural gas and oil-fired boiler which is scheduled for installation in December 1995 as part of a paper production capacity expansion. Rhinelander's existing coal-fired boilers together with the new gas and oil-fired boiler are expected to meet the mill's energy requirements for the next several years. The company is developing a plan for meeting the long range energy needs of the Rhinelander mill.\nPATENTS AND TRADEMARKS\nThe company develops and files trademarks and patents, as appropriate. The company does not own or hold material licenses, franchises or concessions.\nSEASONAL NATURE OF BUSINESS The markets for some of the grades of paper produced by the company tend to be somewhat seasonal. However, the marketing seasons for these grades are not necessarily the same. Overall, the company generally experiences lower sales in the second fiscal quarter, in comparison to the rest of the year, primarily due to downtime typically taken by its customers during the holiday season.\nWORKING CAPITAL\nAs is customary in the paper industry, the company carries adequate amounts of raw materials and finished goods inventory to facilitate the manufacture and rapid delivery of paper products to its customers.\nMAJOR CUSTOMERS\nAvery Dennison Corporation accounted for 12.0% of consolidated net sales in fiscal 1995. The loss of this customer could have an initial material adverse effect; however, the company believes that satisfactory alternative marketing arrangements could be made.\nBACKLOG\nOrder backlog of the company's products at August 31, 1995 amounted to approximately $24,981,000, or approximately 2 weeks of operation. This is 16% lower on a tonnage basis than the backlog of orders of approximately $25,672,000 or nearly 3 weeks of operation at August 31, 1994. The backlog decrease is due to reduced demand for the company's technical specialty grades. Customer demand improved somewhat at the end of fiscal 1995, which the company expects to continue in fiscal 1996.\nBacklog totals are not a true indicator of the strength of the company's business activity. A significant and growing volume of orders are shipped out of inventory promptly upon order receipt. This portion of the business is not reflected in the company's backlog totals. The entire August 31, 1995 backlog is expected to be shipped during fiscal 1996.\nCOMPETITIVE CONDITIONS\nThe company competes in different markets within the paper industry. Each of its two divisions serves distinct market niches. The Printing and Writing Division produces fine printing and writing papers, of which over 60% are colored papers. Fine printing and writing sales are estimated to be less than 3% of the total market. The division's competitors range from small to large paper manufacturers and represent many different product lines. The division distributes its products primarily through paper wholesalers. The Rhinelander Division produces technical specialty papers and is a leader in its markets. Rhinelander's market position varies by product segment and, thus, competition also includes small to large paper manufacturers. Rhinelander sells its products directly to converters and end users. The various markets for the products of the company are highly competitive, with competition based on service, quality and price.\nRESEARCH AND DEVELOPMENT\nExpenditures for product development were approximately $1,219,000 in 1995, $1,158,000 in 1994, and $957,000 in 1993.\nENVIRONMENT\nWausau Papers, like its competitors in the paper industry, is subject to increasingly stringent environmental regulations. The company has made substantial capital investments and operating expenditures in order to construct, maintain and operate the facilities necessary to maintain compliance with environmental regulations. The company is currently rebuilding and expanding the wastewater treatment plant for the Brokaw mill and expects to complete the project in fiscal 1997 at a total cost of $14.5 million. The company estimates that its capital expenditures for other environmental purposes will be less than $5 million per year in fiscal 1996 and 1997.\nThe company has not been identified as a potentially responsible party at any site designated for remedial action under the federal Superfund law. The company is required to monitor conditions relative to its past waste disposal activities and may be required to take remedial action if conditions are discovered which warrant such action.\nThe United States Environment Protection Agency (EPA) has proposed air and water pollution reduction standards which could require significant expenditures by the pulp and paper industry. The final rules are expected to be promulgated within the next calendar year and to require compliance three years after promulgation. One major aspect of the proposed new regulations is extremely stringent standards for the discharge of chlorinated organics that are produced as byproducts of pulp bleaching processes that use elemental chlorine or chlorine compounds. The company maintains pulp bleaching operations only at its Brokaw mill. In 1988, the company installed an oxygen delignification system which eliminated the use of elemental chlorine; however, chlorine compounds are used in other stages of the bleaching process. The company is unable to predict with certainty the amount of capital expenditures and operating costs that it will incur in the future in order to comply with the proposed new EPA rules and other environmental regulations but it believes that such costs will not have a material adverse effect on its financial position or results of operations.\nEMPLOYEES\nThe company had 1,722 employees at August 31, 1995. The company has collective bargaining contracts with the United Paperworkers International Union covering approximately 1,335 employees. These contracts expire in December 1995, May 1996 and March 1997 at the Rhinelander, Brokaw and Groveton mills, respectively. The company considers its relationship with its employees to be excellent. Eligible employees participate in retirement plans and group life, disability and medical insurance programs.\nEXECUTIVE OFFICERS\nThe executive officers of the company as of October 1, 1995, their ages, their positions and offices with the company and their principal occupations during the past five years are as follows:\nSAN W. ORR, JR., 54\nChairman of the Board of Directors since December 1989 and, since July 1994, Chief Executive Officer, and Director since April 1970; also, Attorney, Estates of A.P. Woodson and Family; also, a director of Mosinee Paper Corporation, MDU Resources Group, Inc and Marshall & Ilsley Corporation.\nDANIEL D. KING, 48\nDirector, President and Chief Operating Officer since July 1994; Senior Vice President, Printing and Writing Division, December 1993 to July 1994; Vice President and General Manager, Brokaw Division, September 1990 to December 1993.\nLARRY A. BAKER, 56\nSenior Vice President, Administration since December 1990; prior thereto, Vice President, Administration.\nSTEVEN A. SCHMIDT, 41\nVice President, Finance, Secretary and Treasurer since June 1, 1993; Corporate Controller, August 1992 to June 1993; prior thereto, Plant Controller, Georgia Pacific Corporation, formerly Nekoosa Papers, Inc., March 1989 to August 1992.\nMELVIN L. DAVIDSON, 59\nVice President and General Manager, Rhinelander Division since August 1987; prior thereto, Vice President Marketing and Sales, Rhinelander Division.\nTHOMAS J. HOWATT, 46\nVice President and General Manager, Printing and Writing Division since December 1994; Vice President and General Manager, Groveton, April 1, 1993 to December 1994; Vice President Operations, Brokaw Division, September 1990 to April 1993; prior thereto, Vice President, Administration, Brokaw Division.\nAll executive officers of the company are elected annually by the Board of Directors.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe company's executive offices are located in Wausau, Wisconsin on property leased to the company under a lease which expires on December 31, 2005. There are renewal options for another 25 years.\nThe company's Brokaw, Wisconsin mill operated at 2% below capacity during fiscal 1995 as a result of capital improvement related outages, producing approximately 450 tons of finished paper per day. The mill facility provides approximately 60% of its pulp requirements from its own hardwood sulphite pulp mill. Brokaw mill facilities are situated on approximately 270 acres of land, all owned by the company.\nThe Groveton, New Hampshire mill operated at 96% of capacity in fiscal 1995, producing approximately 276 tons of finished paper per day. At capacity, the Groveton mill can produce over 100,000 tons of finished paper annually. The company's facilities occupy 124 acres of land all owned by the company's wholly-owned subsidiary, Wausau Papers of New Hampshire, Inc.\nThe company's mill in Rhinelander, Wisconsin operated at 95% of capacity in fiscal 1995, producing an average of 385 tons of finished paper per day. Some extended downtime was taken on the four paper machines during the third and fourth quarters of fiscal 1995 due to market weakness in its product lines. Its facilities, which include a yeast and lignosulfonate processing plant capable of producing 21,000 pounds of torula yeast per day, occupy 72 acres of land, all owned by Rhinelander Paper Company, Inc.\nThe company owns approximately 43,500 acres of timberland in Wisconsin. The company believes the market value of these lands exceeds the August 31, 1995 book value of $1,494,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nLegal proceedings are discussed in Note 11 to the Consolidated Financial Statements on page 32 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 shareholders during the fourth quarter of fiscal 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 trades on The Nasdaq Stock Market under the symbol WSAU. The number of shareholders of record as of October 10, 1995 was 2,033. The company believes that there are approximately 4,467 additional beneficial owners whose shares are held in street name accounts or in other fiduciary capacities. The total estimated number of shareholders as of October 10, 1995, is 6,500. Information related to high and low closing prices and dividends is explained in detail in Item 8, Financial Statements and Supplementary Data, and appears on page 33 of this report. Dividend restrictions under certain loan covenants are explained in Note 4 to the Consolidated Financial Statements which is found on page 23 of this report.\nAll shares and per share data have been restated to reflect the 10% stock dividend in 1995, the four-for-three stock splits in 1994 and 1993, the two-for-one stock split in 1992, and the five-for-four stock split-up, effected in the form of a dividend, in 1991. This summary should be read in conjunction with the consolidated financial statements which follow.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nOVERVIEW\nThe company achieved record sales and shipments in fiscal 1995, while earnings were lower compared to the prior year. Net sales were $515.7 million in fiscal 1995, up 21% from 1994. Shipments of 399,300 tons were ahead of last year's level by 12%. Fiscal 1995 net earnings declined 26% to $31.3 million compared to fiscal 1994 earnings, before an accounting change, due to higher pulp costs and a slowdown in demand for the company's technical specialty products.\nThe pulp and paper industry experienced continued strong demand throughout most of fiscal 1995. Favorable market conditions and successful marketing of the company's printing and writing grades supported full operations at the Groveton mill since October 1994. Strong demand for the company's technical specialty grades during the first half of fiscal 1995 was followed by a slowdown in demand during the second half of the year, requiring the company to take extended downtime at its Rhinelander mill.\nStrong world-wide demand for paper caused continued strong demand for pulp in fiscal 1995. Market pulp prices increased approximately 70% on average in 1995 over the prior year. The company was able to implement several paper price increases during the year; however, market pressures prevented the company from recovering all of the increased pulp costs through higher paper prices. Higher paper prices, increased volume, production improvements and cost reduction efforts were not of sufficient magnitude to totally offset the negative effect of higher pulp costs on earnings.\nNET SALES\nNet sales for fiscal 1995 were a record $515.7 million, up 20.9% over fiscal 1994 net sales of $426.5 million. Fiscal 1993 net sales were $381.8 million. Shipments were a record 399,300 tons in 1995, an increase of 12.4% over the 355,100 tons shipped in 1994. Shipments were 310,600 tons in 1993. The shipment growth experienced in fiscal 1995 was mainly due to successfully marketing the production capacity of the Groveton, New Hampshire mill.\nDemand for the company's printing and writing grades was strong in fiscal 1995, supporting the October 1994 start-up and continued operation of the second paper machine at the Groveton mill. Shipments at the Printing and Writing Division increased 23.2% in fiscal 1995 over prior year results. Continued growth of the company's printing and writing products is expected in fiscal 1996. The company's Rhinelander Division experienced strong demand for its technical specialty products during the first half of fiscal 1995, followed by softer customer demand across all of its product lines during the second half of the year. Downtime was taken on all paper machines at the Rhinelander mill in the last four months of the fiscal year as a result of the market weakness and the need to reduce paper inventories. Shipments of Rhinelander's products were down 3.8% in fiscal 1995 compared to the previous year. Shipments of pressure sensitive products, its largest product segment, were down 6.1% over 1994 results. Some improvement in demand was experienced at the end of fiscal 1995 which the company expects to continue in fiscal 1996.\nOrder backlog at August 31, 1995 was $25.0 million, compared to order backlogs of $25.7 million and $22.3 million at August 31, 1994 and 1993, respectively. The order backlog at August 31, 1995, on a tonnage basis, is 16% lower than at the end of fiscal 1994 and 5% below the order backlog at the end of fiscal 1993. Order backlog at the end of fiscal 1995 is lower than a year ago due to the reduced demand for the company's technical specialty grades. Backlog totals are not an accurate indicator of the company's business strength, however, as a significant and growing volume of orders are shipped out of inventory promptly upon order receipt.\nGROSS PROFIT\nGross profit decreased to 15.7% of net sales for fiscal 1995 compared to 22.8% for the previous year. The gross profit margin was 23.3% in fiscal 1993. The reduced gross profit margin in fiscal 1995 compared to the previous year is due primarily to higher prices for purchased pulp, the main raw material in manufacturing paper, and downtime taken on the paper machines at the Rhinelander mill during the third and fourth quarters of fiscal 1995, due to market softness in its product lines.\nIn fiscal 1995, market prices for pulp continued their upward spiral, which began in January 1994. Market pulp prices increased approximately 70% on average in fiscal 1995. The average list price of northern bleached softwood kraft, a commonly used benchmark pulp grade, increased 55% in 1995, following a 4% decline in 1994 and a 5% decrease in 1993. Price discounting from list was experienced in 1995, but to a much lesser extent than in 1994 and 1993. The company implemented several paper price increases during fiscal 1995, however, market pressures prevented the company from completely offsetting the pulp cost increases through higher selling prices. Despite increased paper prices, improved productivity from paper and pulp mill operations and cost reduction efforts, including Total Quality Process generated improvements, the company was not able to offset the effect of increased pulp costs.\nIn October 1995, further pulp price increases took effect, but in varying amounts across pulp grades, as demand for pulp may be leveling off due to an overall slowing in the paper industry. As of October 27, 1995, the company had not announced any further price increases for its paper products in response to the October pulp price increase. Although pulp and paper price increases may not coincide and, historically, paper price increases have generally lagged behind pulp price increases, management continues to expect, in the longer term, to return to historical per ton margins and renewed profit growth momentum.\nProduction of the company's printing and writing grades increased 22.5% in fiscal 1995 over the previous year as the Groveton mill had full production on both of its paper machines since October 1994 as compared to operating one machine for all of fiscal 1994. The Brokaw mill operated at 2% below capacity in fiscal 1995 as a result of capital improvement related outages while the Groveton mill operated at 96% of capacity. Production for the Printing and Writing Division in 1994 was 12.7% higher than in 1993.\nThe Rhinelander mill operated at 83% of capacity in the fourth quarter of fiscal 1995 and 95% for the year. Some extended downtime was taken on all paper machines due to market softness in the second half of fiscal 1995. Production in 1995 was flat compared to the prior year as productivity gains from capital improvements offset the negative impact of the extended machine downtime. Rhinelander's production in 1994 was 5.1% higher than 1993 results.\nMaintenance and repair costs increased $.6 million to $30.2 million in 1995 from $29.6 million in 1994. The increase is primarily attributable to the operation of the second paper machine at the Groveton mill. Maintenance and repair costs were $28.8 million in 1993.\nLABOR\nThe company is currently in the final year of a four-year labor agreement with the United Paperworkers International Union at the Rhinelander Division. The agreement expires in December 1995. The company is also in the final year of a five-year labor agreement with the United Paperworkers International Union at the Brokaw mill. This agreement expires in May 1996. The company is currently in the third year of a four-year labor agreement with the United Paperworkers International Union at the Groveton mill. The agreement, which expires in March 1997, includes a general wage increase of 2.0% in 1996 and increases in employee benefits as part of the agreement.\nThe company considers its relationship with its employees to be excellent and is of the opinion that it will be able to successfully negotiate new labor agreements at the Rhinelander and Brokaw mills in fiscal 1996.\nSELLING, ADMINISTRATIVE AND RESEARCH EXPENSES\nFiscal 1995 selling, administrative and research expenses were $28.0 million, compared to $27.3 million in fiscal 1994 and $26.0 million in fiscal 1993. Increased marketing costs associated with new product offerings and full operations at the Printing and Writing Division, along with higher expense for stock appreciation rights, dividend equivalents and stock option expenses accounted for the increase in fiscal 1995 over the prior year. Stock appreciation rights, dividend equivalents and stock option expense was $.1 million in 1995, compared to income of $.3 million in 1994 and expense of $1.9 million in 1993.\nINTEREST INCOME, INTEREST EXPENSE AND OTHER INCOME\nInterest income was $.2 million in fiscal 1995, compared to $.1 million in fiscal 1994 and less than $.1 million in fiscal 1993. Interest expense in fiscal 1995 totalled $1.7 million, compared to $2.0 million in 1994 and $1.3 million in 1993. Lower interest expense in fiscal 1995 is due to higher capitalized interest compared to the prior year. Capitalized interest was $.7 million in fiscal 1995, $.2 million in 1994, and was $.1 million in 1993. The increase in capitalized interest in fiscal 1995 was due to several major capital projects in process, including the capacity expansion project at the Rhinelander mill, installation of a fiber handling and processing system at the Brokaw mill and upgrades to the wastewater treatment plant at both Wisconsin mills. Other income and expense was $.5 million expense in 1995, compared to $.1 million expense in 1994 and $.1 million income in 1993. Capital asset disposal losses are the primary reasons for the increase in other expense in fiscal 1995.\nINCOME TAXES\nThe fiscal 1995 income tax provision was $19.6 million, for an effective tax rate of 38.5%. The effective tax rates for fiscal years 1994 and 1993 were 38.2% and 37.9%, respectively.\nIn fiscal 1994, the company adopted Statement of Accounting Standard (SFAS) No. 109 \"Accounting for Income Taxes.\" The adoption was reflected as a one- time cumulative reduction in the net deferred tax liability resulting in a $1.0 million increase in fiscal 1994 net earnings.\nNET EARNINGS\nNet earnings in fiscal 1995 were $31.3 million, compared to fiscal 1994 earnings of $42.1 million before the cumulative effect of an accounting change. Fiscal 1993 earnings were $38.4 million before the cumulative effect of an accounting change. After including the impact of accounting changes, net earnings were $43.1 million in fiscal 1994 and were $22.6 million in fiscal 1993.\nIn fiscal 1994, the company adopted Statement of Accounting Standard (SFAS) No. 109 \"Accounting for Income Taxes.\" This change in accounting resulted in a one-time cumulative benefit of $1.0 million in fiscal 1994. In fiscal 1993, the company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" resulting in a one-time cumulative reduction to net earnings of $15.8 million.\nCAPITAL RESOURCES AND LIQUIDITY\nLONG-TERM DEBT\nLong-term debt increased $38.3 million in fiscal 1995 to $68.6 million at August 31, 1995. This compares with long-term debt of $30.3 million and $42.7 million at August 31, 1994 and 1993, respectively. The increase in long-term debt in fiscal 1995 was due mainly to reduced cash flow from operations and increased capital spending. The decrease in long-term debt in fiscal 1994 was due primarily to improved cash flow from operations. Long-term debt as a percent of capital increased to 18.0% in 1995, compared to 9.6% in 1994 and 14.8% in 1993.\nIn August 1995, the company obtained $19.0 million in additional financing from the issuance of variable rate demand sewage and solid waste revenue bonds by a local governmental unit. This additional borrowing will be used to fund the upgrade of the Brokaw mill wastewater treatment plant, the construction of a new landfill and several other projects which qualify for this type of financing. Proceeds relating to the bond issuance are held in a trust fund until they are drawn upon by the company as spending occurs on these projects. At August 31, 1995, the industrial development bond trust fund totalled $14.7 million.\nLong-term debt at August 31, 1995 consisted primarily of $30.0 million in senior promissory notes (less current portion), $14.2 million outstanding under the company's revolving credit facility, $8.3 million in commercial\npaper and $19.0 million in industrial development bonds. This compares with borrowings of $30.0 million in senior promissory notes at August 31, 1994.\nCASH PROVIDED BY OPERATIONS\nCash provided by operations in fiscal 1995 was $47.5 million or 26.6% below 1994 results of $64.7 million. Cash provided by operations in fiscal 1993 was $34.4 million. The lower operating cash flow in fiscal 1995 compared to the prior year was due to higher unit production costs and increased working capital needs. Lower unit production costs in fiscal 1994 and lower working capital requirements associated with the Groveton mill accounted for the improved operating cash flow in 1994 over the previous year.\nCAPITAL EXPENDITURES\nFiscal 1995 capital expenditures totalled $66.1 million, compared to $43.8 million in 1994 and $51.3 million in 1993. Capital expenditures in fiscal 1993 include the purchase of manufacturing facilities in Groveton, New Hampshire for $20.2 million.\nRhinelander's new $12 million silicone coater commenced operation in the third quarter of fiscal 1995. This solventless coater has the capacity to produce 15,000 tons of coated release papers for the pressure sensitive label industry as well as other end users. A $46 million expansion project was approved for the Rhinelander mill in December 1994 to increase its pressure sensitive papermaking capacity. Work is proceeding on this project, which will include a new state-of-the-art supercalender, a duplex rewinder and a major rebuild of No. 7 paper machine. The project will add nearly 38,000 tons of annual pressure sensitive backing paper capacity while improving quality. In connection with mix changes, the mill's total annual capacity is expected to increase by over 26,000 tons. This project is expected to be completed in early calendar 1996. Other major projects in process at the Rhinelander mill include an upgrade to the mill's wastewater treatment plant and modifications to enable the mill to handle, wrap and ship larger diameter rolls.\nSeveral major projects were completed at the Brokaw mill in fiscal 1995 including installation of a new gas-fired boiler and feedwater system, a rebuild to No. 3 paper machine and improvements to No. 2 paper machine to increase productivity and enhance product quality. Work continues on a $16.4 million fiber handling and processing project. This project includes a building expansion, additional pulping capacity and a new fiber handling system to process more recycled post consumer fiber. This project is expected to be completed in the third quarter of fiscal 1996. In addition, work is underway to upgrade the mill's wastewater treatment plant at a cost of over $14 million.\nA softwood kraft refining system was installed at the Groveton mill in fiscal 1995 to improve long fiber refining capabilities, improve sheet formation and reduce fiber costs. Work is underway to add a shrink wrap packaging line and install a new centralized starch kitchen.\nAt the end of fiscal 1995, the company was committed to spend approximately $62 million to complete capital projects currently under construction. Capital commitments at the end of 1994 and 1993 were $30 million and $32 million, respectively. The majority of the committed spending going into fiscal 1996 will be on the Rhinelander expansion project, the fiber handling and processing project at the Brokaw mill and upgrades to the wastewater treatment plant at both of these mills.\nCapital expenditures are expected to increase in fiscal 1996 primarily due to spending on these projects currently in process. The company expects capital expenditures to be in excess of $150 million over the next three years, including approximately $70 million in fiscal 1996.\nFINANCING\nThe company maintains a revolving credit facility agreement with two banks to provide loans up to $35 million. The credit facility will permit the company to borrow $35 million through August 1, 1997, at which time, or earlier at the company's option, the agreement converts to a four-year term loan, requiring equal annual payments of principal. Interest rates on these borrowings are based on bank offered rates, the prime lending rate, certificate of deposit rate, treasury rate, or a eurodollar rate. The credit agreement provides the back-up line of credit necessary for the issuance of commercial paper. The company's commercial paper placement agreement, with one of its two major banks, provides for the issuance of up to $40 million of unsecured debt obligations. The company had $8.3 million in commercial paper outstanding at year end. On August 31, 1995, a combined total of $12.5 million was available for borrowing under the company's credit and commercial paper placement agreements. In a separate agreement, the banks participating in the revolving credit facility have provided a $30 million uncommitted line of credit to the company. The company also has available a $2 million short-term line of credit. There was no borrowing against these lines at August 31, 1995.\nIn June 1993, the company borrowed $30 million through the issuance of notes to Prudential Insurance Company of America and its subsidiaries. The loan was in the form of senior unsecured term notes bearing a fixed interest rate of 6.03%. Principal is payable in ten equal semi-annual installments beginning in December 1995, with the final payment due in June 2000. Proceeds from the notes were used to reduce borrowings from the revolving credit facility.\nIn August 1995, the company obtained $19 million in industrial development bond financing to fund the upgrade of the Brokaw mill wastewater treatment plant, the construction of a new landfill and several other projects which qualify for this type of financing. The bonds, which were issued by a local governmental unit, mature on July 1, 2023 and have a floating interest rate commensurate with short-term municipal bond rates on similar issues. The interest rate can be converted to a fixed rate at the option of the company. Principal is due upon maturity or earlier at the company's option. Proceeds relating to the bond issuance are held in a trust fund until they are drawn upon by the company as spending occurs on these projects. As of August 31, 1995, the company utilized $4.3 million from the bond proceeds.\nCash provided by operations, industrial development bond proceeds and the revolving credit facility are expected to meet working capital needs and dividend requirements, as well as fund the company's stock repurchase program and planned capital expenditure requirements. The company believes additional financing is readily available, should it be needed, to fund a major expansion or acquisition.\nCOMMON STOCK REPURCHASE\nOn June 30, 1994, the Board of Directors authorized the repurchase of up to 1,485,000 shares of the company's common stock, from time-to-time in the open market or through privately negotiated transactions at prevailing market prices. In fiscal 1995, the company repurchased 247,150 shares at market prices ranging from $20.688 per share to $21.364 per share. In fiscal 1994,\nthe company repurchased 99,000 shares at market prices ranging from $21.705 per share to $22.386 per share. Shares and per share data have been restated to reflect the January 1995 10% stock dividend.\nDIVIDENDS\nIn fiscal 1995, the Board of Directors declared cash dividends of $.25 per share, a 14.6% increase over the $.218 per share declared in fiscal 1994.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWIPFLI ULLRICH BERTELSON Certified Public Accountants\nTo the Shareholders and Board of Directors Wausau Paper Mills Company Wausau, Wisconsin\nWe have audited the accompanying consolidated balance sheets of Wausau Paper Mills Company and Subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, cash flows and shareholders' equity for each of the years in the three-year period ended August 31, 1995 and the supporting schedule listed in the accompanying index to financial statements. These financial statements and supporting schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and supporting 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 supporting 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 supporting 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 Wausau Paper Mills Company and Subsidiaries at August 31, 1995 and 1994, and the results of their operations and cash flows for each of the years in the three- year period ended August 31, 1995, and the supporting schedule presents fairly the information required to be set forth therein, all in conformity with generally accepted accounting principles.\nAs discussed in Note 8 and Note 7 of the Notes to Consolidated Financial Statements, the company changed its method of accounting for income taxes in 1994 and its method of accounting for postretirement benefits other than pensions in 1993.\nWe hereby consent to the incorporation by reference of this report in the Registration Statements on Form S-8 and amendments thereto filed with the Securities and Exchange Commission by Wausau Paper Mills Company on August 25, 1995, January 3, 1992 and January 27, 1988.\nWIPFLI ULLRICH BERTELSON WIPFLI ULLRICH BERTELSON September 19, 1995 Wausau, Wisconsin\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Wausau Paper Mills Company is responsible for the integrity and objectivity of the financial data contained in the financial statements and supporting schedule. The financial statements and supporting schedule have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances and, where necessary, reflect informed judgments and estimates of the effects of certain events and transactions based on currently available information at the date the financial statements were prepared.\nThe company's management depends on the company's system of internal accounting controls to assure itself of the reliability of the financial statements. The internal control system is designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded and transactions are executed in accordance with management's authorizations and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles. Periodic reviews are made of internal controls by management and corrective action is taken if needed.\nThe Board of Directors reviews and monitors financial statements through its audit committee. The audit committee meets with the independent public accountants and management to review internal accounting controls, auditing and financial reporting matters.\nThe independent public accountants are engaged to provide an objective and independent review of the company's financial statements in accordance with generally accepted auditing standards and to express an opinion thereon. The report of the company's independent public accountants is included in this annual report.\nSAN W. ORR, JR. DANIEL D. KING SAN W. ORR, JR. DANIEL D. KING Chairman of the Board of Directors President and Chief Operating and Chief Executive Officer Officer\nSTEVEN A. SCHMIDT STEVEN A. SCHMIDT Vice President Finance, Secretary and Treasurer\nINDEX TO FINANCIAL STATEMENTS COVERED BY REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nConsolidated Statements of Income for the years ended August 31, 1995, 1994 and 1993 .................................17\nConsolidated Balance Sheets as of August 31, 1995 and 1994 .......................................................18\nConsolidated Statements of Shareholders' Equity for the years ended August 31, 1995, 1994 and 1993 .................20\nConsolidated Statements of Cash Flows for the years ended August 31, 1995, 1994 and 1993 ...........................21\nNotes to Consolidated Financial Statements .........................22\nSchedule for the years ended August 31, 1995, 1994 and 1993\nSchedule II - Valuation and Qualifying Accounts ................36\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 Consolidated Financial Statements and Notes thereto.\nWAUSAU PAPER MILLS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of the company and its subsidiaries. All significant intercompany transactions, balances and profits have been eliminated in consolidation.\nREVENUE RECOGNITION - Revenue is recognized upon shipment of goods and transfer of title to the customer. The company grants credit to customers in the ordinary course of business. A substantial portion of the company's accounts receivable is with customers in various paper converting industries or the paper merchant business. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers and their geographic dispersion.\nCASH EQUIVALENTS - The company defines cash equivalents as highly liquid, short-term investments with an original maturity of three months or less.\nINVENTORIES - Pulpwood, finished paper products and the majority of raw materials are valued at the lower of cost, determined on the last-in, first- out (LIFO) method, or market. All other inventories are valued at the lower of average cost or market.\nPROPERTY, PLANT AND EQUIPMENT - Plant and equipment are stated at cost and are depreciated over the estimated useful lives of the assets using the straight- line method for financial statement purposes. The cost and related accumulated depreciation of all plant and equipment retired or otherwise disposed of are removed from the accounts and any resulting gains or losses are included in the statements of income.\nBuildings are depreciated over a 25- to 45-year period; machinery and equipment over a 4- to 16-year period. Maintenance and repair costs are charged to expense as incurred. Renewals and improvements which extend the useful lives of the assets are added to the plant and equipment accounts.\nEquipment financed by long-term leases, which in effect are installment purchases, have been recorded as assets and the related obligations as debt.\nLand is stated at cost. Timberlands are at cost less the pro rata cost of timber harvested since acquisition. Depletion expense is calculated using the block method.\nINCOME TAXES - Deferred income taxes have been provided under the liability method. Deferred tax assets and liabilities are determined based upon the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities, as measured by the current enacted tax rates. Deferred tax expense is the result of changes in the deferred tax asset and liability. See Note 8 for change in accounting principle in 1994.\nEARNINGS PER SHARE - Earnings per common share are based on the weighted average number of common shares outstanding. Dilution of earnings per common share due to common stock equivalents (stock options) is negligible and, accordingly, no dilution has been reported.\nBecause various components of the inventories are valued by use of the last- in, first-out (LIFO) method, it is impracticable to segregate the LIFO reserve between raw materials and work in process and finished goods.\nThe company has outstanding $30 million in unsecured senior promissory notes. Interest is payable quarterly on the outstanding balance at a rate of 6.03% per annum. Principal is payable in ten equal semi-annual installments beginning December 18, 1995, with the final payment due June 16, 2000.\nDuring 1995, the company borrowed $19 million related to industrial development bonds issued by a local governmental unit. The variable rate bonds require quarterly interest payments and had an interest rate of 3.85% at August 31, 1995. The company also pays fees for a bank letter of credit and remarketing services related to the bonds which it includes in net interest\nexpense. The interest rate can be converted to a fixed rate, at the company's option, after which semi-annual interest payments will be required. The bonds mature on July 1, 2023. At August 31, 1995, bond proceeds of $14,732,000 were not disbursed and are reflected as an asset on the balance sheet. The company maintains an unsecured revolving credit facility of $35 million with two banks which continues through August 1, 1997 at which time, or earlier at the company's option, the revolving credit converts to a term loan facility, and the loans then outstanding are payable in four equal annual installments. The company may elect the base for interest from either domestic rate loans, eurodollar loans, adjusted CD rate loans, offered loans or treasury rate loans. The weighted average interest rate on borrowings under the revolving credit facility was 6.21% at August 31, 1995. There were no borrowings against this agreement at August 31, 1994. The credit agreement provides for commitment fees during the revolving loan period. Fees are based on .125% per annum on the unused portions of the commitment, payable monthly.\nConsistent with the classification of the revolving credit agreement, fixed asset payables that will be financed through the agreement are classified as long-term debt.\nThe senior promissory notes and the revolving credit facility agreement require the company to comply with certain covenants, one of which requires the company maintain minimum net worth. At August 31, 1995, $69,950,000 of retained earnings was available for payment of cash dividends without violation of the minimum net worth covenant related to the senior promissory notes.\nThe company maintains a commercial paper placement agreement with a bank to issue up to $40 million of unsecured debt obligations which requires unused credit availability under its revolving credit agreement equal to the amount of outstanding commercial paper. The weighted average interest rate on outstanding commercial paper was 6.20% at August 31, 1995. There were no amounts outstanding at August 31, 1994.\nThe difference between the book and the fair market value of the long-term debt is not material.\nAnnual maturities will be affected by future borrowings.\nThe banks participating in the revolving credit agreement have provided separate uncommitted revolving lines of credit to the company in an aggregate amount of up to $30 million. The specific terms of any revolving loans borrowed pursuant to these lines of credit will be negotiated at the time of the borrowing and any revolving loans so borrowed will be payable on demand. In addition, the company has a $2 million line of credit with interest payable at the prime rate. The line does not require a compensating balance or a commitment fee. There was no borrowing against these lines at August 31, 1995.\nNOTE 5. LEASE COMMITMENTS\nThe company has various leases for real estate, mobile equipment and machinery which generally provide for renewal privileges or for purchase at option prices established in the lease agreements. Property, plant and equipment includes the following amounts for capitalized leases:\nLease amortization is included in depreciation expense.\nThe future minimum payments for capitalized leases are reflected in the aggregate annual maturities of long-term debt disclosure in Note 4.\nContingent rentals are based upon usage.\nNOTE 7. RETIREMENT PLAN\nSubstantially all employees are covered under retirement plans. The defined benefit plans covering salaried employees provide benefits based on final average pay formulas; the plans covering hourly employees provide benefits based on years of service and fixed benefit amounts for each year of service. The plans are funded in accordance with federal laws and regulations.\nThe company selected a measurement date of plan assets of May 31, 1995 and 1994.\nProjected benefit obligations were determined using an assumed discount rate of 7.5% and an assumed rate of increases in future compensation levels of 5.0%. The assumed long-term rate of return on plan assets was 8.0%. Plan assets consist principally of publicly traded stocks and fixed income securities and include Wausau Paper Mills Company common stock with a market value of $1,377,000 in 1995 and $1,854,000 in 1994.\nThe company's defined contribution pension plan provides for company contributions based on a percentage of employee contributions. The cost of such plans totaled $232,000 in 1995 and $445,000 in 1994, and $420,000 in 1993.\nThe company has deferred compensation or supplemental retirement agreements with certain present and past key officers and employees. The principal cost of such plans is being or has been accrued over the period of active employment to the full eligibility date. The annual cost of the deferred compensation and supplemental retirement agreements does not represent a material amount.\nIn fiscal 1993, the company adopted the provisions of Statements of Financial Accounting Standard (SFAS) No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" effective as of September 1, 1992.\nSFAS 106 requires the estimated cost of retiree benefit payments, primarily health and life insurance, to be accrued during the employees' active service period. Previously, the cost of these benefits was expensed as paid. The company elected to immediately recognize the accumulated liability as of September 1, 1992, which resulted in a one-time noncash charge against earnings of $25,000,000 before taxes and $15,750,000 after taxes, or $.53 per share (as restated). In addition, the effect of this change on 1993 operating results was to recognize an additional pre-tax expense of $1,590,000 and after-tax expense of $987,000, or $.03 per share (as restated).\nFor 1995, the assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 11% declining by 1% annually for six years to an ultimate rate of 5%. The weighted average discount rate was 7.5%.\nFor 1994, the assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 12% declining by 1% annually for seven years to an ultimate rate of 5%. The weighted average discount rate was 7.5%.\nA one-percentage-point increase in the assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of August 31, by approximately $3,779,000 or 13.1% in 1995 and $3,541,000 or 12.9% in 1994. The effect of this change on the aggregate of the service and interest cost would be an increase of $416,000 or 14.3% in 1995 and $451,000 or 14.6% for 1994.\nNOTE 8. INCOME TAXES\nEffective September 1, 1993, the company adopted the liability method of accounting for income taxes prescribed by Statement of Financial Accounting Standard (SFAS) No. 109. Deferred tax assets and liabilities are determined based on the estimated future tax effects of temporary differences between the financial statement and tax bases of assets and liabilities, as measured by the current enacted tax rates. Deferred tax expense is the result of changes in the deferred tax asset and liability. Previously, the company used the deferral method which provided for deferred income taxes on the basis of income and expense items reported for financial accounting and tax purposes in different periods.\nThe company elected to recognize the cumulative effect of the change as of September 1, 1993, totaling $1,000,000, as a credit to income in 1994. The effect of the change in method did not have a material effect in 1994.\nNOTE 9. STOCK OPTIONS AND APPRECIATION RIGHTS\nThe company maintains the 1981 and 1991 Employee Stock Option Plans. Each plan specifies purchase price, time and method of exercise. Payment of the option price may be made in cash or by tendering an amount of common stock having a fair market value equal to the option price.\nOptions are granted for terms up to 20 years, the option price being equal to the fair market value of the company's common stock at the date of grant under the 1981 plan and for incentive options granted under the 1991 plan. The option price for non-qualified options under the 1991 plan may not be less\nthan 50% of the fair market value of the company's common stock at the date of grant.\nDuring 1995, 36,850 options were granted under the 1991 Employee Stock Option Plan to be earned based upon the satisfaction of operating goals set forth in the agreement. The options terminated when 1995 operating goals were not met.\nDuring 1992, options were granted under the 1991 Employee Stock Option Plan. The options were to be earned over a three-year period based upon the satisfaction of operating goals set forth in the agreement. A total of 97,783 and 72,358 options terminated in 1994 and 1993, respectively, when operating goals were not met.\nThe 1988 Management Incentive Plan entitles certain management employees the right to receive cash equal to the sum of the appreciation in value of the stock and the hypothetical value of cash dividends which would have been paid on the stock covered by the grant assuming reinvestment in company stock. The stock appreciation rights granted may be exercised in whole or in such installments and at such times as specified in the grant. In all instances, the rights lapse if not exercised within 20 years of the grant date. Compensation expense is recorded with respect to the rights based upon the quoted market value of the shares and the exercise provisions.\nAll shares and price ranges have been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock splits occurring in 1994 and 1993.\nThe company maintains the 1991 Dividend Equivalent Plan. Participants are entitled to receive cash based on the hypothetical value of cash dividends which would have been paid on the stock covered by the grant assuming reinvestment in company stock. During 1995, 36,850 dividend equivalents were granted under the plan. The dividend equivalents are earned in the current year based upon the satisfaction of operating goals set forth in the agreement. All dividend equivalents granted in 1995 terminated when operating goals were not met.\nDuring 1992, 196,534 dividend equivalents were granted under the plan. The dividend equivalents granted in 1992 and 26,400 of the dividend equivalents granted in 1993 were to be earned over a three-year period based upon the satisfaction of operating goals set forth in the agreement. A total of 89,956 and 72,358 dividend equivalents terminated in 1994 and 1993, respectively, when operating goals were not met.\nAll shares have been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock splits occurring in 1994 and 1993.\nThe pre-tax impact on earnings of all stock options, dividend equivalents and stock appreciation rights for the years ended August 31, 1995, 1994 and 1993 was expense of $79,000, income of $283,000 and expense of $1,934,000, respectively.\nNOTE 10. RESEARCH EXPENSES\nResearch expenses charged to operations were $1,219,000 in 1995, $1,158,000 in 1994 and $957,000 in 1993.\nNOTE 11. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS\nThe company is involved in various legal proceedings in the normal course of business. It is the opinion of management that any judgment or settlement resulting from pending or threatened litigation would not have a material adverse effect on the financial position or on the operations of the company.\nAs of August 31, 1995, the company was committed to spend approximately $62 million to complete capital projects which were in various stages of completion.\nIn 1993, Rhinelander Paper Company, Inc., a subsidiary of the company, signed an agreement with Wisconsin Public Service Corporation (WPS) under which Rhinelander Paper would become the exclusive steam customer of a high- efficiency cogeneration power plant to be constructed, owned and operated by WPS. The arrangement for ownership and operation by WPS was altered during the regulatory approval process, making it necessary to negotiate a new agreement between WPS and Rhinelander Paper if the project were to proceed. The two companies were unable to agree upon several fundamental issues and after lengthy negotiations, Rhinelander Paper Company decided it was not feasible to continue and terminated further negotiations. WPS and Rhinelander Paper issued a joint press release on July 21, 1995, announcing the cancellation of plans to build the cogeneration power plant.\nDuring fiscal 1994, the company purchased 100,000 shares of the company's no- par value common stock from a director in a private transaction at $27.625 per share, the average market price on the day of the transaction.\nNOTE 12. MAJOR CUSTOMERS\nOne customer accounted for 12.0% of net sales aggregating $61,732,000, 12.3% of net sales aggregating $52,313,000, and 11.2% of net sales aggregating $42,812,000 in 1995, 1994 and 1993, respectively.\nThe estimated effective tax rate utilized for the first three quarters of each fiscal year was different than the final annual effective rate and the adjustment of income taxes was all reflected in the quarter ended August 31 of each fiscal year.\nAll per share data has been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock split occurring in 1994.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.\nNone.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation relating to directors is incorporated into this Form 10-K by reference to the table on page 5 of the registrant's Proxy Statement dated November 9, 1995 (1995 Proxy Statement). Information relating to executive officers is found in Part I of this Form 10-K, page 4.\nITEM 11. EXECUTIVE COMPENSATION.\nInformation relating to director compensation is incorporated into this Form 10-K by reference to the registrant's 1995 Proxy Statement under the subcaption \"Director Compensation\", page 6. Information relating to the compensation of executive officers is incorporated into this Form 10-K by this reference to (1) the material set forth beginning under the caption \"Compensation of Executive Officers\" and ending with the material set forth under the subcaption \"Supplemental Plans\", pages 8 through 13 and (2) the material set forth under the subcaption \"Committee Interlocks and Insider Participation\", page 16, in the 1995 Proxy Statement.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation relating to security ownership of certain beneficial owners and management is incorporated into this Form 10-K by reference to the material set forth in the registrant's 1995 Proxy Statement beginning under the caption \"Beneficial Ownership of Shares\", page 2, through the material immediately preceding the final paragraph under such caption, page 3.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nITEM 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 and required by Item 14(d), are set forth on page 14 herein. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the company during the fourth quarter of fiscal 1995. (c) Exhibits required by Item 601 of Regulation S-K.\nThe following exhibits are filed with the Securities and Exchange Commission as part of this report.\nExhibit 3 - Articles of Incorporation and Bylaws\na. Articles of Incorporation, as amended 12\/18\/91 ................33-45(2) b. Bylaws, as restated 7\/17\/92 ...................................46-81(2)\nExhibit 4 - Instruments Defining the Rights of Security Holders\na. Articles and Bylaws (see Exhibit 3)\nExhibit 10 - Material Contracts*\na. Executive Officers' Deferred Compensation Retirement Plan, as amended 5\/20\/93.............................................40-54(1) b. Incentive Compensation Plans, as amended 10\/23\/92 and 10\/28\/93 (Printing and Writing Division and Rhinelander Paper Company, Inc.)...........................................55-62(1) c. Corporate Management Incentive Plan, as amended 8\/19\/87 .......63-69(1) d. 1988 Stock Appreciation Rights Plan, as amended 4\/17\/91 .....106-114(3) e. 1988 Management Incentive Plan, as amended 4\/17\/91 ..........115-123(3) f. 1990 Stock Appreciation Rights Plan, as amended 4\/17\/91 .....124-132(3) g. Deferred Compensation Agreement dated March 2, 1990, as amended July 1, 1994........................................51-56(4) h. 1991 Employee Stock Option Plan .............................133-146(3) i. 1991 Dividend Equivalent Plan ...............................147-155(3) j. Supplemental Retirement Benefit Plan dated January 16, 1992 ...90-97(2) k. Directors' Deferred Compensation Plan .........................71-86(1) l. Director Retirement Benefit Policy ............................87-88(1)\n*All exhibits represent executive compensation plans and arrangements.\nExhibit 22 - Subsidiaries .............................................89(1)\nExhibit 27 - Financial Data Schedule\nPage numbers set forth herein correspond to the page numbers using the sequential numbering system, where such exhibit can be found in the following Annual Reports on Form 10-K:\n(1) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993; Commission File Number 0-7574. (2) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1992; Commission File Number 0-7574. (3) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1991; Commission File Number 0-7574. (4) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1994; Commission File Number 0-7574.\nThe above exhibits are available upon request in writing from the Secretary, Wausau Paper Mills Company, P.O. Box 1408, Wausau, Wisconsin 54402-1408.\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.\nWAUSAU PAPER MILLS COMPANY\n\/S\/ STEVEN A. SCHMIDT Steven A. Schmidt Vice President Finance, Secretary and Treasurer (Principal Accounting and Financial Officer) Date: October 27, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/S\/ SAN W. ORR, JR. \/S\/ DAVID B. SMITH, JR. San W. Orr, Jr. David B. Smith, Jr. October 27, 1995 October 27, 1995 Chairman of the Board and Director Chief Executive Officer (Principal Executive Officer)\n\/S\/ DANIEL D. KING \/S\/ STANLEY F. STAPLES, JR. Daniel D. King Stanley F. Staples, Jr. October 27, 1995 October 27, 1995 President and Chief Operating Director Officer Director\n\/S\/ HARRY R. BAKER Harry R. Baker October 27, 1995 Director\nEXHIBIT INDEX Pursuant to Item 102(d) of Regulation S-T (17 C.F.R. 232.102(d)\nExhibit 3 - Articles of Incorporation and Bylaws\na. Articles of Incorporation, as amended 12\/18\/91 .............33-45(2) b. Bylaws, as restated 7\/17\/92 ................................46-81(2)\nExhibit 4 - Instruments Defining the Rights of Security Holders\na. Articles and Bylaws (see Exhibit 3)\nExhibit 10 - Material Contracts*\na. Executive Officers' Deferred Compensation Retirement Plan, as amended 5\/20\/93 ...................................40-54(1) b. Incentive Compensation Plans, as amended 10\/23\/92 and 10\/28\/93 (Printing and Writing Division and Rhinelander Paper Company, Inc.) .......................................55-62(1) c. Corporate Management Incentive Plan, as amended 8\/19\/87 ....63-69(1) d. 1988 Stock Appreciation Rights Plan, as amended 4\/17\/91 ..106-114(3) e. 1988 Management Incentive Plan, as amended 4\/17\/91 .......115-123(3) f. 1990 Stock Appreciation Rights Plan, as amended 4\/17\/91 ..124-132(3) g. Deferred Compensation Agreement dated March 2, 1990, as amended July 1, 1994 ....................................51-56(4) h. 1991 Employee Stock Option Plan ..........................133-146(3) i. 1991 Dividend Equivalent Plan ............................147-155(3) j. Supplemental Retirement Benefit Plan dated January 16, 1992........................................................90-97(2) k. Directors' Deferred Compensation Plan ......................71-86(1) l. Director Retirement Benefit Policy .........................87-88(1)\n*All exhibits represent executive compensation plans and arrangements.\nExhibit 22 - Subsidiaries .............................................89(1)\nExhibit 27 - Financial Data Schedule .....................................39\nPage numbers set forth herein correspond to the page numbers using the sequential numbering system, where such exhibit can be found in the following Annual Reports on Form 10-K:\n(1) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993; Commission File Number 0-7574. (2) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1992; Commission File Number 0-7574. (3) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1991; Commission File Number 0-7574. (4) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1994; Commission File Number 0-7574.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nOVERVIEW\nThe company achieved record sales and shipments in fiscal 1995, while earnings were lower compared to the prior year. Net sales were $515.7 million in fiscal 1995, up 21% from 1994. Shipments of 399,300 tons were ahead of last year's level by 12%. Fiscal 1995 net earnings declined 26% to $31.3 million compared to fiscal 1994 earnings, before an accounting change, due to higher pulp costs and a slowdown in demand for the company's technical specialty products.\nThe pulp and paper industry experienced continued strong demand throughout most of fiscal 1995. Favorable market conditions and successful marketing of the company's printing and writing grades supported full operations at the Groveton mill since October 1994. Strong demand for the company's technical specialty grades during the first half of fiscal 1995 was followed by a slowdown in demand during the second half of the year, requiring the company to take extended downtime at its Rhinelander mill.\nStrong world-wide demand for paper caused continued strong demand for pulp in fiscal 1995. Market pulp prices increased approximately 70% on average in 1995 over the prior year. The company was able to implement several paper price increases during the year; however, market pressures prevented the company from recovering all of the increased pulp costs through higher paper prices. Higher paper prices, increased volume, production improvements and cost reduction efforts were not of sufficient magnitude to totally offset the negative effect of higher pulp costs on earnings.\nNET SALES\nNet sales for fiscal 1995 were a record $515.7 million, up 20.9% over fiscal 1994 net sales of $426.5 million. Fiscal 1993 net sales were $381.8 million. Shipments were a record 399,300 tons in 1995, an increase of 12.4% over the 355,100 tons shipped in 1994. Shipments were 310,600 tons in 1993. The shipment growth experienced in fiscal 1995 was mainly due to successfully marketing the production capacity of the Groveton, New Hampshire mill.\nDemand for the company's printing and writing grades was strong in fiscal 1995, supporting the October 1994 start-up and continued operation of the second paper machine at the Groveton mill. Shipments at the Printing and Writing Division increased 23.2% in fiscal 1995 over prior year results. Continued growth of the company's printing and writing products is expected in fiscal 1996. The company's Rhinelander Division experienced strong demand for its technical specialty products during the first half of fiscal 1995, followed by softer customer demand across all of its product lines during the second half of the year. Downtime was taken on all paper machines at the Rhinelander mill in the last four months of the fiscal year as a result of the market weakness and the need to reduce paper inventories. Shipments of Rhinelander's products were down 3.8% in fiscal 1995 compared to the previous year. Shipments of pressure sensitive products, its largest product segment, were down 6.1% over 1994 results. Some improvement in demand was experienced at the end of fiscal 1995 which the company expects to continue in fiscal 1996.\nOrder backlog at August 31, 1995 was $25.0 million, compared to order backlogs of $25.7 million and $22.3 million at August 31, 1994 and 1993, respectively. The order backlog at August 31, 1995, on a tonnage basis, is 16% lower than at the end of fiscal 1994 and 5% below the order backlog at the end of fiscal 1993. Order backlog at the end of fiscal 1995 is lower than a year ago due to the reduced demand for the company's technical specialty grades. Backlog totals are not an accurate indicator of the company's business strength, however, as a significant and growing volume of orders are shipped out of inventory promptly upon order receipt.\nGROSS PROFIT\nGross profit decreased to 15.7% of net sales for fiscal 1995 compared to 22.8% for the previous year. The gross profit margin was 23.3% in fiscal 1993. The reduced gross profit margin in fiscal 1995 compared to the previous year is due primarily to higher prices for purchased pulp, the main raw material in manufacturing paper, and downtime taken on the paper machines at the Rhinelander mill during the third and fourth quarters of fiscal 1995, due to market softness in its product lines.\nIn fiscal 1995, market prices for pulp continued their upward spiral, which began in January 1994. Market pulp prices increased approximately 70% on average in fiscal 1995. The average list price of northern bleached softwood kraft, a commonly used benchmark pulp grade, increased 55% in 1995, following a 4% decline in 1994 and a 5% decrease in 1993. Price discounting from list was experienced in 1995, but to a much lesser extent than in 1994 and 1993. The company implemented several paper price increases during fiscal 1995, however, market pressures prevented the company from completely offsetting the pulp cost increases through higher selling prices. Despite increased paper prices, improved productivity from paper and pulp mill operations and cost reduction efforts, including Total Quality Process generated improvements, the company was not able to offset the effect of increased pulp costs.\nIn October 1995, further pulp price increases took effect, but in varying amounts across pulp grades, as demand for pulp may be leveling off due to an overall slowing in the paper industry. As of October 27, 1995, the company had not announced any further price increases for its paper products in response to the October pulp price increase. Although pulp and paper price increases may not coincide and, historically, paper price increases have generally lagged behind pulp price increases, management continues to expect, in the longer term, to return to historical per ton margins and renewed profit growth momentum.\nProduction of the company's printing and writing grades increased 22.5% in fiscal 1995 over the previous year as the Groveton mill had full production on both of its paper machines since October 1994 as compared to operating one machine for all of fiscal 1994. The Brokaw mill operated at 2% below capacity in fiscal 1995 as a result of capital improvement related outages while the Groveton mill operated at 96% of capacity. Production for the Printing and Writing Division in 1994 was 12.7% higher than in 1993.\nThe Rhinelander mill operated at 83% of capacity in the fourth quarter of fiscal 1995 and 95% for the year. Some extended downtime was taken on all paper machines due to market softness in the second half of fiscal 1995. Production in 1995 was flat compared to the prior year as productivity gains from capital improvements offset the negative impact of the extended machine downtime. Rhinelander's production in 1994 was 5.1% higher than 1993 results.\nMaintenance and repair costs increased $.6 million to $30.2 million in 1995 from $29.6 million in 1994. The increase is primarily attributable to the operation of the second paper machine at the Groveton mill. Maintenance and repair costs were $28.8 million in 1993.\nLABOR\nThe company is currently in the final year of a four-year labor agreement with the United Paperworkers International Union at the Rhinelander Division. The agreement expires in December 1995. The company is also in the final year of a five-year labor agreement with the United Paperworkers International Union at the Brokaw mill. This agreement expires in May 1996. The company is currently in the third year of a four-year labor agreement with the United Paperworkers International Union at the Groveton mill. The agreement, which expires in March 1997, includes a general wage increase of 2.0% in 1996 and increases in employee benefits as part of the agreement.\nThe company considers its relationship with its employees to be excellent and is of the opinion that it will be able to successfully negotiate new labor agreements at the Rhinelander and Brokaw mills in fiscal 1996.\nSELLING, ADMINISTRATIVE AND RESEARCH EXPENSES\nFiscal 1995 selling, administrative and research expenses were $28.0 million, compared to $27.3 million in fiscal 1994 and $26.0 million in fiscal 1993. Increased marketing costs associated with new product offerings and full operations at the Printing and Writing Division, along with higher expense for stock appreciation rights, dividend equivalents and stock option expenses accounted for the increase in fiscal 1995 over the prior year. Stock appreciation rights, dividend equivalents and stock option expense was $.1 million in 1995, compared to income of $.3 million in 1994 and expense of $1.9 million in 1993.\nINTEREST INCOME, INTEREST EXPENSE AND OTHER INCOME\nInterest income was $.2 million in fiscal 1995, compared to $.1 million in fiscal 1994 and less than $.1 million in fiscal 1993. Interest expense in fiscal 1995 totalled $1.7 million, compared to $2.0 million in 1994 and $1.3 million in 1993. Lower interest expense in fiscal 1995 is due to higher capitalized interest compared to the prior year. Capitalized interest was $.7 million in fiscal 1995, $.2 million in 1994, and was $.1 million in 1993. The increase in capitalized interest in fiscal 1995 was due to several major capital projects in process, including the capacity expansion project at the Rhinelander mill, installation of a fiber handling and processing system at the Brokaw mill and upgrades to the wastewater treatment plant at both Wisconsin mills. Other income and expense was $.5 million expense in 1995, compared to $.1 million expense in 1994 and $.1 million income in 1993. Capital asset disposal losses are the primary reasons for the increase in other expense in fiscal 1995.\nINCOME TAXES\nThe fiscal 1995 income tax provision was $19.6 million, for an effective tax rate of 38.5%. The effective tax rates for fiscal years 1994 and 1993 were 38.2% and 37.9%, respectively.\nIn fiscal 1994, the company adopted Statement of Accounting Standard (SFAS) No. 109 \"Accounting for Income Taxes.\" The adoption was reflected as a one- time cumulative reduction in the net deferred tax liability resulting in a $1.0 million increase in fiscal 1994 net earnings.\nNET EARNINGS\nNet earnings in fiscal 1995 were $31.3 million, compared to fiscal 1994 earnings of $42.1 million before the cumulative effect of an accounting change. Fiscal 1993 earnings were $38.4 million before the cumulative effect of an accounting change. After including the impact of accounting changes, net earnings were $43.1 million in fiscal 1994 and were $22.6 million in fiscal 1993.\nIn fiscal 1994, the company adopted Statement of Accounting Standard (SFAS) No. 109 \"Accounting for Income Taxes.\" This change in accounting resulted in a one-time cumulative benefit of $1.0 million in fiscal 1994. In fiscal 1993, the company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" resulting in a one-time cumulative reduction to net earnings of $15.8 million.\nCAPITAL RESOURCES AND LIQUIDITY\nLONG-TERM DEBT\nLong-term debt increased $38.3 million in fiscal 1995 to $68.6 million at August 31, 1995. This compares with long-term debt of $30.3 million and $42.7 million at August 31, 1994 and 1993, respectively. The increase in long-term debt in fiscal 1995 was due mainly to reduced cash flow from operations and increased capital spending. The decrease in long-term debt in fiscal 1994 was due primarily to improved cash flow from operations. Long-term debt as a percent of capital increased to 18.0% in 1995, compared to 9.6% in 1994 and 14.8% in 1993.\nIn August 1995, the company obtained $19.0 million in additional financing from the issuance of variable rate demand sewage and solid waste revenue bonds by a local governmental unit. This additional borrowing will be used to fund the upgrade of the Brokaw mill wastewater treatment plant, the construction of a new landfill and several other projects which qualify for this type of financing. Proceeds relating to the bond issuance are held in a trust fund until they are drawn upon by the company as spending occurs on these projects. At August 31, 1995, the industrial development bond trust fund totalled $14.7 million.\nLong-term debt at August 31, 1995 consisted primarily of $30.0 million in senior promissory notes (less current portion), $14.2 million outstanding under the company's revolving credit facility, $8.3 million in commercial\npaper and $19.0 million in industrial development bonds. This compares with borrowings of $30.0 million in senior promissory notes at August 31, 1994.\nCASH PROVIDED BY OPERATIONS\nCash provided by operations in fiscal 1995 was $47.5 million or 26.6% below 1994 results of $64.7 million. Cash provided by operations in fiscal 1993 was $34.4 million. The lower operating cash flow in fiscal 1995 compared to the prior year was due to higher unit production costs and increased working capital needs. Lower unit production costs in fiscal 1994 and lower working capital requirements associated with the Groveton mill accounted for the improved operating cash flow in 1994 over the previous year.\nCAPITAL EXPENDITURES\nFiscal 1995 capital expenditures totalled $66.1 million, compared to $43.8 million in 1994 and $51.3 million in 1993. Capital expenditures in fiscal 1993 include the purchase of manufacturing facilities in Groveton, New Hampshire for $20.2 million.\nRhinelander's new $12 million silicone coater commenced operation in the third quarter of fiscal 1995. This solventless coater has the capacity to produce 15,000 tons of coated release papers for the pressure sensitive label industry as well as other end users. A $46 million expansion project was approved for the Rhinelander mill in December 1994 to increase its pressure sensitive papermaking capacity. Work is proceeding on this project, which will include a new state-of-the-art supercalender, a duplex rewinder and a major rebuild of No. 7 paper machine. The project will add nearly 38,000 tons of annual pressure sensitive backing paper capacity while improving quality. In connection with mix changes, the mill's total annual capacity is expected to increase by over 26,000 tons. This project is expected to be completed in early calendar 1996. Other major projects in process at the Rhinelander mill include an upgrade to the mill's wastewater treatment plant and modifications to enable the mill to handle, wrap and ship larger diameter rolls.\nSeveral major projects were completed at the Brokaw mill in fiscal 1995 including installation of a new gas-fired boiler and feedwater system, a rebuild to No. 3 paper machine and improvements to No. 2 paper machine to increase productivity and enhance product quality. Work continues on a $16.4 million fiber handling and processing project. This project includes a building expansion, additional pulping capacity and a new fiber handling system to process more recycled post consumer fiber. This project is expected to be completed in the third quarter of fiscal 1996. In addition, work is underway to upgrade the mill's wastewater treatment plant at a cost of over $14 million.\nA softwood kraft refining system was installed at the Groveton mill in fiscal 1995 to improve long fiber refining capabilities, improve sheet formation and reduce fiber costs. Work is underway to add a shrink wrap packaging line and install a new centralized starch kitchen.\nAt the end of fiscal 1995, the company was committed to spend approximately $62 million to complete capital projects currently under construction. Capital commitments at the end of 1994 and 1993 were $30 million and $32 million, respectively. The majority of the committed spending going into fiscal 1996 will be on the Rhinelander expansion project, the fiber handling and processing project at the Brokaw mill and upgrades to the wastewater treatment plant at both of these mills.\nCapital expenditures are expected to increase in fiscal 1996 primarily due to spending on these projects currently in process. The company expects capital expenditures to be in excess of $150 million over the next three years, including approximately $70 million in fiscal 1996.\nFINANCING\nThe company maintains a revolving credit facility agreement with two banks to provide loans up to $35 million. The credit facility will permit the company to borrow $35 million through August 1, 1997, at which time, or earlier at the company's option, the agreement converts to a four-year term loan, requiring equal annual payments of principal. Interest rates on these borrowings are based on bank offered rates, the prime lending rate, certificate of deposit rate, treasury rate, or a eurodollar rate. The credit agreement provides the back-up line of credit necessary for the issuance of commercial paper. The company's commercial paper placement agreement, with one of its two major banks, provides for the issuance of up to $40 million of unsecured debt obligations. The company had $8.3 million in commercial paper outstanding at year end. On August 31, 1995, a combined total of $12.5 million was available for borrowing under the company's credit and commercial paper placement agreements. In a separate agreement, the banks participating in the revolving credit facility have provided a $30 million uncommitted line of credit to the company. The company also has available a $2 million short-term line of credit. There was no borrowing against these lines at August 31, 1995.\nIn June 1993, the company borrowed $30 million through the issuance of notes to Prudential Insurance Company of America and its subsidiaries. The loan was in the form of senior unsecured term notes bearing a fixed interest rate of 6.03%. Principal is payable in ten equal semi-annual installments beginning in December 1995, with the final payment due in June 2000. Proceeds from the notes were used to reduce borrowings from the revolving credit facility.\nIn August 1995, the company obtained $19 million in industrial development bond financing to fund the upgrade of the Brokaw mill wastewater treatment plant, the construction of a new landfill and several other projects which qualify for this type of financing. The bonds, which were issued by a local governmental unit, mature on July 1, 2023 and have a floating interest rate commensurate with short-term municipal bond rates on similar issues. The interest rate can be converted to a fixed rate at the option of the company. Principal is due upon maturity or earlier at the company's option. Proceeds relating to the bond issuance are held in a trust fund until they are drawn upon by the company as spending occurs on these projects. As of August 31, 1995, the company utilized $4.3 million from the bond proceeds.\nCash provided by operations, industrial development bond proceeds and the revolving credit facility are expected to meet working capital needs and dividend requirements, as well as fund the company's stock repurchase program and planned capital expenditure requirements. The company believes additional financing is readily available, should it be needed, to fund a major expansion or acquisition.\nCOMMON STOCK REPURCHASE\nOn June 30, 1994, the Board of Directors authorized the repurchase of up to 1,485,000 shares of the company's common stock, from time-to-time in the open market or through privately negotiated transactions at prevailing market prices. In fiscal 1995, the company repurchased 247,150 shares at market prices ranging from $20.688 per share to $21.364 per share. In fiscal 1994,\nthe company repurchased 99,000 shares at market prices ranging from $21.705 per share to $22.386 per share. Shares and per share data have been restated to reflect the January 1995 10% stock dividend.\nDIVIDENDS\nIn fiscal 1995, the Board of Directors declared cash dividends of $.25 per share, a 14.6% increase over the $.218 per share declared in fiscal 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWIPFLI ULLRICH BERTELSON Certified Public Accountants\nTo the Shareholders and Board of Directors Wausau Paper Mills Company Wausau, Wisconsin\nWe have audited the accompanying consolidated balance sheets of Wausau Paper Mills Company and Subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, cash flows and shareholders' equity for each of the years in the three-year period ended August 31, 1995 and the supporting schedule listed in the accompanying index to financial statements. These financial statements and supporting schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and supporting 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 supporting 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 supporting 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 Wausau Paper Mills Company and Subsidiaries at August 31, 1995 and 1994, and the results of their operations and cash flows for each of the years in the three- year period ended August 31, 1995, and the supporting schedule presents fairly the information required to be set forth therein, all in conformity with generally accepted accounting principles.\nAs discussed in Note 8 and Note 7 of the Notes to Consolidated Financial Statements, the company changed its method of accounting for income taxes in 1994 and its method of accounting for postretirement benefits other than pensions in 1993.\nWe hereby consent to the incorporation by reference of this report in the Registration Statements on Form S-8 and amendments thereto filed with the Securities and Exchange Commission by Wausau Paper Mills Company on August 25, 1995, January 3, 1992 and January 27, 1988.\nWIPFLI ULLRICH BERTELSON WIPFLI ULLRICH BERTELSON September 19, 1995 Wausau, Wisconsin\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Wausau Paper Mills Company is responsible for the integrity and objectivity of the financial data contained in the financial statements and supporting schedule. The financial statements and supporting schedule have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances and, where necessary, reflect informed judgments and estimates of the effects of certain events and transactions based on currently available information at the date the financial statements were prepared.\nThe company's management depends on the company's system of internal accounting controls to assure itself of the reliability of the financial statements. The internal control system is designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded and transactions are executed in accordance with management's authorizations and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles. Periodic reviews are made of internal controls by management and corrective action is taken if needed.\nThe Board of Directors reviews and monitors financial statements through its audit committee. The audit committee meets with the independent public accountants and management to review internal accounting controls, auditing and financial reporting matters.\nThe independent public accountants are engaged to provide an objective and independent review of the company's financial statements in accordance with generally accepted auditing standards and to express an opinion thereon. The report of the company's independent public accountants is included in this annual report.\nSAN W. ORR, JR. DANIEL D. KING SAN W. ORR, JR. DANIEL D. KING Chairman of the Board of Directors President and Chief Operating and Chief Executive Officer Officer\nSTEVEN A. SCHMIDT STEVEN A. SCHMIDT Vice President Finance, Secretary and Treasurer\nINDEX TO FINANCIAL STATEMENTS COVERED BY REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nConsolidated Statements of Income for the years ended August 31, 1995, 1994 and 1993 .................................17\nConsolidated Balance Sheets as of August 31, 1995 and 1994 .......................................................18\nConsolidated Statements of Shareholders' Equity for the years ended August 31, 1995, 1994 and 1993 .................20\nConsolidated Statements of Cash Flows for the years ended August 31, 1995, 1994 and 1993 ...........................21\nNotes to Consolidated Financial Statements .........................22\nSchedule for the years ended August 31, 1995, 1994 and 1993\nSchedule II - Valuation and Qualifying Accounts ................36\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 Consolidated Financial Statements and Notes thereto.\nWAUSAU PAPER MILLS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of the company and its subsidiaries. All significant intercompany transactions, balances and profits have been eliminated in consolidation.\nREVENUE RECOGNITION - Revenue is recognized upon shipment of goods and transfer of title to the customer. The company grants credit to customers in the ordinary course of business. A substantial portion of the company's accounts receivable is with customers in various paper converting industries or the paper merchant business. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers and their geographic dispersion.\nCASH EQUIVALENTS - The company defines cash equivalents as highly liquid, short-term investments with an original maturity of three months or less.\nINVENTORIES - Pulpwood, finished paper products and the majority of raw materials are valued at the lower of cost, determined on the last-in, first- out (LIFO) method, or market. All other inventories are valued at the lower of average cost or market.\nPROPERTY, PLANT AND EQUIPMENT - Plant and equipment are stated at cost and are depreciated over the estimated useful lives of the assets using the straight- line method for financial statement purposes. The cost and related accumulated depreciation of all plant and equipment retired or otherwise disposed of are removed from the accounts and any resulting gains or losses are included in the statements of income.\nBuildings are depreciated over a 25- to 45-year period; machinery and equipment over a 4- to 16-year period. Maintenance and repair costs are charged to expense as incurred. Renewals and improvements which extend the useful lives of the assets are added to the plant and equipment accounts.\nEquipment financed by long-term leases, which in effect are installment purchases, have been recorded as assets and the related obligations as debt.\nLand is stated at cost. Timberlands are at cost less the pro rata cost of timber harvested since acquisition. Depletion expense is calculated using the block method.\nINCOME TAXES - Deferred income taxes have been provided under the liability method. Deferred tax assets and liabilities are determined based upon the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities, as measured by the current enacted tax rates. Deferred tax expense is the result of changes in the deferred tax asset and liability. See Note 8 for change in accounting principle in 1994.\nEARNINGS PER SHARE - Earnings per common share are based on the weighted average number of common shares outstanding. Dilution of earnings per common share due to common stock equivalents (stock options) is negligible and, accordingly, no dilution has been reported.\nBecause various components of the inventories are valued by use of the last- in, first-out (LIFO) method, it is impracticable to segregate the LIFO reserve between raw materials and work in process and finished goods.\nThe company has outstanding $30 million in unsecured senior promissory notes. Interest is payable quarterly on the outstanding balance at a rate of 6.03% per annum. Principal is payable in ten equal semi-annual installments beginning December 18, 1995, with the final payment due June 16, 2000.\nDuring 1995, the company borrowed $19 million related to industrial development bonds issued by a local governmental unit. The variable rate bonds require quarterly interest payments and had an interest rate of 3.85% at August 31, 1995. The company also pays fees for a bank letter of credit and remarketing services related to the bonds which it includes in net interest\nexpense. The interest rate can be converted to a fixed rate, at the company's option, after which semi-annual interest payments will be required. The bonds mature on July 1, 2023. At August 31, 1995, bond proceeds of $14,732,000 were not disbursed and are reflected as an asset on the balance sheet. The company maintains an unsecured revolving credit facility of $35 million with two banks which continues through August 1, 1997 at which time, or earlier at the company's option, the revolving credit converts to a term loan facility, and the loans then outstanding are payable in four equal annual installments. The company may elect the base for interest from either domestic rate loans, eurodollar loans, adjusted CD rate loans, offered loans or treasury rate loans. The weighted average interest rate on borrowings under the revolving credit facility was 6.21% at August 31, 1995. There were no borrowings against this agreement at August 31, 1994. The credit agreement provides for commitment fees during the revolving loan period. Fees are based on .125% per annum on the unused portions of the commitment, payable monthly.\nConsistent with the classification of the revolving credit agreement, fixed asset payables that will be financed through the agreement are classified as long-term debt.\nThe senior promissory notes and the revolving credit facility agreement require the company to comply with certain covenants, one of which requires the company maintain minimum net worth. At August 31, 1995, $69,950,000 of retained earnings was available for payment of cash dividends without violation of the minimum net worth covenant related to the senior promissory notes.\nThe company maintains a commercial paper placement agreement with a bank to issue up to $40 million of unsecured debt obligations which requires unused credit availability under its revolving credit agreement equal to the amount of outstanding commercial paper. The weighted average interest rate on outstanding commercial paper was 6.20% at August 31, 1995. There were no amounts outstanding at August 31, 1994.\nThe difference between the book and the fair market value of the long-term debt is not material.\nAnnual maturities will be affected by future borrowings.\nThe banks participating in the revolving credit agreement have provided separate uncommitted revolving lines of credit to the company in an aggregate amount of up to $30 million. The specific terms of any revolving loans borrowed pursuant to these lines of credit will be negotiated at the time of the borrowing and any revolving loans so borrowed will be payable on demand. In addition, the company has a $2 million line of credit with interest payable at the prime rate. The line does not require a compensating balance or a commitment fee. There was no borrowing against these lines at August 31, 1995.\nNOTE 5. LEASE COMMITMENTS\nThe company has various leases for real estate, mobile equipment and machinery which generally provide for renewal privileges or for purchase at option prices established in the lease agreements. Property, plant and equipment includes the following amounts for capitalized leases:\nLease amortization is included in depreciation expense.\nThe future minimum payments for capitalized leases are reflected in the aggregate annual maturities of long-term debt disclosure in Note 4.\nContingent rentals are based upon usage.\nNOTE 7. RETIREMENT PLAN\nSubstantially all employees are covered under retirement plans. The defined benefit plans covering salaried employees provide benefits based on final average pay formulas; the plans covering hourly employees provide benefits based on years of service and fixed benefit amounts for each year of service. The plans are funded in accordance with federal laws and regulations.\nThe company selected a measurement date of plan assets of May 31, 1995 and 1994.\nProjected benefit obligations were determined using an assumed discount rate of 7.5% and an assumed rate of increases in future compensation levels of 5.0%. The assumed long-term rate of return on plan assets was 8.0%. Plan assets consist principally of publicly traded stocks and fixed income securities and include Wausau Paper Mills Company common stock with a market value of $1,377,000 in 1995 and $1,854,000 in 1994.\nThe company's defined contribution pension plan provides for company contributions based on a percentage of employee contributions. The cost of such plans totaled $232,000 in 1995 and $445,000 in 1994, and $420,000 in 1993.\nThe company has deferred compensation or supplemental retirement agreements with certain present and past key officers and employees. The principal cost of such plans is being or has been accrued over the period of active employment to the full eligibility date. The annual cost of the deferred compensation and supplemental retirement agreements does not represent a material amount.\nIn fiscal 1993, the company adopted the provisions of Statements of Financial Accounting Standard (SFAS) No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" effective as of September 1, 1992.\nSFAS 106 requires the estimated cost of retiree benefit payments, primarily health and life insurance, to be accrued during the employees' active service period. Previously, the cost of these benefits was expensed as paid. The company elected to immediately recognize the accumulated liability as of September 1, 1992, which resulted in a one-time noncash charge against earnings of $25,000,000 before taxes and $15,750,000 after taxes, or $.53 per share (as restated). In addition, the effect of this change on 1993 operating results was to recognize an additional pre-tax expense of $1,590,000 and after-tax expense of $987,000, or $.03 per share (as restated).\nFor 1995, the assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 11% declining by 1% annually for six years to an ultimate rate of 5%. The weighted average discount rate was 7.5%.\nFor 1994, the assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 12% declining by 1% annually for seven years to an ultimate rate of 5%. The weighted average discount rate was 7.5%.\nA one-percentage-point increase in the assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of August 31, by approximately $3,779,000 or 13.1% in 1995 and $3,541,000 or 12.9% in 1994. The effect of this change on the aggregate of the service and interest cost would be an increase of $416,000 or 14.3% in 1995 and $451,000 or 14.6% for 1994.\nNOTE 8. INCOME TAXES\nEffective September 1, 1993, the company adopted the liability method of accounting for income taxes prescribed by Statement of Financial Accounting Standard (SFAS) No. 109. Deferred tax assets and liabilities are determined based on the estimated future tax effects of temporary differences between the financial statement and tax bases of assets and liabilities, as measured by the current enacted tax rates. Deferred tax expense is the result of changes in the deferred tax asset and liability. Previously, the company used the deferral method which provided for deferred income taxes on the basis of income and expense items reported for financial accounting and tax purposes in different periods.\nThe company elected to recognize the cumulative effect of the change as of September 1, 1993, totaling $1,000,000, as a credit to income in 1994. The effect of the change in method did not have a material effect in 1994.\nNOTE 9. STOCK OPTIONS AND APPRECIATION RIGHTS\nThe company maintains the 1981 and 1991 Employee Stock Option Plans. Each plan specifies purchase price, time and method of exercise. Payment of the option price may be made in cash or by tendering an amount of common stock having a fair market value equal to the option price.\nOptions are granted for terms up to 20 years, the option price being equal to the fair market value of the company's common stock at the date of grant under the 1981 plan and for incentive options granted under the 1991 plan. The option price for non-qualified options under the 1991 plan may not be less\nthan 50% of the fair market value of the company's common stock at the date of grant.\nDuring 1995, 36,850 options were granted under the 1991 Employee Stock Option Plan to be earned based upon the satisfaction of operating goals set forth in the agreement. The options terminated when 1995 operating goals were not met.\nDuring 1992, options were granted under the 1991 Employee Stock Option Plan. The options were to be earned over a three-year period based upon the satisfaction of operating goals set forth in the agreement. A total of 97,783 and 72,358 options terminated in 1994 and 1993, respectively, when operating goals were not met.\nThe 1988 Management Incentive Plan entitles certain management employees the right to receive cash equal to the sum of the appreciation in value of the stock and the hypothetical value of cash dividends which would have been paid on the stock covered by the grant assuming reinvestment in company stock. The stock appreciation rights granted may be exercised in whole or in such installments and at such times as specified in the grant. In all instances, the rights lapse if not exercised within 20 years of the grant date. Compensation expense is recorded with respect to the rights based upon the quoted market value of the shares and the exercise provisions.\nAll shares and price ranges have been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock splits occurring in 1994 and 1993.\nThe company maintains the 1991 Dividend Equivalent Plan. Participants are entitled to receive cash based on the hypothetical value of cash dividends which would have been paid on the stock covered by the grant assuming reinvestment in company stock. During 1995, 36,850 dividend equivalents were granted under the plan. The dividend equivalents are earned in the current year based upon the satisfaction of operating goals set forth in the agreement. All dividend equivalents granted in 1995 terminated when operating goals were not met.\nDuring 1992, 196,534 dividend equivalents were granted under the plan. The dividend equivalents granted in 1992 and 26,400 of the dividend equivalents granted in 1993 were to be earned over a three-year period based upon the satisfaction of operating goals set forth in the agreement. A total of 89,956 and 72,358 dividend equivalents terminated in 1994 and 1993, respectively, when operating goals were not met.\nAll shares have been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock splits occurring in 1994 and 1993.\nThe pre-tax impact on earnings of all stock options, dividend equivalents and stock appreciation rights for the years ended August 31, 1995, 1994 and 1993 was expense of $79,000, income of $283,000 and expense of $1,934,000, respectively.\nNOTE 10. RESEARCH EXPENSES\nResearch expenses charged to operations were $1,219,000 in 1995, $1,158,000 in 1994 and $957,000 in 1993.\nNOTE 11. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS\nThe company is involved in various legal proceedings in the normal course of business. It is the opinion of management that any judgment or settlement resulting from pending or threatened litigation would not have a material adverse effect on the financial position or on the operations of the company.\nAs of August 31, 1995, the company was committed to spend approximately $62 million to complete capital projects which were in various stages of completion.\nIn 1993, Rhinelander Paper Company, Inc., a subsidiary of the company, signed an agreement with Wisconsin Public Service Corporation (WPS) under which Rhinelander Paper would become the exclusive steam customer of a high- efficiency cogeneration power plant to be constructed, owned and operated by WPS. The arrangement for ownership and operation by WPS was altered during the regulatory approval process, making it necessary to negotiate a new agreement between WPS and Rhinelander Paper if the project were to proceed. The two companies were unable to agree upon several fundamental issues and after lengthy negotiations, Rhinelander Paper Company decided it was not feasible to continue and terminated further negotiations. WPS and Rhinelander Paper issued a joint press release on July 21, 1995, announcing the cancellation of plans to build the cogeneration power plant.\nDuring fiscal 1994, the company purchased 100,000 shares of the company's no- par value common stock from a director in a private transaction at $27.625 per share, the average market price on the day of the transaction.\nNOTE 12. MAJOR CUSTOMERS\nOne customer accounted for 12.0% of net sales aggregating $61,732,000, 12.3% of net sales aggregating $52,313,000, and 11.2% of net sales aggregating $42,812,000 in 1995, 1994 and 1993, respectively.\nThe estimated effective tax rate utilized for the first three quarters of each fiscal year was different than the final annual effective rate and the adjustment of income taxes was all reflected in the quarter ended August 31 of each fiscal year.\nAll per share data has been restated to reflect the 10% stock dividend occurring in 1995 and the four-for-three stock split occurring in 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation relating to directors is incorporated into this Form 10-K by reference to the table on page 5 of the registrant's Proxy Statement dated November 9, 1995 (1995 Proxy Statement). Information relating to executive officers is found in Part I of this Form 10-K, page 4.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation relating to director compensation is incorporated into this Form 10-K by reference to the registrant's 1995 Proxy Statement under the subcaption \"Director Compensation\", page 6. Information relating to the compensation of executive officers is incorporated into this Form 10-K by this reference to (1) the material set forth beginning under the caption \"Compensation of Executive Officers\" and ending with the material set forth under the subcaption \"Supplemental Plans\", pages 8 through 13 and (2) the material set forth under the subcaption \"Committee Interlocks and Insider Participation\", page 16, in the 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation relating to security ownership of certain beneficial owners and management is incorporated into this Form 10-K by reference to the material set forth in the registrant's 1995 Proxy Statement beginning under the caption \"Beneficial Ownership of Shares\", page 2, through the material immediately preceding the final paragraph under such caption, page 3.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial statements and financial statement schedules, filed as part of this report and required by Item 14(d), are set forth on page 14 herein. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the company during the fourth quarter of fiscal 1995. (c) Exhibits required by Item 601 of Regulation S-K.\nThe following exhibits are filed with the Securities and Exchange Commission as part of this report.\nExhibit 3 - Articles of Incorporation and Bylaws\na. Articles of Incorporation, as amended 12\/18\/91 ................33-45(2) b. Bylaws, as restated 7\/17\/92 ...................................46-81(2)\nExhibit 4 - Instruments Defining the Rights of Security Holders\na. Articles and Bylaws (see Exhibit 3)\nExhibit 10 - Material Contracts*\na. Executive Officers' Deferred Compensation Retirement Plan, as amended 5\/20\/93.............................................40-54(1) b. Incentive Compensation Plans, as amended 10\/23\/92 and 10\/28\/93 (Printing and Writing Division and Rhinelander Paper Company, Inc.)...........................................55-62(1) c. Corporate Management Incentive Plan, as amended 8\/19\/87 .......63-69(1) d. 1988 Stock Appreciation Rights Plan, as amended 4\/17\/91 .....106-114(3) e. 1988 Management Incentive Plan, as amended 4\/17\/91 ..........115-123(3) f. 1990 Stock Appreciation Rights Plan, as amended 4\/17\/91 .....124-132(3) g. Deferred Compensation Agreement dated March 2, 1990, as amended July 1, 1994........................................51-56(4) h. 1991 Employee Stock Option Plan .............................133-146(3) i. 1991 Dividend Equivalent Plan ...............................147-155(3) j. Supplemental Retirement Benefit Plan dated January 16, 1992 ...90-97(2) k. Directors' Deferred Compensation Plan .........................71-86(1) l. Director Retirement Benefit Policy ............................87-88(1)\n*All exhibits represent executive compensation plans and arrangements.\nExhibit 22 - Subsidiaries .............................................89(1)\nExhibit 27 - Financial Data Schedule\nPage numbers set forth herein correspond to the page numbers using the sequential numbering system, where such exhibit can be found in the following Annual Reports on Form 10-K:\n(1) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993; Commission File Number 0-7574. (2) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1992; Commission File Number 0-7574. (3) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1991; Commission File Number 0-7574. (4) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1994; Commission File Number 0-7574.\nThe above exhibits are available upon request in writing from the Secretary, Wausau Paper Mills Company, P.O. Box 1408, Wausau, Wisconsin 54402-1408.\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.\nWAUSAU PAPER MILLS COMPANY\n\/S\/ STEVEN A. SCHMIDT Steven A. Schmidt Vice President Finance, Secretary and Treasurer (Principal Accounting and Financial Officer) Date: October 27, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/S\/ SAN W. ORR, JR. \/S\/ DAVID B. SMITH, JR. San W. Orr, Jr. David B. Smith, Jr. October 27, 1995 October 27, 1995 Chairman of the Board and Director Chief Executive Officer (Principal Executive Officer)\n\/S\/ DANIEL D. KING \/S\/ STANLEY F. STAPLES, JR. Daniel D. King Stanley F. Staples, Jr. October 27, 1995 October 27, 1995 President and Chief Operating Director Officer Director\n\/S\/ HARRY R. BAKER Harry R. Baker October 27, 1995 Director\nEXHIBIT INDEX Pursuant to Item 102(d) of Regulation S-T (17 C.F.R. 232.102(d)\nExhibit 3 - Articles of Incorporation and Bylaws\na. Articles of Incorporation, as amended 12\/18\/91 .............33-45(2) b. Bylaws, as restated 7\/17\/92 ................................46-81(2)\nExhibit 4 - Instruments Defining the Rights of Security Holders\na. Articles and Bylaws (see Exhibit 3)\nExhibit 10 - Material Contracts*\na. Executive Officers' Deferred Compensation Retirement Plan, as amended 5\/20\/93 ...................................40-54(1) b. Incentive Compensation Plans, as amended 10\/23\/92 and 10\/28\/93 (Printing and Writing Division and Rhinelander Paper Company, Inc.) .......................................55-62(1) c. Corporate Management Incentive Plan, as amended 8\/19\/87 ....63-69(1) d. 1988 Stock Appreciation Rights Plan, as amended 4\/17\/91 ..106-114(3) e. 1988 Management Incentive Plan, as amended 4\/17\/91 .......115-123(3) f. 1990 Stock Appreciation Rights Plan, as amended 4\/17\/91 ..124-132(3) g. Deferred Compensation Agreement dated March 2, 1990, as amended July 1, 1994 ....................................51-56(4) h. 1991 Employee Stock Option Plan ..........................133-146(3) i. 1991 Dividend Equivalent Plan ............................147-155(3) j. Supplemental Retirement Benefit Plan dated January 16, 1992........................................................90-97(2) k. Directors' Deferred Compensation Plan ......................71-86(1) l. Director Retirement Benefit Policy .........................87-88(1)\n*All exhibits represent executive compensation plans and arrangements.\nExhibit 22 - Subsidiaries .............................................89(1)\nExhibit 27 - Financial Data Schedule .....................................39\nPage numbers set forth herein correspond to the page numbers using the sequential numbering system, where such exhibit can be found in the following Annual Reports on Form 10-K:\n(1) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993; Commission File Number 0-7574. (2) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1992; Commission File Number 0-7574. (3) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1991; Commission File Number 0-7574. (4) Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1994; Commission File Number 0-7574.","section_15":""}
{"filename":"803771_1995.txt","cik":"803771","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nUSA Real Estate Investment Trust (the \"Trust\") is a California business trust that was formed on October 7, 1986, for the primary purpose of engaging in the business of acquiring, owning and financing real property investments. The Trust commenced operations on October 19, 1987, upon the sale of the minimum offering amount of shares of beneficial interest (\"shares\").\nThe purpose of the Trust is to provide investors with an opportunity to own, through transferable shares, an interest in diversified real estate investments. The Trust invests primarily in income producing real properties in accordance with the investment objectives and policies of the Trust. Through such investments, the Trust seeks to provide investors with an opportunity to participate in a portfolio of professionally managed real estate investments in the same way a mutual fund affords investors an opportunity to invest in a professionally managed portfolio of stocks, bonds and other securities. However, a real estate investment trust is not a mutual fund and is not subject to the same regulations as a mutual fund.\nThe Trust has operated and intends to continue to operate in a manner intended to qualify as a \"real estate investment trust\" (REIT) under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). A qualified REIT is relieved, in part, from federal income taxes on ordinary income and capital gains distributed to its shareholders. State tax benefits also may accrue to a qualified REIT. Pursuant to Code requirements, the Trust distributes to its shareholders at least 95 percent of its taxable income and 100 percent of the net capital gain from the sale of Trust properties.\nThe Trust will terminate 21 years after the death of the last survivor of persons listed in the Trust's Declaration of Trust. The Trust may also be terminated at any time by the majority vote or written consent of shareholders or by a majority vote of the Trustees.\nThe principal offices of the Trust are located at One Scripps Drive, Suite 201, Sacramento, California 95825.\nCURRENT DEVELOPMENTS\nOn August 31, 1994 the Trust became self-administered and 1995 is its first year of operation as a self-administered real estate investment trust.\nIn May, 1995 the Trust sold 1450 Hatch Road in Ceres, California.\nBeginning September 15, 1995 and ending February 29, 1996, the Trust made an offer to repurchase all of their shares from shareholders who owned 50 or fewer shares for the cash price of $3.50 per share. Pursuant to said offer, the Trust repurchased 36,577 shares from 1,791 shareholders at a cost of $137,060.\nINVESTMENT OBJECTIVES\nThe Trust has acquired a diversified portfolio of income producing real property investments. Subject to certain limitations, the Declaration of Trust gives the Trustees discretion to allocate the Trust's investments without the prior approval of shareholders.\nINVESTMENT GUIDELINES\nAcquisition Policies. The Trustees have adopted investment guidelines for the purpose of selecting the Trust's future investments. Pursuant to the guidelines, the allocation of Trust assets among income producing real property investments depends principally upon the following factors:\n1. The number of properties available for acquisition which show current income and potential for appreciation in value due to increases in rental income;\n2. The availability of funds for investment;\n3. The laws and regulations governing investment in and the subsequent sale of real estate investments by a REIT; and\n4. The applicable federal and state income tax, securities, and real estate laws and regulations.\nThe guidelines may vary from time to time, at the sole discretion of the Trustees, in order to adapt to changes in real estate markets, federal income tax laws and regulations and general economic conditions. The Trustees also have discretion to acquire an investment not meeting these guidelines if the Trustees determine that other circumstances justify the acquisition in a particular case.\nPortfolio Turnover. The Trustees have set general guidelines for the disposition of properties in its portfolio which take into consideration certain regulatory restrictions and federal income tax laws regarding REIT portfolio turnover. Income tax regulations preclude the Trust from holding any property (other than foreclosure property) primarily for sale to customers in the ordinary course of the Trust's trade or business, but provide a \"safe harbor\" for property held for at least four years from the date of acquisition. Portfolio turnover policy also depends on whether a favorable sales price can be realized by the Trust, primarily a function of the capitalization rate applied to similar types of property in similar markets. The Trust may elect to hold property as long as is reasonably necessary to provide an attractive sales price.\nOTHER INFORMATION\nThe Trust has no employees. It is administered by its Trustees and by its Chairman, and by independent contractors who work under the supervision thereof as a self-administered real estate investment trust.\nThe Trust is involved in only one industry segment: acquiring, operating and holding for investment income-producing real properties. Revenues, net income and assets from this industry segment are included in the Trust's financial statements which appear at Item 8 of Part II.\nThe Trust's results of operations will depend on the availability of suitable opportunities for investment and the comparative yields available from time to time on real estate and other investments, as well as market conditions affecting leasing and sale of real estate in the areas in which the Trust's investments are located. These factors, in turn, are influenced to a large extent by the type of investment involved, financing available for real estate investment, the nature and geographic location of the property, competition and other factors, none of which can be predicted with certainty. The real estate investment market is highly competitive. The Trust competes for acceptable investments with other financial institutions, including banks, insurance companies, savings and loan associations, pension funds and other real estate investment programs. The Trust also competes with other lessors and sellers of real property. Many of these competitors have greater resources than the Trust. The number of such competitors and funds available for investment in properties of the type suitable for investment by the Trust may increase, resulting in increased competition for such investments and possibly increased costs and thus reduced income for the Trust.\nThe rules and regulations adopted by various agencies of federal, state or local governments relating to environmental controls and the development and operation of real property may operate to reduce the number of investment opportunities available to the Trust or may adversely affect the properties currently owned by it. While the Trust does not believe environmental controls have had a material impact on its activities, there can be no assurance that the trust will not be adversely affected thereby in the future.\nTAX LEGISLATION\nThe Trust has elected to be treated as a real estate investment trust under Sections 856-860 of the Internal Revenue Code of 1986, as amended \"the \"Code\"). The Trust expects to operate and to invest in a manner that will maintain its qualification for real estate investment trust taxation. The Code requirements for such qualificaton are complex. While no assurance can be given that the Trust qualified for taxation as a real estate investment trust for past taxable years, the Trust nevertheless believes that it has so qualified and will endeavor to continue to qualify for its current year and future years.\nThe business of the Trust is uniquely sensitive to tax legislation. Changes in tax laws are made frequently. There is no way for the Trust to anticipate when or what changes in the tax laws may be made in the future, or how such changes might affect the Trust.\nThe Internal Revenue Service (\"IRS\") has not yet issued regulations to carry out numerous provisions enacted as part of the tax legislation passed since 1986. Nor has the IRS addressed the issues relating to the application of some of the new tax rules to entities such as real estate investment trusts. Until such regulations are issued by the IRS, it is difficult to gauge what impact, if any, such new legislaton may have on entities such a real estate investment trusts.\nGENERAL\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Trust owns nine properties all of which are located in California except one which is located in Reno, Nevada. The Trustees believe that most of the properties are quality income producing properties that are well suited for their current uses. Most of the properties are leased under long term leases at competitive rates for the area in which they are located. The lease terms provide for rental adjustments on a periodic basis.\nTitle insurance and liability and property damage insurance in amounts deemed appropriate by the Trust have been obtained for the properties referred to above. The Trust does not carry flood insurance on said properties. Because of the high cost of premiums, excessive deductibles, and limited coverage, the Trust does not carry earthquake insurance on said properties.\nFor additional information concerning the aforesaid properties, see Notes 1 and 3 of the Notes to Financial Statements and Schedule III.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Trust's security holders during the last quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nThe Trust has one class of authorized and outstanding equity consisting of common shares of beneficial interest, par value $1.00 per share. The Trust engaged in a continuous best efforts public offering from May 20, 1987, until May 20, 1992. As of December 31, 1995, the Trust had 4,120,430 shares outstanding to about 12,000 shareholders of record. There is no trading market for the shares of the Trust. Beginning September 15, 1995 and ending February 29, 1996 the Trust made an offer to repurchase all of their shares from shareholders who owned 50 or fewer shares for the cash price of $3.50 per share. Pursuant to said offer the Trust repurchased 36,577 shares from 1,791 shareholders at a cost of $137,060.\nThe Trust pays quarterly cash dividends to shareholders aggregating at least 95 percent of the Trust's taxable income. However, as a matter of policy, the amount of the dividends depends upon the Trustees' evaluation of the general financial condition of the Trust, cash flow, and other factors. The Trustees expect the Trust to continue making future dividends in accordance with the policy stated above.\nIn 1995 the Trust paid dividends of 32 cents per share as compared to 26 cents per share in 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following represents selected financial data for the Trust for the five years ended December 31, 1995. The data should be read in conjunction with the financial statements and related notes included elsewhere herein.\nYears Ended December 31 (Amounts in thousands, except for per share data)\n1995 1994 1993 1992 1991 -------- -------- -------- -------- --------\nOperating Results:\nRevenues $ 2,858 $ 2,978 $ 2,896 $ 2,839 $ 2,980\nNet income (loss) (1) 753 (1,443) (2,507) (2,567) 423\nTotal Assets 23,802 25,924 29,333 34,207 32,775\nLong-term obligations 2,099 3,345 3,268 4,969 none\nNet income (loss) per share $ 0.18 $ (0.35) $ (0.60) $ (0.61) $ 0.10\nCash distributions per share $ 0.32 $ 0.26 $ 0.12 $ 0.39 $ 0.58\n(1) Includes valuation losses of $124,000; $839,000; $2,060,000; $3,162,030 and $1,240,000 for 1995, 1994, 1993, 1992 and 1991, respectively.\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 operating income, proceeds from the sale of rental properties, collections on notes receivable, and borrowings collateralized by specific properties will provide for its future liquidity and capital resource needs.\nRESULTS OF OPERATIONS\nComparison of 1995 to 1994\nEffective August 31, 1994, the Trust terminated its agreements with its former advisor and property manager and became self-administered. 1995 was the first full year the Trust was self-administered.\nInterest revenues decreased $91,099 in 1995 compared to 1994, primarily due to the collection of the $940,000 note receivable collateralized by 151 and 175 Opportunity Street in December, 1994.\nOperating expenses decreased $498,116 in 1995 compared to 1994. $373,464 of this decrease is due to the cost to repair uninsured earthquake damage at 19401 Parthenia in Northridge, California incurred in 1994 and $124,652 is due to our focus on cutting expenses.\nProperty management fees decreased $68,385 in 1995 compared to 1994 because of the termination of the former property management agreement and the hiring of new property managers who provided better service for less money.\nInterest expense decreased $331,570 in 1995 compared to 1994 due to significantly lower outstanding indebtedness at significantly lower interest rates.\nGeneral and administrative expense decreased $265,248 in 1995 compared to 1994 primarily as a result of fewer legal fees in 1995. General and administrative expense is expected to be less than $400,000 in 1996.\nThe legal settlement referred to on the statement of income (operations) was for the settlement of all litigation with the former advisor of the Trust. The Trust is not currently engaged in litigation in any court with any party.\nThe gain on sale of properties was attributed to the sale of 1450 Hatch Road in Ceres, California in May, 1995.\nNet income was $752,898 or 18 cents per share in 1995 compared to a net loss of $(1,442,875) or 35 cents per share in 1994.\nFunds from operations were $1,372,241 or 33 cents per share in 1995 compared to $333,603 or 8 cents per share in 1994.\nThe Trust paid distributions per share of 32 cents and 26 cents in 1995 and 1994, respectively.\nComparison of 1994 to 1993\nRent decreased $11,841 in 1994 compared to 1993. Rent in 1994 includes an insurance recovery of $67,668 for the loss of rent due to the January, 1994, Northridge, California, earthquake. The rent for 1994 would have been $186,701 greater than 1993 had it not been for the earthquake.\nOperating expenses increased $311,685 in 1994 compared to 1993 primarily due to $373,464 in the cost to repair uninsured earthquake damage to property owned by the Trust located at 19401 Parthenia Street in Northridge, California.\nDepreciation and amortization increased $71,142 in 1994 compared to 1993 primarily due to the amortization of leasing commissions. General and administrative expenses increased $147,950 in 1994 compared to 1993 due primarily to legal fees incurred with respect to nonrecurring matters.\nIn 1994, funds from operations were $333,603. Absent the earthquake, funds from operations would have been $893,768.\nIMPACT OF INFLATION\nThe Trust's operations have not been materially affected by inflation. While the rate of inflation has been relatively low since the Trust commenced operations in October, 1987, even if the rate of inflation were to rise, the Trust anticipates that it would be able to offset most of the impact of higher operating expenses through rent escalation clauses and lease clauses that pass on most of the operating expenses to tenants.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage\nIndependent Auditors' Report .............................. 11\nBalance Sheets As of December 31, 1995 and 1994 ........................ 12\nStatements of Income (Operations) Years Ended December 31, 1995, 1994 and 1993 ............ 13\nStatements of Changes in Shareholders' Equity Years Ended December 31, 1995, 1994 and 1993 ............ 14\nStatements of Cash Flows Years Ended December 31, 1995, 1994 and 1993 ............ 15\nNotes to Financial Statements ............................. 16\nSchedule III Real Estate and Accumulated Depreciation ................ 23-26\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Trustees and Shareholders of USA Real Estate Investment Trust\nWe have audited the accompanying balance sheets of USA Real Estate Investment Trust as of December 31, 1995 and 1994 and the related statements of income (operations), changes in shareholders' equity, and cash flows for the years ended December 31, 1995, 1994 and 1993. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and this financial statement schedule are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and this financial statement schedule based on our audit.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluation of the overall financial statement presentation. We believe that our 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 USA Real Estate Investment Trust 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. 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.\nBurnett, Umphress & Kilgour\nRancho Cordova, California January 25, 1996\nUSA REAL ESTATE INVESTMENT TRUST Balance Sheets\nDecember 31, December 31, 1995 1994 ----------- ----------- ASSETS\nRental properties, less accumulated depreciation of $2,218,805 and $1,903,027 in 1995 and 1994, respectively and valuation allowances of $5,837,000 and $6,051,000 in 1995 and 1994, respectively $ 21,153,860 $ 23,983,095 Notes receivable 818,869 966,047 ---------- ----------- 21,972,729 24,949,142\nCash and cash equivalents 1,487,661 378,411 Other assets 341,333 596,319 ----------- ----------- Total assets $ 23,801,723 $ 25,923,872 =========== ===========\nLIABILITIES AND SHAREHOLDERS' EQUITY\nLiabilities: Long-term notes payable $ 2,098,919 $ 3,344,907 Accounts payable 35,320 133,003 Lease deposits 70,371 73,658 ----------- ----------- Total liabilities 2,204,610 3,551,568 ----------- ----------- Shareholders' Equity: Shares of beneficial interest, par value $1 a share; authorized 7,500,000 shares; 4,120,430 and 4,177,723 shares outstanding in 1995 and 1994, respectively $ 4,120,430 $ 4,177,723 Additional paid-in capital 30,395,534 30,535,678 Distributions in excess of net income (12,918,851) (12,341,097) ----------- ----------- Total shareholders' equity 21,597,113 22,372,304 ----------- ----------- Total liabilities and shareholders' equity $ 23,801,723 $ 25,923,872 =========== ===========\nSee accompanying notes to financial statements.\nUSA REAL ESTATE INVESTMENT TRUST Statements of Income (Operations) Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ----------- ----------- -----------\nRevenues: Rent $ 2,706,483 $ 2,734,558 $ 2,746,399 Interest 151,851 242,950 149,272 ----------- ----------- -----------\n2,858,334 2,977,508 2,895,671 ----------- ----------- -----------\nExpenses: Operating expenses 307,968 806,084 494,399 Property taxes 225,342 218,835 275,614 Property management fees 54,000 122,385 144,104 Interest 270,069 601,639 642,745 Depreciation and amortization 655,597 687,478 616,336 General and administative 629,714 894,962 747,012 Legal settlement 250,000 0 0 Valuation loss 124,000 839,000 2,060,000 ----------- ----------- -----------\n2,516,690 4,170,383 4,980,210 ----------- ----------- -----------\nNet income (loss) before gain (loss) on sale of rental properties and disposition of promissory note 341,644 (1,192,875) (2,084,539)\nGain (loss) on sale of rental properties and disposition of promissory note 411,254 (250,000) (422,096) ----------- ----------- -----------\nNet income (loss) $ 752,898 $(1,442,875) $(2,506,635) =========== =========== ===========\nNet income (loss) per share of beneficial interest $ 0.18 $ (0.35) $ ( 0.60) =========== =========== ===========\nWeighted average number of shares $ 4,153,717 $ 4,177,723 $ 4,177,723 =========== =========== ===========\nSee accompanying notes to financial statements.\nUSA REAL ESTATE INVESTMENT TRUST Statements of Changes in Shareholders' Equity Years Ended December 31, 1995, 1994 and 1993\nDistribu- Total Shares of Additional tions in Share- Beneficial Interest Paid-in Excess of holders' Number Amount Capital Net Income Equity --------- --------- ----------- ------------- ----------- Balance at December 31, 1992 4,177,723 $4,177,723 $30,535,678 $ (6,792,748) $27,920,653\nNet loss - - - (2,506,635) (2,506,635) Distributions - - - (502,114) (502,114) --------- --------- ---------- ----------- ---------- Balance at December 31, 1993 4,177,723 4,177,723 30,535,678 (9,801,497) 24,911,904 --------- --------- ---------- ----------- ----------\nNet loss - - - (1,442,875) (1,442,875) Distributions - - - (1,096,725) (1,096,725) --------- --------- ---------- ----------- ---------- Balance at December 31, 1994 4,177,723 4,177,723 30,535,678 (12,341,097) 22,372,304 --------- --------- ---------- ----------- ----------\nRedemption of shares (57,293) (57,293) (140,144) - (197,437) Net income - - - 752,898 752,898 Distributions - - - (1,330,652) (1,330,652) --------- --------- ---------- ----------- ---------- Balance at December 31, 1995 4,120,430 $4,120,430 $30,395,534 $(12,918,851) $21,597,113 ========= ========= ========== =========== ==========\nSee accompanying notes to financial statements.\n15 USA REAL ESTATE INVESTMENT TRUST 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) $ 752,898 $(1,442,875) $(2,506,635) ---------- ---------- ---------- Adjustments to reconcile net income(loss)to net cash provided by operating activities: Depreciation & amortization 655,597 687,478 616,336 Amortization of loan fees 4,290 21,500 6,750 Valuation loss 124,000 839,000 2,060,000 (Gain)loss on sale of properties & disposition of promissory note (411,254) 250,000 422,096 Bad debt expense 0 75,519 0 Changes in other assets & liabilities: Decrease(increase)in other assets 180,222 (276,484) 473,051 Decrease in accounts payable (97,683) (35,988) (212,807) Decrease(increase)in lease deposits (3,287) (10,658) 49,013 Total adjustments to net ---------- ---------- ---------- income(loss) 451,885 1,550,367 3,414,439 ---------- ---------- ---------- Net cash provided by operating activities 1,204,783 107,492 907,804 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases & improvement of properties (1,269,097) (198,338) (347,579) Proceeds from the sale of properties 3,800,463 0 1,172,021 Collections on notes receivable 147,178 1,376,624 1,408,873 ---------- ---------- ---------- Net cash provided by investing activities 2,678,544 1,178,286 2,233,315 ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Redemption of shares (197,437) 0 0 Proceeds from long-term notes payable 0 2,145,000 0 Payments on long-term notes payable (1,245,988) (2,068,236) (1,700,491) Payments on line of credit 0 (900,000) 0 Distributions paid (1,330,652) (1,096,725) (502,114) ---------- ---------- ---------- Net cash used in financing activities (2,774,077) (1,919,961) (2,202,605) ---------- ---------- ---------- Net increase (decrease) in cash 1,109,250 (634,183) 938,514\nCash and cash equivalents at beginning of year 378,411 1,012,594 74,080 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 1,487,661 $ 378,411 $ 1,012,594 ========== ========== ==========\nSee accompanying notes to financial statements. 16 USA REAL ESTATE INVESTMENT TRUST Notes to Financial Statements\n(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGeneral: USA Real Estate Investment Trust (the \"Trust\") was organized under the laws of the State of California pursuant to a Declaration of Trust dated October 7, 1986. The Trust commenced operations on October 19, 1987, upon the sale of the minimum offering amount of shares of beneficial interest. Effective August 31, 1994, the Trust terminated its agreements with its former advisor and its former property manager and became a self-administered real estate investment trust. At the Trust's 1994 Annual Meeting of Shareholders held on December 29, 1994, the Trust's shareholders approved an amendment to the Trust's Declaration of Trust which changed the name of the Trust from Commonwealth Equity Trust USA to its current name.\nCash equivalents: For purposes of the statement of cash flows, all certificates of deposit with original maturities of ninety days or less are considered cash equivalents.\nRental properties: Rental properties are carried at cost, net of accumulated depreciation and less an allowance for possible valuation loss. An allowance for possible investment losses is recognized when the carrying value of individual properties exceeds their appraised value or estimated net realizable value. A gain or loss will be recorded to the extent that the amounts ultimately realized from property sales differ from those currently estimated.\nThe cost of buildings and improvements is depreciated on a straight-line basis over estimated useful lives of 40 years. The cost of tenant improvements are amortized on a straight-line basis over the life of the lease.\nDistributions in excess of net income: The Trust has a general policy of distributing cash to its shareholders in an amount that approximates taxable income plus noncash charges such as depreciation and amortization. As a result, distributions to shareholders exceed cumulative net income.\nIncome taxes: The Trust has elected to be taxed as a real estate investment trust. Accordingly, the Trust does not pay income tax on income as long as income distributed to shareholders is at least equal to ninety five percent of its real estate investment trust taxable income.\nNet income (loss) per share: The net income (loss) per share is computed based on the weighted-average number of shares outstanding during each year.\nReclassifications: Certain items in the 1994 and 1993 financial statements have been reclassified to conform to the 1995 presentation.\nConcentration of credit risk: The Trust operates in one industry segment. The Trust's rental properties and the collateral for its notes receivable are located in California except for one property which is located in Reno, Nevada.\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 recorded amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the recorded amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.\n(2) RELATED PARTY TRANSACTIONS\nB&B Property Investment, Development and Management Company, Inc. (\"B&B\") served as advisor to the Trust, and B&B Property Investments, Inc., a wholly owned subsidiary of B&B, served as property manager for the Trust from inception through August 30, 1994. Effective August 30, 1994, the Trust terminated its agreements with B&B and B&B Property Investments, Inc. In November, 1994 B&B and related parties filed legal actions against the Trust and related parties. In June, 1995 the Trust settled all claims and cross claims between the Trust and B&B and its related parties by the payment to the principal of B&B, Jeffrey Berger, of $250,000.\nCompensation and reimbursement to B&B and B&B Property Investments, Inc. was $153,042 and $560,137 in 1994 and 1993, respectively.\n(3) ALLOWANCE FOR VALUATION LOSSES\nThe Trust recorded allowances for valuation losses on rental properties of $124,000, $839,000 and $1,460,000 in 1995, 1994 and 1993, respectively. In 1995 the Trust charged $338,000 against the valuation allowance in connection with the sale of a property in 1995 and $600,000 in connection with the disposition of a note receivable in 1994.\n(4) NOTES RECEIVABLE\nAs of December 31, 1995 and 1994, the Trust had two notes receivable collateralized by deeds of trust on properties in California. The aggregate amount of both notes was $818,869 at December 31, 1995 and $996,047 at December 31, 1994. As of December 31, 1995, one note bears interest at 8 percent per annum and the other note bears interest at 10 percent per annum. Scheduled aggregate principal collections over the next five years are as follows: $92,869 in 1996, zero in 1997, 1998 and 1999, and $726,000 in 2000. The aggregate fair value of the notes receivable approximates the carrying value as of December 31, 1995 and 1994.\n(5) LONG-TERM NOTES PAYABLE\nAs of December 31, 1995 and 1994, the Trust had long-term notes payable collateralized by deeds of trust on properties in California. The aggregate amount of the notes was $2,098,919 at December 31, 1995 and $3,344,907 at December 31, 1994. As of December 31, 1995, the long-term note payable bears interest at 7 5\/8 percent. As of December 31, 1994, long term notes payable bear interest rates of between 16 and 8 3\/4 percent, having a weighted average interest rate of 11 1\/4 percent. Scheduled principal payments over the next four years are as follows: $51,612, $55,688, $60,086 and $1,931,533, respectively. The fair value of notes payable approximates the carrying value as of December 31, 1995 and 1994. Rates currently available to the Trust for debt with similar terms and maturity were used to estimate the fair value of the existing debt.\n(6) DISTRIBUTIONS\nCash distributions per share of beneficial interest for Federal income tax purposes for the past three years were: 6 percent of the distributions paid in 1995 were capital gains, 37 percent were ordinary income and 57 percent were return of capital; 100 percent of the distributions paid in 1994 and 1993 were a return of capital.\n(7) RENT UNDER OPERATING LEASES\nNoncancelable operating leases provide for minimum rent during each of the next five years of $2,208,915; $2,027,745; $1,472,443; $1,190,845; and $890,905, respectively, and in aggregate $2,314,726 thereafter. The above assumes that all leases which expire are not renewed, therefore neither renewal rent nor rent from replacement tenants is included.\n(8) STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION\nIn 1995, the Trust sold one property for $4,050,000. The Trust received $3,800,463 in cash.\nIn 1993, the Trust sold two properties for $2,523,021. The Trust received $1,172,021 in cash and took back $1,151,000 in notes receivable. The combined cost of the properties sold was $2,784,405.\nInterest paid on the Trust's outstanding debt for 1995, 1994 and 1993 was $270,069, $618,666 and $592,005, respectively.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nGENERAL\nThe Trust has no employees. It is administered by its Trustees and by its Chairman, and by independent contractors who work under the supervision thereof.\nTHE TRUSTEES\nThe trustees of the Trust are as follows:\nTrustee Name Age Since Office ---- --- ------- ------\nGregory E. Crissman 44 1986 Trustee and Chairman and Chief Financial Officer Benjamin A. Diaz 62 1988 Trustee and Secretary William M. Gallagher 76 1992 Trustee Joyce A. Marks 61 1986 Trustee\nThe following is a brief description of the background and business experience of each Trustee.\nGREGORY E. CRISSMAN. Mr. Crissman is the Chairman and Chief Financial Officer of the Trust. He has over 20 years of experience in real estate, accounting, auditing, and taxation. He also served as Chairman of the Board of California Real Estate Investment Trust, a New York Stock Exchange listed real estate investment trust, and was its Chief Financial Officer from 1989 until 1993. Mr. Crissman was an Executive Vice President of B&B Property Investment, Development and Management Company, Inc., (\"B&B\") from 1983 until 1990 and from 1992 until 1993. In addition, Mr. Crissman was a director of B&B and was President of B&B from 1990 until 1992. From 1976 to 1979 Mr. Crissman worked at Bowman & Company, an accounting firm in Stockton, California. In 1976 Mr. Crissman received his BS degree with honors from the California State University at Sacramento and is a Certified Public Accountant. Mr. Crissman is also a member of the American Institute of Certified Public Accountants.\nBENJAMIN A. DIAZ. The Honorable Benjamin A. Diaz is a retired judge of the Superior Court of California. He served as a judge of the Sacramento County Superior Court from April, 1976, to May, 1986. He has been engaged in private practice in Sacramento, California, as a partner in the law firm of Grossfield and Diaz from June, 1986, to September, 1987, and in the law firm of Diaz & Gebers, specializing in real estate transactions, general practice, litigation, business law, and personal injury matters from October, 1987 to December, 1991. From January, 1992, to the present, Judge Diaz has been engaged in pro tem judging, arbitration, mediation and consulting services. Mr. Diaz received his Juris Doctor degree from the University of Pacific, McGeorge School of Law, Sacramento, California, in 1966. Prior to serving on the bench, Mr. Diaz had extensive tax and auditing experience with the State of California Franchise Tax Board, dealing with large corporate unitary tax audits, and with the California State Board of Equalization. WILLIAM M. GALLAGHER. The Honorable William M. Gallagher is a retired judge of the Superior Court of California. He served as a judge of the Sacramento County Superior Court from 1964 until 1980, and of the Sacramento Municipal Court from 1961 to 1964. Mr. Gallagher received his Juris Doctor degree from Hastings College of the Law in San Francisco. After 1980, Mr. Gallagher was engaged in private practice as a partner in the law firm of Hefner, Stark & Marois in Sacramento, California, specializing in Chapter 11 bankruptcy, lender liability litigation and real estate related transactions.\nJOYCE A. MARKS. Ms. Marks has been employed by the Bank of America for more than forty years. During her career with Bank of America, Ms. Marks had extensive experience with land development and subdivision financing, including construction and take-out financing for commercial properties. Ms. Marks was for many years active in the Building Industry Association of Sacramento and from 1976 to 1983 served as a board member of, and in 1983 as President of, its Associate Counsel. Ms. Marks received Bank of America's Award for Excellence in 1985. Her most recent positions include Senior Sales Training Specialist, Marketing Officer, Branch Manager and Credit Administrator at one of Bank of America's Regional Headquarters.\nTrustees of the Trust are elected annually by the Trust's shareholders and hold office until their successors are duly elected and qualified. No family relationship exists between any Trustee and any other Trustee. No arrangement exists or existed between any Trustee and any other person or entity pursuant to which the Trustee was selected as a Trustee or nominee.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION OF OFFICERS\nDuring 1995, the Trust was managed by its Trustees as a self-administered real estate investment trust. The Trust has the following officers: Chairman, Chief Financial Officer, and Secretary. No officer except Gregory E. Crissman is compensated by the Trust in his capacity as a officer. During 1995, none of the Trust's officers received compensation in excess of $24,000.\nSummary Compensation Table\nTotal Long-Term Name and Officer Annual and other Principal Position Year Compensation Compensation Compensation - ----------------------------- ---- ------------ ------------ ------------\nGregory E. Crissman, Chairman 1995 $24,000 $44,939 (1) None\n(1) Includes fees of $1,250 or $313 for each meeting of the Trustees attended.\nCOMPENSATON OF TRUSTEES\nDuring 1995 and currently, the Trustees receive $1,250 or $313 for each Trustees' meeting attended plus direct expenses incurred in connection with such attendance. There are currently no plans to alter this compensation schedule. No Trustee received compensation under any other arrangement during 1995. The Trust does not maintain a nominating or compensation committee or any other standing committee. However, the Trustees have authority to establish such committees and to compensate committee members as appropriate for their service. During 1995, the Trust had twelve regular and six special meetings of its Trustees. No Trustee attended less than 75 percent of the meetings held by the Trustees.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth as of February 29, 1996, the number of Shares owned by each person who is known by the Trust to own beneficially more than 5 percent of its outstanding Shares and the Trustees and officers of the Trust as a group. No Trustee beneficially owns any shares of the Trust except as set forth below. The Trust has been advised that all of such Shares are beneficially owned and the sole investment and voting power is held by the persons named:\nAmount and Nature of Percent Name and Address of Beneficial Owner Beneficial Ownership of Class ------------------------------------ -------------------- --------\nGregory E. Crissman, Chairman and Trustee 1,400 .00034 2561 Fulton Square Lane, #55 Sacramento, CA 95821\nAll Trustees and officers as a group 1,400 .00034\nDuring 1995, based upon a review of the Forms 3, 4 and 5 on file with the Trust, it does not appear that any officer or trustee failed to file such a required report on a timely basis.\nNo person is known to the Trust to hold 10 percent or more of the Trust's outstanding Shares.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS Page ----\nIndependent Auditors' Report ...................... 11\nBalance Sheets: December 31, 1995 and 1994 ....... 12\nStatements of Income (Operations): Years Ended December 31, 1995, 1994 and 1993 ................ 13\nStatements of Shareholders' Equity: Years Ended December 31, 1995, 1994 and 1993 .......... 14\nStatements of Cash Flows: Years Ended December 31, 1995, 1994 and 1993 ................ 15\nNotes to Financial Statements ..................... 16-18\n(a)(2) FINANCIAL STATEMENT SCHEDULES\nSchedule III - Real Estate and Accumulated Depreciation .................................... 23-26\nThe statements and schedules referred to above should be read in conjunction with the financial statements and notes thereto included in Part II of this Form 10-K. Schedules not included in this item have been omitted because they are not applicable or because the required information is presented in the financial statements or notes thereto.\n(a)(3) LIST OF EXHIBITS\n3.1(1) Form of Amended and Restated Declaration of Trust of Commonwealth Equity Trust USA\n3.2(1) Form of Bylaws of the Board of Trustees\n3.4(2) Amendments to Sections 2.3.1, 2.3.7, 2.3.8, 2.4.2 and 2.4.3 of the Amended and Restated Declaration of Trust of Commonwealth Equity Trust USA (adopted on August 29, 1988 at the 1988 Annual Meeting)\n4.1(1) Article VIII of Exhibit 3.1\n4.2(1) Form of Share Certificate\n(b) REPORTS ON FORM 8-K\nNone. USA REAL ESTATE INVESTMENT TRUST SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nPage 1, Part A __________________ ____________ ___________________________ Column A Column B Column C __________________ ____________ ___________________________\n---Initital Cost to Trust--\nBuildings Improvements, & Personal Decription Encumbrances Land Property __________________ ____________ ____________ ____________ RETAIL: Keystone Square, Reno, Nevada $ - $ 708,774 $ 2,208,000 170-174 West Shaw Avenue, Clovis, California 2,098,919 1,690,000 2,542,532 7390 Greenback Lane, Citrus Heights, California - 533,000 179,333 3090 Sunrise Blvd., Rancho Cordova, California - 450,000 - 19401 Parthenia Street, Northridge, California - 5,770,000 3,100,000 1630 Industrial Park Street, Redlands, California - 441,873 679,818 1056 Harbor Blvd., West Sacramento, California - 716,500 - ____________ ____________ ____________ Total Retail 2,098,919 10,310,147 8,709,683 ____________ ____________ ____________ INDUSTRIAL: 4350 Pell Drive, Sacramento, California - 1,500,000 2,213,325 ____________ ____________ ____________ Total Industrial - 1,500,000 2,213,325 ____________ ____________ ____________ OFFICE: One Scripps Drive, Sacramento, California - 650,000 2,274,888 ____________ ____________ ____________ Total Office - 650,000 2,274,888 ____________ ____________ ____________ $ 2,098,919 $ 12,460,147 $ 13,197,896 ============ ============ ============\nUSA REAL ESTATE INVESTMENT TRUST SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nPage 1, Part B __________________ _____________________________ Column A Column D __________________ _____________________________ Cost Capitalization Subsequent to ---------Acquisition---------\nDescription Improvements Carrying Cost __________________ _____________ _____________ RETAIL: Keystone Square, Reno, Nevada $ 365,281 $ - 170-174 West Shaw Avenue, Clovis, California 6,000 - 7390 Greenback Lane, Citrus Heights, California 3,457 - 3090 Sunrise Blvd., Rancho Cordova, California - - 19401 Parthenia Street, Northridge, California 2,292,494 - 1630 Industrial Park Street, Redlands, California 8,352 - 1056 Harbor Blvd., West Sacramento, California - - _____________ _____________ Total Retail 2,675,584 - _____________ _____________ INDUSTRIAL: 4350 Pell Drive, Sacramento, California 38,606 - _____________ _____________ Total Industrial 38,606 - _____________ _____________ OFFICE: One Scripps Drive, Sacramento, California 837,432 - _____________ _____________ Total Office 837,432 - _____________ _____________ $ 3,551,622 $ - ============= =============\nUSA REAL ESTATE INVESTMENT TRUST SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nPage 1, Part C __________________ _________________________________________________________ Column A Column E __________________ _________________________________________________________\nGross Amount at Which ----------------Carried at Close of Period---------------\nValuation Buildings & Write Description Land Improvements Down Total __________________ ____________ ____________ ____________ ____________ RETAIL: Keystone Square, Reno, Nevada $ 708,774 $ 2,573,281 $ - $ 3,282,055 170-174 West Shaw Avenue, Clovis, California 1,690,000 2,548,532 590,000 3,648,532 7390 Greenback Lane, Citrus Heights, California 533,000 182,790 102,000 613,790 3090 Sunrise Blvd., Rancho Cordova, California 450,000 - - 450,000 19401 Parthenia Street, Northridge, California 5,770,000 5,392,494 3,483,000 7,679,494 1630 Industrial Park Street, Redlands, California 441,873 688,170 777,000 353,043 1056 Harbor Blvd., West Sacramento, California 716,500 - 115,000 601,500 ____________ ____________ ____________ ____________ Total Retail 10,310,147 11,385,267 5,067,000 16,628,414 ____________ ____________ ____________ ____________ INDUSTRIAL: 4350 Pell Drive, Sacramento, California 1,500,000 2,251,931 - 3,751,931 ____________ ____________ ____________ ____________ Total Industrial 1,500,000 2,251,931 - 3,751,931 ____________ ____________ ____________ ____________ OFFICE: One Scripps Drive, Sacramento, California 650,000 3,112,320 770,000 2,992,320 ____________ ____________ ____________ ____________ Total Office 650,000 3,112,320 770,000 2,992,320 ____________ ____________ ____________ ____________ $ 12,460,147 $ 16,749,518 $ 5,837,000 $ 23,372,665 ============ ============ ============ ============\n26 USA REAL ESTTE INVESTMENT TRUST SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nPage 1, Part D __________________ ____________ ____________ ____________ ____________ Column A Column F Column G Column H Column I __________________ ____________ ____________ ____________ ____________ Life on Which Depreciation in Latest Accumulated Date of Date Statement is Description Depreciation Construction Acquired Computed __________________ ____________ ____________ ____________ ____________ RETAIL: Keystone Square, Reno, Nevada $ 369,406 1962 06\/89 40 years 170-174 West Shaw Avenue, Clovis, California 354,302 1985 05\/90 40 years 7390 Greenback Lane, Citrus Heights, California 23,993 1980 08\/90 40 years 3090 Sunrise Blvd., Rancho Cordova, California - N\/A 10\/90 N\/A 19401 Parthenia Street, Northridge, California 982,048 1973 11\/90 40 years 1630 Industrial Park Street, Redlands, California 84,986 1965\/1977 01\/91 40 years 1056 Harbor Blvd., West Sacramento, California - N\/A 12\/92 N\/A ____________ Total Retail 1,814,735 ____________ INDUSTRIAL: 4350 Pell Drive, Sacramento, California 199,648 1975 09\/92 40 years ____________ Total Industrial 199,648 ____________ OFFICE: One Scripps Drive, Sacramento, California 204,422 40 years ____________ Total Office 204,422 ____________ $ 2,218,805 ============\nUSA REAL ESTATE INVESTMENT TRUST Signatures\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 25, 1996 USA Real Estate Investment Trust --------------------\nGregory E. Crissman By: ------------------------------- Gregory E. Crissman as Chief Financial Offficer\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 25, 1996 Gregory E. Crissman ------------------- By: ------------------------------- Gregory E. Crissman Chairman\nDated: March 25, 1996 Benjamin A. Diaz ------------------- By: ------------------------------- Benjamin A. Diaz Trustee\nDated: March 25, 1996 William M. Gallagher ------------------- By: ------------------------------- William M. Gallagher Trustee\nDated: March 25, 1996 Joyce A. Marks ------------------- By: ------------------------------- Joyce A. Marks Trustee EXHIBIT INDEX\nExhibit No. Description - ----------- -----------\n27 Financial Data Schedule","section_15":""}
{"filename":"765449_1995.txt","cik":"765449","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS. The information contained in the J.A.M., Inc. 1995 Annual Report to Stockholders for the year ended December 31, 1995 (\"1995 Annual Report\") on pages 1 through 7 inclusive is incorporated herein by reference.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. The business operations of J.A.M., Inc. are primarily development of interactive multimedia products and services. At the present time, J.A.M. can offer clients \"Total Turnkey Solutions\" that encompass both hardware and customized software and applications. Such solutions might range from stand alone CD-ROM based multimedia applications to video-on-demand computer-based multimedia applications such as kiosks or server-based applications utilizing local and wide area networking. Using our technology and expertise, J.A.M. can offer immensely effective solutions to our clients in the areas of training, education, public information, corporate communications, sales, and marketing.\nINFORMATION AS TO LINES OF BUSINESS. The Company's multimedia product and services include:\nSALES OF IT2000 PRODUCT AND RELATED HARDWARE AND SOFTWARE -- This includes IT2000 digital video file servers, kiosks, PCs, and support hardware and software including DCP (Digital Conversion Process) which consists of the conversion of existing paper and analog-based materials to digital platforms. DCP is ideal for the conversion of video and videodisc programs to multimedia PC platforms.\nDEVELOPMENT OF MULTIMEDIA APPLICATIONS AND CONTENT -- Sales of production services and custom development of projects to meet the various needs to our customers (training, informational, sales and marketing, database requirements).\nNETWORK CONSULTING AND INTEGRATION SERVICES -- Sales of consulting and integration services to enable customers to upgrade their computing environments and implement multimedia networking.\nIN-HOUSE SERVICES include:\n* Multimedia Design\/Production * Video Production\/Post Production\/Computer Graphics * Instructional Design\/Writing * CD-ROM & CD-i Production\/Mastering * Conversion of Existing Material to Digital Platforms * Network Design\/Integration\nNARRATIVE DESCRIPTION OF BUSINESS.\nThe information contained in the J.A.M., Inc. 1995 Annual Report, page 4, is incorporated herein by reference, to sub-paragraphs (i) and (ii) of this sub item.\nPRINCIPAL PRODUCTS CUSTOM-DESIGNED TRAINING PROGRAMS.\nFor the years ended December 31, 1995, 1994, and 1993, the Company derived approximately 95%, 95%, and 75%, respectively, of its revenues from the production and design of interactive multimedia training and communications programs.\nVIDEO PRODUCTION AND POST- PRODUCTION SERVICES.\nVideo production and post- production services, which include production related to training programs, accounted for approximately 5%, 5%, and 10% of the Company's revenues for the years ended December 31, 1995, 1994, and 1993 respectively.\nDEPENDENCE UPON KEY CUSTOMERS. During 1995, the Company had three (3) major customer which had approximately $721,600 (46%) of total revenues for 1995, as compared to approximately $200,000 (38%) in 1994, and approximately $388,000 (47%) in 1993.\nBACKLOG. In 1995, the Company produced multimedia and communications services under contracts with its customers. The backlog at the end of 1995 was approximately $350,000.\nCOMPETITION. In marketing its services, the Company competes for sales with many other businesses in training and multimedia communication services. Several companies also compete directly with the Company in providing video- based, computer-based, and interactive videodisc training programs. Many of the Company's competitors have available greater financial, technical, and marketing resources than the Company.\nEMPLOYEES. At December 31, 1995, the Company employed 20 full-time employees. Such employees included 3 officers, 4 administrative and sales personnel, 2 video production professionals, 7 software programmers and designers, and 4 instructional designers. The Company also employs a number of part-time employees and independent contractors depending on the volume and types of services required for various contracts. None of the Company's employees currently are represented by a labor union. Management believes that employee relations are good.\nIn its production of recorded performances, the Company engages various artists and other production personnel who may be members of unions. The Company has not entered into any labor agreement with any such union, but complies with the terms of union agreements when dealing with union members.\nEXECUTIVE OFFICERS OF THE REGISTRANT. John A. Marszalek is the founder of the Company and has served as its President and as a Director since its incorporation in 1977.\nPrior to founding the Company, Mr. Marszalek served as general manager of two radio broadcast facilities in Rochester. He holds a Masters Degree from the University of Katowicace, Poland.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. During August of 1992, the Company moved its headquarters to Fairport, which is a suburb of Rochester, New York, to reduce its expenses. The President of the Company personally guaranteed the five year lease agreement. The Company leases approximately 5,000 square feet of office space under a six-year net lease agreement expiring August 31, 1998, at an annual rental of approximately $70,000. This is a reduction of the Company's former annual rental by $36,000 per year.\nIn December, 1995, the Company signed a second lease agreement for an additional 2,300 square feet on a one-year net lease at an annual rental of approximately $36,000 per year.\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 THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. The information concerning the principal market, sales, prices, number of holders, dividends and dividend policy for the common stock of the Company, contained in the J.A.M., Inc. 1995 Annual Report, Page 5, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. The information contained in the tabulation \"Five Year Summary of Selected Financial Information\" in the J.A.M., Inc. 1995 Annual Report, page 8, is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information bearing the same title contained in the J.A.M., Inc. 1995 Annual Report, pages 6 through 7, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements, prepared by the Company and contained in the J.A.M., Inc. 1995 Annual Report, pages 9 through 14 inclusive, are incorporated herein by reference. Other financial schedules are filed herewith as part of this Report, see Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. The information concerning this matter appears at page 7 of the Company's 1995 Annual Report, and is incorporated herein by reference.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS OF THE REGISTRANT. The Company was not able to hold an Annual Meeting in 1995 due to lack of a quorum.\nJOHN A. MARSZALEK. Mr. Marszalek, 47 years of age, is the founder of the Company and has served as its President and as a Director since its incorporation in 1977. Prior to founding the Company, Mr. Marszalek served as general manager of two radio broadcast facilities in Rochester, New York.\nPETER A. SPINA. Dr. Spina, 57 years of age, has been a Director since June, 1989. He is President of Monroe Community College in Rochester, New York. He also serves as a director and officer of Blue Cross and Blue Shield of Rochester, New York, a director of Trinity Liquid Assets Trust, a director of Home Care Research of Rochester, New York, and is past president of the Association of Public Community Colleges.\nDAVID DELLA PENTA. Mr. DellaPenta, 47 years of age, was elected to the Board of Directors at the September 22, 1994 meeting. He is the President of Nalge Corporation, a Rochester, NY-based manufacturer of high-quality plastic products sold into the scientific research, industrial, and consumer markets worldwide.\nThere are no family relationships between any Director, executive officer, or person nominated or chosen by the Board to become a Director or executive officer. The Board of Directors held four meetings during 1995, and all of the incumbent Directors attended more than 75% of the aggregate of the total number of Board meetings and total number of meetings held by all committees of the Board on which they serve.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. Officers, directors, and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that, during 1995, all filing requirements applicable to its officers, directors, and greater than ten percent beneficial owners were in compliance.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. Under the SEC's executive compensation disclosure rules, information is required to be provided with respect to the compensation and benefits paid by the Company for all services rendered during 1995, 1994 and 1993 to five individuals: the person who was, at December 31, 1995, serving as the Company's Chief Executive Officer, and the four other individuals who were, as of December 31, 1995, the other four most highly compensated executive officers of the Company whose 1995 salary and bonus exceeded $50,000 in amount. Accordingly, the following table setting forth this information applies three (3) employees of J.A.M. in 1995:\nSALARY BONUS\nJohn A. Marszalek $61,836\nLouis Camerlengo $55,000 $7,500\nDavid Colaizzi $50,000 $3,000\nLee Maxey $50,000 $1,312.50\nMANAGEMENT COMPENSATION. The Company's President, Mr. Marszalek, has an employment agreement with the Company, effective as of December 3, 1986. The agreement extends through December 31, 2000, and provides that Mr. Marszalek is to serve full-time Chief Executive Officer and Chairman of the Board of the Company. Pursuant to this agreement, Mr. Marszalek is entitled to participate in any benefit plans or programs for executive officers or employees that may be in effect from time to time and is entitled to reimbursement for the use of an automobile. It also provides for the payment of the greater of one year's salary or his then current salary for the remainder of the contract term in connection with his termination without cause prior to the expiration of the agreement.\nCOMPENSATION OF DIRECTORS. Directors do not receive any compensation for services as a Director. Directors of the Company are reimbursed for out-of- pocket expenses incurred on the Company's behalf.\nCOMPENSATION PURSUANT TO PLANS. STOCK OPTION PLAN. In May of 1986, the shareholders of the Company approved the Incentive Stock Option Plan (the \"ISO Plan\") for officers and key employees. The ISO Plan authorizes the issuance of options to purchase up to 200,000 shares of the Company's common stock. Options granted under the ISO Plan are intended to qualify as \"incentive stock options\" under the Internal Revenue Code of 1986, as amended. Under the ISO Plan, options may be granted at not less than 100% (110% in the case of 10% or greater shareholders) of the fair market value of the Company's common stock on the date of grant. Options granted under the ISO Plan must be exercised, if at all, within ten years from the date of grant (five years in the case of 10% or greater shareholders) and no option may be granted more than ten years from the date of adoption of the Plan. Options granted under the ISO Plan may not be transferred, except by will or by the laws of descent and distribution. Options granted under the plan must be exercised, if at all, within three months after termination of employment for any reason except death or disability and within 60 days after death or within one year after termination of employment due to disability. The Board of Directors of the Company, or the Compensation Committee of the Board, has the power to impose limitations, conditions, and restrictions in connection with the grant of any option.\nCOMPENSATION PURSUANT TO PLANS. (Cont'd) On September 22, 1994, the Board of Directors approved an Incentive Stock Option Plan (the \"ISO Plan\") for officers and key employees. On December 14, 1995, the Board appointed one (1) new officer to the Company: David Colaizzi as Vice President of MultiMedia. Robin Rutkowski has resigned from the Company as of July 11, 1995. The Board also granted David Colaizzi a stock option of 40,000 shares under the ISO Plan. Louis Camerlengo, Vice President of Sales and Marketing has 65,000 shares of stock options previously granted in 1994. The Board also granted Mr. Marszalek's right to exercise his option to acquire 3,000,000 additional shares by converting $150,000 of the Officer Loan. The Board recommended and authorized the President of the Company to develop a proposal for employees incentive program similar to a 401K plan.\n1987 STOCK OPTION PLAN. In May of 1988, the shareholders of the Company approved the 1987 Stock Option Plan (the \"1987 Plan\") under which options to purchase stock may be granted to officers and other key employees of the Company. The 1987 Plan authorizes the issuance of options to purchase up to 500,000 shares of the common stock of the Company. The provisions of this plan are substantially the same as those of the Incentive Stock Option Plan, except that the 1987 Plan authorizes the issuance of both options intended to qualify as \"incentive stock options\" under the Internal Revenue Code of 1986, as well as options that do not so qualify. As of December 31, 1995, there were options outstanding to purchase up to 365,000 shares of Common Stock of the Company. No options were exercised under the 1987 Plan. Mr. Marszalek has no options under this plan.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth as of March 29, 1996, the number and percentage of outstanding shares of common stock beneficially owned by each Director of the Company, by all Directors and current officers of the Company as a group, and by each person known to the Company to be the beneficial owner of more than 5% of the Company's common stock. The Company believes that each individual in this group has sole investment and voting power with respect to his shares unless otherwise noted: Number of Percentage of Shares NAME OF NOMINEE SHARES OUTSTANDING John A. Marszalek* 5,042,716 33% Peter A. Spina** 100,000 1% David DellaPenta** 100,000 1%\n**Includes 100,000 shares issuable under stock options presently exercisable at $.04 per share.\n* Mr. Marszalek, with an address c\/o 530 Willowbrook Office Park, Fairport, New York 14450, is the only person known to the Company to beneficially own more than 5% of its outstanding common stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Not Applicable\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. The following documents are filed as part of this Report.\nThe following financial statements are contained in the J.A.M., Inc. 1995 Annual Report and are incorporated herein by reference in Item 8 of this Report:\n- Balance Sheets, December 31, 1995 and 1994\n- Statements of Operations for the years ended December 31, 1995, 1994 and 1993.\n- Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\n- Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\n- Notes to Financial Statements\nSCHEDULES - The following schedules are filed as a part of this Report:\n- V Property, plant and equipment - VI Accumulated depreciation, depletion and amortization - VIII Valuation and qualifying accounts and reserves - X Supplemental Income Statement Information\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 the notes thereto.\nEXHIBITS - See Exhibit Index attached.\nREPORTS ON FORM 8-K. No report on Form 8-K was filed during the fourth quarter of 1995.\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nFor The Years Ended December 31, 1995, 1994, and 1993\nBalance at Balance beginning at end CLASSIFICATION OF YEAR ADDITIONS RETIREMENTS OF YEAR\nDecember 31, 1995:\nLeasehold improvements $ 13,183 $ 14,766 $ 0 $ 27,949 Production equipment 258,732 242,640 0 501,372 Design and development equipment 137,416 0 511 136,905 Office furniture and equipment 151,239 0 88,025 63,214 $ 560,570 $257,406 $88,536 $729,440\nDecember 31, 1994:\nLeasehold improvements $ 10,722 $ 17,227 $ 14,766 $ 13,183 Production equipment 327,955 23,277 92,500 258,732 Design and development equipment 190,268 2,644 55,496 137,416 Office furniture and equipment 112,514 65,758 27,033 151,239\n$ 641,459 $108,906 $189,795 $ 560,570\nDecember 31, 1993:\nLeasehold improvements $ 10,722 $ 0 $ 0 $ 10,722 Production equipment 327,955 0 0 327,955 Design and development equipment 147,943 42,325 0 190,268 Office furniture and equipment 87,508 25,292 286 112,514\n$ 574,128 $ 67,617 $ 286 $641,459\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFor the Years Ended December 31, 1995, 1994 and 1993\nBalance at Balance beginning at end CLASSIFICATION OF YEAR ADDITIONS RETIREMENTS OF YEAR\nDecember 31, 1995:\nLeasehold improvements $ 969 $ 1,843 $ 0 $ 2,812 Production equipment 243,598 138,772 0 382,370 Design and development equipment 132,153 11,789 0 143,942 Office furniture and equipment 65,651 0 34,144 31,507\n$ 442,371 $152,404 $ 34,144 $ 560,631\nDecember 31, 1994:\nLeasehold improvements 2,820 940 2,791 969 Production equipment 275,822 94,109 126,333 243,598 Design and development equipment 131,405 63,159 62,411 132,153 Office furniture and equipment 46,077 32,691 13,117 65,651\n$ 456,124 $190,899 $ 204,652 $ 442,371\nDecember 31, 1993:\nLeasehold improvements $ 120 $ 2,700 $ 0 $ 2,820 Production equipment 254,222 21,600 0 275,822 Design and development equipment 120,605 10,800 0 131,405 Office furniture and equipment 27,177 18,900 0 46,077 $ 402,124 $ 54,000 $ 0 $ 456,124\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFor the Years Ended December 31, 1995, 1994 and 1993\nAdditions Balance at Charged to Balance beginning Costs and Deduc- at end DESCRIPTION OF YEAR EXPENSES TIONS (1) OF YEAR\nAllowance for doubtful accounts - deducted from accounts and notes receivable in the balance sheet\nDecember 31, 1995 $ 3,600 $ 0 $ 1,803 $1,797\nDecember 31, 1994 $ 3,600 $ 0 $ 0 $3,600\nDecember 31, 1993 $ 3,600 $ 0 $ 0 $3,600\n(1) uncollectable accounts written off.\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFor The Years Ended December 31, 1995, 1994, and 1993\nITEM CHARGED TO COSTS AND EXPENSES\n1995 1994 1993\nMaintenance and repairs $ * $ 8,609 $ *____\nDepreciation and amortization of intangible assets, pre- operating costs and similar deferrals $ 0 $46,082 $55,000\nTaxes, other than payroll and income taxes $ * $ * $ *_____\nRoyalties $ 0 $ 0 $ *_____\nAdvertising costs $28,409 $ 8,072 $ *_____\n* Less than 1% of total sales.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJ.A.M., Inc.\nDated: March 29, 1996 By:\/s\/John A. Marszalek 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 Company and in the capacities and on the dates indicated:\nDated: March 29, 1996 By:\/s\/ John A. Marszalek John A. Marszalek President and Chief Executive Officer, Director\nDated: March 29, 1996 By: \/s\/ Peter A. Spina Peter A. Spina Director\nDated: March 29,1996 By: \/s\/ David DellaPenta David DellaPenta Director\nEXHIBIT INDEX\nExhibit NUMBER DESCRIPTION LOCATION\n3-1 Restated Certificate of Filed herewith Incorporation of J.A.M., Inc., as amended.\n3-2 Bylaws of J.A.M., Inc. Filed herewith\n4-1 Form of Common Stock Certificate of Incorporated by Reference to J.A.M., Inc. Exhibit 4 (a) to Registrant's S-18, registration no. 33-7486-NY, declared effective November 10, 1986\n10-1 Employment Agreement between Registrant Filed herewith and John A. Marszalek dated July 17, 1986.\n10-2 Registrant's Incentive Stock Option Plan Filed herewith\n10-3 Registrant's 1987 Stock Option Plan Filed herewith\n10-4 Employee Agreement Regarding Filed herewith Proprietary Information and Inventions between Registrant and John A. Marszalek\n11 Statement re: Computation of Per Share * Earnings.\n13 J.A.M., Inc. 1995 Annual Report Filed herewith to Shareholders\n27 Financial Data Schedule Filed only with EDGAR filing, per Reg. S-K, Rule 601 (c)(1)(v)\n*See Note 2 to the Notes to Consolidated Financial Statements incorporated by reference in Item e of this Report.","section_15":""}
{"filename":"50326_1995.txt","cik":"50326","year":"1995","section_1":"ITEM 1: BUSINESS - -----------------\n(a) General Development of Business. -------------------------------\nBook Centers, Inc. (formerly known as Industrial Investment Corporation) (the \"Company\" or the \"Registrant\") is an Oregon corporation organized in 1961. Its principal continuing business is the distribution of books on a wholesale basis worldwide to college, university, industrial, and other research libraries either for their own use or for resale. It conducts this business through a wholly-owned subsidiary corporation, Academic Book Center, Inc., an Oregon corporation(\"Academic\").\nAcademic is located in Portland, Oregon, at the same mailing address as the Company. Academic also operates a separate division under a different name. Academic, under the assumed business name Professional Book Center, Inc. (\"Professional\"), sells medical, technical, scientific, and business books.\nAcademic previously provided marketing, promotional, warehousing order fulfillment, accounting, and consulting services to publishers of books and periodicals under the assumed business name International Specialized Book Services, Inc. (\"International\"). Academic sold its assets comprising this division on September 11, 1992, to Chvatel Corporation, and on and after that date, it no longer provides those services.\nThe Company also formerly conducted a part of its business through another wholly-owned subsidiary, Scholarly Book Center, Inc., an Oregon corporation (\"Scholarly\"). Scholarly, located in New York, New York, distributed books throughout the Eastern United States, Canada, and Europe. In June, 1991, the Company's Board of Directors decided to close Scholarly's operations and to transfer them to Academic, including fulfilling all of the orders of Scholarly's former customers out of Academic's offices in Portland, Oregon. The Company completed the transfer of Scholarly's operations to Academic on October 31, 1991.\nThe Company, after it was incorporated, engaged principally in the businesses of agriculture and ownership of real property. It now engages solely in the business of marketing, warehousing, and distributing books.\n(b) Financial Information about Industry Segments. ---------------------------------------------\nThe Company, through its subsidiaries, markets, warehouses, and distributes books on a wholesale basis to college, university, industrial, and other research libraries and to libraries and others (e.g., bookstores) for resale. Book wholesaling is the only industry segment material to its operations. See Note 7 to the consolidated financial statements, Item 8 of this Report.\n- 2 -\n(c) Narrative Description of Business. ---------------------------------\n(i) Principal Products and Services. -------------------------------\nThe Company's principal business is to market, warehouse, and distribute books on a wholesale basis to college, university, industrial, and other research libraries either for their own use or for resale. It also sells medical, technical, scientific, and business books. The Company hires sales representatives to solicit such sales. Such employees solicit these sales from libraries, government agencies, and the purchasing departments of other prospective purchasers either in person or by telephone. The Company sells its products to its customers on credit. Its customers are required to pay for the products sold within 60 days of the date of the invoice. The Company also attends all significant trade shows, including trade shows sponsored by the American Library Association and the American Book Sellers Association.\n(ii) New Products. ------------\nThe Company has nothing to report under this caption.\n(iii) Raw Materials. -------------\nNot applicable.\n(iv) Patents, Trademarks, Licenses, Franchises, and Concessions. ----------------------------------------------------------\nNot applicable.\n(v) Seasonality of Business. -----------------------\nThe Company's business is not seasonal except that its sales decrease during the summer months.\n(vi) Working Capital Practices. -------------------------\nThe Company purchases its inventory on the basis of its customers' projected requirements. If it does not sell the inventory purchased within a reasonable time, it returns it to the publisher for credit. It purchases its inventory from over 50,000 sources. The terms of the Company's purchase of its inventory varies from publisher to publisher. The Company considers its working capital practices similar to other wholesale distributors of books.\n- 3 -\n(vii) Major Customers. ---------------\nThe Company and its subsidiaries provide services to more than 2,000 academic and research libraries worldwide. No one customer accounts for more than 10 percent of consolidated revenues. Sales to customers outside the United States constitute approximately 41 percent of the total volume for the 12 months ended June 30, 1995 (see Note 7 to the consolidated financial statements, Item 8 of this Report).\n(viii) Backlog. -------\nThe Company does not have any backlog. Customers generally place orders on an \"as needed basis\" and expect delivery within a short period of time.\n(ix) Renegotiation or Termination of Contracts or Subcontracts at Government's ------------------------------------------------------------------------- Election. - --------\nNot applicable.\n(x) Competitive Conditions. ----------------------\nThe Company is in a highly competitive business. Competition is principally through customer contacts, price, and service. Adequate service generally requires delivery of a book 30 to 60 days after receipt of an order. Publishers also compete against the Company by selling books directly to consumers. There are approximately 25 significant competitors in this market, some of whom have resources substantially greater than those of the Company.\n(xi) Research and Development. ------------------------\nThe Company has not spent any material amounts during the last three fiscal years for company-sponsored research and development or for customer-sponsored research activities with respect to the development of new products.\n(xii) Environment. -----------\nThe Company has nothing to report under this caption.\n(xiii) Number of Persons Employed. --------------------------\nAs of June 30, 1995, the Company (including its subsidiaries) employed approximately 96 persons. Labor unions do not represent any of the Company's employees. The Company considers its relationships with its employees satisfactory.\n- 4 -\n(d) Financial Information About Foreign and Domestic Operations and Export ---------------------------------------------------------------------- Sales. - -----\nSee Note 7 to the consolidated financial statements, Item 8 of this Report for information with respect to foreign and domestic operations and export sales.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES - -------------------\nThe Company and its subsidiaries lease offices and warehouses in Portland, Oregon, and offices in New York, New York. See Note 3 to the consolidated financial statements, Item 8 of this Report, for obligations under these leases. The Company considers its facilities suitable and adequate for its business purposes. The offices and warehouses provide sufficient additional space for growth.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS - --------------------------\nThere are no pending legal proceedings to which the Company or any of its subsidiaries is a party or to which any of their property is subject.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nThe Company did not submit any matters to a vote of its shareholders during the quarter ended June 30, 1995.\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 not traded on any exchange. An established public trading market for the stock has not existed for the past ten years. Carr Securities in New York, New York, serves as the \"market maker\" for the Company. It has served in such position since 1985. Carr Securities effected only two purchases and sales of common stock for the fiscal year ended June 30, 1995 for the purchase and sale of 500 shares in the aggregate at 25 cents per share. Prospective purchasers and sellers have engaged Carr Securities only sporadically since 1985 with the stock price ranging from a low bid of 1\/8 to a high bid of 1\/2. Information on stock prices on a quarterly basis and for years prior to 1985 is not available due to the absence of an established market.\nThe Company also established an employee stock ownership plan (ESOP) in 1985 to facilitate the purchase and sale of stock in an inactive market. The ESOP may purchase stock in the open market or directly from the Company. Purchases from the Company increase the number of shares outstanding and the Company's equity, but, depending on the sales price, dilute the interests of existing shareholders. The ESOP is designated as a retirement program for all qualified Company employees. At June 30, 1995, the ESOP owned 65,167 shares of the Company's common stock. - 5 -\nAt June 30, 1995, there were 816 shareholders. The Company has not declared any dividends since its incorporation. Under Oregon law, the Company may not pay any dividends if, after the payment of such dividend, the Company would not be able to pay its debts in the usual course of business or the Company's total assets would be less than the sum of its total liabilities. At June 30, 1995, the Company had an accumulated deficit of $1,938,819 and, accordingly, could not pay dividends. The payment of dividends in the future, if the existing deficit is eliminated, is subject to the discretion of the Board of Directors. The Company does not plan to pay dividends in the foreseeable future.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA -----------------------\n- 6 -\n- 7 -\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------------------------------------------------------------------------------- OF OPERATIONS - -------------\n(a) Results of Operations. ---------------------\n1995 Compared to 1994 - ---------------------\nThe Company's sales increased in the fiscal year ended June 30, 1995, in the amount of $1,498,433, from $21,496,122 to $22,994,555, a 6.5 percent increase. Sales increased because of an eight percent increase in units sold. Margins continued to decrease as a percentage of sales because of lower discounts from publishers and increased competition requiring higher discounts to customers. Management cannot determine if these trends will continue.\nOperating and administrative costs declined by $25,895 from $3,443,153 for the fiscal year ended June 30, 1994, to $3,417,258 for the fiscal year ended June 30, 1995. Efficiencies of the Company's new Firm Order computer system and continuous analysis of how various functions are performed caused this decrease. The Company will continue its efforts to improve the productivity of its employees through education and training.\nNegative pressures on the Company include increased competition from large competitors, information being produced in electronic formats, increased use of library materials budgets to purchase journals, and budgetary constraints of state-supported educational institutions.\n1994 Compared to 1993 - ---------------------\nThe Company experienced a decline in sales in 1994 in the amount of $497,193 due to a reduction in products sold. There were two primary reasons for this reduction. One was the lower sales to several commercial customers. The other was in 1993 the Company sold about $125,000 worth of an expensive reference work to libraries. There were no comparable sales in 1994. The cost of goods sold declined for the first time, because of efforts to work with major suppliers to get better terms. It is impossible to tell if this trend will continue.\nOperating and administrative costs declined by $58,734, although as a percentage of sales they increased by 1\/10 of 1 percent. The Company will continue efforts to improve the productivity of employees and to negotiate better terms with suppliers of goods and services in an effort to reduce operating and administrative costs. The Company introduced new software for its Firm Order operations in June, 1994. It is impossible to predict the effect on increased sales or lower costs.\nAs noted in previous years, there are several negative factors affecting the Company. Libraries continue to spend larger portions of the budgets on non- book materials such as journals, audio-visual material, and data base access.\n- 8 -\n1993 Compared to 1992 - ---------------------\nThe Company experienced a decline in sales in 1993 in the amount of $1,865,602 due to a reduction in products sold. This was primarily caused by the loss of several former Scholarly customers and the reduction in sales to a large corporate customer. The cost of goods sold continued to increase for several reasons. Publishers continue to lower discounts to the Company in order to prevent the list price of their material from increasing. Publishers also switch the mix of trade, technical, and text discounts such that their overall discounts decline even though their price structure remains the same. The Company is also actively soliciting orders from its customers for audio-visual material that carries little, if any, discount. It is impossible to predict what the future cost of goods will be.\nOperating and administrative expenses declined by $221,058 in the fiscal year ended June 30, 1993. They continue to decline for two reasons: decreasing volume and attention to all expenditures.\nTwo negative factors facing the Company are the continued upward spiral in the cost of serials (the library term for magazines) and the pressure on governmental agencies and departments at all levels to decrease costs. Serials are bought from the same materials budget that a library uses to buy books. As serials absorb a larger portion of the budget, the number of books purchased by many institutions declines. This trend will not be reversed until the national economy improves.\nThe Company continues to work against these trends by reducing staff, introducing labor-saving technologies, and working with the suppliers of its goods and services to improve prices and the quality of service provided. The Company will introduce a newly programmed Firm Order system in late 1993. It is hoped that this will improve and enhance the quality of the services the\nCompany provides to its customers. It is impossible, at this point, to predict the effect on increased sales or lower costs.\n(b) Inflation, Market Trends, and Business Factors Beyond Company Control. ---------------------------------------------------------------------\nInflation is not considered to be a factor in the Company's business at this time.\nNegative pressures on the Company, as previously stated, include increased competition from large competitors, information being produced in electronic formats, increased use of library materials budgets to purchase journals, and budgetary constraints of state-supported educational institutions.\n(c) Liquidity and Capital Resources. -------------------------------\nIt is anticipated that cash flows from financing and operating activities will be sufficient to meet the Company's liquidity need over the next twelve months and thereafter. The Company entered into a new line of credit in June 1995 with a bank. The new line of credit, which expires September 1996, permits the Company to borrow up to $1,400,000 (subject to certain limitations) and bears interest at a rate of two and one-half percent to four percent above the bank's reference rate (the \"Index\"). The Index equaled nine percent at June 30, 1995.\n- 9 -\nThe new line of credit is secured by all of the Company's assets and is guaranteed by the present officers of the Company who are also stockholders.\nThe Company, at the time it entered into the new line of credit with the bank, terminated its existing line of credit with another lending institution. This line of credit, which the Company entered into in June 1993, permitted the Company to borrow up to $1,250,000 and bore interest at the rate of six percent above the prime rate (15 percent, 13.25 percent, and 12 percent at June 30, 1995, 1994, and 1993, respectively). It was secured by the Company's accounts receivable, inventory, and equipment and was guaranteed by the present officers of the Company who are also stockholders. The weighted average interest rate under this line of credit in 1995 and 1994 was 14.33 and 12.27 percent, respectively.\nThe Company does not have any other unused sources of liquid assets. The Company will continue to improve its working capital situation through profitable operations.\nThe Company did not make any material capital expenditures during the fiscal year ended June 30, 1995.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe financial statements and schedules listed on the Index to Consolidated Financial Statements and Schedules on page 23 are incorporated herein by reference.\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- 10 -\nPART III --------\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS - ------------------------------------------\n(a) Directors. ---------\n- 11 -\nDirectors are elected to hold office until their successors are elected and qualified, subject to prior death, resignation, or removal.\n(b) Executive Officers. ------------------\nCertain of the directors also serve as the executive officers of the Company. Under the Corporation's Bylaws, executive officers are elected by the Board of Directors and serve until their successors are elected and qualified, subject to prior death, resignation, or removal. Those officers are:\nName Position - ---- --------\nDaniel P. Halloran President, Chief Financial Officer, Controller, Secretary\/Treasurer, and Chairman of the Board of Directors\nBarry E. Fast Vice President\n(c) Significant Employees. ---------------------\nJohn F. Knapp serves as the manager of systems development for the Company. He has served in that capacity since January 1, 1987. His responsibilities include computer systems development for the Company.\nCatherine J. Labsch serves as a controller for the Company. She has served in that position since September, 1989. Prior to working for the Company, she worked as the assistant controller for Pihas Schmidt Westerdahl, an advertising agency in Portland, Oregon.\n- 12 -\nRobert Schatz is the sales manager for the Company. He has served in that position since May, 1979. He manages all of the sales for the Company, including serving as a sales representative himself.\n(d) Compliance With Section 16(a) of the Securities Exchange Act of 1934. --------------------------------------------------------------------\nFor a company with a class of equity securities registered under Section 12 of the Securities Exchange Act of 1934 (the \"1934 Act\"), Section 16(a) of the 1934 Act requires the officers, directors, and persons who hold more than 10 percent of a registered class of such company's equity securities (the \"10 Percent Holders\") to file reports of ownership and changes of ownership with the Securities and Exchange Commission (the \"SEC\"). Officers, directors, and 10 Percent Holders are required by the regulations the SEC has promulgated under Section 16 of the 1934 Act to furnish such company with copies of all forms they file pursuant to Section 16(a).\nBased solely on the Company's review of Forms 3 and 4 and amendments thereto furnished to the Company during the fiscal year ended June 30, 1995, Forms 5 and amendments thereto furnished to the Company with respect to such fiscal year, and the written representations from certain of the reporting persons that no Forms 5 were required to be filed also with respect to such fiscal year, all required forms were timely filed, except a Form 5 for the fiscal year ended June 30, 1995, filed by Barry E. Fast on September 5, 1995, was 21 days late.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION - --------------------------------\n(a) Cash Compensation. -----------------\nThe following table sets forth information concerning the compensation for services to the Company in all capacities, for each of the fiscal years ended June 30, 1995, June 30, 1994, and June 30, 1993, of the person who was, at June 30, 1995, the Chief Executive Officer of the Company and each other executive officer of the Company at June 30, 1995 whose compensation for such fiscal year exceeded $100,000.\n- 13 -\n- 14 -\n- 15 -\nFor purposes of each employment agreement, a change of control is deemed to occur if a person becomes the beneficial owner of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities, the persons who at the beginning of any period of 24 consecutive months constitute the Board of Directors of the Company cease for any reason to constitute a majority thereof (unless the election of each director who is not a director of the beginning of such period has been approved in advance by directors representing at least two-thirds of the directors then in office who were directors at the beginning of the period), the Company is merged or consolidated with another corporation and, as a result of such merger or consolidation, less than 75 percent of the outstanding voted securities of the surviving or resulting corporation is owned in the aggregate by the former shareholders of the Company, or the Company sells all or substantially all of its assets to another corporation which is not a wholly- owned subsidiary.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\n(a) Security Ownership of Certain Beneficial Owners. -----------------------------------------------\nThe following table sets forth information as of September 22, 1995, with respect to persons known to the Company to be beneficial owners of more than 5 percent of the Company's outstanding shares of common stock. Unless otherwise indicated, the beneficial ownership of securities includes sole investment and voting power with respect to such securities.\n- 16 -\n- 17 -\n(b) Security Ownership of Management. --------------------------------\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nThe Company has nothing to report under this item.\n- 18 -\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 financial statements and schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules are filed as part of this Report.\n(b) Reports on Form 8-K. -------------------\nThe Company did not file any Reports on Form 8-K during the last quarter of the fiscal year ended June 30, 1995.\n(c) Exhibits. --------\n2. Plan of Acquisition, Reorganization, Arrangement, Liquidation, or Succession: None.\n3. Articles of Incorporation and Bylaws:\n(a) Restated Articles of Incorporation and Restated Bylaws (incorporated herein by reference to Appendices I and II of the Company's Proxy Statement filed May 24, 1988).\n(b) Articles of Amendment to Restated Articles filed with the Corporation Division of the State of Oregon on October 4, 1990 (incorporated herein by reference to Exhibit \"I\" to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990).\n4. Instruments defining the rights of security holders, including indentures: None.\n9. Voting trust agreements: None.\n10. Material contracts:\n10.1 Split Dollar Agreement dated May 1, 1993, between Daniel P. Halloran and Book Centers, Inc. (incorporated herein by reference to Exhibit 10 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993).\n10.2 Amended and Restated Split Dollar Agreement dated May 1, 1993, between Daniel P. Halloran and Book Centers, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1994).\n- 19 -\n10.3 Second Amended and Restated Split Dollar Agreement dated May 1, 1994, between Daniel P. Halloran and Book Centers, Inc.(incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994).\n10.4 Book Centers, Inc. Employee Stock Ownership Plan and Trust (incorporated by reference to Exhibit 10.4 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1995).\n10.5 Loan Agreement dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.6 Promissory Note dated June 28, 1995, in the principal amount of $750,000, the maker of which is Academic Book Center, Inc. and the payee of which is Centennial Bank.\n10.7 Commercial Security Agreement dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.8 Commercial Security Agreement dated June 28, 1995, among Book Centers, Inc., Academic Book Center, Inc., and Centennial Bank.\n10.9 Commercial Pledge Agreement dated June 28, 1995, between Academic Book Center, Inc., Centennial Bank, and Daniel P. and Karen M. Halloran.\n10.10 Agreement to Provide Insurance dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.11 Loan Agreement dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.12 Note dated June 28, 1995, in the principal amount of $650,000 the maker of which is Academic Book Center, Inc. and the payee of which is Centennial Bank.\n10.13 Commercial Security Agreement dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.14 Commercial Security Agreement dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.15 Small Business Administration (SBA) Guaranty dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n10.16 Assignment of Life Insurance Policy as Collateral dated June 28, 1995, among Book Centers, Inc., Academic Book Center, Inc., and Centennial Bank.\n10.17 Commercial Guaranty dated June 28, 1995, among Book Centers, Inc., Academic Book Center, Inc., and Centennial Bank.\n10.18 Commercial Guaranty dated June 28, 1995, between Academic Book Center, Inc., Centennial Bank, and Daniel P. Halloran.\n- 20 -\n10.19 Landlord's Consent dated June 28, 1995, between Academic Book Center, Inc. and Centennial Bank.\n11. Statement regarding computation of per share earnings: Disclosed in note 1 to the consolidated financial statements.\n12. Statements regarding computation of ratios: Not applicable.\n13. Annual report to security holders, Form 10-Q or quarterly report to security holders: None.\n16. Letter regarding change in certifying accountant: None.\n18. Letter regarding change in accounting principles: None.\n21. Subsidiaries of the registrant: See note 1 to the Consolidated Financial Statements.\n22. Published report regarding matters submitted to vote of security holders: None.\n23. Consents of experts and counsel: None.\n24. Power of attorney: None.\n27. Financial Data Schedule (filed electronically only).\n28. Information from reports to state insurance regulation authorities: None.\n99. Additional Exhibits: None.\n(d) Schedules. ---------\nThe schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules are filed as part of this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBOOK CENTERS, INC.\nDate: September 28, 1995 \/s\/ Daniel P. Halloran ------------------------------------- Daniel P. Halloran, President\n- 21 -\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.\nDate: September 28, 1995 \/s\/ Daniel P. Halloran ------------------------------------- Daniel P. Halloran, President, Controller\/Chief Financial Officer, Secretary\/Treasurer, Chairman of the Board of Directors, and Director\nDate: September 28, 1995 \/s\/ Frank L. Ford ------------------------------------- Frank L. Ford, Director\n- 22 -\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nPage\nReport of Independent Certified Public Accountants Relating to the Consolidated Financial Statements and Notes thereto 24\nFinancial Statements\nConsolidated Balance Sheets as of June 30, 1995 and 1994 25\nConsolidated Statements of Operations and Accumulated Deficit for the years ended June 30, 1995, 1994, and 1993 27\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994, and 1993 29\nNotes to Financial Statements 31\nThe schedules, other than those listed above, have been omitted since they are either not required, not applicable, or the information has been included in the aforementioned financial statements.\n- 23 -\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders of Book Centers, Inc. Portland, Oregon\nWe have audited the accompanying consolidated balance sheets of Book Centers, Inc. and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations and accumulated deficit and of 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 financial statements based on our audits.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Book Centers, Inc. and 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.\nAs discussed in Note 6 to the consolidated financial statements, Book Centers, Inc. and subsidiaries changed their method of accounting for income taxes effective June 1, 1993 to conform with Statement of Financial Accounting Standards No. 109.\nDELOITTE & TOUCHE LLP Portland, Oregon\nAugust 24, 1995\n- 24 -\n- 25 -\n- 26 -\n- 27 -\n- 28 -\n- 29 -\n- 30 -\nBOOK CENTERS, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1995, 1994, AND 1993 - -------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Company - Book Centers, Inc. is an Oregon corporation organized in 1961. The Company engages in the business of marketing, warehousing and distributing books worldwide to research and academic libraries.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and its 100%-owned subsidiary, Academic Book Center, Inc. (\"Academic\"). All significant intercompany accounts and transactions have been eliminated upon consolidation.\nRestructuring - During 1991, the Company closed its one hundred percent owned subsidiary Scholarly Book Center, Inc. (\"Scholarly\"), recording restructuring charges of $600,000. These charges included loss on equipment disposal, employee severance liability, lease termination costs and other incremental costs associated with the closure of these operations. The remaining accrual at June 30, 1993 and 1992, was for lease termination costs. These leases substantially expired during the year ended June 30, 1994 and the remaining restructuring accrual of $200,366 was reversed against operating expenses.\nStatements of Cash Flows - For purposes of the statement of cash flows, the Company considers interest bearing deposits with maturities of 90 days or less to be cash. Cash paid for interest was $177,581, $169,711, and $176,346 for the years ended June 30, 1995, 1994, and 1993, respectively.\nAccounts Receivable - Trade receivables are recorded at estimated collectible value.\nBook Inventories - Inventories are valued at lower of cost or market value using the specific identification method.\nIncome Taxes - Effective July 1, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, Accounting for Income Taxes, which requires the provision of deferred income taxes based upon an asset and liability approach and represents the change in deferred income tax accounts during the year, including the effect of enacted tax rate changes. A consolidated federal income tax return is filed by the Company for the consolidated group. Federal tax credits are accounted for, when applicable, under the flow-through method whereby the credit is reflected as a reduction of federal income tax expense in the year in which the credit is used.\nDeferred Revenue - The subsidiary companies receive advance payments from certain customers. These amounts are recognized as revenue when the related books are shipped.\nOffice Furnishings and Equipment and Depreciation - Office furnishings and equipment are stated at cost. Maintenance and repairs are charged to expenses as incurred, and improvements are capitalized. Depreciation is computed on a straight-line method over the estimated useful lives\n- 31 -\n(generally three to ten years) of the related assets. Upon disposal of property subject to depreciation, the accounts are relieved of the related costs and accumulated depreciation and resulting gains and losses are reflected in operations.\nNet Income (Loss) Per Share - Net income (loss) per share of common stock is computed based on the weighted average number of shares of common stock outstanding during each year. The weighted average number of shares for each of the three years ended June 30, 1995 was 636,889.\nReclassifications - Certain amounts from prior periods have been reclassified in order to conform to the 1995 presentation.\n2. EMPLOYEE STOCK OWNERSHIP PLAN\nDuring 1985, the Company adopted a qualified Employee Stock Ownership Plan. This Plan was initially funded with a $25,000 contribution and is available to all eligible personnel who have been employed by the Company for a least one year. As of June 30, 1995, 65,167 shares of the Company's outstanding common stock had been acquired by the Plan. There were no contributions to the Plan for the years ended June 30, 1995, 1994, and 1993.\n3. LEASE COMMITMENTS\nThe Company and one of its subsidiaries are lessees under noncancelable real property leases through 1996. Other leases shown are for automobiles and office equipment. In September 1992, the Company sold certain assets related to an operating division of its wholly-owned subsidiary, Academic. In addition to the purchase of assets, the buyer assumed responsibility for certain liabilities, including the lease for the operating division's primary facility. The sale agreement provided that the Company would guarantee this lease until the expiration of its original term at October 31, 1995.\nMinimum future rentals under capital and operating leases having initial or remaining terms of one year or more as of June 30, 1995 are as follows:\n- 32 -\nTotal rent expense was $129,640, $116,210, and $114,830 for the years ended June 30, 1995, 1994, and 1993, respectively.\n4. NOTES PAYABLE\nIn June 1991, the Company entered into a new line of credit with a lending institution. Beginning July 1, 1993, the line renewed annually unless the Company elected to terminate the agreement. Under this agreement, the Company could borrow up to a capacity of $1,250,000. The line bore interest at 6% above the prime rate (15%, 13.25%, and 12% at June 30, 1995, 1994, and 1993, respectively), was secured by accounts receivable, inventory and equipment and was personally guaranteed by present officers who are stockholders of the Company. The weighted average interest rate in 1995 and 1994 was 14.33% and 12.27%, respectively. In June 1995, the Company paid off their line of credit with this lending institution, and entered into a new line of credit with a bank. This new agreement expires September 1996, and bears interest at a rate of 2.5% to 4% above the bank's reference rate (the \"Index\"). The Index was at 9% at June 30, 1995. The Company may borrow up to a capacity of $1,400,000 subject to certain limitations. These borrowings are secured by assets of the Company and are guaranteed by stockholders of the Company who are also officers.\n- 33 -\n5. LONG-TERM DEBT\nLong-term debt at June 30, 1995 and 1994 consisted of the following:\nMaturities of long-term debt, including minimum capital lease payments, net of interest portion, at June 30, 1995 were as follows:\n1996 $ 16,649 1997 17,738 1998 17,868 1999 7,595 2000 - ----------\nTotal $ 59,850 ==========\nThe above notes payable to related parties are to individuals who are present officers and stockholders of the Company.\n6. INCOME TAXES\nThe Company adopted SFAS No. 109, Accounting for Income Taxes, effective July 1, 1993. The statement requires the provision of deferred income taxes based upon an asset and liability approach and represents the change in deferred income tax accounts during the year, including the effect of enacted tax rate changes. The statement also provides for the recognition of net operating loss (\"NOL\") carryforwards as a deferred tax asset.\n- 34 -\nIncome tax expenses attributable to operations consisted of the following:\nReconciliation between the statutory federal income tax rate and the effective tax is as follows:\nThe tax effort of temporary differences that give rise to significant deferred tax assets and deferred tax liabilities at June 30, 1995 and 1994 are presented below:\n- 35 -\nThere were no deferred tax liabilities at June 30, 1995. Deferred tax assets have been reduced by a valuation allowance as realization of some portion of these future tax benefits is subject to significant uncertainties. The net change in the valuation allowance for the year ended June 30, 1995, was $55,000.\nAt June 30, 1995, the Company's net operating loss carryforwards totaled approximately $1,220,000 for financial reporting purposes expiring through 2008. Net operating loss carryforwards totaled approximately $649,000 for tax purposes and expire as follows:\n- 36 -\nInvestment tax and new jobs credit carryovers approximate $21,000 at June 30, 1995 and expire at various dates through 2000.\n7. BUSINESS SEGMENT INFORMATION\nThe Company's principal industry segment is book wholesaling. Other segments and transfers between segments are immaterial. Export sales were $9,524,537, $8,344,825, and $7,181,519 for the years ended June 30, 1995, 1994, and 1993, respectively, and were made to various countries. In addition, accounts receivable from export sales were $1,726,442, $1,418,251, and $1,529,259 at June 30, 1995, 1994, and 1993, respectively.\n- 37 -\nINDEX TO EXHIBITS\n- 38 -\n- 39 -","section_15":""}
{"filename":"796370_1995.txt","cik":"796370","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nUnited Asset Management Corporation (\"UAM\" or the \"Company\") is a holding company organized in December, 1980 to acquire and own firms that provide investment advisory services primarily for institutional clients. The Company's 45 wholly owned subsidiaries (the \"Affiliated Firms\" or the \"Firms\") operate in one business segment, that is, as investment advisers, managing both domestic and international investment portfolios for corporate, government and union pension funds, endowments and foundations, mutual funds and individuals. UAM intends to continue expanding through the internal growth of its present Affiliated Firms and through the acquisition or organization of additional firms in the future (see \"Affiliated Firms\"). In addition, UAM plans to continue to diversify, both domestically and internationally, with respect to both the classes of assets managed for institutional investors and client base.\nWhile UAM's Affiliated Firms primarily specialize in the management of U.S. equities, bonds and cash, other asset classes under management have grown significantly over recent years to include real estate, international securities and stable value assets.\nAdvisory fees based on the assets of pension plans, profit sharing plans, endowments and foundations provide the substantial portion of the Company's revenues. Such clients are sometimes referred to as \"institutional\" clients, and they are generally \"tax-exempt\" in that the income and any capital gains which result from their portfolio investments are not taxable to them under present law. Advisory fees are primarily based on the value of assets under management. Fee rates typically decline as account size increases. The assets of institutional clients have generally been growing, with the most rapid growth achieved by pension and profit sharing plans (sometimes called employee benefit plans). For the year ended December 31, 1995, no single client of any Affiliated Firm provided more than 2% of the Company's consolidated revenues. Accordingly, the loss of any single client would not have a material adverse effect on the Company's total investment management business.\nEach Affiliated Firm operates under its own name, with its own investment philosophy and approach. Each conducts its own investment analysis, portfolio selection, marketing and client service. During any given period, investment results may vary among Firms. Client fees are set by each Firm based on its own judgment concerning the market for the services it renders. Each Firm is separately regulated under applicable federal, state or foreign law.\nIn addition to the Firms' individual efforts, UAM has established several distribution and client service organizations which are avaialable to the Affiliated Firms to supplement the investment management services being provided by them. This is described more fully under \"Method of Operation.\"\nUAM has established revenue sharing agreements with the Affiliated Firms which are described more fully under \"Revenue Sharing.\" These agreements provide for UAM to derive increased or decreased income from each Affiliated Firm, based on a percentage of the change in each Firm's revenues from year to year, starting from a base amount agreed upon in the year of acquisition. These arrangements allow each Firm to set its own operating expense budget and compensation practices, limited by the share of revenues available to the Firm.\nTHE INDUSTRY\nRevenues in the institutional investment management industry are determined primarily by fees based on assets under management. Therefore, the principal determinant of growth in the industry is the growth of institutional assets under management. In management's judgment, the major factors which influence changes in institutional assets under management are: (a) changes in the market value of securities; (b) net cash flow into or out of existing accounts; (c) gains of new or losses of existing accounts by specific firms or segments of the industry; and (d) the introduction of new products by the industry or by particular firms.\nIn general, assets under management in the institutional segments of the industry have increased steadily. For example, Money Market Directories, Inc. recorded in its 1996 Directory $3.7 trillion in assets under management in accounts of employee benefit plans, foundations and endowments within the United States as of mid-1995, which represents an average compound five-year annual growth rate of 8.4% over the corresponding figure as of mid-1990. The largest institutional segment of assets under management has been employee benefit plan assets. The 1996 Directory reported $3.5 trillion of employee benefit plan assets under management as of mid-1995, which represents an average compound five-year annual growth rate of 8.5% over the corresponding figure as of mid- 1990.\nThe employee benefit plan market includes two principal sectors: defined benefit and defined contribution plans. The majority of U.S. retirement plan assets are in defined benefit plans, which assure workers of a particular level of pension benefits when they retire. The Employee Retirement Income Security Act of 1974 (\"ERISA\") and the Internal Revenue Code of 1986 (the \"Code\") require employers to fund their defined benefit plans sufficiently to generate the benefits they have promised. However, the Code also discourages overfunding of defined benefit plans by employers by limiting tax deductions for contributions to fully funded plans. In management's opinion, high investment returns experienced in the 1980s and thus far in the 1990s has resulted in many defined benefit retirement plans reaching or exceeding their full funding limits based on actuarial calculations; therefore, many corporations ceased to contribute additional cash to the plans. However, if the value of plan assets declines due to market factors, or if sustained periods of low interest rates cause an increase in the actuarial value of plan liabilities, employers will generally be obligated to step up contributions to their defined benefit pension plans. This counter-cyclical funding pattern for defined benefit plans helps to smooth out fluctuations in the growth of plan assets under management by firms that provide investment advisory services to sponsors of defined benefit plans, and therefore, it helps to smooth out fluctuations in the revenues of these investment managers. Under defined contribution plans, on the other hand, employers may contribute to their employees' retirement funds on a tax- advantaged basis, but individual employees often decide how their plan assets will be invested. Defined contribution plans are the fastest growing sector of the employee benefit plan market.\nThe number and size of investment management firms which UAM would consider acquiring have grown in the past five years. The 1991 Money Market Directory showed 1,133 investment advisory firms (including branch offices) within the United States managing $2.9 trillion as of mid-1990. The 1996 Directory showed 1,349 such firms (including branch offices) within the United States managing approximately $6.6 trillion of assets as of mid-1995, which represents an average compound five-year annual growth rate of 18.0% over the corresponding assets of mid-1990.\nCOMPETITION\nThe Affiliated Firms compete with a large number of investment management firms, principally those engaged in the management of institutional accounts. In addition, the Affiliated Firms compete with commercial banks and insurance companies, many of which have substantially greater capital and other resources and some of which offer a wider range of financial services. Furthermore, each of the Affiliated Firms may compete with other Affiliated Firms for clients.\nManagement believes that the most important factors affecting competition in the investment management industry are the abilities and reputations of investment managers, differences in the investment performance of investment management firms and the development of new investment strategies, information technologies and client service capabilities, rather than differences in advisory fees.\nBarriers to entry are low, and firms are relatively long-lived in the investment management business. A new investment management firm has low capital requirements. Maintaining the firm requires only the continued involvement of its professional personnel. A major portion of profits may be regularly withdrawn because new capital commitments are limited and rarely necessary.\nUAM competes, with respect to the acquisition of investment management firms, with many other potential purchasers of investment management firms, including insurance companies, banks and other investment groups. For the most part, these acquirers have sought a single firm rather than undertaking a program of acquisitions similar to UAM's. As a result of its continuing acquisition activities, including regular contacts with potential acquisition candidates, UAM has an extensive knowledge of the candidate population both domestically and internationally.\nUAM'S ACQUISITION PROGRAM\nSince its inception, UAM has sought to acquire or to organize institutional investment management firms. Once it has acquired or organized such firms, UAM seeks to preserve their autonomy by allowing their key employees to retain control of investment decisions and manage the day-to-day operations. Where the Affiliated Firm is acquired from its employee-stockholders, the former stockholders receive the added benefits of a more diversified company by virtue of their equity ownership in UAM.\nUAM conducts its own acquisition activities rather than relying primarily upon outside agents to find and develop acquisition candidates for it. UAM's activities include regular mailing and calling programs through which UAM seeks to contact and visit potential acquisition candidates on a regular basis. UAM is willing to use finders to locate suitable candidates and has paid finders' fees on four occasions. Once acquisition negotiations begin, UAM utilizes its own staff and outside legal counsel to negotiate price, terms and the wording of specific documents required. Typically, a definitive purchase agreement is signed, and then each of the clients of the firm to be acquired is contacted by a principal of that firm in order to obtain the client's consent to the assignment of its advisory contract as required by the Investment Advisers Act of 1940. Once sufficient consents have been received, the acquisition is completed. Consent of all of a firm's clients has been obtained in connection with virtually all of UAM's acquisitions to date.\nAfter acquisition by UAM, Affiliated Firms continue to operate under their own firm name, with their own leadership and individual investment philosophy and approach. UAM seeks to achieve diversity by acquiring investment management firms having different investment philosophies and strategies and specializing in different asset classes. In addition, UAM has acquired or organized firms at various stages of their development, from start-up to relatively mature firms and has acquired both employee-stockholder firms and subsidiaries or divisions of financial institutions.\nUAM has observed that the major reasons that employee-owned firms consider selling to UAM include: (a) the high value of the firm relative to its principals' total net worth; (b) the need for liquidity on the part of the principals; and (c) their desire for diversification and a reduction in their exposure to a single firm's results. Substantially all the key employees of Affiliated Firms continue to be vigorously involved in their firm long after its acquisition by UAM.\nIn purchasing investment management firms, UAM has structured the transactions in order to create incentives for the key personnel to remain with their firm after the expiration of their employment agreements. The key employees have entered into employment and non-competition agreements for terms ranging primarily from five to 12 years, which also prohibit the employees from competing with their firm for a substantial period after termination of employment. Most of the key employees of the Affiliated Firms were stockholders of such firms prior to their acquisition by UAM. In connection with the purchases, the former stockholders and\/or key employees have typically received consideration in the form of cash, subordinated notes and warrants to purchase UAM common stock, or UAM common stock. The subordinated notes, which may be used to exercise the warrants, generally have terms between five and ten years. The key employees of each Affiliated Firm also participate directly, through a revenue sharing arrangement, in revenues of their firm and meet the firm's expenses from their share of these revenues, as described more fully under \"Revenue Sharing.\"\nUAM has over the past several years identified a substantial number of institutional investment management firms both domestically and internationally which it believes may be candidates for future acquisition on the basis of an evaluation of their personnel, investment approach, client base, revenues and profitability.\nTo fund acquisitions, the Company utilizes its existing capital, together with Operating Cash Flow (net income plus amortization and depreciation) and borrowings available under the $400,000,000 Reducing Revolving Credit Agreement (as more fully described in Note 3 to the Consolidated Financial Statements, see Items 8 and 14). Such borrowings are secured by the stock of the Company's subsidiaries. Subsequent to December 31, 1995, the Company is extending and expanding its Credit Agreement into a five year, $500,000,000 revolving facility.\nMETHOD OF OPERATION\nUAM itself does not manage portfolio investments for clients and does not provide any investment advisory services to Affiliated Firms and therefore is not registered as an investment adviser under federal, state or foreign law. UAM respects the individual character of each Affiliated Firm and seeks to preserve an environment in which each Firm may continue to provide investment management services which are intended to meet the particular needs of each Firm's clients. UAM provides assistance to the Affiliated Firms in connection with the preparation of separate company financial statements, tax matters,\ninsurance and maintenance of a company-wide profit sharing retirement plan. In addition, UAM has an operations group composed of senior officers of the Company which is responsible for establishing new marketing and service organizations, creating growth incentives and encouraging the undertaking of new projects and programs by the Affiliated Firms. Upon request, the Operations Group is also available to assist Affiliated Firms in planning for future growth and management development, particularly with respect to succession planning. The Company also sponsors several seminars and meetings for executives from each of the Affiliated Firms and from UAM which serve as forums for sharing business information.\nUAM seeks to assist the Affiliated Firms in their marketing activities by providing resources and support for developing new products and reaching new markets. As a part of these efforts, UAM organized UAM Funds, Inc. previously named The Regis Fund, Inc., a series mutual fund in which Affiliated Firms may open portfolios to pool client accounts in an efficient, cost-effective manner and to provide additional investment styles. As of December 31, 1995, 17 of the Affiliated Firms had opened, in the aggregate, 36 UAM Fund portfolios, and such portfolios held assets totaling $2.1 billion.\nIn 1993, UAM established Regis Retirement Plan Services in response to the growth in the defined contribution plan sector of the market by offering bundled products, including investment management capabilities through the UAM Fund portfolios managed by the Affiliated Firms, as well as employee education, recordkeeping and trustee services to the sponsors of these plans.\nIn 1994, UAM established United Asset Management (Japan), Inc. to offer and service products managed by the Affiliated Firms to Japanese investors. This affiliate is a single entity delivering service locally in Japan, but it represents the great breadth of expertise available in all of UAM's Affiliated Firms. It is currently registered in Japan as a non-discretionary adviser, and is preparing to apply for a license to offer discretionary investment services to Japanese institutional investors.\nIn 1995, UAM established two additional marketing and service organizations. UAM Investment Services, Inc. was organized to provide multi-product and global capabilities to large defined benefit plans and other major institutional investors such as insurance companies, as well as to financial planners. This new unit does not replace but supplements the marketing and client service activities of the Affiliated Firms and participation in it is voluntary on the part of each firm. It will provide a single convenient channel through which clients both domestically and abroad, can utilize the many investment products offered by the affiliated firms. In addition, UAM Fund Services, Inc. was formed to oversee the numerous service providers currently being used by some of UAM's Firms to support their funds that are part of UAM Funds, Inc. or their own separate family of funds.\nUAM believes that the professional independence of the Affiliated Firms and the continuing diversification of investment philosophies and approaches within the Company are necessary ingredients of UAM's success and that of the Affiliated Firms. The key employees of each Affiliated Firm at the time of acquisition by UAM have continued with their Firm in accordance with employment agreements executed in connection with each acquisition, have remained on their Firm's Board of Directors, and have continued to serve as its executive officers. Each Affiliated Firm's directors and officers are responsible for reviewing their respective Firm's results, plans and budgets. UAM intends to continue the method of operation described above as it acquires or organizes additional firms.\nREVENUE SHARING\nUAM operates with the Affiliated Firms under \"revenue sharing\" agreements. The agreements permit each Firm to retain a specified percentage of its revenues (typically 50-70%) for use by its principals at their discretion in paying expenses of operations, including salaries and bonuses. The purposes of the agreements are to provide significant ongoing incentives for the principals of the Affiliated Firms to continue working as they did prior to the sale of their firm to UAM and to allow UAM to participate in the growth of revenues of each Affiliated Firm. The agreements are designed to allow each Firm's principals to participate in that Firm's growth in a substantial manner and to make operating decisions freely within the limits of that portion of the Firm's revenues which is retained under the Firm's control. In effect, the portion of its revenues retained by each Firm that is not used to pay salaries and other operating expenses is available for payment to the principals and other key employees of such Firm in the form of bonuses. Thus, the portion of Affiliated Firm revenues retained by the Firms and used to pay salaries, fund operating expenses and bonuses is included in the Company's Consolidated Statement of Income.\nUnder each agreement, when an Affiliated Firm is acquired by UAM, the \"base revenues\" of the Firm are established, and a share of such revenues is allocated to UAM, with the remaining balance being the acquired Firm's share of revenues. In addition, agreement is reached on the Firm's and UAM's respective percentage shares of changes in such Firm's revenues compared to its base revenues. The Affiliated Firm is required to pay for all of its business expenses out of its share of its revenues. Each year, the amount of the Affiliated Firm's revenues that is paid to UAM and the amount that is retained by the Firm are adjusted upwards in the case of growth in such Firm's revenues over its base, or downwards in the case of decreases in such Firm's revenues below its base, by applying the agreed-upon percentages to the total increase or decrease in the Firm's revenues. Under most of the existing revenue sharing agreements, UAM's share of increases above a Firm's base revenues is between 30% and 50%, and UAM's share of decreases below a Firm's base revenues is between 50% and 70%. Thus, in any year in which the Affiliated Firm's revenues increase over its base revenues, the Firm retains a portion of such additional amounts to use as its principals may decide. The balance of the increase in the Affiliated Firm's revenues is paid to UAM, in addition to UAM's share of such Firm's base revenues. In any year in which the Affiliated Firm's revenues decrease to a level below its base revenues, the Firm's share of its base revenues is reduced by the Firm's portion of the decrease, and therefore, the Firm may need to reduce its expenses. Similarly, the revenue sharing amount paid to UAM will be reduced by UAM's share of any decline in the Affiliated Firm's revenues below its base.\nIn addition to revenue sharing with its Affiliated Firms, UAM has designed several incentive programs to reward business growth, client retention, investment performance and managerial development. Incentives awarded pursuant to these programs are paid in the form of cash, stock options, incentive growth shares or some combination thereof.\nAFFILIATED FIRMS\nEach of the Affiliated Firms conducts its own marketing, client relations, research, portfolio management and administrative functions. Each Firm sets its own investment advisory fees and manages its business independently on a day-to- day basis.\nThe investment philosophy, style and approach of each Affiliated Firm are independently determined by it, and these philosophies, styles and approaches may vary substantially from Firm to Firm. As a consequence, more than one Affiliated Firm may be retained by a single client since many clients employ multiple investment advisers. The strategies employed and securities selected by Affiliated Firms are separately chosen by each of them, with the result that any one Firm may be bullish on the stock or bond market while another Firm is bearish. Two of the Affiliated Firms are full-service institutional real estate investment management firms with $13.3 billion of assets under management at year end. These Firms invest in real estate properties in the U.S. and overseas for their U.S. and foreign clients and provide a broad spectrum of real estate services, including research, acquisition and disposition, financing and asset and property management. In addition, another Affiliated Firm, with $7.4 billion of assets under management at year end, manages stable value asset portfolios such as guaranteed investment contracts (\"GICs\") and synthetic GICs.\nAll of these differences, when combined with the separate names and identities of the various Affiliated Firms may: (a) tend to insulate UAM from the various cycles of market performance for specific asset classes and individual Firms; (b) permit more than one Affiliated Firm to serve any single client; and (c) mean that some Affiliated Firms may attract substantial new business while other Firms may be growing more slowly or losing business.\nOn December 31, 1995, UAM's 45 Affiliated Firms had 6,040 clients with $142.1 billion of assets under management for an average account size of $23.5 million. On a fee basis, the 20 largest clients represented 10% of total revenues and the 100 largest clients represented 21%. On an asset basis, the 20 largest clients represented 16% of the total assets under management and the 100 largest clients represented 34%. The client list includes many of the largest corporate, government, charitable and union funds in the U.S. and abroad along with the funds of several mutual fund organizations, many individuals and a number of professional groups. Additional information regarding the number of clients and types and amounts of assets under management is found in the table on page 38 of the Company's 1995 Annual Report to Shareholders (the \"Annual Report\"), which table is incorporated herein by reference.\nThe following table summarizes UAM's asset mix:\nAs previously described, each of the Affiliated Firms is responsible for and provides its own marketing of its investment management services. Typically, one or more of the employees at each Firm is responsible for making an initial contact with prospective clients. Most Firms have brochures describing the Firm, its principals and its investment approach. These brochures are mailed to prospective clients. In addition, clients are solicited by telephone and in person. Once an initial contact is made, several face-to- face meetings between the principals of such Firm and the prospective client take place at which investment philosophy, management fees and a variety of other related matters are discussed.\nREGULATION\nUAM's domestic investment advisory subsidiaries are registered with and subject to regulation by the Securities and Exchange Commission (the \"SEC\") under the Investment Advisers Act of 1940 and, where applicable, under state advisory laws. The Company's foreign investment advisory affiliates are members of or subject to certain self-regulatory bodies or other regulatory agencies. The Company's brokerage subsidiaries are registered as broker-dealers with the SEC under the Securities Exchange Act of 1934 and, where applicable, under state securities laws, and are regulated by the SEC, state securities administrators and the National Association of Securities Dealers, Inc. Three Affiliated Firms are regulated by the Commodities Futures Trading Commission, and two own trust companies which are subject to regulation by the Office of Comptroller of the Currency or applicable state law.\nUAM's domestic investment advisory subsidiaries are subject to ERISA and to regulations promulgated thereunder to the extent they are \"fiduciaries\" under ERISA with respect to their clients.\nRegistrations, reporting, maintenance of books and records and compliance procedures required by these laws and regulations promulgated thereunder are maintained by each UAM subsidiary on an independent basis.\nThe officers, directors and employees of UAM's investment advisory subsidiaries may from time to time own securities which are also owned by one or more of their clients. Each such Firm has internal guidelines and codes of ethics with respect to individual investments, and requires reporting of securities transactions and restricts certain transactions so as to minimize possible conflicts of interest.\nUAM's Affiliated Firms as of December 31, 1995 are listed below in the order in which they were acquired or organized.\n(1) Name was changed from Analytic Investment Management, Inc. to Analytic-TSA Global Asset Management, Inc., on January 31, 1996, upon the acquisition of TSA Capital Management, Inc.\nEMPLOYEES\nThe UAM holding company has 51 employees, seven of whom are executive officers of UAM (see Item 10, Directors and Executive Officers). Each Affiliated Firm employs its own investment advisory, marketing and client service, administrative and operations personnel as needed to provide advisory services to its clients and to maintain necessary records in accordance with various regulatory agencies (see \"Affiliated Firms\" and \"Regulation\" on pages 7 and 8, respectively). At December 31, 1995, the Company as a whole employed 2,171 persons. These numbers exclude 1,783 individuals who are employed by the property management subsidiaries of The L&B Group and Heitman Financial Ltd. and whose total compensation is billed directly to clients of these affiliates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTY\nUAM's only offices are its executive offices in Boston, Massachusetts, which occupy approximately 17,000 square feet under a lease which expires in 1997. Affiliated Firms are likewise lessees of their respective offices under leases which expire at various dates.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCertain of the Company's subsidiaries are subject to legal proceedings arising in the ordinary course of business. On the basis of information presently available and advice received from counsel, it is the opinion of management that the disposition or ultimate determination of such legal proceedings 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\nNo matters were submitted to the vote of the security holders of the Company during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nAs of December 31, 1995, there were 447 shareholders of record. As of March 4, 1996, there were 471 shareholders of record. The balance of the information required by this item is incorporated herein by reference to the \"Common Stock Information\" appearing on page 57 of the Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated herein by reference to the \"Eleven Year Review\" appearing on pages 42 and 43 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is incorporated herein by reference to the \"Management's Discussion and Analysis\" appearing on pages 39 through 41 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 to the \"Selected Quarterly Financial Data\" on page 57 of the Annual Report, \"Consolidated Financial Statements\" and \"Notes to the Consolidated Financial Statements\" appearing on pages 44 through 55 of the Annual Report and the \"Report of Independent Accountants\" on page 56 of the Annual Report. (See also the \"Financial Statement Schedule\" filed under Item 14 of this Form 10-K.)\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item is incorporated herein by reference to the sections entitled \"Election of Directors-Nominees for Election as Directors\" and \"Executive Compensation-Executive Officers\" included in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 16, 1996 (the \"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-Summary Compensation Table,\" \"Executive Compensation-Option Grants in 1995,\" \"Executive Compensation- Aggregated Option Exercises in 1995 and Option Values at December 31, 1995\" and \"Election of Directors-Directors' Fees\" included in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated herein by reference to the section entitled \"Voting Securities\" included in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference to the section entitled \"Election of Directors-Certain Transactions\" included in the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe following consolidated financial statements of United Asset Management Corporation and report of independent accountants, included on pages 44 through 56 of the Annual Report, are incorporated herein by reference as a part of this Form 10-K:\nPage(s) in the Title Annual Report ----- -------------\nReport of Independent Accountants 56\nConsolidated Balance Sheet as of December 31, 1995 and 1994 44\nConsolidated Statement of Income for the three years ended December 31, 1995 45\nConsolidated Statement of Cash Flows for the three years ended December 31, 1995 46\nConsolidated Statement of Changes in Stockholders' Equity for the three years ended December 31, 1995 47\nNotes to Consolidated Financial Statements 48-55\n2. Financial Statement Schedule\nThe following consolidated financial statement schedule and report of independent accountants are filed as a part of this Form 10-K and are located on the following pages:\nPage ----\nReport of Independent Accountants on Financial Statement Schedule\nSchedule VIII Valuation and Qualifying Accounts for the three years ended December 31, 1995\nAll other schedules have been omitted since they are not required, not applicable or the information is contained in the Financial Statements or Notes thereto.\n3. Exhibits\nExhibit Number Title ------ -----\n(1) 3.1 Restated Certificate of Incorporation of the Registrant.\n(1) 3.2 By-Laws of the Registrant.\n(2) 4.1 Specimen Certificate of Common Stock, $.01 par value, of the Registrant.\n(3) 4.2 Agreement to furnish copies of subordinated debt instruments to the Commission.\n9.0 Not Applicable\n(4) 10.1 Acquisition Agreement by and among United Asset Management Corporation, Heitman Financial Ltd., JMB Institutional Realty Corporation, JMB Realty Corporation and Certain Affiliates of JMB Institutional Realty Corporation and JMB Realty Corporation dated as of October 18, 1994.\n(4) 10.2 Acquisition Agreement by and among United Asset Management Corporation, Provident Investment Counsel, PIC Newco, Inc. and the Stockholders of Provident Investment Counsel dated as of November 10, 1994.\n(1) 10.3 Second Amended and Restated Reducing Credit Agreement dated as of November 18, 1994, among United Asset Management Corporation, the banks parties thereto, Morgan Guaranty Trust Company of New York, as Agent, and The First National Bank of Boston, as Collateral Agent.\n(5) 10.4 Note Purchase Agreement dated as of August 1, 1995.\n(5) 10.5 First Amendment and consent dated as of August 1, 1995 to the Second Amended and Restated Credit Agreement dated as of November 18, 1994.\n(6) 10.6 United Asset Management Corporation Profit Sharing and 401(k) Plan dated as of May 11, 1989 and amended and restated as of November 26, 1990.\n(7) 10.7 Revised First Amendment to United Asset Management Corporation Profit Sharing and 401(k) Plan effective as of January 1, 1992.\n(7) 10.8 Second Amendment to United Asset Management Corporation Profit Sharing and 401(k) Plan effective as of January 1, 1993.\n(1) 10.9 Third Amendment to United Asset Management Corporation Profit Sharing and 401(k) Plan effective as of January 1, 1994.\n10.10 Fourth Amendment to United Asset Management Corporation Profit Sharing and 401(k) Plan effective as of January 1, 1995.\n(1) 10.11 1994 Stock Option Plan.\n(1) 10.12 1994 Eligible Directors Stock Option Plan.\n10.13 United Asset Management Corporation Deferred Compensation Plan effective January 1, 1994.\n(8) 10.14 Consulting Agreement between United Asset Management Corporation and David I. Russell dated as of January 1, 1993.\n11.1 Calculation of Earnings Per Share.\n12.0 Not Applicable\n13.1 Annual Report to Shareholders for the Year Ended December 31, 1995.\n16.0 Not Applicable\n18.0 Not Applicable\n21.1 Subsidiaries of the Registrant.\n22.0 Not Applicable\n23.1 Consent of Independent Accountants.\n24.0 Not Applicable\n27.0 Financial Data Schedule for the Year Ended December 31, 1995.\n28.0 Not Applicable _________________ (1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n(2) Filed as an Exhibit to the Company's Form S-1 as filed with the Commission and which became effective on August 22, 1986, and incorporated herein by reference (Registration No. 33-6874).\n(3) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n(4) Filed as an Exhibit to the Company's Current Report on Form 8-K as filed with the Commission on December 1, 1994, and incorporated herein by reference.\n(5) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.\n(6) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n(7) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference.\n(8) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\nLocation of Documents Pertaining to Executive Compensation Plans and Arrangements:\n(1) 1994 Stock Option Plan, Exhibit 10.11 to this Form 10-K.\n(2) 1994 Eligible Directors Stock Option Plan, Exhibit 10.12 to this Form 10-K.\n(3) United Asset Management Corporation Deferred Compensation Plan effective January 1, 1994, Exhibit 10.13 to this Form 10-K.\n(4) Consulting Agreement between United Asset Management Corporation and David I. Russell dated as of January 1, 1993 - Form 10-K for fiscal year ended December 31, 1992, Exhibit 10.14 to this Form 10-K.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the fourth quarter of the fiscal year 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.\nUNITED ASSET MANAGEMENT CORPORATION ----------------------------------- (Registrant)\nDate: March 28, 1996 By \/s\/ Norton H. Reamer --------------------------------- Norton H. Reamer President and Chief Executive Officer\nBy \/s\/ William H. Park --------------------------------- William H. Park Executive Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.\n\/s\/ Norton H. Reamer - ---------------------------------- (Norton H. Reamer) Director March 28, 1996\n\/s\/ Richard A. Englander - ---------------------------------- (Richard A. Englander) Director March 28, 1996\n\/s\/ Robert J. Greenebaum - ---------------------------------- (Robert J. Greenebaum) Director March 28, 1996\n\/s\/ Charles E. Haldeman, Jr. - ---------------------------------- (Charles E. Haldeman, Jr.) Director March 28, 1996\n\/s\/ Robert M. Kommerstad - ---------------------------------- (Robert M. Kommerstad) Director March 28, 1996\n\/s\/ M. Thomas Lardner - ---------------------------------- (M. Thomas Lardner) Director March 28, 1996\n\/s\/ Jay O. Light - ---------------------------------- (Jay O. Light) Director March 28, 1996\n\/s\/ John F. McNamara - ---------------------------------- (John F. McNamara) Director March 28, 1996\n\/s\/ David I. Russell - ---------------------------------- (David I. Russell) Director March 28, 1996\n\/s\/ Philip Scaturro - ---------------------------------- (Philip Scaturro) Director March 28, 1996\n\/s\/ John A. Shane - ---------------------------------- (John A. Shane) Director March 28, 1996\n\/s\/ Barbara S. Thomas - ---------------------------------- (Barbara S. Thomas) Director March 28, 1996\nExhibit 11.1\nUNITED ASSET MANAGEMENT CORPORATION CALCULATION OF EARNINGS PER SHARE (in thousands, except per-share amounts)\n______________\n(1) The proceeds from the exercise of stock options and warrants in accordance with the modified treasury stock method are first used to buy back up to 20% of the Company's common stock at the average price for the period in the primary calculation and at the higher of the average or closing price in the fully diluted calculation. Any remaining proceeds are used to retire debt, and this adjusts income for the interest assumed to be saved, net of income tax, from the use of such proceeds.\n(2) Adjusts shares for stock options and warrants under the modified treasury stock method and contingently issuable shares based on the probability of issuance, after adjusting for the stock assumed repurchased in accordance with (1) above.\nUNITED ASSET MANAGEMENT CORPORATION Exhibit 21.1 SUBSIDIARIES OF THE REGISTRANT\nJurisdiction of Financial Affiliated Firm Organization Statements - --------------- ------------ ----------\nAcadian Asset Management, Inc. Massachusetts Consolidated Alpha Global Fixed Income Managers Delaware Consolidated Analytic-TSA Global Asset Management, Inc. California Consolidated Barrow, Hanley, Mewhinney & Strauss, Inc. Nevada Consolidated Cambiar Investors, Inc. Colorado Consolidated The Campbell Group, Inc. Delaware Consolidated Chicago Asset Management Company Delaware Consolidated Cooke & Bieler, Inc. Pennsylvania Consolidated Dewey Square Investors Corporation Delaware Consolidated Dwight Asset Management Company Delaware Consolidated Fiduciary Management Associates, Inc. Delaware Consolidated First Pacific Advisors, Inc. Massachusetts Consolidated GSB Investment Management, Inc. Delaware Consolidated Hagler, Mastrovita & Hewitt, Inc. Delaware Consolidated Hamilton, Allen & Associates, Inc. Delaware Consolidated Hanson Investment Management Company California Consolidated Heitman Financial Ltd. Delaware Consolidated Heitman Properties Ltd.(1) Illinois Consolidated Heitman\/JMB Advisory Corporation Illinois Consolidated Hellman, Jordan Management Company, Inc. Delaware Consolidated Investment Counselors of Maryland, Inc. Maryland Consolidated Investment Research Company Illinois Consolidated Jacobs Asset Management Delaware Consolidated Tom Johnson Investment Management, Inc. Massachusetts Consolidated Ki Pacific Asset Management, Inc. Delaware Consolidated L&B Realty Advisors, Inc. (The L&B Group) Delaware Consolidated L&B Institutional Property Managers, Inc.(2) Delaware Consolidated L&B Real Estate Counsel Texas Consolidated C.S. McKee & Company, Inc. Pennsylvania Consolidated Murray Johnstone Limited Scotland Consolidated Nelson, Benson & Zellmer, Inc. Colorado Consolidated Newbold's Asset Management, Inc. Pennsylvania Consolidated Northern Capital Management, Inc. Wisconsin Consolidated NWQ Investment Management Company Massachusetts Consolidated Olympic Capital Management, Inc. Washington Consolidated Pell, Rudman & Co., Inc. Delaware Consolidated Pilgrim Baxter & Associates Delaware Consolidated Provident Investment Counsel Massachusetts Consolidated Regis Retirement Plan Services Delaware Consolidated Rice, Hall, James & Associates California Consolidated Rothschild\/Pell, Rudman & Co., Inc. Maryland Consolidated Sirach Capital Management, Inc. Washington Consolidated Spectrum Asset Management, Inc. Connecticut Consolidated Sterling Capital Management Company North Carolina Consolidated Suffolk Capital Management, Inc. Delaware Consolidated Thompson, Siegel & Walmsley, Inc. Virginia Consolidated UAM Fund Distributors, Inc. Massachusetts Consolidated UAM Fund Services, Inc. Delaware Consolidated UAM Investment Services, Inc. Delaware Consolidated United Asset Management (Japan), Inc. Delaware Consolidated\nAll of the Registrant's subsidiaries do business under the respective names indicated above and are wholly owned.\n(1) Heitman Properties Ltd. has 40 wholly owned property management subsidiaries operating in the U.S.\n(2) L&B Institutional Property Managers, Inc. has 5 wholly owned property management subsidiaries operating in the U.S.\nREPORT OF INDEPENDENT ACCOUNTANTS ON\nFINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of United Asset Management Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 7, 1996 appearing on page 56 of the 1995 Annual Report to Shareholders of United Asset Management 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.\n\/s\/ Price Waterhouse LLP\nPRICE WATERHOUSE LLP Boston, Massachusetts February 7, 1996\nExhibit 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-3 (Nos. 33-36928, 33-44215, 33-46310, 33-63350, 33-69034, 33-51443, 33-52517, 33-57049 and 33-64449) and in the Registration Statements on Form S-8 (Nos. 33-10621, 33-21756, 33-34288, 33-48858 and 33-54233) of United Asset Management Corporation of our report dated February 7, 1996 appearing on page 56 of the Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page of this Form 10-K.\n\/s\/ Price Waterhouse LLP\nPRICE WATERHOUSE LLP Boston, Massachusetts March 25, 1996\nUNITED ASSET MANAGEMENT CORPORATION Schedule VIII VALUATION AND QUALIFYING ACCOUNTS (in $ thousands)\n(A) Due to the structure of this acquisition, tax amortization is less than book amortization.","section_15":""}
{"filename":"27984_1995.txt","cik":"27984","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 LEGAL PROCEEDINGS\nIn the action styled GARCIA V. DELTONA ET. AL, Case No. 86-03542, filed in the Circuit Court for Dade County, Florida, on January 30, 1986, the plaintiff sought to recover $2,000,000 allegedly paid to the Company on four installment land sales contracts, claiming fraud and misrepresentation on the part of one of the Company's independent sales representatives and other violations of law. The Company had cancelled the contracts in question according to their terms for default of the payment obligations by the purchaser. Although the Company negotiated a settlement of this action which provided for the Company to convey to the plaintiff property which has a value equivalent to the monies paid by the plaintiff to the Company under the cancelled contracts, the plaintiff asserted that the Company has breached the settlement agreement by failing to convey sufficient property which met the criteria of the settlement agreement. The Company believed that the property conveyed complied with such criteria. The plaintiff could have sought a judgment of $5,400,000, plus interest, less the value of the property transferred. On October 27, 1995, the parties resolved and settled their dispute by the Company transferring alternative property for settlement purposes. The Company exchanged releases with the plaintiff, which released the Company from any further obligations, except certain obligations and warranties contained in the modification of settlement agreement.\nThe Company was previously sued by its former landlord for breach of lease in the action styled FIVE POINTS LIMITED V. THE DELTONA CORPORATION, Case No. 93-22877, filed in the Circuit Court for Dade County, Florida, which has been settled. The Company had entered into a short term lease agreement with the landlord and\/or its affiliate for a term of lease of one (1) year with a ninety (90) day cancellation provision. Certain payments were made to the landlord and a letter of credit in the amount of $500,000, now called, was conveyed to the landlord. Funding of the settlement was obtained through a loan to the Company. The Company vacated the premises in September 1995 and neither party owes the other any further duty or obligation.\nIn the action entitled ESTATE OF BOBINGER, ET AL. V. THE DELTONA CORPORATION, Case No. 87-45051, filed in the Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida, the plaintiff sued the Company for breach of contract and for recovery of monies paid on contracts for Marco property that will not be developed by the Company. The matter was settled pending performance of the settlement agreement. In the opinion of the Company, residual obligations of the Company that are due and payable in the future may approximate up to $1,300,000. The Company has provided an allowance for Marco permit costs, which encompasses these obligations. See \"Management's Discussion and Analysis\" and Note 9 to the consolidated financial statements.\nIn the action styled LEE SU WEN NI ET. AL. V. THE DELTONA CORPORATION AND SCAFHOLDING B.V., Case No. 95-4422-CA-E, filed in the Circuit Court of Marion County, Florida on October 11, 1995, the plaintiff alleges that the liquidated damages provision in the Company's installment contracts for the sale of its properties is unenforceable under Florida Law and contests the method utilized by the Company to calculate actual damages in the event of contract cancellations. As part of the complaint, the plaintiff is seeking certification as a class action, as well as unspecified compensatory damages, together with interest, costs and fees. The Company filed a Motion to Dismiss in response to the plaintiff's complaint. The Court has dismissed the claim of the class representative against the Company and against Scafholding B.V.; however, the Company expects an appeal to ensue. In the event that any future appeal is successful, class certification is authorized and the Company is not successful in its defenses, a substantial claim could be asserted against the Company.\nIn the action styled BRUCE WEINER V. THE DELTONA CORPORATION, filed in the Circuit Court of Dade County, Florida, Case No. 94- 7825-04, the plaintiff, Bruce Weiner, prior Executive Vice President of the Company, sued the Company on April 28, 1994 for alleged breach of employment contract seeking damages of approximately $750,000 and unspecified employee benefits. The Company settled the matter and a general release was entered into in 1995.\n(15)\nIn the action styled JOSEPH MANCILLA, JR. V. THE DELTONA CORPORATION, files in the Circuit Court of Dade County, Florida, Case No. 94-09116, the plaintiff, Joseph Mancilla, Jr., prior Senior Vice President of the Company, sued the Company on May 17, 1994 for alleged breach of employment contract seeking damages in excess of $391,000 plus an unspecified amount in employee benefits, costs and attorneys' fees. The Company settled the matter and a general release was entered into in 1995. The Company is obligated for certain payments to fulfill settlement obligations through January 1997.\nIn the action styled MICHELLE GARBIS V. THE DELTONA CORPORATION, the plaintiff, Michelle Garbis, prior Senior Vice President and Corporate Secretary of the Company, sued the Company on August 18, 1994 for alleged breach of employment contract. The Company settled the matter and a general release was entered into in 1995.\nIn the action styled THEODORE MAUREAU V. THE DELTONA CORPORATION, the Company was sued by a former Vice President and employee asserting breach of an oral contract and a claim based on fraud. The plaintiff asserted unspecified damages and punitive damages. The Company settled the matter and a general release was entered into in 1995.\nThe Company is also a party to certain other legal and administrative proceedings arising in the ordinary course of business. The outcome will not, in the opinion of the Company, have a material adverse effect on the business or financial condition of the Company. (16)\nITEM 5","section_4":"","section_5":"ITEM 5\nPRICE RANGE OF COMMON STOCK AND DIVIDENDS\nThe Company's Common Stock was traded on the New York and Pacific Stock Exchanges under the ticker symbol DLT. On April 6, 1994, both the New York and Pacific Stock Exchanges suspended the Company's Common Stock from trading and instituted procedures to delist the Company's Common Stock. On June 16, 1994, the Company's Common Stock was formally removed from listing and registration on the New York Stock Exchange. As of December 31, 1995, the Company's Common Stock was traded on a limited basis in the over-the-counter markets. The bid and the ask were as follows at the end of the first, second, third and fourth quarters of 1995:\nThe Company has never paid any cash dividends on its Common Stock. The Company's loan agreements contain certain restrictions which currently prohibit the Company from paying dividends on its Common Stock.\n(17)\nITEM 6","section_6":"ITEM 6 SELECTED CONSOLIDATED FINANCIAL INFORMATION\nThe following table summarizes selected consolidated financial information and should be read in conjunction with the Consolidated Financial Statements. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\n(18)\nITEM 7","section_7":"ITEM 7\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOn June 19, 1992, the Company completed a transaction with Selex, which resulted in a change in control of the Company. Under the transaction, Selex loaned the Company $3,000,000 collateralized by a first mortgage on certain of the Company's property in its St. Augustine Shores, Florida community (the \"First Selex Loan\"). The First Selex Loan initially bears interest at the rate of 10% per annum with a term of four years and payment of interest deferred for the first 18 months.\nIn conjunction with the First Selex Loan: (i) Empire of Carolina, Inc. (\"Empire\") sold Selex its 2,220,066 shares of the Company's Common Stock and assigned Selex its $1,000,000 Note from the Company, with $225,000 of interest accrued thereon; (ii) Maurice A. Halperin, Chairman of the Board of Empire and former Chairman of the Board of the Company, forgave payment of the $200,000 salary due him for the period of April, 1990 through April, 1991, which was in arrears; and (iii) certain changes occurred in the composition of the Company's Board of Directors. Namely, the six directors serving on the Company's Board who were previously designated by Empire resigned and four Selex designees (Messrs. Marcellus H.B. Muyres, Antony Gram, Cornelis van de Peppel and Cornelis L.J.J. Zwaans) were elected to serve as directors in their stead. Marcellus H.B. Muyres was appointed Chairman of the Board and Chief Executive Officer of the Company. These directors, as well as Leonardus G.M. Nipshagen, a Selex designee, were then elected as directors at the Company's 1992 Annual Meeting and re- elected at the Company's 1993 Annual Meeting.\nAs part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, to convert the Selex Loan, or any portion thereof, into a maximum of 850,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). However, on September 14, 1992, Selex formally waived and relinquished its right to exercise the Option as to 250,000 shares of the Company's Common Stock to enable the Company to settle certain litigation involving the Company through the issuance of approximately 250,000 shares of the Company's Common Stock to the claimants, without jeopardizing the utilization of the Company's net operating loss carryforward. On February 17, 1994, Selex exercised the remaining full 600,000 share Option at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As a consequence of such conversion, Selex holds 2,820,066 shares of the Company's Common Stock (41.9% of the outstanding shares of Common Stock of the Company based upon the number of shares of the Company's Common Stock outstanding as of March 22, 1996).\nPursuant to the Selex transaction, $1,000,000 of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan Development Corporation (\"Swan\"), in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in a certain contract with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial land and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain of the multi-family property from the Company (which right had been granted in connection with the June, 1992 transaction) at a price of (19)\n$312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (the \"First Conquistador Acquisition\").\nIn December, 1992, Mr. Gram, a director of the Company and beneficial owner of the Common Stock of the Company held by Selex, acquired all of the Company's outstanding bank debt and then assigned same to Yasawa, of which Mr. Gram is also the beneficial owner. Yasawa simultaneously completed a series of transactions with the Company which involved the transfer of certain assets to Yasawa or its affiliated companies, the acquisition by Yasawa of 289,637 shares of the Company's Common Stock through the exercise of warrants previously held by the banks, the provision of a $1,500,000 line of credit to the Company and the restructuring of the remaining debt as a $5,106,000 Yasawa Loan. Principal repayments aggregating $341,000 have reduced the Yasawa Loan to $4,765,000 as of December 31, 1995. On April 30, 1993, Selex loaned the Company an additional amount of $1,000,000 pursuant to the Second Selex Loan and since July 1, 1993 made further loans to the Company aggregating $4,400,000 under the Third Selex Loan. Principal of $1,000,000 had been repaid under the Second Selex Loan and $1,371,000 under the Third Selex Loan through December 31, 1995. As of December 31, 1995, Yasawa has loaned the Company an additional sum of $4,012,000 pursuant to the Second Yasawa Loan. As a consequence of these transactions, the Company had loans outstanding from Selex, Yasawa and their affiliates on December 31, 1995 in the aggregate amount of approximately $20,378,000. On May 22, 1995, the Company closed a transaction with Conquistador (the \"Second Conquistador Acquisition\") for the sale of an administration building and a multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's FeatherNest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. On that same date, but in a separate transaction, the Company also sold to Conquistador Development Corporation (the \"Third Conquistador Acquisition\") four single family residential lots in the St. Augustine Shores community for $100,000 in cash. These transactions were accounted for in accordance with generally accepted accounting principals for these types of related party transactions. Accordingly, the resulting gain of $1,900,000 was treated as a contribution of capital and recorded directly to capital surplus. The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company. See Note 5 to Consolidated Financial Statements.\nThe Company, Selex and Yasawa entered into loan modification agreements in which all accrued interest was converted into non- interest bearing principal at the earlier of the maturity date or the default date. Accordingly, at December 31, 1995, $4,200,000 of accrued interest was reclassified as principal. The loans were also modified to formalize the elimination of the default interest rate provisions in each of the applicable loan agreements.\nThe Company has stated in previous filings with the Commission and elsewhere herein that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As previously stated, during the last nine months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements and continue its marketing program. Commencing in 1994, Yasawa advanced additional funds (the \"Second Yasawa Loan\") totalling $4,012,000 as of December 31, 1995, to meet the Company's minimum working capital requirements, to pay $750,000 in delinquent real estate taxes, to pay settlements with certain trade creditors and to settle certain litigation.\nOn March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any\n(20)\nsuch transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\nAs a consequence of its liquidity position, the Company has defaulted on certain obligations, including its previously described escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid delinquent real estate taxes which aggregate approximately $2,975,000 as of December 31, 1995; non-payment of these delinquent taxes may adversely affect the financial condition of the Company.\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including, but not limited, to filing for protection under the federal bankruptcy laws. See \"Business: Recent Developments\", and Notes 1, 5 and 8 to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994\nREVENUES\nTotal revenues were $6,688,000 for 1995 compared to $ 8,541,000 for 1994.\nGross land sales were $3,623,000 for 1995 versus $2,994,000 for 1994. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) increased to $2,394,000 for 1995 from $2,058,000 for 1994. The increase in sales reflects the Company's marketing program which was initiated in 1995.\nThere were no bulk land sales in 1995 as compared to bulk land sales of $315,000 in 1994. In light of the Company's diminished bulk land sales inventory it is anticipated that in the future the Company will produce a negligible volume of bulk land sales. See \"Liquidity and Capital Resources: Mortgages and Similar Debt\".\nThe Company re-entered the single-family housing business in December, 1992. Revenues are not recognized from housing sales until the completion of construction and passage of title. Housing revenues were $1,383,000 for 1995 compared to $2,543,000 in 1994. Housing revenues decreased in 1995 due to the lack of an advertising and promotion program.\nThe following table reflects the Company's real estate product mix for 1995 and 1994 (in thousands):\nImprovement revenues result from recognition of revenues deferred from prior period sales. Recognition occurs as development work proceeds on the previously sold property or customers are exchanged to a developed lot. Improvement revenues totalled $1,052,000 in 1995 as compared to $1,214,000 for 1994. The decrease was due to the Company's financial condition which caused the Company to curtail development in the first quarter of 1994.\nInterest income was $1,019,000 for 1995 compared to $1,046,000 for 1994. This decrease is the result of lower escrow balances.\nOther revenues were $840,000 for 1995 compared to $629,000 in 1994. Other revenues are generated principally by the Company's title insurance and real estate brokerage subsidiaries.\nIncluded in the 1995 results is an extraordinary gain of $702,000 related to the settlement of the Marco refund obligation.\nIncluded in the 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nCOSTS AND EXPENSES\nCosts and expenses were $9,593,000 for 1995 compared to $12,447,000 in 1994. Cost of sales totalled $2,432,000 for 1995 versus $3,845,000 for 1994. These decreases are primarily due to lower housing sales in 1995. The Company completed its Compromise and Settlement Agreement program with its trade creditors during the third quarter of 1994. Accordingly, costs and expenses were reduced by approximately $430,000 as a result of these settlements.\nIn 1995, the Company recorded a provision of $650,000 representing the Company's estimate of its liability to replace or repurchase cancelled contracts receivable under the recourse provisions of its prior sales of contracts and mortgages receivable.\nCommissions, advertising and other selling expenses totalled $1,889,000 for 1995 versus $2,608,000 for 1994. Advertising and promotional expenditures decreased to $151,000 in 1995 from $275,000 in 1994 as a result of the reduction in the Company's marketing programs. Other selling expenses decreased to $550,000 in 1995 from $1,595,000 in 1994 as a result of cost reductions.\nGeneral and administrative expenses were $1,869,000 in 1995 versus $2,984,000 for 1994. General and administrative expenses have decreased primarily due to overhead reductions and settlement of the Company's lease obligation on its corporate headquarters in October 1994.\nReal estate tax expense was $1,111,000 in 1995 compared to $1,163,000 in 1994. Included in real estate tax expense is delinquent interest and administrative fees on 1993 and 1994 delinquent taxes, which accrue interest at 18% per annum.\nInterest expense was $1,642,000 for 1995, as compared to $1,847,000 for 1994. The decrease in interest expense is the result of the decrease in debt. No interest was capitalized in 1995 and 1994 since the Company had curtailed land development work at its communities.\n(22)\nNET INCOME\nThe Company reported a net loss of $2,203,000 for 1995, compared to a net loss of $3,906,000 for 1994. Included in the 1995 results is an extraordinary gain of $702,000 related to the settlement of the Marco refund obligation. Included in 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nRESULTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993\nREVENUES\nTotal revenues were $8,541,000 for 1994 compared to $12,099,000 for 1993.\nGross land sales were $2,994,000 for 1994 versus $3,170,000 for 1993. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) decreased to $2,058,000 for 1994 from $2,432,000 for 1993. The decrease in sales reflects the curtailment of the Company's marketing program which was limited in 1994.\nBulk land sales were $315,000 in 1994 as compared to bulk land sales of $113,000 in 1993. In light of the Company's diminished bulk land sales inventory it is anticipated that in the future the Company will produce a negligible volume of bulk land sales. See \"Liquidity and Capital Resources: Mortgages and Similar Debt\".\nThe Company re-entered the single-family housing business in December, 1992. Revenues are not recognized from housing sales until the completion of construction and passage of title. Housing revenues were $2,543,000 for 1994 compared to $344,000 in 1993.\nThe following table reflects the Company's real estate product mix for 1994 and 1993 (in thousands):\nImprovement revenues result from recognition of revenues deferred from prior period sales. Recognition occurs as development work proceeds on the previously sold property or customers are exchanged to a developed lot. Improvement revenues totalled $1,214,000 in 1994 as compared to $4,725,000 for 1993. The decrease was due to the Company's financial condition which caused the Company to stop development in the first quarter of 1994.\nInterest income was $1,046,000 for 1994 compared to $1,197,000 for 1993. This decrease is the result of lower contracts receivable balances.\n(23)\nOther revenues were $629,000 for 1994 compared to $3,401,000 in 1993. This decrease was the result of the termination of its lease on the Marco Shores Country Club on December 31, 1993 and the sale of Marco Island Realty in November, 1993.\nIncluded in 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nCOSTS AND EXPENSES\nCosts and expenses were $12,447,000 for 1994 compared to $20,871,000 in 1993. Cost of sales totalled $3,845,000 for 1994 versus $6,441,000 for 1993. These decreases are primarily due to the termination of development work in the first quarter of 1994 and the sale of the Marco Island Realty and the termination of the lease of the Marco Shores Country Club in 1993. Additionally, the Company completed the first phase of its Compromise and Settlement Agreement program with its trade creditors during the third quarter of 1994. Accordingly, costs and expenses were reduced by approximately $430,000 as a result of these settlements.\nCommissions, advertising and other selling expenses totalled $2,608,000 for 1994 versus $6,008,000 for 1993. Advertising and promotional expenditures decreased to $275,000 in 1994 from $1,521,000 in 1993 as a result of the reduction in the Company's marketing programs.\nGeneral and administrative expenses were $2,984,000 in 1994 versus $3,790,000 for 1993. General and administrative expenses have decreased primarily due to overhead reductions implemented in the first quarter of 1994 and settlement of the Company's lease obligation on its corporate headquarters in October 1994.\nReal estate tax expense was $1,163,000 in 1994 compared to $975,000 in 1993. Included in real estate tax expense is delinquent interest and administrative fees on 1992 and 1993 delinquent taxes, which accrue interest at 18% per annum.\nInterest expense was $1,847,000 for 1994, as compared to $1,257,000 for 1993, or a 47% increase. Total interest costs (including capitalized interest) were $1,847,000 and $1,421,000 for 1994 and 1993, respectively. The increase in interest expense is primarily the result of the increase in debt. No interest was capitalized in 1994 since the Company had stopped land development work at its communities.\nNET INCOME\nThe Company reported a net loss of $3,906,000 for 1994, compared to a net loss of $8,772,000 for 1993. The 1993 results include a provision for contract cancellations of $2,400,000. Included in 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nREGULATORY DEVELOPMENTS WHICH MAY AFFECT FUTURE OPERATIONS\nIn Florida, as in many growth areas, local governments have sought to limit or control population growth in their communities through restrictive zoning, density reduction, the imposition of impact fees and more stringent development requirements. Although the Company has taken such factors into consideration in its master plans, the increased regulation has lengthened the development process and added to development costs.\nOn a statewide level, the Florida Legislature adopted and implemented the Florida Growth Management Act of 1985 (the \"Act\") to aid local governments efforts to discourage uncontrolled growth in Florida. The Act precludes the issuance of development orders or permits if public facilities such as transportation, water and sewer services will not be available concurrent with development. Development orders have been issued for, and development has commenced in, the Company's existing communities (with development being virtually completed in certain of these\n(24)\ncommunities). Thus, such communities are less likely to be affected by the new growth management policies than future communities. Any future communities developed by the Company will be strongly impacted by new growth management policies. Since the Act and its implications are consistently being re-examined by the State, together with local governments and various state and local governmental agencies, the Company cannot further predict the timing or the effect of new growth management policies, but anticipates that such policies may increase the Company's permitting and development costs.\nIn addition to Florida, other jurisdictions in which the Company's properties are offered for sale have recently strengthened, or are considering strengthening, their regulation of subdividers and subdivided lands in order to provide further assurances to the public, particularly given the adverse publicity surrounding the industry which existed in 1990. The Company has attempted to take appropriate steps to modify its marketing programs and registration applications in the face of such increased regulation, but has incurred additional costs and delays in the marketing of certain of its properties in certain states and countries. For example, the Company has complied with regulations of certain states which require that the Company sell its properties to residents of those states pursuant to a deed and mortgage transaction, regardless of the amount of the down payment. The Company intends to continue to monitor any changes in statutes or regulations affecting, or anticipated to affect, the sale of its properties and intends to take all necessary and reasonable action to assure that its properties and its proposed marketing programs are in compliance with such regulations, but there can be no assurance that the Company will be able to timely comply with all regulatory changes in all jurisdictions in which the Company's properties are presently offered for sale to the public.\nLIQUIDITY AND CAPITAL RESOURCES\nMORTGAGES AND SIMILAR DEBT\nIndebtedness under various purchase money mortgages and loan agreements is collateralized by substantially all of the Company's assets, including stock of certain wholly-owned subsidiaries.\nThe Company, Selex and Yasawa entered into loan modification agreements in which all accrued interest was converted into non- interest bearing principal at the earlier of the maturity date or the default date. Accordingly, at December 31, 1995, $4,200,000 of accrued interest was reclassified as principal. The loans were also modified to formalize the elimination of the default interest rate provisions in each of the applicable loan agreements.\nThe following table presents information with respect to mortgages and similar debt (in thousands):\nIncluded in Mortgage Notes Payable is the First Selex Loan ($2,722,000 as of December 31, 1995), the Third Selex Loan ($3,825,000 as of December 31, 1995), the Yasawa Loan ($5,829,000 as of December 31, 1995) and the Second Yasawa Loan ($4,341,000 as of December 31, 1995). Other loans include the $1,656,000 Empire note and the $2,005,000 Scafholding Loan.\nThese mortgage notes payable and other loans are in default as of December 31, 1995 due to the non-payment of principal. The lenders have not taken any other action as a result of these defaults.\nOn June 19, 1992, Selex loaned the Company the sum of $3,000,000 pursuant to the First Selex Loan. The First Selex Loan is collateralized by a first mortgage on certain of the Company's unsold, undeveloped property in its St.\n(25)\nAugustine Shores, Florida community. The Loan matures on June 15, 1996 and provides for principal to be repaid at 50% of the net proceeds per lot for lots requiring release from the mortgage, with the entire unpaid balance becoming due and payable at the end of the four year term. It initially bears interest at the rate of 10% per annum, with payment of interest deferred for the initial 18 months of the Loan and interest payments due quarterly thereafter. As part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, which, as modified, enabled Selex to convert the First Selex Loan, or any portion thereof, into a maximum of 600,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). On February 17, 1994, Selex exercised the Option, in full, at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As of March 22, 1996, the Company was in default of the First Selex Loan inasmuch as accrued interest in the amount of $42,000 remained unpaid.\nOne million dollars of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contracts with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain multi-family property from the Company (which right had been granted in connection with the June, 1992 Selex transaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (the \"First Conquistador Acquisition\").\nOn December 2, 1992, the Company entered into various agreements relating to certain of its assets and the restructuring of its debt with Yasawa, which is beneficially owned by Mr. Antony Gram. The consummation of these agreements, which are further described below, was conditioned upon the acquisition by Mr. Gram of the Company's outstanding bank loan.\nOn December 4, 1992, Mr. Gram entered into an agreement with the lenders, pursuant to which he acquired the bank loan of approximately $25,150,000 (including interest and fees) for a price of $10,750,000. In conjunction with such transaction, the lenders transferred to Mr. Gram the warrants which they held that entitled the holder to purchase an aggregate of 277,387 shares of the Company's Common Stock at an exercise price of $1.00 per share. Immediately after the acquisition of the bank loan, Mr. Gram transferred all of his interest in the bank loan, including the warrants, to Yasawa.\nOn December 11, 1992, the Company consummated the December 2, 1992 agreements with Yasawa. Under these agreements, Yasawa, its affiliates and the Company agreed as follows: (i) the Company sold certain property at its Citrus Springs community to an affiliate of Yasawa in exchange for approximately $6,500,000 of debt reduction credit; (ii) an affiliate of Yasawa and the Company entered into a joint venture agreement with respect to the Citrus Springs property, providing for the Company to market such property and receive an administration fee from the venture (in March, 1994, the Company and the affiliate agreed to terminate the venture); (iii) the Company sold certain contracts receivable at face value to an affiliate of Yasawa for debt reduction credit of approximately $10,800,000; (iv) the Company sold the Marco Shores Country Club and Golf Course to an affiliate of Yasawa for an aggregate sales price of $5,500,000, with the affiliate assuming an existing first mortgage of approximately\n(26)\n$1,100,000 and the Company receiving debt reduction credit of $2,400,000, such that the Company obtained cash proceeds from this transaction of $2,000,000, which amount was used for working capital; (v) an affiliate of Yasawa agreed to lease the Marco Shores Country Club and Golf Course to the Company for a period of approximately one year; (vi) an affiliate of Yasawa and the Company agreed to amend the terms of the warrants to increase the number of shares issuable upon their exercise from 277,387 shares to 289,637 shares and to adjust the exercise price to an aggregate of approximately $314,000; (vii) Yasawa exercised the warrants in exchange for debt reduction credit of approximately $314,000; (viii) Yasawa released certain collateral held for the bank loan; (ix) an affiliate of Yasawa agreed to make an additional loan of up to $1,500,000 to the Company, thus providing the Company with a future line of credit (all of which was drawn and outstanding as of March 22, 1996); and (x) Yasawa agreed to restructure the payment terms of the remaining $5,106,000 of the bank loan as a loan from Yasawa (the \"Yasawa Loan\").\nThe Yasawa Loan bears interest at the rate of 11% per annum, with payment of interest deferred until December 31, 1993, when only accrued interest became payable. Commencing January 31, 1994, principal and interest became payable monthly, with all unpaid principal and accrued interest being due and payable on December 31, 1997. As of March 22, 1996, $5,948,000 in principal and accrued interest was in default under the Yasawa Loan.\nOn April 30, 1993 Selex loaned the Company an additional $1,000,000 collateralized by a first mortgage on certain of the Company's property in its Marion Oaks, Florida community (the \"Second Selex Loan\"). Interest under the Second Selex Loan was 11% per annum, deferred until December 31, 1993, and principal was to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. Although Selex had certain conversion rights under the Second Selex Loan in the event the Company sold any Common Stock or Preferred Stock prior to payment in full of all amounts due to Selex under the Second Selex Loan, such rights were voided. The Second Selex Loan was satisfied on May 22, 1995 through the closing of the Second Conquistador Acquisition, discussed below.\nFrom July 9, 1993 through December 31, 1993, Selex loaned the Company an additional $4,400,000 collateralized by a second mortgage on certain of the Company's property on which Selex and\/or Yasawa hold a first mortgage pursuant to a Loan Agreement dated July 14, 1993 and amendments thereto (the \"Third Selex Loan\"). The Third Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. Principal is to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. The Second Conquistador Acquisition, discussed below, closed on May 22, 1995, provided a reduction of the debt due and payable under the Third Selex Loan. As of March 22, 1996, $1,371,000 in principal had been repaid under the Third Selex Loan. As of March 22, 1996, the remaining principal balance of $3,825,000 and accrued interest of $76,000 remained unpaid and in default.\nIn February, 1994, Yasawa loaned the Company an additional amount of approximately $514,900 at an interest rate of 8% per annum (the \"Second Yasawa Loan\"). Since May, 1994, additional amounts were advanced to the Company under the Second Yasawa Loan to enable the Company to pay certain essential expenses, including payment of certain real estate taxes, and effectuate settlements with the Company's principal creditors. As of March 22, 1996, an aggregate amount of $4,012,000 had been advanced to the Company under the Second Yasawa Loan and the principal balance of $4,341,000 and accrued interest of $73,000 remains unpaid.\nOn May 22, 1995, the Company closed a transaction with Conquistador (the \"Second Conquistador Acquisition\") for the sale of an administration building and a multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's FeatherNest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. In a separate transaction which also closed on the same date, the Company sold to Conquistador (the \"Third Conquistador Acquisition\") four single family residential lots in the St. Augustine Shores community for $100,000 in cash. These transactions were accounted for in accordance with generally accepted accounting principals for these\n(27)\ntypes of related party transactions. Accordingly, the resulting gain of $1,900,000 was treated as a contribution of capital and recorded directly to capital surplus.\nAs previously stated, Messrs. Muyres and Zwaans also serve as directors and executive officers of M&M First Coast Realty (\"M&M\"). The Company had leased certain office space to M&M at its St. Augustine Shores community pursuant to a Lease Agreement dated August 10, 1990. A payment of approximately $21,300 in delinquent rental payments was made on May 22, 1995 upon the closing of the Second Conquistador Acquisition, which included the sale of the St. Augustine Administration Building to which the lease pertained.\nAt December 31, 1995, $4,200,000 of accrued interest due to Selex, Yasawa and their affiliates was reclassified as non-interest bearing principal. Through March 22, 1996, $1,140,000 in principal was repaid under the First Selex Loan through the exercise of the above described Option, the Second Selex Loan was repaid in full, $1,371,000 in principal was repaid under the Third Selex Loan, and $135,900 in principal and $346,000 in accrued interest was repaid under the Yasawa loan. As of March 22, 1996, the Company had loans outstanding from Selex, Yasawa and their affiliates in the aggregate amount of approximately $20,757,000, including interest, all of which are in default, including approximately $8,349,600, which is owed to Selex, including accrued and unpaid interest of approximately $145,900 (10% per annum on the First Selex Loan, 11% per annum on the Third Selex Loan and 12% per annum on the $1,000,000 Empire Note assigned to Selex); approximately $10,361,800, which is owed to Yasawa, including accrued and unpaid interest of approximately $192,500 (11% per annum on the Yasawa Loan and 8% per annum on the Second Yasawa Loan); and approximately $2,046,000, which is owed to an affiliate of Yasawa, including accrued and unpaid interest of approximately $41,000 (12% per annum). The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company.\nOn March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D filed with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\nThe Company has stated in previous filings with the Commission and elsewhere herein that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As previously stated, during the last nine months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements and continue its marketing program. Commencing in 1994, Yasawa advanced additional funds (the \"Second Yasawa Loan\") totalling $4,012,000 as of December 31, 1995, to meet the Company's minimum working capital requirements, to pay $750,000 in delinquent real estate taxes, to pay settlements with certain trade creditors and to settle certain litigation.\nAs a consequence of its liquidity position, the Company has defaulted on certain obligations, including its previously described escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid delinquent real estate taxes which aggregate approximately $2,975,000 as of December 31, 1995; non-payment of these delinquent taxes may adversely affect the financial condition of the Company.\n(28)\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including, but not limited, to filing for protection under the federal bankruptcy laws. See \"Business: Recent Developments\" and Notes 1, 5 and 8 to Consolidated Financial Statements.\nCONTRACTS AND MORTGAGES RECEIVABLE SALES\nIn December, 1992, as described above, the Company sold $10,800,000 of contracts and mortgages receivable to an affiliate of Yasawa at face value, applying the proceeds therefrom to reduce the Bank Loan acquired by Yasawa.\nIn March , 1993, the Company transferred $1,600,000 in contracts and mortgages receivable generating approximately $1,059,000 in proceeds to the Company, which was used for working capital and the creation of a holdback account in the amount of $150,000. As of December 31, 1995, the balance of the holdback account as approximately $108,000.\nIn June, 1992 and February, 1990, the Company completed sales of contracts and mortgages receivable totalling $13,500,000 and $17,000,000, respectively, which generated approximately $8,000,000 and $13,900,000 respectively, in net proceeds to the Company. The anticipated costs of the June, 1992 transaction were included in the extraordinary loss from debt restructuring for 1991 since the restructuring was dependent on the sale. The Company recorded a loss of $600,000 on the February, 1990 sale. In conjunction with these sales the Company granted the purchaser a security interest in certain additional contracts receivable of approximately $2,700,000 and conveyed all of its rights, title and interest in the property underlying such contracts to a collateral trustee. In addition, these transactions, among other things require that the Company replace or repurchase any receivable that becomes 90 days delinquent upon the request of the purchaser. Such requirement can be satisfied from contracts in which the purchaser holds a security interest (approximately $1,388,000 as of December 31, 1995). The purchaser of these receivables experienced financial difficulty and filed in 1994 for protection under Chapter 11 of the Federal Bankruptcy Code. In November 1995, the purchaser of these receivables sold the portfolio to Finova Capital Corporation. The Company is unable to determine what effect this will have, if any, on future cancellations, since it is unable to determine how the bankruptcy or the subsequent sale of the portfolio will impact servicing and collection procedures and the customers' determination to continue to pay under those contracts. The Company has fully reserved for the amount of the holdback account and the estimated future cancellations based on the Company's historical experience for receivables the Company services. However, due to the uncertainty noted above, the Company does not feel there is sufficient information to estimate future cancellations and is unable to determine the adequacy of its reserves to replace or repurchase receivables that become delinquent. The Company was unable to replace or repurchase $1,148,000 in delinquent contracts in 1994 and $524,000 in delinquent contracts in 1995, which amounts were deducted from the deposit held by the purchaser of the receivables as security. In addition, the Company was unable to replace or repurchase $613,000 in delinquent receivables in 1995; however, a replacement of $293,000 in receivables was made in January, 1996.\nThe Company was the guarantor of approximately $15,653,000 of contracts receivable sold or transferred as of December 31, 1995, for the transactions described above, and had $108,000 on deposit with purchasers of the receivables as security to assure collectibility as of such date. A provision of $650,000 has been established for the Company's obligation under the recourse provisions. The Company has been in compliance with all receivable transactions since the consummation of sales.\n(29)\nThe Company anticipates that it will be necessary to complete additional sales and financings of a portion of its receivables in 1996. There can be no assurance, however, that such sales and\/or financings can be accomplished.\nOTHER OBLIGATIONS\nAs a result of the delays in completing the land improvements to certain property sold in certain of its Central and North Florida communities, the Company fell behind in meeting its contractual obligations to its customers. In connection with these delays, the Company, in February, 1980, entered into a Consent Order with the Division which provided a program for notifying affected customers. The Consent Order, which was restated and amended, provided a program for notifying affected customers of the anticipated delays in the completion of improvements (or, in the case of purchasers of unbuildable lots in certain areas of the Company's Sunny Hills community, the transfer of development obligations to core growth areas of the community); various options which may be selected by affected purchasers; a schedule for completing certain improvements; and a deferral of the obligation to install water mains until requested by the purchaser. Under an agreement with Topeka, Topeka's utility companies have agreed to furnish utility service to the future residents of the Company's communities on substantially the same basis as such services were provided by the Company. The Consent Order also required the establishment of an improvement escrow account as assurance for completing such improvement obligations.\nIn June, 1992, the Company entered into the 1992 Consent Order with the Division, which replaced and superseded the original Consent Order, as amended and restated. Among other things, the 1992 Consent Order consolidated the Company's development obligations and provided for a reduction in its required monthly escrow obligation to $175,000 from September, 1992 through December, 1993. Beginning January, 1994 and until development is completed or the 1992 Consent Order is amended, the Company is required to deposit $430,000 per month into the escrow account. As part of the assurance program under the 1992 Consent Order, the Company and its lenders granted the Division a lien on certain contracts receivable (approximately $9,537,600 as of December 31, 1995) and future receivables. The Company defaulted on its obligation to escrow $430,000 per month for the period of January, 1994 through the present and, in accordance with the 1992 Consent Order, collections on Division receivables were escrowed for the benefit of purchasers from March 1, 1994 through April 30, 1994. In May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 22 1996, approximately 83% of the customers whose lots are currently undeveloped have opted to exchange. Consequently, the Division has allowed the Company to utilize collections on receivables since May 1, 1994. Because of the Company's default, the Division could also exercise other available remedies under the 1992 Consent Order, which remedies entitle the Division, among other things, to halt all sales of registered property.\nThe Company's goal is to eliminate its development obligation (with the exception of its maintenance obligation in Marion Oaks and Sunny Hills) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County (entered into in May 1995). Pursuant to the 1992 Consent Order, the Company has limited the sale of single-family lots to lots which front on a paved street and are ready for immediate building.\nAs of December 31, 1995, the Company had estimated development obligations of approximately $1,295,000 on sold property, an estimated liability to provide title insurance and deeding costing $1,217,000 and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $1,150,000, all of which are included in deferred revenue. The total cost to complete improvements at December 31, 1995 to lots subject to the 1992 Consent Order, including the previously mentioned obligations, and to all lots, sold and unsold, including the St. Augustine Shores community, was estimated to be approximately $14,449,000. As of December 31, 1995 and December 31, 1994 the Company had in escrow approximately $489,000 and $911,000, respectively, specifically for land improvements at certain of its Central and North Florida communities.\n(30)\nThe Company's continuing liquidity problems have precluded the timely payment of the full amount of its real estate taxes. On properties where customers have contractually assumed the obligation to pay into a tax escrow maintained by the Company, the Company has and will continue to pay delinquent real estate taxes as monies are collected from customers. Delinquent real estate taxes aggregated approximately $2,975,000 as of December 31, 1995.\nThe Company's corporate performance bonds to assure the completion of development at its St. Augustine Shores community expired in March and June, 1993. Such bonds cannot be renewed due to a change in the policy of the Board of County Commissioners of St. Johns County which precludes allowing any developer to secure the performance of development obligations by the issuance of corporate bonds. In the event that St. Johns County elects to undertake and complete such development work, the Company would be obligated with respect to 1,000 improved lots at St. Augustine Shores in the amount of approximately $6,200,000. The Company intends to submit an alternative assurance program for the completion of such development and improvements to the County for its approval.\nOn September 30, 1988, the Company entered into an agreement with Citrus County, Florida to establish the procedure for transferring final maintenance responsibilities for roads in the Company's Citrus Springs subdivision to Citrus County. The agreement obligated the Company to complete certain remedial work on previously completed improvements within the Citrus Springs subdivision by June 1, 1991. The Company was unable to complete this work by the specified date and negotiated another agreement with Citrus County for the transfer of final maintenance responsibility for the roads to the County. This final agreement was entered into in May 1995.\nIn 1992, the Company conveyed certain properties to the former landlord in satisfaction of its outstanding lease obligations for its executive office building in Miami, Florida. The Company also entered into a modification of its lease agreement, providing for a reduction of its rental expenses through March 31, 1994, at which time the Company would have the option of acquiring the leased premises or reinstating the lease according to its original terms. The modification provided that should the landlord sell the leased premises to a third party at any time the lease, or any modification thereof, is in effect, then the lease with the Company would be cancelled. In December, 1993, the landlord filed suit against the Company alleging that the Company defaulted in its obligation to make rental payments under the lease and sought to accelerate lease payments. The Company completed a settlement of this litigation on October 27, 1994 as a result of funds being advanced under the Second Yasawa Loan and the posting of a letter of credit by Mr. Antony Gram, Chairman and Chief Executive Officer of the Company. See \"Business: Recent Developments\" and \"Legal Proceedings\".\nThe Company had placed certain properties in trust to meet its refund obligations to Marco customers affected by the permit denials. On September 14, 1992, the Circuit Court of Dade County, Florida approved a settlement of certain class action litigation instituted by customers affected by the Marco permit denials, under the terms of which the Company was required, among other things, to convey more than 120 acres of multi-family and commercial land that had been placed in trust to the trustee of the 809 member class. As part of the settlement, the Company guaranteed the amount to be realized from the sale of the conveyed property, not to exceed $2,000,000. Such settlement enabled the Company to resolve the claims of an additional 12.7% of its affected customers and re- evaluate the allowance for Marco permit costs. As a result of such analysis, the Company was able to reduce such allowance by $12,200,000, resulting in a $3,983,000 extraordinary gain in 1992 and a $500,000 credit to accrued expenses to be credited to paid-in capital following issuance of 250,000 shares of restricted Common Stock of the Company to the class members. Following the closing on a majority of the property conveyed to the trust, the Company recorded an extraordinary gain of $702,000 resulting from a reduction in the amount of its guarantee pursuant to the settlement agreement. At December 31, 1995, $1,349,000 remained in the allowance for Marco permit costs, including $39,000 relating to interest accrued on such obligations. Based upon the Company's experience with affected customers, the Company believes that its total obligations to the three remaining affected customers will not materially exceed the amount provided for in the accompanying Consolidated Financial Statements.\n(31)\nLIQUIDITY\nSince 1986, the Company has directed its marketing efforts to rebuilding retail land sales in an attempt to obtain a more stable income stream and achieve a balanced growth of retail land sales and bulk land sales. Retail land sales typically have a higher gross profit margin than bulk land sales and the contracts receivable generated from retail land sales provide a continuing source of income. However, retail land sales also have traditionally produced negative cash flow through the point of sale. This is because the marketing and selling expenses have generally been paid prior to or shortly after the point of sale, while the land is generally paid for in installments. The Company's ability to rebuild retail land sales has been substantially dependent on its ability to sell or otherwise finance contracts receivable and\/or secure other financing sources to meet its cash requirements.\nTo alleviate the negative cash flow impact arising from retail land sales while attempting to rebuild its sales volume, the Company implemented several new marketing programs which, among other things, adjusted the method of commission payments and required larger down payments. However, the nationwide economic recession, which was especially pronounced in the real estate industry, adverse publicity surrounding the industry which existed in 1990, the resulting, more stringent regulatory climate, and worldwide economic uncertainties have severely depressed retail land sales beginning in mid-1990 and continuing thereafter, resulting in a continuing liquidity crisis.\nBecause of this severe liquidity crisis, the Company ceased development work late in the third quarter of 1990 and did not resume development work until the third quarter of 1992. From September 29, 1990 through the fourth quarter of 1991, when the Company ceased selling undeveloped lots, sales of undeveloped lots were accounted for using the deposit method. Under this method, all payments were recorded as a customer deposit liability. In addition, because of the increasing trend in delinquencies during 1990, since the beginning of 1991, the Company has not recognized any sale until 20% of the contract sales price has been received. As a result, the reporting and recognition of revenues and profits on a portion of the Company's retail land sales contracts is being delayed. See Note 1 to Consolidated Financial Statements.\nThe continued economic recession and the increasing adverse effects of such recession on the Florida real estate industry not only resulted in the Company's sales remaining at depressed levels, but caused greater contract cancellations in 1991, particularly in the second half of the year, than were anticipated. Such cancellations required the Company to record an additional provision to its allowance for uncollectible sales of approximately $12,200,000 in the 1991 third quarter, impacting net income by approximately $8,900,000. While the Company is making every effort to reduce its cancellations, the Company could be required to record additional provisions in the future.\nIn December, 1992, the Company's bank debt was acquired by Mr. Gram and assigned to Yasawa. Through the sale of certain assets to Yasawa and its affiliates, including certain contracts receivable, and the exercise of the warrants by Yasawa, the Company was able to reduce such remaining debt from approximately $25,150,000 (including interest and fees) to approximately $5,106,000. During 1994, the Yasawa Loan was reduced to 4,764,600. The agreement with Yasawa also provided the Company with a future line of credit of $1,500,000, all of which is drawn and outstanding as of December 31, 1995. During 1993, Selex loaned the Company an additional $5,400,000 pursuant to the Second and Third Selex Loans, of which $3,825,000 was outstanding as of December 31, 1995, and Yasawa loaned the Company an additional $4,012,000, pursuant to the Second Yasawa Loan, which had an outstanding balance of $4,341,000 as of December 31, 1995. The loans from Selex, Yasawa and their affiliates are collateralized by substantially all of the Company's assets.\nOn March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\n(32)\nThe Company has stated in previous filings with the Commission and elsewhere herein that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As previously stated, during the last nine months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements and continue its marketing program. Commencing in 1994, Yasawa advanced additional funds (the \"Second Yasawa Loan\") a totalling $4,012,000 as of December 31, 1995, to meet the Company's minimum working capital requirements, to pay $750,000 in delinquent real estate taxes, to pay settlements with certain trade creditors and to settle certain litigation.\nAs a consequence of its liquidity position, the Company has defaulted on certain obligations, including its previously described escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid delinquent real estate taxes which aggregate approximately $2,975,000 as of December 31, 1995; non-payment of these delinquent taxes may adversely affect the financial condition of the Company.\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including, but not limited, to filing for protection under the federal bankruptcy laws. See \"Business: Recent Developments\" and Notes 1, 5 and 8 to Consolidated Financial Statements.\n(33)\nITEM 8","section_7A":"","section_8":"ITEM 8\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\n(34)\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE DELTONA CORPORATION:\nWe have audited the consolidated balance sheets of The Deltona Corporation and subsidiaries (the \"Company\") as of December 31, 1995 and 1994 and the related statements of consolidated operations, consolidated stockholders' equity (deficiency) and consolidated cash flows for each of the three years in the period ended December 31, 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 from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 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 consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company incurred substantial operating losses and has continued to experience liquidity crises, causing the Company to be unable to meet certain contractual obligations and has a stockholders' deficiency at December 31, 1995. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP Certified Public Accountants Miami, Florida March 29, 1996\n(35)\nCONSOLIDATED BALANCE SHEETS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nASSETS (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(36)\nCONSOLIDATED BALANCE SHEETS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) (in thousands except share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(37)\nSTATEMENTS OF CONSOLIDATED OPERATIONS THE DELTONA CORPORATION AND SUBSIDIARIES (in thousands except share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(38)\nSTATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY (DEFICIENCY)\nTHE DELTONA CORPORATION AND SUBSIDIARIES (in thousands)\nFOR THE YEARS ENDED DECEMBER 31, 1995, DECEMBER 31, 1994 AND DECEMBER 31, 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\n(39)\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nTHE DELTONA CORPORATION AND SUBSIDIARIES (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(40)\nSTATEMENTS OF CONSOLIDATED CASH FLOWS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES (in thousands)\nRECONCILIATION OF NET INCOME (LOSS) TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:\nThe accompanying notes are an integral part of the consolidated financial statements. (41)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. Basis of Presentation and Significant Accounting Policies\nBasis of Presentation - Going Concern\nThe accompanying financial statements of The Deltona Corporation and subsidiaries (the \"Company\") have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.\nThe Company has incurred a loss from operations for 1993 of $8,772,000, for 1994 of $3,906,000 and for 1995 of $2,905,000, resulting in a stockholders' deficiency of $17,013,000 as of December 31, 1995. The Company has continued to experience liquidity problems, causing it to be unable to fully meet certain contractual obligations, primarily relating to the repayment of debt, payment of real estate taxes and the completion of improvements. The Company must obtain additional financing to accomplish the objectives of satisfying or substantially reducing its current debt obligations and provide the financial stability that will allow the Company to accomplish the objectives of a successful business plan.\nFollowing the completion of the restructuring of its bank debt in 1992 (see Note 5), the Company commenced the implementation of its business plan by undertaking a new marketing program which included the Company's re-entry into the single-family housing business. To accomplish the objectives of its business plan required the Company to obtain financing during 1994 and 1995 and will require the Company to obtain additional financing in 1996. The transactions described in Note 5 with Selex International, B.V., a Netherlands corporation (\"Selex\"), Yasawa Holdings, N.V., a Netherlands Antilles corporation (\"Yasawa\"), and their affiliates provided the Company with a portion of its financing requirements enabling the Company to commence implementation of the marketing program and attempt to accomplish the objectives of its business plan, but additional financing will be required in 1996. Selex, Yasawa and their affiliates are uncertain as to whether they will provide any further funds to the Company. While the Company, together with Selex, Yasawa and their affiliates, is seeking third parties to provide financing for the Company and, as part of any such transaction, Selex, Yasawa and their affiliates have indicated their willingness to sell or restructure all or a portion of their loans and Common Stock in the Company, such financing has not yet become available. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its escrow account obligations to the State of Florida, Department of Business Regulation, Division of Land Sales, Condominiums and Mobile Homes (the \"Division\") pursuant to the Company's 1992 Consent Order with the Division (the \"1992 Consent Order\"), its obligation to pay certain real estate taxes, and its obligation to make required payments under loans from Selex, Yasawa and their affiliates. (See Notes 5 and 8.)\nThere can be no assurance that the Company will be able to timely secure the necessary financing to resolve its liquidity situation or that a new business plan will be successfully implemented. Consequently, there can be no assurance that the Company can continue as a going concern. In the event that these matters are not successfully addressed, the Company's Board of Directors will consider other appropriate action given the severity of the Company's liquidity position, including, but not limited to, filing for protection under the federal bankruptcy laws. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 5 and 8 to Consolidated Financial Statements.\nThe consolidated financial statements do not include any adjustments relating to the recoverability of asset amounts or the amounts of liabilities should the Company be unable to continue as a going concern. (42)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. Basis of Presentation and Significant Accounting Policies - (Continued)\nSignificant Accounting Policies\nThe Company's consolidated financial statements are prepared in accordance with generally accepted accounting principles. Material intercompany accounts and transactions are eliminated.\nSince 1986, the Company has used a 52-53 week fiscal year ending on the last Friday of the year. The year ended December 31, 1993 contained 53 weeks, and the years ended December 25, 1992 and December 27, 1991 contained 52 weeks. Commencing in 1994, the Company returned to a fiscal year ended December 31.\nThe Company sells homesites under installment contracts which provide for payments over periods ranging from 2 to 10 years. Sales of homesites are recorded under the percentage-of-completion method in accordance with Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"FASB No. 66\"). Since 1991, the Company has not recognized a sale until it has received 20% of the contract sales price. During 1995, approximately 72% of sales were through a single independent dealer in New York.\nBecause of the severe liquidity crisis faced by the Company as discussed above, the Company ceased development work late in the third quarter of 1990. From September 29, 1990 through the fourth quarter of 1991, all sales of undeveloped lots were accounted for using the deposit method. Since the fourth quarter of 1991 and in compliance with the 1992 Consent Order, the Company has been offering only developed lots for sale (see Note 8).\nAt the time of recording a sale the Company records an allowance for the estimated cost to cancel the related contracts receivable through a charge to the provision for uncollectible sales. The amount of this provision and the adequacy of the allowance is determined by the Company's continuing evaluation of the portfolio and past cancellation experience. While the Company uses the best information available to make such evaluations, future adjustments to the allowance may be necessary as a result of future national and international economic and other conditions that may be beyond the Company's control. Changes in the Company's estimate of the allowance for previously recognized sales will be reported in earnings in the period in which they become estimable and are charged to the provision for uncollectible contracts.\nLand improvement costs are allocated to individual homesites based upon the relationship that the homesite's sales price bears to the total sales price of all homesites in the community. The estimated costs of improving homesites are based upon independent engineering estimates made in accordance with sound cost estimation and provide for anticipated cost-inflation factors. The estimates are systematically reviewed. When cost estimates are revised, the percentage relationship they bear to deferred revenues is recalculated on a cumulative basis to determine future income recognition as performance takes place.\nBulk land sales are recorded and profit is recognized in accordance with FASB No. 66. Bulk land sales of approximately $315,000 and $113,000 are included in gross land sales for the years ended December 31, 1994 and 1993, respectively.\n(43)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. Basis of Presentation and Significant Accounting Policies - (Continued)\nSales of houses and vacation ownership units, as well as all related costs and expenses, are recorded at the time of closing.\nInterest costs directly related to, and incurred during, a project's construction period are capitalized. Such capitalized interest amounted to $164,000 for the year ended December 31, 1993. Property, plant and equipment is stated at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the respective assets. Additions and betterments are capitalized, and maintenance and repairs are charged to income as incurred. Generally, upon the sale or retirement of assets, the accounts are relieved of the costs and related accumulated depreciation and any gain or loss is reflected in income.\nWhen property exchanges and refund transactions are consummated under the Company's Marco Island-Marco Shores customer programs (see Note 9), any resulting loss is charged to the allowance for Marco permit costs. When property exchanges and refund transactions are consummated under the Consent Order (see Note 8), any resulting loss is charged against the allowance included in accrued expenses and other. The Company accrues interest on its refund obligations in accordance with the various customer refund programs.\nFor the purposes of the statements of cash flows, the Company considers its investments, which are comprised of short term, highly liquid investments purchased with a maturity of three months or less, to be cash equivalents.\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\". SFAS No. 121 requires companies to evaluate long-lived assets for impairment based on the undiscounted future cash flows of the asset. If a long-lived asset is identified as impaired, the value of the asset must be reduced to its fair value. The Company's inventories would be considered long-lived assets under this pronouncement.\nThe statement is effective for years beginning after December 15, 1995. The actual effects of implementing the new standard has not been determined. However, the adoption is not expected to have any material adverse effect on the Company's financial position or results of operations.\nThe estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methods. 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 the Company could realize or incur 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. The Company's financial instruments consist of cash and cash equivalents, contracts and mortgages receivable, and similar debt. The carrying amount of cash and cash equivalents are reasonable estimates of fair value. The fair value of contracts and mortgages receivable and similar debt has been estimated using interest rates currently available for similar terms. The carrying value of the contracts and mortgages receivable and similar debt approximates fair value. (44)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. Basis of Presentation and Significant Accounting Policies - (Continued)\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.\n2. Contracts and Mortgages Receivable\nAt December 31, 1995, interest rates on contracts receivable outstanding ranged from 5% to 12% per annum (weighted average approximately 8.3%). The approximate principal maturities of contracts receivable (including $163,000 restricted for use in the Marco refund program, see Note 9) were:\nIf a regularly scheduled payment on a contract remains unpaid 30 days after its due date, the contract is considered delinquent. Aggregate delinquent contracts receivable at December 31, 1995 and 1994 approximate $1,360,000 and $2,140,000, respectively.\nInformation with respect to interest rates and average contract lives used in valuing new contracts receivable generated from sales follows:\nIn December, 1992, as described above, the Company sold $10,800,000 of contracts and mortgages receivable to an affiliate of Yasawa at face value, applying the proceeds therefrom to reduce the Company's bank loan, which had been acquired by Yasawa.\nIn March, 1993 the Company transferred $1,600,000 in contracts and mortgages receivable, generating approximately $1,059,000 in proceeds to the Company, which was used for working capital, and the creation of a holdback account in the amount of $150,000. As of December 31, 1995, the balance of the holdback account was $108,000.\n(45)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n2. Contracts and Mortgages Receivable - (Continued)\nIn June, 1992 and February, 1990, the Company completed sales of contracts and mortgages receivable totalling $13,500,000 and $17,000,000, respectively, which generated approximately $8,000,000 and $13,900,000, respectively, in net proceeds to the Company. The anticipated costs of the June, 1992 transaction were included in the extraordinary loss from debt restructuring for 1991 since the restructuring was dependent on the sale. The Company recorded a loss of $600,000 on the February, 1990 sale. In conjunction with these sales the Company granted the purchaser a security interest in certain additional contracts and mortgages receivable of approximately $2,700,000 and conveyed all of its rights, title and interest in the property underlying such contracts to a collateral trustee. In addition, these transactions, among other things, require that the Company replace or repurchase any receivable that becomes 90 days delinquent upon the request of the purchaser. Such requirement can be satisfied from contracts in which the purchaser holds a security interest (approximately $1,388,000 as of December 31, 1995). The purchaser of these receivables experienced financial difficulty and filed in 1994 for protection under Chapter 11 of the Federal Bankruptcy Code. In November 1995, the purchaser of these receivables assigned the portfolio to a third party, who now owns the portfolio and will service and collect the receivables. The Company is unable to determine what effect this will have, if any, on future cancellations, since it is unable to determine how the bankruptcy or the servicing and collection procedures of the third party will impact the customers' determination to continue to pay under those contracts. The Company has fully reserved for the amount of the holdback account and the estimated future cancellations based on the Company's historical experience for receivables the Company services. However, due to the uncertainty noted above, the Company does not feel there is sufficient information to estimate future cancellations and is unable to determine the adequacy of its reserves to replace or repurchase receivables that become delinquent. The Company was unable to replace or repurchase $1,148,000 in delinquent contracts in 1994 and $524,000 in delinquent contracts in 1995, which amounts were deducted from the deposit held by the purchaser of the receivables as security. In addition, the Company was unable to replace or repurchase $613,000 in delinquent receivables in 1995; however, a replacement of $293,000 in receivables was made in January, 1996.\nThe Company was the guarantor of approximately $15,653,000 of contracts receivable sold or transferred as of December 31, 1995 and had $108,000 on deposit with purchasers of the receivables as security to assure collectibility as of such date. A provision of $650,000 has been established for the Company's obligation under the recourse provisions. The Company has been in compliance with all receivable transactions since the consummation of sales.\nThe Company anticipates that it will be necessary to complete additional sales and financings of a portion of its receivables in 1996. There can be no assurance, however, that such sales and\/or financings can be accomplished.\n3. Inventories\nInformation with respect to the classification of inventory of land and improvements including land held for sale or transfer is as follows:\n(46)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) THE DELTONA CORPORATION AND SUBSIDIARIES\n3. Inventories - (Continued)\nLand and land improvements include approximately $202,000 of land placed in the Marco Island and Marco Shores trusts for the Marco refund program as of December 31, 1995 and 1994 (see Note 9). Other inventories consists primarily of vacation ownership units completed.\n4. Property, Plant and Equipment\nProperty, plant and equipment and accumulated depreciation consist of the following:\nDepreciation charged to operations for the years ended December 31, 1995, 1994 and 1993 was approximately $64,000, $86,000 and $104,000, respectively.\n5. Mortgages and Similar Debt\nIndebtedness under various purchase money mortgages and loan agreements is collateralized by substantially all of the Company's assets, including stock of certain wholly-owned subsidiaries.\nThe Company, Selex and Yasawa entered into loan modification agreements in which all accrued interest was converted into non- interest bearing principal at the earlier of the maturity date or the default date. Accordingly, at December 31, 1995, $4,200,000 of accrued interest was reclassified as principal. The loans were also modified to formalize the elimination of the default interest rate provisions in each of the applicable loan agreements.\nThe following table presents information with respect to mortgages and similar debt (in thousands):\nIncluded in Mortgage Notes Payable is the First Selex Loan ($2,722,000 as of December 31, 1995), the Third Selex Loan ($3,825,000 as of December 31, 1995), the Yasawa Loan ($5,829,000 as of December 31, 1995) and the Second Yasawa Loan ($4,341,000 as of December 31, 1995). Other loans include the $1,656,000 Empire note and the $2,005,000 Scafholding Loan.\n(47)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. Mortgages and Similar Debt - (Continued)\nThese mortgage notes payable and other loans are in default as of December 31, 1995 due to the non-payment of principal. The lenders have not taken any other action as a result of these defaults.\nOn June 19, 1992, Selex loaned the Company the sum of $3,000,000 pursuant to the First Selex Loan. The First Selex Loan is collateralized by a first mortgage on certain of the Company's unsold, undeveloped property in its St. Augustine Shores, Florida community. The Loan matures on June 15, 1996 and provides for principal to be repaid at 50% of the net proceeds per lot for lots requiring release from the mortgage, with the entire unpaid balance becoming due and payable at the end of the four year term. It initially bears interest at the rate of 10% per annum, with payment of interest deferred for the initial 18 months of the Loan and interest payments due quarterly thereafter. As part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, which, as modified, enabled Selex to convert the First Selex Loan, or any portion thereof, into a maximum of 600,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). On February 17, 1994, Selex exercised the Option, in full, at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As of December 31, 1995, the Company was in default of the First Selex Loan.\nOne million dollars of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador Development Corporation (\"Conquistador\"), in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contracts with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain multi-family property from the Company (which right had been granted in connection with the June, 1992 Selex transaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (the \"First Conquistador Acquisition\").\nOn December 2, 1992, the Company entered into various agreements relating to certain of its assets and the restructuring of its debt with Yasawa, which is beneficially owned by Mr. Antony Gram. The consummation of these agreements, which are further described below, was conditioned upon the acquisition by Mr. Gram of the Company's outstanding bank loan.\nOn December 4, 1992, Mr. Gram entered into an agreement with the lenders, pursuant to which he acquired the bank loan of approximately $25,150,000 (including interest and fees) for a price of $10,750,000. In conjunction with\n(48)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. Mortgages and Similar Debt - (Continued)\nsuch transaction, the lenders transferred to Mr. Gram the warrants which they held that entitled the holder to purchase an aggregate of 277,387 shares of the Company's Common Stock at an exercise price of $1.00 per share. Immediately after the acquisition of the bank loan, Mr. Gram transferred all of his interest in the bank loan, including the warrants, to Yasawa.\nOn December 11, 1992, the Company consummated the December 2, 1992 agreements with Yasawa. Under these agreements, Yasawa, its affiliates and the Company agreed as follows: (i) the Company sold certain property at its Citrus Springs community to an affiliate of Yasawa in exchange for approximately $6,500,000 of debt reduction credit; (ii) an affiliate of Yasawa and the Company entered into a joint venture agreement with respect to the Citrus Springs property, providing for the Company to market such property and receive an administration fee from the venture (in March, 1994, the Company and the affiliate agreed to terminate the venture); (iii) the Company sold certain contracts receivable at face value to an affiliate of Yasawa for debt reduction credit of approximately $10,800,000; (iv) the Company sold the Marco Shores Country Club and Golf Course to an affiliate of Yasawa for an aggregate sales price of $5,500,000, with the affiliate assuming an existing first mortgage of approximately $1,100,000 and the Company receiving debt reduction credit of $2,400,000, such that the Company obtained cash proceeds from this transaction of $2,000,000, which amount was used for working capital; (v) an affiliate of Yasawa agreed to lease the Marco Shores Country Club and Golf Course to the Company for a period of approximately one year; (vi) an affiliate of Yasawa and the Company agreed to amend the terms of the warrants to increase the number of shares issuable upon their exercise from 277,387 shares to 289,637 shares and to adjust the exercise price to an aggregate of approximately $314,000; (vii) Yasawa exercised the warrants in exchange for debt reduction credit of approximately $314,000; (viii) Yasawa released certain collateral held for the bank loan; (ix) an affiliate of Yasawa agreed to make an additional loan of up to $1,500,000 to the Company, thus providing the Company with a future line of credit (all of which was drawn and outstanding as of December 31, 1995); and (x) Yasawa agreed to restructure the payment terms of the remaining $5,106,000 of the bank loan as a loan from Yasawa (the \"Yasawa Loan\").\nThe Yasawa Loan bears interest at the rate of 11% per annum, with payment of interest deferred until December 31, 1993, when only accrued interest became payable. Commencing January 31, 1994, principal and interest became payable monthly, with all unpaid principal and accrued interest being due and payable on December 31, 1997. As of December 31, 1995, $5,829,000 in principal was in default under the Yasawa Loan.\nOn April 30, 1993 Selex loaned the Company an additional $1,000,000 collateralized by a first mortgage on certain of the Company's property in its Marion Oaks, Florida community (the \"Second Selex Loan\"). Interest under the Second Selex Loan was 11% per annum, deferred until December 31, 1993, and principal was to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. Although Selex had certain conversion rights under the Second Selex Loan in the event the Company sold any Common Stock or Preferred Stock prior to payment in full of all amounts due to Selex under the Second Selex Loan, such rights were voided. The Second Selex Loan was satisfied on May 22, 1995 through the closing of the Second Conquistador Acquisition, discussed below.\n(49)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) THE DELTONA CORPORATION AND SUBSIDIARIES\n5. Mortgages and Similar Debt - (Continued)\nFrom July 9, 1993 through December 31, 1993, Selex loaned the Company an additional $4,400,000 collateralized by a second mortgage on certain of the Company's property on which Selex and\/or Yasawa hold a first mortgage pursuant to a Loan Agreement dated July 14, 1993 and amendments thereto (the \"Third Selex Loan\"). The Third Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. Principal is to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. The Second Conquistador Acquisition, discussed below, closed on May 22, 1995, provided a reduction of the debt due and payable under the Third Selex Loan. As of December 31, 1995, $1,371,000 in principal had been repaid under the Third Selex Loan. The remaining principal balance of $3,825,000 remained unpaid and in default.\nIn February, 1994, Yasawa loaned the Company an additional amount of approximately $514,900 at an interest rate of 8% per annum (the \"Second Yasawa Loan\"). Since May, 1994, additional amounts were advanced to the Company under the Second Yasawa Loan to enable the Company to pay certain essential expenses, including payment of certain real estate taxes, and effectuate settlements with the Company's principal creditors. As of December 31, 1995, an aggregate amount of $4,012,000 had been advanced to the Company under the Second Yasawa Loan and the principal balance of $4,341,000 was outstanding as of December 31, 1995.\nOn May 22, 1995, the Company closed a transaction with Conquistador (the \"Second Conquistador Acquisition\") for the sale of an administration building and a multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's FeatherNest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. In a separate transaction which also closed on the same date, the Company sold to Conquistador (the \"Third Conquistador Acquisition\") four single family residential lots in the St. Augustine Shores community for $100,000 in cash. These transactions were accounted for in accordance with generally accepted accounting principals for these types of related party transactions. Accordingly, the resulting gain of $1,900,000 was treated as a contribution of capital and recorded directly to capital surplus.\nAs previously stated, Messrs. Muyres and Zwaans also serve as directors and executive officers of M&M First Coast Realty (\"M&M\"). The Company had leased certain office space to M&M at its St. Augustine Shores community pursuant to a Lease Agreement dated August 10, 1990. A payment of approximately $21,300 in delinquent rental payments was made on May 22, 1995 upon the closing of the Second Conquistador Acquisition, which included the sale of the St. Augustine Administration Building to which the lease pertained.\nAt December 31, 1995, $4,200,000 of accrued interest due to Selex, Yasawa and their affiliates was reclassified as non-interest bearing principal. Through March 22, 1996, $1,140,000 in principal was repaid under the First Selex Loan through the exercise of the above described Option, the Second Selex Loan was repaid in full, $1,371,000 in principal was repaid under the Third Selex Loan, and $133,900 in principal and $346,000 in accrued interest was repaid under the Yasawa loan. As of March 22, 1996, the Company had loans outstanding from Selex, Yasawa and their affiliates in the aggregate amount of approximately $20,757,000, including interest, all of which are in default, including approximately $8,349,600, which is owed to Selex, including accrued and unpaid interest of approximately $145,900 (10% per annum on the First Selex Loan, 11% per annum on the Third Selex Loan\n(50)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. Mortgages and Similar Debt - (Continued)\nand 12% per annum on the Empire Note assigned to Selex); approximately $10,361,800, which is owed to Yasawa, including accrued and unpaid interest of approximately $192,500 (11% per annum on the Yasawa Loan and 8% per annum on the Second Yasawa Loan); and approximately $2,046,000, which is owed to an affiliate of Yasawa, including accrued and unpaid interest of approximately $41,000 (12% per annum). The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company.\n6. Income Taxes\nEffective December 26, 1992, the Company adopted Statement of Accounting Standard No. 109 \"Accounting for Income Taxes.\" There was no effect from the adoption of this standard. Under this standard deferred income assets and liabilities are computed annually for the difference between financial statements and the tax bases of assets and liabilities that will result in taxable or deductible amounts in the future bases on enacted tax and rates applicable to periods in which the differences are expected to affect taxable income. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred assets and liabilities.\nFor the years ended December 31, 1995 and 1994, the Company had a net loss for tax purposes and, as a result, there was no tax payable or refundable and there was no change in the net deferred tax asset. Accordingly, there was no tax provision for such years.\nAs of December 31, 1995, the Company had a net deferred tax asset of approximately $23,615,000 which primarily resulted from the tax effect of the Company's net operating loss carryforward of $17,561,000 and losses on subsidiaries sold in prior years of $3,960,000. A valuation allowance of $23,615,000 has been established against the net deferred tax asset.\nAs of December 31, 1994, the Company had a net deferred tax asset of approximately $25,564,000 which primarily resulted from the tax effect of the Company's net operating loss carryforward of $21,719,000 and losses on subsidiaries sold in prior years of $3,960,000. A valuation allowance of $25,564,000 has been established against the net deferred tax asset.\nThe Company's regular net operating loss carryover for tax purposes is estimated to be $45,519,000 at December 31, 1995, of which $4,733,000 will be available through 1996, $11,022,000 through 1999, $364,000 through 2002, $9,189,000 through 2005, $9,780,000 through 2006, $5,029,000 through 2008, and the remainder through 2009. In addition to the net operating loss carryover, investment tax credit carryovers of approximately $117,000, which expire from 1996 through 2001, are available to reduce federal income tax liabilities only after the net operating loss carryovers have been utilized.\nThe utilization of the Company's net operating loss and tax credit carryforwards could be impaired or reduced under certain circumstances, pursuant to changes in the federal income tax laws effected by the Tax Reform Act of 1986. Events which affect these carryforwards include, but are not limited to, cumulative stock ownership changes of 50% or more over a three-year period, as defined, and the timing of the utilization of the tax benefit carryforwards.\n(51)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n7. Liability for Improvements\nThe Company has an obligation to complete land improvements upon deeding which, depending on contractual provisions, typically occurs within 90 to 120 days after the completion of payments by the customer. The estimated cost to complete improvements to lots and tracts from which sales have been made at December 31, 1995 and 1994 was approximately $14,449,000 and $17,600,000 (as adjusted for the 1992 Consent Order), respectively. The foregoing estimates reflect the Company's current development plans at its communities (see Note 8). These estimates include estimated development obligations applicable to sold lots of approximately $1,295,000 and $2,412,000, respectively, a liability to provide title insurance and deeding costing $1,217,000 and $1,300,000, respectively, and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $1,150,000 and $2,948,000, respectively, all of which are included in deferred revenue. Included in cash at December 31, 1995 and December 31, 1994, are escrow deposits of $489,000 and $911,000, respectively, restricted for completion of improvements in certain of the Company's communities.\nIn May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 22, 1996, approximately 83% of the customers whose lots are currently undeveloped have opted to exchange. The Company's goal is to eliminate its development obligation (with the exception of its road maintenance obligations in Marion Oaks and Sunny Hills) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County. This final agreement was entered into in May, 1995.\nThe anticipated expenditures for land improvements to complete areas from which sales have been made through December 31, 1995 are as follows:\n8. Commitments and Contingent Liabilities\nTotal rental expense for the years ended December 31, 1995, December 31, 1994 and December 31, 1993 was approximately $172,000, $773,000 and $808,000, respectively.\nThe Company has no real estate leases that extend beyond 2000. Estimated rental expense under these leases is expected to be approximately $170,000 annually. The Company has no material equipment leases.\nDuring 1983 the Company entered into a sale-leaseback agreement on its executive office building. In 1992, the Company conveyed certain properties to the landlord in satisfaction of its outstanding lease obligations for its executive office building in Miami, Florida. The Company also entered into a modification of its lease agreement, providing for a reduction of its rental expenses through March 31, 1994, at which time the Company would have\n(52)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. Commitments and Contingent Liabilities - (Continued)\nthe option of acquiring the leased premises or reinstating the lease according to its original terms. If the landlord were to sell the leased premises to a third party at any time that the lease, or any modification thereof, is in effect, then the lease with the Company would be cancelled. In the action styled FIVE POINTS LIMITED V. THE DELTONA CORPORATION, Case No. 93-22877, filed in the Circuit Court for Dade County, Florida and served upon the Company on December 8, 1993, the plaintiff sought damages against the Company for an alleged breach of the lease for its office building. The complaint was settled and a stipulation filed. The Company entered into a short term lease agreement with the landlord and\/or its affiliate for a term of lease of one (1) year with a ninety (90) day cancellation provision. Certain payments were made to the landlord and a letter of credit in the amount of $500,000, now called, was conveyed to the landlord. Funding for the settlement was obtained through a loan from Anthony Gram, Chairman of the Board and Chief Executive Officer of the Company. The Company vacated the premises in September 1995 and neither party owes the other any further duty or obligation.\nThe profit on the sale-leaseback agreement was included in deferred revenue and amortized as a reduction in rent expense over the term of the lease which, according to its terms would expire March 31, 1998. On October 27, 1994, the date on which the above referenced settlement agreement was consummated, all of the profit remaining in deferred revenue was recognized resulting in a gain of $1,051,000.\nHomesite sales contracts provide for the return of all monies paid in (including paid-in interest) should the Company be unable to meet its contractual obligations after the use of reasonable diligence. If a refund is made, the Company will recover the related homesite and any improvement thereto. The aggregate amount of all monies paid in (including paid-in interest) on all homesite contracts having outstanding contractual obligations (primarily to complete improvements) at December 31, 1995 was approximately $5,429,000.\nAs a result of the delays in completing the land improvements to certain property sold in certain of its Central and North Florida communities, the Company fell behind in meeting its contractual obligations to its customers. In connection with these delays, the Company, in February, 1980, entered into a Consent Order with the Division which provided a program for notifying affected customers. The Consent Order, which was restated and amended, provided a program for notifying affected customers of the anticipated delays in the completion of improvements (or, in the case of purchasers of unbuildable lots in certain areas of the Company's Sunny Hills community, the transfer of development obligations to core growth areas of the community); various options which may be selected by affected purchasers; a schedule for completing certain improvements; and a deferral of the obligation to install water mains until requested by the purchaser. Under an agreement with Topeka Group Incorporated (\"Topeka\"), which purchased the Company's utilities in 1989, Topeka's utility companies have agreed to furnish utility service to the future residents of the Company's communities on substantially the same basis as such services were provided by the Company. The Consent Order also required the establishment of an improvement escrow account as assurance for completing such improvement obligations.\nIn June, 1992, the Company entered into the 1992 Consent Order with the Division, which replaced and superseded the original Consent Order, as amended and restated. Among other things, the 1992 Consent Order consolidated the Company's development obligations and provided for a reduction in its required monthly escrow obligation to $175,000 from September, 1992 through December, 1993. Beginning January, 1994 and until\n(53)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. Commitments and Contingent Liabilities - (Continued)\ndevelopment is completed or the 1992 Consent Order is amended, the Company is required to deposit $430,000 per month into the escrow account. As part of the assurance program under the 1992 Consent Order, the Company and its lenders granted the Division a lien on certain contracts receivable (approximately $9,537,600 as of December 31, 1995) and future receivables. The Company defaulted on its obligation to escrow $430,000 per month for the period of January, 1994 through the present and, in accordance with the 1992 Consent Order, collections on Division receivables were escrowed for the benefit of purchasers from March 1, 1994 through April 30, 1994. In May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 22 1996, approximately 83% of the customers whose lots are currently undeveloped have opted to exchange. Consequently, the Division has allowed the Company to utilize collections on receivables since May 1, 1994. Because of the Company's default, the Division could also exercise other available remedies under the 1992 Consent Order, which remedies entitle the Division, among other things, to halt all sales of registered property.\nThe Company's goal is to eliminate its development obligation (with the exception of its maintenance obligation in Marion Oaks and Sunny Hills) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County (entered into in May 1995). Pursuant to the 1992 Consent Order, the Company has limited the sale of single-family lots to lots which front on a paved street and are ready for immediate building.\nBased upon the Company's experience with affected customers, the Company believes that the total refunds arising from delays in completing improvements will not materially exceed the amount provided for in the consolidated financial statements. Approximately $21,000 and $49,000 of the provision for the total refunds relating to the delays of improvements remained in accrued expenses and other at December 31, 1995 and 1994, respectively.\nThe Company's corporate performance bonds to assure the completion of development at its St. Augustine Shores community expired in March and June, 1993. Such bonds cannot be renewed due to a change in the policy of the Board of County Commissioners of St. Johns County which precludes allowing any developer to secure the performance of development obligations by the issuance of corporate bonds. In the event that St. Johns County elects to undertake the completion of such development work, the Company would be obligated with respect to 1,000 unimproved lots at St. Augustine Shores in the amount of approximately $6,200,000. The Company intends to submit an alternative assurance program for the completion of such development and improvements to the County for its approval.\nIn the action styled LEE SU WEN NI ET. AL. V. THE DELTONA CORPORATION AND SCAFHOLDING B.V., Case No. 95-4422-CA-E, filed in the Circuit Court of Marion County, Florida on October 11, 1995, the plaintiff alleges that the liquidated damages provision in the Company's installment contracts for the sale of its properties is unenforceable under Florida Law and contests the method utilized by the Company to calculate actual damages in the event of contract cancellations. As part of the complaint, the plaintiff is seeking certification as a class action, as well as unspecified compensatory damages, together with interest, costs and fees. The Company filed a Motion to Dismiss\n(54)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. Commitments and Contingent Liabilities - (Continued)\nin response to the plaintiff's complaint. The Court has dismissed the claim of the class representative against the Company and against Scafholding B.V.; however, the Company expects an appeal to ensue. In the event that any future appeal is successful, class certification is authorized and the Company is not successful in its defenses, a substantial claim could be asserted against the Company.\nIn addition to the matters discussed above and in Note 9, the Company is a party to other litigation relating to the conduct of its business which is routine in nature and, in the opinion of management, should have no material effect upon the Company's operation.\n9. Marco Island-Marco Shores Permits\nOn April 16, 1976, the U.S. Army Corps of Engineers (the \"Corps\") denied the Company's application for dredge and fill permits required to complete development of the Marco Island community. These denials adversely affected the Company's ability to obtain the required permits for the Marco Shores community as originally platted. Following the denials, the Company instituted legal proceedings, implemented various programs to assist its customers affected by the Corps' action, and applied for permits from certain administrative agencies for other areas of the Company's Marco ownership.\nOn July 20, 1982, the Company entered into an agreement with the State of Florida and various state and local agencies (the \"Settlement Agreement\"), endorsed by various environmental interest groups, to resolve pending litigation and administrative proceedings relative to the Marco permitting issues. The Settlement Agreement became effective when, pursuant thereto, approximately 12,400 acres of the Company's Marco wetlands were conveyed to the State in exchange for approximately 50 acres of State-owned property in Dade County, Florida. In October, 1987, the Company sold the Dade County property for $9,000,000. The Settlement Agreement also allowed the Company to develop as many as 14,500 additional dwelling units in the Marco vicinity. On October 11, 1991, 1,300 acres of Marco property (7,000 dwelling units) were conveyed to the Company's lenders for debt reduction.\nThe Company placed certain properties in trust to meet its refund obligation to affected customers. On September 14, 1992, the Circuit Court of Dade County, Florida approved a settlement of certain class action litigation instituted by customers affected by the Marco permit denials, under the terms of which the Company was required, among other things, to convey more than 120 acres of multi-family and commercial land that had been placed in trust to the trustee of the 809 member class. As part of the settlement, the Company guaranteed the amount to be realized from the sale of the conveyed property. This guaranteed amount shall not exceed $2,000,000.\nAt December 31, 1995, $1,349,000 remained in the allowance for Marco permit costs, including $39,000 relating to interest accrued on such obligations. Based upon the Company's experience with affected customers, the Company believes that its total obligations to the three remaining affected customers will not materially exceed the amount provided for in the accompanying Consolidated Financial Statements. See \"Legal Proceedings\".\n(55)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n9. Marco Island-Marco Shores Permits - (Continued)\nFollowing the closing in 1995 on a majority of the property conveyed to the Trust, the Company recorded an extraordinary gain of $702,000 resulting from a reduction in the amount of its guarantee pursuant to the Settlement Agreement.\nInformation with respect to the allowance for Marco permit costs follows:\n10. Common Stock and Earnings per Share Information\nUnder the Company's 1987 Stock Incentive Plan (the \"Stock Plan\"), an aggregate of 500,000 shares of Common Stock have been reserved for the granting of non-qualified stock options and the award of incentive shares to such executive officers and other key employees of the Company as may be determined by the Committee administering the Stock Plan. The extent to which incentive shares are earned and charged to expense will be determined at the end of the three-year award cycle, based on the achievement of the Company's net income goal for the award cycle. Payment of incentive shares earned may be made in shares of the Company's Common Stock and\/or cash. If paid in cash, such payment will be based on the average daily closing price of the Company's Common Stock during the last month of the award cycle. The option features of the Stock Plan are substantially the same as the Company's incentive stock option plan described above. A total of 79,940 shares were issued and $233,412 was paid with respect to awards earned under the Stock Plan as of December 29, 1989 and no additional awards were granted until March 1993 when Bruce Weiner was granted 20,000 shares of the Company's Common Stock at a price of $4.00 per share, which was in excess of the market value of the Company's Common Stock on the grant date. Such option expired unexercised following Mr. Weiner's removal as an officer of the Company in 1994.\nOn June 18, 1992, the Company issued warrants to its lenders for the purchase of 277,387 shares of Common Stock at $1.00 per share (the Warrants\"). The Warrants became exercisable on June 18, 1992, were subject to mandatory repurchase by the Company at the request of the holder at any time after December 18, 1993 at 75% of the market price of the Company's Common Stock and expired on the later of: (i) 30 days after payment in full of all debt under the Sixth Restatement; (ii) July 31, 1997, or (iii) such later date as to which the expiration date had been extended to implement the provisions applicable to the mandatory repurchase option.\nOn December 2, 1992, the Company entered into a Warrant Exercise and Debt Reduction Agreement with Yasawa, providing for the number of shares issuable upon acquisition of the Warrants by Yasawa and the exercise of such Warrants by Yasawa to be increased from 277,387 shares of Common Stock to 289,637 shares of Common Stock, and adjusting the exercise price to an aggregate of approximately $314,000. On December 11, 1992, following the\n(56)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n10. Common Stock and Earnings per Share Information - (Continued)\nacquisition of the Company's bank loan and the Warrants by Gram and the immediate transfer of the bank loan and the Warrants by Gram to Yasawa, Yasawa exercised the Warrants in exchange for debt reduction credit to the Company of approximately $314,000.\nAs part of the Selex transaction, Selex was granted an option which was approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, to convert the Selex Loan, or any portion thereof, into a maximum of 850,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). However, on September 14, 1992, Selex formally waived and relinquished its right to exercise the Option as to 250,000 shares of the Company's Common Stock to enable the Company to settle certain litigation involving the Company through the issuance of approximately 250,000 shares of the Company's Common Stock to the claimants, without jeopardizing the utilization of the Company's net operating loss carryforward.\nOn February 17, 1994, Selex exercised the remaining full 600,000 share Option at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As a consequence of such conversion, Selex holds 2,820,066 shares of the Company's Common Stock (41.9% of the outstanding shares of Common Stock of the Company based upon the number of shares of the Company's Common Stock outstanding as of March 22, 1996).\nEarnings (loss) per common and common equivalent share were computed by dividing net income (loss) by the weighted average number of shares of Common Stock and common stock equivalents outstanding during each period. The net loss per share and the average number of shares of Common Stock and common stock equivalents used to calculate earnings per share for 1995, 1994 and 1993 were $(2,203,000), $(3,906,000) and $(8,772,000) and 6,699,923, 6,668,765 and 6,065,743, respectively.\n(57)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n11. BUSINESS SEGMENTS\n(58)\nSUPPLEMENTAL UNAUDITED QUARTERLY FINANCIAL DATA (in thousands, except per share amounts)\n(59)\nITEM 14","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14\nEXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. Financial Statements\nSee Item 8, Index to Consolidated Financial Statements and Supplemental Data.\n(A) 2. Financial Statement Schedules\nPAGE ----\nIndependent Auditors' Report................ 61\nSchedule VIII - Valuation and qualifying accounts for the three years ended December 31, 1995. 62\nAll other schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto or the 1996 Annual Meeting Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, incorporated herein by reference.\n(A) 3. Exhibits\nSee the Exhibit Index included herewith.\n(B) Reports on Form 8-K\nNo Reports on Form 8-K were filed for the year ended December 31, 1995. (60)\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE DELTONA CORPORATION:\nWe have audited the consolidated financial statements of The Deltona Corporation and subsidiaries (the \"Company\") as of December 31, 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 29, 1996 (which expresses an unqualified opinion and includes an explanatory paragraph relating to the Company's ability to continue as a going concern), included elsewhere in this Annual Report on Form 10-K. Our audits also included the financial statement schedules listed in Item 14(a)2 of this Annual Report on Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP Certified Public Accountants Miami, Florida March 29, 1996\n(61)\nSCHEDULE VIII\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS (in thousands)\n(62)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE DELTONA CORPORATION (Company)\nBy \/s\/ DONALD O. MCNELLEY DATE: March 29, 1996 ----------------------------- Donald O. McNelley, TREASURER\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the date indicated.\n\/s\/ ANTONY GRAM - ----------------------------------------------- Antony Gram, CHAIRMAN OF THE BOARD OF DIRECTORS & CHIEF EXECUTIVE OFFICER\n\/s\/ NEIL E. BAHR - ----------------------------------------------- Neil E. Bahr, DIRECTOR\n\/s\/ EARLE D. CORTRIGHT, JR. - ----------------------------------------------- Earle D. Cortright, Jr., PRESIDENT, CHIEF OPERATING OFFICER & DIRECTOR\n\/s\/ GEORGE W. FISCHER - ----------------------------------------------- George W. Fischer, DIRECTOR\n\/s\/ RUDY GRAM - ----------------------------------------------- Rudy Gram, DIRECTOR\n\/s\/ THOMAS B. MCNEILL - ----------------------------------------------- Thomas B. McNeill, DIRECTOR DATE: March 29, 1996\n(63)","section_15":""}
{"filename":"82020_1995.txt","cik":"82020","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL. The business of United States Lime & Minerals, Inc. (the \"Company\" or the \"Registrant\"), which was incorporated in 1950, is the production and sale of lime and limestone products. The Company extracts high-quality limestone from its quarries and then processes the limestone for sale as aggregate, pulverized limestone, quicklime and hydrated lime. These operations are conducted through three wholly-owned subsidiaries of the Company: Arkansas Lime Company, Corson Lime Company and Texas Lime Company. The Company sold substantially all of the assets and business of its Virginia Lime Company (\"VLC\") subsidiary on July 15, 1992. See \"Disposition of Assets.\" References to the Company herein include references to its subsidiaries.\nThe Company's principal corporate office is located at 12221 Merit Drive, Suite 500, Dallas, Texas 75251.\nBUSINESS AND PRODUCTS. The Company extracts raw limestone and then processes it for sale as aggregate, pulverized limestone, quicklime and hydrated lime. Aggregate is raw limestone which has been crushed to specified sizes. Pulverized limestone is a dried product ground to granular and finer sizes. Quicklime is produced when carbon dioxide is removed from limestone in a heat process called calcination. Hydrated lime is formed in a process called hydration in which water is added to quicklime to produce a soft powder.\nAggregate is used by the construction industry in concrete, asphalt and road base. Pulverized limestone is used primarily in the production of construction materials such as asphalt paving and roofing shingles, as an additive to agriculture feeds and as a soil enhancement. Quicklime is used primarily in the manufacturing of paper products, in sanitation and water filtering systems and in metal processing. Hydrated lime is used primarily in municipal sanitation\/water treatment, soil stabilization in highway and building construction, the production of chemicals and the production of construction materials such as stucco, plaster and mortar.\nPRODUCT SALES. The Company sells its lime and limestone products primarily in the states of Arkansas, Connecticut, Delaware, Kansas, Louisiana, Mississippi, New Jersey, New Mexico, New York, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas and Virginia. Sales are made primarily by the Company's 10 sales employees. Sales personnel call on potential customers and solicit orders which are generally made on a purchase-order basis. The Company also receives orders in response to bids that it prepares and submits to potential customers.\nPrincipal customers for the Company's lime and limestone products are highway, street and parking lot contractors, chemical producers, paper manufacturers, roofing shingle manufacturers, glass manufacturers, municipal sanitation\/water treatment facilities, poultry and cattle feed producers, governmental agencies, steel producers and electrical utility companies.\nDuring the year ended December 31, 1995, approximately 1,500 customers accounted for the Company's sales of lime and limestone products. No single customer accounted for more than 10% of such sales. The Company is not subject to significant customer risks as its customers are considerably diversified as to geographic location and industrial concentration. However, given the nature of the lime and limestone industry, the Company's profits are very sensitive to changes in volume.\nLime and limestone products are transported by rail and truck to customers generally within a radius of 400 miles of each of the Company's processing plants. Sales of lime and limestone products are highest during the months of March through November.\nSubstantially all of the Company's sales are made within the United States.\nORDER BACKLOG. The Company does not believe that backlog information accurately reflects anticipated annual revenues or profitability from year to year.\nSEASONALITY. The Company's sales have historically reflected seasonal trends, with the largest percentage of total annual revenues being realized in the second and third quarters. Low seasonal demand normally results in reduced shipments and revenues in the first quarter. Inclement weather conditions have a negative impact on the demand for lime and limestone products.\nLIMESTONE RESERVES. The company extracts limestone from three open-pit quarries, all of which are Company-owned. The Cleburne Quarry is located 14 miles from Cleburne, Texas; the Batesville Quarry is located near Batesville, Arkansas; and the Corson Quarry is located at Plymouth Meeting, Pennsylvania. Access to each location is provided by paved roads.\nTexas Lime Company operates out of the Cleburne Quarry, which is situated upon a tract of land containing approximately 459 acres. In addition, the Company owns 2,149 acres of land adjacent to the Cleburne tract containing known high-quality limestone reserves in a bed averaging 28 feet in thickness, with an overburden which ranges from 0 to 50 feet. The Company also has mineral interest in the 560 acres of land adjacent to the northwest boundary of the Company's property. This tract of land has 531 acres of proven limestone reserves. The calculated reserves are approximately 118,000,000 tons. Assuming the present level of production at the Quarry is maintained, the Company estimates the reserves are sufficient to sustain operations for approximately 100 years.\nArkansas Lime Company operates out of the Batesville Quarry, which is situated upon a tract of approximately 420 acres, 100 of which contain known deposits of high-quality limestone reserves. The average thickness of the limestone bed in this deposit is approximately 60 feet, with an overburden averaging 20 feet. Reserves are calculated at approximately 20,000,000 tons. Assuming the present level of production at the Quarry is maintained, the Company estimates that reserves are sufficient to sustain operations in excess of 40 years. In addition, the Company owns approximately 353 acres with certain reserves in three tracts of land, which are located adjacent to the Quarry on its northern, western and southern boundaries. It is probable that these additional reserves would extend the life of the Quarry by approximately 25 years.\nCorson Lime Company operates out of the Corson Quarry, which is situated at Plymouth Meeting, Pennsylvania upon a tract of land containing approximately 315 acres, approximately 153 acres of which are underlain by dolomitic limestone reserves. Permitted reserves are calculated to be approximately 81,000,000 tons at the Quarry. The overburden averages approximately 39 feet. The Company estimates that, assuming the present level of production at the Quarry is maintained, the reserves are sufficient to sustain operations for approximately 50 years.\nMINING. The Company extracts limestone by the open-pit method at its three operating quarries. The open-pit method, which consists of removing the top layer of soil, trees and other substances and then extracting the exposed limestone, is generally less expensive than underground mining. The principal disadvantage of the open-pit method is that operations are subject to inclement weather. To extract limestone, the Company utilizes standard mining equipment which is Company-owned. After extraction, limestone is crushed, screened and ground in the case of aggregate and pulverized limestone, or further processed in kilns and hydrators in the case of quicklime and hydrated lime, before shipment. The Company has no knowledge of any recent changes in the physical quarrying conditions on any of its properties which have materially affected its operations, and no such changes are anticipated.\nPLANTS AND FACILITIES. The Company produces lime and limestone products in the following plants:\nThe Texas plant is located adjacent to the Cleburne Quarry on a tract of land covering approximately 8.4 acres. This plant is equipped with three rotary kilns and has a daily-rated capacity of 1,200 tons of quicklime. The plant has pulverized limestone equipment which has a capacity to produce 550,000 tons of pulverized limestone annually, depending on the product mix. In addition to this plant, the Company owns a plant which is located near Blum, Texas on a tract of land covering approximately 40 acres. It is equipped with two vertical kilns and has a daily-rated capacity of 600 tons of quicklime. The Blum plant was acquired in 1989 and has not been operated since that time; however, the plant's storage and shipment facilities are currently being utilized.\nThe Arkansas plant, situated on a tract of approximately 290 acres, is located roughly two miles from the Batesville Quarry and is connected to the Quarry by a Company-owned railway. Utilizing six vertical kilns, this plant has a daily-rated capacity of 345 tons of quicklime. The plant has two grinding systems which, depending on the product mix, has the capacity to produce 700,000 tons of pulverized limestone annually.\nThe Pennsylvania plant is located adjacent to the Corson Quarry on a tract of land covering approximately 147 acres. It is equipped with a dual crushing system and six vertical kilns and has a daily-rated capacity of 8,000 tons of aggregate and 300 tons of quicklime.\nThe Company also maintains a distribution terminal in Mer Rouge, Louisiana, to service customers in this region.\nThe Company maintains lime hydrating equipment and limestone drying equipment at all three plants. Storage facilities at each of its plants consist primarily of cylindrical tanks, which are considered by the Company to be adequate to protect its lime and limestone products and to provide an available supply for customers' needs at the existing volume of shipments. Equipment is maintained at each plant to load trucks and at the Arkansas and Blum plants to load railroad cars.\nThe Company believes that its processing plants are currently being properly maintained to meet its current needs and are adequately insured. Much of the equipment in the plants is aging and will require maintenance and repair in the future. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" regarding the Company's expected capital expenditures for modernizing and re-equipping the plants.\nEMPLOYEES. The Company employed, at December 31, 1995, 338 persons, 45 of whom are engaged in sales, administrative and management activities. Of the Company's 293 production employees, 235 are covered by collective bargaining agreements. These agreements expire as follows:\nPennsylvania facility in July 1998 Texas facility in November 1996 Arkansas facility in December 1996\nCOMPETITION. The lime and limestone industry has certain limiting factors, including: the availability of high-quality limestone (calcium carbonate) reserves, the ability to secure mining and operating permits for a facility, the cost of building processing plants to create the lime and limestone products and the transportation costs associated with delivering the products to customers. There is not a large number of producers in the United States as a whole, but producers tend to concentrate on known limestone formations where competition takes place on a local basis. The contraction of the U.S. steel industry in the late 1970's and the early 1980's created an excess of supply over demand, thus impacting prices and profit levels. The industry as a whole has expanded its customer base and, while still selling heavily to the steel industry, also counts paper producers and road builders among its major customers. Recently, the environmental-related uses for lime have been expanding, including use in flue gas desulfurization and the treatment of both waste and potable water.\nENVIRONMENTAL MATTERS. The Company's operations are subject to various federal, state and local environmental laws and regulations, including the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation, and Liability Act as well as the Toxic Substances Control Act. Management does not believe that any lack of compliance by the Company with applicable environmental laws will have a material adverse effect on the Company. In part in response to requirements of environmental regulatory agencies, the Company incurred capital expenditures of approximately $220,000 in 1995 on environmental compliance and is planning to incur approximately $600,000 in 1996. In the judgment of management, forecastable expenditure requirements for the future are not of such dimension as to have a materially adverse effect on the Company's financial condition, results of operations, liquidity or competitive position. The Company's recurring costs associated with managing and disposing of potentially hazardous substances (such as fuels and lubricants used in operations) and maintaining pollution control equipment amounted to $150,000 in both 1995 and 1994. The Company has not been named as a potentially responsible party in any superfund cleanup site.\nAs discussed in Notes 2 and 9 of Notes to Consolidated Financial Statements, the Company entered into a settlement agreement with Rangaire Company and Cameron Energy Company in December 1993. Under the settlement, the Company received a secured subordinated promissory note for $530,000 and cash of $200,000. In turn, the Company agreed to reimburse Cameron Energy Company, up to a maximum of $200,000, for clean-up costs incurred with regard to a parcel of land sold in 1989. In this regard, the Company accrued $170,000 at December 31, 1993. In 1994, the Company reimbursed Cameron Energy $165,000 for the clean-up of this parcel of land.\nDISPOSITION OF ASSETS. Effective July 15, 1992, substantially all of the assets and business of VLC, a wholly owned subsidiary of the Company, were sold to Eastern Ridge Lime Company, L.P. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 3 of Notes to Consolidated Financial Statements for a discussion regarding the disposition.\nDISCONTINUED OPERATIONS. Pursuant to an agreement dated June 6, 1989, the Company sold, effective May 31, 1989, to an unrelated joint venture, all of the assets of the Company's manufacturing division, which designed, manufactured and sold appliances and equipment for use in homes and for use in the construction of homes and commercial buildings. See Notes 2 and 9 of Notes to Consolidated Financial Statements for a further discussion with respect to this discontinued operation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nReference is made to Item 1 of this Report for a description of the properties of the Company, and such description is hereby incorporated by reference in answer to this Item 2. As discussed in Note 4 of Notes to Consolidated Financial Statements, plant facilities and mineral reserves are subject to encumbrances to secure the Company's loans.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nInformation regarding legal proceedings is set forth in Note 9 of Notes to Consolidated Financial Statements and is hereby incorporated by reference in answer to this Item 3.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThe Company did not submit any matters to a vote of security holders during the fourth quarter of 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 quoted on the Nasdaq National Market under the symbol \"USLM.\" As of February 1, 1996, the Company had 943 stockholders of record.\nAs of December 31, 1995, 500,000 shares of $5.00 par value preferred stock were authorized, and none was issued.\nThe high and low sales prices for the Company's Common Stock for the periods indicated, as well as dividends declared in 1995, were:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n(dollars in thousands, except per share amounts)\n1. Includes a gain of $372,000, net of related taxes ($425,000 gross), due to the expiration of certain potential post-closing obligations relating to the sale of VLC assets.\n2. Includes a gain on sale of VLC assets of $10,679, net of related taxes.\nSee Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nThe following table sets forth selected financial information of the Company expressed as a percentage of revenues for the periods indicated:\n1995 VS 1994\nRevenues increased from $36,865,000 in 1994 to $41,419,000 in 1995, an increase of $4,554,000 or 12.4%. This resulted from a 12.0% increase in sales volume and a 0.4% increase in sales prices. Volume was up at all plants in 1995. Prices received for lime and limestone products at the Arkansas and Texas plants slightly increased in 1995 compared to 1994. Prices received for lime and limestone products, including aggregates, at the Pennsylvania plant were down slightly when compared to 1994.\nThe Company's gross profit was $10,847,000 for 1995 compared to $7,629,000 for 1994, a 42.2% increase. In addition to increased revenues, gross profit was enhanced by improved efficiencies at the plants and lower amortization of costs in excess of net assets acquired.\nSelling, general and administrative (\"SG&A\") expenses increased by $60,000 in 1995 compared to 1994. SG&A expenses declined as a percent of revenues to 12.5% in 1995, from 13.9% in 1994.\nInterest expense decreased by $161,000 in 1995 over 1994. This decrease was due to lower debt outstanding. The Company's Revolving Credit loan was completely paid down in September 1995.\nThe Company's net income for 1995 increased $2,344,000 or 122.3% from $1,916,000 ($0.50 per share) in 1994, to $4,260,000 ($1.11 per share).\n1994 VS 1993\nCONTINUING OPERATIONS. Revenues increased from $32,359,000 in 1993 to $36,865,000 in 1994, an increase of $4,506,000 or 13.9%. This resulted from a 10.8% increase in sales volume and a 3.1% increase in sales prices. Volume was up at all plants except at Texas, which was down compared to 1993. Prices received for lime and limestone products at all plants improved in 1994 compared to 1993 except the prices received for aggregates at the Pennsylvania plant, which were down slightly when compared to 1993. Volume of shipments were up for aggregate at all plants in 1994.\nThe Company's gross profit was $7,629,000 for 1994 compared to $6,073,000 for 1993, a 25.6% increase. In addition to increased revenues, gross profit was enhanced by lower depreciation costs and lower amortization of costs in excess of net assets acquired.\nSG&A expenses decreased by $730,000 in 1994 compared to 1993. This decrease was primarily the result of both a $325,000 charge included in the third quarter of 1993 for a payment due under an employment agreement and a $392,000 charge in the first quarter of 1993 relating to resolution of the Company's control and stockholder situation. Excluding these charges, SG&A expenses decreased by $13,000 in 1994 from 1993, declining as a percent of revenues to 13.9% in 1994 from 15.9% in 1993.\nInterest expense increased by $84,000 in 1994 over 1993. This increase was due to higher prevailing interest rates, which were partially offset by lower debt outstanding.\nThe Company's net income for 1994 increased $2,357,000 from a loss of $441,000 ($0.11 per share) in 1993, to $1,916,000 ($0.50 per share). Included in 1994 income was $425,000 ($372,000 net of taxes) due to the expiration of certain potential post-closing obligations relating to the sale of VLC assets. See Note 3 of Notes to Consolidated Financial Statements for more information.\nDISCONTINUED OPERATIONS. During 1993, income of $480,000 (net of taxes) was recorded, primarily attributable to a new subordinated secured promissory note for $530,000 received from the buyer of the discontinued manufacturing operations. See Notes 2 and 9 of Notes to Consolidated Financial Statements.\nFINANCIAL CONDITION\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial condition is reflected by the following key financial measurements:\nIn 1995, cash flow from operations was $7,943,000, an improvement of $2,535,000 or 46.9% over 1994. In 1995, this cash flow fully funded the Company's capital expenditure program and reduced the Company's bank debt by $1,844,000.\nIn October 1993, the Company entered into a financing agreement with a commercial bank to replace its then-existing borrowings. The agreement provided for a 5-year $8,000,000 Term Loan with a monthly principal repayment of $95,238, with the remaining principal due in September 1998. The agreement also provided for a 2-year $6,000,000 Revolving Credit. Both are secured by substantially all of the Company's assets. The Term Loan originally carried an interest rate of Prime plus 1%, and the Revolving Credit carried an interest rate of Prime plus 3\/4%, with a 1\/2% fee on the unused Revolving Credit loan. In February 1994, the Company fixed the interest rate on the Term Loan at 7.95% per annum through February 1997. In September 1995, the loan agreements were amended to extend the Revolving Credit maturity date to November 1997. For the period of January 1 to September 29, 1995, the Term Loan, as amended, carried an interest rate of Prime plus 1\/2%, and the Revolving Credit carried an interest rate of Prime plus 1\/4%. In addition, effective September 29, 1995, the Term Loan carries an interest rate of Prime plus 1\/4%, and the Revolving Credit carries an interest rate of Prime. The new Term Loan rate will go into effect after the fixed term rate of 7.95% ends in February 1997. The terms of the financing agreements contain, among other provisions, requirements for maintaining defined levels of working capital, net worth, financial ratios and capital expenditure limitations. The covenants restrict incurrence of debt, liens and lease obligations, mergers, and consolidation or acquisition of assets.\nCapital expenditures for 1995 totaled $4,851,000 compared to $2,682,000 in 1994. The Company expects to spend $15-25 million over the next several years to modernize and re-equip plant facilities to improve efficiency and reduce costs, to effect environmental improvements and to ensure that capacity is in place to meet market demand. Management believes that the necessary funds will be obtained through operations. The Company is not contractually committed to any planned capital expenditures until actual orders are placed for equipment.\nIn addition, the Company has completed the feasibility studies for a new kiln at the Arkansas plant and has decided to proceed with this project. The new kiln will complement the existing shaft kilns by allowing the Company to expand its customer base. The lime produced on the new kiln will meet the specific chemical needs of both the existing customer base and customers the Company currently is unable to serve. The project is expected to cost approximately $9-10 million. The Company's progress on this project has been slowed due to the state regulatory authorities requiring the Arkansas plant to apply for and obtain a new plant wide permit. This new permit replaced the existing permit and now allows the Company to proceed with the permitting process of the new kiln. This permit is expected to be secured by the end of 1996. The new kiln will be financed by internally generated funds and\/or alternative sources of financing.\nENVIRONMENTAL MATTERS\nThe Company's operations are subject to various environmental laws and regulations. In part in response to requirements of environmental regulatory agencies, the Company incurred capital expenditures of approximately $220,000 in 1995. In the judgment of management, forecastable expenditure requirements for the future are not of such dimension as to have a materially adverse effect on the Company's financial condition, results of operations, liquidity or competitive position. See \"Business--Environmental Matters.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders United States Lime & Minerals, Inc.\nWe have audited the consolidated balance sheets of United States Lime & Minerals, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 consolidated financial position of United States Lime & Minerals, Inc. and subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the years then ended in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nDallas, Texas January 22,1996\n-F1-\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders United States Lime & Minerals, Inc.\nWe have audited consolidated statements of income, stockholders' equity and cash flows of United States Lime & Minerals, 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 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 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 results of operations and cash flows of United States Lime & Minerals, Inc. for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nARONSON, FETRIDGE & WEIGLE\nRockville, Maryland February 1, 1994\n-F2- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (dollars in thousands)\nSee accompanying notes to consolidated financial statements\n-F3- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED) (dollars in thousands)\nSee accompanying notes to consolidated financial statements\n-F4- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements\n-F5- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands)\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements\n-F6- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n-F7- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n-F8- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\nYears ended December 31, 1995, 1994, and 1993\n(1) Summary of Significant Accounting Policies\n(a) Organization\nThe Company is a manufacturer of lime and limestone products supplying primarily the steel, paper, agriculture, municipal sanitation\/water treatment and construction industries. The Company is headquartered in Dallas, Texas and operates lime and aggregate plants in Arkansas, Pennsylvania and Texas through its wholly owned subsidiaries, Arkansas Lime Company, Corson Lime Company and Texas Lime Company, respectively.\n(b) Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and all of its subsidiaries. All material intercompany balances and transactions have been eliminated.\n(c) Use of Estimates\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. Actual results could differ from those estimates.\n(d) Statements of Cash Flows\nFor purposes of reporting cash flows, the Company considers all certificates of deposit and highly-liquid debt instruments, such as U.S. Treasury Bills and Notes, with original maturities of three months or less to be cash equivalents.\nSupplemental cash flow information is presented below:\nSupplemental information regarding non-cash investing and financing activities is present as follows:\nA secured promissory note for $530 was recorded in 1993. This transaction has been excluded from the consolidated statements of cash flows.\n(e) Trade Receivables\nTrade receivables are presented net of the related allowance for doubtful accounts, which totaled $115 and $231 at December 31, 1995, and 1994, respectively.\n-F9- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\n(f) Inventories\nInventories are valued principally at the lower of cost or market determined using the average cost method. Such costs include materials, labor and production overhead.\nA summary of inventories is as follows:\n(g) Property, Plant and Equipment\nDepreciation of property, plant and equipment is being provided for by the straight-line and declining-balance methods over estimated useful lives as follows:\nMaintenance and repairs are charged to expense as incurred; renewals and betterments are capitalized. When units of property are retired or otherwise disposed of, their cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is credited or charged to income.\n(h) Other Assets\nOther assets consist of the following:\nIt is the Company's policy to make available for sale assets considered excess and no longer necessary for operations. The carrying values of such assets are periodically reviewed and adjusted downward to market, when appropriate.\nDeferred stripping costs are amortized by the unit-of-production method based on the estimated recoverable reserves in the underlying area.\nDeferred financing costs are expensed over the shorter of the life of the debt or expected life of the loan using the interest method.\n-F10- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\n(i) Earnings Per Share of Common Stock\nEarnings per share of common stock are based on the weighted average number of shares outstanding during each year, which amounted to 3,836,063 for the years ended December 31, 1995, 1994 and 1993.\n(j) Environmental Expenditures\nEnvironmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals will coincide with completion of a feasibility study or the Company's commitment to a formal plan of action.\n(2) Discontinued Operations\nIn June 1989, the Company sold the net assets of its manufacturing division to an unrelated joint venture (Purchaser). As part of this sale, the Company received a $955 subordinated promissory note, the repayment of which was contingent upon the Purchaser having sufficient excess cash flow (as defined). The Company was not receiving interest on the note, collection of the principal was considered to be doubtful and, accordingly, at that time the note was not recorded. Subsequent to December 31, 1993, the Company recorded $200 in cash and a new subordinated note for $530 in substitution of the old note. The new note was secured by all of the assets of the Purchaser, and carried an interest rate of 6% per annum. The new note called for a monthly payment of $10 in interest and principal, and a final payment of $17 at the end of the 60th month. The new note was recorded as income from discontinued operations in 1993. The Purchaser paid the balance of the note in the fourth quarter of 1995.\n(3) Gain on Sale of Virginia Lime Company Assets\nEffective July 15, 1992, substantially all of the assets and business of Virginia Lime Company (VLC) were sold to Eastern Ridge Lime Company, L.P. (Eastern Ridge), an unrelated company. At the time of the sale, a $500 reserve for post-closing adjustments was established. Potential post-closing adjustments included possible additional expenditures for claims relating to a water supply system, workers' compensation matters, environmental matters, representations and warranties made to Eastern Ridge on various issues, employee benefit matters, legal fees and other professional charges. Other than a $50 payment in 1993, in connection with the water supply system, Eastern Ridge asserted no claims for adjustment. The Company recorded a benefit of $425 in the second quarter of 1994, upon payment of certain legal and other expenses and expiration of the post-closing obligations. The Company dissolved this subsidiary in 1995.\n-F11- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\n(4) Long-Term Debt\nIn October 1993, the Company entered into a financing agreement with a commercial bank to replace its then-existing borrowings. The agreement provided for a 5-year $8,000 Term Loan with a monthly principal repayment of $95, with the remaining principal due in September 1998. The agreement also provided for a 2-year $6,000 Revolving Credit. Both are secured by substantially all of the Company's assets. The Term Loan originally carried an interest rate of Prime plus 1%, and the Revolving Credit carried an interest rate of Prime plus 3\/4%, with a 1\/2% fee on the unused Revolving Credit loan. In February 1994, the Company fixed the interest rate on the Term Loan at 7.95% per annum through February 1997. In September 1995, the loan agreements were amended to extend the Revolving Credit maturity date to November 1997. For the period of January 1 to September 29, 1995, the Term Loan, as amended, carried an interest rate of Prime plus 1\/2%, and the Revolving Credit carried an interest rate of Prime plus 1\/4%. In addition, effective September 29, 1995, the Term Loan carries an interest rate of Prime plus 1\/4%, and the Revolving Credit carries an interest rate of Prime. The new Term Loan rate will go into effect after the fixed term rate of 7.95% ends in February 1997. The terms of the financing agreements contain, among other provisions, requirements for maintaining defined levels of working capital, net worth, financial ratios and capital expenditure limitations. The covenants restrict incurrence of debt, liens and lease obligations, mergers, and consolidation or acquisition of assets.\nA summary of Long-term debt is as follows:\nAmounts payable on long-term debt in 1996 and thereafter are: 1996, $1,143; 1997, $1,143; 1998, $3,238.\n(5) Federal and State Income Taxes\nIncome tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993 were as follows:\n-F12- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\nA reconciliation of the computed \"expected\" federal and state income tax expense (benefit) on income (loss) from continuing operations to income taxes at the effective tax rates is as follows:\nAt December 31, 1995, the Company had deferred tax liabilities of $653, deferred tax assets of $4,188 and a valuation allowance of $3,535. The principal temporary difference related to the deferred tax liabilities is depreciation ($653). The principal temporary differences related to the deferred tax assets were net operating loss (NOL) carryforwards ($1,047), general business credits ($510), certain financial statement accruals ($656) and alternative minimum tax credit carryforwards ($1,975).\nAt December 31, 1994, the Company had deferred tax liabilities of $700, deferred tax assets of $4,508 and a valuation allowance of $3,808. The principal temporary difference related to the deferred tax liability is depreciation ($700). The principal temporary differences related to the deferred tax assets were NOL carryforwards ($1,983), general business credit ($756), certain financial statement accruals ($785) and alternative minimum tax credit carryforwards ($984).\nThe Company has NOL carryforwards for tax purposes of $2,755 which will, if unused, expire in 2006 ($1,387), and 2008 ($1,368). General business credits of $510 are available to reduce the Company's federal income tax, which expire starting 1997 through 2001.\nDeferred tax assets have been reduced by a valuation allowance as realization of some portion of these future tax benefits is dependent on generating sufficient taxable income. Favorable resolution of these uncertainties would result in the reduction of the valuation allowance.\n-F13- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\n(6) Employee Retirement Plans\nThe Company has a noncontributory defined benefit pension plan covering substantially all union employees of its wholly-owned subsidiary, Corson Lime Company. Benefits for the Corson Lime Union Pension Plan (Corson Plan) are based on certain multiples of years of service. The Company's funding policy is to contribute annually not less than the minimum required nor more than the maximum amount that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. The Company funded pension costs of $127 for 1995, $96 for 1994 and $96 for 1993.\nA summary of the funding status of the Corson Plan and the amounts recognized in the consolidated balance sheets are as follows:\nA summary of the components of net periodic pension expense for the Corson Plan follows:\nThe Company also has a contributory retirement (401k) savings plan for nonunion employees. The Company contributions to the plan were $58 during 1995, $23 during 1994 and $26 during 1993. The Company has a contributory retirement (401k) savings plan for union employees of Texas Lime Company. The Company contributions to this plan were $12 in 1995, $11 in 1994 and $12 in 1993.\n-F14- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\nIn December 1986, the Company purchased 1,550,000 shares of its outstanding common stock for $10.50 per share. Subsequent to that purchase, 200,000 shares (300,000 shares after stock split) were sold to the Employee Stock Ownership Plan (ESOP) for $8.20 per share. The Company obtained a note receivable from the ESOP for the purchase of the shares, which was classified as a reduction of stockholders' equity. As of December 1994, the Company made all of the necessary contributions to the ESOP to repay all principal and interest due on the note.\nThrough December 31, 1994, the Company contributed to the ESOP which covers substantially all full-time nonunion employees. The ESOP is designed to invest primarily in the Company's common stock. Contributions to the ESOP are made at the option of the Company, except for certain contributions which were required in order for the ESOP to repay the note receivable to the Company. The Company did not make a contribution in 1995 and contributed $205 during each of the years 1994 and 1993.\n(7) Selling, General and Administrative Expenses\nSelling, general and administrative (SG&A) expenses for 1993 include $391 for payments related to the termination of employees. In 1993, SG&A includes $215 of bank fees and professional charges incurred in connection with a proposed ESOP offer to buy the then-majority owner's shares in the Company and the related financing of the then-existing borrowings. In May 1993, the then-majority shareholder sold its shares, and, as a consequence, the proposed ESOP offer was abandoned. SG&A expense also includes change-in-control payments of $177 made in May 1993.\n(8) Stock Option Plan\nThe Company has a stock option plan under which options for shares of common stock may be granted to key employees. As of December 31, 1995, the Company has granted options to purchase a total of 355,000 shares at a range of $4.75 to $8.25 per share, the fair market value of the Company's common stock on the date of grant. The options expire ten years from the date of grant and generally become exercisable after the expiration of one year from the grant date. As of December 31, 1995, 25,000 shares are available for future grant.\n(9) Commitments and Contingencies\nThe Company leases some of the equipment used in its operations. Generally, the leases are for periods varying from one to five years and are renewable at the option of the Company. Total rent expense was $232 for 1995, $134 for 1994 and $213 for 1993. As of December 31, 1995, future minimum payments under noncancelable operating leases are as follows: 1996, $81; 1997, $77; 1998, $75; and 1999, $36.\n-F15- UNITED STATES LIME & MINERALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except per share amounts)\nAs of December 31, 1993, the Company reached agreements to settle two lawsuits styled Rangaire Company v. Rangaire Corporation and Cameron Energy Company v. Scottish Heritable, Inc. In settlement of both lawsuits, the Company and the plaintiffs entered into mutual releases and agreement for dismissal with prejudice of all litigation for claims of any kind. In exchange, the Company (a) agreed to the substitution for an existing unsecured subordinated cash flow promissory note of $955 payable to it by Rangaire Company, bearing interest at 10% per annum, of a new secured subordinated promissory note for $530, bearing interest at 6% per annum, and (b) received $200 in cash from Rangaire Company to be reimbursed to Cameron Energy up to $200 for clean-up costs incurred with regard to a parcel of land sold in 1989. In 1993, the Company accrued $170 for potential claims by Cameron Energy. The unsecured $955 cash flow promissory note previously was not recognized as income. The new $530 secured promissory note and the $200 cash payment were recorded in discontinued operations income in 1993. In 1994, the Company reimbursed Cameron Energy $165,000 for the clean-up costs. The balance remaining on the promissory note as of December 31, 1994 of $447 was completely repaid in the fourth quarter of 1995.\nThe Company is party to other lawsuit and claims arising in the normal course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the Company's financial condition, results of operation, liquidity or competitive position.\n(10) Summary of Quarterly Financial Data (unaudited)\n-F16- ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe information required in response to Item 9 was previously reported in the Company's Current Report on Form 8-K dated October 28, 1994.\nPART III\nThe information required in response to Items 10, 11, 12 and 13 is hereby incorporated by reference to the information under the captions \"Election of Directors\", \"Executive Officers of the Company Who Are Not Also Directors\", \"Executive Compensation\", \"Voting Securities and Principal Shareholders\", and \"Shareholdings of Company Directors and Executive Officers\" in the Proxy Statement for the Company's 1996 Annual Meeting of Shareholders. The Company anticipates that it will file the definitive Proxy Statement with the Securities and Exchange Commission on or before April 30, 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. The following financial statements are included in Item 8:\nReport of Independent Auditors\nReport of Independent Auditors\nConsolidated Financial Statements:\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; and\nNotes to Consolidated Financial Statements.\n2. All financial statement schedules are omitted because they are not applicable or the required information is presented in the consolidated financial statements or the related notes.\n3. The following documents are filed with or incorporated by reference into this Report:\n3(a) Articles of Amendment to the Articles of Incorporation of Scottish Heritable, Inc. dated January 25th, 1994 (incorporated by reference to Exhibit 3(a) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File Number 0-4197).\n3(b) Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File Number 0-4197).\n3(c) Composite Copy of Bylaws of the Company, as currently in effect (incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File Number 0-4197).\n10(a) Summary of the Company's Profit Sharing Bonus Plan (incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the fiscal year ended July 31,1981, File Number 0-4197).\n10(b) United States Lime & Minerals, Inc. Employee Stock Ownership Plan, as restated effective August 1, 1989.\n10(c) Rangaire Employee 401(k) Profit Sharing Plan effective as of August 1, 1983 (incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form l0-K for the fiscal year ended July, 31, 1983, File Number 0-4197).\n10(d) Amendments Nos. First, Second, and Third to Rangaire Employee 401(k) Profit Sharing Plan (incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1986, File Number 0-4197).\n10(e) Amendment No. Fourth to Rangaire Employee 401(k) Profit Sharing Plan effective March 1, 1987 (incorporated by reference to Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1987, File Number 0-4197).\n10(f) Amendment No. Fifth to Rangaire Employees 401(k) Profit Sharing Plan effective as of July 14, 1992 (incorporated by reference to Exhibit 19(g) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, File Number 0-4197).\n10(g) Texas Lime Company Bargaining Unit 401(k) Plan effective as of January 1, 1992 (incorporated by reference to Exhibit 19(f) to the Company's Quarterly Report on Form 10-Q for the quarter ended June, 30, 1992, File Number 0-4197).\n10(h) Executive Retention Agreements dated as of June 10, 1992 between the Company and certain officers of the Company (incorporated by reference to Exhibit 19(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, File Number 0-4197).\n10(i) Employment Agreements between the Company and certain officers of the Company (incorporated by reference to Exhibit 19(c) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, File Number 0-4197).\n10(j) United States Lime & Minerals, Inc. 1992 Stock Option Plan (incorporated by reference to Exhibit A to the Company's definitive Proxy Statement for its 1992 Annual Meeting of Shareholders held on June 9, 1992, File Number 0-4197).\n10(k) Loan and Security Agreement dated October 20, 1993 among Scottish Heritable, Inc. and subsidiaries and CoreStates Bank, N.A. (incorporated by reference to Exhibit 10(u) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File Number 0-4197).\n10(l) Stock Purchase Agreement dated October 23,1986 between Rangaire Corporation and InterFirst Bank Fort Worth, N.A. as trustee of the Rangaire Corporation Employee Stock Ownership Trust (incorporated by reference to Exhibit (c) (2) to the Company's Tender Offer Statement on Schedule 13E-4 for a tender offer first published sent or given to security holders on October 30, 1986, File Number 0-4197).\n10(m) Purchase and Assumption Agreement dated as of May 31, 1989 between Rangaire Corporation and Rangaire Company (incorporated by reference to Exhibit A to the Company's Current Report on Form 8-K dated June 5, 1989, File Number 0-4197).\n10(n) Asset Purchase Agreement dated as of June 5, 1989 by and between Dravo Lime Company and Texas Lime Company (incorporated by reference to Exhibit B to the Company's Current Report on Form 8-K dated June 5, 1989, File Number 0-4197).\n10(o) Asset Purchase Agreement dated as of July 6, 1989 by and between Cadenhead Construction Company, Inc., Cadenhead Rangaire, Inc. and Rangaire Corporation (incorporated by reference to Exhibit A to the Company's Current Report on Form 8-K dated July 7, 1989, File Number 0-4197).\n10(p) Asset Purchase Agreement dated as of July 13, 1992 among Eastern Ridge Lime Company, L.P., Virginia Lime Company, Eastern Ridge Lime, Inc., and Scottish Heritable, Inc. (incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated July 15, 1992, File Number 0-4197).\n10(q) Agreement and Release dated October 29, 1993 between Scottish Heritable, Inc. and Peter C. Timms (incorporated by reference to Exhibit 10(w) to the Company's Annual Report on Form 10-K for the fiscal year ended December, 31, 1993, File Number 0-4197).\n10(r) Employment Agreement dated as of September 27, 1993 between Scottish Heritable, Inc. and Robert F. Kizer (incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, File Number 0-4197).\n10(s) Employment Agreement dated November 24, 1993 between Scottish Heritable, Inc. and Robert K. Murray (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, File Number 0-4197).\n10(t) First Amendment to Term Note dated as of March 1, 1994, among United States Lime & Minerals, Inc. and subsidiaries and CoreStates Bank, N.A. (incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,1994, File Number 0-4197).\n10(u) Amendment No. 1 to Loan and Security Agreement dated as of December 23, 1994, among United States Lime & Minerals, Inc. and subsidiaries and CoreStates Bank, N.A. (incorporated by reference to Exhibit 10(y) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File Number 0-4197).\n10(v) Amendment No. 2 to Loan and Security Agreement dated as of April 28, 1995, among United States Lime & Minerals, Inc. and subsidiaries and CoreStates Bank, N.A. (incorporated by reference to Exhibit 10(z) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, File Number 0-4197).\n10(w) Amendment No. 3 to Loan and Security Agreement dated as of September 29, 1995, among United States Lime & Minerals, Inc. and subsidiaries and CoreStates Bank, N.A. (incorporated by reference to Exhibit 10(aa) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, File Number 0-4197).\n11 Statement regarding computation of per share earnings (loss).\n16 Letter dated November 3, 1994, from Aronson, Fetridge & Weigle to the Securities and Exchange Commission, stating whether it agrees with the statements made by the Company in the Company's Current Report on Form 8-K dated October 28, 1994, concerning its dismissal as the Company's principal accountant (incorporated by reference to Exhibit 16 to the Company's Current Report on Form 8-K dated October 28, 1994, File Number 0-4197).\n21 Subsidiaries of the Company.\n23(a) Consent of Independent Auditors\n23(b) Consent of Independent Auditors\n27 Financial Data Schedule\n- -----------------------\nExhibits 10(a) through 10(j) and 10(q) through 10(s) are management contracts or compensatory plans or arrangements required to be filed as exhibits.\n(b) The Company did not file any Current 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.\nUNITED STATES LIME & MINERALS, 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 dates indicated.\nUNITED STATES LIME & MINERALS, INC.\nAnnual Report on Form 10-K Index to Exhibits\nCertain exhibits to this annual report on Form 10-K have been incorporated by reference. For a list of these exhibits see Item 14 hereof.\nThe following exhibits are being filed herewith:","section_15":""}
{"filename":"77776_1995.txt","cik":"77776","year":"1995","section_1":"ITEM 1. BUSINESS GENERAL The Company provides a broad range of integrated management services, expense management programs and mortgage banking services to more than 3,000 clients, including many of the world's largest corporations, as well as government agencies and affinity groups. Its primary business service segments consist of vehicle management, real estate and mortgage banking. Information as to revenues, operating income and identifiable assets by business segment is included in the Business Segments note in the Notes to Consolidated Financial Statements. As of June 30, 1995, the Company and its subsidiaries had approximately 5,000 employees. VEHICLE MANAGEMENT SERVICES Vehicle management services consist primarily of the management, purchase, leasing and remarketing of vehicles for corporate clients and government agencies, including fuel and cost management programs and other fee-based services for clients' vehicle fleets. FLEET MANAGEMENT SERVICES The Company provides fully integrated vehicle management and leasing programs through PHH Vehicle Management Services Corporation and other vehicle management services subsidiaries. These programs were developed to address the needs of clients using cars and trucks and consist of managerial, leasing and advisory services, aimed at effectively managing the cost of operating their vehicles and improving the productivity within their organizations. The Company's advisory services for automobile fleet management programs are primarily for cars, vans and light-duty trucks. They include recommendations on the makes and models of vehicles and options best suited to the client's needs, the determination of persons eligible for operating their vehicles, the method of reimbursing their employees for actual expenses, the care and maintenance of their vehicles and the personal use of company-provided vehicles. Managerial services for automobile fleet programs include purchasing automobiles, arranging for their delivery through new car dealers located throughout North America, primarily the United States and Canada, the United Kingdom, the Republic of Ireland and Germany, complying with various local registration, title, tax and insurance requirements, pursuing warranty claims with automobile manufacturers and remarketing used vehicles at replacement time. The Company offers similar programs and services for medium- and heavy-duty truck fleets. Advisory services offered include the determination of the vehicle specifications, makes, models and equipment best suited to perform the functions required by the client. Managerial services include purchasing new trucks, trailers, truck bodies and equipment from manufacturers and franchised dealers, the performance of title, registration, tax and insurance functions, arranging for them to be titled, licensed and delivered to locations designated by clients, verifying invoices and remarketing used vehicles at replacement time. The Company offers various leasing plans for its vehicle leasing programs. Under these plans, the Company provides for the financing primarily through the issuance of commercial paper and medium-term notes and through unsecured borrowings under revolving credit agreements and bank lines of credit. See the Liabilities Under Management Programs note in Notes to Consolidated Financial Statements. The Company leases vehicles for minimum lease terms of twelve months or more under either direct financing or operating lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Under the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. The Company has two distinct types of operating leases. Under one type, the open-end operating lease, resale of the vehicles upon termination of the lease is for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding residual value guarantees. Under the other type of operating lease, the closed-end operating lease, resale of the vehicle on termination of the lease is for the account of the Company.\nThe Company's fleet management services may be the same whether the client owns or leases the vehicles. In either case, the client generally operates the vehicles on a net basis, paying all the actual costs incidental to their operation, including gasoline, oil, repairs, tires, depreciation, vehicle licenses, insurance and taxes. The fee charged by the Company for its services is based upon either a percentage of the original cost of the vehicle or a stated management fee and, in the case of a leasing client, includes the interest cost incurred in financing the vehicle. FUEL AND COST MANAGEMENT PROGRAMS The Company offers fuel and cost management programs to corporations and government agencies for the control of automotive business expenses in each of the United States, Canada, United Kingdom, Republic of Ireland and Germany. Through a service card and billing service, a client's employees are able to purchase various products and services such as gasoline, tires, batteries, glass and maintenance services at prescribed network providers. The Company also provides a series of safety and accident management related programs, statistical control reports detailing expenses related to the general operation of vehicles, and a program which monitors and controls the type and cost of vehicle maintenance for individual automobiles. The Company also provides fuel and cost management programs and a centralized billing service for companies operating truck fleets in each of the United States, Canada, United Kingdom, Republic of Ireland and Germany. Drivers of the clients' trucks are furnished with courtesy cards together with a directory listing the names of strategically located truck stops and service garages which participate in this program. Service fees are earned for billing, collection and record keeping services and for assuming credit risk. These fees are paid by the truck stop or service garages and\/or the fleet operator and are based upon the total dollar amount of fuel purchased or the number of transactions processed. COMPETITIVE CONDITIONS The principal methods of competition within vehicle management services are quality of service, range of product and service offering and price. In the United States and Canada, an estimated 50% of the market for vehicle management services is served by third-party providers. There are 5 major providers of such services in North America, as well as an estimated several hundred local and regional competitors. The Company is the second largest provider of comprehensive vehicle management services in North America. In the United Kingdom, the portion of the fuel card services and vehicle management services markets served by third-party providers is an estimated 37% and 35%, respectively. The Company is the market leader among the 4 major nationwide providers of fuel card services, and the 7 major nationwide providers of vehicle management services. Numerous local and regional competitors serve each such market element. The following sets forth certain statistics concerning automobiles, vans, light, medium and heavy-duty trucks for which the Company provides managerial, leasing and\/or advisory services primarily in the United States, Canada, the United Kingdom, the Republic of Ireland and Germany at the end of the fiscal years shown:\nREAL ESTATE SERVICES The Company provides employee real estate services principally to large international corporations, government agencies, affinity groups and financial institutions in the United States, Canada, the United Kingdom and the Republic of Ireland through PHH Real Estate Services Corporation and other real estate services subsidiaries. Principal services consist of counseling transferred employees of clients and the purchase, management and resale of\ntheir homes. The Company's real estate services offer clients the opportunity to reduce employee relocation costs and facilitate employee relocation. The Company may pay a transferring employee his\/her equity in a home based upon a value determined by independent appraisals or based on a contract to sell which has been agreed with the employee. In most circumstances the employee's mortgage is retired concurrently with the purchase of the equity; otherwise the Company accepts the administrative responsibility for making payments on any mortgages. The corporate client normally pays the Company an advance billing to cover costs to be incurred during the period the home is held for resale, including debt service on any existing mortgage. These costs are paid by the Company and, after ultimate resale, a settlement is made with the corporate client reconciling the advance billing and the expense payments. Under the terms of the client contracts, the Company is generally protected against losses from changes in market conditions. Funds to finance the purchase of homes are provided primarily through the issuance of commercial paper and medium-term notes and through unsecured borrowings under revolving credit agreements and bank lines of credit, or may be provided by the client. Interest costs are billed directly to the Company's clients. See the Liabilities Under Management Programs note in Notes to Consolidated Financial Statements. The Company's real estate services subsidiaries also offer employee programs which provide group move planning and implementation, home marketing assistance, property management, household goods movement, destination services and asset management for financial institutions and government agencies. Through its PHH Fantus Corporation subsidiary, the Company provides strategic facilities planning services, site selection and location consulting for corporate clients and economic development consulting for state and local government agencies. Additionally, the Company provides consulting services in the areas of general business strategy, marketing and management for transnational clients. COMPETITIVE CONDITIONS The principal methods of competition within real estate services are quality of service, range of product and service offering and price. In the United States and Canada, and the United Kingdom, an estimated 25% and 50%, respectively, of the market for real estate services is served by third-party providers. In the United States there are 5 major national providers of such services and in each of Canada and the United Kingdom there are 4 major national providers. In addition, there are an estimated several dozen local, regional and smaller national competitors in each such country. The Company is the market leader in the United States and Canada, and third in the United Kingdom. The following sets forth certain statistics concerning real estate services in the United States, Canada and the United Kingdom for the fiscal years shown:\n(1) Revenues for real estate services in the United States are significantly determined based on the value of homes sold, while revenues for the United Kingdom and Canadian segments are not related to the value of homes sold; therefore, this table only includes the average value of U.S. homes sold.\nMORTGAGE BANKING SERVICES The Company provides U.S. residential mortgage banking services through PHH Mortgage Services Corporation. These services consist of the origination, sale and servicing of residential first mortgage loans. A variety of first mortgage products are marketed to consumers through relationships with corporations, affinity groups, credit unions, real estate brokerage firms and other mortgage banks. PHH Mortgage Services is a centralized mortgage lender conducting business in all 50 states. It utilizes its computer system and an extensive telemarketing operation to allow the consumer to complete the entire mortgage transaction over the telephone. Through its own network of appraisers, title companies and closing attorneys, the Company can effectively administer its products and services anywhere in the nation. The mortgage unit customarily sells all mortgages it originates to investors (which include a variety of institutional investors) either as individual loans, as mortgage-backed securities or as participation certificates issued or guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC), or the Government National Mortgage Association (GNMA) while generally retaining mortgage servicing rights. The guarantees provided by FNMA and FHLMC are on a non-recourse basis to the Company. Guarantees provided by GNMA are to the extent recoverable from certain government insurance programs. Mortgage servicing consists of collecting loan payments, remitting principal and interest payments to investors, holding escrow funds for payment of mortgage-related expenses such as taxes and insurance, and otherwise administering the Company's mortgage loan servicing portfolio. COMPETITIVE CONDITIONS The principal methods of competition in mortgage banking services are quality of service, range of product and service offering and price. There are an estimated 20,000 national, regional or local providers of mortgage banking services across the United States. The Company ranked nineteenth among loan originators for both the calendar year 1994 and the three months ended March 31, 1995. The following sets forth certain statistics concerning mortgage banking services for the fiscal years shown:\nSIGNIFICANT CUSTOMERS No customer purchased services totaling 10% or more of consolidated revenues in 1995, 1994, or 1993. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The corporate offices of the Company are located at 11333 McCormick Road, Hunt Valley, Maryland, in an eight-story building which is owned by the Company and contains approximately 163,000 square feet of office space. The offices of PHH Vehicle Management Services North American operations are located throughout the US and Canada. Primary office facilities are located in a six-story, 200,000-square foot office building in Hunt Valley, Maryland, leased until September 2003; and offices in Mississauga, Canada, having 31,600 square feet, leased until February 2003. Other facilities include office space totaling 17,700 square feet in five cities leased as full-service branch offices for fleet management activities for various terms to April 2003; two dealerships, one located in Williamsburg, Virginia, having 101,000 square feet, leased until March 1998 and the other in Edenton, North Carolina, having 337,100 square feet, leased until December 1998; offices in Fort Worth, Texas, having 63,000 square feet, leased until March 2002; and regional offices located in Montreal, Calgary, Vancouver, Mississauga & Quebec, Canada, having a total of 43,100 square feet, leased for various terms to December 2002. The offices of PHH Real Estate Services North American operations are located throughout the US and Canada. Primary office facilities are located in offices located in Wilton, Connecticut, having 42,000 square feet, leased until January 1996 and offices in Danbury, Connecticut, having 92,500 square feet, leased until January 2000. Other facilities include office space totaling\n54,000 square feet in Oak Brook, Illinois leased until April 2003; 23,350 square feet in Concord, California leased until October 1998; 42,300 square feet in Dallas, Texas leased until November 1998; 59,000 square feet in ten other cities for various terms to June 2002; and office space totaling 26,500 square feet in Toronto, Montreal, Vancouver, Ottawa and Nova Scotia, leased for various terms to September 1999. The offices of PHH Fantus are located in Florham Park, New Jersey, in offices having 14,200 square feet, leased until May 1996 and offices in Chicago, Illinois, having 8,800 square feet, leased until September 2004. The offices of PHH Mortgage Services are located primarily in a 127,000-square foot building in Mount Laurel, New Jersey, which is owned by the Company; and offices in Englewood, Colorado, having 27,900 square feet, leased until June 1997. The offices of Vehicle Management Services and Real Estate Services operations located in the United Kingdom and Europe are as follows: a 129,000-square foot building which is owned by the Company located in Swindon, United Kingdom; and field offices having 30,400 square feet located in Swindon and Manchester, United Kingdom; Munich, Germany; and Dublin, Ireland, are leased for various terms to February 2016. The Company considers that its properties are generally in good condition and well maintained and are generally suitable and adequate to carry on the Company's business. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company is party to various litigation arising in the ordinary course of business and is plaintiff in several collection matters which are not considered material either individually or in the aggregate. ITEM 4.","section_4":"ITEM 4. RESULTS OF VOTES OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended April 30, 1995.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Company's common stock is publicly traded on the New York Stock Exchange under the symbol \"PHH \". The common stock is entitled to dividends when and as declared by the Board of Directors. The payment of future dividends will depend upon earnings, the financial condition of the Company and other relevant factors. At April 30, 1995, there were 1,902 holders of common stock. The dividends and high and low prices for each quarter during the Company's 1995 and 1994 fiscal years were as follows:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS RESULTS OF OPERATIONS\nAll comparisons within the following discussion are to the previous year, unless otherwise stated.\nConsolidated net income increased 11% to $71.7 million in fiscal 1995 while net income per share increased 14% to $4.15. Increased income in the vehicle management services and real estate services business segments was partially offset by a decrease in the mortgage banking services business segment. In fiscal 1994, net income increased 14% to $64.6 million and net income per share increased 12% to $3.64, reflecting increases in the mortgage banking services and vehicle management services business segments partially offset by a decrease in the real estate services business segment.\nConsolidated revenues decreased 3% to $2,071 million in fiscal 1995 and increased 6% to $2,135 million in fiscal 1994.\nThe provision for income taxes reflects effective tax rates of 41% in both fiscal 1995 and 1994 and 40% in fiscal 1993. The fiscal 1995 and 1994 rates reflect the increase in the US federal corporate income tax rate to 35% from 34%.\nThe Company incurs and pays certain costs on behalf of its clients which include payments to third parties as a component of its service delivery. These direct costs are billed to clients and recognized as both revenue and expense. Additionally, certain other direct costs represent depreciation on vehicles under operating leases and amortization of mortgage servicing fees. Management analyzes its business results in terms of net revenue and total operating expenses. Net revenue, as defined by the Company, includes revenue earned reduced by the direct costs described above and also reduced by related interest required to fund assets. Operating expenses are all other costs incurred in delivering services to clients.\nNet revenues were $518.3 million in fiscal 1995, a decrease of 4% from the prior year, while operating income increased 10% to $121.3 million. Vehicle management services and real estate services increased in both net revenue and operating income offset by a decline in mortgage banking services. In fiscal 1994 net revenue increased 9% to $542.1 million due to increases in each business segment, while operating income increased 17% to $109.8 million due to increases in both vehicle management services and mortgage banking services offset slightly by a decline in real estate services. The following discussion is an analysis by business segment for net revenue and operating income.\nVehicle Management Services\nVehicle management services are offered to corporations and government agencies to assist them in effectively managing their vehicle fleet costs, reducing in-house administrative costs and enhancing driver productivity. Asset- based services generally require an investment by the Company and include new vehicle purchasing, open- and closed-end leasing, and used vehicle marketing. Fee-based services include maintenance management programs, expense reporting, fuel management programs, accident and safety programs and other driver services for managing clients' vehicle fleets.\nFiscal 1995 Results\nNet revenues for vehicle management services represent revenues earned and billed to clients reduced by depreciation on vehicles under operating leases and related interest. Total net revenues for this segment increased 2% to $240.1 million. Net revenues derived from asset-based products decreased 2% to $137.5 million due to a slight decrease in the number of leased vehicles under management and a reduction in revenue due to the benefit in the prior year of certain vehicle manufacturer incentive programs. The decrease in net revenues was somewhat offset by an increase in management fees per vehicle resulting from a higher average cost of vehicles managed; the effect of interest received from a US federal income tax refund attributable to this segment; as well as the results of a favorable US and UK resale market for disposition of vehicles under closed-end operating leases. Net revenue derived from fee-based services increased 9% to $102.6 million in fiscal 1995. The increase was due to growth in fuel management programs reflecting increased market penetration in the US and UK and increased fuel prices in the UK; growth in accident management programs, primarily in the UK; and growth in other driver services in North America and the UK.\nVehicle management services operating income increased 20% to $55.7 million in fiscal 1995. This was due to the increase in net revenue described above as well as an overall reduction in operating expenses. Cost reductions were achieved primarily in the area of information technology, slightly offset by one-time costs associated with office space consolidation, other costs incurred to integrate our US and Canadian operations and higher operating expenses in support of volume growth in fee-based services.\nThe Company's profitability from vehicle management services is affected by the number of vehicles managed and related services provided for clients. Therefore, profitability can be negatively affected by the general economy as corporate clients exercise a higher degree of fiscal caution by decreasing the size of their vehicle fleets or by extending the service period of existing fleet vehicles. Conversely, operating results are positively affected\nas clients increasingly choose to outsource their vehicle management service operations. Results can also be enhanced as the Company expands into new markets, increases its product diversity, broadens its client base and continues its productivity and quality improvement efforts.\nFiscal 1994 Results\nTotal vehicle management services net revenues increased 3% to $234.8 million. Net revenues derived from asset-based products increased 7% to $140.4 million. This resulted from higher revenues received from manufacturers for vehicle purchases and the benefit of certain vehicle manufacturer incentive programs; increased management fees received due to an increase in the average cost of vehicles managed; as well as the results of a favorable US and UK resale market for disposition of vehicles under closed-end operating leases. There was a slightly offsetting decrease due to a reduced number of vehicles purchased. Net revenue derived from fee-based services decreased 3% to $94.4 million in fiscal 1994. The decrease resulted from a reduction in fuel management programs slightly offset by growth in maintenance management programs in the US and other driver services.\nVehicle management services operating income increased 9% to $46.2 million in fiscal 1994. The increase primarily was due to increases in net revenue described above slightly offset by an increase in operating expenses. Operating expenses increased primarily due to costs related to information technology.\nReal Estate Services\nReal estate services primarily consist of the purchase, management and resale of homes for transferred employees of corporate clients, government agencies and members of affinity group clients. Asset-based services are defined as relocation services involving the purchase and resale of a home. Fee-based services include assistance in selecting homes in destination locations, marketing homes, moving household goods, property disposition services to financial institutions and other consulting services.\nFiscal 1995 Results\nReal estate services net revenues are those earned and billed to clients reduced by direct costs paid on behalf of clients and related interest. Total real estate services net revenues increased 2% to $188.9 million. Asset-based net revenues decreased 6% to $109.4 million. The decrease was primarily due to a reduction in margins reflecting a shift in product mix to more diversified, lower-priced products in response to client demand and to meet clients' changing relocation benefits offered to their transferring employees; a reduction in the number of transferee homes sold; and a lower level of funding provided to clients for equity advances. Asset-based net revenues were affected positively by an increase in the average value of transferee homes sold in the US. Fee- based net revenues increased 15% to $79.6 million primarily due to increased levels of residential properties managed for financial institutions, household goods moves and home finding services for relocating employees and affinity group members.\nReal estate services operating income increased 64% to $35.2 million. The increase was due to improvements in net revenues described above and, to a larger extent, a 6% reduction in operating expenses resulting from productivity improvements; a reduction in cost structure corresponding to the changing product mix for relocation services on a global basis; and a decrease in costs associated with the integration of an acquisition in Canada in the prior year.\nThe Company is generally not at risk on its carrying value of homes should there be a downturn in the housing market. Management anticipates its clients will continue to reassess their relocation plans as part of cost control measures, authorizing fewer home purchase transactions and utilizing a greater portion of fee-based real estate services. At the same time, operating results should be affected positively as clients increasingly choose to outsource their real estate services and as the Company expands into new markets, enhances its product diversity, broadens its client base and continues its productivity and quality improvement efforts.\nFiscal 1994 Results\nReal estate services net revenues increased 2% to $185.2 million. Asset- based net revenues decreased 8% to $116.2 million primarily due to a reduction in margins reflecting a shift to more diversified, lower-priced products in response to client demand as well as a lower level of funding provided to clients for equity advances. Asset-based net revenues were affected positively by an increase in the average value of transferee homes sold in the US. Fee- based net revenues increased 28% to $69.0 million primarily due to volume increases in home finding services for relocating employees and affinity groups, increases in home marketing and household goods moves for relocating employees, as well as the positive effect of the Company's acquisition of a relocation services operation in Canada.\nIn fiscal 1994, operating income decreased 19% to $21.5 million. The decrease was due to the overall increase in net revenues described above offset by an increase in operating expenses. The increase in operating expenses resulted from the Company's efforts to broaden its worldwide consulting business; enhance its information technology capabilities; consolidate office space in North America; and integrate its North American operations resulting from its acquisition in Canada.\nMortgage Banking Services\nMortgage banking services primarily consist of the origination, sale and servicing of residential first mortgage loans. The Company markets a variety of first mortgage products to consumers through relationships with corporations, affinity groups, government agencies, credit unions, real estate brokerage firms and other mortgage banks.\nFiscal 1995 Results\nMortgage banking services net revenues, measured as revenues earned reduced by direct costs for amortization and payments to third-party service providers on behalf of clients, decreased 27% to $89.3 million in fiscal 1995 primarily due to the decline in production net revenue. The sharp increase in mortgage rates greatly reduced refinance and new purchase loan activity creating intense competition within the industry for remaining market share. Such competition, accompanied by a consumer shift to adjustable rate mortgage products, served to reduce margins. As the margins declined on production volume, the Company responded to the market's increased demand for servicing rights and sold $3.6 billion of its servicing portfolio at a gain of $42.1 million. Servicing fee revenue increased as a result of an increase in the average servicing portfolio as well as the significantly reduced effect of portfolio prepayments and payoffs which, in fiscal 1994, required unscheduled amortization of $11.3 million of excess mortgage servicing fees.\nMortgage banking services operating income decreased 28% to $30.4 million. The decrease was due to the decline in net revenues as described above significantly offset by a reduction in operating expenses as the Company responded to the change in loan production volume.\nThe Company's profitability from mortgage banking services will be affected by such external factors as the level of interest rates, the strength of the economy, and the related condition of residential real estate markets. The Company's broad-based marketing strategies including further penetration of existing affinity groups and credit unions, signing new clients, and maintaining its system of delivering mortgages in a cost-efficient manner, should positively affect operating results in the future.\nFiscal 1994 Results\nIn fiscal 1994, net revenues increased 40% to $122.1 million. The increase was due to increased production net revenue caused by a reduction in mortgage rates and an increase in loan closing volume reflecting the increased demand for mortgage loans, especially to individuals interested in refinancing their existing residential property at lower mortgage rates and the increase in market penetration of new and existing clients. Servicing fee revenue increased as a result of growth in the average servicing portfolio partially offset by the unscheduled amortization of $11.3 million of excess mortgage servicing fees in fiscal 1994 and $11.9 million in fiscal 1993.\nMortgage banking services operating income increased 66% to $42.1 million in fiscal 1994. The increase in fiscal 1994 reflects increases in net revenues as discussed above partially offset by higher costs incurred to process increased loan closings and to manage the larger servicing portfolio.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn May 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 122, \"Accounting for Mortgage Servicing Rights.\" Application of this statement will require, among other provisions, that the Company recognize originated mortgage servicing rights, as well as purchased mortgage servicing rights, as assets. Presently, the cost of originated mortgage servicing rights is included with the cost of the related loans and expensed when the loan is sold, but the cost of purchased mortgage servicing rights is recorded as an asset. The Company intends to adopt SFAS No. 122 in the first quarter of fiscal 1996. The effect of this statement has been initially estimated to increase fiscal 1996 net income by approximately $20 million.\nIn March 1995, the FASB issued SFAS No. 121, effective in 1997, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" Application of this statement will require the Company to review long-lived assets and certain intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is not expected to significantly affect the consolidated financial statements of the Company.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company manages its funding sources to ensure adequate liquidity.\nThe sources of liquidity fall into three general areas: ongoing liquidation of assets under management, global capital markets, and committed credit agreements with various high-quality domestic and international banks. In the ordinary course of business, the liquidation of assets under management programs, as well as cash flows generated from operating activities, provide the cash flow necessary for the repayment of existing liabilities. (See Operating Activities and Investing Activities in the Company's Consolidated Statements of Cash Flows.)\nUsing historical information, the Company projects the time period that a client's vehicle will be in service or the length of time that a home will be held in inventory before being sold on behalf of a client. Once the relevant asset characteristics are projected, the Company generally matches the projected dollar amount, interest rate and maturity characteristics of the assets within the overall funding program. This is accomplished through stated debt terms or effectively modifying such terms through other instruments, primarily interest rate swap agreements and revolving credit agreements. (See Note to Liabilities Under Management Programs in Notes to Consolidated Financial Statements.) Within mortgage banking services, the Company funds the mortgage loans on a short-term basis until sale to unrelated investors, which generally occurs within sixty days. Interest rate risk on mortgages originated for sale is managed through the use of forward delivery contracts, financial futures and options.\nThe Company has maintained broad access to global capital markets by maintaining the quality of its assets under management. This is achieved by establishing credit standards to minimize credit risk and the potential for losses. Depending upon asset growth and financial market conditions, the Company utilizes the United States, Euro, Canadian and Sterling commercial paper markets, as well as other cost-effective, short-term instruments. In addition, the Company utilizes the public and private debt markets to issue unsecured senior corporate debt. Augmenting these sources, the Company has reduced outstanding debt by the sale or transfer of managed assets to third parties while retaining fee-related servicing responsibility. The Company's aggregate commercial paper outstanding totaled $2.3 and $2.1 billion at April 30, 1995, and April 30, 1994, respectively. At April 30, 1995, $1.4 billion in medium-term notes and $153 million in other debt securities were outstanding compared to $1.2 billion and $185 million, respectively, in fiscal 1994. (See Financing Activities in the Company's Consolidated Statements of Cash Flows.) From a risk management standpoint, borrowings not in the local currency of the business unit are converted to the local currency through the use of foreign currency forward contracts. The Company has maintained a leverage ratio between 7 to 1 and 8 to 1 over each of the last three years.\nTo provide additional financial flexibility, the Company's current policy is to ensure that minimum committed bank facilities aggregate 80% of the average amount of outstanding commercial paper. Committed revolving credit agreements totaling $2.1 billion and uncommitted lines of credit aggregating $346 million are currently in place with 31 domestic and international banks. Management closely evaluates not only the credit quality of the banks but the maturity of the various agreements to ensure ongoing availability. Of the Company's $2.1 billion in committed facilities at April 30, 1995, the full amount was undrawn and available. Management believes that its current policy provides adequate protection should financial stress occur in the commercial paper or medium-term note markets.\nThese established means of effectively matching floating and fixed interest rate and maturity characteristics of funding to related assets, the variety of short- and long-term domestic and international funding sources, and the committed banking facilities enable the Company to service its debt and offer a broad spectrum of service products to its clients.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT AND CONSENT OF INDEPENDENT AUDITORS The Stockholders and Board of Directors PHH Corporation: We have audited the consolidated financial statements of PHH Corporation and subsidiaries as listed in the accompanying index on page 28. 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 consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PHH Corporation and subsidiaries at April 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 April 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. KPMG Peat Marwick LLP Baltimore, Maryland May 22, 1995 To the Stockholders and Board of Directors PHH Corporation: We consent to incorporation by reference in the Registration Statements on Form S-3 (No. 2-90026, No. 33-48125, No. 33-52669 and No. 33-59376) and Form S-8 (No. 33-38309 and No. 33-53282) of PHH Corporation of our report dated May 22, 1995, relating to the consolidated balance sheets of PHH Corporation and subsidiaries as of April 30, 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 April 30, 1995, and all related schedules, which report appears in the April 30, 1995 annual report on Form 10-K of PHH Corporation. KPMG Peat Marwick LLP Baltimore, Maryland July 25, 1995\nConsolidated Statements of Income\nSee Notes to Consolidated Financial Statements.\nConsolidated Balance Sheets\nSee Notes to Consolidated Financial Statements.\nConsolidated Statements of Cash Flows\nSee Notes to Consolidated Financial Statements.\nConsolidated Statements of Stockholders' Equity\nSee Notes to Consolidated Financial Statements.\nNotes to Consolidated Financial Statements (In thousands except per share data)\nACCOUNTING POLICIES\nThe accounting policies of PHH Corporation conform to generally accepted accounting principles. The consolidated financial statements include the accounts of PHH Corporation and its wholly owned domestic and foreign subsidiaries (the Company). Policies outlined below include all policies considered significant. All significant intercompany balances and transactions have been eliminated.\nVehicle Management Services\nVehicle management services primarily consist of the management, purchase, leasing, and resale of vehicles for corporate clients and government agencies, including fuel, maintenance, accident and safety management programs and other fee-based services for clients' vehicle fleets. Revenues from these services other than leasing are taken into income over the periods in which the services are provided and the related expenses are incurred.\nThe Company leases vehicles to corporate fleet users under operating and direct financing lease arrangements. The initial lease term typically covers a period of twelve months or more and thereafter may be extended at the option of the lessee. The Company records the cost of leased vehicles as an \"investment in leases and leased vehicles.\" Amounts charged to lessees for interest on the unrecovered investment are credited to income on a level yield method which approximates the contractual terms.\nReal Estate Services\nReal estate services primarily consist of the purchase, management and resale of homes for transferred employees of corporations and government agencies. The Company pays transferring employees their equity based on an appraised value of their homes, determined by independent appraisers, after deducting any outstanding mortgages. In certain circumstances the mortgages may be retired concurrently with the purchase of the equity; otherwise, the Company normally accepts administrative responsibility for making payments on any mortgages. These mortgages are either retired at settlement or assumed by the purchaser when the homes are resold, which generally is within six months.\nThe client normally pays an advance billing for a portion of the costs to be incurred during the period the home is held for resale. These advances are included in \"advances from clients.\" These costs are paid by the Company and are identified as \"carrying costs on homes under management\" until resale. After resale, a settlement of actual costs and the advance billing is made with the client.\nRevenues and the related \"costs, including interest, of carrying and reselling homes\" are recognized at closing for the resale of the home. Under the terms of contracts with clients, the Company is generally protected against losses from changes in market conditions.\nThe Company also offers fee-based programs such as home marketing assistance, household goods moves, destination services, property dispositions for financial institutions and government agencies and strategic management consulting. Revenues from these fee-based services are taken into income over the periods in which the services are provided and the related expenses are incurred.\nMortgage Banking Services\nMortgage banking services primarily include the origination, sale and servicing of residential first mortgage loans. The Company markets a variety of first mortgage products to consumers through relationships with corporations, affinity groups, credit unions, real estate brokerage firms and other mortgage banks. Loan origination fees, commitment fees paid in connection with the sale of loans, and direct loan origination costs associated with loans held for resale, are deferred until the loan is sold. Fees received for servicing loans owned by investors are based on the difference between the weighted average yield received on the mortgages and the amount paid to the investor, or on a stipulated percentage of the outstanding monthly principal balance on such loans. Servicing fees are credited to income when received. Costs associated with loan servicing are charged to expense as incurred.\nSales of mortgage loans are generally recorded on the date a loan is delivered to an investor. Sales of mortgage securities are recorded on the settlement date. Gains or losses on sales of mortgage loans are recognized based upon the difference between the selling price and the carrying value of the related mortgage loans sold. Such gains and losses are increased or decreased by the amount of deferred mortgage servicing fees recorded.\nGains or losses on the sale of mortgage servicing rights are recognized when title and all risks and rewards have irrevocably passed to the buyer and there are no significant unresolved contingencies.\nProperty and Equipment\nProperty and equipment are carried at cost less accumulated depreciation and amortization. Depreciation of property and equipment is provided by charges to income over the estimated useful lives of such assets. Buildings are depreciated on the straight-line method (25 to 45 years); building improvements, on the straight-line method (10 to 20 years); equipment and leasehold improvements, on either the double-declining balance or straight-line method (3 to 10 years); and externally developed software is capitalized and amortized on the straight-line method (5 years). Expenditures for improvements that increase value or that extend the life of the assets are capitalized; maintenance and repairs are charged to operations. Gains or losses from retirements and disposals of property and equipment are included in selling, general and administrative expense.\nUnamortized Goodwill\nUnamortized goodwill represents the excess of cost over the net tangible and intangible assets of businesses acquired. It is being amortized by the straight- line method over various periods up to 40 years and is included in selling, general and administrative expense.\nAssets Under Management Programs\nAssets under management programs are held subject to leases or other client contracts. The effective interest rates and maturity characteristics of the leases and other contracts are generally matched with the characteristics of the overall funding program.\nTranslation of Foreign Currencies\nAssets and liabilities of the foreign subsidiaries are translated at the exchange rates as of the balance sheet dates; equity accounts are translated at historical exchange rates. Revenues, expenses and cash flows are translated at the average exchange rates for the periods presented. Translation gains and losses are included in stockholders' equity including, for years prior to 1991,\ntransaction gains and losses resulting from forward exchange contracts on foreign equity amounts net of income tax effects. Gains and losses resulting from the change in exchange rates realized upon settlement of foreign currency transactions are substantially offset by gains and losses realized upon settlement of forward exchange contracts. Therefore, the resulting net income effect of transaction gains and losses in fiscal years 1993 through 1995 was not significant.\nInterest\nInterest expense consists of interest on debt incurred to fund working capital requirements and to finance vehicle leasing activities, real estate services and mortgage banking operations. Interest used to finance equity advances on homes is included in \"costs, including interest, of carrying and reselling homes\" and was $21,102 in 1995, $23,491 in 1994, and $43,041 in 1993. Total interest paid, including amounts within \"costs, including interest, of carrying and reselling homes,\" was $211,206 in 1995, $165,406 in 1994, and $170,628 in 1993.\nIncome Taxes\nThe provision for income taxes includes deferred income taxes resulting from items reported in different periods for income tax and financial statement purposes. The Company computes deferred income taxes using the liability method. No provision has been made for US income taxes on cumulative undistributed earnings of foreign subsidiaries since it is the present intention of management to reinvest the undistributed earnings indefinitely in foreign operations. Undistributed earnings of the foreign subsidiaries at April 30, 1995, were $93,567. The determination of unrecognized deferred US tax liability for unremitted earnings is not practicable. However, it is estimated that foreign withholding taxes of $5,882 may be payable if such earnings were remitted.\nNet Income Per Share\nNet income per share is based on the weighted average number of shares of common stock outstanding during the year and common stock equivalents arising from the assumed exercise of outstanding stock options under the treasury stock method. The number of shares used in the calculations were 17,252,843 for 1995, 17,741,034 for 1994, and 17,356,824 for 1993.\nDerivative Financial Instruments\nAs a matter of policy, the Company does not engage in derivatives trading or market-making activities. Rather, derivative financial instruments such as interest rate swaps are used by the Company principally in the management of its interest rate exposures and foreign currency exposures on intercompany borrowings. Additionally, the Company enters into forward delivery contracts, financial futures programs and options to reduce the risks of adverse price fluctuation with respect to both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued.\nAmounts to be paid or received under interest rate swap agreements are accrued as interest rates change and are recognized over the life of the swap agreements as an adjustment to interest expense. The fair value of the swap agreements is not recognized in the consolidated financial statements since they are accounted for as hedges. Market value gains and losses on the Company's foreign currency transaction hedges are recognized in income and substantially offset the foreign exchange gains and losses on the underlying transactions. Market value gains and losses on positions used as hedges in the mortgage banking services operation are deferred and considered in the valuation of lower of cost or market value of mortgage loans held for sale.\nReclassifications\nCertain reclassifications have been made to the prior years' financial statements for comparative purposes.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn May 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 122, \"Accounting for Mortgage Servicing Rights\", effective for fiscal years beginning after December 15, 1995. Application of this statement will require that the Company recognize originated mortgage servicing rights, as well as purchased mortgage servicing rights, as assets. Presently, the cost of originated mortgage servicing rights is included with the cost of the related loans and recognized when the loan is sold, but the cost of purchased mortgage servicing rights is recorded as an asset. SFAS No. 122 also requires capitalized mortgage servicing rights, stratified based on the risk characteristics of the underlying loans, to be assessed for impairment based on the fair value of those rights. Impairment is to be recognized through a valuation allowance for each impaired stratum. The Company intends to adopt this statement in the first quarter of 1996. The effect of this statement has been initially estimated to increase net income in 1996 by approximately $20 million.\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\", effective in 1997. Application of this statement will require the Company to review long- lived assets and certain intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is not expected to significantly affect the consolidated financial statements of the Company.\nMORTGAGE LOANS HELD FOR SALE\nMortgage loans held for sale represent mortgage loans originated by the Company and held pending sale to permanent investors. Such mortgage loans are recorded at the lower of cost or market value as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis.\nThe Company issues mortgage-backed certificates insured or guaranteed by the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC), Government National Mortgage Association (GNMA) and other private insurance agencies. The insurance provided by FNMA and FHLMC and other private insurance agencies are on a non-recourse basis to the Company. However, the guarantee provided by GNMA is only to the extent recoverable from insurance programs of the Federal Housing Administration and the Veterans Administration. The outstanding principal balance of mortgages backing GNMA certificates issued by the Company aggregated approximately $1,699,233 and $1,139,199 at April 30, 1995 and 1994, respectively. Additionally, the Company sells mortgage loans as part of various mortgage-backed security programs sponsored by FNMA, FHLMC and GNMA. Certain of these sales are subject to recourse or indemnification provisions in the event of default by the borrower. As of April 30, 1995, mortgage loans sold with recourse amounted to $43,383. The Company believes adequate reserves are maintained to cover all potential losses.\nPROPERTY AND EQUIPMENT\nProperty and equipment at April 30 consisted of the following:\nOTHER ASSETS Other assets at April 30 consisted of the following:\nThe unamortized mortgage servicing fees represent the value of purchased servicing rights and excess servicing fees which are deferred. Such servicing rights and fees are charged to income over the estimated effective life of the related mortgages, estimated to average seven years. Mortgage loans serviced were $16,017,416 and $16,644,730 at April 30, 1995 and 1994, respectively. Mortgage-related notes receivable are loans secured by real estate. Residential properties held for resale are located primarily in the US and are carried at the lower of cost or net realizable value.\nASSETS UNDER MANAGEMENT PROGRAMS\nNet Investment in Leases and Leased Vehicles\nThe net investment in leases and leased vehicles at April 30 consisted of the following:\nThe Company leases vehicles for initial periods of twelve months or more under either operating or direct financing lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Lessee repayments of investments in leases and leased vehicles for 1995 and 1994 were $1,452,330 and $1,358,156, respectively; and the ratio of such repayments to the average net investment in leases and leased vehicles was 50% in 1995 and 49% in 1994.\nThe Company has two types of operating leases. Under one type, open-end operating leases, resale of the vehicles upon termination of the lease is generally for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding the residual value guarantees. Maintenance and repairs of vehicles under these agreements are the responsibility of the lessee. The original cost of vehicles under this type of operating lease at April 30, 1995 and 1994, was $3,898,000 and $3,538,000, respectively.\nUnder the other type of operating lease, closed-end operating leases, resale of the vehicles on termination of the lease is for the account of the Company. The lessee generally pays for or provides maintenance, vehicle licenses and servicing. The original cost of vehicles under these agreements at April 30, 1995 and 1994, was $391,000 and $367,000, respectively. The Company believes adequate reserves are maintained in the event of loss on vehicle disposition.\nUnder the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. Maintenance and repairs of these vehicles are the responsibility of the lessee.\nLeasing revenues are included in revenues from vehicle management services. Following is a summary of leasing revenues for years ended April 30:\nThe Company has transferred existing managed vehicles and related leases to unrelated investors and has retained servicing responsibility. Credit risk for such agreements is retained by the Company to a maximum extent in one of two forms: excess assets transferred, which were $8,389 and $12,836 at April 30, 1995 and 1994, respectively; or guarantees to a maximum extent of $907 and $2,749 at April 30, 1995 and 1994, respectively. All such credit risk has been included in the Company's consideration of related reserves. The outstanding balances under such agreements aggregated $166,379 and $189,480 at April 30, 1995 and 1994, respectively.\nOther managed vehicles with balances aggregating $175,111 and $206,740 at April 30, 1995 and 1994, respectively, are included in special purpose entities whose ownership is deemed unrelated to the Company and whose credit and residual value risk characteristics are ultimately not the Company's responsibility.\nEquity Advances on Homes\nEquity advances on homes represent advances paid to transferring employees of clients for their equity based on appraised values of their homes.\nOTHER DEBT\nOther debt at April 30 consisted of the following:\nCommercial paper programs are more fully described in the Note for Liabilities Under Management Programs. The medium-term note represents an unsecured obligation having a fixed interest rate of 6.5% with interest payable semi-annually and a term of seven years payable in full in fiscal 2000.\nINCOME TAXES\nProvisions (credits) for income taxes for the years ended April 30, were comprised as follows:\nDeferred income taxes are recorded based upon differences between the financial statements and the tax bases of assets and liabilities and available tax credit carryforwards. There was no valuation allowance relating to deferred tax assets. Deferred tax assets (liabilities) as of April 30 were comprised as follows:\nThe portions of the 1995 income tax liability and provision classified as current and deferred are subject to final determination based on the actual 1995 income tax returns. The liability and provision amounts for 1994 have been reclassified to reflect the final determination made in filing the 1994 income tax returns.\nThe Company paid income taxes of $26,049 in 1995, $35,739 in 1994, and $50,092 in 1993.\nA summary of the reasons for differences between the statutory federal income tax rate and the Company's effective income tax rate follows:\nThe Company's US federal income tax returns have been examined by the Internal Revenue Service through April 30, 1991.\nLIABILITIES UNDER MANAGEMENT PROGRAMS\nBorrowings to fund assets under management programs are classified as \"liabilities under management programs\" and, at April 30, consisted of the following:\nCommercial paper, all of which matures within ninety days, is supported by committed revolving credit agreements described below and short-term lines of credit. The weighted average interest rates on the Company's outstanding commercial paper were 6.3% and 4.0% at April 30, 1995 and 1994, respectively.\nMedium-term notes represent unsecured loans which mature as follows: $1,161,000 in 1996, and $100,000 in 1997. The weighted average interest rates on medium-term notes were 5.7% and 4.1% at April 30, 1995 and 1994, respectively.\nLimited recourse debt and secured notes payable on vehicles under lease primarily consist of secured loans arranged for certain clients for their convenience. The lenders hold a security interest in the lease payments and the clients' leased vehicles. The debt and notes payable mature concurrently with the related lease payments. The aggregate lease payments due from the lessees exceed the loan repayment requirements. The weighted average interest rates on secured debt were 6.4% and 4.2% at April 30, 1995 and 1994, respectively.\nThe Company has unsecured committed credit agreements with various banks totaling $2,111,000. These agreements have both fixed and evergreen maturities ranging from May 1, 1995, to April 30, 1998. The evergreen revolving credit agreements require a notice of termination of one to three years. Interest rates under all revolvers are either at fixed rates or vary with the prime rate or the London Interbank Offered Rate. Under these agreements, the Company is obligated to pay annual commitment fees which were $2,904 and $3,975 in 1995 and 1994, respectively. The Company has other unused lines of credit of $262,000 and $223,000 at April 30, 1995 and 1994, respectively, with various banks.\nOther unsecured debt, all of which matures in 1996, includes other borrowings under short-term lines of credit and other bank facilities. The weighted average interest rates on unsecured debt were 6.2% and 5.2% at April 30, 1995 and 1994, respectively.\nAlthough the period of service for a vehicle is at the lessee's option, and the period a home is held for resale varies, management estimates, by using historical information, the rate at which vehicles will be disposed and the rate at which homes will be resold. These projections of estimated liquidations of assets under management programs and the related estimated repayment of liabilities under management programs as of April 30, 1995, as set forth in the table below, indicate that the actual repayments of liabilities under management programs will be different than required by contractual maturities.\nDERIVATIVE FINANCIAL INSTRUMENTS The Company employs interest rate swap agreements to match effectively the fixed or floating rate nature of liabilities to the assets funded. A key assumption in the following information is that rates remain constant at April 30, 1995 levels. To the extent that rates change, both the maturity and variable interest rate information will change. However, the net rate the Company pays remains matched with the assets funded.\nThe following table summarizes the maturity and weighted average rates of the Company's interest rate swaps employed at April 30, 1995. These characteristics are effectively offset within the portfolio of assets funded by the Company.\nFor the year ended April 30, 1995, the Company's hedging activities increased interest expense $1,496 and had no effect on its weighted average borrowing rate. For the same periods in 1994 and 1993, hedging activities increased interest expense by $12,632 and $16,382, and increased the weighted average borrowing rate 0.3% and 0.5%, respectively.\nThe Company enters into foreign exchange contracts as hedges against currency fluctuation on certain intercompany loans. Such contracts effectively offset the currency risk applicable to approximately $80,600 and $85,852 of obligations at April 30, 1995 and 1994, respectively.\nThe Company is exposed to credit-related losses in the event of non- performance by counterparties to certain derivative financial instruments. The Company manages such risk by periodically evaluating the financial condition of counterparties and spreading its positions among multiple counterparties. The Company presently does not expect non-performance by any of the counterparties.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:\n(bullet)Cash, accounts receivable, certain other assets and commercial paper borrowings. Due to the short-term nature of these financial instruments, the carrying value equals or approximates fair value.\n(bullet)Mortgage loans held for sale. Fair value is estimated using the quoted market prices for securities backed by similar types of loans and current dealer commitments to purchase loans. These loans are priced to be sold with servicing rights retained. Gains (losses) on mortgage-related positions, used to reduce the risks of adverse price fluctuations, for both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued, are included in the carrying amount of mortgage loans held for sale.\n(bullet)Deferred mortgage servicing fees. Fair value is estimated by discounting future excess cash flows of fees associated with the underlying securities backing this asset using discount rates that approximate market rates and externally published prepayment rates, adjusted, if appropriate, for individual portfolio characteristics.\n(bullet)Borrowings. Fair value of borrowings, other than commercial paper, is estimated based on quoted market prices or market comparables.\n(bullet)Interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options. The fair value of interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options is estimated, using dealer quotes, as the amount that the Company would receive or pay to execute a new agreement with terms identical to those remaining on the current agreement, considering interest rates at the reporting date.\nThe following table sets forth information about financial instruments, except for those noted above for which the carrying value approximates fair value, at April 30, 1995 and 1994:\n* Gains (losses) on mortgage-related positions are already included in the determination of market value of mortgage loans held for sale.\nSTOCK OPTION, INVESTMENT AND INCENTIVE PLANS\nThe Company's employee stock option plans allow for options to be granted to key employees for the purchase of common stock at prices not less than fair market value on the date of grant. Either incentive stock options or non- statutory stock options may be granted under the plans. The Company's Directors' stock option plan allows for options to be granted to outside Directors of the Company for the purchase of common stock at prices not less than fair market value on the date of grant. Options become exercisable after one year from date of grant on a vesting schedule provided by the plans, and expire ten years after the date of the grant. Option transactions during 1995, 1994, and 1993 were as follows:\nIn addition to outstanding options, at April 30, 1995, there were 1,036,196 shares of common stock reserved, including 856,872 shares for issuance under future employee stock option plan awards, 118,324 shares for future issuance under the employee investment plan and 61,000 shares for future issuance under the Director's stock option plan.\nUnder provisions of the Company's employee investment plan, a qualified retirement plan, eligible employees may generally have up to 10% of their base salaries withheld and placed with an independent custodian and elect to invest in common stock of the Company, an index equity fund, a growth equity fund, an international equity fund, a fixed income fund, an asset allocation fund and\/or a money market fund. The Company's contributions vest proportionately in accordance with an employee's years of vesting service, with an employee being 100% vested after three years of vesting service. The Company matches, in common stock of the Company, employee contributions to 3% of their base salaries, with an additional 3% match available at the end of the year based on the Company's operating results. In the three years presented the Company made additional matches of 50% of employee contributions greater than 3% up to 6%. The additional match, initially invested in a money market fund, can be redirected by the employee into any of the investment elections noted above. The Company's expenses for contributions were $4,483, $4,020, and $3,662 for the years ended April 30, 1995 and the two preceding years, respectively.\nThe Company has incentive compensation plans for certain key employees. The plans provide for the payment of cash bonuses or, in some instances, stock incentives, based upon the achievement of predetermined performance objectives. The related expense included in selling, general and administrative expenses for 1995, 1994 and 1993 was $5,581, $6,086 and $5,659, respectively.\nSTOCK RIGHTS\nOn March 17, 1986, the Company declared a dividend of one preferred share purchase right for each share of common stock outstanding on April 11, 1986. The Company adopted an amendment to its rights agreement January 16, 1989. Each right entitles the holder to purchase 1\/100th of a share of series A Junior Participating Preferred Stock at an exercise price of $120. The rights become exercisable in the event any party acquires or announces an offer to acquire 20% or more of the Company's common stock. The rights expire April 10, 1996, and are redeemable at $.05 per right prior to the time any party owns 20% or more of the Company's outstanding common stock. In the event the Company enters into a consolidation or merger after the time rights are exercisable, the rights provide that the holder will receive, upon exercise of the right, shares of common stock of the surviving company having a market value of twice the exercise price of the right. Until the earlier of the time the rights become exercisable, are redeemed or expire, the Company will issue one right with each new share of common stock issued. The Company has designated 200,000 shares of the authorized preferred shares as series A Junior Participating Preferred Stock for issuance upon exercise of the rights.\nPENSION AND OTHER EMPLOYEE BENEFIT PLANS\nPension and Supplemental Retirement Plans\nThe Company has a non-contributory defined benefit pension plan covering substantially all US employees of the Company and its subsidiaries. The Company's subsidiary located in the UK has a contributory defined benefit pension plan, with participation at the employee's option. Under both the US and UK plans, benefits are based on an employee's years of credited service and a percentage of final average compensation. The Company's policy for both plans is to contribute amounts sufficient to meet the minimum requirements plus other amounts as the Company deems appropriate from time to time. The Company also sponsors two unfunded supplemental retirement plans to provide certain key executives with benefits in excess of limits under the federal tax law and to include annual incentive payments in benefit calculations.\nNet costs included the following components for the years ended April 30:\nA summary of the plans' status and the Company's recorded liability recognized in the Consolidated Balance Sheets at April 30 follows:\nAssumptions\nCertain assumptions were used in determining the cost and related obligations under the US pension and unfunded supplemental retirement plans as follows:\nPostretirement Benefits Other Than Pensions\nThe Company provides healthcare and life insurance benefits for certain retired employees up to the age of 65. Such postretirement benefits costs, determined in accordance with SFAS No.106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" for 1995 and 1994, were $1,474 and $1,551, respectively. Prior to adoption of SFAS No. 106, the Company recognized the costs of these benefits by expensing the benefits as paid. The aggregate costs of such benefits did not exceed $500 in 1993.\nLEASE COMMITMENTS\nTotal rental expenses relating to office facilities and equipment were $24,195, $27,264, and $25,368 for 1995, 1994 and 1993, respectively. Minimum rental commitments under non-cancelable leases with remaining terms in excess of one year are as follows:\nThese leases provide for additional rentals based on the lessors' increased property taxes, maintenance and operating expenses.\nCONTINGENT LIABILITIES\nThe Company and its subsidiaries are involved in pending litigation of the usual character incidental to the business transacted by them. In the opinion of management, such litigation will not have a material effect on the Company's consolidated financial statements.\nThe Company is contingently liable under the terms of an agreement involving its discontinued aviation services segment for payment of Industrial Revenue Bonds issued by local governmental authorities operating at three airports. The Company believes its allowance for disposition loss is sufficient to cover all potential liability.\nBUSINESS SEGMENTS\nThe Company operations are classified into three business segments: vehicle management services, real estate services and mortgage banking services. Vehicle management services and real estate services are provided in North America and Europe. Mortgage banking services are provided in the US. Selected information by business segment and geographic area follows:\nBusiness Segments\nGeographic Areas\nQuarterly Financial Data (Unaudited)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to the Directors is contained on pages 2 through 6 of the Registrant's Proxy Statement for its 1995 Annual Meeting of Stockholders, which information is hereby incorporated by reference. EXECUTIVE OFFICERS OF THE REGISTRANT\nOfficers are elected by the Board of Directors to serve at the pleasure of the Board. There is no family relationship between any of such persons. Each of the persons named above has been employed by the Company or one of its subsidiaries for more than the past five years. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Information with respect to executive compensation is contained on pages 9 through 18 of the Registrant's Proxy Statement for its 1995 Annual Meeting of Stockholders, which information is hereby incorporated by reference. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with respect to security ownership of certain beneficial owners and management is contained on pages 7 and 8 of the Registrant's Proxy Statement for its 1995 Annual Meeting of Stockholders, which information is hereby incorporated by reference. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(b) Reports on Form 8-K -- There were no filings on Form 8-K during the fourth quarter of fiscal 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. PHH CORPORATION By ROBERT D. KUNISCH Robert D. Kunisch 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: Principal Executive Officer:\nROBERT D. KUNISCH Robert D. Kunisch Chairman of the Board, Chief Executive Officer and President\nPrincipal Financial Officer:\nROY A. MEIERHENRY Roy A. Meierhenry Senior Vice President and Chief Financial Officer\nPrincipal Accounting Officer:\nNAN A. GRANT Nan A. Grant Controller\nMajority of the Board of Directors: Robert D. Kunisch, James S. Beard, Andrew F. Brimmer, George L. Bunting, Jr., Alan P. Hoblitzell, Jr., Paul X. Kelley, L. Patton Kline, Francis P. Lucier, Kent C. Nelson, Donald J. Shepard, Alexander B. Trowbridge\nROBERT D. KUNISCH Robert D. Kunisch As Attorney-in-fact\nPHH CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED APRIL 30, 1995, 1994 AND 1993\nNOTES:(a) Amounts relate to acquisitions, divestitures and reclassifications of prior year amounts. (b) Deductions from reserves represent accounts charged off, less recoveries, and foreign translation gains and losses. (c) Amounts have been restated for comparative purposes.","section_15":""}
{"filename":"786470_1995.txt","cik":"786470","year":"1995","section_1":"Item 1. BUSINESS\nFidelity Leasing Income Fund III, L.P. (the \"Fund\"), a Delaware limited partnership, was organized in 1985 and acquired equipment, primarily computer peripheral equipment, including printers, tape and disk storage devices, data communications equipment, computer terminals, data processing and office equipment, which was leased to third parties on a short-term basis. The Fund's principal objective is to generate leasing revenues for distribution. The Fund manages the equipment, releasing or disposing of equipment as it comes off lease in order to achieve its principal objective. The Fund does not borrow funds to purchase equipment.\nThe Fund closed on April 30, 1987 and raised $34,985,398 of proceeds through the sale of limited partnership units. Equipment of approximately $42,586,000 was purchased through December 31, 1995 with these proceeds raised, and also with cash distributions which were reinvested by partners and cash from operations which was not distributed to partners. As of December 31, 1995, the Fund has equipment on lease and equipment held for sale or lease with an approximate total net book value of $324,000. The General Partner intends to liquidate the remaining equipment by December 31, 1996.\nThe Fund generally acquired equipment subject to a lease. Purchases of equipment for lease were 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 acquired was generally leased under \"operating\" leases. Operating leases provided the Fund as lessor, aggregate rental payments in an amount that is less than the purchase price of the equipment. Operating leases represent a greater risk but with the potential for increased returns, depending on the realization of renewal and remarketing results, as compared to full payout leases. Full payout leases are generally for longer initial terms whereby the noncancellable rental payments due during the initial term of the lease are at least sufficient to recover the purchase price of the equipment. Due to technological, competitive, market and economic factors, the Fund experienced renewals and remarketing of leases at lower rental rates and residual values than was forecasted at the inception of the leases.\nThe Fund's ability to attain its investment objectives was subject to the factors discussed above. The Fund competed in the equipment leasing industry with leasing companies, equipment manufacturers and distributors, and entities similar to the Fund (including similar programs sponsored by the General Partner), some of which had greater financial resources than the Fund and more experience in the equipment leasing business than the General Partner. This competition may have been in the position to offer equipment to lessees on financial terms more favorable than those which the Fund could offer. The offer of maintenance contracts, trade-in-privileges and other services which the Fund could not provide may have resulted in the Fund leasing its equipment on a less favorable basis than its competitors.\nIn addition, competitive factors in the computer equipment industry, including pricing, technological innovation and methods of financing, could have adversely affected the Fund in its ability to obtain new leases and renewals or to sell equipment for its anticipated net realizable values.\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 $ 2,662,644 43.29% Disk Storage Systems 867,962 14.11 Network Communications 619,568 10.07 Personal Computers, Terminals and Work Stations 200,737 3.26 Printers 1,350,386 21.95 Tape Storage Systems 438,035 7.12 Other 12,514 0.20 ___________ ______\nTotals $ 6,151,846 100.00% =========== ======\nBreakdown of Equipment Usage By Industrial Classification\nPurchase Price Percentage of Type of Business of Equipment Total Equipment\nComputers\/Data Processing $ 1,327,647 21.58% Diversified Financial\/Banking\/ Insurance 915,912 14.89 Manufacturing\/Refining 1,856,787 30.18 Publishing\/Printing 563,309 9.16 Retailing\/Consumer Goods 937,092 15.23 Telephone\/Telecommunications 546,907 8.89 Utilities 4,192 0.07 __________ ______\nTotals $ 6,151,846 100.00% ========== ======\nAverage Initial Term of Leases (in months): 39\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 2,098\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 $2,043,528, $3,819,594 and $4,494,595 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 on operating leases. Rental income from the leasing of computer peripheral equipment accounted for 87%, 94% and 92% of total income in 1995, 1994 and 1993, respectively. In 1995, rental income decreased by approximately $1,850,000 because of equipment which came off lease and was re-leased at lower rental rates or sold. This decrease, however, was offset by rental income of approximately $53,000 generated 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 $733,000 because of equipment which came off lease and was re-leased at lower rental rates or sold. This decrease, however, was offset by rental income of $166,000 generated from 1994 equipment purchases and rents realized on 1993 equipment purchases for which only a partial year was earned in 1993 but a full year was earned in 1994. In addition, the Fund recognized a net gain on sale of equipment of $215,441, $190,212 and $243,108 for the years ended December 31, 1995, 1994 and 1993, respectively which affected the decrease in total revenues for these years. Furthermore, interest income decreased in 1995 and 1994 due to a decrease in cash available for investment and, in 1994, the decline in interest rates also accounts for the decline in interest income. The decrease in interest income contributed to the decrease in total revenues for these years, as well.\nExpenses were $1,118,000, $3,125,716 and $3,769,508 for the years ended December 31, 1995, 1994 and 1993, respectively. Depreciation expense comprised 63% of total expenses in 1995, 80% of total expenses in 1994 and 78% of total expenses in 1993. The decrease in expenses between these years is primarily attributable to the 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 releasing of equipment, technological developments and information provided in third party publications. In 1995, 1994 and 1993, approximately $141,000, $148,000 and $359,000, respectively, was charged to write-down of equipment to net realizable value which also accounts for the decrease in total expenses in 1995 and 1994. 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 sale of its rental equipment. 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. Additionally, the decline in management fees, resulting from the decrease in rental income contributed to the decrease in total expenses in 1995 and 1994.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nThe Fund's net income was $925,528, $693,878 and $725,087 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 $87.50, $43.18 and $27.52 for the years ended December 31, 1995, 1994 and 1993, respectively. The weighted average number of equivalent limited partnership units outstanding were 10,161, 15,240 and 24,357 for 1995, 1994 and 1993, respectively.\nThe Fund generated funds from operations, for the purpose of determining cash available for distribution, of $1,556,199, $3,164,239 and $3,763,637 and declared distributions of $1,892,377, $3,573,922 and $5,470,813 to partners for 1995, 1994 and 1993, respectively. The distributions for 1995, 1994 and 1993 include $336,178, $409,683 and $1,707,176, respectively, of sales proceeds and 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 General Partner has commenced the dissolution process for the Fund with the intent of fully liquidating the Fund by the end of 1996. Therefore, as leases expire, the General Partner will seek to sell the equipment at its market value or extend the equipment for lease terms consistent with the plan of liquidation. The Fund purchased $1,984, $181,144 and $828,475 of equipment during the years ended December 31, 1995, 1994 and 1993 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. 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 $106,214(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 1985, 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 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 $106,214 of management fees by the General Partner. The General Partner will continue to receive 6% of rental payments on equipment under operating leases for administrative and management services performed on behalf of the Fund.\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.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nThe General Partner also receives 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 $31,706 of cash distributions.\nThe Fund incurred $32,766 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 III, L.P. A Delaware limited partnership\nBy: FIDELITY LEASING CORPORATION\nFreddie M. Kotek, Chairman 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 III, L.P.\nWe have audited the accompanying balance sheets of Fidelity Leasing Income Fund III, 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 III, 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 III, L.P.\nBALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND III, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND III, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND III, L.P.\nIn addition, the General Partner declared a cash distribution of $250,000 in February 1996 for the three months ended December 31, 1995, to all admitted partners as of December 31, 1995.","section_15":""}
{"filename":"813621_1995.txt","cik":"813621","year":"1995","section_1":"Item 1. Business\nINTRODUCTION\nAMCOL International Corporation was originally incorporated in South Dakota in 1924 as the Bentonite Mining & Manufacturing Co. Its name was changed to American Colloid Company in 1927, and in 1959, the Company was reincorporated in Delaware. In 1995, its name was changed to AMCOL International Corporation. Except as otherwise noted, or indicated by context, the term \"Company\" refers to AMCOL International Corporation and its subsidiaries.\nThe Company may be generally divided into three principal categories of operations; minerals, absorbent polymers and environmental. The Company also operates a transportation business primarily for delivery of its own products. In general, the Company's products are used for their liquid-absorption properties. The Company is a leading producer of bentonite products, which have a variety of applications, including use as a bonding agent to form sand molds for metal castings, as a cat litter, as a moisture barrier in commercial construction and landfills, and in a variety of other industrial, commercial and agricultural applications. The Company also manufactures absorbent polymers, predominantly superabsorbent polymers, for use in disposable baby diapers and other personal care items, such as adult incontinence and feminine hygiene products.\nThe following table sets forth the percentage contributions to net sales of the Company attributable to its mineral, absorbent polymer, environmental and transportation segments for the last five calendar years.\nNet revenues, operating profit and identifiable assets attributable to each of the Company's business segments are set forth in Note 2 of the Company's Notes to Consolidated Financial Statements included elsewhere herein, which Note is incorporated herein by reference.\nMINERALS\nThe Company's mineral business is principally conducted through American Colloid Company in the United States and Volclay Limited in the United Kingdom.\nCommercially produced bentonite is a type of montmorillonite clay found in beds ranging in thickness from two to ten feet under overburden of up to 120 feet. There are two basic types of bentonite, each having different chemical and physical properties. These are commonly known as sodium (western) bentonite and calcium (southern) bentonite. A third type of clay, a less pure variety of calcium montmorillonite called fuller's earth, is used as a form of cat litter and as a carrier for agri-chemicals in addition to other minor applications.\nThe Company's principal bentonite products are marketed under various internationally registered trade names, including VOLCLAY and PANTHER CREEK. The Company's cat litter is sold under various trade names and private labels.\nPrincipal Markets and Products\nDurable Goods\nMetalcasting. In the formation of sand molds for metal castings, sand is bonded with bentonite and various other additives to yield the desired casting form and surface finish. The Company produces blended mineral binders containing sodium and calcium bentonites, sold under the trade name ADDITROL. In addition, several high-performance specialty products are sold to foundries and companies that service foundries.\nIron Ore Pelletizing. The Company is a major supplier of sodium bentonite for use as a pelletizing aid in the production of taconite pellets in North America.\nWell Drilling. Sodium bentonite and leonardite are ingredients of drilling mud, which allow rock cuttings to be suspended and brought to the surface in oil and gas well drilling. Drilling mud lubricates the drilling bit and coats the underground formations to prevent hole collapse and drill bit seizing. The Company's primary trademark for this application is PREMIUM GEL.\nOther Industrial. The Company is a supplier of fuller's earth products for use as an oil and grease absorbent in industrial applications. It also produces bentonite and bentonite blends for the construction industry, which are used as a plasticizing agent in cement, plaster and bricks, and as an emulsifier in asphalt.\nConsumable Goods\nCat Litter. The Company produces two types of cat litter products, a fuller's earth-based (traditional) product and a sodium bentonite-based scoopable (clumping) litter. The Company's scoopable products' clump-forming capability traps urine, allowing for easy removal of the odor-producing elements from the litter box. Scoopable litter has grown to 42% of the U.S. grocery market for cat litter in 1995 from 0.4% in 1989. Both types of products are sold primarily to private label grocery and mass merchandisers, though the Company also sells its own brands to the grocery, pet store and mass markets. The Company's products are marketed under various trade names.\nFine Chemicals. Purified grades of sodium bentonite are marketed to the pharmaceutical and cosmetics industries. Small amounts of purified bentonite act as a binding agent for pharmaceutical tablets, and bentonite's expansion quality also aids in tablet disintegration. Bentonite also acts as a suspension agent and thickener in lotions and has a variety of other specialized uses as a flow control additive. Calcium bentonite is used as a catalyst or as a clarifying agent for edible oils, fats, dimer acids and petroleum products.\nAgricultural. Sodium bentonite, calcium bentonite and fuller's earth are sold as pelletizing aids in livestock feed and as anticaking agents for feeds during storage or in transit. Fuller's earth and sodium bentonite are used as carriers for agri-chemicals. Fuller's earth is also used as a drying agent in blending liquid and dry fertilizers prior to application.\nSales and Distribution\nIn 1995, the top two customers accounted for approximately 9% of the Company's mineral sales, and the top five customers accounted for approximately 16% of such sales. Products are sold domestically and internationally to approximately 3,700 customers.\nThe Company has established industry-specialized sales groups staffed with technically-oriented salespersons serving each of the Company's major markets. Certain groups have networks of distributors and representatives, including companies that warehouse at strategic locations.\nMost of its customers in the metalcasting industry are served on a direct basis by teams of Company sales, technical and manufacturing personnel. The Company also provides training courses and laboratory testing for customers who use the Company's products in the metalcasting process.\nSales to the oil well drilling industry are primarily made directly to oil well drilling mud service companies, both under the Company's tradename and under private label. Because bentonite is a major component of drilling muds, two service companies have captive bentonite operations. The Company's potential market is, therefore, generally limited to those oil well service organizations which are not vertically integrated, or do not have long-term supply arrangements with other producers.\nSales to the cat litter market are made on a direct basis and through industry brokers. All sales to the iron ore pelletizing industry are made directly to the end user. Sales to the Company's remaining markets are made primarily through independent distributors and representatives.\nCompetition\nBentonite. The Company is one of the largest producers of bentonite products in the United States. There are at least four other major domestic producers of sodium bentonite and at least one other major domestic producer of calcium bentonite. Two of the domestic producers are companies primarily in other lines of business and have substantially greater financial resources than the Company. There also is substantial global competition. The Company's bentonite processing plants in the United Kingdom and Australia compete with a total of six U.K. and Australian processors. Competition in both the Company's domestic and international markets is essentially a matter of product quality, price, delivery, service and technical support, and it historically has been very vigorous.\nFuller's Earth. There are approximately ten major competitors in the United States, some of which are larger and have substantially greater financial resources than the Company. Price, service, product quality and geographical proximity to the market are the principal methods of competition in the Company's markets for fuller's earth.\nSeasonality\nAlthough business activities in certain of the industries in which the Company's mineral products are sold (such as well drilling) are subject to factors such as weather conditions, the Company does not consider its mineral business as a whole to be seasonal.\nENVIRONMENTAL\nPrincipal Products and Markets\nThrough its wholly owned subsidiary, Colloid Environmental Technologies Company (CETCO), the Company sells sodium bentonite, products containing sodium bentonite and various other products and equipment for use in environmental and construction applications.\nCETCO sells bentonite, and its geosynthetic clay liner products under the BENTOMAT and CLAYMAX trade names, for lining and capping landfills and for containment in tank farms, leach pads, waste stabilization lagoons and decorative ponds.\nThe Company's VOLCLAY Waterproofing System is sold to the non-residential construction industry. This line includes a product sold under the registered trade name VOLCLAY PANELS consisting of biodegradable cardboard panels filled with sodium bentonite installed to prevent leakage through underground foundation walls. A waterproofing liner product with the trade name VOLTEX, a joint sealant product with the trade name WATERSTOP-RX and a waterproofing membrane for concrete split slabs and plaza areas sold under the trade name VOLCLAY SWELLTITE, round out the principal components of the product line.\nCETCO sells elastomeric urethane coatings for use in vehicular traffic decks, roofs, balconies and pedestrian walkways. The products, sold under the trade name ACCOGUARD, are among the more environmentally friendly primers and coatings available to the construction industry.\nCETCO's drilling products are used to install monitoring wells and water wells, rehabilitate existing water wells and seal abandoned exploration drill holes. VOLCLAY GROUT, BENTOGROUT and VOLCLAY Tablets are among the trade names for products used in these applications.\nBentonite-based flocculents and customized equipment are used to remove emulsified oils and heavy metals from wastewater. Bentonite-based products are formulated to solidify liquid waste for proper disposal in landfills. These products are sold primarily under the SYSTEM-AC, RM10 and SORBOND trade names.\nCETCO also specializes in providing absorption equipment and services to the environmental remediation industry, water treatment systems employing dissolved air flotation technology and activated carbon purification systems for the beverage and municipal water treatment industries. Its operations include a fully equipped engineering and fabrication facility for producing pressure vessels used in filtration applications. In addition, a network of regional service centers provides services and distribution to support markets such as remediation of petroleum-contaminated groundwater. The Company acquired a carbon regeneration facility during 1995, allowing for the regeneration and reuse of spent carbon obtained from its service centers.\nCompetition\nCETCO has four principal competitors in the geosynthetic clay liner market. The construction and wastewater treatment product lines are niche businesses which compete primarily with alternative technologies. The service center remediation business has three major competitors, one of which is substantially larger and with greater resources. The groundwater monitoring, well drilling and sealants products compete with the Company's traditional rivals in the sodium bentonite business. Competition is based on product quality, service, price, technical support and availability of product. Historically, the competition has been very vigorous.\nSales and Distribution\nIn 1995, no customer accounted for more than 5% of environmental sales. CETCO products are sold domestically and internationally. CETCO sells most of its products through independent distributors and commissioned representatives. Contract remediation work is done on a direct basis working with consulting engineers engaged by the customers.\nCETCO employs technically oriented marketing personnel to support its network of distributors and representatives. In the service center business, salespersons develop business in the regional markets to supplement contract remediation work performed for national accounts.\nSeasonality\nMuch of the business in the environmental sector is impacted by weather and soil conditions. Many of the products cannot be applied in harsh weather conditions and, as such, sales and profits tend to be stronger April through October. As a result, the Company considers this segment to be seasonal.\nResearch and Development\nThe minerals and environmental segments share research and laboratory facilities. Both CETCO and the U.K. minerals operation have independent research capabilities. Technological developments are shared between the companies, subject to license agreements where appropriate.\nMineral Reserves\nBoth the mineral and environmental segments have sodium bentonite reserves and processing plants. The discussion of mineral reserves which follows applies to both units.\nMINERALS\/ENVIRONMENTAL COMMON OPERATIONAL FUNCTIONS\nMineral Reserves\nThe Company has reserves of sodium and calcium bentonite at various locations in Wyoming, South Dakota, Montana, Nevada and Alabama, and reserves of fuller's earth in Tennessee and Illinois. At 1995 consumption rates, based on internal estimates, the Company believes that its proven reserves of commercially usable sodium bentonite will be adequate for approximately 30 years (although reserves for certain specialty uses differ significantly from this 30-year period) and that its proven reserves of calcium bentonite and fuller's earth will be adequate for approximately 20 years and in excess of 40 years, respectively. While the Company, based upon its experience, believes that its reserve estimates are reasonable and its title and mining rights to its reserves are valid, the Company has not obtained any independent verification of such reserve estimates or such title or mining rights. The Company owns or controls the properties on which its reserves are located through long-term leases, royalty agreements and patented and unpatented mining claims. A majority of the Company's bentonite reserves are owned. All of the properties on which the Company's reserves are located are either physically accessible for the purposes of mining and hauling, or the cost of obtaining physical access would not be material.\nOf the total reserves, approximately 20% are located on unpatented mining claims owned or leased by the Company, on which the Company has the right to undertake regular mining activity. To retain possessory rights, a fee of $100 per year for each unpatented mining claim is required. The validity of title to unpatented mining claims is dependent upon numerous factual matters. The Company believes that the unpatented mining claims which it owns have been located in compliance with all applicable federal, state and local mining laws, rules and regulations. The Company is not aware of any material conflicts with other parties concerning its claims. From time to time, members of Congress as well as members of the executive branch of the federal government have proposed amendments to existing federal mining laws. The various amendments would have had a prospective effect on mining operations on federal lands and include, among other things, the imposition of royalty fees on the mining of unpatented claims, the elimination or restructuring of the patent system and an increase in fees for the maintenance of unpatented claims. To the extent that future proposals may result in the imposition of royalty fees on unpatented lands, the mining of the Company's unpatented claims may become uneconomic, and royalty rates for privately leased lands may be affected. The Company cannot predict the form that any amendments might ultimately take or whether or when any such amendments might be adopted.\nThe Company's fuller's earth reserves are both owned and leased. The loss of any of the leased reserves could materially decrease the Company's reserves of fuller's earth, but it is believed that alternative economical reserves could be developed.\nThe Company maintains a continuous program of exploration for additional reserves and attempts to acquire reserves sufficient to replenish its consumption each year, but it cannot assure that additional reserves will continue to become available.\nThe Company oversees all of its mining operations, including its exploration activity and the obtaining of necessary state and federal mining permits.\nThe following table shows a summary of minerals sold by the Company for the last five years in short tons:\nThe Company estimates that available supplies of other materials utilized in its mineral business are sufficient to meet its production requirements for the foreseeable future.\nMining and Processing\nBentonite. Bentonite is surface mined, generally with large earthmoving scrapers, and then loaded into trucks and off-highway haul wagons for movement to the processing plants. The mining and hauling of the Company's clay is done both by the Company and by independent contractors. Each of the Company's processing plants generally maintain stock piles of unprocessed clay of approximately four to eight months' production requirements.\nAt the processing plants, bentonite is dried, crushed and sent through grinding mills, where it is sized into shipping form, then chemically modified where needed and transferred to silos for automatic bagging or shipment in bulk. Virtually all production is shipped as processed, rather than stored for inventory.\nFuller's Earth. Fuller's earth is also surface mined using a combination of scrapers, dozers and loaders. Crude clay is then loaded into dump trucks and hauled to the processing plant where it is dried or calcined, crushed and screened. Inventories of unprocessed clay generally are no more than a two-week supply. Mining is thus performed on a year-round basis.\nProduct Development and Patents\nThe Company works actively with customers in each of its major markets in order to develop commercial applications of specialized grades of bentonite, and it maintains a bentonite research center and laboratory testing facility adjacent to its corporate headquarters as well as one in the United Kingdom When a need for a product which will accomplish a particular goal is perceived, the Company will work to develop the product, research its marketability and study the feasibility of its production. The Company will also continue its practice of co-developing products with customers or others as new needs arise. The Company's development efforts emphasize markets with which it is familiar and products for which it believes there is a viable market.\nThe Company holds a number of U.S. and international patents covering the use of bentonite and products containing bentonite. The Company follows the practice of obtaining patents on new developments whenever feasible. The Company, however, does not consider that any one or more of such patents is material to its Minerals and Environmental businesses as a whole.\nRegulation and Environmental\nThe Company believes it is in material compliance with applicable regulations now in effect with respect to surface mining. Since reclamation of exhausted mining sites has been a regular part of the Company's surface mining operations for the past 27 years, maintaining compliance with current regulations has not had a material effect on its mining costs. The costs of reclamation are reflected in the prices of the bentonite sold.\nThe grinding and handling of dried clay is part of the production process, and, because it generates dust, the Company's mineral processing plants are subject to applicable clean air standards (including Title V of the Clean Air Act). All of the Company's plants are equipped with dust collection systems. The Company has not had and does not presently anticipate any significant problems in connection with its dust emission, though it expects ongoing expenditures for the maintenance of its dust collection systems and required annual fees.\nThe Company's mineral operations are also subject to other federal, state, local and foreign laws and regulations relating to the environment and to health and safety matters. Certain of these laws and regulations provide for the imposition of substantial penalties for non-compliance. While the costs of compliance with, and penalties imposed under, these laws and regulations have not had a material adverse effect on the Company, future events, such as changes in, or modified interpretations of, existing laws and regulations or enforcement policies or further investigation or evaluation of potential health hazards of certain products, may give rise to additional compliance and other costs that could have a material adverse effect on the Company.\nABSORBENT POLYMERS\nSince the early 1970s, the Company has utilized a technique called modified bulk polymerization (\"MBP\") to manufacture water soluble polymers for the oil well drilling industry. This technique has been modified to produce superabsorbent polymers (\"SAP\"), a category of polymers known for its extremely high water absorbency. Chemdal Corporation was formed in 1986 to manufacture and market absorbent polymers, with primary emphasis on SAP. To date, the Company's sales of SAP have been almost exclusively for use as an absorbent in personal care products, primarily disposable baby diapers. The Company produces SAP at its U.S. facility with an annual capacity of 70,000 tons, and at its U.K. facility through Chemdal Limited, with an annual capacity of 40,000 tons.\nDemand for the Company's products in the United States has grown significantly in recent years as the amount of SAP used in new diaper designs has increased. SAP is more absorbent than the fluff pulp used in traditional disposable diapers. The use of SAP in diapers allows for a thinner diaper that occupies less shelf space in stores and less landfill space. SAP also helps to hold moisture inside the diaper, thereby causing less irritation to the wearer's skin and reducing leakage. Based upon the Company's expectations regarding consumer and retail preferences, the Company believes that SAP will continue to be used in new diaper designs. While no assurance can be given that markets in developing countries will follow the trends of developed countries, the Company also believes that disposable diapers containing increasing amounts of SAP will gain more acceptance in developing countries as per capita incomes in those countries rise.\nPrincipal Products and Markets\nThe Company's SAP is primarily marketed under the trade names ARIDALLAE and ASAPAE. To date, the Company's customers have been primarily private label and national brand diaper manufacturers. The Company believes that this segment of the diaper market has grown faster than the brand name segment, which currently accounts for the majority of that market. During 1995, the Company began selling to manufacturers of brand name personal care products and is seeking to increase its sales to that segment of the market.\nSales and Distribution\nThe Company sells SAP to the personal care market in the United States on a direct basis and, in other countries, both on a direct basis and through distributors. The Company expects to rely increasingly on a direct sales approach in the personal care market. The Company's direct sales efforts employ a team approach that includes both technical and marketing representatives. In 1995, the top two customers accounted for approximately 45% of the Company's polymer sales, and the top five customers accounted for approximately 58% of such sales.\nResearch and Development\nThe Company continually seeks to improve the performance of its absorbent polymers. It also intends to pursue additional applications for its absorbent polymers in other markets either directly, or indirectly through marketing or distribution arrangements. Polymers also have applications in water treatment and in cosmetics, and acrylic-based polymers can be used in the newer, more concentrated detergents which use smaller packaging.\nThe Company owns several patents relating to its MBP process developed in the 1970s, and to modifications of its MBP process developed in the 1980s which relate to its SAP manufacturing process. The patents on the MBP process have begun to expire. The patents relating to the SAP modifications thereto expire at various times commencing in 2002.\nThe Company follows the practice of obtaining patents on new developments whenever reasonably practicable. The Company also relies on unpatented know-how, trade secrets and improvements in connection with its SAP manufacturing process. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to or disclose the Company's trade secrets, or that the Company can meaningfully protect its rights to its unpatented trade secrets.\nRaw Materials\nThe process used by the Company to produce SAP primarily uses acrylic acid and, to a lesser extent, potassium and sodium alkalies and catalysts. The Company's polymer operations are supplied by three major producers of acrylic acid. The Company has been able to obtain adequate supplies of acrylic acid to meet its production requirements to date.\nThe Company knows of four acrylic acid suppliers in the United States, three in Europe and four in the Far East. The Company is aware that at least five of these suppliers manufacture SAP and, therefore, compete with the Company in this market.\nPotassium and sodium alkalies are available on a commercial basis worldwide with no meaningful limitations on availability. Catalysts are available from a small number of high-technology chemical manufacturers; however, the Company does not anticipate any difficulties in obtaining catalysts.\nCompetition\nThe Company believes that there are approximately five polymer manufacturers and several importers that compete with its U.S. operation, several of which have substantially greater resources than the Company. The Company's U.K. operation competes with a total of approximately seven producers and several importers. Only one producer has substantially more production capacity and several producers have greater resources than the Company. Further, several of these competitors are vertically integrated and produce acrylic acid, the primary cost component of SAP. The competition in both the Company's domestic and international markets is primarily a matter of product quality and price, and it historically has been very vigorous. The Company believes that its polymer manufacturing process has enabled it to add polymer production capacity at a lower capital investment cost than that required by other processes currently in widespread commercial use.\nRegulation and Environmental\nThe Company's production process for SAP consumes virtually all chemicals and other raw materials used in the process. Virtually all materials which are not consumed by the end product are recycled through the process. The Company's polymer plants, therefore, generate a minimal amount of chemical waste.\nThe handling of dried polymer is part of the production process, and, because this generates dust, the Company's polymer plants must meet clean air standards. The Company's polymer plants are equipped with dust collection systems, and the Company believes that it is in material compliance with applicable state and federal clean air regulations. The Company's absorbent polymer business is subject to other federal, state, local and foreign laws and regulations relating to the environment and to health and safety matters. Certain of these laws and regulations provide for the imposition of substantial penalties for non-compliance. While the costs of compliance with, and penalties imposed under, these laws and regulations have not had a material adverse effect on the Company, future events, such as changes in, or modified interpretations of, existing laws and regulations or enforcement policies or further investigation or evaluation of potential health hazards of certain products, may give rise to additional compliance and other costs that could have a material adverse effect on the Company.\nTRANSPORTATION\nThe Company operates a long-haul trucking business and a freight brokerage business primarily for delivery of its own products in package and bulk form throughout the continental United States. Through its transportation operations, the Company is better able to control costs, maintain delivery schedules and assure equipment availability. The long-haul trucking subsidiary performs transportation services on outbound movements from the Company's production plants and attempts to haul third parties' products on return trips whenever possible. In 1995, approximately 74% of the revenues of this segment involved the Company's products.\nFOREIGN OPERATIONS AND EXPORT SALES\nApproximately 35% of the Company's 1995 net sales were to customers in approximately 60 countries other than the United States. To enhance its overseas market penetration, the Company maintains a mineral processing plant in the United Kingdom A processing plant, 60% owned by the Company, operates in Australia, as well as a blending plant in Canada. Through a joint venture, the Company also has the capability to process minerals in Mexico. Chartered vessels deliver large quantities of the Company's bulk, dried sodium bentonite to the plants in the United Kingdom and Australia, where it is processed and mixed with other clays and distributed throughout Europe and Australia. The Company's U.S. bentonite is also shipped in bulk to Japan. The Company also maintains a worldwide network of independent dealers, distributors and representatives.\nThe Company produces absorbent polymers at its U.S. and U.K. plants, and serves markets in Western Europe, South America, Asia and the Middle East.\nThe Company's international operations are subject to the usual risks of doing business abroad, such as currency devaluations, restrictions on the transfer of funds and import and export duties. The Company, to date, has not been materially affected by any of these risks.\nSee Note 2 of the Company's Notes to Consolidated Financial Statements included elsewhere herein, which Note is incorporated by reference for sales attributed to foreign operations and export sales from the United States.\nEMPLOYEES\nAs of December 31, 1995, the Company employed 1,375 persons, 241 of whom were employed overseas. At December 31, 1995, there were approximately 751, 289, 261 and 24 persons employed in the Company's minerals, absorbent polymers, environmental and transportation segments, respectively, along with 50 corporate employees. Operating plants are adequately staffed, and no significant labor shortages are presently foreseen. Approximately 187 of the Company's employees in the United States and approximately 33 of the Company's employees in the United Kingdom are represented by six labor unions, which have entered into separate collective bargaining agreements with the Company. Employee relations are considered good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company and its subsidiaries operate the following principal plants, mines and other facilities, all of which are owned, except as noted:\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is party to a number of lawsuits arising in the normal course of its business. The Company does not believe that any pending litigation will have a material adverse effect on its consolidated financial position.\nThe Company's processing operations require permits from various governmental authorities. From time to time, the Company has been contacted by government agencies with respect to required permits or compliance with existing permits, while the Company has been notified of certain situations of non-compliance, management does not expect the fines, if any, to be significant.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone. Executive Officers of Registrant\nAll officers of the Company are elected annually by the Board of Directors for a term expiring at the annual meeting of directors following their election or when their respective successors are elected and shall have qualified. All directors are elected by the stockholders for a three-year term or until their respective successors are elected and shall have qualified.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe Common Stock is traded on The Nasdaq Stock Market under the symbol ACOL. The following table sets forth, for the periods indicated, the high and low sale prices of the Common Stock, as reported by The Nasdaq Stock Market, and cash dividends declared per share. Prices and cash dividends have been adjusted to reflect three-for-two and two-for-one stock dividends paid in January 1993 and June 1993, respectively.\nThe Company has paid cash dividends every year for over 58 years. The Company intends to continue to pay cash dividends on its Common Stock, but the payment of dividends and the amount and timing of such dividends will depend on the Company's earnings, capital requirements, financial condition and other factors deemed relevant by the Company's Board of Directors.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following is selected financial data for the Company and its subsidiaries for the five years ended December 31, 1995. Per share amounts have been adjusted to reflect a two-for-one stock split and a three-for-two stock split effected in the nature of stock dividends in June 1993 and January 1993, respectively. All per share calculations are fully diluted, based on weighted average number of common and common equivalent shares outstanding during the year.\nSUMMARY OF OPERATIONS (Dollars in thousands, except per share amounts)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Financial Condition\nAt December 31, 1995, the Company had outstanding debt of $121.1 million (including both long- and short-term debt) and cash and cash equivalents of $1.9 million, compared with $75.0 million in debt and $10.4 million in cash and cash equivalents at December 31, 1994. The long-term debt represented 42.9% of total capitalization at December 31, 1995, compared with 33.3% at December 31, 1994.\nThe Company had a current ratio of 3.52 to 1 on December 31, 1995, with approximately $90.5 million in working capital, compared with 2.97 to 1 and $72.1 million, respectively, at December 31, 1994. The $18.4 million increase (25.5%) in working capital resulted from sales growth of 31.0%, and included increases in accounts receivable of $15.8 million (30.2%), inventories of $6.9 million (17.1%) and prepaid expenses of $3.1 million offset by an $8.5 million reduction in cash balances. Prepaid expenses include approximately $2.0 million in income taxes, which will be applied toward 1996 estimated tax payments. The cash balances were lower, as proceeds of the October 1994 private debt placement were invested in capital expenditures.\nOn September 25, 1995, the Company increased its revolving credit facility from $50 million to $100 million and extended its term from October 1997 to October 2000. The Company had $43.2 million in unused, committed credit lines at December 31, 1995.\nThe Company currently anticipates capital expenditures of approximately $40 million for 1996. Capacity expansion of the U.K. polymer operation and a modification of existing U.S. polymer capacity are anticipated; however, no acquisitions are included in the estimate.\nThe current indicated annual dividend rate is $.28 per share. If the rate remains constant and the Board of Directors continues to declare dividends, the dividend payments will be approximately $5.4 million in 1996, compared with approximately $5.0 million in 1995.\nManagement believes that the Company has adequate resources to fund the capital expenditures discussed above, the dividend payments and anticipated increases in working capital requirements through its existing, committed credit lines, cash balances and operating cash flow. In addition to the capital expenditures which have been authorized by the Board of Directors, management continues to explore growth opportunities in the environmental and minerals markets, as well as further capacity expansion in the polymer segment.\nResults of Operations for the Three Years Ended December 31, 1995\nNet sales increased by $82.2 million, or 31.0% , from 1994 to 1995, and by $46.3 million, or 21.1%, from 1993 to 1994. Operating profits increased by $8.4 million, or 35.0%, from 1994 to 1995, and by $2.7 million, or 12.6%, from 1993 to 1994. A review of sales, gross profit, general, selling and administrative expenses, and operating profit by segment follows:\nMinerals\nSales increased in the durable goods and consumables sectors from 1993 to 1994, both domestically and overseas, as a result of an improved economy, higher U.K. sales volume, $2.3 million higher royalty income and a full year of sales to the agricultural carrier market. Sales decreased domestically during 1995 as royalties declined by approximately $3.8 million, as anticipated, and the principal customer for clay carrier products switched to a local, non-clay alternative at mid-year. Construction and environmental products contributed to the U.K. operation's sales growth, as did favorable translation exchange rates.\nGross profit margins for 1995 declined from those of 1994 by approximately 2.3%, compared with a 12.0% improvement from 1993 to 1994. The 1993 to 1994 gross profit margin improvement was primarily related to the increased royalties, whereas the decline in gross profit margin from 1994 to 1995 was not as severe as would have been anticipated with the royalty decline, largely due to price increases in certain markets.\nGeneral, selling and administrative expenses for 1995 increased by $3.2 million, or 23.2%, over 1994, which were 7.7% higher than the 1993 level. Higher costs for research and development, and management information systems contributed to the higher general, selling and administrative expense increase. A more precise division of expenses shared between minerals and corporate was accomplished during 1995 than for 1994, causing a higher percentage increase.\nThe lower royalty level experienced in 1995 is anticipated to continue, as many of the agreements have been converted to fully paid licenses. Cat litter volume continues to grow. The cat litter facilities added during 1995, however, have yet to be fully utilized. This temporary overcapacity, plus lower business volumes which were experienced in other markets during the last months of 1995, are likely to depress operating margins in the near-term.\nAbsorbent Polymers\nSales of absorbent polymers for 1995 increased by 106.1% over 1994 levels on a unit sales volume increase of 116.1%. This compares to a 13.1% sales increase from 1993 to 1994 on a unit volume increase of 15.9%. The unit volume increase in 1995 was largely attributable to the growth in European market share.\nGross profit margins declined 13.9% from 1993 to 1994 as capacity expanded from 30,000 metric tons to 80,000 metric tons. Unit sales volume increased only 16%. Gross margins declined a further 18.0% in 1995 as the cost of raw materials, principally acrylic acid, increased, and unit selling prices declined.\nThe general, selling and administrative expense increase from 1993 to 1994 was directed to the marketing and administrative infrastructure to accommodate the growth which occurred from 1994 to 1995.\nDespite lower unit selling prices and higher raw material costs, the operating profit margin improved by 2.9% from 1994 to 1995 because of the increase in volume.\nThe Company aggressively expanded its capacity from 1993 to 1995 to produce absorbent polymers. The Company began the three-year period with worldwide capacity of 20,000 metric tons, and ended with 110,000 metric tons. The Company's production capability is presently among the largest in the world. The expansions were undertaken ahead of the industry demand curve. Fourth quarter 1995 capacity utilization was approximately 56%, thus allowing for greater output as demand increases. Depreciation on the most recent U.S. expansion of 30,000 metric tons will be calculated on the units-of-production basis until the third quarter of 1996. All other depreciation is calculated using the straight-line method.\nManagement anticipates lower average unit selling prices as larger volume customers are expected to account for a greater proportion of the sales. The average cost of acrylic acid is expected to be lower in 1996 than in 1995, however it is unknown whether the combination of lower acrylic costs and greater plant throughput will offset the expected price decline. Management does not anticipate a return of operating profit margins to the 20% level experienced during 1993.\nEnvironmental\nApproximately 50% of the sales increase from 1994 to 1995 was attributable to acquisitions. A further 14% of the growth came from increased sales in international markets. Approximately 85% of the sales growth from 1993 to 1994 came from the combination of acquisitions and increased sales of BentomatAE environmental liner products.\nGross profit margins in 1995 improved by 13.3%. Inventory charges and changes in distribution during 1994 accounted for the difference between 1994 and 1995. Increased sales of lower margin products and the non-recurring charges accounted for the 24.1% gross margin decline from 1993 to 1994.\nGeneral, selling and administrative expenses increased from 1993 to 1994, primarily as a result of increased staff associated with the acquisitions and increased staffing in marketing, including the establishment of an international marketing department. The 1995 increase reflected further expansion of the international marketing group and additional staff associated with the Claymax acquisition.\nTransportation\nIncreased brokerage of cat litter and environmental shipments fueled the growth in transportation revenues from 1993 to 1994. The conversion of shipments of bentonite used in the manufacturing of liner products from truck to rail offset the further revenue gains made in the shipment of cat litter products during 1995. Gross profit margins have benefitted from the high volume levels, as well as greater truck availability during the three-year period.\nCorporate\nCorporate costs include management information systems, human resources, investor relations and corporate communications, finance, purchasing, research costs for new markets and corporate governance costs.\nDuring 1994, the Company installed a new management information system and significantly increased research and development activities. These expenditures continued into 1995. The 1995 expenses reflected a more precise split of the costs previously shared by minerals and corporate.\nThe Company is actively engaged in research and development efforts to create new applications for its reserves of bentonite. The Company has formed a wholly-owned subsidiary, Nanocor, Inc., to capitalize on its research and development progress in bentonite-based nanocomposites. When incorporated into plastics, bentonite-based nanocomposites can produce material with significantly improved properties that encompass a variety of commercial applications. Nanocor's technologies are still in the developmental stage, but management feels that these products have the potential to become a significant part of the Company's future growth.\nAn incremental increase in research and development costs of approximately $2 million is expected for 1996 as Nanocor, Inc. expands its product development efforts. All costs associated with Nanocor, Inc. will be carried in corporate for 1996.\nNet interest expense\nNet interest expense increased by $4.4 million from 1994 to 1995 as a result of higher borrowing levels primarily associated with capital expenditures and acquisitions. Net interest expense for 1994 was $.7 million lower than in 1993 as a result of higher levels of capitalized interest.\nOther income (expense)\nOther income for 1995 included investment grants of approximately $.5 million and a $.6 million gain related to the cancellation of an interest rate swap, compared with $.5 million of investment grants in 1994 and $.5 million in recovered defense costs in 1993.\nIncome taxes\nThe income tax rate for 1995 was 33.8% compared with 30.8% in 1994 and 29.7% in 1993. The estimated effective tax rate for 1996 is 36%.\nEarnings Per Share\nEarnings per share were calculated using the weighted average number of shares, including common stock equivalents, outstanding during the year. Stock options issued to key employees and directors are considered common stock equivalents. The 1993 weighted average shares outstanding were approximately 17.2 million shares compared with approximately 19.5 million shares and 19.7 million shares in 1994 and 1995, respectively. An equity offering of 3.5 million shares was completed in October 1993, accounting for most of the difference in the shares outstanding between the periods.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee the Index to Financial Statements and Financial Statement Schedules on Page. Such Financial Statements and Schedules are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe table below lists the names and ages of all directors and nominees of the Company, and all positions each person holds with the Company.\nBoard of Directors of the Registrant\nArthur Brown, 55, (2) Chairman,President and Chief Executive Officer of Hecla Mining Company. Director since 1990.\nRobert E. Driscoll, III, 57, (2, 5) Former Dean and Professor of Law, University of South Dakota. Director since 1985.\nRaymond A. Foos, 67, (2, 3) Former Chairman of the Board, President and Chief Executive Officer of Brush Wellman, Inc. (manufacturer of beryllium and specialty materials). Director since 1981.\nJohn Hughes, 53, (1) President and Chief Executive Officer, AMCOL International Corporation. Director since 1984.\nRobert C. Humphrey, 77, (1, 3, 4) Retired Chairman of the Board, NBD Bank Evanston, N.A. Director since 1977, except for a three-month period in 1989.\nJay D. Proops, 54, (1, 3) Private investor and former Vice Chairman and co-founder of The Vigoro Corporation. Director since June 1995.\nC. Eugene Ray, 63, (1, 2, 3, 4) Chairman of the Board since 1988. Former Executive Vice President - Finance of Signode Industries, Inc. (manufacturer of industrial strapping products). Director since 1981.\nClarence O. Redman, 53, (1, 5) Partner and Chief Executive Officer of the law firm of Keck, Mahin & Cate. Secretary of the Company since 1982. Director since 1989.\nPaul G. Shelton, 46, (1) Senior Vice President - Chief Financial Officer, AMCOL International Corporation. Director since 1988.\nDale E. Stahl, 48, (1, 3) President and Chief Operating Officer of Gaylord Container Corporation. Director since June 1995.\nPaul C. Weaver, 33, (1, 2) Senior Corporate Account Manager for Nielsen Marketing Research. Director since May 1995.\n(1) Member of Executive Committee of the Board of Directors (2) Member of Audit Committee (3) Member of Compensation Committee (4) Member of Nominating Committee (5) Member of Option Committee\nAdditional information regarding the directors of the Company is included under the caption \"Election of Directors\", \"Information Concerning Members of the Board\" and \"Compliance with Section 16(a) of the Securities Exchange Act.\" in the Company's proxy statement to be dated on or about April 8, 1996, and is incorporated herein by reference. Information regarding executive officers of the Company is included under a separate caption in Part I hereof, and is incorporated herein by reference, in accordance with General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation regarding the above is included under the caption \"Compensation and Other Transactions with Management\" in the Company's proxy statement to be dated on or about April 8, 1996, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation regarding the above is included under the caption \"Security Ownership\" in the Company's proxy statement to be dated on or about April 8, 1996, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation regarding the above is included under the caption \"Compensation and Other Transactions with Management\" in the Company's proxy statement to be dated on or about April 8, 1996, and is incorporated herein by reference.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. See Index to Financial Statements and 2. Financial Statement Schedules on Page. Such Financial Statements and Schedules are incorporated herein by reference. 3. See Index to Exhibits immediately following the signature page.\n(b) None.\n(c) See Index to Exhibits immediately following the signature page.\n(d) See Index to Financial Statements and Financial Statement Schedules on Page.\nItem 14(a) Index to Financial Statements and Financial Statement Schedules\nAll other schedules called for under Regulation S-X are not submitted because they are not applicable or not required or because the required information is not material or is included in the financial statements or notes thereto.\nIndependent Auditors' Report\nThe Board of Directors and Stockholders AMCOL International Corporation:\nWe have audited the consolidated financial statements of AMCOL International Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the 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 AMCOL International 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.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 8, 1996\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations (Dollars in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (Dollars in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share amounts)\n(1) Summary of Significant Accounting Policies\nCompany Operations\nAMCOL International Corporation (the Company) may be divided into three principal categories of operations; minerals, absorbent polymers and environmental. The Company also operates a transportation business primarily for delivery of its own products. The Company's revenues are derived 44% from the minerals operation, 35% from absorbent polymers, 15% from environmental and 6% from transportation operations. The Company's sales were approximately 65% domestic and 35% overseas.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its foreign and domestic subsidiaries. All subsidiaries are wholly-owned except for one of the Australian subsidiaries, which is 60% owned by the Company, and a 49% interest in a Mexican subsidiary, which is accounted for at cost. All material intercompany balances and transactions, including profits on inventories, have been eliminated in consolidation.\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.\nTranslation of Foreign Currencies\nThe accounts and transactions of subsidiaries located outside of the United States are translated into U.S. dollars at rates of exchange in accordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation.\" The assets and liabilities of these subsidiaries are translated at the rate of exchange at the balance sheet date. The statements of operations are translated at the weighted average monthly rate. Foreign exchange translation adjustments are accumulated as a separate component of stockholders' equity while realized exchange gains or losses are included in income.\nInventories\nInventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) or moving average methods. During 1995, in order to better match revenues and expenses, the Company adopted the FIFO method for certain inventories that had previously used the last-in, last-out (LIFO) method for determining cost. The Company has applied this change in method retroactively to January 1, 1991, which resulted in an increase in retained earnings of $1,753. The effect on the statement of operations was immaterial.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(1) Summary of Significant Accounting Policies (Continued)\nProperty, Plant, Equipment, and Mineral Rights and Reserves\nProperty, plant, equipment, and mineral rights and reserves are carried at cost. Depreciation is computed using the straight-line method for substantially all of the assets. Certain other assets, primarily field equipment are depreciated on the units-of-production method. Mineral rights and reserves are depleted using the units-of-production method.\nGoodwill and Other Intangible Assets\nGoodwill represents the excess of the purchase price over the fair value of the net assets acquired. Goodwill is being amortized on the straight-line method over periods of 15 to 40 years. Other intangibles, including trademarks and noncompete agreements, are amortized on the straight-line method over periods of up to ten years.\nIncome Taxes\nThe Company and its U.S. subsidiaries file a consolidated tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which those temporary differences are expected to be recovered or settled.\nExploration Costs and Advance Mining\nExploration costs are expensed as incurred. Costs incurred in removing overburden and mining bentonite are capitalized as advance mining costs until the bentonite from such mining area is transported to the plant site, at which point the costs are included in crude bentonite stockpile inventory.\nResearch and Development\nResearch and development costs, included in general, selling and administrative expenses, were approximately $4,801, $2,353, and $1,764 for the years ended December 31, 1995, 1994, and 1993.\nEarnings Per Share\nEarnings per share are computed by dividing net income by the weighted average of common shares outstanding after consideration of the dilutive effect of stock options outstanding at the end of each period. The weighted average number of common and common equivalent shares outstanding was 19,679,480 for 1995, 19,486,520 for 1994, and 17,223,854 for 1993.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(1) Summary of Significant Accounting Policies (Continued)\nCash Equivalents\nFor purposes of the statement of cash flows, the Company considers all highly-liquid investments with original maturities of three months or less as cash equivalents.\nReclassification\nCertain items in the 1994 and 1993 consolidated financial statements have been reclassified to comply with the consolidated financial statements presentation for 1995.\n(2) Business Segment and Geographic Area Information\nThe Company operates in three major industry segments--minerals, absorbent polymers and environmental, and also operates a transportation business. The minerals segment mines, processes, and distributes clays and products with similar applications to various industrial and consumer markets. The absorbent polymers segment produces and distributes superabsorbent polymers primarily for use in consumer markets. The environmental segment processes and distributes clays and products with similar applications for use as a moisture barrier in commercial construction, landfill liners and in a variety of other industrial and commercial applications. The transportation segment includes a long haul trucking business and a freight brokerage business which provide services to both the Company's plants and outside customers.\nIntersegment sales are insignificant. Operating profit is defined as sales and other income directly related to a segment's operations, less operating expenses, which do not include interest costs.\nIdentifiable assets by segments are those assets used in the Company's operations in that segment. Corporate assets are primarily cash and cash equivalents, corporate leasehold improvements and miscellaneous equipment.\nExport sales included in the United States were approximately $28,691, $17,430, and $12,206 for the years ended December 31, 1995, 1994, and 1993. One customer accounted for approximately 11% of sales in 1995.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(2) Business Segment and Geographic Area Information (Continued)\nThe following summaries set forth certain financial information by business segment and geographic area for the years ended December 31, 1995, 1994, and 1993.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(2) Business Segment and Geographic Area Information (Continued)\n(3) Inventories\nInventories consisted of:\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(4) Property, Plant, Equipment, and Mineral Rights and Reserves\nProperty, plant, equipment, and mineral rights and reserves consisted of the following:\nDepreciation and depletion were charged to income as follows:\n(5) Income Taxes\nThe components of the provision for domestic and foreign income tax expense for the years ended December 31, 1995, 1994 and 1993 consist of:\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(5) Income Taxes (Continued)\nThe components of the deferred tax assets and liabilities as of December 31, 1995 and 1994 are as follows:\nThe following analysis reconciles the statutory Federal income tax rate to the effective tax rates:\n(6) Long-term Debt\nLong-term debt consisted of the following:\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(6) Long-term Debt (Continued)\nThe Company has a committed $100,000 revolving credit agreement which matures October 31, 2000, with an option to extend for three one-year periods. As of December 31, 1995, there was $43,167 available in unused lines of credit. The revolving credit note is a multi-currency agreement which allows the Company to borrow at various interest rates including, but not limited to, prime and an adjusted LIBOR rate plus .375% to .75% depending upon debt to capitalization ratios and the amount of the credit line used.\nThe Industrial Revenue Bond outstanding at December 31, 1995, is payable in equal semi-annual installments of $117 until the year 2000. The Aberdeen, Mississippi, bentonite operations of the Company are pledged as collateral. The carrying value of the pledged assets at December 31, 1995 was $1,956.\nMaturities of long-term debt at December 31, 1995 are as follows:\nThe estimated fair value of the term notes above at December 31, 1995, was $65,364 based on discounting future cash payments at current market interest rates for loans with similar terms and maturities.\nAll loan agreements include covenants which require the maintenance of specific minimum amounts of working capital, tangible net worth and financial ratios and limit additional borrowings and guarantees. The Company is not required to maintain a compensating balance.\n(7) Financial Instruments\nThe Company uses financial instruments, principally swaps, forward contracts and options, in its management of foreign currency and interest rate exposures. These contracts hedge transactions and balances for periods consistent with its committed exposures.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(7) Financial Instruments (Continued)\nRealized and unrealized foreign exchange gains and losses are recognized and offset against foreign exchange gains or losses on the underlying exposures. The interest differential paid or received on swap agreements is recognized as an adjustment to interest. The Company had $25,000 interest rate swap in place at December 31, 1994. During June 1995, the swap was cancelled for a gain of $632. The gain was recorded as other income.\nAt December 31, 1995, the Company had $3,825 of forward exchange contracts outstanding. The fair value of these contracts and the Company's other financial instruments (except for term notes - see note (6)) approximates their carrying value.\n(8) Leases\nThe Company leases certain railroad cars, trailers, computer software, office equipment, and office and plant facilities. Total rent expense under operating lease agreements was approximately $2,283, $1,920, and $1,721 in 1995, 1994, and 1993, respectively. Rent expense on railroad cars is offset by mileage earnings paid by the railroads of approximately $115, $124, and $137 in 1995, 1994, and 1993, respectively.\nRailroad cars and computer software under capital leases are included in machinery and equipment as follows:\nThe following is a schedule of future minimum lease payments for the capital leases and for operating leases (with initial terms in excess of one year) as of December 31, 1995:\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(9) Employee Benefit Plans\nThe Company has noncontributory pension plans covering substantially all of its domestic employees. The Company's funding policy is to contribute annually the maximum amount calculated using the actuarially determined entry age normal method that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to services to date, but also for those expected to be earned in the future. The plan is fully funded for tax purposes.\nPension cost in 1995, 1994, and 1993 was comprised of:\nThe following table summarizes the funded status and amounts recognized in the Company's balance sheet at December 31, 1995 and 1994:\nThe Company's pension benefit plan was valued as of October 1, 1995 and 1994, respectively. Approximately 94% of the plan assets are invested in common stocks, corporate bonds and notes, and guaranteed income contracts purchased from insurance companies. The remainder of the plan assets are invested in cash and a real estate trust.\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5% in 1995 and 8.0% in 1994, while the rate of increase in future compensation levels was 5.5% in 1995 and 6.0% in 1994. The expected long-term rate of return on plan assets was 9.0% in 1995 and 9.0% in 1994.\nThe Company also has a savings plan for its domestic personnel. The Company has contributed an amount equal to an employee's contribution up to a maximum of 4% of the employee's annual earnings. Company contributions are made using Company stock purchased on the open market. Company contributions under the savings plan were $985 in 1995, $963 in 1994, and $854 in 1993.\nThe foreign pension plans, not subject to ERISA, are funded using individual annuity contracts and therefore, are not included in the information noted above.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(10) Stockholders' Equity\nOn August 23, 1993, the Board of Directors authorized up to 2,500,000 shares of common stock, $.01 par value per share, to be offered and sold pursuant to a public offering. The public offering was completed on October 27, 1993. The par value for these additional shares was increased by $25 and additional paid-in capital was increased by $58,808, the total of which represents the net proceeds from the sale of 2,500,000 shares of common stock.\nOn May 10, 1993, the stockholders of AMCOL International Corporation approved an amendment to the Company's Restated Certificate of Incorporation to increase the number of authorized shares of common stock of the Company from 12 million to 50 million. The stockholders also approved an amendment to change the par value of the common stock from $1.00 per share to $0.01 per share. Additional paid-in capital was increased and common stock reduced by $9,328 for the change in the par value of the common stock.\nOn May 10, 1993, the Board of Directors declared a two-for-one stock split effected in the nature of a stock dividend to stockholders of record on June 8, 1993, which was paid June 23, 1993. The par value of these additional shares was capitalized by a transfer of $94 from retained earnings to common stock.\nAll current and prior-year common share and per share disclosures have been restated to reflect the stock dividends.\n(11) Stock Option Plans\n1983 Incentive Stock Option Plan\nThe Company reserved 1,800,000 shares of its common stock for issuance of incentive stock options to its officers and key employees. Options awarded under this plan, which entitle the optionee to one share of common stock, may be exercised at a price equal to the fair market value at the time of grant. Options awarded under the plan vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until they are fully vested. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\nThis plan expired during 1993, though options which were granted prior to its expiration continue to be valid until the individual option grants expire.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(11) Stock Option Plans (Continued)\n1993 Stock Plan\nThe Company reserved 840,000 shares of its common stock for issuance to its officers and key employees in the form of incentive stock options, nonqualified stock options, restricted stock, stock appreciation rights and phantom stock. Different terms and conditions apply to each form of award made under the plan. To date, only incentive stock options have been awarded. Options awarded under this plan, which entitle the optionee to one share of common stock, may be exercised at a price equal to the fair market value at the time of grant. Options awarded under the plan generally vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until they are fully vested, unless a different vesting schedule is established by the Option Committee of the Board of Directors on the date of grant. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\n1987 Nonqualified Stock Option Plan\nThe Company reserved 340,000 shares of its common stock for issuance of nonqualified stock options to outside officers and directors, as well as key employees. The stock options are exercisable at a price per share which may be no less than the fair market value at the time of grant according to the vesting provisions of the plan. Options awarded under the plan generally vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until fully vested. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts)\n(12) Accrued Liabilities\n(13) Quarterly Results (Unaudited)\nUnaudited summarized results for each quarter in 1995 and 1994 are as follows:\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (Dollars in thousands, except per share amounts\n(13) Quarterly Results (Unaudited) (Continued)\nAMCOL INTERNATIONAL CORPORATION AND SUBSIDIARIES Schedule II Valuation and Qualifying Accounts (Dollars in thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 28, 1996\nAMCOL INTERNATIONAL CORPORATION\nBy: \/s\/ John Hughes --------------------------------- John Hughes President; Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ John Hughes March 28, 1996 - ---------------------------------------- John Hughes President; Chief Executive Officer and Director\n\/s\/ Paul G. Shelton March 28, 1996 - ---------------------------------------- Paul G. Shelton Senior Vice President - Chief Financial Officer; Treasurer and Director\n\/s\/ C. Eugene Ray March 28, 1996 - ---------------------------------------- C. Eugene Ray Director; Chairman of the Board\n\/s\/ Jay D. Proops March 28, 1996\n- ---------------------------------------- Jay D. Proops Director\n\/s\/ Robert C. Humphrey March 28, 1996 - ---------------------------------------- Robert C. Humphrey Director\n\/s\/ Robert E. Driscoll, III March 28, 1996 - ---------------------------------------- Robert E. Driscoll, III Director\n\/s\/ Raymond A. Foos March 28, 1996 - ---------------------------------------- Raymond A. Foos Director\n\/s\/ Clarence O. Redman March 28, 1996 - ---------------------------------------- Clarence O. Redman Director\n\/s\/ Arthur Brown March 28, 1996 - ---------------------------------------- Arthur Brown Director\n\/s\/ Dale E. Stahl March 28, 1996 - ---------------------------------------- Dale E. Stahl Director\n\/s\/ Paul C. Weaver March 28, 1996 - ---------------------------------------- Paul C. Weaver Director\nINDEX TO EXHIBITS","section_15":""}
{"filename":"62765_1995.txt","cik":"62765","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nElectronics distributors form an integral part of the electronics industry. Most domestic and foreign manufacturers of electronic components rely on independent authorized distributors, such as Marshall Industries (\"the Company\"), to augment their product marketing operations and provide stocking and service capabilities. These manufacturers are relying to an increasing extent on distributors to market their products.\nThe Company is the fourth largest domestic distributor in sales volume of industrial electronic components and production supplies. Through its network of 37 sales and distribution facilities and 3 corporate support and distribution centers in the United States and Canada, the Company supplies and services a broad range of products, including semiconductors, passive components, connectors and interconnect products, and computer systems and peripheral products, as well as production supplies. The distribution of electronic components accounted for approximately 94% of total Company sales in fiscal 1994 and 1995. The distribution of industrial production supplies accounted for the balance, or 6%, of total Company sales in each of such periods. The Company believes it is the largest domestic distributor in sales volume of industrial production supplies to customers in the electronics industry.\nELECTRONIC COMPONENTS DISTRIBUTION\nThe distribution of semiconductor products accounted for approximately 70% and 73%, respectively, of total Company sales in fiscal 1994 and 1995. Passive components, connectors and interconnect products accounted for approximately 13% and 11%, respectively, of total Company sales for those periods. Sales of computer systems and peripheral products accounted for approximately 11% and 10%, respectively, of total Company sales in fiscal 1994 and 1995.\nTexas Instruments (\"TI\") is the Company's largest supplier of semiconductor products. TI's semiconductor products accounted for approximately 15% and 14% of total Company sales in fiscal 1994 and 1995, respectively. The Company carries the full range of semiconductor products manufactured by TI and distributes the products of a number of other leading American manufacturers. The Company is also the major distributor in sales volume of Japanese semiconductor products in the United States. Sales of these products accounted for approximately 19% and 22% of total Company sales in fiscal 1994 and 1995, respectively. Additionally, the Company distributes components manufactured by European suppliers, such as Siemens Components, Inc. (\"Siemens\"), Philips Semiconductors, a North American Philips Company (\"Philips\"), formerly \"Signetics,\" and SGS-Thomson Microelectronics Inc. (\"SGS-Thomson\").\nThe Company purchases electronic components from over 50 major suppliers in the following general categories:\nSEMICONDUCTOR PRODUCTS: Semiconductor products include memory, logic and programmable logic devices, microprocessors and microperipheral components. The Company's principal suppliers are Atmel Corporation, Cypress Semiconductor Corporation, Fujitsu, Hitachi, IBM Technology Products, a unit of IBM, Lattice Semiconductor Corporation, Linear Technology, Philips, NEC Electronics, Inc., Siemens, SGS-Thomson, Sony Electronics, Inc., Sharp Electronics Corporation, TI, Toshiba America, Inc., and Xilinx, Inc.\nPASSIVE COMPONENTS: The Company distributes passive components, including multilayer ceramic, tantalum and foil capacitors as well as resistor networks. These products are manufactured by such leading suppliers as AVX Corporation, a subsidiary of Kyocera Corporation, and Bourns, Inc.\nCONNECTORS AND INTERCONNECT PRODUCTS: Connectors and interconnect products include surface mount sockets and fiber optic systems, along with printed circuit board level connectors. The Company's principal suppliers of connectors and interconnect products are AMP Incorporated and T&B\/Ansley Corporation, which rank among the leading suppliers of these products.\nCOMPUTER SYSTEMS AND PERIPHERALS: The Company's product offerings include printers, keyboards, optical, hard and floppy disk drives, monitors, motherboards for personal computers, power supplies, and other systems components. Computer Products Inc., Fujitsu, IBM Personal Computer Company, NEC Electronics, Inc., Sharp Electronics Corporation, Sony Components Products, and Toshiba America Information Systems, Inc. are the major suppliers of these products to the Company.\nVALUE ADDED SERVICES: In addition to the distribution of component parts, the Company provides a variety of value added services to its customers. The Company provides programmable logic array and PROM and EPROM programming, along with certain types of testing services. The Company also packages electronic component kits to customers' specifications (\"kitting\") and provides cable assembling services. Through the use of third party contractors, the Company provides contract manufacturing capabilities.\nPRODUCTION SUPPLIES DISTRIBUTION\nThe Company believes that it is the largest domestic distributor in sales volume of industrial production supplies to customers in the electronics industry. Such supplies include hand tools, static control products, test equipment, soldering supplies, soldering equipment and work stations. Leading suppliers include CooperTools, a division of Cooper Industries, Kester Solder, a division of Litton Industries, Fluke Corporation, Tektronix, Inc., Loctite Corporation and 3M.\nMARKETS\nThe Company currently has a national distribution network in the United States and Canada consisting of 37 sales and distribution centers and 3 corporate support and distribution centers. The Company believes that it has sales facilities in all of the major electronic products markets in the United States, including the Los Angeles\/Orange County, San Francisco\/Silicon Valley, Boston, Chicago, Denver, Philadelphia, Portland, Seattle, Connecticut, Florida, New Jersey, Georgia, Maryland, Minnesota, Ohio and Texas areas. In Canada, the Company has sales facilities in Toronto, Montreal and Vancouver. As a result of the Company's marketing strategy and expansion programs, the Company is currently distributing products manufactured by over 50 major electronic component suppliers to approximately 30,000 customers.\nAs described in Note 6 to the financial statements, the Company has made an investment in Sonepar Electronique International, the third largest electronic component distributor in Europe.\nAt May 31, 1995, the Company had approximately 1,370 employees, substantially all of whom were employed full-time.\nCUSTOMERS AND MARKETING\nDistributors offer electronics customers the convenience of immediate price and delivery information, backlog status, diverse off-the-shelf inventories in small and large quantities, rapid deliveries and the financing of their purchases. The Company's electronics distribution business services approximately 30,000 customers, the majority of which are small and medium size companies in the following industries: computers, communications, capital and office equipment, industrial control and medical equipment and systems integration. In recent years, contract manufacturers have also become major customers for electronic component distributors, including the Company, as many original equipment manufacturers (\"OEM's\") have outsourced their purchasing and manufacturing functions to them. No single customer accounted for more than 4% of the Company's sales during any of the last five fiscal years.\nThe Company's products are sold by both field and inside sales people. Sales personnel work directly with customers providing price, delivery, backlog and technical information regarding the products which the Company distributes. Each sales and distribution center is electronically linked to the Company's central computer system, which provides fully integrated on-line, real-time data with respect to the Company's nationwide inventory levels. The Company's computer system facilitates the control of purchasing and payables, shipping and receiving, and billing and collections. A salesperson may order shipment of a product from any distribution center within a matter of minutes. The Company has made significant investments, particularly during the last several years, to increase the capabilities of its computerized information systems. In December, 1992, the Company implemented new software for its operating and financial systems. The Company invested approximately $9 million in the design, purchase, and implementation of these systems. In the opinion of the Company, these systems, which were written in a contemporary language and architecture, have the capabilities to support future changes and enhancements required to meet market needs and growth. These systems have also allowed the Company to increase its electronic data interchange (\"EDI\") capabilities with its suppliers and customers. Due to the high volume of transactions and the cost competitiveness of the electronics components distribution industry, the Company believes that the expansion and upgrading of its information systems will be an ongoing requirement. In July, 1994, the Company introduced an electronic telecommunications service that allows customers to design, engineer and purchase products via the \"Internet\". In late fiscal 1995, the outside sales staff at certain sales locations were equipped with laptop computers to increase and enhance their productivity and customer service capabilities. The Company plans to complete this field sales automation program in fiscal 1996.\nThe Company has focused on obtaining franchises with suppliers which are among the leading manufacturers of the product categories that the Company distributes. The Company offers a broad line of products to meet its customers' needs. The Company has also concentrated its inventory and marketing efforts on the following product categories that it believes are the greatest growth areas of the distribution business: (1) high performance memory and programmable logic devices; (2) data conversion products; (3) microprocessors; (4) computer systems and peripherals; (5) printed circuit board level connectors; (6) passive components; and (7) industrial production supplies and instrumentation. Additionally, the Company is focusing on having its sales force sell a balanced mix of all types of products along with expanding its customer base.\nRELATIONSHIP WITH SUPPLIERS\nThe majority of the products sold by the Company are purchased pursuant to distributor agreements. These agreements are typically for terms of one year, renewable annually, non-exclusive, and authorize the Company to sell through its sales and distribution centers all or a portion of the products produced by that manufacturer. These agreements may be cancelled by either party on short notice and generally provide for a return of the manufacturer's inventory upon cancellation. The Company's ten largest suppliers accounted for approximately 54% and 60%, respectively, of total Company sales in fiscal 1994 and 1995. Except for TI, which accounted for 15% and 14% of total Company sales for fiscal 1994 and 1995, no other supplier accounted for\nmore than 10%. Cancellation of an agreement with, or trade restrictions affecting purchases from, a major supplier could have a material adverse effect upon the Company's business. The Company believes that it has a satisfactory relationship with each of its suppliers. The Company considers its relationships with its Japanese suppliers to be sound. Nonetheless, because of uncertainties relating to U.S. trade issues, the possibility exists that continued access to Japanese products could be affected. In addition, the Company cannot determine the direction of U.S. trade issues or their ultimate effect on the competitive environment and the Company's results.\nMost manufacturers of electronic components, including foreign manufacturers, protect authorized distributors, such as the Company, against potential inventory losses from declining prices and obsolescence. To protect its distributors from declining market prices, most electronic component manufacturers allow their distributors pricing adjustments as products are sold to customers as well as credits on unsold inventory when the manufacturers reduce prices on their price lists. In addition, under the terms of many such agreements, the distributor has the right to return to the manufacturer, for credit, any product classified as obsolete by the manufacturer and a specified portion of other inventory items purchased within a designated period of time. A manufacturer who elects to terminate a distribution agreement without cause is generally required to purchase from the distributor the products of such manufacturer carried in the distributor's inventory. While such agreements do not protect the Company totally from inventory losses, such agreements do, in management's opinion, provide substantial protection from such losses. No assurance can be given, however, that such price adjustment and return policies will continue.\nTo service its kitting and contract manufacturing customers, as described on page 3, the Company must buy a certain amount of products from third parties on a non-franchised basis. Since there are typically no return or price protection privileges on these purchases, there are significantly greater inventory risks associated with kitting and contract manufacturing orders than with the purchase and stocking of inventory pursuant to its franchise agreements.\nNATURE OF BUSINESS AND COMPETITION\nAlthough the Company's business is not seasonal to any material extent, its business is affected by the cyclical nature of the electronics industry and overall trends in the general economy. In addition, the Company has experienced industry-wide product shortages and excess supplies from time to time. During the last several months, there has been a tightening of product availability and long lead times for some products, such as certain memory and surface mount devices.\nSupplying and servicing the electronics industry is a highly competitive business. The competition is from other large national distributors, numerous local and regional distributors, as well as some of the Company's suppliers. Providing service to customers is the major competitive factor of the industry. In addition to providing basic distribution services such as technical information, product availability and competitive pricing, prompt delivery and credit, the Company offers many sophisticated value added services. These additional services include component testing and assembly; just in time (\"JIT\") inventory management and delivery systems; kitting and contract assembly. In recent years, the Company has introduced a number of sophisticated automated inventory procurement and management services for its customers through its EDI and auto replenishment programs. The Company considers its emphasis on high-quality customer service, monitored by statistical process control (\"SPC\") methods, to be one of its strengths.\nFrom time to time, the Company has experienced competition from \"unauthorized\" U.S. distributors of Japanese semiconductors who purchase these products in foreign countries at prices below those which the Company may purchase such products directly from its suppliers. In addition, a limited number of the Company's customers have moved their manufacturing operations out of the United States in recent years. Such changes have not had a material impact on the Company's business.\nInformation concerning backlog is not material to an understanding of the Company's business, as the Company's objective is to ship orders on the same day they are received unless the customer has requested a specific future delivery date on an order. Additionally, it is common industry practice for customers, in most cases, to be able to re-schedule or cancel orders with future delivery dates without penalties. In the electronics industry, the book-to-bill ratio, which is the ratio of sales orders received to shipments made, is commonly used as an indicator of business trends. Since late calendar 1991, the book-to-bill ratios for both the industry and the Company have been generally positive.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company presently has 37 sales and distribution facilities and 3 corporate support and distribution centers. The Company's executive offices and corporate support and distribution center are located in El Monte, California. This facility is Company owned, has 258,000 square feet of space and utilizes an automated inventory handling system. The Company owns an additional 65,500 square foot warehouse and office facility in El Monte.\nIn addition to the El Monte facilities, a majority of the sales and distribution facilities located in Marshall's major markets are Company owned. The three largest facilities range from approximately 58,000 to approximately 65,000 square feet in size and are located in Milpitas, California; Irvine, California; and Boston, Massachusetts. The Company also owns facilities in Austin, Texas; Endicott, New York; San Diego, California; and Wallingford, Connecticut of approximately 8,000 to 15,000 square feet each.\nThe Company leases its remaining sales and distribution facilities. They are located in cities throughout the United States and Canada, vary in size depending on sales volume and are subject to leases whose initial terms expire at various dates through fiscal 2000. Substantially all of those leases include renewal provisions.\nIn the opinion of the Company, the current facilities are adequate for the Company's operating requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company 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 security holders during the quarter ended May 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 New York Stock Exchange under the symbol MI. The following table shows, for the periods indicated, the published closing sale prices per share for the Company's Common Stock.\nThe above share prices have been adjusted to reflect the two for one stock split paid on February 28, 1994.\nThe Company had approximately 6,000 shareholders at May 31, 1995. It has never paid a cash dividend. Earnings have been retained to provide for the growth and expansion of the Company's business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data with respect to the statements of income of the Company for the five fiscal years ended May 31, 1995, and the balance sheets of the Company at year end for each of those years. The selected financial data is derived from financial statements for such years and at such dates as audited by Arthur Andersen LLP, independent public accountants, including the statements of income for the three years ended May 31, 1995, and the balance sheets at May 31, 1994 and 1995 included elsewhere 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 items in the statements of income as a percent of net sales for periods shown:\nAs an aid to understanding the results of operations, the following is a summary of the Company's unaudited quarterly results of operations for fiscal years 1993, 1994 and 1995 (in thousands except for per share data):\nAll per share amounts have been restated to reflect the two for one stock split paid on February 28, 1994.\nFISCAL 1995 COMPARED TO FISCAL 1994\nThe increase in net sales for fiscal 1995, as compared to fiscal 1994, was due primarily to an increase in the sales volume of semiconductor products. Sales of semiconductor products increased by $157,126,000 primarily as a result of the strong market demand for such products. The sales volume of the Company's other major products increased modestly from the prior year.\nThe decrease in net margins for fiscal 1995, as compared to fiscal 1994, resulted from market pressures on the pricing of most of the Company's products, including value added products, and an increase in the sales volume of lower margin products, primarily memory products. The Company believes that these conditions affecting margins may continue in the near term.\nThe increase in selling, general and administrative (\"SG & A\") expenses, in dollars, for fiscal 1995, as compared to fiscal 1994, was primarily due to higher operating costs to meet the requirements from the significant increase in sales volume. SG & A expenses as a percentage of sales declined to 12% for fiscal 1995 as compared to 14% for fiscal 1994. Of the $5,067,000 increase in SG & A expenses for fiscal 1995, compared to fiscal 1994, approximately $2,200,000 was attributable to higher salaries, incentives and fringe benefits. There were also increases in delivery costs and bad debt expense, mostly due to the higher sales volume.\nInterest expense, net of interest income, for fiscal 1995 remained at relatively the same amount as fiscal 1994, as the lower borrowing levels were offset by higher interest rates.\nFISCAL 1994 COMPARED TO FISCAL 1993\nThe increase in net sales for fiscal 1994, as compared to fiscal 1993, was due to an increase in the sales volume of semiconductor products. Sales of semiconductor products increased by $178,237,000 as a result of the strong market demand and additional sales of products from new suppliers. The sales volume of the Company's other major products was relatively unchanged or decreased modestly from the prior year.\nThe decrease in net margins for fiscal 1994, as compared to fiscal 1993, was due to a decline in the margins of most of the Company's major products. This decline in margins resulted from market pressures on the pricing of many of the Company's products, including some of the Company's value added products, and an increase in the sales volume of lower margin products, such as DRAMS.\nThe increase in SG & A expenses, in dollars, for fiscal 1994, as compared to fiscal 1993, was primarily due to higher operating costs to support the significant increase in sales volume. In addition, the Company was amortizing $463,000 per quarter of deferred computer software costs associated with its new operating and financial systems that became operational in December, 1992. Fiscal 1994 expenses also included a charge of $890,000 that was recorded in the first quarter related to the costs of the elimination of approximately 120 positions. These positions were eliminated as of August 31, 1993 by a reorganization of the Company's field and corporate support functions. The amounts incurred for the last nine months of fiscal 1994 would have been higher except for the savings from the elimination of these positions. This reorganization reduced the Company's fiscal 1994 expenses by approximately $1,000,000 per quarter beginning the second quarter. Primarily due to the savings from the August, 1993 restructuring and the higher sales volume, SG & A as a percentage of sales declined significantly for fiscal 1994 as compared to fiscal 1993. The SG & A amounts for fiscal 1993 also included some extraordinary levels of expenses related to the Company's conversion to its new computer software systems in December, 1992. The Company estimated that it had incurred approximately $2.4 million to $2.9 million in additional costs, affecting both cost of sales and SG & A expenses in fiscal 1993 associated with the computer software conversion.\nInterest expense for fiscal 1994 remained relatively unchanged from fiscal 1993, as lower borrowing levels were offset by higher interest rates beginning in late fiscal 1994.\nIn August, 1993 the Omnibus Budget Reconciliation Act of 1993 was enacted which essentially increased the Company's Federal tax rate from 34% to 35%. Additionally, as a result of the Act, a retroactive Federal tax adjustment of $163,000, or $.01 per share, was charged to income tax expense in the first quarter of fiscal 1994 for the period of January to May 1993.\nINCOME TAXES\nDuring the fourth quarter of fiscal year 1993, the Company implemented Statement of Financial Accounting Standards No. 109 covering income tax accounting. The adoption did not have a material impact on the financial statements for fiscal year 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has been able to fund its working capital requirements for the past five years through cash flow from operations and bank borrowings.\nFor the five years ended May 31, 1995, the Company incurred approximately $14 million in net aggregate capital expenditures. Costs incurred to upgrade and expand the Company's computer system and the acquisition and construction of several facilities accounted for a significant portion of the capital expenditures for the last five years. Additionally, the Company incurred approximately $9 million for the design, purchase and development of new computer software for its operating and financial systems during fiscal years 1990 to 1993.\nThe Company's sources of liquidity at May 31, 1995 consisted principally of working capital of $254,394,000 and unsecured bank credit lines of $70,000,000, of which $20,000,000 in borrowings were outstanding. The Company believes that its working capital, borrowing capabilities, and the funds generated from operations should be sufficient to finance its anticipated operational requirements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Marshall Industries:\nWe have audited the accompanying balance sheets of Marshall Industries (a California corporation) as of May 31, 1994 and 1995, and the related statements of income, shareholders' investment and cash flows for each of the three years in the period ended May 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 Marshall Industries as of May 31, 1994 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP Los Angeles, California July 21, 1995\nMarshall Industries BALANCE SHEETS May 31, 1994 and 1995 (Dollars in thousands)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS.\nMarshall Industries STATEMENTS OF INCOME For the Years Ended May 31, 1993, 1994 and 1995 (In thousands except per share data)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.\nMarshall Industries STATEMENTS OF SHAREHOLDERS' INVESTMENT For the Years Ended May 31, 1993, 1994 and 1995 (Dollars in thousands)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.\nMarshall Industries STATEMENTS OF CASH FLOWS For the Years Ended May 31, 1993, 1994 and 1995 (In thousands)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.\nMarshall Industries NOTES TO FINANCIAL STATEMENTS May 31, 1995\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nRevenue Recognition: Sales are recognized at the time of product shipment.\nDepreciation and Amortization: Depreciation on buildings is computed using the straight-line method over useful lives of 25 years. Building and leasehold improvements are amortized on the straight-line method over the shorter of the lives of the buildings or the remaining terms of the leases or useful lives of the assets. Depreciation on all other plant and equipment is computed on the straight-line and declining balance methods over useful lives of two to ten years. Maintenance and repairs and minor replacements of property are charged to expense when incurred. Major expenditures for additions and improvements are capitalized at cost. When assets are retired, or otherwise disposed of, the cost and related reserves are removed from the accounts, and any resulting gain or loss is included in income.\nInterest Expense: Interest income of $1,180,000 is netted against interest expense in fiscal 1995. Interest income was not material in fiscal 1994 and 1993.\nTax Deferred Profit Sharing Plan: Under the provisions of the Marshall Industries Tax Deferred Profit Sharing Plan (the \"Plan\"), participating employees may agree to defer from two to twelve percent, with certain limitations, of their earnings each payroll period, and such amount is deposited in a nonforfeitable, fully vested trust account for the employees' benefit. The Company contributes quarterly an amount equal to 50 percent of the employees' contributions, limited to 3% of such employee earnings for the quarter, reduced by employee forfeitures of prior Company contributions. Company contributions may be limited to the extent of net profits and must be invested in the Company's common stock. The Plan, however, may not own more than 20 percent of the Company's outstanding shares. At May 31, 1995, the Plan owned less than 2% of the Company's outstanding shares. Company contributions and expenses related to the Plan amounted to $952,000 in 1993, $1,125,000 in 1994 and $1,141,000 in 1995.\nIncome Taxes: As discussed in Note 3, during fiscal 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Under SFAS No. 109, deferred tax assets and liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted tax rates.\nCash and Accounts Payable: The Company's banking system provides for the daily replenishment of its bank accounts for check clearing requirements. Accordingly, outstanding checks of $11,015,000 and $11,169,000 that had not yet been paid by the Company's banks at May 31, 1994 and 1995, respectively, are reflected in cash and accounts payable in the accompanying financial statements.\nInventories: The Company values its inventories at the lower of average cost or market.\nShareholders' Investment: The Company has authorized 200,000 shares of no par value preferred stock, of which none was outstanding at May 31, 1994 or 1995.\nCapitalized Deferred Software Costs: Deferred software costs are included in other assets and represent payments to vendors for the design, purchase and implementation of the computer software for the Company's operating and financial systems. Such deferred costs, aggregating to $10,088,000, are amortized over periods not to exceed five years. At May 31, 1994 and 1995, the accumulated amortization of such costs were $2,778,000 and $5,084,000, respectively.\nNet Income Per Share: Per share amounts are computed on the basis of weighted average common and common equivalent shares outstanding (17,278,000 in 1993, 17,357,000 in 1994, and 17,439,000 in 1995). Common equivalent shares include the dilutive effect of outstanding stock options, if applicable. All share and per share data included in these financial statements have been restated to reflect the two for one stock split paid on February 28, 1994.\nReclassifications: Certain prior year amounts have been reclassified to conform with the 1995 presentation.\n(2) LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nBank credit lines --\nThe Company has revolving credit line agreements with two major banks to borrow up to $70,000,000 in the aggregate. These unsecured credit line agreements, with borrowing limits of up to $40,000,000 and $30,000,000 each, mature on December 31, 1995 and 1996, respectively. The interest rates under these credit lines are determined at the time of borrowing based on a choice of options as specified in the agreements. The options range from floating rates of LIBOR, IBOR, certificate of deposit, or banker's acceptance plus 1\/2%, up to prime rate. At May 31, 1995, the prime rate was 9.0%. A commitment fee is payable based on 1\/4% per annum on the daily average unused amounts of the lines of credit. In addition, both banks require a facility fee of 1\/8% per annum on the commitment balance. There are no compensating balance requirements.\nThe terms of these credit agreements require the Company, among other things, to maintain a minimum net worth of $170,000,000 which is adjusted upward quarterly by 70 percent of net income and 70 percent of net proceeds from any sales of capital stock or subordinated debentures. At May 31, 1995, at least $231,033,000 of shareholders' investment was required to meet this covenant. The credit agreements also require the Company to meet certain specified working capital and financial ratios and not to make capital expenditures or incur lease liabilities in excess of certain specified amounts. The Company is in compliance with all conditions and covenants of these agreements.\nSubsequent to May 31, 1995, the Company agreed in principle to amend one of its credit line agreements to extend its maturity date and replace the other agreement with a new agreement with a major bank. The maturity date of the amended and new agreements will be September 30, 1998. All of the major terms and conditions of the amended and new agreements are similar to the Company's current agreements. The amended and new agreements will provide the Company a total borrowing capacity of $55,000,000. This reduction in the total credit capacity was due to the Company's anticipated lower borrowing requirements.\nTerm loan --\nIn August 1994, the Company obtained an unsecured term loan in the amount of $25,000,000 with principal repayment due on September 30, 1997. The Company has the option of repaying the loan, or a portion thereof, prior to the maturity date. The interest rate on the loan is based on the 90 day LIBOR rate plus 1\/2%. At May 31, 1995 the interest rate on the loan was 5.75%. The term loan agreement requires the Company to maintain a minimum net worth ($225,502,000 at May 31, 1995) and to meet certain specified working capital and financial ratios. The agreement prohibits capital expenditures in excess of specified amounts and issuance of debt, guarantees, loans or advances beyond specified amounts. The Company is in compliance with all conditions and covenants of the term loan agreement.\nIndustrial revenue bonds --\nThe industrial revenue bonds are secured by real property with a net book value of $2,985,000 at May 31, 1995.\nMaturities of long-term debt --\nLong-term debt at May 31, 1995 based on the amended terms is payable in succeeding fiscal years as follows: 1996 $410,000; 1997 $205,000; 1998 $25,000,000; 1999 $20,000,000.\nThe Company's bank credit lines, term loan and industrial revenue bonds approximate fair value as they bear floating interest rates.\n(3) INCOME TAXES\nThe Company adopted the provisions of SFAS No. 109 effective in fiscal year 1993. The adoption of this Standard did not have a material effect on the financial statements for fiscal year 1993.\nThe provision (benefit) for income taxes consists of the following (in thousands):\nThe difference between the income tax provision at the Federal statutory rate and the recorded income tax provision is reconciled as follows (in thousands):\nAs of May 31, 1994 and 1995, deferred tax assets (liabilities) were comprised of the following (in thousands):\nAs of May 31, 1995, the Company had total deferred tax assets of $10,216,000 and total deferred tax liabilities of $4,524,000. The Company did not record any valuation allowances against deferred tax assets at May 31, 1995.\n(4) COMMITMENTS AND CONTINGENCIES\nLease Commitments: The Company leases certain facilities and equipment under operating leases expiring at various dates through fiscal year 2001. The aggregate rent expense for all operating leases was $2,618,000 in 1993, $2,324,000 in 1994 and $2,665,000 in 1995.\nThe future minimum lease payments under all leases are shown below (in thousands):\nLitigation: There are no material pending legal proceedings to which the Company is a party.\n(5) STOCK OPTIONS\nThe Company has one active stock option plan which provides for the granting of incentive and nonqualified stock options covering 2,040,000 shares of common stock. There were three other plans, which are inactive, during the periods reported. Nonqualified stock options may have an exercise price which is less than market value at the date of grant; incentive stock options must have an exercise price equal to market value at the date of grant. There were 50,000 and 40,000 options granted in fiscal 1994 and 1995, respectively, at exercise prices ranging from $24.00 to $27.875 per share. No options were granted during fiscal 1993. At May 31, 1995, 280,500 shares were available for additional grants.\nThe following is a summary of changes in outstanding options for the Company's stock option plans for the year ended May 31, 1995:\nThe difference between the quoted market value of the shares at the date of grant and the option price for grants made under the nonqualified plans is charged to income as compensation expense over the vesting periods of the related options. During fiscal 1993, 1994 and 1995, $215,000, $103,000 and $92,000, respectively, were charged against income and credited to additional paid-in capital under these plans. Options granted are exercisable over a period of ten to twenty years. The income tax effect of any difference between the market price at the grant date and the market price at the exercise date is credited to additional paid-in capital as the options are exercised.\n(6) INVESTMENT IN SONEPAR ELECTRONIQUE INTERNATIONAL\nIn August, 1994, the Company invested 151 million French Francs ($27.9 million in U.S. dollars) in Sonepar Electronique International (\"SEI\"), one of the three largest electronic component distributors in Europe. This investment is in the form of an interest bearing, convertible note, guaranteed by a major French bank as to default. The interest on the note is the same as the Company's borrowing rates under its unsecured term loan, as described in Note 2. The note plus accrued interest will be converted in 1997 into a minority equity interest of up to 20% in SEI if certain anticipated sales and pre-tax income goals are met. If these goals are not met, the Company will have the option to call for the repayment in U.S. dollar equivalent of the original loan (plus accrued interest) or to convert the loan into a 20% equity interest in SEI. Following the conversion, SEI will have a 2 year option to purchase an equivalent amount in U.S. dollars of the Company's stock of up to 5% of the Company's outstanding shares on a fully diluted basis. The option price will be based on market prices at the time of conversion. In addition, the Company will have the option of increasing its equity investment to 49% in SEI. To finance its investment in SEI, the Company obtained an unsecured term loan in the amount of $25,000,000 (Note 2).\n(7) BUSINESS SEGMENT\nThe Company is engaged in the distribution of industrial electronic components and production supplies through a nationwide network of sales and distribution facilities. In the opinion of management, the Company's products are identifiable to only one industry segment.\nThe Company's Canadian operations are currently not material to its results of operations or financial position.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE\nPART III\nMarshall will file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A involving the election of directors. The Proxy Statement for the Annual Meeting of Shareholders to be held on October 24, 1995 is incorporated herein by this 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 -- The following financial statements of Marshall Industries are set forth in Item 8 of this Annual Report on Form 10-K:\n(A) 2. FINANCIAL STATEMENT SCHEDULES -- All schedules are omitted since they are not applicable, not required, or the required information is included in the financial statements or notes thereto.\n(A) 3. EXHIBITS -- The following exhibits are attached to this Annual Report on Form 10-K:\n(B) REPORTS ON FORM 8-K -- Marshall has not filed any reports on Form 8-K during the quarter ended May 31, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Marshall has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMARSHALL INDUSTRIES\nPursuant to the requirements of the Securities Exchange Act of 1934, 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":"109156_1995.txt","cik":"109156","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nZale Corporation (the \"Company\"), founded in 1924, is the nation's largest chain of specialty retail jewelry stores, operating 1,177 retail locations at July 31, 1995. For the twelve months ended July 31, 1995, total Company retail sales were approximately $1,036.1 million. The Company sells jewelry and giftware throughout the United States, Puerto Rico and Guam through its Zales, Gordon's, Guild and Diamond Park Divisions. The Company operates stores primarily in regional shopping malls and leased departments in department stores. Merchandise is sold for cash, on the Company's private label credit cards and on bank and national credit and charge cards. The Company also markets credit insurance to its private label credit card customers.\nThe Company historically has purchased substantially all of its merchandise in finished form from a network of established suppliers and manufacturers located primarily in the United States, the Orient and Italy. The Company is also centrally purchasing certain commodity items such as gold chains direct from manufacturers or other primary sources. A portion of the merchandise offered by the Company is procured from vendors under consignment programs through which the Company is not obligated to pay for the merchandise until it is sold to retail customers.\nBUSINESS STRATEGY\nThe Company's goal in fiscal 1995 was to restore Zale Corporation as the pre-eminent fine jewelry retailer in the nation. To accomplish this task, the Company developed a three-phase plan, starting with getting back to the basics of retailing. That meant understanding and satisfying customers' needs, offering the right selection and quality of merchandise, and pursuing an effective and efficient marketing strategy. It also entailed paying close attention to the Company's store environment and operations, especially in improving customer service.\nA major element of the Company's three-phase plan was to strengthen the merchandising in the stores. The Company developed a core group of items which have been perennial best-sellers. These items include tennis bracelets, diamond anniversary bands and diamond stud earrings. The Company made certain that these key items were available in a variety of styles and began to fill out the assortments with \"good, better and best\" price points. The Company has been diligent about maintaining a depth of stock on these key items at all times versus the traditional approach of having one or two pieces per store. Inventory management systems have been structured so that key items would be more consistently in stock and systems have been developed for prompt replenishment of key items.\nConsistent with the Company's new merchandising plan, the Company began to make its marketing efforts more product-focused. Print, television and radio advertising feature selected key items in a variety of price points. The Company has broadened its advertising beyond the Christmas season, to tie in with other gift-giving holidays such as Valentine's Day and Mother's Day. In-store promotions have been synchronized to take advantage of high mall traffic periods. These strategies have helped to position Zales and Gordon's as gift-giving destinations.\nAfter refining the merchandise mix and marketing, the Company worked to improve the quality of service and the efficiency of the stores. The Company focused initially on the top 300 stores in the Zales and Gordon's Divisions, moving the most experienced and capable managers into these stores. The Company also modified staff scheduling to put more sales personnel \"on the floor\" during peak traffic periods and introduced more extensive training in sales techniques and customer relationship building in all of its stores. The \"focus\" group of stores also received an increased level of merchandise and marketing support. As a result, the focus group stores outperformed the rest of the chain.\nA majority of the Company's stores are situated in prime, centercourt mall locations or other high traffic areas of shopping malls. Beginning in late fiscal 1994 and continuing into fiscal 1995, the Company set out to establish separate identities for its Zales and Gordon's brand names. Previously managed by a single team, the two divisions were placed under separate management teams. New divisional management was brought in to the Zales, Gordon's and Guild divisions to create and implement an individualized merchandising approach. Different marketing techniques have been adopted, targeted toward each division's specific demographic base. At the same time, the Company is committed to enhancing the cost and efficiency benefits of centralized support operations.\nThe Company offers credit through its own private label credit cards to enable creditworthy customers to finance their purchases without using cash or bank card lines of credit. The Company seeks to establish a relationship with its customers through merchandise and credit card programs that encourages repeat purchases of fashion and gift items as well as substantial purchases on occasions such as engagements, anniversaries, Christmas, birthdays, graduations and other gift-giving holidays. Through mailing lists available from the Company's credit operations, the Company can mail promotional material directly to customers to advertise special sales or unique items that are offered in its stores. The Company encourages customers with major credit cards to apply for a Company credit card even when no purchase is made. This enables the Company to solicit new business from those customers by direct mailings. The Company believes that this program enhances future sales to customers with a strong credit history.\nAs part of the Company's business strategy, it has embarked on a store remodeling and refurbishment program. This program will enable the Company to enhance its stores in certain key markets relative to its competition. Additionally, the Company plans on making expenditures of approximately $15.0 million on its management information systems to migrate to client server based applications from mainframe applications over the next several years. The Company anticipates spending approximately $50.0 million on capital expenditures in fiscal 1996. Capital expenditures are typically scheduled for the late spring through early fall in order to have new or renovated stores ready for the Christmas selling season. During the year ended July 31, 1995, the Company made approximately $42.3 million in capital expenditures principally to open 18 new stores and enhance the appearance of 393 stores. This included 153 relocations, complete remodelings or major refurbishments and 240 stores that were enhanced through addition of either or all of new carpet, paint and new wall coverings and display elements. The Company intends to continue its store upgrade program and open 250 new locations over the next three years.\nSELECTED DIVISIONAL DATA\nThe Company operates principally under four divisions as described below. The following table presents net sales for the Zales, Gordon's, Guild and Diamond Park Divisions of the Company.\n(1) Amounts in this column represent historical income statement data for the twelve months ended July 31, 1993 which includes the four month period ended July 31, 1993 and the eight months ended March 31, 1993.\n(2) Other net sales in fiscal 1995 includes sales from the Company's Outlet stores which are being used to sell overstocked and other merchandise no longer sold in the regular retail locations. Outlet store sales and operating results in the prior years were not significant and were classified in cost of sales.\nZales Division\nAt August 1, 1995, the Zales Division operated 534 stores, including 35 stores transferred from the Gordon's Division effective August 1, 1995, under the name \"Zales\" in 48 states and Puerto Rico. The Zales Division is being positioned as the leading national brand name in jewelry retailing in the United States. Zales' customers represent a solid cross-section of mainstream America, seeking good value in fine-quality merchandise. The average purchase at a Zales location is $257. The Zales Division stores average approximately 1,400 square feet.\nThe following table sets forth the number of stores and average sales per store for the Zales Division for the periods indicated:\nGordon's Division\nAt August 1, 1995, the Gordon's Division operated 332 stores, subsequent to the transfer of 35 stores to the Zales Division effective August 1, 1995. The division operates 318 stores under the name \"Gordon's\"(R) in 39 states and Puerto Rico and 14 stores operating under the name \"Daniel's\"(R) in Arizona. The Company has positioned Gordon's as a dominant regional brand to differentiate it from the national Zales brand. Its merchandise mix features more contemporary and localized looks, and its average sale is $225. The Gordon's Division stores average approximately 1,300 square feet.\nThe following table sets forth the number of stores and average sales per store for the Gordon's Division for the periods indicated:\nGuild Division\nAt August 1, 1995, the Guild Division operated 123 upscale jewelry stores in 26 states and Guam. The following table sets forth the Guild Division's trade names and the number of stores operating under each of those names as of August 1, 1995.\nThe Guild Division offers higher-end merchandise, more exclusive designs and a prestigious shopping environment for the upscale customer. The Guild Division has an average sale of $477. The Guild Division stores average approximately 3,200 square feet.\nThe following table sets forth the number of stores and average sales per store for the Guild Division for the periods indicated:\nDiamond Park Division\nAt August 1, 1995, the Diamond Park Division operated 188 leased locations in department stores including Dillard's(R) (66 locations), Mercantile (59 locations), The Broadway(R) (41 locations), and Marshall Field's(R) (22 locations) in 24 states. The Diamond Park Division offers a service for retailers that wish to turn to an outside provider for specialized management and marketing skills required to sell fine jewelry. The Diamond Park Division creates leased jewelry departments at specified locations, primarily major department stores, tailoring the merchandising concept to that of the host company.\nThe following table sets forth the number of departments and average sales per department for the Diamond Park Division for the periods indicated:\nBUSINESSES OF NON-RETAIL AFFILIATES\nZale Indemnity Company, Zale Life Insurance Company and Jewel Re-Insurance Ltd. are providers of various types of insurance coverage, which typically are marketed to the Company's private label credit card customers. The three companies are the insurers (either through direct written or reinsurance contracts) of the Company's customer credit insurance coverages. In addition to providing replacement property coverage for certain perils, such as theft, credit insurance coverage provides protection to the creditor and cardholder for losses associated with the disability, involuntary unemployment or death of the cardholder. Zale Life Insurance Company also provides group life insurance coverage for eligible employees of the Company. Zale Indemnity Company, in addition to writing direct credit insurance contracts, also has certain discontinued businesses that it continues to run off. Credit insurance operations are dependent on the Company's retail sales on its private label credit cards and are not significant on a stand-alone basis.\nPURCHASING AND INVENTORY\nThe Company purchases substantially all of its merchandise in finished form from a network of established suppliers and manufacturers located primarily in the United States, the Orient and Italy. The Company either purchases merchandise from its vendors or acquires merchandise on consignment. The Company had approximately $85.9 million and $111.4 million of consignment inventory on hand at July 31, 1995 and 1994, respectively. The Company is subject to the risk of fluctuation in prices of diamonds, precious stones and gold. The Company historically has not engaged in any substantial amount of hedging activities with respect to merchandise held in inventory, since the Company has been able to adjust retail prices to reflect significant price fluctuations in the commodities that are used in the merchandise it sells. No assurances, however, can be given that the Company will be able to adjust prices to reflect commodity price fluctuations in the future. The Company is not subject to substantial currency fluctuations because most purchases are dollar denominated. During the years ended July 31, 1995 and March 31, 1994, the Company purchased approximately 29 percent and 38 percent, respectively, of its merchandise from its top five vendors. Although the Company believes that alternate sources of supply are available, the abrupt loss of any significant supplier during the three months ended November 30 of any year, the period leading up to the Christmas selling season, could result in a material adverse effect on the Company's business.\nCOMPETITION\nThe jewelry retailing industry is highly competitive. The industry is fragmented, and the Company competes with a large number of independent regional and local jewelry retailers, as well as nationally recognized jewelry chains. The Company's sales represent approximately 6% of national retail jewelry store sales. The Company must also compete with other types of retailers who sell jewelry and gift items, such as department stores, catalog showrooms, discounters and home shopping programs. The Company believes that it is also competing for consumers' discretionary spending dollars. The Company must, therefore, also compete with retailers who offer merchandise other than jewelry or giftware.\nNotwithstanding the national or regional reputation of its competition, the Company believes that it must compete on a mall-by-mall basis with other retailers of jewelry as well as with retailers of other types of discretionary items. Therefore, the Company competes primarily on the basis of store location, reputation for high- quality, distinctive and value-priced merchandise, personal service and its ability to offer private label credit card programs to customers wishing to finance their purchases. The Company's success is also dependent on its ability to react to and create customer demand for specific product lines.\nThe Company also competes for desirable new store locations with other jewelers and specialty retailers. Historically, the Company has generally been able to lease locations in new or vacated mall space which the Company considered desirable.\nThe Company holds no material patents, licenses (other than its licenses to operate its Diamond Park leased locations), franchises or concessions; however, the established tradenames for stores and products in the Company's Zales, Gordon's and Guild Divisions are important to the Company in maintaining its competitive position in the jewelry retailing industry.\nCREDIT OPERATIONS\nJewelers Financial Services, Inc. (\"JFS\") has credit approval, customer service and collection systems that management considers to be sophisticated. The Company offers and grants credit to qualified customers. See \"Business Strategy\". The credit programs help facilitate the sale of merchandise to customers who wish to finance their purchases rather than use cash or major credit cards. Credit extension, customer service and advanced collections for all the accounts are performed by JFS at servicing centers located in Tempe, Arizona; Clearwater Florida; San Juan, Puerto Rico; and Guam. The Company has Point-of-Sale Instant Credit (\"POSIC\") which allows sales associates to obtain new account credit approval generally within two minutes for most qualified customers. This compares to the previous instant credit turnaround time of approximately fifteen minutes. Flexible payment arrangements, typically twenty-eight to thirty-four months, are extended to credit customers. Early stage collection of accounts, collection agency placement of charged- off accounts and collection of accounts under which the related obligors are involved in bankruptcy proceedings are performed by JFS at the Company's National Collections Center located in San Marcos, Texas. The mailing of statements regarding the accounts and the processing of payments on the accounts are performed by JFS at the Company's headquarters in Irving, Texas. The Company's credit insurance affiliates provide coverage for credit purchasers in the event of total disability, involuntary unemployment, death and losses due to theft, burglary, fire and windstorm. See \"Businesses of Non-Retail Affiliates\".\nApproximately 52 percent of the Company's retail sales during the year ended July 31, 1995 through its Zales, Gordon's and Guild Divisions were generated by credit sales on the private label credit cards. At July 31, 1995, there were approximately 656,000 active customer charge accounts. The Company also has an additional 473,000 promotable charge customers without an outstanding balance and over 2.5 million customer names on file that are not current charge customers.\nThe following table presents certain data concerning sales, credit sales and accounts receivable for the past two fiscal years (1):\n(1) The table excludes the Diamond Park Division which does not have a proprietary credit plan.\nEMPLOYEES\nAs of July 31, 1995, the Company had approximately 9,000 employees, of whom 23 are represented by unions. The Company considers its relations with its employees to be good.\nOTHER\nOn December 13, 1993, the Board of Directors of the Company authorized the change in the Company's fiscal year end to July 31. Such change was effective as of April 1, 1994. The Company's determination to change its fiscal year was based on several considerations. By changing to a July 31 fiscal year end, the Company has established quarterly reporting periods that are more consistent with other companies in the retail industry. Additionally, a July 31 year end coincides with the Company's emergence from bankruptcy proceedings, thereby providing for greater comparability of historical financial data in the future, and, it makes the Company's planning process more effective.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PRINCIPAL PROPERTIES\nThe Company occupies a corporate headquarters facility, completed in March 1984 with 430,000 square feet, under a lease extending through September 1997. The facility is located on a 17-acre tract in Las Colinas, a planned business development in Irving, Texas, near the Dallas\/Fort Worth International Airport. The Company owns 33 acres of land surrounding the corporate headquarters facility and a 120,000 square foot warehouse in Dallas, Texas.\nThe Company also leases four servicing centers located in Clearwater, Florida (30,000 square feet), Tempe, Arizona (24,200 square feet), San Juan, Puerto Rico (2,900 square feet) and Guam (556 square feet) and one national collections center located in San Marcos, Texas (9,000 square feet).\nThe Company rents all of its retail spaces, other than the Diamond Park Division leased locations, under leases with terms ranging from five to fifteen years. Most of the store leases provide for the payment of base rentals plus real estate taxes, insurance, common area maintenance fees and merchants association dues, as well as percentage rents based on the stores' gross sales.\nThe following table indicates the expiration dates of the current terms of the Company's leases:\nThe Company owns several parcels of developed and undeveloped real estate formerly owned by Gordon, which the Company no longer uses in operations and intends to sell.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nJEWEL RECOVERY, L.P. Pursuant to the Plan of Reorganization, Zale assigned certain claims and causes of action and advanced $3.0 million to Jewel Recovery, L.P., a limited partnership (\"Jewel Recovery\") which was formed upon Zale's emergence from bankruptcy. The sole purpose of Jewel Recovery is to prosecute and settle such assigned claims and causes of action. The general partner of Jewel Recovery is Jewel Recovery, Inc., a subsidiary of the Company. Its limited partners are holders of various unsecured claims against Zale.\nThere is a possibility that the Company may recover the $3.0 million advance made to Jewel Recovery as well as other amounts related to the finalization of the Chapter 11 claims settlement process. It is likely that these matters will be resolved by the end of the second quarter of fiscal 1996. The Company does not expect these recoveries to be material to its financial position or recurring operations.\nIn addition, the Company and ZDel have agreed to indemnify certain parties to litigation settlements entered into by the Company in connection with the Plan of Reorganization against cross-claims, similar third-party claims or costs of defending such claims brought against such parties as a result of litigation instigated by the Company, ZDel or Jewel Recovery. At October 6, 1995, no material claims had been asserted against the Company or ZDel for such indemnification.\nOTHER. The Company is involved in certain other legal actions and claims arising in the ordinary course of business. Management believes 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 of the Company during the quarter ended July 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this item is included in the registrant's Annual Report to Stockholders for the year ended July 31, 1995 on page 32 under the caption \"Common Stock Information,\" 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 Annual Report to Stockholders for the year ended July 31, 1995 on page 13 under the caption \"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 Annual Report to Stockholders for the year ended July 31, 1995 on pages 13 through 16 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 Annual Report to Stockholders for the year ended July 31, 1995 on pages 17 through 31, 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\nEXECUTIVE OFFICERS\nThe following individuals serve as executive officers of the Company. Officers are elected by the Board of Directors, each to serve until his successor is elected and qualified, or until his earlier resignation, removal from office or death.\nROBERT J. DINICOLA, Age 48. Chairman of the Board, Chief Executive Officer and Director\nMr. DiNicola has served as Chairman of the Board, Chief Executive Officer and a director of the Company since April 18, 1994. For the three years prior to joining the Company, Mr. DiNicola was a senior executive officer of The Bon Marche Division of Federated Department Stores, Inc., having served as Chairman and Chief Executive Officer of that Division from 1992 to 1994 and as its President and Chief Operating Officer from 1991 to 1992. From 1989 to 1991, Mr. DiNicola was a Senior Vice President of Rich's Department Store Division of Federated. For seventeen years, prior to joining the Federated organization, Mr. DiNicola was associated with Macy's, where he held various executive, management and merchandising positions, except for a one-year period while he held a division officer position with May Co.\nLARRY POLLOCK, Age 48. President, Chief Operating Officer and Director\nThe Board of Directors elected Mr. Pollock President and Chief Operating Officer of the Company on January 10, 1994 and appointed him as a director on July 27, 1994. From January 1990 until joining the Company, Mr. Pollock served as President and Chief Executive Officer of Kartens Jewelers. From 1987 to 1990, Mr. Pollock was a consultant in the retail jewelry industry. For eighteen years prior to 1987, Mr. Pollock was associated with J.B. Robinson Jewelers, Inc. where he held various executive positions including President and Chief Executive Officer from 1981 through 1986. Mr. Pollock has an ownership interest in two radio stations in the Cleveland area and also serves as a director of New West Eyeworks.\nMERRILL J. WERTHEIMER, Age 55. Executive Vice President - Finance and Administration\nMr. Wertheimer was appointed Executive Vice President - Finance and Administration on January 27, 1995. From June 1991 through January 1995, he served as Senior Vice President and Controller of the Company. From February 1990 to May 1991, Mr. Wertheimer served as President and Chief Executive Officer of Henry Silverman Jewelers. Mr. Wertheimer served as Senior Vice President of the Company from September 1987 to October 1989 and also served as Chief Financial Officer of the Company from March 1987 to October 1989.\nBERYL RAFF, Age 44. Senior Vice President and President, Zales Division\nMs. Raff joined the Company on November 21, 1994 as President of the Zales Division. From March 1991 through October 1994, Ms. Raff served as Senior Vice President of Macy's East with responsibilities for its jewelry business in a 12 - state region. From April 1988 to March 1991, Ms. Raff served as Group Vice President of Macy's South\/Bullocks. Prior to 1988, Ms. Raff has seventeen years of retailing and merchandising experience with the Emporium and Macy's department stores.\nMARY FORTE, Age 44 Senior Vice President and President, Gordon's Division\nMs. Forte joined the Company on July 18, 1994 as President of the Gordon's Division. From January 1994 to July 1994, Ms. Forte served as Senior Vice President of QVC - Home Shopping Network. From July 1991 through January 1994, Ms. Forte served as Senior Vice President of the Bon Marche', Home Division. From July 1989 to July 1991, Ms. Forte was Vice President of Rich's Department Store, Housewares Division. In addition to the above, Ms. Forte has an additional thirteen years of retailing and merchandising experience with Macy's, The May Company and Federated Department stores.\nPAUL LEONARD, Age 40. Senior Vice President and President, Guild Division\nMr. Leonard was appointed President of the Company's Fine Jewelers Guild Division on January 27, 1995. From October 1994 to January 1995, Mr. Leonard served as President of Corporate Merchandising for the Company. For three years prior to joining the Company, Mr. Leonard held positions as General Manager of Jewelry and then Senior Vice President of Soft Lines for Ames Department Store. Prior to that, Mr. Leonard was a Merchandise Vice President with The May Company. Mr. Leonard has more than twenty years of retailing and merchandising experience with an emphasis in jewelry.\nMAX BROWN, Age 66. Senior Vice President and President, Diamond Park Division\nMr. Brown has been President of the Company's Diamond Park Division since January 11, 1993. From July 1989 to January 1993, Mr. Brown was Vice President and General Manager of the Diamond Park Division. Prior to 1989, he served as the Director of Stores for the Diamond Park Division.\nJO ANN CONNOLLY, Age 48. Senior Vice President, Corporate Merchandising\nMs. Connolly was appointed Senior Vice President of Corporate Merchandising in January 1995. From 1989 to January 1995, Ms. Connolly served as Vice President and Merchandise Manager in the Zales Division and from 1984 to 1989 as Vice President and Merchandise Manager in the Guild Division.\nPAUL KANNEMAN, Age 38. Senior Vice President and Chief Information Officer\nMr. Kanneman joined the Company on November 14, 1994 as Chief Information Officer. From July 1993 to November 1994, Mr. Kanneman was an Associate Partner with Andersen Consulting LLP. Mr. Kanneman was a Principal from August 1991 to July 1993, and a Senior Associate from August 1989 to July 1991 with Booz, Allen & Hamilton, Inc.\nHERSCHEL KRANITZ, Age 55. Senior Vice President, Human Resources\nMr. Kranitz has been Senior Vice President -- Human Resources of the Company since March 14, 1994. From May 1989 to March 1994, Mr. Kranitz served as Vice President -- Human Resources of Raynet, Inc.\nALAN P. SHOR, Age 36. Senior Vice President, General Counsel and Secretary\nMr. Shor joined the Company on June 5, 1995 as Senior Vice President, General Counsel and Secretary. For two years prior to joining the Company, Mr. Shor was the managing partner of the Washington, D.C. office of the Troutman Sanders law firm, whose principal office is based in Atlanta, Georgia. Mr. Shor, a member of Troutman Sanders since 1983, was a partner of the firm from 1990 to 1995.\nJOHN SKINNER, Age 57. Senior Vice President and President, Jewelers Financial Services, Inc.\nMr. Skinner has been a Senior Vice President of the Company since October 7, 1992. Mr. Skinner has served in various capacities with the Company since September 1984, including President of Jewelers Financial Services, Inc., and Vice President and General Credit Manager of the Company.\nTHOMAS E. WHIDDON, Age 42. Senior Vice President and Chief Financial Officer\nMr. Whiddon was appointed Senior Vice President and Chief Financial Officer on August 28, 1995. From April 1994 through August 1995, he served as Senior Vice President and Treasurer of the Company. From September 1988 to April 1994, Mr. Whiddon served as Vice President and Treasurer of Eckerd Corporation. Prior to becoming Treasurer, Mr. Whiddon served as Vice President and Assistant Treasurer of Eckerd Corporation from April 1986 to August 1988.\nThe information required by this item relating to directors and Section 16(a) Reporting is included in the registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on November 2, 1995 under the captions \"Proposal No. 1 -- Election of Directors,\" on pages 4 through 6, and \"Section 16(a) Reporting,\" on pages 16 to 17, and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is included in the registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on November 2, 1995 under the caption \"Executive and Director Compensation,\" on pages 9 through 12, and, except as stated in the next sentence, is incorporated herein by reference. The foregoing incorporation by reference specifically excludes the discussion in such Proxy Statement under the captions \"Report of the Compensation Committee on Executive Compensation\" and \"Stock Price Performance.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is included in the registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on November 2, 1995 under the caption \"Outstanding Voting Securities of the Company and Principal Holders Thereof,\" on pages 2 to 3, 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 registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on November 2, 1995 under the caption \"Related Party Transactions,\" on pages 12 to 13, and is incorporated herein by reference.\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 this report.\n(1) FINANCIAL STATEMENTS\nSee Item 8 on page 8.\nAll other financial statements and financial statement schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, are not material or are not applicable and, therefore, have been omitted or are included in the consolidated financial statements or notes thereto.\n(3) EXHIBITS\n____________________________________________\n(1) Incorporated by reference from the exhibit shown in parenthesis to the registrant's Form T-3 (No. 22-24-68) filed with the Commission on April 2, 1993.\n(2) Incorporated by reference from the exhibit shown in parenthesis to the registrant's Form 8-A\/A (No. 02-21526) filed with the Commission on July 16, 1993.\n(3) Previously filed as an exhibit to the registrant's Form 10-Q (No. 1-4129) for the quarterly period ended September 30, 1993, and incorporated herein by reference.\n(4) Incorporated by reference to the corresponding exhibit to the registrant's Registration Statement on Form S-1 (No. 33-73310) filed with the Commissions on December 23, 1993, as amended.\n(5) Previously filed as an exhibit to the registrant's Form 10-K (No. 0-21526) for the fiscal year ended March 31, 1994, and incorporated herein by reference.\n(6) Filed herewith.\n* Management Contracts and Compensatory Plans.\n(4) 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, as of the 16 day of October, 1995. ZALE CORPORATION\nBy: \/s\/ ROBERT J. DINICOLA ----------------------------------------- Robert J. DiNicola 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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Zale Corporation:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Zale Corporation (a Delaware corporation) and subsidiaries' Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our reports thereon dated September 12, 1995. Our report on the financial statements for the four months ended July 31, 1993, and for the year ended March 31, 1993, includes an explanatory paragraph with respect to changes in methods of accounting for postretirement benefits other than pensions and accounting for income taxes as discussed in the Notes to Consolidated Financial Statements. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is the responsibility of the Company's management and is presented for 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 audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDallas, Texas, September 12, 1995\nSCHEDULE II\nZALE CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\n(1) Accounts written off, less recoveries and other adjustments.\n(2) Amount includes a provision for excess customer receivable chargeoffs of closed store accounts of $8,230 and a provision for valuation of customer receivables of $12,500.\nINDEX TO EXHIBITS\nINDEX TO EXHIBITS\n- --------------------- (1) Incorporated by reference from the exhibit shown in parenthesis to the registrant's Form T-3 (No. 22-24-68) filed with the Commission on April 2, 1993.\n(2) Incorporated by reference from the exhibit shown in parenthesis to the registrant's Form 8-A\/A (No. 02-21526) filed with the Commission on July 16, 1993.\n(3) Previously filed as an exhibit to the registrant's Form 10-Q (No. 1-4129) for the quarterly period ended September 30, 1993, and incorporated herein by reference. INDEX TO EXHIBITS\n(4) Incorporated by reference to the corresponding exhibit to the registrant's Registration Statement on Form S-1 (No. 33-73310) filed with the Commissions on December 23, 1993, as amended.\n(5) Previously filed as an exhibit to the registrant's Form 10-K (No. 0-21526) for the fiscal year ended March 31, 1994, and incorporated herein by reference.\n(6) Filed herewith.\n* Management Contracts and Compensatory Plans.","section_15":""}
{"filename":"868610_1995.txt","cik":"868610","year":"1995","section_1":"ITEM 1. BUSINESS\nJones Programming Partners 2-A, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed in March 1992 pursuant to the public offering of limited partnership interests in the Jones Programming Partners Limited Partnership Program. Jones Entertainment Group, Ltd., a Colorado corporation, is the general partner of the Partnership (the \"General Partner\"). The Partnership was formed to acquire, develop, produce and distribute original programming (\"Programming\") to be owned by the Partnership. During 1995, the Partnership had three Programming projects: \"Charlton Heston Presents: The Bible,\" \"Household Saints\" and \"The Whipping Boy.\" Following is a description of these Programming projects.\nCharlton Heston Presents: The Bible. In May 1992, the General Partner, on behalf of the Partnership, entered into an agreement with Agamemnon Films, an unaffiliated party, to produce four one-hour programs for television, entitled \"Charlton Heston Presents: The Bible\" (the \"Bible Programs\"). The production costs of the Bible Programs were approximately $2,370,000, which included a $240,000 production and overhead fee to the General Partner. In return for agreeing to fund these production costs, the Partnership acquired all rights to the Bible Programs in all markets and in all media in perpetuity. The Partnership subsequently assigned half of its ownership of the Bible Programs to an unaffiliated party for an investment of $1,000,000 toward the production costs for the Bible Programs. After consideration of the reimbursement, the Partnership's total investment in the Bible Programs is $1,369,764 and its net investment, after consideration of amortization, was $369,873 as of December 31, 1995. From inception to December 31, 1995, the Partnership has recognized $1,094,960 of revenue from this film, of which $431,438 has been retained by the distributors of the film for their fees and marketing costs. Of the remaining $663,522, the Partnership has received $611,342 as of December 31, 1995. The remaining $52,180 was received in March 1996. The Partnership plans to recover its remaining investment in this film from net revenues generated from domestic and international home video markets.\nHousehold Saints. In February 1993, the Partnership acquired a one-third ownership interest in a film scheduled for world-wide theatrical release entitled \"Household Saints.\" The budgeted production costs of \"Household Saints\" were approximately $5,000,000, and the final production costs were approximately $5,300,000. For a one-third ownership interest in the film, the Partnership contributed one-third of the budgeted production costs, or $1,666,667. Two unaffiliated entities contributed similar amounts. Prior to June 30, 1995, the Partnership had invested approximately $1,913,918 in the film, which included a production and overhead fee of $100,000 paid to the General Partner by the Partnership. Prior to June 30, 1995, the Partnership's net investment in the film, after consideration of amortization, was $1,389,166. From inception to June 30, 1995, the Partnership had recognized $603,198 of revenue from this film.\nIn January 1995, the General Partner's Board of Directors agreed in principle to purchase the Partnership's interest in \"Household Saints\" from the Partnership at a price equal to the Partnership's net investment in the film of $1,389,166. The Partnership's limited partnership agreement allows the General Partner to purchase completed programming projects from the Partnership so long as the purchase price is an amount no less than the average of three separate independent appraisals of the fair market value. The General Partner subsequently obtained three separate independent appraisals of the fair market value of the Partnership's interest in \"Household Saints.\" Sunrise Capital of Bainbridge Island, Washington appraised the Partnership's interest in the film at $141,495 as of March 15, 1995. GB Investment Corporation of New York, New York appraised the Partnership's interest in the film at $310,856 as of April 10, 1995. Kagan Media Appraisals Inc. of Carmel, California appraised the Partnership's interest in the film at $443,000 as of April 27, 1995. The average of the three independent appraisals of the fair market value of the Partnership's interest in \"Household Saints\" was approximately $300,000. Closing of the sale occurred on June 30, 1995. The purchase price was paid $500,000 in cash at closing, $500,000 in the form of a non-interest bearing promissory note payable in full 12 months from the closing date and $389,166 in the form of a non-interest bearing promissory note payable in full 24 months from the closing date. Because both promissory notes were non-interest bearing, the Partnership recognized imputed interest of $122,860, thereby reducing the notes' carrying value to $766,306 and incurring a loss on sale of the film of $122,860. This loss will be offset by the Partnership in the form of interest income recognized as\nthe related discount on the promissory notes is amortized to interest income over the next 24 months. For the year ended December 31, 1995, interest income of $43,125 has been recognized from amortization of the related discount.\nThe Whipping Boy. In August 1993, the Partnership acquired the rights to the Newbury Award-winning book, \"The Whipping Boy.\" \"The Whipping Boy\" was produced as a two-hour telefilm which premiered in the North American television market on The Disney Channel. The film's final cost was approximately $4,100,000. As of December 31, 1995, the Partnership had invested $2,661,487 in the film, which included a $468,000 production and overhead fee paid to the General Partner. The film was co-produced by the General Partner and Gemini Films, a German company. The completed picture was delivered to The Disney Channel in the second quarter of 1994. The Partnership's net investment in the film, after consideration of amortization, was $1,051,213 as of December 31, 1995. From inception to December 31, 1995, the Partnership has recognized $2,111,931 of gross revenue from this film, of which $2,100,000 represents the initial license fee from The Disney Channel that was used to finance the film's production. Of the remaining $11,931, $2,808 has been retained by the distributors of the film for their fees and marketing costs and $699 has been received by the Partnership as of December 31, 1995. The remaining $8,424 was received in March 1996.\nThe General Partner on behalf of the Partnership, continues to seek additional licensing agreements for the distribution of the Partnership's filmed entertainment. The Partnership will seek to recover its investment in filmed entertainment by relicensing its assets through international sales, domestic cable or syndication, home video and ancillary markets. It is not anticipated that the Partnership will invest in any additional programming projects, but instead will focus on the distribution of its existing projects. See further discussion of the Partnership's distribution efforts concerning its film projects in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe Partnership has encountered and will continue to encounter intense competition in connection with its attempts to distribute the Programming. There is competition within the television programming industry for exhibition time on cable television networks, broadcast networks and independent television stations. In most cases, potential customers of the Partnership's Programming also produce their own competitive programs. In recent years, the number of television production companies and the volume of programming being distributed have increased, thereby intensifying this competition. Acceptance of the Programming in certain distribution media may be limited and the Programming will compete with other types of television programming in all domestic and international distribution media and markets. The success of programming is also dependent in part on public taste, which is unpredictable and susceptible to change. In international markets, the Partnership will encounter additional risks, such as foreign currency rate fluctuations, compliance and regulatory requirements, differences in tax laws, and economic and political environments. Profitability of the Partnership will depend largely on the Programming's acceptance in various domestic and international television markets, on the level of distribution of the Programming in such markets and the license fees and library values generated thereby, which are outside the control of the Partnership. There can be no assurance that the distribution efforts made by the Partnership, the General Partner or unaffiliated parties on behalf of the Partnership for the Programming will be sufficient to recover the Partnership's investment or produce profits for the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee Item 1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON 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 such a market will develop in the future. As of February 15, 1996, the number of equity security holders in the Partnership was 539.\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 decreased $2,349,068, from $2,673,557 in 1994 to $324,489 in 1995. This decrease was mainly due to the recognition of a $2,100,000 license fee received by the Partnership for \"The Whipping Boy\" in 1994 as compared to revenues from the film in 1995 of $11,931. In addition, revenues from \"Charlton Heston Presents: The Bible\" and \"Household Saints\" decreased $219,844 and $41,155, respectively, from 1994 to 1995.\nFilmed entertainment costs decreased $1,819,363, from $2,123,180 in 1994 to $303,817 in 1995. This decrease resulted primarily from the overall decrease in film revenues as discussed above. Filmed entertainment costs are amortized over the life of the film in the ratio that current gross revenues bear to anticipated total gross revenues.\nDistribution fees and expenses decreased $125,998, from $285,043 in 1994 to $159,045 in 1995. This decrease was the result of the decreased sales of the Partnership's programming in 1995 as discussed above. Distribution fees and expenses relate to the compensation due and cost incurred by distributors in selling the Partnership's programming in the domestic and international markets.\nLoss on sale of film production increased $122,860, from $-0- in 1994 to $122,860 in 1995. This increase was the result of the sale of \"Household Saints\" to the General Partner on June 30, 1995. The loss resulted from the Partnership's recognition of imputed interest on two non-interest-bearing promissory notes received from the General Partner as part of the sale agreement.\nInterest income increased $54,861, from $5,430 in 1994 to $60,291 in 1995. This increase in interest income was primarily the result of $43,125 in interest income recognized during 1995 relating to the amortization of the\ndiscount on the two promissory notes received from the General Partner as part of the \"Household Saints\" sale agreement. In addition, higher average levels of invested cash balances existing during 1995 as compared to 1994 also contributed to the increase in interest income.\nThe Partnership incurred a net loss of $220,238 in 1995 as compared to a net income of $247,629 in 1994. This decrease was primarily the result of the overall decrease in film gross margin of $403,707 during 1995 as compared to 1994. In addition, the $122,860 loss on sale of film production recognized during 1995, which was partially offset by an increase in interest income recognized from amortization of the discount on the two promissory notes received as part of the \"Household Saint\" sale, also contributed to the net loss incurred in 1995.\n1994 Compared to 1993\nRevenues of the Partnership increased $2,061,515, from $612,042 in 1993 to $2,673,557 in 1994. This increase was primarily the result of license fee revenue received by the Partnership for \"The Whipping Boy\" totaling $2,100,000 in 1994. No such license fee was received in 1993. The Partnership also received revenues of $532,402 in 1994 as compared to $50,000 in 1993 for \"Charlton Heston Presents: The Bible\" (the \"Bible Programs\"). These increases in revenues were partially offset by a decrease in revenues from \"Household Saints,\" which totaled $41,155 in 1994 compared to $562,042 in 1993.\nFilmed entertainment costs increased $1,588,569, from $534,611 in 1993 to $2,123,180 in 1994. This increase was the result of the increased revenues as mentioned above. Filmed entertainment costs are amortized over the life of each film in the ratio that current gross revenues bear to anticipated total gross revenues.\nDistribution fees and expenses decreased $309,514, from $594,557 in 1993 to $285,043 in 1994. This decrease was the result of the recognition of prints and advertising costs of approximately $406,000 in 1993, compared to no such costs in 1994, and also to a decrease in international sales of \"Household Saints\" in 1994. Distribution fees and expenses relate to the compensation due and costs incurred by distribution companies in licensing the Partnership's film productions in the international theatrical, television and home video markets. Although revenues increased in 1994 as compared to 1993, the primary reason for the decrease in distribution fees and expenses in 1994 was due to the recognition in 1994 of license fee revenue for \"The Whipping Boy\" which had no distribution costs associated with it.\nInterest income decreased $33,237, from $38,667 in 1993 to $5,430 in 1994. This decrease in interest income was the result of lower average cash balances invested during 1994 as compared to average balances invested in 1993.\nThe Partnership recognized a net loss of $485,458 in 1993 compared to net income of $247,629 in 1994. This change was primarily the result of an increase in revenue relating to \"The Whipping Boy,\" a decrease in distribution fees and expenses relating to \"Household Saints\" and the fact that there were no distribution fees and expenses for \"The Whipping Boy.\"\nFinancial Condition\nLiquidity and Capital Resources\nThe Partnership's principal sources of liquidity are cash on hand and amounts received from the domestic and international distribution of its programming. As of December 31, 1995, the Partnership had $377,368 in cash. It is not anticipated that the Partnership will invest in any additional programming projects, but instead will focus on the distribution of its existing projects. The Partnership had outstanding amount receivable totaling $60,604 as of December 31, 1995. These amounts were received by the Partnership in early 1996.\nOn June 30, 1995, the Partnership sold its interest in \"Household Saints\" to the General Partner for $1,389,166. The purchase price was paid $500,000 in cash at closing, $500,000 in the form of a non-interest bearing\npromissory note payable in full 12 months from the closing date and $389,166 in the form of a non-interest bearing promissory note payable in full 24 months from the closing date. The General Partner has determined that the sale proceeds from \"Household Saints\" will contribute to the liquidity and capital resources of the Partnership, allowing the Partnership to fund its operating needs and enabling the Partnership to fund future distributions to the limited partners.\nFor the year ending December 31, 1995, the Partnership declared distributions to partners totaling $567,124, of which $141,781 was paid in May 1995, $141,781 in August 1995 and $141,781 in November 1995, with the remaining $141,781 paid in February 1996. These distributions were made using cash on hand, interest income, initial proceeds received from the sale of \"Household Saints\" and cash provided by operating activities. Distributions are expected to continue during 1996, although no determination has been made regarding any specific level of distributions. Distributions reduce the financial flexibility of the Partnership.\nThe General Partner believes that the Partnership has, and will continue to have, sufficient liquidity to fund its operations and to meet its obligations. Cash flow from operating activities will be generated primarily from the Partnership's programming projects as follows:\n\"Charlton Heston Presents: The Bible\"\nIn 1992, the General Partner, on behalf of the Partnership, entered into an agreement with Agamemnon Films, an unaffiliated party, to produce four one-hour programs for television, entitled \"Charlton Heston Presents: The Bible\" (the \"Bible Programs\") for Arts and Entertainment Network (\"A&E\"). The production costs of the Bible Programs were approximately $2,370,000, which included a $240,000 production and overhead fee to the General Partner. In return for agreeing to fund these production costs, the Partnership acquired all rights to the Bible Programs in all markets and in all media in perpetuity.\nIn order to reduce the Partnership's financial exposure, the General Partner, on behalf of the Partnership, assigned one-half of the Partnership's interest in the Bible Programs to GoodTimes Home Video Corporation (\"GoodTimes\"), an unaffiliated entity directly involved in the specialty home video and international television distribution business, for an investment by GoodTimes of $1,000,000. The Partnership and GoodTimes funded Jones Documentary Film Corporation (\"JDFC\"), which in turn contracted with Agamemnon Films for the production of the Bible Programs. JDFC was formed to insulate the Partnership and GoodTimes from certain risks and potential liabilities associated with the production of programming in foreign countries because the Bible Programs were filmed on location in the Holy Lands.\nThe Partnership and JDFC granted the General Partner the exclusive rights to distribute the Bible Programs. To accomplish this, the General Partner, on its own behalf, and GoodTimes entered into an agreement to form J\/G Distribution Company to distribute the Bible Programs. J\/G Distribution Company was formed as of June 24, 1992 and the Partnership granted it the sole and exclusive right to exhibit and distribute, and to license others to exhibit and distribute, the Bible Programs in all markets, all languages, and all media in perpetuity. J\/G Distribution Company holds the copyright for the benefit of the Partnership (50 percent interest) and GoodTimes (50 percent interest). J\/G Distribution Company is currently distributing the Bible Programs in the retail home video market. As of December 31, 1995, gross sales made by J\/G Distribution Company totaled $1,689,752, of which $844,876 has been retained by J\/G Distribution Company for its fees and marketing costs, with the remaining $844,876 belonging 50 percent to the Partnership and 50 percent to Goodtimes. Additionally, $250,000 was received directly by the Partnership as its share of the initial license fee from A&E. As of December 31, 1995, the Partnership had received $370,258 from J\/G Distribution and the $250,000 from A&E. The remaining $52,180 due from J\/G Distribution was received in 1996.\nIn 1994, J\/G Distribution Company, an affiliate of the General Partner, and Jones Interactive, Inc. (\"JII\"), also an affiliate of the General Partner, entered into an agreement to produce a CD-ROM version of the Bible Programs. No Partnership funds have been or will be utilized in the production of the CD-ROM version; however, after production costs, distribution fees and costs associated with distribution are recovered, five percent of net revenues (as defined in the agreement) will flow to the Partnership. Revenue proceeds to be received by the\nPartnership under this agreement, if any, are not anticipated to be significant. The production is being done on two separate discs, one for the New Testament, which was completed in the third quarter of 1995, and a second disc for the Old Testament, which is expected to be completed in the first quarter of 1996. Distribution of the CD-ROM version will be done in the United States and Canada by affiliates of J\/G Distribution Company. The Partnership plans to recover its remaining net investment in the Bible Programs of $369,873 from net revenues generated from domestic and international home video markets.\n\"The Whipping Boy\"\nIn August 1993, the Partnership acquired the rights to the Newbury Award-winning book \"The Whipping Boy.\" The project was co-developed by the Partnership and The Disney Channel and produced by the General Partner and German and French co- production partners. The completed telefilm was delivered to The Disney Channel in the second quarter of 1994 and premiered in the North American television market in July 1994. As of December 31, 1995, the Partnership had invested $2,661,487 in the film, which included a $468,000 production and overhead fee payable to the General Partner. The Partnership has received approximately $2,100,000 from The Disney Channel for licensing certain rights to the film to The Disney Channel.\nThe Partnership was responsible for approximately one-half of the $4,100,000 production cost, with the balance of the production budget funded by Gemini Films and other co-production partners and\/or territorial advances from the film's international distributors. The amount contributed to the production budget by the Partnership was partially reimbursed by the license advances totaling $2,100,000 received from the Disney Channel.\nGemini Films will have, in perpetuity, the copyright and all exploitation rights to the film in German language territories (defined as Germany, Austria, German-speaking Switzerland and German-speaking Luxembourg). Although these exploitation rights will remain the sole property of Gemini Films, Gemini Films will account to the Partnership for any revenue therefrom.\nThe Partnership will own the worldwide copyright, excluding German language territories, in perpetuity. Although the Partnership will own all exploitation rights in all media in North America, which is defined as the United States, Canada and their respective territories and possessions, the Partnership will account to Gemini Films for any revenue generated therefrom.\nFrom the movie's North American revenues, the Partnership will first be entitled to recover its investment plus interest. Thereafter, the Partnership will receive 90 percent of all North American revenues and Gemini Films will receive 10 percent of such revenues. With respect to international revenues from the movie's distribution, after Gemini Films recovers $250,000 of its investment in the movie's production budget, any funded overages and interest out of net international revenues, the Partnership will receive 20 percent of net international revenues and Gemini Films will receive 80 percent.\nThe General Partner and Gemini Films have selected Canal Plus Distribution as the company that will distribute and exploit the movie outside of North America. Canal Plus Distribution will earn distribution fees of 15 percent of the film's gross receipts outside of North America, and it will be reimbursed for its expenses capped at 10 percent of the film's gross receipts outside of North America (excluding dubbing costs). Canal Plus Distribution will be responsible for accounting and remitting to Gemini Films the net revenues from the film's distribution in all markets and in all media outside of North America. Gemini Films will be responsible for forwarding the Partnership's share of such revenues within 10 days of receipt of such funds from Canal Plus. The Partnership plans to recover its remaining net investment in this film of $1,051,213 primarily from net revenues generated from domestic home video and television distribution.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nJONES PROGRAMMING PARTNERS 2-A, LTD.\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1995 AND 1994\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Jones Programming Partners 2-A, Ltd.:\nWe have audited the accompanying balance sheets of Jones Programming Partners 2-A, Ltd. (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 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 Jones Programming Partners 2-A, 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.\n\/s\/ ARHTUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDenver, Colorado, March 20, 1996.\nJONES PROGRAMMING PARTNERS 2-A, LTD. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to the financial statements are an integral part of these financial statements.\nJONES PROGRAMMING PARTNERS 2-A, LTD. (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to the financial statements are an integral part of these financial statements.\nJONES PROGRAMMING PARTNERS 2-A, LTD. (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to the financial statements are an integral part of these financial statements.\nJONES PROGRAMMING PARTNERS 2-A, LTD. (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to the financial statements are an integral part of these financial statements.\nJONES PROGRAMMING PARTNERS 2-A, LTD. (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND BUSINESS\nIn March 1992, Jones Programming Partners 2-A, Ltd. (the \"Partnership\"), was formed as a limited partnership pursuant to the laws of the State of Colorado to engage in the acquisition, development, production, licensing and distribution of original entertainment programming. Jones Entertainment Group, Ltd. is the General Partner of the Partnership.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCash and Cash Equivalents - The Partnership considers all highly-liquid investments with a maturity when purchased of three months or less to be cash equivalents.\nFilm Revenue Recognition- The Partnership recognizes revenue in accordance with the provisions of Statement of Financial Accounting Standards No. 53 (\"SFAS No. 53\"). Pursuant to SFAS No. 53, revenues from domestic and international licensing agreements for programming are recognized when such amounts are known and the film is available for exhibition or telecast, and when certain other SFAS No. 53 criteria are met. Advances received for licensing or other purposes prior to exhibition or telecast are deferred and recognized as revenue when the above conditions are met.\nInvestment in and Advances for Film Productions - Investment in film production consists of advances to production entities for story rights, production, and film completion costs, and is stated at the lower of cost or estimated net realizable value. In addition, film production and overhead fees payable to the General Partner have been capitalized and included as investment in film production. Film production costs are amortized based upon the individual-film-forecast method. Estimated losses, if any, will be provided for in full when determined by the General Partner.\nDistribution Costs - Commissions, distribution expenses and marketing costs incurred in connection with domestic and international distribution are recorded at the time that the related license fees are recorded as revenue by the Partnership.\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.\nReclassifications - Certain prior year amounts have been reclassified to conform to the 1995 presentation.\n(3) PARTNERS' CAPITAL:\nThe capitalization of the Partnership is set forth in the accompanying Statements of Partners' Capital (Deficit). Currently, no existing limited partner is obligated to make any additional contributions to the Partnership. The General Partner purchased its interest in the Partnership by contributing $1,000 to Partnership capital.\nAn affiliate of the General Partner, Jones International Securities, Ltd., received a commission of 10 percent of capital contributions of the limited partners, from which the affiliate paid all commissions of participating broker- dealers which sold the Partnership's interests. The General Partner was reimbursed for all offering costs up to 3.75 percent of gross offering proceeds. Commission costs and reimbursements to the General Partner for costs for raising Partnership capital were charged to limited partners' capital.\nProfits, losses and distributions of the Partnership are allocated 99 percent to the limited partners and 1 percent to the General Partner until the limited partners have received distributions equal to 100 percent of their capital contributions plus an annual return thereon of 12 percent, cumulative and non-compounded. Thereafter, profits\/losses and distributions will generally be allocated 80 percent to the limited partners and 20 percent to the General Partner.\n(4) TRANSACTIONS WITH AFFILIATES:\nThe General Partner receives a production and overhead fee for administering the affairs of the Partnership equal to 12 percent of the lower of actual or budgeted direct costs of each of the Partnership's programming projects. This fee was calculated and payable at the time principal photography commences on each particular project and, in the case of a series, is payable on a per episode basis. The Partnership paid a $240,000 production and overhead fee in 1992 for the production of \"Charlton Heston Presents: The Bible.\" The Partnership also paid a $100,000 production and overhead fee in March 1993 for the production of \"Household Saints.\" In addition, the Partnership paid a $468,000 production and overhead fee to the General Partner in June 1994 for the production of \"The Whipping Boy.\" As of December 31, 1995, the General Partner, on behalf of the Partnership, has incurred home video and telecast distribution costs totaling $57,279 relating to \"The Whipping Boy\". The General Partner generally will be entitled to reimbursement of these costs from the Partnership contingent on the receipt of proceeds from future home video and telecast distribution of the film.\nThe General Partner is also entitled to reimbursement from the Partnership for its direct and indirect expenses allocable to the operations of the Partnership, which include, but are not limited to, rent, supplies, telephone, travel, legal expenses, accounting expenses, preparing and distributing reports to investors and salaries of any full or part-time employees. The General Partner allocated $10,865, $3,899 and $1,182 of such expenses to the Partnership for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn 1994, J\/G Distribution Company, an affiliate of the General Partner, and Jones Interactive, Inc. (\"JII\"), also an affiliate of the General Partner, entered into an agreement to produce a CD-ROM version of the Bible Programs. No Partnership funds have been or will be utilized in the production of the CD-ROM version; however, after production costs, distribution fees and costs associated with distribution are recovered, five percent of net revenues (as defined in the agreement) will flow to the Partnership. Revenue proceeds to be received by the Partnership under this agreement, if any, are not anticipated to be significant. The production is being done on two separate discs, one for the New Testament, which was completed in the third quarter of 1995, and a second disc for the Old Testament, which is expected to be completed in the first quarter of 1996. Distribution of the CD-ROM version will be done in the United States and Canada by affiliates of J\/G Distribution Company.\n(5) INVESTMENT IN AND ADVANCES FOR FILM PRODUCTION\n\"Charlton Heston Presents: The Bible\"\nIn May 1992, the General Partner, on behalf of the Partnership, entered into an agreement with Agamemnon Films, an unaffiliated party, to produce four one-hour programs for television, entitled \"Charlton Heston Presents: The Bible\" (the \"Bible Programs\"). The production costs of the Bible Programs were approximately $2,130,000. In addition, the Partnership paid a $240,000 production and overhead fee to the General Partner. In return for agreeing to fund these production costs, the Partnership acquired all rights to the Bible Programs in all markets and in all media in perpetuity. The Partnership subsequently assigned half of its ownership of the Bible Programs to an unaffiliated party for an investment of $1,000,000 toward the production costs for the Bible Programs. After consideration of the reimbursement, the Partnership's total investment in the Bible Programs is $1,369,764 and its net investment, after consideration of amortization, was $369,873 as of December 31, 1995. From inception to December 31, 1995, the Partnership has recognized $1,094,960 of revenue from this film, of which $431,438 has been retained by the distributors of the film for their fees and marketing costs. Of the remaining $663,522, the Partnership has received $611,342 as of December 31, 1995. The remaining $52,180 was received in March 1996.\n\"Household Saints\"\nIn February 1993, the Partnership acquired a one-third ownership interest in a film scheduled for world-wide theatrical release entitled \"Household Saints.\" The budgeted production costs of \"Household Saints\" were approximately $5,000,000, and the final production costs were approximately $5,300,000. For a one-third ownership interest in the film, the Partnership contributed one-third of the budgeted production costs, or $1,666,667. Two unaffiliated entities contributed similar amounts. Prior to June 30, 1995, the Partnership had invested $1,913,918 in the film, which included a production and overhead fee of $100,000 paid to the General Partner by the Partnership. Prior to June 30, 1995, the Partnership's net investment in the film, after consideration of amortization, was $1,389,166. From inception to June 30, 1995, the Partnership had recognized $603,198 of revenue from this film.\nIn January 1995, the General Partner's Board of Directors agreed in principle to purchase the Partnership's interest in \"Household Saints\" from the Partnership at a price equal to the Partnership's net investment in the film of $1,389,166. The Partnership's limited partnership agreement allows the General Partner to purchase completed programming projects from the Partnership so long as the purchase price is an amount no less than the average of three separate independent appraisals of the project's fair market value. The General Partner subsequently obtained three separate independent appraisals of the fair market value of the Partnership's interest in \"Household Saints\". Sunrise Capital of Bainbridge Island, Washington appraised the Partnership's interest in the film at $141,495 as of March 15, 1995. GB Investment Corporation of New York, New York appraised the Partnership's interest in the film at $310,856 as of April 10, 1995. Kagan Media Appraisals Inc. of Carmel, California appraised the Partnership's interest in the film at $443,000 as of April 27, 1995. The average of the three independent appraisals of the fair market value of the Partnership's interest in \"Household Saints\" was approximately $300,000. Closing of the sale occurred on June 30, 1995. The purchase price was paid $500,000 in cash at closing, $500,000 in the form of a non-interest bearing promissory note payable in full 12 months from the closing date and $389,166 in the form of a non-interest bearing promissory note payable in full 24 months from the closing date. Because both promissory notes were non-interest bearing, the Partnership recognized imputed interest of $122,860, thereby reducing the notes' carrying value to $766,306 and incurring a loss on sale of the film of $122,860. This loss will be offset by the Partnership in the form of interest income recognized as the related discount on the promissory notes is amortized to interest income over the next 24 months. For the year\nended December 31, 1995, interest income of $43,125 has been recognized from amortization of the related discount.\n\"The Whipping Boy\"\nIn August 1993, the Partnership acquired the rights to the Newbury Award-winning book \"The Whipping Boy\". \"The Whipping Boy\" was produced as a two hour telefilm which premiered in the North American television market on The Disney Channel. The film's final cost was approximately $4,100,000. As of December 31, 1995, the Partnership had invested $2,661,487 in the film, which included a $468,000 production and overhead fee paid to the General Partner. The film was co-produced by the General Partner and Gemini Films, a German company. The completed picture was delivered to The Disney Channel in the second quarter of 1994. The Partnership's net investment in the film, after consideration of amortization, was $1,051,213 as of December 31, 1995. From inception to December 31, 1995, the Partnership has recognized $2,111,931 of revenue from this film, of which $2,100,000 represents the initial license fee from The Disney Channel that was used to finance the film's production. Of the remaining $11,931, $2,808 has been retained by the distributors of the film for their fees and marketing costs and $699 has been received by the Partnership as of December 31, 1995. The remaining $8,424 was received in March 1996.\n(6) INCOME TAXES\nIncome taxes are not reflected in the accompanying financial statements as such amounts accrue directly to the partners. The Federal and state income tax returns of the Partnership will be prepared and filed by the General Partner.\nThe Partnership's tax returns, the qualification of the Partnership as a limited partnership 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 tax status, or the Partnership's recorded income or loss, the tax liability of the General and limited partners would be adjusted accordingly.\nThe Partnership's only significant book-tax difference between the financial reporting and tax bases of the Partnership's assets and liabilities is associated with the difference between film production cost amortization recognized under generally accepted accounting principles and the amount of expense allowed for tax purposes.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 directors and executive officers of the General Partner of the Registrant 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 inception and he has served as President of the General Partner since April 1994. Mr. Jones is also the Chairman of the Board of Directors and Chief Executive Officer of the General Partner's principal shareholder, Jones 21st Century, Inc., a subsidiary of Jones International, Ltd. Mr. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of Jones Intercable, Inc., one of the nation's largest cable television companies, since its formation in 1970, and he was President of that company 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 other affiliates of the General Partner. He is a 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 and is on the Board of Governors of the American Society of Training and Development. 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. Rosenberg was appointed a director of the General Partner in March 1996 and was elected Executive Vice President of the General Partner in February 1996. Mr. Rosenberg joined Jones Digital Century, Inc., an\naffiliate of the General Partner, in October 1995 as Vice President of Business Affairs. Mr. Rosenberg has been involved in business affairs for the entertainment industry for 23 years. Prior to joining Jones Digital Century, Inc., Mr. Rosenberg was executive vice president and chief operating officer of Spencer Entertainment, a diversified multimedia entertainment company. He also served as vice president of legal and business affairs at Cinetel Films. Mr. Rosenberg has operated his own entertainment and software businesses, including RKR Pictures, inc., an independent production and distribution company, where he financed, produced and distributed six motion pictures, including Alice Sweet Alice, starring Brooke Shields and The Wild Duck with Liv Ullman and Jeremy Irons. Mr. Rosenberg is the author of Entertainment Industry Contracts - - Negotiating and Drafting Guide. He is a member of the editorial board for the Entertainment Law and Finance Journal, the California, New York, New Jersey and Florida Bar Associations, ASCAP and BMI, and currently serves as an arbitrator for both the American Film Marketing Association and the American Arbitration Association's Entertainment Industry Panel.\nMs. Elizabeth M. Steele is Secretary of the General Partner. She is also Vice President\/General Counsel and Secretary of Jones Intercable, Inc. From August 1980 until joining Jones Intercable, Inc., 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. Jay B. Lewis was elected Treasurer of the General Partner in February 1996. Mr. Lewis is Vice President\/Finance and Treasurer for Jones International, Ltd., an affiliate of the General Partner, and certain of its subsidiaries. Mr. Lewis joined Jones Spacelink, Ltd., a former affiliate of the General Partner, in February 1986 as Assistant Controller, was promoted to Controller in June 1987 and was elected its Treasurer in June 1994. Substantially all of the assets of Jones Spacelink, Ltd. were acquired by Jones Intercable, Inc., an affiliate of the General Partner, in December 1994. Prior to joining Jones Spacelink, Ltd., Mr. Lewis was employed by Arthur Young & Company, a public accounting firm.\nMr. Derek H. Burney was appointed a director of the General Partner in December 1994. Mr. Burney is also a director and Vice Chairman of the Board of Directors of Jones Intercable, Inc., an affiliate of the General Partner. 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. Wilfred N. Cooper, Sr. became a director of the General Partner in December 1994. Mr. Cooper has been the principal shareholder and a Director of WNC & Associates, Inc. since its organization in 1971, of Shelter Resource Corporation since its organization in 1981 and of WNC Resources, Inc. from its organization in 1988 through its acquisition by WNC & Associates, Inc. in 1991, serving as President of those companies through June 1992 and as Chief Executive Officer since June 1992.\nMr. J. Rodney Dyer became a director of the General Partner in December 1994. Mr. Dyer has been the President and sole shareholder of Rod Dyer Group, Inc. since its formation in 1967. Rod Dyer Group, Inc. specializes in advertising, marketing and promotion. Rod Dyer Group, Inc. filed for protection under Chapter 11 of the Federal Bankruptcy Act in December 1991 and was released in March 1994.\nMr. William C. Nestel was elected a director of the General Partner in July 1995. Mr. Nestel has been an employee of affiliates of the General Partner since June 1995. From 1994 until joining the Jones organization, Mr. Nestel was a partner with Abracadabra Interactive Entertainment, where he was involved in the design of several interactive projects. During the same time period, Mr. Nestel was also involved in establishing a strategic relationship with Electronic Arts and UnderProd, a major independent production company affiliated with Sony\nEntertainment. During the period 1992 to 1993, Mr. Nestel was a consultant to Rastar Productions. From 1987 to 1992, Mr. Nestel was Vice Chairman of Rastar Productions where his responsibilities included administration of production, business, legal and all other company operations. Prior to joining Rastar Productions, Mr. Nestel was an attorney at the Los Angeles law firm of Wood, Lucksinger and Epstein from 1982 until 1987. In the early 1980s, Mr. Nestel was Vice President\/Business Affairs of CBS Theatrical Films and during the late 1970s he was Vice President of Paramount Pictures.\nMr. David K. Zonker became a director of the General Partner in December 1994. Mr. Zonker has been the President of Jones International Securities, Ltd. since January 1984 and he has been its Chief Executive Officer since January 1988. Mr. Zonker is a member of the Board of Directors of various Jones companies. Mr. Zonker is licensed by the National Association of Securities Dealers, Inc. and he is the immediate past chairman of the Investment Program Association, a trade organization based in Washington, D.C. that promotes direct investments.\nDerek H. Burney and William C. Nestel are directors of the General Partner. Reports by Messrs. Burney and Nestel 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. Neither Mr. Burney nor Mr. Nestel 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 its business. Such personnel are employed by the General Partner and, pursuant to the terms of the Partnership's limited partnership agreement, the cost of such employment can be charged by the General Partner to the Partnership as a reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNo person or entity owns more than 5 percent of the limited partnership interests in 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, which are set forth in the Partnership's limited partnership agreement, 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 receives a production and overhead fee for administering the affairs of the Partnership equal to 12 percent of the lower of direct costs or budgeted direct costs of each programming project. This fee is calculated and payable at the time principal photography commences on each particular project and, in the case of a series, is payable on a per episode basis. The Partnership paid a $468,000 production and overhead fee to the General Partner in June 1994 for the production of \"The Whipping Boy.\"\nIn connection with the distribution of \"Charlton Heston Presents: The Bible,\" J\/G Distribution Company, an affiliate of the General Partner, is entitled to certain distribution rights and fees. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for a description of these distribution rights and fees. As of December 31, 1995, gross sales made by J\/G Distribution Company totaled $1,689,752, of which $844,876 has been retained by J\/G Distribution Company for its fees and marketing costs, with the\nremaining $844,876 belonging 50 percent to the Partnership and 50 percent to Goodtimes. As of December 31, 1995, the Partnership had received both $370,258 from J\/G Distribution. The remaining balance of $52,180 was received in March 1996.\nIn 1994, J\/G Distribution Company and Jones Interactive, Inc., also an affiliate of the General Partner, entered into an agreement to produce a CD-ROM version of the Bible Programs. No Partnership funds have been or will be utilized in the production of the CD-ROM version; however, after production costs, distribution fees and costs associated with distribution are recovered, 5 percent of net revenues (as defined in the agreement) will flow to the Partnership. Revenue proceeds to be received by the Partnership under this agreement, if any, are not anticipated to be significant. The production is being done on two separate discs, one for the New Testament, which was completed in the third quarter of 1995, and a second disc for the Old Testament, which is expected to be completed in the first quarter of 1996. Distribution of the CD-ROM version will be done in the United States and Canada by affiliates of J\/G Distribution Company.\nThe General Partner is entitled to reimbursement from the Partnership for certain allocated general 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 administrative, accounting and legal services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to the Partnership. In 1995, the General Partner allocated $10,865 of such expenses to the Partnership.\nThe General Partner may also advance funds and charge interest on the balance payable from the Partnership. The interest rate charged the Partnership approximates the published prime rate plus 2 percent. No advances were made in 1995, and thus no interest was paid to the General Partner by the Partnership 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:\n1. Financial statements\n2. Schedules - None.\n3. The following exhibits are filed herewith:\n4.1 Limited Partnership Agreement.(1)\n27 Financial Data Schedule __________\n(1) Incorporated by reference from the Partnership's Annual Report on Form 10-K for year ended December 31, 1989.\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 PROGRAMMING PARTNERS 2-A, LTD., a Colorado limited partnership By Jones Entertainment Group, Ltd., its General Partner\nBy: \/s\/ GLENN R. JONES ----------------------------------- Glenn R. Jones Chairman of the Board and Dated: March 29, 1996 Chief Executive Officer\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.\nBy: \/s\/ GLENN R. JONES ----------------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 29, 1996 (Principal Executive Officer)\nBy: \/s\/ JAY B. LEWIS ----------------------------------- Jay B. Lewis Treasurer (Principal Financial and Dated: March 29, 1996 Accounting Officer)\nBy: \/s\/ RICHARD K. ROSENBERG ----------------------------------- Richard K. Rosenberg Dated: March 29, 1996 Executive Vice President and Director\nBy: \/s\/ DEREK H. BURNEY ----------------------------------- Derek H. Burney Dated: March 29, 1996 Director\nBy: ----------------------------------- Wilfred N. Cooper, Sr. Dated: March , 1996 Director\nBy: \/s\/ J. RODNEY DYER ----------------------------------- J. Rodney Dyer Dated: March 29, 1996 Director\nBy: ----------------------------------- William C. Nestel Dated: March 29, 1996 Director\nBy: ----------------------------------- David K. Zonker Dated: March 29, 1996 Director\nEXHIBIT INDEX","section_15":""}
{"filename":"39547_1995.txt","cik":"39547","year":"1995","section_1":"Item 1. Business\nMetromedia International Group, Inc. (\"MIG\" or the \"Company\") is a global entertainment, media and communications company with continuing operations in two business groups: the Entertainment Group, through Orion Pictures Corporation (\"Orion\"), which is engaged primarily in the development, production, acquisition, exploitation and worldwide distribution in all media of motion pictures, television programming and other filmed entertainment product; and the Communications Group, through Metromedia International Telecommunications, Inc. (\"MITI\"), which owns interests in and participates along with local partners in the management of joint ventures which operate wireless cable television systems, paging systems, an international toll call service, a trunk mobile radio service and radio stations in certain countries in Eastern Europe, the former Soviet Republics and other international markets.\nThe Company also owns two non-strategic assets which, for accounting purposes, have been classified as an asset held for disposition: Snapper, Inc. (\"Snapper\"), which is engaged in the manufacture and sale of lawn and garden equipment and approximately 38% of the outstanding shares of Roadmaster Industries, Inc., a New York Stock Exchange (\"NYSE\") listed company which is a leading sporting goods manufacturer.\nMIG was organized in 1929 under Pennsylvania law and reincorporated in 1968 under Delaware law. On November 1, 1995, as a result of a series of mergers discussed below, MIG changed its name from The Actava Group Inc. to Metromedia International Group, Inc. MIG's principal executive offices are located at 945 East Paces Ferry Road, Suite 2210, Atlanta Georgia 30326, and its telephone number is (404) 261-6190.\nDevelopments During Fiscal 1995\nThe Company's operations substantially changed during fiscal 1995. These developments are described below.\nOn November 1, 1995, the Company merged (the \"November 1 Mergers\") with Orion, MITI and MCEG Sterling Incorporated (\"Sterling\"), an independent film production and distribution company. In connection with the November 1 Mergers, Orion and MITI were merged with and into separate wholly-owned subsidiaries of the Company, Sterling merged with and into the Company, Sterling's operating assets were then contributed to Orion and the Company changed its name from The Actava Group Inc. to Metromedia International Group, Inc. The November 1 Mergers were the result of the Company's previously announced intention to maximize the value of its financial resources by redeploying them into entertainment, communications and media businesses, which the Company believes possess greater growth potential than the businesses in which it had previously been engaged.\nUpon consummation of the November 1 Mergers, all of the outstanding shares of the common stock, par value $.25 per share, of Orion (the \"Orion Common Stock\"), the common stock, par value $.001 per share, of MITI (the \"MITI Common Stock\") and the common stock, par value $.001 per share, of Sterling (the \"Sterling Common Stock\") were converted into shares of the common stock, par value $1.00 per share, of the Company (the \"Common Stock\") pursuant to formulas contained in the agreement relating to the November 1 Mergers. Pursuant to such formulas, holders of Orion Common Stock received .57143 shares of Common Stock for each share of Orion Common Stock\n(resulting in the issuance of 11,428,600 shares of Common Stock to the holders of Orion Common Stock), holders of MITI Common Stock received 5.54937 shares of Common Stock for each share of MITI Common Stock (resulting in the issuance of 9,523,817 shares of Common Stock to the holders of MITI Common Stock) and holders of Sterling Common Stock received .04309 shares of Common Stock for each share of Sterling Common Stock (resulting in the issuance of 483,254 shares of Common Stock to the holders of Sterling Common Stock). Simultaneously with the consummation of the November 1 Mergers and pursuant to the terms of a Contribution Agreement dated as of November 1, 1995 (the \"Contribution Agreement\") among the Company and certain affiliates of the Company's largest stockholder, Metromedia Company (\"Metromedia\") and two of its affiliates contributed to the Company an aggregate of $37 million principal amount of indebtedness of Orion, MITI and certain of their affiliates which were owed to Metromedia's affiliates in exchange for an aggregate of 3,530,314 shares of Common Stock.\nImmediately prior to the consummation of the November 1 Mergers, there were approximately 17,490,901 shares of Common Stock outstanding. In connection with the November 1 Mergers and the transactions contemplated by the Contribution Agreement, the Company issued an aggregate of approximately 24,965,985 shares of Common Stock. Of such shares, Metromedia and its affiliates (collectively, the \"Metromedia Holders\") received an aggregate of approximately 15,252,128 shares of Common Stock (or approximately 35.9% of the issued and outstanding shares of Common Stock).\nA three person Office of the Chairman was created to manage the business and affairs of the Company following the consummation of the November 1 Mergers. The Office of the Chairman consists of the following persons: John W. Kluge, the Chairman of the Board of Orion and MITI prior to the November 1 Mergers, as Chairman of the Board of the Company; Stuart Subotnick, the Vice Chairman of Orion and MITI prior to the November 1 Mergers, as Vice Chairman of the Company; and John D. Phillips, the President and Chief Executive Officer of the Company prior to the November 1 Mergers, as President and Chief Executive Officer of the Company.\nAlso in connection with the November 1 Mergers, the Board of Directors of the Company was divided into three classes. Pursuant to the terms of the merger agreement relating to the November 1 Mergers, Orion appointed six of ten members of the Company's Board of Directors and the Company appointed the remaining four directors. The Directors appointed by Orion are John W. Kluge, Stuart Subotnick, Silvia Kessel, Richard J. Sherwin, Arnold L. Wadler and Leonard White. The four members of the Company's Board of Directors appointed by the Company, John D. Phillips, John P. Imlay, Jr., Clark A. Johnson and Carl E. Sanders, were members of the Board of Directors of the Company prior to the November 1 Mergers.\nIn connection with the November 1 Mergers, the Common Stock was delisted from the New York Stock Exchange and is now listed on the American Stock Exchange under the ticker symbol \"MMG.\"\nNarrative Description of Business Groups\nThe Entertainment Group\nGeneral. The Entertainment Group, through Orion, is engaged primarily in the development, production, acquisition, exploitation and worldwide distribution in all media of motion pictures, television programming and other filmed entertainment product. The Entertainment Group distributes its product theatrically and in ancillary markets such as home video and pay and free television throughout the world. Orion also distributes product produced by third parties and acquired by Orion and provides distribution services for third parties. Orion's ability during the past three calendar years to produce or acquire new product has been limited due to certain contractual restrictions described below. As a result, Orion's operations during this period have been generally limited to distributing\ncertain completed but unreleased films and exploiting its existing film and television library. Orion has an extensive film library of over 1,000 titles, including Academy Award-winning films such as Dances with Wolves, and Silence of the Lambs, action films such as the three film RoboCop series and other recent films such as Blue Sky.\nBackground. On December 11 and 12, 1991 (the \"Filing Date\"), due to financial pressure as a result of economically disappointing motion picture releases during 1990 and 1991 as well as the costs of an expanding television production division and increasing overhead and debt service costs, Orion and its subsidiaries filed for protection under chapter 11 of the United States Bankruptcy Code. Orion's Modified Third Amended Joint Consolidated Plan of Reorganization (the \"Plan\") was confirmed on October 20, 1992 and became effective on November 5, 1992. At the Filing Date, all new motion picture production was halted, leaving Orion with only 12 largely completed but unreleased motion pictures. Under certain agreements entered into in connection with the Plan, Orion's ability to produce or invest in new theatrical product was severely limited. Orion was permitted to invest in the production or acquisition of new theatrical product only if, among other things, non-recourse financing for such product could be obtained. Accordingly, acquisition of new product was limited and Orion released five, four and three of the remaining unreleased theatrical motion pictures in the domestic marketplace in each of its fiscal years ended February 28, 1995, 1994 and 1993, respectively. During calendar 1995, Orion did not release theatrically any motion pictures that were fully or substantially financed by Orion. In connection with the November 1 Mergers, the restrictions on Orion's ability to produce and acquire new motion picture product imposed by the agreements entered into in connection with the Plan were eliminated.\nMotion Picture Production and Theatrical Distribution. Freed from such restrictions, the Entertainment Group has adopted what it believes is a conservative theatrical production, acquisition and distribution strategy, consisting primarily of producing or acquiring commercial or specialized films with well-defined target audiences in which the Entertainment Group's portion of the production cost will be generally limited to between $5 million and $10 million per picture consistent with the covenants included in Orion's existing credit facility. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The Entertainment Group also intends to minimize its exposure to the performance of certain films by financing a significant portion of each film's budget by pre-licensing foreign distribution rights.\nMIG has recently announced two acquisitions aimed at augmenting the Entertainment Group's production capabilities. MIG has signed a letter of intent to acquire Motion Picture Corporation of America (\"MPCA\"), an independent film production company, whose management has successfully employed a low-budget strategy at MPCA, producing lower budget commercially successful films such as Dumb and Dumber and Threesome. MIG has also entered into an Agreement and Plan of Merger dated as of January 31, 1996 to acquire The Samuel Goldwyn Company (\"Goldwyn\"), a leader in the production, distribution and exhibition of specialized motion pictures and art films, which has released such films as Much Ado About Nothing, The Madness of King George and Eat Drink Man Woman. See \"Recent Developments.\"\nThe Entertainment Group has acquired certain rights to nine feature films as specified below which as of February 29, 1996, it plans to release in the domestic theatrical market during the year ended December 31, 1996:\nTitle Director Cast Description ----- -------- ---- -----------\nOriginal Gangstas* Larry Cohen Jim Brown A contemporary Fred Williamson action-adventure Pam Grier set in Gary, Indiana Richard with a soundtrack to Roundtree include music from a Ron O'Neal number of popular Paul Winfield rap groups. Isabelle Sanford\nMaybe...Maybe Not** Sonke Wortmann Til Schweiger A hilarious look at Katja Reimann infidelity and Joachim Krol mistaken sexual Rufus Beck identity as an achingly handsome but skirt-chasing boyfriend gets entangled in a web of miscommunications and misinterpreted situations.\nPalookaville*** Alan Taylor William Forsythe Three unemployed Adam Trese auto workers decide Vincent Gallo to make a \"momentary shift in lifestyles\" by committing the perfect crime. Yet, as determined as they are, their good h e a r t s a n d problematic love lives keep getting in the way.\nPhat Beach** Doug Ellin Jermaine Hopkins An unprecedented hip Brian Hooks hop beach comedy Claudia Kalcem involving the c o m e d i c misadventures of two friends during their summer break.\nThe Substitute** Robert Mandel Tom Berenger In this action Ernie Hudson driven film, a Diane Venora mercenary goes under Glenn Plummer c o v e r a s a Marc Anthony substitute teacher after his girlfriend is brutally attacked by a gang of students. In an effort to uncover her attackers, he soon discovers a city wide drug ring that has infiltrated the school and put the entire student body in jeopardy and in a war with the criminals.\nTitle Director Cast Description ----- -------- ---- -----------\nThe Arrival** David Twohy Charlie Sheen This sci-fi thriller Ron Silver revolves around an Lindsay Crouse unassuming scientist Teri Polo who becomes the only thing that stands between our civilization and certain destruction when he investigates an unusual shockwave from outer space and discovers a team of extraterrestrials poised to take over the world.\nTrees Lounge** Steve Buscemi Anthony LaPaglia This film revolves Chloe Savigny around Tommy Mimi Rogers Basilio, who loses Daniel Baldwin his job and his Carol Kane girlfriend to his best friend. But he manages to stumble across friendship, inspiration, and a strange kind of truth in the last place he expected, the local bar.\nNapoleon**** Mario Muffin\/Napoleon In this live action Andreacchio adventure, an adorable puppy gets lost in the wild Australian outback. Befriended by exotic animals, Napoleon overcomes his fears and discovers the magic of nature.\nI Shot Andy Mary Harron Stephen Dorff A l e s b i a n Warhol*** Martha Plimpton revolutionary tries Michael to interest Andy Imperioli Warhol in producing Coco MacPherson a play featuring her Lili Taylor radical anti-male rhetoric. When he doesn't return her calls, she shoots him.\n- ------------------- * Domestic rights in all media. ** Domestic theatrical distribution rights. *** Worldwide rights in all media. ****Domestic rights in all media and certain foreign rights in all media.\nHome Video. Orion Home Video (\"OHV\") distributes the Entertainment Group's new product in the home video market and exploits titles from its existing library, including previously released rental titles, re-issued titles and initially released titles, in the sell-through and premium home video market\nsectors and through arrangements with mail-order and other selected licensees. OHV also acquires product from independent producers for distribution on a fee basis with no investment other than recoupable distribution costs. OHV's acquisition program contemplates output arrangements with producers and the acquisition of existing catalogs, as well as film-by-film acquisitions. In addition to distribution in the traditional videocassette sector, OHV intends to aggressively pursue opportunities to distribute the Entertainment Group's library in other emerging multimedia formats, including DVD (as described below) (see \"The United States Motion Picture Industry Overview--Emerging Technologies\" below). OHV acts as exclusive U.S. distributor for Streamline Pictures, a leading supplier of the increasingly popular Japanese anime genre, ----- and provides exclusive distribution services for Major League Baseball home video product and the Fox-Lorber catalogue of foreign language and specialty films.\nTelevision. The Entertainment Group's television distribution activities involve licensing its film and television library to both domestic pay television services and the domestic free television market. OTE is currently selling various syndication packages to independent television stations and the non-traditional networks nationwide. Such syndication packages will be offered with \"unpackaged\" library titles, on a market-by-market basis. OTE also plans to continue to explore opportunities to produce original programming, including talk and game shows, for pay television, basic cable, first-run syndication and the non-traditional networks.\nForeign Markets. Orion Pictures International (\"OPI\") distributes the Entertainment Group's existing library in traditional media and established markets outside of the United States and Canada, while actively pursuing new areas of exploitation. The Entertainment Group has historically relied upon subdistributors for the distribution of its product in the foreign theatrical marketplace. OPI licenses its product in the foreign pay and free television and home video markets directly to licensees for most major territories, and through a network of sales representatives in other territories. OPI also explores opportunities to acquire and distribute new product in overseas markets, adding freshness and value to the library. Other strategies include the acquisition of foreign language programming for foreign distribution in combination with the Entertainment Group's other library product.\nCompetition and Seasonality. All aspects of the Entertainment Group's operations are conducted in a highly competitive environment. To the extent that the Entertainment Group seeks to distribute the films contained in its library or acquire or produce product, the Entertainment Group competes with many other motion picture distributors, including the \"majors,\" most of which are larger and have substantially greater resources, film libraries and histories of obtaining film properties, as well as greater production capabilities and significantly broader access to distribution and exhibition opportunities. By reason of their resources, these competitors may have access to programming that would not generally be available to the Entertainment Group and may also have the ability to market programming more extensively than the Entertainment Group.\nDistributors of theatrical motion pictures compete with one another for access to desirable motion picture screens, especially during the summer, holiday and other peak movie-going seasons, and several of the Entertainment Group's competitors in the theatrical motion picture distribution business have become affiliated with owners of chains of motion picture theaters. The success of the Entertainment Group's product is also heavily dependent upon public taste, which is both unpredictable and susceptible to change without warning.\nThe United States Motion Picture Industry Overview. The United States motion picture industry encompasses the production and theatrical exhibition of feature-length motion pictures and the subsequent distribution of such pictures in home video, television and other ancillary markets. The\nindustry is dominated by the major studios, including Universal Pictures, Warner Bros., Twentieth Century Fox, Sony Pictures Entertainment (including Columbia Pictures and Tri-Star Pictures), Paramount Pictures and The Walt Disney Company, which historically have produced and distributed the majority of theatrical motion pictures released annually in the United States. The major studios generally own their production studios and have national or worldwide distribution organizations. Major studios typically release films with production costs ranging from $20,000,000 to $50,000,000 or more and provide a continual source of motion pictures to the nation's theater exhibitors.\nIn recent years, \"independent\" motion picture production companies have played a more important role in the production of motion pictures for the worldwide feature film market. The independents do not own production studios and have more limited distribution capabilities than the major studios, often distributing their product through the \"majors.\" Independents typically produce fewer motion pictures at substantially lower average production costs than major studios. Several of the former more prominent independents, including Miramax and New Line, have been acquired by larger entertainment companies, giving them access to greater resources. There are also a large number of smaller production companies such as MPCA that produce theatrical motion pictures.\nMotion Picture Production and Financing. The production of a motion picture begins with the screenplay adaption of a popular novel or other literary work acquired by the producer or the development of an original screenplay having its genesis in a story line or scenario conceived of or acquired by the producer. In the development phase, the producer typically seeks production financing and tentative commitments from a director, the principal cast members and other creative personnel. A proposed production schedule and budget also are prepared during this phase.\nUpon completing the screenplay and arranging financial commitments, pre-production of the motion picture begins. In this phase, the producer engages creative personnel to the extent not previously committed; finalizes the filming schedule and production budget; obtains insurance and secures completion guarantees; if necessary, establishes filming locations and secures any necessary studio facilities and stages; and prepares for the start of actual filming. Principal photography, the actual filming of the screenplay, may extend from six to twelve weeks or more, depending upon such factors as budget, location, weather and complications inherent in the screenplay.\nFollowing completion of principal photography, the motion picture is edited; optical, dialogue, music and any special effects are added, and voice, effects, music sound tracks and picture are synchronized during post-production. This results in the production of the negative from which the release prints of the motion picture are made.\nThe cost of a theatrical motion picture produced by an independent production company for limited distribution ranges from approximately $4,000,000 to $10,000,000 as compared with an average of approximately $30,000,000 for commercial films produced by major studios for wide release. Production costs consist of acquiring or developing the screenplay, film studio rental, cinematography, post-production costs and the compensation of creative and other production personnel. Distribution expenses, which consist primarily of the costs of advertising and release prints, are not included in direct production costs and vary widely depending on the extent of the release and nature of the promotional activities.\nIndependent and smaller production companies generally avoid incurring substantial overhead costs by hiring creative and other production personnel and retaining the other elements required for pre-production, principal photography and post-production activities on a project-by-project basis. Unlike the major studios, the independents and smaller production companies also typically finance their\nproduction activities from discrete sources. Such sources include bank loans, \"pre-sales,\" co-productions, equity offerings and joint ventures. Independents generally attempt to complete their financing of a motion picture production prior to commencement of principal photography, at which point they begin to incur substantial production costs which must be paid.\n\"Pre-sales\" are used by independent film companies and smaller production companies to finance all or a portion of the direct production costs of a motion picture. Pre-sales consist of fees paid to the producer by third parties in return for the right to exhibit the motion picture when completed in theaters or to distribute it in home video, television, foreign or other ancillary markets. Producers with distribution capabilities may retain the right to distribute the completed motion picture either domestically or in one or more foreign markets. Other producers may separately license theatrical, home video, television, foreign and all other distribution rights among several licensees.\nBoth major studios and independent film companies often acquire motion pictures for distribution through a customary industry arrangement known as a \"negative pickup,\" under which the studio or independent film company agrees to acquire from an independent production company all rights to a film upon completion of production. The independent production company normally finances production of the motion picture pursuant to financing arrangements with banks or other lenders in which the lender is granted a security interest in the film and the independent production company's rights under its arrangement with the studio or independent. When the studio or independent \"picks up\" the completed motion picture, it assumes the production financing indebtedness incurred by the production company in connection with the film. In addition, the independent production company is paid a production fee and generally is granted a participation in the net profits from distribution of the motion picture.\nMotion Picture Distribution. Motion picture distribution encompasses the distribution of motion pictures in theaters and in ancillary markets such as home video, pay-per-view, pay television, broadcast television, foreign and other markets. The distributor typically acquires rights from the producer to distribute a motion picture in one or more markets. For its distribution rights, the distributor typically agrees to advance the producer a certain minimum royalty or guarantee, which is to be recouped by the distributor out of revenues generated from the distribution of the motion picture and is generally nonrefundable. The producer also is entitled to receive a royalty equal to an agreed-upon percentage of all revenues received from distribution of the motion picture in excess of revenues covered by the royalty advance.\nTheatrical Distribution. The theatrical distribution of a motion picture involves the manufacture of release prints, the promotion of the picture through advertising and publicity campaigns and the licensing of the motion picture to theatrical exhibitors. The size and success of the promotional advertising campaign can materially affect the revenues realized from the theatrical release of a motion picture. The costs incurred in connection with the distribution of a motion picture can vary significantly, depending on the number of screens on which the motion picture is to be exhibited and the ability to exhibit motion pictures during peak exhibition seasons. Competition among distributors for theaters during such peak seasons is great. Accordingly, the ability to exhibit motion pictures in the most popular theaters in each area can affect theatrical revenues.\nThe distributor and theatrical exhibitor generally enter into a license agreement providing for the exhibitor's payment to the distributor of a percentage of the box office receipts for the exhibition period, in some cases after deduction of the theater's overhead, or a flat negotiated weekly amount. The distributor's percentage of box office receipts generally ranges from an effective rate of 35% to over 50%, depending upon the success of the motion picture at the box office and other factors. Distributors\ncarefully monitor the theaters which have licensed the picture to ensure that the exhibitor promptly pays all amounts due the distributor. Some delays in collections are not unusual.\nMotion pictures may continue to play in theaters for up to six months following their initial release. Concurrently with their release in the United States, motion pictures generally are released in Canada and may also be released in one or more other foreign markets. Typically, the motion picture then becomes available for distribution in other markets as follows:\nMonths After Approximate Market Initial Release Release Period ------ --------------- --------------\nDomestic home video 4-6 months -- Domestic pay-per-view 6-9 months 3 months Domestic pay television 10-18 months 12-21 months Domestic network 30-36 months 18-36 months Domestic syndication or 30-36 months 3-15 years basic cable Foreign home video 6-12 months -- Foreign television 18-24 months 3-12 years\nHome Video. Home video distribution consists of the promotion and sale of videocassettes and videodiscs to local, regional and national video retailers which rent or sell such products to consumers primarily for home viewing.\nPay-Per-View. Pay-per-view television allows cable television subscribers to purchase individual programs, including recently released motion pictures and live sporting, music or other events, on a \"per use\" basis. The subscriber fees are typically divided among the program distributor, the pay-per-view operator and the cable system operator.\nPay Television. Pay television allows cable television subscribers to view HBO, Cinemax, Showtime, The Movie Channel, Encore and other pay television network programming offered by cable system operators for a monthly subscription fee. The pay television networks acquire a substantial portion of their programming from motion picture distributors.\nBroadcast and Basic Cable Television. Broadcast television allows viewers to receive, without charge, programming broadcast over the air by affiliates of the major networks (ABC, CBS, NBC and Fox), independent television stations and cable and satellite networks and stations. In certain areas, viewers may receive the same programming via cable transmission for which subscribers pay a basic cable television fee. Broadcasters or cable systems operators pay fees to distributors for the right to air programming a specified number of times.\nForeign Markets. In addition to their domestic distribution activities, motion picture distributors generate revenues from distribution of motion pictures in foreign theaters and in the foreign home video, pay and free television and other foreign markets. There has been a dramatic increase in recent years in the worldwide demand for filmed entertainment. This growth is largely due to the privatization of television stations, introduction of direct broadcast satellite services, growth of home video and increased cable penetration.\nOther Markets. Revenues also may be derived from the distribution of motion pictures to airlines, schools, libraries, hospitals and the military, licensing of rights to perform musical works and\nsound recordings embodied in a motion picture, and rights to manufacture and distribute games, dolls, clothing and similar commercial articles derived from characters or other elements of a motion picture.\nEmerging Technologies.\nDBS. Direct Broadcast Satellite (DBS) technology also offers a new transmission technology. As the major delivery system for premium television services in Europe, particularly the U.K., DBS is expected to expand the pay television market in the United States.\nVideo-On-Demand. An important advance in the last five years has been the development of the video-on-demand technology through the creation of digital video compression. Digital compression involves the conversion of the analog television signal into digital form and the compression of more than one video signal into one standard channel for delivery to customers. Compression technology will be applied not only to cable but to satellite and over-the-air broadcast transmission systems. This offers the opportunity to dramatically expand the capacity of current transmission systems. Several telecommunications companies are currently testing trial video-on-demand systems. These include Bell Atlantic, Time Warner, Telecommunications, Inc. and Pacific Telesis.\nDVD. Another new technology that has emerged is the video CD or \"digital variable disc.\" Just as compact discs have become the dominant medium for prerecorded music, digital variable disc or \"DVD\" is expected to become a widely-accepted format for home video programming.\nThe Communications Group\nGeneral. Through its Communications Group, MIG owns interests in and participates along with local business and governmental partners in the management of Joint Ventures which operate a variety of communications services in certain countries in Eastern Europe and certain of the former Soviet Republics. MIG's licenses typically cover markets which have large populations and strong economic potential but lack reliable and efficient communications services. MIG also targets markets where systems can be constructed with relatively low capital investments and where multiple communications services can be offered to the population.\nMIG owns interests in and participates in the management of Joint Ventures which operate and\/or are constructing: (i) 10 wireless cable television systems with combined households of approximately 8.8 million; (ii) 8 paging systems with aggregate target populations of approximately 55.9 million; (iii) an international toll calling service in the Republic of Georgia which covers a population of approximately 5.5 million; (iv) a Trunked Mobile Radio service in Romania with an aggregate target population of approximately 2.1 million; and (v) 5 radio stations in 7 cities reaching combined households of approximately 8.6 million in Hungary, Russia and Latvia. The Communications Group recently entered into a letter of intent to purchase 51% of a U.K. company that has ownership interests in 9 companies providing Trunked Mobile Radio services in Europe. MIG is also exploring a number of investment opportunities in wireless telephony systems in Eastern Europe and the former Soviet Republics. The Company is also pursuing licenses for similar services in other emerging markets, including the Pacific Rim.\nMarkets. A summary of the Communications Group's markets and existing projects, their status, MIG's direct or indirect ownership interest in each such project, the year such projects became operational and the amounts of capital loaned and contributed to such projects by MIG is detailed in the chart which follows:\n(1) Covered population is provided for paging, telephony and Trunked Mobile Radio systems and covered households for wireless cable television and radio systems. (2) Represents amounts loaned and contributed as of December 31, 1995. (3) Purchased equity of existing operational company in 1994; the company was formed in 1991. (4) Provides international toll calling services between Georgia and the rest of the world and is the only Intelsat designated representative in Georgia to provide such services. (5) Indicates population MITI intends to cover by the end of 1996. In each of the foregoing markets, MITI covers the capital city and is currently expanding the services of such operations to cover additional cities. (6) Purchased equity of existing company in 1995; the company was formed in 1994. (7) Purchased equity of existing operational company in 1995; the company was formed in 1993. (8) Reflects amounts loaned and contributed to all projects in Tashkent, Uzbekistan. (9) Purchased equity of existing operational company in 1995; the company was formed in 1993. (10) Purchased equity of existing company in 1995; the company was formed in 1994. (11) Purchased equity of existing operational company in 1994; the company was formed in 1989. (12) Total household coverage of AM and FM radio.\nThe markets which the Company targets for its services typically (i) have large populations; (ii) have strong economic potential; (iii) are usually the capital city of a country, republic or province; and (iv) are easily accessible to the Communications Group's central offices. The Company believes that most of its markets have a concentration of educated people who desire quality entertainment, sports and news as well as reliable and efficient communications services. As principal cities of their respective countries, republics or provinces, these markets are, in many cases, home to a significant number of foreign diplomats, businessmen and advisors who the Company anticipates will often become premium service customers.\nThe Company believes that the vast majority of the political and economic leaders of these markets recognize the importance of communications as a means to modernizing their societies. In the Communications Group's markets, the breadth of television programming is somewhat limited and there exists a demand for quality entertainment and news programming. Additionally, the antiquated telephone systems in many of these markets do not have the capacity to adequately serve residents. The Company believes that its systems can provide a solution to these problems because (i) the Company's wireless cable television and AM and FM broadcast services will provide a wide selection of quality entertainment, sports broadcasting, educational programming and international news at an affordable rate to both local and foreign residents; (ii) the Company's wireless telephony services will be a comparatively low-cost means of quickly providing intra-country communications as well as telephone access to the rest of the world using international satellite links; and (iii) the Company's alphanumeric and digital display paging services will be a dependable and efficient means to communicate one-way without the need for a recipient to access a telephone network. The Company is not aware of any significant governmental restrictions with respect to broadcasting time or program content in its existing cable television and radio broadcasting markets which may have a material adverse effect on the Company and its operations in these markets.\nIn most cities where the Company provides or expects to provide service, a substantial percentage of the population (approximately 90% in Moscow) lives in large apartment buildings. This lowers the cost of installation and eases penetration of wireless cable television and wireless telephony services into a city, because a single microwave receiving location can bring service to a large number of people. The Company currently is licensed to provide wireless cable television to markets which have in the aggregate approximately 8.8 million households, and paging services in markets with a population totaling approximately 55.9 million. The Company believes that the cost of constructing a coaxial cable television system covering the same number of households as are covered by each of the Company's\nsystems would be significantly more expensive than the costs incurred by the Company in constructing a wireless system.\nThe Company has obtained political risk insurance from OPIC for its operating cable television systems in Moscow, Riga, Tbilisi and Tashkent, and may endeavor to obtain OPIC insurance for additional systems which are eligible for such insurance. OPIC is a United States governmental agency which provides to United States investors insurance against expropriation, political violence and loss of business income in more than 130 developing nations. The Company currently has expropriation and political violence insurance coverage with OPIC in the amount of (i) $2,800,000 with respect to its Moscow cable television system; (ii) $2,200,000 with respect to its Riga cable television system; (iii) $1,600,000 with respect to its Tbilisi cable television system; and (iv) $2,000,000 with respect to its Tashkent cable television system. The Company currently has loss of business income insurance with OPIC in the amount of (i) $1,500,000 with respect to its Moscow cable television system; (ii) $1,000,000 with respect to its Riga cable television system; and (iii) $550,000 with respect to its Tbilisi cable television system. The Company is also currently eligible to purchase additional expropriation and political violence insurance and loss of business income insurance from OPIC with respect to these systems. There can be no assurance that any insurance obtained by the Company from OPIC will adequately compensate the Company for any losses it may incur or that the Company will elect to obtain or be able to obtain OPIC insurance for any of its additional systems.\nJoint Ventures. After deciding to obtain an interest in a particular communication business, the Company generally enters into discussions with the appropriate Ministry of Communications or local parties which have interests in communications properties in a particular market. If the negotiations are successful, a joint venture agreement is entered into and is registered, and the right to use frequency licenses are contributed to the Joint Venture by the Company's local partner or are allocated by the appropriate governmental authority to the Joint Venture. In the case of the Company's radio station operations, the Company has, in many cases, directly purchased companies with an operating radio station or an ownership interest in a Joint Venture which operates a radio station.\nGenerally, the Company owns approximately 50% of the equity in a Joint Venture with the balance of such equity being owned by a local entity, often a government-owned enterprise. In 1995, the Russian Federation legislature proposed, but did not enact, legislation which would limit the interest which a foreign person is permitted to own in entities holding broadcasting licenses. If legislation is enacted in Russia or any of the Company's other markets limiting foreign ownership of broadcasting licenses and the Company is required to reduce its interests in any of the ventures in which it owns an interest, it is unclear how such reduction would be effected.\nEach Joint Venture's day-to-day activities are managed by a local management team selected by its board of directors or its shareholders. The operating objectives, business plans and capital expenditures of a Joint Venture are approved by the Joint Venture's board of directors, or in certain cases, by its shareholders. In most cases, an equal number of directors or managers of the Joint Venture are selected by the Company and its local partner. In other cases, a differing number of directors or managers of the Joint Venture may be selected by the Company on the basis of the percentage ownership interest of the Company in the Joint Venture.\nIn many cases, the credit agreement pursuant to which the Company loans funds to a Joint Venture provides the Company with the right to appoint the general manager of the Joint Venture and to approve unilaterally the annual business plan of the venture. These rights continue so long as amounts are outstanding under the credit agreement. In other cases, such rights may also exist by reason of the\nCompany's percentage ownership interest in the joint venture or under the terms of the Voint Venture's governing instruments.\nThe Company's Joint Ventures are limited liability entities which are permitted to enter into contracts, acquire property and assume and undertake obligations in their own names. Under the joint venture agreements, each of the Company and the local Joint Venture partner is obligated to make initial capital contributions to the Joint Venture. In general, a local joint venture partner does not have the resources to make cash contributions to the Joint Venture. In such cases, the Company has established or plans to establish an agreement with the Joint Venture whereby, in addition to cash contributions by the Company, each of the Company and the local partner makes in-kind contributions (usually communications equipment in the case of the Company and frequencies, space on transmitting towers and office space in the case of the local partner), and the Joint Venture signs a credit agreement with the Company pursuant to which the Company loans the venture certain funds. Typically, such credit agreements provide for interest payments to the Company at the Company's current cost of borrowing in the United States and for payment of principal and interest from 90% of the Joint Venture's available cash flow prior to any pro rata distributions to the Company and the local partner. After the full repayment of the loan owed by the Joint Venture to the Company, the distributions from the Joint Venture to the Company and the local partner are made on a pro rata basis in accordance with their respective ownership interests.\nIn addition to loaning funds to the Joint Ventures, the Company often provides certain services to each of the Joint Ventures. The Company currently charges certain Joint Ventures for services provided by MITI.\nUnder existing legislation in certain of the Company's markets, distributions from a Joint Venture to its partners will be subject to taxation. The laws in the Company's markets vary markedly with respect to the tax treatment of distributions to joint venture partners and such laws have also recently been revised significantly in many of the Company's markets. There can be no assurance that such laws will not continue to undergo major changes in the future which could have a significant negative impact on the Company and its operations.\nMarketing. The Company targets its wireless cable television service toward foreign national households, embassies, foreign commercial establishments, international and local hotels, local households and local commercial establishments. Paging services are targeted toward people who spend a significant amount of time outside of offices, have a need for mobility and\/or are business people without ready access to telephones. Paging market segments include the local police, the military, foreign and local business people and embassy personnel.\nRadio station programming is targeted toward 25 to 55 year-old consumers, who are believed by management of the Company to be the most affluent in the emerging societies of Eastern Europe and the former Soviet Republics. Each station's format is intended to appeal to the particular listening interests of this consumer group in its market. This is intended to enable the commercial sales departments of each joint venture to present to advertisers the most desirable market for their products and services, thereby heightening the value of the station's commercial advertising time. Advertising on these stations is sold to local and international advertisers.\nDevelopment of Communications Systems\nWireless Cable Television. Wireless cable television is a technology experiencing rapid growth worldwide. In the United States, wireless cable television, also referred to as MMDS (multichannel,\nmulti-point distribution service), is gaining acceptance as a competitor to coaxial cable service. In addition, the service has low installation and maintenance costs relative to coaxial cable services.\nEach of the Company's wireless cable television systems is expected to operate in a similar manner. Various programs, transmitted to satellite transponders, will be received by the joint venture's satellite dishes located in a central facility. The signal will then be transmitted to a video switching system located in the joint venture's facilities, generally near the city's main transmission tower. Other programs, such as movies, will be combined into a predetermined set of channels and fed to solid state, self-diagnostic transmitters and antennae located on the transmission tower. Encrypted multichannel signals will then be broadcast as far as 50 kilometers in all directions.\nThe specialized compact receiving antenna systems, installed on building rooftops as part of the system, will receive the multichannel signals transmitted by the transmission tower antennae and convert and route the signals to a set-top converter and a television receiver via a coaxial cabling system within the building. The set-top converter descrambles the signal and is also used as a channel selector to augment televisions having a limited number of channels.\nThe Company currently offers English, French, German and Russian programming, with plans to expand into other languages as demand increases. Some of the Company's channels are dubbed and others are subtitled into the local language. Generally, the Company's \"basic\" service provides programming of local off-air channels and an additional five to six channels with a varied mixture of distant off-air channels, European or American sports, music, international news and general entertainment. The Company's \"premium\" service generally includes the channels which make up its \"basic\" service as well as an additional number of satellite channels and a movie channel that offers recent and classic movies featuring such actors as Robert De Niro, Candice Bergen, Charles Bronson and Sean Connery.\nThe Company's programming options currently include news channels such as BBC World, CNN International, Sky News and Euronews, music, sports and entertainment channels such as BBC Prime, MTV Europe, Eurosport, TNT\/Cartoon Network, NBC Super Channel and Discovery Channel Europe and movie channels.\nThe Company currently offers \"Pay Per View\" movies on its Baltcom cable television system which operates in Riga, Latvia and is planning in the future to add such service to its program lineups in certain of its other markets. The subscriber pays for \"Pay Per View\" services in advance, and the intelligent decoders that the Company uses automatically deduct the purchase of a particular service from the amount paid in advance.\nPaging. The Company's paging systems represent a moderately priced service which is complementary to telephony. Alphanumeric and digital display paging systems are useful in Eastern European countries, the former Soviet Republics and other emerging markets for sending information one-way without the need for a recipient to access a telephone network, which in many of these markets are often overloaded or unavailable.\nThe Company offers service with three types of pagers: (i) tone only, which upon encoded signaling produces several different tones depending on the code transmitted; (ii) digital display, which emits a variety of tones and permits the display of up to 16 digits; and (iii) alphanumeric, which emits a variety of tones and displays as many as 63 characters. Subscribers may also purchase additional services, such as paging priority, group calls and other options.\nAs an adjunct to paging services, the joint ventures operate 24-hour service bureaus to receive calls and record and transmit messages. In addition, automatic paging messages are accepted from personal computers, telex machines and cellular telephones.\nAM and FM Radio. Programming in each of the Company's AM and FM markets is designed to appeal to the particular interests of a specific demographic group in such markets. Although the Company's radio programming formats are constantly changing, programming generally consists of popular music from the United States, Western Europe, and the local area. News is delivered by local announcers in the language appropriate to the region, and announcements and commercials are locally produced. By developing a strong listenership base comprised of a specific demographic group in each of its markets, the Company believes it will be able to attract advertisers seeking to reach these listeners. The Company believes that the technical programming and marketing expertise that it provides to its joint ventures enhances the performance of the joint ventures' radio stations.\nInternational Toll Calling. The Company owns approximately 30% of Telecom Georgia. Telecom Georgia handles all international calls inbound to and outbound from the Republic of Georgia to the rest of the world. Telecom Georgia is currently making interconnect arrangements with several international long distance carriers such as Sprint and Telespazio of Italy. For every international call made to the Republic of Georgia, a payment will be due to Telecom Georgia by the interconnect carrier and for every call made from the Republic of Georgia to another country, Telecom Georgia will bill its subscribers and pay a destination fee to the interconnect carrier.\nTrunked Mobile Radio. The Company's Romanian joint venture provides Trunked Mobile Radio (\"TMR\") services in certain areas in Romania. The Company also recently signed a letter of intent to purchase a 51% interest in Protocall Ventures, Ltd., a U.K. company with ownership interests in 9 Trunked Mobile Radio systems operating in Portugal, Spain, Germany and Belgium. TMR systems are primarily designed to provide mobile voice communications among members of user groups and interconnection to the public switched telephone network. TMR systems are commonly used by taxi companies, construction teams, security services and other groups with need for significant internal communications.\nWireless Telephony. MIG is currently exploring a number of investment opportunities in wireless telephony systems and has installed test systems in a number of countries in Eastern Europe, the former Soviet Republics, including Uzbekistan and Georgia, and the emerging markets in the Pacific Rim. The Company believes that its proposed wireless telephony systems are a time and cost effective means of improving the communications infrastructure in these markets. The current telephone systems in these markets are antiquated and overloaded, and consumers in these markets typically must wait several years to obtain telephone service.\nThe Company's proposed fixed wireless local loop telephony offers the current telephone service provider a rapid and cost effective method to expand their service base. The system eliminates the need to build additional fixed wire line infrastructure by utilizing a microwave connection directly to the subscriber.\nCompetition\nWireless Cable. Most of the Company's current cable television competitors in its markets are undercapitalized, small, local companies that are providing limited programming to their subscribers. The Company does not, however, have or expect to have exclusive franchises with respect to its cable television operations and may therefore face more significant competition in the future from highly\ncapitalized entities seeking to provide services similar to the Company's in its markets. The Company also encounters competition in some markets from unlicensed competitors which may have lower operating expenses and may be able to provide cable television service at lower prices than the Company. The Company currently competes in all of its markets with over-the-air broadcast television stations. The Company is also aware that equipment is being manufactured for the purpose of unlawfully receiving and decoding encrypted signals transmitted by wireless cable television ventures. The Company believes that it has thus far only experienced unlawful receipt of its signal on a limited basis with respect to certain of its wireless cable television services. In addition, another possible source of competition for the Company are videotape cassettes. The Company's wireless cable also competes with individual satellite dishes.\nPaging. In some of the Company's paging markets, the Company has experienced and can expect to continue to experience competition from existing small, local, paging operators who have limited areas of coverage and as well as competition by, in some cases, paging operators established by Western European and U.S. investors with substantial experience in paging. The Company also faces competition from a segment of radio paging operations utilizing FM Subcarrier Frequency transmissions. The local phone systems are also considered to be a significant competitor to the Company's paging operations. The Company does not have or expect to have exclusive franchises with respect to its paging operations and may therefore face more significant competition in the future from highly capitalized entities seeking to provide services similar to the Company's in its markets.\nWireless Telephony. While the existing wireline telephone systems in Eastern Europe and the former Soviet Republics are often antiquated, the fact that these systems are already well-established and operated by governmental authorities means that they are a source of competition for the Company's proposed wireless telephony operations. In addition, one-way paging service may be a competitive alternative which is adequate for those who do not need a two-way service, or it may be a service that reduces wireless telephony usage among wireless telephony subscribers. The Company does not have or expect to have exclusive franchises with respect to its wireless telephony operations and may therefore face more significant competition in the future from highly capitalized entities seeking to provide services similar to or competitive with the Company's in its markets. In certain markets, cellular telephone operators exist and represent a competitive alternative to the Company's proposed wireless telephony. A cellular telephone can be operated in the same manner as a wireless loop telephone in that either type of service can simulate the conventional telephone service by providing local and international calling from a fixed position in its service area. Both services are connected directly to a telephony switch operated by the local telephone company and therefore can initiate calls to or receive calls from anywhere in the world currently served by the international telephone network. Cellular telephony and wireless loop telephony eliminate the need for trenching and laying of wires for telephone services and thus deploy telephone service quickly and cost effectively. Wireless loop technology utilizes radio frequencies, instead of copper or fiber optic cable, to transmit between a central telephone and a subscriber's building. Cellular telephony enables a subscriber to move from one place in a city to another while using the service while wireless loop telephony is intended to provide fixed telephone services which can be deployed as rapidly as cellular telephony and at a significantly lower cost.\nFM and AM Radio. In each of the Company's existing markets, there are either a number of stations in operation already or plans for competitive stations to be in service shortly. As additional stations are constructed and commence operations, the Company expects to face significantly increased competition for listeners and advertising revenues from parties with programming, engineering and marketing expertise comparable to the Company's. Other media businesses, including broadcast television, cable television, newspapers, magazines and billboard advertising also compete with the Company's radio stations for advertising revenues.\nSnapper and Roadmaster\nThe Company currently engages in two non-strategic businesses. The Company is involved in the lawn and garden equipment industry through its Snapper subsidiary which does business under the name \"Snapper Power Equipment Company.\" In addition, the Company is indirectly engaged in the sporting good business through its ownership interest in Roadmaster.\nSnapper. Snapper manufactures Snapper(R) brand power lawnmowers, lawn tractors, garden tillers, snow throwers and related parts and accessories, and distributes blowers, string trimmers and edgers. The lawnmowers include rear engine riding mowers, front engine riding mowers or lawn tractors, and self-propelled and push-type walk-behind mowers. Snapper also manufactures a line of commercial lawn and turf equipment and a Blackhawk(TM) line of mowers and markets a fertilizer line under the Snapper(R) brand.\nOn February 29, 1996, Snapper sold its European subsidiaries to an employee of such subsidiaries. The purchase price consisted of the payment of a promissory note of one of Snapper's European subsidiaries in the amount of $8,621,027, which represents a portion of the intercompany indebtedness ($10,703,718 at December 31, 1995) owed to Snapper by its European subsidiaries. Principal payments under the promissory note shall be made as follows: (i) $3,000,000 on May 31, 1996; (ii) $2,524,310 on July 31, 1996; (iii) 2,500,000 on September 30, 1996 and (iv) the remainder on December 31, 1996. The promissory note is secured by a standby letter of credit.\nFor accounting purposes, Snapper has been classified as an asset held for disposition. The Company has adopted a plan to dispose of Snapper during 1996 and is actively exploring a sale of Snapper. Although the Company has received several proposals regarding a sale of Snapper, it has not reached an agreement in principle or entered into a definitive agreement providing for the disposition of Snapper. No assurances can be given that the Company in the future will engage in such a transaction or effect such a plan.\nInvestment in Roadmaster Industries, Inc. In December 1994, the Company acquired 19,169,000 shares of Roadmaster common stock, or approximately 38% of the outstanding Roadmaster common stock, in exchange for all of the issued and outstanding capital stock of four of its wholly-owned subsidiaries (the \"Exchange Transaction\"). Roadmaster, 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. Its common stock is listed on the New York Stock Exchange. As of December 31, 1995, the closing price per share of Roadmaster common stock was $2.375 and the quoted market value of the Company's investment in Roadmaster was $45,526,375. As disclosed in Amendment No. 1 to its Schedule 13D relating to Roadmaster, filed with the SEC on March 1, 1996, MIG intends to dispose of its investment in Roadmaster during 1996.\nIn connection with the Exchange Transaction, the Company, Roadmaster and certain officers of Roadmaster entered into a Shareholders Agreement (the \"Shareholders Agreement\") pursuant to which, among other things, the Company obtained the right to designate four individuals to serve on Roadmaster's nine-member Board of Directors (the \"MIG Designated Directors\"), subject to certain reductions.\nIn addition, the Shareholders Agreement generally grants Roadmaster a right of first refusal with respect to any proposed sale by the Company of any shares of Roadmaster common stock received by the Company in the Exchange Transaction for as long as the MIG Designated Directors have been nominated and elected to the Board of Directors of Roadmaster. Such right of first refusal will not,\nhowever, apply to any proposed sale, transfer or assignment of such shares to any persons who would, after consummation of such transaction, own less than 10% of the outstanding shares of Roadmaster common stock or to any sale of such shares pursuant to a registration statement filed under the Securities Act, provided the Company has used its reasonable best efforts not to make any sale pursuant to such registration statement to any single purchaser or \"Acquiring Person\" who would own 10% or more of the outstanding shares of Roadmaster common stock after the consummation of such transaction. \"Acquiring Person\" generally is defined in the Shareholders Agreement to mean any person or group which together with all affiliates is the beneficial owner of 5% or more of the outstanding shares of Roadmaster common stock.\nAlso in connection with the Exchange Transaction, the Company and Roadmaster entered into a Registration Rights Agreement (the \"Registration Rights Agreement\") under which Roadmaster agreed to register such shares (\"Registrable Stock\") at the request of the Company or its affiliates or any transferee who acquires at least 1,000,000 shares of the Roadmaster common stock issued to the Company in the Exchange Transaction. Under the Registration Rights Agreement, registration may be required at any time during a ten-year period beginning as of the closing date of the Exchange Transaction (the \"Registration Period\") by the holders of at least 50% of the Registrable Stock if a \"long-form\" registration statement (i.e., a registration statement on Form S-1, S-2 or other similar form) is requested or by the holders of Registrable Stock with a value of at least $500,000 if a \"short-form \"registration statement (i.e., a registration statement on Form S-3 or other similar form) is requested. Roadmaster is required to pay all expenses incurred (other than the expenses of counsel, if any, for the holders of Registrable Stock, the expenses of underwriter's counsel, and underwriting fees) for any two registrations requested by the holders of Registrable Stock during the Registration Period. Roadmaster will become obligated to pay the expenses of up to two additional registrations if Roadmaster is not eligible to use a short-form registration statement to register the Registrable Stock at any time during the Registration Period. All other registrations will be at the expense of the holders of the Registrable Stock. Roadmaster will have the right at least once during each twelve-month period to defer the filing of a demand registration statement for a period of up to 90 days after request for registration by the holders of the requisite number of shares of Registrable Stock. In connection with entering into the MIG Revolver (as defined below), MIG requested that Roadmaster register its shares of Roadmaster common stock.\nEnvironmental Protection\nSnapper's manufacturing plant is subject to federal, state and local environmental laws and regulations. Compliance with such laws and regulations has not, and is not expected to, materially affect Snapper's competitive position. Snapper's capital expenditures for environmental control facilities, its incremental operating costs in connection therewith and Snapper's environmental compliance costs were not material in 1995 and are not expected to be material in future years.\nThe Company has agreed to indemnify a former subsidiary of the Company for certain obligations, liabilities and costs incurred by the subsidiary arising out of environmental conditions existing on or prior to the date on which the subsidiary was sold by the Company. The Company sold the subsidiary in 1987. Since that time, the Company has been involved in various environmental matters involving property owned and operated by the subsidiary, including clean-up efforts at landfill sites and the remediation of groundwater contamination. The costs incurred by the Company with respect to these matters have not been material during any year through and including the fiscal year ended December 31, 1995. As of December 31, 1995, the Company had a remaining reserve of approximately $1,250,000 to cover its obligations to its former subsidiary. During 1995, the Company was notified by certain potentially responsible parties at a superfund site in Michigan that the former subsidiary may also be a\npotentially responsible party at the superfund site. The former subsidiary's liability, if any, has not been determined but the Company believes that such liability will not be material.\nThe Company, through a wholly-owned subsidiary, owns approximately 17 acres of real property located in Opelika, Alabama (the \"Opelika Property\"). The Opelika Property was formerly owned by Diversified Products Corporation, a former subsidiary of the Company (\"DP\"), and was transferred to a wholly -owned subsidiary of the Company in connection with the Exchange Transaction. DP previously used the Opelika Property as a storage area for stockpiling cement, sand, and mill scale materials needed for or resulting from the manufacture of exercise weights. In June 1994, DP discontinued the manufacture of exercise weights and no longer needed to use the Opelika Property as a storage area. In connection with the Exchange Transaction, Roadmaster and the Company agreed that the Company, through a wholly-owned subsidiary, would acquire the Opelika Property, together with any related permits, licenses, and other authorizations under federal, state and local laws governing pollution or protection of the environment. In connection with the closing of the Exchange Transaction, the Company and Roadmaster entered into an Environmental Indemnity Agreement (the \"Indemnity Agreement\") under which the Company agreed to indemnify Roadmaster for costs and liabilities resulting from the presence on or migration of regulated materials from the Opelika Property. The Company's obligations under the Indemnity Agreement with respect to the Opelika Property are not limited. The Indemnity Agreement does not cover environmental liabilities relating to any property now or previously owned by DP except for the Opelika Property.\nOn January 22, 1996, the Alabama Department of Environmental Management (\"ADEM\") wrote a letter to the Company stating that the Opelika Property contains an \"unauthorized dump\" in violation of Alabama environmental regulations. The letter from ADEM requires the Company to present for ADEM's approval a written environmental remediation plan for the Opelika Property. The Company has retained an environmental consulting firm to develop an environmental remediation plan for the Opelika Property. The consulting firm is currently conducting soil samples and other tests on the Opelika Property. Although the Company has not received the results of these tests, the Company believes that the reserves of approximately $1,800,000 previously established by the Company for the Opelika Property will be adequate to cover the cost of the remediation plan that is currently being developed.\nEmployees\nAs of February 29, 1996, the Company had approximately 289 regular employees, of whom less than 1% were members of labor unions.\nCertain of the Entertainment Group's subsidiaries are signatories to various agreements with unions that operate in the entertainment industry. In addition, a substantial number of the artists and talent and crafts people involved in the motion picture and television industry are represented by trade unions with industry-wide collective bargaining agreements.\nRecent Developments\nAt the time the November 1 Mergers were consummated, the Company disclosed that one of the benefits of such mergers was that they would enhance the Company's ability to make strategic acquisitions of other companies whose businesses and\/or assets complement the Company's entertainment, media and communications assets. As noted above, the Company has entered into a merger agreement to acquire Goldwyn and a letter of intent to acquire MPCA. In addition, the Company has entered into an Agreement and Plan of Merger to acquire Alliance Entertainment Company (\"Alliance\"), which is the largest full-service distributor of pre-recorded music in the United States and\nwhich also is engaged in the exploitation of proprietary music product. The acquisition of Alliance will enable the Company to expand its entertainment related business by entering the music distribution business in the United States and certain international markets and provide the Company with a growing library of artists and previously released music catalogs. In connection with the proposed mergers, the Company intends to refinance substantially all of its indebtedness and that of its subsidiaries, as well as substantially all of the indebtedness of Alliance and Goldwyn.\nMerger Agreement with Alliance\nOn December 20, 1995, the Company and Alliance entered into an Agreement and Plan of Merger (the \"Alliance Merger Agreement\") pursuant to which a newly-formed, wholly-owned subsidiary of the Company (\"Alliance Mergerco\") will merge with and into Alliance (the \"Alliance Merger\"). Alliance is the largest full-service distributor of pre-recorded music and music related products in the United States and is also actively engaged in the exploitation of proprietary rights with respect to recorded music, video and video CDs. Alliance has expanded rapidly over the past several years through strategic acquisitions and the internal growth of its operations and has built a distribution infrastructure which it believes provides it with competitive advantages in purchasing and distributing inventory and servicing its customers. Alliance believes it is currently among the top five purchasers of pre-recorded music in the United States and that it is four times the size of its largest direct competitor in terms of annual revenues.\nPursuant to the Alliance Merger Agreement, upon consummation of the Alliance Merger, Alliance stockholders will exchange each of their shares of Alliance common stock for (i) .7 shares of Common Stock, and (ii) a ten-year warrant to purchase .285 shares of Common Stock at an exercise price of $20.00 per share. Also in connection with the Alliance Merger, Metromedia has entered into Stock Purchase Agreements (the \"Stock Purchase Agreements\") with Joseph J. Bianco, the Chairman and Chief Executive Officer of Alliance, and Anil K. Narang, the Vice Chairman and President of Alliance, providing for the sale by Messrs. Bianco and Narang to Metromedia of (i) 2,100,000 and 420,000 shares of Common Stock, respectively, and 886,920 and 171,000 Warrants, respectively, to be received by Messrs. Bianco and Narang in the Alliance Merger and (ii) all Warrants received by Messrs. Bianco and Narang upon the exercise of certain options or warrants to purchase Alliance common stock held by them (expected to be 829,350 Warrants for Mr. Bianco and 177,816 Warrants for Mr. Narang), for a cash purchase price of $36,000,000 and $7,200,000 to Messrs. Bianco and Narang, respectively. These purchases will take place immediately following the effective time of the Alliance Merger and will enable the Metromedia Holders, who currently collectively control approximately 35.9% of the outstanding Common Stock, to reduce the substantial dilution to their interests which would otherwise result from the issuance of Common Stock to Alliance Stockholders in the Alliance Merger.\nConsummation of the Alliance Merger is subject to various conditions, including (i) the receipt of approval of the stockholders of each of MIG and Alliance; (ii) the receipt of certain opinions of counsel with respect to certain legal matters and as to the qualification of the Alliance Merger as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the \"Code\"); (iii) that since September 30, 1995, no change or event shall have occurred which has or could reasonably be expected to have a material adverse effect with respect to MIG or Alliance; (iv) the receipt of certain fairness opinions by the Board of Directors of each of MIG and Alliance; (v) that the Stock Purchase Agreements shall have been executed by the parties thereto; (vi) that Metromedia Company or an affiliate shall purchase all of Alliance's $125,000,000 11 1\/4% Senior Subordinated Notes due 2005 (the \"Existing Alliance Notes\") which may be tendered pursuant to the change of control provisions contained in the indenture governing the Existing Alliance Notes or Metromedia Company or an affiliate shall otherwise take action to ensure that there will not be a default under MIG's or\nAlliance's existing indebtedness as a result of Existing Alliance Notes being tendered by their holders; (vii) that the shares of Common Stock and the Warrants to be issued in the Alliance Merger shall have been authorized for listing on the AMEX or any other national securities exchange or automated quotation system approved by MIG and Alliance, in each case, subject to official notice of issuance; and (viii) that Alliance Stockholders holding, in the aggregate, fewer than 10% of the shares of Alliance Common Stock shall have perfected their dissenters' rights of appraisal.\nThe Alliance Merger Agreement provides that Alliance has the right to terminate the Alliance Merger Agreement in the event that the average closing price for the Common Stock is below $14.50 per share for the 20 consecutive trading days ending six calendar days prior to the date of the stockholder meetings held to consider the proposed Alliance Merger (the \"Minimum Price Condition\"). In addition, The Alliance Merger Agreement may be terminated at any time prior to the effective time of the Alliance Merger, whether before or after approval thereof by the stockholders of MIG and\/or Alliance: (i) by the mutual written consent of MIG and Alliance, (ii) unilaterally, by the Board of Directors of MIG or Alliance if the Alliance Merger has not been consummated on or before September 30, 1996, (iii) by the non-breaching party in case of certain material breaches by the other party or (iv) by the Board of Directors of MIG or Alliance if a court of competent jurisdiction or any other governmental entity shall have issued an order, decree or ruling or taken any other action restraining, enjoining or otherwise prohibiting the consummation of the Alliance Merger and such order, decree, ruling or other action shall have become final and non-appealable. The Alliance Merger Agreement may also be terminated by MIG or Alliance if the Alliance Board of Directors recommends a competing offer or otherwise modifies or changes, in a manner adverse to MIG, its recommendation that its stockholders approve the Alliance Merger Agreement. Upon any termination resulting from circumstances contemplated by the preceding sentence, the Alliance Merger Agreement provides that Alliance will pay MIG a termination fee of $18 million plus the reimbursement of certain expenses. In addition, if the Alliance Merger is not consummated by Alliance because the Minimum Price Condition is not satisfied, MIG has agreed to reimburse certain of Alliance's expenses up to $1,250,000.\nSubsequent to the execution of the Alliance Merger Agreement, in response to certain comments to such agreement received from the Special Committee of the Board of Directors of Alliance formed to consider the proposed merger and for certain other considerations, MIG and Alliance have agreed in principle to amend and restate the Alliance Merger Agreement to clarify the intent of the parties with respect to certain matters, including the parties' agreement that (i) the date for determining whether the Minimum Price Condition has been satisfied will be six calendar days prior to the effective time of the Alliance Merger rather than six calendar days prior to the day of the stockholder meetings to be held to consider the merger, as is currently contemplated by the Alliance Merger Agreement, (ii) the inability to consummate the refinancing of substantially all of MIG's and Alliance's outstanding indebtedness on commercially reasonable terms will not in itself constitute a material adverse effect with respect to MIG or Alliance that would permit either MIG or Alliance to not consummate the Alliance Merger and (iii) Alliance will be merged into Alliance Mergerco rather than merging Alliance Mergerco into Alliance, as is provided for in the Alliance Merger Agreement.\nMerger Agreement with The Samuel Goldwyn Company\nOn January 31, 1996, the Company and Goldwyn entered into an Agreement and Plan of Merger (the \"Goldwyn Merger Agreement\") pursuant to which Goldwyn will merge with a newly-formed, wholly-owned subsidiary of the Company (the \"Goldwyn Merger\") and, in connection therewith, will be re-named \"Goldwyn Entertainment Company\".\nGoldwyn is a diversified independent entertainment company engaged in the production and worldwide distribution of motion pictures and television programming and in theatrical exhibition. Goldwyn's Film Division is a producer and leading distributor of specialized motion pictures and art films, which are substantially less expensive to produce and distribute than films produced by major studios for wide release. Specialized films also are characterized by underlying literary and artistic elements intended to appeal primarily to sophisticated audiences. Certain specialized motion pictures, such as the recent independently produced films, The Remains of the Day, In the Name of the Father and The Piano have \"crossover\" commercial potential as well, that is, artistic and creative elements, such as an exceptional cast, critically acclaimed performances or a timely or compelling storyline, which appeal to a broader audience. Specialized films released by Goldwyn in recent years include the Academy Award-winning The Madness of King George, the crossover commercial success Much Ado About Nothing, and Academy Award-nominated films Eat, Drink, Man, Woman, The Wedding Banquet, Longtime Companion and Henry V.\nGoldwyn's Television Division (the \"Television Division\") produces original programming for the first-run syndication market and distributes feature films and other television programming worldwide. The Television Division produces and syndicates the athletic competition series American Gladiators, which is currently in its sixth season. American Gladiators is syndicated in over 90% of the United States television markets and over 40 foreign markets. In the fall of 1995, the Television Division introduced a remake of its original television series Flipper for broadcast in the 1995-1996 season. In addition, the Television Division syndicates movie packages from Goldwyn's library of over 850 feature films.\nGoldwyn believes that its Samuel Goldwyn Theatre Group (the \"Theatre Group\"), with 140 screens in 52 theaters, is the largest exhibitor of specialized motion pictures and art films in the United States. The operation of the Theatre Group allows Goldwyn to participate in revenues from the exhibition of films distributed by Goldwyn as well as films produced and distributed by others. The Theatre Group fulfills a key element of Goldwyn's strategy by broadening Goldwyn's presence in the market for specialized motion pictures and art films and providing a source of relatively stable revenues and cash flow to Goldwyn.\nThe Goldwyn Merger Agreement provides that upon consummation of the Goldwyn Merger, Goldwyn stockholders will receive $5.00 worth of Common Stock for each share of Goldwyn common stock, provided that the average closing price of the Common Stock over the 20 consecutive trading days ending five days prior to the meeting of the Company's stockholders held to vote upon the Goldwyn Merger is between $12.50 and $16.50. If the average closing price of Common Stock over such period is less than $12.50 it will be deemed to be $12.50 and Goldwyn stockholders will receive .4 shares of Common Stock for each share of Goldwyn common stock, and if the average closing price of the Common Stock over such period is greater than $16.50, it will be deemed to be $16.50 and Goldwyn stockholders will receive .3030 shares of Common Stock for each share of Goldwyn common stock.\nConsummation of the Goldwyn Merger is subject to various conditions, including, but not limited to: (i) the receipt of approval of the stockholders of each of MIG and Goldwyn (though under certain circumstances the Company may unilaterally waive the condition of approval of its stockholders); (ii) the receipt of certain opinions of counsel with respect to certain legal matters and as to the qualification of the Goldwyn Merger as a reorganization within the meaning of Section 368(a) of the Code; (iii) that since December 31, 1995, no change or event shall have occurred which has had or could reasonably be expected to have a material adverse effect with respect to MIG or Goldwyn; (iv) the receipt of certain fairness opinions by the Board of Directors of each of MIG and Goldwyn; (v) that the Samuel Goldwyn Family Trust (the \"Goldwyn Family Trust\"), of which Samuel Goldwyn, Jr., Chairman\nand Chief Executive Officer of Goldwyn, is trustee, and the surviving corporation of the Goldwyn Merger shall have entered into a distribution agreement pursuant to which such corporation will acquire distribution rights to the Samuel Goldwyn Classics Library for a term which extends until the year 2020; (vi) that Samuel Goldwyn, Jr., Chairman and Chief Executive Officer of Goldwyn, and Meyer Gottlieb, President of Goldwyn, shall each have entered into employment agreements with the surviving corporation of the Goldwyn Merger on terms satisfactory to the parties; (vii) that Goldwyn's indebtedness shall have been refinanced or repaid in full or extended beyond the effective time of the Goldwyn Merger; (viii) that Orion shall have provided to Goldwyn up to $5.5 million of interim financing as an advance for certain distribution rights in six feature films; (ix) that the surviving corporation of the Goldwyn Merger and Mr. Goldwyn shall have entered into an agreement pursuant to which such corporation will acquire a license to use the trademark \"Samuel Goldwyn\" in perpetuity royalty-free with regard to existing product and a license to use the name \"Goldwyn\" in perpetuity royalty-free in connection with its film and television business; (x) that an Option Agreement among Goldwyn, Mr. Goldwyn and the Goldwyn Family Trust shall be amended and restated to clarify that the option granted to Goldwyn under the existing agreement, which option entitles Goldwyn to \"put\" shares of Goldwyn common stock to the Goldwyn Family Trust under certain circumstances, may be exercised utilizing the Common Stock instead of Goldwyn common stock; and (xi) that the shares of Common Stock to be issued in the Goldwyn Merger shall have been authorized for listing on the AMEX or any other national securities exchange or automated quotation system approved by MIG and Goldwyn, in each case, subject to official notice of issuance.\nThe Goldwyn Merger Agreement may be terminated at any time prior to the effective time of the Goldwyn Merger, whether before or after approval thereof by the stockholders of MIG and\/or Goldwyn: (i) by the mutual written consent of MIG and Goldwyn, (ii) unilaterally, by the Board of Directors of MIG or Goldwyn if the Goldwyn Merger has not been consummated on or before September 30, 1996, (iii) by the non-breaching party in case of certain material breaches by the other party or (iv) by the Board of Directors of MIG or Goldwyn if a court of competent jurisdiction or any other governmental entity shall have issued an order, decree or ruling or taken any other action restraining, enjoining or otherwise prohibiting the consummation of the Goldwyn Merger and such order, decree, ruling or other action shall have become final and non-appealable. The Goldwyn Merger Agreement may also be terminated by MIG or Goldwyn if the Goldwyn Board of Directors recommends a competing offer or otherwise modifies or changes, in a manner adverse to MIG, its recommendation that its stockholders approve the Goldwyn Merger Agreement. Upon any termination resulting from circumstances contemplated by the preceding sentence and under certain other circumstances, the Goldwyn Merger Agreement provides that Goldwyn will pay MIG a termination fee of $3 million and reimburse MIG for certain of its expenses.\nPursuant to the terms of a voting agreement entered into simultaneously with the execution of the Goldwyn Merger Agreement, the Samuel Goldwyn, Jr. Family Trust, beneficial owner of approximately 64% of the outstanding common stock of Goldwyn, has agreed to vote its shares in favor of the Goldwyn Merger. Accordingly, the vote of the Goldwyn Family Trust in accordance with the Voting Agreement will be sufficient to approve the Goldwyn Merger Agreement without any action on the part of any other stockholders of Goldwyn.\nMPCA Acquisition\nOn November 17, 1995, the Company entered into a letter of intent to acquire MPCA and its affiliated companies for $32.5 million in Common Stock and cash in repayment of stockholder loans to MPCA. MPCA is an independent film production company which focuses on producing and acquiring commercially marketable films featuring popular actors at substantially less than average industry cost.\nMPCA is headed by Bradley Krevoy and Steven Stabler, who have produced low budget, profitable movies like Threesome, released in 1993, which cost $3.5 million to produce and grossed a reported total of $60 million. A more recent success produced by Krevoy and Stabler MPCA was the film Dumb and Dumber, which cost $16 million to produce and grossed a reported total of approximately $250 million.\nConsummation of the proposed MPCA acquisition is subject to the execution of definitive documentation, approval of the transaction by the Board of Directors of the Company, satisfactory completion by the Company of its legal and financial due diligence with respect to MPCA, the execution by Messrs. Krevoy and Stabler of employment agreements with the Company, the execution of certain ancillary agreements and receipt of all requisite regulatory approvals, including the termination or expiration of the requisite waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. Following the consummation of the MPCA acquisition, it is anticipated that MPCA will merge into a wholly-owned subsidiary of the Company and that Krevoy and Stabler will join the Entertainment Group's management team.\nSegment and Geographic Data\nBusiness segment data and information regarding the Company's foreign revenues by geographic area are included in Notes 7 and 12 of the \"Notes to Consolidated Financial Statements\" included in Item 8 hereof.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table contains a list of the Company's principal properties.\nNumber ----------------- Description Owned Leased Location - ----------------- -------- -------- --------------- Orion: Office space -- 1 Los Angeles, Sales office -- 1 California Sales office -- 1 New York, New York Dallas, Texas MITI: Executive 1 Stamford, offices -- 1 Connecticut Office space -- 1 Moscow, Russia Office space Vienna, Austria\nGeneral Corporate: -- 1 Atlanta, Georgia Office space\nThe Company's management believes that the facilities listed above are generally adequate and satisfactory for their present usage and are generally well utilized.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFuqua Industries, Inc. Shareholder Litigation - ---------------------------------------------\nBetween February 25, 1991 and March 4, 1991, three lawsuits were filed against the Company (formerly named Fuqua Industries, Inc.) in the Delaware Chancery Court. On May 1, 1991, these three\nlawsuits were consolidated by the Delaware Chancery Court in In re Fuqua ----------- Industries, Inc. Shareholders Litigation, Civil Action No. 11974. The named - ---------------------------------------- defendants are certain current and former members of the Company's Board of Directors and certain former members of the Board of Directors of Intermark, Inc. (\"Intermark\"). Intermark is a predecessor to Triton Group Ltd., which at one time owned approximately 25% of the outstanding shares of the Company's Common Stock. The Company was named as a nominal defendant in this lawsuit. The action was brought derivatively in the right of and on behalf of the Company and purportedly was filed as a class action lawsuit on behalf of all holders of the Company's Common Stock other than the defendants. The complaint alleges, among other things, a long-standing pattern and practice by the defendants of misusing and abusing their power as directors and insiders of the Company by manipulating the affairs of the Company to the detriment of the Company's past and present stockholders. The complaint seeks (i) monetary damages from the director defendants, including a joint and several judgment for $15,700,000 for alleged improper profits obtained by Mr. J.B. Fuqua in connection with the sale of his shares in the Company to Intermark; (ii) injunctive relief against the Company, Intermark and its former directors, including a prohibition against approving or entering into any business combination with Intermark without specified approval; and (iii) costs of suit and attorneys' fees. On December 28, 1995, plaintiffs filed a consolidated second amended derivative and class action complaint, purporting to assert additional facts in support of their claim regarding an alleged plan, but deleting their prior request for injunctive relief. On January 31, 1996, all defendants moved to dismiss the second amended complaint and filed a brief in support of that motion. The motion to dismiss is still pending.\nLitigation Relating to the November 1 Mergers - ---------------------------------------------\nThree stockholder suits relating to the November 1 Mergers were filed in the Delaware Chancery Court prior to the consummation of such mergers. Set forth below is a brief description of the status of such litigations.\nJerry Krim v. John W. Kluge, Silvia Kessel, Joel R. Packer, Michael I. Sovern, Raymond L. Steele, Stuart Subotnick, Arnold L. Wadler, Stephen Wertheimer, Leonard White and Orion Pictures Corporation (Delaware Chancery Court, C.A. No. 13721); complaint filed September 2, 1994. Orion and each of its directors were named as defendants in this purported class action lawsuit, which alleged that Orion's Board of Directors failed to use the required care and diligence in considering the November 1 Mergers and sought to enjoin the consummation of such mergers. The lawsuit further alleged that as a result of the actions of Orion's directors, Orion's stockholders would not receive the fair value of Orion's assets and business in exchange for their Orion Common Stock in the November 1 Mergers.\nHarry Lewis v. John W. Kluge, Leonard White, Stuart Subotnick, Silvia Kessel, Joel R. Packer, Michael I. Sovern, Raymond L. Steele, Arnold L. Wadler, Stephen Wertheimer, The Actava Group, Inc. and Orion Pictures Corp. (Delaware Chancery Court, C.A. No. 14234); complaint filed April 17, 1995. Orion, each of its directors and Actava were named in this purported class action lawsuit which was filed after the execution of the initial merger agreement relating to the November 1 Mergers. The complaint contained similar allegations and sought similar relief to the Krim case described above.\nOn January 22, 1996, the parties to these two lawsuits executed a Memorandum of Understanding embodying a tentative settlement agreement. In the tentative settlement agreement, the plaintiffs accept the September 27, 1995 amended and restated merger agreement relating to the November 1 Mergers as full settlement of all claims that were asserted or could have been asserted in such litigations.\nJames F. Sweeney, Trustee of Frank Sweeney Defined Benefit Plan Trust v. John D. Phillips, Frederick B. Beilstein, III, John E. Aderhold, Michael B. Cahr, J.M. Darden, III, John P. Imlay, Jr., Clark A. Johnson, Anthony F. Kopp, Richard Nevins, Carl E. Sanders, Orion Picture Corporation, International Telcell, Inc., Metromedia International, Inc. and MCEG Sterling Inc. (Delaware Chancery Court, C.A. No. 13765); complaint filed September 23, 1994. This class action lawsuit was filed by stockholders of the Company (then known as The Actava Group Inc.) against the Company and its directors, and against each of Orion, MITI and Sterling, the other parties to the November 1 Mergers. The complaint alleges that the terms of the November 1 Mergers constitute an overpayment by the Company for the assets of Orion and, accordingly, would result in a waste of the Company's assets. The complaint further alleges that Orion, MITI and Sterling each knowingly aided, abetted and materially assisted the Company's directors in breach of their fiduciary duties to the Company's stockholders. On November 23, 1994, the Company and its directors filed a motion to dismiss the complaint. The plaintiff never responded to the motion to dismiss. On February 22, 1996, however, the plaintiff filed a status report with the Court of Chancery in Delaware indicating that the case is moot but that the plaintiff intends to pursue an application for fees and expenses. The Company believes such application to be without merit.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nA special meeting of stockholders of the Company was held on November 1, 1995 for the purpose of enabling stockholders to consider and vote on the Amended and Restated Agreement and Plan of Merger relating to the November 1 Mergers and the transactions contemplated thereby. At such meeting, a majority of the Company's stockholders voted to approve such mergers and certain amendments to the Company's Restated Certificate of Incorporation and By-Laws effected by virtue of the approval of such merger agreement, including amendments to the Company's Restated Certificate of Incorporation increasing the number of authorized number of shares of Common Stock, dividing the Company's Board of Directors into three classes, and renaming the Company \"Metromedia International Group, Inc.,\" and amendments to the Company's By-laws prohibiting stockholder action by written consent, limiting the right to call special meetings of the Company's stockholders to the Chairman or Vice Chairman of the Board of Directors and authorizing the Board of Directors to issue preferred stock in one or more classes or series without any action on the part of stockholders. The following is a summary of the voting results with respect to the Amended and Restated Merger Agreement from the November 1, 1995 special meeting:\nFor Against Abstain --- ------- -------\n10,911,937 297,685 95,385\nNo other matters were submitted to a vote of the Company's stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 1995.\nExecutive Officers of the Company\nEach of the executive officers of the Company (other than Messrs. Phillips and Chmar) have served in their respective capacities since the consummation of the November 1 Mergers. Each executive officer shall, except as otherwise provided in MIG's By-Laws, hold office until his or her successor shall have been chosen and qualify.\nPosition Name Age Office Held Since ---- --- ------ ---------- John W. Kluge . . . 81 Chairman November 1995 Stuart Subotnick . 54 Vice Chairman November 1995 John D. Phillips . 53 President and Chief April 1994 Executive Officer Silvia Kessel . . . 45 Senior Vice November 1995 President, Chief Financial Officer and Treasurer Arnold L. Wadler . 52 Senior Vice November 1995 President, General Counsel and Secretary W. Tod Chmar . . . 42 Senior Vice President June 1994 Robert A. Maresca . 61 Senior Vice President November 1995 (Chief Accounting Officer)\nMr. Kluge has served as Chairman of the Board of Directors of MIG since the consummation of the November 1 Mergers and as Chairman of the Board of Orion since 1992. In addition, Mr. Kluge has served as Chairman and President of Metromedia and its predecessor-in-interest, Metromedia, Inc. for over five years. Mr. Kluge is also a director of The Bear Stearns Companies, Inc., WorldCom, Inc. (formerly LDDS Communications, Inc.), Occidental Petroleum Corporation and Conair Corporation. Mr. Kluge is Chairman of MIG's Executive Committee.\nMr. Subotnick has served as Vice Chairman of the Board of Directors of MIG since the consummation of the November 1 Mergers and as Vice Chairman of the Board of Orion since November 1992. In addition, Mr. Subotnick has served as Executive Vice President of Metromedia and its predecessor-in-interest, Metromedia, Inc., for over five years. Mr. Subotnick is also a director of Carnival Cruise Lines, Inc. and WorldCom, Inc. Mr. Subotnick is Chairman of the Audit Committee and a member of the Executive and Nominating Committees of MIG.\nMr. Phillips has served as President and Chief Executive Officer of MIG since April 19, 1994 and was elected to the Board of Directors of MIG and to the Executive Committee on the same date. Mr. Phillips served as Chief Executive Officer of Resurgens Communications Group, Inc. from May 1989 until Resurgens was merged with Metromedia Communications Corporation and WorldCom, Inc. in September 1993. Mr. Phillips also serves as a director of Restor Industries, Inc. and Roadmaster Industries, Inc.\nMs. Kessel has served as Senior Vice President, Chief Financial Officer and Treasurer of MIG since the consummation of the November 1 Mergers, as Executive Vice President of Orion since January 1993, Senior Vice President of Metromedia since 1994 and President of Kluge & Company since January 1994. Prior to that time, Ms. Kessel served as Senior Vice President of Orion from June 1991 to November 1992 and Managing Director of Kluge & Company (and its predecessor) from April 1990 to January 1994. Ms. Kessel also serves as a director of WorldCom, Inc. Ms. Kessel is a member of the Nominating Committee of MIG.\nMr. Wadler has served as Senior Vice President, General Counsel and Secretary of MIG since the consummation of the November 1 Mergers, as a Director of Orion since 1991 and as Senior Vice President, Secretary and General Counsel of Metromedia and its predecessor-in-interest, Metromedia, Inc., for over five years. Mr. Wadler is Chairman of the Nominating Committee of MIG.\nMr. Chmar was elected to the position of Senior Vice President of the Company on June 10, 1994. Mr. Chmar served as a partner in the law firm of Long, Aldridge & Norman from January 1985 until September 1993.\nMr. Maresca has served as a Senior Vice President of MIG since November 1, 1995. Mr. Maresca has served as a Senior Vice President -- Finance of Metromedia for the prior five years.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.\nSince November 2, 1995, the Common Stock has been listed and traded on the American and the Pacific Stock Exchanges under the symbol \"MMG.\" Prior to November 2, 1995, the Common Stock was listed and traded on both the New York and the Pacific Stock Exchanges under the symbol \"ACT.\" The following table sets forth the quarterly high and low closing sales prices per share for the Common Stock according to the New York Stock Exchange Composite Tape for the period from January 1, 1994 through November 1, 1995 and the quarterly high and low closing sales prices per share for Common Stock as reported by the American Stock Exchange from November 2, 1995 through the present.\nMarket Price of Common Stock ---------------------------- 1995 1994 ---------------- ----------------- Quarters Ended High Low High Low -------------- ---------------- -----------------\nMarch 31 . . . . . . . . . . $ 11 8 3\/4 $ 9 1\/4 $ 5 7\/8\nJune 30 . . . . . . . . . . . 13 3\/8 8 5\/8 9 3\/8 5 3\/4\nSeptember 30 . . . . . . . . 19 1\/8 13 1\/4 13 3\/4 8 1\/4\nDecember 31 . . . . . . . . . 18 7\/8 13 3\/4 10 3\/8 8 3\/8\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 the payment of dividends. On March 2, 1994, the Company announced that its Board of Directors had suspended the dividends on Common Stock. The Company intends to retain earnings to finance the development and expansion of its businesses and does not anticipate paying cash dividends in the foreseeable future. The decision of the Board of Directors as to whether or not to pay cash dividends in the future will depend upon a number of factors, including the Company's future earnings, capital requirements, financial condition, and the existence or absence of any contractual limitations on the payment of dividends. The Company is currently a party to a credit agreement with Chemical Bank which restricts the payment of dividends. The Company's ability to pay dividends is further limited because, as a result of the November 1 Mergers, the Company operates as a holding company, conducting its operations solely through its subsidiaries. Certain of the Company's subsidiaries' existing credit arrangements contain, and it is expected that their future arrangements will similarly contain, substantial restrictions on dividend payments to the Company by such subsidiaries. See Item 7 -- \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nAs of February 27, 1996, there were approximately 7,873 record holders of Common Stock. The last reported sales price for the Common Stock on such date was $13.75 per share as reported by the American Stock Exchange.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSee accompanying 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 should be read in conjunction with the Company's consolidated financial statements and related notes thereto and the \"Business\" section included as Item 1 herein.\nGeneral\nOn November 1, 1995, (the \"Merger Date\"), Orion, MITI, the Company and MCEG Sterling Incorporated (\"Sterling\") consummated the November 1 Mergers. In connection with the November 1 Mergers, the Company changed its name from \"The Actava Group Inc.\" (\"Actava\") to \"Metromedia International Group, Inc.\"\nFor accounting purposes only, Orion and MITI have been deemed to be the joint acquirors of Actava and Sterling. The acquisition of Actava and Sterling has been accounted for as a reverse acquisition. As a result of the reverse acquisition, the historical financial statements of the Company for periods prior to the November 1 Mergers are the combined financial statements of Orion and MITI, rather than Actava's.\nThe operations of Actava and Sterling have been included in the accompanying consolidated financial statements from November 1, 1995, the date of acquisition. During December 1995, the Company adopted a formal plan to dispose of Snapper. In addition, the Company's investment in Roadmaster has been deemed to be a non-strategic asset. The Company intends to dispose its investment in Roadmaster during 1996. Snapper and Roadmaster are included in the consolidated financial statements of the Company as assets held for sale.\nThe Company is presently evaluating new opportunities and strategies for enhancing stockholder value. As discussed above, the Company has entered into definitive agreements to acquire Alliance and Goldwyn and has signed a letter of intent to acquire MPCA. See \"Item 1. Business--Recent Developments.\" The acquisition of Alliance will enable MIG to expand its Entertainment Group by entering the music distribution business and providing MIG with proprietary music product which it owns or otherwise controls through license or distribution agreements. The acquisition of Goldwyn will provide MIG with a valuable library of over 850 film and television titles, including numerous Hollywood classics and more critically acclaimed recent films. Goldwyn also owns a leading specialized theatre circuit of 52 theatres with 140 screens. The acquisition of MPCA will enhance the Entertainment Group's ability to produce and acquire new film product. The acquisitions of Alliance, Goldwyn and MPCA are important steps in MIG's plan to enhance its role as a leading global entertainment, media and communications company.\nConsummation of the Alliance and Goldwyn mergers and the MPCA acquisition are each subject to various conditions described above in \"Item 1. Business--Recent Developments.\" In addition, the Company intends to pursue a strategy of making selective acquisitions of attractive entertainment and communications assets that complement its existing business groups. In particular, the Company is interested in expanding its library of proprietary motion picture and music rights and in expanding the network through which it distributes various entertainment and communication products and services.\nThe business activities of the Company consist of two business segments: (i) filmed entertainment, which includes the development, production, acquisition, exploitation and worldwide distribution in all media of motion pictures, television programming and other filmed entertainment\nproduct, and (ii) communications, which includes wireless cable television, paging services, radio broadcasting, and various types of telephone services.\nFilmed Entertainment\nThe Company operates its filmed entertainment operations through Orion. Until November 1, 1995, Orion operated under the terms of the Plan, which severely limited Orion's ability to finance and produce additional theatrical motion pictures. See Notes 2 and 3 to the \"Notes to the Consolidated Financial Statements\" included in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data required under this item are included in Item 14 of this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThe information required under this item is included in the Company's Current Report on Form 8-K dated November 1, 1995.\nPART III\nThe information called for by this PART III (Items 10, 11, 12 and 13) is not set forth herein because the Company intends to file with the SEC not later than 120 days after the end of the fiscal year ended December 31, 1995 the Joint Proxy Statement\/Prospectus for the 1996 Annual Meeting of Stockholders, except that certain of the information regarding the Company's 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) and (a)(2) Financial Statements and Schedules\nThe financial statements and schedules listed in the accompanying Index to Financial Statements are filed as part of this Annual Report on Form 10-K.\n(a)(3) Exhibits\nThe exhibits listed in the accompanying Exhibit Index are filed as part of this Annual Report on Form 10-K.\n(b) Current Reports on Form 8-K\n4 Current Reports on Form 8-K were filed during the fourth quarter of 1995:\n(i) On November 1, 1995, a Form 8-K was filed to report the consummation of the November 1 Mergers involving the Company (formerly known as The Actava Group Inc.), Metromedia International Telecommunications, Inc., MCEG Sterling Incorporated, Orion Pictures Corporation, OPC Merger Corp. and MITI Merger Corp., and the hiring of KPMG Peat Marwick LLP as the Company's independent certified public accountants for 1995.\n(ii) On November 28, 1995, a Form 8-K was filed to report the execution of a letter of intent by and among the Company, Motion Picture Corporation of America, Bradley R. Krevoy and Steven Stabler.\n(iii) On November 30, 1995, a Form 8-K was filed to report the execution of a letter of intent by and among the Company and Alliance Entertainment Corp.\n(iv) On December 20, 1995, a Form 8-K was filed to report the execution of an Agreement and Plan of Merger, dated December 20, 1995, by and among the Company, Alliance Merger Corp. and Alliance Entertainment Corp.\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.\nMETROMEDIA INTERNATIONAL GROUP, INC.\nBy: \/s\/ JOHN D. PHILLIPS -------------------------------------------- John D. Phillips President and Chief Executive Officer\nDated: March 1, 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.\nSignature Title Date --------- ----- ----\n\/s\/ JOHN W. KLUGE Chairman of the Board March 1, 1996 ------------------------------ John W. Kluge\n\/s\/ STUART SUBOTNICK Vice Chairman of the Board March 1, 1996 ------------------------------ Stuart Subotnick\n\/s\/ JOHN D. PHILLIPS President and Chief March 1, 1996 ------------------------------ John D. Phillips Executive Officer and Director (Principal Executive Officer)\n\/s\/ SILVIA KESSEL Senior Vice President -- March 1, 1996 ------------------------------ Silvia Kessel Chief Financial Officer and Director (Principal Financial Officer)\n\/s\/ ARNOLD L. WADLER Senior Vice President, March 1, 1996 ------------------------------ Arnold L. Wadler General Counsel and Director\n\/s\/ ROBERT A. MARESCA Senior Vice President March 1, 1996 ------------------------------ Robert A. Maresca (Principal Accounting Officer)\n\/s\/ JOHN P. IMLAY, JR. Director March 1, 1996 ------------------------------ John P. Imlay, Jr.\n\/s\/ CLARK A. JOHNSON Director March 1, 1996 ------------------------------ Clark A. Johnson\n\/s\/ RICHARD J. SHERWIN Director March 1, 1996 ------------------------------ Richard J. Sherwin\n\/s\/ LEONARD WHITE Director March 1, 1996 ------------------------------ Leonard White\n\/s\/ CARL E. SANDERS Director March 1, 1996 ------------------------------ Carl E. Sanders\nEXHIBIT INDEX\nExhibits Incorporated Herein by Reference --------------------------------- Designation Document with Designation of of Exhibit Which Exhibit Was Such Exhibit in This Previously Filed in That Form 10-K Description of Exhibits with Commission Document --------- ----------------------- ----------------- --------\n2.1 Stock Purchase Agreement by Current Report on Exhibit 2(a) and among JCJ, Inc., Eastman Form 8-K filed on Kodak Company and The Actava August 25, 1994 Group Inc. dated August 12, 1994. Also filed as exhibits thereto are: Exhibit A - Promissory Note; Exhibit B - Seller Release; and Exhibit C - Noncompetition Agreement. The following is a list of omitted schedules (or similar attachments) which The Actava Group Inc. as registrant agrees to furnish supplementally to the Commission upon request: Exhibit D - Certificate of Incorporation of Qualex Inc.; Exhibit E - By-Laws of Qualex Inc.; Exhibit F - Buyer Release; Schedule 1- Shares Owned by Seller; Schedule 2.02 - Capitalization of Qualex Inc.; and Schedule 2.06 - Agreements between The Actava Group Inc. and Qualex Inc.\n2.2 Agreement and Plan of Quarterly Report Exhibit 2 Reorganization dated as of on Form 10-Q for July 20, 1994 by and among, the three months The Actava Group Inc., ended Diversified Products June 30, 1994 Corporation, Hutch Sports USA Inc., Nelson\/Weather-Rite, Inc., Willow Hosiery Company, Inc. and Roadmaster Industries, Inc.\n2.3 Amended and Restated Current Report on Exhibit 99(a) Agreement and Plan of Merger Form 8-K for dated as of September 27, event occurring 1995 by and among The Actava on September 27, Group Inc., Orion Pictures 1995 Corporation, MCEG Sterling Incorporated, Metromedia International Telecommunications, Inc., OPG Merger Corp. and MITI Merger Corp. and exhibits thereto. The Registrant agrees to furnish copies of the schedules supplementally to the Commission on request.\n2.4 Agreement and Plan of Merger Current Report on Exhibit 99.1 dated as of December 20, 1995 Form 8-K dated by and among Metromedia December 20, 1995 International Group, Inc., Alliance Entertainment Corp. and Alliance Merger Corp. and exhibits thereto. The Registrant agrees to furnish copies of the schedules supplementally to the Commission on request.\nExhibits Incorporated Herein by Reference --------------------------------- Designation Document with Designation of of Exhibit Which Exhibit Was Such Exhibit in This Previously Filed in That Form 10-K Description of Exhibits with Commission Document --------- ----------------------- ----------------- --------\n2.5 Agreement and Plan of Merger Current Report on Exhibit 99.1 dated as of January 31, 1996 Form 8-K dated by and among Metromedia January 31, 1996 International Group, Inc., The Samuel Goldwyn Company and SGC Merger Corp. and exhibits thereto. The registrant agrees to furnish copies of the schedules to the Commission upon request.\n3.1 Restated Certificate of Registration Exhibit 3(a) Incorporation of Metromedia Statement on Form International Group, Inc. S-3 (Registration No. 33-63853)\n3.2 Restated By-laws of Registration Exhibit 3(b) Metromedia International Statement on Form Group, Inc. S-3 (Registration No. 33-6353)\n4.1 Indenture dated as of Application of Exhibit T3C August 1, 1973, with respect Form T-3 for to 9 1\/2% Subordinated Qualification of Debentures due August 1, Indenture under 1998, between The Actava the Trust Group Inc. and Chemical Bank, Indenture Act of as Trustee. 1939 (File No. 22-7615)\n4.2 Agreement among The Actava Registration Exhibit 4(d)(ii) Group, Inc., Chemical Bank Statement on and Manufacturers Hanover Form S-14 Trust Company, dated as of (Registration September 26, 1980, with No. 2-81094) respect to successor trusteeship of the 9 1\/2% Subordinated Debentures due August 1, 1998.\n4.3 Instrument of registration, Annual Report on Exhibit 4(d)(iii) appointment and acceptance Form 10-K for the dated as of June 9, 1986 year ended among The Actava Group Inc., December 31, 1986 Manufacturers Hanover Trust Company and Irving Trust Company, with respect to successor trusteeship of the 9 1\/2% Subordinated Debentures due August 1, 1998.\n4.4 Indenture dated as of Registration Exhibit 2(d) March 15, 1977, with respect Statement on to 9 7\/8% Senior Subordinated Form S-7 Debentures due March 15, (Registration 1997, between The Actava No. 2-58317) Group Inc. and The Chase Manhattan Bank, N.A., as Trustee.\n4.5 Agreement among The Actava Registration Exhibit 4(e)(ii) Group Inc., The Chase Statement on Manhattan Bank, N.A. and Form S-14 United States Trust Company (Registration of New York, dated as of No. 2-281094) June 14, 1982, with respect to successor trusteeship of the 9 7\/8% Senior Subordinated Debentures due March 15, 1997.\nExhibits Incorporated Herein by Reference ---------------------------------\nExhibits Incorporated Herein by Reference ---------------------------------\nExhibits Incorporated Herein by Reference ---------------------------------\nExhibits Incorporated Herein by Reference ---------------------------------\nExhibits Incorporated Herein by Reference --------------------------------- Designation Document with Designation of of Exhibit Which Exhibit Was Such Exhibit in This Previously Filed in That Form 10-K Description of Exhibits with Commission Document --------- ----------------------- ----------------- --------\n10.35 Credit, Security and Guaranty Registration Exhibit 10(g) Agreement dated as of Statement on Form November 1, 1995 among Orion S-3 (Registration Pictures Corporation, the No. 33-63853) Corporation Guarantors referred to therein, the Lenders referred to therein and Chemical Bank.\n10.36 Credit Agreement dated as of Registration Exhibit 10(h) November 1, 1995 between Statement on Form Metromedia International S-3 (Registration Group, Inc. and Chemical No. 33-63853) Bank.\n10.37* Management Agreement dated November 1, 1995 between Metromedia Company and Metromedia International Group, Inc.\n10.38* The Metromedia International Group, Inc. 1996 Incentive Stock Plan.\n10.39* License Agreement dated November 1, 1995 between Metromedia Company and Metromedia International Group, Inc.\n10.40* MITI Bridge Loan Agreement, dated February 29, 1996, among Metromedia Company and MITI relating to a $15 million bridge loan from Metromedia Company to MITI.\n11* Statement of computation of earnings per share.\n16 Letter from Ernst & Young to Current Report on Exhibit 99.1 the Securities and Exchange Form 8-K dated Commission. November 1, 1995\n21* List of subsidiaries of Metromedia International Group, Inc.\n23.1* Consent of KPMG Peat Marwick LLP regarding Metromedia International Group, Inc.\n27* Financial Data Schedule\n_______________________\n*Filed herewith.\nMETROMEDIA INTERNATIONAL GROUP, INC. AND SUBSIDIARIES\nPage ----\nReport of Independent Auditors . . . . . . . . . .\nConsolidated Statements of Operations for the years ended December 31, 1995, February 28, 1995 and February 28, 1994 . . . . . . . . . . . . . . . . Consolidated Balance Sheets as of December 31, 1995 and February 28, 1995 . . . . . . . . . . . . .\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, February 28, 1995 and February 28, 1994 . . . . . . . . . . . . . . . .\nConsolidated Statements of Common Stock, Paid-in Surplus and Accumulated Deficit for the years ended December 31, 1995, February 28, 1995 and February 28, 1994 . . . . . . . . . . . . . . . .\nNotes to Consolidated Financial Statements . . . .\nConsolidated Financial Statement Schedules\nI. Condensed Financial Information of Registrant . . . . . . . . . . . . . . . . . . . . S-1\nII. Valuation and Qualifying Accounts . . . S-5\nAll other schedules have been omitted either as inapplicable or not required under the Instructions contained in Regulation S-X or because the information is included in the Consolidated Financial Statements or the Notes thereto listed above.\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders Metromedia International Group, Inc.:\nWe have audited the accompanying consolidated financial statements of Metromedia International Group, Inc. and subsidiaries 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 the consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and 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 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Metromedia International Group, Inc. and its subsidiaries as of December 31, 1995 and February 28, 1995, and the results of their operations and their cash flows for the year ended December 31, 1995 and for each of the years in the two year period ended February 28, 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\nNew York, New York February 29, 1996\nMETROMEDIA INTERNATIONAL GROUP, INC. Consolidated Statements of Operations (in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements.\nMETROMEDIA INTERNATIONAL GROUP, INC. Consolidated Balance Sheets (in thousands except per share amounts)\nDecember February 31, 28, 1995 1995 --------- --------- ASSETS:\nCurrent Assets: Cash and cash equivalents $ 26,889 $ 27,422 Short-term investments 5,366 - Accounts receivable, net: Film 27,306 35,402 Other 2,146 1,073 Film inventories 59,430 69,867 Other assets 6,314 4,763 --------- --------- Total current assets 127,451 138,527\nInvestments in and advances to joint ventures 36,934 24,311 Asset held for sale - Roadmaster 47,455 - Industries, Inc. Asset held for sale - Snapper Inc. 79,200 - Property, plant and equipment, net 6,021 4,577 Film inventories 137,233 179,807 Long term film accounts receivable 31,308 24,308 Intangible assets, less accumulated 119,485 9,697 amortization Other assets 14,551 10,643 -------- --------- Total assets $ 599,638 $391,870 ======== =========\nLIABILITIES AND SHAREHOLDERS' EQUITY: Current Liabilities: Accounts payable $ 4,695 $ 3,633 Accrued expenses 96,696 36,385 Participation and residuals 19,143 21,902 Current portion of long-term debt 40,597 96,177 Due to Metromedia Company - 37,738 Deferred revenues 15,097 36,026 --------- -------- Total current liabilities 176,228 231,861\nLong-term debt 264,046 103,112 Participations and residuals 28,465 24,025 Deferred revenues 47,249 32,461 Other long-term liabilities 395 201 ------- -------- Total liabilities 516,383 391,660 ------- --------\nCommitments and contingencies Shareholders' equity Preferred Stock, authorized 70,000,000 shares, none issued Common Stock, $1.00 par value, authorized 110,000,000 shares, issued and - - outstanding 42,613,738 shares at December 31, 1995 42,614 20,935 Paid-in surplus 728,747 289,413 Accumulated deficit (688,106) (310,138) --------- --------- Total shareholders' equity 83,255 210 -------- -------- Total liabilities and $ 599,638 $ 391,870 shareholders' equity ======== ========\nSee accompanying notes to consolidated financial statements.\nMETROMEDIA INTERNATIONAL GROUP, INC. Consolidated Statements of Cash Flows (in thousands except per share amounts)\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nMETROMEDIA INTERNATIONAL GROUP, INC. Consolidated Statements of Common Stock, Paid-in Surplus and Accumulated Deficit (in thousands, except share amounts)\nSee accompanying notes to consolidated financial statements.\nMetromedia International Group, Inc.\nNotes to Consolidated Financial Statements\n1. Basis of Presentation, Liquidity and Summary of Significant Accounting Policies\nBasis of Presentation (see Note 2)\nThe accompanying consolidated financial statements include the accounts of Metromedia International Group, Inc. (\"MIG\" or the \"Company\") and its wholly- owned subsidiaries, Orion Pictures Corporation (\"Orion\") and Metromedia International Telecommunications, Inc. (\"MITI\"). MITI was formed in August 1994 as part of a corporate reorganization and common control merger of International Telcell, Inc. and Metromedia International, Inc. Snapper, Inc. (\"Snapper\"), also a wholly-owned subsidiary, is included in the accompanying consolidated financial statements as a discontinued operation and asset held for sale. All significant intercompany transactions and accounts have been eliminated.\nInvestments in other companies and Joint Ventures (\"Joint Ventures\") which are not majority owned, or in which the Company does not control but exercises significant influence are accounted for using the equity method. The Company reflects its net investments in Joint Ventures under the caption \"Investments in and advances to Joint Ventures\". Generally, under the equity method of accounting, original investments are recorded at cost and adjusted by the Company's share of undistributed earnings or losses of the investee company. Equity in the losses of the Joint Ventures are recognized according to the percentage ownership in each Joint Venture until the Company's Joint Venture partner's contributed capital has been fully depleted. Subsequently, the Company recognizes the full amount of losses generated by the Joint Venture if it is the principal funding source for the Joint Ventures.\nDuring the year ended February 28, 1995 (\"fiscal 1995\"), the Company changed its policy of accounting for the Joint Ventures by recording its equity in their earnings and losses based upon a three month lag. As a result, the December 31, 1995 Consolidated Statement of Operations reflects twelve months of operations through September 30, 1995 for the Joint Ventures, the February 28, 1995 Consolidated Statement of Operations reflects nine months of operations through September 30, 1994 for the Joint Ventures, and the February 28, 1994 Consolidated Statement of Operations reflects twelve months of operations through December 31, 1993 for the Joint Ventures.\nDuring the year ended December 31, 1995 (\"calendar 1995\"), the Company changed its policy of consolidating two indirectly owned subsidiaries by recording the related assets and liabilities and results of operations based on a three-month lag. As a result, the December 31, 1995 balance sheet includes the accounts of these subsidiaries at September 30, 1995, and the calendar 1995 Statement of Operations reflects the results of operations of these subsidiaries for the nine months ended September 30, 1995. Had the Company applied this method from October 1, 1994, the effect on reported December 31, 1995 results would not have been material. Future years will reflect twelve months of activity based upon a September 30 fiscal year end for these subsidiaries.\nLiquidity\nMIG is a holding company and, accordingly, does not generate cash flows. Orion, the Company's filmed entertainment subsidiary, is restricted under covenants contained in the Orion Credit Agreement from making dividend payments or advances to MIG. MITI, the Company's communications subsidiary, is dependent on MIG for significant capital infusions to fund its operations, as well as its commitments to make capital contributions and loans to its Joint Ventures. MIG\nMetromedia International Group, Inc.\nanticipates that MITI's funding requirements for 1996 will be approximately $40.0 million based in part on the anticipated funding needs of the Joint Ventures. Future capital requirements of MITI will depend on the ability of MITI's Joint Ventures to generate positive cash flows.\nMIG is obligated to make principal and interest payments under its own various debt agreements (see note 8), in addition to funding its working capital needs, which consist principally of corporate overhead and payments on self insurance claims (see note 1).\nIn the short term, MIG intends to satisfy its current obligations and commitments with available cash on hand and the proceeds from the sale of certain assets. At December 31, 1995, MIG had approximately $11 million of available cash on hand. During December 1995, the Company adopted a formal plan to dispose of Snapper. At December 31, 1995 the carrying value of Snapper was approximately $79 million. The Snapper carrying value represents the Company's estimated proceeds from the sale of Snapper and the cash flows from the operations of Snapper, principally repayment of intercompany loans, through the date of sale. Management believes that Snapper will be disposed of by October 1996. In addition, the Company anticipates disposing of its investment in Roadmaster during 1996. The carrying value of the Company's investment in Roadmaster at December 31, 1995 was approximately $47 million.\nManagement believes that its available cash on hand, proceeds from the disposition of Snapper and its investment in Roadmaster, borrowings under the MITI Bridge Loan and collections of intercompany receivables from Snapper will provide sufficient funds for the Company to meet its obligations, including MITI's funding requirements, in the short term. However, no assurances can be given that the Company will be able to dispose of such assets in a timely fashion and on favorable terms. Any delay in the sale of assets or reductions in the proceeds anticipated to be received upon this disposition of assets may result in the Company's inability to satisfy its obligations during the year ended December 31, 1996. Delays in funding the Company's MITI capital requirements may have a materially adverse impact on the results of operations of MITI's Joint Ventures.\nIn connection with the consummation of the Alliance Merger and the Goldwyn Merger, MIG intends to refinance substantially all of its indebtedness and the indebtedness of Orion. MIG intends to use the proceeds of this refinancing to repay substantially all of such indebtedness and to provide itself and MITI with liquidity to finance its existing commitments and current business strategies. In addition to the refinancing, management believes that its long term liquidity needs will be satisfied through a combination of (i) MIG's successful implementation and execution of its growth strategy to become a global entertainment, media and communications company, including the integration of Alliance, Goldwyn and MPCA, (ii) MITI's Joint Ventures achieving positive operating results and cash flows through revenue and subscriber growth and control of operating expenses, and (iii) Orion's ability to continue to generate positive cash flows sufficient to meet its planned film production release schedule and service its existing debt. There can be no assurance that the Company will be successful in refinancing its indebtedness or that such refinancing can be accomplished on favorable terms. In the event the Company is unable to successfully complete such a refinancing, the Company, in addition to disposing of Snapper and its investment in Roadmaster, may be required to (i) attempt to obtain additional financing through public or private sale of debt or equity securities of the Company or one of its subsidiaries, (ii) otherwise restructure its capitalization or (iii) seek a waiver or waivers under one or more of its subsidiaries' credit facilities to permit the payment of dividends to the Company. There can be no assurance that any of the foregoing can be accomplished by the Company on reasonably acceptable terms, if at all.\nMetromedia International Group, Inc.\nDifferent Fiscal Year Ends\nThe Company reports on the basis of a December 31 year end. In connection with the mergers discussed in Note 2, Orion and MITI, for accounting purposes only, were deemed to be the joint acquirors of the Actava Group Inc. (\"Actava\") in a reverse acquisition. As a result, the historical financial statements of the Company for periods prior to the merger are the combined financial statements of Orion and MITI. Orion historically reported on the basis of a February 28 year end.\nThe consolidated financial statements for the twelve months ended December 31, 1995 include two months for Orion (January and February 1995) that were included in the February 28, 1995 consolidated financial statements. The revenues and net loss for the two month duplicate period are $22.5 and $11.4 million, respectively. The December 31, 1995 accumulated deficit has been adjusted to eliminate the duplication of the January and February 1995 net losses. The consolidated financial statements for the years ended February 28, 1995 and February 28, 1994 (\"fiscal 1994\"), contain certain reclassifications to conform to the presentation for the year ended December 31, 1995 (\"calendar 1995\").\nSummary of Significant Accounting Policies\nInvestments\nThe Company invests in various debt and equity securities. In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" 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 shareholders' equity.\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, net of tax, reported in 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 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.\nMetromedia International Group, Inc.\nRevenue Recognition\nRevenue from the theatrical distribution of films is recognized as the films are exhibited. Distribution of the Company's films to the home video market in the United States and Canada is effected through Orion Home Video (\"OHV\"), a division of Orion Home Entertainment Corporation, a wholly-owned subsidiary of Orion. OHV's home video revenue, less a provision for returns, is recognized when the video cassettes are shipped. Distribution of the Company's films to the home video markets in foreign countries is generally effected through subdistributors who control various aspects of distribution. When the terms of sale to such subdistributors include the receipt of nonrefundable guaranteed amounts by the Company, revenue is recognized when the film is available to the subdistributors for exhibition or exploitation and other conditions of sale are met. When the arrangements with such subdistributors call for distribution of the Company's product without a minimum amount guaranteed to the Company, such sales are recognized when the Company's share of the income from exhibition or exploitation is earned.\nRevenue from the licensing of the Company's film product to networks, basic and pay cable companies and television stations or groups of stations in the United States and Canada, as well as in foreign territories, is recognized when the license period begins and when certain other conditions are met. Such conditions include the availability of such product for exhibition by the licensee.\nThe Company's and its Joint Ventures' cable, paging and telephony operations recognize revenues in the period the service is provided. Installation fees are recognized as revenues upon subscriber hook-up to the extent installation costs are incurred. Installation fees in excess of installation costs are deferred and recognized over the length of the related individual contract. The Company's and its Joint Ventures' radio operations recognize advertising revenue when commercials are broadcast.\nFilm Inventories and Cost of Rentals\nTheatrical and television program inventories consist of direct production costs, production overhead and capitalized interest, print and exploitation costs, less accumulated amortization. Film inventories are stated at the lower of unamortized cost or estimated net realizable value. Selling costs and other distribution costs are charged to expense as incurred.\nFilm inventories and estimated total costs of participations and residuals are charged to cost of rentals under the individual film forecast method in the ratio that current period revenue recognized bears to management's estimate of total gross revenue to be realized. Such estimates are re-evaluated quarterly in connection with a comprehensive review of the Company's inventory of film product, and estimated losses, if any, are provided for in full. Such losses include provisions for estimated future distribution costs and fees, as well as participation and residual costs expected to be incurred.\nMetromedia International Group, Inc.\nProperty Plant and Equipment\nProperty, plant and equipment, net consists of the following (in thousands):\nDecember 31, February 28, 1995 1995 ---- ---- Office furniture and equipment $ 7,855 $ 5,338 Automobile 133 95 Leasehold improvements 419 173 -------- -------- 8,407 5,606 Less: Accumulated depreciation and amortization (2,386) (1,029) -------- -------- $ 6,021 $ 4,577 ======== ========\nProperty, plant and equipment are recorded at cost and are depreciated over their expected useful lives. Generally, depreciation is provided on the straight-line method for financial reporting purposes. Leasehold improvements are amortized using the straight-line method over the life of the improvements or the life of the lease, whichever is shorter.\nIntangible Assets\nIntangible assets are stated at historical cost, net of accumulated amortization. Intangibles such as broadcasting licenses and frequency rights are amortized over periods of 20-25 years. Goodwill has been recognized for the excess of the purchase price over the value of the identifiable net assets acquired. Such amount is amortized over 25 years using the straight-line method. Until the Merger Date (see Note 2), a guarantee of Orion's bank borrowings was stated at its estimated fair value at the Effective Date (see Note 3), less accumulated amortization. Amortization of the guarantee was being calculated utilizing the effective interest method over certain related cash flows estimated in the Plan.\nManagement continuously monitors and evaluates the realizability of recorded intangibles to determine whether their carrying values have been impaired. In evaluating the value and future benefits of the intangible assets, their carrying value would be reduced by the excess, if any, of their carrying value over management's best estimate of undiscounted future cash flows over the remaining amortization period. The Company believes that the carrying value of recorded intangibles is not impaired.\nEarnings Per Share of Common Stock\nPrimary earnings per share are computed by dividing net income (loss) by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares include shares issuable upon the assumed exercise of stock options using the treasury stock method when dilutive. Computations of common equivalent shares are based upon average prices during each period.\nFully diluted earnings per share are computed using such average shares adjusted for any additional shares which would result from using end-of-year prices in the above computations, plus the additional shares that would result from the conversion of the 6-1\/2% Convertible Subordinated Debentures (see Note 8). Net income (loss) is adjusted by interest (net of income taxes) on the 6-1\/2% Convertible Subordinated Debentures. The computation of fully diluted earnings per share is used only when it results in an earnings per share number which is lower than primary earnings per share.\nMetromedia International Group, Inc.\nThe loss per share amounts for fiscal 1995 and fiscal 1994 represent combined Orion and MITI's common shares converted at the exchange ratios used in the Merger (see Note 2).\nFair Value of Financial Instruments\nStatement of Financial Accounting Standards 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 settlements using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. SFAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value to the Company.\nThe following methods and assumptions were used in estimating the fair value disclosures for financial instruments:\nCash and Cash Equivalents, Receivables, Notes Receivable and Accounts --------------------------------------------------------------------- Payable -------\nThe carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, current receivables, notes receivable and accounts payable approximate fair values. The carrying value of receivables with maturities greater than one year have been discounted, and if such receivables were discounted based on current market rates, the fair value of these receivables would not be materially different than their carrying values.\nShort-term Investments ----------------------\nFor short-term investments, fair values are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or dealer quotes. See Note 4 for fair values on investment securities.\nLong-term Debt --------------\nFor long-term and subordinated debt, fair values are based on quoted market prices, if available. If the debt is not traded, fair value is estimated based on the present value of expected cash flows. See Note 8 for fair values of long-term debt.\nIncome Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\"). SFAS 109 requires the use of the liability method of accounting for deferred taxes. Under the 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 rates expected to be in effect when those assets and liabilities are 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.\nMetromedia International Group, Inc.\nBarter Transactions\nThe Company trades commercial air time for goods and services used principally for promotional, sales and other business activities. An asset and a liability are recorded at the fair market value of the goods or services received. Barter revenue is recorded and the liability is relieved when commercials are broadcast, and barter expense is recorded and the assets are relieved when the goods or services are received or used.\nForeign Currency Translation\nThe statutory accounts of the Company's consolidated foreign subsidiaries and Joint Ventures are maintained in accordance with local accounting regulations and are stated in local currencies. Local statements are translated into U.S. generally accepted accounting principles and U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 (\"SFAS 52\"), \"Accounting for Foreign Currency Translation\".\nUnder SFAS 52, foreign currency assets and liabilities are generally translated using the exchange rates in effect at the balance sheet date. Results of operations are generally translated using the average exchange rates prevailing throughout the year. The effects of exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated as part of the foreign currency translation adjustment in shareholders' equity. Gains and losses from foreign currency transactions are included in net income in the period in which they occur.\nUnder SFAS 52, the financial statements of foreign entities in highly inflationary economies are remeasured, in all cases using the U.S. dollar as the functional currency. U.S. dollar transactions are shown at their historical value. Monetary assets and liabilities denominated in local currencies are translated into U.S. dollars at the prevailing period-end exchange rate. All other assets and liabilities are translated at historical exchange rates. Results of operations have been translated using the monthly average exchange rates. Translation differences resulting from the use of these different rates are included in the accompanying consolidated statements of operations.\nAccrued Expenses Accrued expenses consists of the following (in thousands):\nDecember 31, February 28, 1995 1995 ---- ----\nAccrued salaries and wages $ 9,627 $10,850 Accrued taxes 11,000 - Accrued interest 9,822 3,104 Self-insurance claims payable 31,549 - Other 34,698 22,431 -------- ------- $ 96,696 $ 36,385 ======== ========\nSelf-Insurance\nThe Company is self-insured for workers' compensation, health, automobile, product and general liability costs of certain discontinued businesses. The self-insurance claim liability is determined based on claims filed and an estimate of claims incurred but not yet reported. The Company is not self- insured in connection with any continuing operations.\nMetromedia International Group, Inc.\nCash and Cash Equivalents\nCash equivalents consists of highly liquid instruments with maturities of three months or less at the time of purchase. Included in cash at December 31, 1995, is approximately $10 million of restricted cash which represents amounts required to be held in the Company's captive insurance company. Supplemental Disclosure of Cash Flow Information\nSupplemental disclosure of cash flow information (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ---- Cash paid during the year for:\nInterest $ 12,270 $ 13,108 $ 14,907 ======== ======== ======== Taxes $ 996 $ 1,804 $ 2,934 ======== ======== ========\nSupplemental schedule of non-cash investing and financing activities (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ----\nAcquisition of business: Fair value of assets acquired $290,456 $ - $ - Fair value of liabilities assumed 239,109 - - -------- -------- -------- Net value $ 51,347 $ - $ - ======== ======== ========\nMetromedia International Group, Inc.\n2. The Mergers\nOn November 1, 1995, (the \"Merger Date\") Orion, MITI, the Company and MCEG Sterling Incorporated (\"Sterling\"), consummated the mergers contemplated by the Amended and Restated Agreement and Plan of Merger (the \"Merger Agreement\") dated as of September 27, 1995 among Orion, the Company, MITI and Sterling. The Merger Agreement provided for, among other things, the simultaneous mergers of each of Orion and MITI with and into the Company's recently-formed subsidiaries, OPC Mergerco and MITI Mergerco, and the merger of Sterling with and into theCompany (the \"Mergers\"). In connection with the Mergers, the Company changed its name from The Actava Group Inc. to Metromedia International Group, Inc.\nUpon consummation of the Mergers, all of the outstanding shares of the common stock, par value $.25 per share of Orion (the \"Orion Common Stock\"), the common stock, par value $.001 per share, of MITI (the \"MITI Common Stock\") and the common stock, par value $.001 per share, of Sterling (the \"Sterling Common Stock\") were exchanged for shares of the Company's common stock, par value $1.00 per share, pursuant to exchange ratios contained in the Merger Agreement. Pursuant to such ratios, holders of Orion Common Stock received .57143 shares of the Company's common stock for each share of Orion Common Stock (resulting in the issuance of 11,428,600 shares of common stock to the holders of Orion Common Stock), holders of MITI Common Stock received 5.54937 shares of the Company's common stock for each share of MITI Common Stock (resulting in the issuance of 9,523,817 shares of the Company's common stock to the holders of MITI Common Stock) and holders of Sterling Common Stock received .04309 shares of the Company's common stock for each share of Sterling Common Stock (resulting in the issuance of 483,254 shares of the Company's common stock to the holders of Sterling Common Stock).\nIn addition, pursuant to the terms of a contribution agreement dated as of November 1, 1995 among the Company and two affiliates of Metromedia Company (\"Metromedia\"), MetProductions, Inc. (\"MetProductions\") and Met International, Inc. (\"Met International\"), MetProductions and Met International contributed to the Company an aggregate of $37,068,303 of interests in a partnership and principal amount of indebtedness of Orion and its affiliate, and indebtedness of an affiliate of MITI, owed to MetProductions and Met International respectively, in exchange for an aggregate of 3,530,314 shares of the Company's common stock.\nImmediately prior to the consummation of the Mergers, there were 17,490,901 shares of the Company's common stock outstanding. As a result of the consummation of the Mergers and the transactions contemplated by the contribution agreement, the Company issued an aggregate of 24,965,985 shares of common stock. Following consummation of the Mergers and the transactions contemplated by the contribution agreement, Metromedia Company (an affiliate of the Company) and its affiliates (the \"Metromedia Holders\") collectively received an aggregate of 15,252,128 shares of common stock (or 35.9% of the issued and outstanding shares of common stock).\nDue to the existence of Metromedia Holders' common control of Orion and MITI prior to consummation of the Mergers, their combination pursuant to the Mergers was accounted for as a combination of entities under common control. Orion was deemed to be the acquiror in the common control Merger. As a result, the combination of Orion and MITI was effected utilizing historical costs for the ownership interests of the Metromedia Holders in MITI. The remaining ownership\nMetromedia International Group, Inc.\ninterests of MITI, were accounted for in accordance with the purchase method of accounting based on the fair value of such ownership interests, as determined by the value of the shares received by the holders of such interests at the effective time of the Mergers.\nFor accounting purposes only, Orion and MITI have been deemed to be the joint acquirors of Actava and Sterling. The acquisition of Actava and Sterling has been accounted for as a reverse acquisition. As a result of the reverse acquisition, the historical financial statements of the Company for periods prior to the Mergers are those of Orion and MITI, rather than Actava. The operations of Actava and Sterling have been included in the accompanying consolidated financial statements from November 1, 1995, the date of acquisition. During December 1995, the Company adopted a formal plan to dispose of Snapper, a wholly-owned subsidiary of Actava. In addition, the Company's investment in Roadmaster was deemed to be a non-strategic asset and the Company plans to dispose of its investment during 1996. (see Note 4B. below).\nSnapper is included in the accompanying consolidated balance sheet in an amount equal to the sum of the estimated cash flows from the operations of Snapper from November 1, 1995 to October 15, 1996, the expected date of sale (the \"Holding Period\") plus the anticipated proceeds from the sale of Snapper. At November 1, 1995, such estimated cash flows and proceeds from sale are expected to amount to $79.2 million. The earnings and losses of Snapper during the Holding Period will be excluded from the results of operations of the Company. The excess of the allocated purchase price to Snapper in the Actava acquisition over the estimated cash flows from the operations and sale of Snapper in the amount of $294 million has been reflected in the accompanying consolidated statement of operations as a loss on disposal of a discontinued operation. No income tax benefits were recognized in connection with this loss on disposal because of the Company's losses from continuing operations and net operating loss carryforwards.\nThe results of Snapper for the period November 1, 1995 through December 31, 1995, which are excluded from the accompanying consolidated statement of operations, are as follows (in thousands):\nNet Sales $ 14,385 Operating expenses 23,784 -------- Operating loss (9,399) Interest expense (1,213) Other expenses (259) -------- Loss before taxes (10,871) Income taxes - -------- Net loss $(10,871) ========\nThe Company has advanced $4.2 million to Snapper during the period from November 1, 1995 to December 31, 1995 and has not received any repayments of cash. Accordingly, $4.2 million has been added to the carrying value of Snapper at December 31, 1995.\nMetromedia International Group, Inc.\nThe purchase price of Actava, Sterling and MITI minority interests, exclusive of transaction costs, amounted to $438.9 million at November 1, 1995 as follows (in thousands):\nActava shares outstanding 17,491 Common stock to MITI minority shareholders 4,211 Common stock to Sterling stockholders 483 --------- Number of shares issued to acquire Actava, MITI minority and Sterling 22,185\nMerger Date stock price 18.625 ---------\nValue of stock $413,207 Value of Actava options 8,780 Value of MITI options 16,897 ---------\nTotal purchase price $438,884 ========= The excess purchase price over the net fair value of assets acquired amounted to $404 million at November 1, 1995 before writeoff of Snapper goodwill of $294 million.\nThe following unaudited proforma consolidated results of operations illustrate the effect of the Mergers, the deconsolidation of Snapper and the associated refinancing of Orion's indebtedness (see Note 8) and assumes that the transactions occurred at the beginning of each of the periods presented (in thousands): Calendar Fiscal 1995 1995 ---- ----\nRevenues $ 145,150 $ 203,232\nLoss from continuing operations and before loss on early extinguishment of debt and extraordinary item (89,946) (88,717) Loss per share (2.11) (2.18)\nOrion, MITI and Sterling were parties to a number of material contracts and other arrangements under which Metromedia Company and certain of its affiliates had, among other things, made loans or provided financing to, or paid obligations on behalf of, each of Orion, MITI and Sterling. On November 1, 1995 such indebtedness, financing and other obligations of Orion, MITI and Sterling to Metromedia and its affiliates were refinanced, repaid or converted into equity of MIG.\nCertain of the amounts owed by Orion ($20.4 million), MITI ($34.1 million) and Sterling ($524,000) to Metromedia were financed by Metromedia through borrowings under a $55 million credit agreement between the Company and Metromedia (the \"Actava-Metromedia Credit Agreement\"). Orion, MITI and Sterling repaid such amounts to Metromedia, and Metromedia repaid the Company the amounts owed by Metromedia to the Company under the Actava-Metromedia Credit Agreement. In addition, certain amounts owed by Orion to Metromedia under the Reimbursement Agreement (see Note 8) were repaid on November 1, 1995.\nMetromedia International Group, Inc.\n3. Chapter 11 Reorganization Costs\nOn December 11 and 12, 1991, Orion Pictures Corporation and substantially all of its subsidiaries filed petitions for relief under chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of New York (the \"Court\"). In this regard, the Court confirmed the \"Debtors' Joint Consolidated Plan of Reorganization\" (the \"Plan\") on October 20, 1992, which became effective on November 5, 1992 (the \"Effective Date\").\nStatement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\", issued by the American Institute of Certified Public Accountants requires direct costs of administering the chapter 11 filing, particularly professional fees, to be expensed as incurred. Accordingly, Chapter 11 reorganization items presented on the Consolidated Statements of Operations for calendar 1995, fiscal 1995 and 1994 are comprised primarily of legal fees incurred during those periods.\n4. Investments\nA. Short-Term Investments - -------------------------\nAll of the Company's short-term investments are classified as available-for-sale and are summarized as follows (in thousands): Available-for-Sale Securities ---------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---- ----- ------ ----- U.S. securities $ 5,319 $ 47 $ - $ 5,366\nThe net adjustment to unrealized holding gains on available-for-sale securities is immaterial in 1995.\nThe amortized cost and estimated fair value of debt and marketable equity securities at December 31, 1995, are shown below (in thousands), by contractual maturity. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.\nEstimated Amortized Fair Available-for-Sale Cost Value ---- ----- Due in one year or less $ 2,001 $ 2,008 Due after one year through three years 2,008 2,034 Due after three years 1,310 1,324 ------ ------ Total $ 5,319 $ 5,366 ====== ======\nAll available-for-sale securities are classified as current since they are available for use in the Company's current operations.\nMetromedia International Group, Inc.\nB. Roadmaster Industries, Inc. - ------------------------------\nOn December 6, 1994, Actava transferred ownership of its four sporting goods subsidiaries to Roadmaster Industries, Inc. (\"Roadmaster\") in exchange for 19,169,000 shares of Roadmaster's Common Stock. The Company intends to dispose of its Roadmaster stock during 1996. The equity in earnings and losses of Roadmaster will be excluded from the Company's results of operations through the date of sale. As of November 1, 1995, the Company's investment in Roadmaster was adjusted to the anticipated proceeds from its sale under the purchase method of accounting and included in the accompanying consolidated balance sheet as an asset held for sale.\nAs of December 31, 1995, the Company owned 38% of the issued and outstanding shares of Roadmaster Common Stock based on approximately 48,600,000 shares of Roadmaster Common Stock outstanding. Summarized financial information for Roadmaster is shown below (in thousands):\nNine Months Ended Year Ended September 30, December 31, 1995 1994 ---- ---- (Unaudited)\nNet sales $ 523,480 $ 455,661 Gross profit 68,111 66,790 Net income (loss) (9,259) 5,000 Current assets 391,003 358,169 Non-current assets 188,954 158,478 Current liabilities 250,673 181,778 Non-current liabilities 233,062 231,772 Minority interest - - Redeemable common stock 2,000 2,000 Total shareholders' equity 94,222 101,097\n5. Film Accounts Receivable and Deferred Revenues\nFilm accounts receivable consists primarily of trade receivables due from film distribution, including theatrical, home video, basic cable and pay television, network, television syndication, and other licensing sources which have payment terms generally covered under contractual arrangements. Film accounts receivable is stated net of an allowance for doubtful accounts of $11.6 million at December 31, 1995 and of $14.0 million at February 28, 1995.\nThe Company has entered into contracts for licensing of theatrical and television product to the pay cable, home video and free television markets, for which the revenue and the related accounts receivable will be recorded in future periods when the films are available for broadcast or exploitation. These contracts, net of advance payments received and recorded in deferred revenues as described below, aggregated approximately $157.0 million at December 31, 1995. Included in this amount is $62.0 million of license fees for which the revenue and the related accounts receivable will be recorded only when the Company produces or acquires new products.\nDeferred revenues consist principally of advance payments received on pay cable, home video and other television contracts for which the films are not yet available for broadcast or exploitation.\nMetromedia International Group, Inc.\n6. Film Inventories\nThe following is an analysis of film inventories (in thousands):\nDecember 31, February 28, 1995 1995 ---- ---- Current: Theatrical films released, less amortization $ 53,813 $ 67,051 Television programs released, less amortization 5,617 2,816 --------- -------- 59,430 69,867 --------- -------- Non current: Theatrical films released, less amortization 132,870 173,279 Television programs released, less amortization 4,363 6,528 --------- -------- 137,233 179,807 --------- -------- $ 196,663 $249,674 ========= ========\nOrion had in prior years made substantial writeoffs to its released and unreleased product. As a result, approximately two-thirds of the film inventories are stated at estimated net realizable value and will not result in the recording of gross profit upon the recognition of related revenues in future periods.\nSince the date of Orion's quasi-reorganization (February 28, 1982), when the Company's inventories were restated to reflect their then current market value, the Company has amortized 94% of the gross cost of its film inventories, including those produced or acquired subsequent to the quasi-reorganization. Approximately 98% of such gross film inventory costs will have been amortized by December 31, 1998. As of December 31, 1995, approximately 61% of the unamortized balance of film inventories will be amortized within the next three- year period based upon the Company's revenue estimates at year end.\n7. Investments in and Advances to Joint Ventures\nMITI has recorded its investments in Joint Ventures at cost, net of its share of losses. Advances to the Joint Ventures under line of credit agreements are reflected based on amounts recoverable under the credit agreements, plus accrued interest.\nAdvances are made to Joint Ventures in the form of cash for working capital purposes and capital expenditures, or in the form of equipment purchased or payment of expenses on behalf of the Joint Venture. Interest rates charged to the Joint Ventures range from prime rate to prime rate plus 4%. The credit agreements generally provide for the payment of principal and interest from 90% of the Joint Ventures' available cash flow, as defined, prior to any substantial distributions of dividends to the Joint Venture partners. As of December 31, 1995, MITI has entered into credit agreements with its Joint Ventures to provide up to $46.8 million in funding, of which $16.9 million remains available. MITI funding commitments are contingent on its approval of the Joint Ventures' business plans.\nMetromedia International Group, Inc.\nAs of December 31, 1995 and 1994, MITI's investments in and advances to Joint Ventures were as follows (in thousands):\nThe ability of MITI and its Joint Ventures to establish profitable operations is subject to (among other things) special political, economic and social risks inherent in doing business in Eastern Europe and the former Soviet Republics. These include matters arising out of government policies, economic conditions, imposition of or changes to taxes or other similar charges by governmental bodies, foreign exchange fluctuations and controls, civil disturbances, deprivation or unenforceability of contractual rights, and taking of property without fair compensation.\nMITI has obtained political risk insurance policies from the Overseas Private Investment Corporation (\"OPIC\") for certain of its Joint Ventures. The policies cover loss of investment and losses due to business interruption caused by political violence or expropriation.\nMetromedia International Group, Inc.\nSummarized combined financial information of Joint Ventures accounted for under the equity method, that have commenced operations as of the dates indicated above is as follows (in thousands):\nCombined Balance Sheets\nSeptember 30, September 30, December 31, 1995 1994 1993 ---- ---- ---- Assets\nCurrent assets $ 6,937 $ 1,588 $ 841 Investments in wireless systems and equipment, net 31,349 17,040 10,758 Other assets 2,940 895 28 ------- ------- -------\nTotal Assets $ 41,226 $ 19,523 $ 11,627 ======= ======= =======\nLiabilities and Joint Ventures' Equity (Deficit)\nCurrent liabilities $ 10,954 $ 2,637 $ 1,022 Amount payable under MITI credit facility 33,699 11,327 6,635 Other long-term liabilities - 1,513 74 ------- ------- -------\nTotal Liabilities 44,653 15,477 7,731 ------- ------- -------\nJoint Ventures' Equity (Deficit) (3,427) 4,046 3,896 ------- ------- -------\nTotal Liabilities and Joint Ventures' Equity (Deficit) $ 41,226 $ 19,523 $ 11,627 ======= ======= =======\nCombined Statements of Operations\nNine months Year ended ended Year ended September 30, September 30, December 31, 1995 1994 1993 ---- ---- ----\nRevenues $ 19,344 $ 3,280 $ 1,452 ------- ------- ------- Expenses: Cost of service 9,993 2,026 969 Selling, general and administrative 11,746 2,411 973 Depreciation and amortization 3,917 1,684 911 Other - 203 67 ------- ------- -------\nTotal Expenses 25,656 6,324 2,920 ------- ------- -------\nOperating Loss (6,312) (3,044) (1,468)\nInterest Expense (1,960) (632) (64) Other Income (Expense) (1,920) 47 2 Foreign Currency Translation Gain (Loss) (203) 15 (91) ------- ------- -------\nNet Loss $(10,395) $ (3,614) $ (1,621) ======= ======= =======\nFinancial information for Joint Ventures which are not yet operational as of September 30, 1995 is not included in the above summary. MITI's investment in and advances to those Joint Ventures at December 31, 1995, 1994 and 1993 amounted to approximately $7.1 million, $5.7 million and $89,000, respectively.\nThe Company and its consolidated and unconsolidated Joint Ventures operate four types of services in their communications segment: wireless cable television, paging, radio broadcasting and telephony.\nMetromedia International Group, Inc.\nThe following tables represent summary financial information for consolidated subsidiaries and Joint Ventures, unconsolidated equity method joint ventures and combined consolidated and unconsolidated subsidiaries and joint ventures by type of service for all operations in the Company's Communications segment (excluding MITI's headquarter's operations - see Note 12), as of and for the years ended December 31, 1995, February 28, 1995 and February 28, 1994 (in thousands):\nWireless Radio Calendar 1995 Cable TV Paging Broadcasting Telephony Total - ------------- -------- ------ ------------ --------- -----\nConsolidated Subsidiaries and Joint Ventures\nRevenues $ - $ 690 $ 3,879 $ - $ 4,569 Depreciation and amortization - 132 366 - 498 Operating income (loss) before taxes - (23) (237) - (260) Assets - 2,398 7,999 - 10,397 Capital expenditures - 40 172 - 212 ======== ======== ======== ======== =========\nUnconsolidated Equity Joint Ventures\nRevenues $ 8,809 $ 2,427 $ 918 $ 7,190 $ 19,344 Depreciation and amortization 3,071 345 36 465 3,917 Operating income (loss) before taxes (4,152) (613) (1,255) (292) (6,312)\nAssets 22,727 3,495 247 14,757 41,226 Capital expenditures 9,727 1,933 46 9,740 21,446 ======== ======== ======== ======== =========\nNet investment in Joint Ventures $21,592 $ 4,980 $ 1,174 $ 2,078 $29,824 MITI equity in losses of unconsolidated investees (5,885) (403) (1,388) (305) (7,981) ======== ======== ======== ======== ========\nCombined\nRevenues $ 8,809 $ 3,117 $ 4,797 $ 7,190 $ 23,913 Depreciation and amortization 3,071 477 402 465 4,415 Operating income (loss) before taxes (4,152) (636) (1,492) (292) (6,572)\nAssets 22,727 5,893 8,246 14,757 51,623 Capital expenditures 9,727 1,973 218 9,740 21,658 ======== ======== ======== ======== =========\nMetromedia International Group, Inc.\nWireless Radio Fiscal 1995 Cable TV Paging Broadcasting Telephony Total - ----------- -------- ------ ------------ --------- -----\nConsolidated Subsidiaries and Joint Ventures\nRevenues $ 416 $ 266 $ 2,863 $ - $ 3,545 Depreciation and amortization 320 101 214 - 635 Operating income (loss) before taxes (359) (331) (795) - (1,485)\nAssets 704 1,956 10,135 - 12 795 Capital expenditures - 49 97 - 146 ======== ======== ======== ======== ========\nUnconsolidated Equity Joint Ventures\nRevenues $ 2,672 $ 180 $ 373 $ 55 $ 3,280 Depreciation and amortization 1,655 - 20 9 1,684 Operating income (loss) before taxes (2,026) (425) (15) (578) (3,044) Assets 15,090 1,030 856 2,547 19,523 Capital expenditures 5,072 766 8 2,487 8,333 ======== ======== ======== ======== =========\nNet investment in Joint Ventures $14,033 $ 1,829 $ 1,256 $ 1,485 $18,603 MITI equity in losses of unconsolidated investees (1,838) (147) (99) (173) (2,257) ======== ======== ======== ======== ========\nCombined\nRevenues $ 3,088 $ 446 $ 3,236 $ 55 $ 6,825 Depreciation and amortization 1,975 101 234 9 2,319 Operating income (loss) before taxes (2,385) (756) (810) (578) (4,529)\nAssets 15,794 2,986 10,991 2,547 32,318 Capital expenditures 5,072 815 105 2,487 8,479 ======== ======== ======== ======== =========\nMetromedia International Group, Inc.\nWireless Radio Fiscal 1994 Cable TV Paging Broadcasting Telephony Total - ----------- -------- ------ ------------ --------- -----\nConsolidated Subsidiaries and Joint Ventures\nRevenues $ 51 $ - $ - $ - $ 51 Depreciation and amortization 110 - - - 110 Operating income (loss) before taxes (303) (55) - - (358)\nAssets 256 1,069 - - 1,325 Capital expenditures - 34 - - 34 ======== ======== ======== ======== ========\nUnconsolidated Equity Joint Ventures\nRevenues $ 1,452 $ - $ - $ - $ 1,452 Depreciation and amortization 909 2 - - 911 Operating income (loss) before taxes (1,400) (68) - - (1,468) Assets 10,520 1,107 - - 11,627 Capital expenditures 3,411 764 - - 4,175 ======== ======== ======== ======== ========\nNet investment in Joint Ventures $ 7,123 $ 1,445 $ 1,055 $ - $ 9,623 MITI equity in losses of unconsolidated investees (752) (25) - - (777) ======== ======== ======== ======== ========\nCombined\nRevenues $ 1,503 $ - $ - $ - $ 1,503 Depreciation and amortization 1,019 2 - - 1,021 Operating income (loss) before taxes (1,703) (123) - - (1,826) Assets 10,776 2,176 - - 12,952 Capital expenditures 3,411 798 - - 4,209 ======== ======== ========= ========= =========\nMore than 90% of the Company's assets are located in, and substantially all of the Company's operations are derived from, Republics in the Commonwealth of Independent States or Eastern Europe.\nMetromedia International Group, Inc.\n8. Long-term Debt\nLong-term debt at December 31, 1995 and February 28, 1995 consisted of the following (in thousands): December 31, February 28, 1995 1995 ---- ----\nMIG (excluding Orion and MITI) - ------------------------------\nMIG Revolver $ 28,754 $ - 6 1\/2% Convertible Debentures due 2002, net of unamortized discount of $17,994 57,006 - 9 1\/2% Debentures due 1998, net of unamortized discount of $140 59,344 - 9 7\/8% Senior Debentures due 1997, net of unamortized premium of $217 18,217 - 10% Debentures due 1999 6,075 - Other long-term debt: Secured 6.25% due 1998 1,020 - ------- -------\n170,416 - ------- ------- Orion - -----\nNotes payable to banks under Credit, Security & Guaranty Agreements 123,700 - Notes payable to banks under the Third Restated Credit Agreement - 58,619 Obligation to Metromedia Company under Reimbursement Agreement - 19,544 Talent Notes due 1999, net of unamortized discount of $8,488 - 26,057 Creditor Notes due 1999, net of unamortized discount of $21,745 - 40,630 Non-interest bearing payment obligation to Sony, net of unamortized discount of $1,191 - 16,756 Other guarantees and contracts payable, net of unamortized discounts of $2,402 and $2,943 9,939 8,124 10% Subordinated Debentures due 2001, net of unamortized discount of $8,097 - 42,349 ------- -------\n133,639 212,079 ------- ------- MITI - ----\nHungarian Foreign Trade Bank 588 1,057 Other - 168 Demand Notes payable - 5,529 Notes payable to Metromedia Company - 18,194 ------- -------\n588 24,948 ------- -------\nLess: current portion - Metromedia Company - 37,738 - Other 40,597 96,177 ------- -------\nLong-term debt, net of current portion $264,046 $103,112 ======= =======\nMetromedia International Group, Inc.\nAggregate annual repayments of long-term debt over the next five years and thereafter are as follows (in thousands):\n1996 $ 40,597 1997 44,548 1998 88,714 1999 31,923 2000 39,453 Thereafter 77,325\nMIG (excluding Orion and MITI)\nOn November 1, 1995, the Company entered into a $35 million revolving credit agreement (\"MIG Revolver\") with Chemical Bank. On December 31, 1995, the Company had utilized $28.8 million. At the borrower's option, the MIG Revolver bears interest at a rate of LIBOR plus 2%, or Chemical Bank's alternative base rate plus 1%. The MIG Revolver terminates October 30, 1996.\nUnder terms of the MIG Revolver, the aggregate amount of all outstanding loans cannot exceed 65% of the market value of Roadmaster stock (see Note 4). Borrowings under the MIG Revolver are secured by all of the stock of Roadmaster owned by the Company, and a subordinated lien of the assets of Snapper, Inc. The loan is guaranteed by MITI. It is assumed that the carrying value of the MIG Revolver approximates its fair value because of its floating interest rate feature.\nIn 1987 the Company issued $75.0 million of 6 1\/2% Convertible Subordinated Debentures due in 2002 in the Euro-dollar market. The Debentures are convertible into common stock at a conversion price of $41-5\/8 per share. At the Company's option, the Debentures may be redeemed at 100% plus accrued interest until maturity.\nThe 9 7\/8% Senior Subordinated Debentures are redeemable at the option of the Company, in whole or in part, at 100% of the principal amount plus accrued interest. Mandatory sinking fund payments of $3.0 million (which the Company may increase to $6.0 million annually) began in 1982 and are intended to retire, at par plus accrued interest, 75% of the issue prior to maturity.\nAt the option of the Company, the 10% Subordinated Debentures are redeemable, in whole or in part, at the principal amount plus accrued interest. Sinking fund payments of 10% of the outstanding principal amount commenced in 1989, however, the Company receives credit for Debentures redeemed or otherwise acquired in excess of sinking fund payments.\nThe carrying value of the Company's long-term and subordinated debt, including the current portion at December 31, 1995, approximates fair value. The estimate is based on a discounted cash flow analysis using current incremental borrowing rates for similar types of agreements and quoted market prices for issues which are traded.\nOrion Debt\nOn November 1, 1995 Orion entered into a credit agreement with Chemical Bank, as agent, and a syndicate of lenders (the \"Orion Credit Agreement\") The Orion Credit Agreement consists of a $135 million term loan (\"Orion Term Loan\") with quarterly repayments of $6.75 million commencing March 1996 with a final payment due December 31, 2000; and a $50 million revolver (\"Orion Revolver\") with a final maturity of December 31, 2000. The amount available under the Orion Revolver as of December 31, 1995 was $38 million (of which $9 million is reserved for an outstanding letter of credit).\nMetromedia International Group, Inc.\nInterest is charged on the Orion Term Loan at the agent bank's prime rate plus 2% or at 3% above the LIBOR rate, at Orion's option; and for the Orion Revolver at the agent bank's prime rate plus 1\/2% or at 1-1\/2% above the LIBOR rate, also at Orion's option. Indebtedness under the Orion Credit Agreement is secured by all of Orion's assets, including the common stock of Orion and its subsidiaries. In addition to the quarterly amortization schedule, the Orion Credit Agreement provides that in the event that the ratio of the value of the eligible accounts receivable in Orion's borrowing base to the amount outstanding under the Orion Term Loan (the \"Borrowing Base Ratio\") does not exceed a designated threshold, all cash received by Orion must be used to prepay principal and interest on the Orion Term Loan until such Borrowing Base Ratio exceeds such designated threshold. All prepayments may be applied against scheduled quarterly repayments.\nAs a result of prepayments, Orion has satisfied its scheduled amortization payments through December 31, 1996. To the extent the Borrowing Base Ratio exceeds the threshold set forth in the Orion Credit Agreement, and is not needed to amortize the Orion Term Loan, Orion may use excess cash to pay its operating expenses, including the costs of acquiring new film product or new production. The Borrowing Base Ratio currently exceeds the designated threshold. In addition, Orion has established a system of lockbox accounts and collection accounts to maintain Chemical's security interest in the cash proceeds of Orion's accounts receivable. Amounts outstanding under the Orion Revolver are guaranteed jointly and severally by Metromedia and by John W. Kluge.\nThe Orion Credit Agreement also contains customary covenants, including limitations on the incurrence of additional indebtedness and guarantees, the creation of new liens and on the number of films Orion may produce, restrictions on the development costs and budgets for such films, limitations on the aggregate amount of unrecouped print and advertising costs Orion may incur, limitations on the amount of Orion's leases, capital and overhead expenses, prohibitions on the declaration of dividends or distributions by Orion to MIG, limitations on the merger or consolidation of Orion or the sale by Orion of any substantial portion of its assets or stock and restrictions on Orion's line of business, other than activities relating to the production and distribution of entertainment product. The Orion Credit Agreement also contains several financial covenants, including the requirement that Orion maintain the ratio of Orion's Free Cash Flow (as defined in the Orion Credit Agreement) to its cumulative investment in film product above certain specified levels at the end of each fiscal quarter, and that Orion's cumulative investment in film product not exceed Free Cash Flow by more than $50,000,000. In addition, the Orion Credit Agreement contains a covenant which would be triggered if the amount of Orion's net losses exceeds certain levels for each fiscal year beginning with the fiscal year ended December 31, 1996 or in the event of a change in control of MIG.\nIt is assumed that the carrying value of Orion's bank debt approximates its face value because it is a floating rate instrument.\nMetromedia International Group, Inc.\nAs a result of the Plan (see Note 3), Orion had certain obligations outstanding, including: Notes payable to the banks under the Third Restated Credit Agreement, obligations to Metromedia and its affiliate under a Reimbursement Agreement, Talent Notes, Creditor Notes, obligations to Sony Entertainment Inc. (\"Sony\") and 10% Subordinated Debentures (\"Plan Debt\"). Notwithstanding mandatory minimum payments and maturity dates, while operating under the Plan, and to the extent Orion generated positive net cash flow, interest and principal payments were made to the individual obligations included in Plan Debt based upon certain formulas. At August 31, 1995 Orion had not generated sufficient net cash flow to satisfy certain mandatory minimum payments and an event of default could have been asserted by the Trustees or holders of certain obligations of the Plan Debt. However, at the Merger Date (see Note 2), proceeds from the Orion Term Loan, as well as amounts advanced from MIG under a subordinated promissory note, were used directly or indirectly to repay and terminate all outstanding Plan Debt obligations ($210.7 million) and to pay certain transaction costs. To record the repayment and termination of the Plan Debt, Orion removed certain unamortized discounts associated with such obligations from its accounts and recognized an extraordinary loss of $32.4 million on the extinguishment of debt.\nMITI Debt\nA loan from a Hungarian Foreign Trade Bank is due on September 14, 1997 and is repayable in three annual installments with an interest rate of 34.5%. The loan is a Hungarian Forint based loan and is secured by a letter of credit issued by Metromedia International, Inc. in the amount of $1.2 million.\nOn November 1, 1995, MIG issued 2,537,309 shares of common stock in repayment of $26.6 million of MITI notes payable.\nIncluded in interest expense for calendar 1995 and fiscal 1995 are $3.8 million and $430,000, respectively, of interest on amounts due to Metromedia Company, an affiliate of MIG. No such amounts were included in fiscal 1994 interest expense.\n9. Stockholders' Equity\nPreferred Stock\nThere are 70,000,000 shares of Preferred Stock authorized, none of which were outstanding or designated as to a particular series at December 31, 1995.\nCommon Stock\nThere are 110,000,000 authorized shares of Common Stock, $1 par value. At December 31, 1995, February 28, 1995 and February 28, 1994 there were 42,613,738, 20,934,898 and 17,188,408 shares issued and outstanding, respectively.\nAfter giving effect to the Merger, the Company has reserved the shares of Common Stock listed below for possible future issuance: December 31, ---- Stock options 2,014,258 6 1\/2% Convertible Subordinated Debentures (see Note 8) 1,801,802 Restricted stock plan 132,800 ---------\n3,948,860 =========\nMetromedia International Group, Inc.\nStock Plans\nThe Company's stock option plans provide for the issuance of incentive stock options and nonqualified stock options. Incentive stock options may be issued at a per share price not less than the market value at the date of grant. Nonqualified options may be issued generally at prices and on terms determined in the case of each stock option.\nFollowing the Merger (see Note 2), options granted pursuant to the MITI stock option plan and the Actava stock option plans, became exercisable for stock of MIG in accordance with the respective exchange ratios.\nAfter giving effect to the Merger, the following table reflects changes in the stock options issued under these plans:\nShares Average Subject to Option Price Option Per Share ------ --------- Incentive Stock Options - -----------------------\nBalance at December 31, 1993 - -------\nOptions granted - Options exercised - Options canceled - -------\nBalance at December 31, 1994 - ------- Transfer of Actava options in Merger 203,000 $ 8.00 - $12.00 Options granted - Options exercised (19,000) $ 8.00 - $ 9.00 Options canceled - -------\nBalance at December 31, 1995 184,000 $ 8.00 - $ 9.00 =======\nOptions exercisable at end of year 78,000 $ 8.00 - $12.00 =======\nNonqualified Stock Options - -------------------------- Balance at December 31, 1993 - -------\nOptions granted 283,000 $ 5.41 Options exercised - Options canceled - -------\nBalance at December 31, 1994 283,000 $ 5.41 -------\nTransfer of Actava options in Merger 234,000 $ 8.00 - $14.50 Options granted 366,000 $ 5.41 Options exercised (74,000) $ 8.00 - $14.50 Options canceled (89,000) $ 5.41 --------\nBalance at December 31, 1995 720,000 $ 5.41 - $14.50 =======\nOptions exercisable at end of year 178,000 $ 5.41 - $14.50 =======\nThere were 153,000 shares under the stock option plans at December 31, 1995 which were available for the granting of additional stock options.\nMetromedia International Group, Inc.\nDuring 1994, an officer of MITI was granted an option, not pursuant to any plan, to purchase 657,908 shares of common stock (the \"MITI Options\") at a purchase price of $1.08 per share. The MITI Options expire on September 30, 2004, or earlier if the officer's employment is terminated. Included in 1994 expenses is $3.6 million of compensation expense in connection with these options.\nPrior to the Merger, an officer of Actava was granted an option, not pursuant to any plan, to purchase 300,000 shares of common stock (the \"Actava Options\") at a purchase price of $6.375 per share. The Actava Options expire on April 18, 2001.\nOn December 13, 1995, the Board of Directors of the Company terminated the Actava 1991 Non-Employee Director Stock Option Plan. The Company had previously reserved 150,000 shares for issuance upon the exercise of options granted under this plan and had granted 20,000 options thereunder. Also on January 31, 1996, the Board of Directors adopted the 1996 Incentive Stock Option Plan, subject to shareholder approval. Assuming adoption of the 1996 Incentive Stock Option Plan by shareholders, it is the intention of the Board of Directors not to grant any additional options under the MITI and Actava stock option plans.\nNo shares have been granted under the Company's restricted stock plan during 1995 and 102,800 shares of common stock remain available under this plan.\n10. Income Taxes\nThe provision for income taxes for calendar 1995, fiscal 1995 and 1994, all of which is current, consists of the following (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ---- Federal $ - $ - $ - State and local 167 100 100 Foreign 600 1,200 2,000 -------- -------- -------\nCurrent 767 1,300 2,100 Deferred - - - -------- -------- -------\nTotal $ 767 $ 1,300 $ 2,100 ======== ======== =======\nSuch provision has been allocated to continuing operations before extraordinary items, discontinued operations and extraordinary items as follows (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ---- Operations before extraordinary items $ 767 $ 1,300 $ 2,100 Discontinued operations - - - Extraordinary items - - - ------- ------ ------\n$ 767 $ 1,300 $ 2,100 ======= ====== ======\nThe federal income tax portion of the provision for income taxes includes the benefit of state income taxes provided. The Company recognizes investment tax credits on the flow-through method.\nMetromedia International Group, Inc.\nState and local income tax expense in calendar 1995, fiscal 1995 and 1994 includes an estimate for franchise and other state tax levies required in jurisdictions which do not permit the utilization of the Company's calendar 1995, fiscal 1995 and 1994 operating losses to mitigate such taxes. Foreign tax expense in calendar 1995, fiscal 1995 and 1994 reflects estimates of withholding and remittance taxes. Cash utilized for the payment of income taxes during calendar 1995, fiscal 1995 and 1994 was $1.0 million, $1.8 million and $2.9 million, respectively.\nThe temporary differences and carryforwards which give rise to deferred tax assets and (liabilities) for calendar 1995 and fiscal 1995 are as follows (in thousands):\nDecember 31, February 28, 1995 1995 ---- ----\nNet Operating loss carryforward $241,877 $177,846 Deferred income 22,196 24,245 Investment credit carryforward 28,000 28,000 Allowance for doubtful accounts 4,395 5,346 Capital loss carryforward 3,850 - Film costs (1,832) (15,077) Shares payable 15,670 14,986 Reserves for self-insurance 10,970 - State tax accruals 3,811 - Investment in equity investee 22,146 - Purchase of safe harbor lease investment (9,115) - Minimum tax credit (ATM) carryforward 8,805 - Other reserves 6,331 6,958 Other 3,843 (1,285) --------- ---------\nSubtotal before valuation allowance 360,947 241,019 Valuation allowance (360,947) (241,019) --------- --------- Deferred taxes $ - $ - ========= =========\nThe valuation allowance for deferred assets as of February 28, 1995 was $241.0 million. The net change in the total valuation allowance for the year ended December 31, 1995 was an increase in the allowance of $119.9 million.\nMetromedia International Group, Inc.\nThe Company's provision for income taxes for calendar 1995, fiscal 1995 and 1994, differs from the provision that would have resulted from applying the federal statutory rates during those periods to income (loss) before provision for income taxes. The reasons for these differences are explained in the following table (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ---- Provision (benefit) based upon federal statutory rate of 35% $(132,138) $(23,839) $(43,084) State taxes, net of federal benefit 109 65 65 Foreign taxes in excess of federal credit 600 1,200 2,000 Non-deductible direct expenses of chapter 11 filing 448 214 596 Current year operating loss not benefitted 26,943 22,832 42,201 Equity in losses of Joint Ventures 2,778 790 272\nExtraordinary loss on early extinguishment of debt (11,344) - - Reduction of extraordinary loss not benefitted 11,344 - - Discontinued operations, not tax benefitted 101,999 - - Other, net 28 38 50 --------- --------- --------- Provision for income taxes $ 767 $ 1,300 $ 2,100 ========= ========= =========\nAt December 31, 1995, the Company had available net operating loss carryforwards, capital loss carryforwards, unused alternative tax credits and unused investment tax credits of approximately $631 million, $11 million, $9 million and $28 million, respectively, which can reduce future federal income taxes. If not utilized, these carryforwards and credits will begin to expire in 1996. The alternative tax credit may be carried forward indefinitely, to offset regular tax in certain circumstances.\nThe use by the Company of any net operating loss carryforwards reported or which will be reported by Orion, Actava, MITI and Sterling and the subsidiaries included in their respective affiliated groups of corporations which filed consolidated Federal income tax returns with Orion, Actava, MITI and Sterling as the parent corporations (such Orion, Actava, MITI and Sterling affiliated groups hereinafter being referred to as the \"Orion Group,\" the \"Actava Group,\" the \"MITI Group\" and the \"Sterling Group,\" respectively, and individually as a \"Former Group\" and collectively as the \"Former Groups\") for taxable years ending on or before November 1, 1995 (such Pre-November 1, 1995 net operating loss carryforwards hereinafter referred to collectively as the \"Pre-November 1 Losses\") will be subject to certain limitations as a result of the Mergers.\nUnder Section 382 of the Internal Revenue Code, annual limitations will generally apply to the use of the Pre-November 1 Losses of the Former Groups by the Company. The amount of the annual limitation with respect to a Former Group will depend upon the application of certain principles contained in Section 382 of the Internal Revenue Code relating to the valuation of such Former Group immediately prior to the November 1 Mergers and an interest factor published by the Internal Revenue Service on a monthly basis. Based on the market price of the Company's stock at the effective time of the Mergers, the exchange ratios with respect to the shares of Orion, MITI and Sterling, and the published interest factor of 5.75 percent (applicable to transactions that occurred in November 1995), the annual limitations on the use of the Pre-November 1 Losses of the Orion Group, Actava Group, the MITI Group and the Sterling Group, respectively, by the MIG Group would currently be approximately $11.9 million, $18.3 million, $10.0 million and\nMetromedia International Group, Inc.\n$510,000 per year, respectively. To the extent Pre-November 1 Losses equal to the annual limitation with respect to any of the Former Groups are not used in any year, the unused amount would generally be available to be carried forward and used to increase the limitation with respect to such Former Group in the succeeding year.\nThe use of Pre-November 1 Losses of the Orion Group, the MITI Group and the Sterling Group will also be separately limited by the income and gains recognized by the corporations that were members of each of the Orion Group, the MITI Group and the Sterling Group, respectively, including corporations such as the Company (in the case of Sterling) that are successors by merger to any of such members. Under proposed Treasury regulations, such Pre-November 1 Losses of any such former members of any such Former Group, or successors thereof, would be usable on an aggregate basis to the extent of the income and gains of such former members of such Former Group, or successors thereof on an aggregate basis.\nAs a result of the Merger, the Company succeeded to approximately $92.2 million of Pre-November 1 Losses of the Actava Group. SFAS 109 requires assets acquired and liabilities assumed to be recorded at their \"gross\" fair value. Differences between the assigned values and tax bases of assets acquired and liabilities assumed in purchase business combinations are temporary differences under the provisions of SFAS 109. However, since all of the Actava intangibles have been eliminated, when the Pre-November 1 Losses are utilized they will reduce income tax expense.\n11. Employee Benefit Plans\nActava had a noncontributory defined benefit plan which is \"qualified\" under Federal tax law and covered substantially all Actava's employees. In addition, Actava had a \"nonqualified\" supplemental retirement plan which provided for the payment of benefits to certain employees in excess of those payable by the qualified plans. Following the Mergers (see Note 2), the Company froze the Actava noncontributory defined benefit plan and \"nonqualified\" supplemental retirement plan effective as of December 31, 1995. Employees will no longer accumulate benefits under these plans.\nIn connection with the Merger, the projected benefit obligation and fair value of plan assets were remeasured considering the Company's freezing of the plan. The excess of the projected benefit obligations over the fair value of plan assets in the amount of $4.9 million was recorded in the allocation of purchase price. The recognition of the net pension liability in the allocation of the purchase price eliminated any previously existing unrecognized gain or loss, prior service cost, and transition asset or obligation related to the acquired enterprise's pension plan.\nSome of the Company's subsidiaries also have defined contribution plans which provide for discretionary annual contributions covering substantially all of their employees. Effective January 1, 1993, MITI established a 401(k) Salary Deferral Plan (\"401(k) Plan\") on behalf of its employees. Under the 401(k) Plan participating employees can defer receipt of up to 15% of their compensation, subject to certain limitations. MITI has the discretion to match amounts contributed by the employee up to 3% of their compensation. The Company contributed $60,000 for the year ended December 31, 1995.\nMetromedia International Group, Inc.\nOrion has a 401(k) defined contribution retirement and savings plan covering all eligible employees who prior to March 1 or September 1, have completed 1,000 hours of service, as defined in the plan. Participants may make pretax contributions to the plan of up to 15% of their compensation, as defined, subject to certain limitations as prescribed by the Internal Revenue Code. Orion matches 50 % of amounts contributed up to $500 per participant per plan year. Orion may make discretionary contributions on an annual basis to the plan. The exact amount of discretionary contributions is decided each year by the Board of Directors. There have been no discretionary contributions since the inception of the plan. Total employer contribution expense for calendar 1995, fiscal 1995 and fiscal 1994 was approximately $64,000 each year.\n12. Business Segment Data\nThe business activities of the Company constitute two business segments, (i) filmed entertainment, which includes the financing and production of theatrical motion pictures as well as the distribution of theatrical motion pictures and television programming, and (ii) communications, which includes wireless cable television, paging services, radio broadcasting, and telephony.\nFilmed Entertainment\nThe Company operates its filmed entertainment operations through Orion. Until the Merger Date (see Note 2), Orion operated under the terms of the Plan (see Note 3) which severely limited Orion's ability to finance and produce additional theatrical motion pictures. Therefore, Orion's primary activity prior to the Merger was the ongoing distribution of its present library of theatrical motion pictures and television programming. Orion believes the lack of a continuing flow of newly produced theatrical product while operating under the Plan adversely affected the marketability of its library.\nTheatrical motion pictures are produced initially for exhibition in theaters. Initial theatrical release generally occurs in the United States and Canada. Foreign theatrical exhibition generally begins within the first year after initial release. Home video distribution in all territories usually begins six to twelve months after theatrical release in that territory, with pay television exploitation beginning generally six months after initial home video release. Exhibition of the Company's product on network and on other free television outlets begins generally three to five years from the initial theatrical release date in each territory.\nMetromedia International Group, Inc.\nCommunications\nThe Company, through MITI and subsidiaries, owns various interests in Joint Ventures that are currently in operation or planning to commence operations in certain republics of the Commonwealth of Independent States (\"CIS\") (formerly the Union of Soviet Socialist Republics) and other Eastern European countries. During 1995, the Company began to pursue opportunities to extend its communications businesses into other emerging markets in the Pacific Rim. The Joint Ventures currently offer wireless cable television, radio paging systems, radio broadcasting, trunked mobile radio services and various types of telephone services. Joint Ventures are principally entered into with governmental agencies or ministries under the existing laws of the respective countries.\nThe Joint Venture agreements generally provide for the initial contribution of assets or cash, and for the creation of a line of credit agreement to be entered into between the Joint Venture and MITI. Under a typical arrangement, MITI's venture partner contributes the necessary license or permits under which the Joint Venture will conduct its business, studio or office space, transmitting tower rights and other equipment. MITI's contribution is generally cash and equipment but may consist of other specific assets as required by the Joint Venture agreement. The line of credit agreement generally specifies a commitment amount, interest rates and repayment terms.\nThe consolidated financial statements include the accounts and results of operations of MITI and its majority owned and controlled Joint Venture, CNM Paging, and its subsidiaries. Investments in other companies and Joint Ventures which are not majority owned, or in which the Company does not control but exercises significant influence are accounted for using the equity method (see Notes 1 and 7).\nMetromedia International Group, Inc.\nBUSINESS SEGMENT DATA (in thousands)\nCalendar Fiscal Fiscal 1995 1995 1995 ---- ---- ----\nFilmed Entertainment: Net revenues $133,812 $191,244 $175,662 Direct operating costs (155,720) (208,755) (263,961) Depreciation and (694) (767) (708) amortization --------- --------- ---------\nLoss from operations (22,602) (18,278) (89,007) ========= ========= =========\nAssets at year end 283,093 351,588 508,014 Capital expenditures 1,151 1,198 (785) ======== ======== =========\nCommunications: Net revenues 5,158 3,545 51 Direct operating costs (26,937) (19,067) (6,086)\nDepreciation and (2,101) (1,149) (174) amortization --------- --------- ---------\nLoss from operations (23,880) (16,671) (6,209) ========= ========= =========\nEquity in losses of Joint 7,981 2,257 777 ======== ======== ======== Ventures\nAssets at year end 161,089 40,282 12,637\nCapital expenditures 2,548 3,610 (1,423) ======== ======== =========\nHeadquarters and Eliminations: Net revenues (99) - - Direct operating costs (876) - - Depreciation and - - - amortization -------- -------- --------\nIncome from operations (975) - - ========= ======== ========\nAssets at year end including discounted operations and eliminations 155,456 - - ======== ======== ========\nConsolidated - Continuing Operations: Net revenues 138,871 194,789 175,713 Direct operating costs (183,533) (227,822) (270,047) Depreciation and (2,795) (1,916) (882) amortization --------- --------- ---------\nLoss from operations (47,457) (34,949) (95,216) ========= ========= =========\nEquity in losses of joint 7,981 2,257 777 ventures ======== ======== ========\nAssets at year end 599,638 391,870 520,651 Capital expenditures $ 3,699 $ 4,808 $ 2,208 ======== ======== ========\nManagement fees of $100,000 charged to operations are eliminated from the business segment data.\nMetromedia International Group, Inc.\nThe sources of the Company's revenues from continuing operations by market for each of the last three fiscal years are set forth in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\". The Company derives significant revenues from the foreign distribution of its theatrical motion pictures and television programming. The following table sets forth Orion's export sales from continuing operations (excluding Canada) by major geographic area for each of the last three fiscal years (in thousands):\nCalendar Fiscal Fiscal 1995 1995 1994 ---- ---- ----\nEurope $ 32,126 $ 36,532 $ 62,107 Mexico and South America 2,454 4,586 5,782 Asia and Australia 8,841 13,820 23,876 --------- --------- --------- $ 43,421 $ 54,938 $ 91,765 ========= ========= =========\nRevenues, operating losses and assets of MITI's foreign operations are disclosed in Note 7.\nShowtime Networks, Inc. (\"Showtime\") and Lifetime Television (\"Lifetime\") have been significant customers of the Company. During calendar 1995 and fiscal 1995, the Company recorded approximately $15.4 million and $45.5 million, respectively, of revenues under its pay cable agreement with Showtime, and during calendar 1995, fiscal 1995 and fiscal 1994, the Company recorded approximately $15.0 million, $12.5 million and $15.1 million of revenues, respectively, under its basic cable agreement with Lifetime.\n13. Commitments and Contingent Liabilities\nCommitments\nThe Company is obligated under various operating leases. Total rent expense amounted to $2.6 million, $2.3 million, and $2.2 million, in calendar 1995, fiscal 1995 and fiscal 1994, respectively.\nMinimum rental commitments under noncancellable operating leases are set forth in the following table (in thousands):\nYear Amount ---- ------\n1996 $ 1,911 1997 954 1998 832 1999 519 2000 252 Thereafter 526 ------- Total minimum rental commitments $ 4,994 =======\nThe Company and certain of its subsidiaries have employment contracts with various officers, with remaining terms of less than one year, at amounts approximating their current levels of compensation. The Company's remaining aggregate commitment at December 31, 1995 under such contracts is approximately $8.1 million.\nMetromedia International Group, Inc.\nIn addition, the Company and certain of its subsidiaries have postemployment contracts with various officers. The Company's remaining aggregate commitment at December 31, 1995 under such contracts is approximately $1.1 million.\nAcquisition Commitments\nDuring December 1995, MITI, Protocall Ventures Ltd. (\"Protocall\"), and the shareholders of Protocall, executed a letter of intent together with a loan agreement relating to the purchase of Protocall.\nThe letter of intent states that pending the consummation of purchase, MITI will loan up to $1.5 million to Protocall and negotiate definitive documentation relating to the purchase of 51% of Protocall for $2.6 million. Principal and accrued interest under the loan will be applied to the purchase price at the time the transactions contemplated by the purchase agreement are consummated, which is expected to be on or before March 31, 1996. The letter of intent provides that the shareholders of Protocall have the right to purchase $250,000 of MIG's common stock during the five year period after closing of the purchase agreement and further provides the right to purchase an additional $250,000 of MIG's common stock one year after closing if Protocall achieves certain budgeted objectives. The purchase price will be the trading price of MIG stock at the time of the closing of the purchase agreement. However, the entire purchase price for all the shares will be forgiven and, as such, these amounts will be considered part of the acquisition cost.\nThe agreements also provide that MITI will arrange for or make direct loans to Protocall relating to existing joint venture commitments of [up to] $3.4 million, plus any additional amounts agreed to by the parties.\nIn connection with MITI's activities directed at entering into Joint Venture agreements in the Pacific Rim, MITI's 90% subsidiary, Metromedia Asia Limited (\"MAL\") has entered into certain agreements with Communications Technology International, Inc., (\"CTI\"), which owns 7% of the equity of MAL. Under these agreements, MAL has agreed, to loan up to $2.5 million to CTI, and permit CTI to purchase up to an additional 7% of the equity of MAL, provided that CTI is successful in obtaining rights to operate certain services, as defined, and MAL is provided with the right to participate in the operation of such services. MAL has also agreed to loan a portion of the funds required to purchase the equity interests in MAL to CTI.\nContingencies\nThe Company is contingently liable under various guarantees of debt totaling approximately $1.6 million. The debt is primarily Industrial Revenue Bonds which were issued to finance manufacturing facilities and equipment of certain of the Company's former subsidiaries which were disposed of prior to 1995. The Bonds are secured by the facilities and equipment. In addition, upon the sale of the subsidiaries, the Company received lending institution guarantees or bank letters of credit to support the Company's contingent obligations. There are no material defaults on the debt agreements.\nThe Company is contingently liable under various real estate leases of certain of its former subsidiaries which were sold prior to 1995. The total future payments under these leases, including real estate taxes, is estimated to be approximately $2.4 million. The leased properties generally have financially sound subleases.\nMetromedia International Group, Inc.\nIn 1975, the Russian Federation legislature proposed legislation that would limit to 35%, the interest which a foreign person is permitted to own in entities holding broadcast licenses. While such proposed legislation was not enacted, it is possible that such legislation could be reintroduced and enacted in Russia. Further, even if enacted, such law may be challenged on constitutional grounds and may be inconsistent with Russian Federation treaty obligations. In addition, it is unclear how Russian Federation regulators would interpret and apply the law to existing license holders. However, if the legislature passes a law restricting foreign ownership of broadcast license holding entities and such a law is found to be constitutional and fails to contain a grandfathering clause to protect existing companies, it could require MITI to reduce its ownership interests in its Russian Joint Ventures. It is unclear how such reductions would be effected.\nThe Republic of Latvia passed legislation in September, 1995 which purports to limit to 20% the interest which a foreign person is permitted to own in entities engaged in certain communications businesses such as radio, cable television and other systems of broadcasting. This legislation will require MITI to reduce to 20% its existing ownership interest in joint ventures which operate a wireless cable television system and an FM radio station in Riga, Latvia.\nMetromedia International, Inc., a subsidiary of MITI, is contingently liable for an outstanding letter of credit amounting to $1.2 million.\nLitigation\nFuqua Industries, Inc. Shareholder Litigation - --------------------------------------------- Between February 25, 1991 and March 4, 1991, three lawsuits were filed against the Company (formerly named Fuqua Industries, Inc.) in the Delaware Chancery Court. On May 1, 1991, these three lawsuits were consolidated by the Delaware Chancery Court in In re Fuqua Industries, Inc. Shareholders ----------------------------------------- Litigation, Civil Action No. 11974. The named defendants are certain current - ---------- and former members of the Company's Board of Directors and certain former members of the Board of Directors of Intermark, Inc. (\"Intermark\"). Intermark is a predecessor to Triton Group Ltd., which formerly owned approximately 25% of the outstanding shares of the Company's Common Stock. The Company was named as a nominal defendant in this lawsuit. The action was brought derivatively on behalf of the Company and purportedly was filed as a class action lawsuit on behalf of all holders of the Company's Common Stock, other than the defendants. The complaint alleges, among other things, a long-standing pattern and practice by the defendants of misusing and abusing their power as directors and insiders of the Company by manipulating the affairs of the Company to the detriment of the Company's past and present stockholders. The complaint seeks (i) monetary damages from the director defendants, including a joint and several judgment for $15,700,000 for alleged improper profits obtained by Mr. J.B. Fuqua in connection with the sale of his shares in the Company to Intermark; (ii) injunctive relief against the Company, Intermark and its former directors, including a prohibi- tion against approving or entering into any business combination with Intermark without specified approval; and (iii) costs of suit and attorneys' fees. On December 28, 1995, plaintiffs filed a consolidated second amended derivative and class action complaint, purporting to assert additional facts in support of their claim regarding an alleged plan, but deleting their prior request for injunctive relief. On January 31, 1996, all defendants moved to dismiss the second amended complaint and filed a brief in support of that motion. The motion to dismiss is still pending.\nThe Company and its subsidiaries are contingently liable with respect to various matters, including litigation in the ordinary course of business and otherwise. Some of the pleadings in the various litigation matters contain prayers for material awards. Based upon management's review of the underlying facts and circumstances and consultation with counsel, management believes such matters will not result in significant additional liabilities which would have a material adverse effect upon the consolidated financial position or results of operations of the Company.\nMetromedia International Group, Inc.\nEnvironmental Protection\nSnapper's manufacturing plant is subject to federal, state and local environmental laws and regulations. Compliance with such laws and regulations has not, and is not expected to, materially affect Snapper's competitive position. Snapper's capital expenditures for environmental control facilities, its incremental operating costs in connection therewith and Snapper's environmental compliance costs were not material in 1995 and are not expected to be material in future years.\nThe Company has agreed to indemnify the purchaser of a former subsidiary of the Company for certain obligations, liabilities and costs incurred by such subsidiary arising out of environmental conditions existing on or prior to the date on which the subsidiary was sold by the Company. The Company sold the subsidiary in 1987. Since that time, the Company has been involved in various environmental matters involving property owned and operated by the subsidiary, including clean-up efforts at landfill sites and the remediation of groundwater contamination. The costs incurred by the Company with respect to these matters have not been material during any year through and including the fiscal year ended December 31, 1995. As of December 31, 1995, the Company had a remaining reserve of approximately $1,250,000 to cover its obligations to its former subsidiary.\nDuring 1995, the Company was notified by certain potentially responsible parties at a superfund site in Michigan that the former subsidiary may be a potentially responsible party at such site. The former subsidiary's liability, if any, has not been determined but the Company believes that such liability will not be material.\nThe Company, through a wholly-owned subsidiary, owns approximately 17 acres of real property located in Opelika, Alabama (the \"Opelika Property\"). The Opelika Property was formerly owned by Diversified Products Corporation, a former subsidiary of the Company (\"DP\"), and was transferred to a wholly owned subsidiary of the Company in connection with the Exchange Transaction. DP previously used the Opelika Property as a storage area for stockpiling cement, sand, and mill scale materials needed for or resulting from the manufacture of exercise weights. In June 1994, DP discontinued the manufacture of exercise weights and no longer needed to use the Opelika Property as a storage area. In connection with the Exchange Transaction, Roadmaster and the Company agreed that the Company, through a wholly-owned subsidiary, would acquire the Opelika Property, together with any related permits, licenses, and other authorizations under federal, state and local laws governing pollution or protection of the environment. In connection with the closing of the Exchange Transaction, the Company and Roadmaster entered into an Environmental Indemnity Agreement (the \"Indemnity Agreement\") under which the Company agreed to indemnify Roadmaster for costs and liabilities resulting from the presence on or migration of regulated materials from the Opelika Property. The Company's obligations under the Indemnity Agreement with respect to the Opelika Property are not limited. The Indemnity Agreement does not cover environmental liabilities relating to any property now or previously owned by DP except for the Opelika Property.\nOn January 22, 1996, the Alabama Department of Environmental Management (\"ADEM\") wrote a letter to the Company stating that the Opelika Property contains an \"unauthorized dump\" in violation of Alabama environmental regulations. The letter from ADEM requires the Company to present for ADEM's approval a written environmental remediation plan for the Opelika Property. The Company has retained an environmental consulting firm to develop an environmental remediation plan for the Opelika Property. The consulting firm is currently conducting soil samples and other tests on the Opelika Property. Although the Company has not received the results of these tests, the Company believes that the reserves of approximately $1,800,000 previously established by the Company for the Opelika Property will be adequate to cover the cost of the remediation plan that is currently being developed.\nMetromedia International Group, Inc.\n14. Selected Quarterly Financial Data (unaudited)\nSelected financial information for the quarterly periods in calendar 1995 and fiscal 1995 is presented below (in thousands, except per-share amounts):\n(a) Operating loss for the first of calendar 1995 includes $5.4 million of writedowns to previously released film product.\n(b) As more fully described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" significant revenues ($40.0 million) were recognized in conjunction with the Showtime Settlement in the first quarter of fiscal 1995.\n(c) Operating loss for the second quarter of fiscal 1995 includes writedowns to estimated net realizable value of an aggregate of $2.6 million of writedowns of theatrical product unreleased at that time and $5.3 million of writedowns to previously released product.\n(d) Operating loss for the fourth quarter of calendar 1995 includes writedowns to estimated realizable value of $3.0 million for unreleased theatrical product and $4.8 million for writedowns to previously released product. (e) Operating loss for the fourth quarter of fiscal 1995 includes $8.1 million of writedowns to previously released product.\nMetromedia International Group, Inc.\n(f) As more fully discussed in Note 2, the excess of the allocated purchase price attributed to Snapper in the Actava acquisition, over the estimated cash flows from the operations and the anticipated sale of Snapper, amounted to $293.6 million.\n(g) As more fully discussed in Note 8, Orion removed certain unamortized discounts associated with such obligations from the accounts and recognized an extraordinary loss of $32.4 million on the extinguishment of debt.\nThe quarterly financial data presented above differs from amounts previously reported in Orion's 10 Q's due to the restatement of historical financial statements to account for the common control merger with MITI (see Note 2). In addition, Orion's previously filed fiscal 1996 quarters have been restated and presented on a calendar year basis in calendar 1995.\n15. Subsequent Developments\nSubsequent to year-end, the Company entered into an Agreement and Plan of Merger to acquire The Samuel Goldwyn Company (\"Goldwyn\") and entered into a letter of intent to acquire Motion Picture Corporation of America (\"MPCA\"). In addition, the Company has entered into an Agreement and Plan of Merger to acquire Alliance Entertainment Company (\"Alliance\"). In connection with the proposed acquisition of Alliance and Goldwyn, the Company intends to refinance substantially all of its indebtedness and that of its subsidiaries, as well as substantially all of the indebtedness of Alliance and Goldwyn.\nOn December 20, 1995, the Company and Alliance entered into an Agreement and Plan of Merger (the \"Alliance Merger Agreement\") pursuant to which a newly-formed, wholly-owned subsidiary of the Company (\"Alliance Mergerco\") will merge with and into Alliance (the \"Alliance Merger\").\nPursuant to the Alliance Merger Agreement, upon consummation of the Alliance Merger, Alliance stockholders will exchange each of their shares of Alliance common stock for (i) .7 shares of Common Stock, and (ii) a ten-year warrant to purchase .285 shares of Common Stock at an exercise price of $20.00 per share. In connection with the Alliance Merger, Metromedia has entered into Stock Purchase Agreements (the \"Stock Purchase Agreements\") with the Chairman and Chief Executive Officer of Alliance, and the Vice Chairman and President of Alliance. The Stock Purchase Agreements provide for the sale by such officers to Metromedia of (i) 2,520,000 shares of Common Stock and 1,026,000 Warrants to be received by such officers in the Alliance Merger and (ii) any additional Warrants received by such officers as consideration in the Alliance Merger (anticipated to be 31,920 Warrants) and (iii) all Warrants received by such officers upon the exercise of certain options or warrants to purchase Alliance common stock held by them (expected to be 1,007,166 Warrants) for a cash purchase price of $43,200,000. These purchases will take place immediately following the effective time of the Alliance Merger and will enable the Metromedia Holders, who currently collectively control approximately 35.9% of the outstanding Common Stock, to reduce the substantial dilution to their interests which would otherwise result from the issuance of Common Stock to Alliance Stockholders in the Alliance Merger.\nOn January 31, 1996, the Company and Goldwyn entered into an Agreement and Plan of Merger (the \"Goldwyn Merger Agreement\") pursuant to which Goldwyn will merge with a newly-formed, wholly-owned subsidiary of the Company (the \"Goldwyn Merger\") and, in connection therewith, will be re-named \"Goldwyn Entertainment Company.\"\nMetromedia International Group, Inc.\nThe Goldwyn Merger Agreement provides that upon consummation of the Goldwyn Merger, Goldwyn stockholders will receive $5.00 worth of Common Stock for each share of Goldwyn common stock, provided that the average closing price of the Common Stock over the 20 consecutive trading days ending five days prior to the meeting of the Company's stockholders held to vote upon the Goldwyn Merger is between $12.50 and $16.50. If the average closing price of Common Stock over such period is less than $12.50 it will be deemed to be $12.50 and Goldwyn stockholders will receive .4 shares of Common Stock for each share of Goldwyn common stock, and if the average closing price of the Common Stock over such period is greater than $16.50, it will be deemed to be $16.50 and Goldwyn stockholders will receive .3030 shares of Common Stock for each share of Goldwyn common stock.\nMetromedia International Group, Inc.\nMETROMEDIA INTERNATIONAL GROUP, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nMETROMEDIA INTERNATIONAL GROUP, INC. Statement of Operations (Registrant only in thousands, except per share amounts)\nPeriod Ended December 31, ----------- Revenues $ - Cost and expenses: Selling, general and administrative 1,109\n------------ Operating loss (1,109)\nInterest expense, net 2,208 Equity in losses of subsidiaries 83,707\n------------\nLoss from continuing operations (87,204) before extraordinary item\nDiscontinued Operations - loss on disposal (293,570) Equity in extraordinary item - early extinguishment of debt (32,382) ------------\nNet Loss $ (412,976) ===========\nLoss per common share: Primary: Continuing Operations: $ (3.54) =========== Discontinued Operation $ (11.97) =========== Extraordinary Item $ (1.32) =========== Net Loss $ (16.83) ===========\nThe accompanying notes are an integral part of the condensed financial information.\nSee Notes to Condensed Financial Information on page S-4.\nS-1\nMetromedia International Group, Inc.\nMETROMEDIA INTERNATIONAL GROUP, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - continued\nMETROMEDIA INTERNATIONAL GROUP, INC. Balance Sheet (Registrant only in thousands)\nDecember 31, ----------- Current Assets: Cash and cash equivalents $ 21,848 Other assets 3,010 ------------ Total current assets 24,858\nInvestment in Roadmaster Industries, Inc. 47,455 Investment in Snapper, Inc. 79,200 Investment in subsidiaries 81,565 Intercompany accounts 86,102 Other assets 2,566 ----------- Total assets $ 321,746 ===========\nCurrent Liabilities: Accounts payable $ 943 Accrued expenses 66,750 Current portion of long term debt 32,682 ----------- Total current liabilities 100,375\nLong term debt 137,734 Other long term liabilities 382 ------------ Total liabilities 238,491\nStockholders' equity Common stock 42,614 Paid-in surplus 728,747 Accumulated deficit (688,106) ------------ Total stockholders' equity 83,255 ------------ Total liabilities and stockholder equity $ 321,746 -----------\nThe accompanying notes are an integral part of the condensed financial information. See Notes to Condensed Financial Information on page S-4.\nS-2\nMetromedia International Group, Inc.\nMETROMEDIA INTERNATIONAL GROUP, INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - continued\nMETROMEDIA INTERNATIONAL GROUP, INC. Statement of Cash Flows (Registrant only in thousands)\nPeriod Ended December 31, 1995 ----------\nNet loss $ (412,976)\nAdjustments to reconcile net loss to net cash provided by (used in) operating activities: Loss on discontinued operations 293,570 Equity in losses of investees 116,089 Amortization of debt discounts and costs 434\n(Increase) decrease in prepaid expenses (5,567) (Increase) decrease in other current assets 5,434\n(Increase) decrease in other assets 1,769 ---------- Cash provided by (used in) operations (1,247) ---------- Investment activities: Proceeds from notes receivable 45,320 Investment in subsidiaries (4,230) Cash acquired, net in merger 72,068 ---------- Cash provided by (used in) investment 113,158 ---------- activities Financing Activities:\nProceeds from revolving term loan 28,754 Payments on notes and subordinated debt (48,222) Proceeds from issuance of stock 2,282 Due from subsidiary (72,877) ---------- Cash provided by (used in) financing (90,063) ---------- activities Net increase (decrease) in cash: 21,848 Cash and cash equivalents at beginning of year - ---------- Cash and cash equivalents at end of year $ 21,848 =========\nThe accompanying notes are an integral part of the condensed financial information. See Notes to Condensed Financial Information on page S-4.\nS-3\nMetromedia International Group, Inc.\nNOTES TO CONDENSED FINANCIAL INFORMATION\n(A) Prior to the merger discussed in Note 2 to the Consolidated Financial Statements, there was no parent company. The accompanying parent company only financial statements reflect the operations of MIG from November 1, 1995 to December 31, 1995 and the equity in losses of subsidiaries for the year ended December 31, 1995. The Calendar 1995, Fiscal 1995 and 1994 amounts shown in the historical consolidated financial statements represent the combined financial statements of Orion and MITI prior to the merger and formation of MIG.\n(B) Principal repayments of the Registrant's borrowings under debt agreements and other debt outstanding at December 31, 1995 are expected to be required no earlier than as follows:\nActava ------\nFY 1996 32,682 FY 1997 15,887 FY 1998 60,336 FY 1999 4,428 FY 2000 - After FY 2000 75,000\nFor additional information regarding the Registrant's borrowings under debt agreements and other debt, see Note 8 to the Consolidated Financial Statements.\nS-4\nMetromedia International Group, Inc.\nS-5","section_15":""}
{"filename":"69659_1995.txt","cik":"69659","year":"1995","section_1":"Item 1. BUSINESS THE SYSTEM\nSYSTEM ORGANIZATION\nNew England Electric System (NEES) is a voluntary association created under Massachusetts law on January 2, 1926, and is a registered holding company under the Public Utility Holding Company Act of 1935 (the 1935 Act). NEES owns voting stock in the amounts indicated of the following companies, which together constitute the System.\n% Voting Securities State of Type of Owned by Name of Company Organization Business NEES --------------- ------------ -------- ---------\nSubsidiaries:\nGranite State Electric Company N.H. Retail 100 (Granite State) Electric\nMassachusetts Electric Company Mass. Retail 100 (Mass. Electric) Electric\nThe Narragansett Electric Company R.I. Retail 100 (Narragansett) Electric\nNarragansett Energy Resources R.I. Wholesale 100 Company (Resources) Electric Generation\nNew England Electric Resources, Inc. (NEERI) Mass. Development 100 Services\nNew England Electric Transmission N.H. Electric 100 Corporation (NEET) Transmission\nNew England Energy Incorporated Mass. Oil and Gas 100 (NEEI) Exploration & Development\nNew England Hydro-Transmission N.H. Electric 53.97(a) Corporation (N.H. Hydro) Transmission\nNew England Hydro-Transmission Mass. Electric 53.97(a) Electric Company, Inc. Transmission (Mass. Hydro)\nNew England Power Company (NEP) Mass. Wholesale 98.85(b) Electric Generation & Transmission\nNew England Power Service Company Mass. Service 100 (Service Company) Company\n(a) The common stock of these subsidiaries is owned by NEES and certain participants (or their parent companies) in Phase II of the Hydro-Quebec project. See Interconnection with Quebec, page 28.\n(b) Holders of common stock and 6% Cumulative Preferred Stock of NEP have general voting rights. The 6% Cumulative Preferred Stock represents 1.15% of the total voting power.\nThe facilities of NEES' three retail electric subsidiaries, Mass. Electric, Narragansett, and Granite State (collectively referred to as the Retail Companies), and of its principal wholesale electric subsidiary, NEP, constitute a single integrated electric utility system that is directly interconnected with other utilities in New England and New York State, and indirectly interconnected with utilities in Canada. See ELECTRIC UTILITY OPERATIONS, page 3.\nNEET owns and operates a portion of an international transmission interconnection between the electric systems of Hydro-Quebec and New England. Mass. Hydro and N.H. Hydro own and operate facilities in connection with an expanded second phase of this interconnection. See Interconnection with Quebec, page 28.\nNEEI is engaged in various activities relating to fuel supply for the System. These activities primarily include participation (principally through a partnership with a non-affiliated oil company) in domestic oil and gas exploration, development, and production (see OIL AND GAS OPERATIONS, page 50) and the sale to NEP of fuel purchased in the open market.\nResources is a general partner, with a 20% interest, in each of two partnerships formed in connection with the Ocean State Power project. See Ocean State Power, page 28.\nThe Service Company has contracted with NEES and its subsidiaries to provide, at cost, such administrative, engineering, construction, legal, and financial services as the companies request.\nNEERI is a wholly-owned, non-utility subsidiary of NEES which provides consulting and independent project development services domestically and internationally to non-affiliates and seeks investment opportunities in power plant modernization, transmission, and environmental improvement. NEERI also provides maintenance and construction services under contract to certain non-affiliated utility customers.\nEMPLOYEES\nAs of December 31, 1995, NEES subsidiaries had approximately 4,830 employees. As of that date, the total number of employees was approximately 800 at NEP, 1,715 at Mass. Electric, 765 at Narragansett, 75 at Granite State, and 1,475 at the Service Company. Of the 4,830 employees, approximately 3,100 are members of labor organizations. Collective bargaining agreements with the Brotherhood of Utility Workers of New England, Inc., the International Brotherhood of Electrical Workers, and the Utility Workers Union of America, AFL-CIO were signed in May, 1995 and expire in May, 1999.\nELECTRIC UTILITY OPERATIONS\nGENERAL\nNEP's business is principally generating, purchasing, transmitting, and selling electric energy in wholesale quantities. In 1995, 95% of NEP's revenue from the sale of electricity was derived from sales for resale to affiliated companies and 5% from sales for resale to municipal and other utilities. NEP is the wholesale supplier of the electric energy requirements of the Retail Companies under contracts that require seven years notice of termination. Narragansett receives credits against its purchases of power from NEP for the cost of generation from its Providence units, which are functionally integrated with NEP's facilities to achieve maximum economy and reliability. Discussions of NEP's generating properties, load growth, energy mix, and fuel supplies include the related properties of Narragansett. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 27 of the New England Power Company 1995 Annual Report to Stockholders (the NEP 1995 Annual Report). (For a discussion of electric utility operations in a more competitive environment, see COMPETITIVE CONDITIONS, page 7).\nThe combined service area of the Retail Companies constitutes the retail service area of the System and covers more than 4,400 square miles with a population of about 3,000,000 (1990 census). See Map, page 24. The largest cities served are Worcester, Mass. (population 170,000) and Providence, R.I. (population 161,000).\nMass. Electric and Narragansett are engaged principally in the distribution and sale of electricity at retail. Mass. Electric provides approximately 950,000 customers with electric service at retail in a service area comprising approximately 43% of the area of The Commonwealth of Massachusetts. The population of the\nservice area is about 2,160,000 or 36% of the total population of the Commonwealth (1990 Census). Mass. Electric's territory consists of 146 cities and towns including rural, suburban, and urban communities with Worcester, Lowell, and Quincy being the largest cities served. The economy of the area is diversified. Principal industries served by Mass. Electric include electrical and industrial machinery, computer manufacturing and related products, plastic goods, fabricated metals and paper, and chemical products. In addition, a broad range of professional, banking, high-technology, medical, and educational concerns is served. During 1995, 41% of Mass. Electric's revenue from the sale of electricity was derived from residential customers, 37% from commercial customers, 21% from industrial customers, and 1% from others. In 1995, the 20 largest customers of Mass. Electric accounted for approximately 7% of its electric revenue. For details of sales of energy and operating revenue for the last five years, see OPERATING STATISTICS on page 21 of Mass. Electric's 1995 to Stockholders (the Mass. Electric 1995 Annual Report).\nNarragansett provides approximately 328,000 customers with electric service at retail. Its service territory, which includes urban, suburban, and rural areas, covers about 839 square miles or 80% of the area of Rhode Island, and encompasses 27 cities and towns including the cities of Providence, Warwick, Cranston, and East Providence. The population of the area is about 725,000 (1990 Census) which represents about 72% of the total population of the state. The economy of the territory is diversified. Principal industries served by Narragansett produce fabricated metal products, jewelry, silverware, electrical and industrial machinery, transportation equipment, textiles, and chemical and allied products. In addition, a broad range of professional, banking, medical, and educational institutions is served. During 1995, 42% of Narragansett's revenue from the sale of electricity was derived from residential customers, 41% from commercial customers, 15% from industrial customers, and 2% from others. In 1995, the 20 largest customers of Narragansett accounted for approximately 9% of its electric revenue. For details of sales of energy and operating revenue for the last five years see OPERATING STATISTICS on page 21 of Narragansett's 1995 Annual Report to Stockholders (the Narragansett 1995 Annual Report).\nGranite State provides approximately 36,000 customers in 21 New Hampshire communities with electric service at retail in the State of New Hampshire in a service area having a population of about 73,000 (1990 Census), including the city of Lebanon and the towns of Hanover, Pelham, Salem and surrounding communities. During 1995, 48% of Granite State's revenue from the sale of electricity was derived from commercial customers, 39% from residential customers, 12% from industrial customers, and 1% from others. In\n1995, the 10 largest customers of Granite State accounted for about 18% of its electric revenue. Granite State is not subject to the reporting requirements of the Securities Exchange Act of 1934, and its financial impact on the System is relatively small. Information on Granite State is provided herein solely for the purpose of furnishing a more complete description of System operations.\nOn March 22, 1995, NEES agreed to acquire Nantucket Electric Company for $3.5 million. Completion of the acquisition occured on March 22, 1996.\nThe electric utility business of NEP and the Retail Companies is not highly seasonal. For NEP and the Retail Companies, industrial customers are broadly distributed among standardized industrial classifications. No single industrial classification exceeds 3% of operating revenue, and no single customer of the System contributes more than 1% of operating revenue.\nKilowatt hour (kWh) sales to ultimate customers increased less than 1 percent in 1995. This increase was primarily due to a return to more normal weather in the fourth quarter of 1995, along with a warmer summer in 1995, partially offset by lower sales in the first quarter of 1995, due to unusually mild weather. In 1994, kWh sales to ultimate customers increased 1.6 percent over 1993, reflecting an improved economy.\nCOMPETITIVE CONDITIONS\nThe electric utility business is being subjected to rapidly increasing competitive pressures, stemming from a combination of trends, including the presence of surplus generating capacity, a disparity in electric rates among regions of the country, improvements in generation efficiency, increasing demand for customer choice, and new regulations and legislation intended to foster competition. To date, this competition has been most prominent in the bulk power market, in which non-utility generators have significantly increased their market share. Electric utilities have had exclusive franchises for the retail sale of electricity in specified service territories. As a result, competition in the retail market has been limited to (i) competition with alternative fuel suppliers, primarily for heating and cooling, (ii) competition with customer-owned generation, and (iii) direct competition among electric utilities to attract major new facilities to their service territories. These competitive pressures have led the subsidiaries of NEES (NEES Companies) and other utilities to offer, from time to time, special discounts or service packages to certain large customers.\nIn states across the country, including Massachusetts, Rhode Island, and New Hampshire, there have been an increasing number of proposals to allow retail customers to choose their electricity supplier, with incumbent utilities required to deliver that electricity over their transmission and distribution systems (also known as \"retail wheeling\"). If electric customers were allowed to choose their electricity supplier, the Retail Companies' role would change and they would provide only distribution services. Power would be provided by power generators and marketers, which could be either affiliated or non-affiliated companies. In these competitive circumstances, utilities across the country that operate generation plants, such as NEP, would face the risk that market prices may not be sufficient to recover the costs of the commitments incurred to supply customers under a regulated industry structure. The amount by which costs exceed market prices is commonly referred to as \"stranded costs\".\nThe NEES Companies derive approximately 70 percent, 23 percent, and 3 percent of their electric sales revenues from ultimate customers in Massachusetts, Rhode Island, and New Hampshire, respectively. Each of the Retail Companies purchases electricity under wholesale all-requirements contracts with NEES's wholesale generating subsidiary, NEP and resell it to their customers. Legislative or utility initiatives, such as Choice: New England, could ultimately result in changes in the relationship between NEP and its all-requirements customers.\nChoice: New England\nIn October 1995, the NEES Companies announced a plan to allow all customers of electric utilities in Massachusetts, Rhode Island, and New Hampshire to choose their power supplier beginning in 1998. The plan, Choice: New England, was developed in response to 1995 decisions by the Massachusetts Department of Public Utilities (MDPU) and the Rhode Island Public Utilities Commission (RIPUC) that approved a set of principles for industry restructuring. These principles include allowing utilities the opportunity to recover stranded costs. Choice: New England was formally filed by Mass. Electric with the MDPU in February 1996. In March 1995, the RIPUC ordered all utilities in Rhode Island to file restructuring plans by April 12, 1996. In response to a RIPUC order, Narragansett plans to file a similar version of Choice: New England with the RIPUC in April 1996.\nUnder Choice: New England, the Retail Companies would no longer sell electricity to their customers. Instead, customers would purchase electricity from a supplier of their choice, with the Retail Companies remaining responsible for providing distribution services to customers under regulated rates. Transmission services would be provided by a new affiliate, NEES Transmission Services, Inc. (NEES Trans), which would be formed by NEES to provide comparable service across the NEES Companies' transmission system. NEP has recently filed a proposed tariff rate with the Federal Energy Regulatory Commission (FERC) whereby its transmission facilities would be operated by NEES Trans subsidiary pursuant to a support agreement. See RATES, page 14.\nUnder Choice: New England, the pricing of generation would be deregulated. However, customers would have the right to receive service under a \"standard offer\" from the incumbent utility or its affiliate, the pricing of which would be approved in advance by legislators or regulators. Customers electing the standard offer would be eligible to choose an alternative power supplier at any time, but would not be allowed to return to the standard offer. Under Choice: New England, transmission and distribution rates would remain regulated.\nUnder Choice: New England, the Retail Companies' wholesale contracts with NEP would be terminated. In return, Choice: New England proposes that the cost of NEP's past generation commitments be recovered from the Retail Companies through a contract termination charge. The Retail Companies would, in turn, seek to recover the payments to NEP through a wires access or transition charge to retail customers. Those commitments, which are currently estimated at approximately $4 billion on a present value basis, primarily consist of (i) generating plant commitments, (ii) regulatory assets, (iii) purchased power contracts, and (iv) the operating cost of nuclear plants which cannot be mitigated by shutting down the plants (otherwise referred to as \"nuclear costs independent of operation\"). Sunk costs associated with utility generating plants, such as past capital investments, and regulatory assets would be recovered over ten years. The return on equity related to the unrecovered capital investments and regulatory assets would be reduced to one percentage point over the rate on long-term \"BBB\" rated utility bonds. Purchased power contract costs and nuclear costs independent of operation would be recovered as incurred over the life of those obligations, a period expected to extend beyond ten years. The access charge would be set at three cents per kWh for the first three years. Thereafter, the access charge would vary, but is expected to decline. The provisions of Choice: New England, including the proposed access charge, are subject to state approval and FERC approval.\nIn March 1996, Mass. Electric filed a request with the MDPU to allow the implementation of two pilot programs to test the plan. The first would allow certain high technology customers in Massachusetts representing 1 percent of the NEES Companies' retail sales to have direct access to alternative power suppliers beginning in July 1996. The second would allow residential and small business customers in Massachusetts representing 0.5 percent of the NEES Companies' retail sales to have direct access beginning September 1, 1996.\nThree other utilities and the Massachusetts Division of Energy Resources (DOER) also filed plans with the MDPU in February 1996. The DOER's plan calls for direct access for all customers beginning in 1998 with a pilot program beginning in 1997. The DOER plan, however, proposes that, in exchange for stranded cost recovery, utilities divest their generating assets, either through sale or spinoff. The NEES Companies do not support the DOER mandatory divestiture proposal. The MDPU is expected to issue regulations on industry restructuring in September 1996 and to issue orders on the individual utility plans in 1997.\nRhode Island Legislation\nIn February 1996, the Speaker and Majority Leader of the House of Representatives of the Rhode Island Legislature announced the filing of legislation which would allow electric consumers in Rhode Island to choose their power supplier. Under the proposed legislation, large manufacturing customers and new large non- manufacturing customers would gain access to alternative power suppliers over a two-year period beginning in 1998. These customers represent approximately 14 percent of Narragansett's retail kWh sales. The balance of Rhode Island customers would gain access over a two- year period beginning in the year 2000, or earlier if consumers of 50 percent of the electricity in New England gain similar rights to choose their power supplier. The NEES Companies have announced their support for the proposed legislation.\nA key provision of the legislation authorizes utilities to recover the cost of past generation commitments through a transition access charge on utility distribution wires. The legislation divides those past commitments in the same manner as Choice: New England. The legislation proposes a 12-year recovery period for utility generation commitments and regulatory assets. The legislation would require Narragansett to transfer its 10 percent share of the Manchester Street Station and its transmission facilities to separate affiliates at net book value. (For further discussion on the Manchester Street Station repowering project, see Construction and Financing, page 44.)\nThe legislation also establishes performance-based rates for distribution utilities, such as Narragansett. Under the legislation, Narragansett would be entitled to increase its distribution rates by approximately $10 million annually, for the period 1997 through 1999, less any increases in wholesale base rates from NEP passed on by Narragansett to customers. For those three years, Narragansett's return on equity would be subject to a floor of 6 percent and a ceiling of 11 percent. Earnings over the ceiling would be shared equally between customers and shareholders up to an absolute cap on return on equity of 12.5 percent. To the extent that earnings fall below the floor, Narragansett would be authorized to surcharge customers for the shortfall. Consideration by the Rhode Island Legislature of the proposed legislation is expected to be completed by the summer of 1996.\nPreviously, in 1995, the Rhode Island Legislature passed legislation that would have allowed certain industrial customers to buy power from alternative suppliers, rather than through the local electric utility. Narragansett urged the Governor of Rhode Island\nto veto the legislation because Narragansett believed it would result in piecemeal deregulation that would not be fair to customers or shareholders. The Governor vetoed the proposed legislation, in part because of commitments by Narragansett to provide a two-year rate discount to manufacturing customers (see RATES, page 14) and to submit a specific and detailed proposal to the RIPUC addressing the issues associated with providing large customers with access to Narragansett's distribution system for the purpose of choosing an alternative power supplier.\nOther Legislative and Regulatory Initiatives\nIn February 1996, the New Hampshire House of Representatives passed a bill requiring utilities in that state to file plans by June 1996 with the New Hampshire Public Utilities Commission (NHPUC) to provide customers with access to alternative suppliers. The bill allows the NHPUC significant discretion in determining the appropriate level of stranded cost recovery. The bill would authorize the NHPUC to impose a plan on utilities if none is filed and approved by July 1997. The bill is pending in the state Senate.\nIn January 1996, Granite State reached an agreement with the NHPUC staff to conduct a retail access pilot for 3 percent of Granite State's customers. If approved by the NHPUC and the FERC, participating customers in the pilot will pay access charges that are on average over 90 percent of the charges proposed under Choice: New England. The agreement was reached in response to 1995 legislation which directed the NHPUC to establish a pilot program for the state's utilities. The agreement includes more favorable terms regarding stranded cost recovery than preliminary pilot guidelines issued by the NHPUC. In February 1996, the NHPUC indicated that further review of certain assumptions made in the agreement was necessary. The Commission also expanded the pilot to include new large commercial and industrial customers. Separately, in June 1995, the NHPUC issued a decision stating that franchise territories in New Hampshire are not exclusive as a matter of law. That decision is under appeal.\nIn February 1996, the MDPU denied the recovery of stranded power generation costs in the context of the town of Stow, Massachusetts, attempting to purchase the distribution assets in that town owned by the neighboring Hudson Municipal Light Department. Although the MDPU reaffirmed its general position that utilities should have a reasonable opportunity to recover net, non- mitigable, stranded costs, it refused to allow recovery in this case stating that Hudson had not sufficiently demonstrated that stranded costs would be incurred and made no effort to mitigate any such costs. Both parties have appealed the MDPU decision, and the MDPU has stayed its decision pending appeal.\nIn August 1995, the MDPU issued an order requiring a customer of another utility who installed cogenerating equipment to pay 75 percent of that utility's stranded costs attributable to serving the customer's load. The MDPU indicated the decision did not set a precedent for stranded cost recovery as part of industry restructuring. In March 1996, the FERC ruled that it would not review the MDPU's decision. The customer is expected to appeal the decision to the courts.\nIn March 1995, the FERC issued a Notice of Proposed Rulemaking (NOPR) in which it stated that it is appropriate that legitimate and verifiable stranded costs be recovered from departing customers as a result of wholesale competition. The FERC also indicated that costs stranded as a result of retail competition would be subject to state commission review if the necessary statutory authority exists and subject to FERC review if the state commission does not have such authority. A final decision is expected during 1996. The NOPR also addressed open access transmission and indicated that those utilities owning transmission facilities would be required to file a tariff to make available comparable transmission service. For further discussion, see RATES, page 14.\nRisk Factors\nThe major risk factors affecting recovery of at-risk assets are: (i) regulatory and legal decisions, (ii) the market price of power, and (iii) the amount of market share retained by the NEES Companies. First, there can be no assurance that a final restructuring plan ordered by regulatory bodies, or the courts, or through legislation will include an access charge that would fully recover stranded costs. If laws are enacted or regulatory decisions are made that do not offer an opportunity to recover stranded costs, NEES believes it has strong legal arguments to challenge such laws or decisions. Such a challenge would be based, in part, on the assertion that subjecting utility generating assets to competition without compensation for stranded costs, while requiring utilities to open access to their wires at historic cost-based rates, would constitute an unconstitutional taking of property without just compensation. Second, the access charge proposed under Choice: New England recovers only sunk costs, such as plant expenditures and contractual commitments. Because of a regional surplus of electric generation capacity, current wholesale power prices in the short-term market are based on the short-run fuel costs of generating units. Such wholesale prices are not currently providing a significant contribution toward other marginal costs, such as operation and maintenance expenses. The NEES Companies expect this situation to continue in a retail\nmarket. Third, revenues will also be affected by the NEES Companies' ability to retain existing customers and attract new customers in a competitive environment. As a result of the pressure on market prices and market share, it is likely that, even if Choice: New England is implemented, the NEES Companies would experience losses in revenue for an indeterminate period and increased revenue volatility.\nThe major risk factors affecting the Retail Companies relate to the possibility of adverse regulatory decisions or legislation which limit the level of revenues the Retail Companies are allowed to charge for their services. Each of the Retail Companies' all- requirements purchased power contract with NEP requires either party to give seven years notice prior to terminating the contract. Termination of the contract would create stranded costs at NEP that NEP would seek to recover from the Retail Companies pursuant to the contract. In that event, the Retail Companies would seek recovery of such stranded costs from their customers. However, there is no assurance that the final restructuring plans ordered by state regulatory bodies or state legislatures will include provisions that allow the Retail Companies to fully recover any stranded costs passed on to the Retail Companies by NEP. In such an event, the Retail Companies could be faced with a significant amount of costs being billed to them by NEP that the Retail Companies could not fully recover from retail customers, for which the Retail Companies would seek a remedy in the courts. In addition, there is no assurance that any performance incentive system, which regulators might ultimately adopt with respect to any of the Retail Companies' distribution activities, would allow the Retail Companies to fully recover prudently incurred costs and earn a reasonable return on investment.\nHistorically, electric utility rates have been based on a utility's costs. As a result, electric utilities are subject to certain accounting standards that are not applicable to other business enterprises in general. Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS 71), requires regulated entities, in appropriate circumstances, to establish regulatory assets and liabilities, and thereby defer the income statement impact of certain costs that are expected to be recovered in future rates. The effects of regulatory, legislative, or utility initiatives could, in the near future, cause all or a portion of the NEES Companies' operations to cease meeting the criteria of FAS 71. In that event, the application of FAS 71 to such operations would be discontinued and a non-cash write-off of previously established regulatory assets and liabilities related to such operations would be required. At December 31, 1995, NEES had consolidated pre-tax regulatory assets (net of regulatory liabilities) of approximately $600 million, of\nwhich about $500 million is related to its subsidiaries' generation business (including approximately $200 million related to oil and gas properties regulated as part of the generation business which is recoverable in its entirety from NEP), $54 million is related to Mass. Electric, and $48 million is related to Narragansett. If competitive or regulatory change should cause a substantial revenue loss or lead to the permanent shutdown of any generating facilities, a write-down of plant assets could be required pursuant to 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 addition, FAS 121 requires that all regulatory assets, which must have a high probability of recovery to be initially established, must continue to meet that high probability standard to avoid being written off. FAS 121, which is effective for NEES and its subsidiaries in January 1996, is not expected to have a material adverse impact on the financial condition or results of operations upon adoption, based on the current regulatory environment in which NEES's subsidiaries operate. However, the impact in the future may change as competitive factors and potential restructuring influence the electric utility industry.\nRATES\nGeneral\nIn 1995, 73% of the System's electric utility revenues was attributable to NEP, whose rates are subject to regulation by the FERC. The rates of Mass. Electric, Narragansett, and Granite State are subject to the respective jurisdictions of the state regulatory commissions in Massachusetts, Rhode Island, and New Hampshire.\nThe rates of each of the Retail Companies contain a purchased power cost adjustment clause (PPCA). The PPCA is designed to allow the Retail Companies to pass on to their customers changes in purchased power expense resulting from changes allowed by the FERC in NEP's rates. PPCA changes become effective on the dates specified in the filing of the adjustments with the state regulatory commission (not earlier than 30 days after such filing) unless the state regulatory commission orders otherwise. There have been, on occasion, regulatory delays in permitting PPCA increases. Narragansett and Granite State rates have PPCA clauses that fully reconcile on an annual basis purchased power expenses incurred by the companies against purchased power related revenues.\nUnder a case decided by the Rhode Island Supreme Court in 1977 (Narragansett v. Burke), NEP's wholesale rates must be accepted as\nallowable expenses for rate-making purposes by state commissions in retail rate proceedings. In 1986 and 1988 the U.S. Supreme Court reaffirmed this doctrine in two cases that did not involve NEP. However, the Narragansett v. Burke doctrine has been indirectly challenged by a number of state regulatory commissions which have held that federal preemption of the regulation of wholesale electric rates does not preclude the state commission from reviewing the prudence of a utility's decision to purchase power under a FERC-approved rate, and from disallowing costs if it finds that the purchase was an imprudent choice among alternative sources. In a 1985 opinion, the New Hampshire Supreme Court took this position on the issue of state regulation of wholesale power purchases. Also, legislation has been filed from time to time in Congress that would have eroded or repealed the doctrine. If state commissions were to refuse to allow the Retail Companies to include the full cost of power purchased from NEP in their rates, System earnings could be adversely affected.\nThe rates of NEP and the Retail Companies contain fuel adjustment clauses that allow the rates to be adjusted to reflect changes in the cost of fuel. NEP's fuel clause is on a current basis. Mass. Electric has a fuel clause billing procedure that provides for billing of fuel costs estimated on a quarterly basis, while fuel costs billed by Narragansett and Granite State are estimated on a semi-annual basis. Billings are adjusted in the subsequent period for any excess or deficiency in fuel cost recovery.\nFor a discussion of rates in a more competitive environment, see COMPETITIVE CONDITIONS, page 7.\nNEP Rates\nIn February 1995, the FERC approved a rate agreement filed by NEP. Under the agreement, which became effective January 1995, NEP's base rates are frozen through 1996. Before this rate agreement, NEP's rate structure contained two surcharges that were recovering the costs of a coal conversion project and a portion of NEP's investment in the Seabrook 1 nuclear unit (Seabrook 1). These two surcharges fully recovered their related costs by mid-1995. However, under the rate agreement, the revenues continue to be collected as part of base rates. The agreement also provides for (i) full recovery of costs associated with the Manchester Street Station repowering project, which began commercial operation during the second half of 1995, (ii) the recovery of approximately $50 million of deferred costs associated with terminated purchased power contracts and postretirement benefits other than pensions (PBOPs) over seven years, (iii) full recovery of currently incurred PBOP costs, (iv) the recovery over three years of $27 million of\ncosts related to the dismantling of a retired generating station in Rhode Island and the replacement of a turbine rotor at one of NEP's generating units, and (v) increased recovery of depreciation expense by approximately $8 million annually to recognize costs that will be incurred upon the eventual dismantling of its Brayton Point and Salem Harbor generating plants. Under the agreement, approximately $15 million of the $38 million in Seabrook 1 costs scheduled for recovery in 1995 pursuant to a 1988 settlement agreement were deferred for recovery in 1996.\nFinally, the agreement provided that NEP would reimburse its wholesale customers for discounts provided by those wholesale customers to their retail customers under service extension discount (SED) programs. Under these programs, retail customers are entitled to such discounts only if they have signed an agreement not to purchase power from another supplier or generate any additional power themselves for a three to five year period. Reimbursements in 1995 totaled $12 million.\nThe FERC's approval of this rate agreement applies to all of NEP's customers except the Milford Power Limited Partnership (MPLP). MPLP, owner of a gas-fired power plant in Milford, Massachusetts, has protested this rate agreement based on issues related to the Manchester Street Station repowering project. See LEGAL PROCEEDINGS , page 60.\nTransmission Rates\nIn response to the FERC NOPR discussed above, NEP and NEES Trans, a proposed new subsidiary of NEES, filed transmission tariffs in March 1996 at the FERC that will become applicable for all wholesale transmission transactions, including those of the Retail Companies. Under the proposed tariffs and accompanying support agreements, NEES Trans will provide all wholesale transmission services involving the NEES Companies' facilities under comparable, nondiscriminatory transmission rates. The existing NEES Companies would turn operational control of their transmission facilities over to NEES Trans in exchange for support payments from NEES Trans for these facilities. The existing NEES Companies may, at a later date, transfer their transmission assets to NEES Trans. The net book values of NEP's and Narragansett's transmission systems are approximately $340 million and $80 million, respectively. NEP is requesting that its filing become effective by June 1, 1996 or upon approval by the Securities and Exchange Commission (SEC), for the establishment of this new company. If approved as filed, the implementation of the tariffs would not have a significant impact on NEP's revenues.\nMass. Electric Rates\nRate schedules applicable to electric services rendered by Mass. Electric are on file with the MDPU.\nThe MDPU approved a $31 million increase to base rates for Mass. Electric, effective October 1, 1995.\nIn 1993, the MDPU approved a rate agreement filed by Mass. Electric, the Massachusetts Attorney General, and two groups of large commercial and industrial customers. Under the agreement, effective December 1, 1993, Mass. Electric implemented an 11-month general rate decrease of $26 million (annual basis). This rate reduction continued in effect through October 31, 1994, at which time rates increased to the previously approved levels. The agreement also provided for the recognition of electricity delivered but not yet billed (unbilled revenues) for accounting purposes. Unbilled revenues at September 30, 1993 of approximately $35 million were amortized to income over 13 months ending December 1994. The agreement further provided for rate discounts for large commercial and industrial customers who signed agreements to give a five year notice to Mass. Electric before they purchase power from another supplier or generate any additional power themselves. In addition, commencing in 1995 the cost of these discounts is being passed on to NEP as a result of a NEP rate settlement that was approved by the FERC in early 1995.\nThe 1993 agreement also resolved all rate recovery issues associated with environmental remediation costs of Massachusetts manufactured gas waste sites formerly owned by Mass. Electric and its affiliates, as well as certain other environmental cleanup costs. See Hazardous Substances, page 40.\nNarragansett Rates\nRate schedules applicable to electric services rendered by Narragansett are on file with the RIPUC and the Rhode Island Division of Public Utilities and Carriers.\nThe RIPUC approved a settlement agreement that provides for a $15 million increase to base rates for Narragansett effective December 1, 1995. The RIPUC also approved $3 million of new discounts for manufacturing customers, the costs of which are not being recovered from other customers. In February 1995, the FERC approved a rate agreement, effective in January 1995, for NEP. This rate agreement, among other things, increased the credits Narragansett receives from NEP for the costs of owning and operating its generation and transmission facilities\nby $14 million on an annual basis. Narragansett supplies all of the output of its generating facilities to NEP. The increase in the credits reflects Narragansett's 10 percent investment in the Manchester Street Station, which entered commercial operation in the second half of 1995, and the transmission facilities associated with the station, which were placed in service in September 1994. An additional increase in these credits of approximately $2 million took effect in January 1996.\nIn 1994, the RIPUC approved a rate agreement between Narragansett and the Rhode Island Division of Public Utilities and Carriers that provided for Narragansett to recognize, for accounting purposes, $14 million of unbilled revenues over a 21 month period which ended in December 1995. The agreement further provided for rate discounts for large commercial and industrial customers who signed agreements to give a five-year notice to Narragansett before they purchase power from another supplier or generate any additional power themselves. In addition, commencing in 1995 the cost of these discounts is being passed on to NEP as a result of the NEP rate settlement referred to above.\nEffective March 1993, the RIPUC approved a new PPCA mechanism for the recovery of all of Narragansett's purchased power costs, excluding fuel charges which continue to be recovered through a separate adjustment mechanism. Under the new mechanism any over or under-collections of purchased power expense will ultimately be passed on to customers including the effects of peak-demand billing fluctuations. Narragansett accrues the effects of this new mechanism on its books on a current basis.\nEffective January 1993, the RIPUC approved a $1.5 million increase in rates for Narragansett, representing the first step of a three-year phase-in of Narragansett's recovery of costs associated with PBOPs. The second and third $1.5 million increases took effect in January 1994 and 1995, respectively.\nA 1986 Rhode Island Supreme Court decision held that the RIPUC's rate-making power includes the authority to order refunds of amounts earned in excess of an allowed return. As a result, the RIPUC monitors Narragansett's earnings on a regular basis.\nGranite State Rates\nIn July 1995, Granite State filed a $2.6 million rate increase request with the NHPUC. On October 31, 1995, Granite State received approval to collect an interim increase of $0.9 million, effective November 1, 1995, subject to refund or surcharge pending the final outcome of the full case. The NHPUC staff is recommending a rate decrease of approximately $0.3 million. A final decision is expected in 1996.\nCommencing in 1995, Granite State began offering discounts to large commercial and industrial customers who give Granite State a five year notice before they purchase power from another supplier or generate additional power themselves. Granite State is reimbursed for these discounts by NEP. Effective July 1, 1993, the NHPUC approved a $0.7 million increase in rates for Granite State to recover costs associated with PBOPs.\nEffective March 1993, the NHPUC authorized a $2.0 million rate increase for Granite State, with a retroactive adjustment to September 15, 1992 to reflect the difference between the authorized amount and the $1.4 million Granite State had been collecting on an interim basis since September 15, 1992.\nRecovery of Demand-Side Management Expenditures\nThe three Retail Companies offer conservation and load management programs, usually referred to in the industry as Demand- Side Management (DSM) programs, which are designed to help customers use electricity efficiently, as a part of meeting the NEES Companies' future resource needs and customers' needs for energy services.\nThe Retail Companies regularly file their DSM programs with their respective regulatory agencies and have received approval to recover DSM program expenditures in rates on a current basis. Mass. Electric's expenditures were $53 million, $59 million, $47 million in 1995, 1994, and 1993, respectively. Narragansett's expenditures were $9 million, $10 million, and $12 million in 1995, 1994, and 1993, respectively. Since 1990, the Retail Companies have been allowed to earn incentives based on the results of their DSM programs. The Retail Companies must be able to demonstrate the electricity savings produced by their DSM programs to their respective state regulatory agencies before incentives are recorded. Mass Electric recorded $5.1 million, $7.1 million, and $6.7 million of before-tax incentives in 1995, 1994, and 1993, respectively. Narragansett recorded $0.5 million, $0.6 million, and $0.5 million of before-tax incentives in 1995, 1994, and 1993, respectively. The Retail Companies have received regulatory orders that will give them the opportunity to continue to earn incentives based on 1996 DSM program results.\nGENERATION\nEnergy Mix\nThe following table displays the contributions of various fuel sources and other generation to total net generation of electricity by NEP during the past three years, as well as an estimate for 1996:\nElectric Utility Properties\nThe electric utility properties of the System companies consist of NEP's and Narragansett's fossil-fuel base load and intermediate load steam and combined cycle generating units, conventional and pumped storage hydroelectric stations, internal combustion peaking units, portions of fossil fuel and nuclear generating units, the ownership interests of NEET, Mass. Hydro, and N.H. Hydro in the Hydro-Quebec Interconnection, and an integrated system of transmission lines, substations, and distribution facilities. See MAP - ELECTRIC UTILITY PROPERTIES, page 24.\nNEP's integrated system consists of 2,284 circuit miles of transmission lines, 117 substations with an aggregate capacity of 13,718,538 kVA, and 7 pole or conduit miles of distribution lines. The properties of Mass. Electric and Narragansett include substations and distribution and transmission lines, which are interconnected with transmission and other facilities of NEP. At December 31, 1995, Mass. Electric owned 256 substations, which had\nan aggregate capacity of 2,794,364 kVA, 142,636 line transformers with the capacity of 7,315,338 kVA, and 15,726 pole or conduit miles of distribution lines. Mass. Electric also owns 83 circuit miles of transmission lines. At December 31, 1995, Narragansett owned 237 substations, which had an aggregate capacity of 2,803,118 kVA, 48,828 line transformers with the capacity of 2,090,935 kVA, and 4,297 pole or conduit miles of distribution lines. Narragansett, in addition, owns 325 circuit miles of transmission lines.\nSubstantially all of the properties and franchises of Mass. Electric, Narragansett, and NEP are subject to the liens of indentures under which mortgage bonds have been issued. For details of the mortgage liens on these properties see the long-term debt note in Notes to Financial Statements in each of these companies' respective 1995 annual reports. The properties of NEET are subject to a mortgage under its financing arrangements.\n(a) These units currently burn coal, but are also capable of burning oil. In addition Brayton Point Units 1, 2, and 3 are capable of limited co-firing of natural gas.\n(b) For a discussion of the Manchester Street Station repowering project, see Construction and Financing on page 44.\n(c) Includes (i) an interest in a jointly owned oil-fired unit in Yarmouth, Maine, and (ii) diesel units at various locations.\n(d) See Hydroelectric Project Licensing, page 38.\n(e) See Nuclear Units, page 29.\n(f) Capability includes contracted purchases (1,402) less contract sales (364 MW). Net generation includes the effects of the above contracted purchases and economy interchanges through the New England Power Exchange (including a 2 MW capacity credit associated with purchases from Hydro-Quebec and purchases from non-utility generation). For further information see Non- Utility Power Producer Information, page 27.\nNEP and Narragansett are members of the New England Power Pool (NEPOOL). Mass. Electric and Granite State participate in NEPOOL through NEP. The NEPOOL Agreement provides for coordination of the planning and operation of the generation and transmission facilities of its members. The NEPOOL Agreement incorporates generating capacity reserve obligations, provisions regarding the use of major transmission lines, and provisions for payment for facilities usage. The NEPOOL Agreement further provides for New England-wide central dispatch of generation through the New England Power Exchange. Through NEPOOL, operating and capital economies are achieved and reserves are established on a region-wide rather than an individual company basis.\nThe 1995 NEPOOL peak demand of 20,499 MW occurred on July 27, 1995. This was slightly below the all time NEPOOL peak demand of 20,519 MW set on July 21, 1994.\nThe 1995 summer peak for the System of 4,381 MW occurred at the same day as the NEPOOL peak demand. The previous all-time peak load of 4,385 MW occurred on July 21, 1994. The 1995-1996 winter peak of 4,069 MW occurred on December 14, 1995.\nMAP\n(Displays electric utility properties of NEES subsidiaries)\nFuel for Generation\nNEP burned the following amounts of coal, residual oil, and gas during the past three years:\n1995 1994 1993 ---- ---- ---- Coal (in millions of tons) 3.4 3.3 3.2\nOil (in millions of barrels) 1.7 3.4 5.0\nNatural Gas (in billions of cubic feet) 16.2 4.0 0.7\nCoal Procurement Program\nDepending on coal-fired generating unit availability and the degree to which the units are dispatched, NEP's 1996 coal requirements should range between 3.5 and 3.8 million tons. NEP obtains its domestic coal under contracts of varying lengths and on a spot basis from domestic coal producers in Kentucky, West Virginia, and Virginia, and from mines in Colombia and Venezuela. Two different rail systems (CSX and Norfolk Southern) transport coal from domestic sources to loading ports on the east coast. NEP's coal is transported from east coast ports by ocean-going collier to Brayton Point and Salem Harbor. NEP has a term charter with the Energy Enterprise, a self-unloading collier, which carries most of NEP's U.S. coal and a portion of foreign coal. See LEGAL PROCEEDINGS, page 60. NEP also charters other coal-carrying vessels for the balance of foreign coal, and presently has contracts of affreightment with Canada Steamship Lines, International and Malbulk Shipping Inc.. As protection against interruptions in coal deliveries, NEP maintains average coal inventories at its generating stations of 35 to 55 days.\nTo meet environmental requirements, NEP uses coal with a relatively low sulphur content. NEP's average price for coal burned, including transportation costs, calculated on a 26 million Btu per ton basis, was $43.53 per ton in 1993, $42.90 in 1994, and $42.25 in 1995. Based on a 42 gallon barrel of oil producing 6.3 million Btu's, these coal prices were equivalent to approximately $10.57 per barrel of oil in 1993, $10.41 in 1994, and $10.25 in 1995.\nOil Procurement Program\nDepending on unit availability, dispatch, and the relationship of oil and gas prices, the System's 1996 oil requirements are expected to be approximately 1.5 to 2.0 million barrels. The System obtains its oil requirements through contracts with oil\nsuppliers and purchases on the spot market. Current contracts provide for minimum purchases of 0.4 million barrels at market related prices. The System currently has a total storage capacity for approximately 1.5 million barrels of residual and diesel fuel oil. The System's average cost of oil burned, calculated on a 6.3 million Btu per barrel basis, was $13.30 in 1993, $13.17 in 1994, and $14.46 in 1995.\nNatural Gas\nNEP uses natural gas at Manchester Street (see Construction and Financing, page 44) and, when gas is priced less than residual fuel oil, at Brayton Point Unit 4. Brayton Point Units 1, 2, and 3 also have limited capability to co-fire natural gas with coal. In 1995, approximately 56 billion cubic feet of gas were purchased at an average cost (excluding pipeline demand charges) of $1.70\/MMBTU, 16 billion cubic feet of which were consumed at Brayton Point and Manchester Street Station. This price was equivalent to approximately 10.77 per barrel of oil. The remaining gas was sold to third parties or delivered to an independent power producer project from which NEP purchases power.\nNEP's principal service agreements for firm transportation are with the following pipeline companies:\n(1) 60 million cubic feet per day on TransCanada PipeLines, Ltd (TransCanada) from western Canada supply sources to an interconnection with Iroquois Gas Transmission System (Iroquois). NEP has released 25 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(2) 60 million cubic feet per day on Iroquois to an interconnection with Tennessee Gas Pipeline Company (Tennessee).\n(3) 60 million cubic feet per day on Tennessee to an interconnection with Algonquin Gas Transmission Company (Algonquin).\n(4) 60 million cubic feet per day on ANR Pipeline Company from mid-continent supply sources to an interconnection with Columbia Gas Transmission (Columbia). NEP has released 15 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(5) 60 million cubic feet per day on Columbia to an interconnection with Algonquin. NEP has released 15 million cubic feet per day of this pipeline capacity on a limited, recallable basis.\n(6) 95 million cubic feet per day on Algonquin to NEP's facilities.\n(7) 120 million cubic feet per day on an Algonquin lateral for deliveries to Brayton Point Station.\nNEP has contracts with two Canadian natural gas suppliers for a total of 35 million cubic feet per day . NEP has not signed any long-term supply arrangements with mid-continent producers. In addition, NEP has a 7.5 million cubic feet per day supply contract with Distrigas Corporation of Massachusetts (DOMAC). Service commenced December 1, 1995.\nService under the pipeline agreements listed above and the DOMAC supply contract require minimum fixed payments. NEP's minimum fixed payments under all pipeline and supply agreements (including those listed above) are currently estimated to be approximately $60 million to $65 million per year from 1996 to 2000. Remaining fixed payments from 2001 through 2014 total approximately $625 million. The amount of the fixed payments is subject to FERC regulation and will depend on FERC actions affecting the rates on each of the pipelines.\nIn connection with managing its fuel supply, NEP uses a portion of this pipeline capacity to sell natural gas. Proceeds from the sale of natural gas and pipeline capacity of $71 million, $55 million, and $21 million in 1995, 1994, and 1993, respectively, have been passed on to customers through NEP's fuel clause. Natural gas sales are expected to decrease as a result of the Manchester Street Station entering commercial operation in the second half of 1995.\nNuclear Fuel Supply\nAs noted below, NEP participates with other New England utilities in the ownership of several nuclear units. See Nuclear Units, page 29. The utilities responsible for supply for these units are not experiencing any difficulty in obtaining commitments for the supply of each element of the nuclear fuel cycle.\nNon-Utility Power Producer Information\nThe System companies purchase a portion of the electricity generated by, or provide back-up or standard service to, 136 small power producers, cogenerators, or independent power producers (a total of 5,178,209 MWh of purchases in 1995). As of December 31, 1995, these non-utility generation sources include 26 low-head\nhydroelectric plants, 49 wind or solar generators, seven waste to energy facilities, 51 cogenerators, and three independent power producers. The total capacity of these sources is as follows:\nIn Service Future Projects (12\/31\/95) Under Contract Source (MW) (MW) ------ ---------- --------------- Hydro 37 - Wind - 20 Waste to Energy 173 16 Cogeneration 304 - Independent Power Producers 380 - ---- -- Total 894 36\nThe in-service amount includes 743 MW of long-term capacity, 16 MW of short-term capacity, and 135 MW treated as load reductions and includes the Ocean State Power contracts discussed below.\nOcean State Power\nOcean State Power (OSP) and Ocean State Power II (OSP II) are general partnerships that own and operate a two unit gas-fired combined cycle electric power plant in Burrillville, R.I. The first unit began commercial operation on December 31, 1990 and the second unit went into service on October 1, 1991. The two units have a combined winter net electrical capability of approximately 562 MW. Each unit's capacity and energy output is sold under 20-year unit power agreements to a group of New England utilities, including NEP, which has contracts for 48.5% of the output of each unit. NEP is required to make certain minimum fixed payments to cover capital and fixed operating costs of these units in amounts estimated to be $75 million per year.\nResources is a general partner with a 20% interest in both OSP and OSP II and had an equity investment of approximately $36 million at December 31, 1995.\nInterconnection with Quebec\nNEET, Mass. Hydro, and New Hampshire Hydro own and operate, on behalf of NEPOOL participants in the project, a 450 kV direct current transmission line and related terminals to interconnect the New England and Quebec transmission systems (the Interconnection). The transfer capability of the Interconnection is 2,000 MW. Operating limits implemented by adjacent Power Pools covering New York, New Jersey, Pennsylvania, and Maryland often restrict the effective transfer capability to a lower level. NEPOOL members\npurchase from and sell energy to Hydro-Quebec pursuant to several agreements. The principal agreement calls for NEPOOL members to purchase 7 billion kWh of energy each year for ten years (the Firm Energy Contract). Purchases under the Firm Energy Contract totaled over 5.2 billion kWh in 1995. Net energy deliveries from Hydro- Quebec over the Interconnection totaled more than 8 billion kWh in 1995. These additional deliveries reflect the use of the Interconnection by participants to conduct independent transactions with Hydro-Quebec on a regular basis.\nNEP is a participant in both the Phase I and Phase II projects of the Interconnection. NEP's participation percentage in both projects is approximately 18%. NEP and the other participants have entered into support agreements that end in 2020, to pay monthly their proportionate share of the total cost of constructing, owning, and operating the transmission facilities. NEP accounts for these support agreements as capital leases and accordingly recorded approximately $73 million in utility plant at December 31, 1995. Under the support agreements, NEP has agreed, in conjunction with any Phase II project debt financing, to guarantee its share of project debt. At December 31, 1995, NEP had guaranteed approximately $30 million of project debt. In the event any Interconnection facilities are abandoned for any reason, each participant is contractually committed to pay its pro-rata share of the net investment in the abandoned facilities.\nNuclear Units\nGeneral\nNEP is a stockholder of Yankee Atomic Electric Company (Yankee Atomic), Vermont Yankee Nuclear Power Corporation (Vermont Yankee), Maine Yankee Atomic Power Company (Maine Yankee), and Connecticut Yankee Atomic Power Company (Connecticut Yankee). Each of these companies (collectively referred to as the Yankee Companies) owns a single nuclear generating unit. In addition, NEP is a joint owner of the Millstone 3 nuclear generating unit in Connecticut and the Seabrook 1 nuclear generating unit in New Hampshire. Millstone 3 and Seabrook 1 are operated by subsidiaries of Northeast Utilities (NU). NEP pays its proportionate share of costs and receives its proportionate share of each unit's output. NEP's interest and investment in each of the Yankee Companies, Millstone 3, and Seabrook 1 and the net capability of each plant are as follows:\nEquity Net Investment Capability (12\/31\/95) Interest (MW) (in millions) -------- ---------- ------------- Yankee Atomic 30.0% * $ 7 Vermont Yankee 20.0% 96 10 Maine Yankee 20.0% 158 15 Connecticut Yankee 15.0% 87 15 ---- ---- Subtotal 341 $47\nNet Investment in Plant** (12\/31\/95) (in millions) ------------- Millstone 3 12.2% 140 $386 Seabrook 1 9.9% 115 62 ---- ---- Subtotal 255 $448 ---- Total 595 ====\n*Operations permanently ceased **Excludes nuclear fuel\nNEP has a 30% ownership interest in Yankee Atomic which owns a 185 megawatt nuclear generating station in Rowe, Massachusetts. In 1992, the Yankee Atomic board of directors decided to permanently cease power operation of the facility and to proceed with decommissioning.\nNEP has recorded an estimate of its total future payment obligations for post-operating costs to Yankee Atomic as a liability and an offsetting regulatory asset of $68 million each at December 31, 1995, reflecting its expected future rate recovery of such costs.\nNEP purchases the output of the other Yankee nuclear electric generating plants in the same percentages as its stock ownership of the Yankee Companies, less small entitlements taken by municipal utilities for Maine Yankee and Vermont Yankee. NEP has power contracts with each Yankee Company that require NEP to pay an amount equal to its share of total fixed and operating costs (including decommissioning costs) of the plant plus a return on equity.\nThe stockholders of three Yankee Companies (Vermont Yankee, Maine Yankee, and Connecticut Yankee) have agreed, subject to regulatory approval, to provide capital requirements in the same proportion as their ownership percentages of the particular Yankee Company.\nThere is widespread concern about the safety of nuclear generating plants. The Nuclear Regulatory Commission (NRC) regularly reviews the adequacy of its comprehensive requirements for nuclear plants. Many local, state, and national public officials have expressed their opposition to nuclear power in general and to the continued operation of nuclear power plants. From time to time, various organizations and individuals file petitions raising safety concerns at particular nuclear units. It is possible that this controversy will result in cost increases and modifications to, or premature shutdown of, the operating nuclear units in which NEP has an interest.\nMaine Yankee is currently operating at 90% power (790 MW) while the NRC conducts an investigation of allegations made by an anonymous individual. The allegations contend that Yankee Atomic, acting as agent for Maine Yankee, knowingly performed inadequate analyses of the plant's cooling system and that Maine Yankee misrepresented the analyses to the NRC in order to attain two license amendments to increase the rated thermal power at which Maine Yankee may operate. Maine Yankee and Yankee Atomic are also conducting an internal investigation into the matter. Maine Yankee is performing a new cooling system analysis in order to address the NRC's concerns with the existing analyses and intends to submit the new analysis to the NRC by mid-1996. The schedule for NRC review of, and action upon, the filing is unknown. The NRC also has on- going investigations into allegations about safety violations made by a whistle blower employee at Vermont Yankee.\nIn January 1996, the NRC added the three units at Millstone Station to its Category 2 problem plant list. This designation indicates that \"weaknesses have been identified that warrant increased NRC attention until the licensee demonstrates a period of improved performance.\" Although there are significant variations in the performance of the three units, a number of problems over the last five years, combined with a failure to sustain improved performance across all three units and to resolve employee concerns, resulted in the entire station being placed on the problem plant list. In addition, the NRC has ordered Millstone 1 and 2 to remain shutdown pending safety verification. NEP has no ownership interest in either Millstone 1 or 2. In March 1996, the NRC issued a letter requiring Millstone 3 and Connecticut Yankee to demonstrate to the NRC within 30 days a plan and schedule\nto ensure that the future operation of those units will be conducted in accordance with their operating licenses and safety provisions or face license suspension. The letter was issued based upon internal documentation provided to the NRC which stated that Millstone 3 and Connecticut Yankee may have some of the same underlying problems as Millstone 1 and 2. It is unknown what effect the increased NRC scrutiny will have on the operations and cost of Millstone 3 and Connecticut Yankee. Other non-affiliated facilities which have been on the problem plant list have incurred substantial additional capital and operating expenditures before the NRC designation was changed.\nOn three occasions (most recently in 1987), referenda appeared on the ballot in Maine that, if passed, would have required the prompt shutdown of Maine Yankee. All the referenda were defeated. There is no assurance that similar measures will not appear on future ballots.\nAging Units\nThe remaining Yankee plants may experience age-related deterioration of essential plant equipment or facilities. To the extent that costly repair, replacement, or maintenance becomes necessary due to such deterioration, the overall economics of the unit would have to be re-evaluated and early shut-down of such units could occur, as was the case with the Yankee Atomic plant.\nMaine Yankee was shut down from January 1995 to January 1996 for refueling and repairs to the plant's steam generators. Analyses of the plant's steam generator tubes during the 1995 refueling revealed that approximately 60% of the tubes had sustained some level of circumferential cracking. Maine Yankee repaired the tubes by inserting reinforcing \"sleeves\" into all 17,100 tubes in its three steam generators. The sleeving repair was completed at a cost of $26.8 million ($4.8 million NEP share), significantly under the original $40 million ($7.2 million NEP share) budget. Maine Yankee has been operating at 90% capacity since January 1996, and plans to operate at 100% capacity upon resolution of the NRC investigation referred to above.\nDecommissioning\nEach of the Yankee Companies includes charges for all or a portion of decommissioning costs in its cost of energy. These charges vary depending upon rate treatment, the method of decommissioning assumed, economic assumptions, site and unit specific variables, and other factors. Any increase in these charges is subject to FERC approval.\nEach of the operating nuclear units has established decommissioning trust funds or escrow funds into which payments are being made to meet the projected cost of decommissioning and dismantling its plant. If any of the units were shut down prior to the end of its operating license, the funds collected for decommissioning to that point would be insufficient. Estimates of NEP's pro-rata share (based on ownership) of decommissioning costs, NEP's share of the actual book values of decommissioning fund balances set aside for each unit at December 31, 1995, and the expiration date of the operating license of each plant are as follows:\nNEP is currently collecting through rates amounts for decommissioning based upon cost estimates and funding methodologies authorized by FERC. Such estimates are determined periodically for each plant and may not reflect the current projected cost of decommissioning.\nThere is no assurance that decommissioning costs actually incurred by the Yankee Companies, Millstone 3, or Seabrook 1 will not substantially exceed these amounts. For example, current decommissioning cost estimates assume the availability of permanent repositories for both low-level and high-level nuclear waste which do not currently exist. NRC rules require that reasonable assurance be provided that adequate funds will be available for the decommissioning of commercial nuclear power plants. The rule\nestablishes minimum funding levels that licensees must satisfy. Each of the units in which NEP has an interest has filed a report with the NRC providing assurance that funds will be available to decommission the facility.\nA Maine statute provides that if both Maine Yankee and its decommissioning trust fund have insufficient assets to pay for the plant decommissioning, the owners of Maine Yankee are jointly and severally liable for the shortfall. The definition of owner under the statute covers NEP and may cover companies affiliated with it. NEP and the Retail Companies cannot determine, at this time, the constitutionality, applicability, or effect of this statute. If NEP or the Retail Companies were required to make payments under this statute, they would assess their legal remedies at that time. In any event, NEP and the Retail Companies would attempt to recover through rates any payments required. If any claim in excess of NEP's ownership share were enforced against a NEES company, that company would seek reimbursement from any other Maine Yankee stockholder which failed to pay its share of such costs.\nHigh-Level Waste Disposal\nThe Nuclear Waste Policy Act of 1982 provides a framework and timetable for selection of sites for repositories of high-level radioactive waste (spent nuclear fuel) from United States nuclear plants. The U.S. Department of Energy (DOE) has entered into contracts with the Yankee Companies, the Millstone 3 joint owners, and the Seabrook 1 joint owners for acceptance of title to, and transportation and storage of, this waste. Under these contracts, each operating unit will pay fees to the DOE to cover the development and creation of waste repositories. Fees for fuel burned since April 1983 have been collected by the DOE on an ongoing basis at the rate of one tenth of a cent per kWh of net generation. Fees for generation up through April 1983 were determined by the DOE as follows: $13.2 million for Yankee Atomic, $48.7 million for Connecticut Yankee, $50.4 million for Maine Yankee, and $39.3 million for Vermont Yankee. Neither Millstone 3 nor Seabrook 1 has been assessed any fees for fuel burned through April 1983, because they did not enter commercial operation until 1986 and 1990, respectively.\nThe Yankee Companies had several options to pay these fees. Yankee Atomic paid its fee to the DOE for the period through April 1983. The other three Yankee Companies elected to defer payment until a future date, thereby incurring interest expense. However, payment to the DOE must occur prior to the first delivery of spent fuel. Connecticut, Maine, and Vermont Yankee have segregated a portion of their respective DOE obligations in external accounts. The remainder of the funds have been used to support general\ncapital requirements. All expect to separately fund in full in external accounts their DOE obligation (including accrued interest) prior to payment to the DOE. To the extent that any of the three Yankee Companies is unable to fully meet its DOE obligation at the prescribed time, NEP might be required to provide additional funds.\nPrior to such time that the DOE takes delivery of a plant's spent nuclear fuel, it is stored on site in spent fuel pools. Connecticut Yankee, Maine Yankee, Millstone 3, and Seabrook are in the process of reconfiguring their spent fuel pools to allow for additional storage capability. Upon successful completion of the reconfiguring, Connecticut Yankee, Maine Yankee, and Millstone 3 will have sufficient spent fuel pool capacity to support plant operation through the expiration of their respective current NRC license. Seabrook 1's licensed storage capacity will allow a full core discharge until 2011. Vermont Yankee is able to maintain a full core discharge capability until 2001. Yankee Atomic has adequate on-site storage capacity for all its spent fuel.\nFederal legislation enacted in 1987 directed the DOE to proceed with the studies necessary to develop and operate a permanent high-level waste disposal site at Yucca Mountain, Nevada. There is local opposition to development of this site. Although originally scheduled to open in 1998, the DOE currently estimates that the permanent disposal site is not expected to open before 2015. Nuclear waste legislation mandating DOE acceptance of spent fuel at an interim storage site in Nevada by January 1, 1998 was introduced in Congress in 1995. To date, the legislation has not been brought before the House or the Senate for vote. In January 1996, oral arguments were heard in a lawsuit filed in the U.S. Court of Appeals for the District of Columbia Circuit by 25 utilities, 22 public utilities commissions, and 17 states. The lawsuit petitions the court to declare the 1998 contract date a binding legal obligation and to order DOE to report back to the court with a plan for meeting that obligation. The Court is expected to issue a decision by May 1996.\nThe legislation enacted in 1987 also provides for the development of a Monitored Retrievable Storage (MRS) facility and abandons plans to identify and select a second, permanent disposal site. An MRS facility would provide temporary storage for high-level waste prior to eventual permanent disposal. Pending a vote on the legislation mentioned above, it is not known when an MRS facility would begin accepting deliveries. Additional delays due to political and technical problems are likely.\nFederal authorities have deferred indefinitely the commercial reprocessing of spent nuclear fuel.\nLow-Level Waste Disposal\nIn 1986, the Low-Level Radioactive Waste Policy Amendments Act was enacted by Congress. This statute allowed the states in which the three existing low-level waste disposal sites were located to deny access to non-regional waste generators after 1992. Under the statute, individual states are responsible for finding local sites for disposal or forming regional disposal compacts by defined milestone dates.\nNone of the states in which NEP holds an interest in a nuclear facility has met the statutory milestones toward developing disposal sites. Currently, two low-level waste disposal sites in the U.S. are accepting non-regional waste, Chem-Nuclear Systems, Inc.'s site in Barnwell, South Carolina and Envirocare of Utah, Inc's site in Clive, Utah. The Barnwell facility reopened its services to most non-regional generators, on July 1, 1995 and is authorized to remain open until July 1, 2005. In March 1996, the South Carolina Supreme Court will hear oral arguments on a challenge to the constitutionality of the legislation re-opening the Barnwell facility to non-regional generators. Envirocare began accepting Class A low-level waste in 1995. Class A waste is the least contaminated of the three categories defining low-level waste. The Barnwell facility accepts all three categories of waste. Connecticut Yankee, Maine Yankee, Millstone 3, Seabrook, and Yankee Atomic are currently shipping low-level waste to these sites.\nThe states of Maine and Vermont have established a compact with Texas for the disposal of low-level waste in Hudspeth County, Texas. The compact agreement has been approved in all three states and is now before the U.S. Congress. If Congress approves, the site is expected to begin accepting waste during 1997 or 1998. While Maine Yankee has been shipping its low-level waste off-site, Vermont Yankee has elected to store low-level waste on-site until that time. The compact releases Maine and Vermont from having to site an in-state disposal facility. Connecticut, Massachusetts, and New Hampshire are still required to pursue local or regional low-level waste disposal facilities. However, Massachusetts is expected to suspend its search for a local disposal facility in 1996.\nNuclear Insurance\nThe Price-Anderson Act limits the amount of liability claims that would have to be paid in the event of a single incident at a nuclear plant to $8.9 billion (based upon 110 licensed reactors). The maximum amount of commercially available insurance coverage to pay such claims is only $200 million. The remaining $8.7 billion\nwould be provided by an assessment of up to $79.3 million per incident levied on each of the nuclear units in the United States, subject to a maximum assessment of $10 million per incident per nuclear unit in any year. The maximum assessment, which was most recently adjusted in 1993, is adjusted for inflation at least every five years. NEP's current interest in the Yankee Companies (excluding Yankee Atomic), Millstone 3, and Seabrook 1 would subject NEP to a $58.0 million maximum assessment per incident. NEP's payment of any such assessment would be limited to a maximum of $7.3 million per incident per year. As a result of the permanent cessation of power operation of the Yankee Atomic plant, Yankee Atomic has received from the NRC a partial exemption from obligations under the Price-Anderson Act. However, Yankee Atomic must continue to maintain $100 million of commercially available nuclear insurance coverage.\nEach of the nuclear units in which NEP has an ownership interest also carries nuclear insurance to cover the costs of property damage, decontamination or premature decommissioning and workers' claims resulting from a nuclear incident. These policies may require additional premium assessments if losses relating to nuclear incidents at units covered by this insurance occurring in a prior six year period exceed the accumulated funds available. NEP's maximum potential exposure for these assessments, directly, or indirectly through purchased power payments to the Yankees, is approximately $17 million per year.\nOther Items\nFederal legislation requires emergency response plans, approved by federal authorities, for nuclear generating units. The Yankee Companies, Seabrook 1, and Millstone 3 are not currently experiencing difficulty in maintaining approval of their emergency response plans.\nREGULATORY AND ENVIRONMENTAL MATTERS\nRegulation\nNumerous activities of NEES and its subsidiaries are subject to regulation by various federal agencies. Under the 1935 Act, many transactions of NEES and its subsidiaries are subject to the jurisdiction of the SEC. With the intensifying competitive pressures within the electric utility industry, there has been increasing debate about modifying or repealing the 1935 Act. The System supports its repeal. (See COMPETITIVE CONDITIONS, page 7). Under the Federal Power Act, certain electric subsidiaries of NEES are subject to the jurisdiction of the FERC with respect to rates,\naccounting, and hydroelectric facilities. In addition, the NRC has broad jurisdiction over nuclear units and federal environmental agencies have broad jurisdiction over environmental matters. The electric utility subsidiaries of NEES are also subject to the jurisdiction of regulatory bodies of the states and municipalities in which they operate.\nFor more information, see: RATES, page 14, Nuclear Units, page 29, Fuel for Generation, page 25, Environmental Requirements, page 39, and OIL AND GAS OPERATIONS, page 50.\nHydroelectric Project Licensing\nNEP is the largest operator of conventional hydroelectric facilities in New England. Most of NEP's hydroelectric projects are licensed by the FERC. These licenses expire periodically and the projects must be relicensed at that time. NEP's present licenses expire over a period from 2001 to 2020, excluding the Deerfield River Project discussed below. Upon expiration of a FERC license for a hydro project, the project may be taken over by the United States or licensed to the existing, or a new licensee. If the project were taken over, the existing licensee would receive an amount equal to the lesser of (i) fair value of the project or (ii) original cost less depreciation and amounts held in amortization reserves, plus in either case severance damages. The net book value of NEP's hydroelectric projects was $241 million as of December 31, 1995.\nIn the event that a new license is not issued when the existing license expires, FERC must issue annual licenses to the existing licensee which will allow the project to continue operation until a new license is issued. A new license for a project may incorporate operational restrictions and requirements for additional non-power facilities (e.g., fish passage or recreational facilities) that could affect operation of the project, and may also require additional capital investment. For example, NEP has previously received new licenses for projects on the Connecticut River that involved construction of an extensive system of fish ladders.\nThe license for the 84 MW Deerfield River Project expired at the end of 1993. NEP filed an application for a new license in 1991, which is still under review. NEP has signed, with 15 governmental agencies and advocacy groups, an Offer of Settlement which embodies operational, environmental and recreational conditions acceptable to the parties. NEP has received water quality certifications from the Commonwealth of Massachusetts and the State of Vermont needed to complete the FERC relicensing processing. In Vermont the certificate has been appealed by two\nadvocacy groups who did not participate in the Offer of Settlement process. FERC has issued NEP an annual license to continue operation of the project under the terms and conditions of the expired license until a new license is issued or other disposition of the project takes place.\nThe next NEP project to require a new license will be the 368 MW Fifteen Mile Falls Project on the Connecticut River in New Hampshire and Vermont. This license expires in 2001. The formal process of preparing an application for a new license will begin in 1996.\nIn 1994, the FERC adopted a policy statement in which it asserted that it has authority over the decommissioning of licensed hydroelectric projects being abandoned or denied a new license. However, the FERC has recognized in the process leading to the policy statement, that mandated project removal would occur in only rare circumstances. The FERC also declined to require any generic funding mechanism to cover decommissioning costs. If a project is decommissioned, the licensee may incur substantial costs.\nEnvironmental Requirements\nExisting Operations\nThe NEES subsidiaries are subject to federal, state, and local environmental regulation of, among other things: wetlands and flood plains; air and water quality; storage, transportation, and disposal of hazardous wastes and substances; underground storage tanks; and land-use. It is likely that the stringency of environmental regulation affecting the System and its operations will increase in the future.\nSiting and Construction Activities for New Facilities\nAll New England states require, in certain circumstances, regulatory approval for site selection or construction of electric generating and major transmission facilities. Connecticut, Maine, Massachusetts, New Hampshire, and Rhode Island also have programs of coastal zone management that might restrict construction of power plants and other electrical facilities in, or potentially affecting, coastal areas. All agencies of the federal government must prepare a detailed statement of the environmental impact of all major federal actions significantly affecting the quality of the environment. The New England states have environmental laws which require project proponents to prepare reports of the environmental impact of certain proposed actions for review by various agencies. The System is not currently constructing generating plants or major transmission facilities.\nEnvironmental Expenditures\nTotal System capital expenditures for environmental protection facilities have been substantial. System capital expenditures for such facilities amounted to approximately $23 million in 1993, $51 in 1994, and $39 million in 1995, including expenditures by NEP of $14 million, $44 million, and $32 million, respectively, for those years. The System estimates that capital expenditures for environmental protection facilities in 1996 and 1997 will not be material to the System.\nHazardous Substances\nThe Federal Comprehensive Environmental Response, Compensation and Liability Act, more commonly known as the \"Superfund\" law, imposes strict, joint and several liability, regardless of fault, for remediation of property contaminated with hazardous substances. A number of states, including Massachusetts, have enacted similar laws.\nThe electric utility industry typically utilizes and\/or generates a range of potentially hazardous products and by-products in its operations. NEES subsidiaries currently have an environmental audit program in place intended to enhance compliance with existing federal, state, and local requirements regarding the handling of potentially hazardous products and by-products.\nNEES and\/or its subsidiaries have been named as potentially responsible parties (PRPs) by either the U.S. Environmental Protection Agency (EPA) or the Massachusetts Department of Environmental Protection for 22 sites at which hazardous waste is alleged to have been disposed. Private parties have also contacted or initiated legal proceedings against NEES and certain subsidiaries regarding hazardous waste cleanup. The most prevalent types of hazardous waste sites with which NEES and its subsidiaries have been associated with are manufactured gas locations. (Until the early 1970s, NEES was a combined electric and gas holding company system.) NEES is aware of approximately 40 such locations (including eight of the 22 locations for which NEES Companies are PRPs) mostly located in Massachusetts. NEES and its subsidiaries are currently aware of other sites, and may in the future become aware of additional sites, that they may be held responsible for remediating.\nNEES has been notified by the EPA that it is one of several PRPs for cleanup of the Pine Street Canal Superfund site in Burlington, Vermont, where coal tar and other materials were deposited. Between 1931 and 1951, NEES and its predecessor owned all of the common stock of Green Mountain Power Corporation (GMP).\nPrior to, during, and after that time, gas was manufactured at the Pine Street Canal site by GMP. In 1989, NEES was one of 14 parties required to pay the EPA's past response costs related to this site. NEES remains a PRP for ongoing and future response costs. In November 1992, the EPA proposed a cleanup plan estimated by the EPA to cost $50 million. In June 1993, the EPA withdrew this cleanup plan in response to public concern about the plan and its cost. The cost of any cleanup plan and NEES's share of such cost are uncertain at this time. NEES signed a settlement agreement in March 1996 establishing NEES's apportioned share of these costs. NEES believes it has adequate reserves for this site.\nIn 1993, the MDPU approved a Mass. Electric rate agreement that allows for remediation costs of former manufactured gas sites and certain other hazardous waste sites located in Massachusetts to be met from a non-rate- recoverable interest-bearing fund of $30 million established on Mass. Electric's books in 1993. Rate- recoverable contributions of $3 million, adjusted for inflation, are added to the fund annually in accordance with the agreement. Any shortfalls in the fund would be paid by Mass. Electric and be recovered through rates over seven years.\nPredicting the potential costs to investigate and remediate hazardous waste sites continues to be difficult. There are also significant uncertainties as to the portion, if any, of the investigation and remediation costs of any particular hazardous waste site that may ultimately be borne by NEES or its subsidiaries. A preliminary review by a consultant hired by the NEES Companies of the potential cost of investigating and, if necessary, remediating Rhode Island manufactured gas sites resulted in costs per site ranging from less than $1 million to $11 million. An informal survey of other utilities conducted on behalf of NEES and its subsidiaries indicated costs in a similar range. Where appropriate, the NEES Companies intend to seek recovery from their insurers and from other PRPs, but it is uncertain whether, and to what extent, such efforts would be successful. At December 31, 1995, NEES had total reserves for environmental response costs of $50 million and a related regulatory asset of $19 million. NEES believes that hazardous waste liabilities for all sites of which it is aware, and which are not covered by a rate agreement, are not be material to its financial position.\nElectric and Magnetic Fields (EMF)\nConcerns have been raised about whether EMF, which occur near transmission and distribution lines as well as near household wiring and appliances, cause or contribute to adverse health effects. Numerous studies on the effects of these fields, some of them sponsored by electric utilities (including NEES Companies), have been conducted and are continuing. Some of the studies have\nsuggested associations between certain EMF and health effects, including various types of cancer, while other studies have not substantiated such associations. It is impossible to predict the ultimate impact on NEES subsidiaries and the electric utility industry if further investigations were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems.\nMany utilities, including the NEES Companies, have been contacted by customers regarding the potential relationship between EMF and adverse health effects. To date, no court in the United States has ruled that EMF from electrical facilities cause adverse health effects and no utility has been found liable for personal injuries alleged to have been caused by EMF. In any event, the NEES Companies believe that they currently have adequate insurance coverage for personal injury claims.\nSeveral state courts have recognized a cause of action for damage to property values in transmission line condemnation cases based on the fear that power lines cause cancer. It is difficult to predict what the impact on the NEES Companies would be if this cause of action is recognized in the states in which NEES Companies operate and in contexts other than condemnation cases.\nAir\nApproximately 45 percent of NEP's electricity is produced at eight older thermal generating units in Massachusetts. Six are principally fueled by coal, one by oil, and one by oil and gas. The federal Clean Air Act requires significant reduction in utility sulfur dioxide (SO2) and nitrogen oxides (NOx) emissions that result from burning fossil fuels by the year 2000 to reduce acid rain and ground-level ozone (smog).\nNEP reduced SO2 emissions under Phase 1 of the federal acid rain program and SO2 and NOx emissions under Massachusetts regulations, all of which took effect in 1995. The SO2 and NOx reductions that were made to meet 1995 requirements have resulted in one-time operation and maintenance costs of $21 million and capital costs of $110 million through December 31, 1995. Additional capital expenditures in 1996 are expected to be less than $3 million. Depending on fuel prices, NEP also expects to incur not more than $5 million annually in increased costs to purchase cleaner fuels to meet SO2 emission reduction requirements.\nAll eight of NEP's thermal units will be subject to Phase 2 of the federal and state acid rain regulations that become effective in 2000. NEP believes that the SO2 controls already installed for the 1995 requirements will satisfy the Phase 2 acid rain regulations.\nIn connection with the federal ozone emission requirements, state environmental agencies in ozone non-attainment areas are developing a second phase of NOx reduction regulations that would have to be fully implemented by NEP no later than 1999. While the exact costs are not known, NEP estimates that the cost of implementing these regulations would not jeopardize continued operation of NEP's units.\nThe generation of electricity from fossil fuel also emits trace amounts of certain hazardous air pollutants and fine particulates. An EPA study of utility hazardous air pollutant emissions is expected to be completed in 1996. The study's conclusions could lead to new emission standards requiring costly controls or fuel restrictions on NEP plants. At this time, NEES and its subsidiaries cannot estimate the impact the findings of this research might have on NEP's operations.\nUnder the System's own 1993 corporate resource plan, also known as NEESPLAN 4, the System has a goal to reduce CO2, SOx, and NOx emissions by 2000 to 20%, 60%, and 60%, respectively, below 1990 levels. Consistent with the CO2 goal, in 1995, the NEES Companies and the DOE executed an accord in which the Companies committed to reduce greenhouse gas emissions (e.g. CO2) 20% below 1990 levels by 2000. The accord was executed pursuant to the Climate Challenge Program, a joint voluntary effort of the DOE and the electric utility industry. Climate Challenge is a component of President Clinton's Climate Change Action Plan.\nWater\nThe federal Clean Water Act prohibits the discharge of any pollutant (including heat), except in compliance with a discharge permit issued by the states or the EPA for a term of no more than five years. NEP and Narragansett have received required permits for all their steam-generating plants. NEET has received its required surface water discharge permits for all of its current operations.\nNEES facilities store substantial amounts of oil and are required to have spill prevention control and counter-measure (SPCC) plans. Currently, major System facilities such as Brayton Point and Salem Harbor have up-to-date SPCC plans. A comprehensive study of smaller facilities has been completed to determine the appropriate plans for these facilities and a five-year implementation plan is underway.\nNuclear\nThe NRC, along with other federal and state agencies, has extensive regulations pertaining to environmental aspects of nuclear reactors. Safety aspects of nuclear reactors, including design controls and inspection programs to mitigate any possibility of nuclear accidents and to reduce any damages therefrom, are also subject to NRC regulation. See Nuclear Units, page 29.\nCONSTRUCTION AND FINANCING\nIn 1995, NEES subsidiaries' completed the approximately 500 MW repowering of Manchester Street Station in Providence, R.I.\nNarragansett and NEP operated three steam electric generating units of approximately 45 MW each which went into service at Manchester Street Station in the 1940s. During 1992, NEP acquired a 90% interest in the site and the Station in anticipation of the repowering project. As part of the repowering project, three new combustion turbines and heat recovery steam generators were added to the Station, replacing the existing boilers. The existing steam turbines were replaced with new and more efficient turbines of slightly larger capacity. The fuel for generation, which was primarily residual oil, was be replaced with natural gas, using distillate oil as an emergency backup. See Fuel for Generation, page 25.\nRepowering more than tripled the power generation capacity of Manchester Street Station and has substantially increased the plant's thermal efficiency. It is expected that the plant's capacity factor will also increase. Certain air emissions are projected to decrease relative to historical levels because of the change in fuels and the increase in efficiency.\nSubstantial additions to Narragansett's high voltage transmission network were necessary in order to accommodate the output of the plant. Two 7-mile 115 kV underground transmission cables (located primarily in public ways) are in service, which connect the repowered station to existing 115 kV lines at a new substation. Total cost for the generating station will be approximately $450 million, including allowance for funds used during construction (AFDC). In addition, related transmission improvements were placed in service in September 1994 at a cost of approximately $60 million.\nEstimated construction expenditures (including nuclear fuel) for the System's electric utility companies are shown below for 1996 through 1998.\nThe System conducts a continuing review of its construction and financing programs. These programs and the estimates shown below are subject to revision based upon changes in assumptions as to System load growth, rates of inflation, receipt of adequate and timely rate relief, the availability and timing of regulatory approvals, new environmental and legal or regulatory requirements, total costs of major projects, and the availability and costs of external sources of capital.\nThe anticipated capital requirements for oil and gas operations are not included in the table below. See OIL AND GAS OPERATIONS page 50.\nFinancing\nAll of NEP's construction expenditures during the period from 1996 to 1998 will be financed by internally generated funds. The proportion of the Retail Companies' construction expenditures estimated to be financed by internally generated funds during the period from 1996 to 1998 is:\nMass. Electric 85% Narragansett 90% Granite State 75%\nThe general practice of the operating subsidiaries of NEES has been to finance construction expenditures in excess of internally generated funds initially by issuing unsecured short-term debt. This short-term debt is subsequently reduced through sales by such subsidiaries of long-term debt securities and preferred stock, and through capital contributions from NEES to the subsidiaries. NEES, in turn, generally has financed capital contributions to the operating subsidiaries through retained earnings and the sale of additional NEES shares. Since April 1991, NEES has been meeting all of the requirements of its dividend reinvestment and common share purchase plan and employee share plans through open market purchases. Under these plans, NEES may revert to the issuance of new common shares at any time.\nThe ability of NEP and the Retail Companies to issue short-term debt is limited by regulatory restrictions, by provisions contained in their charters, and by certain debt and other instruments. Under the charters or by-laws of NEP, Mass. Electric, and Narragansett, short-term debt is limited to 10% of capitalization. The preferred stockholders authorized these limitations to be increased to 20% of capitalization until 1998 for NEP and Narragansett, and until 1999 for Mass. Electric, at which time the limits will revert to 10% of capitalization. The following table summarizes the short-term debt limits at December 31, 1995, and the amount of outstanding short-term debt and lines of credit and standby bond facilities at such date.\nNEES and certain subsidiaries, with regulatory approval, operate a money pool to more effectively utilize cash resources and to reduce outside short-term borrowings. Short-term borrowing needs are met first by available funds of the money pool participants. Borrowing companies pay interest at a rate designed to approximate the cost of outside short-term borrowings. Companies which invest in the pool share the interest earned on a basis proportionate to their average monthly investment in the money pool. Funds may be withdrawn from or repaid to the pool at any time without prior notice. At December 31, 1995, NEP, Mass. Electric, and Narragansett each had money pool borrowings of approximately $1 million and Granite State had money pool borrowings of approximately $4 million.\nIn order to issue additional long-term debt and preferred stock, NEP and the Retail Companies must comply with earnings coverage requirements contained in their respective mortgages, note agreements, and preference provisions. The most restrictive of these provisions in each instance generally requires (1) for the issuance of additional mortgage bonds by NEP, Mass. Electric, and Narragansett, for purposes other than the refunding of certain outstanding mortgage bonds, a minimum earnings coverage (before income tax) of twice the pro forma annual interest charges on mortgage bonds, and (2) for the issuance of additional preferred stock by NEP, Mass. Electric, and Narragansett, minimum gross income coverage (after income tax) of one and one-half times pro forma annual interest charges and preferred stock dividends, in each case for a period of twelve consecutive calendar months within the fifteen calendar months immediately preceding the proposed new issue.\nThe respective long-term debt and preferred stock coverages of NEP and the Retail Companies under their respective mortgage indentures, note agreements, and preference provisions, are stated in the following table for the past three years:\nRESEARCH AND DEVELOPMENT\nExpenditures for the System's research and development activities totaled $9.5 million, $8.3 million, and $7.5 million in 1993, 1994, and 1995, respectively. Total expenditures are expected to be about $8.6 million in 1996.\nAbout 37% of these expenditures support the Electric Power Research Institute, which conducts research and development activities on behalf of its sponsors and provides the System with access to a wide range of relevant research results at minimum cost.\nThe System also directly funds research projects of a more site-specific concern to the System and its customers. These projects include:\n- creating options to allow the use of economically-priced fossil fuels without adversely\naffecting plant performance, and to insure safe, reliable and environmentally sound production of electric energy at the lowest cost;\n- developing and assessing new information and methods to understand and reduce the environmental impacts of System operations including investigation of offset methods for counterbalancing greenhouse gas emissions away from the source;\n- developing, assessing and demonstrating new generation technologies and fuels that will ensure economic, efficient and environmentally sound production of electric energy in the future; an example of this is the planned demonstration project linking advanced fuel cell technology to a biomass fuel at the Massachusetts Water Resources Authority Deer Island facility;\n- creating options to maintain electric service quality and reliability for customers at the lowest cost; and\n- developing conservation, load control, and rate design measures that will help customers use electric energy more efficiently.\nOIL AND GAS OPERATIONS\nGENERAL\nSince 1974, NEEI has engaged in oil and gas exploration and development, primarily through a partnership with Samedan Oil Corporation (Samedan), a subsidiary of Noble Affiliates, Inc. NEEI's oil and gas activities are regulated by the SEC under the 1935 Act.\nUnder the terms of the Samedan-NEEI partnership agreement, Samedan is the managing partner and oversees all partnership operations including the sale of production. Effective January 1, 1987, NEEI decided not to acquire new oil and gas prospects due to prevailing and expected oil and natural gas market conditions. This decision did not affect NEEI's interests and commitments in oil and gas properties owned as of December 31, 1986 by the Samedan-NEEI partnership. Samedan continues to explore, develop, and manage these properties on behalf of the partnership. Thus, the results of NEEI's operations are substantially affected by the performance of Samedan. Samedan may elect to terminate the partnership at the end of any calendar year upon one year's prior notice.\nNEEI is required to obtain SEC approval for further investment in these oil and gas properties. On December 20, 1994, the SEC issued an order authorizing NEEI to invest up to $30 million in its partnership with Samedan for the years 1995-1998. NEEI is winding down its oil and gas program. The level of expenditures for exploration and development of existing properties has declined as a result of the decision not to acquire new oil and gas prospects after December 31, 1986.\nNEEI's activities are primarily rate-regulated and consist of all prospects entered into prior to 1984. Losses from this rate-regulated program are being passed on to NEP and ultimately to retail customers, under an intercompany pricing policy (Pricing Policy) approved by the SEC. Due to declines in oil and gas prices, NEEI has incurred operating losses since 1986 and expects to generate substantial additional losses in the future. NEP's ability to pass such losses on to its customers was favorably resolved in NEP's 1988 FERC rate settlement. This settlement covered all costs incurred by or resulting from commitments made by NEEI through March 1, 1988. Other subsequent costs incurred by NEEI are subject to normal regulatory review. NEEI follows the full cost method of accounting for its oil and gas operations, under which capitalized costs (including interest paid to banks) relating to wells and leases determined to be either commercial or non-commercial are amortized using the unit of production method.\nDue to the Pricing Policy, NEEI's rate-regulated program has not been subject to certain SEC accounting rules, applicable to non-rate-regulated companies, which limit the costs of oil and gas property that can be capitalized. The Pricing Policy has allowed NEEI to capitalize all costs incurred in connection with fuel exploration activities of its rate regulated program, including interest paid to banks of which $10 million was capitalized in 1995 and 1994, and $9 million in 1993, respectively. In the absence of the Pricing Policy, the SEC's full cost \"ceiling test\" rule requires non-rate regulated companies to write-down capitalized costs to a level which approximates the present value of their proved oil and gas reserves. Based on NEEI's 1995 average oil and gas selling prices at December 31, 1995, if this test were applied, it would have resulted in a write-down of approximately $112 million after-tax.\nRESULTS OF OPERATIONS\nRevenues from natural gas sales were lower in 1995 versus 1994 due to decreased production levels and a decrease in natural gas prices. NEEI expects 1996 natural gas revenues to be lower than 1995 revenues due to lower production. NEEI's 1995 oil and gas exploration and development expenditures were $7 million.\nNEEI's estimated proved reserves decreased from 12.4 million barrels of oil and gas equivalent at December 31, 1994, to 10.8 million barrels of oil and gas equivalent at December 31, 1995. Production, primarily from offshore Gulf properties, decreased reserves by 3.0 million equivalent barrels. Additions and revisions primarily on offshore Gulf properties increased reserves by 1.4 million equivalent barrels.\nPrices received by NEEI for its natural gas from its major producing properties varied considerably during 1995, from approximately $0.85\/MCF to $1.66\/MCF, due principally to seasonal fluctuations and regional variations in gas prices. NEEI's overall average gas price in 1995 was $1.48\/MCF.\nThe results of NEEI's oil and gas program will continue to be affected by developments in the world oil market and the domestic market for natural gas, including actions by the federal government and by foreign governments, which may affect the price of oil and gas, and the terms of contracts under which gas is sold.\nThe following table summarizes NEEI's crude oil and condensate production in barrels, natural gas production in MCF, and the average sales price per barrel of oil and per MCF of natural gas produced by NEEI during the years ended December 1995, 1994, and 1993, and the average production (lifting) cost per dollar of gross revenues.\nOIL AND GAS PROPERTIES\nDuring 1995, principal producing properties, representing approximately 65% of NEEI's 1995 revenues, were (i) a 50% working interest in Brazos Blocks A-52, A-65, and A-37, located in federal waters offshore Texas, (ii) a 25% working interest in Main Pass Blocks 93, 94, 102, and 90, located in Federal waters offshore Louisiana, (iii) a 15% working interest in High Island Blocks 21, 22, 34, 50, and 51, located in Federal waters offshore Texas, (iv) a 12.5% working interest in Main Pass Blocks 107 and 108, located in Federal waters offshore Louisiana, and (v) a 7.5% working interest in High Island Blocks 365 and 376, located in Federal waters offshore Texas. Other major producing properties during 1995 included a 15% working interest in Eugene Island 28 located in Federal waters offshore Louisiana, a 15% working interest in Brazos Blocks 399, 400, 412, 413, and 435, located in Federal waters offshore Texas, a 13.3% working interest in Matagorda Island Block 587, located in Federal waters offshore Texas, a 3.2% working interest in the Sand Dunes Units, Derrick Draw Field, Converse County, Wyoming, and a 9.7% interest in Eugene Island 24, located in Federal waters offshore Louisiana.\nAs used in the tables below, (i) a productive well is an exploratory or a development well that is not a dry well, (ii) a dry well is an exploratory or development well found to be incapable of producing either oil or gas in commercial quantities, (iii) \"gross\" refers to the total acres or wells in which NEEI has a working interest, and (iv) \"net,\" as applied to acres or wells, refers to gross acres or wells multiplied by the percentage working interest owned by NEEI.\nThe following table shows the approximate undeveloped acreage held by NEEI as of December 31, 1995. Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether such acreage contains proved reserves.\nDuring the years ended December 31, 1995, 1994, and 1993 NEEI participated in the completion of the following net exploratory and development wells:\nThe following table summarizes the total gross and net productive wells and the approximate total gross and net developed acres, both as of December 31, 1995:\nAt December 31, 1995 NEEI was drilling or completing two gross wells, which represents less than one net well.\nCAPITAL REQUIREMENTS AND FINANCING\nEstimated expenditures in 1996 for NEEI's exploration and development program are approximately $15 million, of which capitalized interest costs are approximately $10 million.\nInternal funds are expected to provide 100% of NEEI's capital requirements for 1996. In April 1995, NEEI refinanced its outstanding borrowings through a credit agreement which currently provides for borrowings of up to $225 million. Borrowings under this credit agreement are principally secured by a pledge of NEEI's rights with respect to NEP under the Pricing Policy covering the rate-regulated program. The amount available for borrowing under the revolving credit agreement decreases annually, beginning April 13, 1996 and expiring April 13, 2002.\nNEEI MAP\nMajor Oil and Gas Properties\nEXECUTIVE OFFICERS\nNEES - ----\nAll executive officers are elected to continue in office subject to Article 19 of the Agreement and Declaration of Trust until the first meeting of the Board of Directors following the next annual meeting of shareholders, or the special meeting of shareholders held in lieu of such annual meeting, and until their successors are chosen and qualified. The executive officers also serve as officers and\/or directors of various subsidiary companies.\nJohn W. Rowe - Age: 50 - President and Chief Executive Officer since 1989 - Elected Chairman of NEP in 1993 - President of NEP from 1991 to 1993 - Chairman of NEP from 1989 to 1991.\nAlfred D. Houston - Age: 55 - Executive Vice President since 1994 - Senior Vice President-Finance from 1987 to 1994 - Vice President of NEP from 1987 to 1994 - Vice President of Narragansett since 1976 - Treasurer of Narragansett since 1977.\nRichard P. Sergel - Age: 46 - Elected Senior Vice President in 1996 - Vice President from 1992 to 1995 - Treasurer from 1990 to 1991 - Chairman of Mass. Electric and Narragansett since 1993 - Treasurer of NEP and Mass. Electric from 1990 to 1991 - Vice President of the Service Company from 1988 to 1993.\nJeffrey D. Tranen - Age: 49 - Elected Senior Vice President in 1996 - Vice President from 1991 to 1995 - President of NEP since 1993 - Vice President of NEP from 1984 to 1993 - President of Mass. Hydro, N.H. Hydro, and NEET since 1991.\nCheryl A. LaFleur - Age: 41 - Elected Vice President, Secretary, and General Counsel in 1995 - Vice President of Mass. Electric from 1993 to 1995 - Vice President of the Service Company from 1992 to 1993 - Senior Counsel for the Service Company from 1989 to 1991 - Elected Vice President of NEP in 1995.\nMichael E. Jesanis - Age: 39 - Treasurer since 1992 - Director of Corporate Finance from 1990 to 1991.\nNEP - ---\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive\nofficers are elected by the Board of Directors to hold office subject to the pleasure of the directors and until the first meeting of directors after the next annual meeting of stockholders and until their successors are duly chosen and qualified. Certain officers of NEP are, or at various times in the past have been, officers and\/or directors of the System companies with which NEP has entered into contracts and had other business relations. John W. Rowe* - Chairman since 1993 - President from 1991 to 1993 - Chairman from 1989 to 1991.\nJeffrey D. Tranen* - President since 1993 - Vice President from 1984 to 1993.\nAndrew H. Aitken - Age: 51 - Elected Vice President in 1995 - Director of Environmental and Safety for the Service Company since 1993 - Director, Environmental Affairs for the Service Company from 1981 to 1993.\nLawrence E. Bailey - Age: 52 - Vice President since 1989 - Plant Manager of Brayton Point Station from 1987 to 1991.\nJeffrey A. Donahue - Age: 37 - Vice President since 1993 - various engineering positions with the Service Company since 1983 - Director of Construction since 1992 - Chief Electrical Engineer since 1991.\nCheryl A. LaFleur* - Elected Vice President effective December 31, 1995.\nJohn F. Malley - Age: 47 - Vice President since 1992 - Manager of Generation Planning for the Service Company from 1986 to 1991.\nArnold H. Turner - Age: 55 - Vice President since 1989 - Director of Transmission Marketing since 1993.\nJeffrey W. VanSant - Age: 42 - Vice President since 1993 - Manager of Oil and Gas Exploration and Development for the Service Company from 1985 to 1993 - Manager of Oil and Gas Procurement from 1992 to 1993 - Manager of Natural Gas Supply from 1989 to 1992.\nMichael E. Jesanis* - Treasurer since 1992.\nHoward W. McDowell - Age: 52 - Controller since 1987 - Controller of Mass. Electric and Narragansett since 1987 - Treasurer of Granite State since 1984.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding this officer.\nMass. Electric - --------------\nThe Treasurer is elected by the stockholders to hold office until the next annual meeting of stockholders and until the successor is duly chosen and qualified. The other executive officers are elected by the board of directors to hold office subject to the pleasure of the directors and until the first meeting of the directors after the next annual meeting of stockholders. Certain officers of Mass. Electric are, or at various times in the past have been, officers and directors of System companies with which Mass. Electric has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nJohn H. Dickson - Age: 53 - President since 1990.\nJohn C. Amoroso - Age: 57 - Vice President since 1993 - District Manager, Southeast District from 1992 to 1993 - Manager, Southeast District from 1985 to 1992.\nEric P. Cody - Age: 45 - Elected Vice President in 1995 - Vice President and Director, Information Services for the Service Company from 1991 to 1995.\nPeter H. Gibson - Age: 50 - Vice President since 1995 - Director of Business Marketing since 1995 - Director of Business Marketing for the Service Company from 1993 to 1994 -Director of Conservation and Load Management (C&LM) and Commercial and Industrial Services for the Service Company from 1992 to 1993 - Manager of C&LM for the Service Company from 1987 to 1991.\nCharles H. Moser - Age: 55 - Vice President since 1993 - Chief Protection and Planning Engineer for the Service Company from 1984 to 1993.\nLydia M. Pastuszek - Age: 42 - Vice President since 1993 - Vice President of NEP from 1990 to 1993 - President of Granite State since 1990.\nAnthony C. Pini - Age: 43 - Vice President since 1993 - Assistant Controller for the Service Company from 1985 to 1993.\nThomas E. Rogers - Age: 45 - Elected Vice President in 1995 - Project Director for the Service Company from 1991 to 1995.\nChristopher E. Root - Age: 36 - Elected Vice President in 1995 - Director, Retail Distribution Services for the Service Company from 1993 to 1995 - Chief of Division Engineering for the Service Company from 1992 to 1993 - Manager, Distribution Engineering for Narragansett from 1990 to 1992.\nNancy H. Sala - Age: 44 - Vice President since 1992 - Central District Manager since 1992 - Assistant to the President of Mass. Electric from 1990 to 1992.\nDennis E. Snay - Age: 54 - Vice President and Merrimack Valley District Manager since 1990.\nMichael E. Jesanis - Treasurer since 1992 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Jesanis.\nHoward W. McDowell - Controller since 1987 and Assistant Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nNarragansett - ------------\nOfficers are elected by the board of directors or appointed, as appropriate, to serve until the meeting of directors following the annual meeting of stockholders, and until their successors are chosen and qualified. Officers other than the President, Treasurer, and Secretary, serve also at the pleasure of the directors. Certain officers of Narragansett are, or at various times in the past have been, officers and directors of System companies with which Narragansett has entered into contracts and had other business relations.\nRichard P. Sergel - Chairman since 1993 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Sergel.\nRobert L. McCabe - Age: 54 - President since 1986.\nWilliam Watkins, Jr. - Age 63 - Executive Vice President since 1992 - Vice President of the Service Company from 1981 to 1992.\nFrancis X. Beirne - Age: 52 - Vice President since 1993 - Manager, Southern District from 1988 to 1993.\nRichard W. Frost - Age: 56 - Vice President since 1993 - District Manager - Southern District from 1990 to 1993.\nAlfred D. Houston - Vice President since 1976 - Treasurer since 1977 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEES for other information regarding Mr. Houston.\nRichard Nadeau - Age: 60 - Vice President since 1994 - Director of Customer Service since 1993 - Assistant to the President from 1990 to 1993.\nMarcy L. Reed - Age: 32 - Elected Vice President in 1995 - Assistant Controller for the Service Company from 1993 to 1995 - Manager, Internal Audit for the Service Company from 1991 to 1993.\nMichael F. Ryan - Age: 44 - Vice President since 1994 - Rhode Island Director for U.S. Senator John H. Chafee from 1986 to 1994.\nHoward W. McDowell - Controller since 1987 - Reference is made to the material supplied under the caption EXECUTIVE OFFICERS - NEP for other information regarding Mr. McDowell.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nSee Item 1. Business - ELECTRIC UTILITY PROPERTIES, page 20 and OIL AND GAS PROPERTIES, page 53.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn October 1994, NEP was sued by MPLP, a venture of Enron Corporation and Jones Capital that owns a 149 megawatt gas-fired power plant in Milford, Massachusetts. NEP purchases 56 percent of the power output of the facility under a long-term contract with MPLP. The suit alleges that NEP has engaged in a scheme to cause MPLP and its power plant to fail and has prevented MPLP from finding a long-term buyer for the remainder of the facility's output. The complaint includes allegations that NEP has violated the Federal Racketeer Influenced and Corrupt Organizations Act, engaged in unfair or deceptive acts in trade or commerce, and breached contracts. MPLP also asserts that NEP deliberately misled\nregulatory bodies concerning the Manchester Street Station repowering project. MPLP seeks compensatory damages in an unspecified amount, as well as treble damages. NEP believes that the allegations of wrongdoing are without merit. NEP has filed counterclaims and crossclaims against MPLP, Enron Corporation, and Jones Capital, seeking monetary damages and termination of the purchased power contract.\nMPLP also intervened in NEP's current rate filing before the FERC, making similar allegations to those asserted in MPLP's lawsuit. Hearings on this claim concluded in October 1995. An Administrative Law Judge initial decision is expected by mid-1996.\nIn August 1995, an arbitration panel upheld NEP's right to terminate its charter of a ship, the SS. Energy Independence, to purchase the ship from its owner, Intercoastal Bulk Carriers, Inc. (\"IBC\"), and sell the ship to a nominee of International Shipping Company (\"ISC\"). That same month, the Massachusetts Superior Court dismissed a lawsuit filed against NEP by Keystone Shipping Company (\"Keystone\"), an affiliate of IBC, challenging NEP's right to do so. In September 1995, the ship was transferred to ISC's nominee and sent to dry dock for routine maintenance and inspection, which revealed that further work was needed to make the ship seaworthy. Under NEP's charter with IBC, these costs, which are estimated to be in excess of $10 million, are IBC's responsibility. NEP therefore initiated arbitration against both IBC and Keystone before the same panel. Hearings are tentatively scheduled to commence in June 1996. Keystone has filed an action in federal district court seeking to stay the arbitration as to Keystone.\nSee Item 1. COMPETITIVE CONDITIONS, page 7; RATES, page 14; Coal Procurement Program, page 25; Nuclear Units, page 29; Hydroelectric Project Licensing, page 38; Environmental Requirements, page 39; OIL AND GAS OPERATIONS, page 50.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nNEES information in response to the disclosure requirements specified by this Item 5. appears under the captions in the NEES Annual Report indicated below:\nRequired Information Annual Report Caption -------------------- ---------------------\n(a) Market Information Shareholder Information\n(b) Holders Shareholder Information\n(c) Dividends Financial Highlights\nThe information referred to above is incorporated by reference in this Item 5.\nNEP, Mass. Electric, and Narragansett - The information required by this item is not applicable as the common stock of all these companies is held solely by NEES. Information pertaining to payment of dividends and restrictions on payment of dividends is incorporated herein by reference to each company's 1995 Annual Report.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to page 23 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to page 28 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to page 22 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to page 22 of the Narragansett 1995 Annual Report.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 14 through 22 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 2 through 9 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 2 through 7 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 2 through 7 of the Narragansett 1995 Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNEES ----\nThe information required by this item is incorporated herein by reference to pages 23 through 42 of the NEES 1995 Annual Report.\nNEP ---\nThe information required by this item is incorporated herein by reference to pages 1, 10 through 26, and 28 of the NEP 1995 Annual Report.\nMass. Electric --------------\nThe information required by this item is incorporated herein by reference to pages 1, 8 through 20, and 22 of the Mass. Electric 1995 Annual Report.\nNarragansett ------------\nThe information required by this item is incorporated herein by reference to pages 1, 8 through 20, and 22 of the Narragansett 1995 Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNEES, NEP, Mass. Electric, and Narragansett - None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption ELECTION OF DIRECTORS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated. Reference is also made to the information under the caption EXECUTIVE OFFICERS - NEES in Part I of this report.\nNEP ---\nThe names of the directors of NEP, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - NEP in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok - Director since 1979 - Age: 66 - Chairman of the Board of NEES - Chairman or Vice Chairman of the Company from 1988 to 1994 - Chairman of NEES from 1984 to 1994 (Chairman, President, and Chief Executive Officer from July 26, 1988 until February 13, 1989). Directorships of NEES System companies: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company. Other directorships: Avery Dennison Corporation, John Hancock Mutual Life Insurance Company, and Monsanto Company.\nAlfred D. Houston* - Director since 1984. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\nCheryl A. LaFleur* - Elected Director effective December 31, 1995. Directorships of NEES System companies: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro- Transmission Electric Company, Inc., and New England Power Service Company.\nJohn W. Rowe* - Director since 1989. Directorships of NEES System companies and affiliates: New England Electric System, Massachusetts Electric Company, The Narragansett Electric Company, Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric Transmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro-Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., New England Power Service Company, and Maine Yankee Atomic Power Company. Other directorships: Bank of Boston Corporation and UNUM Corporation.\nJeffrey D. Tranen* - Director since 1991. Directorships of NEES System affiliates: Narragansett Energy Resources Company, New England Electric Resources, Inc., New England Electric\nTransmission Corporation, New England Energy Incorporated, New England Hydro Finance Company, Inc., New England Hydro- Transmission Corporation, New England Hydro-Transmission Electric Company, Inc., and New England Power Service Company.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES and EXECUTIVE OFFICERS - NEP in Part I of this report for other information regarding this director.\nMass. Electric --------------\nThe names of the directors of Mass. Electric, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Mass. Electric in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nUrville J. Beaumont - Director since 1984 - Age: 64 - Treasurer and Director, law firm of Beaumont & Campbell, P.A.\nJoan T. Bok* - Director since 1979.\nSally L. Collins - Director since 1976 - Age: 60 - Director of Workplace Health Services since 1993 - Health Services Administrator at Kollmorgen Corporation EOD from 1989 to 1993.\nJohn H. Dickson - Director since 1990 - Reference is made to material supplied under the caption EXECUTIVE OFFICERS - Mass. Electric for other information regarding Mr. Dickson. Other directorship: Worcester Business Development Corporation.\nKalyan K. Ghosh - Director since 1995 - Age: 58 - President of Worcester State College since 1992 - CEO and Acting President, Worcester State College from 1990 to 1992.\nCharles B. Housen - Director since 1979 - Age: 63 - Chairman, President, and Director of Erving Industries, Inc., Erving, Mass.\nPatricia McGovern - Director since 1994 - Age: 54 - Director of law firm of Goulston & Storrs, P.C. since 1995 - Counsel to Goulston & Storrs, P.C. from 1993 to 1995 - Massachusetts State Senator and Chair of the Senate Ways and Means Committee from 1985 to 1992.\nJohn F. Reilly - Director since 1988 - Age: 63 - President and CEO of Fred C. Church, Inc., Lowell, Mass. - Other directorships: Colonial Gas Company, Family Bank, and New England Insurance Co., Ltd.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Director since 1993.\nRoslyn M. Watson - Director since 1992 - Age: 46 - President of Watson Ventures (commercial real estate development and management) Boston, Mass. since 1993 - Vice President of the Gunwyn Company (commercial real estate development) Cambridge, Mass. from 1986 - 1993 - Other directorships: The Dreyfus Laurel Funds and American Express Centurion Bank.\n*Please refer to the material supplied under the caption EXECUTIVE OFFICERS - NEES in Part I of this report and\/or the material supplied under the caption DIRECTORS AND OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nNarragansett ------------\nThe names of the directors of Narragansett, their ages, and a brief account of their business experience during the past five years appear below. Information required by this item for Executive Officers is provided under the caption EXECUTIVE OFFICERS - - Narragansett in Part I of this report.\nDirectors are elected to hold office until the next annual meeting of stockholders or special meeting held in lieu thereof and until their respective successors are chosen and qualified.\nJoan T. Bok* - Director since 1979.\nStephen A. Cardi - Director since 1979 - Age: 54 - Treasurer of Cardi Corporation (construction), Warwick, R.I.\nFrances H. Gammell - Director since 1992 - Age: 46 - Director, Senior Vice President, Treasurer, and Secretary of Original Bradford Soap Works, Inc.\nJoseph J. Kirby - Director since 1988 - Age: 64 - President of Washington Trust Bancorp, Inc., Westerly, R.I. and President and Director of the Washington Trust Company.\nRobert L. McCabe - President and Director of Narragansett since 1986 - Other directorship: Citizens Savings Bank - Please refer to the material supplied under the caption EXECUTIVE OFFICERS - Narragansett in Part I of this report for other information regarding Mr. McCabe.\nJohn W. Rowe* - Director since 1989.\nRichard P. Sergel* - Chairman and Director since 1993.\nWilliam E. Trueheart - Director since 1989 - Age: 53 - President of Bryant College, Smithfield, Rhode Island - Other directorships: Fleet National Bank.\nJohn A. Wilson, Jr. - Director since 1971 - Age: 66 - Consultant to and former President of Wanskuck Co., Providence, R.I., - Consultant to Hinckley, Allen, Snyder & Comen (attorneys), Providence, R.I.\n*Please refer to the material supplied under the caption DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - NEP in this Item for other information regarding this director.\nSection 16(a) of the Securities Exchange Act of 1934 requires the System's officers and directors, and persons who own more than 10% of a registered class of the System's equity securities, to file reports on Forms 3, 4, and 5 of share ownership and changes in share ownership with the SEC and the New York Stock Exchange and to furnish the System with copies of all Section 16(a) forms they file.\nBased solely on NEP's, Mass. Electric's, and Narragansett's review of the copies of such forms received by them, or written representations from certain reporting persons that such forms were not required for those persons, NEP, Mass. Electric, and Narragansett believe that, during 1995, all filing requirements applicable to its officers, directors, and 10% beneficial owners were complied with.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the captions BOARD STRUCTURE AND COMPENSATION, EXECUTIVE COMPENSATION, PAYMENTS UPON A CHANGE IN\nCONTROL, PLAN SUMMARIES, and RETIREMENT PLANS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT -------------------------------------\nEXECUTIVE COMPENSATION\nThe following tables give information with respect to all compensation (whether paid directly by NEP, Mass. Electric, or Narragansett or billed to it as hourly charges) for services in all capacities for NEP, Mass. Electric, or Narragansett for the years 1993 through 1995 to or for the benefit of the Chief Executive Officer and the four other most highly compensated executive officers for each company.\nNEP\n(a) Certain officers of NEP are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by NEP. See description under Plan Summaries.\n(d) Includes amounts reimbursed by NEP for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. Rowe 20,370 shares, $807,161 value; Mr. Tranen 4,582 shares, $181,561 value; Mr. Newsham 4,117 shares, $163,136 value; Mr. Greenman 5,961 shares, $236,204 value; and Mr. Bailey 2,807 shares, $111,227 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes NEP contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by NEP.\n(g) For Mr. Rowe, the amount and type of compensation in 1995 is as follows: $876 for contributions to the thrift plan and $511 for life insurance.\n(h) For Mr. Tranen, the amount and type of compensation in 1995 is as follows: $2,831 for contributions to the thrift plan and $545 for life insurance.\n(i) For Mr. Newsham, the amount and type of compensation in 1995 is as follows: $2,870 for contributions to the thrift plan, $1,609 for life insurance, and $119,315 one-time supplemental cash payment upon retirement.\n(j) For Mr. Greenman, the amount and type of compensation in 1995 is as follows: $2,027 for contributions to the thrift plan and $949 for life insurance.\n(k) For Mr. Bailey, the amount and type of compensation in 1995 is as follows: 2,894 for contributions to the thrift plan and $704 for life insurance.\nMASS. ELECTRIC\n(a) Certain officers of Mass. Electric are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Mass. Electric. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Mass. Electric for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. Sergel 4,355 shares, $172,567 value; Mr. Dickson 4,036 shares, $159,926 value; Mr. Holt 2,953 shares, $117,012 value; Ms. LaFleur 2,166 shares, $85,827 value; Ms. Sala 1,227 shares, $48,619 value; and Mr. Pini 1,966 shares, $77,902 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes Mass. Electric contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Mass. Electric.\n(g) For Mr. Sergel, the type and amount of compensation in 1995 is as follows: $2,002 for contributions to the thrift plan and $283 for life insurance.\n(h) For Mr. Dickson, the type and amount of compensation in 1995 is as follows: $3,000 for contributions to the thrift plan and $601 for life insurance.\n(i) For Mr. Holt, the type and amount of compensation in 1995 is as follows: 1,778 for contributions to the thrift plan and $629 for life insurance.\n(j) For Ms. LaFleur, the type and amount of compensation in 1995 is as follows: $2,373 for contributions to the thrift plan and $197 for life insurance.\n(k) For Ms. Sala, the type and amount of compensation in 1995 is as follows: $2,310 for contributions to the thrift plan and $188 for life insurance.\n(l) For Mr. Pini, the type and amount of compensation in 1995 is as follows: $2,225 for contributions to the thrift plan and $177 for life insurance.\n(m) Mr. Holt resigned as of December 20, 1995 to take a position at an affiliate company, Ms. LaFleur resigned as of December 31, 1995 to take a position at an affiliate company.\nNARRAGANSETT\n(a) Certain officers of Narragansett are also officers of NEES and various other System companies.\n(b) Includes deferred compensation in category and year earned.\n(c) The bonus figure represents cash bonuses under an incentive compensation plan, the value of unrestricted shares under the incentive share plan, special bonuses, the goals program award, and the variable portion of the incentive thrift plan match by Narragansett. See description under Plan Summaries.\n(d) Includes amounts reimbursed by Narragansett for the payment of taxes.\n(e) For the 1993 awards, shares were awarded that become unrestricted after five years. Those shares receive the same dividends as the other common shares of NEES. The awards made for 1994 were, at the executives' option, in the form of restricted shares (with a five year restriction) or deferred share equivalents, which have been deferred for receipt for at least five years. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in shares. See also Payments Upon a Change in Control, below. The shares awarded for 1995 were unrestricted and the value of the awards is included in the bonus column. As of December 31, 1995, the following executive officers held the amount of restricted shares with the value indicated: Mr. McCabe 3,799 shares, $150,535 value; Mr. Watkins 2,140 shares, $84,797 value; Mr. Frost 1,672 shares, $66,253 value, Mr. Beirne 375 shares, $14,859 value; and Mr. Nadeau 335 shares, $13,275 value. The value was calculated by multiplying the closing market price on December 29, 1995 by the number of shares.\n(f) Includes Narragansett contributions to life insurance and the incentive thrift plan that are not bonus contributions. See description under Plan Summaries. The life insurance contribution is calculated based on the value of term life insurance for the named individuals. The premium costs for most of these policies have been or will be recovered by Narragansett.\n(g) For Mr. McCabe, the type and amount of compensation in 1995 is as follows: $2,720 for contributions to the thrift plan and $2,130 for life insurance.\n(h) For Mr. Watkins, the type and amount of compensation in 1995 is as follows: $2,563 for contributions to the thrift plan and $1,491 for life insurance.\n(i) For Mr. Frost, the type and amount of compensation in 1995 is as follows: $2,065 for contributions to the thrift plan and $722 for life insurance.\n(j) For Mr. Beirne, the type and amount of compensation in 1995 is as follows: $1,919 for contributions to the thrift plan and $412 for life insurance.\n(k) For Mr. Nadeau, the type and amount of compensation in 1995 is as follows: $1,916 for contributions to the thrift plan and $986 for life insurance.\nDirectors' Compensation\nMembers of the Mass. Electric and Narragansett Boards of Directors, except Dickson, McCabe, Rowe, and Sergel receive a quarterly retainer of $1,250, a meeting fee of $600 plus expenses, and 50 NEES common shares each year. Since all members of the NEP Board are employees of NEES System companies, no fees are paid for service on the Board except as noted below for Mrs. Bok.\nMrs. Bok retired as an employee of the System on January 1, 1994 (remaining as Chairman of the Board of NEES and a director for NEES subsidiaries). Mrs. Bok has agreed to waive the normal fees and annual retainers otherwise payable for services by non-employees on NEES subsidiary boards and receives in lieu thereof a single annual stipend of $60,000. Mrs. Bok also serves as a consultant to NEES. Under the terms of her contract, she receives an annual retainer of $100,000.\nMass. Electric and Narragansett permit directors to defer all or a portion of their retainers and meeting fees. Special accounts are maintained on Mass. Electric's and Narragansett's books showing the amounts deferred and the interest accrued thereon.\nOther\nNEP, Mass. Electric, and Narragansett do not have any share option plans.\nThe NEES Compensation Committee administers certain of the incentive compensation plans, and the Management Committee administers the others (including the incentive share plan).\nRetirement Plans\nThe following table shows estimated annual benefits payable to executive officers under the qualified pension plan and the supplemental retirement plan, assuming retirement at age 65 in 1996.\nFor purposes of the retirement plans, Messrs. Rowe, Tranen, Newsham, Greenman, and Bailey currently have 18, 26, 45, 30, and 27 credited years of service, respectively. Mr. Sergel, Mr. Dickson, Mr. Holt, Ms. LaFleur, Ms. Sala, and Mr. Pini currently have 17, 22, 24, 10, 26, and 17 credited years of service, respectively. Messrs. McCabe, Watkins, Frost, Beirne, and Nadeau currently have 27, 23, 33, 24, and 40 credited years of service, respectively.\nBenefits under the pension plans are computed using formulae based on percentages of highest average compensation computed over five consecutive years. The compensation covered by the pension plan includes salary, bonus, and incentive share awards. The benefits listed in the pension table are not subject to deduction for Social Security and are shown without any joint and survivor benefits.\nThe Pension Table above does not include annuity payments to be received in lieu of life insurance for Messrs. Rowe, Houston, and Greenman. The policies are described below under Plan Summaries.\nMr. Newsham will also receive a supplemental pension payment of $5,000 per year.\nUnder the Retirement Supplement Plan, participants receive an annual adjustment to their pension benefits. The amount of the adjustment is equal to the rate of interest on AAA bonds for the prior year less two percent (but in no case more than the increase in the cost of living).\nThe System contributes the full amount toward post-retirement health benefits for senior executives.\nPAYMENTS UPON A CHANGE OF CONTROL\nNEES has approved agreements with certain of its executives, including Ms. LaFleur, and Messrs. Greenman, Newsham, Rowe, Sergel, and Tranen, which provide severance benefits in the event of certain terminations of employment following a Change in Control of NEES (as defined below). If, following a Change in Control, the executive's employment is terminated other than for cause (as defined) or if the executive terminates employment for good reason (as defined), NEES will pay to the executive a lump sum cash payment equal to three times (two times for some executives) the sum of the executive's most recent annual base compensation and the average of his or her bonus amounts for the prior three years. If Mr. Rowe receives payments under his severance agreement that would subject him to any federal excise tax due under section 280G of the Internal Revenue Code, he will receive a cash \"gross-up\" payment so he would be in the same net after-tax position he would have been in had such excise tax not been applied. In addition, NEES will provide disability and health benefits to the executive for two to three years, provide such post-retirement health and welfare benefits as the executive would have earned within such two to three years, and grant two or three additional years of pension credit. Mr. Rowe would become eligible for benefits under the Retirement Supplement Plan described above prior to the five-year vesting term.\nChange in Control, including potential change of control, occurs (1) when any person becomes the beneficial owner of 20% of the voting securities of NEES, (2) when the prior members of the Board of NEES no longer constitute a 2\/3 majority of the Board, or (3) NEES enters into an agreement that could result in a Change in Control.\nThe terms of the agreements are for three years with automatic annual extensions, unless terminated by NEES.\nThe System's bonus plans, including the incentive compensation plans, the Incentive Thrift Plan I, and the Goals Program, provide for payments equal to the average of the bonuses for the three prior years in the event of a Change of Control. This payment would be made in lieu of the regular bonuses for the year in which the Change in Control occurs. The new Long-Term Performance Share Award Plan provides for a cash payment equal to the value of the performance shares in the participants' account times the average target achievement percentage for the Incentive Thrift Plan I for the three prior years. The System's Retirees Health and Life Insurance Plan I has provisions preventing changes in benefits\nadverse to the participants for three years following a Change in Control. The Incentive Share Plan and the related Incentive Share Deferral Agreements provide that, upon the occurrence of a change in control (defined more narrowly than in other plans), restrictions on all shares and account balances would cease.\nNEP, MASS. ELECTRIC, AND NARRAGANSETT PLAN SUMMARIES\nA brief description of the various plans through which compensation and benefits are provided to the named executive officers is presented below to better enable shareholders to understand the information presented in the tables shown earlier. The amounts of compensation and benefits provided to the named executive officers under the plans described below (and charged to NEP, Mass. Electric, or Narragansett) are presented in the Summary Compensation Tables.\nGoals Program\nThe goals program covers all employees who have completed one year of service with any NEES subsidiary. Goals are established annually. For 1995, these goals related to earnings per share, customer costs, safety, absenteeism, demand-side management, generating station availability, transmission reliability, environmental and OSHA compliance, and customer satisfaction. Some goals apply to all employees, while others apply to particular functional groups. Depending upon the number of goals met, and provided the minimum earnings goal is met, employees may earn a cash bonus of 1% to 4-1\/2% of their compensation.\nIncentive Thrift Plan\nThe incentive thrift plan (a 401(k) program) provides for a match of 40% of up to the first 5% of base compensation contributed to the System's incentive thrift plan (shown under All Other Compensation in the Summary Compensation Tables) and, based on an incentive formula tied to earnings per share, may fully match the first 5% of base compensation contributed (the additional amount, if any, is shown under Bonus in the Summary Compensation Tables). Under Federal law, contributions to these plans are limited. In 1995, the salary reduction amount was limited to $9,240.\nIncentive Compensation Plan\nThe System bonus plan for certain senior employees provides that in order for cash bonuses to be awarded, NEES must achieve a return on equity that places NEES in the top 50% of the electric\nutilities listed in the Duff & Phelps Utility Group or in the top 50% of the New England\/New York regional utilities. Bonuses are also dependent upon the achievement of individual goals. In order to provide a long-term component to the incentive compensation plan, participants may also be awarded NEES common shares. An individual's award of shares under the incentive share plan is a fixed percentage of her or his cash bonus for that year. If no cash award is made, no shares are distributed.\nLong-Term Performance Share Award Plan\nThis plan was established in 1996. There will be no payments under the plan until the Spring of 1999. Awards under the plan are based upon various measures of NEES performance over a three-year period. Each award factor or measurement functions independently. The factors include financial and operating performance. Performance is rated on rolling three-year periods, with a new cycle beginning each year. An individual's potential award under the plan is a fixed percentage (ranging from 15% to 50%) of base pay. At the end of the three-year cycle, the participant receives NEES shares based upon the performance against the various factors.\nDeferred Compensation Plan\nThose executives whose contributions to the Incentive Thrift Plan were limited by Federal law may make further contributions to the Deferred Compensation Plan and the System will match them under the Deferred Compensation Plan on the same terms as if the full amount had been contributed to the Incentive Thrift Plan. However, these amounts under the Deferred Compensation Plan may only be invested at the then applicable prime rate or in NEES shares.\nLife Insurance\nNEES has established for certain senior executives life insurance plans funded by individual policies. The combined death benefit under these insurance plans is three times the participant's annual salary.\nAfter termination of employment, participants in one of the insurance plans may elect, commencing at age 55 or later, to receive an annuity income equal to 40% of annual salary. In that event, the life insurance is reduced over fifteen years to an amount equal to the participant's final annual salary. Due to changes in the tax law, this plan was closed to new participants, and an alternative was established with only a life insurance benefit. The individuals listed in the NEP summary compensation\ntable and Ms. LaFleur and Messrs. Dickson, McCabe, and Sergel are in one or the other of these plans. These plans are structured so that, over time, the System should recover the cost of the insurance premiums.\nFinancial Counseling\nNEP, Mass. Electric, and Narragansett pay for personal financial counseling for senior executives. As required by the IRS, a portion of the amount paid is reported as taxable income for the executive. Financial counseling is also offered to other employees through a limited number of seminars conducted at various locations each year.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNEES ----\nThe information required by this item is incorporated herein by reference to the material under the caption TOTAL COMMON EQUITY BASED HOLDINGS in the definitive proxy statement of NEES, dated March 11, 1996, for the 1996 Annual Meeting of Shareholders, provided that the information under the headings \"Compensation Committee Report on Executive Compensation\" and \"Corporate Performance\" are not so incorporated.\nNEP, Mass. Electric, and Narragansett -------------------------------------\nNEES owns 100% of the voting securities of Mass. Electric and Narragansett. NEES owns 98.85% of the voting securities of NEP.\nSECURITY OWNERSHIP\nThe following tables list the holdings of NEES common shares as of March 1, 1996 by NEP, Mass. Electric, and Narragansett directors, the executive officers named in the Summary Compensation Tables, and all directors and executive officers, as a group.\n(a) Number of shares beneficially owned includes: (i) shares directly owned by certain relatives with whom directors or officers share voting or investment power; (ii) shares held of record individually by a director or officer or jointly with others or held in the name of a bank, broker, or nominee for such individual's account; (iii) shares in which certain directors or officers maintain exclusive or shared investment or voting power whether or not the securities are held for their benefit; and (iv) with respect to the executive officers, allocated shares in the Incentive Thrift Plan described above.\n(b) Deferred share equivalents are held under the Deferred Compensation Plan or pursuant to individual deferral agreements. Under the Plan or deferral agreements, executives may elect to defer cash compensation and share awards. There are various deferral periods available under the plans. At the end of the deferral period, the compensation may be paid out in NEES common shares, cash, or a combination thereof. The rights of the executives to payment are those of general, unsecured creditors. While deferred, the shares do not have\nvoting rights or other rights associated with ownership. As cash dividends are declared, the number of deferred share equivalents will be increased as if the dividends were reinvested in NEES common shares.\n(c) Amount is less than 1% of the total number of shares of NEES outstanding.\n(d) Mr. Beaumont disclaims a beneficial ownership interest in 200 of these shares held under an irrevocable trust.\n(e) Ms. Sala disclaims a beneficial ownership interest in 247 shares held under the Uniform Gift to Minors Act.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe construction company of Mr. Stephen A. Cardi, a director of Narragansett, was paid approximately $77,000 in 1995 pursuant to a contract to provide gravel to Narragansett.\nMr. John A. Wilson, Jr., a director of Narragansett, is a consultant to Hinckley, Allen, Snyder & Comen (Attorneys). Hinckley, Allen, Snyder & Comen was retained by Narragansett and its affiliates in 1995.\nMs. Patricia McGovern, a director of Mass. Electric, was paid a retainer of $15,000 by Mass. Electric for serving as a member of a Massachusetts policy advisory committee regarding external relations in Massachusetts.\nReference is made to Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT and Item 11. EXECUTIVE COMPENSATION.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS AND REPORTS ON FORM 8-K\nList of Exhibits\nUnless otherwise indicated, the exhibits listed below are incorporated by reference to the appropriate exhibit numbers and the Commission file numbers indicated in parentheses.\nNEES ----\n(3) Agreement and Declaration of Trust dated January 2, 1926, as amended through April 28, 1992 (Exhibit 3 to 1994 NEES Form 10-K, File No. 1-3446).\n(4) Instruments Defining the Rights of Security Holders\n(a) Massachusetts Electric Company First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty-one supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(a) to 1993 Form 10-K, File No. 1-3446; Twenty-first Supplemental Indenture (filed herewith)).\n(b) The Narragansett Electric Company First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-two supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4 to 1991 Form 10-K, File No. 0-898; Exhibit 4(b) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(b) to 1993 Form 10-K, File No. 1-3446; Twenty-second Supplemental Indenture (filed herewith)).\n(c) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1- 3446).\n(d) New England Power Company Indentures General and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and twenty supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1988 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1989 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 Form 10-K, File No. 1-3446; Exhibit 4(d) to 1993 Form 10-K, File No. 1-3446; Twentieth Supplemental Indenture (filed herewith)).\n(10) Material Contracts\n(a) Boston Edison Company et al. and New England Power Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and New England Power Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986; (Exhibit 10(b), to 1990 Form 10-K, File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to NEP with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and New England Power Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-23006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 1-3446); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006);\nTransmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to 1979 Form 10-K, File No. 1-3446); Amendment revising Transmission Agreement dated as of January 19, 1994 (filed herewith); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and New England Power Company: Capital Funds Agreement dated May 20, 1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to 1983 Form 10-K, File No. 1-3446), October 1, 1984, and August 1, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20, File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to 1985 Form 10-K, File No. 1-3446).\n(e) New England Energy Incorporated Contracts\n(i) Capital Funds Agreement with NEES dated November 1, 1974 (Exhibit 10-29(b), File No. 2-52969); Amendment dated July 1, 1976, and Amendment dated July 26, 1979 (Exhibit 10(g)(i) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(i) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1990 (Exhibit 10(e)(i) to 1990 Form 10-K, File No. 1-3446).\n(ii) Loan Agreement with NEES dated July 19, 1978 and effective November 1, 1974, and Amendment dated July 26, 1979 (Exhibit 10(g)(iii) to 1980 Form 10-K, File No. 1-3446); Amendment dated August 26, 1981 (Exhibit 10(f)(ii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985 (Exhibit 10(e)(ii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(ii) to 1989 Form 10-K, File No. 1-3446);\nAmendment dated as of June 1, 1990 (Exhibit 10(e)(ii) to 1990 Form 10-K, File No. 1-3446).\n(iii) Fuel Purchase Contract with New England Power Company dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 Form 10-K, File No. 1-3446).\n(iv) Partnership Agreement with Samedan Oil Corporation as Amended and Restated on February 5, 1985 (Exhibit 10(e)(iv) to 1984 Form 10-K, File No. 1-3446); Amendment dated as of January 14, 1992 (Exhibit 10(e)(iv) to 1991 Form 10-K, File No. 1- 3446).\n(v) Credit Agreement dated as of April 13, 1995 (filed herewith).\n(vi) Capital Maintenance Agreement dated November 15, 1985, and Assignment and Security Agreement dated November 15, 1985 (Exhibit 10(e)(vi) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(vi) to 1989 Form 10-K, File No. 1-3446).\n(f) New England Power Company and New England Electric Transmission Corporation et al.: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982, and November 1, 1982 (Exhibit 10(f) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit (10)(f) 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of New England Power Company's Transmission System dated as of April 1, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446); Upper Development - Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to 1983 Form 10-K, File No. 1-3446).\n(g) New England Electric Transmission Corporation and PruCapital Management, Inc. et al: Note Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Mortgage, Deed of Trust and Security Agreement dated as of September 1, 1986 (Exhibit 10(g) to 1986 Form 10-K, File No. 1-3446); Equity Funding Agreement with New England Electric System dated as of December 1, 1985 (Exhibit 10(g) to 1991 Form 10-K, File No. 1-3446).\n(h) Vermont Electric Transmission Company, Inc. et al. and New England Power Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982, and November 1, 1982 (Exhibit 10(g) to 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to 1986 Form 10-K, File No. 1-3446).\n(i) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (filed herewith).\n(j) Public Service Company of New Hampshire et al. and New England Power Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, December 31, 1980 (Exhibit 10(i) to 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984, June 15, 1984 (Exhibit 10(j) to 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986 and September 19, 1986 (Exhibit 10(j) to 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of November 1, 1990 (Exhibit 10(j) to 1991 Form 10-K, File No. 1- 3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to NEP with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 10-16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent (Exhibit 10(j) to 1991 Form 10-K, File No. 1- 3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10-K, File No. 1- 3446); Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, and amendment to Seabrook Project Managing Agent Agreement dated as of June 29, 1992 (Exhibit 10(j) to 1992 Form 10- K, File No. 1-3446).\n(k) Vermont Yankee Nuclear Power Corporation et al. and New England Power Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968, and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972 and April 15, 1983 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446) and April 24, 1985 (Exhibit 10(k) to 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(k) to 1987 Form 10-K, File No.\n1-3446); Amendments dated as of May 6, 1988 (Exhibit 10(k) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to 1981 Form 10-K, File No. 1-3446).\n(l) Yankee Atomic Electric Company et al. and New England Power Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10(l) to 1989 Form 10-K, File No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(n) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (filed herewith).\n*(o) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1,1995 (filed herewith).\n*(p) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(q) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (filed herewith).\n*(r) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (filed herewith).\n*(s) New England Electric System Directors Deferred Compensation Plan as amended dated November 24, 1992 (Exhibit 10(s) to 1992 Form 10-K, File No. 1-3446).\n*(t) Forms of Life Insurance Program (Exhibit 10(s) to 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to 1991 Form 10-K, File No. 1-3446).\n*(u) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (filed herewith).\n(v) New England Power Company and New England Hydro-Transmission Electric Company, Inc. et al: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10(u) to 1990 Form 10-K, File No. 1-3446).\n(w) New England Power Company and New England Hydro-Transmission Corporation et al: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1,1988 (Exhibit 10(v) to 1988 Form 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10(v) to 1990 Form 10-K, File No. 1-3446).\n(x) New England Power Company et al: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to 1988 Form 10-K, File No. 1-3446).\n(y) New England Hydro-Transmission Electric Company, Inc. and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(w) to 1986 Form 10-K, File No. 1-3446); Amendment dated\nas of September 1, 1987 (Exhibit 10(x) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(x) to 1988 Form 10-K, File No. 1-3446).\n(z) New England Hydro-Transmission Corporation and New England Electric System et al: Equity Funding Agreement dated as of June 1, 1985 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(x) to 1986 Form 10-K, File No. 1-3446); Amendment dated as of September 1, 1987 (Exhibit 10(y) to 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(y) to 1988 Form 10-K, File No. 1-3446).\n(aa) Ocean State Power, et al., and Narragansett Energy Resources Company: Equity Contribution Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power, et al., and New England Electric System: Equity Contribution Support Agreement dated as of December 29, 1988 (Exhibit 10(aa) to 1988 Form 10-K, File No. 1-3446); Amendment dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K, File No. 1-3446); Ocean State Power II, et al., and Narragansett Energy Resources Company: Equity Contribution Agreement dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446); Ocean State Power II, et al., and New England Electric System: Equity Contribution Support Agreement dated as of September 29, 1989 (Exhibit 10(aa) to 1989 Form 10-K File No. 1-3446).\n*(bb) New England Power Service Company and Joan T. Bok: Service Credit Letter dated October 21, 1982 (Exhibit 10(cc) to 1992 Form 10-K, File No. 1-3446).\n*(cc) New England Electric System and John W. Rowe: Service Credit Letter dated December 5, 1988 (Exhibit 10(dd) to 1992 Form 10-K, File No. 1-3446).\n*(dd) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 Form 10-K, File No. 1-3446).\n*(ee) New England Electric System and Frederic E. Greenman: Service Credit Letter dated February 23, 1994 (Exhibit 10(ee) to 1994 Form 10-K, File No. 1- 3446).\n*(ff) New England Electric System and John W. Newsham; Pension Service Credit Agreement dated February 23, 1994 (Exhibit 10(ff) to 1994 Form 10-K, File No. 1- 3446).\n* Compensation related plan, contract, or arrangement.\n(13) 1995 Annual Report to Shareholders (filed herewith).\n(21) Subsidiary list appears in Part I of this document.\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nNEP ---\n(3) (a) Articles of Organization as amended through June 27, 1987 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-1229).\n(b) By-laws of the Company as amended May 10, 1995 (filed herewith).\n(4) General and Refunding Mortgage Indenture and Deed of Trust dated as of January 1, 1977 and twenty supplements thereto (Exhibit 4(b) to 1980 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1982 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1983 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1985 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1986 Form 10-K, File No. 0-1229; Exhibit 4(b) to 1988 Form 10-K, File No. 0-1229; Exhibit 4(c)(ii) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1990 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1991 NEES Form 10-K, File No. 1-3446; Exhibit 4(c)(ii) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(d) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(d) to 1995 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) The Connecticut Light and Power Company et al. and the Company: Sharing Agreement for Joint Ownership, Construction and Operation of Millstone Unit No. 3 dated as of September 1, 1973, and Amendment dated as of August 1, 1974 (Exhibit 10-5, File No. 2-52820); Amendments dated as of December 15, 1975 and April 1, 1986 (Exhibit 10(b) to NEES' 1990 Form 10-K File No. 1-3446). Transmission Support Agreement dated August 9, 1974; Instrument of Transfer to the Company with respect to the 1979 Connecticut Nuclear Unit, and Assumption of Obligations, dated December 17, 1975 (Exhibit 10-6(b), File No. 2-57831).\n(c) Connecticut Yankee Atomic Power Company et al. and the Company: Stockholders Agreement dated July 1, 1964 (Exhibit 13-9-A, File No. 2-2006); Power Purchase Contract dated July 1, 1964 (Exhibit 13-9-B, File No. 2-23006); Supplementary Power Contract dated as of April 1, 1987 (Exhibit 10(c) to 1987 Form 10-K, File No. 0-1229); Capital Funds Agreement dated September 1, 1964 (Exhibit 13-9-C, File No. 2-23006); Transmission Agreement dated October 1, 1964 (Exhibit 13-9-D, File No. 2-23006); Agreement revising Transmission Agreement dated July 1, 1979 (Exhibit to NEES' 1979 Form 10-K, File No. 1-3446); Amendment revising Transmission Agreement dated as of January 19, 1994 (Exhibit 10(c) to NEES' 1995 Form 10-K, File No. 1-3446; Five Year Capital Contribution Agreement dated November 1, 1980 (Exhibit 10(e) to NEES' 1980 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 13, 1981 (Exhibit 10(d) to NEES' 1981 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of August 1, 1985 (Exhibit 10(c) to NEES' 1985 Form 10-K, File No. 1-3446).\n(d) Maine Yankee Atomic Power Company et al. and the Company: Capital Funds Agreement dated May 20, 1968 and Power Purchase Contract dated May 20, 1968 (Exhibit 4-5, File No. 2-29145); Amendments dated as of January 1, 1984, March 1, 1984 (Exhibit 10(d) to NEES' 1983 Form 10-K, File No. 1-3446); October 1, 1984, and August 1, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Stockholders Agreement dated May 20, 1968 (Exhibit 10-20; File No. 2-34267); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of September 23, 1985 (Exhibit 10(d) to NEES' 1985 Form 10-K, File No. 1-3446).\n(e) Mass. Electric and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated June 22, 1983 (Exhibit 10(b) to Mass. Electric's 1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(e) to 1993 Form 10-K, File No. 0-1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 Form 10-K, File No. 0-1229).\n(f) The Narragansett Electric Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service Agreement dated July 26, 1990 (Exhibit 4(f) to New England Power Company's 1990 Form 10-K, File No. 0-1229). Amendment of Service Agreement dated July 24, 1991 (Exhibit 10(f) to 1991 Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(f) to 1993 Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 Form 10-K, File No. 0-1229); Amendment of Service Agreement effective January 1, 1995 (filed herewith).\n(g) Time Charter between International Shipholding Corp., and New England Power Company dated as of October 27, 1994 (filed herewith); Amendments dated as of September 22, 1995 (filed herewith).\n(h) Consent and Agreement among New England Power Company, Central Gulf Lines, Inc., Enterprise Ship Company, Inc., and The Bank of New York dated as of September 28, 1995 (filed herewith).\n(i) New England Electric Transmission Corporation et al. and the Company: Phase I Terminal Facility Support Agreement dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Agreement with respect to Use of the Quebec Interconnection dated as of December 1, 1981 (Exhibit 10(g) to NEES' 1981 Form 10-K, File No. 1-3446); Amendments dated as of May 1, 1982 and November 1, 1982 (Exhibit 10(f) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(f) to NEES' 1986 Form 10-K, File No. 1-3446); Agreement for Reinforcement and Improvement of the Company's\nTransmission System dated as of April 1, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446); Lease dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446); Upper Development-Lower Development Transmission Line Support Agreement dated as of May 16, 1983 (Exhibit 10(f) to NEES' 1983 Form 10-K, File No. 1-3446).\n(j) Vermont Electric Transmission Company, Inc. et al. and the Company: Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981; Amendments dated as of June 1, 1982 and November 1, 1982 (Exhibit 10(g) to NEES' 1982 Form 10-K, File No. 1-3446); Amendment dated as of January 1, 1986 (Exhibit 10(h) to NEES' 1986 Form 10-K, File No. 1-3446).\n(k) New England Energy Incorporated and the Company: Fuel Purchase Contract dated July 26, 1979, and Amendment dated August 26, 1981 (Exhibit 10(f)(iii) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated March 26, 1985, and Amendment effective January 1, 1984 (Exhibit 10(e)(iii) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of April 28, 1989 (Exhibit 10(e)(iii) to 1989 NEES Form 10-K, File No. 1-3446).\n(l) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, March 1, 1973 (Exhibit 10-15, File No. 2-48543);Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File\nNo. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated October 1, 1990 Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to 1995 NEES Form 10-K, File No. 1-3446).\n(m) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(l) to 1994 Form 10-K, File No. 0-1229).\n(n) Public Service Company of New Hampshire et al. and the Company: Agreement for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units dated as of May 1, 1973; Amendments dated May 24, 1974, June 21, 1974, September 25, 1974 and October 25, 1974 (Exhibit 10-18(b), File No. 2-52820); Amendment dated January 31, 1975 (Exhibit 10-16(b), File No. 2-57831); Amendments dated April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, and December 31, 1980 (Exhibit 10(i) to NEES' 1980 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, April 27, 1984, and June 15, 1984 (Exhibit 10(j) to NEES' 1984 Form 10-K, File No. 1-3446); Amendments dated March 8, 1985, March 14, 1986, May 1, 1986, and September 19, 1986 (Exhibit 10(j) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated November 12, 1987 (Exhibit 10(j) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated January 13, 1989 (Exhibit 10(j) to NEES' 1990 Form 10-K, File No. 1-3446); Seventh Amendment as of November 1, 1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Transmission Support Agreement dated as of May 1, 1973 (Exhibit 10-23, File No. 2-49184); Instrument of Transfer to the Company with respect to the New Hampshire Nuclear Units and Assumptions of Obligations dated December 17, 1975 and Agreement Among Participants in New Hampshire Nuclear Units, certain Massachusetts Municipal Systems and Massachusetts Municipal Wholesale Electric Company dated May 28, 1976 (Exhibit 16(c), File No. 2-57831); Seventh Amendment To and Restated Agreement for Seabrook Project Disbursing Agent dated as of November 1,\n1990 (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446); Amendments dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446). Settlement Agreement dated as of July 19, 1990 between Northeast Utilities Service Company and the Company (Exhibit 10(m) to NEES' 1991 Form 10-K, File No. 1-3446). Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992, Amendment to Seabrook Project Managing Agent Operating Agreement dated as of June 29, 1992 (Exhibit 10(j) to NEES' 1992 Form 10-K, File No. 1- 3446).\n(o) Vermont Yankee Nuclear Power Corporation et al. and the Company: Capital Funds Agreement dated February 1, 1968, Amendment dated March 12, 1968 and Power Purchase Contract dated February 1, 1968 (Exhibit 4-6, File No. 2-29145); Amendments dated as of June 1, 1972, April 15, 1983 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 0-1229) and April 24, 1985 (Exhibit 10(n) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated as of June 1, 1985 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendments dated May 6, 1988 (Exhibit 10(n) to 1988 Form 10-K, File No. 0-1229); Amendment dated as of June 15, 1989 (Exhibit 10(k) to 1989 NEES Form 10-K, File No. 1-3446); Additional Power Contract dated as of February 1, 1984 (Exhibit 10(k) to NEES' 1983 Form 10-K, File No. 1-3446); Guarantee Agreement dated as of November 5, 1981 (Exhibit 10(j) to NEES' 1981 Form 10-K, File No. 1-3446).\n(p) Yankee Atomic Electric Company et al. and the Company: Amended and Restated Power Contract dated April 1, 1985 (Exhibit 10(l) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated May 6, 1988 (Exhibit 10(l) to NEES' 1988 Form 10-K, File No. 1-3446); Amendments dated as of June 26, 1989 and July 1, 1989 (Exhibit 10(l) to 1989 NEES Form 10-K, File No. 1-3446); Amendment dated as of February 1, 1992 (Exhibit 10(l) to 1992 NEES Form 10-K, File No. 1-3446).\n*(q) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(r) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(s) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(t) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446); New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(u) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(v) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(w) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10 (u) to NEES 1995 Form 10-K, File No. 1-3446).\n(x) New England Hydro-Transmission Electric Company, Inc. et al. and the Company: Phase II Massachusetts Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(t) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(u) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(u) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated January 1, 1989 (Exhibit 10(u) to NEES' 1990 Form 10-K, File No. 1-3446).\n(y) New England Hydro-Transmission Corporation et al. and the Company: Phase II New Hampshire Transmission Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(u) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated as of February 1, 1987, June 1, 1987, September 1, 1987, and October 1, 1987 (Exhibit 10(v) to NEES' 1987 Form 10-K, File No. 1-3446). Amendment dated as of August 1, 1988 (Exhibit 10(v) to NEES' 1988\nForm 10-K, File No. 1-3446); Amendments dated January 1, 1989 and January 1, 1990 (Exhibit 10 (v) to NEES' 1990 Form 10-K, File No. 1-3446).\n(z) Vermont Electric Power Company et al. and the Company: Phase II New England Power AC Facilities Support Agreement dated as of June 1, 1985 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated as of May 1, 1986 (Exhibit 10(v) to NEES' 1986 Form 10-K, File No. 1-3446). Amendments dated as of February 1, 1987, June 1, 1987, and September 1, 1987 (Exhibit 10(w) to NEES' 1987 Form 10-K, File No. 1-3446); Amendment dated as of August 1, 1988 (Exhibit 10(w) to NEES' 1988 Form 10-K, File No. 1-3446).\n(aa) TransCanada Pipelines Limited and the Company: Firm Service Contract for Firm Transportation Service for natural gas dated as of January 6, 1992; Amendment dated as of March 2, 1992 (Exhibit 10(y) to 1992 Form 10-K, File No. 0-1229); Amendment dated as of October 29, 1993 (Exhibit 10(y) to 1994 Form 10-K, File No. 0-1229); Temporary Assignment effective as of October 26, 1995 (filed herewith).\n(bb) Renaissance Energy Ltd. and the Company: Temporary Transportation Contract Assignment (capacity swap) for Firm Transportation Service for natural gas dated as of October 27, 1993; Amendment dated as of October 25, 1994 (Exhibit 10(z) to 1994 Form 10-K, File No. 0-1229).\n(cc) Algonquin Gas Transmission Company and the Company: X-38 Service Agreement for Firm Transportation of natural gas dated July 3, 1992; Amendment dated July 31, 1992 (Exhibit 10(aa) to 1992 Form 10-K, File No. 0-1229); Amendment dated April 15, 1994 (Exhibit 10(aa) to 1994 Form 10-K, File No. 0- 1229).\n(dd) ANR Pipeline Company and the Company: Gas Transportation Agreement dated July 18, 1990 (Exhibit 10(bb) to 1992 Form 10-K, File No. 0-1229).\n(ee) Columbia Gas Transmission Corporation and the Company: Service Agreement for Service under FTS Rate Schedule dated June 13, 1991 (Exhibit 10(cc) to 1993 Form 10-K, File No. 0-1229).\n(ff) Iroquois Gas Transmission System, L.P. and the Company: Gas Transportation Contract for Firm Reserved Service dated as of June 5, 1991 (Exhibit 10(dd) to 1992 Form 10-K, File No. 0-1229).\n(gg) Tennessee Gas Pipeline Company and the Company: Firm Natural Gas Transportation Agreement dated July 9, 1992 (Exhibit 10(ee) to 1992 Form 10-K, File No. 0-1229).\n* Compensation related plan, contract, or arrangement.\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(21) Subsidiary list (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nMass. Electric --------------\n(3) (a) Articles of Organization of the Company as amended March 5, 1993, August 11, 1993, September 20, 1993, and November 15, 1993 (Exhibit 3(a) to 1993 Form 10-K, File No. 0-5464).\n(b) By-Laws of the Company as amended February 4, 1993, July 30, 1993, and September 15, 1993 (Exhibit 3(b) to 1993 Form 10-K, File No. 0-5464).\n(4) First Mortgage Indenture and Deed of Trust, dated as of July 1, 1949, and twenty-one supplements thereto (Exhibit 7-A, File No. 1-8019; Exhibit 7-B, File No. 2-8836; Exhibit 4-C, File No. 2-9593; Exhibit 4 to 1980 Form 10-K, File No. 2-8019; Exhibit 4 to 1982 Form 10-K, File No. 0-5464; Exhibit 4 to 1986 Form 10-K, File No. 0-5464); Exhibit 4 to 1988 Form 10-K, File No. 0-5464; Exhibit 4(a) to 1989 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(a) to 1995 NEES Form 10-K, File No. 1-3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 5-17(a), File No. 2-52969); Amendment of Service Agreement dated July 22, 1983 (Exhibit 10(b) to\n1986 Form 10-K, File No. 0-5464); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(e) to 1993 NEP Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(e) to 1994 NEP Form 10-K, File No. 0-1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated as of December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10(i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendments dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to 1992 NEES Form 10-K, File No. 1-3446). Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to 1995 NEES Form 10-K, File No. 1- 3446).\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 10(l) to 1994 NEP Form 10-K, File No. 0-1229).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 4(e), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan as amended dated January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan as amended dated December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(i) New England Electric Companies' Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program: (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(n) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10(u) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(o) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Mass. Electric registration statement on Form S-3, Commission File No. 33-59145 (filed herewith).\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nNarragansett ------------\n(3) (a) Articles of Incorporation as amended June 9, 1988 (Exhibit 3(a) to 1988 Form 10-K, File No. 0-898).\n(b) By-Laws of the Company (Exhibit 3 to 1980 Form 10-K, File No. 0-898).\n(4) (a) First Mortgage Indenture and Deed of Trust, dated as of September 1, 1944, and twenty-two supplements thereto (Exhibit 7-1, File No. 2-7042; Exhibit 7-B, File No. 2-7490; Exhibit 4-C, File No. 2-9423; Exhibit 4-D, File No. 2-10056; Exhibit 4 to 1980 Form 10-K, File No. 0-898; Exhibit 4 to 1982 Form 10-K, File No. 0-898; Exhibit 4 to 1983 Form 10-K, File No. 0-898; Exhibit 4 to 1985 Form 10-K, File No. 0-898; Exhibit 4 to 1986 Form 10-K, File No. 0-898; Exhibit 4 to 1987 Form 10-K, File No. 0-898; Exhibit 4(b) to 1991 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1992 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1993 NEES Form 10-K, File No. 1-3446; Exhibit 4(b) to 1995 NEES Form 10- K, File No. 1-3446).\n(b) The Narragansett Electric Company Preference Provisions, as amended, dated March 23, 1993 (Exhibit 4(c) to 1993 NEES Form 10-K, File No. 1- 3446).\n(10) Material Contracts\n(a) Boston Edison Company et al. and the Company: Amended REMVEC Agreement dated August 12, 1977 (Exhibit 5-4(d), File No. 2-61881).\n(b) New England Power Company and the Company: Primary Service for Resale dated February 15, 1974 (Exhibit 4-1(b), File No. 2-51292); Amendment of Service\nAgreement dated July 26, 1990 (Exhibit 10(f) to 1990 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement dated July 24, 1991 (Exhibit 4(f) to 1991 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement effective November 1, 1993 (Exhibit 10(f) to 1993 NEP Form 10-K, File No. 0- 1229); Memorandum of Understanding effective May 22, 1994 (Exhibit 10(f) to 1994 NEP Form 10-K, File No. 0-1229); Amendment of Service Agreement effective January 1, 1995 (Exhibit 10(f) to 1995 NEP Form 10-K, File No. 0-1229).\n(c) New England Power Pool Agreement: (Exhibit 4(e), File No. 2-43025); Amendments dated July 1, 1972, and March 1, 1973 (Exhibit 10-15, File No. 2-48543); Amendment dated March 15, 1974 (Exhibit 10-5, File No. 2-52775); Amendment dated June 1, 1975 (Exhibit 10-14, File No. 2-57831); Amendment dated September 1, 1975 (Exhibit 10-13, File No. 2-59182); Amendments dated December 31, 1976, January 31, 1977, July 1, 1977, and August 1, 1977 (Exhibit 10-16, File No. 2-61881); Amendments dated August 15, 1978, January 3, 1980, and February 1980 (Exhibit 10-3, File No. 2-68283); Amendment dated September 1, 1981 (Exhibit 10(h) to NEES' 1981 Form 10-K, File No. 1-3446); Amendment dated December 1, 1981 (Exhibit 10(h) to NEES' 1982 Form 10-K, File No. 1-3446); Amendments dated June 1, 1982, June 15, 1983, and October 1, 1983 (Exhibit 10(i) to NEES' 1983 Form 10-K, File No. 1-3446); Amendments dated August 1, 1985, August 15, 1985, September 1, 1985, and January 1, 1986 (Exhibit 10 (i) to NEES' 1985 Form 10-K, File No. 1-3446); Amendment dated September 1, 1986 (Exhibit 10(i) to NEES' 1986 Form 10-K, File No. 1-3446); Amendment dated April 30, 1987 (Exhibit 10(i) to NEES' 1987 Form 10-K, File No. 1-3446); Amendments dated March 1, 1988 and May 1, 1988 (Exhibit 10(i) to NEES' 1988 Form 10-K, File No. 1-3446); Amendment dated March 15, 1989 (Exhibit 10(i) to 1989 NEES Form 10-K, File No. 1-3446). Amendment dated October 1, 1990 (Exhibit 10(i) to 1990 NEES' Form 10-K, File No. 1-3446); Amendment dated as of September 15, 1992 (Exhibit 10(i) to NEES' 1992 Form 10-K, File No. 1-3446); Amendments dated as of June 1, 1993, July 1, 1995, and September 1, 1995 (Exhibit 10(i) to NEES' 1995 Form 10-K, File No. 1-3446).\n(d) New England Power Service Company and the Company: Specimen of Service Contract (Exhibit 4(l) to 1994 NEP Form 10-K, File No. 0-1229).\n(e) New England Telephone and Telegraph Company and the Company: Specimen of Joint Ownership Agreement for Wood Poles (Exhibit 3(d), File No. 2-24458).\n*(f) New England Electric Companies' Deferred Compensation Plan for Officers, as amended January 1, 1995 (Exhibit 10(m) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(g) New England Electric System Companies Retirement Supplement Plan, as amended December 1, 1995 (Exhibit 10(n) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(h) New England Electric Companies' Executive Supplemental Retirement Plan, as amended dated January 1, 1995 (Exhibit 10(o) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(i) New England Companies' Incentive Compensation Plan, as amended dated January 1, 1995 (Exhibit 10(p) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(j) New England Electric Companies' Form of Deferred Compensation Agreement for Directors (Exhibit 10(p) to NEES' 1980 Form 10-K, File No. 1-3446).\n*(k) New England Electric Companies' Senior Incentive Compensation Plan as amended dated January 1, 1995 (Exhibit 10(q) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(l) Forms of Life Insurance Program (Exhibit 10(s) to NEES' 1986 Form 10-K, File No. 1-3446); and Form of Life Insurance (Collateral Assignment) (Exhibit 10(t) to NEES' 1991 Form 10-K, File No. 1-3446).\n*(m) New England Electric Companies' Incentive Compensation Plan II as amended dated January 1, 1995 (Exhibit 10(r) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(n) New England Electric Companies' Incentive Share Plan as amended dated January 1, 1994 (Exhibit 10(u) to NEES' 1995 Form 10-K, File No. 1-3446).\n*(o) New England Power Service Company and the Company: Form of Supplemental Pension Service Credit Agreement (Exhibit 10(ee) to 1992 NEES Form 10-K, File No. 1-3446).\n* Compensation related plan, contract, or arrangement.\n(12) Statement re computation of ratios for incorporation by reference into the Narragansett registration statement on Form S-3, Commission File No. 33-61131 (filed herewith).\n(13) 1995 Annual Report to Stockholders (filed herewith).\n(24) Power of Attorney (filed herewith).\n(27) Financial Data Schedule (filed herewith).\nReports on Form 8-K\nNEES ----\nNEES filed reports on Form 8-K dated January 12, 1995, February 8, 1995, March 1, 1995, March 15, 1995, May 17, 1995, July 3, 1995, August 16, 1995, September 8, 1995, and September 29, 1995, all of which contained Item 5.\nNEP ---\nNEP filed reports on Form 8-K dated January 12, 1995, February 8, 1995, May 17, 1995, and August 16, 1995, all of which contained Item 5.\nMass. Electric --------------\nMass. Electric filed reports on Form 8-K dated March 15, 1995, August 16, 1995, and September 29, 1995, all of which contained Item 5.\nNarragansett ------------\nNarragansett filed reports on Form 8-K dated March 1, 1995, July 3, 1995, August 16, 1995, September 8, 1995, and October 11, 1995, all of which contained Item 5.\nNEW ENGLAND ELECTRIC SYSTEM\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf, by the undersigned thereunto duly authorized.\nNEW ENGLAND ELECTRIC SYSTEM*\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer March 28, 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.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John W. Rowe\nJohn W. Rowe President and Chief Executive Officer\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Executive Vice President and Chief Financial Officer\nPrincipal Accounting Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nDirectors (a majority)\nJoan T. Bok Paul L. Joskow John M. Kucharski Edward H. Ladd Joshua A. McClure John W. Rowe s\/John G. Cochrane George M. Sage All by: Charles E. Soule John G. Cochrane Anne Wexler Attorney-in-fact James Q. Wilson James R. Winoker\nDate (as to all signatures on this page)\nMarch 28, 1996\n*The name \"New England Electric System\" means the trustee or trustees for the time being (as trustee or trustees but not personally) under an agreement and declaration of trust dated January 2, 1926, as amended, which is hereby referred to, and a copy of which as amended has been filed with the Secretary of the Commonwealth of Massachusetts. Any agreement, obligation or liability made, entered into or incurred by or on behalf of New England Electric System binds only its trust estate, and no shareholder, director, trustee, officer or agent thereof assumes or shall be held to any liability therefor.\nNEW ENGLAND POWER COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nNEW ENGLAND POWER COMPANY\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Jeffrey D. Tranen\nJeffrey D. Tranen President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nJoan T. Bok Alfred D. Houston s\/John G. Cochrane Cheryl A. LaFleur All by: John G. Cochrane Attorney-in-fact\nDate (as to all signatures on this page)\nMarch 28, 1996\nMASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nMASSACHUSETTS ELECTRIC COMPANY\ns\/John H. Dickson\nJohn H. Dickson President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/John H. Dickson\nJohn H. Dickson President\nPrincipal Financial Officer\ns\/Michael E. Jesanis\nMichael E. Jesanis Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nUrville J. Beaumont Sally L. Collins John H. Dickson Kalyan K. Ghosh Charles B. Housen s\/John G. Cochrane Patricia McGovern All by: John F. Reilly, Jr. John G. Cochrane Richard M. Shribman Attorney-in-fact Roslyn M. Watson\nDate (as to all signatures on this page)\nMarch 28, 1996\nTHE NARRAGANSETT ELECTRIC COMPANY\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company.\nTHE NARRAGANSETT ELECTRIC COMPANY\ns\/Robert L. McCabe\nRobert L. McCabe President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company.\n(Signature and Title)\nPrincipal Executive Officer\ns\/Robert L. McCabe\nRobert L. McCabe President\nPrincipal Financial Officer\ns\/Alfred D. Houston\nAlfred D. Houston Vice President and Treasurer\nPrincipal Accounting Officer\ns\/Howard W. McDowell\nHoward W. McDowell Controller\nDirectors (a majority)\nJoan T. Bok Stephen A. Cardi s\/John G. Cochrane Joseph J. Kirby All by: Robert L. McCabe John W. Rowe John G. Cochrane Willliam E. Trueheart Attorney-in-fact\nDate (as to all signatures on this page)\nMarch 28, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe consent to the incorporation by reference in the registration statements of New England Electric System on Form S-3 of the Dividend Reinvestment and Common Share Purchase Plan (File No. 33-12313) and on Forms S-8 of the New England Electric System Companies Incentive Thrift Plan (File No. 33-26066), the New England Electric System Companies Incentive Thrift Plan II (File No. 33-35470) and the Yankee Atomic Electric Company Thrift Plan (File No. 2-67531) of our report dated March 1, 1996 on our audits of the consolidated financial statements of New England Electric System and subsidiaries as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, which report is incorporated by reference in this Annual Report on Form 10-K.\nWe also consent to the incorporation by reference in the registration statements of New England Power Company on Forms S-3 (File Nos. 33-48257, 33-48897, and 33-49193) Massachusetts Electric Company on Form S-3 (File No. 33-59145) and The Narragansett Electric Company on Form S-3 (File No. 33-61131) of our reports dated March 1, 1996 on our audits of the financial statements of New England Power Company, Massachusetts Electric Company and The Narragansett Electric Company, respectively, as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, which reports are incorporated by reference in this Annual Report on Form 10-K.\ns\/ Coopers & Lybrand L.L.P.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. March 28, 1996","section_15":""}
{"filename":"811596_1995.txt","cik":"811596","year":"1995","section_1":"ITEM 1. BUSINESS\nIndustry Overview\nPrimary aluminum is produced by the refining of bauxite into alumina and the reduction of alumina into primary aluminum. Approximately two pounds of bauxite are required to produce one pound of alumina, and approximately two pounds of alumina are required to produce one pound of primary aluminum. Aluminum's valuable physical properties include its light weight, corrosion resistance, thermal and electrical conductivity, and high tensile strength.\nDemand\nThe packaging, transportation and construction industries are the principal consumers of aluminum in the United States, Japan, and Western Europe. In the packaging industry, which accounted for approximately 20% of aluminum consumption in 1994, aluminum's recyclability and weight advantages have enabled it to gain market share from steel and glass, primarily in the beverage container area. Nearly all beer cans and soft drink cans manufactured for the United States market are made of aluminum. Kaiser Aluminum Corporation (\"Kaiser\" or the \"Company\") believes that growth in the packaging area is likely to continue through the 1990s due to general population increase and to further penetration of the beverage container market in Asia and Latin America, where aluminum cans are a substantially lower percentage of the total beverage container market than in the United States. Kaiser believes that growth in demand for can sheet in the United States will follow the growth in population, offset, in part, by the effects of the use of lighter gauge aluminum for can sheet and of plastic container production from newly installed capacity.\nIn the transportation industry, which accounted for approximately 28% of aluminum consumption in the United States, Japan, and Western Europe in 1994, automotive manufacturers use aluminum instead of steel, ductile iron, or copper for an increasing number of components, including radiators, wheels, suspension components, and engines, in order to meet more stringent environmental, safety, and fuel efficiency requirements. Kaiser believes that sales of aluminum to the transportation industry have considerable growth potential due to projected increases in the use of aluminum in automobiles. In addition, Kaiser believes that consumption of aluminum in the construction industry will follow the cyclical growth pattern of that industry, and will benefit from higher growth in Asian and Latin American economies.\nSupply\nAs of year-end 1995, Western world aluminum capacity from 107 smelting facilities was approximately 16.6 million tons* per year. Western world production of primary aluminum for 1995 increased approximately 1.8% compared to 1994. Net exports of aluminum from the former Sino Soviet bloc increased approximately 250% from 1990 levels during the period from 1991 through 1994 to approximately 2.2 million tons per year. These exports contributed to a significant increase in London Metal Exchange (\"LME\") stocks of primary aluminum which peaked in June 1994 at 2.7 million tons. By the end of 1995, LME stocks of primary aluminum had declined 2.1 million tons from this peak level and 1.1 million tons from the beginning of 1995. See \"-Recent Industry Trends.\"\nBased upon information currently available, the Company believes that moderate additions will be made during 1996-1998 to Western world alumina and primary aluminum production capacity. The increases in alumina capacity during 1996-1998 are expected to come from one new refinery which began operations in 1995 and incremental expansions of existing\n- ---------- * All references to tons in this Report refer to metric tons of 2,204.6 pounds.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nrefineries. In addition, Kaiser believes that there is currently approximately .9 million tons of curtailed smelting capacity that could be restarted by aluminum producers. The increases in primary aluminum capacity during 1996-1998 are expected to come from one new smelter, which began operations in 1995 and is expected to reach its rated capacity of approximately 466,000 tons per year in 1996, and the remainder principally from incremental expansions of existing smelters.\nRecent Industry Trends\nMarket fundamentals for aluminum improved significantly in 1994 as aluminum producers worldwide curtailed primary aluminum production, Western world consumption of aluminum grew strongly, and customers replenished inventories, particularly in the United States. In 1995, production of primary aluminum increased and consumption of aluminum continued to grow, but at a much lower rate than in 1994. In general, the overall aluminum market was strongest in the first half of 1995. By the second half of 1995, orders and shipments for certain products had softened and the rate of decline in LME inventories had leveled off. By the end of 1995, some small increases in LME inventories occurred, and prices of aluminum weakened from first-half levels. The Midwest U.S. transaction price for primary aluminum in 1995 averaged approximately 86 cents per pound, compared to a 1994 annual average of approximately 72 cents per pound. The Midwest U.S. transaction price for primary aluminum averaged approximately 79 cents per pound in December 1995.\nWestern world demand for alumina, and the price of alumina, declined in 1994 in response to the curtailment of Western world smelter production of primary aluminum, partially offset by increased usage of Western world alumina by smelters in the Commonwealth of Independent States (the \"CIS\") and in the People's Republic of China (the \"PRC\"). Increased Western world production of primary aluminum, as well as continued imports of Western world alumina by the CIS and the PRC, during 1995 resulted in higher demand for Western world alumina and significantly stronger alumina pricing. United States shipments of domestic fabricated aluminum products in 1995 were approximately at 1994 levels, although in 1995 demand for can sheet in the United States softened relative to 1994. Overall, Kaiser believes that the market fundamentals for aluminum will be good for the near future, barring prolonged economic recession, and that demand is likely to continue growing at levels sufficient to absorb the output from restarts of industry smelter capacity and from the limited additions of new supply under construction.\nThe Company\nGeneral\nThe Company is a direct subsidiary of MAXXAM Inc. (\"MAXXAM\"). The Company, through its subsidiary, Kaiser Aluminum & Chemical Corporation (\"KACC\"), operates in all principal aspects of the aluminum industry - the mining of bauxite, the refining of bauxite into alumina, the production of primary aluminum from alumina, and the manufacture of fabricated (including semi-fabricated) aluminum products. In addition to the production utilized by KACC in its operations, KACC sells significant amounts of alumina and primary aluminum in domestic and international markets. In 1995, KACC produced approximately 2,838,000 tons of alumina, of which approximately 72% was sold to third parties, and produced 413,600 tons of primary aluminum, of which approximately 66% was sold to third parties. KACC is also a major domestic supplier of fabricated aluminum products. In 1995, KACC shipped approximately 368,200 tons of fabricated aluminum products to third parties, which accounted for approximately 6% of the total tonnage of United States domestic shipments. A majority of KACC's fabricated products are sold to distributors or used by customers as components in the manufacture and assembly of finished end-use products. Note 10 of the Notes to Consolidated Financial Statements contained in the Company's 1995 Annual Report to Shareholders (the \"Annual Report\") is incorporated herein by reference.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nThe following table sets forth total shipments and intracompany transfers of KACC's alumina, primary aluminum, and fabricated aluminum operations:\nSensitivity to Prices and Hedging Programs\nKaiser's operating results are sensitive to changes in the prices of alumina, primary aluminum, and fabricated aluminum products, and also depend to a significant degree upon the volume and mix of all products sold and on KACC's hedging strategies. Fabricated aluminum prices, which vary considerably among products, are influenced by changes in the price of primary aluminum and generally lag behind primary aluminum prices for periods of up to six months. Changes in the market price of primary aluminum also affect Kaiser's production costs of fabricated products because they influence the price of aluminum scrap purchased by Kaiser and Kaiser's labor costs, to the extent such costs are indexed to primary aluminum prices. Through its variable cost structures, forward sales, and hedging programs, KACC has attempted to mitigate its exposure to possible declines in the market prices of alumina, primary aluminum, and fabricated aluminum products while retaining the ability to participate in favorable pricing environments that may materialize. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Trends - Sensitivity to Prices and Hedging Programs\" and Note 9 of the Notes to Consolidated Financial Statements in the Annual Report.\nProduction Operations\nThe Company's operations are conducted through KACC's decentralized business units which compete throughout the aluminum industry.\no The alumina business unit, which mines bauxite and obtains additional bauxite tonnage under long-term contracts, produced approximately 8% of Western world alumina in 1995. During 1995, KACC third party shipments of bauxite represented approximately 21% of bauxite mined. In addition, KACC third party shipments of alumina represented approximately 72% of alumina produced. KACC's share of total Western world alumina capacity was approximately 7% in 1995.\no The primary aluminum products business unit operates two domestic smelters wholly owned by KACC and two foreign smelters in which KACC holds significant ownership interests. During 1995, KACC third party shipments of primary aluminum represented approximately 66% of primary aluminum production. KACC's share of total Western world primary aluminum capacity was approximately 3% in 1995.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\no Fabricated aluminum products are manufactured by three business units - flat-rolled products, extruded products and engineered components. The products include body, lid, and tab stock for beverage containers, sheet and plate products, heat-treated products, screw machine stock, redraw rod, forging stock, truck wheels and hubs, air bag canisters, engine manifolds, and other castings, forgings and extruded products, which are manufactured at plants located in principal marketing areas of the United States and Canada. The aluminum utilized in KACC's fabricated products operations is comprised of primary aluminum, obtained both internally and from third parties, and scrap metal purchased from third parties.\nAlumina - -------\nThe following table lists KACC's bauxite mining and alumina refining facilities as of December 31, 1995:\nBauxite mined in Jamaica by KJBC is refined into alumina at KACC's plant at Gramercy, Louisiana, or is sold to third parties. In 1979, the Government of Jamaica granted KACC a mining lease for the mining of bauxite sufficient to supply KACC's then-existing Louisiana alumina refineries at their annual capacities of 1,656,000 tons per year until January 31, 2020. Alumina from the Gramercy plant is sold to third parties.\nAlpart holds bauxite reserves and owns a 1,450,000 tons per year alumina plant located in Jamaica. KACC owns a 65% interest in Alpart, and Hydro Aluminium a.s (\"Hydro\") owns the remaining 35% interest. KACC has management responsibility for the facility on a fee basis. KACC and Hydro have agreed to be responsible for their proportionate shares of Alpart's costs and expenses. The Government of Jamaica has granted Alpart a mining lease and has entered into other agreements with Alpart designed to assure that sufficient reserves of bauxite will be available to Alpart to operate its refinery as it may be expanded to a capacity of 2,000,000 tons per year through the year 2024. Alpart has entered into an agreement for the supply of substantially all of its fuel oil through 1996. The balance of Alpart's fuel oil requirements through 1996 will be purchased in the spot market.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nKACC owns a 28.3% interest in Queensland Alumina Limited (\"QAL\"), which owns the largest and one of the most efficient alumina refineries in the world, located in Queensland, Australia. QAL refines bauxite into alumina, essentially on a cost basis, for the account of its stockholders under long-term tolling contracts. The stockholders, including KACC, purchase bauxite from another QAL stockholder under long-term supply contracts. KACC has contracted with QAL to take approximately 792,000 tons per year of capacity or pay standby charges. KACC is unconditionally obligated to pay amounts calculated to service its share ($88.9 million at December 31, 1995) of certain debt of QAL, as well as other QAL costs and expenses, including bauxite shipping costs. QAL's annual production capacity is approximately 3,300,000 tons, of which approximately 934,000 tons are available to KACC.\nKACC's principal customers for bauxite and alumina consist of large and small domestic and international aluminum producers that purchase bauxite and reduction-grade alumina for use in their internal refining and smelting operations, trading intermediaries who resell raw materials to end-users, and users of chemical-grade alumina. In 1995, KACC sold all of its bauxite to two customers, the largest of which accounted for approximately 74% of such sales. KACC also sold alumina to nine customers, the largest and top five of which accounted for approximately 23% and 90% of such sales, respectively. See \"- Competition.\" The Company believes that among alumina producers KACC is now the world's second largest seller of alumina to third parties. KACC's strategy is to sell a substantial portion of the bauxite and alumina available to it in excess of its internal refining and smelting requirements under multi-year sales contracts.\nPrimary Aluminum Products - -------------------------\nThe following table lists KACC's primary aluminum smelting facilities as of December 31, 1995:\nKACC owns two smelters located at Mead and Tacoma, Washington, where alumina is processed into primary aluminum. The Mead facility uses pre-bake technology and produces primary aluminum. Approximately 71% of Mead's 1995 production was used at KACC's Trentwood fabricating facility and the balance was sold to third parties. The Tacoma plant uses Soderberg technology and produces primary aluminum and high-grade, continuous-cast, redraw rod, which currently commands a premium price in excess of the price of primary aluminum. Both smelters have achieved significant production efficiencies in recent years through retrofit technology, cost controls, and semi-variable wage and power contracts, leading to increases in production volume and enhancing their ability to compete with newer smelters. At the Mead plant, KACC\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nhas converted to welded anode assemblies to increase energy efficiency, extended the anode life-cycle in the smelting process, changed from pencil to liquid pitch to produce carbon anodes which achieved environmental and operating savings, and engaged in efforts to increase production through the use of improved, higher-efficiency reduction cells.\nElectric power represents an important production cost for KACC at its aluminum smelters. In 1995 electric power purchase agreements for KACC's facilities in the Pacific Northwest were successfully restructured, which the Company anticipates will result in significantly lower electric power costs in 1996 and beyond for the Mead and Tacoma, Washington, smelters and the Trentwood, Washington, rolling mill compared to 1995 electric power costs. From 1981 until 1995, electric power for KACC's Mead and Tacoma smelters was purchased exclusively from the Bonneville Power Administration (the \"BPA\") by KACC under a contract which expires in 2001. In April 1995 the BPA agreed to allow each of its direct service industrial customers (the \"DSIs\"), which include KACC, to purchase a portion of its requirement for electric power from sources other than the BPA beginning October 1, 1995. In June 1995 KACC entered into an agreement with The Washington Water Power Company (the \"WWP\") to purchase up to 50 megawatts of electric power for its Northwest facilities for a five-year term beginning October 1, 1995. KACC is receiving power under that contract, which power displaces a portion of KACC's interruptible power from the BPA. In addition, in 1995 KACC entered into a new power purchase contract with the BPA, which amends the existing BPA power contract and which contemplates reductions during 1996 in the amount of power which KACC is obligated to purchase from the BPA and which the BPA is obligated to sell to KACC, and the replacement of such power with power to be purchased from other suppliers. KACC is negotiating power purchase agreements for such power with suppliers other than the BPA. Contracts for the purchase of all power required by KACC's Mead and Tacoma smelters and Trentwood rolling mill for 1996, and for approximately one-half of such power for the period 1997-2000, have been finalized. Two lawsuits were filed in December 1995 against the BPA by various parties, one of which petitions for a review of the BPA's \"Record of Decision on Direct Service Industrial Customer Requirements Power Sales Contract\" issued on September 28, 1995, and one of which petitions for review of, and to set aside, suspend, or modify, the action of the BPA to decide to offer five-year \"block\" power sales to the DSIs. The effect of such lawsuits, if any, on KACC's new power purchase contract with the BPA is not known. Certain of the DSIs, including KACC, have intervened in the two lawsuits.\nIn 1995 KACC also entered into agreements with the BPA and with the WWP, with terms ending in 2001, under which the BPA and the WWP would provide to KACC transmission services for power purchased from sources other than the BPA. The term of the transmission services agreement with the BPA was subsequently extended for an additional fifteen years, which extension has been challenged. Four lawsuits have been filed against the BPA by various parties, which lawsuits either challenge the BPA's record of decision offering such an extension agreement to the DSIs or challenge the BPA's Business Plan Environmental Impact Statement record of decision in connection therewith. Certain of the DSIs, including KACC, have intervened in the four lawsuits.\nKACC began operating its Mead and Tacoma smelters in Washington at approximately 75% of their full capacity in January 1993, when three reduction potlines were removed from production (two at Mead and one at Tacoma) in response to a power reduction imposed by the BPA. In March 1995, the BPA offered to its industrial customers, including KACC, surplus firm power at a discounted rate for the period April 1, 1995, through July 31, 1995, to enable such customers to restart idle industrial loads. In April 1995, KACC and the BPA entered into a contract for an amount of such power, and thereafter KACC restarted one-half of an idle potline (approximately 9,000 tons of annual capacity) at its Tacoma, Washington, smelter. The Tacoma smelter was returned to full production in October 1995. In 1995 KACC entered into a one-year power supply contract with the BPA, for a term ending September 30, 1996, in connection with the restart of idled capacity at its Mead smelter. The Mead smelter returned to full production in December 1995.\nKACC manages, and owns a 90% interest in, the Volta Aluminium Company Limited (\"Valco\") aluminum smelter in Ghana. The Valco smelter uses pre-bake technology and processes alumina supplied by KACC and the other participant into primary aluminum under long-term tolling contracts which provide for proportionate payments by the participants\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nin amounts intended to pay not less than all of Valco's operating and financing costs. KACC's share of the primary aluminum is sold to third parties. Power for the Valco smelter is supplied under an agreement which expires in 2017. The agreement indexes two-thirds of the price of the contract quantity of power to the market price of primary aluminum. The agreement also provides for a review and adjustment of the base power rate and the price index every five years. The most recent review was completed in April 1994 for the 1994-1998 period. Valco has entered into an agreement with the government of Ghana under which Valco has been assured (except in cases of force majeure) that it will receive sufficient electric power to operate at its current level of three and one-half potlines through December 31, 1996. Kaiser believes that, assuming normal rainfall during 1996, Valco should have available sufficient electric power to operate at its current level through 1996.\nKACC owns a 49% interest in the Anglesey Aluminium Limited (\"Anglesey\") aluminum smelter and port facility at Holyhead, Wales. The Anglesey smelter uses pre-bake technology. KACC supplies 49% of Anglesey's alumina requirements and purchases 49% of Anglesey's aluminum output. KACC sells its share of Anglesey's output to third parties. Power for the Anglesey aluminum smelter is supplied under an agreement which expires in 2001.\nKACC has developed and installed proprietary retrofit and control technology in all of its smelters, as well as at third party locations. This technology - which includes the redesign of the cathodes and anodes that conduct electricity through reduction cells, improved feed systems that add alumina to the cells, and a computerized system that controls energy flow in the cells - enhances KACC's ability to compete more effectively with the industry's newer smelters. KACC is actively engaged in efforts to license this technology and sell technical and managerial assistance to other producers worldwide, and may participate in joint ventures or similar business partnerships which employ KACC's technical and managerial knowledge. See \"-Research and Development.\"\nKACC's principal primary aluminum customers consist of large trading intermediaries and metal brokers, who resell primary aluminum to fabricated product manufacturers, and large and small international aluminum fabricators. In 1995, KACC sold its primary aluminum production not utilized for internal purposes to approximately 35 customers, the largest and top five of which accounted for approximately 25% and 62% of such sales, respectively. See \"- Competition.\" Marketing and sales efforts are conducted by a small staff located at the business unit's headquarters in Pleasanton, California, and by senior executives of KACC who participate in the structuring of major sales transactions. A majority of the business unit's sales are based upon long-term relationships with metal merchants and end-users.\nFabricated Aluminum Products - ----------------------------\nKACC manufactures and markets fabricated aluminum products for the packaging, transportation, construction, and consumer durables markets in the United States and abroad. Sales in these markets are made directly and through distributors to a large number of customers. In 1995, four domestic beverage container manufacturers were among the leading customers for KACC's fabricated products and accounted for approximately 12% of KACC's sales revenue.\nKACC's fabricated products compete with those of numerous domestic and foreign producers and with products made of steel, copper, glass, plastic, and other materials. Product quality, price, and availability are the principal competitive factors in the market for fabricated aluminum products. KACC has focused its fabricated products operations on selected products in which KACC has production expertise, high-quality capability, and geographic and other competitive advantages.\nFlat-Rolled Products - The flat-rolled products business unit, the largest of KACC's fabricated products businesses, operates the Trentwood sheet and plate mill at Spokane, Washington. The Trentwood facility is KACC's largest fabricating plant and accounted for approximately 64% of KACC's 1995 fabricated aluminum products shipments. The business unit supplies the beverage container market (producing body, lid, and tab stock), the aerospace market, and the tooling plate, heat-treated alloy and common alloy coil markets, both directly and through distributors. During 1995, KACC successfully\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\ncompleted the two year restructuring of its flat-rolled products operation at its Trentwood plant to reduce that facility's annual operating costs by at least $50.0 million.\nKACC's flat-rolled products are sold primarily to beverage container manufacturers located in the western United States and in the Asian Pacific Rim countries where the Trentwood plant's location provides KACC with a transportation advantage. Quality of products for the beverage container industry and timeliness of delivery are the primary bases on which KACC competes. Kaiser believes that capital improvements at Trentwood have enhanced the quality of KACC's products for the beverage container industry and the capacity and efficiency of KACC's manufacturing operations, and that KACC is one of the highest quality producers of aluminum beverage can stock in the world.\nIn 1995, the flat-rolled products business unit had 31 domestic and foreign can stock customers, including the five major domestic beverage can manufacturers. The largest and top five of such customers accounted for approximately 14% and 41%, respectively, of the business unit's revenue. See \"- Competition.\" In 1995, the business unit shipped products to approximately 150 customers in the aerospace, transportation, and industrial (\"ATI\") markets, most of which were distributors who sell to a variety of industrial end-users. The top five customers in the ATI markets for flat-rolled products accounted for approximately 13% of the business unit's revenue. The marketing staff for the flat-rolled products business unit is located at the Trentwood facility and in Pleasanton, California. Sales are made directly to customers (including distributors) from eight sales offices located throughout the United States. International customers are served by sales offices in the Netherlands and Japan and by independent sales agents in Asia and Latin America.\nExtruded Products - The extruded products business unit is headquartered in Dallas, Texas, and operates soft-alloy extrusion facilities in Los Angeles, California; Santa Fe Springs, California; Sherman, Texas; and London, Ontario, Canada; a cathodic protection business located in Tulsa, Oklahoma, that also extrudes both aluminum and magnesium; rod and bar facilities in Newark, Ohio, and Jackson, Tennessee, which produce screw machine stock, redraw rod, forging stock, and billet; and a facility in Richland, Washington, which produces seamless tubing in both hard and soft alloys for the automotive, other transportation, export, recreation, agriculture, and other industrial markets. Each of the soft-alloy extrusion facilities has fabricating capabilities and provides finishing services.\nThe extruded products business unit's major markets are in the transportation industry, to which it provides extruded shapes for automobiles, trucks, trailers, cabs, and shipping containers, and in the distribution, durable goods, defense, building and construction, ordnance and electrical markets. In 1995, the extruded products business unit had approximately 825 customers for its products, the largest and top five of which accounted for approximately 6% and 20%, respectively, of its revenue. See \"- Competition.\" Sales are made directly from plants as well as marketing locations across the United States.\nEngineered Components - The engineered components business unit operates forging facilities at Erie, Pennsylvania; Oxnard, California; and Greenwood, South Carolina; a machine shop at Greenwood, South Carolina; and a casting facility in Canton, Ohio. The engineered components business unit is one of the largest producers of aluminum forgings in the United States and is a major supplier of high-quality forged parts to customers in the automotive, commercial vehicle and ordnance markets. The high strength-to-weight properties of forged and cast aluminum make it particularly well-suited for automotive applications. The business unit's casting facility manufactures aluminum engine manifolds for the automobile, truck and marine markets.\nIn 1995, the engineered components business unit had approximately 250 customers, the largest and top five of which accounted for approximately 34% and 77%, respectively, of the business unit's revenue. See \"- Competition.\" The engineered components business unit's headquarters is located in Erie, Pennsylvania, and there is a sales and engineering office located in Detroit, Michigan, which works with car makers and other customers, the Center for Technology (see \"-Research and Development\"), and plant personnel to create new automotive component designs and improve existing products.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nCompetition\nAluminum competes in many markets with steel, copper, glass, plastic, and numerous other materials. In recent years, plastic containers have increased and glass containers have decreased their respective shares of the soft drink sector of the beverage container market. In the United States, beverage container materials, including aluminum, face increased competition from plastics as increased polyethylene (\"PET\") container capacity is brought on line by plastics manufacturers. Within the aluminum business, KACC competes with both domestic and foreign producers of bauxite, alumina and primary aluminum, and with domestic and foreign fabricators. Many of KACC's competitors have greater financial resources than KACC. KACC's principal competitors in the sale of alumina include Alcoa Alumina and Chemicals LLC, Billiton Marketing and Trading BV, and Alcan Aluminium Limited. KACC competes with most aluminum producers in the sale of primary aluminum.\nPrimary aluminum and, to some degree, alumina are commodities with generally standard qualities, and competition in the sale of these commodities is based primarily upon price, quality and availability. KACC also competes with a wide range of domestic and international fabricators in the sale of fabricated aluminum products. Competition in the sale of fabricated products is based upon quality, availability, price and service, including delivery performance. KACC concentrates its fabricating operations on selected products in which KACC has production expertise, high-quality capability, and geographic and other competitive advantages. Kaiser believes that, assuming the current relationship between worldwide supply and demand for alumina and primary aluminum does not change materially, the loss of any one of KACC's customers, including intermediaries, would not have a material adverse effect on the Company's financial condition or results of operations.\nResearch and Development\nKACC conducts research and development activities principally at three facilities - the Center for Technology (\"CFT\") in Pleasanton, California; the Primary Aluminum Products Division Technology Center (\"DTC\") adjacent to the Mead smelter in Washington; and the Alumina Development Laboratory (\"ADL\") at the Gramercy, Louisiana, refinery, which supports Kaiser Alumina Technical Services (\"KATS\") and the facilities of the alumina business unit. Net expenditures for Company-sponsored research and development activities were $18.5 million in 1995, $16.7 million in 1994, and $18.5 million in 1993. KACC's research staff totaled 157 at December 31, 1995. KACC estimates that research and development net expenditures will be approximately $22.5 million in 1996.\nCFT performs research and development across a range of aluminum process and product technologies to support KACC's business units and new business opportunities. It also selectively offers technical services to third parties. Significant efforts are directed at product and process technology for the can stock, aircraft and automotive markets, and aluminum reduction cell models which are applied to improving cell designs and operating conditions. The largest and most notable single project being developed at CFT is a strip-casting micromill process for producing can sheet. The conversion and capital costs of these micromills are expected to be significantly lower than conventional rolling mills and to result in improved economics compared with historical manufacturing and transportation costs for can stock. A pilot facility has been constructed and operated at CFT. The first micromill is being constructed in Nevada as a demonstration production facility, and KACC expects operational startup of the facility at the end of 1996. KACC currently intends to finance the cost of the construction of the Nevada micromill, estimated to be approximately $45.0 million, from general corporate funds, including possible borrowings under the 1994 Credit Agreement (defined below), although KACC is in discussions with third parties which might provide some or all of such funding. DTC maintains specialized laboratories and a miniature carbon plant where experiments with new anode and cathode technology are performed. DTC supports KACC's primary aluminum smelters, and concentrates on the development of cost-effective technical innovations such as equipment and process improvements. KATS provides improved alumina process technology to KACC's facilities and technical support to new business ventures in cooperation with KACC's international business development group.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nKACC is actively engaged in efforts to license its technology and sell technical and managerial assistance to other producers worldwide. KACC's technology has been installed in alumina refineries, aluminum smelters and rolling mills located in the United States, Jamaica, Sweden, Germany, Russia, India, Australia, Korea, New Zealand, Ghana, United Arab Emirates, and the United Kingdom. KACC's revenue from technology sales and technical assistance to third parties were $5.7 million in 1995, $10.0 million in 1994, and $12.8 million in 1993.\nKACC has entered into agreements with respect to the Krasnoyarsk smelter in Russia under which KACC has licensed certain of its technology for use in such facility and agreed to provide purchasing services in obtaining Western-sourced technology and equipment to be used in such facility. These agreements were entered into in November 1990, and the services under them are expected to be completed in 1996. In addition, in 1993 KACC entered into agreements with respect to the Nadvoitsy smelter in Russia and the Korba smelter of the Bharat Aluminum Co. Ltd., in India, under which KACC has licensed certain of its technology for use in such facilities. Services under the Nadvoitsy agreement were completed in 1995, and KACC expects that services under the Korba agreement will be completed in 1996.\nOperations in China\nIn 1994, KACC commenced efforts to increase its activities in certain countries that are expected to be important suppliers of aluminum and large customers for aluminum and alumina. KACC intends to use its technical skills, together with capital investments, to form joint ventures or acquire equity in facilities in such countries.\nIn 1995, Kaiser Yellow River Investment Limited (\"KYRIL\"), a subsidiary of the Company, was formed to participate in the privatization, modernization, expansion, and operation of aluminum smelting facilities in the PRC. KYRIL has entered into a Joint Venture Agreement and related agreements (the \"Joint Venture Agreements\") with the Lanzhou Aluminum Smelters (\"LAS\") of the China National Nonferrous Metals Industry Corporation relating to the formation and operation of Yellow River Aluminum Industry Company Limited, a Sino-foreign joint equity enterprise organized under PRC law (the \"Joint Venture\").\nThe Joint Venture constitutes the first large-scale privatization in the Chinese aluminum smelting industry. The Joint Venture's assets and operations are located primarily in the industrial city of Lanzhou, the capital of Gansu Province in northwestern China, and in nearby Lianhai, a special economic zone also in Gansu Province. The smelter at Lanzhou is the fifth largest aluminum smelter in the PRC and produces approximately 55,000 tons of primary aluminum per year. The smelter at Lianhai produces approximately 30,000 tons of primary aluminum per year. LAS's capital contribution to the Joint Venture consisted primarily of the Lanzhou and Lianhai smelters.\nThe Joint Venture Agreements include provisions for KYRIL to contribute up to $59.7 million to the Joint Venture in exchange for up to a 49% interest in the Joint Venture (the \"Capital Contribution\") and contemplate that such capital may be used to expand the annual production capacity of LAS from 85,000 to 115,000 tons, construct a dry Soderberg paste plant, install and upgrade pollution control equipment, and provide for general corporate purposes, including working capital. KYRIL contributed $9.0 million as a contribution to the capital of the Joint Venture in July 1995. The parties to the Joint Venture are currently engaged in discussions concerning the amount, timing and other conditions relating to KYRIL's additional contributions to the Joint Venture. Governmental approval in the PRC will be necessary in order to implement any arrangements agreed to by the parties, and there can be no assurance such approvals will be obtained.\nKACC, through its extruded products business unit, has entered into contracts to form two small joint venture companies in the PRC. KACC will indirectly acquire equity interests of approximately 45% and 49%, respectively, in these two companies which will manufacture aluminum extrusions, in exchange for the contribution to those companies of certain used equipment, technology, services and cash. The majority equity interests in the two companies will be owned by affiliates of Guizhou Guang Da Construction Company.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nEmployees\nDuring 1995, KACC employed an average of 9,546 persons, compared with an average of 9,744 employees in 1994, and 10,220 employees in 1993. At December 31, 1995, KACC's work force was 9,624, including a domestic work force of 5,946, of whom 4,010 were paid at an hourly rate. Most hourly paid domestic employees are covered by collective bargaining agreements with various labor unions. Approximately 74% of such employees are covered by a master agreement (the \"Labor Contract\") with the United Steelworkers of America (\"USWA\") expiring September 30, 1998. The Labor Contract covers KACC's plants in Spokane (Trentwood and Mead) and Tacoma, Washington; Gramercy, Louisiana; and Newark, Ohio. The Labor Contract replaced a contract that expired October 31, 1994, and was reached after an eight-day work stoppage by the USWA at these plants in February 1995.\nThe Labor Contract provides for base wages at all covered plants. In addition, workers covered by the Labor Contract may receive quarterly bonus payments based on various indices of profitability, productivity, efficiency, and other aspects of specific plant performance, as well as, in certain cases, the price of alumina or primary aluminum. Pursuant to the Labor Contract, base wage rates were raised effective January 2, 1995, were raised again effective November 6, 1995, and will be raised an additional amount effective November 3, 1997, and an amount in respect of the cost of living adjustment under the previous master agreement will be phased into base wages during the term of the Labor Contract. In the second quarter of 1995, KACC acquired up to $2,000 of preference stock held in a stock plan for the benefit of each of approximately 82% of the employees covered by the Labor Contract and in the first half of 1998 will acquire up to an additional $4,000 of such preference stock held in such plan for the benefit of substantially the same employees. In addition, a profitability test was satisfied and, therefore, KACC will acquire during 1996 up to an additional $1,000 of such preference stock held in such plan for the benefit of substantially the same employees. KACC made and will make comparable acquisitions of preference stock held for the benefit of each of certain salaried employees.\nIn February 1995, Alpart's employees engaged in a six-day work stoppage by its National Workers Union, which was settled by a new contract.\nManagement considers KACC's employee relations to be satisfactory.\nEnvironmental Matters\nKaiser and KACC are subject to a wide variety of international, federal, state and local environmental laws and regulations (the \"Environmental Laws\"). From time to time the Environmental Laws are amended and new ones are adopted. The Environmental Laws regulate, among other things, air and water emissions and discharges; the generation, storage, treatment, transportation, and disposal of solid and hazardous waste; the release of hazardous or toxic substances, pollutants and contaminants into the environment; and, in certain instances, the environmental condition of industrial property prior to transfer or sale. In addition, Kaiser and KACC are subject to various federal, state, and local workplace health and safety laws and regulations (\"Health Laws\").\nFrom time to time, KACC is subject, with respect to its current and former operations, to fines or penalties assessed for alleged breaches of the Environmental and Health Laws and to claims and litigation brought by federal, state or local agencies and by private parties seeking remedial or other enforcement action under the Environmental and Health Laws or damages related to alleged injuries to health or to the environment, including claims with respect to certain waste disposal sites and the remediation of sites presently or formerly operated by KACC. See \"Legal Proceedings.\" KACC currently is subject to a number of lawsuits under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986 (\"CERCLA\"). KACC, along with certain other entities, has been named as a Potentially Responsible Party (\"PRP\") for remedial costs at certain third-party\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 1. BUSINESS (continued)\nsites listed on the National Priorities List under CERCLA and, in certain instances, may be exposed to joint and several liability for those costs or damages to natural resources. KACC's Mead, Washington, facility has been listed on the National Priorities List under CERCLA. In addition, in connection with certain of its asset sales, KACC has agreed to indemnify the purchasers with respect to certain liabilities (and associated expenses) resulting from acts or omissions arising prior to such dispositions, including environmental liabilities. While uncertainties are inherent in the final outcome of these matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, Kaiser believes that the resolution of such uncertainties should not have a material adverse effect on KACC's consolidated financial position, results of operations, or liquidity.\nEnvironmental capital spending was $9.2 million in 1995, $11.9 million in 1994, and $12.6 million in 1993. Annual operating costs for pollution control, not including corporate overhead or depreciation, were approximately $26.0 million in 1995, $23.1 million in 1994, and $22.4 million in 1993. Legislative, regulatory, and economic uncertainties make it difficult to project future spending for these purposes. However, Kaiser currently anticipates that in the 1996-1997 period, environmental capital spending will be within the range of $27.0 - $33.0 million per year, and operating costs for pollution control will be within the range of $28.0 - $29.0 million per year. In addition, $4.5 million in cash expenditures in 1995, $3.6 million in 1994, and $7.2 million in 1993 were charged to previously established reserves relating to environmental costs. Approximately $8.4 million is expected to be charged to such reserves in 1996.\nBased on Kaiser's evaluation of these and other environmental matters, Kaiser has established environmental accruals primarily related to potential solid waste disposal and soil and groundwater remediation matters. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Environmental Contingencies.\" The portion of Note 8 of the Notes to Consolidated Financial Statements in the Annual Report under the heading \"Environmental Contingencies\" is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe locations and general character of the principal plants, mines, and other materially important physical properties relating to KACC's operations are described in \"Business - The Company - Production Operations\" and those descriptions are incorporated herein by reference. KACC owns in fee or leases all the real estate and facilities used in connection with its business. Plants and equipment and other facilities are generally in good condition and suitable for their intended uses, subject to changing environmental requirements. Although KACC's domestic aluminum smelters and alumina facility were initially designed early in KACC's history, they have been modified frequently over the years to incorporate technological advances in order to improve efficiency, increase capacity, and achieve energy savings. Kaiser believes that KACC's domestic plants are cost competitive on an international basis. Due to KACC's variable cost structure, the plants' operating costs are relatively lower in periods of low primary aluminum prices and relatively higher in periods of high primary aluminum prices.\nKACC's obligations under the Credit Agreement entered into on February 17, 1994, as amended (the \"1994 Credit Agreement\") are secured by, among other things, mortgages on KACC's major domestic plants (other than the Gramercy alumina plant). See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital Structure\" in the Annual Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAberdeen Pesticide Dumps Site Matter\nThe Aberdeen Pesticide Dumps Site, listed on the Superfund National Priorities List, is composed of five separate sites around the town of Aberdeen, North Carolina (collectively, the \"Sites\"). The Sites are of concern to the United States Environmental Protection Agency (the \"EPA\") because of their past use as either pesticide formulation facilities or pesticide\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 3. LEGAL PROCEEDINGS (continued)\ndisposal areas from approximately the mid-1930's through the late-1980's. The United States filed a cost recovery complaint (the \"Complaint\") in the United States District Court for the Middle District of North Carolina, Rockingham Division, No. C-89-231-R, which, as amended, includes KACC and a number of other defendants. The Complaint, as amended, seeks reimbursement for past and future response costs and a determination of liability of the defendants under Section 107 of CERCLA. The EPA has performed a Remedial Investigation\/Feasibility Study and issued a Record of Decision (\"ROD\") for the Sites in September 1991. The estimated cost of the major soil remediation remedy selected for the Sites is approximately $32 million. Other possible remedies described in the ROD would have estimated costs of approximately $53 million and $222 million, respectively. The EPA has stated that it has incurred past costs at the Sites in the range of $7.5-$8 million as of February 9, 1993, and alleges that response costs will continue to be incurred in the future.\nOn May 20, 1993, the EPA issued three unilateral Administrative Orders under Section 106(a) of CERCLA ordering the respondents, including KACC, to perform the soil remedial design and remedial action described in the ROD for three of the Sites. The estimated cost as set forth in the ROD for the remedial action at the three Sites is approximately $27 million. A number of other companies are also named as respondents. KACC has entered into a PRP Participation Agreement with certain of the respondents (the \"Aberdeen Site PRP Group\" or the \"Group\") to participate jointly in responding to the Administrative Orders dated May 20, 1993, regarding soil remediation, to share costs incurred on an interim basis, and to seek to reach a final allocation of costs through agreement or to allow such final allocation and determination of liability to be made by the United States District Court. By letter dated July 6, 1993, KACC has notified the EPA of its ongoing participation with such group of respondents which, as a group, are intending to comply with the Administrative Orders to the extent consistent with applicable law. By letters dated December 30, 1993, the EPA notified KACC of its potential liability for, and requested that KACC, along with a number of other companies, undertake or agree to finance, groundwater remediation at certain of the Sites. The ROD-selected remedy for the groundwater remediation selected by EPA includes a variety of techniques. The EPA has estimated the total present worth cost, including thirty years of operation and maintenance, at approximately $11.8 million. On June 22, 1994, the EPA issued two unilateral Administrative Orders under Section 106(a) of CERCLA ordering the respondents, including KACC, to undertake the groundwater remediation at three of the Sites. A PRP Participation Agreement with respect to groundwater remediation has been entered into by certain of the respondents, including KACC.\nBy letter dated March 6, 1996, KACC gave notice of withdrawal from the Aberdeen Site PRP Group pursuant to the provisions of the PRP Participation Agreement. KACC advised the Group and the EPA that even if it were liable for cleanup at the Sites, which it expressly denies, it had already contributed far more than its allocable potential share of response costs. KACC has advised the Group and the EPA that it has fully complied with the Unilateral Orders and that should additional evidence be presented which demonstrates KACC's liability in excess of the amount contributed to date, KACC would be willing to discuss the matter further at that time.\nUnited States of America v. Kaiser Aluminum & Chemical Corporation\nIn February 1989, a civil action was filed by the United States Department of Justice (the \"DOJ\") at the request of the EPA against KACC in the United States District Court for the Eastern District of Washington, Case No. C-89-106-CLQ. The complaint alleged that emissions from certain stacks at KACC's Trentwood facility in Spokane, Washington intermittently violated the opacity standard contained in the Washington State Implementation Plan (\"SIP\"), approved by the EPA under the federal Clean Air Act. The complaint sought injunctive relief, including an order that KACC take all necessary action to achieve compliance with the SIP opacity limit and the assessment of civil penalties of not more than $25,000 per day.\nKACC and the EPA, without adjudication of any issue of fact or law, and without any admission of the violations alleged in the underlying complaint, have entered into a Consent Decree, which was approved by a Consent Order entered by the United States District Court for the Eastern District of Washington in January 1996. As approved, the Consent Decree\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 3. LEGAL PROCEEDINGS (continued)\nsettles the underlying disputes and requires KACC to (i) pay a $.5 million civil penalty (which penalty has been paid), (ii) complete a program of plant improvements and operational changes that began in 1990 at its Trentwood facility, including the installation of an emission control system to capture particulate emissions from certain furnaces, and (iii) achieve and maintain furnace compliance with the opacity standard in the SIP by no later than February 28, 1997. The Company anticipates that capital expenditures for the environmental upgrade of the furnace operation at its Trentwood facility, including the improvements and changes required by the Consent Decree, will be approximately $20.0 million.\nCatellus Development Corporation v. Kaiser Aluminum & Chemical Corporation and James L. Ferry & Son Inc.\nIn January 1991, the City of Richmond, et al. (the \"Plaintiffs\") filed a Second Amended Complaint for Damages and Declaratory Relief against the United States, Catellus Development Corporation (\"Catellus\") and other defendants (collectively, the \"Defendants\") alleging, among other things, that the Defendants caused or allowed hazardous substances, pollutants, contaminants, debris and other solid wastes to be discharged, deposited, disposed of or released on certain property located in Richmond, California (the \"Property\") formerly owned by Catellus and leased to KACC for the purpose of shipbuilding activities conducted by KACC on behalf of the United States during World War II. The Plaintiffs sought recovery of response costs and natural resource damages under CERCLA. Certain of the Plaintiffs alleged they had incurred or expected to incur costs and damages of approximately $49.0 million. Catellus subsequently filed a third party complaint (the \"Third Party Complaint\") against KACC in the United States District Court for the Northern District of California, Case No. C-89-2935 DLJ. Thereafter, the Plaintiffs filed a separate complaint against KACC, Case No. C-92-4176. The Plaintiffs settled their CERCLA and tort claims against the United States for $3.5 million plus thirty-five percent (35%) of future response costs.\nThe trial involving this case commenced in March 1995. During the trial, Plaintiffs settled their claims against Catellus in exchange for payment of approximately $3.25 million. Subsequently, on June 2, 1995, the United States District Court for the Northern District of California issued an order on the remaining claims in that action. On December 7, 1995, the District Court issued the Final Judgment on those claims concluding that KACC is liable for various costs and interest, aggregating approximately $2.2 million, fifty percent (50%) of future costs of cleaning up certain parts of the Property and certain fees and costs associated specifically with the claim by Catellus against KACC. In January 1996, Catellus filed a notice of appeal with respect to its indemnity judgment against KACC. KACC has since filed a notice of cross appeal as to the Court's decision adjudicating that KACC is obligated to indemnify Catellus. In February 1996, the Plaintiffs filed motions, which KACC intends to contest, seeking reimbursement of fees and costs from KACC in the aggregate amount of $2.76 million. Based on KACC's estimate of future costs of cleanup, resolution of the Catellus matter is not expected to have a material adverse effect on Kaiser's consolidated financial condition, results of operations, or liquidity.\nWaste Inc. Superfund Site\nOn December 8, 1995, the EPA issued a unilateral Administrative Order for Remedial Design and Remedial Action under CERCLA to KACC and thirty-one other respondents for remedial design and action at the Waste Inc. Superfund Site at Michigan City, Indiana. This site was operated as a landfill from 1965 to 1982. KACC is alleged to have arranged for the disposal of waste from its formerly-owned plant at Wanatah, Indiana, during the period from 1964 to 1972. In its Record of Decision, the EPA estimated the cost of the work to be performed to have a present value of $15.7 million. KACC's share of the total waste sent to the site is unknown. A consultant retained by a group of PRPs estimated that KACC contributed 2.0% of the waste sent to the site by the forty-one largest contributors. KACC's ultimate exposure will depend on the number of PRPs that participate and the volume of waste properly allocable to KACC. Based on the EPA's cost estimate, KACC believes that its financial exposure for remedial design and remedial action at this site is less than $500,000. A PRP participation agreement is under negotiation.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 3. LEGAL PROCEEDINGS (continued)\nHammons v. Alcan Aluminum Corp. et al\nOn March 5, 1996, a class action complaint was filed in California against the Company, Alcan Aluminum Corp., Aluminum Company of America, Alumax, Inc, Reynolds Metal Company, the Aluminum Association and others in the Superior Court of California for the County of Los Angeles, Case No. BC145612. The complaint claims that the defendants conspired, in violation of state antitrust laws, to raise, stabilize and maintain the price of primary aluminum and aluminum products through cuts in production allegedly in connection with the ratification of a Memorandum of Understanding in 1994 by representatives of the authorities of Australia, Canada, the European Union, Norway, the Russian Federation and the United States. The complaint seeks certification of a class consisting of persons who at any time between January 1, 1994, and the date of the complaint purchased aluminum or aluminum products manufactured by one or more of the defendants and estimates damages sustained by the class to be $4.4 billion, before trebling.\nMatheson et al v. Kaiser Aluminum Corporation et al\nOn September 11, 1995, Kaiser announced that it had appointed an independent committee of its Board of Directors to consider a possible recapitalization transaction. On February 5, 1996, Kaiser publicly announced that it had filed a preliminary proxy statement with the Securities and Exchange Commission relating to a proposed recapitalization. A special shareholders' meeting to consider the recapitalization was subsequently scheduled for April 10, 1996, and the definitive proxy statement was mailed to shareholders commencing on March 20, 1996. See Note 7 of the Notes to Consolidated Financial Statements of the Company, under the heading Proposed Recapitalization, at pages 50-51 of the Annual Report for a description of the proposed recapitalization. On March 19, 1996, a lawsuit was filed against MAXXAM, Kaiser, and Kaiser's directors challenging and seeking to enjoin the recapitalization and the April 10, 1996, special shareholders' meeting. The suit, which is entitled Matheson et al v. Kaiser Aluminum Corporation et al (No. 14900) and was filed in the Delaware Court of Chancery, purports to be a class action by persons who as of March 18, 1996 (the record date for the April 10, 1996, meeting) owned Kaiser's outstanding common stock and 8.255% PRIDES, Convertible Preferred Stock (\"PRIDES\"). Plaintiffs allege, among other things, breaches of fiduciary duties by certain defendants and that the proposed recapitalization violates Delaware law and the certificate of designation for the PRIDES. Plaintiffs seek injunctive relief, rescission, rescissory damages and other relief. A hearing on the motion for injunctive relief is presently scheduled for April 8, 1996.\nAsbestos-related Litigation\nKACC is a defendant in a number of lawsuits, some of which involve claims of multiple persons, in which the plaintiffs allege that certain of their injuries were caused by, among other things, exposure to asbestos during, and as a result of, their employment or association with KACC or exposure to products containing asbestos produced or sold by KACC. The lawsuits generally relate to products KACC has not manufactured for at least 15 years. At December 31, 1995, the number of such claims pending was approximately 59,700, as compared with 25,200 at December 31, 1994. In 1995, approximately 41,700 of such claims were received and 7,200 settled or dismissed. KACC has been advised by its regional counsel that, although there can be no assurance, the recent increase in pending claims may be attributable in part to tort reform legislation in Texas which was passed by the legislature in March 1995 and which became effective on September 1, 1995. The legislation, among other things, is designed to restrict, beginning September 1, 1995, the filing of cases in Texas that do not have a sufficient nexus to that jurisdiction, and to impose, generally as of September 1, 1996, limitations relating to joint and several liability in tort cases. A substantial portion of the asbestos-related claims that were filed and served on KACC between June 30, 1995, and November 30, 1995, were filed in Texas prior to September 1, 1995. For additional information, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Asbestos Contingencies.\" The portion of Note 8 of the Notes to Consolidated Financial Statements in the Annual Report under the heading \"Asbestos Contingencies\" is incorporated herein by reference.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 3. LEGAL PROCEEDINGS (continued)\nOther Proceedings\nOn August 24, 1994, the DOJ issued Civil Investigative Demand No. 11356 (\"CID No. 11356\") requesting information from Kaiser regarding (i) its production, capacity to produce, and sales of primary aluminum from January 1, 1991, to the date of the response; (ii) any actual or contemplated reduction in its production of primary aluminum during that period; and (iii) any communications with others regarding any actual, contemplated, possible or desired reductions in primary aluminum production by Kaiser or any of its competitors during that period. Management believes that Kaiser's actions have at all times been appropriate, and Kaiser has submitted documents and interrogatory answers to the DOJ responding to CID No. 11356.\nOn March 27, 1995, the DOJ issued Civil Investigative Demand No. 12503 (\"CID No. 12503\"), as part of an industry-wide investigation, requesting information from KACC regarding (i) any actual or contemplated changes in its method of pricing can stock from January 1, 1994, through March 31, 1995, (ii) the percentage of aluminum scrap and primary aluminum ingot used by KACC to produce can stock and the manner in which KACC's cost of acquiring aluminum scrap is factored into its can stock prices, and (iii) any communications with others regarding any actual or contemplated changes in its method of pricing can stock from January 1, 1994, through March 31, 1995. Kaiser believes that KACC's actions have at all times been appropriate, and KACC has submitted documents and interrogatory answers to the DOJ responding to CID No. 12503.\nVarious other lawsuits and claims are pending against KACC. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders of the Company during the fourth quarter of 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 New York Stock Exchange under the symbol \"KLU\". The number of record holders of the Company's common stock at March 15, 1996 was 169. Page 59 of the Annual Report, and the information in Note 7 of the Notes to Consolidated Financial Statements under the heading \"Dividends on Common Stock\" at page 50 of the Annual Report, are incorporated herein by reference. The Company has not paid any dividends on its common stock during the two most recent fiscal years.\nThe 1994 Credit Agreement (Exhibits 4.6 through 4.11 to this Report) contains restrictions on the ability of the Company to pay dividends on or make distributions on account of the Company's common stock, and the 1994 Credit Agreement and the Indentures (Exhibits 4.1 through 4.5 to this Report) contain restrictions on the ability of the Company's subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. Exhibits 4.1 through 4.11 to this Report, Note 4 of the Notes to Consolidated Financial Statements at pages 37-39 of the Annual Report, and the information under the heading \"Liquidity and Capital Resources - Capital Structure\" at pages 22-24 of the Annual Report, are incorporated herein by reference.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for the Company is incorporated herein by reference to the table at page 3 of this Report, to the table at page 20 of the Annual Report, to the discussion under the heading \"Results of Operations\" at page 21 of the Annual Report, to Note 1 of the Notes to Consolidated Financial Statements at pages 33-35 of the Annual Report, and to pages 57-58 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPages 20-28 of the Annual Report are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 29-56 and page 59 of the Annual Report are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nInformation required under PART III (Items 10, 11, 12, and 13) has been omitted from this Report since the Company intends to file with the Securities and Exchange Commission, not later than 120 days after the close of its fiscal year, a definitive proxy statement pursuant to Regulation 14A which involves the election of directors.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Index to Financial Statements and Schedules\n1. Financial Statements --------------------\nThe Consolidated Financial Statements of the Company, the Notes to Consolidated Financial Statements, the Report of Independent Public Accountants, and Quarterly Financial Data are included on pages 29-56 and 59 of the Annual Report.\n2. Financial Statement Schedules . . . . . . . . . . . . . Page ----------------------------- ----\nReport of Independent Public Accountants. . . . . . . . 19\nSchedule I - Condensed Balance Sheets - Parent Company, Condensed Statements of Income - Parent Company, Condensed Statements of Cash Flows - Parent Company, and Notes to Condensed Financial Statements - Parent Company . . . . . . . . . . . .20-23\nAll other schedules are inapplicable or the required information is included in the Consolidated Financial Statements or the Notes thereto.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued)\n3. Exhibits --------\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 25), which index is incorporated herein by reference.\n(b) Reports on Form 8-K\nNo Report on Form 8-K was filed by the Company during the last quarter of the period covered by this Report.\n(c) Exhibits\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 25), which index is incorporated herein by reference.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Kaiser Aluminum Corporation and Subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K and have issued our report thereon dated February 16, 1996. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule I listed in the index at Item 14(a)2. above is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP Houston, Texas February 16, 1996\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nSCHEDULE I CONDENSED BALANCE SHEETS - PARENT COMPANY\n(In millions of dollars, except share amounts)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I CONDENSED STATEMENTS OF INCOME - PARENT COMPANY\n(In millions of dollars)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I CONDENSED STATEMENTS OF CASH FLOWS - PARENT COMPANY\n(In millions of dollars)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I\nNOTES TO CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY\n1. Basis of Presentation\nThe accompanying parent company financial statements of Kaiser Aluminum Corporation (\"Kaiser\") should be read in conjunction with the 1995 consolidated financial statements of Kaiser and Subsidiary Companies.\nKaiser is a holding company and conducts its operations through its wholly owned subsidiary, Kaiser Aluminum & Chemical Corporation (\"KACC\"), which is reported herein using the equity method of accounting.\n2. Intercompany Note Payable\nThe Intercompany Note to KACC was amended in July 1993 to decrease the fixed interest rate from 13% to 6-5\/8%. No interest or principal payments are due until December 31, 2000, after which interest and principal will be payable over a 15-year term pursuant to a predetermined schedule.\n3. Restricted Net Assets\nThe investment in KACC is substantially unavailable to Kaiser pursuant to the terms of certain debt instruments. The obligations of KACC in respect of the credit facilities under the 1994 Credit Agreement are guaranteed by Kaiser and by all significant subsidiaries of KACC. See Note 4 of the Notes to Consolidated Financial Statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKAISER ALUMINUM CORPORATION Date: March 27, 1996 By George T. Haymaker, Jr. ----------------------------- George T. Haymaker, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: March 27, 1996 George T. Haymaker, Jr. ----------------------------- George T. Haymaker, Jr. Chairman of the Board and Chief Executive Officer (Principal Executive Officer)\nDate: March 27, 1996 John T. La Duc ----------------------------- John T. La Duc Vice President and Chief Financial Officer (Principal Financial Officer)\nDate: March 27, 1996 Arthur S. Donaldson ----------------------------- Arthur S. Donaldson Controller (Principal Accounting Officer)\nDate: March 27, 1996 Robert J. Cruikshank ----------------------------- Robert J. Cruikshank Director\nDate: March 27, 1996 Charles E. Hurwitz ----------------------------- Charles E. Hurwitz Director\nDate: March 27, 1996 Ezra G. Levin ----------------------------- Ezra G. Levin Director\nDate: March 27, 1996 Robert Marcus ----------------------------- Robert Marcus Director\nDate: March 27, 1996 Robert J. Petris ----------------------------- Robert J. Petris Director\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nINDEX OF EXHIBITS\nExhibit Number Description - ------ ------------\n3.1 Restated Certificate of Incorporation of Kaiser Aluminum Corporation (the \"Company\" or \"KAC\"), dated February 21, 1991 (incorporated by reference to Exhibit 3.1 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n*3.2 Certificate of Retirement of KAC, dated October 24, 1995.\n3.3 By-laws of KAC, amended as of February 26, 1991 (incorporated by reference to Exhibit 3.2 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n4.1 Indenture, dated as of February 1, 1993, among KACC, as Issuer, Kaiser Alumina Australia Corporation, Alpart Jamaica Inc., and Kaiser Jamaica Corporation, as Subsidiary Guarantors, and The First National Bank of Boston, as Trustee, regarding KACC's 12-3\/4% Senior Subordinated Notes Due 2003 (incorporated by reference to Exhibit 4.1 to Form 10-K for the period ended December 31, 1992, filed by KACC, File No. 1-3605).\n4.2 First Supplemental Indenture, dated as of May 1, 1993, to the Indenture, dated as of February 1, 1993 (incorporated by reference to Exhibit 4.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n*4.3 Second Supplemental Indenture, dated as of February 1, 1996, to the Indenture, dated as of February 1, 1993.\n4.4 Indenture, dated as of February 17, 1994, among KACC, as Issuer, Kaiser Alumina Australia Corporation, Alpart Jamaica Inc., Kaiser Jamaica Corporation, and Kaiser Finance Corporation, as Subsidiary Guarantors, and First Trust National Association, as Trustee, regarding KACC's 9-7\/8% Senior Notes Due 2002 (incorporated by reference to Exhibit 4.3 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n*4.5 First Supplemental Indenture, dated as of February 1, 1996, to the Indenture, dated as of February 17, 1994.\n4.6 Credit Agreement, dated as of February 17, 1994, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.4 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.7 First Amendment to Credit Agreement, dated as of July 21, 1994, amending the Credit Agreement, dated as of February 17, 1994, among KAC, KACC, the financial institutions party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n4.8 Second Amendment to Credit Agreement, dated as of March 10, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.6 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\n4.9 Third Amendment to Credit Agreement, dated as of July 20, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1995, filed by KAC, File No. 1-9447).\n4.10 Fourth Amendment to Credit Agreement, dated as of October 17, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended September 30, 1995, filed by KAC, File No. 1-9447).\n*4.11 Fifth Amendment to Credit Agreement, dated as of December 11, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent.\n4.12 Certificate of Designations of Series A Mandatory Conversion Premium Dividend Preferred Stock of KAC, dated June 28, 1993 (incorporated by reference to Exhibit 4.3 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KAC, File No. 1-9447).\n4.13 Deposit Agreement between KAC and The First National Bank of Boston, dated as of June 30, 1993 (incorporated by reference to Exhibit 4.4 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KAC, File No. 1-9447).\n4.14 Intercompany Note between KAC and KACC (incorporated by reference to Exhibit 4.2 to Amendment No. 5 to the Registration Statement on Form S-1, dated December 13, 1989, filed by KACC, Registration No. 33-30645).\n4.15 Senior Subordinated Intercompany Note between KACC and a subsidiary of MAXXAM, dated December 15, 1992 (incorporated by reference to Exhibit 4.10 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n4.16 Certificate of Designations of 8.255% PRIDES, Convertible Preferred Stock of KAC, dated February 17, 1994 (incorporated by reference to Exhibit 4.21 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.17 Senior Subordinated Intercompany Note between KAC and KACC dated February 15, 1994 (incorporated by reference to Exhibit 4.22 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.18 Senior Subordinated Intercompany Note between KAC and KACC dated March 17, 1994 (incorporated by reference to Exhibit 4.23 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.19 Senior Subordinated Intercompany Note between KAC and KACC dated June 30, 1993 (incorporated by reference to Exhibit 4.24 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\nKAC has not filed certain long-term debt instruments not being registered with the Securities and Exchange Commission where the total amount of indebtedness authorized under any such instrument does not exceed 10% of the total assets of KAC and its subsidiaries on a consolidated basis. KAC agrees and undertakes to furnish a copy of any such instrument to the Securities and Exchange Commission upon its request.\n10.1 Form of indemnification agreement with officers and directors (incorporated by reference to Exhibit (10)(b) to the Registration Statement of KAC on Form S-4, File No. 33-12836).\n10.2 Tax Allocation Agreement between MAXXAM and KACC (incorporated by reference to Exhibit 10.21 to Amendment No. 6 to the Registration Statement on Form S-1, dated December 14, 1989, filed by KACC, Registration No. 33-30645).\n10.3 Tax Allocation Agreement between KAC and MAXXAM (incorporated by reference to Exhibit 10.23 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n10.4 Tax Allocation Agreement, dated as of June 30, 1993, between KACC and KAC (incorporated by reference to Exhibit 10.3 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n10.5 Assumption Agreement, dated as of October 28, 1988 (incorporated by reference to Exhibit HHH to the Final Amendment to the Schedule 13D of MAXXAM Group Inc. and others in respect of the Common Stock of KAC, par value $.33-1\/3 per share).\n10.6 Agreement, dated as of June 30, 1993, between KAC and MAXXAM (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\nExecutive Compensation Plans and Arrangements [Exhibits 10.7 - 10.20, inclusive]\n10.7 KACC's Bonus Plan (incorporated by reference to Exhibit 10.25 to Amendment No. 6 to the Registration Statement on Form S-1, dated December 14, 1989, filed by KACC, Registration No. 33-30645).\n10.8 Kaiser 1993 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n10.9 Kaiser 1995 Employee Incentive Compensation Program (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended March 31, 1995, filed by KAC, File No. 1-9447).\n10.10 Kaiser 1995 Executive Incentive Compensation Program (incorporated by reference to Exhibit 99 to the Proxy Statement, dated April 26, 1995, filed by KAC, File No. 1-9447).\n10.11 Employment Agreement, dated April 1, 1993, among KAC, KACC, and George T. Haymaker, Jr. (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended March 31, 1993, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\n10.12 Promissory Note, dated October 4, 1990, by Robert W. Irelan and Barbara M. Irelan to KACC (incorporated by reference to Exhibit 10.54 to Form 10-K for the period ended December 31, 1990, filed by MAXXAM, File No. 1-3924).\n10.13 Promissory Note, dated February 1, 1989, by Anthony R. Pierno and Beverly J. Pierno to MAXXAM (incorporated by reference to Exhibit 10.30 to Form 10-K for the period ended December 31, 1988, filed by MAXXAM, File No. 1-3924).\n10.14 Promissory Note, dated July 19, 1990, by Anthony R. Pierno to MAXXAM (incorporated by reference to Exhibit 10.31 to Form 10-K for the period ended December 31, 1990, filed by MAXXAM, File No. 1-3924).\n10.15 Promissory Note, dated July 20, 1993, between MAXXAM and Byron L. Wade (incorporated by reference to Exhibit 10.59 to Form 10-K for the period ended December 31, 1993, filed by MAXXAM, File No. 1-3924).\n10.16 Employment Agreement, dated August 20, 1993, between KACC and Robert E. Cole (incorporated by reference to Exhibit 10.63 to Form 10-K for the period ended December 31, 1993, filed by MAXXAM, File No. 1-3924).\n10.17 Compensation Agreement, dated July 18, 1994, between KACC and Larry L. Watts (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n10.18 Compensation Agreement, dated July 18, 1994, between KACC and Geoff S. Smith (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n10.19 Letter Agreement, dated January 1995, between KAC and Charles E. Hurwitz, granting Mr. Hurwitz stock options under the Kaiser 1993 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.17 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n10.20 Form of letter agreement with persons granted stock options under the Kaiser 1993 Omnibus Stock Incentive Plan to acquire shares of KAC common stock (incorporated by reference to Exhibit 10.18 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n*11 Computation of Earnings Per Common and Common Equivalent Share.\n*13 The portions of KAC's Annual Report to shareholders for the year ended December 31, 1995, which are incorporated by reference into this Report.\n*21 Significant Subsidiaries of KAC.\n*27 Financial Data Schedule.\n__________\n* Filed herewith\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit 21\nSUBSIDIARIES\nListed below are the principal subsidiaries of Kaiser Aluminum Corporation, the jurisdiction of their incorporation or organization and the names under which such subsidiaries do business. Certain subsidiaries are omitted which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary.\nPlace of Incorporation Name or Organization ----- --------------- Alpart Jamaica Inc. . . . . . . . . . . . . Delaware Alumina Partners of Jamaica (partnership). . Delaware Anglesey Aluminium Limited . . . . . . . . . United Kingdom Kaiser Alumina Australia Corporation . . . . Delaware Kaiser Aluminium International, Inc. . . . . Delaware Kaiser Aluminum & Chemical Corporation . . . Delaware Kaiser Aluminum & Chemical of Canada Limited Ontario Kaiser Bauxite Company . . . . . . . . . . . Nevada Kaiser Finance Corporation . . . . . . . . . Delaware Kaiser Jamaica Bauxite Company (partnership) Jamaica Kaiser Jamaica Corporation . . . . . . . . . Delaware Queensland Alumina Limited . . . . . . . . . Queensland Volta Aluminium Company Limited. . . . . . . Ghana\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Index to Financial Statements and Schedules\n1. Financial Statements --------------------\nThe Consolidated Financial Statements of the Company, the Notes to Consolidated Financial Statements, the Report of Independent Public Accountants, and Quarterly Financial Data are included on pages 29-56 and 59 of the Annual Report.\n2. Financial Statement Schedules . . . . . . . . . . . . . Page ----------------------------- ----\nReport of Independent Public Accountants. . . . . . . . 19\nSchedule I - Condensed Balance Sheets - Parent Company, Condensed Statements of Income - Parent Company, Condensed Statements of Cash Flows - Parent Company, and Notes to Condensed Financial Statements - Parent Company . . . . . . . . . . . .20-23\nAll other schedules are inapplicable or the required information is included in the Consolidated Financial Statements or the Notes thereto.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued)\n3. Exhibits --------\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 25), which index is incorporated herein by reference.\n(b) Reports on Form 8-K\nNo Report on Form 8-K was filed by the Company during the last quarter of the period covered by this Report.\n(c) Exhibits\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 25), which index is incorporated herein by reference.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Kaiser Aluminum Corporation and Subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K and have issued our report thereon dated February 16, 1996. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule I listed in the index at Item 14(a)2. above is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP Houston, Texas February 16, 1996\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - -----------------------------------------------------\nSCHEDULE I CONDENSED BALANCE SHEETS - PARENT COMPANY\n(In millions of dollars, except share amounts)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I CONDENSED STATEMENTS OF INCOME - PARENT COMPANY\n(In millions of dollars)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I CONDENSED STATEMENTS OF CASH FLOWS - PARENT COMPANY\n(In millions of dollars)\nThe accompanying notes to condensed financial statements are an integral part of these statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSCHEDULE I\nNOTES TO CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY\n1. Basis of Presentation\nThe accompanying parent company financial statements of Kaiser Aluminum Corporation (\"Kaiser\") should be read in conjunction with the 1995 consolidated financial statements of Kaiser and Subsidiary Companies.\nKaiser is a holding company and conducts its operations through its wholly owned subsidiary, Kaiser Aluminum & Chemical Corporation (\"KACC\"), which is reported herein using the equity method of accounting.\n2. Intercompany Note Payable\nThe Intercompany Note to KACC was amended in July 1993 to decrease the fixed interest rate from 13% to 6-5\/8%. No interest or principal payments are due until December 31, 2000, after which interest and principal will be payable over a 15-year term pursuant to a predetermined schedule.\n3. Restricted Net Assets\nThe investment in KACC is substantially unavailable to Kaiser pursuant to the terms of certain debt instruments. The obligations of KACC in respect of the credit facilities under the 1994 Credit Agreement are guaranteed by Kaiser and by all significant subsidiaries of KACC. See Note 4 of the Notes to Consolidated Financial Statements.\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKAISER ALUMINUM CORPORATION Date: March 27, 1996 By George T. Haymaker, Jr. ----------------------------- George T. Haymaker, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: March 27, 1996 George T. Haymaker, Jr. ----------------------------- George T. Haymaker, Jr. Chairman of the Board and Chief Executive Officer (Principal Executive Officer)\nDate: March 27, 1996 John T. La Duc ----------------------------- John T. La Duc Vice President and Chief Financial Officer (Principal Financial Officer)\nDate: March 27, 1996 Arthur S. Donaldson ----------------------------- Arthur S. Donaldson Controller (Principal Accounting Officer)\nDate: March 27, 1996 Robert J. Cruikshank ----------------------------- Robert J. Cruikshank Director\nDate: March 27, 1996 Charles E. Hurwitz ----------------------------- Charles E. Hurwitz Director\nDate: March 27, 1996 Ezra G. Levin ----------------------------- Ezra G. Levin Director\nDate: March 27, 1996 Robert Marcus ----------------------------- Robert Marcus Director\nDate: March 27, 1996 Robert J. Petris ----------------------------- Robert J. Petris Director\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nINDEX OF EXHIBITS\nExhibit Number Description - ------ ------------\n3.1 Restated Certificate of Incorporation of Kaiser Aluminum Corporation (the \"Company\" or \"KAC\"), dated February 21, 1991 (incorporated by reference to Exhibit 3.1 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n*3.2 Certificate of Retirement of KAC, dated October 24, 1995.\n3.3 By-laws of KAC, amended as of February 26, 1991 (incorporated by reference to Exhibit 3.2 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n4.1 Indenture, dated as of February 1, 1993, among KACC, as Issuer, Kaiser Alumina Australia Corporation, Alpart Jamaica Inc., and Kaiser Jamaica Corporation, as Subsidiary Guarantors, and The First National Bank of Boston, as Trustee, regarding KACC's 12-3\/4% Senior Subordinated Notes Due 2003 (incorporated by reference to Exhibit 4.1 to Form 10-K for the period ended December 31, 1992, filed by KACC, File No. 1-3605).\n4.2 First Supplemental Indenture, dated as of May 1, 1993, to the Indenture, dated as of February 1, 1993 (incorporated by reference to Exhibit 4.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n*4.3 Second Supplemental Indenture, dated as of February 1, 1996, to the Indenture, dated as of February 1, 1993.\n4.4 Indenture, dated as of February 17, 1994, among KACC, as Issuer, Kaiser Alumina Australia Corporation, Alpart Jamaica Inc., Kaiser Jamaica Corporation, and Kaiser Finance Corporation, as Subsidiary Guarantors, and First Trust National Association, as Trustee, regarding KACC's 9-7\/8% Senior Notes Due 2002 (incorporated by reference to Exhibit 4.3 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n*4.5 First Supplemental Indenture, dated as of February 1, 1996, to the Indenture, dated as of February 17, 1994.\n4.6 Credit Agreement, dated as of February 17, 1994, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.4 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.7 First Amendment to Credit Agreement, dated as of July 21, 1994, amending the Credit Agreement, dated as of February 17, 1994, among KAC, KACC, the financial institutions party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n4.8 Second Amendment to Credit Agreement, dated as of March 10, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.6 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\n4.9 Third Amendment to Credit Agreement, dated as of July 20, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1995, filed by KAC, File No. 1-9447).\n4.10 Fourth Amendment to Credit Agreement, dated as of October 17, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent (incorporated by reference to Exhibit 4.1 to the Report on Form 10-Q for the quarterly period ended September 30, 1995, filed by KAC, File No. 1-9447).\n*4.11 Fifth Amendment to Credit Agreement, dated as of December 11, 1995, amending the Credit Agreement, dated as of February 17, 1994, as amended, among KAC, KACC, the financial institutions a party thereto, and BankAmerica Business Credit, Inc., as Agent.\n4.12 Certificate of Designations of Series A Mandatory Conversion Premium Dividend Preferred Stock of KAC, dated June 28, 1993 (incorporated by reference to Exhibit 4.3 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KAC, File No. 1-9447).\n4.13 Deposit Agreement between KAC and The First National Bank of Boston, dated as of June 30, 1993 (incorporated by reference to Exhibit 4.4 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KAC, File No. 1-9447).\n4.14 Intercompany Note between KAC and KACC (incorporated by reference to Exhibit 4.2 to Amendment No. 5 to the Registration Statement on Form S-1, dated December 13, 1989, filed by KACC, Registration No. 33-30645).\n4.15 Senior Subordinated Intercompany Note between KACC and a subsidiary of MAXXAM, dated December 15, 1992 (incorporated by reference to Exhibit 4.10 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n4.16 Certificate of Designations of 8.255% PRIDES, Convertible Preferred Stock of KAC, dated February 17, 1994 (incorporated by reference to Exhibit 4.21 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.17 Senior Subordinated Intercompany Note between KAC and KACC dated February 15, 1994 (incorporated by reference to Exhibit 4.22 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.18 Senior Subordinated Intercompany Note between KAC and KACC dated March 17, 1994 (incorporated by reference to Exhibit 4.23 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\n4.19 Senior Subordinated Intercompany Note between KAC and KACC dated June 30, 1993 (incorporated by reference to Exhibit 4.24 to the Report on Form 10-K for the period ended December 31, 1993, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\nKAC has not filed certain long-term debt instruments not being registered with the Securities and Exchange Commission where the total amount of indebtedness authorized under any such instrument does not exceed 10% of the total assets of KAC and its subsidiaries on a consolidated basis. KAC agrees and undertakes to furnish a copy of any such instrument to the Securities and Exchange Commission upon its request.\n10.1 Form of indemnification agreement with officers and directors (incorporated by reference to Exhibit (10)(b) to the Registration Statement of KAC on Form S-4, File No. 33-12836).\n10.2 Tax Allocation Agreement between MAXXAM and KACC (incorporated by reference to Exhibit 10.21 to Amendment No. 6 to the Registration Statement on Form S-1, dated December 14, 1989, filed by KACC, Registration No. 33-30645).\n10.3 Tax Allocation Agreement between KAC and MAXXAM (incorporated by reference to Exhibit 10.23 to Amendment No. 2 to the Registration Statement on Form S-1, dated June 11, 1991, filed by KAC, Registration No. 33-37895).\n10.4 Tax Allocation Agreement, dated as of June 30, 1993, between KACC and KAC (incorporated by reference to Exhibit 10.3 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n10.5 Assumption Agreement, dated as of October 28, 1988 (incorporated by reference to Exhibit HHH to the Final Amendment to the Schedule 13D of MAXXAM Group Inc. and others in respect of the Common Stock of KAC, par value $.33-1\/3 per share).\n10.6 Agreement, dated as of June 30, 1993, between KAC and MAXXAM (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\nExecutive Compensation Plans and Arrangements [Exhibits 10.7 - 10.20, inclusive]\n10.7 KACC's Bonus Plan (incorporated by reference to Exhibit 10.25 to Amendment No. 6 to the Registration Statement on Form S-1, dated December 14, 1989, filed by KACC, Registration No. 33-30645).\n10.8 Kaiser 1993 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1993, filed by KACC, File No. 1-3605).\n10.9 Kaiser 1995 Employee Incentive Compensation Program (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended March 31, 1995, filed by KAC, File No. 1-9447).\n10.10 Kaiser 1995 Executive Incentive Compensation Program (incorporated by reference to Exhibit 99 to the Proxy Statement, dated April 26, 1995, filed by KAC, File No. 1-9447).\n10.11 Employment Agreement, dated April 1, 1993, among KAC, KACC, and George T. Haymaker, Jr. (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended March 31, 1993, filed by KAC, File No. 1-9447).\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit Number Description - ------ ------------\n10.12 Promissory Note, dated October 4, 1990, by Robert W. Irelan and Barbara M. Irelan to KACC (incorporated by reference to Exhibit 10.54 to Form 10-K for the period ended December 31, 1990, filed by MAXXAM, File No. 1-3924).\n10.13 Promissory Note, dated February 1, 1989, by Anthony R. Pierno and Beverly J. Pierno to MAXXAM (incorporated by reference to Exhibit 10.30 to Form 10-K for the period ended December 31, 1988, filed by MAXXAM, File No. 1-3924).\n10.14 Promissory Note, dated July 19, 1990, by Anthony R. Pierno to MAXXAM (incorporated by reference to Exhibit 10.31 to Form 10-K for the period ended December 31, 1990, filed by MAXXAM, File No. 1-3924).\n10.15 Promissory Note, dated July 20, 1993, between MAXXAM and Byron L. Wade (incorporated by reference to Exhibit 10.59 to Form 10-K for the period ended December 31, 1993, filed by MAXXAM, File No. 1-3924).\n10.16 Employment Agreement, dated August 20, 1993, between KACC and Robert E. Cole (incorporated by reference to Exhibit 10.63 to Form 10-K for the period ended December 31, 1993, filed by MAXXAM, File No. 1-3924).\n10.17 Compensation Agreement, dated July 18, 1994, between KACC and Larry L. Watts (incorporated by reference to Exhibit 10.1 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n10.18 Compensation Agreement, dated July 18, 1994, between KACC and Geoff S. Smith (incorporated by reference to Exhibit 10.2 to the Report on Form 10-Q for the quarterly period ended June 30, 1994, filed by KAC, File No. 1-9447).\n10.19 Letter Agreement, dated January 1995, between KAC and Charles E. Hurwitz, granting Mr. Hurwitz stock options under the Kaiser 1993 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.17 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n10.20 Form of letter agreement with persons granted stock options under the Kaiser 1993 Omnibus Stock Incentive Plan to acquire shares of KAC common stock (incorporated by reference to Exhibit 10.18 to the Report on Form 10-K for the period ended December 31, 1994, filed by KAC, File No. 1-9447).\n*11 Computation of Earnings Per Common and Common Equivalent Share.\n*13 The portions of KAC's Annual Report to shareholders for the year ended December 31, 1995, which are incorporated by reference into this Report.\n*21 Significant Subsidiaries of KAC.\n*27 Financial Data Schedule.\n__________\n* Filed herewith\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------\nExhibit 21\nSUBSIDIARIES\nListed below are the principal subsidiaries of Kaiser Aluminum Corporation, the jurisdiction of their incorporation or organization and the names under which such subsidiaries do business. Certain subsidiaries are omitted which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary.\nPlace of Incorporation Name or Organization ----- --------------- Alpart Jamaica Inc. . . . . . . . . . . . . Delaware Alumina Partners of Jamaica (partnership). . Delaware Anglesey Aluminium Limited . . . . . . . . . United Kingdom Kaiser Alumina Australia Corporation . . . . Delaware Kaiser Aluminium International, Inc. . . . . Delaware Kaiser Aluminum & Chemical Corporation . . . Delaware Kaiser Aluminum & Chemical of Canada Limited Ontario Kaiser Bauxite Company . . . . . . . . . . . Nevada Kaiser Finance Corporation . . . . . . . . . Delaware Kaiser Jamaica Bauxite Company (partnership) Jamaica Kaiser Jamaica Corporation . . . . . . . . . Delaware Queensland Alumina Limited . . . . . . . . . Queensland Volta Aluminium Company Limited. . . . . . . Ghana\nKAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES - ----------------------------------------------------","section_15":""}
{"filename":"11544_1995.txt","cik":"11544","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral Description of the Company's Business\nW. R. Berkley Corporation (the \"Company\"), a Delaware corporation, is an insurance holding company which through its subsidiaries, presently operates in four segments of the insurance business: regional property casualty insurance; reinsurance (conducted through Signet Star Holdings, Inc.); specialty lines of insurance (including excess and surplus lines and commercial transportation); and alternative markets (including the management of alternative insurance market mechanisms). The Company was founded on the concept that a group of autonomous regional and specialty insurance entities could compete effectively in selected markets within a very large industry. Decentralized control allows each subsidiary to respond to local or specialty market conditions while capitalizing on the effectiveness of centralized investment and reinsurance management, and actuarial, financial and legal staff support.\nThe Company's regional insurance operations are conducted primarily in the midwest, southern and northeast sections of the United States. The reinsurance operations, specialty insurance and alternative markets are conducted nationwide.\nIn 1995 the Company established Berkley International, LLC (\"Berkley International\"). Berkley International, which is 65% owned by the Company, was established to acquire interests outside the United States in existing and start-up property casualty, life insurance and reinsurance businesses, including insurance-related financial services businesses, located in emerging markets including Asia and Latin America (see: Other information about the Company's business, for a further explanation).\nNet premiums written, as reported on a generally accepted accounting principles (\"GAAP\") basis, by the Company's four major insurance industry segments for the five years ended December 31, 1995 were as follows:\n(1) Berkley International's results, which to date are immaterial, are included in Regional insurance operations.\n(2) Premiums written by the Company's Reinsurance operations prior to July 1, 1993, including the alternative markets operation, are included in Specialty insurance operations (see other information about the Company's business).\nThe following sections briefly describe the Company's insurance segments and subsidiaries. The statutory information contained herein is derived from that reported to state regulatory authorities in accordance with statutory accounting practices (\"SAP\"). The amount of statutory net premiums shown for the subsidiaries exclude the effects of intercompany reinsurance. In connection with the acquisition of Midwest Employers Casualty Company (\"Midwest\") in November 1995, the Company established the alternative markets segment to reflect the markets served by each of its business segments. The alternative markets segment consists of Midwest, Signet Star Holding's alternative markets division and the Company's insurance services units which manage alternative market mechanisms. The descriptions contain each significant insurance subsidiary's rating by A.M. Best and Company, Inc. (\"A.M. Best\"). A.M. Best's Ratings are based upon factors of concern to policyholders, insurance agents and brokers and are not directed toward the protection of investors. A.M. Best states: \"Best's Ratings reflect [its] opinion as to the relative financial strength and performance of each insurer in comparison with others, based on [its] analysis of the information provided to [it]. These Ratings are not a warranty of an insurer's current or future ability to meet its contractual obligations.\"\nREGIONAL INSURANCE OPERATIONS\nThe Company's regional property casualty subsidiaries write standard commercial and personal lines insurance for such risks as automobiles, homes and businesses. American West Insurance Company (\"American West\"), Continental Western Insurance Company (\"Continental Western\"), Great River Insurance Company (\"Great River\"), Tri-State Insurance Company (\"Tri-State\"), Union Insurance Company (\"Union\") and Union Standard Insurance Company (\"Union Standard\") obtain their business primarily in the smaller communities of the midwest and southwest through over 2,000 independent insurance agencies, which represent them on a non-exclusive basis and are compensated on a commission basis. Firemen's Insurance Company (\"Firemen's\") primarily sells its policies through agents in the District of Columbia, and the States of Maryland, North Carolina, Pennsylvania and Virginia. Certain of Firemen's commercial lines of business are marketed principally through brokers in the New York metropolitan area. Acadia Insurance Company (\"Acadia\") currently operates in the States of Maine, New Hampshire and Vermont, and sells its personal and commercial coverages through independent agencies. Berkley Insurance Company of the Carolinas, formed in December 1995 and domiciled in North Carolina, will write standard commercial and personal lines insurance.\nAcadia Insurance Company\nAcadia was organized by the Company and incorporated in April 1992. It writes multiple line property and casualty coverages in the States of Maine, New Hampshire and Vermont. Acadia is rated A+ by A.M. Best. Acadia's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $29,304,000 and $97,547,000, respectively.\nAmerican West Insurance Company\nAmerican West is a successor to a company that was organized in 1903 as a mutual insurance company and converted to a stock company in June 1986. Its business consists primarily of personal lines in the States of Minnesota, Montana, Wisconsin and South Dakota. American West is rated A- by A.M. Best. American West's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $8,358,000 and $19,003,000, respectively.\nBerkley Insurance Company of the Carolinas\nIn December 1995, the Company organized Berkley Insurance Company of the Carolinas, a North Carolina domiciled company. It will write personal and commercial lines in North Carolina. Berkley Insurance Company of the Carolinas has not been rated by A.M. Best. Berkley Insurance Company of the Carolinas statutory surplus as of December 31, 1995 was $4,500,000.\nContinental Western Insurance Company\nContinental Western was organized in 1907. It writes a diverse commercial lines book of business as well as personal lines principally in the States of Iowa, Nebraska, Kansas, Illinois, Missouri, Wisconsin and Montana. Continental Western is rated A+ by A.M. Best. Continental Western's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $81,095,000 and $138,498,000, respectively.\nFiremen's Insurance Company of Washington, D.C.\nFiremen's was incorporated by an act of Congress in 1836. Firemen's, through its Habitational Insurance Division, writes commercial business consisting primarily of multiple dwelling coverages principally in the State of New York. In addition, it insures homeowners, other personal lines and commercial risks in the District of Columbia, and in the States of Maryland, North Carolina and Virginia. In September 1993, Firemen's established Chesapeake Insurance Division in order to expand its operations in the State of Virginia. In March 1995, Firemen's established a new division, Presque Isle Insurance Division, in order to expand its operations into the State of Pennsylvania. Firemen's is rated A+ by A.M. Best. Firemen's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $27,346,000 and $39,736,000, respectively.\nGreat River Insurance Company\nIn December 1993, the Company organized Great River Insurance Company, a Mississippi domiciled company. It writes personal and commercial lines in Mississippi and is expanding to surrounding states. Great River is rated A+ by A.M. Best. Great River's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $12,731,000 and $25,673,000, respectively.\nTri-State Insurance Company of Minnesota\nTri-State was organized in 1902 as a mutual insurance company. It writes various commercial lines (specializing in grain elevator coverages), as well as personal lines primarily in the States of Minnesota, Iowa, North and South Dakota, Nebraska, Wisconsin and Illinois. Tri-State is rated A+ by A.M. Best. Tri-State's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $44,067,000 and $47,909,000, respectively.\nUnion Insurance Company\nUnion was organized in 1886 as a mutual insurance company. Union's business consists of personal lines as well as commercial lines insurance concentrated in the States of Nebraska, Kansas, Colorado and South Dakota. Union is rated A by A.M. Best. Union's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $30,701,000 and $46,743,000, respectively.\nUnion Standard Insurance Company\nUnion Standard is a successor to a company that was organized in 1970. Union Standard writes personal lines and commercial lines insurance for small businesses in the States of Texas, Oklahoma, Arkansas and Colorado. Union Standard is rated A by A.M. Best. Union Standard's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $28,415,000 and $56,674,000, respectively.\nRegional operations: Business\nThe following table sets forth the percentages of direct premiums written, by line, by the Company's regional insurance operations:\nThe following table sets forth the percentages of direct premiums written, by state, by the Company's regional insurance operations:\n(1) Other includes the direct premiums written by Berkley International.\nREINSURANCE OPERATIONS\nSignet Star, through its broker market reinsurance subsidiary Signet Star Reinsurance Company, specializes in underwriting property, casualty and fidelity reinsurance on a treaty basis and casualty reinsurance on a facultative basis. Signet Star has significant expertise in alternative risk transfer business and, accordingly, the results of this section are included in the alternative markets segment. Signet Star's facultative underwriting manager, Facultative ReSources, Inc., underwrites reinsurance primarily on a risk-by-risk basis. The Fidelity and Surety Division of Signet Star combines extensive underwriting and claims expertise with professional treaty design capabilities to provide customized reinsurance products to fidelity and surety companies. Signet Star Reinsurance Company is rated A by A.M. Best. Signet Star Reinsurance Company's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $243,729,000 and $217,018,000, respectively.\nReinsurance Operations: Business\nThe following table sets forth the percentages of gross premiums written, by line, by the Company's reinsurance operations:\nSPECIALTY INSURANCE OPERATIONS\nThe Company's specialty lines of insurance consists primarily of excess and surplus lines (\"E & S\"), commercial transportation, professional liability, directors and officers liability and surety. Specialty lines also included the results of the Company's Reinsurance Operations through June 30, 1993 (see: \"Other information about the Company's business\")\nAdmiral Insurance Company\nThe majority of the Company's E & S insurance business is conducted by Admiral Insurance Company (\"Admiral\"). Admiral specializes in general liability coverages, including products liability and professional liability. Admiral insures risks requiring specialized treatment not available in the conventional market, with coverage designed to meet the specific needs of the insured. Business is received from wholesale brokers and general agents via retail agents, whose clients are the insureds. E & S carriers operate on a non-admitted basis in the states where they write business. They are generally free from rate regulation and policy form requirements. Admiral's business is obtained on a nationwide basis from approximately 190 non-exclusive brokers, who do not have the authority to commit the Company, and who are compensated on a commission basis. In November 1992, Admiral began writing directors and officers liability insurance through operations conducted by Monitor Liability Managers, Inc., an underwriting manager established by the Company. Admiral is rated A++ by A.M. Best. Admiral's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $175,596,000 and $57,796,000, respectively.\nCarolina Casualty Insurance Company\nThe Company's commercial transportation operations are primarily conducted by Carolina Casualty Insurance Company (\"Carolina\"). Carolina writes liability, physical damage and cargo insurance for the transportation industry, concentrating on long-haul trucking companies. Municipal bus lines, charter buses and school buses also make up a substantial part of Carolina's book of business. Carolina's business is obtained nationwide from approximately 120 agents and brokers who are compensated on a commission basis. In June 1995, Carolina began writing surety bonds through operations conducted by Monitor Surety Managers, Inc., an underwriting manager established by the Company. Carolina is rated A by A.M. Best. Carolina's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $59,327,000 and $70,586,000, respectively.\nNautilus Insurance Company\nNautilus Insurance Company (\"Nautilus\") was established in 1985 to insure E & S risks which involve a lower degree of expected severity than those covered by Admiral. Nautilus obtains its business nationwide from approximately 135 non-exclusive brokers, some of which also provide business to Admiral. A substantial portion of Nautilus' business is written on a binding authority basis, subject to certain contractual limitations. Nautilus is rated A by A.M. Best. Nautilus's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $50,446,000 at $27,843,000, respectively. Great Divide Insurance Company (\"Great Divide\"), a subsidiary of Nautilus, writes transportation risks, as well as other specialty lines written on an admitted basis.\nSpecialty Operations: Business\nThe following table sets forth the percentages of gross premiums written, by line, by the Company's specialty insurance operations:\nALTERNATIVE MARKETS\nThe Company's alternative markets operations specializes in insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms for public entities, private employers and associations. Typical clients are those who are driven by various factors to seek less costly and more efficient techniques to manage their exposure to claims. The Company's alternative markets segment consists of: Excess Workers' Compensation insurance written by Midwest Employers Casualty Company (\"Midwest\"); reinsurance of alternative risk business; and insurance services entities which manage alternative market mechanisms.\nMidwest Employers Casualty Company\nIn November 1995, the Company acquired Midwest (see other information about the Company's business). Midwest markets and underwrites excess workers' compensation (\"EWC\") insurance. EWC insurance is marketed to employers and employer groups which have elected and have qualified or been approved by state regulatory authorities to self-insure their workers' compensation programs. EWC insurance provides coverage to a self-insured employer once the employers' losses exceed the employer's retention amount. Midwest offers a complete line of EWC products, including specific and aggregate EWC insurance policies and surety bonds. Midwest is rated A- by A.M. Best. Midwest's statutory surplus and statutory net premiums written as of December 31, 1995 and for the year then ended were $97,676,000 and $67,513,000, respectively.\nSignet Star - Alternative Markets Division\nSignet Star Reinsurance Company's Alternative Markets Division specializes in providing custom designed reinsurance products and services to alternative markets (\"ARM\") clients, such as captive insurance companies, risk retention groups, public entity insurance trusts and governmental pools. ARM clients are generally self insured vehicles which provide insurance buyers with a mechanism for assuming part of their own risk, managing their exposures, modifying their loss costs and, ultimately, participating in the underwriting results. Signet Star has been an active reinsurer of ARM clients for over ten years and is considered to be one of the leading broker market reinsurers of ARM business. The Alternative Markets Division will have access to substantial additional resources within the Company, which will enable it to concentrate and coordinate the Company's focus on this growing sector of the reinsurance market.\nInsurance Services Entities\nThe Company's insurance service operations offer a variety of products, which includes underwriting and claims administration and alternative insurance market mechanisms. In addition, subsidiaries of the Company provide agency and brokerage services to both affiliated and unaffiliated entities.\nBerkley Administrators\nBerkley Administrators, headquartered in Minneapolis, Minnesota, provides risk management and administration services to its clients, including underwriting, loss control, policy issuance and claims handling. A significant portion of Berkley Administrators' present business is the administration of the Minnesota Workers' Compensation Assigned Risk Plan.\nBerkley Risk Services, Inc.\nThe Company acquired Berkley Risk Services, Inc. and its affiliated companies in 1988. Berkley Risk, based in Minneapolis, Minnesota, is a property casualty risk management firm which specializes in the development and administration of group and single-employer alternative insurance funding techniques. Subsidiaries of Berkley Risk also manage entities which provide liability insurance and claim adjusting services to public entities and not for profit organizations.\nKey Risk Services, Inc.\nThe Company acquired Key Risk Services, Inc. in 1994. Key Risk, based in Greensboro, North Carolina is a property casualty risk management firm which specializes in management and administration of group self insured funds. A significant portion of Key Risk's present business is the administration of the North Carolina Associated Industries Workers' Compensation Fund.\nBerkley Risk Managers\nBerkley Risk Managers is a successor to a Company acquired in 1990. Berkley Risk Managers, based in Somerset, New Jersey, is primarily involved in the development and administration of self-funded property casualty and health insurance programs primarily for municipalities and other governmental entities.\nAll American Agency Facilities, Inc.\nAll American Agency Facilities, Inc., based in Redmond, Washington, provides insurance agency and brokerage services on a nationwide basis for unaffiliated insurance carriers as well as certain of the Company's insurance subsidiaries.\nBerkley Care Network\nThe Company established Berkley Care Network in 1995. Berkley Care Network, based in Greensboro, North Carolina, is a managed health care company offering a preferred provider network, utilization review and case management services for workers' compensation carriers on a nationwide basis.\nAlternative Markets Operations: Business\nThe following table sets forth the percentages of revenues, by major source of business, of the alternative markets operations:\nResults by Industry Segment\nSummary financial information about the Company's operating segments is presented on a GAAP basis in the following table (all amounts include realized capital gains and losses):\n(1) Berkley International's results, which to date are immaterial, are included in Regional insurance operations.\n(2) Prior to July 1, 1993 the Reinsurance operations, including the alternative markets operation, are included in Specialty insurance operations (see other information about the Company's business).\nThe combined ratio represents a measure of underwriting profitability, excluding investment income. A number in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. Summary information for the Company's insurance companies and the insurance industry is presented in the following table (1):\n(1) Based on statutory accounting practices. (2) Results of the Company's Reinsurance operations prior to July 1, 1993, including the alternative markets operation, are included in Specialty insurance operations. (see other information about the Company's business). (3) The Alternative Markets segments combined ratio reflects the underwriting results of Midwest, since November 1995, the date it was acquired, and the Signet Star Alternative Markets division from July 1, 1993. Midwest discounts its reserves for Losses and loss expenses, and accordingly, the annual change in the discount is reflected in the loss ratio. (4) Based on the Company's consolidated net premiums written to statutory surplus. (5) Estimated by A.M. Best (6) Source: A.M. Best Aggregates & Averages, for stock companies. (7) Source: A.M. Best Aggregates & Averages, for total industry.\nInvestments\nInvestment results before income tax effects were as follows:\n(1) The change in unrealized investment gains (losses) represents the difference between fair value and cost of investments at the beginning and end of the calendar year, including investments carried at cost.\nThe percentages of the fixed maturity portfolio categorized by contractual maturity, based on fair value, on the dates indicated, are set forth below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations.\nLoss and Loss Adjustment Expense Reserves\nIn the property casualty industry, it is not unusual for significant periods of time, ranging up to several years or more, to elapse between the occurrence of an insured loss, the report of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. The Company's loss reserves reflect current estimates of the ultimate cost of closing outstanding claims; other than its Excess Workers Compensation business, as discussed below, the Company does not discount its reserves to estimated present value for financial reporting purposes.\nIn general, when a claim is reported, claims personnel establish a \"case reserve\" for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis which provide for losses incurred but not yet reported to the insurer, potential inadequacy of case reserves, the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process (\"LAE\"), and a provision for potentially uncollectible reinsurance. Each insurance subsidiary's net retention for each line of insurance is taken into consideration in the computation of ultimate losses.\nIn examining reserve adequacy, historical data is reviewed and consideration is given to such factors as legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, judgmentally adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. Reserve amounts are necessarily based on management's informed estimates and judgments using data currently available. As additional experience and other data become available and are reviewed, these estimates and judgments are revised, resulting in increases or decreases to reserves for insured events of prior years. The reserving process implicitly recognizes the impact of inflation and other factors affecting loss costs by taking into account changes in historic claim patterns and perceived trends. There is no precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the ultimate cost of closing claims is influenced by numerous factors.\nWhile the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to fluctuation. In particular, high levels of jury verdicts against insurers, as well as judicial decisions which \"re-formulate\" policies to expand their coverage to previously unforeseen theories of liability, including those regarding pollution and other environmental exposures, have produced unanticipated claims and increased the difficulty of estimating the loss and loss adjustment expense reserves provided by the Company.\nDue to the nature of Excess Workers Compensation (\"EWC\") business and the long period of time over which losses are paid in this line of business, the Company discounts its liabilities for EWC losses and loss expenses. Discounting liabilities for losses and loss expenses gives recognition to the time value of money set aside to pay claims in the future and is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from Midwest's loss payout experience and is supplemented with data compiled by insurance companies writing workers' compensation on an excess-of-loss basis. The expected payout pattern has a very long duration because it reflects the nature of losses which generally penetrate self-insured retention limits contained in excess workers' compensation policies. The Company has limited the expected payout duration to 30 years in order to introduce an additional level of conservatism into the discounting process. These liabilities have been discounted using \"risk-free\" discount rates determined by reference to the U.S. Treasury yield curve weighted for EWC premium volume to reflect the seasonality of the anticipated duration of losses associated with such coverages. The average discount rate for accident years 1995 and prior was approximately 5.80%.\nTo date, known pollution and environmental claims at the insurance company subsidiaries have not had a material impact on the Company's operations. Environmental claims have not materially impacted the Company because our subsidiaries generally did not insure the larger industrial companies which are subject to significant environmental exposures.\nThe Company's net reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $30.8 million and $22.8 million at December 31, 1995 and 1994, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $59.4 million and $50.6 million at December 31, 1995 and 1994, respectively. Net incurred losses and loss expenses for reported pollution and environmental claims were approximately $8.0 million, $5.6 million and $3.5 million in 1995, 1994 and 1993, respectively. Net paid losses and loss expenses has averaged approximately $3 million for each of the last three years. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential affect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties is highly uncertain.\nThe table below provides a reconciliation of the beginning and ending reserve balances, on a gross of reinsurance basis (dollars in thousands):\nA reconciliation, as of December 31, 1995, between the reserves reported in the accompanying consolidated financial statements which have been prepared in accordance with GAAP and those reported on a SAP basis is as follows (in thousands):\n(1) The 1995 decline in ceded reserves is due to the sale of North Star Reinsurance Company (see: Other information about the Company's business, for a further explanation).\n(2) For statutory purposes, Midwest uses a discount rate of 3.0% as permitted by the Department of Insurance of the State of Ohio. For GAAP purposes, Midwest uses a discount rate based on the U. S. Treasury yield curve weighted for the expected payout period, as described above.\nThe table on page 16 presents the development of net reserves for 1985 through 1995. The top line of the table shows the estimated reserves for unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This represents the estimated amount of losses and loss expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The upper portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years.\nThe \"cumulative redundancy (deficiency)\" represents the aggregate change in the estimates over all prior years. For example, the 1985 reserves have developed a $92 million deficiency over ten years. That amount has been reflected in income over the ten years. The impact on the results of operations of the past three years of changes in reserve estimates is shown in the reconciliation tables above.\nIt should be noted that the table presents a \"run off\" of balance sheet reserves, rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years. For example, assume a claim that occurred in 1985 is reserved for $2,000 as of December 31, 1985. Assuming this claim was settled for $2,300 in 1995, the $300 deficiency would appear as a deficiency in each year from 1985 through 1994.\nRegulation\nThe Company's insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they do business, under statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. This regulation relates to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; deposits of securities for the benefit of policyholders; approval of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. In general, the Company's regional property casualty subsidiaries as well as Carolina, Great Divide and Midwest must file all rates for personal and commercial insurance with the insurance department of each state in which they operate. The E & S and reinsurance subsidiaries of the Company generally operate free of rate and form regulation.\nIn addition to regulatory supervision of its insurance subsidiaries, the Company is subject to state statutes governing insurance holding company systems. Typically, such statutes require the Company periodically to file information with the state insurance commissioner, including information concerning its capital structure, ownership, financial condition and general business operations. Under the terms of applicable state statutes, any person or entity desiring to purchase more than a specified percentage (commonly 10%) of the Company's outstanding voting securities would be required to obtain regulatory approval of the purchase. Under Florida law, which is applicable to the Company due to its ownership of Carolina, a Florida domiciled insurer, the acquisition of more than 5% of the Company's capital stock must receive regulatory approval. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect their solvency. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nDuring the past several years, various regulatory and legislative bodies adopted or proposed new laws or regulations to deal with the cyclical nature of the insurance industry, catastrophic events and their effects on shortage of capacity and pricing. These regulations, which have not had a material impact on the Company's operations, include (i) the creation of \"market assistance plans\" under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to cancel certain policies in mid-term, (iii) advance notice requirements or limitations imposed for certain policy non-renewals and (iv) limitations upon or decreases in rates permitted to be charged. The passage of Proposition 103 in the State of California did not have a material adverse impact on the Company's operations because the Company's subsidiaries operate in that state primarily on a non-admitted basis. The non-admitted market in California, however, has been subjected to increased levels of regulation. Admiral and Nautilus, both of which derive significant premiums from California, may be adversely impacted by increased regulation which causes business to remain in the admitted market.\nVarious state and federal organizations, including Congressional committees and the National Association of Insurance Commissioners (\"NAIC\"), have been conducting investigations into various aspects of the insurance business. The NAIC has adopted risk based capital (\"RBC\") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. The implementation of RBC did not effect the operations of the Company's insurance subsidiaries since all of its subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC. Federal legislation is being considered which would either abolish or limit the current exemption of the insurance industry from portions of the antitrust laws, impose direct federal oversight or federal solvency standards. No assurance can be given that future legislative or regulatory\nchanges resulting from such activity will not adversely affect the Company's insurance subsidiaries.\nThe Company's insurance subsidiaries are also subject to assessment by state guaranty funds when an insurer in that jurisdiction has been judicially declared insolvent and insufficient funds are available from the liquidated company to pay policyholders and claimants. The protection afforded under a state's guaranty fund to policyholders of the insolvent insurer varies from state to state. Generally, all licensed property casualty insurers are considered to be members of the fund, and assessments are based upon their pro rata share of direct written premiums. The NAIC Model Post-Assessment Guaranty Fund Act, which many states have adopted, limits assessments to an insurer to 2% of its subject premium and permits recoupment of assessments through rate setting. Likewise, several states (or underwriting organizations of which the Company's insurance subsidiaries are required to be members) have limited assessment authority with regard to deficits in certain lines of business. To date, assessments have not had a material adverse impact on operations.\nThe Company receives funds from its insurance subsidiaries in the form of dividends and fees for management services. Annual dividends in excess of maximum amounts prescribed by state statutes (\"extraordinary dividends\") may not be paid without the approval of the insurance commissioner of the state in which an insurance subsidiary is domiciled. The 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. Similarly, the 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.\nTax Law Changes\nFor a review of Federal income tax changes and their impact on the Company see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nCompetition\nThe property casualty insurance and reinsurance business is competitive, with over 2,000 insurance companies transacting business in the United States. The Company competes directly with a large number of these companies. The Company's strategy in this highly fragmented industry is to seek specialized areas or geographic regions where its insurance subsidiaries can gain a competitive advantage by responding quickly to changing market conditions. Each of the Company's subsidiaries establishes its own pricing practices. Such practices are based upon a Company-wide philosophy to price products with the general intent of making an underwriting profit. Competition in the industry generally changes with profitability.\nThe regional property casualty subsidiaries compete with mutual and other regional stock companies as well as national carriers. Direct writers of property casualty insurance compete with the regional subsidiaries by writing insurance through their salaried employees, generally at a lower cost than through independent agents such as those used by the Company.\nSignet Star's competition comes from domestic and foreign reinsurers, some of which have greater financial resources, who place their business either on a direct basis or through the broker market.\nThe E & S area is a highly specialized segment of the insurance industry. Admiral and Nautilus compete with other E & S carriers, some of which are larger and have greater resources. Under certain market conditions, standard carriers may compete for the types of business written by Admiral and Nautilus. In addition, there are regional and specialty carriers competing with Admiral and Nautilus when they underwrite business in their regions or specialties.\nCarolina and Great Divide's competition comes mainly from other specialty transportation insurers and large national multi-line companies.\nMidwest's competition comes from insurance and reinsurance companies, some of which have greater financial resources. Most of theses carriers write specific EWC coverage, do not offer aggregate EWC coverage and tend to focus on risks larger than those targeted by Midwest. In addition, Midwest competes with other specialty EWC insurers.\nThe insurance services operations face competition from several large nationally known service organizations as well as local competitors.\nEmployees\nAs of February 29, 1996, the Company employed 2,982 persons. Of this number, the Company's subsidiaries employed 2,948 persons, of whom 1,691 were executive and administrative personnel and 1,257 were clerical personnel. The Company employed the remaining 34 persons in its parent company and investment operations, of whom 27 were executive and administrative personnel and 7 were clerical personnel.\nOther information about the Company's business:\nThe Company maintains an ongoing interest in acquiring additional companies and developing new insurance entities, products and packages as opportunities arise. In addition, the insurance subsidiaries develop new coverages or lines of business to meet the needs of insureds.\nSeasonal weather variations affect the severity and frequency of losses sustained by the insurance and reinsurance subsidiaries. Although the effect on the Company's business of such natural catastrophes as tornadoes, hurricanes, hailstorms and earthquakes is mitigated by reinsurance, they nevertheless can have a significant impact on the results of any one reporting period.\nThe Company has no customer which accounts for 10 percent or more of its consolidated revenues.\nCompliance by the Company and its subsidiaries 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, has not had a material effect upon the capital expenditures, earnings or competitive position of the Company.\nThe Company currently does not engage in material operations in foreign countries nor is a material portion of its revenues derived from customers in foreign countries. However, the Company's insurance subsidiaries regularly purchase a portion of their catastrophe reinsurance coverage from foreign reinsurers, including syndicate members of Lloyd's of London. While Queen's Island is domiciled in Bermuda, to date its business has exclusively been reinsurance of its domestic affiliates.\nDuring the last two years the Company has been actively exploring emerging insurance markets in Latin America and South East Asia. On September 11, 1995, the Company and Northwestern Mutual Life International, Inc. (\"NML\"), a wholly-owned subsidiary of Northwestern Mutual Life Insurance Company, entered into a Subscription\nAgreement, Operating Agreement and Management Agreement with respect to Berkley International, a limited liability company. Berkley International was established as the exclusive vehicle of the Company and NML to acquire interests outside the United States in existing and start-up property and casualty, life insurance and reinsurance businesses, including insurance-related financial services businesses, located in emerging markets including Asia and Latin America (\"Portfolio Companies\").\nThe Company and NML agreed, subject to certain limitations set forth in the Operating Agreement, that Berkley International would be their exclusive vehicle for investments in Portfolio Companies of which they from time to time become aware; provided, however, that as of the end of any fiscal year, the Company and NML may terminate this exclusivity provision. The Company agreed to contribute up to $65 million to Berkley International in exchange for a 65% membership interest and NML agreed to contribute up to $35 million to Berkley International in exchange for a 35% membership interest. Subsequent to the third anniversary of the Company's and NML's subscription for interests in Berkley International, either party upon not less than six months' prior written notice may terminate its obligation to make any remaining portion of its capital contribution, such termination to be effective on December 31 of the year in which the notice is give. The Company and NML may also terminate their obligations to make any remaining portion of their capital contributions in the event either party terminates the exclusivity provision referred to above. During 1995, the Company purchased majority interests in La Union Gremial Compania de Seguros, S. A. and Independencia Compania Argentina de Seguros, S. A., two property and casualty companies in Argentina, for approximately $9.2 million, which constituted a portion of the Company's initial contribution to Berkley International. The Company will act as manager of Berkley International for a fee based on a percentage of the aggregate commitments of the members. To date, Berkley International's results have not been material to the Company.\nOn November 8, 1995 the Company acquired 100% of the stock of MECC, Inc. the Parent of Midwest Employers Casualty Company for $141,908,000. The Company also retired approximately $19,590,000 million of MECC, Inc.'s debt. The purchase was substantially funded by the issuance of 3,450,000 shares of Common Stock at $43.75 per share.\nOn July 1, 1993, the Company exchanged all of the outstanding capital stock of Signet Reinsurance Company (Signet) for 60% of the common stock of Signet Star Holdings, Inc. (\"Signet Star\"). Signet Star simultaneously acquired all of the outstanding capital stock of Signet Star Reinsurance Company (\"Signet Star Reinsurance\") from General Re Corporation (\"General Re\") in exchange for 40% of the common stock of Signet Star and other consideration. Signet Star is reported as a separate industry segment. Signet's operations through June 30, 1993 are included in the specialty segment.\nOn December 31, 1995, the Company purchased General Re's interest in Signet Star by issuing to General Re 458,667 shares of Series B Cumulative Redeemable Preferred Stock of the Company having an aggregate liquidation preference of $68,800,000. In addition, the Company guaranteed a senior subordinated promissory note of Signet Star which was issued to General Re in exchange for the convertible note which General Re held. As part of this transaction, Signet Star sold to General Re Signet Star Reinsurance Company and renamed Signet Reinsurance Company, Signet Star Reinsurance Company.\nIn February 1996, Signet Star Reinsurance Company established a Latin American and Caribbean division. The new division, which is located in Coral Gables Florida, will specialize in providing treaty reinsurance services to a wide variety of clients in Latin America and the Caribbean.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. Owned property is as follows:\n(1) Occupied by Admiral's branch office. (2) Presently leased to a third party.\nIn addition, the Company and its subsidiaries lease office facilities in various other cities under leases with varying terms and expiration dates.\nThe Company has executed an agreement for the acquisition of a building to be used as the Company's headquarters, which is expected to close by June 1, 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nClaims under insurance policies written by the Company's subsidiaries are investigated and settled either by claims adjusters employed by them, by their independent agents or by independent adjusters. Each subsidiary employs a staff of claims adjusters at its home office and at some regional offices. Some independent agents may have the authority to settle small claims. Independent claims adjusting firms are used to assist in handling various claims in areas where insurance volume does not warrant the maintenance of a staff adjuster. If a claim or loss cannot be settled and results in litigation, the subsidiary generally retains outside counsel.\nAt present, neither the Company nor any of its subsidiaries is engaged in any litigation known to the Company which is expected to have a material adverse effect upon the Company's business. As is common with property casualty insurance companies, the Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business.\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 holders of the Company's Common Stock.\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 traded in the over-the-counter market and is quoted on the National Association of Securities Dealers Automated Quotation (\"NASDAQ\") National Market System under the symbol \"BKLY\". The following table sets forth the high and low sale prices for the indicated periods, all as reported by NASDAQ.\nThe closing price on March 4, 1996, as reported on the NASDAQ National Market System, was $45 1\/4 per share. The approximate number of record holders of the Common Stock on March 4, 1996 was 915.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1995\n(1) Investments and stockholders' equity reflect the adoption of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" as of December 31, 1993. Included in the calculation of common stockholders' equity per share are unrealized investments gains (losses), net of federal income taxes, of $48,450,000, ($33,973,000) and $36,450,000 as of December 31, 1995, 1994 and 1993, respectively.\n(2) Total assets and reserves for losses and loss expenses reflect the adoption of SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short Duration and Long-Duration Contracts,\" as of December 31, 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL\nCONDITION AND RESULTS OF OPERATIONS\nIndustry Overview\nThe demand for insurance can be characterized as fairly stable and is influenced primarily by general economic conditions, while the supply of insurance is directly related to available capacity, i.e., the level of policyholders' surplus employed in the industry and the willingness of insurance management to risk that capital. In general, it is believed that the amount of available capacity changes as the perceived rate of return on capital employed fluctuates based on the adequacy of premium rates and available investment returns. The adequacy of premium rates is affected mainly by the severity and frequency of claims which are influenced by many factors including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. In addition, investment rates of return may impact policy rates. These factors can have a significant impact on the ultimate adequacy of premium rates because a property casualty insurance policy is priced before its costs are known, as premiums usually are determined long before claims are reported. Over the past several years a trend of increasing price competition, combined with an increase in the number and size of catastrophic losses, has produced a significant reduction in underwriting profitability for the Company and the industry.\nOperating Results for the Year Ended December 31, 1995 as Compared to the Year Ended December 31, 1994\nNet income attributable to common shareholders (\"Net Income\") for 1995 was $50 million, or $2.86 per share, compared with 1994 earnings of $25 million, or $1.44 per share. The 1995 results include after-tax realized investment gains of $6 million or $.36 per share, compared with after-tax realized investment losses of $86,000 or $.01 per share recorded in 1994.\nNet premiums written in 1995 grew by 20% to $860 million from $718 million written during 1994 due to increases recorded by all four segments of our operations. Premiums written by the regional segment grew by 24% in 1995 to $478 million compared to $387 million written during 1994. Approximately 60% of the growth was from three operations which the Company established in 1992 and 1993. The balance of this increase primarily results from the expansion by the regional operations into new markets. Premiums written by the reinsurance segment grew by 11% to $196 million from $177 million written during 1994. The growth in reinsurance premiums written was mainly due to growth in facultative and fidelity and surety premiums written. Premiums written by the specialty segment grew by 19% in 1995 to $161 million from $135 million in 1994. The growth in the specialty premiums written is due mainly to decreases in the amounts of business ceded to unaffiliated reinsurers. Premiums written by the alternative markets segment grew by 30% in 1995, to $26 million from $20 million in 1994. The growth in this segment's premiums written is due to the inclusion of Midwest, which was acquired in November 1995, and modest premium growth recorded by Signet Star's alternative markets division.\nNet investment income increased, on a pre-tax basis, to $137 million from $110 million earned in 1994. The higher level of investment earnings is due primarily to growth in investable assets generated by an increase in cash flow from operations and increased portfolio yields. The pretax yield of the portfolio increased as a result of a change in the mix of fixed maturity investments, an increase in the duration of the portfolio and an increase in trading account profits (see \"Liquidity and Capital Resources\").\nManagement fees and commissions consists primarily of fees and commissions earned by the alternative markets operating units. These fees and commissions grew by 6% to $68 million in 1995 from $65 million earned in 1994. This increase was due mainly to the inclusion of a full year's results for Key Risk Services, Inc. which was acquired in May 1994 as well as fees earned by Berkley Care Network which the Company established in June 1995. These increases were partially offset by a restructuring of one alternative markets operating unit.\nThe combined ratio (on a statutory basis) of the Company's insurance operations decreased to 102.5% in 1995 from 105.0% (101.9% before the Northridge Earthquake) in 1994 due to an improvement in the consolidated loss ratio which was partially offset by a slight increase in the expense ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) decreased to 70.7% from 73.7% primarily due to the effect of the Northridge Earthquake, which significantly impacted 1994 results. This improvement was partially offset by an increase in the frequency and severity of losses incurred by our commercial transportation unit.\nOther operating costs and expenses, which consists of the expenses of the Company's insurance and alternative markets segments as well as the Company's corporate and investment expenses, increased by 19% to $340 million from $286 million recorded in 1994. This increase was due primarily to the substantial growth in premium volume which in turn results in an increase in variable underwriting expenses. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums written) of the Company's insurance operations increased to 31.3% from 30.8% in 1994. The expense ratio increased due to the effects of start-up operations which generally incur a higher expense ratio in the early stages of their development.\nMinority interest for 1995 was an expense of $4 million as compared to income of $3 million reported in 1994. The change in minority interest was due to earnings generated by Signet Star in 1995 versus a loss in 1994.\nOperating Results for the Year Ended December 31, 1994 as Compared to the Year Ended December 31, 1993\nNet income for 1994 was $25 million, or $1.44 per share, compared with 1993 earnings of $52 million, or $2.87 per share. The 1994 results include after-tax realized investment losses of $86,000, or $.01 per share, compared with after-tax realized investment gains of $15 million, or $.82 per share, realized in 1993. In addition, the 1994 results were adversely impacted by a higher level of catastrophes losses including the Company's share of losses incurred by Signet Star due to the Northridge earthquake in California. Furthermore, in January 1994 the Company issued $150 million of 7.375% Series A Cumulative Redeemable Preferred Stock which resulted in preferred dividends of $10 million and had a negative impact on the comparative results.\nNet premiums written in 1994 grew by 33.5% to $718 million from $538 million written during 1993, primarily due to growth in reinsurance premium volume as a result of the inclusion of Signet Star's results for the entire year. In addition, premiums written by the Company's regional insurance operations increased by $85 million. Approximately two thirds of this increase was due to the three new operations referred to above. The balance of this increase resulted primarily from the expansion into new markets by the remainder of the regional group. Premium volume for the alternative markets segment was $20 million in 1994, compared with $5 million in 1993. The increase is due primarily to the inclusion of the results of Signet Star's alternative markets division for the entire year.\nNet investment income increased, on a pre-tax basis, to $110 million from $93 million earned in 1993. The higher level of investment earnings is due to a full year of earnings of Signet Star and growth in investable assets, generated by cash flow from operations and the issuance of 7.375% Series A Cumulative Redeemable Preferred Stock. The higher level of interest expense resulted from the issuance of subsidiary debt in connection with the formation of Signet Star (see \"Liquidity and Capital Resources\").\nManagement fees and commissions increased by 20% to $65 million from $54 million recorded in 1993 due primarily to a full year's earnings of Signet Star's alternative markets division and the acquisition of Key Risk in April 1994. The pre-tax earnings of this segment decreased to $7 million from $8 million earned in 1993 due to the affects of the restructuring referred to above.\nThe combined ratio (on a statutory basis) of the Company's insurance operations increased to 105.0% (101.9% before the Northridge Earthquake) in 1994 from 103.3% in 1993 due to an increase in the consolidated loss ratio. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) increased to 73.7% from 71.1% in 1993. The increase in the loss ratio was due to a higher level of catastrophes including after-tax catastrophe losses of $7.5 million resulting from the Northridge Earthquake.\nOther operating costs and expenses increased by 27% to $286 million. This increase is due to the inclusion of a full year of operating results of Signet Star, a higher level of costs associated with the three new insurance operations and increased expenses in the alternative markets segment as a result of the acquisition of Key Risk Services, Inc. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums written) of the Company's insurance operations decreased to 30.8% in 1994 from 31.7% in 1993 due primarily to significant increases in the premium volume of Signet Star which has a lower expense ratio than our other insurance operations.\nLiquidity and Capital Resources\nGeneral\nThe Company's subsidiaries are highly liquid, receiving substantial cash from premiums, investment income, management fees and proceeds from sales and maturities of portfolio investments. The principal outflows of cash are payments of claims, taxes, interest and operating expenses. The net cash provided from operating activities (before trading account transactions) was $206.6 million in 1995 and $170.3 million in 1994. The increase in cash flow in 1995 was due primarily to additional cash flow generated by the Company's regional operations due to a significant increase in the premium volume.\nAs a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company is obligated to service its debt, pay consolidated Federal income taxes and pay its expenses. Tax payments and management fees from the insurance subsidiaries are made under agreements which generally are subject to approval by state insurance departments. Maximum amounts of dividends that can be taken without regulatory approval are prescribed by statute; to date, cash dividends have not required regulatory approval (See Note 13 of \"Notes to Consolidated Financial Statements\").\nFinancing Activity\nIn January 1994, the Company issued 6 million depositary shares each representing a one-sixth interest in a share of 7.375% Series A Cumulative Redeemable Preferred Stock and received net proceeds of approximately $145 million. A portion of the proceeds of this offering were contributed to the start up insurance subsidiaries to support their growth.\nIn March 1995, the Company purchased 117,000 shares of its Common Stock for approximately $4.1 million. Pursuant to an authorization of the Board of Directors, up to 334,000 additional shares may be purchased from time to time.\nIn October 1995, the Company issued 3,450,000 shares of common stock, and received net proceeds of approximately $145 million which was used to finance the acquisition of Midwest.\nOn December 31, 1995, in connection with the acquisition of the remaining 40% of Signet Star, the Company issued to General Reinsurance Corporation (General Re), 458,667 shares of Series B Cumulative Redeemable Preferred Stock having an aggregate liquidation preference of $68,800,000. The Series B Preferred Stock has a dividend rate increasing up to 6% during the first twelve months. The rate is subject to readjustment based on certain predetermined conditions. In addition, the Company guaranteed a senior subordinated promissory note of Signet Star in the principal amount of $35,793,085, which matures July 1, 2003 and bears interest at the rate of 6.5%. This note was issued to General Re in exchange for the convertible note previously held by General Re. In November 1993, Signet Star borrowed the maximum amount available under its revolving credit facility and used the proceeds to redeem senior notes issued in connection with the July 1, 1993 acquisition. The revolving credit facility was repaid on January 19, 1996 as discussed below.\nOn January 19, 1996 the Company issued $100 million of 6.25%, ten-year notes which are not redeemable until maturity and utilized a portion of the proceeds to retire $28.4 million of Signet Star's bank debt. The balance of the proceeds from all of the above-mentioned offerings of securities is available for acquisitions, working capital and other general corporate purposes.\nThe Company has on file two \"shelf\" Registration Statements with the Securities and Exchange Commission with a combined remaining balance of $190 million in additional equity and\/or debt securities. The securities may be offered from time-to-time as determined by funding requirements and market conditions.\nInvestments\nIn its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities which, combined with expected cash flow, is believed adequate to meet foreseeable payment obligations. As part of this strategy, the Company attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations.\nThe Company's investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, active management of the portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as changes in financial market conditions alter the assumptions underlying the purchase of certain securities.\nSales of fixed income securities in 1995 were the result of financial market conditions and the Company's strategy of maintaining an appropriate balance between the duration of its assets and liabilities.\nThe investment portfolio, valued on a cost basis, grew in 1995 by $553.0 million to approximately $2,508 million primarily due to the combined effects of the acquisition of Midwest and net cash flow from operations.\nDuring 1995, the Company invested approximately $66 million of its available cash inflow in equity securities and $127 million in corporate bonds (principally mortgage-backed securities). At December 31, 1995, the portion of the portfolio invested in tax-exempt securities was 32% (36% in 1994) and U.S. Government securities and cash equivalents comprised 30% (33% in 1994) of invested assets. Investments in corporate fixed maturity securities (including mortgage-backed securities) were 28% (24% in 1994) of the portfolio at December 31, 1995, and equity securities represented the balance.\nFederal Income Taxes\nThe Company files a consolidated Federal income tax return with all its subsidiaries except Signet Star. Federal income tax expense in 1995 was $17.6 million (21% effective rate) as compared to a benefit of $1.6 million recorded in 1994. The 1995 effective tax rate is lower than the statutory tax rate of 35% because a substantial portion of investment income is tax-exempt. The 1994 tax benefit is due to the fact that tax-exempt investment income exceeded total pre-tax income. At December 1995, the Company had a deferred tax liability of $57.7 million, which results primarily from unrealized investment gains and intangible assets, and a deferred tax asset of $43.3 million, which results primarily from the discounting of loss reserves for Federal income tax purposes.\nThe realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. In establishing the amount of the deferred tax asset, management has included a valuation allowance for the future uncertainty associated with the extended time period required for the complete reversal of the effects of loss reserve discounting.\nReinsurance\nThe Company follows the customary industry practice of reinsuring a portion of its exposures, paying to reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased principally to reduce 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 policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial, financially sound carriers. The Company has established reserves for potentially uncollectible reinsurance.\nRegional Operations\nIn 1995, Continental Western and the Habitational Division of Firemen's generally retained $475,000 on individual risks while the Company's other regional subsidiaries generally retained $400,000 on individual risks. The regional group also maintained catastrophe reinsurance protection for approximately 95% of weather-related losses above $3 million per occurrence up to a maximum of $35 million and carried additional catastrophe protection on an aggregate basis for storms resulting in loss events between $500,000 and $6 million ($8 million in 1996).\nReinsurance Operations\nSignet Star's retrocessional program provides coverage for property losses in three layers as follows: (i) 100% of $6.5 million in excess of $7 million per occurrence; (ii) 95% of $9 million in excess of $13.5 million per occurrence; and (iii) 90% of $7.5 million in excess of $22.5 million per occurrence. In 1995, Signet Star had retrocessional coverage for its casualty facultative business which provides coverage for 40% (20% in 1996) of $5 million per certificate on a pro-rata basis; this coverage applies to Signet Star's individual certificate business only. During 1995, Signet Star had retrocessional coverage for its fidelity and surety business for approximately 60% (80% in 1996) of each loss up to $2,250,000 in excess of $750,000 per occurrence.\nSpecialty Operations\nAdmiral's retention in 1995 was $170,000 ($175,000 in 1996) per risk for most classes of business and $2.1 million ($5.0 million in 1996), per insured, for business written by Monitor Liability Managers. In addition, in 1996 Admiral's Directors and Officer coverage will also include additional protection on an aggregate basis. Nautilus generally retained $97,500 per risk in 1995 ($140,000 in 1996) and Carolina maintained its retention at $300,000 on liability exposures.\nAlternative Markets Operations\nMidwest's retention is generally $1 million per occurrence above the self insured's underlying retention.\nCapitalization\nFor the year ended December 31, 1995 as a result of retained earnings and the transactions discussed above under \"Financing Activity\", stockholders' equity increased by approximately $332.2 million and the total amount of capital employed in the business grew to $1,249.1 million. Accordingly, the percentage of the Company's capital attributable to debt decreased to 26% at December 31, 1995 from 36% at December 31, 1994. In January 1996 the Company issued $100 million of 6.25% ten-year notes. On a proforma basis, assuming the issuance of these notes occurred on December 31, 1995, the percentage of the Company's capital attributable to debt would have been 31%.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Report\nBoard of Directors and Stockholders W. R. Berkley Corporation\nWe have audited the consolidated balance sheets of W. R. Berkley 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. 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 W. R. Berkley 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.\nAs discussed in note 1 to the consolidated financial statements, W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" on December 31, 1993.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 1993, 1992 and 1991, and the related consolidated statements of operations, stockholders' equity 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 consolidated financial statements. In 1992, W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nIn our opinion, the information set forth in the selected financial data for each of the years in the five-year period ended December 31, 1995, appearing on page 23, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived.\nKPMG Peat Marwick LLP\nNew York, New York February 22, 1996\nW. R. Berkley Corporation and Subsidiaries\nConsolidated Balance Sheets December 31, 1995 and 1994 (Dollars in thousands, except share data)\nSee accompanying notes to consolidated financial statements.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Operations Years ended December 31, 1995, 1994 and 1993 (Dollars in thousands, except per share data)\nSee accompanying notes to consolidated financial statements.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Stockholders' Equity Years ended December 31, 1995, 1994 and 1993 (Dollars in thousands, except per share data)\nSee accompanying notes to consolidated financial statements.\nW. R. Berkley Corporation and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 1995, 1994 and 1993 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements For the Years Ended December 31, 1995, 1994 and 1993\n(1) Summary of Significant Accounting Policies\n(A) Principles of consolidation and basis of presentation\nThe consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (\"the Company\"), have been prepared on the basis of 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 disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 1993 and 1994 financial statements to conform them to the presentation of the 1995 financial statements.\n(B) Revenue recognition\nInsurance premiums written are recognized as earned generally on a pro-rata basis over the contract period. Management fees on insurance services contracts are recorded as earned primarily on a pro-rata basis over the policy period. Commission income is recognized as earned on the effective date of the applicable insurance policies.\n(C) Investments\nThe Company has classified its investments into three categories. Securities that the Company has the positive intent and ability to hold to maturity are classified as \"held to maturity\" and reported at amortized cost. Securities which the Company purchased with the intent to sell in the near term are classified as \"trading\" and are reported at estimated fair value, with unrealized gains and losses reflected in the statement of operations. The remaining securities are classified as \"available for sale\" and carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a separate component of stockholders' equity.\nRealized gains or losses represent the difference between the cost of securities sold and the proceeds realized upon sale. The cost of securities is adjusted where appropriate to include provision for declines in value which are considered to be other than temporary. The Company uses the specific identification method where possible and the first-in, first-out method in other instances, to determine the cost of securities sold. Realized gains or losses, including any provision for decline in value, are included in the statement of operations.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies, continued\n(D) Deferred policy acquisition costs\nAcquisition costs (primarily commissions and premium taxes) incurred in writing insurance and reinsurance business are deferred and amortized ratably over the terms of the related contracts. Deferred policy acquisition costs are limited to the amounts estimated to be recoverable from the applicable unearned premiums and the related anticipated investment income by giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force.\n(E) Reserves for losses and loss expenses\nReserves for losses and loss expenses are an accumulation of amounts determined on the basis of (1) evaluation of claims for business written directly by the Company; (2) estimates received from other companies for reinsurance assumed; and (3) estimates for losses incurred but not reported (based on Company and industry experience). These estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in results of operations in the period in which they are determined.\nA subsidiary of the Company, Midwest Employers Casualty Company (\"Midwest\") which was acquired in November 1995, discounts its liabilities for excess workers' compensation (\"EWC\") losses and loss expenses using a \"risk-free\" rate. Midwest discounts its EWC liabilities because of the long period of time over which it pays losses. The Company believes that utilizing a \"risk-free\" rate to discount these reserves more closely reflects the economics associated with the excess workers' compensation line of business (see Note 11 of notes to consolidated financial statements).\n(F) Reinsurance ceded\nCeded unearned premiums are reported as prepaid reinsurance premiums and estimated amounts of reinsurance recoverable on unpaid losses are included in due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the liability must be discharged by the Company. The Company has provided reserves for this potential uncollectability.\n(G) Excess of cost over net assets acquired\nCosts in excess of the net assets of subsidiaries acquired are being amortized on a straight-line basis over 25 to 40 years. The Company continually evaluates the amortization period of its intangible assets. Estimates of useful lives are revised when circumstances or events indicate that the original estimate is no longer appropriate.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies, continued\n(H) Federal income taxes\nThe Company and its 80% or more owned subsidiaries file a consolidated Federal income tax return. In 1995 and prior years, Signet Star filed its own consolidated Federal income tax return.\nThe Company's method of accounting for income taxes is the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are measured annually using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse.\n(I) Recent Accounting Pronouncements\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued statements of financial accounting standards (\"SFAS\") No. 123, Accounting for Stock-Based Compensation. This statement addressed the accounting for the cost of stock-based compensation, such as stock options. SFAS No. 123 permits either expensing the cost of stock-based compensation over the vesting period or disclosing in the financial statement footnotes what this expense would have been. This cost would be measured at the grant date based upon estimated fair values, using option pricing models. The Company expects to adopt the disclosure alternative of this statement in 1996.\n(2) Acquisitions\nOn September 11, 1995, the Company formed Berkley International, LLC (\"Berkley International\"), a limited liability company. The Company agreed to contribute up to $65 million to Berkley International in exchange for a 65% membership interest. During 1995, the Company purchased majority interests in two property and casualty companies in Argentina for consideration of approximately $9.2 million, which constituted a portion of the Company's initial contribution to Berkley International. The proforma effect of these transactions on the Company's results of operations is not significant.\nOn November 8, 1995, the Company acquired 100% of the stock of MECC, Inc., the Parent of Midwest Employer's Casualty Company, for $141,908,000. In connection with this acquisition, the Company also retired approximately $19,590,000 million of MECC, Inc.'s debt. The purchase was funded by the issuance of 3,450,000 shares of Common Stock issued at $43.75 per share. On December 31, 1995, the Company acquired General Re Corporation's (\"General Re\") 40% interest in Signet Star Holdings, Inc. (\"Signet Star\") by issuing to General Re 458,667 shares of Series B Cumulative Redeemable Preferred Stock of the Company having an aggregate liquidation preference of $68,800,000. The only significant effect on the Company's financial statements from this acquisition is an increase in preferred stock outstanding and the elimination of the related minority interest because Signet Star's results of operations were previously consolidated.\nAll of the acquisitions were accounted for as purchases and, accordingly, the results of operations of the acquired companies have been included from the dates of acquisition.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(2) Acquisitions, continued\nThe net assets acquired in 1995 were as follows (dollars in thousands):\nOn July 1, 1993, the Company exchanged all the stock of Signet Reinsurance Company (\"Signet\") for 60% of the stock of Signet Star, a newly formed holding company. Signet Star simultaneously acquired all the stock of North Star Reinsurance Company (\"North Star Reinsurance\") from General Re in exchange for 40% of the stock of Signet Star and senior and convertible notes. In connection with the formation of Signet Star, North Star Reinsurance entered into a Retrocessional Agreement (the \"Retrocessional Agreement\") with General Reinsurance Corporation (\"GRC\"), pursuant to which North Star Reinsurance reinsured its respective liabilities and assigned its respective rights and obligations arising from any insurance or reinsurance contracts written prior to January 1, 1993 with and to GRC.\nIn connection with the 1995 acquisition of the remaining 40% interest in Signet Star, North Star Reinsurance was sold to General Re and all business written subsequent to July 1, 1993 was novated to Signet Star. As a result, business written by North Star Reinsurance prior to January 1, 1993, which had been retroceded to General Re, is no longer reflected in the Company's financial statements. The only effect on the Company's financial statements resulting from this aspect of the transaction is that the Company's reserves for losses and loss expenses is reduced by $735,144,000 and \"due from reinsurers\" is reduced by the same amount. This aspect of the transaction does not effect the Company's cash flow, equity or statements of operations.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(2) Acquisitions, continued\nThe Company's consolidated Proforma results of operations assuming the acquisitions of MECC, Inc. and the remaining 40% interest in Signet Star occurred as of January 1, 1995 and 1994, respectively, are as follows (dollars in thousands):\nThe Proforma consolidated financial data do not purport to represent what the Company's results of operations actually would have been had the acquisitions and related financings occurred on the dates indicated, or to project the Company's results of operations for any future period. The above amounts primarily reflect adjustments for the effects of the revaluation of assets and liabilities of the purchased companies and the financing of such acquisitions on the results of operations.\n(3) Federal Income Taxes\nThe Federal income tax expense (benefit) consists of (in thousands):\nA reconciliation of the Federal income tax expense (benefit) and the amounts computed by applying the Federal income tax rate of 35% to pre-tax income is as follows (in thousands):\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(3) Federal Income Taxes, continued\nAt December 31, 1995, 1994 and 1993, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows (dollars in thousands):\nThe Federal income tax expense (benefit) applicable to realized investment gains (losses) was $3,664,000, ($61,000) and $8,233,000 in 1995, 1994 and 1993, respectively. The Company had a current income tax receivable of $210,000 and $1,073,000 at December 31, 1995 and 1994, respectively.\nThe realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. In establishing the amount of the deferred tax asset, management has included a valuation allowance for the future uncertainty associated with the extended time period required for the complete reversal of the effects of loss reserve discounting. At December 31, 1994, the Company recorded an additional valuation allowance of $4.2 million, which represented the tax benefit the Company would have had on its share of Signet Star's unrealized investment losses. This additional valuation allowance was established because Signet Star filed a separate consolidated return, and no capital loss carryback benefit was available. At December 31, 1995, Signet Star had an unrealized investment gain; therefore, the valuation allowance was not required. The change in the valuation allowance did not affect the Company's results of operations.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(4) Debt\nLong-term debt consists of the following:\nThe difference between the face value of long-term debt and the carrying value is unamortized discount. All outstanding long-term debt is not redeemable until maturity and ranks on a parity with all other outstanding indebtedness of the Company.\nNotes Payable to Banks\nNotes payable to banks represents debt outstanding pursuant to a revolving credit facility entered into by Signet Star. The face value of the debt at December 31, 1995 was $28,400,000 and the carrying value was $28,306,000. The interest rate was based on the London Interbank offered rate plus .75% to 1.50% and was 5.75% at December 31, 1995. The debt was retired in January 1996.\n(5) Commitments, Litigation and Contingent Liabilities\nAt present, neither the Company nor any of its subsidiaries are engaged in any litigation known to the Company which management believes will have a material adverse effect upon the Company's business. As is common with other insurance companies, the Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. In the aggregate, the Company's commitments for future buildings, land and equipment is approximately $50 million as of December 31, 1995.\n(6) Lease Obligations\nThe Company and several of its subsidiaries use office space and equipment under leases expiring at various dates through September 1, 2004. These leases are operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was approximately; $9,437,000, $8,000,000 and $6,029,000 for 1995, 1994 and 1993 respectively. Future minimum lease payments (without provision for sublease income) are: $8,755,000 in 1996; $7,404,000 in 1997; $6,520,000 in 1998; $5,074,000 in 1999; $3,899,000 in 2000; and $9,474,000 thereafter.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(7) Stockholders' Equity\nPer share data have been computed based on the weighted average number of common shares outstanding. The assumed dilutive effect of employee stock options was not material. Treasury shares have been excluded from average outstanding shares from the date of acquisition. The number of shares used in the computations was 17,414,000, 17,182,000, and 17,946,000 for 1995, 1994 and 1993, respectively.\nChanges in shares of common stock outstanding, net of treasury shares, are as follows (in thousands):\nPreferred stock consists of 1,000,000 shares of 7 3\/8% Series A Cumulative Redeemable Preferred Stock and 458,667 shares of Variable Rate Series B Cumulative Redeemable Preferred Stock.\nThe Company has the option of redeeming the Series A preferred stock after January 23, 1999 at the liquidation value of $150 per share. The Series B preferred stock has a dividend rate increasing up to 6% during the first twelve months after issuance. The rate is thereafter subject to readjustment, based on certain predetermined conditions. The Series B preferred stock is reflected at its estimated fair value of $66,000,000, based upon the current estimate of the ultimate effective dividend rate, and will be accreted to its stated value of $68,800,000 over eighteen months.\n(8) Stock Option Plan\nThe Company adopted the W. R. Berkley Corporation 1992 Stock Option Plan under which 1,750,000 shares of common stock were reserved for issuance. Pursuant to the Plan, options may be granted at prices determined by the Board of Directors but not less than 85% of the fair market value on the date of grant.\nThe following table summarizes option information, including options granted under both the 1992 and prior Plans:\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(9) Profit Sharing Retirement Plan\nThe Company and its subsidiaries have profit sharing retirement plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary's profitability. Employees become eligible to participate in the Retirement Plans on the first day of the month following the first full three months in which they are employed. Profit sharing expense amounted to $6,344,000, $5,625,000 and $4,605,000 for 1995, 1994 and 1993, respectively.\n(10) Investments\nAt December 31, 1995 and 1994, there were no investments, other than investments in United States government securities, which exceeded 10% of stockholders' equity. At December 31, 1995 and 1994, investments were as follows:\n(a) Adjusted as necessary for amortization of premium or discount. (b) Includes United States government agencies and authorities. (c) Short-term investments which mature within three months of the date of purchase.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(10) Investments, continued\n(a) Adjusted as necessary for amortization of premium or discount. (b) Includes United States government agencies and authorities. (c) Short-term investments which mature within three months of the date of purchase.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(10) Investments, continued\nThe amortized cost and fair value of fixed maturity securities at December 31, 1995, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations (dollars in thousands):\nRealized gains (losses) and the change in difference between fair value and cost of investments, before applicable income taxes, are as follows (dollars in thousands):\n(a) During 1995, 1994 and 1993, gross gains of $11,570,000, $5,601,000 and $22,893,000, respectively, and gross losses of $3,751,000, $8,177,000 and $1,879,000, respectively, were realized.\n(b) The provision for decline in value of investments is $3,333,000, $7,172,000 and $11,869,000 as of December 31, 1995, 1994 and 1993, respectively. The reductions resulted from the sale of securities.\n(c) Parentheses indicate a net unrealized decline in fair value.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(10) Investments, continued\nInvestment income consists of the following (dollars in thousands):\n(a) The primary focus of the trading account activities is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Merger arbitrage differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes merger arbitrage investments less vulnerable to changes in general financial market conditions. Potential changes in market conditions are also mitigated by the implementation of short sales. Short sales of $60,720,000 and $18,500,000 have been included in other liabilities as of December 31, 1995 and 1994, respectively. Investment income earned from trading account activity includes unrealized trading gains of $352,000 and $1,271,000 for 1995 and 1994, respectively.\n(11) Reserves for losses and loss expenses\nThe table below provides a reconciliation of the beginning and ending reserve balances, on a gross of reinsurance basis, (dollars in thousands):\nDue to the nature of Excess Workers Compensation (\"EWC\") business and the long period of time over which losses are paid in this line of business, the Company discounts the liability for losses and loss expenses established for the excess workers' compensation line of business. Discounting liabilities for losses and loss expenses gives recognition to the time value of money set aside to pay claims in the future and is intended to appropriately match losses and loss expense to income earned\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(11) Reserves for losses and loss expenses, continued\non investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from Midwest's loss payout experience and is supplemented with data compiled from insurance companies writing workers' compensation on an excess-of-loss basis. The expected payout pattern has a very long duration because it reflects the nature of losses which generally penetrate self-insured retention limits contained in excess workers' compensation policies. The Company has limited the payout duration to 30 years in order to introduce an additional level of conservatism into the discounting process. The liabilities for losses and loss expenses have been discounted using \"risk-free\" discount rates determined by reference to the U.S. Treasury yield curve weighted for the EWC premium volume to reflect the seasonality of the anticipated duration of losses associated with such coverages. The average discount rate for accident years 1995 and prior is 5.80%. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $152,235,000 at December 31, 1995. For Statutory purposes, Midwest uses a discount rate of 3.0% as permitted by the Department of Insurance of the State of Ohio.\nTo date, known pollution and environmental claims at the insurance company subsidiaries have not had a material impact on the Company's operations. Environmental claims have not materially impacted the Company because our subsidiaries generally did not insure the larger industrial companies which are subject to significant environmental exposures.\nThe Company's net reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $30.8 million and $22.8 million at December 31, 1995 and 1994, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to pollution and environmental claims were $59.4 million and $50.6 million at December 31, 1995 and 1994, respectively. Net incurred losses and loss expenses for reported pollution and environmental claims were approximately $8.0 million, $5.6 million and $3.5 million in 1995, 1994 and 1993, respectively. Net paid losses and loss expenses has averaged approximately $3 million for each of the last three years. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential affect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties is highly uncertain.\n(12) Reinsurance Ceded\nThe Company follows the customary industry practice of reinsuring a portion of its exposures principally to reduce net liability on individual risks and to protect against catastrophic losses. The following amounts arising under reinsurance ceded contracts have been deducted in arriving at the amounts reflected in the statement of operations (dollars in thousands):\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(13) Dividends From Subsidiaries and Statutory Financial Information\nThe Company's insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 1996, the maximum amount of dividends which can be paid without such approval is approximately $93,361,000.\nCombined net income and policyholders' surplus of the Company's consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows (dollars in thousands):\nThe National Association of Insurance Commissioners (\"NAIC\") has adopted risk based capital (\"RBC\") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. The implementation of RBC did not effect the operations of the Company's insurance subsidiaries since all of its subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC.\n(14) Supplemental Financial Statement Data\nOther operating costs and expenses consist of the following (dollars in thousands):\n(15) Industry Segments\nThe Company's operations are presently conducted through four basic segments: regional property casualty insurance; reinsurance; specialty lines of insurance; and alternative markets operations. The Company established an international segment in 1995; the results of this segment have been included as part of the regional segment, due to immateriality. Summary financial information about the Company's operating segments is presented in the following table. Income before income taxes by segment consists of revenues less expenses related to the respective segment's operations. These amounts include realized gains (losses) where applicable. Intersegment revenues consist primarily of dividends, interest on intercompany debt and fees paid by subsidiaries for portfolio management and other services to the Company. Identifiable assets by segment are those assets used in the operation of each segment.\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(15) Industry Segments, continued\nW. R. BERKLEY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(16) Fair value of Financial Instruments\nThe following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1995 and 1994 (dollars in thousands):\nThe estimated fair value of investments is based on quoted market prices as of the respective reporting dates. The fair value of the long-term debt is based on rates available for borrowings similar to the Company's outstanding debt as of the respective reporting dates.\n(17) Quarterly Financial Information (unaudited)\nThe following is a summary of quarterly financial data:\n(18) Subsequent Events\nOn January 19, 1996 the Company issued $100 million of 6.25% ten-year notes which are not redeemable until maturity and subsequently retired $28.4 million of outstanding bank debt\nPART III\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is provided as to the Directors and executive officers of the Company as of March 4, 1996:\nAs permitted by Delaware law, the Board of Directors of the Company is divided into three classes, the classes being divided as equally as possible and each class having a term of three years. Directors generally serve until their respective successors are elected at the annual meeting of stockholders which ends their term. None of the Company's Directors has any family relationship with any other Director or executive officer. Each year the term of office of one class expires. In May 1995, the term of a class consisting of three Directors expired. Henry Kaufman and Martin Stone were elected as Directors to hold office for a term of three years until the Annual Meeting of Stockholders in 1998 and until their successors are duly chosen. At a meeting of the Board of Directors held on September 13, 1995 John D. Vollaro was elected a Director to the class of Directors which expires at the Annual Meeting of Stockholders in 1998. Officers of the Company are elected annually and serve at the pleasure of the Board of Directors.\nWilliam R. Berkley has been Chairman of the Board and Chief Executive Officer of the Company since its formation in 1967. He also served as President at various times from 1967 to 1995. He also serves as Chairman of the Board or Director of a number of public and private companies. These include Signet Star Holdings, Inc., a reinsurance holding company owned by the Company; Pioneer Companies, Inc., a chemical manufacturing and marketing company; Strategic Distribution, Inc., an industrial products distribution and services company, and Interlaken Capital, Inc., a private investment firm with interests in various businesses. His current term as a Director expires in 1997.\nJohn D. Vollaro was elected President and Chief Operating Officer of the Company effective January 2, 1996 and Director effective September 13, 1995. He has been Chief Executive Officer of Signet Star Holdings, Inc., an affiliate of the Company, since July 1993 and President and a Director of Signet Star Holdings, Inc. since February 1993. He served as Executive Vice President of the Company from 1991 until 1993 and was, Chief Financial Officer and Treasurer of the Company from 1983 through 1993; and Senior Vice President, Chief Financial Officer and Treasurer of the Company from 1983 to 1991. Mr. Vollaro's current term as a Director expires in 1998.\nSam Daniel, Jr. has been Senior Vice President - Regional Operations since April 1990. Prior thereto, he was employed by Hanover Insurance Company for more than five years as Vice President.\nAnthony J. Del Tufo has been Senior Vice President, Chief Financial Officer and Treasurer of the Company since September 1993. Before joining the Company Mr. Del Tufo was a partner with KPMG Peat Marwick from 1975 to 1993.\nRobert S. Gorin has been Senior Vice President, General Counsel and Secretary since July 1989. Prior to joining the Company, Mr. Gorin was Assistant Secretary and Assistant General Counsel of J.C. Penney Co., Inc., where he had been employed since 1971.\nE. LeRoy Heer has been Senior Vice President - Chief Corporate Actuary since January 1991. Prior thereto, he had been Vice President - Corporate Actuary since May 1978.\nEdward A. Thomas has been Senior Vice President - Specialty Operations of the Company since April 1991. Prior thereto, he was President of Signet Reinsurance Company, a subsidiary of the Company, for more than five years.\nIra S. Lederman has been Vice President and Assistant Secretary since May 1986. He has also been Assistant General Counsel since July 1989. Prior thereto he was Insurance Counsel of the Company since May 1986 and Associate Counsel from April 1983.\nJames G. Shiel has been Vice President - Investments of the Company since January 1992. Since February 1994, he has been President of Berkley Dean & Company, Inc., a subsidiary of the Company, which he joined in 1987.\nScott M. Cunningham has been a Director of the Company since 1986. Mr. Cunningham is a Managing Director of Interlaken Capital, Inc., which he joined in January 1987. Mr. Cunningham's current term as a director expires in 1997.\nRobert B. Hodes has been a Director of the Company since 1970. Mr. Hodes is Counsel to the New York law firm of Willkie Farr & Gallagher. He is a director of Aerointernational, Crystal Oil Company; Global Telecommunications, Limited.; Loral Corporation; Loral Space & Communications Ltd.; Mueller Industries, Inc.; R.V.I. Guaranty, Ltd.; LCH Investments N.V. and Restructured Capital Holdings, Ltd. Mr. Hodes' current term as a Director expires in 1997.\nHenry Kaufman has been a Director of the Company since 1994. Dr. Kaufman is President of Henry Kaufman & Co., Inc., an investment management and economic and financial consulting company since its establishment in 1988. Dr. Kaufman serves as Chairman of the Board of Overseers, Stern Schools of Business of NYU; Member of the Board of Directors, Federal Home Loan Mortgage Corp.; Member of the Board of Directors, Lehman Brothers Holdings Inc.; Member of the Board of Trustees, New York University; and Member of the International Capital Markets Advisory Committee of the Federal Reserve Bank of New York. Dr. Kaufman's current term as a Director expires in 1998.\nRichard G. Merrill has been a Director of the Company since 1994. Mr. Merrill was Executive Vice President of Prudential Insurance Company of America from August 1987 to March 1991 when he retired. Prior thereto, Mr. Merrill served as Chairman and President of Prudential Asset Management Company since 1985. Mr. Merrill is a Director of Sysco Corp. Mr. Merrill's current term as a Director expires in 1996.\nJack H. Nusbaum has been a Director of the Company since 1967. Mr. Nusbaum is the Chairman in the New York law firm of Willkie Farr & Gallagher where he has been a partner for more than the last five years. He is a director of Pioneer Companies, Inc.; Prime Hospitality Corp. and The Topps Company, Inc. Mr. Nusbaum's current term as a Director expires in 1996.\nMark L. Shapiro has been a Director of the Company since 1974. Mr. Shapiro is a Managing Director in the investment banking firm of Schroder Wertheim & Co. Incorporated for more than the past five years. Mr. Shapiro's current term as a Director expires in 1996.\nMartin Stone has been a Director of Berkley since 1990. Mr. Stone is Chairman of Professional Sports, Inc. (the Phoenix Firebirds AAA baseball team) and Chairman of Adirondack Corporation, for more than five years. Mr. Stone is also a director of Canyon Ranch, Inc. and a member of the Advisory Board of Yosemite National Park. Mr. Stone's current term as a Director expires in 1998.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995, and which is 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\nReference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995, and which is incorporated herein by reference.\n(b) Security ownership of management\nReference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995, and which is incorporated herein by reference.\n(c) Changes in control\nReference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995, and which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995, and 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) Index to Financial Statements\nThe financial statements filed as part of this report are listed on the Index to Financial Statements on page 30 hereof.\n(b) Reports on Form 8-K\nOn November 8, 1995 the Company filed a current report on Form 8-K announcing that it had completed its acquisition of MECC, Inc.\nOn December 28, 1995 the Company filed a current report on Form 8-k announcing that it had completed its acquisition of the remaining 40% interest in Signet Star Holdings, Inc. from General Re Corporation.\n(c) Exhibits\nThe exhibits filed as part of this report are listed on pages 58 and 59 hereof.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nW. R. BERKLEY CORPORATION\nBy WILLIAM R. BERKLEY ------------------------------------------------- William R. Berkley, Chairman of the Board and Chief Executive Officer\nMarch 7, 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.\nITEM 14. (c) EXHIBITS\nNumber\n(2.1) Agreement and Plan of Merger between the Company, Berkley Newco Corp. and MECC, Inc. (incorporated by reference to Exhibit 2.1 of the current reports on Form 8-K (file No. 0-7849) filed with the Commission September 28, 1995).\n(2.2) Agreement and Plan of Restructuring, dated July 20, 1995, by and among the Company, Signet Star Holdings, Inc., Signet Star Reinsurance Company, Signet Reinsurance Company and General Re Corporation (incorporated by reference to Exhibit 2.2 of the Company's current Report on Form 8-K (file No. 0-7849) filed with the Commission on September 28, 1995).\n(3.1) Restated Certificate of Incorporation, as amended\n(3.2) By-laws\n(4) The instruments defining the rights of holders of the long-term debt securities of the Company are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Company agrees to furnish supplementally copies of these instruments to the Commission upon request.\n(10.1) The Company's 1982 Stock Option Plan, (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1 (File No. 2-98396) filed with the Commission on June 14, 1985).\n(10.2) The Company's 1992 Stock Option Plan, (incorporated by reference to Exhibit 28.1 of the Company's Registration Statement on Form S-8 (File No. 33-55726) filed with the Commission on December 15, 1992).\n(10.2a) Signet Star Holdings, Inc. 1993 Stock Option Plan, (incorporated by reference to Exhibit 10.14 of Signet Star Holdings, Inc. Registration Statement on Form S-1 (File No. 33-69964) filed with the Commission on October 4, 1993).\n(10.3) The Company's lease dated June 3, 1983 with the Ahneman, Devaul and Devaul Partnership, incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-1 (File No. 2-98396) filed with the Commission on June 14, 1985.\n(10.4) W.R. Berkley Corporation Deferred Compensation Plan for officers as amended January 1, 1991.\n(10.5) W. R. Berkley Corporation Deferred Compensation Plan for Directors as adopted March 7, 1996.\n(10.6) Sale Agreement by and between the Company and Lembo-Feinerman Fleming Morell Trust for the acquisition of real property.\n(23) See Independent Auditors' report on schedules and consent.\n(21) Following is a list of the Company's significant subsidiaries.\nSubsidiaries of subsidiaries are indented and the parent of each such corporation owns 100% of the outstanding voting securities of such corporation except as noted below.\n(28) Information from reports furnished to state insurance regulatory authorities.\nThis exhibit which will be filed supplementally includes the Company's combined Schedule P as prepared for its 1995 combined Annual Statement which will be provided to state regulatory authorities. The schedule has been prepared on a statutory basis. The combined schedule includes the historical results of the Company's insurance subsidiaries as if they had been owned from their inception date. It should be noted that the combined schedule includes data of seventeen operating companies and, as a result, any statistical extrapolation from the schedule may not be meaningful.\n(The combined Schedule P as filed with the Securities and Exchange Commission, has been omitted from this copy. It is available upon request from Mr. Anthony J. Del Tufo, Senior Vice President, Chief Financial Officer and Treasurer of the Company, at the address shown on page 1.)\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES AND CONSENT\nBoard of Directors and Stockholders W. R. Berkley Corporation\nThe audit referred to in our report dated February 22, 1996 included the related financial statement schedules as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995 included in the Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in note 1 to the consolidated financial statements, W. R. Berkley Corporation adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" on December 31, 1993.\nWe consent to the use of our reports incorporated by reference in the Registration Statements (No. 2-98396) on Form S-1 and (No. 33-55726) on Form S-8 and (No. 33-30684) and (No. 33-95552) and (No. 333-00459) on Forms S-3 and (No. 33-88640) on Form S-8 of W. R. Berkley Corporation.\nKPMG Peat Marwick LLP\nNew York, New York March 22, 1996\nSchedule II\nW. R. Berkley Corporation Condensed Financial Information of Registrant Balance Sheets (Parent Company) (Amounts in thousands)\nSee note to condensed financial statements.\nSchedule II, Continued\nW. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statements of Operations (Parent Company) (Amounts in thousands)\nSee note to condensed financial statements.\nSchedule II, Continued\nW. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statement of Cash Flows (Parent Company) (Amounts in thousands)\nSee note to condensed financial statements.\nSchedule II, Continued\nW. R. Berkley Corporation\nCondensed Financial Information of Registrant, Continued\nDecember 31, 1995, 1994 and 1993\nNote to Condensed Financial Statements (Parent Company)\nThe accompanying condensed financial statements should be read in conjunction with the notes to consolidated financial statements included elsewhere herein. Reclassifications have been made in the 1994 and 1993 financial statements as originally reported to conform them to the presentation of the 1995 financial statements.\nThe Company and its 80% or more owned subsidiaries file a consolidated federal tax return with the results of its domestic insurance subsidiaries included on a statutory basis. Under present Company policy, Federal income taxes payable by (or refundable to) subsidiary companies on a separate-return basis are paid to (or refunded by) W. R. Berkley Corporation, and the Company pays the tax due on a consolidated return basis.\nSchedule III\nW. R. Berkley Corporation and Subsidiaries Supplementary Insurance Information December 31, 1995, 1994 and 1993 (Amounts in thousands)\n(1) Net investment income and other operating expenses, as presented above, are based on actual amounts recorded by each operating unit.\nSchedule IV\nW. R. Berkley Corporation and Subsidiaries Reinsurance Years ended December 31, 1995, 1994 and 1993 (Amounts in thousands)\nSchedule VI\nW. R. Berkley Corporation and Subsidiaries Supplementary Information Concerning Property-Casualty Insurance Operations December 31, 1995, 1994 and 1993 (Amounts in thousands)","section_15":""}
{"filename":"766769_1995.txt","cik":"766769","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors 85-Series III A Real Estate Limited Partnership (the \"Registrant\") is a limited partnership formed in 1984 under the laws of the State of Illinois. The Registrant raised $59,087,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire eight real property investments and a minority joint venture interest in one additional real property. The Registrant has since disposed of three of these properties. The five remaining properties and the minority joint venture interest held at December 31, 1995 are described under \"Properties\" (Item 2). The Partnership Agreement generally provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\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 Registrant's remaining assets over the next four to five 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 November 1995, the Registrant has begun actively marketing three of its\nproperties and the property in which it holds a minority joint venture interest for sale, and if the market remains favorable, intends to begin actively marketing the two remaining properties. 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 5.86% of the total interests outstanding in the Registrant and assigned the interests to its affiliate, WIG 85-III. 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 is an affiliate of Insignia Financial Group, Inc., which provides property management services to all of the Registrant's properties. Metropolitan has 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 the impact of this tender offer or any future tender offers will have on the operations or management of the Registrant.\nLakeville Resort Apartments is owned by a joint venture consisting of the Registrant and an affiliate. During 1995, the joint venture completed the refinancing of the Lakeville Resort Apartments mortgage loan. See \"Item 7. Liquidity and Capital Resources\" for additional information.\nThe Registrant, by virtue of its ownership of real estate is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor Partners-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.\nItem 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 - -------- -----------------------\nFarmington Hills, Michigan Country Ridge Apartments: a 252-unit apartment complex located on approximately 22.5 acres.\nDeKalb County, Georgia * North Hill Apartments: a 420-unit apartment complex located on approximately 30 acres.\nPlymouth, Minnesota Park Place Apartments Phase II: a 250-unit apartment complex located on approximately 14.9 acres.\nLas Vegas, Nevada * Shadowridge Apartments: a 312-unit apartment complex located on approximately 13.6 acres.\nDuluth, Georgia Howell Station Apartments (formerly Tempo Station): a 228-unit apartment complex located on approximately 28.6 acres.\n* Owned by Registrant through a joint venture with an affiliated partnership. See Note 6 of Notes to Financial Statements for additional information.\nThe Registrant also holds a minority joint venture interest in Lakeville Resort Apartments in Petaluma, California. See Note 7 of Notes to Financial Statements for additional information.\nEach of these 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 be reasonably determined. For information regarding distributions, see Item 7. Liquidity and Capital Resources.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 5,288.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ---------- ---------- ---------- ----------\nTotal income $12,060,495 $11,194,480 $11,489,788 $12,706,318 $12,021,222 Loss before extraordinary items (17,476) (471,133) (1,079,762) (2,009,380) (2,607,265) Net (loss) income (27,411) (70,139) 2,213,346 (2,009,380) (2,607,265) Net (loss) income per Limited Partnership Interest (.46) (1.18) 37.08 (33.66) (43.68) Total assets 46,399,416 47,696,255 48,168,158 60,949,491 63,108,896 Mortgage notes payable 50,428,070 50,987,329 51,850,501 65,816,872 65,800,830 Distributions per Limited Part- nership Interest (A) 7.50 None 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 - ---------------------\nBalcor Realty Investors 85-Series III A Real Estate Limited Partnership (the \"Partnership\") experienced improved operations during 1995 as a result of increased rental income at all of the Partnership's properties. In addition, the Partnership recognized gains on forgiveness of debt in 1995, 1994 and 1993 and a gain related to the foreclosure of the Oakland Hills Apartments in 1993. The 1993 gains are the primary reasons the Partnership generated net income during 1993 as compared to a net loss for 1995 and 1994. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nRental and service income and, consequently, property management fees increased during 1995 as compared to 1994 as a result of higher average rental rates and stable occupancy at each of the Partnership's five remaining properties.\nDuring December 1994, the North Hill Apartments mortgage loan was refinanced and the remaining deferred expenses relating to the previous mortgage loan were fully amortized. As a result, amortization expense decreased during 1995 as compared to 1994.\nAs a result of exterior painting costs at the Country Ridge, North Hill and Shadowridge apartment complexes and costs related to structural repairs at Shadowridge Apartments, property operating expense increased during 1995 as compared to 1994.\nReal estate tax expense decreased during 1995 as compared to 1994 as a result of lower tax rates at the Country Ridge and Park Place - Phase II apartment complexes. An increase in the assessed value at the North Hill Apartments partially offset this decrease.\nThe Partnership incurred higher 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.\nThe Partnership holds a minority interest in the Lakeville Resort Apartments. The loss from joint venture with an affiliate decreased during 1995 as compared to 1994 due to improved property operations, which was partially offset by higher interest expense. In June 1995, the mortgage note was refinanced with a new lender. In connection with this transaction, the Partnership recognized an extraordinary debt extinguishment expense of $58,521.\nThe Shadowridge and North Hill apartment complexes are both owned by joint ventures consisting of the Partnership and an affiliate. As a result of increased exterior painting costs at both properties, affiliates' participation in loss from joint venture increased in 1995 as compared to 1994.\nIn connection with a settlement reached with the seller of the Shadowridge Apartments, the Partnership recognized an extraordinary gain on forgiveness of debt in 1995 of $69,409, of which $20,823 represents the affiliate's share.\nIn connection with the December 1994 North Hill Apartments' mortgage loan 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% guarantee fee on the original North Hill Apartments' mortgage loan. As a result, the Partnership recognized a $534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665 represents the affiliate's share.\n1994 Compared to 1993 - ---------------------\nDue to the foreclosure of Oakland Hills Apartments in June 1993, rental and service income, interest on mortgage notes payable, depreciation expense, amortization expense, property operating expense and property management fees decreased for 1994 as compared to 1993.\nIncreased rental rates and\/or occupancy at all of the Partnership's remaining properties partially offset the decrease in rental and service income due to the Oakland Hills Apartments foreclosure.\nInterest income on short-term investments increased during 1994 as compared to 1993 due to higher average cash balances in 1994 as a result of cash flow from property operations, as well as an increase in short term interest rates. In addition, interest income was recognized in 1994 on the funds held in escrow relating to the previous North Hill Apartments mortgage bond financing. (See Note 10 of Notes to Financial Statements for additional information.)\nDuring December 1993, the Howell Station Apartments mortgage loan was refinanced. The new loan bears interest at a rate of 7.94% per annum whereas the previous loan had a rate of 10%. The Howell Station loan refinancing, the Oakland Hills Apartments foreclosure and an interest rate adjustment in 1993 in accordance with the mortgage loan agreement on Shadowridge Apartments all contributed to the decrease in interest expense on mortgage notes payable for 1994 as compared to 1993.\nDuring 1993, the Park Place - Phase II and the Howell Station Apartments mortgage loans were refinanced and the remaining deferred expenses relating to the previous mortgage loans were written-off. This, along with the decrease due to the foreclosure of Oakland Hills Apartments during 1993, resulted in a decrease in the amortization of deferred expenses for 1994 as compared to 1993.\nThe decrease in property operating expense as a result of the Oakland Hills foreclosure was partially offset by increases in insurance expense at all of the Partnership's properties, an increase in contract services at Park Place - Phase II Apartments, increases in utilities and payroll expense at Shadowridge Apartments and an increase in exterior repairs at North Hill Apartments. As a result, property operating expense decreased during 1994 as compared to 1993.\nReal estate tax expense decreased during 1994 as compared to 1993 primarily as a result of a decrease in the tax rate at the Country Ridge and Park Place - Phase II apartment complexes. This decrease was partially offset by an increase in the tax rate at the Howell Station Apartments.\nAdministrative expense increased for 1994 as compared to 1993 primarily due to an increase in accounting, portfolio management, and data processing expenses. A decrease in legal fees partially offset the increase in administrative expense for 1994 as compared to 1993.\nThe Partnership holds a minority interest in the Lakeville Resort Apartments. Increased exterior painting and carpet replacement expenses at the Lakeville Resort Apartments resulted in the Partnership recognizing a loss from joint venture with an affiliate in 1994 as compared to income in 1993.\nImproved operations at the North Hill and Shadowridge apartment complexes, as well as a reduction in interest expense at both properties, resulted in a decrease in affiliates' participation in loss from joint venture in 1994 as compared to 1993.\nIn June 1993, title to the Oakland Hills Apartments was relinquished through foreclosure and the Partnership recognized a $3,101,599 extraordinary gain for financial statement purposes.\nThe Partnership refinanced the Howell Station Apartments mortgage loan in 1993, received a discount on the prepayment of the previous mortgage note and recognized a $191,509 extraordinary gain on debt forgiveness in 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership increased as of December 31, 1995 when compared to December 31, 1994. The Partnership's operating activities consisted primarily of cash flow generated from the operations of the properties and interest income on short-term investments, which were partially offset by the payment of administrative expenses. Investing activities consisted of a net contribution to joint venture with an affiliate. The Partnership's financing activities consisted of a distribution to Limited Partners, distributions to joint venture partners - affiliates 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 properties' revenue receipts less property related expenditures, which include debt service payments. During 1995 and 1994, the Country Ridge, Howell Station, North Hill and Park Place - Phase II apartment complexes generated positive cash flow. Shadowridge Apartments generated a marginal cash flow deficit in 1995 as compared to positive cash flow in 1994 primarily as a result of exterior painting costs. In addition, Lakeville Resort Apartments, in which the Partnership holds a minority joint venture interest, generated positive cash flow in 1995 as compared to a marginal cash flow deficit in 1994 as a result of improved property operations. 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 four to five 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 begun actively marketing three of its properties and the property in which it holds a minority joint venture interest for sale, and if the market remains favorable, intends to begin actively marketing the two remaining properties. 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. In certain instances, it may be difficult for the Partnership to refinance a property in an amount sufficient to retire in full the current mortgage financing with respect to the property. In the event negotiations with the existing lender for a loan modification or with new lenders for a refinancing are unsuccessful, the Partnership may sell the collateral property or other properties to satisfy an obligation, or may relinquish title to the collateral property in satisfaction of the outstanding mortgage loan balance. The third-party financing of approximately $8,765,000 on Country Ridge Apartments matures in 1996 and the General Partner expects to be able to refinance this mortgage loan or sell the property.\nThe Lakeville Resort Apartments is owned by a joint venture consisting of the Partnership and an affiliate. In June 1995 the mortgage note was refinanced with a new lender. The interest rate decreased from a variable rate of approximately 10.4% to a fixed rate of 8.2%, the maturity date was extended from April 1997 to July 2030 and the monthly payment of principal and interest decreased from a variable payment which was $208,555 at the time of the refinancing to a fixed payment of $151,727. A portion of the proceeds from the new $20,932,600 first mortgage loan was used to repay the existing mortgage note of $18,728,280, as well as pay loan fees of $499,868 and fund an improvement escrow of $1,604,551.\nDuring January 1996, the Partnership paid $443,190 ($7.50 per Interest) to holders of Limited Partnership Interests for the fourth quarter of 1995. During October 1995, the Partnership commenced distributions and paid $443,190 to the holders of Limited Partnership Interests for the third quarter of 1995. The General Partner expects to continue quarterly distributions to Limited Partners based on the current performance of the Partnership's properties. 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 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 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 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 $46,399,416 $33,253,424 $47,696,255 $35,256,710 Partners' deficit accounts: General Partner (574,525) (846,053) (574,251) (838,192) Limited Partners (4,743,765) (15,632,680) (4,273,438) (14,411,474) Net loss: General Partner (274) (7,861) (701) (7,231) Limited Partners (27,137) (778,016) (69,438) (717,504) Per Limited Part- nership Interest (.46) (13.17) (1.18) (12.14)\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-XVIII, 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 ----- -------- 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'spartnerships. 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 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 - -------------------------------------------------------------------------------\nLimited WIG 85-III 3,461.5 5.86% Partnership Partners Limited Interests Chicago, Partnership Illinois Interests\n(b) Balcor 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 1,180 Interests Less than 2%\nRelatives and affiliates of the officers and partners of the General Partner own an additional 35 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 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 and Certificate of Limited Partnership, set fourth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated August 2,1985 (Registration No. 2-97249), is incorporated herein by reference.\n(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated August 2, 1985 (Registration No. 2-97249), 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. 0-14350) 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 were 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 Schedules: See Index to Financial Statements and Financial Statement Schedule attached to this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR REALTY INVESTORS 85-SERIES III A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Brian D. Parker ---------------------------------\nBrian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor 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 - ---------------------- ------------------------------- -------------- President and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XVIII, \/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-XVIII, \/s\/Brian D. Parker the 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 Realty Investors 85-Series III A Real Estate Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors 85-Series III A Real Estate Limited Partnership (An Illinois Limited Partnership) as listed in the index of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Balcor Realty Investors 85-Series III 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 III A REAL ESTATE LIMITED PARTNERSHIP (AN ILLINOIS LIMITED PARTNERSHIP)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------ ------------ Cash and cash equivalents $ 2,310,596 $ 1,965,737 Escrow deposits 1,400,287 1,371,141 Accounts and accrued interest receivable 89,717 5,712 Prepaid expenses 361,640 227,783 Deferred expenses, net of accumulated amortization of $362,375 in 1995 and $221,054 in 1994 1,227,709 1,369,030 ------------ ------------ 5,389,949 4,939,403 ------------ ------------ Investment in real estate: Land 6,536,422 6,536,422 Buildings and improvements 56,884,371 56,884,371 ------------ ------------ 63,420,793 63,420,793 Less accumulated depreciation 22,411,326 20,663,941 ------------ ------------ Investment in real estate, net of accumulated depreciation 41,009,467 42,756,852 ------------ ------------ $ 46,399,416 $ 47,696,255 ============ ============ LIABILITIES AND PARTNERS' DEFICIT\nAccounts payable $ 96,080 $ 129,946 Due to affiliates 19,310 64,125 Security deposits 334,467 295,948 Loss in excess of investment in joint venture with an affiliate 1,139,760 1,124,922 Mortgage notes payable 50,428,070 50,987,329 ------------ ------------ Total liabilities 52,017,687 52,602,270\nAffiliates' participation in joint ventures (299,981) (58,326) ------------ ------------ 51,717,706 52,543,944 Limited Partners' deficit (59,092 Interests issued and outstanding) (4,743,765) (4,273,438) General Partner's deficit (574,525) (574,251) ------------ ------------ Total partners' deficit (5,318,290) (4,847,689) ------------ ------------ $ 46,399,416 $ 47,696,255 ============ ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85 - SERIES III A REAL ESTATE LIMITED PARTNERSHIP (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 $ (6,990,896)$ (595,683)$ (6,395,213)\nNet income for the year ended December 31, 1993 2,213,346 22,133 2,191,213 -------------- ------------- ------------ Balance at December 31, 1993 (4,777,550) (573,550) (4,204,000)\nNet loss for the year ended December 31, 1994 (70,139) (701) (69,438) -------------- ------------- ------------ Balance at December 31, 1994 (4,847,689) (574,251) (4,273,438)\nCash distributions to Limited Partners (A) (443,190) (443,190) Net loss for the year ended December 31, 1995 (27,411) (274) (27,137) -------------- ------------- ------------ Balance at December 31, 1995 $ (5,318,290)$ (574,525)$ (4,743,765) ============== ============= ============\n(A) Represents a distribution paid in the fourth quarter of 1995 of $7.50 per Limited Partnership Interest.\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85 - SERIES III 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 $ 11,889,557 $ 11,036,707 $ 11,437,845 Interest on short-term investments 170,938 157,773 51,943 -------------- ------------- ------------ Total income 12,060,495 11,194,480 11,489,788 -------------- ------------- ------------ Expenses: Interest on mortgage notes payable 4,259,221 4,099,437 4,767,770 Depreciation 1,747,385 1,747,384 1,908,944 Amortization of deferred expenses 141,321 210,353 291,383 Property operating 3,859,285 3,421,828 3,662,907 Real estate taxes 1,028,753 1,136,617 1,180,830 Property management fees 593,254 550,710 573,228 Administrative 515,975 410,825 340,827 Participation in loss (income) of joint venture with an affiliate 2,596 104,619 (13,140) -------------- ------------- ------------ Total expenses 12,147,790 11,681,773 12,712,749 -------------- ------------- ------------ Loss before affiliates' participation in joint ventures and extraordinary items (87,295) (487,293) (1,222,961) Affiliates' participation in loss from joint ventures before extraordinary items 69,819 16,160 143,199 -------------- ------------- ------------ Loss before extraordinary items (17,476) (471,133) (1,079,762) -------------- ------------- ------------ Extraordinary items: Gain on foreclosure of property 3,101,599 Gain on forgiveness of debt 69,409 534,659 191,509 Affiliate's participation in gain on forgiveness of debt (20,823) (133,665) Participation in debt extinguishment expense of joint venture with an affiliate (58,521) -------------- ------------- ------------ Total extraordinary items (9,935) 400,994 3,293,108 -------------- ------------- ------------ Net (loss) income $ (27,411)$ (70,139)$ 2,213,346 ============== ============= ============ The accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85 - SERIES III 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 -------------- ------------- ------------ Loss before extraordinary items allocated to General Partner $ (175)$ (4,711)$ (10,798) ============== ============= ============ Loss before extraordinary items allocated to Limited Partners $ (17,301)$ (466,422)$ (1,068,964) ============== ============= ============ Loss before extraordinary items per Limited Partnership Interest (59,092 issued and outstanding) $ (0.29)$ (7.90)$ (18.09) ============== ============= ============ Extraordinary items allocated to General Partner $ (99)$ 4,010 $ 32,931 ============== ============= ============ Extraordinary items allocated to Limited Partners $ (9,836)$ 396,984 $ 3,260,177 ============== ============= ============ Extraordinary items per Limited Partnership Interest (59,092 issued and outstanding) $ (0.17)$ 6.72 $ 55.17 ============== ============= ============ Net (loss) income allocated to General Partner $ (274)$ (701)$ 22,133 ============== ============= ============ Net (loss) income allocated to Limited Partners $ (27,137)$ (69,438)$ 2,191,213 ============== ============= ============ Net (loss) income per Limited Partnership Interest (59,092 issued and outstanding) $ (0.46)$ (1.18)$ 37.08 ============== ============= ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85 - SERIES III 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 (loss) income $ (27,411)$ (70,139)$ 2,213,346 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Gain on foreclosure of property (3,101,599) Gain on forgiveness of debt (69,409) (534,659) (191,509) Release of escrow deposits 534,659 Affiliate's participation in gain on forgiveness of debt 20,823 133,665 Participation in debt extinguishment expense 58,521 Affiliates' participation in loss from joint ventures (69,819) (16,160) (143,199) Participation in loss (income) of joint venture with an affiliate 2,596 104,619 (13,140) Depreciation of properties 1,747,385 1,747,384 1,908,944 Amortization of deferred expenses 141,321 210,353 291,383 Net change in: Escrow deposits (29,146) (266,569) (95,754) Accounts and accrued interest receivable (84,005) 495,423 Prepaid expenses (133,857) (118,266) (2,229) Accounts payable (33,866) 74,025 (94,259) Due to affiliates (44,815) 6,148 (16,006) Accrued liabilities (11,687) (50,823) Security deposits 38,519 (2,477) 13,497 -------------- ------------- ------------ Net cash provided by operating activities 1,516,837 1,790,896 1,214,075 -------------- ------------- ------------ Investing activities:\nContributions to joint venture with an affiliate (374,657) (47,041) (123,638) Distributions from joint venture with an affiliate 328,378 131,556 -------------- ------------- ------------ Net cash used in or provided by investing activities (46,279) 84,515 (123,638) -------------- ------------- ------------ The accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85 - SERIES III 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:\nDistributions to Limited Partners (443,190) Distributions to joint venture partners - affiliates (192,659) (163,551) (54,171) Contributions from joint venture partner - affiliate 252,311 Repayment of mortgage notes payable (18,700,000) (14,744,366) Proceeds from issuance of mortgage notes payable 16,795,600 15,820,400 Proceeds from issuance of note payable 1,350,000 Funding of capital improvement escrows (209,445) (444,382) Payment of deferred expenses (842,617) (512,912) Principal payments on mortgage notes payable (489,850) (308,772) (281,956) -------------- ------------- ------------ Net cash used in financing activities (1,125,699) (1,826,474) (217,387) -------------- ------------- ------------ Net change in cash and cash equivalents 344,859 48,937 873,050 Cash and cash equivalents at beginning of year 1,965,737 1,916,800 1,043,750 -------------- ------------- ------------ Cash and cash equivalents at end of year $ 2,310,596 $ 1,965,737 $ 1,916,800 ============== ============= ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES III 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 III 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: Years ----- Buildings 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.\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 loan financing and modification 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) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(g) Loss in excess of investment in joint venture with an affiliate represents the Partnership's 40.25% interest, under the equity method of accounting, in a joint venture with an affiliated partnership. Under the equity method of accounting, the Partnership records its initial investment at cost and adjusts its investment account for additional capital contributions, distributions and its share of joint venture income or loss. Depreciation recognized in connection with the ownership of real estate by the joint venture has resulted in the Partnership's share of cumulative losses exceeding the net amounts invested in the joint venture. This has resulted in the classification of the investment as \"Loss in excess of investment in joint venture with an affiliate\" in the accompanying financial statements.\n(h) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less.\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 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 October 25, 1984. The Partnership Agreement provides for Balcor Partners-XVIII to be the General Partner and for the admission of Limited Partners through the sale of up to 70,000 Limited Partnership Interests at $1,000 per Interest, 59,092 of which were sold on or prior to December 31, 1985, the termination date of the offering.\nPursuant to the Partnership Agreement, Partnership losses will be allocated 99% to the Limited Partners and 1% to the General Partner. 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 General Partner as its distributive share from operations an amount equal to approximately 1% of the total Net Cash Receipts being distributed which will bepaid only out of distributed Net Cash Proceeds. The accrued amount will be\npaid as a part of the General Partner's share of distributed Net Cash Proceeds and will be paid only out of distributed Net Cash Proceeds in excess of total 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 Net Cash Proceeds and is subordinated to the return of Original Capital plus any deficiency in a Cumulative Distribution of 6% on Adjusted Original Capital to the holders of Interests.\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:\nCountry Ridge $8,798,060 $8,859,773 10.875% 1996 $85,183 $8,765,000\nHowell Station 6,532,938 6,593,783 7.940% 2001 48,517 6,153,000\nNorth Hill (A) 16,657,089 16,795,600 8.090% 2024 124,920 14,859,981 1,350,000 1,350,000 (A) (A) (A) (A)\nPark Place - Phase II 9,030,058 9,084,774 8.700% 2028 66,470 None\nShadowridge 8,059,925 8,303,399 7.750% 1998 65,826 7,655,000 ----------- -----------\nTotal $50,428,070 $50,987,329 =========== ===========\nA) North Hill Apartments is owned by a joint venture (\"Joint Venture\") consisting of the Partnership and an affiliate. In December 1994, the bonds which funded the previous North Hill Apartments mortgage loan were repaid. In connection with the refinancing, 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 new bonds will either be repaid or remarketed. Under the terms of the loan, monthly payments increased from $105,188 to $124,920.\nThe 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 from 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 for additional information.\nThe $1,350,000 note to an unaffiliated party is non-interest bearing and is not collateralized by the North Hill Apartments. It will be repaid only to the extent North Hill Apartments' net sales proceeds exceed a certain predetermined level. The note is included with Mortgage Notes Payable due to its relationship to the North Hill Apartments.\nDuring 1995, 1994 and 1993, the Partnership incurred interest expense on mortgage notes payable of $4,259,221, $3,564,778 and $4,767,770 and paid interest expense of $4,259,221, $3,576,465 and $4,756,083, respectively.\nThe Partnership's loans described above require current monthly payments of principal and interest.\nReal estate with an aggregate carrying value of $41,009,467 at December 31, 1995 was pledged as collateral for repayment of mortgage loans.\nFuture annual maturities of the above notes payable during each of the next five years are approximately as follows:\n1996 $ 9,245,000 1997 483,000 1998 8,027,000 1999 351,000 2000 380,000\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. Affiliates' Participation in Joint Ventures:\nThe North Hill and Shadowridge apartment complexes are each owned by the Partnership and an affiliated partnership. Profits and losses are allocated 75% to the Partnership and 25% to the affiliate for North Hill Apartments, and 70% to the Partnership and 30% to the affiliate for Shadowridge Apartments. All assets, liabilities, income and expenses of the joint ventures are included in the financial statements of the Partnership with the appropriate adjustment to profit or loss for each affiliate's participation. Distributions of $192,659 and $54,171 were made to joint venture partners during 1995 and 1993, respectively. In addition, a net contribution of $88,760 was received in 1994.\n7. Investment in Joint Venture with an Affiliate:\nThe Partnership owns a 40.25% joint venture interest in Lakeville Resort Apartments. The joint venture partner is an affiliate with investment objectives similar to those of the Partnership. During 1995 and 1993, the Partnership made net capital contributions of $46,279 and $123,638, respectively, and received a net distribution from property operations of $84,515 in 1994.\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 loss for 1995 in the financial statements is $758,466 less than the tax loss 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 ------ ------- ------ ------- ------ -------\nProperty management fees None None $500,733 None $593,008 $44,310 Reimbursement of expenses to the General Partner, at cost: Accounting $40,855 $2,792 64,274 $23,131 44,684 3,694 Data processing 26,055 2,074 36,034 9,534 21,877 4,438 Investor communica- tions 4,926 None 12,306 4,134 10,189 842 Legal 19,064 2,828 8,561 3,118 5,270 436 Portfolio management 81,974 10,952 45,636 20,651 44,898 3,712 Property sales admin- istration 3,006 577 None None None None Other 5,665 87 13,887 3,557 6,591 545\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third party in November 1994.\nThe Partnership participates in an insurance deductible program with other affiliated partnerships in which the program pays claims up to the amount of the deductible under the master insurance policies for its properties. The program is administered by an affiliate of the General Partner who receives no fee for administering the program; however, the General Partner is reimbursed for program expenses. The Partnership paid premiums to the deductible insurance program of $82,931, $104,139 and $71,202 for 1995, 1994 and 1993, respectively.\n10. Extraordinary Items:\n(a) Shadowridge Apartments is owned by a joint venture consisting of the Partnership and an affiliate. During 1995, the joint venture recognized an extraordinary gain on forgiveness of debt of $69,409 in connection with the settlement reached with the seller, of which $20,823 represents the affiliate's share.\n(b) The Partnership owns a minority joint venture interest in Lakeville Resort Apartments. In June 1995, the mortgage note was refinanced with a new lender.\nIn connection with this transaction, the Partnership recognized an extraordinary debt extinguishment expense of $58,521.\n(c) 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 mortgage loan 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 North Hill Apartments' mortgage loan. As a result, the Partnership recognized a $534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665 represents the affiliate's share.\n(d) During 1993, title to the Oakland Hills Apartments was relinquished through foreclosure. The Partnership wrote-off the first mortgage loan of $12,842,863,\nan equity note balance of $67,928, a second mortgage loan of $1,658,149, accrued real estate taxes of $514,988, security deposits of $31,581 and the property basis of $12,013,910, net of accumulated depreciation of $4,816,560. An extraordinary gain on foreclosure of $3,101,599 was recognized in 1993.\n(e) During 1993, the Partnership completed the refinancing of the $6,385,403 Howell Station Apartments first mortgage loan and obtained a $6,650,000 new first mortgage loan from an unaffiliated lender. The Partnership received a $191,509 discount from the previous lender for prepayment of the mortgage note, which was recorded as an extraordinary gain on debt forgiveness in 1993.\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.\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 approximates the carrying value.\n12. Subsequent Events:\n(a) In January 1996, the Partnership made a distribution of $443,190 ($7.50 per Interest) to the holders of Limited Partnership Interests 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 REALTY INVESTORS 85-SERIES III A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 85-SERIES III A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 85-SERIES III A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction-period interest.\n(b) The aggregate cost of land for Federal income tax purposes is $5,950,267 and the aggregate cost of buildings and improvements for Federal income tax purposes is $54,036,831. The total of these is $59,987,098.\n(c) Reconciliation of Real Estate -----------------------------\n1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $63,420,793 $63,420,793 $80,251,263\nDeductions during year: Foreclosure of investment property (16,830,470) ----------- ----------- ----------- Balance at close of year $63,420,793 $63,420,793 $63,420,793 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $20,663,941 $18,916,557 $21,824,173\nDepreciation expense for the year 1,747,385 1,747,384 1,908,944\nAccumulated depreciation of foreclosed investment property (4,816,560) ----------- ----------- ----------- Balance at close of year $22,411,326 $20,663,941 $18,916,557 =========== =========== ===========\n(d) See description of Mortgage Notes Payable in Note 4 of Notes to Financial Statements.\n(e) Depreciation expense is computed based upon the following estimated useful lives: Years ----- Buildings and improvements 30 Furniture and fixtures 5\n(f) 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.","section_15":""}
{"filename":"785994_1995.txt","cik":"785994","year":"1995","section_1":"ITEM 1.BUSINESS\nGENERAL\nU.S. Restaurant Properties Master L.P. (the \"Partnership\") owns properties on which chain restaurants operate. The Partnership, formerly Burger King Investors Master L.P., was formed in 1986 by Burger King Corporation (\"BKC\") and QSV Properties Inc. (\"QSV\"), at that time a wholly-owned subsidiary of The Pillsbury Company (\"Pillsbury\"). In May 1994, QSV was sold to a management and investor group led by Robert J. Stetson and Fred H. Margolin (the \"Stetson\/Margolin Group\"), who have no affiliation with Pillsbury. In 1995, the name of QSV was changed to U.S. Restaurant Properties, Inc. U.S. Restaurant Properties, Inc. is the Managing General Partner of the Partnership. BKC was a Special General Partner of the Partnership until its withdrawal on November 30, 1994.\nThe Partnership operates through U.S. Restaurant Properties Operating L.P. (the \"Operating Partnership\"), formerly Burger King Operating Limited Partnership, which holds the interests in the Properties. Through its ownership of all of the limited partnership interest in the Operating Partnership, the Partnership owns a 99.01 percent partnership interest in the Operating Partnership. (The Partnership and the Operating Partnership are generally referred to collectively herein as the \"Partnership\" or the \"Partnerships,\" and all references herein to the Partnership when used with respect to the acquisition, ownership and operation of the Properties refer to the combined operations of the Partnership and Operating Partnership.) The Partnerships are Delaware limited partnerships and will continue in existence until December 31, 2035, unless sooner dissolved or terminated. The principal executive offices of the Partnership and the Managing General Partner are located at 5310 Harvest Hill Road, Suite 270, Dallas, Texas 75230, telephone number (214) 387-1487.\nThe Partnership's agreement of limited partnership was amended by vote of the limited partners in March 1995 to expand the purpose of the Partnership. See \"- Business Strategy,\" below.\nPROPERTIES\nAs of February 29, 1996, the Partnership owned or leased 162 properties located in 37 states (collectively, the \"Properties\"). Of such Properties, 143 in 37 states were leased to franchisees of BKC (and also to BKC) who operate BURGER KING (a registered trademark and service mark of BKC) restaurants (\"BK Restaurants\"). Such Properties are referred to herein as the \"BK Properties.\" The remaining 19 Properties in five states were leased to non-BKC restaurant operators who operate other restaurants on the Properties. All such other Properties are referred to herein as the \"Non-BK Properties.\" All restaurants operated on Partnership Properties are collectively referred to herein as the \"Restaurants.\" Additional information regarding the Properties is set forth below under \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGENERAL\nThe Partnership acquired 128 properties from BKC on February 27, 1986 for a total purchase price of $94,592,000. From such date through March 1995, five of such properties were sold or leases on such properties were allowed to expire and were not renewed.\nSince the business strategy of the Partnership was changed in March 1995 as a result of the amendments to the partnership agreement, the Partnership has acquired 39 restaurant properties in 13 states. Of such properties, 22 are Burger King restaurants and the remainder encompass 12 other tradenames. The Partnership has an additional 108 restaurant properties located in 20 states under letters of intent or contracts for acquisition. Such properties represent seven transactions in various stages of negotiation and due diligence and there can be no assurance that such transactions will be closed. Such acquisitions represent an aggregate consideration of $57 million. Of such properties, 28 are BK restaurant properties, 37 are Dairy Queen restaurant properties, 26 are Hardee's restaurant properties, 11 are Pizza Hut restaurant properties and six restaurants are operated under other tradenames. The Partnership also intends to make loans to tenants to renovate and improve their restaurants, purchase additional restaurant properties and related equipment, construct new Properties and finance the improvement of existing Properties and the purchase of additional restaurant properties and related property through borrowings and the issuance of additional Units.\nPROPERTIES\nThe Partnership property portfolio currently consists of 99 Properties that are owned in fee simple (the \"Fee Properties\") and 63 Properties that are leased (the \"Leasehold Properties\") under leases with third-party lessors (the \"Primary Leases\").\nThe table below lists, as of February 29, 1996, the number of Properties in each state and how many of such properties are Fee Properties and Leasehold Properties.\nThe Properties are leased to a total of 104 different BKC franchisees and 14 other restaurant operators. Except for BKC, none of the lessees operates a Restaurant on more than three Properties, and only 18 of the lessees operate a Restaurant on more than one BK Property. Seven Properties are leased to BKC. The restaurant on one of the Properties is closed and a new lessee is being sought. A portion of one Property is subleased, pursuant to an agreement entered into prior to the acquisition of the Property by the Partnership, to Pearle, Inc., an affiliate of BKC.\nAll equipment, furniture, fixtures, and other similar personal property used on the Properties generally is owned or leased from third parties by the lessee of the Property.\nPRIMARY LEASES. As described above, 63 of the Properties are Leasehold Properties. Under the terms of 13 Primary Leases, the Partnership leases both the underlying land and the restaurant building and other improvements thereon. Under the terms of the remaining 50 Primary Leases, the Partnership leases the underlying land and owns the restaurant building and other improvements constructed thereon. In any event, upon expiration or termination of a Primary Lease, the owner of the underlying land will become the owner of all improvements thereon.\nIn addition to variations required to reflect whether the Partnership owns or leases the improvements on a Leasehold Property, the other terms and conditions of the Primary Leases vary substantially. However, the Primary Leases generally have certain provisions in common. For example, the Primary Leases generally provide that (i) the initial term is 20 years or less, (ii) the Partnership may renew the term one or more times at its option (although the provisions governing any such renewal vary significantly in that, for example, some renewal options are at a fixed rental amount, while others are at fair rental value at the time of renewal), (iii) the rentals payable are stated amounts that may escalate over the terms of the Primary Leases (and\/or during renewal terms) but normally (although not always) are not based upon a percentage of sales of the Restaurants thereon, and (iv) the Partnership is required to pay all taxes and operating, maintenance, and insurance expenses for the Leasehold Properties (that is the Primary Leases are \"net\" leases). Several Primary Leases also require the Partnership, upon the termination or expiration thereof, to remove all improvements situated on the Property.\nAlthough the Partnership, as lessee under each Primary Lease, generally has the right to assign or sublet all of its rights and interests thereunder without obtaining the landlord's consent, the Partnership is not permitted to assign or sublet any of its rights or interests under 22 Primary Leases without obtaining the landlord's consent or satisfying certain other conditions. In addition, approximately 20 percent of the Primary Leases require the Partnership to use such Leasehold Properties only for the purpose of operating a BK Restaurant or another type of restaurant thereon. In any event, no transfer will release the Partnership from any of its obligations under the Primary Lease, including the obligation to pay rent. The fact that all applicable conditions were satisfied in connection with the Partnership's acquisition of such Leasehold BK Properties will not permit the Partnership to transfer such Leasehold BK Properties in the future without again satisfying such conditions.\nAs of December 31, 1995, the remaining terms of the Primary Leases for all of the Leasehold BK Properties (excluding renewal option terms) ranged from approximately 1 to 11 years and the average remaining term (excluding renewal options terms) was 5 years. With renewal options exercised, the remaining terms of the Primary Leases ranged from approximately 8 to 33 years and the average remaining term was 20 years. Only 25 Primary Leases had a remaining term (including renewal option terms) of less than 25 years.\nLEASES. As described above, 115 of the BK Properties are leased or subleased to a BKC franchisee under a Lease\/Sublease, pursuant to which the franchisee is required to operate a BK Restaurant thereon in accordance with the lessee's Franchise Agreement and to make no other use thereof. Upon its acquisition of the BK Properties, the Partnership assumed the rights and obligations of BKC under the Leases\/Subleases. Five Properties are leased to Burger King on substantially the same terms and conditions as those contained in the Lease\/Sublease with the prior lessees. A portion of one of the BK Properties also is leased to a tenant that does not operate a Restaurant, and this lease was also assumed by the Partnership. Two properties are leased to lessees operating \"fast food\" type restaurants not franchised by or affiliated with BKC.\nAlthough the provisions of BKC's standard form of lease to franchisees have changed over time, the material provisions of the Lease\/Subleases generally are substantially similar to BKC's current standard form of lease (except to the extent BKC has granted rent reductions or deferrals or made other lease modifications in order to alleviate or lessen the impact of business or other economic problems that a franchisee may have encountered). The Leases\/Subleases generally provide for a term of 20 years from the date of opening of the Restaurant and do not grant the lessee any renewal options. The Partnership, however, is required to renew a Leases\/Sublease if BKC renews or extends the lessee's Franchisee Agreement. The Partnership believes BKC's policy generally is to renew a Franchise Agreement if BKC determines, in its sole discretion, that economic and other factors justify renewal or extension and if the franchisee has complied with all obligations under the Franchise Agreement. As of December 31, 1995, the remaining terms of all the Leases range from approximately 1 to 15 years, the average remaining term was 6 years, and 24 Leases\/Subleases had a remaining term of more than 10 years.\nThe Leases\/Subleases generally require the franchisees to pay minimum rent, percentage rent (based upon sales) in excess of minimum rent, and all taxes and operating, maintenance, and insurance costs for the Properties (that is, the Leases\/Subleases are \"net\" leases). Minimum rent is payable monthly and generally is equal to 13.4 percent or 14.5 percent (depending on when the Lease\/Sublease was executed) of BKC's \"investment\" in the BK Property (which investment generally is determined on the basis of BKC's land acquisition cost (if any), certain construction and other costs (if any), and capitalized interest, rent and taxes (if any)) plus, in the case of a Leasehold Property, 113.4 percent or 114.5 percent (depending on when the Lease\/Sublease was executed) of all periodic Primary Lease rent payments after the construction period. Percentage rent generally is payable quarterly with an annual adjustment and is equal to the amount (if any) by which a specified percentage (typically 8.5 percent) of the franchisee's sales at the Property for each lease year exceeds the minimum rent. The term \"sales\" includes all sums charged for goods, merchandise or services sold at or from the BK Property; the term excludes any federal, state, county or city sales tax, excise tax or other similar taxes collected by a franchisee from customers based on sales, as well as cash received as payments in credit transactions where the extension of credit itself has already been included in the figure on which any previous percentage rent has been computed. In the case of Leasehold BK Properties, the Leases\/Subleases generally provide that the minimum rent thereunder (but not percentage rent) will increase to reflect any increase in rent under the corresponding Primary Lease. If the franchisee is paying percentage rent at the time of such an increase, however, an increase in rent under a Primary Lease will not be borne by the franchisee, and this will result in a decrease in the net revenue derived by the Partnership from such BK Property.\nUSE AND OTHER RESTRICTIONS ON THE OPERATION AND TRANSFER OF BK RESTAURANT PROPERTIES. The Partnership was originally formed for the purpose of acquiring all of BKC's interests in the existing BK Properties and leasing or subleasing them to BKC franchisees under the Leases\/Subleases. Accordingly,\nthe Partnership Agreement provides that, except as expressly permitted thereby, the Partnership may not use its BK Restaurant Properties for any purpose other than the operations thereon of a BK Restaurant. In furtherance thereof, the Partnership Agreement (i) requires the Partnership, in certain specified circumstances, to renew or extend a Lease\/Sublease and enter into a new lease with another franchisee of BKC, to approve an assignment of a Lease\/Sublease, to permit BKC to assume a Lease\/Sublease at any time, and to renew a Primary Lease, and (ii) imposes certain restrictions and limitations upon the Partnership's ability to sell, lease, or otherwise transfer any interest in its BK Restaurant Properties. The Partnership Agreement also requires the Partnership to provide BKC notice of default under a Lease\/Sublease and an opportunity to cure such defaults prior to taking any remedial action. These restrictions could lapse with respect to a particular Property if the Partnership were to transfer that Property to a third party following BKC's failure to exercise its right of first refusal (as described below). The Partnership Agreement, however, specifically provides that the Managing General Partner is under no obligation to seek to sell any BK Restaurant Property or to consider any offer to purchase any BK Restaurant Property so long as BKC maintains a Franchise Agreement in effect with respect to the BK Property or itself operates a BK Restaurant on the BK Property.\nThe Partnership Agreement provides that the Partnership may not sell, lease or otherwise transfer any of its interest in any BK Restaurant Property without first offering to sell, lease or otherwise transfer to BKC such interest at the price and on the terms and conditions contained in a bona fide third-party offer. BKC generally must elect whether or not to exercise its right to acquire such interest in the BK Property pursuant to its right of first refusal within 30 days after its receipt of the offer.\nThe foregoing restrictions do not apply to any restaurant property acquired after March 17, 1995 so long as a BK Restaurant is not located thereon. The Partnership Agreement does not restrict the restaurant properties that the Partnership may acquire after such date.\nRESTAURANT ALTERATIONS AND RECONSTRUCTION. It is important that existing Properties be improved, expanded, rebuilt, or replaced from time to time. In addition to normal maintenance and repair requirements, each franchisee is required under BKC's Franchise Agreement and Lease\/Sublease, at its own cost and expense, to make such alterations to a BK Restaurant as may be reasonably required by BKC from time to time in order to modify the appearance of the restaurant to reflect the then current image requirements for BK Restaurants. Most of the existing BK Properties are 15 to 20 years old, and the Partnership believes that many of its existing BK Properties require substantial improvements to maximize sales. Moreover, the conditions of many of the BK Properties is below BKC's current image requirements.\nBKC maintains a \"Successor Policy\" relating to the renewal and extension of Franchise Agreements with BKC franchisees. In connection with such renewals and extensions, the \"Successor Policy\" includes provisions intended to encourage the reconstruction, expansion or other improvement of the older BK Restaurants leased or subleased by BKC to franchisees in order to upgrade those restaurants to BKC's current standards for physical facilities and to take advantage of opportunities that may exist to increase sales through improving an existing restaurant's facilities (for example, by increasing parking or seating capacity or by adding a \"drive-thru\" facility).\nSubstantially all of the Partnership's existing Properties will be subject to the \"Successor Policy\" over the next seven years. Under the current \"Successor Policy,\" (i) a restaurant leased by BKC to a franchisee where the Franchise Agreement is scheduled to expire within five years or (ii) a restaurant leased by BKC to a franchisee where the property and improvements are more than ten years old and the\nFranchise Agreement is at least two years old and has more than five years remaining on its term, may qualify for financial assistance if BKC, in its sole discretion, determines that the restaurant should be improved under the \"Successor Policy.\" If BKC determines that a restaurant should be reconstructed under the \"Successor Policy\" and BKC elects to pay the cost of such reconstruction, then the terms of the Lease\/Sublease and the Franchise Agreement with respect to such restaurant are extended, the minimum rent payable under the Lease\/Sublease is increased, but the applicable percentage rent rate under the Lease\/Sublease generally will remain at (or increase to) 8.5 percent. If, however, BKC elects not to pay the cost of reconstructing a particular restaurant but the franchisee, with BKC's consent, agrees to pay the cost thereof, then the terms of the Lease\/Sublease and the Franchise Agreement are extended, the minimum rent under the Lease\/Sublease is increased, and the percentage rent payable under such Lease\/Sublease is permanently reduced (generally from 8.5 percent to 5.5 percent of annual sales). In addition, the franchisee may be granted a reduction or abatement of rent for up to 60 days while the reconstruction is underway. The Partnership believes that some of the requirements of the \"Successor Policy,\" if invoked, could have a negative effect on the Partnership's cash flow and borrowing capacity. The Partnership believes, however, that because of BKC's regulations to partially subsidize this process, there will be little incentive for BKC to invoke this policy on properties that are in good repair and condition.\nThe Partnership Agreement requires the Managing General Partner to cause the Partnership to implement those aspects of BKC's \"Successor Policy\" related to reconstruction of BK Restaurants as such policy currently is in effect and as it may be revised from time to time, with respect to any BK Restaurant Property or Properties that BKC in its discretion, decides should be reconstructed under the \"Successor Policy\". The Partnership generally is required to extend the Lease\/Sublease with respect to any Property reconstructed pursuant to the \"Successor Policy,\" and, in the discretion of BKC, either to pay for the cost of reconstruction directly or to reduce the percentage rent rate under such Lease\/Sublease if the franchisee pays the cost of reconstruction. BKC, however, must pay to the Partnership an amount equal to the portion of the cost of any reconstruction undertaken or any rent reduction granted, as the case may be, determined by reference to BKC's relative share (i.e., the franchisee royalty fee, (but excluding amounts required to be expended for advertising and other income received by BKC)) of the total rental and royalty income derived by BKC and the Partnership from the Property. BKC's obligation to make payments to the Partnership in connection with a rent reduction pursuant to the \"Successor Policy\" would continue for the remainder of the term of the Lease\/Sublease, even if the Partnership were to transfer the Property prior to expiration of the Lease\/Sublease. In addition, BKC would subsidize a portion of the 60-day reduction or abatement in rent while the construction is completed under the provisions for \"rent relief\" described below.\nBKC, in its sole and absolute discretion, may modify or discontinue at any time the current version or any subsequent version of the \"Successor Policy,\" but such a change would not affect the basis on which the Partnership and BKC will share the cost of any reconstruction undertaken pursuant to the \"Successor Policy.\"\nIn addition to the reconstruction of BK Restaurants under the \"Successor Policy\" BKC has the right under the Partnership Agreement to require the Partnership to acquire land adjacent to a BK Restaurant Property if such land is necessary for the expansion of the BK Restaurant on the Property (for example, to provide additional parking facilities), even though the expansion is not undertaken pursuant to the \"Successor Policy.\" However, BKC is required to pay the Partnership a portion of the cost of any\nsuch adjacent land, determined under the formula described above in connection with the \"Successor Policy.\"\nThe Partnership believes that it can reduce the likelihood of having to rebuild the restaurant properties at the Partnership's expense, if it assists tenants in repairing and updating their restaurants. In many cases, the tenants have difficulty borrowing to finance improvements to the restaurants because they do not own them. The recent amendments to the Partnership Agreement permit the Partnership to make loans to tenants for such purposes. The Partnership would realize interest income from these loans, with the possibility of receiving increased percentage rent because of increased sales at the improved restaurants. As an alternative, the Partnership is also permitted to make and provide for such improvements through increased rents on the properties. The Partnership envisions that the typical repairs and updates that tenants would make would involve constructing playgrounds, repairing roofs and parking lots, and generally remodeling a restaurant to conform to Burger King's current image requirements.\nThe Partnership believes that if the \"Successor Policy\" is invoked, the increased base rent and any incremental percentage rent on the improved restaurant property would be insufficient to compensate the Partnership adequately for its rebuilding costs. As a consequence, the cash flow of the Partnership could be adversely effected by implementation of the \"Successor Policy.\" The Partnership believes that because the \"Successor Policy\" includes payments by BKC, it would not be in BKC's economic interest to invoke the \"Successor Policy\" with respect to restaurant properties that have already been renovated and updated. The Partnership believes that it is unlikely that a tenant would elect to pay for the improvements itself because any improvements would belong to the Partnership.\nRENT RELIEF. In connection with Properties leased or subleased by BKC to franchisees, BKC, from time to time, in its discretion, has granted \"rent relief\" to a limited number of franchisees, in the form of a permanent or temporary reduction of rent payment otherwise owed, in order to alleviate or lessen the impact of business or other economic problems that those franchisees have encountered. The Partnership Agreement provides that the Managing General Partner, in its discretion, may cause the Partnership to grant \"rent relief\" with respect to a BK Property at the request of BKC or the lessee. Any grant of \"rent relief\" by the Partnership, however, is subject to the condition that BKC agrees to pay the Partnership a portion of such \"rent relief,\" determined by reference to BKC's relative share (i.e. the franchise royalty fee (but excluding amounts required to be expended for advertising and other amounts received by BKC)) of the total rental and royalty income derived by BKC and the Partnership from such Property. BKC's obligation to make payments to the Partnership would continue for the duration of the rent reduction, even if the Partnership were to transfer the BK Property prior to expiration of the Lease\/Sublease.\nAs defined in the Partnership Agreement, \"rent relief\" is limited to any reduction in rent for a period in excess of 90 days and reductions for 90 days or less that are specifically designated by the Managing General Partner as \"rent relief\" or that are in connection with the improvement of a BK Restaurant pursuant to BKC's \"Successor Policy.\" No other reduction for a period of 90 days or less would be considered \"rent relief.\" In addition, a franchisee's failure to make a payment of rent under a Lease\/Sublease would not be considered \"rent relief\" if either such Lease\/Sublease were to have terminated automatically or the Managing General Partner were to seek to terminate such Lease\/Sublease and were to cause the Partnership to initiate and pursue such actions (including, if appropriate, litigation) against the defaulting franchisee as the Managing General Partner, in its sole discretion, determined\nreasonable under the circumstances. The Partnership would not be entitled to any payment from BKC in these various circumstances that are not considered \"rent relief.\"\nDuring the year ended December 31, 1995, the Partnership had not provided \"rent relief\" for any BK Properties.\nPERIODIC CONSIDERATION OF SALE OR FINANCING\nThe Partnership Agreement provides that the Managing General Partner may (but is not obligated to) consider at least once every five years, beginning in the year 2000, whether or not it would be in the interest of the Partnership to effectuate a sale and\/or financing of all or a portion of the Properties held as of March 17, 1995 in order to return to the Unitholders all or a substantial portion of their unrecovered capital investments in the Partnership. If at any such time the Managing General Partner, in its judgment, determines that such a sale or financing would be in the interest of the Partnership, it will use reasonable efforts to effectuate such a transaction, assuming market conditions permit. In the case of a sale of all or a portion of such Properties on which BK Restaurants are located, BKC would have the right to exercise its right of first refusal to the extent it had not lapsed.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFrom time to time, the Partnership is involved in litigation relating to claims arising in the ordinary course of business. Currently, the Partnership is not a party to any material litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThere were no matters submitted to Unitholders in the quarter ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Partnership's Units are traded on the New York Stock Exchange under the symbol \"USV\". Quarterly distributions are declared for payment early in the next calendar quarter. The high and low sales prices of the Units and the distributions declared during each calendar quarter of 1994 and 1995 and during 1996 through February 29, 1996 are set forth below:\nAs of February 29, 1996, there were 1,903 holders of record in the Partnership.\nIn July 1995, the Partnership announced its intention to repurchase up to 300,000 Units. Through December 31, 1995, the Partnership had purchased 30,000 Units and no further repurchases have been made or are presently contemplated.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n______________ * Includes special capital transaction distributions of $.24.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS.\nTotal restaurant sales, the primary determinant of Partnership revenues, are a function of the number of restaurants in operation and their performance. Sales at individual restaurants are influenced by local market conditions, by the efforts of specific restaurant operators, and by marketing, new product and program support by the franchiser, and by the general state of the economy.\nRevenues in 1995 totaled $9,780,289 up 11.2 percent from the $8,793,056 recorded in 1994. Revenues in 1994 were up 5.5 percent from the $8,331,643 recorded in 1993. The partnership owned and leased 122 sites throughout 1994 and 1995. Revenues from these properties were up 6.4 percent in 1995 over 1994. The remaining increase in revenues in 1995 over 1994 is attributable to 16 properties acquired on various dates during 1995. No additions were made to the portfolio during 1994 and 1993.\nTotal sales in the restaurants located on Partnership real estate in 1995 were $135,296,834 up 10.6 percent from the $122,314,903 reported in 1994 which was up 8.4 percent from the $112,880,007 reported for 1993. There were 138, 122 and 121 Partnership restaurant sites in operation on December 31, 1995, 1994 and 1993 respectively.\nExpenses excluding the provision for write down of properties for the year were $4,557,701, up 18.4 percent from 1994 which was up 3.2 percent from 1993. The increase in expenses was primarily due to the increase in the number of restaurant sites owned by the Partnership and related financing costs.\nThere was no write down of assets and intangible values relating to closed properties during the year. Write downs of $11,061 and $73,739 were made in 1994 and 1993 respectively.\nNet income allocable to Unitholders in 1995 was $5,119,180 or $1.10 per Partnership Unit, up 5.8 percent or six cents per Unit from $4,837,017 or $1.04 per Unit achieved in 1994. The 1994 results were up 8.3 percent or eight cents per Unit from the 1993 results. Excluding provisions for write down or dispositions of properties, net income allocable to Unitholders was $1.10 in 1995, $1.05 in 1994 and 97 cents in 1993.\nRegular cash distributions to the Limited Partners for 1995 totaled $1.69 per Unit with 42 cents per Unit paid in the first three quarters and 43 cents in the fourth quarter. Total cash distributions to Unitholders in 1994 and 1993 were $1.56 and $1.72 per Unit, respectively.\nFUNDS GENERATED FROM OPERATIONS.\nIndustry analysts generally consider funds generated from operations to be an appropriate measure of performance. Funds generated from operations is calculated as the sum of taxable income plus charges for depreciation and amortization. Funds generated 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 and cash distributions. Funds generated from operations should not be considered as an alternative to net income (determined in accordance with generally accepted accounting principles) as an indication of the Partnership's performance or as an\nalternative to cash flow (determined in accordance with generally accepted accounting principles) as a measure of liquidity. Funds generated from operations on a tax basis allocable to Unitholders in 1995 were $1.78 per Partnership Unit, up 13 cents per Unit from the $1.65 achieved in 1994 which was up 11 cents per Unit from $1.54 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES.\nCash and equivalents on December 31, 1995 totaled $7,127 down $673,519 from December 31, 1994 and down $1,252,976 from December 31, 1993. Year-end 1995 net receivables of $951,095 were up 33 percent and 130 percent from December 31, 1994 and December 31, 1993, respectively, as a result of increases in lease revenues and a change in the procedure for paying property taxes and billing them to the lessees.\nSince formation, the Partnership has paid all regular distributions from its operating cash flow. Funds generated from operations on a tax basis allocable to Unitholders were seven cents more than the related cash distributions for 1995 earnings, four cents more than the related cash distributions for 1994 earnings and 18 cents per Unit more than the related cash distribution for 1993 earnings. Management of the Partnership believes that cash generated from operations will be sufficient to meet operating requirements.\nAs a result of amendments to the Partnership Agreement approved by the limited partners in March 1995, the Partnership has undertaken a program of substantial capital expenditures for the addition of new properties and to assist existing tenants in the remodeling of their restaurants. To finance these expenditures, the Partnership has incurred debt and issued additional Units. In June 1995, the Partnership obtained a revolving bank credit line in the amount of $10 million (subsequently increased to $20 million and again in February 1996 to $40 million). Borrowings have been used to acquire additional restaurant properties and additional borrowings may also be used to fund additional property acquisitions. The credit agreement expires June 27, 1998 and provides that borrowings under the agreement will bear interest at 180 basis points over the London Interbank Rate (LIBOR). The borrowings are secured by the Partnership's interest in the real estate and leases owned by the Partnership. At February 29, 1996, approximately $20 million remained available under the credit agreement. Interest expense for 1995 was $193,530.\nAt February 29, 1996 the Partnership had an additional 108 restaurant properties located in 20 states under letters of intent or contracts for acquisition. Such properties represent seven transactions in various stages of negotiation and due diligence and there can be no assurance that such transactions will be closed. Such acquisitions will require expenditures of $57 million. Of such properties, 28 are Burger King restaurant properties, 37 are Dairy Queen restaurant properties, 26 are Hardee's restaurant properties, 11 are Pizza Hut restaurant properties and six are restaurant properties operated under other tradenames. The Partnership expects to raise such consideration (and the consideration for future property acquisitions) through the use of the remaining availability under the existing credit agreement, from additional borrowings and from the issuance of additional Units. The Partnership is currently negotiating an additional credit facility which would be used to fund these and other potential acquisitions. There can be no assurance such financing will be available and the failure of the Partnership to obtain such additional financing would adversely impact the Partnership's ability to acquire additional properties.\nDuring 1995, three properties were acquired in part for 54,167 Units. As a term of the acquisition, the Partnership agreed, in the event the market price for the Units issued did not equal or exceed $24 per Unit three years from the date of issuance and such Units were still held on such date by\nthe seller of the properties, to pay the difference in cash. In connection with the acquisition of ten properties in 1996, the Partnership agreed, as a term of those acquisitions, in the event the market price for the Units issued did not equal or exceed $23 per Unit (as to 28,261 Units) three years from the date of issuance or $24 per Unit (as to 299,575 Units) two years from the date of issuance and such Units were still held on such date by the sellers of the properties, to pay the difference by the issuance of additional Units.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial information and supplementary data begin on page of this Annual Report on Form 10-K. Such information is incorporated herein by reference into this Item 8.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Registrant is a limited partnership (of which U.S. Restaurant Properties, Inc. is the Managing General Partner) and has no directors or officers. The executive officers of the Managing General Partner are Robert J. Stetson, President and Chief Executive Officer, and Fred H. Margolin, Chairman of the Board, Secretary and Treasurer. They have served in such positions and as directors since the acquisition of the Managing General Partner on May 27, 1994. Messrs. Stetson and Margolin serve as executive officers of the Managing General Partner at the pleasure of its board of directors.\nMr. Stetson is 45 years old. Since 1978, Mr. Stetson has been primarily engaged in restaurant chain management, including the acquisition and management of restaurant properties. From 1987 until 1992, Mr. Stetson served as a senior executive in restaurant and retailing subsidiaries of Grand Metropolitan PLC, the ultimate parent of Burger King. During this period, Mr. Stetson served as the Chief Financial Officer and later President - - Retail Division of Burger King and Chief Financial Officer and later Chief Executive Officer of Pearle Vision. As Chief Financial Officer of Burger King, Mr. Stetson was responsible for managing more than 750 restaurants that Burger King leased to tenants. Prior to 1987, Mr. Stetson served in several positions with PepsiCo Inc. and its subsidiaries, including Chief Financial Officer of Pizza Hut. Mr. Stetson is also a director of Bayport Restaurant Group and Bugaboo Creek Steakhouse Inc., both publicly-traded restaurant companies. In 1972, Mr. Stetson received a Bachelor of Arts degree from Harvard College. In 1975, Mr. Stetson received an M.B.A. from Harvard Business School.\nMr. Margolin is 46 years old. In 1979, Mr. Margolin founded and became the President of American Eagle Premium Finance Company, one of the largest independent premium finance companies in Texas. From 1982 through 1988, Mr. Margolin developed and then leased or sold shopping centers having an aggregate cost of $50,000,000. In 1977, Mr. Margolin founded Intercon General Agency, a national insurance agency specializing in the development and marketing of insurance products for\nfinancial institutions. Mr. Margolin served as the Chief Executive Officer of Intercon General Agency from its inception until its sale to a public company in 1982. In 1971, Mr. Margolin received a Bachelor of Science degree from the Wharton School of the University of Pennsylvania. In 1973, Mr. Margolin received an M.B.A. from Harvard Business School.\nIn addition to Messrs. Stetson and Margolin, the board of directors of the Managing General Partner consists of Messrs. Gerald H. Graham, David Rolph, Darrel Rolph, and Eugene G. Taper. Each director serves a one-year term. Mr. Graham, age 58, is the Dean of the Barton School of Business at Wichita State University. David Rolph, age 47, and Darrel Rolph, age 58, own and operate the Tex-Mex restaurant chain, \"Carlos O'Kelleys,\" which has 25 units, and were formerly one of the largest Pizza Hut franchisees. Mr. Taper, age 59, a certified public accountant, is a consultant and a retired partner, since 1993, of Deloitte & Touche LLP, an international public accounting firm.\nSECTION 16(A) REPORTS. Section 16(a) of the Securities and Exchange Act of 1934, as amended, requires the Managing General Partner, its directors and executive officers, and persons who beneficially own more than 10 percent of the Units to file with the SEC initial reports of Unit ownership and reports of changes in ownership therein. The Managing General Partner, directors and executive officers of the Managing General Partner, and greater than 10 percent owners of the Units are required by SEC regulation to furnish the Partnership with copies of all Section 16(a) forms they file.\nTo the Partnership's knowledge, based solely upon a review of the copies of such reports furnished to the Partnership and written representations that no other reports were required during the year ended December 31, 1995, the Partnership believes that all Section 16(a) filing requirements applicable to the foregoing Managing General Partner, director, executive officers, and greater than 10 percent owners were complied with.\nThe year-end report is not required to be filed if there are no previously unreported transactions or holding to report. Nevertheless, the Partnership is required to disclose the names of directors, executive officers and greater than 10 percent owners who did not file the year-end report, unless the Partnership has received a written statement that no filing was required. As of the date of this report, the Partnership has not received any such statements.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe Managing General Partner, U.S. Restaurant Properties, Inc., is responsible for managing the business and affairs of the Partnership. The Partnership pays the Managing General Partner a non-accountable annual allowance (adjusted annually to reflect increases in the Consumer Price Index), plus reimbursement of out-of-pocket costs incurred to other parties for services rendered to the Partnerships. The allowance for the years ended December 31, 1995, 1994 and 1993 was $585,445, $542,508 and $528,000, respectively. For 1996, the allowance will be $600,081. For 1995, the one-time property acquisition fee equaled $109,238 which was capitalized and the annual allowance includes $29,375 of increased management fees due to acquisitions. The allowance is paid quarterly, in arrears. The Partnership's accounts payable balance includes $187,204 and $135,627 for this allowance as of December 31, 1995 and 1994, respectively. The Managing General Partner paid no out-of-pocket costs to other parties on behalf of the Partnership during 1995, 1994 and 1993. See \"Item 1. Business - Distributions and Allocations\" and \"- Payments to the Managing General Partner,\" above, and \"Item 13. Certain Relationships and Related Transactions,\" below.\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 Units and the capital stock of the Managing General Partner (the \"U.S. Restaurant Shares\"), respectively, as of February 29, 1996 by: (i) all persons who are beneficial owners of 5 percent or more of the Units or the U.S. Restaurant Shares, respectively, (ii) all directors and executive officers of the Managing General Partner, and (iii) all directors and executive officers of the Managing General Partner as a group. The Managing General Partner does not itself own any Units but does hold a partnership interest as a general partner and options to purchase 400,000 Units at $15.50 per Units. The disclosure that no person is the beneficial owner of 5 percent or more of the Units is based upon the Partnership not having received any Schedule 13D or 13G to the contrary on or before February 29, 1996. Unless stated otherwise, the persons named below possess sole voting and investment power with respect to the securities set forth opposite their names.\n_____________ * Less than one percent.\n(1) Does not include 4,375 Units held by Mr. Margolin's wife as trustee for their minor children. (2) Does not include 4,000 Units held by Mr. Rolph's wife as trustee for their minor children. (3) Does not include 1,000 Units held by Mr. Stetson as trustee for his minor child.\nThe address for Messrs. Margolin and Stetson is 5310 Harvest Hill Rd., Suite 270, LB 168, Dallas, Texas 75230. The address for Messrs. Darrel Rolph and David Rolph Sasnack Management, is 1877 N. Rock Rd., Wichita, Kansas 67206.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Managing General Partner, U.S. Restaurant Properties, Inc. (formerly QSV), is responsible for managing the business and affairs of the Partnership. The Partnership pays the Managing General Partner a non-accountable annual allowance (adjusted annually to reflect increases in the Consumer Price Index), plus reimbursement of out-of-pocket costs incurred to other parties for services rendered to the Partnerships. The allowance for the years ended December 31, 1995, 1994 and 1993 was $585,448, $542,508 and $528,000, respectively. For 1996, the allowance will be $600,081. For 1995, the one-time property acquisition fee equaled $109,238 which was capitalized and the annual allowance includes $29,375 of increased management fees due to acquisitions. The allowance is paid quarterly, in arrears. The Partnership's accounts payable balance includes $187,204 and $135,627 for this allowance as of December 31, 1995 and 1994, respectively. The Managing General Partner paid no out-of-pocket costs to other parties on behalf of the Partnership during 1995, 1994 and 1993.\nThe Managing General Partner has agreed to make available to the Partnership an unsecured, interest-free, revolving line of credit in the principal amount of $500,000 to provide the Partnership with the necessary working capital to minimize or avoid seasonal fluctuation in the amount of quarterly cash distributions. No loans were made by the Managing General Partner or were outstanding at any time during the years ended December 31, 1995, 1994 and 1993.\nOn March 17, 1995, the limited partners approved the grant to the Managing General Partner of options to purchase 400,000 Units. The exercise price is $15.50 per Unit which was the average closing market price on the New York Stock Exchange for the five trading days immediately following the date of grant.\nOn March 24, 1995, the Managing General Partner assigned its rights to purchase a property in Amarillo, Texas to the Partnership for no consideration.\nBurger King Corporation withdrew as a Special General Partner in November 1994. On January 20, 1995, the Partnership paid Burger King Corporation $16,000 for its interest in the operating and master limited partnerships.\nDuring 1995, the Partnership loaned $255,000 to Arkansas Restaurants #10 L.P. The balance is due September 1, 1996 and bears interest at nine percent per annum. The Managing General Partner owns a 90 percent interest in Arkansas Restaurants #10 L.P.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements.\nFor a list of the consolidated financial statements of the Registrant filed as part of this Annual Report on Form 10-K, see page, herein.\n(a)(2) Financial Statement Schedules.\nIII. Real Estate and Accumulated Depreciation.\n(a)(3) For a list of the Exhibits filed as part of this Annual Report on Form 10-K, see page E-1, herein.\n(b) Reports on Form 8-K.\nNone.\n(c) Exhibits.\nThe Exhibits filed as part of this Annual Report on Form 10-K are submitted as a separate section.\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.\nDate: March 29, 1996 U.S. RESTAURANT PROPERTIES MASTER L.P.\nBy: U.S. RESTAURANT PROPERTIES, INC., its Managing General Partner\nBy: s\/Robert J. Stetson ------------------- Robert J. Stetson 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 Managing General Partner of the Partnership and in the capacities and on the dates indicated:\nSIGNATURE TITLE DATE --------- ----- ----\ns\/Robert J. Stetson Director of U.S. Restaurant March 29, 1996 - ------------------- Properties, Inc. Robert J. Stetson\ns\/Fred H. Margolin Director of U.S. Restaurant March 29, 1996 - ------------------ Properties, Inc. Fred H. Margolin\ns\/Eugene G. Taper Director of U.S. Restaurant March 29, 1996 - ----------------- Properties, Inc. Eugene G. Taper\ns\/Gerald H. Graham Director of U.S. Restaurant March 29, 1996 - ------------------ Properties, Inc. Gerald H. Graham\ns\/Darrel Rolph Director of U.S. Restaurant March 29, 1996 - -------------- Properties, Inc. Darrel Rolph\ns\/David Rolph Director of U.S. Restaurant March 29, 1996 - ------------- Properties, Inc. David Rolph\nU.S. RESTAURANT PROPERTIES MASTER L.P.\nCONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 WITH INDEPENDENT AUDITORS' REPORT\nINDEPENDENT AUDITORS' REPORT\nThe Partners U.S. Restaurant Properties Master L.P.\nWe have audited the accompanying consolidated balance sheets of U.S. Restaurant Properties Master L.P. (the Partnership) as of December 31, 1995 and 1994, 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. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and financial statement schedule are the responsibility of the 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 consolidated financial statements present fairly, in all material respects, the consolidated financial position of U.S. Restaurant Properties Master L.P. 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\nDallas, Texas February 17, 1996\nU.S. RESTAURANT PROPERTIES MASTER L.P. CONSOLIDATED BALANCE SHEETS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nU.S. RESTAURANT PROPERTIES MASTER L.P. CONSOLIDATED STATEMENTS OF INCOME\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nU.S. RESTAURANT PROPERTIES MASTER L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nU.S. RESTAURANT PROPERTIES MASTER L.P. CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION\nU.S. Restaurant Properties Master L.P. (Partnership), formerly Burger King Investors Master L.P., a Delaware limited partnership, was formed on December 10, 1985. The Partnership, through its 99% limited partnership interest in U.S. Restaurant Properties Operating Limited Partnership (Operating Partnership), also a Delaware Limited Partnership, acquired from Burger King Corporation (BKC) in February 1986 an interest in 128 restaurant properties (Properties) owned or leased by BKC and leased or subleased on a net lease basis to BKC franchisees for $94,592,000. (The Partnership is the sole limited partner of the Operating Partnership, and they are referred to collectively as the \"Partnerships\".) U.S. Restaurant Properties, Inc., formerly QSV Properties, Inc., (QSV), the managing general partner and BKC, the special general partner, were both indirect wholly-owned subsidiaries of Grand Metropolitan PLC prior to May 17, 1994, at which time QSV was sold to the current owners. On January 20, 1995, the Partnership paid Burger King Corporation $16,000 for its 0.02% interest in the Operating and Master Limited Partnership.\nThe Partnership may issue an unlimited number of units. The units outstanding as of December 31, 1995 and 1994 totaled 4,659,167 and 4,635,000, respectively.\n2. ACCOUNTING POLICIES\nThe financial statements have been prepared in accordance with generally accepted accounting principles; however, this will not be the basis for reporting taxable income to unitholders (see Note 9 for a reconciliation of financial reporting income to taxable income). The financial statements reflect the consolidated accounts of the Partnerships after elimination of significant inter-partnership transactions.\nCash and equivalents include short-term, highly liquid investments with original maturities of three months or less.\nMarketable securities consist of U.S. treasury securities which have been treated as trading securities as of December 31, 1994. As a result, they are stated at market value.\nAn intangible asset was recorded for the excess of cost over the net investment in direct financing leases in 1986. This intangible asset represents the acquired value of future contingent rent receipts (based on a percentage of each restaurant's sales) and is being amortized on a straight-line basis over 40 years.\nAlso included in intangible assets is the amount paid to acquire certain leases with favorable rents payable to third party lessors. This amount is being amortized over the remaining lease terms.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. ACCOUNTING POLICIES (CONTINUED)\nDEPRECIATION\nDepreciation is computed using the straight-line method over estimated useful lives of 10 to 20 years for financial statement purposes. Accelerated and straight-line methods are used for tax purposes.\nUSE OF ESTIMATES\nThe preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, and revenues and expenses as of and for the reporting periods. Actual results may differ from such estimates.\nLONG-LIVED ASSETS\nIn March 1995, Statement of Financial Accounting Standard (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of\" was issued. The Partnerships adopted SFAS No. 121 in 1995. Long-lived assets include real estate, direct financing leases, and intangibles which are evaluated on an individual property basis. Based on the Partnership's policy for reviewing impairment of long-lived assets, there was no adjustment necessary to the accompanying consolidated financial statements.\nINCOME TAXES\nNo federal or, in most cases, state income taxes are reflected in the consolidated financial statements because the Partnerships are not taxable entities. The partners must report their allocable shares of taxable income or loss in their individual income tax returns.\nFAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS\nThe notes receivable and the line of credit are carried at amounts that approximate their fair value.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. ACCOUNTING POLICIES (CONTINUED)\nSTOCK-BASED COMPENSATION\nIn October 1995, Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" was issued, effective for calendar year 1996. This statement applies to transactions in which an entity issues its equity instruments to acquire goods or services from non-employees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The Partnership has not completed the process of evaluating the impact that will result from adopting such statement and therefore is unable to disclose the impact the adoption will have on its financial position and results of operations. Additionally, the effect of adopting the statement will depend on the calculated value of the units issued and the extent to which units are used in acquiring real estate properties in the future.\n3. OTHER BALANCE SHEET INFORMATION\nTotal purchase deposits of $1,791,682 included $1,075,000 of non-refundable deposits.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. PROPERTIES\nOn December 31, 1995, the Partnerships owned the land at 79 Properties and leased the land at 60 Properties from third party lessors under operating leases. The Partnerships in turn leased or subleased the land primarily to BKC franchisees under operating leases.\nOn December 31, 1995, the Partnerships owned the buildings on 124 Properties and leased the buildings on 14 Properties from third party lessors under leases accounted for as capital leases. The Partnerships own one property in which only the land is owned and leased. The Partnerships leased 28 owned buildings to franchisees under operating leases. These 28 buildings are stated at cost, net of accumulated depreciation, on the balance sheet. A total of 109 buildings are leased primarily to franchisees under direct financing leases. The net investment in the direct financing leases represents the present value of the future minimum lease receipts for these 109 buildings. One property is not currently leased.\nOn December 31, 1995, there were 138 Partnership restaurant sites in operation, and there was one closed site. The Partnerships continue to seek a suitable tenant for the remaining site. The write-down of the closed site was $11,061 and $73,739 in 1994 and 1993, respectively.\n5. GUARANTEED STOCK PRICE\nThree properties were acquired on October 10, 1995, with a combination of cash and 54,167 partnership units. The partnership units are guaranteed to have a value of $24 per unit three years from the transaction date. The unit price on the date issued was $18 3\/8. Any difference between the guaranteed value and the actual value of the units at the end of the three year period is to be paid in cash. These properties were recorded at the guaranteed value of the units discounted to reflect the present value on the date the units were issued.\n6. LINE OF CREDIT\nOn December 31, 1995, $10,930,647 had been drawn on the $20 million line of credit. All properties are included as collateral on this line of credit. The interest rate floats at 1.8 percentage points above LIBOR. The LIBOR rate at December 31, 1995, was 5.375%. The line of credit also requires the Partnerships to maintain a tangible net worth in excess of $40,500,000, a debt to tangible net worth ratio of not more than 0.5 to 1, and a cash flow coverage ratio of not less than 2 to 1 based upon a Proforma Five Year Bank Debt Amortization. The $20 million line of credit matures on June 27, 1998.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. INVESTMENTS AND COMMITMENTS AS LESSOR\nThe Partnerships lease land and buildings primarily to BKC franchisees. The building portions of most of the leases are direct financing leases while the land portions are operating leases. The leases generally provide for a term of 20 years from the opening of the related restaurant, and do not contain renewal options. The Partnerships, however, have agreed to renew a franchise lease if BKC renews or extends the lessee's franchise agreement. As of December 31, 1995, the remaining lease terms ranged from 1 to 28 years. The leases provide for minimum rents and contingent rents based on a percentage of each restaurant's sales, and require the franchisee to pay executory costs.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. INVESTMENTS AND COMMITMENTS AS LESSOR (CONTINUED)\nIf the restaurant properties are not adequately maintained during the term of the tenant leases, such properties may have to be rebuilt before the leases can be renewed, either by the Partnership as it considers necessary or pursuant to Burger King's successor policy. The successor policy, which is subject to change from time to time in Burger King's discretion, is intended to encourage the reconstruction, expansion, or other improvement of older Burger King restaurants and generally affects properties that are more than ten years old or are the subject of a franchise agreement that will expire within five years.\nUnder the current partnership agreement, Burger King can require that a restaurant property be rebuilt. If the tenant does not elect to undertake the rebuilding, the Partnership would be required to make the required improvement itself. However, as a condition to requiring the Partnership to rebuild, Burger King would be required to pay the Partnership its percentage share (\"Burger King's Percentage Share\") of the rebuilding costs. Such percentage share would be equal to (i) the average franchise royalty fee percentage rate payable to Burger King with respect to such restaurant, divided by (ii) the aggregate of such average franchise royalty fee percentage rate and the average percentage rate payable to the Partnership with respect to such restaurant property. The managing general partner believes that Burger King's Percentage Share would typically be 29% for a restaurant property.\nThe managing general partner believes it is unlikely that any material amount of rebuilding of Burger King restaurant properties will be required in the next several years, if ever.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. COMMITMENTS\nThe land at 46 Properties and the land and buildings at 14 Properties are leased by the Partnerships from third party lessors. The building portions of the leases are generally capital leases while the land portions are operating leases. Commitment leases provide for an original term of 20 years and most are renewable at the Partnership's option. As of December 31, 1995, the remaining lease terms (excluding renewal option terms) ranged from 1 to 11 years. If all renewal options are taken into account, the terms ranged from 8 to 33 years. Rents payable may escalate during the original lease and renewal terms. For six properties, the leases provide for contingent rent based on each restaurant's sales.\n(A) MINIMUM LEASE OBLIGATIONS HAVE NOT BEEN REDUCED BY MINIMUM SUBLEASE RENTALS.\nOn July 21, 1995, the managing general partner authorized the Partnership to repurchase up to 300,000 of its units in the open market. During 1995, 30,000 units were repurchased by the Partnership.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. RECONCILIATION OF FINANCIAL REPORTING INCOME TO TAXABLE INCOME\nFinancial reporting income differs from taxable income primarily because generally accepted accounting principles reflect the building portion of leases from Partnerships to franchisees as a net investment in direct financing leases. For tax purposes, these leases are treated as operating leases. In addition, differences exist in depreciation methods and asset lives.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n10. RELATED PARTY TRANSACTIONS\nThe managing general partner is responsible for managing the business and affairs of the Partnerships. The Partnerships pay the managing general partner a non-accountable annual allowance (adjusted annually to reflect increases in the Consumer Price Index), plus reimbursement of out-of-pocket costs incurred to other parties for services rendered to the Partnerships. The allowance for the years ended December 31, 1995, 1994, and 1993, was $585,445, $542,508, and $528,000, respectively. The Partnerships' accounts payable balance includes $187,204 and $135,627 for this allowance as of December 31, 1995 and 1994, respectively. The managing general partner paid no out-of-pocket costs to other parties on behalf of the Partnerships during 1995, 1994, and 1993.\nTo compensate the Managing General Partner for its efforts and increased internal expenses with respect to additional properties, the Partnership will pay the Managing General Partner, with respect to each additional property purchased: (i) a one-time acquisition fee equal to one percent of the purchase price for such property and (ii) an annual fee equal to one percent of the purchase price for such property, adjusted for increases in the Consumer Price Index. For 1995, the one-time acquisition fee equaled $109,238 which was capitalized, and the increase in the non-accountable annual fee equaled $29,375. In addition, if the Rate of Return (as defined) on the Partnership's equity in all additional properties exceeds 12 percent per annum for any fiscal year, the Managing General Partner will be paid an additional fee equal to 25 percent of the cash flow received with respect to such additional properties in excess of the cash flow representing a 12 percent Rate of Return thereon. However, to the extent such distributions are ultimately received by the Managing General Partner in excess of those provided by its 1.98 percent Partnership interest, they will reduce the fee payable with respect to such excess flow from any additional properties.\nIn 1994, the Partnerships with the consent and financial participation of BKC, continued rent relief for three properties.\nIn 1993, the Partnerships sold two non-operating properties at slightly less than their book values to BKC. At that time, BKC was the special general partner and had an ownership interest of 0.02% in the Partnerships.\nThe managing general partner has agreed to make available to the Partnership an unsecured, interest-free, revolving line of credit in the principal amount of $500,000 to provide the Partnerships with the necessary working capital to minimize or avoid seasonal fluctuation in the amount of quarterly cash distributions. No loans were made or were outstanding at any time during the years ended December 31, 1995, 1994, and 1993.\nA note receivable of $255,000 is due from Arkansas Restaurants #10 L.P. at December 31, 1995. The note receivable is due on September 1, 1996, and has an interest rate of 9.0% per annum.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAs of December 31, 1995, the managing general partner owned 90% of Arkansas Restaurants #10 L.P..\nOn March 17, 1995 the limited partners granted the managing general partner options to acquire up to 400,000 units, subject to certain adjustments under anti-dilution provisions. The initial exercise price of each option is $15.50 which is the average closing price of the depository receipts for the units on the New York Stock Exchange for the five trading days immediately after the date of grant. The options are non-transferable except by operation of law and vest and become exercisable on the first anniversary of the date as of which the exercise price is determined, subject to earlier vesting and exercisability if the managing general partner is removed as general partner. The term of the options expires on the tenth anniversary of the date as of which the exercise price is determined.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. DISTRIBUTIONS AND ALLOCATIONS\nUnder the amended partnership agreement, cash flow from operations of the Partnerships each year will be distributed 98.02% to the unitholders and 1.98% to the general partners until the unitholders have received a 12% simple (noncumulative) annual return for such year on the unrecovered capital per unit ($20.00, reduced by any prior distributions of net proceeds of capital transactions); then any cash flow for such year will be distributed 75.25% to the unitholders and 24.75% to the general partners until the unitholders have received a total simple (noncumulative) annual return for such year of 17.5% on the unrecovered capital per unit; and then any excess cash flow for such year will be distributed 60.40% to the unitholders and 39.60% to the general partners. The unitholders received 98.02% of all cash flow distributions for 1995 and 98% for 1994 and 1993.\nUnder the amended partnership agreement, net proceeds from capital transactions (for example, disposition of the Properties) will be distributed 98.02% to the unitholders and 1.98% to the general partners until the unitholders have received an amount equal to the unrecovered capital per unit plus 12.0% cumulative, simple return on the unrecovered capital per unit outstanding from time to time (to the extent not previously received from distribution of cash flow or proceeds of prior capital transactions); then such proceeds will be distributed 75.25% to the unitholders and 24.75% to the general partners until the unitholders have received the total cumulative, simple return of 17.5% on the unrecovered capital per unit; and then such proceeds will be distributed 60.40% to the unitholders and 39.60% to the general partners. There were no capital transactions in 1995 or 1994.\nDuring 1993 two non-operating properties were sold at slightly less than their book values. Both dispositions were capital transactions and resulted in the special distributions to unitholders of 11 cents and 13 cents per unit on September 13, and December 13, 1993, respectively.\nAll operating income and loss of the Partnership for each year generally will be allocated among the partners in the same aggregate ratio as cash flow is distributed for that year. Gain and loss from a capital transaction generally will be allocated among the partners in the same aggregate ratio as proceeds of the capital transactions are distributed except to the extent necessary to reflect capital account adjustments.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n12. SUMMARY BY QUARTER (UNAUDITED)\n* REPRESENTS AMOUNTS DECLARED AND PAID IN THE FOLLOWING QUARTER.\n** INCLUDES SPECIAL CASH DISTRIBUTIONS OF $0.11 FOR THE SECOND QUARTER AND $0.13 FOR THE THIRD QUARTER.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n13. PROFORMA (UNAUDITED)\nThe 1995 acquisitions consisted of 16 properties that were valued at $10,731,187 based upon the purchase method of accounting. These properties were acquired on various dates from March 1995 through December 1995. Three of the properties were acquired with a combination of cash and 54,167 partnership units. The 54,167 partnership units are guaranteed to have a market value of $24 three years from the transaction date and have certain registration rights.\nThe following proforma information was prepared by adjusting the actual consolidated results of the Partnership for the years ended December 31, 1995 and 1994 for the effects of the 1995 acquisitions as if all such acquisitions and related financing transactions including the issuance of 54,167 units had occurred on January 1, 1994. Interest expense for proforma purposes was calculated assuming a 7.7% interest rate for both years presented, which approximates the rate the Partnership paid during 1995.\nThese proforma operating results are not necessarily indicative of what the actual results of operations of the Partnership would have been assuming all of the properties were acquired as of January 1, 1994, and they do not purport to represent the results of operations for future periods.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n14. SUBSEQUENT EVENTS\nIn January 1996, 23 properties were purchased in six separate transactions. The total purchase price was $14 million which consisted of cash and 327,836 Partnership units. Among the properties acquired were 13 Burger Kings, 3 Dairy Queens, and 2 KFCs. Of the 327,836 units issued, 299,575 units have a guaranteed market price of $24 per unit within two years of the date issued, any difference being payable through issuance of additional partnership units. The units must be registered by the Partnership by January 1997, which will result in related registration costs. The remaining units have a guaranteed market price of $23 per unit within three years of the date issued, any difference being payable through issuance of additional partnership units. There is no registration requirement in respect to the latter units.\nOn February 15, 1996, the $20 million line of credit was increased to $40 million.\nU.S. RESTAURANT PROPERTIES MASTER L.P. FORM 10-K SUPPLEMENTAL SCHEDULE: REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nEXHIBIT INDEX\n2.1 Amended and Restated Purchase and Sale Agreement dated as of February 3, 1986. (Incorporated by reference to Exhibit 10(a) to Amendment No. 2 to the Registration Statement).\n3.1 The original Certificate of Limited Partnership of U.S. Restaurant Properties Master L.P. (Incorporated by reference to Exhibit 4.3 to the Registration Statement). Amendments filed on July 1, 1994, November 7, 1994 and November 30, 1994. (Incorporated by reference to Exhibit 3.1 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\n3.2 Second Amended and Restated Agreement of Limited Partnership of U.S. Restaurant Properties Master L.P. dated as of March 17, 1995. (Incorporated by reference to Exhibit 3.2 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\n3.3 Certificate of Limited Partnership of U.S. Restaurant Properties Operating L.P. (Incorporated by reference to Exhibit 4.4 to the Registrant Statement.) Amendments filed on July 26, 1994 and November 30, 1994. (Incorporated by reference to Exhibit 3.3 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\n3.4 Second Amended and Restated Agreement of Limited Partnership of U.S. Restaurant Properties Operating L.P. dated as of March 17, 1995. (Incorporated by reference to Exhibit 3.4 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\n4.1 Deposit Agreement and Form of Depositary Receipt and Application for Transfer of Depositary Units. (Incorporated by reference to Exhibit 4.5 to Amendment No. 3 to the Registration Statement.) First Amendment to Deposit Agreement. (Incorporated by reference to Exhibit (4)A to Registrant's 8-K Current Report dated September 30, 1987.)\n10.1 Amendment No. 91 - Burger King Corporation Withdrawal as Special General Partner and Name Change (Incorporated by reference to Exhibit 10.1 to the Registrant's 10-Q Report for the period ended September 30, 1994.)\n10.2 Consulting Agreement dated April 30, 1987. (Incorporated by reference to Exhibit 10.2 to the Registrant's 10-K Annual Report for the year ended December 31, 1987.)\n#10.3 Option Agreement, dated as of March 24, 1995, between U.S. Restaurant Properties Master L.P. and QSV Properties Inc. (Incorporated by reference to Exhibit 10.3 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\nE-1\n#10.4 Agreement between BKC and Robert J. Stetson regarding sale of QSV Properties Inc. (Incorporated by reference to Exhibit 10.1 to the Registrant's 10-Q Report for the period ended June 30, 1994.)\n10.5 Letter re change of Registrar and Stock Transfer Agent. (Incorporated by reference to Exhibit 10.2 to the Registrant's 10-Q Report for the period ended September 30, 1994.)\n*10.6 Amended and Restated Secured Loan Agreement dated as of February 15, 1996 between Registrant and various banks.\n12.1 Subsidiaries of the Registrant. (Incorporated by reference to Exhibit 22.1 to the Registrant's 10-K Annual Report for the year ended December 31, 1994.)\n27.1 Financial Data Schedule __________________ * Filed herewith. # Management compensatory document.\nE-2","section_15":""}
{"filename":"12355_1995.txt","cik":"12355","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS The Black & Decker Corporation (collectively with its subsidiaries, the Corporation), incorporated in Maryland in 1910, is a global marketer and manufacturer of quality products used in and around the home and for commercial applications. With products and services marketed in over 100 countries, the Corporation enjoys worldwide recognition of strong brand names and a superior reputation for quality, design, innovation, and value. The Corporation is the world's leading producer of power tools, power tool accessories and residential security hardware, and the Corporation's product lines hold leading market share positions in these industries. The household products business is the North American leader and is among the major global competitors in the small electric household appliance industry. The Corporation is the worldwide leader in the manufacturing of steel golf club shafts and glass container-making equipment and is the largest global supplier of engineered fastening systems to the markets it serves. These assertions are based on total volume of sales of products compared to the total market for those products and are supported by market research studies sponsored by the Corporation as well as independent industry statistics available through various trade organizations and periodicals, internally generated market data, and other sources. The Corporation's unsecured revolving credit facility (the Credit Facility) provides that the interest rate margin over the London Interbank Offered Rate (LIBOR) declines as the Corporation's leverage ratio improves. Borrowings under the Credit Facility were at LIBOR plus .4375% at December 31, 1994. Due to improvements in the Corporation's leverage ratio, the borrowing rate under the Credit Facility declined by .1125%, effective January 1, 1995, to LIBOR plus .325% and declined by .075%, effective January 1, 1996, to LIBOR plus .25%. The interest rate margin over LIBOR, which cannot exceed .4375%, is determined quarterly based upon the leverage ratio at that time. During 1994, the Corporation filed a shelf registration statement with the Securities and Exchange Commission to issue up to $500 million of debt securities, which may consist of debentures, notes or other unsecured evidences of indebtedness (the Medium Term Notes). During 1994, the Corporation issued $151.8 million aggregate principal amount of Medium Term Notes under this shelf registration statement. During 1995, the Corporation issued an additional $85.0 million aggregate principal amount of Medium Term Notes. For additional information about the shelf registration statement, see Note 9 of Notes to Consolidated Financial Statements, included in Item 8 of Part II of this report. During 1995, the Corporation sold PRC Realty Systems, Inc. (RSI) and PRC Environmental Management, Inc. (EMI) for aggregate proceeds of approximately $100 million. On December 13, 1995, the Corporation announced that it had signed a definitive agreement to sell PRC Inc., to Litton Industries, Inc., for approximately $425 million. Together, PRC Inc., RSI and EMI comprised the Corporation's information technology and services (PRC) segment. On February 16, 1996, the Corporation completed the sale of PRC Inc. For additional information about the discontinued PRC segment, see the discussion under the caption \"Discontinued Operations\" and Note 2 of Notes to Consolidated Financial Statements included in Item 8 of Part II of this report.\n(b) DISCONTINUED OPERATIONS On December 13, 1995, the Corporation announced that it had signed a definitive agreement to sell PRC Inc., the remaining business in its information technology and services (PRC)segment, for $425.0 million. The sale of PRC Inc. was completed on February 16, 1996. Proceeds from the sale were used to reduce debt. A net gain on the sale of PRC Inc. of approximately $80.0 to $90.0 million will be recognized in the first quarter of 1996. For additional information with respect to the pro forma effects of the consummation of the sale of PRC Inc. on the Corporation's financial position as of December 31, 1995, and the pro forma effects of the sales of PRC Inc., RSI, and EMI on the Corporation's earnings from continuing operations for the year then ended, see the unaudited pro forma financial information included in Item 14(d) of Part IV of this report. The Corporation acquired PRC through its acquisition of Emhart Corporation in April 1989. The sale of PRC will allow the Corporation to reduce its debt level and concentrate on its more strategic businesses. Operating results, net assets, and cash flows of the discontinued PRC segment have been reported separately from the continuing operations of the Corporation in the Consolidated Financial Statements included in Item 8 of Part II of this report. Net earnings of the discontinued PRC segment were $38.4 million ($.41 per share on a fully diluted basis) in 1995, $37.5 million ($.44 per share on a fully diluted basis) in 1994, and $31.1 million ($.37 per share on a fully diluted basis) in 1993 on revenues of $800.1 million, $883.1 million, and $760.7 million, respectively. The results of the discontinued PRC segment do not reflect any expense for interest allocated by or management fees charged by the Corporation.\n(c) FINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS\nUnless otherwise indicated, the following discussion of the Corporation's business segments pertains to the continuing operations of the Corporation and excludes any matters in respect of the discontinued PRC segment.\nThe Corporation operates in two business segments: Consumer and Home Improvement Products, including consumer and professional power tools and accessories, household products, security hardware, outdoor products (composed of electric lawn and garden tools and recreational products), plumbing products, and product service; and Commercial and Industrial Products, including fastening systems and glass container-making equipment. See Note 16 of Notes to Consolidated Financial Statements included in Item 8 of Part II, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of Part II of this report. Revenues from continuing operations by product group within business segments are presented in the following table.\nThere is no single class of product within the product groups listed in the above table that represents more than 10% of the Corporation's consolidated revenues from continuing operations.\n(d) NARRATIVE DESCRIPTION OF THE BUSINESS\nUnless otherwise indicated, the following discussion of the business of the Corporation pertains to the continuing operations of the Corporation and excludes any matters in respect of the discontinued PRC segment.\nThe following is a brief description of each of the business segments.\nCONSUMER AND HOME IMPROVEMENT PRODUCTS SEGMENT The Consumer and Home Improvement Products segment is composed of consumer (home use) and professional power tools and accessories, household products, security hardware, outdoor products (composed of electric lawn and garden tools and recreational products), plumbing products, and product service. Power tools include both corded and cordless electric portable power tools, such as drills, screwdrivers, saws, sanders, grinders, car care products, Workmate workcenters and related products, and bench and stationary tools. Accessories include accessories and attachments for power tools, and a variety of consumer-use fastening products, including gluing, stapling and riveting products. Household products include a variety of both corded and cordless small electric household appliances, including hand-held vacuums; irons; lighting products; food mixers, processors and choppers; can openers; blenders; coffee makers; kettles; toasters and toaster ovens; wafflebakers; knives; breadmakers; and fans. Security hardware includes both residential and commercial door hardware, including locksets, high security and electronic locks and locking devices, deadbolts, door closers, hinges and exit devices, and master keying systems. Outdoor products include a variety of both corded and cordless electric lawn and garden tools, such as hedge and yard trimmers, lawn mowers and edgers, blower\/vacuums, shredders, grass shears, lawnrakers, and related accessories. Outdoor products also include recreational products, which include a variety of steel and composite golf club shafts and specialty tubing. Plumbing products include a variety of conventional and decorative faucets, shower valves, and bath accessories. Power tools, household products, electric lawn and garden tools, and related accessories are marketed around the world under the Black & Decker name as well as other trademarks and trade names, including DeWALT, Black & Decker Industry & Construction, Elu, Proline, Macho, TimberWolf, Cyclone, Trimcat, Kodiak, Scrugun, Wildcat, Guaranteed Tough, Versa-Clutch, VersaPak, Workmate, ShopBox, Alligator, Air Station, Dustbuster, SnakeLight, Toast-R-Oven, Handy Steamer, HandyChopper, Light 'N Easy, Groom 'N' Edge, Hedge Hog, Vac 'N' Mulch, Reflex, B&D, Piranha, Piranha Pro, Bullet, Pilot-Point, Scorpion Anti-Slip, Master Series, PowerShot, and POP. Security hardware products are marketed under a variety of trademarks and trade names, including Black & Decker, Geo, Kwikset, TITAN, TITAN Commercial Series, Lane, NEMEF, DOM, and Corbin Co. Recreational products are marketed under the trademarks and trade names True Temper, Dynamic, Dynamic Gold, Dynalite, EI-70, Comet, Rocket, True Lite, SensiCore, TT Lite, Release, and others. Plumbing products are marketed under the trademarks and trade names Price Pfister, The Pfabulous Pfaucet With The Pfunny Name, Genesis, Society Brass Collection, Verve, Windsor, Georgetown, Jet Setter, Society Finishes, and others. The Corporation's product service program supports its power tools, electric lawn and garden products, and household products businesses. Replacement parts and product repair services are available through a network of company-operated service centers, which are identified and listed in product information material generally included in product packaging. At December 31, 1995, there were over 200 such service centers, of which approximately one-half were located in the United States. The remainder were located around the world, primarily in Europe, Mexico, Australia, Canada, and Latin America. These company-operated service centers are supplemented by several hundred authorized service centers operated by independent local owners. The Corporation also operates a reconditioning center in which power tools and household appliances are reconditioned and then re-sold through numerous company-operated factory outlets and service centers. Most of the Corporation's consumer products sold in the United States carry a two-year warranty, pursuant to which the consumer can return defective products during the two years following the purchase in exchange for a replacement product or repair at no cost to the consumer. Consumer products sold outside the United States generally have similar warranty arrangements. Such arrangements vary, however, depending upon local market conditions and laws and regulations. The Corporation's product offerings in the Consumer and Home Improvement Products segment are sold primarily to retailers, wholesalers, distributors, and jobbers, although some reconditioned power tools and household products are sold through company-operated service centers and factory outlets directly to end users. Certain security hardware products are sold to commercial, institutional, and industrial customers. The principal materials used in the manufacturing of products in the Consumer and Home Improvement Products segment are plastics, aluminum, copper, steel, bronze, zinc, brass, certain electronic components, and batteries. These materials are used in various forms. For example, aluminum or steel may be used in wire, sheet, bar, and strip stock form. The materials used in the various manufacturing processes are purchased on the open market, and the majority are available through multiple sources and are in adequate supply. The Corporation has experienced no significant work stoppages to date as a result of shortages of materials. The Corporation has certain long-term commitments for the purchase of various component parts and raw materials and believes that it is unlikely that any of these agreements would be terminated prematurely. Alternate sources of supply at competitive prices are available for most, if not all, materials for which long-term commitments exist. The Corporation believes that the termination of any of these commitments would not have a material adverse effect on operations. From time to time, the Corporation enters into commodity hedges on certain raw materials used in the manufacturing process to reduce the risk of market price fluctuations. As of December 31, 1995, the amount of product under commodity hedges was not material to the Corporation. As a global marketer and manufacturer, the Corporation purchases materials and supplies from suppliers in many different countries around the world. Certain of the finished products and component parts are purchased from suppliers that have manufacturing operations in mainland China. China has been granted Most Favored Nation (MFN) status through July 3, 1996, and currently there are no significant trade restrictions or tariffs imposed on such products. The Corporation has investigated alternate sources of supply in case the MFN status is not extended. Alternative sources of supply are available, or can be developed, for many of these products. The Corporation believes that, although there could be some disruption in the supply of certain of these finished products and component parts if China's MFN status is not extended or if significant trade restrictions or tariffs are imposed, the impact would not have a material adverse effect on the operating results of the Corporation. Principal manufacturing and assembly facilities in the United States are located in Fayetteville and Asheboro, North Carolina; Easton and Hampstead, Maryland; Anaheim and Pacoima, California; Denison, Texas; Amory and Olive Branch, Mississippi; and Bristow, Oklahoma. Principal facilities outside the United States are located in Buchlberg and Bruhl, Germany; Molteno and Perugia, Italy; Spennymoor, Meadowfield, and Rotherham, England; Brockville, Canada; Queretaro, Mexico; Jurong Town, Singapore; Kuantan, Malaysia; Newcastle, Australia; and Apeldoorn, Netherlands. For additional information with respect to these and other properties owned or leased by the Corporation, see Item 2, \"Properties.\" As previously announced, during 1995, the Corporation closed its manufacturing facilities located in Tarboro, North Carolina, and Delemont, Switzerland, and transferred production from those locations to other manufacturing facilities of the Corporation. The Corporation ceased manufactuing at its facility in Santo Andre, Brazil, late in 1995 and will begin to manufacture at a new owned facility in Uberaba, Brazil, in early 1996. Administrative offices remain at the Santo Andre site. These plant actions are part of the Corporation's continuing effort to identify opportunities to improve its manufacturing cost structure. The Corporation holds various patents and licenses on many of its products and processes in the Consumer and Home Improvement Products segment. Although these patents and licenses are important, the Corporation is not materially dependent on such patents or licenses with respect to its operations. The Corporation holds various trademarks that are employed in its businesses and operates under various trade names, some of which are stated above. The Corporation believes that these trademarks and trade names are important to the marketing and distribution of its products. A significant portion of the Corporation's revenues in the Consumer and Home Improvement Products segment is derived from the do-it-yourself and home modernization markets, which generally are not seasonal in nature. However, sales of household products and certain consumer power tools tend to be higher during the period immediately preceding the Christmas gift-giving season, while the sales of most electric lawn and garden tools are at their peak during the winter and early spring period. Most of the Corporation's other product lines within this segment are not generally seasonal in nature but may be influenced by trends in the residential and commercial construction markets and other general economic trends. The Corporation is one of the world's leaders in the manufacturing and marketing of portable power tools, small electric household appliances, electric lawn and garden tools, security hardware, plumbing products, and accessories. Worldwide, the markets in which the Corporation sells these products are highly competitive on the basis of price, quality, and after-sale service. A number of competing domestic and foreign companies are strong, well-established manufacturers that compete on a global basis. Some of these companies manufacture products that are competitive with a number of the Corporation's product lines. Other competitors restrict their operations to fewer categories, and some offer only a narrow range of competitive products. Competition from certain of these manufacturers has been intense in recent years and is expected to continue.\nCOMMERCIAL AND INDUSTRIAL PRODUCTS SEGMENT The Corporation's fastening systems business manufactures an extensive line of metal and plastic fasteners and engineered fastening systems for commercial applications, including blind riveting and stud welding systems, specialty screws, prevailing torque nuts and assemblies, and insert systems. The fastening systems products are marketed under the trademarks and trade names Emhart Fastening Teknologies, POP, HeliCoil, Parker-Kalon, Gripco, Warren, Tucker, NPR, Dodge, POP NUT, WELL-NUT, and others. The principal markets for these products include the automotive, transportation, construction, electronics, aerospace, machine tool, and appliance industries. Substantial sales are made to automotive manufacturers worldwide. Some of these products also are sold through the Corporation's Consumer and Home Improvement Products segment. Products are marketed directly to customers and also through distributors and representatives. These products face competition from many manufacturers in several countries. Product quality, performance, reliability, price, delivery, and technical and application engineering services are the primary competitive factors. Except for sales to automotive manufacturers, which historically schedule plant shutdowns during July and August of each year, there is little seasonal variation. The Corporation owns a number of United States and foreign patents, trademarks, and license rights relating to the fastening systems business. While the Corporation considers those patents, trademarks, and license rights to be valuable, the Corporation is not materially dependent upon such patents or license rights with respect to its operations. Principal manufacturing facilities for the fastening systems business in the United States are located in Danbury and Shelton, Connecticut; South Whitley and Montpelier, Indiana; Campbellsville and Hopkinsville, Kentucky; and Mt. Clemens, Michigan. Principal facilities outside the United States are located in Birmingham, England; Giessen, Germany; and Toyohashi, Japan. For additional information with respect to these and other properties owned or leased by the Corporation, see Item 2, \"Properties.\" The raw materials used in the fastening systems business consist primarily of ferrous and nonferrous metals in the form of wire, bar stock, strip and sheet metals, and chemical compounds, plastics, and rubber. These materials are readily available from a number of suppliers. The Corporation manufactures a variety of automatic, high-speed machines for the glass container-making industry, including machines for supplying molten glass for the forming process and electronic inspection equipment for monitoring quality levels. These machines are used in producing bottles, jars, tumblers, and other glass containers primarily for food, beverage, pharmaceutical, and household products packaging. The Corporation also provides replacement parts and a variety of engineering, repairing, rebuilding, and other services to the glass container-making industry throughout the world, and these activities generate nearly two-thirds of the sales in this business. These products and services are marketed principally under the trademarks and trade names Emhart, Emhart Glass, Powers, FlexLine, T-600 Forming Control System, Verti-Flow Cooling System, and Total Inspection Machine. The Corporation sells glass container-making machinery and replacement parts primarily through its own sales force directly to glass container manufacturers throughout the world. The business is not dependent on one or a few customers, the loss of which would have a material adverse effect on operating results of the business. Some domestic manufacturers and a number of foreign manufacturers compete with the Corporation in the manufacture and sale of various types of glass container-making equipment. However, the Corporation believes that it is the leading supplier and offers the most complete line of glass container-making and inspection machinery, parts, and service. In recent years, the glass container-making equipment business has experienced the effects of increased competition with packaging applications of plastic and other non-glass containers. Important competitive factors are price, technological and machine performance features, product reliability, and technical and application engineering services. There is little seasonal variation in this business. The Corporation owns a number of United States and foreign patents, trademarks, and license rights relating to the glass container-making business. While the Corporation considers those patents, trademarks, and license rights to be valuable, this business is not materially dependent upon such patents or license rights with respect to its operations. The principal glass container-making machinery manufacturing facility in the United States is located in Windsor, Connecticut. Principal manufacturing facilities outside the United States are located in Oerebro and Sundsvall, Sweden. For additional information with respect to these and other properties owned or leased by the Corporation, see Item 2, \"Properties.\" The principal raw materials required for the glass container-making equipment business are steel, iron, copper and copper-based materials, aluminum and refractory materials, and electronic components. Manufactured parts are purchased from a number of suppliers. All such materials and components are generally available in adequate quantities. During 1992, the Corporation commenced a restructuring plan which included the reorganization of Dynapert, the Corporation's printed circuit board assembly equipment business. The business was divided into the through-hole and surface-mount machinery product lines. This restructuring plan included the withdrawal from the manufacturing of surface-mount machinery in Europe which was completed in 1993. The Corporation sold the remaining through-hole business in 1993 and the remaining surface-mount business in 1995.\nNone of the backlog at December 31, 1995, or at December 31, 1994, included unfunded amounts.\nOTHER INFORMATION The Corporation's product development program in the United States for the Consumer and Home Improvement Products segment is coordinated from the Corporation's headquarters in Towson, Maryland, for power tools and accessories; from Shelton, Connecticut, for household products; from Anaheim, California, for residential security hardware; and from Pacoima, California, for plumbing products. Outside the United States, product development activities for power tools and accessories and household products are coordinated from Slough, England, and are carried on at facilities in Spennymoor, England; Brockville, Canada; Civate, Italy; Idstein, Germany; and Croydon, Australia. Product development activities for the Commercial and Industrial Products segment are currently carried on at various product or business group headquarters or at principal manufacturing locations as previously noted. Costs associated with development of new products and changes to existing products are charged to operations as incurred. See Note 1 of Notes to Consolidated Financial Statements included in Item 8 of Part II of this report for amounts of expenditures for product development activities. As of December 31, 1995, the Corporation employed approximately 29,300 persons in its continuing operations worldwide (approximately 34,200 persons, including the employees of its discontinued PRC segment). Approximately 2,100 employees in the United States are covered by collective bargaining agreements. During 1995, several collective bargaining agreements in the United States were negotiated without material disruption to operations. A number of other agreements are scheduled for negotiation during 1996. Also, the Corporation has government-mandated collective bargaining arrangements or union contracts with employees in other countries. The Corporation's operations have not been affected significantly by work stoppages and, in the opinion of management, employee relations are good. The Corporation's operations worldwide are subject to certain foreign, federal, state and local environmental laws and regulations. In recent years, many state and local governments have enacted laws and regulations that govern the labeling and packaging of products and limit the sale of products containing certain materials deemed to be environmentally sensitive. These laws and regulations not only limit the acceptable methods for disposal of products and components that contain certain substances, but also require that products be designed in a manner to permit easy recycling or proper disposal of environmentally sensitive components such as nickel cadmium batteries. The Corporation is in substantial compliance with these laws and regulations. Although compliance involves continuing costs, it has not materially increased capital expenditures and has not had a material adverse effect on the Corporation. Pursuant to authority granted under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), the United States Environmental Protection Agency (EPA) has issued a National Priority List (NPL) of sites at which action is to be taken by the EPA or state authorities to mitigate the risk of release of hazardous substances into the environment. The Corporation is engaged in continuing activities with regard to various sites on the NPL and other sites covered under CERCLA. As of December 31, 1995, the Corporation had been identified as a potentially responsible party (PRP) in connection with approximately 27 sites being investigated by federal or state agencies under CERCLA. The Corporation also is engaged in site investigations and remedial activities to address environmental contamination from past operations at current and former manufacturing facilities in the United States and abroad. To minimize the Corporation's potential liability, when appropriate, management has undertaken, among other things, active participation in steering committees established at the sites and has agreed to remediation through consent orders with the appropriate government agencies. Due to uncertainty over the Corporation's involvement in some of the sites, uncertainty over the remedial measures to be adopted at various sites and facilities, and the fact that imposition of joint and several liability with the right of contribution is possible under CERCLA, the liability of the Corporation with respect to any site at which remedial measures have not been completed cannot be established with certainty. On the basis of periodic reviews conducted with respect to these sites, however, appropriate liability accruals have been established by the Corporation. As of December 31, 1995, the Corporation's aggregate probable exposure with respect of environmental liabilities, for which accruals have been established in the Consolidated Financial Statements, was $61.0 million. With respect to environmental liabilities, unless otherwise noted below, the Corporation does not believe that its liability with respect to any individual site will exceed $10.0 million. Pursuant to the terms of the Corporation's agreement to sell the Bostik chemical adhesives business to Orkem S.A., the Corporation agreed to indemnify Orkem against costs incurred or claims made with respect to environmental matters at Bostik facilities within four years from the date of sale to the extent that the aggregate costs and claims exceeded $5.0 million; provided, however, that the Corporation's total liability to Orkem for all environmental matters with respect to Bostik facilities shall not exceed $10.0 million. By letter dated November 22, 1993, Orkem's successor in interest (\"Total, S.A.\") notified the Corporation that within the four-year period following the closing it had incurred costs of approximately $5.4 million and demanded payment of the amount in excess of $5.0 million. Total, S.A. also demanded indemnification for a number of environmental conditions identified in its letter, the cost of which it estimated would exceed the $10.0 million limitation of the Corporation's indemnification obligation. The Corporation and Total, S.A. continue to review the indemnification claims and, as of December 31, 1995, the Corporation had paid $2,225,670 of the claims. Emhart previously received a notice of responsibility from the Massachusetts Department of Environmental Protection for the 90-acre site of the former United Shoe Machinery business at Beverly, Massachusetts. The site has been classified a non-priority site, with a waiver of approvals allowed. An investigation of contamination has been completed, and a remediation plan has been proposed (estimated at $1.0 million) under the Massachusetts Contingency Plan. In or about 1985, as a consequence of investigations stemming from an underground storage tank leak from a nearby gas station, the Corporation discovered certain groundwater contamination at its facility located in Hampstead, Maryland. Upon discovery of the groundwater contamination, the Corporation, in cooperation with the Department of the Environment of the State of Maryland (MDE), embarked on a program to remediate groundwater contamination, including installation of an air stripping system designed to remove contaminants from groundwater. The Corporation, in cooperation with MDE, conducted extensive investigations as to potential sources of the groundwater contamination. Following submission of the results of its investigations to MDE, the Corporation proposed to expand its groundwater remediation system and also proposed to excavate and remediate soils in the vicinity of the plant that appear to be a source area for certain contamination. The Corporation has received all permits necessary to operate its expanded groundwater treatment facility at the Hampstead facility, and the system is fully operational. In October 1994, suit was filed in the United States District Court for the District of Maryland against the Corporation by the owners of a farm that is adjacent to the Hampstead facility (Leister et al. v. The Black & Decker Corporation (Civil Action No. JFM 94-2809)). Plaintiffs claim that contamination, allegedly emanating from the facility, has migrated in groundwater and has adversely affected plaintiffs' property. Plaintiffs have alleged various claims for relief, including causes of action under the Federal Resource Conservation and Recovery Act, CERCLA, and the Clean Water Act, as well as various state tort claims, including claims for negligence, nuisance, intentional misrepresentation, and negligent misrepresentation. Plaintiffs seek various forms of relief, including compensatory damages of $20.0 million and punitive damages of $100.0 million. The Corporation filed various motions to, among other things, dismiss plaintiffs' claims, and the Court granted the Corporation's motion to dismiss all but one claim. Following that ruling, both the Corporation and plaintiffs filed motions for summary judgment on the remaining claim. The Corporation believes that plaintiffs' claims are without merit and intends to defend vigorously against the allegations made in this matter. Management is of the opinion that the ultimate resolution of this matter will not have a material adverse effect on the Corporation. In October 1992, the Corporation's Price Pfister subsidiary received a 60-day notice of intent to file suit under California's Proposition 65 from the Natural Resources Defense Council (NRDC) and the Environmental Law Foundation (ELF), alleging improper warnings and discharge of lead into drinking water in California. On December 15, 1992, Price Pfister and numerous other plumbing manufacturers were sued by the State of California in the Superior Court for the City and County of San Francisco. On the same day, a separate suit was filed by the NRDC and the ELF. The suits filed by the State of California and the NRDC and the ELF included substantially the same allegations, namely that lead leaches from brass faucets into tap water in violation of California's lead discharge prohibitions of Proposition 65, that the manufacture and sale of brass faucets exposes individuals to lead without a proper \"clear and reasonable warning,\" and that such violations of Proposition 65 also constitute unfair business practices under California law. The NRDC and the ELF suit also alleged breach of warranty and breach of contract claims against Price Pfister and the other plumbing manufacturers. The State of California and the NRDC and the ELF generally sought the following relief: (a) elimination of lead from brass faucets; (b) improved public disclosure programs regarding lead in brass faucets; (c) commencement of a public information campaign regarding alleged health risks arising from lead exposure; (d) restitution to purchasers of faucets; (e) statutory penalties and punitive damages in unstated amounts; and (f) attorneys' fees and other costs. Subsequent to the filing of their complaints, plaintiffs filed a motion for a preliminary injunction seeking to require Price Pfister and certain other defendants to provide specific warning language in a particular manner with faucets at the time of sale. Plaintiff's motion for a preliminary injunction was denied, and the trial court accepted defendants' proposed warning system. Defendants filed demurrers to the State of California's claim that brass faucets result in a \"prohibited discharge\" of lead into drinking water under California law and to the standing of the NRDC and the ELF to bring their claims. In May 1994, Judge Bea of the California Superior Court for the City and County of San Francisco issued an order rejecting the Attorney General's claims that lead which leaches from faucets constitutes a prohibited discharge of lead into water or onto or into land where lead will pass or is at least likely to pass into a source of drinking water. Judge Bea's order granted the Attorney General 20 days to amend his complaint to state a cause of action under Proposition 65. In the companion case involving similar claims by the NRDC and the ELF, Judge Cahill of the California Superior Court for the City and County of San Francisco denied defendants' challenges to the standing of the NRDC and the ELF to bring these claims and refused to stay the proceedings pending resolution of the claims by the Attorney General. Subsequent to Judge Bea's order rejecting the Attorney General's claims and granting the Attorney General 20 days to amend his complaint to state a cause of action under Proposition 65, the Attorney General filed an appeal of Judge Bea's order. Prior to a final ruling on the appeal in the case involving the Attorney General's claims, the Corporation entered into a settlement pursuant to which the Corporation agreed to take certain actions with respect to the future sale of its products in California and agreed to the payment of specified amounts to the State of California and the attorneys for the NRDC and the ELF. In 1988, J.C. Rhodes, a former subsidiary of Emhart Industries, Inc., was notified by both the EPA and the State of Massachusetts that it was considered a PRP with regard to the Sullivan's Ledge site in New Bedford, Massachusetts. Emhart and 11 other companies formed a PRP group to respond to the EPA's and Massachusetts' demands, and, in September 1990, executed a Consent Order to perform the remedial action recommended by the EPA in its Record of Decision. The remedial action is now underway. A second area of the Sullivan's Ledge site, known as Middle Marsh, was investigated by the EPA, and a Record of Decision was issued in September 1991. In September 1992, Emhart, 11 other companies, and the City of New Bedford, Massachusetts, executed a Consent Order to perform the remediation required in the Middle Marsh section of the site. At this time, Emhart's estimated liability for remediation cost at the Sullivan's Ledge site is estimated at $2.0 million. The Corporation has been investigating certain environmental matters at its NEMEF security hardware facility in the Netherlands. The NEMEF facility has been a manufacturing operation since 1921. During building construction in 1990, soil and groundwater contamination was discovered on the property. Investigations to understand the full extent of the contamination were undertaken at that time, and those investigations are continuing. The Corporation is continuing to work with consultants and local authorities to develop a comprehensive remediation plan in conjunction with neighboring property owners. In the opinion of management, the costs of compliance with respect to the matters set forth above and other remedial costs have been adequately accrued, and the ultimate resolution of these matters will not have a material adverse effect on the Corporation. The ongoing costs of compliance with existing environmental laws and regulations have not had, nor are they expected to have, a material adverse effect upon the Corporation's capital expenditures or financial position.\n(e) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS Reference is made to Note 16 of Notes to Consolidated Financial Statements, entitled \"Business Segment and Geographic Areas,\" included in Item 8 of Part II and to the section entitled \"Business Segments\" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of Part II of this report.\n(f) EXECUTIVE OFFICERS AND OTHER SENIOR OFFICERS OF THE CORPORATION The current Executive Officers and Other Senior Officers of the Corporation, their ages, current offices or positions, and their business experience during the past five years is set forth below.\nNolan D. Archibald - 52 Chairman, President, and Chief Executive Officer, January 1990 - present; President and Chief Executive Officer, May 1989 - January 1990.\nRaymond A. DeVita - 59 Executive Vice President and President - Commercial and Industrial Group, May 1989 - present.\nDennis G. Heiner - 52 Executive Vice President and President - Security Hardware Group, January 1992 - present; Executive Vice President and President - Household Products Group, May 1989 - January 1992.\nDon R. Graber - 52 Group Vice President and President - Household Products, July 1994 - present; Group Vice President and President - International, March 1993 - July 1994; Vice President and President - International, February 1992 - March 1993; President - Black & Decker Canada, September 1988 - February 1992.\nRoger H. Thomas - 53 Group Vice President and Chairman - Eastern Hemisphere, October 1995 - present; Group Vice President and President - Eastern Hemisphere, April 1994 - October 1995; Group Vice President and President - Europe, May 1989 - April 1994.\nCharles E. Fenton - 47 Vice President and General Counsel, May 1989 - present.\nJoseph Galli - 37 Group Vice President and President - Power Tools, October 1995 - present; Vice President and President - North American Power Tools, October 1993 - October 1995; President - U.S. Power Tools, February 1993 - October 1993; Vice President Sales and Marketing - U.S. Power Tools, May 1991 - February 1993; Vice President Marketing - U.S. Power Tools, August 1990 - May 1991.\nKathleen W. Hyle - 37 Vice President and Treasurer, May 1994 - present; Assistant Treasurer, Domestic, December 1992 - May 1994; Director, Domestic Finance, February 1990 - December 1992.\nBarbara B. Lucas - 50 Vice President - Public Affairs and Corporate Secretary, July 1985 - present.\nThomas M. Schoewe - 43 Vice President and Chief Financial Officer, October 1993 - present; Vice President - Finance, January 1990 - October 1993.\nSteven E. Simms - 39 Group Vice President and President - Accessories, October 1995 - present; President - North American Accessories, April 1993 - October 1995; Vice President - European Marketing and Product Planning, September 1990 - April 1993.\nLeonard A. Strom - 50 Vice President - Human Resources, May 1986 - present.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUnless otherwise indicated, the following discussion of the Corporation's properties pertains to the continuing operations of the Corporation and excludes any matters in respect of the discontinued PRC segment.\nThe Corporation and its subsidiaries operate 47 manufacturing facilities around the world, including 22 located outside the United States in 13 foreign countries. The major properties associated with each business segment are listed in Narrative Description of the Business in Item 1(d) of Part I of this report. The Corporation owns most of its facilities with the exception of the following major leased facilities. In the United States: Mt. Clemens, Michigan; Amory, Mississippi; Shelton, Connecticut; and Towson, Maryland. Outside the United States: Rotherham, England, and Kuantan, Malaysia. During 1993, the Corporation recorded a charge of $29 million for the closure and reorganization of certain manufacturing sites. These plant actions were substantially completed during 1994. During 1995, the Corporation closed its manufacturing facilities in Tarboro, North Carolina, and Delemont, Switzerland, and transferred production from those locations to other manufacturing facilities of the Corporation. The Corporation ceased manufacturing at its facility in Santo Andre, Brazil late in 1995 and will begin to manufacture at a new owned facility in Uberaba, Brazil, in early 1996. These plant actions are part of the Corporation's continuing effort to identify opportunities to improve its manufacturing cost structure. Additional property both owned and leased by the Corporation in Towson, Maryland, is used for administrative offices. Subsidiaries of the Corporation lease certain locations primarily for smaller manufacturing and\/or assembly operations, service operations, sales and administrative offices, and for warehousing and distribution centers. The Corporation also owns a manufacturing plant which is located on leased land in Jurong Town, Singapore. The Corporation's average utilization rate for its manufacturing facilities for 1995 was in the range of 75% to 85%. The Corporation continues to evaluate its worldwide manufacturing cost structure to identify opportunities to improve capacity utilization and will take appropriate action as deemed necessary. Management believes that its owned and leased facilities are suitable and adequate to meet the Corporation's anticipated needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Corporation is involved in various lawsuits in the ordinary course of business. These lawsuits primarily involve claims for damages arising out of the use of the Corporation's products and allegations of patent and trademark infringement. The Corporation also is involved in litigation and administrative proceedings involving employment matters and commercial disputes. Some of these lawsuits include claims for punitive as well as compensatory damages. The Corporation, using current product sales data and historical trends, actuarially calculates the estimate of its exposure for product liability. The Corporation is insured for product liability claims for amounts in excess of established deductibles and accrues for the estimated liability as described above up to the limits of the deductibles. As previously noted under Item 1 of Part I of this report, the Corporation also is party to litigation and administrative proceedings with respect to claims involving the discharge of hazardous substances into the environment. Certain of these matters assert damages and liability for remedial investigations and clean-up costs with respect to sites at which the Corporation has been identified as a PRP under federal and state environmental laws and regulations. Other matters involve sites that the Corporation owns and operates or previously sold. On or about March 31, 1989, a purported class action complaint, titled Cooperman et al. v. The Black & Decker Corporation et al., No. 89 Civ 2177 (the Cooperman Complaint), was filed in the United States District Court for the Southern District of New York alleging that the Corporation's settlement agreement with Topper Acquisition Corp. and Topper L.P., bidders for Emhart Corporation, and the payments by the Corporation thereunder violated the federal securities laws, particularly sections 10(b) and 14(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations, including rules 10b-13 and 14d-10, thereunder. Plaintiffs initially sought injunctive relief prohibiting the Corporation from consummating its tender offer for Emhart and now seek rescissory damages as well as costs, disbursements, and reasonable attorneys' and other fees. The Corporation's request for leave to move for summary judgment was denied by the District Court, and the District Court issued an order directing that discovery be completed by June 1, 1991, and providing that the Corporation might again apply for leave to move for summary judgment on or before June 15, 1991. The parties subsequently have entered into a number of stipulations and orders amending the date for the completion of discovery and the date before which the Corporation may again apply for leave to move for summary judgment. The Corporation believes the claims made in the Cooperman Complaint are without merit and intends to defend vigorously against the allegations made in this matter. In the opinion of management, the ultimate resolution of the Cooperman Complaint will not have a material adverse effect on the Corporation. In March 1990, the Corporation's former PRC subsidiary was served by the Inspector General of the United States Department of Defense with a subpoena for documents from the period 1986 to 1990 in connection with a criminal investigation of bid and proposal cost charging practices of certain divisions of PRC. Since that date, PRC has been served with two additional Inspector General subpoenas for marketing and proposal-related documents. During 1992, PRC and some former employees also received grand jury subpoenas issued by the United States District Court for the Eastern District of Virginia. During 1993, PRC received an additional subpoena from the grand jury directing PRC to provide information concerning the procurement and government property management functions of certain divisions of PRC. In January 1996, the United States Attorney advised PRC that the criminal investigation has concluded without further action and the matter is being transferred to the Civil Division of the Department of Justice. In connection with the Corporation's sale of PRC to Litton Industries, Inc., the Corporation agreed to indemnify Litton for various liabilities, including liabilities relating to the matters subject to the foregoing subpoenas. The Corporation cannot predict the eventual outcome of these investigations, but, based on currently available information, management believes that the investigations will not have a material adverse effect on the Corporation. On June 1, 1994, Masco Corporation of Indiana (\"Masco\") filed suit against the Corporation's Price Pfister subsidiary in the United States District Court for the Eastern District of Virginia (Civ. No. 94-728A). Masco alleged that Price Pfister's manufacture, use and sale of its Genesis Model 42 Series of lavatory faucets infringed and induced infringement of Masco's U.S. Design Patent No. 323,877, was unfair competition under federal and Virginia law, and infringed the trade dress rights associated with lavatory faucets of Delta Faucet Company, a division of Masco. Masco sought an injunction, profits, damages (trebled), costs and attorneys' fees. Price Pfister filed a counterclaim for infringement by Masco of Price Pfister's rights in U.S. Design Patent Nos. 329,911, 328,335, and 327,732, for unfair competition and patent misuse under common statutory law, for abuse of process, and for trademark infringement under Price Pfister's U.S. Trademark Registration No. 1,808,996 and trademark registrations of several states. Masco counterclaimed for cancellation of U.S. Trademark Registration No. 1,808,996 and also instituted a separate Cancellation Proceeding in the U.S. Patent and Trademark Office. Following the filing by Masco and Price Pfister of a number of motions, trial on the claims and counterclaims in this matter was held in November 1994. The trial resulted in a verdict in favor of Masco on Masco's design patent infringement claim with damages being awarded against Price Pfister in the amount of $1,374,596.35, plus interest, and Price Pfister being enjoined from continued infringement of Masco's rights. All other claims and counterclaims were dismissed. Price Pfister filed an appeal of this decision, but on appeal the decision of the trial court was upheld. Price Pfister has paid the judgment in this matter. In the opinion of management, amounts accrued for awards or assessments in connection with the matters specified above and in Item 1 of Part I of this report with respect to environmental matters and other litigation and administrative proceedings to which the Corporation is a party are adequate and, accordingly, ultimate resolution of these matters will not have a material adverse effect on the Corporation. As of December 31, 1995, the Corporation had no known probable but inestimable exposures for awards and assessments in connection with the matters specified above and in Item 1 of Part I of this report with respect to environmental matters and other litigation and administrative proceedings that could have a material effect on the Corporation.\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 STOCK AND RELATED SECURITY HOLDER MATTERS\n(a) MARKET INFORMATION The Corporation's Common Stock is listed on the New York Stock Exchange and the Pacific Stock Exchange and also is traded on the London, Frankfurt, and Swiss exchanges. The following table sets forth, for the periods indicated, the high and low sales prices of the Common Stock as reported in the consolidated reporting system for the New York Stock Exchange Composite Transactions:\n(b) HOLDERS OF THE CORPORATION'S CAPITAL STOCK As of February 20, 1996, there were 18,811 holders of record of the Corporation's Common Stock. As of February 20, 1996, there was one holder of record of the Corporation's Series B Cumulative Convertible Preferred Stock (the Series B Preferred Stock).\n(c) DIVIDENDS The Corporation has paid consecutive quarterly dividends on its Common Stock since 1937. Future dividends necessarily will depend upon the Corporation's earnings, financial condition, and other factors, and the payment of dividends on the outstanding shares of Series B Preferred Stock. The Credit Facility does not restrict the Corporation's ability to pay regular dividends in the ordinary course of business on the Common Stock or the Series B Preferred Stock. In the event that dividends on the Series B Preferred Stock are in arrears, thereafter and until all accrued but unpaid dividends on the shares of Series B Preferred Stock shall have been paid in full, the Corporation may not declare or pay dividends on, make any other distributions on, or redeem or purchase or otherwise acquire for consideration, any shares of Common Stock.\nQuarterly dividends per common share for the most recent two years are as follows:\nIn February 1996, the Board of Directors approved a 20% increase in the quarterly cash dividend per common share, from $.10 to $.12 per share, beginning in March 1996. During each of the quarters in 1995 and 1994, the Corporation declared a dividend of approximately $2.9 million on its shares of Series B Preferred Stock. During the most recent two years, no other dividends were declared or paid in respect of shares of preferred stock of the Corporation.\nCommon Stock: 150,000,000 authorized, $.50 par value; 86,447,588 shares and 84,688,803 shares outstanding as of December 31, 1995 and 1994, respectively.\nPreferred Stock: 5,000,000 authorized, without par value; 150,000 shares of Series B Cumulative Convertible Preferred Stock outstanding as of December 31, 1995 and 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(a) Earnings from continuing operations for 1995 include a $65.0 million reduction in income tax expense as a result of the reversal of a portion of the Corporation's deferred tax asset valuation allowance. In 1995, the Corporation recognized a $30.9 million extraordinary loss from extinguishment of debt, net of income tax benefit of $2.6 million. (b) Effective January 1, 1993, the Corporation changed its method of accounting for postemployment benefits. In addition, earnings from continuing operations for 1993 include a restructuring credit of $6.3 million before tax ($.2 million after tax). (c) Effective January 1, 1992, the Corporation changed its methods of accounting for income taxes and postretirement benefits other than pensions. In 1992, the Corporation recognized a $22.7 million extraordinary loss from extinguishment of debt. In addition, earnings from continuing operations for 1992 included a restructuring charge of $142.4 million before tax ($134.7 million after tax). (d) Earnings from discontinued operations represent the earnings, net of applicable income taxes, of the Corporation's discontinued PRC segment. The earnings of the discontinued PRC segment do not reflect any charge for interest allocated to that segment by the Corporation. For additional information about the discontinued PRC segment, see the discussion under the caption \"Discontinued Operations\" included in Item 1 of Part I of this report and Note 2 of Notes to Consolidated Financial Statements included in Item 8 of Part II of this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW The Corporation reported net earnings of $224.0 million or $2.37 per share on a fully diluted basis for the year ended December 31, 1995, compared to net earnings of $127.4 million or $1.37 per share on a fully diluted basis in 1994. Excluding the effects of a $65.0 million decrease in income tax expense as a result of the Corporation's reduction in its deferred tax asset valuation allowance in 1995, earnings from continuing operations increased from $89.9 million ($.93 per share on a fully diluted basis) in 1994 to $151.5 million ($1.60 per share on a fully diluted basis) in 1995. This improvement in earnings from continuing operations in 1995 over 1994 was a function of strong operating results, a lower effective tax rate, and lower interest expense. No interest expense was allocated by the Corporation to its discontinued operations. On December 13, 1995, the Corporation announced that it had reached a definitive agreement to sell PRC Inc., the remaining business in its information technology and services segment. The sale of PRC Inc. is expected to be completed in the first quarter of 1996. During 1995, the Corporation generated free cash flow (cash available for debt reduction prior to the effects of cash proceeds received from sales of businesses, equity offerings, and sales of receivables) of $34.7 million compared to free cash flow of $116.1 million in 1994. The decrease in free cash flow in 1995 from the 1994 level was primarily the result of higher working capital levels and capital expenditures in 1995 than in 1994 when the Corporation experienced particularly strong free cash flow from the initial effects of more stringent working capital management. The combination of strong operating results and the proceeds received from sales of portions of the discontinued information technology and services segment in 1995 enabled the Corporation to reduce its ratio of debt to total capitalization from 67% at December 31, 1994, to 62% at December 31, 1995.\nDISCONTINUED OPERATIONS On December 13, 1995, the Corporation announced that it had signed a definitive agreement to sell PRC Inc., the remaining business in its information technology and services segment, for $425.0 million. The sale is expected to be completed in the first quarter of 1996. A net gain on the sale of PRC Inc., estimated at $80.0 to $90.0 million, will be recognized upon completion of the sale. Proceeds from the sale of PRC Inc. will be used to reduce debt. The Corporation sold PRC Realty Systems, Inc. (RSI) and PRC Environmental Management, Inc. (EMI) earlier in 1995 for aggregate proceeds of approximately $100 million. Together, PRC Inc., RSI, and EMI comprised the Corporation's information technology and services (PRC) segment. The Corporation acquired PRC through its acquisition of Emhart Corporation in April 1989. The sale of PRC will allow the Corporation to reduce its debt level and concentrate on its more strategic businesses. Operating results, net assets, and cash flows of the discontinued PRC operations have been segregated in the accompanying Consolidated Financial Statements. Net earnings of the discontinued PRC segment were $38.4 million ($.41 per share on a fully diluted basis) in 1995, $37.5 million ($.44 per share on a fully diluted basis) in 1994, and $31.1 million ($.37 per share on a fully diluted basis) in 1993 on revenues of $800.1 million, $883.1 million and $760.7 million, respectively.\nCONTINUING OPERATIONS\nREVENUES The following chart sets forth an analysis of the consolidated changes in revenues for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nANALYSIS OF CHANGES IN REVENUES OF CONTINUING OPERATIONS For the Year Ended December 31, (Dollars in Millions) 1995 1994 1993 ------- ------- ------- Total revenues ........................... $ 4,766 $ 4,365 $ 4,122 Unit volume - existing (1) ............... 6% 8% 5% - disposed (2) ............... --% (3)% --% Price .................................... 1% 1% 1% Currency ................................. 2% --% (4)% ------- ------- ------- Change in total revenues ................. 9% 6% 2% ======= ======= ======= In the above chart and throughout the remainder of this discussion, the following definitions apply:\n(1) Existing - Reflects the change in unit volume for businesses where period-to-period comparability exists. (2) Disposed - Reflects the change in total revenues from continuing operations for businesses that were included in prior year results, but subsequently have been sold.\nTotal revenues for the year ended December 31, 1995, were $4.8 billion, which represents a 9% increase over 1994 revenues of $4.4 billion. Despite an increasingly difficult retail environment throughout 1995, the Corporation achieved 6% growth in existing unit volume in 1995 over the level experienced in 1994. The 1995 growth in unit volume was experienced both in the Consumer and Home Improvement Products (Consumer) segment and in the Commercial and Industrial Products (Commercial) segment. Total revenues for the year ended December 31, 1994, were $4.4 billion, which represented a 6% increase over 1993 revenues of $4.1 billion. During 1994, existing unit volume grew by 8% compared to 5% growth in 1993, due primarily to revenue growth in the Consumer segment.\nEARNINGS Operating income from continuing operations as a percentage of revenues was 8.9% for 1995 compared to 8.1% and 7.3% for 1994 and 1993, respectively. Gross margin as a percentage of revenues in 1995 was 36.7% compared to 36.6% for 1994 and 35.5% for 1993. Gross margin in 1995 was slightly higher than the prior year level. The impact of increased manufacturing productivity and cost reduction initiatives during 1995, however, was substantially offset by rising commodity costs and by reduced gross margin in the European operations. Gross margin in 1995 was adversely affected by a softening European retail environment in the fourth quarter of 1995 and by residual inefficiencies in European operations associated with the closure of two manufacturing facilities since mid 1994. The improvement in gross margin during 1994 over the 1993 level stemmed from improvements in the Consumer segment, which resulted primarily from increased manufacturing productivity, the implementation of cost reduction initiatives, and the realization of the leverage effects of higher sales volume on fixed and semi-fixed costs. Marketing and administrative expenses as a percentage of revenues were 27.8% for 1995 compared to 28.5% for 1994 and 28.2% for 1993. The improvement in 1995 compared to 1994 was the result of cost reduction initiatives and the leverage of fixed and semi-fixed costs over a higher sales base. Marketing and administrative expenses as a percentage of revenues increased by .3% from 28.2% for 1993 to 28.5% for 1994 as a result of higher promotion costs in 1994, partially offset by the effects on 1994 results of cost reduction initiatives and the leverage of fixed and semi-fixed costs over a higher sales base. Net interest expense (interest expense less interest income) was $184.4 million in 1995 compared to $187.9 million in 1994 and $171.8 million in 1993. Net interest expense for 1995 was below the 1994 level as a result of reduced borrowing levels during the year, partially offset by higher interest rates on variable rate debt. Higher interest rates during 1994, partially offset by reduced borrowing levels in that year, caused an increase in net interest expense in 1994 over the 1993 level. Other expense for 1995, 1994, and 1993 primarily included costs associated with the sale of receivables programs. As more fully described in Note 12 of Notes to Consolidated Financial Statements, a full valuation allowance was provided on net deferred tax assets in the United States at December 31, 1994, based on the Corporation's history of taxable earnings (losses) over the past several years and the volatility of comprehensive taxable earnings (losses) in the United States due to foreign exchange contracts. In addition, a full valuation allowance on net tax assets in certain foreign taxing jurisdictions was provided at December 31, 1994, based on the history of taxable earnings (losses), the tax carryforward periods, and projected earnings. During 1995, the Corporation reversed a portion of the deferred tax asset valuation allowance based on its projection of future taxable earnings in the United States, including the impact of the pending sale of PRC Inc. The effect of this reduction in the deferred tax asset valuation allowance was to decrease 1995 income tax expense by $65.0 million. An analysis of taxes on earnings is included in Note 12 of Notes to Consolidated Financial Statements. Excluding the effects of the $65.0 million income tax benefit that resulted from the reduction of its deferred tax asset valuation allowance in 1995, the Corporation's reported tax rate on continuing operations was 33% in 1995 compared to a rate of 40% in 1994 and 48% in 1993. Contributing to the lower tax rate for 1995 compared to 1994 and 1993 were higher taxable earnings in the United States and a change in mix of operating income outside the United States from those subsidiaries in higher rate tax jurisdictions to subsidiaries in lower rate tax jurisdictions or subsidiaries that profit from the utilization of net operating loss carryforwards.\nBUSINESS SEGMENTS The Corporation operates in two business segments: Consumer and Home Improvement Products, including consumer and professional power tools and accessories, household products, security hardware, outdoor products (composed of electric lawn and garden tools and recreational products), plumbing products, and product service; and Commercial and Industrial Products, including fastening systems and glass container-making equipment.\nREVENUES AND OPERATING INCOME BY BUSINESS SEGMENT For the Year Ended December 31, (Millions of Dollars) 1995 1994 1993 ------ ------ ------ Consumer and Home Improvement Products Total revenues ...................................... $4,076 $3,774 $3,530 Operating income .................................... 348 294 216 Operating income excluding restructuring costs or credits and goodwill amortization ....... 400 351 281 Commercial and Industrial Products Total revenues ...................................... 690 591 592 Operating income .................................... 75 53 77 Operating income excluding restructuring costs or credits and goodwill amortization ....... 92 69 73 Corporate and Eliminations Operating income .................................... 3 5 10 ------ ------ ------ Total revenues ...................................... $4,766 $4,365 $4,122 Total operating income .............................. $ 426 $ 352 $ 303 Total operating income excluding restruc- turing credits and goodwill amortization ......... $ 495 $ 425 $ 364 ------ ------ ------\nCONSUMER AND HOME IMPROVEMENT PRODUCTS The following chart sets forth an analysis of the change in revenues for the year ended December 31, 1995, compared to the year ended December 31, 1994, by geographic area within the Consumer segment. United Total States Europe Other Consumer Existing unit volume .......... 7% 4% 4% 5% Price ......................... --% --% 4% 1% Currency ...................... --% 9% (5)% 2% ----- ----- ----- ----- Total Consumer ................ 7% 13% 3% 8% ===== ===== ===== =====\nTotal revenues in the Consumer segment for 1995 were 8% higher than in 1994, with existing unit volume up 5% over the 1994 level. Unit volume in the United States increased by 7% in 1995 over the 1994 level as a result of strong unit volume growth in the power tools and accessories and household products businesses, partially offset by unit volume declines in the security hardware and plumbing products businesses. The 1995 domestic growth in the power tools and accessories business was the result of continued strong demand for DeWALT professional power tools and accessories and the successful expansion in the latter half of 1995 of a line of consumer products that use the VersaPak interchangeable battery system. During 1995, the household products business achieved a double-digit rate of growth in unit volume driven by the continued success of the SnakeLight flexible flashlight, which was introduced late in 1994. The domestic security hardware and plumbing products businesses each experienced modest unit volume declines from 1994 levels during 1995. The decrease in unit volume of the security hardware business was due to inventory reductions made by its customers in the latter part of 1995. While the plumbing products business experienced unit volume growth in the second half of 1995 over the corresponding period in 1994, that growth was not sufficient to cover revenue shortfalls experienced in the first half of 1995 as a result of poor weather conditions in the western United States and the resulting soft demand in professional distribution channels. Excluding the substantial positive effects of changes in foreign exchange rates, revenues in the Corporation's Consumer businesses in Europe increased by 4% in 1995 over the 1994 level despite a weak fourth quarter in 1995. This 4% increase was composed of increased sales of power tools and accessories, household products, and security hardware, offset by decreased sales of outdoor products. The growth in power tools and accessories revenues during 1995 over the prior year level was attributable to strong sales of professional products, partially offset by sales declines in consumer power tools and accessories. The increased household products revenues in 1995 over the 1994 level was due primarily to the introduction of the SnakeLight flexible flashlight in Europe late in 1995. An extremely dry winter and late spring resulted in decreased revenues for outdoor products in 1995 compared to 1994. Exclusive of positive effects of changes in foreign exchange rates during 1995, some European countries achieved results substantially higher than the prior year level, and other countries, most notably, Germany, the United Kingdom, and France, reported results essentially equal to or below the prior year level. Excluding the negative effects of changes in foreign exchange rates principally due to the Mexican peso devaluation, revenues in the Corporation's Consumer businesses in other geographic regions increased by 8% in 1995 over the 1994 level. Revenue growth occurred in a number of countries, including Canada and, most strongly, Brazil, while revenues in other countries were essentially equal to or below the prior year level. Operating income as a percentage of revenues for the Consumer segment was 8.6% in 1995 compared to 7.8% in 1994. Excluding the effect of goodwill amortization, operating income as a percentage of revenues would have been 9.8% in 1995 compared to 9.3% in 1994. The household products business achieved strong improvement in operating income in 1995 as a result of increased sales volume, higher manufacturing productivity, and actions taken by the business to either improve profitability or drop certain lower margin products from its product lines. Improved operating income levels in 1995 over 1994 in the worldwide power tools and accessories business resulted principally from substantial improvements in the domestic power tools and accessories business as a result of increased sales volume, higher manufacturing productivity, and the impact of cost reduction initiatives, partially offset by reduced profitability in the European operations. A softening retail environment in the fourth quarter of 1995, expenses incurred in connection with the reorganization of certain European operations, and residual inefficiencies associated with the closure of two manufacturing facilities since mid 1994 contributed to markedly lower profitability in the Corporation's Consumer businesses in Europe in 1995 than in 1994. Cost reduction initiatives and manufacturing productivity improvements resulted in increased operating income as a percentage of revenues during 1995 compared to 1994 in the security hardware business, despite year-to-year sales declines in its domestic operations. A decline in operating income in the plumbing products business in 1995 compared to 1994 resulted from reduced sales and rising material costs. Total revenues in the Consumer segment for 1994 were 7% higher than in 1993. Existing unit volume increased by 8% for 1994 over the 1993 level. Unit volume in the United States for 1994 rose by 8% over the 1993 level. The domestic unit volume increase resulted from double-digit rates of growth in the power tools and accessories, security hardware, and plumbing products businesses. This growth primarily stemmed from the continued strong demand for the DeWALT professional power tools and accessories line, expanded distribution of TITAN locksets, and the introduction of the Genesis series of single-control faucets. Despite strong demand experienced late in 1994 when the SnakeLight flexible flashlight and a new line of under-the-cabinet kitchen appliances were introduced in the United States, unit volume in the household products business was down slightly in 1994 compared to the prior year level. The Corporation's consumer power tools business in Europe achieved moderate unit volume growth in 1994 over the 1993 level. All major European power tool markets achieved unit volume increases in 1994, except the United Kingdom and Germany, where unit volumes were essentially flat compared to the prior year levels. Unit volume in the European security hardware business was also essentially flat compared to the prior year. Unit volume in the Far East and in a number of consumer businesses in Latin America, including those in Brazil and Mexico, increased substantially in 1994 over the 1993 level. Operating income as a percentage of total revenues for the Consumer segment was 7.8% for 1994 compared to 6.1% for 1993. Excluding the effects of goodwill amortization and, for 1993, restructuring charges of $13.1 million, operating income as a percentage of total revenues for the Consumer segment would have been 9.3% for 1994 compared to 8.0% for 1993. The improvement in operating income levels in 1994 over 1993 in the worldwide power tools and accessories business as well as in the domestic security hardware and plumbing products businesses was primarily the result of increased manufacturing productivity, the implementation of cost reduction initiatives, and the effect of leveraging fixed and semi-fixed costs over a higher sales base. Partially offsetting this improvement was a decline in the operating income level in 1994 over 1993 for the household products business. This decline was primarily the result of increased promotion spending and administrative expenses in 1994, which were not offset by revenue increases. In addition, operating income improved during 1994 for the golf club shafts business over the low level experienced in 1993 due to shifting consumer preferences to graphite golf club shafts from steel golf club shafts.\nCOMMERCIAL AND INDUSTRIAL PRODUCTS The following chart sets forth an analysis of the change in revenues for the year ended December 31, 1995, compared to the year ended December 31, 1994, by geographic area within the Commercial segment. United Total States Europe Other Commercial Existing unit volume ............. (2)% 24% 7% 10% Price ............................ 1% 1% --% 1% Currency ......................... --% 13% 7% 6% ----- ----- ----- ----- Total Commercial ................. (1)% 38% 14% 17% ===== ===== ===== =====\nTotal revenues in the Commercial segment for 1995 were 17% higher than the 1994 level. Excluding the substantial positive effects of changes in foreign exchange rates, revenues in the Commercial segment were 11% higher in 1995 than in the preceding year. The fastening systems (Fastening) business achieved solid unit volume growth in 1995 over the prior year level, as softening industrial sales in the United States and Europe were more than offset by increased automotive sales in those regions. The glass container-making equipment (Glass) business experienced a double-digit rate of growth in unit volume in 1995 compared to a weak 1994 despite declines in volumes in the United States. The backlog of orders in the Glass business at December 31, 1995, was slightly above the 1994 level, reflecting strong order levels experienced during 1995. Operating income as a percentage of revenues for the Commercial segment was 10.8% in 1995 compared to 8.9% in 1994. Excluding the effects of goodwill amortization, operating income as a percentage of revenues would have been 13.3% in 1995 compared to 11.6% in 1994. The Fastening and Glass businesses each experienced improvements in operating income percentages. Total revenues in the Commercial segment for 1994 were essentially flat compared to those of the prior year. An increase of 4% in existing unit volume, coupled with the positive effects of pricing and changes in foreign exchange rates, were offset by the effects of the sale of the remaining Dynapert business late in 1993. A double-digit rate of increase in unit volume in the Fastening business was partially offset by a volume decline in the Glass business. Fastening business sales improved during 1994 in the United States and Europe, primarily as a result of the strengthening of the automotive industry. Sales in the Glass business were weak throughout all geographic areas during 1994. Operating income as a percentage of total revenues for the Commercial segment for 1994 was 8.9% compared to 12.9% for 1993. Excluding the effects of goodwill amortization and, for 1993, restructuring credits of $19.4 million relating to the gain on the sale of Dynapert's through-hole business, operating income as a percentage of total revenues for the Commercial segment would have been 11.6% for 1994 compared to 12.4% for 1993. Operating income improved in the Fastening business in 1994 as a result of increased sales and cost reduction initiatives, but was offset by an operating income decline in the Glass business due to revenue shortfalls.\nFINANCIAL CONDITION Operating activities of continuing operations before the sale of receivables generated cash of $316.9 million for the year ended December 31, 1995, compared to $304.4 million for the year ended December 31, 1994. This increase in cash generation during 1995 was primarily the result of increased profitability, partially offset by increased working capital levels. The major cause of the working capital increase at December 31, 1995, over the prior year level was an increase in inventories. Despite a weakening retail environment, the Corporation achieved sales growth of 6%, excluding the positive effects of changes in foreign exchange rates, in the fourth quarter of 1995 over the corresponding period in 1994. That growth, however, was below the Corporation's expectations, and inventory levels at year end were higher than planned. While a portion of the inventory increase is required to support new product initiatives and manufacturing rationalizations that are underway and should further improve manufacturing productivity, the Corporation will actively seek to reduce inventory levels in 1996. In addition to measuring its cash flow generation and usage based upon the operating, investing, and financing classifications included in the Consolidated Statement of Cash Flows, the Corporation monitors its free cash flow, a measure commonly employed by bond rating agencies and banks. The Corporation defines free cash flow as cash available for debt reduction (including short-term borrowings), prior to the effects of cash proceeds received from sales of divested businesses, equity offerings, and sales of receivables. Free cash flow, a more inclusive measure of cash flow generation than cash flows from operating activities included in the Consolidated Statement of Cash Flows, considers items such as cash used for capital expenditures and dividends, as well as net cash inflows or outflows from hedging activities. During the year ended December 31, 1995, the Corporation generated free cash flow of $34.7 million compared to $116.1 million of free cash flow generated in 1994. The decrease in free cash flow in 1995 from the 1994 level was primarily the result of higher working capital levels and capital expenditures in 1995 than in 1994 when the Corporation experienced particularly strong free cash flow from the initial effects of more stringent working capital management. The Corporation expects to reduce debt by approximately $400.0 million in the first quarter of 1996 upon receipt of the proceeds from the sale of PRC Inc. Had the sale of PRC Inc. closed prior to December 31, 1995 and a net gain of $80.0 million been recognized upon the sale, the Corporation's ratio of debt to total capitalization would have decreased from 62.3% at December 31, 1995, to approximately 57%. The total amount of receivables sold under the Corporation's sale of receivables program at December 31, 1995, was $230.0 million compared to $244.0 million at December 31, 1994. The sale of receivables program provides for a seasonal expansion of the amount of receivables that may be sold, from $200.0 million to $275.0 million during the period from October 1 through January 31. The Corporation's liquidity facility, which supports the sale of receivables program, expires in May 1996. The Corporation expects to be able to extend this facility beyond December 1996. Excluding amounts related to discontinued operations, investing activities for 1995 used cash of $195.5 million compared to $205.0 million of cash used in 1994. Capital expenditures of $203.1 million during 1995 exceeded the 1994 level of $181.5 million. During 1995, approximately 91% of the capital expenditures were in the Consumer segment, primarily in support of new product initiatives and productivity enhancements. The Corporation expects capital spending in 1996 to approximate the 1995 level. The Corporation actively seeks to identify opportunities to improve its cost structure. These opportunities may involve the closure of manufacturing facilities or the reorganization of other operations. The ongoing costs of compliance with existing environmental laws and regulations have not had, nor are they expected to have, a material adverse effect on the Corporation's capital expenditures or financial position. The Corporation has a number of manufacturing sites throughout the world and sells its products in over 100 countries. As a result, the Corporation is exposed to movements in the exchange rates of various currencies against the United States dollar. The major foreign currencies in which the Corporation has foreign currency risk are the pound sterling, deutsche mark, Dutch guilder, Canadian dollar, Swedish krona, Japanese yen, French franc, Italian lira, Australian dollar, Mexican peso, and Brazilian real. Assets and liabilities of the Corporation's subsidiaries located outside the United States are translated at rates of exchange at the balance sheet date, as more fully explained in Note 1 of Notes to Consolidated Financial Statements. The resulting translation adjustments are included in equity adjustment from translation, a separate component of stockholders' equity. During 1995, translation adjustments, recorded in the equity adjustment from translation component of stockholders' equity, increased stockholders' equity by $44.9 million compared to an increase of $98.7 million in 1994. As more fully explained in Note 10 of Notes to Consolidated Financial Statements, the Corporation historically has hedged a portion of its net investment in foreign subsidiaries. During 1995, the Corporation decided to limit the future hedging of its net investment in foreign subsidiaries. This action may increase the volatility of reported equity in the future, but will result in more predictable cash flows from hedging activities. During 1994, the Corporation elected to hedge a portion, generally limited to tangible net worth, of its foreign subsidiaries. Prior to 1994, the Corporation operated under a full hedge policy, hedging the net assets, including goodwill, of its foreign subsidiaries. In hedging the exposure to foreign currency fluctuations on its net investments in subsidiaries located outside the United States, the Corporation has entered into various currency forward contracts and options. These hedging activities generate cash inflows and outflows that offset the translation adjustment. During 1995, these activities netted to a cash outflow of $4.7 million compared to a cash outflow of $35.5 million in 1994. The corresponding gains and losses on these hedging activities were recorded in the equity adjustment from translation component of stockholders' equity. Also included in the equity adjustment from translation component were the costs of maintaining the hedge portfolio of foreign exchange contracts. These hedge costs decreased stockholders' equity by $8.7 million and $33.0 million in 1995 and 1994, respectively. As more fully described in Note 10 of Notes to Consolidated Financial Statements, the Corporation seeks to minimize through its foreign currency hedging activities the risk that its United States dollar cash flows resulting from product sales outside the United States will be affected by changes in exchange rates. Foreign currency commitment and transaction exposures generally are an integral part of the responsibility of management of the Corporation's individual operating units. These management responses to foreign exchange movements vary. For example, pricing actions, changes in cost structures, and changes in hedging strategies may all be effective responses to a change in exchange rates. In late 1994, the Mexican peso was severely devalued. Because the Corporation's Mexican peso exposure was hedged, this devaluation did not have a significant effect on earnings in 1994. While the currency situation in Mexico had an adverse effect on Mexican revenues in 1995, the effect on operating income was substantially offset by pricing actions and changes in cost structures and by the lower relative costs of Mexican production during 1995. Financing activities for 1995 used cash of $127.0 million compared to $210.9 million of cash used in 1994. During 1995, the Corporation recognized a $30.9 million extraordinary loss, $26.5 million of which was a non-cash charge, as a result of the early redemption of its Emhart subsidiary's 9.25% sinking fund debentures in the aggregate principal amount of $150.0 million. This extraordinary loss consisted of the write-off of the associated debt discount, plus premiums and costs associated with the redemption, net of related income tax benefits. As more fully explained in Note 10 of Notes to Consolidated Financial Statements, the Corporation seeks to issue debt opportunistically, whether at fixed or variable rates, at the lowest possible costs. Based upon its assessment of the future interest rate environment and its desired variable rate debt to total debt ratio, the Corporation may later convert such debt from fixed to variable or from variable to fixed interest rates, or from United States dollar-based rates to rates based upon another currency, through the use of interest rate swap agreements. In addition, the Corporation may enter into interest rate cap agreements in order to limit the effects of increasing interest rates on a portion of its variable rate debt. In order to meet its goal of fixing or limiting interest costs, the Corporation maintains a portfolio of interest rate hedge instruments. These interest rate hedges could change the mix of fixed and variable rate debt as actual interest rates move outside the ranges covered by these instruments. The Corporation's variable rate debt to total debt ratio, after taking interest rate hedges into account, was 43% at December 31, 1995, compared to 34% at December 31, 1994, and 46% at December 31, 1993. At December 31, 1995, average debt maturity was 4.0 years compared to 4.9 years at December 31, 1994, and 4.8 years at December 31, 1993. The Corporation's unsecured revolving credit facility (the Credit Facility) includes certain covenants that require the Corporation to meet specified minimum cash flow coverage and maximum leverage (debt to equity) ratios during the term of the loan, as more fully explained in Note 9 of Notes to Consolidated Financial Statements. The Corporation's leverage ratio during the life of the Credit Facility may not exceed 2.2 at the end of any fiscal quarter. The cash flow coverage ratio calculated as of the end of each fiscal quarter must be greater than 2.5 for any 12-month period. At December 31, 1995, the Corporation was well within the limits specified for the leverage and cash flow coverage ratios and was in compliance with all other covenants and provisions of the Credit Facility. The Corporation began the process of negotiating a replacement to the Credit Facility during the first quarter of 1996. The replacement facility is not expected to contain terms more stringent than those set forth in the Credit Facility and is expected to expire in the year 2001. The Corporation expects to continue to meet the covenants imposed by the Credit Facility (or any replacement facility) over the next 12 months. The Corporation will continue to have cash requirements to support seasonal working capital needs and capital expenditures, to pay interest, and to service debt. In order to meet these cash requirements, the Corporation intends to use internally generated funds and to borrow under the Credit Facility or under short-term borrowing facilities. Management believes that cash generated from these sources will be adequate to meet the Corporation's cash requirements over the next 12 months.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the Corporation and its subsidiaries are included herein as indicated below:\nConsolidated Financial Statements Consolidated Statement of Earnings - years ended December 31, 1995, 1994, and 1993\nConsolidated Balance Sheet - December 31, 1995 and 1994\nConsolidated Statement of Cash Flows - years ended December 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Auditors\nSee Notes to Consolidated Financial Statements\nSee Notes to Consolidated Financial Statements\nSee Notes to Consolidated Financial Statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Black & Decker Corporation and Subsidiaries\nNOTE 1: SUMMARY OF ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION: The Consolidated Financial Statements include the accounts of the Corporation and its subsidiaries. Intercompany transactions have been eliminated. RECLASSIFICATIONS: The accompanying Consolidated Financial Statements for 1994 and 1993 have been reclassified to identify separately the results of operations, net assets, and cash flows of the Corporation's discontinued information technology and services segment (see Note 2). In addition, certain prior year's amounts in the Consolidated Financial Statements have been reclassified to conform to the presentation used in 1995. 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 inevitably will differ from those estimates, and such differences may be material to the financial statements. FOREIGN CURRENCY TRANSLATION: The financial statements of subsidiaries outside the United States, except those subsidiaries located in highly inflationary economies, are generally measured using the local currency as the functional currency. Assets, including goodwill, and liabilities of these subsidiaries are translated at the rates of exchange at the balance sheet date. The resultant translation adjustments are included in equity adjustment from translation, a separate component of stockholders' equity. Income and expense items are translated at average monthly rates of exchange. Gains and losses from foreign currency transactions of these subsidiaries are included in net earnings. For subsidiaries operating in highly inflationary economies, gains and losses from balance sheet translation adjustments are included in net earnings. CASH AND CASH EQUIVALENTS: Cash and cash equivalents includes cash on hand, demand deposits, and short-term investments with original maturities of three months or less. INVENTORIES: Inventories are stated at the lower of cost or market. The cost of United States inventories is based primarily on the last-in, first-out (LIFO) method; all other inventories are based on the first-in, first-out (FIFO) method. PROPERTY AND DEPRECIATION: Property, plant and equipment is stated at cost. Depreciation is computed generally on the straight-line method for financial reporting purposes and on accelerated and straight-line methods for tax reporting purposes. GOODWILL AND OTHER INTANGIBLES: Goodwill and other intangibles are amortized on the straight-line method over periods ranging up to 40 years. On a periodic basis, the Corporation estimates the future undiscounted cash flows of the businesses to which goodwill relates in order to ensure that the carrying value of goodwill has not been impaired. PRODUCT DEVELOPMENT COSTS: Costs associated with the development of new products and changes to existing products are charged to operations as incurred. Product development costs were $96.1 million in 1995, $89.2 million in 1994, and $90.6 million in 1993. ADVERTISING AND PROMOTION: All costs associated with advertising and promoting products are expensed in the year incurred. Advertising and promotion expense, including expense of consumer rebates, was $265.1 million in 1995, $249.9 million in 1994, and $209.3 million in 1993. POSTRETIREMENT BENEFITS: The Corporation and its subsidiaries have pension plans covering substantially all of their employees, who are primarily covered by non-contributory defined benefit plans. The plans are funded in conformity with the funding requirements of applicable government regulations. Generally, benefits are based on age, years of service, and the level of compensation during the final years of employment. Prior service costs for defined benefit plans are generally amortized over the estimated remaining service periods of employees. Certain employees are covered by defined contribution plans. The Corporation's contributions to the plans are based on a percentage of employee compensation or employee contributions. The plans are funded on a current basis. In addition to pension benefits, the Corporation provides certain postretirement medical, dental, and life insurance benefits, principally to certain United States employees. Retirees in other countries are generally covered by government-sponsored programs. The Corporation uses the corridor approach in the valuation of defined benefits plans and other postretirement benefits. The corridor approach defers all actuarial gains and losses resulting from variances between actual results and economic estimates or actuarial assumptions. For defined benefit pension plans, these unrecognized gains and losses are amortized when the net gains and losses exceed 10% of the greater of the market-related value of plan assets or the projected benefit obligation at the beginning of the year. For other postretirement benefits, amortization occurs when the net gains and losses exceed 10% of the accumulated postretirement benefit obligation at the beginning of the year. The amount in excess of the corridor is amortized over the average remaining service period to retirement date of active plan participants or, for retired participants, the average remaining life expectancy. DERIVATIVE FINANCIAL INSTRUMENTS: Derivative financial instruments are used by the Corporation principally in the management of its interest rate and foreign currency exposures. Amounts to be paid or received under interest rate swap agreements are accrued as interest rates change and are recognized over the life of the swap agreements as an adjustment to interest expense. The related amounts payable to, or receivable from, the counterparties are included in other accrued liabilities. The fair value of the swap agreements is not recognized in the Consolidated Financial Statements, since they are accounted for as hedges. The costs of interest rate cap agreements are included in interest expense ratably over the lives of the agreements. Payments to be received as a result of the cap agreements are accrued as a reduction of interest expense. The unamortized costs of the cap agreements are included in other assets. In the case of an early termination of an interest rate swap or cap, gains or losses resulting from the early termination are deferred and amortized as an adjustment to the yield of the related debt instrument over the remaining period originally covered by the terminated swap or cap. Gains and losses on hedges of net investments are not included in the Consolidated Statement of Earnings, but are reflected in the Consolidated Balance Sheet in the equity adjustment from translation component of stockholders' equity, with the related amounts payable to or due from the counterparties included in other liabilities or other assets. Gains and losses on foreign currency transaction hedges are recognized in income and offset the foreign exchange gains and losses on the underlying transactions. Gains and losses of foreign currency firm commitment hedges are deferred and included in the basis of the transactions underlying the commitments. STOCK-BASED COMPENSATION: The Financial Accounting Standards Board (FASB) recently issued Statement of Financial Accounting Standards (SFAS) No.123, \"Accounting for Stock-Based Compensation.\" This new standard encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments based on a fair-value method of accounting. Companies that do not choose to adopt the new expense recognition rules of SFAS No. 123 will continue to apply the existing accounting rules contained in Accounting Principles Board Opinion (APBO) No. 25, but will be required to provide pro forma disclosures of the compensation expense determined under the fair-value provisions of SFAS No. 123, if material. APBO No. 25 requires no recognition of compensation expense for most of the stock-based compensation arrangements provided by the Corporation, namely, broad-based employee stock purchase plans and option grants where the exercise price is equal to the market price at the date of grant. The Corporation is required to adopt either the recognition or the disclosure provisions of SFAS No. 123 by no later than January 1, 1997. The Corporation expects to continue to follow the accounting provisions of APBO No. 25 for stock-based compensation and to furnish the pro forma disclosures required under SFAS No. 123, if material. IMPAIRMENT OF LONG-LIVED ASSETS: The FASB recently issued SFAS No. 121, \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which the Corporation is required to adopt effective January 1, 1996. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles held and used by a company be reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS No. 121 also requires that long-lived assets and certain identifiable intangibles held for sale, other than those related to discontinued operations, be reported at the lower of carrying amount or fair value less cost to sell. The Corporation does not expect the effect of its adoption of SFAS No.121 to be material. NET EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE: Primary earnings per common and common equivalent share are computed by dividing net earnings, after deducting preferred stock dividends, by the weighted average number of common shares outstanding during each year plus, for 1995, the incremental shares that would have been outstanding under certain employee benefit plans and upon the assumed exercise of dilutive stock options. For 1994 and 1993, these incremental shares were immaterial and, accordingly, were not considered in the calculation of primary earnings per share. In 1995, fully diluted earnings per share are computed by dividing net earnings by the weighted average number of common shares outstanding during 1995 plus the incremental shares that would have been outstanding under certain employee benefit plans and upon the assumed exercise of dilutive stock options and conversion of the preferred shares. In 1994 and 1993, conversion of the preferred shares would have been anti-dilutive and, therefore, was not considered in the computation of fully diluted earnings per share. Also, in 1994 and 1993, the incremental shares that would have been outstanding under certain employee benefit plans and upon the assumed exercise of dilutive stock options were immaterial and, accordingly, were not considered in the calculation of fully diluted earnings per share. As a result, fully diluted earnings per share for 1994 and 1993 are not materially different from primary earnings per share.\nNOTE 2: DISCONTINUED OPERATIONS On December 13, 1995, the Corporation announced that it had signed a definitive agreement to sell PRC Inc. for $425.0 million. The sale of PRC Inc. to Litton Industries, Inc., is expected to be completed in the first quarter of 1996. A net gain on the sale of PRC Inc., estimated at $80.0 to $90.0 million, will be recognized upon completion of the sale. The Corporation sold PRC Realty Systems, Inc. (\"RSI\") on March 31, 1995, and sold PRC Environmental Management, Inc. (\"EMI\") on September 15, 1995, for proceeds of $60.0 million and $35.5 million, respectively. The aggregate gain on the sale of RSI and EMI of $2.5 million, net of applicable income taxes of $5.5 million, is included in earnings of discontinued operations for 1995. Together, PRC Inc., RSI, and EMI comprised the Corporation's information technology and services (\"PRC\") segment. Earnings from the discontinued PRC segment amounted to $38.4 million in 1995, $37.5 million in 1994, and $31.1 million in 1993, net of applicable income taxes of $8.7 million, $4.0 million, and $1.3 million, respectively, and are shown separately in the Consolidated Statement of Earnings. The results of the discontinued operations of PRC do not reflect any expense for interest allocated by or management fees charged by the Corporation. Revenues of the discontinued PRC segment were $800.1 million in 1995, $883.1 million in 1994, and $760.7 million in 1993. These revenues are not included in revenues as reported in the Consolidated Statement of Earnings. Net assets of the discontinued PRC segment at the end of each year, in millions of dollars, consisted of the following: 1995 1994 ------ ------ Cash and cash equivalents ............................... $ 2.8 $ .9 Accounts receivable, net of allowances ................... 251.9 275.8 Inventories .............................................. 13.5 22.5 Current deferred tax benefits ............................ 40.0 -- Other current assets ..................................... 22.6 23.3 Plant and equipment, net of accumulated depreciation ..... 20.0 35.4 Goodwill, net of accumulated amortization ................ 40.1 98.3 Other non-current assets ................................. 46.0 46.3 Accounts payable ......................................... (97.5) (121.1) Accrued expenses and other liabilities ................... (37.0) (48.3) ------ ------ $302.4 $333.1 ====== ======\nNOTE 3: TRADE RECEIVABLES CONCENTRATION OF CREDIT: The Corporation sells products and services to customers in diversified industries and geographic regions, and, therefore, has no significant concentrations of credit risk. The Corporation continuously evaluates the creditworthiness of its customers and generally does not require collateral. SALE OF RECEIVABLES PROGRAM: The Corporation's sale of receivables program provides for a seasonal expansion of capacity from $200.0 million to $275.0 million during the period from October 1 through January 31. Receivables under this program are sold on a revolving basis and are not subject to any significant recourse provisions. At December 31, 1995, the Corporation had sold $230.0 million of receivables under this program compared to $244.0 million at December 31, 1994. The discount on the sale of receivables is included in other expense.\nNOTE 4: INVENTORIES The classification of inventories at the end of each year, in millions of dollars, was as follows: 1995 1994 ------- ------- FIFO Cost Raw materials and work-in-process ................. $231.6 $198.6 Finished products ................................. 665.0 543.1 ------- ------- 896.6 741.7 Excess of FIFO cost over LIFO inventory value ........ (40.9) (41.2) ------- ------- $855.7 $700.5 ======= =======\nThe cost of United States inventories stated under the LIFO method was approximately 44% and 50% of the value of total inventories at December 31, 1995 and 1994, respectively.\nNOTE 5: PROPERTY,PLANT AND EQUIPMENT Property, plant and equipment at the end of each year, in millions of dollars, consisted of the following: 1995 1994 -------- -------- Property, plant and equipment at cost: Land and improvements ............................ $ 69.4 $ 68.3 Buildings ........................................ 360.7 342.6 Machinery and equipment .......................... 1,342.1 1,257.9 -------- -------- 1,772.2 1,668.8 Less accumulated depreciation .................... 905.4 846.1 -------- -------- $ 866.8 $ 822.7 ======== ========\nNOTE 6: GOODWILL Goodwill at the end of each year, in millions of dollars, was as follows: 1995 1994 -------- -------- Goodwill ..................................... $2,635.0 $2,619.3 Less accumulated amortization ................ 493.0 424.6 -------- -------- $2,142.0 $2,194.7 ======== ========\nNOTE 7: OTHER ACCRUED LIABILITIES Other accrued liabilities at the end of each year, in millions of dollars, included the following: 1995 1994 ------- ------- Salaries and wages ....................... $ 91.8 $ 84.1 Employee benefits ........................ 66.2 53.5 All other ................................ 585.0 619.9 ------- ------- $743.0 $757.5 ======= =======\nAll other at December 31, 1995 and 1994, primarily consisted of accruals for trade discounts and allowances, insurance, warranty costs, advertising, interest, and income and other taxes.\nNOTE 8: SHORT-TERM BORROWINGS Short-term borrowings at December 31, 1995 and 1994, included unsecured money market loans in the amounts of $206.5 million and $293.3 million, respectively, at contracted interest rates based on a margin over the London Interbank Offered Rate (LIBOR). These loans are payable on demand with a one-to-five day notice period. Short-term borrowings at December 31, 1995 and 1994, also included $150.0 million and $75.0 million, respectively, of competitive bid rate loans under the Corporation's unsecured revolving credit facility, as more fully described in Note 9. Short-term borrowings in the amounts of $242.7 million and $180.7 million at December 31, 1995 and 1994, respectively, primarily consisted of borrowings of subsidiaries outside the United States under the terms of uncommitted lines of credit or other short-term borrowing arrangements. The weighted average interest rate on short-term borrowings outstanding at December 31, 1995 and 1994, was 6.2% and 7.0%, respectively. Under the terms of uncommitted lines of credit at December 31, 1995, certain subsidiaries outside the United States may borrow up to an additional $396.7 million on such terms as may be mutually agreed upon. These arrangements do not have termination dates and are reviewed periodically. No material compensating balances are required or maintained.\nNOTE 9: LONG-TERM DEBT The composition of long-term debt at the end of each year, in millions of dollars, was as follows: 1995 1994 -------- -------- Revolving credit facility expiring 1997 ............ $ 436.8 $ 426.2 7.50% notes due 2003 ............................... 500.0 500.0 6.625% notes due 2000 .............................. 250.0 250.0 7.0% notes due 2006 ................................ 250.0 250.0 Medium Term Notes due from 1996 through 2002 ....... 236.8 151.8 9.25% sinking fund debentures ...................... -- 150.0 6.75% deutsche mark bearer bonds ................... -- 111.4 Other loans due through 2009 ....................... 78.9 37.6 Less current maturities of long-term debt .......... (48.0) (121.1) Less debt discounts ................................ -- (32.7) -------- -------- $1,704.5 $1,723.2 ======== ========\nIn 1995, the Corporation recognized a $30.9 million extraordinary loss as a result of the early redemption of the 9.25% sinking fund debentures of its subsidiary, Emhart Corporation. The extraordinary loss consisted primarily of the write-off of the associated debt discount plus premiums and costs associated with the redemption, net of income tax benefits of $2.6 million. The Corporation financed Emhart's redemption of the sinking fund debentures through internally generated cash and proceeds from the sales of the RSI and EMI businesses during 1995. During 1994, the Corporation filed a shelf registration statement to issue up to $500.0 million of debt securities, which may consist of debentures, notes, or other unsecured evidences of indebtedness (the Medium Term Notes). As of December 31, 1995, $236.8 million aggregate principal amount of the Medium Term Notes had been issued under this shelf registration statement. Of that amount, $194.8 million bear interest at fixed rates ranging from 6.93% to 8.95%, while the remainder bears interest at variable rates. As a result of the issuance of public debt, the Corporation reduced the amount of credit available under its unsecured revolving credit facility (the Credit Facility) from $1.7 billion as of December 31, 1994, to $1.4 billion as of December 31, 1995. The amount available for borrowing under the Credit Facility at December 31, 1995, was $813.2 million. Borrowing options under the Credit Facility are at LIBOR plus a specified percentage, or at other variable rates set forth therein. The interest rate margin over LIBOR declines as the Corporation's leverage ratio improves. At December 31, 1994, borrowings under the Credit Facility were at LIBOR plus .4375% (borrowings were at LIBOR plus .50% prior to the renegotiation of pricing under the Credit Facility in October 1994). Due to improvements in the Corporation's leverage ratio, the borrowing rate under the Credit Facility declined by .1125%, effective January 1, 1995, to LIBOR plus .325% and declined by .075%, effective January 1, 1996, to LIBOR plus .25%. The Corporation also is able to borrow by means of competitive bid rate loans under the Credit Facility. Competitive bid rate loans are made through an auction process at then-current market rates and are classified as short-term borrowings in the Consolidated Balance Sheet. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Facility, the Corporation is required to pay an annual facility fee to each bank equal to .175% (.25%, prior to October 1994) of the amount of the bank's commitment, whether used or unused. The Credit Facility includes various customary covenants, including covenants limiting the ability of the Corporation and its subsidiaries to pledge assets or incur liens on assets, and financial covenants requiring the Corporation to maintain a specified leverage ratio and to achieve certain levels of cash flow to fixed expense coverage. As of December 31, 1995, the Corporation was in compliance with all terms and conditions of the Credit Facility. The Corporation expects to continue to meet the covenants imposed by the Credit Facility over the next 12 months. Meeting the cash flow coverage ratio is dependent upon the level of future earnings and interest rates, each of which can have a significant impact on the ratio. Indebtedness of subsidiaries in the aggregate principal amounts of $759.1 million and $773.8 million were included in the Consolidated Balance Sheet at December 31, 1995 and 1994, respectively, in short-term borrowings, current maturities of long-term debt, and long-term debt. Principal payments on long-term debt obligations due over the next five years are as follows: $48.0 million in 1996, $488.4 million in 1997, $56.7 million in 1998, $57.0 million in 1999, and $250.0 million in 2000. Interest payments on all indebtedness were $209.0 million in 1995, $184.9 million in 1994, and $165.0 million in 1993.\nNOTE 10: DERIVATIVE FINANCIAL INSTRUMENTS The Corporation is exposed to market risks arising from changes in interest rates. With products and services marketed in over 100 countries and with manufacturing sites in 14 countries, the Corporation also is exposed to risks arising from changes in foreign exchange rates. As an end user of derivative financial instruments, the Corporation utilizes derivatives to manage these risks by creating offsetting market positions. The Corporation's use of derivatives with respect to interest rate and foreign currency exposures is discussed below. CREDIT EXPOSURE: The Corporation is exposed to credit-related losses in the event of non-performance by counterparties to certain derivative financial instruments. The Corporation monitors the creditworthiness of the counterparties and presently does not expect default by any of the counterparties. The Corporation does not obtain collateral in connection with its derivative financial instruments. The credit exposure that results from interest rate and foreign exchange contracts is represented by the fair value of contracts with a positive fair value as of the reporting date, as indicated below. Some derivatives are not subject to credit exposures. The fair value of all financial instruments is summarized in Note 11. INTEREST RATE RISK MANAGEMENT: The Corporation manages its interest rate risk, primarily through the use of interest rate swap and cap agreements, in order to achieve a cost effective mix of fixed to variable rate indebtedness. The Corporation seeks to issue debt opportunistically, whether fixed or variable, at the lowest possible cost and then, based upon its assessment of the future interest rate environment, may, through the use of interest rate derivatives, convert such debt from fixed to variable or from variable to fixed interest rates. Similarly, the Corporation may, at times, seek to limit the effects of rising interest rates on its variable rate debt through the use of interest rate caps. The amounts exchanged by the counterparties to interest rate swap and cap agreements normally are based upon notional amounts and other terms, generally related to interest rates, of the derivatives. While notional amounts of interest rate swaps and caps form part of the basis for the amounts exchanged by the counterparties, the notional amounts are not themselves exchanged and, therefore, do not represent a measure of the Corporation's exposure as an end user of derivative financial instruments. The notional amounts of the Corporation's interest rate derivatives at the end of each year, in millions of dollars, were as follows: 1995 1994 ------- ------- Interest rate swaps: Fixed to variable rates ..................... $700.0 $850.0 Variable to fixed rates ..................... 450.0 750.0 Rate basis swaps ............................ 150.0 200.0 U.S. rates to foreign rates ................. 175.0 175.0\nInterest rate caps purchased ................... $150.0 $100.0\nThe Corporation's portfolio of interest rate swap instruments as of December 31, 1995, included $700.0 million notional amounts of fixed to variable rate swaps with a weighted average fixed rate receipt of 6.25%. The basis of the variable rate swaps paid is LIBOR. A number of the fixed to variable rate swaps contain provisions that permit, during a portion of the terms of the swap, the setting of the variable rates at either the beginning or the end of the reset periods, at the option of the counterparties. The reset periods generally occur every three to six months. The maturities of these swaps, by notional amounts, are as follows: $100.0 million in 1998, $150.0 million in 2000, and the balance in the years 2001 through 2004. A total of $300.0 million of these swaps, maturing in 2003, contains provisions that permit the counterparties to terminate the swap, without penalty, beginning in 1998. As of December 31, 1995, the portfolio also included $450.0 million notional amounts of variable to fixed rate swaps with a weighted average fixed rate payment of 6.52%. The basis of the variable rate received is LIBOR. Of these swaps to fixed rates, $200.0 million and $250.0 million mature in 1997 and 1998, respectively. As of December 31, 1995, the portfolio also contained $150.0 million notional amounts of rate basis swaps, which swap to the higher of a specified weighted average fixed rate payment of 6.85% or a weighted average variable rate payment of LIBOR minus 1.49%. The basis of the variable rates received is LIBOR. Rates received under these rate basis swaps are generally reset every three months. The maturities of these swaps, by notional amounts, are as follows: $50.0 million in 1996, $50.0 million in 1997, and $50.0 million in 1998. At December 31, 1995, payments under these swaps were based on the weighted average fixed rate payment provisions of the swap agreements. The remainder of the interest rate swap portfolio as of December 31, 1995, consisted of $175.0 million notional amounts of interest rates swaps that swap from United States dollars into foreign currencies. Of that amount, $150.0 million had been swapped from fixed rate United States dollars (with a weighted average fixed rate of 6.75%) into fixed rate Japanese yen (with a weighted average fixed rate of 4.68%). Of the $150.0 million notional amounts, $100.0 million mature in 1996, and the balance in 1997. A total of $25.0 million notional amounts of interest rate swaps, maturing in 1997, had been swapped from variable rate United States dollars (with the variable rate based on LIBOR) into fixed rate Swiss francs (with a weighted average fixed rate of 5.17%). As of December 31, 1995, the Corporation also had $150.0 million notional amounts of interest rate caps, which have the effect of limiting the Corporation's exposure to high interest rates. The interest rate caps mature in 1997 and have cap rates of 7.0%. For a total of $100.0 million notional amounts of the interest rate caps, the cap rates increase from 7.0% to 9.0% for any period in which LIBOR exceeds 9.0%. The Corporation's credit exposure on its interest rate derivatives as of December 31, 1995 and 1994, was $3.5 million and $22.2 million, respectively. Deferred gains and losses on the early termination of interest rate swaps as of December 31, 1995 and 1994, were not significant. FOREIGN CURRENCY MANAGEMENT: The Corporation enters into various foreign currency contracts in managing its foreign exchange risks. The contractual amounts of foreign currency derivative financial instruments (principally, forward exchange contracts and options) are generally exchanged by the counterparties. In order to limit the volatility of reported equity, the Corporation historically has hedged a portion of its net investment in subsidiaries located outside the United States, where practicable, except for those subsidiaries located in highly inflationary economies. This has been accomplished through the use of foreign currency forward contracts, foreign currency swaps, and purchased foreign currency options with little or no intrinsic value at the inception of the options. During 1995, the Corporation decided to limit the future hedging of its net investment in foreign subsidiaries. This action may increase the volatility of reported equity in the future but will result in more predictable cash flows from hedging activities. During 1994, the Corporation elected to hedge a portion, generally limited to tangible net worth, of its net investment in subsidiaries outside the United States. Prior to 1994, the Corporation generally operated under a full hedge policy, hedging the net assets, including goodwill, of its subsidiaries outside the United States. Through its foreign currency hedging activities, the Corporation seeks to minimize the risk that cash flows resulting from the sales of products outside the United States will be affected by changes in exchange rates. Foreign currency transaction and commitment exposures generally are the responsibility of the Corporation's individual operating units to manage as an integral part of their business. Management responds to foreign exchange movements through many alternative means, such as pricing actions, changes in cost structure, and changes in hedging strategies. The Corporation hedges its foreign currency transaction and firm purchase commitment exposures, including firm intercompany foreign currency purchases, based on management's judgment, generally through the use of forward exchange contracts and purchased options with little or no intrinsic value at the inception of the options. Some of the contracts involve the exchange of two foreign currencies, according to the local needs of the subsidiaries. The Corporation utilizes some natural hedges to mitigate its transaction and commitment exposures. Intercompany foreign currency purchase commitments are considered to be firm when performance under the commitments is probable because of sufficiently large disincentives to the Corporation for non-performance. Deferred gains and losses on hedged intercompany purchases are recognized in cost of sales when the related inventory is sold or when a hedged purchase is no longer expected to occur. The following table summarizes the contractual amounts of the Corporation's forward exchange contracts as of December 31, 1995 and 1994, in millions of dollars, including details by major currency as of December 31, 1995. Foreign currency amounts are translated at current rates as of the reporting date. The \"Buy\" amounts represent the United States dollar equivalent of commitments to purchase currencies, and the \"Sell\" amounts represent the United States dollar equivalent of commitments to sell currencies.\nAs of December 31, 1995 Buy Sell -------- -------- United States dollar .................... $ 964.8 $ (754.0) Pound sterling .......................... 375.8 (168.5) Deutsche mark ........................... 162.4 (312.7) Swedish krona ........................... 129.7 (137.1) Japanese yen ............................ 24.2 (178.8) French franc ............................ 82.0 (131.8) Canadian dollar ......................... 290.8 (254.3) Italian lira ............................ 113.1 (107.3) Swiss franc ............................. 59.3 (54.8) Other ................................... 103.7 (222.9) -------- -------- Total ................................... $2,305.8 $(2,322.2) ======== ========\nAs of December 31, 1994\nTotal ..................................... $2,120.5 $(2,137.1) ======== ========\nThe contractual amounts of the Corporation's purchased currency options to buy currencies, predominantly the United States dollar, and to sell various currencies were $25.1 million and $25.6 million, respectively, at December 31, 1995, and $266.7 million and $262.3 million, respectively, at December 31, 1994. The Corporation's credit exposure on its foreign currency derivatives as of December 31, 1995 and 1994, was $28.9 million and $43.2 million, respectively. Gross deferred realized gains and losses on commitment hedges were not significant at December 31, 1995 and 1994. Substantially all of the amounts deferred at December 31, 1995, are expected to be recognized in earnings during 1996, when the gains or losses on the underlying transactions also will be recognized.\nNOTE 11: FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument represents the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. Significant differences can arise between the fair value and carrying amount of financial instruments that are recognized at historical cost amounts. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS, TRADE RECEIVABLES, CERTAIN OTHER CURRENT ASSETS, SHORT-TERM BORROWINGS, AND CURRENT MATURITIES OF LONG-TERM DEBT: The amounts reported in the Consolidated Balance Sheet approximate fair value. LONG-TERM DEBT: Publicly traded debt is valued based on quoted market values. The amount reported in the Consolidated Balance Sheet for the remaining long- term debt approximates fair value since such debt was either variable rate debt or fixed rate debt that had been recently issued as of the reporting date. INTEREST RATE HEDGES: The fair value of interest rate hedges, including interest rate swaps and caps, reflects the estimated amounts that the Corporation would receive or pay to terminate the contracts at the reporting date, thereby taking into account unrealized gains and losses of open contracts as of the reporting date. FOREIGN CURRENCY CONTRACTS: The fair values of forward exchange contracts and options are estimated using prices established by financial institutions for comparable instruments. The following table sets forth the carrying amounts and fair values of the Corporation's financial instruments, except for those noted above for which carrying values approximate fair values, in millions of dollars:\nAssets (Liabilities) Carrying Fair As of December 31, 1995 Amount Value -------- -------- Non-derivatives: Long-term debt .......................... $(1,704.5) $(1,779.9) -------- -------- Derivatives relating to: Debt Assets ................................ 2.6 3.5 Liabilities ........................... (.5) (16.4) Foreign Currency Assets ................................ 12.6 28.9 Liabilities ........................... (32.6) (46.3) -------- --------\nAssets (Liabilities) Carrying Fair As of December 31, 1994 Amount Value -------- -------- Non-derivatives: Long-term debt .......................... $(1,723.2) $(1,637.3) -------- -------- Derivatives relating to: Debt Assets ................................ .6 22.2 Liabilities ........................... (1.4) (101.8) Foreign Currency Assets ................................ 38.0 43.2 Liabilities ........................... (43.9) (62.6) -------- --------\nThe carrying amounts of debt-related derivatives are included in the Consolidated Balance Sheet in other accrued liabilities. The carrying amounts of foreign currency-related derivatives related to net investment and commitment hedges are included in the Consolidated Balance Sheet in other current assets and other accrued liabilities. The carrying amounts of foreign currency-related derivatives related to transaction hedges are included in the same balance sheet line item as the hedged transaction.\nNOTE 12: INCOME TAXES Earnings (losses) from continuing operations before income taxes, extraordinary item, and cumulative effect of change in accounting principle, for each year, in millions of dollars, were as follows: 1995 1994 1993 ------- ------- ------- United States ................. $ 83.5 $(16.6) $ 19.9 Other countries ............... 142.0 165.2 103.6 ------- ------- ------- $225.5 $148.6 $123.5 ======= ======= =======\nSignificant components of income taxes (benefits) for each year, in millions of dollars, were as follows: 1995 1994 1993 ------- ------- ------- Current: United States ..................... $20.2 $ 4.7 $ 7.3 Other countries ................... 33.5 43.7 32.3 Withholding on remittances from other countries ............ 1.4 1.4 1.0 ------- ------- ------- 55.1 49.8 40.6 ------- ------- ------- Deferred: United States ..................... (50.2) 12.0 20.7 Other countries ................... 4.1 (3.1) (1.9) ------- ------- ------- (46.1) 8.9 18.8 ------- ------- ------- $ 9.0 $58.7 $59.4 ======= ======= =======\nDuring 1995, 1994 and 1993, the Corporation utilized United States tax loss carryforwards and capital loss carryforwards obtained in a prior business combination. The effect of utilizing these carryforwards was to recognize deferred income tax expense and to reduce goodwill by $21.0 million in 1995, $15.5 million in 1994, and $21.7 million in 1993. In 1995, income tax benefits of $2.6 million were recorded on the extraordinary loss on extinguishment of debt. In 1993, no income tax benefits were recorded on the cumulative effect adjustment for postemployment benefits. The tax assets related to this adjustment were predominantly in the United States and were offset by a corresponding increase in the deferred tax asset valuation allowance. Income tax expense recorded directly as an adjustment to equity as a result of hedging activities in 1995, 1994, and 1993 was not significant. Income tax payments were $56.3 million in 1995, $44.5 million in 1994, and $92.2 million in 1993. Taxes paid during 1993 included $49.0 million of previously accrued tax payments relating to settlement of prior-year tax audit issues. Deferred tax assets (liabilities) at the end of each year, in millions of dollars, were composed of the following: 1995 1994 ------- ------- Deferred tax liabilities: Fixed assets ...................................... $ (45.8) $ (54.4) Postretirement benefits ........................... (32.5) (31.2) Other ............................................. (8.8) (28.1) ------- ------- Gross deferred tax liabilities ....................... (87.1) (113.7) ------- ------- Deferred tax assets: Bad debt allowance ................................ 6.0 4.1 Inventories ....................................... 16.3 17.2 Postretirement benefits ........................... 7.9 19.2 Fixed assets ...................................... -- 5.7 Net assets of discontinued operations ............. 40.0 -- Other accruals .................................... 97.8 131.5 Tax loss carryforwards ............................ 115.9 144.3 Tax credit and capital loss carryforwards ......... 58.0 55.1 ------- ------- Gross deferred tax assets ............................ 341.9 377.1 ------- ------- Deferred tax asset valuation allowance ............... (187.7) (301.2) ------- ------- Net deferred tax assets (liabilities) ................ $ 67.1 $ (37.8) ======= =======\nDeferred income taxes are included in the Consolidated Balance Sheet in other current assets, net assets of discontinued operations, other accrued liabilities, and deferred income taxes. Net deferred tax assets (prior to the valuation allowance) of $41.0 million as of December 31, 1995, resulted from a prior business combination and, accordingly, will result in a reduction of goodwill if realized for financial reporting purposes. At December 31, 1994, a full valuation allowance was provided on net deferred tax assets in the United States based upon the Corporation's history of taxable earnings (losses) over the past several years and the volatility of comprehensive taxable earnings (losses) in the United States due to foreign exchange contracts. In addition, a full valuation allowance on net tax assets in certain foreign taxing jurisdictions was provided at December 31, 1994, based on the history of taxable earnings (losses), the tax carryforward periods, and projected earnings. During the year ended December 31, 1995, the deferred tax asset valuation allowance decreased by $113.5 million. Included in the decrease was $109.0 million, which resulted from the Corporation's reversal of a portion of the deferred tax asset valuation allowance based on the projection of estimable taxable earnings in the United States, including the effect of the pending sale of PRC Inc. The remaining decrease was due to the utilization of domestic tax loss carryforwards, offset by increased tax losses generated by foreign operations. During the year ended December 31, 1994, the deferred tax asset valuation allowance decreased by $45.3 million, primarily due to utilization of tax loss carryforwards and capital loss carryforwards. Tax basis carryforwards at December 31, 1995, consisted of net operating losses expiring from 1996 to 2011, capital loss carryforwards expiring in 1996, and other tax credits expiring from 1998 to 2008. At December 31, 1995, unremitted earnings of subsidiaries outside the United States were approximately $1.3 billion, on which no United States taxes have been provided. The Corporation's intention is to reinvest these earnings permanently or to repatriate the earnings only when tax effective to do so. It is not practicable to estimate the amount of additional tax that might be payable upon repatriation of foreign earnings; however, the Corporation believes that United States foreign tax credits would largely eliminate any United States tax and offset any foreign withholding tax. A reconciliation of income taxes at the federal statutory rate to the Corporation's income taxes for each year, in millions of dollars, is as follows: 1995 1994 1993 ------- ------- ------- Income taxes at federal statutory rate .............................. $78.9 $52.0 $43.2 Lower effective taxes on earnings of other countries ............................. (16.5) (18.7) (15.0) Effect of net operating loss carryforwards ..... (19.4) (2.7) (.7) Effect of reduction in deferred tax asset valuation allowance due to projection of estimable earnings in the United States, including the effect of the pending sale of PRC Inc. .................... (65.0) -- -- Withholding on remittances from other countries ................................... 1.4 1.4 1.0 Amortization and write-off of goodwill ......... 24.6 24.5 23.7 Other-net ...................................... 5.0 2.2 7.2 ------- ------- ------- Income taxes ................................... $ 9.0 $58.7 $59.4 ======= ======= =======\nNOTE 13: POSTEMPLOYMENT AND POSTRETIREMENT BENEFITS Net pension cost (credit) for all domestic defined benefit plans included the following components for each year, in millions of dollars: 1995 1994 1993 ------- ------- ------- Service cost ................................ $ 11.3 $14.0 $11.8 Interest cost on projected benefit obligation 47.9 45.6 44.0 Actual return on assets ..................... (108.2) (20.8) (98.6) Net amortization and deferral ............... 39.3 (38.2) 33.4 ------- ------- ------- Net pension cost (credit) ................ $ (9.7) $ .6 $(9.4) ======= ======= =======\nThe funded status of the domestic defined benefit plans at the end of each year, in millions of dollars, was as follows: 1995 1994 ------- ------- Actuarial present value of benefit obligations: Vested benefit ..................................... $585.2 $492.9 ======= ======= Accumulated benefit ................................ $611.5 $505.4 ======= ======= Projected benefit .................................. $653.0 $553.1 Plan assets at fair value ............................... 750.6 686.6 ------- ------- Plan assets in excess of projected benefit obligation ... 97.6 133.5 Unrecognized net loss ................................... 129.3 79.6 Unrecognized prior service cost ......................... 5.6 6.3 Unrecognized net asset at date of adoption net of amortization ........................................ (4.2) (5.3) ------- ------- Net pension asset recognized in the Consolidated Balance Sheet........................................... $228.3 $214.1 ======= ======= Discount rates .......................................... 7.75% 9.0% Salary scales ........................................... 5.0-6.0% 5.0-6.0% Expected return on plan assets .......................... 10.5% 10.5%\nThe Corporation's net pension expense (credit) for defined benefit pension plans outside the United States was $.8 million in 1995, $(2.0) million in 1994, and $(.7) million in 1993. The net pension asset recognized in the Consolidated Balance Sheet for those plans outside the United States where assets exceeded accumulated benefits was $102.0 million and $96.6 million at December 31, 1995 and 1994, respectively. Liabilities of these plans were discounted at rates ranging from 8.0% to 9.0% in 1995 and from 5.0% to 9.0% in 1994, and expected rates of return on assets of these plans ranged from 10.0% to 10.5% in 1995 and from 5.5% to 12.0% in 1994. The net pension liability recognized in the Consolidated Balance Sheet for those plans outside the United States where accumulated benefits exceeded assets was $71.7 million and $66.9 million at December 31, 1995 and 1994, respectively. Liabilities of these predominantly unfunded plans were discounted at rates ranging from 4.5% to 9.0% in 1995 and from 7.0% to 10.0% in 1994. Assets of domestic plans and plans outside the United States consist principally of investments in equity securities, debt securities, and cash equivalents. The expected returns on plan assets during 1993 for defined benefit plans were 10.5% for plans in the United States and 5.5% to 12.0% for funded plans outside the United States. Expense for defined contribution plans amounted to $11.6 million, $8.3 million, and $7.1 million in 1995, 1994, and 1993, respectively. The Corporation has several unfunded health care plans that provide certain postretirement medical, dental, and life insurance benefits for most United States employees. The postretirement medical and dental plans are contributory and include certain cost-sharing features, such as deductibles and co-payments. Net periodic postretirement benefit expense included the following components, in millions of dollars: 1995 1994 1993 ------- ------- ------- Service expense ............................... $ 1.6 $ 1.8 $ 1.7 Interest expense .............................. 14.0 12.9 14.8 Net amortization .............................. (7.0) (8.0) (7.7) ------- ------- ------- Net periodic postretirement benefit expense ... $ 8.6 $ 6.7 $ 8.8 ======= ======= =======\nThe reconciliation of the accumulated postretirement benefit obligation to the liability recognized in the Consolidated Balance Sheet at the end of each year, in millions of dollars, was as follows: 1995 1994 ------- ------- Accumulated postretirement benefit obligation: Retirees ............................................ $129.0 $133.1 Fully eligible active participants .................. 15.7 10.7 Other active participants ........................... 13.5 22.2 ------- ------- Total .................................................. 158.2 166.0 ------- ------- Unrecognized prior service cost ........................ 59.7 63.5 Unrecognized net loss .................................. 22.3 15.8 ------- ------- Net postretirement benefit liability recognized in the Consolidated Balance Sheet ...................... $240.2 $245.3 ======= =======\nThe health care cost trend rate used to determine the postretirement benefit obligation was 8.75% for 1995 and 1996, decreases gradually to an ultimate rate of 4.75% in 2001, and remains at that level thereafter. The trend rate is a significant factor in determining the amounts reported. The effect of a 1% annual increase in these assumed health care cost trend rates would increase the accumulated postretirement benefit obligation by approximately $11.8 million. The effect of a 1% increase on the aggregate of the service and interest cost components of net periodic postretirement benefit cost is immaterial. An assumed discount rate of 7.75% was used to measure the accumulated postretirement benefit obligation for 1995 compared to 9.0% used in 1994. As of January 1, 1993, the Corporation adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which addresses the accounting for certain benefits provided to former employees prior to retirement. These benefits primarily relate to disability and workers' compensation. Prior to January 1, 1993, the Corporation recognized the cost of providing these benefits principally on the cash basis. Since that date, the Corporation's policy has been to accrue these benefits when payment of such benefits is probable and when sufficient information exists to make reasonable estimates of the amounts to be paid. As a result of the adoption of SFAS No. 112, a $29.2 million cumulative effect adjustment was recorded as a reduction of net income during 1993.\nNOTE 14: STOCKHOLDERS'EQUITY (Dollars in Millions Except Per Share Amounts)\nThe Corporation has one class of $.50 par value common stock with 150,000,000 authorized shares. The Corporation has authorized 5,000,000 shares of preferred stock without par value, of which 1,500,000 shares have been designated as Series A Junior Participating Preferred Stock (Series A) and 150,000 shares have been designated as Series B Cumulative Convertible Preferred Stock (Series B). Holders of Series B stock are entitled to dividends, payable quarterly, at an annual rate of $77.50 per share. In accordance with the terms of the Articles Supplementary that set forth the terms and conditions of the Series B stock, each share of Series B stock now is convertible into 42-1\/3 shares of common stock and is entitled to 42-1\/3 votes on matters submitted generally to the stockholders of the Corporation. The conversion rate and the number of votes per share are subject to adjustment under certain circumstances pursuant to anti-dilution provisions. The Corporation has reserved 6,350,000 shares of common stock for issuance upon conversion of the shares of Series B stock. The shares of Series B stock are not redeemable at the option of the Corporation until September 2001. For a 90-day period thereafter, the Corporation is entitled to redeem all, but not less than all, of the shares of Series B stock at a redemption price equal to the current market price of the shares of common stock into which the Series B stock is then convertible. The shares of Series B stock are not subject to redemption at the option of the holders of the shares under any circumstances. The Corporation also has the option, after September 1996, to require the conversion of the shares of Series B stock into shares of common stock if the current market price of the shares of common stock is at least equal to $39.45 per share (subject to adjustment) for a period of 20 trading days out of 30 consecutive trading days. In connection with the sale of the Series B stock, the Corporation and the purchaser of Series B stock entered into a standstill agreement that includes, among other things, provisions limiting the purchaser's ownership and voting of shares of the Corporation's capital stock, provisions limiting actions by the purchaser with respect to the Corporation, and provisions generally restricting the purchaser's equity interest to 15%. The standstill agreement expires in September 2001. The Corporation has a Stockholder Rights Plan pursuant to which, under certain conditions, each stockholder has share purchase rights for each outstanding share of common stock and Series B stock of the Corporation. The Corporation has reserved 1,500,000 shares of Series A stock for possible issuance upon exercise of the rights.\nNOTE 15: STOCK OPTION AND PURCHASE PLANS Under various stock option plans, options to purchase common stock may be granted until 2002. Options generally are granted at fair market value at the date of grant, are exercisable in installments beginning one year from the date of grant, and expire 10 years after the date of grant. The plans permit the issuance of either incentive stock options or non-qualified stock options, which, for certain of the plans, may be accompanied by stock or cash appreciation rights or limited stock appreciation rights issued simultaneously with the grant of the stock options. Additionally, certain plans allow for the granting of stock appreciation rights on a stand-alone basis. As of December 31, 1995, 14,500 incentive stock options, 5,387,434 non-qualified stock options without cash appreciation rights, and 150,000 non-qualified stock options with cash appreciation rights were outstanding under domestic plans. There were 236,754 stock options outstanding under the Corporation's United Kingdom plan.\nUnder all plans, there were 358,564 shares of common stock reserved for future grants as of December 31, 1995. Transactions are summarized as follows: Stock Options Outstanding Price Range ------------- ------------ December 31, 1994 ....................... 6,452,282 $ 9.88-25.25 Granted ................................. 736,100 30.13-35.38 Exercised ............................... 1,165,152 9.88-25.25 Cancelled or expired .................... 234,542 9.88-25.25 ------------ ------------ December 31, 1995 ....................... 5,788,688 9.88-35.38 ------------ ------------\nStock Options Outstanding Price Range ------------- ------------ Shares exercisable at December 31, 1995 ..................... 3,910,292 $9.88-25.25 ------------ ------------ Shares exercised during the year ended December 31, 1994 ............... 343,702 9.88-21.63 ------------ ------------ Shares exercised during the year ended December 31, 1993 ............... 330,024 9.88-20.88 ------------ ------------\nUnder the 1991 Employees Stock Purchase Plan, employees may subscribe to purchase shares of the Corporation's common stock at the lower of 90% of market value on the date offered or on the date purchased. Transactions under this plan are summarized as follows: Common Shares Subscribed Prices ---------- ------ December 31, 1994 ......................... 152,880 $19.13 Subscriptions ............................. 193,120 25.50 Purchases ................................. 135,686 19.13 Cancellations ............................. 19,651 19.13-25.50 --------- ----------- December 31, 1995 ......................... 190,663 25.50 --------- ----------- Shares purchased during the year ended December 31, 1994 ................ 208,529 16.25 --------- ----------- Shares purchased during the year ended December 31, 1993 ................ 87,064 16.75 --------- -----------\nNOTE 16: BUSINESS SEGMENTS AND GEOGRAPHIC AREAS The Corporation operates in two business segments: Consumer and Home Improvement Products, including consumer and professional power tools and accessories, household products, security hardware, outdoor products (composed of electric lawn and garden tools and recreational products), plumbing products, and product service; and Commercial and Industrial Products, including fastening systems and glass container-making equipment. Sales, operating income, capital expenditures, and depreciation set forth in the following table exclude the results of the discontinued PRC segment. Corporate assets included in corporate and eliminations were $688.1 million at December 31, 1995, $575.4 million at December 31, 1994, and $567.9 million at December 31, 1993, and consist principally of cash and cash equivalents, other current assets, property, other sundry assets, and net assets of the discontinued PRC segment. The remainder of corporate and eliminations includes certain pension credits and amounts to eliminate intercompany items, including accounts receivable and payable and intercompany profit in inventory.\nFor 1993, the Consumer and Home Improvement Products segment included charges of $29.0 million for plant closures and reorganizations offset by a gain of $15.9 million for the sale of Corbin Russwin. The Commercial and Industrial Products segment included a gain of $19.4 million for the sale of Dynapert. In the Geographic Areas table, United States includes all domestic operations and several intercompany manufacturing facilities outside the United States, which manufacture products predominantly for sale in the United States. Other includes subsidiaries located in Canada, Latin America, Australia, and the Far East. For 1993, restructuring credits in the amount of $6.3 million were included in the United States geographic segment. Transfers between geographic areas are accounted for at cost plus a reasonable profit. Transfers between business segments are not significant. Identifiable assets are those assets identified with the operations in each area or segment, including goodwill.\nNOTE 17: OTHER EXPENSE Other expense for 1995, 1994, and 1993 primarily included the costs associated with the sale of receivables program.\nNOTE 18: LEASES The Corporation leases certain service centers, offices, warehouses, manufacturing facilities, and equipment. Generally, the leases carry renewal provisions and require the Corporation to pay maintenance costs. Rental payments may be adjusted for increases in taxes and insurance above specified amounts. Rental expense charged to earnings from continuing operations for 1995, 1994, and 1993 amounted to $68.0 million, $64.9 million, and $61.2 million, respectively. Capital leases are immaterial in amount and are generally treated as operating leases. Future minimum payments under non-cancellable operating leases with initial or remaining terms of more than one year as of December 31, 1995, in millions of dollars, were as follows:\n1996......................... $ 42.4\n1997......................... 33.3\n1998......................... 24.2\n1999......................... 16.9\n2000......................... 12.1\nThereafter................... 37.6 ------ Total $166.5 ======\nNOTE 19: LITIGATION AND CONTINGENT LIABILITIES The Corporation is involved in various lawsuits in the ordinary course of business. These lawsuits primarily involve claims for damages arising out of the use of the Corporation's products and allegations of patent and trademark infringement. The Corporation also is involved in litigation and administrative proceedings involving employment matters and commercial disputes. Some of these lawsuits include claims for punitive as well as compensatory damages. The Corporation, using current product sales data and historical trends, actuarially calculates the estimate of its current exposure for product liability. The Corporation is insured for product liability claims for amounts in excess of established deductibles and accrues for the estimated liability up to the limits of the deductibles. All other claims and lawsuits are accrued for on a case-by-case basis. The Corporation also is involved in lawsuits and administrative proceedings with respect to claims involving the discharge of hazardous substances into the environment. Certain of these claims assert damages and liability for remedial investigations and cleanup costs with respect to sites at which the Corporation has been identified as a potentially responsible party under federal and state environmental laws and regulations (off-site). Other matters involve sites that the Corporation currently owns and operates or has previously sold (on-site). For off-site claims, the Corporation makes an assessment of the costs involved based on environmental studies, prior experience at similar sites, and the experience of other named parties. The Corporation also considers the ability of other parties to share costs, the percentage of the Corporation's exposure relative to all other parties, and the effects of inflation on these estimated costs. For on-site matters associated with properties currently owned, an assessment is made as to whether an investigation and remediation would be required under applicable federal and state laws. For on-site matters associated with properties previously sold, the Corporation considers the terms of sale as well as applicable federal and state laws to determine if the Corporation has any remaining liability. If the Corporation is determined to have potential liability for properties currently owned or previously sold, an estimate is made of the total costs of investigation and remediation and other potential costs associated with the site. The Corporation's estimate of the costs associated with legal, product liability, and environmental exposures is accrued if, in management's judgment, the likelihood of a loss is probable. These accrued liabilities are not discounted. Insurance recoveries for environmental and certain general liability claims are not recognized until realized. In the opinion of management, amounts accrued for awards or assessments in connection with these matters are adequate and, accordingly, ultimate resolution of these matters will not have a material effect on the Corporation. As of December 31, 1995, the Corporation had no known probable but inestimable exposures that could have a material effect on the Corporation.\nNOTE 20: QUARTERLY RESULTS (UNAUDITED) (Millions of Dollars Except Per Share Data)\nAs described in Note 2, during the fourth quarter of 1995, the Corporation agreed to sell the remainder of its PRC segment. Changes in previously reported results are due to the reclassification of amounts applicable to the discontinued operations of PRC. The results of the discontinued operations do not reflect any expense for interest allocated by or management fees charged by the Corporation. The extraordinary loss recognized in the fourth quarter of 1995 resulted from the early extinguishment of debt. The three-month period ended December 31, 1995, included a tax benefit of $65.0 million ($.73 per share on a primary basis and $.68 per share on a fully diluted basis) related to the reduction of the Corporation's deferred tax asset valuation allowance. Earnings per common and common equivalent share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not necessarily be equal to the full year earnings per share amounts due to stock transactions which occurred during 1995 and 1994 and, with respect to fully diluted earnings per share, whether the assumed conversion of preferred shares was dilutive or anti-dilutive during each quarter.\nREPORT OF INDEPENDENT AUDITORS To the Stockholders and Board of Directors of The Black & Decker Corporation:\nWe have audited the accompanying consolidated balance sheets of The Black & Decker Corporation 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. 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 Corporation's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Black & Decker 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. As discussed in Note 13 to the financial statements, effective January 1, 1993, the Corporation changed its method of accounting for postemployment benefits.\n\/s\/ERNST & YOUNG LLP Baltimore, Maryland 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\nInformation required under this Item with respect to Directors is contained in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996, under the captions Election of Directors and Board of Directors - Section 16 and is incorporated herein by reference. Information required under this Item with respect to Executive Officers of the Corporation is included in Item 1 of Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required under this Item is contained in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996, under the captions Board of Directors and Executive Compensation and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required under this Item is contained in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996, under the captions Voting Securities and Security Ownership of Management and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under this Item is contained in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996, under the caption Executive Compensation 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) LIST OF FINANCIAL STATEMENTS,FINANCIAL STATEMENT SCHEDULES, AND EXHIBITS\n(1) List of Financial Statements The following consolidated financial statements of the Corporation and its subsidiaries are included in Item 8 of Part II:\nConsolidated Statement of Earnings - years ended December 31, 1995, 1994, and 1993.\nConsolidated Balance Sheet - December 31, 1995 and 1994.\nConsolidated Statement of Cash Flows - years ended December 31, 1995, 1994, and 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\n(2) List of Financial Statement Schedules The following financial statement schedule of the Corporation and its subsidiaries is included herein.\nSchedule II - Valuation and Qualifying Accounts and Reserves.\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 inapplicable and, therefore, have been omitted.\n(3) List of Exhibits The following exhibits are either included in this report or incorporated herein by reference as indicated below:\nExhibit No. Exhibit 3(a)(1) Charter of the Corporation, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended December 25, 1988, is incorporated herein by reference.\n3(a)(2) Articles Supplementary of the Corporation, as filed with the State Department of Assessments and Taxation of the State of Maryland on September 5, 1991, included in the Corporation's Current Report on Form 8-K dated September 25, 1991, is incorporated herein by reference.\n3(b) By-Laws of the Corporation, as amended.\n4(a) Indenture dated as of March 24, 1993, by and between The Black & Decker Corporation and Security Trust Company, National Association, included in the Corporation's Current Report on Form 8-K filed with the Commission on March 26, 1993, is incorporated herein by reference.\n4(b) Form of 7-1\/2% Notes due April 1, 2003, included in the Corporation's Current Report on Form 8-K filed with the Commission on March 26, 1993, is incorporated herein by reference.\n4(c) Form of 6-5\/8% Notes due November 15, 2000, included in the Corporation's Current Report on Form 8-K filed with the Commission on November 22, 1993, is incorporated herein by reference.\n4(d) Form of 7% Notes due February 1, 2006, included in the Corporation's Current Report on Form 8-K filed with the Commission on January 20, 1994, is incorporated herein by reference.\n4(e)(1) Credit Agreement dated as of November 18, 1992, among The Black & Decker Corporation, Black & Decker Holdings Inc., Black & Decker GmbH, DOM Sicherheitstechnik GmbH & Co. KG, Black & Decker(France) S.A.R.L., the banks listed on the signature pages thereto, Chemical Bank, Credit Suisse and The Bank of Nova Scotia, as Managing Agents, and Credit Suisse, as Administrative Agent, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated herein by reference.\n4(e)(2) Amendment No. 1 dated as of October 21, 1994, to Credit Agreement dated as of November 18, 1992, by and among The Black & Decker Corporation, Black & Decker Holdings Inc., Black & Decker GmbH, DOM Sicherheitstechnik GmbH & Co. KG, Black & Decker(France) S.A.R.L., the banks listed therein, Chemical Bank, Credit Suisse and The Bank of Nova Scotia, as Managing Agents, and Credit Suisse, as Administrative Agent, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended October 2, 1994, is incorporated herein by reference.\n4(f) Indenture dated as of September 9, 1994, by and between The Black & Decker Corporation and Marine Midland Bank, as Trustee, included in the Corporation's Current Report on Form 8-K filed with the Commission on September 9, 1994, is incorporated herein by reference.\nThe Corporation agrees to furnish a copy of any other documents with respect to long-term debt instruments of the Corporation and its subsidiaries upon request.\n4(g)(1) Rights Agreement, dated as of April 17, 1986, by and between the Corporation and Morgan Guaranty Trust Company of New York, included in the Corporation's Current Report on Form 8-K dated April 29, 1986, is incorporated herein by reference.\n4(g)(2) Amendment Agreement to the Rights Agreement dated as of March 31, 1988, between the Corporation and Morgan Guaranty Trust Company of New York as Rights Agent, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 27, 1988, is incorporated herein by reference.\n4(g)(3) Second Amendment Agreement to the Rights Agreement dated as of September 6, 1991, by and between the Corporation and First Chicago Trust Company of New York as successor Rights Agent, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10(a) The Black & Decker Corporation Deferred Compensation Plan For Non-Employee Directors, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended October 2, 1994, is incorporated herein by reference.\n10(b) The Black & Decker 1982 Stock Option Plan, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 29, 1991, is incorporated herein by reference.\n10(c) The Black & Decker 1986 Stock Option Plan, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 29, 1991, is incorporated herein by reference.\n10(d) The Black & Decker 1986 U.K. Approved Option Scheme, as amended, included in the Corporation's Registration Statement on Form S-8 (Reg.No.33-47651), filed with the Commission on May 5, 1992, is incorporated herein by reference.\n10(e) The Black & Decker 1989 Stock Option Plan, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 29, 1991, is incorporated herein by reference.\n10(f) The Black & Decker 1992 Stock Option Plan, included in the Corporation's Registration Statement on Form S-8 (Reg.No.33-47652), filed with the Commission on May 5, 1992, is incorporated herein by reference.\n10(g) The Black & Decker 1995 Stock Option Plan for Non-Employee Directors, included in the definitive Proxy Statement for the 1995 Annual Meeting of Stockholders of the Corporation dated March 9, 1995, is incorporated herein by reference.\n10(h)(1) The Black & Decker Performance Equity Plan, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 29, 1992, is incorporated herein by reference.\n10(h)(2) The Black & Decker Performance Equity Plan, as amended subject to approval of the stockholders of the Corporation at the 1996 Annual Meeting of Stockholders.\n10(i) Annual Incentive Plan, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated herein by reference.\n10(j) The Black & Decker Executive Annual Incentive Plan subject to the approval of the stockholders of the Corporation at the 1996 Annual Meeting of Stockholders.\n10(k) Amended and Restated Employment Agreement, dated as of November 1, 1995, by and between the Corporation and Nolan D. Archibald.\n10(l) Letter Agreement, dated May 31, 1989, by and between the Corporation and Raymond A. DeVita, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10(m) Letter Agreement, dated February 1, 1975, by and between the Corporation and Alonzo G. Decker, Jr., included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, is incorporated herein by reference.\n10(n) The Black & Decker Supplemental Pension Plan, as amended, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10(o) The Black & Decker Executive Deferred Compensation Plan, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended October 3, 1993, is incorporated herein by reference.\n10(p) The Black & Decker Supplemental Retirement Savings Plan, included in the Corporation's Registration Statement on Form S-8 (Reg.No.33- 65013), filed with the Commission on December 14, 1995, is incorporated herein by reference.\n10(q) The Black & Decker Supplemental Executive Retirement Plan, as amended.\n10(r) The Black & Decker Executive Life Insurance Program, as amended, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended April 4, 1993, is incorporated herein by reference.\n10(s) The Black & Decker Executive Salary Continuance Plan, included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended April 12, 1995, is incorporated herein by reference.\n10(t) Description of the Corporation's policy and procedure for relocation of existing employees (individual transfers), included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10(u) Description of the Corporation's policy and procedures for relocation of new employees, included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10(v) Form of Amendment and Restatement of Severance Benefits Agreement by and between the Corporation and approximately 17 of its key employees.\n10(w) Amendment and Restatement of Severance Benefits Agreement, dated November 20, 1995, by and between the Corporation and Nolan D. Archibald.\n10(x) Amendment and Restatement of Severance Benefits Agreement, dated November 21, 1995, by and between the Corporation and Raymond A. DeVita.\n10(y) Amendment and Restatement of Severance Benefits Agreement, dated November 14, 1995, by and between the Corporation and Charles E. Fenton.\n10(z) Amendment and Restatement of Severance Benefits Agreement, dated December 5, 1995, by and between the Corporation and Joseph Galli.\n10(aa) Amendment and Restatement of Severance Benefits Agreement, dated November 18, 1995, by and between the Corporation and Don R. Graber.\n10(bb)(1) Agreement and Plan of Merger dated as of March 19, 1989, included in the Corporation's Schedule 14D-1 in respect of Emhart Corporation filed on March 22, 1989, is incorporated herein by reference.\n10(bb)(2) Amendment Agreement dated as of April 26, 1989, included in the Corporation's Amendment No. 5 to Schedule 14D-1 in respect of Emhart Corporation filed on April 28, 1989, is incorporated herein by reference.\n10(cc) Letter Agreement dated as of August 13, 1991, by and between the Corporation and Newell Co., included in the Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference.\n10(dd) Standstill Agreement dated as of September 24, 1991, between the Corporation and Newell Co., included in the Corporation's Current Report on Form 8-K dated September 25, 1991, is incorporated herein by reference.\n10(ee) Distribution Agreement dated September 9, 1994, by and between The Black & Decker Corporation, Lehman Brothers Inc., Citicorp Securities, Inc., Goldman, Sachs & Co., Morgan Stanley & Co. Incorporated, NationsBanc Capital Markets, Inc. and Salomon Brothers Inc., included in the Corporation's Current Report on Form 8-K filed with the Commission on September 9, 1994, is incorporated herein by reference.\n10(ff) Stock Purchase Agreement dated as of December 13, 1995, by and among The Black & Decker Corporation, PRC Investments Inc., PRC Inc. and Litton Industries, Inc.\n11 Computation of Earnings Per Share.\n12 Computation of Ratios.\n21 List of Subsidiaries.\n23 Consent of Independent Auditors.\n24 Powers of Attorney.\n27 Financial Data Schedule.\nAll other items are \"not applicable\" or \"none\".\n(b) Reports on Form 8-K The Corporation filed a Current Report on Form 8-K with the Commission on December 21, 1995. This Current Report on Form 8-K was filed pursuant to Item 5 of Form 8-K and reported the Corporation's definitive agreement to sell PRC Inc. to Litton Industries, Inc., for $425.0 million.\nAll other items are \"not applicable\" or \"none\".\n(c) Exhibits The exhibits required by Item 601 of Regulation S-K are filed herewith.\n(d) Financial Statement Schedules and Other Financial Statements (1) The Financial Statement Schedule required by Regulation S-X is filed herewith.\n(2) The following Unaudited Pro Forma Financial Information contemplated by Article 11 of Regulation S-X, reflecting the Corporation's sales of the businesses comprising its discontinued information technology and services segment, is filed herewith:\nPro Forma Statement of Earnings (Unaudited) - for the year ended December 31, 1995\nPro Forma Balance Sheet (Unaudited) - as of December 31, 1995\nThe Unaudited Pro Forma Financial Information set forth below is being provided in this Annual Report on Form 10-K in lieu of the filing of a separate Current Report on Form 8-K pursuant to Item 2 thereof.\nAs indicated above in Item 1 of Part I of this Annual Report on Form 10-K, during 1995 the Corporation sold PRC Realty Systems, Inc. and PRC Environmental Management, Inc. and entered into an agreement to sell PRC Inc. for $425 million to Litton Industries, Inc. On February 16, 1996, the Corporation completed the sale of PRC Inc. to Litton Industries, Inc. A copy of the Stock Purchase Agreement dated as of December 13, 1995, by and among the Corporation, PRC Investments Inc., PRC Inc., and Litton Industries, Inc. is being filed herewith as Exhibit 10(ff), and is incorporated herein by reference.\nUNAUDITED PRO FORMA FINANCIAL INFORMATION The Black & Decker Corporation and Subsidiaries\nThe Corporation completed the sale of PRC Inc. on February 16, 1996. The Corporation sold Realty Systems, Inc. (RSI) on March 31, 1995, and PRC Environmental Management, Inc. (EMI) on September 15, 1995. Together, PRC Inc., RSI, and EMI comprised the Corporation's discontinued information technology and services (PRC) segment.\nThe following unaudited Pro Forma Consolidated Statement of Earnings and Pro Forma Consolidated Balance Sheet are based on the historical Consolidated Statement of Earnings and Consolidated Balance Sheet of the Corporation, adjusted to reflect the sales of PRC Inc. and, for purposes of the Pro Forma Consolidated Statement of Earnings, RSI and EMI.\nThe unaudited Pro Forma Consolidated Statement of Earnings for the year ended December 31, 1995, presents the Corporation's results from continuing operations prior to the extraordinary loss on extinguishment of debt, adjusted to give effect to the sale of the discontinued PRC segment, assuming that the sales of PRC Inc., RSI, and EMI, and the reduction of the Corporation's debt with the proceeds therefrom, had taken place on January 1, 1995.\nThe unaudited Pro Forma Consolidated Balance Sheet as of December 31, 1995, presents the Corporation's financial position, adjusted to give effect to the sale of PRC Inc., assuming that the sale of PRC Inc., and the reduction of the Corporation's debt with the proceeds therefrom, had taken place on December 31, 1995. The proceeds received from the sales of RSI and EMI, and the associated debt reductions therefrom, are reflected in the Corporation's historical Consolidated Balance Sheet as of December 31, 1995.\nThe pro forma adjustments are based upon available information and certain assumptions that management believes are reasonable under the circumstances. The following unaudited pro forma financial information should be read in conjunction with the Corporation's historical Consolidated Financial Statements and notes thereto, included in Item 8 of Part II of this report. In addition, the following unaudited pro forma financial information is provided for informational purposes only, and is not necessarily indicative of what the actual results from continuing operations of the Corporation would have been had the sales of PRC Inc., RSI, and EMI and the associated debt reductions taken place on January 1, 1995, or what the actual financial position of the Corporation would have been had the sale of PRC Inc. and the associated debt reduction taken place on December 31, 1995. Further, the unaudited pro forma financial information does not purport to indicate the future results of operations or financial position of the Corporation.\n(a) The actual results shown herein reflect only those of the Corporation's continuing operations and exclude the extraordinary loss on extinguishment of debt that occurred during 1995. The operating results of PRC Inc., RSI, and EMI (collectively, the discontinued PRC segment) are reflected in earnings from discontinued operations in the Corporation's historical Consolidated Statement of Earnings included in Item 8 of Part II of this report. As a result, no adjustment to earnings from continuing operations is necessary to eliminate the operating results of the discontinued PRC segment.\n(b) To reflect the reduction of interest expense due to the following: (i) the Corporation's assumed repayment of $405.0 million of variable rate short- term borrowings with the proceeds from the sale of PRC Inc.; (ii) the Corporation's assumed repayment of $60.0 million of variable rate short-term borrowings with the proceeds from the sale of RSI; and (iii) the Corporation's assumed repayment of $35.5 million of variable rate short-term borrowings with the proceeds from the sale of EMI. In all cases, an assumed interest rate of 6.25% was used, which approximates the Corporation's weighted average interest rate on its domestic variable rate short-term borrowings during 1995. The effect on pro forma earnings from continuing operations of a 1\/8% variance in the assumed interest rate would be approximately $.5 million.\n(c) To reflect the income tax effect of adjustment (b) above at the Corporation's marginal tax rate for the tax jurisdictions affected. That marginal tax rate differs from the statutory tax rate as a result of the Corporation's net operating loss carryforwards. The Corporation's historical income tax expense of $9.0 million for the year ended December 31, 1995, includes a $65.0 million tax benefit ($.74 per share on a primary basis and $.69 per share on a fully diluted basis) due to the reduction of its deferred tax asset valuation allowance, a portion of which related to the anticipated gain on the sale of PRC Inc. For purposes of the Pro Forma Statement of Earnings, no pro forma adjustment was made to that $65.0 million tax benefit, since any such adjustment will not have a continuing impact on the Corporation.\n(a) To reflect the Corporation's receipt of cash proceeds from the sale of PRC Inc.\n(b) To reflect the Corporation's reduction of short-term borrowings upon receipt of the cash proceeds from the sale of PRC Inc.\n(c) To eliminate the net assets of discontinued operations.\n(d) To reverse the Corporation's deferred tax asset related to the gain on the sale of PRC Inc.\n(e) To reflect the accrual of expenses related to the sale of PRC Inc.\n(f) To reflect an estimated gain on the sale of PRC Inc., net of income taxes, in the amount of $85.0 million. The Corporation estimates that its net gain on the sale of PRC Inc. will be in the range of $80.0 to $90.0 million.\nPursuant to the requirements of Section 13 or 15(d) of the 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 BLACK & DECKER CORPORATION\nDate: February 29, 1996 By \/s\/ NOLAN D. ARCHIBALD ----------------- ---------------------- Nolan D. Archibald 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 29, 1996, by the following persons on behalf of the registrant and in the capacities indicated.\nSignature Title Date\nPrincipal Executive Officer\n\/s\/ NOLAN D. ARCHIBALD February 29, 1996 - ---------------------- ----------------- Nolan D. Archibald Chairman, President, and Chief Executive Officer\nPrincipal Financial Officer\n\/s\/ THOMAS M. SCHOEWE February 29, 1996 - --------------------- ----------------- Thomas M. Schoewe Vice President and Chief Financial Officer\nPrincipal Accounting Officer\n\/s\/ STEPHEN F. REEVES February 29, 1996 - --------------------- ----------------- Stephen F. Reeves Corporate Controller\nThis report has been signed by the following directors, constituting a majority of the Board of Directors, by Nolan D. Archibald, Attorney-in-Fact.\nNolan D. Archibald J. Dean Muncaster Barbara L. Bowles Lawrence R. Pugh Malcolm Candlish Mark H. Willes Alonzo G. Decker, Jr. M. Cabell Woodward, Jr. Anthony Luiso\n\/s\/ NOLAN D. ARCHIBALD Date: February 29, 1996 - ---------------------- Nolan D. Archibald Attorney-in-Fact","section_15":""}
{"filename":"101880_1995.txt","cik":"101880","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2 Properties 74, 55 Item 3","section_3":"Item 3 Legal Proceedings None 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 Common Equity and Related Shareholder Matters 60, 80, Back Cover Item 6","section_6":"Item 6 Selected Financial Data 13 Item 7","section_7":"Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 13-41 Item 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplementary Data Consolidated Financial Statements: Crestar Financial Corporation and Subsidiaries Consolidated Balance Sheets 42 Consolidated Statements of Income 43 Consolidated Statements of Cash Flows 44 Consolidated Statements of Changes in Shareholders' Equity 45 Notes to Consolidated Financial Statements 46-70 Independent Auditors' Report 71 Condensed Financial Information of Registrant 57, 60, 65-66 Selected Quarterly Financial Data 70 Item 9","section_9":"Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors (1) and Executive Officers of the Registrant 72, 73 Item 11","section_11":"Item 11 Executive Compensation (1) Item 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management (1) Item 13","section_13":"Item 13 Certain Relationships and Related Transactions (1)\nPART IV\nItem 14","section_14":"Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K: See Item 8 for a listing of all Financial Statements and Supplementary Data Reports on Form 8-K None Exhibits (2) 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 on February 23, 1996 by the undersigned, thereunto duly authorized.\nCRESTAR FINANCIAL CORPORATION, Registrant\n\/s\/John C. Clark III JOHN C. CLARK III, Corporate Senior Vice President, General Counsel and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on February 23, 1996 by the following persons in the capacities indicated.\n\/s\/Richard G. Tilghman RICHARD G. TILGHMAN, Chairman and Chief Executive Officer\n\/s\/James M. Wells III JAMES M. WELLS III, President\n\/s\/Richard F. Katchuk RICHARD F. KATCHUK, Corporate Executive Vice President and Chief Financial Officer\n\/s\/James D. Barr JAMES D. BARR, Group Executive Vice President, Controller and Treasurer\nA MAJORITY OF THE DIRECTORS OF THE REGISTRANT whose names appear on page 72.\n- ------------------------------------------------------------------------------- 1 This information is omitted pursuant to Instruction G of Form 10-K since the Registrant intends to file with the Commission a definitive Proxy Statement, pursuant to Regulation 14A, not later than 120 days after December 31, 1995.\n2 A list of Exhibits was filed separately. Copies of any Exhibits not contained herein may be obtained by writing to John C. Clark III, Secretary, Crestar Financial Corporation, 919 East Main Street, Richmond, VA 23261-6665.\nNOTE: Any information not included herein has been omitted because it is not applicable.\nSUPPLEMENTAL FINANCIAL INFORMATION Crestar Financial Corporation And Subsidiaries\nMATURITY AND RATE SENSITIVITY OF SELECTED LOANS\nTIME DEPOSITS $100,000 AND OVER December 31, 1995 In millions Maturity ----------------------------------------- 0-3 mos. 3-6 mos. 6-12 mos. over 1 yr. Total Certificates of deposit $100,000 and over $81.5 $12.3 $11.2 $ 11.2 $116.2 Domestic time deposits 17.2 25.4 36.6 103.0 182.2 - ------------------------------------------------------------------------------- Total $98.7 $37.7 $47.8 $114.2 $298.4 ===============================================================================\nMAXIMUM SHORT-TERM BORROWINGS In thousands Maximum Outstanding At Any Month End ------------------------------------------ 1995 1994 1993 Federal funds purchased $1,318,928 $1,522,138 $ 699,202 Securities sold under repurchase agreements 826,671 1,026,502 1,359,351 Federal Home Loan Bank borrowings 484,200 371,200 96,800 Notes payable 177,300 163,731 112,365 Term federal funds purchased - - 50,000 Other 5,200 4,660 39,318 ================================================================================\nSHORT-TERM BORROWINGS--AVERAGE BALANCES AND RATES\nCONSOLIDATED STATEMENTS OF INCOME (FIVE YEARS) AND SUPPLEMENTARY DATA Crestar Financial Corporation And Subsidiaries\nCONSOLIDATED AVERAGE BALANCES\/NET INTEREST INCOME\/RATES (1) Crestar Financial Corporation And Subsidiaries\n1 Income and yields are computed on a tax-equivalent basis using the statutory federal income tax rate exclusive of the alternative minimum tax and nondeductible interest expense\n2 Indicates earning asset or interest-bearing liability\n(continued)\n3 Nonaccrual loans are included in the average loan balances and income on such loans is recognized on a cash basis\n4 The tax-equivalent adjustment to net interest income was $11.3 million in 1995, $10.9 million in 1994, $12.6 million in 1993, $16.0 million in 1992 and $22.1 million in 1991.\nSELECTED RATIOS AND OTHER DATA Crestar Financial Corporation And Subsidiaries\n1 Tax-equivalent basis\n2 Loans which are both past due 90 days or more and not deemed nonaccrual due to an assessment of collectibility are specifically excluded from the definition of nonperforming\n3 Dividends declared per common share represent historical dividends per common share declared by Crestar Financial Corporation\nGENERAL INFORMATION Crestar Financial Corporation And Subsidiaries\nCORPORATE HEADQUARTERS Crestar Center 919 East Main Street, P.O. Box 26665 Richmond, Virginia 23261-6665 (804)782-5000 TELEX: 827420\nANNUAL MEETING The 1996 Annual Meeting of Shareholders will be held at 10:00 a.m. on Friday, April 26, 1996 in our Corporate Headquarters auditorium.\nCOMMON STOCK Crestar's common stock is traded on the New York Stock Exchange where our symbol is CF. Dividends are customarily paid on the 21st of February, May, August and November.\nQUARTERLY COMMON STOCK PRICES AND DIVIDENDS The high, low and last price of Crestar's common stock for each quarter of 1995 and 1994 and the dividends declared per share are shown below.\nMarket Price Quarter ---------------------- Dividends Ended High Low Last Declared March 31 $44 1\/4 $37 $44 $.40 June 30 49 1\/4 43 1\/8 49 .45 September 30 58 3\/8 47 3\/4 55 7\/8 .45 December 31 61 55 59 1\/8 .45 - ---------------------------------------------------- March 31 $46 $39 3\/8 $42 5\/8 $.33 June 30 49 1\/2 40 3\/4 45 1\/2 .40 September 30 49 3\/4 44 5\/8 45 5\/8 .40 December 31 45 5\/8 36 1\/8 37 5\/8 .40 ====================================================\nIn January 1996, a quarterly dividend on common stock of $.45 per share was declared.\nFINANCIAL INFORMATION To obtain financial information on Crestar, contact Eugene S. Putnam, Jr., Senior Vice President-Investor Relations and Corporate Finance, at the Corporate Headquarters, (804)782-5619.\nCORPORATE PUBLICATIONS Crestar's Annual Report and Form 10-K, Quarterly Reports and other corporate publications are available on request by writing or calling our Investor Relations Department at the Corporate Headquarters, (804)782-7152.\nSHAREHOLDER INFORMATION In you have questions about a specific stock ownership account, write or call our Investor Relations Department at the Corporate Headquarters, (804)782-7933.\nDIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN Common shareholders receive a 5% discount from market price when they reinvest their Crestar dividends in additional shares. Shareholders participating in the Plan can also make optional cash purchases of common stock at market price and pay no brokerage commissions. To obtain our Plan prospectus and enrollment card, write or call our Investor Relations Department at the Corporate Headquarters, (804)782-7933.\nCASH DIVIDEND DIRECT DEPOSIT Shareholders may elect to have their Crestar dividends directly deposited to a checking, savings or money market account. This service provides a convenient and safe method of receiving dividends and is offered at no cost to shareholders. To obtain additional information and an enrollment form, write or call our Investor Relations Department at the Corporate Headquarters, (804)782-7933.\n[RECYCLE LOGO] This annual report is printed on recycled paper.\nEXHIBITS\nThe following exhibits are filed with this form or are incorporated by reference in response to Item 14(c). Those exhibits not included herein are not applicable or the required information is shown in the Consolidated Financial Statements or the notes thereto.\n2(a) Agreement and Plan of Merger By and Between Crestar Financial Corporation and Loyola Capital Corporation dated May 16, 1995 (filed as Annex 1 to Registrant's Form S-4, Registration Statement No. 33-60637, and incorporated by reference herein).\n3(a) Restated Articles of Incorporation (filed as Exhibit 3(a) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n3(b) Bylaws as amended through September 22, 1995 (filed herewith).\n4(a) Indenture dated as of September 1, 1993 for subordinated debt securities (filed as Exhibit 4.1 to Registration Statement No. 33-50387 and incorporated by reference herein). Pursuant to his indenture, a series of $150,000,000 of 8 3\/4% subordinated Notes due 2004 have been issued, the terms of which are described in 4(g) below.\n4(b) Indenture dated as of February 1, 1985 for subordinated debt securities (filed as Exhibit 4(c) to Registrant's 1985 Form 10-K and incorporated by reference herein). Pursuant to this Indenture, a series of $50,000,000 of 8 5\/8% Subordinated Notes Due 1998 and a series of $125,000,000 of 8 1\/4% Subordinated Notes Due 2002 have been issued, the terms of which are described in 4(c) and 4(e) below.\n4(c) First Supplemental Indenture dated as of March 1, 1986 covering $50,000,000 of 8 5\/8% Subordinated Notes due 1998 (filed as Exhibit 4(b) to Registration Statement No., 33-4332 and incorporated by reference herein).\n4(d) Second Supplemental Indenture dated as of September 1, 1986 (filed as Exhibit 4.1 to Registrant's Form 8-K current report dated July 16, 1992 and incorporated by reference herein).\n4(e) Third Supplemental Indenture dated as of July 1, 1992 covering $125,000,000 of 8 1\/4% Subordinated Notes Due 2002 (filed as Exhibit 4(c) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n4(f) Rights Agreement dated June 23, 1989, between the Registrant and Mellon Bank, NA, as Rights Agent (filed as Exhibit 4.1 to the Registrant's Form 8-K current report dated June 23, 1989, and incorporated by reference herein).\n4(g) Board of Directors Resolutions approving issuance of $150,000,000 of 8 3\/4% Subordinated Notes due 2004 (filed as Exhibit 4(g) to Registrant's 1994 Form 10-K and incorporated by reference herein).\n10(a) Performance Equity Plan of United Virginia Bankshares Incorporated (filed as Exhibit 10(a) to Registrant's 1987 Form 10-K and incorporated by reference herein).\n10(b) Management Incentive Compensation Plan of Crestar Financial Corporation (filed as Exhibit 10(b) to Registrant's 1989 Form 10-K and incorporated by reference herein).\n10(c) Crestar Financial Corporation Executive Life Insurance Plan as amended and restated effective January 1, 1991 (filed as Exhibit 10(d) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n10(d) Crestar Financial Corporation Executive Welfare Plan (filed as Exhibit 10(d) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(e) Amendments (effective December 18, 1992) to Crestar Financial Corporation Executive Welfare Plan (filed as Exhibit 10(e) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(f) 1981 Stock Option Plan of Crestar Financial Corporation and Affiliated Corporations as amended through January 25, 1991 (filed as Exhibit 10(e) to Registrant's 1991 Form 10-K and incorporated by reference herein).\n10(g) Severance Agreement between the Corporation and Richard G. Tilghman dated February 23, 1996 (filed herewith).\n10(h) Severance Agreement between the Corporation and James M. Wells III dated February 23, 1996 (filed herewith).\n10(i) Severance Agreement between the Corporation and O. H. Parrish, Jr. dated February 23, 1996 (filed herewith).\n10(j) Severance Agreement between the Corporation and William C. Harris dated February 23, 1996 (filed herewith).\n10(k) Severance Agreement between the Corporation and C. Garland Hagen dated February 23, 1996 (filed herewith).\n10(l) Crestar Financial Corporation Executive Severance Plan, as amended and restated effective February 23, 1996 (filed herewith).\n10(m) Crestar Financial Corporation Excess Benefit Plan (filed as Exhibit 10(k) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(n) Amendments (effective December 18, 1992) to Crestar Financial Corporation Excess Benefit Plan (filed as Exhibit 10(m) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(o) United Virginia Bankshares Incorporated Deferred Compensation Program under Incentive Compensation Plan of United Virginia Bankshares Incorporated and Affiliated Corporations (filed as Exhibit 10(m) to Registrant's 1988 Form 10-K and incorporated by reference herein).\n10(p) Amendment (effective 1\/1\/87) to United Virginia Bankshares Incorporated Deferred Compensation Program Under Incentive Compensation Plan of United Virginia Bankshares Incorporated and Affiliated Corporations (filed herewith).\n10(q) Amendments (effective 1\/1\/87 and 1\/1\/88) to United Virginia Bankshares Incorporated Deferred Compensation Program Under Incentive Compensation Plan of United Virginia Bankshares Incorporated and Affiliated Corporations (filed herewith).\n10(r) Amendment (effective 1\/1\/94) to Crestar Financial Corporation Deferred Compensation Program Under Incentive Compensation Plan of Crestar Financial Corporation and Affiliated Corporations (filed herewith).\n10(s) Crestar Financial Corporation Deferred Compensation Plan for Outside Directors of Crestar Financial Corporation and Crestar Bank (filed as Exhibit 10(n) to Registrant's 1988 10-K and incorporated by reference herein).\n10(t) Amendments (effective April 24, 1991) to Crestar Financial Corporation Deferred Compensation Plan for Outside Directors of Crestar Financial Corporation and Crestar Bank (filed as Exhibit 10(p) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(u) Crestar Financial Corporation Additional Nonqualified Executive Plan (filed as Exhibit 10(n) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(v) Amendments (effective December 18, 1992) to Crestar Financial Corporation Additional Nonqualified Executive Plan (filed as Exhibit 10(r) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(w) Crestar Financial Corporation Benefit Assurance Plan (filed as Exhibit 10(p) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(x) Amendments (effective December 18, 1992) to Crestar Financial Corporation Benefit Assurance Plan (filed as Exhibit 10(v) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(y) Crestar Financial Corporation Supplemental Benefit Plan (filed as Exhibit 10(q) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(z) Amendments (effective December 18, 1992) to Crestar Financial Corporation Supplemental Benefit Plan (filed as Exhibit 10(x) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(aa) Deferred Compensation Plan for Selected Employees of United Virginia Bankshares Incorporated and Affiliated Corporations (filed as Exhibit 10(r) to Registrant's 1990 Form 10-K and incorporated by reference herein).\n10(ab) Amendment (effective January 1, 1987) to Deferred Compensation Plan for Selected Employees of United Virginia Bankshares Incorporated and Affiliated Corporations (filed as Exhibit 10(z) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(ac) Amendments (effective 1\/1\/87 and 1\/1\/88) to Deferred Compensation Plan for Selected Employees of United Virginia Bankshares Incorporated and Affiliated Corporations (filed herewith).\n10(ad) Amendment (effective 1\/1\/94) to Deferred Compensation Plan for Selected Employees of Crestar Financial Corporation and Affiliated Corporations (filed herewith).\n10(ae) Crestar Financial Corporation Premium Assurance Plan (filed as Exhibit 10(s) to Registrant's 1991 Form 10-K and incorporated by reference herein).\n10(af) Amendments (effective December 18, 1992) to Crestar Financial Corporation Premium Assurance Plan (filed as Exhibit 10(ab) to Registrant's 1992 Form 10-K and incorporated by reference herein).\n10(ag) Crestar Financial Corporation 1993 Stock Incentive Plan (filed as Exhibit 10(ad) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n10(ah) Amendments (effective October 27, 1995) to Crestar Financial Corporation 1993 Stock Incentive Plan (filed herewith).\n10(ai) Crestar Financial Corporation Directors' Stock Compensation Plan (filed as Exhibit 10(ae) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n10(aj) Crestar Financial Corporation Temporary Executive Benefit Plan as amended through December 18, 1992 (filed as Exhibit 10(af) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n10(ak) Crestar Financial Corporation Permanent Executive Benefit Plan as amended through December 18, 1992 (filed as Exhibit 10(ag) to Registrant's 1993 Form 10-K and incorporated by reference herein).\n10(al) Crestar Financial Corporation Supplemental Executive Retirement Plan, effective January 1, 1995 (filed herewith).\n21 Subsidiaries (filed herewith).\n23 Consent of KPMG Peat Marwick LLP (filed herewith).\nNote: All Item 10 documents represent Executive Compensation Plans or Arrangements, or Amendments thereto.","section_15":""}
{"filename":"277809_1995.txt","cik":"277809","year":"1995","section_1":"ITEM 1: BUSINESS - -----------------\nOverview - --------\nComparator Systems Corporation started life as a manufacturer of biometric identity verification systems utilizing the fingerprint to confirm people's identities. The Company is one of the pioneers in the Biometrics Industry. It has been engaged in the development, manufacture and marketing of fingerprint-based identity verification systems since its initial public offering in 1979.\nIn the 1980s the Company introduced and marketed its first-generation fingerprint comparison system, the Comparator Model ID-1, to the law enforcement market. That device was designed primarily for use in jails and prisons, to verify that the right prisoner was being released. Model ID-1 systems have been in continuous use across the country for many years, and have had the backing and endorsement of police and prison officials. ID-1's have the unique distinction that, in what is now estimated to be over 1,000,000 cumulative prisoner identity verifications, not one error by an ID-1 has ever been reported by a law enforcement customer. The ID-1, however, was a relatively high-cost electro-optical-mechanical system that required an operator, and the use of hard-copy inked fingerprints.\nThe Company therefore initiated further research to develop a computerized identity verification system that would retain the reliability and the ruthless accuracy of the Model ID-1, but that would incorporate instantaneous \"live-scan\" fingerprint comparison and networking capability. This program led to the development of successive generations of engineering prototypes, culminating in the development of an entirely new software-driven technology for an identity verification system that now meets all of Comparator Systems Corporation's technical and price criteria.\nMeanwhile, Comparator Systems Corporation's view of itself has been evolving as it has become clear that the Company's core products - identity verification devices - are, in effect, \"yes\" or \"no\" switches that authorize a transaction to proceed, or not. In this context, a transaction may be any one of innumerable interactions between or among people, ranging from the release of a prisoner, to withdrawing cash from an ATM, gaining access to a nuclear plant, logging-on to a computer network, crossing a border, verifying the identity of an unconscious surgical patient, making a credit card purchase, boarding an aircraft, entering a hotel room, applying for welfare benefits, or cashing a check. The Company is actually now in the transactions processing business, only one aspect of which is transaction authentication.\nCompany History - ---------------\nThe Company was formed in California July 12, 1976 and reincorporated in Colorado October 12, 1978. Prior to the summer of 1979, the Company had engaged only in limited engineering and development of a fingerprint comparison system. In July, 1979 the Company obtained the net proceeds of approximately $799,000 of an initial public offering of 10,000,000 shares of its one cent par value common stock at 10 cents per share. By 1981 the proceeds of the IPO had been fully disbursed and the Company's founding president was forced to withdraw from\nactive participation due to health problems. During the following years the Company had continuous and increasing difficulty in raising working capital and sustaining operations under a succession of three presidents.\nIn 1983 a new Chairman and President was recruited, and through personal investments of his, and loans to the Company guaranteed by him, limited working capital was obtained from time to time. In 1984 the Company was able to complete production engineering of the prototypes of its Model ID-1 Comparator. It established a production facility, and initiated manufacturing and limited sales of its first-generation system, although it was financially unable to mount a full-scale marketing program.\nIn 1987 the Company obtained additional working capital and in 1987 and 1988 was able to initiate its first significant marketing program of the Model ID-1 to law enforcement customers. The Company obtained excellent acceptance of the product from police throughout the country, but due to chronic insufficiency of capital experienced by law enforcement customers, and to the long lead-time in completing sales to them resulting from their annual budgeting procedures, the Company was not financially able to sustain its marketing effort long enough to achieve a positive cash flow.\nDuring this period, the Company also determined that commercial customers required a faster and more automated product than the ID-1, and it therefore chose to redirect its limited capital from marketing the ID-1 into development of a successor system. Due to continued intermittent working capital shortages, operational progress moved more slowly than would have otherwise been possible.\nIn 1992, at the invitation of Dr. Mahathir, the Prime Minister, the Company established operations in Malaysia, and temporarily relocated its senior management and key scientists to Kuala Lumpur, the capital. There, with financial backing from Malaysian investors, development moved ahead quickly of the Company's new fingerprint comparison technology. In 1993 a manufacturing plant was established in Petaling Jaya, a suburb of Kuala Lumpur, Malaysia by a joint venture company owned by Comparator Systems Corporation and the Malaysian investors.\nIn October 1993 it was discovered that the Company's vice president administration\/corporate secretary, an employee of ten years standing who had been acting general manager during the president's absence in Malaysia, had misappropriated an estimated $830,000 in stock and cash. Her services were terminated, a criminal complaint was lodged with the Irvine, California Police Department, and, in light of these developments, the Company reorganized its internal operations and initiated new administrative controls in an effort to preclude the possibility of similar problems occurring in the future. As an apparent consequence of the misappropriation, together with a crash of the Kuala Lumpur stock market in 1994, the Malaysian investment was halted, and the Company was forced to close-down operations there and return to the United States.\nSubsequently the Company has been negotiating with major funding sources to replace the lost Malaysian financing, while product engineering efforts have been progressing at a reduced rate, commensurate with the funds available to the Company.\nOn June 1, 1995 the Company retained Richard E. Floegel as its new President and Chief Operating Officer. Robert Reed Rogers, who joined the Company in 1983, remains as Chairman and CEO.\nSubsequent to the end of fiscal year 1995, the Company acquired, through a purchase of assets for cash and stock, International Financial Systems, Inc. (IFSI), which is operated as a wholly-\nowned subsidiary. IFSI markets integrated operating systems to the banking industry in the United States and in Central America. IFSI's operating systems include proprietary software of its own design integrated with computers and peripheral equipment of other manufacturers. The Company believes that its own fingerprint comparison software can readily be incorporated into IFSI's operating software to provide biometric identification capability to new banking industry customers, as well as to IFSI's existing customers on a retrofit basis.\nThe Company's Products - ----------------------\nProducts produced by or for the Company at this point include its original core product line of proprietary automated fingerprint identity verification systems, as well as identification cards, electronic time and attendance systems, and accounting software and integrated operating systems for the banking industry.\nThe Company's biometric identification products include:\n. Comparator 4000 electro-optical single fingerprint scanner, capable of capturing in less than one second a high-resolution fingerprint image, and transmitting it to a PC or to a remote site, for full finger viewing or subsequent processing.\n. Comparator 5000 transaction processing terminal, employed either as a peripheral for PCS or as a fingerprint acquisition terminal on a local or wide area network, utilizing external processing.\n. Comparator 5500 fully-integrated transaction terminal capable of acquiring a \"live\" fingerprint image, processing and storing the image data either internally or in a remote data base, and comparing the stored image data with that of a subsequent live finger presented for identity verification, and with a fingerprint stored on an identification card by an ID-1 has ever been reported.\nAdditionally, in 1995 Comparator Systems Corporation secured distribution rights for a recently-developed multi-tasking, software-driven time and attendance system (the 1990's version of what used to be known as a time clock) and is in the process of incorporating its fingerprint identification technology into the system.\nAlso, International Financial Systems markets fully-integrated operating systems and accounting software for the banking industry, including credit unions and savings and loans across the United States and in Central America. IFSI provides an open door into the banking industry for Comparator Systems Corporation, whose fingerprint comparison software can readily be integrated with IFSI's installed operating systems software to provide financial institutions with transaction authentication capability.\nThe Market For Biometric Identification - ---------------------------------------\nGrowing worldwide concern with issues such as military security, terrorism, industrial security, narcotics trade, computer fraud, border control, alien movement control, forgery, credit card fraud, inmate control, mis- identification of medical and psychiatric patients, tax evasion and internal fraud in financial institutions is creating a rapidly growing demand for positive personal\nidentification products and methods.\nBiometrics methods presently used or being developed include visual recognition by guards; photographs; personal identification numbers (\"PINs\") or other secret codes; identification cards; fingerprints; retina prints; hand geometry; voice prints; gait analysis; handwriting analysis; brainwave analysis; and qualitative analysis of body tissues and fluids. Generally speaking, the less exotic the technology used, the less certain is the identification, but the more exotic the technology used, the greater is the cost, the complexity, the inconvenience, the risk of injury and the resistance of users to the identification procedure. Among the identification procedures available or being developed, however, fingerprint verification stands alone in several respects:\n. The fingerprint is absolutely unique to each individual, yet it is relatively convenient, easy, noninvasive and quick to obtain.\n. Properly utilized, the fingerprint is virtually impossible to forge, and its use is not affected by the memories of individuals, or changes with age.\n. Fingerprinting does not involve physical discomfort or a real or perceived danger to the subject, and it is the only positive identification method which has been in use extensively enough to be a broadly-accepted procedure.\nThe major drawback of fingerprinting as a generally-useful identification procedure has until recently been the necessity that highly- trained experts be employed to visually compare fingerprints, in the absence of practical technologies to perform the task.\nThere are two basic uses of the fingerprint as an identification method:\n. Criminal Justice\/Forensic Systems for the comparison of the fingerprint of an --------------------------------- unknown person (e.g. a latent print found at the scene of a crime) with the recorded fingerprints of many known persons, in order to identify the unknown person. This has been the traditional use of fingerprinting by law enforcement agencies, employing experts trained in such comparisons. Such systems are generally multi-million dollar, skilled labor intensive, dedicated mainframes.\n. Identity Verification Systems for the authentication of the identity of a ----------------------------- \"known\" person by comparing his or her freshly-taken fingerprint with one previously taken and stored for future reference. This use of fingerprinting was not practical for commercial applications in the past due to the limited availability of fingerprint technicians and to the high cost of employing them in this manner if they had been available. Even so, the INS has required a fingerprint on the resident alien identification card, and some banks have required fingerprints on the backs of checks, as a psychological deterrent.\nIdentity Verification applications exist wherever one or another of multiple parties are required to prove or verify their identity. Typical applications include:\n. Welfare benefits . Social Security\/Provident Fund benefits . National identification cards . Passports, resident alien identification cards . Drivers licenses\n. Aircraft boarding control . Credit and debit cards . Restricted area access . Electronic or data access . Patient ID, drug access control . Insurance benefits identification . Employee time and attendance verification\nComparator Systems Corporation has specialized since its founding in identity verification systems. These are access control\/transaction control systems used to verify whether an entry matches a designated record. A finger is scanned and the collected data is compared with data stored in system memory or on a card. No search is normally performed, since the task of these systems is to perform only a one-to-one comparison, allowing an individual access to an area or to an electronic system (e.g. computer or network) if a scanned finger matches the individual's stored finger data.\nCompetition - -----------\nThe three largest of the known fingerprint systems producers serve the Criminal Justice\/Forensic System market, producing specialized dedicated \"AFIS\" (Automated Fingerprint Identification System) computers, costing from $1,000,000 to over $30,000,000, designed to accelerate the processing by law enforcement agencies of fingerprint comparisons of unknown persons with computerized fingerprint files. This is not a market in which the Company participates, and these manufacturers represent potential, but not immediate competition.\nThe market for Identity Verification Systems was until recently mainly a potential market, with limited actual industry sales. In the Company's opinion, this was due in part to the fact that reliable, accurate and cost effective biometric identification systems were not available to prospective users, and in part to perceived public resistance to the use of fingerprint identification. In the past several years this market has begun to expand rapidly, and a growing, but still small number of firms worldwide is believed to be in the business of developing or marketing fingerprint identification systems. The largest of these firms, however, are systems integrators that do not themselves possess biometric identification systems, and must subcontract with firms such as Comparator Systems Corporation for this technology.\nSeveral firms other than the Company have pursued the development of Identity Verification Systems, typically employing \"minutiae\" technology to digitize and store fingerprint details for later retrieval and comparison with real-time fingerprints. The Company, in contrast to its competitors, does not employ minutiae comparison, but rather employs proprietary image processing comparison technology for comparing entire prints with each other. Based on such information as it has, the Company believes that certain features of the its own products, including durability, simplicity, and, above all, high accuracy, constitute significant competitive advantages.\nSome of the companies referred to above are believed to have substantially larger financial resources than does the Company. There are also several firms producing identification devices based on other biometric methods such as signature dynamics, hand geometry, retinal vasculature or voice characteristics of the person to be identified. The Company does not know whether such devices may ultimately be competitive with its products, but believes that the most significant competitive factors in the field are and will be accuracy, price, ease of operation, reliability and non-\ninvasiveness. The Company believes it is in a position to compete effectively with respect to these factors. Name recognition may also be significant, and although the names of the Company's competitors have been better known than that of the Company, the reputation of the Comparator product has credibility, particularly in the law enforcement community, whose endorsement the Company feels will be valuable as it enters other markets.\nMarketing - ---------\nIn the past, the Company's primary customers have been law enforcement agencies, and the nature of marketing new, pioneering products required that the Company employ a direct sales force rather than relying on dealers and distributors.\nThe Company's new commercially-oriented products are useful in such a wide variety of applications that it is necessary to use a variety of distribution methods to reach prospective customers. Major government and commercial accounts are handled either directly by Company sales executives, or through strategic alliances with larger companies, or through subcontractor relationships with systems integration companies. Other markets, such as industrial security and time and attendance are reached through distributors and dealers. Markets such as the ATM market are reached through OEM relationships.\nIn preparation for completion of production engineering of its new product line, the Company has begun reconfirming prior distribution relationships and establishing new ones, and has several such agreements in the United States and overseas in place. It is believed that substantial investment in marketing and sales, beyond what has been financially possible in the past, and completion of production engineering of its new products, will be required for the Company to achieve sustained profitability. There can be no assurance that the Company will be able to achieve this result.\nManufacturing and Supply - ------------------------\nIn the late 1980's the Company closed the manufacturing facility it had established and operated in Costa Mesa, California for production of its Model ID-1, and in 1994, with the cessation of its funding in Malaysia, the Company vacated the manufacturing plant it had established there to manufacture its new products. The passage of NAFTA has opened up attractive new possibilities for manufacturing in Mexico. Negotiations are currently in progress, although no decision has been made and no manufacturing agreements have yet been formally executed.\nThe Company's production involves the assembly and testing of the various components and sub-components used in its products. These include electronic circuit boards, switches, transformers, optical assemblies, and other components purchased from independent suppliers. Certain key items are manufactured in-house or are fabricated by independent contractors to the Company's specifications. There are presently qualified suppliers for all required parts and services.\nIndustry Segment - ----------------\nThe Company is not presenting revenue and operating profit or loss by industry segment since it has not yet produced significant sales and earnings in any segment.\nEmployees - ---------\nThe Company had thirteen employees and or part-time consultants in the United States as of June 30, 1995. As of the date hereof, the Company has twenty-two employees and\/or part-time consultants. See Items 7 and 11 below, for information regarding the discharge of the Company's obligations to employees for unpaid past compensation.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTY - -----------------\nThe Company leases office and engineering space in Newport Beach, California. The present space of approximately 5,900 square feet is leased by the Company under a five year lease, with a average annual rental of $71,004, beginning October 1993.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS - --------------------------\nOn June 30, 1995, the Company was a judgment debtor in approximately 27 cases in which judgments against the Company had become final, with an aggregate unsatisfied judgment debt of approximately $323,526 and accrued interest of $155,028.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nPART II -------\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - -----------------------------------------------------------------------------\na. The Company's common stock is traded over the counter on NASDAQ. For the period beginning June 30, 1993 and ending August 30, 1994, the approximate high and low inter-dealer bid quotations were as set forth below. The source of such quotation data is the National Quotation Bureau, Inc. Such prices are without retail markup, markdown or commission and may not necessarily represent actual transactions.\nb. The approximate number of record holders of the Company's common stock at August 1, 1995 was 8,245.\nc. The Company has never paid any cash dividends on its common stock and intends to retain earnings, if any, to finance the development and expansion of its business. The future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, capital requirements and the financial condition of the Company.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA - --------------------------------\nFiscal Years Ended June 30 (Dollars Except Per Share Data)\nSee \"Financial Statements\" below. The Company will incur a substantial loss for the Fiscal Year ended June 30, 1994.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATION ------------\nLiquidity, Capital Resources and Results of Operation - -----------------------------------------------------\nThe Company has since its inception been essentially engaged in research and development and in the limited sale of its biometric identification products. It was not in the past able to generate from operations sufficient income to meet the Company's need for cash, and material losses have been generated in each period since inception. The net proceeds of the Company's $1,000,000 initial public offering in 1979 were employed primarily for the development of engineering prototypes of the Company's first-generation product, the Comparator Model ID-1, and were essentially expended by 1981. From 1981 until September 1987, at which time the Company closed a $2,550,000 private placement, the Company had no capital resources excepting only erratic and occasional funds generated by private sales of common stock and loans from officers and other persons interested in the Company. Subsequent to 1987, liquidity remained a problem as the Company attempted to stretch its working capital in order to fund its market research, new product development, product field testing, in preparation for initiation of operations that could generate sales sufficient to cover operating expenses. Some vendors of the Company were not paid, and the Company was for the most part not able to pay its officers, employees and consultants, except by issuance of stock as consideration for products and services.\nIn 1992 and 1993 the Company entered into agreements with investors in Malaysia to establish a jointly-owned company to manufacture the Company's products for worldwide sale. Subsequently, the Company's top management and key scientists, relocated to Malaysia, were successful in developing new technology supporting a new software-driven generation of Comparator products. The Malaysian investors also subscribed to purchase a substantial block of the Company's common stock. They paid-in ten percent of the agreed-upon investments, before discontinuing their financial participation in 1994, as described above.\nSubsequent to that time the Company has been preserving its financial resources, while negotiating with others for funding to replace the Malaysian financing.\nPrivate Placements - ------------------\nThe proceeds from funds received as a result of its past private placements have been used to defray costs of US operations, including product research and development, market testing and preparation for initiating full- scale marketing efforts upon availability of marketable product. Proceeds from the latest For its private placements, the Company has relied on various exemptions from registration under applicable securities laws, including the private placement exemption under Regulation D and Section 4(4) of the Securities Act.\nOther Commitments to Issue Stock - --------------------------------\nDuring the fiscal year ended June 30, 1993, no stock was issued for employee salaries; 49,199,817 shares were issued for services of $511,002; and 5,128,666 shares were issued for debt reduction of $84,896.\nDuring the fiscal year ended June 30, 1994, 37,002,828 shares were issued in consideration of accrued salaries of $615,570; 12,779,683 shares of stock were issued in consideration of services of $582,437; and debtors accepted 19,393,157 shares in consideration of $317,886.\nDuring the fiscal year ended June 30, 1995, 24,596,273 were issued to pay accrued salaries of $721,323; 5,595,749 shares were issued to pay debt of $138,296; and 797,097 shares were issued for services of $14,501.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe Financial Statements included herein are attached following the signature page of this report.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE --------------------\nNone.\nPART III --------\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY - ---------------------------------------------------------\nAt June 30, 1995, the following were the directors and executive officers of the Company. Directors serve until the next annual meeting of shareholders and until their successors have been elected and qualified. The officers are serving pursuant to employment agreements described under Item 11","section_11":"Item 11 below.\nAmbassador Maxwell M. Rabb joined the Company as Honorary Chairman of the Board in April, 1991. Among his positions with the US Government, he served for nine years as US Ambassador to Italy, for presidents Reagan and Bush. He is a graduate of Harvard University and Harvard Law School.\nRobert Reed Rogers has been President of the Company since August, 1983. Previously he was variously President of The Protcus Group, Inc; President of Kensington Associates, Inc.; Group Vice President, American Electric, Inc.; President, North American subsidiaries, Muirhead & Co., Ltd.; Manager of Planning, Industrial Group, Litton Industries, Inc.; Consultant, McKinsey & Co., Inc., Faculty Member, Department of Business and Economics, Illinois Institute of Technology; and C.O., Training Aids Department, U.S. Ninth Naval District.\nFred Bezold has been employed by the Company since January 1986. Prior to that time he was variously President of Technical Development Industries; President, Westel, Inc.; VP Marketing, Data Memory, Inc.; VP and General Mgr., Ralph M. Parsons Electronics, XVP, Eicor, Inc.\nGregory Armijo has been employed by the Company since September, 1987. Before joining the Company he had seven years experience in management with retail, service industry, and telecommunications industries.\nRichard E. Floegel has been employed by the Company since June, 1995. For the previous six years he was Vice President Operations of Adaptive Information Systems, a Hitachi Group company. Before that he was Director of Product Sales for Laser Magnetic Storage International, and Director of product Marketing for Control Data Corporation.\nITEM 11: EXECUTIVE COMPENSATION - --------------------------------\nDuring the Company's fiscal years ended June 30, 1993, 1994 and 1995, respectively, none of the executive officers of the Company had cash compensation equal to or which exceeded $60,000 per year.\nSince January 1, 1995, the compensation of the Company's current executive officers and key employees is as follows, subject to the agreements described below:\nDuring the fiscal year ended June 30, 1995, 24,596,273 shares were issued to reduce accrued salaries of employees by $721,323.\nDuring the fiscal year ended June 30, 1994, 37,002,828 shares were issued to reduce total salaries accrued and common stock payable of $615,570.\nDuring the fiscal year ended June 30, 1993, no shares were issued to reduce salaries of employees.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND - ---------------------------------------------------------------------------- POTENTIAL CHANGE IN CONTROL ---------------------------\nSecurity Ownership Of Certain Beneficial Owners. - ------------------------------------------------\nThe following table shows the ownership of common stock by persons other than members of management owning more than 5% of the 564,344,703 outstanding shares as of June 30, 1995. Unless otherwise indicated, all persons have voting and investment power over the shares listed as beneficially owned by them in the table.\nSecurity Ownership of Management. - --------------------------------\nThe following table shows the ownership of common stock by directors, and all directors and executive officers as a group, as of June 30, 1995. The percentages given under \"Percentage of Class Owned\" are based on a total of 564,344,703 shares outstanding. Unless otherwise indicated, all persons have voting and investment power over the shares listed as beneficially owned by them in the table.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nDuring the fiscal year ended June 30, 1993, the Company issued to its officers shares of its common stock based on performance and not in cancellation of accrued or unpaid salaries. The dollar balance represents unpaid salary accounts at June 30, 1993.\nDuring the fiscal year ended June 30, 1994, the Company issued to its officers shares of its common stock in cancellation of accrued or unpaid salaries. The dollar balance represents unpaid salary accounts at June 30, 1994.\nDuring the fiscal year ended June 30, 1995, the Company issued to its officers shares of its common stock in cancellation of accrued and unpaid salaries. The dollar balance represents unpaid salary accounts at June 30, 1995.\nPART IV -------\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------\n(a) The following financial information for the Registrant for the fiscal years ended June 30, 1995, 1994 and 1993 is filed as part of this report.\n(1) Financial Statements Index\nAll other schedules are omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Financial Statements and noted thereto.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company had duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOMPARATOR SYSTEMS CORPORATION\nBy: \/s\/ ROBERT REED ROGERS ---------------------------------- Robert Reed Rogers, CEO and Treasurer\nDate: September 20, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nBy: \/s\/ ROBERT REED ROGERS Date: September 20, 1995 ------------------------------ Robert Reed Rogers, Director, Chairman of the Board, CEO and Treasurer\nBy: \/s\/ GREGORY ARMIJO Date: September 20, 1995 ------------------------------ Gregory Armijo, Vice President and Corporate Secretary\nCOMPARATOR SYSTEMS CORPORATION\nAll other Schedules are omitted since the required information is not present in amounts sufficient to require submission of the Schedule, or because the information required is included in the financial statements and noted thereto\nELI BUCHALTER ACCOUNTANCY CORPORATION REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT\nTo the Board of Directors Comparator Systems Corporation Irvine, California\nI have examined the balance sheets of Comparator Systems Corporation as of June 30, 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 June 30, 1995. 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 audit.\nI conducted my audit in accordance with generally accepted auditing standards. Those standards require that I plan and perform the audit to obtain reasonable assurance about whether the Financial Statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Financial Statements. 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 audit provides a reasonable basis for my opinion.\nIn my opinion the aforementioned Financial Statements present fairly in all material respects the financial position of Comparator Systems Corporation 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 30th, 1995, in conformity with generally accepted accounting principles.\nThe accompanying Financial Statements have been prepared on a going-concern basis which contemplates continuity of operations and realization of assets and liquidation of liabilities in the ordinary course of business. Because of significant operating losses, the Company's ability to continue in existence is dependent upon the attainment of future profitable operations and obtaining adequate financing. The Financial Statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.\n\/s\/ Eli Buchalter ----------------------- Eli Buchalter Accountancy Corporation\nSeptember 20, 1995 Los Angeles, California\nCOMPARATOR SYSTEMS CORPORATION\nBALANCE SHEETS\nJUNE 30\nASSETS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS\nCOMPARATOR SYSTEMS CORPORATION\nBALANCE SHEETS\nJUNE 30\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS\nCOMPARATOR SYSTEMS CORPORATION\nSTATEMENT OF OPERATIONS\nYEARS ENDED JUNE, 30\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS\nCOMPARATOR SYSTEMS CORPORATION\nSTATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS\nCOMPARATOR SYSTEMS CORPORATION\nSTATEMENT OF CASH FLOWS\nFOR THE FISCAL YEARS ENDED JUNE 30\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS\nCOMPARATOR SYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nDESCRIPTION OF BUSINESS - The Company was organized to exploit, through ----------------------- licensing and manufacturing rights, patented technology for a fingerprint comparison device.\nAlthough the Company has had limited sales activity, with the passage of time to develop this technology, the Company is no longer considered a development stage enterprise.\nBASIS OF FINANCIAL STATEMENTS - The accompanying financial statements have ----------------------------- been prepared on a going-concern basis which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. The Company has an operating history of losses.\nManagement is of the opinion that with the infusion of additional capital, the Company can achieve profitable operations. However, no assurance can be given that the Company will be able to fully develop, establish and market the technology so as to generate profitable operations. Continuation of the Company as a going concern is dependent upon future funding.\nPROPERTY AND EQUIPMENT - Property and equipment are carried at cost. ---------------------- Depreciation is computed using the straight line method over a five to seven- year life. 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 recognized in income for the period. The cost of maintenance and repairs is charged to income as incurred; significant renewals and betterments are capitalized. Deduction is made for retirements resulting from renewals or betterments.\nPATENTS AND LICENSES - Patents and licenses are being amortized over a 17 -------------------- year period using the straight-line method and are carried at cost, less accumulated amortization.\nINVENTORY VALUATION - Inventories are valued at the lower of cost or market ------------------- on a first-in, first-out basis.\nINCOME TAX - The Company has not provided for income taxes as, in the ---------- opinion of management, no taxes are due except for minimal amounts applicable to certain states. Investment tax credits are recognized when the related tax benefits are realized.\nREVENUE RECOGNITION - The Company recognizes revenue when a machine is sold ------------------- and approved by its customer.\nNET LOSS PER SHARE - Net loss per share is calculated using the weighted ------------------ average number of shares outstanding and authorized to be issued during the applicable period.\n2. JUDGEMENT AND CLAIMS PAYABLE AND SETTLEMENT -------------------------------------------\nThe Company during the past fiscal years incurred obligations which it failed to liquidate under the terms of the related agreements or open account. Various creditors have filed lawsuits in an attempt to perfect their claims. In most instances they received judgements for the amounts claimed plus interest and certain costs related to the litigation. The Company during the current period was attempting to negotiate settlements at reduced amounts with these creditors. In certain instances the Company has been successful. The amount reflected in the financial statements reflect the total amounts claimed plus costs or the settled amounts which remained unpaid as of the applicable date.\nDuring the fiscal year 1995, the Company negotiated settlements of certain debt aggregating reductions of $5,369; during 1994, the amount was $78,644: during 1993, the amount was $127,704.\nCOMPARATOR SYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS\n3. INVENTORIES -----------\nInventories comprised the following:\n4. PATENTS -------\nOn March 30, 1977 the Company's predecessor, Comparator Systems Corporation (a California Corporation) entered into an agreement with Harold Green, (hereinafter referred to as \"Green\") then a major shareholder, officer and director, to be the exclusive licensee of the U.S. Patents on the Comparator Systems, in consideration of shares of its common stock.\nOn January 4 1983, August 30, 1983 and May 30, 1985, the license agreement was modified and extended and a new exclusive license agreement was reached replacing all previous agreements and granting the Company the sole and exclusive right to manufacture, distribute, sell and otherwise exploit the devices described in the licensed patents and any other devices invented by licenser, which are used or useful for the purposes described above.\nThe license was to terminate on the expiration of the term of the last of the U.S. Patents to expire, which occurred on September 27, 1993. Minimum royalties were $50,000 per year against five percent (5%) of defined gross revenues derived by the Company from sales or other dispositions of the licensed devices and related services and accessories.\nDuring each of the three years ended June 30th, 1990, the Company charged the minimum annual royalty of $50,000 to expense. No royalty was accrued during fiscal year 1993, 1994 or 1995, as none was due. $42,000 has been accrued as royalty payable, since 1990.\nThe Company was informed in April 1987, that a third party, Strategic Asset Recovery Group, Inc., (a Nevada Corporation), (hereinafter referred to as \"SARG\") had purchased the two patents licensed to the Company. \"SARG\" claimed that the Company had breached the license agreement and sought to terminate the license agreement. On April 24 1987, the Company filed an action against \"SARG\" and various individuals and corporations affiliated with \"SARG\". The Company sought and was granted injunctive relief and requested damages for wrongful interference with the Company's prospective advantages and business relations. On May 26, 1987, the defendants filed a cross-complaint against the Company and certain officers for breach of the license agreement, seeking declaratory relief, termination of the license agreement and an accounting. On June 11, 1987, the court preliminary enjoined \"SARG\" and other defendants, among other things, to attempt to terminated the license agreement.\nBy letter of intent dated April 20, 1989, and agreement dated July 13, 1989, and closed October 4, 1989, Strategic Asset Recovery Group, Inc., Ronald Froelich and Harold Green entered into a settlement with the Company of the above law suits and negotiated terms upon which the Company acquired all the right, title and interest in the two United States Patents (No. 3,928,842 dated December 23, 1975 and No. 3,982,836 dated September 28, 1976 and certain foreign patents) all pertaining to the optical comparison of patterns such as fingerprints. In addition,\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\n4. PATENTS (CONTINUED) -------------------\nthe Company acquired exclusive sub license agreements from TRI-G Associates, Ltd. (a California Limited Partnership) concerning the development, manufacture, use and sale of products described in United States Patent No. 4,829,166 dated May 9, 1989, for a computerized data bearing card and reader\/writer therefore; and in United States Patent Application No. 286214 filed December 19, 1989, regarding major security through a digitized fingerprint, known as the \"Intelligent Card\". In addition, Ronald Froelich assigned all of his right, title and interest in and to that certain United States Patent No. 4,690,554 dated September 1, 1987, and foreign patents regarding the development and manufacture of stand alone fingerprint comparison device using advanced technology to compare two fingerprints.\nAs a result of these agreements, the Company paid Ronald Froelich the sum of $10,125 plus accrued interest at June 30, 1989 of $4,299. In addition, Ronald Froelich was to be retained to render research and development services to be compensated at the rate of $3,000 per month and $90 per hour for services in excess of 33 hours during any calendar month in connection with the development and manufacturing of The Enhanced Comparator Fingerprint Device. The Company also reimbursed Ronald Froelich $23,502 as reimbursement for costs and expenses advanced by Ronald Froelich in the development of the Intelligent Card. No payments were made to Ronald Froelich during the fiscal year 1993, 1994 or 1995.\nPreviously, Ronald Froelich had granted Tri-G Associates, Ltd. (a California Limited Partnership) an exclusive license agreement to manufacture, distribute, use, lease, sell and otherwise exploit the technology concerning Froelich's \"Enhanced Version of the Comparator ID-1 Device\" and the \"Intelligent Card\". Subject to earned royalties and a minimum royalty payment of $12,500 per quarter. By agreements dated July 13, 1989, these rights were sub licensed to the Company, in consideration of a payment of $25,000 and subject to the royalty payments, the Company has authorized issuance to Tri-G of 46,109,903 shares (being 9,221,981 shares as a result of the one for five reverse stock split in August 1990) of common stock as consideration for all the exclusive agreement rights valued at $1,613,847.\nThe consideration, other than the cash payments which had been accrued for financial reporting at June 30, 1989, were paid through issuance of stock as follows:\nThe original license agreement was capitalized at $225,586. During the Fiscal Year Ended June 30, 1989 the Company acquired all of Mr. Green's rights outstanding for an additional capitalization of $55,000.\nDuring December 1989 TRI-G Associate, Ltd were authorized to receive 46,109,903 shares of Common Stock for the exclusive license agreement (now being 9,221,981 shares).\nLegal counsel for TRI-G Associates, Ltd., a California Limited Partnership amended the terms of the July 13, 1989, agreement and which has been extended by TRI-G and COMPARATOR, and accordingly, the exclusive of the partnership has been extended and the shares issuable under the agreement is 9,221,981, to reflect the one for five reverse stock split. These shares had been issued in May 1994.\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\n4. PATENTS (CONTINUED) -------------------\nCapitalized Costs and accumulated amortization for the past three years was as follows.\n5. PROPERTY AND EQUIPMENT ----------------------\nProperty and equipment consists of the following:\n6. INCOME TAXES ------------\nAs of June 30, 1995, the Company has net operating loss carry forwards of approximately $15,700,000 available to reduce future federal taxable income which expire in the years 1995 through 2009. During the next three years; $245,409 will expire in 1995, and $576,586 will expire in 1996 and $434,889 will expire in 1997.\n7. COMMITMENTS AND CONTINGENCIES -----------------------------\nLEASE - In October, 1993, the Company moved to new quarters under a 5-year ----- lease providing for an annual rental of $77,965. At June 30, 1995 the Company owed $47,162 for the lease at 18552 MacArthur Blvd., Irvine, California; and, owed $38,010 for the office space at 2862 McGaw Avenue, Irvine, California; and, $35,168 for the office space at 16591 Millikan Avenue, Irvine, California.\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\n7. COMMITMENTS AND CONTINGENCIES (CONTINUED) -----------------------------------------\nAGREEMENTS WITH EMPLOYEES - Employees have agreed to accept stock for accrued ------------------------- salaries payable; during fiscal year 1993, no stock was issued for employee salaries. During fiscal year 1994, 37,002,828 shares were issued in consideration of $615,570. During fiscal year 1995, 24,596,273 shares were issued in consideration of $721,323.\nAGREEMENTS WITH CONSULTANTS AND DEBTORS - During fiscal year 1993, consultants --------------------------------------- agreed to accept stock for accrued and current services; 41,824,120 shares of stock in consideration of services of $470,855. During fiscal year 1994, consultants accepted 12,779,683 shares of stock in consideration of services of $582,437; During fiscal year 1994 debtors accepted 19,393,157 shares of stock in consideration of $317,886. During fiscal year 1995, consultants accepted 5,595,749 shares of stock in consideration of services of $138,296. During fiscal year 1995, debtors accepted 797,097 shares in consideration of $14,501.\nEMPLOYMENT AGREEMENTS - On December 31, 1993, the Company extended the existing --------------------- Employment Agreements, which have various completion dates. Each contract contains the following Common conditions:\na. Provide a Stock Option Program b. The Company shall provide a reasonable automobile allowance. c. The Company shall reimburse the employee for reasonable entertainment, travel, and similar items, subject to review and approval of the Board of Directors. d. The Company will provide dental and health insurance for the employee and his or her immediate family, and to include term life insurance.\nThe following compensation was effective 1995:\n8. COMMON STOCK, STOCK OPTIONS, WARRANT AND OTHER COMMITMENTS TO ISSUE STOCK -------------------------------------------------------------------------\nIn March, 1989, a majority of shareholders of the Company voted to increase the authorized common stock from 250,000,000 shares to 500,000,000 shares, and authorized 50,000,000 shares of a $5.00 par value Preferred Stock. In December 1989, a majority of shareholders voted to increase the authorized common stock from 500,000,000 shares to 750,000,000 shares.\n9. INVESTMENT IN VALCORP, INC. ---------------------------\nThe Company acquired a 49.76% investment interest in a New Jersey based company engaged in the nationwide sale of x-ray film and supplies. Their sales for the fiscal year ended December 31, 1988 (Audited) reflected sales $6,954,786 with a net loss of $539,298 for the year. The carrying value was based on 49.76% of shareholders equity at December 31, 1987, as adjusted to the fiscal year audit for the period ended December 31, 1988. Valcorp markets its product through dealers who may provide a ready-made distribution system for planned medical identification systems to be made by the Company.\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\nINVESTMENT IN VALCORP, INC.(CONTINUED) --------------------------------------\nThe Company issued 328,006 shares of its five dollar par non-voting, non- dividend paying convertible preferred stock. The preferred stock issued was converted at a price of fifteen cents ($0.15) per share of common stock. This preferred stock was converted by negotiation to 7,993,533 shares of pre-split common stock, being 1,598,707 post-split shares by letter agreement dated April 16, 1990. The carrying value of this asset held for investment is $407,950.\nSince the inception of the investment in Valcorp, the Company has never had any influence in managerial or financial activities in Valcorp. Therefore, the Company elects to carry Valcorp investment at cost method rather than the equity method.\nINVESTMENT IN TRUST DEEDS -------------------------\nThe Company acquired three first trust deeds on acreage in Spotsylvania, Virginia, in consideration of the issuance of 9,833,333 shares of one cent par value common stock valued at three cents ($0.03) per share, for a purchase cost of $295,000. The trust deeds carried an interest rate of 12%. Two of the trust deeds required the owner to make quarterly payments of princeipal and interest of $3,000 until payment of the principal sum of $112,500,000. Two notes covers 25 lots, with release clauses of $5,000 per lot. The payments were current. In May, 1993 the trust deeds were converted into 250,000 shares of a preferred stock of the debtor. The trust deeds were cancelled. The preferred stock carries a six percent dividend and rights of conversion.\nINVESTMENT IN WIRA ASSETS -------------------------\nIn November, 1993 the Company acquired Wira Assets Sdn Bhd in consideration for the issuance of 5,000,000 shares of one cent par value common stock valued at ten cents ($0.10) per share, for a purchase cost of $500,000. The acquisition of Wira Assets Sdn Bhd gave the Company an 25% of Carini Sdn Bhd which, in turn, owned 60% of Comparator Systems Malaysia. Effectively giving the Company a controlling interest (55%) in Comparator Systems Malaysia.\n10. LEGAL PROCEEDINGS -----------------\nAt June 30, 1995, the Company was a debtor in approximately 27 cases in which judgements against the Company had become final, with an aggregate unsatisfied judgement debt of $323,526 principal and accrued interest of $155,028. All of these cases has been finalized. Eight(8) other cases for a total of approximately $300,000 are in dispute and have not been finalized.\n11. PREPAID FEES ------------\nUnder a compensation agreement, an independent contractor was retained to perform consulting services on Russian sales and marketing for the Company, for a term of ten years, with a right to extend. The initial payment of $400,000 was in the form of ten million shares of restricted one cent par value common stock. This retainer will be amortized over the life of the contract. In addition, the contractor will receive a commission of fourteen percent (14%) on each one million dollars of sales, not to exceed a payment of three million five hundred thousand dollars during the initial ten year term. During fiscal year 1993, the Board of Directors authorized management and key employees to be issued forty two million shares as a bonus contingent on the closing of the joint venture manufacturing and financing agreements in Malaysia. The value of the restricted one cent par value was capitalized at $420,000. This value will be amortized over five years.\n12. NOTES RECEIVABLE ----------------\nDuring fiscal year 1989, the Company advanced funds to a non-affiliate to be prepaid within one year, at twelve percent interest. The note was carried as a current asset in the financials for fiscal year 1990. The note was not paid timely,\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\nhowever management extended the due date. The note has been reclassified in the balance sheet to \"Other Assets.\" It is management's opinion that the note will be paid in full, with accrued interest.\n13. INVESTMENT NOTES PAYABLE ------------------------\nDuring the period from March 26 through June 30, 1991, the Company borrowed funds from individuals on an individual basis which provided the investor with a share of the Company's restricted common stock based on three cents ($0.03) per share and a note due in one year for the principal amount plus thirty three and one-third percent (33 1\/3%) interest payable in a lump sum on the due date. The principal amount recorded was recorded as a prepaid interest, accrued as an expense on a quarterly amortization basis to interest expense. At June 30, 1995 the outstanding notes were in default.\nAt June 30, 1991, the total notes amounted to $47,500 principal (received by the Company) and the stipulated interest to be paid was $15,829. The total accrual, being $63,329, was amortized at June 30, 1991 as $7,811 interest expense. The prepaid interest of $55,518 was recorded in the deposits and prepaid expenses, to be amortized quarterly. The total of the principal and stipulated interest is recorded in the liabilities as investment notes payable. Prepaid interest has been expensed in Fiscal Year 1992. The total amount past due at June 30, 1995 was $31,431.\n14. NOTES PAYABLE-OTHERS --------------------\nThe Company has executed promissory notes to twelve (12) individuals for funds to be used in operations in fiscal year 1990 and before. All of these notes are past due along with accrued interest at 10% per annum.\n15. ACCOUNTS PAYABLE AND ACCRUED EXPENSES -------------------------------------\nThese two accounts represents accruals at the end of the fiscal year for costs of operations and administration that remain unpaid.\n16. OFFICER EMBEZZLEMENT\/IMPROPER ISSUANCE OF STOCK -----------------------------------------------\nThe Company has terminated the services of it's Corporate Secretary\/Vice President Administration, due to misconduct on her part. In October, 1993, the Company became aware of several unusual and suspicious financial transactions involving this Officer and placed her on administrative leave pending an internal investigation. The Company retained independent outside legal counsel to conduct this investigation and also instituted an internal audit of its banking activities and stock issuances. Although this investigation is still continuing, the Company has reluctantly concluded that this Officer has improperly issued Comparator stock to herself, her family, and her friends, without knowledge of the Company's President or Board of Directors. In addition to these unauthorized issuances, the Company's investigation suggests that this Officer has misapplied Company funds to satisfy personal obligations. The Company currently estimates the value of the misappropriated stock to be $747,778 and the cash to be $97,201. The Company was able to recover $100,000 of these stock issuances.\nA complaint against the Officer has been filed with the Irvine Police Department. The Company has also recently been successful in obstructing the proposed transfer of some of the misappropriated shares from the Officer to a third party. The Company is currently weighing all available options to recoup any and all damages suffered on account of the Officer's activities, including the filing of a civil action against her and other possible defendants.\nCOMPARATOR SYSTEMS CORPORATION NOTES TO THE FINANCIAL STATEMENTS\n17. CURRENT EVENTS --------------\nSubsequent to the end of the fiscal year 1995, the Company acquired, through a purchase of assets, International Financial Systems, Inc., a supplier of integrated hardware\/software operating systems to the banking industry. IFSI has an existing customer base of credit union and cooperative customers in the United States and in Central America. The Company's fingerprint comparison software can readily be integrated with IFSI's operating system software, to provide new banking industry customers with fingerprint identity verification capability as well as to provide IFSI's existing customer base with biometric identification on a retrofit basis. IFSI is operated as a wholly-owned subsidiary of the Company.\nEND OF NOTES TO THE FINANCIAL STATEMENTS\nELI BUCHALTER ACCOUNTANCY CORPORATION\nTo the Board of Directors Comparator Systems Corporation Irvine, California\nMy examinations were made for the purpose of forming an opinion on the basic Financial Statements taken as a whole. The supplementary information for the years ended June 30, 1995, 1994, 1993, is presented for purposes of additional analysis and is not a required part of the basic Financial Statements. My opinion covering the basic Financial Statements (page) describes an uncertainty regarding the realizability of the assets and the carrying value in the Financial Statements. The supplementary information has been subjected to the auditing procedures applied in the examination of the basic Financial Statements and, in my opinion, subject to the effects of the information presented or any adjustments, if any, as might have been required had the resolution of such matters discussed above been known, is fairly stated in all material respects in relation to the basic Financial Statements taken as a whole.\n\/s\/ ELI BUCHALTER ----------------------- Eli Buchalter Accountancy Corporation\nSeptember 20, 1995 Los Angeles, California\nCOMPARATOR SYSTEMS CORPORATION STATEMENT OF SUPPLEMENTARY INFORMATION FOR THE YEARS ENDED JUNE 30\nELI BUCHALTER ACCOUNTANCY CORPORATION\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT\nThe report on the financial statements of Comparator Systems Corporation for the year ended June 30, 1995 is included in this Form 10-K. In connection with my examination of such Financial Statements, I have also examined the related Financial Statement Schedules V, VI, and X for the three years ended June 30, 1994 and 1993.\nIn my 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, in conformity with generally accepted accounting principles applies on a consistent basis.\n\/s\/ Eli Buchalter ------------------------------------- Eli Buchalter Accountancy Corporation\nSeptember 20, 1995 Los Angeles, California\nCOMPARATOR SYSTEMS CORPORATION SCHEDULE V - PROPERTIES EQUIPMENT IMPROVEMENTS\nCOMPARATOR SYSTEMS CORPORATION SCHEDULE VI - ACCUMULATED DEPRECIATION PROPERTIES, EQUIPMENT IMPROVEMENTS","section_15":""}
{"filename":"785940_1995.txt","cik":"785940","year":"1995","section_1":"Item 1. Business\n(a) \tGeneral Development of Business\nParticipating Development Fund 86, A Real Estate Limited Partnership (the \"Partnership\"), was formed on December 9, 1985 under the Uniform Limited Partnership Act of the State of Connecticut. The Partnership was originally formed to make five participating investments by entering into land purchase leaseback transactions and concurrently funding leasehold mortgage loans secured by commercial and multi-family residential real estate (the \"Participating Investments\"). The Partnership made its Participating Investments in the following five properties (the \"Properties\" or individually a \"Property\"): Sunnyvale R&D, a one-story research and development building located in Sunnyvale, California; Foothills Tech Plaza, two research and development\/service buildings in Phoenix, Arizona; Harris Pond Apartments, a 170-unit luxury apartment complex in Charlotte, North Carolina; Pebblebrook Apartments, a 267-unit luxury apartment complex in Overland Park (Kansas City), Kansas; and 1899 Powers Ferry Road, a four-story office building located in Atlanta, Georgia. The Participating Investment in Harris Pond Apartments was sold on November 1, 1989. As a result of defaults under ground leases on the Sunnyvale, Phoenix, Atlanta and Overland Park Properties, the Partnership took title to these Properties in their entirety. The Partnership anticipated liquidating its remaining investments within seven years from their respective dates of funding, however, competitive market conditions limited favorable sales opportunities. The Partnership does not plan to invest in any additional property.\nOn June 15, 1992, Phoenix Realty Management, Inc., (\"Phoenix\") sent a notice of resignation as co-General Partner of the Partnership to PDF86 Real Estate Services Inc. (\"RE Services\" or the \"General Partner\"), formerly Shearson Lehman Brothers\/PDF 86, Inc. (See Item 10. \"Certain Matters Involving Affiliates of RE Services\"), the Partnership's other co-General Partner. The effective date of the resignation was June 16, 1992. As a result of the resignation of Phoenix, RE Services, as sole General Partner, manages the affairs of the Partnership.\nFoothills Tech Plaza was sold on September 29, 1995 for $10,011,512, net of $226,000 in contracted roof repairs. Additional information regarding the sale is incorporated by reference to the section entitled \"Message to Investors\" and Note 3 \"Real Estate Investments\" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\nOn May 11, 1995, the General Partner executed a letter of intent with an unaffiliated third party to sell Pebblebrook Apartments. During the 1995 third quarter, the prospective buyer rescinded its offer. However, the General Partner subsequently agreed to a letter of intent with another unaffiliated third party to sell Pebblebrook Apartments, and on January 31, 1995 the General Partner executed a purchase and sale agreement for a sales price of $10,570,000, net of commissions. The sale was originally expected to close in late January, 1996 and was subsequently posponed until March, 1996. However, during the due diligence period, the prospective buyer raised certain concerns regarding the physical condition of the Property. While negotiations are continuing and the General Partner remains confident that the sale will be successfully concluded, there is no assurance that an agreement can be reached with the buyer concerning the remaining issues. Therefore, it remains possible that the sale will be further delayed or possibly not close at all.\nAdditional information regarding the historical development of business is incorporated by reference to Note 1 \"Organization,\" Note 2 \"Accounting Policies\" and Note 3 \"Real Estate Investments\" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\n(b)\tFinancial Information About Industry Segment\nThe Partnership's sole business is the ownership and operation of the Properties. All of the Partnership's revenues, operating profit or losses and assets relate solely to such industry segment.\n(c)\tNarrative Description of Business\nIncorporated by reference to Note 1 \"Organization\" and Note 3 \"Real Estate Investments\" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\n(d) Competition\nIncorporated by reference to the section entitled \"Property Profiles & Leasing Update\" contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\n(e)\tEmployees\nThe Partnership has no employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nDescription of Properties and material leases incorporated by reference to the \"Property Profiles & Leasing Update\" and Note 3 \"Real Estate Investments\" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995, filed as an exhibit under Item 14.\nItem 3.","section_3":"Item 3. Legal Proceedings\nDiscussion regarding class action settlement agreement incorporated by reference to Note 7 \"Litigation\" of Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended 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 Unit Holders during the fourth quarter of 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters\n(a)\tMarket Information\nThere is no established trading market for the Units of the Partnership.\n(b)\tHolders\nAs of December 31, 1995, there were 7,759 holders of record, owning an aggregate of 1,124,000 Units.\n(c)\tDistributions\nA discussion of cash distributions paid to the Limited Partners for the two years ended December 31, 1995 is incorporated by reference to the section entitled \"Message to Investors\" contained in the Partnership's Annual Report To Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated by reference to the section entitled \"Financial Highlights\" contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources - ------------------------------- Foothills Tech Plaza was sold to an unaffiliated third party on September 29, 1995 for $10,011,512, net of $226,000 in contracted roof repairs. The gain on disposition of the property totaled $1,088,860. In anticipation of the sale of Pebblebrook Apartments, the property was reclassified, in the amount of $7,780,273, to \"Real estate assets held for sale\" on the Partnership's balance sheet. Land, buildings and improvements, net of accumulated depreciation, decreased by $17,452,829 from December 31, 1994 to December 31, 1995 primarily as a result of the Foothills Tech Plaza sale and reclassification of Pebblebrook Apartments.\nAt December 31, 1995, the Partnership had cash and cash equivalents of $1,480,034 compared with $140,886 at December 31, 1994. The increase is primarily attributable to proceeds from the sale of Foothills Tech Plaza and net cash provided by operating activities in excess of cash distributions paid to Partners. The cash and cash equivalents balance includes amounts reserved for capital and tenant improvements, leasing costs, working capital reserves and cash flow generated from operations of the properties. The Partnership also maintains a restricted cash balance, which is comprised of tenant security deposits. Restricted cash totaled $100,286 at December 31, 1995, compared with $152,162 at December 31, 1994. The decrease is primarily due to the sale of Foothills Tech Plaza.\nPrepaid expenses totaled $273,681 at December 31, 1995, compared with $389,472 at December 31, 1994. The decrease is primarily the result of the amortization of leasing commissions associated with the lease-up of Powers Ferry in 1994 and the sale of Foothills Tech Plaza in 1995. Incentives to lease were $188,693 at December 31, 1995 compared to $283,555 at December 31, 1994. The decrease is largely the result of the amortization of a lease buyout at Powers Ferry Office Building. Deferred rent receivable totaled $193,634 at December 31, 1995, compared to $269,701 at December 31, 1994. The decrease is largely due to the write-off of deferred rent resulting from the sale of Foothills Tech Plaza.\nAccounts payable and accrued expenses totaled $133,022 at December 31, 1995, compared with $323,897 at December 31, 1994. The decrease primarily is due to a reduction in accrued lease incentives relating to a lease buyout at Powers Ferry Office Building. Security deposits payable totaled $100,286 at December 31, 1995, compared to $152,162 at December 31, 1994. The decrease is mainly due to the sale of Foothills Tech Plaza. Prepaid rent totaled $79,555 at December 31, 1995, compared to $4,085 at December 31, 1994. The increase is largely attributable to the timing of rental payments.\nThe General Partner has determined that an adequate cash reserve exists to fund anticipated tenant improvement costs and leasing commissions associated with leasing efforts at the Properties, and pay cash distributions to the Limited Partners. For the year ended December 31, 1995, the Partnership declared cash distributions to the Limited Partners totaling $9.79 per Unit. Included in this total was a special distribution in the amount of $8.59 per Unit which was paid on November 24, 1995 and represented proceeds from the sale of Foothills Tech Plaza, and a fourth quarter cash distribution of $0.30 per Unit which was paid on February 9, 1996. In addition, on March 29, 1996 the Partnership paid a special cash distribution in the amount of $.55 per Unit. The distribution was made from the Partnership's cash reserves. The timing and amount of future distributions will depend on several factors, including the adequacy of rental income being generated by current leases and Partnership cash flow.\nOn February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. \"Change of Control\" means any purchase or offer to purchase more than 10% of the Units that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a form 8-K disclosing this resolution on February 23, 1996.\nResults of Operations\n1995 Versus 1994 - ---------------- Partnership operations resulted in net income of $2,662,237 for the year ended December 31, 1995, compared with net income of $1,449,548 for the corresponding period in 1994. The increase in net income in 1995 is primarily attributable to the gain on the sale of Foothills Tech Plaza in the amount of $1,088,860.\nRental income totaled $4,397,667 for the year ended December 31, 1995, compared to $4,387,259 for the year ended December 31, 1994. The increase is primarily attributable to higher average occupancy at Powers Ferry Office Building and higher rental rates at Pebblebrook Apartments and Powers Ferry Office Building, partially offset by the sale of Foothills Tech Plaza. Interest income totaled $142,161 for the year ended December 31, 1995, compared to $11,912 for the year ended December 31, 1994. The increase is largely due to the Partnership's higher average cash balance in 1995 resulting from the sale of Foothills Tech Plaza. Other income totaled $8,807 for the year ended December 31, 1995, compared to $189,508 for the year ended December 31, 1994. The decrease is mainly attributable to the receipt of a lease cancellation fee at Powers Ferry Office Building in 1994.\nProperty operating expenses totaled $1,403,161 for the year ended December 31, 1995, relatively unchanged from $1,407,195 for the year ended December 31, 1994. Depreciation and amortization totaled $1,358,528 for the year ended December 31, 1995, compared to $1,513,099 for the year ended December 31, 1994. The decrease is primarily attributable to a lower depreciable asset base resulting from the sale of Foothills Tech Plaza. The Partnership recognized bad debt expense for the year ended December 31, 1994 totaling $16,905 reflecting the write-off of a former tenant's receivable balance.\nAs of December 31, 1995, the lease levels at each of the properties were as follows: Powers Ferry Office Building - 94%; Sunnyvale R&D - 100%; and Pebblebrook Apartments - 96%.\n1994 Versus 1993 - ---------------- Partnership operations resulted in net income of $1,449,548 for the year ended December 31, 1994, compared with net income of $931,882 for the corresponding period in 1993. The increase in net income in 1994 is primarily attributable to higher rental income and other income in 1994, as well as lower general administrative, bad debt and depreciation expenses. These were offset by lower interest income and higher property operating expenses.\nRental income totaled $4,387,259 for the year ended December 31, 1994, compared with $3,990,962 in 1993. The increase in 1994 is primarily attributable to a rental rate increase at Sunnyvale, increased occupancy at Powers Ferry, scheduled rental rate increases at Pebblebrook and a tenant taking occupancy at Foothills. Other income was $189,508 for the year ended December 31, 1994, compared to $67,093 for the year ended December 31, 1993. The increase of $122,415 is due primarily to the receipt of a tenant's cancellation fee at Powers Ferry. Interest income totaled $11,912 for the year ended December 31, 1994 compared with $42,812 in 1993, reflecting the Partnership's lower average cash balances.\nProperty operating expenses totaled $1,407,195 for the year ended December 31, 1994, compared to $1,206,605 in 1993. The $200,590 increase is primarily due to higher real estate taxes at the Pebblebrook property and higher repairs and maintenance, payroll, administrative and utility expenses at the Powers Ferry and Pebblebrook properties. Depreciation and amortization expense totaled $1,513,099 for the year ended December 31, 1994, compared with $1,690,501 in 1993. Depreciation and amortization expense was lower for the twelve month period in 1994 due to certain assets becoming fully depreciated during 1994, primarily at the Sunnyvale and Pebblebrook properties.\nAs of December 31, 1994, the lease levels at each of the properties were as follows: Foothills Tech Plaza - 100%; 1899 Powers Ferry Road - 91%; Sunnyvale R&D - 100%; and Pebblebrook Apartments - 97%.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIncorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit 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\nThe General Partner of the Partnership is PDF86 Real Estate Services Inc. (\"RE Services\"), formerly Shearson Lehman Brothers, Inc.\/PDF 86, Inc., an affiliate of Lehman Brothers Inc. (\"Lehman\"). See a section captioned \"Certain Matters Involving Affiliates of RE Services\" for a description of the sale of certain of Shearson Lehman Brothers, Inc. (\"Shearson\") domestic retail brokerage and asset management business to Smith Barney, Harris Upham & Co. Incorporated, which resulted in a change in the general partner's name. Brief descriptions of the business experience of the directors and officers of the General Partner are provided below. Each of the directors of the General Partner is elected annually. There is no family relationship among any of the persons currently serving as directors or officers of the General Partner.\nCertain officers and directors of RE Services are now serving (or in the past have served) as officers and directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought the protection of bankruptcy laws to protect the partnership's assets from losses through foreclosure.\nThe executive officers and directors of RE Services are listed below.\nName Office ---------- ------------- Kenneth L. Zakin President and Director William Caulfield Vice President and Chief Financial Officer Lawrence M. Ostow Vice President \t Kenneth L. Zakin, 48, is a Senior Vice President of Lehman Brothers Inc. and has held such title since November 1988. He is currently a senior manager in Lehman Brothers' Diversified Asset Group and was formerly group head of the Commercial Property Division of Shearson Lehman Brothers' Direct Investment Management Group responsible for the management and restructuring of limited partnerships owning commercial properties throughout the United States. From January 1985 through November 1988, Mr. Zakin was a Vice President of Shearson Lehman Brothers Inc. Mr. Zakin is a director of Lexington Corporate Properties, Inc. He is a member of the Bar of the State of New York and previously practiced as an attorney in New York City from 1973 to 1984 specializing in the financing, acquisition, disposition, and restructuring of real estate transactions. Mr. Zakin is a member of the Real Estate Lender's Association and is currently an associate member of the Urban Land Institute and a member of the New York District Council Advisory Services Committee. He received a Juris Doctor degree from St. John's University School of Law in 1973 and a B.A. degree from Syracuse University in 1969.\nWilliam Caulfield, 36, is a Vice President of Lehman Brothers Inc. and is responsible for investment management of commercial real estate in the Diversified Asset Group. Prior to the Shearson\/Hutton merger in 1988, Mr. Caulfield was a Senior Analyst with E.F. Hutton since October 1986 in Hutton's Partnership Administration Group. Before joining Hutton, Mr. Caulfield was a Business Systems Analyst at Eaton Corp. from 1985 to 1986. Prior to Eaton, he was an Assistant Treasurer with National Westminster Bank USA. Mr. Caulfield holds a B.S. degree in Finance from St. John's University and an M.B.A. from Long Island University - C.W. Post Campus.\nLawrence M. Ostow, 28, is a Vice President of Lehman Brothers and is responsible for the management of commercial real estate in the Diversified Asset Group. Mr. Ostow joined Lehman Brothers in September 1992. Prior to that, Mr. Ostow was a Senior Consultant with Arthur Andersen & Co. in the Real Estate Services Group, beginning in July 1990. Mr. Ostow is a candidate for an M.B.A. from the Stern School of Business in 1997 and earned a B.A. degree in Economics from the University of Michigan in 1990.\nCertain Matters Involving Affiliates of RE Services - --------------------------------------------------- On July 31, 1993, Shearson Lehman Brothers, Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the Partnership's General Partner. However, the assets acquired by Smith Barney included the name \"Shearson.\" Consequently, the Shearson Lehman Brothers\/PDF 86, Inc. general partner changed its name to PDF86 Real Estate Services Inc. to delete any reference to \"Shearson.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nThe General Partner and its Affiliates have received certain fees, commissions and reimbursements for expenses incurred as provided for on pages 13 through 17 of the Prospectus which are contained under \"Management Compensation\" (See Exhibit 3 incorporated herein by reference). The General Partner is entitled to receive a share of cash distributed when and as cash distributions are made to Unit Holders and a share of taxable income or taxable loss, and may be reimbursed for certain out-of-pocket expenses. In addition, the General Partner is entitled to receive various fees and distributions during the liquidation stages of the Partnership. Descriptions of such fees, distribution allocations, and reimbursements is incorporated by reference to Note 5 \"Transactions with Related Parties\" and Note 6 \"Partners' Equity\" of the Notes to Financial Statements. Certain officers and directors of the General Partner are employees of Lehman Brothers Inc. and are not compensated by the Partnership or the General Partner for services rendered in connection with the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security of Ownership of Certain Beneficial Owners\nNo person (including any \"group\" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) is known to the Registrant to be the beneficial owner of more than five percent of the outstanding voting Interests as of December 31, 1995.\n(b) Security Ownership of Management\nNo officer or director of the General Partner beneficially owned or owned of record directly or indirectly any Interests as of December 31, 1995.\n(c) Changes in Control\nNone.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(a) Transactions With Management and Others\nIncorporated by reference to Note 3 \"Real Estate Investments,\" Note 5 \"Transactions with Related Parties\" and Note 6 \"Partners' Equity\" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)(i) Index to Financial Statements\nBalance Sheets at December 31, 1995 and 1994 (1)\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 (1)\nStatements of Partners' Capital (Deficit) for the Years Ended December 31, 1995, 1994 and 1993 (1)\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 (1)\nNotes to the Financial Statements (1)\nIndependent Auditors' Report (1)\n(a)(ii) Financial Statement Schedule\nIndependent Auditors' Report on Schedule III \t Schedule III - Real Estate and Accumulated Depreciation\n(1) Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1995.\n(b) Reports on Form 8-K filed in the fourth quarter of 1995:\nThe Partnership filed a report on Form 8-K on October 12, 1995 regarding the sale of Foothills Tech Plaza. \t (c) See Exhibit Index contained herein.\nExhibit Number\n3 - Agreement of Limited Partnership of Participating Development Fund 86, A Real Estate Limited Partnership. Reference is made to Exhibit A of the Prospectus (the \"Prospectus\") contained in Amendment No. 2 to Registrant's Form S-11 Registration Statement filed with the Securities and Exchange Commission on December 20, 1985 (the \"Registration Statement\").\n13 - Annual Report to Unitholders for the year ended December 31, 1995.\n27 - Financial Data Schedule\nPursuant to the requirements of Section 13 or 15(d) of the 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\nPARTICIPATING DEVELOPMENT FUND 86\nBY: PDF86 Real Estate Services Inc. General Partner\nBY: \/s\/Kenneth L. Zakin Name: Kenneth L. Zakin Title: Director and President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nPDF86 REAL ESTATE SERVICES INC. General Partner\nDate: March 29, 1996 BY: \/s\/Kenneth L. Zakin Kenneth L. Zakin Director and President\nDate: March 29, 1996 BY: \/s\/William Caulfield William Caulfield Vice President and Chief Financial Officer\nDate: March 29, 1996 BY: \/s\/Lawrence M. Ostow Lawrence M. Ostow Assistant Vice President\nINDEPENDENT AUDITORS' REPORT\nThe Partners Participating Development Fund 86:\nUnder date of February 16, 1996 we reported on the balance sheets of Participating Development Fund 86 (a Connecticut 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 to unit holders. These 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 financial statements, we also have audited the related financial statements 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 the financial statement schedule based on our audits.\nIn 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.\nKPMG Peat Marwick LLP\nBoston, Massachusetts February 16, 1996\nPARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership)\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nInitial Cost to Partnership\nBuildings and Description Encumbrances (1) Land Improvements\nCommercial Property:\nSunnyvale R&D Building Sunnyvale, CA -- $6,336,962 $4,848,999\n1899 Powers Ferry Road Office Building Marietta, GA -- 2,050,628 6,774,215\n8,387,590 11,623,214 Real Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS -- 2,095,205 8,118,985\n$10,482,795 $19,742,199\nPARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership)\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nCost Capitalized Subsequent To Acquisition --------------\nBuildings and Description Improvements (3) Retirements\nCommercial Property:\nSunnyvale R&D Building Sunnyvale, CA $3,141,469 $(2,976,402)\n1899 Powers Ferry Road Office Building Marietta, GA 2,189,066 (1,282,863)\n5,330,535 (4,259,265)\nReal Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS 863,301 (1,250,320)\n$6,193,836 $(5,509,585)\nPARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership)\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nGross Amount at Which Carried at Close of Period --------------------------\nBuildings and Accumulated Description Land Improvements Total(1) Depreciation(2)\nCommercial Property:\nSunnyvale R&D Building Sunnyvale, CA $6,336,962 $5,014,066 $11,351,028 $(1,369,338)\n1899 Powers Ferry Road Office Building Marietta, GA 2,050,628 7,680,418 9,731,046 (2,314,185)\n8,387,590 12,694,484 21,082,074 (3,683,523)\nReal Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS 2,095,205 7,731,966 9,827,171 (2,046,898)\n$10,482,795 $20,426,450 $30,909,245 $(5,730,421)\nPARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership)\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed\nCommercial Property:\nSunnyvale R&D Building Sunnyvale, CA 8\/86 8\/28\/86 5 - 35 years\n1899 Powers Ferry Road Office Building Marietta, GA 2\/86 7\/7\/87 5 - 35 years\nReal Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS N\/A 9\/4\/86 5 - 35 years\n(1) For Federal Income Tax Purposes, the aggregate cost of land, building and improvements is $40,039,600.\n(2) For Federal income tax purposes, the amount of accumulated depreciation is $3,630,345.\n(3) Tenant improvements are depreciated over the terms of the respective leases.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended December 31, 1995, 1994 and 1993:\nReal Estate Investments: 1995 1994 1993\nBeginning of year $42,595,901 $46,380,563 $46,170,294 Additions 211,470 1,691,770 493,591 Less Retirements (33,151) (5,476,432) (283,322) Dispositions (11,864,975) 0 0\nEnd of year $30,909,245 $42,595,901 $46,380,563\nAccumulated Depreciation:\nBeginning of year $ 7,744,521 $11,772,231 $10,371,081 Depreciation 1,251,637 1,448,722 1,684,472 Less Retirements (26,391) (5,476,432) (283,322) Depositions (3,239,346) 0 0\nEnd of year $ 5,730,421 $ 7,744,521 $11,772,231","section_15":""}
{"filename":"3453_1995.txt","cik":"3453","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------\nSee \"Business and Properties - Ocean Transportation - Rate Regulation\" above for a discussion of rate and other regulatory matters in which Matson is routinely involved.\nIn June 1990, Matson Terminals filed a complaint in the Superior Court of California against Home Insurance Company, Hobbs Group, Inc. and Arkwright- Boston Insurance Company for breach of contract and negligence. The complaint sought recovery of damages sustained at Matson Terminals' Oakland terminal as a result of the October 1989 Loma Prieta earthquake. The court awarded Matson Terminals $23,516,000, which included $11,250,000 in punitive damages. Defendant Home Insurance Company has filed an appeal of the court's award.\nIn February 1992, Pan Ocean Shipping Co., Ltd. (\"Pan Ocean\") served on Matson an amended complaint alleging that a Matson vessel negligently dis- charged contaminated ballast water into Los Angeles harbor on January 9, 1991. Pan Ocean admits that a vessel owned and operated by Pan Ocean discharged fuel oil into Los Angeles harbor on January 8, 1991. Pan Ocean is seeking contri- bution and indemnification for the in-harbor clean-up charges which it alleged to be between $16,000,000 and $19,000,000. On April 12, 1993, Pan Ocean amended its complaint to allege fraud and seek unspecified punitive damages. The parties have stipulated to binding arbitration before a Special Master appointed by the United States District Court for the Central District of California. The Special Master's findings will be incorporated into a judgment by the United States District Court, which judgment may be appealed to the Ninth Circuit Court of Appeals only on the issues of punitive damages and mis- conduct of the Special Master. Arbitration hearings, which commenced January 13, 1994, are ongoing. Management believes, after consultation with legal counsel and given the Protection and Indemnity coverage under Matson's insurance policy in effect at the time of the alleged conduct, that any ultimate liability in connection with this action will not have a material adverse effect on Matson's financial condition.\nOn November 1, 1994, the Division of Water Quality, Department of Wastewater Management, City and County of Honolulu (\"City and County\") issued a Cease and Desist Order to C&H, alleging violations of a City and County ordinance arising out of C&H's discharge of industrial wastewater from its liquid sugar refinery into the City and County's sewer system. Among other things, the Cease and Desist Order ordered C&H to stop discharging wastewater into the sewer system, ordered C&H to provide a corrective action plan, and warned that the violation might carry civil and\/or criminal penalties. Subsequently, the City and County issued Amended Order No. 1 on November 9, 1994, and Amended Order No. 2 on December 2, 1994. All orders were con- solidated under Docket No. 94-021 (\"Amended Orders\"). Amended Order No. 2, among other things, permitted C&H to discharge wastewater into the sewer system, provided C&H did not violate its permit, and imposed a fine on C&H in the amount of $1,650,000, which was suspended, provided C&H comply with the Amended Orders. C&H appealed the Amended Orders.\nIn May 1995, C&H presented a settlement proposal to the City and County which provided, among other things, that both C&H and the City and County agreed that certain modifications completed at the refinery have alleviated the unanticipated operational difficulties that led to the issuance of the Amended Orders. On March 4, 1996, the City and County accepted the terms and condi- tions of C&H's proposal, which are contained in a Consent Agreement pursuant to which the fine was rescinded. The Consent Agreement resolves all issues raised in the Amended Orders and Docket No. 94-021, including the Petitions to Appeal filed by C&H.\nA&B and its subsidiaries are parties to, or may be contingently liable in connection with, other legal actions arising in the normal conduct of their businesses, the outcomes of which, in the opinion of management after consulta- tion with counsel, would not have a material adverse effect on A&B's financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nFor the information about executive officers of A&B required to be included in this Part I, see paragraph B of \"Directors and Executive Officers of the Registrant\" in Part III below, which is incorporated into Part I by reference.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED - ----------------------------------------------------------\nSTOCKHOLDER MATTERS -------------------\nThis information is contained in the sections captioned \"Common Stock\" and \"Dividends\" on pages 19 and 20 of the 1995 Annual Report, which sections are incorporated herein by reference.\nAt February 16, 1996, there were 6,270 record holders of A&B common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nInformation for the years 1985 through 1995 is contained in the compara- tive table captioned \"Eleven-Year Summary of Selected Financial Data\" on pages 22 and 23 of the 1995 Annual Report, which information is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - ---------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nA&B's financial statements, including the results of operations discussed herein, are based on the historical-cost method of accounting, in accordance with generally accepted accounting principles. If estimated current costs of property and inventory were applied to reflect the effects of inflation on A&B's businesses, total assets would be higher and net income lower than shown by the historical-cost financial statements. However, the carrying values of current assets (other than inventories, real estate held for sale, deferred income taxes and prepaid and other assets) and of debt instruments are reason- able estimates of their fair values. Investments in marketable securities are stated in the financial statements at market values in accordance with State- ment of Financial Accounting Standards No. 115. Certain investments held in the Capital Construction Fund at amortized cost exceeded their fair values at December 31, 1995 and 1994. This matter is described more fully in Note 11 on page 39 of the 1995 Annual Report, which Note is incorporated herein by reference.\nAdditional information applicable to this Item 7 is contained in the section captioned \"Management's Discussion and Analysis\" on pages 25 through 27 of the 1995 Annual Report, which section is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThis information is contained in the financial statements and accompanying notes on pages 28 through 39 of the 1995 Annual Report, the Independent Auditors' Report on page 21 of the 1995 Annual Report, and the Industry Segment Information for the years ended December 31, 1995, 1994 and 1993 appearing on page 24 of the 1995 Annual Report and incorporated into the financial state- ments by Note 13 thereto, all of which are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON - ---------------------------------------------------------\nACCOUNTING 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 ---------\nFor information about the directors of A&B, see the section captioned \"Election of Directors\" on pages 2 and 3 of A&B's proxy statement dated March 4, 1996 (\"A&B's 1996 Proxy Statement\"), which section is incorporated herein by reference.\nB. EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nThe name of each executive officer of A&B (in alphabetical order), age (in parentheses) as of March 31, 1996, and present and prior positions with A&B and business experience for the past five years are given below.\nGenerally, the term of office of executive officers is at the pleasure of the Board of Directors. With regard to compliance with Section 16(a) of the Securities Exchange Act of 1934, A&B believes that during fiscal 1995 its directors and executive officers filed on a timely basis all reports required to be filed under Section 16(a), except that Mr. Robert G. Reed III, a director, was required to file a Form 4 on or before November 10, 1995 with respect to a transfer of 1,000 shares, but such transfer was reported on a Form 5 filed on February 12, 1996. For a discussion of severance agreements between A&B and certain of A&B's executive officers, see the subsection cap- tioned \"Severance Agreements\" on page 13 of A&B's 1996 Proxy Statement, which subsection is incorporated herein by reference.\nMeredith J. Ching (39) - ----------------------\nVice President (Government & Community Relations) of A&B, 10\/92-present; Vice President of ABHI (Government & Community Relations), 10\/92-present; Vice President of ABHI (Natural Resources Development & Government Affairs), 4\/89- 9\/92; first joined A&B or a subsidiary in 1982.\nJohn C. Couch (56) - ------------------\nChairman of the Board of A&B, 4\/95-present; President of A&B, 4\/91-present; Chief Executive Officer of A&B, 4\/92-present; Chief Operating Officer of A&B, 4\/91-4\/92; Chairman of the Board of ABHI, 4\/95-present; Chief Executive Officer of ABHI, 4\/89-present; President of ABHI, 4\/89-4\/95; Chairman of the Board of Matson, 4\/95-present; Vice Chairman of the Board of Matson, 4\/92-3\/95; Chairman of the Board of C&H, 7\/90-present; Director of A&B, 10\/85-present; Director of Matson, 4\/91-present; Director of ABHI, 4\/89-present; prior to 4\/89, held various executive positions with A&B, Matson and Matson's subsidiaries; first joined A&B or a subsidiary in 1976.\nW. Allen Doane (48) - -------------------\nPresident of ABHI, 4\/95-present; Chief Operating Officer of ABHI, 4\/91- present; Executive Vice President of ABHI, 4\/91-4\/95; first joined A&B or a subsidiary in 1991.\nRaymond J. Donohue (59) - -----------------------\nSenior Vice President of Matson, 4\/86-present; Chief Financial Officer of Matson, 2\/81-present; first joined Matson in 1980.\nG. Stephen Holaday (51) - -----------------------\nSenior Vice President of ABHI, 4\/89-present; Vice President and Controller of A&B, 4\/93-1\/96; Vice President, Chief Financial Officer and Treasurer of A&B, 4\/89-4\/93; Chief Financial Officer and Treasurer of ABHI, 4\/89-1\/96; first joined A&B or a subsidiary in 1983.\nJohn B. Kelley (50) - -------------------\nVice President (Investor Relations) of A&B, 1\/95-present; Vice President (Corporate Planning & Development, Investor Relations) of A&B, 10\/92-12\/94; Vice President (Community & Investor Relations) of A&B, 2\/91-10\/92; Vice Presi- dent (Corporate & Investor Relations) of A&B, 8\/88-1\/91; Vice President of ABHI, 8\/89-present; first joined A&B or a subsidiary in 1979.\nMiles B. King (48) - ------------------\nVice President and Chief Administrative Officer of A&B, 4\/93-present; Senior Vice President (Industrial Relations) of ABHI, 4\/93-present; Senior Vice President (Human Resources) of Matson, 10\/92-present; Executive Vice President of The Hay Group, 1988-1992.\nDavid G. Koncelik (54) - ----------------------\nSenior Vice President of ABHI, 1\/94-present; President and Chief Executive Officer of C&H, 1\/94-present; Executive Vice President and Chief Operating Officer of C&H, 1\/91-12\/93; Chief Financial Officer of C&H, 12\/88-12\/93; Senior Vice President of C&H, 12\/88-12\/90.\nMichael J. Marks (57) - ---------------------\nVice President, General Counsel and Secretary of A&B, 4\/89-present; Senior Vice President and General Counsel of ABHI, 4\/89-present; first joined A&B or a subsidiary in 1975.\nC. Bradley Mulholland (54) - --------------------------\nPresident of Matson, 5\/90-present; Chief Executive Officer of Matson, 4\/92-present; Chief Operating Officer of Matson, 7\/89-4\/92; Executive Vice President of Matson, 9\/87-5\/90; Director of A&B, 4\/91-present; Director of Matson, 7\/89-present; Director of ABHI, 4\/91-present; first joined Matson in 1965.\nGlenn R. Rogers (52) - --------------------\nVice President, Chief Financial Officer and Treasurer of A&B, 4\/93- present; Senior Vice President, Chief Financial Officer and Treasurer of ABHI, 1\/96-present; Senior Vice President, Marketing of Matson, 1\/89-4\/93; first joined A&B or a subsidiary in 1975.\nRobert K. Sasaki (55) - ---------------------\nVice President of A&B, 7\/90-present; Senior Vice President (Properties) of ABHI, 4\/89-present; first joined A&B or a subsidiary in 1965.\nThomas A. Wellman (37) - ----------------------\nController of A&B, 1\/96-present; Assistant Controller of A&B, 4\/93-1\/96; Vice President of ABHI, 1\/96-present; Controller of ABHI, 11\/91-present; Area Controller (Hawaii), Matson, 9\/90-10\/91; Internal Auditor, A&B, 7\/89-8\/90; first joined A&B or a subsidiary in 1989.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nSee the section captioned \"Executive Compensation\" on pages 8 through 13 of A&B's 1996 Proxy Statement, which section is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS - --------------------------------------------------------- AND MANAGEMENT --------------\nSee the section titled \"Security Ownership of Certain Shareholders\" and the subsection titled \"Security Ownership of Directors and Executive Officers\" on page 5 and on pages 6 and 7, respectively, of A&B's 1996 Proxy Statement, which section and subsection are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nSee the subsection titled \"Certain Relationships and Transactions\" on page 7 of A&B's 1996 Proxy Statement, the section titled \"Compensation Committee Interlocks and Insider Participation\" on page 16 of A&B's 1996 Proxy Statement, and the last paragraph of the subsection titled \"Compensation of Directors\" on page 4 of A&B's 1996 Proxy Statement, which are incorporated herein by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND - ------------------------------------------------------ REPORTS ON FORM 8-K -------------------\nA. FINANCIAL STATEMENTS --------------------\nFinancial Statements of Alexander & Baldwin, Inc. and Subsidiaries and Independent Auditors' Report (in-corporated by reference to the pages of the 1995 Annual Report shown in parentheses below):\nBalance Sheets, December 31, 1995 and 1994 (pages 30 and 31). Statements of Income for the years ended December 31, 1995, 1994 and 1993 (page 28). Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 (page 32). Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 (page 29). Notes to Financial Statements (pages 33 through 39 and page 24 to the extent incorporated by Note 13). Independent Auditors' Report (page 21).\nB. FINANCIAL STATEMENT SCHEDULES -----------------------------\nFinancial Schedules of Alexander & Baldwin, Inc. and Subsidiaries as required by Rule 5-04 of Regulation S-X (filed herewith):\nI - Condensed Financial Information of Registrant - Balance Sheets, December 31, 1995 and 1994; Statements of Income and Cash Flows for the years ended December 31, 1995, 1994 and 1993; Notes to Condensed Financial Statements.\nNOTE: All other schedules are omitted because of the absence of the condi- tions under which they are required or because the information called for is included in the financial statements or notes thereto.\nC. EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K -----------------------------------------------\nExhibits not filed herewith are incorporated by reference to the exhibit number and previous filing shown in parentheses. All previous exhibits were filed with the Securities and Exchange Commission in Washington, D.C. Exhibits filed pursuant to the Securities Exchange Act of 1934 were filed under file number 0-565. Shareholders may obtain copies of exhibits for a copying and handling charge of $0.15 a page by writing to Michael J. Marks, Vice President, General Counsel and Secretary, Alexander & Baldwin, Inc., P. O. Box 3440, Honolulu, Hawaii 96801.\n3. Articles of incorporation and bylaws.\n3.a. Restated Articles of Association of A&B, as restated effective May 5, 1986, together with Amendments dated April 28, 1988 and April 26, 1990 (Exhibits 3.a.(iii) and (iv) to A&B's Form 10-Q for the quarter ended March 31, 1990).\n3.b. Bylaws of A&B as amended effective October 24, 1991 (Exhibit 3.b.(i) to A&B's Form 10-Q for the quarter ended September 30, 1991).\n4. Instruments defining rights of security holders, including indentures.\n4.a. Equity.\n4.a. Rights Agreement, dated as of December 8, 1988 between Alexander & Baldwin, Inc. and Manufacturers Hanover Trust Company, Press Release of Alexander & Baldwin, Inc. and Form of Letter to Shareholders of Alexander & Baldwin, Inc. (Exhibits 4, 28(a) and 28(b) to A&B's Form 8-K dated December 13, 1988).\n4.b. Debt.\n4.b. (i) Amended and Restated Revolving Credit and Term Loan Agreement effective as of April 1, 1989 among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and Wells Fargo Bank, N.A., First Hawaiian Bank, Chemical Bank, Bank of Hawaii, Chase Manhattan Bank, and The Bank of California, N.A. (Exhibit 4.b.(xi) to A&B's Form 10-Q for the quarter ended September 30, 1989).\n(ii) First Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of December 21, 1989, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and Wells Fargo Bank, N.A., First Hawaiian Bank, Chemical Bank, Bank of Hawaii, Chase Manhattan Bank and The Bank of California, N.A. (Exhibit 4.b.(ii) to A&B's Form 10-K for the year ended December 31, 1989).\n(iii) Second Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of May 4, 1990, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and Wells Fargo Bank, N.A., First Hawaiian Bank, Chemical Bank, Bank of Hawaii, Chase Manhattan Bank and The Bank of California, N.A. (Exhibit 4.b.(iii) to A&B's Form 10-Q for the quarter ended June 30, 1990).\n(iv) Third Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of February 8, 1991, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and Wells Fargo Bank, N.A., First Hawaiian Bank, Bank of Hawaii, Bank of America National Trust & Savings Association and The Bank of California, N.A. (Exhibit 4.b.(iv) to A&B's Form 10-K for the year ended December 31, 1990).\n(v) Fourth Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of November 26, 1991, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and Wells Fargo Bank, N.A., First Hawaiian Bank, Bank of America National Trust & Savings Association, Bank of Hawaii, The Bank of California, N.A., and Credit Lyonnais San Francisco Branch and Credit Lyonnais Cayman Island Branch (Exhibit 4.b.(vi) to A&B's Form 10-K for the year ended December 31, 1991).\n(vi) Fifth Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of December 29, 1992, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and First Hawaiian Bank, Bank of America National Trust & Savings Association, Bank of Hawaii, The Bank of California, N.A., Credit Lyonnais San Francisco Branch and Credit Lyonnais Cayman Island Branch (Exhibit 4.b.(vii) to A&B's Form 10-K for the year ended December 31, 1992).\n(vii) Sixth Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of December 30, 1993, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and First Hawaiian Bank, Bank of America National Trust & Savings Association, Bank of Hawaii, The Bank of California, N.A., Credit Lyonnais Los Angeles Branch and Credit Lyonnais Cayman Island Branch (Exhibit 4.b.(vii) to A&B's Form 10-K for the year ended December 31, 1993).\n(viii) Seventh Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of November 30, 1994, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and First Hawaiian Bank, Bank of America National Trust & Savings Association, Bank of Hawaii, The Bank of California, N.A., Credit Lyonnais Los Angeles Branch and Credit Lyonnais Cayman Island Branch (Exhibit 4.b.(viii) to A&B's Form 10-K for the year ended December 31, 1994).\n(ix) Eighth Amendment to Amended and Restated Revolving Credit and Term Loan Agreement, dated as of November 30, 1995, among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and First Hawaiian Bank, Bank of America National Trust & Savings Association, Bank of Hawaii, The Bank of California, N.A., Credit Lyonnais Los Angeles Branch and Credit Lyonnais Cayman Island Branch.\n10. Material contracts.\n10.a. (i) Purchase and Exchange Agreement, by and between Wailea Development Company, Inc. and Wailea Resort Company, Ltd., dated as of January 15, 1989; Letters of Guaranty of Alexander & Baldwin, Inc. and Shinwa Golf Kabushiki Kaisha, respectively, dated as of January 15, 1989; Press Release of Alexander & Baldwin, Inc., dated February 10, 1989; and Pro Forma Financial Information relative to the transaction (Ex- hibits 10.b.(vii)(a) through 10.b.(vii)(e) to A&B's Form 8-K dated February 10, 1989).\n(ii) Contract for the Construction of One Containership by and between Matson Navigation Company, Inc. and National Steel and Ship- building Company, dated January 31, 1990 (Exhibit 10.b.(vii) to A&B's Form 10-K for the year ended December 31, 1989).\n(iii) Issuing and Paying Agent Agreement between Matson Navigation Company, Inc. and Security Pacific National Trust (New York), with respect to Matson Navigation Company, Inc.'s $150 million commercial paper program dated September 18, 1992 (Exhibit 10.b.1.(xxviii) to A&B's Form 10-Q for the quarter ended September 30, 1992).\n(iv) Issuing and Paying Agent Agreement among Matson Leasing Company, Inc., Matson Navigation Company, Inc. and Security Pacific National Trust (New York), with respect to Matson Leasing Company, Inc.'s $115 million commercial paper program dated September 18, 1992 (Exhibit 10.b.1.(xxix) to A&B's Form 10-Q for the quarter ended September 30, 1992).\n(v) Revolving Credit Agreement between Alexander & Baldwin, Inc., A&B-Hawaii, Inc. and First Hawaiian Bank, dated July 9, 1991 (Exhibit 10.b.(xi) to A&B's Form 10-Q for the quarter ended September 30, 1991).\n(vi) Note Agreement among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and The Prudential Insurance Company of America, effec- tive as of December 20, 1990 (Exhibit 10.b.(ix) to A&B's Form 10-K for the year ended December 31, 1990).\n(vii) Note Agreement among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and The Prudential Insurance Company of America, dated as of June 4, 1993 (Exhibit 10.a.(xiii) to A&B's Form 8-K dated June 4, 1993).\n(viii) Amendment dated as of May 20, 1994 to the Note Agreements among Alexander & Baldwin, Inc., A&B-Hawaii, Inc. and The Prudential Insurance Company of America, dated as of December 20, 1990 and June 4, 1993 (Exhibit 10.a.(xviv) to A&B's Form 10-Q for the quarter ended June 30, 1994).\n(ix) Amendment dated January 23, 1995 to the Note Agreement among Alexander & Baldwin, Inc. and A&B-Hawaii, Inc. and The Prudential Insurance Company of America, effective as of December 20, 1990 (Exhi- bit 10.a.(xvi) to A&B's Form 10-K for the year ended December 31, 1994).\n(x) General Lease between the State of California and California and Hawaiian Sugar Company, dated September 24, 1992 (Exhibit 10.a.(xiv) to A&B's Form 10-Q for the quarter ended June 30, 1993). (xi) Amendment to Lease and Reservation of Easements, between the State of California and California and Hawaiian Sugar Company, dated as of July 29, 1993 (Exhibit 10.a.(xv) to A&B's Form 10-Q for the quarter ended September 30, 1993).\n(xii)(a) Commercial Paper Dealer Agreement between California and Hawaiian Sugar Company and First Chicago Capital Markets, Inc., dated April 22, 1991, with respect to California and Hawaiian Sugar Company's $100 million revolving credit facility (Exhibit 10.a.(xviii) to A&B's Form 10-K for the year ended December 31, 1993).\n(xii)(b) Depositary Agreement between California and Hawaiian Sugar Company and the First National Bank of Chicago, dated as of April 6, 1989 (Exhibit 10.a.(xix)(b) to A&B's Form 10-K for the year ended December 31, 1994).\n(xiii) Amendment dated as of February 10, 1995, to Depositary Agreement between California and Hawaiian Sugar Company and The First National Bank of Chicago, dated as of April 6, 1989 (Exhibit 10.a.(xx) to A&B's Form 10-K for the year ended December 31, 1994).\n(xiv) Revolving Credit Agreement between Alexander & Baldwin, Inc., A&B-Hawaii, Inc., and First Hawaiian Bank, dated December 30, 1993 (Exhibit 10.a.(xx) to A&B's Form 10-Q for the quarter ended September 30, 1994).\n(xv) Amendment dated August 31, 1994 to the Revolving Credit Agreement between Alexander & Baldwin, Inc., A&B-Hawaii, Inc., and First Hawaiian Bank dated December 30, 1993 (Exhibit 10.a.(xxi) to A&B's Form 10-Q for the quarter ended September 30, 1994).\n(xvi) Second Amendment dated March 29, 1995 to the Revolving Credit Agreement between Alexander & Baldwin, Inc., A&B-Hawaii, Inc., and First Hawaiian Bank, dated December 30, 1993 (Exhibit 10.a.(xxiii) to A&B's Form 10-Q for the quarter ended March 31, 1995).\n(xvii) Amendment dated November 29, 1995 to the Note Agreement among Alexander & Baldwin, Inc., A&B-Hawaii, Inc., and The Prudential Insurance Company of America, dated as of December 20, 1990 and June 4, 1993.\n(xviii) Asset Purchase Agreement among XTRA, Inc., Matson Navigation Company, Inc. and Matson Leasing Company, Inc., dated June 30, 1995 (Exhibit 10.a.(xxiv) to A&B's Form 8-K dated June 30, 1995).\n(xix) Revised pro forma financial information relative to the Asset Purchase Agreement among XTRA, Inc., Matson Navigation Company, Inc. and Matson Leasing Company, Inc., dated June 30, 1995 (Exhibit 10.a.(xxv) to A&B's Form 8-K\/A dated June 30, 1995).\n(xx) Balance sheets as of December 31, 1993 and 1994 and State- ments of Income and Statements of Cash Flows for the years ended December 31, 1992, 1993 and 1994, relative to the Asset Purchase Agreement among XTRA, Inc., Matson Navigation Company, Inc. and Matson Leasing Company, Inc., dated June 30, 1995 (Exhibit 10.a.(xxvi) to A&B's Form 8-K\/A dated June 30, 1995).\n(xxi) Commercial Paper Dealer Agreement among California and Hawaiian Sugar Company, Inc., Alexander & Baldwin, Inc., A&B-Hawaii, Inc. and Goldman Sachs Money Markets, L.P. dated June 20, 1995, with respect to California and Hawaiian Sugar Company, Inc.'s $100 million revolving credit facility (Exhibit 10.a.(xxvi) to A&B's Form 10-Q for the quarter ended June 30, 1995).\n(xxii) Amendment dated as of June 30, 1995 to the Note Agreements, among Alexander & Baldwin, Inc., A&B-Hawaii, Inc. and The Prudential Insurance Company of America, dated as of December 20, 1990 and June 4, 1993 (Exhibit 10.a.(xxvii) to A&B's Form 10-Q for the quarter ended June 30, 1995).\n(xxiii) Note Agreement between Matson Leasing Company, Inc. and The Prudential Insurance Company of America, dated as of June 28, 1991 (Exhibit 10.b.(x) to A&B's Form 10-Q for the quarter ended June 30, 1991).\n(xxiv) Amendment dated March 11, 1992 to the Note Agreement between Matson Leasing Company, Inc. and The Prudential Insurance Company of America, dated as of June 28, 1991 (Exhibit 10.a.(vii) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxv) Second Amendment dated as of August 31, 1993 to the Note Agreement between Matson Leasing Company, Inc. and The Prudential Insurance Company of America, dated as of June 28, 1991 (Exhibit 10.a.(viii) to A&B's Form 10-K for the year ended December 31, 1993).\n(xxvi) Note Agreement between Matson Leasing Company, Inc. and The Prudential Insurance Company of America, dated as of March 11, 1992 (Exhibit 10.a.(x) to A&B's Form 10-Q for the quarter ended March 31, 1992).\n(xxvii) First Amendment dated as of August 1, 1993 to the Note Agreement between Matson Leasing Company, Inc. and The Prudential Insurance Company of America, dated as of March 11, 1992 (Exhibit 10.a.(xi) to A&B's Form 10-K for the year ended December 31, 1993).\n(xxviii)(a) Assignment and Assumption Agreement dated as of June 30, 1995, among Matson Leasing Company, Inc., Matson Navigation Company, Inc. and The Prudential Insurance Company of America, with respect to the Note Agreements between Matson Leasing Company, Inc. and The Prudential Insurance Company of America dated as of June 28, 1991 and March 11, 1992 (Exhibit 10.a.(xxviii)(a) to A&B's Form 10-Q for the quarter ended June 30, 1995).\n(xxviii)(b) Consent and Amendment Agreement dated as of June 30, 1995, among Matson Leasing Company, Inc., Matson Navigation Company, Inc. and The Prudential Insurance Company of America, with respect to the Note Agreements between Matson Leasing Company, Inc. and The Prudential Insurance Company of America dated as of June 28, 1991 and March 11, 1992 (Exhibit 10.a.(xxviii)(b) to A&B's Form 10-Q for the quarter ended June 30, 1995).\n(xxix) Agreement to Implement the Execution and Closing of Vessel Purchase, Purchase of Guam Assets and Alliance Slot Hire Agreement between Matson Navigation Company, Inc. and American President Lines, Ltd., dated as of September 22, 1995 (Exhibit 10.a.(xxix) to A&B's Form 10-Q for the quarter ended September 30, 1995).\n(xxx) Amendments Nos. 1 through 7, dated as of October 10, 1995, October 30, 1995, November 30, 1995, December 8, 1995, December 15, 1995, January 31, 1996 and February 8, 1996, respectively, to the Agreement to Implement the Execution and Closing of Vessel Purchase, Purchase of Guam Assets and Alliance Slot Hire Agreement between Matson Navigation Company, Inc., and American President Lines, Ltd., dated as of September 22, 1995.\n(xxxi) Vessel Purchase Agreement between Matson Navigation Company, Inc., and American President Lines, Ltd., dated December 20, 1995.\n(xxxii) Amendment No. 1 dated December 28, 1995 to the Vessel Purchase Agreement between Matson Navigation Company, Inc., and American President Lines, Ltd., dated December 20, 1995.\n*10.b.1. (i) Alexander & Baldwin, Inc. Restricted Stock Bonus Plan, as restated effective April 28, 1988 (Exhibit 10.c.1.(xi) to A&B's Form 10-Q for the quarter ended June 30, 1988).\n(ii) Alexander & Baldwin, Inc. 1983 Stock Option Plan (Exhibit 10.c.1.(vii) to A&B's Form 10-K for the year ended December 31, 1982).\n* All exhibits listed under 10.b.1. are management contracts or compensatory plans or arrangements.\n(iii) Amendment No. 1 to Alexander & Baldwin, Inc. 1983 Stock Option Plan, effective December 14, 1983 (Exhibit 10.c.1.(viii) to A&B's Form 10-K for the year ended December 31, 1983).\n(iv) Amendment No. 2 to Alexander & Baldwin, Inc. 1983 Stock Option Plan, effective January 1, 1987 (Exhibit 10.c.1.(xii) to A&B's Form 10-K for the year ended December 31, 1986).\n(v)Amendment No. 3 to the Alexander & Baldwin, Inc. 1983 Stock Option Plan (Exhibit 10.b.1.(xxv) to A&B's Form 10-Q for the quarter ended June 30, 1992).\n(vi) Alexander & Baldwin, Inc. 1989 Stock Option\/ Stock Incentive Plan (Exhibit 10.c.1.(ix) to A&B's Form 10-K for the year ended December 31, 1988).\n(vii) Amendment No. 1 to the Alexander & Baldwin, Inc. 1989 Stock Option\/Stock Incentive Plan (Exhibit 10.b.1.(xxvi) to A&B's Form 10-Q for the quarter ended June 30, 1992).\n(viii) Amendment No. 2 to the Alexander & Baldwin, Inc. 1989 Stock Option\/Stock Incentive Plan, effective as of January 27, 1994 (Exhibit 10.b.1.(iv) to A&B's Form 10-Q for the quarter ended March 31, 1994).\n(ix) Amendment No. 3 to the Alexander & Baldwin, Inc. 1989 Stock Option\/Stock Incentive Plan, effective as of October 27, 1994 (Exhibit 10.b.1.(ix) to A&B's Form 10-K for the year ended December 31, 1994).\n(x) Alexander & Baldwin, Inc. 1989 Non-Employee Director Stock Option Plan (Exhibit 10.c.1.(x) to A&B's Form 10-K for the year ended December 31, 1988).\n(xi) Amendment No. 1 to the Alexander & Baldwin, Inc. 1989 Non- Employee Director Stock Option Plan (Exhibit 10.b.1.(xxiv) to A&B's Form 10-K for the year ended December 31, 1991).\n(xii) Amendment No. 2 to the Alexander & Baldwin, Inc. 1989 Non- Employee Director Stock Option Plan (Exhibit 10.b.1.(xxvii) to A&B's Form 10-Q for the quarter ended June 30, 1992).\n(xiii) Second Amended and Restated Employment Agreement between Alexander & Baldwin, Inc. and R. J. Pfeiffer, effective as of October 25, 1990 (Ex-hibit 10.c.1.(xiii) to A&B's Form 10-K for the year ended December 31, 1990).\n(xiv) A&B Deferred Compensation Plan for Outside Directors (Exhibit 10.c.1.(xviii) to A&B's Form 10-K for the year ended December 31, 1985).\n(xv) Amendment No. 1 to A&B Deferred Compensation Plan for Outside Directors, effective October 27, 1988 (Exhibit 10.c.1.(xxix) to A&B's Form 10-Q for the quarter ended September 30, 1988).\n(xvi) A&B Life Insurance Plan for Outside Directors (Exhibit 10.c.1.(xix) to A&B's Form 10-K for the year ended December 31, 1985).\n(xvii) A&B Excess Benefits Plan, Amended and Restated Effective July 1, 1991 (Exhibit 10.b.1.(xvi) to A&B's Form 10-K for the year ended December 31, 1992).\n(xviii) Amendment No. 1 to the A&B Excess Benefits Plan, effective January 1, 1994 (Exhibit 10.b.1.(xvii) to A&B's Form 10-K for the year ended December 31, 1993).\n(xix) Amendment No. 2 to the A&B Excess Benefits Plan, effective August 24, 1994 (Exhibit 10.b.1.(xix) to A&B's Form 10-K for the year ended December 31, 1994).\n(xx) Amendment No. 3 to and Restatement of the A&B Excess Benefits Plan, effective February 1, 1995 (Exhibit 10.b.1.(xx) to A&B's Form 10-K for the year ended December 31, 1994).\n(xxi) A&B Executive Survivor\/Retirement Benefit Plan, Amended and Restated Effective July 1, 1991 (Exhibit 10.b.1.(xvii) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxii) Amendment No. 1 to and Restatement of the A&B Executive Survivor\/Retirement Benefit Plan, effective February 1, 1995 (Exhibit 10.b.1.(xxii) to A&B's Form 10-K for the year ended December 31, 1994).\n(xxiii) A&B 1985 Supplemental Executive Retirement Plan, Amended and Restated Effective July 1, 1991 (Exhibit 10.b.1.(xviii) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxiv) Amendment No. 1 to and Restatement of the A&B 1985 Supple- mental Executive Retirement Plan, effective February 1, 1995 (Exhibit 10.b.1.(xxiv) to A&B's Form 10-K for the year ended December 31, 1994).\n(xxv) A&B Retirement Plan for Outside Directors, Amended and Restated Effective October 24, 1991 (Exhibit 10.b.1.(xix) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxvi) Amendment No. 1 to and Restatement of the A&B Retirement Plan for Outside Directors, effective February 1, 1995 (Exhibit 10.b.1.(xxvi) to A&B's Form 10-K for the year ended December 31, 1994).\n(xxvii) Form of Severance Agreement entered into with certain executive officers, as amended and restated effective August 22, 1991 (Exhibit 10.c.1.(xxiv) to A&B's Form 10-Q for the quarter ended September 30, 1991).\n(xxviii) Alexander & Baldwin, Inc. One-Year Performance Improvement Incentive Plan, as restated effective October 22, 1992 (Exhibit 10.b.1.(xxi) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxix) Alexander & Baldwin, Inc. Three-Year Performance Improvement Incentive Plan, as restated effective October 22, 1992 (Exhibit 10.b.1.(xxii) to A&B's Form 10-K for the year ended December 31, 1992).\n(xxx) Alexander & Baldwin, Inc. Deferred Compensation Plan effective August 25, 1994 (Exhi-bit 10.b.1.(xxv) to A&B's Form 10-Q for the quarter ended September 30, 1994).\n11. Statement re computation of per share earnings.\n13. Annual report to security holders.\n13. Alexander & Baldwin, Inc. 1995 Annual Report.\n22. Subsidiaries.\n22. Alexander & Baldwin, Inc. Subsidiaries as of February 29, 1996\n24. Consent of Deloitte & Touche LLP dated March 27, 1996 (included as last page of A&B's Form 10-K for the year ended December 31, 1995).\nD. REPORTS ON FORM 8-K -------------------\nAn amendment on Form 8-K\/A, to a report on Form 8-K dated June 30, 1995, was filed on December 12, 1995, for the purpose of filing under Item 7 certain required pro forma financial information and financial statements relative to the sale by Matson Leasing and Matson (collectively, the \"Sellers\"), of Matson Leasing's container leasing business, through the sale of certain assets and liabilities of the Sellers (primarily of Matson Leasing).\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the 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 & BALDWIN, INC. (Registrant)\nDate: March 27, 1996 By \/s\/ John C. Couch --------------------------------\nJohn C. Couch 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 in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ John C. Couch Chairman of the March 27, 1996 - ------------------------- Board, President John C. Couch and Chief Execu- tive Officer and Director\n\/s\/ Glenn R. Rogers Vice President, March 27, 1996 - ------------------------- Chief Financial Glenn R. Rogers Officer and Treasurer\n\/s\/ Thomas A. Wellman Controller March 27, 1996 - ------------------------- Thomas A. Wellman\n\/s\/ Michael J. Chun Director March 27, 1996 - ------------------------- Michael J. Chun\n\/s\/ Leo E. Denlea, Jr. Director March 27, 1996 - ------------------------- Leo E. Denlea, Jr.\n\/s\/ Walter A. Dods, Jr. Director March 27, 1996 - -------------------------- Walter A. Dods, Jr.\n\/s\/ Charles G. King Director March 27, 1996 - -------------------------- Charles G. King\n\/s\/ Carson R. McKissick Director March 27, 1996 - -------------------------- Carson R. McKissick\n\/s\/ C. Bradley Mulholland Director March 27, 1996 - -------------------------- C. Bradley Mulholland\n\/s\/ Robert G. Reed III Director March 27, 1996 - -------------------------- Robert G. Reed III\n\/s\/ Maryanna G. Shaw Director March 27, 1996 - -------------------------- Maryanna G. Shaw\n\/s\/ Charles M. Stockholm Director March 27, 1996 - -------------------------- Charles M. Stockholm\nINDEPENDENT AUDITORS' REPORT\nAlexander & Baldwin, Inc.:\nWe have audited the financial statements of Alexander & Baldwin, Inc. 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 January 25, 1996; 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 schedules of Alexander & Baldwin, Inc. and its subsidiaries, listed in Item 14.B. 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 shown therein.\n\/s\/ Deloitte & Touche LLP Honolulu, Hawaii\nJanuary 25, 1996\nINDEPENDENT AUDITORS' CONSENT\nAlexander & Baldwin, Inc.:\nWe consent to the incorporation by reference in Registration Statements No. 2-72008, 2-84179, 33-31922, 33-31923 and 33-54825 of Alexander & Baldwin, Inc. and its subsidiaries on Form S-8 of our reports dated January 25, 1996, appearing in and incorporated by reference in the Annual Report on Form 10-K of Alexander & Baldwin, Inc. and its subsidiaries for the year ended December 31, 1995.\n\/s\/ Deloitte & Touche LLP Honolulu, Hawaii\nMarch 27, 1996\nSCHEDULE I Page 1 of 4 ALEXANDER & BALDWIN, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nALEXANDER & BALDWIN, INC. (Parent Company) CONDENSED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (In thousands)\n1995 1994 ------ ------ ASSETS Current Assets: Cash and cash equivalents $44 $37 Accounts and notes receivable, net 75 1 Prepaid expenses and other 7,033 5,913 -------- -------- Total current assets 7,152 5,951 -------- -------- Investments: Subsidiaries consolidated, at equity 584,151 596,070 Other 81,538 61,031 -------- -------- Total investments 665,689 657,101 -------- -------- Real Estate Developments - 8,196 -------- -------- Property, at cost 97,193 80,814 Less accumulated depreciation and amortization 10,512 7,595 -------- -------- Property -- net 86,681 73,219 -------- -------- Other Assets 1,234 1,232 -------- -------- Total $760,756 $745,699 ======== ========\nLIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $319 $1,640 Due to subsidiaries 53,805 54,162 Other 4,361 9,188 -------- -------- Total current liabilities 58,485 64,990 -------- -------- Long-Term Liabilities 5,127 7,485 -------- -------- Deferred Income Taxes 43,818 40,610 -------- -------- Commitments and Contingencies\nShareholders' Equity: Capital stock 37,133 37,493 Additional capital 40,138 38,862 Unrealized holding gains on securities 39,830 29,073 Retained earnings 550,042 541,910 Cost of treasury stock (13,817) (14,724) -------- -------- Total shareholders' equity 653,326 632,614 -------- -------- Total $760,756 $745,699 ======== ========\nSee accompanying notes.\nSCHEDULE I Page 4 of 4\nALEXANDER & BALDWIN, INC. (Parent Company) NOTES TO CONDENSED FINANCIAL STATEMENTS\n(a) ORGANIZATION AND OPERATIONS\nAlexander & Baldwin, Inc. is the parent company of A&B-Hawaii, Inc. (ABHI) and Matson Navigation Company, Inc. (Matson). ABHI has principal business opera- tions of Food Products and Property Development and Management. Matson has principal business operations of Ocean Transportation and until June 1995, of Container Leasing. The net assets of Matson Leasing Company, Inc., the Company's container leasing subsidiary, were sold in June 1995 for $361.7 million in cash. Accordingly, the operating results and the gain on sale of The container leasing segment have been separately reported.\n(b) LONG-TERM LIABILITIES\nAt December 31, 1995 and 1994, long-term liabilities consisted of the following:\n1995 1994 (In thousands) Long-term debt: Limited partnership subscription notes, no interest, payable through 1996 $850 $1,700 Mortgage loans, collateralized by land and buildings, 9% to 12.5%, repaid in 1995 - 6,041 Total 850 7,741 Less current portion 850 6,657 Long-term debt 0 1,084 Other--principally deferred compensation and executive survivors 5,127 6,401 Total $5,127 $7,485\nAt December 31, 1995, maturities of long-term debt during 1996 will be $850,000.\n(c)COMMITMENTS AND CONTINGENCIES\nThe Company and certain subsidiaries are parties to various legal actions and are contingently liable in connection with claims and contracts arising in the normal course of business, the outcome of which, in the opinion of management after consultation with legal counsel, will not have a material adverse effect on the Company's financial position.\nAt December 31, 1995, the Company did not have any significant firm commitments.\n(d)CASH DIVIDENDS FROM AFFILIATES\nCash dividends from a consolidated subsidiary were $70,000,000 in 1995, $60,000,000 in 1994 and $39,000,000 in 1993.","section_15":""}
{"filename":"315852_1995.txt","cik":"315852","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nLomak Petroleum, Inc. (\"Lomak\" or the \"Company\") is an independent oil and gas company engaged in the acquisition, development, exploration and enhancement of oil and gas properties in the United States. Lomak's core areas of operation are located in Texas, Oklahoma and Appalachia. The Company has grown through a combination of acquisition, development, exploration and enhancement activities. Since January 1, 1990, 60 acquisitions have been consummated at a total cost of approximately $200 million and $24 million has been expended on development and exploration activities. As a result, proved reserves and production have each grown during this period at a rate in excess of 80% per annum. At December 31, 1995, proved reserves totaled 298 Bcfe, having a pre-tax present value at constant prices of $229 million and a reserve life of nearly 12 years.\nLomak's acquisition effort is focused on properties with prices of less than $30 million within its core areas of operation. Management believes these purchases are less competitive than those involving larger property interests. To the extent purchases continue to be made primarily within existing core areas, efficiencies in operations, drilling, gas marketing and administration should be realized. In 1993, Lomak initiated a program to exploit its growing inventory of development projects. In the future, Lomak expects its growth to be driven principally by a combination of acquisitions and development and, to a lesser extent, exploration.\nAt December 31, 1995, Lomak held interests in 6,596 gross (4,965 net) productive oil and gas wells. The Company currently operates over 6,200 wells which account for more than 93% of its developed reserves. In addition, the Company owns and operates approximately 1,900 miles of gas gathering systems in proximity to its principal gas properties. The Company also provides oil field services, including brine disposal and various well services primarily for certain of its own properties. The operations of the Company are considered to fall within a single industry segment; the exploration for, development and production of crude oil and natural gas.\nThe Company's common stock is listed on the Nasdaq National Market (\"Nasdaq\") under the symbol \"LOMK\". During 1995, trading volume averaged 82,000 shares per day. The Company maintains its corporate headquarters at 500 Throckmorton Street, Fort Worth, Texas 76102 and its telephone number is (817) 870-2601.\nDESCRIPTION OF THE BUSINESS\nStrategy\nThe Company's objective is to continue to increase its asset base, cash flow and earnings through a balanced strategy of acquisitions, development, exploration and enhancement activities in core operating areas. In each core area, the Company establishes separate acquisition, engineering, operating, geological and other technical expertise. The Company currently has core operating areas in Texas, Oklahoma and Appalachia. Through its strategy, the Company does not depend solely on any one region or activity to grow its asset base. In addition, by operating in three core areas, the Company has expanded its acquisition, development and exploration opportunities.\nAcquisitions. Since 1990, 60 acquisitions have been completed for a total consideration of $200 million. Over 295 Bcfe of proved reserves have been acquired at an average cost of $.63 per Mcfe. The Company's acquisition strategy is based on: (i) Size: targeting smaller, less competitive transactions having a cost below $30 million; (ii) Locale: focusing in areas containing many small oil and gas operators and where larger companies are no longer active; (iii) Efficiency: targeting acquisitions in which operating and cost efficiencies can be obtained; (iv) Reserve Potential: pursuing properties with the potential for reserve increases through recompletions and drilling; (v) Incremental Purchases: seeking acquisitions where opportunities for purchasing additional interests in the same or adjoining properties exist; and (vi) Complexity: pursuing more complex but less competitive corporate or partnership acquisitions.\nDevelopment. The Company's development activities include recompletions of existing wells, infield and step-out drilling and installation of secondary recovery projects. Development projects are generated within core operating areas where the Company has significant operational and technical experience. At December 31, 1995, over 750 proven development projects were in inventory. These projects are located in eight different fields, vary between oil and gas, and are balanced between low and medium risk. Approximately 100 of these projects are expected to be initiated in 1996 at a total cost of approximately $13 million. Based on the number of projects currently in inventory, development expenditures are currently projected to approximate $45 million over the three year period 1996 through 1998.\nExploration. To date, the Company has concentrated on its acquisition and development activities while building its asset base and cash flow. In the future, exploration activities are expected to be expanded within the Company's core operating areas. These activities are expected to be an extension of the Company's development activities and will be initiated by its in-house technical staff.\nEnhancements. The Company's enhancement activities include all activities other than acquisitions, development and exploration which maximize the value of its assets. Enhancements include: reducing overhead, operating and development costs; concentrating operations to increase efficiency; the rapid disposal of non-strategic properties; expanding marketing options; and applying new technology to exploit additional reserves. Enhancements increase margins and help maintain profitability during downward phases of energy price cycles.\nAcquisition Activities\nSince 1990, the Company has completed 60 acquisitions for $200 million of consideration. During 1995, $71.1 million of purchases were completed. The Company's acquisition strategy is to concentrate on smaller transactions that offer higher expected returns. The Company believes that it can continue to implement its acquisition strategy based on the following:\nSIZE: The Company believes that smaller transactions (less than $30 million in cost) provide the opportunity for higher returns due to the limited number of buyers that have the interest, financial capabilities and the operational efficiencies necessary to consummate such transactions. Smaller companies generally do not have sufficient capital or the requisite expertise to engage in such transactions while the larger companies are focusing on other areas, such as overseas operations, or larger transactions. Additionally, because of the continuing restructuring of the domestic oil and gas industry, many small oil and gas entities are for sale and many larger companies are selling their smaller or non-strategic properties. As the Company grows, it may review acquisitions in excess of $30 million, however, the significant portion of its acquisitions are still expected to be $30 million or below.\nLOCALE: Focusing on areas containing many small, less capitalized operators. These typically are areas in which many of the major and larger independent companies are no longer active and where, in some cases, they are divesting their remaining assets. The potential for reserve increases in these areas exists through the application of new operating and technical advances.\nEFFICIENCY: Targeting acquisitions in which operating and cost efficiencies can be obtained. The Company concentrates on acquiring oil and gas assets in areas in which it already operates and seeks to subsequently merge into its existing infrastructure the overhead functions of companies, partnerships and direct property interests it acquires. Not only does the increased efficiency result in increased profitability, but it also enables the Company to be an aggressive buyer while still generating an attractive return.\nRESERVE POTENTIAL: Pursuing properties with the potential for reserve increases through workovers, recompletions, drilling and secondary recovery operations.\nINCREMENTAL PURCHASES: Seeking acquisitions where opportunities for purchasing incremental interests in the same or adjoining properties exist. Properties in which the Company currently owns an interest contain over $100 million of estimated value attributable to the reserves for interests held by third parties. The purchase of incremental interests results in only minor increases in overhead cost.\nCOMPLEXITY: A number of companies and partnerships which own oil and gas assets have been acquired at attractive prices. Due to the added complexity involved in acquiring and integrating these entities and their assets, many buyers do not have the expertise or desire to compete for such acquisitions.\nThe following table sets forth information pertaining to acquisitions completed during the past six years.\n(1) Includes purchase price for proved reserves as well as other acquired assets, including gas gathering lines, undeveloped leasehold and field service assets.\n(2) Includes purchase price for proved reserves only.\nDevelopment Activities\nDevelopment activities include recompletions of existing wells, the drilling of infield and step-out wells and secondary recovery projects. Approximately $3.7, $9.5 and $11.1 million was expended on these activities during 1993, 1994 and 1995, respectively. The Company estimates that it will spend up to $15 million on development activities in 1996. Based on over 750 proven development projects currently in inventory, capital expenditures are currently estimated to be approximately $45 million over the three year period 1996 through 1998.\nThe Company's development strategy is to own as large an interest as possible in more established, lower risk development projects. Conversely, in development activities that are less established and therefore deemed to be of higher risk, the Company generally seeks to participate for no more than a 50% interest. As more confidence is gained in regard to the higher risk development activities, the Company may increase its ownership percentage.\nTexas. At December 31, 1995, Texas accounted for 182 proved development projects. The majority of these projects include recompletions and infield drilling locations in the Big Lake Area of west Texas and the Laura LaVelle Field of east Texas. The production from these two fields is predominantly oil. The Company has performed 29 recompletions and drilled 40 wells in these two fields. As a result of development and additional acquisitions, gross production from the two fields has increased from 500 Boe per day to over 1,850 Boe per day. In 1996, the Company expects to recomplete 12 wells and drill 18 new wells in the two fields at a cost of approximately $2.5 million.\nOklahoma. Essentially all of the 207 Oklahoma proved development projects are in the Okeene Field located in the northwestern portion of the Anadarko Basin. These projects include 133 recompletions and 74 drilling locations. The Company's primary producing area is situated in a four township area that straddles the Blaine-Major County line, with over 250 Company operated wells. The majority of the reserves are gas and are produced from six geologic horizons at depths ranging from 7,000 to 9,000 feet. The Company acquired its interests in the field during the fourth quarter of 1994. In 1996, the Company estimates it will undertake 24 recompletions and drill 9 new wells for approximately $4.0 million. An extensive geologic study of the area has been initiated to further identify additional development opportunities.\nAppalachia. In Ohio, Pennsylvania and West Virginia 392 proved development projects have been identified in the shallow Clinton, Medina and Upper Devonian Sandstone formations. These projects are located on 448,000 gross (341,000 net) acres under lease and range in depth from 2,000 to 6,000 feet. The reserves are characterized by initial flush production, followed by extremely gradual decline rates resulting in a projected life of over twenty years. During 1996 the Company estimates that it will recomplete 10 wells and drill 30 new wells at a cost of approximately $4.0 million. The Company currently has a sufficient inventory of proved infield drilling locations to drill over 75 wells per year over the next five years.\nIn addition to the shallow formations discussed above, the Appalachian Basin has less developed formations including the Rose Run-Beekmantown and Trempealeau which range in depths from 4,000 to 8,000 feet. The geological boundaries of these formations lie approximately 2,500 feet below the shallower Clinton and Medina Sandstone formations. While the industry has drilled over 100,000 Clinton and Medina Sandstone wells, fewer than 1,700 wells have been drilled to the Rose Run-Beekmantown and 5,000 wells to the Trempealeau. The industry's initial results were poor because the wells were based strictly upon regional geology and limited seismic data was utilized. However, more recent activities using modern seismic technologies have significantly improved the returns from these deeper zones. Since 1993, the Company has participated in 29 deeper wells with an average working interest of 11%, of which, 16 were productive and 13 were dry. Currently, the Company owns leases covering 318,000 gross (237,000 net) acres in the deeper \"Rose Run Trend.\" The Company's 1996 budget allocates approximately $2 million to acquire acreage and seismic and to drill wells in this area.\nEnhancement Activities\nThe Company defines enhancements as those activities, other than acquisitions or drilling, which maximize the value of its asset base. Enhancements include: reducing overhead, operating and development costs on a per Mcfe basis; concentrating operations to increase efficiency; disposing non-strategic properties rapidly; expanding marketing options; and applying new technology to exploit additional reserves. Enhancements create higher margins and help maintain profitability during the downward phase of energy price cycles. Despite low oil and gas prices in recent years, the Company posted increased cash flow and profits, partly due to enhancements. Primarily as a result of its enhancement activities during the past five years the Company has: (i) decreased overhead costs per Mcfe by 89%; (ii) cut operating costs per Mcfe by 30%; (iii) reduced development costs per Mcfe by 31%; (iv) now operates properties representing more than 93% of its reserves; (v) sold over 1,000 non-strategic properties; (vi) expanded gas marketing to neraly 90 MMcf per day through 1,900 miles of Company-owned gas gathering systems; and (vii) improved seismic and completion techniques by applying new technology.\nProduction\nProduction revenue is generated through the sale of oil and gas from properties held directly and through partnerships and joint ventures. Additional revenue is received from royalties. While oil and gas production is sold to a limited number of purchasers, it is believed that the loss of any one of them would not have a material adverse effect on the business. Proximity to local markets, availability of competitive fuels and overall supply and demand are factors affecting the ability to market production. There has been a worldwide surplus of oil and gas for more than a decade which has weakened oil prices and depressed the price of natural gas. While the Company anticipates an upward trend in energy prices, factors outside its control such as political developments in the Middle East, overall energy supply, weather conditions and economic growth rates have had, and may continue to have, an unpredictable effect on energy prices.\nThe following table sets forth historical revenue and expense information for the periods indicated (in thousands, except average sales price and operating cost data).\n(a) Oil is converted to Mcfe at a rate of 6 Mcf per barrel.\nOn a Mcfe basis, approximately 69% of 1995 production was natural gas. Gas production was sold to utilities, brokers or directly to industrial users. Gas sales are made pursuant to various arrangements ranging from month-to-month contracts, one year contracts at fixed or variable prices and contracts at fixed prices for the life of the well. All contracts other than the fixed price contracts contain provisions for price adjustment, termination and other terms customary in the industry. A number of the Appalachian gas contracts hold favorable sales prices when compared to spot market prices. Oil is sold on a basis such that the purchaser can be changed on 30 days notice. The price received is generally equal to a posted price set by the major purchasers in the area. Oil purchasers are selected on the basis of price and service. In 1995, revenues from oil and gas production amounted to $37.4 million, representing 72% of revenues. Oil and gas revenues for 1995 increased 53% over 1994.\nField Services\nThe field services area is comprised of three components -- well operations, brine disposal and well servicing. As of December 31, 1995, Lomak acted as operator of, or provided pumping services for, over 6,200 wells. Lomak performs virtually all day-to-day services required by these operations, rather than subcontracting them. For its services, Lomak receives a monthly fee plus reimbursement of third party charges.\nPrior to 1995, Lomak conducted brine disposal and well servicing operations on its properties as well as for third parties primarily in Ohio and to a lesser extent in Pennsylvania and Texas. In 1994, Lomak sold substantially all of brine disposal and well servicing assets located in Ohio. Through an acquisition completed in early 1995, the Company began conducting brine disposal and well services in Oklahoma.\nGas Transportation and Marketing\nThe gas transportation and marketing revenues are comprised of fees for the transportation of production through gathering lines and, to a lesser extent, income from marketing of oil and gas. In 1994, the Company began to take a more active role in marketing both its oil and gas production. As a result, at year end 1995, the Company was marketing approximately 90 MMcfe per day, including its production and the production of third parties. Gas transportation and marketing revenues were $2.2 and $3.3 million for 1994 and 1995, respectively.\nThe Company has currently hedged through the financial markets less than 3% of its monthly production through September 1996. These hedges involve fixed price arrangements and other price arrangements at a variety of prices, floors and caps. Although these hedging activities provide the Company some protection against falling prices, these activities also reduce the potential benefits to the Company of price increases above the levels of the hedges. In the future, the Company may increase the percentage of its production covered by hedging arrangements, however, it currently anticipates that such percentage would not exceed 50%.\nThe Company prefers to hedge its gas production through fixed price gas contracts. At December 31, 1995, approximately 42% of the Company's gas production was under fixed priced arrangements. These contracts vary in length from one year to the life-of-the-well. A majority of the contracts are for three years or less. Essentially all these contracts are with industrial end-users and utilities.\nIn total, field services provided revenues of $10.1 million in 1995, representing 19% of total revenues. Field service revenues for 1995 increased 32% over the prior year.\nInterest and Other\nThe Company earns interest on its cash and investment accounts, as well as on various notes receivable. Other income in 1995 was comprised principally of gains on sales of non-strategic properties and various fees charged to third parties. The Company expects to continue to sell assets which have no strategic benefit. Interest and other income in 1995 amounted to $1.3 million, representing 3% of total revenues. Revenues from interest and other for 1995 increased 180% from the 1994 level.\nCOMPETITION\nThe Company encounters substantial competition in acquiring properties, marketing oil and gas, securing personnel and conducting its field services operations. Many competitors have financial and other resources which substantially exceed those of the Company. The competitors in acquisitions, development, exploration and production include the major oil companies in addition to numerous independents, individual proprietors and others. Therefore, competitors may be able to pay more for desirable leases and to evaluate, bid for and purchase a greater number of properties or prospects than the financial or personnel resources of the Company permit. The ability of the Company to replace and expand its reserve base in the future will be dependent upon its ability to select and acquire suitable producing properties and prospects for future drilling.\nThe Company's acquisitions have been partially financed through issuances of equity and debt securities and internally generated cash flow. The competition for capital to finance oil and gas acquisitions and drilling is intense. The ability of the Company to obtain such financing is uncertain and can be affected by numerous factors beyond its control. The inability of the Company to raise capital in the future could have an adverse effect on certain areas of its business.\nEMPLOYEES\nAs of December 31, 1995, the Company had 281 full time employees, 198 of whom were field personnel. None are covered by a collective bargaining agreement and management believes that its relationship with its employees is good.\nSUBSEQUENT EVENTS\nIn February 1996, the Company completed three oil and gas property acquisitions for $17.5 million of consideration. The properties are located in Lomak's core operating areas of Appalachia and Texas. In aggregate, the acquisitions are estimated to contain proved reserves of 20.2 Bcf of gas and 240,000 barrels of oil, or 21.6 Bcfe in total.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOn December 31, 1995, the Company's properties included working interests in 6,596 gross (4,965 net) productive oil and gas wells and royalty interests in 614 additional wells. The properties contained, net to the Company's interest, estimated proved reserves of 10.9 million barrels of oil and 232.9 Bcf of gas or a total of 298 Bcfe. The Company also held interests in 311,200 gross (225,100 net) undeveloped acres at year end.\nPROVED RESERVES\nThe following table sets forth as of December 31 estimated proved reserves for the preceding five years.\nProved developed reserves are expected to be recovered from existing wells with existing equipment and operating methods. Proved undeveloped reserves are expected to be recovered from new wells drilled to known reservoirs on undrilled acreage for which the existence and recoverability of such reserves can be estimated with reasonable certainty. On a Mcfe basis, approximately 77% of the Company's proved reserves were developed at December 31, 1995. Approximately 93% of the proved reserves set forth above were engineered by independent petroleum consultants, while the remaining 7% was evaluated by the Company's engineering staff.\nThe following table sets forth as of December 31, 1995 the estimated future net cash flow from and the present value of the proved reserves. Future net cash flow represents future gross cash flow from the production and sale of proved reserves, net of production costs (including production taxes, ad valorem taxes and operating expenses) and future development costs. Such calculations, which are prepared in accordance with the Statement of Financial Accounting Standards No. 69 \"Disclosures about Oil and Gas Producing Activities\" are based on cost and price factors on December 31, 1995. Average product prices in effect at December 31, 1995 were $18.14 per barrel of oil and $2.28 per Mcf of gas. There can be no assurance that the proved reserves will be developed within the periods indicated or that prices and costs will remain constant. There are numerous uncertainties inherent in estimating reserves and related information and different reservoir engineers often arrive at different estimates for the same properties. No estimates of reserves have been filed with or included in reports to another federal authority or agency since December 31, 1995.\nSIGNIFICANT PROPERTIES\nUntil 1990, virtually all of the Company's properties were located in Ohio. Since that time, properties have been acquired in Texas and Oklahoma and other areas of Appalachia. At December 31, 1995, on a pre-tax present value basis, 49% of the reserves were located in Appalachia, 25% were in Texas and 22% were in Oklahoma. The Company also held interests in 272,200 gross (211,200 net) undeveloped acres at December 31, 1995. The following table sets forth information with respect to the Company's estimated proved oil and gas reserves as of December 31, 1995.\nThe largest concentration of reserves is in Appalachia with 49% of total present value. On an Mcfe basis, gas accounts for approximately 96% of these reserves. These reserves are ascribed to over 5,200 wells located in Pennsylvania, Ohio, West Virginia and New York. The Company operates nearly all of these wells. The reserves produce principally from the Medina, Clinton, Upper Devonian and Rose Run formations at depths of 3,000 to 7,000 feet. After initial flush production, these properties are characterized by extremely gradual decline rates and often have a projected life of more than twenty years. Gas production is transported through Company-owned gas gathering systems and is sold primarily to utilities and industrial end-users.\nThe second largest concentration of reserves is in Texas, totaling 25% of present value. On an Mcfe basis, oil makes up 67% of the reserves. The largest portion of these reserves is ascribed to 354 operated wells in the Big Lake Area of west Texas. These wells produce from the San Andres\/Grayburg formation at a depth of approximately 2,500 feet. The properties have a projected remaining life of over 25 years. Over 80% of these reserves are oil. Oil production is sold to Scurlock Permian and gas to J.L. Davis Company. The second largest portion of these reserves are ascribed to 93 operated wells in the Laura LaVelle Field in east Texas. These wells produce from the shallow Carrizo section of the Wilcox formation at a depth of approximately 1,600 feet. These properties have a projected remaining life of twenty years. All of the reserves are oil and production is sold to Texaco. The third largest portion is in Hagist Ranch Field in south Texas. The Company operates 62 wells in this field which produces primarily from the Wilcox at approximately 8,000 feet. Arco purchases the gas production from the Hagist Ranch Field.\nThe third largest concentration of reserves is in Oklahoma, totaling 22% of present value. On an Mcfe basis, gas makes up 83% of these reserves. The largest portion of these reserves is ascribed to over 257 operated wells in and around the Okeene Field of the Anadarko Basin. These wells produce from numerous formations ranging in depth from approximately 6,000 to 9,000 feet. The properties have a projected remaining life of over fifteen years. Gas production is sold primarily to Phillips Petroleum and Natural Gas Clearinghouse on an index or percent of plant proceeds basis.\nPRODUCTION\nThe following table sets forth production information for the preceding five years (in thousands, except average sales price and operating cost data).\n(a) Oil is converted to Mcfe at a rate of 6 Mcf per barrel.\nPRODUCING WELLS\nThe following table sets forth certain information relating to productive wells at December 31, 1995. The Company owns royalty interests in an additional 614 wells. Wells are classified as oil or gas according to their predominant production stream.\nACREAGE\nThe following table sets forth the developed and undeveloped acreage held at December 31, 1995.\nDRILLING RESULTS\nThe following table summarizes drilling activities for the preceding three years.\nREAL PROPERTY\nThe Company's primary office facilities are located in Ft. Worth, Texas, Hartville, Ohio and Oklahoma City, Oklahoma. These offices total approximately 40,000 square feet of which 60% is owned with the remainder leased. The Company also owns a number of smaller field offices in proximity to its areas of operations. The office leases are standard arrangements expiring at various times through September 1996. All facilities are adequate to meet the Company's existing needs and can be expanded with minimal expense.\nThe Company owns various rolling stock and other equipment which is used in its field operations. Such equipment is believed to be in good repair and, while such equipment is important to its operations, it can be readily replaced as necessary.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various legal actions and claims arising in the ordinary course of business. In the opinion of management, such litigation and claims will be resolved without material adverse effect on the Company's financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMMON STOCK AND RELATED MATTERS\nThe Company's Common Stock is listed on Nasdaq under the symbol \"LOMK\". During 1995, trading volume averaged 82,200 shares per day. The stock prices below are based on the last trade price.\nDIVIDENDS\nDividends of $.01 per share were initiated on the Common Stock in December 1995. The 7-1\/2% Convertible Preferred Stock receives cumulative quarterly dividends at the annual rate of $1.875 per share. The $2.03 Convertible Preferred Stock receives cumulative quarterly dividends at the annual rate of $2.03 per share.\nThe Company currently retains substantially all of its earnings to support the development of its business. Any future determination as to the payment of dividends will be at the discretion of the Board of Directors of the Company, and will depend on the Company's financial condition, results of operations and capital requirements, and such other factors as the Board of Directors deems relevant. In addition, the Company's bank credit facility limits the amount of cash dividends that can be paid in one year to 75% of the Company's net income, plus the cumulative net proceeds from all equity offerings completed after January 1, 1996.\nHOLDERS OF RECORD\nAt December 31, 1995, the number of holders of record of the Common Stock, 7-1\/2% Convertible Preferred Stock and $2.03 Convertible Preferred Stock were 5,062, 48 and 17, respectively.\nOn March 11, 1996, the closing price of the Common Stock was $10.50. To date in 1996, trading volume has averaged 154,000 shares per day.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial information covering the preceding five years.\nThe following table sets forth summary unaudited financial information on a quarterly basis for the past two years (in thousands, except per share data).\nThe 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.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFACTORS EFFECTING FINANCIAL CONDITION AND LIQUIDITY\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial position continues to strengthen. The Company had working capital of $4.4 million at December 31, 1995 compared to $1.0 million at December 31, 1994. The Company had cash and cash equivalents of $3.0 million at year end 1995. The Company's primary sources of cash in 1995 consisted of (i) operating cash flow of $21.5 million (net income plus deferred taxes, depreciation, depletion and amortization and exploration expense); (ii) proceeds from the sale of preferred stock of $27.8 million; (iii) proceeds from the sale of common stock of $10.6 million; and, (iv) proceeds from the issuance of long-term debt of $21.3 million. The Company's primary uses of cash in 1995 consisted of (i) acquisitions of oil and gas properties of $67.1; (ii) capital expenditures for development and exploration activities of $10.2; (iii) payments on long-term debt of $808,000 and (iv) dividend payments of $859,000.\nThe Company has three principal operating sources of cash: (i) sales of oil and gas, (ii) revenues from field services and (iii) revenues from gas transportation and marketing. The Company's cash flow is highly dependent upon oil and gas prices. Decreases in the market price of oil or gas could result in reductions of both cash flow and estimated reserves that would result in decreased funds available, including funds intended for planned capital expenditures.\nVirtually all oil and gas properties are subject to production declines over time. Through acquisitions, the Company has increased its reserves in each of the last six years. It is anticipated that the Company will continue to build reserves primarily through acquisitions and development over the next several years. The profitability of production and, to a lesser extent, other areas of the Company's business are influenced by energy prices.\nThe Company funds its short-term working capital requirements through cash flow provided by operations and borrowings under its bank credit facility. The bank credit facility provides for a maximum capacity of $250 million and has a borrowing base which is subject to semi-annual redeterminations. At December 31, 1995, the borrowing base on the credit facility was $105 million and $22 million was available under the facility. The Company's ratio of total debt to total capitalization was 45.6% at December 31, 1995, down from 56.3% at December 31, 1994. Total capitalization is defined by the Company as the sum of long-term debt, minority interest and stockholders' equity. The increase in the Company's long-term debt in recent years is due to acquisition and development activities. As of December 31, 1995, only $53,000 of long-term debt matures within one year.\nDuring 1995, the Company sold 1,150,000 shares of preferred stock and 1,319,000 shares of common stock for total net proceeds of $38.4 million. In addition, 2.3 million shares of common stock were issued in completion of the acquisition of the Company's Oklahoma operating unit. The proceeds from the sale of stock were used to repay the bank credit facility.\nManagement believes that, in addition to current financial resources, adequate financial resources are available to satisfy the Company's acquisition, development and enhancement programs. Such sources of capital would include, but not be limited to, bank borrowings and the issuance of equity and debt securities.\nCAPITAL EXPENDITURES\nDuring 1995, the Company acquired oil and gas properties, gas transportation and field service assets for $71.1 million. Additionally, the Company incurred capital expenditures for development and exploration activities of $10.2 million. In total, $79.4 million of capital expenditures were incurred in 1995, versus $69.2 million in 1994. The Company currently estimates that capital expenditures for acquisition and development activities will range from $50 million to $75 million in 1996. All of these expenditures are discretionary and could increase or decrease based upon the level of activity and the availability of capital.\nThe only material requirements for capital during the next twelve months are $2.7 million of preferred stock dividends, interest payments on the Company's credit facility and $53,000 of debt payments. Working capital and cash flow from operations will be more than sufficient to fund these expenditures. Excess funds will be used to help fund acquisitions and development activities.\nIn March 1996, the Company's Board of Directors approved resolutions authorizing the Company to repurchase shares of its Common Stock from odd-lot holders. The Company will acquire any and all shares from stockholders owning 99 or fewer shares for cash at market prices. Additionally, the Board of Directors approved a dividend of $.01 per share to holders of its Common Stock to be paid on March 29, 1996.\nINFLATION AND CHANGES IN PRICES\nThe Company's revenues and the value of its oil and gas properties have been and will be affected by changes in oil and gas prices. The Company's ability to maintain current borrowing capacity and to obtain additional capital on attractive terms is also substantially dependent on oil and gas prices. Oil and gas prices are subject to significant seasonal and other fluctuations that are beyond the Company's ability to control or predict. During 1995, the Company received an average of $16.57 per barrel of oil and $1.79 per Mcf of gas. Although certain of the Company's costs and expenses are affected by the level of inflation, inflation did not have a significant effect in 1995. Should conditions in the industry improve, inflationary cost pressures may resume.\nRESULTS OF OPERATIONS\nComparison of 1995 to 1994\nThe Company reported net income for the year ended December 31, 1995 of $4.4 million, a 68% increase over 1994. This increase is the result of higher production volumes attributable to acquisition and development activities. During the year, oil and gas production volumes increased 66% to 17.9 Bcfe, an average of 49,172 Mcfe per day. The increased revenues recognized from production volumes were partially offset by an 8% decrease in the average price received per Mcfe of production to $2.08. The average oil price increased 9% to $16.57 per barrel while average gas prices dropped 15% to $1.79 per Mcf. As a result of the Company's larger base of producing properties and production, oil and gas production expenses increased 49% to $14.9 million in 1995 versus $10.0 million in 1994. However, the average operating cost per Mcfe produced decreased 11% from $.93 in 1994 to $.83 in 1995.\nGas transportation and marketing revenues increased 50% to $3.3 million versus $2.2 million in 1994. Coupled with this increase in gas transportation and marketing revenues was a 73% increase in associated expenses for the year. These increases were due primarily to the acquisition of several pipeline systems, as well as the expansion of the gas marketing efforts.\nField services revenues increased 32% in 1995 to $10.1 million, despite the September 1994 sale of virtually all well servicing and brine disposal assets in Ohio. The decrease in activities due to this sale was more than offset by an increase in well servicing and brine disposal activities in Oklahoma and well operations on acquired properties. Field services expenses increased 12% in 1995 to $6.5 million versus $5.8 million. The increase is attributed to the Oklahoma well servicing and the cost of operating a larger base of properties. The increase in well operating costs was offset to a great extent by the disposal in September 1994 of the Company's lower margin well servicing and brine hauling and disposal businesses.\nExploration expense increased 43% to $512,000 due to the Company's increased involvement in exploration projects. These costs include delay rentals, seismic and exploratory drilling activities.\nGeneral and administrative expenses increased 10% from $2.5 million in 1994 to $2.7 million in 1995. As a percentage of revenues, general and administrative expenses were 5% in 1995 as compared to 7% in 1994. This decreasing trend reflects the spreading of administrative costs over a growing asset base.\nInterest and other income rose 180% primarily due to higher sales of non-strategic properties. Interest expense increased 99% to $5.6 million as compared to $2.8 million in 1994. This was primarily as a result of the higher average outstanding debt balance during the year due to the financing of capital expenditures. The average outstanding balances on the bank credit facility were $42.0 million and $73.3 million for 1994 and 1995, respectively. The weighted average interest rate on these borrowings were 6.3% and 7.3% for the years ended December 31, 1994 and 1995, respectively.\nDepletion, depreciation and amortization increased 47% compared to 1994 as a result of increased production volumes during the year. The increased depletion of oil and gas properties was partially offset by the reduction of depreciation of field services assets due to the 1994 sale of field service assets. The Company-wide depletion, depreciation and amortization rate for 1995 was $.83 per Mcfe versus $.93 in 1994.\nComparison of 1994 to 1993\nThe Company reported net income for the year ended December 31, 1994 of $2.6 million, an 88% increase over 1993 net income. This increase can be attributed primarily to the realization of income from properties acquired in the fourth quarter of 1993 and in 1994, as well as the success of the 1994 drilling program.\nDuring the year, oil and gas production volumes increased 141% to 10.8 MMcfe, an average of 29,680 Mcfe per day. The increased revenues recognized from production volumes were partially offset by a 9% decrease in the average price received per Mcfe of production to $2.26. The average oil price decreased 5% to $15.23 per barrel and average gas prices dropped 9% to $2.10 per Mcf. As a result of the Company's larger base of producing properties and production, oil and gas production expenses increased 126% to $10.0 million in 1994 versus $4.4 million in 1993. However, the average operating cost per Mcfe produced decreased 5% from $0.98 in 1993 to $0.93 in 1994.\nGas transportation and marketing revenues rose almost four fold to $2.2 million versus $0.6 million in 1993. Coupled with this increase in gas transportation and marketing revenues was an increase in associated expenses for the year. These increases were due primarily to the acquisition of several pipeline systems in late 1993, as well as the expansion of the gas marketing efforts.\nField services revenues increased in 1994, despite the September 1994 sale of virtually all well servicing and brine hauling and disposal assets in Ohio. The decrease was offset by a marked increase in well operating revenues recognized on acquired properties. Field services expenses increased marginally in 1994 to $5.8 million versus $5.7 million. The slight increase can be attributed to the cost of operating a growing base of properties. The increase in well operating costs was offset to a great extent by the disposal in September 1994 of the Company's low-margin well servicing and brine hauling and disposal businesses.\nExploration expense increase four-fold due to the Company's increased involvement in drilling projects. The results of these costs can be seen in the increase in production due partially to its 1994 drilling program.\nGeneral and administrative expenses increased 21% from $2.0 million in 1993 to $2.5 million in 1994. As a percentage of revenues, general and administrative expenses were 7% in 1994 as compared to 11% in 1993. This decreasing trend reflects the spreading of administrative costs over a growing asset base.\nInterest and other income rose 13% primarily due to a higher level of non-strategic property sales. Interest expense increased 151% to $2.8 million as compared to $1.1 million in 1993. This was as a result of the higher average outstanding debt balance during the year due to the financing of acquisitions and rising interest rates.\nDepletion, depreciation and amortization increased 132% compared to 1993 as a result of increased production volumes during the year. The increased depletion of oil and gas properties was partially offset by the reduction of depreciation of field services assets due to the September 1994 sale of field service assets.\nComparison of 1993 to 1992\nTotal revenue for 1993 rose 37% to $19.1 million compared to $13.9 million in 1992. Net income increased 103% from $686,000 in 1992 to $1,391,000 in 1993. The increases in revenues and net income was due primarily to higher oil and gas volumes from acquisitions. The earnings increase was partially offset by higher operating expenses and increased depletion associated with higher production volumes.\nOil production averaged 872 barrels per day, an increase of 60% from 1992. The average oil price received for 1993 was $16.07 per barrel compared to $18.40 for 1992. Average daily gas production was 7,095 Mcf in 1993 versus 4,921 Mcf in the prior year, a 44% increase. Gas prices averaged $2.32 per Mcf, $.07 higher than 1992. Production operating expenses increased to $4.5 million during 1993 compared to $3.1 million during 1992 due to higher volumes. The average operating cost (including production taxes) was $0.98 per Mcfe, slightly less than the prior year figure.\nField service revenues rose to $7.0 million in 1993, a 32% increase compared to 1992. The increase was primarily the result of operating more oil and gas properties during 1993 and a full year's operations of Wellworks, Inc. (\"Wellworks\") versus one-half year of operations in 1992. Field service expenses increased 45% reflecting the higher expense ratio of well servicing.\nInterest and other income decreased 28% to $418,000 in 1993. The lower revenues were principally due to a lower level of property dispositions. Interest expense increased 18% to $1,120,000 as a result of a higher average outstanding debt balance from acquisitions. General and administrative expenses increased 7% and as a percentage of revenues was 11% in 1993 versus 14% in 1992. The reduction reflects cost efficiencies as well as higher cost reimbursements. Depletion, depreciation and amortization increased 39% in 1993 from the prior year principally due to increased oil and gas production volumes. The depletion rate in 1993 was $0.74 per Mcfe compared to $0.76 for 1992.\nACCOUNTING STANDARDS\nIn March 1995, the Financial 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 standard requires the review of long-lived assets for impairment. Although the Company in the past has routinely reviewed its oil and gas assets for impairment, the new accounting rules may require a different grouping which may affect the amount of impairment, if any. SFAS No. 121 is required to be adopted for financial statements with fiscal years beginning after December 15, 1995 and allows the cumulative effect of the accounting change to be reported in net income in the year of adoption. The Company is currently reviewing the accounting standard and has not yet determined the effect, if any, on its consolidated financial position or results of operations.\nIn October 1995, FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard requires an audited pro forma footnote disclosure of what net income and earnings per share would have been for the Company based upon valuing employee options and other stock based compensation, at their estimated fair value using an option pricing model. SFAS No. 123 is required to be adopted for financial statements with fiscal years beginning after December 15, 1995. The Company is currently reviewing the accounting standard and has not yet determined the effect, if any, on its financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the Index to Financial Statements on page 26 for a listing of the Company's financial statements and notes thereto and for supplementary schedules. Schedules I, III, IV, V, VI, VII, VIII, IX, X, XI, XII and XIII have been omitted as not required or not applicable or because the information required to be presented is included in the financial statements and related notes.\nMANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe financial statements have been prepared by management in conformity with generally accepted accounting principles. Management is responsible for the fairness and reliability of the financial statements and other financial data included in this report. In the preparation of the financial statements, it is necessary to make informed estimates and judgments based on currently available information on the effects of certain events and transactions.\nThe Company maintains accounting and other controls which management believes provide reasonable assurance that financial records are reliable, assets are safeguarded, and that transactions are properly recorded. However, limitations exist in any system of internal control based upon the recognition that the cost of the system should not exceed benefits derived.\nThe Company's independent auditors, Arthur Andersen LLP, are engaged to audit the financial statements and to express an opinion thereon. Their audit is conducted in accordance with generally accepted auditing standards to enable them to report whether the financial statements present fairly, in all material respects, the financial position and results of operations in accordance with generally accepted accounting principles.\nITEM 9.","section_9":"ITEM 9. CHANGE IN ACCOUNTANTS AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information required by Item 304 of Regulation S-K regarding changes in accountants was previously filed on Form 8-K dated May 25, 1994.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nThe current executive officers and directors of the Company are listed below, together with a description of their experience and certain other information. Each of the directors was elected for a one-year term at the Company's 1995 annual meeting of stockholders. Executive officers are appointed by the Board of Directors.\nTHOMAS J. EDELMAN, holds the office of Chairman and is Chairman of the Board of Directors. Mr. Edelman joined the Company in 1988 and served as its Chief Executive Officer until 1992. Since 1981, Mr. Edelman has been a director and President of Snyder Oil Corporation. Prior to 1981, Mr. Edelman was a Vice President of The First Boston Corporation. From 1975 through 1980, Mr. Edelman was with Lehman Brothers Kuhn Loeb Incorporated. Mr. Edelman received his Bachelor of Arts Degree from Princeton University and his Masters Degree in Finance from Harvard University's Graduate School of Business Administration. Mr. Edelman is also a director of Petroleum Heat & Power Co., Inc., a Connecticut based fuel oil distributor, Star Gas Corporation, a private company which distributes propane gas, Amerac Energy Corporation, a public domestic exploration and production company, and Command Petroleum Limited, an international exploration and production company affiliated with Snyder Oil Corporation.\nJOHN H. PINKERTON, President, Chief Executive Officer and a Director, joined the Company in 1988. He was appointed President in 1990 and Chief Executive Officer in 1992. Previously, Mr. Pinkerton was Senior Vice President-Acquisitions of SOCO. Prior to joining SOCO in 1980, Mr. Pinkerton was with Arthur Andersen & Co. Mr. Pinkerton received his Bachelor of Arts Degree in Business Administration from Texas Christian University and his Master of Arts Degree in Business Administration from the University of Texas.\nROBERT E. AIKMAN, a Director, joined the Company in 1990. Mr. Aikman has more than 40 years experience in petroleum and natural gas exploration and production throughout the United States and Canada. From 1984 to 1994 he was Chairman of the Board of Energy Resources Corporation. From 1979 through 1984, he was the President and principal shareholder of Aikman Petroleum, Inc. From 1971 to 1977, he was President of Dorchester Exploration Inc., and from 1971 to 1980, he was a Director and a Member of the Executive Committee of Dorchester Gas Corporation. Mr. Aikman is also Chairman of Provident Trade Company, President of EROG, Inc., and President of The Hawthorne Company, an entity which organizes joint ventures and provides advisory services for the acquisition of oil and gas properties, including the financial restructuring, reorganization and sale of companies. He was President of Enertec Corporation which was reorganized under Chapter 11 of the Bankruptcy Code in December 1994. In addition, Mr. Aikman is a director of the Panhandle Producers and Royalty Owners Association and a member of the Independent Petroleum Association of America, Texas Independent Producers and Royalty Owners Association and American Association of Petroleum Landmen. Mr. Aikman graduated from the University of Oklahoma in 1952.\nALLEN FINKELSON, was appointed a Director in 1994. Mr. Finkelson has been a partner at Cravath, Swaine & Moore since 1977, with the exception of the period from September 1983 through August 1985, when he was a managing director of Lehman Brothers Kuhn Loeb Incorporated. Mr. Finkelson was first employed by Cravath, Swaine & Moore as an associate in 1971. Mr. Finkelson received his Bachelor of Arts Degree from St. Lawrence University and his Doctor of Laws Degree from Columbia University School of Law.\nANTHONY V. DUB, was elected to serve as a Director of the Company in 1995. Mr. Dub is Managing Director-Senior Advisor of CS First Boston, an international investment banking firm with headquarters in New York City. Mr. Dub joined CS First Boston in 1971 and was named a Managing Director in 1981. Mr. Dub received his Bachelor of Arts Degree from Princeton University in 1971.\nBEN A. GUILL, was elected to serve as a Director of the Company in 1995. Mr. Guill is a Partner and Managing Director of Simmons & Company International, an investment banking firm located in Houston, Texas focused exclusively on the oil service and equipment industry. Mr. Guill has been with Simmons & Company since 1980. Prior to joining Simmons & Company, Mr. Guill was with Blyth Eastman Dillon & Company from 1978 to 1980. Mr. Guill received his Bachelor of Arts Degree from Princeton University and his Masters Degree in Finance from the Wharton Graduate School of Business at the University of Pennsylvania.\nC. RAND MICHAELS, who holds the office of Vice Chairman and is a Director, served as President and Chief Executive Officer of the Company from 1976 through 1988 and Chairman of the Board from 1984 through 1988, when he became Vice Chairman. Mr. Michaels received his Bachelor of Science Degree from Auburn University and his Master of Business Administration Degree from the University of Denver. Mr. Michaels is also a director of American Business Computers Corporation of Akron, Ohio, a public company serving the beverage dispensing and fast food industries.\nJEFFERY A. BYNUM, Vice President-Land and Secretary, joined the Company in 1985. Previously, Mr. Bynum was employed by Crystal Oil Company and Kinnebrew Energy Group of Shreveport, Louisiana. Mr. Bynum holds a Professional Certification with American Association of Petroleum Landmen and attended Louisiana State University in Baton Rouge, Louisiana and Centenary College in Shreveport, Louisiana.\nSTEVEN L. GROSE, Vice President-Appalchia Region, joined the Company in 1980. Previously, Mr. Grose was employed by Halliburton Services, Inc. as a Field Engineer from 1971 until 1974. In 1974, he was promoted to District Engineer and in 1978, was named Assistant District Superintendent based in Pennsylvania. Mr. Grose is a member of the Society of Petroleum Engineers and a trustee of The Ohio Oil and Gas Association. Mr. Grose received his Bachelor of Science Degree in Petroleum Engineering from Marietta College.\nCHAD L. STEPHENS, Vice President-Midcontinent Region, joined the Company in 1990. Previously, Mr. Stephens was a landman with Duer Wagner & Co., an independent oil and gas producer, since 1988. Prior thereto, Mr. Stephens was an independent oil operator in Midland, Texas for four years. From 1979 to 1984, Mr. Stephens was a landman for Cities Service Company and HNG Oil Company. Mr. Stephens received his Bachelor of Arts Degree in Finance and Land Management from the University of Texas.\nTHOMAS W. STOELK, Vice President - Finance and Chief Financial Officer, joined the Company in 1994. Mr. Stoelk is a Certified Public Accountant and was a Senior Manager with Ernst & Young LLP. Prior to rejoining Ernst & Young LLP in 1986 he was with Partners Petroleum, Inc. Mr. Stoelk received his Bachelor of Science Degree in Industrial Administration from Iowa State University.\nJOHN R. FRANK, Controller and Chief Accounting Officer, joined the Company in 1990. From 1989 until he joined Lomak in 1990, Mr. Frank was Vice President Finance of Appalachian Exploration, Inc. Prior thereto, he held the positions of Internal Auditor and Treasurer with Appalachian Exploration, Inc. beginning in 1977. Mr. Frank received his Bachelor of Arts Degree in Accounting and Management from Walsh College and attended graduate studies at the University of Akron.\nThe Lomak Board has established three committees to assist in the discharge of its responsibilities.\nAUDIT COMMITTEE. The Audit Committee reviews the professional services provided by Lomak's independent public accountants and the independence of such accountants from management of Lomak. This Committee also reviews the scope of the audit coverage, the annual financial statements of Lomak and such other matters with respect to the accounting, auditing and financial reporting practices and procedures of Lomak as it may find appropriate or as have been brought to its attention. Messrs. Aikman, Dub and Guill members of the Audit Committee.\nCOMPENSATION COMMITTEE. The Compensation Committee reviews and approves executive salaries and administers bonus, incentive compensation and stock option plans of Lomak. This Committee advises and consults with management regarding pensions and other benefits and significant compensation policies and practices of Lomak. This Committee also considers nominations of candidates for corporate officer positions. The members of Compensation committee are Messrs. Aikman, Guill and Finkelson.\nEXECUTIVE COMMITTEE. The Executive Committee reviews and authorizes actions required in the management of the business and affairs of Lomak, which would otherwise be determined by the Board, where it is not practicable to convene the full Board. One of the principal responsibilities of the Executive Committee will be to review and approve smaller acquisitions. The members of the Executive Committee are Messrs. Edelman, Finkelson and Pinkerton.\nITEM 11.","section_11":"ITEM 11. COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\nInformation with respect to executive compensation is ]incorporated herein by reference to the Proxy Statement for its 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 of certain beneficial owners and management is incorporated herein by reference to the Company's Proxy Statement for its 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 Company's Proxy Statement for its 1996 annual meeting of stockholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. and 2. Financial Statements and Financial Statement Schedules The items listed in the accompanying index to financial statements are filed as part of this Annual Report on Form 10-K.\n3. Exhibits. The items listed on the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K.\nNovember 8, 1995 - Acquisition of Transfuel Interests for $20.2 million and $755,000 in Lomak common stock. The acquisition includes approximately 1,800 producing gas wells, 1,100 miles of gathering lines, 175,000 net acres of undeveloped leases and associated real estate and equipment.\n(c) Exhibits required by Item 601 of Regulation S-K. Exhibits required to be filed by the Company pursuant to Item 601 of Regulation S-K are contained in Exhibits listed in response to Item 14 (a)3, and are incorporated herein by reference.\n(d) Financial Statement Schedules Required by Regulation S-X. The items listed in the accompanying index to financial statements are filed as part of this Annual Report on Form 10-K.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nDated: March 19, 1996\nLOMAK PETROLEUM, INC.\nBy:\/s\/ John H. Pinkerton ------------------- John H. Pinkerton President\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE PERSONS ON BEHALF OF THE COMPANY AND IN THE CAPACITIES AND ON THE DATES INDICATED.\n\/s\/ Thomas J. Edelman - ------------------------ Thomas J. Edelman, March 19, 1996 Chairman and Chairman of the Board\n\/s\/ John H. Pinkerton - ------------------------ John H. Pinkerton, March 19, 1996 Chief Executive Officer, President and Director\n\/s\/ Thomas W. Stoelk - ------------------------ Thomas W. Stoelk, March 19, 1996 Chief Financial Officer and Vice President-Finance\n\/s\/ John R. Frank - ------------------------ John R. Frank, March 19, 1996 Chief Accounting Officer and Controller\n\/s\/ Robert E. Aikman - ------------------------ Robert E. Aikman, Director March 19, 1996\n\/s\/ Allen Finkelson - ------------------------ Allen Finkelson, Director March 19, 1996\n\/s\/ Anthony V. Dub - ------------------------ Anthony V. Dub, Director March 19, 1996\n\/s\/ Ben A. Guill - ------------------------ Ben A. Guill, Director March 19, 1996\n\/s\/ C. Rand Michaels - ------------------------ C. Rand Michaels March 19, 1996 Vice Chairman and Director\nLOMAK PETROLEUM, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\n(ITEM 14[A], [D])\nAll other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements or footnotes.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS LOMAK PETROLEUM, INC.\nWe have audited the accompanying consolidated balance sheets of Lomak Petroleum, Inc. (a Delaware corporation) as of December 31, 1994 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lomak Petroleum, Inc. as of December 31, 1994 and 1995, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nCleveland, Ohio, February 27, 1996\nREPORT OF INDEPENDENT AUDITORS\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS LOMAK PETROLEUM, INC.\nWe have audited the consolidated statements of income, stockholders' equity and cash flows of Lomak Petroleum, Inc. 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 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 of Lomak Petroleum, Inc. referred to above present fairly, in all material respects, the consolidated results of its operations and its cash flows for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 10 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes.\nERNST & YOUNG LLP\nCleveland, Ohio March 8, 1994\nLOMAK PETROLEUM, INC.\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSEE ACCOMPANYING NOTES.\nLOMAK PETROLEUM, INC.\nCONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSEE ACCOMPANYING NOTES.\nLOMAK PETROLEUM, INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)\nSEE ACCOMPANYING NOTES.\nLOMAK PETROLEUM, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSEE ACCOMPANYING NOTES.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(1) ORGANIZATION AND NATURE OF BUSINESS\nLomak Petroleum, Inc. (\"Lomak\" or the \"Company\") is an independent oil and gas company engaged in the acquisition, development, exploration and enhancement of oil and gas properties in the United States. Lomak's core areas of operation are located in Texas, Oklahoma and Appalachia. The Company has grown through a combination of acquisition, development, exploration and enhancement activities. Since January 1, 1990, 60 acquisitions have been consummated at a total cost of approximately $200 million and approximately $24 million has been expended on development and exploration activities. As a result, proved reserves and production have each grown during this period at a rate in excess of 80% per annum. At December 31, 1995, proved reserves totaled 298 Bcfe, having a pre-tax present value at constant prices on that date of $229 million and a reserve life of nearly 12 years.\nLomak's acquisition effort is focused on properties with prices of less than $30 million within its core areas of operation. Management believes these purchases are less competitive than those involving larger property interests. To the extent purchases continue to be made primarily within existing core areas, efficiencies in operations, drilling, gas marketing and administration should be realized. In 1994, Lomak initiated a program to exploit its inventory of over 500 development projects. In the future, Lomak expects its growth to be driven principally by a combination of acquisitions and development and, to a lesser extent, exploration.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe accompanying financial statements include the accounts of the Company, all majority owned subsidiaries and its pro rata share of the assets, liabilities, income and expenses of certain oil and gas properties. Temporary investments with an initial maturity of ninety days or less are considered cash equivalents.\nOIL AND GAS PROPERTIES\nThe Company follows the successful efforts method of accounting for oil and gas properties. Exploratory costs which result in the discovery of reserves and the cost of development wells are capitalized. Geological and geophysical costs, delay rentals and costs to drill unsuccessful exploratory wells are expensed. Depletion is provided on the unit-of-production method. Oil is converted to Mcfe at the rate of six Mcf per barrel. The depletion rates per Mcfe were $.74, $.74 and $.73 in 1993, 1994 and 1995, respectively. Approximately $5.3 million, $12.9 million and $12.2 million of oil and gas properties were classified as proved undeveloped or unproved and, therefore, not subject to depletion as of December 31, 1993, 1994 and 1995, respectively. These costs are assessed periodically to determine whether their value has been impaired, and if impairment is indicated, the excess costs are charged to expense.\nGAS TRANSPORTATION AND FIELD SERVICE ASSETS\nThe Company owns and operates approximately 1,900 miles of gas gathering lines in proximity to its principal gas properties. Depreciation is calculated on the straight-line method based on estimated useful lives ranging from four to fifteen years.\nThe Company receives fees for providing field related services. These fees are recognized as earned. Depreciation is calculated on the straight-line method based on estimated useful lives ranging from one to six years, except for buildings which are being depreciated over ten to twenty-five year periods.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\nIn September 1994, the Company sold substantially all of its brine disposal and well servicing assets located in the Appalachian region for approximately $1.8 million. Through an acquisition completed in early 1995, the Company began conducting brine disposal and well services in Oklahoma.\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.\nNATURE OF BUSINESS\nThe Company operates in an environment with many financial risks, including, but not limited to, the ability to acquire additional economically recoverable oil and gas reserves, the inherent risks of the search for, development of and production of oil and gas, the ability to sell oil and gas at prices which will provide attractive rates of return, and the highly competitive nature of the industry and worldwide economic conditions. The Company's ability to expand its reserve base and diversify its operations is also dependent upon the Company's ability to obtain the necessary capital through operating cash flow, additional borrowings or additional equity funds.\nFINANCIAL INSTRUMENTS\nThe Company's financial instruments include cash and equivalents, accounts receivable, accounts payable and debt obligations. The book value of cash and equivalents, accounts receivable and payable and short term debt are considered to be representative of fair value because of the short maturity of these instruments. The Company believes that the carrying value of its borrowings under its bank credit facility approximates their fair value as they bear interest at the bank's prime rate or Libor. The Company's accounts receivable are concentrated in the oil and gas industry. The Company does not view such a concentration as an unusual credit risk.\nInterest rate swap agreements, which are used by the Company in the management of interest exposure, is accounted for on an accrual basis. Income and expense resulting from these agreements are recorded in the same category as expense arising from the related liability. Amounts to be paid or received under interest rate swap agreements are recognized as an adjustment to expense in the periods in which they accrue. At December 31, 1995, the Company had $40 million of borrowings subject to two swap agreements at rates of 6.25% and 6.49% through July 12, 1999 and October 12, 1999, respectively.\nThe Company uses futures, option and swap contracts to reduce the effects of fluctuations in crude oil and natural gas prices. At December 31, 1995, the Company had open contracts for natural gas price swaps in the amount of 360,000 MMbtu's. These contracts expire monthly through September 1996. The resulting transaction gains and losses are included in net income and are determined monthly. Net gains for the year ended December 31, 1995 approximated $221,000 relating to these derivatives.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\nACCOUNTING STANDARDS\nIn March 1995, the Financial 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 standard requires the review of long-lived assets for impairment. Although the Company in the past has routinely reviewed its oil and gas assets for impairment, the new accounting rules may require a different grouping which may affect the amount of impairment, if any. SFAS No. 121 is required to be adopted for financial statements with fiscal years beginning after December 15, 1995 and allows the cumulative effect of the accounting change to be reported in net income in the year of adoption. The Company is currently reviewing the accounting standard and has not yet determined the effect, if any, on its consolidated financial position or results of operations.\nIn October 1995, FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard requires an audited pro forma footnote disclosure of what net income and earnings per share would have been for the Company based upon valuing employee options and other stock based compensation, at their estimated fair value using an option pricing model. SFAS No. 123 is required to be adopted for financial statements with fiscal years beginning after December 15, 1995. The Company is currently reviewing the accounting standard and has not yet determined the effect, if any, on its financial statements.\nEARNINGS PER COMMON SHARE\nNet income per share is computed by subtracting preferred dividends from net income and dividing by the weighted average number of common and common equivalent shares outstanding. The calculation of fully diluted earnings per share assumes conversion of convertible securities when the result would be dilutive. Outstanding options and warrants are included in the computation of net income per common share when their effect is dilutive.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior period presentation to conform with current period classifications.\n(3) ACQUISITION AND DEVELOPMENT\nSince 1990, the Company has acquired $200 million of oil and gas properties and field service assets. During 1995, the Company completed $71.1 million of acquisitions. The purchases were funded by working capital, advances under a revolving credit facility and the issuance of common stock. These acquisitions are discussed below.\n1995 ACQUISITIONS\nAPPALACHIA\nTransfuel, Inc. In September 1995, the Company acquired proved oil and gas reserves, 1,100 miles of gas gathering lines and 175,000 undeveloped acres in Ohio, Pennsylvania and New York from Transfuel, Inc. for $20.2 million and approximately $800,000 of Common Stock.\nParker & Parsley Petroleum Company. In August 1995, the Company purchased proved oil and gas reserves, 300 miles of gas gathering lines and 16,400 undeveloped acres in Pennsylvania and West Virginia from Parker & Parsley Petroleum Company for $20.2 million.\nInterests in approximately 470 Company operated properties in Pennsylvania and Ohio were purchased for $5.4 million.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\nOKLAHOMA - --------\nThe Company purchased interests in 52 wells in the Caddo and Canadian counties for $4.8 million. The Company assumed operation of half of these wells.\nInterests in Company operated properties were acquired for $3.2 million.\nTEXAS - -----\nThe Company purchased interests in 140 wells located primarily in the Big Lake Area of west Texas and the Laura LaVelle Field of east Texas for $2.8 million.\n1994 ACQUISITIONS\nOKLAHOMA - --------\nRed Eagle Resources Corporation. In December 1994, the Company acquired effective control of Red Eagle principally through the purchase of two common stockholders' holdings. In February 1995, the remaining stockholders of Red Eagle common stock voted to approve the merger of Red Eagle with a wholly owned subsidiary of the Company in exchange for approximately 2.2 million shares of the Company's common stock. The additional equity of Red Eagle acquired in February 1995 is reflected as minority interest on the Company's balance sheet at December 31, 1994. Acquisition costs of approximately $46.5 million have been capitalized in regards to this acquisition. Red Eagle's assets included interests in approximately 370 producing wells located primarily in the Okeene Field of Oklahoma's Anadarko Basin. Subsequently, the Company acquired additional interests in 70 Red Eagle wells for $1.7 million.\nTEXAS - -----\nGrand Banks Energy Company. The Company purchased Grand Banks for $3.7 million. Grand Banks' assets included interests in 182 producing wells located in west Texas, essentially all of which are now operated by the Company. Grand Banks owned an average working interest of 70% in the producing reserves, of which 60% was oil. Approximately 40% of Grand Banks' proved reserves are attributed to the Mills-Strain Unit located in the Sharon Ridge Field of Mitchell County, Texas. The Mills-Strain Unit is a waterflood unit producing from the Clearfork Formation at a depth of approximately 2,000 feet. The Mills-Strain Unit has a remaining life of over 20 years. The Company also purchased, for $1.2 million, additional interests in a number of the Grand Banks properties.\nGillring Oil Company. The Company acquired Gillring for $11.5 million. Gillring's assets included $5.2 million of working capital and interests in 106 producing oil and gas wells located in south Texas. Gillring owned an average working interest of 80% in the producing reserves of which 80% were gas. The Gillring properties are located principally in two fields producing from the Wilcox and Vicksburg formations ranging in depths from 4,000 to 11,000 feet. Subsequent to the purchase of Gillring, the Company acquired, for $2.1 million, the limited partner interests and associated debt of a partnership for which Gillring acted as general partner.\nThe Company acquired from four parties interests in 118 producing wells in the Big Lake Area of west Texas and the Laura LaVelle Field of east Texas for $6.5 million.\nAPPALACHIA - ----------\nThe Company acquired, for $5.0 million, interests in 98 new wells and additional interests in 436 wells which the Company already operated.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n1993 ACQUISITIONS\nAPPALACHIA - ----------\nMark Resources Corporation. In December 1993, the Company acquired Mark for approximately $28.4 million. Mark's assets were located primarily in the Meadville Area of the Appalachian Basin. Mark owned interests in 655 producing wells, 230 miles of gas gathering lines and over 180 proven drilling locations. Mark operated nearly all of its properties.\nOhio Trend Area. The Company acquired interests in 119 wells and over 70 miles of gas gathering systems in Ohio for $2.9 million.\nMeadville Area. The Company acquired interests in 274 wells, one disposal facility and various undeveloped leaseholds for $2.5 million.\nTEXAS - -----\nBig Lake Area. The Company acquired from three parties interests in 84 producing wells in the Big Lake Area of west Texas for $4.2 million.\nLaura LaVelle Field. The Company acquired interests in 7,734 gross (7,524 net) acres in the Laura LaVelle Field located in east Texas for $2.5 million. The Company assumed operations of 44 producing wells.\nUNAUDITED PRO FORMA FINANCIAL INFORMATION\nThe following table presents unaudited, pro forma operating results as if the transactions had occurred at the beginning of each period presented. The pro forma operating results include the following acquisitions, all of which were accounted for as purchase transactions; (i) the purchase of Grand Banks Energy Company, (ii) the purchase of Gillring Oil Company, (iii) the purchase of Red Eagle Resources Corporation, (iv) the purchase by the Company of certain oil and gas properties from a subsidiary of Parker & Parsley Petroleum, Co., (v) the purchase by the Company of certain oil and gas properties from Transfuel, Inc., (vi) the private placement of 1.15 million shares of Convertible Preferred Stock and the application of the net proceeds therefrom and (vii) the private placement of 1.2 million shares of Common Stock and the application of the net proceeds therefrom.\nThe pro forma operating results have been prepared for comparative purposes only. They do not purport to present actual operating results that would have been achieved had the acquisition been made at the beginning of each period presented or to necessarily be indicative of future operations. Included in the 1994 pro forma financial information are revenues regarding partnership activities which contributed $0.22 per share. These same activities did not occur in 1995.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(4) NOTES RECEIVABLE\nIn 1994, the Company issued $165,000 in notes receivable to three of its officers in connection with their exercise of stock options. The notes accrued interest at the prime rate plus 1% payable quarterly. In 1995, the notes were repaid.\n(5) INDEBTEDNESS\nThe Company had the following debt outstanding as of the dates shown. Interest rates at December 31, 1995 are shown parenthetically:\nThe Company maintains a $250 million revolving bank credit facility. The facility provides for a borrowing base which is subject to semi-annual redeterminations. At December 31, 1995, the borrowing base on the credit facility was $105 million. The facility bears interest at prime rate or LIBOR plus 0.75% to 1.25% depending upon the percentage of the borrowing base drawn. Interest is payable quarterly and the loan is payable in sixteen quarterly installments beginning February 1, 1999. A commitment fee of 3\/8% of the undrawn balance is payable quarterly. It is the Company's policy to extend the term period of the credit facility annually. The weighted average interest rate on these borrowings were 6.3% and 7.3% for the years ended December 31, 1994 and 1995, respectively. The weighted average interest rate gives effect to interest rate swap arrangements which have the effect of fixing the interest rate on $40 million of the credit facility at a rate of 6.4%. The existing interest rate swap arrangements will remain in effect through no less than July 1997 and no longer than October 1999. The Company's other debt is comprised of secured equipment financings.\nThe debt agreements contain various covenants relating to net worth, working capital maintenance and financial ratio requirements. Interest paid during the years ended December 31, 1993, 1994 and 1995 totaled $1.2 million, $2.8 million and $4.9 million, respectively.\nMaturities of indebtedness as of December 31, 1995 were as follows (in thousands):\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(6) COMMITMENTS AND CONTINGENCIES\nIn January 1995, a lawsuit (the \"Lawsuit\") was filed in the Delaware Court of Chancery, New Castle County, against Red Eagle Resources Corporation, each of the members of the Board of Directors of Red Eagle and the Company. The Plaintiff sought to represent all holders (the \"Class\") of Red Eagle common stock, excluding the Red Eagle Directors and Lomak. A settlement was reached during 1995 under which the Company paid $250,000 in cash plus 74,286 shares of the Company's Common Stock.\nThe Company is involved in various other legal actions and claims arising in the ordinary course of business. In the opinion of management, such litigation and claims will be resolved without material adverse effect on the Company's financial position.\n(7) EQUITY SECURITIES\nIn 1993, $5,000,000 of 7-1\/2% cumulative convertible exchangeable preferred stock (the \"7-1\/2% Preferred Stock\") was privately placed. The 7-1\/2% Preferred Stock is convertible, at the option of the holders, into 576,945 shares of common stock, at an average conversion price of $8.67 per share. The Company may convert the 7-1\/2% Preferred Stock into common stock if the closing price for the common stock exceeds an average price of $11.70 for twenty out of thirty consecutive trading days. Beginning in July 1996, the Company may redeem the 7-1\/2% Preferred Stock at a 7-1\/2% premium to liquidation value. Holders of the 7-1\/2% Preferred Stock are entitled to two votes per share on matters presented to the shareholders. At the Company's option, it can exchange the 7-1\/2% Preferred Stock for convertible subordinate notes due July 1, 2003. The notes carry the same conversion and redemption terms as the 7-1\/2% Preferred Stock.\nIn November 1995, the Company sold 1,150,000 shares of $2.03 convertible exchangeable preferred stock (the \"$2.03 Preferred Stock\") for $28.8 million. The $2.03 Preferred Stock is convertible into the Company's common stock at a conversion price of $9.50 per share, subject to adjustment in certain events. The $2.03 Preferred Stock is redeemable, at the option of the Company, at any time on or after November 1, 1998, at redemption prices beginning at 105%. At the option of the Company, the $2.03 Preferred Stock is exchangeable for the Company's 8-1\/8% convertible subordinated notes due 2005. The notes would be subject to the same redemption and conversion terms as the $2.03 Preferred Stock\nIn December 1995, the Company privately placed 1.2 million shares of its Common Stock for $10.2 million to a state sponsored retirement plan. Warrants to acquire 40,000 shares of common stock were outstanding at December 31, 1995. The warrants have an exercise price of $7.50 per share and expire in December 1996.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(8) STOCK OPTION AND PURCHASE PLAN\nThe Company maintains a Stock Option Plan which authorizes the grant of options of up to 1.5 million shares of Common Stock. However, no new options may be granted which would result in their being outstanding aggregate options exceeding 10% of the Company's common shares outstanding plus those shares issuable under convertible securities. Under the plan, incentive and non-qualified options may be issued to officers, key employees and consultants. The plan is administered by the Compensation Committee of the Board. All options issued under the plan vest 30% after one year, 60% after two years and 100% after three years. The following is a summary of stock option activity:\nIn 1994, the stockholders approved the 1994 Outside Directors Stock Option Plan (the \"Directors Plan\"). Only Directors who are not employees of the Company are eligible under the Directors Plan. The Directors Plan covers a maximum of 200,000 shares. At December 31, 1995, 44,000 options were outstanding under the Directors Plan of which 3,600 were exercisable as of that date. The exercise price of the options ranges from $7.75 to $8.00 per share.\nIn 1994, the stockholders approved the 1994 Stock Purchase Plan (the \"1994 Plan\") which authorizes the sale of up to 500,000 shares of common stock to officers, directors, key employees and consultants. Under the Plan, the right to purchase shares at prices ranging from 50% to 85% of market value may be granted. The Company had a 1989 Stock Purchase Plan (the \"1989 Plan\") which was identical to the 1994 Plan except that it covered 333,333 shares. Upon adoption of the 1994 Plan, the 1989 Plan was terminated. The plans are administered by the Compensation Committee of the Board. During the year ended December 31, 1995, the Company sold 85,800 unregistered common shares to officers and outside directors. From inception of the 1989 Plan through December 31, 1995, a total of 388,000 unregistered shares had been sold, for a total consideration of approximately $1.8 million at prices equal to 75% of market value at the time of the sale.\n(9) BENEFIT PLAN\nThe Company maintains a 401(K) Plan for the benefit of its employees. The Plan permits employees to make contributions on a pre-tax salary reduction basis. The Company makes discretionary contributions to the Plan. Company contributions for 1993, 1994 and 1995 were $189,000, $226,000 and $346,000, respectively.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(10) INCOME TAXES\nFederal income tax (benefit) expense was ($81,000), $139,000 and $1.8 million for the years 1993, 1994 and 1995, respectively. The current portion of the income tax provision represents alternative minimum tax currently payable. A reconciliation between the statutory federal income tax rate and the Company's effective federal income tax rate is as follows:\nIn 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 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, income tax expense was determined using the deferred method and the Company reported tax expense equal to current alternative minimum taxes payable. Deferred taxes have not been provided on temporary differences prior to adoption due to the existence of net operating loss and other carryforwards.\nSignificant components of the Company's deferred tax liabilities and assets are as follows (in thousands):\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\nAs permitted by Statement 109, the Company has elected not to restate prior year financial statements. As a result of tax basis in excess of the basis on the financial statements at January 1, 1993, the Company estimated deferred tax assets of $2.6 million and deferred tax liabilities of $0.9 million, for net deferred tax assets of $1.7 million. Due to uncertainty as to the realizability of the tax benefit, a valuation allowance was established for the full amount of the net deferred tax assets. In 1993, 1994 and 1995, income taxes were reduced from the statutory rate of 34% by approximately $0.5 million, $0.9 million and $0.3 million, respectively, through realization of a portion of the valuation allowance, resulting in $1.2 million, $0.3 million and $40,000, respectively of the remaining allowance at December 31, 1993, 1994 and 1995.\nDuring 1993, the Company acquired Mark Resources Corporation (See Note 3), a taxable business combination accounted for as a purchase. Deferred tax assets of $3.9 million and a deferred tax liability of $8.1 million were recorded in connection with the business combination. During 1994, the Company acquired Gillring Oil Company and Grand Banks Energy Company, taxable business combinations accounted for as purchases. Deferred tax assets of $3.5 million and deferred tax liabilities of $3.4 million were recorded in connection with these transactions. The Company acquired Red Eagle Resources Corporation, a taxable business combination accounted for as a purchase. Deferred tax liabilities of $12.3 million and deferred tax assets of $0.3 million were recorded in connection with this transaction.\nAs a result of the Company's issuance of equity and convertible debt securities, it experienced a change in control during 1988 as defined by Section 382 of the Internal Revenue Code. The change in control placed limitations to the utilization of net operating loss carryovers. At December 31, 1995, the Company had available for federal income tax reporting purposes net operating loss carryovers of approximately $13.3 million which are subject to annual limitations as to their utilization and otherwise expire between 1996 and 2010, if unused. The Company has alternative minimum tax net operating loss carryovers of $8.2 million which are subject to annual limitations as to their utilization and otherwise expire from 1996 to 2009 if unused. The Company has statutory depletion carryover of approximately $8.5 million and an alternative minimum tax credit carryover of approximately $500,000. The statutory depletion carryover and alternative minimum tax credit carryover are not subject to limitation or expiration.\n(11) MAJOR CUSTOMERS\nThe Company markets its oil and gas production on a competitive basis. The type of contract under which gas production is sold varies but can generally be grouped into three categories: (a) life-of-the-well; (b) long-term (1 year or longer); and (c) short-term contracts which may have a primary term of one year, but which are cancelable at either party's discretion in 30-120 days. At December 31, 1995, approximately 59% of the Company's gas production was being sold under market sensitive contracts which do not contain floor price provisions. For the year ended December 31, 1995, no one customer accounted for more than 10% of the Company's total oil and gas revenues. Oil is sold on a basis such that the purchaser can be changed on 30 days notice. The price received is generally equal to a posted price set by the major purchasers in the area. The Company sells to oil purchasers on a basis of price and service.\nThe Company has currently hedged less than 3% of its monthly production through September 1996. These hedges involve fixed price arrangements and other price arrangements at a variety of prices, floors and caps. Although these hedging activities provide the Company some protection against falling prices, these activities also reduce the potential benefits to the Company of price increases above the levels of the hedges.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(12) OIL AND GAS ACTIVITIES\nThe following summarizes selected information with respect to oil and gas producing activities:\n(13) SUBSEQUENT EVENTS\nIn February 1996, the Company completed three oil and gas property acquisitions for $17.5 million of consideration. The properties are located in Lomak's core operating areas of Appalachia and Texas. In aggregate, the acquisitions are estimated to contain proved reserves of 20.2 Bcf of gas and 240,000 Bbls of oil, or 21.6 Bcfe in total.\nIn March 1996, the Company's Board of Directors approved resolutions authorizing the Company to repurchase shares of its Common Stock from odd-lot holders. The Company will acquire any and all shares from stockholders owning 99 or fewer shares for cash at market prices. Additionally, the Board of Directors approved a dividend of $.01 per share to holders of its Common Stock to be paid on March 29, 1996.\n(14) RELATED PARTY TRANSACTIONS\nMr. Edelman, Chairman of the Company, is also an executive officer and shareholder of Snyder Oil Corporation (\"SOCO\"). At December 31, 1995, Mr. Edelman owned 6.0% of the Company's common stock. In 1994, the Company repurchased 30,000 shares of its common stock from SOCO for $240,000. The purchase price was based upon the prior day's closing price for the stock. In 1995, SOCO sold its remaining shares of the Company's common stock.\nIn 1995, the Company acquired SOCO's interest in certain wells located in Appalachia for $4 million. The price was determined based on arms-length negotiations through a third-party broker retained by SOCO. Subsequent to the transaction, the Company and SOCO no longer held interests in any of the same properties.\nDuring 1994 and 1995, the Company incurred fees of $369,000 and $145,000, respectively, to the Hawthorne Company in connection with acquisitions. Mr. Aikman, a director of the Company, is an executive officer and a principal owner of the Hawthorne Company. The fees were consistent with those paid by the Company to third parties for similar services.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\n(15) UNAUDITED SUPPLEMENTAL RESERVE INFORMATION\nThe Company's proved oil and gas reserves are located in the United States. Proved reserves are those quantities of crude oil and natural gas which, upon analysis of geological and engineering data, can with reasonable certainty be recovered in the future from known oil and gas reservoirs. Proved developed reserves are those proved reserves which can be expected to be recovered from existing wells with existing equipment and operating methods. Proved undeveloped oil and gas reserves are proved reserves that are expected to be recovered from new wells on undrilled acreage.\nQUANTITIES OF PROVED RESERVES\nThe \"Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves\" (Standardized Measure) is a disclosure requirement under Statement of Financial Accounting Standards No. 69 \"Disclosures about Oil and Gas Producing Activities\". The Standardized Measure does not purport to present the fair market value of proved oil and gas reserves. This would require consideration of expected future economic and operating conditions, which are not taken into account in calculating the Standardized Measure.\nLOMAK PETROLEUM, INC. Notes to Consolidated Financial Statements\nFuture cash inflows were estimated by applying year end prices to the estimated future production less estimated future production costs based on year end costs. Future net cash inflows were discounted using a 10% annual discount rate to arrive at the Standardized Measure.\nSTANDARDIZED MEASURE\nCHANGES IN STANDARDIZED MEASURE\nLOMAK PETROLEUM, INC.\nINDEX TO EXHIBITS\n(Item 14[a 3])\n* Filed herewith.","section_15":""}
{"filename":"73887_1995.txt","cik":"73887","year":"1995","section_1":"ITEM 1. Business\nOffshore Logistics, Inc. was incorporated in Louisiana in 1969 and its state of incorporation was changed to Delaware in 1988. Unless the context herein indicates otherwise, all references to the \"Company\" refer to Offshore Logistics, Inc. and subsidiaries. The Company's executive offices are located at 224 Rue de Jean, Post Office Box 5-C, Lafayette, Louisiana 70505, and its telephone number is (318) 233-1221.\nOffshore Logistics, Inc., through its Air Logistics division, is a major supplier of helicopter transportation services to the worldwide offshore oil and gas industry. At June 30, 1995, the Company's operations included 188 aircraft (including 27 aircraft operated through unconsolidated entities). The Company's operations until 1991 also included a Marine Division, wherein the Company owned vessels that supplied marine transportation services to the international oil and gas industry. During 1991, the Company sold substantially all of the remaining assets in its Marine Division and ceased its marine operations.\nDuring 1993, the Company expanded its operations to include production management services by acquiring a 50% interest in Seahawk Services Ltd. (\"Seahawk\") in a transaction in which Seahawk acquired all of the business of PPI-Seahawk Services, Inc., a company engaged in the production management services business. In October 1993, the Company exchanged its interest in Seahawk for a 27.5% interest in Grasso Corporation whose wholly-owned subsidiary, Grasso Production Management, Inc. (\"GPM\"), also was engaged in the production management services business. In September 1994, GPM became a wholly-owned subsidiary of the Company through a merger of Grasso Corporation into the Company.\nDuring October 1994, the Company acquired a 75% interest in Cathodic Protection Services Company (\"CPS\"). CPS manufactures, installs, and maintains cathodic protection systems to arrest corrosion in oil and gas drilling and production facilities, pipelines, and other metal structures.\nSee Note I in \"Notes to Consolidated Financial Statements\" for information on the Company's operating revenue, operating profit, and identifiable assets by industry segment and geographical distribution for the three years ended June 30, 1995.\nHELICOPTER SERVICES\nThe Company charters its helicopters to customers for use in transporting personnel and time-sensitive equipment from onshore bases to offshore drilling rigs, platforms, and other installations. The helicopter charters are for varying periods and, in some cases, may contain provisions for cancellation prior to completion of the contract. Charges under these charter agreements are generally based on either a daily or monthly fixed fee plus additional hourly charges. Helicopter services are seasonal in nature and influenced by weather conditions and level of offshore construction activity.\nThe following table sets forth the number and type of aircraft operated by the Company at the end of the year for the past three fiscal years.\nThe Company owns 151 of the 161 aircraft that it operates. The following table sets forth certain information concerning these aircraft:\nIn addition to the foregoing 151 aircraft, the Company operates 10 aircraft pursuant to various types of operating lease arrangements at June 30, 1995. The Company also provides services and technical support to entities that operate 22 helicopters of various types and 5 fixed wing aircraft.\nDomestic Operations\nThe Company's domestic helicopter services are conducted primarily from operating facilities along the Gulf of Mexico. As of June 30, 1995, the Company operated 139 aircraft in that area. The Company also operates 11 aircraft in Alaska. Although the Company's business is primarily dependent upon activity levels in the offshore oil and gas industry, the existence of a secondary market for helicopters distinguishes the helicopter business from other segments of the oil service industry. Other uses for which helicopters are employed, include emergency medical transportation, agricultural and forestry support, and general aviation activities. These additional uses enable the Company to scale down operations through the sale of excess equipment to companies in the aforementioned industries. Because of this ability to react to market conditions, management believes the helicopter segment of the oil service industry is less affected by downturns in offshore oil and gas activities.\nInternational Operations\nUtilization of helicopters in international service is dependent on the worldwide level of oil and gas exploration and development offshore and in remote areas. This, in turn, is dependent on the funds available to the major oil companies to conduct such activities and upon the number and location of new foreign concessions. As of June 30, 1995, the Company operated 11 of its helicopters in international locations, including Bolivia, Brazil, Colombia, and Mexico.\nIn addition to its direct operations in international areas, the Company has service agreements with, and equity interests in, entities that operate 27 aircraft in Egypt and Mexico. The Company provides services and technical support to these entities and, from time to time, leases aircraft to these entities as additional support for these operations. As of June 30, 1995, three of the Company's helicopters were being leased to its Mexican affiliate for operations in that country.\nCustomers\nThe principal customers for the Company's helicopter services are national and international petroleum and offshore construction companies. During 1994, one customer accounted for approximately 13% of the Company's operating revenues. During 1995 and 1993, no one customer accounted for more than 10% of the Company's consolidated operating revenues.\nCompetition\nThe Company's business is highly competitive. Chartering of helicopters is usually done on the basis of competitive bidding among those having the necessary equipment and resources. The technical requirements of operating helicopters offshore have increased over the past several years as oil and gas activities moved into deeper water and more sophisticated aircraft were required to service the market. The number of small helicopter operators in the Gulf of Mexico has declined over the past several years, as it has become increasingly difficult to maintain an adequate shorebased infrastructure and provide the working capital required to conduct such operations, especially when the associated costs must be spread over a relatively small number of helicopters. One of the Company's competitors has substantially more helicopters in service in the Gulf of Mexico and there are at least four companies internationally that operate more helicopters than the Company. Certain of the Company's competitors have substantially greater resources than the Company.\nIndustry Hazards and Insurance\nHazards, such as adverse weather and marine conditions, crashes, collisions, and fire are inherent in the offshore oil and gas industry and in the related transportation and supply of such industry, and may result in losses of equipment and revenues. On August 26, 1992, Hurricane Andrew struck the Gulf Coast of Louisiana. There was no material loss to the Company's aircraft or facilities as a result of the hurricane.\nThe Company maintains Hull and Liability Insurance which generally insures the Company against certain legal liabilities to others, as well as damage to the aircraft. It is also the Company's policy to carry insurance for, or require its customers to provide indemnification against, expropriation, war risk, and confiscation of its helicopters employed in international operations. There is no assurance that in the future the Company will be able to maintain its existing coverage or that the premiums therefrom will not increase substantially.\nGovernment Regulation\nDomestic. As a commercial operator of small aircraft, the Company is subject to regulations pursuant to the Federal Aviation Act of 1958, as amended, and other statutes. The Company carries persons and property in its helicopters pursuant to an Air Taxi or Commercial Operator of Small Aircraft Certificate granted by the Civil Aeronautics Board (\"CAB\"). Unlike an air carrier, the Company is not required to file with the CAB tariffs showing rates, fares, and other charges.\nThe Federal Aviation Administration (\"FAA\") regulates the flight operations of the Company, and in this respect, exercises jurisdiction over personnel, aircraft, ground facilities, and certain technical aspects of the Company's operations. The National Transportation Safety Board is authorized to investigate aircraft accidents and to recommend improved safety standards. The Company is also subject to the Communications Act of 1934 because of the use of radio facilities in its operations.\nUnder the Federal Aviation Act, it is unlawful to operate certain aircraft for hire within the United States unless such aircraft are registered with the FAA and the operator of such aircraft has been issued an operating certificate by the FAA. As a general rule, aircraft may be registered under the Federal Aviation Act only if the aircraft is owned or controlled by one or more citizens of the United States, and an operating certificate may be granted only to a citizen of the United States. For the purposes of these requirements, a corporation is deemed to be a citizen of the United States only if, among other things, at least 75% of the voting interest therein is owned or controlled by United States citizens. In the event that persons other than United States citizens should come to own or control more than 25% of the voting interest in the Company, the Company has been advised that the Company's aircraft may be subject to deregistration under the Federal Aviation Act and loss of the privilege of operating within the United\nStates. At June 30, 1995, the Company had approximately 713,000 common shares held by persons with foreign addresses representing approximately 3.7% of the 19,442,114 common shares outstanding.\nThe Company's operations are subject to federal, state, and local laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the environment. To date, such laws and regulations have not had a material adverse effect on the Company's business or financial condition. Increased public awareness and concern over the environment, however, may result in future changes in the regulation of the oil and gas industry, which in turn could adversely affect the Company.\nInternational. The Company's international operations are subject to local governmental regulations and to uncertainties of economic and political conditions in those areas. Because of the impact of local laws, the Company's international operations are conducted primarily through entities (including joint ventures) in which local citizens own interests and the Company holds only a minority interest, or pursuant to arrangements under which the Company operates assets or conducts operations under contracts with local entities. There can be no assurance that there will not be changes in local laws, regulations or administrative requirements, or the interpretation thereof, any of which could have a material adverse effect on the business or financial condition of the Company or on its ability to continue operations in certain regions.\nPRODUCTION MANAGEMENT SERVICES\nBeginning in 1993, through Seahawk and, subsequent thereto, through a 27.5% equity ownership interest in Grasso Corporation and its wholly-owned subsidiary, GPM, the Company began providing oil and gas production management services. On September 16, 1994, GPM became a wholly-owned subsidiary of the Company through the merger of Grasso Corporation into the Company.\nGPM is the leading independent operator of oil and gas production facilities in the Gulf of Mexico. In addition, GPM also provides services for certain onshore facilities. In providing these services, GPM operates oil and gas production facilities for major and smaller independent oil and gas companies. Typical project assignments may involve full or limited management of operations of oil and gas production facilities located offshore, particularly in the Gulf of Mexico. The work involves placing experienced crews, employed by GPM, to operate the facilities and providing all necessary services and products for the offshore operations. When servicing offshore oil and gas production facilities, GPM's employees normally live on the facility for a seven day rotation. GPM's services include furnishing personnel, production operating services, paramedic services and the provision of boat and helicopter transportation of personnel and supplies between onshore bases and offshore facilities. GPM also handles regulatory and production reporting, joint interest accounting and royalty and working interest revenue disbursement services for certain of its customers.\nDomestic Operations\nGPM's domestic production management services are conducted primarily from production facilities in the Gulf of Mexico. As of June 30, 1995, GPM managed or had personnel assigned to 195 production facilities in the Gulf of Mexico. Although GPM's business is primarily dependent upon activity levels in the offshore oil and gas industry, 90% of GPM's production management costs consist of labor and contracted transportation services. This enables GPM to scale down operations rapidly should the market conditions change. Because of this ability to react to market conditions, management believes the production management segment of the oil service industry is less affected by downturns in offshore oil and gas activities.\nInternational Operations\nTo date, GPM's international activities have been limited primarily to consulting and paramedic assignments. As of June 30, 1995, the Company's production management division had a total of three personnel providing services in Singapore, Chad, and Russia.\nCustomers\nGPM's customers are primarily major and small independent oil and gas companies that own oil and gas production facilities in the Gulf of Mexico. These companies are increasingly inclined to outsource services provided by companies such as GPM which are able to operate more efficiently and with a lower cost structure. This allows the customer to focus their efforts on their core activities, which is the exploration and production of oil and gas. During 1995, no single GPM customer accounted for more than 10% of the Company's consolidated operating revenues.\nCompetition\nGPM's business is highly competitive. There are five to six direct competitors that are substantially smaller than GPM but maintain a Gulf wide presence. In addition, there are many smaller operators that compete on a local basis or for single projects or jobs. Management of the Company anticipates that the market for oil and gas production management operations will continue to increase over the next few years as oil and gas producing companies continue to reduce the size of field personnel and further utilize outside contractors as efforts to reduce their operating costs continue. Typically, GPM will be requested to bid on one or more production facilities owned by an oil and gas producer. The two key elements in the pricing of the bid are personnel and transportation costs. In addition to price, an additional consideration is the competence and stability of the operator since this can greatly affect the revenue flow to the producer and reduce the risk of possible damage to the production facility. There are no assurances that an increase in the market for production management will occur.\nIndustry Hazards and Insurance\nGPM's operations are subject to the normal risks associated of working on an oil and gas production facility. These risks could result in damage to or loss of property and injury to or death of personnel. GPM carries normal business insurance including general liability, worker's compensation, automobile liability and property and casualty insurance coverages. Management believes GPM is adequately protected from most business risks normally subject to insurance.\nGovernment Regulation\nThe Mineral Management Service (\"MMS\") regulates the production operations of GPM, and in this respect, exercises jurisdiction over personnel, production facilities, and certain technical aspects of GPM's operations.\nGPM's operations are subject to federal, state, and local laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the environment. To date, such laws and regulations have not had a material adverse effect on GPM's business or financial condition. Increased public awareness and concern over the environment, however, may result in future changes in the regulation of the oil and gas industry, which in turn could adversely affect the Company.\nCATHODIC PROTECTION SERVICES\nCathodic Protection Services Company was established in 1946 in Houston, Texas, as the first commercial engineering firm in the United States solely devoted to corrosion control by cathodic protection. CPS specializes in providing cathodic protection systems and services for the purpose of arresting corrosion in steel structures such as pipelines, oil and gas well casings, offshore facilities, hydrocarbon processing plants, water tanks, oil and gas storage tanks, and other metal structures. CPS revenues have traditionally been derived from three major activities: the construction and installation of cathodic protection systems; the sale of materials for cathodic protection systems; and the engineering, evaluation, and other ancillary services provided for cathodic protection systems. The majority of CPS's revenues are derived from single project contracts and material orders; however, CPS is a party to certain maintenance contracts varying in duration from one to five years and certain \"blanket\" material contracts that are normally agreed to for one year at a time.\nIn May 1995, CPS formed an 80% owned subsidiary, CPS Technologies, for the purpose of pursuing various opportunities relating to the remote monitoring of cathodic protection systems by means of low orbital satellite, cellular telephones or other communication media. Management views this subsidiary as a development stage business and, although optimistic as to opportunities, has no assurances as to its ultimate profitability.\nCPS provides materials and services to the cathodic protection market in the domestic United States through eleven district office locations as follows: Billings, Montana; Carson, California; Denver, Colorado; Farmington, New Mexico; Houston, Texas; Liberal, Kansas; Lombard, Illinois; Metairie, Louisiana; Midland, Texas; Sand Springs (Tulsa), Oklahoma; and Springfield, New Jersey. The Springfield, New Jersey office, in addition to providing normal customer services, specializes in servicing the water tank needs of municipalities throughout the U.S. The Company also has a manufacturing facility in Sand Springs, Oklahoma that assembles various types of cathodic protection anodes and a corporate office in Houston, Texas. CPS is the major customer, under a tolling agreement, with an aluminum anode foundry located in McAllen, Texas.\nCompetition\nCPS is the second largest provider of cathodic protection services and materials in the United States. The largest provider of cathodic protection services is the primary competitor of CPS on a nationwide basis. CPS also competes with numerous regional and local cathodic protection companies with respect to engineering, construction and installation, and related services. Many of the regional and local competitors are not able to provide cathodic protection materials to customers without purchasing them from CPS or other manufacturers\/suppliers.\nSuppliers\nCertain of the cathodic protection materials provided by CPS, for example, magnesium anodes and aluminum anodes, depend largely on the supply of the associated base metals. For metals such as magnesium and aluminum there are a limited number of suppliers and, at times, shortages of supply. These factors also cause price volatility for these metals. CPS has developed and maintained relationships with all potential suppliers and protects itself from price risks by passing this risk to customers on virtually all contracts and contract bids. Although shortages of supply can have an impact on the revenues of CPS by delaying sales of materials of this type, it is management's belief that CPS is not placed at a competitive disadvantage in its markets as a result of shortages since all suppliers of cathodic protection materials face the same shortages at the same time.\nIndustry Hazards and Insurance\nThe construction and installation of cathodic protection systems and the providing of materials for such systems are subject to seasonality based upon weather conditions. This seasonality can be slightly offset by the providing of engineering services which are not as dependent upon weather conditions. Since the energy industry, including pipelines, refineries and tank farms, is the primary user of cathodic protection systems, the business of CPS is also subject to cyclical downturns caused by oil and gas prices, regulations, and other factors affecting the energy industry. The impact of these factors is slightly offset by sales to other industries such as the marine industry and state and local governments.\nCPS carries normal business insurance including worker's compensation, general liability, automobile liability, and property coverage. CPS does not carry professional liability insurance since, in the opinion of management and consistent with traditional industry practices, the engineering services provided by CPS do not involve detail design work. In the belief of management, CPS is adequately protected from most business risks normally protected by insurance.\nGovernment Regulation\nCPS believes that its historical and current operations including its use of property, plant, and equipment, conform in all material respects with all applicable laws and regulations. Periodically, the Company is subject to various inspections or reviews by regulatory agencies; however, the Company has not experienced nor does it anticipate, any material claim in connection with environmental, safety, or other regulations.\nThe business of CPS can be directly impacted by the issuance of government regulations. The recent trends toward increased federal, state, and local involvement in environmental and safety matters should result in an increased emphasis on cathodic protection systems. Many CPS customers must comply with regulations issued by the United States Environmental Protection Agency, the United States Department of Transportation - Office of Pipeline Safety, and other such federal, state, and local agencies. CPS continually monitors the pronouncements of these agencies, and, in the opinion of management, believes that such regulations will have a positive impact rather than a negative impact on the Company's business.\nGENERAL\nEmployees\nAs of June 30, 1995 and 1994, the Company employed 1,347 and 619 persons, respectively, who are or were involved in the following operations:\nThe Company's employees are not represented by unions. In 1983, the Company was petitioned by the Oil, Chemical, and Atomic Workers Union (\"OCAW\") for representation of the Company's helicopter pilots. The OCAW effort was defeated by election results in February 1984.\nIn 1975, the Company was petitioned by the Teamsters Union for an election. However, the Union decided not to seek an election after several months of union solicitation. Union campaigns at a major helicopter competitor in 1970, 1974, and 1980 also failed. If the Company's helicopter pilots were to elect to be represented by a union, the Company would, it believes, be the only unionized company in the domestic helicopter service industry. The Company believes that, in light of current market conditions, being a unionized company in a non-union industry could place the Company at a competitive disadvantage in the industry. This could have a material adverse effect on its revenues from helicopter operations in the Gulf of Mexico and on its results of operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nSee Business--Helicopter Services for a discussion of the number and types of aircraft operated by the Company.\nThe Company leases approximately 11 acres of land in the vicinity of Morgan City, Louisiana, under a lease expiring in 2000, with a renewal option for an additional ten year period. The Company has constructed a heliport, hangar, and office facility on the site. The Company is subleasing approximately 50% of the land to Gulf Offshore Marine, a subsidiary of GulfMark International, Inc., who acquired the Company's Marine Division.\nThe Company leases approximately 8 1\/3 acres of land at the Acadiana Regional Airport in New Iberia, Louisiana, under a lease expiring in fiscal year ending 2030. The Company has constructed office and helicopter maintenance facilities on the site containing approximately 44,000 square feet of floor space. The property has access to the airport facilities, as well as a major highway.\nThe Company's Corporate offices occupy 8,300 square feet in a building in Lafayette, Louisiana, under a lease expiring in 1998. Other office and operating facilities in the United States and abroad, including most of the operating facilities along the Gulf of Mexico, are held under leases, the rental obligations under which are not material in the aggregate.\nSome of the property owned by the Company and used in domestic operations are subject to security interests in favor of the Company's creditors (see Note B in \"Notes to Consolidated Financial Statements\").\nGPM's Corporate offices occupy 24,000 square feet in a building in Houston, Texas, under a lease expiring in December 1998. Other office and operating facilities along the Gulf of Mexico are held under leases, the rental obligations under which are not material in the aggregate.\nCPS's Corporate offices occupy 16,000 square feet in a building in Houston, Texas, under a lease expiring in December 1999. Other office and operating facilities throughout the United States and abroad are held under leases, the rental obligations under which are not material in the aggregate.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nIn January 1989, the Company received notice from the United States Environmental Protection Agency (\"EPA\") that it is a potentially responsible party (\"PRP\") for clean up and other response costs at the Sheridan Disposal Services Superfund Site in Waller County, Texas. The Company is among approximately 160 PRPs identified with respect to the site. The EPA has estimated that the cost of remedial activities at the site will be approximately $30 million. In August 1989, the Company received a similar notice with respect to the D.L. Mud Services Site and the Gulf Coast Vacuum Services Site, both of which are near Abbeville, Louisiana. The Company is among over 300 PRPs identified with respect to each site. The EPA alleged that the Company is a generator or transporter of hazardous substances found at the three sites. In February 1991, the Company received a request for information from the EPA relating to the Western Sand and Gravel Superfund Site in Rhode Island, as to which the Company had been named a PRP after an earlier request for information from the EPA issued in 1983 - 1984.\nBased on presently available information, the Company believes that it generated only a small portion, if any, of the substances found at the above described sites. In addition, many of the other PRPs at all of the aforementioned sites are large companies with substantial resources. As a result, the Company believes that its potential liability for clean up and other response costs in connection with these sites is not likely to have a material adverse effect on the Company's business or financial condition.\nIn addition to notification of PRP responsibility, the EPA notices to the Company also contained information requests regarding the Company's connection with the various sites. The responses to the information requests were due in early March 1989 for the Sheridan site and in early September 1989 for the two Louisiana sites. Through oversight, the Company did not respond to the requests until April and May 1990. The EPA is authorized to seek civil penalties for failure to respond to its information requests in a timely manner in an amount up to a maximum of $25,000 per day for each day of continued non-compliance; however, to date, no such penalties have been sought. While it is not possible to predict whether any civil penalties might be assessed against the Company for the delays in responding to the EPA requests, the Company believes the amount of such penalties, if any, will not have a material adverse effect on its business or financial condition.\nThe Company is not a party to any other litigation which, in the opinion of management, will have a material adverse effect on the Company's business or financial condition.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNo voting matters were submitted to security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the current fiscal year.\nExecutive Officers of the Registrant\nAll executive officers hereunder are, in accordance with the By-laws, elected annually and hold office until a successor has been duly elected and qualified. There are no family relationships among any of the Company's executive officers. The executive officers of the Company as of September 27, 1995, are as follows:\nMr. Clement joined the Company in 1976 as Controller and served in various financial capacities until 1981 when he was appointed the General Manager -- Marine Division. Mr. Clement was elected President and Chief Operating Officer of the Company in May 1986, Chief Executive Officer in November 1987 and Chairman of the Board of Directors in June 1995.\nMr. Small joined the Company in 1977 as Controller and was elected Vice President -- Treasurer in 1979, and Chief Financial Officer and Secretary in 1986. He is a CPA.\nMr. Murphy joined the Company in 1984 as Vice President -- Corporate Sales. He received a Bachelor of Science degree from Rice University in 1950. He has forty-five years of experience in the oil service industry.\nMr. Graves joined the Company in 1993 as Vice President -- Aviation Marketing and was appointed Vice President -- Domestic Aviation in 1994. Prior to joining the Company, Mr. Graves had 26 years experience in the commercial helicopter service business in the Gulf of Mexico as Vice President -- Marketing and several operating positions.\nMr. Albert joined the Company in 1972 as a pilot and served in several operating capacities before being appointed Director of International Aviation Operations in 1980. He was elected Vice President in 1987. Mr. Albert has thirty years of experience in the aviation industry.\nMr. Milke joined the Company in 1988 as Director of Planning and Development and was elected Vice President in 1990. Prior to joining the Company, Mr. Milke was a Manager with Arthur Andersen LLP.\nMrs. Como joined the Company in 1990 as Controller. Prior to joining the Company, Mrs. Como was a Manager with Arthur Andersen LLP. She is a CPA.\nMr. Underwood joined the Company in 1995 as General Counsel. He received a Juris Doctorate from Loyola University in 1987 and has a degree in risk management from the University of Georgia. Prior to joining the Company, Mr. Underwood was General Counsel for another oilfield service 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 traded in the over-the-counter market and is reported on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol \"OLOG\". The Company's Common Stock has been quoted on the NASDAQ National Market System since 1984. Prices listed below represent actual closing prices.\nThe approximate number of holders of record of Common Stock as of August 31, 1995 was 1,500.\nThe Company has not paid dividends on its Common Stock since January 1984. Certain of the Company's financing agreements contain limitations on the payment of dividends. See Note B in \"Notes to Consolidated Financial Statements\".\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\n(1) Includes an extraordinary gain of $1,012,000 in 1993. There were no extraordinary items in 1995, 1994, 1992, or 1991.\n(2) Includes income from discontinued operations of $5,522,000 in 1991. There were no discontinued operations in 1995, 1994, 1993, or 1992. The discontinued operations relate to the Company's Marine Division which was sold during the year ended June 30, 1991.\n(3) Includes financial data for GPM and CPS after effective dates of their consolidation (See Note E in Notes to Consolidated Financial Statements).\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGeneral\nDemand for the Company's services has traditionally been influenced by the level of worldwide offshore oil and gas production and drilling activity. During the 1970's and early 1980's, the helicopter and marine services provided by the Company expanded rapidly in response to the growth of the oil and gas industry. The decline in oil and gas prices that began in 1982 and the resulting decline in drilling activity led to excess capacity and increased competition in the offshore oil service industry. In response to these adverse conditions, management took several steps, including restructuring substantially all of its long-term obligations, discontinuing its domestic marine services, and adopting cost reduction measures. Beginning in 1987, the market for helicopter services began to improve, and accordingly, the Company commenced an expansion of its helicopter fleet. At that time, the focus of the Company's operations shifted from predominately marine services to helicopter services. As the Company's helicopter services expanded, the Company's Marine Division became a smaller segment of the Company's total business and during the year ended June 30, 1991, the Company made the decision to dispose of the Marine Division.\nDuring 1992, the Company was engaged exclusively in aviation services and related operations. During 1993, the Company expanded its operations to include production management services through an acquisition of a 50% interest in Seahawk Services Ltd. (\"Seahawk\"), which acquired all of the business of PPI- Seahawk Services, Inc. Seahawk provided platform and production management services, offshore medical support services, and temporary personnel to the oil and gas industry.\nDuring 1994, the Company exchanged its 50% interest in Seahawk for a 27.5% interest in Grasso Corporation whose wholly-owned subsidiary, Grasso Production Management, Inc. (\"GPM\"), also was engaged in the production management services business. On September 16, 1994, GPM became a wholly-owned subsidiary of the Company in a merger in which the Company acquired the remaining 72.5% interest in Grasso Corporation by issuing .49 of a share of the Company's Common Stock for each share of Grasso Corporation Common Stock owned. See Note E in \"Notes to Consolidated Financial Statements.\"\nIn determining to acquire 100% of GPM, the Company's management was influenced by its belief that a restructuring in the United States oil and gas industry is taking place, resulting in part from the instability of oil prices over the last several years. As part of this restructuring, major oil companies have been reducing the size of their field organizations and concentrating more on foreign exploration and production. Management believes that this restructuring is creating opportunities, first, for smaller, independent oil companies as the major oil companies have been selling properties in the Gulf of Mexico, and, second, for companies providing production management services to smaller, independent oil companies, which frequently lack the personnel to operate these properties. Although there can be no assurances, the Company's management believes that, through its acquisition of GPM, the Company will have the opportunity to take advantage of any increase in the market for oil and gas production management services that may occur over the next few years. Management also believes that the addition of the production management services business may permit the Company, by providing helicopter services through the production management services business to smaller, independent companies, to enhance its market share for its helicopter transportation services in the very competitive and rapidly changing Gulf of Mexico environment.\nCathodic Protection Services Company (\"CPS\") manufactures, installs, and maintains cathodic protection systems to arrest corrosion in oil and gas drilling and production facilities, pipelines, and other metal structures. In October 1994, the Company acquired 75% of CPS. The minority interest owner may increase their ownership at the end of five years if certain financial goals are met. At that time, the Company has the election to retain a majority ownership in CPS.\nResults of Operations\nOperating results and other income statement information for the three years ended June 30, 1995 follows (in thousands of dollars):\nHelicopter Services\nDemand for the Company's helicopter services increased until the latter part of fiscal 1991. At that time, construction activity and the rig count in the Gulf of Mexico declined to its lowest level in four years and remained at low levels throughout 1992 causing a reduction in domestic flight hours. Management implemented stringent cost controls over its domestic operations and increased international activities to combat the negative effect of reduced flight hours. The Gulf of Mexico rig count improved during fiscal 1993 leading to increased flight activity by the end of fiscal 1993 and during 1994 and 1995.\nOperating revenues for helicopter services were $89.5 million, $91.7 million, and $80.2 million for 1995, 1994, and 1993, respectively. The decrease in operating revenues of approximately 2% from 1994 to 1995 is primarily due to a decrease in International and Alaskan operations. Gulf of Mexico helicopter activity has remained relatively unchanged from 1994 to 1995. The increase in operating revenues of approximately 14% from 1993 to 1994 is primarily due to the increased market share of the Company in the Gulf of Mexico and from Heli- Lift, Inc., the Company's Alaskan helicopter subsidiary acquired during 1993. Operating revenues from Heli-Lift were $8.4 million, $9.6 million, and $4.5 million for 1995, 1994, and 1993, respectively (1993 includes only six months of operations).\nOperating expenses for helicopter services were $66.7 million, $70.1 million, and $59.2 million for 1995, 1994, and 1993, respectively. The decrease in operating expenses of approximately 5% from 1994 to 1995 is due to a decrease in International and Alaskan operations, as well as continued cost controls over Gulf of Mexico operations. The increase in operating expenses of approximately 16% from 1993 to 1994 is primarily due to the increased market share of the Company in the Gulf of Mexico and from Heli-Lift, Inc., as well as increases in the price of helicopter parts. Operating expenses from Heli-Lift were $6.1 million, $6.6 million, and $3.1 million for 1995, 1994, and 1993, respectively.\nGross margin percentages for helicopter services, excluding gain on disposal of equipment, were 25%, 24%, and 26% for 1995, 1994, and 1993, respectively. The increase in gross margin percentages from 1994 to 1995 is due to the improved cost controls in the Gulf of Mexico operations. The decrease\nin gross margin percentages from 1993 to 1994 was due to the inability of the Company to increase helicopter rates in the Gulf of Mexico market since 1990 despite the increase in the price of helicopter parts and other costs during that period.\nThe Company's helicopter services are conducted principally in the Gulf of Mexico, where the Company provides helicopter services to support the production and exploration activities of oil and gas companies. The Company also charters helicopters to offshore construction companies and governmental entities involved in offshore oil and gas operations in the Gulf of Mexico. The Company has service agreements with, and equity interests in, entities that operate aircraft in Egypt and Mexico (\"unconsolidated entities\"). The Company also operated in various other international areas (including Bolivia, Brazil, Colombia, El Salvador, Kuwait, Taiwan, Mexico, Papua New Guinea, and Trinidad and Tobago). The Company's international operations are subject to local governmental regulations and to uncertainties of economic and political conditions in those areas. The following table sets forth certain information regarding aircraft operated by the Company and unconsolidated entities.\nDuring 1994, the Company's helicopter joint venture in Brazil was terminated. Costs associated with this termination of approximately $2.7 million were charged against previously established accruals. The three helicopters involved were redeployed into the Company's other operations. The termination of the venture did not have a material effect on the Company's operations.\nProduction Management Services\nOperating revenues from GPM were approximately $32.8 million for the period from consolidation through June 30, 1995. Approximately 70% of GPM's revenues are from production management. The other 30% of revenues are from contract personnel and medic systems.\nOperating expenses for GPM were $32.6 million for 1995. Gross margin percentages for production management was approximately 6% and gross margin percentages for contract personnel and medic systems was approximately 20%. Overall, GPM operations were breakeven for 1995 with operating income of approximately $0.2 million.\nCathodic Protection Services\nOperating revenues and operating expenses from CPS were approximately $25.3 million and $26.6 million, respectively, for the period from consolidation through June 30, 1995. CPS generated a $1.3 million operating loss for 1995. Certain overhead costs were higher than anticipated and attempts to expand the business internationally resulted in higher than anticipated operating costs. Management has taken measures to reduce overhead costs and its international operations. Although there can be no assurance of improved results, management believes that these measures will have a positive impact on CPS's operations during fiscal 1996.\nConsolidated\nNet income for 1995 was $18.5 million, compared to net income of $17.2 million and $17.1 million for 1994 and 1993, respectively after gains from restructuring debt of $1.0 million for 1993 (see Note B in \"Notes to Consolidated Financial Statements\").\nLiquidity and Capital Resources\nCash and cash equivalents (including marketable securities) were $68.0 million as of June 30, 1995, a $20.8 million increase from 1994. Long-term debt was $5.6 million as of June 30, 1995, all related to CPS and non-recourse to the Company.\nCash flows provided by operating activities were $30.8 million, $18.2 million, and $19.4 million in 1995, 1994, and 1993, respectively. The increase in cash flows from operating activities in 1995 compared to the prior years is primarily due to the change in the Company's net working capital.\nCash flows used in investing activities were $8.4 million, $9.5 million, and $23.9 million for 1995, 1994, and 1993, respectively. During 1995, the Company utilized $8.2 million for the acquisitions of GPM and CPS, net of cash on hand for the two subsidiaries. Capital expenditures during 1995 of $3.2 million included the purchase of one new Bell 206L-IV and two used MBB Boelkow 105's previously under a lease arrangement.\nCapital expenditures during 1994 of $11.5 million included the purchase of six new helicopters, five Bell 206L-IV's and one Bell 214ST, and one used Sikorsky S-76. Proceeds from asset dispositions during 1994 of $3.5 million was primarily from the sale of two Bell 212's.\nThe Company implemented a new cash management policy in 1993 whereby $19.8 million was invested in U.S. Treasury Notes with maturities less than three years. Capital expenditures during 1993 totalled $4.3 million and related primarily to seven helicopters purchased from Hemisco Helicopters International, Inc.\nCash flows used in financing activities were $1.7 million, $8.7 million, and $9.1 million in 1995, 1994, and 1993, respectively. During 1995, repayment of debt was $4.2 million and the Company received $2.5 million from common stock issued, primarily from the exercise of warrants for 200,000 shares of common stock. Financing activities during 1994 and 1993 were primarily for the repayment of debt.\nDuring February 1993, the Company made a cash payment of $1.6 million to the Maritime Administration (\"MARAD\") to repay all of its outstanding debt to MARAD. The Company realized an extraordinary net gain from the early retirement of debt of approximately $ 1.0 million, after the income tax effect of the transaction.\nDuring 1995, the Company executed a $10 million unsecured working capital line of credit with a bank that expires on January 31, 1996. Management believes that normal operations will provide sufficient working capital and cash flow to meet debt service for the foreseeable future.\nThe effective income tax rates from continuing operations were 29%, 27%, and 25% for 1995, 1994, and 1993, respectively. The variance between the Federal statutory rate and the effective rate for these periods is due primarily to the utilization of foreign net operating losses, the utilization of investment tax credits available to offset deferred taxes for financial reporting purposes, and foreign tax credits available to reduce domestic taxable income.\nThe Company has received notices from the EPA that it is one of approximately 160 PRPs at one Superfund site in Texas and one of over 300 PRPs at two sites in Louisiana, and a PRP at one site in Rhode Island. The Company believes, based on presently available information, that its potential liability for clean up and other response costs in connection with these sites is not likely to have a material adverse effect on the Company's business or financial condition. See Item 3 -- Legal Proceedings for additional information regarding EPA notices.\nIn March 1995, the Statement of Financial Accounting Standard No. 121 -- \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" was issued and required to be adopted by the Company no later than the fiscal year ended June 30, 1997. Management believes that such adoption will not have a material effect on the Company's financial statements taken as a whole.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Offshore Logistics, Inc.:\nWe have audited the accompanying consolidated balance sheets of Offshore Logistics, Inc. (a Delaware corporation) and subsidiaries as of June 30, 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 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 Offshore Logistics, 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.\n\/s\/ ARTHUR ANDERSEN LLP\nNew Orleans, Louisiana, August 14, 1995\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS June 30, 1995 and 1994\nASSETS\nThe accompanying notes are an integral part of these statements.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these statements.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT\nThe accompanying notes are an integral part of these statements.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these statements.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA--SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation--The consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions.\nCash and Cash Equivalents--The Company's cash equivalents includes funds invested in highly liquid debt instruments with original maturities of 90 days or less.\nInvestment in Marketable Securities--The Company invests in U.S. Treasury Notes with maturities not exceeding three years. Effective July 1, 1994, the Company adopted the provisions of the Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". The effect of the adoption of SFAS No. 115 was not material to the Company's consolidated financial statements and there was no cumulative effect of an accounting change as a result of the adoption.\nAccounts Receivable--Trade and other receivables are stated at net realizable value and the allowance for uncollectible accounts was $1,568,000 and $1,454,000 at June 30, 1995 and 1994, respectively. The Company's primary business is a supplier of helicopter transportation services to the worldwide offshore oil and gas industry. In addition, the Company, through its GPM and CPS subsidiaries, provides oil and gas production management services to major and smaller independent oil and gas companies and provides cathodic protection services throughout the United States. The Company grants credit to its customers, primarily major and independent oil and gas companies operating in the Gulf of Mexico, on a short-term basis.\nInventories--Inventories are stated at the lower of average cost or market and consist primarily of spare parts. The valuation reserve related to obsolete and excess inventory was $4,324,000 and $4,204,000 at June 30, 1995 and 1994. There were no related charges to operations in 1995, 1994, or 1993.\nOther Assets--In 1995, $25,046,000 of goodwill, net of accumulated amortization of $1,340,000, was included in other assets. Goodwill is amortized using the straight-line method over a period of 20 years. Goodwill is recognized for the excess of the purchase price over the value of the identifiable net assets. See Note E. Realization of goodwill is periodically assessed by management based on the expected future profitability and cash flows of acquired companies and their contribution to the overall operations of the Company.\nDepreciation and Amortization--Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the assets. Estimated residual value used in calculating depreciation of aircraft is 30% of cost.\nMaintenance and repairs are expensed as incurred; betterments and improvements are capitalized. The costs and related reserves of assets sold or otherwise disposed of are removed from the accounts and resultant gains or losses included in income.\nInterest, based on rates applicable to specific and general corporate funds required to finance major construction projects, is capitalized to reflect the full economic cost of the asset. There was no interest capitalized during 1995, 1994, or 1993.\nIncome Taxes--Income taxes are accounted for in accordance with the provisions of the SFAS No. 109 \"Accounting for Income Taxes\". Under this statement, deferred income taxes are provided for by the asset and liability method.\nEarnings per Common Share--Earnings per common share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the years (19,313,276 in 1995; 17,997,207 in 1994; and 17,815,439 in 1993) computed on the treasury stock method.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nReference is made to the footnotes entitled \"Operating Leases\" and \"Investments in Unconsolidated Entities\" for applicable accounting policies.\nB--LONG-TERM DEBT\nIn February 1993, the Company made a cash payment of $1.6 million to repay all of its outstanding debt to MARAD which had been previously restructured. The Company realized an extraordinary gain on the early retirement of debt of $1,012,000, after the related income tax effect of approximately $537,000.\nLong-term debt at June 30,1995 and 1994, consisted of (thousands of dollars):\nAs of June 30, 1995, the Company had a $10 million unsecured line of credit with a bank that expires on January 31, 1996. There were no amounts outstanding during the year ended June 30, 1995.\nThe revolving credit facility is for CPS, a subsidiary of the Company and is non-recourse to the Company. The maximum borrowing level is limited to a borrowing base of eligible receivables, inventory, and equipment not to exceed $7.5 million.\nCertain of the Company's debt obligations contain covenants related to certain financial ratios, minimum capital levels, and limitations on the payment of dividends.\nInterest paid during the year was $827,000; $1,138,000; and $1,532,000 for 1995, 1994, and 1993, respectively.\nIn the Company's opinion, based on the borrowing rates currently available to the Company and its subsidiaries for loans with similar terms and maturities, the fair value of total debt was $7,672,000 at June 30,1995.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe following is a summary of scheduled debt maturities by year (thousands of dollars):\nC--INVESTMENTS IN UNCONSOLIDATED ENTITIES\nThe Company has two principal unconsolidated entities that are accounted for on the cost method as the Company is unable to exert significant influence over the operations.\nThe Company has a 49% investment in Hemisco Helicopters International, Inc. (\"HHII\") and related venture companies. The Company's investment in HHII was $2,637,000 and $2,596,000 at June 30, 1995 and 1994, respectively, which is less than the estimated fair value of the Company's share of unencumbered assets. In the following unaudited table, HHII represents $4,727,000 and $9,630,000 of the assets and $2,984,000 and $6,371,000 of the equity for June 30, 1995 and 1994, respectively. HHII also represents $13,685,000; $19,777,000; and $8,311,000 of revenues and $(305,000); $2,478,000; and $(188,000) of net income for the years 1995, 1994, and 1993, respectively. During 1995, $1,550,000 in dividends were received from HHII. No material dividends were received from HHII during 1994 or 1993.\nThe Company has a 25% investment in an Egyptian helicopter venture. The Company's investment in the venture was $5,986,000 at June 30, 1995 and 1994. During 1995, 1994, and 1993, $2,500,000; $2,027,000; and $2,500,000, respectively, in dividends were received from the venture. During 1995, the venture's Board of Directors approved a cash dividend, of which the Company's share applicable to fiscal year 1996 is approximately $2,500,000.\nA summary of unaudited financial information of these principal unconsolidated entities is set forth below (thousands of dollars):\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nDuring 1995, 1994, and 1993, respectively, revenues of $5,295,000; $6,269,000; and $1,768,000 were recognized for services provided to these affiliates by the Company.\nDuring 1994, the Company's helicopter joint venture in Brazil was terminated. Costs associated with this termination of approximately $2.7 million were charged against previously established accruals. The three helicopters involved were redeployed into the Company's other operations. The termination of the venture did not have a material effect on the Company's operations.\nD--INVESTMENT IN MARKETABLE SECURITIES\nUnder the provision of SFAS No. 115, investments in debt and equity securities are required to be classified in one of three categories: held-to- maturity, available-for-sale, or trading. As of June 30, 1995, the Company classified all of its U.S. Treasury investments, with original maturities of more than 90 days, as available-for-sale. These investments are carried at cost which approximates market value. Approximately $11,971,000 of the U.S. Treasury investments mature within one year and approximately $8,007,000 mature from one to three years. There were no sales of investments in U.S. Treasury investments for the year ended June 30, 1995.\nE--ACQUISITIONS\nProduction Management Services\nThe Company expanded its operations in July 1992 to include production management services. During fiscal 1993 and until October 29, 1993, the Company owned 50% of Seahawk Services Ltd. (\"Seahawk\"), a company which provided platform and production management services, offshore medical support services, and temporary personnel to the oil and gas industry. On October 29, 1993, the Company further expanded its interest in production management services when the Company exchanged its 50% investment in Seahawk for a 27.5% interest in Grasso Corporation whose wholly-owned subsidiary, Grasso Production Management, Inc. (\"GPM\"), also was engaged in the production management services business. The Company's investment in Grasso Corporation was approximately $4,128,000 at June 30, 1994. Revenues of approximately $1,556,000 and $6,232,000 were recognized for helicopter services provided to GPM and Seahawk during 1995, prior to consolidation, and 1994, respectively, and revenues of $1,530,000 were recognized for helicopter services provided to Seahawk during 1993. The Company's share of net income related to production management services was not material.\nOn September 16, 1994, GPM became a wholly-owned subsidiary of the Company in a merger in which the Company acquired the remaining 72.5% interest in Grasso Corporation by issuing .49 of a share of the Company's Common Stock for each share of Grasso Corporation Common Stock owned. In addition, holders of Grasso Corporation Class B Warrants received similar warrants for shares of the Company's Common Stock. The merger was treated as a purchase for accounting purposes which resulted in goodwill of approximately $22.3 million after stepping up the assets and liabilities of Grasso Corporation. The goodwill is being amortized over a 20 year period.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe following summarized unaudited income statement data reflects the impact the GPM merger would have had on the Company's results of operations had the transaction taken place on July 1, 1993:\nCathodic Protection Services\nCPS manufactures, installs, and maintains cathodic protection systems to arrest corrosion in oil and gas drilling and production facilities, pipelines, oil and gas well casings, hydrocarbon processing plants, and other metal structures. In October 1994, the Company acquired 75% of CPS. The acquisition was treated as a purchase for accounting purposes which resulted in goodwill of approximately $3.8 million. The goodwill is being amortized over a 20 year period. The minority interest owner may increase their ownership at the end of five years if certain financial goals are met. At that time, the Company has the election to retain a majority ownership in CPS. The operating results from CPS have been included in the consolidated operating results since the date of acquisition. The proforma effect of this acquisition as though it had been acquired at the beginning of each of the periods presented is not material to the operating results of the Company.\nAviation Services\nDuring 1993, in conjunction with the restructuring of its investment in HHII, the Company acquired the remaining 50% of Heli-Lift, Inc., an Alaskan helicopter company, and consolidated the results of this company. The Company's 1993 results included revenues of approximately $4.5 million and net income before provision for income taxes of $1.2 million related to Heli-Lift, Inc.\nF--OPERATING LEASES\nThe Company has non-cancellable operating leases in connection with the lease of certain equipment, land, and facilities. Rental expense incurred under these leases was $2,195,000 in 1995; $1,741,000 in 1994; and $1,886,000 in 1993. As of June 30, 1995, aggregate future payments under non-cancellable operating leases are as follows: 1996--$2,415,000; 1997--$1,289,000; 1998-- $1,276,000; 1999--$416,000; 2000--$185,000; and thereafter $585,000.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nG--INCOME TAXES\nThe amounts of deferred tax assets and liabilities are as follows (thousands of dollars):\nThe components of and changes in the net deferred taxes are as follows (thousands of dollars):\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nIncome before provision for income taxes for the years ended June 30 was as follows (thousands of dollars):\nThe provision for income taxes for each of the three years ended June 30, 1995 consisted of the following (thousands of dollars):\nA reconciliation of Federal statutory and effective income tax rates is shown below:\nFederal Income Tax returns of the Company and subsidiaries have been settled through 1990. In addition, Federal Income Tax returns of the Company and subsidiaries have been examined through 1994. The Company does not expect any significant net unfavorable adjustment as a result of this examination.\nUnremitted foreign earnings reinvested abroad upon which deferred income taxes have not been provided aggregated approximately $18.8 million at June 30, 1995. Due to the timing and circumstances of repatriation of such earnings, if any, it is not practicable to determine the unrecognized deferred tax liability relating to such amounts. Withholding taxes, if any, upon repatriation would not be significant.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nIncome taxes paid during 1995, 1994, and 1993 were $3,843,000; $3,097,000; and $3,301,000, respectively.\nH--EMPLOYEE BENEFIT PLANS\nSavings and Retirement Plans--\nThe Company currently has four defined contribution plans which cover substantially all employees.\nThe Offshore Logistics, Inc. Employee Savings and Retirement Plan (\"OLOG Plan\") covers Corporate and Aviation Division employees, except for those covered under the Alaska Plan. Under the OLOG Plan, the Company matches each participant's contributions up to 3% of the employee's compensation. In addition, if net income exceeds 10% of stockholders' investment at the beginning of the year, the Company contributes funds to acquire Company Stock up to an additional 3% of the employee's compensation, subject to a scheduled vesting period.\nThe Air Logistics of Alaska, Inc. Cash or Deferred Profit Sharing Plan and Trust (\"Alaska Plan\") covers Aviation Division employees working in the State of Alaska. Under the Alaska Plan, the Company matches each participant's contributions up to 4% of the employee's compensation.\nThe Grasso Production Management, Inc. Thrift & Profit Sharing Trust covers eligible GPM employees. The Company matches 25% of each participant's contributions up to 6% of the employee's compensation.\nCPS is a participant in the Curran Companies 401(k) Plan which covers eligible CPS employees. The Company matches 50% of each participant's contributions up to 3% of the employee's compensation.\nThe Company's contributions to the four plans were $1,102,000; $952,000; and $821,000 for the years ended June 30, 1995, 1994, and 1993, respectively.\nIncentive and Stock Option Plans--\nUnder the 1994 Long-Term Management Incentive Plan (\"1994 Plan\"), a total of 900,000 shares of Common Stock, or cash equivalents of Common Stock, are available for awards to officers and key employees. Awards granted under the 1994 Plan may be in the form of stock options, stock appreciation rights, restricted stock, deferred stock, other stock-based awards or any combination thereof. Options become exercisable at such time or times as determined at the date of grant, and expire no more than ten years after the date of grant. Incentive stock option prices are determined by the Board and cannot be less than fair market value at date of grant. Non-qualified stock option prices cannot be less than 50% of the fair market value at date of grant.\nThe Annual Incentive Compensation Plan (\"Annual Plan\") provides for an annual award of cash bonuses to key employees based on pre-established objective measures of Company performance. Participants are permitted to receive all or any part of their annual incentive bonus in the form of shares of Restricted Stock in accordance with the terms of the 1994 Plan. The amount of bonuses related to this plan were $407,000 and $518,000 for the years ended June 30, 1995 and 1994, respectively.\nThe 1991 Non-qualified Stock Option Plan for Non-employee Directors (\"1991 Plan\") provides for 200,000 shares of Common Stock to be reserved for issuance pursuant to such plan. As of the date of each annual meeting each non-employee director, who meets certain attendance criteria, will automatically be granted an option to purchase 2,000 shares of the Company's Common Stock. The exercise price of the options granted shall be equal to the fair market value of the Common Stock on the date of grant and are exercisable not earlier than six months after the date of grant.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe Company also has in effect two other stock option plans under which options to purchase the Company's Common Stock have been issued to employees. Since approval of the 1994 Plan and the Annual Plan, no further grants or awards under these two stock option plans can be made. Options were granted at fair market value and expire ten years after date of grant.\nA summary of stock option transactions for all of the Company's stock option plans are as follows:\nAs of June 30, 1995 and 1994, 699,960 and 556,500, respectively, options were exercisable at prices ranging from $1.00 to $15.4375 per share. Under the Company's stock option plans there were 1,796,000 shares of Common Stock reserved for issue at June 30, 1995.\nIn December 1990, the SFAS No. 106 -- \"Employers' Accounting for Post Retirement Benefits Other Than Pensions\" was issued and required to be adopted by the Company no later than the fiscal year ended June 30, 1994. The Company presently offers no post retirement benefits which would be required to be recorded by the Statement.\nIn November 1992, the SFAS No. 112 -- \"Accounting for Post Employment Benefits\" was issued and required to be adopted by the Company no later than the fiscal year ended June 30, 1995. The Company presently offers no post employment benefits which would be required to be recorded by the Statement.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nI--SEGMENT INFORMATION\nThe Company operates principally in three business segments: Aviation Services, GPM, and CPS. The Company's Aviation Division, Air Logistics, is a major supplier of helicopter transportation services to the worldwide offshore oil and gas industry. GPM provides production management services, contract personnel, and medical support services to the domestic and international oil and gas industry. CPS manufactures, installs, and maintains cathodic protection systems to arrest corrosion in oil and gas drilling and production facilities, pipelines, oil and gas well casings, hydrocarbon processing plants, and other metal structures. The following shows industry segment information for the year ended June 30, 1995 (in thousands):\nAll of the Company's operating revenues and operating profits for each of the years ended June 30, 1994 and 1993 were from Aviation Services.\n(1) Net of Inter-Segment revenues of $4,764,000.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nSegment information by geographic areas for the years ended June 30, 1995, 1994, and 1993 is as follows (thousands of dollars):\nDuring 1995, 1994, and 1993, the Company conducted operations in approximately ten foreign countries as well as in the United States. Due to the nature of the principal assets of the Company, they are regularly and routinely moved between operating areas (both domestic and foreign) to meet changes in market and operating conditions. Identifiable assets in 1995, 1994, or 1993 attributable to operations in any one foreign country or any single customer were not \"significant\" as defined in SFAS No. 14. The Company earned revenues totaling $11,964,000 from one customer in 1994. Revenue earned from any single customer did not exceed 10% of total revenues during 1995 or 1993. United States registered equipment is chartered to foreign subsidiaries from time to time at rates sufficient to cover costs plus a reasonable return. These revenues ($7,118,000 in 1995; $5,630,000 in 1994; and $7,400,000 in 1993) have been eliminated in the amounts shown above.\nOFFSHORE LOGISTICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nJ--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\nThere is incorporated by reference herein the information under the caption \"Information Concerning Nominees\" contained in the registrant's definitive proxy statement in connection with the Annual Stockholders Meeting to be held on December 6, 1995.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThere is incorporated by reference herein the information under the caption \"Executive Compensation\" contained in the registrant's definitive proxy statement in connection with the Annual Stockholders Meeting to be held on December 6, 1995.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nThere is incorporated by reference herein the information under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Information Concerning Nominees\" contained in the registrant's definitive proxy statement in connection with the Annual Stockholders Meeting to be held on December 6, 1995.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nThere is incorporated by reference herein the information under the caption \"Executive Compensation\" contained in the registrant's definitive proxy statement in connection with the Annual Stockholders Meeting to be held on December 6, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements-- Report of Independent Public Accountants Consolidated Balance Sheet--June 30, 1995 and 1994 Consolidated Statement of Income for the three years ended June 30, 1995 Consolidated Statement of Stockholders' Investment for the three years ended June 30, 1995 Consolidated Statement of Cash Flows for the three years ended June 30, 1995 Notes to Consolidated Financial Statements\nAll schedules have been omitted since the information required is included in the financial statements or notes or have been omitted as not applicable or not required.\nAgreements with respect to certain of the Company's long-term debt are not filed as Exhibits hereto inasmuch as the debt authorized under any such Agreement does not exceed 10% of the Company's total assets. The Company agrees to furnish a copy of each such Agreement to the Securities and Exchange Commission upon request.\n(21) Subsidiaries of the registrant.\n(23) Consent of Independent Public Accountants.\n(27) Financial Data Schedule.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the fiscal year ended 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.\nOFFSHORE LOGISTICS, INC.\n\/s\/ George M. Small By: _________________________________ George M. Small Vice President -- Chief Financial Officer (Principal Financial and Accounting Officer)\nSeptember 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.","section_15":""}
{"filename":"67182_1995.txt","cik":"67182","year":"1995","section_1":"Item 1. Business.\n(a) General\nMobil Corporation (Mobil) was incorporated in March, 1976 in the state of Delaware. Mobil's principal business, which is conducted primarily through wholly-owned subsidiaries, is in the petroleum industry. Mobil is also a manufacturer and marketer of petrochemicals, packaging films and specialty chemical products. Through its subsidiaries, Mobil had business interests in over 125 countries and employed approximately 50,400 people worldwide at December 31, 1995.\nThrough its subsidiaries, Mobil operates a worldwide oil and gas exploration and producing business, a global marketing and refining complex, a network of pipelines and tankers linking these worldwide oil and gas businesses, a world- scale chemical business and a highly sophisticated research and engineering operation.\nA list of Mobil's most significant subsidiaries is contained on pages 27 through 29 of this Annual Report on Form 10-K. Summarized financial data for Mobil Oil Corporation is included on page 21 of this Annual Report on Form 10- K. In this Report, except as otherwise indicated by the context, the term \"Mobil\" refers to the parent corporation and all of its subsidiaries and affiliates and their operating divisions collectively, and sometimes to one or more of them.\nMobil makes no representations as to the future trend of its business and earnings, or as to future events and developments that could affect the oil industry in particular and that may affect other businesses in which Mobil is directly or indirectly engaged. These include such matters as the divestiture of certain operations, environmental quality control standards, oil imports, new discoveries of hydrocarbons and the demand for petroleum products. Furthermore, Mobil's business could be affected by future price changes or controls, material and labor costs, legislation, taxes, labor conditions, transportation regulations, tariffs, litigation, embargoes, foreign currency exchange restrictions and changes in foreign currency exchange rates. Mobil has direct and indirect investments and interests in many enterprises worldwide and makes no representation as to future developments which may have a profound effect on its business enterprises throughout the world. Mobil also recognizes that such enterprises are subject to political uncertainties in many of the countries in which it operates. Countries outside of the U.S. which currently are, and are expected to continue to be, significant contributors to Mobil's operating earnings are Australia, Indonesia, Japan, Nigeria, Norway, Saudi Arabia, Singapore and the United Kingdom (U.K.).\n(b) Environmental Matters\nThe discussions of Environmental Matters on pages 26 and 47 of Mobil's 1995 Annual Report to Shareholders are incorporated herein by reference.\nMobil and certain of its subsidiaries and affiliates are parties to numerous proceedings instituted by governmental authorities and others under provisions of applicable laws or regulations relating to the discharge of materials into the environment. Such environmental proceedings are further discussed herein on page 16 under Item 3. Legal Proceedings.\nMobil - 1 -\n(c) Segment and Geographic Information\nSegment and Geographic information for 1993, 1994 and 1995 on pages 34 and 35 of Mobil's 1995 Annual Report to Shareholders is incorporated herein by reference.\n(d) Business Description and Properties\nIn addition to the business description and properties contained herein, the following data included in Mobil's 1995 Annual Report to Shareholders are incorporated herein by reference: 1995 Annual Report to Shareholders Description Page\nEstimated Quantities of Net Proved Oil and Natural Gas Liquids Reserves (Table 1) ..... 50 Estimated Quantities of Net Proved Natural Gas Reserves (Table 2) ..................... 51 Petroleum Product Sales ...................... 55 Refinery Runs ................................ 55 Chemical Sales by Product Category ........... 55\nPETROLEUM OPERATIONS\nMobil is one of the largest oil companies in the world, with petroleum product sales of 3.2 million barrels a day. In 1995 Mobil produced the oil equivalent of 1.6 million barrels daily of crude oil, natural gas liquids and natural gas and had refinery runs of 2.1 million barrels per day. Petroleum net sales in 1995 were $58,121 million, up 12% from 1993 and about 9% from 1994.\nPrices for crude oil have experienced dramatic fluctuations during the past several years, making it difficult to forecast future trends in prices or margins in Petroleum Operations. During 1995 the worldwide average price of crude oil increased nearly $1.50 per barrel primarily reflecting higher demand in the Asia-Pacific region and supply disruptions caused by hurricanes in the Gulf of Mexico.\nMobil's Petroleum Operations are divided into two primary business activities -- Upstream, which refers to exploration and producing; and Downstream, which refers to marketing, refining, supply and transportation.\nMobil - 2 -\nPETROLEUM OPERATIONS -- UPSTREAM\nExploration and Producing\nSignificant developments in 1995 in Mobil's exploration and producing operations included the following:\nWorldwide In 1995, Mobil conducted exploration and producing activities in 35 countries. Net production of liquids (crude oil and natural gas liquids) averaged 810 thousand barrels a day (TBD) in 1995, a decrease of 44 TBD, from 854 TBD in 1994. Net natural gas production of 4,554 million cubic feet a day (MMCFD) in 1995 was 116 MMCFD lower than 1994. Combined production in the United States was down 7% compared with 1994. International total production was down 2%, primarily due to operational interruptions in Nigeria, natural declines in Canada and expiration of short-term sales contracts in Indonesia, somewhat offset by full year production from new fields in the United Kingdom and Germany. Worldwide natural gas sales in 1995 were 6,626 MMCFD, up 689 MMCFD from the preceding year, as the gas marketing business expanded in the U.S. and Europe. Proved liquids and natural gas reserve additions replaced 106% of 1995 production on a barrel of oil equivalent (BOE) basis, excluding purchases and sales. The following table summarizes net production of crude oil and natural gas liquids (NGL) and of natural gas for 1993 through 1995.\nCrude Oil & NGL(TBD) Natural Gas(MMCFD) Net Production 1993 1994 1995 1993 1994 1995\nFully consolidated companies United States .................... 305 300 282 1,529 1,568 1,439 Europe ........................... 161 173 173 887 948 1,098 Asia-Pacific ..................... 90 100 97 1,658 1,664 1,554 Other Areas ...................... 228 234 213 492 461 432 --- --- --- ----- ----- ----- Total Consolidated ............. 784 807 765 4,566 4,641 4,523 --- --- --- ----- ----- ----- Mobil's share of production of equity companies ................. 54 47 45 44 29 31 --- --- --- ----- ----- ----- Total Production ................... 838 854 810 4,610 4,670 4,554 === === === ===== ===== =====\nThis table presents Mobil's net production from properties in which it has a working or royalty interest and its share of production of investees accounted for on the equity method. Net production excludes royalties and quantities due others when produced, whether taken in kind or settled in cash.\nUnited States In the United States, Mobil produced 1,439 MMCFD of natural gas and 282 TBD of liquids, or a total of 538 TBDOE during 1995. When compared with 1994, total production decreased 7% due to natural decline of maturing fields, asset divestment, and operational disruptions including shut-in production associated with a number of hurricanes in the Gulf of Mexico.\nMobil has narrowed its exploration focus in the U.S., concentrating resources on high-potential Gulf of Mexico, outer continental shelf and deep water opportunities. Mobil is also using advanced technologies to find and develop low-cost reserves around existing infrastructures. To support these\nMobil - 3 -\nSignificant developments -- continued\nefforts and ensure continued growth, Mobil has consolidated both exploitation and exploration activities within a single new business opportunities team. In 1995, the team's efforts resulted in proved reserve additions replacing 65% of Mobil's U.S. production, excluding purchases and sales. This represents Mobil's highest replacement rate in the U.S. since 1990.\nSubsequent to year-end, Mobil announced that a non-binding letter of intent had been signed with PanEnergy Corporation to negotiate the sale of Mobil's natural gas gathering and processing assets (seven operated natural gas plants and about 2,600 miles of pipeline) for approximately $300 million. The sale would also include Mobil's equity interest in 17 additional gas-gathering and processing operations which are operated by others in Texas, Utah, Louisiana and Oklahoma.\nIn a separate but related move, Mobil Natural Gas Inc. and PanEnergy's marketing unit are negotiating the formation of an energy marketing joint venture which would represent the third largest gas marketing operation in North America, with sales of more than 7 BCFD. Mobil would own 40%, with PanEnergy controlling the remaining 60%.\nEurope 1995 was a year of continued development and production growth in Europe. Mobil's United Kingdom production reached a record 75 TBD of liquids and 577 MMCFD of natural gas for a cumulative total of 178 TBD oil equivalent, up 16% from the previous year. Liquids production increased 7% from productivity improvements in the Beryl, Scott and Hudson fields; gas production increased 23%, reflecting the first full year of production from the Excalibur field and the startup of four new fields (Gawain, Galahad, Ganymede and Dawn) brought on stream in the Southern Gas Basin.\nFull year contributions from these new fields, together with commencement of production from Nevis South, Mordred and Katrine fields, are expected to increase 1996 production to over 185 TBD of oil equivalent.\nMobil was a successful participant in the U.K. government's 16th offshore licensing round and received four new licenses, including one in the West of Shetlands province. Within this promising area, Mobil is also progressing plans to drill its first wildcat well in 1997 on previously awarded acreage.\nIn Norway, Mobil produced 91 TBD of liquids and 51 MMCFD of gas during 1995, primarily from two of Europe's largest fields, Statfjord and Oseberg. To maximize the value of these key areas, new fields are being tied into the existing infrastructure. Two satellites are on stream in the Statfjord area, and development will begin in 1996 on two Oseberg satellites, Oseberg East and Oseberg South, scheduled for production start up in 1998 and 1999, respectively.\nTo help replace declining production from existing assets, Mobil acquired a 20% interest in the Njord field, and increased its share in the unitized development on Haltenbanken. The Njord field development was approved in 1995 and development is now under way with pre-drilling scheduled to begin by mid- 1996. Production start up is planned for late 1997 with Mobil's share at peak rate expected to be 13 TBD.\nMobil - 4 -\nSignificant developments - continued\nWith a good position in the Aasgard unit, and a recent exploration discovery on a license south of Aasgard, the Haltenbanken area will become Mobil's next core area in Norway. The development of the Aasgard project is expected to yield liquids production starting in 1998, and gas sales two years later. Mobil's share of peak production will be 17 TBD and 85 MMCFD.\nIn early 1996, Mobil was awarded five licenses in the 15th Norwegian licensing round, including its three top-ranked bids. These awards will allow Mobil to continue exploring and to build on core production within the Norwegian sector of the North Sea.\nGermany's reserve replacement for gas was 135%, the result of a very successful drilling program, including contributions from Mobil's first horizontal well in Europe (Soehlingen Z-10) and a new gas field, Alvern.\nAlso in 1995, Mobil started natural gas deliveries to the former East Germany, with an initial sales rate of 50 MMCFD, and finalized a new 500 BCF gas import contract with Norway.\nAsia-Pacific In Indonesia, the Arun field, located in northern Sumatra, supplies virtually all Mobil's Indonesian production. In 1995, production volumes averaged 1,542 MMCFD of natural gas, 41 TBD of condensate and 36 TBD of liquefied petroleum gas (LPG). Booster compression facilities, needed to maintain Arun's high gas deliverability rates, were completed and placed in operation during 1995.\nOther gas fields in North Sumatra are being developed to supplement Arun production that will begin to decline. Development of the onshore South Lhok Sukon A and D fields began in 1995 with first production scheduled for 1998. The NSO \"A\" offshore field is planned for development beginning in 1996 with production start up in 1999.\nMobil also has a 68.6% interest in the Madura Block offshore East Java. Development of the Madura BD field will begin in 1996 to provide fuel for an electric power generation plant.\nP.T. Stanvac Indonesia, which was owned 50% each by Mobil and Exxon, has been sold to an Indonesian company, Medco Energy. The sale was finalized in December, 1995.\nOther In Canada, the Hibernia development project continued to progress in 1995 with construction of the production platform components at the main construction site located at Bull Arm, 90 miles northwest of St. John's, Newfoundland. The eventual site of the platform will be in 260 feet of water at the Hibernia field some 195 miles offshore southeast of St. John's.\nProduction from this 615 million-barrel oil field will begin in late 1997 and should reach its peak production of approximately 135 TBD (Mobil's share, 45 TBD) before the year 2000. The crude will be transported to market by specially built, state-of-the-art, double hulled shuttle tankers. Mobil's share in the Hibernia project is 33.1%.\nMobil - 5 -\nSignificant developments -- continued\nThe Sable area, 130 miles off the east coast of Nova Scotia, has commercial potential for gas production. The group of producers (Mobil and Shell together hold about 70% of the interest) hope to tap into approximately three trillion cubic feet of natural gas believed recoverable from six fields on the Scotian Shelf. Mobil's interest in this area is roughly 40%. An additional consortium, which includes Mobil and Shell, is studying the transportation system which must be built to transport this gas to the Maritimes and northeastern U. S. markets.\nThis project is expected to produce about 400 MMCFD of natural gas and 10 TBD of condensate through the staged development of the six fields. Facilities will require the construction and installation of seven offshore platforms, drilling of about 30 wells, laying about 250 miles of pipeline and construction of an onshore gas processing plant. If current plans move ahead, production from Sable could commence around the turn of the century.\nIn Nigeria, 1995 average equity production was 157 TBD, somewhat lower than the 1994 level of 175 TBD due to temporary operational disruptions experienced during the year. Despite this, there was an overall increase in field producibility due to development projects associated with reservoir management and workovers. Ubit field producibility, among others, increased from 18 TBD (Mobil share) in 1994 to a record 32 TBD in 1995 as a result of technology applications, including horizontal drilling, major facilities upgrades and debottlenecking field processing.\nThe Inanga field development was fast-tracked in 1995 by leveraging existing infrastructure. The field came on stream in late December within a year of discovery. A peak producing rate of 20 TBD (Mobil's share, 8 TBD) is expected in 1996 when the field is fully developed.\nProved reserves in Nigeria have grown by 50% over the past six years as a result of exploration, 3-D seismic and reservoir management efforts. Mobil replaced over 300% of its 1995 production, the highest replacement ratio for any country where Mobil has production. Mobil's cost of finding and development is among the lowest in Nigeria, inasmuch as existing infrastructure continues to be optimized in progressing new development opportunities.\nThe Oso natural gas liquids project moved a step closer in 1995 with approval to proceed by the joint venture partners. The engineering, procurement and construction contract was awarded in early 1995, and construction is now progressing. Oso NGL is expected to stream in 1998, with peak production of 51 TBD (Mobil's share, 26 TBD) being reached by year 2000.\nDespite recent political problems in the country, our operations have continued without any adverse impact.\nIn Qatar, Mobil participates in two liquefied natural gas (LNG) projects in partnership with the Qatar General Petroleum Corporation. Mobil's first LNG venture in Qatar, the Qatargas project (Mobil share 10%), expects to start producing gas and condensate in late 1996. Initial gas production will be used to commission the LNG facilities, while condensate production will be sold. Qatargas expects to deliver its first cargo to Chubu Electric Power Company of Japan in early 1997.\nMobil - 6 -\nSignificant developments -- Continued\nMobil's second LNG project in Qatar, Ras Laffan LNG Co. Ltd. (Mobil share, 30%), signed an agreement to supply Korea Gas Corporation with 2.4 million metric tons of LNG annually for 25 years beginning in 1999. As a result of the sales commitment, Mobil added 230 MMBOE of proved reserves, more than doubling its proved reserves in Qatar.\nNew Business Development (NBD) Mobil has been very active to capitalize on anticipated growth in regions such as South America and Africa, as governments begin to allow participation by foreign companies in upstream projects.\n- Venezuela: In the Venezuelan Exploration Round in January 1996, Mobil and partners were successful bidders on the first block awarded, the 445,000- acre La Ceiba block located on the eastern shore of Lake Maracaibo in western Venezuela. Mobil will have a 50% interest in the La Ceiba block. A seismic program is scheduled to begin in 1996. During 1995, in conjunction with Lagoven, an affiliate of Petroleos de Venezuela, Mobil progressed negotiations for a heavy oil project.\n- Peru: Mobil joined in negotiations for development of the large Camisea gas\/condensate discovery, as well as for adjacent exploration acreage. Negotiations for additional exploration acreage in the Peruvian portion of the Madre de Dios basin of southern Peru are ongoing.\n- Equatorial Guinea: Mobil and partner, United Meridian, discovered oil in the Zafiro prospect on the 547,000-acre B Block concession. The block is located offshore in the Gulf of Guinea in close proximity to Mobil production in Nigeria. Mobil, with a 75% interest, assumed operatorship of the concession at the beginning of 1995 and made the discovery shortly thereafter. Subsequent to the discovery, Mobil drilled three successful appraisal wells on the Zafiro structure.\nThe Zafiro complex has been declared commercial. The fast-track development plan will consist of a floating production, storage and offloading vessel (FPSO) connected via flexible risers to subsea wells. The four existing wells will be completed as producing wells, and four more wells will be drilled in 1996. Production by year-end 1996 is projected to be at 40 TBD (Mobil Share, 30 TBD). The FPSO has been designed with the flexibility to process up to 80 TBD of crude.\n- Angola: Mobil acquired a 21% interest in offshore Block 1 and participated in two wildcat wells during 1995. While the first well was unsuccessful, the second encountered significant signs of oil and gas. A 3-D seismic survey was acquired in late 1995 and evaluation of the area is ongoing. Mobil expects to drill a third wildcat well in 1996.\nToward the end of 1995, Mobil and Sinangol, the national oil company, reached agreement on a production sharing contract for the deep water Block 20 in which Mobil holds a 50% interest and will operate. Mobil is acquiring new seismic data and expects to drill the first wildcat well of a two-well commitment in mid-1996.\n- Algeria: Mobil's first wildcat well drilled on the 3.2 million-acre Touggourt concession tested 1 TBD per day of light crude. Evaluation of additional seismic data and another wildcat well are currently scheduled for 1996.\nMobil - 7 -\nSignificant developments -- continued\n- Egypt: Production sharing contracts were negotiated on three new Western Desert concessions: East Bahariya, Marakia and Northeast Abu El Ghadariq. Government approval of the production sharing contracts is expected in early 1996. Future plans call for gathering new seismic data on all three concessions and wildcat wells on two of the concessions by year-end 1996. Mobil will hold non-operated interests of 50% in East Bahariya; 33-1\/3% in Marakia; and 24% in Northeast Abu El Ghadariq.\n- Kazakstan: Mobil is the only U.S.-based member of an international consortium selected to carry out extensive exploration of a 25 million- acre area in the environmentally sensitive northern Caspian Sea. The geophysical study is ongoing and expected to last through mid-1996, after which selection of blocks by each member company is scheduled to begin.\nIn April 1995, Mobil signed a joint venture agreement and exploration and development contract with the government of Kazakstan to explore for oil and gas on the 4 million-acre Tulpar block. This block is located near the large Karachagnak and Orenburg fields in northwestern Kazakstan.\n- Azerbaijan: Mobil initiated and completed a Work Study Agreement with the State Oil Company of the Azerbaijan Republic (SOCAR) which provided improved technical data covering prospective areas of the south Caspian offshore area.\nReserves\nMobil is required to report reserve estimates to the U.S. Department of Energy. During 1995 Mobil filed proved reserve estimates covering the year 1994 under forms EIA-23, Annual Survey of Domestic Oil and Gas Reserves, and EIA-28, Financial Reporting System. Such estimates were consistent with reserve data filed with the Securities and Exchange Commission (S.E.C.).\nWells in Process of Being Drilled Total at December 31, 1995 Gross Net\nUnited States ......................................... 24 17 International ......................................... 42 20 -- -- Worldwide ............................................. 66 37 == ==\nImproved Recovery Projects Being Installed In Operation at December 31, 1995 Gross Net Gross Net\nUnited States .................... 1 1 250 98 International .................... 1 - 83 39 - - --- --- Worldwide ........................ 2 1 333 137 = = === ===\nMobil - 8 -\n------- International -------- Productive Wells at Asia- Other World- Mult. December 31, 1995 U.S. Europe Pacific Areas Total wide Compl.(a)\nOil: Gross ....... 19,801 1,106 9 2,352 3,467 23,268 753 Net ......... 7,221 344 3 1,337 1,684 8,905 291\nGas: Gross ....... 4,723 485 79 1,156 1,720 6,443 770 Net ......... 2,959 140 79 272 491 3,450 411\n(a) Multiple completions included in geographic totals.\nNet Exploratory and ------- International -------- Development Wells Asia- Other World- Drilled U.S. Europe Pacific Areas Total wide\nExploratory wells Productive ............. 23 5 1 7 13 36 Dry .................... 14 4 2 9 15 29 Development wells Productive ............. 313 8 7 28 43 356 Dry .................... 15 - - 1 1 16\nExploratory wells Productive ............. 42 2 - 17 19 61 Dry .................... 19 7 5 23 35 54 Development wells Productive ............. 393 14 2 17 33 426 Dry .................... 14 - - 1 1 15\nExploratory wells Productive ............. 41 - - 25 25 66 Dry .................... 18 7 3 17 27 45 Development wells Productive ............. 476 14 1 62 77 553 Dry .................... 15 - 1 1 2 17\nOil and Gas Acreage at December 31, 1995 Undeveloped Acreage Developed Acreage (Thousands of acres) Gross Net Gross Net\nUnited States .................. 4,191 2,482 4,580 2,845\nEurope ......................... 17,370 8,563 1,473 560 Asia-Pacific ................... 33,565 19,310 102 51 Other .......................... 44,985 22,910 2,708 1,329 ------- ------ ------ ----- Total International .......... 95,920 50,783 4,283 1,940 ------- ------ ------ ----- Worldwide ...................... 100,111 53,265 8,863 4,785 ======= ====== ====== =====\nMobil - 9 -\nAverage Sales Price\/Transfer Value\nThe following table shows Mobil's average sales price\/transfer value (transfer values are essentially equal to third-party sales prices) and average production costs in oil and gas producing activities in 1993, 1994 and 1995. In calculating the \"dollar per barrel\" data, the divisor used is net production. Natural gas volumes have been converted to oil equivalent barrels on a BTU (British Thermal Unit) basis, with 5,626 cubic feet of gas per barrel. Mobil's share of equity companies represents Mobil's share of results of operations for producing activities of investees accounted for on the equity method. The geographic segment \"Other Areas\", in this table, includes principally Canada and Nigeria.\nUNITED STATES 1993 1994 1995\nRevenues Crude oil (per barrel) ............................ $13.54 $12.91 $14.52 NGL (per barrel) .................................. $11.25 $10.37 $ 9.94 Natural gas (per thousand cubic feet) ............. $ 2.22 $ 1.90 $ 1.58 Average dollars per barrel of oil equivalent Revenues .......................................... $11.76 $10.51 $10.23 Production (lifting) costs ........................ (4.64) (4.48) (5.00) Exploration expenses .............................. ( .31) ( .54) ( .37) Depreciation, depletion and amortization .......... (4.01) (4.49) (5.92) Other operating revenues\/(expenses) ............... ( .20) ( .15) .16 Income tax expense ................................ ( .87) ( .26) .35 ------ ------ ------- Results of operations for producing activities ...... $ 1.73 $ .59 $( .55) ====== ====== ======= Above results include the following special items: Asset sales and write-downs ....................... ( .06) ( .86) ( .11) Environmental provision ........................... ( .02) - - Restructuring provisions .......................... ( .05) - ( .26) Tax rate change ................................... ( .11) - - Inventory adjustment .............................. ( .09) - - Asset impairment (FAS 121) ........................ - - (1.87)\nEUROPE 1993 1994 1995\nRevenues Crude oil (per barrel) ............................ $17.42 $16.21 $17.47 NGL (per barrel) .................................. $14.55 $11.69 $14.32 Natural gas (per thousand cubic feet) ............. $ 2.87 $ 2.70 $ 2.70 Average dollars per barrel of oil equivalent Revenues .......................................... $16.70 $15.58 $16.16 Production (lifting) costs ........................ (5.85) (5.30) (5.35) Exploration expenses .............................. (1.65) (1.16) ( .95) Depreciation, depletion and amortization .......... (3.18) (3.43) (3.47) Other operating revenues\/(expenses) ............... .52 .53 .92 Income tax expense ................................ (3.18) (3.68) (4.10) ------ ------ ------ Results of operations for producing activities ...... $ 3.36 $ 2.54 $ 3.21 ====== ====== ====== Mobil's share of equity companies ................... $ .92 $ 1.99 $ 2.84 ====== ====== ====== Total ............................................... $ 3.34 $ 2.53 $ 3.20 ====== ====== ====== Above results include the following special items: Asset sales and write-downs ...................... - ( .13) .04 Restructuring provisions .......................... - ( .07) ( .19) Tax related items ................................. .77 - .19 Asset impairment (FAS 121) ........................ - - ( .10)\nMobil - 10 -\nASIA-PACIFIC 1993 1994 1995\nRevenues Crude oil (per barrel) ............................ $14.03 $14.93 $15.09 NGL (per barrel) .................................. $10.09 $11.77 $16.35 Natural gas (per thousand cubic feet) ............. $ 2.12 $ 1.99 $ 2.15 Average dollars per barrel of oil equivalent Revenues .......................................... $12.02 $11.87 $12.97 Production (lifting) costs ........................ (1.73) (1.80) (1.75) Exploration expenses .............................. ( .36) ( .72) ( .56) Depreciation, depletion and amortization .......... (1.25) (1.59) (1.50) Other operating revenues\/(expenses) ............... .05 ( .04) ( .06) Income tax expense ................................ (5.12) (4.61) (5.26) ------ ------ ------ Results of operations for producing activities ...... $ 3.61 $ 3.11 $ 3.84 ====== ====== ====== Mobil's share of equity companies ................... $ 2.65 $ .42 $ 1.75 ====== ====== ====== Total ............................................... $ 3.57 $ 3.06 $ 3.80 ====== ====== ======\nAbove results include the following special items: Asset sales and write-downs ....................... - - .13\nOTHER AREAS 1993 1994 1995\nRevenues Crude oil (per barrel) ............................ $16.72 $15.26 $17.03 NGL (per barrel) .................................. $12.53 $11.44 $14.74 Natural gas (per thousand cubic feet) ............. $ 1.37 $ 1.29 $ .78 Average dollars per barrel of oil equivalent Revenues .......................................... $14.03 $13.01 $13.57 Production (lifting) costs ........................ (4.92) (4.40) (5.86) Exploration expenses .............................. ( .84) (1.32) (1.42) Depreciation, depletion and amortization .......... (2.06) (2.61) (3.77) Other operating revenues\/(expenses) ............... 1.50 .96 .73 Income tax expense ................................ (4.57) (4.17) (3.46) ------ ------ ------ Results of operations for producing activities ...... $ 3.14 $ 1.47 $( .21) ====== ====== ====== Mobil's share of equity companies ................... $ .99 $ .96 $ .94 ====== ====== ====== Total ............................................... $ 2.88 $ 1.40 $( .07) ====== ====== ====== Above results include the following special items: Asset sales and write-downs ....................... .05 ( .32) - Tax related items ................................. .72 - - Restructuring provision ........................... - - ( .12) Asset impairment (FAS 121) ........................ - - ( .90)\nWORLDWIDE 1993 1994 1995\nRevenues Crude oil (per barrel) ............................ $15.53 $14.64 $16.10 NGL (per barrel) .................................. $10.07 $ 8.99 $10.38 Natural gas (per thousand cubic feet) ............. $ 2.12 $ 1.96 $ 1.87 Average dollars per barrel of oil equivalent Revenues .......................................... $13.26 $12.38 $12.89 Production (lifting) costs ........................ (4.23) (3.98) (4.47) Exploration expenses .............................. ( .70) ( .87) ( .75) Depreciation, depletion and amortization .......... (2.79) (3.20) (3.89) Other operating revenues\/(expenses) ............... .34 .23 .39 Income tax expense ................................ (3.09) (2.79) (2.73) ------ ------ ------ Results of operations for producing activities ...... $ 2.79 $ 1.77 $ 1.44 ====== ====== ====== Mobil's share of equity companies ................... $ 1.37 $ .96 $ 1.15 ====== ====== ====== Total ............................................... $ 2.73 $ 1.75 $ 1.43 ====== ====== ====== Above results include special items, net ............ .20 ( .40) ( .93)\nMobil - 11 -\nPETROLEUM OPERATIONS -- DOWNSTREAM\nRefining\nAt December 31, 1995, Mobil owned or had an operating interest in 20 refineries in 12 countries. Mobil's share of crude oil refinery capacity was 2,256 TBD, 43% of which was located in the United States. Worldwide utilization of Mobil's refining capacity averaged 94% in 1993, 92% in 1994 and 92% in 1995.\nSignificant developments in 1995 in Mobil's refining operations included the following projects:\n- At Altona, Australia, construction began in May, 1995 on a new fluid catalytic cracking unit, which will increase gasoline and distillate production at the refinery.\n- At Adelaide, Australia, construction is under way on an expansion of the refinery's lube base stock capacity. It is scheduled for completion in late 1996.\n- Construction is under way on a residual fuel oil upgrading unit at a joint venture refinery (Mobil's share 25%) in Kawasaki, Japan, and will be completed in 1997. It will increase production of gasoline and low-sulfur distillates and fuel oil.\n- Approval was obtained to construct an 8 TBD lubricant base stock unit which will enhance the Jurong, Singapore, refinery. It is scheduled to start-up in late 1997.\n- In Saudi Arabia, the Petromin Lubricating Oil Refining Company (Mobil share, 30%) is constructing a new 5.5 TBD lubricant basestock refinery in Yanbu, Saudi Arabia, with completion scheduled in early 1997.\n- In order to improve European downstream operations, the 104 TBD Woerth, Germany, refinery was closed in 1995.\nMarketing\nPetroleum Sales Volumes By Product (TBD) 1993 1994 1995\nAutomotive gasoline ............................ 1,152 1,216 1,291 Jet fuel ....................................... 215 246 262 Distillate ..................................... 895 911 954 Other products ................................. 672 702 715 ----- ----- ----- Total .......................................... 2,934 3,075 3,222 ===== ===== =====\nPetroleum products are marketed extensively in the U.S. and in more than 100 other countries. Mobil has nearly 19,000 retail outlets, about 40% of which are located in the United States. Petroleum products include automotive and aviation gasolines, motor oils, lubricants and greases, marine fuels, jet fuels, fuel oil, diesel oil, kerosene, asphalts, naphthas, solvents, waxes and liquefied petroleum gas.\nThe principal brand names identifying Mobil's products are \"Mobil Unleaded\", \"Mobil Super Unleaded+\", \"Mobil Special\", \"Mobil Regular\", and \"Mobil Premium\" gasolines, and \"Mobiloil\", \"Mobilheat\", \"Mobilgrease\", \"Mobil 1\", \"Delvac 1\", and \"Mobil\" industrial and marine lubricants and process products.\nIn Tianjin, China, construction is under way on a lubricant blending plant scheduled for streaming in 1996. This is the first 100% foreign-owned oil industry facility approved in China. A second lubricant blending plant, located at Taicang, China (near Shanghai), has been approved and is scheduled to be streamed in 1997. Mobil has entered the lubricants market in Venezuela and the retail fuels markets in Peru and Ecuador.\nMobil - 12 -\nMarketing -- continued\nTankers\nAt December 31, 1995, Mobil owned 30 ocean-going tankers with an aggregate of 3,866 thousand deadweight tons, of which one, with a capacity of 49 thousand deadweight tons, was registered in the United States. An additional 4 tankers, aggregating 324 thousand deadweight tons, were under term charter. Mobil's second double-hull, 280 thousand deadweight-ton, very large crude carrier was ordered in 1994, with estimated delivery in mid-1996. The vessel, with a capacity of 2.2 million barrels of crude oil, will be similar to the \"Eagle\" which was commissioned in 1993.\nPipelines\nAt December 31, 1995, Mobil's U.S. pipeline system, including partly-owned facilities, consisted of 15,368 miles of crude oil, natural gas liquids, natural gas, and carbon dioxide trunk and gathering lines, and 7,880 miles of product lines. Also at that date, Mobil's pipeline system outside the U.S., including partly owned facilities, consisted of 9,182 miles of crude oil, natural gas liquids, and natural gas trunk and gathering lines, and 2,069 miles of product lines.\nCHEMICAL OPERATIONS\nMobil Chemical, with manufacturing operations in 10 countries, is a large producer of petrochemicals, packaging films and specialty chemical products.\nMobil Chemical Facilities United Inter- World- at December 31, 1995 States national (a) wide\nPetrochemicals ....................... 5 7 12 Plastics\/OPP Films ................... 7 5 12 Additives and Synthetics ............. 2 2 4 Research and Development ............. 3 - 3 -- -- -- Total Chemical facilities ............. 17 14 31 == == == (a) Includes six partly owned facilities.\nPrincipal chemical products include basic petrochemicals (ethylene, propylene, benzene, paraxylene), intermediates (ethylene glycol) and a key derivative (polyethylene). Other products include synthetic lubricant base stocks and lube additives, plastic films for packaging and industrial applications and molded plastics products.\nMobil - 13 -\nChemical Operations -- continued\nSignificant developments in 1995 in Mobil's chemical operations included the following:\n- The Plastics Division, consisting of the fabricated packaging and consumer businesses, was sold in November for $1.27 billion. The sale included plants in Macedon and Canandaigua, New York; Covington, Georgia; Temple, Texas; Frankfort and Jacksonville, Illinois; Bakersfield, California; and Belleville, Ontario, Canada. In 1995, Plastics had sales revenue of approximately $1 billion. In addition, the resin trading operation, H. Muehlstein & Co, Inc., was sold in early 1996.\n- In November, a grass-roots plant for the manufacture of lubricant esters was streamed in Amsterdam, the Netherlands. The 4.4 million gallon capacity plant will be capable of producing esters for synthetic lubricants such as Advanced Formula Mobil 1(TM), refrigeration lubricants for non-CFC compressors and biodegradable esters for environmentally sensitive applications.\n- A second orienter streamed in March 1995 at the oriented polypropylene (OPP) plant in Kerkrade, the Netherlands. This doubles OPP capacity at the plant to over 60 million pounds.\n- In January, 1996 Mobil announced worldwide oriented polypropylene (OPP) capacity expansions totaling 145 million pounds. This additional capacity will be installed at various North American and overseas locations, and will increase Mobil's annual worldwide OPP capacity from 430 million pounds to 575 pounds by year-end 1998.\n- Mobil authorized projects to expand capacity at Chalmette, Louisiana, and Beaumont, Texas, as part of a program that will more than double its worldwide paraxylene production capacity. Combined, the paraxylene capacity of these expansions is 365,000 metric tons.\nOTHER OPERATIONS\nMining and Minerals\nMobil Mining and Minerals produces and sells phosphate rock and fertilizers, markets Mobil's recovered sulfur in the U.S. and administers other mineral resources. The newly completed, 3.5 million ton (annual capacity) mine at South Fort Meade, Florida, was sold in December, 1995 for $283 million. We expect to divest our remaining mining assets in 1996. Phosphate rock production totaled 2.7 million tons in 1995 compared with 2.3 million tons in 1994. Phosphate minerals net sales to trade were $192 million in 1995.\nMobil - 14 -\nOther Operations - Continued\nReal Estate\nMobil Land Development Corporation (Mobil Land) carries on Mobil's real estate activities in the United States. Mobil Land has various properties in Arizona, California, Colorado, Florida, Georgia, Texas and Virginia. Mobil Land sales to trade were $128 million in 1993, $201 million in 1994 and $275 million in 1995. Included in 1995 is the sale of Colonial Place in Arlington, Virginia. Rents to trade were $28 million in 1993, $29 million in 1994 and $20 million in 1995. Mobil Land is a 50% partner in a resort community development in North Scottsdale, Arizona. Mobil Land is also the 100% owner of a commercial office and retail complex in Reston, Virginia.\nResearch\nMobil engages in research and development, principally in the U.S., Australia, France, Germany, Japan, Norway and the United Kingdom. Activities include the development of technologies and services which improve Mobil's competitiveness in core business areas -- finding oil and gas, and converting them to fuels, lubricants and chemicals while meeting environmental, health and safety standards. Annual research expense was $301 million in 1993, $275 million in 1994 and $252 million in 1995.\nMobil - 15 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nMobil and its subsidiaries own, lease or have interests in extensive production, manufacturing, marketing, transportation and other facilities worldwide. Information on these properties has been incorporated into Item 1. Business.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nEnvironmental Litigation\nMobil periodically receives notices from the Environmental Protection Agency (EPA) or equivalent agencies at the state level that Mobil is a \"potentially responsible party\" under Superfund or equivalent state legislation with respect to various waste disposal sites. The majority of these sites are either still under investigation by the EPA or the state agencies concerned, or under remediation, or both. In certain instances, Mobil and other potentially responsible parties have been named in court or administrative proceedings by federal or state agencies seeking the cleanup of these sites. Mobil has also been named as a defendant in various suits brought by private parties alleging injury from disposal of wastes at these sites. The ultimate impact of these proceedings on the business or accounts of Mobil cannot be predicted at this time due to the large number of other potentially responsible parties and the speculative nature of clean-up cost estimates, but based on our long experience in managing environmental matters, we do not anticipate that the aggregate level of future remediation costs will increase above recent levels so as to materially and adversely affect our consolidated financial position or liquidity.\nOn October 20, 1995, a proceeding involving Mobil Oil Corporation's Joliet, Illinois, refinery was brought by the Environmental Protection Agency. The penalty sought is $146,000. It is alleged that Mobil Oil Corporation violated the Illinois State Implementation Plan under the Clean Air Act, violated the state air regulatory standards for opacity, particulates and carbon monoxide and failed to comply with an Agency request under the Clean Air Act.\nThe matter described in the preceding paragraph is not of material importance in relation to Mobil's accounts and is described in compliance with SEC rules regarding disclosure of such matters although not material.\nOther Than Environmental Litigation\nMobil and its subsidiaries are engaged in various litigations and have a number of unresolved claims pending. While the amounts claimed are substantial and the ultimate liability in respect of such litigations and claims cannot be determined at this time, Mobil is of the opinion that such liability, to the extent not provided for through insurance or otherwise, is not likely to be of material importance in relation to its accounts.\nMobil has provided in its accounts for items and issues not yet resolved based on management's best judgement.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone submitted.\nMobil - 16 -\nPART II\nThe information required by Items 5 through 7 is incorporated herein by reference to Mobil's 1995 Annual Report to Shareholders. The charts, graphs and associated captions appearing on pages 17 through 32 of Mobil's 1995 Annual Report to Shareholders are not incorporated into this Annual Report on Form 10-K. Below is an index to the incorporated information. Annual Report to Shareholders Item Description Page(s)\n5. Market for Registrant's Common Stock and Related Stockholder Matters .............................. 27 6. Selected Financial Data ............................ 56-57 7. Management's Discussion and Analysis of Results of Operations and Financial Condition ............... 17-28,30,32\nItem 8.","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee page 19 for a list of the financial statements and supplementary data including those incorporated herein by reference to Mobil'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\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 Item 10, the names and ages of the Executive Officers of Mobil as of March 1, 1996, and the position(s) each of them has held during the past five years, are provided on page 18 of this Annual Report on Form 10-K. The other information called for by Item 10, and the information called for by Items 11, 12 and 13, is incorporated by reference to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, to be held on May 9, 1996, which will be filed with the S.E.C. within 120 days after December 31, 1995.\nMobil - 17 -\nInformation required by Item 10 of this report related to the names and ages of the Executive Officers of Mobil Corporation as of March 1, 1996, and the position(s) each of them has held during the past five years, is provided below.\nMobil - 18 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nMobil's consolidated financial statements, together with the report thereon of Ernst & Young LLP, independent auditors, dated February 23, 1996, and Supplementary Information appearing in Mobil's 1995 Annual Report to Shareholders on the pages indicated below, are incorporated herein by reference. With the exception of the aforementioned information, no other data appearing in Mobil's 1995 Annual Report to Shareholders are deemed to be filed as part of this Annual Report under Items 8 and 14. The charts, graphs and associated captions appearing on pages 30 through 48 of Mobil's 1995 Annual Report to Shareholders are not incorporated into this Annual Report on Form 10-K.\nFinancial Statement Schedules: Page(s) 1995 1995 Annual Annual Report on Report to Form 10-K Shareholders (a)1. Financial Statements.\nConsolidated Statement of Income .......... - 29 Consolidated Statement of Changes in Shareholders' Equity ..................... - 29 Consolidated Balance Sheet ................ - 31 Consolidated Statement of Cash Flows ...... - 33 Segment and Geographic Information ........ - 34,35 Notes to Financial Statements ............. - 36-48 Report of Ernst & Young LLP, Independent Auditors ................................. - 49 Supplementary Information ................. - 27,50-53 Summarized Financial Data for Mobil Oil Corporation .............................. 21 -\n(a)2. Financial Statement Schedules.\nSchedule II -- Valuation and Qualifying Accounts.................................. 22 -\nSchedules not included above have been omitted because they are not applicable, not material, or the required information is given in the financial statements or notes thereto or combined with the information presented in other schedules.\n(a)3. Exhibits\nAn index to exhibits filed as part of this Annual Report on Form 10-K is included on page 24.\nMobil - 19 -\n(b) Reports on Form 8-K.\nDate of 8-K Description of 8-K\nOctober 2, 1995 Submitted a copy of the Mobil News Release dated October 2, 1995, announcing the sale of Mobil Chemical Company's Plastics Division to Tenneco Inc.\nOctober 23, 1995 Submitted a copy of the Mobil News Release dated October 23, 1995, reporting estimated earnings for the third quarter of 1995.\nDecember 15, 1995 Submitted (1) a copy of the Mobil News Release dated December 15, 1995, reporting that Mobil will adopt the Statement of Financial Accounting Standard (FAS) 121 in the fourth quarter of 1995 and (2) a copy of the Mobil News Release dated December 15, 1995, announcing that Mobil's board of directors has approved an updated Preferred Share Purchase Rights Plan to replace the current plan when it expires April 30, 1996.\nJanuary 22, 1996 Submitted a copy of the Mobil News Release dated January 22, 1996, reporting estimated earnings for the fourth quarter and full year of 1995.\nFebruary 14, 1996 Submitted a copy of the Mobil News Release dated February 14, 1996, announcing that Mobil Exploration and Producing Australia Pty. Ltd. (MEPA) has acquired a substantial position in Ampolex Limited through the purchase of its listed securities and has made a proposal to acquire the Australian oil and gas exploration and producing company.\nFebruary 29, 1996 Submitted a copy of the Mobil News Release dated February 29, 1996, announcing that BP and Mobil will combine their European operations in the refining and marketing of fuels and lubricants.\nMobil - 20 -\n(c) Supplemental Financial Information.\nSUMMARIZED FINANCIAL DATA\nSummarized financial data of Mobil Oil Corporation, a wholly-owned subsidiary of Mobil Corporation, are presented below. The year-end net obligations to Mobil Corporation amounted to $2,676 million in 1993, $1,737 million in 1994 and $3,373 million in 1995.\nMobil Oil Corporation engages in an integrated petroleum business and a chemical business in the U.S., and certain of its subsidiaries are engaged in petroleum operations outside the U.S. On December 31, 1995, Mobil Oil Corporation transferred to its parent corporation, Mobil Corporation, its ownership of the shares of Mobil International Petroleum Corporation, whose subsidiaries conduct the bulk of the non-U.S. petroleum operations of the Mobil group of companies. This transfer of ownership is reflected in Exhibit 21, Subsidiaries of the Registrant, and in the summarized balance sheet data below.\nMOBIL OIL CORPORATION (Millions of dollars) 1993 1994 1995\nAt December 31: Current assets ............................ $ 10,863 $ 12,942 $ 4,117 Noncurrent assets ......................... 24,209 25,006 11,946 Current liabilities ....................... (11,113) (12,398) ( 5,794) Long-term debt ............................ (6,218) (6,639) (4,301) Deferred credits and other liabilities .... (4,617) (4,899) (2,586) Minority interests, primarily Mobil Corporation ............................. (1,138) (1,165) (1,202) -------- ------- ------- Net assets ................................ $ 11,986 $ 12,847 $ 2,180 ======== ======= ======= Year ended December 31: Gross revenues ............................ $ 60,522 $64,032 $ 71,893 Income before taxes and change in accounting principle .................... 2,274 2,487 3,791 Income after taxes but before change in accounting principle .................... 1,032 1,186 2,269 Cumulative effect of change in accounting principle (a) ........................... - (680) - Net income ................................ 1,032 506 2,269\n(a)Reflects the adoption of a change in the accounting method used to apply the lower of cost or market test for crude oil and product inventories in 1994.\nMobil - 21 -\nSupplemental Financial Information -- continued\nFINANCIAL STATEMENT SCHEDULE\nMOBIL CORPORATION SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1993, 1994 and 1995 (Millions of dollars)\nBalance Balance Beginning End of Description of Period Additions Deductions Period - - - - -------------------------------- --------- --------- ---------- ------- For the year ended December 31, 1993: Reserves deducted in the balance sheet from the assets to which they apply: For doubtful accounts (a) .... $115 $ 76 $63 $128 For investments and long-term receivables ...... 31 4 3 32 For deferred tax assets ...... 134 37 - 171\nFor the year ended December 31, 1994: Reserves deducted in the balance sheet from the assets to which they apply: For doubtful accounts (a) .... $128 $ 36 $42 $122 For investments and long-term receivables ...... 32 3 - 35 For deferred tax assets (b) .. 171 256 48 379\nFor the year ended December 31, 1995: Reserves deducted in the balance sheet from the assets to which they apply: For doubtful accounts (a) .... $122 $ 58 $74 $106 For investments and long-term receivables ...... 35 5 - 40 For deferred tax assets (b) .. 379 9 77 311\n(a) Deductions include accounts written off. (b) Deductions reflect utilization of tax credit carryforwards\nMobil - 22 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant, Mobil Corporation, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nREGISTRANT MOBIL CORPORATION\nBy:\/s\/ George Broadhead (George Broadhead, Acting Controller, Principal 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 March 11, 1996 on behalf of the registrant and in the capacities indicated.\nSignature Title\nLucio A. Noto* Director, Chairman of the Board and (Lucio A. Noto) President, Principal Executive and Operating Officer\nThomas C. DeLoach, Jr.* Principal Financial Officer (Thomas C. DeLoach, Jr.)\nGeorge Broadhead* Acting Controller, Principal Accounting Officer (George Broadhead)\nDIRECTORS\nLewis M. Branscomb* Donald V. Fites* Charles A. Heimbold, Jr.* Paul J. Hoenmans* Allen F. Jacobson* Samuel C. Johnson* Helene L. Kaplan* J. Richard Munro* Aulana L. Peters* Eugene A. Renna* Charles S. Sanford, Jr.* Robert G. Schwartz* Robert O. Swanson*\n*By \/s\/ Gordon G. Garney (Gordon G. Garney, Attorney-in-fact) Date: March 11, 1996\nMobil - 23 -\nEXHIBIT INDEX\nEXHIBIT SUBMISSION MEDIA\n3(i).1 Certificate of Incorporation Incorporated by reference to Exhibit of Mobil Corporation, as amended, 3-a(i) to the Registration Statement in effect October 27, 1989. on Form S-3 (S.E.C. File No. 33-32651), filed under Form SE dated December 14, 1989.\n3(i).2 Certificate of Designation, Incorporated by reference to Exhibit Preferences and Rights of Series 3-a(ii) to the Registration Statement A Junior Participating Preferred on Form S-3 (S.E.C. File No. Stock of Mobil Corporation dated 33-32651), filed under Form SE dated April 25, 1986. December 14, 1989.\n3(i).3 Certificate of Designation, Incorporated by reference to Exhibit Preferences and Rights of Series 3-a(iii) to the Registration B ESOP Convertible Preferred Statement on Form S-3 (S.E.C. File Stock of Mobil Corporation dated No.33-32651), filed under Form SE November 22, 1989. dated December 14, 1989.\n3(ii).4 By-laws of Mobil Corporation, Incorporated by reference to Exhibit as amended to December 16, 1994. 3.4 filed on Form 8-K dated July 6, 1995.\n10.1 1995 Mobil Incentive Compensation Incorporated by reference to and Stock Ownership Plan. definitive Proxy Statement filed March 20, 1995.\n10.2 1991 Mobil Incentive Compensation Incorporated by reference to Exhibit and Stock Option Plan. 15 to the Registration Statement on Form S-8 (S.E.C. File No. 33-48887) filed August 10, 1992.\n10.3 1986 Mobil Incentive Compensation Incorporated by reference to Exhibit and Stock Option Plan. 15 to the Registration Statement on Form S-8 (S.E.C. File No. 33-5797) filed May 20, 1986.\n11. Computation of Earnings per Electronic Common Share. (Page 25)\n12. Computation of Ratio of Earnings Electronic to Fixed Charges. (Page 26)\n13. Mobil Corporation 1995 Annual Electronic Report to Shareholders.\n21. Subsidiaries of the Registrant. Electronic (Pages 27-29)\n23. Consent of Ernst & Young LLP, Electronic Independent Auditors, dated March 6, 1996. (Page 30)\n24.1 Power of attorney dated as of Electronic February 23, 1996, executed by the Board of Directors of Mobil Corporation authorizing execution of Annual Report on Form 10-K.\n24.2 Certified copy of Board of Electronic Directors' Resolutions adopted February 23, 1996, authorizing signature by officers pursuant to power of attorney.\n27. Financial Data Schedule Electronic\nMobil - 24 -","section_15":""}
{"filename":"808516_1995.txt","cik":"808516","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business\nAMERICAN INCOME PARTNERS III-D LIMITED PARTNERSHIP (the \"Partnership\") was organized as a limited partnership under the Massachusetts Uniform Limited Partnership Act (the \"Uniform Act\") on December 30, 1987 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 Managing General Partner (AFG Leasing Incorporated) and $100 from the Initial Limited Partner (AFG Assignor Corporation). On April 15, 1988, the Partnership issued 519,926 units representing assignments of limited partnership interests (the \"Units\") to 1,129 investors. Unitholders and Limited Partners (other than the Initial Limited Partner) are collectively referred to as Recognized Owners. The 519,926 Units include 76 bonus Units. Subsequent to the Partnership's Closing, the Partnership had five General Partners: AFG Leasing Incorporated, a Massachusetts corporation, Kestutis J. Makaitis, Daniel J. Roggemann, Martin F. Laughlin, and Geoffrey A. MacDonald (collectively the \"General Partners\"). Messrs. Makaitis, Roggemann and Laughlin subsequently elected to withdraw as Individual General Partners. The General Partners, each of whom is affiliated with American Finance Group (\"AFG\"), a Massachusetts partnership, are not required to make any other capital contributions except as may be required under the Uniform Act and Section 6.1(b) of the Amended and Restated Agreement and Certificate of Limited Partnership (the \"Restated Agreement\").\n(b) Financial Information About Industry Segments\nThe Partnership is 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 equal or 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 are to acquire and lease equipment which will:\n1. Generate quarterly cash distributions;\n2. Preserve and protect invested capital; and\n3. Maintain substantial residual value for ultimate sale.\nThe Partnership has the additional objective of providing certain federal income tax benefits.\nThe Closing Date of the Offering of Units of the Partnership was April 15, 1988. The initial purchase of equipment and the associated lease commitments occurred on April 19, 1988. The acquisition of the equipment and its associated leases is described in detail in Note 3 to the financial statements included in Item 14, herein. The Partnership is expected to terminate no later than December 31, 1999.\nThe Partnership has no employees; however, it entered into a Management Agreement with AFG (the \"Manager\"). The Manager's role, among other things, is 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 is compensated for such services as described in 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 is, and will continue to be, subject to various risks, including physical deterioration, technological obsolescence and defaults by lessees. A principal business risk of owning and leasing equipment is the possibility that aggregate lease revenues 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 is largely dependent upon the ability of the Managing 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.\nIn addition, the leasing industry is very competitive. Although all funds available for acquisitions have been invested in equipment, subject to noncancellable lease agreements, the Partnership will encounter considerable competition when equipment is re-leased or sold at the expiration of primary lease terms. The Partnership will compete with lease programs offered directly by manufacturers and other equipment leasing companies, including limited partnerships and trusts organized and managed similarly to the Partnership and including other AFG sponsored partnerships and trusts, which may seek to re-lease or sell equipment within their own portfolios to the same customers as the Partnership. Many competitors have greater financial resources and more experience than the Partnership, the Managing General Partner and the Manager.\nGenerally, the Partnership is prohibited from reinvesting the proceeds generated by refinancing or selling equipment. Accordingly, it is anticipated that the Partnership will begin to liquidate its portfolio of equipment at the expiration of the initial and renewal lease terms and to distribute the net liquidation proceeds. As an alternative to sale, the Partnership may enter re-lease agreements when considered advantageous by the Managing General Partner and the Manager. In accordance with the Partnership's stated investment objectives and policies, the Managing General Partner is also considering winding-up the Partnership's operations, including the liquidation of its entire portfolio.\nRevenue 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.\nDefault by a lessee under a lease may cause equipment to be returned to the Partnership at a time when the Managing General Partner or the Manager is unable to arrange for the re-lease or sale of such equipment. This could result in the loss of a material portion of anticipated revenues and significantly weaken the Partnership's ability to repay related debt.\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.\nIncorporated herein by reference to Note 3 to the financial statements in the 1995 Annual Report.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIncorporated herein by reference to Note 7 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 1,015 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 are determined and distributed to the Partners quarterly. Each quarter's distribution may vary in amount. Distributions may be made to the Managing General Partner prior to the end of the fiscal quarter; however, the amount of such distribution reflects only amounts to which the Managing General Partner is entitled at the time such distribution is made. Currently, there are no restrictions that materially limit the Partnership's ability to distribute Distributable Cash From Operations and Distributable Cash From Sales or Refinancings or that the Partnership believes are likely to materially limit the future distribution of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings. The Partnership expects to continue to distribute all Distributable Cash From Operations and Distributable Cash From Sales or Refinancings on a quarterly basis.\nDistributions payable were $98,470 and $164,118 at December 31, 1995 and 1994, respectively.\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 Managing General Partner, and increased by any portion of such reserves deemed by the Managing 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 Managing 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 Managing 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 Managing General Partner, and (b) the proceeds from the sale of an interest in equipment pursuant to any agreement governing a joint venture which the Managing 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 Partners, 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 Managing General Partner and (ii) increased by any portion of such reserves deemed by the Managing 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 Recognized Owners and 1% to the General Partners until Payout and 85% to the Recognized Owners and 15% to the General Partners after Payout.\n\"Payout\" is defined as the first time when the aggregate amount of all distributions to the Recognized Owners of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings equals the aggregate amount of the Recognized Owners' original capital contributions plus a cumulative annual return of 10% (compounded quarterly 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 Recognized Owners exceed the amount required to satisfy the cumulative annual return of 10% (compounded quarterly) on the Recognized Owners' aggregate unreturned capital contributions, such calculation to be based on the aggregate unreturned capital contributions outstanding on the first day of each fiscal quarter.\nDistributable Cash From Operations and Distributable Cash From Sales or Refinancings (\"Distributions\") are distributed within 60 days after the completion of each quarter, beginning with the first full fiscal quarter following the Partnership's Closing Date. Each Distribution is described in a statement sent to the Recognized Owners.\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.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated herein by reference to the financial statements and supplementary data included in 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 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 Incorporated is the Managing General Partner of the Partnership. Under the Restated Agreement, as amended, the Managing General Partner is responsible for the operation of the Partnership's properties and the Recognized Owners have no right to participate in the control of such operations. The names, titles and ages of the Directors and Executive Officers of the Managing General Partner as of March 15, 1996 are as follows:\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 Managing General Partner or its Affiliates. There is no plan at the present time to make any officers or employees of the Managing 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 Managing General Partner or its Affiliates.\n(b) Compensation Pursuant to Plans\nNone.\n(c) Other Compensation\nAlthough the Partnership has no employees, as discussed in Item 11(a), pursuant to section 10.4 of the Restated Agreement, as amended, the Partnership incurs 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 services 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 the General Partners or the Managing 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 outstanding no 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 Recognized Owners have voting rights with respect to:\n1. Amendment of the Restated Agreement;\n2. Termination of the Partnership;\n3. Removal of the General Partners; and\n4. Approval or disapproval of the sale of all, or substantially all, of 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 Managing General Partner of the Partnership is AFG Leasing Incorporated, an affiliate of AFG.\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 the years ended December 31, 1995, 1994 and 1993, 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 is compensated for its services to the Partnership. Such services include all aspects of acquisition, management and sale of equipment. For acquisition services, AFG is compensated by an amount equal to 4.75% of Equipment Base Price paid by the Partnership. For management services, AFG is compensated by an amount equal to the lesser of (i) 5% of gross lease rental revenue or (ii) fees which the Managing General Partner reasonably believes to be competitive for similar services for similar equipment. Both of these fees are subject to certain limitations defined in the Management Agreement. Compensation to AFG for services connected to the sale of equipment is calculated as the lesser of (i) 3% of gross sale proceeds or (ii) one-half of reasonable brokerage fees otherwise payable under arm's length circumstances. Payment of the remarketing fee is subordinated to Payout and is subject to certain limitations defined in the Management Agreement.\nInterest 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 10.4 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 purchased 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 are paid directly to either AFG or to a lender. AFG temporarily deposits collected funds in a separate interest-bearing account prior to remittance to the Partnership. At December 31, 1995, the Partnership was owed $37,479 for such funds and the interest thereon. These funds were remitted to the Partnership in January 1996.\nOn August 18, 1995, Atlantic Acquisition Limited Partnership (\"AALP\"), a newly formed Massachusetts limited partnership owned and controlled by certain principals of AFG, commenced a voluntary cash Tender Offer (the \"Offer\") for up to approximately 45% of the outstanding units of limited partner interest in this Partnership and 20 affiliated partnerships sponsored and managed by AFG. The Offer was subsequently amended and supplemented in order to provide additional disclosure to unitholders; increase the offer price; reduce the number of units sought to approximately 35% of the outstanding units; and extend the expiration date of the Offer to October 20, 1995. Following commencement of the Offer, certain legal actions were initiated by interested persons against AALP, each of the general partners (4 in total) of the 21 affected programs, and various other affiliates and related parties. One action, a class action brought in the United States District Court for the District of Massachusetts (the \"Court\") on behalf of the unitholders (limited partners), sought to enjoin the Offer and obtain unspecified monetary damages. A settlement of this litigation was approved by the Court on November 15, 1995. A second class action, brought in the Superior Court of the Commonwealth of Massachusetts (the \"Superior Court\") seeking to enjoin the Offer, obtain unspecified monetary damages, and intervene in the first class action, was dismissed by the Superior Court. The Plaintiffs have filed an appeal in this matter. The limited partners of the Partnership tendered approximately 37,604 units or 7.23% of the total outstanding units of the Partnership to AALP. The operations of the Partnership are not expected to be adversely affected by these proceedings or settlements.\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 Number\n99 (b) Lease agreement with Northwest Airlines, Inc. was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 as Exhibit 28 (d) and is incorporated herein by reference.\n99 (c) Lease agreement with Equicor, Incorporated was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 as Exhibit 28 (e) and is incorporated herein by reference.\n99 (d) Lease agreement with ING Aviation Lease is filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 and is included herein.\n(b) Reports on Form 8-K\nNone.\nExhibit 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of American Income Partners III-D Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to the Partners of American Income Partners III-D 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 Recognized Owners. A report will be furnished to the Recognized Owners subsequent to the date hereof.\nNo proxy statement has been or will be sent to the Recognized Owners.","section_14":"","section_15":""}
{"filename":"756939_1995.txt","cik":"756939","year":"1995","section_1":"Item 1. BUSINESS\nIn December 1995, the Registrant completed the liquidation of its lease portfolio and ceased its business operations. Cash from operations and sales of equipment have been or will be distributed to the Partners to liquidate the Partnership's business activity. The final distribution is scheduled to occurred by April 15 1996. The Partnership was formed in 1985 with a capitalization of $7,500,00.00. Limited Partner distributions from the inception of the Partnership to date are as follows;\nDistributions noted herein are on an accrual basis of accounting as shown on the Statement of Partners' Capital. The Registrant has accrued a liquidation distribution of $243,102 to the limited partners for the quarter ended December 31, 1995 due to be distributed by February 29 1996. The Registrant's operating assets were fully liquidated by December 31, 1995, the final year of operation. Receivables of $26,143 as of December 31, 1995 were collected by January 10, 1996.\nPrior to 1992, the Registrant's primary business was to acquire a diversified portfolio of capital equipment for lease subject to operating and direct finance leases with terms of 36 to 60 months. The equipment leased was selected by the lessees and was purchased directly from the manufacturer, independent third parties and the lessees (via sale lease back transactions). Operating leases, primarily of data processing equipment, are those in which the Registrant maintains ownership of the equipment at the end of the lease. Direct finance leases are those in which the lessee is contractually obligated to purchase the equipment at a predetermined amount at the end of the lease. Since the Operating leases did not transfer ownership through a purchase obligation, the Registrant was actively independent on re-lease or sale of the equipment to realize a profitable return on its investment in the leased equipment.\nPrior to 1992, the Registrant reinvested cash in excess of partners distributions into new lease transactions. Starting in 1992, the Registrant began to wind down its leasing operations by returning all cash proceeds from operations to the partners through quarterly distributions. During the wind down or liquidation phase, cash proceeds from the rents, equipment sold and all available cash from operations have been distributed to the limited partners in proportion to their respective tax basis capital accounts.\nCompetition\nWhile the Registrant has ceased operations, it has competed in the past with manufacturer leasing companies, independent leasing companies, affiliates of banks, commercial credit companies and other leasing partnerships. Competition with these entities was based primarily on lease rates and terms as well as the type and amount of equipment. In addition the condition and relative obsolescence of equipment were major factors in the Partnership's ability to re-lease or sell its equipment from operating leases and to realize income for distribution to partners. Other factors include the demand for a type of equipment, the cost of maintenance, the availability of financing, trends in the economy, interest rates, tax laws as well as many other factors over which neither the Registrant or its competitors had control.\nWorking Capital\nThe Partnership maintained cash reserves for normal operating expenses, working capital and certain leasing costs such as payment of personal property taxes, refurbishment cost, and repossession costs. The Registrant has no statistical information to compare its reserves with those of its competitors. The Registrant has no employees. Leastec Corporation is performing all management duties for the Fund. In 1995 the General Partner of the Registrant, Leastec Corporation, received management fees of six percent (6%) of the Registrant's gross receipts, or $62,783, for managing the Registrant's operations. The Registrant's revenues, income, and assets for the years ended December 31, 1995, 1994, and 1993, are as follows:\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Registrant has no plants, mines or other physical properties. At December 31,1995, the portfolio of leases was fully liquidated.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Registrant is not a party to any material pending legal proceedings at this time.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the period from September 30, 1995 to December 31, 1995, no matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise.\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) The Registrant's Limited Partner Units and General Partner's Units were not publicly traded. There was no established public trading market for such Units and none is expected to develop. However the Registrant's units were freely transferable.\n(b) The number of holders of partnership interests are set forth below:\n(c) Distributions\nDuring 1995, the Registrant made four (4) quarterly distributions (the first distribution in 1995 related to 1994) to all limited partners in the amount of $445,000 as follows:\nAdditionally, $243,102 has been accrued for the fourth quarter 1995 to be paid by February, 29 1996.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nCash dividend declared per limited partner unit data is not applicable as cash distributions are distributed to those investors electing to receive them at a fixed rate as determined by the general partner based on the investors original investment for years 1985 to 1991. Distributions for the quarters subsequent to 1991 were based on each partner's tax basis capital account.\nThe above selected financial data should be read in conjunction with the audited financial statements and related notes to the financial statements appearing in Item 8 of the Form 10-K.\nItem 7.","section_7":"Item 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBasis of Financial Statement Preparation\nThe Partnership has presented its 1995 financial statements to reflect its leasing activities on a basis consistent with prior periods.\nRESULTS OF OPERATIONS\n1995 Versus 1994\nThe Registrant completed ten (10) full years of operations and has liquidated its operating assets. During the liquidation phase of the Partnership, all cash flows in excess of partnership expenses were distributed to the limited partners in proportion to their respective tax basis capital accounts. Operating lease income declined from $431,747 in 1994 to $175,303 in 1995 as a result of the leasing portfolio wind down. As operating leases terminated during the year, the equipment returned from lease was sold. Equipment on lease (subject to operating leases), net of depreciation decreased from $78,984 at December 31, 1994 to $-0- at December 31,1995. The original cost of the equipment on operating leases declined from $1,338,858 in 1994 to $-0-in 1995, and consequently, depreciation expense decreased from $177,462 in 1994 to $78,186 in 1995. Rental income from operating leases comprised 73% and 36% of total revenue in 1994 and 1995, respectively, with interest and other, direct financing lease income and gain on disposition of equipment and on direct financing leases making up the remainder. The decline in the percentage of income derived from operating leases reflects the Registrant's effort to invest in finance leases, the decrease in the investment inequipment subject to operating leases and termination of partnership operations. The Registrant recorded a net gain on disposition of equipment and direct financing leases of $259,430 in 1995 and $45,452 in 1994. Management fees increased slightly from $61,163 in 1994 to $62,783 in 1995, primarily due to the increase in gain on sale offsetting the declining rental revenues. Management fees are dependent on both operating and direct financing lease income. As previously mentioned, income derived from operating leases has decreased due to a decrease in the size of the lease portfolio. Direct services from general partners increased from $73,510 in 1994 to $101,478 in 1995. Direct services are the administrative and personnel costs (payroll) incurred on behalf of the Partnership. The increase in this final year is attributed to the accrual of additional expenses associated with the closing and dissolution of the Partnership. Included in these expenses are the costs of the final audit, tax reporting, financial reporting, withdrawal as a business entity from the various states, as well as the cost of preparing the final investor reporting and cash distribution General and administrative expenses decreased from $133.080 in 1994 to $98,456 in 1995. This decrease reflected the decrease in the cost related to the sales and disposition of equipment and leases. Total operating expenses decreased from $474,438 in 1994 to $342,698 in 1995. A substantial portion of the decrease relates to the reduction of depreciation expense on the operating lease portfolio. Depreciation expense comprised 37% of total expenses in 1994 compared to 23% in 1995. The foregoing factors resulted in the Registrant reporting a net income of $147,440 for 1995 ($4.94 per weighted average Limited Partner Unit) compared to $120,041 for 1994 ($4.02 per weighted average Limited Partner Unit).\nLiquidity and Capital Resources\nOperating activities provided the Registrant with cash flows of $196,258 in 1994 compared to cash used in operating activities of $53,649 in 1995. The decrease from year to year is a result of the decline in operating lease income due to the planned liquidation of the Partnership. During 1995, investing activities provided cash from the collections of moneys from direct financing leases. The sale of equipment related to direct financing leases provided cash in the amount of $6,000 in 1994 and $210,810 in 1995. Cash proceeds from the disposition of equipment from operating leases were $256,442 in 1995 and $60,594 in 1994. The net assets of the Partnership were fully liquidated at December 31, 1995. During 1994, financing activities used cash to repay notes payable, which amounted to $210,338, and to make distributions to Limited Partners, which amounted to $479,993. In 1995, financing activities used cash to repay notes payable in the amount of $115,580 and to make distributions to the Limited Partners totaling $445,000. Operating lease income declined from $431,747in 1994 to $175,303 in 1995 due to the cessation of leasing activities. The cash position as of December 31, 1995 was $339,506. This remaining cash will be used to pay closing expenses and an accrued distribution to the limited partners of $243,102. At December 31, 1995 the Registrant held no equipment.\n1994 versus 1993\nOperating lease income declined from $571,796 in 1993 to $431,747 in 1994 as the investment in leases has decreased as a result of the leasing portfolio wind down. The Registrant entered into direct financing leases with equipment totaling $167,288 in 1993 and $0 in 1994. The Registrant did not enter into any operating leases in 1993 or 1994. As operating leases terminated during the year, the equipment returning from lease was sold. Equipment on lease (subject to operating leases), net of depreciation decreased from $271,588 at December 31, 1993 to $78,984 at December 31, 1994. The original cost of the equipment on operating leases declined from $1,764,399 in 1993 to $1,338,858 in 1994, and consequently, depreciatiom expense decreased from $396,765 in 1993 to $177,462 in 1994. Rental income from operating leases comprised 75% and 73% of total revenue in 1993 and 1994, respectively, with interest and other, direct financing lease income and gain on disposition of equipment or on direct financing leases making up the remainder. The decline in the percentage of income derived from operating leases reflects the Registrant's effort to invest in finance leases and the decrease in the investment in equipment subject to operating leases. There was no provision for decline in market value of equipment held for sale during the years ending 1993 or 1994. Most of the assets held for sale at that time were fully depreciated or in line with their current market value. The Registrant recorded a net gain on disposition of equipment and direct financing leases of $40,080 in 1994 and a net loss of $14,703 in 1993. Management fees decreased from $89,820 in 1993 to $61,163 in 1994. Management fees are dependent on both operating and direct financing lease income. As previously mentioned, income derived from operating leases has decreased due to a decrease in the size of the lease portfolio. Direct services from general partners decreased from $77,463 in 1993 to $73,510 in 1994. Direct services are the administrative and personnel costs (payroll) incurred on behalf of the Partnership. The decrease from year to year is attributed to the decrease in the cost related to the sales of operating lease equipment as well as reducing the staffing requirements needed to manage the leasing activities. General and administrative expenses increased slightly from $116,800 in 1993 to $133,080 in 1994. This increase reflected a one time marketing cost for re-leasing equipment subject to operating leases. Total operating expenses decreased from $747,462 in 1993 to $474,438 in 1994. The majority of the decrease relates to the reduction of depreciation expense on the operating lease portfolio. Depreciation expense comprised 53% of total expenses in 1993 compared to 37% in 1994. The foregoing factors resulted in the Registrant reporting a net income of $120,041 for 1994 ($4.02 per weighted average Limited Partner Unit) compared to $18,039 for 1993 ($.60 per weighted average Limited Partner Unit).\nLiquidity and Capital Resources\nOperating activities provided the Registrant with cash flows of $412,375 in 1993 and $196,258 in 1994. The decrease from year to year is a result of the decline in operating lease income due to the planned liquidation of the Partnership. During 1993 and 1994, investing activities provided cash from the collections of moneys from direct financing leases. The net investment in direct financing leases decreased by $576,648 during 1993 and by $422,912 during 1994. The sale of equipment related to direct financing leases provided cash in the amount of $126,017 in 1993 and $6,000 in 1994. Cash used in investing activities of $167,288 in 1993 consisted of direct finance leases committed to during 1993 but not completed until 1993 compared to no cash used in investing activities in 1994. Cash proceeds from the disposition of equipment from operating leases were $60,594 in 1994 and $45,206 in 1993. The Registrant intends to liquidate the net assets of the Partnership by the end of 1996. During 1993, financing activities used cash to repay notes payable, which amounted to $185,857, and to make distributions to Limited Partners, which amounted to $1,100,000. In 1994, financing activities used cash to repay notes payable in the amount of $210,338 and to make distributions to the Limited Partners totaling $479,993.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n1. Financial Statements Page Number\nIndependent Auditors' Report Balance Sheets Statements of Operations Statements of Partners' Capital Statements of Cash Flows Notes to Financial Statements\nLEASTEC INCOME FUND 1985-I (a California Limited Partnership)\nFinancial Statements\nDecember 31, 1995, 1994 and 1993\n(With Independent Auditors' Report Thereon)\nLEASTEC INCOME FUND 1985-I (A California Limited Partnership)\nPage Number\nINDEPENDENT AUDITORS' REPORT\nFINANCIAL STATEMENTS:\nBALANCE SHEETS - 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\nIndependent Auditors' Report ----------------------------\nThe Partners Leastec Income Fund 1985-I:\nWe have audited the accompanying balance sheets of Leastec Income Fund 1985-I (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 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.\nAs discussed in note 1 to the financial statements, the Partnership discontinued operations on December 31, 1995 and intends to make the final liquidating cash distribution to the partners in 1996.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Leastec Income Fund 1985-I (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 years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\n(signed) KPMG Peat Marwick LLP\nFebruary 8, 1996\nLEASTEC INCOME FUND 1985-1 (A California Limited Partnership)\nNotes to Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(1) Organization and Summary of Significant Accounting Policies -----------------------------------------------------------\n(a) Organization ------------ Leastec Income Fund 1985-1 (the Partnership) was formed on November 1, 1984 and commenced operations on March 6, 1985 as a California limited partnership. The Partnership was formed primarily for the purpose of purchasing, holding, leasing and selling peripheral computer equipment.\nThe Partnership leases to various companies in a variety of industries throughout the United States. The Partnership's operations consisted of direct financing leases and operating leases.\nThe Partnership's general partner is Leastec Corporation (Leastec). Leastec manages the Partnership, including investment of funds, purchase and sale of equipment, lease negotiation and other administrative duties.\nThe Partnership ceased operations and prepared for a final liquidating cash distribution as of December 31, 1995. In accordance with the Partnership agreement, the general partner will distribute the net assets of the Partnership based on the limited partners' tax basis capital accounts. Provision has been made in the financial statements for expenses necessary to complete the liquidation of the Partnership.\n(b) Allowance for Doubtful Accounts ------------------------------- The Partnership provides an allowance for doubtful accounts for receivables deemed uncollectible. Allowance for doubtful accounts of $0 and $5,736 was recorded at December 31, 1995 and 1994, respectively.\n(c) Net Investment in Direct Financing Leases ----------------------------------------- Net investment in direct financing leases is the total of the future minimum lease payments and the guaranteed residual value accruing to the benefit of the lessor at the end of the lease term less the unearned income in the lease.\nGenerally, the leases are secured by the equipment on lease. In the event of a default on a lease, the Partnership has the right to foreclose on the assets leased. Assets acquired in the foreclosure are recorded at the lesser of the net investment in the direct financing lease or their estimated fair value as of the date of the foreclosure. Gains or losses from subsequent disposition of the assets are recorded at the date of sale.\n(Continued)\nLEASTEC INCOME FUND 1985-1 (A California Limited Partnership)\nNotes to Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(1) Organization and Summary of Significant Accounting Policies, Continued ----------------------------------------------------------------------\n(d) Equipment on Operating Leases ---------------------------- Equipment on operating leases is recorded at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the equipment ranging from two to seven years. The estimated useful lives of equipment on operating leases and depreciation rates are adjusted to reflect changes in the estimated salvage value of the equipment at the end of the related leases caused by technological advances or other market change during the lease term.\n(e) Recognition of Lease Income --------------------------- Operating leases income is recognized ratably over the lease term.\nUnearned income on direct financing leases is recognized as revenue over the lease term at a constant rate of return on the net investment in the lease.\n(f) Income Taxes ------------ No provision is made for income taxes since the Partnership is not a taxable entity. Individual partners report their allocable share of partnership taxable income or loss.\n(g) Cash Equivalents ---------------- For purposes of the statements of cash flows, the Partnership considers all investments with an initial maturity at date of purchase of three months or less to be cash equivalents.\n(h) Net Income Per Weighted Average Limited Partner Unit ---------------------------------------------------- Net income per weighted average limited partner unit is computed by dividing net income allocated to the limited partners ($147,440 in 1995, $120,041 in 1994 and $18,039 in 1993) by the weighted average number of limited partner units outstanding during the year (29,856 in 1995, 1994 and 1993).\n(i) Estimates --------- The preparation of financial statements in conformity with the 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(Continued)\nLEASTEC INCOME FUND 1985-1 (A California Limited Partnership)\nNotes to Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(2) Direct Financing Leases -----------------------\nNet investment in direct financing lease at December 31 consists of the following:\n(3) Notes Payable -------------\nThe entire note payable balance of $115,580 outstanding as of December 31, 1994 matured and was paid during the year ended December 31, 1995.\n(4) Transactions with the General Partner and Affiliates ----------------------------------------------------\nThe following is a summary of Partnership transactions with the general partner and affiliates.\n(a) Management Fees --------------- The general partner is entitled to receive management fees as compensation for services performed in connection with managing the operations of the Partnership, equal to 6% of gross receipts as defined in the Partnership agreement. These fees totaled $62,783 in 1995, $61,163 in 1994 and $89,820 in 1993.\n(b) Direct Services --------------- The general partner provides various services directly related to the operations of the Partnership. The Partnership reimburses the general partner for administrative and personnel costs incurred on its behalf. Such reimbursements totaled $101,478 in 1995, and $73,510 in 1994 and $77,463 in 1993.\n(c) Direct Financing Lease Sales ---------------------------- The Partnership sold direct financing leases to affiliates of the general partner for an amount of $110,391 in 1995. The direct financing leases sale prices approximated the net book values of the leases as recorded in the Partnership at the date of sale.\n(d) Due to Affiliates ----------------- Amounts due to affiliates totaled $43,740 and $15,735, respectively, at December 31, 1995 and 1994 for services performed.\n(Continued)\nLEASTEC INCOME FUND 1985-1\n(A California Limited Partnership)\nNotes to Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(5) Cash Distributions and Allocations of Profits and Losses --------------------------------------------------------\n(a) Cash Distributions ------------------ Cash available for distribution, as defined in the Partnership agreement, is distributed first to the general partner in an amount sufficient to restore their capital account to equal their initial capital contribution. Second, to the general partner equal to 15% of cumulative net income less cumulative distributions as of the beginning of each fiscal year. To the extent cumulative distributions to the general partner exceed cumulative net income allocated to the general partner, no distribution is made. The remaining cash available for distribution is allocated to the limited partners.\nUnder the terms of the limited partnership agreement, limited partners may elect to reinvest their share of cash distributions in their capital accounts.\nUpon dissolution and termination of the Partnership, in the event the general partner's capital account is less than zero, the general partner shall contribute to the Partnership an amount equal to the deficit balance in its capital account.\nCash distributions of $325,000 relating to the 1995 financial year of operations of the Partnership were made to the limited partners. In accordance with the Partnership agreement, a liquidating distribution of $243,102 was declared and accrued to bring the limited partners capital account to zero. Under the Partnership agreement, the general partner's capital account was reduced to zero as the general partner was not entitled to any liquidating distributions.\n(b) Profit and Loss Allocations --------------------------- The general partner is allocated profits equal to their cash distributions, or to the extent of prior allocated losses. Remaining profits, if any, are allocated to the limited partners.\nNet losses are allocated 99% to the limited partners and 1% to the general partner.\n(Continued)\nLEASTEC INCOME FUND 1985-1 (A California Limited Partnership)\nNotes to Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(6) Tax Information ---------------\nThe following reconciles net income for financial reporting purposes and federal income tax purposes for the years ended December 31:\nThe following reconciles partners' capital for financial reporting purposes and federal income tax purposes as of December 31:\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\n(a) At December 31, 1995, the General Partner of the Registrant was Leastec Corporation, a California corporation, a wholly owned subsidiary of The Earnest Group, formerly Partners Fund Management, Inc.\n(b) The directors and executive officers of the General Partner of the Registrant who are not themselves general partners of the Registrant are: Ernest V. Lavagetto, 46, President, Chief Financial Officer, Secretary and Director of Leastec Corporation since April 1980. Mr. Lavagetto's term of office as Director ended on August 31, 1996. Mr. Lavagetto joined Leastec Corporation in 1980. He is a Certified Public Accountant and a member in good standing of the American Institute of Certified Public Accountants. The officer noted above is not subject to an employment contract but serves at the pleasure of the Board of Directors of the respective corporation.\n(c) All significant employees are identified in Item 10 (b) above.\n(d) Leastec Corporation was formed in December 1976. Since its formation, Leastec has sponsored numerous tenancies-in-common, direct ownership transactions, and limited partnerships involving the leasing of computer and high technology medical equipment. Since 1980, Leastec has sponsored and served as a general partner of the following partnerships:\nLeastec Investors No. 1 Leastec Investors No. 2 Leastec Investors No. 3 Leastec Investors No. 4 Leastec Investors No. 5 Leastec Investors No. 6 Equipment Investors of Pacific No. 1 Equipment Investors of Pacific No. 2 Equipment Investors of Pacific No. 3 Equipment Investors of Pacific No. 4 Equipment Investors of Pacific No. 5 Equipment Investors of Pacific No. 6 Leastec Associates I Leastec Associates II Leastec Associates III Leastec Associates IV Leastec Associates V Leastec Associates VI Leastec Partners I Leastec Partners II Leastec Partners III Leastec Partners IV Leastec Partners V Leastec Partners VI Leastec Partners VII Leastec Partners VIII Leastec Partners IX Leastec Partners X Leastec Partners XI Leastec Partners XII Leastec Partners XIII Leastec Partners XV Leastec Partners XVI Leastec Systems I Western Trailer Associates Catscan Associates Leastec Income Fund 1984-1 Leastec Income Fund III Leastec Income Fund IV Leastec Income Fund V\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe Registrant has no employees. For information relating to fees and compensation paid to the General Partner, see Item 13.\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 five percent (5%) of the Limited Partner Units. As noted below, the General Partner owns 100 percent of the General Partner Units.\n(b) The General Partner of the Registrant owns the equity securities of the Registrant set forth in the following table:\n(1) (2) (3) (4) --- --- --- --- Title of Class Name of Beneficial Amount and Percent Class Owner Nature Ownership of Class\nGeneral Partner's Leastec Corporation 302 Units 100.0% Unit\nLimited Partner 1st Trust Corporation 8 Units .0266% Unit Trustee IRA FBO Ernest V. Lavagetto (Ernest V. Lavagetto)\nThe person or entity noted in Column 2 of the above table has the right to acquire all of the Limited Partner Units of which he or it is the beneficial owner as specified in Rule 13d-3(d)(1) under the Exchange Act.\n(c) There are no arrangements known to the Registrant, including any pledge by any person of securities of 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\nSet forth is information relating to all compensation paid or accrued by the Registrant to the General Partner during the fiscal year ended December 31, 1995:\n(A) (B) (C) Name of Individual Capacities in Cash or Number in Group Which Served Compensation\nLeastec Corporation General Partner $62,783\nThe General Partner receives all of its compensation in cash from the Registrant. The Registrant also reimburses the General Partner for administrative and personnel costs incurred by the General Partner on behalf of the Registrant. Such expenses totaled $101,478 in 1995 Profits are allocated first to the General Partner to restore their capital accounts to their original capital contribution or if losses occur 1% of the Registrant's net loss in conformity with generally accepted accounting principles. In 1995, no income was allocated to the General Partner.\nSubstantially all equipment leased by the Registrant is initially purchased by the Registrant from the manufacturer or independent third parties. The Registrant does not purchase any inventory of equipment but usually acquires equipment that is already subject to a lease. The Registrant purchases the equipment at cost. In addition, the Registrant's purchase price includes commissions paid to independent brokers for originating lease transactions and acquiring equipment.\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements\nPage Number Independent Auditors' Report Balance Sheets Statements of Operations Statements of Partners Capital Statements of Cash Flows Notes to Financial Statements\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(2) Exhibits\nExhibit Page Number Exhibit Name Number 3 Leastec Income Fund 1985-1 Limited Partnership (Incorporated by reference from Exhibit 3.1 on Form S-18 filed with the Commission on January 18, 1985 File Number 2-94054-LA)\nExhibit Page Number Exhibit Name Number 4 Subscription Agreement and Power of Attorney (Incorporated by reference from Exhibit 4.1 on Form S-18, January 18, 1985, File No. 2-94054-LA)\nElection to Accumulate Cash Distributions (Incorporated by reference from Exhibit 4.1 on Form S-18, January 18, 1985, File No. 2-94054-LA)\n(b) No reports on Form 8-K have been filed during the last quarter of the fiscal year ending December 31, 1995.\n(c) Exhibits None ( Annual Report to Limited Partners consists of substantially all of the information contained in Items 6,7 and 8.)\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.\nLEASTEC INCOME FUND 1985-1 (Registrant)\nBy: LEASTEC CORPORATION General Partner\nDated: March 30, 1996 BY: ERNEST LAVAGETTO Ernest Lavagetto President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the Registrant, and in the capacity and on the date indicated.\nDated: March 30, 1996\nBy: ERNEST LAVAGETTO Ernest Lavagetto, Director, Leastec Corporation","section_15":""}
{"filename":"756427_1995.txt","cik":"756427","year":"1995","section_1":"ITEM 1. BUSINESS - ------ --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund XXIV, L.P. (the \"Partnership\"), formerly known as Southmark Equity Partners, Ltd., was organized on October 19, 1984 as a limited partnership under the provisions of the California Revised Limited Partnership Act to acquire and operate commercial and residential properties. 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 Southmark Investment Group, Inc. (the \"Original General Partner\"), a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"). The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas, 75240.\nOn January 8, 1985, the Partnership registered with the Securities and Exchange Commission (\"SEC\") under the Securities Act of 1933 (File No. 2-93979) and commenced a public offering for sale of $40,000,000 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 December 15, 1985 with 40,000 Units sold at $1,000 each, or gross proceeds of $40,000,000 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. 0-14267).\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 and 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 limited partners approved a restructuring proposal that provided for (i) the replacement of the Original General Partner with a new general partner, McNeil Partners, L.P.; (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; (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 XXIV, L.P. Under the Amended Partnership Agreement, the Partnership began accruing an asset management fee, retroactive to February 14, 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.\nConcurrent with the approval of the restructuring, the General Partner acquired from Southmark and its affiliates, for aggregate consideration of $43,193, (i) the right to receive payment on the advances owing from the Partnership to Southmark and its affiliates in the amount of $642,581, and (ii) the general partner interest of the Original General Partner. None of the Units are owned by the General Partner or its affiliates.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership is engaged in the ownership, operation and management of residential and retail real estate. At December 31, 1995, the Partnership owned seven 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 by the Partnership in fee and are unencumbered by mortgage indebtedness, with the exception of Southpointe Plaza Shopping Center, which is subject to a first lien deed of trust as set forth more fully in Item 8 - - Note 5 - \"Mortgage Note Payable.\" 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 - 240 units Retail Centers - 394,229 sq. ft.\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 residential 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:\nIsland Plaza - ------------\nIsland Plaza is a 60,076 square foot, single-story retail strip shopping center located near a major intersection of a suburban market in Ft. Myers, Florida. The property is set back from its frontage road behind three out parcels. The center is anchored by a grocery chain which occupies 30,800 square feet. Two new grocery-anchored shopping centers have recently been developed within the area which have brought strong competition to Island Plaza. The competitors' grocery anchors occupy approximately 65,000 square feet--more than twice the square footage of Island Plaza's anchor. As a result, the anchor tenant at Island Plaza has filed for reorganization under the U.S. bankruptcy laws. In order to keep the anchor open and maintain the viability of Island Plaza, it was necessary to negotiate a modification of the lease resulting in a reduction in rent. Additionally, road construction completed during 1995 has moved the flow of traffic away from Island Plaza toward the two new shopping centers previously described. These events have caused a decline in anticipated future cash flows that are considered to be a permanent impairment; accordingly, the Partnership recorded a write-down for permanent impairment of $1,500,085 during the fourth quarter of 1995.\nPine Hills - ----------\nPine Hills is a two-story class \"A\" apartment community located in the small town of Livingston, approximately 60 miles north of Houston, Texas. There is no class \"A\" competition within the area at present. If a vacant wooded lot in front of the property is developed, it could block the view of the property. However, development has not begun and is somewhat in question. The Partnership projects one rental rate increase in 1996 and expects to maintain occupancy in the high 90% range.\nRiverbay Plaza - --------------\nRiverbay Plaza is a single-story retail shopping center located at the busiest intersection of a rural area near Riverview, Florida. It is anchored by a grocery store and a drugstore and there are two out parcels in front of the center that draw customers to the center. Currently, there is only one competing shopping center in the area which is not as well maintained as Riverbay Plaza. Building improvements were made in 1995 to enhance marketability and aid retention. The Partnership expects to maintain occupancy in the low 90% range.\nSleepy Hollow - -------------\nSleepy Hollow is a two-story class \"A\" apartment community located in the small town of Cleveland, approximately 30 miles north of Houston, Texas. There is no class \"A\" competition within the area at present. Although exterior renovations completed in 1995 have made a neighboring apartment community more competitive than Sleepy Hollow, the Partnership expects to maintain occupancy in the mid 90% range in 1996.\nSouthpointe Plaza - -----------------\nSouthpointe Plaza is a retail strip shopping center located in the southern quadrant of Sacramento, California. The declining economic conditions in the area have resulted in increased criminal activity. The property is easily accessible and highly visible from the highway. Southpointe Plaza is aesthetically superior to its immediate competitors. The center has strong anchor tenants which, while doing well, seem to be destination stores and do not generate a lot of foot traffic for the center. Management is currently restructuring the tenant mix to accommodate changing demographics and appeal to value consciousness. The Partnership anticipates maintaining occupancy in 1996 and reducing concessions to tenants.\nSpringwood Plaza - ----------------\nSpringwood Plaza is a multi-leveled strip shopping center located in a suburb of St. Louis, Missouri. The center is anchored by a popular local grocery chain and contains fifteen other retail spaces. The area surrounding the property has been in a slow state of decline for the past few years. Occupancy, which had declined in 1994, increased in 1995 due to capital improvements made to improve the appearance of the center. Most of the comparable properties in the area are superior to Springwood Plaza. However, with continued attention to the appearance of the property and rental rates lower than the newer centers in the area, management expects to increase occupancy in 1996.\nTowne Center - ------------\nTowne Center is a retail strip shopping center located in a suburb 10 miles south of Wichita, Kansas. The property is one of five strip shopping centers located in Derby, and it is by far the largest. The property is in good physical condition; however, a new retail center is being developed approximately two miles from Towne Center that could affect the center's performance.\nIn 1994, the center became 100% occupied due to the leasing of a large space that had been vacant for several years. The lease on this space expires in 1997 as does the lease for the center's grocery store anchor tenant. The Partnership expects to maintain occupancy in the high 90% range in 1996.\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 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) Martha Hess, et al. v. Southmark Equity Partners II, Ltd., Southmark Income Investors, Ltd., Southmark Equity Partners, Ltd. (presently known as McNeil Real Estate Fund XXIV, L.P.), Southmark Realty Partners III, Ltd., and Southmark Realty Partners II, Ltd., et al. (\"Hess\"); Kotowski v. Southmark Equity Partners, Ltd. and Donald Arceri v. Southmark Income Investors, Ltd. These cases were previously pending in the Illinois Appellate Court for the First District (\"Appellate Court\"), as consolidated Case No. 90-107. Consolidated with these cases are an additional 14 matters against unrelated partnership entities. The Hess case was filed on May 20, 1988, by Martha Hess, individually and on behalf of a putative class of those similarly situated. The original, first, second and third amended complaints in Hess sought rescission, pursuant to the Illinois Securities Act, of over $2.7 million of principal invested in five Southmark (now McNeil) partnerships, and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The original, first, second and third amended complaints in Hess were dismissed against the defendant-group because the Appellate Court held that they were not the proper subject of a class action complaint. Hess was, thereafter, amended a fourth time to state causes of action against unrelated partnership entities. Hess went to judgment against that unrelated entity and the judgment, along with the prior dismissal of the class action, was appealed. The Hess appeal was decided by the Appellate Court during 1992. The Appellate Court affirmed the dismissal of the breach of fiduciary duty and consumer fraud claims. The Appellate Court did, however, reverse in part, holding that certain putative class members could file class action complaints against the defendant-group. Although leave to appeal to the Illinois Supreme Court was sought, the Illinois Supreme Court refused to hear the appeal. The effect of the denial is that the Appellate Court's opinion remains standing. On June 15, 1994, the Appellate Court issued its mandate sending the case back to trial court.\nIn late January 1995, the plaintiffs filed a Motion to File an Amended Consolidated Class Action Complaint, which amends the complaint to name McNeil Partners, L.P. as the successor general partner to Southmark Investment Group. In February 1995, the plaintiffs filed a Motion for Class Certification. The amended cases against the defendant-group, and others, are proceeding under the caption George and Joy Kugler v. I.R.E. Real Estate Income Fund, Jerry and Barbara Neumann v. Southmark Equity Partners II, Richard and Theresa Bartoszewski v. Southmark Realty Partners III, and Edward and Rose Weskerna v. Southmark Realty Partners II.\nIn September 1995, the court granted the plaintiffs' Motion to File an Amended Complaint, to Consolidate and for Class Certification. The defendants have answered the complaint and have plead that the plaintiffs did not give timely notice of their right to rescind within six months of knowing that right. The ultimate outcome of this litigation cannot be determined at this time.\n4) 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, L.P. (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 4, 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 4, 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.\n5) 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 5, 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 5, 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.\n6) 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 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) 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 7, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 7, 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.\n8) Henry Lim, Charles Chen, Paul Van dba Shangri-La Restaurant & Bar, Robert Narayan and Jackie Kim v. McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Management, Inc. (\"McREMI\") et al. This was a complaint for breach of contract, breach of covenant to extend term of lease, intentional and negligent interference with respective economic relationships, civil rights violations, intentional and negligent misrepresentation, injurious false suit and negligent and intentional infliction of emotional distress brought by former tenants of the Southpointe Plaza Shopping Center, based on a purported claim that both the Partnership and McREMI orally promised to agree to extend the lease and approve an assignment of lease from three of the plaintiffs to two of the other plaintiffs for a restaurant and bar. On April 10, 1995, a settlement was reached such that the Partnership agreed to pay the first three plaintiffs $42,500, of which $20,000 was paid by the Partnership's insurance carrier. The remaining two plaintiffs are free to continue to pursue their action, however, they would only be able to prove damages up to $1,500.\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.\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 3,450 as of February 16, 1996\n(C) No distributions were paid to the partners in 1995 or 1994. 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 - Financial Statements and Supplementary Data.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------ ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL CONDITION - -------------------\nThe Partnership was formed to engage in the business of acquiring and operating income-producing real properties and holding the properties for investment. Since completion of its capital formation and property acquisition phases in 1985, when it completed the purchase of seven properties, the Partnership has operated its properties for production of income.\nIsland Plaza, a 60,076 square foot single-story strip shopping center, is located in Fort Myers, Florida. It is anchored by a grocery chain which occupies 30,800 square feet. Two new grocery-anchored shopping centers have recently been developed within the area which have brought strong competition to Island Plaza. The competitors' grocery anchors occupy approximately 65,000 square feet--more than twice the square footage of Island Plaza's anchor. As a result, the anchor tenant at Island Plaza has filed for reorganization under the U.S. bankruptcy laws. In order to keep the anchor open and maintain the viability of Island Plaza, it was necessary to negotiate a modification of the lease resulting in a reduction in rent. Additionally, road construction completed during 1995 has moved the flow of traffic away from Island Plaza toward the two new shopping centers previously described. These events have caused a decline in anticipated future cash flows that are considered to be a permanent impairment; accordingly, the Partnership recorded a write-down for permanent impairment of $1,500,085 during the fourth quarter of 1995.\nRESULTS OF OPERATIONS - ---------------------\n1995 compared to 1994\nRevenue:\nTotal Partnership revenues increased by $18,582 in 1995 as compared to 1994. The increase was primarily due to a refund of property taxes and an increase in interest income, partially offset by a decrease in rental revenue, as discussed below.\nRental revenue decreased by $68,893 in 1995 in relation to 1994. Rental revenue decreased by approximately $81,000 at Riverbay Plaza Shopping Center, mainly due to the property receiving approximately $58,000 for land condemned by the county in 1994. In addition, there was a decrease in property taxes billed to tenants in 1995 due to a decrease in the assessed taxable value of the property by taxing authorities. Rental revenue also decreased by approximately $53,000 at Island Plaza Shopping Center as a result of a reduction in rent charged to the center's main anchor tenant due to financial difficulties experienced by the tenant. These decreases were partially offset by increases in rental revenue of approximately $31,000 and $33,000 at Pine Hills and Sleepy Hollow apartments, respectively, due to an increase in rental rates in 1995. See Item 2 - Properties for a more detailed analysis of occupancy and rents per square foot.\nInterest income increased by $52,333 in 1995 as compared to 1994, primarily due to a greater amount of cash available for short-term investment. The partnership held approximately $2.4 million of cash and cash equivalents at December 31, 1995, as compared to $1.7 million at December 31, 1994. In addition, there was an increase in interest rates earned on invested cash in 1995.\nIn 1995, the Partnership received $35,142 in refunds of prior years' property taxes for Riverbay Plaza, Southpointe Plaza and Springwood Plaza shopping centers. No such refunds were received in 1994.\nExpenses:\nTotal Partnership expenses in 1995 increased by $1,647,858 as compared to 1994, primarily due to a write-down for permanent impairment of real estate and an increase in general and administrative expenses, as discussed below.\nInterest expense increased $52,901 in 1995 in relation to 1994. The increase was primarily due to an increase in the adjustable interest rate on the Southpointe Plaza mortgage note payable.\nDepreciation and amortization expense increased by $76,508 in 1995 compared to 1994 due to the addition of depreciable capital improvements.\nProperty taxes decreased by $72,242 in 1995 as compared to the prior year. The decrease was primarily attributable to a decrease in the assessed taxable value of Riverbay Plaza, Southpointe Plaza and Springwood Plaza shopping centers by taxing authorities as a result of an appeal filed by the Partnership on behalf of the properties.\nOther property expenses decreased by $64,217 in 1995 as compared to 1994. The decrease was mainly due to a decrease in bad debt expense at Southpointe Plaza and Springwood Plaza in 1995. In addition, there was a higher amount of legal fees incurred at Riverbay Plaza in 1994 concerning their sewage treatment system. Leasing commissions recognized in 1995 were less than in 1994 at Southpointe Plaza, due to a tenant vacating their space early in 1994.\nGeneral and administrative expenses increased by $142,903 in 1995 in relation to 1994. The increase was mainly due to approximately $122,000 in legal fees in 1995 relating to evaluation and dissemination of information regarding an unsolicited tender offer as discussed in Item 1 - Business and Item 3 - Legal Proceedings. In addition, the Partnership paid $22,500 to settle a lawsuit involving a former tenant's lease as discussed in Item 3 - Legal Proceedings.\nIn 1995, the Partnership recorded a $1,500,085 write-down for permanent impairment of Island Plaza Shopping Center. No such write-down was recorded in 1994.\n1994 compared to 1993\nRevenue:\nTotal Partnership revenues increased by $135,263 in 1994 as compared to 1993. The increase was primarily due to an increase in rental revenue, partially offset by the recognition of a gain on involuntary conversion in 1993 as discussed below.\nRental revenue increased by $223,446 in 1994 in relation to 1993. Rental revenue increased by approximately $103,000, $78,000 and $26,000 at Riverbay Plaza, Southpointe Plaza and Towne Center shopping centers, respectively. These increases were mainly due to increased occupancy and an increase in common area maintenance costs billed to tenants. Rental revenue also increased by approximately $37,000 and $13,000 at Pine Hills and Sleepy Hollow apartments, respectively, due to an increase in occupancy and an increase in rental rates in 1994. These increases were partially offset by decreases in rental revenue at Springwood Plaza and Island Plaza of approximately $33,000 and $28,000, respectively. Rental revenue decreased at these two shopping centers due to decreased occupancy and a decline in rental rates. See Item 2 - Properties for a more detailed analysis of occupancy and rents per square foot.\nInterest income increased by $27,596 in 1994 as compared to 1993, primarily due to a greater amount of cash available for short-term investment. The Partnership held approximately $1.7 million of cash and cash equivalents at December 31, 1994 as compared to $1.4 million at December 31, 1993. In addition, there was a slight increase in interest rates earned on invested cash in 1994.\nThe Partnership recognized a $115,778 gain on involuntary conversion in 1993, which relates to hail damage that occurred at Towne Center Shopping Center in 1992. No such gain was recorded in 1994.\nExpenses:\nTotal Partnership expenses increased by $169,928 in 1994 as compared to 1993. The increase was primarily due to an increase in repairs and maintenance expense in 1994 as discussed below.\nInterest expense in 1994 decreased by $23,448 in relation to the prior year. The decrease was primarily due to a decrease in the adjustable interest rate on the Southpointe Plaza mortgage note payable.\nProperty taxes increased by $28,765 in 1994 as compared to the prior year. The increase was primarily attributable to an increase in the appraised taxable value of Riverbay Plaza Shopping Center by taxing authorities.\nRepairs and maintenance expense increased by $77,038 in 1994 as compared to the prior year. The increase was mainly due to a greater amount of termite exterminating at Pine Hills and Sleepy Hollow Apartments in 1994. In addition, there was an increase in security services at Southpointe Plaza Shopping Center as a result of the increased crime rate in the area and the high incidence of graffiti at the property. Additional landscape work was also performed at Southpointe Plaza in 1994 in an effort to improve the attractiveness of the property.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Partnership's primary source of cash flows is from operating activities which generated $1,215,207 of cash through operating activities in 1995 as compared to $1,205,005 in 1994 and $1,065,891 in 1993. The majority of the increase in 1995 and 1994 in relation to 1993 was attributable to an increase in cash received from tenants due to an increase in rental revenue, as previously discussed.\nIn 1993, the Partnership received $115,779 of net insurance proceeds for hail damage suffered at Towne Center Shopping Center in 1992. The Partnership spent $432,154, $706,253 and $534,621 on capital additions to its real estate investments in 1995, 1994 and 1993, respectively. The increase in expenditures in 1994 in relation to 1995 and 1993 was primarily due to the modification of the sewage treatment system at Riverbay Plaza in 1994. The Partnership also paid $224,829 for two parcels of land in front of Island Plaza Shopping Center in 1993.\nThe Partnership made a total of $122,031, $214,182 and $251,664 in principal payments on the Southpointe Plaza mortgage loan in 1995, 1994 and 1993, respectively. The interest rate on this loan varies monthly as more fully discussed 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 XXIV, L.P.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund XXIV, L.P. (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 XXIV, 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 6, 1996\nMcNEIL REAL ESTATE FUND XXIV, L.P.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIV, L.P.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIV, 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 XXIV, L.P.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee discussion of noncash investing and financing activities in Note 6 - \"Gain on Involuntary Conversion\/Deferred Gain.\"\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIV, L.P.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Loss to Net Cash Provided by Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXIV, L.P.\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ------ -----------------------------------------------------------\nOrganization - ------------\nMcNeil Real Estate Fund XXIV, L.P. (the \"Partnership\"), formerly known as Southmark Equity Partners, Ltd., was organized on October 19, 1984, as a limited partnership under the provisions of the California Revised Limited Partnership Act to acquire and operate commercial and residential properties. 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 Southmark Investment Group, Inc. (the \"Original General Partner\"), a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"). 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 properties. At December 31, 1995, the Partnership owned seven income-producing properties as described in Note 4 - \"Real Estate Investments.\" Six of the Partnership's seven properties were acquired in transactions involving payment of all cash to the sellers. A large portion of the Partnership's rental revenue is attributable to one property, Southpointe Plaza Shopping Center. Southpointe Plaza Shopping Center contributed approximately 30% of the total Partnership rental revenue in 1995, 1994 and 1993.\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.\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 are included in prepaid expenses and other assets on the Balance Sheets. Amortization is recorded 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 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 life 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 generally provides that net income and net loss (other than net income arising from sales or refinancing) shall be allocated 1% to the General Partner and 99% to the limited partners.\nFor financial statement purposes, net income arising from sales or refinancing shall be allocated 1% to the General Partner and 99% to the limited partners.\nFor tax reporting purposes, net income arising from sales or refinancing shall be allocated as follows: (a) first, amounts of such net income shall be allocated among the General Partner and limited partners in proportion to, and to the extent of, the portion of such partners' share of the net decrease in Partnership Minimum Gain determined under Treasury Regulations, (b) second, to the General Partner and limited partners in proportion to, and to the extent of, the amount by which their respective capital account balances are negative by more than their respective remaining shares of the Partnership's Minimum Gain attributable to properties still owned by the Partnership and (c) third, 1% of such net income shall be allocated to the General Partner and 99% of such net income shall be allocated 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 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, distributable cash (other than cash from sales or refinancing) shall be distributed to the limited partners until the limited partners have received distributions of cash flow equal to 10% per annum cumulative on their Adjusted Invested Capital, as defined, and then 100% to the limited partners as a class. At the discretion of the General Partner, cash from sales or refinancing shall be distributed to limited partners: (first) in an amount which when added to prior distributions from all sources to such limited partners is equal to a cumulative preferred return of 10% per annum; and (second) to limited partners in an amount which when added to prior distributions of cash from sales and refinancing to such limited partners is equal to such limited partners' Original Invested Capital, as defined; and (third) to the limited partners on a per limited partnership unit (\"Unit\") basis.\nIn connection with a Terminating Disposition as defined, cash from sales or refinancing and any remaining reserves shall be allocated among, and distributed to, the General Partner and limited partners in proportion to, and to the extent of, their positive capital account balances after the net income has been allocated pursuant to the above.\nNo distributions were made to the partners in 1995, 1994 or 1993. The Partnership distributed $375,000 to the limited partners in March 1996.\nNet Loss Per Limited Partnership Unit - -------------------------------------\nNet loss per limited partnership unit is computed by dividing net loss allocated to the limited partners by the weighted average number of Units outstanding. Per Unit information has been computed based on 40,000 Units outstanding in 1995, 1994 and 1993.\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 for its residential properties 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 residential and commercial properties and leasing services for its residential properties. 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 $10,000 per apartment unit for residential properties 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:\nOn June 25, 1993, the Partnership purchased two parcels of vacant land from McNeil. The parcels are located in front of Island Plaza Shopping Center and were purchased to ensure an unobstructed view of the shopping center from the road located in front of the property. The parcels were purchased for $224,829, the approximate market value and McNeil's basis in the parcels; accordingly, no gain or loss was recorded by McNeil on the transaction.\nPayable to affiliates - General Partner at December 31, 1995 and 1994 consisted primarily of unpaid property management fees, Partnership general and administrative expenses and asset management fees and are due and payable from current operations.\nNOTE 3 - TAXABLE INCOME (LOSS) - ------ --------------------\nMcNeil Real Estate Fund XXIV, 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 tax purposes exceeded the net assets and liabilities for financial reporting purposes by $5,490,840 in 1995, $4,043,975 in 1994 and $4,145,675 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:\nIsland Plaza, a 60,076 square foot single-story strip shopping center, is anchored by a grocery chain which occupies 30,800 square feet. Two new grocery-anchored shopping centers have recently been developed within the area which have brought strong competition to Island Plaza. The competitors' grocery anchors occupy approximately 65,000 square feet--more than twice the square footage of Island Plaza's anchor. As a result, the anchor tenant at Island Plaza has filed for reorganization under the U.S. bankruptcy laws. In order to keep the anchor open and maintain the viability of Island Plaza, it was necessary to negotiate a modification of the lease resulting in a reduction in rent. Additionally, road construction completed during 1995 has moved the flow of traffic away from Island Plaza toward the two new shopping centers previously described. These events have caused a decline in future cash flows that are considered to be a permanent impairment; accordingly, the Partnership recorded a write-down for permanent impairment of $1,500,085 during the fourth quarter of 1995.\nIn December 1995, wind and hail damage occurred at Pine Hills Apartments. Although $75,000 was received from the insurance carrier in February 1996, repairs to the property had not been completed as of March 1996. A determination as to the total cost of repairs cannot be made at this time.\nThe Partnership leases its commercial properties under non-cancelable operating leases. Future minimum rents to be received as of December 31, 1995 are as follows:\n1996.................................... $ 2,260,000 1997.................................... 2,059,000 1998.................................... 1,656,000 1999.................................... 1,474,000 2000.................................... 1,209,000 Thereafter.............................. 5,011,000 ---------- Total $13,669,000\nFuture minimum rents do not include expense reimbursements for common area maintenance, property taxes and other expenses. These expense reimbursements amounted to $444,862, $487,347 and $402,121 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 5 - MORTGAGE NOTE PAYABLE - ------ ---------------------\nThe following sets forth the mortgage note payable of the Partnership, related to Southpointe Plaza Shopping Center, at December 31, 1995 and 1994. The mortgage note payable is secured by the related real estate investment.\n(a) The debt is non-recourse to the Partnership.\n(b) The interest rate varies monthly based on the monthly weighted average cost of savings, borrowings and advances by the Federal Home Loan Bank of San Francisco, with a minimum rate of 5% and a maximum interest rate of 13%. The rate listed above represents the interest rate in effect at December 31, 1995.\nThe mortgage encumbering Southpointe Plaza Shopping Center contains a provision which gave the lender the right to accelerate the mortgage debt as a result of the March 1992 restructuring of the Partnership. The Original General Partner requested that the lender consent to the restructuring, thereby waiving its right to accelerate the mortgage debt. In 1993, the Partnership paid approximately $62,000 in fees in order to obtain such consent from the lender. These fees were capitalized as deferred borrowing costs and are being amortized over the remaining term of the related mortgage note payable.\nScheduled principal maturities of the mortgage note payable under existing terms are as follows:\n1996.................................... $ 102,832 1997.................................... 5,435,695 --------- Total $5,538,527 =========\nThe Partnership will attempt to obtain refinancing or extension of the mortgage note when it matures in 1997.\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 $5,170,000 at December 31, 1995.\nNOTE 6 - GAIN ON INVOLUNTARY CONVERSION\/DEFERRED GAIN - ------ --------------------------------------------\nIn 1993, the Partnership received $168,544 in reimbursement from the insurance company for hail damage suffered at Towne Center Shopping Center in 1992. The Partnership recorded a $115,779 gain in 1993, which represents the amount by which the insurance reimbursement received exceeded the basis of the damaged property.\nThe Partnership also recorded a deferred gain relating to a tenant's early buy out of a lease. The balance of this deferred gain totaled $17,000 at December 31, 1994, and was recognized as rental revenue in 1995 as payments were received from the tenant.\nNOTE 7 - 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) Martha Hess, et al. v. Southmark Equity Partners II, Ltd., Southmark Income Investors, Ltd., Southmark Equity Partners, Ltd. (presently known as McNeil Real Estate Fund XXIV, L.P.), Southmark Realty Partners III, Ltd., and Southmark Realty Partners II, Ltd., et al. (\"Hess\"); Kotowski v. Southmark Equity Partners, Ltd. and Donald Arceri v. Southmark Income Investors, Ltd. These cases were previously pending in the Illinois Appellate Court for the First District (\"Appellate Court\"), as consolidated Case No. 90-107. Consolidated with these cases are an additional 14 matters against unrelated partnership entities. The Hess case was filed on May 20, 1988, by Martha Hess, individually and on behalf of a putative class of those similarly situated. The original, first, second and third amended complaints in Hess sought rescission, pursuant to the Illinois Securities Act, of over $2.7 million of principal invested in five Southmark (now McNeil) partnerships, and other relief including damages for breach of fiduciary duty and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The original, first, second and third amended complaints in Hess were dismissed against the defendant-group because the Appellate Court held that they were not the proper subject of a class action complaint. Hess was, thereafter, amended a fourth time to state causes of action against unrelated partnership entities. Hess went to judgment against that unrelated entity and the judgment, along with the prior dismissal of the class action, was appealed. The Hess appeal was decided by the Appellate Court during 1992. The Appellate Court affirmed the dismissal of the breach of fiduciary duty and consumer fraud claims. The Appellate Court did, however, reverse in part, holding that certain putative class members could file class action complaints against the defendant-group. Although leave to appeal to the Illinois Supreme Court was sought, the Illinois Supreme Court refused to hear the appeal. The effect of the denial is that the Appellate Court's opinion remains standing. On June 15, 1994, the Appellate Court issued its mandate sending the case back to trial court.\nIn late January 1995, the plaintiffs filed a Motion to File an Amended Consolidated Class Action Complaint, which amends the complaint to name McNeil Partners, L.P. as the successor general partner to Southmark Investment Group. In February 1995, the plaintiffs filed a Motion for Class Certification. The amended cases against the defendant-group, and others, are proceeding under the caption George and Joy Kugler v. I.R.E. Real Estate Income Fund, Jerry and Barbara Neumann v. Southmark Equity Partners II, Richard and Theresa Bartoszewski v. Southmark Realty Partners III, and Edward and Rose Weskerna v. Southmark Realty Partners II.\nIn September 1995, the court granted the plaintiffs' Motion to File an Amended Complaint, to Consolidate and for Class Certification. The defendants have answered the complaint and have plead that the plaintiffs did not give timely notice of their right to rescind within six months of knowing that right. The ultimate outcome of this litigation cannot be determined at this time.\n4) 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, L.P. (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 4, 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 4, 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.\n5) 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 5, 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 5, 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.\n6) 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 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) 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 7, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 7, 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.\n8) Henry Lim, Charles Chen, Paul Van dba Shangri-La Restaurant & Bar, Robert Narayan and Jackie Kim v. McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Management, Inc. (\"McREMI\") et al. This was a complaint for breach of contract, breach of covenant to extend term of lease, intentional and negligent interference with respective economic relationships, civil rights violations, intentional and negligent misrepresentation, injurious false suit and negligent and intentional infliction of emotional distress brought by former tenants of the Southpointe Plaza Shopping Center, based on a purported claim that both the Partnership and McREMI orally promised to agree to extend the lease and approve an assignment of lease from three of the plaintiffs to two of the other plaintiffs for a restaurant and bar. On April 10, 1995, a settlement was reached such that the Partnership agreed to pay the first three plaintiffs $42,500, of which $20,000 was paid by the Partnership's insurance carrier. The remaining two plaintiffs are free to continue to pursue their action, however, they would only be able to prove damages up to $1,500.\nMcNEIL REAL ESTATE FUND XXIV, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXIV, 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 $38,075,103 and accumulated depreciation was $14,831,777 at December 31, 1995.\n(b) The carrying values of Pine Hills Apartments and Towne Center Shopping Center were reduced by $692,000 and $500,000, respectively, in 1991. The carrying value of Island Plaza Shopping Center was reduced by $1,500,085 in 1995.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXIV, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nMcNEIL REAL ESTATE FUND XXIV, L.P.\nNotes to Schedule III Real 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.\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 High River Limited Partnership which owns 2,113 Units at February 29, 1996 (approximately 5.28% of the outstanding Units). The business address for High River Limited Partnership is 100 South Bedford Road, Mount Kisco, New York 10549.\n(B) Security ownership of management.\nNeither the General Partner nor any of the officers or directors of its general partner own any limited partnership units.\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 $10,000 per apartment unit for residential properties 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 $339,920 of such asset management fees.\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of residential properties and 6% for commercial properties 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 $542,394 of such property management fees and reimbursements. See 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(A) Exhibits --------\nExhibit Number Description ------- -----------\n4. Amended and Restated Limited Partnership Agreement of McNeil Real Estate Fund XXIV, L.P. dated March 30, 1992 (incorporated by reference to the Current Report of the registrant on Form 8-K dated March 30, 1992, as filed on April 10, 1992).\n4.1 Amendment No. 1 to the Amended and Restated Limited Partnership Agreement of McNeil Real Estate Fund XXIV, L.P. dated June 1995 (incorporated by reference to the Quarterly Report of the registrant on Form 10-Q dated June 30, 1995, as filed on August 14, 1995).\n10.1 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 dated December 31, 1993, as filed on March 30, 1994).\n10.2 Portfolio Services Agreement dated February 14, 1991, between Southmark Equity Partners, Ltd. and McNeil Real Estate Management, Inc. (1)\n10.3 Promissory Note dated March 23, 1987, between Southmark Equity Partners, Ltd. and Great Western Savings relating to Southpointe Plaza Shopping Center. (1)\n10.4 Property Management Agreement dated March 30, 1992, between McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Management, Inc. (2)\n10.5 Amendment of Property Management Agreement dated March 5, 1993, by McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Management, Inc. (2)\n11. Statement regarding computation of Net Income per Limited Partnership Unit (see Note 1 to Financial Statements).\n(1) Incorporated by reference to the Quarterly Report of the registrant on Form 10-Q for the period ended March 31, 1991, as filed on May 14, 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 during the quarter ended December 31, 1995.\nMcNEIL REAL ESTATE FUND XXIV, 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":"797543_1995.txt","cik":"797543","year":"1995","section_1":"Item 1. BUSINESS\nWTD Industries, Inc. is a forest products company organized in Oregon in 1983, whose subsidiaries manufacture softwood and hardwood lumber and by-products. WTD Industries, Inc. and its subsidiaries are hereinafter referred to as \"WTD\" or the \"Company.\" The Company markets its products primarily in the United States and Canada through its subsidiary TreeSource, Inc.\nThe Company and its subsidiaries filed for protection under Chapter 11 of the Federal Bankruptcy Code in late January 1991 following extreme adverse conditions in the forest products industry in 1990. WTD emerged from bankruptcy on November 30, 1992 pursuant to the Company's court-approved Second Amended Joint Plan of Reorganization (\"Plan\") under which it continues to operate.\nPRODUCTS AND MARKETS\nSoftwood Lumber\nThe Company manufactures a wide variety of softwood lumber products, predominantly from Douglas fir, hemlock, and white fir. The Company produces softwood studs in several species, generally as 2x4 or 2x6 lumber in lengths of 8 to 10 feet. The Company also makes dimension softwood lumber in a wide range of widths and thicknesses in lengths from 6 to 26 feet. Softwood lumber accounted for 84% of net sales in fiscal 1995, 83% in fiscal 1994, and 78% in fiscal 1993.\nThe Company sells softwood lumber to a large number of customers, primarily distribution centers, wholesalers and directly to large retailers. Softwood lumber is used in a variety of applications, including residential and commercial construction, packaging, and industrial uses.\nOther Products\nThe Company produces a small quantity of hardwood lumber in sizes targeted principally for the furniture and cabinet industries. Wood chips, a by-product of the manufacturing process, are sold principally to pulp and paper manufacturers. Wood chips and other by-products accounted for 12% of net sales in fiscal 1995, 11% in fiscal 1994, and 13% in fiscal 1993.\nDistribution and Marketing\nThe Company markets, distributes, and arranges transportation for its lumber products through its wholly owned subsidiary and sales agent, TreeSource, Inc. Through TreeSource, the production capabilities of individual mills are coordinated to meet a broad range of customer needs. TreeSource sells primarily through telephone contacts from its office in Portland, Oregon.\nShipments of wood products are generally made by rail or truck directly from the mill. The Company also makes shipments by barge from certain of its mills with access to port facilities to destinations in Southern California and Hawaii. Exports do not represent a material portion of the Company's net sales.\nThe Company does not attempt to accumulate a large backlog of orders. WTD's general practice is to maintain an order file representing about two to four weeks' production. The filling of orders for certain items, however, may require a substantially longer period of time. The dollar value of the Company's backlog of orders at April 30, 1995 was $6.0 million compared to $7.2 million at April 30, 1994. Backlog on any particular date may not be indicative of the Company's average backlog, or of net sales or the backlog for any succeeding period.\nOne customer accounted for 12% of the Company's net sales during fiscal 1995. The loss of any one customer would not, in management's opinion, have a material adverse impact on the Company and its subsidiaries taken as a whole.\nTimber Supply\nThe Company generally purchases timber and logs in sufficient quantities to match the current operating requirements of its mills. Management attempts to maintain log inventories equal to an average of three to four weeks' operating requirements, except where seasonal or weather factors necessitate larger volumes. The goals of the Company's procurement strategy are to limit the speculative aspects of timber purchasing and to maintain the Company's adaptability to changing lumber market conditions.\nThe Company relies mainly on open market log purchases to supply its raw materials needs. It also purchases timber-cutting contracts (\"timber contracts\"), primarily at public timber sales, and has historically obtained logs to a minor extent from its own fee timberlands. At April 30, 1995, the Company owned a small amount of fee timberlands in the vicinity of various mills. The following table shows the percentages of logs supplied by open market purchases, timber contracts and fee timberlands, and total log footage required:\nYear Ended Open Timber Fee Log April 30, Market Contracts Timber Requirements\n1991 75% 19% 6% 408,000 MBF 1992 88% 8% 4% 338,000 MBF 1993 90% 6% 4% 306,000 MBF 1994 94% 5% 1% 305,100 MBF 1995 95% 5% -- 317,100 MBF\nMBF - Thousand Board Feet\nThe availability and cost of timber and logs have been, and should continue to be, influenced by a variety of factors, including demand by competitors and exporters, the environmental and harvest policies of federal and state agencies, and, in the long term, the level of reforestation. For further discussion of current industry conditions relating to timber supply, see the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nEmployees\nThe Company and its subsidiaries had approximately 1,100 employees at July 10, 1995. The Company believes that its relations with employees are good. The Company provides its employees with health insurance, paid holidays and vacation time, and maintains an IRC 401(k) retirement savings plan.\nEnvironmental Regulation\nThe Company is subject to federal, state and local waste disposal and pollution control regulations, including air, water and noise pollution, which have required, and are expected to continue to require, additional operating and capital expenditures. The Company believes that it is in substantial compliance with all existing regulations and orders. During fiscal 1995, the Company incurred expenditures of approximately $500,000 for waste disposal and pollution control. Such expenditures are projected to be about $900,000 for fiscal 1996 and $600,000 for fiscal 1997. Various governmental agencies are considering regulations regarding log yard management and disposal of log yard waste. The final regulations in these areas may require material expenditures in the future.\nIndustry Conditions\nThe United States lumber industry is highly sensitive to the condition of the nation's economy and tends to experience poor financial results during general economic downturns. In addition, sales traditionally increase in the spring and summer months and decline during the fall and winter months in response to seasonal building construction cycles. However, in fiscal 1993 and 1994, relatively strong lumber demand occurred in the winter months and relatively weak demand occurred during the spring months. Management believes this situation occurred because lumber buyers, concerned about supply in light of public timber harvest restrictions, made defensive purchases before the traditional spring buying period. In addition, demand in the early part of 1994 was muted by severe winter conditions in the midwestern and eastern portions of the U.S. In fiscal 1995, the Company experienced a more typical winter slowdown in lumber demand. Conditions remained weak in the spring due in large measure to high interest rates, increased lumber imports from Canada and high raw materials costs. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for further discussion.\nCompetition\nThe wood products industry is highly competitive and includes a large number of companies manufacturing relatively standardized products. The principal means of competition in the lumber industry are unit production costs, pricing, product quality, and the ability to satisfy customer needs promptly. The Company feels it competes effectively based on the foregoing factors. Some of WTD's competitors are large, integrated companies with substantially greater total resources than those of the Company. Some of these competitors have a significant base of low-cost fee timberlands and timber contracts. The Company could be at a disadvantage to such competitors since it relies on the open log market to supply the bulk of its raw materials requirements. See the sections entitled \"Timber Supply\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nOn or about January 30, 1991, WTD Industries, Inc. and each of its subsidiaries (see Exhibit 21 for list) filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code. The proceeding was filed in the United States Bankruptcy Court for the Western District of Washington in Seattle (the \"Bankruptcy Court\"). The jointly administered proceeding is entitled: \"In re Sedro-Woolley Lumber Co., WTD Industries, Inc., TreeSource, Inc., et al.\", Case Numbers 91-00707 through 91-00721, 91-00736 through 91-00741, 91-00752 through 91-00756, 91-00773 through 91-00778, and 91-01140 through 91-01149. The Company's Second Amended Joint Plan of Reorganization was confirmed by the Bankruptcy Court on November 23, 1992, effective November 30, 1992.\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\nPrincipal Market\nRegistrant's Common Stock is traded in the over-the-counter market. Quotations are reported on the National Market System of the National Association of Securities Dealers (NASD). The Company's stock trades under the NASDAQ symbol WTDI. The number of holders of record of WTD Industries, Inc. Common Stock at July 10, 1995 was 735. The Company estimates that the total number of its direct and beneficial shareholders is approximately 5,000.\nStock Price and Dividend Information\nFrom December 2, 1991 through March 17, 1994, WTD Common Stock was reported in the Small Cap Issues section of NASDAQ. Since March 18, 1994, the Common Stock of WTD has been included in the NASDAQ National Market System.\nThe following tables show the stock price range or the price quotes, as applicable, for the two years ended April 30, 1995:\nFiscal Year Ended Stock Price Range April 30, 1995 Low High ----------------- ----------------- First Quarter $2.21875 $3.250 Second Quarter $1.953125 $2.750 Third Quarter $1.625 $2.50 Fourth Quarter $1.625 $2.125\nStock Quotes Fiscal Year Ended Bid Ask April 30, 1994 Low High Low High ------------------- ------ ------ ------ ------ First Quarter $1.625 $2.750 $1.750 $2.875 Second Quarter $1.625 $2.125 $1.750 $2.250 Third Quarter $1.625 $2.625 $1.875 $2.750 Fourth Quarter (1) $2.375 $3.875 $2.625 $4.125\nFiscal Year Ended Stock Price Range April 30, 1994 Low High ------------------- ---------- ---------- Fourth Quarter (2) $2.875 $4.750\n(1) Quotes reported for the period February 1, 1994 through March 17, 1994.\n(2) Prices reported for the period March 18, 1994 through April 30, 1994.\nThe share prices shown are those published by the NASD and represent prices between dealers. They do not include retail markups, markdowns, or commissions and, in the case of bid and ask quotes, may not represent actual transactions. Prior to the Company's October 1986 public stock offering, there was no public trading market for its Common Stock.\nWTD does not pay any cash dividends on its Common Stock. The Company's various debt instruments restrict the payment of dividends. See Notes 4 and 6 to Consolidated Financial Statements.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOverview\nOn a quarter-to-quarter basis, the Company's financial results have and will vary widely, due to seasonal fluctuations and market factors affecting the demand for logs, lumber and other wood products. Therefore, past results for any given year or quarter are not necessarily indicative of future results.\nThe industry is subject to fluctuations in sales and earnings due to such factors as industry production in relation to product demand and variations in interest rates and housing starts. Currency fluctuations affect the forest products industry when exchange rates spur log exports and drive up domestic log prices, and when a relatively strong U.S. Dollar encourages imports of lumber from competing countries.\nThe industry is also affected by weather conditions and changing timber management policies. Fire danger and excessively dry or wet conditions temporarily reduce logging activity and may increase open market log prices. Timber management policies of various governmental agencies change from time to time, periodically causing actual or perceived shortages in some areas. These policies change because of environmental concerns, public agency budget issues and a variety of other reasons.\nIt is generally WTD's practice to curtail production at facilities from time to time due to conditions which temporarily impair log flow or when imbalances between log costs and product prices cause the cost of operation to exceed the cost of shutdown. Management believes that WTD's labor practices and compensation systems, as well as a relatively low capital cost in relation to production capacity, give it the flexibility to curtail operations and resume production as conditions warrant. The Company may also permanently close facilities that are determined to lack future profit potential under expected operating conditions.\nIn fiscal 1995, demand for U.S. lumber experienced a protracted decline. This appears to be primarily the result of two factors. First, mortgage interest rates continued rising from about 7% in January 1994 to a high of 9.2% in December 1994. This rise had a negative impact on U.S. lumber demand during the second half of the Company's 1995 fiscal year. Second, a widening gap in the exchange rate between the U.S. Dollar and the Canadian Dollar, combined with government-subsidized logs in Canada costing substantially less than those in much of the U.S., encouraged imports of lumber from Canada. The combination of reduced domestic demand and increased imports caused an overall 10% reduction in the Company's fiscal 1995 lumber prices when compared to those of the prior year, and an 18% decline in prices in the second half of fiscal 1995 when compared to the same period in 1994. Although a resurgent paper market led to substantial chip price increases in the second half of fiscal 1995, this also helped to maintain higher log prices. Log pricing also remained high in relation to the domestic lumber market because of strong export log demand due in part to a strong Japanese Yen. As a result of these factors, the percentage decline in lumber prices for the year ended April 30, 1995 was approximately double the percentage decline in the Company's log costs. This caused a 48% decline in gross margins in fiscal 1995.\nThe Company curtailed operations in response to these weak market conditions. Reduced operations at selected mills and temporary curtailments at others will continue until operating conditions improve.\nRaw Materials\nRaw materials comprise the majority of the cost of products sold by the Company. The Company depends principally on open market log purchases for its raw materials needs. WTD's log inventory policy is to maintain, where possible, a supply equal to three to four weeks of production.\nDuring the 1980's, public timber accounted for a significant portion of the supply used by the forest products industry in the Pacific Northwest. On June 22, 1990, the northern spotted owl was listed by the U.S. Fish and Wildlife Service as a threatened species in Oregon, Washington and Northern California. This required the U.S. Forest Service (USFS) and Bureau of Land Management (BLM) to develop plans to protect the owl's habitat, primarily in old-growth timber, by limiting timber harvests on public lands in the Pacific Northwest. This decision resulted from many years of controversy and litigation surrounding the harvest of \"old-growth\" timber in Oregon, Washington and Northern California. Since that time, new controversies surrounding ecosystem management, biological diversity, and species such as the marbled murrelet and various strains of wild salmon, have caused the USFS and BLM to further limit timber harvests.\nThe USFS and BLM have proposed new policies regarding logging on public lands that would reduce public timber harvests to 20% to 30% of the 1980's harvest levels. Programs have also been proposed in Congress to increase the harvest of diseased timber. However, implementation of such plans have been delayed by industry and preservationist litigation. This will extend the period before implementation can occur, and may require significant changes to the proposed rules.\nDuring fiscal years 1993, 1994 and 1995, the Company operated most of its mills on a one-shift basis, typically using logs purchased on the open market from industrial and non-industrial private land owners. The ability to maintain the present level of operations at the Company's mills depend on a continuing supply of logs from these private sources. The Company's ability to increase production above present levels would be enhanced by an increased availability of timber from public lands in the Northwest.\nThe sharp reduction in available timber in the Pacific Northwest contributed to increased open market log costs since the late 1980's. However, log costs have stabilized, although at much higher levels, in the Company's last two fiscal years. The Company has generally been able to obtain sufficient raw materials for its mills from private sources at prices which ensure a gross margin. However, management anticipates that uncertainty associated with timber supply issues, combined with a continued lack of significant public timber sale activity, may contribute to further log price volatility. Log and lumber markets may continue to experience rapid changes in values due to actual and perceived market conditions throughout the Company's 1996 fiscal year, which may sometimes result in inconsistent relationships between log and lumber prices. These changes could result in large swings in the gross margin on lumber produced. The long-term impact of this issue cannot be predicted at this time.\nYearly Comparisons\nThe following table compares certain income and expense items as a percentage of net sales, and the period-to-period percentage change for each item:\nEffective November 30, 1992, the Company and each of its subsidiaries reorganized under Chapter 11 of the Federal Bankruptcy Code and made distributions under its Plan of Reorganization (the \"Plan\").\nComparison of 1995 to 1994\nNet sales for the year ended April 30, 1995 decreased by $3.1 million (1 percent) from the year ended April 30, 1994. This decrease was mainly the result of a 10 percent decrease in lumber prices, partially offset by a 5 percent increase in lumber production, a 6 percent increase in chip production and a 7 percent increase in chip prices.\nGross profit in fiscal 1995 was 4.6 percent of sales versus 8.8 percent of sales in fiscal 1994. Lumber prices received by the Company during fiscal 1995 were, on average, 10 percent lower than in fiscal 1994, while the Company's log costs were, on average, only 3 percent lower than in the prior year.\nSelling, general and administrative (SG&A) expenses in the year ended April 30, 1995 decreased by $2.1 million (17 percent) from those of a year earlier. This decrease was the result of lower profit-sharing bonus payments resulting from a lower level of pretax profits, as well as from ongoing efforts to reduce overhead expenses. SG&A expenses were 3.8 percent of sales in fiscal 1995 versus 4.5 percent of sales in fiscal 1994.\nReorganization credits in fiscal 1995 primarily reflect the reduction of certain valuation and holding cost reserves associated with the Company's remaining non-core assets. Reorganization credits in fiscal 1994 primarily reflect gains recognized on the sale of idle assets. See Note 7 to Consolidated Financial Statements.\nInterest expense in the year ended April 30, 1995 was $0.6 million below that incurred in the year ended April 30, 1994. This decrease was the result of both scheduled and voluntary reductions of debt.\nThe Company's tax benefit in fiscal 1995 was 290 percent of its pretax loss, pursuant to the provisions of SFAS Number 109. See Note 5 to Consolidated Financial Statements.\nComparison of 1994 to 1993\nNet sales for the year ended April 30, 1994 increased by $31.2 million (13 percent) from the year ended April 30, 1993. This increase was mainly the result of a 23 percent increase in lumber prices and a 2 percent increase in lumber production, partially offset by a 10 percent decline in chip production. The chip production decrease from the prior year resulted from improved raw materials utilization and less whole log chipping activity.\nGross profit in fiscal 1994 was 8.8 percent of sales versus 8.0 percent of sales in fiscal 1993. Lumber prices received by the Company during fiscal 1994 were, on average, 23 percent higher than in fiscal 1993, while log costs were, on average, 28 percent higher than in the prior year. The Company was able to offset some of the increase in log prices by improving its raw materials utilization by 2 percent.\nSelling, general and administrative (SG&A) expenses in the year ended April 30, 1994 decreased by $0.2 million (1.5 percent) from those of a year earlier. This decrease was the result of ongoing efforts to reduce overhead expenses. SG&A expenses were 4.5 percent of sales in fiscal 1994 versus 5.1 percent of sales in fiscal 1993.\nReorganization credits in fiscal 1994 primarily reflect gains recognized on the sale of idle assets. Reorganization charges in fiscal 1993 primarily reflect professional fees related to the Chapter 11 proceedings, net of interest income on restricted cash and changes in reserve accounts. See Note 7 to Consolidated Financial Statements.\nInterest expense in the year ended April 30, 1994 was $3.7 million above that incurred in the year ended April 30, 1993. In accordance with AICPA Statement of Position 90-7, the Company did not accrue interest between January 30, 1991 and November 30, 1992 on unsecured and under-secured instruments. Interest expense in fiscal 1993 would have been approximately $3.9 million higher if interest had been accrued for the entire fiscal year under the terms of the obligations issued pursuant to the Plan.\nThe Company's tax provision in fiscal 1994 was 24 percent of pretax income, pursuant to the provisions of SFAS Number 109. In accordance with APB 11, the Company in fiscal 1993 recorded a tax provision at statutory rates and an offsetting extraordinary credit due to net operating loss carryforward utilization. See Notes 5 and 7 to Consolidated Financial Statements.\nIn fiscal 1993 the Company recognized an extraordinary gain (before tax effect) on debt restructure of $19.8 million as a result of distributions under the Plan. See Note 7 to Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nAt April 30, 1995, the Company had net working capital of $33.7 million, or $11.1 million less than at April 30, 1994. The working capital decrease was primarily the result of capital spending, scheduled principal payments and voluntary prepayments of certain debts, and dividends paid on the Company's Series A preferred stock, offset by operating activity and the return of deposits held to secure certain obligations.\nCash and cash equivalents decreased by $2.1 million during the year ended April 30, 1995, to $6.0 million at year-end. Approximately $14.3 million of cash was provided by operations. About $9.0 million was used to repay various debt obligations. The Company also paid $2.2 million in dividends to holders of its Series A preferred stock.\nDuring fiscal 1995, the Company spent $6.5 million for capital improvements to its facilities. Capital spending for the year ending April 30, 1996 is currently projected to be approximately $3.5 million. The Company had no material commitments for capital additions at April 30, 1995.\nDuring fiscal 1995, the Company entered into bonding agreements for its timber acquisition and workers' compensation self-insurance (WCSI) activities. Such bonding allowed the return of approximately $2.1 million in cash deposits made to secure its timber and WCSI activities.\nThe Company does not have a credit facility for working capital and therefore relies on cash provided by its operations to fund its working capital needs. There is no assurance that such cash will be sufficient to fund the Company's operations. Substantially all of the Company's assets are pledged to secure various debt obligations.\nThe Company's Credit and Security Agreement dated as of November 30, 1992 contains certain covenants, including the maintenance of prescribed levels of tangible net worth and adjusted cumulative operating income (as defined). See Note 4 to Consolidated Financial Statements. At April 30, 1995 the Company's tangible net worth was $19.3 million compared to $10 million required by the covenant. At that same date, the Company's adjusted cumulative operating income was $24.1 million, compared to $20.0 million required. The fiscal 1995 results and the expectation of results for the first quarter of fiscal 1996 were such that the Company negotiated an amendment to the tangible net worth and adjusted cumulative operating income covenants as of May 1, 1995. The required level of tangible net worth increases to $15 million for the period from May 1, 1995 through October 31, 1995, decreases to $13.5 million from November 1, 1995 through April 30, 1996, and increases to $15.0 million from May 1, 1996 through April 30, 1998. The covenant originally required maintenance at the $15 million level for the period May 1, 1995 through April 30, 1998. The required level of adjusted cumulative operating income increases to $22.5 million at January 1, 1996, to $27.5 million at May 1, 1996 and to $35.0 million at May 1, 1997. The covenant originally required maintenance at the $33 million level from August 1, 1995 through April 30, 1996, $40 million during fiscal 1997, and $50 million for fiscal 1998. During the year ended April 30, 1995, the Company's adjusted cumulative operating income increased by $3.2 million despite a pretax loss of $1.9 million. Improved operating results will be necessary for the Company to remain in compliance with its Credit and Security Agreement.\nThe Company has no floating rate debt, but the dividend rate on its Series A preferred stock varies based on Bank of America's prime rate in effect at the time the dividends are declared. Based on the prime rate in effect at July 10, 1995, annual preferred dividends would increase by about $0.2 million from the amount incurred in the year ended April 30, 1995.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data required by this item are listed in Item 14 of Part IV of this report which begins at page 26.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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:\nName Age Position H. Raymond Bingham 49 Director Scott Christie 46 Director Bruce L. Engel 54 Director and President L. Robert Hoffman 42 Vice President David J. Loftus 53 Treasurer K. Stanley Martin 53 Director, Vice President- Finance and Chief Financial Officer Robert J. Riecke 45 Director, Vice President- Administration, General Counsel and Secretary John C. Stembridge 36 Vice President-Sales and Marketing James R. Wilson 45 Vice President-Timber William H. Wright 60 Director\nThe composition of the Board of Directors of the Company is determined by Article XII of the Company's Second Amended Joint Plan of Reorganization (the \"Plan\"). The Plan provides that from its Effective Date until the Company's 1995 annual meeting of shareholders, the Board of Directors of the Company shall consist of seven positions, including six that existed prior to the Effective Date, and the seventh to be filled by certain creditors of the Company. Mr. Howard E. Leppla was named as director by these creditors. Mr. Leppla resigned his directorship, effective July 6, 1995. At its annual meeting in calendar year 1995, the Board seats held by Mr. Bingham and Mr. Christie will be filled by election of the shareholders. The seat vacated by Mr. Leppla will also be filled if a suitable candidate is identified for nomination prior to the Annual Meeting of Shareholders in September 1995. At its annual meeting during calendar year 1996, the remaining four Board seats will be filled by election of the shareholders. In the event the Company fails to make a certain number of scheduled dividend payments or if a certain financial ratio covenant violation has occurred and is continuing on its Series A preferred stock, holders of such stock may, under the circumstances and in the manner provided in the Company's Fourth Restated Articles of Incorporation, elect a majority of the Board of Directors by replacing incumbent Board members or increasing the size of the Board.\nH. Raymond Bingham has been a director of the Company since 1988. He is currently executive vice president-chief financial officer of Cadence Design Systems, Inc., a manufacturer of electronic design software. Mr. Bingham was formerly executive vice president and chief financial officer of Red Lion Hotels and Inns, a Vancouver, Washington based hotel chain, a position he held until 1993. Mr. Bingham was also formerly managing director of Agrico Overseas Investment Company where he was in charge of development of industrial projects.\nScott Christie has been a director of the Company since 1988. Mr. Christie is currently general partner of Christie Capital Management. From 1987 until 1994, Mr. Christie was engaged as an investment advisor for his own account and the account of other individuals. From 1983 until 1987 Mr. Christie was senior vice president of Kidder, Peabody & Co. Incorporated, an investment banking firm. Mr. Christie headed Kidder, Peabody's underwriting team for the Company's initial public offering and 1987 debenture offering.\nBruce L. Engel, the Company's founder, has been president and a director of the Company since its inception. Mr. Engel, a graduate of the University of Chicago Law School, practiced business and corporate law, including representation of clients in the wood products industry, from 1964 to 1984. Mr. Engel became engaged in sawmill operations in 1981 with the acquisition of a mill in Glide, Oregon, now owned by a subsidiary of the Company. Mr. Engel is involved in various other businesses. Mr. Engel is president and a director of Encore Group, Inc. Mr. Engel is a former executive officer of Kimber of Oregon, Inc., a company which filed a petition under Chapter 7 of the U.S. Bankruptcy Code in January 1991.\nL. Robert Hoffman is vice president of the Company, a position held since January 1988. Mr. Hoffman is responsible for financial reporting and other accounting matters for the Company. From 1985 to 1988, Mr. Hoffman was an assistant vice president specializing in acquisitions and business development for PacifiCorp's international telecommunications subsidiaries. From 1984 to 1985, he was manager of corporate planning for PacifiCorp and from 1983 to 1984 was director of financial services for Nerco, Inc., a company engaged in mining and resource development operations. Mr. Hoffman's earlier experience includes logging and manufacturing management responsibilities for Simpson Timber Company.\nDavid J. Loftus was appointed treasurer of the Company in October 1993 and continues to serve as vice president-finance of TreeSource, the Company's marketing subsidiary, a position he has held since May 1986. As treasurer, Mr. Loftus is primarily responsible for cash management matters and credit and banking relationships. For the eight years prior to joining TreeSource, Mr. Loftus served as the assistant treasurer for a publicly-traded company with operations in the forest products industry.\nK. Stanley Martin is vice president-finance of the Company, a position held since September 1983, and has been chief financial officer since April 1991. Mr. Martin has been a director of the Company since January 1994. Mr. Martin is responsible for all financial affairs of the Company. For the eleven years prior to 1983, Mr. Martin served as a financial officer for publicly-traded companies having all or a substantial portion of their operations in the forest products industry. Mr. Martin is a certified public accountant.\nRobert J. Riecke became vice president-administration of the Company in May 1989, has been general counsel of the Company since January 1987, assistant secretary from March 1983 until January 1994, and a director of the Company since March 1986. Mr. Riecke was named corporate secretary in January 1994. Mr. Riecke has primary responsibility for the Company's legal, risk management, environmental compliance, investor relations, and human resources functions. From 1976 through 1986, Mr. Riecke was in private law practice. Since 1983, Mr. Riecke has devoted much of his professional endeavors to legal matters relating to the Company and its subsidiaries. Mr. Riecke is a graduate of the University of Illinois School of Law.\nJohn C. Stembridge was appointed vice president-sales and marketing of the Company in February 1995. Mr. Stembridge joined TreeSource, the Company's marketing subsidiary, in 1989 and continues to serve as its vice president and general manager, a position he has held since June 1991. Mr. Stembridge has primary responsibility for managing all aspects of the Company's lumber sales and transportation. For the nine years prior to joining TreeSource, Mr. Stembridge was involved in domestic and export lumber sales, primarily with North Pacific Lumber Co.\nJames R. Wilson was appointed vice president-timber of the Company in October 1993. Mr. Wilson has primary responsibility for the Company's timber supply program. Prior to his present position, Mr. Wilson served at both mill and corporate levels of WTD Industries commencing in February 1992. Prior to 1992, Mr. Wilson served as general manager of Estacada Lumber Company, a division of RSG Forest Products. From 1973 to 1984, Mr. Wilson was involved in all phases of the wood products industry with Crown Zellerbach Corporation.\nWilliam H. Wright has been a director of the Company since April of 1992. Mr. Wright has held a variety of management positions in the forest products industry since 1957. He is currently president of Heartwood Consulting Service, which advises forest products clients. From 1989 until 1994 he was president and chief executive officer of Dee Forest Products Inc., a manufacturer of hardboard and related products. From 1984 to 1989 Mr. Wright was general manager of Stevenson Co-Ply Inc., a manufacturer of veneer and plywood.\nReporting of Securities Transactions\nUnder the federal securities laws, officers and directors of the Company and persons holding more than 10 percent of the Company's Common Stock are required to report, within specified monthly and annual due dates, their initial ownership in the Company's Common Stock and all subsequent acquisitions, dispositions or other transfers of beneficial interests therein, if and to the extent reportable events occur which require reporting by such due dates. The Company is required to describe in this section whether, to its knowledge, any person required to file such a report may have failed to do so in a timely manner.\nBased solely on its review of the copies of such forms received by it and written representations that no other reports were required for those persons, the Company believes that, during fiscal 1995, all Section 16(a) filing requirements applicable to its executive officers, directors and owners of more than 10 percent of the Company's Common Stock were complied with.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table shows the cash and non-cash compensation paid by the Company for the last three fiscal years to the chief executive officer and the four other most highly compensated executive officers.\nOPTION GRANTS IN LAST FISCAL YEAR\nNo executive officer named above received option grants during the fiscal year ended April 30, 1995.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table provides information on option exercises for the last fiscal year by the named executive officers and the value of such officers' unexercised options as of April 30, 1995:\nBenefits\nThe Company maintains an IRC Section 401(k) retirement savings plan under which employees, including executive officers, are permitted to make salary deferral contributions. Executive officers are not entitled to employer matching contributions pursuant to this plan. The Company pays the costs of administration of the retirement savings plan.\nCompensation of Directors\nEach of the Company's outside directors is paid an annual retainer of $15,000 for attending up to six Board meetings, plus $750 for each additional meeting attended and $225 for each telephone conference meeting attended or written consent minutes executed. Directors who are also employees of the Company do not receive additional compensation for their services as directors. Pursuant to the Company's Stock Option Plan, directors who are not employees of the Company each received initial option grants with respect to 35,000 shares of the Company's Common Stock and are entitled to receive option grants with respect to 10,000 shares in subsequent fiscal years to a maximum aggregate of 80,000 shares. Each director was granted options with respect to 10,000 shares in fiscal 1995.\nExecutive Bonuses\nMonthly discretionary bonuses are paid to the Company's executive officers, as well as other management and administrative employees, pursuant to the Company's profit sharing bonus plan. The bonuses are based upon net pretax profits and are generally allocated according to base salary level. Bonuses paid to executive officers for services rendered to the Company during the year ended April 30, 1995 are included in the amounts shown in the \"Summary Compensation Table.\"\nStock Option Plan\nIn July 1986 the Company adopted a Stock Option Plan (\"Option Plan\"). The Option Plan was amended by the Company's Chapter 11 Plan of Reorganization to (a) increase to 1,245,900 the number of shares available for grant, (b) provide for the grant of nonqualified stock options, as well as incentive stock options, (c) permit nonemployee agents, consultants, and independent contractors to participate in the Option Plan and (d) provide automatic initial and annual option grants in defined amounts to the Company's non- employee directors. The purpose of the Option Plan is to motivate special achievement by the Company's officers and key employees by encouraging them to acquire an equity interest in the Company.\nCompensation Committee Interlocks and Insider Participation\nThe Compensation Committee of the Board of Directors is composed of Mr. Bingham, Mr. Christie, and Mr. Wright. The Compensation Committee determines compensation for executive officers, including executive officers who are directors. It also administers the Company's Option Plan.\nBoard Compensation Committee Report on Executive Compensation\nThe Compensation Committee is composed of three independent non-employee directors.\nThe Compensation Committee is responsible for recommending to the full Board of Directors, for its approval, the base compensation for all executive officers. Executive officers who serve on the Company's Board of Directors do not participate in any deliberations or decisions regarding their own compensation. The Compensation Committee receives recommendations from the Chief Executive Officer regarding appropriate levels of base compensation for the other executive officers.\nAwards to executive officers (and other employees) under the Company's 1986 Amended and Restated Stock Option Plan are made by the Compensation Committee acting as an Administrative Committee.\nThe Company's executive officer compensation policies are designed to attract, motivate and retain senior management by providing an opportunity for overall competitive compensation based on an adequate base compensation amount and participation in a profit based bonus system in effect for all salaried employees of the Company.\nThe profit sharing component of the overall compensation system is designed to reward all salaried employees, including executive officers, in relation to the Company's monthly performance and to encourage salaried employees at all levels of the Company to work together for the common goal of maximizing profits. Salaried employees at the WTD corporate level (including all executive officers) receive 10% of monthly consolidated pre-tax profits, allocated according to base salary level.\nIt is the Company's practice to participate in and use, as a basis for comparison, an analysis of executive compensation in the Northwest prepared by the compensation consulting group of Milliman & Robertson, Inc. This analysis is useful in establishing base salary levels and monitoring overall compensation levels as compared to other publicly-traded companies of similar size. Executive officers' compensation paid during fiscal 1995, with respect to both base and total cash compensation, was below the median levels published in the 1994\/1995 Milliman & Robertson compensation survey of all industries.\nThe Company also uses long term stock-based incentive opportunities in the form of options to purchase the Company's Common Stock. The Company's Amended and Restated 1986 Stock Option Plan provides for the grant of stock options to employees of the Company to purchase shares of the Company's Common Stock subject to minimum exercise price limitations imposed by the Company's Plan of Reorganization. Stock option awards are determined on a discretionary basis by the Compensation Committee. No stock options were awarded to executive officers during the 1995 fiscal year.\nStock options remaining available for grant to employees (including executive officers) have a minimum exercise price of the greater of 85% of the fair market value per share of the Company's stock at the time of grant or $3.00 per share.\nThe Committee believes that stock-based performance compensation arrangements are beneficial in aligning management's and shareholders' interests in the advancement of shareholder value.\nWTD provides the same group life and health insurance coverage to executive officers as other employees and requires all employees, including executive officers, to pay approximately 25% of health insurance premiums by payroll deduction.\nThe Company allows its executive officers and all other employees to contribute a percentage of their compensation to the Company-sponsored 401(k) Retirement Savings Plan. Executive officers and other salaried employees are not generally entitled to matching contributions.\nNeither the executive officers nor other employees are covered by any other Company-sponsored retirement plans.\nChief Executive Officer Compensation\nAll of the policies described above apply to Mr. Engel's compensation. No additional benefits or requirements specifically apply to the chief executive officer.\nMr. Engel's 1995 base salary of $300,000 is below the median for chief executive officers of comparably sized public companies, as published by the Milliman & Robertson compensation survey. Mr. Engel received a cash bonus of $48,200 during fiscal 1995 under the profit sharing plan described above, reflecting profitable operations during the first half of the fiscal year. Mr. Engel's bonus and total compensation amounts were below the published median levels.\nStock Performance Graph\nThe stock performance graph required by this item is included under the caption Executive Compensation in the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table shows beneficial ownership of the Company's Common Stock by each director, shareholders known to the Company to beneficially own more than 5 percent of the Common Stock, by the executive officers named in the Summary Compensation Table, and all directors and officers as a group. Except as otherwise specifically noted, each person noted below has sole investment and voting power with respect to shares indicated.\n(1) As determined by reference to the beneficial owner's most recent 13 D or G filing. (2) Mr. Leppla shares with his spouse Mary Leppla voting and investment power as to 608,009 shares beneficially owned. Includes 41,250 shares reserved for issuance to Mr. Leppla under stock options exercisable within 60 days of July 10, 1995. Mr. Leppla was a director of the Company from November 30, 1992 until his resignation on July 6, 1995. (3) Beneficial Ownership is calculated as of July 10, 1995. (4) Includes shares reserved for issuance under options exercisable within 60 days of July 10, 1995 as follows: Mr. Bingham 55,000; Mr. Christie 55,000; Mr. Engel 230,400; Mr. Martin 24,200; Mr. Riecke 27,400; Mr. Stembridge 6,000; Mr. Wilson 6,000; and Mr. Wright 55,000. (5) Mr. Engel shares with his spouse Teri E. Engel voting and investment power as to 386,040 shares beneficially owned. See Note 4 above for details of individual option rights. Certain of Mr. Engel's shares are pledged to third parties in connection with certain personal obligations.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements Page\nThe following consolidated financial statements of the Registrant and its subsidiaries are contained in this report:\nReport of Independent Certified Public Accountants 31\nConsolidated Statements of Income for the Years Ended April 30, 1995, 1994 and 1993 32\nConsolidated Balance Sheets at April 30, 1995 and 1994 33\nConsolidated Statements of Cash Flows for the Years Ended April 30, 1995, 1994 and 1993 35\nConsolidated Statement of Changes in Stockholders' Equity for the Years Ended April 30, 1995, 1994 and 1993 36\nNotes to Consolidated Financial Statements 37\n(a) (2) Financial Statement Schedules\nThe schedules called for under Regulation S-X are not submitted because they are not applicable, are not required, or because the required information is not material or is included in the financial statements or notes thereto.\n(a) (3) Exhibit Index Page\n2.1 Final form of Registrant's Second Amended Joint Plan of Reorganization dated October 5, 1992, filed with the United States Bankruptcy Court for the Western District of Washington. (1)\n3.1 Fourth Restated Articles of Incorporation of the Registrant adopted November 27, 1992. (1)\n3.2 Second Restated Bylaws of the Registrant effective November 27, 1992. (9)\n4.2 Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle-First National Bank, and Bank of America Oregon. (2)\n4.2.1 Amendment dated as of October 18, 1994 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle- First National Bank, and Bank of America Oregon. (10)\n4.2.2 Amendment dated as of January 27, 1995 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle- First National Bank, and Bank of America Oregon. 52\n4.2.3 Amendment dated as of May 1, 1995 to Credit and Security Agreement dated as of November 30, 1992, between Registrant and Principal Mutual Life Insurance Company, Aetna Life Insurance Company, The Northwestern Mutual Life Insurance Company, Chemical Bank, Seattle- First National Bank, and Bank of America Oregon. 56\n4.3 Indenture dated as of November 30, 1992, between Registrant and State Street Bank and Trust Company, as Trustee, with respect to 8% Senior Subordinated Notes due 2005. (3)\n10.1 Amended and Restated 1986 Stock Option Plan dated December 30, 1992. (4)\n10.1.2 Form of Stock Option Agreement for directors of Registrant. (9)\n10.1.3 Form of Stock Option Agreement for executive officers of the Registrant. (9)\n10.2 General Indemnity Agreement dated March 29, 1984, among the Registrant, Bruce L. Engel (\"Engel\"), Teri E. Engel and Employers Insurance of Wausau (\"Wausau\") and other related parties and an Agreement dated June 25, 1986, among Wausau, the Registrant, Engel and other related parties. (5)\n10.2.1 Letter dated November 18, 1986, from Wausau to the Registrant and General Agreement of Indemnity dated January 19, 1987, among Wausau, the Reg- istrant, Bruce L. Engel and Teri E. Engel. (6)\n10.3 Form of Indemnification Agreement for directors, officers and certain employees effective January 30, 1991. (9)\n10.4 Description of Management Profit-Sharing Bonus Plan. (5)\n10.61 WTD Industries, Inc. Retirement Savings Plan and Trust dated as of May 1, 1989. (7)\n10.62 Amendment No. 1 to WTD Industries, Inc. Retirement Savings Plan and Trust Effective May 1, 1989. (8)\n10.63 Amendment No. 2 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted May 30, 1991. (8)\n10.64 Amendment No. 3 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted June 26, 1992. (8)\n10.65 Amendment No. 4 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted April 30, 1993. (9)\n10.66 Amendment No. 5 to WTD Industries, Inc. Retirement Savings Plan and Trust adopted December 28, 1994. (11)\n12.2 Computation of Registrant's Net Income (Loss) to Average Total Assets. 58\n12.3 Computation of Registrant's Net Income (Loss) to Average Stockholders' Equity (Deficit). 59\n12.4 Computation of Registrant's Average Stockholders' Equity (Deficit) to Average Total Assets. 60\n21 Subsidiaries of the Registrant (list updated as of July 10, 1995). 61\n23 Consent of Independent Certified Public Accountants. 62\n(1) Incorporated by reference to the exhibit of like number to the Registrant's report on Form 8-K dated November 23, 1992.\n(2) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1992, dated December 14, 1992, previously filed with the Commission.\n(3) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1993, dated March 15, 1993, previously filed with the Commission.\n(4) Incorporated by reference to exhibit 6.0 to the Registrant's Registration Statement on Form S-8 (No. 33- 62714) filed with the Commission on May 14, 1993.\n(5) Incorporated by reference to the exhibit of like number to the Registrant's Registration Statement on Form S-1 (No. 33-7389) filed with the Commission on July 21, 1986, as amended by Amendment Nos. 1 through 3 thereto filed with the Commission on September 3, 1986, October 14, 1986 and October 24, 1986, respectively.\n(6) Incorporated by reference to the exhibit of like number to the Registrant's Registration Statement on Form S-1 (No. 33-12644) filed with the Commission on March 16, 1987, as amended by Amendment Nos. 1 and 2 thereto filed with the Commission on April 1, 1987 and April 24, 1987, respectively.\n(7) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1989, previously filed with the Commission.\n(8) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1992, previously filed with the Commission.\n(9) Incorporated by reference to the exhibit of like number to the Registrant's annual report on Form 10-K for the year ended April 30, 1993, previously filed with the Commission.\n(10) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended October 31, 1994, previously filed with the Commission.\n(11) Incorporated by reference to the exhibit of like number to the Registrant's quarterly report on Form 10-Q for the quarter ended January 31, 1995, previously filed with the Commission.\nExcept for instruments already filed as exhibits to this Form 10-K, the Registrant agrees to furnish the Commission upon request a copy of each instrument with respect to long-term debt of the Registrant and its consolidated subsidiaries, the amount of which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.\nOther exhibits listed in Item 601 of Regulation S-K are not applicable.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed 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.\nWTD Industries, Inc. (Registrant)\nBy: s\/ Bruce L. Engel - ----------------------------------- Bruce L. Engel President July 14, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\ns\/ Bruce L. Engel s\/ K. S. Martin - ------------------------------ ------------------------------ Bruce L. Engel K. Stanley Martin President Vice President-Finance (Principal Executive Officer) (Principal Financial and and Director Accounting Officer) and Director\ns\/ H. Raymond Bingham s\/ Scott Christie - ------------------------------ ------------------------------- H. Raymond Bingham, Director Scott Christie, Director\ns\/ William H. Wright s\/ Robert J. Riecke - ------------------------------ -------------------------------- William H. Wright, Director Robert J. Riecke Vice President-Administration and Director\nEach of the above signatures is affixed as of July 14, 1995.\n[MOSS ADAMS LETTERHEAD]\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Shareholders WTD Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of WTD Industries, Inc. and subsidiaries (the \"Company\") as of April 30, 1995 and 1994, and the related consolidated statements of income, cash flows and changes in stockholders' equity, for each of the years in the three-year 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of WTD Industries, Inc. and subsidiaries as of April 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 April 30, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Moss Adams ----------------------------------- MOSS ADAMS\nBeaverton, Oregon June 13, 1995\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation and operations - The consolidated financial statements include the accounts of WTD Industries, Inc. and its wholly owned subsidiaries (hereinafter \"WTD\" or \"the Company\"). All significant intercompany accounts and transactions have been eliminated.\nThe Company operates in one industry segment, the manufacture and sale of softwood and hardwood lumber products, wood chips and other by-products. Most lumber products are sold to wholesalers, distributors or directly to large retailers. The Company's products are used in many applications, including residential and commercial construction, packaging and industrial uses.\nMarket conditions in the housing sector deteriorated during the third and fourth quarters of fiscal 1995. Low lumber prices combined with high log prices created losses for the Company during the fourth quarter, a period in which operating results have been historically strong. The Company curtailed production in response to these weak market conditions. Reduced operations at selected mills and temporary curtailments at others will continue until operating conditions improve.\nThe fiscal 1995 results and the expectation of results for the first quarter of fiscal 1996 were such that management initiated an amendment to its primary debt agreement. This debt agreement was amended as of May 1, 1995, with respect to certain affirmative financial performance covenants. Improved operating conditions will be necessary for the Company to remain in compliance with its primary debt agreement. See Note 4 to Consolidated Financial Statements.\nThe Company's sales are predominantly in the United States; export sales are not material. During the year ended April 30, 1995, the Company had sales to one major customer of $33,346,000, or 12.1% of net sales. During the year ended April 30, 1994, WTD had no sales to any one customer in excess of 10 percent of net sales. The loss of any one customer would not, in the opinion of management, have a material adverse impact on the financial results of the Company.\nTemporary cash investments and trade receivables potentially subject the Company to concentrations of credit risk. 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 institution. The Company reviews a customer's credit history before extending credit and continuously evaluates its accounts receivable. Concentrations of credit risk on trade receivables are limited due to the Company's large number of customers and their widely varying locations. Generally, the Company does not require collateral or other security to support its trade receivables.\nWTD has from time to time utilized futures contracts to minimize the Company's exposure to adverse movements in the log and lumber markets. This activity has not been significant in the past and the Company had no material futures position at April 30, 1995.\nCash and cash equivalents - Financial instruments with a maturity of three months or less are considered to be cash equivalents.\nAccounts receivable - Trade accounts receivable are shown net of allowances for doubtful accounts and discounts of $199,000 and $658,000 at April 30, 1995 and 1994, respectively.\nInventories - Inventories are valued at the lower of cost or market. Cost is determined using the average cost and first-in, first-out (FIFO) methods. A summary of inventory by principal product classification follows (in thousands):\nAPRIL 30, 1995 1994 -------- -------- Logs $ 6,100 $ 11,777 Lumber 10,808 13,818 Supplies 1,196 1,201 -------- -------- $ 18,104 $ 26,796 ======== ========\nAt April 30, 1995 and 1994, $375,000 and $3,094,000, respectively, of log inventory was valued at market, which approximated cost. At both April 30, 1995 and 1994, all lumber inventory was valued at market, which represented reductions of $2,729,000 and $2,511,000, respectively, from cost.\nProperty, plant and equipment - Property, plant and equipment of the Company's facilities are stated at cost. For financial reporting purposes, the Company uses the units-of-production method for computing depreciation over the estimated useful lives of assets, ranging from ten to thirty years for buildings and improvements, and three to ten years for machinery and equipment. When assets are retired or disposed of, cost and accumulated depreciation are reversed from the related accounts and any gain or loss is included as income.\nTimber and timberlands - Timber and timberlands are stated at the lower of aggregate cost or estimated disposal value, less the amortized cost of timber harvested. The portion of the cost attributable to standing timber is charged against income as timber is cut, at rates determined periodically based on the relationship between unamortized timber value and the estimated volume of recoverable timber. The costs of roads and land improvements are capitalized and amortized over their economic lives. The carrying costs of timber, timberlands and related assets are expensed as incurred. The Company classifies timber and timber-related assets as current or long-term assets based upon expected harvest and disposal plans.\nTimber-cutting contracts - The Company purchases timber under various types of contracts. Certain contracts, for which the total purchase price is fixed, are recorded as assets along with the related liability at the date acquired. The remaining contracts, for which the total purchase price depends on the volume of timber removed, are considered to be commitments (as discussed in Note 9) and are not recorded until the timber is removed.\nIncome taxes - Income taxes are provided for transactions in the year in which they are reflected in earnings, even though they may be reported for tax purposes in a different year. The resulting difference between taxes charged to operations and taxes paid is reported as deferred income taxes. Tax credits are recognized in the year utilized, using the flow-through method. Effective May 1, 1993, the Company adopted Statement of Financial Accounting Standard Number 109 \"Accounting for Income Taxes\". No gain or loss was recorded as a result of implementing this pronouncement. See Note 5 to Consolidated Financial Statements.\nAccrued expenses - The following is a summary of the components of accrued expenses (in thousands):\nAPRIL 30, 1995 1994 -------- -------- Payroll and related items $ 5,127 $ 5,442 Freight payable 867 868 Reserve for disputed and unallowed prepetition claims 40 290 Other 1,432 1,346 -------- -------- $ 7,466 $ 7,946 ======== ========\nNOTE 2 - NET INCOME PER SHARE\nThis computation is based on net income less preferred dividends for the period, divided by the weighted average number of shares of Common Stock and equivalents assumed to be outstanding during the period. Anti-dilutive common stock equivalents are excluded from the calculations.\nThe calculations of net income per share for the years ended April 30, 1995, 1994 and 1993 are summarized below (in thousands, except per-share data):\nNOTE 3 - TIMBER, TIMBERLANDS AND TIMBER-RELATED ASSETS\nThe following summarizes the components of timber, timberlands and timber-related assets (in thousands):\nAPRIL 30, 1995 1994 -------- -------- Timber held under contract $ 5,565 $ 6,730 Timber, timberlands and timber deposits 3,353 4,936 Logging roads (at amortized cost) 381 77 -------- -------- $ 9,299 $ 11,743 ======== ========\nTimber and timberlands, long-term $ 705 $ 845 ======== ========\nTimber held under contract is comprised of various public and private timber contracts representing approximately 23 million board feet (MMBF) at April 30, 1995 and 19 MMBF at April 30, 1994. Outstanding obligations relating to these contracts at April 30, 1995 and 1994, were $1,660,000 and $2,292,000, respectively.\nNOTE 4 - LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nAPRIL 30, 1995 1994 -------- --------\nSenior secured debt, bearing interest at 10%; principal payable in quarterly installments of $225 through December 15, 1997, then quarterly installments of $400 through December 15, 1998, then quarterly installments of $1,000 beginning March 15, 1999, and a final payment in December 2004; secured by substantially all assets of the Company not otherwise encumbered. $ 50,523 $ 56,894\nSecured notes, interest at rates from 8.8% to 11%; payable on various dates; secured by various assets. 987 1,931\nPriority notes, $228 payable in fiscal 1996, $29 payable in fiscal 1997, $18 payable in fiscal 1998, plus interest at 8.3%; senior to all other unsecured obligations. 275 468\nUnsecured Senior Subordinated Notes, net of discount of $428 ($624 at April 30, 1994); 8% coupon, effective interest rate of 13.3%; semi-annual interest payments each June 30 and December 31; principal due in full June 30, 2005. 1,048 1,435\nOther unsecured debt, net of discount of $229 ($592 at April 30, 1994); pay- able in equal annual installments of $478; non-interest bearing; effective interest rate of 12.3%. 886 1,797 -------- -------- 53,719 62,525\nLess current maturities (2,298) (1,938) -------- -------- $ 51,421 $ 60,587 ======== ========\nThe Company's primary debt agreement includes covenants for maintaining specified levels of income, cash flow, working capital, and collateral coverage. This agreement also imposes certain restrictions and limitations on capital expenditures, investments, dividend payments, new indebtedness, and transactions with officers, directors, shareholders and affiliates. This debt agreement was amended as of May 1, 1995, with respect to two affirmative financial performance covenants. One covenant requires the Company to maintain tangible net worth of $10 million at April 30, 1995, and the second covenant requires the Company to maintain adjusted cumulative operating income (as defined) of $20 million. At April 30, 1995, the Company's tangible net worth and adjusted cumulative operating income were $19.3 million and $24.1 million, respectively. These debt covenants contain escalation provisions over the term of the agreement. The tangible net worth covenant increased to $15 million at May 1, 1995, declines to $13.5 million at November 1, 1995, and increases to $15 million at May 1, 1996. The adjusted cumulative operating income covenant increases to $22.5 million at January 1, 1996, and $27.5 million at May 1, 1996.\nDuring the year ended April 30, 1995, the Company's adjusted cumulative operating income increased by $3.2 million despite a loss before tax benefit of $1.9 million. See Note 1 to Consolidated Financial Statements.\nIn accordance with the Company's primary debt agreement, mandatory additional prepayments are required if the Company's cumulative operating income exceeds certain specified amounts. No such prepayment will be required for the year ended April 30, 1995.\nFuture minimum repayments under the terms of all of the Company's debt are as follows (in thousands):\n1996 2,298 1997 1,126 1998 1,313 1999 2,447 2000 4,007 thereafter 42,528 -------- $ 53,719 ========\nNOTE 5 - PROVISION FOR INCOME TAXES\nThe income tax provision (benefit) is based on the estimated effective annual tax rate for each fiscal year. The provision (benefit) includes anticipated current income taxes payable or refundable, the tax effect of anticipated differences between the financial reporting and tax basis of assets and liabilities, and the expected utilization of net operating loss (NOL) carryforwards.\nEffective May 1, 1993, the Company adopted Statement of Financial Accounting Standard (SFAS) Number 109, \"Accounting for Income Taxes.\" This statement mandates the asset and liability approach to determining income tax provision or benefit. Deferred income tax benefits and liabilities are recognized for the tax consequences of temporary differences in the carrying value of assets and liabilities for financial reporting and income tax purposes. The cumulative effect of adopting SFAS Number 109 as of May 1, 1993 was not material. The Company's prior year financial statements have not been restated for the provisions of this pronouncement. The federal and state income tax provision consists of the following (in thousands):\nYear Ended April 30, 1995 1994 1993 ------- ------- ------- Income (loss) before income taxes $(1,946) $ 8,324 $ 3,956 ======= ======= ======= Income tax provision (benefit): Federal $(5,052) $ 1,984 $ 1,345 State (594) 40 198 ------- ------- ------- $(5,646) $ 2,024 $ 1,543 ======= ======= =======\nCurrent $(1,384) $ 2,040 $ - Deferred (4,262) (16) - ------- ------- ------- $(5,646) $ 2,024 $ - ======= ======= =======\nThe fiscal 1993 tax provision was calculated at statutory rates and the estimated benefits of net operating loss (NOL) carryforwards were recognized as extraordinary items. The tax benefit of NOL carryforwards in fiscal 1993 includes $7.7 million associated with an extraordinary gain on debt restructure.\nThe income tax provision in fiscal 1993 differs from the amount computed by applying the federal statutory rate principally as a result of state income taxes. The income tax provision in fiscal 1994 differs from the amount computed by applying the federal statutory rate principally as a result of recognizing the tax benefits of NOL carryforwards. The tax provision in fiscal 1995 differs from the amount computed by applying the federal statutory rate principally as a result of elections made under the Internal Revenue Code regarding the calculation and use of NOL carryforwards.\nIn the quarter ended January 31, 1995, the Company recorded current and deferred income tax benefits of $5.4 million associated with elections made by the Company under Internal Revenue Service (IRS) Regulations regarding the calculation and use of NOL carryforwards. These elections required the Company to reduce its federal NOL by approximately $8.2 million and its state NOL by approximately $5.9 million. These reductions relate to interest expense recorded on debts which were converted to equity in the reorganization and taxable income not recognized on the conversion of debt to stock. However, the elections permit the remaining NOL to offset taxable income without annual limitation.\nAccordingly, the Company amended its tax returns for fiscal year 1993 and filed its fiscal year 1994 tax returns to reflect utilization of its remaining federal and state NOL without annual limitation. This results in anticipated refunds of prior year and current year taxes and deposits aggregating approximately $1.9 million, of which $1.45 million had been received as of April 30, 1995. The Company can expect audits of its tax returns by various taxing authorities for the years ending after April 30, 1991. The results of any such examinations could affect the amount of NOL carryforwards available to offset future tax liabilities. The Company's remaining NOL at April 30, 1995 is approximately $18.6 million for federal income tax and $15.9 million for state income tax purposes. These carryforwards expire in 2006 and 2007.\nSFAS Number 109 requires that all current deferred tax assets and liabilities be grouped and reported as one amount and that all noncurrent deferred tax assets and liabilities be grouped and reported as one amount. Classification as current or noncurrent is based upon the classification of the related asset or liability for financial reporting. For deferred tax amounts that do not relate to an asset or liability for financial reporting, classification is to be based upon the expected utilization.\nAt April 30, 1995 and 1994, deferred tax assets and liabilities were comprised of the following (in thousands):\nYear Ended April 30, 1995 1994 -------- --------\nCurrent deferred tax assets: Non-deductible accruals $ 1,741 $ 1,953 Reserves for doubtful accounts and discounts 89 244 -------- -------- Net current deferred tax assets $ 1,830 $ 2,197 ======== ========\nNon-current deferred tax assets: Tax benefit of net operating loss carryforward $ 7,107 $ 11,028 Valuation allowance against tax benefit of net operating loss carryforwards (2,946) (11,028) -------- -------- 4,161 -- Non-current deferred tax liabilities: Differences in depreciation and capitalization of assets for financial reporting and tax purposes (1,713) (2,181) -------- --------\nNet long-term deferred tax assets (liabilities) $ 2,448 $ (2,181) ======== ========\nTotal net deferred tax asset $ 4,278 $ 16 ======== ========\nManagement has assessed the likelihood of utilizing the recorded deferred tax asset related to its NOL carryforwards, including its operating history, the cyclical nature of the industry in which the Company operates, current economic conditions and the potential outcome of any IRS audits. Based upon the above factors, management believes that a valuation allowance of approximately $2.9 million is necessary. Management periodically reviews the above factors and may change the amount of valuation allowance as facts and circumstances dictate.\nNOTE 6 - STOCKHOLDERS' EQUITY\nStockholders' equity at April 30, 1995 consists of the following:\nSeries A preferred stock, $100 per share liquidation preference; 500,000 shares authorized; 270,079 shares issued and outstanding, limited voting rights; cumulative dividends payable quarterly in advance at the prime rate, with a minimum rate of 6% and a maximum rate of 9%; convertible into Common Stock at $7.50 per share after April 30, 1999; redeemable at original issue price plus any accrued dividends at the option of the Board of Directors, in the form of cash or in exchange for senior unsecured debt with 12% coupon. The holders of the Series A preferred stock will be granted voting control of the Company's Board of Directors in the event the Company misses three consecutive quarterly dividend payments, four quarterly dividend payments within twenty-four months or a total of eight quarterly dividend payments.\nSeries B preferred stock, $100 per share liquidation preference; 500,000 shares authorized; 6,111 shares issued and outstanding; limited voting rights; convertible into 212,693 shares of Common Stock; dividends payable only if paid on the Company's Common Stock; redeemable at original issue price plus accrued dividends at the option of the Board of Directors after all Series A preferred stock has been redeemed.\nCommon Stock, no par value; 40,000,000 shares authorized; 11,077,074 shares issued and outstanding. Before giving effect to any shares that might be issued pursuant to the management incentive stock option plan or conversion of any Series A preferred stock, the total number of common shares would increase to 11,289,767 shares if the remaining outstanding Series B preferred stock is converted to Common Stock.\nNOTE 7 - EXTRAORDINARY ITEMS AND REORGANIZATION CHARGES (CREDITS)\nIn fiscal 1993, the Company reorganized under Chapter 11 of the Federal Bankruptcy Code and recognized a gain on its debt restructure of $12,102,000 and a tax benefit related to the use of net operating loss carryforwards of $9,243,000. These items, aggregating $21,345,000, were recognized as extraordinary items. In conjunction with the restructuring, management reduced the value of assets associated with certain facilities to their estimated net realizable value and established certain reserves for expenses related to the cost of holding and disposing of such facilities. In fiscal years 1993, 1994 and 1995, the reorganization charges and credits related to the Company's sale of idle assets and settlement of obligations at amounts which varied from their original estimates.\nNOTE 8 - STOCK OPTIONS, WARRANTS AND EMPLOYEE BENEFIT PLANS\nEffective December 30, 1992, the Company's Stock Option Plan (\"Option Plan\") was amended and restated, and new options were granted. Non-qualified stock options may be granted to directors, independent contractors, consultants, and employees, and incentive stock options may be granted to employees, to acquire up to 1,245,900 shares of Common Stock. Options may be granted for a term not to exceed 10 years and are not transferable other than by will or the laws of descent and distribution. The Option Plan terminates on July 11, 1996, or such earlier time as the Board of Directors may determine. The Option Plan provides for incremental vesting based upon the optionee's period of service with the Company and is administered by the Compensation Committee of the Board of Directors.\nFollowing is a summary of the activity with respect to the Option Plan for the years ended April 30, 1993, 1994 and 1995:\nOptions for 312,700 shares remain available for grant. The balance of the options will have an exercise price of the greater of $3.00 per share or an amount per share determined by the Plan Administrator, but not less than 85 percent of the fair market value of the Company's Common Stock on the date of grant.\nThe Company maintains a weekly discretionary bonus program for its mill workers based on the performance of each production shift at individual mills. The bonus program for mill workers is designed to reward productivity, safety and regular attendance. The Company also has a monthly discretionary profit sharing bonus program for management and administrative employees. Profit sharing bonuses are based on net pre-tax profits and are generally allocated according to base salary level. Amounts paid under all bonus programs were approximately $6,800,000; $8,500,000; and $7,400,000 in fiscal years 1995, 1994 and 1993, respectively.\nThe Company maintains a 401(k) Retirement Savings Plan. Under the plan, eligible participants may contribute 2 percent to 20 percent of their compensation. The Company matches contributions of employees participating in the Production\/Safety\/Attendance Bonus program on a monthly basis in an amount as determined from time to time by the Board of Directors. Salaried employees are not generally entitled to matching contributions. During the years ended April 30, 1995, 1994 and 1993 the Company incurred expenses for matching contributions and plan administration of $377,000; $391,000; and $402,000; respectively. Company contributions to this plan are funded on a current basis.\nNOTE 9 - COMMITMENTS AND CONTINGENCIES\n(a) Timber commitments - At April 30, 1995, the Company had contracts to purchase approximately 27.9 MMBF of timber from the U.S. Forest Service and others for an estimated stumpage cost of $8.9 million. Deposits were made on these contracts and additional payments are required as timber is removed. Under current lumber market conditions, the Company may sustain a loss in conversion of certain of these contracts. Because of the volatility of product prices, the long-term nature of these contracts and the options of selling logs, or processing them into lumber, it is not possible to estimate potential losses, if any, that might be incurred under these contracts at April 30, 1995. The expiration dates of the contracts are as follows:\nFootage Stumpage Year Ending April 30, MMBF Cost -------- ----------- 1996 7.1 $1,289,000 1997 15.2 5,060,000 1998 5.6 2,563,000 -------- ------------ 27.9 $8,912,000 ======== ============\n(b) Leases - At April 30, 1995, the Company had future minimum rental commitments for new or assumed operating leases as follows: 1996 - $819,000; 1997 - $373,000; 1998 - $312,000; 1999 - $176,000; 2000 - $125,000; thereafter - $70,000.\nTotal rental expense for all leases was $1,196,000, $1,131,000 and $1,199,000 for the years ended April 30, 1995, 1994 and 1993, respectively. Actual rental expense includes short-term rentals and leases shorter than one year, which are not included in the commitments.\n(c) Litigation - Certain claims arising from the Company's reorganization have not been settled. A reserve of $40,000 was included as a current liability at April 30, 1995 to reflect the aggregate estimated liability of such claims.\nThe Company is involved in other litigation primarily arising in the normal course of its business. In the opinion of management, the Company's liability, if any, under such pending litigation will not have a material impact upon the Company's consolidated financial condition or results of operations.\n(d) Environmental compliance - The Company is subject to various federal, state and local regulations regarding waste disposal and pollution control. The Company believes it is in substantial compliance with all existing regulations and orders. Various government agencies are considering new regulations, including those related to log yard management and disposal of log yard waste. Management believes that it will be able to comply with any final regulations in this area without a material adverse impact on its financial condition or results or operations.\nNOTE 10 - NON-CASH INVESTING AND FINANCING ACTIVITIES\nIn connection with the Company's reorganization, certain of the Company's liabilities were discharged in fiscal 1993 through the issuance of various debt and equity securities with a market value of $101.1 million. These transactions affected the financial position of the Company but did not directly affect its cash flow during the periods presented.\nNOTE 11 - UNAUDITED QUARTERLY FINANCIAL INFORMATION\nThe following quarterly information for the years ended April 30, 1995 and 1994 is unaudited but includes all adjustments (which consist of normal recurring adjustments) which management considers necessary for a fair presentation of such information (in thousands, except per-share amounts):\nNOTE 12 - VALUATION AND QUALIFYING RESERVES\nThe following table summarizes the activity associated with the Company's reserves for doubtful accounts and allowances for discounts for the years ended April 30, 1995, 1994 and 1993 (in thousands):\nAllowance for doubtful accounts - deducted from accounts receivable in the balance sheet Year Ended April 30, 1995 1994 1993 ------ ------ ------ Balance at beginning of year $ 584 $ 504 $ 307\nCharged (credited) to costs and expenses (10) 458 268\nDeductions (1) 459 378 71 ------ ------ ------ Balance at end of year $ 115 $ 584 $ 504 ====== ====== ======\nAllowance for discounts - deducted from accounts receivable in the balance sheet Year Ended April 30, 1995 1994 1993 ------ ------ ------ Balance at beginning of year $ 74 $ 135 $ 101\nCharged to costs and expenses 2,482 2,520 2,135\nDeductions (1) 2,472 2,581 2,101 ------ ------ ------ Balance at end of year $ 84 $ 74 $ 135 ====== ====== ======\n(1) Uncollected receivables written off, net of recoveries, and discounts taken by customers.","section_15":""}
{"filename":"87777_1995.txt","cik":"87777","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nScientific-Atlanta, Inc. (the \"Company\") designs, manufactures and markets a variety of standard and proprietary commercial electronic signal generating and receiving equipment. The Company's products connect information generators with information users via broadband terrestrial and satellite networks, and include applications for the converging cable, telephone, and data networks.\nThe Company operates primarily in one business segment, Communications, providing satellite and terrestrial based networks to a range of customers and applications, and providing network management and systems integration to add value to those networks. This segment represents over 90 percent of consolidated sales, operating profit and identifiable assets.\nThe Company has evolved from a manufacturer of electronic test equipment for antennas and electronics for the cable industry to a producer of a wide variety of products for terrestrial and satellite communications networks, including digital video, voice and data communications products. The Company's products include receivers, transmitters, distribution amplifiers, modulators, demodulators, signal encoders and decoders, controllers, signal processors, set-top (home communications) terminals, digital audio terminals, fiber optic distribution equipment, and satellite earth station antennas. These products, and integrated systems and networks using these and other products, are sold to CATV system operators, telephone companies, communications carriers, communications network operators, and multi-facility business organizations which use communications satellites for intracompany communications. Sales are also made to independent system integrators, distributors and dealers who resell the products to some of the above types of customers.\nThe Company sells modulators, demodulators and signal processors for video and audio receiving stations (often referred to as \"headend\" systems), products for distributing communications signals by coaxial cable and fiber optics from headend systems to subscribers, set-top terminals that enable television sets to receive all channels transmitted by system operators, and interdiction equipment which enables connections, disconnections and changes in service to be made from the headend. The Company's set-top terminals include units which are addressable from the headend system so as to permit control of channel authorizations, including authorizations for pay-per-view events, impulse ordering and automatic recording of billing information at the cable operator's central facility, and menu-driven volume controllable units. The Company manufactures equipment for transmitting compact-disc quality music programming via satellite and cable media.\nSales of set-top terminals constituted approximately 25% of the Company's total sales for fiscal year 1995, and approximately 21% and 18% of such sales in each of the fiscal years 1994 and 1993, respectively. Proprietary software used in the terminals, as well as system manager software at the headend system, was developed by the Company and is updated from time to time. The Company's new digital home communications terminals will enable subscribers to access new services such as advanced pay-per-view ordering of special events and movies, fully interactive home shopping services, electronic program guides and more.\nThe Company's products, both analog and digital, are being utilized by the Company's traditional cable operator customers to upgrade their networks to provide new services and by the Regional Bell Operating Companies to build new video, voice and data networks. They are also utilized by electric utilities in load management systems which monitor and control power usage and monitor power outages.\nThe Company's satellite earth stations receive and transmit signals for video, voice and data and are utilized in satellite-band telephone, data and television distribution networks. Some of these earth stations are part of national and international communications systems which communicate by means of a satellite with earth stations in other countries or with other earth stations in the same national network. Earth stations in these systems may be connected with local telephone, teletype, television or other terrestrial communications networks. The Company's earth stations, signal\nencoders and decoders, packet switches and controllers are also used in private business networks for the exchange of audio, video and data via satellite among various office, manufacturing and sales facilities and for the delivery of television programming to hotels, motels and apartment complexes. The Company's data communications product offerings include private interactive data systems using VSAT (very small aperture terminal) technology.\nThe Company designs, manufactures and sells digital video compression communications products for direct satellite broadcast and cable television systems and digital storage and retrieval products for applications such as ad insertion for television broadcasters and cable operators. The Company's compression products utilize the open architecture MPEG-2 technology developed by an international standards group. MPEG-2 digital equipment allows cable, telephone, computer and consumer electronics products and systems to operate together across networks and in the home.\nThe Company's satellite products and systems include tracking and telemetry equipment, earth observation satellite ground stations, shipboard and command telephony and facsimile communications products and intercept systems. The Company produces telemetry instruments, radar platforms, special receivers, special measurement devices and other equipment used to track aircraft, missiles, satellites and other moving objects and to communicate with and receive and record various measurements and other data from the object.\nThe Company develops services and applications which can be utilized by its customers on their terrestrial and satellite-based networks. Applications recently introduced include a system which enables power companies to detect power failures automatically, telephony capability over cable networks, interactive systems for video conferencing, retail banking and distance learning and interactive video games.\nOTHER PRODUCTS AND SERVICES\nThe Company produces advanced products and systems that measure, analyze or control processes associated with acoustics, signal analysis and machinery diagnostics. Their applications range from sonars and anti-submarine warfare analysis tools to vibration and acoustic analyzers used to measure jet engine vibration, helicopter rotor wing trim and balance and non-intrusive medical testing. Products include acoustic systems, machinery diagnostic systems, signal processors and trainers and are used in engineering design, structural evolution, acoustic and electronic testing and turbine engine balancing.\nThe Company's microwave instrumentation systems are used to design and manufacture antennas for communication and radar systems. Products include pattern recorders, receivers, positioners and various display units, which measure, record and display various characteristics of antennas such as signal pattern, gain, phase, amplitude and frequency.\nSTATUS OF THE 8600X HOME COMMUNICATIONS TERMINAL\nThe Company's rollout of the 8600x home communications terminal was delayed in fiscal 1995 as a result of the continued development of headend software requested by a customer to maximize the functionality of the 8600x terminals. Such software has been fully developed, and the Company does not anticipate any further delays in this rollout.\nMARKETING AND SALES\nThe Company's products are sold primarily through its own sales personnel who work out of offices in Atlanta and other metropolitan areas in the United States. Certain products are also marketed in the United States through independent sales representatives and distributors. Sales in foreign countries are made through wholly-owned subsidiaries and branch offices, as well as through independent distributors and sales representatives. The Company's management personnel are also actively involved in marketing and sales activities.\nThe Company's sales to various units of the United States Government constituted 11% of the Company's sales for fiscal year 1993. Such sales were less than 10% during fiscal years 1995 and 1994.\nThe Company's sales to customers in foreign countries constituted 33% of the Company's total sales for fiscal years 1995 and 1994 and 26% of total sales in fiscal year 1993. Substantially all of these sales were export sales. Foreign subsidiary sales were not material for any of these fiscal years. Sales to no one geographic area constituted 10% or more of the Company's total sales during those years.\nApproximately 12% of the Company's total sales for fiscal year 1995 were made to Time Warner, Inc. and its affiliates, with such sales being comprised of products to be used in the cable industry.\nBACKLOG\nThe Company's backlog consists of unfilled customer orders believed to be firm and long-term contracts which have not been completed. The Company's backlog as of June 30, 1995, and July 1, 1994, was $457,455,000 and $405,860,000, respectively.\nThe Company believes that approximately 90% of the backlog existing at June 30, 1995 will be shipped within the succeeding fiscal year. The Company includes in its backlog with respect to long-term contracts only amounts representing orders currently released for production. The amount contained in backlog for any contract or order may not be the total amount of the contract or order. The amount of the Company's backlog at any time does not reflect expected revenues for any fiscal period.\nPRODUCT RESEARCH AND DEVELOPMENT AND PATENTS\nThe Company conducts an active research and development program to strengthen and broaden its existing products and systems and to develop new products and systems. The Company's development strategy is to identify products and systems which are, or are expected to be, needed by substantial numbers of customers in the Company's markets and to allocate a greater share of its research and development resources to areas with the highest potential for future benefits to the Company. In addition, the Company develops specific applications related to its present technology. Expenditures in fiscal 1995, 1994 and 1993 were principally for development of commercial cable and telephone digital products, satellite network products and interactive data communications products. In fiscal 1995, 1994 and 1993, the Company's research and development expenses were approximately $83,316,000, $60,417,000 and $60,161,000, respectively.\nThe Company holds patents with respect to certain of its products and actively seeks to obtain patent protection for significant inventions and developments.\nMANUFACTURING\nThe Company develops, designs, fabricates, manufactures, assembles or acquires its products. Manufacturing operations range from complete assembly of a particular product by one individual or small group of individuals to semi-automated assembly lines for volume production. Because many of the Company's products include precision electronic components requiring close tolerances, the Company maintains rigorous and exacting test and inspection procedures designed to prevent production errors, and also constantly reviews its overall production techniques to enhance productivity and reliability. The Company's set-top terminals and certain pole-line hardware for the CATV industry are manufactured by contract vendors with high-quality, high-volume production facilities. In addition to such manufacturing by contract vendors, the Company commenced its own manufacturing of set-top terminals in fiscal year 1995 in its new Juarez, Mexico facility.\nMATERIALS AND SUPPLIES\nThe materials and supplies purchased by the Company are standard electronic components, such as custom integrated circuits, wire, circuit boards, transistors, capacitors and resistors, all of which are produced by a number of manufacturers. The principal supplier of the Company's set-top terminals is Matsushita Electronic Components Co., Ltd. The Company also purchases aluminum and steel, including castings and semi-fabricated items produced by a variety of sources. The Company considers its sources of supply to be adequate and is not dependent upon any single supplier, except for Matsushita Electronic Components Co., Ltd., for any significant portion of the materials used in the products it manufactures.\nEMPLOYEES\nThe Company had approximately 4,700 employees (approximately 700 of which were employed through temporary employment agencies) on June 30, 1995. The Company believes its employee relations are satisfactory.\nCOMPETITION\nThe businesses in which the Company is engaged are highly competitive. The Company competes with companies which have substantially greater resources and a larger number of products, as well as with smaller specialized companies. Some of the Company's customers are in businesses closely related to the production of such products and are, therefore, potential competitors of the Company. The Company believes that its ability to compete successfully results from its marketing strategy, engineering skills, ability to provide quality products at competitive prices and broad coverage by its sales personnel.\nINDUSTRY REGULATORY UNCERTAINTY AND RESTRUCTURING\nFederal, state and local regulatory uncertainty was a dominant feature of the communications industry during fiscal 1995, and such uncertainty is expected to continue for all or a portion of fiscal 1996. During 1995, the House and the Senate passed differing telecommunications reform bills aimed at deregulating and removing barriers to competition in the telecommunications industry. It is not known when (or whether) the Senate and House bills will be reconciled and passed by both houses of Congress and signed by President Clinton.\nSeveral states passed legislation designed to deregulate their telecommunications industries and several regional telephone companies challenged in court existing laws and regulations that prohibit or limit their entry into cable service.\nMost of the regional Bell operating companies filed applications under Section 214 of the Federal Communications Act for the construction and operation of video delivery systems called \"video dialtone networks.\" Some of these applications were granted, some delayed or denied and some withdrawn. In at least one case, a regional telephone company chose to proceed with a cable television franchise without filing an application under Section 214 in apparent contradiction of FCC regulations.\nAs the regional telephone companies sought entry into the video delivery industry during fiscal 1995, the cable industry itself was changing through consolidation, merger, acquisition and exchanges of local cable systems. Regional telephone companies also acquired cable companies outside of their regions. At the same time that telephone companies were attempting to develop or acquire video networks, some of the traditional cable operators began efforts to provide telephony on their networks.\nUncertainty and change were also prevalent with respect to sources for content for video entertainment networks. Some content providers formed alliances or joint ventures with other content and network providers, including cable companies and telephone companies. Proposed acquisitions of two of the major broadcast networks (ABC and CBS) were announced.\nOverall, the telecommunications industry was characterized during fiscal 1995 by a changing yet uncertain regulatory climate, the beginning of competition between cable companies and telephone companies, consolidation of\ncable franchise territories, and uncertainty in the source of program content. These factors caused a degree of uncertainty in the demand for the Company's products. It is not possible to predict the impact of these factors on future orders and sales volumes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns office and manufacturing facilities in metropolitan Atlanta, Georgia, San Diego, California, and Juarez, Mexico, which comprise five sites containing a total of approximately 561,800 square feet.\nThe Company also owns approximately 130 acres of land in Gwinnett County, Georgia, where antenna test ranges and a hub station used in providing interactive data communications services are located, and 219 acres of land in Walton County, Georgia, held for future antenna test range expansion. The Company presently owns one building and leases two buildings in San Diego County, California, all of which are not required for present operations and are under lease or sublease to other tenants.\nAdditional major manufacturing facilities containing an aggregate of approximately 437,200 square feet are leased by the Company at the following locations under leases expiring (including renewal options) from 1996 to 2015:\nThe Company also leases office and warehouse space in several buildings in the Atlanta, Georgia, San Jose, California, and Tempe, Arizona areas and leases sales and service offices in 24 U.S. and foreign cities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any legal proceedings which may or could have a material adverse impact on the Company or its 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 last quarter of its fiscal year ended June 30, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following persons are the executive officers of the Company:\nEach executive officer is elected annually and serves at the pleasure of the Board of Directors.\nMr. McDonald was elected President and Chief Executive Officer of the Company effective July 15, 1993. He was a general partner of J. H. Whitney & Company, a private investment firm, from 1991 until his employment by the Company. From 1989 to 1991 he was President and Chief Executive Officer of Prime Computer, Inc., a supplier of CAD\/CAM software and computer systems. Prior to that time he was President and Chief Operating Officer of Gould, Inc., a computer and electronics company (1984 to 1989) and held a variety of positions with IBM Corporation (1963 to 1984).\nMr. Eason has been a partner at Paul, Hastings, Janofsky & Walker since 1989. He has been Secretary of the Company since August, 1993, and became Senior Vice President and General Counsel in February, 1994. Paul, Hastings, Janofsky & Walker performs legal services for the Company. Mr. Eason receives a fixed salary from the Firm for work which he performs for clients of the Firm other than the Company, but has no interest in the Firm's earnings and profits.\nMr. Koenig was elected Senior Vice President, Human Resources in 1995. Prior to that time he served as Vice President, Human Resources for more than five years.\nMr. Levergood re-joined the Company in December 1992. He had previously been employed by the Company in various managerial positions (most recently as Chief Operating Officer) until December 1989. From January through June, 1990, he was President and Chief Operating Officer of Dowden Communications, an operator of cable television systems. He was an independent communications consultant from June, 1990 until he re-joined the Company in 1992.\nMr. Simpson was President and Chief Executive Officer of Mead Data Central, Inc., an electronic publisher, from June, 1982 through November, 1992. From December, 1992 until joining the Company in October, 1993, he was President of Infobyte, Inc., a consulting firm.\nMr. Wagner was Vice President-Finance and Chief Financial Officer of Computervision Corporation, a supplier of CAD\/CAM\/CAE software and services from September, 1989 until he joined the Company in June, 1994.\nMr. Enterline has been employed by the Company in a variety of positions since 1989. He was elected Vice President in February, 1995.\nMr. McIntyre was elected Vice President in February, 1995. He has been employed by the Company since 1991. Prior to his employment with the Company, Mr. McIntyre was employed by Augat, Inc., a computer components supplier, as Vice President and General Manager of its Interconnection Products Division, from 1988 to 1991.\nMr. Wredberg joined the Company in 1995 and was elected to the position of Vice President in May, 1995. Mr. Wredberg served as President of American Microsystem, Inc., a supplier of semiconductors, from 1985 until 1995.\nAll other executive officers have been employed by the Company in the same or similar capacities for more than five years. There are no family relationships among the executive officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED MATTERS\nThe Common Stock of the Company is traded on the New York Stock Exchange (symbol SFA). The approximate number of holders of record of the Company's Common Stock at September 8, 1995, was 6,256.\nIt has been the policy of the Company to retain a substantial portion of its earnings to finance the expansion of its business. In 1976 the Company commenced payment of quarterly cash dividends and intends to consider the continued payment of dividends on a regular basis; however, the declaration of dividends is discretionary with the Board of Directors, and there is no assurance regarding the payment of future dividends by the Company.\nInformation as to the high and low stock prices and dividends paid for each quarter of fiscal years 1995 and 1994 is included in Note 5 of the Notes to Financial Statements included in this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data is set forth on page 20 of this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's Discussion of Consolidated Statement of Financial Position, Consolidated Statement of Earnings, and Consolidated Statement of Cash Flows are set forth on pages 12, 14, 15 and 18 of this Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company and notes thereto, the schedule containing certain supporting information and the report of independent public accountants are set forth on pages 11 through 29 of this Report. See Part IV, Item 14 for an index of the statements, notes and schedule.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 (except for the information set forth at the end of Part I with respect to Executive Officers of the Company) 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_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:\n(1) The consolidated financial statements listed below are included on pages 11 through 28 of this Report.\nReport of Independent Public Accountants\nConsolidated Statement of Financial Position as of June 30, 1995 and July 1, 1994\nConsolidated Statement of Earnings for each of the three years in the period ended June 30, 1995\nConsolidated Statement of Cash Flows for each of the three years in the period ended June 30, 1995\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedule:\nAll other Schedules called for under Regulation S-X are not submitted because they are not applicable or not required or because the required information is not material or is included in the financial statements or notes thereto.\n(3) Exhibits:\n(3) (a) The following is incorporated by reference to the registrant's report on Form 10-K for its fiscal year ended June 29, 1990:\n(i) Amended and Restated Articles of Incorporation, as amended.\n(b) The following is incorporated by reference to the registrant's report on form 10-K for its fiscal year ended July 1, 1994:\n(i) By-laws of registrant, as amended.\n(10) MATERIAL CONTRACTS -\n(a) The following material contract is incorporated by reference to the registrant's report on Form 10-Q for its fiscal quarter ended March 31, 1987:\n(i) Agreement pertaining to the compensation of Sidney Topol.*\n(b) The following material contract is incorporated by reference to the registrant's report on Form 10-Q for its fiscal quarter ended December 29, 1989:\n(i) Scientific-Atlanta, Inc. Non-Employee Directors Stock Option Plan. *\n(c) The following material contracts are incorporated by reference to the registrant's report on Form 10-K for the fiscal year ended June 26, 1992:\n(i) Scientific-Atlanta, Inc. 1981 Incentive Stock Option Plan, as amended.*\n(ii) 1985 Executive Deferred Compensation Plan of Scientific-Atlanta, Inc., as amended.*\n(iii) Scientific-Atlanta, Inc. Annual Incentive Plan for Key Executives, as amended.*\n(iv) Scientific-Atlanta, Inc. Long Term Incentive Compensation Plan, as amended.*\n(v) Scientific-Atlanta, Inc. 1978 Non-Qualified Stock Option Plan for Key Employees, as amended.*\n(d) The following material contract is incorporated by reference to the registrant's report on Form 10-K for the fiscal year ended July 2, 1993:\n(i) Scientific-Atlanta, Inc. 1992 Employee Stock Option Plan.*\n(e) The following material contracts are incorporated by reference to the registrant's report on Form 10-K for the fiscal year ended July 1, 1994:\n(i) Scientific-Atlanta, Inc. Supplemental Executive Retirement Plan. *\n(ii) 1994 Scientific-Atlanta, Inc. Executive Deferred Compensation Plan.*\n(iii) Form of Severance Protection Agreement between the Registrant and Certain Officers and Key Employees.*\n(iv) Scientific-Atlanta, Inc. Retirement Plan for Non-Employee Directors, as amended.*\n(f) The following material contract is incorporated by reference to the exhibit filed with the registrant's proxy statement filed on October 3, 1994, as amended by the revised cover page thereto incorporated by reference to the registrant's report on Form 10-Q for the fiscal quarter ended December 31, 1994:\n(i) Scientific-Atlanta, Inc. Long-Term Incentive Plan, adopted by the shareholders on November 11, 1994.*\n(g) Credit Agreement, dated May 11, 1995, by and between the Company and NationsBank of Georgia, National Association, for itself and as agent for other banks participating in the credit facility.\n(11) Computation of Earnings Per Share of Common Stock\n(23) Consent of Independent Public Accountants\n(27) Financial Data Schedule\n___________________\n* Indicates management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Scientific-Atlanta, Inc.:\nWe have audited the accompanying consolidated statement of financial position of Scientific-Atlanta, Inc. (a Georgia corporation) and subsidiaries as of June 30, 1995 and July 1, 1994 and the related consolidated statements of earnings and cash flows for each of the three years in the period ended June 30, 1995 appearing on pages 13, 17 and 19, respectively. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Scientific-Atlanta, Inc. and subsidiaries as of June 30, 1995 and July 1, 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.\nAs explained in Notes 9 and 10 to the financial statements, effective June 27, 1992, the Company changed its method of accounting for income taxes, postretirement and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedule listed in Item 14(a)(2) of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic 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.\nAtlanta, Georgia ARTHUR ANDERSEN LLP August 4, 1995\nREPORT OF MANAGEMENT\nThe management of Scientific-Atlanta, Inc. (the Company) has the responsibility for preparing the accompanying financial statements and for their integrity and objectivity. The statements, which include amounts that are based on management's best estimates and judgments, have been prepared in conformity with generally accepted accounting principles and are free of material misstatement. Management also prepared the other information in the Form 10-K and is responsible for its accuracy and consistency with the financial statements.\nThe Company maintains a system of internal control over the preparation of its published annual and interim financial statements. It should be recognized that even an effective internal control system, no matter how well designed, can provide only reasonable assurance with respect to the preparation of reliable financial statements; further, because of changes in conditions, internal control system effectiveness may vary over time.\nManagement assessed the Company's system of internal control in relation to criteria for effective internal control over the preparation of its published annual and interim financial statements. Based on its assessment, it is management's opinion that its system of internal control as of June 30, 1995 is effective in providing reasonable assurance that its published annual and interim financial statements are free of material misstatement.\nAs part of their audit of our financial statements, Arthur Andersen LLP considered certain elements of our system of internal controls in determining their audit procedures for the purpose of expressing an opinion on the financial statements.\nThe audit committee of the board of directors is composed solely of outside directors and is responsible for recommending to the board the independent public accountants to be retained for the year, subject to stockholder approval. The audit committee meets three times each year to review with management the Company's system of internal accounting controls, audit plans and results, accounting principles and practices, and the annual financial statements.\n\/s\/ James F. McDonald \/s\/ Harvey A. Wagner ------------------------------------- ------------------------------------- James F. McDonald Harvey A. Wagner President and Chief Executive Officer Senior Vice President Chief Financial Officer and Treasurer\nMANAGEMENT'S DISCUSSION OF CONSOLIDATED STATEMENT OF FINANCIAL POSITION\nScientific-Atlanta had stockholders' equity of $474.2 million and cash on hand of $80.3 million at June 30, 1995. The current ratio of 2.2:1 at June 30, 1995 compared to 2.5:1 at July 1, 1994. Cash on hand and cash generated from earnings was used to fund working capital requirements and for capital expenditures.\nCASH AND CASH EQUIVALENTS at the end of 1995 were $80.3 million, down from $123.4 million last year. Cash decreased as expenditures for inventories, equipment and expansion of manufacturing capacity exceeded cash generated from earnings. Ending working capital, excluding cash, was $259.4 million, or 22.6 percent of sales, as compared to 22.1 percent in the prior year.\nRECEIVABLES were $243.4 million at year-end, compared to $206.1 million at the prior fiscal year-end. The increase reflects the sales growth in 1995. Average days sales outstanding decreased to 71 for 1995 from 74 for 1994. The allowance for doubtful accounts as a percent of gross receivables declined in 1995 due to a lower level of delinquent balances and write-offs.\nINVENTORY TURNOVER was 4.2 times in 1995, compared to 4.4 in the prior year. Inventories of $257.4 million at year-end were $120.6 million higher than at the end of the prior year, reflecting the higher production and sales levels in 1995 and delays in the shipments of certain home communications terminals.\nCURRENT DEFERRED INCOME TAXES increased $0.4 million due to increases in nondeductible reserves.\nOTHER CURRENT ASSETS, which include prepaid insurance, deposits, royalties, license fees and other miscellaneous prepaid expenses, decreased $4.8 million due primarily to lower deposits and royalties.\nNET PROPERTY, PLANT AND EQUIPMENT increased by $38.8 million in 1995 as capital spending exceeded depreciation and disposals. Capital additions of $64.8 million included expenditures for equipment and expansion of manufacturing capacity including the construction of a manufacturing facility in Juarez, Mexico.\nCOST IN EXCESS OF NET ASSETS ACQUIRED decreased in 1995, reflecting amortization of goodwill.\nOTHER ASSETS, which include license fees, investments, noncurrent deferred tax charges, intellectual property, various prepaid expenses and cash surrender value of company-owned life insurance, decreased $3.4 million in 1995 due primarily to lower prepaid license fees. See Note 2.\nTOTAL BORROWINGS at year-end amounted to $2.2 million, down $5.4 million from the prior year. The borrowings include industrial development bonds and working capital loans for foreign subsidiaries. Working capital borrowings by foreign subsidiaries were reduced $5.1 million during 1995. Details of borrowings are shown in Note 6.\nIn May 1995 the Company established a $300 million senior credit facility consisting of a $150 million one-year facility and a $150 million five-year facility to be available for general corporate purposes. There were no borrowings under this facility at June 30, 1995. The facility will be used to supplement funds generated internally to support the growth of the Company.\nACCOUNTS PAYABLE were $148.3 million at year-end, up from $82.3 million last year. The increase reflects higher production and inventory levels and an increase to 43 days in accounts payable from 33 in 1994.\nACCRUED LIABILITIES of $113.9 million include accruals for compensation, warranty and service, customer down-payments and taxes, excluding income taxes. Higher accruals for compensation and retirement benefits and other miscellaneous accruals were the principal factors in the year-to-year increase. See Note 7 for details.\nOTHER LIABILITIES of $34.6 million are comprised of deferred compensation, postretirement benefit plans, postemployment benefits and other miscellaneous accruals. See Note 8 for details.\nSTOCKHOLDERS' EQUITY was $474.2 million at the end of 1995, up $78.5 million from the prior year. Net earnings of $63.5 million and the issuance of stock grants and stock pursuant to stock option plans of $19.7 million were partially offset by dividends of $4.6 million and a decrease in accumulated translation adjustments. See Note 15 for details of changes in stockholders' equity.\nRETURN ON AVERAGE STOCKHOLDERS' EQUITY for 1995 was 14.7 percent, up from 9.5 percent the prior year, reflecting improved earnings performance.\nCONSOLIDATED STATEMENT OF FINANCIAL POSITION\nSee accompanying notes\nMANAGEMENT'S DISCUSSION OF CONSOLIDATED STATEMENT OF EARNINGS\nThe Consolidated Statement of Earnings summarizes Scientific-Atlanta's operating performance over the last three years, during which time the company has accelerated development of new products and expanded into international markets.\nEARNINGS IN 1995 WERE UP $28.5 MILLION OVER 1994.\nHigher sales volume was the primary factor in the year-to-year increase.\nEarnings in 1994 were up $15.0 million over 1993. Higher sales volume and improved margins were the primary factors in the increase.\nThe Company's fiscal year is comprised of fifty-two or fifty-three weeks, ending on the Friday nearest to June 30 each year. Fiscal years 1995 and 1994 included fifty-two weeks while fiscal year 1993 included fifty-three weeks. The effect on the results of operations of the inclusion of fifty-two weeks in 1995 and 1994 versus fifty-three weeks in 1993 was not material.\nSALES INCREASED 41 PERCENT OVER 1994. Strong growth in sales volume of transmission and addressable converter products and Sega game adapters and deliveries of equipment to Orbit Communications Company for its direct to home satellite services contributed to the year-to-year increase in sales. Sales of instrumentation products continue to be adversely affected by spending reductions in the defense industry. International sales were 33 percent of total sales in 1995.\nSales in 1994 increased 11 percent over 1993. Continued strong sales volume growth in cable television distribution equipment and addressable home communications terminals (converters) and significant improvement in sales of network systems were offset partially by reduced sales due to completion of the PrimeStar television contract, lower digital audio sales and sales of defense related products. International sales increased to 33 percent of total sales in 1994, up from 26 percent in the prior year. Higher sales of cable equipment and network systems contributed to the growth in international sales.\nCOST OF SALES AS A PERCENT OF SALES INCREASED 2.2 PERCENTAGE POINTS OVER 1994. Gains from cost improvements in satellite networks and increased volumes in transmission and addressable converter products were offset by unfavorable exchange rate changes in Japanese yen, production startup costs, product mix and cost overuns on defense contracts. The Company believes that gross margins may be negatively impacted in future periods by planned expansion of manufacturing capacity and the continued increase in sales of addressable converter products and Sega adapters which have lower margins than some of the Company's other products. Continued strength of the yen would also adversely affect gross margins.\nCertain material purchases are denominated in Japanese yen and, accordingly, the purchase price in U.S. dollars is subject to change based on exchange rate fluctuations. Currently, the Company has forward exchange contracts to purchase yen to hedge its exposure on purchase commitments for a period of twelve months.\nCost of sales as a percent of sales decreased 2.2 percentage points in 1994. Favorable mix change was the primary factor in the year-to-year improvement. Manufacturing efficiencies, higher margins on addressable converter products and improved program management also contributed to the improved margins.\nSALES AND ADMINISTRATIVE EXPENSE INCREASED 26 PERCENT OVER THE PRIOR YEAR. Increased expenses reflect costs associated with ongoing investments to support expansion into international markets, the introduction of new products and a build-up in the infrastructure of the Company to handle the growth the Company is experiencing. Sales and administrative expenses as a percent of sales declined to 13 percent in 1995 from 14 percent in 1994.\nSales and administrative expense increased 3 percent in 1994. Increases in sales and marketing costs associated with expansion into international markets and the introduction of new products were offset slightly by administrative costs which declined 2 percent, primarily due to lower professional fees.\nRESEARCH AND DEVELOPMENT EXPENSES INCREASED $22.9 MILLION OVER THE PRIOR YEAR. Increased research and development activity, particularly development of digital products, was the primary factor in the year-to-year increase. Product development activity is expected to continue near current levels.\nResearch and development expenses of $60.4 million in 1994 were up slightly over the prior year. Accelerated research and development activity, particularly development of digital products, was offset by declines in defense related products and the\nreallocation of engineering resources from research and development efforts to specific customer orders. The revenue from these orders was recognized in 1995, and, accordingly the related costs were inventoried at July 1, 1994.\nINTEREST EXPENSE WAS $0.8 MILLION IN 1995 AND $1.1 MILLION IN 1994. The decrease reflects lower average working capital borrowings by foreign subsidiaries.\nINTEREST INCOME WAS $2.8 MILLION IN 1995 AND $3.2 MILLION IN 1994. The decrease in interest income reflects lower average cash balances.\nOTHER INCOME WAS $1.5 MILLION IN 1995. Other income included rental income, royalty income, net gains from partnership activities and other miscellaneous items. There were no significant items in other income and other expense during 1995.\nOther expense of $17.4 million in 1994 included a $17.5 million charge to settle securities class action litigation, losses of $1.0 million from partnership activities and net gains from other miscellaneous items of $1.1 million.\nThe securities class action suit, which was filed in 1988, related to events which occurred during the early 1980's principally as a result of the difficulties experienced by the Company in the production and delivery of a new product. The Company firmly believes it fully complied with the law in this matter and that the suit was without merit. The litigation was settled in 1994 in the best interest of the Company's shareholders to avoid protracted and costly legal proceedings and eliminate the uncertainty of a jury trial.\nTHE PROVISION FOR INCOME TAXES WAS 32 PERCENT OF PRE-TAX EARNINGS IN 1995, UNCHANGED FROM THE PRIOR YEAR. The provision for income taxes was 25 percent of pre-tax earnings in 1993. The lower provision in 1993 reflects interest income on tax-exempt investments and benefits from international tax planning. Details of the provision for income taxes are discussed in Note 9.\nACCOUNTING CHANGES RESULTED IN A CHARGE OF $4.7 MILLION TO EARNINGS IN 1993. Effective as of the first quarter of fiscal 1993, the Company adopted the provisions of SFAS No. 106 \"Postretirement Benefits\", SFAS No. 112 \"Postemployment Benefits\" and SFAS No. 109 \"Accounting for Income Taxes\". The adoption of these standards did not have a significant impact on income from operations and is not expected to significantly impact earnings in subsequent years. See Notes 9 and 10.\nEARNINGS PER SHARE OF $0.83 IN 1995 INCREASED $0.37 AFTER AN INCREASE OF $0.19 IN 1994. Shares outstanding and share equivalents decreased slightly to 76.2 million in 1995 from 76.6 million in 1994.\n(THIS PAGE INTENTIONALLY LEFT BLANK.)\nCONSOLIDATED STATEMENT OF EARNINGS\nSee accompanying notes.\nMANAGEMENT'S DISCUSSION OF CONSOLIDATED STATEMENT OF CASH FLOWS\nThe Statement of Cash Flows summarizes the main sources of Scientific-Atlanta's cash and its uses. These flows of cash provided or used are summarized by the Company's operating activities, investing activities and financing activities.\nCash on hand at the end of 1995 was $80.3 million. Cash on hand and cash generated from earnings were used for capital expenditures and to fund working capital requirements.\nIn May 1995 the Company established a $300 million senior credit facility consisting of a $150 million one-year facility and a $150 million five-year facility to be available for general corporate purposes. There were no borrowings under this facility at June 30, 1995. The facility will be used to supplement funds generated internally to support the growth of the Company.\nCASH PROVIDED BY OPERATING ACTIVITIES was $24.0 million for 1995, compared to $48.5 million for 1994. In 1995 and 1994 cash provided by improved earnings and increases in payables was partially offset by increases in inventories and accounts receivable. See Management's Discussion of the Statement of Financial Position for details of this performance.\nCASH USED BY INVESTING ACTIVITIES of $65.3 million during 1995 included expenditures of $64.8 million for equipment and expansion of manufacturing capacity, including the construction of a manufacturing facility in Juarez, Mexico. In 1994, cash used by investing activities included $34.9 million for purchases of plant and equipment and $5.2 million for investments in partnerships. Expenditures focused on increased capacity and productivity improvements. Cash provided by investing activities included $11.2 million from the sale of ICT shares.\nCASH USED BY FINANCING ACTIVITIES WAS $1.8 MILLION IN 1995. The issuance of stock pursuant to stock option and employee benefit plans generated $8.2 million. Cash used by financing activities included a $5.1 million reduction of working capital borrowings by foreign subsidiaries and dividend payments of $4.6 million.\nCash provided by financing activities was $0.8 million in 1994. The issuance of stock pursuant to stock option and employee benefit plans and increases in short-term borrowings generated $5.0 million and $0.5 million, respectively, of cash during the year.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\nSELECTED FINANCIAL DATA\nNOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share data)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFISCAL YEAR-END The Company's fiscal year ends on the Friday closest to June 30 of each year. Fiscal year ends are as follows: 1995: June 30, 1995 1994: July 1, 1994 1993: July 2, 1993\nFiscal 1993 includes fifty-three weeks.\nCONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and all subsidiaries after elimination of all material intercompany accounts and transactions.\nFOREIGN CURRENCY TRANSLATION The financial statements of certain foreign operations are translated into U.S. dollars at current exchange rates. Resulting translation adjustments are accumulated as a component of stockholders' equity and excluded from net earnings. Foreign currency transaction gains and losses are included in cost of sales and other income. Such gains and losses were not material during the periods being reported.\nMETHOD OF RECORDING CONTRACT PROFITS Revenues from progress-billed contracts are primarily recorded using the percentage-of-completion method based on contract costs incurred to date. Losses, if any, are recorded when determinable. Costs incurred and accrued profits not billed on these contracts are included in receivables. These receivables from commercial customers and government agencies were $32,738 at June 30, 1995, and $17,628 at July 1, 1994. It is anticipated that substantially all such amounts will be collected within one year.\nDEPRECIATION, MAINTENANCE AND REPAIRS Depreciation is provided using principally the straight-line method over the estimated useful lives of the assets. Maintenance and repairs are charged to expense as incurred. Renewals and betterments are capitalized. The cost and accumulated depreciation of property retired or otherwise disposed of are removed from the respective accounts, and the gains or losses thereon are included in the consolidated statement of earnings.\nWARRANTY COSTS The Company accrues warranty costs at the time of sale. Expenses related to unusual product warranty problems and product defects are recorded in the period the problem is identified.\nEARNINGS PER SHARE Earnings per share in 1995 was computed based on the weighted average number of shares of common stock outstanding. Earnings per share in 1994 and 1993 were computed based on the weighted average number of shares of common stock outstanding and equivalent shares derived from dilutive stock options.\nCASH AND CASH EQUIVALENTS For purposes of the statement of cash flows, the Company considers all liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nINVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market. Cost includes materials, direct labor, and manufacturing overhead. Market is defined principally as net realizable value. Inventories include purchased and manufactured components in various stages of assembly as presented in the following table:\n1995 1994 -------- -------- Raw Materials and Work-In-Process $142,418 $ 94,890 Finished Goods 115,009 41,923 -------- -------- Total Inventory $257,427 $136,813 ======== ========\nCOST IN EXCESS OF NET ASSETS ACQUIRED Cost in excess of net assets of businesses acquired is amortized on a straight-line basis over seventeen years.\nFINANCIAL PRESENTATION Certain prior year amounts have been reclassified to conform with the current year presentation. All per share amounts have been restated to reflect the 2-for-1 stock split effected as a dividend issued in October 1994 and the 3-for-2 stock split effected as a dividend issued in December 1992.\n2. INVESTMENTS AND ACQUISITION\nDuring 1994 the Company entered into partnership agreements in connection with the formation of two joint ventures, Comunicaciones Broadband and Scientific-Atlanta of Shanghai, Ltd., and invested a total of $5,240 in the partnerships. During 1995 the Company invested an additional $2,410 in these partnerships and disposed of its investment in Comunicaciones Broadband for a loss of $0.2 which was included in other (income) expense. The Company's equity in the losses of these partnerships was $296 and $345 in 1995 and 1994, respectively.\nIn February 1993 the Company acquired certain net assets of Nexus Engineering Corp. for $6,314 cash and obligations of $4,398 in a purchase transaction. The pro forma effect on operations for prior periods and the effect on 1993 were immaterial.\nDuring 1994, the Company disposed of its investment in International Cablecasting Technologies, Inc., for a loss of $549 which was included in other (income) expense.\n3. SALES AND BUSINESS SEGMENT INFORMATION\nSales to Time Warner, Inc. and affiliates were 12 percent of total sales in 1995. Sales were not material to any one customer in 1994. Sales to the United States government were 12 percent of total sales in 1993. Export sales accounted for 33 percent of total sales in 1995 and 1994 and 26 percent of total sales in 1993. Foreign subsidiary sales were not material for any of the three fiscal years presented, nor were they material to any one geographic location.\nThe Company operates primarily in one business segment, Communications, providing satellite and terrestial based networks to a range of customers and applications and network management and systems integration to add value to those networks.\n4. OTHER (INCOME) EXPENSE\nOther income of $1,524 in 1995 included rental income, royalty income, net gains from partnership activities and other miscellaneous items. There were no significant items in other income and other expense during 1995.\nOther expense of $17,416 in 1994 included a $17,500 charge to settle securities class action litigation, losses of $992 from partnership activities and net gains from other miscellaneous items of $1,076.\nThe securities class action suit, which was filed in 1988, related to events which occurred during the early 1980's principally as a result of the difficulties experienced by the Company in the production and delivery of a new product. The Company firmly believes it fully complied with the law in this matter and that the suit was without merit. The litigation was settled in 1994 in the best interest of the Company's shareholders to avoid protracted and costly legal proceedings and eliminate the uncertainty of a jury trial.\nOther income of $694 in 1993 included royalty income, rental income and other miscellaneous items of $1,656 and losses from foreign currency transactions of $962.\n5. QUARTERLY FINANCIAL DATA (UNAUDITED)\n(1) Includes charge of $11,900 ($0.15 per share) to settle securities class action litigation.\n6. INDEBTEDNESS\nCredit Facility:\nAt June 30, 1995, the Company had a $300,000 senior credit facility that provides for unsecured borrowings up to $150,000 which expire May 10, 1996 and $150,000 which expire May 10, 2000. There were no borrowings under this facility at June 30, 1995. Interest on borrowings under this facility are at varying rates and fluctuate based on market rates. Facility fees based on the average daily aggregate amount of the facility commitments are payable quarterly.\nLong-term debt consisted of:\nLong-term debt at June 30, 1995 had scheduled maturities as follows: 1996--$315; 1997--$321; 1998--$252; 1999--$200.\nAt June 30, 1995, property, plant and equipment costing approximately $5,925 were pledged as collateral on long-term debt.\nForeign short-term debt was $ 1,071 and $6,177 at the end of 1995 and 1994, respectively. The average interest rates for foreign short-term debt at June 30, 1995 and July 1, 1994 were 9.2 percent and 8.3 percent, respectively.\nTotal interest paid was $811, $1,071, and $831 in 1995, 1994, and 1993, respectively.\n7. ACCRUED LIABILITIES\nAccrued liabilities consisted of:\n8. OTHER LIABILITIES\nOther liabilities consisted of:\n9. INCOME TAXES\nThe Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes\", effective the first quarter of fiscal 1993. The statement requires that deferred income taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts. The cumulative effect of this change increased net income by $3,856.\nThe tax provision differs from the amount resulting from multiplying earnings before income taxes by the statutory federal income tax rate as follows:\nIncome tax provision (benefit) includes the following:\nTotal income taxes paid include settlement payments for federal, state and foreign audit adjustments. The total income taxes paid were $28,937, $1,551, and $3,464 in 1995, 1994, and 1993, respectively.\nThe tax effect of significant temporary differences representing deferred tax assets and liabilities are as follows:\nValuation allowances for current deferred tax assets and noncurrent deferred tax assets were not required in 1995 or 1994.\nThe net noncurrent deferred tax asset is included in Other Assets at June 30, 1995 and July 1, 1994.\nIn 1995, 1994, and 1993, earnings before income taxes included $8,571, $2,641, and $83, respectively, of earnings generated by the Company's foreign operations.\n10. RETIREMENT AND BENEFIT PLANS\nThe Company has a defined benefit pension plan covering substantially all of its domestic employees. The benefits are based upon the employees' years of service and compensation.\nThe Company's funding policy is to contribute annually the amount expensed each year consistent with the requirements of federal law to the extent that such costs are currently deductible.\nThe following table sets forth the plan's funded status, amounts recognized in the Company's Consolidated Statement of Financial Position at year-end, using March 31 as a measurement date for all actuarial calculations of asset and liability values and significant actuarial assumptions:\nPlan assets are invested in listed stocks, bonds and short-term monetary investments.\nThe Company's net pension expense was $2,483 in 1995, $2,709 in 1994, and $2,686 in 1993.\nThe components of pension expense are as follows:\nThe Company has unfunded defined benefit retirement plans for certain key officers and non-employee directors. Accrued pension cost for these plans was $5,521 at June 30, 1995 and $4,338 at July 1, 1994. Retirement expense for these plans was $1,223, $906, and $156 in 1995, 1994, and 1993, respectively.\nIn addition to providing pension benefits, the Company has contributory plans that provide certain health care and life insurance benefits to eligible retired employees.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective the first quarter of fiscal 1993. This statement requires the accrual of the cost of providing postretirement benefits, including medical and life insurance coverage, during the active service period of the employee. The Company elected to immediately recognize the accumulated liability, measured as of April 1, 1992. This resulted in a one-time charge of $6,696, net of a deferred tax benefit of $4,104.\nThe following table sets forth the plan's funded status and amounts recognized in the Company's Consolidated Statement of Financial Position at year-end, using March 31 as a measurement date for all actuarial calculations of liability values:\nThe components of postretirement benefit expense are as follows:\nSignificant actuarial assumptions are as follows:\nThe Company also adopted SFAS No. 112, \"Employers Accounting for Postemployment Benefits\" effective the first quarter of 1993. This statement requires the accrual method of accounting for benefits to former or inactive employees after employment but before retirement. Postemployment benefits include disability benefits, severence benefits, and continuation of health care benefits. A one-time charge of $1,860, net of a deferred tax benefit of $1,140, related to the adoption of SFAS No. 112 was recognized effective June 27, 1992. The effect of this change on 1993 operating results, after recording the one time charge, was not material.\n11. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount of cash and cash equivalents approximates fair value because of the short maturity of those instruments. The fair value of foreign currency contracts is based on quoted market prices.\nThe Company enters into foreign exchange forward contracts to hedge certain firm commitments and assets denominated in currencies other than the U.S. dollar, primarily Japanese yen. These contracts are for periods consistent with the exposure being hedged and generally have maturities of one year or less. Gains and losses on foreign exchange forward contracts are deferred and recognized in income in the same period as the hedged transactions. The Company's foreign exchange forward contracts do not subject the Company's results of operations to risk due to exchange rate fluctuations because gains and losses on these contracts generally offset losses and gains on the exposure being hedged. The Company does not enter into any foreign exchange forward contracts for speculative trading purposes.\n12. RELATED PARTY TRANSACTIONS\nDuring 1995 the Company had sales of $3,384 to Scientific-Atlanta of Shanghai, Ltd. and a net receivable of $420 at June 30, 1995.\nDuring 1994 the Company had sales of $12,127 to Comunicaciones Broadband and Scientific-Atlanta of Shanghai, Ltd. and had a net receivable of $4,774 from these partnerships at July 1, 1994.\n13. COMMITMENTS, CONTINGENCIES, AND OTHER MATTERS\nRental expense under operating lease agreements for facilities and equipment for 1995, 1994 and 1993 was $10,696, $9,303, and $7,983, respectively. The Company pays taxes, insurance, and maintenance costs with respect to most leased items. Remaining operating lease terms, including renewals, range up to twenty years. Future minimum payments at June 30, 1995, under operating leases were $38,796. Payments under these leases for the next five years are as follows: 1996-- $11,144; 1997-- $7,639; 1998-- $4,952; 1999-- $3,367; 2000-- $3,066.\nThe Company has agreements with certain officers which include certain benefits in the event of termination of the officers' employment as a result of a change in control of the Company.\nThe Company is also committed under certain purchase agreements which are intended to benefit future periods.\nThe Company is a party to various legal proceedings arising in the ordinary course of business. In management's opinion, the outcome of these proceedings will not have a material adverse effect on the Company's financial position or results of operations.\n14. COMMON STOCK AND RELATED MATTERS\nIn October 1994, the Company issued a 2-for-1 stock split effected in the form of a 100 percent stock dividend. This stock split was accounted for as of July 1, 1994, by a transfer from retained earnings to common stock in the amount of the par value of stock outstanding at July 1, 1994. In December 1992, the Company issued a 3-for-2 stock split effected in the form of a 50 percent stock dividend. The stock split has been accounted for by a transfer from retained earnings to common stock in the amount of the par value of the additional stock issued. All per share amounts and options have been restated to reflect the stock splits.\nThe following information pertains to options on the Company's common stock for the years ended June 30, 1995, July 1, 1994 and July 2, 1993:\nAt June 30, 1995, an additional 2,285,212 shares were reserved under employee and director stock option plans.\nThe Company has an employee stock purchase plan whereby the Company provides certain purchase benefits for participating employees. At June 30, 1995, 628,171 shares were reserved for issuance to employees under the plan.\nThe Company has a 401(k) plan whereby the Company matches eligible employee contributions in Company stock, subject to certain limitations. The Company's expense to match contributions was $4,940, $3,373 and $1,487 in 1995, 1994 and 1993, respectively. At June 30, 1995, 1,012,994 shares were reserved for issuance to employees under the plan.\nThe Company issues restricted stock awards to certain officers and key employees. Compensation expense for restricted stock awards was $1,102 in 1995 and $1,232 in 1994.\nIn April 1987 the Company adopted a Shareholder Rights Plan (which was amended in August 1988 and May 1994) and pursuant thereto declared a dividend of one Common Stock Purchase Right (\"Right\") for each outstanding share of common stock. For shares issued after such dividend, a right attaches to each share of common stock issued. The Rights will become exercisable if a person or group (an \"Acquiring Shareholder\") (i) holds 10 percent or more of the Company's common stock and is determined by the Board of Directors to be an \"adverse person\" as defined by the Plan, or (ii) acquires or makes a tender offer to acquire 15 percent of the Company's common stock. Either such event is referred to as the \"Distribution Date\". If a person acquires 15 percent of the Company's common stock or is determined by the Board of Directors to be an \"adverse person\" or, after the \"Distribution Date\" the Company is merged with any entity, each Right will entitle the holder thereof, other than the Acquiring Shareholder, to purchase $33 worth of the Company's or the surviving corporation's common stock, as the case may be, based on the Company's market price at the time, for $16.67.\nThe Rights may be redeemed by the Company at a price of $.0167 per Right until the expiration of the rights or 10 days after any party acquires 15 percent of more of the Company's common stock. Rights are exercisable until the Company's right of redemption discussed above has expired. The Rights have no voting power and, until exercised, no dilutive effect on earnings per share. If not previously redeemed, the Rights will expire on April 13, 1997. At June 30, 1995, 127,583,148 shares were reserved for Common Stock Purchase Rights. At June 30, 1995, a total of 131,509,525 shares of authorized stock were reserved for the above purposes.\n15. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nSCIENTIFIC-ATLANTA, INC., AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1995 (In Thousands)\nNotes:\n(1) Represents recoveries on accounts previously written off, and in fiscal 1993, the $167 acquired with purchase of Nexus Engineering Corp.\n(2) Amounts represent 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.\nScientific-Atlanta, Inc. (Registrant)","section_15":""}
{"filename":"318346_1995.txt","cik":"318346","year":"1995","section_1":"Item 1: Description of Business\nTASA PRODUCTS LIMITED (hereinafter call the \"Partnership\"), is a Washington State limited partnership organized as of June 19, 1980 for the purpose of acquiring the rights in a group of related electronic products and developing these products further to a point where they could be commercially produced and marketed. The Partnership conducts no other business. Michel E. Maes and James R. Steffey are General Partners, and may remain as General Partners for the life of the Partnership unless removed pursuant to the Partnership Agreement. The sale of the Limited Partnership Interests in the Partnership were made pursuant to Registration Statement No. 2-68566 filed with the Securities and Exchange Commission and declared effective on November 7, 1980. The purchasers of said Limited Partnership Interests for Phases 1, 2, 3, 4, 5 and 6 of the Partnership are the Limited Partners of the Partnership as of December 31, 1981.\nThe Partnership's business is more fully described under the caption \"Projects of the Partnership\" in the Prospectus forming a part of the Registration Statement described above (hereinafter called the \"Prospectus\"), which, except for the balance sheet and report of accountants contained herein, is incorporated herein by this reference for all purposes.\nThe Partnership has no employees. The partnership originally licensed the manufacture and sale of its products to Communications Research Corporation, (CRC), a subsidiary of Energy Sciences Corporation, (ESC). The Partnership subsequently has licensed LINC Technology Corporation, an affiliate of the General Partners, as more fully described in Item 7 below. TASA's principal products currently being sold by LINC are the Data Over Voice Encoder, (DOVE), and Line Carrier Modem, (LCM).\nItem 2:","section_1A":"","section_1B":"","section_2":"Item 2: Properties\nThe Partnership does not have any principal plants or physical properties.\nItem 3:","section_3":"Item 3: Legal Proceedings\nThe staff of the Securities and Exchange Commission's Division of Enforcement recommended to the Commission that it authorize the staff to file a civil injunctive action against Energy Sciences Corporation, Michel E. Maes, James R. Steffey, and the Partnership to require timely filing of reports with the commission. Such an injunction was entered on June 25, 1986. All subsequent reports have been timely filed.\nOn April 29, 1986, TASA Products Limited and Energy Sciences Corporation filed petitions for reorganization under Chapter 11 of the Bankruptcy Laws. The Petitions were filed in the United States Bankruptcy Court for the Western District of Washington, at Seattle, as Case No.'s 86-02993- Wll and 86-02994-Wll.\nEnergy Sciences Corporation was dismissed from Chapter 11 on May 13, 1988. ESC had financial dealings and intercompany transactions with the partnership. The assets of ESC, which included amounts owed by the partnership to ESC and the license rights to manufacture and market the partnership's products granted by the partnership to a subsidiary of ESC, were foreclosed upon by the sole secured creditor of ESC, the law firm of Murphy, Elgot & Moore, but the full effect on the partnership has not yet been determined. (See item 7 below).\nOn October 16, 1989 the United States Bankruptcy Court ordered that the partnership's Chapter 11 be converted to a Chapter 7. Mr. Ronald Brown of Leach, Brown & Andersen, Seattle Washington, was appointed trustee. On May 11, 1990, the General Partners of the partnership filed an ammended motion to dismiss the Chapter 7. This motion was granted and the partnership is no longer in bankruptcy..\nItem 4:","section_4":"Item 4: Submission of Matters to a Vote of Security Holders\nNone\nItem 5:","section_5":"Item 5: Market Price of and Dividends on the Registrant's Common Equity Related Security Holder Matters\n(a) There is no market for the Securities of the Registrant.\n(b) There are 588 investor limited partners as of December 31, 1995.\n(c) The partnership does not pay dividends. Royalties, based on a percentage of gross sales of the partnership products, if any, made by a licensee of the partnership's products are to be distributed to the partners, less reserves and payments for partnership operating, maintenance and reporting expenses as determined by the General Partners. Under terms of the present license agreement in place, royalties were owed on amounts collected by the licensee on sales made after September 1991 to be accrued and paid in the following accounting quarter starting with the first quarter of 1992. See Item 7 below.\nItem 6:","section_6":"Item 6: Selected Financial Data\nTASA Products Limited is a Limited Partnership and the partners hold partnership interests rather than stock. A summary of financial activity for 1995 is a follows:\nRoyalty Revenues $ 0.00 Other Revenues 0.00 Loss from Continuing Operations (Reporting Expenses) ($ 0.00) Net Income per Partnership Unit 0.00\nTotal Assets $ 0.00 Long Term Obligations $2,384,819.00\nRoyalty Payments to Partners per Unit 0.00\nItem 7:","section_7":"Item 7: Management's Discussion and Analysis of the Financial Condition and Results of Operation\nThe partnership owns the proprietary rights to certain products which are licensed to LINC Technology Corporation as described more fully below. The partnership conducts no operations itself and its revenues will be solely from royalty income. Under the terms of a new license now in effect, no sales were subject to royalties in 1995. Tax, Securities and Exchange Commission, and Partnership Reporting expenses were not charged to the partnership in 1995. There has been no change in the net assets.\nWhen ESC's bankruptcy was dismissed in May 1988, all remaining assets were repossesed by the sole secured creditor of ESC, Murphy, Elgot & Moore, represented by Mr. Thomas Murphy. These assets are primarily amounts owed to ESC by the partnerships and the rights to produce electronics products at CRC. The General Partners began discussions with Mr. Murphy, (who was also counsel for ESC and the partnerships), on plans to recommercialize the electronic products. They were joined by Mr. Keith Nichols, who had purchased a portion of the electronics inventory from CRC when ESC was still in Chapter 11. After conducting preliminary market research and reaching a basic understanding with Mr. Murphy, a new company was formed in September 1988, called LINC Technology Corporation. The company is owned, at present, by Messrs. Maes, Steffey, and Nichols in the amount of 19% each; Mr. Murphy owns 10% and the balance of 33% is owned by outside investors. Mr. Nichols left the company in 1991 and is no longer an active participant, but remains a stockholder. LINC was formed, and was initially privately financed with $49,000 of cash, plus donated time, to pursue a variety of opportunities in electronics and data communications. LINC believes that a market remains for the partnership's products. Continued emphasis is on LCM and DOVE.\nThe Partnership made only one attempt to negotiate a license for its products following the dissolution of Energy Sciences Corporation and its subsidiary, Communications Research Corporation (the initial licensee), in 1988. A non-affiliated company had been formed in 1987 called CRC, Inc., of which Mr. Keith Nichols was a co-founder and partner. (As described above, Mr. Nichols was subsequently a co-founder of LINC Technology Corporation in 1988, along with Mr. Steffey and Mr. Maes, general partners of the partnership). CRC, Inc. purchased inventory of the partnership's products in 1987 from the Energy Sciences Corporation Trustee. Because there are no patents or trade secrets covering any of the partnerships products, the owners of CRC, Inc. felt no responsibility to pay royalties to the partnership (and had no legal obligation to do so) when the issue was discussed with them. It was felt that this would be the case with any outside third party the general partners might approach. When Mr. Nichols expressed a desire to pursue the market more aggressively than CRC, Inc. was doing, Mr. Steffey and Mr. Maes proposed the formation of LINC Technology Corporation with the understanding that LINC would pay royalties on partnership products in the future. LINC was formed and Mr. Nichols subsequently sold the inventory of partnership products he owned personally to LINC for ultimate resale to outside customers. The royalty arrangement arrived at between the partnership and LINC was modeled after one negotiated with New Detonics Manufacturing Corporation (NDMC) for a group of affiliated partnerships, as part of the sale of assets of another Energy Sciences Corporation subsidiary, Detonics Manufacturing Corporation to NDMC. That royalty arrangement called for 4% royalties and a four year deferment.\nThe license entered into between the partnerships and LINC calls for a royalty building to 5% of gross sales to be paid to each partnership on sales, if any, of its own products (compared to the prior formula with CRC which ranged from 10% down to 6%). Royalties are paid on amounts actually collected by LINC from sales of partnership products and calculated and accrued in the following quarterly accounting period. The details of the royalty arrangement are as follows: Initial royalties of 1% are payable on collected invoices for sales starting in September 1990, followed by 2% in September 1991 and 5% per year starting in September 1992 and thereafter. The royalty is divided between partnerships in the case of joint ownership of product rights. TASA receives 45% of the 5% royalty from sales of DOVE and 90% of the 5% from sales of LCM. In 1995, a new royalty agreement was put into effect in order to reduce administrative expenses. Under the new plan, no royalties will accrue to the partnership until a total of $300,000.00 of sales on products licensed to LINC Technology Corporation have been generated and collected. At that point, a lump sum royalty payment of $15,000.00 will be paid to the patrnership group of TASA Products Limited (the Partnership), Energy Sciences Limited Partnership, Telemetric Controls Limited Partnership, and Communications Link Limited Partnership. After such payment, again no royalty will accrue or be owed until another $300,000.00 in sales has occured, after which a second lump sum of $15,000.00 is due, and so forth. LINC Technology Corporation will be responsible for periodic mailings to the partnership at its expense. Bases on IRS regulations, no partnership 1065 tax returns and K-1s will have to be filed or issued until the royalty accrues.\nLINC Technology Corporation's address is 6855 176th Ave NE, #252, and telephone 206-882-2206. LINC Technology Corporation also uses the DBA of DATA-LINC Group.\nAs previously reported, one remaining item from the dismissal of Energy Sciences Corporation's bankruptcy is the residual amount owed to ESC by the partnership, and now to the law firm of Murphy & Elgot. The general partners expect to settle the matter by the payment to Murphy & Elgot of a small percentage of the partnership's overall royalty cash flow.\nThe partnership's ultimate success is dependant on LINC's ability to generate sales and to obtain capital, which can not be assured, and remains difficult. Total sales at LINC in 1995 were still a modest $249,000.00 compared to $155,000.00 for 1994 and $125,000.00 for 1993. Only about $60,000.00 of LINCs sales were on products licensed from the partnership.\nSince 1991, new product development work was been undertaken at Linc and other affiliates, including independent R&D efforts by the general partners personally, which created some products that interface with and complement the products owned by the partnership and could enhance sales of the partnership's products in the future. Sales for calender 1996 can not be predicted but are expected to remain modest. LINC has limited working capital and is not able to do advertising. LINC relies on Manufacturers Representatives to generate most of its sales leads. Production is self funded through inventory turnover. LINC's major marketing effort remains on industrial data communications\nItem 8:","section_7A":"","section_8":"Item 8: Financial Statements and Supplementary Data\n(a) Unaudited financial statements, submitted in accordance with Reg. 210.3-11 of Regulation S-X, are attached as Exhibit 1 and are herein incorporated by reference.\nItem 9:","section_9":"Item 9: Disagreements on Accounting and Financial Disclosure Matters\nTASA has no independent accountant at present.\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. Management of the Partnership is vested in the General Partners. The name of each present General Partner of the Partnership, the nature of other positions held by him, and his educational background is set forth below.\nMichel E. Maes, age 58, graduated from the University of Washington in Physics in 1959. He subsequently did post-graduate work in various phases of physics. He was an engineer of the Boeing Company from 1959 to 1961; an engineer and later Director of Advanced Projects for Rocket Research Corporation, from 1961 to 1966; President of Explosives Corporation of America and Chairman of the Board of Petroleum Technology Corporation, both subsidiaries of Rocket Research Corporation, from 1966 to 1971. Up until December 5, 1986, Mr. Maes served as Chairman of the Board at ESC. Mr. Maes is now President of LINC Technology Corporation.\nJames R. Steffey, age 59, is a graduate of the University of Washington in Physics, with post-graduate study in plasma physics. He was Director of International Operations at Explosives Corporation of America from 1969 to 1972. From 1972 to 1973 he was a consultant with Stevens and Company, an investment counseling firm. He joined ESC in 1973 and until December 5, 1986, was President and a Director of ESC. Mr. Steffey is now Vice-President of Marketing of LINC Technology Corporation. Mr. Steffey was not closely involved with the technical aspects of the Partnership's activities.\nItem 11:","section_11":"Item 11: Executive Compensation\nThe Partnership has no directors, officers or employees and thus pays no direct compensation. The General Partners were paid a one-time management fee in 1982. The General Partners and their affiliates received certain compensation as described in the table \"Compensation and Fees to General Partners and Affiliates\" in the Prospectus which is hereby incorporated by reference.\nItem 12:","section_12":"Item 12: Security Ownership of Certain Beneficial Owners and Management\n(a) The only outstanding voting securities of the Limited Partnerships are those Limited Partnership interests owned by the investors or their successors in interest. No single person owns 5% or more.\n(b) The General Partners hold no limited partnership interests. However, they have interests in Profits and Losses and Cash Available for Distribution of 5%. The interest in Cash Available for Distribution is subordinated to the Limited Partners' receipt of distributions equal to their capital contributions.\n(c) There are no agreements or arrangements known which could affect control of TASA.\nItem 13:","section_13":"Item 13: Certain Relationships and Related Transactions\nAs described in the prospectus, TASA was a party to several contracts with affiliates of the Limited Partners which resulted in compensation to the General Partners. See \"Compensation and Fees to the General Partners and Affiliates\" and \"Certain Transactions\" in the Prospectus, which hereby is incorporated herein by reference. Also see Item 7 above.\nPART IV\nItem 14:","section_14":"Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K\na) Documents filed as part of this Annual Report: Unaudited financial statements, filed in accordance with Reg. 210.3-11 of Regulation S-X.\nb) Reports on Form 8-K: None\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nRegistrant: TASA PRODUCTS LIMITED\nBy: Date:\nMichel E. Maes, General Partner\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacity and on the date indicated.\nBy: Date:\nMichel E. Maes, General Partner\nSupplemental Information to be furnished with Reports filed pursuant to Sections 15(d) of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act.\nNo annual reports or proxy materials have been or will be sent to security holders.\nTASA PRODUCTS LIMITED BALANCE SHEET DECEMBER 31, 1995 AND 1994 (UNAUDITED)\n12\/31\/95 12\/31\/94\nASSETS\nCurrent Assets: Cash $ .00 .00 Royalties Receivable .00 1569.00 __ __\nTOTAL CURRENT ASSETS $ 0.00 1569.00\nIntangible Assets Less Amortization .00 .00 Receivable from Affiliates Less Allowance .00 .00\nTOTAL ASSETS 0.00 1569.00\nLIABILITIES AND PARTNERS' EQUITY\nCurrent Liabilities: Accounts Payable $ .00 1569.00 Taxes Payable .00 .00 Reporting Reserve .00 .00\nTOTAL CURRENT LIABILITIES .00 1569.00\nPayable to Affiliates 109,443.00 109,443.00 Interest Payable 875,376.00 875,376.00 Notes Payable 1,400,000.00 1,400,000.00 __ __\nTOTAL LIABILITIES 2,384,819.00 2,386,388.00\nPartners' Capital (2,384,819.00) (2,384,819.00) __ __\nTOTAL LIABILITIES AND PARTNER'S EQUITY .00 .00\nThe accompanying notes are an integral part of the financial statements\nTASA PRODUCTS LIMITED STATEMENT OF INCOME FOR THE YEAR ENDING DECEMBER 31, 1995, 1994 & 1993 (UNAUDITED)\n12\/31\/95 12\/31\/94 12\/31\/93\nRevenue Royalty Revenue $ 0.00 1569.00 2833.00 Other Revenue .00 .00 .00 __ __ _\nTOTAL REVENUE 0.00 1569.00 2833.00\nCosts and Expenses: Bank Charges .00 .00 .00 Commissions .00 .00 .00 Filing Fee for 10-K .00 250.00 250.00 Operating Expense (Reporting) .00 1319.00 1258.00 Reporting Reserve .00 .00 1325.00 Professional Fees .00 .00 .00 Supplies .00 .00 .00 Taxes .00 .00 .00 __ __ __\nTOTAL COSTS AND EXPENSES 0.00 1569.00 2833.00\nNet Income (Loss) .00 .00 .00\nThe accompanying notes are an integral part of the financial statements\nTASA PRODUCTS LIMITED STATEMENT OF CASH FLOWS FOR THE YEARS ENDING DECEMBER 31, 1995, 1994, & 1993 (UNAUDITED)\n12\/31\/95 12\/31\/94 12\/31\/93\nNet Cash From Operating Activities $ .00 .00 .00 Net Cash Used By Investing Actvts. .00 .00 .00 Net Cash From Financing Actvts .00 .00 .00 Net Increase In Cash .00 .00 .00 Cash At Begining of Period .00 .00 .00 Cash At End Of Period .00 .00 .00\nTASA PRODUCTS LIMITED STATEMENT OF PARTNERS' CAPITAL FOR THE YEAR ENDING DECEMBER 31, 1995, 1994 & 1993 (UNAUDITED)\n12\/31\/95 12\/31\/94 12\/31\/93\nContributions by Partners .00 .00 .00\nCapital Withdrawals .00 .00 .00\nSyndication Costs .00 .00 .00\nAccumulated Surplus (Deficit) (2,384,819.00) (2,384,819.00) (2,384,819.00)\nNet Income (Loss) .00 .00 .00\nPartners' Capital (Deficit) (2,384,819.00) (2,384,819.00) (2,384,819.00)\nThe accompanying notes are an integral part of the financial statements\nTASA PRODUCTS LIMITED (a Washington State limited partnership) NOTES TO THE FINANCIAL STATEMENTS\n1. Partnership Organization and Operations\nTASA Products Limited, a Washington State limited partnership (\"the partnership\"), was formed on June 19, 1980 for the purpose of raising certain capital through the public offering of Limited Partnership interests (4,100 units; $1,000 per unit), and acquiring the rights to and conducting research and development with respect to a group of electronic products. Subsequently, the Partnership commenced limited manufacturing and marketing activities for certain products. The Partnership shall continue for a period of thirty (30) years from the date of organization unless the Partnership is sooner dissolved according to the provisions of the Amended Certificate of Limited Partnership and Agreement. The Partnership has two general partners and limited partners comprised of certain investor groups.\nResearch and development was completed and sales of products began. For admission to the Partnership, an investor was assigned to a group (one group is associated with each phase), based on the timing of receipt of the contribution. Sale of all of the 4,100 limited partnership units was completed in 1981. The units of the Partnership are nonassessable.\nPartners' Capital\nInitial contributions aggregating $4,100,00 were made by the Limited Partners. The General Partners have not and will not make any capital contributions. Partners share in income or loss of the partnership as set forth below.\nAllocation of Income, Loss and Cash Distributions\nThe loss attributable to the research and development efforts of each phase was allocated to the partners included in such phase as follows:\nLimited Partners, pro rata 98% General Partners 2%\nAll income and\/or loss attributable to the operations after the research and development program has been completed, including revenues derived from the sale or other disposition of any rights or interest, shall be allocated as follows:\nLimited Partners, all groups, pro rata 98% General Partners 2%\nThe Limited Partners shall receive one hundred percent of the cash available for distribution, until such time as the Limited Partners\n1. Partnership Organization and Operations, continued\nhave received in distribution an amount equal to the cumulative capital contributions received from Limited Partners.\nAfter the Limited Partners have received cash distributions in an amount equal to the cumulative capital contributions received from Limited Partners, the General Partners will receive one hundred percent of the cash available for distribution, until such time as the General Partners have received an amount equal to five percent of the cumulative capital contributions received from Limited Partners.\nThereafter, the cash available for distribution shall be allocated as follows:\nLimited Partners, all groups, pro rata 95% General Partners 5%\nUpon dissolution of the Partnership, proceeds of the liquidation will be applied in accordance with the terms of the Amended Certificate and Agreement of Limited Partnership in the following order of priority:\n1) To the payment of liabilities of the Partnership and expenses of liquidation;\n2) To the setting up on any reserves which the General Partners may deem reasonably necessary for any contingent or unforeseen liabilities or obligations of the Partnership, or of the General Partners, arising out of or in connection with the Partnership;\n3) To the repayment of the Limited Partners' contributions to the capital of the Partnership, plus an amount equal to six percent of the capital contributions per annum cumulative, less the sum of prior distributions to investors from cash available for distribution;\n4) Any balance then remaining shall be apportioned among all the partners as follows:\nLimited Partners, pro rata 98% General Partners 2%\nPursuant to the terms of the Partnership Agreement, the General Partners are not required to contribute to the Partnership any deficit in their capital accounts which exist after application of proceeds of liquidation as set forth above.\nThe Partnership filed for Bankruptcy protection under Chapter 11 in April 1986. The Chapter 11 was converted to a Chapter 7 by the Bankruptcy Court in October 1989 and then the Bankruptcy was dismissed in June 1990. The dismissal did not involve any discharge of the Partnership's\n1. Partnership Organization and Operations, continued\nobligations, some of which were accrued property taxes in the amount of under $1,000. These were paid by the General Partners and are now included in the Amounts Payable To Affiliates.\n2. Significant Accounting Policies\nBasis of Reporting\nThe records of the Partnership are maintained using the accrual method of accounting. A substantial portion of the transactions of the Limited Partnership have been, and will continue to be, with the entities affiliated with the General Partners.\nInventories\nThe partnership has no inventories.\nProperty and Equipment\nThe partnership has no tangable properties.\nOther Assets\nThe partnership has no tangable assets.\nOffering Costs\nOffering costs, including sale commissions to brokers for sales of limited partnership interests were charged directly to the respective partners' capital account.\nIncome Taxes\nThe Partnership is not a tax-paying entity. No provision is made in these financial statements for federal and state income taxes.\nResearch and Development Expenses\nResearch and development costs paid or accrued under terms of a contract with an affiliated company were charged to expense in the period in which the obligation was incurred.\nNet Loss Attributable to Limited Partners Units\nThe net loss attributable to each $1,000 limited partnership unit represents the loss for the period allocated to limited partners divided by the number of partnership units outstanding at the end of the period. The net loss allocated to specific individual units will vary from the amount shown depending on the group to which a limited partner has been assigned.\n3. Notes and Accrued Interest Payable to an Affiliated Company\nAt December 31, 1980, the Partnership executed a promissory note under the terms of a research and development contract. The note in the amount of $1,148,000 bears interest at the rate of eight and one-half percent compounded annually. Upon completion of the Partnership funding in 1981, an additional note of $252,000 with the same terms was executed. The principal and accrued interest was to be paid in full no later than December 31, 1986, and are collateralized by a pledge of certain rights to inventions held by the Partnership. The date for repayment could be extended at the request of the Partnership to December 31, 1993, provided the Partnership has made payments toward the principal and the accrued interest by December 31, 1986. After December 31, 1990, interest shall be at a rate of ten percent compounded annually. Failure of the Partnership to complete payment in full of the entire contract price plus interest on or before December 31, 1986 or such other date if the payment period is extended gives the affiliate the right to foreclose the pledge of the Partnership's ownership interest in the rights to inventions referred to above. In the event the Partnership assigns, licenses or sells its rights to the inventions to any other party, the affiliate retains an interest in any royalties or income from such assignment, license or sale until such time as the note is paid in full.\nDue to the filing of Chapter 11 by the Partnership's affiliate, and by the Partnership, and due to the cessation of commercial activity relating to the Partnership's products, all accrual of interest and right of foreclosure was suspended for the years beyond 1987. The Chapter 11 proceeding of the Partnership's affiliate was dismissed on May 13, 1988. As of March 28, 1995, no final settlement has been reached with the sole secured creditor of the Partnership's affiliate regarding the debt owed by the Partnership.\n4. Transactions with Related Parties\nA substantial portion of the transactions of the Partnership have been, and are anticipated in the future to be, with the General Partners and their affiliates. Significant transactions with these parties are summarized in the following paragraph.\nManagement fees to the General Partners of $18,500 and $84,000 (2.5% of the limited partners' contributions), were incurred in 1981 and 1980, respectively. The fees represent compensation to the General Partners for organization of the Partnership and for expense incurred in connection with the offering of the limited partnership units. The fees were allocated to organization and offering costs.\nAn affiliate of the General Partners entered into a fixed price research and development contract with the Partnership. The affiliate received $756,000 (cash of $504,00 and a promissory note in the amount of $252,000), and $3,444,000 (cash of $2,296,000 and a promissory note in the amount of $1,148,000), in 1981 and 1980, respectively, as payment for conducting all present and future research and development of the Partnership. The affiliate's costs for performing the research and development activities included certain general and administrative and overhead costs allocated by its parent company, an affiliate of the General Partners.\nPrior to transferring product rights under the licensing agreement, the Partnership can manufacture and market any products developed. In 1982, the Partnership elected to do so and entered into a manufacturing and marketing agreement whereby the Partnership reimbursed the affiliate for all costs incurred in the manufacturing and marketing activities. In addition, the affiliate would receive 40% of net profits (as defined in the agreement), derived from the manufacture and sale of the products produced under this agreement. Substantially all operating costs of this affiliate have been allocated to the Partnership under this agreement.\nThe Partnership has been charged for certain general and administrative services provided by other affiliates of the General Partners. The General Partners have and will provide management, research and development and other technical services to affiliates which provide services to the Partnership. The General Partners are and will be compensated by the affiliated companies for such services.\nA new license agreement has been entered into by the Partnership with a newly created entity, which, as with the prior license, the General Partners are part owners, officers and directors. The General Partners have received and are expected to receive compensation in the future from this entity.\n5. Commitments and Contingencies\nThe Partnership has entered into agreements with several individuals to obtain title to inventions and designs relating to the electronic products the Partnership is developing. Pursuant to the terms of the agreements, the individuals are entitled to royalties received by the Partnership under licensing agreements associated with the products.\nThe Partnership has entered into a licensing agreement with an affiliate of the General Partners providing manufacturing and marketing services under which the licensee has, upon transfer of the product rights, the exclusive right to manufacture, use and sell any products successfully developed by the Partnership. The terms of the agreement extend throughout the life of the Partnership. In return for granting this license, the Partnership shall receive royalties from the licensee as set forth in the licensing agreement for its own products. The details of the royalty arrangement are as follows: Initial royalties of 1% are payable on collected invoices for sales starting in September 1990, followed by 2% in September 1991 and 5% per year starting in September 1992 and thereafter. (Accounting is done in the quarter following the quarter in which the sales receipts occur). The royalty is divided between partnerships in the case of joint ownership of rights. TASA receives 45% of the 5% royalty from sales of DOVE and 90% of the 5% from sales of LCM.","section_15":""}
{"filename":"894049_1995.txt","cik":"894049","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant is engaged in the development, manufacture, sale and marketing of its UC'NWIN System, an in-store interactive informational solutions software program designed to be furnished to corporations in the US, UK, Europe and Asia, the system is delivered through interactive kiosks and websites on the Internet. Corporations use the registrant's software programs and delivery systems to disseminate catalogs, product information, promotional offers, to collect and collate consumer research data and provide a direct communications link with consumers. The software programs are designed to serve as sales driving, value added vehicles that will build consumer loyalty to manufacturer and retailer and thus increase overall sales. UC'NWIN's exclusive merchandising system is believed by management to provide a significant competitive advantage for participating retailers.\nThe registrant through its wholly owned U.S. subsidiary, UC'NWIN Systems, Inc., has licensed the worldwide rights (except for the United States) to Winners All Ltd., to manufacture or lease the UC'NWIN system. By agreement dated December, 1994 and as subsequently amended in June, 1995, the registrant through its wholly owned U.S. subsidiary, UC'NWIN Systems, Inc. and Winners All Ltd. (a wholly owned subsidiary of Winners All International, Inc.) created WIN Network, LLC., (\"WinNet\") a limited liability company, registered under the laws of the State of New York, to exploit the UC'NWIN system. The registrant and Winners All Ltd. contributed the tangible and intangible rights to the UC'NWIN System (other than those sub-licensed to Winners All Asia Pacific) with the registrant owning 51% of WinNet and Winners All Ltd. owning the remaining 49%.\nReference is made to Item 1, pages 1-14 of Form 10 of the registrant, as amended, SEC File # 0-22954, for full information concerning the registrant's entire business history, which is incorporated herein by reference.\nRECENT DEVELOPMENTS\nThe Board of Directors of registrant and the Board of Directors of Winners All International, Inc., a Delaware corporation the shares of which are traded on NASD Bulletin Board, (\"Winners All\") announced an agreement in principle to combine the two companies on the basis of one share of common stock of Winners All to be issued to registrant's shareholders for each outstanding share of common stock of registrant. Winners All (NASD (BB)-\"WINA\") is the parent of Winners All Ltd., the licensee of the worldwide rights (except for the United States) for the registrant's UC'NWIN Systems. The joint announcement cited a reduction of overhead expenses, combining of research and development costs and the elimination of inter-company license fees as significant factors contributing to the decision to combine. The proposed merger did not take place at that time but negotiations have continued.\nUnder an agreement made as of December 1, 1994, and as subsequently amended in June 1995, the registrant's subsidiary, UC'NWIN Systems, Inc. (the \"Subsidiary\") and Winners All Ltd. (an Isle of Jersey corporation all the shares of which are owned by Winners All) formed WIN Network, LLC (\"WinNet\") a limited liability company under the laws of the State of New York to minimize operation costs and maximize the exploitation of the UC'NWIN System. The Subsidiary and Winners All Ltd. contributed the tangible and intangible rights to the UC'NWIN System (other than those sub-licensed to Winners All Asia Pacific) the Subsidiary owns 51% of WinNet with Winners All Ltd. owning the remaining 49%. Winners All Ltd. has agreed to contribute to WinNet upto $5,000,000 of capital of which $3,182,000 has been received. These contributions started being funded in January 1995.\nIn December 1995, the registrant acquired 5,825,000 shares of common stock of Winners All, or 41% of the outstanding common stock, these shares of common stock were acquired by issuing one share of common stock of the registrant for four shares of common stock of Winners All. At March 31, 1996 the market price of such stock was $0.09 per share. In January, 1996, the Company acquired another 825,000 shares of common stock in Winners All International, Inc. for 206,250 shares of common stock in the Company. The Joint Venture is governed by a four member executive committee consisting of three representatives of the Subsidiary who are directors of the Subsidiary and one representative of Winners All, Ltd. who is a director of Winners All. A management committee of four (consisting of four members of the executive committee) shall manage day to day operations. The executive committee serves at the pleasure of and is accountable to the members of the Joint Venture (the Subsidiary and Winners All Ltd.) and is elected by the unanimous vote of the members.\nDuring March 1995, WinNet had commenced the placement of 137 kiosks for a joint promotion with Shell Oil Company. The promotion included planning and advertising for multiple household name products on behalf of manufacturers. WinNet has since received a strong interest from such advertisers for continuing similar promotional efforts for a fee. WinNet is aggressively pursuing signing advertising contracts with these manufacturers and other interested parties. Additionally, WinNet has received significant interest in supplying kiosks and software programs for a proprietary system and networks under long term lease contracts. Additional promotional efforts are being negotiated with multi-national companies in the United Kingdom and Europe for the use of the UC'NWIN system. Aside from Royalty income of $531,346 and $583,332 for the years ended December 31, 1994 and 1993 respectively, the registrant has not generated any other revenues from the UC'NWIN System. Such royalty revenues have ceased pursuant to the WinNet agreement as above indicated. Also, WinNet has initiated discussions with financial institutions to secure financing for the manufacturing of kiosks related to the leasing of proprietary systems and networks.\nWinNet has retained counsel to research the legal implications surrounding WinNet's purchases of Common Stock in Winners All International, Inc.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nNeither the registrant nor the subsidiary owns any real estate. The subsidiary presently leases 4,000 square feet of office and warehouse space at Powerline Business Center, 5601 Powerline Road, Unit 403-404, Fort Lauderdale, Florida 33309, from which the Subsidiary and WinNet operate. The lease is for five years, terminating December 1996 at an annual rental of $39,700. An additional 2,200 square feet at 5601 Powerline Road, Unit 306 is presently leased as additional warehouse space for a period of two years terminating February 1997, at an annual rental of $20,000. There are twelve offices and 2,400 square feet of warehouse space at the Powerline Business Center location in Fort Lauderdale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(1) On January 18, 1996 Jerome Schulman (\"Schulman\"), sued the registrants wholly owned subsidiary, UC'NWIN Systems, Inc., (\"the Company\"), as well as Lynx Development Corporation (\"Lynx\"), in the United States District for the Southern District of Florida. The original action was dismissed by the Court sua sponte, for failure to allege sufficient jurisdictional allegations. Thereafter on February 20th, 1996, Schulman refiled the action in the same Court. Schulman has brought a four count Complaint suing the company for fraud in the inducement, breach of promissory note and civil theft. Schulman has also sued Lynx separately for breach of guaranty of the promissory note. The Company and Lynx filed a motion to Dismiss and Motion to Strike which has been fully briefed by the parties and is pending before the Court. All of Schulman's claims are premised upon the alleged failure to pay a $200,000 promissory note upon maturity and failure to provide certain warrants and shares in the Company. No discovery has yet been conducted but the Company believes there are meritorious defenses and counter claims arising out of the conduct of Schulman in connection with his acquisition of Company stock. Also, the Company is exploring a method by which the claim can be amicably resolved.\n(2) On March 22, 1996, Raymond Kalley, as Trustee of the EB Trust and the PB Trust, (\"Plaintiff\"), sued UC'NWIN Systems Corporation (\"the Company\") in the Southern District Court for the Southern District of Florida (Miami Division). In this five count Complaint, Plaintiff has sued the Company for an alleged violation of Section 18 of the Securities Act of 1934 (15U.S.C.78r). Plaintiff alleges that the Company acting singly and in concert, filed misleading reports under the Securities Exchange Act 1934, including without limitation, the filing of form 10-K. Plaintiff failed to identify which form 10-K was allegedly misleading or how Plaintiff has been damaged by this alleged misleading statement. Although Plaintiff alleges that it purchased stock in the Company, from another shareholder in a private transaction unbeknown to the Company, for approximately $1,000,000, Plaintiff does not identify the damage that it allegedly incurred. The Company believes this lawsuit is without merit and intends to defend this lawsuit vigorously and expects to file a Motion to Dismiss Plaintiff's Complaint no later than May 6, 1996.\n(3) On April 17, 1995 AG Industries, (\"Plaintiff\"), sued Winners All International, Inc., (\"Win\"), and UC'NWIN Systems, Inc., (\"the Company\") for a breach of contract and causes of action for unjust enrichment and breach of implied contract. AG Industries seeks damages in excess of $400,000. On August 22, 1995 the Company filed a Motion to Dismiss and Alternative Motion for a Change of Venue. AG Industries has responded and opposed the defendants' motion but the Court has not yet ruled on it. There has been no discovery and it is too early to evaluate this case.\n(4) On January 9th, 1996 a former employee, (\"the Plaintiff\"), filed a Charge of Discrimination, (\"Charge\"), against UC'NWIN Systems, Inc. and Win Network LLC., (\"the Company\"), with the Equal Employment Opportunity Commission (\"EEOC\"). The Plaintiff voluntarily resigned her position with the Company in October 1995 and waited four months to file her claim. The Company has filed a statement of position denying the allegations of the Charge. At the present time, the EEOC is investigating the charge and will ultimately make determinations of \"cause\" or \"no cause\". At this time the Company is unable to predict the likelihood of a favorable or unfavorable result in this matter.\n(5) On July 3rd, 1995 Brian A. Travis, an ex-officer of Win Network LLC and Winners All International, Inc. files an action against Win Network LLC to enforce a purported Employment Agreement which he claims was entered into between Win Network LLC and Mr Travis in which Mr Travis claims he is entitled to a ten year employment term with damages of $10,000,000. Mr Travis also sued Winners All International, Inc. as a purported guarantor. Win Network LLC is comprised of UC'NWIN Systems, Inc., a subsidiary of UC'NWIN Systems Corporation and Winners All Ltd, a subsidiary of Winners All International, Inc. On March 5th, 1996 both defendants filed a motion to dismiss the Travis action on the grounds that the purported Employment Agreement violated applicable provisions of the New York Limited Liability Corporation Law, the Win Network LLC Operating Agreement and the Winners All International, Inc. by-laws. Defendants motion is now pending before the Court.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\n(N\/A)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\n(N\/A)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. YEAR ENDED DECEMBER 31\nAS OF DECEMBER 31\n(1) No dividends have been declared by the registrant to date.\n(2) The aforementioned data has been restated to conform with U.S. GAAP since prior financial data was reported under Canadian GAAP. ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nCURRENT OPERATIONS\nThe registrant's business activity is designing, developing, marketing and producing hardware and software for a computerized inter-active media marketing program known as \"The UC'NWIN System\". It is the intention of management to lease these systems, or otherwise place systems in locations and obtain advertising revenues from a wide variety of businesses. In 1992, the registrant licensed the worldwide rights to manufacture and lease the UC'NWIN System, exclusive of the United States, to Winners All Ltd. (\"WIN\") a wholly owned subsidiary of Winners All International, Inc., which subsequently granted an exclusive sub-license for certain Pacific Rim countries to Winners All Asia Pacific. The registrant is continuing to market its UC'NWIN system, although, with the exception of royalties of $531,346 and $583,332, no leases or advertising revenues have been received for the year ended 1994 and 1993, respectively. In 1995 the Company received $178,770 of rental and service revenues relating to the UC'NWIN System.\nIn December 1994, WIN and UC'NWIN Systems, Inc., a subsidiary of the registrant created Win Network, LLC (\"WinNet\"), a limited liability company to exploit the UC'NWIN System. WIN and UC'NWIN Systems, Inc. contributed to WinNet the tangible and intangible rights to the UC'NWIN System (other than those sub-licensed to Winners All Asia Pacific). WIN owns 49% of WinNet and UC'NWIN Systems, Inc. owns the remaining 51%. Since its formation, WinNet has lost $178,246 of which $90,905 has been shown as a loss of WIN. WIN has agreed to contribute upto $5,000,000 of capital to WinNet, of which $3,182,000 has been received, contributions started being funded in January 1995.\nWIN has ceased paying royalties pursuant to the WinNet arrangement.\nDuring March 1995, WinNet commenced the placement of 137 kiosks for a joint promotion with shell Oil Company, and during September 1995 WinNet commenced the placement of 35 kiosks for Ignis Ltd in the United Kingdom promoting Gallaher Tobacco products. WinNet has since received strong indications of interest from advertisers for continuing similar promotional efforts for a fee. WinNet is aggressively pursuing advertising contracts with these manufacturers and other interested parties. Additionally, the registrant is developing additional software programs and kiosk delivery systems in the United States for BellSouth Mobility, in the United Kingdom for Ignis Ltd. promoting Gallagher Tobacco, and Total Oil (GB) Ltd. and in Asia for Allied Domeq. WinNet has received income of $178,770 up to December 31, 1995 and is receiving significant interest from corporations in leasing software programs and kiosks for proprietary systems and networks under long term contracts i.e. contracts under which the manufacturer has exclusive rights to the program. Additional negotiations are being undertaken with multi-national companies in the United States, United Kingdom, Europe and Asia for the use of the UC'NWIN System.\nAside from royalty income of $531,346 and $583,332 for the years ended December 31, 1994 and 1993 respectively, and the $178,770 in 1995 the registrant has not generated any other revenues from the UC'NWIN System. Such royalty revenues have ceased pursuant to the WinNet agreement as above indicated.\nThe registrant recognized a gain on the WinNet arrangement of $1,739,475 pursuant to Staff Accounting Bulletin No. 68 \"Accounting for sales of stock by a subsidiary\", for the increase in the carrying value derived from the direct sale of equity in a subsidiary, of which Winners All Ltd. contributed capital of $3,182,075.\nOperating expenses, for the year ended December 31, 1995, of $5,213,490 increased by $3,689,781 from the prior year. Operating and administrative expenses increased to $3,534,208 for the year ended December 31, 1995 from $1,202,525 for the year ended December 31, 1994 primarily due to increased professional fees and the increased payroll and related benefit costs after the formation of the joint venture. Advertising and marketing costs increased to $512,449 for the year ended December 31, 1995 from $275,789 from the year ended December 31, 1994. Additionally, the registrant increased the research and development costs to $102,000 for the year ended December 31, 1995 from $0 for the year ended December 31, 1994 primarily to produce software programs to be delivered on the World Wide Web and the Internet.\nOperating expenses, for the year ended December 31, 1994, of $1,523,709 basically remained the same from the prior year. Operating and Administrative expenses increased to $1,202,522 for the year ended December 31, 1994 from $ 885,829 for the year ended December 31, 1993 primarily due to the increased payroll and related benefit costs before the formation of the Joint Venture and the write-down of inventory for $130,000. Professional fees remained the same; approximately $440,000. The registrant reduced the advertising and marketing costs to $275,789 for the year ended December 31, 1994 from $448,471 for the year ended December 31, 1993 due to the decreased use of advertising consultants. Additionally, the registrant eliminated research and development costs, primarily due to formation of WinNet.\nOperating expenses, for the year ended December 31, 1993, amounted to $2,336,371. Out of its total operating expenses, the registrant incurred expenses of $447,002 for professional fees, $843,764 for depreciation and amortization, $158,307 for research and development, and $448,471 for expenses involving promotion, introduction, marketing, feasibility analysis, and advertising costs relating to the marketability of the UC'NWIN Systems.\nDISCONTINUED OPERATIONS\nEffective January 1992, Management decided to discontinue the operations of its former business activity of outbound automated telephone marketing and polling services. All associated costs of disposal have been reclassified as discontinued operations. During this period, restrictive legislation had the effect of causing the registrant to discontinue commercial advertising. During 1991 and 1990 the registrant made several unsuccessful attempts to sell the machines to overseas purchasers.\nFINANCIAL CONDITION AND LIQUIDITY\nThe registrant's working capital decreased to a $1,617,825 working capital deficiency, primarily due to the significant losses incurred during 1995. The Company has reduced its staff and overhead significantly in late 1995 and early 1996 to accommodate the limited working capital of the Company.\nThe registrant's working capital liquidity improved at December 31, 1994 to $2,118,670 as opposed to $671,754 at December 31, 1993, primarily due to the recognition of a $3,182,750 capital contribution to WinNet by Winners All Ltd. These monies were received by March 20, 1995. The registrant has since spent the $3,182,950 for the funding of operations, the promotional (Shell) roll-out described earlier and the purchase of certain assets including kiosks. The registrant is actively pursuing various financing alternatives to fund operations and future expansion efforts, including additional funding pursuant to Winners All Ltd.'s agreement to fund the operations of WinNet and discussions with financial institutions to secure financing for the manufacturing of kiosks related to the sale or lease of proprietary systems.\nThe registrant has continued merger negotiations with Winners All International, Inc. parent company of Winners All, Ltd. Winners All International, Inc.'s shares are traded on NASD (BB) under symbol \"WINA\". Although negotiations are continuing, no assurances can be given that such negotiations will result in a merger. Such a merger would minimize corporate overhead, administrative expenses and better utilize the working capital resources of the two companies for the promotion and development of the UC'NWIN System. The Company has acquired a 46% interest in Winners All International, Inc. At December 31, 1995 the cash position of the registrant increased to $14,304 from ($3,772).The change in cash is attributable to cash provided by operating activities of $178,770 and cash provided by financing activities of $2,000,000 including increase in debt.\nAt December 31, 1994 the cash position of the registrant decreased to ($3,772) from $48,879. The change in cash is attributable to cash expended by operating activities of $2,017,649, cash provided by financing activities of $681,558 including increase in debt of $596,955 sales of equity of $84,603 and cash provided by investing activities of $1,283,490. The foregoing takes into account an increase of minority interest of $1,583,918, sale of investments of $800,569 and acquisition of capital assets of $1,100,997.\nAt December 31, 1993 the cash position of the Company decreased to $48,879 from $1,100,071. The change in cash is attributable to cash provided by operating activities of $122,323, cash expended of $124,087 in financing activities including retirement of related party obligations of $257,710, sales of equity of $133,623 and cash expended of $894,033 in investing activities. The foregoing takes into account the acquisition of short-term investment of $300,509, acquisition of capital assets of $93,464, and the election by the registrant to exercise its stock option and acquire 400,000 shares of Winners All, Ltd. for $500,000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe required financial statements of the Registrant are set forth immediately following the signature page to this registration statement. See \"Item 14 - Exibits, Financial Statement, Schedules, and Reports on Form 8-K\" for index to the financial statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nOn January 12, 1996, the registrant having emigrated from Canada and become a Delaware corporation retained Mazars And Company, Certified Public Accountants, of 140 East 45th Street, New York to audit the financial statements of the registrant for the year ended December 31, 1995 and assist management and legal counsel in preparing the Form 10-K and the Management Discussion and Analysis.. Prior audits of the financial statements of the registrant had been completed by Iscove Gold & Glatt, Chartered Accountants, of 45 Clair Avenue West, Suite 200, Toronto, Oantario, Canada. At no time have their been any disagreements with Iscove Gold & Glatt on accounting or financial matters.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table and the notes thereto state the names and municipalities of residence of all directors and Executive Officers of the registrant, the respective offices of each, the term of office and period during which he served:\n* Members of Audit Committee NOTES:\n(1) On March 31, 1993 Ira Rubin and Shirley Pascoe resigned as officer and director and director of registrant, respectively.\n(2) Leopold Cohen, a former officer and director died in August, 1994.\n(3) Ian Medad resigned as an officer and director of registrant in August, 1994\n(4) John Neilson succeeded the late Theodore Ruderman, who passed away April 20, 1995.\n(5) Lord Charles Spencer Churchill succeeded the late Leopold Cohen as a director of the registrant.\n(6) Eugene Tuma was elected to the board of directors December 21, 1995.\nLORD CHURCHILL, a member of the House of Lords, has been affiliated with Forte PLC of London, England, one of the world's largest hotel chains, since 1982 and is presently Vice-President of Sales and Marketing. EUGENE TUMA, is the President and Chief Executive Officer of Eugene Tuma & Associates, Inc. management consultants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table summarizes all compensation awarded to, earned by or paid to the Company's Chief Executive Officer and its other Executive Officers during the fiscal years ended December 31, 1995, 1994 and 1993. SUMMARY COMPENSATION TABLE\nANNUAL COMPENSATION & LONG TERM COMPENSATION\n(1) The Company entered into a four year consulting agreement with Olam Company Limited of Toronto, Ontario, Canada dated the 1st of May, 1993, pursuant to which Olam furnished the services of Ian Medad as Chief Executive Officer of the Company. Olam earned consulting fees from the Company at the rate of $6,000 (US) per month plus expenses. Mr. Medad resigned August 18, 1994 and received $25,000 (U.S.) in severance compensation.\n(2) The Subsidiary provided a furnished apartment and a leased automobile. The aggregate value of such compensation in 1993 was $13,545 (U.S.) and in 1994 was $15,200 (U.S.)\n(3)(a) Pursuant to an agreement dated November 8, 1991 as amended, between the Company, the late Leopold Cohen and Charles Bernhaut as Vendors, and the Subsidiary, the Subsidiary acquired from the Vendors all of their right, title and interest as inventors of the UC'NWIN System for a consideration of $123,500 (U.S.) cash and the issuance of 3,000,000 shares of the Company, 2,000,000 shares to Mr. Cohen and 1,000,000 to Mr. Bernhaut, upon satisfaction of certain earnings requirements by the Subsidiary. The earnings requirements were duly satisfied, the cash payment was completed on October 1, 1992 and the 3,000,000 shares were duly issued to Messrs. Cohen and Bernhaut in 1993 in the numbers above indicated.\n(b) In addition to the foregoing, the agreement provided that Messrs. Cohen and Bernhaut should be employed by the Subsidiary on a \"bonus and non-salaried position\" for a period of ten years from the date of the UC'NWIN Agreement, and in the event that pre-tax profits as therein defined attributable to the UC'NWIN System equal or exceed $1,000,000 in any one or more years, Messrs. Cohen and Bernhaut collectively should receive annual bonuses equaling ten percent (10%) of the aggregate of such pre-tax profits. In pursuance of such provisions the sum of $249,000 U.S. was accrued in 1992 and duly paid in equal shares to Messrs. Cohen and Bernhaut.\n(c) The above agreement has since been superseded by the Replacement Agreement dated May 25, 1994 which provides that in each of the ten annual fiscal years of the Subsidiary after the date of the new agreement, upon which the Subsidiary or its affiliates to successors as defined, earned net profits cumulatively of $10,000,000, the Subsidiary shall pay a 5% bonus to Messrs. Cohen and Bernhaut from the net profits for the fiscal year. Each bonus is subject to a $150,000 limit in any one fiscal year. Net profits are defined as annual pre-tax profits plus bonuses paid or payable to all executives and\/or directors for the respective years. The foregoing rights are stated to be assignable in the event of death or incapacity of either Messrs. Cohen or Bernhaut. Leopold Cohen died on August 24, 1994, and his rights have devolved upon his heirs.\n(4) Leopold Cohen and Robert Grindell were the owners of 65% of the outstanding shares of S.R.Information Solutions Inc., a private software company, which performed software services for the Subsidiary. In November, 1992, the Subsidiary purchased from Leopold Cohen and Robert Grindell (a) their 65% outstanding shareholder interests and (b) notes payable to Leopold Cohen in the aggregate amount of $157,700 U.S. for a purchase price consisting of (i) the sum of $2 cash and (ii) the promissory note of the Subsidiary in favor of Mr. Cohen in the amount of $157,700, which was duly paid in 1993.\n(5) Ivan Thornley-Hall, President of the Company until May, 1993, Vice-President until August 18, 1994, President until December 1, 1995, and thereafter Vice-President and Secretary, has received no cash remuneration in his capacity as officer or director, but as Counsel renders legal accounts for fees and disbursements. Legal accounts for fees rendered for the years 1995, 1994 and 1993 were as follows:\n1995 $ 68,261 (Cdn.) 1994 $ 92,180 (Cdn.) 1993 $108,426 (Cdn.)\nAGGREGATE OPTIONS EXERCISED IN FISCAL YEARS 1993, 1994 AND 1995 AND FISCAL YEAR END OPTION.\nThe following table sets forth information with respect to each exercise of stock options during the fiscal years ended December 31, 1995, 1994 and 1993 respectively by the named executive officers and employees of the Company and the Subsidiary, the option values and the dates on exercise, the number of shares covered by both exercisable and unexercisable options as of each fiscal year end. There was no activity in 1995.\n(1) Value is based on market value of the common stock at exercise date (for value realized) minus the option exercise price.\n(2) Fiscal year-end quoted value of $227,500 was $10,000 less than aggregate exercise price.\nThe following table sets forth information as at December 31, 1993, 1994 and 1995 concerning individual grants of stock options made during the fiscal years to the named executive officers.\n(1) Market Price on date of grant was $4.75 per share. Fiscal year-end-value of $227,500 was $10,000 less than the aggregate exercise price for all shares subject to options.\n(2) Mr. Medad resigned August 18, 1994 and his above option was cancelled.\n(3) Exercised in full. (See \"Aggregate Options Exercised in Fiscal Years 1993 and 1994 and Fiscal Year-End Option\")\n(4) No present potential realized value. Present market value $.75 U.S. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth certain information as of March 31, 1996 with respect to persons who are of record or are known by the Company to be beneficial owners of more than 5% of its outstanding shares of common stock, and by directors and all officers and directors as a group. As of March 31, 1996 there were 25,149,747 shares of common stock outstanding.\n(1) Messrs. Krauss and Clark are not related to management and do not own any stock beneficially. The beneficiaries of the four trusts are individuals, none of whom are related to any officers or directors of the Company, or its subsidiary, excepting as follows, and none of whose entitlements exceed 5% of the common stock outstanding. Sam Weiss, a member of the Executive Committee of the Joint Venture is the son of Elizabeth Manus, a beneficiary under the Fairway Trust. Reference is made to \"Certain Relationships and Related Transactions\" herein and to form 10 of registrant filed under SEC Registration Number 0-22954 for historical information surrounding the trusts, the family relationships of beneficiaries and former management which is incorporated herein by reference.\n(2) The inter-family relationships of the beneficiaries are as follows:\n(a) Shirley Pascoe is the sister of Allen Manus; she is also a former director of the registrant.\n(b) Ellen Sue Goldberg is the daughter of Shirley Pascoe and niece of Allen Manus.\n(c) Jane Von Szamwold is the daughter of Allen Manus.\n(d) Elizabeth Manus, also known as Elizabeth Weiss, is the wife of Allen Manus.\n(e) Ann R. Jonas is the adult daughter of Jane Von Szamwold and the granddaughter of Allen Manus.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nPursuant to agreement dated November 8, 1991, as amended by amending agreement dated August 14, 1992, between the late Leopold Cohen, a director and Chairman of the Corporation until his death on August 24, 1994 and Charles Bernhaut as Vendors, the Corporation and the Subsidiary, Impact Telemedia, Inc., (now UC'NWIN Systems, Inc.) as Purchaser (the \"UC'NWIN Agreement) the Subsidiary acquired from the Vendors all of their right, title and interest as inventors of the UC'NWIN System for a consideration of $123,500 (US) cash and the issuance of 3,000,000 shares of the Corporation to be issued to the Vendors, 2,000,000 to Mr Cohen and 1,000,000 shares to Mr. Bernhaut, upon satisfaction of certain earnings requirements by the Subsidiary, namely, 1,500,000 shares to be issued upon the receipt by the UC'NWIN Division of the Subsidiary of $500,000 (US) in net earnings before taxes prior to February 5, 1994, and thereafter the additional 1,500,000 shares issuable upon receipt by the Subsidiary of net earnings of $0.24 per share for each of the $1,500,000 shares. The earnings requirements were duly satisfied, the cash payment was completed on October 1, 1992 and the 3,000,000 shares were duly issued to Messrs. Cohen and Bernhaut in 1993. At the date of execution of the UC'NWIN Agreement Mr. Cohen was not a director of the Corporation or the Subsidiary, having been first elected on March 23, 1993. In addition to the foregoing arrangement, the UC'NWIN Agreement provides that Messrs. Cohen and Bernhaut shall be employed by the Subsidiary on a \"bonus and non-salaried position\" for a period of ten years from the date of the UC'NWIN Agreement and that in the event that pre-tax net profits as therein defined attributable to the UC'NWIN System, equal or exceed $1,000,000 (US) in any one or more such years, Messrs. Cohen and Bernhaut collectively shall receive annual bonuses equalling 10% in the aggregate of such pre-tax profits. The foregoing rights are assignable in the event of death or incapacity of either Messrs. Cohen and Bernhaut. In pursuance of the foregoing provision, the sum of $249,000 (US) was accrued in 1992 and duly paid to Mr. Cohen in 1993. Mr. Cohen paid half that sum to Charles Bernhaut, the co-developer of the UC'NWIN System.\nBy agreement dated May 25, 1994, between the Corporation, the Subsidiary and Messrs. Cohen and Bernhaut, the UC'NWIN Agreement has been declared terminated, to be replaced by a new agreement, (the \"Replacement Agreement\") which provides, among other things, that in each of the first ten annual fiscal years after the date of the new agreement, upon which the Subsidiary will pay a 5% bonus to Messrs. Cohen and Bernhaut from the net profits for the fiscal year. Each bonus is subject to a $150,000 limit in any one fiscal year. Net profits are defined as annual pre-tax profits plus bonuses paid or payable to all executives and or directors for the respective year.\nReference is made elsewhere herein to \"Business - Recent Developments\" for information regarding the Joint Venture Agreement between registrant's subsidiary UC'NWIN Systems, Inc. and Winners All's subsidiary Winners All, Ltd.\nDuring the latter part of 1994, and again in 1995, a major shareholder of the registrant (a trust beneficiary), contacted Allen Manus who, on behalf of the shareholder, consulted with the registrant to ascertain, among other things, the state of operations and on-going funding, new developments in the registrant's business, the exit from Canada and the status of payment of obligations to and on behalf of registrant by the Joint Venture. On December 16, 1981, a permanent injunction was entered against Allen Manus (U.S. District Court, Southern District of New York, FED.SEC.L.REP. Dec. 16, 1981) for violations of the securities laws. Although Allen Manus is not an officer, director or shareholder of the Company, historically, he has been involved with the Company as disclosed herein. As of the date of this filing, Mr. Manus is not involved, either directly or indirectly with the operations of the Company. See \"Security Ownership of Certain Beneficial Owners and Management\" herein, and Form 10 of Registrant for further information concerning the history of registrant and the family relationships of Allen Manus to the registrant and its shareholders, which is incorporated herein by reference.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES, AND REPORTS ON FORM 8K.\n(a) FINANCIAL STATEMENTS:\n(i) Report of Independant Accountants\n(ii) Consolidated Balance Sheets for the years ended, 1993, 1994 and 1995.\n(iii) Consolidated Statements of Loss and Deficit for years ended 1992, 1993, 1994 and 1995.\n(iv) Consolidated Statements of Changes in Financial Position for the years ended 1992, 1993, 1994 and 1995. (b) EXHIBITS:\n1 Hereby incorporated by Reference to the Filing of the definitive proxy material of the Registrant on August 11, 1995.\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.\nUC'NWIN Systems Corporation\nBy: \\s\\ John Neilson ---------------------- John Neilson 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 and on the dates indicated.\nFORM 10K - ITEM 8 UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD.) (A DEVELOPMENT STAGE COMPANY) INDEX TO FINANCIAL STATEMENTS AND 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 not applicable, and therefore have been omitted.\nLETTERHEAD OF MAZARS AND COMPANY LLP\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors UC'NWIN Systems Corporation (formerly known as UC'NWIN Systems, Ltd.) Fort Lauderdale, FL.\nWe have audited the accompanying consolidated balance sheet of UC'NWIN Systems Corporation (formerly known as UC'NWIN Systems Ltd.), (a development stage company) as of December 31, 1995, and the related consolidated statements of stockholder's equity (deficit), operations, and cash flows for the year 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. We did not audit the statement of operations or cash flows for the period January 1, 1992 (reorganization) to December 31, 1994, which has been included in cumulative operations from January 1, 1992 (reorganization) to December 31, 1995, although we have audited the combination of such amounts. 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 UC'NWIN Systems Corporation is based solely on the report of the other 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 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 audit provides a reasonable basis for our opinion.\nThe Company has recorded the investment in Winners All International, Inc., which represents 41% of the public entity on the cost method (see Note 6), which should be recorded on the equity method in order to be in conformity with generally accepted accounting principles. Based on the July 31, 1995 financial statements of Winners All International, Inc., the investment in Winners All International, Inc., would be reduced by approximately $475,000 if the equity method were used to account for such investment after excluding the related investment in Win Network LLC which may have a significantly lower value.\nIn our opinion, except for the effect of not recording the investment in Winners All International, Inc. on the equity basis as discussed in the preceding paragraph, the consolidated financial statements\nreferred to above present fairly, in all material respects, the financial position of UC'NWIN Systems Corporation as of December 31, 1995, and the results of its operations and its cash flows for the year ended December 31, 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 1 to the financial statements, the Company has defaulted on debt payments, has a negative working capital of $1.6 million, and suffered recurring losses from operations that raise substantial doubt about its ability to continue as a going concern.\nAs described in Note 20, the Company has been named in a number of lawsuits, many of which are potentially material. The ultimate outcome of the Company's aforementioned lawsuits can not be reasonably determined at the present time.\nCertified Public Accountants February 14, 1996 and March 22, 1996 as to Note 20\nLETTERHEAD OF ISCOVE GOLD & GLATT\nAUDITORS' REPORT\nTo the Shareholders of UC'NWIN SYSTEMS CORPORATION\nWe have audited the consolidated balance sheets OF UC'NWIN SYSTEMS CORPORATION (FORMERLY KNOWN AS UC'NWIN SYSTEMS LTD.) as at December 31, 1994 and the consolidated statements of shareholders' equity, income and deficit and changes in financial position for the years ended December 31, 1994 and 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with Canadian 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 consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 1994 and the results of its operations and the changes in its financial position for the years ended December 31, 1994 and 1993 in accordance with Canadian generally accepted accounting principles.\nChartered Accountants\nToronto, Ontario March 20, 1995\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED BALANCE SHEET\nASSETS ------\nSee Notes to consolidated financial statements UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED BALANCE SHEET\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee Notes to consolidated financial statements UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED STATEMENT OF OPERATIONS\nSee Notes to consolidated financial statements UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED STATEMENT OF OPERATIONS (CONT'D.)\nSee Notes to consolidated financial statements UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY\nSee Notes to consolidated financial statements UC'N WIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED STATEMENT OF CASH FLOWS\nSee Notes to consolidated financial statements UC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nORGANIZATION AND NATURE OF BUSINESS\nUC'NWIN Systems Corporation (the \"Company\") formerly known as UC'NWIN Systems Ltd. was a publicly held Canadian corporation which reincorporated as a Delaware corporation on December 11, 1995 in the United States.\nThe Company's principal business activity is designing, developing, marketing and producing hardware and software for a computerized inter-active media marketing program known as \"The UC'NWIN System\". The Company is currently marketing the UC'NWIN System in the United States and the United Kingdom.\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.\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe Company's 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.\nThe Company has incurred significant losses in the last three years, has a negative working capital of $1.6 million, and recently defaulted on repayments of debt. Accordingly, the Company's continued existence is dependent upon the Company developing sales and resolving its liquidity problem.\nManagement is actively pursuing equity and\/or debt financing. This includes, among other things, the exercise of common stock warrants outstanding as described in Note 6, or a rights offering with the existing common stockholders and warrant holders.\nPrinciples of Consolidation\nThe consolidated financial statements as of December 31, 1995 include the financial statements of the Company, UC'NWIN Systems, Inc. and Win Network, LLC, a 51%-owned subsidiary (see Note 4). All significant intercompany accounts and transactions have been eliminated in consolidation.\nFurniture and Equipment\nMachinery and equipment are recorded at historical cost. Depreciation of machinery and equipment is provided on the straight-line method over the estimated useful lives of the related assets.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D.)\nKiosks\nDepreciation of fully operational UC'NWIN Systems, also known as operating kiosks, begins upon the commencement date of the kiosks being placed in service, using the straight-line method over 36 months. The Company placed in service the UC'NWIN Systems in March 1995 and accordingly commenced depreciating such assets.\nIntangible Assets\nThe legal costs incurred in obtaining patents are being amortized over their statutory lives (17 years) on a straight line basis.\nPurchased computer software is stated at historical cost. Amortization is computed using the straight-line method based on the estimated life of the related product (generally 3 years).\nReclassification\nCertain prior year amounts have been reclassified to conform to the current year's presentation.\nIncome Taxes\nThe Company has adopted Statement of Financial Accounting Standards No. 109 which requires the recognition of deferred tax assets and deferred tax liabilities based on the differences in carrying value of fixed assets, goodwill, warranty and bad debt allowance for financial and income tax reporting purposes.\nAs of December 31, 1995, the Company had unused net operating loss carryforwards, of approximately $11,700,000 available to offset future taxable income, which if not used, will expire commencing in the year 1998 through 2010. The recognition of the $1,739,475 increase in equity from WinNet is not a taxable event, therefore an income tax provision is not required for the year ended December 31, 1994. The Company is not current with its corporate income tax filings\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D.)\nFor 1995, due to the significant losses incurred by the Company and the likelihood that deferred tax assets, arising from temporary differences, will not reverse in the foreseeable future, management has decided not to record a deferred tax asset of $3,700,000 and related valuation account of $3,700,000.\nRecapitalization\nThe Company reorganized itself form a Canadian Corporation to a Delaware Corporation, accordingly the financial statements reflect the retroactive application of such reorganization.\nNOTE 2: CONVERSION FROM CANADIAN GAAP TO UNITED STATES GAAP\nThe financial statements of the Company were reported utilizing Canadian generally accepted accounting principles \"Canadian GAAP\" through September 30, 1995, since the Company was based in Canada. Since the Company exited Canada in November 1995, the Company has amended its prior financial statements prepared on a Canadian GAAP included herein to a United States generally accepted accounting principles basis.\nThe fundamental difference in accounting between the two countries relates to the acquisition of computer software and development technology (and the related amortization of such software) acquired through the issuance of common stock. Under U.S. GAAP the computer software had a historical cost estimated at $10,000. A reconciliation of the adjustment is as follows:\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 2: CONVERSION FROM CANADIAN GAAP TO UNITED STATES GAAP (CONT'D.)\nNOTE 3: DEVELOPMENT STAGE OPERATIONS\nUC'NWIN Systems Corporation is a development stage company. Effective January 1, 1992, the Company reorganized operations into a new business of redesigning, developing, marketing, and producing hardware and software for a computerized inter-active media marketing program known as the \"UC'NWIN System\".\nIn December 1992, the Company licensed the worldwide marketing rights, exclusive of the United States, of the UC'NWIN System to Winner's All Ltd.\nAside from royalty income and the non-recurring sale of worldwide rights, the Company has not generated any significant current revenue from the UC'NWIN System.\nNOTE 4: ESTABLISHMENT OF WIN NETWORK, LLC\nIn December 1994 and as subsequently amended in June 1995, the Company and Winner's All Ltd. created Win Network, LLC (\"WinNet\"), a limited liability company to exploit the UC'NWIN System. The Company and Winner's All Ltd. contributed the tangible and intangible rights to the UC'NWIN System (other than those sub-licensed to Winners All Asia Pacific). The Company owns 51% of WinNet with Winners All Ltd. owning the remaining 49%. Since its formation, WinNet has lost $3,800,000 of which $2,050,000 has been shown as a loss on the Company. A portion of the current years' loss recorded on the Company's books $197,918 represents losses attributed to the minority interest in excess of capital, pursuant to Accounting Research Bulletin No. 51 such losses should have be\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 4: ESTABLISHMENT OF WIN NETWORK, LLC (CONT'D.)\ncharged against the Company, since there is no obligation of the minority interest to make good on such losses. Winner's All Ltd. had agreed to contribute to WinNet an amount necessary to achieve profitability presently estimated to be an amount not less than $5,000,000 of capital. Such contributions started being funded in January 1995. The Company has ceased receiving royalties due under the license agreement as a result of the WinNet arrangement.\nPursuant to Staff Accounting Bulletin No. 68 \"Accounting for sales of stock by a subsidiary\", the increase in the carrying value derived from the direct sale of equity in a subsidiary shall be reflected as a gain in the consolidated financial statements of the parent company. As a result of Winners All Ltd. capital contribution of $3,182,075 to WinNet during 1994, the Company recognized a $1,739,475 gain on the transaction.\nSee Note 20, regarding WinNet litigation.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nSummarized financial data for Win Network, LLC is as follows:\nBALANCE SHEET\nAssets\nSTATEMENT OF OPERATIONS\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 5: SUBSCRIPTION RECEIVABLE.\nThe receivable recorded at December 31, 1994 of $3,182,075 was received through March 31, 1995 as a result of the Win Network, LLC Agreement (see Note 4).\nThe subscription receivable recorded at December 31, 1995 of $318,750 represented cash received through the sale of common stock prior to February 14, 1996 (see Note 14), which has since been expended to fund operations.\nNOTE 6: INVESTMENT IN WINNERS ALL INTERNATIONAL, INC.\nInvestment in Winners All International, Inc. (\"WAI\") comprises 5,825,000 shares of common stock in WAI or 41% of the outstanding common stock in the publicly held company. These shares of common stock were acquired by issuing one share of common stock in the Company for 4 shares of common stock in WAI or 1,456,250 shares of common stock in the Company. Such shares acquired were recorded at $.19 per share. The market price of such stock has declined to $.09 per share or a decrease in value of $500,000 as of February 15, 1996.\nThe investment in Winners All International, Inc. represents 41% of a public entity. The Winners All International, Inc. stock is traded on the NASDAQ Bulletin Board where stock have traditionally traded under a dollar and have wide variations in price due to the limited market conditions.\nIn January 1996, the Company acquired another 825,000 shares of common stock in WAI for 206,250 shares of common stock in the Company.\nSummarized financial data on Winners All International, Inc. for the year ended July 31, 1995 (unaudited) is as follows:\nBALANCE SHEET\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 6: INVESTMENT IN WINNERS ALL INTERNATIONAL, INC. (CONT'D)\nSTATEMENT OF OPERATIONS\nNOTE 7: FURNITURE AND EQUIPMENT\nA summary of furniture and equipment is as follows:\nNOTE 8: KIOSKS\nKiosks consist of the following:\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 9: INTANGIBLE ASSETS\nIntangible assets consist of the following:\nNOTE 10: ACCOUNTS PAYABLE\nIncluded in accounts payable are two trade payables in the amount of $140,000, which were converted to interest bearing notes payable due in installments through October 1996. The notes bear interest at 6% per annum. The Company has defaulted on the payment of these notes.\nNOTE 11: ACCRUED EXPENSES\nAccrued expenses consist of the following:\nNOTE 12 PAYROLL TAXES PAYABLE\nThe Company has made minimal payments of payroll taxes during the period July 1995 through March 1996 and is delinquent for payroll taxes at December 31, 1995. The Company is currently negotiating a work-out plan for the payment of such delinquent payroll taxes.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 13: LOANS PAYABLE -RELATED PARTY\nLoans payable - related party represents advances from an affiliate WAI or its subsidiaries which are not interest-bearing and due on demand. The Company has a significant ownership interest in WAI (see Note 6).\nNOTE 14: NOTES PAYABLE\nIn August 1995, two individuals loaned the Company $300,000. Such loans are interest bearing at 10% per annum and due in sixty days. These loans were convertible into common shares and warrants of the Company at a share price to be determined by the market value on the day of conversion. The Company has since defaulted on the payment of such loans. In January 1996, one of the individuals initiated a lawsuit for the repayment of such funds.\nNOTE 15: DUE TO SHAREHOLDERS\nDue to shareholders are unsecured, bear no interest and are due on demand. An interest cost has been imputed resulting in a charge to expense of $50,103. Such interest expense was recorded as a contribution to capital.\nNOTE 16: STOCKHOLDERS' EQUITY\nOn December 11, 1995, the Company reorganized and recapitalized itself as a Delaware corporation having authorized 60,000,000 shares of common stock at $.01 par value. The financial statements reflect the retroactive application of such recapitalization.\nDuring 1995, the Company:\na) Issued 1,456,250 shares of common stock for the purchase of 5,825,000 shares of common stock in WAI.\nb) Issued 3,400,000 shares of common stock and 3,400,000 warrants to purchase 3,400,000 shares of common stock at $1.50 per warrant expiring January 31, 1999 in connection with the conversion of indebtedness of $1,381,250 and the sale of common stock for $318,750.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 16: STOCKHOLDERS' EQUITY (CONT'D)\nDuring 1994, the Company:\na) Stock options for 50,000 shares were exercised for a cash consideration of $18,315.\nb) The Company issued 17,500 shares for services rendered in the amount of $66,288.\nc) By agreement dated August 1993, stock options for 600,000 shares were granted at the lower of $6.00 Canadian per share of $5.00 U.S. per share subject to regulatory approval. These options expired September 30, 1995.\nd) Stock options for 50,000 shares at $4.75 Canadian were granted during the year and are outstanding at year end. The options expire June 17, 1996.\nDuring 1993:\na) Stock options for 45,000 shares were exercised for a cash consideration of $22,500.\nb) Debentures of $300,000, which were issued during 1992, were converted at $0.50 per share to 600,000 shares.\nc) The Company issued 10,000 shares for services rendered in the amount of $25,000.\nd) The Company issued 3,000,000 shares per a contractual obligation.\ne) Stock options for 25,000 shares were exercised in the amount of $86,123 by settlement of a debt to an officer and director.\nNOTE 17: LICENSING OF WORLDWIDE RIGHTS\nThe Company pursuant to a December 1992 agreement, granted to Winners All Ltd. the worldwide (exclusive of the United States) licensing rights \"the License\" to use the technology for manufacturing and marketing of the UC'NWIN System for $2,660,000. Winners All Ltd. subsequently sub-licensed a portion of the License with respect to certain Asian countries. After the first three years of the agreement, provided that Winner's All Ltd. (licensee) is in compliance with all terms and conditions, the contract will automatically renew from year to year.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 17: LICENSING OF WORLDWIDE RIGHTS (CONT'D.)\nWinner's All Ltd. is obligated to pay as a royalty the greater of $145,833 or 7% of the gross revenue received, quarterly for the years 1994 and 1995. Commencing January 1, 1996, Winner's All Ltd. is obligated to pay royalties, quarterly, on the greater of 7% of gross revenues, including any sublicencee revenues received or $1,750,000 per annum, until the expiration of the license agreement on September 29, 2009.\nWinners All Ltd. has ceased paying royalties due under the license agreement as a result of the WinNet arrangement.\nNOTE 18: COMMITMENTS AND CONTINGENCIES\na) Future minimum rental payments including operating payments, such as common area maintenance, real estate taxes, etc. are as follows:\nThe Company's rent expense for the year ended December 31, 1995, 1994 and 1993 was $126,620, $39,563 and $18,743, respectively.\nb) In November 1991, the Company entered into a ten year employment contract with Leopold Cohen, the late chairman of UC'NWIN Systems, Inc., and an unrelated third party. On May 25, 1994, the contract was terminated mutually and replaced with a new ten year agreement, which provides that in each of the ten annual fiscal years after the date of the new agreement in which the Company has earned net profits cumulatively of $10,000,000, the Company will pay a 5% bonus to each of the aforementioned individuals from the net profits for the fiscal year.\nEach bonus is subject to a $150,000 limit in any one fiscal year. Net profits are defined as annual pre-tax profits plus bonuses paid or payable to all executives and\/or directors for the respective year. The contract is assignable and inures to their heirs and beneficiaries.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 18: COMMITMENTS AND CONTINGENCIES (CONT'D.)\nc) Pursuant to a June 1992 assignment of technology agreement, the Company will pay a royalty to an unrelated third party of $125 per UC'NWIN System sold or leased in the United States during a period of sixty months commencing January 1, 1993, with minimum monthly payments of $375 up to a maximum of $125,000. On May 31, 1995, the Company entered into an agreement to terminate the technology agreement for a payment of $9,250 payable June 15, 1995 in full satisfaction of all further payment obligations of the Company under the technology agreement.\nd) In August 1993, the Company engaged GSTI Corp. to provide consulting services with regard to the marketing and selling of the UC'NWIN System. GSTI Corp. will introduce potential lessees and assist in drafting the related lease agreements. In consideration for such services, the Company will pay;\n1) For each machine leased by referral of GSTI Corp., an amount equal to the greater of 10% of the lease rent paid during the year or $600;\n2) 4% of the total lease rentals from referral customers;\n3) 2% of the total lease rentals from referral customers when such customers have entered into an agreement to have their products promoted by the UC'NWIN System.\n4) If during the period of January 1, 1995 to December 31, 1999 the Company has not leased UC'NWIN Systems Kiosks to referred customers by GSTI Corp. in the minimum amount of $2,000 in 1995, $4,000 in 1996 and $6,000 for each year thereafter until 1999, the Company will pay 2% of the revenues from non-referred customers to meet the minimum amount of UC'NWIN System Kiosks leased.\n5) 4% of any other revenues derived from customers referred to the Company other than lease rentals.\nPayments due under this agreement are payable 10 days after each quarter end.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 18: COMMITMENTS AND CONTINGENCIES (CONT'D.)\nAdditionally, the agreement provides for the parent Company UC'NWIN Systems, Ltd. to grant to GSTI Corp. 600,000 stock options exercisable at $5.00 U.S. or $6.00 Canadian expiring on September 30, 1995, subject to regulatory approval. Such regulatory approval has been denied.\nThis agreement expires on December 31, 1996, which at the option of GSTI Corp. and provided GSTI Corp. has not breached in any material respect the provisions of the agreement, may be automatically renewed for successive one-year terms through December 31, 1999. The Company may terminate the agreement should GSTI Corp. fail to secure any leasing agreements for a period of twelve consecutive months.\nNOTE 19: DISCONTINUED OPERATIONS\nDuring 1992, UC'NWIN Systems, Inc. decided to reorganize its operations and discontinue the operations of its former business activity of outbound automated telephone marketing and polling services, which resulted in the write down of the machinery and equipment to the net residual value of $300,000. All associated costs of disposal have been reclassified as discontinued operations. During 1993, UC'NWIN Systems, Inc. wrote off all of the remaining net assets of the discontinued operations.\nNOTE 20: LITIGATION\na) On March 22, 1996, Raymond Kalley, as Trustee of the EB Trust and PB Trust, (\"Plaintiff\"), sued the following in the Southern District of Florida (Miami Division): UC'NWIN Systems Corporation (\"the Company\"), a consultant to the Company, a beneficiary to the EB Trust, and to the PB Trust, and Winners All International, Inc. an affiliate. In this five count Complaint, Plaintiff has sued the Company for an alleged violation of Section 18 of the Securities Act of 1934. Plaintiff alleges that the Company acting singly and in concert, filed misleading reports under the Securities Exchange Act 1934, including without limitation, the filing of form 10-K. Plaintiff failed to identify which form 10-K was allegedly misleading or how Plaintiff has been damaged by this alleged misleading statement. Although Plaintiff alleges that it purchased stock in the Company, from another shareholder in a private transaction unbeknown to\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 20: LITIGATION (CONT'D.)\nthe Company, for approximately $1,000,000. Plaintiff does not identify the damage that it allegedly incurred. The Company believes this lawsuit is without merit and intends to defend this lawsuit vigorously and expects to file a Motion to Dismiss Plaintiff's Complaint. The ultimate outcome cannot be determined at the present time.\nb) On April 17, 1995, AG Industries sued Winners All International, Inc. and UC'NWIN Systems, Inc. for a breach of contract and causes of action for unjust enrichment and breach of implied contract. AG Industries seeks damages in excess of $400,000. On August 22, 1995 the Company filed a Motion to Dismiss and Alternative Motion for a Change of Venue. AG Industries has responded and opposed the defendants' motion but the Court has not yet ruled on it. There has been no discovery and it is too early to evaluate this case.\nc) On January 9th, 1996, a former employee filed a Charge of Discrimination, (\"Charge\"), against UC'NWIN Systems, Inc. and Win Network, LLC, (\"the Company\"), with the Equal Employment Opportunity Commission (\"EEOC\"). The Plaintiff voluntarily resigned her position with the Company in October 1995 and waited four months to file her claim. The Company has filed a statement of position denying the allegations of the Charge. At the present time, the EEOC is investigating the charge and will ultimately make determinations of \"cause\" or \"no cause\". At this time, the Company is unable to predict the likelihood of a favorable or unfavorable result in this matter.\nd) Notes payable default litigation - See Note 13.\ne) An action, Brian A. Travis v. Win Network, LLC and Winners All International, Inc., (an ex-officer of Win Network, LLC and Winners All International, Inc.), on or about July 3, 1995. In this action, Mr. Travis seeks to enforce a purported Employment Agreement which he claims was entered into between Win Network, LLC and Mr. Travis in which Mr. Travis claims he is entitled to a ten-year employment term and damages of $10,000,000. Mr. Travis also sues Winners All International, Inc. as a purported guarantor to the agreement. Win Network, LLC is comprised of UC'NWIN Systems, Inc. and Winners All Ltd., a subsidiary of Winners All International, Inc.\nUC'NWIN SYSTEMS CORPORATION (FORMERLY UC'NWIN SYSTEMS, LTD) (A DEVELOPMENT STAGE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\nNOTE 20: LITIGATION (CONT'D.)\nOn March 5, 1996, both defendants filed a motion to dismiss the Travis action on the ground that the purported Employment Agreement violated applicable provisions of the New York Limited Liability Corporation Law, the Win Network, LLC Operating Agreement and the Winners All International, Inc. by-laws. Defendants motion is now pending before the Court.\nEXHIBIT INDEX -------------\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"947117_1995.txt","cik":"947117","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nPursuant to Section 3.04(b) of the Pooling and Servicing Agreement, dated as of August 1, 1995 relating to the AT&T Universal Card Master Trust among AT&T Universal Funding Corp., as Transferor, AT&T Universal Card Services Corp., as Servicer, and Bankers Trust Company, as Trustee, AT&T Universal Card Services Corp., as Servicer, is required to deliver to the Trustee a monthly servicer certificate (the \"Monthly Report\") for each outstanding series of investor certificates. Exhibits 20.1, 20.2 and 20.3 contain the Annual Statement for Series 1995-1, Series 1995-2 and Series 1995-3 aggregating the information for each such series contained in the Monthly Reports for calendar year 1995.\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 Stockholders Matters.\nThe certificates representing investors' interests in the Trust are represented by one or more Certificates registered in the name of Cede & Co., the nominee of the Depository Trust Company.\nTo the best knowledge of the registrant, there is no established public trading market for the Certificates.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nNot Applicable.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\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.\n(a) the Certificates of each Class of Series representing investors' interests in the Trust are represented by one or more Certificates registered in the name of Cede & Co., the nominee of The Depository Trust Company (\"DTC\"), and an investor holding an interest in the Trust is not entitled to receive a Certificate representing such interest except in certain limited circumstances. Accordingly, Cede & Co. is the sole holder of record of Certificates, which it held on behalf of brokers, dealers, banks and other direct participants in the DTC system at December 31, 1995. Such direct participants may hold Certificates for their own accounts or for the accounts of their customers. At December 31, 1995, the following direct DTC participants held positions in the Certificates representing interests in the Trust equal to or exceeding 5% of the total principal amount of the Certificates of each Class of each Series outstanding on that date:\nSERIES 1995-1\nSERIES 1995-2\nSERIES 1995-3\nThe address of each above participant is:\nc\/o The Depository Trust Company 55 Water Street New York, New York 10041\n(b) Not Applicable.\n(c) Not Applicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNone.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) The following are filed as part of this report.\nExhibit 20.1 Annual Statement for the Period Ending\nDecember 31, 1995 with respect to the AT&T Universal Card Master Trust Series 1995-1.\nExhibit 20.2 Annual Statement for the Period Ending December 31, 1995 with respect to the AT&T Universal Card Master Trust Series 1995-2.\nExhibit 20.3 Annual Statement for the Period Ending December 31, 1995 with respect to the AT&T Universal Card Master Trust Series 1995-3.\nExhibit 20.4 Agreed Upon Procedures Letter, dated March 29, 1996, issued by Coopers & Lybrand LLP.\nExhibit 20.5 AT&T Universal Card Services Corp. Officers Certificate dated March 29, 1996.\n(b) No reports on Form 8-K were filed by the registrant during the 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 hereunto duly authorized.\nAT&T UNIVERSAL CARD MASTER TRUST\nBY: AT&T UNIVERSAL CARD SERVICES CORP., AS SERVICER\nBy: \/s\/ Robert A. Miller --------------------------- Name: Robert A. Miller Title: Vice President Finance","section_15":""}
{"filename":"23778_1995.txt","cik":"23778","year":"1995","section_1":"Item 1. Business --------\n(a) ConSil Corp., formerly Consolidated Silver Corporation (the Company or ConSil), held mineral properties in Shoshone County, Idaho known as the Silver Summit mine which were leased effective August 1, 1980, to a joint venture composed of certain substantial stockholders of the Company. This lease was terminated by the lessees effective February 11, 1988. On November 1, 1988, the Company entered into a new Mining Lease and Agreement and a Participation Agreement (collectively, the Agreement) of its properties to ASARCO Incorporated (ASARCO). Due to continued depressed metals prices, the Agreement between the Company and ASARCO was terminated effective August 17, 1992. From 1992 to 1994, management of the Company endeavored to interest other companies in further exploration and development of the Company's property without success.\nOn November 14, 1995, the Company's stockholders approved the sale of its interest in the Silver Summit mine and adjacent mining properties located in Shoshone County, Idaho to Sunshine Precious Metals, Inc. for a cash payment of $750,000, plus a variable production royalty tied to the price of silver.\nIn December 1995, the Company purchased from Hecla Mining Company (Hecla), the majority stockholder of the Company, its interest in the Ojo Caliente exploration project for $706,822. The project is located near the town of Zacatecas, Mexico. The Company also entered into an agreement with Minera Hecla, S.A. de C.V. (Minera Hecla), a wholly owned subsidiary of Hecla, whereby Minera Hecla will conduct exploration work on the Ojo Caliente property and the Company will reimburse Minera Hecla (See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------\nOn November 14, 1995, at the annual meeting of the Company, stockholders approved the sale of all of the Company's interest in the Silver Summit mine, plant, equipment and all patented and unpatented mining properties located in Shoshone County, Idaho, to\nSunshine Precious Metals, Inc. for a cash payment of $750,000 plus a variable production royalty tied to the price of silver. A gain on this sale of $750,000 was recognized in 1995.\nOn December 22, 1995, the Company acquired Hecla's right to earn a 50 percent interest in Minera El Morro, S.A. de C.V., which holds the Ojo Caliente silver exploration project in Zacatecas, Mexico. The other investor in the project is Minera Portree de Zacatecas, S.A. de C.V., a Mexican exploration company. The Company acquired Hecla's interest in the project by reimbursing Hecla $706,822 for all expenditures incurred by Hecla in its acquisition and for exploration costs related to the Ojo Caliente project. In addition, should the Company decide to seek a partner to assist in developing the Ojo Caliente project or putting it into production, Hecla will have the first opportunity to provide that assistance. Minera Hecla, Hecla's wholly owned Mexican subsidiary, is conducting the exploration under ConSil's direction.\nThe Ojo Caliente project includes at least four zones of mineralization that have never been systematically explored. The main veins have been mapped and sampled recently by Hecla. The geology is similar to veins in the nearby Zacatecas District, which has produced more than 600 million ounces of silver. Past underground silver production in the Ojo Caliente area occurred in the seventeenth century. Hecla's exploration activity during 1995 consisted of seven drill holes which tested two of the four vein systems. Results of the 1995 drilling confirmed the presence of the target veins at depth. The Company plans to continue the drilling program during 1996 to explore the previously drilled vein systems at further depth and to explore the additional two vein systems.\nItem 3.","section_3":"Item 3. Legal Proceedings -----------------\nThere are no pending legal proceedings.\nItem 4.","section_4":"Item 4. Matters Voted on by Security Holders ------------------------------------\nThe Company sent out a notice and proxy statement to each of the Company's security holders on October 16, 1995 advising that the Company would hold its annual meeting on November 14, 1995. At the meeting, security holders voted and passed the following resolutions:\nREPORT OF INSPECTORS OF ELECTION:\n1. WITH RESPECT TO THE SALE OF THE SILVER SUMMIT MINE TO SUNSHINE:\n2. WITH RESPECT TO THE NOMINATION AND ELECTION OF DIRECTORS:\n3. WITH RESPECT TO THE APPROVAL OF ADOPTION OF CERTAIN AMENDMENTS TO THE COMPANY'S AMENDED ARTICLES OF INCORPORATION:\n4. WITH RESPECT TO THE APPROVAL OF AN AMENDMENT TO THE COMPANY'S AMENDED ARTICLES OF INCORPORATION TO INCREASE AUTHORIZED COMMON STOCK AND ALTER THE TERMS OF THE COMPANY'S PREFERRED STOCK:\n5. WITH RESPECT TO THE APPROVAL OF AN AMENDMENT TO THE COMPANY'S AMENDED ARTICLES OF INCORPORATION TO ELIMINATE THE RIGHT OF CERTAIN STOCKHOLDERS TO A POSITION ON THE COMPANY'S BOARD OF DIRECTORS:\n6. WITH RESPECT TO THE APPROVAL OF AN AMENDMENT TO THE COMPANY'S AMENDED ARTICLES OF INCORPORATION TO ADD A PROVISION WITH REGARD TO INDEMNIFICATION AND LIABILITY OF DIRECTORS, OFFICERS AND EMPLOYEES:\n7. WITH RESPECT TO THE APPROVAL OF AN AMENDMENT TO THE COMPANY'S AMENDED ARTICLES OF INCORPORATION ADDING A PROVISION ELIMINATING CUMULATIVE VOTING RIGHTS OF COMMON SHARES IN THE ELECTION OF DIRECTORS TO THE COMPANY'S BOARD OF DIRECTORS:\n8. WITH RESPECT TO THE APPROVAL OF AUDITORS:\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 has been traded since June 28, 1991, on the over-the-counter market and quotations are published on the National Association of Securities Dealers Automated Quotation (NASDAQ) Bulletin Board and in the National Quotation Bureau \"pink sheets\" under the symbol CSLV. There has not been an established trading market for the common stock and the below- described quotations, when available, do not constitute a reliable indication of the price that a holder of the common stock could expect to receive upon sale of any particular quantity thereof.\nThe following table sets forth the high and low bid prices for the Company's common stock, as reported by the National Quotation Bureau and the Spokane Quotation Service for the quarterly periods indicated. The prices reported by the National Quotation Bureau and the Spokane Quotation Service represent prices between dealers, do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions.\nThe approximate number of holders of record of the Company's common stock as of March 1, 1996 was 3,479.\nThere have been no dividends declared or paid since the Company's inception in 1969.\nIn August 1995, Hecla, the majority stockholder of the Company, acquired Coeur d'Alene Mines Corporation's 630,888 shares of the Company's outstanding common stock which increased Hecla's\nholdings of the Company's outstanding common stock to 6,168,300 shares or 75.171% of the outstanding common stock. In September 1995, the Company issued Hecla 1,250,000 shares of common stock in exchange for Hecla's 12,500 shares of the Company's preferred stock\nwhich represented the total preferred stock outstanding. The preferred stock, formerly held by Hecla, was subsequently canceled. At December 31, 1995, Hecla held 7,418,300, or 78.453%, shares of the Company's outstanding common stock.\nIn January 1996, the Company applied to the Vancouver Stock Exchange, Vancouver, British Columbia, to list and trade the Company's stock on the exchange. Approval of the listing is still pending.\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 -----------------------------------\n1995 vs 1994 - ------------\nThe Company's general financial condition declined during the year ended December 31, 1995. Cash and cash equivalents decreased from $753,486 in 1994 to $588,787 in 1995. The decline was due principally to cash requirements for the purchase of the Company's interest in the Ojo Caliente project, an income tax payment on the gain on the sale of the Silver Summit mine and adjacent mining properties and increased general and administrative expenses, which were partially offset by the proceeds from the sale of the Silver Summit mine. Working capital also decreased, from $751,702 in 1994 to $394,831 in 1995. The decrease in working capital was primarily due to the net decrease in cash and cash equivalents as previously discussed and an increase in accounts payable for amounts due on the purchase of the Company's interest in the Ojo Caliente exploration project.\nThe net loss increased from $30,179 in 1994 to $514,731 in 1995. The increase in the net loss was due to exploration expenses, primarily the result of the purchase of the Company's interest in the Ojo Caliente exploration project for $706,822, noncash compensation expense totaling $228,800 related to common stock options granted by Hecla for the Company's common stock owned by Hecla, a $104,125 income tax provision primarily due to the sale of the Silver Summit mine and adjacent mining properties, and a $115,742 increase in general and administrative expenses other than\nnoncash compensation related to stock options; all of which were partially offset by $750,000 in proceeds from the sale of the Silver Summit mine and related properties.\nOn September 21, 1995, the Company issued 1,250,000 shares of common stock to Hecla in exchange for 12,500 shares of the Company's preferred stock held by Hecla which represented the total outstanding shares of the Company's preferred stock. The preferred stock previously held by Hecla was canceled. Common stock held by Hecla at December 31, 1995 totaled 7,418,300 shares which is approximately 78.453% of the Company's total outstanding common stock.\nThe Company used the proceeds from the sale of the Silver Summit mine and other available cash to invest in silver exploration projects. In this regard, the Company acquired Hecla's right to earn a 50 percent interest in Minera El Morro, S.A. de C.V., which holds the Ojo Caliente silver exploration project in Zacatecas, Mexico. The other investor in the project is Minera Portree de Zacatecas, S.A. de C.V., a Mexican exploration company. The Company acquired Hecla's interest in the project by reimbursing Hecla $706,822 for all expenditures incurred by Hecla in its acquisition and for exploration costs related to the Ojo Caliente project. In addition, should the Company decide to seek a partner to assist in developing the Ojo Caliente project or putting it into production, Hecla will have the first opportunity to provide that assistance. Minera Hecla, Hecla's wholly owned Mexican subsidiary, is conducting the exploration under ConSil's direction.\nThe Ojo Caliente project includes at least four zones of mineralization that have never been systematically explored. The main veins have been mapped and sampled recently by Hecla. The geology is similar to veins in the nearby Zacatecas District, which has produced more than 600 million ounces of silver. Past underground silver production in the Ojo Caliente area occurred in the seventeenth century. Hecla's exploration activity during 1995 consisted of seven drill holes which tested two of the four vein systems. Results of the 1995 drilling confirmed the presence of the target veins at depth. The Company plans to continue the drilling program during 1996 to explore the previously drilled vein systems at further depth and to explore the additional two vein systems.\nMinimum exploration and development commitments for the Ojo Caliente project total $265,000, $1,000,000 and $1,200,000 for the years ending March 1996, 1997, and 1998, respectively. The $265,000 requirement for the first period was satisfied by September 30, 1995. In fiscal 1996, the Company anticipates spending a minimum of approximately $500,000 on Ojo Caliente exploration and development to satisfy minimum spending requirements. However, this amount could increase if the Company is able to raise funds to accelerate exploration efforts. The Company anticipates funding the cost of future exploration at the Ojo Caliente project from a combination of existing cash and cash\nequivalents and future financing arrangements. These financing arrangements may include the issuance of common or preferred stock in 1996. However, there can be no assurance that the Company will be able to complete one or more financing arrangements to raise additional funds.\nOn February 13, 1996, the Company announced it had entered into a letter agreement for a three-month pre-option period to purchase a 100% interest in the Sombrerete silver mine in the state of Zacatecas, Mexico. The letter agreement calls for the Company to make three payments of $5,000 per month during the pre-option period to Grupo Catorce, S.A. de C.V. During this period, the Company will perform an investigation of the property, and at the end of the period, the Company can elect to enter into an option to purchase 100% of the property, subject to certain royalties defined therein.\nOn February 1, 1996, the Company entered into a four-year noncancellable office space lease for $2,150 (Canadian) per month.\nThe 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 No. 121) effective January 1, 1995. The adoption of the provisions of SFAS No. 121 had no material effect on the results of operations, financial condition, or cash flows of the Company.\n1994 vs 1993 - ------------\nThe Company's general financial condition declined during 1994. Cash and cash equivalents decreased from $785,987 in 1993 to $753,486 in 1994, primarily due to the use of cash for the care and maintenance of the Company's Silver Summit mine property. Working capital declined from $781,881 to $751,702 in 1994 due to the costs of maintaining the property and a decrease in income tax refunds receivable which were partially offset by a decrease in accounts and property taxes payable.\nThe net loss decreased $4,988 from $35,167 in 1993 to $30,179 in 1994. The decline in the net loss was primarily due to a $11,726 decrease in general and administrative costs which was partially offset by a $6,382 decrease in income tax benefits resulting from 1994 operating losses carried back to prior years being less than 1993 losses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nSee Item 14 for index of Financial Statements and Supplemental Data filed herewith.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on ------------------------------------------------ Accounting and Financial Disclosures\nNone.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nThe Board of Directors and Stockholders ConSil Corp.\nWe have audited the consolidated financial statements of ConSil Corp. (formerly Consolidated Silver Corporation) and subsidiary 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 au- diting standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 po- sition of ConSil Corp. 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 Notes 1 and 3 to the financial statements, the Company changed its methods of accounting for long-lived assets in 1995 and income taxes in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P.\nSpokane, Washington\nMarch 26, 1996\nCONSIL CORP. CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n----------\nASSETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSIL CORP.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFor the years ended December 31, 1995, 1994 and 1993 _________\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSIL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the years ended December 31, 1995, 1994 and 1993 __________\nFor noncash financing activities see Notes 4 and 5\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSIL CORP.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nFor the Years Ended December 31, 1995, 1994 and 1993\n_______________\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSIL CORP.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n1. Summary of Significant Accounting Policies ------------------------------------------ Organization ------------\nConSil Corp. (the Company or ConSil), formerly Consolidated Silver Corporation, and its wholly owned subsidiary Minera ConSil, S.A. de C.V. (formed on December 20, 1995) currently hold interests in mining and mineral-bearing properties in Mexico. Although the Company has no operating properties, its management continues to evaluate potential mineral exploration projects and business opportunities with particular emphasis on properties in Mexico.\nThe accompanying consolidated financial statements include the accounts of ConSil and its wholly owned subsidiary. All significant intercompany transactions and accounts are eliminated in consolidation. 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nAt December 31, 1995, the Company had 9,455,683 common shares outstanding of which Hecla Mining Company (Hecla, the majority stockholder of the Company) owned 7,418,300 shares or 78.453% of the issued shares.\nProperty, Plant and Equipment -----------------------------\nProperty, plant and equipment are stated at the lower of cost or estimated net realizable value. Maintenance, repairs and renewals are charged to operations. Betterments of a major nature are capitalized. When assets are retired or sold, the costs and related allowances for depreciation and amortization are eliminated from the accounts and any resulting gain or loss is reflected in operations. Depreciation is based on the estimated useful lives of assets and is computed using the straight-line method.\nThe Company adopted the provisions of Statement of Financial Accounting Standards, No. 121, \"Accounting for the Impairment\nof Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (SFAS No. 121) effective January 1, 1995. The adoption of the provisions of SFAS No. 121 had no material effect on the results of operations, financial condition, or cash flows of the Company.\nExploration -----------\nExploration costs are charged to operations as incurred. The purchase of Hecla's interest in the Ojo Caliente exploration project in 1995, which principally included a reimbursement of Hecla's exploration costs expended on the property (see Note 2), was charged to operations.\nNet Loss Per Share ------------------\nNet loss per share of common stock is based on the weighted average number of common shares outstanding during each period.\nCash Equivalents ----------------\nThe Company considers cash equivalents to be highly liquid investments purchased with a remaining maturity of three months or less. The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash and temporary cash investments with institutions of high credit- worthiness. At times such investments may be in excess of the FDIC insurance limit.\nIncome Taxes ------------\nThe Company records deferred tax liabilities and assets for the expected future income tax consequences of events that have been recognized in its financial statements. Deferred tax liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse.\nReclassifications -----------------\nCertain 1994 and 1993 financial statement amounts have been reclassified to conform to the 1995 presentation. These reclassifications had no effect on the net loss or accumulated deficit as previously reported.\n2. Mineral Rights --------------\nIn December 1995, the Company purchased from Hecla its interest in the Ojo Caliente exploration project located near the town of Zacatecas in the state of Zacatecas, Mexico, for $706,822. At December 31, 1995, the Company had made payments to Hecla totaling $501,646 and recorded a current liability of $205,176 for the balance due Hecla.\nIn conjunction with the Ojo Caliente purchase, the Company's wholly owned Mexican subsidiary, Minera ConSil, entered into an agreement with Minera Hecla, S.A. de C.V. (Minera Hecla), a wholly owned subsidiary of Hecla, whereby Minera Hecla would carry out exploration activities on the Ojo Caliente project for which the Company would reimburse Minera Hecla for its costs. During the year ended December 31, 1995, the Company incurred $78,134 of additional exploration expense under this agreement. At December 31, 1995, $70,469 of these exploration services are included in accounts payable.\nThe Company has a commitment to spend the following minimum amounts on exploration and development at the Ojo Caliente exploration project (any amounts spent in excess of any one year's commitment can be applied to the minimum expenditures of the following year):\nIf the Company does not spend the above minimum amounts, the Company's rights to the property will terminate.\nThe commitment for April 1995 to March 1996 was satisfied as of September 30, 1995 by Hecla, prior to the Company's purchase from Hecla.\nOn February 13, 1996, the Company announced it had entered into a letter agreement for a three-month pre-option period to purchase a 100% interest in the Sombrerete silver mine in the state of Zacatecas, Mexico. The letter agreement calls for the Company to make three payments of $5,000 per month during the pre-option period to Grupo Catorce, S.A. de C.V. During this period, the Company will perform an investigation of the property, and at the end of the period, the Company can elect\nto enter into an option to purchase 100% of the property, subject to certain royalties defined therein.\nIn November 1995, the Company completed the sale of the Silver Summit mine property located in Shoshone County, Idaho, to Sunshine Precious Metals, Inc. (Sunshine). The sales agreement conveyed all of the Company's subsurface mineral rights and the mill site in exchange for a cash payment of $750,000 to the Company. The Company also transferred all on- site reclamation and environmental liabilities to Sunshine. All off-site reclamation and environmental liabilities, if any, related to the Silver Summit mine property were retained by the Company. In addition, Sunshine shall pay the Company a variable production royalty, based on the price of silver, ranging from 2.0% to 4.0% of the net smelter returns. The assets sold had no net book value; therefore, the Company recognized the $750,000 as a gain on sale of the mining property.\n3. Income Taxes ------------\nThe components of the Company's income tax provision (benefit) for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe income tax provision (benefit) for the years ended December 31, 1995, 1994 and 1993 differs from the amounts which would be provided by applying the statutory federal income tax rate to the loss before income taxes. The reasons for the differences are as follows:\nAt December 31, 1995, the Company had the following deferred tax asset:\nCapitalized exploration costs $ 296,714 Valuation allowance (197,714) ---------\nNet deferred tax asset $ 99,000 =========\nThe Company has recorded the above valuation allowance to reflect the estimated amount of the deferred tax asset which may not be realized principally due to limitation of the refunds available during the carryback period and the uncertainty regarding the generation of future taxable income to utilize reversing deductible items. The realization of the Company's future deductible items that are not recoverable through the refund of prior income taxes is dependent upon the Company's ability to generate future taxable income. If it becomes more likely than not that the Company will generate future taxable income, the valuation allowance could be adjusted in the near term.\n4. Common and Preferred Stock --------------------------\nIn September 1995, the Company issued 1,250,000 shares of common stock to Hecla in exchange for 12,500 shares of preferred stock held by Hecla which represented the total outstanding shares of preferred stock. The preferred shares previously held by Hecla were subsequently canceled. The rights of the authorized preferred stock will be determined by the Board of Directors, if and when any preferred stock is issued.\n5. Related Party Transactions --------------------------\nIn addition to related party transactions described in Notes 2 and 4, during the years ended December 31, 1995, 1994 and 1993, general and administrative expenses of $88,172, $26,885, and $28,082, respectively, were charged to the Company by Hecla.\nOn November 14, 1995, Hecla granted the Company's President and Chairman of the Board of Directors the following options to purchase the Company's common stock which is currently owned by Hecla:\n(1) Contingent upon obtaining financing, as defined. (2) Contingent upon the delivery of a mining feasibility study.\nThe non-contingent options are fully vested and expire in November 1999.\nThe estimated fair value of the Company's common stock at the date of grant exceeded the $0.10 option price. Accordingly, the Company has recorded $228,800 of compensation expense and a related capital contribution from Hecla relating to these options. Additional compensation expense may be recorded on the contingent option grants upon the removal of the contingency and based upon the fair value of the Company's common stock at that time.\n6. Fair Value of Financial Instruments -----------------------------------\nThe following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data and 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.\nThe estimated fair values of financial instruments are as follows:\n(1) Identifiable assets of each country are those that are directly identified with those operations. General corporate assets consist primarily of cash, receivables and deferred income taxes.\nAs of and for the year ended December 31, 1994 and 1993, there were no operations or assets outside of the United States.\n8. Lease Commitment ----------------\nIn February 1996, the Company entered into a noncancelable lease agreement for office space. The lease agreement requires 48 monthly payments of $2,150 (Canadian).\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 Item 12 of this report.\nItem 11.","section_11":"Item 11. Executive Compensation ----------------------\nThe following table sets forth information regarding the aggregate compensation for the fiscal year ended December 31, 1995, paid or accrued for (i) the Chief Executive Officer of the Company and (ii) the Chairman of the Company. The Company had no other paid executive officers nor other employees prior to July, 1995.\nSUMMARY COMPENSATION TABLE1\n1. Information for deleted columns is not required because no such compensation is paid by the Company for any such deleted column.\n2. The annual compensation set forth in the table is based upon the salary actually paid to the President for the period from July 1, 1995 through December 31, 1995. The Chairman was not paid any salary, bonus or other compensation during 1995.\n3. No bonuses were paid and the Company has no plan for paying bonuses.\n4. All stock options to acquire common stock, par value $0.10 per share, of the Company (Common Stock) referred to in the table above were granted pursuant to two Stock Option Agreements dated as of November 14, 1995, between the parties named above and Hecla Mining Company (Hecla), and such options entitled the holder thereof to acquire Common Stock owned by Hecla. The terms of both Stock Option Agreements are substantially identical. Each of the Stock Option Agreements provides that upon and only upon the occurrence of certain conditions precedent each of the named parties has the right to be granted up to an aggregate of 300,000 additional stock options\nat an exercise price of $0.50 per share and an additional 300,000 stock options at an exercise price of $1.00 per share.\n5. Mr. Carlson commenced employment as President of the Company in July, 1995.\nOPTION GRANTS IN LAST FISCAL YEAR ---------------------------------\n1. All stock options to acquire Common Stock referred to in the table above were granted pursuant to two Stock Option Agreements dated as of November 14, 1995, between the parties named above and Hecla, and such options entitled the holder thereof to acquire Common Stock owned by Hecla. The terms of both Stock Option Agreements are substantially identical. Each of the Stock Option Agreements provides that upon and only upon the occurrence of certain conditions precedent each of the named parties has the right to be granted up to an aggregate of 300,000 additional stock options at an exercise price of $0.50 per share and an additional 300,000 stock options at an exercise price of $1.00 per share.\n2. The Potential Realizable Value shown in the table represents the maximum gain if held for the full two-year term at each of the assumed annual appreciation rates. Gains, if any, are dependent upon the actual performance of the Common Stock and the timing of any sale of the stock.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES1\nThe following table shows information concerning the exercise of stock options during fiscal year 1995 by each of the named executive officers and the fiscal year-end value of unexercised options.\n1. All stock options to acquire Common Stock referred to in the table above were granted pursuant to two Stock Option Agreements dated as of November 14, 1995, between the parties named above and Hecla, and such options entitled the holder thereof to acquire Common Stock owned by Hecla. The terms of both Stock Option Agreements are substantially identical. Each of the Stock Option Agreements provides that upon and only upon the occurrence of certain conditions precedent each of the named parties has the right to be granted up to an aggregate of 300,000 additional stock options at an exercise price of $0.50 per share and an additional 300,000 stock options at an exercise price of $1.00 per share.\n2. The Common Stock is traded in the over-the-counter market and quotations are published on the National Association of Securities Dealers Automated Quotation (NASDAQ) Bulletin Board and in the National Quotation Bureau \"pink sheets.\" The figures presented assume that the Common Stock could be sold in one transaction without any discount to the market price as of December 29, 1995. However, because the Common Stock trades only intermittently and at extremely low volumes, the likelihood of a seller liquidating the volume of stock indicated in the table above at market price as of December 29, 1995 is very speculative.\nThe salary for the President was set by the entire Board of Directors of the Company based on its familiarity with what constitutes competitive wages for the president of companies engaged in the mineral exploration industry. Members of the Board of Directors included Mr. Ralph R. Noyes, Vice President - Metal Mining of Hecla, and Mr. Michael B. White, Vice President - General Counsel and Secretary of Hecla. Mr. Noyes resigned from Hecla effective January 1, 1996. The Company has no retirement plan. The Board of Directors did not designate a compensation committee to set the compensation of the President.\nCOMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN* CONSIL CORP., S&P 500, AND PEER GROUP\nThe following graph illustrates the yearly change in the cumulative total shareholder return on the Company's common stock, compared with the cumulative total return on the Standard & Poor's 500 stock index and a custom peer group, for five years ended December 31, 1995.\nThe custom peer group was selected on the basis of market capitalization as of December 31, 1995. The custom peer group is comprised of:\nThese companies were selected from all publicly traded companies on the basis of their market capitalization value ranging from -3 to +3 percent of the Company's market capitalization. The graph assumes that the value of the investment in the Company's Common Stock and each index was $100 at December 31, 1990 and that all dividends were reinvested quarterly.\nMembers of the Company's Board of Directors were compensated during 1995 at the rate of $150 per meeting attended, until the Board of Directors on November 14, 1995 changed the policy to pay members of the Board of Directors an annual retainer of $750 and a meeting fee of $200 per meeting attended. Four directors were compensated pursuant to the former policy for attending two meetings; six directors were paid retainers and five directors were paid for attending one meeting pursuant to the latter policy.\nCharges of $88,172 and $26,885 were made to the Company by Hecla in 1995 and 1994, respectively, for accounting and other services rendered by employees of Hecla.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and --------------------------------------------------- Management ----------\n(A) Security ownership of certain beneficial owners as of March 1, 1996:\nIn February 1996, the Company purchased 5,770 shares from dissenting stockholders which increased the balance of treasury shares from 6 shares to 5,776 shares and thereby reduced overall outstanding shares and increased Hecla's percentage ownership of the Company's outstanding common stock from 78.453% to 78.501%.\n(B) Security ownership of management as of March 1, 1996:\nNotes: - ----- (a) Mr. Ralph R. Noyes owns 1,000 shares, and Mr. Michael B. White owns 618 shares of Hecla Mining Company common stock, which had 51,130,252 common shares outstanding as of March 1, 1996.\nThere are no family relationships between any of the executive officers or directors.\nThe Registrant has one subsidiary, Minera ConSil, S.A. de C.V., incorporated under the laws of Mexico.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ----------------------------------------------\nSee Notes 2, 4 and 5 to the Consolidated Financial Statements for description of certain business relations required to be reported under this item.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on ------------------------------------------------------- Form 8-K --------\n(a) (1) Index to Consolidated Financial Statements:\nPage ------\nReport of Independent Accountants 13\nConsolidated Balance Sheets at December 31, 1995 and 1994 14\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 15\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 16\nConsolidated Statements of Changes in Stockholders' Equity for Years Ended December 31, 1995, 1994 and 1993 17\nNotes to Consolidated Financial Statements 18\n(b) Reports on Form 8-K\nReport on Form 8-K dated November 15, 1995, related to press release dated November 15, 1995 describing the Company's name change and sale of the Silver Summit mine.\n(c) Exhibits\nThe exhibit numbers in the following list correspond to the numbers assigned to such Exhibits in Item 601 of Regulation S-K.\nNumber and Description of Exhibits ----------------------------------\n3.1 Articles of Incorporation of the Registrant as amended to date\n3.2 Bylaws of the Registrant as amended to date\n10.1 Purchase and Sale Agreement dated August 23, 1995 between Hecla Mining Company and Consolidated Silver Corporation, relating to the Ojo Caliente Project located in Zacatecas, Mexico**\n10.2 Purchase Agreement dated July 1, 1995 between Consolidated Silver Corporation and Sunshine Precious Metals, Inc. relating to the Company's sale of the Silver Summit mine property**\n22.1 Proxy Materials for Annual Meeting of Stockholders held November 14, 1995**\n27 Financial Data Schedule\n__________\n** These exhibits were filed in SEC File #0-4846-3 as indicated below and are incorporated herein by this reference thereto:\nExhibit in Corresponding Exhibit in Annual Report on this Report Form 10-K or Quarterly Report on Form 10-Q, ----------- ------------------------------------------- as indicated ------------\n10.1 10 (Quarterly Report on Form 10-Q dated September 30, 1995)\n10.2 10.1 (Quarterly Report on Form 10-Q dated June 30, 1995)\n22 22 (Quarterly Report on Form 10-Q dated 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 annual report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 29, 1996.\nCONSIL CORP.\nBy \/s\/ Gerald G. Carlson --------------------------------- Gerald G. Carlson, 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.","section_15":""}
{"filename":"858558_1995.txt","cik":"858558","year":"1995","section_1":"ITEM 1.BUSINESS\nThe Reader's Digest Association, Inc. (\"RDA\" and, together with its subsidiaries, the \"Company\") is a preeminent global leader in publishing and direct marketing, creating and delivering products, including magazines, books, recorded music collections, home videos and other products, that inform, enrich, entertain and inspire.\nRDA is a Delaware corporation that was originally incorporated in New York in 1926 and was reincorporated in Delaware in 1951. The mailing address of its principal executive offices is Pleasantville, New York 10570 and its telephone number is (914) 238-1000.\nThe Company's operations are reported in four business segments: (1) Reader's Digest magazine, (2) books and home entertainment products, (3) special interest magazines and (4) other businesses. For financial information by business segment, see Note 15 to the Company's consolidated financial statements appearing in the Company's 1995 Annual Report to Stockholders, which note is incorporated herein by reference.\nThe Company's businesses are organized in four operating groups. The organization of the Company's three geographic groups- - -Reader's Digest Europe, Reader's Digest U.S.A. and Reader's Digest Pacific--recognizes the distinct business needs and strategies appropriate in different markets throughout the world. The Company's fourth operating group--Special Markets--operates the Company's school and youth group fundraising business and focuses on developing new products and entering new marketing channels. (Reported geographic results for the Special Markets Group are included in the United States segment and reported business segment results are included in the Other Businesses segment.) For financial information by geographic area, see Note 15 to the Company's consolidated financial statements appearing in the Company's 1995 Annual Report to Stockholders.\nReader's Digest Magazine\nReader's Digest magazine is a monthly, general interest magazine consisting of original articles and previously published articles in condensed form, a condensed version of a previously published or soon-to-be published full-length book, monthly humor columns, such as \"Laughter, The Best Medicine(r),\" \"Life In These United States(r),\" \"Humor In Uniform(r),\" \"Campus Comedy(r)\" and \"All In A Day's Work(r),\" and other regular features, including \"Heroes For Today(r),\" \"It Pays To Enrich Your Word Power(r),\" \"News From The World Of Medicine(r)\" and \"The Verbal Edge(tm).\" DeWitt and Lila Wallace founded Reader's Digest magazine in 1922. Today, Reader's Digest has a worldwide circulation of approximately 27 million and an estimated 100 million readers each month, generating revenues of $732.9 million in fiscal 1995, as compared with $689.1 million in fiscal 1994 and $720.0 million in fiscal 1993. Reader's Digest is published in 47 editions and 18 languages. The Company began publication of a Polish edition in May 1995 and over the next few years plans to launch several new editions of Reader's Digest, with principal emphasis on Asia and Latin America. The Company announced in September 1995 that it will publish a new edition in Thailand beginning in April 1996.\nCirculation\nBased on the most recent audit report issued by the Audit Bureau of Circulation, Inc. (\"ABC\"), a not-for-profit organization that monitors circulation in the United States and Canada, the Company has determined that the United States edition of Reader's Digest has the largest circulation of any United States magazine, other than one that is automatically distributed to all members of the American Association of Retired Persons. Approximately 94% of the United States circulation of Reader's Digest consists of subscriptions. The balance consists of single copy sales at newsstands and in supermarkets and similar establishments.\nReader's Digest is truly a global magazine. Most of its international editions have the largest paid circulation both in the individual countries and in the regions in which they are published. For most international editions of Reader's Digest, subscriptions comprise about 90% of circulation. The balance is attributable to newsstand and other retail sales.\nThe Company maintains its circulation rate base through annual subscription renewals and new subscriptions. The global circulation rate base for Reader's Digest of 26,923,810 includes a circulation rate base of 15,000,000 for the United States-- English language edition. In the United States, the Company sells approximately five million new subscriptions each year in order to maintain its circulation rate base. New subscriptions are sold primarily by direct mail, with extensive use of sweepstakes entries and, in some cases, premium merchandise offers. The largest percentage of subscriptions is sold between July and December of each year. Subscriptions to Reader's Digest may be canceled at any time and the unused subscription price is refunded.\nWorldwide revenues from circulation accounted for $571.7 million, or 78% of the total revenues of Reader's Digest magazine, in the fiscal year ended June 30, 1995.\nAdvertising\nIn fiscal 1995, Reader's Digest carried 1,033 advertising pages in its United States--English language edition and 13,082 advertising pages in its other editions. The estimated gross advertising revenues for the United States--English edition were $169.3 million and for the other editions were $126.3 million in fiscal 1995. (Figures for the United States--English language edition are as reported by Publishers Information Bureau, Inc. (\"PIB\") and for the other editions are based on data contained in the LNA\/Rome Report of Expenditures in International Media. Gross advertising revenues are computed from basic one-time rates and the number of advertising pages carried and, therefore, exceed actual advertising revenues as included in the Company's financial statements. Actual advertising revenues reflect lower rates for multiple insertion, volume discounts and cash discounts.)\nThe United States and the larger international editions of Reader's Digest offer advertisers different regional editions, major market editions and demographic editions. These editions, containing the same editorial material, permit advertisers to concentrate their advertising in specific markets or to target specific audiences. Reader's Digest sells advertising in both the United States and international editions principally through an internal advertising sales force. The Company sells advertisements in multiple editions worldwide, and offers advertisers discounts for placing advertisements in more than one edition.\nWorldwide revenues from advertising accounted for $161.3 million, or 22% of the total revenues of Reader's Digest magazine, in the fiscal year ended June 30, 1995.\nEditorial\nReader's Digest is a reader-driven, family magazine. Editorial content is, therefore, crucial to the loyal subscriber base that constitutes the cornerstone of the Company's operations. The editorial goal of Reader's Digest is to inform, enrich, entertain and inspire. The articles, book section and features included in Reader's Digest cover a broad range of contemporary issues and reflect an awareness of traditional values.\nA substantial portion of the selections in Reader's Digest are original articles written by staff writers or free-lance writers. The balance is selected from existing published sources. All material is condensed by Reader's Digest editors. The Company employs a professional staff to research and fact- check all published pieces.\nEach international edition has a local editorial staff responsible for the editorial content of the edition. The mix of locally generated editorial material, material taken from the United States edition and material taken from other international editions varies greatly among editions. In general, the Company's larger international editions, for example, those in Canada, France, Germany and the United Kingdom, carry more original or locally adapted material than do smaller editions.\nProduction and Fulfillment\nAll editions of Reader's Digest are printed by independent third parties. The United States edition is currently printed by one printer at its location in New York State. In September 1994, the Company signed a new 10-year printing agreement with another printer, commencing in late 1996, to produce the United States edition at its Pennsylvania location. The Company believes that generally there is an adequate supply of alternative printing services available to the Company at competitive prices, should the need arise. The Company has developed plans to minimize recovery time in the event of a disaster at an existing printing facility.\nThe principal raw materials used in the publication of Reader's Digest are coated and uncoated paper. The Company has supply contracts with a number of global suppliers of paper and believes that those supply contracts provide an adequate supply of paper for its needs and that, in any event, alternative sources are available at competitive prices. Paper prices are affected by a variety of factors, including demand, capacity, pulp supply, and by general economic conditions.\nSubscription copies of the United States edition of Reader's Digest are delivered through the United States Postal Service as second class mail. Subscription copies of international editions are also delivered through the postal service in each country. For additional information about postal rates and service, see \"Direct Marketing Operations and Sweepstakes.\"\nNewsstand and other retail distribution is accomplished through a distribution network. The Company has contracted in each country with a magazine distributor for the distribution of Reader's Digest.\nLicensed Editions\nThree international editions--the Korean and the two Indian editions--are not produced by subsidiaries of the Company, but rather are published by third parties to whom the Company has licensed the right to publish Reader's Digest and use the Company's trademarks (subject to Company approval of editorial content). The Reader's Digest Fund for the Blind, Inc., a New York not-for-profit corporation, publishes a large-type edition of Reader's Digest, pursuant to a royalty-free license. The Company also licenses, royalty-free, the right to publish a braille edition and a recorded edition of Reader's Digest. Revenues from licensed editions are not material. Books and Home Entertainment Products\nThe Company publishes and markets, principally by direct mail, Reader's Digest Condensed Books, series books, general books, recorded music collections and series and home video products. See \"Direct Marketing Operations and Sweepstakes.\"\nCondensed Books\nReader's Digest Condensed Books is a continuing series of condensed versions of current popular fiction and, to a limited extent, nonfiction. Condensation reduces the length of an existing text, while retaining the author's style, integrity and purpose. Today, 15 editions of Condensed Books, published in 12 languages, are marketed in 23 countries. In fiscal 1995, Condensed Books generated worldwide revenues of $392.1 million, as compared with $363.9 million in fiscal 1994 and $352.3 million in fiscal 1993.\nInternational editions of Condensed Books generally include some material from the United States edition or from other international editions, translated and edited as appropriate, and some condensations of locally published works. Each local editorial staff determines whether existing Condensed Books selections are appropriate for their local market.\nThe Company publishes six volumes of Condensed Books a year in the United States. Some of the Company's international subsidiaries also publish six volumes a year, while others publish five. Condensed Books are marketed as an open-ended series.\nSeries Books\nThe Company markets two types of series books: reading series and illustrated series. These book series may be open- ended continuing series, or may consist of a limited number of volumes. Series books are published in nine languages and marketed in 18 countries. In fiscal 1995, series books generated worldwide revenues of $236.6 million, as compared with $214.9 million in fiscal 1994 and $228.8 million in fiscal 1993.\nSeries marketed in the United States include Today's Best Nonfiction(r), which consists of five volumes per year each generally containing condensed versions of four contemporary works of nonfiction and World's Best Reading, consisting of full- length editions of classic works of literature, of which six volumes are published each year. Today's Best Nonfiction is published in 12 countries in three languages and World's Best Reading is published in 12 countries in four languages. The Company recently introduced in selected European markets the Enhanced Reading Series, featuring condensations of existing books enhanced with additional information and photographs.\nIllustrated series, which are marketed in the United States and several other countries, include The Reader's Digest American Medical Association Home Medical Library, People and Places of the World, and Successful Gardening. In addition, the Vie Sauvage illustrated series is marketed in 10 countries outside of the United States. Illustrated series are generally closed ended.\nGeneral Books\nThe Company's general books consist primarily of reference books, cookbooks, \"how-to\" and \"do-it-yourself\" books, songbooks, and books on subjects such as history, travel, religion, health, nature and the home. General books are published in 12 languages and are marketed in 31 countries. In fiscal 1995, general books generated worldwide revenues of $816.5 million, as compared with $755.2 million in fiscal 1994 and $826.4 million in fiscal 1993.\nNew general books are generally original Reader's Digest books, but may also be books acquired from other publishers. During the development period for an original Reader's Digest book, the Company conducts extensive research and prepares an appropriate marketing strategy for the book.\nAlthough most sales of a general book will result from the initial bulk promotional mailing, substantial additional sales occur through subsequent promotions, catalog sales and the use of sales inserts in mailings for other Reader's Digest products. The Company also distributes a small portion of its books for retail sale in stores, through third-party distributors.\nThe Company is pursuing the use of electronic media and new technologies, such as CD-ROM and computer on-line services. In September 1994, the Company announced an agreement with Microsoft Corporation to produce original multimedia software for home computer users based on editorial content of the Company's best- selling books. The CD-ROM will be marketed by both companies and will carry both the Reader's Digestr and the Microsoftr Home brand names. Under the agreement, the Company has global direct mail rights and Microsoft Corporation has worldwide retail rights to the product.\nIn March 1995, the Company entered into a worldwide agreement with Dove Audio, Inc. (\"Dove Audio\") for direct marketing rights to Dove Audio's library of audio books, which currently numbers more than 800 titles. The agreement also provides that the Company may authorize Dove Audio to create new titles under the Reader's Digest brand using the content of the Company's books.\nIn July 1995, the Company and Meredith Corporation (\"Meredith) entered into an agreement forming a strategic alliance that grants the Company certain exclusive direct marketing rights with respect to books and other products, such as music tapes and CDs, CD-ROMs and videotapes, published under Meredith's Better Homes and Gardens(r) and Ladies' Home Journal(r) trademarks. The agreement covers all such products bearing Meredith's brands and any other products created by Meredith or by the Company. The agreement also gives the Company direct access to Meredith's 60-million-name consumer database. The term of the strategic alliance will be approximately 16-1\/2 years, with a five-year renewal option. The Company will pay Meredith royalties based on product sales and the use of Meredith's database.\nMusic\nThe Company publishes recorded music packages, which it sells by direct mail on cassettes and compact discs. The music packages are generally collections of previously recorded material by a variety of artists, although they may include selections from the Company's 16,000-selection library. The collections span a broad range of musical styles. In certain markets, the Company also sells music series, which are marketed in the same manner as Condensed Books and series books. The marketing strategy for music packages is similar to that for general books. The Company markets music products in 21 countries, offering different music products in the various international markets because of diverse tastes. In fiscal 1995, music products generated worldwide revenues of $435.9 million, as compared with $392.4 million in fiscal 1994 and $399.9 million in fiscal 1993.\nVideo\nThe Company's home video products are in genres similar to its general books. Several original video products have won awards of excellence, including three Emmy awards, and have appeared on the Disney Channel and the Discovery Channel. The Company continues to expand its video operations in the United States and in international markets and is presently marketing video products in the United States and 17 other countries. Most of the Company's original video programs have been licensed to cable television networks. The Company has also begun to sell its home video products through retail establishments. In fiscal 1995, home video products generated worldwide revenues of $218.7 million, as compared with $173.9 million in fiscal 1994 and $150.6 million in fiscal 1993.\nReader's Digest Young Families, Inc.\nReader's Digest Young Families, Inc., a wholly owned subsidiary of the Company, creates and markets children's books and home entertainment products. The subsidiary brings together in one stand-alone operation the business of Joshua Morris Publishing, Inc., a book publisher and packager acquired in 1991, and the publishing imprint of Reader's Digest Kids(r). Reader's Digest Young Families publishes books in 29 languages and is introducing more than 45 titles for the fall 1995 season. Beginning in fiscal 1996, Reader's Digest Young Families will be operated as part of the Special Markets Group and its financial results will be reported as part of the Special Markets Group.\nIn October 1994, Reader's Digest Young Families obtained direct marketing rights from Children's Television Workshop to create new books featuring Sesame Street licensed characters from the popular children's television program. In addition, Reader's Digest Young Families acquired from Western Publishing Company, Inc. the direct marketing rights for four children's book series, including the Sesame Street Book Club and Berenstain Bears Book Club.\nProduction and Fulfillment\nThe various editions of Condensed Books are printed and bound by third-party contractors. In September 1994, the Company entered into a seven-year exclusive agreement for printing Condensed Books distributed in the United States and Canada. The Company solicits bids for the printing and binding of each general book or book series. Production and manufacture of music and video products is typically accomplished through third parties.\nThe principal raw material necessary for the publication of Condensed Books, series books and general books is paper. The Company has a number of paper supply arrangements relating to paper for Condensed Books. Paper for series books and general books is purchased for each printing. The Company believes that existing contractual and other available sources of paper provide an adequate supply at competitive prices. Third parties arrange for the acquisition of some of the necessary raw materials for the manufacture of music and video products.\nFulfillment, warehousing, customer service and payment processing are conducted principally by independent contractors. Most of the Company's products are packaged and delivered to the Postal Service directly by the printer or supplier. For information about postal rates and service, see \"Direct Marketing Operations and Sweepstakes.\"\nIn all of the Company's direct marketing sales, a customer may return any book or home entertainment product to the Company either prior to payment or after payment for a refund. The Company believes that its returned goods policy is essential to its reputation and also elicits a greater number of orders, many of which are not returned because of the generally high satisfaction rate of consumers with the Company's products. Nonetheless, this policy and a \"first book free\" policy for Condensed Books and series books result in a significant amount of returned goods.\nSales of the Company's books and home entertainment products are seasonal to some extent. In the direct marketing industry as a whole, the winter months have traditionally had higher consumer response than other times of the year. Sales are also higher during the pre-Christmas season than in spring and summer.\nDirect Marketing Operations and Sweepstakes\nThe sale of magazine subscriptions, Condensed Books, series books, general books, music and video products, as well as certain other products, is accomplished principally through direct marketing solicitations to households on the Company's customer lists, usually accompanied by sweepstakes entries and, in some cases, premium merchandise offers. For many years the Company has been acknowledged as a pioneer and innovator in the direct mail industry. As part of its growth strategy, the Company has begun to pursue increased distribution of its products through direct response channels other than direct mail, such as catalogs, clubs and direct response television.\nTo promote the sale of its products in the United States, the Company offers in its promotional mailings participation in an annual sweepstakes, whose prizes totaled $13.4 million for the 1995 edition and will total about $13.7 million for 1996. Generally, each of the Company's international subsidiaries sponsors its own sweepstakes, the mechanics of which vary from jurisdiction to jurisdiction, depending upon local law.\nFrom time to time, the Company is involved in proceedings concerning its direct marketing promotions. Also from time to time, more restrictive laws or regulations governing sweepstakes or direct marketing are considered in some jurisdictions, principally in Europe. The Company does not believe that such proceedings and proposed laws and regulations will have a material adverse effect on the Company's direct marketing business.\nThe Company is subject to postal rate increases, which affect its product deliveries, promotional mailings and billings. Postage is one of the Company's largest expenses in its promotional and billing activities. In the past, the Company has had sufficient advance notice of most increases in postal rates so that the higher rates could be factored into the Company's pricing strategies and operating plans. Because increased prices (or increased delivery charges paid by customers) may have a negative effect on sales, the Company may strategically determine from time to time the extent, if any, to which these cost increases are passed on to its customers.\nThe Company relies on postal delivery service in the jurisdictions in which it operates for timely delivery of its products and promotional mailings. In the United States, delivery service is generally satisfactory. Some international jurisdictions, however, experience periodic work stoppages in postal delivery service or less than adequate postal efficiency, although these problems have not had a significant impact on the Company.\nIn some states in the United States and in some foreign jurisdictions, some or all of the Company's products are subject to sales tax or value added tax. Tax, like delivery, is generally stated separately on bills where permitted by applicable law. Nonetheless, tax increases or imposition of new taxes increases the total cost to the customer and thus may have a negative effect on sales. Moreover, in jurisdictions where applicable tax must be included in the purchase price, the Company may be unable to fully recover from customers the amount of any tax increase or new tax.\nManagement Information Systems and List Enhancement\nThe size and quality of the Company's computerized customer list in each country in which it operates contribute significantly to its business and the Company is constantly striving to improve its lists. The Company believes that its United States list of about 50 million households, over half the total number of households in the country, is one of the largest direct response lists in the United States. The Company's international lists include a comparable number of households, in the aggregate. Unlike many publishers, the Company does not rent or sell its lists to third parties, although the Company's special interest magazines do rent their subscription lists. As part of the Company's marketing strategy to expand and enhance its customer lists, the Company may from time to time engage in limited exchanges of information from its customer lists.\nThe Company is making and will continue to make significant investments in management information systems in order to improve its operating efficiencies, increase the level of service provided to its customer base and facilitate globalization of the Company.\nList management activity is limited in some international subsidiaries because local jurisdictions, particularly in Europe, have data protection laws or regulations prohibiting or limiting the exchange of such information. Certain jurisdictions also prohibit the retention of information, other than certain basic facts, about noncurrent customers. Although data protection laws may hinder the Company's list enhancement capacity, the Company believes that current laws and regulations do not prevent the Company from engaging in activities necessary to its business.\nSpecial Interest Magazines\nThe Company publishes several special interest magazines that it deems consistent with its image, editorial philosophy and market expertise. Travel Holiday(r) magazine is a practical travel magazine aimed at middle income travelers. The Family Handyman(r) magazine provides instructions and guidance for \"do-it-yourself\" home improvement projects. New Choices for Retirement Living(r) magazine is aimed at active, mature readers and provides information on entertainment, travel, health and leisure time activities. American Health(r) magazine provides helpful information on medicine, nutrition, psychology and fitness. These magazines are sold by subscription. The Family Handyman and American Health are also sold on newsstands. In addition, Travel Holiday is distributed to members of a travel club, which also provides its members with various other benefits, such as travel insurance. Like most magazines, the Company's special interest magazines are highly dependent on advertising revenue. Each of these magazines publishes 10 issues per year. The Company also publishes Moneywise magazine, a magazine devoted to helping families manage their finances, in the United Kingdom.\nThe following table sets forth the circulation rate base of each of the Company's United States special interest magazines at June 30, 1995, as well as the number of advertising pages carried and the advertising revenues (before deducting discounts and commissions) for the fiscal years then ended. Circulation rate base data is as reported to ABC and advertising data is as reported by PIB.\nNumber of Gross Circulation Advertising Advertising Rate Base Pages Carried Revenues\nThe Family Handyman 1,000,000 500 $17,234,390 American Health 800,000 465 $13,611,041 Travel Holiday 600,000 531 $15,025,664 New Choices for Retirement Living 600,000 448 $14,100,365\n____________ Gross advertising revenues are computed from basic one- time rates and the number of advertising pages carried and, therefore, exceed actual advertising revenues as included in the Company's financial statements. Actual advertising revenues reflect lower rates for multiple insertion, volume discounts and cash discounts.\nMoneywise had a circulation rate base of 132,500 as of the end of fiscal 1995.\nOf total revenues of $95.6 million for the Company's special interest magazines in fiscal 1995, 61% was generated by circulation revenues and 39% by advertising revenues.\nThe U.S. magazines are promoted to the Company's U.S. customer list and the Company's other products are promoted to each magazine's customer list, as appropriate. This strategy helps to expand the Company's customer base for all of its products.\nThe Company is working with software developers and computer on-line services to adapt its special interest magazines to new technologies. For example, The Family Handyman is available through The CompuServe Information Service and Travel Holiday is available through America Online and the Electronic Newsstand on the Internet. The Company plans to launch a site on the World Wide Web in fiscal 1996.\nOther Businesses; Special Markets\nThe Company's wholly owned subsidiary, QSP, Inc. (\"QSP\") and a Canadian affiliate, are in the business of assisting schools and youth groups in the United States and Canada in their fundraising efforts. QSP's staff helps schools and youth groups prepare fundraising campaigns in which participants sell magazine subscriptions, music and video products, books, food and gifts. QSP derives its revenue from a portion of the proceeds of each sale. Several hundred publishers (including the Company) make magazine subscriptions available to QSP at a substantial discount. QSP also obtains discounted music products from a large music publisher. Processing of magazine subscription orders and payments is performed for QSP by an independent contractor. In August 1995, a Canadian subsidiary of the Company acquired the remaining 50% of the Company's Canadian affiliate from another large Canadian publisher.\nIn some markets, the Company also sells other products by direct response marketing, principally language courses (consisting of written materials and cassettes) and globes. Revenues from these activities are not material to the Company's business.\nThe foregoing other businesses are operated as part of the Company's Special Markets Group. Beginning in fiscal 1996, Reader's Digest Young Families will also be operated as part of that group and its financial results, which in fiscal 1995 are reported in the United States geographic and Books and Home Entertainment Products business segments, will be reported with the Special Markets Group in the United States geographic and Other Businesses business segments.\nCompetition and Trademarks\nAlthough Reader's Digest magazine is a unique and well- established institution in the magazine publishing industry, it competes with other magazines for subscribers and with magazines and all other media, including radio and television, for advertising. The Company believes that the extensive and longstanding international operations of Reader's Digest provide the Company with a significant advantage over competitors seeking to establish a global publication.\nThe Company owns numerous trademarks that it uses in its business worldwide. Its two most important trademarks are \"Reader's Digest\" and the \"Pegasus\" logo. The Company believes that the name recognition, reputation and image that it has developed in each of its markets significantly enhance customer response to the Company's direct marketing sales promotions. Accordingly, trademarks are important to the Company's business and the Company aggressively defends its trademarks.\nThe Company believes that its name, image and reputation, as well as the quality of its customer lists, provide a significant competitive advantage over many other direct marketers. However, the Company's books and home entertainment products business is in competition with companies selling similar products at retail as well as by direct marketing. Because tests show that consumers' responses to direct marketing promotions can be adversely affected by the overall volume of direct marketing promotions, the Company is also in competition with all other direct marketers, regardless of whether the products being offered are similar to the Company's products.\nEach of the Company's special interest magazines is in competition with other magazines of the same genre for readers and advertising. Nearly all of the Company's products compete with other products and services that utilize leisure activity time or disposable income.\nEmployees\nAs of June 30, 1995, the Company employed approximately 6,200 persons worldwide. Approximately 2,000 were employed in the United States and 4,200 were employed by the Company's international subsidiaries. The Company's relationship with its employees is generally satisfactory.\nExecutive Officers of the Company\nThe following paragraphs set forth the name, age and offices with the Company of each present executive officer of the Company, the period during which each executive officer has served as such and each executive officer's business experience during the past five years:\nName and Age Positions and Offices With the Company\nJames P. Schadt (57) Mr. Schadt is Chairman and Chief Executive Officer of the Company. He became Chairman on August 1, 1995 and became Chief Executive Officer on August 1, 1994. He joined the Company as President and Chief Operating Officer and was elected to the Board of Directors of the Company in September 1991. He served as President of the Company until September 8, 1995. He was a member of the board of directors of Cadbury Schweppes plc of London and Chief Executive Officer of its worldwide beverage business, Cadbury Beverages, Inc., from 1986 through July 1991.\nKenneth A. Gordon (58) Mr. Gordon was elected President and Chief Operating Officer of the Company and a member of the Board of Directors on September 8, 1995. He has been President, Reader's Digest U.S.A. since July 1993. Mr. Gordon was an Executive Vice President of the Company from April 1995 to September 1995, a Senior Vice President from January 1994 to April 1995 and a Vice President prior thereto. In addition, Mr. Gordon was President, International Group from October 1989 to June 1993. He joined the Company in 1960.\nJoseph M. Grecky (56) Mr. Grecky has been Senior Vice President, Human Resources since January 1994. He had been Vice President, Human Resources since he joined the Company in 1987.\nHeikki K. Helenius (53) Mr. Helenius has been President, Reader's Digest Europe and Vice President of the Company since July 1993. He was Vice President, International Group from January 1992 to June 1993 and was Managing Director of the Company's Finnish subsidiary prior thereto. Mr. Helenius joined the Company in 1972.\nMelvin R. Laird (73) Mr. Laird has been a member of the Board of Directors of the Company since 1990. He has served as Senior Counsellor since 1974 and was elected to the additional position of Vice President in 1989. Mr. Laird joined the Company in 1974.\nBarbara J. Morgan (50) Mrs. Morgan has been Senior Vice President and Editor-in-Chief, Books and Home Entertainment since April 1995. She was Vice President and Editor-in-Chief, Condensed Books from August 1987 to April 1995. She joined the Company in 1973.\nName and Age Positions and Offices With the Company\nMartin J. Pearson (48) Mr. Pearson, who joined the Company in August 1973, has been President, Reader's Digest Pacific and Vice President of the Company since July 1993. He was Managing Director of Reader's Digest Australia from January 1990 to June 1993 and was its Marketing Director prior thereto.\nJack A. Smith (47) Mr. Smith has been Vice President, Corporate Planning, Research and Development since April 1995. He joined the Company as Vice President, Corporate Planning and Development in June 1991 and was a partner in the Consulting Services Division at Marketing Corporation of America prior thereto.\nPaul A. Soden (51) Mr. Soden has been Senior Vice President and General Counsel since he joined the Company in February 1995. He became Secretary of the Company in September 1995. Prior thereto, he was Vice President, General Counsel and Secretary for Sterling Winthrop, Inc. (pharmaceutical and consumer products).\nKenneth Y. Tomlinson (51) Mr. Tomlinson, who joined the Company in 1968, has been Editor-in- Chief, Reader's Digest magazine since December 1990. In addition, he has been a Senior Vice President of the Company since April 1995 and was a Vice President prior thereto.\nWilliam H. Willis (44) Mr. Willis has been President, Special Markets Group and Vice President of the Company since he joined the Company in January 1994. He was previously Executive Vice President, Marketing and Sales of Ogden Services Corporation (facility management services).\nStephen R. Wilson (48) Mr. Wilson joined the Company as Executive Vice President and Chief Financial Officer in April 1995. He was Executive Vice President and Chief Financial Officer of RJR Nabisco Holdings Corp. (tobacco and food products) and its wholly owned subsidiary, RJR Nabisco, Inc. from May 1993 to April 1995, and was Senior Vice President, Corporate Development prior thereto.\nAdditional Corporate Officers\nConnie K. Beck Vice President and Associate General Counsel Gregory G. Coleman Vice President and Publisher, U.S. Reader's Digest and Special Interest Magazines Peter J.C. Davenport Senior Vice President, Global Direct Marketing Thomas M. Kenney Vice President and President, U.S. Magazine Publishing Bruce G. Koe Vice President, Global Operations Milan Kofol Vice President and Treasurer Marcia M. Lefkowitz Vice President, Marketing, Reader's Digest U.S.A. Kenneth A. Nelson Vice President, Global Management Information Systems George S. Scimone Vice President and Controller\nPursuant to the By-Laws of the Company, officers serve at the pleasure of the Board of Directors. Officers of the Company are elected annually to serve until their respective successors are elected and qualified.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters and principal operating facilities are situated on approximately 120 acres in Westchester County, New York, much of which the Company acquired in 1940. The site includes five principal buildings aggregating approximately 697,000 square feet that house executive, administrative, editorial and operational offices, and data processing and other facilities. In New York City, the Company leases approximately 181,000 square feet of office space in a total of four buildings, portions of which are used as editorial offices for its books and home entertainment products business, as advertising sales offices for Reader's Digest magazine and as offices for the Company's special interest magazines. The Company leases space for an editorial bureau, advertising sales offices and other purposes in various cities in the United States.\nThe Company leases approximately 10,000 square feet of warehouse space in Brewster, New York. QSP leases approximately 163,000 square feet in Conyers, Georgia, 4,000 square feet in Danbury, CT, 20,000 square feet in Stone Mountain, Georgia and 21,000 square feet in Ridgefield, Connecticut. Reader's Digest Young Families leases approximately 36,000 square feet of office space in Westport, Connecticut.\nThe Company owns approximately 1,613,900 square feet and leases approximately 756,000 square feet of space outside the United States that is utilized by the Company's international operating subsidiaries principally as headquarters, administrative and editorial offices and warehouse space. The foregoing properties owned by the Company include 263,000 square feet of space in Swindon, United Kingdom, in a building owned by the Company on land leased by the Company through 2076.\nThe Company believes that its current facilities, together with expansions and upgrading of facilities presently underway or planned, are adequate to meet its present and reasonably foreseeable needs. The Company also believes that adequate space will be available to replace any leased facilities for which the leases expire in the near future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are defendants in several lawsuits and claims arising in the regular course of business. Based on the opinions of management and counsel for such matters, recoveries, if any, by plaintiffs and claimants would not materially affect the financial position of the Company or its results of operations.\nOn December 21, 1993, the Roman Catholic Bishop of San Diego and the Chino Unified School District commenced a lawsuit in the U.S. District Court for the Southern District of California against a subsidiary of the Company, QSP, Inc., and the Company, alleging violation of the federal antitrust laws and seeking treble damages in an unspecified amount and certain injunctive relief. The complaint alleges that QSP, Inc. is unlawfully monopolizing a claimed school and youth group magazine fund raising market. The suit was certified as a class action on July 1, 1994. Extensive depositions and discovery have taken place and are expected to conclude before the end of 1995. While the final outcome of this lawsuit cannot be determined with certainty, management believes that the final outcome will not have a material adverse effect on the Company's results of operations or financial position and the Company intends to defend this action 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 of the Company 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\nThe information contained under the caption \"Selected Quarterly Financial Data and Dividend and Market Information\" in the Company's 1995 Annual Report to Stockholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information contained under the caption \"Selected Quarterly Financial Data and Dividend and Market Information\" and \"Selected Financial Data\" in 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\nThe information contained under the caption \"Management's Discussion and Analysis\" in 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 Company's Consolidated Financial Statements appearing on pages 26 through 35 of the Company's 1995 Annual Report to Stockholders, together with the report thereon of KPMG Peat Marwick LLP appearing on page 37, 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 with respect to directors of the Company under the caption \"Election of Directors\" in the Proxy Statement for the Annual Meeting of Stockholders of the Company to be held on November 10, 1995 is incorporated herein by reference. Information with respect to executive officers of the Company appears under the caption \"Executive Officers of the Company\" in Item 1 of Part I hereof and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to executive compensation under the captions \"Executive Compensation,\" \"Report of the Compensation & Nominating Committee\" and \"Performance Graph\" in the Proxy Statement for the Annual Meeting of Stockholders of the Company to be held on November 10, 1995 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to security ownership of certain beneficial owners and management under the caption \"Equity Security Ownership\" in the Proxy Statement for the Annual Meeting of Stockholders of the Company to be held on November 10, 1995 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 under the caption \"Executive Compensation-- Miscellaneous\" in the Proxy Statement for the Annual Meeting of Stockholders of the Company to be held on November 10, 1995 is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements See the Index to Consolidated Financial Statements on page 20 of this Report.\n(2) Financial Statement Schedules All schedules have been omitted since the information required to be submitted has been included in the Consolidated Financial Statements or Notes thereto or has been omitted as not applicable or not required.\n(3) Exhibits\n3.1.1 Restated Certificate of Incorporation of The Reader's Digest Association, Inc. filed with the State of Delaware on February 7, 1990 filed as Exhibit 3.1.1 to the registrant's Form 10-K for the year ended June 30, 1993, is incorporated herein by reference.\n3.1.2 Certificate of Amendment of the Certificate of Incorporation of The Reader's Digest Association, Inc. filed with the State of Delaware on February 22, 1991 filed as Exhibit 3.1.2 to the registrant's Form 10-K for the year ended June 30, 1993, is incorporated herein by reference.\n3.2 Amended and Restated By-Laws of The Reader's Digest Association, Inc., effective February 22, 1991 filed as Exhibit 3.2 to the registrant's Form 10-K for the year ended June 30, 1993, is incorporated herein by reference.\n10.1 The Reader's Digest Association, Inc. Management Incentive Compensation Plan (Amendment and Restatement as of July 1, 1994) filed as Exhibit 10.1 to the registrant's Form 10-K for the year ended June 30, 1994, is incorporated herein by reference.*\n10.2 The Reader's Digest Association, Inc. 1989 Key Employee Long Term Incentive Plan filed as Exhibit 10.2 to the Registration Statement on Form S-1 (Registration No. 33- 32566) filed by registrant on December 19, 1989, is incorporated herein by reference.*\n10.3 The Reader's Digest Association, Inc. 1994 Key Employee Long Term Incentive Plan filed as Exhibit 10.17 to the registrant's Form 10-Q for the quarter ended March 31, 1994, is incorporated herein by reference.*\n10.4 The Reader's Digest Association, Inc. Deferred Compensation Plan (Amendment and Restatement as of July 8, 1994) filed as Exhibit 10.4 to the registrant's Form 10-K for the year ended June 30, 1994, is incorporated herein by reference.*\n10.5 The Reader's Digest Association, Inc. Severance Plan for Senior Management (Amendment and Restatement as of July 8, 1994) filed as Exhibit 10.5 to the registrant's Form 10-K for the year ended June 30, 1994, is incorporated herein by reference.*\n10.6 The Reader's Digest Association, Inc. Income Continuation Plan for Senior Management (amended and restated) filed as Exhibit 10.5 to the registrant's Form 10-K for the year ended June 30, 1993, is incorporated herein by reference.*\n10.7 Excess Benefit Retirement Plan of The Reader's Digest Association, Inc. (Amendment and Restatement as of July 1, 1994) filed as Exhibit 10.7 to the registrant's Form 10-K for the year ended June 30, 1994, is incorporated herein by reference.*\n10.8 Supplemental Retirement Agreement dated as of May 15, 1985 between the registrant and George V. Grune filed as Exhibit 10.12 to the Registration Statement on Form S-1 (Registration No. 33-32566) filed by registrant on December 19, 1989, is incorporated herein by reference.*\n*Denotes a management contract or compensatory plan.\n10.9 Supplemental Retirement Benefit Agreement dated as of August 22, 1988 between the registrant and George V. Grune filed as Exhibit 10.7 to the Registration Statement on Form S-1 (Registration No. 33-32566) filed by registrant on December 19, 1989, is incorporated herein by reference.*\n10.10 Supplemental Retirement Benefit Agreement dated as of August 25, 1988 between the registrant and Kenneth A. Gordon filed as Exhibit 10.10 to the Registration Statement on Form S-1 (Registration No. 33-32566) filed by registrant on December 19, 1989, is incorporated herein by reference.*\n10.11 Supplemental Retirement Benefit Agreement dated as of December 12, 1989 between the registrant and Thomas M. Kenney filed as Exhibit 10.21 to the registrant's Form 10-K for the year ended June 30, 1991, is incorporated herein by reference.*\n10.12 Supplemental Retirement Benefit Agreement dated as of August 16, 1990 between the registrant and Anthony W. Ruggiero filed as Exhibit 10.22 to the registrant's Form 10- K for the year ended June 30, 1991, is incorporated herein by reference.*\n10.13 Supplemental Retirement Benefit Agreement dated as of September 13, 1991 between the registrant and James P. Schadt filed as Exhibit 10.16 to the registrant's Form 10-K for the year ended June 30, 1993, is incorporated herein by reference.*\n10.14 Supplemental Retirement Benefit Agreement dated as of August 25, 1988 between the registrant and Joseph M. Grecky.*\n10.15 Supplemental Retirement Benefit Agreement dated as of June 8, 1994 between the registrant and Martin J. Pearson.*\n10.16 Supplemental Retirement Benefit Agreement dated as of August 23, 1988 between the registrant and Kenneth Y. Tomlinson.*\n10.17 The Reader's Digest 1992 Executive Retirement Plan (Amendment and Restatement as of September 8, 1995).*\n10.18 The Reader's Digest Association, Inc. Deferred Compensation Plan for Non--Employee Directors filed as Exhibit 10.20 to the registrant's Form 10-K for the year ended June 30, 1990, is incorporated herein by reference.*\n10.19 Resolution of the Board of Directors of the registrant adopted January 10, 1986 relating to compensation for former members of the Board of Directors.*\n10.20 Agreement dated July 10, 1992 between the registrant and George V. Grune filed as Exhibit 10.15 to the registrant's Form 10-K for the year ended June 30, 1992, is incorporated herein by reference.*\n10.21 Agreement dated as of February 17, 1995 between the registrant and an executive officer filed as Exhibit 10.17 to the registrant's Form 10-Q for the quarter ended March 31, 1995, is incorporated by reference.*\n*Denotes a management contract or compensatory plan.\n13 Financial Review appearing at pages 20 through 36 of the registrant's 1995 Annual Report to Stockholders, together with the report thereon of KPMG Peat Marwick LLP appearing on page 37 (furnished for the information of the Securities and Exchange Commission only and not to be deemed filed as part of this Annual Report on Form 10-K, except for the portions thereof that are specifically incorporated herein by reference).\n21 Subsidiaries of the registrant.\n23 Consent of KPMG Peat Marwick LLP.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K\nNo report on Form 8-K was 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.\nTHE READER'S DIGEST ASSOCIATION, INC.\nBy: James P. Schadt (James P. Schadt) Chairman and Chief Executive Officer Date: September 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 dates indicated.\nSignature Title Date\nJames P. Schadt Chairman and Chief September 26, 1995 (James P. Schadt) Executive Officer and a Director\nKenneth A. Gordon President and Chief September 26, 1995 (Kenneth A. Gordon) Operating Officer and a Director\nMelvin R. Laird Vice President and September 26, 1995 (Melvin R. Laird) Senior Counsellor and a Director\nStephen R. Wilson Executive Vice September 26, 1995 (Stephen R. Wilson) President and Chief Financial Officer\nGeorge S. Scimone Vice President and September 26, 1995 (George S. Scimone) Controller\nWilliam G. Bowen Director September 26, 1995 (William G. Bowen)\nLynne V. Cheney Director September 26, 1995 (Lynne V. Cheney)\nM. Christine DeVita Director September 26, 1995 (M. Christine DeVita)\nJames E. Preston Director September 26, 1995 (James E. Preston)\nRobert G. Schwartz Director September 26, 1995 (Robert G. Schwartz)\nWalter V. Shipley Director September 26, 1995 (Walter V. Shipley)\nC.J. Silas Director September 26, 1995 (C.J. Silas)\nTHE READER'S DIGEST ASSOCIATION, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage Report of KPMG Peat Marwick LLP, Independent Auditors *\nFinancial Statements:\nConsolidated Statements of Income--For the Years Ended June 30, 1995, 1994 and 1993 *\nConsolidated Balance Sheets--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 Stockholders' Equity-- For the Years Ended June 30, 1995, 1994 and 1993 *\nNotes to Consolidated Financial Statements *\n____________ *Incorporated by reference to the Company's 1995 Annual Report to Stockholders. See Item 8 of the Annual Report on Form 10-K.","section_15":""}
{"filename":"275605_1995.txt","cik":"275605","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nJones Intercable, Inc. (the \"Company\") is a Colorado corporation organized in 1970. The Company is primarily engaged in the cable television business. See Item 1, The Company's Cable Television Business. The Company also holds equity interests in a number of programming and other cable-related subsidiaries. See Item 1, The Company's Other Businesses.\nJones International, Ltd. (\"International\") beneficially owns approximately 48% of the Common Stock of the Company and approximately 9% of the Class A Common Stock of the Company. Glenn R. Jones, the Chairman of the Board of Directors and Chief Executive Officer of the Company, personally owns approximately 9% of the Company's Common Stock and approximately 2% of the Company's Class A Common Stock. Because of his 100% ownership of International, Mr. Jones is deemed to be the beneficial owner of all shares of the Company owned by International, and his direct and indirect stock ownership enables him to control the election of a majority of the Company's Board of Directors and gives him voting power over approximately 41% of votes to be cast by all shareholders of the Company on matters not requiring a class vote. As of December 31, 1995, Bell Canada International Inc. (\"BCI\") owned 9,914,300 shares, or approximately 38%, of the Company's Class A Common Stock and, through such ownership, BCI owned an approximate 30% economic interest in the Company. In addition, BCI holds an option to purchase 2,878,151 shares of Common Stock of the Company from International, Glenn R. Jones and certain of their affiliates which, if and when exercised, would enable BCI to elect a majority of the members of the Board of Directors of the Company. In February 1996, BCI purchased 43,200 additional shares of the Company's Class A Common Stock in the market, thereby raising BCI's aggregate ownership to 9,957,500 shares of the Company's Class A Common Stock, and BCI has informed the Company that BCI intends to purchase additional shares of Class A Common Stock of the Company in the market from time to time in the future.\nAt December 31, 1995, the Company had a total of approximately 3,686 employees. The executive offices of the Company are located at 9697 E. Mineral Avenue, Englewood, Colorado 80112, and its telephone number is (303) 792-3111. Unless the context otherwise requires, the term \"Company\" as used herein refers to Jones Intercable, Inc. and its subsidiaries, including Jones Cable Holdings, Inc. (\"JCH\"), a wholly owned subsidiary that owns a majority of the cable television assets of the Company.\nTHE CABLE TELEVISION INDUSTRY\nThe cable television industry developed in the late 1940s and early 1950s in response to the needs of residents in predominantly rural and mountainous areas of the country where the quality of television reception was inadequate because of geographic location, surrounding terrain, man-made structures or the curvature of the earth. During recent decades, cable television systems have also been constructed in suburban areas and larger cities where signal interference problems or limited\navailability of channels created a desire for better reception and expanded service. Television reception is substantially improved by cable television because of its insulation from outside interference.\nThe cable television industry, which started as a technical solution to the problem of delivering television signals to remote areas of rural America, has now become an entertainment staple in a majority of American homes. It is a dynamic, evolving and ever more complex industry. Cable penetration, or the percentage of U.S. television households that subscribe to cable television, now stands at approximately 65%.\nA cable television system is a facility that receives satellite, broadcast and FM radio signals by means of high antennas, a microwave relay service or earth stations, amplifies the signals and distributes them by coaxial and\/or fiber-optic cable to the premises of its subscribers, who pay a fee for the service. A cable television system may also originate its own programming for distribution through its cable plant.\nThe physical plant of a cable television system consists of four principal operating components. The first, known as the \"headend\" facility, receives television and radio signals with microwave relay systems, special antennae and satellite earth stations. The second component, the distribution network, originating at the headend and extending throughout the system, consists of coaxial and\/or fiber-optic cables placed on poles or buried underground, and associated electronic equipment. The third component of the system is a \"drop cable\" that extends from the distribution network into the subscriber's home and connects to the subscriber's television set. The fourth component, a converter, is the home terminal device necessary to expand channel capacity and to deliver pay-per-view and other premium services.\nThe cable television industry is undergoing significant change. With recent announcements of alliances between cable television companies and telephone, computer and software companies, the Company believes that the nature of the cable television business is evolving from a traditional coaxial network delivering only video entertainment to a more sophisticated, digital platform environment where cable systems may deliver traditional programming as well as other services, including data, telephone and expanded educational and entertainment services on an interactive basis. See Item 1, The Company's Cable Television Business.\nINDUSTRY GROWTH. Based upon information obtained by the Company from industry sources, the Company believes that the following table demonstrates the growth of the cable television industry in the United States for the periods indicated:\n(1) The number of basic subscribers is computed by dividing the sum of total individual-dwelling subscribers and total revenues from bulk-rate subscribers by the standard basic service rate.\n(2) The percentage is computed by dividing the number of basic subscribers by the number of TV households in the United States (95,360,730 estimated TV households in 1995).\n(3) As of July 1995.\nSYSTEM OPERATIONS. The operation of cable television systems is generally conducted pursuant to the terms of a franchise or similar license granted by the local governing body for the area to be served or by a state agency. Franchises generally are granted on a non-exclusive basis for a period of 5 to 15 years. Joint use or pole rental agreements are normally entered into with electric and\/or telephone utilities serving a cable television system's area and annual rentals generally range from $5 to $15 for each pole used. These rates may increase in the future. See Item 1, Cable Television Franchises; Item 1, Competition; and Item 1, Regulation and Legislation.\nPROGRAMMING. Cable television systems generally offer various types of programming, which include basic service, tier service, premium services, pay-per-view programs and packages including several of these services at combined rates.\nBasic cable television service usually consists of signals of all four national television networks, various independent and educational television stations (both VHF and UHF) and certain signals received from satellites and also usually includes programs originated locally by the system, which may consist of music, news, weather reports, stock market and financial information and live or videotaped programs of a public service or entertainment nature. FM radio signals are also frequently distributed to subscribers as part of the basic service. The Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") contains signal carriage requirements. Rules promulgated under the 1992 Cable Act allow each commercial television broadcast station to elect every three years whether to require the cable systems in its area to carry its signal or to require the cable systems to negotiate with the station for \"retransmission consent\" to carry the station. If a local commercial broadcast television station requires a cable system to negotiate with the station for retransmission consent, and the cable system is unable to obtain retransmission consent, the cable\nsystem is not permitted to continue carriage of such station. See Item 1, Regulation and Legislation. During the initial three-year election period which began on October 6, 1993 and continues through December 31, 1996, no broadcast stations carried on Company-owned cable television systems that elected retransmission consent have withheld consent to the retransmission of their signals. These arrangements will have to be renewed by October 6, 1996 in order to permit continued carriage of broadcast signals by Company-owned systems.\nIn most systems, tier services are also offered on an optional basis to subscribers. These channels generally include most of the cable networks such as Entertainment and Sports Programming Network (ESPN), Cable News Network (CNN), Turner Network Television (TNT), Family Channel, Discovery and others. Systems also offer a package that includes the basic service channels and the tier services.\nCable television systems offer premium services to their subscribers, which consist of feature films, sporting events and other special features that are presented without commercial interruption. The cable television operator buys premium programming from suppliers such as HBO, Showtime, Cinemax or others at a cost based on the number of subscribers served by the cable operator. The per service cost of premium service programming usually is significantly more expensive for the system operator than the basic service or tier service programming, and consequently the system operator prices premium service separately when sold to subscribers.\nCable television systems offer to subscribers pay-per-view programming. Pay-per-view is a service that allows subscribers to receive single programs, frequently consisting of motion pictures and major sporting events, and to pay for such service on a program-by-program basis.\nSYSTEM REVENUES. Monthly service fees for basic, tier and premium services constitute the major source of revenue for cable television systems. A subscriber to a cable television system generally pays an initial connection charge and a fixed monthly fee for the cable programming services received. The amount of the monthly service fee varies from one area to another, and historically has been a function, in part, of the number of channels and services included in the service package and the cost of such services to the cable television system operator. In most instances, a separate monthly fee for each premium service and certain other specific programming is charged to subscribers, with discounts generally available to subscribers receiving multiple premium services.\nCable television operators have been able to generate additional revenue through the sale of commercial spots and channel space to advertisers. As with other forms of advertising, the cable television operator receives a fee from the advertisers that is based on the programming service on which the advertisements appear, the volume of advertising and the time of the day at which it is broadcast. Advertising, as well as fees generated by home shopping and pay-per- view, represent additional sources of revenue for cable television systems. These services are not regulated under the 1992 Cable Act.\nThe 1992 Cable Act mandated a greater degree of regulation of the cable television industry, including rate regulation. Under the 1992 Cable Act's definition of \"effective competition,\" nearly all cable systems in the United States, including almost all of those owned and managed by the Company, are subject to rate regulation with respect to basic cable services. In addition, the FCC is permitted to regulate rates for non-basic service tiers other than premium services in response to complaints filed by franchising authorities and\/or cable subscribers. Rate regulations adopted by the FCC, which became effective September 1, 1993, provide for a benchmark and price cap system that is used to regulate basic and non-basic service rates, and cost-of-service showings are available to cable operators to allow them to justify rates above benchmark levels. The Telecommunications Competition and Deregulation Act of 1996 eliminates regulation of this service tier for small cable operators and, in some circumstances, will reduce, and by 1999 eliminate, rate regulation for cable programming service packages for all cable television systems. See Item 1, Regulation and Legislation.\nCost-of-service showings justifying rates above benchmark levels were filed for the following Company-owned systems: Alexandria, Virginia; Augusta, Georgia; Charles County, Maryland; Dale City, Virginia; Jefferson County, Colorado; Manassas, Virginia and Pima County, Arizona. For these systems, the Company anticipates no further reductions in revenues or operating income before depreciation and amortization resulting from the FCC's rate regulations. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the cost-of-service showings will prevent further rate reductions unless such final approvals are received. The Company complied with the February 22, 1994 benchmark regulations and reduced rates in the following Company-owned systems: Hilo, Hawaii; Kenosha, Wisconsin; Oxnard and Walnut Valley, California; and Panama City Beach, Florida. The Company's Anne Arundel System is currently subject to effective competition as defined by the 1992 Cable Act, and, as a result, is not subject to rate regulation.\nTHE COMPANY'S CABLE TELEVISION BUSINESS\nThe Company operates cable television systems for itself and for its managed limited partnerships. At December 31, 1995, the Company managed 54 cable television systems, 41 of which, operating in 19 states, were owned by Company-managed partnerships and 13 of which, operating in 10 states, were owned by the Company. The Company's existing managed partnerships own cable television systems located in California, Colorado, Florida, Illinois, Indiana, Maryland, Michigan, Minnesota, Missouri, Nebraska, Nevada, New Jersey, New Mexico, New York, Ohio, Oregon, South Carolina, Texas and Wisconsin. The Company-owned cable television systems are located in Arizona, California, Colorado, Florida, Georgia, Hawaii, Maryland, South Carolina, Virginia and Wisconsin. In January 1996, the Company acquired another cable television system in Virginia, and in February 1996, the Company acquired additional cable television systems in Maryland and Virginia. See Item 1, Recent Acquisitions of Cable Television Systems and Proposed Acquisitions of Cable Television Systems.\nAt December 31, 1995, Company-owned systems served approximately 439,400 basic subscribers who subscribed to a total of approximately 367,600 pay units. And, at such date, systems held by Company-managed partnerships served approximately 997,200 basic subscribers who\nsubscribed to a total of approximately 716,000 pay units. (Each premium service subscribed to equals one pay unit.) According to industry sources, as of December 31, 1995, the Company ranked among the top 10 multiple system cable television operators in the United States.\nThe Company historically has grown by acquiring and developing cable television systems for both itself and its managed limited partnerships, primarily in suburban areas with attractive demographic characteristics. The Company intends to liquidate its managed limited partnerships as opportunities for sales of partnership cable television systems arise in the marketplace over the next several years. See Item 1, Recent and Proposed Dispositions of Cable Television Systems.\nKey elements of the Company's operating strategy include increasing basic penetration levels and revenue per subscriber through targeted marketing, superior customer service and maintenance of high technical standards. The Company has deployed fiber optic cable wherever practical in its current rebuild and upgrade projects, which improves system reliability and picture quality, increases channel capacity and provides the potential for new business opportunities. The Company has focused on pay-per-view and advertising as revenue growth opportunities, and expects to continue to do so in the future.\nThe Company is implementing a balanced strategy of acquiring cable television systems from Company-managed limited partnerships and from third parties. See Item 1, Recent Acquisitions of Cable Television Systems and Proposed Acquisitions of Cable Television Systems. As part of this process, certain systems owned by the Company and its managed partnerships may be sold to third parties and Company-owned systems may be exchanged for systems owned by other cable system operators. See Item 1, Recent and Proposed Dispositions of Cable Television Systems, Recent Exchange of Cable Television Systems and Proposed Exchange of Cable Television Systems. It is the Company's plan to cluster its cable television properties, to the extent feasible, in geographic areas. Clustering systems may enable the Company to obtain operating efficiencies, and it should position the Company to capitalize on new revenue and business opportunities as the telecommunications industry evolves. The Company also intends to maintain and enhance the value of its current cable television systems through capital expenditures. Such expenditures will include, among others, cable television plant extensions and the upgrade and rebuild of certain systems. The Company also intends to institute new services as they are developed and become economically viable.\nAcquisitions of cable television systems, the development of new services and capital expenditures for system extensions and upgrades are subject to the availability of cash generated from operations, debt and\/or equity financing. The capital resources needed to accomplish these strategies are expected to be provided by the sale of debt and\/or equity securities (subject to market conditions), borrowings under the Company's new $500 million credit agreement and cash generated from the Company's operating activities. In addition, the Company may explore other financing options such as private equity capital and the disposition of non-strategic assets. There can be no assurance that the capital resources necessary to accomplish the Company's acquisition and development plans will be available on terms and conditions acceptable to the Company, or at all. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nWithin the past several years, and at an increasing pace recently, the cable television industry has seen much change. With recent alliances between cable television companies and telephone, computer and software companies, the Company believes that the nature of the cable television business is evolving from a traditional coaxial network delivering only video entertainment to a more sophisticated, digital platform environment where cable systems may be capable of delivering traditional programming as well as other services, including data, telephone and expanded educational and entertainment services on an interactive basis. As this convergence of various technologies progresses, cable television companies will have to reevaluate their system architecture, upgrade their cable plants in order to take advantage of new opportunities and consider clustering their systems in geographic areas where they can achieve economies of scale and reasonable returns on the investments made. The Company is also directly affected by the entry into the marketplace of local telephone companies that, as a result of the passage of recent legislation, now have the ability to provide telephone and video services in direct competition with the Company. See Item 1, Regulation and Legislation. This direct competition with local telephone companies is an additional consideration in the ongoing evaluation by the Company of its position in this changing marketplace. The Company intends, where possible, to pursue these new technological opportunities as they evolve. The ability of the Company to do so, however, will be dependent in large part on the availability of debt and equity financing.\nThe Company is involved in analyzing and testing new technologies used in the telecommunications area, including combined telephone and video services to multiple dwelling units. The Company is utilizing the experience of BCI to provide expertise in the telecommunications area. BCI, through its parent company and its affiliates, is engaged in many areas of the telecommunications business. BCE Inc., the parent of BCI, is the largest telecommunications company in Canada. BCE Inc. is also the parent company of Bell Canada, the largest provider of telecommunications services in Canada. Bell Northern Research, an affiliate of BCI, is Canada's largest research and development organization and is engaged in developing and analyzing new technologies used in the telecommunications area. Northern Telecom, a 52% subsidiary of BCE Inc., is a leading global manufacturer of telecommunications equipment. As cable television systems in the United States evolve and change into more sophisticated digital networks providing traditional television entertainment, but also telephone and data services, and as competition between cable television operators, telephone companies and others develops, the relationship between BCI and the Company may provide the Company with access to expertise and experience that it would not otherwise have available.\nWith respect to the systems owned by the Company and its subsidiaries, the Company earns revenues through monthly service rates and related charges to cable television subscribers. The Company's subscribers have the option to choose a limited basic service consisting generally of broadcast stations and a few cable networks (\"basic\" service) or a package of services consisting of basic service and tier services (\"basic plus\" service). The basic plus service generally consists of most of the cable networks, including ESPN, USA Network, CNN, Discovery, Lifetime and others. See Item 1, The Cable Television Industry, Programming.\nMonthly service rates include fees for basic service, basic plus service and premium services. At December 31, 1995, monthly basic service rates ranged from $4.95 to $15.50 for residential subscribers, monthly basic plus service rates ranged from $10.00 to $26.33 for residential subscribers, and monthly premium services ranged from $1.13 to $14.95 per premium service. In addition, the Company earns revenues from pay-per-view programs and advertising fees. Pay-per- view programs, which usually are either unique sporting events or recently released movies, are available on many of the Company's cable television systems. Subscribers are permitted to choose individual movies for a set fee ranging from $1.99 to $6.95 per movie and individual special events for a set fee ranging from $4.95 to $54.95 per event. Related charges may include a nonrecurring installation fee that ranges from $1.99 to $50.00; however, from time to time the Company has followed the common industry practice of reducing the installation fee during promotional periods. Commercial subscribers such as hotels, motels and hospitals are charged a nonrecurring connection fee that usually covers the cost of installation. Except under the terms of certain contracts with commercial subscribers and residential apartment and condominium complexes, subscribers are free to discontinue the service at any time without penalty, and most terminations occur because a subscriber moves to another home or to another city. For the year ended December 31, 1995, of the total subscriber fees received by Company-owned systems, basic and basic plus service fees accounted for approximately 65% of total revenues, premium service fees accounted for approximately 17% of total revenues, pay-per-view fees were approximately 3% of total revenues, advertising fees were approximately 7% of total revenues and the remaining 8% of total revenues came from equipment rentals, installation fees and program guide charges. The Company is dependent upon timely receipt of service fees to provide for maintenance and replacement of plant and equipment, current operating expenses and other costs.\nAs the general partner of its managed limited partnerships, the Company earns management fees which are generally 5% of the gross revenues of the partnership, not including revenues from the sale of cable television systems or franchises. The Company also receives reimbursement from the partnerships for certain allocated overhead and administrative expenses incurred by the Company in its management activities. From time to time, the Company has made advances to certain of its managed limited partnerships and has deferred collection of management fees and expense reimbursements owed by certain of its managed limited partnerships to allow for expansion of a cable television system or other cash needs of such a partnership. Upon dissolution of a Company-managed partnership or the sale or refinancing of its cable television systems, the Company is generally entitled to receive 25 percent of the net remaining assets of such partnership, after payment of partnership debts and after investors have received an amount equal to their capital contributions plus, in most cases, a stated preferential return on their investment. Pursuant to the terms of the various limited partnership agreements, the Company has full operational control of the management and day-to-day business of the partnerships.\nThe Company historically has found that the cash flow of a particular cable television system and the long-term value of that system can be increased as a result of (i) the addition of new subscribers through increased market penetration, (ii) the building of extensions to reach new potential subscribers in the franchise area, (iii) the addition of new programming services or products, and (iv) periodic rate adjustments. Increases in subscribers usually result from specific marketing efforts undertaken by a cable system operator within the community, which may include telephone\nsolicitation, particular program promotions, direct mailings, increased advertising or other means. A cable operator also can build extensions to systems, which increase the number of homes passed by the cable system and the number of potential subscribers, and thereby increase the potential revenue from additional subscriber fees. The building of extensions to cable television systems usually occurs due to the development within the system's franchise area of a new housing area adjacent to areas then served by the system or the availability of a franchise for an area adjacent to the current franchise area. In addition, increased revenues may be generated from the offering of additional services to subscribers. New cable services have been developed and introduced since the inception of the cable television industry, and new cable services are expected to continue to develop. These services could include new services which offer movies or other entertainment on demand or nearly on demand by a subscriber (known as \"near video on demand\"), interactive services including both games and entertainment, as well as information and consumer services. No assurance can be given that the Company will be able to increase the cash flow of any particular cable television system or the value of that system by any of the methods described above, the rate regulations promulgated by the FCC under the 1992 Cable Act may limit the amount of any rate increases with respect to regulated services the Company will be able to implement in the future. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe Company's business consists of providing cable television services to a large number of customers, the loss of any one or more of which would have no material effect on the Company's business. Each of the cable television systems owned or operated by the Company has had some subscribers who later terminated the service. Terminations occur primarily because people move to another home or to another city. In other cases, people terminate on a seasonal basis or because they no longer can afford or are dissatisfied with the service. The amount of past due accounts in systems owned or operated by the Company is not significant. The Company's policy with regard to these accounts is basically one of disconnecting service before a past due account becomes material.\nThe Company does not depend to any material extent on the availability of raw materials, it carries no significant amounts of inventory and it has no material backlog of customer orders. The Company has engaged in research and development activities relating to the provision of new services. Compliance with Federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has had no material effect upon the capital expenditures, earnings or competitive position of the Company.\nTHE COMPANY'S OTHER BUSINESSES\nThe Company operates a number of non-cable television businesses through subsidiaries: The Jones Group, Ltd., a cable television brokerage company; Jones Futurex, Inc. which manufactures and markets data encryption products and provides contract manufacturing services; Jones Satellite Networks, Inc., a second-tier subsidiary of the Company that delivers radio programming to radio stations throughout the United States via satellite; and Superaudio, a joint venture between a subsidiary of the Company, Jones Galactic Radio, Inc., and an unaffiliated party that offers FM stereo audio service programming to cable television system subscribers. The Company also has an interest\nin the cable\/telephony business in the United Kingdom through its approximate 10% equity ownership of Bell Cablemedia plc, the United Kingdom's third largest cable communications operator. The Company also owns direct and indirect minority interests in Mind Extension University and Jones Computer Network, affiliated programming services. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation.\nRECENT ACQUISITIONS OF CABLE TELEVISION SYSTEMS\nAugusta System. In October 1995, JCH purchased from Cable TV Fund 12-B, Ltd. (\"Fund 12-B\"), a Company-managed limited partnership, the cable television system serving areas in and around Augusta, Georgia (the \"Augusta System\") for a purchase price of $142,618,000, subject to normal closing adjustments. The Company, as general partner of Fund 12-B, received a distribution from Fund 12-B of $13,222,000 upon the closing of this transaction. As result of such distribution, the net capital required to purchase the Augusta System was $129,396,000, which was provided from cash on hand. The Augusta System serves approximately 68,200 basic subscribers and passes approximately 102,000 homes. The Augusta System is contiguous with the cable television system already owned by the Company serving areas in and around North Augusta, South Carolina (the \"North Augusta System\"), and since closing they have been operated as one system. Together, the Augusta System and the North Augusta System serve approximately 84,100 basic subscribers and pass approximately 125,700 homes. Unless the context otherwise requires, references hereinafter to the \"Augusta System\" refer to both the Augusta System and the North Augusta System.\nDale City System. In November 1995, JCH, through its wholly-owned subsidiary, Jones Communications of Virginia, Inc., purchased from an unaffiliated company the cable television systems serving areas in and around Dale City, Lake Ridge, Woodbridge, Fort Belvoir, Triangle, Dumfries, Quantico, Accoquan and portions of Prince William County, all in the State of Virginia (the \"Dale City System\") for $123,000,000, subject to normal closing adjustments. Jones Financial Group, Ltd. (\"Financial Group\"), an affiliate of the Company, was paid a fee of $1,328,400 upon closing of this transaction for acting as the Company's financial advisor in connection with this transaction. The fee paid to Financial Group and all other fees paid or payable to Financial Group as hereinafter described, are based upon 90% of the estimated commercial rate charged by unaffiliated brokers. The Dale City System serves approximately 49,300 subscribers and passes approximately 65,100 homes.\nManassas System. In January 1996, JCH, through its wholly-owned subsidiary, Jones Communications of Virginia, Inc., purchased from unaffiliated companies the cable television systems serving areas in and around Manassas, Manassas Park, Haymarket and portions of Prince William County, all in the State of Virginia (the \"Manassas System\") for a purchase price of $71,100,000, subject to normal closing adjustments. Financial Group was paid a fee of $896,000 upon closing of this transaction for acting as the Company's financial advisor in connection with this transaction. The Manassas System serves approximately 26,500 basic subscribers and passes approximately 39,300 homes.\nCarmel System. In February 1996, JCH purchased from IDS\/Jones Growth Partners 87-A, Ltd., a Company-managed partnership, the cable television system serving areas in and around Carmel, Indiana (the \"Carmel System\") for a purchase price of $44,235,333, subject to normal closing adjustments. The purchase price represented the average of three separate independent appraisals of the fair market value of the Carmel System. The Carmel System serves approximately 19,200 basic subscribers and passes approximately 24,400 homes.\nOrangeburg System. In February 1996, JCH purchased from Jones Cable Income Fund 1-B, Ltd., a Company-managed partnership, the cable television system serving areas in and around Orangeburg, South Carolina (the \"Orangeburg System\") for a purchase price of $18,347,667, subject to normal closing adjustments. The purchase price represented the average of three separate independent appraisals of the fair market value of the Orangeburg System. The Orangeburg System serves approximately 12,500 basic subscribers and passes approximately 16,530 homes.\nTampa System. In February 1996, JCH purchased from Cable TV Fund 12-BCD Venture, a venture comprised of three Company-managed partnerships, the cable television system serving areas in and around Tampa, Florida (the \"Tampa System\") for a purchase price of $110,395,667, subject to normal closing adjustments. The purchase price represented the average of three separate independent appraisals of the fair market value of the Tampa System. The Tampa System serves approximately 65,000 basic subscribers and passes approximately 128,500 homes.\nThe Company's purchase of the Carmel System, the Orangeburg System and the Tampa System was funded by borrowings available under the Company's $500 million revolving credit facility. The Carmel System, the Orangeburg System and the Tampa System have been subsequently transferred to TWEAN as discussed below.\nPROPOSED ACQUISITIONS OF CABLE TELEVISION SYSTEMS\nManitowoc System. JCH has agreed to purchase from Cable TV Joint Fund 11 (the \"Venture\"), a venture comprised of four Company-managed partnerships, the cable television system serving the City of Manitowoc, Wisconsin (the \"Manitowoc System\") for a purchase price of $15,735,667, subject to normal closing adjustments. The Manitowoc System serves approximately 10,800 basic subscribers and passes approximately 16,000 homes. JCH's acquisition of the Manitowoc System is subject to a number of conditions that have not yet been satisfied, including the approval of the holders of a majority of the limited partnership interests of each of the four constituent partnerships of the venture that owns the Manitowoc System and the approval of the City of Manitowoc to the renewal and transfer of the franchise. The Company will receive from the four partnerships that comprise the Venture general partner distributions totaling approximately $3,900,000 upon the closing of the sale of the Manitowoc System.\nLodi System. JCH has agreed to purchase from Jones Spacelink Income Partners 87-1, L.P., a Company-managed partnership, the cable television systems serving areas in and around Lodi, Ohio (the \"Lodi System\") for a purchase price of $25,706,000, subject to normal closing adjustments. The Lodi System serves approximately 15,100 basic subscribers and passes approximately 20,600 homes.\nRipon System. JCH has agreed to purchase from Jones Spacelink Income\/Growth Fund 1-A, Ltd., a Company-managed partnership, the cable television system serving areas in and around Ripon, Wisconsin (the \"Ripon System\") for a purchase price of $3,712,667, subject to normal closing adjustments. The Ripon System serves approximately 2,450 basic subscribers and passes approximately 2,500 homes.\nLake Geneva System. JCH has agreed to purchase from Jones Spacelink Income\/Growth Fund 1-A, Ltd., a Company-managed partnership, the cable television system serving areas in and around Lake Geneva, Wisconsin (the \"Lake Geneva System\") for a purchase price of $6,345,667, subject to normal closing adjustments. The Lake Geneva System serves approximately 3,600 basic subscribers and passes approximately 5,400 homes.\nThe closings of these four acquisitions are expected to occur during the first half of 1996, and such closings are not contingent upon the closing of the Time Warner exchange discussed below.\nRECENT AND PROPOSED DISPOSITIONS OF CABLE TELEVISION SYSTEMS\nAs described above, Company-managed partnerships recently have sold or have agreed to sell the Augusta System, the Carmel System, the Orangeburg System, the Tampa System, the Manitowoc System, the Lodi System, the Ripon System and the Lake Geneva System to JCH. In addition, as described below, one of the Company's managed partnerships has agreed to sell its cable television system to an unaffiliated cable television system operator. The Company is generally entitled to a general partner distribution from its managed partnerships upon the sale of partnership-owned cable television systems provided that the limited partners have received an amount equal to their capital contributions plus, in most cases, a stated preferential return on their investment. The Company received such a distribution on the sale of the Augusta System and the Tampa System and will receive general partner distributions upon the sale of the Lancaster System and the Manitowoc System. The Company did not or will not receive general partner distributions on the sales of the Carmel System, the Orangeburg System, the Lodi System, the Ripon System or the Lake Geneva System.\nLancaster System. Cable TV Fund 11-B, Ltd. (\"Fund 11-B\"), a Company-managed partnership that owns the cable television system serving areas in and around Lancaster, New York (the \"Lancaster System\"), has entered into an agreement to sell the Lancaster System to an unaffiliated party for a sales price of approximately $84,000,000. The Company, as general partner of the partnership, is entitled to receive a distribution of approximately $13,950,000 upon the closing of the sale of the Lancaster System, which is expected to occur during the first half of 1996. In addition, The Jones Group, Ltd., a wholly owned subsidiary of the Company, will receive a fee of $2,100,000 for acting as the broker in this transaction.\nRECENT EXCHANGE OF CABLE TELEVISION SYSTEMS\nIn August 1995, the Company entered into an asset exchange agreement (the \"TWEAN Exchange Agreement\") with Time Warner Entertainment-Advance\/Newhouse Partnership (\"TWEAN\"), an unaffiliated cable television operator. The Company subsequently assigned the TWEAN Exchange Agreement to JCH. On February 29, 1996, JCH conveyed to TWEAN the Carmel System, the Orangeburg System and the Tampa System and cash in the amount of $3,500,000, subject to normal closing adjustments. In return, JCH received substantially all of the assets of cable television systems serving Andrews Air Force Base, Capitol Heights, Cheltenham, District Heights, Fairmont Heights, Forest Heights, Morningside, Seat Pleasant, Upper Marlboro and portions of Prince Georges County, Maryland (the \"Prince Georges County System\") and a portion of\nFairfax County, Virginia (the \"Reston System\"). Taking into account the aggregate purchase price paid by JCH for the Carmel System, the Orangeburg System and the Tampa System, plus the $3,500,000 cash consideration paid by JCH to TWEAN, the aggregate consideration paid for the Prince Georges County System and the Reston System was approximately $176,468,000. The Prince Georges County System and the Reston System serve approximately 85,000 subscribers. The Company paid Financial Group a $1,668,000 fee upon the completion of the exchange as compensation to it for acting as the Company's financial advisor.\nThe Prince Georges County System is contiguous to the Alexandria, Virginia, Calvert County, Maryland and Charles County, Maryland cable television systems, all of which are owned or managed by the Company. The Reston System is approximately 12 miles from the Company's Alexandria, Virginia system. The acquisition of the Prince Georges County System and the Reston System, together with the acquisition of the Dale City System in November 1995 and the Manassas System in January 1996 and the other cable television systems already owned or managed by the Company in the area, have brought the total number of basic subscribers owned or managed by the Company in the Baltimore\/Washington, D.C. metropolitan area to approximately 300,000 subscribers.\nPROPOSED EXCHANGE OF CABLE TELEVISION SYSTEMS\nIn September 1995, the Company entered into an asset exchange agreement (the \"Time Warner Exchange Agreement\") with Time Warner Entertainment Company, L.P. (\"Time Warner\"), an unaffiliated cable television operator. The Company has assigned the Time Warner Exchange Agreement to JCH. Pursuant to the Time Warner Exchange Agreement, JCH will convey to Time Warner the Manitowoc System, the Lodi System, the Ripon System and the Lake Geneva System, all of which systems are currently owned by Company-managed partnerships but are to be transferred to JCH prior to the exchange, and JCH will also convey to Time Warner the cable television system serving areas in and around Hilo, Hawaii (the \"Hilo System\") and the cable television system serving areas in and around Kenosha, Wisconsin (the \"Kenosha System\"), both of which systems are currently owned by the Company but are to be transferred to JCH prior to the exchange. In return, JCH will receive from Time Warner the cable television systems serving the communities in and around Savannah, Georgia (the \"Savannah System\") and cash in the amount of $4,000,000 subject to normal closing adjustments. Taking into account the aggregate purchase price to be paid by the Company for the Lodi System, the Lake Geneva System, the Ripon System and the Manitowoc System and the estimated valuation of the Hilo System and the Kenosha System, less the $4,000,000 cash consideration to be paid by Time Warner to JCH, the aggregate consideration to be paid for the Savannah System is approximately $119,195,000. The Savannah System passes approximately 100,000 homes and serves approximately 63,000 subscribers.\nThe closing of the transactions contemplated by the Time Warner Exchange Agreement is subject to customary closing conditions, including obtaining necessary governmental and other third party consents. The parties intend to complete the transactions during the first half of 1996, but there can be no assurance that all conditions will be satisfied or waived by that time. Either party may terminate the exchange if it is not completed on or before September 30, 1996. The Company will pay Financial Group a $1,286,000 fee upon completion of the exchange as compensation to it for acting as the Company's financial advisor.\nREFINANCING OF THE COMPANY'S CREDIT FACILITY\nOn October 31, 1995, the Company, through JCH, refinanced its bank borrowing on terms and conditions that included, among other things, an increase in its overall corporate (parent and subsidiary) borrowing capacity from $300 million to $500 million, a decrease in borrowing costs and an increase in financial flexibility. As required by the new credit facility, the Company restructured by transferring a majority of the Company-owned cable television systems to JCH, which is the borrower under this new credit facility. The Company anticipates that the transfers required under this new credit facility will be completed during the first quarter of 1996.\nREDEMPTION BY THE COMPANY OF 7.5% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2007\nOn October 12, 1995, the Company redeemed the remaining outstanding 7.5% Convertible Subordinated Debentures (the \"Debentures\") due 2007, at a price equal to 101.5% of the principal amount, plus accrued interest. The total principal amount of Debentures was $43,100,000, $23,732,000, of which were held by the Company and $19,368,000 of which were held by unaffiliated investors. The Debentures were repurchased with cash on hand.\nEXECUTION OF LETTER OF INTENT\nOn November 1, 1995, the Company entered into a letter of intent with an unaffiliated party to set forth the preliminary understanding of the parties as to their intent to enter into an asset purchase agreement whereby the Company would agree to purchase a cable television system servicing subscribers in portions of Anne Arundel County, Maryland for a purchase price of $96,500,000 subject to certain closing adjustments. Execution of a definitive asset purchase agreement and the closing of the transaction are subject to a number of conditions, including clearance by various governmental agencies.\nCHANGE OF THE COMPANY'S FISCAL YEAR\nOn September 12, 1995, the Company filed an application with the Internal Revenue Service to change its fiscal year end from May 31 to December 31, and the Internal Revenue Service has approved the requested change in the Company's fiscal year.\nINCREASE IN THE COMPANY'S AUTHORIZED CLASS A COMMON STOCK\nOn July 10, 1995, at the annual meeting of the shareholders of the Company, the shareholders approved an amendment to the Company's Articles of Incorporation to increase the number of authorized shares of the Company's Class A Common Stock from 30,000,000 shares to 60,000,000 shares.\nCABLE TELEVISION FRANCHISES\nThe cable television systems owned or managed by the Company are constructed and operated under fixed-term franchises or other types of operating authorities (referred to collectively herein as \"franchises\") that are generally non-exclusive and are granted by state and\/or local governmental authorities. These franchises typically contain many conditions, such as time limitations on commencement and completion of construction, conditions of service, including the number of channels, types of programming and the provision of free service to schools and certain other public institutions, and the maintenance of insurance and indemnity bonds. The provisions of local franchises are subject to federal regulation.\nThe Company holds approximately 70 franchises. These franchises provide for the payment of fees to the issuing authorities and range from 3% to 5% of gross revenues. The 1984 Cable Act prohibits franchising authorities from imposing annual franchise fees in excess of 5% of gross revenues and also permits the cable television system operator to seek renegotiation and modification of franchise requirements if warranted by changed circumstances.\nThe Company has never had a franchise revoked. The Company's franchises initially had terms of approximately 10 to 15 years. The duration of the Company's outstanding franchises presently varies from a period of months to an indefinite period of time. The Company is currently negotiating the renewal of six franchises that are either operating under extensions or will expire prior to December 31, 1996. During the next three to five years, the renewal process must commence for a significant number of the franchises for cable television systems owned or managed by the Company and its affiliates. The Company recently has experienced lengthy negotiations with some franchising authorities for the granting of franchise renewals. Some of the issues involved in recent renewal negotiations include rate regulation, customer service standards, cable plant upgrade or replacement and shorter terms of franchise agreements.\nCOMPETITION\nCable television systems currently experience competition from several sources.\nHigh-powered direct-to-home satellites have made possible the wide-scale delivery of programming by several companies to individuals throughout the United States using small roof-top or wall-mounted antennas. Companies offering direct broadcast satellite (\"DBS\") services use video compression technology to increase channel capacity of their systems and to provide packages of movies, network and other program services which are competitive to those of cable television systems. However, DBS cannot offer its subscribers local video services or programming. Two companies offering DBS services began operations in 1994 and together offer more than 150 channels of service using video compression technology. Two other companies offering DBS service recently began operations. In addition, a joint venture comprised of MCI Telecommunications, Inc. and the News Corporation Limited won the rights to provide a DBS service through a FCC spectrum auction. Other companies have proposed providing similar DBS program packages. A medium-powered satellite distribution also offers 100 channels of service. The FCC has initiated a new interactive television service which will permit non-video transmission of information between an individual's\nhome 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 new interactive television services. This service may also be used by the cable television industry. Although the cable television industry does not generally provide two-way interactive service from its subscribers' homes to cable television offices, such services may be provided on a wider basis in the future. Not all subscribers terminate cable television service upon acquiring a DBS system. The Company has observed that a number of DBS subscribers also elect to subscribe to cable television service in order to obtain the greatest variety of programming on multiple television sets, including local video services or programming not available through DBS service. The ability of DBS service providers to compete successfully with the cable television industry will depend on, among other factors, the availability of equipment at reasonable prices.\nAlthough the Company has not yet encountered competition from a telephone company providing video services as a cable operator or video dialtone provider, it is anticipated that the Company's cable television systems will face such competition in the near future. Federal cross-ownership restrictions have historically limited entry into the cable television business by potentially strong competitors such as telephone companies. Legislation recently enacted into law will result in the elimination of such restrictions, making it possible for companies with considerable resources, and consequently a potentially greater willingness or ability to overbuild, to enter the business. Several telephone companies have begun seeking cable television franchises from local governmental authorities as a consequence of litigation that successfully challenged the constitutionality of the cable television\/telephone company cross-ownership restrictions. See Item 1, Regulation and Legislation, Ownership and Market Structure for a description of the potential participation of the telephone industry in the delivery of cable television services. The Company cannot predict at this time when and to what extent telephone companies will provide cable television services within service areas in competition with Company owned or managed cable television systems.\nThe Company is aware of the following imminent competition from telephone companies: Ameritech, one of the seven regional Bell operating companies, which provides telephone service in a multi-state region including Illinois, has just obtained a franchise that will allow it to provide cable television service in Naperville, Illinois, a community currently served by a cable system owned by one of the Company's managed partnerships. Chesapeake and Potomac Telephone Company of Virginia and Bell Atlantic Video Service Company, both subsidiaries of Bell Atlantic, another of the regional Bell operating companies, have announced their intention to build a cable television system in Alexandria, Virginia in competition with a Company-owned cable television system. Bell Atlantic is preparing for the construction and operation of a cable telecommunications business in northern Virginia, including the Alexandria metropolitan area. The FCC has granted GTE Virginia's application for authority to construct, operate, own and maintain video dialtone facilities in northern Virginia, including in the Dale City System's service area. To date, GTE has not begun construction of a video distribution system. The entry of telephone companies as direct competitors could adversely affect the profitability and market value of the Company's owned and managed systems.\nAdditional competition is present from private cable television systems known as Master Antenna Television (MATV) and Satellite Master Antenna Television (SMATV) serving multi-unit\ndwellings such as condominiums, apartment complexes, and private residential communities. These private cable systems may enter into exclusive agreements with apartment owners, condominium associations, and homeowners associations, which may preclude operators of franchised systems from serving residents of such private complexes. In 1991, the FCC made available a microwave service to SMATV systems which will facilitate the ability of private cable television systems to distribute video entertainment programming among several SMATV systems within a local area. Private cable systems that do not cross public rights of way or interconnect separately owned and managed buildings are free from the federal regulatory requirements imposed on franchised cable television operators. The telecommunications bill which Congress recently passed exempts any facilities that do not use public rights of way (such as SMATVs serving multiple buildings not under common ownership) from classification as a cable system and from franchise and other requirements applicable to cable operators. A number of states have enacted laws to afford operators of franchised cable television systems access to multi-unit dwellings, although some of these statutes have been successfully challenged in the courts.\nRecently, companies that install and operate private cable television systems have been installing telephone systems as well as providing cable television services in some areas in which the Company's cable television systems provide cable television service to multi-unit dwellings and similar complexes. In some cases, the Company has been unable to provide cable television service in buildings in which these private operators have secured exclusive contracts to provide video and telephony services. The Company expects that the market to install and provide these services in multi-unit buildings will continue to be highly competitive. In November 1995, the Company launched in its Alexandria System a telephone service in selected apartments and condominium units.\nCable television franchises are not exclusive, so that more than one cable television system may be built in the same area (known as an \"overbuild\"), with potential loss of revenues to the operator of the original cable television system. The Company has experienced overbuilds in connection with certain systems that it has owned or managed for limited partnerships, and currently there are several overbuilds in the Company's systems. Constructing and developing a cable television system is a capital intensive process and, because most cable television systems provide essentially the same programming, it is often difficult for a new cable system operator to create a marketing edge over the existing system. Generally, an overbuilder also would be required to obtain franchises from the local governmental authorities, although in some instances, the overbuilder could be the local government, such as a city or town, and in some such cases, no franchise would be required. In any case, an overbuilder would be required to obtain programming contracts from entertainment programmers and, in most cases, would have to build a complete cable system, including headends, trunk lines and drops to individual subscribers homes, throughout the franchise areas. The Panama City Beach System has lost basic subscribers and commercial units to an overbuilder. This overbuild continues to provide significant competition and has had an adverse effect on this system's operations.\nCable television systems also may compete with wireless program distribution services such as multichannel, multipoint distribution service (\"MMDS\") systems, commonly called wireless cable which are licensed to serve specific areas. MMDS uses low-power microwave frequencies to transmit television programming over-the-air to subscribers. MMDS systems have generally focused on\nproviding service to residents of rural areas that are not served by cable television systems, but providers of programming via wireless cable systems will generally have the potential to compete directly with cable television systems in urban areas as well. Wireless cable systems are now in direct competition with cable television systems in several areas of the country. Telephone companies have recently invested in wireless systems located in California and Maryland as well as other states. These wireless systems could be used on an interim or permanent basis by telephone companies to provide video services within their service areas in lieu of the video dialtone or other wired delivery systems which have been proposed. The MMDS industry is less capital intensive than the cable television industry, and it is therefore more practical to construct MMDS systems in areas of lower subscriber penetration, but the previous unavailability of frequency spectrum, programming services and the regulatory delays encountered by MMDS systems in obtaining licenses have delayed the growth of the MMDS industry. To date, the Company has not lost a significant number of subscribers, nor a significant amount of revenue, to MMDS operators competing with the Company's cable television systems.\nA series of actions taken by the FCC, including reallocating certain frequencies to the wireless services, are intended to facilitate the development of wireless cable television systems as an alternative means of distributing video programming. The FCC recently held auctions for spectrum that will be used by wireless operators to provide additional channels of programming over larger distances.\nAn emerging technology, Local Multipoint Distribution Services (\"LMDS\"), could also pose a significant threat to the cable television industry, if and when it becomes established. LMDS, sometimes referred to as cellular television, could have the capability of delivering approximately 50 channels, or if two systems were combined 100 channels, of video programming to a subscriber's home, and this capacity could be increased by using video compression technology. The potential impact, however, of LMDS is difficult to assess due to the newness of the technology and the absence of any current fully operational LMDS systems.\nThe FCC has established a new wireless telecommunications service known as Personal Communications Service (\"PCS\"). It is envisioned that PCS would provide portable non-vehicular mobile communications services similar to that available from cellular telephone companies, but at a lower cost. PCS is delivered by placing numerous microcells in a particular area to be covered, accessible to both residential and business customers. Because of the need to link the many microcells necessary to deliver this service economically, many parties are investigating integration of PCS with cable television operations. Several cable television multiple system operators hold or have requested experimental licenses from the FCC to test PCS technology, and the FCC has allocated spectrum to PCS licensees which is being awarded through an auction process.\nIn addition to competing with one another, cable television systems compete with broadcast television, which consists of television signals that the viewer is able to receive directly on his television using his antenna (\"off- air\"). The extent of such competition is dependent in part upon the quality and quantity of signals available by such antenna reception as compared to the services provided by the available cable systems. Accordingly, it has generally been less difficult to obtain higher penetration rates in areas where there is signal interference from surrounding mountains or\nwhere signals available off-air are limited, than in metropolitan areas where higher quality off-air signals are often available without the aid of cable television systems.\nCable television systems also compete with translator and low power television stations. Translators receive broadcast signals and rebroadcast them on different frequencies at low power pursuant to an FCC license. Low power television stations increase the number of television signals in many areas of the country, and provide off-air television programs, either pay or advertiser-supported, to limited local areas. Cable television systems are also in competition, in various degrees, with other communications and entertainment media including motion pictures and home video cassette recorders, and are dependent upon the continued popularity of television itself. The construction of more powerful transmission facilities near a cable television system or an increase in the number of television signals in such an area also could have an adverse effect on revenues.\nREGULATION AND LEGISLATION\nThe cable industry is regulated under the Telecommunications Act of 1996 (the \"1996 Cable Act\"), the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") and the Cable Communications Policy Act of 1984 (the \"1984 Cable Act\") and the regulations implementing these statutes. The Federal Communications Commission (the \"FCC\") has promulgated regulations covering such areas as the registration of cable television systems, cross-ownership between cable television and other communications businesses, carriage of television broadcast programming, consumer protection and customer service standards and lockbox enforcement, origination cablecasting and sponsorship identification, limitations on commercial advertising in children's programming, the regulation of basic cable and cable programming service rates in areas where cable television 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. In addition, cable operators periodically are required to file various informational reports with the FCC. 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 administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities often used in connection with cable operations. State or local franchising authorities, as applicable, also have the right to enforce various regulations, impose fines or sanctions, issue orders or seek revocation subject to the limitations imposed upon such franchising authorities by federal, state and local laws and regulations. Several states have assumed regulatory jurisdiction of the cable television industry, and it is anticipated that other states will do so in the future. To the extent the cable television industry begins providing telephone service, additional state and federal regulations will be applied to the cable television industry. Cable television operations are subject to local regulation insofar as systems operate under franchises granted by local authorities.\nThe following is a summary of federal laws and regulations materially affecting the cable television industry, and a description of state and local laws with which the cable industry must comply.\nTELECOMMUNICATIONS ACT OF 1996. The 1996 Cable Act, which became law on February 8, 1996, substantially revised the Communications Act of 1934, as\namended, including the 1984 Cable Act and 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 Cable 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 Cable 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 Cable Act.\nAmong other provisions, the 1996 Cable Act modifies various rate regulation provisions of the 1992 Cable Act. Generally, under the 1996 Cable Act, cable programming service tier rates are deregulated on March 31, 1999. Upon enactment, the cable programming service rates charged by \"small\" cable operators are deregulated in systems serving 50,000 or fewer subscribers. Subscribers are no longer permitted to file programming service complaints with the FCC, and complaints may only be brought by a franchising authority if, within 90 days after a rate increase becomes effective, it receives subscriber complaints. The FCC is required to act on such complaints within 90 days. In addition to the existing definition of \"effective competition,\" a new effective competition test permits deregulation of both the basic and programming service tier rates where a telephone company offers cable service by any means other than direct-to-home satellite services, provided that such service is comparable to the services provided by the unaffiliated cable operator. The uniform rate provision of the 1992 Cable Act was amended to exempt bulk discounts to multiple dwelling units so long as a cable operator that is not subject to effective competition does not charge predatory prices to a multiple dwelling unit.\nThe most far-reaching changes in the communications business will result from the telephony provisions of the 1996 Cable Act. The statute expressly preempts any legal barriers to competition in the local telephone business that previously existed in state and local laws and regulations. Many of these barriers had been lifted by state actions over the last few years, but the 1996 Cable Act completed the task. The 1996 Cable Act also establishes new requirements for maintaining and enhancing universal telephone service and new obligations for telecommunications providers to maintain privacy of customer information. The 1996 Cable Act establishes uniform requirements and standards for entry, competitive carrier interconnection and unbundling of LEC monopoly services. Depending on the degree and form of regulatory flexibility afforded the LECs, the Company's ability to competitively offer telephone services may be adversely affected. In addition, the Company's ability to effectively compete and provide telephone services will depend upon the outcome of various FCC rulemakings, including the proceeding dealing with interconnection obligations of telecommunications carriers.\nThe 1996 Cable Act repealed the cable television\/telephone cross-ownership ban adopted in the 1984 Cable Act. The federal cross-ownership ban was particularly important to the cable industry because telephone companies already own certain facilities such as poles, ducts and associated rights of way. While this ban had been overturned by several courts, formal removal of the ban ended the last legal constraints on telephone company plans to enter the cable market. Under the 1996 Cable Act, telephone companies in their capacity as common carriers now may lease capacity to others to provide cable television service. Telephone companies have the option of providing video service as cable operators or through \"open video systems\" (\"OVS\"), a regulatory regime that may provide\nmore flexibility than traditional cable service. The 1996 Cable Act exempts OVS operators from many of the regulatory obligations that currently apply to cable operators, such as rate regulation and franchise fees, although other requirements are still applicable. OVS operators, although not subject to franchise fees as defined by the 1992 Cable Act, are subject to fees charged by local franchising authorities or other governmental entities in lieu of franchise fees. (Under certain circumstances, cable operators also will be able to offer service through open video systems.) In addition, the 1996 Cable Act eliminated the requirement that telephone companies file Section 214 applications with the FCC before providing video service. This limits the opportunity of cable operators to mount challenges at the FCC regarding telephone company entry into the video market. The 1996 Cable Act also contains restrictions on buying out incumbent cable operators in a telephone company's service area, especially in suburban and urban markets.\nOther parts of the 1996 Cable Act also will affect cable operators. Under the 1996 Cable Act, the FCC is required to revise the current pole attachment rate formula. This revision will result in an increase in the rates paid by entities, including cable operators, that provide telecommunication services. The rates will be phased in after a five-year period. (Cable operators that provide only cable services are unaffected.) Under the V-chip provisions of the 1996 Cable Act, cable operators and other video providers are required to pass along any program rating information that programmers include in video signals. Cable operators also are subject to new scrambling requirements for sexually explicit programming, and cable operators that provide Internet access or other online services are subject to the new indecency limitations for computer services. These provisions already have been challenged, and the courts have preliminarily enjoined the enforcement of these content-based provisions.\nUnder the 1996 Cable Act, a franchising authority may not require a cable operator to provide telecommunications services or facilities, other than an institutional network, as a condition to a grant, renewal or transfer of a cable franchise, and franchising authorities are preempted from regulating telecommunications services provided by cable operators and from requiring cable operators to obtain a franchise to provide such services. The 1996 Cable Act also repealed the 1992 Cable Act's anti-trafficking provision, which generally required the holding of cable television systems for three years.\nIt is premature to predict the specific effects of the 1996 Cable Act on the cable industry in general or the Company in particular. The FCC shortly will be undertaking numerous rulemaking proceedings to interpret and implement the 1996 Cable Act. It is not possible at this time to predict the outcome of those proceedings or their effect on the Company.\nCABLE TELEVISION CONSUMER PROTECTION AND COMPETITION ACT OF 1992. The 1992 Cable Act effected significant changes to the legislative and regulatory environment in which the cable television industry operated. The 1992 Cable Act generally mandated a greater degree of regulation of the cable television industry. Pursuant to the FCC's definition of \"effective competition\" adopted following enactment of the 1984 Cable Act, and under the FCC's rules and regulations, substantially all of the Company's systems were rate deregulated in the mid-1980s. Under the 1992 Cable Act's definition of \"effective competition,\" nearly all cable systems in the United States, including those owned and managed by the Company, were again subjected to rate regulation of basic cable services.\nThe 1992 Cable Act also allowed the FCC to regulate rates for non-basic service tiers (other than premium services) in response to complaints filed by franchising authorities and\/or cable subscribers. As discussed above, the 1996 Cable Act will over time again allow for rate deregulation of cable service programming.\nIn 1993, the FCC adopted a benchmark regulatory scheme for the regulation of basic and cable programming service rates. Rather than relying on the benchmark scheme, however, operators may submit cost-of-service showings to justify rates above the applicable benchmarks. A cable operator that can demonstrate through a cost-of-service showing that rates for basic and non-basic services are justified will not be required to reduce rates or be regulated under the benchmark and price cap system. Franchising authorities may not elect cost-of-service as their primary form of rate regulation but must apply the FCC benchmark system. Except for those operators that filed cost-of-service showings, cable operators whose rates are subject to regulation and that were above the benchmark levels generally reduced those rates to the benchmark level, or by 10%, whichever was less, adjusted forward for inflation. Operators who did not adjust rates pursuant to the FCC's regulations, or whose cost-of-service showings fail to justify current rates, could be subject to refund liability and interest.\nIn 1994, the FCC revised its benchmark regulations. Effective May 1994, cable television systems not seeking to justify rates with a cost-of-service showing were required to reduce rates up to 17% of the rates in effect on September 30, 1992, adjusted for inflation, channel modifications, equipment costs and certain increases in programming costs. Under certain conditions, systems were permitted to defer these rate adjustments until July 1994. Further rate reductions for cable systems whose rates are below the revised benchmark levels, as well as reductions that would require operators to reduce rates below benchmark levels in order to achieve a 17% rate reduction, were held in abeyance pending completion of cable system cost studies. The FCC recently requested some of these \"low price\" systems to complete cost study questionnaires. After review of these questionnaires, the FCC could decide to permanently defer any further rate reductions, or require the additional 7% rate roll back for some or all of these systems. The FCC has instituted a streamlined upgrade methodology by which operators may recover the costs of upgrading their plant.\nThe FCC also regulates the manner in which cable operators may charge subscribers for new channels added to cable programming services tiers. The FCC instituted a three-year flat fee mark-up plan. Commencing on January 1, 1995, operators may charge subscribers up to $.20 per channel for any channels added after May 14, 1994, but may not make adjustments to monthly rates totaling more than $1.20 plus an additional $.30 to cover programming license fees for those channels over the first two years of the three-year period. In year three, an additional channel may be added with another $.20 increase in rates. Rates may also increase in the third year to cover any additional costs for the programming for any of the channels added during the entire three-year period. Cable operators electing to use the $.20 per channel adjustment may not also take a 7.5% mark-up on programming cost increases, which is otherwise permitted under the FCC's regulations. The FCC has requested further comment on whether cable operators should continue to receive the 7.5% mark-up on increases in license fees on existing programming services.\nThe FCC will permit cable operators to exercise their discretion in setting rates for new product tiers so long as, among other conditions, the channels that are subject to rate regulation are\npriced in conformity with applicable regulations and cable operators do not remove programming services from existing rate-regulated service tiers and offer them on the new product tiers.\nIn September 1995, the FCC authorized a new, alternative method of implementing rate adjustments which will allow cable operators to increase rates for programming 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 a preceding 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 December 1995, the FCC adopted final cost-of-service rate regulations requiring, among other things, cable operators to exclude 34% of system acquisition costs 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. After a rate has been set pursuant to a cost-of-service showing, rate increases for regulated services are indexed for inflation, and operators are permitted to increase rates in response to increases in costs beyond their control, such as taxes and increased programming costs.\nNew a la carte services that are offered by cable operators in a package will be subject to rate regulation by the FCC, although only if the FCC deems it necessary to do so. The FCC has indicated that it could not envision circumstances in which any price for a collective offering of premium channels that had traditionally been offered on a per-channel basis would be found to be unreasonable.\nThe United States Court of Appeals for the District of Columbia recently upheld the FCC's rate regulations implemented pursuant to the 1992 Cable Act, but ruled that the FCC impermissibly failed to permit cable operators to adjust rates for certain cost increases incurred during the period between the 1992 Cable Act's passage and the initial date of rate regulation. The FCC has not yet implemented the court's ruling.\nThe 1992 Cable Act encouraged competition by allowing municipalities, which are otherwise legally qualified, to own and operate their own cable systems without having to obtain a franchise by preventing franchising authorities from granting exclusive franchises or unreasonably refusing to award additional franchises covering an existing cable system's service area. The 1992 Cable Act also made several procedural changes to the process under which a cable operator may seek to enforce renewal rights, which could make it easier in some cases for a franchising authority to deny renewal. The 1992 Cable Act also precluded video programmers affiliated with cable companies from favoring cable operators over competitors and required such programmers to sell their programs to other multichannel video distributors. This provision may limit the ability of cable program suppliers to offer exclusive programming arrangements with cable companies and could affect the volume discounts that program suppliers currently offer to the Company as a multiple system operator. The 1992 Cable Act prohibits the common ownership of cable systems and co-located MMDS or SMATV systems; however, the 1996 Cable Act repealed the ban on cable MMDS cross-ownership where a cable system is subject to effective competition.\nThe 1992 Cable Act contained new signal carriage requirements. The FCC adopted rules implementing the must-carry provisions for non-commercial and commercial stations and retransmission consent for commercial stations in March 1993. These rules allow commercial television broadcast stations that are \"local\" to a cable system, i.e., the system is located in the station's Area of Dominant Influence (\"ADI\"), to elect every three years whether to require the cable system to carry the station, subject to certain exceptions, or whether to require the cable system to negotiate for \"retransmission consent\" to carry the station. The first such election was made in June 1993 and thus the Company will go through the process again in 1996. Cable systems must 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). All commercial stations entitled to carriage were to have been carried by June 1993, and any non-must-carry stations (other than superstations) for which retransmission consent had not been obtained could no longer be carried after October 5, 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, non-commercial stations are not given the option to negotiate retransmission consent for the carriage of their signal. The must-carry provisions for non-commercial stations became effective in December 1992.\nIn 1993, a federal district court upheld the constitutional validity of the must-carry signal carriage requirements. This decision was vacated by the United States Supreme Court in 1994 and remanded for further development of a factual record. The Supreme Court's majority determined that the must-carry rules were content neutral, but that it was not yet proven that the rules were needed to preserve the economic health of the broadcasting industry. In 1995, the federal district court again upheld the must-carry rules' validity. The United States Supreme Court is currently reviewing this decision.\nIn 1993, a federal district court upheld provisions of the 1992 Cable Act concerning rate regulation, retransmission consent, restrictions on vertically integrated cable television operators and programmers, mandatory carriage of programming on commercial leased channels and public, educational and governmental access channels and the exemption for municipalities from civil damage liability arising out of local regulation of cable services. The 1992 Cable Act's provisions providing for multiple ownership limits for cable operators and advance notice of free previews for certain programming services have been found unconstitutional, and these decisions have been appealed. The FCC's regulations relating to the carriage of indecent programming, which were recently upheld by the United States Court of Appeals for the District of Columbia, have been appealed to the United States Supreme Court.\nThe 1992 Cable Act required the FCC to establish national customer service standards and the FCC adopted regulations governing office hours, telephone availability, installations, outages, service calls, and billing and refund policies. State or municipal authorities may enact laws or regulations which impose stricter or different customer service standards than those set by the FCC.\nCABLE COMMUNICATIONS POLICY ACT OF 1984. The 1984 Cable Act was the first federal legislation to impose comprehensive and uniform national regulations on cable television systems and franchising authorities. Among other things, the legislation regulated the provision of cable television service pursuant to a franchise, specified those circumstances under which a cable television operator may obtain modification of its franchise, established criteria under which a franchise shall be renewed and established maximum fees payable by cable television operators to franchising authorities. The law prescribes a standard of privacy protection for cable subscribers, and imposes equal employment opportunity requirements on the cable television industry. It restricts the amount of fees paid by a cable television operator to a franchising authority to a maximum of 5% of gross revenues during the term of the franchise. Franchising authorities are granted authority to establish requirements in new franchises and renewal of existing franchises for the designation and use of public educational and governmental access channels. Franchising authorities are empowered to establish requirements for cable-related facilities and equipment, which may include requirements that relate to channel capacity, system configuration and other facility or equipment requirements related to the establishment and operation of a cable television system. Many of the other provisions of the 1984 Cable Act have been superseded by the 1992 Cable Act and the 1996 Cable Act.\nFRANCHISING. The responsibility for franchising or other authorization of cable television systems is left to state and local authorities. There are, however, several provisions in the 1984 Cable Act that govern the terms and conditions under which cable television systems provide service. These include uniform standards and policies that are applicable to cable television operators seeking renewal of a cable television franchise. The procedures established provide for a formal renewal process should the franchising authority and the cable television operator decline to use an informal procedure. A franchising authority unable to make a preliminary determination to renew a franchise is required to hold a hearing in which the operator has the right to participate. In the event a determination is made not to renew the franchise at the conclusion of the hearing, the franchising authority must provide the operator with a written decision stating the specific reasons for non-renewal. Generally, the franchising authority can finally decide not to renew a franchise only if it finds that the cable operator has not substantially complied with the material terms of the present franchise, has not provided reasonable service in light of the community's needs, does not have the financial, legal or technical ability to provide the services being proposed for the future, or has not presented a reasonable proposal for future service. A final decision of non-renewal by the franchising authority is appealable in court.\nThe 1996 Cable Act preempts franchising authorities from regulating telecommunications services provided by cable operators and from requiring cable operators to obtain a franchise to provide such services. A franchising authority may not require a cable operator to provide telecommunications services or facilities, other than an institutional network, as a condition to a grant, renewal or transfer of a cable franchise.\nOWNERSHIP AND MARKET STRUCTURE. FCC rules generally prohibit the direct or indirect common ownership, operation, control or interest in a cable television system, on the one hand, and a local television broadcast station whose television signal (predicted grade B contour as defined under FCC regulations) reaches any portion of the community served by the cable television system, on the\nother hand. For purposes of the cross-ownership rules, \"control\" of licensee companies is attributed to all 5% or greater stockholders, except for mutual funds, banks and insurance companies which may own less than 10% without attribution of control. The FCC has requested comment as to whether to raise the attribution criteria from 5% to 10% and for passive investors from 10% to 20%, and whether it should exempt from attribution certain widely held limited partnership interests where each individual interest represents an insignificant percentage of total partnership equity. The 1996 Cable Act eliminated the statutory ban on the cross-ownership of a cable system and a television station, and permits the FCC to amend or revise its own regulations regarding the cross-ownership ban. The FCC recently lifted its ban on the cross-ownership of cable television systems by broadcast networks and revised its regulations to permit broadcast networks to acquire cable television systems serving up to 10% of the homes passed in the nation, and up to 50% of the homes passed in a local market. The local limit would not apply in cases where the network-owned cable system competes with another cable operator.\nThe 1996 Cable Act generally restricts common carriers from holding greater than a 10% financial interest or any management interest in cable operators that provide cable service within the carrier's telephone exchange service area or from entering joint ventures or partnerships with cable operators in the same market subject to four general exceptions, which include population density and competitive market tests. The FCC may waive the buyout restrictions if it determines that, because of the nature of the market served by the cable system or the telephone exchange facilities, the cable operator or LEC would be subject to undue economic distress by enforcement of the restrictions; the system or LEC facilities would not be economically viable if the provisions were enforced; the anticompetitive effects of the proposed transaction clearly would be outweighed by the public interest in serving the community; and the local franchising authority approves the waiver.\nThe FCC has imposed limits on the number of cable systems that a single cable operator may own. In general, no cable operator may hold an attributable interest in cable systems that pass more than 30% 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 of the United States District Court decision holding the multiple ownership limit restrictions of the 1992 Cable Act unconstitutional.\nFOREIGN OWNERSHIP RESTRICTION. The Communications Act restricts the extent to which non-U.S. citizens may have ownership or control rights in certain categories of licenses issued by the FCC. Licenses subject to these restrictions (the \"Restricted Licenses\") include broadcast licenses, common carrier radio licenses (such as common carrier point-to-point microwave licenses), and commercial mobile radio service (\"CMRS\") licenses (such as cellular telephone, paging and personal communications service (\"PCS\") licenses). Section 310(b)(4) of the Communications Act provides that, absent a specific public interest determination by the FCC, a corporation may not control the licensee of any of these restricted licenses if non-U.S. citizens hold more than 25% of the ownership or voting rights of the corporation. (Different and more restrictive standards apply if non-U.S. entities hold interests directly in the licensee of a Restrictive License.)\nSection 310(b)(4) precludes the Company from controlling any Restricted Licenses unless the Company obtains a public interest determination by the FCC that it may hold restricted licenses even though non-U.S. participation in the Company, including levels of non-U.S. ownership and voting rights, exceed the benchmarks under Section 310(b)(4). The FCC licenses commonly employed in cable television operations do not fall within the category of Restricted Licenses subject to the foreign ownership restrictions in Section 310(b) of the Communications Act. The category of Restricted Licenses, however, includes licenses commonly used in the provision of conventional and mobile telephone service, such as common carrier point-to-point microwave licenses, common carrier transmit satellite earth station licenses, cellular telephone licenses and PCS licenses. Although Section 310(b) restricts the control of Restricted Licenses by the Company due to BCI's investment in the Company, the Company may acquire carriage services from existing U.S. carriers holding these licenses to the extent that it finds a need for these communications links in the conduct of its business.\nIn November 1995, the FCC issued its Report and Order in IB Docket No. 95-22, in which, among other things, the FCC adopted a new policy of considering the competitive opportunities provided to U.S. carriers in foreign markets as a basis for permitting corporations with foreign participation above the benchmarks of Section 310(b)(4) to control Restricted Licenses other than broadcast licenses. This policy may expand the opportunities for corporations with foreign participation above the Section 310(b)(4) benchmarks to obtain FCC approval allowing them to hold non-broadcast Restricted Licenses, provided that the home country of the non-U.S. participants provides effective competitive opportunities for U.S. carriers.\nPROGRAM ORIGINATION AND EXCLUSIVITY OBLIGATIONS. Cable television systems may originate programs and may present advertising subject to compliance with the FCC's regulations governing political broadcasts, political advertisements and sponsorship identification, and prohibitions on lotteries and obscene programming. FCC regulations currently require cable television systems located within 35 miles of a television market to delete syndicated programs on distant broadcast signals upon request of the copyright owner or the local station holding the exclusive rights to broadcast the same program within its television market. Similar blackout regulations also are applicable to network programming in which local network affiliates hold exclusive rights.\nCOPYRIGHT MATTERS. The Copyright Act of 1976 grants cable television systems a \"compulsory license\" to carry distant television signals authorized by the FCC. In consideration for the compulsory license, cable television systems are required to pay royalties to the owners of the copyrighted material which is carried. These copyright royalty payments are based upon a percentage of a cable television system's gross revenues from basic subscriber service. Every cable television system must submit statements of account and royalty payments to the Copyright Office. The Copyright Act contains specific formulas for calculating the amount of the royalty fee. In general, under these formulas, the larger the system and the greater the number of distant signals carried, the greater will be the royalty fees. Failure to comply constitutes copyright infringement and may result in the imposition of fines and other penalties. The distribution of royalties is administered by the Library or Congress which will use arbitration panels to resolve royalty distribution disputes.\nThe possible simplification, modification or elimination of the compulsory license is the subject of continuing legislative review. Consequently, the nature or amount of future royalty payments for broadcast signal carriage cannot presently be predicted. 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 would remain available for distribution to the Company's cable subscribers.\nCopyrighted music performed in programming supplied to cable television systems by pay cable networks (such as HBO) and cable programming 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. ASCAP and BMI offer \"through to the viewer\" licenses to the cable networks which cover the retransmission of the cable networks' programming by cable television systems to their customers. The cable industry has just concluded negotiations on licensing fees with BMI for the use of music performed in programs locally originated by cable television systems, although no actual agreements are in place; negotiations with ASCAP are ongoing. ASCAP has filed an infringement suit against several cable operators as representatives of cable systems using its music in the pay programming and cable programming networks provided to subscribers.\nSTATE REGULATION. Several states have subjected cable television systems to the jurisdiction of state governmental agencies, some of which have exercised jurisdiction over transfers of control of cable systems, customer service standards and franchising requirements. Attempts in other states to so regulate cable television systems are continuing and can be expected to increase.\nLOCAL REGULATION. A cable television system is generally operated pursuant to a non-exclusive franchise or permit granted by the local governing body of the area to be served. Franchises are granted for a stated term, generally 10 to 15 years, and in many cases are cancelable for failure to comply with various conditions and limitations, including compliance with national, state and local safety and electrical codes, required rates of construction and conditions of service. Franchises usually call for the payment of fees to the granting authority. Some state and local regulations governing cable television systems may be subject to requirements imposed by the FCC and are also subject to the requirements imposed by Federal law. The FCC has generally preempted local regulation of the technical standards with which cable television systems must comply, and has recently implemented uniform standards for the industry.\nTECHNICAL AND REPORTING REQUIREMENTS. The FCC licenses radio, microwave and satellite facilities used by cable television systems. The FCC rules include technical standards for cable television systems with which all systems must comply. The FCC requires cable television systems to file annual reports pertaining to frequency usage, subscriber information and equal employment opportunity practices. The FCC has recently adopted new technical standards, and franchising authorities may not require cable television systems to adhere to standards that are stricter than those of the FCC.\nREGULATORY FEES AND OTHER MATTERS. Pursuant to the dictates of the Communications Act, the FCC has adopted requirements for payment of annual \"regulatory fees\" by the various industries it regulates, including the cable television industry. Currently, cable television systems are required to pay regulatory fees which may be passed on to subscribers as \"external cost\" adjustments to rates for basic cable service. Effective September 18, 1995, the per subscriber fee increased from $0.37 per subscriber per year to $0.49. Fees for other FCC licenses increased as well, including licenses for business radio, cable television relay systems (CARS) and earth stations. Those fees however, may not be collected directly from subscribers.\nIn addition, the 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-event 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 cable systems must become technically capable of complying with the statutory obligation by December 2002. Consistent with its statutory obligations the FCC also has adopted a number of measures for improving compatibility between existing cable systems and consumer electronics equipment, including a prohibition from scrambling program signals carried on the basic tier, absent a waiver. The FCC also is considering whether to extend this prohibition to cover all regulated tiers of programming.\nMISCELLANEOUS PROVISIONS. The Communications Act specifically empowers the FCC to impose fines upon cable television system operators for willful or repeated violation of the FCC's rules and regulations. The FCC has adjudicatory authority over pole attachment disputes where a state has not asserted jurisdiction. The 1996 Cable Act extends the regulation of rates, terms and conditions of pole attachments to telecommunications service providers and requires the FCC to prescribe regulations to govern the charges for pole attachments used by telecommunications carriers to provide telecommunications services when the parties fail to resolve the dispute over such charges. The 1996 Cable Act, among other provisions, increases significantly future pole attachment rates for cable systems which used pole attachments in connection with the provision of telecommunications services as a result of a new rate formula charged to telecommunication carriers for the non-usable space of each pole. These rates are to be phased in after a five-year period.\nThe 1996 Cable Act requires the FCC, in consultation with industry standard-setting organizations, to adopt regulations which would encourage commercial availability to consumers of all services offered by multichannel video programming distributors. The regulations adopted may not prohibit programming distributors from offering consumer equipment, so long as the cable operator's rates for such equipment are not subsidized by charges for the services offered. The rules also may not compromise the security of the services offered, or the efforts of service providers from preventing theft of service. The FCC may waive these rules so as not to hinder the development of advanced services and equipment. The 1996 Cable Act requires the FCC to examine the market for closed captioned programming and prescribe regulations which ensure that video programming, with certain exceptions, is fully accessible through closed captioning.\nIn December 1994, the FCC announced that its long-standing Emergency Broadcast System rules were to be replaced. The new rules establish cable television and technical standards to support\na new Emergency Alert System. Cable operators must install and activate equipment necessary for the new system by July 1, 1997.\nThe FCC has initiated a rulemaking to consider, among other issues, whether to adopt uniform regulations governing telephone and cable inside wiring. The regulations ultimately adopted by the FCC could affect the Company's ownership interests and access to inside wiring used to provide telephony and video programming services. In a related rulemaking proceeding, the FCC will consider the appropriate treatment of cable inside wiring in multiple dwelling unit buildings. The outcome of that rulemaking could affect cable operators' access to inside wiring in MDUs.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases a portion of its executive offices from Jones Properties, Inc., a subsidiary of International. The offices consist of a 101,500 square foot office building located at 9697 East Mineral Avenue, Englewood, Colorado. This building was completed in July 1985. The lease has a 15-year term expiring in July 2000 with three 5-year renewal options at market rates existing at the beginning of the option period. The annual rent is currently $24.00 per square foot, plus operating expenses and will not, by the terms of the lease, exceed such amount during the remainder of the term. The Company subleases approximately 49% of the building to International and certain other affiliates on the same terms and conditions as the primary lease.\nThe Company leases from Jones Panorama Properties, Inc., a wholly-owned subsidiary of the Company, an approximate 60,000 square foot office building (the \"Panorama Falls Building\") located at 9085 E. Mineral Avenue, Englewood, Colorado for a lease price of $12.00 per square foot. The Panorama Falls Building contains additional executive offices of the Company. The Company has subleased approximately 35% of the Panorama Falls Building to International and others on the same terms and conditions as the primary lease.\nCABLE TELEVISION SYSTEMS OWNED BY THE COMPANY\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 cable television systems owned by the Company. The monthly basic plus service rates set forth herein represent, with respect to systems with multiple headends, the basic plus 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 Company-owned cable television systems passed approximately 650,800 homes, representing an approximate 67% penetration rate. Figures for numbers of subscribers and homes passed are compiled from the Company's records and may be subject to adjustments.\n* In December 1995, the Augusta System (acquired by the Company in October 1995 from one of its managed limited partnerships) and the North Augusta System were combined.\n* The Clear Creek County and Jefferson County Systems have been combined.\n* During 1995, the Panama City Beach System has lost subscribers to an overbuilder. (See Item 1, Competition.)\n** The number of pay units in the Panama City Beach System has fluctuated during fiscal years 1994 and 1995 due to pay unit marketing promotions. These marketing promotions resulted in periodic increases in pay units, followed by decreases in pay units upon the expiration of the promotional period.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAlexandria Litigation\nOn February 22, 1994, the Company and The Jones Group, Ltd. (the \"Jones Group\"), a subsidiary of the Company engaged in the cable television system brokerage business, were named as defendants in a lawsuit brought by three individuals who are Class A Unitholders in Jones Intercable Investors, L.P. (the \"Partnership\"), a master limited partnership in which the Company is general partner. The litigation, entitled Luva Vaughan et al v. Jones Intercable, Inc. et al, Case No. CV 94-3652, was filed in the Circuit Court for Jackson County, Missouri, and purports to be \"for the use and benefit of\" the Partnership. As originally filed, the suit sought rescission of the sale of the Alexandria, Virginia cable television system (the \"Alexandria System\") by the Partnership to the Company, which sale was completed on November 2, 1992. It also sought a constructive trust on the profits derived from the operation of the Alexandria System since the date of the sale and an accounting and other equitable relief. The plaintiffs also alleged that the $1,800,000 commission paid to Jones Group by the Partnership in connection with such sale was improper, and asked the Court to order that such commission be repaid to the Partnership.\nUnder the terms of the partnership agreement of the Partnership, the Company has the right to acquire cable television systems from the Partnership at a purchase price equal to the average of three independent appraisals of the cable television system to be acquired. The plaintiffs claim that the appraisals obtained in connection with the sale of the Alexandria System were improperly obtained, were not made by qualified appraisers and were otherwise improper. The purchase price paid by the Company upon such sale was approximately $73,200,000. The amount of damages being sought by the plaintiffs has not been specified.\nOn October 21, 1994, plaintiffs filed a motion to dismiss Jones Group in response to Jones Group's argument that Missouri lacked personal jurisdiction over it. Plaintiffs' motion was granted, and plaintiffs then filed an action in Colorado against Jones Group seeking a return of the brokerage commission.\nThe Company and Jones Group filed motions for summary judgment in the Missouri and Colorado cases, respectively. The Missouri court granted the Company's motion in part and dismissed all counts of the complaint for rescission. It also struck the plaintiffs' jury demand. The Colorado court also granted Jones Group's motion in part finding that the payment of the brokerage commission was not a breach of the partnership agreement, but leaving for trial the issue of whether such payment constituted a breach of fiduciary duty.\nSubsequently, the plaintiffs have filed an amended complaint in the Missouri case, recasting their allegations in terms of breach of contract, common law fraud, conversion and breach of fiduciary duty. The plaintiffs have reasserted their right to a jury trial. On October 4, 1995, the Court granted the Company's motion for summary judgment on the common law fraud, conversion and breach of fiduciary duty claims and also struck plaintiffs' demand for a jury trial. As a result,\nthere is only one remaining substantive claim (breach of contract); no claim for punitive damages; and the trial will be to the Court commencing on April 29, 1996.\nOn October 25, 1995, plaintiffs and Jones Group filed, in the Colorado action, a joint motion to stay the Colorado action until the resolution of the Missouri action. The motion to stay is pending before the Colorado court.\nThe Company has conducted written discovery in the form of interrogatories and requests for production of documents; has noticed the depositions of plaintiffs and plaintiffs' expert and has retained an expert to testify that the three appraisals were performed in accordance with standard appraisal methodologies. Although plaintiffs have retained an \"expert\" appraiser to testify that the value of the Alexandria System in November 1992 was $85 million, approximately $12 million more than the purchase price, the Company believes both that the purchase price was fair and that the brokerage commission was properly paid to Jones Group in accordance with the express terms of the partnership agreement. Consequently, the Company intends to defend the litigation at trial in April 1996.\nTampa Litigation\nIn August 1995, Cable TV Fund 12-BCD Venture (the \"Venture\"), a Colorado joint venture in which Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd., Colorado limited partnerships, are general partners, entered into a purchase and sale agreement pursuant to which the Venture agreed to sell its Tampa, Florida cable television system (the \"Tampa System\") to the Company. The Company is the general partner of each of Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd. The Company subsequently assigned its rights and obligations under the purchase and sale agreement to JCH. JCH acquired the Tampa System on February 28, 1996, and the Tampa System, together with other systems owned by JCH, was exchanged for systems owned by an unaffiliated cable television operator on February 29, 1996. See Item 1, Recent Acquisitions of Cable Television Systems and Recent Exchange of Cable Television Systems.\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 class action on behalf of himself and all other limited partners of Cable TV Fund 12-D, Ltd. (\"Fund 12-D\") against the Company seeking to recover damages caused by the Company's alleged breaches of its fiduciary duties to the limited partners of Fund 12-D in connection with the sale of the Tampa System. On January 25, 1996, the plaintiff filed an amended complaint and request for a jury trial. On February 20, 1996, the Company 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 Company believes that it has meritorious defenses, and the Company 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,\nCounty 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 Company seeking to recover damages caused by the Company's alleged breaches of its fiduciary duties to the Venture and to the limited partners of the three partnerships that comprise the Venture in connection with the sale of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television operator in return for systems owned by that operator. On February 1, 1996, the Company 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 Company believes that it has meritorious defenses, and the Company intends to defend this lawsuit vigorously.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE COMPANY\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the Company since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones was elected a member of the Executive Committee of the Board of Directors in April 1985. Mr. Jones is the sole shareholder, President and Chairman of the Board of Directors of Jones International, Ltd. He is also Chairman of the Board of Directors of the subsidiaries of the Company and of certain other affiliates of the Company. Mr. Jones was appointed Vice Chairman of the Board of Directors of Bell Canada International Inc. in February 1995. 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\nBoard 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, the Company's President, joined the Company in January 1982. Prior to being elected President and a Director of the Company 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 Company'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 Company. Mr. O'Brien is also President and a Director of Jones Cable Group, Ltd., Jones Global Funds, Inc. and Jones Global Management, Inc., all affiliates of the Company. 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 Company 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 Company 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 Company 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 Company in September 1991 as Group Vice President\/Technology and Chief Technical Officer. Previous to joining the Company, 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 Company in January 1996 as Group Vice President\/Telecommunications. Prior to joining the Company, Mr. Newton was President of his\nown 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 Company 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 Company in June 1993 as Group Vice President\/Human Resources. Previous to joining the Company, Mr. Vigil served as Executive Director of Learning with USWest. Prior to USWest, Mr. Vigil worked in various human resources posts over a 14-year term with the IBM Corporation.\nMs. Cynthia A. Winning joined the Company as Group Vice President\/Marketing in December 1994. Previous to joining the Company, 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 Company in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining the Company, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to the Company.\nMr. Larry Kaschinske joined the Company in 1984 as a staff accountant in the Company's former Wisconsin Division, was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock and Class A Common Stock are traded in the over-the-counter market and authorized for quotation on the National Market System operated by the National Association of Securities Dealers, Inc. (NASDAQ), under the following symbols:\nCommon Stock - JOIN Class A Common Stock - JOINA\nThe following table shows the high and low prices as quoted on the NASDAQ\/National Market System for each quarterly period of calendar years ended December 31, 1995 and 1994 for each class of the Company's stock:\nAt December 31, 1995, the Common Stock and Class A Common Stock of the Company were held of record by 793 and 1,524 shareholders, respectively.\nThe Company has never paid a cash dividend with respect to its shares of Common Stock or Class A Common Stock, and it has no present intention to pay cash dividends in the foreseeable future. The current policy of the Company's Board of Directors is to retain earnings to provide funds for the operation and expansion of its business. Future dividends, if any, will be determined by the Board of Directors in light of the circumstances then existing, including the Company's earnings and financial requirements and general business conditions. If cash dividends are paid in the future, the holders of the Class A Common Stock will be paid $.005 per share per quarter in addition to the amount payable per share of Common Stock. Such additional dividends on the Class A Common Stock are not cumulative but would be adjusted appropriately if cash dividends are declared with respect to a period other than a quarterly period. Certain of the Company's credit arrangements restrict the right of the Company to declare and pay cash dividends without the consent of the holders of the debt.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe Company changed its fiscal year end from May 31 to December 31, effective December 31, 1995. The following table sets forth selected financial data regarding the Company's financial position and operating results restated to reflect the change in fiscal year end. This data should be read in conjunction with the Company's consolidated financial statements and the notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing in Item 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\nRevenues\nThe Company derives its revenues from four primary sources: subscriber fees from Company-owned cable television systems, management fees from revenues earned by managed limited partnerships, fees and distributions payable upon the sale of cable television properties owned by managed limited partnerships and revenues from non-cable television subsidiaries. Total revenues for the year ended December 31, 1995 totaled $188,838,000, an increase of $56,949,000, or 43%, over the total of $131,889,000 for the year ended December 31, 1994. This increase reflects the Company's acquisition of the assets of Jones Spacelink, Ltd. (\"Spacelink\") on December 20, 1994, the purchase of the cable television system serving areas in and around Augusta, Georgia (the \"Augusta System\") on October 20, 1995, the purchase of the cable television system serving areas in and around Dale City, Virginia (the \"Dale City System\") on November 29, 1995 and were offset, in part, by the sale of the Company's Gaston County, North Carolina cable television system (the \"Gaston System\") on July 22, 1994 (the \"Purchase and Sale Transactions\"). Disregarding the effect of the Purchase and Sale Transactions, total revenues would have increased $10,898,000, or 9%.\nThe Company's subscriber service fees increased $32,015,000, or 31%, to $135,350,000 in 1995 from $103,335,000 in 1994. The effect of the Purchase and Sale Transactions accounted for $22,865,000, or 71%, of this increase. Disregarding the effect of the Purchase and Sale Transactions, subscriber service fees would have increased $8,068,000, or 8%. This increase was due primarily to an increase in the number of basic subscribers and basic service rate adjustments in the cable television systems owned by the Company.\nThe Company receives management fees generally equal to 5% of the gross operating revenues of its managed partnerships. Management fees totaled $21,462,000 for 1995, an increase of $3,510,000, or 20%, over the total of $17,952,000 reported in 1994. The growth of management fee revenue is the result of the acquisition of Spacelink's assets, which included general partner interests in a number of limited partnerships, as well as increases in operating revenues of the Company's managed partnerships. Partnership revenues increased as a result of increases in basic subscribers, increases in advertising sales revenue and basic service rate adjustments. Disregarding the effect of the Spacelink transaction, management fees increased approximately 10%.\nIn its capacity as the general partner of its managed partnerships, the Company also receives revenues in the form of distributions upon the sale of cable television properties owned by such partnerships. No such revenues were recognized during the years ended December 31, 1995, 1994 or 1993. The general partner distribution received by the Company as a result of the sale of the Augusta System by Fund 12-B in October 1995 was recorded as a reduction in the basis of the assets of the Augusta System due to the Company's continuing interest in the Augusta System.\nThe Company also operates certain non-cable subsidiaries. Such subsidiaries include Jones Satellite Programming, Inc. (\"JSP\"), a distributor of satellite programming to satellite dish owners; Jones Futurex, Inc. (\"Futurex\"), a manufacturer of various electronic components; and Jones Satellite Networks, Inc. (\"JSN\"), a distributor of radio programming to radio stations. Futurex and JSN were acquired as part of the acquisition of Spacelink's assets. Non-cable revenue totaled $32,026,000 in 1995, an increase of $21,424,000, or 202%, over the $10,602,000 recorded in 1994. The acquisition of Futurex and JSN accounted for 79% of this increase. The remainder of this increase was due to an increase in the revenue of JSP.\nCosts and Expenses\nOperating, general and administrative expenses consist primarily of costs associated with the administration of Company-owned cable television systems, the administration of managed partnerships and the administration of the non-cable television entities. The Company is reimbursed by its managed partnerships for costs associated with the administration of the partnerships. The principal administrative cost components are salaries paid to corporate and system personnel, programming expenses, professional fees, subscriber billing costs, data processing costs, rent for leased facilities, cable system maintenance expenses and consumer marketing expenses.\nCable operating expenses increased $22,442,000, or 41%, to $77,638,000 in 1995 compared to $55,196,000 in 1994. The Purchase and Sale Transactions accounted for $13,954,000, or 62%, of this increase. Disregarding the effect of the Purchase and Sale Transactions, cable operating expense would have increased $6,406,000, or 12%. This increase was due primarily to increases in premium and satellite programming costs.\nCable general and administrative expense increased $164,000, or 2%, to $8,284,000 in 1995 from $8,120,000 in 1994. Disregarding the effect of the Purchase and Sale Transactions, cable general and administrative expenses decreased $718,000, or 9%. This decrease was due primarily to the fact that the Company paid no transponder fees to Jones Earth Segment, Inc. in 1995. The remainder of the decrease is due to a reduction in general and administrative expense.\nNon-cable operating, general and administrative expense increased $20,572,000, or 174%, to $32,382,000 in 1995 from $11,810,000 in 1994. The acquisition of Futurex and JSN accounted for this increase.\nDepreciation and amortization expense increased $10,220,000, or 22%, to $55,805,000 in 1995 from $45,585,000 in 1994. The effect of the Purchase and Sale Transactions, as well as capital additions in 1995, were responsible for this increase.\nOperating Income\nOperating income increased $3,551,000, or 32%, to $14,729,000 in 1995 from $11,178,000 in 1994, due to the factors discussed above.\nThe cable television industry generally measures the 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 $13,771,000, or 24%, to $70,534,000 in 1995 from $56,763,000 in 1994. Disregarding the effect of the Purchase and Sale Transactions, operating income before depreciation and amortization would have increased $5,218,000, or 10%.\nOther Income (Expense)\nInterest expense increased $12,669,000, or 34%, to $49,552,000 in 1995 from $36,883,000 in 1994. This increase was due primarily to interest on the $200 million of Senior Notes sold in March 1995 which was offset, in part, by a decrease in interest expense on the Company's credit facility due to lower outstanding balances.\nIn 1995, the Company recorded net equity in the losses of affiliates totaling $58,000 compared to $3,707,000 in 1994. The Company recognized equity in the losses of its managed partnerships, Mind Extension University, IDS\/Jones Joint Venture Partners and Jones Customer Service Management, LLC. Such losses were offset, in part, by equity in the net income of Jones Intercable Investors, L.P. and Jones Global Group, Inc. (\"JGG\"). JGG, an affiliate of which the Company owns a 38% interest, recognized gains on the sale of certain of JGG's Bell Cablemedia ADSs.\nInterest income increased $8,497,000, or 144%, to $14,383,000 in 1995 from $5,886,000 in 1994. This increase was due to the increase in the Company's cash on hand during the year, prior to the acquisition of the Augusta System and the Dale City System, from the Bell Canada International Inc. investment in December 1994 and the sale of $200 million of Senior Notes in March 1995.\nThe Company recorded a gain of $15,496,000 in July 1994 on the sale of its Gaston System. No similar gain was recognized during 1995.\nThe Company recognized a loss of $692,000 in 1995 related to the redemption of its 7.5% Convertible Subordinated Debentures. No similar loss was recognized in 1994.\nNet loss increased $13,025,000, or 150%, to $21,716,000 in 1995 from $8,691,000 in 1994. This increase was primarily due to the gain recognized in 1994 on the sale of the Gaston System.\nThe Company anticipates the continued recognition of operating income prior to depreciation and amortization charges, but net losses resulting from depreciation, amortization and interest expenses may continue in the future. To the extent the Company recognizes general partner distributions from its managed partnerships and\/or gains on the sale of Company-owned systems in the future, such losses may be reduced or eliminated; however, there is no assurance as to the timing or recognition of these distributions or sales.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nRevenues\nTotal revenues for the year ended December 31, 1994 increased $7,572,000, or 6%, to $131,889,000 in 1994 from $124,317,000 in 1993. An increase in the revenues of JSP accounted for approximately 39% of this increase. Increases in the number of basic subscribers and advertising revenue accounted for 41% of this increase. The net effect of the purchase of the North Augusta System and the sales of the Gaston System and the Company's cable television system serving areas around San Diego, California (the \"San Diego System\") accounted for approximately 11% of this increase. The increase in revenue would have been greater but for the effect of the reduction in basic rates due to rate regulations issued by the FCC in implementing the 1992 Cable Act.\nIn 1994, the Company's subscriber service fees increased $3,897,000, or 4%, from $99,438,000 in 1993 to $103,335,000 in 1994. The net effect of the purchase of the North Augusta System and the sale of the Gaston System and the San Diego System accounted for 21% of this increase. The remainder of this increase was due to increases in subscribers and advertising sales revenue.\nManagement fees increased approximately 4%, from $17,255,000 in 1993 to $17,952,000 in 1994. Partnership revenues increased as a result of increases in the number of basic subscribers in partnership systems as well as increases in revenues from pay-per-view, advertising sales and the installation of service. These increases somewhat mitigated the effect of the reduction in basic rates by the Company's managed partnerships due to the FCC's basic rate regulations.\nNon-cable revenue increased $2,978,000, or 39%, from $7,624,000 in 1993 to $10,602,000 in 1994. This increase was due to an increase in the revenues of JSP.\nCosts and Expenses\nFor the year ended December 31, 1994, cable operating expenses increased $889,000, or 2%, from $54,307,000 in 1993 to $55,196,000 in 1994. This increase was due primarily to increases in satellite programming fees and premium service programming fees.\nFor the year ended December 31, 1994, cable general and administrative expense decreased $1,914,000, or 19%, from $10,034,000 in 1993 to $8,120,000 in 1994. This decrease was due to a decrease in transponder fees paid to Jones Earth Segment, Inc. In addition, the Company recognized non-cash compensation expense related to the grant of certain stock options in 1993. No such expense was recognized in 1994.\nFor the year ended December 31, 1994, non-cable operating, general and administrative expenses increased $3,821,000, or 48%, from $7,989,000 in 1993 to $11,810,000 in 1994. This increase was due to increases in the expenses of JSP, which consist primarily of programming costs.\nDepreciation and amortization expense increased $2,257,000, or 5%, for the year ended December 31, 1994 totaling $45,585,000 in 1994 and $43,328,000 in 1993. This increase was due to the purchase of the North Augusta System and to capital additions in 1994.\nOperating Income\nOperating income increased $2,519,000, or 29%, to $11,178,000 in 1994 from $8,659,000 in 1993. This increase was due primarily to the decrease in general and administrative expenses.\nOperating income before depreciation and amortization increased $4,776,000, or 9%, to $56,763,000 in 1994 from $51,987,000 in 1993. Disregarding the net effect of the purchase of the North Augusta System and the sale of the Gaston System and the San Diego System, operating income before depreciation and amortization increased 8%.\nOther Income (Expense)\nInterest expense decreased $3,897,000, or 10%, to $36,883,000 in 1994 from $40,780,000 in 1993. This decrease was due primarily to the redemption of the remaining $138,000,000 principal amount of the Company's 13% Subordinated Debentures due 2000 in May 1993. The effect of this redemption was somewhat mitigated by an increase in interest expense as a result of higher balances outstanding on the Company's revolving credit facility.\nEquity in losses of affiliated entities decreased $110,000, or 3%, from $3,817,000 in 1993 to $3,707,000 in 1994.\nInterest income increased $1,967,000, or 50%, for the year ended December 31, 1994 from $3,919,000 in 1993 to $5,886,000 in 1994. This increase was due to higher average balances outstanding from certain managed partnerships as well as interest income earned on advances made to Mind Extension University, Inc.\nThe Company recognized a $15,496,000 gain on the sale of its Gaston System in 1994. In 1993, the Company recognized a $3,231,000 loss on the sale of its San Diego System.\nIn 1993, the Company recognized a loss on the early extinguishment of debt totaling $12,781,000. No similar loss was recognized in 1994.\nFor the year ended December 31, 1994, net loss decreased $40,156,000, from $48,847,000 in 1993 to $8,691,000 in 1994. This decrease was due primarily to the effect of the gain on the Gaston System, the loss of the San Diego System and the loss on early extinguishment of debt.\nRegulatory Matters\nAs a result of rate orders issued by the FCC, cost-of-service showings have been filed for the following Company-owned cable television systems: Jefferson County, Colorado; Charles County, Maryland; Dale City, Virginia; Manassas, Virginia; Pima County, Arizona; Alexandria, Virginia; and Augusta, Georgia. For these systems, the Company anticipates no further reductions in revenues or operating income before depreciation and amortization resulting from the FCC's rate regulations. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the cost-of-service showings will prevent further rate reductions until such final approvals are received.\nOn January 31, 1996, Congress passed the Telecommunications Competition and Deregulation Act of 1996 (the \"1996 Act\") which substantially revised the federal laws regulating the Company's cable television business. The President signed the 1996 Act into law on February 8, 1996. Among other things, the 1996 Act promotes increased competition from the delivery of video, data and other services by local telephone companies (also known as local exchange carriers or \"LECs\") and others, permits cable television operators to provide local voice and data communications services and deregulates the customer programming service rates of smaller operations upon enactment and other operators in 1999. The 1996 Act allows telephone companies to provide cable television services within their telephone service areas operating as conventional cable systems, or \"open video systems\" that afford access to other video providers. Telephone companies offering stand-alone cable television service or cable television service in connection with an open video system could provide substantial competition to the Company's owned and managed systems. The 1996 Act also permits entities to provide local telecommunications services in competition with the LECs. The 1996 Act establishes local exchange competition as a national policy by preempting laws that prohibit competition in the local exchange and establishes uniform requirements and standards for entry, competitive carrier interconnection and unbundling of LEC monopoly services. One premise of the 1996 Act is that additional regulatory flexibility for LECs is necessary to allow them to respond to competition. Depending on the degree and form of regulatory flexibility afforded the LECs, the Company's ability to compete to provide telephony services may be adversely affected.\nFINANCIAL CONDITION\nThe Company historically has grown by acquiring and developing cable television systems for both itself and its managed limited partnerships, primarily in suburban areas with attractive demographic characteristics. The Company intends to liquidate its Company-managed limited partnerships as opportunities for sales of partnership cable television systems arise in the marketplace over the next several years.\nThe Company is implementing a balanced strategy of acquiring cable television systems from Company-managed limited partnerships and from third parties. As part of this process, certain systems owned by the Company and its managed partnerships may be sold to third parties and Company-owned systems may be exchanged for systems owned by other cable system operators. It is the Company's plan to cluster its cable television properties, to the extent feasible, in geographic areas. Clustering systems may enable the Company to obtain operating efficiencies, and it should position the Company to capitalize on new revenue and business opportunities as the telecommunications industry evolves. The Company also intends to maintain and enhance the value of its current cable television systems through capital\nexpenditures. Such expenditures will include, among others, cable television plant extensions and the upgrade and rebuild of certain systems. The Company also intends to institute new services as they are developed and become economically viable.\nAcquisitions of cable television systems, the development of new services and capital expenditures for system extensions and upgrades are subject to the availability of cash generated from operations, debt and\/or equity financing. The capital resources to accomplish these strategies are expected to be provided by the sale of debt and\/or equity securities (subject to market conditions), borrowings under the Company's $500 million revolving credit facility and cash generated from the Company's operating activities. In addition, the Company may explore other financing options such as private equity capital and\/or the sale of non-strategic assets. There can be no assurance that the capital resources necessary to accomplish the Company's acquisition and development plans will be available on terms and conditions acceptable to the Company, or at all.\nIn conjunction with the Company's acquisition strategy, the Company purchased the cable television systems serving areas in and around Augusta, Georgia (the \"Augusta System\") in October 1995, Dale City, Virginia (the \"Dale City System\") in November 1995 and Manassas, Virginia (the \"Manassas System\") in January 1996. These transactions are described in detail in Note 2 of the Notes to Consolidated Financial Statements.\nThe $129,396,000 of capital required to purchase the Augusta System, which represents the purchase price of $142,618,000 less the Company's general partner distribution of approximately $13,222,000, was provided by cash on hand. The $123,000,000 of capital required to purchase the Dale City System was provided by cash on hand and $30,000,000 of borrowings available under the Company's credit facility. The $71,000,000 of capital required to purchase the Manassas System was provided by borrowings available under the Company's revolving credit facility.\nOn February 28, 1996, the Company purchased the cable television systems serving areas in and around Tampa, Florida (the \"Tampa System\"), areas in and around Carmel, Indiana (the \"Carmel System\") and areas in and around Orangeburg, South Carolina (the \"Orangeburg System\") from certain of its limited partnerships. The $172,979,000 of capital required to purchase such systems was provided by borrowings available under the Company's revolving credit facility. On February 29, 1996, the Company transferred the Tampa System, the Carmel System and the Orangeburg System to an unaffiliated party in exchange for the cable television systems serving portions of Prince Georges County, Maryland (the \"Prince Georges County System\") and portions of Fairfax County, Virginia (the \"Reston System\").\nThe above transactions increased the Company's basic subscriber base by approximately 229,000 basic subscribers to approximately 547,000 basic subscribers. In addition, these transactions are part of the Company's strategy to cluster its cable systems. The Augusta System is contiguous to the Company's cable television system serving areas in and around North Augusta, South Carolina (the \"North Augusta System\"). The Dale City System, the Manassas System, the Prince Georges County System and the Reston System are near other Company owned and managed systems in the Washington\/Baltimore area.\nThe Company has entered into agreements with certain of its managed partnerships to purchase the cable television systems serving Manitowoc, Wisconsin (the \"Manitowoc System\"), Lodi, Ohio (the \"Lodi System\"), Lake Geneva, Wisconsin (the \"Lake Geneva System\") and Ripon, Wisconsin (the \"Ripon System\"). Such transactions are expected to close in the first half of 1996.\nIn addition, the Company has entered into an agreement to acquire the cable television system serving Savannah, Georgia (the \"Savannah System\"). This transaction is also part of the Company's strategy to cluster its cable systems since the Savannah System is in relatively close proximity to the Company's Augusta System. This transaction is expected to close in the first half of 1996. To acquire the Savannah System, the Company will transfer the Manitowoc System, the Lodi System, the Ripon System\nand the Lake Geneva System, together with the Company-owned cable television systems serving Kenosha, Wisconsin and Hilo, Hawaii, to an unaffiliated party in exchange for the Savannah System. The Savannah System serves approximately 63,000 subscribers.\nFrom time to time, the Company makes loans to its managed partnerships, although it is not required to do so. As of December 31, 1995, the Company had advanced funds to various managed partnerships and other affiliates of the Company totaling approximately $14,311,000, a decrease of approximately $13,712,000 over the amount advanced at December 31, 1994. Of the total balance of $14,311,000, an advance to Cable TV Fund 15-A Ltd. (\"Fund 15-A\"), one of the Company's managed partnerships, accounted for approximately $4,815,000, or 34%. The Company advanced funds to Fund 15-A primarily to fund that partnership's capital expenditures. It is anticipated that Fund 15-A will repay this advance over time with cash generated from operations and borrowings available under its credit facility. In addition, an advance to Cable TV Fund 12-BCD Venture (the \"Venture\") accounted for approximately $4,113,000, or 29%, of the outstanding balance. The Venture renogotiated its credit agreements and repaid the advance in February 1996. The remainder of the advances represent funds for capital expansion and improvements of properties owned by 22 partnerships where additional credit sources were not then available to the partnerships. None of these advances are individually significant. These advances reduce the Company's available cash and its liquidity. The Company anticipates the repayment of these advances over time. The Company does not anticipate significant increases in the amount advanced to its managed partnerships during 1996. These advances bear interest at rates equal to the Company's weighted average cost of borrowing.\nThe Company purchased property, plant and equipment totaling approximately $63,216,000 during the year ended December 31, 1995. Such expenditures were principally the result of the following: (a) the upgrade and rebuild of the cable plant in the Alexandria, Virginia and North Augusta, South Carolina systems; and (b) new extension projects, drop materials, converters and various maintenance projects in the Pima County, Arizona; Anne Arundel, Maryland; and Charles County, Maryland systems. Estimated capital expenditures, excluding acquisitions, for 1996 are approximately $78,000,000. Funding for such expenditures is expected to be provided by cash generated from operations and borrowings available under the Company's credit facility, as discussed below.\nOn October 12, 1995, the Company redeemed the remaining outstanding 7.5% Convertible Subordinated Debentures (the \"Debentures\") due 2007, at a price equal to 101.5% of the principal amount, plus accrued interest. The total principal amount of the debentures was $43,100,000, of which $23,732,000 were held by the Company and $19,368,000 were held by unaffiliated investors. The Debentures were redeemed with cash on hand. The Company recognized a loss of $692,000 related to the redemption.\nSources of Funds\nThe Company's cash balance at December 31, 1995, was $2,314,000. The decrease in such balance from December 31, 1994 reflects the cash used for the acquisitions of the Augusta System and the Dale City System.\nOn October 31, 1995, the Company, through Jones Cable Holdings, Inc. (\"JCH\"), a new wholly owned subsidiary, entered into a $500,000,000 reducing revolving credit facility with a group of commercial banks. The new credit facility provides for the transfer of a majority of the Company's cable television properties to JCH, which is the borrower under the new credit facility. The entire $500,000,000 commitment is available through March 31, 1999, at which time the commitment will be reduced quarterly with a final maturity of December 31, 2004. As of December 31, 1995, $30,000,000 was outstanding under this agreement. Interest on outstanding obligations ranges from Base Rate to Base Rate plus 1\/8% or LIBOR plus 5\/8% to LIBOR plus 1 1\/8% based on certain leverage covenants. In addition, a commitment fee of 3\/16% to 3\/8% on the unused commitment is also required. The effective\ninterest rate on amounts outstanding at December 31, 1995 was 6.56%. Upon the completion of the acquisition of the Manassas System, the Prince Georges County System and the Reston System in the first quarter of 1996, the balance outstanding on this credit facility was approximately $285,000,000.\nOn October 6, 1995, Cable TV Fund 11-B, Ltd. (\"Fund 11-B\"), one of the Company's managed limited partnerships, entered into an agreement to sell the cable television systems serving areas in and around Lancaster, New York to an unaffiliated third party for $84,000,000. Upon closing of this transaction, Fund 11-B will repay its indebtedness, a brokerage fee and a sales tax liability, and Fund 11-B then will distribute the remaining proceeds to its partners. The Company, as general partner of Fund 11-B, expects to receive a distribution of approximately $13,950,000 related to this transaction. In addition, The Jones Group, Ltd., a wholly-owned subsidiary of the Company, will receive a fee of $2,100,000 for acting as the broker in this transaction. The closing of this transaction is expected to occur in the first half of calendar 1996.\nThe Company has an effective registration statement relating to the sale of $600 million of senior debt securities, senior subordinated debt securities, subordinated debt securities and Class A Common Stock. The Company may, from time to time, issue securities not to exceed $600 million pursuant to this registration statement. Proceeds would be used for general corporate purposes, which may include acquisitions of cable television systems from managed partnerships and\/or from unaffiliated parties, refinancings of indebtedness, working capital, capital expenditures, and repurchases and redemptions of securities.\nThe Company has sufficient sources of capital available, consisting of cash generated from operations and available borrowings from its credit facility, to complete the above described acquisitions and meet its operational needs.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO JONES INTERCABLE, INC.:\nWe have audited the accompanying consolidated balance sheets of JONES INTERCABLE, INC. (a Colorado corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' investment 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 Jones Intercable, 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.\nDenver, Colorado, March 1, 1996 ARTHUR ANDERSEN LLP\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\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.\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended December 31, 1995, 1994 and 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nJones Intercable, Inc. was formed in 1970 to own, operate and manage cable television systems. Jones Intercable, Inc. and its subsidiaries are referred to herein as the \"Company.\" As of December 31, 1995, through a total of 54 owned and managed cable television systems, the Company served approximately 1.4 million subscribers in the United States. On December 19, 1994, the shareholders of the Company approved an Exchange Agreement and Plan of Reorganization and Liquidation dated May 31, 1994, as amended, between the Company and Jones Spacelink, Ltd. (\"Spacelink\") providing for the acquisition by the Company of substantially all of the assets of Spacelink and the assumption by the Company of all of the liabilities of Spacelink. On December 20, 1994, the Company acquired all of the assets of Spacelink (except for the 2,859,240 shares of the Company's Common Stock owned by Spacelink) and assumed all of the liabilities of Spacelink (other than liabilities with respect to Spacelink shareholders exercising dissenters' rights) in exchange for 3,900,000 shares of the Company's Class A Common Stock. Glenn R. Jones, Chairman and Chief Executive Officer of the Company, controls the election of a majority of the Company's Board of Directors, through his ownership of a majority of the Company's outstanding Common Stock.\nIn May 1994, the Company and Bell Canada International Inc. (\"BCI\") entered into an agreement whereby BCI agreed to acquire an approximate 30% economic interest in the Company through the purchase of approximately 38% of the Class A Common Stock of the Company. BCI is a wholly owned subsidiary of BCE Inc., Canada's largest telecommunications company. On December 19, 1994, the shareholders of the Company approved the agreement. The investment by BCI was made in two installments: the purchase of 2,500,000 newly issued shares of Class A Common Stock of the Company at $22 per share for $55,000,000 in March 1994, and the purchase of 7,414,300 newly issued shares of Class A Common Stock of the Company at $27.50 per share for $203,893,250 in December 1994, resulting in BCI owning an approximate 30% economic interest in the Company for a total consideration of approximately $258,900,000. BCI also has a contractual commitment to invest up to an additional $141,100,000 to maintain its 30% interest in the event the Company offers additional Class A Common Stock. BCI has the right to maintain or increase its ownership by investing amounts beyond the $141,100,000 commitment.\nOn December 20, 1994, Jones International, Ltd. (\"International\"), which is wholly owned by Glenn R. Jones, Chairman and Chief Executive Officer of the Company, as well as certain subsidiaries of International, and Mr. Jones individually, granted BCI options to acquire 2,878,151 shares of the Common Stock of the Company. Except in limited circumstances, the option will only be exercisable during the eighth year after December 20, 1994. The exercise of such options would result in BCI holding a sufficient number of shares of the Common Stock of the Company to enable BCI to elect a majority of the Company's Board of Directors.\nEffective Registration Statement\nThe Company has an effective registration statement relating to the sale of $600 million of senior debt securities, senior subordinated debt securities, subordinated debt securities and Class A Common Stock. The Company, from time to time, may issue securities not to exceed $600 million pursuant to this\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nregistration statement. Proceeds would be used for general corporate purposes, which may include the acquisition of cable television systems from managed partnerships and\/or from unaffiliated parties, refinancings of indebtedness, working capital, capital expenditures, and repurchases and redemptions of securities.\nSummary of Significant Accounting Policies\nBasis of Presentation\nThe Company has changed its fiscal year end from May 31 to December 31, effective December 31, 1995. Accordingly, the accompanying financial statements have been restated to present the Company's financial position as of December 31, 1995 and 1994 and its results of operations, changes in shareholders' investments and cash flows for each of the three years in the period ended December 31, 1995.\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.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, including Jones Cable Holdings, Inc. (\"JCH\"), a wholly owned subsidiary formed in October 1995 that owns a majority of the cable television assets currently held by the Company. The Company's investments in affiliates and domestic cable television partnerships (Note 4) are carried at cost plus equity in profits and losses. All significant intercompany transactions have been eliminated in consolidation.\nStatements of Cash Flows\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Income taxes and interest paid during the periods presented are as follows:\nNon-cash transactions: On July 22, 1994, the Company and certain of its wholly owned subsidiaries transferred all of their interests in their cable\/telephony properties in the United Kingdom to Bell Cablemedia plc (\"Bell Cablemedia\"), in exchange for 6,035,648 ADSs representing 30,178,240 Ordinary Shares of Bell Cablemedia. On October 13, 1994, Jones Spanish Holdings, Inc. (\"Spanish\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nHoldings\") and Jones International Spanish Investments, Inc. transferred all of their interests in their Spanish cable\/telephony properties to Bell Cablemedia in exchange for a total of 190,148 ADSs, representing 950,740 Ordinary Shares of Bell Cablemedia. As described above, on December 20, 1994, the Company acquired substantially all of the assets of Spacelink and assumed all of the liabilities of Spacelink in exchange for 3,900,000 shares of the Company's Class A Common Stock. As described in Note 4, on April 11, 1995, the Company converted its $20,000,000 in advances to the Mind Extension University, Inc. (\"ME\/U\") into Class A Common Shares of Jones Education Networks, Inc. (\"JEN\"). During 1995 and 1994, the Company recorded $261,000 and $261,000, respectively of Additional Paid-in Capital related to Class A Common Stock option grants as discussed in Note 9.\nRestricted Cash\nRestricted cash consists of $3,413,000 relating to a non-qualified deferred compensation plan in which certain employees of the Company participate and $6,357,000 pledged to commercial banks for letters of credit. In February 1996, $4,600,000 of the cash pledged for letters of credit was released by the banks.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided using the straight-line method over the following estimated service lives:\nFranchise Costs\nCosts incurred in obtaining cable television franchises and other operating authorities are initially deferred and amortized over the lives of the franchises. Franchise rights acquired through purchase of cable television systems are stated at estimated fair value at the date of acquisition and amortized over the remaining terms of the franchises. Amortization is determined using the straight-line method over lives of one to 18 years.\nCost in Excess of Interests in Net Assets Purchased\nThe cost of acquisitions in excess of the fair values of net assets acquired is being amortized using the straight- line method over a 40-year life. The Company assesses the realizability of these assets through periodic independent appraisals. Any impairments are recognized as an expense on the Company's Consolidated Statements of Operations.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nInvestment in Equity Securities\nThe 6,225,796 American Depository Shares (\"ADSs\") of Bell Cablemedia plc held by the Company are now considered available for sale because of an effective shelf registration statement that is available to the Company. In accordance with Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities,\" the ADSs are reflected at their quoted fair market value with the unrealized holding gain reflected as a separate component of shareholders' investment.\nDeferred Financing Costs\nCosts incurred in connection with the issuance of debentures and the execution of revolving credit agreements are deferred and amortized using the effective interest method over the life of such issues and agreements.\nDistributions from Managed Partnerships\nDistributions earned by the Company as general partner of its managed partnerships related to cable television properties sold by such partnerships to unaffiliated parties are recorded as revenues when received. Distributions earned by the Company as general partner of its managed partnerships related to cable television properties sold by such partnerships to the Company are treated as a reduction of the purchase prices of the cable television systems purchased. Distributions earned by the Company as general partner of its managed partnerships related to cable television properties sold by such partnerships to entities in which the Company has a continuing equity interest are deferred and recognized as revenue in future periods.\nEarnings Per Share of Class A Common Stock and Common Stock\nNet loss per share of Class A Common Stock and Common Stock is based on the weighted average number of shares outstanding during the periods. Common stock equivalents were not significant to the computation of primary earnings per share.\nTreasury Stock\nShares held in treasury have been retired and classified as authorized but unissued shares in accordance with the Colorado Business Corporation Act.\n2. ACQUISITIONS, EXCHANGES AND SALES\nAcquisitions by the Company\nOn October 20, 1995, the Company purchased the cable television system serving areas in and around Augusta, Georgia (the \"Augusta System\") from Cable TV Fund 12-B, Ltd. (\"Fund 12-B\"), one of the Company's managed limited partnerships. The purchase price was $142,618,000, subject to normal closing adjustments. The purchase price was determined by averaging three separate independent appraisals of the fair market value of the Augusta System. The Company, as general partner of Fund 12-\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nB, received a distribution from Fund 12-B of $13,222,000 upon the closing of this transaction. Such distribution reduced the Company's basis in the assets of the Augusta System. The Augusta System passes approximately 102,000 homes and serves approximately 68,200 basic subscribers. Funding for this transaction was provided by cash on hand.\nOn November 29, 1995, the Company purchased the cable television system serving Dale City, Lake Ridge, Woodbridge, Fort Bevoir, Triangle, Dumfries, Quantico, Accoquan and portions of Prince William County, all in the state of Virginia (the \"Dale City System\") from an unaffiliated party. The purchase price was $123,000,000, subject to normal closing adjustments. The purchase was funded by cash on hand and borrowings available under the Company's credit facility. The Company paid Jones Financial Group, Ltd. (\"Financial Group\"), a subsidiary of Jones International, Ltd., a fee of $1,328,400 for acting as the Company's financial advisor in connection with this transaction. All fees paid to Financial Group by the Company are based upon 90% of the estimated commercial rate charged by unaffiliated brokers. The Dale City System passes approximately 65,100 homes and serves approximately 49,300 basic subscribers.\nOn January 10, 1996, the Company purchased the cable television systems serving Manassas, Manassas Park, Haymarket and portions of unincorporated Prince William County, all in the State of Virginia (the \"Manassas System\") from an unaffiliated party. The purchase price of the Manassas System was $71,000,000, subject to normal closing adjustments. The purchase was funded by borrowings available under the Company's credit facility. The Company paid Financial Group a fee of $896,000 for acting as the Company's financial advisor in connection with this transaction. All fees paid to Financial Group by the Company are based upon 90% of the estimated commercial rate charged by unaffiliated brokers. The Manassas System passes approximately 39,300 homes and serves approximately 26,500 basic subscribers.\nOn August 11, 1995, the Company entered into a purchase and sale agreement with IDS\/Jones Growth Partners 87-A, Ltd., one of the Company's managed partnerships, to acquire from such partnership the cable television system serving areas in and around Carmel, Indiana (the \"Carmel System\"). The purchase price was $44,235,333, which was the average of three separate independent appraisals of the fair market value of the Carmel System. The Carmel System passes approximately 24,400 homes and serves approximately 19,200 basic subscribers. Closing of this transaction was completed February 28, 1996. The purchase of the Carmel System was funded by borrowings available under the Company's revolving credit facility.\nOn August 11, 1995, the Company entered into a purchase and sale agreement with Jones Cable Income Fund 1-B, Ltd., one of the Company's managed partnerships, to acquire from such partnership the cable television system serving areas in and around Orangeburg, South Carolina (the \"Orangeburg System\"). The purchase price was $18,347,667, which was the average of three separate independent appraisals of the fair market value of the Orangeburg System. The Orangeburg System passes approximately 16,530 homes and services approximately 12,500 basic subscribers. Closing of this transaction was completed February 28, 1996. The purchase of the Orangeburg System was funded by borrowings available under the Company's revolving credit facility.\nOn August 11, 1995, the Company entered into a purchase and sale agreement with the Cable TV Fund 12-BCD Venture (the \"Venture\"), a joint venture of three of the Company's managed partnerships,\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nto acquire from the Venture the cable television system serving areas in and around Tampa, Florida (the \"Tampa System\"). The purchase price was $110,395,667, which was the average of three separate independent appraisals of the fair market value of the Tampa System. The Tampa System passes approximately 128,500 homes and serves approximately 65,000 basic subscribers. Closing of this transaction was completed February 28, 1996. The purchase of the Tampa System was funded by borrowings available under the Company's revolving credit facility.\nExchange by the Company\nOn August 11, 1995, the Company entered into an asset exchange agreement (the \"TWEAN Exchange Agreement\") with Time Warner Entertainment-Advance\/Newhouse Partnership (\"TWEAN\"), an unaffiliated cable television system operator. Pursuant to the TWEAN Exchange Agreement, on February 29, 1996, the Company conveyed to TWEAN the Carmel System, the Orangeburg System and the Tampa System and cash in the amount of $3,500,000 (subject to normal closing adjustments). In return, the Company received from TWEAN the cable television systems serving Andrews Air Force Base, Capitol Heights, Cheltenham, District Heights, Fairmount Heights, Forest Heights, Morningside, Seat Pleasant, Upper Marlboro, and portions of Prince Georges County, all in Maryland (the \"Prince Georges County System\"), and portions of Fairfax County, Virginia (the \"Reston System\"). These systems serve approximately 85,000 subscribers. This transaction was considered a non-monetary exchange of similar productive assets for accounting purposes and the Prince Georges County System and the Reston System were recorded at the historical cost of the assets given up plus the $3,500,000 cash consideration. The Company paid Financial Group a $1,668,000 fee upon the completion of the TWEAN Exchange Agreement as compensation to it for acting as the Company's financial advisor. All fees paid to Financial Group by the Company are based upon 90% of the estimated commercial rate charged by unaffiliated brokers.\nThe pro forma effect of the above-described acquisitions and exchange on the Company's results of operations for the year ended December 31, 1995, assuming the transactions occurred January 1, 1995, are presented in the following unaudited tabulation. The Company expects operating income before depreciation and amortization to increase approximately $40,230,000 as a result of these transactions, but depreciation and amortization charges will cause operating income to decrease and net loss to increase.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nThe pro forma effect of the above-described acquisitions and exchange and the acquisition of the assets of Jones Spacelink, Ltd. in December 1994 on the Company's results of operations for the year ended December 31, 1994, assuming the transactions occurred January 1, 1994, are presented in the following unaudited tabulation:\nPrior Year Acquisition\nIn December 1993, the Company acquired the cable television systems serving North Augusta, South Carolina and surrounding areas (the \"North Augusta System\") for $27,200,000. The Company paid The Jones Group, Ltd. $680,000 for brokerage services related to this acquisition. At that time, the Company owned only 20% of The Jones Group, Ltd. The North Augusta System acquisition was accounted for using the purchase method of accounting. Its results of operations are included in the Company's Consolidated Statements of Operations from December 15, 1993 forward.\nProposed Acquisitions by the Company\nOn September 5, 1995, the Company entered into an asset purchase agreement with Cable TV Joint Fund 11, a joint venture (the \"Venture\") among Cable TV Fund 11-A, Ltd., Cable TV Fund 11-B, Ltd., Cable TV Fund 11-C, Ltd. and Cable TV Fund 11-D, Ltd., Colorado limited partnerships managed by the Company, to acquire from the Venture the cable television system serving the City of Manitowoc, Wisconsin (the \"Manitowoc System\"). The purchase price is $15,735,667, which is the average of three separate independent appraisals of the fair market value of the Manitowoc System. The closing of this transaction is contingent upon the City of Manitowoc's approval of the renewal and transfer of the City of Manitowoc cable television franchise and the approval of the transaction by a majority of the limited partners of each of the four partnerships that form the Venture. The Company, as general partner of the partnerships that form the Venture, will receive a distribution of approximately $3,900,000 upon the closing of this transaction. The Manitowoc System passes approximately 16,000 homes and serves approximately 10,800 basic subscribers.\nOn September 5, 1995, the Company entered into an asset purchase agreement with Jones Spacelink Income Partners 87- 1, L.P., a Colorado limited partnership managed by the Company, to acquire from that partnership the cable television systems serving the communities of Lodi, Burbank, Lafayette Township, New London, Bailey Lakes, Savannah Shreve, Jeromesville, West Lafayette, Loudonville, Perrysville, Creston, Gloria Glens, Sterling, Seville, Westfield Center, Chippewa, Lake\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nArea, Rittman, West Salem, Bloomville, Spencer, Polk and Congress, all in the State of Ohio (the \"Lodi System\"). The purchase price is $25,706,000, which is the average of three separate independent appraisals of the fair market value of the Lodi System. The Lodi System passes approximately 20,600 homes and serves approximately 15,100 basic subscribers.\nOn September 5, 1995, the Company entered into an asset purchase agreement with Jones Spacelink Income\/Growth Fund 1-A, Ltd., a Colorado limited partnership managed by the Company, to acquire from that partnership the cable television system serving the areas in and around Ripon, Wisconsin (the \"Ripon System\"). The purchase price is $3,712,667, which is the average of three separate independent appraisals of the fair market value of the Ripon System. The Ripon System passes approximately 2,500 homes and serves approximately 2,450 basic subscribers.\nOn September 5, 1995, the Company entered into a second asset purchase agreement with Jones Spacelink Income\/Growth Fund 1-A, Ltd. to acquire from that partnership the cable television system serving the areas in and around Lake Geneva, Wisconsin (the \"Lake Geneva System\"). The purchase price is $6,345,667, which is the average of three separate independent appraisals of the fair market value of the Lake Geneva System. The Lake Geneva System passes approximately 5,400 homes and serves approximately 3,600 basic subscribers.\nFunding for these acquisitions is expected to be provided by borrowings available under the Company's revolving credit facility. The closings of the Company's acquisitions of the Manitowoc System, the Lodi System, the Ripon System and the Lake Geneva System are not contingent upon the closing of the Time Warner exchange.\nProposed Exchange by the Company\nOn September 1, 1995, the Company entered into an asset exchange agreement (the \"Time Warner Exchange Agreement\") with Time Warner Entertainment Company, L.P. (\"Time Warner\"), an unaffiliated party. Pursuant to the Time Warner Exchange Agreement, the Company will convey to Time Warner the cable television system serving Hilo, Hawaii (the \"Hilo System\") and the cable television system serving Kenosha, Wisconsin (the \"Kenosha System\") as well as the Manitowoc System, the Lodi System, the Ripon System and the Lake Geneva System. The Hilo System and the Kenosha System serve approximately 17,000 and 27,000 basic subscribers, respectively, and pass approximately 23,000 and 39,000 homes, respectively. In return, the Company will receive from Time Warner the cable television systems serving the communities in and around Savannah, Georgia (the \"Savannah System\") and cash in the amount of $4,000,000, subject to normal closing adjustments. Taking into account the aggregate purchase price to be paid by the Company for the Lodi System, the Lake Geneva System, the Ripon System and the Manitowoc System and the estimated valuation of the Hilo System and the Kenosha System, less the $4,000,000 cash purchase price to be paid by Time Warner to the Company, the aggregate consideration to be paid for the Savannah System is approximately $119,195,000. The Savannah System passes approximately 100,000 homes and serves approximately 63,000 subscribers. This transaction will be considered a non-monetary exchange of similar productive assets for accounting purposes and the Savannah System will be recorded at the historic costs of the assets given up less the $4,000,000 cash consideration.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nThe closing of the transaction contemplated by the Time Warner Exchange Agreement is subject to customary closing conditions, including obtaining necessary governmental and other third party consents. The parties intend to complete the transactions during the first half of 1996, but there can be no assurance that all conditions will be satisfied or waived by that time. Either party may terminate the Time Warner Exchange Agreement if the transactions are not completed on or before September 30, 1996. The Company will pay Financial Group a $1,286,000 fee upon the completion of the Time Warner Exchange Agreement as compensation to it for acting as the Company's financial advisor. All fees paid to Financial Group by the Company are based upon 90% of the estimated commercial rate charged by unaffiliated brokers.\nSales by the Company\nDuring 1993, the Company sold the cable television system serving a portion of San Diego County, California for $15,258,000. Brokerage fees totaling approximately $381,000, or 2 1\/2% of the sales prices, were paid to The Jones Group, Ltd., which at the time was owned 20% by the Company. The Company recognized a loss relating to this transaction of $3,231,000 during 1993.\nOn January 7, 1994, the Company entered into an agreement with Bresnan Communications Company (\"Bresnan\") to sell its Gaston County, North Carolina cable television system (the \"Gaston System\") to Bresnan for $36,500,000, subject to normal closing adjustments. Closing on this transaction occurred in July 1994. The Company paid The Jones Group, Ltd., which at the time was owned 20% by the Company, $912,500 for brokerage services related to this acquisition. Proceeds from the sale of the Gaston System were used to repay amounts outstanding on the Company's credit facility. The Company recognized a gain of $15,496,400 related to this transaction.\nProposed Sale by Managed Partnership\nOn October 6, 1995, Cable TV Fund 11-B, Ltd. (\"Fund 11-B\"), one of the Company's managed partnerships, entered into an agreement to sell the cable television systems serving areas in and around Lancaster, New York to an unaffiliated third party for $84,000,000. Upon closing of this transaction, Fund 11-B will repay its indebtedness, a brokerage fee and a sales tax liability, and Fund 11-B then will distribute the remaining proceeds to its partners. The Company, as general partner of Fund 11-B, expects to receive a distribution of approximately $13,950,000 related to this transaction. In addition, The Jones Group, Ltd., which became a wholly owned subsidiary of the Company on December 20, 1994, will receive a fee of $2,100,000 for acting as the broker in this transaction. The closing of this transaction is expected to occur in the first half of 1996.\n3. TRANSACTIONS WITH RELATED PARTIES\nThe Company and the limited partnerships for which the Company is general partner (Note 5) have had, and will continue to have, certain transactions with International and its other subsidiaries. Principal recurring transactions are as follows:\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nCosts Shared by the Company and Managed Partnerships\nJones Interactive, Inc. (\"Jones Interactive\"), a wholly-owned subsidiary of International, provides information management and data processing services for all companies affiliated with International. Charges to the various operating companies are based on usage of computer time by each entity. Amounts charged to the Company and its affiliated partnerships for the years ended December 31, 1995, 1994 and 1993 totaled $6,439,000, $5,361,000 and $4,175,000, respectively.\nThe Company is party to a lease with Jones Properties, Inc., a wholly-owned subsidiary of International, under which the Company has leased a 101,500 square foot office building in Englewood, Colorado. The lease agreement, as amended, has a 15-year term, expiring July 2000, with three 5-year renewal options. The annual rent is not to exceed $24.00 per square foot, plus operating expenses. The Company has subleased approximately 49% of the building to International and certain affiliates of International on the same terms and conditions as the above-mentioned lease. Rent payments to Jones Properties, Inc., net of subleasing reimbursements, for the three years ended December 31, 1995, 1994 and 1993 were $1,645,000, $1,762,000 and $1,735,000, respectively.\nUpon the closing of the BCI investment in December 1994, the Company entered into a Secondment Agreement with BCI. Pursuant to the Secondment Agreement, BCI provided nine secondees during 1995. These secondees worked for the Company and its managed partnerships. The Company reimbursed BCI for the full employment costs of such individuals. The Company reimbursed BCI $823,000 during the year ended December 31, 1995. No such reimbursements were made during 1994 or 1993.\nThe Company paid approximately 25%, 21% and 21% of the above-described data processing, rental and secondment expenses during the years ended December 31, 1995, 1994 and 1993, respectively. The remainder of the expenses were allocated to and paid by the Company's managed limited partnerships.\nCosts Borne and Payments Received by the Company\nIn 1992, the Company entered into a license agreement with Jones Space Segment, Inc. (\"Space Segment\"), an affiliate of International, to use a non-preemptible transponder on a domestic communications satellite leased by Space Segment. Under the license agreement, as amended, which expired December 31, 1994, the Company, Jones Infomercial Networks, Inc. and Jones Computer Network, Ltd. (\"JCN\"), both affiliates of International, had a license to use the transponder for their respective purposes. The Company recognized $1,172,000 and $2,400,000 of rental expense related to this lease agreement during the years ended December 31, 1994 and 1993, respectively. Because the license has expired, no expense related to this lease agreement was recognized during the year ended December 31, 1995.\nProduct Information Network, Inc. (\"PIN\") is an affiliate of International that provides a satellite programming service. PIN shows product infomercials 24 hours a day, seven days a week. A portion of the revenues generated by PIN are paid to the cable television systems that carry PIN's programming. Most of the Company's owned cable television systems carry PIN for all or part of each day. Aggregate payments received by the Company from PIN relating to the Company's owned cable television systems\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\ntotaled approximately $300,000 and $103,000 for the years ended December 31, 1995 and 1994, respectively. No such payments were made for the year ended December 31, 1993.\nThe Company has incurred approximately $2,717,000, $2,994,000 and $3,849,000 of related party expenses in connection with the related party transactions shared with managed partnerships and the related party costs borne solely by the Company, which have been charged to operating, general and administrative expenses during the years ended December 31, 1995, 1994 and 1993, respectively.\nEffective upon the closing of the BCI investment in December 1994, the Company entered into a Supply and Services Agreement with BCI. Pursuant to the Supply and Services Agreement, BCI provides the Company with access to the expert advice of personnel from BCI and its affiliates for the equivalent of three man-years on an annual basis. The Company will pay an annual fee of $2,000,000 to BCI during the term of the agreement. Payments to BCI under the Supply and Services Agreement during the year ended December 31, 1995 totaled $2,000,000. No payments were made during the years ended December 31, 1994 and 1993.\nFinancial Group, which is owned by International and Glenn R. Jones, performs services for the Company as its agent in connection with negotiations regarding various financial arrangements of the Company. The Company has entered into a Financial Services Agreement with Financial Group pursuant to which Financial Group has agreed to render financial advisory and related services to the Company for a fee equal to 90% of the fees that would be charged to the Company by unaffiliated third parties for the same or comparable services. The Company will pay Financial Group an annual $1,000,000 retainer as an advance against payments due pursuant to this agreement and will reimburse Financial Group for its reasonable out-of-pocket expenses. The term of the Financial Services Agreement is for eight years. The Company paid fees totaling $1,328,400 in 1995 related to the purchase of the Dale City System. In December 1994, the Company paid fees of $2,000,000 to Financial Group for its services to the Company in connection with the BCI investments in the Company (see Note 1). In addition, the Company paid an advisory fee of L.414,854 (approximately $632,600) to Financial Group in 1994 for its services to the Company in connection with the Company's transfer of all of its interests in its cable\/telephony properties in the United Kingdom to Bell Cablemedia plc (see Note 4).\nDuring 1994 and 1993, the Company carried accounts receivable from International and its affiliates totaling $2,000,000. This receivable was repaid in January 1995. Interest on such receivables was charged at the Company's average cost of borrowing plus 2%.\nFor information about additional transactions between the Company and related parties, see Note 4 below.\n4. INVESTMENTS IN CABLE TELEVISION PARTNERSHIPS AND JOINT VENTURES\nJones Global Group, Inc.\nThe Company owns a 38% interest in Jones Global Group, Inc. (\"Jones Global Group\"), a Colorado corporation of which 62% is owned by International. On July 22, 1994, Jones Global Group and certain of Jones Global Group's wholly owned subsidiaries transferred all of their interests in their cable\/telephony properties in the United Kingdom to Bell Cablemedia plc, a public limited company\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nincorporated under the laws of England and Wales, in exchange for 3,663,584 American Depository Shares (\"ADSs\") representing 18,317,920 Ordinary Shares of Bell Cablemedia. In July 1994, Jones Global Group sold 1,100,000 ADSs. Jones Global Group paid an advisory fee of L.251,812 (approximately $384,000) to Financial Group for its services to Jones Global Group in connection with the aforementioned United Kingdom transactions. In 1995, Jones Global Group sold an additional 444,200 ADSs. The Company accounts for Jones Global Group using the equity method of accounting and accordingly has recorded its share of gain relating to the sale of ADSs by Jones Global Group.\nBell Cablemedia plc\nOn July 22, 1994, the Company and certain of its wholly owned subsidiaries transferred all of their interests in their cable\/telephony properties in the United Kingdom to Bell Cablemedia plc in exchange for 6,035,648 ADSs representing 30,178,240 Ordinary Shares of Bell Cablemedia. As a result of this transaction, the Company no longer owns any direct interest in cable\/telephony properties in the United Kingdom. Jones Spanish Holdings, Inc. (\"Spanish Holdings\") is an affiliate indirectly owned 38% by the Company and 62% by International. On October 13, 1994, Spanish Holdings and Jones International Spanish Investments, Inc., a subsidiary of International, transferred all of their interests in their cable\/telephony properties in Spain to Bell Cablemedia in exchange for a total of 190,148 ADSs representing 950,740 Ordinary Shares of Bell Cablemedia. Such shares subsequently were transferred to the Company in repayment of advances made to finance such affilates' Spanish operations. As a result of this transaction, the Company and its affiliates no longer own any direct interest in cable\/telephony properties in Spain. The Company paid an advisory fee of L.414,854 (approximately $632,600) to Financial Group in 1994 for its services to the Company in connection with the aforementioned United Kingdom and Spain transactions. The 6,225,796 ADSs of Bell Cablemedia plc held by the Company are now considered available for sale because of an effective shelf registration statement that is available to the Company. In accordance with Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities,\" the ADSs are reflected at their estimated fair market value with the unrealized holding gain reflected as a separate component of shareholders' investment.\nMind Extension University, Inc.\nDuring 1992, the Company invested $10,000,000 in ME\/U, an affiliated company and subsidiary of JEN, that provides educational programming through affiliated and unaffiliated cable television systems, for 25% of the stock of ME\/U, which also received certain advertising avails and administrative and marketing considerations from the Company. The number of shares of Class A Common Stock of ME\/U issued to the Company was based on the average of two separate independent appraisals of ME\/U. Through its acquisition of the assets of Spacelink, the Company obtained an additional 13% interest in ME\/U in December 1994. Spacelink had acquired such interest for $3,135,000. Payments made to ME\/U by the Company for programming provided to the Company's owned cable television systems for the years ended December 31, 1995, 1994 and 1993 totaled approximately $196,000, $116,000 and $90,000, respectively. At December 31, 1995, the Company's net investment in ME\/U was $2,419,977.\nJones Education Networks, Inc.\nIn 1993, 1994 and 1995, the Company advanced a total of $20,000,000 to ME\/U. Interest on such advances was charged at the Company's weighted average cost of borrowing plus two percent. On\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nApril 11, 1995, the Company converted its advances to ME\/U into shares of Class A Common Stock of Jones Education Networks, Inc. (\"JEN\"), the parent company of ME\/U, for an approximate 17% equity interest in JEN. JEN is an affiliate of International and, in addition to its 51% ownership of ME\/U, JEN owns an 81% interest in Jones Computer Network, Ltd. (\"JCN\"). Payments made to JCN by the Company for programming provided to the Company's owned cable television systems for the years ended December 31, 1995 and 1994 totaled approximately $488,000 and $68,000, respectively. No such payments were made for the year ended December 31, 1993.\nJones Intercable Investors, L.P.\nThe Company is the general partner of Jones Intercable Investors, L.P., a Colorado limited partnership, which was formed on September 18, 1986, and the Company owns a 1% general partner interest. In a series of transactions, the Company purchased limited partnership units, giving the Company an approximate 19% limited partner interest in Jones Intercable Investors, L.P. The Company's net investment in this partnership totaled approximately $3,982,000 at December 31, 1995. Based upon the quoted market price of $12.38 per unit at December 31, 1995, the quoted market value of this investment was approximately $19,709,000. The Company has accounted for this investment using the equity method of accounting.\nJones Cyber Solutions, Ltd.\nThe Company and Jones Cyber Solutions, Ltd. (\"JCS\"), an indirect subsidiary of International, have formed a venture, known as Jones Customer Service Management, L.L.C., for the purpose of developing a subscriber billing and management system. As of December 31, 1995, the Company had invested $5,200,000 in the venture. JCS is performing the basic system development work for the venture and is being paid periodically on a time and materials basis, plus 10% of the amount charged, for its own service. Upon the completion of the billing and management system software, the Company and JCS will have license rights to use such system in perpetuity. The venture will also perform additional services to the Company in the implementation of the new subscriber billing and management system. The venture intends to subcontract such maintenance and conversion services to JCS on the basis of time and materials plus 10% of the amount of the JCS services. The venture will grant to JCS the exclusive right to distribute the system to third parties for a period of five years for a commission on the license fees to be earned by the venture from such licensing.\n5. MANAGED PARTNERSHIPS\nOrganization\nThe Company is general partner for a number of limited partnerships formed to acquire, construct, develop and operate cable television systems. In addition, through its acquisition of Spacelink, the Company obtained general partner interests in a number of partnerships previously managed by Spacelink. Partnership capital has been raised principally through a series of public offerings of limited partnership interests. The Company made a capital contribution of $1,000 to each partnership and is allocated 1% of all partnership profits and losses. The Company also purchased limited partner interests in certain of the partnerships and generally participates with respect to such interests on the same basis as other limited partners.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nManagement Fees\nAs general partner, the Company manages the partnerships and receives a fee for its services generally equal to 5% of the gross revenues of the partnerships, excluding revenues from the sale of cable television systems or franchises.\nDistributions\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% to the limited partners and 1% to the general partner. With respect to Cable TV Funds 11 and 12, any distributions other than from cash flow, such as from sale or refinancing of the system or upon dissolution of the partnership, are generally made as follows: first, to the limited partners in an amount which, together with all prior distributions, will equal the amount initially contributed to the partnership capital by the limited partners and the balance, 75% to the limited partners and 25% to the general partner. With respect to Cable TV Fund 14, 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 from cash flow, will equal 125% of the amount initially contributed to the partnership and the balance, 75% to the limited partners and 25% to the general partner. With respect to Cable TV Fund 15, any distributions other than from cash flow are generally made as follows: first, to the limited partners and general partner in an amount which, together with all prior distributions, will equal the amount initially contributed to the partnership capital by the limited partners and general partner; second, to the limited partners which, together with all prior distributions, will equal a 6% per annum cumulative and noncompounded return on the capital contributions of the limited partners; the balance, 75% to the limited partners and 25% to the general partner.\nWith respect to the Jones Cable Income Fund partnerships, 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; second, to the limited partners in an amount which, together with all prior distributions from cash flow, will equal a liquidation preference ranging from 10% to 12% per annum, cumulative and noncompounded, on their initial capital contributions and the balance, 75% to the limited partners and 25% to the general partner.\nAny distributions other than from cash flow made by Jones Intercable Investors, L.P. (Note 4) are generally distributed as follows: first, to the holders of the Class A Units an amount which, together with all prior distributions of cash flow from operations, will equal a preferred return equal to 10% per annum, cumulative and noncompounded, on an amount equal to $16.00 per Class A Unit, less any portion of such amount which may have been returned to the Unitholders from prior sale or refinancing proceeds; second, to the holders of Class A Units an amount which, together with all prior distributions other than distributions of cash flow from operations, will equal $16.00 per Class A Unit, and the remainder, 60% to the holders of the Class A Units and 40% to the general partner.\nFor the partnerships formerly managed by Spacelink, any partnership distributions made from cash flow, as defined, are generally allocated 99% to the limited partners and 1% to the general partner. The\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\ngeneral partner is also entitled to partnership distributions other than from cash flow, such as from the sale or refinancing of systems or upon dissolution of the partnerships, which are a portion of the net remaining assets of such partnership ranging from 15% to 40% after payment of partnership debts and after investors have received an amount equal to their capital contribution plus, in most cases, a preferential return on their investment.\nThe Company recognized distributions from managed partnerships totaling $13,222,000 for the year ended December 31, 1995. No such distributions were recognized during 1994 or 1993. The $13,222,000 distribution received during 1995 from Cable TV Fund 12-B, Ltd. upon the sale to the Company of the cable television system serving the area in and around Augusta, Georgia was recorded as a reduction in the Company's basis in the assets of the Augusta System.\nAllocations\nThe Company's managed limited partnerships reimburse the Company for certain allocated overhead and administrative expenses. These expenses generally consist of salaries and related benefits paid to corporate personnel (including secondees of BCI), rent, data processing services and other corporate facilities costs. The Company provides engineering, marketing, administrative, accounting, information management, legal, investor relations and other services to the partnerships. Allocations of personnel costs have been based primarily on actual time spent by Company employees with respect to each partnership managed. Remaining overhead costs have been allocated based on revenues and\/or the relative cost of partnership assets managed. As of December 1993, remaining overhead costs have been allocated based solely on revenues. Company-owned systems are also allocated a proportionate share of these expenses under the allocation formulas described above. Amounts charged partnerships and other affiliated companies have directly offset the Company's general and administrative expenses by approximately $31,987,000, $32,645,000 and $30,196,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nAdvances\nThe Company has made advances to certain of the limited partnerships primarily to accommodate expansion and other financing needs of the partnerships. Such advances bear interest at rates equal to the Company's weighted average cost of borrowing which, for the year ended December 31, 1995 was 10.51%. Interest charged to the limited partnerships for the years ended December 31, 1995, 1994 and 1993 was $2,592,000, $4,250,000 and $1,814,000, respectively.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nCertain condensed financial information regarding managed partnerships, on a combined basis, is as follows:\nThe fair market values of the partnerships' assets, as determined by independent appraisals, exceed the combined amounts due the Company and other outstanding indebtedness for each individual partnership, with the exception of Spacelink Fund 4, Ltd. (\"Fund 4\"). The Company has reserved the portion of its advance to Fund 4 that exceeds the fair value of Fund 4's assets.\nThe amount reported as combined net income (loss) for all managed limited partnerships for the year ended December 31, 1995 included gains on sales and liquidations recognized by certain partnerships which totaled approximately $91,693,000. No such gains were recognized during the years ended December 31, 1994 or 1993.\n6. NOTES RECEIVABLE\nOn December 19, 1994, Spacelink received a promissory note from Jones Earth Segment, Inc.(\"Earth Segment\"), then an affiliate of Spacelink, in conjunction with the transfer of Earth Segment to International. The Company acquired this note as part of the acquisition of Spacelink's assets. The principal sum is $6,554,500. Interest on the principal is at the prime rate plus one percent and is paid quarterly. The note matures on December 19, 1999. The note is secured by the real and personal property of Earth Segment.\nPursuant to a tax sharing agreement with International, Spacelink was allocated tax benefits based on its pro rata share of taxable loss generated as part of the consolidated group. The tax sharing agreement was terminated effective June 1, 1993. The allocated benefits are to be paid no later than five years from the date they were created. The benefits accrue interest at the prime rate in effect at the time they were created. The Company, through its acquisition of Spacelink's assets, acquired a receivable from International relating to this tax sharing agreement. The balance of this receivable at December 31, 1995 was $1,834,000.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\n7. DEBT\nDebt consists of the following:\nOn October 31, 1995, the Company, through JCH, entered into a $500,000,000 reducing revolving credit facility with a group of commercial banks. The new credit facility provides for the transfer of a majority of the Company's cable television properties to JCH, which is the borrower under the credit facility. The entire $500,000,000 commitment is available through March 31, 1999, at which time the commitment will be reduced quarterly with a final maturity of December 31, 2004. As of December 1995, $30,000,000 was outstanding under this agreement. Interest on outstanding obligations ranges from Base Rate to Base Rate plus 1\/8% or LIBOR plus 5\/8% to LIBOR plus 1 1\/8% based on certain financial covenants. In addition, a commitment fee of 3\/16% to 3\/8% on the unused commitment is also required. The effective interest rate on amounts outstanding at December 31, 1995 was 6.56%.\nOn March 23, 1995, the Company sold $200 million of 9 5\/8% Senior Notes due 2002. The Senior Notes mature on March 15, 2002. The Senior Notes bear interest from the date of issuance at the rate of 9 5\/8% per annum, payable semi-annually on March 15 and September 15 of each year, commencing September 15, 1995. The Senior Notes are not redeemable prior to maturity and are not\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nsubject to any sinking fund. The Senior Notes are senior unsecured obligations of the Company. The Company paid fees of $3,500,000 relating to this transaction. Such fees will be amortized over the life of the notes.\nThe 11.5% Senior Subordinated Debentures due 2004 described above provide for annual sinking fund payments of $50,000,000 commencing July 15, 2002 which are calculated to retire 62 1\/2% of the issue prior to maturity after consideration of the debt redemptions. There are no sinking fund requirements related to the 10.5% Senior Subordinated Debentures due March 1, 2008.\nOn October 12, 1995, the Company redeemed the remaining outstanding 7.5% Convertible Subordinated Debentures (the \"Convertible Debentures\") due 2007, at a price equal to 101.5% of the principal amount, plus accrued interest. The total principal amount of the Convertible Debentures was $43,100,000, of which $23,732,000 were held by the Company and $19,368,000 were held by unaffiliated investors. The Convertible Debentures were redeemed with cash on hand. The Company recognized a loss of $692,000 relating to this redemption.\nThe Company has never paid a cash dividend with respect to its shares of Common Stock or Class A Common Stock, and it has no present intention to pay cash dividends in the foreseeable future. The current policy of the Company's Board of Directors is to retain earnings to provide funds for the operation and expansion of its business. Certain of the Company's credit arrangements restrict the right of the Company to declare and pay cash dividends without the consent of the holders of the debt.\nAt December 31, 1995, the carrying amount of the Company's long-term debt was $492,714,000 and the estimated fair value was $536,814,000. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same issues. There are not significant debt maturities in the five years ended December 31, 2000.\n8. INCOME TAXES\nDeferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Deferred tax expense or benefit is the result of changes in the liability or asset recorded for deferred taxes.\nDuring 1995, 1994, and 1993, changes in the Company's temporary differences and losses from operations, which result primarily from depreciation and amortization, resulted in deferred tax benefits which were offset by a valuation allowance of an equal amount. No current or deferred federal income tax expense or benefit was recorded from continuing operations during the reporting periods.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nIncome tax expense attributable to income or loss from continuing operations differs from the amounts computed by applying the Federal income tax rate of 35% in 1995, 1994, and 1993 as a result 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:\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nAt December 31, 1995, the Company had net operating loss carryforwards for income tax purposes aggregating approximately $75,371,000 for alternative minimum tax (\"AMT\") and $152,709,000 for regular tax which expire $43,126,000 in 2004, $26,203,000 in 2007, $40,809,000 in 2008, $30,216,000 in 2009, 4,025,000 in 2010 and $8,330,000 in 2011. The Company also had investment tax credit carryforwards of $1,076,000 expiring in 1998 through 2005.\nThe Company entered into transactions during the current year which resulted in a change in greater than 50% of the ownership interests of the Company shares. Tax statutes limit the utilization of existing tax NOLs when this occurs to a specified amount each year plus the amount of existing built-in gain in corporate assets at the ownership change. Management believes that the application of the limitation will not likely cause taxable income to occur in a future period due to unavailability of limited NOLs.\nManagement believes that sufficient taxable income will be incurred during the loss carryforward period to utilize approximately $81,961,000 of the $152,709,000 of regular tax loss carryforwards at December 31, 1995. Therefore, a valuation allowance has been established for approximately $70,748,000 of net operating losses and for all investment tax credits and alternative minimum tax credit carryforwards.\n9. STOCK OPTIONS\nIn 1984, the shareholders of the Company approved the adoption of a nonqualified stock option plan (the \"1984 Plan\") to provide for the grant of stock options to key contributors to the Company. As of December 31, 1995, options to purchase 708,396 shares had been granted under the 1984 Plan, of which 411,131 shares were exercised and options to purchase 216,005 shares had been terminated or forfeited upon resignation of the holders. No additional options will be granted pursuant to the 1984 Plan.\nThe Company's 1992 stock option plan (the \"1992 Plan\") was approved by the Company's shareholders in August 1992. Under the terms of the 1992 Plan, a maximum of 1,800,000 shares of Class A Common Stock and 200,000 shares of Common Stock are available for grant. All employees of the Company, its parent or any participating subsidiary, including directors of the Company who are also employees, are eligible to participate in the 1992 Plan. Options generally become exercisable in equal installments over a four-year period commencing on the first anniversary of the date of grant. The options expire, to the extent not exercised, on the tenth anniversary of the date of grant, or upon the recipient's earlier termination of employment with the Company. Options can be incentive stock options or non-statutory stock options. The exercise price may not be less than 100% of the fair market value for incentive stock options, but may be less than fair market value for non-statutory options. Stock appreciation rights may be granted in tandem with the grant of stock options. The Board of Directors may, in its discretion, establish provisions for the exercise of options different from those described above. In 1994 and 1995, the Company recognized approximately $261,000 and $261,000, respectively, of non-cash compensation expense related to stock options granted on November 9, 1993 under the 1992 Plan. As of December 31, 1995, options to purchase 1,445,039 shares of Class A Common Stock had been granted, of which options to purchase 10,367 shares had been exercised and 34,078 shares had been terminated or forfeited upon resignation of the holders. As of December 31, 1995, all 200,000 of the Common Stock options authorized by the 1992 Plan had been granted and exercised.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nInformation concerning Class A Common Stock options is as follows:\n10. CLASS A COMMON STOCK\nThe Class A Common Stock has certain preferential rights with respect to cash dividends and upon liquidation of the Company. In the case of cash dividends, the holders of the Class A Common Stock will be paid one-half cent per share per quarter in addition to any amount payable per share for each share of Common Stock. In the event of liquidation, holders of the Class A Common Stock are entitled to a preference of $1 per share. After such amount is paid, holders of the Common Stock are entitled to receive $1 per share for each share of Common Stock outstanding. Any remaining amount would be distributed to the holders of the Class A Common Stock and the Common Stock on a pro rata basis.\nIn general, with respect to the election of directors, the holders of Class A Common Stock, voting as a separate class, are entitled to elect that number of directors which constitutes 25% of the total membership of the Board of Directors. In all other matters not requiring a class vote, the holders of the Common Stock and the holders of Class A Common Stock vote as a single class provided that holders of Class A Common Stock have one-tenth of a vote for each share held and the holders of the Common Stock have one vote for each share held.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\n11. COMMITMENTS AND CONTINGENCIES\nThe Company rents office facilities and equipment under various long-term lease arrangements. Minimum commitments under noncancellable operating leases for the five years ending December 31, 2000 and thereafter are as follows:\nRent paid during the years ended December 31, 1995, 1994 and 1993, totaled $3,698,000, $3,062,000 and $2,925,000, respectively.\nCertain amounts included in lease commitments will be allocated to managed limited partnerships using the method discussed in Note 5.\nOn February 22, 1994, the Company and Jones Group were named as defendants in a lawsuit brought by three individuals who are Class A Unitholders in Jones Intercable Investors, L.P. (the \"Partnership\"), a master limited partnership in which the Company is general partner. The litigation, entitled Luva Vaughan et al v. Jones Intercable, Inc. et al, Case No. CV 94-3652 was filed in the Circuit Court for Jackson County, Missouri, and purports to be \"for the use and benefit of\" the Partnership. As originally filed, the suit sought rescission of the sale of the Alexandria, Virginia cable television system (the \"Alexandria System\") by the Partnership to the Company, which sale was completed on November 2, 1992. It also sought a constructive trust on the profits derived from the operation of the Alexandria System since the date of the sale and an accounting and other equitable relief. The plaintiffs also alleged that the $1,800,000 commission paid to Jones Group by the Partnership in connection with such sale was improper, and asked the Court to order that such commission be repaid to the Partnership.\nUnder the terms of the partnership agreement of the Partnership, the Company has the right to acquire cable television systems from the Partnership at a purchase price equal to the average of three independent appraisals of the cable television system to be acquired. The plaintiffs claim that the appraisals obtained in connection with the sale of the Alexandria System were improperly obtained, were not made by qualified appraisers and were otherwise improper. The purchase price paid by the Company upon such sale was approximately $73,200,000. The amount of damages being sought by the plaintiffs has not been specified.\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nOn October 21, 1994, plaintiffs filed a motion to dismiss Jones Group in response to Jones Group's argument that Missouri lacked personal jurisdiction over it. Plaintiffs' motion was granted, and plaintiffs then filed an action in Colorado against Jones Group seeking a return of the brokerage commission.\nThe Company and Jones Group filed motions for summary judgment in the Missouri and Colorado cases, respectively. The Missouri court granted the Company's motion in part and dismissed all counts of the complaint for rescission. It also struck the plaintiffs' jury demand. The Colorado court also granted Jones Group's motion in part finding that the payment of the brokerage commission was not a breach of the partnership agreement, but leaving for trial the issue of whether such payment constituted a breach of fiduciary duty.\nSubsequently, the plaintiffs have filed an amended complaint in the Missouri case, recasting their allegations in terms of breach of contract, common law fraud, conversion and breach of fiduciary duty. The plaintiffs reasserted their right to a jury trial. On October 4, 1995, the court granted the Company's motion for summary judgment on the common law fraud, conversion and breach of fiduciary duty claims and also struct plaintiffs' demand for a jury trial. As a result, there is only one remaining substantive claim (breach of contract); no claim for punitive damages; and the trial will be to the Court commencing on April 29, 1996.\nOn October 25, 1995, plaintiffs and Jones Group filed, in the Colorado action, a joint motion to stay the Colorado action until the resolution of the Missouri action. The motion to stay is pending before the Colorado court.\nThe Company has conducted written discovery in the form of interrogatories and requests for production of documents; has noticed the depositions of plaintiffs and plaintiffs' expert and has retained an expert to testify that the three appraisals were performed in accordance with standard appraisal methodologies. Although plaintiffs have retained an \"expert\" appraiser to testify that the value of the Alexandria System in November 1992 was $85 million, approximately $12 million more than the purchase price, the Company believes both that the purchase price was fair and that the brokerage commission was properly paid to Jones Grouip in accordance with the express terms of the partnership agreement. Consequently, the Company intends to defend the litigation at trial in April 1996.\nIn August 1995, Cable TV Fund 12-BCD Venture (the \"Venture\"), a Colorado joint venture in which Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd., Colorado limited partnerships, are general partners, entered into a purchase and sale agreement pursuant to which the Venture agreed to sell the Tampa, Florida cable television system (the \"Tampa System\") to the Company. The Company is the general partner of each of Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd. Closing of the purchase of the Tampa System by the Company occurred on February 28, 1996. After closing, the Company exchanged the Tampa System with an unaffiliated cable television operator in return for systems owned by that operator.\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 class action on behalf of himself and all other limited partners of Cable TV Fund 12-D, Ltd. against the\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended December 31, 1995, 1994 and 1993\nCompany seeking to recover damages caused by the Company's alleged breaches of its fiduciary duties to the limited partners of Cable TV Fund 12-D, Ltd. in connection with the sale to the Company of the Tampa System. On January 25, 1996, the Plaintiff filed an amended complaint and request for a jury trial. The Company believes that it has meritorious defenses, and the Company 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 Company seeking to recover damages caused by the Company's alleged breaches of its fiduciary duties to the Venture and to the limited partners of the three partnerships that comprise the Venture in connection with the sale to the Company of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television operator in return for systems owned by that operator. On February 1, 1996, the Company 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 Company believes that it has meritorious defenses, and the Company intends to defend this lawsuit vigorously.\nIn addition to the above matters, the Company is involved in certain other litigation in its normal course of business. The Company is also negotiating the renewal of certain franchise agreements with franchising authorities. Management believes that the ultimate resolution of such matters will not have a material adverse effect on the Company's financial position or results of operations.\n12. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1995 and 1994, consisted of the following:\nJONES INTERCABLE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded) For the years ended December 31, 1995, 1994 and 1993\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than April 29, 1996. The information regarding executive officers required by Item 401 of Regulation S-K of the Form 10-K may be found under the caption \"Executive Officers of the Company\" at the end of Part I of this Form 10-K.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K\n(A)(1) FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.\n(A)(2) SCHEDULES.\n(A)(3) EXHIBITS.\nThe following exhibits, which are numbered in accordance with Item 601 of Regulation S-K, are filed herewith or, as noted, incorporated by reference herein:\n2.1 Exchange Agreement and Plan of Reorganization and Liquidation, dated as of May 31, 1994 by and between the Company and Jones Spacelink, Ltd. (1)\n2.2 Stock Purchase Agreement dated as of May 31, 1994, between Bell Canada International Inc. and the Company. (1)\n2.3 Transaction Agreement dated as of May 31, 1994, among Glenn R. Jones, Jones International, Ltd., Bell Canada International Inc. and Jones Spacelink, Ltd. (1)\n2.4 Purchase and Sale Agreement dated February 22, 1995 between Cable TV Fund 12-B, Ltd. and the Company. (22)\n2.5 Amendment No. 1 dated July 24, 1995 to Purchase and Sale Agreement dated February 22, 1995 between Cable TV Fund 12-B, Ltd. and the Company. (25)\n2.6 Asset Purchase Agreement dated May 31, 1995 between Benchmark Manassas Cable Fund Limited Partnership and the Company. (23)\n2.7 Asset Purchase Agreement dated May 31, 1995 between Cablevision of Manassas Park, Inc. and the Company. (23)\n2.8 Asset Purchase Agreement dated as of June 30, 1995 between Columbia Associates, L.P. and the Company. (25)\n2.9 Purchase and Sale Agreement dated as of August 11, 1995 between IDS\/Jones Growth Partners 87-A, Ltd. and the Company. (25)\n2.10 Purchase and Sale Agreement dated as of August 11, 1995 between Jones Cable Income Fund 1-B, Ltd. and the Company. (25)\n2.11 Purchase and Sale Agreement dated as of August 11, 1995 between Cable TV Fund 12-BCD Venture and the Company. (25)\n2.12 Asset Exchange Agreement dated as of August 11, 1995 between Time Warner Entertainment-Advance\/Newhouse Partnership and the Company. (25)\n2.13 Asset Purchase Agreement dated September 5, 1995 between Cable TV Joint Fund 11 and the Company relating to the Manitowoc System. (26)\n2.14 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income Partners 87-1, L.P. and the Company relating to the Lodi System. (26)\n2.15 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income\/Growth Fund 1-A, Ltd. and the Company relating to the Ripon System. (26)\n2.16 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income\/Growth Fund 1-A, Ltd. and the Company relating to the Lake Geneva System. (26)\n2.17 Asset Exchange Agreement dated September 1, 1995, between the Company and Time Warner Entertainment Company, L.P. (26)\n2.18 Assignment and Assumption Agreement dated as of September 15, 1995 between the Company and Jones Cable Holdings, Inc.\n2.19 Purchase and Sale Agreement dated as of October 18, 1995 between the Company and Jones Cable Holdings, Inc.\n3.1 Articles of Incorporation and amendments thereto of the Company. (2)\n3.2 Amendment to Articles of Incorporation of Company filed July 24, 1995. (25)\n3.3 Bylaws of the Company. (25)\n4.1 Indenture, dated as of May 15, 1987, between the Company and United Bank of Denver National Association. (4)\n4.2 Indenture, dated as of July 15, 1992, between the Company and First Trust National Association. (5)\n4.3 First Supplemental Indenture, dated as of July 15, 1992, between the Company and First Trust National Association. (5)\n4.4 Second Supplemental Indenture, dated as of March 1, 1993, between the Company and First Trust National Association. (6)\n4.5 Form of Shareholders Agreement among Glenn R. Jones, Jones International, Ltd., Bell Canada International Inc. and the Company. (1)\n4.6 Indenture dated March 23, 1995 with respect to the Senior Notes, between the Company and U.S. Trust Company of California, N.A. (31)\n4.7 First Supplemental Indenture dated as of March 23, 1995 with respect to $200,000,000 aggregate principal amount of the Company's 9 5\/8% Senior Notes due 2002, between the Company and the Trustee. (31)\n10.1.1 Form of Financial Services Agreement between Jones Financial Group, Ltd. and the Company. (1)\n10.1.2 Form of Employment Agreement between Glenn R. Jones and the Company. (1)\n10.1.3 Form of Supply and Services Agreement between Bell Canada International Inc. and the Company. (1)\n10.1.4 Form of Secondment Agreement between Bell Canada International Inc. and the Company. (1)\n10.1.5 Form of Option Agreement for Glenn R. Jones and Jones International, Ltd. between Bell Canada International Inc. and Newco. (1)\n10.1.6 Affiliate Agreement dated August 1, 1994 between the Company and Jones Computer Network, Ltd. (25)\n10.1.7 Affiliate Agreement dated August 1, 1994 between the Company and Jones Infomercial Networks, Inc. (25)\n10.1.8 Services Agreement between the Company and Jones Interactive, Inc. (25)\n10.1.9 Indemnification Agreement dated March 14, 1994, among the Company, Howard O. Thrall and George J. Feltovich. (21)\n10.2.1 Non-Qualified Stock Option Plan of the Company. (7)\n10.2.2 Form of Non-Qualified Stock Option Agreement. (7)\n10.2.3 1992 Stock Option Plan. (8)\n10.2.4 Form of Basic Incentive Stock Option Agreement. (8)\n10.2.5 Form of Basic Non-Qualified Stock Option Agreement. (8)\n10.3.1 Office Lease, dated June 8, 1984, between the Company and Jones Properties, Inc., regarding office space at 9697 East Mineral Avenue, Englewood, Colorado. (9)\n10.3.2 Office Building Lease dated December 9, 1994 between Jones Panorama Properties, Inc. and the Company regarding Lot 4, Panorama Office Park. (25)\n10.4.1 Partnership Agreement for Cable TV Fund 11. (10)\n10.4.2 Partnership Agreement for Cable TV Fund 12. (9)\n10.4.3 Partnership Agreement for Cable TV Fund 14. (11)\n10.4.4 Partnership Agreement for Jones Cable Income Fund 1. (12)\n10.4.5 First Restated Agreement of Limited Partnership for Jones Intercable Investors, L.P. (13)\n10.4.6 Partnership Agreement for IDS\/Jones Growth Partners. (14)\n10.4.7 Partnership Agreement for Cable TV Fund 15. (15)\n10.4.8 Partnership Agreement for IDS\/Jones Growth Partners II, L.P. (16)\n10.4.9 Partnership Agreement of Jones United Kingdom Fund, Ltd. (18)\n10.5.1 Credit Agreement dated December 8, 1992 among the Company, Barclays Bank PLC, Corestates Bank, N.A. and The Bank of Nova Scotia, as Co-Agents and the various lenders named therein. (3)\n10.5.2 First Amendment and Waiver to Credit Agreement dated as of January 22, 1993, among the Company, Barclays Bank PLC, Corestates Bank, N.A. and The Bank of Nova Scotia, as Co-Agents and NationsBank of Texas, N.A., as Managing Agent for various lenders. (3)\n10.5.3 Second Amendment to Credit Agreement dated November 30, 1994 among the Company, Barclays Bank PLC, CoreStates Bank, N.A. and The Bank of Nova Scotia, as Lenders and as co-agents, and NationsBank of Texas, N.A., as a Lender and as Managing Agent. (25)\n10.5.4 Third Amendment dated as of December 19, 1994 among the Company, Barclays Bank PLC, CoreStates Bank, N.A. and The Bank of Nova Scotia, as Lenders and as co-agents, and NationsBank of Texas, N.A., as a Lender and as Managing Agent. (25)\n10.5.5 Credit Agreement among Jones Cable Holdings, Inc. and NationsBank of Texas, N.A. and The Bank of Nova Scotia, as lenders and as managing agents and various other lenders.\n10.6.1 Copy of a franchise and related documents thereto granting a cable television system franchise for Town of Marana, Arizona. (3)\n10.6.2 Copy of a franchise and related documents thereto granting a cable television system franchise for Oro Valley, Arizona. (2)\n10.6.3 Copy of a franchise and related documents thereto granting a cable television system franchise for Pima County, Arizona. (2)\n10.6.4 Copy of a franchise and related documents thereto granting a cable television system franchise for The Tucson National Golf Club. (2)\n10.6.5 Copy of a franchise and related documents thereto granting a cable television system franchise for Los Angeles County, California. (17)\n10.6.6 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Diamond Bar, California. (17)\n10.6.7 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Oxnard, California. (2)\n10.6.8 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Port Hueneme, California. (3)\n10.6.9 Copy of a franchise and related documents thereto granting a cable television system franchise for the Naval Construction Battalion Center, Port Hueneme, California. (2)\n10.6.10 Modification of franchise agreement dated June 23, 1993 for the Naval Construction Battalion Center, Port Hueneme, California. (3)\n10.6.11 Copy of a franchise and related documents thereto granting a cable television system franchise for the County of Ventura, California. (3)\n10.6.12 Copy of a franchise and related documents thereto granting a cable television system franchise for Arapahoe County, Colorado. (2)\n10.6.13 Copy of a franchise and related documents thereto granting a cable television system franchise for certain portions of Jefferson County, Colorado. (2)\n10.6.14 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Morrison, Colorado. (3)\n10.6.15 Copy of a franchise and related documents thereto granting a cable television system franchise for Clear Creek County, Colorado. (32)\n10.1.16 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Empire, Colorado. (32)\n10.1.17 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Georgetown, Colorado. (32)\n10.1.18 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Idaho Springs, Colorado. (33)\n10.1.19 Copy of a franchise and related documents thereto granting a cable television system franchise for the Municipality of Silver Plume, Colorado. (32)\n10.1.20 Copy of a franchise and related documents thereto granting a cable television system franchise for Bay County, Florida. (33)\n10.1.21 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Panama City Beach, Florida. (33)\n10.1.22 Copy of a franchise and related documents thereto granting a cable television system franchise for the District of Hamakua, Hawaii. (34)\n10.1.23 Copy of a franchise and related documents thereto granting a cable television system franchise for the Districts of South Hilo and Puna, Hawaii. (34) and (32)\n10.6.24 Copy of a franchise and related documents thereto granting a cable television system franchise for Aiken County, South Carolina. (21)\n10.6.25 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Dearing, Georgia. (21)\n10.6.26 Copy of a franchise and related documents thereto granting a cable television system franchise for Edgefield County, South Carolina. (21)\n10.6.27 Copy of a franchise and related documents thereto granting a cable television system franchise for McDuffie County, Georgia. (21)\n10.6.28 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of North Augusta, South Carolina. (21)\n10.6.29 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Thomson, Georgia. (21)\n10.6.30 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Trenton, South Carolina. (21)\n10.1.31 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Augusta, Georgia (Fund 12-B). (27)\n10.1.32 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Blythe, Georgia (Fund 12-B). (28)\n10.1.33 Copy of a franchise and related documents thereto granting a cable television system franchise for the County of Burke, Georgia (Fund 12-B). (29)\n10.1.34 Copy of a franchise and related documents thereto granting a cable television system franchise for the Unincorporated Area of Columbia County, Georgia (Fund 12- B). (30)\n10.1.35 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Hephzibah, Georgia (Fund 12-B). (27)\n10.1.36 Copy of a franchise and related documents thereto granting a cable television system franchise for the Unincorporated Area of Richmond County, Georgia (Fund 12- B). 27)\n10.6.37 Copy of a franchise and related documents thereto granting a cable television system franchise for Anne Arundel County, Maryland. (2)\n10.6.38 Copy of a franchise and related documents thereto granting a cable television system franchise for Elizabeth Landing, Maryland. (2)\n10.6.39 Copy of a franchise and related documents thereto granting a cable television system franchise for Ft. George G. Meade, Maryland. (17)\n10.6.40 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Indian Head, Maryland. (3)\n10.6.41 Copy of a franchise and related documents thereto granting a cable television system franchise for the Indian Head Division, Naval Surface Warfare Center, Indian Head, Maryland. (3)\n10.6.42 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of La Plata, Maryland. (2)\n10.6.43 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Cherryville, North Carolina. (2)\n10.6.44 Copy of a franchise and related documents thereto granting a cable television system franchise for Cleveland County, North Carolina. (2)\n10.6.45 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Cramerton, North Carolina. (3)\n10.6.46 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Gastonia, North Carolina. (2)\n10.6.47 Copy of a franchise and related documents thereto granting a cable television system franchise for the Williamsburg and Jamestown subdivision of Gastonia, North Carolina. (2)\n10.6.48 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kings Mountain, North Carolina. (2)\n10.6.49 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Lowell, North Carolina. (2)\n10.6.50 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of McAdenville, North Carolina. (3)\n10.6.51 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Ranlo, North Carolina. (3)\n10.6.52 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Stanley, North Carolina. (3)\n10.6.53 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Clover, South Carolina. (3)\n10.6.54 Copy of a franchise and related documents thereto granting a cable television system franchise for York County, South Carolina. (3)\n10.6.55 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Alexandria, Virginia. (24)\n10.6.56 Copy of a franchise and related documents thereto granting a cable television system franchise for Fort Myer, Virginia. (18)\n10.6.57 Amendment dated April 6, 1990, of franchise granting a cable television system franchise for Fort Myer, Virginia. (20)\n10.6.58 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Dumfries, Virginia.\n10.6.59 Copy of a franchise and related documents thereto granting a cable television system franchise for Fort Belvoir, Virginia.\n10.6.60 Copy of a franchise and related documents thereto granting a cable television system franchise for Lake Ridge Parks & Recreation Association, Lake Ridge, Virginia.\n10.6.61 Copy of a franchise and related documents thereto granting a cable television system franchise for Prince William County, Virginia.\n10.6.62 Copy of a franchise and related documents thereto granting a cable television system franchise for Quantico, Virginia.\n10.6.63 Copy of a franchise and related documents thereto granting a cable television system franchise for the United States Marine Corps Base, Quantico, Virginia.\n10.6.64 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Haymarket, Virginia.\n10.6.65 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Manassas, Virginia.\n10.6.66 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Manassas Park, Virginia.\n10.6.67 Copy of a franchise and related documents thereto granting a cable television system franchise for Prince William County, Virginia.\n10.6.68 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kenosha, the Town of Somers and the Village of Pleasant Prairie, Wisconsin. (35)\n10.6.69 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kenosha, Wisconsin. (32)\n10.6.70 Copy of a franchise and related documents thereto granting a cable television system franchise for the Village of Pleasant Prairie, Wisconsin. (32)\n10.6.71 Copy of a franchise and related documents thereto granting a cable television system franchise for Town of Somers, Wisconsin. (32)\n21 List of Subsidiaries of the Company.\n23 Consent of Arthur Andersen & Co., independent public accountants, to the incorporation by reference of its report into the Company's Form S-8 and Form S-3 Registration Statements.\n27 Financial Data Schedule.\n_______________ (1) Incorporated by reference from the Company's Current Report on Form 8-K, filed on June 6, 1994.\n(2) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1988.\n(3) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31,\n(4) Incorporated by reference from Registration Statement No. 33-13545 on Form S-2, filed on April 17, 1987, and Amendment No. 1 thereto, filed on May 8, 1987.\n(5) Incorporated by reference from Registration Statement No. 33-47030 on Form S-3, filed on April 8, 1992, and Amendment Nos. 1 and 2 thereof, filed on April 24, 1992 and June 4, 1992, respectively, and Post-Effective Amendment No. 1 thereof, filed on July 15, 1992.\n(6) Incorporated by reference from the Company's Current Report on Form 8-K, filed on March 1, 1993.\n(7) Incorporated by reference from Registration Statement No. 2-91911 on Form S-2, filed on June 27, 1984, and Amendment No. 1 thereto, filed on July 17, 1984.\n(8) Incorporated by reference from Registration No. 33-54596 on Form S-8, filed on November 16, 1992.\n(9) Incorporated by reference from Registration Statement No. 2-94127.\n(10) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1983.\n(11) Incorporated by reference from Registration Statement No. 33-6976, filed on July 3, 1986, and Amendment No. 1 thereto, filed on November 17, 1986.\n(12) Incorporated by reference from Registration Statement No. 33-00968 on Form S-1, filed on October 18, 1985.\n(13) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992.\n(14) Incorporated by reference from Registration Statement No. 33-12473.\n(15) Incorporated by reference from Registration Statement No. 33-24358.\n(16) Incorporated by reference from the Company's Registration Statement on Form 8-A No. 0-18133, dated November 16, 1989.\n(17) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1989.\n(18) Incorporated by reference from Form 8-A of Jones United Kingdom Fund, Ltd. (Commission File No. 0-19889).\n(19) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n(20) Incorporated by reference from the Annual Report on Form 10-K of Jones Intercable Investors, L.P. (Commission File No. 1-9287) for the fiscal year ended May 31, 1986.\n(21) Incorporated by reference from the Company's Form S-4 Registration Statement filed on July 11, 1994.\n(22) Incorporated by reference from the Company's Current Report on Form 8-K dated March 10, 1995.\n(23) Incorporated by reference from the Company's Current Report on Form 8-K dated June 7, 1995.\n(24) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1994.\n(25) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1995.\n(26) Incorporated by reference from the Company's Current Report on form 8-K dated September 8, 1995.\n(27) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(28) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(29) Incorporated by reference from Cable TV Fund 12-B, Ltd.'s Report on Form 10-K for the fiscal year ended December 31, 1990 (Commission File Nos. 0-13193, 0-13807, 0- 13964 and 0-14206).\n(30) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(31) Incorporated by reference from the Company's Current Report on form 8-K dated March 23, 1995.\n(32) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1993 (Commission File No. 0-8947).\n(33) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n(34) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1988.\n(35) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1985.\n(b) Reports on Form 8-K\nCurrent Report on Form 8-K dated October 10, 1995, describing the David Hirsch civil action regarding the sale of the Tampa System.\nCurrent Report on Form 8-K dated Noember 1, 1995, describing the acquisition by Jones Cable Holdings, Inc. of the Augusta System.\nCurrent Report on Form 8-K dated November 10, 1995, describing the execution of a letter of intent to acquire a cable television system serving subscribers in Anne Arundel County, Maryland.\nCurrent Report on Form 8-K dated December 4, 1995, describing the Martin Ury civil action regarding the sale of the Tampa System.\nCurrent Report on Form 8-K dated December 4, 1995 describing the acquisition by Jones Communications of Virginia, Inc. of the Dale City System.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 - ------ -----------\n2.1 Exchange Agreement and Plan of Reorganization and Liquidation, dated as of May 31, 1994 by and between the Company and Jones Spacelink, Ltd. (1)\n2.2 Stock Purchase Agreement dated as of May 31, 1994, between Bell Canada International Inc. and the Company. (1)\n2.3 Transaction Agreement dated as of May 31, 1994, among Glenn R. Jones, Jones International, Ltd., Bell Canada International Inc. and Jones Spacelink, Ltd. (1)\n2.4 Purchase and Sale Agreement dated February 22, 1995 between Cable TV Fund 12-B, Ltd. and the Company. (22)\n2.5 Amendment No. 1 dated July 24, 1995 to Purchase and Sale Agreement dated February 22, 1995 between Cable TV Fund 12-B, Ltd. and the Company. (25)\n2.6 Asset Purchase Agreement dated May 31, 1995 between Benchmark Manassas Cable Fund Limited Partnership and the Company. (23)\n2.7 Asset Purchase Agreement dated May 31, 1995 between Cablevision of Manassas Park, Inc. and the Company. (23)\n2.8 Asset Purchase Agreement dated as of June 30, 1995 between Columbia Associates, L.P. and the Company. (25)\n2.9 Purchase and Sale Agreement dated as of August 11, 1995 between IDS\/Jones Growth Partners 87-A, Ltd. and the Company. (25)\n2.10 Purchase and Sale Agreement dated as of August 11, 1995 between Jones Cable Income Fund 1-B, Ltd. and the Company. (25)\n2.11 Purchase and Sale Agreement dated as of August 11, 1995 between Cable TV Fund 12-BCD Venture and the Company. (25)\n2.12 Asset Exchange Agreement dated as of August 11, 1995 between Time Warner Entertainment-Advance\/Newhouse Partnership and the Company. (25)\n2.13 Asset Purchase Agreement dated September 5, 1995 between Cable TV Joint Fund 11 and the Company relating to the Manitowoc System. (26)\n2.14 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income Partners 87-1, L.P. and the Company relating to the Lodi System. (26)\n2.15 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income\/Growth Fund 1-A, Ltd. and the Company relating to the Ripon System. (26)\n2.16 Asset Purchase Agreement dated September 5, 1995, between Jones Spacelink Income\/Growth Fund 1-A, Ltd. and the Company relating to the Lake Geneva System. (26)\n2.17 Asset Exchange Agreement dated September 1, 1995, between the Company and Time Warner Entertainment Company, L.P. (26)\n2.18 Assignment and Assumption Agreement dated as of September 15, 1995 between the Company and Jones Cable Holdings, Inc.\n2.19 Purchase and Sale Agreement dated as of October 18, 1995 between the Company and Jones Cable Holdings, Inc.\n3.1 Articles of Incorporation and amendments thereto of the Company. (2)\n3.2 Amendment to Articles of Incorporation of Company filed July 24, 1995. (25)\n3.3 Bylaws of the Company. (25)\n4.1 Indenture, dated as of May 15, 1987, between the Company and United Bank of Denver National Association. (4)\n4.2 Indenture, dated as of July 15, 1992, between the Company and First Trust National Association. (5)\n4.3 First Supplemental Indenture, dated as of July 15, 1992, between the Company and First Trust National Association. (5)\n4.4 Second Supplemental Indenture, dated as of March 1, 1993, between the Company and First Trust National Association. (6)\n4.5 Form of Shareholders Agreement among Glenn R. Jones, Jones International, Ltd., Bell Canada International Inc. and the Company. (1)\n4.6 Indenture dated March 23, 1995 with respect to the Senior Notes, between the Company and U.S. Trust Company of California, N.A. (31)\n4.7 First Supplemental Indenture dated as of March 23, 1995 with respect to $200,000,000 aggregate principal amount of the Company's 9 5\/8% Senior Notes due 2002, between the Company and the Trustee. (31)\n10.1.1 Form of Financial Services Agreement between Jones Financial Group, Ltd. and the Company. (1)\n10.1.2 Form of Employment Agreement between Glenn R. Jones and the Company. (1)\n10.1.3 Form of Supply and Services Agreement between Bell Canada International Inc. and the Company. (1)\n10.1.4 Form of Secondment Agreement between Bell Canada International Inc. and the Company. (1)\n10.1.5 Form of Option Agreement for Glenn R. Jones and Jones International, Ltd. between Bell Canada International Inc. and Newco. (1)\n10.1.6 Affiliate Agreement dated August 1, 1994 between the Company and Jones Computer Network, Ltd. (25)\n10.1.7 Affiliate Agreement dated August 1, 1994 between the Company and Jones Infomercial Networks, Inc. (25)\n10.1.8 Services Agreement between the Company and Jones Interactive, Inc. (25)\n10.1.9 Indemnification Agreement dated March 14, 1994, among the Company, Howard O. Thrall and George J. Feltovich. (21)\n10.2.1 Non-Qualified Stock Option Plan of the Company. (7)\n10.2.2 Form of Non-Qualified Stock Option Agreement. (7)\n10.2.3 1992 Stock Option Plan. (8)\n10.2.4 Form of Basic Incentive Stock Option Agreement. (8)\n10.2.5 Form of Basic Non-Qualified Stock Option Agreement. (8)\n10.3.1 Office Lease, dated June 8, 1984, between the Company and Jones Properties, Inc., regarding office space at 9697 East Mineral Avenue, Englewood, Colorado. (9)\n10.3.2 Office Building Lease dated December 9, 1994 between Jones Panorama Properties, Inc. and the Company regarding Lot 4, Panorama Office Park. (25)\n10.4.1 Partnership Agreement for Cable TV Fund 11. (10)\n10.4.2 Partnership Agreement for Cable TV Fund 12. (9)\n10.4.3 Partnership Agreement for Cable TV Fund 14. (11)\n10.4.4 Partnership Agreement for Jones Cable Income Fund 1. (12)\n10.4.5 First Restated Agreement of Limited Partnership for Jones Intercable Investors, L.P. (13)\n10.4.6 Partnership Agreement for IDS\/Jones Growth Partners. (14)\n10.4.7 Partnership Agreement for Cable TV Fund 15. (15)\n10.4.8 Partnership Agreement for IDS\/Jones Growth Partners II, L.P. (16)\n10.4.9 Partnership Agreement of Jones United Kingdom Fund, Ltd. (18)\n10.5.1 Credit Agreement dated December 8, 1992 among the Company, Barclays Bank PLC, Corestates Bank, N.A. and The Bank of Nova Scotia, as Co-Agents and the various lenders named therein. (3)\n10.5.2 First Amendment and Waiver to Credit Agreement dated as of January 22, 1993, among the Company, Barclays Bank PLC, Corestates Bank, N.A. and The Bank of Nova Scotia, as Co-Agents and NationsBank of Texas, N.A., as Managing Agent for various lenders. (3)\n10.5.3 Second Amendment to Credit Agreement dated November 30, 1994 among the Company, Barclays Bank PLC, CoreStates Bank, N.A. and The Bank of Nova Scotia, as Lenders and as co-agents, and NationsBank of Texas, N.A., as a Lender and as Managing Agent. (25)\n10.5.4 Third Amendment dated as of December 19, 1994 among the Company, Barclays Bank PLC, CoreStates Bank, N.A. and The Bank of Nova Scotia, as Lenders and as co-agents, and NationsBank of Texas, N.A., as a Lender and as Managing Agent. (25)\n10.5.5 Credit Agreement among Jones Cable Holdings, Inc. and NationsBank of Texas, N.A. and The Bank of Nova Scotia, as lenders and as managing agents and various other lenders.\n10.6.1 Copy of a franchise and related documents thereto granting a cable television system franchise for Town of Marana, Arizona. (3)\n10.6.2 Copy of a franchise and related documents thereto granting a cable television system franchise for Oro Valley, Arizona. (2)\n10.6.3 Copy of a franchise and related documents thereto granting a cable television system franchise for Pima County, Arizona. (2)\n10.6.4 Copy of a franchise and related documents thereto granting a cable television system franchise for The Tucson National Golf Club. (2)\n10.6.5 Copy of a franchise and related documents thereto granting a cable television system franchise for Los Angeles County, California. (17)\n10.6.6 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Diamond Bar, California. (17)\n10.6.7 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Oxnard, California. (2)\n10.6.8 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Port Hueneme, California. (3)\n10.6.9 Copy of a franchise and related documents thereto granting a cable television system franchise for the Naval Construction Battalion Center, Port Hueneme, California. (2)\n10.6.10 Modification of franchise agreement dated June 23, 1993 for the Naval Construction Battalion Center, Port Hueneme, California. (3)\n10.6.11 Copy of a franchise and related documents thereto granting a cable television system franchise for the County of Ventura, California. (3)\n10.6.12 Copy of a franchise and related documents thereto granting a cable television system franchise for Arapahoe County, Colorado. (2)\n10.6.13 Copy of a franchise and related documents thereto granting a cable television system franchise for certain portions of Jefferson County, Colorado. (2)\n10.6.14 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Morrison, Colorado. (3)\n10.6.15 Copy of a franchise and related documents thereto granting a cable television system franchise for Clear Creek County, Colorado. (32)\n10.1.16 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Empire, Colorado. (32)\n10.1.17 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Georgetown, Colorado. (32)\n10.1.18 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Idaho Springs, Colorado. (33)\n10.1.19 Copy of a franchise and related documents thereto granting a cable television system franchise for the Municipality of Silver Plume, Colorado. (32)\n10.1.20 Copy of a franchise and related documents thereto granting a cable television system franchise for Bay County, Florida. (33)\n10.1.21 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Panama City Beach, Florida. (33)\n10.1.22 Copy of a franchise and related documents thereto granting a cable television system franchise for the District of Hamakua, Hawaii. (34)\n10.1.23 Copy of a franchise and related documents thereto granting a cable television system franchise for the Districts of South Hilo and Puna, Hawaii. (34) and (32)\n10.6.24 Copy of a franchise and related documents thereto granting a cable television system franchise for Aiken County, South Carolina. (21)\n10.6.25 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Dearing, Georgia. (21)\n10.6.26 Copy of a franchise and related documents thereto granting a cable television system franchise for Edgefield County, South Carolina. (21)\n10.6.27 Copy of a franchise and related documents thereto granting a cable television system franchise for McDuffie County, Georgia. (21)\n10.6.28 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of North Augusta, South Carolina. (21)\n10.6.29 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Thomson, Georgia. (21)\n10.6.30 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Trenton, South Carolina. (21)\n10.1.31 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Augusta, Georgia (Fund 12-B). (27)\n10.1.32 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Blythe, Georgia (Fund 12-B). (28)\n10.1.33 Copy of a franchise and related documents thereto granting a cable television system franchise for the County of Burke, Georgia (Fund 12-B). (29)\n10.1.34 Copy of a franchise and related documents thereto granting a cable television system franchise for the Unincorporated Area of Columbia County, Georgia (Fund 12- B). (30)\n10.1.35 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Hephzibah, Georgia (Fund 12-B). (27)\n10.1.36 Copy of a franchise and related documents thereto granting a cable television system franchise for the Unincorporated Area of Richmond County, Georgia (Fund 12- B). 27)\n10.6.37 Copy of a franchise and related documents thereto granting a cable television system franchise for Anne Arundel County, Maryland. (2)\n10.6.38 Copy of a franchise and related documents thereto granting a cable television system franchise for Elizabeth Landing, Maryland. (2)\n10.6.39 Copy of a franchise and related documents thereto granting a cable television system franchise for Ft. George G. Meade, Maryland. (17)\n10.6.40 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Indian Head, Maryland. (3)\n10.6.41 Copy of a franchise and related documents thereto granting a cable television system franchise for the Indian Head Division, Naval Surface Warfare Center, Indian Head, Maryland. (3)\n10.6.42 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of La Plata, Maryland. (2)\n10.6.43 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Cherryville, North Carolina. (2)\n10.6.44 Copy of a franchise and related documents thereto granting a cable television system franchise for Cleveland County, North Carolina. (2)\n10.6.45 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Cramerton, North Carolina. (3)\n10.6.46 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Gastonia, North Carolina. (2)\n10.6.47 Copy of a franchise and related documents thereto granting a cable television system franchise for the Williamsburg and Jamestown subdivision of Gastonia, North Carolina. (2)\n10.6.48 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kings Mountain, North Carolina. (2)\n10.6.49 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Lowell, North Carolina. (2)\n10.6.50 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of McAdenville, North Carolina. (3)\n10.6.51 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Ranlo, North Carolina. (3)\n10.6.52 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Stanley, North Carolina. (3)\n10.6.53 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Clover, South Carolina. (3)\n10.6.54 Copy of a franchise and related documents thereto granting a cable television system franchise for York County, South Carolina. (3)\n10.6.55 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Alexandria, Virginia. (24)\n10.6.56 Copy of a franchise and related documents thereto granting a cable television system franchise for Fort Myer, Virginia. (18)\n10.6.57 Amendment dated April 6, 1990, of franchise granting a cable television system franchise for Fort Myer, Virginia. (20)\n10.6.58 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Dumfries, Virginia.\n10.6.59 Copy of a franchise and related documents thereto granting a cable television system franchise for Fort Belvoir, Virginia.\n10.6.60 Copy of a franchise and related documents thereto granting a cable television system franchise for Lake Ridge Parks & Recreation Association, Lake Ridge, Virginia.\n10.6.61 Copy of a franchise and related documents thereto granting a cable television system franchise for Prince William County, Virginia.\n10.6.62 Copy of a franchise and related documents thereto granting a cable television system franchise for Quantico, Virginia.\n10.6.63 Copy of a franchise and related documents thereto granting a cable television system franchise for the United States Marine Corps Base, Quantico, Virginia.\n10.6.64 Copy of a franchise and related documents thereto granting a cable television system franchise for the Town of Haymarket, Virginia.\n10.6.65 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Manassas, Virginia.\n10.6.66 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Manassas Park, Virginia.\n10.6.67 Copy of a franchise and related documents thereto granting a cable television system franchise for Prince William County, Virginia.\n10.6.68 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kenosha, the Town of Somers and the Village of Pleasant Prairie, Wisconsin. (35)\n10.6.69 Copy of a franchise and related documents thereto granting a cable television system franchise for the City of Kenosha, Wisconsin. (32)\n10.6.70 Copy of a franchise and related documents thereto granting a cable television system franchise for the Village of Pleasant Prairie, Wisconsin. (32)\n10.6.71 Copy of a franchise and related documents thereto granting a cable television system franchise for Town of Somers, Wisconsin. (32)\n21 List of Subsidiaries of the Company.\n23 Consent of Arthur Andersen & Co., independent public accountants, to the incorporation by reference of its report into the Company's Form S-8 and Form S-3 Registration Statements.\n27 Financial Data Schedule. _______________ (1) Incorporated by reference from the Company's Current Report on Form 8-K, filed on June 6, 1994.\n(2) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1988.\n(3) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31,\n(4) Incorporated by reference from Registration Statement No. 33-13545 on Form S-2, filed on April 17, 1987, and Amendment No. 1 thereto, filed on May 8, 1987.\n(5) Incorporated by reference from Registration Statement No. 33-47030 on Form S-3, filed on April 8, 1992, and Amendment Nos. 1 and 2 thereof, filed on April 24, 1992 and June 4, 1992, respectively, and Post-Effective Amendment No. 1 thereof, filed on July 15, 1992.\n(6) Incorporated by reference from the Company's Current Report on Form 8-K, filed on March 1, 1993.\n(7) Incorporated by reference from Registration Statement No. 2-91911 on Form S-2, filed on June 27, 1984, and Amendment No. 1 thereto, filed on July 17, 1984.\n(8) Incorporated by reference from Registration No. 33-54596 on Form S-8, filed on November 16, 1992.\n(9) Incorporated by reference from Registration Statement No. 2-94127.\n(10) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1983.\n(11) Incorporated by reference from Registration Statement No. 33-6976, filed on July 3, 1986, and Amendment No. 1 thereto, filed on November 17, 1986.\n(12) Incorporated by reference from Registration Statement No. 33-00968 on Form S-1, filed on October 18, 1985.\n(13) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992.\n(14) Incorporated by reference from Registration Statement No. 33-12473.\n(15) Incorporated by reference from Registration Statement No. 33-24358.\n(16) Incorporated by reference from the Company's Registration Statement on Form 8-A No. 0-18133, dated November 16, 1989.\n(17) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1989.\n(18) Incorporated by reference from Form 8-A of Jones United Kingdom Fund, Ltd. (Commission File No. 0-19889).\n(19) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n(20) Incorporated by reference from the Annual Report on Form 10-K of Jones Intercable Investors, L.P. (Commission File No. 1-9287) for the fiscal year ended May 31, 1986.\n(21) Incorporated by reference from the Company's Form S-4 Registration Statement filed on July 11, 1994.\n(22) Incorporated by reference from the Company's Current Report on Form 8-K dated March 10, 1995.\n(23) Incorporated by reference from the Company's Current Report on Form 8-K dated June 7, 1995.\n(24) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1994.\n(25) Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1995.\n(26) Incorporated by reference from the Company's Current Report on form 8-K dated September 8, 1995.\n(27) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(28) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(29) Incorporated by reference from Cable TV Fund 12-B, Ltd.'s Report on Form 10-K for the fiscal year ended December 31, 1990 (Commission File Nos. 0-13193, 0-13807, 0- 13964 and 0-14206).\n(30) Incorporated by reference from Cable TV Fund 12-B, Ltd.'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(31) Incorporated by reference from the Company's Current Report on form 8-K dated March 23, 1995.\n(32) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1993 (Commission File No. 0-8947).\n(33) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n(34) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1988.\n(35) Incorporated by reference from the Jones Spacelink, Ltd. Annual Report on Form 10-K for the fiscal year ended May 31, 1985.","section_15":""}
{"filename":"792013_1995.txt","cik":"792013","year":"1995","section_1":"ITEM 1. BUSINESS. - ------- ---------\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nHarleysville Group Inc. (the \"Company\") is a regional insurance holding company headquartered in Pennsylvania which engages, through its subsidiaries, in the property and casualty insurance business. As used herein, \"Harleysville Group\" refers to Harleysville Group Inc. and its subsidiaries. Harleysville Group is approximately 56% owned by Harleysville Mutual Insurance Company (the \"Mutual Company\").\nHarleysville Group and the Mutual Company operate together as a network of regional insurance companies that underwrite a broad line of personal and commercial coverages. These insurance coverages are marketed primarily in the eastern half of the United States through approximately 13,700 independent insurance agents associated with approximately 2,300 insurance agencies. Regional offices are maintained in Georgia, Illinois, Indiana, Maryland, Massachusetts, Michigan, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee and Virginia. The Company's property and casualty insurance subsidiaries are: Great Oaks Insurance Company (\"Great Oaks\"), Harleysville-Atlantic Insurance Company (\"Atlantic\"), Harleysville Insurance Company of New Jersey (\"HNJ\"), Huron Insurance Company (\"Huron\"), Lake States Insurance Company (\"Lake States\"), Mid-America Insurance Company (\"Mid- America\"), New York Casualty Insurance Company (\"New York Casualty\") and Worcester Insurance Company (\"Worcester\").\nThe Company is pursuing a strategy of building a national network of regional insurance companies. Management believes that the Company's regional organization permits each regional operation to benefit from economies of scale provided by centralized support while encouraging local marketing autonomy and managerial entrepreneurship. Services which directly involve the insured or the agent (i.e., underwriting, claims and marketing) generally are performed locally in accordance with Company-wide standards to promote high quality service, while actuarial, investment, legal, data processing and similar services are performed centrally. The Company's network of regional insurance companies has expanded significantly in the last thirteen years. In 1983, the Company acquired Worcester, a property and casualty insurer which has conducted business in New England since 1823. In 1984, HNJ was formed by the Company and began underwriting property and casualty insurance in New Jersey. In 1987, the Company acquired Atlantic, a property and casualty insurer which has conducted business in the southeastern United States since 1905. In 1991, the Company acquired Mid-America, (formerly named Connecticut Union Insurance Company) which conducted business in Connecticut, and New York Casualty, which conducts business in upstate New York. In 1993, the Company acquired Lake States, which primarily conducts business in Michigan. In 1994, the Company formed Great Oaks which began underwriting property and casualty insurance in Ohio.\nThe Company's property and casualty subsidiaries other than Lake States participate in an intercompany pooling arrangement whereby these subsidiaries cede to the Mutual Company all of their net premiums written and assume from the Mutual Company a portion of the pooled business, which included all of the Mutual Company's property and casualty insurance business except for new and renewal Pennsylvania personal automobile insurance insured after January 1, 1991 by a subsidiary of the Mutual Company, Pennland Insurance Company (\"Pennland\") and new and renewal New Jersey personal automobile insurance insured after January 1, 1992 by another subsidiary of the Mutual Company, Harleysville-Garden State Insurance Company (\"Garden State\"). Beginning January 1, 1996, Harleysville Group's participation in the pooling arrangement increased from 60% to 65% and Pennland became a participant in the pooling arrangement. See \"Business - Narrative Description of Business - Pooling Arrangement.\"\nThe Company is a Delaware corporation formed in 1979 as a wholly-owned subsidiary of the Mutual Company. In May 1986, the Company completed an initial public offering of its Common Stock, reducing the percentage of outstanding shares owned by the Mutual Company to approximately 70%. In April 1992, the Mutual Company completed a secondary public offering further reducing the percentage of outstanding shares owned by the Mutual Company to approximately 55%.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nThe Company is of the opinion that all of its operations are within one industry segment and that no information as to industry segments is required pursuant to Statement of Financial Accounting Standards No. 14 or Regulation S-K.\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\nPROPERTY AND CASUALTY UNDERWRITING\nHarleysville Group and the Mutual Company together underwrite a broad line of personal and commercial property and casualty coverages, including automobile, homeowners, commercial multi-peril and workers compensation. The Mutual Company and the Company's insurance subsidiaries other than Lake States participate in an intercompany pooling arrangement under which such subsidiaries and the Mutual Company combine their property and casualty business. Pennland and Garden State have not participated in the pooling arrangement. Beginning January 1, 1996, Pennland participates in the pooling arrangement and Harleysville Group's participation increased to 65%.\nHarleysville Group (except for Lake States) and the Mutual Company have maintained a pooled rating of \"A+\" (superior) by A.M. Best Company, Inc. (\"Best's\") based upon 1994 statutory results and operating performance. Lake States' Best's rating is \"A-\" (excellent). Best's ratings are based upon factors relevant to\npolicyholders and are not directed toward the protection of investors. Management believes that the Best's rating is an important factor in marketing Harleysville Group's products to its agents and customers.\nThe following table sets forth the premiums earned, by line of insurance, for Harleysville Group for the periods indicated:\nHARLEYSVILLE GROUP BUSINESS ONLY\nYEAR ENDED DECEMBER 31, --------------------------------\n1995 1994 1993 -------- -------- -------- (in thousands) PREMIUMS EARNED - --------------- Commercial: Automobile $ 85,210 $ 81,052 $ 74,011 Workers compensation 103,794 91,684 83,285 Commercial multi-peril 100,375 90,303 73,174 Other 24,767 23,021 21,105 -------- -------- -------- Total commercial 314,146 286,060 251,575 -------- -------- -------- Personal: Automobile 92,315 92,631 73,802 Homeowners 62,599 61,197 55,324 Other 7,982 7,843 7,840 -------- -------- -------- Total personal 162,896 161,671 136,966 -------- -------- --------\nTotal Harleysville Group Business $477,042 $447,731 $388,541 ======== ======== ========\nThe following table sets forth ratios for the Company's property and casualty subsidiaries, prepared in accordance with generally accepted accounting principles (\"GAAP\") and with statutory accounting practices (\"SAP\") prescribed or permitted by state insurance authorities. The statutory combined ratio is a standard measure of underwriting profitability. This ratio is the sum of (i) the ratio of incurred losses and loss settlement expenses to net earned premium (\"loss ratio\"); (ii) the ratio of expenses incurred for commissions, premium taxes, administrative and other underwriting expenses to net written premium (\"expense ratio\"); and (iii) the ratio of dividends to policyholders to net earned premium (\"dividend ratio\"). The GAAP combined ratio is calculated in the same manner except that it is based on GAAP amounts and the denominator for each component is net earned premium. 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 expense. Harleysville Group's operating income is a function of both underwriting results and investment income.\nHARLEYSVILLE GROUP BUSINESS ONLY\nYEAR ENDED DECEMBER 31, ------------------------------- 1995 1994 1993 ------ ------ ------\nGAAP combined ratio 104.0% 111.5% 106.7% ===== ===== ===== Statutory operating ratios: Loss ratio 70.3% 77.9% 72.9% Expense and dividend ratios 33.1% 33.5% 33.8% ----- ----- ----- Statutory combined ratio 103.4% 111.4% 106.7% ===== ===== ===== Industry statutory combined ratio 107.2% 108.5% 106.9% ===== ===== =====\n- ------------------ [FN] Source: Best's Insurance Management Reports, Property\/Casualty Supplement, January 3, 1996.\nPOOLING ARRANGEMENT\nThe Company's property and casualty subsidiaries other than Lake States participate in an intercompany pooling arrangement with the Mutual Company. The underwriting pool is intended to produce a more uniform and stable underwriting result from year to year for all companies in the pool than they would experience individually and to reduce the risk of loss of any of the pool participants by spreading the risk among all the participants. Each company participating in the pool has at its disposal the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own capital and surplus. The additional capacity exists because such policy exposures are spread among all the pool participants which each have their own capital and surplus. Regulation is applied to the individual companies rather than to the pool.\nPursuant to the terms of the pooling agreement with the Mutual Company, each of the Company's subsidiary participants cedes premiums, losses and expenses on all of their business to the Mutual Company which, in turn, retrocedes to such subsidiaries a specified portion of premiums, losses and expenses of the Mutual Company and such subsidiaries. Under the terms of the intercompany pooling agreement which became effective January 1, 1986, Huron and HNJ ceded to the Mutual Company all of their insurance business written on or after January 1, 1986. All of the Mutual Company's property and casualty insurance business written or in force on or after January 1, 1986, was also included in the pooled business. The pooling agreement provides, however, that Harleysville Group is not liable for any losses occurring prior to January 1, 1986. The pooling agreement does not legally discharge Harleysville Group from its primary liability for the full amount of the policies ceded. However, it makes the Mutual Company liable to Harleysville Group to the extent of the business ceded.\nThe following table sets forth a chronology of the changes that have occurred in the pooling agreement since it became effective on January 1, 1986.\nCHRONOLOGY OF CHANGES IN POOLING AGREEMENT\nHARLEYSVILLE MUTUAL GROUP COMPANY DATE PERCENTAGE PERCENTAGE EVENT ------ ------------ ---------- ----------------------------------\nJanuary 1, 1986 30% 70% Current pooling agreement began with Huron and HNJ as participants with the Mutual Company.\nJuly 1, 1987 35% 65% Atlantic acquired and included in the pool.\nJanuary 1, 1989 50% 50% Worcester included in the pool.\nJanuary 1, 1991 60% 40% New York Casualty and Mid-America acquired and included in the pool and the Mutual Company formed Pennland (not a pool participant) to write Pennslyvania personal automobile business.\nJanuary 1, 1996 65% 35% Pennland included in the pool.\nEffective as of January 1, 1992, Garden State began insuring new and renewal New Jersey personal automobile insurance policies that had been included in the pooling arrangement.\nWhen pool participation percentages increased as described above, cash and investments equal to the net increase in liabilities assumed less a ceding commission related to the net increase in the liability for unearned premiums, was transferred from the Mutual Company to Harleysville Group. See Note 3(a) of the Notes to Consolidated Financial Statements.\nAll premiums, losses, loss settlement expenses and other underwriting expenses are prorated among the parties to the pooling arrangement on the basis of their participation in the pool. The method of establishing reserves is set forth under \"Business - Reserves.\" The pooling agreement may be amended or terminated by agreement of the parties. Termination may occur only at the end of a calendar year. The Company and the Mutual Company maintain a coordinating committee which reviews and evaluates the pooling arrangements between the Company and the Mutual Company. See \"Business-Relationship with the Mutual Company.\" In evaluating pool participation changes, the coordinating committee considers current and proposed acquisitions, the relative capital positions and revenue contributions of the pool participants, and growth prospects and ability to access capital markets to support that growth. Harleysville Group does not intend to terminate its participation in the pooling agreement.\nThe following table sets forth the net written premiums and combined ratios by line of insurance for the total pooled business after elimination of management fees, prepared in accordance with statutory accounting practices prescribed or permitted by state insurance authorities, for the periods indicated.\nTOTAL POOLED BUSINESS\nYEAR ENDED DECEMBER 31, --------------------------------------- 1995 1994 1993 -------- --------- --------- (dollars in thousands)\nPREMIUMS WRITTEN - ---------------- Commercial: Automobile $136,197 $122,807 $121,342 Workers compensation 154,812 125,881 138,981 Commercial multi-peril 144,742 122,964 119,763 Other 39,703 36,007 35,393 -------- -------- -------- Total commercial 475,454 407,659 415,479 -------- -------- --------\nPersonal: Automobile 113,440 110,900 121,806 Homeowners 93,141 88,864 91,501 Other 13,751 13,088 12,610 -------- -------- -------- Total personal 220,332 212,852 225,917 -------- -------- --------\nTotal pooled business $695,786 $620,511 $641,396 ======== ======== ========\nCOMBINED RATIOS - --------------- Commercial: Automobile 107.5% 105.2% 103.8% Workers compensation 87.5% 110.6% 114.6% Commercial multi-peril 111.3% 110.3% 101.5% Other 110.6% 109.7% 87.9% Total commercial 102.4% 109.0% 105.4%\nPersonal: Automobile 112.2% 107.6% 107.1% Homeowners 104.8% 140.2% 113.7% Other 88.6% 108.1% 115.6% Total personal 107.7% 121.0% 110.2%\nTotal pooled business 104.1% 113.2% 107.1%\n- ----------------- [FN] See the definition of combined ratio in \"Business-Property and Casualty Underwriting\".\nThe following table sets forth the net written premiums and statutory combined ratios by line of insurance for Lake States for 1995 and for 1994, the first full year after being acquired by the Company.\nLAKE STATES\nYEAR ENDED DECEMBER 31, ----------------------- 1995 1994 -------- -------- (dollars in thousands)\nPREMIUMS WRITTEN - ---------------- Commercial: Automobile $ 8,024 $ 7,622 Workers compensation 21,381 16,157 Commercial multi-peril 21,799 18,744 Other 2,785 1,365 ------- ------- Total commercial 53,989 43,888 ------- -------\nPersonal: Automobile 26,030 24,642 Homeowners 7,985 8,521 ------- ------- Total personal 34,015 33,163 ------- -------\nTotal Lake States $88,004 $77,051 ======= =======\nCOMBINED RATIOS - ------------------ Commercial: Automobile 145.4% 107.8% Workers compensation 81.0% 100.9% Commercial multi-peril 101.9% 95.6% Other 43.2% 52.1% Total commercial 97.6% 97.0%\nPersonal: Automobile 112.7% 105.5% Homeowners 102.4% 136.7% Total personal 110.1% 113.2%\nTotal Lake States 102.7% 104.0%\n- ---------------- [FN] See the definition of combined ratio in \"Business-Property and Casualty Underwriting\".\nRESERVES. Loss reserves are estimates at a given point in time of what the insurer expects to pay to claimants for claims occurring on or before such point in time, including claims which have not yet been reported to the insurer. These are estimates, and it can be expected that the ultimate liability will exceed or be less than such estimates. During the loss settlement period, additional facts regarding individual claims may become known, and consequently it often becomes necessary to refine and adjust the estimates of liability.\nHarleysville Group maintains reserves for the eventual payment of losses and loss settlement expenses with respect to both reported and unreported claims. Loss settlement expense reserves are intended to cover the ultimate costs of settling all claims, including investigation and litigation costs relating to such claims. The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved and knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported claims and loss settlement expense reserves are determined on the basis of historical information by line of insurance as adjusted to current conditions. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. Reserves are closely monitored and are recomputed periodically by Harleysville Group and the Mutual Company using new information on reported claims and a variety of statistical techniques. With the exception of reserves relating to some workers compensation long-term disability cases, loss reserves are not discounted.\nThe following table sets forth a reconciliation of beginning and ending net reserves for unpaid losses and loss settlement expenses for the years indicated for the total pooled business on a statutory basis.\nTOTAL POOLED BUSINESS\nYEAR ENDED DECEMBER 31, ----------------------------------- 1995 1994 1993 --------- --------- --------- (in thousands) Reserves for losses and loss settlement expenses, beginning of the year $855,305 $825,028 $784,514 -------- -------- -------- Incurred losses and loss settlement expenses: Provision for insured events of the current year 483,560 497,983 464,399 Decrease in provision for insured events of prior years (18,050) (5,534) (2,767) -------- -------- -------- Total incurred losses and loss settlement expenses 465,510 492,449 461,632 -------- -------- -------- Payments: Losses and loss settlement expenses attributable to insured events of the current year 173,544 207,094 176,908 Losses and loss settlement expenses attributable to insured events of prior years 246,935 255,078 244,210 -------- -------- -------- Total payments 420,479 462,172 421,118 -------- -------- --------\nReserves for losses and loss settlement expenses, end of the year $900,336 $855,305 $825,028 ======== ======== ========\nThe following table sets forth the development of net reserves for unpaid losses and loss settlement expenses from 1985 through 1995 for the pooled business of the Mutual Company and Harleysville Group. \"Reserve for losses and loss settlement expenses\" sets forth the estimated liability for unpaid losses and loss settlement expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and loss settlement expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including losses incurred but not reported.\nThe \"Reserves reestimated as a percent of initial reserves\" portion of the table shows the reestimated amount (expressed as a percentage of the initial reserve) of the previously recorded liability based on experience of each succeeding year. The estimate is increased or decreased as payments are made and more information becomes known about the severity of remaining unpaid claims. For example, the 1990 liability has developed a deficiency after five years, in that reestimated losses and loss settlement expenses are expected to exceed the initial estimated liability established in 1990 of $676.5 million by 0.3%.\nThe \"Cumulative paid as a percent of current reserves\" portion of the table shows the cumulative losses and loss settlement expense payments (expressed as a percentage of current reserves) made in succeeding years for losses incurred prior to the balance sheet date. For example, the 1990 column indicates that as of December 31, 1995, payments equal to 83.1% of the currently reestimated ultimate liability for losses and loss settlement expenses had been made.\nThe \"Redundancy (deficiency) expressed as a percentage of year end reserves\" shows the cumulative redundancy or deficiency at December 31, 1995 of the reserve estimate shown on the top line of the corresponding column. A redundancy in reserves means that reserves established in prior years exceeded actual losses and loss settlement expenses or were reevaluated at less than the original reserved amount. A deficiency in reserves means that the reserves established in prior years were less than actual losses and loss settlement expenses or were reevaluated at more than the originally reserved amount.\nThe following table includes all 1995 pool participants as if they had participated in the pooling arrangement in all years indicated except for acquired pool participant companies, which are included from their date of acquisition. Under the terms of the pooling arrangement, Harleysville Group is not responsible for losses on the pooled business occurring prior to January 1, 1986.\nHarleysville Group's reserves are derived from those established for the total pooled business. The terms of the pooling agreement provide that Harleysville Group is responsible only for pooled losses incurred on or after the effective date, January 1, 1986. The GAAP loss reserve experience of Harleysville Group, as reflected in its financial statements, is shown in the following table which sets forth a reconciliation of beginning and ending net reserves for unpaid losses and loss settlement expenses for the years indicated for the business of Harleysville Group only.\nHARLEYSVILLE GROUP BUSINESS ONLY\nYEAR ENDED DECEMBER 31, ------------------------------------ 1995 1994 1993 --------- --------- --------- (in thousands) Reserves for losses and loss settlement expenses, beginning of the year $535,452 $499,272 $437,883 -------- -------- -------- Reserves of acquired companies 32,293 -------- -------- -------- Incurred losses and loss settlement expenses: Provision for insured events of the current year 346,383 352,085 283,526 Increase (decrease) in provision for insured events of prior years (10,887) (3,215) 252 -------- -------- -------- Total incurred losses and loss settlement expenses 335,496 348,870 283,778 -------- -------- -------- Payments: Losses and loss settlement expenses attributable to insured events of the current year 129,446 151,133 110,217 Losses and loss settlement expenses attributable to insured events of prior years 164,849 161,557 144,465 -------- -------- -------- Total payments 294,295 312,690 254,682 -------- -------- -------- Reserves for losses and loss settlement expenses, end of the year $576,653 $535,452 $499,272 ======== ======== ========\nHarleysville Group recognized a decrease in the provision for insured events of prior years (favorable development) of $10.9 and $3.2 million in 1995 and 1994, respectively. The favorable development primarily related to lower than expected claim severity in workers compensation. The development in 1993 was not significant.\nThe following table is a reconciliation of reserves for losses and loss settlement expenses based on GAAP to those based on SAP.\nYEAR ENDED DECEMBER 31, ----------------------------------- 1995 1994 1993 -------- -------- -------- (in thousands) Gross reserves for losses and loss settlement expenses, based on GAAP $645,941 $603,088 $560,811\nReinsurance recoverable 69,288 67,636 61,539 -------- -------- -------- Net reserves for losses and loss settlement expenses, based on GAAP 576,653 535,452 499,272\nSalvage and subrogation recoverable on property lines 3,474 -------- -------- -------- Reserves for losses and loss settlement expenses, based on SAP $576,653 $535,452 $502,746 ======== ======== ========\nThe following table sets forth the development of the 1994, 1993 and 1992 net reserves for losses and loss settlement expenses, reinsurance recoverable and gross reserves for losses and loss settlement expenses as of December 31, 1995:\n1994 1993 1992 --------- --------- --------- (in thousands)\nGross re-estimated reserve $594,625 $551,080 $477,960 Re-estimated recoverable 70,060 67,445 47,232 -------- -------- --------\nNet re-estimated reserve $524,565 $483,635 $430,728 ======== ======== ========\nNet cumulative redundancy $(10,887) $(15,637) $ (7,155) ======== ======== ========\nThe following table sets forth the development of net reserves for unpaid losses and loss settlement expenses for Harleysville Group from 1986, the year of the Company's initial public offering and the commencement of the pooling arrangement, to 1995. The effect of changes to the pooling agreement participation is reflected in this table. For example, the January 1, 1989 increase in Harleysville Group's pooling participation from 35% to 50% is reflected in the first line of the 1989 column. Amounts\nof assets equal to increases in net liabilities was transferred to Harleysville Group from the Mutual Company in conjunction with each respective pooling change. The amount of the assets transferred has been netted against and has reduced the cumulative amounts paid for years prior to the pooling changes. For example, the 1988 column of the \"Cumulative paid as a percent of current reserves\" portion of the table reflects the assets transferred in conjunction with the 1989 increase in the pooling percentage from 35% to 50% as a decrease netted in the \"one year later\" line.\nREINSURANCE. Harleysville Group follows the customary industry practice of reinsuring a portion of its exposures and paying to the reinsurers a portion of the premiums received on all policies. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. Reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, although it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. Therefore, a ceding company is subject to credit risk with respect to its reinsurers.\nThe reinsurance described below is maintained for the participants in the pooling arrangement with the Mutual Company. Reinsurance premiums and recoveries are allocated according to pooling percentages.\nReinsurance for property and auto physical damage losses is currently maintained under a per risk excess of loss treaty affording recovery to $4,250,000, above a retention paid by the pool participants of $750,000. In addition, the Company's subsidiaries (other than Lake States) and the Mutual Company and its wholly-owned subsidiaries are reinsured under a catastrophe reinsurance treaty effective for one year from July 1, 1995 which provides coverage for 85% of up to $127 million in excess of a retention of $20 million for any given catastrophe. Accordingly, pursuant to the terms of the treaty, the Company's maximum recovery would be $108 million for any catastrophe involving an insured loss equal to or greater than $147 million. The treaty includes reinstatement provisions providing for coverage for a second catastrophe and requiring payment of an additional premium in the event of a first catastrophe occurring. Harleysville Group has not purchased funded catastrophe covers.\nCasualty reinsurance (including liability and workers compensation) is currently maintained under an excess of loss treaty affording recovery to $19,000,000 above a retention of $1,000,000 each loss occurrence. In addition, there is reinsurance to protect Harleysville Group from large workers compensation losses. For umbrella liability coverages, reinsurance protection up to $4,000,000 is provided over a retention of $1,000,000.\nEffective January 1, 1996, Lake States reinsurance for property, casualty and umbrella liability coverages are under the same treaties described above. Furthermore, Lake States has purchased a lower layer of reinsurance from the Mutual Company on each of these coverages with retentions of $300,000, $250,000 and $250,000, respectively. Effective January 1, 1996, Lake States has purchased property catastrophe reinsurance from the Mutual Company affording recovery of 95% of $19,000,000 in excess of $1,000,000. Since the premiums and recoveries for such reinsurance would be subject to the pooling arrangement, Harleysville Group's participation is eliminated in consolidation.\nThe terms and charges for reinsurance coverage are typically negotiated annually. The reinsurance market is subject to conditions which are similar to those in the direct property and casualty insurance market, and there can be no assurance that reinsurance will remain available to the Company to the same extent and at the same cost currently maintained by the Company.\nThe Company considers numerous factors in choosing reinsurers, the most important of which is the financial stability of the reinsurer. The Company has not experienced any material collectibility problems for its reinsurance recoverables.\nCOMPETITION. The property and casualty insurance industry is highly competitive on the basis of both price and service. There are numerous companies competing for this business in the geographic areas where the Harleysville Group operates, many of which are substantially larger and have considerably greater financial resources than Harleysville Group. In addition, because the insurance products of Harleysville Group and the Mutual Company are marketed exclusively through independent insurance agencies, most of which represent more than one company, Harleysville Group faces competition within each agency.\nINVESTMENTS\nAn important element of the financial results of Harleysville Group is the return on invested assets. Harleysville Group's investment objective is to maintain a widely diversified fixed maturities portfolio structured to maximize after-tax investment income while minimizing credit risk through investments in high quality instruments. Its objective also is to provide adequate funds to pay claims without forced sales of investments. During 1995 and 1994, Harleysville Group invested $30 million in equity securities with the objective of capital appreciation and expects to gradually increase this investment to $48 million in the next few years. At December 31, 1995, the investment portfolio did not contain any securities that were rated at less than investment grade, and it did not contain any real estate or mortgage loans.\nHarleysville Group has adopted and follows an investment philosophy which precludes the purchase of non-investment grade securities. However, due to uncertainties in the economic environment, it is possible that the quality of investments held in Harleysville Group's portfolio may change.\nThe following table shows the composition of Harleysville Group's fixed maturity investment portfolio at amortized cost, excluding short- term investments, by rating as of December 31, 1995:\nDECEMBER 31, 1995 --------------------- AMOUNT PERCENT -------- ------- RATING (dollars in thousands) ---------\nU.S. Treasury and U.S. agency bonds $234,273 23.9% Aaa 171,967 17.6% Aa 314,763 32.2% A 250,319 25.6% Baa 6,730 .7% -------- ----- Total $978,052 100.0% ======== ===== - ---------------- [FN] Ratings assigned by Moody's Investors Services, Inc. Includes GNMA pass-through obligations and collateralized mortgage obligations.\nHarleysville Group invests in both taxable and tax-exempt securities as part of its strategy to maximize after-tax income. Such strategy considers, among other factors, the impact of the alternative minimum tax. Tax-exempt bonds made up approximately 37%, 42% and 44% of the total investment portfolio at December 31, 1995, 1994 and 1993, respectively.\nThe following table shows the composition of Harleysville Group's investment portfolio at carrying value, excluding short- term investments, by type of security as of December 31, 1995:\nDECEMBER 31, 1995 --------------------- AMOUNT PERCENT -------- ------- (dollars in thousands) Fixed maturities: U.S. Treasury obligations $ 55,662 5.3% U.S. agency obligations 75,464 7.3% GNMA pass-through obligations 3,025 .3% Collateralized mortgage obligations 115,790 11.1% Obligations of states and political subdivisions 383,026 36.8% Corporate securities 373,474 35.9% ---------- ----- Total fixed maturities 1,006,441 96.7% ---------- ----- Equity securities 34,584 3.3% ---------- ----- Total $1,041,025 100.0% ========== =====\nInvestment results of Harleysville Group's fixed maturity investment portfolio for the three years ended December 31, 1995 are shown in the following table:\nYEAR ENDED DECEMBER 31, --------------------------------------- 1995 1994 1993 --------- --------- --------- (dollars in thousands)\nInvested assets $960,114 $917,368 $796,266 Investment income $ 67,428 $ 63,293 $ 59,143 Average yield 7.0% 6.9% 7.4%\n- --------------- [FN] Average of the aggregate invested amounts at amortized cost at the beginning and end of the period, adjusted for the 1993 Lake States acquisition and proceeds from the related public note offering.\nInvestment income does not include investment expenses, realized investment gains or losses or provision for income taxes.\nThe following table indicates the composition of Harleysville Group's fixed maturity investment portfolio at carrying value, excluding short-term investments, by time to maturity as of December 31, 1995:\nDECEMBER 31, 1995 --------------------- AMOUNT PERCENT -------- ------- (dollars in thousands) DUE IN --------- 1 year or less $ 46,041 4.6% Over 1 year through 5 years 206,711 20.5% Over 5 years through 10 years 357,976 35.6% Over 10 years 276,898 27.5% ---------- ----- 887,626 88.2% Mortgage-backed securities 118,815 11.8% ---------- ----- Total $1,006,441 100.0% ========== =====\n- ---------------- [FN] Based on stated maturity dates with no prepayment assumptions. Actual maturities may differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe average life of Harleysville Group's investment portfolio as of December 31, 1995 was approximately 7 years.\nREGULATION\nInsurance companies are subject to supervision and regulation in the states 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. The extent of such regulation varies, but generally derives from state statutes which 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, premium rates for property and casualty insurance, the provisions which insurers must make for current losses and future liabilities, the deposit of securities for the benefit of policyholders and the approval of policy forms. Such 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.\nAll of the states in which Harleysville Group and the Mutual Company do business have guaranty fund laws under which insurers doing business in such states can be assessed up to 2% of annual written premiums earned by the insurer in that state in order to fund policyholder liabilities of insolvent insurance companies. Under these laws in general, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of policyholder and third party claims against insolvent insurers. Since the likelihood and amount of any particular assessment cannot be determined until an insolvency has occurred, potential liabilities for assessments are not reflected in the reserves of insurers. During the five years ended December 31, 1995, the amount of such insolvency assessments paid by Harleysville Group and the Mutual Company was not material.\nState laws also require Harleysville Group to participate in involuntary insurance programs for automobile insurance, as well as other property and casualty lines, in states in which Harleysville Group operates. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements (\"FAIR\") plans, reinsurance facilities and wind storm plans. These state laws generally require all companies that write lines covered by these programs to provide coverage (either directly or through reinsurance) for insureds who cannot obtain insurance in the voluntary market. The legislation creating these programs usually allocates a pro rata portion of risks attributable to such insureds to each company on the basis of direct written premiums or the number of automobiles insured. Generally, state law requires participation in such programs as a condition to doing business. The loss ratio on insurance written under involuntary programs generally has been greater than the loss ratio on insurance in the voluntary market.\nState insurance holding company acts regulate insurance holding company systems. Each insurance company in the holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurer within the system. Such laws further require disclosure of material transactions including the payment of \"extraordinary dividends\" from the insurance subsidiaries to the Company.\nInsurance holding company acts require that all transactions within the holding company system affecting the Mutual Company and the Company's insurance subsidiaries must be fair and equitable. Further, approval of the applicable insurance commissioner is required prior to the consummation of transactions affecting the control of an insurer.\nThe property and casualty insurance industry has been subject to significant public scrutiny and comment primarily due to concerns regarding solvency issues, rising insurance costs, and the industry's methods of operations. Accordingly, new regulations and legislation are being proposed to bring the insurance industry under federal control; to strengthen state oversight, particularly in the field of solvency and investments; to further restrict an insurer's ability to underwrite and price risks; and to impose new taxes and assessments. It is not possible to predict whether, in what form or in what jurisdictions any of these proposals might be adopted or the effect, if any, on the Company.\nThe Company's insurance subsidiaries are restricted by the insurance laws of their respective states of domicile as to the amount of dividends they may pay to the Company without the prior approval of the respective state regulatory authorities. Generally, the maximum dividend that may be paid by an insurance subsidiary during any year without prior regulatory approval is limited to a stated percentage of that subsidiary's statutory surplus as of a certain date, or adjusted net income of the subsidiary, for the preceding year. Applying current regulatory restrictions as of December 31, 1995, the Company's insurance subsidiaries would have been able to pay, without prior regulatory approval, approximately $37.6 million in dividends to the Company. The Company's insurance subsidiaries have not paid any dividends to Harleysville Group Inc. in 1995, 1994 or 1993.\nThe National Association of Insurance Commissioners (NAIC) has adopted risk-based capital (RBC) standards that require insurance companies to calculate and report statutory capital and surplus needs based on a formula measuring underwriting, investment and other business risks inherent in an individual company's operations. These RBC standards have not affected the operations of Harleysville Group since each of the Company's insurance subsidiaries have statutory capital and surplus in excess of RBC requirements.\nHarleysville Group is required to file financial statements for its subsidiaries, prepared by using statutory accounting practices, with state regulatory authorities. SAP differs from GAAP primarily in the recognition of revenue and expense. The adjustments necessary to reconcile net income and stockholders' equity determined by using SAP to net income and stockholders' equity determined in accordance with GAAP are as follows:\nNET INCOME STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31 DECEMBER 31, -------------------------------- ---------------------- 1995 1994 1993 1995 1994 -------- -------- -------- --------- --------- (in thousands) SAP amounts $36,063 $16,674 $26,103 $303,675 $262,841 Adjustments: Deferred policy acquisition costs 6,619 143 1,820 59,109 52,490 Deferred income taxes (502) 5,647 2,949 23,875 38,767 Unrealized investment gains (losses) 27,834 (8,215) Other, net (608) (4,579) (28) 8,322 3,527 Holding company (241) 569 1,096 (77,806) (72,486) ------- ------- ------- -------- -------- GAAP amounts $41,331 $18,454 $31,940 $345,009 $276,924 ======= ======= ======= ======== ======== [FN] Represents the GAAP income and equity amounts for Harleysville Group Inc., excluding the earnings of and investment in subsidiaries.\nRELATIONSHIP WITH THE MUTUAL COMPANY\nHarleysville Group's operations are interrelated with the operations of the Mutual Company due to the pooling arrangement and other factors. The Mutual Company owns approximately 56% of Harleysville Group. Harleysville Group employees provide a variety of services to the Mutual Company and its wholly-owned subsidiaries. The cost of facilities and employees required to conduct the business of both companies is charged on a cost- allocated basis. Harleysville Group also manages the operations of the Mutual Company and its wholly owned subsidiaries pursuant to a management agreement which commenced January 1, 1993 under which Harleysville Group receives a management fee. Harleysville Group also manages the operations of Berkshire Mutual Insurance Company,\na small property and casualty insurance company, pursuant to a management services agreement. Harleysville Group received $6.9 million, $6.6 million and $4.7 million for the years ended December 31, 1995, and 1994 and 1993 for all such management services.\nAll of the Company's officers are officers of the Mutual Company, and six of the Company's nine directors are directors of the Mutual Company. A coordinating committee exists to review and evaluate the pooling agreement and is responsible for matters involving actual or potential conflicts of interest between the two companies. The decisions of the coordinating committee are binding on the two companies. No intercompany transaction can be authorized by the coordinating committee unless the Company's committee members conclude that such transaction is fair and equitable to Harleysville Group. The coordinating committee consists of seven non-employee directors, three from Harleysville Group Inc. and three from the Mutual Company all of whom are not members of both Boards and one, the Chairman, who is a member of both Boards. For information concerning the members of the coordinating committee, see \"The Board of Directors and its Committees\" section on pages 5 to 6 of the Company's proxy statement relating to the annual meeting of the stockholders to be held April 24, 1996 which is incorporated by reference in this Form 10-K Report.\nThe Mutual Company leases the home office from Harleysville Group with which it shares most of the facility. Rental income under the lease was $2,750,000, $2,668,000 and $2,569,000 for 1995, 1994 and 1993, respectively. Harleysville Group believes that the lease terms are no less favorable to it than if the property were leased to a non-affiliate.\nIn connection with the acquisition of Lake States, the Company borrowed $44 million from the Mutual Company on a short- term basis. It was repaid with the proceeds of a public note offering. In connection with the acquisition of Mid-America and New York Casualty, the Company borrowed approximately $18.5 million from the Mutual Company. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition -- Liquidity and Capital Resources\" and Notes 2 and 8 of the Notes to Consolidated Financial Statements. For additional information with respect to transactions with the Mutual Company, see Note 3 of the Notes to Consolidated Financial Statements.\nEMPLOYEES\nAll employees are paid by Harleysville Group and, accordingly, are considered to be employees of Harleysville Group. As of December 31, 1995, there were 2,508 employees. They provide a variety of services to the Mutual Company and its wholly-owned subsidiaries. See \"Business-Relationship with the Mutual Company\" and Note 3(c) of the Notes to Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. - ------- -----------\nThe buildings which house the headquarters of Harleysville Group and the Mutual Company are leased by the Mutual Company from a subsidiary of Harleysville Group. See \"Business-Relationship with the Mutual Company.\" The Mutual Company charges Harleysville Group for an appropriate portion of the rent under an intercompany allocation agreement. The buildings containing the headquarters of Harleysville Group and the Mutual Company have approximately 220,000 square feet of office space. Harleysville Group also rents office facilities in certain of the states in which it does business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. - ------- ------------------\nHarleysville Group is a party to numerous lawsuits arising in the ordinary course of its insurance business. Harleysville Group believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------- ----------------------------------------------------\nNo matter was submitted during the fourth quarter of 1995 to a vote of holders of the Company's Common Stock.\nEXECUTIVE OFFICERS OF THE COMPANY\nAll of the persons listed below are executive officers of Harleysville Group or its affiliates. There are no family relationships between any of the Company's executive officers and directors, and there are no arrangements or understandings between any of these officers and any other person pursuant to which the officer was selected as an officer.\nName Age Position - --------------------- --- ---------------------------------- Walter R. Bateman, II 48 President, Chief Executive Officer and Director Thomas E. Roden 60 Executive Vice President Mark R. Cummins 39 Senior Vice President, Chief Investment Officer and Treasurer Bruce J. Magee 41 Senior Vice President and Chief Financial Officer Spencer M. Roman 47 Senior Vice President Robert G. Whitlock, Jr. 39 Senior Vice President and Chief Actuary Roger J. Beekley 53 Vice President and Controller Roger A. Brown 47 Vice President, Secretary and General Counsel\nWalter R. Bateman, II has been Chief Executive Officer since January 1, 1994 and has been President, Chief Operating Officer and Director of Harleysville Group and the Mutual Company since 1992. Mr. Bateman was Executive Vice President of Harleysville Group and the Mutual Company responsible for all insurance operations from 1991 to 1992.\nThomas E. Roden is Executive Vice President of Harleysville Group and the Mutual Company. He is in charge of insurance operations for both companies and was previously in charge of underwriting for both companies since 1983.\nMark R. Cummins has been Senior Vice President, Chief Investment Officer and Treasurer of Harleysville Group and the Mutual Company since 1992. Since January 1, 1996, he also has been in charge of various administrative areas. Mr. Cummins was employed at Selective Insurance Company from 1982 to 1992, most recently as Vice President in the investment and treasury department.\nBruce J. Magee has been Senior Vice President and Chief Financial Officer of Harleysville Group and the Mutual Company since January 1, 1994. From 1986 to 1993 he was Vice President and Controller of Harleysville Group.\nSpencer M. Roman has been Senior Vice President since 1993. Since January 1, 1996, he has been in charge of marketing, claims, underwriting and policy and information services. He was in charge of marketing for the three preceding years. From 1970 to 1993 he was employed by General Accident Insurance Company, most recently as Vice President of Marketing\/Planning.\nRobert G. Whitlock, Jr. has been Senior Vice President and Chief Actuary of Harleysville Group and the Mutual Company since February 1995. He was Vice President and Actuary before assuming his present position and was in charge of various actuarial functions since 1991.\nRoger J. Beekley has been Vice President and Controller of Harleysville Group since January 1, 1994 and is Vice President and Controller of the Mutual Company, a position he has held since 1982.\nRoger A. Brown has been Vice President, Secretary and General Counsel of Harleysville Group and the Mutual Company since April 1995. He was Assistant General Counsel from 1986 until assuming his present position.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED - ------- ---------------------------------------------------- STOCKHOLDER MATTERS. - -------------------\nThe \"Market for Common Stock and Related Security Holder Matters\" section from the Company's annual report to stockholders for the year ended December 31, 1995, which is included as Exhibit (13)(D) to this Form 10-K Report, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. - ------- ------------------------\nThe \"Selected Consolidated Financial Data\" section from the Company's annual report to stockholders for the year ended December 31, 1995, which is included as Exhibit (13)(A) to this Form 10-K 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 \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" section from the Company's annual report to stockholders for the year ended December 31, 1995, which is included as Exhibit (13)(B) to this Form 10-K Report, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------- --------------------------------------------\nThe consolidated financial statements from the Company's annual report to stockholders for the year ended December 31, 1995, which is included as Exhibit (13)(C) to this Form 10-K Report, are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------- ----------------------------------------------------------- AND FINANCIAL DISCLOSURE. - ------------------------- None.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- ---------------------------------------------------\nThe \"Election of Directors\" section, which provides information regarding the Company's directors, on pages 3 to 5 of the Company's proxy statement relating to the annual meeting of stockholders to be held April 24, 1996, is incorporated herein by reference.\nThe information concerning executive officers called for by Item 10 of Form 10-K is set forth in Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. - -------- -----------------------\nThe \"Executive Compensation and Other Information\" section on pages 8 to 13 and the \"Compensation of Directors\" section on pages 6 to 7 of the Company's proxy statement relating to the annual meeting of stockholders to be held April 24, 1996, are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND - -------- --------------------------------------------------- MANAGEMENT. - -----------\nThe \"Beneficial Ownership of Common Stock\" section on pages 2 to 3 of the Company's proxy statement relating to the annual meeting of stockholders to be held April 24, 1996, are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------- -----------------------------------------------\nThe \"Certain Transactions\" section on pages 21 to 22 of the Company's proxy statement relating to the annual meeting of stockholders to be held April 24, 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 following consolidated financial statements are filed as a part of this report:\nConsolidated Financial Statements PAGE ------ Consolidated Balance Sheets as of December 31, 1995 and 1994 29* Consolidated Statements of Income for Each of the Years in the Three-year Period Ended December 31, 1995 30* Consolidated Statements of Stockholders' Equity for Each of the Years in the Three- year Period Ended December 31, 1995 31* Consolidated Statements of Cash Flows for Each of the Years in the Three-year Period Ended December 31, 1995 32* Notes to Consolidated Financial Statements 33* Independent Auditors' Report 42*\n(2) The following consolidated financial statement schedules for the years 1995, 1994 and 1993 are submitted herewith:\nFinancial Statement Schedules Schedule I. Summary of Investments - Other Than Investments in Related Parties 38 Schedule III. Condensed Financial Information of Parent Company 39 Schedule V. Supplementary Insurance Information 42 Schedule VI. Reinsurance 43 Schedule X. Supplemental Insurance Information Concerning Property and Casualty Subsidiaries 44 Independent Auditors' Consent and Report on Schedules (filed as Exhibit 23)\nAll other schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.\n- -------------------- *Refers to the respective page of Harleysville Group Inc.'s 1995 Annual Report to Stockholders. The Consolidated Financial Statements and Independent Auditors' Report, which are included as Exhibit (13)(C), are incorporated herein by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and Items 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part of this Form 10-K or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\n(3) Exhibits\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- ------------------------------------------------- ( 3)(A) Amended and restated Certificate of Incor- poration of Registrant - incorporated herein by reference to Exhibit 3(A) to the Registrant's 10-Q filed May 10, 1994.\n( 3)(B) Amended and Restated By-laws of Registrant - incorporated herein by reference to Exhibit 4(B) to the Post-Effective Amendment No. 12 of Registrant's Form S-3 Registration Statement No. 33-90810 filed October 10, 1995.\n( 4) Indenture between the Registrant and CoreStates Bank, N.A., dated as of November 15, 1993 - incorporated herein by reference to Exhibit (4) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n*(10)(A) Deferred Compensation Plan, as amended, for Directors of Harleysville Mutual Insurance Company, Harleysville Group Inc. and Harleysville Life Insurance Company - incorporated herein by reference to Exhibit 10(A) to the Registrant's Form S-3 Registration Statement No. 33-28948 filed May 25, 1989.\n*(10)(B) Harleysville Insurance Companies Director Deferred Compensation Plan Approved by the Board of Directors November 25, 1987 - incorporated herein by reference to Exhibit 10(B) to the Registrant's Form S-3 Registration Statement No. 33-28948 filed May 25, 1989.\n*(10)(C) Harleysville Group Inc. Non-qualified Deferred Compensation Plan - incorporated herein by reference to Exhibit 10(C) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n*(10)(D) Pension Plan of Harleysville Group Inc. and Associated Employers dated December 1, 1994 and amendment dated February 6, 1995 - incorporated herein by reference to Exhibit 10(D) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n*(10)(E) Harleysville Insurance Companies Senior Executive Supplemental Retirement Plan dated May 25, 1982 - incorporated herein by reference to Exhibit 10(E) to the Registrant's Form S-1 Registration Statement No. 33-4885 declared effective May 23, 1986.\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- -----------------------------------------------\n*(10)(F) Harleysville Mutual Insurance Company\/ Harleysville Group Inc. Senior Management Incentive Bonus Plan As Amended and Restated December 22, 1993 - incorporated herein by reference to Exhibit 10(F) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(10)(G) Proportional Reinsurance Agreement effective as of January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company and Harleysville Insurance Company of New Jersey - incorporated herein by reference to Exhibit 10(N) to the Registrant's Form S-1 Registration Statement No. 33-4885 declared effective May 23, 1986.\n*(10)(H) Equity Incentive Plan of Registrant, as amended - incorporated herein by reference to Exhibit (10)(I) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(10)(I) Tax Allocation Agreement dated December 24, 1986 among Harleysville Insurance Company of New Jersey, Huron Insurance Company, Worcester Insurance Company, McAlear Associates, Inc. and the Registrant - incorporated herein by reference to Exhibit 10(Q) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(10)(J) Amended and Restated Financial Tax Sharing Agreement dated March 20, 1995 among Huron Insurance Company, Harleysville Insurance Company of New Jersey, Worcester Insurance Company, Harleysville-Atlantic Insurance Company, New York Casualty Insurance Company, Connecticut Union Insurance Company, Great Oaks Insurance Company, Lakes States Insurance Company and the Registrant - incorporated herein by reference to Exhibit (10)(L) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n(10)(K) Amendment, effective July 1, 1987, to the Proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey and Atlantic Insurance Company of Savannah - incorporated herein by reference to the Registrant's Form 8-K Report dated July 1, 1987.\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- -----------------------------------------------\n(10)(L) Amendment, effective January 1, 1989, to the Proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey, Atlantic Insurance Company of Savannah and Worcester Insurance Company - incorporated herein by reference to Exhibit 10(U) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(10)(M) Amendment, effective January 1, 1991, to the Proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey, Atlantic Insurance Company of Savannah, Worcester Insurance Company, Phoenix General Insurance Company and New York Casualty Insurance Company - incorporated herein by reference to Exhibit (10)(O) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(10)(N) Amendments, effective January 1, 1995 and 1993, respectively, to the Proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey, Harleysville-Atlantic Insurance Company, Worcester Insurance Company, Connecticut Union Insurance Company, New York Casualty Insurance Company and Great Oaks Insurance Company - incorporated herein by reference to Exhibit (10)(P) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n(10)(0) Amendment, effective January 1, 1996 to the Proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey, Harleysville-Atlantic Insurance Company, Worcester Insurance Company, Connecticut Union Insurance Company, New York Casualty Insurance Company, Great Oaks Insurance Company and Pennland Insurance Company.\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- -----------------------------------------------\n*(10)(P) Long-Term Incentive Plan for senior officers of Harleysville Mutual Insurance Company and Registrant - incorporated herein by reference to Exhibit 10(V) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(10)(Q) Lease effective January 1, 1995 between Harleys- ville, Ltd. and Harleysville Mutual Insurance Company - incorporated herein by reference to Exhibit (10)(R) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n*(10)(R) 1990 Directors' Stock Option Program of Registrant - incorporated herein by reference to Exhibit (10)(R) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n*(10)(S) 1995 Directors' Stock Option Program of Registrant - incorporated herein by reference to Exhibit (10)(S) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(10)(T) Loan Agreement dated as of March 19, 1991 by and between Harleysville Group Inc. and Harleysville Mutual Insurance Company - incorporated herein by reference to Exhibit 10.5 to the Registrant's Form S-3 Registration Statement No. 33-41845 filed September 17, 1991.\n(10)(U) Form of Management Agreements dated January 1, 1994 between Harleysville Group Inc. and Harleysville Mutual Insurance Company, Harleysville-Garden State Insurance Company, Pennland Insurance Company, Berkshire Mutual Insurance Company and Harleysville Life Insurance Company - incorporated herein by reference to Exhibit (10)(U) to the Registrant's Annual Statement on Form 10-K for the year ended December 31, 1993.\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- -----------------------------------------------\n(10)(V) Form of Salary Allocation Agreements dated January 1, 1993 between Harleysville Group Inc. and Harleysville Mutual Insurance Company, Harleysville-Garden State Insurance Company, Pennland Insurance Company, Berkshire Mutual Insurance Company and Harleysville Life Insurance Company - incorporated herein by reference to Exhibit (10)(U) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n(10)(W) Equipment and Supplies Allocation Agreement dated January 1, 1993 between Harleysville Mutual Insurance Company and Harleysville Group Inc. - incorporated herein by reference to Exhibit (10)(V) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n*(10)(X) 1992 Incentive Stock Option Plan for Employees Amended and Restated August 26, 1992 - incorporated herein by reference to Exhibit (10)(W) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n*(10)(Y) Harleysville Group Inc. Supplemental Pension Plan dated May 25, 1994 - incorporated herein by reference to Exhibit (10)(AA) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n(13)(A) Selected Consolidated Financial Data from the Company's 1995 annual report to stockholders.\n(13)(B) Management's Discussion and Analysis of Results of Operations and Financial Condition from the Company's 1995 annual report to stockholders.\n(13)(C) Consolidated financial statements from the Company's 1995 annual report to stockholders.\n(13)(D) Market for Common Stock and Related Security Holder Matters from the Company's 1995 annual report to stockholders.\n(21) Subsidiaries of Registrant.\n(23) Independent Auditors' Consent and Report on Schedules.\nEXHIBIT NO. DESCRIPTION OF EXHIBITS - -------- -----------------------------------------------\n(28) Statement re Registrant.\nP(28)(A) Schedule P, of the 1995 statutory annual statement, for the total pooled business of Harleysville Mutual Insurance Company and the pool participant property and casualty insur- ance subsidiaries of Harleysville Group Inc.\nP(28)(B) Schedule P, of the 1995 statutory annual statement of Lake States Insurance Company.\n(99) Form 11-K Annual Report for the Harleysville Group Inc. Employee Stock Purchase Plan for the year ended December 31, 1995.\n- ---------------- * Management contract or compensatory plan, contract or arrangement filed pursuant to Item 14(c) of this report. P - Filed in paper format pursuant to Rule 311, paragraph (c).\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 report.\nHARLEYSVILLE GROUP SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1995 (in thousands)\nAMOUNT AT WHICH SHOWN IN THE BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ------------------------- ---------- ---------- ----------- Fixed maturities:\nUnited States government and government agencies and authorities $ 124,822 $ 131,998 $ 131,126\nStates, municipalities and political subdivisions 372,727 396,263 383,026\nMortgage-backed securities 111,646 118,815 118,815\nAll other corporate bonds 368,857 392,414 373,474 ---------- ---------- ---------- Total fixed maturities 978,052 1,039,490 1,006,441 ---------- ---------- ---------- Equity securities:\nCommon stocks Public utilities 993 1,323 1,323 Banks, trust and insurance companies 4,053 4,998 4,998 Industrial, miscellaneous and all other 25,301 28,263 28,263 ---------- ---------- ---------- Total equities 30,347 34,584 34,584 ---------- ---------- ---------- Short-term investments 44,126 44,126 ---------- ---------- Total investments $1,052,525 $1,085,151 ========== ==========\nHARLEYSVILLE GROUP INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY CONDENSED BALANCE SHEETS (in thousands, except share data)\nDECEMBER 31, ------------------------ 1995 1994 --------- ---------\nASSETS Cash $ 525 Short-term investments 1,860 $ 464 Fixed maturities: Available for sale, at fair value (cost $12,299 and $22,608) 12,780 20,383 Investments in common stock of subsidiaries (equity method) 422,815 349,410 Accrued investment income 165 333 Due from affiliate 3,109 2,826 Other assets 3,128 2,299 -------- -------- Total assets $444,382 $375,715 ======== ========\nLIABILITIES AND SHAREHOLDERS' EQUITY\nDebt $ 93,500 $ 93,500 Accounts payable and accrued expenses 4,419 3,901 Federal income taxes payable 1,454 1,390 -------- -------- Total liabilities 99,373 98,791 -------- -------- Shareholders' equity: Preferred stock, $1 par value; authorized 1,000,000 shares, none issued Common stock, $1 par value; authorized 23,000,000 shares; shares issued and outstanding 1995, 13,718,086 and 1994, 13,364,062 13,718 13,364 Additional paid-in capital 111,519 103,851 Net unrealized investment gains (losses), net of deferred income taxes 21,207 (7,276) Retained earnings 198,565 166,985 -------- -------- Total shareholders' equity 345,009 276,924 -------- -------- Total liabilities and shareholders' equity $444,382 $375,715 ======== ========\nHARLEYSVILLE GROUP INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY CONDENSED STATEMENTS OF INCOME (in thousands)\nYEAR ENDED DECEMBER 31, ------------------------------------ 1995 1994 1993 -------- -------- -------- Revenues $ 7,528 $ 8,491 $ 5,630 Expenses: Interest 6,526 6,143 1,657 Expenses other than interest 1,386 1,472 1,478 ------- ------- ------- (384) 876 2,495 Income tax expense (benefit) (143) 307 888 ------- ------- ------- Income (loss) before equity in undistributed net income of subsidiaries and cumulative effect of accounting changes (241) 569 1,607\nEquity in undistributed income of subsidiaries before cumulative effect of accounting changes 41,572 17,885 30,614 ------- ------- ------- Income before cumulative effect of accounting changes, net of income taxes 41,331 18,454 32,221\nCumulative effect of accounting changes, net of income taxes (Harleysville Group Inc., ($511)) (281) ------- ------- -------\nNet income $41,331 $18,454 $31,940 ======= ======= =======\nHARLEYSVILLE GROUP INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY CONDENSED STATEMENTS OF CASH FLOWS (in thousands)\nYEAR ENDED DECEMBER 31, ---------------------------------------- 1995 1994 1993 --------- --------- --------- Cash flows from operating activities: Net income $ 41,331 $ 18,454 $ 31,940 Adjustments to reconcile net income to net cash provided (used) by operating activities: Equity in undistributed earnings of subsidiaries (41,572) (17,885) (30,844) Increase (decrease) in accrued investment income 168 88 (189) Increase (decrease) in accrued income taxes (883) 1,260 2,365 (Gain) loss on sale of investments 667 (70) 21 Other, net (737) (1,236) (800) ------- -------- -------- Net cash provided (used) by operating activities (1,026) 611 2,493 ------- -------- -------- Cash flows from investing activities: Fixed maturity investments: Purchases (5,964) (499) (22,717) Sales 15,616 7,937 1,479 Net sales (purchases) or maturities of short-term investments (1,396) (70) (392) Acquisition (44,300) Contributions to subsidiaries (5,000) (6,000) (10,008) -------- -------- -------- Net cash provided (used) by investing activities 3,256 1,368 (75,938) -------- -------- -------- Cash flows from financing activities: Issuance of common stock 8,022 6,712 6,172 Debt proceeds 119,000 Debt repayment (44,000) Dividends from subsidiaries 24 24 24 Dividends paid (9,751) (8,715) (7,751) -------- -------- -------- Net cash provided (used) by financing activities (1,705) (1,979) 73,445 -------- -------- -------- Change in cash 525 - -\nCash at beginning of year - - - -------- -------- --------\nCash at end of year $ 525 $ - $ - ======== ======== ========\nHARLEYSVILLE GROUP SCHEDULE VI - REINSURANCE\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)\nASSUMED PERCENTAGE CEDED FROM OF AMOUNT GROSS TO OTHER OTHER NET ASSUMED AMOUNT COMPANIES COMPANIES AMOUNT TO NET -------- --------- --------- -------- ---------- Year ended December 31, 1995 Property and casualty premiums $426,486 $388,950 $439,506 $477,042 92.1% ======== ======== ======== ======== ======\nYear ended December 31, 1994 Property and casualty premiums $401,495 $373,778 $420,014 $447,731 93.8% ======== ======== ======== ======== ======\nYear ended December 31, 1993 Property and casualty premiums $324,285 $360,727 $424,983 $388,541 109.4% ======== ======== ======== ======== ======\nNote: The amounts ceded and assumed include the amounts ceded and assumed under the terms of the pooling arrangement.\nHARLEYSVILLE GROUP SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)\nLOSSES AND LOSS LIABILITY SETTLEMENT EXPENSES FOR UNPAID DISCOUNT, (BENEFITS) INCURRED LOSSES AND IF ANY, RELATED TO PAID LOSSES ------------------- LOSS DEDUCTED AND LOSS SETTLEMENT FROM CURRENT PRIOR SETTLEMENT EXPENSES RESERVES YEAR YEARS EXPENSES ---------- -------- -------- ------- ----------- Year ended:\nDecember 31, 1995 $645,941 $5,271 $346,383 $(10,887) $294,295 ======== ====== ======== ======== ========\nDecember 31, 1994 $603,088 $5,464 $352,085 $ (3,215) $312,690 ======== ====== ======== ======== ========\nDecember 31, 1993 $560,811 $5,243 $283,526 $ 252 $254,682 ======== ====== ======== ======== ========\nNotes: (1) The amount of discount relates to certain long-term disability workers' compensation cases. A discount rate of 3.5% (5% on New Jersey cases) was used.\n(2) Information required by remaining columns is contained in Schedule V.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nHARLEYSVILLE GROUP INC.\nDate: March 27, 1996 By: \/s\/WALTER R. BATEMAN -------------------------------- Walter R. Bateman President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE - ----------------------- ------------------------- ---------------\nChairman of the Board \/s\/BRADFORD W. MITCHELL and a Director March 27, 1996 - ----------------------- Bradford W. Mitchell\nPresident, Chief Executive Officer \/s\/WALTER R. BATEMAN and a Director March 27, 1996 - ---------------------- Walter R. Bateman\nSenior Vice President and Chief Financial Officer (principal financial officer and principal \/s\/BRUCE J. MAGEE accounting officer) March 27, 1996 - ---------------------- Bruce J. Magee\nSIGNATURES (Continued)\nSIGNATURE TITLE DATE - ----------------------- ------------------------- --------------\n\/s\/MICHAEL L. BROWNE Director March 27, 1996 - ---------------------- Michael L. Browne\nDirector March , 1996 - ---------------------- Robert D. Buzzell\nDirector March , 1996 - ---------------------- Gerard G. Johnson\nDirector March , 1996 - ---------------------- H. Bryce Jordan\n\/s\/JOHN J. KEENAN Director March 27, 1996 - ---------------------- John J. Keenan\n\/s\/FRANK E. REED Director March 27, 1996 - ---------------------- Frank E. Reed\n\/s\/WILLIAM E. STRASBURG Director March 27, 1996 - ----------------------- William E. Strasburg\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION OF EXHIBITS ------- -----------------------------------------------\n(10)(O) Amendment, effective January 1, 1996 to the proportional Reinsurance Agreement effective January 1, 1986 among Harleysville Mutual Insurance Company, Huron Insurance Company, Harleysville Insurance Company of New Jersey, Harleysville-Atlantic Insurance Company, Worcester Insurance Company, Connecticut Union Insurance Company, New York Casualty Insurance Company, Great Oaks Insurance Company and Pennland Insurance Company.\n(13)(A) Selected Consolidated Financial Data from the Company's 1995 annual report to stockholders.\n(13)(B) Management's Discussion and Analysis of Results of Operations and Financial Condition from the Company's 1995 annual report to stockholders.\n(13)(C) Consolidated financial statements from the Company's 1995 annual report to stockholders.\n(13)(D) Market for Common Stock and Related Security Holder Matters from the Company's 1995 annual report to stockholders.\n(21) Subsidiaries of Registrant.\n(23) Independent Auditors' Consent and Report on Schedules.\n(28) Statement re Registrant\n(99) Form 11-K Annual Report for the Harleysville Group Inc. Employee Stock Purchase Plan for the year ended December 31, 1995.","section_15":""}
{"filename":"85973_1995.txt","cik":"85973","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nEstablished in 1911, Rykoff-Sexton, Inc., (the \"Company\") is a leading broadline distributor of high quality food and related non-food products for the foodservice industry throughout the United States. The Company distributes its product line of approximately 41,000 items to restaurants, industrial cafeterias, healthcare facilities, hotels, schools and colleges, supermarket service delicatessen departments and other establishments where food is prepared or consumed away from home. It also offers design and engineering services for all types of foodservice operations through its contract\/design group. The Company's products consist of a broad line of private label and national branded food and foodservice equipment and supplies. The Company's proprietary private label products accounted for approximately 56% of the Company's net sales in fiscal 1995. The Company develops and manufactures many of its private label products, and it also manufactures other products for certain customers under their own brand labels.\nThe Company's principal operations are conducted through the Rykoff- Sexton Distribution Division (the \"Distribution Division\"), the Rykoff-Sexton Manufacturing Division (the \"Manufacturing Division\") and San Francisco International Cheese Imports (\"San Francisco International Cheese Imports\").\nDISTRIBUTION DIVISION\nThe Distribution Division is comprised of 25 distribution branches and eight additional sales offices that are largely located in major metropolitan areas throughout the United States. The Distribution Division also offers design and engineering services for all types of foodservice operations through its ten contract\/design offices. In fiscal 1995, sales of the Distribution Division (including products sold through this division by the Manufacturing Division and San Francisco International Cheese Imports) generated approximately 99% of the Company's net sales.\nMANUFACTURING DIVISION\nAt its four plants, the Manufacturing Division manufactures products primarily under the Company's proprietary private labels and also manufactures products for other manufacturers, distributors, restaurant chains and other large users under their own brand labels. Approximately 90% of the Manufacturing Division's products are sold through the Distribution Division, and the remainder are sold directly to customers.\nSAN FRANCISCO INTERNATIONAL CHEESE IMPORTS\nThe Company also has a smaller division, San Francisco International Cheese Imports, which distributes domestic and imported cheeses and specialty and gourmet products both through the Distribution Division and directly to customers.\nPRODUCTS\nThe Company offers to the foodservice industry a single source of supply for approximately 41,000 private label and national branded items that are distributed to approximately 100,000 foodservice establishments. The principal product lines are:\nFOOD PRODUCTS\nThe Company's food products include canned fruits and vegetables, tomatoes and tomato products, juices, relishes and pickle products, dry package foods, syrups, dressings and salad oils, baking supplies, extracts and colors, spices, condiments, seasonings and sauces, jellies and preserves, coffee, tea and fountain goods, prepared convenience entrees, meats, desserts and puddings, dietary foods, imported and domestic cheeses and specialty and gourmet items. Frozen foods include soups, prepared convenience entrees, bakery products, fruits and vegetables, desserts, frozen meat, chicken and fish and other frozen products customarily distributed to the foodservice industry.\nJANITORIAL AND PAPER PRODUCTS\nThe Company's non-food products include janitorial supplies such as detergents and cleaning compounds; plastic products such as refuse container liners, cutlery, straws and sandwich bags; and paper products such as napkins, cups, hats, placemats, coasters and lace doilies.\nEQUIPMENT AND SUPPLIES\nThe Company also distributes smallware restaurant equipment and supply items, including cookware, glassware, dinnerware and other commercial kitchen equipment.\nThe Company's products include approximately 1,400 food and 900 non- food items that are manufactured, processed and packaged at its four plants located in Los Angeles, California; Indianapolis, Indiana; Englewood, New Jersey; and Brooklyn, New York. These products are primarily manufactured under the Company's private labels. The Company also manufactures products for certain customers such as other manufacturers, distributors, restaurant chains and other large users under their own brand labels.\nThe Manufacturing Division's food products include mayonnaise and salad dressings, oils, margarine and shortenings, gelatins and dessert powders, vinegars, sauces, pancake and waffle mixes, biscuit and flour mixes, soup bases, jams and jellies, canned and frozen soups, canned and frozen entrees, relishes and tea. Its non-food products include detergents, cleaning compounds, refuse container liners, cutlery, straws and sandwich bags, paper napkins, placemats, chefs' hats, coasters, paper lace doilies and a line of low temperature dishwashers.\nIn addition to its extensive product line, the Company's contract\/design group has ten offices that provide design and engineering services and equipment installations for restaurants and other foodservice establishments.\nMARKETING AND DISTRIBUTION\nThe Company markets its products and contract\/design services to customers in the foodservice industry, including restaurants, industrial cafeterias, healthcare facilities, hotels, schools and colleges, airlines, clubs, supermarket service delicatessen departments and other establishments where food is prepared or consumed away from home.\nThe following table sets forth the approximate customer base of the Company for the fiscal year ended April 29, 1995:\nNo customer of the Company accounted for as much as two percent of the Company's sales for the fiscal year ended April 29, 1995. No product distributed by the Company accounts for a material part of the Company's sales volume. The Company does not experience material seasonal variations in its sales volume.\nThe Company believes that product quality, close contact with customers, prompt and accurate delivery of orders, and the ability to provide related services are of primary importance in the distribution of products to the foodservice industry. Sales offices are maintained at each of the Company's 25 distribution branches and eight additional locations as listed in the table below. The Company's sales force of approximately 1,600 employees includes\nfoodservice specialists from the Distribution Division who are organized by region and who are each assigned to a distribution branch. The sales force also includes account executives who handle multi-unit accounts such as restaurant chains and other large users. In addition to soliciting orders, sales personnel are trained to advise customers on menu selection, methods of preparing and serving food, merchandising techniques, unit cost controls and other operating procedures.\nProducts are distributed to customers nationwide through the Company's 25 distribution branches listed in the table below, as well as through independent distributors. With the exception of an equipment and supply branch, each branch stocks a broad line of between 5,900 and 15,000 items for sale in its marketing area. Customer orders are usually processed and shipped within 24 hours of receipt and are delivered directly to the customer. The Company uses its warehouse facilities in Los Angeles, Indianapolis and Dorsey, Maryland to store and consolidate product orders from vendors for subsequent shipment to the distribution branches.\nInternational sales presently account for less than two percent of the Company's total sales. However, the Company believes that the potential for growth in sales to foreign markets is significant, and it is exploring selected opportunities to further develop this segment of its business. The Company currently exports products to the Pacific Rim countries, Micronesia, Canada, the Caribbean, Mexico, Europe, South America and Australia.\nSOURCES OF SUPPLY\nThe Company purchases from approximately 7,500 suppliers. No supplier represented more than two percent of the Company's purchases in fiscal 1995. These suppliers, which include both large multi-line and smaller specialty processors and packagers, are selected primarily on the basis of their ability to meet the Company's quality standards. The Company has no significant long- term purchasing obligations and believes that it has adequate alternative sources of supply for almost all of the purchased items and raw materials used in its manufacturing operations.\nQUALITY CONTROL AND REGULATION\nThe Company maintains quality control laboratories in its Los Angeles, Indianapolis and Englewood facilities. These laboratories are staffed by chemists and food technologists who are trained to control product quality for both self-manufactured and purchased private label products and to provide research and development support for the Company's manufactured products. Quality control procedures include the sampling and testing of raw materials, purchased private label products and Company manufactured items for quality, taste and appearance and the microbiological testing of Company manufactured food items.\nEMPLOYEES\nAs of April 29, 1995, the Company employed a total of approximately 5,400 people, of whom approximately 1,900 were covered by collective bargaining agreements. These agreements expire at various times over the next several years. The Company believes its labor relations are good.\nCOMPETITION\nThe Company operates on a nationwide basis and encounters significant competition from a number of sources in each of its marketing areas. The Company competes with two other large national distribution companies, Sysco Corporation and Kraft Foodservice Group, both of which have substantially greater financial and other resources than the Company. The Company also competes with numerous regional and local distributors that offer broad lines of products. In recent years, the foodservice distribution industry has been characterized by significant consolidation and the emergence of larger competitors, principally through acquisitions. There can be no assurances that the Company will not encounter increased competition in the future, which could adversely affect the Company's business.\nThe Company believes that although price is a consideration, competition in the foodservice industry is generally on the basis of product quality, customer relations and service. As one of the leading national broadline distributors to the foodservice industry, the Company believes that it carries a wider selection of food products of superior quality and value and a greater variety of package sizes than most of its competitors. The Company attributes its ability to compete effectively in its markets to this wider food product selection and its broad line of related non-food products, which are offered through a dedicated, highly skilled and customer-oriented sales force. Further, the Company differentiates itself in part from its competitors by (i) providing many specialty products that have been developed specifically for the foodservice industry or for particular foodservice customers, (ii) maintaining an extensive selection of imported and specialty products, equipment and supplies and (iii) offering its design and engineering services for all types of foodservice operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company relocated its corporate headquarters from its owned property in Los Angeles, California to a leased facility in Lisle, Illinois, where the Distribution Division headquarters is also situated. Both the corporate headquarters and executive offices of the Distribution Division occupy approximately 54,500 square feet pursuant to a lease which expires in November 2001.\nThe Company's owned property in Los Angeles, California continues to house the Manufacturing Division headquarters, a large manufacturing plant and a warehouse that is used to store and consolidate product orders from vendors. The property consists of four buildings with approximately 1.4 million square feet of space on 20.2 acres. In June 1995, the Company relocated the Los Angeles distribution branch to a new facility of approximately 420,000 square feet in La Mirada, California.\nIn addition to the manufacturing plant located on the Los Angeles property, the Company owns and operates manufacturing plants totaling 234,000 square feet in Indianapolis, Indiana and Englewood, New Jersey. The Company also leases approximately 32,000 square feet in Brooklyn, New York for office, warehouse and manufacturing facilities. The lease on this property expires in August 1996.\nEquipment and machinery owned by the Company and used in its operations consist principally of electronic data processing equipment, food and non-food processing and packaging equipment and chemical compounding, blending and product handling equipment. The Company owns a fleet of approximately 870 vehicles consisting of tractors, trailers, vans and bobtails, which are used for long hauls and local deliveries. In addition, the Company leases approximately 700 delivery vehicles under terms which expire at various dates through 2000.\nDuring fiscal year 1995, the Company completed expansions of its Greensboro, North Carolina, and Detroit, Michigan Branches, primarily with new freezers and coolers, which doubled both of their capacities. At present, the Company is completing the consolidation of its Capitol Branch into the recently acquired 230,000 square foot Continental Foods facility in Baltimore, Maryland and is also completing construction of a new 183,000 square foot distribution center in Cincinnati, Ohio. In addition, the Company recently acquired an 86,400 square foot distribution center in St. Louis, Missouri for relocation of its present St. Louis Branch. This will allow the St. Louis Branch to more than double its capacity for growth. The Company expects to complete the sale of the old facility at the time the St. Louis Branch moves into the new facility in August 1995.\nThe Company considers that its office, warehouse and manufacturing facilities are adequate to support present and immediately foreseeable future operations. However, the Company continues to locate and occupy new facilities because of its expanding business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nReference is made to discussions with respect to legal proceedings in which the Company is a party thereto, as set forth on page 20 of the Company's 1995 Annual Report to shareholders, and by such reference, such information is integrated therein.\n(THE REMAINDER OF THIS PAGE HAS BEEN LEFT BLANK.)\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nCORPORATE EXECUTIVE OFFICERS\nThe following are the corporate executive officers of the Company:\nAll of the executive officers serve in their capacities by approval of the Board of Directors. Each executive officer has, as his principal occupation, been employed by the Company in the capacities set forth or in similar capacities for more than the last five years, except as follows: Mr. Neil I. Sell's principal occupation has been as a partner in the law firm of Maslon Edelman Borman & Brand, a Professional Limited Liability Partnership; Mr. Mark Van Stekelenburg was elected Executive Vice President in 1991 and President and Chief Executive Officer in 1992; Mr. Richard J. Martin was elected Vice President in 1988 and Senior Vice President and Chief Financial Officer in 1993; Mr. Robert J. Harter, Jr. was elected Vice President and General Counsel in 1989 and Senior Vice President, Human Resources and General Counsel in 1993; Mr. Alan V. Giuliani was elected Vice President in 1990 and President, Rykoff-Sexton Manufacturing Division in 1992; Mr. Harold E. Feather was elected President, Rykoff-Sexton Distribution Division in 1992 and Executive Vice President, Corporate Planning in 1994; Mr. Donald E. Willis, Jr. was elected Senior Vice President and Chief Information Officer in 1994; and Mr. Gary L. Cooper was elected President, Rykoff-Sexton Distribution Division in 1994.\nMr. Van Stekelenburg joined the Company in March 1991 and was previously, since 1986, President and Chief Executive Officer of G.V.A. and Kok-Ede, the foodservice division of Royal Ahold, N.V., the largest food retailer in the Netherlands which also has substantial holdings in food retailing in the United States. Mr. Martin joined the Company in August 1988 and was previously a partner with the accounting firm of Arthur Andersen LLP; he had been associated with that firm for twenty-one years. Mr. Harter joined the Company in October 1989 and was previously Senior Vice President, General Counsel and Secretary for Tiger International, Inc. He had been an officer of Tiger International, Inc. for eleven years. Mr. Giuliani joined the Company in August 1990. Previously, Mr. Giuliani was employed by Mars, Inc., a food manufacturer, where he held various senior management positions including Vice President-Research and Development\/Engineering for the Dove International Division, and Vice President-New Business Development and Vice President-Plant Manager for the M&M\/Mars Division. Mr. Harold E. Feather joined the Company in 1983 when the Company acquired John Sexton & Co. He has held various positions within the Company and was elected Executive Vice President, Corporate Planning in 1994; his most recent previous position was President, Rykoff-Sexton Distribution Division, which he held since 1992. Mr. Donald E. Willis, Jr. joined the Company in January 1994, and previously served in several management information systems positions with other companies, the most recent of which was at HomeBase, a California-based specialty retailer. Mr. Gary L. Cooper joined the Company in October 1994, after thirty-two years with American Hospital Supply Corporation and Baxter International. He was a corporate officer and President of the Baxter Hospital Supply Division.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nReference is made to the information with respect to the principal markets on which the Company's common stock is being traded, prices for each quarterly period and dividend record for the last three years set forth on page 1 of the Company's 1995 Annual Report to shareholders, and by such reference, such information is incorporated herein.\nThe Company estimates that there are approximately 8,300 shareholders including those through nominees, as of June 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to the financial data with respect to the Company set forth on pages 6 and 7 of the Company's 1995 Annual Report to shareholders and by such reference, such financial data is incorporated herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to Management's Discussion and Analysis set forth on pages 8 and 9 of the Company's 1995 Annual Report to shareholders, and by such reference, such information is incorporated herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the consolidated financial statements set forth on pages 10 through 21 of the Company's 1995 Annual Report to shareholders, and by such reference, such information is incorporated herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nReference is made to the definitive proxy statement pursuant to Regulation 14A, which involves the election of directors at the annual meeting of shareholders to be held September 15, 1995 and will be filed with the Commission within 120 days after the close of its fiscal year ended April 29, 1995, and by such reference said proxy statement is incorporated herein in response to the information called for by Part III (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 financial statements listed below are filed as part of this Annual Report on Form 10-K:\nPage Reference -------------- Form Annual 10-K Report ---- ------ Data is incorporated by reference from the attached Annual Report to shareholders of Rykoff-Sexton, Inc. for the fiscal year ended April 29, 1995. With the exception of the information specifically incorporated herein by reference, the 1995 Annual Report to shareholders is not to be deemed \"filed\" as part of this Annual Report on Form 10-K.\nConsolidated statements of operations for each of the three years in the period ended April 29, 1995 10\nConsolidated balance sheets as of April 29, 11 1995 and April 30, 1994\nConsolidated statements of cash flows for each of the three years in the period ended April 29, 1995 12\nConsolidated statements of shareholders' equity for each of three years in the period ended April 29, 1995 13\nNotes to consolidated financial statements 14-21\nReport of independent public accountants 22\nAttachments incorporated herewith to Form 10-K:\nReport of independent public accountants on supplemental schedules to the consolidated financial statements 17\nPage Reference -------------- Form Annual 10-K Report ---- ------ (2) Supplemental Schedules incorporated herewith to Form 10-K:\nSchedule II - Valuation and qualifying accounts for each of the three years in the period ended April 29, 1995 18\n(3) The following exhibits, as required by Item 601 of Regulation S-K, are filed as part of this report:\n3.1 Restated Certificate of Incorporation of Rykoff-Sexton, Inc. (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n3.2 Rykoff-Sexton, Inc. By-Laws (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n4.1 Indenture, dated as of November 1, 1993, between Rykoff- Sexton, Inc. and Norwest Bank Minnesota, N.A., as trustee (Incorporated by reference from the Company's report Form 10-Q for the quarter ended October 30, 1993)\n4.2 Rights Agreement, dated December 8, 1986 between Rykoff- Sexton, Inc. and Bank of America National Trust and Savings Association (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended May 1, 1993, as amended)\n4.2.1 Amendment, dated as of October 5, 1989 to Rights Agreement, dated December 8, 1986, between Rykoff-Sexton, Inc. and Bank of America National Trust and Savings Association, as Rights Agent (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended October 30, 1993)\n10.1 Credit Agreement dated October 25, 1993 between Rykoff- Sexton, Inc. and Bank of America National Trust and Savings Association (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended October 30, 1993)\n10.1.1 First Amendment to Credit Agreement between Rykoff-Sexton, Inc. and Bank of America National Trust and Savings Association dated as of December 29, 1993; (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended January 29, 1994)\n10.1.2 Second through Fourth Amendments to Credit Agreement between Rykoff-Sexton, Inc. and Bank of America National Trust and Savings Association dated as of March 18, 1994; April 15, 1994; and April 30, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)\n10.1.3 Fifth Amendment to Credit Agreement between Rykoff-Sexton, Inc. and Bank of America National Trust and Savings Association, dated as of August 29, 1994 (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended July 30, 1994)\n10.1.4 Sixth Amendment to Credit Agreement between Rykoff-Sexton, Inc. and Bank\nof America National Trust and Savings Association dated as of September 30, 1994 (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended October 29, 1994)\n10.2 Final Amendment to Employment Contract and Settlement Agreement dated March 8, 1993 between Roger W. Coleman and Rykoff-Sexton, Inc. (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.3 1980 Stock Option Plan (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.4 1988 Stock Option and Compensation Plan, as amended on September 13, 1991 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.4.1 Form of Restricted Stock Agreement (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.4.2 Form of Non-Qualified Stock Option Agreement (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.4.3 Form of Converging Non-Qualified Stock Option Agreement (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.5 1989 Director Stock Option Plan (Incorporated by reference from the Company's Report on Form 10-K for the year ended April 28, 1990)\n10.6 Junior Demand Promissory Note dated March 31, 1995 by Mark Van Stekelenburg and Mirjam Van Stekelenburg\n10.7 Form of Change in Control Agreements (Incorporated by reference from the Company's Report on 10-K for the year ended April 28, 1990)*\n10.7.1 Change in Control Agreement for Mark Van Stekelenburg (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.7.2 Change in Control Agreement for Harold Feather (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)*\n10.7.3 Amended and Restated Change in Control Agreement, dated October 12, 1993 between Rykoff-Sexton, Inc. and Mark Van Stekelenburg (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended October 30, 1993)\n10.8 Form of Indemnity Agreement (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.9 Form of Fiduciary Indemnity Agreement (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.10 Agreement between S.E. Rykoff and Co. and Food Drug and Beverage Warehousemen and Clerical Employees Union, Local No. 630, International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America, Independent dated as of April 30, 1992 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.11 Agreement between Rykoff-Sexton, Inc. and Union Local No. 630, International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America dated as of October 23, 1992 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.12 Agreement between Rykoff-Sexton, Inc. and Union Locals 848, 14, 87, 381 and 542, International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America dated as of October 23, 1992 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.13 Agreement between Rykoff-Sexton, Inc. and Union Local No. 78, Teamsters Warehouse, Automotive and Miscellaneous Employees dated as of April 1, 1991 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.14 Agreement between Rykoff-Sexton, Inc. and Union Local No. 85, Brotherhood of Teamsters and Auto Truck Drivers dated as of April 1, 1991 (Incorporated by reference from the Company's report on Form 10-K for the year ended May 1, 1993, as amended)\n10.15 Rykoff-Sexton, Inc. 1993 Director Stock Option (Incorporated by reference from the Company's report on Form 10-Q for the quarter ended October 30, 1993)\n10.16 Participation Agreement, entered into among Rykoff-Sexton, Inc., as Lessee (\"Lessee\"), Tone Brothers, Inc., as Sublessee (\"Sublessee\"), BAS Leasing & Capital Corporation, as Agent (\"Agent\"), and BA Leasing & Capital Corporation, Manufacturers Bank and Pitney Bowes Credit Corporation, as Lessors (the \"Lessors\"), dated as of April 29, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)\n10.16.1 Lease Intended as Security, among Lessee, Agent and the Lessors, dated as of April 29, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)\n10.16.2 Sublease, between Lessee and Sublessee, dated as of April 29, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)\n10.16.3 Lease supplement, among Lessee and the Lessors, dated as of April 29, 1994\n10.16.4 Lease supplement, among Lessee and the Lessors, dated as of January 27, 1995\n10.16.5 Lease supplement, among Lessee and the Lessors, dated as of April 18, 1995\n10.17 Employment Agreement between Harold E. Feather and Rykoff- Sexton, Inc. as of June 20, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)*\n10.18 Employment Agreement between Rykoff-Sexton, Inc. and Mark Van Stekelenburg as of July 20, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)*\n10.19 Rykoff-Sexton, Inc. Supplemental Executive Retirement Plan for Mark Van Stekelenburg as of July 20, 1994 (Incorporated by reference from the Company's report on Form 10-K for the fiscal year ended April 30, 1994)*\n13 1995 Annual Report to Shareholders\n21 Subsidiaries of Rykoff-Sexton, Inc.\n24.1 Power of Attorney of R. Burt Gookin\n24.2 Power of Attorney of James I. Maslon\n24.3 Power of Attorney of James P. Miscoll\n24.4 Power of Attorney of Neil I. Sell\n24.5 Power of Attorney of Bernard Sweet\n24.6 Power of Attorney of Robert G. Zeller\n27 Financial Data Schedule\n* Management contract or compensatory plan\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(b) Reports on Form 8-K\nDuring the fourth quarter of fiscal year 1995, the Company filed a Form 8K dated February 21, 1995 reporting the following items:\nItem 2. Acquisition or Disposition of Assets.\nItem 7. Financial Statements, Pro Forma Financial Information and Exhibits.\n(THE REMAINDER OF THIS PAGE HAS BEEN LEFT BLANK.)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Rykoff-Sexton, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: July 27, 1995 RYKOFF-SEXTON, INC.\nBy \/s\/ Mark Van Stekelenburg ---------------------------------- Mark Van Stekelenburg President and Chief Executive Officer\nBy \/s\/ Richard J. Martin ---------------------------------- Richard J. Martin Senior Vice President and Chief Financial Officer\nBy \/s\/ Victor B. Chavez ---------------------------------- Victor B. Chavez 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 directors on behalf of the Registrant on the date indicated.\nR. Burt Gookin\nJames I. Maslon \/s\/ Mark Van Stekelenburg James P. Miscoll ------------------------------- Mark Van Stekelenburg, signing Neil I. Sell personally as a director and as attorney in fact for the directors Bernard Sweet whose names appear opposite.\nRobert G. Zeller July 27, 1995\nPowers of attorney authorizing Mark Van Stekelenburg, Richard J. Martin and Victor B. Chavez, and each of them, to sign this Annual Report on Form 10-K on behalf of the above named directors of Rykoff-Sexton, Inc. have been filed as an exhibit to this report.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Rykoff-Sexton, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Rykoff-Sexton, Inc.'s Form 10-K and have issued our report thereon dated June 9, 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.(a)(2) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the 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\nLos Angeles, California June 9, 1995\nRYKOFF-SEXTON, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED APRIL 29, 1995\nExhibit No. Description - ----------- -----------\n10.6 Junior Demand Promissory Note dated March 31, 1995 by Mark Van Stekelenburg and Mirjam Van Stekelenburg 10.16.3 Lease supplement, among Lessee and the Lessors, dated as of April 29, 1994 10.16.4 Lease supplement, among Lessee and the Lessors, dated as of January 27, 1995 10.16.5 Lease supplement, among Lessee and the Lessors, dated as of April 18, 1995 13 Selected Portions of 1995 Annual Report to Shareholders 21 Subsidiaries of Rykoff-Sexton, Inc. 24.1 Power of Attorney of R. Burt Gookin 24.2 Power of Attorney of James I. Maslon 24.3 Power of Attorney of James P. Miscoll 24.4 Power of Attorney of Neil I. Sell 24.5 Power of Attorney of Bernard Sweet 24.6 Power of Attorney of Robert G. Zeller 27 Financial Data Schedule","section_15":""}
{"filename":"77476_1995.txt","cik":"77476","year":"1995","section_1":"ITEM 1. BUSINESS\nPepsiCo, Inc. (the \"Company\") was incorporated in Delaware in 1919 and was reincorporated in North Carolina in 1986. Unless the context indicates otherwise, when used herein the term \"PepsiCo\" shall mean the Company and its various divisions and subsidiaries. PepsiCo is engaged in the following businesses: beverages, snack foods and restaurants.\nBEVERAGES\nPepsiCo's beverage business consists of Pepsi-Cola North America (\"PCNA\") and Pepsi-Cola International (\"PCI\").\nPCNA manufactures and sells beverage products, primarily soft drinks and soft drink concentrates, in the United States and Canada. PCNA sells its concentrates to licensed bottlers (\"Pepsi-Cola bottlers\"). Under appointments from PepsiCo, bottlers manufacture, sell and distribute, within defined territories, soft drinks and syrups bearing trademarks owned by PepsiCo, including PEPSI-COLA, DIET PEPSI, MOUNTAIN DEW, SLICE, MUG, ALL SPORT and, within Canada, 7UP and DIET 7UP (the foregoing are sometimes referred to as \"Pepsi-Cola beverages\"). The Pepsi\/Lipton Tea Partnership, a joint venture of PCNA and Thomas J. Lipton Co., develops and sells tea concentrate to Pepsi-Cola bottlers and develops and markets ready-to-drink tea products under the LIPTON trademark. Such products are distributed by Pepsi-Cola bottlers throughout the United States and Canada. Pepsi-Cola bottlers distribute single-serve sizes of OCEAN SPRAY juice products throughout the United States pursuant to a distribution agreement.\nPepsi-Cola beverages are manufactured in approximately 200 plants located throughout the United States and Canada. PCNA operates approximately 70 plants, and manufactures, sells and distributes beverages throughout approximately 160 licensed territories, accounting for approximately 56% of the Pepsi-Cola beverages sold in the United States and Canada. Approximately 130 plants are operated by independent licensees or joint ventures in which PCNA participates, which manufacture, sell and distribute approximately 44% of the Pepsi-Cola beverages sold in the United States and Canada. PCNA has a minority interest in 7 of these licensees, comprising approximately 70 licensed territories.\nPCI manufactures and sells beverage products, primarily soft drinks and soft drink concentrates outside the United States and Canada. PCI sells its concentrates to Pepsi-Cola bottlers. Under appointments from PepsiCo, bottlers manufacture, sell and distribute, within defined territories, beverages bearing PEPSI-COLA, 7UP, MIRINDA, DIET PEPSI, PEPSI MAX, MOUNTAIN DEW, TEEM, DIET 7UP and other trademarks. There are approximately 590 plants outside the United States and Canada bottling PepsiCo's beverage products. These products are available in 192 countries and territories outside the United States and Canada. Principal international markets include Mexico, Saudi Arabia, Brazil, Argentina, Venezuela, Thailand, Spain, the United Kingdom, China and Japan.\nPCNA and PCI make programs available to assist licensed bottlers in servicing markets, expanding operations and improving production methods and facilities. PCNA and PCI also offer assistance to bottlers in the distribution, advertising and marketing of PepsiCo's beverage products and offer sales assistance through special merchandising and promotional programs and by training bottler personnel. PCNA and PCI maintain control over the composition and quality of beverages sold under PepsiCo trademarks.\nSNACK FOODS\nPepsiCo's snack food business consists of Frito-Lay North America (\"Frito-Lay\") and PepsiCo Foods International (\"PFI\").\nFrito-Lay manufactures and sells a varied line of salty snack foods throughout the United States and Canada, including LAY'S (in the United States) and RUFFLES brands potato chips, DORITOS and TOSTITOS brands tortilla chips, FRITOS brand corn chips, CHEEoTOS brand cheese flavored snacks, ROLD GOLD brand pretzels and SUNCHIPS brand multigrain snacks.\nFrito-Lay's products are transported from its manufacturing plants to major distribution centers, principally by company-owned trucks. Frito-Lay utilizes a \"store-door-delivery\" system, whereby its approximately 16,000 person sales force delivers the snacks directly to the store shelf. This system permits Frito-Lay to work closely with approximately 470,000 retail trade customers weekly and to be responsive to their needs. Frito-Lay believes this form of distribution is a valuable marketing tool and is essential for the proper distribution of products with a short shelf life.\nPFI manufactures and markets snack foods in 38 countries outside the United States and Canada through company-owned facilities and joint ventures. On most of the European continent, PepsiCo's snack food business consists of Snack Ventures Europe, a joint venture between PepsiCo and General Mills, Inc., in which PepsiCo owns a 60% interest. PFI also sells a variety of snack food products which appeal to local tastes including, for example WALKERS snack foods, which are sold in the United Kingdom, WEDEL sweet snacks, which are sold in Poland and GAMESA cookies and ALEGRO (formerly SONRICS) sweet snacks, which are sold in Mexico. In addition, RUFFLES, CHEEoTOS, DORITOS, FRITOS and SUNCHIPS salty snack foods have been introduced to international markets. Principal international markets include Mexico, the United Kingdom, Poland, Brazil, Spain, France, the Netherlands, and Australia.\nRESTAURANTS\nPepsiCo's restaurant business principally consists of Pizza Hut North America (\"PHNA\"), Taco Bell North America (\"TBNA\"), KFC North America (\"KFCNA\") and PepsiCo Restaurants International (\"PRI\").\nPHNA is engaged principally in the operation, development, franchising and licensing of a system of casual full service family restaurants, delivery\/carryout units and kiosks throughout the United States and Canada, operating under the name PIZZA HUT. The full service restaurants serve several varieties of pizza as well as pasta, salads and sandwiches. PHNA (through its subsidiaries and affiliates) operates approximately 5,100 PIZZA HUT restaurants, delivery\/carryout units and other outlets and approximately 240 in Canada. Franchisees operate approximately 2,800 additional restaurants, delivery\/carryout units and other outlets in the United States and approximately 160 in Canada. Licensees operate approximately 860 kiosk outlets in the United States and approximately 115 kiosk outlets in Canada.\nTBNA is engaged principally in the operation, development, franchising and licensing of a system of fast-service restaurants serving carryout and dine-in moderately priced Mexican-style food, including tacos, burritos, taco salads and nachos, throughout the United States and Canada, operating under the name TACO BELL. TBNA (through its subsidiaries and affiliates) operates approximately 3,000 TACO BELL outlets in the United States and approximately 85 in Canada. Franchisees operate approximately 1,800 additional units in the United States. Licensees operate approximately 1,600 special concept outlets in the United States and approximately 25 in Canada.\nKFCNA is engaged principally in the operation, development, franchising and licensing of a system of carryout and dine-in restaurants featuring chicken throughout the United States and Canada, operating under the names KENTUCKY FRIED CHICKEN and\/or KFC. KFCNA (through its subsidiaries and\/or affiliates) operates approximately 2,000 restaurants in the United States and approximately 250 in Canada. Franchisees operate approximately 3,000 additional restaurants in the United States and approximately 580 in Canada. Licensees operate approximately 110 outlets in the United States and approximately 50 in Canada.\nPRI is engaged principally in the operation and development of casual dining and fast-service restaurants, delivery units and kiosks which sell PIZZA HUT, KFC and, to a lesser extent, TACO BELL products outside the United States and Canada. PRI operates approximately 925 PIZZA HUT restaurants, delivery\/carryout units and kiosks, franchisees operate approximately 1,350 units, and joint ventures in which PRI participates operate approximately 535 units. PIZZA HUT units are located in a total of 81 countries and territories outside of the United States and Canada, and principal markets include Australia, the United Kingdom, Brazil, France, Germany, Korea, Spain, Belgium, Puerto Rico and Poland. PRI also operates approximately 915 KFC restaurants and kiosks, franchisees operate approximately 2,300 restaurants and kiosks, and joint ventures in which PRI participates operate approximately 395 restaurants and kiosks. KFC units are located in 67 countries and territories outside of the United States and Canada, and principal markets include Japan, Australia, the United Kingdom, South Africa, New Zealand, China, Singapore, Puerto Rico, Thailand and Mexico. PRI also operates approximately 25 TACO BELL outlets, and franchisees and licensees operate approximately 45 outlets, in a total of 16 countries and territories outside of the United States and Canada.\nPepsiCo also owns, operates, or participates as a joint venturer in other restaurant concepts in the United States. PHNA operates approximately 100 D'ANGELO SANDWICH SHOPS and franchisees operate approximately 55 additional outlets. TBNA also operates approximately 70 CHEVYS Mexican restaurants. PepsiCo participates in a joint venture which operates approximately 80 CALIFORNIA PIZZA KITCHEN restaurants.\nPFS, a division of PepsiCo, is engaged in the distribution of food, supplies and equipment and in providing services to approximately 17,000 company-operated, franchised and licensed PIZZA HUT, TACO BELL and KFC restaurants in the United States, Canada, Mexico, Puerto Rico and Poland.\nCOMPETITION\nAll of PepsiCo's businesses are highly competitive. PepsiCo's beverages and snack foods compete in the United States and internationally with widely distributed products of a number of major companies that have plants in many of the areas PepsiCo serves, as well as with private label soft drinks and snack foods and with the products of local and regional manufacturers. PepsiCo's restaurants compete in the United States and internationally with other restaurants, restaurant chains, food outlets and home delivery operations. PFS competes in the United States and internationally with other food distribution companies. For all of PepsiCo's industry segments, the main areas of competition are price, quality and variety of products, and customer service.\nEMPLOYEES\nAt December 30, 1995, PepsiCo employed, subject to seasonal variations, approximately 480,000 persons (including approximately 290,000 part-time employees), of whom approximately 358,409 (including 235,959 part-time employees) were employed within the United States. PepsiCo believes that its relations with employees are generally good.\nRAW MATERIALS AND OTHER SUPPLIES\nThe principal materials used by PepsiCo in its beverage, snack food and restaurant businesses are corn sweeteners, sugar, aspartame, flavorings, vegetable and essential oils, potatoes, corn, flour, tomato products, pinto beans, lettuce, cheese, butter, beef, pork and chicken products, seasonings and packaging materials. Since PepsiCo relies on trucks to move and distribute many of its products, fuel is also an important commodity. PepsiCo employs specialists to secure adequate supplies of many of these items and has not experienced any significant continuous shortages. Prices paid by PepsiCo for such items are subject to fluctuation. When prices increase, PepsiCo may or may not pass on such increases to its customers. Generally, when PepsiCo has decided to pass along price increases, it has done so successfully. There is no assurance that PepsiCo will be able to do so in the future.\nGOVERNMENTAL REGULATIONS\nThe conduct of PepsiCo's businesses, and the production, distribution and use of many of its products, are subject to various federal laws, such as the Food, Drug and Cosmetic Act, the Occupational Safety and Health Act and the Americans with Disabilities Act. The conduct of PepsiCo's businesses is also subject to state, local and foreign laws.\nPATENTS, TRADEMARKS, LICENSES AND FRANCHISES\nPepsiCo owns numerous valuable trademarks which are essential to PepsiCo's worldwide businesses, including PEPSI-COLA, PEPSI, DIET PEPSI, PEPSI MAX, MOUNTAIN DEW, SLICE, MUG, ALL SPORT, 7UP and DIET 7UP (outside the United States), MIRINDA, FRITO-LAY, DORITOS, RUFFLES, LAY'S, FRITOS, CHEEoTOS, SANTITAS, SUNCHIPS, TOSTITOS, ROLD GOLD, SMARTFOOD, SABRITAS, WALKERS, PIZZA HUT, TACO BELL, KENTUCKY FRIED CHICKEN and KFC. Trademarks remain valid so long as they are used properly for identification purposes, and PepsiCo emphasizes correct use of its trademarks. PepsiCo has authorized (through licensing or franchise arrangements) the use of many of its trademarks in such contexts as Pepsi-Cola bottling appointments, snack food joint ventures and wholly-owned operations and Pizza Hut, Taco Bell and KFC franchise agreements. In addition, PepsiCo licenses the use of its trademarks on collateral products for the primary purpose of enhancing brand awareness.\nPepsiCo either owns or has licenses to use a number of patents which relate to certain of its products and the processes for their production and to the design and operation of various equipment used in its businesses. Some of these patents are licensed to others.\nRESEARCH AND DEVELOPMENT\nPepsiCo expensed $96 million, $152 million and $113 million on research and development activities in 1995, 1994 and 1993, respectively.\nENVIRONMENTAL MATTERS\nPepsiCo continues to make expenditures in order to comply with federal, state, local and foreign environmental laws and regulations, which expenditures have not been material with respect to PepsiCo's capital expenditures, net income or competitive position.\nBUSINESS SEGMENTS\nInformation as to net sales, operating profits and identifiable assets for each of PepsiCo's industry segments, United States restaurant chains and major geographic areas of operations, as well as capital spending, acquisitions and investments in unconsolidated affiliates, amortization of intangible assets and depreciation expense for each industry segment and United States restaurant chain, for 1995, 1994 and 1993 is contained in Item 8 \"Financial Statements and Supplementary Data\" in Note 19 on page.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nBEVERAGES\nPepsiCo's beverage segment operates approximately 110 plants throughout the world, of which 100 are owned and 10 are leased. Beverage joint ventures, in which PepsiCo participates, operate approximately 115 plants and distribution operations. In addition, PepsiCo's beverage business operates approximately 380 warehouses or offices in the United States and Canada, of which approximately 270 are owned and approximately 110 are leased.\nPepsiCo owns a research and technical facility in Valhalla, New York, for its beverage businesses. PepsiCo also owns the headquarters facilities for its beverage businesses in Somers, New York.\nSNACK FOODS\nFrito-Lay operates 48 food manufacturing and processing plants in the United States and Canada, of which 41 are owned and 7 are leased. In addition, Frito-Lay owns approximately 190 warehouses and distribution centers and leases approximately 50 warehouses and distribution centers for storage of food products in the United States and Canada. Approximately 1,600 smaller warehouses and storage spaces located throughout the United States and Canada are leased or owned. Frito-Lay owns its headquarters building and a research facility in Plano, Texas. Frito-Lay also leases offices in Dallas, Texas and leases or owns sales\/regional offices throughout the United States. PepsiCo's snack food businesses also operate 65 plants and approximately 725 distribution centers, warehouses and offices outside of the United States and Canada.\nRESTAURANTS\nThrough PHNA, TBNA, KFCNA and PRI, PepsiCo owns approximately 4,000 and leases approximately 6,900 restaurants, delivery\/carryout units and other outlets in the United States and Canada, and owns approximately 900 and leases approximately 1,000 additional units outside the United States and Canada. PIZZA HUT, TACO BELL and KFC restaurants in the United States which are not owned are generally leased for initial terms of 15 or 20 years, and generally have renewal options, while PIZZA HUT delivery\/carryout units in the United States generally are leased for significantly shorter initial terms with shorter renewal options. Joint ventures, in which PepsiCo participates, operate approximately 925 units outside the United States and Canada. PHNA owns and leases office facilities in Wichita, Kansas, Dallas, Texas and other locations, some of which are shared with PFS. TBNA leases its corporate headquarters in Irvine, California. KFCNA owns a research facility and its corporate headquarters building in Louisville, Kentucky. PFS owns 1 and leases 23 distribution centers in the United States and owns 2 and leases 3 distribution centers outside of the United States.\nGENERAL\nThe Company owns its corporate headquarters buildings in Purchase, New York.\nWith a few exceptions, leases of plants in the United States and Canada are on a long-term basis, expiring at various times, with options to renew for additional periods. Most international plants are leased for varying and usually shorter periods, with or without renewal options.\nThe Company believes that its properties and those of its subsidiaries and divisions are in good operating condition and are suitable for the purposes for which they are being used.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nPepsiCo is subject to various claims and contingencies related to lawsuits, taxes, environmental and other matters arising out of the normal course of business. Management believes that the ultimate liability, if any, in excess of amounts already provided arising from such claims or contingencies, is not likely to have a material adverse effect on PepsiCo's annual results of operations or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company and their current positions and ages are as follows:\nNAME POSITION AGE\nD. Wayne Calloway Chairman of the Board and 60 Chief Executive Officer\nRoger A. Enrico Vice Chairman of the Board 51 and Chairman and Chief Executive Officer, PepsiCo Worldwide Restaurants\nRobert G. Dettmer Executive Vice President 64 and Chief Financial Officer\nRandall C. Barnes Senior Vice President and 44 Treasurer\nRobert L. Carleton Senior Vice President and 55 Controller\nEdward V. Lahey, Jr. Senior Vice President, 57 General Counsel and Secretary\nIndra K. Nooyi Senior Vice President, 40 Strategic Planning\nEach of the above-named officers has been employed by PepsiCo in an executive capacity for at least five years except Indra K. Nooyi. Ms. Nooyi has held her current position at PepsiCo since 1994. Prior to joining PepsiCo, Ms. Nooyi spent four years as Senior Vice President of Strategy, Planning and Strategic Marketing for Asea Brown Boveri.\nExecutive officers are elected by the Company's Board of Directors, and their terms of office continue until the next annual meeting of the Board or until their successors are elected and have qualified. There are no family relationships among the Company's executive officers.\nInformation regarding directors of the Company other than those provided below is set forth in the Proxy Statement for the Company's 1996 Annual Meeting of Shareholders and is incorporated herein by reference.\nDIRECTORS OF THE COMPANY RETIRING AS OF MAY 1, 1996\nANDRALL E. PEARSON was elected a director of PepsiCo in 1970. Mr. Pearson was PepsiCo's President and Chief Operating Officer from 1971 through 1984. He was a Professor at the Harvard Business School from 1985 until 1993, and is a director of The May Department Stores Company, Lexmark International, Inc and The Travelers Group. He is also a general partner of Clayton, Dubilier & Rice, Inc and Chairman of the Board of Kraft Foodservice Company. Mr. Pearson is 70 years old.\nROGER B. SMITH, former Chairman and Chief Executive Officer of General Motors Corp., was elected to PepsiCo's Board in 1989. Mr. Smith joined General Motors Corp. in 1949 and served as its Chairman and Chief Executive Officer from 1981 to 1990. He serves on the Board of Directors of Citicorp, International Paper Co. and Johnson & Johnson. Mr. Smith is 70 years old.\nROBERT H. STEWART, III, a director since 1965 and Chairman of the Board's Compensation Committee, is Vice Chairman of Bank One, Texas, N.A. In 1987, Mr. Stewart became Chairman of the Board of First RepublicBank Corporation, a position he held until joining LaSalle Energy Corp. where he was Vice Chairman of the Board from August 1987 until its sale in November 1989. Mr. Stewart then became Vice Chairman of the Board of Team Bank, assuming his present position in November 1992 upon the acquisition of Team Bancshares Inc. by BANC ONE CORPORATION. He is also a director of ARCO Chemical Co. Mr. Stewart is 70 years old.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nStock Trading Symbol - PEP\nStock Exchange Listings - The New York Stock Exchange is the principal market for PepsiCo Capital Stock, which is also listed on the Amsterdam, Chicago, Swiss and Tokyo Stock Exchanges.\nShareholders - At year-end 1995, there were approximately 167,000 shareholders of record.\nDividend Policy - Quarterly cash dividends are usually declared in November, February, May and July and paid at the beginning of January and the end of March, June and September. The dividend record dates for 1996 are expected to be March 8, June 7, September 6 and December 6. Quarterly cash dividends have been paid since 1965, and dividends paid per share have increased for 23 consecutive years.\nCash Dividends Declared Per Share (in cents)\nQuarter 1995 1994 ------- ---- ---\n1 18 16 2 20 18 3 20 18 4 20 18 -- -- Total 78 70 == ==\nStock Prices - The high, low and closing prices for a share of PepsiCo Capital Stock on the New York Stock Exchange, as reported by The Dow Jones News\/Retrieval Service, for each fiscal quarter of 1995 and 1994 were as follows (in dollars):\n1995 High Low Close - ---- ---- --- ----- First Quarter 41 33 7\/8 40 1\/4 Second Quarter 49 37 7\/8 46 5\/8 Third Quarter 47 7\/8 43 1\/4 45 3\/4 Fourth Quarter 58 3\/4 45 5\/8 55 7\/8\n1994 High Low Close - ---- ---- --- ----- First Quarter 42 1\/2 35 3\/4 37 5\/8 Second Quarter 37 3\/4 29 7\/8 31 1\/8 Third Quarter 34 5\/8 29 1\/4 33 3\/4 Fourth Quarter 37 3\/8 32 1\/4 36 1\/4\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncluded on pages through.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS, CASH FLOWS AND FINANCIAL CONDITION\nMANAGEMENT'S ANALYSIS\nINTRODUCTION PepsiCo's Management's Analysis is structured in four sections. The first section provides an overview and focuses on items that either significantly impact comparability of reported financial information or are anticipated to significantly impact future operating results. The second section analyzes the results of operations; first on a consolidated basis and then for each of PepsiCo's three industry segments. The final sections address PepsiCo's consolidated cash flows and financial condition. Management's Analysis should be read in conjunction with PepsiCo's audited consolidated financial statements, including Notes, on pages through.\nWORLDWIDE MARKETPLACE PepsiCo's worldwide businesses operate in highly competitive markets that are subject to both global and local economic conditions, including the effects of inflation, commodity price and currency fluctuations, governmental actions and political instability and its related dislocations. In addition to extensive market and product diversification, PepsiCo's operating and investing strategies are designed, where possible, to mitigate these factors through focused actions on several fronts, including: (a) enhancing the appeal and value of its products through brand promotion, product innovation, quality improvement and prudent pricing actions; (b) providing excellent service to customers; (c) increasing worldwide availability of its products; (d) acquiring businesses and forming alliances to increase market presence and utilize resources more efficiently; and (e) containing costs through efficient and effective purchasing, manufacturing, distribution and administrative processes. In 1995, international businesses represented 29% of PepsiCo's net sales and 18% of operating profit excluding the initial, noncash charge upon adoption of 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,\" (see Accounting Changes below). Management believes that these percentages will increase in the future as PepsiCo continues to invest internationally to take advantage of market opportunities. It is therefore important to consider that movements in currency exchange rates not only result in a related translation impact on PepsiCo's earnings, but also, and probably more importantly, can result in significant economic impacts that affect operating results as well. Changes in exchange rates are often linked to variability in real growth, inflation, interest rates, governmental actions and other factors. In addition, material changes generally cause PepsiCo to adjust its financing, investing and operating strategies; for example, promotions and product strategies, pricing and decisions concerning capital spending, sourcing of raw materials and packaging (see discussion on Mexico below). The following paragraphs describe the effect of currency exchange rate movements on PepsiCo's reported results.\nAs currency exchange rates change, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. With the exception of Mexico in 1995, sales and operating profit growth rates for our combined international businesses were not materially impacted by the translation effects of changes in currency exchange rates in the last three years. Material effects on comparability of sales and operating profit arising from translation are identified in Management's Analysis of operating results. By definition, these translation effects exclude the impact of businesses in highly inflationary countries, where the accounting functional currency is the U.S. dollar. Changes in currency exchange rates also result in reported foreign exchange gains and losses, which are included as a component of selling, general and administrative expenses. PepsiCo reported a net foreign exchange loss of $6 million in 1995 compared to a net foreign exchange gain of $4 million in 1994 and a net foreign exchange loss of $41 million in 1993. These reported amounts include translation gains and losses arising from remeasurement into U.S. dollars of the monetary assets and liabilities of businesses in highly inflationary countries as well as transaction gains and losses. Transaction gains and losses arise from monetary assets such as receivables and short-term interest-bearing investments as well as payables (including debt) denominated in currencies other than a business unit's functional currency. In implementing strategies to minimize net after-tax financing costs, the effects of anticipated currency exchange rate movements on debt and short-term investments are considered together with related interest rates. In 1995, Mexico was an extreme example of how movements in currency exchange rates impact operating results. In Mexico, PepsiCo's largest international market in 1994, operations were adversely impacted by the effects of the approximately 50% devaluation of the Mexican peso which triggered an extremely high level of inflation. Consumer demand shrank dramatically for most goods and services in response to declining real incomes and increased unemployment. Price increases taken to offset rising operating and product costs further dampened weak consumer demand. Actions taken by PepsiCo to mitigate these adverse effects, such as introducing various volume building programs to stimulate demand and reducing costs and capital spending, resulted in only a modest decline in local currency segment operating profit for Mexico. However, on a U.S. dollar basis, combined segment operating profit and identifiable assets in Mexico declined dramatically, reflecting the unfavorable translation effect of the much weaker peso in 1995.\nThe following estimated decline in net income and net income per share for PepsiCo's operations in Mexico reflected the decrease in Mexico's combined segment operating profit (see each industry segment discussion for the impact by segment) and PepsiCo's equity share of the increased net losses of our unconsolidated affiliates in Mexico:\n($ in millions except per share amounts) Year-Over-Year Decline ---------------------- 1995 1994 Reported Ongoing* ---- ---- -------- ------- Net sales $1,228 $2,023 (39%) (39%)\nOperating profit $ 80 $ 261 (69%) (61%)\nOperating profit margin 7% 13% (6 points) (5 points)\n% of total international segment operating profit 18% 42% (24 points) (26 points)\n% of total segment operating profit 3% 8% (5 points) (5 points)\nNet income $ 55 $ 175 (69%) (57%)\nNet income per share $ 0.07 $ 0.22 (68%) (55%)\nIdentifiable assets $ 637 $ 995 (36%) (34%)\n- -------------------------------------------------------------------------------- * Excluded Mexico's portion of the 1995 initial, noncash charge upon adoption of SFAS 121 of $21 million ($21 million after-tax or $0.03 per share) (see below).\nAll amounts for Mexico presented above and, unless otherwise noted, in Management's Analysis of Industry Segments included an allocation of the international divisions' headquarters expenses, but excluded any allocation of PepsiCo's corporate expenses and financing costs.\nCERTAIN FACTORS AFFECTING COMPARABILITY\nACCOUNTING CHANGES PepsiCo's financial statements reflect the noncash impact of accounting changes adopted in 1995 and 1994. PepsiCo early adopted SFAS 121 as of the beginning of the fourth quarter of 1995. The initial, noncash charge upon adoption of SFAS 121 was $520 million ($384 million after-tax or $0.48 per share), which included $68 million ($49 million after-tax or $0.06 per share) related to restaurants for which closure decisions were made during the fourth quarter. As a result of the reduced carrying amount of certain of PepsiCo's long-lived assets to be held and used in the business, depreciation and amortization expense for the\nfourth quarter of 1995 was reduced by $21 million ($15 million after-tax or $0.02 per share) and full-year 1996 depreciation and amortization expense is expected to be reduced by approximately $58 million ($39 million after-tax or $0.05 per share). As the initial charge was based upon estimated cash flow forecasts requiring considerable management judgment, actual results could vary significantly from these estimates.Therefore, future charges, though not of the magnitude of the initial charge, are reasonably possible although not currently estimable. See Note 2. See Management's Analysis - Restaurants on page 33 for a discussion of other possible future effects related to this change in accounting. In 1994, PepsiCoadopted Statement of Financial Accounting Standards No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" The cumulative effect of adopting SFAS 112, an $84 million charge ($55 million after-tax or $0.07 per share), principally represented estimated future severance costs related to services provided by employees prior to 1994. As compared to the previous accounting method, the ongoing impact of adopting SFAS 112 was immaterial to 1994 operating profit. See Note 14. Also in 1994, PepsiCo adopted a preferred method for calculating the market-related value of plan assets used in determining the return-on-asset component of annual pension expense and the cumulative net unrecognized gain or loss subject to amortization. The cumulative effect of adopting this change, which related to years prior to 1994, was a benefit of $38 million ($23 million after-tax or $0.03 per share). As compared to the previous accounting method, the change reduced 1994 pension expense by $35 million ($22 million after-tax or $0.03 per share). See Note 13.\nRESTAURANT SEGMENT In addition to reporting U.S. and international results, PepsiCo has historically provided detailed information and Management's Analysis of operating results for each of its three major restaurant concepts (which included the results of other small U.S. concepts managed by Taco Bell and Pizza Hut) on a worldwide basis. Beginning with the fourth quarter of 1995, PepsiCo has changed the presentation of the restaurant information to more closely reflect how we currently manage the business. Detailed information and Management's Analysis of operating results are now provided for each of PepsiCo's three major U.S. concepts (including the results of the other small U.S. concepts managed by Taco Bell and Pizza Hut) and in total for the international operations of our restaurant concepts. Prior year amounts in Note 19 and Management's Analysis - Restaurants have been restated to reflect this change. As discussed in Management's Analysis - Restaurants on page 33, we began to take actions in 1995 to improve restaurant returns, in part, by selling restaurants to franchisees. In addition, we have more aggressively closed stores that do not meet our performance expectations. As a result, restaurant operating profit included a net gain of $51 million in 1995 from sales of restaurants to franchisees in excess of the costs of closing other restaurants. This compares to $10 million of costs in 1994 to close stores. Management expects these kinds of actions to continue over the next few years as we implement our strategies to improve restaurant returns.\nOTHER FACTORS Comparisons of 1995 to 1994 are affected by an additional week of results in the 1994 reporting period. Because PepsiCo's fiscal year ends on the last Saturday in December, a fifty-third week is added every 5 or 6 years. The fifty-third week increased 1994 net sales by\nan estimated $434 million and earnings by an estimated $54 million ($35 million after-tax or $0.04 per share). See Items Affecting Comparability - Fiscal Year in Note 19 for the impact on each of PepsiCo's industry segments. In 1994, PepsiCo recorded a onetime, noncash gain of $18 million ($17 million after-tax or $0.02 per share) resulting from a public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America. See Note 16. Although it will not affect comparison of full-year operating results, international beverages' 1996 quarterly results will not be comparable to 1995's results because its 1996 quarterly reporting will be changed for all international countries except Canada. Due to the increase in company-owned bottling operations, in combination with the requirements that calendar year results generally need to be maintained internationally for statutory purposes, international beverages has elected to simplify its administrative processes by reporting results on a monthly basis. Beginning in 1996, the first through the fourth quarters will include two, three, three and four months, respectively. The comparable quarters in 1995 included twelve, twelve, twelve and sixteen weeks, respectively.\nSIGNIFICANT U.S. TAX CHANGES AFFECTING HISTORICAL AND FUTURE RESULTS U.S. Federal income tax legislation enacted in August 1993 included a provision for a 1% statutory income tax rate increase effective for the full year. As required under Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" the increase in the tax rate resulted in a noncash charge of $30 million ($0.04 per share) for the adjustment of net deferred tax liabilities as of the beginning of 1993. The 1993 legislation also included a provision to reduce the tax credit associated with beverage concentrate operations in Puerto Rico. In the first year of this change, the tax credit on income earned in Puerto Rico was limited to 60% of the amount allowed under the previous tax law, with the limit further reduced ratably over the following four years to 40%. The provision, which became effective for PepsiCo's operations on December 1, 1994, had an immaterial impact on 1994 earnings. The provision reduced 1995 earnings by approximately $58 million or $0.07 per share. In 1994, the U.S. Department of the Treasury proposed a change to a current regulation (known as Q&A 12), which would further reduce the tax incentives associated with beverage concentrate operations in Puerto Rico. If it had been adopted as proposed in 1994, the change would have become effective for PepsiCo on December 1, 1994 with an immaterial impact on 1994 earnings. Had the currently proposed Q&A 12 been in effect at the beginning of 1995, earnings for the year would have been reduced by an estimated $44 million, or $0.05 per share, and the 1995 full-year effective tax rate would have increased 1.8 points. Assuming retroactivity to December 1, 1994 and assuming 1996 profitability levels comparable to 1995, enactment of the proposed change to Q&A 12 in 1996 would increase PepsiCo's 1996 full-year effective tax rate by about 3.7 points. Slightly more than half of the potential increase is due to the retroactive application of the change to Q&A 12 to years prior to 1996 with the balance attributable to 1996 earnings. The estimated impacts and the proposed retroactive effective date to December 1, 1994 are subject to change depending upon the final provisions of Q&A 12, if enacted, and the actual level of profitability in 1996. Under generally accepted accounting principles, the unfavorable effect of the proposed change in Q&A 12 cannot be included in PepsiCo's effective tax rate until it is enacted. Due to its proposed retroactivity, the amount related to the periods prior to its\nenactment date will be recognized in full in the quarter it is enacted. This, along with PepsiCo's policy to recognize settlement of prior year audit issues at the time they are resolved, may result in volatility in PepsiCo's 1996 quarterly effective tax rates due to the timing of these events, as well as other factors.\nDERIVATIVES PepsiCo's policy prohibits the use of derivative instruments for trading purposes and we have procedures in place to monitor and control their use. PepsiCo uses interest rate and foreign currency swaps to effectively change the interest rate and currency of specific debt issuances with the objective of reducing borrowing costs. These swaps are generally entered into concurrently with the issuance of the debt they are intended to modify. The notional amount, interest payment dates and maturity dates of the swaps match the principal, interest payment dates and maturity dates of the related debt. Accordingly, any market impact (risk or opportunity) associated with these swaps is fully offset by the opposite market impact on the related debt. PepsiCo's credit risk related to interest rate and currency swaps is considered low because they are only entered into with strong creditworthy counterparties, are generally settled on a net basis and are of relatively short duration. See Notes 7, 8 and 9 for additional details regarding interest rate and currency swaps. In 1995, PepsiCo issued a seven-year put option in connection with the formation of a joint venture with the principal shareholder of GEMEX, an unconsolidated franchised bottling affiliate in Mexico. The put option allows the principal shareholder to sell up to 150 million GEMEX shares to PepsiCo at 66 2\/3 cents per share. PepsiCo accounts for this put option by marking it to market with gains or losses recognized currently as an adjustment to equity in net income of unconsolidated affiliates, which is included in selling, general and administrative expenses in the Consolidated Statement of Income. The put option liability, which was valued at $26 million at the date of the original transaction, increased to $30 million by year-end, resulting in a $4 million charge to earnings. See Notes 7, 9 and 17. PepsiCo hedges commodity purchases with futures contracts traded on national exchanges. While such hedging activity has historically been done on a limited basis, PepsiCo could increase its hedging activity in the future if it believes it would result in lower total costs. Open contracts at year-end 1995 and 1994 and gains and losses realized in 1995 and 1994 or deferred at the respective year-ends were not significant.\nFORWARD-LOOKING STATEMENTS Included from time to time in statements by PepsiCo's senior executives and in Management's Analysis beginning on page 11 are certain forward-looking statements reflecting management's current expectations. Uncertainties that could impact those forward-looking statements are described in Management's Analysis - Worldwide Marketplace on page 11. In addition, forward-looking statements related to future earnings growth contemplate double-digit combined segment operating profit growth and the ability, for the next several years, to generate significant gains from the sale of our restaurants to franchisees in excess of costs of closing restaurants and impairment charges, but do not consider the retroactive impact of the proposed change to Q&A 12 discussed above.\nRESULTS OF OPERATIONS\nCONSOLIDATED REVIEW To improve comparability, Management's Analysis identifies the impact, where significant, of beverage and snack food acquisitions, net of operations sold or contributed to joint ventures (collectively, \"net acquisitions\"). The impact of acquisitions represents the results of the acquired businesses for periods in the current year corresponding to the prior year periods that did not include the results of the businesses. Restaurant units acquired, principally from franchisees, and constructed units are treated the same for purposes of this analysis. These units, net of units closed or sold, principally to franchisees, are collectively referred to as \"additional restaurant units.\"\nNET SALES\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nU.S. $21,674 $20,246 $18,309 7 11 International 8,747 8,226 6,712 6 23 ------- ------- ------- $30,421 $28,472 $25,021 7 14 ======= ======= ======= - -------------------------------------------------------------------------------\nWorldwide net sales rose $1.9 billion or 7% in 1995. The fifty-third week in 1994 reduced the worldwide, U.S. and international net sales growth by approximately 2 points each. The sales growth benefited from higher effective net pricing, volume gains of $934 million, driven by worldwide snack foods and beverages, and $623 million due to additional restaurant units. The higher effective net pricing reflected increases in international snack foods, driven by Mexico, and U.S. beverages, primarily in response to significantly higher prices for packaging. These benefits were partially offset by the unfavorable currency translation impact of the devaluation of the Mexican peso on international snack foods. Worldwide net sales grew $3.5 billion or 14% in 1994. The fifty-third week favorably affected worldwide, U.S. and international sales growth by about 2 points each. The increase reflected volume gains of $2.2 billion, $934 million due to additional restaurant units and $215 million contributed by net acquisitions. International net sales grew 6% in 1995 and 23% in 1994 with net acquisitions contributing 1 point in both years. International net sales represented 29%, 29% and 27% of total net sales in 1995, 1994 and 1993, respectively. The unfavorable impact of the devaluation of the Mexican peso beginning in late 1994 through 1995, and its related effects, slowed PepsiCo's trend of an increasing international component of net sales.\nCOST OF SALES\n($ in millions) 1995 1994 1993 ---- ---- ----\nCost of sales $14,886 $13,715 $11,946 As a percent of 48.9% 48.2% 47.7% net sales - -------------------------------------------------------------------------------\nThe .7 point increase in 1995 was primarily due to worldwide beverages and international snack foods. The increase in worldwide beverages reflected higher packaging prices in the U.S., the effects of which were partially mitigated by increased pricing, and an unfavorable mix shift in international sales from concentrate to packaged products. The international snack foods increase was due to the effect of increased costs, primarily in Mexico, which were partially mitigated by price increases. The .5 point increase in 1994 reflected an unfavorable mix shift in international beverages, from concentrate to packaged products, and in worldwide restaurants, as well as lower net pricing in U.S. beverages. These unfavorable effects were partially offset by a favorable package and product mix shift in international snack foods and manufacturing efficiencies in U.S. snack foods.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES (S,G&A)\n($ in millions) 1995 1994 1993 ---- ---- ----\nSG&A $11,712 $11,244 $9,864 As a percent of net sales 38.5% 39.5% 39.4% - -------------------------------------------------------------------------------\nSG&A is comprised of selling and distribution expenses (S&D), advertising and marketing expenses (A&M), and general and administrative expenses (G&A) which include gains on sales of assets as well as other income and expense. SG&A grew 4% to $11.7 billion in 1995, slower than sales, and 14% to $11.2 billion in 1994, the same rate as sales. In 1995, A&M grew at a substantially slower rate than sales reflecting a slower rate of spending in worldwide beverages and U.S. restaurants. G&A also grew at a substantially slower rate than sales, driven by worldwide beverages and U.S. restaurants. Worldwide beverages benefited from international cost containment initiatives, a gain on sale of an international bottling plant, savings in U.S. beverages from a 1994 reorganization as well as benefits of increased pricing in U.S. beverages. U.S. restaurants benefited from a net gain on sales of restaurants in excess of costs of closing other restaurants. S&D grew at a slightly slower rate than sales, in part reflecting the benefits of increased pricing in U.S. beverages and a slower rate of spending in international snack foods.\nAMORTIZATION OF INTANGIBLE ASSETS increased 1% to $316 million in 1995 and 3% to $312 million in 1994. This noncash expense reduced net income per share by $0.30, $0.29 and $0.28 in 1995, 1994 and 1993, respectively.\nIMPAIRMENT OF LONG-LIVED ASSETS reflected the initial, noncash charge of $520 million ($384 million after-tax or $0.48 per share) upon adoption of SFAS 121. See Note 2.\nOPERATING PROFIT\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nOperating Profit Reported $2,987 $3,201 $2,907 (7) 10 Ongoing* $3,507 $3,201 $2,907 10 10\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Note 2. - -------------------------------------------------------------------------------\nReported operating profit declined $214 million or 7% in 1995. Ongoing operating profit increased $306 million or 10% in 1995. The fifty-third week in 1994 reduced the operating profit growth by approximately 2 points. The profit growth was driven by combined segment ongoing operating profit growth of 11%, which benefited from volume growth of $283 million ($430 million excluding the impact of the fifty-third week), driven by U.S. snack foods and worldwide beverages, and $76 million due to additional restaurant units. These advances were partially offset by net unfavorable currency translation impacts, primarily from Mexico. The benefit of higher effective net pricing for all segments combined was almost entirely offset by increased product and operating costs, primarily in Mexico, and higher packaging prices in the U.S. The ongoing profit margin increased slightly to 11.5% in 1995. Operating profit increased $294 million or 10% in 1994. The fifty-third week increased the operating profit growth by approximately 2 points. The profit growth was driven by combined segment operating profit growth of 8%, which reflected $850 million from higher volumes ($703 million excluding the impact of the fifty-third week) and $73 million from additional restaurant units, partially offset by higher operating expenses. The profit margin decreased almost one-half point to 11.2% in 1994. International segment ongoing profit grew 4% in 1995, a slower rate than sales growth, which reflected the adverse effects of the Mexican peso devaluation, particularly in snack foods, partially offset by very strong restaurant performance. International segment ongoing profit represented 18%, 19% and 18% of combined segment ongoing operating profit in 1995, 1994 and 1993, respectively.\nGAIN ON STOCK OFFERING BY AN UNCONSOLIDATED AFFILIATE of $18 million ($17 million after-tax or $0.02 per share) in 1994 related to the public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America. See Note 16.\nINTEREST EXPENSE, NET\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nInterest expense $(682) $(645) $(573) 6 13 Interest income 127 90 89 41 1 --- --- --- Interest expense, $(555) $(555) $(484) - 15 net ===== ===== =====\n- -------------------------------------------------------------------------------\nInterest expense, net in 1995 was even with 1994, reflecting the net impact of higher average interest rates offset by lower average borrowings. The 15% increase in 1994 reflected higher average borrowings, partially offset by higher interest rates on investment balances. Excluding the impact of net acquisitions, interest expense, net decreased 3% in 1995 and increased 10% in 1994.\nPROVISION FOR INCOME TAXES\n($ in millions) 1995 1994 1993 ---- ---- ----\nReported Provision for $826 $880 $835 Income Taxes Effective Tax Rate 34.0% 33.0% 34.5%\nOngoing* Provision for $962 $880 $809 Income Taxes Effective Tax Rate 32.6% 33.0% 33.3%\n* Excluded the effects of the initial, noncash charge upon adoption of SFAS 121 in 1995 (see Note 2) and the deferred tax charge due to the U.S. tax legislation in 1993 (see Note 11). - -------------------------------------------------------------------------------\nThe 1995 reported effective tax rate increased 1 point to 34.0%. The 1995 ongoing effective tax rate declined slightly, reflecting a reversal of prior year accruals no longer required and tax refunds, both a result of the current year resolution of certain prior years' audit issues. These benefits were partially offset by a higher foreign effective tax rate, primarily due to a provision in the 1993 U.S. tax legislation that reduced the tax credit associated with beverage concentrate operations in Puerto Rico and became effective for PepsiCo on December 1, 1994 (see Management's Analysis Significant U.S. Tax Changes Affecting Historical and Future Results on page 15), and a decrease in the proportion of income taxed at lower foreign rates. The 1994 reported effective tax rate declined 1 1\/2 points to 33.0%. The slight decline in the ongoing effective tax rate in 1994 reflected a reversal of certain valuation allowances related to deferred tax assets and an increase in the proportion of income taxed at lower\nforeign rates offset by the absence of a favorable adjustment in 1993 of certain prior years' foreign accruals.\nINCOME AND INCOME PER SHARE BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES\n($ in millions except per share amounts) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nReported Income $1,606 $1,784 $1,588 (10) 12 Income Per Share $ 2.00 $ 2.22 $ 1.96 (10) 13\nOngoing* Income $1,990 $1,767 $1,618 13 9 Income Per Share $ 2.48 $ 2.20 $ 2.00 13 10\n* Excluded the initial, noncash charge upon adoption of SFAS 121 in 1995 (see Note 2), the 1994 BAESA gain (see Note 16) and the deferred tax charge due to the U.S. tax legislation in 1993 (see Note 11). - -------------------------------------------------------------------------------\nGrowth in ongoing income per share was depressed by estimated dilution from acquisitions of $0.04 or 2 points in 1995 and $0.03 or 2 points in 1994, primarily due to international beverage acquisitions and investments in new unconsolidated affiliates in both years.\nINDUSTRY SEGMENTS\nBEVERAGES\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales U.S. $ 6,977 $6,541 $5,918 7 11 International 3,571 3,146 2,720 14 16 ------- ------ ------ $10,548 $9,687 $8,638 9 12 ======= ====== ======\nOperating Profit Reported: U.S. $ 1,145 $1,022 $ 937 12 9 International 164 195 172 (16) 13 ------- ------ ------ $ 1,309 $1,217 $1,109 8 10 ======= ====== ======\nOngoing:* U.S. $ 1,145 $1,022 $ 937 12 9 International 226 195 172 16 13 ------- ------ ------ $ 1,371 $1,217 $1,109 13 10 ======= ====== ======\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. - ------------------------------------------------------------------------------- [Note: Unless otherwise noted, operating profit comparisons within the 1995 vs. 1994 discussion are based on ongoing operating profit. Net sales and operating profit comparisons within the following discussions include the impact of the fifty-third week in 1994 (see Note 19). System bottler case sales of Pepsi Corporate brands (BCS) were not impacted by the fifty-third week because they are measured on a calendar year basis.]\n1995 vs. 1994\nWorldwide net sales increased $861 million or 9%. The fifty-third week in 1994 reduced the worldwide net sales growth by approximately 1 point. Comparisons are also affected by the start-up of international company-owned bottling and distribution operations within the past twelve months (\"start-up operations\") and acquisitions, principally international, as well as the absence of certain small operations sold or contributed to joint ventures (collectively, \"net acquisitions\"). The start-up operations and net acquisitions contributed $93 million and $56 million, respectively, or 2 points on a combined basis to the sales growth. Reported worldwide operating profit increased $92 million or 8%. Excluding the initial charge upon adoption of SFAS 121, which for beverages only affected our operations in Germany, operating profit increased $154 million or 13%. The fifty-third week in 1994 reduced ongoing worldwide operating profit growth by approximately 1 point.\nSales in the U.S. rose $436 million or 7%. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The sales growth reflected higher pricing on most carbonated soft drink (CSD) packages, primarily in response to significantly higher prices for packaging. Sales growth also benefited from increased volume which contributed $107 million. BCS consists of sales of packaged products to retailers and through vending machines and fountain syrup by company-owned and franchised bottlers. BCS in the U.S. increased 4%, reflecting double-digit growth in the Mountain Dew brand and solid increases in Brand Pepsi. BCS growth also benefited from increased sales of Mug brand root beer. Total alternative beverages, which include Lipton brand ready-to-drink tea, All Sport and Ocean Spray Lemonade products, grew at a strong double-digit rate, reflecting growth in Lipton brand tea and All Sport, partially offset by significant declines in Ocean Spray Lemonade products, albeit on a small base. The growth in Lipton, which represents approximately 80% of our alternative beverages BCS, was due to volume gains from Lipton Brisk and fountain syrup which more than offset lower volume of the premium-priced Lipton Original. Excluding the alternative beverages, BCS growth was 3%. Packaged products BCS grew at a faster rate than fountain syrup. Profit in the U.S. increased $123 million or 12%. The fifty-third week in 1994 reduced the operating profit growth by approximately 1 point. Profit growth reflected the higher pricing on CSD packages and concentrate which exceeded the increased product costs, primarily for packaging. Volume gains, driven by packaged products, contributed $52 million ($107 million excluding the impact of the fifty-third week) to the profit growth. Administrative expenses declined, reflecting savings from a 1994 consolidation of headquarters and field operations. Selling and distribution expenses grew at a slower rate than sales, in part reflecting the benefits of increased pricing, partially offset by the effects of a 6-week strike in California that ended in August. Advertising and marketing expenses increased modestly. Profit growth was aided by favorable results from alternative beverages due to higher profit from Lipton. Profit growth was dampened by the absence of 1994 gains totaling $9 million resulting from sales of bottling businesses. The profit margin increased nearly 1 point to 16.4%. In 1995, U.S. beverages continued to execute actions related to the previously disclosed 1992 restructuring. Benefits in 1995 were offset by incremental costs associated with the continued development and implementation of the restructuring actions. The amount and timing of currently projected benefits are consistent with the revised projections as noted below in the 1994 vs. 1993 discussion. International sales rose $425 million or 14%. The sales growth was not affected by the fifty-third week in 1994. Start-up operations, principally in Eastern Europe, and net acquisitions, consisting primarily of franchised and independent bottling operations in Asia, contributed $93 million and $44 million, respectively, or 5 points to the sales growth on a combined basis. Sales growth benefited from volume advances of $194 million, reflecting increased volume of packaged product sales and concentrate shipments to franchised bottlers, particularly in markets where we are investing heavily because we believe they have high growth potential (Growth Markets). Growth Markets primarily include Brazil, China, Eastern Europe and India. Sales growth was also aided by higher effective net prices on concentrate and packaged products due, in part, to product, package and country mix. Unfavorable currency translation impacts, primarily due to a weaker Mexican peso, were\nsubstantially offset by favorable currency translation impacts, primarily reflecting the strength of the Japanese yen and Western European currencies. International BCS grew 8%. This advance reflected broad-based growth led by Growth Markets which, on a combined basis, grew about 50%. Each of the countries in our Growth Markets had strong double-digit growth, led by near triple-digit growth in Brazil and strong gains in China and India. The international BCS growth also reflected double-digit growth in Thailand, Venezuela, Turkey and Pakistan, as well as advances in Saudi Arabia, Spain and the U.K. These advances were partially offset by declines in Mexico, our largest international BCS market, and Argentina, primarily reflecting adverse economic conditions in these countries. Reported international profit decreased $31 million or 16%. Ongoing operating profit increased $31 million or 16%. The fifty-third week in 1994 reduced the ongoing operating profit growth by approximately 2 points. The net acquisitions and start-up operations reduced profit by $8 million and $3 million, respectively, or 6 points on a combined basis. Profit growth benefited from the higher effective net prices on concentrate and packaged products and increased volume, primarily concentrate, of $52 million. These benefits were partially offset by net unfavorable currency translation impacts, principally due to the devaluation of the Mexican peso, and higher field operating costs and headquarters administrative expenses, reflecting normal increases and costs to support expansion. Profit growth was aided by an $8 million gain on the sale of a bottling plant in Greece. Following is a discussion of international results by key geographic market. Ongoing profit growth reflected a significant net reduction in losses from the Growth Markets, led by increased profit in Brazil and reduced losses in India, the Czech Republic and Poland. Profit growth was also aided by increased volume and higher effective net prices in Saudi Arabia and the U.K. Our largest international sales markets are Canada, Japan and Spain, which have sizable company-owned bottling operations. Double-digit profit growth in Canada benefited from cost reduction initiatives, while strong double-digit profit growth in Japan was led by increased volume, favorable currency translation impacts and lower operating costs, partially offset by lower effective net prices. Profit in Spain was slightly lower, reflecting a higher level of promotional activity which was only partially offset by increased volume. These net gains were partially offset by significantly lower profits in Mexico and Argentina, primarily reflecting the adverse economic conditions in those countries. The ongoing operating profit margin was essentially unchanged at 6.3%. As discussed on pages 12 and 13, results in Mexico have been adversely impacted by economic difficulties resulting from the significant devaluation of the Mexican peso. Net sales in Mexico declined 37%, while operating profit declined $32 million or 73% to $12 million. Mexico represented approximately 5% and 23% of 1995 and 1994 international beverage segment ongoing operating profit, respectively.\n1994 vs. 1993\nWorldwide net sales increased $1.0 billion or 12%. The fifty-third week contributed approximately 1 point to the worldwide net sales growth. International start-up operations and net acquisitions, principally in the U.S., contributed $73 million and $161 million, respectively, or 3 points on a combined basis to worldwide sales growth. Worldwide operating profit increased $108 million or 10%. The fifty-third week enhanced the profit growth by approximately 2 points. International start-up operations\nreduced operating profit by $19 million or 2 points, while net acquisitions had no impact on profit growth. Sales in the U.S rose $623 million or 11%. The fifty-third week aided the sales growth by approximately 2 points. Net acquisitions contributed $158 million or 3 points to sales growth. Volume growth contributed $510 million, driven by CSD packaged products. This benefit, combined with a mix shift to the higher-priced alternative beverage packaged products and higher concentrate and fountain syrup pricing, was partially offset by lower net pricing to retailers and a mix shift to The Cube, our value-priced 24-pack. The lower net pricing reflected increased price discounts and promotional allowances for CSD, in response to private label competition, and Lipton brand tea. See Note 1 for discussion concerning classification of promotional price allowances. BCS in the U.S. increased 6%, reflecting strong double-digit growth in the Mountain Dew brand and solid gains in Brand Pepsi. BCS growth also benefited by strong double-digit growth in Lipton brand tea and gains in the Diet Pepsi brand. These advances, combined with the national distribution of All Sport and Ocean Spray Lemonade in 1994 and gains in the Slice brands, were partially offset by significant declines in the Crystal Pepsi brands. Alternative beverages contributed 2 points to the BCS growth. BCS of fountain syrup grew at a slower rate than packaged products. Profit in the U.S. increased $85 million or 9%. The fifty-third week enhanced the profit growth by approximately 1 point. Volume gains, driven by packaged products, contributed $305 million ($250 million excluding the impact of the fifty-third week) to profit growth. This benefit, combined with the higher concentrate and fountain syrup pricing, was partially offset by higher operating expenses, the lower net pricing to retailers, the mix shift to The Cube and increased product costs. Selling and distribution expenses grew at a faster rate than sales, driven by higher volume-driven labor costs. Advertising and marketing costs grew at a slower rate than sales. Administrative expenses declined modestly, reflecting savings from a 1994 consolidation of headquarters and field operations and a reduction in the scope of the 1992 restructuring actions, both discussed below. These benefits were largely offset by normal increases in administrative expenses. The increased product costs reflected the mix shift to the higher cost alternative beverages and higher ingredient prices, partially offset by lower packaging prices. Alternative beverages, driven by Lipton brand tea, aided the profit growth. The profit margin declined slightly to 15.6%. In the third quarter of 1994, U.S. beverages reversed into income $24 million of a $115 million restructuring accrual established in 1992 and, in the third and fourth quarters, recorded additional charges totaling $22 million, primarily reflecting management's decision to further consolidate headquarters and field operations. The 1994 charges cover severance costs associated with employee terminations and relocation costs for employees who, in 1994, accepted offers to relocate. The 1992 charge arose from an organizational restructuring designed to improve customer focus by realigning resources consistent with Pepsi-Cola's \"Right Side Up\" operating philosophy, as well as a redesign of key administrative and business processes. The charge included provisions for costs associated with redeployed and displaced employees, the redesign of core processes and office closures. The $24 million reversal reflects both refinements of the estimates originally used to establish the accrual, principally for costs associated with displaced employees, and management's decision to reduce the scope of the restructuring. The organizational restructuring was completed in 1992. The nationwide implementation of several of the\nanticipated administrative and business process redesigns has been completed, with the balance of the redesigns projected to be completed over the next three years. The benefits of the restructuring activities, when fully implemented, were originally projected to be approximately $105 million annually, based on reduced employee and facility costs. The current projection of annual benefits from these sources has decreased to approximately $40 million reflecting, in part, the reduced scope of the restructuring. While difficult to measure, in 1994 U.S. beverages estimated other sources of benefits from the restructuring of approximately $90 million annually, based on centralization of purchasing activities and incremental volume and pricing from improvements in administrative and business processes. These additional sources of benefits, although identified when the 1992 restructuring accrual was established, were not included in the projected annual benefits due to significant uncertainties and difficulties in quantifying the amounts, if any, of such benefits. Due to delays in implementing some of the restructuring actions, full realization of the expected benefits also has been delayed. Benefits in 1994 were offset by incremental costs associated with the continued development and implementation of the restructuring actions. This offset is expected to continue into 1995. Net benefits are expected to begin in 1996 and to increase annually until fully realized in 1998. All benefits derived from the restructuring actions will be reinvested in the business to strengthen our competitive position. International sales rose $426 million or 16%. The fifty-third week enhanced the sales growth by approximately 1 point. This growth reflected higher volume of $300 million, the start-up of company-owned bottling and distribution operations, principally in Eastern Europe, and the first year of sales of Stolichnaya vodka under the 1994 appointment of an affiliate of Grand Metropolitan as the exclusive U.S. and Canadian distributor. Higher concentrate pricing was offset by an unfavorable currency translation impact and lower net pricing on packaged products. The unfavorable currency translation impact reflected a weaker Canadian dollar, Spanish peseta and Mexican peso, partially offset by a stronger Japanese yen. International case sales increased 9%, reflecting strong double-digit growth in Asia, led by China and India, and solid advances in Latin America, as growth in Mexico more than offset declines in Venezuela. Latin America and Mexico represent our largest international BCS region and country, respectively. Double-digit advances in Eastern Europe and the Middle East, combined with single-digit growth in Western Europe and Canada, were partially offset by declines in Africa. Pepsi Max, a new low-calorie cola, aided BCS growth. International profit increased $23 million or 13%. The fifty-third week enhanced the profit growth by approximately 2 points. Net acquisitions reduced profit by $9 million or 5 points. The increased profit reflected volume growth of $75 million, led by concentrate shipments. This benefit, combined with a decline in advertising and marketing expenses not attributed to volume growth, was partially offset by increased field and headquarters administrative expenses, start-up losses, principally in Eastern Europe, and an unfavorable currency translation impact, primarily from the Mexican peso and the Canadian dollar. The increased administrative expenses reflected costs to support expansion in Growth Markets. The higher concentrate pricing was partially offset by a decline in finished product sales to franchised bottlers, principally in Japan, and the lower net pricing on packaged products. Increased profit from the first year of sales of Stolichnaya, under the 1994 appointment of an affiliate of Grand Metropolitan as the exclusive U.S. and Canadian distributor, aided profit growth. The new Pepsi Max product significantly\ncontributed to profit growth. Profit increased in Latin America, led by Mexico, and in Western Europe, reflecting significantly reduced losses in Germany. Profit also grew in Asia, reflecting advances in Japan. The profit growth was restrained by start-up losses in Eastern Europe and declines in Canada, reflecting private label competition. The profit margin remained relatively unchanged at 6.2%. The 1992 restructuring actions to streamline the acquired Spanish franchised bottling operation were substantially completed in 1994. These actions have resulted in total savings approximating $15 million in 1994, with total annual savings expected to grow to about $20 million in 1995, consistent with our original projection. These savings will continue to be reinvested in our businesses to strengthen our competitive position. The significant devaluation of the Mexican peso in late 1994 and early 1995 did not materially impact 1994 international beverage operating profit. However, because Mexico, our largest profit country, represented approximately 23% of international beverage operating profit in 1994, the devaluation and its related effects were expected to have an unfavorable impact on 1995 operating profit. The operations in Mexico had begun to take actions to increase volume, enhance net pricing and reduce costs, including evaluating alternative sourcing of raw materials. Nonetheless, significant uncertainties remained in Mexico and, as a result, it was not possible to quantify the impact. International beverages had also begun to take actions in several other countries in 1995 to help mitigate the impact.\nSNACK FOODS\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales U.S. $5,495 $5,011 $4,365 10 15 International 3,050 3,253 2,662 (6) 22 ----- ----- ------ $8,545 $8,264 $7,027 3 18 ====== ====== ======\nOperating Profit U.S. $1,132 $1,025 $ 901 10 14 International 300 352 289 (15) 22 ------ ------ ----- $1,432 $1,377 $1,190 4 16 ====== ====== ====== - ------------------------------------------------------------------------------- [Note: Net sales and operating profit comparisons within the following discussions include the impact of the fifty-third week in 1994 (see Note 19), while pound and kilo growth have been adjusted to exclude its impact.]\n1995 vs. 1994\nWorldwide net sales rose $281 million or 3%. Worldwide operating profit increased $55 million or 4%. The fifty-third week in 1994 reduced both worldwide net sales and operating profit growth by approximately 2 points. Sales in the U.S. grew $484 million or 10%. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The sales increase reflected volume growth of $411 million and increased pricing across all major brands. The volume growth reflected gains in almost all major brands, led by our low-fat and no-fat snacks, which accounted for\nover 45% of the total sales growth. Volume growth was further aided by increased promotional price allowances and merchandising programs to retailers, which are reported as marketing expenses and therefore do not reduce reported sales. See Note 1 for further discussion concerning classification of promotional allowances. Pound volume in the U.S. advanced 11%, reflecting exceptional performance from the low-fat and no-fat categories. These categories contributed over 45% of the total pound growth, driven by Rold Gold brand pretzels, Baked Tostitos brand tortilla chips, Tostitos brand salsa and Ruffles Light and Baked Lay's brand potato chips. Doritos brand tortilla chips, driven by new flavor extensions and packaging, had solid single-digit pound growth. Lay's brand potato chips and other Ruffles brand products grew single-digits, benefiting from new flavor extensions like Hidden Valley Ranch Wavy Lay's brand potato chips, Lay's and Ruffles KC Masterpiece Barbecue Flavor brand potato chips, French Onion Flavored Ruffles and Lay's Salsa & Cheese Flavored brand potato chips. Chee.tos brand cheese flavored snacks, fueled by fried Chee.tos, had single-digit growth, while Fritos brand corn chips declined slightly reflecting lower promotional spending. Profit in the U.S. grew $107 million or 10%. The fifty-third week in 1994 reduced the profit growth by approximately 3 points. The low-fat and no-fat categories contributed about 40% of the total profit growth. The total profit increase reflected strong volume growth, which contributed $193 million ($244 million excluding the impact of the fifty-third week) and higher pricing that exceeded increased promotional price allowances and merchandising support. This growth was partially offset by increased operating costs, which were driven by higher selling, distribution and administrative expenses and increased investment in brand marketing to support and maintain strong volume momentum. The higher administrative expenses reflected investment spending to maintain volume growth and a competitive advantage, including new manufacturing and delivery systems, feasibility studies related to a joint venture arrangement with Sara Lee Bakery and a reorganization of field operations to improve customer service. The profit growth was also hampered by higher manufacturing costs, reflecting increased capacity costs and an unfavorable sales mix shift to lower-margin value-oriented packages. Increased carton and packaging prices were partially offset by favorable potato and oil prices. Although difficult to forecast, 1996 potato and oil prices are expected to remain about even with 1995, while prices of corn and potato flakes, used in Baked Lay's, are expected to increase. However, due to extreme weather conditions in recent years, potato prices have been less predictable. Carton and packaging prices in 1996 are expected to remain even with 1995. The profit margin remained about the same at 20.6%. As discussed on pages 12 and 13, 1995 results in Mexico have been adversely impacted by economic difficulties resulting from the significant devaluation of the Mexican peso. This effect was particularly dramatic on international snack food results as Mexico represented approximately 64% of international snack food 1994 operating profit. Net sales in Mexico declined 39% in 1995, while operating profit declined $120 million or 53% to $106 million. As a result, Mexico represented only 35% of 1995 international snack food profit. Since the change in results of Mexico had such a distortive effect on international snack food results, net sales and operating profit discussions that follow exclude the effects of Mexico where noted. However, Sabritas and Gamesa, our operations in Mexico, are discussed separately below. International sales decreased $203 million or 6%. Sweet snacks (primarily candy and cookies) accounted for approximately 25% of international snack food sales in 1995,\ncompared to 30% in 1994. Excluding Mexico, international sales grew more than 25%; the fifty-third week in 1994 reduced the sales growth by approximately 2 points. This growth reflected increased volumes of $288 million, led by Brazil and the U.K. The sales growth also benefited from a favorable mix shift to higher-priced packages and products and acquisitions, which contributed $43 million. International kilo growth is reported on a systemwide basis, which includes both consolidated businesses and joint ventures operating for at least one year. Salty snack kilos rose 9%, reflecting strong double-digit volume growth in Brazil, due to a more stable economy; the U.K., the Netherlands and Spain achieved double-digit growth fueled, in part, by in-bag promotions. These advances were partially offset by double-digit declines at Sabritas. Sweet snack kilos grew 12%, reflecting double-digit advances at Gamesa and in France, and single-digit advances at the Alegro sweet snack division (formerly Sonrics) of Sabritas. International operating profit decreased $52 million or 15%. The fifty-third week in 1994 reduced the operating profit growth by approximately 1 point. Excluding Mexico, international operating profit increased $68 million or 54%; the fifty-third week in 1994 reduced the profit growth by approximately 1 point. This growth reflected the favorable mix shift to higher-priced packages and products and increased volumes of $48 million, partially offset by higher operating costs and increased administrative expenses. The increased operating costs reflected increased manufacturing costs due to higher commodity and packaging prices. The increased administrative costs reflected broad-based investment spending on regional business development initiatives and increased headquarters expenses. Including Mexico, the profit margin decreased 1 point to 9.8%. The following discussions of profitability by key business exclude any allocation for division or corporate overhead. Operating profit declined over 50% at Sabritas, reflecting an increase in operating costs, an unfavorable currency translation impact and lower volumes, partially offset by higher pricing. The increased operating costs reflected significantly higher manufacturing costs due to higher ingredient prices and wage rates, as well as increased selling and distribution expenses. Lower-margin sweet snack kilo volume from the Alegro division increased 7% despite lapping of a successful 1994 promotion. Although Sabritas maintained its high market share, higher-margin salty snack kilos declined almost 20% due, in part, to reduced demand, higher pricing and lapping strong volume gains in 1994 as a result of a successful in-bag promotion. Gamesa's profit more than doubled, on a small base, despite the effects of the economic difficulties resulting from the devaluation of the Mexican peso, as higher pricing and increased volumes more than offset higher operating costs, the unfavorable currency translation impact and higher administrative costs. The increased operating costs primarily reflected higher manufacturing costs due to higher ingredient prices and wage rates, increased selling and distribution expenses, and higher advertising expenses. Sweet snack kilos grew 15%, driven by route expansion and successful promotions. Walkers' profit grew 37%, driven by increased volume reflecting gains in the Walkers crisps brand as a result of successful in-bag promotions, and Doritos brand tortilla chips. Higher manufacturing costs, reflecting higher potato and packaging prices, were more than offset by favorable selling and distribution, administrative and advertising and marketing expenses. Increased sales of Doritos, introduced late in the second quarter of\n1994, represented approximately 25% of the strong kilo growth in the U.K. Doritos generated a slight profit compared to a loss last year. Brazil's profit more than doubled, on a small base, as increased volumes of core brands, reduced selling and distribution expenses and a favorable mix shift to higher-priced packages were partially offset by higher manufacturing costs, primarily potato prices. Brazil is operating at maximum capacity and therefore, investments are currently being made to expand production capacity to meet the strong consumer demand, due in part to the substantial improvement in the country's economy. These investments are expected to be completed early in the second quarter of 1996.\n1994 vs. 1993\nWorldwide net sales rose $1.2 billion or 18%. The fifty-third week contributed approximately 2 points to the worldwide net sales growth. Worldwide operating profits increased $187 million or 16%. The worldwide operating profit growth benefited from the fifty-third week by approximately 2 points. Sales in the U.S. grew $646 million or 15%. The fifty-third week contributed about 2 points to the sales growth. The increase in sales reflected volume growth of $660 million. Volume gains reflected growth in most major brands and line extensions of existing products. Sales growth was further aided by increased promotional price allowances and marketing programs to retailers, which are reported as marketing expenses and therefore do not reduce reported sales. Higher gross pricing was offset by a sales mix shift to larger, value-oriented packages and products with lower gross prices. Total U.S. pound volume advanced 13%. This performance was led by strong double-digit growth in Lay's brand potato chips, reflecting the successful promotion of Wavy Lay's brand potato chips and growth of Lay's KC Masterpiece Barbecue Flavor brand potato chips, Rold Gold and Rold Gold Fat Free Thins brand pretzels and Tostitos brand tortilla chips, driven by Restaurant Style Tostitos brand and the expanded distribution of Baked Tostitos brand. Doritos brand tortilla chips had solid single-digit volume growth while Fritos brand corn chips and Chee.tos brand cheese flavored snacks reflected low double-digit growth. Ruffles brand potato chips showed modest growth. Profit in the U.S. grew $124 million or 14%. The fifty-third week contributed about 3 points to the profit growth. This performance reflected strong volume growth, which contributed $340 million ($289 million excluding the impact of the fifty-third week). This growth was partially offset by the impact of increased operating and manufacturing costs and an unfavorable sales mix shift to lower-margin packages and products. Increased operating costs were driven by higher selling, distribution and new system costs in addition to increased investment in marketing costs to maintain strong momentum in 1995. Increased capacity costs were partially offset by manufacturing efficiencies. Higher vegetable oil prices were substantially offset by lower packaging and potato prices. Increased promotional price allowances and merchandising support largely offset higher pricing on certain brands. The profit margin remained relatively unchanged at 20.5%. Though difficult to forecast, there were no material changes expected in potato costs for 1995. However, potato prices have been less predictable in recent years due to weather conditions. Vegetable oil prices were expected to decline slightly from the high 1994 levels, while the cost of packaging was expected to increase.\nInternational sales rose $591 million or 22%. The fifty-third week contributed approximately 1 point to the sales growth. Sweet snacks (primarily candy and cookies) accounted for approximately 30% of international snack food sales in both 1994 and 1993. Acquisitions contributed $67 million or 2 points to sales growth. The balance of the sales growth was driven by higher volume, which contributed $590 million, led by successful promotions by the Sabritas salty snack and sweet snack business in Mexico. A favorable brand mix shift to higher-priced products, primarily in Latin America and the U.K., and higher pricing were largely offset by the unfavorable currency translation impact of a stronger U.S. dollar, principally against the Mexican peso. International systemwide salty snack kilos rose 16%, led by strong double-digit growth at Sabritas, in Spain and Brazil and solid gains in the U.K. Systemwide sweet snack kilos also grew 16%, reflecting double-digit advances at Gamesa and Sabritas and gains in Egypt and Poland. International profit increased $63 million or 22%. The fifty-third week contributed about 1 point to the profit growth. Higher volume contributed $95 million ($87 million excluding the impact of the fifty-third week) to international profit growth, led by Sabritas. The combined impact of the favorable product and package mix shifts, primarily in the U.K. and Latin America, and modestly higher pricing were more than offset by higher direct and administrative costs and an unfavorable currency translation impact from the Mexican peso. Higher direct costs resulted primarily from investment initiatives to build brand equity and enhance distribution channels in Mexico. Profit growth was also dampened by the lapping oflast year's noncash credit of $6 million resulting from the decision to retain a small snack chip business in Japan previously held for sale. The profit margin remained relatively unchanged at 10.8%. The international restructuring charge in 1992 related primarily to actions to consolidate and streamline the Walkers business in the U.K. that were substantially completed during 1994. These actions were estimated to result in annual savings of about $32 million, which continue to be reinvested in the business to strengthen our competitive position. Following is a discussion of the results of our key international businesses. Strong double-digit profit growth at Sabritas was driven by higher salty and sweet snack volumes. This benefit, combined with a favorable product mix shift to higher-margin snacks and lower manufacturing overhead and administrative costs, more than offset increased potato costs, higher promotional spending and an unfavorable currency translation impact. Walkers' profit advanced at a strong double-digit rate, driven by a favorable product mix shift reflecting increased sales of higher-margin branded products and the elimination of most lower-margin private label products, increased volumes, lower raw material and packaging costs and lower manufacturing expenses resulting from the 1992 restructuring actions. These benefits offset start-up costs related to the launch of Doritos brand tortilla chips which exceeded incremental profit generated. Gamesa posted strong profit growth on a relatively small base, reflecting a favorable package mix shift to higher-margin single-serve products and lower manufacturing overhead and administrative costs resulting from cost reduction initiatives. These benefits were partially offset by higher product costs, selling and distribution costs associated with the expansion of a direct delivery system and an unfavorable currency translation impact.\nThe significant devaluation of the Mexican peso in late 1994 and early 1995 did not materially impact 1994 international snack food operating profit. However, because Sabritas and Gamesa combined represented approximately 64% of international snack food operating profit in 1994, the devaluation and its related effects were expected to have an unfavorable impact on 1995 operating profit. Sabritas and Gamesa had begun to increase pricing and reduce costs, including evaluating alternative sourcing of raw materials. Nonetheless, significant uncertainties remained in Mexico and, as a result, it was not possible to quantify the impact. International snack foods had also begun to take actions in several of its other countries in 1995 to help mitigate the impact.\nRestaurants\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales U.S. $ 9,202 $ 8,694 $8,026 6 8 International 2,126 1,827 1,330 16 37 ------- ------- ------ $11,328 $10,521 $9,356 8 12 ======= ======= ====== Operating Profit Reported U.S. $ 451 $ 659 $ 685 (32) (4) International (21) 71 93 NM (24) ----- ------ ------ $ 430 $ 730 $ 778 (41) (6) ===== ====== ======\nOngoing* U.S. $ 753 $ 659 $ 685 14 (4) International 114 71 93 61 (24) ------- ------- -----\n$ 867 $ 730 $ 778 19 (6) ======= ======= ======\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. NM = Not Meaningful. - ------------------------------------------------------------------------------- [Note: Unless otherwise noted, operating profit comparisons within the 1995 vs. 1994 discussion are based on ongoing operating profit. Net sales and operating profit comparisons within the following discussions include the impact of the fifty-third week in 1994 (see Note 19), while same store sales growth has been adjusted to exclude its impact. For purposes of this discussion, net sales by PFS, PepsiCo's restaurant distribution operation, to the franchisee and licensee operations of each restaurant chain and the related estimated operating profit have been allocated to each restaurant chain.]\n1995 vs. 1994\nWorldwide net sales increased $807 million or 8%. Sales in the U.S. increased $508 million or 6%, while international sales increased $299 million or 16%. The fifty-third week in 1994 reduced the worldwide, U.S. and international net sales growth by approximately 2 points each. Reported worldwide operating profit declined $300 million or 41%. Ongoing worldwide operating profit increased $137 million or 19%; U.S. increased $94 million or 14% and international increased $43 million or 61%. The fifty-third week in 1994 reduced the ongoing worldwide operating profit growth by approximately 4 points. U.S. and international profit growth were reduced by 4 and 7 points, respectively. As discussed in Notes 2 and 19, PepsiCo recorded the initial, noncash charge upon adoption of SFAS 121 in 1995, which had a significant effect on restaurant results. Historically, PepsiCo had evaluated and measured impairment on a total division basis. As a result of adopting SFAS 121, PepsiCo now evaluates each individual restaurant for impairment. This change resulted in a charge of $437 million to reduce the carrying amount of 1,247 or 10% of PepsiCo's company-operated restaurants. The charge represented approximately 7% of the total carrying amount of restaurant long-lived assets. The reduced carrying amount of restaurant assets is expected to reduce 1996 depreciation and amortization expense by approximately $45 million. Also, because PepsiCo now evaluates each restaurant for impairment, future charges, though not of the magnitude of the initial charge recorded in 1995, are reasonably possible although not currently estimable. These charges will generally arise as estimates used in the evaluation and measurement of impairment upon adoption of SFAS 121 are refined based upon new information or as a result of future events or changes in circumstances that cause other restaurants to be impaired. Also, any future expenditures for impaired stores that would normally be capitalized will have to be immediately evaluated for recoverability. The initial impact of adopting SFAS 121, as well as its ongoing application, will also generally result in lower closure costs or increased gains for impaired restaurants that are closed or sold, respectively. As disclosed in our 1994 Annual Report and updated in our 1995 reports on Form 10-Q, we have evaluated and begun to execute actions in 1995 in an effort to improve total restaurant operating results and returns on our restaurant investments. Our overall strategy is to leverage the collective strength of our three restaurant concepts by strengthening our brand leadership, leveraging our business systems and restaurant development activities, and achieving operational excellence. Brand leadership contemplates, in part, the need to be innovative by providing new products and programs to respond to consumer needs while maintaining a value orientation. This year, for example, we have introduced several new products such as Pizza Hut's Stuffed Crust Pizza and Buffalo Wings, KFC's Tumble Marinated Original Recipe product Colonel's, Crispy Strips and Chunky Chicken Pot Pies and Taco Bell's Double Decker Taco, Texas Taco and new line of Sizzlin' Bacon products. In addition, we have also offered new programs to respond to consumer needs such as \"You'd Be Crazy to Cook\" promotion, delivery service and the Mega Meal value offering at KFC and Extreme Value Meals, Kids' meals and the low-fat Border Lights menu at Taco Bell. We believe our ability to develop and bring to market new products that attract and maintain our customer base is an important factor for continued profit growth in the restaurant segment.\nWith respect to leveraging our business systems, consolidation of international headquarters administration of our three concepts was completed this year and consolidation of international regional and country administration is well under way. The consolidation of administrative operations in the U.S., such as payroll and accounts payable, has begun and is expected to be completed over the next few years. Also, consolidation of restaurant procurement on a worldwide basis is substantially completed with significant annual savings anticipated beginning in 1996. As we move forward, our concepts will share restaurant facilities where appropriate. For example, early indications are that our combined Taco Bell - KFC units in the U.S. are performing well, as the Taco Bell lunch business complements the strong KFC dinner business. In fact, the current plan calls for us to approximately triple the current number of combined U.S. units to over 300 units during 1996. In addition, we plan to continue to selectively use franchisees and licensees in certain markets where their expertise can be leveraged to improve the overall operational excellence of our concepts systemwide. In 1995, we began to refranchise (sell company-operated restaurants to franchisees) and license company-operated restaurants and more aggressively close stores that do not meet our performance expectations. These unit-related actions aided worldwide restaurant operating profit growth by $61 million, reflecting a net gain of $51 million in 1995 ($88 million of refranchising gains offset by $37 million of costs of closing other restaurants) as compared to $10 million of store closure costs in 1994. Included in the $37 million are costs associated with 185 stores scheduled to be closed in 1996. Operating profit in 1996 is not expected to be significantly affected by the estimated net impact of the absence of profits attributed to those units sold in 1995 and those units currently anticipated to be sold in 1996 compared to the additional franchise royalty revenues related to those units and the losses avoided for restaurants closed in 1995 and scheduled to be closed in 1996. Though difficult to forecast, management anticipates a favorable impact from these kinds of unit-related actions over the next few years as we continue the implementation of our strategies to improve restaurant returns. We expect that total system units will, on average, continue to expand at 1995's annual rate of approximately 6%, though only about 1% of the net growth will be company-operated. As a result, although our overall ownership percentage of total system units declined by about 2 1\/2 points in 1995, we continue to anticipate that our percentage ownership will decline on average by 1 to 2 points annually over the next 3 to 5 years, driven by declines in the U.S.\n1995 RESTAURANT UNIT ACTIVITY Company- Joint Operated Venture Franchised Licensed Total -------- ------- ---------- -------- ----- Worldwide Restaurants Beginning of 12,742 933 11,364 1,830 26,869 Year New Builds & Acquisitions 678 96 553 1,016 2,343\nRefranchising & Licensing (308) (6) 269 45 - Closures (293) (19) (161) (143) (616) ------ ---- ------ ----- ------\nEnd of Year 12,819* 1,004 12,025 2,748 28,596 ====== ===== ====== ===== ======\nU.S. Restaurants** Beginning of Year 10,520 70 7,238 1,693 19,521 New Builds & Acquisitions 416 11 217 951 1,595 Refranchising & Licensing (302) - 257 45 -\nClosures (269) (3) (113) (138) (523) ------ ----- ----- ----- ------ End of Year 10,365* 78 7,599 2,551 20,593 ====== ===== ===== ===== ======\n* As of year-end 1995, closure costs have been recorded for 185 of these units (141 in the U.S.), which are expected to close in 1996. ** The U.S. joint venture units represent California Pizza Kitchen. - ------------------------------------------------------------------------------- [Note: A summary of the 1995 restaurant unit activity for each U.S. concept and for international restaurant operations is included in each of the following discussions.]\nRestaurants generated cash flows of nearly $600 million in 1995 compared to marginally positive cash flows in 1994. This primarily reflected reduced capital spending and acquisitions of $322 million and $78 million, respectively, and proceeds of $165 million from our refranchising efforts. We currently estimate that our level of capital spending in 1996 will approximate the $750 million invested in 1995; however, we expect more of the spending to be used for refurbishing our existing restaurants and less on new store development. With respect to operational excellence, we have made investments in a number of initiatives during the past year targeted at consistently providing our customers with high quality products, courteous and timely service and clean and attractive restaurants. We believe this is an important factor in maintaining our current customer base as well as attracting new customers. We have implemented customer satisfaction measures to evaluate the success of these initiatives.\n1994 vs. 1993\nWorldwide net sales increased $1.2 billion or 12%. The fifty-third week contributed approximately 1 point to the sales growth, with U.S. and international operations benefiting by about 1 point and 2 points, respectively. Sales in the U.S. increased $668 million or 8% and international sales rose $497 million or 37%. Worldwide operating profit declined $48 million or 6%. The fifty-third week mitigated the profit decline by approximately 3 points, with U.S. and international operations benefiting at the same rate. Profit in the U.S. declined $26 million or 4% and international profit fell $22 million or 24%, which included a $7 million charge to consolidate the U.S. headquarters for the three international restaurant concepts into one. The significant devaluation of the Mexican peso in late 1994 and early 1995 did not materially impact 1994 international restaurant operating profit. Results from Mexico constituted an immaterial portion of international restaurant profit. However, the devaluation and its related effects were expected to have an unfavorable impact on 1995 results. The operations in Mexico had begun increasing pricing and reducing costs, including evaluating alternative sourcing of raw materials. In addition, further expansion of company-operated units was temporarily halted pending stabilization of the economy. Nonetheless, significant uncertainties remained in Mexico and, as a result, it was not possible to quantify the impact. Late in 1994, Roger Enrico was named Chairman, PepsiCo Worldwide Restaurants. He began to evaluate several options to improve their operating results and returns on our total restaurant investments. Examples of options considered to improve investment returns included a reduced company share of future new restaurant development and sale of some existing company restaurants to franchisees. The cash generated from these options would most likely be reinvested in our nonrestaurant businesses or used to repurchase PepsiCo capital stock. We expected to begin making decisions on these and other options during 1995 as we continued to refine our restaurant operating strategies.\nPIZZA HUT - U.S.\nThe tables of operating results and unit activity presented below include Pizza Hut as well as D'Angelo Sandwich Shops (D'Angelo) and East Side Mario's concepts, which are managed by Pizza Hut. As D'Angelo is generally fully integrated within Pizza Hut units, the elements in the year-over-year discussion of net sales and operating profit that follows relate to Pizza Hut as well as D'Angelo and excludes East Side Mario's, unless otherwise indicated.\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales $3,977 $3,712 $3,595 7 3\nOperating Profit Reported $ 308 $ 285 $ 338 8 (16)\nOngoing* $ 376 $ 285 $ 338 32 (16)\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. - ------------------------------------------------------------------------------- 1995 RESTAURANT UNIT ACTIVITY\nCompany- Operated Franchised Licensed Total -------- ---------- -------- ----- Beginning of 5,249 2,708 661 8,618 Year New Builds & Acquisitions 213 89 257 559 Refranchising & Licensing (88) 88 - -\nClosures (173) (66) (55) (294) ----- ----- --- ----- End of Year 5,201* 2,819 863 8,883 ===== ===== === =====\n* As of year-end 1995, closure costs have been recorded for 104 of these units, which are expected to be closed in 1996. - -------------------------------------------------------------------------------\n1995 vs. 1994\nNet sales increased $265 million or 7%. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The sales growth reflected $148 million from additional units (units constructed and acquired, principally from franchisees, net of units closed or sold, principally to franchisees) and growth in same store sales for company-operated units of 4%. The improved same store sales performance was driven by Stuffed Crust Pizza, introduced nationally early in the second quarter, and reflected strong growth in carryout and\ndelivery, and modest growth in dine-in. Same store sales increases were also fueled by a higher average guest check resulting from less promotional pricing than in 1994 and the early 1995 national introduction of Buffalo Wings. Reported operating profit grew $23 million or 8%. Ongoing operating profit increased $91 million or 32%, in part, reflecting a weak profit performance in 1994 combined with the exceptional performance of Stuffed Crust Pizza. The fifty-third week in 1994 reduced the profit growth by approximately 3 points. The profit growth reflected additional units that contributed $31 million, a net gain of $24 million in 1995 ($42 million of refranchising gains offset by $18 million of costs of closing other restaurants) as compared to $4 million of store closure costs in 1994, lower store operating costs and increased franchise royalty revenues. The lower store operating costs primarily reflected increased labor productivity, favorable food prices, led by lower cheese and meat prices, and reduced advertising expenses, partially offset by increased spending for our customer satisfaction program. The profit growth was depressed by a net $17 million charge in 1995 composed of a $20 million charge recorded in the second quarter for the relocation of certain functions of Pizza Hut's U.S. headquarters from Wichita to Dallas, partially offset by net favorable adjustments of $3 million primarily as a result of better than expected costs. The ongoing profit margin increased almost 2 points to 9.5%.\n1994 vs. 1993\nNet sales increased $117 million or 3%. The fifty-third week contributed approximately 1 point to the sales growth. The increased sales were driven by additional units that contributed $271 million, including $80 million from the acquisition of D'Angelo late in 1993. This benefit was partially offset by lower volumes of $105 million, primarily due to lapping the successful national roll-out of Bigfoot Pizza in 1993, and lower net pricing. Same store sales for company-operated units declined 6%, though volume decreased at a slightly slower rate. The decline was primarily in the delivery and carryout channels, reflecting the lapping of the national roll-out of Bigfoot Pizza in 1993. Operating profit decreased $53 million or 16%. The fifty-third week mitigated the profit decline by approximately 2 points. The profit decline reflected lower volumes of $49 million ($60 million excluding the impact of the fifty-third week), lower net pricing and increased overhead costs, due in part to increased store closure costs, partially offset by additional units that contributed $17 million. Store operating costs were essentially unchanged primarily reflecting lower advertising and favorable food costs, as slightly higher cheese prices were more than offset by favorable meat prices, offset by increased depreciation attributable to new equipment related to Bigfoot Pizza. Though difficult to forecast, the prices of these key ingredients were expected to decrease in 1995. The profit decline was also mitigated by a favorable impact of $14 million from extending depreciable lives on certain U.S. delivery assets and the absence of last year's start-up costs associated with Bigfoot Pizza. The profit margin declined almost 2 points to 7.7%.\nTACO BELL - U.S.\nThe tables of operating results and unit activity presented below include Taco Bell as well as the Hot `n Now (HNN) and Chevys concepts, which are managed by Taco Bell. The elements in the year-over-year discussion of net sales and operating profit that follows do not include HNN and Chevys, unless otherwise indicated.\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales $3,503 $3,340 $2,855 5 17\nOperating Profit Reported $ 105 $ 273 $ 256 (62) 7\nOngoing* $ 274 $ 273 $ 256 - 7\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. - ------------------------------------------------------------------------------- 1995 RESTAURANT UNIT ACTIVITY\nCompany- Operated Franchised Licensed Total -------- ---------- -------- -----\nBeginning of Year 3,232 1,523 929 5,684 New Builds & Acquisitions 190 98 668 956 Refranchising & Licensing (214) 169 45 - Closures (75) (11) (64) (150) ----- ----- ---- ----- End of Year 3,133 1,779 1,578 6,490 ===== ===== ===== ===== - -------------------------------------------------------------------------------\n1995 vs. 1994\nNet sales increased $163 million or 5%. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The sales growth was led by additional units which contributed $228 million. A decline in restaurant volume of $143 million, reflecting a 4% decline in same store sales for company-operated units, was partially offset by increased PFS sales to franchisees of $50 million. A decline in sales at HNN, primarily reflecting the absence of sales associated with company-operated units licensed in 1995 (see below for additional discussion), was substantially offset by increased sales at Chevys, primarily reflecting additional units.\nReported operating profit declined $168 million or 62%. Ongoing operating profit increased $1 million. Absent the fifty-third week in 1994, ongoing operating profit for 1995 would have increased 4 points. The slight increase in profit reflected a net gain of $40 million in 1995 ($42 million of refranchising gains offset by $2 million of costs of closing other restaurants). This net gain was offset by $12 million in 1995 for the write-off of costs associated with sites that will not be developed (undeveloped sites), compared to $6 million of undeveloped sites costs in 1994. Profit growth was also aided by additional units which contributed $23 million and lower store operating costs. The decrease in store operating costs primarily reflected favorable food costs, as lower meat and bean prices were partially offset by higher lettuce prices experienced in the second quarter. Although difficult to forecast, food prices for the full year 1996 are expected to be favorable as compared to 1995, led by lower meat prices. Profit growth also reflected increased franchise royalty revenues, in part reflecting initial franchise fees related to refranchised restaurants, and increased license fees. These benefits were substantially offset by net volume declines of $44 million ($34 million excluding the impact of the fifty-third week) and a net unfavorable product mix shift to lower-margin products. The net volume declines resulted from the reduced same store sales partially offset by the lower-margin PFS increases. Operating profit was also adversely impacted by roll-out costs incurred during the first half of the year for the low-fat Border Lights products. Increased field training costs were offset by reduced headquarters administrative expenses. HNN and Chevys incurred $103 million of the initial charge upon adoption of SFAS 121, with HNN responsible for almost all of the charge. Excluding the initial charge, operating losses at Chevys increased, primarily reflecting costs associated with a curtailment of company-operated restaurant development activities. Excluding the initial charge, HNN's losses declined, primarily reflecting the absence of costs associated with undeveloped sites in 1994. As disclosed in our 1994 Annual Report and updated in our 1995 reports on Form 10-Q, during 1995, Taco Bell initiated a plan to license or franchise all of its HNN units in an effort to eliminate HNN's operating losses over time. Through the end of the third quarter, almost 75% of HNN's 200 units had been licensed or franchised. Late in the fourth quarter, certain of the HNN licensees returned 42 of their units to Taco Bell as a result of poor operating results. Almost all of these units were closed, de-identified as HNN units and are held for sale. Subsequent to year-end, our largest licensee closed and returned its 23 remaining units to Taco Bell. In addition, there are some indications that the current operating performance of the majority of the remaining licensed units is also below expectations. It is reasonably possible that some or all of these underperforming units may be returned during 1996 by the licensees. Any costs associated with units returned in 1996 are expected to be immaterial to Taco Bell's results. Taco Bell will continue its efforts to license or sell the remaining company-operated HNN units and undeveloped sites. The Taco Bell ongoing profit margin declined nearly one-half point to 7.8%.\n1994 vs. 1993\nNet sales increased $485 million or 17%. The fifty-third week benefited the sales growth by approximately 2 points. The sales growth was led by additional units which contributed $267 million and volume gains that provided $121 million, half of which was the result of PFS food and paper sales to additional franchisees. The sales growth also reflected $84\nmillion due to the acquisition of Chevys in the third quarter of 1993 and new Chevys units. Same store sales for company-operated units grew 2%, though volume grew at a slower rate. Operating profit rose $17 million or 7%. The fifty-third week enhanced the profit growth by approximately 4 points. The profit growth reflected lower food costs, additional units which contributed $25 million, volume gains of $25 million ($15 million excluding the impact of the fifty-third week), higher soft drink prices and increased franchise royalty revenues. These benefits were partially offset by higher store operating costs, driven by increased labor costs, an unfavorable mix shift to lower-margin products and higher headquarters administrative expenses. Profit growth was restrained by increased losses posted by HNN. Taco Bell planned to transition HNN during 1995 from primarily a company-operated to a licensee\/franchisee-operated business. This was expected to significantly reduce HNN's operating losses in 1995. The profit margin fell almost 1 point to 8.2%.\nKFC - U.S.\n% Growth Rates ($ in millions) -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales $1,722 $1,642 $1,576 5 4\nOperating Profit Reported $ 38 $ 101 $ 91 (62) 11\nOngoing* $ 103 $ 101 $ 91 2 11\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. - ------------------------------------------------------------------------------- 1995 RESTAURANT UNIT ACTIVITY\nCompany- Operated Franchised Licensed Total -------- ---------- -------- ----- Beginning of Year 2,039 3,007 103 5,149 New Builds & Acquisitions 13 30 26 69 Refranchising & Licensing - - - - Closures (21) (36) (19) (76) ----- ----- ----- ----- End of Year 2,031* 3,001 110 5,142 ===== ===== ===== =====\n* As of year-end 1995, closure costs have been recorded for 31 of these units, which are expected to be closed in 1996. - -------------------------------------------------------------------------------\n1995 vs. 1994\nNet sales rose $80 million or 5%. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The increased sales were driven by volume gains of $61 million and higher effective net pricing. The volume gains benefited from new product offerings during the year such as Colonel's Crispy Strips, Chunky Chicken Pot Pies and a Tumble Marinated Original Recipe product as well as the national introduction of the value-oriented Mega Meal late in 1994, which was complemented by the 1995 high-end \"You'd Be Crazy To Cook\" offerings. Same store sales for company-operated units advanced 7%, primarily reflecting strong volume growth. Reported operating profit decreased $63 million or 62%. Ongoing operating profit increased $2 million or 2%. The fifty-third week in 1994 reduced the ongoing profit growth by approximately 4 points. The profit growth reflected volume gains of $18 million ($24 million excluding the impact of the fifty-third week) and the higher effective net pricing. Almost fully offsetting these gains were increased store operating costs, increased overhead costs, primarily for new product development, reduced favorable actuarial adjustments for casualty claims liabilities and losses attributed to expanding delivery service. The higher store operating costs reflected increased labor costs, primarily as a result of efforts to improve restaurant quality and service. The profit growth was also mitigated by $7 million of store closure costs in 1995 compared to $5 million in 1994. The ongoing profit margin decreased slightly to 6.0%.\n1994 vs. 1993\nNet sales rose $66 million or 4%. The fifty-third week contributed approximately 2 points to the sales growth. The increased sales reflected an increase in volume of $49 million, as gains from the Colonel's Rotisserie Gold roasted chicken product and accompanying side items (collectively, \"CRG\"), and the value-oriented Mega Meal were partially offset by lower volumes of existing products, and higher net pricing. Same store sales for company-operated units advanced 2%, though volumes grew at a slightly slower rate. Operating profit increased $10 million or 11%. The fifty-third week contributed approximately 4 points to the profit growth. The increased profit benefited from the absence of last year's start-up costs associated with CRG. Higher net pricing and volume gains of $16 million ($10 million excluding the impact of the fifty-third week) were offset by a mix shift to the lower-margin CRG and Mega Meal offerings. Reduced store operating costs, including lower product costs, primarily due to reformulation of side items late in the second quarter, and the 1994 impact of favorable actuarial adjustments to prior years workers' compensation claim accruals, were partially offset by increased administrative costs. Profit growth was depressed by lapping last year's $3 million favorable adjustment to a 1991 reorganization accrual. The profit margin increased nearly one-half point to 6.2%.\nINTERNATIONAL\n($ in millions) % Growth Rates -------------- 1995 1994 1993 1995 1994 ---- ---- ---- ---- ----\nNet Sales $2,126 $1,827 $1,330 16 37\nOperating Profit Reported $ (21) $ 71 $ 93 NM (24)\nOngoing* $ 114 $ 71 $ 93 61 (24)\n* 1995 excluded the initial, noncash charge upon adoption of SFAS 121. See Notes 2 and 19. NM = Not Meaningful. - ------------------------------------------------------------------------------- 1995 RESTAURANT UNIT ACTIVITY\nCompany- Joint Operated Venture Franchised Licensed Total -------- ------- ---------- -------- -----\nBeginning of 2,222 863 4,126 137 7,348 Year New Builds & Acquisitions 262 85 336 65 748 Refranchising & Licensing (6) (6) 12 - - Closures (24) (16) (48) (5) (93) ---- --- --- --- --- End of Year 2,454* 926 4,426 197 8,003 ===== === ===== === =====\n* As of year-end 1995, closure costs have been recorded for 44 of these units, which are expected to be closed in 1996. - -------------------------------------------------------------------------------\n1995 vs. 1994\nThe KFC, Pizza Hut and Taco Bell concepts represented approximately 55%, 40% and 5%, respectively, of total international restaurant sales in 1995 and 1994. Net sales increased $299 million or 16%, with Pizza Hut representing approximately 65% of the increased sales. The fifty-third week in 1994 reduced the sales growth by approximately 2 points. The sales increase primarily reflected additional units of $244 million. Reported operating profit declined $92 million to a loss of $21 million. Excluding the initial charge upon adoption of SFAS 121, with Spain, Canada and Mexico accounting for almost three quarters of the charge, operating profit increased $43 million or 61%. Excluding shared overhead costs, Pizza Hut and KFC contributed about equally to the increased operating profit. The fifty-third week in 1994 reduced the ongoing operating profit\ngrowth rate by approximately 7 points. The increased profit reflected higher effective net pricing, additional units that contributed $22 million, increased franchise royalty revenues and net favorable currency translation impacts. These gains were partially offset by higher store operating costs, led by increased food prices, increased administrative and support costs, and a $17 million reduction in volumes ($14 million excluding the impact of the fifty-third week). The increased administrative and support costs reflected spending to support country development strategies, partially offset by lapping a $7 million charge late in 1994 to consolidate the international headquarters operations in the U.S. of the three concepts and the related savings in 1995 from this consolidation as well as savings from a consolidation of regional and country headquarter operations. The ongoing profit margin increased 1 1\/2 points to 5.4%. Following is a discussion of ongoing operating profit by key international market. Increased profit in Australia, our largest international sales market, was primarily driven by the full implementation of its value strategy, the adoption of store cost control measures and a gain resulting from the sale of several store properties leased to a franchisee as well as the refranchising of a few stores. Profit gains in Korea primarily reflected additional units, while higher profit in New Zealand primarily reflected volume growth and acquired units. Profit also rose in Canada and the U.K., reflecting higher guest check averages and acquired units, respectively. Partially offsetting these profit gains were significantly increased losses in Spain, Mexico and Brazil. Spain reflected closure costs for a significant number of stores scheduled to be closed in 1996, poor performance by new units, volume declines and increased costs. As discussed on pages 12 and 13, results in Mexico have been adversely impacted by the economic difficulties resulting from the significant devaluation of the Mexican peso. Net sales in Mexico declined 44%, while operating losses increased $8 million to $17 million, reflecting lower volumes and higher costs, which were only partially offset by higher effective pricing and the favorable currency translation impact on increased local currency operating losses. Brazil's increased losses were primarily due to higher administrative and support costs.\n1994 vs. 1993\nKFC, Pizza Hut and Taco Bell represented approximately 55%, 40% and 5%, respectively, of total international sales in 1994 and 1993. Net sales increased $497 million or 37%, with KFC and Pizza Hut each contributing about equally to the sales increase. The fifty-third week contributed approximately 2 points to the sales growth. The sales growth primarily reflected additional units of $398 million and volume growth of $121 million, partially offset by lower net pricing. Operating profit declined $22 million or 24%. The decline in operating profit was due to Pizza Hut. The fifty-third week mitigated the rate of profit decline by approximately 3 points. The decreased profit reflected lower net pricing, increased administrative and support costs, primarily to support an extraordinary rate of unit development, higher store operating costs and a $7 million charge to consolidate the headquarters operations in the U.S. for the three international restaurant concepts into one. These were partially offset by increased volumes of $52 million ($49 million excluding the impact of the fifty-third week), additional units that contributed $29 million and higher franchise royalty revenues. Following is a discussion of operating profit by key international market. Australia, our largest international sales market, had slightly lower profit. Korea's operating profit increased significantly, driven by additional units and volume gains. Profit declined sharply\nin Mexico and Canada, due in part to increased administrative costs. Brazil incurred an operating loss as a result of losses on acquired units. Poland experienced additional start-up losses from new operations. Profit increases in New Zealand and the U.K. reflected volume gains and acquired units, respectively. The profit margin declined more than 3 points to 3.9%.\nCONSOLIDATED FINANCIAL CONDITION\nASSETS increased $640 million or 3% to $25.4 billion. The increase reflected the normal growth of the businesses, partially offset by the impact of the initial charge of $520 million upon adoption of SFAS 121 (see Note 2) primarily affecting property, plant and equipment, intangible assets and, to a much lesser extent, investments in unconsolidated affiliates and other noncurrent assets. Increased accounts and notes receivable reflected slower collections and volume advances in worldwide beverages and snack foods. Short-term investments largely represent high-grade marketable securities portfolios held outside the U.S. Our portfolio in Puerto Rico, which totaled $816 million at year-end 1995 and $853 million at year-end 1994, arises from the operating cash flows of a centralized concentrate manufacturing facility that operates under a tax incentive grant. The grant provides that the portfolio funds may be remitted to the U.S. without any additional tax. PepsiCo remitted $792 million of the portfolio to the U.S. in 1995 and $380 million in 1994. PepsiCo continually reassesses its alternatives to redeploy its maturing investments in this and other portfolios held outside the U.S., considering other investment opportunities and risks, tax consequences and overall financing strategies. LIABILITIES rose $183 million or 1% to $18.1 billion. The $643 million increase in other long-term liabilities was partially offset by a $304 million reduction in debt. The increase in other long-term liabilities primarily reflected normal growth and a reclassification of amounts to current liabilities. At year-end 1995 and 1994, $3.5 billion and $4.5 billion, respectively, of short-term borrowings were classified as long-term, reflecting PepsiCo's intent and ability, through the existence of its unused revolving credit facilities, to refinance these borrowings. PepsiCo's unused credit facilities with lending institutions, which exist largely to support the issuances of short-term borrowings, were $3.5 billion at year-end 1995 and 1994. Effective January 3, 1995, PepsiCo replaced its existing credit facilities with revolving credit facilities aggregating $4.5 billion, of which $1.0 billion was to expire in 1996 and $3.5 billion was to expire in 2000. Effective December 8, 1995, PepsiCo terminated the $1.0 billion due to expire in 1996 based upon a current assessment of the amount of credit facilities required compared to its related cost. The expiration of the remaining credit facilities of $3.5 billion was extended to 2001. Annually, these facilities can be extended an additional year upon the mutual consent of PepsiCo and the lending institutions.\nFINANCIAL LEVERAGE is measured by PepsiCo on both a market value and historical cost basis. PepsiCo believes that the most meaningful measure of debt is on a net basis, which takes into account its large investment portfolios held outside the U.S. These portfolios are managed as part of PepsiCo's overall financing strategy and are not required to support day-to-day operations. Net debt reflects the pro forma remittance of the portfolios (net of related taxes) as a reduction of total debt. Total debt includes the present value of operating lease commitments.\n1995 1994 1993 ----- ----- ---- Graph: MARKET NET DEBT RATIO 18% 26% 22%\n1995 1994 1993 ----- ----- ---- Graph: HISTORICAL COST NET DEBT 46% 49% 50% RATIO\nPepsiCo believes that market leverage (defined as net debt as a percent of net debt plus the market value of equity, based on the year-end stock price) is an appropriate measure of PepsiCo's long-term financial leverage. Unlike historical cost measures, the market value of equity primarily reflects the estimated net present value of expected future cash flows that will both support debt and provide returns to shareholders. PepsiCo has established a long-term target range of 20%-25% for its market net debt ratio to optimize its cost of capital. The market net debt ratio declined 8 points to 18% at year-end 1995 due primarily to a 54% increase in PepsiCo's stock price. The 4 point increase to 26% at year-end 1994 was due to a 13% decline in PepsiCo's stock price as well as an 8% increase in net debt. As measured on an historical cost basis, the ratio of net debt to net capital employed (defined as net debt, other liabilities, deferred income taxes and shareholders' equity) declined 3 points to 46%, reflecting a 2% decline in net debt and a 4% increase in net capital employed. The 1 point decline to 49% at year-end 1994 was due to a 9% increase in net capital employed, partially offset by the increase in net debt. Because of PepsiCo's strong cash generating capability and its strong financial condition, PepsiCo has continued access to capital markets throughout the world. At year-end 1995, about 62% of PepsiCo's net debt portfolio, including the effects of interest rate and currency swaps (see Note 8), was exposed to variable interest rates, compared to about 60% in 1994. In addition to variable rate long-term debt, all net debt with maturities of less than one year is categorized as variable. PepsiCo prefers funding its operations with variable rate debt because it believes that, over the long-term, variable rate debt provides more cost effective financing than fixed rate debt. PepsiCo will issue fixed rate debt if advantageous market opportunities arise. A 1 point change in interest rates on variable rate net debt would impact annual interest expense, net of interest income, by approximately $36 million ($19 million after-tax or $0.02 per share) assuming the level and mix of the December 30, 1995 net debt portfolio were maintained. PepsiCo's negative operating working capital position, which principally reflects the cash sales nature of its restaurant operations, effectively provides additional capital for investment. Operating working capital, which excludes short-term investments and short-term borrowings, was a negative $94 million and $677 million at year-end 1995 and 1994, respectively. The $583 million decline in negative working capital primarily reflected the reclassification of amounts from long-term to current liabilities, base business growth in the\nmore working capital intensive bottling and snack food operations exceeding the growth in restaurant operations and an increase in prepaid taxes. SHAREHOLDERS' EQUITY increased $457 million or 7% to $7.3 billion. This change reflected a 13% increase in retained earnings due to $1.6 billion in net income less dividends declared of $615 million. This growth was reduced by a $337 million unfavorable change in the currency translation adjustment account (CTA) and a $322 million increase in treasury stock, reflecting repurchases of 12 million shares offset by 10 million shares used for stock option exercises. The CTA change primarily reflected the effects of the Mexican peso devaluation.\nRETURN ON AVERAGE SHAREHOLDERS' EQUITY Based on income before cumulative effect of accounting changes, PepsiCo's return on average shareholders' equity was 23% and 27% in 1995 and 1994, respectively. Excluding the initial charge upon adoption of SFAS 121 in 1995 (see Note 2) and the 1994 BAESA gain (see Note 16), the return on average shareholders' equity was 27% in 1995 and 1994.\nCONSOLIDATED CASH FLOWS\nCash flow activity in 1995 reflected strong cash flows from operations of $3.7 billion which were used to fund capital spending of $2.1 billion, dividend payments of $599 million, purchases of treasury stock totaling $541 million and acquisition and investment activity of $466 million.\nGraph: Net Cash Provided by Operating Activities vs. Capital Spending, Dividends Paid, Acquisitions and Purchases of Treasury Stock ($ in millions) 1995 1994 1993 ----- ----- -----\nNet Cash Provided By $3,742 $3,716 $3,134 ====== ====== ====== Operating Activities\nCapital spending $2,104 $2,253 $1,982 Dividends paid 599 540 462 Acquisitions 466 316 1,011 Treasury stock 541 549 463 ------ ------ ------ $3,710 $3,658 $3,918 ====== ====== ======\nOne of PepsiCo's most significant financial strengths is its internal cash generation capability. In fact, after capital spending and acquisitions, each of our three industry segments generated positive cash flows in 1995, led by restaurants, which generated nearly $600 million in cash flow compared to marginally positive cash flows in 1994. Net cash flows from PepsiCo's U.S. businesses were partially offset by international uses of cash, reflecting strategies to accelerate growth of international operations.\nCASH FLOWS - SUMMARY OF OPERATING ACTIVITIES ($ in millions)\n1995 1994 1993 ---- ---- ----\nIncome before cumulative effect of accounting $1,606 $1,784 $1,588 changes\nImpairment of long-lived 520 - - assets Other noncash charges, net 2,027 1,901 1,872 ----- ----- ----- Income before noncash charges and credits 4,153 3,685 3,460 Net change in operating working capital (411) 31 (326) ---- ---- ----- Net Cash Provided by Operating Activities $3,742 $3,716 $3,134 ====== ====== ====== - -------------------------------------------------------------------------\nNet cash provided by operating activities in 1995 rose $26 million or 1% over 1994, and in 1994, grew $582 million or 19% over 1993. Income before noncash charges and credits rose 13% in 1995 and 7% in 1994. Increased noncash charges of $646 million in 1995 reflected the $520 million initial, noncash impact of adopting SFAS 121 and increased depreciation and amortization charges of $163 million, partially offset by increased deferred income tax benefits of $44 million, primarily resulting from the adoption of SFAS 121. The $29 million increase in 1994 reflected increased depreciation and amortization charges of $133 million and a decrease of $150 million in the deferred income tax provision, primarily due to the effect in 1994 of converting from premium-based casualty insurance to self-insurance for most of these risks, and adopting SFAS 112 for accounting for postemployment benefits. The working capital net cash outflows of $411 million in 1995 compared to cash inflows of $31 million in 1994 primarily reflected increased growth in accounts and notes receivable, a decrease in income taxes payable in 1995 compared to an increase in 1994 and reduced growth in other current liabilities in 1995 compared to 1994, partially offset by increased growth in accounts payable, led by U.S. beverages, and a reduction in the amounts prefunded in 1995 for employee benefits. The growth in accounts and notes receivable was driven by worldwide beverages, which reflected slower collections and volume growth. The 1994 over 1993 net increase of $357 million reflected normal increases in accrued liabilities across all of our businesses, lapping the effect of higher income tax payments and a lower provision in 1993, and improved trade receivable collections, partially offset by the impact on accounts payable of the timing of a large year-end payment to prefund employee benefits.\nCASH FLOWS - SUMMARY OF INVESTING ACTIVITIES ($ in millions) 1995 1994 1993 ---- ---- ----\nAcquisitions and investments in unconsolidated $(466) $ (316) $(1,011) affiliates Capital spending (2,104) (2,253) (1,982) Sales of restaurants 165 - 7 Net short-term 64 421 259 investments Other investing (109) (213) (44) activities, net Net Cash Used for Investing Activities $(2,450) $(2,361) $(2,771) ======= ======= =======\n- -------------------------------------------------------------------------\nInvesting activities over the past three years reflected strategic investments in all three industry segments through capital spending, and acquisitions and investments in unconsolidated affiliates. PepsiCo's investments are expected to generate cash returns in excess of its long-term cost of capital, which is estimated to be approximately 10% at year-end 1995. See Note 17 for a discussion of acquisitions and investments in unconsolidated affiliates. About 85% of the total acquisition and investment activity in 1995 represented international transactions compared to 75% in 1994. PepsiCo continues to seek opportunities to strengthen its position in its industry segments, particularly in beverages and snack foods, through strategic acquisitions.\nGraph: Capital Spending ($ in millions)\nBeverages Snack Foods Restaurants Corporate TOTAL\n1995 27% 37% 35% 1% $2,104 1994 30 23 47 0 2,253 1993 25 25 50 0 1,982\nThe $149 million decline in capital spending in 1995 reflected substantially reduced spending in restaurants, consistent with our restaurant strategy discussed on page 33. Increased U.S. snack food spending, primarily for capacity expansion and new products, was partially offset by a decline in beverages. Increased capital spending of $271 million in 1994 reflected beverage investments in equipment for new packaging and new products in the U.S. and emerging international markets, primarily Eastern Europe. International capital spending represented 29%, 35% and 31% of total segment spending in 1995, 1994 and 1993, respectively. Beverages, snack foods and restaurants represent about 30%, 40% and 30%, respectively, of the $2.5 billion of planned spending in 1996. This reflects the continued shift from restaurants to snack foods. Snack food and beverage 1996 capital spending reflects production capacity expansion for both established and new products, and equipment replacements. Although restaurant spending in 1996 is expected to be about equal to 1995's level, we expect more of the spending in 1996 to be used for refurbishing our existing restaurants and less spent on new store development. Approximately 25% of the planned 1996 capital spending relates to international businesses.\nConsistent with management's strategy to improve restaurant returns (see Management's Analysis - Restaurants on page 33), proceeds from sales of restaurants in 1995 were $165 million. Although difficult to forecast, management anticipates continued cash flow from this kind of activity over the next few years. As discussed in Financial Leverage on page 46, PepsiCo manages the investment activity in its short-term portfolios, primarily held outside the U.S., as part of its overall financing strategy.\nCASH FLOWS - SUMMARY OF FINANCING ACTIVITIES ($ in millions) 1995 1994 1993 ---- ---- ----\nNet short and $ (303) $ (205) $ 590 long-term debt Cash dividends paid (599) (540) (462) Purchases of treasury (541) (549) (463) stock Proceeds from exercises of stock options 252 97 69 Other, net (42) (43) (37) Net Cash Used for ------- ----- ----- Financing Activities $(1,233) $(1,240) $(303) ======= ====== =====\n- -------------------------------------------------------------------------\nThe net cash flow used for financing activities in 1995 was about even with 1994. In 1995, increased proceeds from exercises of stock options of $155 million were offset by increased net repayments of short and long-term debt of $98 million and higher cash dividends paid of $59 million. The 1994 over 1993 change in cash flows from financing activities was a use of $937 million, primarily reflecting net repayment of short and long-term debt of $205 million compared to net proceeds of $590 million in 1993. Cash dividends declared were $615 million in 1995 and $555 million in 1994. PepsiCo targets a dividend payout of about one-third of the prior year's income from ongoing operations, thus retaining sufficient earnings to provide financial resources for growth opportunities. Share repurchase decisions are evaluated considering management's target capital structure and other investment opportunities. PepsiCo expects to repurchase at least 1% to 2% of its outstanding shares each year for the next several years. During 1995, PepsiCo repurchased 1.6% of its shares outstanding at the beginning of 1995, or 12.3 million shares, at a cost of $541 million. Subsequent to year-end, PepsiCo repurchased 1.7 million shares through February 6, 1996 at a cost of $99 million. During 1994, PepsiCo repurchased 1.9% of the shares outstanding at the beginning of 1994, or 15.0 million shares, at a cost of $549 million. Through February 6, 1996, 29.4 million shares have been repurchased under the 50 million share repurchase authority granted by PepsiCo's Board of Directors in July 1993. In February 1996, PepsiCo's Board of Directors replaced the 1993 share repurchase authority with a new authority for 50 million shares.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index to Financial Information 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 name, age and background of each of the Company's directors nominated for reelection are contained under the caption \"Election of Directors\" in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders on pages 2 through 4 and are incorporated herein by reference. Pursuant to Item 401(b) of Regulation S-K, the directors retiring on May 1, 1996 and the executive officers of the Company are reported in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation on compensation of the Company's directors and executive officers is contained in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders under the caption \"Executive Compensation\" and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation on the number of shares of PepsiCo Capital Stock beneficially owned by each director and by all directors and officers as a group is contained under the caption \"Ownership of Capital Stock by Directors and Officers\" in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders and is incorporated herein by reference. As far as is known to the Company, no person owns beneficially more than 5% of the outstanding shares of PepsiCo Capital Stock.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot applicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K\n(a) 1. Financial Statements\nSee Index to Financial Information on page.\n2. Financial Statement Schedule\nSee Index to Financial Information on page.\n3. Exhibits\nSee Index to Exhibits on page E-1.\n(b) Reports on Form 8-K\nNone.\nS-1\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, PepsiCo has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 26, 1996\nPEPSICO, INC.\nBy: \/s\/ D. WAYNE CALLOWAY D. Wayne Calloway 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 PepsiCo and in the capacities and on the date indicated.\nSIGNATURE TITLE DATE\n\/s\/ D. WAYNE CALLOWAY Chairman of the Board and - --------------------- Chief Executive Officer March 26, 1996 D. Wayne Calloway (Principal Executive Officer)\nExecutive Vice President \/s\/ ROBERT G. DETTMER and Chief Financial March 26, 1996 - --------------------- Officer (Principal Robert G. Dettmer Financial Officer)\n\/s\/ ROBERT L. CARLETON Senior Vice President and March 26, 1996 Robert L. Carleton Controller (Principal Accounting Officer)\nVice Chairman of the \/s\/ ROGER A. ENRICO Board,Chairman and Chief March 26, 1996 - ------------------- Executive Officer, PepsiCo Roger A. Enrico Worldwide Restaurants\n\/s\/ JOHN F. AKERS Director March 26, 1996 - ----------------- John F. Akers\nS-2\n\/s\/ ROBERT E. ALLEN Director March 26, 1996 - ------------------- Robert E. Allen\n\/s\/ JOHN J. MURPHY Director March 26, 1996 - ------------------ John J. Murphy\n\/s\/ ANDRALL E. PEARSON Director March 26, 1996 - ---------------------- Andrall E. Pearson\n\/s\/ SHARON PERCY ROCKEFELLER Director March 26, 1996 --------------------------- Sharon Percy Rockefeller\n\/s\/ ROGER B. SMITH Director March 26, 1996 - ------------------ Roger B. Smith\n\/s\/ ROBERT H. STEWART, III Director March 26, 1996 - -------------------------- Robert H. Stewart, III\n\/s\/ FRANKLIN A. THOMAS Director March 26, 1996 - ---------------------- Franklin A. Thomas\n\/s\/ P. ROY VAGELOS Director March 26, 1996 - ------------------ P. Roy Vagelos\n\/s\/ ARNOLD R. WEBER Director March 26, 1996 - ------------------- Arnold R. Weber\nE-1\nINDEX TO EXHIBITS ITEM 14(a)(3) EXHIBIT\n3.1 Restated Articles of Incorporation of PepsiCo, Inc., which is incorporated herein by reference from Exhibit 4(a) to PepsiCo's Registration Statement on Form S-3 (Registration No. 33-57181).\n3.2 Copy of By-Laws of PepsiCo, Inc., as amended to February 22, 1996.\n4 PepsiCo, Inc. agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any instrument defining the rights of holders of long-term debt of PepsiCo, Inc. and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the Securities and Exchange Commission.\n10.1 Description of PepsiCo, Inc. 1988 Director Stock Plan, which is incorporated herein by reference from Post-Effective Amendment No. 2 to PepsiCo's Registration Statement on Form S-8 (Registration No. 33-22970).\n10.2 Copy of PepsiCo, Inc. 1987 Incentive Plan (the \"1987 Plan\"), which is incorporated by reference from Exhibit 10(b) to PepsiCo's Annual Form 10-K for the Fiscal Year ended December 26, 1992.\n10.3 Copy of PepsiCo, Inc. 1979 Incentive Plan (the \"Plan\"), which is incorporated by reference from Exhibit 10(c) to PepsiCo's Annual Report on Form 10-K for the Fiscal year ended December 28, 1991.\n10.4 Copy of Operating Guideline No. 1 under the 1987 Plan, as amended through July 25, 1991, which is incorporated by reference from Exhibit 10(d) to PepsiCo's Annual Report on Form 10-K for the fiscal year ended December 28, 1991.\n10.5 Copy of Operating Guideline No. 2 under the 1987 Plan and the Plan, as amended through January 22, 1987, which is incorporated herein by reference from Exhibit 28(b) to PepsiCo's Registration Statement on Form S-8 (Registration No. 33-19539).\n10.6 Amended and Restated PepsiCo Long Term Savings Program, dated June 29, 1994, which is incorporated herein by reference from Exhibit 10(f) to PepsiCo's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.7 Amendment to Amended and Restated PepsiCo Long Term Savings Program, dated September 14, 1994 which is incorporated herein by reference from Exhibit 10(g) to PepsiCo's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\nE-1\n10.8 Amendment to Amended and Restated PepsiCo Long Term Savings Program, dated November 9, 1995.\n10.9 Amendment to Amended and Restated PepsiCo Long Term Savings Program, dated December 21, 1995.\n10.10 Copy of PepsiCo, Inc. 1995 Stock Option Incentive Plan, which is incorporated herein by reference from PepsiCo's Registration Statement on Form S-8 (Registration No. 33-61731).\n10.11 Copy of PepsiCo, Inc. 1994 Long-Term Incentive Plan, which is incorporated herein by reference from Exhibit A to PepsiCo's Proxy Statement for its 1994 Annual Meeting of Shareholders.\n10.12 Copy of PepsiCo, Inc. Executive Incentive Compensation Plan, which is incorporated herein by reference from Exhibit B to PepsiCo's Proxy Statement for its 1994 Annual Meeting of Shareholders.\n10.13 Copy of PepsiCo, Inc. Restaurant Deferred Compensation Plan, which is incorporated herein by reference from PepsiCo's Registration Statement on Form S-8 (Registration No. 333-01377).\n11 Computation of Net Income Per Share of Capital Stock -- Primary and Fully Diluted.\n12 Computation of Ratio of Earnings to Fixed Charges.\n21 Active Subsidiaries of PepsiCo, Inc.\n23 Report and Consent of KPMG Peat Marwick LLP.\n24 Copy of Power of Attorney.\n27 Financial Data Schedule.\nPepsiCo, Inc. and Subsidiaries ------------------------------\nFINANCIAL INFORMATION\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED DECEMBER 30, 1995\nPEPSICO, INC. AND SUBSIDIARIES\nINDEX TO FINANCIAL INFORMATION Item 14(a)(1)-(2)\nPage Reference Item 14(a)(1) Financial Statements\nConsolidated Statement of Income for the fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993............... Consolidated Balance Sheet at December 30, 1995 and December 31, 1994................................. Consolidated Statement of Cash Flows for the fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993............... Consolidated Statement of Shareholders' Equity for the fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993............... Notes to Consolidated Financial Statements............... Management's Responsibility for Financial Statements..... Report of Independent Auditors, KPMG Peat Marwick LLP.... Selected Quarterly Financial Data........................ Selected Financial Data..................................\nItem 14(a)(2) Financial Statement Schedule\nII Valuation and Qualifying Accounts and Reserves for the fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993.......\nAll other financial statements and 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 above listed financial statements or the notes thereto.\n- ------------------------------------------------------------------------ CONSOLIDATED STATEMENT OF INCOME (in millions except per share amounts) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993\n1995 1994 1993 (52 Weeks) (53 Weeks) (52 Weeks) - ----------------------------------------------------------------------------- NET SALES............................. $30,421 $28,472 $25,021 COSTS AND EXPENSES, NET Cost of sales......................... 14,886 13,715 11,946 Selling, general and administrative expenses.............. 11,712 11,244 9,864 Amortization of intangible assets..... 316 312 304 Impairment of long-lived assets....... 520 - - ------- ------- ------- OPERATING PROFIT 2,987 3,201 2,907\nGain on stock offering by an unconsolidated affiliate............. - 18 - Interest expense...................... (682) (645) (573) Interest income....................... 127 90 89 ------- ------- -------\nINCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES........ 2,432 2,664 2,423\nPROVISION FOR INCOME TAXES............ 826 880 835 ------- ------- -------\nINCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES.................. 1,606 1,784 1,588\nCUMULATIVE EFFECT OF ACCOUNTING CHANGES Postemployment benefits (net of income tax benefit of $29).................. - (55) - Pension assets (net of income tax expense of $15)...................... - 23 - ------- ------- -------\nNET INCOME............................ $ 1,606 $ 1,752 $ 1,588 ======= ======= =======\nINCOME (CHARGE) PER SHARE Before cumulative effect of accounting changes.............................. $ 2.00 $ 2.22 $ 1.96 Cumulative effect of accounting changes Postemployment benefits.............. - (0.07) - Pension assets....................... - 0.03 - ------- ------- -------\nNET INCOME PER SHARE.................. $ 2.00 $ 2.18 $ 1.96 ======= ======= =======\nAverage shares outstanding............ 804 804 810 - ----------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements. - -----------------------------------------------------------------------------\n- --------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET (in millions except per share amount) PepsiCo, Inc. and Subsidiaries December 30, 1995 and December 31, 1994 1995 1994 - --------------------------------------------------------------------------- ASSETS\nCURRENT ASSETS Cash and cash equivalents...................... $ 382 $ 331 Short-term investments, at cost................ 1,116 1,157 ------- ------- 1,498 1,488 Accounts and notes receivable, less allowance: $150 in 1995 and $151 in 1994................ 2,407 2,051 Inventories.................................... 1,051 970 Prepaid expenses, taxes and other current assets.......................... 590 563 ------- ------- TOTAL CURRENT ASSETS...................... 5,546 5,072\nINVESTMENTS IN UNCONSOLIDATED AFFILIATES....... 1,635 1,295 PROPERTY, PLANT AND EQUIPMENT, NET............. 9,870 9,883 INTANGIBLE ASSETS, NET......................... 7,584 7,842 OTHER ASSETS................................... 797 700 ------- ------- TOTAL ASSETS............................ $25,432 $24,792 ======= =======\nLIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable............................... $ 1,556 $ 1,452 Accrued compensation and benefits.............. 815 753 Short-term borrowings.......................... 706 678 Accrued marketing.............................. 469 546 Income taxes payable........................... 387 672 Other current liabilities...................... 1,297 1,169 ------- ------- TOTAL CURRENT LIABILITIES................. 5,230 5,270\nLONG-TERM DEBT................................. 8,509 8,841 OTHER LIABILITIES.............................. 2,495 1,852 DEFERRED INCOME TAXES.......................... 1,885 1,973\nSHAREHOLDERS' EQUITY Capital stock, par value 1 2\/3 cents per share: authorized 1,800 shares, issued 863 shares.... 14 14 Capital in excess of par value................. 1,060 935 Retained earnings.............................. 8,730 7,739 Currency translation adjustment and other...... (808) (471) ------- ------- 8,996 8,217 Less: Treasury stock, at cost: 75 shares and 73 shares in 1995 and 1994, respectively.......................... (1,683) (1,361) ------- ------- TOTAL SHAREHOLDERS' EQUITY................ 7,313 6,856 ------- -------\nTOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................... $25,432 $24,792 ======= ======= - --------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements. - ---------------------------------------------------------------------------\n- --------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS (PAGE 1 OF 2) (in millions) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993\n1995 1994 1993 (52 Weeks) (53 Weeks) (52 Weeks) - ----------------------------------------------------------------------------- CASH FLOWS - OPERATING ACTIVITIES Income before cumulative effect of accounting changes................. $ 1,606 $ 1,784 $ 1,588 Adjustments to reconcile income before cumulative effect of accounting changes to net cash provided by operating activities Depreciation and amortization..... 1,740 1,577 1,444 Impairment of long-lived assets.......................... 520 - - Deferred income taxes............. (111) (67) 83 Other noncash charges and credits, net.................... 398 391 345 Changes in operating working capital, excluding effects of acquisitions Accounts and notes receivable... (434) (112) (161) Inventories..................... (129) (102) (90) Prepaid expenses, taxes and other current assets................. 76 1 3 Accounts payable................ 133 30 143 Income taxes payable............ (97) 55 (125) Other current liabilities....... 40 159 (96) ------- ------- ------- Net change in operating working capital.................. (411) 31 (326) ------- ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES......................... 3,742 3,716 3,134 ------- ------- -------\nCASH FLOWS - INVESTING ACTIVITIES Acquisitions and investments in unconsolidated affiliates....... (466) (316) (1,011) Capital spending.................... (2,104) (2,253) (1,982) Sales of property, plant and equipment...................... 138 55 73 Sales of restaurants................ 165 - 7 Short-term investments, by original maturity More than three months-purchases.. (289) (219) (579) More than three months-maturities. 335 650 846 Three months or less, net......... 18 (10) (8) Other, net.......................... (247) (268) (117) ------- ------- ------- NET CASH USED FOR INVESTING ACTIVITIES......................... (2,450) (2,361) (2,771) ------- ------- ------- - --------------------------------------------------------------------------- (Continued on following page) - ---------------------------------------------------------------------------\n- --------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS (PAGE 2 OF 2) (in millions) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993\n1995 1994 1993 (52 Weeks) (53 Weeks) (52 Weeks) - --------------------------------------------------------------------------- CASH FLOWS - FINANCING ACTIVITIES Proceeds from issuances of long-term debt..................... 2,030 1,285 711 Payments of long-term debt.......... (928) (1,180) (1,202) Short-term borrowings, by original maturity More than three months-proceeds.. 2,053 1,304 3,034 More than three months-payments.. (2,711) (1,728) (2,792) Three months or less, net........ (747) 114 839 Cash dividends paid................. (599) (540) (462) Purchases of treasury stock......... (541) (549) (463) Proceeds from exercises of stock options...................... 252 97 69 Other, net.......................... (42) (43) (37) ------- ------- ------- NET CASH USED FOR FINANCING ACTIVITIES............... (1,233) (1,240) (303) ------- ------- -------\nEFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS.......... (8) (11) (3) ------- ------- -------\nNET INCREASE IN CASH AND CASH EQUIVALENTS............... 51 104 57 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR................ 331 227 170 ------- ------- ------- CASH AND CASH EQUIVALENTS - END OF YEAR...................... $ 382 $ 331 $ 227 ======= ======= ======= - --------------------------------------------------------------------------- SUPPLEMENTAL CASH FLOW INFORMATION CASH FLOW DATA Interest paid....................... $ 671 591 550 Income taxes paid................... $ 790 663 676 SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Liabilities assumed in connection with acquisitions....... $ 66 224 897 Issuance of treasury stock and debt for acquisitions.............. $ 9 39 365 Book value of net assets exchanged for investments in unconsolidated affiliates........................ $ 39 - 61 - --------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements. - ---------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (PAGE 1 OF 2) (in millions except per share amounts) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993\nCapital Stock ------------------------------------- Issued Treasury ---------------- ------------------ Shares Amount Shares Amount - --------------------------------------------------------------------------- Shareholders' Equity, December 26, 1992.................. 863 $14 (64) $ (667) ------------------------------------ 1993 Net income.................... - - - - Cash dividends declared (per share-$0.61)................. - - - - Currency translation adjustment.... - - - - Purchases of treasury stock........ - - (12) (463) Shares issued in connection with acquisitions...................... - - 9 170 Stock option exercises, including tax benefits of $23............... - - 3 46 Pension liability adjustment, net of deferred taxes of $5........... - - - - Other.............................. - - - 1 ------------------------------------ Shareholders' Equity, December 25, 1993.................. 863 $14 (64) $ (913) ------------------------------------ 1994 Net income.................... - - - - Cash dividends declared (per share-$0.70)................. - - - - Currency translation adjustment.... - - - - Purchases of treasury stock........ - - (15) (549) Stock option exercises, including tax benefits of $27............... - - 5 81 Shares issued in connection with acquisitions...................... - - 1 15 Pension liability adjustment, net of deferred taxes of $5........... - - - - Other.............................. - - - 5 ------------------------------------ Shareholders' Equity, December 31, 1994.................. 863 $14 (73) $(1,361) ------------------------------------ 1995 Net income.................... - - - - Cash dividends declared (per share-$0.78)................. - - - - Currency translation adjustment.... - - - - Purchases of treasury stock........ - - (12) (541) Stock option exercises, including tax benefits of $91.............. - - 10 218 Other.............................. - - - 1 ------------------------------------ Shareholders' Equity, December 30, 1995.................. 863 $14 (75) $(1,683) ==================================== - --------------------------------------------------------------------------- (Continued on next page) - ---------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (PAGE 2 OF 2) (in millions except per share amounts) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 1995, December 31, 1994 and December 25, 1993\nCapital Currency in Translation Excess of Retained Adjustment Par Value Earnings and Other Total\nShareholders' Equity, December 26, 1992.................. $ 668 $5,440 $ (99) $5,356 ----------------------------------- 1993 Net income.................... - 1,588 - 1,588 Cash dividends declared (per share-$0.61)................. - (486) - (486) Currency translation adjustment.... - - (77) (77) Purchases of treasury stock........ - - - (463) Shares issued in connection with acquisitions...................... 165 - - 335 Stock option exercises, including tax benefits of $23............... 46 - - 92 Pension liability adjustment, net of deferred taxes of $5........... - - (8) (8) Other.............................. 1 - - 2 ----------------------------------- Shareholders' Equity, December 25, 1993.................. $ 880 $6,542 $(184) $6,339 ----------------------------------- 1994 Net income.................... - 1,752 - 1,752 Cash dividends declared (per share-$0.70)................. - (555) - (555) Currency translation adjustment.... - - (295) (295) Purchases of treasury stock........ - - - (549) Stock option exercises, including tax benefits of $27............... 44 - - 125 Shares issued in connection with acquisitions...................... 14 - - 29 Pension liability adjustment, net of deferred taxes of $5........... - - 8 8 Other.............................. (3) - - 2 ----------------------------------- Shareholders' Equity, December 31, 1994.................. $ 935 $7,739 $(471) $6,856 ----------------------------------- 1995 Net income.................... - 1,606 - 1,606 Cash dividends declared (per share-$0.78)................. - (615) - (615) Currency translation adjustment.... - - (337) (337) Purchases of treasury stock........ - - - (541) Stock option exercises, including tax benefits of $91.............. 125 - - 343 Other.............................. - - - 1 ----------------------------------- Shareholders' Equity, December 30, 1995.................. $1,060 $8,730 $(808) $7,313 ===================================\n- --------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements. - ---------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tabular dollars in millions except per share amounts)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe preparation of the Consolidated 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 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. To facilitate the closing process, certain of PepsiCo's international operations close their fiscal year up to one month earlier than PepsiCo's fiscal year. Certain reclassifications were made to prior year amounts to conform with the 1995 presentation. ACCOUNTING CHANGES. As discussed below and in Note 2, in 1995 PepsiCo early 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.\" In 1994, PepsiCo adopted Statement of Financial Accounting Standards No. 112, \"Accounting for Postemployment Benefits,\" (see Note 14) and a preferred method of calculating the market-related value of plan assets used in determining pension expense (see Note 13). Statement of Financial Accounting Standards No. 123 (SFAS 123), \"Accounting for Stock-Based Compensation,\" permits stock compensation cost to be measured using either the intrinsic value-based method or the fair value-based method. When adopted in 1996, PepsiCo intends to continue to use the intrinsic value-based method and will provide the expanded disclosures required by SFAS 123. PRINCIPLES OF CONSOLIDATION. The financial statements reflect the consolidated accounts of PepsiCo, Inc. and its controlled affiliates. Intercompany accounts and transactions have been eliminated. Investments in unconsolidated affiliates in which PepsiCo exercises significant influence but not control are accounted for by the equity method and PepsiCo's share of the net income or loss of its affiliates is included in selling, general and administrative expenses. FISCAL YEAR. PepsiCo's fiscal year ends on the last Saturday in December and, as a result, a fifty-third week is added every five or six years. The fiscal year ending December 31, 1994 consisted of 53 weeks. MARKETING COSTS. Marketing costs are reported in selling, general and administrative expenses and include costs of advertising, marketing and promotional programs. Promotional discounts are expensed as incurred and other marketing costs not deferred at year-end are charged to expense ratably in relation to sales over the year in which incurred. Marketing costs deferred at year-end, which are classified in prepaid expenses in the Consolidated Balance Sheet, consist of media and personal service advertising prepayments, promotional materials in inventory and production costs of future media advertising; these assets are expensed in the year first used. Promotional discounts to retailers in the beverage segment are classified as a reduction of sales; in the snack food segment, such discounts are generally classified as marketing costs. The difference in classification reflects our view that promotional discounts are so pervasive in the beverage industry, compared to the snack food industry, that they are effectively price discounts and should be classified accordingly. A current survey of the accounting practice of others in the\nbeverage and snack food industries confirmed that our beverage classification is consistent with others in that industry while practice in the snack food industry is mixed. Advertising expense was $1.8 billion, $1.7 billion and $1.6 billion in 1995, 1994 and 1993, respectively. Prepaid advertising as of year-end 1995 and 1994 was $78 million and $70 million, respectively. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses, which are expensed as incurred, were $96 million, $152 million and $113 million in 1995, 1994 and 1993, respectively. STOCK-BASED COMPENSATION. PepsiCo uses the intrinsic value-based method for measuring stock-based compensation cost which measures compensation cost as the excess, if any, of the quoted market price of PepsiCo's capital stock at the grant date over the amount the employee must pay for the stock. PepsiCo's policy is to grant stock options at fair market value at the date of grant. NET INCOME PER SHARE. Net income per share is computed by dividing net income by the weighted average number of shares and dilutive share equivalents (primarily stock options) outstanding during each year (\"average shares outstanding\"). DERIVATIVE INSTRUMENTS. PepsiCo's policy prohibits the use of derivative instruments for trading purposes and PepsiCo has procedures in place to monitor and control their use. PepsiCo enters into interest rate and currency swaps with the objective of reducing borrowing costs. Interest rate and currency swaps are used to effectively change the interest rate and currency of specific debt issuances. In general, the terms of these swaps match the terms of the related debt and the swaps are entered into concurrently with the issuance of the debt they are intended to modify. The interest differential to be paid or received on an interest rate swap is recognized as an adjustment to interest expense as the differential occurs. The interest differential not yet settled in cash is reflected in the Consolidated Balance Sheet as a receivable or payable under the appropriate current asset or liability caption. If an interest rate swap position was to be terminated, the gain or loss realized upon termination would be deferred and amortized to interest expense over the remaining term of the underlying debt instrument it was intended to modify or would be recognized immediately if the underlying debt instrument was settled prior to maturity. The differential to be paid or received on a currency swap is charged or credited to income as the differential occurs. This is fully offset by the corresponding gain or loss recognized in income on the currency translation of the related non-U.S. dollar denominated debt, as both amounts are based upon the same exchange rates. The currency differential not yet settled in cash is reflected in the Consolidated Balance Sheet under the appropriate current or noncurrent receivable or payable caption. If a currency swap position was to be terminated prior to maturity, the gain or loss realized upon termination would be immediately recognized in income. A seven-year put option, issued in connection with the formation of a joint venture with the principal shareholder of GEMEX, an unconsolidated franchised bottling affiliate in Mexico (see Note 17), is marked-to-market with gains or losses recognized currently as an adjustment to PepsiCo's share of the net income of unconsolidated affiliates. The offsetting amount adjusts the carrying amount of the put obligation, classified in other liabilities in the Consolidated Balance Sheet. Gains and losses on futures contracts designated as hedges of future commodity purchases are deferred and included in the cost of the related raw materials when purchased. Changes in the value of futures contracts that PepsiCo uses to hedge commodity purchases are highly correlated to the\nchanges in the value of the purchased commodity. If the degree of correlation between the futures contracts and the purchase contracts were to diminish such that the two were no longer considered highly correlated, subsequent changes in the value of the futures contracts would be recognized in income. CASH EQUIVALENTS. Cash equivalents represent funds temporarily invested (with original maturities not exceeding three months) as part of PepsiCo's management of day-to-day operating cash receipts and disbursements. All other investment portfolios, largely held outside the U.S., are primarily classified as short-term investments. INVENTORIES. Inventories are valued at the lower of cost (computed on the average, first-in, first-out or last-in, first-out [LIFO] method) or net realizable value. PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment (PP&E) are stated at cost except for PP&E that have been impaired, for which the carrying amount is reduced to estimated fair value. Depreciation is calculated principally on a straight-line basis over the estimated useful lives of the assets. INTANGIBLE ASSETS. Intangible assets are amortized on a straight-line basis over appropriate periods, generally ranging from 20 to 40 years. RECOVERABILITY OF LONG-LIVED ASSETS TO BE HELD AND USED IN THE BUSINESS. As noted above, PepsiCo early adopted SFAS 121 in 1995 for purposes of determining and measuring impairment of certain long-lived assets to be held and used in the business. See Note 2. PepsiCo reviews most long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used in the business for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or a group of assets may not be recoverable. PepsiCo considers a history of operating losses to be its primary indicator of potential impairment. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets (\"Assets\"). PepsiCo has identified the appropriate grouping of Assets to be individual restaurants for the restaurant segment and, for each of the snack food and beverage segments, Assets are generally grouped at the country level. PepsiCo deems an Asset to be impaired if a forecast of undiscounted future operating cash flows directly related to the Asset, including disposal value if any, is less than its carrying amount. If an Asset is determined to be impaired, the loss is measured as the amount by which the carrying amount of the Asset exceeds its fair value. Fair value is based on quoted market prices in active markets, if available. If quoted market prices are not available, an estimate of fair value is based on the best information available, including prices for similar assets or the results of valuation techniques such as discounting estimated future cash flows as if the decision to continue to use the impaired Asset was a new investment decision. PepsiCo generally measures fair value by discounting estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates. Recoverability of other long-lived assets, primarily investments in unconsolidated affiliates and identifiable intangibles and goodwill not identified with impaired Assets covered by the above paragraph, will continue to be evaluated on a recurring basis. The primary indicators of recoverability are current or forecasted profitability over the estimated remaining life of these assets, based on the operating profit of the businesses directly related to these assets. If recoverability is unlikely based on the evaluation, the carrying amount is reduced by the amount it exceeds the forecasted operating profit and any estimated disposal value.\nNOTE 2 -IMPAIRMENT OF LONG-LIVED ASSETS PepsiCo early 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,\" as of the beginning of the fourth quarter of 1995. This date was chosen to allow adequate time to collect and analyze data related to the long-lived assets of each of our worldwide operations for purposes of identifying, measuring and reporting any impairment in 1995. The initial, noncash charge upon adoption of SFAS 121 was $520 million ($384 million after-tax or $0.48 per share), which included $68 million ($49 million after-tax or $0.06 per share) related to restaurants for which closure decisions were made during the fourth quarter. This initial charge resulted from PepsiCo grouping assets at a lower level than under its previous accounting policy for evaluating and measuring impairment. Under PepsiCo's previous accounting policy, each of PepsiCo's operating divisions' (\"Division\") long-lived assets to be held and used by the Division, other than intangible assets, were evaluated as a group for impairment if the Division was incurring operating losses or was expected to incur operating losses in the future. Because of the strong operating profit history and prospects of each Division, no impairment evaluation had been required for 1994 or 1993 under PepsiCo's previous accounting policy. The initial charge represented a reduction of the carrying amounts of the impaired Assets (as defined in Note 1) to their estimated fair value, as determined by using discounted estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates. This charge affected worldwide restaurants, international beverages and, to a much lesser extent, international snack foods and certain unconsolidated affiliates. See Note 19. As a result of the reduced carrying amount of the impaired Assets, depreciation and amortization expense for the fourth quarter of 1995 was reduced by $21 million ($15 million after-tax or $0.02 per share) and full-year 1996 depreciation and amortization expense is expected to be reduced by approximately $58 million ($39 million after-tax or $0.05 per share). See Management's Analysis - Restaurants on page 33 for a discussion of other possible future effects related to this change in accounting. SFAS 121 also requires, among other provisions, that long-lived assets and certain identifiable intangibles to be disposed of that are not 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,\" be reported at the lower of the asset's carrying amount or its fair value less cost to sell. Under PepsiCo's previous accounting policy, PepsiCo reported an asset to be disposed of at the lower of its carrying amount or its estimated net realizable value. There were no material adjustments to the carrying amounts of assets to be disposed of in 1995, 1994 or 1993 under PepsiCo's previous accounting policy. The impact of adopting SFAS 121 on assets held for disposal during 1995 was immaterial.\nNOTE 3 - ITEMS AFFECTING COMPARABILITY\nThe effect on comparability of 1995 net gains from sales of restaurants to franchisees in excess of the cost of closing other restaurants is provided under Net Refranchising Gains in Note 19. The fifty-third week in 1994, as described under Fiscal Year in Note 1, increased 1994 net sales by an estimated $434 million and earnings by approximately $54 million ($35 million after-tax or $0.04 per share). See Fiscal Year in Note 19 for the estimated impact of the fifty-third week on comparability of segment net sales and operating profit. The effects of unusual items on comparability of operating profit, primarily restructuring charges and accounting changes, are provided under Unusual Items and Accounting Changes, respectively, in Note 19. Information regarding the 1994 gain from a public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America, and a 1993 charge to increase net deferred tax liabilities as of the beginning of 1993 for a 1% statutory income tax rate increase due to 1993 U.S. Federal tax legislation is provided in Notes 16 and 11, respectively.\nNOTE 4 - INVENTORIES\n1995 1994 - --------------------------------------------------------- Raw materials and supplies.............$ 550 $455 Finished goods......................... 501 515 ------ ---- $1,051 $970 ====== ==== - ---------------------------------------------------------\nThe cost of 32% of 1995 inventories and 38% of 1994 inventories was computed using the LIFO method. The carrying amount of total LIFO inventories was lower than the approximate current cost of those inventories by $11 million at year-end 1995, but higher by $6 million at year-end 1994.\nNOTE 5 - PROPERTY, PLANT AND EQUIPMENT, NET\n1995 1994 - -------------------------------------------------------- Land........................... $ 1,327 $ 1,322 Buildings and improvements..... 5,668 5,664 Capital leases, primarily buildings..................... 531 451 Machinery and equipment........ 8,598 8,208 Construction in progress....... 627 485 ------- ------- 16,751 16,130\nAccumulated depreciation....... (6,881) (6,247) ------- ------- $ 9,870 $ 9,883 ======= ======= - -----------------------------------------------------------\nDepreciation expense in 1995, 1994 and 1993 was $1.3 billion, $1.2 billion and $1.1 billion, respectively. The adoption of SFAS 121 reduced the carrying amount of property, plant and equipment, net by $399 million. See Note 2.\nNOTE 6 - INTANGIBLE ASSETS, NET\n1995 1994 - ------------------------------------------------------------------------\nReacquired franchise rights.... $3,826 $3,974\nTrademarks..................... 711 768\nOther identifiable intangibles................... 286 250\nGoodwill....................... 2,761 2,850 ------ ------ $7,584 $7,842 ====== ====== - ------------------------------------------------------------------------\nIdentifiable intangible assets primarily arose from the allocation of purchase prices of businesses acquired and consist principally of reacquired franchise rights and trademarks. Reacquired franchise rights relate to acquisitions of franchised bottling and restaurant operations and trademarks principally relate to acquisitions of international snack food and beverage businesses. Amounts assigned to such identifiable intangibles were based on independent appraisals or internal estimates. Goodwill represents the residual purchase price after allocation to all identifiable net assets. Accumulated amortization, included in the amounts above, was $1.8 billion and $1.6 billion at year-end 1995 and 1994, respectively. The adoption of SFAS 121 reduced the carrying amount of intangible assets, net by $86 million. See Note 2.\nNOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS\nPepsiCo's policy prohibits the use of derivative instruments for trading purposes and PepsiCo has procedures in place to monitor and control their use. PepsiCo's use of derivative instruments is primarily limited to interest rate and currency swaps, which are entered into with the objective of reducing borrowing costs. PepsiCo enters into interest rate and foreign currency swaps to effectively change the interest rate and currency of specific debt issuances. These swaps are generally entered into concurrently with the issuance of the debt they are intended to modify. The notional amount, interest payment dates and maturity dates of the swaps match the principal, interest payment dates and maturity dates of the related debt. Accordingly, any market impact (risk or opportunity) associated with these swaps is fully offset by the opposite market impact on the related debt. PepsiCo's credit risk related to interest rate and currency swaps is considered low because they are only entered into with strong creditworthy counterparties, are generally settled on a net basis and are of relatively short duration. See Note 8 for the notional amounts, related interest rates and maturities of the interest rate and currency swaps along with the original terms of the related debt and Note 9 for the fair value of these instruments.\nIn 1995, PepsiCo issued a seven-year put option in connection with the formation of a joint venture with the principal shareholder of GEMEX, an unconsolidated franchised bottling affiliate in Mexico. The put option allows the principal shareholder to sell up to 150 million GEMEX shares to PepsiCo at 66 2\/3 cents per share. PepsiCo accounts for this put option by marking it to market with gains or losses recognized currently. The put option liability, which was valued at $26 million at the date of the original transaction, increased to $30 million by year-end, resulting in a $4 million charge to earnings.\nNOTE 8 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT\n1995 1994 - ------------------------------------------------------------------------------- SHORT-TERM BORROWINGS Commercial paper (5.7% and 5.4%)(A)............ $ 2,006 $ 2,254 Current maturities of long-term debt issuances (A)(B)......................... 1,405 988 Notes (6.9% and 5.4%) (A)...................... 252 1,492 Other borrowings (7.9% and 6.5%) (C)........... 543 444 Amount reclassified to long-term debt (D)......................... (3,500) (4,500) ------- ------- $ 706 $ 678 ======= ======= LONG-TERM DEBT Short-term borrowings, reclassified (D)........ $ 3,500 $ 4,500 Notes due 1996 through 2010 (6.3% and 6.6%) (A)..................................... 3,886 3,725 Euro notes due 1997 through 1998 (7.5% and 8.0%) (A)........................... 550 250 Zero coupon notes, $780 million due 1996 through 2012 (14.4% annual yield to maturity) (A)................................. 234 219 Swiss franc perpetual Foreign Interest Payment bonds (E)............................. 214 213 Australian dollar 6.3% bonds due 1997 through 1998 with interest payable in Japanese yen (A)(C)........................... 212 - Japanese yen 3.3% bonds due 1997 (C)........... 194 201 Zero coupon notes, $200 million due 1999 (6.4% annual yield to maturity) (A)........... 161 - Swiss franc 5.0% notes due 1999 (A)(C)......... 108 - Italian lira 11.4% notes due 1998 (A)(C)....... 95 - Luxembourg franc 6.6% notes due 1998 (A)(C).... 68 - Swiss franc 5 1\/4% bearer bonds due 1995 (C).................................. - 100 Capital lease obligations (See Note 10)................................. 294 298 Other, due 1996-2020 (6.8% and 8.1%)........... 398 323 ------- ------- 9,914 9,829\nLess current maturities of long-term debt issuances (B)............................ (1,405) (988) ------- ------- $ 8,509 $ 8,841 ======= ======= - ------------------------------------------------------------------------------- The interest rates in the above table indicate, where applicable, the weighted average of the stated rates at year-end 1995 and 1994,\nrespectively, prior to the effects of any interest rate swaps. See (A) below for PepsiCo's weighted average interest rates after giving effect to the impact of the interest rate swaps. The carrying amount of long-term debt includes any related discount or premium and unamortized debt issuance costs. The debt agreements include various restrictions, none of which are currently significant to PepsiCo. The annual maturities of long-term debt through 2000, excluding capital lease obligations and the reclassified short-term borrowings, are: 1996-$1.4 billion, 1997-$1.5 billion, 1998-$1.5 billion, 1999-$572 million and 2000-$651 million. See Note 7 for a discussion of PepsiCo's use of interest rate and currency swaps and its management of the inherent credit risk and Note 9 for fair value information related to debt and interest rate and currency swaps. (A) The following table indicates the notional amount and weighted average interest rates, by category, of interest rate swaps outstanding at year-end 1995 and 1994, respectively. The weighted average variable interest rates that PepsiCo pays, which are primarily indexed to either commercial paper or LIBOR rates, are based on rates as of the respective balance sheet date and are subject to change. Terms of interest rate swaps generally match the terms of the debt they modify and the swaps terminate in 1996 through 2010.\n1995 1994 -------- ------\nReceive fixed-pay variable Notional amount....................... $2,657 $1,557 Weighted average receive rate......... 6.8% 5.9% Weighted average pay rate............. 5.7% 6.1%\nReceive variable-pay variable Notional amount....................... $ 577 $1,009 Weighted average receive rate......... 5.7% 4.9% Weighted average pay rate............. 5.8% 6.0%\nReceive variable-pay fixed Notional amount....................... $ 215 $ 215 Weighted average receive rate......... 5.8% 6.6% Weighted average pay rate............. 8.2% 8.2%\nThe following table identifies the composition of total debt (excluding capital lease obligations and before the reclassification of amounts from short-term borrowings) after giving effect to the impact of interest rate swaps. All short-term borrowings are considered variable interest rate debt for purposes of this table. 1995 1994 ------------------- ------------------- Weighted Weighted Average Average Carrying Interest Carrying Interest Amount Rate Amount Rate --------- -------- -------- -------- Variable interest rate debt Short-term borrowings.......... $4,177 6.4% $5,149 6.2% Long-term debt....... 2,103 5.8% 937 6.1% ------ ------ 6,280 6.2% 6,086 6.2%\nFixed interest rate debt................... 2,641 7.4% 3,135 7.4% ------ ------ $8,921 6.6% $9,221 6.6% ====== ======\n(B) Included certain long-term notes aggregating $248 million which are reasonably expected to be called, without penalty, by PepsiCo in 1996. The expectation is based upon the belief of PepsiCo management that, based upon projected yield curves, our counterparties to interest rate swaps, which were entered into to modify these notes, will exercise their option to early terminate the swaps without penalty. Also included the $214 million carrying amount of the Swiss franc perpetual Foreign Interest Payment bonds (see (E) below). (C) PepsiCo has entered into currency swaps to hedge its foreign currency exposure on non-U.S. dollar denominated debt. At year-end 1995, the aggregate carrying amount of the debt was $696 million and the receivables and payables under related currency swaps were $5 million and $12 million, respectively, resulting in a net effective U.S. dollar liability of $703 million with a weighted average interest rate of 5.8%, including the effects of related interest rate swaps. At year-end 1994, the carrying amount of this debt aggregated $301 million and the receivables and payables under related currency swaps aggregated $50 million and $2 million, respectively, resulting in a net effective U.S. dollar liability of $253 million with a weighted average interest rate of 7.9%, including the effects of related interest rate swaps. (D) At year-end 1995 and 1994, PepsiCo had unused revolving credit facilities covering potential borrowings aggregating $3.5 billion. Effective January 3, 1995, PepsiCo replaced its existing credit facilities with new revolving credit facilities aggregating $4.5 billion, of which $1.0 billion was to expire in 1996 and $3.5 billion was to expire in 2000. Effective December 8, 1995, PepsiCo terminated the $1.0 billion due to expire in 1996 based upon a current assessment of the amount of credit facilities required compared to its related cost. The expiration of the remaining credit facilities of $3.5 billion was extended to 2001. At year-end 1995 and 1994, $3.5 billion and $4.5 billion, respectively, of short-term borrowings were classified as long-term debt, reflecting PepsiCo's intent and ability, through the existence of the unused credit facilities, to refinance these borrowings. These credit facilities exist largely to support the issuances of short-term borrowings and are available for acquisitions and other general corporate purposes.\n(E) The coupon rate of the Swiss franc 400 million perpetual Foreign Interest Payment bonds issued in 1986 is 7 1\/2% through 1996. The bonds have no stated maturity date. At the end of each 10-year period after the issuance of the bonds, PepsiCo and the bondholders each have the right to cause redemption of the bonds. If not redeemed, the coupon rate will be adjusted based on the prevailing yield of 10-year U.S. Treasury Securities. The principal of the bonds is denominated in Swiss francs. PepsiCo can, and intends to, limit the ultimate redemption amount to the U.S. dollar proceeds at issuance, which is the basis of the carrying amount. Interest payments are made in U.S. dollars and are calculated by applying the coupon rate to the original U.S. dollar principal proceeds of $214 million. Although PepsiCo does not currently intend to cause redemption of this debt, this debt has been included in current maturities of long-term debt (see (B) above) at year-end 1995 because the bondholders may exercise their right to cause PepsiCo to redeem the debt in 1996 on its 10-year anniversary date. Since the redemption feature is only available on each 10-year anniversary date, the bonds will be reclassified to long-term if redemption does not occur in 1996.\nNOTE 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS\n1995 1994 --------------- -------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- -------- ----- Assets Cash and cash equivalents............. $ 382 $ 382 $ 331 $ 331 Short-term investments.................. $1,116 $1,116 $1,157 $1,157 Other assets (noncurrent investments)................. $ 23 $ 23 $ 48 $ 48\nLiabilities Debt Short-term borrowings and long-term debt, net of capital leases.................... $8,921 $9,217 $9,221 $9,266 Debt-related derivative instruments Open contracts in asset position.................. (25) (96) (52) (52) Open contracts in liability position.................. 13 26 8 54 ------ ------ ------ ------ Net debt................ $8,909 $9,147 $9,177 $9,268 ------ ------ ------ ------\nOther liabilities (GEMEX put option).......... $ 30 $ 30 - -\nGuarantees.................... - $ 4 - $ 3\n- ------------------------------------------------------------------------------\nThe carrying amounts in the above table are included in the Consolidated Balance Sheet under the indicated captions, except for debt-related derivative instruments (interest rate and currency swaps), which are included in the appropriate current or noncurrent asset or liability caption. Short-term investments consist primarily of debt securities and\nhave been classified as held-to-maturity. Noncurrent investments mature at various dates through 2000. Because of the short maturity of cash equivalents and short-term investments, the carrying amount approximates fair value. The fair value of noncurrent investments is based upon market quotes. The fair value of debt, debt-related derivative instruments and guarantees is estimated using market quotes, valuation models and calculations based on market rates. The fair value of the GEMEX put option is based upon a valuation model. See Note 7 for more information regarding PepsiCo's use of derivative instruments and its management of the inherent credit risk related to those instruments.\nNOTE 10 - LEASES\nPepsiCo has noncancelable commitments under both capital and long-term operating leases, primarily for restaurant units. In addition, PepsiCo is lessee under noncancelable leases covering vehicles, equipment and nonrestaurant real estate. Capital and operating lease commitments expire at various dates through 2088 and, in many cases, provide for rent escalations and renewal options. Most leases require payment of related executory costs, which include property taxes, maintenance and insurance. Sublease income and sublease receivables are insignificant. Future minimum commitments under noncancelable leases are set forth below:\nLater 1996 1997 1998 1999 2000 Years Total ---- ---- ---- ---- ---- ----- -----\nCapital $ 57 49 68 37 38 299 $ 548 Operating $350 297 269 240 218 1,170 $2,544 - --------------------------------------------------------------------------------\nAt year-end 1995, the present value of minimum payments under capital leases was $294 million, after deducting $1 million for estimated executory costs and $253 million representing imputed interest.\nThe details of rental expense are set forth below:\n1995 1994 1993 ---- ---- ---- Minimum................................... $439 $433 $392 Contingent................................ 40 32 28 ---- ---- ---- $479 $465 $420 ==== ==== ==== - -------------------------------------------------------------------------------\nContingent rentals are based on sales by restaurants in excess of levels stipulated in the lease agreements.\nNOTE 11 - INCOME TAXES\nThe details of the provision for income taxes on income before cumulative effect of accounting changes are set forth below:\n1995 1994 1993 - --------------------------------------------------------------- Current: Federal........... $ 706 $642 $467 Foreign........... 154 174 196 State............. 77 131 89 ------ ---- ---- 937 947 752 ------ ---- ---- Deferred: Federal........... (92) (64) 78 Foreign........... (18) (2) (13) State............. (1) (1) 18 ------ ---- ---- (111) (67) 83 ------ ---- ---- $ 826 $880 $835 ====== ==== ==== - ---------------------------------------------------------------\nIn 1993, a charge of $30 million ($0.04 per share) was recorded to increase net deferred tax liabilities as of the beginning of 1993 for a 1% statutory income tax rate increase under 1993 U.S. Federal tax legislation. U.S. and foreign income before income taxes and cumulative effect of accounting changes are set forth below:\n1995 1994 1993 - ------------------------------------------------------------ U.S............................ $1,792 $1,762 $1,633 Foreign........................ 640 902 790 ------ ------ ------ $2,432 $2,664 $2,423 ====== ====== ====== - ------------------------------------------------------------\nPepsiCo operates centralized concentrate manufacturing facilities in Puerto Rico and Ireland under long-term tax incentives. The U.S. amount in the above table included approximately 70% in 1995 and 50% in 1994 and 1993 (consistent with the income subject to U.S. tax) of the income from sales of concentrate manufactured in Puerto Rico. The increase in 1995 reflected the effects of the 1993 Federal income tax legislation, which limited the U.S. Federal tax credit on income earned in Puerto Rico. See Management's Analysis - Significant U.S. Tax Changes Affecting Historical and Future Results on page 15 for a discussion of the reduction of the U.S. Federal tax credit associated with beverage concentrate operations in Puerto Rico.\nA reconciliation of the U.S. Federal statutory tax rate to PepsiCo's effective tax rate is set forth below:\n1995 1994 1993 - ---------------------------------------------------------------------- U.S. Federal statutory tax rate.... 35.0% 35.0% 35.0% State income tax, net of Federal tax benefit..................... 2.0 3.2 2.9 Effect of lower taxes on foreign income (including Puerto Rico and Ireland)..................... (3.0) (5.4) (3.3) Adjustment to the beginning-of- the-year deferred tax assets valuation allowance.............. - (1.3) - Reduction of prior years' foreign accruals.................. - - (2.0) Settlement of prior years' audit issues...................... (4.1) - - Effect of 1993 tax legislation on deferred income taxes............. - - 1.1 Effect of adopting SFAS 121........ 1.4 - - Nondeductible amortization of U.S. goodwill..................... 1.0 0.8 0.8 Other, net......................... 1.7 0.7 - ---- ---- ---- Effective tax rate................. 34.0% 33.0% 34.5% ==== ==== ==== - ----------------------------------------------------------------------\nThe details of the 1995 and 1994 deferred tax liabilities (assets) are set forth below: 1995 1994 - ------------------------------------------------------------------------ Intangible assets other than nondeductible goodwill........... $ 1,631 $ 1,628 Property, plant and equipment....... 496 506 Safe harbor leases.................. 165 171 Zero coupon notes................... 100 111 Other............................... 257 337 ------- ------- Gross deferred tax liabilities...... 2,649 2,753 ------- -------\nNet operating loss carryforwards.... (418) (306) Postretirement benefits............. (248) (248) Casualty claims..................... (119) (71) Various accrued liabilities and other.......................... (790) (637) ------- ------- Gross deferred tax assets........... (1,575) (1,262) ------- ------- Deferred tax assets valuation allowance................ 498 319 ------- -------\nNet deferred tax liability.......... $ 1,572 $ 1,810 ======= =======\nIncluded in Prepaid expenses, taxes and other current assets............ $ (313) $ (167) Other current liabilities........ - 4 Deferred income taxes............ 1,885 1,973 ------- ------- $ 1,572 $ 1,810 ======= ======= - ------------------------------------------------------------------------\nThe valuation allowance related to deferred tax assets increased by $179 million in 1995, primarily resulting from additions related to current year operating losses in a number of state and foreign jurisdictions and the adoption of SFAS 121.\nIn accordance with generally accepted accounting principles, deferred tax liabilities have not been recognized for bases differences that are essentially permanent in duration related to investments in foreign subsidiaries and joint ventures. These differences, which consist primarily of unremitted earnings intended to be indefinitely reinvested, aggregated approximately $4.5 billion at year-end 1995 and $3.8 billion at year-end 1994, exclusive of amounts that if remitted in the future would result in little or no tax under current tax laws and the Puerto Rico tax incentive grant. Determination of the amount of unrecognized deferred tax liabilities is not practicable. Net operating loss carryforwards totaling $2.3 billion at year-end 1995 are available to reduce future tax of certain subsidiaries and are related to a number of state and foreign jurisdictions. Of these carryforwards, $16 million expire in 1996, $2.1 billion expire at various times between 1997 and 2010 and $173 million may be carried forward indefinitely. Tax benefits associated with exercises of stock options of $91 million in 1995, $27 million in 1994 and $23 million in 1993 were credited to shareholders' equity. A change in the functional currency of operations in Mexico from the U.S. dollar to local currency in 1993 resulted in a $19 million decrease in the net deferred foreign tax liability that was credited to shareholders' equity.\nNOTE 12 - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nPepsiCo provides postretirement health care benefits to eligible retired employees and their dependents, principally in the U.S. Retirees who have 10 years of service and attain age 55 while in service with PepsiCo are eligible to participate in the postretirement benefit plans. The plans are not funded and were largely noncontributory through 1993. Effective in 1993 and 1994, PepsiCo implemented programs intended to stem rising costs and introduced retiree cost-sharing, including adopting a provision that limits its future obligation to absorb health care cost inflation. These amendments resulted in an unrecognized prior service gain of $191 million, which is being amortized on a straight-line basis over the average remaining employee service period of approximately 10 years as a reduction in postretirement benefit expense beginning in 1993. The components of postretirement benefit expense for 1995, 1994 and 1993 are set forth below:\n1995 1994 1993 - ------------------------------------------------------------------------ Service cost of benefits earned........... $ 13 $ 19 $ 15 Interest cost on accumulated postretirement benefit obligation........ 46 41 41 Amortization of prior service cost (gain).............................. (20) (20) (20) Amortization of net (gain) loss........... (1) 6 - ---- ---- ----\n$ 38 $ 46 $ 36 ==== ==== ==== - ------------------------------------------------------------------------\nThe components of the 1995 and 1994 postretirement benefit liability recognized in the Consolidated Balance Sheet are set forth below:\n1995 1994 - ------------------------------------------------------------------------ Actuarial present value of postretirement benefit obligation: Retirees.......................................... $(344) $(289) Fully eligible active plan participants........... (96) (88) Other active plan participants.................... (171) (148) ----- -----\nAccumulated postretirement benefit obligation....... (611) (525)\nUnrecognized prior service cost (gain).............. (132) (152)\nUnrecognized net loss............................... 68 12 ----- -----\n$(675) $(665) ===== ===== - ------------------------------------------------------------------------\nThe discount rate assumptions used in computing the information above are set forth below:\n1995 1994 1993 - ------------------------------------------------------------------------\nPostretirement benefit expense.... 9.1% 6.8 8.2 Accumulated postretirement benefit obligation............... 7.7% 9.1 6.8 - ------------------------------------------------------------------------\nThe year-to-year fluctuations in the discount rate assumptions primarily reflect changes in U.S. interest rates. The discount rate represents the expected yield on a portfolio of high-grade (AA rated or equivalent) fixed-income investments with cash flow streams sufficient to satisfy benefit obligations under the plans when due. As a result of the plan amendments discussed above, separate assumed health care cost trend rates are used for employees who retire before and after the effective date of the amendments. The assumed health care cost trend rate for employees who retired before the effective date is 9.0% for 1996, declining gradually to 5.5% in 2005 and thereafter. For employees retiring after the effective date, the trend rate is 7.5% for 1996, declining gradually to 0% in 2001 and thereafter. A 1 point increase in the assumed health care cost trend rate would have increased the 1995 postretirement benefit expense by $2 million and would have increased the 1995 accumulated postretirement benefit obligation by $24 million.\nNOTE 13 - PENSION PLANS\nPepsiCo sponsors noncontributory defined benefit pension plans covering substantially all full-time U.S. employees as well as contributory and noncontributory defined benefit pension plans covering certain international employees. Benefits generally are based on years of service and compensation or stated amounts for each year of service. PepsiCo funds the U.S. plans in amounts not less than minimum statutory funding requirements nor more than the maximum amount that can be deducted for U.S.\nincome tax purposes. International plans are funded in amounts sufficient to comply with local statutory requirements. The plans' assets consist principally of equity securities, government and corporate debt securities and other fixed income obligations. The U.S. plans' assets included 6.9 million shares of PepsiCo capital stock for 1995 and 1994, with a market value of $350 million and $227 million, respectively. Dividends on PepsiCo capital stock of $5 million were received by the U.S. plans in both 1995 and 1994.\nThe components of net pension expense for U.S. company-sponsored plans are set forth below:\n1995 1994 1993 - ------------------------------------------------------------------------ Service cost of benefits earned........... $ 60 $ 70 $ 57 Interest cost on projected benefit obligation............................... 92 84 76 Return on plan assets Actual (gain) loss...................... (338) 20 (162) Deferred gain (loss).................... 221 (131) 71 ----- ----- ----- (117) (111) (91)\nAmortization of net transition gain....... (19) (19) (19) Net other amortization.................... 5 9 9 ----- ----- -----\n$ 21 $ 33 $ 32 ===== ===== ===== - ------------------------------------------------------------------------\nReconciliations of the funded status of the U.S. plans to the pension liability recognized in the Consolidated Balance Sheet are set forth below:\nAssets Exceed Accumulated Benefits Accumulated Benefits Exceed Assets ==================== ==================== 1995 1994 1995 1994 - ------------------------------------------------------------------------ Actuarial present value of benefit obligation Vested benefits............. $ (824) $ (774) $(270) $(22) Nonvested benefits.......... (110) (98) (30) (1) ------ ------ ----- ----\nAccumulated benefit obligation................... (934) (872) (300) (23) Effect of projected compensation increases....... (155) (111) (78) (48) ------ ------ ----- ----\nProjected benefit obligation.. (1,089) (983) (378) (71) Plan assets at fair value..... 1,152 1,134 267 3 ------ ------ ----- ----\nPlan assets in excess of (less than) projected benefit obligation.......... 63 151 (111) (68) Unrecognized prior service cost................. 37 31 51 30 Unrecognized net (gain) loss ................. (20) (72) 34 4 Unrecognized net transition (gain) loss....... (51) (73) (3) - Adjustment required to recognize minimum liability. - - (26) - ------ ------ ------ -----\nPrepaid (accrued) pension liability.................... $ 29 $ 37 $ (55) $(34) ====== ====== ===== ==== - ------------------------------------------------------------------------\nThe assumptions used to compute the U.S. information above are set forth below:\n1995 1994 1993 - ------------------------------------------------------------------------ Discount rate - pension expense........... 9.0% 7.0 8.2\nExpected long-term rate of return on plan assets........................... 10.0% 10.0 10.0\nDiscount rate - projected benefit obligation............................... 7.7% 9.0 7.0\nFuture compensation growth rate........... 3.3%-6.6% 3.3-7.0 3.3-7.0 - ------------------------------------------------------------------------\nThe components of net pension expense for international company-sponsored plans are set forth below:\n1995 1994 1993 - ------------------------------------------------------------------------ Service cost of benefits earned........... $ 11 $ 15 $ 12 Interest cost on projected benefit obligation............................... 16 15 15 Return on plan assets Actual (gain) loss...................... (31) 8 (41) Deferred gain (loss).................... 6 (32) 21 ---- ---- ---- (25) (24) (20)\nNet other amortization.................... - 2 2 ---- ---- ----\n$ 2 $ 8 $ 9 ==== ==== ==== - ------------------------------------------------------------------------\nReconciliations of the funded status of the international plans to the pension liability recognized in the Consolidated Balance Sheet are set forth below:\nAssets Exceed Accumulated Benefits Accumulated Benefits Exceed Assets -------------------- -------------------- 1995 1994 1995 1994 - -------------------------------------------------------------------------- Actuarial present value of benefit obligation Vested benefits............. $(144) $(125) $(34) $(23) Nonvested benefits.......... (2) (2) (1) (7) ----- ----- ---- ----\nAccumulated benefit obligation................... (146) (127) (35) (30) Effect of projected compensation increases....... (23) (24) (12) (10) ----- ----- ---- ----\nProjected benefit obligation.. (169) (151) (47) (40) Plan assets at fair value..... 235 213 18 15 ----- ----- ---- ----\nPlan assets in excess of (less than) projected benefit obligation.......... 66 62 (29) (25) Unrecognized prior service cost................. 3 4 - - Unrecognized net loss (gain).................. 16 14 4 (3) Unrecognized net transition (gain) loss....... (1) (2) 4 5 Adjustment required to recognize minimum liability................... - - (2) - ----- ----- ---- ----\nPrepaid (accrued) pension liability.................... $ 84 $ 78 $(23) $(23) ===== ===== ==== ==== - ------------------------------------------------------------------------\nThe assumptions used to compute the international information above are set forth below: 1995 1994 1993 - ------------------------------------------------------------------------ Discount rate - pension expense........... 9.2% 7.3 9.0\nExpected long-term rate of return on plan assets........................... 11.3% 11.3 10.8\nDiscount rate - projected benefit obligation............................... 8.8% 9.3 7.4\nFuture compensation growth rate........... 3.0%-11.8% 3.0-8.5 3.5-8.5 - ------------------------------------------------------------------------ The discount rates and rates of return for the international plans represent weighted averages.\nThe year-to-year fluctuations in the discount rate assumptions primarily reflect changes in interest rates. The discount rates represent the expected yield on a portfolio of high-grade (AA rated or equivalent) fixed-income investments with cash flow streams sufficient to satisfy benefit obligations under the plans when due. The lower assumed discount rates used to measure the 1995 projected benefit obligation compared to the assumed discount rates used to measure the 1994 projected benefit obligation changed the funded status of certain plans from overfunded to underfunded. In 1994, PepsiCo changed the method for calculating the market-related value of plan assets used in determining the return-on-assets component of annual pension expense and the cumulative net unrecognized gain or loss subject to amortization. Under the previous accounting method, the calculation of the market-related value of assets reflected amortization of the actual capital return on assets on a straight-line basis over a five-year period. Under the new method, the calculation of the market-related value of assets reflects the long-term rate of return expected by PepsiCo and amortization of the difference between the actual return (including capital, dividends and interest) and the expected return over a five-year period. PepsiCo believes the new method is widely used in practice and preferred because it results in calculated plan asset values that more closely approximate fair value, while still mitigating the effect of annual market-value fluctuations. Under both methods, only the cumulative net unrecognized gain or loss that exceeds 10% of the greater of the projected benefit obligation or the market-related value of plan assets is subject to amortization. This change resulted in a noncash benefit in 1994 of $38 million ($23 million after-tax or $0.03 per share) representing the cumulative effect of the change related to years prior to 1994 and $35 million in lower pension expense ($22 million after-tax or $0.03 per share) related to 1994 as compared to the previous accounting method. Had this change been applied retroactively, 1993 pension expense would have been reduced by $16 million ($11 million after-tax or $0.01 per share).\nNOTE 14 - POSTEMPLOYMENT BENEFITS OTHER THAN TO RETIREES\nEffective the beginning of 1994, PepsiCo adopted Statement of Financial Accounting Standards No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" SFAS 112 requires PepsiCo to accrue the cost of certain postemployment benefits to be paid to terminated or inactive employees other than retirees. The principal effect to PepsiCo results\nfrom accruing severance benefits to be provided to employees of certain business units who are terminated in the ordinary course of business over the expected service lives of the employees. Previously, these benefits were accrued upon the occurrence of an event. Severance benefits resulting from actions not in the ordinary course of business will continue to be accrued when those actions occur. The cumulative effect charge upon adoption of SFAS 112, which relates to years prior to 1994, was $84 million ($55 million after-tax or $0.07 per share). As compared to the previous accounting method, the ongoing impact of adopting SFAS 112 was immaterial to 1994 operating profits. PepsiCo's cash flows have been unaffected by this accounting change as PepsiCo continues to largely fund postemployment benefit costs as incurred.\nNOTE 15 - EMPLOYEE STOCK OPTIONS\nPepsiCo grants stock options to employees pursuant to three different incentive plans -- the SharePower Stock Option Plan (SharePower), the Long-Term Incentive Plan (LTIP) and the Stock Option Incentive Plan (SOIP). All stock option grants are authorized by the Compensation Committee of PepsiCo's Board of Directors (the Committee), which is comprised of outside directors. In each case, a stock option represents the right to purchase a share of PepsiCo capital stock (Stock) in the future at a price equal to the fair market value of the Stock on the date of the grant. Under SharePower, approved by the Board of Directors and effective in 1989, essentially all employees, other than executive officers and short-service employees, may be granted stock options annually. The number of options granted is based on each employee's annual earnings. The options generally become exercisable ratably over 5 years from the grant date and must be exercised within 10 years of the grant date. SharePower options of 8 million were granted to approximately 134,000 employees in 1995; 12 million to 128,000 employees in 1994; and 9 million to 118,000 employees in 1993. The shareholder-approved 1994 Long-Term Incentive Plan succeeds and continues the principal features of the shareholder approved 1987 Long-Term Incentive Plan (the 1987 Plan). PepsiCo ceased making grants under the 1987 Plan at the end of 1994. Together, these plans comprise the LTIP. At year-end 1995 and 1994, there were 74 million and 75 million shares, respectively, available for future grants under the LTIP. Most LTIP stock options are granted every other year to senior management employees. Most of these options become exercisable after 4 years and must be exercised within 10 years from their grant date. In 1995, 1994 and 1993, 1 million, 16 million and 3 million stock options, respectively, were granted under the LTIP. In addition, the LTIP allows for grants of performance share units (PSUs). The value of a PSU is fixed at the value of a share of Stock at the grant date and vests for payment 4 years from the grant date, contingent upon attainment of prescribed Corporate performance goals. PSUs are not directly granted, as certain stock options granted may be surrendered by employees for a specified number of PSUs within 60 days of the option grant date. At year-end 1995, 1994 and 1993, there were 599,100, 629,200 and 491,200 PSUs outstanding, respectively. Payment of PSUs are made in cash and\/or Stock as approved by the Committee. Amounts expensed for PSUs were $5 million, $7 million and $3 million in 1995, 1994 and 1993, respectively. In 1995, the Committee approved the 1995 Stock Option Incentive Plan for middle management employees, under which a maximum of 25 million stock options may be granted. SOIP stock options are expected to be granted\nannually and are exercisable after 1 year and must be exercised within 10 years after their grant date. In 1995, 4 million stock options were granted resulting in 21 million shares available for future grants at year-end. In 1994 and 1993, grants similar to those under the SOIP were made under the LTIP to a more limited number of middle management employees.\nStock option activity for 1993, 1994 and 1995 is set forth below:\n(options in thousands) SharePower LTIP\/SOIP - -------------------------------------------------------------------------------- Outstanding at December 26, 1992........................ 28,796 32,990 Granted................................... 9,121 2,834 Exercised................................. (1,958) (1,412) Surrendered for PSUs...................... - (96) Canceled.................................. (2,524) (966) ------ ------\nOutstanding at December 25, 1993........................ 33,435 33,350 Granted................................... 11,633 16,237 Exercised................................. (1,820) (3,052) Surrendered for PSUs...................... - (1,541) Canceled.................................. (3,443) (2,218) ------ ------\nOutstanding at December 31, 1994........................ 39,805 42,776 Granted................................... 8,218 4,977 Exercised................................. (5,722) (4,868) Surrendered for PSUs...................... - (101) Canceled.................................. (2,939) (1,815) ------ ------\nOutstanding at December 30, 1995........................ 39,362 40,969 ====== ======\nExercisable at December 30, 1995........................ 16,932 15,804 ====== ======\nOption prices per share Exercised during 1993................... $17.58 to $36.75 $4.11 to $36.31 Exercised during 1994................... $17.58 to $36.75 $4.11 to $38.75 Exercised during 1995................... $17.58 to $46.00 $7.69 to $41.81\nOutstanding at year-end 1995.......................... $17.58 to $46.00 $7.69 to $51.19\nNOTE 16 - STOCK OFFERING BY AN UNCONSOLIDATED AFFILIATE\nIn 1993, PepsiCo entered into an arrangement with the principal shareholders of Buenos Aires Embotelladora S.A. (BAESA), a franchised bottler which currently has operations in Brazil, Argentina, Chile, Uruguay and Costa Rica, to form a joint venture. PepsiCo contributed certain assets, primarily bottling operations in Chile and Uruguay, while the principal shareholders contributed all of their shares in BAESA, representing 73% of the voting control and 43% of the ownership interest. Through this arrangement, PepsiCo's beneficial ownership in BAESA, which is accounted for by the equity method, was 26%. Under PepsiCo's partnership agreement with the principal shareholders of BAESA, voting control of BAESA will be transferred to PepsiCo no later than December 31, 1999. On March 24, 1994, BAESA completed a public offering of 3 million American Depositary Shares (ADS) at $34.50 per ADS, which are traded on the New York Stock Exchange. In conjunction with the offering, PepsiCo and certain other shareholders exercised options for the equivalent of 2 million ADS. As a result of these transactions, PepsiCo's ownership in BAESA declined to 24%. The transactions generated cash proceeds for BAESA of $136 million. The resulting onetime, noncash gain to PepsiCo was $18 million ($17 million after-tax or $0.02 per share).\nNOTE 17 - ACQUISITIONS AND INVESTMENTS IN UNCONSOLIDATED AFFILIATES\nDuring 1995, PepsiCo completed acquisitions and investments in unconsolidated affiliates aggregating $475 million, principally for cash. In addition, approximately $15 million of debt was assumed in these transactions. This activity included equity investments in international franchised bottling operations, primarily Grupo Embotellador de Mexico, S.A. (GEMEX) in Mexico, and in Simba, a snack food operation in South Africa. In addition, acquisitions included worldwide restaurant operations, primarily in New Zealand and the buyout of a joint venture partner in Singapore, and worldwide bottling operations. PepsiCo formed a joint venture with the principal shareholder of GEMEX, an unconsolidated franchised bottling affiliate in Mexico. PepsiCo acquired a 27% interest for $207 million in cash and the contribution of a small company-owned bottling operation and our interest in an existing small franchised bottling joint venture with GEMEX. In addition, PepsiCo provided the principal shareholder of GEMEX a seven-year put option which allows the shareholder to sell up to 150 million GEMEX shares (which represented about 11% of GEMEX's outstanding shares at the date of the transaction) to PepsiCo at 66 2\/3 cents per share, which approximated the market value at the date of the transaction. This is equivalent to 8.3 million of GEMEX American Depository Receipts (ADRs) at $12 per ADR. This option was valued at $26 million at the date of the transaction. Under PepsiCo's agreement with the principal shareholder of GEMEX, voting control of GEMEX will be transferred to PepsiCo no later than December 31, 2002. During 1994, PepsiCo completed acquisitions and investments in unconsolidated affiliates aggregating $355 million, principally for cash. In addition, approximately $41 million of debt was assumed in these transactions, most of which was subsequently retired. This activity included equity investments in international franchised bottling operations, primarily in Thailand and China, and acquisitions of international and U.S. franchised restaurant operations and franchised and independent bottling operations, primarily in India and Mexico. During 1993, PepsiCo completed acquisitions and investments in unconsolidated affiliates aggregating $1.4 billion, principally comprised of $1.0 billion in cash and $335 million in PepsiCo capital stock.\nApproximately $307 million of debt was assumed in these transactions, more than half of which was subsequently retired. This activity included acquisitions of U.S. and international franchised restaurant operations, the buyout of PepsiCo's joint venture partners in a franchised bottling operation in Spain and the related acquisition of their fruit-flavored beverage concentrate operation, the acquisition of the remaining 85% interest in a large franchised bottling operation in the Northwestern U.S., the acquisition of Chevys, a regional Mexican-style casual dining restaurant chain in the U.S., and equity investments in certain franchised bottling operations in Argentina and Mexico. The acquisitions have been accounted for by the purchase method; accordingly, their results are included in the Consolidated Financial Statements from their respective dates of acquisition. The aggregate impact of acquisitions was not material to PepsiCo's net sales, net income or net income per share; accordingly, no related pro forma information is provided.\nNOTE 18 - CONTINGENCIES\nPepsiCo is subject to various claims and contingencies related to lawsuits, taxes, environmental and other matters arising out of the normal course of business. Management believes that the ultimate liability, if any, in excess of amounts already recognized arising from such claims or contingencies is not likely to have a material adverse effect on PepsiCo's annual results of operations or financial condition. At year-end 1995 and 1994, PepsiCo was contingently liable under guarantees aggregating $283 million and $187 million, respectively. The guarantees are primarily issued to support financial arrangements of certain PepsiCo joint ventures, and bottling and restaurant franchisees. PepsiCo manages the risk associated with these guarantees by performing appropriate credit reviews in addition to retaining certain rights as a joint venture partner or franchisor. See Note 9 for information related to the fair value of the guarantees.\nNOTE 19 - BUSINESS SEGMENTS\nPepsiCo operates on a worldwide basis within three industry segments: beverages, snack foods and restaurants.\nBeverages - --------- The beverage segment (\"Beverages\") markets and distributes its Pepsi-Cola, Diet Pepsi, Mountain Dew and other brands worldwide, and 7UP, Diet 7UP, Mirinda, Pepsi Max and other brands internationally. Beverages manufactures concentrates of its brands for sale to franchised bottlers worldwide. Beverages operates bottling plants and distribution facilities located in the U.S. and in various international markets for the production of company-owned and non-company-owned brands. Beverages also manufactures and distributes ready-to-drink Lipton tea products in the U.S. and Canada. Beverages products are available in 193 countries outside the U.S., including emerging markets such as China, Hungary, India, Poland and Russia. Principal international markets include Argentina, Brazil, Canada, China, Japan, Mexico, Saudi Arabia, Spain, Thailand, the U.K. and Venezuela. Beverages' joint venture (\"JV\") investments are primarily in franchised bottling and distribution operations. Internationally, the largest JVs are GEMEX (Mexico), BAESA (South America) and Serm Suk (Thailand), as well as the aggregate of several JVs in China. The primary JV in the U.S. is General Bottlers.\nSnack Foods - ----------- The snack food segment (\"Snack Foods\") manufactures, distributes and markets salty and sweet snacks worldwide, with Frito-Lay representing the U.S. business. Products manufactured and distributed in the U.S. (primarily salty snacks) include Lay's and Ruffles brand potato chips, Doritos and Tostitos brand tortilla chips, Fritos brand corn chips, Chee.tos brand cheese flavored snacks, Rold Gold brand pretzels, a variety of dips and salsas and other brands. Snack Foods products are available in 39 countries outside the U.S. Principal international markets include Australia, Brazil, Canada, France, Mexico, the Netherlands, Poland, Spain and the U.K. International snack foods manufactures and distributes salty snacks in all countries and sweet snacks in certain countries, primarily in France, Mexico and Poland. Snack Foods has investments in several JVs outside the U.S., the largest of which are Snack Ventures Europe (SVE), a JV with General Mills, Inc., which has operations on most of the European continent, and a recent investment in Simba, a snack food operation in South Africa.\nRestaurants - ----------- The restaurant segment (\"Restaurants\") is engaged principally in the operation, development, franchising and licensing of the worldwide Pizza Hut, Taco Bell and KFC concepts. Restaurants also operates other smaller U.S. concepts which are managed by Taco Bell (Hot `n Now and Chevys) and Pizza Hut (East Side Mario's). PFS, PepsiCo's restaurant distribution operation, provides food, supplies and equipment to company-operated, franchised and licensed units, principally in the U.S. Net sales and the related estimated operating profit of PFS' franchisee and licensee operations have been allocated to each restaurant chain.\nPizza Hut, Taco Bell and KFC operate throughout the U.S. Pizza Hut, KFC and, to a lesser extent, Taco Bell operate in 93 countries outside the U.S. Principal international markets include Australia, Canada, Japan, Korea, Mexico, New Zealand, Spain and the U.K. Restaurants has investments in several JVs outside the U.S., the most significant of which are located in Japan and the U.K. PepsiCo also participates in a JV which operates California Pizza Kitchen (CPK), a U.S. casual dining restaurant chain. In 1995, PepsiCo changed the presentation of its restaurant segment to provide information by each of PepsiCo's major U.S. concepts, which include the smaller concepts managed by Pizza Hut and Taco Bell, and in total for the international operations, to more closely reflect how we currently manage the business. Prior year amounts have been restated. Unallocated expenses, net included corporate headquarters expenses, minority interests, primarily in the Gamesa (Mexico) and Wedel (Poland) snack food businesses, foreign exchange translation and transaction gains and losses and other items not allocated to the business segments. Corporate identifiable assets consist principally of cash and cash equivalents and short-term investments, primarily held outside the U.S. PepsiCo has invested in about 80 joint ventures in which it exercises significant influence but not control. As noted above, the JVs are primarily international and principally within PepsiCo's three industry segments. Equity in net (loss) income of these unconsolidated affiliates was ($3) million, $38 million, and $30 million in 1995, 1994 and 1993, respectively. Excluding the initial charge upon adoption of SFAS 121 (see Accounting Changes below), 1995 equity in net income was $14 million. The $24 million decline in 1995 primarily reflected increased losses in our international beverages affiliates in Mexico, reflecting the devaluation of the Mexican peso, costs related to the formation of the GEMEX JV and an unrealized loss on a put option issued in connection with the formation of the GEMEX JV (see Notes 7 and 17). This decline was partially offset by increased equity in net income from our Pepsi-Lipton Tea partnership and SVE. The increase in 1994 primarily reflected increased profit at SVE. Dividends received from these unconsolidated affiliates totaled $29 million, $33 million and $16 million in 1995, 1994 and 1993, respectively. PepsiCo's year-end investments in unconsolidated affiliates totaled $1.6 billion in 1995 and $1.3 billion in 1994. The increase in 1995 reflected the acquisition of a 27% interest in GEMEX and the investment in Simba (see Note 17), advances to BAESA and investments in international franchised bottling operations in China, partially offset by dividends received and equity in net loss that are discussed above. Significant investments in unconsolidated affiliates at year-end 1995 included $244 million in General Bottlers, $201 million in GEMEX, $168 million in BAESA, $157 million in a KFC Japan JV, $147 million in CPK and $107 million in SVE.\nITEMS AFFECTING COMPARABILITY\nNET REFRANCHISING GAINS Restaurant operating profit in 1995 included net gains of $51 million from sales of restaurants to franchisees by Pizza Hut, Taco Bell and International in excess of the cost of closing other restaurants in all of our concepts (net gains at Pizza Hut-$24 million and Taco Bell-$38 million; net losses at KFC-($7) million and International-($4) million).\nFISCAL YEAR Fiscal year 1994 consisted of 53 weeks and the years 1990 through 1993 and 1995 consisted of 52 weeks. The fifty-third week increased 1994 net sales by an estimated $434 million, increasing beverage, snack food and restaurant net sales by $119 million, $143 million and $172 million, respectively. The estimated impact of the fifty-third week on 1994 operating profit was $65 million, increasing beverage, snack food and restaurant operating profit by $17 million, $26 million and $23 million, respectively, and increasing unallocated expenses, net by $1 million.\nUNUSUAL ITEMS Unusual charges totaled $193 million in 1992 and $170 million in 1991. These unusual items were as follows:\nBeverages - 1992 included $145 million in charges consisting of $115 million and $30 million to reorganize and streamline U.S. and international operations, respectively. Snack Foods - 1992 included a $40 million charge, principally to consolidate the Walkers businesses in the U.K. 1991 included $127 million in charges consisting of $91 million and $24 million to streamline U.S. and U.K. operations, respectively, and $12 million to dispose of all or part of a small unprofitable business in Japan. Restaurants - 1991 included $43 million in charges at KFC primarily to streamline operations. Unallocated expenses, net - 1992 included an $8 million charge to streamline operations of the SVE joint venture. See Management's Analysis - Beverages performance on pages 22 through 27 for additional information on the 1992 beverage restructurings.\nACCOUNTING CHANGES PepsiCo adopted SFAS 121 as of the beginning of the fourth quarter of 1995. See Note 2. The initial, noncash charge upon adoption reduced operating profit as follows: International Beverages ................ $ 62 International Snack Foods ............. 4 Restaurants Pizza Hut U.S. ........................ 68 Taco Bell U.S. (a) .................... 169 KFC U.S. .............................. 65 ---- Total U.S. Restaurants................ 302 International Restaurants.............. 135 ---- Combined Segments ...................... 503 Equity (Loss) Income (b) ............... 17 ---- $520 ==== (a) Hot `n Now and Chevys incurred $103 of this charge, with Hot `n Now responsible for almost all of the charge. (b) Primarily related to CPK.\nIncluded in the initial charge above was $68 million related to restaurants for which closure decisions were made during the fourth quarter (Pizza Hut-$21 million, Taco Bell-$16 million, KFC-$6 million, International-$21 million and equity (loss) income-$4 million). As a result of the reduced carrying amount of certain of PepsiCo's assets used in the business, depreciation and amortization expense for the fourth quarter of 1995 was reduced by $21 million, affecting international\nbeverages by $4 million, restaurants by $16 million and equity (loss) income by $1 million. In 1994, PepsiCo adopted a preferred method for calculating the market-related value of plan assets used in determining annual pension expense (see Note 13) and extended the depreciable lives on certain Pizza Hut U.S. delivery assets. As compared to the previous accounting methods, these changes increased 1994 operating profit by $49 million, increasing beverage, snack food and restaurant segment operating profit by $12 million, $15 million and $20 million, respectively, and decreasing 1994 unallocated expenses, net by $2 million. In 1992, PepsiCo adopted Statements of Financial Accounting Standards No. 106 and 109, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and \"Accounting for Income Taxes,\" respectively. As compared to the previous accounting methods, these changes reduced 1992 operating profit by $73 million, decreasing beverage, snack food and restaurant segment operating profit by $22 million, $31 million and $16 million, respectively, and increasing 1992 unallocated expenses, net by $4 million.\n- ------------------------------------------------------------------------------ INDUSTRY SEGMENTS - NET SALES (page 1 of 5)\n- ------------------------------------------------------------------------------ Growth Rate 1990-1995(a) 1995 1994 1993 1992 1991\n- ------------------------------------------------------------------------------ Beverages: U.S. 7% $ 6,977 $ 6,541 $ 5,918 $ 5,485 $ 5,171 International 19% 3,571 3,146 2,720 2,121 1,744 ------- ------- ------- ------- ------- 10% 10,548 9,687 8,638 7,606 6,915 ------- ------- ------- ------- -------\nSnack Foods: U.S. 10% 5,495 5,011 4,365 3,950 3,738 International 19% 3,050 3,253 2,662 2,182 1,512 ------- ------- ------- ------- ------- 12% 8,545 8,264 7,027 6,132 5,250 ------- ------- ------- ------- -------\nRestaurants: U.S. 11% 9,202 8,694 8,026 7,115 6,258 International 25% 2,126 1,827 1,330 1,117 869 ------- ------- ------- ------- ------- 13% 11,328 10,521 9,356 8,232 7,127 ------- ------- ------- ------- -------\nCOMBINED SEGMENTS U.S. 9% 21,674 20,246 18,309 16,550 15,167 International 20% 8,747 8,226 6,712 5,420 4,125 ------- ------- ------- ------- ------- 12% $30,421 $28,472 $25,021 $21,970 $19,292 ======= ======= ======= ======= =======\n- ------------------------------------------------------------------------------ BY U.S. RESTAURANT CHAIN Pizza Hut 8% $ 3,977 $ 3,712 $ 3,595 $ 3,183 $ 2,937 Taco Bell 15% 3,503 3,340 2,855 2,426 2,017 KFC 9% 1,722 1,642 1,576 1,506 1,304 ------- ------- ------- ------- ------- 11% $ 9,202 $ 8,694 $ 8,026 $ 7,115 $ 6,258 ======= ======= ======= ======= =======\n- ------------------------------------------------------------------------------ (a) Five-year compounded annual growth rate.\n- ------------------------------------------------------------------------------ INDUSTRY SEGMENTS - OPERATING PROFIT (b) (page 2 of 5)\n- ------------------------------------------------------------------------------ Growth Rate 1990-1995(a) 1995 1994 1993 1992 1991\n- ------------------------------------------------------------------------------ Beverages: U.S. 11% $1,145 $1,022 $ 937 $ 686 $ 746 International 19% 164 195 172 113 117 ------ ------ ------ ------ ------ 12% 1,309 1,217 1,109 799 863 ------ ------ ------ ------ ------\nSnack Foods: U.S. 9% 1,132 1,025 901 776 617 International 14% 300 352 289 209 140 ------ ------ ------ ------ ------ 10% 1,432 1,377 1,190 985 757 ------ ------ ------ ------ ------\nRestaurants: U.S. 10% 451 659 685 598 480 International 8% (21) 71 93 120 96 ------ ------ ------ ------ ------ 9% 430 730 778 718 576 ------ ------ ------ ------ ------\nCombined Segments U.S. 10% 2,728 2,706 2,523 2,060 1,843 International 14% 443 618 554 442 353 ------ ------ ------ ------ ------ 10% 3,171 3,324 3,077 2,502 2,196\nEquity (Loss) Income (3) 38 30 40 32\nUnallocated Expenses, net (181) (161) (200) (171) (116) ------ ------ ------ ------ ------\nOperating Profit 11% $2,987 $3,201 $2,907 $2,371 $2,112 ====== ====== ====== ====== ======\n- ------------------------------------------------------------------------------ BY U.S. RESTAURANT CHAIN Pizza Hut 9% $ 308 $ 285 $ 338 $ 300 $ 286 Taco Bell 12% 105 273 256 214 183 KFC 7% 38 101 91 84 11 ------ ------ ------ ------ ------ 10% $ 451 $ 659 $ 685 $ 598 $ 480 ====== ====== ====== ====== ======\n- ------------------------------------------------------------------------------ (a) Five-year compounded annual growth rate. Growth rates exclude the impacts of the initial, noncash charge upon adoption of SFAS 121 in 1995 (see Accounting Changes on page) and the previously disclosed 1990 unusual items affecting U.S. beverages and snack foods, worldwide restaurants and unallocated expenses, net. (b) The amounts for the years 1991-1995 represent reported amounts. See page for Items Affecting Comparability.\n- ----------------------------------------------------------------------- GEOGRAPHIC AREAS (c) (page 3 of 5) - -----------------------------------------------------------------------\nNET SALES ----------------------------- 1995 1994 1993 - ----------------------------------------------------------------------- United States $21,674 $20,246 $18,309 Europe 2,783 2,177 1,819 Mexico 1,228 2,023 1,614 Canada 1,299 1,244 1,206 Other 3,437 2,782 2,073 ------- ------- -------\nCOMBINED SEGMENTS $30,421 $28,472 $25,021 ======= ======= ======= - ----------------------------------------------------------------------- SEGMENT OPERATING PROFIT (LOSS) ------------------------------- 1995(d) 1994 1993 - ----------------------------------------------------------------------- United States $ 2,728 $ 2,706 $ 2,523 Europe (65) 17 47 Mexico 80 261 223 Canada 86 82 102 Other 342 258 182 ------- ------- -------\nCOMBINED SEGMENTS $ 3,171 $ 3,324 $ 3,077 ======= ======= ======= - ----------------------------------------------------------------------- IDENTIFIABLE ASSETS ------------------------------ 1995 1994 1993 - ----------------------------------------------------------------------- United States $14,505 $14,218 $13,590 Europe 3,127 3,062 2,666 Mexico 637 995 1,217 Canada 1,344 1,342 1,364 Other 2,629 2,196 1,675 ------- ------- -------\nCOMBINED SEGMENTS 22,242 21,813 20,512\nInvestments in Unconsolidated Affiliates 1,635 1,295 1,091 Corporate 1,555 1,684 2,103 ------- ------- -------\n$25,432 $24,792 $23,706 ======= ======= ======= - ---------------------------------------------------------------------- (c) The results of centralized concentrate manufacturing operations in Puerto Rico and Ireland have been allocated based upon sales to the respective geographic areas. (d) The initial charge upon adoption of SFAS 121 (see Accounting Changes on page) reduced combined segment operating profit by $503 (United States - $302, Europe - $119, Mexico - $21, Canada - $30, Other - $31).\n- ----------------------------------------------------------------------- INDUSTRY SEGMENTS (page 4 of 5) - ----------------------------------------------------------------------- AMORTIZATION OF INTANGIBLE ASSETS Growth Rate ---------------------------------- 1990-1995 (a) 1995 1994 1993 - ----------------------------------------------------------------------- Beverages 7% $ 166 $ 165 $ 157 Snack Foods 2% 41 42 41 Restaurants 23% 109 105 106 ------- ------- ------- 10% $ 316 $ 312 $ 304 ======= ======= ======= By U.S. Restaurant Chain Pizza Hut 14% $ 36 $ 38 $ 35 Taco Bell 24% 23 27 23 KFC 18% 18 22 23 ------- ------- ------- Total U.S. 16% 77 87 81 International 61% 32 18 25 ------- ------- ------- 23% $ 109 $ 105 $ 106 ======= ======= ======= - ----------------------------------------------------------------------- DEPRECIATION EXPENSE Growth Rate ---------------------------------- 1990-1995 (a) 1995 1994 1993 - ----------------------------------------------------------------------- Beverages 15% $ 445 $ 385 $ 359 Snack Foods 9% 304 297 279 Restaurants 17% 579 539 457 Corporate 7 7 7 ------- ------- ------- 14% $ 1,335 $ 1,228 $ 1,102 ======= ======= ======= By U.S. Restaurant Chain Pizza Hut 13% $ 189 $ 178 $ 159 Taco Bell 21% 179 153 122 KFC 11% 101 107 101 ------- ------- ------- Total U.S. 15% 469 438 382 International 27% 110 101 75 ------- ------- ------- 17% $ 579 $ 539 $ 457 ======= ======= ======= - ----------------------------------------------------------------------- IDENTIFIABLE ASSETS Growth Rate ------------------------------ 1990-1995 (a) 1995 1994 1993 - ----------------------------------------------------------------------- Beverages 9% $10,032 $ 9,566 $ 9,105 Snack Foods 7% 5,451 5,044 4,995 Restaurants 14% 6,759 7,203 6,412 Investments in Unconsolidated Affiliates 9% 1,635 1,295 1,091 Corporate 1,555 1,684 2,103 ------- ------- ------- 8% $25,432 $24,792 $23,706 ======= ======= ======= By U.S. Restaurant Chain Pizza Hut 8% $ 1,700 $ 1,832 $ 1,733 Taco Bell 19% 2,276 2,327 2,060 KFC 7% 1,111 1,253 1,265 ------- ------- ------- Total U.S. 12% 5,087 5,412 5,058 International 27% 1,672 1,791 1,354 ------- ------- ------- 14% $ 6,759 $ 7,203 $ 6,412 ======= ======= ======= - ----------------------------------------------------------------------- (a) Five-year compounded annual growth rate.\n- ----------------------------------------------------------------------- INDUSTRY SEGMENTS (page 5 of 5) - ----------------------------------------------------------------------- CAPITAL SPENDING (e) Growth Rate ----------------------------- 1990-1995 (a) 1995 1994 1993 - ----------------------------------------------------------------------- Beverages 11% $ 566 $ 677 $ 491 Snack Foods 15% 769 532 491 Restaurants 10% 750 1,072 1,005 Corporate 34 7 21 ------ ------ ------ 12% $2,119 $2,288 $2,008 ====== ====== ======\nU.S. 12% $1,496 $1,492 $1,388 International 13% 623 796 620 ------ ------ ------ 12% $2,119 $2,288 $2,008 ====== ====== ======\nBy U.S. Restaurant Chain: Pizza Hut 1% $ 168 $ 225 $ 209 Taco Bell 17% 305 442 442 KFC -% 93 69 106 ------ ------ ------ Total U.S. 8% 566 736 757 International 20% 184 336 248 ------ ------ ------ 10% $ 750 $1,072 $1,005 ====== ====== ====== - ----------------------------------------------------------------------- ACQUISITIONS AND INVESTMENTS IN UNCONSOLIDATED AFFILIATES (f) -------------------------------- 1995 1994 1993 - ----------------------------------------------------------------------- Beverages $ 323 $ 195 $ 711 Snack Foods 82 12 76 Restaurants 70 148 589 ------ ------ ------ $ 475 $ 355 $1,376 ====== ====== ======\nU.S. $ 73 $ 88 $ 757 International 402 267 619 ------ ------ ------ $ 475 $ 355 $1,376 ====== ====== ======\nBy U.S. Restaurant Chain Pizza Hut $ 3 $ 52 $ 219 Taco Bell 34 32 187 KFC - - 30 ------ ------ ------ Total U.S. 37 84 436 International 33 64 153 ------ ------ ------ $ 70 $ 148 $ 589 ====== ====== ====== - ---------------------------------------------------------------------- (a) Five-year compounded annual growth rate. (e) Included immaterial, noncash amounts related to capital leases, largely in the restaurant segment. (f) Included noncash amounts related to treasury stock and debt issued of $9 in 1995, $39 in 1994 and $365 in 1993. Of these noncash amounts, 100%, 86% and 35%, respectively, related to the restaurant segment and the balance related to the beverage segment.\nManagement's Responsibility for Financial Statements\nTo Our Shareholders:\nManagement is responsible for the reliability of the consolidated financial statements and related notes, which have been prepared in conformity with generally accepted accounting principles and include amounts based upon our estimates and assumptions, as required. The financial statements have been audited and reported on by our independent auditors, KPMG Peat Marwick LLP, who were given free access to all financial records and related data, including minutes of the meetings of the Board of Directors and Committees of the Board. We believe that management representations made to the independent auditors were valid and appropriate.\nPepsiCo maintains a system of internal control over financial reporting, designed to provide reasonable assurance as to the reliability of the financial statements, as well as to safeguard assets from unauthorized use or disposition. The system is supported by formal policies and procedures, including an active Code of Conduct program intended to ensure employees adhere to the highest standards of personal and professional integrity. PepsiCo's internal audit function monitors and reports on the adequacy of and compliance with the internal control system, and appropriate actions are taken to address significant control deficiencies and other opportunities for improving the system as they are identified. The Audit Committee of the Board of Directors, which is composed solely of outside directors, provides oversight to our financial reporting process and our controls to safeguard assets through periodic meetings with our independent auditors, internal auditors and management. Both our independent auditors and internal auditors have free access to the Audit Committee.\nAlthough no cost effective internal control system will preclude all errors and irregularities, we believe our controls as of December 30, 1995 provide reasonable assurance that the financial statements are reliable and that our assets are reasonably safeguarded.\nWayne Calloway Robert L. Carleton Chairman of the Board Senior Vice President and Chief Executive Officer and Controller\nRobert G. Dettmer Executive Vice President and Chief Financial Officer\nFebruary 6, 1996\nReport of Independent Auditors\nBoard of Directors and Shareholders PepsiCo, Inc.\nWe have audited the accompanying consolidated balance sheet of PepsiCo, Inc. and Subsidiaries as of December 30, 1995 and December 31, 1994, and the related consolidated statements of income, cash flows and shareholders' equity for each of the years in the three-year period ended December 30, 1995. These consolidated financial statements are the responsibility of PepsiCo, 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 PepsiCo, Inc. and Subsidiaries as of December 30, 1995 and December 31, 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 30, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, PepsiCo, Inc. in 1995 adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" As discussed in Notes 13 and 14 to the consolidated financial statements, PepsiCo, Inc. in 1994 changed its method for calculating the market-related value of pension plan assets used in the determination of pension expense and adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" respectively.\nKPMG Peat Marwick LLP New York, New York February 6, 1996\n- ----------------------------------------------------------------------- SELECTED QUARTERLY FINANCIAL DATA (page 1 of 4) ($ in millions except per share amounts, unaudited) PepsiCo, Inc. and Subsidiaries\n- ----------------------------------------------------------------------- First Quarter (12 Weeks) 1995 1994 - ----------------------------------------------------------------------- Net sales...................................... $ 6,191 5,729 Gross profit................................... $ 3,169 2,944 Operating profit............................... $ 629 550 Income before income taxes and cumulative effect of accounting changes.................. $ 496 438 Provision for income taxes..................... $ 175 155 Income before cumulative effect of accounting changes............................ $ 321 283 Cumulative effect of accounting changes (e).... $ - (32) Net income..................................... $ 321 251 Income (charge) per share Income before cumulative effect of accounting changes.......................... $ 0.40 0.35 Cumulative effect of accounting changes (e)................................. $ - (0.04) Net income per share........................... $ 0.40 0.31 Cash dividends declared per share.............. $ 0.18 0.16 Stock price per share (f) High......................................... $ 41 42 1\/2 Low.......................................... $33 7\/8 35 3\/4 Close........................................ $40 1\/4 37 5\/8 - -------------------------------------------------------------------------------- (e) Represented the cumulative net effect related to years prior to 1994 of adopting SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" and the change to a preferred method for calculating the market-related value of pension plan assets. See Notes 14 and 13, respectively. (f) Represented the high, low and closing prices for a share of PepsiCo capital stock on the New York Stock Exchange, as reported by The Dow Jones News\/Retrieval Service, for each respective period.\n- -------------------------------------------------------------------------- SELECTED QUARTERLY FINANCIAL DATA (page 2 of 4) ($ in millions except per share amounts, unaudited) PepsiCo, Inc. and Subsidiaries\n- -------------------------------------------------------------------------- Second Quarter (12 Weeks) 1995 1994(a) - -------------------------------------------------------------------------- Net sales...................................... $ 7,286 6,557 Gross profit................................... $ 3,735 3,420 Operating profit............................... $ 869 785 Income before income taxes..................... $ 735 672 Provision for income taxes..................... $ 248 225 Net income .................................... $ 487 447 Net income per share........................... $ 0.61 0.55 Cash dividends declared per share.............. $ 0.20 0.18 Stock price per share (f) High......................................... $ 49 37 3\/4 Low.......................................... $37 7\/8 29 7\/8 Close........................................ $46 5\/8 31 1\/8 - -------------------------------------------------------------------------------- (a) Included an $18 gain ($17 after-tax or $0.02 per share) arising from a public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America. See Note 16. (f) Represented the high, low and closing prices for a share of PepsiCo capital stock on the New York Stock Exchange, as reported by The Dow Jones News\/Retrieval Service, for each respective period.\n- ---------------------------------------------------------------------- SELECTED QUARTERLY FINANCIAL DATA (page 3 of 4) ($ in millions except per share amounts, unaudited) PepsiCo, Inc. and Subsidiaries\n- ----------------------------------------------------------------------- Third Quarter (12 Weeks) 1995 1994 - ----------------------------------------------------------------------- Net sales...................................... $ 7,693 7,064 Gross profit................................... $ 3,942 3,684 Operating profit............................... $ 1,031 962 Income before income taxes..................... $ 901 830 Provision for income taxes..................... $ 284 289 Net income .................................... $ 617 541 Net income per share........................... $ 0.77 0.68 Cash dividends declared per share.............. $ 0.20 0.18 Stock price per share (f) High......................................... $47 7\/8 34 5\/8 Low.......................................... $43 1\/4 29 1\/4 Close........................................ $45 3\/4 33 3\/4 - ----------------------------------------------------------------------- Fourth Quarter (16\/17 Weeks) (d) 1995(b)(c) 1994 - ----------------------------------------------------------------------- Net sales...................................... $ 9,251 9,122 Gross profit................................... $ 4,689 4,709 Operating profit............................... $ 458 904 Income before income taxes..................... $ 300 724 Provision for income taxes..................... $ 119 211 Net income .................................... $ 181 513 Net income per share........................... $ 0.22 0.64 Cash dividends declared per share.............. $ 0.20 0.18 Stock price per share (f) High......................................... $58 3\/4 37 3\/8 Low.......................................... $45 5\/8 32 1\/4 Close........................................ $55 7\/8 36 1\/4 - ----------------------------------------------------------------------- (b) Included the initial, noncash charge of $520 ($384 after-tax or $0.48 per share) upon adoption of SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" at the beginning of the fourth quarter. As a result of the reduced carrying amount of certain long-lived assets to be held and used in the business, depreciation and amortization expense for the fourth quarter was reduced by $21 ($15 after-tax or $0.02 per share). See Note 2. (c) Included a net gain of $51 ($27 after-tax or $0.03 per share), primarily in the fourth quarter, from sales of restaurants to franchisees in excess of the cost of closing other restaurants. (d) Fiscal years 1995 and 1994 consisted of 52 and 53 weeks, respectively. The fifty-third week increased 1994 fourth quarter and full-year earnings by an estimated $54 ($35 after-tax or $0.04 per share). (f) Represented the high, low and closing prices for a share of PepsiCo capital stock on the New York Stock Exchange, as reported by The Dow Jones News\/Retrieval Service, for each respective period.\n- ------------------------------------------------------------------------- SELECTED QUARTERLY FINANCIAL DATA (page 4 of 4) ($ in millions except per share amounts, unaudited) PepsiCo, Inc. and Subsidiaries\n- ------------------------------------------------------------------------- Full Year (52\/53 Weeks)(d) 1995(b)(c) 1994(a) - ------------------------------------------------------------------------- Net sales...................................... $30,421 28,472 Gross profit................................... $15,535 14,757 Operating profit............................... $ 2,987 3,201 Income before income taxes and cumulative effect of accounting changes.................. $ 2,432 2,664 Provision for income taxes..................... $ 826 880 Income before cumulative effect of accounting changes............................ $ 1,606 1,784 Cumulative effect of accounting changes (e).... $ - (32) Net income..................................... $ 1,606 1,752 Income (charge) per share Income before cumulative effect of accounting changes.......................... $ 2.00 2.22 Cumulative effect of accounting changes (e)................................. $ - (0.04) Net income per share........................... $ 2.00 2.18 Cash dividends declared per share.............. $ 0.78 0.70 Stock price per share (f) High......................................... $58 3\/4 42 1\/2 Low.......................................... $33 7\/8 29 1\/4 Close........................................ $55 7\/8 36 1\/4 - ----------------------------------------------------------------------- (a) Included an $18 gain ($17 after-tax or $0.02 per share) arising from a public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America. See Note 16. (b) Included the initial, noncash charge of $520 ($384 after-tax or $0.48 per share) upon adoption of SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" at the beginning of the fourth quarter. As a result of the reduced carrying amount of certain long-lived assets to be held and used in the business, depreciation and amortization expense for the fourth quarter was reduced by $21 ($15 after-tax or $0.02 per share). See Note 2. (c) Included a net gain of $51 ($27 after-tax or $0.03 per share), primarily in the fourth quarter, from sales of restaurants to franchisees in excess of the cost of closing other restaurants. (d) Fiscal years 1995 and 1994 consisted of 52 and 53 weeks, respectively. The fifty-third week increased 1994 fourth quarter and full-year earnings by an estimated $54 ($35 after-tax or $0.04 per share). (e) Represented the cumulative net effect related to years prior to 1994 of adopting SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" and the change to a preferred method for calculating the market-related value of pension plan assets. See Notes 14 and 13, respectively. (f) Represented the high, low and closing prices for a share of PepsiCo capital stock on the New York Stock Exchange, as reported by The Dow Jones News\/Retrieval Service, for each respective period.\n- ------------------------------------------------------------------------------ SELECTED FINANCIAL DATA (Page 1 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - ------------------------------------------------------------------------------ Growth Rates --------------------------- Compounded Annual ----------------- ------- 10-Year 5-Year 1-Year 1985-95 1990-95 1994-95 ------- ------- ------- SUMMARY OF OPERATIONS Net sales................................. 15% 12% 7% Operating profit.......................... 14% 8% (7)% Gain on stock offering by an unconsolidated affiliate (j)............. Interest expense, net..................... Income from continuing operations before income taxes and cumulative effect of accounting changes 14% 8% (9)% Income from continuing operations before cumulative effect of accounting changes....................... 14% 8% (10)% Cumulative effect of accounting changes (k).............................. Net income (l)............................ 11% 8% (8)% CASH FLOW DATA (m) Provided by operating activities.......... 16% 12% 1% Capital spending.......................... 11% 12% (7)% Operating free cash flow.................. 43% 12% 12% Dividends paid............................ 14% 15% 11% Purchases of treasury stock............... Acquisitions and investments in unconsolidated affiliates................ PER SHARE DATA AND OTHER SHARE INFORMATION Income from continuing operations before cumulative effect of accounting changes....................... 15% 8% (10)% Cumulative effect of accounting changes (k).............................. Net income (l)............................ 12% 8% (8)% Cash dividends declared................... 15% 15% 11% Book value per share at year-end.......... 15% 8% 7% Market price per share at year-end........ 22% 17% 54% Number of shares repurchased.............. Shares outstanding at year-end............ Average shares outstanding used to calculate income (charge) per share (n)................................ BALANCE SHEET Total assets.............................. 16% 8% 1% Long-term debt............................ 22% 8% (4)% Total debt (o)............................ 20% 4% (3)% Shareholders' equity...................... STATISTICS Return on average shareholders' equity (p)............................... Market net debt ratio (q)................. Historical cost net debt ratio (r)........ Employees................................. 12% 9% 2%\n- ------------------------------------------------------------------------------\nSELECTED FINANCIAL DATA (Page 2 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - ------------------------------------------------------------------------------\n1995(a)(b) 1994(c)(d) 1993(e) - ------------------------------------------------------------------------------ SUMMARY OF OPERATIONS Net sales................................. $30,421 28,472 25,021 Operating profit.......................... $ 2,987 3,201 2,907 Gain on stock offering by an unconsolidated affiliate (j)............. - 18 - Interest expense, net..................... (555) (555) (484) ------- ------- ------- Income from continuing operations before income taxes and cumulative effect of accounting changes............. $ 2,432 2,664 2,423 ======= ======= ======= Income from continuing operations before cumulative effect of accounting changes....................... $ 1,606 1,784 1,588 Cumulative effect of accounting changes (k).............................. $ - (32) - Net income (l)............................ $ 1,606 1,752 1,588 CASH FLOW DATA (m) Provided by operating activities.......... $ 3,742 3,716 3,134 Capital spending.......................... 2,104 2,253 1,982 ------- ------- ------- Operating free cash flow.................. $ 1,638 1,463 1,152 ======= ======= ======= Dividends paid............................ $ 599 540 462 Purchases of treasury stock............... $ 541 549 463 Acquisitions and investments in unconsolidated affiliates................ $ 466 316 1,011 PER SHARE DATA AND OTHER SHARE INFORMATION Income from continuing operations before cumulative effect of accounting changes....................... $ 2.00 2.22 1.96 Cumulative effect of accounting changes (k).............................. $ - (0.04) - Net income (l)............................ $ 2.00 2.18 1.96 Cash dividends declared................... $ 0.780 0.700 0.610 Book value per share at year-end.......... $ 9.28 8.68 7.93 Market price per share at year-end........ $55 7\/8 36 1\/4 41 7\/8 Number of shares repurchased.............. 12.3 15.0 12.4 Shares outstanding at year-end............ 788 790 799 Average shares outstanding used to calculate income (charge) per share (n)................................ 804 804 810 BALANCE SHEET Total assets.............................. $25,432 24,792 23,706 Long-term debt............................ $ 8,509 8,841 7,443 Total debt (o) ........................... $ 9,215 9,519 9,634 Shareholders' equity...................... $ 7,313 6,856 6,339 STATISTICS Return on average shareholders' equity (p)............................... 23% 27 27 Market net debt ratio (q)................. 18% 26 22 Historical cost net debt ratio (r)........ 46% 49 50 Employees................................. 480,000 471,000 423,000\n- -------------------------------------------------------------------------- SELECTED FINANCIAL DATA (Page 3 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - -------------------------------------------------------------------------- 1992(f)(g) 1991(h) 1990(i) - -------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net sales................................. $21,970 19,292 17,516 Operating profit.......................... 2,371 2,112 2,042 Gain on stock offering by an unconsolidated affiliate (j)............. - - 118 Interest expense, net..................... (472) (452) (506) ------- ------- ------- Income from continuing operations before income taxes and cumulative effect of accounting changes............. $ 1,899 1,660 1,654 ======= ======= ======= Income from continuing operations before cumulative effect of accounting changes....................... $ 1,302 1,080 1,091 Cumulative effect of accounting changes (k).............................. $ (928) - - Net income (l) ........................... $ 374 1,080 1,077 CASH FLOW DATA (m) Provided by operating activities.......... $ 2,712 2,430 2,110 Capital spending.......................... 1,550 1,458 1,180 ------- ------- ------- Operating free cash flow.................. $ 1,162 972 930 ======= ======= ======= Dividends paid............................ $ 396 343 294 Purchases of treasury stock............... $ 32 195 148 Acquisitions and investments in unconsolidated affiliates................ $ 1,210 641 631 PER SHARE DATA AND OTHER SHARE INFORMATION Income from continuing operations before cumulative effect of accounting changes....................... $ 1.61 1.35 1.37 Cumulative effect of accounting changes (k) ............................. $ (1.15) - - Net income (l) ........................... $ 0.46 1.35 1.35 Cash dividends declared................... $ 0.510 0.460 0.383 Book value per share at year-end.......... $ 6.70 7.03 6.22 Market price per share at year-end........ $42 1\/4 33 3\/4 25 3\/4 Number of shares repurchased.............. 1.0 6.4 6.3 Shares outstanding at year-end............ 799 789 788 Average shares outstanding used to calculate income (charge) per share (n)................................ 807 803 799 BALANCE SHEET Total assets.............................. $20,951 18,775 17,143 Long-term debt............................ $ 7,965 7,806 5,900 Total debt (o) ........................... $ 8,672 8,034 7,526 Shareholders' equity...................... $ 5,356 5,545 4,904 STATISTICS Return on average shareholders' equity (p) .............................. 24% 21 25 Market net debt ratio (q) ................ 19% 21 24 Historical cost net debt ratio (r) ....... 49% 51 51 Employees................................. 372,000 338,000 308,000\n- ----------------------------------------------------------------------- SELECTED FINANCIAL DATA (Page 4 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - -------------------------------------------------------------------------- 1989 1988(d) 1987 - -------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net sales................................. $15,049 12,381 11,018 Operating profit.......................... $ 1,773 1,342 1,128 Gain on stock offering by an unconsolidated affiliate (j) ............ - - - Interest expense, net..................... (433) (222) (182) ------- ------- ------- Income from continuing operations before income taxes and cumulative effect of accounting changes............. $ 1,340 1,120 946 ======= ======= ======= Income from continuing operations before cumulative effect of accounting changes....................... $ 901 762 605 Cumulative effect of accounting changes (k) ............................. $ - - - Net income (l) ........................... $ 901 762 595 CASH FLOW DATA (m) Provided by operating activities.......... $ 1,886 1,895 1,335 Capital spending.......................... 944 726 771 ------- ------- ------- Operating free cash flow.................. $ 942 1,169 564 ======= ======= ======= Dividends paid............................ $ 242 199 172 Purchases of treasury stock............... $ - 72 19 Acquisitions and investments in unconsolidated affiliates................ $ 3,297 1,416 372 PER SHARE DATA AND OTHER SHARE INFORMATION Income from continuing operations before cumulative effect of accounting changes....................... $ 1.13 0.97 0.77 Cumulative effect of accounting changes (k) ............................. $ - - - Net income (l) ........................... $ 1.13 0.97 0.76 Cash dividends declared................... $ 0.320 0.267 0.223 Book value per share at year-end.......... $ 4.92 4.01 3.21 Market price per share at year-end........ $21 3\/8 13 1\/8 11 1\/4 Number of shares repurchased.............. - 6.2 1.9 Shares outstanding at year-end............ 791 788 781 Average shares outstanding used to calculate income (charge) per share (n)................................ 796 790 789 BALANCE SHEET Total assets.............................. $15,127 11,135 9,023 Long-term debt............................ $ 6,077 2,656 2,579 Total debt (o) ........................... $ 6,943 4,107 3,225 Shareholders' equity...................... $ 3,891 3,161 2,509 STATISTICS Return on average shareholders' equity (p) .............................. 26% 27 27 Market net debt ratio (q) ................ 26% 24 22 Historical cost net debt ratio (r) ....... 54% 43 41 Employees................................. 266,000 235,000 225,000\n- ----------------------------------------------------------------------- SELECTED FINANCIAL DATA (Page 5 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - ----------------------------------------------------------------------- 1986 1985 - ----------------------------------------------------------------------- SUMMARY OF OPERATIONS Net sales................................. $ 9,017 7,585 Operating profit.......................... 829 782 Gain on stock offering by an unconsolidated affiliate (j)............. - - Interest expense, net..................... (139) (99) ------- ------- Income from continuing operations before income taxes and cumulative effect of accounting changes............. $ 690 683 ======= ======= Income from continuing operations before cumulative effect of accounting changes....................... $ 464 427 Cumulative effect of accounting changes (k).............................. $ - - Net income (l)............................ $ 458 544 CASH FLOW DATA (m) Provided by operating activities.......... $ 1,212 817 Capital spending.......................... 859 770 ------- ------- Operating free cash flow.................. $ 353 47 ======= ======= Dividends paid............................ $ 160 161 Purchases of treasury stock............... $ 158 458 Acquisitions and investments in unconsolidated affiliates................ $ 1,680 160 PER SHARE DATA AND OTHER SHARE INFORMATION Income from continuing operations before cumulative effect of accounting changes....................... $ 0.59 0.51 Cumulative effect of accounting changes (k).............................. $ - - Net income (l)............................ $ 0.58 0.65 Cash dividends declared................... $ 0.209 0.195 Book value per share at year-end.......... $ 2.64 2.33 Market price per share at year-end........ $ 8 3\/4 7 7\/8 Number of shares repurchased.............. 20.2 66.0 Shares outstanding at year-end............ 781 789 Average shares outstanding used to calculate income (charge) per share (n)................................ 787 842 BALANCE SHEET Total assets.............................. $ 8,027 5,889 Long-term debt............................ $ 2,633 1,162 Total debt (o) ........................... $ 2,865 1,506 Shareholders' equity...................... $ 2,059 1,838 STATISTICS Return on average shareholders' equity (p) .............................. 24% 23 Market net debt ratio (q) ................ 28% 15 Historical cost net debt ratio (r)........ 46% 30 Employees................................. 241,000 150,000\n- -------------------------------------------------------------------------------- SELECTED FINANCIAL DATA (Page 6 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - -------------------------------------------------------------------------------- All share and per share amounts reflect three-for-one stock splits in 1990 and 1986. Additionally, PepsiCo made numerous acquisitions in most years presented and a few divestitures in certain years. Such transactions did not materially affect the comparability of PepsiCo's operating results for the periods presented, except for certain large acquisitions made in 1986, 1988 and 1989, and the divestiture discussed in (l) below.\n(a) Included the initial, noncash charge of $520 ($384 after-tax or $0.48 per share) upon adoption of SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" at the beginning of the fourth quarter. As a result of the reduced carrying amount of certain long-lived assets to be held and used in the business, depreciation and amortization expense for the fourth quarter was reduced by $21 ($15 after-tax or $0.02 per share). See Note 2. (b) Included a net gain of $51 ($27 after-tax or $0.03 per share) from sales of restaurants to franchisees in excess of the cost of closing other restaurants. (c) Included a benefit of changing to a preferred method for calculating the market-related value of plan assets in 1994, which reduced full-year pension expense by $35 ($22 after-tax or $0.03 per share). See Note 13. (d) Fiscal years 1994 and 1988 each consisted of 53 weeks. Normally, fiscal years consist of 52 weeks; however, because the fiscal year ends on the last Saturday in December, a week is added every 5 or 6 years. The fifty-third week increased 1994 earnings by approximately $54 ($35 after-tax or $0.04 per share) and 1988 earnings by approximately $23 ($16 after-tax or $0.02 per share). (e) Included a $30 charge ($0.04 per share) to increase net deferred tax liabilities as of the beginning of 1993 for a 1% statutory income tax rate increase due to 1993 U.S. Federal tax legislation. See Note 11. (f) Included $193 in unusual charges for restructuring ($129 after-tax or $0.16 per share). See Note 19. (g) Included increased postretirement benefits expense of $52 ($32 after-tax or $0.04 per share) as a result of adopting SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Included the impact of adopting SFAS 109, \"Accounting for Income Taxes,\" which reduced pretax income by $21 and the provision for income taxes by $34. (h) Included $170 in unusual charges ($120 after-tax or $0.15 per share). See Note 19. (i) Included $83 in unusual charges ($49 after-tax or $0.06 per share) for costs of closing restaurants, U.S. trade receivables exposures, accelerated contributions to the PepsiCo Foundation and a reduction in the carrying amount of an unconsolidated international Pizza Hut affiliate. (j) The $18 gain ($17 after-tax or $0.02 per share) in 1994 arose from a public share offering by BAESA, an unconsolidated franchised bottling affiliate in South America. See Note 16. The $118 gain ($53 after-tax or $0.07 per share) in 1990 arose from an initial public offering of new shares by an unconsolidated KFC joint venture in Japan and a sale by PepsiCo of a portion of its shares.\n- -------------------------------------------------------------------------------- SELECTED FINANCIAL DATA (Page 7 of 7) (in millions except per share and employee amounts, unaudited) PepsiCo, Inc. and Subsidiaries - -------------------------------------------------------------------------------- (k) Represented the cumulative effect of adopting in 1994 SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" and changing to a preferred method for calculating the market-related value of plan assets used in determining the return-on-asset component of annual pension expense and the cumulative net unrecognized gain or loss subject to amortization (see Notes 14 and 13, respectively) and adopting in 1992 SFAS 106 ($575 ($357 after-tax or $0.44 per share)) and SFAS 109 ($571 tax charge ($0.71 per share)). Prior years were not restated for these changes in accounting. (l) Included impacts of discontinued operations, the most significant of which were in 1985, which included income of $124 after-tax ($0.15 per share) resulting from PepsiCo disposing of its sporting goods and transportation segments. (m) Cash flows from other investing and financing activities, which are not presented, are an integral part of total cash flow activity. (n) See Net Income Per Share in Note 1. (o) Total debt includes short-term borrowings and long-term debt, which for 1987 through 1990 included a nonrecourse obligation. (p) The return on average shareholders' equity is calculated using income from continuing operations before cumulative effect of accounting changes. (q) The market net debt ratio represents net debt as a percent of net debt plus the market value of equity, based on the year-end stock price. Net debt is total debt, which for this purpose includes the present value of long-term operating lease commitments, reduced by the pro forma remittance of investment portfolios held outside the U.S. For 1987 through 1990, total debt was also reduced by the nonrecourse obligation in the calculation of net debt. (r) The historical cost net debt ratio represents net debt (see (q) above) as a percent of capital employed (net debt, other liabilities, deferred income taxes and shareholders' equity).\nPEPSICO, INC. AND SUBSIDIARIES\nSCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FISCAL YEARS ENDED DECEMBER 30, 1995, DECEMBER 31, 1994 AND DECEMBER 25, 1993 (IN MILLIONS)\nAdditions --------------------------- Balance Charged Deduct- Balance at to ions at beginning costs and Other from end of year expenses additions reserves of year -------- -------- --------- -------- -------- (1) (2)\nDeductions from assets:\n1995 (52 weeks) - --------------- Allowance for doubtful accounts $151 $ 49 $ 6 $ 56 $150 ==== ==== === ==== ====\nDeferred tax assets valuation allowance $319 $150 $ 29 $ - $498 ==== ==== ==== ==== ====\n1994 (53 weeks) - --------------- Allowance for doubtful accounts $128 $ 59 $ 8 $ 44 $151 ==== ==== ==== ==== ====\nDeferred tax assets valuation allowance $249 $ 69 $ 1 $ - $319 ==== ==== ==== ==== ====\n1993 (52 weeks) - --------------- Allowance for doubtful accounts $112 $ 44 $ 17 $ 45 $128 ==== ==== ==== ==== ====\nDeferred tax asstes valuation allowance $181 $ 68 $ - $ - $249 ==== ==== ==== ==== ====\n(1) Other additions principally related to acquisitions and reclassifications.\n(2) Principally accounts written-off.","section_15":""}
{"filename":"785959_1995.txt","cik":"785959","year":"1995","section_1":"Item 1. Business.\nFormation\nML Media Partners, L.P. (\"Registrant\"), a Delaware limited partnership, was organized February 1, 1985. Media Management Partners, a New York general partnership (the \"General Partner\"), is Registrant's sole general partner. The General Partner is a joint venture, organized as a general partnership under New York law, between RP Media Management (\"RPMM\") and ML Media Management Inc. (\"MLMM\"). MLMM is a Delaware corporation and an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. and an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\"). RPMM is organized as a general partnership under New York law, consisting of The Elton H. Rule Company and IMP Media Management Inc., as a result of the death of Elton H. Rule, the owner of The Elton H. Rule Company, the general partner interest of the Elton H. Rule Company may either be redeemed or acquired by a company controlled by I. Martin Pompadur. The General Partner was formed for the purpose of acting as general partner of Registrant.\nRegistrant was formed to acquire, finance, hold, develop, improve, maintain, operate, lease, sell, exchange, dispose of and otherwise invest in and deal with media businesses and direct and indirect interests therein. (Reference is made to Note 9 of \"Financial Statements and Supplementary Data\" included in Item 8 hereof for segment information).\nOn February 4, 1986, Registrant commenced the offering through Merrill Lynch of up to 250,000 units of limited partnership interest (\"Units\") at $1,000 per Unit. Registrant held four closings of Units; the first for subscriptions accepted prior to May 14, 1986 representing 144,990 Units aggregating $144,990,000; the second for subscriptions accepted thereafter and prior to October 9, 1986 representing 21,540 Units aggregating $21,540,000; the third for subscriptions accepted thereafter and prior to November 18, 1986 representing 6,334 Units aggregating $6,334,000; and the fourth and final closing of Units for subscriptions accepted thereafter and prior to March 2, 1987 representing 15,130 Units aggregating $15,130,000. At these closings, including the initial limited partner capital contribution, subscriptions for an aggregate of 187,994.1 Units representing the aggregate capital contributions of $187,994,100 were accepted. During 1989, the initial limited partner's capital contribution of $100 was returned.\nThe Registration Statement relating to the offering was filed on December 19, 1985 pursuant to the Securities Act of 1933 under Registration Statement No. 33-2290 and was declared effective on February 3, 1986 and amendments thereto became effective on September 18, 1986, November 4, 1986 and on December 12, 1986 (such Registration Statement, as amended from and after each such date, the \"Registration Statement\").\nMedia Properties\nAs of December 29, 1995, Registrant's investments in media properties consist of a 50% interest in a joint venture which owns two cable television systems, an FM and AM radio station combination and a background music service in Puerto Rico; four cable television systems in California; an FM and AM radio station combination in Bridgeport, Connecticut; a corporation which owns an FM radio station in Cleveland, Ohio; and an FM and AM radio station combination in Anaheim, California.\nRegistrant has completed the sale of the following media properties, all further detailed below. Two radio stations located in Tulsa, Oklahoma and Jacksonville, Florida were sold on July 31, 1990. The Universal Cable systems were sold on July 8, 1992 and an FM and AM radio station combination in Indianapolis, Indiana was sold on October 1, 1993. In addition, two VHF television stations located in Lafayette, Louisiana and Rockford, Illinois were sold on September 30, 1995 and July 31, 1995, respectively.\nPuerto Rico Investments\nCable Television Investments\nPursuant to the management agreement and joint venture agreement dated December 16, 1986 (the \"Joint Venture Agreement\"), as amended and restated, between Registrant and Century Communications Corp., a Texas corporation (\"Century\"), the parties formed a joint venture under New York law, Century-ML Cable Venture (the \"Venture\"), in which each has a 50% ownership interest. Century is a wholly-owned subsidiary of Century Communications Corp., a publicly held New Jersey corporation unaffiliated with the General Partner or any of its affiliates. On December 16, 1986 the Venture, through its wholly-owned subsidiary corporation, Century-ML Cable Corporation (\"C-ML Cable Corp.\"), purchased all of the stock of Cable Television Company of Greater San Juan, Inc. (\"San Juan Cable\"), and liquidated San Juan Cable into C-ML Cable Corp. C-ML Cable Corp., as successor to San Juan Cable, is the operator of the largest cable television system in Puerto Rico.\nOn September 24, 1987, the Venture acquired all of the assets of Community Cable-Vision of Puerto Rico, Inc., Community Cablevision of Puerto Rico Associates, and Community Cablevision Incorporated (collectively, the \"Community Companies\"), which consisted of a cable television system serving the communities of Catano, Toa Baja and Toa Alta, Puerto Rico, which are contiguous to San Juan Cable.\nC-ML Cable Corp. and the Community Companies are herein referred to as C-ML Cable (\"C-ML Cable\"). Registrant's two cable properties in Puerto Rico are herein defined as the \"Puerto Rico Systems.\" The Puerto Rico Systems currently serve approximately 115,655 basic subscribers, pass approximately 272,198 homes and consist of approximately 1,810 linear miles of cable plant.\nDuring 1995, Registrant's share of the net revenues of the Puerto Rico Systems totalled $24,126,675 (22.1% of operating revenues of Registrant).\nDuring 1994, Registrant's share of the net revenues of the Puerto Rico Systems totalled $21,525,793 (20.3% of operating revenues of Registrant).\nDuring 1993, Registrant's share of the net revenues of the Puerto Rico Systems totalled $20,206,318 (20.1% of operating revenues of Registrant).\nRadio Investments\nOn February 15, 1989, Registrant and Century entered into a Management Agreement and Joint Venture Agreement whereby a new joint venture, Century-ML Radio Venture (\"C-ML Radio\"), was formed under New York law, and responsibility for the management of radio stations to be acquired by C-ML Radio was assumed by Registrant.\nOn March 10, 1989, C-ML Radio acquired all of the issued and outstanding stock of Acosta Broadcasting Corporation (\"Acosta\"), Fidelity Broadcasting Corporation (\"Fidelity\"), and Broadcasting and Background Systems Consultants Corporation (\"BBSC\"); all located in San Juan, Puerto Rico. The purchase price for the stock was approximately $7.8 million. At the time of acquisition, Acosta owned radio stations WUNO-AM and Noti Uno News, Fidelity owned radio station WFID-FM, and BBSC owned Beautiful Music Services, all serving various communities within Puerto Rico.\nIn February, 1990, C-ML Radio acquired the assets of Radio Ambiente Musical Puerto Rico, Inc. (\"RAM\"), a background music service. The purchase price was approximately $200,000 and was funded with cash generated by C-ML Radio. The operations of RAM were consolidated into those of BBSC.\nEffective January 1, 1994, all of the assets of C-ML Radio were transferred to the Venture in exchange for the assumption by the Venture of all the obligations of C-ML Radio and the issuance to Century and Registrant by the Venture of new certificates evidencing partnership interests of 50% and 50%, respectively. The transfer was made pursuant to a Transfer of Assets and Assumption of Liabilities Agreement. At the time of this transfer, Registrant and Century entered into an amended and restated management agreement and joint venture agreement (the \"Revised Joint Venture Agreement\") governing the affairs of the revised Venture (herein referred to as the \"Revised Venture\").\nUnder the terms of the Revised Joint Venture Agreement, Century is responsible for the day-to-day operations of the Puerto Rico Systems and Registrant is responsible for the day-to-day operations of the C-ML Radio properties. For providing services of this kind, Century is entitled to receive annual compensation of 5% of the Puerto Rico Systems' net gross revenues (defined as gross revenues from all sources less monies paid to suppliers of pay TV product, e.g., HBO, Cinemax, Disney and Showtime) and Registrant is entitled to receive annual compensation of 5% of the C-ML Radio properties' gross revenues (after agency commissions, rebates or discounts and excluding revenues from barter transactions). All significant policy decisions relating to the Revised Venture, the operation of the Puerto Rico Systems and the operation of the C-ML Radio properties, however, will only be made upon the concurrence of both Registrant and Century. Registrant may require a sale of the assets and business of the Puerto Rico Systems or the C-ML Radio properties at any time. If Registrant proposes such a sale, Registrant must first offer Century the right to purchase Registrant's 50% interest in the Revised Venture at 50% of the total fair market value of the Venture at such time as determined by independent appraisal. If Century elects not to purchase Registrant's 50% interest, Registrant may elect to purchase Century's interest in the Revised Venture on similar terms.\nDuring 1995, Registrant's share of the net revenues of the C-ML Radio properties totalled $2,772,238 (2.5% of operating revenues of Registrant).\nDuring 1994, Registrant's share of the net revenues of the C-ML Radio properties totalled $2,761,508 (2.6% of operating revenues of Registrant).\nDuring 1993, Registrant's investment in the C-ML Radio properties was accounted for under the equity method of accounting.\nCalifornia Cable Systems\nIn December, 1986, ML California Cable Corporation (\"ML California\"), a wholly-owned subsidiary of Registrant, entered into an agreement with SCIPSCO, Inc. (\"SCIPSCO\"), a wholly-owned subsidiary of Storer Communications, Inc. for the acquisition by ML California of four cable television systems servicing the California communities of Anaheim, Manhattan\/Hermosa Beach, Rohnert Park\/Yountville, and Fairfield and surrounding areas. The acquisition was completed on December 23, 1986 with the purchase by ML California of all of the stock of four subsidiaries of SCIPSCO which at closing owned all the assets of the California cable television systems. The term \"California Cable Systems\" or \"California Cable\" as used herein means either the cable systems or the owning entities, as the context requires. The California Cable Systems currently serve approximately 138,864 basic subscribers, pass 221,256 homes and consist of approximately 2,382 linear miles of plant.\nOn December 30, 1986, ML California was liquidated into Registrant and transferred all of its assets, except its FCC licenses, subject to its liabilities, to Registrant. The licenses were transferred to ML California Associates, a partnership formed between Registrant and the General Partner for the purpose of holding the licenses in which Registrant is Managing General Partner and 99.99% equity holder.\nThe daily operations of the California Cable Systems are managed by MultiVision Cable TV Corp. (\"MultiVision\"), a cable television multiple system operator (\"MSO\") controlled by I. Martin Pompadur. Mr. Pompadur, President, Secretary and Director of RP Media Management and Chairman and Chief Executive Officer of MultiVision, organized MultiVision in January 1988 to provide MSO services to cable television systems acquired by entities under his control, with those entities paying cost for those services pursuant to an agreement to allocate certain management costs, (the \"Cost Allocation Agreement\") with MultiVision. Mr. Pompadur is, indirectly, the general partner of ML Media Opportunity Partners, L.P., a publicly held limited partnership, and Registrant. ML Media Opportunity Partners, L.P. and its subsidiaries had invested in cable television systems that were managed by MultiVision, prior to their sale, pursuant to the same Cost Allocation Agreement.\nRegistrant engaged Merrill Lynch & Co. and Daniels & Associates in January, 1994 to act as its financial advisors in connection with a possible sale of all or a portion of Registrant's California Cable Systems.\nOn November 28, 1994, Registrant entered into an agreement (the \"Asset Purchase Agreement\") with Century Communications Corp. (\"Century\") to sell to Century substantially all of the assets used in Registrant's California Cable operations serving Anaheim and Hermosa Beach\/Manhattan Beach and Rohnert Park\/Yountville and Fairfield (the \"California Cable Systems\"). The base purchase price specified in the Asset Purchase Agreement for the California Cable Systems is $286 million, subject to reduction by an amount equal to 11 times the amount, if any, by which the operating cash flow of the California Cable Systems (as adjusted in accordance with the Asset Purchase Agreement) is less than $26 million for the 12-month period prior to the closing, and subject to further adjustment as provided in the Asset Purchase Agreement. In addition, Registrant has the right to terminate the Asset Purchase Agreement if the purchase price would be less than $260 million based on the formula described above. Consummation of the transactions provided for in the Asset Purchase Agreement is subject to the satisfaction of certain conditions, including obtaining approvals of the sale from the Federal Communications Commission (\"FCC\") and the municipal authorities issuing the franchises for the California Cable Systems and the approvals of certain franchise extensions, including the renewal of the franchises for the Anaheim, and Villa Park communities.\nAs of December 29, 1995, all such approvals had been obtained, other than the transfer\/renewal approvals for the Anaheim and Villa Park communities. After several months of negotiations, Registrant and Century had been unable to reach agreement with the City of Anaheim and the City of Villa Park regarding the terms of the renewal of each City's franchise, and therefore Century agreed to waive the condition precedent of obtaining a renewal of such franchises and was requiring instead a transfer to Century of the Anaheim franchise (the \"Anaheim Transfer\") and a transfer to Century of the Villa Park franchise (the \"Villa Park Transfer\").\nThe Asset Purchase Agreement provides that Registrant and Century each have the right to terminate the Asset Purchase Agreement if the Closing did not occur by December 31, 1995 (the \"Optional Termination Date\"). Accordingly, as of January 1, 1996, each party became vested with the right to elect to terminate the Asset Purchase Agreement. The parties sought to reach agreement with regard to an extension of the Optional Termination Date but were unable to finalize such agreement. Nevertheless, on January 17, 1996, Registrant notified Century that if the Closing does not occur on or before March 29, 1996, Registrant will terminate the Asset Purchase Agreement as of that date. However, Registrant does not intend to terminate the Asset Purchase Agreement on March 29, 1996 and will continue its attempts to consummate the Asset Purchase Agreement with Century.\nRegistrant, Century and the City of Anaheim have reached agreement on the terms of the Anaheim Transfer and the Anaheim Transfer has been approved; the approval will become final on April 4, 1996 unless a legally sufficient objection is raised under the Anaheim City Charter procedure for a public referendum. Registrant, Century and Villa Park have also reached agreement on the terms of the Villa Park Transfer and the Villa Park Transfer was approved by the Villa Park City Council on March 26, 1996.\nNo assurances can be given that the Anaheim Transfer will become final or the other conditions precedent necessary to enable the Closing to occur will occur. Accordingly, no assurances can be given that the sale of the California Cable Systems under the Asset Purchase Agreement will be consummated. (Refer to Notes 5 and 8 of \"Item 8. Financial Statements and Supplementary Data\" for a description of possible defaults under the ML California Cable Credit Agreement, as amended).\nAlthough no assurances can be given as to the timing of any sale of the California Cable Systems or as to the sale price that might be realized in connection with any such sale, if the sale to Century is not consummated, Registrant believes that, under current market conditions, the California Cable Systems represent an attractive investment opportunity for a suitable buyer.\nMerrill Lynch & Co. did not, nor will it, receive a fee or other form of compensation for acting as financial advisor in connection with the sale of the California Cable Systems.\nDuring 1995, California Cable generated operating revenues of $57,115,752 (52.3% of operating revenues of Registrant).\nDuring 1994, California Cable generated operating revenues of $55,024,025 (52.0% of operating revenues of Registrant).\nDuring 1993, California Cable generated operating revenues of $55,197,638 (55.0% of operating revenues of Registrant).\nWREX Television Station\nOn April 29, 1987, Registrant entered into an acquisition agreement with Gilmore Broadcasting Corporation, a Delaware corporation (\"Gilmore\"), for the acquisition by Registrant of substantially all the assets of television station WREX-TV, Rockford, Illinois (\"WREX-TV\" or \"WREX\"). The acquisition was consummated on August 31, 1987 for $18 million.\nDuring 1995, until its sale on July 31, 1995, WREX-TV generated operating revenues of $3,053,336 (2.8% of operating revenues of Registrant).\nDuring 1994, WREX-TV generated operating revenues of $5,506,056 (5.2% of operating revenues of Registrant).\nDuring 1993, WREX-TV generated operating revenues of $4,925,030 (4.9% of operating revenues of Registrant).\nOn July 31, 1995, Registrant completed the sale to Quincy Newspapers, Inc. (\"Quincy\") of substantially all of the assets used in the operations of Registrant's television station WREX- TV, other than cash and accounts receivable. The purchase price for the assets was approximately $18.4 million, subject to certain adjustments. A reserve of approximately $2.3 million was established to cover certain purchase price adjustments and expenses and liabilities relating to WREX, and the balance of approximately $16.1 million was applied to repay a portion of the bank indebtedness secured by the assets of WREX and KATC. Quincy did not assume certain liabilities of WREX and Registrant will remain liable for such liabilities. On the sale of WREX, Registrant recognized a gain for financial reporting purposes of approximately $8.8 million.\nKATC Television Station\nOn September 17, 1986, Registrant entered into an acquisition agreement with Loyola University, a Louisiana non-profit corporation (\"Loyola\"), for the acquisition by Registrant of substantially all the assets of television station KATC-TV, Lafayette Louisiana (\"KATC-TV\" or \"KATC\"). The acquisition was completed on February 2, 1987 for a purchase price of approximately $26.7 million.\nDuring 1995, until its sale on September 30, 1995, KATC generated operating revenues of $5,263,423 (4.8% of operating revenues of Registrant).\nDuring 1994, KATC generated operating revenues of $6,078,081 (5.7% of operating revenues of Registrant).\nDuring 1993, KATC generated operating revenues of $5,276,512 (5.3% of operating revenues of Registrant).\nOn September 30, 1995, Registrant completed the sale to KATC Communications, Inc. (the \"KATC Buyer\") of substantially all of the assets used in the operations of Registrant's television station KATC-TV, other than cash and accounts receivable. The KATC Buyer did not assume certain liabilities of KATC and Registrant will remain liable for such liabilities. The purchase price for the assets was $24.5 million. From the proceeds of the sale, approximately $6.3 million was applied to repay in full the remaining bank indebtedness secured by the assets of KATC; a reserve of approximately $2.0 million was established to cover certain purchase price adjustments and expenses and liabilities relating to KATC; $1.0 million was deposited into an indemnity escrow account to secure Registrant's indemnification obligations to the KATC Buyer; approximately $7.6 million was applied to pay a portion of deferred fees and expenses owed to the General Partner; and the remaining amount of approximately $7.6 million was distributed to Partners in December, 1995. Registrant recognized a gain for financial reporting purposes of approximately $14.0 million on the sale of KATC in 1995.\nWEBE-FM Radio\nOn August 20, 1987, Registrant entered into an Asset Purchase Agreement with 108 Radio Company, L.P., for the acquisition of the business and assets of radio station WEBE-FM, Westport, Connecticut (\"WEBE-FM\" or \"WEBE\") which serves Fairfield and New Haven counties for $12.0 million.\nOn July 19, 1989, Registrant entered into an Amended and Restated Credit Security and Pledge Agreement (the \"Wincom-WEBE-WICC Loan\") which provided for borrowings up to $35.0 million. On July 30, 1993, Registrant and Chemical Bank executed an amendment to the Wincom-WEBE-WICC Loan (the \"Restructuring Agreement\"), effective January 1, 1993, which cured all previously outstanding defaults pursuant to the Wincom-WEBE-WICC Loan. Refer to Note 5 of \"Item 8. Financial Statements and Supplementary Data\" for further information regarding the Wincom-WEBE-WICC Loan and the Restructuring Agreement.\nDuring 1995, WEBE-FM generated operating revenues of $5,949,654 (5.5% of operating revenues of Registrant).\nDuring 1994, WEBE-FM generated operating revenues of $5,286,984 (5.0% of operating revenues of Registrant).\nDuring 1993, WEBE-FM generated operating revenues of $4,403,464 (4.4% of operating revenues of Registrant).\nWincom\nOn August 26, 1988, Registrant acquired 100% of the stock of Wincom Broadcasting Corporation (\"Wincom\"), an Ohio corporation headquartered in Cleveland for $46.0 million. At acquisition, Wincom and its subsidiaries owned and operated five radio stations - WQAL-FM, Cleveland, Ohio; WCKN-AM\/WRZX-FM, Indianapolis, Indiana (the \"Indianapolis Stations\", including the Indiana University Sports Radio Network, which was discontinued after the first half of 1992); KBEZ-FM, Tulsa, Oklahoma; and WEJZ- FM, Jacksonville, Florida. On July 31, 1990, Registrant sold the business and assets of KBEZ-FM and WEJZ-FM to Renda Broadcasting Corp. for net proceeds of approximately $10.3 million.\nOn April 30, 1993, WIN Communications of Indiana, Inc., a 100%- owned subsidiary of Wincom, entered into an Asset Purchase Agreement to sell substantially all of the assets of the Indianapolis Stations to Broadcast Alchemy, L.P.(\"Alchemy\") for gross proceeds of approximately $7 million. On October 1, 1993, the date of the sale of the Indianapolis Stations, the net proceeds from such sale, which totalled approximately $6.1 million, were remitted to Chemical Bank, as required by the terms of the Restructuring Agreement, to reduce the outstanding principal amount of the Series B Term Loan due Chemical Bank. Registrant recognized a gain of approximately $4.7 million on the sale of the Indianapolis Stations. In addition, Registrant recognized an extraordinary gain of approximately $490,000 as a result of the forgiveness of the entire Series C Term Loan due Chemical Bank. Refer to Notes 2 and 5 of \"Item 8. Financial Statements and Supplementary Data\" for further information regarding the Restructuring Agreement.\nDuring 1995, Wincom generated operating revenues of $5,079,292 (4.7% of operating revenues of Registrant).\nDuring 1994, Wincom generated operating revenues of $4,349,191 (4.1% of operating revenues of Registrant).\nDuring 1993, Wincom generated operating revenues of $5,269,021 (5.2% of operating revenues of Registrant).\nUniversal\nOn September 19, 1988, Registrant acquired 100% of the stock of Universal Cable Holdings, Inc. (\"Universal Cable\"), a Delaware Corporation, pursuant to a stock purchase agreement executed on June 17, 1988 for approximately $43 million. Universal Cable, through three wholly-owned subsidiaries, owned and operated cable television systems located in Kansas, Nebraska, Colorado, Oklahoma and Texas.\nOn July 8, 1992, Registrant sold Universal Cable; all proceeds of the sales were paid to the lender to Universal and Registrant was released from all obligations under a Revolving Credit Agreement.\nWICC-AM\nOn July 19, 1989, Registrant purchased all of the assets of radio station WICC-AM located in Bridgeport, Connecticut (\"WICC-AM or \"WICC\") from Connecticut Broadcasting Company, Inc. The purchase price of $6.25 million was financed solely from proceeds of the Wincom-WEBE-WICC Loan.\nDuring 1995, WICC-AM generated operating revenues of $2,397,808 (2.2% of operating revenues of Registrant).\nDuring 1994, WICC-AM generated operating revenues of $2,115,461 (2.0% of operating revenues of Registrant).\nDuring 1993, WICC-AM generated operating revenues of $1,875,348 (1.9% of operating revenues of Registrant).\nAnaheim Radio Stations\nOn November 16, 1989, Registrant acquired KORG-AM (\"KORG\")and KEZY-FM (\"KEZY\") ( jointly the \"Anaheim Radio Stations\" or \"KORG\/KEZY\") located in Anaheim, California, from Anaheim Broadcasting Corporation. The total acquisition cost was $15,125,000.\nTo finance the acquisition of the Anaheim Radio Stations, on November 16, 1989, Registrant entered into a $16.5 million revolving credit bridge loan (\"the Anaheim Radio Loan\") with Bank of America.\nOn May 15, 1990, Registrant entered into the revised ML California Credit Agreement, which was used in part to repay and refinance the Anaheim Radio Loan. Refer to Notes 5 and 8 of \"Item 8. Financial Statements and Supplementary Data\" for further information regarding the ML California Credit Agreement.\nDuring 1995, the Anaheim Radio Stations generated operating revenues of $3,455,853 (3.1% of operating revenues of Registrant).\nDuring 1994, the Anaheim Radio Stations generated operating revenues of $3,263,109 (3.1% of operating revenues of Registrant).\nDuring 1993, the Anaheim Radio Stations generated operating revenues of $3,049,363 (3.1% of operating revenues of Registrant).\nEmployees.\nAs of December 29, 1995, Registrant employed approximately 348 persons. The business of Registrant is managed by the General Partner. RPMM, MLMM and ML Leasing Management Inc., all affiliates of the General Partner, employ individuals who perform the management and administrative services for Registrant. COMPETITION.\nCable Television\nCable television systems compete with other communications and entertainment media, including off-air television broadcast signals that a viewer is able to receive directly using the viewer's own television set and antenna. The extent of such competition is dependent in part upon the quality and quantity of such off-air signals. In the areas served by Registrant's systems, a substantial variety of broadcast television programming can be received off-air. In those areas, the extent to which cable television service is competitive depends largely upon the system's ability to provide a greater variety of programming than that available off-air and the rates charged by Registrant's cable systems for programming. Cable television systems also are susceptible to competition from other multichannel video programming distribution (\"MVPD\") systems, from other forms of home entertainment such as video cassette recorders, and in varying degrees from other sources of entertainment in the area, including motion picture theaters, live theater and sporting events.\nIn recent years, the level of competition in the MVPD market has increased significantly. Notably, approximately 170 channels of high-powered direct broadcast satellite (\"DBS\") service are now available in the continental U.S., with another 126 channels of DBS service scheduled to commence later this year. In addition, the FCC has adopted polices providing for authorization of new technologies and a more favorable operating environment for certain existing technologies which provide, or have the potential to provide, substantial additional competition to cable television systems. For example, the FCC has revised its rules on MMDS (or \"wireless cable\") to foster MMDS services competitive with cable television systems, has authorized certain telephone companies to deliver directly to their subscribers video programming over enhanced telephone facilities, and intends to authorize later this year a new service, the Local Multipoint Distribution Service (\"LMDS\"), which would employ technology analogous to that used by cellular telephone systems to distribute multiple channels of video programming and other data directly to subscribers. Moreover, the Telecommunications Act of 1996 (the \"1996 Act\") substantially reforms the Communications Act of 1934 by, among other things, permitting telephone companies to enter the MVPD market through a number of means, including in-region cable systems. Regulatory initiatives that will result in additional competition for cable television systems are described in the following sections.\nThe competitive environment surrounding cable television was further altered during the past year by a series of marketplace announcements documenting the heightened involvement of telephone companies in the cable television business. Some of these involve the purchase of existing cable systems by telephone companies outside their own exchange areas, while others contemplate expanded joint ventures between certain major cable companies and providers of long distance telephone services, as well as local telephone companies.\nBroadcast Television\nOperating results for broadcast television stations are affected by the availability, popularity and cost of programming; competition for local, regional and national advertising revenues; the availability to local stations of compensation payments from national networks with which the local stations are affiliated; competition within the local markets from programming on other stations or from other media; competition from other technologies, including cable television; and government regulation and licensing. Due primarily to increased competition from cable television, with that medium's plethora of viewing alternatives and from the Fox Network, the share of viewers watching the major U.S. networks, ABC, CBS, and NBC, has declined significantly over the last ten years. This reduction in viewer share has made it increasingly difficult for local stations to increase their revenues from advertising. The combination of these reduced shares and the impact of the economic recession at the beginning of this decade on the advertising market resulted in generally deteriorating performance at many local stations affiliated with ABC, CBS, and NBC. Although the share of viewers watching the major networks has recently leveled off or increased slightly, additional audience and advertiser fragmentation may occur if, as planned, one or more of the additional, recently launched broadcast networks develops program offerings competitive with those of the more established networks.\nRadio Industry\nThe radio industry is highly competitive and dynamic, and reaches a larger portion of the population than any other medium. There are generally several stations competing in an area and most larger markets have twenty or more viable stations; however, stations tend to focus on a specific target market by programming music or other formats that appeal to certain demographically specific audiences. As a result of these factors, radio is an effective medium for advertisers as it can have mass appeal or be focused on a specific market. While radio has not been subject to an erosion in market share such as that experienced by broadcast television, it was also subject to the depressed nationwide advertising market at the beginning of this decade. Recent changes in FCC multiple ownership rules have led to more concentration in some local radio markets as a single party is permitted to own additional stations or provide programming and sell advertising on stations it does not own. The provisions of the 1996 Act eliminating national ownership caps and easing local ownership caps are likely to accelerate this trend, as described more fully below.\nRegistrant is subject to significant competition, in many cases from competitors whose media properties are larger than Registrant's media properties.\nLEGISLATION AND REGULATION.\nCable Television Industry\nThe cable television industry is extensively regulated by the federal government, some state governments and most local franchising authorities. In addition, the Copyright Act of 1976 (the \"Copyright Act\") imposes copyright liability on all cable television systems for their primary and secondary transmissions of copyrighted programming. The regulation of cable television systems at the federal, state and local levels is subject to the political process and has been in constant flux over the past decade. This process continues to generate proposals for new laws and for the adoption or deletion of administrative regulations and policies. Further material changes in the law and regulatory requirements, especially as a result of both the 1996 Act and the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), must be expected. There can be no assurance that the Registrant's Cable Systems will not be adversely affected by future legislation, new regulations or judicial or administrative decisions. The following is a summary of federal laws and regulations materially affecting the cable television industry and a description of certain state and local laws with which the cable industry must comply.\nFederal Statutes\nThe 1992 Cable Act imposed certain uniform national standards and guidelines for the regulation of cable television systems. Among other things, the legislation regulates the provision of cable television service pursuant to a franchise, specifies a procedure and certain criteria under which a cable television operator may request modification of its franchise, establishes criteria for franchise renewal, sets maximum fees payable by cable television operators to franchising authorities, authorizes a system for regulating certain subscriber rates and services, outlines signal carriage requirements, imposes certain ownership restrictions, and sets forth customer service, consumer protection, and technical standards.\nThe 1996 Act's cable provisions expand and in some cases significantly modify the rules established by the Cable Act. Most significantly, the 1996 Act takes steps to reduce, or in some cases eliminate, rate regulation of cable systems, while also allowing substantially greater telephone company participation in the MVPD market, as well as promoting cable operator provision of telecommunications services.\nViolations of the Communications Act of 1934, as amended by the 1996 Act and the 1992 Cable Act or any FCC regulations implementing the statutory laws can subject a cable operator to substantial monetary penalties and other sanctions.\nFederal Regulations\nFederal regulation of cable television systems under the Communications Act of 1934, as amended, is conducted primarily through the FCC, although, as discussed below, the Copyright Office also regulates certain aspects of cable television system operation. Among other things, FCC regulations currently contain detailed provisions concerning non-duplication of network programming, sports program blackouts, program origination, ownership of cable television systems and equal employment opportunities. There are also comprehensive registration and reporting requirements and various technical standards. Moreover, pursuant to the 1992 Cable Act, the FCC has, among other things, established regulations concerning mandatory signal carriage and retransmission consent, consumer service standards, the rates for service, equipment, and installation that may be charged to subscribers, and the rates and conditions for commercial channel leasing. The FCC also issues permits, licenses or registrations for microwave facilities, mobile radios and receive-only satellite earth stations, all of which are commonly used in the operation of cable systems.\nThe FCC is authorized to impose monetary fines upon cable television systems for violations of existing regulations and may also suspend licenses and other authorizations and issue cease and desist orders. It is likewise authorized to promulgate various new or modified rules and regulations affecting cable television, many of which are discussed in the following paragraphs.\nThe 1996 Act and the 1992 Cable Act\nThe 1992 Cable Act clarified and modified certain provisions of the Cable Communications and Policy Act of 1984, (\"1984 Cable Act\"). It also codified certain FCC regulations and added a number of new requirements. Throughout 1993-94 the FCC undertook or completed a substantial number of complicated rulemaking proceedings resulting in a host of new regulatory requirements or guidelines. Several of the provisions of the 1992 Cable Act and certain FCC regulations implemented pursuant thereto are still being tested in court. At the same time, a number of provisions have been recently modified by the 1996 Act. Registrant cannot predict the result of any pending or future court challenges or the shape any still-pending or proposed FCC regulations may ultimately take, nor can Registrant predict the effect of either on its operations.\nAs discussed in greater detail elsewhere in this filing, some of the principal provisions of the 1992 Cable Act include: (1) a mandatory carriage requirement coupled with alternative provisions for retransmission consent as to over-the-air television signals; (2) rate regulations that completely replace the rate provisions of the 1984 Cable Act; (3) consumer protection provisions; (4) a three-year ownership holding requirement; (5) some clarification of franchise renewal procedures; and (6) FCC authority to examine and set limitations on the horizontal and vertical integration of the cable industry. Of these provisions, the 1996 Act sunsets the rate regulations in three years and eliminates the three-year ownership requirement.\nOther provisions of the 1992 Cable Act include: a prohibition on \"buy-throughs,\" an arrangement whereby subscribers are required to subscribe to a program tier other than basic in order to receive certain per-channel or per-program services; requiring the FCC to develop minimum signal standards, rules for the disposition of home wiring upon termination of cable service, and regulations regarding compatibility of cable service with consumer television receivers and video cassette recorders; a requirement that the FCC promulgate rules limiting children's access to indecent programming on access channels; notification requirements regarding sexually explicit programs; and more stringent equal employment opportunity rules for cable operators. Of these provisions, the 1996 Act addresses cable equipment compatibility, as further discussed below.\nThe 1992 Cable Act also contains a provision barring both cable operators and certain vertically integrated program suppliers from engaging in practices which unfairly impede the availability of programming to other multichannel video programming distributors. In sum, the 1992 Cable Act codifies, initiates, or mandates an entirely new set of regulatory requirements and standards. It is an unusually complicated and sometimes confusing legislative enactment that has spawned a multitude of FCC enforcement decisions as well as certain yet-to-be concluded FCC proceedings. It also is subject to certain pending judicial challenges. Adding to the complexity is the 1996 Act, which in some areas mandates additional regulation to that required by the 1992 Cable Act and in other areas modifies or eliminates extant cable laws.\nThe FCC has adopted new regulations in a number of areas mandated by the 1992 Cable Act. These include rules and regulations governing the following areas: indecency on leased access channels, obscenity on public, educational and governmental (\"PEG\") channels, mandatory carriage and retransmission consent of over-the-air signals, home wiring, equal employment opportunity, tier \"buy-throughs,\" customer service standards, cable television ownership standards, program access, carriage of home shopping stations, and rate regulation. Most of these new regulations went into effect by 1994. However, in November 1993, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit found the indecency rules to be unconstitutional and remanded them to the Commission. Subsequently, the U.S. Court of Appeals for the D.C. Circuit vacated the panel decision pending rehearing and a decision by the full court. On rehearing, the en banc court sustained the Commission's regulations. However, the Supreme Court has agreed to review the en banc court's decision and is expected to issue a decision in 1996. Similarly, challenges to the constitutionality of the mandatory carriage provision remain pending. Although a special three judge panel of the U.S. District Court for the District of Columbia initially upheld the constitutionality of the mandatory carriage provision, the U.S. Supreme Court vacated that decision in June 1994 and remanded the case to the district court for further proceedings. In December 1995, the district court reaffirmed its decision upholding the law. The Supreme Court has again agreed to review the case and will likely issue a decision in 1997. Currently, the must carry rules remain in effect. On a separate matter, in September 1993 the U.S. District Court for the District of Columbia found that the horizontal ownership limits called for by the 1992 Cable Act are unconstitutional. Accordingly, the Commission has stayed the effect of horizontal ownership rules until final judicial resolution of the issue. Registrant is unable to predict the ultimate outcome of these proceedings or the impact upon its operations of various FCC regulations still being formulated and\/or interpreted. As previously noted, under the broad statutory scheme, cable operators are subject to a two- level system of regulation with some matters under federal jurisdiction, others subject strictly to local regulation, and still others subject to both federal and local regulation. Following are descriptions of some of the more significant regulatory areas of concern to cable operators.\nFranchises\nThe 1984 Cable Act affirms the right of franchising authorities to award one or more franchises within their jurisdictions and prohibits future cable television systems from operating without a franchise. The 1992 Cable Act provides that franchising authorities may not grant an exclusive franchise or unreasonably deny award of a competing franchise. The 1984 Cable Act also provides that in granting or renewing franchises, franchising authorities may establish requirements for cable-related facilities and equipment but may not specify requirements for video programming or information services other than in broad categories.\nUnder the 1992 Cable Act, franchising authorities are now exempt from money damages in cases involving their exercise of regulatory authority, including the award, renewal, or transfer of a franchise, except for cases involving discrimination on race, sex, or similar impermissible grounds. Remedies are limited exclusively to injunctive or declaratory relief. Franchising authorities may also build and operate their own cable systems without a franchise.\nThe 1984 Cable Act permits local franchising authorities to require cable operators to set aside certain channels for PEG access programming and to impose a franchise fee of up to 5% of gross annual system revenues. The 1984 Cable Act further requires cable television systems with 36 or more channels to designate a portion of their channel capacity for commercially leased access by third parties, which generally is available to commercial and non-commercial parties to provide programming (including programming supported by advertising). As required by the 1992 Cable Act, the FCC adopted rules setting maximum reasonable rates and other terms for the use of such leased channels. The FCC also has jurisdiction to resolve disputes over the provision of leased access.\nThe 1996 Act modifies the definition of a \"cable system\" by expanding the so-called \"private cable\" exemption so that a system serving subscribers without using any public rights-of-way is not a cable system, and need not obtain a local franchise.\nIn 1992, the FCC permitted local exchange carriers to engage in so-called \"video dialtone\" operations in their local telephone exchange areas pursuant to which neither they nor the programming entities they serve are required to obtain a local cable franchise. However, the 1996 Act repealed the FCC's video dialtone rules and enacted a related (but yet to be implemented) \"open video system\" regulation regime.\nRate Regulation\nUnder the 1992 Cable Act, cable systems' rates for service and related subscriber equipment are subject to regulation by the FCC and local franchising authorities. However, only the rates of cable systems that are not subject to \"effective competition\" may be regulated. A cable system is subject to effective competition if one of the following conditions is met: (1) fewer than 30% of the households in the franchise area subscribe to the system; (2) at least 50% of the households in the franchise area are served by two MVPDs and at least 15% of the households in the franchise area subscribe to any MVPD other than the dominant cable system; or (3) a franchising authority for that franchise area itself serves as an MVPD offering service to at least 50% of the households in the franchise area. The 1996 Act adds a fourth condition: the mere offering (regardless of penetration) by a local exchange carrier, or an entity using the local exchange carrier, (\"LEC\") facilities, of video programming services (including 12 or more channels of programming, at least some of which are television broadcasting signals) directly to subscribers by any means (other than direct-to-home satellite services) in the franchise area of an unaffiliated cable operator. Under these regulations the Partnership's systems, like most cable systems in most areas, are not currently subject to effective competition. Consequently, the rates charged by the Partnership's systems are subject to rate regulation under certain circumstances.\nUnder the 1992 Cable Act, a local franchising authority may certify with the FCC to regulate the Basic Service Tier (\"BST\") and associated subscriber equipment of a cable system within its jurisdiction. By law, the BST must include all broadcast signals (with the exception of national \"superstations\"), including those required to be carried under the mandatory carriage provisions of the 1992 Cable Act , as well as public, educational, and governmental (\"PEG\") access channels required by the franchise. The FCC has jurisdiction over the Cable Programming Service Tier (\"CPST\"), which generally includes programming other than that carried on the BST or offered on a per-channel or per-program basis. The 1996 Act, however, confines rate regulation to the BST after three years: on March 31, 1999, the CPST will be exempted from regulation. On enactment, the 1996 Act also modifies the rules governing complaints for rate increases on the CPST by replacing the current procedure. The current procedure, mandated by the 1992 Cable Act, allows subscribers to file complaints directly with the FCC. Under the new procedure, only a local franchising authority may file an FCC complaint, and then only if the franchising authority receives \"subscriber complaints\" within 90 days of the effective date of a rate increase. The FCC must issue a final order within 90 days after receiving a franchising authority's complaint.\nEffective September 1, 1993, regulated cable systems were required to use the FCC-prescribed \"benchmark\" approach to set initial rates for BSTs and CPSTs. Cable systems whose rates exceeded the applicable benchmark were required to reduce their rates either to the benchmark or by 10%, whichever reduction was less. The Commission subsequently modified its rules, however, to establish a second round of benchmark rate rollbacks, which became effective May 15, 1994. Under this more stringent regime, each cable system whose BST or CPST is subject to regulation is required to select from among the following methodologies to set a permitted rate: (1) a full reduction rate; (2) a transition rate; (3) a rate based on a streamlined rate reduction; or (4) a cost-of-service showing. The full reduction rate is a system's September 30, 1992 rate, measured on an average regulated revenue per subscriber basis, reduced by 17%. Under the transition rate approach, low-price cable systems (as determined under the FCC's revised benchmark formula) and systems owned by small operators (operators with a total subscriber base of 15,000 or less and not affiliated with or controlled by another operator) are not initially required to reduce rates to the full reduction rate level, but instead are permitted to cap their rates at March 31, 1994 levels, subject to possible further reduction based on cost studies. The streamlined rate reduction approach allows a cable system to reduce each billed item of regulated cable service as of March 31, 1994 by 14%, rather than completing various FCC rate regulation forms and establishing cost-based equipment and installation charges. This approach is available only to cable systems of 15,000 or fewer subscribers that are owned by a cable company serving a total of 400,000 or fewer subscribers over all of its systems. While the U.S. Court of Appeals for the D.C. Circuit has upheld these regulations, the regulations may be subject to further judicial review, and may be altered by ongoing FCC rulemakings and case-by-case adjudications.\nThe cost-of-service approach allows a cable system to recover through regulated rates its normal operating expenses and a reasonable return on investment. Prior to May 15, 1994, the effective date of FCC \"interim\" cost-of-service rules, the Commission permitted cable systems to use general cost-of-service principles, such as those historically used to set rates for public utilities. Beginning May 15, 1994, the FCC's interim rules took effect, which, among other things, established an industry-wide rate of return of 11.25% and presumptively excluded from a cable system's rate base acquisition costs above book value (while allowing certain intangible, above-book costs, such as start-up losses incurred during a two-year start-up period) and the costs of obtaining franchise rights. The FCC recently adopted final cost-of-service rules, which modify the interim rules, in relevant part, by: (1) retaining the 11.25% rate of return, but proposing, in a further notice of proposed rulemaking, to use a system's actual debt cost and capital structure to determine its final rate of return; (2) establishing a rebuttable presumption that 34% of the purchase price of cable systems purchased prior to May 15, 1994 (and not just the portion of the price allocable to intangibles) must be excluded from rate base; and (3) replacing the presumption of a two-year period for accumulated start-up losses with a case-by-case determination of the appropriate period. Additionally, the 1996 Act also restricts the FCC from disallowing certain operator losses for cost-of-service filings. There are no threshold requirements limiting the cable systems eligible for a cost-of-service showing except that, once rates have been set pursuant to a cost-of- service approach, cable systems may not file a new cost-of- service showing to justify new rates for a period of two years. An appeal of the interim rules brought before the U.S. Court of Appeals for the D.C. Circuit has been held in abeyance pending adoption of the final rules. Given the recent changes to the interim rules, it is uncertain whether the appeal will now go forward.\nHaving set an initial permitted rate for regulated service using one of the above methodologies, a cable system may adjust its rate going forward either quarterly or annually under the FCC's \"price cap\" mechanism, which accounts for inflation, changes in \"external costs,\" and changes in the number of regulated channels. External costs include state and local taxes applicable to the provision of cable television service, franchise fees, the costs of complying with certain franchise requirements, and retransmission consent fees and copyright fees incurred for the carriage of broadcast signals. In addition, a cable system may treat as external (and thus pass through to its subscribers) the costs, plus a 20 cent per channel mark-up, for channels newly added to a CPST. Through 1996, however, each cable system is subject to an aggregate cap of $1.50 on the amount it may increase CPST rates due to channel additions.\nThe FCC's regulatory treatment of \"a la carte\" packages of channels has been a source of particular regulatory uncertainty for many cable systems and -- like the rate rollbacks -- has negatively affected the Partnership's revenues and profits. Under the 1992 Cable Act, per-channel and per-program offerings (\"a la carte\" channels) are exempt from rate regulation. In implementing rules pursuant to the 1992 Cable Act, the FCC likewise exempted from rate regulation packages of a la carte channels if certain conditions were met. Upon reconsideration, however, the FCC tightened its regulatory treatment of these a la carte packages by supplementing its initial conditions with a number of additional criteria designed to ensure that cable systems creating collective a la carte offerings do not improperly evade rate regulation. The FCC later reversed its approach to a la carte packages by ruling that all non-premium packages of channels -- even if also available on an a la carte basis -- would be treated as a regulated tier. To ease the negative effect of these policy shifts on cable systems (and to further mitigate the rate regulations' disincentive for adding new program services) the FCC at the same time adopted rules allowing systems to create currently unregulated \"new products tiers\", provided that the fundamental nature of preexisting regulated tiers is preserved.\nThe charges for subscriber equipment and installation also are regulated by the FCC and local franchising authorities. FCC rules require that charges for converter boxes, remote control units, connections for additional television receivers, and cable installations must be based on a cable system's actual costs, plus an 11.25% rate of return. The regulations further dictate that the charges for each variety of subscriber equipment or installation charge be listed individually and \"unbundled\" from the charges for cable service. The 1996 Act, however, directs the FCC, within 120 days, to revise these rules to permit cable operators to aggregate, on a franchise, system, regional, or company level, their equipment costs into broad categories (except for equipment used only to receive a rate regulated basic service tier).\nIn accordance with the intent of the 1992 Cable Act, the FCC has established special rate and administrative treatment for small cable systems and small cable companies. In addition to the transition rate relief and streamlined rate reduction approaches to setting initial permitted rates (discussed above), the Commission has provided for the following relief mechanisms for small cable systems and companies: (1) a simplified cost-of- service approach for small systems owned by small companies in which a per-channel rate below $1.24 is considered presumptively reasonable; and (2) a system of any size owned by a small cable company that incurs additional monthly per subscriber headend costs of one full cent or more for the addition of a channel may recover a 20 cent mark-up, the license fee (if any) for the channel, as well as the actual cost of the headend equipment necessary to add new channels (not to exceed $5,000 per channel) for adding not more than seven new channels through 1997. By these actions, the FCC stated that it has expanded the category of systems eligible for special rate and administrative treatment to include approximately 66% of all cable systems in the U.S. serving approximately 12% of all cable subscribers. The 1996 Act further deregulates small cable companies: under the 1996 Act, an operator that, directly or through an affiliate, serves fewer than 1% of all subscribers in the U.S. (600,000 subscribers) and is not affiliated with an entity whose gross annual revenues exceed $250 million is exempt from rate regulation of the cable programming services tier and also of the basic service tier (provided that the basic tier was the only tier subject to regulation as of 12\/31\/94) in any franchise area in which that operator serves 50,000 or fewer subscribers.\nIn late 1995, the FCC demonstrated increasing willingness to settle some or all of the rate cases pending against a multiple system operator (\"MSO\") by entering into a \"social contract\" or rate settlement (collectively \"social contract\/settlement\"). While the terms of each social contract\/settlement vary according to the underlying facts unique to the relevant cable systems, the common elements include an agreement by an MSO to make a specified subscriber refund (generally in the form of in-kind service or a billing credit) in exchange for the dismissal, with prejudice, of pending complaints and rate proceedings. In addition, the FCC recently has adopted or proposed two measures that may mitigate the negative effect of the Commission's rate regulations on cable systems' revenues and profits, and allow systems to more efficiently market cable service. The FCC implemented an abbreviated cost-of-service mechanism for cable systems of all sizes that permits systems to recover the costs of \"significant\" upgrades (e.g., expansion of system bandwidth capacity) that provide benefits to subscribers to regulated cable service. This mechanism could make it easier for cable systems to raise rates to cover the costs of an upgrade. The Commission also has preliminarily proposed, but not yet adopted, an optional rate-setting methodology under which a cable operator serving multiple franchise areas could establish uniform rates for uniform cable service tiers offered in multiple franchise areas.\nThe 1996 Act also provides operator flexibility for subscriber notification of rate and service changes. The Act permits cable operators to use \"reasonable\" written means to notify subscribers of rate and service changes; notice need not be inserted in subscriber bills. Prior notice of a rate change is not required for any rate change that is the result of regulatory fee, franchise fee, or any other fee, tax, assessment, or change of any kind imposed by a regulator or on the transaction between a cable operator and a subscriber.\nRenewal and Transfer\nThe 1984 Cable Act established procedures for the renewal of cable television franchises. The procedures were designed to provide incumbent franchisees with a fair hearing on past performances, an opportunity to present a renewal proposal and to have it fairly and carefully considered, and a right of appeal if the franchising authority either fails to follow the procedures or denies renewal unfairly. These procedures were intended to provide an incumbent franchisee with substantially greater protection than previously available against the denial of its franchise renewal application. Recently, however, a federal district court in Kentucky upheld a city's denial of franchise renewal because the incumbent cable operator's renewal proposal failed to meet community needs and interests, which the court gave city officials broad discretion in determining. This case is now on appeal to the U.S. Court of Appeals for the Sixth Circuit.\nThe 1992 Cable Act sought to address some of the issues left unresolved by the 1984 Cable Act. It established a more definite timetable in which the franchising authority is to act on a renewal request. It also narrows the range of circumstances in which a franchised operator might contend that the franchising authority had constructively waived non-compliance with its franchise.\nCable system operators are sometimes confronted by challenges in the form of proposals for competing cable franchises in the same geographic area, challenges which may arise in the context of renewal proceedings. In Rolla Cable Systems v. City of Rolla, a federal district court in Missouri in 1991 upheld a city's denial of franchise renewal to an operator whose level of technical services was found deficient under the renewal standards of the 1984 Cable Act. Local franchising authorities also have, in some circumstances, proposed to construct their own cable systems or decided to invite other private interests to compete with the incumbent cable operator. Judicial challenges to such actions by incumbent system operators have, to date, generally been unsuccessful. Registrant cannot predict the outcome or ultimate impact of these or similar franchising and judicial actions.\nThe 1996 Act repealed the anti-trafficking rules of the 1992 Cable Act. Those rules generally prohibited a cable operator from selling a cable system within three years of acquiring or constructing it. The 1992 Cable Act continues to provide, however, that where local consent to a transfer is required, the franchise authority must act within 120 days of submission of a transfer request or the transfer is deemed approved. The 120-day period commences upon the submission to local franchising authorities of information now required on a new standardized FCC transfer form. The franchise authority may request additional information beyond that required under FCC rules. Further, the 1992 Cable Act gives local franchising officials the authority to prohibit the sale of a cable system if the proposed buyer operates another cable system in the jurisdiction or if such sale would reduce competition in cable service.\nCable\/Telephone Competition and Cross-Ownership Restrictions\nThe 1996 Act completely revises the law governing cable and telephone company competition and cross-ownership: the Act eliminates the cable\/telco cross-ownership ban, 214 certification requirement, and all of the FCC's current video dialtone rules, but retains (in modified form) the prohibitions on cable\/telco buy-outs. Prior to the passage of the 1996 Act, however, the 1984 Cable Act generally prohibited an LEC from owning a cable television system or offering video programming directly to subscribers in the LEC's local telephone service area. This cross-ownership ban had been the subject of a number of successful judicial challenges brought by LECs claiming that the ban violated their constitutional right of free speech.\nIn addition, in early 1995, the Commission had announced that it would use the \"good cause\" waiver provision of the statutory ban to permit LECs to provide video programming through the agency's \"video dialtone\" (\"VDT\") common carrier regulatory scheme. The Commission's original VDT policy permitted in-service-area delivery of video programming by LECs and exempted them from the 1984 Cable Act's franchising requirements so long as the LECs' facilities were used for transmission of video programming on a common carrier basis. The 1996 Act, however, explicitly nullifies all of these regulatory efforts. The Act also provides that elimination of the VDT rules does not require a VDT system that has already been approved by the FCC prior to the enactment of the Act to terminate operation.\nIn place of these repealed regulations, the 1996 Act gives telephone companies four options for entering into the MVPD market, all four of which are subject to the buy-out provisions: (1) wireless entry (which is not subject to cable regulation); (2) common carrier entry (which is subject to Title II common carrier regulation, but not subject to cable regulation); (3) cable system entry (which is subject to cable regulation); and (4) \"open video system\" entry, which is a new mode of entry established by the 1996 Act that allows a common carrier to program 33% of its video distribution system, while making the rest of its capacity available to unaffiliated program providers. The hybrid common carrier\/cable rules governing open video entirely replace the VDT rules. The open video system rules generally subject open video system operators to reduced regulation. For example, such operators are not required to obtain a local franchise, nor are they subject to rate regulation. The 1996 Act also limits fees that open video operators may have to pay to local franchises and clarifies that such operators are not subject to Title II common carrier requirements. Open video system operators are required, however, to comply with certain cable regulations, including the must- carry\/retransmission consent requirements and the rules governing carriage of public educational and governmental (\"PEG\") channels. Depending on yet to be adopted FCC rules, cable companies also may be permitted to operate open video systems.\nUnder the 1996 Cable Act, the FCC is to issue new open video system rules within six months that (1) restrict the amount of capacity that a carrier or its affiliates may use to provide programming directly to subscribers; (2) prohibit an operator from discriminating among video programming providers with regard to carriage; (3) permit an operator to carry on only one channel any video programming service that is offered by more than one programming provider; and (4) prohibit an operator from unreasonably discriminating in favor of itself and its affiliates with regard to material or information provided for the purpose of selecting programming or presenting information to subscribers.\nAlthough telephone companies may now provide video programming to their telephone subscribers, the 1996 Act maintains the general prohibition on cable\/telco buy-outs. A LEC or any affiliate may not acquire more than a 10% financial interest, or any management interest, in a cable operator serving the LEC's telephone service area. Similarly, a cable operator may not acquire a 10% financial interest, or any management interest, in a LEC providing telephone exchange service within the cable operator's franchise area. Joint ventures between LECs and cable operators to provide video or telecommunications in the same market are also prohibited. The 1996 Act does provide for a number of limited exceptions to the buy-out and joint venture prohibitions. These exceptions generally relate to systems in rural areas and small cable systems and LECs. The 1996 Act also authorizes the FCC to waive the buy-out and joint venture prohibitions only (1) if the cable operator or LEC would otherwise be subject to undue economic distress or if benefits to the community clearly outweigh the anticompetitive effects of the proposed transaction and (2) if the local franchising authority approves of the waiver.\nThe 1996 Act also clears the way for cable provision of telephony. For example, the 1996 Act preempts cable franchising authority regulation of telecommunications services. Moreover, under the 1996 Act, Title VI (which governs cable operators) does not apply to cable operators' provision of telecommunications services. The 1996 Act also clarifies that franchise fees do not include gross revenue derived from the provision of telecommunications services. State regulations that may prohibit the ability to provide telecommunications services are preempted. The 1996 Act also revises the rules governing pole attachments in order to foster competitive telecommunications services and remedy inequity in the current charges for pole attachments.\nConcentration of Ownership: The 1992 Cable Act directed the FCC to establish reasonable limits on the number of cable subscribers a single company may reach through cable systems it owns (\"horizontal concentration\") and the number of system channels that a cable operator could use to carry programming services in which it holds an ownership interest (\"vertical concentration\"). The horizontal ownership restrictions of the Act were struck down by a federal district court as an unconstitutional restriction on speech. Pending final judicial resolution of this issue, the FCC stayed the effective date of its horizontal ownership limitations, which would place a 30% nationwide limit on subscribers by any one entity. The FCC's vertical restriction consists of a \"channel occupancy\" standard which places a 40% limit on the number of channels that may be occupied by services from programmers in which the cable operator has an attributable ownership interest. Further, the 1992 Act and FCC rules restrict the ability of programmers to enter into exclusive contracts with cable operators.\nVideo Marketplace: As required by the 1992 Cable Act, in December 1995 the Commission issued its second report assessing the status of competition in the market for the delivery of video programming. Although the Commission found that cable television continues to dominate the MVPD market in most localities, it also noted that competing distribution technologies have continued to make substantial strides, in particular DBS (see below). The Commission identified several types of dominant firm strategic behavior, policy-relevant barriers to entry, and technological bottlenecks that could adversely affect the development of competition in the multichannel video distribution market. Although the Commission determined that several specific reforms might improve market performance, it concluded that most of the competitive issues identified would require ongoing monitoring.\nCable Ownership and Cross-Ownership: The 1996 Act repeals or curtails several cable-related ownership and cross-ownership restrictions. In addition to the repeal of the anti-trafficking rules (discussed above), the 1996 Act eliminates the broadcast network\/cable cross-ownership ban. The FCC, however, is allowed to adopt necessary regulations to ensure carriage, channel positioning, and nondiscriminatory treatment of nonaffiliated broadcast stations. The 1996 Act also eliminates the statutory prohibition on broadcast\/cable cross-ownership, but leaves in place the FCC's rules which continue to restrict the common ownership of cable and television properties in the same market area. When a cable operator faces effective competition, the Act also eliminates the cable\/MMDS and cable\/SMATV cross-ownership prohibitions.\nAlternative Video Programming Services\nDirect Broadcast Satellites:\nThe FCC has authorized the provision of video programming directly to home subscribers through high-powered direct broadcast satellites (\"DBS\"). DBS systems currently are capable of broadcasting as many as 175 channels of digital television service directly to subscribers equipped with 18-inch receive dishes and decoders. Generally, the signal of local broadcast stations are not carried on DBS systems. On December 17, 1993, Hughes Communications Galaxy (\"Hughes\"), an affiliate of the General Motors Company, and United States Satellite Broadcasting Company (\"USSB\") jointly launched a high-powered satellite with 16 transponders, from which they currently can provide approximately 170 channels of DBS service to the entire continental U.S. In December 1994, two DBS permittees, EchoStar Satellite Corporation (\"EchoStar\") and Directsat Corporation (\"Directsat\"), merged their DBS authorizations. In December 1995, EchoStar launched its first satellite. EchoStar and Directsat plan to commence approximately 120 channels of DBS service in 1996. On April 27, 1995, the International Bureau of the FCC released an order (1) denying Advanced Communications Corporation's (\"Advanced\") request for an extension of time to make its DBS system operational and (2) revoking its permit. On October 18, 1995, the Commission affirmed the Bureau's decision. An appeal of this decision is currently pending before the U.S. Court of Appeals for the D.C. Circuit. The Commission auctioned the channels previously held by Advanced to MCI Communications Corp. for $682.5 million on January 24, 1996, subject to the outcome of the appeal. Notices of Appeal of the Commission's auction Order have also been filed. On January 22, 1996, the AT&T Corp. announced that it had agreed to make a major investment in DirecTV, Inc., the DBS affiliate of Hughes. This arrangement will also permit AT&T to begin marketing DirecTV products and services. Other parties hold authorizations to provide DBS service, but have not yet launched their proposed satellites. It is uncertain when additional service may commence. Registrant cannot predict the effect of existing and future DBS services on its cable television operations.\nWireless Cable: The FCC has expanded the authorization of MMDS services to provide \"wireless cable\" via multiple microwave transmissions to home subscribers. In 1990, the FCC increased the availability of channels for use in wireless cable systems by eliminating MMDS ownership restrictions and simplifying various processing and administrative rules. The FCC also modified equipment and technical standards to increase service capabilities and improve service quality. Since then, the FCC has resolved certain additional wireless cable issues, including channel allocations for MMDS, Operational Fixed Service (\"OFS\") and Instructional Television Fixed Service (\"ITFS\") facilities, direct application by wireless operators for use of certain ITFS channels, and restrictions on ownership or operation of wireless facilities by cable entities.\nLocal Multipoint Distribution Service: In 1992, the FCC proposed a new service, LMDS, which also could be used to supply multichannel video and other communications services directly to subscribers. This service would operate in the 28 GHz frequency range and, consistent with the nature of operations in that range, the FCC envisions that LMDS transmitters could serve areas of only six to twelve miles in diameter. Accordingly, it is proposed that LMDS systems utilize a grid of transmitter \"cells,\" similar to the structure of cellular telephone operations. In July 1994, the Commission established a negotiated rulemaking committee to develop technical rules and to reach a consensus on sharing the 28 GHz band between terrestrial (LMDS) and satellite users. In September, however, the negotiated rulemaking committee reported to the Commission that it was unable to reach a consensus on sharing. Additional sharing discussions in the latter half of 1995, prompted by a further notice of proposed rulemaking released by the FCC in July, are expected to lead to Commission authorization of the service in the Spring of 1996. Auctions for LMDS licenses are expected to be held sometime in 1996. Registrant cannot predict how the LMDS sharing issue will be resolved.\nPersonal Communications Service (\"PCS\"): In August, 1993, the FCC established rules for a new portable telephone service, the Personal Communications Service (\"PCS\"). PCS has potential to compete with landline local telephone exchange services. Among several parties expressing interest in PCS were cable television operators, whose plant structures present possible synergies for PCS operation. In September 1993, the FCC adopted rules for \"broadband PCS\" service. It allocated 120 MHz of spectrum in the 2 GHz band for licensed broadband PCS services, divided into three 30 MHz blocks (blocks A, B and C) and three 10 MHz blocks (blocks D, E and F). The Commission has also established two different service areas for these blocks based on Rand McNally's Basic Trading Areas (BTAs) and Major Trading Areas (MTAs). Thus, there are up to six PCS licenses available in each geographic area. The Commission will use competitive bidding to assign the PCS licenses. The auction rules were finalized in July 1994 and modified in November 1994, and July 1995. Auctions for the A and B block authorizations concluded in March of 1995 and the licenses were granted in June of 1995. The auction for the 493 C block PCS licenses commenced in December of 1995. Three broadband PCS licenses were awarded to \"pioneer's preference\" winners in December 1994. Registrant cannot predict the outcome of this auction, nor the outcome of the remaining D, E and F block PCS auctions.\nInformation and Interexchange Services (Modified Final Judgment): The 1996 Act explicitly supersedes the judicial and regulatory regime created by the Consent Decree that terminated the United States v. AT&T antitrust litigation in 1982 (known as the Modification of Final Judgment or \"MFJ\"). The Consent Decree prohibited the Bell Operating Companies and their affiliates (collectively, the \"Regional Bells\") from, inter alia providing telecommunications services, including certain cable services, across Local Access and Transport Areas (\"LATAs\") as defined in the Consent Decree. A Regional Bell was required to obtain a waiver from the FCC in order to provide such services. The 1996 Act eliminates this requirement.\nOther Multichannel Video Programming Technologies: Several additional technologies exist or have been proposed that also have the potential to increase competition in the provision of video programming. Currently, many cable subscribers can receive programming received by C-band home satellite dishes or via satellite master antenna television facilities (\"SMATV\").\nProgramming Issues\nMandatory Carriage and Retransmission Consent: The 1992 Cable Act requires cable operators to carry the signals of local commercial and non-commercial television stations and certain low power television stations. The 1992 Cable Act also includes a retransmission consent provision that prohibits cable operators and other multichannel video programming distributors from carrying broadcast stations without obtaining their consent in certain circumstances.\nThe \"must carry\" and retransmission consent provisions are related in that television broadcasters, on a cable system-by- cable system basis, must make a choice once every three years whether or not to proceed under the must carry rules or to waive that right to mandatory but uncompensated carriage and negotiate a grant of retransmission consent to permit the cable system to carry the station's signal. The FCC's implementing regulations initially required broadcasters to elect between must-carry and retransmission consent by June 17, 1993. The next required election date is October 1, 1996.\nWhile monetary compensation is possible in return for stations granting retransmission consent, many broadcast station operators have accepted arrangements that do not require payment but involve other types of consideration, such as use of a second cable channel, advertising time, and joint programming efforts.\nThe must carry provisions of the FCC's rules have been challenged as unconstitutional. After a special three-judge district court rejected the challenge, the Supreme Court vacated the panel's decision and remanded the case to the panel, directing it to determine the factual validity of the Congressional premise for enacting the law -- that \"the economic health of local broadcasting is in genuine jeopardy.\" In December 1995, the panel, by a 2-1 majority, affirmed its prior decision, finding that Congress did indeed have substantial evidence to draw the reasonable inference that the must-carry provisions are necessary to protect the local broadcasting industry. The Supreme Court again has agreed to review the case and will likely issue a decision in 1997. Registrant cannot predict the timing or outcome of the case.\nProgram Content Regulation: In contrast to its deregulatory approach to media ownership, the 1996 Act contains a number of new regulations affecting program content. For example, upon request by a subscriber, a cable operator is required to fully scramble or block the audio and video programming of each channel carrying sexually explicit adult programming without charge. Also, the FCC is required to take certain steps to effectuate the accessibility of \"closed captioned\" and \"video description\" programming. Last, if distributors of video programming -- including cable operators -- fail voluntarily to establish rating rules to identify programming that contains sexual, violent, or other indecent material, the Act requires the FCC to formulate, in conjunction with a nonpartisan advisory committee, a system to identify and rate such programming. Distributors of rated programs are required to transmit these ratings, thereby permitting parents to block the programs.\nCopyright: Cable television systems are subject to the Copyright Act which, among other things, covers the carriage of television broadcast signals. Pursuant to the Copyright Act, cable operators obtain a compulsory license to retransmit copyrighted programming broadcast by local and distant stations in exchange for contributing a percentage of their revenues as statutory royalties to the U.S. Copyright Office. 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 locations of the cable television system with respect to off- air television stations and markets. Copyright royalty arbitration panels, to be convened by the Librarian of Congress as necessary, are responsible for distributing the royalty payments among copyrights owners and for periodically adjusting the royalty rates.\nRecently, several types of multichannel video distributors that compete with cable television systems were successful in gaining compulsory license coverage of their retransmission of television broadcast signals. Legislation enacted in 1994 provided an alternative compulsory license for satellite distributors through January 1, 2000 and extended permanent coverage of the cable copyright license to \"wireless cable\" systems (MMDS). The Copyright Office also has tentatively ruled that some SMATV systems are eligible for the cable compulsory license and is scheduled to issue new regulations covering SMATV copyright payments and filings in 1996.\nCongress established the compulsory license in 1976 to serve as a means of compensating program suppliers for cable retransmission of broadcast programming. The FCC has recommended that Congress eliminate the compulsory copyright license for cable retransmission of both local and distant broadcast programming. In addition, legislative proposals have been and may continue to be made to simplify or eliminate the compulsory license. As noted, the 1992 Cable Act requires cable systems to obtain permission of certain broadcast licensees in order to carry their signals (\"retransmission consent\") should such stations so elect. (See \"Mandatory Carriage and Retransmission Consent\" above). This permission is needed in addition to the copyright permission inherent in the compulsory license. Without the compulsory license, cable operators would need to negotiate rights for the copyright ownership of each program carried on each broadcast station transmitted by the system. Registrant cannot predict whether Congress will act on the FCC recommendations or similar proposals.\nExclusivity: Except for retransmission consent, the FCC imposes no restriction on the number or type of distant (or \"non-local\") television signals a system may carry. FCC regulations, however, require cable television systems serving more than 1,000 subscribers, at the request of a local network affiliate, to protect the local affiliate's broadcast of network programs by blacking out duplicated programs of any distant network- affiliated stations carried by the system. Similar rules require cable television systems to black out the broadcast on distant stations of certain local sporting events not broadcast locally.\nThe FCC rules also provide exclusivity protection for syndicated programs. Under these rules, television stations may compel cable operators to black out syndicated programming broadcast from distant signals where the local broadcaster has negotiated exclusive local rights to such programming. Syndicated program suppliers are afforded similar rights for a period of one year from the first sale of that program to any television broadcast station in the United States. The FCC rules allow any broadcaster to bargain for and enforce exclusivity rights. However, exclusivity protection may not be granted against a station that is generally available over-the-air in the cable system's market. Cable systems with fewer than 1,000 subscribers are exempt from compliance with the rules. Although broadcasters generally may, under certain circumstances, acquire exclusivity only within 35 miles of their community of license, they may acquire national exclusive rights to syndicated programming. The ability to secure national rights is intended to assist so-called \"superstations\" whose local broadcast signals are then distributed nationally via satellite. The 35-mile limitation has been subject to possible re-examination by the FCC the past several years.\nCable Origination Programming: The FCC also requires that cable origination programming meet certain standards similar to those imposed on broadcasters. These standards include regulations governing political advertising and programming, advertising during children's programming, rules on lottery information, and sponsorship identification requirements.\nCustomer Service: On July 1, 1993, following a public rulemaking proceeding mandated by the 1992 Cable Act, new FCC rules on customer service standards became effective. The standards govern cable system office hours, telephone availability, installations, outages, service calls, and communications between the cable operator and subscriber, including billing and refund policies. Although the FCC has stated that its standards are \"self effectuating,\" it has also provided that a franchising authority wishing to enforce particular customer service standards must give the system at least 90 days advance written notice. Franchise authorities also may agree with cable operators to adopt stricter standards and may enact any state or municipal law or regulation which imposes a stricter or different customer service standard than that set by the FCC. Enforcement of customer service standards, including those set by the FCC, is entrusted to local franchising authorities.\nPole Attachment Rates and Technical Standards\nThe FCC currently regulates the rates and conditions imposed by public utilities for use of their poles, unless, under the Federal Pole Attachments Act, a state public service commission demonstrates that it is entitled to regulate the pole attachment rates. The FCC has adopted a specific formula to administer pole attachment rates under this scheme. The validity of this FCC function was upheld by the U.S. Supreme Court. The 1996 Act revises the pole attachment rules in a number of ways to encourage competition in the provision of telecommunications services and to address inequity in the current pole attachment rates.\nIn 1990, new FCC standards on signal leakage became effective. Like all systems, Registrant's cable television systems are subject to yearly reporting requirements regarding compliance with these standards. Further, the FCC has instituted on-site inspections of cable systems to monitor compliance. Any failure by Registrant's cable television systems to maintain compliance with these new standards could adversely affect the ability of Registrant's cable television systems to provide certain services.\nThe 1992 Cable Act empowers the FCC to set certain technical standards governing the quality of cable signals and to preempt local authorities from imposing more stringent technical standards. The FCC's preemptive authority over technical standards for channels carrying broadcast signals has been affirmed by the U.S. Supreme Court. On March 4, 1992, the FCC adopted new mandatory technical standards for cable carriage of all video programming, including retransmitted broadcast material, cable originated programs and pay channels. The 1992 Cable Act includes a provision requiring the FCC to prescribe regulations establishing minimum technical standards. The FCC has determined that its 1992 rulemaking proceeding satisfied the mandate of the 1992 Cable Act. The new standards, which became effective December 30, 1992, focus primarily on the quality of the signal delivered to the cable subscriber's television. In a related vein, the 1996 Act provides that no local franchising authority may prohibit, condition, or restrict a cable system's use of any type of subscriber equipment or any transmission technology.\nThe 1996 Act also limits the FCC to the adoption of only minimal standards to achieve compatibility between cable equipment and consumer electronics (as Congress required the agency to do in the 1992 Cable Act) and to rely on the marketplace for other features, services, and devices. The FCC, however, has already made much progress with regard to compatibility pursuant to its 1992 Cable Act mandate. On May 4, 1994, the Commission released an order implementing the 1992 Cable Act requirements. In this order, the Commission adopted a three-phase plan for achieving compatibility between cable systems and consumer electronics. The Phase I requirements include the following: (1) cable operators are prohibited from scrambling or otherwise encrypting signals carried on the basic tier; (2) cable operators are prohibited from taking actions that would prevent equipment with remote control capabilities from operating with commercially available remote controls; (3) cable operators must offer subscribers supplemental equipment for resolving specific compatibility problems; and (4) cable operators must provide more compatibility information to subscribers. During Phase II, cable operators must use the new \"Decoder Interface\" standard that is presently being developed. Finally, the third phase of the compatibility plan addresses future standards issues to be raised in a future Notice of Inquiry. A number of cable and electronic company interests have sought reconsideration of this order. Whether and to what extent the provisions of the 1996 Act affect the Commission plan is unclear to the Registrant at this time.\nThe 1996 Act directs the FCC, in consultation with private standard setting organizations, to prescribe regulations to ensure the commercial availability of converter boxes and other interactive communications equipment used by consumers to access services provided by cable operators and MVPDs. The 1996 Act specifies that the regulations should ensure the availability of such equipment from manufacturers, retailers, and other vendors not affiliated with an MVPD. However, MVPDs are not prohibited from offering such equipment to consumers, provided that they charge separately for equipment and service, and do not subsidize the equipment charge. Once the market for MVPDs and converter equipment is fully competitive, the FCC is required to sunset any pertinent regulations if it determines that such an elimination would promote competition and be the public interest.\nState and Local Regulation\nLocal Authority: Cable television systems are generally operated pursuant to non-exclusive franchises, permits or licenses issued by a municipality or other local governmental entity. The franchises are generally in the nature of a contract between the cable television system owner and the issuing authority and typically cover a broad range of provisions and obligations directly affecting the business of the systems in question. Except as otherwise specified in the Cable Act or limited by specific FCC rules and regulations, the Cable Act permits state and local officials to retain their primary responsibility for selecting franchisees to serve their communities and to continue regulating other essentially local aspects of cable television. The constitutionality of franchising cable television systems by local governments has been challenged as a burden on First Amendment rights but the U.S. Supreme Court has declared that while cable activities \"plainly implicate First Amendment interest\" they must be balanced against competing societal interests. The applicability of this broad judicial standard to specific local franchising activities is subject to continuing interpretation by the federal courts.\nCable television franchises generally contain provisions governing the fees to be paid to the franchising authority, the length of the franchise term, renewal and sale or transfer of the franchise, design and technical performance of the system, use and occupancy of public streets, and the number and types of cable services provided. The specific terms and conditions of the franchise directly affect the profitability of the cable television system. Franchises are generally issued for fixed terms and must be renewed periodically. There can be no assurance that such renewals will be granted or that renewals will be made on similar terms and conditions.\nVarious proposals have been introduced at 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 public utility character. Increased state and local regulations may increase cable television system expenses.\nRadio Industry\nThe 1996 Act completely revises the radio ownership rules most recently changed by the FCC in 1992. The 1996 Act eliminates the national radio ownership restriction. Any number of AM or FM broadcast stations may be owned or controlled by one entity nationally. The 1996 Act also greatly eases local radio ownership restrictions. As with the old rules, the maximum varies depending on the number of radio stations within the market. In markets with more than 45 stations, one company may own, operate, or control eight stations, with no more than five in any one service (AM or FM). In markets of 30-44 stations, one company may own seven stations, with no more than four in any one service; in markets with 15-29 stations, one entity may own six stations, with no more than four in any one service. In markets with 14 commercial stations or less, one company may own up to five stations or 50% of all of the stations, whichever is less, with no more than three in any one service.\nIn 1992, the FCC placed limitations on local marketing agreements (\"LMAs\") through which the licensee of one radio station provides the programming for another licensee's station in the same market. Stations operating in the same service (e.g., where both stations are AM) and in the same market are prohibited from simulcasting more than 25% of their programming. Moreover, in determining the number of stations that a single entity may control, an entity programming a station pursuant to an LMA is required, under certain circumstances, to count that station toward its maximum even though it does not own the station.\nIn addition, in January 1995, the FCC adopted rules to allocate spectrum for satellite digital audio radio service (\"DARS\"). Satellite DARS systems potentially could provide for regional or nationwide distribution of radio programming with fidelity comparable to compact disks. The FCC has solicited comment on proposed service and licensing regulations in a current rulemaking proceeding. Four applications for licenses to provide satellite DARS are currently pending before the FCC. In addition, the FCC has undertaken an inquiry into the terrestrial broadcast of DARS signals, addressing, inter alia, the need for spectrum outside the existing FM band and the role of existing broadcasters. Further, in 1995 the laboratory testing of a number of competing in-band on-channel DARS technologies was completed, with many of the systems progressing to the next stage of field testing. Registrant cannot predict the outcome of these proceedings.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nA description of the media properties of Registrant is contained in Item 1 above. Registrant owns or leases real estate for certain headend and transmitting equipment along with space for studios and offices. Registrant believes that the properties owned by the stations and the other equipment and furniture and fixtures owned are in reasonably good condition and are adequate for the operations of the stations. Refer to Item 8. \"Financial Statements and Supplementary Data\" for further information regarding Registrant's properties.\nIn addition, the offices of RPMM and MLMM are located at 350 Park Avenue - 16th Floor, New York, New York 10022 and at The World Financial Center, South Tower - 14th Floor, New York, New York, 10080-6114; respectively.\nFor additional description of Registrant's business refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material legal proceedings against Registrant or to which Registrant is a party.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters which required a vote of the limited partners of Registrant during the fourth quarter of fiscal year covered by this report. Part II.\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Stockholder Matters.\nAn established public market for Registrant's Units does not now exist, and it is not anticipated that such a market will develop in the future. Accordingly, accurate information as to the market value of a Unit at any given date is not available.\nAs of February 9, 1996, the number of owners of Units was 15,622.\nEffective November 9, 1992, Registrant was advised that Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\") introduced a new limited partnership secondary service available to its clients through Merrill Lynch's Limited Partnership Secondary Transaction Department.\nBeginning with the December 1994 client account statements, Merrill Lynch implemented new guidelines for providing estimated values of limited partnerships and other direct investments reported on client account statements. As a result, Merrill Lynch no longer reports general partner estimates of limited partnership net asset value on its client account statements, although the Registrant may continue to provide its estimate of net asset value to Unit holders. Pursuant to the guidelines, estimated values for limited partnership interests originally sold by Merrill Lynch (such as Registrant's Units) will be provided two times per year to Merrill Lynch by independent valuation services. The estimated values will be based on financial and other information available to the independent services on the prior August 15th 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 Merrill Lynch client account statements. Merrill Lynch clients may contact their Merrill Lynch Financial Consultants or telephone the number provided to them on their account statements to obtain a general description of the methodology used by the independent valuation services to determine their estimates of value. The estimated values provided by the independent services and the Registrant's current net asset value are not market values and Unit holders may not be able to sell their Units or realize either amount upon a sale. In addition, Unit holders may not realize the independent estimated value or the Registrant's current net asset value upon the liquidation of Registrant over its remaining life.\nRegistrant does not distribute dividends, but rather distributes Distributable Cash From Operations and Distributable Sale and Refinancing Proceeds, to the extent available. There were no distributions in 1993 or 1994. In 1995, $7.5 million ($40 per Unit) was distributed to its Limited Partners and $75,957 to its General Partner from the proceeds of the sale of KATC-TV.\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\nAs of December 29, 1995, Registrant had $41,124,366 in cash and cash equivalents, of which $37,275,625 was limited for use at the operating level and the remaining $3,848,741 was Registrant's working capital.\nAs of December 30, 1994, Registrant had $26,682,289 in cash and cash equivalents, of which $22,115,559 was limited for use at the operating level and the remaining $4,566,730 was Registrant's working capital.\nDuring 1995, Registrant continued its operations phase and the process of liquidating certain of its media properties. Registrant engaged Merrill Lynch & Co. and Daniels & Associates in January, 1994 to act as its financial advisors in connection with a possible sale of all or a portion of Registrant's California Cable Systems (the \"California Cable Systems\").\nRegistrant has an agreement to sell California Cable Systems (see below).\nRegistrant consummated the sale of WREX and KATC on July 31, 1995 and September 30, 1995, respectively (see below). A cash distribution of approximately $7.5 million ($40 per Unit) was made to Limited Partners and $75,957 to its General Partner from net distributable sales proceeds.\nCalifornia Cable\nOn November 28, 1994, Registrant entered into an agreement (the \"Asset Purchase Agreement\") with Century Communications Corp. (\"Century\") to sell to Century substantially all of the assets used in Registrant's California Cable operations serving Anaheim and Hermosa Beach\/Manhattan Beach and Rohnert Park\/Yountville and Fairfield (the \"California Cable Systems\"). The base purchase price specified in the Asset Purchase Agreement for the California Cable Systems is $286 million, subject to reduction by an amount equal to 11 times the amount, if any, by which the operating cash flow of the California Cable Systems (as adjusted in accordance with the Asset Purchase Agreement) is less than $26 million for the 12-month period prior to the closing, and subject to further adjustment as provided in the Asset Purchase Agreement. In addition, Registrant has the right to terminate the Asset Purchase Agreement if the purchase price would be less than $260 million based on the formula described above. Consummation of the transactions provided for in the Asset Purchase Agreement is subject to the satisfaction of certain conditions, including obtaining approvals of the sale from the Federal Communications Commission (\"FCC\") and the municipal authorities issuing the franchises for the California Cable Systems and the approvals of certain franchise extensions, including the renewal of the franchises license for the Anaheim and Villa Park communities.\nAs of December 29, 1995, all such approvals had been obtained, other than the transfer\/renewal approvals for the Anaheim and Villa Park communities. After several months of negotiations, Registrant and Century had been unable to reach agreement with the City of Anaheim and the City of Villa Park regarding the terms of the renewal of each City's franchise, and therefore Century agreed to waive the condition precedent of obtaining a renewal of such franchises and was requiring instead a transfer to Century of the Anaheim franchise (the \"Anaheim Transfer\") and a transfer to Century of the Villa Park franchise (the \"Villa Park Transfer\").\nThe Asset Purchase Agreement provides that Registrant and Century each have the right to terminate the Asset Purchase Agreement if the Closing did not occur by December 31, 1995 (the \"Optional Termination Date\"). Accordingly, as of January 1, 1996, each party became vested with the right to elect to terminate the Asset Purchase Agreement. The parties sought to reach agreement with regard to an extension of the Optional Termination Date but were unable to finalize such agreement. Nevertheless, on January 17, 1996, Registrant notified Century that if the Closing does not occur on or before March 29, 1996, Registrant will terminate the Asset Purchase Agreement as of that date. However, Registrant does not intend to terminate the Asset Purchase Agreement on March 29, 1996 and will continue its attempts to consummate the Asset Purchase Agreement with Century.\nRegistrant, Century and the City of Anaheim have reached agreement on the terms of the Anaheim Transfer and the Anaheim Transfer has been approved; the approval will become final on April 4, 1996 unless a legally sufficient objection is raised under the Anaheim City Charter procedure for a public referendum. Registrant, Century and Villa Park have also reached agreement on the terms of the Villa Park Transfer and the Villa Park Transfer was approved by the Villa Park City Council on March 26, 1996.\nNo assurances can be given that the Anaheim Transfer will become final or the other conditions precedent necessary to enable the Closing to occur will occur. Accordingly, no assurances can be given that the sale of the California Cable Systems under the Asset Purchase Agreement will be consummated. (Refer to Notes 5 and 8 of \"Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nML Media Partners, L.P.\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 29, 1995 and December 30, 1994\nConsolidated Statements of Operations for the three years ended December 29, 1995\nConsolidated Statements of Cash Flows for the three years ended December 29, 1995\nConsolidated Statements of Changes in Partners' Capital\/(Deficit) for the three years ended December 29, 1995\nNotes to Consolidated Financial Statements for the three years ended December 29, 1995\nSchedule I - Condensed Financial Information of Registrant as of December 29, 1995, December 30, 1994 and December 31, 1993\nSchedule II - Valuation and Qualifying Accounts as of December 29, 1995, December 30, 1994 and December 31, 1993\nSchedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the financial statements or the notes thereto. INDEPENDENT AUDITORS' REPORT\nML Media Partners, L.P.:\nWe have audited the accompanying consolidated financial statements and the related financial statement schedules, of ML Media Partners, L.P. (the \"Partnership\") and its affiliated entities, as listed in the accompanying table of contents. These consolidated financial statements and financial statement schedules are the responsibility of the Partnership's general partner. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the general partner, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Partnership and its affiliated entities 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. 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 respect the information set forth therein.\nAs discussed in Note 8 to the consolidated financial statements, the Partnership expects that it will be unable to meet the scheduled April 1, 1996 principal payment pursuant to the ML California Credit Agreement. As a result of this, the maturity of the outstanding borrowing under the ML California Credit Agreement could be accelerated and, if so, the Partnership would be required to satisfy the remaining loan balance ($120,148,500 as of December 29, 1995). In addition, the banks could also take other action to enforce their rights under the ML California Credit Agreement. Such debt is without recourse to the Partnership.\nNew York, New York March 11, 1996 (March 26, 1996 as to Note 8, Pending Transactions)\n(Continued on the following page.)\nSee Notes to Consolidated Financial Statements.\n(Continued on the following page.)\nSee Notes to Consolidated Financial Statements.\n(Continued on the following page.)\n(Continued on the following page.)\nML MEDIA PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE YEARS ENDED DECEMBER 29, 1995 (continued)\nSupplemental Disclosure:\nProperty, plant and equipment of approximately $184,000, $696,000 and $1,067,000 was acquired but not paid for as of December 29, 1995, December 30, 1994 and December 31, 1993, respectively.\nEffective July 31, 1995, the Partnership sold substantially all of the assets of Television station WREX.\nEffective September 30, 1995 the Partnership sold substantially all of the assets of television station KATC.\nSee Notes to Consolidated Financial Statements.\nML MEDIA PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL\/(DEFICIT) FOR THE THREE YEARS ENDED DECEMBER 29, 1995\nSee Notes to Consolidated Financial Statements.\nML MEDIA PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED DECEMBER 29, 1995\n1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nML Media Partners, L.P. (the \"Partnership\") was formed and the Certificate of Limited Partnership was filed under the Delaware Revised Uniform Limited Partnership Act on February 1, 1985. Operations commenced on May 14, 1986 with the first closing of the sale of units of limited partnership interest (\"Units\"). Subscriptions for an aggregate of 187,994 Units were accepted and are now outstanding.\nMedia Management Partners (the \"General Partner\") is a joint venture, organized as a general partnership under the laws of the State of New York, between RP Media Management, a joint venture organized as a general partnership under the laws of the State of New York, consisting of The Elton H. Rule Company and IMP Media Management, Inc., and ML Media Management Inc., a Delaware corporation and an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. The General Partner was formed for the purpose of acting as general partner of the Partnership. The General Partner's total capital contribution amounts to $1,898,934 which represents 1% of the total Partnership capital contributions.\nPursuant to the terms of the Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\"), the General Partner is liable for all general obligations of the Partnership to the extent not paid by the Partnership. The limited partners are not liable for the obligations of the Partnership in excess of the amount of their contributed capital.\nThe Partnership was formed to acquire, finance, hold, develop, improve, maintain, operate, lease, sell, exchange, dispose of and otherwise invest in and deal with media businesses and direct and indirect interests therein.\nAs of December 29, 1995, the Partnership's investments in media properties consisted of a 50% interest in Century - ML Cable Venture (the \"Revised Venture\") which owns an FM (WFID-FM)and AM (WUNO-AM) radio station combination and a background music service in San Juan, Puerto Rico and, through its wholly-owned subsidiary corporation, Century-ML Cable Corporation (\"C-ML Cable\"), operates two cable television systems in Puerto Rico (the \"Puerto Rico Systems\"); four cable television systems in California (\"California Cable\" or the \"California Systems\"); an FM (WEBE-FM) and AM (WICC-AM) radio station combination in Bridgeport, Connecticut; an FM (KEZY-FM) and AM (KORG-AM) radio station combination in Anaheim, California and Wincom Broadcasting Corporation (\"Wincom\"), a corporation that owns an FM radio station (WQAL-FM) in Cleveland, Ohio.\nBasis of Accounting and Fiscal Year\nThe Partnership's records are maintained on the accrual basis of accounting for financial reporting and tax purposes. Pursuant to generally accepted accounting principles, the Partnership recognizes revenue as various services are provided. The Partnership consolidates its 100% interest in Wincom; its 99.999% interests in ML California Associates, KATC Associates, WREX Associates, WEBE Associates, WICC Associates and Anaheim Radio Associates; and its pro rata 50% interest in the Revised Venture, which effective January 1, 1994, also includes the operations of C-ML Radio. All intercompany accounts have been eliminated.\nThe fiscal year of the Partnership ends on the last Friday of each calendar year.\nCash and Cash Equivalents\nShort-term investments which have an original maturity of ninety days or less are considered cash equivalents.\nShort-term Investments Held by Agent\nAt December 30, 1994, the Partnership had short-term investments held by agent with maturities of less than 30 days.\nProperty and Depreciation\nProperty, plant and equipment is stated at cost, less accumulated depreciation. Property, plant and equipment is depreciated using the straight-line method over the following estimated useful lives:\nInitial subscriber connection costs, as it relates to the cable television systems, are capitalized and included as part of the distribution systems. Costs related to disconnects and reconnects are expensed as incurred. Expenditures for maintenance and repairs are also expensed as incurred. Betterments, replacement equipment and additions are capitalized and depreciated over the remaining life of the assets.\nIntangible Assets and Deferred Charges\nIntangible assets and deferred charges are being amortized on a straight-line basis over various periods as follows:\nThe excess of cost over fair value of net assets acquired (\"Goodwill\") in business combinations consummated since inception of the Partnership is being amortized to expense over forty years using the straight-line method.\nAsset Impairment\nThe Partnership assesses the impairment of assets on a regular basis or immediately upon the occurrence of a significant event in the marketplace or an event that directly impacts its assets. The methodology varies depending on the type of asset but typically consists of comparing the net book value of the asset to either the undiscounted expected future cash flows generated by the asset or the current market values obtained from industry sources.\nIf the net book value of a particular asset is materially higher than the estimated net realizable value, and the asset is considered to be permanently impaired, the Partnership will write down the net book value of the asset accordingly; however, the Partnership may not write its assets down to a value below the asset-related non-recourse debt. The Partnership relies on industry sources and its experience in the particular marketplace to determine whether an asset impairment is other than temporary.\nBarter Transactions\nAs is customary in the broadcasting industry, the Partnership engages in the bartering of commercial air time for various goods and services. Barter transactions are recorded based on the fair market value of the products and\/or services received. The goods and services are capitalized or expensed as appropriate when received or utilized. Revenues are recognized when the commercial spots are aired.\nBroadcast Program Rights\nThe Partnership's television stations' broadcast program rights, included in other assets as of December 30, 1994, represent license agreements for the right to broadcast programs which are available at the balance sheet date. Prior to the sale of the two television stations, amortization was recorded on a straight- line basis over the period of the license agreements or upon run usage. (See Note 2).\nRevenue Recognition\nOperating revenue, as it relates to the cable television systems, includes earned subscriber service revenues and charges for installation and connections. Subscriber services paid for in advance are recorded as income when earned. Operating revenue, as it relates to the radio broadcasting properties is net of commissions paid to advertising agencies.\nManagement 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.\nIncome Taxes\nThe Partnership accounts for income taxes pursuant to SFAS No. 109 \"Accounting for Income Taxes\". No provision for income taxes has been made for the Partnership because all income and losses are allocated to the partners for inclusion in their respective tax returns. However, the Partnership owns certain entities which are consolidated in the accompanying financial statements and which are taxable entities.\nFor entities owned by the Partnership which are consolidated in the accompanying financial statements, SFAS No. 109 requires the recognition of deferred income taxes for the tax consequences of differences between the bases of assets and liabilities for income tax and financial statement reporting, based on enacted tax laws. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. For the Partnership, SFAS No. 109 requires the disclosure of the difference between the tax bases and the reported amounts of the Partnership's assets and liabilities (see Note 12).\nStatement of Financial Accounting Standards No. 112\nEffective January 1, 1994, the Partnership adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits\". This pronouncement establishes accounting standards for employers who provide benefits to former or inactive employees after employment, but before retirement. These benefits include, but are not limited to, salary-continuation, disability related benefits including workers' compensation, and continuation of health care and life insurance benefits. SFAS No. 112 requires employers to accrue the obligations associated with service rendered to date for employee benefits accumulated or vested where payment is probable and can be reasonable estimated. The effect of the adoption of SFAS No. 112 was not material to the Partnership's financial position or results of operations as of and for the year ending December 30, 1994.\nStatement of Financial Accounting Standards No. 121\nIn March 1995, 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\". (\"SFAS No. 121\"). This pronouncement, effective in 1996, 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. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles to be held and used and certain identifiable intangibles to be disposed of 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 effect of adopting SFAS No. 121 will not have a material effect on the Partnership's financial position and results of operations.\n2. DISPOSITION OF ASSETS\nWREX-KATC\nOn July 31, 1995, the Partnership completed the sale to Quincy Newspapers, Inc. (\"Quincy\") of substantially all of the assets used in the operations of the Partnership's television station WREX-TV, Rockford, Illinois (\"WREX\"), other than cash and accounts receivable. The purchase price for the assets was approximately $18.4 million, subject to certain adjustments. A reserve of approximately $2.3 million was established to cover certain purchase price adjustments and expenses and liabilities relating to WREX, and the balance of approximately $16.1 million was applied to repay a portion of the bank indebtedness secured by the assets of WREX and KATC. Quincy did not assume certain liabilities of WREX and the Partnership will remain liable for such liabilities. On the sale of WREX, the Partnership recognized a gain for financial reporting purposes of approximately $8.8.\nOn September 30, 1995, the Partnership completed the sale to KATC Communications, Inc. (the \"KATC Buyer\") of substantially all of the assets used in the operations of the Partnership's television station KATC-TV, Lafayette, Louisiana (\"KATC\") other than cash and accounts receivable. The KATC Buyer did not assume certain liabilities of KATC and the Partnership will remain liable for such liabilities. The purchase price for the assets was $24.5 million. From the proceeds of the sale, approximately $6.3 million was applied to repay in full the remaining bank indebtedness secured by the assets of KATC; a reserve of approximately $2.0 million was established to cover certain purchase price adjustments and expenses and liabilities relating to KATC; $1.0 million was deposited into an indemnity escrow account to secure the Partnership's indemnification obligations to the KATC Buyer; approximately $7.6 million was applied to pay a portion of deferred fees and expenses owed to the General Partner; and the remaining amount of approximately $7.6 million ($40 per unit) was distributed to Partners in December, 1995.\nThe Partnership recognized a gain for financial reporting purposes of approximately $14.0 million on the sale of KATC in 1995.\nWincom\nOn April 30, 1993, WIN Communications of Indiana, Inc., a 100%- owned subsidiary of Wincom, entered into an Asset Purchase Agreement to sell substantially all of the assets of WCKN-AM\/WRZX- FM, Indianapolis, Indiana (the \"Indianapolis Stations\") to Broadcast Alchemy, L.P.(\"Alchemy\") for gross proceeds of approximately $7 million. Alchemy is not affiliated with the Partnership. The proposed sale was subject to approval by the FCC, which granted its approval on September 22, 1993. On October 1, 1993, the date of the sale of the Indianapolis Stations, the net proceeds from such sale, which totalled approximately $6.1 million, were remitted to Chemical Bank, as required by the terms of the Restructuring Agreement, to reduce the outstanding principal amount of the Series B Term Loan due Chemical Bank. The Partnership recognized a gain of approximately $4.7 million on the sale of the Indianapolis Stations. In addition, the Partnership recognized an extraordinary gain of approximately $490,000 as a result of the remittance to Chemical Bank of the approximately $6.1 million net proceeds to reduce the outstanding principal amount of the Series B Term Loan and the simultaneous forgiveness of the entire Series C Term Loan due Chemical Bank pursuant to the Restructuring Agreement (see Note 5). The remaining portion of the forgiveness of the Series C Note will be amortized against interest expense over the remaining life of the loan.\n3. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of the following:\n4. INTANGIBLE ASSETS\nIntangible assets consisted of the following:\n5. BORROWINGS\nThe aggregate amount of borrowings as reflected on the balance sheet of the Partnership is as follows:\nA) Borrowings under the C-ML Notes bear semi-annual interest at a fixed annual rate of 9.47% with annual principal payments of $20 million payable beginning November 30, 1998 and the final principal payment due November 30, 2002. The C-ML Notes require that C-ML Cable maintain certain ratios such as debt to operating cash flow, interest expense coverage and debt service coverage and restricts such items as cash distributions and certain additional indebtedness. Borrowings under the C-ML Notes are nonrecourse to the Partnership and are collateralized with substantially all of the Venture's interest in the Puerto Rico Systems, as well as by all of the assets of the Venture, the Venture's interest in C-ML Cable, and all of the assets of C-ML Radio.\nAs of December 29, 1995 and December 30, 1994, outstanding borrowings under the C-ML Notes totalled $100 million, of which $50 million is reflected on the Partnership's balance sheet (see Note 10).\nOn September 30, 1993, C-ML Cable entered into an amendment to the C-ML Revolving Credit Agreement whereby the Termination Date (the date upon which all revolving credit borrowings outstanding under the C-ML Revolving Credit Agreement are converted into a term loan) was extended from September 30, 1993 to December 15, 1993. Effective December 15, 1993, C-ML Cable entered into a second amendment to the C-ML Revolving Credit Agreement whereby the debt facility was converted into a reducing revolving credit with a final maturity of December 31, 1998. Beginning December 31, 1993, the amount of borrowing availability under the C-ML Revolving Credit Agreement is reduced quarterly each year. Outstanding amounts under the debt facility may be prepaid at any time subject to certain conditions. As of December 29, 1995, there were no borrowings outstanding under the C- ML Revolving Credit Agreement.\nB) The ML California Credit Agreement is structured as a term loan that is scheduled to fully amortize by September 30, 1999.\nThe ML California Credit Agreement contains numerous covenants and restrictions regarding the California Media Operations, including limitations on indebtedness, acquisitions and divestitures of media properties, and distributions to the Partnership. The California Media Operations must also meet certain tests such as the ratio of Funded Debt to Operating Cash Flow, the Fixed Charge Ratio and the ratio of Operating Cash Flow to Debt Service, as defined. Proceeds from the ML California Credit Agreement are restricted to the use of the California Media Operations and are generally not available for the working capital needs of the Partnership.\nAll borrowings under the ML California Credit Agreement bear interest at floating rates. The overall effective interest rate for the borrowings under the revised ML California Credit Agreement was approximately 9.55%, 5.83% and 6.48% during 1995, 1994 and 1993, respectively. Pursuant to the terms of the Third Amendment, dated as of December 29, 1995, to the revised ML California Credit Agreement, the applicable margin was increased for periods following December 29, 1995, to 3.75% for Offshore Rate Loans and 2.75% for Reference Rate Loans.\nBorrowings under the ML California Credit Agreement are nonrecourse to the Partnership and are collateralized with substantially all of the assets of the California Media Operations as well as a pledge of the Partnership's interest in Anaheim Radio Associates.\nAs of December 31, 1995, $120,148,500 of principal amount was outstanding under the ML California Credit Agreement. Pursuant to the ML California Credit Agreement, a payment of principal in the amount of approximately $13.1 million (the \"Principal Payment\") became due and payable by the Partnership on December 29, 1995. Since the sale of the California Cable Systems did not occur by that date (see Note 8), the Partnership was unable to make the entire Principal Payment, but did make a $3,555,000 partial payment. The Banks have amended the ML California Credit Agreement and waived the payment default on the balance of the Principal Payment and deferred the due date of the balance of the Principal Payment until April 1, 1996, pending a sale of the California Cable Operations.\nThe Partnership expects that the sale of the California Cable Systems will not occur by April 1, 1996 and, therefore, the Partnership will be unable to make the principal payment of $15,812,500 due under the ML California Credit Agreement on such date. Accordingly, as of April 1, 1996, the Partnership expects to be in default under the terms of the ML California Credit Agreement. However, the Partnership and the banks party to the ML California Credit Agreement are currently negotiating an amendment to the ML California Credit Agreement to defer the April 1, 1996 principal payment due date. The Partnership has advised the banks that it will continue its attempts to consummate the Asset Purchase Agreement with Century assuming approval of the Anaheim Transfer becomes final. Although such negotiations with the banks continue, no assurances can be given that the Partnership will be successful in its attempt to obtain an amendment to the ML California Credit Agreement. Should such amendment not be obtained, upon such default the banks may accelerate the payment obligations with respect to the full amount owing under the ML California Credit Agreement and take other action to enforce their rights under the ML California Credit Agreement.\nC) The WREX-KATC Loan was repaid in 1995 with the proceeds from the sale of WREX-KATC (see Note 2).\nD) On July 30, 1993, the Partnership and Chemical Bank executed an amendment to the Wincom-WEBE-WICC Loan (the \"Restructuring Agreement\"), effective January 1, 1993, which cured all previously outstanding principal and interest payment and covenant defaults pursuant to the Wincom-WEBE- WICC Loan. In addition, as part of the restructuring process, the Partnership agreed to sell substantially all of the assets of the Indianapolis Stations (see Note 2).\nThe Restructuring Agreement provided for the outstanding principal and interest due Chemical Bank as of December 31, 1992 (approximately $24.7 million and $2.0 million, respectively) to be divided into three notes as follows: a Series A Term Loan in the amount of $13 million; a Series B Term Loan in the amount of approximately $11.7 million; and a Series C Term Loan in the amount of approximately $2.0 million (which represented all the accrued interest outstanding under the Wincom-WEBE-WICC Loan as of December 31, 1992).\nThe Series A Term Loan bears interest, payable monthly, at Chemical Bank's Alternate Base Rate plus 1-3\/4% effective January 1, 1993, with principal payments due quarterly in increasing amounts beginning March 31, 1994 and continuing through the final maturity at December 31, 1997. Additional principal payments are also required annually from Excess Cash Flow, as defined. There was approximately $10.3 million outstanding under the Series A Term Loan as of December 29, 1995.\nThe Series B Term Loan bears interest at a rate equal to Chemical Bank's Alternate Base Rate plus 1-3\/4% beginning on April 30, 1994, with interest payments accruing, and payable annually only from Excess Cash Flow. As of December 29, 1995, there was approximately $2.4 million of principal due under the Series B Term Loan. The remaining principal amount of the Series B Term Loan is due on December 31, 1997.\nThe Series C Term Loan was to bear interest at a fixed rate equal to 6% per annum beginning April 30, 1994, with interest payments accruing, and payable annually only from Excess Cash Flow. As a result of the principal payment made on the Series B Term Loan from the net proceeds from the sale of the Indianapolis Stations exceeding $6 million, the full principal amount of the Series C Term Loan was forgiven by Chemical Bank on October 1, 1993 pursuant to the terms of the Restructuring Agreement (see Note 2).\nThe Wincom-WEBE-WICC Loan required that the Wincom-WEBE-WICC group maintain minimum covenant levels of certain ratios such as debt to operating profit and debt service coverage, and restricts such items as: cash; the payment of management fees, distributions or dividends; additional indebtedness; or asset sales by or at Wincom, WEBE-FM or WICC-AM. The Wincom-WEBE-WICC Loan also included other standard and usual loan covenants. Borrowings under the Wincom-WEBE-WICC Loan are nonrecourse to the Partnership and are collateralized with substantially all of the assets of the Wincom-WEBE-WICC group.\nAfter principal and interest due under the Series A Term Loan and the Series B Term Loan have been satisfied in full, any remaining cash proceeds generated from the operations of, or the sale proceeds from the sale of, the stations in the Wincom-WEBE-WICC Group will be divided between the Partnership and Chemical Bank, with the Partnership receiving 85% and Chemical Bank receiving 15%, respectively. As of December 29, 1995, the Partnership was in full compliance with all covenants under the Restructuring Agreement.\nRegistrant does not have sufficient cash to meet all of its contractual debt obligations of all of its investments, however such debt obligations are recourse only to specified assets. Registrant does not currently expect to, nor is it obligated to, advance any of its unrestricted working capital to California Cable Systems.\nAt December 29, 1995, the annual aggregate amounts of principal payments (without considering potential accelerations made possible by defaults) required for the borrowings as reflected in the consolidated balance sheet of the Partnership are as follows:\nBased upon the restrictions of the borrowings as described above, approximately $198,843,475 million of assets are restricted from distribution by the entities in which the Partnership has an interest at December 29, 1995.\n6. TRANSACTIONS WITH THE GENERAL PARTNER AND ITS AFFILIATES\nDuring the three years ended December 29, 1995 the Partnership incurred the following expenses in connection with services provided by the General Partner and its affiliates:\nIn addition, the Partnership, through the California Cable Systems, is party to an agreement with MultiVision Cable TV Corp. (\"MultiVision\"), an affiliate of the General Partner, whereby MultiVision provides the California Cable Systems with certain administrative services. The reimbursed cost charged to the California Cable Systems for these services amounted to an aggregate of $2,629,560 for 1995, $1,937,332 for 1994, and $1,481,562 for 1993. These costs do not include programming costs that are charged, without markup, to the California Cable Systems under an agreement to allocate certain management costs.\nApproximately $7.6 million of the proceeds from the sale of KATC were applied to pay a portion of deferred fees and expenses owed to the General Partner. The Partnership paid $1.0 million to the General Partner representing partial payment for third and fourth quarter management fees and out-of-pocket expenses. As of December 29, 1995 and December 30, 1994, the amounts payable to the General Partner were approximately $7.9 million and $14.1 million, respectively.\n7. COMMITMENTS AND CONTINGENCIES\nLease Commitments\nC-ML Cable rents office and warehouse facilities under various operating lease agreements. In addition, Wincom, the Anaheim Radio Stations, KATC-TV, WEBE-FM and WICC-AM lease office space, broadcast facilities and certain other equipment under various operating lease agreements. The California Systems rent office space, equipment, and space on utility poles under operating leases with terms of less than one year, or under agreements which are generally terminable on short notice. Rental expense was incurred as follows:\nFuture minimum commitments under all of the above agreements in excess of one year are as follows:\n8. PENDING TRANSACTION\nCalifornia Cable\nOn November 28, 1994, the Partnership entered into an agreement (as heretofore amended, supplemented or otherwise modified, the \"Asset Purchase Agreement\") with Century Communications Corp. (\"Century\") where, among other things, the Partnership agreed to sell and Century agreed to buy substantially all of the assets used in the Partnership's California Cable operations (the \"California Cable Operations\") serving the Anaheim, Hermosa Beach\/Manhattan Beach, Rohnert Park\/Yountville and Fairfield communities (the \"California Cable Systems\"). The base purchase price specified in the Asset Purchase Agreement for the California Cable Systems is $286 million, subject to reduction by an amount equal to 11 times the amount, if any, by which the operating cash flow of the Systems (as adjusted in accordance with the Asset Purchase Agreement) is less than $26 million for the 12-month period prior to the closing, and subject to further adjustment as provided in the Asset Purchase Agreement. In addition, the Partnership has the right to terminate the Asset Purchase Agreement if the purchase price would be less than $260 million based on the formula described above. Consummation of the purchase and sale of the California Cable Operations (the \"Closing\") is subject to the satisfaction of certain enumerated conditions precedent set forth in the Asset Purchase Agreement, including obtaining a transfer or extension from the appropriate municipal authorities that issue the franchises for the California Cable Systems, including renewals of the franchises for the Anaheim and Villa Park communities.\nAs of December 29, 1995, all such approvals had been obtained, other than the transfer\/renewal approvals for the Anaheim and Villa Park communities. After several months of negotiations, the Partnership and Century had been unable to reach agreement with the City of Anaheim and the City of Villa Park regarding the terms of the renewal of each City's franchise, and therefore Century agreed to waive the condition precedent of obtaining a renewal of such franchises and was requiring instead a transfer to Century of the Anaheim franchise (the \"Anaheim Transfer\") and a transfer to Century of the Villa Park franchise (the \"Villa Park Transfer\").\nThe Asset Purchase Agreement provides that the Partnership and Century each have the right to terminate the Asset Purchase Agreement if the Closing did not occur by December 31, 1995 (the \"Optional Termination Date\"). Accordingly, as of January 1, 1996, each party became vested with the right to elect to terminate the Asset Purchase Agreement. The parties sought to reach agreement with regard to an extension of the Optional Termination Date but were unable to finalize such agreement. Nevertheless, on January 17, 1996, the Partnership notified Century that if the Closing does not occur on or before March 29, 1996, the Partnership will terminate the Asset Purchase Agreement as of that date. However, the Partnership does not intend to terminate the Asset Purchase Agreement on March 29, 1996 and will continue its attempts to consummate the Asset Purchase Agreement with Century.\nThe Partnership, Century and the City of Anaheim have reached agreement on the terms of the Anaheim Transfer and the Anaheim Transfer has been approved; the approval will become final on April 4, 1996 unless a legally sufficient objection is raised under the Anaheim City Charter procedure for a public referendum. The Partnership, Century and Villa Park have also reached agreement on the terms of the Villa Park Transfer and the Villa Park Transfer was approved by the Villa Park City Council on March 26, 1996.\nNo assurances can be given that the Anaheim Transfer will become final or the other conditions precedent necessary to enable the Closing to occur will occur. Accordingly, no assurances can be given that the sale of the California Cable Systems under the Asset Purchase Agreement will be consummated.\nAs of December 31, 1995, $120,148,500 of principal amount was outstanding under the ML California Credit Agreement. Pursuant to the ML California Credit Agreement, a payment of principal in the amount of approximately $13.1 million (the \"Principal Payment\") became due and payable by the Partnership on December 29, 1995. Since the Sale of the California Cable Systems did not occur by that date, the Partnership was unable to make the entire Principal Payment, but did made a $3,555,000 partial payment. The Banks have amended the ML California Credit Agreement to waive the payment default on the balance of the Principal Payment and defer the due date of the balance of the Principal Payment until April 1, 1996, pending a sale of the California Cable Operations.\nThe Partnership expects that the sale of the California Cable Systems will not occur by April 1, 1996 and, therefore, the Partnership will be unable to make the principal payment of $15,812,500 due under the ML California Credit Agreement on such date. Accordingly, as of April 1, 1996, the Partnership expects to be in default under the terms of the ML California Credit Agreement. However, the Partnership and the banks party to the ML California Credit Agreement are currently negotiating an amendment to the ML California Credit Agreement to defer the April 1, 1996 principal payment due date. The Partnership has advised the banks that it will continue its attempts to consummate the Asset Purchase Agreement with Century assuming approval of the Anaheim Transfer becomes final. Although such negotiations with the banks continue, no assurances can be given that the Partnership will be successful in its attempt to obtain an amendment to the ML California Credit Agreement. Should such amendment not be obtained, upon such default the banks may accelerate the payment obligations with respect to the full amount owing under the ML California Credit Agreement and take other action to enforce their rights under the ML California Credit Agreement.\n9. SEGMENT INFORMATION\nThe following analysis provides segment information for the two main industries in which the Partnership operates. The Cable Television Systems segment consists of the Partnership's 50% share of C-ML Cable and the California Systems. The Television & Radio Stations segment consists of KATC-TV until its sale on September 30, 1995, WREX-TV until its sale on July 31, 1995, WEBE- FM, Wincom, WICC-AM, the Anaheim Radio Stations, and the Partnership's 50% share of the C-ML Radio Stations.\n(Continued on the following page.)\n(Continued on the following page.)\n10. JOINT VENTURES\nPursuant to a management agreement and joint venture agreement dated December 16, 1986 (the \"Joint Venture Agreement\"), as amended and restated, between the Partnership and Century (the \"Venture\"), the parties formed a joint venture in which each has a 50% ownership interest. The Venture subsequently acquired and operated Cable Television Company of Greater San Juan, Inc. (\"San Juan Cable\"). The Venture also acquired all of the assets of Community Cable-Vision of Puerto Rico, Inc., Community Cablevision of Puerto Rico Associates, and Community Cablevision Incorporated (\"Community Companies\"), which consisted of a cable television system serving the communities of Catano, Toa Baja and Toa Alta, Puerto Rico, which are contiguous to San Juan Cable. The Community Companies and San Juan Cable are collectively referred to as C-ML Cable.\nOn February 15, 1989, the Partnership and Century entered into a Management Agreement and joint venture agreement whereby C-ML Radio was formed as a joint venture and responsibility for the management of radio stations acquired by C-ML Radio was assumed by the Partnership.\nEffective January 1, 1994, all of the assets of C-ML Radio were transferred to the Venture, in exchange for the assumption by the Venture of all the obligations of C-ML Radio and the issuance to Century and the Partnership by the Venture of new certificates evidencing a partnership interest of 50% and 50%, respectively. The transfer was made pursuant to a Transfer of Assets and Assumption of Liabilities Agreement. At the time of this transfer, the Partnership and Century entered into an amended and restated management agreement and joint venture agreement (the \"Revised Joint Venture Agreement\") governing the affairs of the revised Venture (herein referred to as the \"Revised Venture\").\nUnder the terms of the Revised Joint Venture Agreement, Century is responsible for the day-to-day operations of the C-ML Cable Systems and the Partnership is responsible for the day-to-day operations of the C-ML Radio properties. For providing services of this kind, Century is entitled to receive annual compensation of 5% of the Puerto Rico Systems' net gross revenues (defined as gross revenues from all sources less monies paid to suppliers of pay TV product, e.g., HBO, Cinemax, Disney and Showtime) and the Partnership is entitled to receive annual compensation of 5% of the C-ML Radio properties' gross revenues (after agency commissions, rebates or discounts and excluding revenues from barter transactions). All significant policy decisions relating to the Venture, the operation of the Puerto Rico Systems and the operation of the C-ML Radio properties, however, will only be made upon the concurrence of both the Partnership and Century. The Partnership may require a sale of the assets and business of C-ML Cable or the C-ML Radio properties at any time. If the Partnership proposes such a sale, the Partnership must first offer Century the right to purchase the Partnership's 50% interest in the assets being sold at 50% of the total fair market value at such time as determined by independent appraisal. If Century elects to sell either the C-ML Cable or the C-ML Radio properties, the Partnership may elect to purchase Century's interest in the assets being sold on similar terms.\nThe total assets, total liabilities, net capital, total revenues and net loss of the Revised Venture (which does not include C-ML Radio for the year ended December 31, 1993 during which time such investment was accounted for under the equity method) are as follows:\n11. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement on Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\", requires companies to report the fair value of certain on- and off-balance sheet assets and liabilities which are defined as financial instruments.\nConsiderable judgment is required in interpreting data to develop the estimates of fair value. Accordingly, the estimates presented herein are not indicative of the amounts that the Partnership could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nAssets, including cash and cash equivalents and accounts receivable, and liabilities, such as trade payables, are carried at amounts which approximate fair value.\nThe General Partner has been able to determine the estimated fair value of the C-ML Notes based on a discounted cash flow analysis. As of December 29, 1995 and December 30, 1994, the estimated fair value of the C-ML Notes is approximately $110 million and $94 million, respectively, of which approximately 50% of the estimated fair value or $55 million and $47 million, respectively pertains to the carrying amount reflected on the Partnership's Consolidated Balance Sheet.\nThe General Partner has been able to estimate the fair value of the revised ML California Credit Agreement based on (i) the price at which the Partnership expects to sell the California Cable Systems to Century; and (ii) the floating rate nature of all borrowings outstanding under the revised ML California Credit Agreement. Based on this analysis, the General Partner determined that, as of December 29, 1995 and December 30, 1994, the estimated fair value of the revised ML California Credit Agreement approximated its carrying value.\nThe General Partner has determined that the carrying value of the Wincom-WEBE-WICC Restructuring Agreement approximates fair value due to the floating rate nature of the outstanding borrowings as of December 29, 1995 and December 30, 1994.\n12. INCOME TAXES\nCertain entities owned by the Partnership are taxable entities and thus are required under SFAS No. 109 to recognize deferred income taxes. The components of the net deferred tax asset are as follows:\nThere is no provision for income taxes required for the years ended December 29, 1995 and December 30, 1994. The change in the deferred tax asset of approximately $5.6 million relates primarily to the utilization and expiration of net operating loss carryforwards and was fully offset by a reduction in the deferred tax liability and valuation allowance.\nThe components of the provision for income taxes for the year ended December 31, 1993 relate to Wincom and are as follows:\nAt December 30, 1995, the taxable entities have available net operating loss carryforwards of approximately $53.0 million which may be applied against future taxable income. Such net operating loss carryforwards expire at various dates from 1996 through 2007.\nFor the Partnership, the differences between the tax bases of assets and liabilities and the reported amounts are as follows:\nSee Notes to Condensed Financial Statements.\nContinued on following page.\nSee Notes to Condensed Financial Statements.\nSee Notes to Condensed Financial Statements.\nML MEDIA PARTNERS, L.P. FOR THE THREE YEARS ENDED DECEMBER 29, 1995,\nSchedule I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Cont'd)\nML Media Partners, L.P. Notes To Condensed Financial Statements For the Three Years Ended December 29, 1995\n1. Organization\nAs of December 29, 1995, ML Media Partners, L.P. (the \"Partnership\") wholly-owned Wincom, WEBE-FM, WICC-AM, the California Systems and the Anaheim Radio Stations. In addition, the Partnership wholly-owned KATC-TV for all of 1993 and 1994 and a 273-day period in 1995, and WREX-TV for all of 1993 and 1994 and a 212-day period in 1995. The Partnership also has a 99.999% interest in KATC Associates, WREX Associates, WEBE Associates, WICC Associates, Anaheim Radio Associates, and ML California Associates; as well as a 50% interest in The Venture (see Note 10 to the consolidated financial statements). All of the preceding investments shall herein be referred to as the \"Subsidiaries\".\n2. Investment in Subsidiaries\nThe Partnership's investment in the Subsidiaries is accounted for under the equity method in the accompanying condensed financial statements.\nThe following is a summary of the financial position and results of operations of the Subsidiaries:\nML MEDIA PARTNERS, L.P. FOR THE THREE YEARS ENDED DECEMBER 29, 1995,\nSchedule I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Cont'd)\nML Media Partners, L.P. Notes To Condensed Financial Statements For the Three Years Ended December 29, 1995\nML MEDIA PARTNERS, L.P. FOR THE THREE YEARS ENDED DECEMBER 29, 1995\nSchedule I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Cont'd)\nML MEDIA PARTNERS, L.P. NOTES TO CONDENSED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED DECEMBER 29, 1995\n3. Cash and Cash Equivalents\nAt December 29, 1995, the Partnership had $3,848,741 in cash and cash equivalents, of which $3,752,736 was invested in commercial paper. In addition, the Partnership had $96,005 in cash. These funds are held in reserve for the operating requirements of the Partnership.\nAt December 30, 1994, the Partnership had $4,566,730 in cash and cash equivalents, of which $4,550,590 was invested in commercial paper. In addition, the Partnership had $16,140 invested in cash. These funds were held in reserve for the operating requirements of the Partnership.\nML MEDIA PARTNERS, L.P. AS OF DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993\nSchedule II Valuation and Qualifying Accounts\n(1) Deductions and Other for Intangible Assets consists of the accumulated amortization of intangible assets related to the sale of the Indianapolis Stations in the amount of $13,090,160 (see Note 2).\n(2) Deductions and Other for Intangible Assets consists of the accumulated amortization of intangible assets related to the sale of television stations WREX and KATC in the amount of $10,967,767 (see Note 2).\n(3) Deductions and Other for Prepaid Expenses and Deferred Charges consists of the accumulated amortization of prepaid expenses and deferred charges related to the sale of television stations WREX and KATC in the amount of $917,847 (see Note 2). Item 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.\nRegistrant has no executive officers or directors. The General Partner manages Registrant's affairs and has general responsibility and authority in all matters affecting its business. The responsibilities of the General Partner are carried out either by executive officers of RP Media Management or ML Media Management Inc. acting on behalf of the General Partner. The executive officers and directors of RP Media Management and ML Media Management Inc. are:\nRP Media Management (the \"Management Company\")\nServed in Present Capacity Name Since (1) Position Held\nI. Martin Pompadur 1\/01\/86 President, Chief Executive Officer, Chief Operating Officer, Secretary, Director\nElizabeth McNey Yates 4\/01\/88 Executive Vice President\n(1) The Director hold office until his successor is elected and qualified. All officers serve at the pleasure of the Board of Director.\nML Media Management Inc. (\"MLMM\")\nServed in Present Capacity Name Since (1) Position Held\nKevin K. Albert 02\/19\/91 President 12\/16\/85 Director\nRobert F. Aufenanger 02\/02\/93 Executive Vice President 03\/28\/88 Director\nMichael E. Lurie 08\/10\/95 Vice President 08\/11\/95 Director\nSteven N. Baumgarten 02\/02\/93 Vice President\nDavid G. Cohen 08\/11\/95 Vice President\nDiane T. Herte 08\/11\/95 Treasurer\n(1) Directors hold office until their successors are elected and qualified. All executive officers serve at the pleasure of the Board of Directors. I. Martin Pompadur, 60, is Director and Manager of RP Media Management. Mr. Pompadur is also the Chairman and Chief Executive Officer of GP Station Partners which is the General Partner of Television Station Partners, L.P., a private limited partnership that owned and operated four network affiliated television stations. These stations were sold in January, 1996 and this partnership is currently in its liquidation phase. Mr. Pompadur is the Chairman and Chief Executive Officer of PBTV, Inc., the Managing General Partner of Northeastern Television Investors Limited Partnership, a private limited partnership which owns and operates WBRE-TV, a network affiliated station in Wilkes-Barre\/Scranton, Pennsylvania. Mr. Pompadur is also Chairman and Chief Executive Officer of U.S. Cable Partners, a general partner of U.S. Cable Television Group, L.P. (\"U.S. Cable\"), which owns and operates cable systems in ten states. Mr. Pompadur is also the President and a Director of RP Opportunity Management, L.P. (\"RPOM\"), a limited partnership organized under the laws of Delaware, which is indirectly owned and controlled by Mr. Pompadur. RPOM is a partner in Media Opportunity Management Partners, an affiliate of the General Partner, and the general partner of ML Media Opportunity Partners, L.P. which was formed to invest in under performing and turnaround media businesses and which presently owns 51.005% interest in an entity which owns two network affiliated television stations, and an equity position in a cellular telecommunications company. Mr. Pompadur is the Principal Executive Officer of ML Media Opportunity Partners, L.P. Mr. Pompadur is also Chief Executive Officer of MultiVision Cable TV Corp. (\"MultiVision\"), a cable television multiple system operator (\"MSO\") organized in January 1988 and owned principally by Mr. Pompadur and the estate of Elton H. Rule to provide MSO services to cable television systems acquired by entities under his control. Mr. Pompadur is a principal owner, member of the Board of Directors and Secretary of Caribbean International News Corporation (\"Caribbean\"). Caribbean owns and publishes EL Vocero, the largest Spanish language daily newspaper in the U.S.\nElizabeth McNey Yates, 33, Executive Vice President of RP Media Management and Senior Vice President of Media Management Partners, joined RP Companies Inc., an entity controlled by Mr. Pompadur, in April 1988 and has senior executive responsibilities in the areas of finance, operations, administration and acquisitions. Ms. Yates is Chief Operating Officer and Executive Vice President of RP Companies, Inc., and since October 1, 1994 has also been President and Chief Operating Officer of MultiVision. Ms. Yates is also the Executive Vice President of RPOM.\nKevin K. Albert, 43, a Managing Director of Merrill Lynch Investment Banking Group (\"ML Investment Banking\"), joined Merrill Lynch in 1981. Mr. Albert works in the Equity Private Placement Group and is involved in structuring and placing a diversified array of private equity financings including common stock, preferred stock, limited partnership interests and other equity-related securities. Mr. Albert is also a director of ML Film Entertainment Inc. (\"ML Film\"), an affiliate of MLMM and the managing general partner of the general partners of 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 MLMM and a joint venturer in Media Opportunity Management Partners, the general partner of ML Media Opportunity Partners, L.P.; a director of ML Mezzanine II Inc. (\"ML Mezzanine II\"), an affiliate of MLMM and sole general partner of the managing general partner of ML-Lee Acquisition Fund II, L.P. and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.; a director of ML Mezzanine Inc. (\"ML Mezzanine\"), an affiliate of MLMM 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 MLMM and the general partner of the Managing General Partner of ML Venture Partners I, L.P. (\"Venture I\"), ML Venture Partners II, L.P. (\"Venture II\"), and ML Oklahoma Venture Partners Limited Partnership (\"Oklahoma\"); and a director of Merrill Lynch R&D Management Inc. (\"ML R&D\"), an affiliate of MLMM and the general partner of the General Partner of ML Technology Ventures, L.P. Mr. Albert also serves as an independent general partner of Venture I and Venture II.\nRobert F. Aufenanger, 42, a Vice President of Merrill Lynch & Co. Corporate Credit 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 Opportunity, ML Film, ML Venture, ML R&D, ML Mezzanine and ML Mezzanine II.\nMichael E. Lurie, 52, a First Vice President of Merrill Lynch & Co. Corporate Credit and the Director of the Asset Recovery Management Department, joined Merrill Lynch in 1970. Prior to his present position, Mr. Lurie was the Director of Debt and Equity Markets Credit responsible for the global allocation of credit limits and the approval and structuring of specific transactions relating to debt and equity products. Mr. Lurie also served as Chairman of the Merrill Lynch International Bank Credit Committee. Mr. Lurie is also a director of ML Opportunity, ML Film, ML Venture and ML R&D.\nSteven N. Baumgarten, 40, a Vice President of Merrill Lynch & Co. Corporate Credit, joined Merrill Lynch in 1986. Mr. Baumgarten shares responsibility for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Baumgarten is also a director of ML Film.\nDavid G. Cohen, 33, a Vice President of Merrill Lynch & Co. Corporate Credit, joined Merrill Lynch in 1987. Mr. Cohen shares responsibility for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners.\nDiane T. Herte, 35, an Assistant Vice President of Merrill Lynch & Co., Corporate Credit since 1992, joined Merrill Lynch in 1984. Ms. Herte's responsibilities include controllership and financial management functions for certain partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners.\nMr. Pompadur and Ms. Yates were each executive officers of Maryland Cable Corp. and Maryland Cable Holdings Corp. at and during the two years prior to the filing Maryland Cable and Holdings on March 10, 1994 of a consolidated plan of reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. Maryland Cable Holdings Corp. was at the time of such filings a subsidiary of ML Media Opportunity Partners, L.P.\nMr. Aufenanger is an executive officer of Mid-Miami Diagnostics Inc. (\"Mid-Miami Inc.\"). On October 28, 1994 both Mid-Miami Inc. and Mid-Miami Diagnostics, L.P. filed voluntary petitions for protection from creditors under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York.\nAn Investment Committee of Registrant was established to have the responsibility and authority for developing, in conjunction with the Management Company, disversification objectives for the investments to be made by Registrant, for reviewing and approving each investment proposed by the Management Company for Registrant and for evaluating and approving dispositions of investments of Registrant. The Investment Committee will also establish reserves for Registrant for such purposes and in such amounts as it deems appropriate. A simple majority vote shall be required for any proposed investment or disposition. The Investment Committee also has the responsibility and authority for monitoring the management of the investments of Registrant by the Management Company.\nThe current members of the Investment Committee are as follows:\nRPMM Representative MLMM Representatives I. Martin Pompadur Kevin K. Albert Robert F. Aufenanger\nItem 11.","section_11":"Item 11.Executive Compensation.\nRegistrant does not pay the executive officers or directors of the General Partner any remuneration. The General Partner does not presently pay any remuneration to any of its executive officers or directors. See Note 6 to the Financial Statements included in Item 8 hereof, however, for amounts paid by Registrant to the General Partner and its affiliates for the years ended December 29, 1995, December 30, 1994 and December 31, 1993.\nItem 12.","section_12":"Item 12.Security Ownership of Certain Beneficial Owners and Management.\nAs of February 9, 1996, no person was known by Registrant to be the beneficial owner of more than 5 percent of the Units.\nTo the knowledge of the General Partner, as of February 9, 1996, the officers and directors of the General Partner in aggregate own less than 1% of the outstanding common stock of Merrill Lynch & Co., Inc.\nRP Media Management is owned 50% by IMP Media Management, Inc. and 50% by the Elton H. Rule Company. IMP Media Management is wholly-owned by Mr. I. Martin Pompadur and The Elton H. Rule Company is wholly-owned by the estate of Mr. Elton H. Rule.\nItem 13.","section_13":"Item 13.Certain Relationships and Related Transactions.\nRefer to Note 6 to the Financial Statements included in Item 8 hereof, and in Item 1 for a description of the relationship of the General Partner and its affiliates to Registrant and its subsidiaries. Part 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 and Financial Statement Schedules\nSee Item 8. \"Financial Statements and Supplementary Data\".\n(c) Exhibits.\nSee (a) (2) above.\n(d) Financial Statement Schedules.\nSee (a) (1) 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.\nML MEDIA PARTNERS, L.P. By: Media Management Partners General Partner\nBy: ML Media Management Inc.\nDated: March 28, 1996 \/s\/ Kevin K. Albert Kevin K. Albert 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 Registrant in the capacities and on the dates indicated.\nRP MEDIA MANAGEMENT\nSignature Title Date\n\/s\/ I. Martin Pompadur President, Secretary March 28, 1996 (I. Martin Pompadur) and Director (principal executive officer of the Registrant)\n\/s\/Elizabeth McNey Yates Executive Vice March 28, 1996 (Elizabeth McNey Yates) President\nML MEDIA MANAGEMENT INC.\nSignature Title Date\n\/s\/ Kevin K. Albert Director and March 28, 1996 (Kevin K. Albert) President\n\/s\/ Robert F. Aufenanger Director and March 28, 1996 (Robert F. Aufenanger) Executive Vice President\n\/s\/ Michael E. Lurie Director and Vice March 28, 1996 (Michael E. Lurie) President\n\/s\/ Diane T. Herte Treasurer (principal March 28, 1996 (Diane T. Herte) financial officer and principal accounting officer of the Registrant)","section_15":""}
{"filename":"18827_1995.txt","cik":"18827","year":"1995","section_1":"Item 1. BUSINESS - ------- --------\nGeneral - -------\nEkco Group, Inc. (\"Ekco\" or the \"registrant\" and, together with its subsidiaries, the \"Company\") is a leading U.S. manufacturer and marketer of multiple categories of branded houseware products for everyday home use. The Company believes it is the leading U.S. supplier of metal bakeware, kitchen tools and gadgets and non-toxic pest control products. In addition, the Company believes it is a leading U.S. supplier of plastic storage products (including crates, containers, baskets and office organizers), cleaning products (primarily brushes, brooms and mops) and small animal care and control products. The Company markets its products primarily in the U.S. through substantially all distribution channels that sell houseware products for everyday home use, including mass merchandisers, supermarkets, hardware, drug and specialty stores.\nThe Company was incorporated in Delaware in 1968. The current business of the Company was established in 1987 through the Company's purchase of Ekco Housewares, Inc. and through subsequent acquisitions and internal development. The Company has acquired or developed the following businesses and product lines (net of divestitures):\nOctober 1987--acquisition of Ekco Housewares, Inc. (\"Housewares\"), a manufacturer and marketer of bakeware and kitchen tools and gadgets.\nJanuary 1989--acquisition of Woodstream Corporation (\"Woodstream\"), a manufacturer and marketer of non-toxic pest control products.\nDecember 1989--acquisition of the non-toxic pest control product line of McGill Metal Products Company.\nDecember 1991--acquisition of the small animal care product line of Beacon Industries, Inc.\nJanuary 1992--acquisition of Frem Corporation (\"Frem\"), a manufacturer and marketer of molded plastic products.\nApril 1993--acquisition of Kellogg Brush Manufacturing Co. and subsidiaries (\"Kellogg\"), a manufacturer and marketer of brushes, brooms and mops.\nJanuary 1995--introduction of an internally developed line of upscale bakeware and kitchen tools, gadgets and other houseware products by B. VIA International Housewares, Inc. (\"VIA!\"), a newly formed subsidiary of the Company.\nThe Company operates in one industry segment. See Note 14 of Notes to Consolidated Financial Statements appearing in Exhibit 13 hereto, incorporated herein by reference, for industry and geographic area information.\nThe Company's business strategy is to (i) leverage the Company's brand names to further increase brand recognition and reputation among retailers and consumers and expand sales to existing and future customers across multiple product categories, (ii) focus on customer sales and service, (iii) increase market and customer penetration by offering differentiated product lines and\nnew and proprietary products and by cross-marketing the full range of the Company's product lines, and (iv) pursue growth through acquisition of additional consumer product lines and businesses.\nSince the fourth quarter of Fiscal 1993, Ekco has taken a series of actions to position the Company for long-term growth (the \"Ekco Integration\"). The Ekco Integration included (i) the combination of four of the Company's principal business units into a single operating division, and (ii) the introduction of a new branding strategy to capitalize on the strength of the Ekco(R) brand name. The Ekco Integration combined the management and operations of the Company's bakeware, kitchenware, cleaning products and molded plastic products businesses, which sell through common channels of distribution and accounted for over 75% of the Company's net revenues in Fiscal 1995. The newly created single organization combines and coordinates the sales, marketing, manufacturing, distribution, administrative and financial activities for the four product categories. The Company also consolidated a large portion of the distribution of bakeware and kitchenware products as well as certain cleaning products into its new distribution facility in Bolingbrook, Illinois from four separate warehousing and distribution locations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes to the Consolidated Financial Statements appearing in Exhibit 13 hereto, incorporated herein by reference.\nAs part of the Ekco Integration, in January 1996 the Company introduced its new branding strategy in which the Ekco(R) brand name is used to market most of the products in these four categories. The new strategy enables the Company to capitalize on the strength of the Ekco(R) brand name by improving the brand identification of these products by consumers and increasing promotional opportunities for retailers. In addition, management believes that the new branding strategy enhances the effectiveness of the Company's newly consolidated sales and marketing effort by facilitating cross-marketing of the Company's products to retail customers under Ekco(R), one of the strongest brand names in the housewares industry.\nRecent Developments ------------------- OFFERING OF SENIOR NOTES. On March 25, 1996, the Company completed a private offering to institutional investors of an aggregate of $125 million principal amount of 9 1\/4% Senior Notes due 2006 (the \"Senior Notes\") at a price of 99.291% of face value. The net proceeds of the offering were used by the Company to (i) repurchase all of the outstanding 12.70% Senior Subordinated Notes due 1998 of Housewares, (ii) repurchase the Company's outstanding 7.0% Subordinated Convertible Note due 2002, and (iii) repay amounts outstanding under the Company's existing $75 million revolving credit facility. The offering was effected without registration under the Securities Act of 1933, as amended, or any applicable state securities law. The Company, however, has agreed to file with the Securities and Exchange Commission (the \"Commission\") and use its best efforts to become effective, a registration statement with respect to a new issue of senior notes (the \"Exchange Notes\") with terms substantially identical to those of the Senior Notes and, upon becoming effective, to offer the holders of the Senior Notes the opportunity to exchange their Senior Notes for a like principal amount of Exchange Notes and, under certain circumstances, to file a shelf registration statement to cover resales of the Senior Notes by the holders thereof. Concurrently with the closing of the above-described private offering, the Company amended its $75 million revolving credit facility (as so amended, the \"Revolving Credit Facility\") by consolidating the outstanding debt and borrowing capacity of the Company and its subsidiaries and by revising certain financial covenants. See Note 19 to Notes to Consolidated Financial Statements appearing in Exhibit 13 hereto, incorporated herein by reference, for further information regarding the offering and the Revolving Credit Facility.\nProducts - --------\nBAKEWARE. The Company manufactures and markets a broad line of metal bakeware for home use, including non-stick coated bakeware marketed under a group of Baker's Secret(R) trademarks and uncoated bakeware marketed under the Ekco(R) trademark. Through Housewares, the Company has over 100 years of experience in the metal bakeware market, and its bakeware products include cookie sheets, muffin tins, brownie pans, loaf pans and similar metal bakeware items. The Company emphasizes value, quality, functionality and, in the case of coated products, ease of cleaning and release. The Company believes it is the leading U.S. supplier of metal bakeware in the U.S.\nThe Company regularly develops new products to capitalize on its high consumer brand recognition and broad retail distribution. New product development efforts are conducted by the Company's internal staff and by third parties on a contract basis. In 1995, the Company introduced specialty muffin pans marketed under the Baker's Secret(R) trademark. In January 1996, the Company expanded its insulated, non-stick coated bakeware product line with the introduction of a variety of baking sheets and baking pans marketed under the Baker's Secret Air Insulated(TM) trademark. The Company also introduced its \"Healthy Cooking Made Simple\" non-stick coated ovenware, including broiling pans featuring porcelain-coated racks which double as grill tops, and non-stick roasters which hold poultry vertically during cooking for self-basting. The Company also introduced two new merchandising display systems for bakeware: a \"cross bar\" system which provides full-view product presentation, and its Air Pockets(TM) slanted-shelf peg-board system.\nKITCHENWARE. The Company sells kitchen tools and gadgets under the Ekco(R) and Ekco Pro(TM) trademarks. The Company markets more than 1,000 products in its kitchen tools and gadgets line, including multiple colors of the same item and various packaging combinations. Kitchen tools include metal, plastic and wooden spoons, spatulas, serving forks, ladles and other cooking accessories. Gadgets include peelers, corkscrews, whisks, can openers, bottle openers and similar items. The Company also markets stainless steel and carbon steel cutlery and stainless steel flatware, mixing bowls and colanders. The Company believes that it is the leading U.S. supplier of kitchen tools and gadgets. The Company believes that it has obtained this position because of its broad product lines, brand name recognition, quality and service.\nThe Company believes that the sale of kitchenware is more dependent on impulse buying by the consumer than any other line of products the Company offers. The Company regularly updates its kitchenware line and introduces new items. For example, in January 1996 the Company introduced a line of upscale kitchen tool, gadget and cutlery products under the Ekco Pro(TM) trademark. The Company also introduced a line of boxed gadgets which include various kitchenware items and sets such as spice racks, gadget organizers and canisters and updated the colors of its Nova(TM) line of kitchen tools. In addition, the Company supplemented its merchandising display program by adding a movable vertical \"power tower\" which utilizes only one square foot of selling space.\nCLEANING PRODUCTS. The Company manufactures and markets a broad line of cleaning products, including brushes, brooms and mops for home use, indoor and outdoor specialty cleaning and janitorial use. The Company believes that it is a leading manufacturer of cleaning brushes for household, kitchen and personal use.\nIn 1995, the Company introduced a line of indoor and outdoor push brooms and a line of professional-grade janitorial dust and wet mops. Consistent with its strategy of leveraging the Ekco(R) brand name, in January 1996 the Company reintroduced its cleaning products in new packaging utilizing the Ekco(R) trademark for distribution in the mass merchandise and supermarket distribution channels. The Company continues to market brooms and brushes under the Wright-Bernet(TM) trademark to specialty hardware retailers, and mops to janitorial supply and professional cleaning companies. In January 1996, the Company introduced its line of short-handle and long-handle cleaning products with comfortable non-slip grips marketed under the Clean Results(TM) trademark, and further expanded its long-handle product line to include \"better\" and \"best\" dust mops and a ceiling fan brush. The Company also expanded its cleaning product line to include lint traps, dust, glass and quick wipes and scrub and scour mitts.\nPEST CONTROL AND SMALL ANIMAL CARE AND CONTROL PRODUCTS. The Company manufactures and markets non-toxic pest control and small animal care and control products under the Victor(R) and Havahart(R) trademarks, respectively. The Company's products include spring-action rodent traps and glue-based rodent and insect traps marketed under the Victor(R) trademark, pet cages marketed under the Havahart(R) trademark and live animal cage traps marketed under the Havahart(R) trademark, which are used to control garden pests and other nuisance animals such as raccoons. The Company believes it is the leading supplier of non-toxic pest control products, rodent traps and live animal cage traps in the U.S. In 1995, the Company introduced a no-see, no-touch, pre-set and pre-baited mouse trap, and the Roach Magnet(TM), a non-toxic roach trap containing a pheromone attractant.\nMOLDED PLASTIC PRODUCTS. The Company manufactures and markets injection molded plastic housewares, office and juvenile products. The Company's houseware products include a variety of storage crates and bins, laundry and storage baskets, organizers, wastebaskets and utility caddies. Office products include file crates, desk-top organizers, file caddies and carts. Juvenile products include pocket trays, activity desks and organizing bins and baskets. The Company's molded plastic products emphasize functionality as well as fashion and color and currently consist of more than 60 products in a variety of distinctive colors.\nThe Company develops new products and works with retailers on design concepts. In January 1995, the Company introduced a storage locker with a lift out tray, a flip-top storage crate for files and a smaller carry-all box. Consistent with its strategy of leveraging the Ekco(R) brand name, in January 1996 the Company reintroduced its molded plastic products with new packaging that utilizes the Ekco(R) brand name. In January 1996, the Company expanded its plastic stacking bin product line to include big and jumbo-sized storage bins for garage, pantry, closet and children's use, and added a jumbo-sized cart to its line of plastic rolling carts. The Company introduced an expanded line of laundry products, including a divided laundry basket organizer, a three-handle \"hip rider\" laundry basket and a wheeled hamper with a built-in handle. The Company also introduced a multi-purpose bin with a folding handle marketed under the Tag Along(TM) trademark.\nVIA! In January 1995, the Company introduced its VIA!(TM) line of houseware products designed for the upscale and specialty marketplace. Initial products included VIA!'s kitchen tools and gadgets such as \"Tutto\nItaliano\" pasta, garlic and pizza cooking and storage items, multi-function items, such as a combination spoon rest\/tea bag holder\/utility dish, and bakeware products, including cookie sheets, loaf pans and muffin tins in heavy-gauge coated and uncoated steel, tin steel pans, and heavy-gauge coated steel roasting pans, racks, bakers and broilers. In January 1996, the VIA!(TM) product line was expanded to include tea kettles marketed under the \"House Blend\" brand, pantryware marketed under the \"Classic Pantry\" brand, a line of trivets and tool jugs and additional multi-function gadgets marketed under the \"2 Tools in 1\" brand.\nCustomers and Distribution - --------------------------\nManagement believes that the Company has one of the broadest distribution networks of any company in the housewares industry. The Company markets its products primarily in the U.S. through substantially all distribution channels that sell houseware products for everyday home use, including mass merchandisers, supermarkets, hardware stores, drug stores, specialty stores and other retail channels. The Company sells its products to each of the 30 largest mass merchandisers (as ranked by the July 3, 1995 Discount Industry Annual Report published by Discount Store News), including Wal-Mart, Kmart and Target. The Company estimates that it sells its products in over 90% of the approximately 38,000 U.S. supermarkets, including Winn-Dixie, Kroger and Albertson's. The Company sells its products to many of the largest hardware chains, including Ace Hardware, Home Depot, True Value, ServiStar and Lowe's Home Centers. Of its customers, Wal-Mart and Kmart accounted for 13.4% and 9.0%, respectively, of the Company's net revenues in Fiscal 1995. No other customer accounted for more than 5% of the Company's net revenues in Fiscal 1995.\nThe Company's products are distributed through the following retail channels: Bakeware is distributed primarily through mass merchandisers and supermarkets; kitchenware is distributed primarily through supermarkets and mass merchandisers, as well as hardware and drug stores; cleaning products are marketed under the Ekco(R) trademark primarily to mass merchandisers and supermarkets; broom and brush products are marketed under the Wright-Bernet(TM) trademark to hardware retailers and mops are marketed to janitorial supply and professional cleaning companies; pest control and small animal care and control products are marketed to mass merchandisers, supermarkets, hardware, drug and variety stores, agricultural centers and farm stores, home centers and professional pest control companies; molded plastic products are distributed through mass merchandisers, as well as large specialty retailers such as office supply stores and drug stores; and VIA!(TM) products are distributed through department stores and upscale and specialty stores, including Lechter's, Crate & Barrel, Linens 'N Things and Bed, Bath & Beyond.\nSales and Marketing - -------------------\nThe Ekco Integration has enabled the Company to shift the focus of its sales and marketing strategy from individual product categories to the broader needs of each of its customers. Each of the Company's customers now has one Ekco sales person responsible for selling and marketing most of the Company's products. As part of the Ekco Integration, the Company has created a new Ekco(R) logo and new \"family\" look packaging and marketing materials designed to present consumers with a uniform message of Ekco(R) quality, value, design and functionality.\nThe Company markets its product lines directly through its own sales and marketing organization and through a network of representatives and brokers. Outside the U.S., the Company's products are marketed through its Canadian and U.K. subsidiaries and distributors and agents who\nprovide marketing support to supermarkets, mass merchandising stores, specialty stores and department stores. The Company's agreements with its distributors and agents are generally terminable upon 30 days notice and are not deemed to be material by the Company.\nManufacturing and Sourcing - --------------------------\nThe Company manufactures most of its bakeware, cleaning, molded plastic and pest control and small animal care and control products. High volume kitchenware products (representing approximately 25% of kitchenware sales) are generally manufactured and assembled by the Company and the remainder are sourced from third parties. The Company utilizes a variety of standard manufacturing processes, including metal stamping, injection molding, mesh welding, wire forming, and automatic staple setting. The Company regularly evaluates its manufacturing and third party sourcing options to maintain an appropriate balance between quality and cost.\nRaw Materials and Components - ----------------------------\nThe Company purchases primary raw materials, including plastic resin, tin-plated steel, wood and corrugated boxes and packaging, from a number of suppliers, including several major steel companies and a number of plastic resin suppliers. All of these materials are subject to price fluctuations which may adversely affect the Company's profitability. The Company purchases primarily on the spot market and does not maintain long-term contracts with suppliers. The Company also purchases components and complete products, primarily for kitchen tools and gadgets, from several domestic and foreign suppliers. The Company believes that raw materials, component items and complete products are available from other suppliers, and that the loss of any one of its suppliers would not have a material adverse effect on the Company.\nTrademarks and Patents - ----------------------\nThe Company believes that its Ekco(R) trademark, as well as its Baker's Secret(R), Havahart(R), Victor(R), Wright-Bernet(TM) and VIA!(TM) trademarks are significant to its competitive position. The Company holds a number of patents, none of which is believed to be material to the Company's business.\nCompetition - -----------\nThe Company believes that the markets for all of its product lines are highly competitive and that competition for retail sales to consumers is based on several factors, including brand name recognition, value, quality, price and availability. Primary competitive factors with respect to selling such products to retailers are brand reputation, number of product categories offered, broad product coverage within each product category, support and service of the retailer and price.\nThe Company competes with established companies, several of which have substantially greater resources than those of the Company. There are no substantial regulatory or other barriers to entry of new competitors in the housewares industry. However, suppliers that are able to maintain, or increase, the amount of retail space allocated to a product may gain a competitive advantage in that product market. The Company believes that the allocation of space by retailers is influenced by many factors, including the brand name recognition by consumers, quality and price of the supplier's products, the level of service provided by the supplier and the supplier's ability to support promotions.\nThe Company believes that its ability to compete successfully is based on the wide recognition of its brand names, its multiple category product offerings, its ability to design, develop, acquire, manufacture and market competitively priced products, its broad product coverage within most product categories, its attention to retailer and consumer needs and its access to major channels of distribution. There can be no assurance that the Company will be able to compete successfully against current and future sources of competition or that the competitive pressures faced by the Company will not adversely affect its profitability or financial performance.\nSeasonality - -----------\nMany of the Company's product categories are affected by seasonal consumer purchasing patterns, including holiday cooking and baking, back-toschool shopping and spring cleaning. Historically, the Company's revenues in the last half of the fiscal year have been greater than in the first half. See Note 16 of Notes to Consolidated Financial Statements appearing in Exhibit 13 hereto, incorporated herein by reference, for information regarding quarterly results of operations.\nBacklog - -------\nInformation as to backlog is not material to an understanding of the Company's business because most of the Company's net revenues result from short lead-time customer orders. The Company generally is able to fill orders from inventory, and has generally been able to adjust production levels to meet increases in customers' orders that cannot be filled from inventory.\nEmployees - ---------\nAs of December 31, 1995, the Company employed 1,255 persons in the U.S. of whom 671 were represented under collective bargaining agreements which expire on dates ranging from February 1997 to February 2000. As of such date, the Company also employed 33 persons in Canada, of whom 13 were represented under a collective bargaining agreement which expires in July 1997, and three persons in the U.K. The Company considers its employee relations to be satisfactory.\nBusiness Outlook - ----------------\nThis annual report on Form 10-K, including \"Business,\" \"Properties,\" \"Legal Proceedings\" and \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in Exhibit 13 hereto, 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 which 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 impact of the level of the Company's indebtedness; restrictive covenants contained in the Company's various debt documents; general economic conditions and conditions in the retail environment; the Company's dependence on a few large customers; price fluctuations in the raw materials used by the Company; competitive conditions in the Company's markets; the seasonal nature of the Company's business; and the impact of federal, state and local environmental requirements (including the impact of current or future environmental claims against the Company). As a result, the Company's operating results may fluctuate, especially when measured on a quarterly basis.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES - ------- ----------\nAs of December 31, 1995, the Company owned or leased for use in its business the properties set forth in the table below:\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS - ------- -----------------\nEnvironmental Regulation and Claims - -----------------------------------\nFrom time to time, the Company has had claims asserted against it by regulatory agencies or private parties for environmental matters relating to the generation or handling of hazardous substances by the Company or its predecessors and has incurred obligations for investigations or remedial actions with respect to certain of such matters. While the Company does not believe that any such claims asserted or obligations incurred to date will result in a material adverse effect upon the Company's financial position, results of operations or liquidity, the Company is aware that at its facilities at Massillon (more fully described below) and Hamilton, Ohio; Easthampton, Massachusetts (more fully described in Note 13 of Notes to Consolidated Financial Statements appearing in Exhibit 13 and incorporated herein by reference); Chicago, Illinois and Lititz, Pennsylvania, and at its previously owned facility in Hudson, New Hampshire hazardous substances and oil have been detected and that additional investigations will be, and remedial actions will or may be, required at such facilities. Operations at these and other facilities currently or previously owned or leased by the Company utilize, or in the past have utilized, hazardous substances. There can be no assurance that activities at these or any other facilities or future facilities may not result in additional environmental claims being asserted against the Company or additional investigations or remedial actions being required.\nPrior to the Company's acquisition of Housewares in 1987, Housewares' Massillon, Ohio steel bakeware manufacturing facility was the subject of administrative proceedings before the United States Environmental Protection Agency by issuance of an administrative complaint alleging violations of the Resource Conservation and Recovery Act resulting from operation of a wastewater lagoon at the facility. American Home Products Corporation (\"AHP\"), a former owner of Housewares, pursuant to an indemnity agreement (the \"Indemnity Agreement\") with Housewares relating to acts occurring prior to September 7, 1984, assumed the costs of remediation measures in addition to the defense of the administrative proceedings with federal and state environmental protection agencies, as well as preparation of closure plans and other plans called for as a result of these proceedings. While AHP has acknowledged its full responsibility under the Indemnity Agreement with respect to the wastewater lagoon, it has asserted that Housewares should contribute to the cost of a remediation study and certain remediation measures to the extent that Housewares exacerbated contamination at the facility since September 7, 1984. Housewares has denied that it has exacerbated contamination at the facility since such date. AHP and Housewares have agreed to allocate such costs in proportion to their respective responsibilities based on the results of an engineering study but in no event will Housewares' share with respect to the wastewater lagoon exceed the lesser of 25% of the total cost or $750,000. The Company is unable to determine to what extent, if any, it will be responsible to contribute to such costs but the Company does not believe that any such contribution that it may be required to make will have a material adverse effect on its financial position, results of operations or liquidity.\nIn June 1992, the United States filed an action in the U.S. District Court for the Northern District of Ohio against Housewares seeking penalties and injunctive relief and alleging violations as a result of an alleged failure to provide certain closure and post-closure financial assurances with respect to the Massillon, Ohio site. Pursuant to the Indemnity Agreement and\na confirmatory letter from AHP to Housewares on December 19, 1988 (the \"Indemnity Documents\"), AHP conducted and controlled all matters relating to such financial assurances and the defense of the action filed in June 1992. In January 1994, the court entered judgment against Housewares in the amount of $4.6 million in the lawsuit. AHP filed a notice of appeal on behalf of Housewares. In March 1994, AHP informed Housewares that, should it be unsuccessful in its appeal, it would attempt to hold Housewares responsible for a portion of the penalties (approximately $600,000, exclusive of interest) arising from Housewares' alleged delay in furnishing certain information to the Ohio Environmental Protection Agency. In March 1994, Housewares notified AHP that Housewares denies all liability and that AHP is liable for all liabilities, losses, costs or damages arising from the lawsuit pursuant to the Indemnity Documents. In August 1995, the Appeals Court affirmed the Company's liability, reversed the imposition of civil penalties for certain periods of time and remanded the redetermination of such penalties to the District Court. The District Court has not yet completed its redetermination. The Company is unable to predict the result of the redetermination or AHP's attempts to obtain contribution from Housewares, but the Company does not believe that any such liability will have a material adverse effect on its financial position, results of operations or liquidity.\nLitigation - ----------\nIn addition to the environmental claims discussed above, from time to time the Company is a party to litigation and other legal proceedings, including product liability claims. In many cases, claims are covered by insurance, subject to standard deductibles. Although the outcome of such proceedings cannot be determined with certainty, the Company believes that the final outcome of such proceedings will not have a material adverse effect on the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nNot applicable.\nThe executive officers of the Company are elected annually by the Board of Directors and serve, subject to the provisions of any employment agreement between the executive and the Company, until their respective successors are chosen and qualified or until their earlier resignation or removal.\nPart II -------\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------- ---------------------------------------------------------------------\nThe information set forth in the section entitled \"Common Stock Price Range and Dividends\" appearing in Exhibit 13 hereto is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe information set forth in the section entitled \"Selected Consolidated Financial Data\" appearing in Exhibit 13 hereto is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nThe information set forth in the section entitled \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" appearing in Exhibit 13 hereto is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nThe information set forth in the consolidated financial statements and notes thereto (including the note which sets forth certain supplementary information) and the Report of Independent Auditors appearing in Exhibit 13 hereto are incorporated herein by reference. Reference is also made to Item 14(a)2 with respect to Financial Statement Schedules filed herewith.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------- --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nNone.\nPart III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------\na) Directors - The information set forth in the section entitled \"Election of Directors\" appearing in the Company's definitive proxy statement with respect to the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nb) Executive Officers - See \"Executive Officers of the Registrant\" appearing in Part I above.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION - -------- ----------------------\nThe information set forth in the sections entitled \"Compensation of Directors\" and \"Compensation of Executive Officers\" (except for the information under the captions \"Report of the Compensation Committee on Executive Compensation\" and \"Performance Graph\") appearing in the Company's definitive proxy statement with respect to 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 in the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" appearing in the Company's definitive proxy statement with respect to the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nThe information set forth in the section entitled \"Certain Relationships and Related Transactions\" appearing in the Company's definitive proxy statement with respect to the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nPart IV -------\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEKCO GROUP, INC.\nBy: \/s\/ ROBERT STEIN ------------------------------------ Robert Stein, President and Chief Executive Officer (Principal Executive Officer) Date: March 29, 1996\nBy: \/s\/ DONATO A. DeNOVELLIS ------------------------------------ Donato A. DeNovellis, Executive Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial Officer) Date: March 29, 1996\nBy: \/s\/ BRIAN R. McQUESTEN ------------------------------------ Brian R. McQuesten, Vice President and Controller (Principal Accounting Officer) Date: March 29, 1996\nINDEPENDENT AUDITORS' REPORT ----------------------------\nBoard of Directors and Stockholders Ekco Group, Inc.\nUnder date of February 5, 1996, except as to note 19, which is as of March 25, 1996, we reported on the consolidated balance sheets of Ekco Group, Inc. and subsidiaries as of December 31, 1995 and January 1, 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the fiscal 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 this 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 schedules as listed in Item 14(a)2 of this report. 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 herein.\nIn 1993, the Company changed its method of accounting for income taxes, post-retirement benefits other than pensions and post-employment benefits.\n\/s\/ KPMG Peat Marwick LLP\nBoston, Massachusetts March 25, 1996\nThe accompanying notes are an integral part of the consolidated condensed financial statements.\nThe accompanying notes are an integral part of the consolidated condensed financial statements.\nThe accompanying notes are an integral part of the consolidated condensed financial statements.\nEKCO GROUP, INC. AND SUBSIDIARIES SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (CONTINUED) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS\n1. BASIS OF PRESENTATION AND OTHER MATTERS:\nThe condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes included in this Form 10-K.\nThe consolidated condensed financial statements include the accounts of the Company and its subsidiaries all of which are reported under the equity method of accounting. The accompanying condensed financial statements include the fiscal years ended December 31, 1995 (\"Fiscal 1995\"), January 1, 1995 (\"Fiscal 1994\") and January 2, 1994 (\"Fiscal 1993\"). Certain amounts from prior periods have been reclassified to conform with the presentation for the current fiscal year.\nEquity in earnings of the Company's subsidiaries is presented after elimination of management fees payable to the Company, for Fiscal 1995 $4.4 million, for Fiscal 1994 $4.3 million and for Fiscal 1993 $4.2 million and interest payable of $4.9 million for Fiscal 1995.\nUnder the terms of the Ekco Housewares' 12.70% Notes, the amount which may be paid to the Company by Ekco Housewares is limited in accordance with a formula, which is based primarily on the consolidated net revenues and net income of Ekco Housewares, plus reimbursement for expenses and amounts due pursuant to a tax sharing arrangement. At December 31, 1995, the amount payable to the Company by Ekco Housewares was approximately $800,000.\nDuring Fiscal 1995, Fiscal 1994 and Fiscal 1993, no dividends were paid to the Company by its subsidiaries.\n2. 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, if any, on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n27 Financial Data Schedule.\n- -------------------------------------------------------------------------------- Schedules to Exhibits 10,21, 10.22, 10.23(a) and 10.23(c) will be supplied upon request by the Commission.\nTHE FOREGOING EXHIBITS WILL NOT BE INCLUDED IN COPIES OF THIS ANNUAL REPORT ON FORM 10-K SUPPLIED TO STOCKHOLDERS. A COPY OF THESE EXHIBITS WILL BE FURNISHED TO STOCKHOLDERS UPON WRITTEN REQUEST ADDRESSED TO JOHN T. HARAN, VICE PRESIDENT AND TREASURER, EKCO GROUP, INC., 98 SPIT BROOK ROAD, NASHUA, NEW HAMPSHIRE 03062.","section_14":"","section_15":""}
{"filename":"352507_1995.txt","cik":"352507","year":"1995","section_1":"Item 1. Business - -----------------\nTexland Drilling Program-1981 (a Limited Partnership) was formed on July 20, 1981 with $12,125,000 in aggregate Limited Partnership subscriptions for the purpose of engaging in the exploration for oil and gas. Such exploration has taken place principally in the geological area known as the Texas Permian Basin. The Partnership's drilling and exploration phase is complete. Development of the Partnership's properties is also substantially complete; however, development drilling will be undertaken on the Partnerships secondary recovery properties to the extent necessary to insure the maximum commercial recovery of reserves.\nThe Partnership has no plans to borrow funds or reinvest significant amounts of oil and gas revenues. To the extent that in-fill development is deemed necessary, however; such operations will be funded from available cash flow.\nSee Note 6 of Notes to the Financial Statements on page 17 for information about major purchasers. Sales to such purchasers are on a competitive basis on short- term contracts customarily used in the industry. Should sales to these refineries become interrupted, management believes alternative purchasers would be immediately available on similar terms.\nThe price of oil and gas is affected by world wide supply and demand beyond the Partnership's control. The average posted price during the past five years for West Texas Sour (before adjustment for gravity), the primary type of Partnership oil, is as follows:\n1991 $18.66 1992 $17.87 1993 $15.60 1994 $14.28 1995 $15.42\nFrom January 1, 1996 to April 30, 1996 oil prices have been particularily volatile with the posted price of such oil ranging from a low of $13.75 to a high of $21.50.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties - -------------------\nThe Partnership currently has an interest in 287 active gross oil and gas wells, representing 20.33 net wells. Two of the gross wells and .6393 of the net wells are gas wells and the remainder are oil wells.\nThe Partnership currently has 279 oil wells included in 10 different enhanced recovery projects operated by Texland Petroleum, Inc. Such enhanced recovery projects are designed to repressure the oil bearing reservoirs and increase the producing rates, property life and overall ultimate recovery of oil.\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 - -------------------\nOmitted. Not applicable.\nItem 6","section_6":"Item 6 - Selected Financial Data - --------------------------------\nThe following tables present selected financial data for each of the past five years ended December 31, 1995. The data has been derived from the audited financial statements:\nTEXLAND DRILLING PROGRAM-1981 SELECTED FINANCIAL INFORMATION FOR THE YEAR ENDED DECEMBER 31 ------------------------------\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations. - --------------\nOil and gas sales increased by approximately 14% in 1995 as compared to 1994. The average price of Partnership oil increased by approximately 8.0% in 1995. In addition, several additional in-fill development wells were drilled on a property in which the Partnership owns a 10% working interest. Increased production from this lease in 1995 accounted for an additional $67,000 in oil sales. Modest but normal declines in production were also experienced on most other Partnership properties in 1995. Oil and gas sales were down 18% in 1994 over that experienced in 1993 due primarily to a decline in the average price of oil and normal expected declines in production rates from Partnership properties. Gas sales are not a significant part of overall sales.\nDepreciation, depletion and amortization are calculated on the units-of- production method. A decline in these expenses from 1994 to 1993 are due to upward revisions in future reserve estimates offset somewhat by production declines on properties with high capitalized costs. The decline in the price of oil had the effect of reducing the ultimate estimated recovery of oil and gas and the resulting units-of-production provisions for 1994.\nProduction expenses decreased by 14% in 1995. Partnership workover costs decreased by approximately $68,000 in 1995, primrily due to a decrease in the number of wells on which remedial work was performed. Production expenses were relatively stable in 1994 as compared to 1993.\nChanges in oil prices substantially impact the net income and cash flow of the Partnership. All oil produced by the Partnership is sold under short term contracts which are immediately affected by changes in oil prices. Since 1981, world oil supply and demand conditions have caused prices to rise and decline in an essentially unpredictable manner. No changes in these circumstances is foreseen in the immediate future.\nTexland Drilling Program-1981 has substantially completed all the exploration and development on the oil and gas properties in which it has an interest. No long-term debt will be incurred and no new properties will be acquired. Therefore, no future liquidity problems are anticipated by the Partnership.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data: - -----------------------------------------------------\nSee Index to Financial Statements on Page 9 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 - ------------------------------------------------------------\nThe Partnership has no officers, employees or directors. The background of the General Partners is as follows:\nR. J. Schumacher - Age 67, President and Director of Texland Petroleum, Inc. - ---------------- since May, 1967, has been an independent oil operator involved in drilling and producing operations and the financing of oil and gas prospects, principally in West Texas, Oklahoma and Arkansas. He has served as an executive officer with Texland since its incorporation. For more than ten years prior to becoming an independent oil operator, Mr. Schumacher was the chief financial officer, contract drilling manager and land supervisor for an independent oil and gas drilling contractor and operator. Mr. Schumacher is a Certified Public Accountant. He received a Bachelor of Science in Commerce degree from Texas Christian University in 1950 and a Master in Professional Accounting degree from the University of Texas in 1951.\nW. E. Rector - Age 61 Chairman of the Board and Director of Texland Petroleum, - ------------ Inc., has been an independent petroleum geologist and oil operator since May, 1969. He has served as an executive officer with Texland since its incorporation. He has had experience as a consulting petroleum geologist and as an independent oil operator, has been involved in the origination and development of oil and gas prospects and in raising funds for their financing in the Mid-Continent area since 1969. For more than ten years prior to becoming an independent oil operator, Mr. Rector was associated with Pan American Petroleum as an exploration petroleum geologist. Mr. Rector received a Bachelor of Science degree in Geology from Ohio State University in 1957 and a Master of Science degree in Geology from the University of Michigan in 1958. He is a member of the American Association of Petroleum Geologists and is a Certified Petroleum Geologist.\nJ. N. Namy - Age 57 Vice-President and Director of Texland Petroleum, Inc., was - ---------- employed by Texland as a geologist in June, 1978. From 1967 to 1970 he was employed by Pan American Petroleum Corp. in the Fort Worth Division. From 1970 to 1978 he taught at Baylor University achieving the rank of Associate Professor. During this time, he served as a consultant for several independent petroleum companies working on exploration and development projects in the Eastern Shelf and the Permian Basin of West Texas and New Mexico, as well as the southern Rockies of New Mexico and Colorado. He received his Bachelor and Master degrees from Western Reserve University in Cleveland, Ohio and his Ph. D. degree from the University of Texas at Austin in 1969. Mr. Namy is a member of the American Association of Petroleum Geologists, Geological Society of America and the Society of Economic Paleontologists and Mineralogists.\nJ. H. Wilkes - Age 40, Senior Vice President of Production and Director of - ------------ Texland Petroleum, Inc. , was employed by Texland as a reservoir engineer in August 1984. From 1978 to 1984, he was employed by Sun Exploration and Production Company in Midland and Abilene, Texas. The first three years he served as a production engineer and for the remaining three years he served as a reservoir engineer. He received a Bachelor of Science degree in Petroleum Engineering from Texas A&M University in 1978. He is a member of the Society of Petroleum Engineers, A.I.M.E. and is a registered professional engineer in Texas.\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nSee Note 5 of Notes to Financial Statements on page 17 of this report for information with respect to payments to the Managing General Partner.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nOmitted. Not applicable to Registrant.\nTexland Petroleum, Inc. and Texland Properties-1981 are General Partners of the Partnership. Texland Petroleum, Inc. is the managing General Partner. Texland Properties-1981 is a general partnership formed between W. E. Rector, R. J. Schumacher and Texland Petroleum, Inc.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nSee Notes 4 and 5 of Notes to Financial Statement on page 17 of this report for information with respect to certain relationships and related transactions.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------\n(a)1 and (a)2 Financial Statement and Financial Statement Schedules See Index to Financial Statements on page 9 of this report. (a)3 Item 601 (Reg S-K) Exhibits: None (b) Reports on Form 8-K: None (c) Item 601 (Reg. S-K) Exhibits: None (d) Other Financial Statements and Financial Statement Schedules: Not applicable.\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.\nTEXLAND DRILLING PROGRAM-1981 - ----------------------------- Registrant\nBy__________________________________. M.E.Chapman, Vice President Texland Petroleum, Inc., Managing General Partner Date May 21, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacities and on the dates indicated.\nBy__________________________________. W.E.Rector, Chairman of the Board, Texland Petroleum, Inc. Managing General Partner.\nBy__________________________________. R.J.Schumacher, President, Director, Texland Petroleum, Inc. Managing General Partner\nBy__________________________________. J.N.Namy, Executive Vice President, Director, Texland Petroleum, Inc. Managing General Partner\nBy__________________________________. J.H.Wilkes, Senior Vice President Director, Texland Petroleum, Inc. Managing General Partner\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD.\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995 AND 1994\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD.\n- --------------------------------------------------------------------------------\nAll other financial statement 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 not required.\n- --------------------------------------------------------------------------------\n[LETTERHEAD OF SPROLES WOODARD L.L.P APPEARS HERE]\nREPORT OF INDEPENDENT AUDITORS\nThe Partners Texland Drilling Program-1981, Ltd.\nWe have audited the balance sheets of Texland Drilling Program-1981, Ltd. 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 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 listed in the accompanying table of contents to the financial statements present fairly, in all material respects, the financial position of Texland Drilling Program-1981, Ltd. 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.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental information listed in the accompanying table of contents to the financial statements 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 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.\n\/s\/ Sproles Woodard L.L.P.\nFort Worth, Texas April 4, 1996\nTEXLAND DRILLING PROGRAM-1981, LTD.(A LIMITED PARTNERSHIP) BALANCE SHEET DECEMBER 31, 1995 AND 1994\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nSee accompanying notes to financial statements\nTEXLAND DRILLING PROGRAM-1981, LTD.(A LIMITED PARTNERSHIP) STATEMENT OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n- --------------------------------------------------------------------------------\n- -------------------------------------------------------------------------------- See accompanying notes to financial statements\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) STATEMENT OF PARTNERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nSee accompanying notes to financial statements.\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nSee accompanying notes to financial statements.\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nTexland Drilling Program-1981, Ltd. (the \"Partnership\") was organized as a limited partnership on July 20, 1981, for the purpose of engaging in oil and gas exploration and production. Texland Properties-1981, a general partnership, and Texland Petroleum, Inc. are the general partners. The managing general partner is Texland Petroleum, Inc. Partnership operations are conducted predominately in West Texas.\nThe Partnership shall continue in existence, unless terminated sooner through the occurrence of a final terminating event as defined by the partnership agreement, until December 31, 2001, as extended through approval by the limited partners owning a majority of aggregate Partnership subscriptions.\nThe Partnership's accounting policies are summarized below:\nBASIS OF ACCOUNTING The Partnership maintains its financial records on the income tax basis. The financial statements are presented in accordance with generally accepted accounting principles. The primary differences in accounting methods are identified in Note 7.\nUSE OF ESTIMATES The preparation of financial statements in accordance 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 revenues and expenses during the reported period. Actual results could differ from those estimates.\nPROPERTY AND EQUIPMENT Costs incurred for the acquisition of producing and nonproducing leaseholds are capitalized. Costs of intangible development and lease and well equipment incurred to drill and equip successful exploratory and development wells are capitalized. Costs to drill and equip unsuccessful exploratory wells are charged to operations while costs of unsuccessful development wells remain capitalized. Costs associated with uncompleted wells are capitalized as wells- in-progress.\nNONPRODUCING LEASEHOLDS Costs of nonproducing properties are charged to expense at such time as they are deemed to be impaired, based upon periodic assessments of such costs.\nAMORTIZATION AND DEPLETION Leasehold costs of producing properties are amortized on the unit-of-production method based on estimated proved oil and gas reserves. Intangible development costs of producing properties are amortized on the unit-of-production method based on estimated proved developed oil and gas reserves.\nDEPRECIATION Depreciation of equipment is provided by the unit-of-production method based on estimated proved developed oil and gas reserves.\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nFEDERAL INCOME TAX The Partnership (which pays no federal income tax) files its federal income tax return on the accrual basis maintained for income tax purposes.\nSTATEMENT OF CASH FLOWS For purposes of these statements, the Partnership considers cash on deposit and highly liquid money market funds as cash and cash equivalents.\nNET INCOME ALLOCATION Revenues and costs of the Partnership are allocated between the general and limited partners in accordance with the Partnership agreement.\n2. COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES\nThe following summarizes the Partnership's costs incurred in its oil and gas activities, all of which were domestic, for the years ended December 31:\n3. ACQUISITION OF NONPRODUCING PROPERTIES\nThe Partnership acquired working interests in certain oil and gas properties through assignments from other Texland Drilling Program partnerships. These acquisitions involved no cost to the Partnership and are subject to retained nonworking interests by the assignor. Upon payout of these properties, the assignor has an option to convert the retained nonworking interest to a working interest.\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\n4. CONTRIBUTIONS BY GENERAL PARTNERS\nUnder terms of the Partnership agreement, Texland Properties-1981 is charged for certain costs related to drilling and production operations, which are required to be capitalized for federal income tax purposes. These costs are treated as capital contributions. In addition, Texland Properties-1981 and Texland Petroleum, Inc. have invested in limited partnership units in the amount of $95,000 and $30,000, respectively. These investments as a limited partner are reported with other limited partners' equity in the accompanying financial statements.\n5. FEES TO MANAGING GENERAL PARTNER\nThe Partnership was charged $138,998, $180,218, and $175,016 in 1995, 1994, and 1993, respectively, for technical and accounting services performed by employees of the managing general partner. These charges are included in intangible development costs, production expenses and fees to managing general partner.\nSupervisory fees charged to the Partnership by the managing general partner for drilling and operating the partnership wells were $142,980, $131,054, and $141,629 in 1995, 1994, and 1993, respectively, and are included in intangible development costs and production expenses.\nThese charges are allocated between the general and limited partners based upon applicable revenue and expense sharing rates.\n6. MAJOR PURCHASERS\nPurchasers which accounted for 10 percent or more of the Partnership's sales were:\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\n7. RECONCILIATION OF BOOK-TAX REPORTING DIFFERENCES\nAlthough the Partnership financial statements are prepared in accordance with generally accepted accounting principles, its books and records are maintained on the basis of accounting used for federal income tax purposes.\nThe following summarizes book-tax reporting differences for the year ended December 31, 1995:\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECE4MBER 31, 1995\n- --------------------------------------------------------------------------------\n7. RECONCILIATION OF BOOK-TAX REPORTING DIFFERENCES (CONTINUED)\n- --------------------------------------------------------------------------------\nTEXTLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\n8. ESTIMATED FUTURE NET REVENUES FROM PROVED RESERVES\nAt December 31, 1995, the estimated future net reserves from partnership proved reserves as determined by Texland Petroleum, Inc., using product prices and operating conditions existing as of that date were as follows:\nBecause of uncertainties inherent in the reserve estimation process, management's estimate of future net revenues and the timing of such revenues may change in the near term as the result new engineering or economic conditions. However, the amount of the change that is reasonably possible cannot be estimated.\n- --------------------------------------------------------------------------------\nTEXLAND DRILLING PROGRAM-1981, LTD. (A LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENT FOR THE YEAR ENDED DECEMBER 31, 1995\n- --------------------------------------------------------------------------------\nSCHEDULE V - PROPERTY AND EQUIPMENT\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nNeither total additions nor total retirements during the years ended December 31, 1995, 1994, or 1993 amounted to more than 10 percent of the ending asset balance for these years. Accordingly, no detailed information is provided for schedules V and VI.\nTotal property and equipment additions and retirements for each of the three years ended December 31, 1995, are as follows:\n- --------------------------------------------------------------------------------","section_15":""}
{"filename":"68366_1995.txt","cik":"68366","year":"1995","section_1":"ITEM 1. BUSINESS\nThiokol Corporation (the \"Company\") manufactures solid rocket propulsion systems and related products, ordnance, flares, gas generators, actuators, and provides services for the aerospace and defense markets and specialty fastening systems for aerospace and industrial applications. Founded in 1930, Thiokol Corporation and its successor, Thiokol Chemical Corporation (old Thiokol), operated in various corporate forms until merged in 1982 with Morton-Norwich Products, Inc., and operated thereafter as a division of Morton Thiokol, Inc. After the 1989 spin-off of the specialty chemicals, salt and automotive-restraint businesses to a newly-formed publicly-traded company, Morton International, Inc., the Company's aerospace and defense business operated independently as Thiokol Corporation. In 1991, the Company acquired the aerospace and industrial fastener business of Huck Manufacturing Company. The Company operates this fastening systems segment of the business as a wholly-owned subsidiary, Huck International, Inc. Huck acquired the threaded lock bolts, locknuts and related product line assets of the Deutsch Manufacturing Company in 1994; and the assets of Automatic Fastener Company, manufacturer of blind fasteners for automotive and industrial applications, in January of 1995. During fiscal year 1995, the Company established the Defense and Launch Vehicles Division reflecting the consolidation of certain of its defense and solid propulsion product lines.\nBusiness Segments\nThe Company operates in three business segments: (i) Space; (ii) Defense; and (iii) Fastening Systems. This business segmentation reflects the Company's reorganization of its business units during fiscal year 1995.\nSpace Systems. The space systems segment consists of solid rocket propulsion systems and related products, research and development, and launch support services for the National Aeronautics and Space Administration (NASA), and commercial space applications. Such systems include the Reusable Solid Rocket Motor (RSRM) used for NASA's Space Shuttle. The current Buy III Space Shuttle contract awarded to the Company in 1991 to build 142 solid rocket motor boosters for the NASA Space Shuttle program has $1.6 billion remaining through its projected completion date in fiscal year 2000. The delivery rate and the Company's contract accrual rate for financial statement purposes is subject to continuing NASA's funding, NASA's Shuttle flight scheduling and program performance. The Company has been notified that NASA's production schedule is being reduced from eight to seven flight sets per year. The NASA contract is subject to termination for convenience by the Federal Government with the Company retaining such rights of recovery for costs and expenses provided by the government procurement laws and regulations, and contract terms and conditions. NASA has announced plans to\nrestructure and reorganize the Shuttle program to include a single prime contractor or prime contractor group to manage many program functions now managed by NASA. Such restructuring will occur over a transition period of several years. The Company anticipates continuing participation in the Shuttle program. The Company's position as a contractor to NASA is expected over time, most probably with completion of the Buy III contract, to shift to the role of a subcontractor to the prime contractor. The Company's service contract at the Kennedy Space Center in Florida includes stacking of RSRM motors, mating them to the external fuel tank and orbiter, prelaunch testing and recovery of the RSRM's. An option until October 1995 to renew this service contract has not been exercised by the prime contractor, Lockheed\/Martin Aeronautics, thereby effectively reducing the Company's long-term participation in the Shuttle's RSRM solid rocket motor launch oversight, launch, and recovery activities at the Kennedy Space Center. During fiscal year 1995, the Company received notification from NASA of the termination of the Company's contract to manage and convert NASA's Yellow Creek, Mississippi facility for the production of nozzles used in the Shuttle's RSRM solid rocket motors, which eliminates the relocation requirements from the Company's facilities in Northern Utah. The Company expects to recover all costs, expenses and investments made or incurred in connection with the performance of the Yellow Creek contract.\nThe Company's family of Castor motors is used in the first and second stages of a number of expendable launch vehicles and as strap-on boosters for medium and heavy lift vehicles for space, defense, and commercial applications.\nThe Company's CASTOR 120(R) motor has been designed as a low-cost 120,000 pound class motor for the small launch vehicle market. This motor is designed for first and second stage propulsion and for strap-on booster applications. The CASTOR 120 motor has been selected as the propulsion system for the Lockheed Launch Vehicle, the Orbital Science Taurus(R) launch vehicle and the McDonnell Douglas Med-Lite launch vehicles. The application of the CASTOR 120 motor includes launch vehicles for placement of communications, mapping and scientific satellites into earth orbit. The Company is currently under contract to provide four Castor motors to Lockheed\/Martin Aeronautics for its LLV family of launch vehicles and one motor to Orbital Science. Although the first demonstration launch vehicle utilizing the CASTOR 120 motor failed to properly place the satellite payload in orbit, the Company anticipates technical problems associated with the launch vehicle will be resolved and there will be minimal delay in the future launch schedule of the Lockheed Launch Vehicle system. The motor loss is covered by insurance.\nThe CASTOR IVA motor is designed with 110,000 pounds of thrust for use as strap-on boosters. The Company is currently under contract for the production and delivery of 24 CASTOR IVA motors to Lockheed\/Martin Aeronautics for the Atlas IIAS program. The Company CASTOR IVB motors equipped with thrust vector control deliver 100,000 pounds of thrust and have been selected to support the Target Critical Measurement Program.\nWith the restructuring of the Company's Defense and Launch Vehicles Division, the Huntsville, Alabama facility will be closed and its CASTOR IVA's and CASTOR IVB motor production transferred to the Company's Promontory, Utah, facility.\nThe Company's family of STAR(TM) motors manufactured at its Elkton, Maryland, facilities provide upper stage propulsion systems for a number of launch vehicle systems. The STAR motors also provide satellite positioning for space, defense, and commercial applications. The Company has successfully tested movable nozzle technology for STAR motor applications. During fiscal year 1995, the Company's STAR motors successfully completed 12 missions including the European Ariane-IV, the Japanese H-2, Chinese Long March, and the Delta II and Titan IV.\nDefense Systems. The Defense Systems segment of the Company's business consists of design, manufacturing and related services and sale of propulsion systems, gas generators and ordnance to the Federal Government and for qualifying foreign military sales.\nFor strategic and tactical markets, the Company produces or is otherwise a qualified producer on a number of propulsion-related programs and products. Major strategic programs include a joint venture arrangement with Alliant Technologies, Inc., which was restructured and consolidated during 1995 to produce the first, second and third stages of United States Navy submarine launched, Trident II missile systems. The Company has an Air Force contract to monitor the service life of the Minuteman III, Stage I and Stage III motors and a development contract for the Minuteman propulsion replacement program including the development and qualification of new materials, propellants and refurbishment of components for the Minuteman Stage I.\nThe Company is a qualified manufacturer of tactical propulsion systems and related products for the Aegis, Standard, HARM, Patriot, Sea Gnat, Harpoon, Hellfire, Sidewinder, and Maverick fixed price programs. The Company has also been awarded a contract for the development of insensitive munition technology for the Mark 104 Standard Missile. The Standard, HARM, Patriot, Sidewinder and Hellfire programs are scheduled for substantial completion of motor production during fiscal year 1996. Continuing declines in the level of Department of Defense spending on strategic and tactical programs and production over capacity within the industry and the Company's defense systems product lines resulted in the Company's reorganizing and consolidating operations forming the Defense and Launch Vehicles Division. The accounting for this restructuring for financial statement purposes is described in Note A and Note B of the Company's consolidated financial statements. The Company is consolidating certain of its tactical motor manufacturing operations from the Huntsville, Alabama, facility to the Company's facilities in Northern Utah and Elkton, Maryland, which should be completed during fiscal year 1996. Other tactical programs not otherwise transferred will not be renewed as they are completed in anticipation of the closure of the Huntsville facility. The Company's Omneco\nOperations in Carson City, Nevada, manufacturer of metal parts for tactical propulsion systems, will also be closed and operations discontinued during the first half of fiscal year 1996.\nThe Company's gas generator operations consist of research, development, production, and sale of solid propellant gas generators. This family of products is designed for a variety of functions for space, defense, and commercial applications including thrust vector control actuation, missile launch eject systems and altitude control, and propulsion for dispensing ordnance.\nThe Company's flare operations consist of research, development and production of visible and infrared illuminating and decoy flares for primarily military applications as well as search and rescue missions.\nOrdnance operations consist of research, development, production and sale of munitions, munitions simulators for training, and the manufacture and sale of conventional artillery mortar and rocket munitions and components.\nThe Company has developed technology used for demilitarization of both solid and liquid propulsion systems. The Company has received a contract funded by the Federal Government's Defense Nuclear Agency for the conversion of liquid propellant from missile systems located in the former Soviet Union into commercial materials. The Company is also conducting solid rocket propulsion studies for conversion of solid propulsion motor propellants to commercially usable explosives for the mining industry.\nThe Company provides services to the United States Army under facilities and operations management contracts for Army-owned ammunition factories near Marshall, Texas and Shreveport, Louisiana. The Louisiana Army Ammunition Plant ceased loading operations during fiscal year 1995. Both plants are operated under a facilities contract permitting the Company use of a facility for both Department of Defense and third party contracts. The Company is pursuing contracts that can be produced in these facilities.\nThe Company continues work on a number of product developments including support work on a heavy-lift launch vehicle system, hybrid propulsion, booster technologies, propellant, and nozzle technology for Theater Missile Defense applications. Development work continues in both solid and liquid explosives technologies for both commercial and military applications. Present technology used in conjunction with the Company's propulsion motor case is being developed and tested for commercial applications. During fiscal year 1995, the Company organized the TCR Composites Division for the commercial development of a lower cost carbon fiber resin technology. The Company's Science and Engineering group maintains ongoing research projects funded under various Company, commercial and government programs and provides support to the Company's space and defense propulsion system programs. Federal export\nlaws, controls and regulations impact or otherwise restrict the export of the Company's propulsion products and technical knowledge.\nFastening Systems. The fastening systems segment consists of the development, production and sale of threaded and non-threaded fasteners consisting of lock bolts, blind bolts, locknuts, blind rivets, cap screws, and product installation tooling. Fasteners and fastening systems are sold to customers directly by the Company and through a distribution network, domestic and foreign. The fasteners are manufactured from high strength metal and metal alloys and are sold under various trade names and trademarks to aerospace and industrial markets. Product installation tooling is also manufactured and marketed to provide customers complete fastener installation systems. The aerospace market consists of both commercial and military aerospace manufacturing companies, domestic and foreign. Customer product qualification is important for aerospace market acceptance of the Company's fasteners. The Company's fasteners have been qualified by major domestic and foreign aerospace companies. Principal domestic and foreign industrial markets include automotive, truck, trailer, railcar, and mining applications. The construction industry utilizes the Company's products for certain structural applications such as bridges and building columns.\nCompetition\nSpace Systems. The Company is the sole source supplier of RSRM solid rocket motors, the only domestically human-rated solid rocket propulsion, for NASA's Space Shuttle program. The Company, Alliant Technologies, Inc. and the CSD Division of United Technologies, Inc. are the major suppliers of heavy-lift solid propulsion launch vehicles for space and strategic applications and are competitive with each other with regard to medium, light and strap-on launch vehicles for commercial space applications. Both foreign governments and foreign private enterprises have solid rocket propulsion systems competitive with propulsion systems manufactured by the Company. Principal competitive factors are cost, technical performance, quality, reliability, depth and capability of personnel and adequacy of facilities.\nDefense Systems. The Company's defense-related solid rocket propulsion systems, services and related products are competitive with Alliant Technologies, Inc. and CSD's strategic programs. The Company is also competitive with the Aerojet Division of Gen Corp. and the ARC Division of Sequa Corporation on a number of tactical motor programs.\nReductions in Department of Defense expenditures and for the quantity being procured for strategic and tactical solid rocket motor programs have substantially increased the competitive pressure for these products. Price, quality, reliability, performance, depth and capability of personnel and adequacy of facilities are the principal competitive factors in the defense market for strategic and tactical solid propulsion products.\nFastening Systems. Fastening systems are manufactured by a number of competitors with no one manufacturer having a major position in the aerospace or industrial fastening markets. Competitive with the Company's threaded and non-threaded fastening systems are alternative fastening methods. The Company's fastening systems compete on quality, delivery, price and ability to provide customer fastening installation solutions through specific purpose tooling and fasteners. Competition for orders from aerospace original equipment manufacturers is often dependent on customer qualification of the Company's fasteners. The Company maintains a proprietary patented position for certain of its fastener designs for which certain limited licenses have been granted to competitors. The Company also manufactures certain fasteners under licenses from competitors.\nResearch and Development\nCompany-sponsored research and development activities relate to new products and services and improvement of existing products and services. The Company's R&D cost was $15.0 million, $15.4 million and $15.7 million and represents 1.6 percent, 1.5 percent and 1.3 percent of revenues for fiscal years 1995, 1994, and 1993, respectively, while the amount spent during the same periods for customer-sponsored R&D (primarily U.S. government-funded) was approximately $25.1 million, $25.5 million and $23.2 million respectively.\nEnvironmental Matters\nCompliance with federal, state, and local environmental requirements with respect to the Company's facilities, including formerly owned and operated facilities, while having the potential to be a significant cost and liability, are not at this time expected to have a material adverse effect on the Company's financial condition or upon the competitive position of the Company or its subsidiaries. Capital expenditures and amounts expensed related to environmental matters respectively were $5.3 million and $9.7 million for fiscal year 1995 and are estimated to be $2.6 million and $9.6 million for fiscal year 1996. The Company maintains ongoing programs for environmental site evaluations, continues its cooperation with federal and state agencies in site investigations, and engages in environmental remediation activities of its sites and sites of third parties where appropriate. The Company continues working on the reduction of ozone depleting and other hazardous chemicals, the cost of which will be recovered under the pricing of its products.\nThe Company is involved with two Environmental Protection Agency (EPA) superfund sites designated under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") in Morris County, New Jersey, operated about thirty years ago by the Company for government contract work. The Company has negotiated a consent decree with the EPA concerning the Rockaway Borough Well Field Site, (\"Klockner\") Site. At this site, the Company's estimated cost for response costs, site\nremediation and future operation and maintenance costs is approximately $5.8 million of which approximately $.75 million will be spent during fiscal year 1996. The Company has received notice from the State of New Jersey that it has been identified along with others as a \"potentially responsible party\" at the Rockaway Township Well Field (\"Denville\") Site. The Company is negotiating with the State of New Jersey to complete site remediation requirements. Anticipated costs for remediation and future operation and maintenance at this site are estimated to be approximately $4.5 million. Management believes that it has valid claims, regarding both sites, for insurance recovery.\nDuring fiscal year 1995, the Company settled a third party claim covering environmental issues at the Woodbine, Georgia site operated by the Company from 1963 to 1976. Under the terms of the agreement, the Company agreed to pay $.425 million for past costs incurred by the third party relating to ownership of the site. The Company has also agreed to investigate and remediate certain solid waste management units (SWMU's) related to past operations conducted by the Company with an estimated cost of $.6 million. The third party retains all other environmental liability for the site.\nDuring fiscal year 1995, the Company paid $105,000 for two Northern Utah environmental projects under an agreement with the Utah Department of Environmental Quality to complete the Company's Settlement Agreement with the State regarding wastewater treatment issues at the Promontory, Utah, facilities. A subsidiary of the Company paid a $10,000 fine to the Environmental Protection Agency to settle wastewater discharge issues at its Kingston, New York, facility.\nThe Company believes that the eventual cost for site remediation matters known at this time, before any recoveries from insurance, third party contributions by other responsible parties including the federal government, is estimated to be $21 million. The Company has established a receivable in the amount of $11 million for expected reimbursement or recovery for environmental claims, costs and expenses from third parties, insurance and federal government. The Company's policy and accounting for environmental matters is set forth in Note A and Note L of the Company's consolidated financial statements. Resolution of the environmental matters discussed above could have a material effect on a future period's income or cash flows if the Company is unsuccessful in obtaining reimbursement from other parties, including its insurance carriers, and is unable to recover such costs from the federal government. The Company believes that after recoveries from third parties, insurance carriers and the federal government, any net liability for which it may ultimately be responsible in excess amounts currently accrued, would not be material to the Company's financial condition and results of operations.\nDuring fiscal year 1995, the Company successfully negotiated an agreement with the federal government to recover certain environmental costs and expenses incurred in connection with the performance of government contracts in the forward pricing on certain of the Company's government contracts.\nEmployees\nThe approximate number of employees of the Company on June 30, 1995, was 7,200 compared to 8,000 on June 30, 1994. Space Systems employees totaled approximately 3,200 on June 30, 1995, compared to 3,400 on June 30, 1994. Defense Systems employees totaled approximately 1,600 on June 30, 1995, reflecting the recognition and formation of the Company's Defense and Launch Vehicles Division. Fastening systems employees totaled approximately 1,700 on June 30, 1995, compared to 1,500 on June 30, 1994. Reduced employment levels, except for fastening systems, reflect lower levels of business activity in non-Shuttle related propulsion programs and the reorganization and formation of the Company's Defense and Launch Vehicles Division. Reductions in Shuttle-related employment reflect continuing improvements in production efficiencies. Ordnance-related employment levels are down due to closure of the Louisiana Army ammunition plants and low level of production activity at the Marshall, Texas, plant. Increased fastening systems employment levels reflect an acquisition and improved volumes for industrial fasteners.\nRaw Materials\nAlthough most of the raw materials used by the Company are readily available, certain key raw material suppliers (such as suppliers of propellant raw materials and nozzle and case component materials) must be approved by the federal government. With a limited number of such approved suppliers, delivery of these materials could be disrupted at the supplier level at any time and have a material adverse impact on production and delivery schedules until government approval of alternative suppliers is obtained.\nSeasonality\nThe business of the Company is not subject to seasonal fluctuations.\nPatents and Trademarks\nThe Company has approximately 415 patents and patent applications, of which 317 relate to the Space and Defense Systems business segments, and 98 relate to the fastening systems segment. As a government contractor, the Company conducts independent research and development (IR&D) to enable it to maintain its competitive position. Research and development work is also performed under contracts with the Department of Defense, NASA, and other government agencies (Contract R&D).\nApproximately 86 percent of the Company's patents in the Space and Defense Systems business segment were developed under Company funded IR&D related budgets. The Company has full ownership interest in its patents developed under these budgets and lesser rights in the patents it developed under Contract R&D programs.\nThe Space and Defense Systems business segment patents have the following remaining duration: approximately 74 percent of the patents have a duration of more than 10 years; 12 percent, 5-10 years; and 14 percent less than 5 years. Patent coverage includes propulsion system design, case, nozzle and propellants. Patents also cover gas generators, ordnance and flare-related products. Under contracts with the federal government, licenses have been granted to the government for limited use of certain patented technology.\nFastening Systems segment patents have the following remaining duration: approximately 49 percent of the patents have a duration of more than 10 years; 29 percent, 5-10 years; and 22 percent less than 5 years. Major aerospace fastening systems covered by patents include the lightweight grooved proportional lock bolt with a remaining patent life of 7 years, and the \"Unimatic\" blind bolt with a remaining patent life of more than 10 years. The \"Unimatic\" blind rivet has a remaining patent life of 7 years. Major industrial fastening systems covered by patents include \"Huck-Fit\" lock bolts, \"Magna-Lok\" blind rivets, and \"Magna-Grip\" lock bolts with patent lives remaining of more than 10 years. Certain of the Company's fastener products are manufactured under licenses from competitors.\nAlthough the Company believes that its present competitive position is enhanced by its patent and its technical expertise, know-how and proprietary information, no patent or group of patents is material to the conduct of the business of the Company.\nTrademarks are important for product identification in the fastening systems segment of the business but are not significant to the Company's propulsion business.\nCustomers\nThe customers of the Space and Defense Systems business segment are primarily the federal government and its prime and subcontractors. Commercial propulsion customers, primarily in the light and medium launch vehicle market, are being developed but are not yet material to the Company's customer base. federal government contracts and subcontracts entered into by the Company, are by their terms, subject to termination by the government or the prime contractor either for convenience or default. Such contracts are also subject to funding appropriations by Congress. Since the federal government provided, directly and indirectly, approximately 72 percent of the Company's business in fiscal year 1995, the termination or discontinuance of funding of a substantial portion of such business would have a material adverse effect on its operations. No single non-government customer is material to the overall business conducted by the Company. Fastening systems customers are comprised of industrial and aerospace original equipment manufacturers and distributors, domestic and foreign, doing business with the Company on a purchase order basis. Foreign customers and sales base are developing but are not yet material to the Company's customer and sales base.\nBacklog Orders\nThe Company's backlog of propulsion systems orders on June 30, 1995, and June 30, 1994, was $2.3 billion and $2.5 billion, respectively. The NASA Space Shuttle solid rocket motor booster and related contracts comprise approximately 83 percent of the backlog. It is expected that approximately 30 percent of the orders in backlog on June 30, 1995, will be completed by June 30, 1996; and the remainder thereafter through fiscal year 2000. The backlog represents the value of contracts for which goods and services are to be provided and includes $.5 billion in government contracts for which funds have been approved. The backlog is believed to consist of firm contracts and although they can be changed or canceled, the amount of changes and cancellations for which the Company would not receive reimbursement is not expected to be materially significant to the Company's business. The contract backlog consists of a combination of cost plus award fee, cost plus fixed fee, cost plus incentive fee, fixed price incentive fee, and firm fixed price contracts. The Company's fastening systems backlog was approximately $45 million on June 30, 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company operates manufacturing, research and development facilities at 15 locations, and administrative and sales offices, warehouses and service centers at approximately 22 locations worldwide. The Company considers its manufacturing facilities, warehouses, and other properties to be generally in good operating condition and suitable for their intended purposes. All Company-owned property is held in fee with no encumbrances. Company leased property obligations are set forth in Note M of the Company's consolidated financial statements.\nSelected key facilities at the Company's Utah Space Operations have been recently upgraded and modernized to achieve performance and operating efficiencies. The NASA facilities at Iuka, Mississippi (\"Yellow Creek\"), will not be developed for nozzle fabrication as the result of the Company's receipt of a notice of contract termination from NASA during fiscal year 1995 for the development of such facility. The Company's Space and Defense Systems business segment facilities are considered adequate and sufficient to meet operating needs.\nDuring fiscal year 1995, the Company reviewed capacity utilization for its strategic and tactical propulsion and ordnance product lines and consolidated and reorganized these operations into the Defense and Launch Vehicles Division. As a result of such restructuring, the Company's operations will be discontinued and facilities closed at Huntsville, Alabama and Carson City, Nevada during fiscal year 1996.\nLoading operations at the Shreveport, Louisiana, Army Ammunition plant have been completed. Under maintenance contracts with the United States Army, the Company maintains this plant in an inactive status. The Marshall, Texas, Army Ammunition plant is maintained under an agreement with the Army that permits the Company to compete and perform government ordnance contracts and commercial production.\nThe Fastening Systems facilities are sufficient and adequate to meet anticipated improvements in the aerospace fastening market. Industrial fastening systems facilities were expanded in fiscal year 1995 to eliminate certain production constraints to improve production capabilities and lower costs. The Branford, Connecticut, facility was added as a result of an asset acquisition.\nDuring fiscal year 1995, additions to property, plant, and equipment totaled $33.8 million and the net property, plant and equipment added as the result of an acquisition totaled $4.8 million.\nThe following table sets forth manufacturing locations and the approximate square footage.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLitigation and Regulation\nAetna Casualty & Surety Co., et., al. v. Pacific Engineering and Production Company of Nevada, et. al., Clark County, Nevada, District Court, filed on September 16, 1988, was settled on September 13, 1992, upon payment into escrow by all defendants of agreed upon settlement amounts. These claims resulted from explosions which occurred on May 4, 1988, at the ammonium perchlorate (AP) plant of defendant Pacific Engineering located in Henderson, Nevada. Some of the explosions involved AP manufactured pursuant to orders from the Company for use in Space Shuttle solid rocket motors. Plaintiffs alleged that the Company was responsible, at least in part, for the design and operation of certain storage equipment and activities at the Pacific Engineering plant. The Company's settlement contribution of $18.7 million was funded by its aircraft products liability carrier under a continuing partial reservation of rights. During fiscal year 1995, the Company, the insurance carrier, and the federal government concluded a settlement of all outstanding insurance coverage issues without additional liability to the Company, bringing this litigation to a final conclusion.\nMcDonnell Douglas v. Thiokol Corporation, United States District Court, Central District of California, was filed in July 1992 by plaintiff claiming damages of $17 million for breach of warranty and tort damages, plus about $19 million in prejudgment interest. The action is based upon the failure in 1984 of two STAR 48 satellite placement motors, manufactured to plaintiff's specifications at the Company's Elkton division, to lift telecommunication satellites into geosynchronous orbit. In its action, plaintiff seeks recovery of its costs incurred to conduct its failure analysis and motor redesign. These two STAR 48 motors were the subject of litigation brought by different plaintiffs in California state courts and resolved in favor of the Company. The courts determined the Company did not negligently manufacture the STAR 48 motors and that there was no cause of action against the Company for breach of warranty. The Company is defending the present suit under an agreement with its insurance carrier pursuant to which past and future costs of defense are being reimbursed subject to a reservation of rights. Although the damage claim is not covered by insurance and the ultimate outcome of the current litigation is uncertain at this time, the Company believes it has substantial legal defenses and that the outcome of this suit will not have a material adverse effect on the financial condition of the Company. The action originally scheduled for trial during the fall of 1994 has been postponed and rescheduled a number of times by the Court, with a new trial date set for the fall of 1995.\nMiscellaneous.\nThe Company is involved in a number of other pending legal and administrative proceedings which are not expected individually or in the aggregate to have a material adverse effect upon the Company's financial condition.\nDepending on the amount and the timing of an unfavorable resolution of these matters, it is possible that the Company's future results of operations or cash flows could be materially affected in a particular period.\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 stockholders during the fourth quarter of fiscal year 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT (as required by Instruction 3. to Item 401(b) of Registration S-K)\nGenerally, Executive Officers are elected by the Board of Directors at its first meeting following the Annual Meeting of Stockholders. The officers generally serve until the next such meeting, or until their successors are elected and qualified. The next Annual Meeting of Stockholders will be held on October 26, 1995.\nThe Executive Officers of the Company on June 30, 1995, were:\nPositions Held During Past Five Name and Age Years and Terms of Office - ------------ -------------------------\nJames R. Wilson (54). . . . . . . . . President and Chief Executive Officer since October 1993; Executive Vice President, Chief Financial Officer and Treasurer (1992-October 1993); Vice President and Chief Financial Officer (1989-92).\nRichard L. Corbin (49). . . . . . . . Senior Vice President and Chief Financial Officer since May 1994; Chief Financial Officer and Vice President, Administration Space Systems Division of General Dynamics Corporation (1976-94).\nPositions Held During Past Five Name and Age Years and Terms of Office - ------------ -------------------------\nH George Faulkner (51). . . . . . . . Vice President Fastening Systems, since October 1994, President Huck Interna- tional, Inc., a company subsidiary since 1991; President of Huck Manufacturing Co. (1983-91).\nJames E. McNulty (51). . . . . . . . .Executive Vice President Human Resources and Administration since 1991; Vice Presi- dent Human Resources (1989-91).\nJoseph A. Lombardo (62). . . . . . . .Vice President Space Operations since April 1992; (1989-April 1992) Assistant General Manager Space Operations; prior to 1989, NASA Marshall Space Flight Center.\nWinston N. Brundige (50). . . . . . . Vice President and General Manager, Defense and Launch Vehicles Division since July 1994; Vice President and Divi- sion Manager Elkton Division (1991-June 1994); Director of Production (1990-91).\nR. Robert Harris (61). . . . . . . . .Vice President and General Counsel since 1989.\nRobert K. Lund (57). . . . . . . . . .Vice President, Science and Engineering and Technical Director since 1991; Tech- nical Director Advanced Technology (1989-91).\nLuther C. Johnson (55). . . . . . . . Vice President and General Manager Ordnance Operations since 1992; Vice President Tactical Operations (1987-92).\nRoyce W. Searle (62). . . . . . . . . Vice President and Controller since 1989.\nNicholas J. Iuanow (35). . . . . . . .Treasurer since 1994; Assistant Treasurer of the Company (1989-93).\nEdwin M. North (50). . . . . . . . . .Secretary since 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation concerning the market for the Company's common equity and related security holder matters is included in the section \"Dividends and Recent Market Prices\" and \"Quarterly Financial Highlights\" on page 47 of the Company's Annual Report to Stockholders for fiscal year 1995, and is incorporated herein by reference in Exhibit Number 13. As of August 31, 1995, there were 6,499 stockholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for the five fiscal years ended June 30, 1995, is included on page 48 of the Company's Annual Report to Stockholders for fiscal year 1995 and is incorporated herein by reference in Exhibit Number 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 for the three fiscal years ended June 30, 1995, is included on pages 43 through 46 of the Company's Annual Report to Stockholders for fiscal year 1995 and is incorporated herein by reference in Exhibit Number 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated balance sheets of the Company as of June 30, 1995 and 1994, and the consolidated statements of income, cash flows, and stockholders' equity for each of the three years for the periods ended June 30, 1995, 1994, and 1993 and notes to consolidated financial statements are included on pages 29 through 42 of the Company's Annual Report to Stockholders for fiscal year 1995 and are incorporated herein by reference in Exhibit Number 13.\nQuarterly financial highlights are included on page 42 of the Company's Annual Stockholders' Report to Stockholders for the fiscal year ended June 30, 1995, and are incorporated herein by reference in Exhibit Number 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the Company's directors and nominees for director is included on pages 4 through 5 of the Company's definitive Proxy Statement dated September 22, 1995 and is incorporated herein by reference. Information concerning disclosure of delinquent files pursuant to Item 405 of Regulation S-K is set forth on page 8 of the Company's definitive Proxy Statement dated September 22, 1995, and is incorporated herein by reference.\nInformation concerning the Company's Executive Officers is included on pages 14 through 15 of Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning executive compensation for fiscal year 1995 is included on pages 9 through 13 of the Company's definitive Proxy Statement dated September 22, 1995, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning beneficial ownership of the Company's common stock is included on page 8 of the Company's definitive Proxy Statement dated September 22, 1995, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning certain relationships and related transactions is included on page 14 of the Company's definitive Proxy Statement dated September 22, 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) DOCUMENTS FILED AS PART OF THIS REPORT\n1. Financial Statements\nThe following consolidated financial statements are included on pages 28 through 42 the Company's Annual Report to Stockholders for the fiscal year ended June 30, 1995, and are incorporated herein by reference in Exhibit Number 13:\nConsolidated Statements of Income -- Years ended June 30, 1995, 1994, and 1993.\nConsolidated Balance Sheets -- June 30, 1995, and June 30, 1994.\nConsolidated Statements of Cash Flows -- Years ended June 30, 1995, 1994, and 1993.\nConsolidated Statements of Stockholders' Equity -- Years ended June 30, 1995, 1994, and 1993.\nNotes to Consolidated Financial Statements.\nManagement's Report on Financial Statements.\nReport of Ernst & Young LLP, Independent Auditors.\n2. Financial Statement Schedules\nAll schedules for which provision is made under the applicable accounting regulation of the Securities and Exchange Commission are omitted as they are either not required under the related instructions or are otherwise inapplicable.\n3. Index to Exhibits\nExhibit Number Description ------- -----------\n(3) Certificate of Incorporation and By-Laws.\n3.01 Restated Certificate of Incorporation of the Company, effective July 3, 1989: Incorporated by reference as Exhibit 3 to Form 10-K for fiscal year ended June 30, 1989.\n3.02 Amended By-Laws of the Company: Incorporated by reference to Annex IV to Proxy Statement\/Prospectus dated May 22, 1989, for Special Stockholders meeting held June 23, 1989.\n3.03 Amended By-Laws of the Company June 19, 1993, increasing Board of Directors: Incorporated by reference as Exhibit 3 to Form 10-K for fiscal year ended June 30, 1993.\n(4) Instruments defining the rights of security holders including indentures.\n4.01 Rights Agreement dated January 26, 1989, between the Company and The First National Bank of Chicago: Incorporated by reference to Exhibit 1 to Form 8-A dated February 8, 1989.\n4.02 Amendment dated June 22, 1989, to Rights Agreement between the Company and The First National Bank of Chicago: Incorporated by reference to Exhibit 2 to Form 8-K dated 1989.\n4.03 Amendment No. 2 to Rights Agreement dated January 18, 1990, between the Company and The First National Bank of Chicago: Incorporated by reference to Exhibit 3 to Form 8-K dated January 18, 1990.\n4.04 See Exhibits 3.01, 3.02 and 3.03 above.\n(10) Material contracts.\n10.01 (1)Key Executive Long-Term Incentive Plan effective for fiscal year 1990: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\nExhibit Number Description ------- -----------\n10.02 (1)Key Executive Long-Term Bonus Plans effective fiscal year 1991: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1991.\n10.03 (1)Key Executive Annual Bonus Plan (Plan 1) effective for fiscal year 1990: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\n10.04 (1)Staff Annual Bonus Plan effective for fiscal year 1991: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1990.\n10.05 (1)Staff Executive Annual Bonus Plan (Plan 2) effective for fiscal year 1990: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\n10.06 (1)1989 Stock Awards Plan: Incorporated by reference to Annex VI to Proxy Statement\/Prospectus dated May 22, 1989, for Special Stockholders Meeting held June 23, 1989.\n10.07 (1)1989 Stock Awards Plan as amended by stockholder approval October 15 1993: Incorporated by reference to the definitive Proxy Statement dated September 11, 1992.\n10.08 (1)Survivor Income Benefits Plan, amended through March 24, 1983: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\n10.09 (1)Arrangements, whereby the Company compensates its independent auditors for tax services to certain key executives, for which there is no written document: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\n10.10 (1)Form of Employment Agreement between the Company and certain of its executive officers including the Chief Executive Officer and the other four highest paid executive officers: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1989.\nExhibit Number Description ------- -----------\n10.11 (1)Amended Form of Employment Agreement between certain of its executive officers including the five most highly compensated: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1990.\n10.12 (2)Consulting Agreement effective July 1, 1993, as amended, between the Company and U. Edwin Garrison, the terms of which are described and are incorporated by reference from the 1994 Proxy Statement dated September 23, 1994.\n10.13 Note Agreement $120,000,000 dated June 19, 1990: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1990.\n10.14 Credit Agreement dated 09\/30\/93 among Thiokol Corporation and The First National Bank of Chicago, Bank of America National Trust and Savings Association, NBD Bank, N.A. and The Northern Trust Company: Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1994.\n10.15 (1)(2)Thiokol Corporation Pension Plan (Second Restatement Effective January 1, 1989): Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1994.\n10.16 (1)(2)Thiokol Corporation Supplemental Executive Retirement Plan (Effective July 1, 1992): Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1992.\n10.17 Huck International, Inc. Personal Retirement Account Plan (Second Restatement Effective as of January 1, 1992): Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1995.\n10.18 Huck International, Inc. Supplemental Executive Retirement Plan (Effective January 1, 1992): Incorporated by reference as Exhibit 10 to Form 10-K for fiscal year ended June 30, 1995.\nExhibit Number Description ------- -----------\n(11) Statement re computation of per share earnings.\nStatement re computation of per share earnings of the Company and subsidiaries for the three years ended June 30, 1995, 1994 and 1992.\n(13) Annual Report to security holders.\nApplicable sections of the Annual Report to Stockholders of the Company for fiscal year 1995 incorporated by reference.\n(22) Subsidiaries of the registrant.\nSubsidiaries of the Company.\n(24) Consents.\nConsent of Ernst & Young LLP, independent auditors.\n(27) Financial Data Schedule.\n(b) REPORTS ON FORM 8-K\nNone.\n- -------------\n(1)Participation by the Company's Chief Executive Officer and four most highly compensated Executive Officers as a group in the compensation plans identified in Exhibit 10 described on page 9 in the Company's definitive Proxy Statement dated September 22, 1995, which description is incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Form 10-K pursuant to Item 14c.\n(2)A description of these contracts are set forth in the Company's definitive Proxy Statement dated September 22, 1995, and are filed as Exhibits pursuant to Form 10-K, Part IV, Item 14(a)3.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of the 25th day of September 1995.\nTHIOKOL CORPORATION (Registrant)\ns\/Richard L. Corbin By__________________________ Richard L. Corbin 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 in the capacities indicated, as of the 25th day of September 1995.\nSIGNATURE TITLE\ns\/James R. Wilson - ----------------------------- President, Chief Executive Officer and James R. Wilson Director (Principal Executive Officer)\ns\/Richard L. Corbin Senior Vice President and Chief - ----------------------------- Financial Officer (Principal Financial Richard L. Corbin Officer)\ns\/Royce W. Searle Vice President and Controller - ----------------------------- (Principal Accounting Officer) Royce W. Searle\ns\/U. Edwin Garrison - ----------------------------- Director, Chairman of the Board U. Edwin Garrison\ns\/Neil A. Armstrong - ----------------------------- Director Neil A. Armstrong\ns\/James R. Burnett - ----------------------------- Director James R. Burnett\ns\/Michael P.C. Carns - ----------------------------- Director Michael P.C. Carns\ns\/Edsel D. Dunford - ----------------------------- Director Edsel D. Dunford\ns\/L. Dennis Kozlowski - ----------------------------- Director L. Dennis Kozlowski\ns\/Charles S. Locke - ----------------------------- Director Charles S. Locke\ns\/James M. Ringler - ----------------------------- Director James M. Ringler\ns\/Donald C. Trauscht - ----------------------------- Director Donald C. Trauscht\nEXHIBIT (22)\nSUBSIDIARIES OF THIOKOL CORPORATION\nThe following is a list of operating subsidiary corporations of the Company as of June 30, 1995. Certain subsidiaries not considered significant have been omitted.\nState or Other Jurisdiction Subsidiary of Incorporation - ---------- ----------------\nHuck International, Inc.........................................Delaware\nHuck S.A........................................................France\nHuck International GmbH & Co....................................Germany\nHuck International Ltd..........................................United Kingdom\nEXHIBIT (24)\nConsent of Independent Auditors\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Thiokol Corporation of our report dated July 31, 1995, included in the 1995 Annual Report to Shareholders of Thiokol Corporation.\nWe also consent to the incorporation by reference in the Registration Statements (Form S-8, Nos. 33-18630, 33-2921, 33-10316, 2-76672, 2-90885 and 33-38322) pertaining to certain Retirement Savings and Investment Plans and Stock Option Plans of Thiokol Corporation of our report dated July 31, 1995, with respect to the consolidated financial statements of Thiokol Corporation incorporated by reference in the Annual Report (Form 10-K) of Thiokol Corporation for the year ended June 30, 1995.\nERNST & YOUNG LLP\nSalt Lake City, Utah September 22, 1995","section_15":""}
{"filename":"225648_1995.txt","cik":"225648","year":"1995","section_1":"ITEM 1. BUSINESS.\nINTRODUCTION\nDanielson Holding Corporation (\"DHC\" or \"Registrant\") is a holding company incorporated in Delaware. DHC is continuing to grow by acquisition, as a corporation having separate subsidiaries (collectively with DHC, the \"Company\") offering a variety of insurance, trust and investment management and other financial service products. The largest subsidiary of DHC is its indirectly wholly-owned California insurance company, National American Insurance Company of California (\"NAICC\"). NAICC writes workers' compensation, non-standard private passenger and commercial automobile insurance in the western United States, primarily California.\nDHC also owns a California trust company subsidiary, Danielson Trust Company (\"Danielson Trust\"), which formerly was known, prior to November 13, 1993, as HomeFed Trust. In February 1994, Danielson Trust acquired the assets of the Western Trust Services (\"WTS\") division of Grossmont Bank. See Note 2 of the Notes to Consolidated Financial Statements.\nAs part of DHC's ongoing corporate strategy, DHC has continued to seek ways to acquire or start-up profitable businesses and\/or to expand into the financial services business in a manner that will both complement its existing operations and enable DHC to earn an attractive return on investment. Most recently, DHC has entered into an agreement to acquire, by merger, Midland Financial Group, Inc. (\"Midland\"). See Note 15 of the Notes to Consolidated Financial Statements. DHC retains cash and investments at the holding company of $11 million.\nThe Company has reported, as of the beginning of its 1995 tax year, aggregate consolidated net operating tax loss carryforwards (\"NOLs\") for Federal income tax purposes of approximately $1.4 billion. These losses will start to expire in 1998 unless utilized prior thereto. See Note 8 of the Notes to Consolidated Financial Statements.\nDESCRIPTION OF BUSINESSES\nSet forth below is a description of the business operations of each industry segment for which financial information, as at December 31, 1995, is presented in the Company's Consolidated Financial Statements incorporated by reference in this Report. Such industry segments are Insurance and Trust Services.\nINSURANCE BUSINESS\nDHC's wholly-owned subsidiary, NAICC, is a California corporation engaged in writing workers' compensation, non-standard and commercial automobile insurance. NAICC is an indirect wholly-owned subsidiary of DHC. NAICC's immediate parent corporation is KCP Holding Company (\"KCP\"). NAICC is the immediate parent of Danielson National Insurance Company (\"DNIC\") and Danielson Insurance Company (\"DIC\"). KCP is wholly-owned by Mission American Insurance Company (\"MAIC\") which, in turn, is wholly-owned by DHC.\nNAICC's lines of business are described below.\nWorkers' Compensation Insurance\nWorkers' compensation insurance policies provide coverage for workers' compensation and employers' liability. The workers' compensation portion of the coverage provides for statutory 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 prescribed by statute, and vary with the nature and severity of the injury or disease and the wages, occupation and age of the employee. The employers' 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. NAICC issues policies having a maximum term of one year.\nNet written premiums for workers' compensation were $38.2 million, $77.2 million and $79.3 million in 1995, 1994 and 1993, respectively. NAICC writes workers' compensation business primarily in the states of California, Oregon, Arizona and Idaho through approximately 650 independent property and casualty insurance agents and brokers. NAICC does not write workers' compensation business through managing general agents and no independent agent produces more than 4.5 percent of the total premium. At December 31, 1995, NAICC had 3,871 workers' compensation policies in force with an average estimated annual premium size of $10,200, compared to 7,253 and 7,161 such policies in force at December 31, 1994 and 1993, respectively, with an average estimated annual premium size of $11,300 and $12,000 in each respective year. The 1995 decrease of approximately 50.5 percent in the net written premium from 1994 is attributable to significantly increased price competition in California. In 1995, 87 percent of NAICC's workers' compensation business was in the state of California.\nIn July 1993, the California legislature passed several bills reforming the State's workers' compensation system. In connection with this reform, cost savings from favorable loss experience resulting from reform legislation, stabilization of the California economy, and highly-publicized anti-fraud activity were passed along to employers in the form of minimum rate decreases. Thus, at the direction of the California Department of Insurance (the \"Insurance Department\"), the minimum rate was decreased by seven percent, 12.7 percent and 16 percent effective in July 1993, January 1994 and October 1994, respectively.\nIn addition, effective January 1, 1995, a new \"open rating\" law replaced the old workers' compensation \"minimum rate\" law. The new open rating law provides for a significant change in the way insurance companies price workers' compensation insurance in California. Although the Workers' Compensation Insurance Rating Bureau of California (the \"Bureau\") is still the designated statistical agent for the Insurance Department and will continue to accumulate statewide loss and remuneration data, under the new law the Bureau now only promulgates advisory pure premium rates instead of final rates. Pure premium rate is the loss and loss adjustment expense (\"LAE\") portion of the final rate charged. Non-loss related expenses constitute the other portion of the final rate charged.\nAn insurer establishes its own final rates prospectively based on pure premium rates promulgated by the Bureau and\/or from its own experience. An insurer may establish the pure premium portion of its rates below the Bureau's advisory pure premium rates. The pure premium rates are then increased to provide for non-loss related expenses, which are based solely upon that company's experience and expectation. Non-loss related expenses include items such as commissions to agents, general and administrative expenses and premium taxes. To obtain approval to use any workers' compensation rates in California, an insurer is required to file its proposed rates with the Insurance Department. The Insurance Department may disapprove a rate filing only if it finds that the rates are unfairly discriminatory, could threaten the solvency of the insurer, or could cause a single insurer, other than the California State Compensation Insurance Fund (the \"State Fund\"), to control more than 20 percent of the market.\nThe favorable loss experience of the 1992, 1993 and 1994 loss years, and the elimination of the minimum rate law have created a new and highly competitive environment in the California workers' compensation market. NAICC has filed premium rates with the Insurance Department which are based on the pure premium rates promulgated by the Bureau. NAICC's management believes that the pure premium rates promulgated by the Bureau will best reflect NAICC's actual loss costs and LAE. NAICC continues its policy to underwrite policies at prices which are expected to achieve an underwriting profit. Consequently, management of NAICC believes that its premium volume has decreased because competitors are willing to price policies using pure premium rates which are below the average pure premium rates promulgated by the Bureau. However, it is the view of NAICC's management that NAICC will continue to partially offset its decline in workers' compensation premium by increasing its participation in other markets.\nNAICC competes with both the State Fund and more than 300 other companies writing workers' compensation insurance in California. In 1994, the most recent year for which information is available, the State Fund wrote approximately $1.4 billion in premiums, which represented approximately 18.1 percent of the insured California workers' compensation market. No single company wrote in excess of $500 million in workers' compensation premiums in California in 1994. NAICC, which has a market share of approximately one percent of the insured market, does not believe that it is a dominant writer of workers' compensation insurance in California.\nBecause of the existence of the State Fund, California does not require licensed insurers to participate in any involuntary pools or assigned risk plans for workers' compensation insurance. California, like other states, has a post insolvency guarantee fund, the California Insurance Guarantee Association, to protect policyholders of insolvent insurance companies. Under current law, the maximum amount that can be assessed against any insurer for this purpose in any one year is one percent of its net direct premiums written in the preceding year. These assessments are passed through to all policyholders. There were no such assessments for the 1994 policy year.\nNon-Standard Private Passenger Automobile Insurance\nNAICC began writing non-standard private passenger automobile insurance in California in July 1993. NAICC writes this business through a general agent which utilizes over 600 sub-agents to obtain applications for policies. The selection of policyholders is governed by underwriting guidelines established by NAICC. Non-standard risks are those segments of the driving public which generally are not considered to be \"preferred\" business, such as drivers with a record of prior accidents or driving violations, drivers involved in particular occupations or driving certain types of vehicles, or those who have been non- renewed or declined by another insurance company.\nGenerally, non-standard premium rates are higher than standard premium rates and policy limits are lower than typical policy limits. NAICC's private passenger automobile policies provide maximum coverage up to $15,000 per person, $30,000 per accident for liability for bodily injury and $10,000 per accident for liability for property damage. NAICC also writes physical damage coverage for up to $33,000 per vehicle. NAICC's management believes that it may enhance its underwriting as a result of refinement of various risk profiles, thereby dividing the non-standard insurance market into more defined segments which can be adequately priced.\nFor the 1995 calendar year, NAICC billed $28.8 million in direct written premiums and, at December 31, 1995, NAICC had 29,000 private passenger automobile policies in force, compared to 20,000 and 15,419 policies in force in 1994 and 1993, respectively. In 1995, NAICC's non-standard private passenger automobile business represented approximately 40.6 percent of its total direct premiums written and 27.2 percent of total net premiums written, respectively. NAICC cedes 50 percent of its non-standard private passenger automobile direct written premium, direct losses and allocated LAE to a major reinsurance company under a quota share reinsurance agreement.\nThe California Automobile Assigned Risk Plan (the \"Assigned Risk Plan\") provides 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 in the voluntary market. The Assigned Risk Plan allocates risks to private passenger automobile insurers in the voluntary market based on each insurer's proportionate share of the private passenger automobile direct written premiums. Premium rates for assigned risk business are established by the Insurance Department and, by law, these rates must be actuarially sound. To be eligible for the Assigned Risk Plan, an applicant must first be denied coverage by three admitted insurance carriers. The Assigned Risk Plan rates were increased by 8.5 percent on October 1, 1990 and by 5.2 percent on June 1, 1995. The combination of these events have caused the number of drivers applying for insurance to the Assigned Risk Plan to decline as well as to reduce the underwriting losses from assigned risk business. The population of drivers in the Assigned Risk Plan has declined by approximately 90 percent in the period from 1988 to 1995 and continued declines are anticipated. NAICC does not expect assignments which will be material nor should they have a material adverse effect upon the profitability of this line of business.\nPrior to 1989, California automobile insurance rates, other than assigned risk rates discussed above, were not subject to approval by any governmental agency. In November 1988, Proposition 103, a California ballot initiative, was passed into law by the California voters. Among other things, Proposition 103 requires insurance companies to obtain prior regulatory approval of any new rates prior to use. Proposition 103 does not apply to workers' compensation. Proposition 103 also requires automobile insurers to renew policies of good drivers as defined in Proposition 103.\nThe rates for NAICC's California non-standard private passenger automobile policies are subject to Proposition 103. NAICC filed for and received approval to adjust its rates effective December 1, 1994. The average overall effect was to increase liability premium rates by 7.7 percent and to decrease physical damage premium rates by 8.5 percent, for an overall weighted average increase of five percent. Rating factors also were adjusted to reflect NAICC's experience in each classification of driver in each territory in California. In December 1995, NAICC filed to decrease liability premium rates by 0.1 percent, and to increase physical damage premium rates by 21.8 percent as well as certain other minor plan changes. Such rate filing was approved in February 1996. Management of NAICC believes that the new rates will continue to be competitive and yield a profit for NAICC.\nCommercial Automobile Insurance\nIn March 1995, NAICC commenced a non-standard commercial automobile program in Arizona, Idaho, Nevada and Oregon. In August 1995, NAICC began writing non-standard commercial automobile insurance in California. Direct written premiums for commercial automobile insurance were $2.3 million in each of 1995 and 1994. NAICC intends to continue to market this program in California, as well as Arizona, Idaho, Nevada and Oregon to independent agents through its field marketing staff in those states.\nCommercial Property-Casualty Insurance\nThe commercial property and casualty market has been highly competitive and has offered limited profit potential since 1987. As a result, NAICC ceased writing this business in 1994.\nCombined Ratio\nNAICC had a combined ratio of 113.4 percent, 106.2 percent and 110.9 percent for 1995, 1994 and 1993, respectively. These ratios compare to an overall national industry average for workers' compensation insurers of 101.4 percent for the 1994 year, the most recent year for which such information is available. For additional information regarding the foregoing statistics, see \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, 2. RESULTS OF NAICC'S OPERATIONS.\"\nLosses and Loss Adjustment Expenses\nNAICC's unpaid losses and loss adjustment expenses (\"LAE\") represent the estimated indemnity cost and LAE necessary to cover the ultimate net cost of investigating and settling claims. Such estimates are based upon estimates for reported losses, NAICC's historical experience of losses reported by reinsured companies for insurance assumed, and actuarial estimates based upon historical NAICC and industry experience for development of reported and unreported (incurred but not reported) claims. Any changes in estimates of ultimate liability are reflected in current operating results. Inflation is assumed, along with other factors, in estimating future claim costs and related liabilities. NAICC does not discount any of its loss reserves.\nThe ultimate cost of claims is difficult to predict for several reasons. Claims may not be reported until many years after they are incurred. Changes in the rate of inflation and the legal environment have created forecasting complications. Court decisions in the time between the dates on which a claim is reported and its resolution may dramatically increase liability. Punitive damages awards have grown in frequency and magnitude. The courts have imposed increasing obligations on insurance companies to defend policyholders. As a result, the frequency and severity of claims have grown rapidly and unpredictably.\nNAICC has claims relating to environmental cleanup against policies issued prior to 1980 which are currently in run-off. The principal exposure arises from excess and primary policies of business in run-off, the obligations of which were assumed by NAICC. These excess and primary claims are relatively few in number and have policy limits of between $50,000 and $1,000,000, with reinsurance generally above $500,000. NAICC also has environmental claims primarily associated with participation in excess of loss reinsurance contracts assumed by NAICC. These reinsurance contracts have relatively low limits, generally less than $25,000, and estimates of unpaid losses are based on information provided by the primary insurance company.\nThe unpaid losses and LAE related to environmental cleanup are established based upon facts currently known and the current state of the law and coverage litigation. Liabilities are estimated for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific contract of insurance or reinsurance and management can reasonably estimate its liability. Liabilities for unknown claims and development of reported claims are included in NAICC's bulk unpaid losses. The liability for unknown or unreported claims is not estimated to be material based on historical reporting experience. The liability for the development of reported claims is based on estimates of the range of potential losses for reported claims in the aggregate as well as currently established case estimates and industry development factors for reported claims. Estimates of liabilities are reviewed and updated continually and exposure exists in excess of amounts which are currently recorded which could be material. However, management does not expect that liabilities associated with these types of claims will result in a material adverse effect on future liquidity or financial position. Liabilities such as these are based upon estimates and there can be no assurance that the ultimate liability will not exceed such estimates. Additionally, significant uncertainty exists about the outcome of coverage litigation which can impact current estimates. As of December 31, 1995, NAICC's net unpaid losses and LAE relating to environmental claims were $4.1 million.\nDue to these factors, among others, the process used in estimating unpaid losses and LAE cannot provide an exact result. Management of NAICC believes that the provisions for unpaid losses and LAE are adequate to cover the net cost of losses and loss expenses incurred to date; however, such liability necessarily is based on estimates and there can be no assurance that the ultimate liability will not exceed such estimates.\n(continued on following page)\nAnalysis of Losses and Loss Adjustment Expenses\nThe following table provides a reconciliation of NAICC's net unpaid losses and LAE (dollars in thousands):\nThe losses and LAE incurred in 1995 relating to prior years are primarily attributable to claims from business which is in run-off. Two claims from business in run-off comprise substantially all of the losses and LAE incurred related to prior years: one being a claim for asbestosis exposure, which was settled in 1995 in the form of a policy buy back; the other, a construction defect claim in which a court decision was contrary to previously established case law.\nThe following table indicates the manner in which unpaid losses and LAE at the end of a particular year change as time passes. The first line reflects the liability as originally reported, net of reinsurance, at the end of the stated year. Each calendar year-end liability includes the estimated liability for that accident year and all prior accident years relating to that liability. The second section shows the original recorded net liability as of the end of successive years adjusted to reflect facts and circumstances which are later discovered. The next line, cumulative (deficiency) or redundancy, compares the adjusted net liability amount to the net liability amount as originally established and reflects whether the net liability as originally recorded was adequate to cover the estimated cost of claims. The third section reflects the cumulative amounts related to that liability which were paid, net of reinsurance, as of the end of successive years.\nAnalysis of Net Losses and Loss Adjustment Expense (\"LAE\") Development (dollars in thousands):\nThe table above ordinarily would present a ten year development of unpaid losses and LAE, however, the loss and LAE data of NAICC relating to periods prior to 1988 are not comparable to such data for periods subsequent to 1988. In 1988, NAICC assumed the unpaid policyholder liabilities of MAIC for accident years 1985, 1986 and 1987. The data subsequent to 1987 necessary to update the unpaid losses and LAE of NAICC as of December 31, 1987 and earlier includes loss and LAE data relating to MAIC which is not reflected in the December 31, 1987 unpaid losses and LAE of NAICC, and such data cannot be segregated because of the assumption of those 1985, 1986 and 1987 accident year liabilities in 1988. The 1988 assumption of the policyholder liabilities of MAIC was the last of a series of significant events and transactions which resulted in, among other things, the acquisition by DHC of a majority ownership interest in NAICC, a change in the management of NAICC, and a material change in the business and operations of NAICC. As a result of these material changes affecting NAICC, the table above, reflecting information commencing in 1988, provides the most meaningful and relevant historical analysis possible of unpaid losses and LAE of NAICC. Although NAICC continues to receive claims related to 1988 and earlier, the liability recorded represents the best estimate by NAICC's management of the liability for currently foreseeable claims.\nThe net cumulative deficiency as of December 31, 1995 of $10.2 million, $18.2 million and $12.9 million for 1990, 1991 and 1992 unpaid losses and LAE, respectively, is primarily attributable to adverse development subsequent to 1991 of the workers' compensation loss experience in the 1990 and 1991 loss years. The California workers' compensation industry, including NAICC, experienced adverse development of those loss years, primarily in Southern California, largely as a result of a significant increase in the number of workers' compensation post-termination stress claims primarily due to a downturn in the California economy and an increase in unemployment. Workers' compensation reform legislation passed in July 1993, which effectively reduced the number of successful post-termination stress claims, as well as a decrease in unemployment in California and highly-publicized anti-fraud activity, have contributed to significantly more favorable loss experience in the 1992, 1993 and 1994 loss years. In 1995, favorable development of approximately $4.9 million in the 1992 and 1993 loss years for workers' compensation was offset by $2.6 million of adverse development of other ongoing business lines and loss years as well as $5.4 million of adverse development of the businesses in run- off. As stated above, the losses and LAE reflected in the tables above are reduced both for amounts ceded to other insurers and other recoveries.\nConditions and trends that have affected the development of these liabilities in the past may not necessarily recur or have similar effects in the future. It would not be appropriate to use this cumulative history in the projection of future performance.\nCeded Reinsurance and Reinsurance with Affiliates\nIn its normal course of business in accordance with industry practice, NAICC reinsures a portion of its exposure with other insurance companies to limit effectively its maximum loss arising out of any one occurrence. Contracts of reinsurance do not legally discharge the original insurer from its primary liability. In accordance with generally accepted accounting principles, estimated reinsurance receivables arising from these contracts of reinsurance are reported separately as assets. NAICC retains the first $400,000 of each workers' compensation loss and has purchased reinsurance for up to $99.6 million in excess of its retention, of which the first $9.6 million is placed with two major reinsurance companies and the remaining $90 million is provided by 18 other companies. NAICC cedes 50 percent of its non-standard private passenger automobile direct written premium, direct losses and LAE to a major reinsurance company under a quota share reinsurance agreement. Premiums for reinsurance ceded by NAICC in 1995 were 22 percent of written premiums for the period.\nAs of December 31, 1995, General Reinsurance Corporation (\"GRC\") and Munich American Reinsurance Company (\"MARC\") were the only reinsurers that comprised more than ten percent of NAICC's reinsurance recoverables on paid and unpaid claims. NAICC monitors all reinsurers by reviewing A.M. Best and Company (\"A.M. Best\") reports and rating information from reinsurance intermediaries and analyzing financial statements. At December 31, 1995, NAICC had reinsurance recoverables on paid and unpaid claims of $10 million from GRC and $9.8 million from MARC. Both GRC and MARC had an A.M. Best rating of \"A++.\" See Note 3 of the Notes to Consolidated Financial Statements for further information on reinsurance.\nNAICC and its subsidiaries participate in an intercompany pooling and reinsurance agreement under which DIC and DNIC cede 100 percent of their net liability, defined to include premiums, losses and allocated LAE, to NAICC to be combined with the net liability for policies of NAICC in formation of a \"pool.\" NAICC simultaneously cedes to DIC and DNIC ten percent of the net liability of the pool. DNIC and DIC commenced participation in the pool in July 1993 and January 1994, respectively. DIC and DNIC further reimburse NAICC for executive and professional services and administrative expenses based on designated percentages of net premiums written for each line of business. This intercompany pooling and reinsurance agreement has been approved by the California Department of Insurance (the \"Insurance Department\").\nRegulation\nInsurance companies are subject to insurance laws and regulations established by the states in which they transact business. The agencies established pursuant to these state laws have broad administrative and supervisory powers relating to the granting and revocation of licenses to transact insurance business, regulation of trade practices, establishment of guaranty associations, licensing of agents, approval of policy forms, premium rate filing requirements, reserve requirements, the form and content of required regulatory financial statements, periodic examinations of insurers' records, capital and surplus requirements and the maximum concentrations of certain classes of investments. Most states also have enacted legislation regulating insurance holding company systems, including with respect to acquisitions, extraordinary dividends, affiliate transactions and other related matters. DHC and its insurance subsidiaries have registered as a holding company system pursuant to such legislation in California and routinely report to other jurisdictions. The National Association of Insurance Commissioners (the \"Association\") has formed committees and appointed advisory groups to study and continue to formulate regulatory promulgations on such diverse issues as the use of surplus debentures, accounting for reinsurance transactions and the adoption of risk based capital (\"RBC\") requirements. It is not possible to predict the impact of future state and federal regulation on the operations of DHC or its insurance subsidiaries.\nNAICC is an insurance company domiciled in the State of California and is regulated by the Insurance Department for the benefit of policyholders. The Insurance Department is currently conducting a routine examination of the statutory basis financial statements of NAICC, DNIC and DIC as of December 31, 1995 and has disclosed no findings to date. The California Insurance Code prohibits the payment, from other than accumulated earned surplus, of shareholder dividends which exceed the greater of net income or ten percent of statutory surplus, without prior approval of the Insurance Department. As a result of NAICC's negative unassigned surplus, NAICC is not permitted to pay dividends in 1996 without prior regulatory approval.\nCapital Adequacy and Risk Based Capital\nSeveral measures of capital adequacy are common in the property-casualty industry. The two most often used are (a) premiums-to-surplus (which measures pressure on capital from inadequate pricing), and (b) reserves-to-surplus (which measures pressure on capital from inadequate loss and LAE reserves). A commonly accepted maximum premiums-to-surplus ratio is 3 to 1; commonly accepted maximum reserves-to-surplus ratio is 5 to 1.\nThe following table sets forth the consolidated premiums-to-surplus and reserves-to-surplus ratios of NAICC (on a statutory basis):\nGiven the foregoing relatively conservative financial security ratios, NAICC's management believes that existing capital is adequate to support above average premium growth from its current premium levels for the foreseeable future.\nIn December 1993, the Association adopted a model for determining the RBC requirements for property and casualty insurance companies. Under the RBC model, property and casualty insurance companies are required to report their RBC ratios based on their statutory annual statements as filed with the regulatory authorities. NAICC has calculated its RBC requirement under the Association's model, and has capital in excess of any regulatory action or reporting level.\nTRUST BUSINESS\nDanielson Trust Company (\"Danielson Trust\") is chartered by the California State Banking Department to provide trust and fiduciary services. Danielson Trust is located in San Diego, California. Prior to January 31, 1996, Danielson Trust also maintained a branch office in Santa Barbara, California. In March 1993 (the \"Acquisition Date\"), DHC acquired all of the common stock of Danielson Trust, which was known as HomeFed Trust until November 13, 1993. In February 1994, Danielson Trust acquired the assets of the Western Trust Services (\"WTS\") division of Grossmont Bank. On January 31, 1996, following approval of the California State Banking Department, Danielson Trust sold substantially all of the fiduciary accounts administered by its Santa Barbara branch to The Bank of Montecito. In connection with the sale, in January 1996, Danielson Trust recognized a gain of $32,874.\nThe accounts and operations of Danielson Trust subsequent to and as of the Acquisition Date are reflected in the Company's Consolidated Financial Statements; however, comparisons of the financial results of Danielson Trust's operations for the years ended December 31, 1995 and 1994 with the results of its operations during the partial 1993 period have been omitted as they do not relate to equivalent periods (nor, in some instances, to equivalent operations) and would not provide meaningful information relating to historical trends and financial results. The results of Danielson Trust's operations during the years ended 1995 and 1994 are not entirely comparable in that they relate, in part, to different assets, accounts and lines of business. See \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, 3. RESULTS OF DANIELSON TRUST COMPANY'S OPERATIONS.\"\nDanielson Trust's business consists of providing trust and investment services to individuals, not-for-profit corporations and retirement service clients, including its affiliates. In addition, since 1994 Danielson Trust has provided custodial services for certificates of deposit to affiliated and unaffiliated broker-dealers, as well as other custodial services to an affiliated mutual fund. See \"Custody Services.\" In connection with Danielson Trust's efforts to expand its sources of business within its primary market areas, Danielson Trust has developed enhanced product lines for its private trust and retirement services lines of business. See \"New Business and Capital Resources.\"\nIn January 1995, Danielson Trust announced the appointment of A. Vincent Siciliano as its President and Chief Executive Officer. The appointment became effective on February 6, 1995.\nDanielson Trust's lines of business are described below.\nPrivate Trust\nThe private trust unit of Danielson Trust primarily provides trust, custody and investment management services for individuals and not-for-profit corporations. In the performance of its private trust business, this unit may serve in the capacities of executor, trustee, investment agent, conservator or custodian. Danielson Trust has increased its marketing support of the private trust business, including the development of an enhanced product line. Danielson Trust plans to offer investment management services provided by regionally and nationally known investment managers. The company also intends to introduce customized trust, investment and financial planning, utilizing a variety of individualized asset allocation models designed to achieve clients' particular investment objectives. The company also intends to simplify and clarify the performance measurement process in portfolio management reporting. Danielson Trust anticipates that it will introduce such new services, together with an expansion of its client calling program and increased efforts to involve local professionals in the referral process, by the first quarter of 1996. Danielson Trust's private trust unit generated fee income of $1.3 million and $1.7 million for the years ended December 31, 1995 and 1994, respectively.\nRetirement Services\nDanielson Trust's retirement services unit (formerly known as employee benefit trust) provides trustee, custodial, and investment management services to corporations, typically for qualified employee benefit plans, often in the form of defined benefit plans, 401(k) plans, or profit sharing plans. Additionally, this unit provides cash management services to corporations desiring short term investments in excess of $1 million. Danielson Trust is strengthening its commitment to the retirement services business with the development of an enhanced product line for this market which it anticipates introducing late in the second quarter of 1996. Danielson Trust has designed a bundled retirement services product offering prospective retirement services clients a variety of investment management, administrative and consulting services for employee benefit plans of every size, including third party recordkeeping and an employee education component. Danielson Trust believes that such diversity of investment advisory, fiduciary and consulting services for employee benefit plans also will enhance the company's ability to satisfy customized client service requirements. For the years ended December 31, 1995 and 1994, the retirement services unit of Danielson Trust generated fee income of approximately $2.6 million and $2.3 million, respectively (excluding retirement services custodial revenues). See \"Business Related to Former Parent.\"\nCustody Services\nIn addition to custodial services associated with the private and retirement services businesses, since 1994 Danielson Trust has provided certificate of deposit (CD) custodial services to broker-dealers and other financial institutions. Danielson Trust also provides custody services for an affiliated mutual fund. Total fee income for all custody services provided by Danielson Trust for the years ended December 31, 1995 and 1994 were $537,000 and $427,000, respectively, which constituted 11.7 percent and 8.9 percent, respectively, of Danielson Trust's total revenue for the comparable periods. Of that amount, fee income for CD custody services for the years ended December 31, 1995 and 1994 was $401,000 and $339,000, respectively. Approximately one percent of Danielson Trust's total revenues in 1995 and 1994 was generated by each of mutual fund-related custody services and other retirement custody services. Fee income for custody services are not reflected in the private trust or retirement services revenue amounts referred to above.\nBusiness Related to Former Parent\nDuring the first quarter of 1994, as previously anticipated, Danielson Trust ceased providing various trust services to HomeFed Bank (Danielson Trust's former parent prior to DHC's acquisition of Danielson Trust) following the sale of HomeFed Bank's branch offices by the Resolution Trust Corporation. All of the revenues associated with such services ceased by the end of the second quarter of 1994. For the year ended December 31, 1994, the run-off of HomeFed Bank-related business of Danielson Trust generated non-recurring total fee income of $310,000, or less than seven percent of Danielson Trust's 1994 revenues.\nNew Business and Capital Resources\nHistorically, Danielson Trust has generated new business from direct marketing efforts of Danielson Trust's officers, referrals from independent professionals, and referrals from and captive business of its former parent company, HomeFed Bank. As noted above, the HomeFed Bank-related appointments ceased entirely during 1994. Virtually all of Danielson Trust's new business during 1995 and 1994 (apart from business associated with the acquisition of WTS) resulted from client and professional referrals, as well as from Danielson Trust's marketing efforts.\nDanielson Trust has increased its marketing efforts to expand Danielson Trust's private trust and retirement services business within its primary market areas with the development of enhanced product lines which it anticipates will be introduced by the second quarter of 1996. See \"Private Trust\" and \"Retirement Services\" above. Danielson Trust also is in the process of implementing various marketing initiatives which commenced in 1994, including systematic calling programs to identified business sectors within the San Diego area, a bi-monthly local radio program and a business expansion initiative involving medical groups. During 1995, Danielson Trust was appointed to serve as the designated trustee for PaineWebber in its west coast region. In connection with this appointment, Danielson Trust will provide trust services to PaineWebber investment executives and their clients throughout California, as well as Arizona, Colorado, Montana, Nevada, Oregon, Utah, Washington and Wyoming. Danielson Trust intends to seek out additional such established distribution channels for its services. Management of Danielson Trust is hopeful that its increased business development efforts will result in continued enhancement of Danielson Trust's reputation as a quality provider of trust and investment services with a strong commitment to the San Diego community.\nIn connection with the sale of its Santa Barbara branch, Danielson Trust has entered into a servicing agreement with The Bank of Montecito pursuant to which Danielson Trust provides investment management and operational services with respect to the accounts that were sold. Management of Danielson Trust believes that the fee income it anticipates to be generated by such servicing agreement, together with fee income from retained Santa Barbara accounts, will partially replace the amount of fee income previously generated by the former branch office. The former Santa Barbara branch generated fee income of approximately $200,000 for each of the years ended December 31, 1995 and 1994, which is included in the private trust and retirement services fee income previously noted. Danielson Trust continues to maintain a trust services referral arrangement with San Diego National Bank, whereby each cooperates in order to offer each company's clients access to services that are not provided by the separate companies.\nThe market for Danielson Trust's business is highly competitive and competition is based primarily upon such factors as price and service. Several of Danielson Trust's competitors are affiliated with large financial institutions and, accordingly, enjoy the benefits of referrals from such institutions. Among the types of financial institutions with which Danielson Trust competes are banks, brokerage firms, insurance companies and mutual funds.\nLiquidity and Capital Resources\nDanielson Trust requires liquid assets to meet the working capital needs of its continuing business. The primary source of these liquid assets are fees charged to Danielson Trust's trust clients. In connection with the cessation of fee revenues derived from HomeFed Bank-related business during the first half of 1994, as well as the incurrence by Danielson Trust since 1994 of significant costs for communications, computer equipment upgrades and unanticipated systems conversion expenses associated with the acquisition of the assets of WTS (see Note 2 of the Notes to Consolidated Financial Statements), DHC made a $300,000 unsecured intercompany loan to Danielson Trust in 1994 in the form of a promissory demand note, with quarterly interest payments at the annual rate of 7.75 percent. At December 31, 1995, the entire principal amount of the promissory demand note was outstanding. Danielson Trust is servicing such interest payments from fee revenues generated by its operations. DHC intends to refrain from making demand for payment of principal until such time as Danielson\nTrust has sufficient capital to make such payment. As of January 1, 1996, DHC agreed to make an additional unsecured loan to Danielson Trust in the principal amount of $600,000, bearing interest at the rate of prime plus one percent, and to consider making additional such loans in the aggregate amount of $600,000 upon the request of Danielson Trust. As of the date hereof, Danielson Trust has not borrowed any amount under such loan agreement. To the extent that timing differences exist between the collection of revenue and the actual payment of expenses, or where revenues generated by Danielson Trust's business are insufficient to cover its expenses, or to maintain compliance with regulatory capital requirements, the primary sources of funds to meet those obligations would be the sale of short term investments, additional intercompany loans, parent company capital contributions or financing provided by a third party.\nIn accordance with California banking regulations, Danielson Trust has pledged assets with a fair value of $603,000 to the State as a reserve in connection with certain types of fiduciary appointments, which is the maximum amount of such reserves that may be required. State banking laws also regulate the nature of trust companies' investments of contributed capital and surplus, and generally restrict such investments to debt type investments in which banks also are permitted to invest. In order to satisfy such regulations, a majority of Danielson Trust's investments are in U.S. Government obligations and, as of December 31, 1995, Danielson Trust was in compliance with the foregoing requirements.\nHOLDING COMPANY BUSINESS\nDHC is a holding company incorporated under the General Corporation Law of the State of Delaware. As of December 31, 1995, DHC had the following material assets and no material liabilities:\n(i) ownership of its MAIC subsidiary, an insurance holding company that owns, directly or indirectly, all of the stock of NAICC, DNIC, DIC, and two licensed insurance subsidiaries which are expected to commence writing insurance lines in the future;\n(ii) ownership of 100 percent of the stock of Danielson Trust; and\n(iii) approximately $11 million in cash and investments.\nOn December 21, 1994, DHC received a partial distribution in the amount of $750,000 from an unaffiliated trust that owns certain assets and liabilities of a former subsidiary of DHC. The partial distribution is recorded as an extraordinary item in the Company's 1994 Consolidated Statements of Operations. The Company has been advised that the trust is anticipated to be terminated in the near future. DHC does not anticipate that any amount it may receive upon termination of the trust will be material.\nOn December 30, 1993, following approval of the California Superior Court, MAIC received a distribution of approximately $268,000 upon termination of an unaffiliated trust formerly administered by the California Insurance Commissioner as trustee. Such trust had assumed the liabilities and substantially all of the assets of MAIC and a former subsidiary of DHC. Under the terms of the trust agreement, the trust was required to distribute to MAIC all amounts which remained in the trust after satisfying or otherwise resolving all claims against MAIC and such former subsidiary. The distribution was recorded as an extraordinary item in the Company's 1993 Consolidated Statements of Operations. MAIC distributed such funds to DHC following approval of the California Insurance Department (the \"Insurance Department\"). The termination of the trust had the effect of finalizing a Superior Court-approved interim distribution by such former trust to MAIC in 1992 of approximately $6.2 million, the proceeds of which also were distributed to DHC upon approval of the Insurance Department, as well as releasing all indemnities and pledges running from MAIC to the trust, including a pledge of 3,526,140 shares of KCP common stock owned by MAIC.\nAlso during 1993, MAIC received proceeds of $220,000 from the liquidation of the estate of a former Texas subsidiary of DHC. The distribution was accounted for as an extraordinary item in the Company's 1993 Consolidated Statements of Operations.\nTax Loss Carryforward\nAs of December 31, 1995, the Company had a consolidated net operating loss carryforward of approximately $1.4 billion for Federal income tax purposes. This number is based upon actual Federal consolidated income tax filings for the periods through December 31, 1994 and an estimate of the 1995 taxable loss. Some or all of the carryforward may be available to it to offset, for Federal income tax purposes, the future taxable income, if any, of DHC and its wholly- owned subsidiaries. The Internal Revenue Service (\"IRS\") may attempt to challenge the amount of this net operating loss in the event of a future tax audit. Management believes, based in part upon the views of its tax advisors, that its net operating loss calculations are reasonable and that it is reasonable to conclude that the Company's net operating losses of in excess of $1 billion would be available for use by the Company. These tax loss attributes are currently fully reserved, for valuation purposes, on the Company's financial statements. The amount of the deferred asset considered realizable could be increased in the near term if estimates of future taxable income during the carryforward period are increased.\nThe Company's net operating tax loss carryforwards will expire, if not used, in the following approximate amounts in the following years (dollars in thousands):\nThe Company's ability to utilize its net operating tax loss carryforwards would be substantially reduced if DHC were to undergo an \"ownership change\" within the meaning of Section 382(g)(1) of the Internal Revenue Code. In an effort to reduce the risk of an ownership change, DHC has imposed restrictions on the ability of holders of five percent or more of common stock of DHC, par value $0.10 per share (\"Common Stock\") to transfer the Common Stock owned by them and to acquire additional Common Stock, as well as the ability of others to become five percent stockholders as a result of transfers of Common Stock. Notwithstanding such transfer restrictions, there could be circumstances under which an issuance by DHC of a significant number of new shares of Common Stock or other new class of equity security having certain characteristics (for example, the right to vote or to convert into Common Stock) might result in an ownership change under the Internal Revenue Code. See Note 7 of the Notes to the Consolidated Financial Statements for a description of certain restrictions on the transfer of Common Stock.\nDHC's Business Plan and Development\nDHC's business plan is to grow by making strategic acquisitions that are expected to contribute higher than average returns for our stockholders. On February 26, 1996, DHC entered into a merger agreement pursuant to which DHC will acquire all of the outstanding stock of Midland Financial Group, Inc. (\"Midland\") in a merger transaction. The purchase price will be 1.6 times the 1995 year-end book value of Midland. As part of the transaction, DHC will make a $30 million capital contribution to Midland at the closing.\nThe consideration to be received by the Midland shareholders will be paid 50 percent in cash, 40 percent in DHC non-convertible preferred stock having a market dividend rate, and ten percent in Common Stock to be valued based upon a trading average prior to the closing date. DHC expects to finance the cash portion of the purchase price and the $30 million capital contribution with the net proceeds of an underwritten public offering of Common Stock to raise approximately $80 million, which is expected to close concurrently with the acquisition. The DHC public offering will be made as soon as possible and currently is anticipated to occur during the second quarter of 1996.\nMidland is engaged primarily in non-standard automobile insurance and related activities in 16 states located primarily in the southern and western United States. DHC anticipates that operating management of Midland will remain with the business following the merger.\nManagement of DHC believes that both Midland and DHC will benefit from operating synergies and efficiencies between the two companies' businesses and operations. DHC anticipates that the transaction will have many positive effects for the acquired company, including particularly providing support for Midland's Best's ratings at the time of closing. In addition, DHC believes that the availability of DHC's $1.4 billion net operating tax loss carryforward will enable Midland to enhance its results through a shift in its investment portfolio to higher yielding instruments, as well as by offsetting Midland's pre-tax operating income. Management of DHC currently contemplates that DHC will recognize the book value of a portion of its approximately $1.4 billion net operating tax loss carryforward in conjunction with the merger.\nThe closing of the transaction is subject to various conditions, including approvals by the stockholders of both companies, the receipt of regulatory approvals, and financing. No assurance can be given that the conditions to the transaction can be satisfied or that the transaction will be completed.\nAs previously described, in March 1993, DHC completed the acquisition of the common stock of Danielson Trust from a subsidiary of the Resolution Trust Corporation. In February 1994, DHC's trust subsidiary, Danielson Trust, completed the acquisition of the assets of the Western Trust Services (\"WTS\") division of Grossmont Bank. See Note 2 of the Notes to Consolidated Financial Statements.\nEMPLOYEES\nAs of December 31, 1995, the number of employees of DHC and its consolidated subsidiaries was approximately as follows:\nNone of these employees is covered by any collective bargaining agreement. DHC believes that the staffing levels are adequate to conduct future operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nDHC leases a minimal amount of space for use as administrative and executive offices. DHC's lease has a term of approximately five years which is scheduled to expire in 1998. DHC believes that the space available to it is adequate for DHC's current and foreseeable needs.\nNAICC's headquarters are located in a leased office facility in Rancho Dominguez, California, pursuant to a long term lease which is scheduled to expire in 1999. In addition, NAICC has entered into short term leases in connection with its operations in various locations on the west coast of the United States. NAICC believes that the foregoing leased facilities are adequate for NAICC's current and anticipated future needs.\nDanielson Trust's headquarters are located in a leased office facility in San Diego, California. This lease has a term of approximately ten years which is scheduled to expire in 2004, with options to extend. Prior to January 31, 1996, Danielson Trust maintained a branch office in Santa Barbara, California. On January 31, 1996, following approval of the California State Banking Department, Danielson Trust sold its Santa Barbara branch to The Bank of Montecito which assumed the lease of that branch office. In addition, in connection with the acquisition of the WTS assets and during the process of integrating such assets into Danielson Trust's operations, from February 22, 1994 through July 31, 1994, Danielson Trust also occupied office space that was previously occupied by WTS, pursuant to a short term sublease with Grossmont Bank. Danielson Trust believes that its existing leased premises are adequate for Danielson Trust's current and foreseeable needs. See Note 11 of the Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNAICC and Danielson Trust are parties to various legal proceedings which are considered routine and incidental to their respective insurance and trust businesses and are not material to the financial condition and operation of such respective businesses. For information regarding the resolution of NAICC's claim to recover a reinsurance receivable, see Note 3 of the Notes to Consolidated Financial Statements. DHC is not a party to any legal proceeding which is considered material to the financial condition and operation of its business. See Note 12 of the Notes to Consolidated Financial Statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n\"Stock Market Prices\" on page 98 of DHC's 1995 Annual Report to Stockholders (included as an exhibit hereto) is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n\"Selected Consolidated Financial Data\" on page 60 of DHC's 1995 Annual Report to Stockholders (included as an exhibit hereto) 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 61 through 72 of DHC's 1995 Annual Report to Stockholders (included as an exhibit hereto) is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Consolidated Financial Statements of DHC and its subsidiaries, together with the Notes thereto, and \"Quarterly Financial Data,\" included on pages 73 through 76, 77 through 96, and 98, respectively, of DHC's 1995 Annual Report to Stockholders (included as an exhibit hereto), 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.\nDIRECTORS.\nThe Directors of DHC are listed on the following pages with brief statements of their principal occupation and other information. A listing of the Directors' and officers' beneficial ownership of Common Stock appears on subsequent pages under the heading \"Item 12. \"Security Ownership of Certain Beneficial Owners and Management.\" All of the Directors were elected to their present terms of office by the stockholders at the Annual Meeting of Stockholders of DHC held on April 25, 1995. The term of office of each Director continues until the election of Directors to be held at the next Annual Meeting of Stockholders or until his successor has been elected. There is no family relationship between any Director and any other Director or executive officer of DHC. The information set forth below concerning the Directors has been furnished by such Directors to DHC.\nMr. Whitman, Chairman of the Board, Chief Investment Officer and a Director of DHC, is a Managing Director of Whitman Heffernan Rhein & Co., Inc. (\"WHR\"), an investment and financial advisory firm which he founded with Messrs. Heffernan and Rhein during the first quarter of 1987. Since 1974, Mr. Whitman has been the President and controlling stockholder of M.J. Whitman & Co., Inc. (now known as Martin J. Whitman & Co., Inc.) (\"MJW&Co\") which, until August 1991, was a registered broker-dealer. From August 1994 to December 1994, Mr. Whitman served as the Managing Director of M.J. Whitman, L.P. (\"MJWLP\"), then a registered broker-dealer which succeeded to the broker-dealer business of MJW&Co. Since January 1995, Mr. Whitman has served as the Chairman and Chief Executive Officer (and, until June 1995, as President) of M.J. Whitman, Inc. (\"MJW\"), which succeeded at that time to MJWLP's broker-dealer business. Also since January 1995, Mr. Whitman has served as the Chairman and Chief Executive Officer of M.J.Whitman Holding Corp. (\"MJWHC\"), the parent of MJW and other affiliates. Since March 1990, Mr. Whitman has been the Chairman of the Board, Chief Executive Officer and a Director (and, since January 1991, the President) of Third Avenue Value Fund, Inc. (\"TAVF\"), an investment company registered under the Investment Company Act of 1940. Until April 1994, Mr. Whitman also served as the Chairman of the Board, Chief Executive Officer and a Director of Equity Strategies Fund, Inc., previously a registered investment company. Since March 1991, Mr. Whitman has served as a Director of Nabors Industries, Inc., a publicly-traded company. Mr. Whitman also serves as a Director of DHC's subsidiaries, including National American Insurance Company of California (\"NAICC\"), KCP Holding Company (\"KCP\") and Danielson Trust Company (\"Danielson Trust\"). Mr. Whitman co-authored the book The Aggressive Conservative Investor. ------------------------------------ Mr. Whitman is a Distinguished Faculty Fellow in Finance at the Yale University School of Management. Mr. Whitman graduated from Syracuse University magna cum laude in 1949 with a Bachelor of Science degree and received his Masters degree in Economics from the New School for Social Research in 1956. Mr. Whitman is a Chartered Financial Analyst.\nMr. Rhein is President, Chief Executive Officer and a Director of DHC. He also is a Managing Director of WHR and was, prior to April 1987, a partner in the law firm of Anderson Kill Olick & Oshinsky, P.C. Mr. Rhein specialized in corporate transactions and securities law during his law practice. Since March 1991, Mr. Rhein has served as a Director and, since May 1991, as Vice Chairman of Reading & Bates Corporation, a publicly-traded company listed on the New York Stock Exchange. Mr. Rhein also serves as a Director of DHC's subsidiaries, including NAICC, KCP and Danielson Trust. Mr. Rhein graduated from the College of Wooster with a Bachelor of Arts degree. In 1976, Mr. Rhein received his Juris Doctor degree from Columbia University School of Law.\nMr. Heffernan is Chief Financial Officer and a Director of DHC. From 1990 through March 1996, Mr. Heffernan served as Chief Investment Officer of DHC. He also is a Managing Director of WHR. Prior to April 1987, he was a partner of Anderson Kill Olick & Oshinsky, P.C. During his law practice, Mr. Heffernan concentrated in the area of bankruptcy law and reorganizations. Since May 1993, Mr. Heffernan has served as a Director of The Columbia Gas System, Inc., a publicly-traded company listed on the New York Stock Exchange. Beginning in February 1995, Mr. Heffernan has served as Chairman of the Board of Herman's Sporting Goods, Inc., a retail sporting goods chain. Mr. Heffernan also serves as a Director of DHC's subsidiaries, including NAICC, KCP and Danielson Trust. Mr. Heffernan graduated with a Bachelor of Arts degree from LeMoyne College in 1967 and received his Juris Doctor degree from Fordham University Law School in 1970.\nMr. Isenberg, since 1987, has been Chairman and Chief Executive Officer of Nabors Industries, Inc., a publicly-traded oil and gas drilling company listed on the American Stock Exchange. Mr. Isenberg is a member of the Board of Directors of Continental Mortgage Investors (an equipment leasing and photo finishing business) and a Managing Partner of EMI Capital Associates, Ltd. (a manager of private investments and assets). Mr. Isenberg graduated from the University of Massachusetts magna cum laude in 1950 with a Bachelor of Arts degree in Economics and from Princeton University in 1952 with a Masters degree in Economics.\nMr. Porrino has been Executive Vice President of the New School for Social Research since September 1991. Prior to that time, Mr. Porrino was a partner in the New York law firm of Putney, Twombly, Hall & Hirson, concentrating his practice in the area of labor law. Mr. Porrino received a Bachelor of Arts degree from Bowdoin College in 1966, and was awarded a Juris Doctor degree from Fordham University School of Law in 1970.\nDr. Ryan, since August 1990, has been a Professor of Mathematics and Computational and Applied Mathematics at Rice University. Since March 1996, Dr. Ryan has served as a Director of Sequoia Systems, Inc., a computer systems company, the capital stock of which is traded on National Association of Securities Dealers Automated Quotation. Since March 1995, Dr. Ryan has served as a Director of America West Airlines, Inc., a publicly-traded company listed on the New York Stock Exchange. From August 1990 to February 1995, Dr. Ryan also served as Vice President-External Affairs at Rice University. For two years ending August 1990, Dr. Ryan was the President and Chief Executive Officer of Contex Electronics Inc., a subsidiary of Buffton Corporation, the capital stock of which is publicly traded on the American Stock Exchange. Prior to that, and beginning in 1977, Dr. Ryan was a Lecturer in Mathematics at Yale University, where he was also the Associate Vice President in charge of institutional planning. Dr. Ryan obtained a Bachelor of Arts degree in Physics in 1958 from Rice University, a Masters degree in Mathematics from Rice in 1961, and a Doctorate in Mathematics from Rice in 1965.\nMr. Story, since September 1991, has been President and Chief Executive Officer of NAICC and KCP. Prior to that time, Mr. Story was President and Chief Operating Officer of NAICC, with which he has been employed since 1987. Before that time, Mr. Story held underwriting and executive positions with Mission American Insurance Company, Prudential Reinsurance Company, and The Hartford. Mr. Story also serves as a Director of KCP, NAICC and Danielson Trust. Mr. Story received a Bachelor of Arts degree in Business from the University of Northern Iowa in 1968 and holds the designations of Chartered Property and Casualty Underwriter, and Associate in Risk Management (IIA).\nMr. Sellers is a Director of Enhance Financial Group, Inc. (\"Enhance Group\"), a financial services corporation the capital stock of which is publicly traded on the New York Stock Exchange. Until December 31, 1994, Mr. Sellers was the President and Chief Executive Officer of Enhance Group, from its inception in 1986, as well as its principal subsidiaries, Enhance Reinsurance Company and Asset Guaranty Insurance Company, from their inceptions in 1986 and 1988, respectively. From 1987 to 1994, Mr. Sellers served as a Director, and from 1992 to 1993 as the Chairman, of the Association of Financial Guaranty Insurors in New York. From 1990 through 1994, Mr. Sellers served on the Board of Directors of EIC Corporation Ltd. and Exporters Insurance Company Ltd., both of Bermuda. Mr. Sellers was a Director and, in 1990, Chairman, of the Foreign Credit Insurance Association from 1990 through 1994. From 1990 through 1994, Mr. Sellers was a Director of Van-American Insurance Company in Lexington, Kentucky. From 1982 through 1991, Mr. Sellers was a member of the Board of Directors of Financial News Network in Santa Monica, California. From 1985 through 1990, Mr. Sellers was a Director of Intex Holdings (Bermuda) Limited. Mr. Sellers served on the Board of Directors of The Learning Channel in Washington, DC. Mr. Sellers received a Bachelor of Arts degree in Economics, Anthropology and Archaeology form the University of New Mexico in 1951 and a Masters degree in Economics from New York University (\"NYU\") in 1956. Mr. Sellers also is a Doctoral candidate at the NYU Graduate School of Business Administration. Mr. Sellers attended the Advanced Management Program at Harvard University in 1975. Mr. Sellers is a Chartered Financial Analyst.\nEXECUTIVE OFFICERS.\nThe executive officers of DHC are as follows:\nFor additional information about Messrs. Whitman, Heffernan and Rhein, see \"Directors\" above.\nMs. Levey has been the General Counsel and Secretary of DHC since January 1991. Ms. Levey also has served as General Counsel and Secretary of Danielson Trust since March 1993, of NAICC since 1992, and of WHR since 1991. Prior to January 1991, Ms. Levey was a partner with the law firm of Anderson Kill Olick & Oshinsky, P.C. specializing in commercial transactions. Ms. Levey graduated magna cum laude with a Bachelor of Arts degree from the University of Pennsylvania in 1978 and received her Juris Doctor degree from New York University School of Law in 1981.\nMs. Cosenza has been Controller of DHC since April 1992. Prior to that time, Ms. Cosenza was a Senior Accountant with DHC. In addition, since June 1990, Ms. Cosenza has served as Controller of Martin J. Whitman & Co., Inc. (which formerly was known as MJW&Co.) and various affiliated entities. From June 1990 through 1993, Ms. Cosenza also served as Controller of MJWLP. Ms. Cosenza graduated from Adelphi University in 1985 with a Bachelor of Business Administration degree in Accounting. Ms. Cosenza is a Certified Public Accountant.\nCOMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\nSection 16(a) of the Securities Exchange Act of 1934 requires DHC's Directors and executive officers, and persons who own more than ten percent of a registered class of the DHC's equity securities, to file with the Securities and Exchange Commission and the American Stock Exchange initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of DHC. Officers, Directors and greater than ten percent stockholders are required by Federal securities regulations to furnish DHC with copies of all Section 16(a) forms they file.\nTo DHC's knowledge, based solely upon review of the copies of such reports furnished to DHC and written representations that no other reports were required, except for one Form 3 and one Form 4 with respect to Ms. Cosenza (involving one transaction) and one Form 3 with respect to Mr. Sellers (not involving any transaction), all Section 16(a) filing requirements applicable to DHC's officers, Directors and greater than ten percent beneficial owners were complied with for the fiscal year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSUMMARY COMPENSATION TABLE\nThe following Summary Compensation Table presents certain information relating to compensation paid by DHC for services rendered in 1995 by the Chief Executive Officer and the three other executive officers of DHC as of the last day of the fiscal year whose cash compensation for such year exceeded $100,000. Only those columns which call for information applicable to DHC or the individuals named for the periods indicated have been included in such table.\nFor information regarding compensation paid during 1995 by NAICC to Mr. Story, who is a member of the Board of Directors, see \"Item 13. Certain Relationships and Related Transactions\" below.\n- ---------- \/a\/ Amounts shown indicate cash compensation earned and received by executive officers in the year shown. Executive officers also participate in DHC group health insurance.\n\/b\/ Amounts shown indicate bonuses earned, if any, with respect to services to DHC in the fiscal year shown whether or not paid in such fiscal year.\n\/c\/ Amounts shown reflect portion of compensation allocated to DHC based upon percentage of time spent in connection with DHC matters.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table presents certain information relating to the value of unexercised stock options as of the end of 1995, on an aggregated basis, owned by the Chief Executive Officer and the three other executive officers of DHC as of the last day of the fiscal year whose cash compensation for such year exceeded $100,000. None of such officers who owned options to purchase Common Stock during 1995 exercised any of such options during 1995. Only those tabular columns which call for information applicable to DHC or the named individuals have been included in such table.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring 1995, none of the persons who served as members of the Compensation Committee of DHC's Board of Directors also was, during that year or previously, an officer or employee of DHC or any of its subsidiaries or had any other relationship requiring disclosure herein.\n- ---------- \/1\/ As previously disclosed, these options were granted March 13, 1991 under the 1990 Stock Option Plan and are currently exercisable at an exercise price of $3.00 per share (which equals the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the 30 days prior to the date of grant). The options expire ten years after the date of grant. Options to purchase 70,000 shares of Common Stock became exercisable on each of March 13, 1992, March 13, 1993 and March 13, 1994.\n\/2\/ The value of unexercised in-the-money options, whether or not exercisable, equals the difference between the fair market value of such options at fiscal year-end (i.e., the closing price of the Common Stock on the American Stock Exchange on December 31, 1995, namely, $6-3\/4) and the exercise price of such options (i.e., the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the 30 days prior to the date of grant, March 13, 1990, namely, $3.00).\nBOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Compensation Committee of the Board of Directors of DHC's (the \"Committee\"), during 1995, was comprised of three independent (i.e., non- employee) Directors. The Committee provided the following report on executive compensation during 1995 as required by applicable securities regulations:\n\"The Committee's goal continues to be to structure compensation in a way that will attract and retain highly qualified executives who will conduct the business of the Company in a manner that will maximize stockholder values. Toward that end, the Committee seeks to reward effective executive performance with reference to the Company's achievements, and each individual executive's contribution to those successes, each year.\nDHC does not require its officers to own any amount of Common Stock, nor does DHC maintain a stock retention policy for officers. However, it is the Committees's belief that the substantial voluntary stock ownership position of DHC's executive officers is an extremely strong indication of the alignment of its officers' interest with that of DHC's stockholders.\nFor the first time since the inception of the Company's operations in August 1990, the annual base salary of each of C. Kirk Rhein, Jr., the Chief Executive Officer of DHC, Martin J. Whitman, the Chairman of the Board and Chief Investment Officer of DHC, and James P. Heffernan, the Chief Financial Officer of DHC, was raised, from its prior level of $75,000 to $200,000. As the Committee has noted in prior Reports, the historic reason for setting and maintaining low cash compensation has been those executives' collective desire not to take significant cash out of the Company in the form of executive compensation at the very early stages of the Company's development. However, the Committee believed it was necessary to acknowledge in a tangible manner these executives' unstinting efforts on the Company's behalf over its first five years of operations and, therefore, the Committee increased those individuals' base salary.\nThe three executives' primary goal in 1995 was to identify a suitable acquisition candidate for the Company. To accomplish this objective, Messrs. Rhein, Whitman and Heffernan devoted a substantial portion of their time evaluating numerous potential strategic opportunities -- reviewing materials, following up introductions, meeting with candidates' management. At the time of this writing, their efforts appear to have been worthwhile, in light of the Company's public announcement of its February 26, 1996 agreement to acquire Midland Financial Group, Inc. in a merger transaction. The Committee is confident that DHC's executive management will direct all of their abilities towards consummation of the transaction, including a public offering of DHC's Common Stock to raise the cash portion of the purchase price, as well as the capital contribution to be made to Midland at closing. Notwithstanding their apparent success in achieving their 1995 corporate objective, Messrs. Rhein, Whitman and Heffernan felt it would be premature to accept any bonus or other compensation for 1995 beyond their base salary described above. The Committee notes that there are no employment contracts between DHC and any of its executive officers.\nThe Committee recommended an increase in the 1995 base salary of Lisa D. Levey, DHC's General Counsel and Secretary, from $150,000 to $175,000. This was the first change in Ms. Levey's base salary since she joined the Company in 1991. The base compensation of $158,675 paid to Ms. Levey in 1995 reflects the Company's allocated portion of her total base salary amount, based upon the percentage of Ms. Levey's time actually devoted to Company matters. In addition to base salary, pursuant to the Committee's recommendation, the Company paid a $100,000 cash bonus to Ms. Levey with respect to 1995. In arriving at the bonus amount, the Committee reviewed Ms. Levey's overall performance as well as her achievement of specific goals identified jointly by DHC's executive management and Ms. Levey early in 1995. As part of this evaluation, the Committee considered a variety of Ms. Levey's accomplishments in 1995, including the development of DHC's 1995 Stock and Incentive Plan (the \"1995 Plan\") adopted at the last annual meeting of stockholders, and her involvement in a variety of legal matters relating to Danielson Trust Company,\nincluding in connection with its integration of the Western Trust Services assets acquired in 1994, as well as with respect to the sale of its Santa Barbara branch to The Bank of Montecito, which closed in January 1996. Ms. Levey was one of the recipients of stock options granted by the Committee in January 1996 pursuant to the 1995 Plan, noted below.\nDuring 1995, the Committee did not make any stock-based compensation grants under DHC's 1995 Plan. However, in keeping with the Committee's view, shared by management of the Company, of the value of non-cash compensation both to motivate performance and reward the creation of long term stockholder value, on January 15, 1996, the Committee granted an aggregate of 158,900 options under the 1995 Plan to certain executives and employees of DHC's (other than Messrs. Rhein, Whitman and Heffernan) and its subsidiaries, NAICC and Danielson Trust. The exercise price of such options is $6.6875 (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). These awards will be described in detail in the 1996 Committee Report. The Committee also notes that, in accordance with the terms of the 1995 Plan, Wallace O. Sellers received an automatic grant of 40,000 options upon his election as a Director of DHC at the last annual meeting of stockholders on April 25, 1995.\nThe Committee does not rely upon quantitative measures or other measurable objective indicia, such as earnings or specifically weighted factors or compensation formulae, in reaching compensation determinations. Rather, since DHC at the parent-company level is simply a holding company operation having only a small group of executives responsible for numerous and diverse areas of the Company's business and management, and given the high level of awareness each executive has of the others' activities and contributions, the Committee evaluates executive performance and reaches compensation decisions based, in part, upon the recommendations of DHC's executives. The Committee also reviews quantitative and comparative compensation data and, in some instances, analyses provided by an independent consulting firm to assist it in reaching its compensation determinations.\nFinally, the Committee notes that Section 162(m) of the Internal Revenue Code, in most circumstances, limits to $1 million the deductibility of compensation, including stock-based compensation, paid to top executives by public companies. None of the 1995 compensation paid to the executive officers named in the Summary Compensation Table exceeded the threshold for deductibility under Section 162(m). See \"EXECUTIVE COMPENSATION -- Summary Compensation Table\" above. There were no awards under the 1995 Plan during 1995. However, the 1995 Plan is intended to comply with Section 162(m) and, therefore, awards under that Plan are anticipated to qualify for the corporate tax deduction.\"\nTHE COMPENSATION COMMITTEE:\nJoseph F. Porrino Frank B. Ryan Wallace O. Sellers\nPERFORMANCE GRAPH\nThe following graph sets forth a comparison of the semiannual percentage change in Registrant's cumulative total stockholder return on the Common Stock with the Standard & Poor's 500 Stock Index\/*\/ and the AMEX Industrial (Financial) Index\/**\/. The foregoing cumulative total returns are computed assuming (i) an initial investment of $100, and (ii) the reinvestment of dividends at the frequency with which dividends were paid during the applicable years. DHC has never paid any dividend on shares of Common Stock. The graph below reflects comparative information for the five fiscal years of DHC beginning with the close of trading on December 31, 1990 and ending December 29, 1995. The foregoing information is presented in tabular format immediately following the graphic presentation. The stockholder return reflected below is not necessarily indicative of future performance.\n[GRAPH APPEARS HERE]\n- ---------\n\/*\/ The Standard & Poor's 500 Stock Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.\n\/**\/ The AMEX Industrial (Financial) Index (\"AIFI\") is maintained by the American Stock Exchange (\"AMEX\"). As described by the AMEX, the AIFI is one of eight industrial subindexes of the AMEX Market Value Index, which is a capitalization-weighted index reflecting the performance of AMEX-traded common shares, American Depositary Receipts and warrants.\n1990 STOCK OPTION PLAN\nThe 1990 Stock Option Plan (the \"1990 Plan\") of DHC is a non-qualified stock option plan which is intended to attract, retain and provide incentives to key employees of DHC by offering them an opportunity to acquire or increase a proprietary interest in DHC. Options under the 1990 Plan may be granted to existing officers or employees of DHC for, in the aggregate, the purchase of up to 1,260,000 shares of Common Stock (all subject to adjustment in connection with events affecting the capitalization of DHC). No options were granted under the 1990 Plan during 1990. On March 13, 1991, options to purchase 210,000 shares were granted to each of Messrs. Whitman, Heffernan and Rhein, all of whom are Directors and officers of DHC. The exercise price for all options granted on March 13, 1991 is $3.00 per share, the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the 30 days prior to the date of grant. The options expire ten years after the date of grant and became exercisable in equal annual installments commencing on the first anniversary thereof and on each of the next two anniversaries thereafter. An additional 630,000 options were granted outside the 1990 Plan as of that date to Junkyard Partners, L.P. (\"Junkyard Partners\"), upon the same terms as those granted on that date under the 1990 Plan. After giving effect to the options granted outside the 1990 Plan to Junkyard Partners (and excluding options granted to non-employee Directors, described below), DHC has issued options to purchase 1,260,000 shares of Common Stock, the total number of options which may be granted under the 1990 Plan. In order to prevent additional dilution, the Compensation Committee of the Board of Directors of DHC (the \"Committee\"), on September 16, 1991, resolved that it intends to refrain from granting any additional options under the 1990 Plan in excess of the 630,000 options currently outstanding under the 1990 Plan. During 1994, Junkyard Partners transferred 257,910 of its 630,000 options to one of its limited partners. On December 29, 1994, DHC issued 257,910 restricted shares of Common Stock upon the exercise of such transferred options. In connection therewith, DHC received a total exercise price of $773,730. Effective May 19, 1995, DHC purchased 69,453 of the remaining 372,090 options to purchase Common Stock owned by Junkyard Partners. The options were exercisable at the time of such purchase and otherwise would have expired on March 13, 2001. The aggregate purchase price paid by DHC for the options was approximately $286,500, which was equal to the difference between the closing price of Common Stock on May 19, 1995 ($7.125 per share) the effective date of such purchase, and the exercise price of such options ($3.00 per share), or $4.125 per share. As of December 31, 1995, Junkyard Partners continued to own 302,637 options to purchase shares of Common Stock, and Messrs. Whitman, Heffernan and Rhein continued to own their options, all of which are currently exercisable.\nDHC also was authorized by the terms of its Plan of Reorganization to grant to non-employee Directors of DHC, outside the 1990 Plan, options to purchase 140,000 shares of Common Stock (subject to adjustment in events affecting the capitalization of DHC). On September 16, 1991, DHC granted to each of Mr. Porrino and Dr. Ryan, both of whom are unaffiliated Directors of DHC, options to purchase 46,667 shares of Common Stock and granted to Mr. Isenberg, also an unaffiliated Director of DHC, options to purchase 46,666 shares of Common Stock. See \"Item 10. Directors and Executive Officers of the Registrant, Compensation of Directors.\" The exercise price of all such options is $3.63, the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the 30 days prior to the date of grant. These options expire ten years after the date of grant and become exercisable in three equal annual installments commencing on the first anniversary of the date of grant and on each of the next two anniversaries thereafter. As of December 31, 1995, all of the options granted outside the 1990 Plan, all of which are currently exercisable, remained unexercised.\n1995 STOCK AND INCENTIVE PLAN\nThe 1995 Stock and Incentive Plan (the \"1995 Plan\") is a qualified plan. The purpose of the 1995 Plan is to enable DHC to provide incentives to increase the personal financial identification of key personnel with the long term growth of DHC and the interests of DHC's stockholders through the ownership and performance of DHC's Common Stock, to enhance DHC's ability to retain key personnel, and to attract outstanding prospective employees and Directors.\nThe 1995 Plan provides for the grant of any or all of the following types of awards: stock options, including incentive stock options and non-qualified stock options; stock appreciation rights, whether in tandem with stock options or freestanding; restricted stock; incentive awards; and performance awards. Any stock option granted in the form of an incentive stock option must satisfy the applicable requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the \"Code\"). Awards may be made to the same person on more than one occasion and may be granted singly, in combination, or in tandem as determined by the Committee. The 1995 Plan is effective as of March 21, 1995. No incentive stock options may be granted under the 1995 Plan after March 21, 2005. The 1995 Plan will remain in effect until all awards have been satisfied or expired.\nThe 1995 Plan is administered by the Committee. Other than participating in formula awards, no member of the Committee shall be eligible to participate in the 1995 Plan while serving on the Committee. The Board of Directors intends that each member of the Committee shall be a \"Disinterested Person\" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\") and an \"Outside Director\" within the meaning of Section 162(m) of the Code; provided, however, that a Director who is a \"Disinterested Person\" within the meaning of the Exchange Act will be treated as satisfying the requirements of an \"Outside Director\" until the first meeting of stockholders at which Directors are to be elected that occurs after July 1, 1994 or such later date as may be permissible under the Code or regulations promulgated thereunder. Subject to the terms of the 1995 Plan, the Committee has authority to select personnel to receive awards, to determine the timing, form, amount or value and terms of grants and awards, and the conditions and restrictions, if any, subject to which grants and awards will be made and become payable under the 1995 Plan, and to construe the 1995 Plan and to prescribe rules and regulations with respect to the administration of the 1995 Plan, except that only executive officers of DHC and its subsidiaries, as designated by the Committee, may be entitled to incentive stock awards under the 1995 Plan. The selection of participants from eligible personnel, other than members of the Committee, is within the discretion of the Committee.\nThe aggregate number of shares of Common Stock which may be issued under the 1995 Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 1,700,000, of which a maximum of 1,500,000 shares may relate to awards to eligible individuals (including employee Directors) and a maximum of 200,000 shares may relate to awards to non-employee Directors (all subject to adjustment in the event of stock dividends, stock splits, reorganizations, mergers, and other events affecting the capitalization of DHC, and subject to acceleration in the event of changes in control or ownership of DHC). The maximum number of shares of Common Stock that may be subject to options, stock appreciation rights, restricted stock awards, performance awards or incentive awards granted under the 1995 Plan to an individual during any calendar year cannot exceed 125,000 shares in any calendar year (subject to adjustment in the event of stock dividends, stock splits and certain other events). On April 25, 1995, options to purchase 40,000 shares automatically were granted under the 1995 Plan to Mr. Sellers upon his election as a Director of DHC. The exercise price for such options is $7.00 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). The options expire ten years after the date of grant and become exercisable in three equal annual installments commencing on the first anniversary thereof and on each of the next two anniversaries thereafter. None of the options granted to Mr. Sellers is currently exercisable; however, 13,333 such options will become exercisable within the next 60 days (on April 25, 1996). On January 15, 1996, options to purchase an aggregate of 158,900 shares of Common Stock were granted under the 1995 Plan to certain officers and employees of DHC and its subsidiaries, NAICC and Danielson Trust. Among the recipients of such options were Ms. Cosenza and Ms. Levey, who are officers of DHC, who were granted options to acquire 3,000 shares and 15,000 shares, respectively, and Mr. Story, who is a member of the Board of Directors, who received a grant of options to acquire 80,000 shares. The exercise price for all of such options is $6.6875 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of the grant). The options expire ten years after the date of grant. The options become exercisable at various times, depending upon the holder of the options. Continued employment with DHC or its subsidiaries is a condition to all of the foregoing options. For information regarding compensation paid during 1995 by NAICC to Mr. Story, see \"Item 13. Certain Relationships and Related Transactions\" below.\nThe Registrant has no incentive compensation plans, employment agreements or other benefit plans, other than medical and similar plans available to all employees.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth the beneficial ownership of Common Stock as of March 13, 1996 of (a) each Director, (b) each executive officer, and (c) each person known by DHC to own beneficially more than five percent of the outstanding shares of Common Stock. DHC believes that, except as otherwise stated, the beneficial holders listed below have sole voting and investment power regarding the shares reflected as being beneficially owned by them.\n(continued on following page)\n* Percentage of shares beneficially owned does not exceed one percent of the outstanding Common Stock.\n\/1\/ Share percentage ownership is rounded to nearest tenth of one percent and reflects the effect of dilution as a result of outstanding options to the extent such options are, or within 60 days will become, exercisable. As of March 13, 1996 (the date as of which this table was prepared), there were exercisable options outstanding to purchase 1,085,970 shares of Common Stock. Shares underlying any option which was exercisable on March 13, 1996 or becomes exercisable within the next 60 days are deemed outstanding only for purposes of computing the share ownership and share ownership percentage of the holder of such option.\n\/2\/ In accordance with provisions of DHC's Certificate of Incorporation, all certificates representing shares of Common Stock beneficially owned by holders of five percent or more of Common Stock are owned of record by DHC, as escrow agent, and are physically held by DHC in that capacity.\n\/3\/ Beneficially owned by the Commissioner of Insurance of the State of California in his capacity as trustee for the benefit of holders of certain deficiency claims against certain trusts which assumed liabilities of certain present and former insurance subsidiaries of DHC.\n\/4\/ Includes 373,397 shares of Common Stock beneficially owned by Carl Marks Strategic Investments, L.P. (\"CMSI\"), an investment limited partnership; 803,669 shares beneficially owned by Third Avenue Value Fund, Inc. (\"TAVF\"), an investment company registered under the Investment Company Act of 1940; 103,428 shares beneficially owned by Martin J. Whitman & Co., Inc. (\"MJW&Co\"), a private investment company; and 66,167 shares beneficially owned by Mr. Whitman's wife and three adult family members. Mr. Whitman is a minority general partner of the partnership that is the general partner of CMSI. Mr. Whitman controls the investment adviser of TAVF, and may be deemed to own beneficially a five percent equity interest in TAVF. Mr. Whitman is the principal stockholder in MJW&Co, and may be deemed to own beneficially the shares owned by MJW&Co. Mr. Whitman disclaims beneficial ownership of the shares of Common Stock owned by CMSI, TAVF, MJW&Co, and Mr. Whitman's family members.\n\/5\/ Includes 1,054,996 shares of Common Stock beneficially owned by Whitman Heffernan & Rhein Workout Fund, L.P. (\"WHR Fund\"), an investment limited partnership. Each of Messrs. Whitman, Heffernan and Rhein is a general partner of the partnership that is the general partner of WHR Fund. Each disclaims beneficial ownership of the shares owned by the WHR Fund. Does not include 134,763 shares owned by the Employee Stock Ownership Plan and Trust of KCP Holding Company and Subsidiaries (\"ESOP\"). Messrs. Heffernan and Rhein are, with Mr. Story, the trustees of the ESOP; neither Mr. Heffernan nor Mr. Rhein is a participant in the ESOP.\n\/6\/ Includes shares underlying currently exercisable options to purchase an aggregate of 210,000 shares of Common Stock at an exercise price of $3.00 per share.\n\/7\/ Includes 28,184 shares of Common Stock owned by a trust, of which Mr. Rhein serves as trustee, for the benefit of Mr. Rhein's children. Mr. Rhein disclaims beneficial ownership of the shares of Common Stock owned by the trust.\n\/8\/ Includes shares underlying currently exercisable options to purchase an aggregate of 46,667 shares of Common Stock at an exercise price of $3.63 per share.\n\/9\/ Includes 20,088 shares owned by Mentor Partnership, a partnership controlled by Mr. Isenberg, and 28 shares owned by Mr. Isenberg's wife. Also includes shares underlying currently exercisable options to purchase an aggregate of 46,666 shares of Common Stock at an exercise price of $3.63 per share.\n\/10\/ Includes 36,500 shares of Common Stock beneficially owned by Mr. Story and an aggregate of approximately 2,472 shares owned by the ESOP which have been allocated to Mr. Story's account; does not include 132,291 additional shares owned by the ESOP but not allocated to Mr. Story's account. Mr. Story is a participant in the ESOP and is, together with Messrs. Heffernan and Rhein, a trustee of the ESOP. Does not include shares underlying options to purchase an aggregate of 80,000 shares of Common Stock at an exercise price of $6.6875 per share which are not currently exercisable nor become exercisable within the next 60 days.\n\/11\/ Includes shares underlying options to purchase an aggregate of 13,333 shares of Common Stock at an exercise price of $7.00 per share, which become exercisable within the next 60 days. Does not include shares underlying options to purchase an aggregate of 26,667 shares of Common Stock at an exercise price of $7.00 per share which are not currently exercisable nor become exercisable within the next 60 days.\n\/12\/ Includes 100 shares of Common Stock beneficially owned by Ms. Levey's children. Ms. Levey disclaims beneficial ownership of the shares of Common Stock owned by her children. Does not include shares underlying options to purchase an aggregate of 15,000 shares of Common Stock at an exercise price of $6.6875 per share which are not currently exercisable nor become exercisable within the next 60 days.\n\/13\/ Does not include shares underlying options to purchase an aggregate of 3,000 shares of Common Stock at an exercise price of $6.6875 per share which are not currently exercisable nor become exercisable within the next 60 days.\n\/14\/ In calculating the shares owned by officers and Directors as a group, the 1,054,996 shares of Common Stock owned by WHR Fund referred to in footnote 5 above and included in the beneficial ownership amounts of each of Messrs. Whitman, Heffernan and Rhein reflected in the table above are counted only once in order to avoid a misleading total. In calculating the percentage of shares owned by officers and Directors as a group, the shares of Common Stock underlying all options which are beneficially owned by officers and Directors and which are currently exercisable or become exercisable within the next 60 days are deemed outstanding.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nWilliam R. Story, a Director of DHC, is the President and Chief Executive Officer of NAICC. During 1995, Mr. Story received from NAICC cash compensation of $250,000, as well as non-cash compensation in the approximate aggregate amount of $14,020 (in respect of various business-related expenses including group term life insurance). NAICC paid a $200,000 bonus to Mr. Story in 1996 with respect to 1995 services. NAICC does not anticipate paying any other compensation or bonus to Mr. Story or any other Director or officer of DHC in 1996 with respect to 1995 services. In addition, NAICC in 1995 made a contribution to a pension plan in which\nMr. Story participates. The amount of such contribution allocable to the account of Mr. Story is approximately $7,500. Further, NAICC in 1995 made a contribution to the 401(k) plan and ESOP account of such individual in the aggregate amount of $4,620. As noted above, in January 1996, Mr. Story received 80,000 options to acquire Common Stock under DHC's 1995 Stock and Incentive Plan. See \"Item 11. Executive Compensation, 1995 Stock and Incentive Plan.\"\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 -- see Index to Financial Statements and Financial Statement Schedules appearing on Page.\n(2) Financial Statement Schedules -- see Index to Financial Statements and Financial Statement Schedules appearing on Page.\n(3) Exhibits:\nEXHIBIT NO.\/1\/ NAME OF EXHIBIT - ----------- ---------------\nPlan of Acquisition: -------------------\n2.1 * Agreement and Plan of Merger dated as of February 26, 1996 among Midland Financial Group, Inc., Danielson Holding Corporation and Mission Sub E, Inc. (Filed with Report on Form 8-K dated March 1, 1996, Exhibit 2.1.)\nOrganizational Documents: ------------------------\n3.1 * Certificate of Incorporation of Registrant.\n3.2 * Bylaws of Registrant.\nMaterial Contracts--Miscellaneous: ---------------------------------\n10.1 * Stock Sale Agreement dated as of January 27, 1993 between Nationwide Capital Corporation and Danielson Holding Corporation. (Filed with Report on Form 10-K dated March 26, 1993, Exhibit 10.16.)\n10.2 * Deposit Escrow Agreement dated as of January 19, 1993 among Nationwide Capital Corporation, Danielson Holding Corporation and Mission Valley Escrow. (Filed with Report on Form 10-K dated March 26, 1993, Exhibit 10.17.)\n10.3 * Guarantee Agreement dated as of March 26, 1993 between Resolution Trust Corporation, in its capacity as conservator of HomeFed Bank, and Danielson Holding Corporation. (Filed with Report on Form 10-K dated March 26, 1993, Exhibit 10.18.)\n10.4 * Guarantee Agreement dated as of March 26, 1993 between Resolution Trust Corporation, in its corporate capacity, and Danielson Holding Corporation. (Filed with Report on Form 10-K dated March 26, 1993, Exhibit 10.19.)\n- ---------- \/1\/ Exhibit numbers are referenced to Item 601 of Regulation S-K under the Securities Exchange Act of 1934.\n* Asterisk indicates an exhibit previously filed with the Securities and Exchange Commission and incorporated herein by reference.\nEXHIBIT NO.\/1\/ NAME OF EXHIBIT - ----------- ---------------\n10.5 * Asset Purchase Agreement dated as of December 31, 1993 by and among Grossmont Bank, Donald A. Levi, Murray R. Steeg and Danielson Trust Company. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.20.)\n10.6 * Amendment No. 1 dated as of February 16, 1994 to Asset Purchase Agreement dated as of December 31, 1993 by and among Grossmont Bank, Donald A. Levi, Murray R. Steeg and Danielson Trust Company. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.21.)\n10.7 * Amendment No. 2 dated as of February 17, 1994 to Asset Purchase Agreement dated as of December 31, 1993 by and among Grossmont Bank, Donald A. Levi, Murray R. Steeg and Danielson Trust Company. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.22.)\n10.8 * Consulting Services Agreement dated as of February 22, 1994 between Danielson Trust Company and Tenney-Levi Corporation. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.23.)\n10.9 * Consulting Services Agreement dated as of February 22, 1994 between Danielson Trust Company and Murray R. Steeg. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.24.)\n10.10 * Agreement dated as of February 22, 1994 between Grossmont Bank and Danielson Trust Company. (Filed with Report on Form 10-K dated March 18, 1994, Exhibit 10.25.)\nMaterial Contracts--Executive Compensation Plans and ---------------------------------------------------- Arrangements: ------------\n10.11 * 1990 Stock Option Plan. (Filed with Report on Form 8-K dated September 4, 1990, Exhibit 10.8.)\n10.12 * 1995 Stock and Incentive Plan. (Included as Exhibit A to Proxy Statement filed on March 30, 1995.)\nAnnual Report to Security-Holders: ---------------------------------\n13.1 1995 Annual Report of Danielson Holding Corporation. (To be included herewith at page 49.)\nPowers of Attorney: ------------------\n24.1 Powers of Attorney executed by certain directors of Danielson Holding Corporation. (Filed herewith at page 101.)\nFinancial Data Schedule: -----------------------\n27.1 Financial Data Schedule for Article 7 Registrant (Insurance Company). (Filed electronically herewith.)\n- ----------\n\/1\/ Exhibit numbers are referenced to Item 601 of Regulation S-K under the Securities Exchange Act of 1934.\n* Asterisk indicates an exhibit previously filed with the Securities and Exchange Commission and incorporated herein by reference.\nMiscellaneous: -------------\n99.1 * Press Release dated February 27, 1996. (Filed with Report on Form 8-K dated March 1, 1996, Exhibit 99.1.)\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1995:\nNot applicable.\n- ---------- \/1\/ Exhibit numbers are referenced to Item 601 of Regulation S-K under the Securities Exchange Act of 1934.\n* Asterisk indicates an exhibit previously filed with the Securities and Exchange Commission and incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Danielson Holding Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDANIELSON HOLDING CORPORATION (Registrant)\nBy \/S\/ C. KIRK RHEIN, JR. ------------------------------------ C. Kirk Rhein, Jr. President and Chief Executive Officer\nDate: March 19, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Danielson Holding Corporation and in the capacities and on the dates indicated.\nDate: March 19, 1996 By \/S\/ C. KIRK RHEIN, JR. ------------------------------------ C. Kirk Rhein, Jr. President and Chief Executive Officer and a Director\nDate: March 19, 1996 By \/S\/ MARTIN J. WHITMAN ------------------------------------ Martin J. Whitman Chairman of the Board and Chief Investment Officer and a Director\nDate: March 19, 1996 By \/S\/ JAMES P. HEFFERNAN ------------------------------------ James P. Heffernan Chief Financial Officer and a Director\nDate: March 19, 1996 By \/S\/ CLAUDIA C. COSENZA ------------------------------------ Claudia C. Cosenza Controller\nDate: March 19, 1996 By \/S\/ WILLIAM R. STORY ------------------------------------ William R. Story Director\nDate: March 19, 1996 By \/S\/ JOSEPH F. PORRINO ------------------------------------ Joseph F. Porrino Director\nDate: March 19, 1996 By \/S\/ FRANK B. RYAN ------------------------------------ Frank B. Ryan Director\nDate: March 19, 1996 By ------------------------------------ Eugene M. Isenberg Director\nDate: March 19, 1996 By \/S\/ WALLACE O. SELLERS ------------------------------------ Wallace O. Sellers Director\nDANIELSON HOLDING CORPORATION\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPage Number -----------\nIndependent Auditors' Report......................................... Danielson Holding Corporation and Consolidated Subsidiaries: Statements of Operations - For the years ended December 31, 1995, 1994 and 1993.............................................. * Balance Sheets - December 31, 1995 and 1994........................ * Statements of Stockholders' Equity - For the years ended December 31, 1995, 1994 and 1993................................. * Statements of Cash Flows - For the years ended December 31, 1995, 1994 and 1993.............................................. * Schedule I - Summary of Investments - Other than Invest- ments in Related Parties.......................... S-1 Schedule II - Condensed Financial Information of the Registrant........................................ S-2-4 Schedule IV - Reinsurance......................................... S-5 Schedule V - Valuation and Qualifying Accounts................... S-6 Schedule III - Supplemental Information Concerning Property-Casualty and VI Insurance Operations................................ S-7\nSchedules other than those listed above are omitted because either they are not applicable or not required or the information required is included in the Company's Consolidated Financial Statements.\n- ---------- * Incorporated by reference to DHC's 1995 Annual Report to Stockholders.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Danielson Holding Corporation:\nUnder date of February 26, 1996, we reported on the consolidated balance sheets of Danielson Holding 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, 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 audited the related consolidated financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs described in Note 1 of the Notes to Consolidated Financial Statements, in 1995 the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\"\n\/S\/ KPMG PEAT MARWICK LLP ---------------------------- KPMG Peat Marwick LLP\nNew York, New York February 26, 1996\nSCHEDULE I\nDANIELSON HOLDING CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES\n(In thousands)\nSCHEDULE II\nDANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only)\nSTATEMENTS OF OPERATIONS (In thousands)\nSCHEDULE II, CONTINUED\nDANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only)\nBALANCE SHEETS (In thousands, except share and per share information)\nSCHEDULE II, CONTINUED\nDANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only) STATEMENTS OF CASH FLOWS (In thousands)\nSCHEDULE IV\nDANIELSON HOLDING CORPORATION REINSURANCE (in thousands)\nSCHEDULE V\nDANIELSON HOLDING CORPORATION VALUATION AND QUALIFYING ACCOUNTS (in thousands)\nSCHEDULES III AND VI\nDANIELSON HOLDING CORPORATION\nSUPPLEMENTARY INSURANCE INFORMATION AND SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (in thousands)\nEXHIBITS","section_15":""}
{"filename":"96677_1995.txt","cik":"96677","year":"1995","section_1":"ITEM 1. BUSINESS.\nTechnalysis Corporation (the \"Company\"), incorporated under Minnesota law in 1967, provides computer software analysis, design and programming services to computer users and manufacturers. These services are provided on either an hourly rate or fixed price basis. Opportunities for both types of contracts are developed by calling on potential customers, by repeat business and by referrals. Customer considerations in selecting personnel for hourly rate contracts include rate, availability of personnel, and personnel qualifications per resumes and interviews. Customer considerations for fixed price contracts include price, delivery date, personnel to be assigned and reputation of the Company. Most of the Company's revenue is generated from analysis, design and programming contracts in the development of general business applications and governmental applications on an hourly-rate basis. Revenues increased in 1995 reversing a downward trend since 1992. (See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation.)\nOn January 10, 1996, the Company entered into an agreement to be acquired by Compuware Corporation for $14.00 per share in cash, subject to shareholder approval. The closing date is tentatively scheduled for April 30, 1996.\nPRINCIPAL PRODUCTS, MARKET AREAS AND DISTRIBUTION METHODS\nDuring 1995, the Company provided computer software services through offices located in four geographic areas - Minneapolis, Minnesota; Southfield, Michigan; Falls Church, Virginia; and Cincinnati, Ohio. The Minneapolis office contributed approximately 78% of the total revenue for 1995, and the remaining 22% split between the other three offices.\nService fees from two major customers were 18% (3M) and 19% (State of Minnesota) of total revenues in 1995. These fees were derived from contracts with several different divisions of each customer. Each division is marketed independently of the other divisions with separate purchase orders obtained from each division. It is highly unlikely that all purchase orders with all divisions would be canceled unexpectedly at the same time. If this happened, it would have an adverse effect on the Company's revenues and earnings until such time as the Company could find additional revenues from other customers.\nThe Company contracts primarily on a time and material basis at a negotiated hourly rate which varies depending on the skill of the technical personnel assigned to a given project and the customer rates prevailing in the area. The contract term generally runs from two to six months although, in some cases, the contract can run for more than one year. Fees for services rendered on a time and material basis are payable monthly.\nThe Company also contracts on a fixed price basis to provide specified computer software systems. Fees for services rendered on a fixed price basis are payable on a negotiated basis over the term of the project with final payment being made after customer acceptance of the completed systems.\nServices are provided primarily at the customer's location, utilizing the customer's computer system.\nBACKLOG\nSince the Company generally has very few long term fixed price contracts, the backlog of orders at any one time does not present a useful projection of anticipated contracts and revenues for the entire year. Most time and material contracts have a 15 to 30 day cancellation clause. As of December 31, 1995 and December 31, 1994, however, the Company's backlog, which consists primarily of estimated revenue under existing time and material contracts, was approximately $7,000,000 and $8,000,000 respectively.\nEMPLOYEES\nAt December 31, 1995, the Company had 250 employees. Of that number, 217 were systems analysts\/programmers who directly provide systems and programming services to customers.\nContinued growth depends in part on the availability of experienced technical personnel. The Company has not experienced significant difficulties in obtaining additional technical employees at its current staffing levels.\nCOMPETITION\nThe Company competes with software divisions of many large computer companies, as well as other independent software companies. With the exception of the Minneapolis branch, these other independent software companies are generally much larger in terms of sales and personnel than the other branch offices.\nPrincipal means of competing include extensive marketing, quality of service, referrals, responsiveness to customers' needs, reputation, credibility and price. The Company emphasizes its marketing efforts by (1) stressing personal calls to customers by its salespersons and managers; (2) providing the qualified person for the job; and (3) maintaining a follow through with the customer to assure that the job is being done in a timely and professional manner.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe principal executive offices and the Minneapolis branch office of the Company are located in leased space at 6700 France Avenue South, Minneapolis, Minnesota 55435. The other three branch offices are located at 26211 Central Park Blvd., Southfield, Michigan 48076; 7700 Leesburg Pike, Falls Church, Virginia 22043; and 4675 Cornell Road, Cincinnati, Ohio 45241. All four locations occupy an aggregate of approximately 20,000 square feet of office space under leases with expiration dates ranging from 6 to 45 months. The Company believes that the total space now occupied is adequate for its uses and believes that additional office space, if required, will be available for the Company's purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings to which the Company is a party.\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nSince February 19, 1985, the Common Stock of the Company has traded on the NASDAQ National Market System under the symbol TECN. The information contained in the following table was derived from NASDAQ's National Market System Statistical Reports. The price ranges set forth the low and high prices of transactions as reported for the quarters indicated.\nPRICE RANGE ----------- LOW HIGH --- ----\n1994 1st Quarter 10-1\/2 12-1\/4 2nd Quarter 11 12-1\/2 3rd Quarter 10-3\/4 11-3\/4 4th Quarter 10-1\/4 11-3\/4\n1995 1st Quarter 10-1\/4 12-1\/4 2nd Quarter 11-1\/2 12 3rd Quarter 11 12-3\/4 4th Quarter 12 12-3\/4\n1996 1st Quarter 12 13-9\/16 (through March 15)\nThe approximate number of record holders of Common Stock as of March 15, 1996 was 320.\nAnnual dividends on the Common Stock of the Company have been paid since 1972. Payment of semi-annual dividends began for fiscal year 1989. The total dividends paid for 1994 and 1995 were $.57 per share and $.39 per share, respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n(1) Includes a $.10 per share dividend declared in January, 1996 relating to 1995 earnings.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nBACKGROUND OF MATERIAL CONTRACT\nIn April, 1993, the Company was awarded a fixed-price contract to develop a large information system for the State of Minnesota. The original contract price was in excess of $4.1 million with a completion date of October 1, 1994. The development included functional specifications, general systems design, detailed program specifications, programming, training, documentation and implementation. It was originally bid utilizing normal billing rates with a time estimate that seemed reasonable to accomplish all of the tasks identified by the scheduled due dates. The functional specifications and general systems design were completed on time and within budget. As the general systems design was nearing completion and the detailed program specifications were being developed, it became apparent the original contract was not sufficient to complete the project, when considering the many change orders being requested by the customer. A total of an additional $2.7 million was added to the contract in May, 1995 to cover change orders.\nIn 1994, a reduction in revenue of $363,000 occurred in the fourth quarter due to change orders for the State of Minnesota contract that were expected to be approved in 1994, but which were not approved until 1995. This resulted in a reduction in earnings in 1994 of approximately $220,000 after taxes. In July, 1995, the customer decided to change the hardware\/software platforms and the database definitions for the entire project. The customer and the Company could not agree on the fees for implementing these changes and, as a result, negotiations began to terminate the contract. After long discussions concerning the status of the portions of the contract which were partially completed, a settlement agreement was agreed upon which allowed the Company to terminate the contract. The settlement, which Management believes was in the best interest of the Company, resulted in a reduction in accrued revenue of $841,000 in the third quarter of 1995, and a one-time\nadjustment to earnings of $550,000 after taxes. In conjunction with these two specific reductions in revenue, the effective billings rates on the contract were significantly less than normal rates.\nRESULTS OF OPERATIONS\nRevenues increased in 1995 reversing a downward trend since 1992. The decrease in revenues from 1992-1994 was the result of a very competitive environment at a time when the economy was in a recovery mode. The number of billable analysts and programmers decreased in all offices and especially in the branch offices. The Company was not able to increase hourly billing rates. Changes in senior management personnel at the Company were not effective and the branch offices, in particular, were not able to grow as anticipated. Additional expenses were incurred in the branch offices in hope of increasing revenue by specifically adding additional sales and recruiting personnel. The impact of this investment has not yet resulted in increased revenues. The significant decrease in the Unbilled Work on Contracts in Process in 1995 as compared to 1994 was due to the final billing and subsequent payment of the State of Minnesota fixed price contract described above. The increase in Unbilled Work on Contracts in Process between 1994 and 1993 was due to revenue accrued, but not billable for the same fixed-price contract. There are no material positive or negative trends and uncertainties which are reasonably likely to impact future results of operations and financial position.\nRevenues increased overall approximately 12% for 1995 as compared to 1994 due primarily to an increase in billing rates and the number of billable personnel, even though approximately $841,000 was recorded as a reduction in revenue in the third quarter of 1995 as discussed above. Expenses increased approximately 18% primarily due to the increase in personnel necessary for the fixed price contract described above. Salaries and contracted services increased approximately 19% and employee benefits increased 20% due to the increase in personnel company-wide. Selling, administrative, and other operating costs\nincreased 12% due to adding additional sales and recruiting personnel, along with corresponding administrative expenses, in the remote branch offices. As a result, net earnings for the year ended December 31, 1995 decreased approximately 29% compared to the year ended December 31, 1994.\nRevenues decreased approximately 6% for 1994 as compared to 1993 due to a reduction in revenue in the Company's remote offices and because of the unrecognized revenues for certain change orders awaiting approval on the State of Minnesota contract as discussed above. Expenses decreased approximately 4% due to the monthly average number of personnel being less for 1994 as compared to 1993 even though the number of personnel at the end of 1994 was higher than at the end of 1993. As a result, net earnings for the year ended December 31, 1994 decreased approximately 18% compared to the year ended December 31, 1993.\nAlthough revenues increased for 1995, primarily due to the increase in the number of analysts and programmers in the Minneapolis office and an increase in billing rates on contracts other than the State of Minnesota contract, it is anticipated that 1996 revenues will not increase significantly.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's source of funding to meet liquidity requirements, capital expenditures, and dividends over the past three years has been cash flow from operations. Net cash provided from operating activities increased to $1,734,167 in 1995 from $257,207 in 1994. This increase was primarily related to the termination of the fixed-price contract with the State of Minnesota which allowed the billing and collection of the unbilled work on contracts in process that existed at December 31, 1994. Management believes the Company's current cash position and the cash flow generated by operating activities will continue to be adequate for short-term and long-term liquidity and future dividend requirements for the next year.\nOn January 10, 1996, the Company entered into an agreement to be acquired by Compuware Corporation for $14.00 per share in cash, subject to shareholder approval. The closing date is tentatively scheduled for April 30, 1996.\nIMPLEMENTATION OF NEW ACCOUNTING STANDARD\nIn October, 1995, the FASB issued Statement No. 123, Accounting for Stock- Based Compensation, which is effective for the year ending December 31, 1996. The Company does not intend to adopt Statement No. 123 in measuring expense, however they must present the pro forma disclosures and those pro forma amounts will likely be less than the amounts shown in future statements of earnings.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\n(See the following pages 13-22)\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors and Stockholders Technalysis Corporation Minneapolis, Minnesota\nWe have audited the accompanying balance sheets of Technalysis Corporation as of December 31, 1995 and 1994, and the related 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 financial position of Technalysis 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 8 to the financial statements, on January 9, 1996, the Company agreed to be merged into Compuware Corporation.\nMcGladrey & Pullen, LLP\nMinneapolis, Minnesota February 2, 1996\nTECHNALYSIS CORPORATION\nBALANCE SHEETS December 31, 1995 and 1994\nSee Notes to Financial Statements.\nTECHNALYSIS CORPORATION\nSTATEMENTS OF EARNINGS Years Ended December 31, 1995, 1994 and 1993\nSee Notes to Financial Statements.\nTECHNALYSIS CORPORATION\nSTATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1995, 1994 and 1993\nSee Notes to Financial Statements.\nTECHNALYSIS CORPORATION\nSTATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993\nSee Notes to Financial Statements.\nTECHNALYSIS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nREVENUES: The Company provides computer systems and programming services on a credit basis throughout the United States on terms it establishes with individual customers.\nRevenues on the majority of systems and programming service contracts are recognized as the services are rendered, although the customer may be billed in advance or when the work is substantially complete. Charges at normal hourly billing rates are included in unbilled work in process. Revenues on fixed fee contracts are recorded on the basis of the Company's estimate of the percentage of completion of individual contracts. Provisions are made for all anticipated losses.\nDISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS: At December 31, 1995, the Company implemented FASB No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. The following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCASH AND CASH EQUIVALENTS: The carrying amount approximates fair value because of the short maturity of those instruments.\nAVAILABLE-FOR-SALE SECURITIES: The fair values of investments are estimated based on quoted market prices.\nCASH EQUIVALENTS: The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. At December 31, 1995, cash equivalents include approximately $3,111,000 of short-term commercial paper.\nThe Company maintains its cash in bank deposit accounts and financial institution money market funds which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts.\nINVESTMENT IN DEBT SECURITIES AND ACCOUNTING CHANGE: The Company follows the provisions of the FASB Statement No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Statement No. 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 neither buys investment securities in anticipation of short-term fluctuations in market prices nor can commit to holding debt securities to their maturities, the investment in debt securities has been classified as available-for-sale in accordance with Statement No. 115. 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 (see Note 2). 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 the specific securities sold.\nDEPRECIATION: Depreciation is being provided on equipment and office furniture using straight-line and accelerated methods over the estimated useful lives of three to eight 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 the reported\nTECHNALYSIS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\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.\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. The effect of deferred tax assets and liabilities does not have a material impact on the Company's financial position or operations.\nNET EARNINGS PER SHARE: Net earnings per share is computed by dividing net earnings by the average number of shares of common stock and common stock equivalents outstanding during the year. Common stock equivalents consist of the dilutive effect of common shares which may be issued upon exercise of stock options.\nISSUED BUT NOT YET ADOPTED STANDARD: In October, 1995, the FASB issued Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. Statement No. 123 establishes financial accounting and reporting standards for stock-based compensation plans. Statement No. 123 encourages the adoption of a FAIR VALUE BASED METHOD of accounting for stock-based compensation plans, but also allows entities to continue to measure compensation cost using the INTRINSIC VALUE BASED METHOD of accounting prescribed by APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Entities electing to remain with the accounting in Opinion No. 25 must make pro forma disclosures of net income and earnings per share as if the fair value based method had been applied.\nStatement No. 123 is effective for the year ending December 31, 1996. The Company does not intend to adopt Statement No. 123 in measuring expense, however they must present the pro forma disclosures and those pro forma amounts will likely be less than the amounts shown in future statements of earnings.\nNOTE 2. INVESTMENT IN AVAILABLE-FOR-SALE SECURITIES\nThe following is a summary of the Company's investment in available-for-sale securities as of December 31, 1995 and 1994:\nAt December 31, 1995, the Company's available-for-sale securities consisted of $1,000,944 invested in a mutual fund of mortgage-backed securities and $981,795 invested in commercial paper that matures in February, 1996. At December 31, 1994, the Company's available-for-sale securities consisted entirely of a mutual fund invested in mortgage-backed securities.\nTECHNALYSIS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 3. STOCKHOLDERS' EQUITY\nThe Company has a 1992 Incentive Stock Option Plan and has reserved 250,000 shares of common stock for future grants. The Company also had a 1982 Incentive Stock Option Plan which expired in 1992, and no further grants may be made under this plan.\nThe options generally become exercisable in 25 percent increments on the four anniversary dates following such options' date of grant. A summary of stock option activity under the Plans during the three years ended December 31, 1995 follows:\nOptions outstanding at December 31, 1995, consist of 64,750 options granted under the 1982 Plan and 61,000 options granted under the 1992 Plan.\nThe options granted are to purchase common stock at not less than 100 percent of market price as of the date of grant ($10.38 to $11.88 per share as of December 31, 1995). At December 31, 1995, options for 65,250 shares are exercisable. Upon consummation of the merger, an additional 3,500 options granted under the 1992 plan will become immediately exercisable. There are 189,000 shares of common stock reserved for future grants.\nTECHNALYSIS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 4. COMMITMENTS AND CONTINGENCIES\nLEASES: The Company leases office space under non-cancellable operating leases. Certain leases require additional payments for a proportionate share of real estate taxes and operating expenses. Approximate future minimum rental payments under operating leases for the next five years are as follows:\nTotal rent expense for the years ended December 31, 1995, 1994, and 1993 was approximately $326,000, $301,000, and $341,000, respectively.\nEMPLOYMENT AGREEMENT: The Company has an employment agreement with the Chairman and CEO of the Company. The agreement calls for the CEO to continue with the Company through December 31, 1996, as CEO or, upon terminating his employment, as a consultant. His salary as CEO is to be not less than $135,000, plus any bonuses. As a consultant, he is to receive annually 60 percent of his average salary and bonus of the highest five of the previous ten years. The CEO resigned as an employee effective February, 1996, but will continue as Chairman and a consultant for the duration of the agreement.\nNOTE 5. INCOME TAXES\nThe effective tax rate was 40 percent for 1995, 1994, and 1993. State income taxes, net of the federal benefit, are the only significant items in reconciling from the expected statutory federal income tax rate of 34 percent to the actual rate provided.\nDeferred income tax assets consist solely of the tax effects of the unrealized holding losses on the Company's investment in available-for-sale securities.\nNOTE 6. EMPLOYEE BENEFIT PLAN\nThe Company maintains a savings plan for employees, which conforms to IRS provisions for 401(k) plans. The Company, at its discretion, may match employee contributions in an amount not to exceed 20 percent of the employees' contribu- tions and $1,000 per employee. Operations have been charged for the matching contributions to the plan of $51,459, $30,600, and $0 for the years ended December 31, 1995, 1994, and 1993, respectively.\nTECHNALYSIS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 7. MAJOR CUSTOMERS\nThe Company had revenues from major customers as follows:\n* During 1994, the Company recognized revenues on one of its contracts with this customer based on the expectation that certain change orders would be approved at or near year end. However, the change orders were not approved by the customer as of December 31, 1994 and, as a result, the Company recorded a reduction of revenues on this contract totalling $363,000 in the fourth quarter of 1994. This resulted in a reduction in net earnings in 1994 of approximately $220,000, or $0.10 per share. In the third quarter of 1995, the customer significantly changed the scope of the contract which resulted in the Company and the customer agreeing to terminate the above mentioned contract. In conjunction with the contract settlement, the Company recorded a reduction of revenues of approximately $841,000 and certain other settlement costs in the third quarter. This resulted in a reduction in net earnings in 1995 of approximately $550,000, or $0.25 per share.\nNOTE 8. MERGER\nOn January 9, 1996, the Company agreed to be merged into Compuware Corporation (Compuware). Closing of the transaction is subject to completion of due diligence, receipt of a fairness opinion, the approval of Technalysis sharehold- ers, and the receipt of regulatory approvals.\nUpon closing of the transaction, Compuware will pay a cash price of $14.00 per share for each outstanding share of Technalysis stock. Additionally, the Company will pay a $.10 per share dividend on February 8, 1996 to shareholders of record on January 25, 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.\na) The names and ages of the Company's directors, their current positions with the Company, their principal occupations for the past five years, and their years of election are as follows:\nPrincipal Occupation Name and Age For Past Five Years Director Since - ------------ ------------------- --------------\nVictor A. Rocchio, 68 Chairman and Treasurer of the 1967 Company since 1967; CEO from 1967-1996; President from 1967-1993, 1995\nMilan L. Elton, 56 CEO & President of the 1988 Company since 1996; Vice President from 1983-1995; Secretary since 1987; Controller from 1977-1995\nRobert S. Erickson, 75 Private Investor 1967\nEdward D. Zimmer, 70 Consulting Engineer 1967\nJohn M. Schulzetenberg, 49 Chairman, Geneva Group of Companies, 1992 since 1993, a manufacturer of audio, video and computer accessories; Executive Vice President of the Company from 1992-1993; Private investor and consultant from 1990 to 1992; Managing Partner, Touche Ross & Co., Denver, CO 1986-1990\nFranklin E. Triplett, 62 Business Consultant since 1993 1993; Vice President, Stillwater Systems, Inc. from 1992-1993; Management Consultant from 1988-1992; Management, Control Data Corporation from 1966-1988\nDirectors serve until the next annual meeting of the stockholders at which time their successors are elected and qualified, or until their prior resignation or removal, unless the merger is approved. See Item 1. Business.\n(b) The names and ages of the executive officers of the Company, their current positions with the Company, their principal occupations for the past five years, and their years of appointment are as follows:\nName and Age Principal Occupation for Past Five Years - ------------ ----------------------------------------\nVictor A. Rocchio, 68 Chairman and Treasurer of the Company since 1967 CEO from 1967-1996 President from 1967-1993, 1995\nMilan L. Elton, 56 CEO and President of the Company since 1996 Vice President from 1983-1995 Secretary since 1987 Controller from 1977-1995\nOfficers serve until their successors are appointed by the Board, or until their prior resignation or removal.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSUMMARY COMPENSATION. The following table contains summary information concerning the annual compensation paid by the Company for the past three years to the Company's Chief Executive Officer, and to each of the other executive officers whose combined salary and bonus for the year ended December 31, 1995 was in excess of $100,000:\nIn January, 1985, the Company entered into an employment and consulting agreement with Mr. Rocchio, providing for his continued services until December 31, 1996, either as an employee or as a consultant. On February 15, 1996, Mr. Rocchio resigned as CEO and President, but continues as Chairman and Treasurer. Pursuant to his agreement, he receives an annual base salary of not less than $135,000, plus a bonus computed in a manner similar to that of the bonuses paid during recent years. As a consultant, he will receive compensation equal to 60 percent of his average salary and bonus of the highest five of the previous ten years of employment, will perform certain consulting services, and will refrain from competitive activities for two years following his termination.\nSTOCK OPTION PLANS. The Company maintains the 1982 Incentive Stock Option Plan and the 1992 Incentive Stock Option Plan (the \"Plans\") for the purpose of attracting, retaining and motivating key employees and to encourage stock ownership by key employees. The 1982 Plan expired in 1992 and no additional options can be granted under the 1982 Plan, although previously-granted options remain exercisable until they are exercised or expire according to their terms. The Plans are administered by the Compensation Committee whose members are ineligible to receive options under the Plans. The exercise price for options granted under the Plans cannot be less than the fair market value of the Common Stock on the date the options are granted. Options are not exercisable until one year after the date of grant and then become exercisable to the extent of 25 percent of the underlying shares on each of the first four anniversaries of the date of grant, although most options granted under the 1992 Plan become immediately exercisable in the event the Company is acquired.\nThe following table contains information concerning the grant of options under the plans during the year ended December 31, 1995, for the executive officers named in the Summary Compensation table:\nPotential Realizable Value at Assumed Percent Rates of Stock Price of Total Appreciation for Grants Expir- Option Term Options To All Exercise ation -------------------- Name Granted Employees Price Date 10% 5% - ---- ------- --------- -------- ---- --- --\nVictor A. -0- - - - - - Rocchio\nMilan L. -0- - - - - - Elton\nThe following table contains information concerning options exercised in 1995, and options held at December 31, 1995, for the executive officers named in the Summary Compensation table:\nNumber of Securities Value of Unexercised Shares Underlying Unexercised in-the-Money Acquired Options at Fiscal Options at Fiscal on Value Year-End (#) Year-End (#) Exercise Realized Exercisable\/ Exercisable\/ Name (#) ($) Unexercisable Unexercisable - ---- -------- -------- ---------------------- --------------------\nVictor A. 0 0 0\/0 0\/0 Rocchio\nMilan L. 0 0 0\/0 0\/0 Elton\nThe outside directors are paid a fee of $1,500 for each meeting attended, $750 for each committee meeting held on a day other than a board meeting day, and an annual retainer of $100 for each year of service on the Board.\nSAVINGS PLAN. The Company maintains a Savings Plan for its employees which is qualified under Section 401(k) of the Internal Revenue Code. Employees can contribute a percentage of their regular salary or wages to the plan on a pre- tax basis. In 1995, the Company matched employee contributions at the rate of 10% to a maximum of $1,000 per employee. Future matching contributions are subject to approval by the Company. Any matching contributions are made in the form of the Company's Common Stock and vest in stages over seven years. Officers, directors and other key employees are also eligible to receive matching contributions effective January 1, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth the number of shares of Common Stock of the Company beneficially owned as of March 15, 1996 by each person known to the Company to be the beneficial owner of five percent or more of the Company's Common Stock, by each director and executive officer, and by all directors and executive officers as a group, and the percentage of outstanding shares so owned at that time: Percentage Name Shares Owned Owned - ---- ------------ ----------\nT. Rowe Price Associates, Inc. 190,000 (1) 8.6% 100 East Pratt Street Baltimore, MD 21202\nVictor A. Rocchio, 338,525 (2) 15.4% Chairman, Treasurer and Director\nMilan L. Elton, 114,750 5.2% President and CEO, Secretary and Director\nRobert S. Erickson, 59,347 2.7% Director\nEdward D. Zimmer, 39,100 1.8% Director\nJohn M. Schulzetenberg, 1,000 * Director\nFrank E. Triplett, 11,407 * Director\nAll directors and officers 564,129 (2) 25.7% as a group (6 in number)\n* Less than one percent.\n(1) Includes shares owned by various individual and institutional investors (including T. Rowe Price Small Cap Value Fund, Inc., which owns 160,000 shares), for which T. Rowe Price Associates, Inc. serves as investment advisor.\n(2) Includes 35,025 shares owned by Mr. Rocchio's spouse.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Not applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as a part of this report.\nPage ----\n1. Financial Statements 12 Independent Auditor's Report 13 Balance Sheets 14 Statements of Earnings 15 Statements of Stockholders' Equity 16 Statements of Cash Flows 17 Notes to Financial Statements 18\n2. Financial Statement Schedules - None\nAll schedules are omitted because they are not applicable or because the required information is included in the financial statements or notes thereto.\n3. Exhibits\n(10) Contract Settlement Agreement 35 with State of Minnesota\n(11) Statement recomputation of 38 per share earnings\n(23) Independent Auditors' Consent 39\n(b) Reports on Form 8-K filed during the last quarter of the period covered - 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.\n(Registrant) Technalysis Corporation ------------------------------------------------------------- By (Signature and Title \/s\/Milan L. Elton, CEO --------------------------------------------------- Milan L. Elton, CEO -------------------------------------------------------- (Date) 3\/18\/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.\nSignature Title Date - --------- ----- ----\nChairman - ------------------------- Treasurer and Director ------------ Victor A. Rocchio\n\/s\/ Milan L. Elton President, CEO 3\/18\/96 - ------------------------- Secretary and Director ------------ Milan L. Elton (Principal Accounting Officer)\nDirector - ------------------------- ------------ Robert S. Erickson\n\/s\/ Edward D. Zimmer Director 3\/18\/96 - ------------------------- ------------ Edward D. Zimmer\n\/s\/ John Schulzetenberg Director 3\/18\/96 - ------------------------- ------------ John Schulzetenberg\n\/s\/ F. E. Triplett Director 3\/18\/96 - ------------------------- ------------ Frank E. Triplett\nEXHIBIT INDEX\nEXHIBIT NO.\n10 Contract Settlement Agreement with State of Minnesota\n11 Statement recomputation of per share earnings\n23 Independent Auditors' Consent\n27 Financial Data Schedule","section_15":""}
{"filename":"23197_1995.txt","cik":"23197","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nComtech Telecommunications Corp. (the \"Company\"), a Delaware corporation, is principally engaged in the design, development, manufacture and installation of high technology electronic products and systems. The Company's communications products are used worldwide for voice, data, facsimile and video transmissions at microwave frequencies in satellite, tropospheric scatter, terrestrial line-of-sight and wireless telecommunications. The Company's solid state high power amplifiers are used in electronic defense, electromagnetic compatibility and susceptibility testing, wireless communications, and high power test instrumentation applications. The Company sells its products directly to end-users, as well as to subcontractors and prime contractors which incorporate such products in full system installations.\nThe Company has been in operation since 1967 and currently has a product line of over 200 products. It sells its products to many of the world's providers of telecommunication services and users of high power electronic test systems, including domestic and foreign common carriers and telephone companies, defense systems, medical and automotive equipment producers, electromagnetic compatibility and susceptibility system suppliers, oil and gas companies (for communicating with offshore platforms) private and wireless networks, broadcasters, cable television operators, utilities and municipal, state and national governments. The Company works closely with customers and potential customers to develop product lines in market niches where it believes that it can become a leading supplier. It believes that this strategy is best effected through decentralized subsidiaries and operating units that can respond quickly to changing market and customer requirements.\nThe Company's products are based primarily on microwave technologies, with the same basic technological concepts being applied across the Company's product lines. In the last decade, the Company's products have increasingly incorporated digital microwave technology. The Company believes its expertise in satellite, troposcatter and wireless telecommunications and solid state high power amplification provides a solid base for the development of future products and services, including new instrumentation and communications products and systems.\nComtech has four operating units, Comtech Antenna Systems, Inc. (\"CASI\"), Comtech Communications Corp. (\"CCC\"), Comtech Microwave Products Corp. (\"CMPC\") and Comtech Systems, Inc. (\"CSI\").\nCASI is a supplier of antenna products used in satellite and troposcatter communication systems. CCC, which was formed in February 1994, designs and manufactures satellite communications products including frequency converters, solid state power amplifiers, low noise amplifiers and satellite subsystems. CMPC supplies state-of-the-art high power solid state amplifiers to meet the needs of the electronic defense, wireless communications and high power test instrument systems and state-of-the-art automated\nelectromagnetic compatibility and susceptibility instrumentation systems. CSI designs, manufactures and installs troposcatter, satellite and terrestrial line- of-sight communications systems and equipment for defense and commercial applications for communicating with offshore oil and gas platforms.\nTELECOMMUNICATIONS OVERVIEW\nTelecommunications Market. The demand for telecommunications is increasing worldwide as emerging economies seek to modernize and as increasingly information-intensive countries introduce new telecommunications services. The telecommunications industry has expanded rapidly during the last decade due to both technological advances and regulatory changes. Regulatory initiatives have enhanced competition in telecommunications, thereby opening new markets and providing incentives for the development of new products. Examples of these changes include the development of facsimile communications, the assignment of radio frequencies to cellular telephone services and the development of private satellite networks. Advances in technology have lowered per-unit communications costs, increased product reliability, and encouraged a proliferation of new and enhanced communications products and services.\nTransmission Technology Options. Customers for telecommunications equipment must weigh the relative costs and advantages of the six presently available transmission technologies: copper cable, fiber optic cable, high frequency radio systems, wireless\nmicrowave systems, tropospheric scatter systems and satellite systems. Rarely is a complete communications network or system based solely on one of these technologies. Transmission is normally routed through a combination of technologies, each employed where most cost-effective. The Company's products are used in satellite, tropospheric scatter and wireless microwave communications.\n. Copper cable, the traditional transmission medium most familiar to consumers, is being replaced and supplemented by the other media, particularly for high-volume and long distance transmissions where it has substantial capacity, cost and reliability limitations.\n. Fiber optic cable is best suited to high-volume, point-to-point, short- or long-distance links where its advantages - capacity, quality and security - justify the long lead time and high cost to equip and install a network.\n. High frequency radio systems (\"HF\") employ long wavelengths which are propagated beyond line-of-sight distances either by surface waves traveling along the earth's perimeter or by skywave reflection of the transmitted waves off different layers of the ionosphere. Communications using HF surface wave propagation are reliable to distances of 300 miles and skywave propagation can support communication ranges of from 50 to 6000 miles. Skywave propagation is, however, subject to the variations in height and density of the ionospheric layers. Such variations are diurnal, seasonal, and cyclical, with the occasional added impact of solar flare disturbances and magnetic storms. Improvements in modern technology and the use of adaptive frequency\nmanagement techniques that enhance propagation prediction have greatly increased HF communication reliability and data throughput. HF radio is used as a prime military and defense communications means for short and medium range applications.\n. Microwave communications systems, generally used for point-to-point communications, employ signals with extremely short wave-lengths which travel only in line-of-sight paths over relatively short distances, generally under 30 miles, can be quickly and easily installed, require relatively low initial capital investment, and can be upgraded and expanded over time. There are a wide variety of microwave communication systems offering different frequencies, modulation techniques (analog or digital), and data transmission capacities.\n. Tropospheric scatter microwave communication systems transmit signals over distances from 30 to 400 miles by reflection of the transmitted signals off the troposphere, an atmospheric layer located approximately seven miles above the earth's surface. These systems, which use microwave technology, are well suited for rapid introduction of service in remote areas or where other communication alternatives are unavailable because of terrain problems, such as large bodies of water, mountains, etc. Such systems offer a high level of reliability and security and are particularly suited to defense and commercial voice and data communication applications. In addition, they have special purpose point-to-point commercial applications, such as communications to offshore gas and oil platforms and along pipelines or railroads.\n. Satellite communications systems have grown and diversified in response to demand for efficient and accurate long-distance voice and video communication and digital information exchange. In a satellite communication system, information is relayed to and from microwave transmitting and receiving stations on the ground by means of a low earth orbit satellite or a geostationary satellite in an equatorial orbit, generally 22,300 miles, above the earth's equator. Satellite communication systems are particularly useful where long-range, high capacity and high quality point-to-point or point-to-multipoint communication is desirable. As few as three geostationary satellites can provide global communications coverage. These systems, which use microwave technology, are well suited for rapid introduction of service in remote areas or where communication alternatives are unavailable, such as mobile, shipboard or military applications. Satellite systems require a sizeable initial capital investment by service providers to build and launch. Once the satellites are in orbit, however, there are substantial incentives to use this capacity, which typically requires continued investment in satellite earth stations.\nAMPLIFIER TECHNOLOGY OVERVIEW\nIncluded in the Company's products are solid state high power amplifiers. Amplifiers are a class of electronic apparatus that reproduce signals with greater power, current or voltage amplitude. Indispensable in the world of signal processing, amplifiers can be as tiny\nas a microchip for a hearing aid or as massive as a multi-story building for transmitting radio signals to submerged submarines. Although the majority of amplifier applications are satisfied by solid-state transistor and integrated circuit technology, vacuum tubes still play an important role in the very high power microwave applications.\nAmplifiers can be separated into three groups: DC Amplifiers, Audio Frequency Amplifiers, and Radio Frequency Amplifiers. Each group can, in turn be segregated into the general categories of Small Signal Amplifiers and the higher power Large Signal Amplifiers. Small Signal Amplifiers in all three groups employ solid-state technologies to create flexible, easily implemented microelectronic building blocks, and are produced by established semiconductor manufacturers as either catalog products or custom devices for special applications specified by end-item products suppliers.\nThe Company's solid-state high power amplifiers are in the category of Large Signal Amplifiers in the Radio Frequency Spectrum. Radio Frequency Large Signal Amplifiers are used in telecommunications, defense systems and instrumentation applications, where they are employed to amplify radio frequency (\"RF\") energy for the emission of signals. Other applications are as power supply sources of RF energy for lasers and for the cyclotrons used in atomic physics. Solid-state transistor technology dominates the field at output power levels up to 3000 watts for radio frequencies up to 2000 Mhz. At higher frequencies, electron tube technology continues to be the most economical means of achieving high power at acceptable instantaneous bandwidths. For applications that require both high power and narrow bandwidths, electron tubes are still used at frequencies extending down to the commercial broadcast bands. Because of their greater instantaneous bandwidths, greater reliability and generally smaller size, however, solid-state amplifiers are constantly being sought as replacements for vacuum tube amplifiers for all applications throughout the useable frequency spectrum.\nIn telecommunications, solid-state high power amplifiers are used to amplify signals for radiation from transmitting antennas in satellite or wireless telecommunications systems. They are also used to amplify signals in defense radar and electronic jamming systems. In the laboratory, solid-state high power amplifiers are used to test the performance of high power microwave and cellular electronic system components by simulating operating environment conditions.\nSolid-state high power amplifiers are also used in electromagnetic compatibility and susceptibility testing. The proliferation of electronic systems in products such as automobiles, computers, cellular telephones, radios, televisions, medical equipment, sound amplifiers, aircraft and other products has led to increasingly serious problems with electromagnetic interference. Manufacturers, therefore, test these electronic systems for electromagnetic compatibility and susceptibility. For example, such testing may be used to determine whether the various electronic systems in a commercial aircraft are likely to be affected by the use of laptop computers or video games by passengers in flight.\nNARRATIVE DESCRIPTION OF BUSINESS\nThe Company's product designs are based on both analog and digital microwave technologies. Digital microwave technology can significantly enhance performance. The\nCompany has invested significant resources in developing its technological expertise, and works closely with customers and potential customers to develop product lines in market niches where it believes its technical expertise in solid-state high power amplification and telecommunication technologies can enable it to become a leading supplier.\nThe Company operates through subsidiaries, each of which maintains its own sales, marketing, product development and manufacturing functions. The Company believes that this organizational structure allows the key personnel of each subsidiary, some of which are the founders of their subsidiaries, to be more responsive to their particular markets and customers. Brief descriptions of the operations of the Company's subsidiaries follow.\nCOMTECH ANTENNA SYSTEMS, INC. (\"CASI\")\nCASI, located in St. Cloud, Florida, designs and manufactures a wide variety of fiberglass and aluminum antennas for tropospheric scatter and satellite communication applications, including distributed network programming, cable and broadcast television, radio and other forms of information and entertainment distribution. CASI designs antennas for specific types of telecommunications systems and, typically, sells standardized products to independent distributors, prime contractors and end user customers. CASI's antenna product line includes fixed and mobile antenna systems and specialized multi-beam satellite antenna systems that are capable of receiving signals simultaneously from many independent satellites located up to 60 degrees apart.\nCOMTECH COMMUNICATIONS CORP. (\"CCC\")\nCCC, located in Tempe, Arizona, designs and manufactures equipment used in commercial and defense satellite communications applications with satellites operating in the C, X and Ku-bands. The equipments include frequency up converters (which convert the intermediate frequency (\"IF\") carrier to high frequency transmit carrier, frequency down converters (which convert the higher frequency transmit carrier to an IF carrier at the receive end), solid state power amplifiers (which provide the final amplification of the transmit carriers to a signal sufficient for transmission) in the C, X and Ku-frequency bands, and low noise amplifiers (which amplify the transmit carrier at the receive end). These products comprise a broad range of receiving and transmitting equipment offering a variety of state-of-the-art technical capabilities with respect to performance, degree of complexity and value.\nCOMTECH MICROWAVE PRODUCTS CORP. (\"CMPC\") GOVERNMENT SYSTEM DIVISION (\"GSD\")\nGSD, located in Melville, New York, designs and manufactures equipment for satellite earth stations. GSD's products and services are marketed to agencies of the United States and foreign governments, as well as other prime contractors serving such end users. These products comprise a range of receiving and transmitting equipment offering a variety of technical capabilities with respect to both performance and degree of complexity. GSD's products include frequency up and down converters, high power klystron tube amplifiers (which provide the final amplification of the transmit carriers to a signal strength sufficient for transmission) and control, monitoring and alarm components. GSD also supports and\nservices sophisticated cryogenically cooled low noise parametric amplifiers, which are used in receiving down links of satellite telecommunication earth stations and monitoring telemetry data systems from deep space probing vehicles.\nPOWER SYSTEMS TECHNOLOGY DIVISION (\"PST\")\nPST, headquartered in Melville, New York, designs, develops and manufactures solid state high power amplifiers for defense, communications, and for instrumentation systems. It sells its products to domestic and foreign commercial users, governmental agencies and prime contractors. The Company believes that PST has emerged as an innovative supplier of solid state high power amplifiers and related power processing equipment, which products also replace amplifiers using vacuum tube systems. PST is extending its ability to serve commercial wireless and electromagnetic compatibility and susceptibility amplification markets.\nSCIENTIFIC POWER SYSTEMS DIVISION (\"SPS\")\nSPS, located in Melville, New York, designs, develops and manufactures state-of-the-art automated electromagnetic compatibility and susceptibility instrumentation equipments and systems for commercial and defense applications incorporating solid state high power amplifiers manufactured by PST and high power electron tube amplifiers manufactured by SPS, thereby producing an instrumentation product line over a wide range of radio frequencies and power levels. SPS's systems are expanding the Company's product line in the growing electromagnetic compatibility and susceptibility instrumentation market.\nCOMTECH SYSTEMS, INC. (\"CSI\")\nCSI, headquartered in St. Cloud, Florida, designs, manufactures and installs telecommunication systems and equipment for domestic and international applications. CSI supplies telecommunication systems incorporating equipment manufactured by it, other Comtech subsidiaries and third parties. Currently, a significant portion of CSI's sales are for tropospheric scatter communication products and systems sold to oil and gas companies.\nCSI's product line consists primarily of equipment for tropospheric scatter and satellite systems and networks. CSI has a turnkey capability that ranges from system and network planning through equipment and system training and operation and maintenance programs. CSI's products and services are marketed to oil and gas companies and other commercial users, foreign defense commands, and other system prime contractors. The Company believes that CSI's products, which employ digital transmission technology, offer high speed data benefits over the traditional analog tropospheric scatter products offered by most of its competitors.\nSALES, MARKETING AND CUSTOMER SUPPORT\nThe Company's sales and marketing efforts are handled independently by each subsidiary. The sales and marketing strategy of the Company's subsidiaries vary with particular markets served, and include direct sales by the subsidiary's own sales force (sales, marketing and engineering personnel), sales through independent representatives, value-\nadded resellers or a combination of the foregoing. Subsidiaries have also entered into sales distribution agreements for certain products with distributors. Unlike sales representatives, who merely find customers for the Company on a commission basis, distributors purchase products from the Company for resale. The Company intends to continue to expand its domestic and international marketing efforts through both independent sales representatives and distributors.\nRelationships with customers are established and maintained by management, technical and marketing personnel. The Company's strategy includes a commitment to provide ongoing customer support for its systems and equipment. This support involves providing direct access to engineering staff or trained technical representatives to resolve technical or operational problems.\nThe Company's sales of tropospheric scatter communications, satellite communications and solid state high power amplifier products internationally represented approximately 37%, 39% and 62% of net sales in the fiscal years ended July 31, 1995, 1994 and 1993, respectively. Although the percentage of the Company's total net sales to international customers has declined over the past three years, such sales are expected to increase due to the global expansion of telecommunications and microwave instrumentation, particularly in Asia, South America, the Middle East and Europe and the Company expects that international sales will remain a substantial proportion of its total sales.\nIn fiscal 1995, there were no total sales to any one customer which amounted to over 10% of the consolidated net sales. During fiscal 1994, sales to one foreign customer amounted to $3,410,000, or 23% of consolidated net sales. During fiscal 1993, sales to two foreign customers amounted to $4,035,000 and $2,520,000, or 18% and 11% of consolidated net sales, respectively.\nInternational sales expose the Company to certain risks, including barriers to trade, fluctuations in foreign currency exchange rates (which may make the Company's products less price competitive), political and economic instability, availability of suitable export financing, export license requirements, tariff regulations, and other United States and foreign regulations that may apply to the export of the Company's products, as well as the generally greater difficulties of doing business abroad. The Company attempts to reduce the risk of doing business in foreign countries by seeking contracts denominated in United States dollars, advance payments and irrevocable letters of credit in its favor.\nAlthough the percentage of the Company's total net sales to agencies of the United States or to contractors or subcontractors under contracts with United States agencies has declined over the past five years, such sales remain significant, accounting for approximately 14%, 17% and 18% of total net sales for the fiscal years ended July 31, 1995, 1994 and 1993, respectively. These sales are subject to various risks, regulatory provisions applicable to government contracts, including, among other things, unpredictable reductions in funds available for the Company's projects and contract termination at the convenience of the government. Government contracts are generally less profitable than contracts with private industry but typically provide progress payment funding.\nThe Company attributes the decline in Government sales and orders principally to\nreduced United States defense spending. The Company anticipates that United States defense spending will remain at reduced levels for the foreseeable future.\nThe Company's domestic sales represented approximately 49%, 44% and 20% of net sales in the fiscal years ended July 31, 1995, 1994 and 1993, respectively. Domestic sales are expected to increase due to the expansion of wireless and satellite telecommunications, and microwave electromagnetic compatibility instrumentation and the Company expects that domestic sales will remain a substantial proportion of its sales.\nThere is no material effect on the Company's capital expenditures, earnings or competitive position resulting from compliance with Federal, state or local environment protection laws.\nBACKLOG\nThe Company's backlog as of July 31, 1995 and 1994 was approximately $10,242,000 and $5,003,000, respectively. Substantially all of the backlog as of July 31, 1995 is expected to be recognized as sales during the fiscal year ending July 31, 1996. The Company had received progress billings and advance payments aggregating approximately $414,000 as of July 31, 1995 in connection with orders included in the backlog at that date. Approximately 16% of that backlog consisted of United States government contracts, subcontracts and government funded programs, approximately 51% consisted of orders with foreign customers and approximately 33% consisted of orders with domestic commercial customers.\nAll of the contracts in the Company's backlog are subject to cancellation at the convenience of the customer or for default in the event that the Company is unable to complete the contract.\nVariations in backlog from time to time are attributable in part to the timing of the Company's preparation and submission of contract proposals, the timing of contract awards and the delivery schedules on specific contracts. As a result, management believes its backlog at any point in the fiscal year is not necessarily indicative of the total sales anticipated for any particular future period. New business orders for some of the Company's products may not be reflected in the revenues of the Company for a year or more. CASI's business, as well as a major portion of CMPC's and CCC's businesses, operate under a short lead time and usually generate sales out of inventory.\nMANUFACTURING\nThe Company's manufacturing operations consist principally of the assembly and testing of electronic products designed by the Company and built by it from purchased fabricated parts, printed circuits and electronic components and, in the case of CASI, the casting of fiberglass antennas and the shaping of aluminum antennas. The Company employs formal quality management programs and other training programs, and expects to qualify its subsidiaries for the International Standards Organization's (ISO 9000) quality procedure registration programs, which is anticipated to be required in the future for product sales into the European Community.\nThe Company's ability to deliver its products to customers on a timely basis is dependent in part upon the availability and timely delivery by subcontractors and suppliers of the components and subsystems that are used by the Company in manufacturing its products. Electronic components and raw materials used in the Company's products are generally obtained from independent suppliers. Some components are standard items and are available from a number of suppliers. Others are manufactured to the Company's specifications by subcontractors. The Company obtains certain components and subsystems from a single source or a limited number of sources. The Company believes that most components and equipment are available from existing or alternative suppliers and subcontractors. A significant interruption in the delivery of such items could have a material adverse effect on the Company's business and results of operations.\nRESEARCH AND DEVELOPMENT\nThe technology used in the Company's products is subject to rapid development and frequent change, and the Company's business position is in large part contingent upon the continuous refinement of its scientific and engineering expertise and the development, either through internal research and development or acquisitions of new or enhanced products and technologies.\nResearch and development expenses were $1,036,000, $760,000 and $314,000 in the fiscal years ended 1995, 1994 and 1993, respectively, representing 6.3%, 5.1% and 1.4% of total net sales, respectively, for such periods.\nA portion of the Company's research and development efforts is related to specific contracts and is recoverable under such contracts, and such expenditures are not included in research and development expenses for financial reporting purposes. During the fiscal years ended July 31, 1995, 1994 and 1993, the Company was reimbursed in the amounts of $382,000, $178,000 and $364,000, respectively, representing 2.3%, 1.2% and 1.6%, respectively, of total net sales by customers for such activities.\nThe Company obtains customer funding for research and development where possible to adapt the Company's basic technology to specialized customer requirements.\nPATENTS AND LICENSES\nAlthough the Company owns or holds licenses for a number of patents, patents and licenses have been of substantially less significance in the Company's business than have been its scientific and engineering know-how, production techniques, the timely application of its technology and the design development and marketing capabilities of its personnel. The Company relies on the laws of unfair competition, restrictions in licensing agreements and confidentiality agreements to protect such knowledge and techniques.\nCOMPETITION\nThe Company's business is highly competitive and characterized by rapid technological change. In addition, the number of potential customers for the Company's products is limited. The Company's growth and financial position depends, among other\nthings, on its ability to keep pace with such changes and developments and to respond to the sophisticated requirements of an increasing variety of electronic equipment users. Many of the Company's competitors are substantially larger, have significantly greater financial, marketing and operating resources and broader product lines than does the Company. A significant technological breakthrough by others, including smaller competitors or new companies, could have a material adverse effect on the Company's business. In addition, certain of the Company's customers have technological capabilities in the Company's product areas and could choose to replace the Company's products with their own.\nThe Company believes that competition in its markets is based primarily on price, product performance, reputation, delivery times and customer support. The Company believes that, due to its organizational structure and proprietary know-how, it has the ability to develop, produce and to deliver equipment on a cost-effective basis faster than many of its competitors.\nKEY PERSONNEL\/EMPLOYEES\nThe Company operates through a number of subsidiaries, an organizational structure which the Company believes fosters responsiveness to specific markets and customers. This structure, however, leaves the Company with less central control over the operations of its subsidiaries. The Company's success is dependent upon the continued contributions of its key management personnel, including the key management at each of its subsidiaries and depends to a significant extent upon its President and Chief Executive Officer. Many of the Company's key personnel, particularly the key engineers of its subsidiaries, would be difficult to replace, and are not subject to employment or non- competition agreements. The Company's growth and future success will depend in large part upon its ability to attract and retain highly qualified engineering, sales and marketing personnel. Competition for such personnel from other companies, academic institutions, government entities and other organizations is intense. Although the Company has been successful to date in recruiting and retaining key personnel, there can be no assurance that the Company will be successful in attracting and retaining the personnel it requires in order to continue to grow and operate profitably. Also, there can be no assurance that management skills which have been appropriate for the Company in the past will continue to be appropriate if the Company continues to grow and diversify.\nAt July 31, 1995, the Company had 188 employees, 106 of whom were engaged in production and production support, 46 in research and development and other engineering support and 36 in marketing and administrative functions. None of the employees is represented by a labor union. The Company believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate offices are located in a portion of the 46,000 square foot facility on 2 acres of land in Melville, New York which also houses CMPC and its divisions.\nThe Company leases this facility in Melville, New York from a partnership controlled by the Company's Chairman, Chief Executive Officer and President. The lease, as amended, provides for the Company's exclusive use of the premises as they now exist for an initial\nterm of ten years through December 27, 2001. The Company has the option to extend the term of the lease for an additional ten-year period and a right of first refusal in the event of a sale of the facility. The base annual rental under the lease is subject to adjustments. The Company believes that the terms of this lease are not less advantageous to the Company than those that would have been available to the Company from an unrelated party.\nThe Company leases the 32,000 square foot facility used by CASI and CSI and the nine and one-half acres of land on which the facility is situated in St. Cloud, Florida from a Florida land trust, controlled by the Company's Vice President and Chief Financial Officer. The lease provides for the Company's exclusive use of the premises as they now exist for a term of ten years through September 30, 1998. The base annual rental under the lease is subject to adjustments. The Company believes that the terms of this lease are not less advantageous to the Company than those that would have been available to the Company from an unrelated party.\nThe Company leases a 10,000 sq. ft. building in Tempe, Arizona for its Comtech Communications Corp. subsidiary. The lease provides for the exclusive use of the premises as they now exist for a term of five years through February 1999.\nThe Company also owns an approximately 4,000 square foot facility in Hauppauge on a one-acre plot of land. This facility currently is used for general storage.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to certain legal actions which arise out of the normal course of business. It is management's belief that the outcome of these actions will not have a material 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 to stockholders during the fourth quarter of the fiscal year ended July 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 traded on the NASDAQ National Market System under the symbol \"CMTL\". The following table sets forth the range of high and low closing sales prices for the Common Stock, as reported by NASDAQ. Such prices do not include retail markups, markdowns, or commissions.\nDIVIDENDS\nThe Company has never paid a cash dividend on its Common Stock and the Company's Board of Directors intends to continue this policy for the foreseeable future. Earnings, if any, will be used to finance the development and expansion of the Company's business.\nAPPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS\nAs of October 17, 1995, there were approximately 1,500 holders of the Company's Common Stock. Such number of record owners was determined from the Company shareholders' records and does not include beneficial owners of the Company's Common Stock, held in the names of various security holders, dealers and clearing agencies.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nEarnings per share data presented herein for 1991 has been adjusted retroactively for the Company's one for five share reverse stock split effected on January 8, 1991.\n(1) Reflects $817,000 relating to an income tax refund that was recorded as a $351,000 reduction of income tax expense and $466,000 of interest income.\n(2) Represents an extraordinary gain for the early retirement of debt, net of applicable income taxes of $46,000, pursuant to which the Company reissued to Storage Technology Corporation a warrant to purchase 90,000 shares of Common Stock at $7.50 per share. The warrants expired unexercised in September 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, certain income and expense items expressed as a percentage of the Company's net sales:\nCOMPARISON OF THE FISCAL YEARS 1995 AND 1994\nRESULT OF OPERATIONS\nNET SALES. Net sales were $16,455,000 and $14,873,000 for the fiscal years ended July 31, 1995 and 1994, respectively, representing an increase of $1,582,000 or 11%. This increase was primarily due to an increase in domestic commercial sales, principally sales at the Comtech Communications Corp. subsidiary which was formed in February 1994 and commenced significant levels of shipments of products in the latter part of fiscal 1995. International sales represented approximately 37% and 39% of total net sales for fiscal 1995 and 1994, respectively. Although the Company has been experiencing delays and deferrals of orders in the international marketplace, it expects that international sales will remain a significant proportion of its total sales. Sales to agencies of the United States Government or to end users of such agencies (\"Government Sales\") represented approximately 14% and 17% of total net sales for fiscal 1995 and 1994, respectively. The Company anticipates that Government Sales will remain at reduced levels for the foreseeable future due to the reduction in United States defense spending. Domestic sales are anticipated to increase due to the expansion of wireless and satellite telecommunications and microwave electromagnetic compatibility instrumentation.\nGROSS MARGIN. Gross profit was $4,359,000 or 26.5% of net sales in fiscal 1995 as compared to $2,647,000 or 17.8% of net sales in fiscal 1994. The lower gross margins in the fiscal 1994 period were attributable to technical difficulties experienced with respect to certain projects. Additionally, improved margins were experienced in fiscal 1995 in system sales and a product mix of equipment sales.\nSELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses were $4,658,000 or 28.3% of net sales and $4,706,000 or 31.6% of net sales in fiscal 1995 and 1994, respectively, representing a modest decline of approximately 1%. Increased amounts of expenses in these areas at the Comtech Communications Corp. subsidiary, due to its growth and development, partially offset the decrease which was realized at the other subsidiaries as a result of the cost reduction measures we instituted.\nRESEARCH AND DEVELOPMENT. Research and development expense were $1,036,000 and $760,000 in fiscal years ended July 31, 1995 and 1994, respectively, representing an increase of $276,000 or 36%. Research and development expenses as a percentage of net sales were 6.3% and 5.1% in fiscal 1995 and 1994, respectively. The increase was due to increased research and development and product development costs at Comtech Communications Corp. subsidiary.\nWhenever possible, the Company seeks customer-funding for research and development to adapt the Company's products to specialized customer requirements. During the fiscal years ended July 31, 1995 and 1994, the Company was reimbursed $382,000, and $178,000, respectively.\nOPERATING EARNINGS. As a result of the foregoing factors, the Company had a operating loss of $1,335,000 in fiscal 1995 as compared to a loss of $2,819,000 in fiscal 1994.\nINTEREST EXPENSE. Interest expense was $341,000 and $279,000 in the fiscal years ended July 31, 1995 and 1994, respectively. Interest expense in both years was substantially due to interest associated with the Company's capital lease obligations. There was no borrowing against the Company's bank line of credit in either year.\nINTEREST INCOME. Interest income for the fiscal years ended July 31, 1995 and 1994 was $171,000 and $253,000, respectively. This decrease was due primarily to the decrease in the amount of cash available to invest in the fiscal 1995 period.\nPROVISION FOR INCOME TAXES. The provision for income taxes was $17,000 and $25,000 in fiscal 1995 and 1994, respectively, which principally relates to state income taxes. The Company believes its tax benefits are subject to 100% valuation allowance due to earnings fluctuations inherent in the Company's operations and the potential limitations on utilization of loss and credit carry forwards pursuant to Sections 382 and 383 of the Internal Revenue code of 1986.\nCOMPARISON OF THE FISCAL YEARS 1994 AND 1993\nRESULT OF OPERATIONS\nNET SALES. Net sales were $14,873,000 and $22,265,000 for the fiscal years ended July 31, 1994 and 1993, respectively, representing a decrease of $7,392,000 or 33.2%. This decrease consisted of a decline in International sales of approximately $7,899,000 and a decrease in Government sales of $1,526,000 which were partially offset by an increase in domestic Commercial sales of $2,033,000. International sales represented approximately 39% and 62% of total net sales for fiscal 1994 and 1993, respectively. Government sales represented approximately 17% and 18% of the total net sales during such periods, respectively. Decreased net sales were primarily the result of decreases in the amount of equipment and systems sold rather than decreased unit prices.\nThe Company experienced delays and deferrals of orders, primarily in the international marketplace, which contributed to the decrease in sales recognized for fiscal 1994.\nGROSS MARGIN. Gross profit was $2,647,000, or 17.8% of net sales in fiscal 1994 as compared to $6,487,000, or 29.1% of net sales in fiscal 1993. The net decrease in gross margins was partially attributable to previously reported technical difficulties experienced with respect to certain projects (which have been resolved), generally lower gross margins on our solid state amplifier products and lower gross margins on Government Sales.\nDuring the fourth quarter, charges for potential losses on a major project reduced gross profit by $650,000 inclusive of a $475,000 reserve and a charge to income of $175,000 due to revisions of profit estimates. These charges pertained to the Company's inability to achieve anticipated production efficiencies due to customer requested delivery deferrals.\nSELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses were $4,706,000 and $4,420,000 in fiscal 1994 and 1993, respectively, representing an increase of $286,000, or 6.5%. This increase was primarily attributable to the expanded efforts in these areas at the Comtech Microwave Products Corp. SPS division and the initial expenses of the Comtech Communications Corp. subsidiary.\nIn general, equipment sales require relatively higher selling, general and administrative expenses than system sales.\nRESEARCH AND DEVELOPMENT. Research and development expense were $760,000 and $314,000 in fiscal years ended July 31, 1994 and 1993, respectively, representing an increase of $446,000 or 142%. Research and development expenses as a percentage of net sales were 5.1% and 1.4% in fiscal 1994 and 1993, respectively. The increase was due primarily to increased research and development efforts at the Comtech Microwave Products Corp. SPS division, general product improvements at Comtech Systems, Inc. and product development costs associated with the Comtech Communications Corp. subsidiary.\nDuring the fiscal years ended July 31, 1994 and 1993, the Company was reimbursed $178,000, and $364,000, respectively, by customers for such activities, representing 1.2% and 1.6% of total sales, respectively.\nOPERATING EARNINGS. As a result of the foregoing factors, the Company had a loss of $2,819,000 in fiscal 1994 as compared to earnings of $1,753,000 in fiscal 1993.\nINTEREST EXPENSE. Interest expense was $279,000 and $321,000 in the fiscal years ended July 31, 1994 and 1993, respectively. Interest expense incurred in fiscal 1994 was attributable solely to the Company's capitalized lease obligations.\nINTEREST INCOME. Interest income for the fiscal years ended July 31, 1994 and 1993 was $253,000 and $47,000, respectively. This increase was due primarily to the increased cash available to invest as a result of our July 1993 public offering.\nPROVISION FOR INCOME TAXES. The provision for income taxes was $25,000 and $45,000 in fiscal 1994 and 1993, respectively, which principally relates to state income taxes and a federal provision for alternative minimum taxes. In 1993, the Company was able to use its net operating loss carryforwards for United States federal income tax purposes. Effective August 1, 1994, the Company adopted SFAS 109 \"Accounting for Income Taxes.\" The\nCompany applied the provisions of the statement without restating prior years financial statements. No benefit was provided for operating losses in fiscal 1994 because they were subject to a 100% valuation allowance due to earnings fluctuations inherent in the Company's operations and the potential limitations on utilization of loss and credit carry forwards pursuant to Sections 382 and 383 of the Internal Revenue Code of 1986.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash and cash equivalents position increased by $1,514,000 from $505,000 at July 31, 1994 to $2,019,000 at July 31, 1995. This increase resulted from the reduction in investments in marketable securities by $5,090,000. The additional cash was necessary to fund the Company's working capital, capital asset purchase requirements and net loss it sustained for the year.\nOperating activities used $2,476,000 in cash. This was the result of the net loss, an increase in accounts receivable, inventories, prepaid expenses and other assets, a decrease in accrued expenses and other current liabilities partially offset by an increase in accounts payable.\nAccounts receivable were $4,490,000 at July 31, 1995 as compared to $3,778,000 at July 31, 1994, net of an allowance for doubtful accounts of $137,000 in fiscal 1995 and $136,000 in fiscal 1994. Of these amounts, $3,570,000 and $2,581,000, respectively, represented amounts due from customers for products and services rendered as of July 31, 1995 and July 31, 1994, and the balances of $920,000 and $1,197,000, respectively, represented unbilled amounts for sales recorded on a percentage-of-completion basis as of such dates. The portion of accounts receivable represented by unbilled accounts receivable will vary at any time as a function of the volume of contracts being performed by the Company that are accounted for on a percentage-of-completion basis. The Company believes that its allowance for doubtful accounts is sufficient based on past experience and the Company's credit standards. The Company generally requires international customers to secure their obligations by letter of credit.\nInventory levels of materials and components and work-in-process, net of progress payments and reserves were $5,011,000 and $3,891,000, respectively for fiscal years ended July 31, 1995 and 1994. This increase was primarily due to the additional inventory required to address the increased backlog at year end. The Company generally operates on a job-order cost basis, that is, costs are incurred as work-in-process inventory for specific contracts or \"jobs\" and, accordingly, inventory levels will vary as a function of the status of the Company's order backlog. The Company does have some product lines which require a more competitive response to customers requirements and require the company to provide for a level of \"off-the-shelf\" equipment. The only other general inventory that the Company maintains is for basic components which are common for most of its products.\nAccounts payable increased by $531,000, primarily as a result of the increased purchases needed for the higher inventory level.\nInvesting activities provided $4,544,000 of cash as a result of the proceeds from the sale of marketable securities partially offset by purchases of capital equipment. This\nequipment was primarily needed by the Comtech Communications Corp. subsidiary as they continued to develop to the production stage and at the Comtech Microwave Products Corp. subsidiary to respond to increased operating levels.\nFinancing activities used $560,000 of cash for principal payments of long- term debt.\nFrom time to time the Company utilizes short-term bank financing to fund its working capital requirements. The Company has a $4.5 million credit facility which expires on January 31, 1996. The facility is to finance working capital requirements and is available for direct borrowing and standby letters of credit. Direct borrowings under the line will bear interest at 1% over the prime rate and is secured at the time of borrowing with collateral satisfactory to the financial institution. There were no borrowings under the Company's credit facility during fiscal 1995.\nThe Company believes that its current cash position, funds generated from operations and funds available from its current credit facility, collectively, would be adequate to meet the Company's cash requirements.\nThe Company's cash investments consist of highly liquid interest bearing commercial grade securities and certificates of deposit.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Report, Consolidated Financial Statements, Notes to Consolidated Financial Statements and related financial schedules are listed in the index to Consolidated Financial Statements and Schedules annexed hereto.\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 REGISTRANT\nCertain information concerning the directors of the Company is incorporated by reference to the Proxy Statement of the Company for the Annual Meeting of Stockholders to be held December 19, 1995 (the \"Proxy Statement\") which will be filed with the Securities and Exchange Commission.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------\nMr. Kornberg has been Chief Executive Officer of the Company since 1976 and President of the Company during the periods 1974 to May 1982 and April 1984 to the present.\nDr. Bugliarello is Chancellor of Polytechnic University since 1994 and was President of the University since 1973. He is also a director of Long Island Lighting Company and Symbol Technologies, Inc.\nMr. Goldberg has been a partner since 1990 in the law firm Proskauer Rose Goetz & Mendelsohn, attorneys which render legal services to the Company. Prior to that, Mr. Goldberg was a partner since 1966 of the firm Botein Hays & Sklar. He is also a director of Anthony Industries, Inc..\nMr. Nocita is presently Treasurer of the Incorporated Village of Patchogue. Previously, he was affiliated with the Company since its inception in 1967 until his retirement in 1993. He had been Treasurer of the Company since 1987 and Vice President and Secretary since 1990.\nMr. Payne has been a founder, Chairman, President and Chief Executive Officer of Nucomm, Inc. since 1990. From 1973 to 1990, he was a founder, Chairman, President and Chief Executive Officer of Communication Techniques, Inc.\nMr. Weiner is President of Sol S. Weiner Investments, Inc. since 1995. Previously he was Managing Director of Stenhouse, Weiner, Sherman Ltd., commodity pool managers, since March 1982. He is also a director of Anthony Industries, Inc..\nMr. Burt has been President of Comtech Systems, Inc. since 1989 and Vice President since its founding in 1984. He first joined the Company in 1979 as Director of Marketing of the Comtech Government Systems Division. He became Vice President of the Company in 1992.\nMr. Higgins has been President of Comtech Antenna Systems, Inc. since 1989 and Vice President since its acquisition in 1977. He became Vice President of the Company in 1992.\nMr. Javits has been Vice President of the Company since 1987. He has been President of Comtech Government Systems Division of Comtech Microwave Products Corp. subsidiary since 1984 and has been employed by the Company since 1977.\nMr. Windus was appointed Vice President, Chief Financial Officer and Secretary in September 1993 and President of Comtech Microwave Products Corp. in 1994. He was President and Chief Operating Officer at Fairchild Data Corporation from 1991 to 1993 and Executive Vice President from 1989 to 1991. From 1981 to 1989, he was President of Comtech Systems, Inc..\nThe terms of office of each of the Executive Officers named above runs until the next Annual Meeting of the Board of Directors or until his successor is elected and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated by reference to the Company's Proxy Statement which will be filed with the Securities and Exchange Commission no more than 120 days after close of its fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding security ownership of certain beneficial owners and management is incorporated by reference to the Company's Proxy Statement which will be filed with the Securities and Exchange Commission no later than 120 days after the close of its fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is incorporated by reference to the Company's Proxy Statement which will be filed with the Securities and Exchange Commission no more 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) Documents filed as part of this report:\n1. and 2. Financial Statements and Financial Statement Schedules\nThe Financial Statements filed as part of this report are listed in the accompanying Index to Consolidated Financial Statements and Schedules.\nExhibits to this Annual Report on Form 10-K are available upon request for a fee to the Company of $25.\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.\nCOMTECH TELECOMMUNICATIONS CORP.\nOctober 27, 1995 By: s\/Fred Kornberg ---------------------------- -------------------------------------- (Date) Fred Kornberg, Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title --------- -----\n10\/27\/95 s\/Fred Kornberg Chairman of the Board -------- -------------------------- Chief Executive Officer (Date) Fred Kornberg and Director (Principal Executive Officer)\n10\/27\/95 s\/J. Preston Windus, Jr. Vice President, -------- -------------------------- (Date) J. Preston Windus, Jr. Chief Financial Officer and Secretary\n10\/27\/95 s\/George Bugliarello Director -------- -------------------------- (Date) George Bugliarello\n10\/27\/95 s\/Richard L. Goldberg Director -------- -------------------------- (Date) Richard L. Goldberg\n10\/27\/95 s\/Gerard R. Nocita Director -------- -------------------------- (Date) Gerard R. Nocita\n10\/27\/95 s\/John B. Payne III Director -------- -------------------------- (Date) John B. Payne III\n10\/27\/95 s\/Sol S. Weiner Director -------- -------------------------- (Date) Sol S. Weiner\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nIndex to Consolidated Financial Statements\nIndependent Auditors' Reports\nConsolidated Financial Statements:\nBalance Sheets at July 31, 1995 and 1994\nStatements of Operations for each of the years in the three year period ended July 31, 1995\nStatements of Stockholders' Equity for each of the years in the three year period ended July 31, 1995\nStatements of Cash Flows for each of the years in the three year period ended July 31, 1995\nNotes to Consolidated Financial Statements\nAdditional Financial Information Pursuant to the Requirements of Form 10-K:\nSchedule II - Valuation and Qualifying Accounts and Reserves\nExhibit 11 - Computation of Earnings (Loss) Per Share\nSchedules not listed above have been omitted because they are either not applicable or the required information has been given elsewhere in the consolidated financial statements or notes thereto.\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders Comtech Telecommunications Corp.:\nWe have audited the consolidated balance sheets of Comtech Telecommunications Corp. and subsidiaries as of July 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 July 31, 1995. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule II 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 Comtech Telecommunications Corp. and subsidiaries as of July 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 July 31, 1995 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule II, 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 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No.115, \"Accounting for Certain Investments in Debt and Equity Securities\" in fiscal 1995 and No.109, \"Accounting for Income Taxes\" in fiscal 1994.\nKPMG PEAT MARWICK LLP\nJericho, New York October 18, 1995\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nConsolidated Balance Sheets\nJuly 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nConsolidated Statements of Operations\nYears ended July 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nConsolidated Statements of Stockholders' Equity\nYears ended July 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nYears ended July 31, 1995, 1994 and 1993\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows, Continued\nSee accompanying notes to consolidated financial statements.\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nJuly 31, 1995 and 1994\n(1) Summary of Significant Accounting and Reporting Policies --------------------------------------------------------\n(a) Principles of Consolidation ---------------------------\nThe accompanying consolidated financial statements include the accounts of Comtech Telecommunications Corp. and its subsidiaries (the Company), all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation.\n(b) Nature of Business ------------------\nThe Company is engaged in the design, development, manufacture and installation, for commercial and government applications, of high technology communications and radio frequency amplifier equipment.\n(c) Revenue Recognition -------------------\nSales on long-term, fixed price contracts, including pro-rata profits, are generally recorded based on the relationship of total costs incurred to date to total projected final costs or, alternatively, as progress billings or deliveries are made. Sales under cost reimbursement contracts are recorded as costs are incurred.\nSales on other contract orders are recognized under the units of delivery method. Under this method, sales are recorded as units are delivered with the related cost of sales recognized on each shipment based upon a percentage of estimated final contract costs. Contract costs include material, direct labor, manufacturing overhead and other direct costs. Retainages and estimated earnings in excess of amounts billed on certain multi-year programs are reported as unbilled receivables.\nSales not associated with long-term contracts are generally recognized when the earnings process is complete, generally upon shipment or customer acceptance.\nProvision for anticipated losses on uncompleted contracts are made in the period in which such losses are determined.\n(d) Cash and Cash Equivalents -------------------------\nCash equivalents consist of highly liquid direct obligations of the United States government with a maturity at acquisition of three months or less. These investments are carried at cost plus accrued interest, which approximates market. At July 31, 1995, the Company had $25,000 of restricted cash securing letter of credit obligations with a financial institution.\n(e) Statement of Cash Flows -----------------------\nThe Company acquired equipment financed by capital leases in the amounts of $383,000, $204,000 and $349,000 in 1995, 1994 and 1993, respectively. In January 1994, the Company issued a $250,000 note payable in connection with the purchase of equipment and an intellectual property rights agreement. In July 1993, the Company issued a warrant to purchase up to 100,000 shares of common stock in connection with the settlement of the Premier Microwave litigation (note 13(c)).\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(f) Marketable Investment Securities --------------------------------\nThe Company adopted the provisions of Statement of Financial Accounting Standards No.115 \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No.115) effective August 1, 1994 and the cumulative effect of this change was immaterial. Under SFAS No.115, the Company classifies its investments in debt and equity securities as available-for- sale. Accordingly, these investments are reported at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of tax. Classification of investments is determined at acquisition and reassessed at each reporting date. Realized gains and losses are included in the determination of net earnings at the time of sale and are derived using the specific identification method for determining cost of securities sold.\nPrior to fiscal year 1995, marketable securities were stated at the lower of aggregate cost or market.\n(g) Inventories -----------\nWork in process inventory reflects all accumulated production costs, which are comprised of direct production costs and overhead, reduced by amounts attributable to units delivered. These inventories are reduced to their estimated net realizable value by a charge to cost of sales in the period such excess costs are determined.\nRaw materials and components and work-in-process inventory associated with short-term contracts and purchase orders are stated at the lower of cost or market, computed on the first-in, first-out (FIFO) method.\n(h) Depreciation and Amortization -----------------------------\nThe Company's plant and equipment, recorded at cost, are depreciated or amortized over their estimated useful lives (building and improvements - 40 years, equipment - three to eight years) under the straight line method. Capitalized values of properties under leases are amortized over the life of the lease or the estimated life of the asset, whichever is less.\n(i) Other Assets ------------\nIncluded in other assets at July 31, 1995 and 1994 is approximately $335,000 relating to an intellectual property rights agreement, which is being amortized over the eight year term of the agreement. At July 31, 1995 and 1994, accumulated amortization related to this purchased technology were approximately $58,000 and $15,000, respectively. The Company assesses the recoverability of the intangible asset by determining whether the amortization of purchased technology over its remaining life can be recovered through undiscounted future operating cash flows from product sales utilizing the technology.\n(j) Research and Development Costs -------------------------------\nThe Company charges research and development costs to operations as incurred, except in those cases in which such costs are reimbursable under customer- funded contracts.\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(k) Income Taxes ------------\nEffective August 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No.109 \"Accounting for Income Taxes\" (SFAS 109) and the cumulative effect of that change in the method of accounting for income taxes was immaterial. 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 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.\nThe Company previously used the asset and liability method under Statement 96. Under the asset and liability method of Statement 96, deferred tax assets and liabilities were recognized for all events that had been recognized in the financial statements. Under Statement 96, the future tax consequences of the recovering assets or settling liabilities at their financial statement carrying amounts were considered in calculating deferred taxes. Generally, Statement 96 prohibited consideration of any other future events in calculating deferred taxes.\n(l) Net (loss) Income Per Share ---------------------------\nNet (loss) income per share are based on the weighted average number of common and common equivalent shares (if dilutive) outstanding during each year. Fully diluted per share information has been omitted because it does not differ materially from primary (loss) income per share.\n(2) Marketable Investment Securities --------------------------------\nAs discussed in note 1, the Company adopted the provisions of SFAS No.115 effective August 1, 1994 and the cumulative effect of this change in the method of accounting for certain investments in debt and equity securities, net of income taxes was immaterial.\nThe following table presents the amortized cost, gross unrealized losses and fair value of the investments available-for-sale as of July 31, 1995:\nAt July 31, 1994, marketable securities were comprised principally of commercial debt obligations and obligations of the United States Treasury. Marketable securities were carried at cost.\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(3) Accounts Receivable ------------------- Accounts receivable consist of the following at July 31, 1995 and 1994:\nSubstantially all of the unbilled balances will be billed and collected during fiscal 1996.\n(4) Inventories -----------\nInventories consist of the following at July 31, 1995 and 1994:\n(5) Property, Plant and Equipment -----------------------------\nProperty, plant and equipment consists of the following:\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nDepreciation and amortization expense on property, plant and equipment amounted to approximately $709,000, $665,000 and $591,000 for the years ended July 31, 1995, 1994 and 1993, respectively.\n(6) Accrued Expenses and Other Current Liabilities ----------------------------------------------\nAccrued expenses and other current liabilities consist of the following at July 31, 1995 and 1994:\n(7) Note Payable ------------\nThe Company has a $250,000 note payable which matured in fiscal year 1995 related to an asset acquisition agreement. The Company and the note holder are in discussions regarding settlement of the note payable. In the opinion of management, the final settlement discussions will not result in a settlement more than the amount provided for in the accompanying consolidated financial statements.\n(8) Short-Term Borrowings ---------------------\nThe Company has a $4,500,000 secured line of credit facility with a financial institution which expires on January 31, 1995. Borrowings under the facility will be secured by collateral satisfactory to the financial institution and will bear interest at 1% above the prime rate, as defined. At July 31, 1995, the interest rate for the facility was 9.75% and there were no direct borrowings outstanding.\n(9) Long-Term Debt --------------\nLong-term debt consists of the following at July 31, 1995 and 1994:\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe obligations under capital leases relate to the St. Cloud, Florida and Melville, New York facilities, as well as certain equipment, the net carrying value of which was $2,759,000 at July 31, 1995.\nFuture minimum lease payments under capital leases as of July 31, 1995 are:\nIn September 1988, the Company sold and simultaneously leased back its St. Cloud, Florida facility for $600,000, comprised of $450,000 in cash and a $150,000 interest-bearing note payable. The buyer\/ lessor is a partnership in which one of the Company's officers is a general partner. The $150,000 note provided for a five-year term with semi-annual installments of principal and interest, which was satisfied at July 31, 1993. The lease is for a ten-year period and provides for annual rentals of approximately $177,000 for fiscal 1995, subject to annual adjustment. For financial reporting purposes, the Company has capitalized this lease at inception in the amount of $840,000, net of deferred interest of $492,000. The outstanding balance at July 31, 1995 and 1994 approximated $360,000 and $453,000, respectively.\nIn December 1991, the Company and a partnership controlled by the Company's Chairman and Chief Executive Officer entered into an agreement in which the Company leases from the partnership its corporate headquarters and Melville production facility. The lease is for a ten-year period and provides for annual rentals of approximately $403,000 for fiscal 1995 subject to annual adjustments equal to the lesser of 5% or the change in the Consumer Price Index. For financial reporting\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\npurposes, the Company has capitalized this lease at inception in the amount of $2,450,000, net of deferred interest of $1,345,000. The outstanding balance at July 31, 1995 and 1994 approximated $1,821,000 and $2,018,000, respectively.\n(10) Income Taxes ------------\nAs discussed in note 1, the Company adopted SFAS 109 as of August 1, 1993. The cumulative effect of this change in accounting for income taxes is not material and is not reported separately in the consolidated statement of operations for the year ended July 31, 1994. Fiscal 1993 financial statements have not been restated to apply the provisions of SFAS 109. The provision for income taxes included in the accompanying consolidated statements of operations consists of the following:\nThe provision for income taxes was $17,000, $25,000 and $45,000 for fiscal 1995, 1994 and 1993, respectively and differed from the amounts computed by applying the U.S. Federal income tax rate of 34 percent as a result of the following:\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. 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 at July 31, 1995 and 1994 are presented below. There are no temporary differences that give rise to deferred tax liabilities.\nThe valuation allowance for deferred tax assets as of August 1, 1994 was $5,288,000. The change in the total valuation allowance for the year ended July 31, 1995 was $507,000. 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 be not 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 projected future taxable income and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the Company will need to generate future taxable income of approximately $16,500,000. Taxable loss for the year ended July 31, 1995 was approximately $1,100,000. 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 not realize the benefits of these deferred tax assets and has fully reserved the deferred asset.\nIn accordance with Section 382 of the Internal Revenue Code of 1986, as amended and Section 383 of the Code, a change in more than 50% in the beneficial ownership of the Company within a three-year period (an Ownership Change) will place an annual limitation on the Company's ability to utilize its existing NOL and general business tax credit carryforwards (together, the Carryforwards) to offset United States Federal taxable income in the current and future years. The Company does not believe that an Ownership Change has occurred due to changes in the beneficial ownership of the Company's common stock in the current three-year testing period immediately prior to the completion in July 1993 of the Company's common stock offering (the Offering).\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(11) Stockholders' Equity --------------------\n(a) Option and Warrant Plans and Agreements ---------------------------------------\nThe Company has several option and warrant plans and agreements.\n1982 Incentive Stock Option Plan - The 1982 Incentive Stock Option and -------------------------------- Appreciation Plan provided for the granting to key employees and officers of incentive stock options to purchase up to 160,000 shares of the Company's common stock through September 29, 1992 at prices not less than the fair market value of such shares on the date the option is granted.\n1993 Incentive Stock Option Plan - On January 20, 1993, the stockholders of -------------------------------- the Company ratified the adoption of the 1993 Incentive Stock Option Plan (\"the Plan\"). The Plan is intended to replace the 1982 Incentive Stock Option Plan which expired on September 29, 1992, but options granted under the 1982 Plan to purchase an aggregate of approximately 95,420 shares of common stock remain outstanding. 125,000 shares of common stock were originally reserved for issuance under the 1993 Plan.\nPursuant to a January 1994 Plan amendment, the number of shares that may be granted was increased to 245,000 shares. In addition, the Plan was amended to provide formula grants to non-employee members of the Board of Directors. Both incentive and non-qualified stock options may be granted under the Plan. The term of the options may be no more than ten years except for incentive stock options granted to any employee who, prior to the granting of the option, owns stock representing more than 10% of the voting power, for whom the option term may be no more than five years. The exercise price for incentive stock options can generally be no less than the fair market value at the date of grant, with the exception of any employee who, prior to the granting of the option, owns stock representing more than 10% of the voting power, as to whom the exercise price cannot be less than 110% of the fair market value of the Company's common stock at the date of grant. The Plan expires in 2002, unless terminated earlier by the Board of Directors under conditions specified in the Plan.\nAs of July 31, 1995, the Company had granted incentive stock options representing the right to purchase an aggregate of 126,660 shares at prices ranging between $2.25-$9.13 per share, of which 22,900 options were canceled and 103,760 are outstanding. The options are exercisable ratably over a five-year period commencing one year from the dates of grant.\nDirectors' Option Plan - The 1987 Directors' Stock Option Plan provides for ---------------------- the granting of options to purchase up to 2,000 shares to each of the Company's four outside directors at an option price of not less than the fair market price per share at the date of grant. Options become exercisable at the rate of 20 percent per year commencing one year from the date of grant. At July 31, 1995, options to purchase 6,000 shares of the Company's common stock are outstanding.\nWarrant Held by Storage Technology Corp. (STC) - STC held a warrant, pursuant ---------------------------------------------- to a debt agreement, to purchase 90,000 shares of the Company's common stock at an exercise price of $10.00 per share through March 8, 1990. No portion of this warrant was exercised. In September 1990, STC agreed to accept a cash payment of $708,000, including accrued interest of $22,000, in full satisfaction of the outstanding principal balance of approximately $1,372,000. As part of the settlement, the Company agreed to reissue a warrant which provides for the purchase of up to 90,000 shares of the Company's common stock for $7.50 per share. The warrant was not exercised and expired on September 26, 1995.\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nWarrant Issued to PMCC Acquisition Corp. - Pursuant to a settlement of the ---------------------------------------- litigation arising from the sale of the Company's former Premier Microwave Division (see note 13 (c)), the Company issued to PMCC Acquisition Corporation a warrant to purchase 100,000 shares of the Company's common stock at an exercise price of $8.40. For financial reporting purposes, this warrant was valued at $50,000. The warrants are exercisable for a period of five years, commencing August 1, 1993 and shares purchased through the exercise of this warrant contain both voting and transferability restrictions.\nUnderwriter Warrants - Pursuant to the Company's common stock offering -------------------- completed in July 1993 (note 11(d)), the Underwriter received warrants to purchase 100,000 shares of common stock at a price of 140% of the offering price, or $9.80, for a term of four years beginning on July 14, 1994.\n(b) Option and Warrant Activity ---------------------------\nThe following table sets forth summarized information concerning the Company's stock options and warrants:\n(c) Restricted Common Stock -----------------------\nAs part of an amended and restated employment agreement dated August 20, 1992, the Company sold 50,000 shares of its common stock, par value $.10 per share, to its president and chief executive\n(Continued)\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nofficer at a purchase price of $.50 per share, which was ratified by the stockholders. The market value of the Company's common stock at the date of grant was $4.25 per share. The employment agreement requires the forfeiture of these shares, if the recipient leaves the employ of the Company, as defined in the agreement, prior to August 31, 1997.\nIn February 1994, a total of 120,000 restricted shares of the Company's common stock were granted by the Board of Directors to the principal officers of the Company's subsidiary, CCC, at a cost of $.10 per share. The award relates to services to be provided over future years and, as a result, the stock awards are subject to certain restrictions which may be removed earlier upon CCC attaining certain business plan milestones, as provided in the agreement, but no later than ten years from the date of the award. The excess of market value over cost of the shares awarded of $633,000 was recorded as deferred compensation and is being amortized to expense over a ten year period subject to the aforementioned accelerated provisions, if appropriate, as evaluated on an annual basis. The deferred compensation is reflected as a reduction of stockholder's equity in the accompanying balance sheets.\n(d) Common Stock Offering ---------------------\nIn July 1993, the Company completed a public offering of its common stock in which it sold 1,000,000 shares at an offering price of $7.00 per share. The net proceeds from the offering, after deducting Underwriter's commissions and other expenses of approximately $1,343,000, were $5,657,000.\nIn August 1993, the Underwriter exercised its overallotment option to purchase an additional 150,000 shares of common stock at the offering price, less the underwriting discounts and commissions, which resulted in additional proceeds to the Company of $883,000.\n(12) Segment and Principal Customer Information ------------------------------------------\nFor the purposes of segment reporting, management considers Comtech to operate in one industry, the communications equipment industry.\nIn fiscal 1995, there were no sales to any one foreign or domestic customer which amounted to over 10% of the consolidated net sales. During fiscal 1994, sales to one foreign customer amounted to $3,410,000 or 23% of consolidated net sales. During fiscal 1993, sales to two foreign customers amounted to $4,035,000 and $2,520,000 or 18% and 11% of consolidated net sales, respectively. During the fiscal years ended July 31, 1995, 1994 and 1993, approximately 14%, 17% and 18%, respectively, of the Company's net sales resulted from contracts with the United States government and its agencies. Export sales comprised 37%, 39% and 62% of net sales in fiscal 1995, 1994 and 1993, respectively.\n(13) Commitments and Contingencies -----------------------------\n(a) Operating Leases ----------------\nThe Company is obligated under noncancellable operating lease agreements. At July 31, 1995, the future minimum lease payments under operating leases are as follows:\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nLease expense charged to operations was $126,000, $90,000 and $40,000 in fiscal 1995, 1994 and 1993, respectively.\n(b) United States Government Contracts ----------------------------------\nCertain of the Company's contracts are subject to audit by applicable governmental agencies. Until such audits are completed, the ultimate profit on these contracts cannot be determined; however, it is management's belief that the final contract settlements will not have a material adverse effect on the Company's consolidated financial condition.\n(c) Litigation ----------\nThe Company is subject to certain legal actions which arise out of the normal course of business. It is management's belief that outcome of these actions will not have a material adverse effect on the Company's consolidated financial position.\nIn July 1993, the Company, its Chairman, Chief Executive Officer and President, and former auditors settled a litigation arising from the sale of the Company's former Premier Microwave Division (Premier). The plaintiffs had alleged, among other charges, fraud, misrepresentation and breach of contract relating to the acquisition of Premier and sought compensatory and punitive damages in excess of $10,000,000. Pursuant to the settlement agreement, among other things, the parties exchanged releases and the Company paid $51,000 to PMCC Acquisition Corporation (PMCC), canceled PMCC's promissory note to the Company in the principal amount of $1,000,000, plus accrued interest of $418,000 (which amounts had been fully reserved by the Company), and issued to PMCC a warrant to purchase up to 100,000 shares of Common Stock (note 11(a)). For financial reporting purposes, this warrant was valued at $50,000.\nSchedule II -----------\nCOMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES\nValuation and Qualifying Accounts and Reserves\nYears ended July 31, 1995, 1994 and 1993\n(A) Settlement of Premier litigation including write-off of note and related accrued interest. (B) Increase in reserves for contract and other adjustments. (C) Reduction of excess reserves for contract and other adjustments. (D) Reduction of excess allowance for doubtful accounts. (E) Increase of allowance for doubtful accounts. (F) Write-off of uncollectible receivables.","section_15":""}
{"filename":"745026_1995.txt","cik":"745026","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Company was incorporated in Kentucky in 1980 as Newport Steel Corporation for the purpose of purchasing the operating assets of the Newport Steel Works from Interlake, Inc. (Interlake). The Company changed its name to NS Group, Inc. in 1987 and transferred its tubular manufacturing operations to a subsidiary renamed Newport Steel Corporation. As used herein, the terms \"Company\" and \"NS Group\" refer to NS Group, Inc. and its subsidiaries, unless otherwise required by the context.\nIn October 1990, the Company, through a newly- formed wholly-owned subsidiary, acquired certain assets now comprising Koppel Steel Corporation (\"Koppel\"), a steel mini-mill located in western Pennsylvania. Koppel manufactures seamless tubular products, special bar quality (SBQ) products and semi-finished steel products. Koppel operates melting and casting facilities and a bar mill in Koppel, Pennsylvania as well as a seamless tube-making facility approximately 20 miles from Koppel in Ambridge, Pennsylvania. Koppel's seamless tubular products are used in oil and natural gas drilling and production operations and in the transmission of oil, natural gas and other fluids. SBQ products are primarily used by forgers and original equipment manufacturers of heavy equipment and off-road vehicles.\nIn October, 1993, the Company sold its wholly- owned subsidiary, Kentucky Electric Steel Corporation, to a newly formed public company in exchange for $45.6 million in cash and 400,000 shares (approximately 8%) of the new public company, then valued at $4.8 million. Kentucky Electric Steel Corporation was sold in order to enhance the Company's financial flexibility. Incorporated herein by reference from the 1995 Annual Report to Shareholders is \"Note 2: Sale of Subsidiary\", which contains additional information pertaining to this transaction.\nNS Group conducts business in two industry segments.\nSpecialty Steel -- includes three wholly-owned subsidiaries: Newport Steel Corporation (Newport), a mini-mill manufacturer of welded tubular steel products and hot rolled coils, located near Newport, Kentucky; Erlanger Tubular Corporation (Erlanger), a tubular steel finishing operation acquired in late fiscal 1986, located near Tulsa, Oklahoma; and Koppel Steel Corporation (Koppel), a mini-mill manufacturer of seamless tubular steel products, special bar quality products and semi-finished steel products, acquired in October, 1990, located in western Pennsylvania.\nAdhesives -- includes the wholly-owned subsidiary, Imperial Adhesives, Inc. (Imperial), a manufacturer of industrial adhesives products, located in Cincinnati, Ohio.\nIncorporated herein by reference from the 1995 Annual Report to Shareholders is \"Note 13: Business Segment Information\", for additional information pertaining to industry segment data.\nSpecialty Steel Segment\nThe Company's specialty steel products consist of: (i) seamless and welded tubular goods primarily used in oil and natural gas drilling and production operations (oil country tubular goods, or OCTG); (ii) line pipe used in the transmission of oil, natural gas and other fluids; (iii) SBQ products primarily used in the manufacture of heavy industrial equipment, trucks and off-road vehicles; and (iv) hot rolled coils which are sold to service centers and other manufacturers for further processing. The Company manufactures these specialty steel products at its two mini-mills, located in Koppel, Pennsylvania and near Newport, Kentucky. The term mini-mill connotes a smaller, relatively low- cost mill that typically uses scrap steel as its basic raw material and offers a relatively limited range of products.\nProducts\nSeamless OCTG Products. The Company's seamless OCTG products are used as drill pipe, casing and production tubing. Drill pipe is used and may be reused to drill several wells. Casing forms the structural wall of oil and natural gas wells to provide support and prevent caving during drilling operations and is generally not removed after it has been installed in a well. Production tubing is placed within the casing and is used to convey oil and natural gas to the surface. The Company's seamless OCTG products are sold as a finished threaded and coupled product in both carbon and alloy grades. Compared to similar welded products, seamless production tubing and casing are better suited for use in hostile drilling environments such as off-shore drilling or deeper wells because of their greater strength and durability. The production of seamless tubular products with these properties requires a more costly and specialized manufacturing process than does the production of welded tubular products.\nWelded OCTG Products. The Company's welded OCTG products are used primarily as casing in oil and natural gas wells during drilling operations. Welded OCTG products are generally used when higher strength is not required, typically in wells less than 10,000 feet in depth. The Company sells its welded OCTG products as both a plain end and as a finished tubular product in both carbon and alloy grades.\nLine Pipe Products. The Company's line pipe products are primarily used in gathering lines for the transportation of oil and natural gas at the drilling site and in transmission lines by both gas utility and transmission companies. The Company's seamless and welded line pipe products are shipped as a plain end product and welded together on site. The majority of the Company's line pipe sales are welded products.\nSpecial Bar Quality Products. The Company manufactures SBQ products in a specialized market niche of products ranging in size from 2.875 to 6.0 inches. The Company produces its SBQ products from continuous cast blooms that enables substantial size reduction in the bloom during processing and provides heavier strength-to-weight ratios. These SBQ products are primarily used in critical weight-bearing applications such as suspension systems, gear blanks, drive axles for tractors and off-road vehicles, heavy machinery components and hydraulic and pneumatic cylinders.\nHot Rolled Coils. The Company produces commercial quality grade hot rolled coils, from 28 to 50 inches in width, between 0.125 and 0.500 inches in gauge, and in 15 ton coil weights. These products are sold to service centers and to others for use in high-strength applications.\nOther Products. The Company's OCTG products are inspected and tested to ensure that they meet API specifications. Products that do not meet specification are classified as secondary or limited service products and are sold at substantially reduced prices.\nFinishing Facilities. The Company processes and finishes a portion of its own welded and seamless tubular products, and to a lesser extent, those of other tubular producers, at Erlanger and at its Koppel- owned facility in Baytown, Texas (Baytown). The finishing processes at Erlanger include upsetting, which is a forging process that thickens tube ends; heat treating, which is a furnace operation designed to strengthen the steel; straightening; coating for rust prevention; and threading. Currently, Baytown is capable of upsetting, coating and threading. After finishing, products are either immediately reshipped to customers or stored as inventory to enable the Company to respond quickly to customer needs.\nThe demand for the Company's OCTG products is cyclical in nature, being dependent on the number and depth of oil and natural gas wells being drilled in the United States. The level of drilling activity is largely a function of the current prices of oil and natural gas and the industry's future price expectations. Demand for OCTG products is also influenced by the levels of inventory held by producers, distributors and end users. In addition, the demand for OCTG products produced domestically is also significantly impacted by the level of foreign imports of OCTG products. The level of OCTG imports is affected by: (i) the value of the U.S. dollar versus other key currencies; (ii) overall world demand for OCTG products; (iii) the production cost competitiveness of domestic producers; (iv) trade practices of, and government subsidies to, foreign producers; and (v) the presence or absence of governmentally imposed trade restrictions in the United States. The demand for line pipe is only partially dependent on oil and gas drilling activities. Line pipe demand is also dependent on factors such as the level of pipeline construction activity, line pipe replacement requirements, new residential construction and gas utility purchasing programs. The demand for the Company's SBQ and hot rolled coil products is also cyclical in nature and is sensitive to general economic conditions. The demand for and the pricing of the Company's SBQ and hot rolled coil products is also affected by economic trends in areas such as commercial and residential construction, automobile production and industrial investment in new plants and facilities.\nMarkets and Distribution\nThe Company sells its specialty steel products to its customers through an in-house sales force which is supplemented by a number of independent sales representatives. The primary end markets for the Company's seamless tubular products has been the southwest United States and certain foreign markets. Nearly all of the Company's OCTG products are sold to domestic distributors, some of whom subsequently sell the Company's products into the international marketplace. The Company has historically marketed its welded tubular products in the east, central and southwest regions of the United States, in areas where shallow oil and gas drilling and exploration activity utilize welded tubular products. The Company sells its SBQ products to customers located generally within 400 miles of the Koppel facilities.\nAll of the Company's steel-making and finishing facilities are located on or near major rivers or waterways, enabling the Company to transport its tubular products into the southwest by barge. The Company ships substantially all of its seamless and welded OCTG products destined for the southwest region by barge.\nCustomers\nThe Company has approximately 300 specialty steel product customers. The Company's OCTG and line pipe products are used by major and independent oil and natural gas exploration and production companies in drilling and production applications in the United States, Canada, Mexico and overseas. Line pipe products are also used by gas utility and transmission companies. The majority of the Company's OCTG and line pipe products are sold to domestic distributors and directly to end users. The Company sells its SBQ products to service centers, cold finishers, forgers and original equipment manufacturers, and primarily sells its hot rolled coils to service centers and other manufacturers for further processing. The Company has long-standing relationships with many of its larger customers; however, the Company believes that it is not dependent on any customer and that it could, over time, replace lost sales attributable to any one customer.\nCompetition\nThe markets for the Company's specialty steel products are highly competitive and cyclical. The Company's principal competitors in its primary markets include integrated producers, mini-mills, welded tubular product processing companies as well as foreign steel producers. The Company believes that the principal competitive factors affecting its business are price, quality and customer service.\nThe Company competes with a number of domestic as well as foreign producers in the welded tubular market, which includes both OCTG and line pipe products. In the seamless OCTG market, the Company competes principally with one domestic producer as well as a number of foreign producers. With respect to its SBQ products, the Company competes with numerous other domestic steel manufacturers.\nTrade Cases. In response to the rising level of foreign imports of OCTG products, on June 30, 1994, the Company and six other U.S. steel companies filed antidumping petitions against imports of OCTG products from seven foreign nations (the Trade Cases). The Trade Cases asked the United States government to take action to offset injury to the domestic OCTG industry from unfairly traded imports. The antidumping petitions were filed against OCTG imports from Argentina, Austria, Italy, Japan, Korea, Mexico and Spain. The Company also joined in filing countervailing duty cases charging subsidization of OCTG imports from Austria and Italy. In July 1995, following evaluation of determinations made by the International Trade Administration of the United States Department of Commerce, the International Trade Commission (ITC) announced final affirmative determinations, resulting in the collection of duties by the Customs Service on imports of OCTG and drill pipe products from Argentina, Japan and Mexico, and OCTG products (other than drill pipe) from Italy and Korea. No duties were imposed on OCTG and drill pipe imports from Austria and Spain because the ITC issued negative determinations. Several foreign OCTG producers, as well as certain U.S. producers, have appealed the determinations to international courts or panels. The Company cannot predict the outcome or timing of these appeals at this time.\nRaw Materials and Supplies\nThe Company's major raw material is steel scrap, which is generated principally from industrial, automotive, demolition, railroad and other steel scrap sources. Steel scrap is purchased by the Company either through scrap brokers or directly in the open market. The long-term demand for steel scrap and its importance to the domestic steel industry may be expected to increase as steel-makers continue to expand steel scrap-based electric arc furnace and thin slab casting capacities. For the foreseeable future, however, the Company believes that supplies of steel scrap will continue to be available in sufficient quantities at competitive prices. In addition, a number of technologies exist for the processing of iron ore into forms which may be substituted for steel scrap in electric arc furnace-based steel-making operations. Such forms include direct-reduced iron, iron carbide and hot-briquette iron. While such forms may not be cost competitive with steel scrap at present, a sustained increase in the price of steel scrap could result in increased implementation of these alternative technologies.\nThe Company's steel manufacturing facilities consume large amounts of electricity. The Company purchases its electricity from utilities near its steel-making facilities pursuant to contracts that expire in 1996 for Koppel and 2001 for Newport. The contracts contain provisions that provide for lower priced demand charges during off-peak hours and known maximums in higher cost firm demand power. Also, the Company receives discounted demand rates in return for the utilities' right to periodically curtail service during periods of peak demand. These curtailments are generally limited to a few hours and historically have had a negligible impact on the Company's operations.\nThe Company also consumes smaller quantities of additives, alloys and flux which are purchased from a number of suppliers.\nAdhesives Segment\nImperial is a manufacturer of industrial adhesives products. Imperial maintains over 1,000 active formulas for the manufacture of water-borne, solvent- borne, and hot-melt adhesives, which are used in product assembly applications, including footwear, foam bonding, marine and recreational vehicles, and consumer packaging. Raw materials are available from multiple sources and consist primarily of petrochemical-based materials. Pricing generally follows trends in the petrochemical markets.\nImperial produces adhesives products at manufacturing plants located in Ohio, Tennessee and Virginia. Imperial markets its adhesives products throughout the United States and Caribbean basin through an in-house sales force as well as numerous independent sales representatives. Products are distributed from three manufacturing sites and a number of public warehouses across the United States and in Puerto Rico.\nCompetition in the industrial adhesives products market is highly-fragmented. The Company believes that it competes in this market on the basis of price, product performance and customer service. Imperial competes with numerous small or comparably-sized companies, as well as major adhesives producers.\nEnvironmental Matters\nThe Company is subject to federal, state and local environmental laws and regulations, including, among others, the Resource Conservation and Recovery Act (RCRA), the Clean Air Act, the 1990 Amendments to the Clean Air Act (the 1990 Amendments), the Clean Water Act and all regulations promulgated in connection therewith, including, among others, those concerning the discharge of contaminants as air emissions or waste water effluents and the disposal of solid and\/or hazardous wastes such as electric arc furnace dust. As such, the Company is from time to time involved in administrative and judicial proceedings and administrative inquiries related to environmental matters.\nAs with other similar mills in the industry, the Company's steel mini-mills produce dust which contains lead, cadmium and chromium, and is classified as a hazardous waste. The Company currently collects the dust resulting from its electric arc furnace operations through emission control systems and contracts with a company for treatment and disposal of the dust at an EPA-approved facility. The Company also has on its property at Newport a permitted hazardous waste disposal facility.\nIn March 1995, Koppel and the EPA signed a Consent Order relating to an April 1990 RCRA facility assessment (the Assessment) completed by the EPA and the Pennsylvania Department of Environmental Resources. The Assessment was performed in connection with a permit application pertaining to a landfill that is adjacent to the Koppel facilities. The Assessment identified potential releases of hazardous constituents at or adjacent to the Koppel facilities prior to the Company's acquisition of the Koppel facilities. The Consent Order establishes a schedule for investigating, monitoring, testing and analyzing the potential releases. Contamination documented as a result of the investigation will require cleanup measures and certain remediation has begun. Pursuant to various indemnity provisions in agreements entered into at the time of the Company s acquisition of the Koppel facilities, certain parties have agreed to indemnify the Company against various known and unknown environmental matters. While such parties have not at this time acknowledged full responsibility for potential costs under the Consent Order, the Company believes that the indemnity provisions provide for it to be fully indemnified against all matters covered by the Consent Order, including all associated costs, claims and liabilities.\nIn two separate incidents occurring in fiscal 1993 and 1992, radioactive substances were accidentally melted at Newport, resulting in the contamination of the melt shop s electric arc furnace emission control facility, or baghouse facility . The occurrences of the accidental melting of radioactive materials have not resulted in any notice of violations from federal or state environmental regulatory agencies. The losses and costs incurred in 1993, net of insurance claims, resulted in an extraordinary charge of $1.1 million, net of applicable income tax benefit of $0.7 million, or an $.08 loss per share. The Company is investigating and evaluating various issues concerning storage, treatment and disposal of the radiation contaminated baghouse dust; however a final determination as to method of treatment and disposal, cost and further regulatory requirements cannot be made at this time. Depending on the ultimate timing and method of treatment and disposal, which will require appropriate federal and state regulatory approval, the actual cost of disposal could substantially exceed current estimates and the Company s insurance coverage. The Company expects to recover and has recorded a $2.3 million receivable relating to insurance claims for the recovery of disposal costs which will be filed with the Company s insurance company at the time such disposal costs are incurred. As of September 30, 1995, claims recorded in connection with disposal costs exhaust available insurance coverage. Based on current knowledge, management believes the recorded gross reserves of $4.4 million for disposal costs pertaining to these incidents are adequate.\nSubject to the uncertainties concerning the Consent Order and the storage and disposal of the radiation contaminated dust, the Company believes that it is currently in compliance in all material respects with all applicable environmental regulations.\nRegulations under the 1990 Amendments to the Clean Air Act that will pertain to the Company s operations are currently not expected to be promulgated until 1997 or later. The Company cannot predict the level of required capital expenditures or operating costs resulting from future environmental regulations such as those forthcoming as a result of the 1990 Amendments. However, the Company believes that while the 1990 Amendments may require additional expenditures, such expenditures will not have a material impact on the Company s business or consolidated financial position for the foreseeable future.\nCapital expenditures for the next twelve months relating to environmental control facilities are not expected to be material, however, such expenditures could be influenced by new or revised environmental regulations and laws.\nAs of September 30, 1995, the Company had environmental remediation reserves of $4.5 million, of which $4.4 million pertain to accrued disposal costs for radiation contaminated baghouse dust. As of September 30, 1995, the possible range of estimated losses related to the environmental contingency matters discussed above in excess of those accrued by the Company is $0 to $3.0 million; however, with respect to the Consent Order, the Company cannot estimate the possible range of losses should the Company ultimately not be indemnified. Based upon its evaluation of available information, management does not believe that any of the environmental contingency matters discussed above are likely, individually or in the aggregate, to have a material adverse effect upon the Company s consolidated financial position, results of operations or cash flows. However, the Company cannot predict with certainty that new information or developments with respect to the Consent Order or its other environmental contingency matters, individually or in the aggregate, will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.\nEmployees\nAs of September 30, 1995, the Company had 1,728 employees, of whom 405 were salaried and 1,323 were hourly. Substantially all of the Company's hourly employees are represented by the United Steelworkers of America under contracts expiring in 1997 for Erlanger; 1999 for Newport and Koppel; and 1998 for Imperial.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal operating properties are listed in the table below. The Company believes its facilities are adequate and suitable for its present level of operations.\nLocation and Properties\nSpecialty Steel Segment:\nNewport, Kentucky - The Company owns approximately 250 acres of real estate upon which are located a melt shop, hot strip mill, two welded pipe mills, machine and fabricating shops and storage and repair facilities aggregating approximately 636,000 square feet, as well as the Company's administrative offices.\nKoppel, Pennsylvania - The Company owns approximately 227 acres of real estate upon which are located a melt shop, bar mill, blooming mill, pickling facility, machine and fabricating shops, storage and repair facilities and administrative offices aggregating approximately 900,000 square feet.\nAmbridge, Pennsylvania - The Company owns approximately 45 acres of real estate upon which are located a seamless tube making facility and seamless tube finishing facilities aggregating approximately 659,000 square feet.\nTulsa, Oklahoma - The Company leases approximately 36 acres of real estate upon which are located a tubular processing facility. The facility is located at the Tulsa Port of Catoosa where barge facilities are in close proximity. Located on this property are six buildings aggregating approximately 119,000 square feet which house the various finishing operations.\nBaytown, Texas - The Company owns approximately 55 acres of real estate upon which is located a tubular processing facility and barge facilities. Located on the property are eight buildings aggregating approximately 65,000 square feet which house the various finishing operations.\nAdhesives Segment:\nCincinnati, Ohio; Lynchburg, Virginia; Nashville, Tennessee - The Company owns approximately seven acres of property in Cincinnati, Ohio, and 1.5 acres of property in Lynchburg, Virginia for use in its adhesives operations. The Cincinnati properties contain five buildings aggregating approximately 150,000 square feet and the Lynchburg property consists of one 10,000 square foot building. The Company also leases approximately 3.1 acres in Nashville, Tennessee for use in its adhesives operations, including one building aggregating approximately 60,000 square feet.\nOther:\nNewport, Kentucky - The Company owns approximately 37 acres of partially developed land near Newport, Kentucky, acquired in fiscal 1989, which is held as investment property and is listed for sale. The Company also owns approximately 85 acres of additional real estate which is currently not used in operations.\nInformation regarding encumbrances on the Company's properties, included in Note 5 to the Consolidated Financial Statements of the 1995 Annual Report to Shareholders, is incorporated herein by reference.\nCapacity Utilization\nThe Company's capacity utilization for fiscal 1995 was as follows:\nRated Capacity Facility (in tons) Capacity Utilization\nKoppel facilities Melt shop ............... 400,000 88.4% Bar mill ................ 200,000 98.5% Seamless tube mill ...... 200,000 69.0%\nNewport facilities Melt shop ............... 700,000 59.4% Hot strip rolling mill .. 750,000 51.1% Welded pipe mills ....... 580,000 55.8%\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee \"Environmental Matters\" regarding the Consent Order entered into by Koppel and the EPA.\nThe Company is subject to various claims, lawsuits and administrative proceedings arising in the ordinary course of business with respect to commercial, product liability and other matters which seek remedies or damages. Based upon its evaluation of available information, management does not believe that any such matters are likely, individually or in the aggregate, to have a material adverse effect upon the Company's consolidated financial position, results of operations or cash flows.\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\nIncorporated herein by reference from the 1995 Annual Report to Shareholders, \"Stock Market Information\" and \"Stock Price\" and Note 5 to the Consolidated Financial Statements.\nAs of December 1, 1995, there were approximately 338 record holders of Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated herein by reference from the 1995 Annual Report to Shareholders, \"Consolidated Historical Summary\" and Note 2 to the Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated herein by reference from the 1995 Annual Report to Shareholders, \"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\nIncorporated herein by reference from the 1995 Annual Report to Shareholders, \"Consolidated Statements of Operations\"; \"Consolidated Balance Sheets\"; \"Consolidated Statements of Cash Flows\"; Consolidated Statements of Common Shareholders' Equity\"; \"Notes to Consolidated Financial Statements\"; \"Report of Management\"; and \"Report of Independent Public Accountants\".\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated herein by reference from the Company's Proxy Statement dated December 27, 1995 for the Annual Meeting of Shareholders on February 15, 1996, under the caption \"Election of Directors - Nominees for Election as Directors\"; \"Information Regarding Meetings and Committees of the Board of Directors - Committees of the Board\"; \"Executive Compensation\"; and \"Compliance With Section of 16(a) of the Exchange Act\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference from the Company's Proxy Statement dated December 27, 1995 for the Annual Meeting of Shareholders on February 15, 1996, under the caption \"Information Regarding Meetings and Committees of the Board of Directors - Director Compensation\"; \"Executive Compensation\"; and \"Compensation Committee Interlocks and Insider Participation\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference from the Company's Proxy Statement dated December 27, 1995 for the Annual Meeting of Shareholders on February 15, 1996, \"Share Ownership of Certain Beneficial Owners and Management\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference from the Company's Proxy Statement dated December 27, 1995 for the Annual Meeting of Shareholders on February 15, 1996, under the caption \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\". PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Consolidated Financial Statements - The following Consolidated Financial Statements included in the 1995 Annual Report to Shareholders for the fiscal year ended September 30, 1995, are incorporated by reference in Item 8:\n- Consolidated Statements of Operations - Consolidated Balance Sheets - Consolidated Statements of Cash Flows - Consolidated Statements of Common Shareholders' Equity - Notes to Consolidated Financial Statements - Report of Independent Public Accountants\n(a) 2. Consolidated Financial Statement Schedule - The following schedule is included herein:\n- Report of Independent Public Accountants on Financial Statement Schedule\n- Schedule II - Valuation and Qualifying Accounts\n(a) 3. Exhibits\nReference is made to the Index to Exhibits, which is incorporated herein by reference.\n(b) Reports on Form 8-K\nCurrent Report on Form 8-K dated September 29, 1995 and filed October 10, 1995, reporting under Item 5 the Company's earnings expectations for the fourth fiscal quarter ending September 30, 1995; and under Item 7(c), the Company's press release dated September 29, 1995.\nCurrent Report on Form 8-K dated October 24, 1995 and filed November 3, 1995, reporting under Item 5 the Company's estimate for earnings for the fourth fiscal quarter ending September 30, 1995; and under Item 7(c), the Company's press release dated October 24, 1995.\nCurrent Report on Form 8-K dated November 10, 1995 and filed November 15, 1995, reporting under Item 5 the Company's results for its fiscal year and fourth quarter ending September 30, 1995; and under Item 7(c), the Company's press release dated November 10, 1995\nCurrent Report on Form 8-K dated December 4, 1995 and filed December 7, 1995, reporting under Item 5 certain management changes; and under Item 7(c), the Company's press release dated December 5, 1995.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo NS Group, Inc.:\nWe have audited in accordance with generally accepted auditing standards the consolidated financial statements included in NS Group, Inc. and subsidiaries annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated November 6, 1995. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in 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.\nCincinnati, Ohio ARTHUR ANDERSEN LLP November 6, 1995\nSCHEDULE II NS GROUP, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n(Dollars in thousands)\nReserves Deducted from Assets in Balance Sheets Allowance for Allowance Doubtful for Cash Accounts(1) Discounts(1)\n(1) Deducted from 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. NS GROUP, INC.\nDate: December 15, 1995 By: \/s\/John R. Parker John R. Parker, Vice President, Treasurer and Chief Financial Officer\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Clifford R. Borland and John R. Parker, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K and any other documents and instruments incidental thereto, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents and\/or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: December 15, 1995 By: \/s\/Clifford R.Borland Clifford R. Borland, Chief Executive Officer and Director\nDate: December 15, 1995 By: \/s\/Paul C. Borland Paul C. Borland, President and Chief Operating Officer\nDate: December 15, 1995 \/s\/John R. Parker John R. Parker, Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer)\nDate: December 15, 1995 \/s\/Thomas J. Depenbrock Thomas J. Depenbrock Vice President and Corporate Controller\nDate: December 15, 1995 \/s\/Ronald R. Noel Ronald R. Noel, Director\nDate: December 15, 1995 \/s\/John B. Lally John B. Lally, Director\nDate: December 15, 1995 \/s\/Patrick J. B. Donnelly Patrick J. B. Donnelly, Director\nDate: December 15, 1995 \/s\/R. Glen Mayfield R. Glen Mayfield, Director\nINDEX TO EXHIBITS\nNumber Description\n3.1 Amended and Restated Articles of Incorporation of Registrant, filed as Exhibit 3.1 to Amendment No. 1 to Registrants' Form S-1 dated January 17, 1995, File No. 33- 56637, and incorporated herein by this reference\n3.2 Amended and restated By-Laws of Registrant, dated December 4, 1995, filed herewith\nExhibits 4.1 through 4.22 were filed under their respective Exhibit numbers to Registrant's Form 10-Q for the quarterly period ended July 1, 1995, File No. 1-9838, and are incorporated herein by this reference\n4.1 Indenture (including form of Senior Secured Note) between the Company and The Huntington National Bank, as trustee (the \"Trustee\")\n4.2 Leasehold and Fee Mortgage, Assignment of Rents and Leases and Security Agreement from Newport to the Trustee (Kentucky)\n4.3 Mortgage, Assignment of Rents and leases and Security Agreement from Koppel to the Trustee (Pennsylvania)\n4.4 Deed of Trust, Assignment of Rents and Leases and Security Agreement from Koppel to the Trustee (Texas)\n4.5 Leasehold Mortgage, Assignment of Rents and Leases and Security Agreement from Erlanger to the Trustee (Oklahoma)\n4.6 Junior Leasehold and Fee Mortgage, Assignment of Rents and Leases and Security Agreement from Newport to the Company (Kentucky)\n4.7 Junior Mortgage, Assignment of Rents and Leases and Security Agreement from Koppel to the Company (Pennsylvania)\n4.8 Junior Deed of Trust, Assignment of Rents and Leases and Security Agreement from Koppel to the Company (Texas)\n4.9 Junior Leasehold Mortgage, Assignment of Rents and Leases and Security Agreement from Erlanger to the Company (Oklahoma)\n4.10 Subsidiary Security Agreement between Newport and the Trustee\n4.11 Subsidiary Security Agreement between Koppel and the Trustee\n4.12 Subsidiary Security Agreement between Erlanger and the Trustee\n4.13 ICN Security Agreement between Newport and the Company\n4.14 ICN Security Agreement between Koppel and the Company\n4.15 ICN Security Agreement between Erlanger and the Company\n4.16 Pledge and Security Agreement between the Company and the Trustee\n4.17 Subsidiary Guarantee\n4.18 Intercreditor Agreement between the Trustee and the Bank of New York Commercial Corporation, as agent under the Credit Facility\n4.19 Agreement between the Trustee, Koppel and the Commonwealth of Pennsylvania, Department of Commerce\n4.20 Subordination Agreement between the Trustee and the City of Dayton, Kentucky\n4.21 Revolving Credit, Guaranty and Security Agreement among Bank of New York Commercial Corporation, PNC Bank Ohio, N.A., Newport, Koppel, Imperial, the Company, Erlanger, Northern Kentucky Air, Inc. and Northern Kentucky Management, Inc.\n4.22 Warrant Agreement between the Company and The Huntington National Bank, as warrant agent\n10.1 Company's Amended Employee Incentive Stock Option Plan, filed as Exhibit 10(a) to Company's Form 10-K for the fiscal year ended September 30, 1989, File No. 1-9838, and incorporated herein by this reference\n10.2 Company's Executive Bonus Plan, filed as Schedule B to Exhibit 10.4 to Company's Registration Statement on Form S-18, File No. 2-90643, and incorporated herein by this reference\n10.3 Company's Non-Qualified Stock Option and Stock Appreciation Rights Plan of 1988, filed as Exhibit 1 to Company's Proxy Statement dated January 13, 1989, File No. 1-9838, and incorporated herein by this reference\n10.4 Rights Agreement dated as of November 17, 1988 between Company and Pittsburgh National Bank, filed as Exhibit 1 to Company's Form 8- K dated November 17, 1988, File No. 1-9838, and incorporated herein by this reference, and Appointment and Amendment Agreement dated July 29, 1994 between Registrant and Registrar and Transfer Company, filed as Exhibit 10(d) to Company's Form 10-Q dated May 29, 1994, File No. 1-9838, and incorporated herein by this reference\n10.5 Company's 1993 Incentive Stock Option Plan, filed as Exhibit 1 to Company's Proxy Statement dated December 22, 1992, File No. 1-9838, and incorporated herein by this reference\n10.6 Transfer Agreement, dated September 29, 1993, filed on September 28, 1993 as Exhibit 10.2 to the Amendment No. 2 to the Registration Statement on Form S-1 of Kentucky Electric Steel, Inc., File No. 33-67140, and incorporated herein by this reference\n10.7 Tax Agreement, dated October 6, 1993, by and among NS Group,Inc., Kentucky Electric Steel, Inc. and NSub I, Inc. (formerly Kentucky Electric Steel Corporation), filed as Exhibit 10(h) to Company's Form 10-K for the fiscal year ended September 25, 1993, File No. 1- 9383, and incorporated herein by this reference\n10.8 Registration Rights Agreement dated October 6, 1993 among Kentucky Electric Steel, Inc., NS Group, Inc. and NSub I, Inc. (formerly Kentucky Electric Steel Corporation), filed as Exhibit 10(i) to Company's Form 10-K for fiscal year ended September 25, 1993, File No. 1-9383, and incorporated herein by this reference\n10.9 Form of 11% Subordinated Convertible Debenture due 2005, filed as Exhibit 4.1 to Company's Form 8-K dated October 18, 1990, File No. 1-9838, and incorporated herein by this reference\n10.10 Form of Warrant dated October 4, 1990, filed as Exhibit 4.2 to Company's Form 8-K dated October 18, 1990, File No. 1-9838, and incorporated herein by reference; and First Amendment to Warrant dated September 26, 1992, filed as Exhibit 4(c) to Company's Form 10-K for the fiscal year ended September 26, 1992, File No. 1-9838, and incorporated herein by this reference\n13 1995 Annual Report to Shareholders (not deemed \"filed\" except for portions which are expressly incorporated by reference), filed herewith\n21 Subsidiaries of Registrant\n23 Consent of Independent Public Accountants\n24 Power of Attorney (contained on Signature Page)\n27 Financial Data Schedule","section_15":""}
{"filename":"67887_1995.txt","cik":"67887","year":"1995","section_1":"ITEM 1. Business.\nCertain information required herein is contained in part in the 1995 Annual Report, specific pages of which are referred to in parentheses. Description of the Company's Business. (See pages 2 through 16.)\nDistribution. Moog primarily uses its own sales and engineering personnel in the sale of its products. In selective markets, independent manufacturers' representatives are retained.\nIndustry and Competitive Conditions. Moog experiences considerable competition in its Domestic Controls segment, principally in the areas of product performance, delivery and price. These competitors are associated with parent companies larger than the Company as measured by total assets and sales. These include the Hydraulics Research and Manufacturing Division of Textron Inc., Abex NWL Division of Power Control Technologies Inc., the Parker Bertea Aerospace Group of Parker Hannifin Corporation, E-Systems Corporation owned by Raytheon Company and Vickers, a Division of Trinova Corporation.\nThe International Controls segment experiences similar competition from numerous domestic and foreign corporations, particularly Mannesmann Rexroth, a Mannesmann AG company, and Robert Bosch AG.\nBacklog. Substantially all backlog will be recorded as sales in the next twelve months. The information required herein is incorporated by reference to Item 6, Selected Financial Data, on page 21 .\nRaw Materials. Materials, supplies and components are purchased from numerous suppliers. The loss of any one supplier would not materially affect the Company's operations.\nSeasonality. Moog's business is generally not seasonal.\nPatents. Moog has a number of patents and has filed applications for others. While the aggregate protection afforded by these is of value, the Company does not consider the successful conduct of any material part of its business dependent upon such protection. The Company's patents and patent applications, including U.S., Canadian, European and Japanese patents, relate to electrohydraulic, pneumatic and mechanical actuation mechanisms and control valves, electronic control component systems and interface devices.\nResearch Activities. Research and product development activity has been and continues to be significant to the Company. The information required herein is incorporated by reference to Item 6, Selected Financial Data, on page 21.\nEmployees. The information required herein is incorporated by reference to Item 6, Selected Financial Data, on page 21.\nSegment Financial Information. The information required herein is incorporated by reference to Note 14 of Item 8. See page 37.\nCustomers. The information required herein is incorporated by reference to pages 2 through 16 and 37. Moog's military activities in aerospace, through its Domestic Controls segment, are subject to changes in national defense policy, Department of Defense (DoD) procurement practice, and contract termination. In commercial aerospace, principally commercial aviation, Moog's activities are subject to changes in the delivery schedules of the major commercial aircraft manufacturers.\nInternational Operations. Moog's International Controls segment is an aggregate of operations located predominantly in Europe and the Asian-Pacific region. (See pages 2 through 16, 37 and 43.) The Company's international operations are subject to the usual risks inherent in international trade, including currency fluctuations, local governmental foreign investment restrictions, exchange controls, regulation of the import and distribution of foreign goods, as well as changing economic and social conditions in countries in which such operations are conducted.\nWorking Capital. Working capital includes items which will not be realized within one year, reflecting the procurement and production cycle associated with long term contracts. Long-term contract receivables include substantial amounts not yet billed under progress payment terms of contracts, and which provide that certain holdback amounts cannot be billed until shipment of completed units. Inventories reflect the extended production and procurement cycle on most Moog products. Contract loss reserves represent expenditures to be incurred over development and production periods extending beyond one year.\nEnvironmental Matters. See pages 25 and 38.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nCorporate headquarters are located in East Aurora, New York. Principal manufacturing facilities for the Domestic Controls segment are located in East Aurora, New York and Torrance, California. These facilities consist of 756,000 square feet which are owned, and 54,000 square feet which are under capital lease and financed primarily by industrial revenue bonds which allow the Company to purchase the facilities at nominal prices upon expiration. The Domestic Controls segment leases 140,000 square feet in East Aurora and 7,200 square feet in Torrance under operating leases. With respect to the Company's facilities, third parties have leased 91,000 square feet of owned space through December 1996 and 67,000 square feet of leased space through August 1997. Outside of the U.S., the Domestic Controls segment owns manufacturing centers in the Philippines and India. The Philippines facility consists of 64,000 square feet and the India facility consists of 23,000 square feet.\nThe International Controls segment maintains major manufacturing facilities in Germany, England and Japan. Of the major European facilities, 4,000 square feet are owned and 200,000 square feet are leased under operating lease agreements. The Japanese facility, consisting of 68,000 square feet, is owned. A specialty manufacturing operation with 26,000 square feet which is owned is located in Ireland. In various other major markets, including Italy, France, Spain, Sweden, Finland, Denmark, Brazil,\nAustralia, South Korea, Hong Kong and Singapore, the Company has sales and applications engineering offices. Of these facilities, 30,000 square feet are owned and 48,000 square feet are leased under operating leases. Operating leases of the International facilities expire at varying times from December 1995 through June 2013.\nThe capacity of Moog's manufacturing facilities is considered adequate for current and future production requirements.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nLegal proceedings presently pending by or against Moog or its subsidiaries are not expected to have a material adverse effect on the financial condition or results of operations of Moog and its subsidiaries 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 the Registrant's Common Equity and Related Stockholder Matters.\nDividend restrictions are detailed in Note 7 on page 32 of Item 8, Financial Statements and Supplementary Data.\nOther information required herein is incorporated by reference to pages 21 and 44.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data - Notes and Discussion.\nRefer to the table on the following page for the Selected Financial Data for the five year fiscal period 1991 - 1995. For a more detailed discussion of 1993 through 1995 refer to Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 22 through 25 and Notes to Consolidated Financial Statements on pages 30 through 39.\nITEM 6. Selected Financial Data. (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 - 1995 Compared with 1994\nEarnings per share in 1995 were $1.00 compared with $.27 in 1994. Net earnings in 1995 were $7.8 million on sales of $374 million, compared with net earnings of $2.1 million on sales of $307 million in 1994. Net earnings in 1995 were favorably affected by the strong recovery of capital goods markets in Europe. Also in 1995, incremental net earnings from the hydraulic and mechanical actuation product lines of AlliedSignal Inc. acquired in June 1994 (the Product Lines), served to partially offset declining revenues and profits on various mature defense programs. Conversely, 1994 earnings were adversely affected by pre-tax inventory obsolescence and restructuring charges of $4.7 million. The inventory obsolescence charge of $2.6 million was taken in response to the decline in repair activities and spare parts requirements on certain military programs. Of the pre-tax restructuring charge, $1.8 million related to workforce reductions in the Company's operations in the U.S., England, Germany and Denmark, while $.3 million related to lease termination costs. The 1994 restructuring actions were taken in response to defense spending reductions and, at the time, weak capital goods markets in Europe. The workforce reductions and related cost savings, in conjunction with the recovery of European capital goods markets and, to a lesser extent, the Product Line acquisition, provided the basis for the improved earnings performance in 1995.\nOperating profit for the Domestic Controls segment was $25.2 million in 1995, representing 9.6% of segment sales, compared with $20.4 million, or 9.2% of segment sales in 1994. Excluding the pre-tax Domestic inventory obsolescence and restructuring charges of $3.4 million in 1994, Domestic Segment 1994 operating profit would have been $23.8 million, or 10.7% of segment sales. In absolute terms, the increase in operating profit is due to the Product Line acquisition along with the aforementioned cost reduction measures. These benefits were, however, in part offset by declining revenue on both the B-2 program and the Missiles product line, along with now complete one-time transition service costs paid to AlliedSignal Inc. related to various overhead functions.\nOperating profit for the International Controls segment in 1995 was $8.5 million, or 6.8% of segment sales compared with $1.1 million or 1.1% of segment sales in 1994. International Controls segment operating profit for 1994 includes $1.3 million in inventory obsolescence and restructuring charges. Excluding these 1994 charges, operating profit would have been $2.4 million or 2.4% of segment sales. The improvement in capital goods markets in Europe, along with the aforementioned cost reduction measures, led to a dramatic turnaround in European operating profit. Within the Pacific Group, operating profit is down from a year ago, primarily due to costs of penetrating new Asian markets.\nNet sales in 1995 of $374 million were 21.8% higher than 1994 sales of $307 million. For the Domestic Controls segment net sales increased 19.1% in 1995 to $254 million compared to $213 million in 1994. The increase is attributable to the Product Lines acquisition, in part offset by lower revenue on the B-2 program and the Missiles product line. International Controls segment net sales increased 27.9% in 1995 to $120 million from $94.1 million in the prior year. The increase reflects the improvement in\nEuropean capital goods markets, and to a much lesser extent, the increase in value of certain foreign currencies relative to the U.S. dollar. Excluding the effect of changing currency values, International Controls segment net sales increased 18%.\nWorldwide commercial sales were $193 million in 1995, or 51% of sales, with government sales being $181 million or 49% of sales. In 1994, commercial sales were $133 million, or 43% of sales. Going back to 1991, commercial sales were only 39% of sales. The shift of the sales mix to commercial sales reflects the focus the Company has placed on development and acquisition of commercial product lines.\nThe increase in consolidated net sales in 1995, exclusive of the Product Lines acquisition, relates primarily to unit volume. There were both minor price increases and decreases in most European markets, while in Japan, the Company experienced overall declines in pricing due to worldwide competitive pressures.\nOther Income was $2.2 million in 1995 compared to $2.5 million in 1994. Other income generally includes rents, royalties and interest. The decline is principally due to lower interest income.\nCost of sales increased to 70.8% of net sales in 1995 compared with 69.5% in 1994. The International Controls segment cost of sales percentages have declined as a result of increased sales and related improvements in facility utilization, along with the cost reduction efforts made over the previous three years. The International Controls segment improvement was more than offset, however, by increasing cost of sales percentages for the Domestic Controls segment. The Domestic Controls segment increase is principally due to the costs associated with the transition services and a change in product mix which reflects a greater percentage of lower margin production and development contracts sales in 1995 compared to 1994.\nResearch and Development expenses were $15.8 million, or 4.2% of net sales in 1995 compared to $18.7 million, or 6.1% of net sales in 1994. The decline is attributable to significant expenditures in 1994 on brushless motor development for entertainment motion platforms, radio controls, engine thrust vectoring controls, and helicopter vibration controls. Further, more engineering resources are currently being utilized on production related activity.\nTotal Company sponsored and customer sponsored research and development expenses were $37.4 million in 1995 compared to $44.0 million in 1994. Customer sponsored R&D was $21.6 million in 1995 compared with $25.3 million in 1994. Customer sponsored R&D reflects the Company's involvement in a number of development programs including the B-2, the Taiwanese Indigenous Defense Fighter (IDF) and various military ground vehicle programs in Europe.\nSelling, General and Administrative Expenses in 1995 were $68.5 million, or 18.3% of sales, compared to $58.3 million, or 19.0% of sales in 1994. In absolute terms, the increase is primarily due to a full year of costs for the Product Lines. Further, $2.6 million of the increase reflects the higher average value of foreign currencies relative to the U.S. dollar. The decline as a percentage of sales reflects the benefits of additional sales from the Product Lines and increasing sales in the International Controls segment.\nInterest Expense increased in 1995 to $17.5 million or 4.7% of net sales compared to $11.4 million or 3.7% of net sales in 1994. The increase in interest expense is due to the additional debt associated with the acquisition of the Product Lines.\nForeign Currency Exchange Loss (Gain) was a loss of $.1 million in 1995 compared with a gain of $.5 million in 1994. The 1994 gain primarily related to a short-term loan denominated in Deutsche Marks between the parent company and the German subsidiary during which time the Deutsche Mark appreciated.\nIncome Tax Expense at an effective rate of 11.7% for 1995 compares with a 1994 effective rate of 46.8%. The effective tax rate for 1995 reflects the relatively strong earnings at the Company's German operation, which benefits from its net operating loss carryforward position. Conversely, the higher effective tax rate for 1994 resulted from losses at the German subsidiary which provided limited tax benefits.\nIn the fourth quarter of 1995 and 1994, the Company reduced its valuation allowance for deferred tax assets to reflect the improved German operating results. See Note 9 of Item 8","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nNotes To Consolidated Financial Statements (dollars in thousands except per share data)\nNote 1 - Summary of Significant Accounting Policies\nConsolidation: The consolidated financial statements include the accounts of Moog Inc. and all of its U.S. and International subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to conform the prior years financial statements with the 1995 presentation.\nCash and Cash Equivalents: All highly liquid investments with an original maturity of three months or less are considered cash equivalents.\nRevenue Recognition: The percentage of completion (cost-to-cost) method of accounting is followed for long-term contracts. Under this method, revenues are recognized as the work progresses toward completion. Contract incentive awards affect earnings when the amounts can be determined. For contracts with anticipated losses at completion, the projected loss is accrued. Revenues other than on long term contracts are recognized as units are delivered.\nInventories: Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method of valuation. Consistent with industry practice, aerospace related inventories include amounts relating to contracts having long production and procurement cycles, portions of which are not expected to be realized within one year.\nForeign Currency: Foreign subsidiary assets and liabilities are translated using rates of exchange as of the balance sheet date and the statements of income are translated at the average rates of exchange for the year. Gains and losses resulting from translation and hedging of net investments in, or long term advances to, foreign subsidiaries are accumulated in the equity section as \"Equity Adjustments.\" Gains and losses resulting from foreign currency transactions are included in income.\nDepreciation and Amortization: Plant and equipment are depreciated principally using the straight-line method over the estimated useful lives of the assets. Leasehold improvements and assets considered capital leases are amortized on a straight-line basis over the term of the lease or the estimated useful life of the asset, whichever is shorter. Debt issuance costs are amortized over the term of the related debt agreements.\nIntangibles associated with acquisitions are amortized over their estimated useful lives, generally 7 to 12 years. The Company annually reviews acquisition related intangibles for impairment. The method used to determine whether such intangibles have been impaired is generally based upon forecasted undiscounted cash flows.\nIncome Taxes: The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" in 1994. The Company separately reported the cumulative effect of the adoption of SFAS No. 109 in the Consolidated Statements of Income.\nUnder the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for future tax consequences\nNote 1 - (continued)\nattributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Under the previously used asset and liability method of SFAS No. 96, deferred tax assets and liabilities were recognized for all events that had been recognized in the financial statements, with generally no consideration of any future events in calculating deferred taxes.\nNote 2 - Acquisition\nOn June 17, 1994, the Company acquired the hydraulic and mechanical actuation product lines (the Product Lines) of AlliedSignal Inc., located in Torrance, California. The Product Lines include mechanical drive systems for leading edge flaps and hydraulic servoactuators for primary and secondary flight controls used on a wide variety of commercial and military aircraft. The purchase price for the Product Lines, including payment for specified transition services, was $68,800 based upon finalization of the net assets transferred. The acquisition has been accounted for under the purchase method, and accordingly, the operating results for the Product Lines have been included in the Consolidated Statements of Income since the date of acquisition. The cost of the acquisition was allocated on the basis of the estimated fair value of assets acquired and the liabilities assumed.\nThe acquisition was financed with proceeds from a Revolving Credit and Term Loan Agreement with a banking group (Note 7). The acquisition resulted in Product Line intangible assets, as adjusted for the final purchase price allocation, of $14,565, which are being amortized over a 12 year period.\nThe following summary, prepared on a pro-forma basis, combines the unaudited consolidated results of operations as if the Product Lines had been acquired at the beginning of the periods presented. The pro-forma consolidated results include the impact of certain adjustments, including amortization of intangibles, increased interest expense on acquisition debt, and related income tax effects.\n(Unaudited) 1994 1993\nNet sales $ 375,545 $ 394,130 Net earnings before extraordinary item and cumulative effect of change in accounting principle 6,916 7,461 Net earnings 7,421 7,104 Earnings per share $ .96 $ .92\nThe pro-forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the periods presented.\nNote 3 - Receivables\nReceivables consist of:\nSeptember 30 1995 1994\nLong term contracts: Amounts billed $ 38,542 $ 35,168 Unbilled recoverable costs and profits 61,400 63,151 Unbilled costs and profits subject to negotiation 116 571 __________ __________ Total long-term contract receivables 100,058 98,890 Trade 45,582 40,679 Refundable income taxes 3,331 5,504 Other 1,323 617 __________ __________ Total receivables 150,294 145,690 Less allowance for doubtful accounts (1,379) (1,493) __________ __________ Receivables, net $ 148,915 $ 144,197\nThe long term contract amounts are primarily associated with prime U.S. Government contractors and the major commercial aircraft manufacturers. These amounts include retainage in accordance with the terms of the contracts. Unbilled costs and profits subject to negotiation represent claims on terminated contracts. Substantially all unbilled amounts are expected to be collected within one year. In situations where billings exceed revenues recognized, the excess is included in customer advances.\nNote 4 - Inventories\nInventories consist of the following:\nSeptember 30 1995 1994\nRaw materials and purchased parts $ 23,028 $ 19,356 Work in process 52,839 48,517 Finished goods 10,309 10,769 _________ _________ $ 86,176 $ 78,642\nIn 1994, the Company incurred a pre-tax charge of $2,574 to write off obsolete Domestic Controls segment inventory. The special charge reflected a decline in repair activities and spare parts requirements on various government programs.\nNote 5 - Property, Plant and Equipment\nProperty, plant and equipment consists of:\nSeptember 30 1995 1994\nLand $ 7,864 $ 7,870 Buildings and improvements 89,323 87,124 Machinery and equipment 212,026 207,769 ________ ________ Property, plant and equipment, at cost 309,213 302,763 Less accumulated depreciation and amortization (170,082) (156,291) ________ ________ Property, plant and equipment, net $139,131 $146,472\nNote 6 - Notes Payable\nThe Company maintains short term lines of credit with various banks throughout the world. The short term credit lines are principally demand lines and subject to revision by the banks. At September 30, 1995, $6,606 of notes payable to banks at an average rate of 7.4% were outstanding under these lines of credit. During 1995, an average of $8,355 in notes payable were outstanding at an average interest rate of 8.1%. These short term lines of credit, along with $39,701 available on the amended long term U.S. revolving credit agreement detailed in Note 7, provide credit availability amounting to $56,900. Commitment fees are charged on some of these arrangements based on a percentage of the unused amounts available.\nNote 7 - Long Term Debt and Subordinated Debentures\nLong-Term Debt consist of the following:\nSeptember 30 1995 1994\nU.S. revolving credit agreement $ 95,299 $ 70,000 U.S. term loan agreements 30,000 67,000 10-1\/4% Note 18,350 20,000 International and other U.S. term loan agreements 16,452 13,359 Obligations under capital leases 3,654 3,448 ________ ________ 163,755 173,807 Less current installments: Long-term debt 4,859 12,978 Capital lease obligations 821 823 ________ ________ Long term debt excluding current installments $158,075 $160,006\nSubordinated Debentures consist of the following:\nSeptember 30 1995 1994\nSubordinated debentures 19,400 20,800 Less current installment 1,400 1,400 Subordinated debentures excluding current ________ ________ installment 18,000 19,400\nNote 7 - (continued)\nThe U.S. Revolving Credit and Term Loan Agreement (Agreement) was amended in November 1995, increasing the facility to $165,000,which consists of a $135,000 revolving credit facility and a $30,000 term loan. The original facility, entered into in June 1994 to finance the acquisition of the Product Lines and to refinance existing debt, was a $151,750 total facility consisting of an $84,750 revolving credit facility and a $67,000 term loan. The amended revolving credit facility is for a five year period which expires in October 2000. The amended term loan is for six years through July 2001, with quarterly principal payments of $1,500 commencing October 1, 1996. As a result of this amendment $ 6,930 otherwise due in 1996 was converted to long term and has been classified as such on the September 30, 1995 Consolidated Balance Sheet.\nInterest on the Agreement is LIBOR plus 1.75%. In order to provide for interest rate protection, the Company has entered into interest rate swap agreements for $100,000, effectively converting this amount to fixed rate debt averaging 8.0%. The swaps expire at various times from June 1996 through July of 1998.\nThe 10-1\/4% Note has quarterly principal payments of $550 through October 1, 1995, increasing to $700 on January 1, 1996 and $750 on January 1, 1997, with a final payment due in July 2001.\nBoth the Agreement and the Note contain various covenants which, among others, specify minimum interest and payment coverage, maintenance of tangible net worth, required working capital and current ratio levels, and limit liabilities in relation to tangible net worth. The Agreement prohibits payment of cash dividends on common stock. The Agreement and the Note are secured by substantially all of the Company's U.S. assets and the common shares of all Domestic and International subsidiaries. The Agreement and the Note will convert to unsecured arrangements when the Company has three consecutive quarters whereby the ratio of consolidated liabilities to tangible net worth is less than 200%.\nInternational and other U.S. term loan agreements of $16,452 at September 30, 1995 consist principally of financing provided by various banks to individual International subsidiaries. These term loans are being repaid through 2004, and carry interest rates ranging from 2.6% to 14.3% in 1995 and 2.875% to 16.1% in 1994.\nConvertible subordinated debentures at 9-7\/8% are subordinated in right of payment to all senior indebtedness, as defined, and are convertible, subject to prior redemption, into shares of Class A Common Stock at $22.88 per share at any time up to and including the maturity date of January 15, 2006. At September 30, 1995, the debentures are convertible into 847,902 shares of Class A Common Stock (Note 13). The debentures are redeemable at the option of the Company, at any time, in whole or in part, at 100% of their principal amount. The quoted market price of the debentures at September 30, 1995 and 1994, was 102 and 100, respectively.\nMaturities of long-term debt and subordinated debentures for the next five years are $7,080 in 1996, $13,600 in 1997, $18,322 in 1998, $12,663 in 1999, $107,578 in 2000, and $23,912 thereafter.\nIn the first quarter of 1993, the Company extinguished $10,186 of 12-7\/8% Domestic long-term debt prior to its scheduled maturity in order to take advantage of a decline in U.S. interest rates. Funds from existing\ncredit facilities were used to accomplish the extinguishment. The cost of the extinguishment was $357, net of $119 in income tax benefits, and was recorded as an extraordinary charge in the Consolidated Statement of Income.\nAt September 30, 1995, the Company has pledged assets with a net book value of $265,425 as security for long-term debt.\nNote 8 - Leases\nThe Company leases certain facilities and equipment under various lease arrangements. Such arrangements generally include fair market value renewal and\/or purchase options. Some of the capital leases (primarily land and buildings) allow for the Company to purchase the asset at a nominal price upon expiration. Substantially all leases provide that the Company pay applicable taxes, maintenance, insurance, and certain other operating expenses. Amortization of assets recorded as capital leases is included with depreciation and amortization of plant and equipment. Assets under leases that have been accounted for as capital leases and included in property, plant and equipment are summarized as follows:\nSeptember 30 1995 1994\nCapital leases at cost $ 6,945 $ 6,861 Less accumulated amortization (2,841) (2,534) ________ ________ Net assets under capital leases $ 4,104 $ 4,327\nRent expense under operating leases amounted to $6,957 in 1995, $7,049 in 1994 and $6,366 in 1993. Future minimum rental payments required under noncancelable operating leases are $5,680 in 1996, $4,536 in 1997, $3,697 in 1998, $2,982 in 1999, $2,372 in 2000, and $10,832 thereafter.\nThe Company subleases various facilities to third parties. Gross rental income from such activities was $1,535 in 1995, $1,247 in 1994, $780 in 1993. Future minimum rental income under noncancelable operating leases is $1,135 in 1996, $610 in 1997, $170 in 1998.\nInterest expense includes $217 in 1995, $261 in 1994 and $715 in 1993 attributable to obligations under capital leases.\nNote 9 - Income Taxes\nThe Company adopted SFAS No. 109 \"Accounting for Income Taxes\" in 1994. SFAS No. 109 supersedes SFAS No. 96 \"Accounting For Income Taxes.\" The impact of adopting SFAS No. 109 on the Consolidated Statement of Income was to increase 1994 earnings by $505, which was recorded as a cumulative effect of change in accounting principle.\nThe reconciliation of the provision for income taxes with the amount computed by applying the U.S. federal statutory tax rate of 34% to earnings before income taxes, extraordinary item and cumulative effect of change in accounting principle is as follows:\nNote 9 - (continued)\n1995 1994 1993 Earnings before income taxes, extraordinary item and cumulative effect of change in accounting principle: Domestic $ 6,042 $ 6,054 $ 10,376 Foreign 2,967 (3,440) (1,741) Eliminations (219) 426 (15) _____________________________ Total $ 8,790 $ 3,040 $ 8,620\nComputed expected tax expense $ 2,988 $ 1,034 $ 2,931 Increase (decrease) in income taxes resulting from: Foreign tax rates 356 (419) 402 Deferred tax rate differential - - (1,092) Nontaxable FSC earnings (280) (350) (325) State taxes net of federal benefit 226 79 168 Change in beginning of the year valuation allowance (765) (420) - Utilization of net operating losses (2,136) - - Limitation on benefits from foreign net operating losses 192 1,054 1,498 Other 448 444 (80) _____________________________ Income taxes $ 1,029 $ 1,422 $ 3,502 =============================\nEffective income tax rate 11.7% 46.8% 40.6%\nAt September 30, 1995, certain International subsidiaries had net operating loss carryforwards totalling $4,254. These loss carryforwards do not expire and can be used to reduce current taxes otherwise due on future earnings of those subsidiaries.\nAccumulated undistributed earnings of International subsidiaries intended to be permanently reinvested are $19,021 at September 30, 1995. If such earnings were remitted to the Company, income taxes, based on the applicable current rates, would be payable after reductions for any foreign taxes previously paid on such earnings and subject to applicable limitations.\nThe components of income taxes excluding the extraordinary item and cumulative effect of change in accounting principle are as follows:\n1995 1994 1993 Current: Federal $ (828) $ (3,255) $ 1,320 Foreign 292 (249) 2,180 State - - 213 _____________________________ Total current (536) (3,504) 3,713 _____________________________\nNote 9 - (continued)\nDeferred: Federal $ 2,466 5,440 305 Foreign (1,243) (634) (558) State 342 120 42 _____________________________ Total deferred 1,565 4,926 (211) _____________________________ Total income taxes $ 1,029 $ 1,422 $ 3,502\nThe tax effects of temporary differences that generated deferred tax assets and liabilities are detailed in the following table. 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 projected future taxable income and tax planning strategies in making this assessment. 1995 1994 Deferred tax assets: Contract loss reserves not currently deductible $ 5,890 $ 5,575 Net operating loss carryforwards 2,578 3,730 Accrued vacation 4,440 3,621 Deferred compensation 4,099 3,212 Accrued expenses not currently deductible 2,392 2,698 Inventory 3,031 2,436 Other 62 845 ________ ________ Total gross deferred tax assets 22,492 22,117 Less: Valuation reserve (3,366) (5,223) ________ ________ Net deferred tax assets 19,126 16,894 ________ ________ Deferred tax liabilities: Differences in bases and depreciation of property, plant and equipment 20,720 13,591 Intangible assets - 2,832 Prepaid pension 552 884 Other 712 866 ________ ________ Total gross deferred tax liabilities 21,984 18,173 ________ ________ Net deferred tax liabilities $ 2,858 $ 1,279\nNet deferred taxes are presented in the accompanying Consolidated Balance Sheets as follows: 1995 1994\nNoncurrent deferred tax liabilities $ 19,674 $ 16,671 Current deferred tax assets 16,816 15,392 ________ ________ Net deferred tax liabilities $ 2,858 $ 1,279\nIn 1993, deferred taxes resulted from differences in the tax and financial accounting for depreciation, restructuring charges, and estimated losses on contracts and inventories.\nNote 10 - Restructuring Charges\nIn 1994, the Company provided $2,107 in pre-tax restructuring charges, with $890 related to the Domestic Controls segment and $1,217 related to the International Controls segment. The restructuring actions were taken in response to U.S. defense spending reductions and the persistently weak capital goods markets in Europe. The restructuring charge included $1,757 of severance benefit costs relating to work force reductions totalling 140 employees in the Company's operations in the United States, England, Germany and Denmark. The Company has completed the work force reductions by September 30, 1995. The total severance related charges were paid in their entirety by September 30, 1995. A charge of $350 was also recorded and paid for the termination of a long term operating lease in September 1994.\nNote 11 - Employee Benefit Plans\nEmployee and management profit share plans provide for the computation of profit share based on net earnings as a percent of net sales multiplied by base wages, as defined. The profit share plan was suspended for 1995. Profit share expense was $459 in 1994 and $1,119 in 1993.\nThe Company has a Savings and Stock Ownership Plan (SSOP) which includes an Employee Stock Ownership Plan (ESOP). As one of the investment alternatives, participants in the SSOP can acquire Company stock at market value, with the Company providing a 25% share match. The SSOP purchase of the matching Class B shares was funded by a Company loan. The loan is repaid with Company contributions. Interest on the loan is computed at the Company's U.S. Revolving Credit and Term Loan borrowing rate. Shares are allocated and compensation expense is recognized as the employer share match is earned. Compensation expense was $446 in 1995, $180 in 1994 and $161 in 1993. Class B shares allocated to ESOP participants for 1995, 1994 and 1993 were 23,397, 12,236 and 10,891, respectively. At September 30, 1995, 502,382 Class B Common Shares were owned by the SSOP participants, including the Company match, representing 30% of the issued and outstanding Class B shares. An additional 50,779 Class B shares related to the Company match remain to be allocated to participants. The SSOP began purchasing shares of Class A Common Stock in 1995 in addition to the Class B Common Stock. At September 30, 1995, a total of 63,947 Class A Common Shares were owned by the SSOP participants, representing 1% of Class A Common Shares issued and outstanding. All SSOP shares, both allocated and those remaining to be allocated, are considered outstanding for calculating earnings per share.\nIn 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" Under SFAS No. 106, the cost of postretirement benefits other than pensions must be recognized as employees perform services to earn the benefits, instead of when benefits are paid, as had been the practice in 1993 and prior years. Postretirement health care benefits for U.S. employees are the only costs that need to be accrued by the Company in accordance with SFAS No. 106. Substantially all of the Company's U.S. employees hired prior to March 1, 1989 will become eligible for benefits when they reach normal retirement age while working for the Company. Further, changes in the Company's health care plans have limited the amount of retiree health care benefits to employees who retire after October 1, 1989.\nNote 11 - (continued)\nThe 1995 SFAS No. 106 cost of $1,011 included $119 for service cost, $599 for interest cost and $394 for amortization of the October 1, 1993 transition obligation over a twenty year period and ($101) for the amortization of actuarial gains and losses. The 1994 cost of $1,075 was comprised of $103 for service cost, $577 for interest cost and $395 for the amortization of the transition obligation. The health care costs for retirees expensed in 1993 was $741, based on expensing claims as paid.\nThe discount rate assumed at September 30, 1995 was 7.75% compared with the 9.0% rate used to determine the September 30, 1994 obligation. In June 1994, the Company's SFAS No. 106 obligation increased by $569 due to the acquisition of the Product Lines (Note 2). For pre October 1, 1989 retiree's, the health care cost trend rates assumed are 2.5% per year for qualified employees who are presently under 65 years of age, and 11.0% in 1996, 10.0% in 1997 and 2.5% for 1998 and all subsequent years for Plan participants who are currently older than 65 years of age. Premiums for post October 1, 1989 retiree's are frozen and no trend schedule is applied. The effect of a one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of September 30, 1995 by approximately 3.8%, and increase the aggregate of the service and interest cost components of net annual postretirement benefit cost by approximately 3.3%.\nA reconciliation of the funded status of the plan with the accrued liability at September 30, 1995 is shown below. There were no Plan Assets at September 30, 1995 or 1994.\nSeptember 30 1995 1994\nAccumulated Postretirement Benefit Obligation (APBO) - Inactives $ (5,307) $ (4,414) - Actives fully eligible (367) (342) - Actives not fully eligible (2,724) (2,167) _________ _________ Total APBO (Funded Status) (8,398) (6,923) Unrecognized Transition Obligation 7,098 7,493 Unrecognized Gains (158) (1,498) _________ _________ Accrued Postretirement Benefit Cost $ (1,458) $ (928)\nThe Company maintains defined benefit and defined contribution plans covering substantially all employees. With the exception of certain International subsidiaries, the Company funds defined benefit pension costs accrued, including amortization of prior service costs, over a 15-year period. Plan Assets where applicable, consist primarily of government obligations and publicly traded stocks, bonds and mutual funds. At September 30, 1995 and 1994, the minimum pension liability adjustments were $2,072 and $989, respectively. This liability is offset by an intangible asset of $743 in 1995 and $891 in 1994 and a reduction of shareholders' equity of $1,329 in 1995, and $98 in 1994. The 1995 and 1994 minimum pension liability adjustment reflects the change in the discount rate for measuring U.S. plan obligations. At September 30, 1995, the discount rate for the U.S. was decreased to 7.75% from 9.0% at September 30, 1994. The comparable discount rate at September 30, 1993 was 7.5%.\nNote 11 - (continued)\nThe tables below set forth the funded status of the domestic and foreign defined benefit plans at September 30, 1995, 1994, and pension expense in 1995, 1994 and 1993 for all plans. Principal actuarial assumptions weighted for all plans are: 1995 1994\nDiscount rate 7.4% 8.7% Return on assets 8.2% 8.9% Rate of compensation increase 3.6% 3.3%\nNote 11 - (continued)\nNote 11 - (continued)\nPension Expense for 1995, 1994 and 1993:\n1995 1994 1993 Service cost - benefits earned during the year $ 4,523 $ 4,217 $ 3,940 Interest cost on projected benefit obligation 9,019 8,472 7,836 Actual return on Plan assets (16,939) (3,017) (11,246) Net amortization, deferral and other 9,038 (3,005) 4,889 ________ ________ ________ Pension expense for defined benefit plans 5,641 6,667 5,419 Pension expense for other plans 317 383 265 ________ ________ ________ Total Pension Expense $ 5,958 $ 7,050 $ 5,684 ________ ________ ________\nNote 12 - Stock Option Plans\nThe 1983 Non-Statutory Stock Option Plan granted options on Class B Shares to directors, officers, and key employees. Stock appreciation rights were granted in tandem with the options and are exercisable only to the extent the options are exercised. The 1983 Incentive Stock Option Plan granted options on Class A shares to officers and key employees. The Plans terminated on December 31, 1992 and outstanding options expire no later than ten years after the date of grant.\nOptions were granted at prices not less than market value on the date of the grant. Shares under option are as follows:\nNon-Statutory Incentive Plan Plan (Class B) (Class A)\nOutstanding at September 30, 1992: 145,020 343,400 Granted in 1993 - ($5.625 per share) - 57,000 Cancelled in 1993 (5,304) (11,100) _______ _______ Outstanding at September 30, 1993: 139,716 389,300 Cancelled or expired in 1994 (6,304) (3,800) Exercised in 1994 - (5,500) _______ _______ Outstanding at September 30, 1994: 133,412 380,000 Cancelled or expired in 1995 (500) (3,400) Exercised in 1995 (1,000) (6,000) _______ _______ Outstanding and exercisable at September 30, 1995: Class A ($5.625 to $10.50 per share) 370,600 Class B ($11.00 to $17.25 per share) 131,912\nNote 13 - Capital Stock\nClass A and Class B Common Stock share equally in the earnings of the Company, and are identical in most respects except (i) Class A has limited voting rights, each share of Class A being entitled to one-tenth of a vote on most matters and each share of Class B being entitled to one vote, (ii) Class A shareholders are entitled to elect at least 25% of the Board of Directors (rounded up to the nearest whole number) with Class B shareholders entitled to elect the balance of the directors, (iii) cash dividends may be paid on Class A without paying a cash dividend on Class B and no cash dividend may be paid on Class B unless at least an equal cash dividend is paid on Class A, and (iv) Class B shares are convertible at any time into Class A on a one-for-one basis at the option of the shareholder. The number of common shares issued reflects conversion of Class B to Class A of 317 shares in 1994, and 373 shares in 1993. Convertible subordinated debentures were also converted into 87 Class A shares in 1995.\nSeries B Preferred Stock is 9% Cumulative, Convertible, Exchangeable, Preferred Stock with a $1.00 par value. Series B Preferred Stock consists of 100,000 issued and outstanding shares, and are convertible into Class A Common Shares. The Board of Directors may authorize, without further shareholder action, the issuance of additional Preferred Stock which ranks senior to both classes of Common Stock of the Company with respect to the payment of dividends and the distribution of assets on liquidation. The Preferred Stock, when issued, would have such designations relative to voting and conversion rights, preferences, privileges and limitations as determined by the Board of Directors.\nOf the Class B common stock, 131,912 shares are reserved for issuance under the 1983 Non-Statutory Stock Option Plan (note 12). Class A shares reserved for issuance at September 30, 1995 are as follows:\nShares\nConversion of Class B to Class A shares 2,666,829 Conversion of 9-7\/8% convertible subordinated debentures (note 7) 847,902 1983 Incentive Stock Option Plan (note 12) 370,600 Conversion of Series B Preferred Stock to Class A shares 8,585 _________ 3,893,916\nNote 14 - Industry Segments\nThe Company's two industry segments, Domestic Controls and International Controls, manufacture and market precision control systems and components primarily for North America and for industrialized economies in Europe and the Far East, respectively.\nNote 14 - (continued)\n1995 1994 1993 Domestic Controls Net Sales: Government $ 163,714 $ 157,928 $ 147,532 Commercial 90,212 55,322 41,833 Intersegment sales 10,446 7,804 12,488 _________ _________ _________ Total sales $ 264,372 $ 221,054 $ 201,853 ========= ========= =========\nOperating profit (O.P.) $ 25,242 $ 20,373 $ 21,726 Inventory obsolescence and restructuring charges included in O.P. - 3,390 - Net earnings 4,030 4,394 7,604 Identifiable assets 282,323 290,644 186,147 Capital expenditures 5,633 5,263 6,093 Depreciation expense 10,363 7,725 7,389\nInternational Controls Net Sales: Government $ 18,064 $ 16,385 $ 19,240 Commercial 102,294 77,735 85,075 Intersegment sales 4,728 5,634 4,231 _________ _________ _________ Total sales $ 125,086 $ 99,754 $ 108,546 ========= ========= ========= Operating profit (O.P.) $ 8,464 $ 1,135 $ 5,097 Inventory obsolescence and restructuring charges included in O.P. - 1,291 - Net earnings (loss) 3,918 (2,366) (2,842) Identifiable assets 120,499 100,261 100,902 Capital expenditures 3,977 3,019 2,888 Depreciation expense 5,337 5,129 5,996\nConsolidated operations Net Sales $ 374,284 $ 307,370 $ 293,680 Operating profit (O.P.) 33,706 21,508 26,823 Inventory obsolescence and restructuring charges included in O.P. - 4,681 - Deductions from operating profit: Interest expense 17,492 11,402 10,974 Currency loss (gain) 143 (451) 60 Corporate and other expenses 7,354 7,613 7,170 Eliminations (73) (96) (1) _________ _________ _________ Total deductions 24,916 18,468 18,203 Earnings before income taxes, extraordinary item and cumulative effect of change in accounting principle 8,790 3,040 8,620 Income taxes 1,029 1,422 3,502 _________ _________ _________\nNote 14 - (continued)\nEarnings before extraordinary item and cumulative effect of change in accounting principle 7,761 1,618 5,118 Extraordinary item - - (357) Cumulative effect of change in accounting principle - 505 - _________ _________ _________ Net earnings $ 7,761 $ 2,123 $ 4,761 ========= ========= ========= Total identifiable segment assets $ 402,822 $ 390,905 $ 287,049 Corporate assets 39,864 50,179 42,085 Eliminations (17,729) (16,628) (11,004) _________ _________ _________ Total assets $ 424,957 $ 424,456 $ 318,130\nIntersegment sales, which are transacted at appropriate arms length transfer prices, have been eliminated in net sales. Operating profit is total revenue less cost of sales and identifiable operating expenses. The deductions from operating profit have been charged to the respective segments by being directly identified with the segments or allocated on the basis of assets or earnings.\nIncluded in net sales for Domestic Controls is $136,261 in 1995, $118,807 in 1994, and $125,369 in 1993, in sales to the U.S. government or to prime U.S. government contractors. Net sales in 1994 and 1993 included $38,752 and $37,200 respectively, for the B-2 Advanced Technology Bomber with the Northrup Corporation.\nNote 15 - Geographic Areas and Export Sales\nUnited Europe Pacific & Corporate & Consol- States Other Eliminations idated Identifiable Assets:\n1995 $282,323 $ 79,910 $ 40,589 $ 22,135 $424,957 1994 290,644 66,086 34,175 33,551 424,456 1993 186,147 67,128 33,774 31,081 318,130\nSales to Unaffiliated Customers:\n1995 $253,926 $ 90,076 $ 30,282 $374,284 1994 213,250 67,568 26,552 307,370 1993 189,365 78,776 25,539 293,680\nInter-area Sales to Affiliates:\n1995 $ 10,446 $ 4,062 $ 666 $ 15,174 1994 7,804 4,738 896 13,438 1993 12,488 2,864 1,367 16,719\nNote 15 - (continued)\nExport Sales:\n1995 $ 54,364 $ 25,370 $ 1,610 $ 81,344 1994 41,698 18,575 1,867 62,140 1993 25,623 31,954 3,103 60,680\nNet Earnings (Loss):\n1995 $ 4,030 $ 4,082 $ (164) $ (187) $ 7,761 1994 4,394 (3,583) 1,217 95 2,123 1993 7,604 (4,233) 1,391 (1) 4,761\nSales between geographic areas are generally transacted and accounted for at comparable arms length pricing. Export sales from the United States are primarily to areas other than Europe. Export sales from Europe and all other geographic areas are principally to countries within their geographic area.\nNote 16 - Commitments and Contingencies\nThe Company, over the past five years, has been named as a potentially responsible party (PRP) with respect to three Superfund sites. The clean up actions with regard to the three Superfund sites has been completed, and the Company's share of the related financial accommodations was not significant. No further actions have been initiated by Federal or State regulators. In addition, the Company was notified in August 1993 by a PRP group at a site related to one of the Superfund sites referenced above that it will seek contribution from the Company to the extent the PRP group is responsible for remediation costs. The Company is also in the process of voluntarily remediating an area identified in 1994 at a Company-owned facility leased to a third party.\nAt September 30, 1995, the Company believes that adequate reserves have been established for environmental issues, and does not expect these environmental matters will have a material effect on the financial position of the Company in excess of amounts previously reserved.\nLegal proceedings pending by or against the Company and it's subsidiaries are not expected to have a material effect on the financial condition or results of operations of the Company and its subsidiaries taken as a whole.\nIn the ordinary course of business, subsidiaries of the Company have discounted promissory notes received in settlement of trade receivables at banks. The aggregate proceeds from discounted notes were $8,091 in 1995, $14,809 in 1994, $13,663 in 1993. Under the recourse provisions of such transactions, the subsidiaries are contingently liable for $661 at September 30, 1995.\nThe Company has $5,894 in open letters of credit at September 30, 1995, which principally relate to cash advances received on a contract.\nNote 17 - Financial Instruments and Credit Concentration\nThe Company uses a variety of financial instruments, including foreign exchange instruments, letters of credit and interest rate swaps to reduce financial risk. The Company is exposed to credit loss in the event of nonperformance by the counter-parties to the instruments. The Company, however, does not expect nonperformance by the counter-parties.\nForeign exchange instruments are used to hedge the Company's equity in, and long term advances to, various International subsidiaries. At September 30, 1995 and September 30, 1994, the Company had $6,107 and $9,935, respectively, of such instruments outstanding at fair value. Gains and losses on these hedges of equity and long term advances are included in shareholders' equity. Foreign currency forward contracts are periodically utilized to hedge known foreign currency cash flows. Gains and losses on such contracts are netted against the gain or loss on the underlying amounts receivable or payable. Foreign currency forward contracts outstanding at fair value on September 30, 1995 were $2,020.\nThe Company has three interest rate swap agreements which convert a notional amount of $100,000 in variable rate long term debt to 8.0% fixed rate debt. The agreements expire at various times from June 1996 through June 1998. The differential interest paid or received is accrued as interest rates change and is recognized over the life of the agreements.\nCash and cash equivalents and notes payable are carried at amounts which approximate fair value at September 30, 1995 because of their short maturity. The fair value of long-term debt was estimated based on a discounted cash flow analysis using current rates offered to the Company for debt with the same remaining maturities. At September 30, 1995, the carrying value and estimated fair value of long-term debt was $183,155 and $188,763, respectively.\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary investments with highly rated financial institutions for maturities of generally three months or less. Concentrations of credit risk with respect to trade receivables are limited due to the significant amount of business with prime U.S. Government contractors or large commercial aerospace companies, and to the number of customers and their dispersion over a large geographic area.\nNote 18 - Quarterly Data - Unaudited\nREPORT OF INDEPENDENT AUDITORS\nShareholders and Board of Directors of Moog Inc.:\nWe have audited the consolidated financial statements of Moog Inc. and subsidiaries listed in Item 14 (a)(1) of the annual report on Form 10-K for the fiscal year 1995. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in Item 14 (a)(2) of the annual report on Form 10-K for the fiscal year 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 financial statement schedule based on our audits. We did not audit the financial statements or schedule of certain wholly-owned consolidated subsidiaries, which statements reflect total assets constituting 13% as of September 30, 1995 and 1994, and total net sales constituting 17%, 18% and 22% of the related consolidated totals for the years ended September 30, 1995, 1994 and 1993, respectively. Those statements and schedule 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 consolidated subsidiaries, 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 Moog Inc. 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 schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all materials respects, the information set forth therein.\nAs discussed in Notes 1 and 9 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1994 to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As discussed in Note 11, the Company has also adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" in 1994.\nKPMG PEAT MARWICK LLP Buffalo, New York November 22, 1995\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant.\nThe information required herein with respect to directors of the Company is incorporated by reference to \"Election of Directors\" in the 1996 Proxy.\nExecutive Officers of the Registrant.\nThe names and ages of all executive officers of Moog are set forth on the following page.\nOther than John B. Drenning, the principal occupations of the following officers for the past five years have been their employment with the Company. Mr. Drenning's principal occupation is partner in the law firm of Phillips, Lytle, Hitchcock, Blaine & Huber.\nExecutive Officers and Positions Held Age Year First Elected Officer\nRobert T. Brady President; Chief Executive Officer; Director; Member, Executive Committee 54 1967\nRichard A. Aubrecht Chairman of the Board; Director; Member, Executive Committee 51 1980\nJoe C. Green Executive Vice President; Chief Administrative Officer; Director; Member, Executive Committee 54 1973\nRobert R. Banta Executive Vice President; Chief Financial Officer; Director; Assistant Secretary; Member, Executive Committee 53 1983\nKenneth D. Garnjost Vice President - Engineering 69 1961\nPhilip H. Hubbell Vice President - Contracts and Pricing 56 1988\nStephen A. Huckvale Vice President - International 46 1990\nRobert H. Maskrey Vice President 54 1985\nRichard C. Sherrill Vice President 57 1991\nKenneth G. Smith Vice President 59 1990\nWilliam P. Burke Treasurer 60 1985\nJohn B. Drenning Secretary 58 1989\nDonald R. Fishback Controller 39 1985\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nThe information required herein is incorporated by reference to \"Compensation Committee Report,\" \"Stock Price Performance Graph,\" \"Summary Compensation Table,\" \"Fiscal Year-End Option\/SAR Values,\" \"Employees' Retirement Plan,\" \"Supplemental Retirement Plan,\" \"Employment Termination Benefits Agreements\" and \"Compensation of Directors\" in the 1996 Proxy.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required herein is incorporated by reference to \"Certain Beneficial Owners\" and \"Election of Directors\" in the 1996 Proxy.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nThe information required herein is incorporated by reference to \"Transactions With Moog Controls Inc.\" in the 1996 Proxy.\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. Index to Financial Statements. The following financial statements are included: (i) Consolidated Statements of Income for the years ended September 30, 1995, 1994, and 1993. (ii) Consolidated Balance Sheets as of September 30, 1995 and 1994. (iii) Consolidated Statements of Cash Flows for the years ended September 30, 1995, 1994, and 1993. (iv) Consolidated Statements of Shareholders' Equity for the years ended September 30, 1995, 1994, and 1993. (v) Notes to Consolidated Financial Statements. (vi) Report of Independent Auditors.\n2. Index to Financial Statement Schedules. The following Financial Statement Schedule as of and for the years ended September 30, 1995, 1994, and 1993, is included in this Annual Report on Form 10-K:\nII. Valuation and Qualifying Accounts.\nSchedules other than that listed above are omitted because the conditions requiring their filing do not exist, or because the required information is provided in the Consolidated Financial Statements, including the notes thereto.\n3. Exhibits. The exhibits required to be filed as part of this Annual Report on Form 10-K have been included as follows:\n(2) Stock Purchase Agreement between Moog Inc., Moog Torrance Inc. and AlliedSignal Inc., incorporated by reference to exhibit 2.1 of the Company's report on Form 8-K dated June 15, 1994.\n(3) Restated Certificate of Incorporation and By-laws of the Company, incorporated by reference to exhibit (3) of the Company's Annual Report on Form 10-K for its fiscal year ended September 30, 1989.\n(4) Instruments defining the rights of security holders. Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not being filed since the total amount of securities authorized under any such instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of any such instruments to the Securities and Exchange Commission upon request.\n(9) (i) Agreement as to Voting, effective October 15, 1988, incorporated by reference to exhibit (i) of October 15, 1988 Report on Form 8-K dated November 30, 1988. (ii) Agreement as to Voting, effective November 30, 1983, incorporated by reference to exhibit (i) of November 1983 Report on Form 8-K dated December 9, 1983.\n(10) Material contracts. (i) Management Profit Sharing Plan, incorporated by reference to exhibit 10(i) of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1991. (ii) Supplemental Retirement Plan dated October 1980, as amended, incorporated by reference to exhibit (iv) of November 1983 Report on Form 8-K, dated December 9, 1983, as amended, and reported in August 30, 1988 Report on Form 8-K, dated October 3, 1988, and amended on October 20, 1988, incorporated by reference thereto. (iii) Deferred Compensation Plan for Directors and Officers, incorporated by reference to exhibit (i) of November 1985 Report on Form 8-K, dated December 3, 1985. (iv) Incentive Stock Option Plan, incorporated by reference to exhibit 4(b) of the Registration Statement on Form S-8, File No. 33-36721, filed with the Securities and Exchange Commission on September 7, 1990. (v) Non-Statutory Stock Option Plan, as amended, incorporated by reference to exhibits 10(v) and 10(vi) of the Company's Annual Report on Form 10-K for its fiscal year ended September 30, 1989. (vi) Savings and Stock Ownership Plan, incorporated by reference to exhibit 4(b) of the Company's Annual Report on Form 10-K for its fiscal year ended September 30, 1989. (vii) Executive Termination Benefits Agreement incorporated by reference to January 29, 1988 Report on Form 8-K dated February 4, 1988. (viii) Indemnity Agreement, incorporated by reference to Annex A to 1988 Proxy Statement dated January 4, 1988. (ix) Revolving Credit and Term Loan Agreement dated June 15, 1994\n(11) Statement re: Computation of per share earnings.\n(13) 1995 Report to Shareholders. (Except for those portions which are expressly incorporated by reference to the Annual Report on Form 10-K, this exhibit is furnished for the information of the Securities and Exchange Commission and is not deemed to be filed as part of this Annual Report on Form 10-K.)\n(21) Subsidiaries of the Company. Subsidiaries of the Company are listed below:\n(i) Moog AG, Incorporated in Switzerland, wholly-owned subsidiary with branch operation in Ireland (ii) Moog Australia Pty. Ltd., Incorporated in Australia, wholly-owned subsidiary (iii) Moog do Brasil Controles Ltda., Incorporated in Brazil, wholly-owned subsidiary (iv) Moog Buhl Automation, a branch office of Moog Inc. operating under Danish law (v) Moog Controls Corporation, Incorporated in Ohio, wholly-owned subsidiary with branch operation in the Republic of the Philippines (vi) Moog Controls Hong Kong Ltd., Incorporated in Hong Kong, wholly-owned subsidiary (vii) Moog Controls (India) Private Ltd., Incorporated in India, wholly-owned subsidiary (viii) Moog Controls Ltd., Incorporated in the United Kingdom, wholly-owned subsidiary (a) Moog Norden A.B., Incorporated in Sweden, wholly-owned subsidiary of Moog Controls Ltd. (b) Moog OY, Incorporated in Finland, wholly-owned subsidiary of Moog Controls Ltd. (ix) Moog FSC Ltd., Incorporated in the Virgin Islands, wholly-owned subsidiary (x) Moog GmbH, Incorporated in Germany, wholly-owned subsidiary (a) Moog Italiana S.r.l., Incorporated in Italy, wholly-owned subsidiary, 90% owned by Moog GmbH; 10% owned by Moog Inc. (xi) Moog Industrial Controls Corporation, Incorporated in New York, wholly-owned subsidiary (xii) Moog Japan Ltd., Incorporated in Japan, 90% owned subsidiary (xiii) Moog Korea Ltd., Incorporated in South Korea, wholly-owned subsidiary (xiv) Moog Properties, Inc., Incorporated in New York, wholly-owned subsidiary (xv) Moog Sarl, Incorporated in France, wholly-owned subsidiary, 95% owned by Moog Inc; 5% owned by Moog GmbH. (a) Moog SNC, Incorporated in France, wholly-owned subsidiary of Moog Sarl (xvi) Moog Singapore Pte. Ltd., Incorporated in Singapore, wholly-owned subsidiary (xvii) Moog Torrance Inc., Incorporated in Delaware, wholly-owned subsidiary\n(23) Consent of KPMG Peat Marwick LLP; Consents and Audit Reports of Coopers & Lybrand LLP\n(99) Additional Exhibits.\nInformation, Financial Statements and Exhibits required by Form 11-K for the Moog Inc. Savings and Stock Ownership Plan (to be filed by amendment).\nQuarterly Stock Prices Stock Prices Fiscal Year Class B Class A Ended High Low High Low\nSept. 30, 1995 1st Quarter $15-1\/8 $12 $ 9-1\/2 $ 7-1\/2 2nd Quarter 14-7\/8 11-5\/8 9-5\/8 8-5\/8 3rd Quarter 15 12-1\/4 13 9-1\/2 4th Quarter 15-1\/2 14-3\/8 14-3\/8 12-1\/4\nSept. 30, 1994 1st Quarter $11 $ 9-3\/8 $ 9-1\/2 $ 7-1\/2 2nd Quarter 13 9-3\/8 9-3\/8 7 3rd Quarter 12-3\/4 11-1\/2 9 7-5\/8 4th Quarter 14 12-3\/8 9-5\/8 7-1\/2\nStock Listing\nMoog Inc.'s two classes of common shares (symbols MOGA and MOGB) and convertible subordinated debentures are listed on the American Stock Exchange.\nEXHIBIT 13-ANNUAL REPORT TO SHAREHOLDERS\nContents\nFinancial Highlights 1 Letter to Shareholders 2 Moog at a Glance 4\nMarket Segment Facts\nMilitary Aircraft 6 Commercial Aircraft 8 Space and Missiles 10 Industrial Hydraulics 12 Industrial Electrics 14\nForm 10K 17 Investor Information 46\nFinancial Highlights\nThe Start of a New Era\nFiscal '95 was the beginning of a new era for our company. A lot of hard work on many different fronts finally paid off. Sales increased by 22%. Earnings gained 266%. We made $1.00 per share for the first time since '87. Our strong cash flow allowed us to bring our worldwide debt down by $14 million. In view of these improving financials, the same lenders that financed last year's big acquisition have modified our loan agreement. They've increased our credit availability, relaxed their restrictive covenants and lowered our interest rate. We regard this as a real vote of confidence.\nThe Acquisition Is A Perfect Fit\nWe closed on our acquisition of the AlliedSignal actuation product line shortly before the end of fiscal '94. Our job this year was integration. We transformed the factory we acquired in Torrance (Los Angeles) into a facility specialized in the design and manufacture of rotary actuation systems for military and commercial aircraft flight controls. This factory has a big job on each of two new airplanes. The Navy has just rolled out the F\/A-18E\/F, the successor to the F\/A-18C\/D, the only fighter that the U.S. government buys in production quantities. The E\/F is a bigger, better airplane and deliveries will start in '99. Our Torrance factory builds the rotary actuation for the maneuvering leading edge and for the wingfold on both of these planes, making the F\/A -18 our largest military aircraft program.\nIn June of '95, Boeing's handsome new 777 entered international service. It also has a leading edge actuation system built by Moog Torrance. This system is one of a number of Moog products on the 777. The flight spoiler actuators and primary flight control servovalves are the production responsibility of our commercial aircraft team in East Aurora. In the acquisition, it was always our plan to concentrate production responsibility for hydraulic actuators in East Aurora, and the transfer was one of the major tasks in '95. Responsibility for Boeing's 747 aileron and spoiler actuators, 757 elevator, rudder and spoiler actuators and Airbus' A330\/340 aileron actuators has been combined now with our other commercial airplane production. The arrangement we envisioned when we made the acquisition is now a reality.\nThe integration of the AlliedSignal product line allowed our U. S. operations to grow by 19% and to earn $4.0 million in fiscal '95 in spite of the costs of transition. The newly acquired product lines generated revenue of almost $95 million, about $15 million more than anticipated. The higher revenues were the result of the scale of activity on development contracts for the F\/A-18E\/F and the swashplate actuators for the production version of the V-22 Osprey. Swashplate actuators adjust the pitch of the aircraft's huge propellers when it's operating in its helicopter mode. They are big actuators and extremely complex. These two development contracts turned out to be bigger than we expected and all the work had to be done in '95. This made our '95 military aircraft sales higher than they would have been otherwise, and, in comparison, '96 sales will be slightly lower.\nWe'll be supplying the swashplate actuators as well as flaperon and elevator actuators and mechanical bladefold mechanisms for the V-22, which is planned to go into service in 1998. In production, our sales for each aircraft will be well in excess of $500,000. The Marines are planning,\nultimately, to buy 523 and the manufacturer, a Bell-Boeing team, has hopes of additional U. S. Army and foreign military orders that could extend the production to 1,500 aircraft.\nEurope Came Roaring Back\nShortly after fiscal '95 began, our European industrial business began a spectacular recovery after 30 months of recession. While the recession was underway, we consolidated European production of industrial servovalves in our factory in Germany. The explosion in order intake overwhelmed that production capacity. At a time when all our customers were determined to shorten supplier lead-times, we found ourselves extending deliveries. We brought on additional capacity in the U. S. and in the Philippines to meet this demand.\nThe upswing was not confined to servovalves. Sales of electric drives were up over 50% in Europe, just as they were in the U.S. The increased order activity was broadly based. The principal applications continue to be robotics, material handling, packaging and printing. We have a new application this year to provide motors for use on mail sorting equipment which Bell and Howell will supply to the German and Dutch postal systems.\nThe only real disappointment in our international business was the slow pace of orders in the Pacific Rim for our injection molding controls. Our revenues there fell far short of our expectations. We've seen some improvement lately and are expecting a recovery in fiscal '96.\nInternational sales were up 35% in Europe and 14% in Asia\/Pacific. This increased volume, in combination with our reorganized operations, generated much improved profitability, particularly because of our tax loss carryforward in Germany. Our international segment had net profits of $3.8 million, almost half of our total earnings.\nCommercial and Industrial\nSales Are Now More Than Half\nOur Company has a proud history of providing advanced technology to defense agencies in the U.S. and around the world. Not too many years ago, government-funded revenues were close to two-thirds of our business. In fiscal '95, for the first time in our history, commercial and industrial revenues were more than half of our business (51%), and this occurred in spite of the surge in military aircraft development work. We expect this trend to continue. Almost all of our expected growth in fiscal '96 will be in the commercial aircraft and industrial product lines. Even in the space business, which used to be a primarily government-funded activity, future growth will come on commercial satellites and satellite launch vehicles.\nFiscal '96 Looks Like a Good Year Too\nWith a little luck, we'll be a $400 million company in fiscal '96. Growth in our commercial aircraft business is expected to offset a slight decline in military aircraft sales. We're anticipating some growth in the satellite business. Our strong growth prospects, though, are in our combined industrial businesses for which we're forecasting growth of nearly 20%. Increased earnings in '96 and our strong cash flow will allow further reduction in debt as well as the consideration of additional strategic acquisitions.\nWe'll get a small boost in '96 from our acquisition in December of the servovalve product line from Ultra Hydraulics Ltd. The Ultra servovalve traces its history back to a Moog license extended to the Dowty Group in the late '50's. We expect it will add nearly $5.0 million in revenues.\nThe fiscal '95 results demonstrate that our people can deal with the challenges of an evolving global marketplace. We've made a lot of adjustments that have worked. We're confident that the pattern of improvement begun in '95 was just the beginning of a new era of growth and prosperity.\nRobert T. Brady, President, CEO\nRichard A. Aubrecht, Chairman of the Board\nMoog at a Glance\nFor forty-four years, our Company has applied leading-edge technology to solve motion control problems in whatever industries required our kind of precision performance. As a result, we offer a broad array of products to an equally broad spectrum of customers. These products can generally be grouped into five categories: aerospace products can be differentiated by market - military aircraft, commercial aircraft and space. The industrial product lines can be distinguished by the technology - hydraulics versus electronics\/electrics. Here's a synopsis of our product evolution.\nMoog was founded in 1951 on the development of the electrohydraulic servovalve, a device that controls lots of hydraulic horsepower in response to a tiny electrical command signal. Originally, servovalves were used to control aerodynamic fins on small missiles and to gimbal rocket motor nozzles on big missiles. They were sold to missile builders skilled in guidance systems and designers of aircraft flight controls. These customers persuaded Moog to begin building the piston and cylinder assemblies, called actuators, which deliver the motion.\nIn 1959, Moog adapted the aerospace servovalve for use in high performance industrial machinery. Applications included various kinds of metal cutting machines, fatigue test machines, injection and blow molding machines and gauge control in steel mills. Many of our early industrial customers were not familiar with the technology that commands servovalves and so Moog also developed electronics for controlling servosystems.\nOver the last thirty-five years our industrial hydraulic servovalve product line flourished. But electric servosystems kept getting better and competing more effectively with hydraulics. In the early 1980's the Company resolved to develop state-of-the-art electric drives and to have this technology within our own product line.\nBelow is a summary of the product lines. In the fact sheets that follow, we describe the character of our business in each of the five categories.\nMilitary Aircraft Controls = 35%\nMoog is now one of the world's leading suppliers of fly-by-wire flight controls for military aircraft. In a fly-by-wire system an electrical signal runs from the pilot's control stick to a flight control computer. This signal is modified to conform to the aircraft's pre-programmed \"control laws\" and then delivered to servoactuators which move the ailerons, elevators and rudder. Moog's extensive experience in this area culminated in Northrop and the Air Force selecting us to design the flight control actuation system for the B-2 bomber. Some aircraft experts consider the B-2 flight control system the \"eighth wonder of the world\".\nCommercial Aircraft Controls = 20%\nMoog specialized in military aircraft until 1978 when Boeing selected Moog to design autopilot actuators for the 767. We've had a thriving relationship with Boeing ever since. Moog now supplies autopilot actuators for both the 767 and the 747, flight spoilers for the new 777 and servovalves for all Boeing production aircraft. In the summer of 1994, Moog acquired the AlliedSignal Actuation Systems product line. As a result we supply most of the flight control actuators for the 747 and 757 and the rotary actuation system for the 777 leading edge flap. The Boeing Company is now Moog's No. 1 customer in annual sales.\nSpace and Missiles = 12%\nThe first Moog servovalve was applied in the control of aerodynamic fins to steer a tactical missile. The Company moved then to supplying servoactuators for controlling the direction of thrust in rocket motor nozzles. Steering rockets through control of the thrust vector has been used on strategic missiles, the Space Shuttle and the large rockets that launch satellites. Once a satellite is launched into orbit, its position is optimized by the use of attitude control engines. These are small thrust chambers in which fuel and oxidizer are mixed to produce a precisely controlled explosion. The valving that controls the flow of these propellants has become another of Moog's product specialties.\nIndustrial Hydraulic Servovalves = 20%\nToday, hydraulic servovalves are used in all manner of high performance industrial equipment. About 25% of Moog servovalves are used on machinery that forms plastics. Servovalves are used to control the pressure that moves plastic into the mold chamber in an injection molding machine and also provide the clamp pressure on the mold. Servovalves are also used to control the flow of a tube of plastic into a blow molding chamber where it will be formed into a plastic bottle. These are two examples of the hundreds of applications of industrial servovalves in the automated machinery of the '90's.\nIndustrial Electronics and Electric Drives = 13%\nMoog supplies proprietary electronic systems for total machine control of both injection molding and blow molding processes. In addition, the Company designs customized electronic controls for all kinds of high performance industrial machinery. These \"front end\" control systems may direct electrohydraulic servovalves provided by the Company or they may communicate through a digital data bus to Moog's high performance brushless DC drives. The Company provides electric drives used as subsystems in various robotic applications as well as other sorts of automated machinery and in azimuth and elevation gun control systems for military howitzers. In addition, the Company provides a complete line of electrically actuated entertainment motion simulators and transportation industry training platforms.\nMany of our shareholders are interested in the proportions of our business. The charts below illustrate these balances for fiscal '95:\nBy Product Line:\nBy Customer:\nBy Geographical Area:\nMilitary Aircraft - 35% of '95 sales, 32% of '96 forecast\nFY95 Actual Sales = $132 million FY96 Forecast Sales = $128 million\nProducts\n- - Primary and secondary flight control actuation for bombers, fighters, helicopters\n- - Servovalves used in digital electronic engine controls\n- - Active vibration control actuation\n- - Structural fatigue measurement systems\nMajor Programs & Applications\nB-2 Flight control actuation system F\/A-18 Leading edge flap and wingfold actuation, switching valve, spoiler actuator Pitch and roll control assembly, aileron rudder interconnect Leading edge flap drive Taiwanese IDF All primary flight control actuators Indian LCA All primary flight control actuators Japanese FSX Leading edge flap actuation Tiger IV Armament control unit Canadian Tutor Flight loads data system V-22 Swashplate, flaperon, elevator, bladefold actuator RAH-66 Main rotor, tail rotor actuator, active vibration control actuators Blackhawk Pitch, trim, roll trim actuators EH-101 Active vibration control actuators\nServovalves for engines: Inlet guide vane, afterburner position and fuel control (F\/A-18C\/D) Fan and compressor geometry, exhaust nozzle control (F\/A-18E\/F) Main fuel control, exhaust nozzle and afterburner fuel control (F-14D,C\/D) Vane and nozzle control (F-22)\nCompetitive Advantages\n- - Extensive international experience in design of flight critical fly-by-wire flight controls\n- - Product innovation in engine control servovalves and active vibration control\n- - World-class manufacturing capability focused on flight safety and quality\n- - Skilled, experienced and dedicated workforce Competitors\n- - Curtiss-Wright, HR Textron, Parker Hannifin, Power Control Technologies, Smiths Industries\nMarket Developments\n- - F\/A-18C\/D, E\/F are funded for production\n- - B-2 included in '96 defense budget\n- - V-22 Osprey approved for limited production, 523 are planned, program could accelerate\n- - RAH-66 Comanche rolled out, 6 development helos planned for 2001, production in 2004\n- - Japanese FSX planned for 1998\n- - Taiwanese IDF production nearing completion\n- - Demand for engine controls improving\nStrategies & Initiatives\n- - Maintain market position through the current production lull\n- - Partner with prime contractor R&D Centers\n- - Pursue opportunities in international markets (Korean KTX-2)\n- - Develop next generation technology in flight control, engine control, vibration suppression\nBell-Boeing V-22 Osprey\nMoog's fly-by-wire flight control actuators give the V-22 its unique flying capability.\nCommercial Aircraft - 20% of '95 sales, 19% of '96 forecast\nFY95 Actual Sales = $73 million FY96 Forecast Sales = $76 million\nProducts\n- - Primary and secondary flight control actuation\n- - Flight control servovalves for Boeing and Airbus\n- - Servovalves used in digital electronic engine controls\nMajor Programs & Applications\n747 Autopilot, aileron and spoiler actuators 757 Elevator, rudder and spoiler actuators 767 Autopilot actuators 777 Leading edge rotary and spoiler actuators A330\/A340 Aileron actuators Boeing All flight control servovalves Airbus All flight control servovalves Citation X All primary flight controls Gulfstream IV Trailing edge flap system Challenger Trailing edge flap system\nServovalves for engines:\nGE CF-6 Fuel flow, vane position and blade tip clearance (A330, A310, 747, 767, MD-11) AlliedSignal APU Inlet guide vane actuators, surge control (A310, A320, 737, 757, 767, 777, MD-90) GE90 Burner staging and turbine clearance control (777) Rolls Royce Trent Main fuel metering, turbine overspeed shutoff (A330, 777)\nCompetitive Advantages\n- - Extensive experience in design and production of flight-critical control surface actuators\n- - Product innovation in engine control servovalves\n- - World-class manufacturing capability focused on flight safety and quality\n- - Outstanding and timely aftermarket support\n- - Skilled, experienced and dedicated workforce\nCompetitors\n- - Curtiss-Wright, E-Systems, HR Textron, Parker Hannifin, Power Control Technologies, Teijin Seiki\nMarket Developments\n- - Current delivery rates of 747, 757, 767, A330\/340 are stable\n- - Boeing 777 has entered service and deliveries are increasing\n- - 747 production increase expected later in 90's\n- - Engine controls market shows signs of recovery\nStrategies & Initiatives\n- - Align our strategies with customers' objectives\n- - Pursue aggressive cost reduction to meet market pricing demand\n- - Develop relationships with Canadair, Gulfstream, Cessna, Bombardier and Fokker\n- - Transfer technology developed in military applications\n- - Develop next generation technology in engine control\nAirbus A330\nThe Airbus A330's fly-by-wire flight controls depend on Moog's eight inboard and outboard aileron actuators for primary roll control.\nSpace & Missiles - 12% of '95 sales, 12% of '96 forecast\nFY95 Actual Sales = $46 million FY96 Forecast Sales = $49 million\nProducts\n- - Thrust vector control actuation (steering controls) for launch vehicles, strategic missiles, and space shuttle\n- - Bipropellant and monopropellant thrusters and valves for satellites and launch vehicles\n- - Electric propulsion components and systems for satellite attitude control\n- - Electrohydraulic, electromechanical and electropneumatic fin controls for tactical missiles\n- - Quick disconnects for fluid systems in space vehicles\n- - Electric drives for Space Station segment attachment\nMajor Programs & Applications\nTrident (D-5) Thrust vector control (TVC) actuators Titan IV Core vehicle and solid rocket motor upgrade TVC Space Shuttle Main engine and booster TVC, orbiter elevon actuators and rudder speed brake valves Standard Missile 2 BLK IV Electromechanical fin controls Patriot Electrohydraulic servos VLASROC Electropneumatic fin controls\nAriane V Engine TVC and fuel control Space Station Quick disconnects and segment attachment drives THAAD Attitude control thrusters for kill vehicle\nPropulsion components for every satellite manufacturer worldwide\nElectric propulsion components for next generation geosynchronous communication satellites\nCompetitive Advantages\n- - Extensive experience in design and manufacture of thrust vector control systems\n- - Unparalleled experience in creative design and manufacture of thrusters and valves for space applications\n- - Leading edge technology in electric propulsion and gel propellant controls\n- - World class manufacturing capabilities\n- - Skilled, experienced and dedicated workforce\nCompetitors\n- - AlliedSignal, HR Textron, Parker Hannifin\nMarket Developments\n- - Trident is only strategic missile in production\n- - Theater High Altitude Area Defense (THAAD) is funded and progressing\n- - Standard Missile 2 BLK IV will be used for Navy missile defense\n- - Our customers, Hughes and Lockheed Martin, dominate U.S. satellite production\n- - Traditional launch vehicles (Titan, Atlas, Delta, Space Shuttle) continue as workhorses\nStrategies & Initiatives\n- - Develop leading edge technologies for launch vehicle TVC and tactical fin controls\n- - Develop leading edge technology for satellite propulsion (electric, gel etc.)\n- - Outlast competition in space propulsion\n- - Support satellite and launch vehicle manufacturers worldwide\nLockheed Martin Titan IV\nMoog's forty year involvement in the Titan family of launch vehicles has evolved from supplying thrust vector control (TVC) actuators on the core vehicle to additionally supplying the complete TVC system on the solid-rocket-motor booster.\nIndustrial Hydraulics - 20% of '95 sales, 22% of '96 forecast\nFY95 Actual Sales = $76 million\nFY96 Forecast Sales = $88 million\nProducts\n- - Mechanical feedback, nozzle flapper servovalves\n- - Electrical feedback, nozzle flapper servovalves\n- - Mechanical feedback, servojet servovalves\n- - Electrical feedback, servojet servovalves\n- - Electrical feedback, direct drive, industrial servovalves\nMajor Applications\nElectrical feedback servovalves for control of clamp and injection operations on plastic injection molding equipment\nMechanical feedback and direct drive valves for parison control of plastic blow molding machines\nFuel metering, steam bypass, and override control servovalves for gas and steam turbines\nHydraulic position control actuators and servovalves for fatigue testing systems\nCarriage control servovalves to provide precise positioning for sawmill equipment\nCompetitive Advantages\n- - Leading edge technology for 36 years\n- - Unmatched, worldwide application engineering to optimize custom solutions\n- - Worldwide engineering, manufacturing, support and service facilities\n- - Skilled, experienced and dedicated workforce\nCompetitors\n- - Bosch, E-Systems, IMC, Rexroth\nMarket Developments\n- - Remarkable increase in demand in Europe\n- - Increased competition throughout market\n- - Consistent pressure to reduce lead time\nStrategies & Initiatives\n- - Continue development of leading edge technology\n- - Consolidate production in global manufacturing centers\n- - Aggressive cost reduction to meet market pricing\n- - Develop inventory stocking plan to address lead-time demands\n- - Acquired servovalve product line from Ultra Hydraulics Ltd. (U.K.)\nSchloemann Siemag Rolling Mill\nModern, highly automated steel mills throughout the world each use over eighty Moog servovalves to control the steel's final form.\nIndustrial Electronics & Electric Drives - 13% of '95 sales, 15% of '96 forecast\nFY95 Actual Sales = $47 million FY96 Forecast Sales = $58 million\nProducts\n- - Brushless D.C. servomotors and digital motor controllers\n- - Electronic controls for injection and blow molding machines\n- - Electronic controls for specialized automated machinery\n- - Radio controls for automatic mining machines\n- - Electric and hydraulic azimuth and elevation gun controls for military* vehicles\nMajor Applications\nElectric drives for assembly robots, brush making machines, material handling robots, postal sorting machines\nFull performance total machine control for injection molding and blow molding\nCustom tailored attachment controls for Tuftco carpet tufting and scrolling machine\nFour and six degree of freedom motion platforms with capacities between 2,000 and 13,000 pounds\nCompetitive Advantages\n- - Highest power density of available brushless D.C. servodrives\n- - Full range of capability in total machine control for injection molding and blow molding\n- - Design capability for customized machine control solutions\n- - Leading edge digital two-way radio control for automated mining machinery\n- - Extensive experience in high reliability electrically actuated motion platforms\n- - Demonstrated experience in electric gun controls for military* vehicles\n* Electrically actuated gun controls are included in the category of industrial controls because of the similarity to the industrial products.\nCompetitors\n- - Barber Coleman, Indramat, Pacific Scientific, Siemens\nMarket Developments\n- - Resurgence in demand for high performance brushless D.C. drives\n- - Rebound in demand for plastics machine controls in Europe, market softening in Pacific\n- - Entertainment industry is still taking shape, no supplier dominance yet established\n- - Temporary production lull in military* vehicles\nStrategies & Initiatives\n- - Refine product design and reduce costs to improve profitability in electric drives\n- - Improve plastics machine controls and broaden worldwide distribution, increase market share\n- - Broaden product range in electric motion simulators\n- - Repackage electric gun controls to maintain technology advantage\nBell and Howell Postal Sorting Machine\nMoog's brushless motors and controllers provide the high speed control and power for Bell and Howell's latest mail sorting machinery.\nMoog Worldwide\nMoog Inc. Headquarters East Aurora, New York, USA\nMoog Australia Pty., Ltd Mulgrave, Australia\nMoog do Brasil Controles Ltda. Sao Paulo, Brazil\nMoog Buhl Automation Copenhagen, Denmark\nMoog Controls Ltd. Tewkesbury, England\nUltra Servovalves Glocester, England\nMoog OY Espoo, Finland\nMoog Sarl Rungis, France\nMoog GmbH Boblingen, Germany\nMoog Controls Hong Kong Ltd. Hong Kong\nMoog Controls (India) Pvt. Ltd. Bangalore, India\nMoog Ltd. Ringaskiddy, Ireland\nMoog Italiana S.r.l. Malnate, Italy\nMoog Japan Ltd. Hiratsuka, Japan\nMoog Korea Ltd. Kwangju-Kun, Korea\nMoog Controls Corporation Baguio City, Philippines\nMoog Singapore Pte. Ltd. Singapore\nMoog Sarl Sucursal En Espana Orio, Spain\nMoog Norden A.B. Askim, Sweden\nEXHIBIT 23\nCONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors Moog Inc.:\nWe consent to incorporation by reference in the Registration Statements (No. 33-62968, 33-36722, 33-36721, 33-33958, 33-20069 and 33-57131) on Form S-8 of Moog Inc. of our report dated November 22, 1995, relating to the consolidated balance sheets of Moog Inc. and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows and related schedule for each of the years in the three-year period ended September 30, 1995, which report appears in the September 30, 1995 annual report on Form 10-K of Moog Inc.\nKPMG Peat Marwick LLP\nBuffalo, New York December 27, 1995\nCOOPERS chartered Lennox House telephone (01452 423031) & LYBRAND accountants Beaufort Buildings Spa Road Gloucester GL1 1XD telex 887474 COLYRN G facsimile (01452) 300699\nyour reference\nour reference The Board of Directors MSHB\/PR\/AMP\/CNR1063.95 Moog Inc. East Aurora NEW YORK USA 22 November 1995\nDear Sirs\nIndependent Auditors' Report\nWe have audited the consolidated balance sheet of Moog Controls Limited (a wholly-owned subsidiary of Moog Inc.) and subsidiaries as at September 30, 1995 and 1994, and the related consolidated statement of earnings and retained earnings and cashflows 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 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 of the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Moog Controls Limited and subsidiaries as of September 30, 1995 and 1994, and the results of their operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.\nOur audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The supplemental information in Schedules marked by us as \"For identification purposes only\" are presented for purposes of additional analysis and may not be a required part of the basic financial statements. Such 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 so far as the information in them relates to the basic consolidated financial statements taken as whole.\nCOOPERS & LYBRAND\nChartered Accountants Gloucester, UK\nCOOPERS Telefon (0711) 7843-0 Mitglied von & LYBRAND 70565 Stuttgart telefax (0711) 7843-100 Coopers Postiach 800107 & Lybrand 70501 Stuttgart International\nMOOG INC. East Aurora, New York 14052-0018 U.S.A. November 22, 1995 TRI\/EGN\/MOOGBV3.DOC\nIndependent Auditors Report\nThe Board of Directors Moog Inc.:\nWe have audited the consolidated balance sheet of Moog GmbH (a wholly-owned subsidiary of Moog Inc.) and subsidiary (Moog Italiana SRL) as of September 30, 1995 and 1994, and the related consolidated statements of Earnings and Retained Earnings, changes in shareholder's equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Moog GmbH 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 accounting principles generally accepted in the United States.\nOur audits were made for the purposes of forming an opinion on the consolidated financial statements taken as a whole. The supplemental information in exhibits A through H and Schedule 1 through 22 are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such 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 whole.\nCOOPERS & LYBRAND GmbH Wirtschaftsprufungsgesellschaft","section_15":""}
{"filename":"47111_1995.txt","cik":"47111","year":"1995","section_1":"Item 1. BUSINESS\nHershey Foods Corporation and its subsidiaries (the \"Corporation\") are engaged in the manufacture, distribution and sale of consumer food products. The Corporation, primarily through its Hershey Chocolate North America, Hershey Grocery, Hershey International and Hershey Pasta Group divisions, produces and distributes a broad line of chocolate and non-chocolate confectionery, grocery and pasta products.\nThe Corporation was organized under the laws of the State of Delaware on October 24, 1927, as a successor to a business founded in 1894 by Milton S. Hershey.\nThe Corporation's principal product groups include: chocolate and non-chocolate confectionery products sold in the form of bar goods, bagged items and boxed items; grocery products in the form of baking ingredients, chocolate drink mixes, peanut butter, dessert toppings and beverages; and pasta products sold in a variety of shapes, sizes and packages. The Corporation believes it is a major factor in these product groups in North America. Operating profit margins vary considerably among individual products and brands. Generally, such margins on chocolate and non-chocolate confectionery products are greater than those on pasta and other food products.\nIn North America, the Corporation manufactures chocolate and non- chocolate confectionery products in a variety of packaged forms and markets them under more than 50 brands. The different packaged forms include various arrangements of the same bar products, such as boxes, trays and bags, as well as a variety of different sizes and weights of the same bar product, such as snack size, standard, king size, large and giant bars. Among the principal chocolate and non-chocolate confectionery products in the United States are: HERSHEY'S COOKIES 'N' CREME chocolate bars, HERSHEY'S COOKIES 'N' MINT chocolate bars, HERSHEY'S HUGS chocolates, HERSHEY'S HUGS WITH ALMONDS chocolates, HERSHEY'S KISSES chocolates, HERSHEY'S KISSES WITH ALMONDS chocolates, HERSHEY'S milk chocolate bars, HERSHEY'S milk chocolate bars with almonds, HERSHEY'S MINIATURES chocolate bars, HERSHEY'S NUGGETS chocolates, AMAZIN' FRUIT gummy bears fruit candy, CADBURY'S CREME EGGS candy, CARAMELLO candy bars, KIT KAT wafer bars, LUDEN'S throat drops, MR. GOODBAR milk chocolate bars with peanuts, PETER PAUL ALMOND JOY candy bars, PETER PAUL MOUNDS candy bars, REESE'S crunchy peanut butter cups, REESE'S NUTRAGEOUS candy bars, REESE'S peanut butter cups, REESE'S PIECES candies, ROLO caramels in milk chocolate, SKOR toffee bars, SYMPHONY milk chocolate bars, TWIZZLERS candy, WHATCHAMACALLIT candy bars, YORK peppermint pattie candy and 5TH AVENUE candy bars. Principal products in Canada include CHIPITS chocolate chips, GLOSETTE chocolate- covered raisins, peanuts and almonds, OH HENRY! candy bars, POT OF GOLD boxed chocolates, REESE PEANUT BUTTER CUPS candy, and TWIZZLERS candy. The Corporation also manufactures, imports, markets, sells and distributes chocolate products in Mexico under the HERSHEY'S brand name.\nThe Corporation manufactures and markets a line of grocery products in the baking, beverage, peanut butter and toppings categories. Principal products in the United States include HERSHEY'S baking chips, HERSHEY'S drink boxes, HERSHEY'S chocolate milk mix, HERSHEY'S cocoa, HERSHEY'S CHOCOLATE SHOPPE toppings, HERSHEY'S HOT COCOA COLLECTION cocoa mix, HERSHEY'S syrup, REESE'S peanut butter and REESE'S peanut butter baking chips. HERSHEY'S chocolate milk is produced and sold under license by certain independent dairies throughout the United States, using a chocolate milk mix manufactured by the Corporation.\nThe Corporation's chocolate and non-chocolate confectionery and grocery products are sold primarily to grocery wholesalers, chain grocery stores, candy distributors, mass merchandisers, chain drug stores, vending companies, wholesale clubs, convenience stores, concessionaires and food distributors by full-time sales representatives, food brokers and part-time retail sales merchandisers throughout the United States, Canada and Mexico. The Corporation believes its chocolate and non-chocolate confectionery products are sold in over 2 million retail outlets in North America. In 1995, sales to Wal-Mart Stores, Inc. and subsidiaries amounted to approximately 11% of total net sales.\nThe Corporation manufactures and markets high-quality assorted pralines and seasonal chocolate products in Germany under the GUBOR brand name which are sold directly to retailers. In Italy, the Corporation manufactures and markets\nvarious confectionery and grocery products under the SPERLARI and several other brand names. In Japan, the Corporation imports and markets selected HERSHEY'S chocolate and non-chocolate confectionery products. The Corporation also exports chocolate and non-chocolate confectionery products to over 60 countries worldwide.\nThe Corporation manufactures and sells quality pasta products throughout the United States. The Corporation markets its products on a regional basis under several brand names, including AMERICAN BEAUTY, IDEAL BY SAN GIORGIO, LIGHT 'N FLUFFY, MRS. WEISS, P&R, RONZONI, SAN GIORGIO and SKINNER, as well as certain private labels. These products are sold through chain grocery stores, grocery wholesalers, wholesale clubs, convenience stores and food distributors.\nIn June 1995, the Corporation completed the sale of the outstanding stock of Overspecht B.V. (OZF Jamin), which manufactures and distributes chocolate and confectionery products, cookies, biscuits and ice cream in Western Europe. During December 1995, the Corporation completed the acquisition of Henry Heide, Incorporated, a privately held company located in New Jersey which manufactures and markets a variety of non- chocolate confectionery products including JUJYFRUITS candies and WUNDERBEANS jellybeans. Also during December 1995, the Corporation entered into definitive agreements to sell the assets of Hershey Canada, Inc.'s BEECH-NUT cough drop, BREATH SAVERS and LIFE SAVERS hard candy and PLANTERS nut businesses. These divestitures were completed in January, 1996.\nThe Corporation's marketing strategy is based upon the consistently superior quality of its products, mass distribution and the best possible consumer value in terms of price and weight. In addition, the Corporation devotes considerable resources to the identification, development, testing, manufacturing and marketing of new products. The Corporation utilizes a variety of promotional programs for customers and advertising and promotional programs for consumers. The Corporation employs promotional programs at various times during the year to stimulate sales of certain products. Chocolate and non-chocolate confectionery and grocery seasonal and holiday-related sales have typically been highest during the third and fourth quarters of the year.\nThe Corporation recognizes that the mass distribution of its consumer food products is an important element in maintaining sales growth and providing service to its customers. The Corporation attempts to meet the changing demands of its customers by planning optimum stock levels and reasonable delivery times consistent with achievement of efficiencies in distribution. To achieve these objectives, the Corporation has developed a distribution network from its manufacturing plants, distribution centers and field warehouses strategically located throughout the United States, Canada and Mexico. The Corporation uses a combination of public and contract carriers to deliver its products from the distribution points to its customers. In conjunction with sales and marketing efforts, the distribution system has been instrumental in the effective promotion of new, as well as established, products on both national and regional scales.\nFrom time to time the Corporation has changed the prices and weights of its products to accommodate changes in manufacturing costs, the competitive environment and profit objectives, while at the same time maintaining consumer value. As a result of higher raw material and packaging costs and the cumulative affect of inflation on other costs since the last standard candy bar price increase in 1991, the Corporation, in December 1995, implemented a wholesale price increase of approximately 11% on its standard and king-size candy bars sold in the United States.\nThe most significant raw material used in the production of the Corporation's chocolate products is cocoa beans. This commodity is imported principally from West African, South American and Far Eastern equatorial regions. West Africa accounts for approximately 60% of the world's crop. Cocoa beans are not uniform, and the various grades and varieties reflect the diverse agricultural practices and natural conditions found in the many growing areas. The Corporation buys a mix of cocoa beans to meet its manufacturing requirements. The table below sets forth annual average cocoa prices as well as the highest and lowest monthly averages for each of the calendar years indicated. The prices are the monthly average of the quotations at noon of the three active futures trading contracts closest to maturity on the New York Coffee, Sugar and Cocoa Exchange. Because of the Corporation's forward purchasing practices discussed below, and premium prices paid for certain varieties of cocoa beans, these average futures contract prices are not necessarily indicative of the Corporation's average cost of cocoa beans or cocoa products.\nCocoa Futures Contract Prices (cents per pound)\n1991 1992 1993 1994 1995\nAnnual Average. . . 52.8 47.6 47.3 59.1 61.2 High. . . . . . . . 60.0 56.2 56.7 66.1 64.1 Low . . . . . . . . 45.6 41.3 41.8 51.3 58.3\nSource: International Cocoa Organization Quarterly Bulletin of Cocoa Statistics\nThe price of sugar, the Corporation's second most important commodity for its domestic chocolate and non-chocolate confectionery products, is subject to price supports under farm legislation. Due to import quotas and duties imposed to support the price of sugar established by that legislation, sugar prices paid by United States users are currently substantially higher than prices on the world sugar market. The average wholesale list price of refined sugar, F.O.B. Northeast, has remained relatively stable in a range of $.28 to $.32 per pound for the past ten years.\nOther raw materials purchased in substantial quantities for domestic confectionery manufacturing purposes include milk, peanuts and almonds. The price of milk is affected by Federal Marketing Orders and the prices of milk and peanuts are affected by price support programs administered by the United States Department of Agriculture. The Food, Agriculture, Conservation, and Trade Act of 1990, which is a five-year extension of prior farm legislation, was passed by Congress in October 1990. This legislation has an impact on the prices of sugar, peanuts, and milk because it sets price support levels for these and other commodities. This law is currently being reviewed by Congress and the nature of any new legislation is uncertain at this time.\nDuring the first quarter of 1995, domestic milk prices averaged well below the prior year's levels, as a result of improved milk production in Minnesota and Wisconsin. The extreme heat throughout the country during the summer of 1995 negatively affected milk production and production of dairy feeds. As a result, prices rose during the fourth quarter.\nPeanut prices were stable throughout the first three quarters of 1995 due to stagnant demand and a favorable 1994 crop. However, prices increased slightly during the fourth quarter of the year due to a below average 1995 crop.\nAlmond prices rose significantly in early 1995 as California experienced adverse weather during the growing season. As prospects for a favorable new crop diminished, prices rose again in late summer to an unprecedented level and remained near this level for the balance of the year.\nPasta is made from semolina milled from durum wheat, a class of hard wheat grown in the United States and Canada. The Corporation purchases semolina from commercial mills and is also engaged in a custom milling agreement to obtain sufficient quantities of semolina. In 1995, the market price for semolina remained near historic highs. The exceptionally high cost resulted from short supplies of durum wheat combined with U.S. Government tariffs on imports of Canadian wheat. The tariffs expired as scheduled in September 1995 but prices remained high due to a continued worldwide shortage of durum wheat.\nThe Corporation attempts to minimize the effect of price fluctuations related to the purchase of its major raw materials primarily through the forward purchasing of such commodities to cover future manufacturing requirements generally for periods ranging from 3 to 24 months. With regard to cocoa, sugar and corn sweeteners, price risks are also managed by entering into futures and options contracts. At the present time, similar futures and options contracts are not available for use in pricing the Corporation's other major raw materials. Futures contracts are used in combination with forward purchasing of cocoa, sugar and corn sweetener requirements principally to take advantage of market fluctuations which provide more favorable pricing opportunities and to increase diversity or flexibility in sourcing these raw materials. The Corporation's commodity procurement practices are intended to reduce the risk of future price increases, but also may potentially limit the Corporation's ability to benefit from possible price decreases.\nThe primary effect on liquidity from using futures contracts is associated with margin requirements related to cocoa and sugar futures. Cash outflows and inflows result from original margins which are \"good faith deposits\" established by the New York Coffee, Sugar and Cocoa Exchange to ensure that market participants will meet their contractual financial obligations. Additionally, variation margin payments and receipts are required when the value of open positions is adjusted to reflect daily price movements. The magnitude of such cash inflows and outflows is dependent upon price coverage levels and the volatility of the market. Historically, cash flows related to margin requirements have not been material to the Corporation's total working capital requirements.\nThe Corporation manages the purchase of forward and futures contracts by developing and monitoring procurement strategies for each of its major commodities. These procurement strategies, including the use of futures contracts to hedge the pricing of cocoa, sugar and corn sweeteners, are directly linked to the overall planning and management of the Corporation's business, since the cost of raw materials accounts for a significant portion of the cost of finished goods. Procurement strategies with regard to cocoa, sugar and other major raw material requirements are developed by the analysis of fundamentals, including weather and crop analysis, and by discussions with market analysts, brokers and dealers. Procurement strategies are determined, implemented and monitored on a regular basis by senior management. Procurement activities for all major commodities are also reported to the Board of Directors on a regular basis.\nThe Corporation has license agreements with several companies to manufacture and\/or sell products worldwide. Among the more significant are agreements with affiliated companies of Cadbury Schweppes p.l.c. to manufacture and\/or market and distribute PETER PAUL ALMOND JOY and PETER PAUL MOUNDS confectionery products worldwide as well as YORK, CADBURY and CARAMELLO confectionery products in the United States. The Corporation's rights under these agreements are extendable on a long- term basis at the Corporation's option. The license for CADBURY and CARAMELLO products is subject to a minimum sales requirement which the Corporation exceeded in 1995. The Corporation also has an agreement with Societe des Produits Nestle SA, which licenses the Corporation to manufacture and distribute in the United States KIT KAT and ROLO confectionery products. The Corporation's rights under this agreement are extendable on a long-term basis at the Corporation's option, subject to certain conditions, including minimum unit volume sales. In 1995, the minimum volume requirements were exceeded.\nCompetition\nMany of the Corporation's brands enjoy wide consumer acceptance and are among the leading brands sold in the marketplace. However, these brands are sold in highly competitive markets and compete with many other multinational, national, regional and local firms, some of which have resources in excess of those available to the Corporation.\nTrademarks\nThe Corporation owns various registered and unregistered trademarks and service marks, and has rights under licenses to use various trademarks which are of material importance to the Corporation's business.\nBacklog of Orders\nThe Corporation manufactures primarily for stock and fills customer orders from finished goods inventories. While at any given time there may be some backlog of orders, such backlog is not material in respect to total sales, nor are the changes from time to time significant.\nResearch and Development\nThe Corporation engages in a variety of research activities. These principally involve development of new products, improvement in the quality of existing products, improvement and modernization of production processes, and the development and implementation of new technologies to enhance the quality and value of both current and proposed product lines.\nRegulation\nThe Corporation's domestic plants are subject to inspection by the Food and Drug Administration and various other governmental agencies, and its products must comply with regulations under the Federal Food, Drug and Cosmetic Act and with various comparable state statutes regulating the manufacturing and marketing of food products.\nEnvironmental Considerations\nIn the past the Corporation has made investments based on compliance with environmental laws and regulations. Such expenditures have not been material with respect to the Corporation's capital expenditures, earnings or competitive position.\nEmployees\nAs of December 31, 1995, the Corporation had approximately 13,300 full-time and 1,500 part-time employees, of whom approximately 6,000 were covered by collective bargaining agreements. The Corporation considers its employee relations to be good.\nFinancial Information by Geographic Area\nInformation concerning the Corporation's geographic segments is contained in Footnote 17 of the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Appendix to the Proxy Statement for its 1996 Annual Meeting of Stockholders (the \"Proxy Statement\"), which information is incorporated herein by reference and filed as Exhibit 13 hereto.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe following is a list of the Corporation's principal manufacturing properties. The Corporation owns each of these properties.\nUNITED STATES Hershey, Pennsylvania - confectionery and grocery products (3 principal plants) Lancaster, Pennsylvania - confectionery products Oakdale, California - confectionery and grocery products Stuarts Draft, Virginia - confectionery products Winchester, Virginia - pasta products\nCANADA Smiths Falls, Ontario - confectionery products\nIn addition to the locations indicated above, the Corporation owns or leases several other properties used for manufacturing chocolate and non-chocolate confectionery, grocery and pasta products and for sales, distribution and administrative functions.\nThe Corporation's plants are efficient and well maintained. These plants generally have adequate capacity and can accommodate seasonal demands, changing product mixes and certain additional growth. The largest plants are located in Hershey, Pennsylvania. Many additions and improvements have been made to these facilities over the years and the plants' manufacturing equipment includes equipment of the latest type and technology.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Corporation has no 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\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation concerning the principal United States trading market for, market prices of and dividends on the Corporation's Common Stock and Class B Common Stock, and the approximate number of stockholders, may be found in the section \"Market Prices and Dividends\" on pages A-7 and A-8 of the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Appendix to the Proxy Statement which is deemed to be part of the Annual Report to Stockholders and which information is incorporated herein by reference and filed as Exhibit 13 hereto.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following information, for the five years ended December 31, 1995, found in the section \"Eleven-Year Consolidated Financial Summary\" on pages A-29 through A-31 of the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Proxy Statement, is incorporated herein by reference and filed as Exhibit 13 hereto: Net Sales; Income from Continuing Operations Before Accounting Changes; Income Per Share from Continuing Operations Before Accounting Changes (excluding Notes g, h, i and j); Dividends Paid on Common Stock (and related Per Share amounts); Dividends Paid on Class B Common Stock (and related Per Share amounts); Long-term Portion of Debt; and Total Assets.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe section \"Management's Discussion and Analysis\", found on pages A- 1 through A-8 of the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Appendix to the Proxy Statement, is incorporated herein by reference and filed as Exhibit 13 hereto.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following audited consolidated financial statements of the Corporation and its subsidiaries are found at the indicated pages in the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Appendix to the Proxy Statement, and such financial statements, along with the report of the independent public accountants thereon, are incorporated herein by reference and filed as Exhibit 13 hereto.\n1. Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.(Page A-9)\n2. Consolidated Balance Sheets as of December 31, 1995 and 1994. (Page A-10)\n3. Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993. (Page A-11)\n4. Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993. (Page A-12)\n5. Notes to Consolidated Financial Statements (Pages A-13 through A-26), including \"Quarterly Data(Unaudited).\" (Page A-26)\n6. Report of Independent Public Accountants. (Page A-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 EXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, positions held with the Corporation, periods of service as a director, principal occupations, business experience and other directorships of nominees for director of the Corporation are set forth in the section \"Election of Directors\" in the Proxy Statement. This information is incorporated herein by reference.\nExecutive Officers of the Corporation as of March 1, 1996\nName Age Positions Held During the Last Five Years\nCORPORATE\nK. L. Wolfe. . . 57 Chairman of the Board and Chief Executive Officer (1993); President and Chief Operating Officer (1985)\nJ. P. Viviano. . 57 President and Chief Operating Officer (1993); President, Hershey Chocolate U.S.A., now Hershey Chocolate North America, a division of Hershey Foods Corporation (1985)\nW. F. Christ . . 55 Senior Vice President and Chief Financial Officer (1994); President, Hershey International, a division of Hershey Foods Corporation (1988)\nR. E. Bentz. . . 48 Vice President, Information Technology Integration (1995); Vice President, Finance and Administration, Hershey Chocolate North America (1995); Vice President, Finance and Administration, Hershey Chocolate U.S.A. (1989)\nC. L. Duncan . . 56 Vice President, Research and Development (1981)\nT. C. Fitzgerald . 56 Vice President and Treasurer (1990)\nS. A. Lambly . . 55 Vice President, Human Resources (1989)\nR. M. Reese . . 46 Vice President, General Counsel and Secretary (1995); Vice President and General Counsel (1992); Assistant General Counsel (1987)\nD. W. Tacka. . . 42 Corporate Controller and Chief Accounting Officer (1995); Vice President, Finance and Administration, Hershey Pasta Group, a division of Hershey Foods Corporation (1989)\nB. L. Zoumas . . 53 Vice President, Science and Technology (1992); Vice President, Technical, Hershey Chocolate U.S.A. (1990)\nExecutive Officers of the Corporation (continued)\nName Age Positions Held During The Last Five Years\nDIVISION\nR. Brace . . . 52 Vice President, Manufacturing, Hershey Chocolate North America (1995); Vice President, Manufacturing, Hershey Chocolate U.S.A. (1987)\nJ. F. Carr . . 51 President, Hershey International (1994); Vice President, Marketing, Hershey Chocolate U.S.A. (1984)\nF. Cerminara . . 47 Vice President, Procurement, Hershey Chocolate North America (1995); Vice President, Commodities Procurement, Hershey Chocolate U.S.A. (1994); Vice President, Corporate Development and Commodities (1988)\nD. N. Eshleman . 41 General Manager, Hershey Grocery, a division of Hershey Foods Corporation (1994); Director, Marketing, Hershey Chocolate U.S.A. (1988)\nM. H. Holmes . . 51 Vice President and General Manager, Chocolate Confectionery, Hershey Chocolate U.S.A. (1994); General Manager, Grocery, Hershey Chocolate U.S.A. (1989)\nM. T. Matthews . 49 Vice President, Sales, Hershey Chocolate U.S.A. (1989)\nR. W. Meyers . . 52 President and General Manager, Hershey Canada Inc., a subsidiary of Hershey Foods Corporation (1995); President, Hershey Canada Inc. (1990)\nM. F. Pasquale . 48 President, Hershey Chocolate North America (1995); President, Hershey Chocolate U.S.A. (1994); Senior Vice President and Chief Financial Officer (1988)\nC. M. Skinner. . 62 President, Hershey Pasta Group (1984) __________________\nThere are no family relationships among any of the above-named officers of the Corporation.\nCorporate Officers and Division Presidents are generally elected each year at the organization meeting of the Board of Directors following the Annual Meeting of Stockholders in April.\nReporting of an inadvertent late filing of a Securities and Exchange Commission Form 4 under Section 16 of the Securities Exchange Act of 1934, as amended, is set forth in the Section \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" of the Proxy Statement.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation concerning compensation of the five most highly- compensated executive officers, including the Chairman of the Board and Chief Executive Officer, of the Corporation individually, and compensation of directors, is set forth in the sections \"1995 Executive Compensation\" and \"Compensation of Directors\" in the Proxy Statement. This information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning ownership of the Corporation's voting securities by certain beneficial owners, individual nominees for directors, and by management, including the five most highly- compensated executive officers, is set forth in the section \"Voting Securities\" in the Proxy Statement. This information is incorporated herein by reference. Item 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning \"Certain Relationships and Related Transactions\" is set forth in the section \"Certain Transactions and Relationships\" in the Proxy Statement. This information 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): Financial Statements\nThe audited consolidated financial statements of the Corporation and its subsidiaries and the Report of Independent Public Accountants thereon, as required to be filed with this report, are set forth in Item 8 of this report and are incorporated therein by reference to specific pages of the Corporation's Consolidated Financial Statements and Management's Discussion and Analysis included in the Appendix to the Proxy Statement and filed as Exhibit 13 hereto.\nItem 14(a)(2): Financial Statement Schedule\nThe following consolidated financial statement schedule of the Corporation and its subsidiaries for the years ended December 31, 1995, 1994 and 1993 is filed herewith on the indicated page in response to Item 14(d):\nSchedule II -- Valuation and Qualifying Accounts (Page 15)\nOther schedules have been omitted as not applicable or required, or because information required is shown in the consolidated financial statements or notes thereto.\nFinancial statements of the parent corporation only are omitted because the Corporation is primarily an operating corporation and there are no significant restricted net assets of consolidated and unconsolidated subsidiaries.\nItem 14(a)(3): Exhibits\nThe following items are attached or incorporated by reference in response to Item 14(c):\n(3) Articles of Incorporation and By-laws\nThe Corporation's Restated Certificate of Incorporation, as amended, is incorporated by reference from Exhibit 3 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended April 3, 1988. The By-laws, as amended on October 3, 1995, are incorporated by reference from Exhibit 3 to the Corporation's Report on Form 10-Q for the quarter ended October 1, 1995.\n(4) Instruments defining the rights of security holders, including indentures\nThe Corporation has issued certain long-term debt instruments, no one class of which creates indebtedness exceeding 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. These classes consist of the following:\na. 8.45% to 9.92% Medium-Term Notes due 1995-1998\nb. 6.7% Notes due 2005\nc. 8.8% Debentures due 2021\nd. Other Obligations\nThe Corporation will furnish copies of the above debt instruments to the Commission upon request.\n(10) Material contracts\na. Kit Kat and Rolo License Agreement (the \"License Agreement\") between Hershey Foods Corporation and Rowntree Mackintosh Confectionery Limited is incorporated by reference from Exhibit 10(a) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1980. The License Agreement was amended in 1988 and the Amendment Agreement is incorporated by reference from Exhibit 19 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended July 3, 1988. The License Agreement was assigned by Rowntree Mackintosh Confectionery Limited to Societe des Produits Nestle SA as of January 1, 1990. The Assignment Agreement is incorporated by reference from Exhibit 19 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\nb. Peter Paul\/York Domestic Trademark & Technology License Agreement between Hershey Foods Corporation and Cadbury Schweppes Inc. (now CBI Holdings, Inc.) dated August 25, 1988, is incorporated by reference from Exhibit 2(a) to the Corporation's Current Report on Form 8-K dated September 8, 1988.\nc. Cadbury Trademark & Technology License Agreement among Hershey Foods Corporation and Cadbury Schweppes Inc. (now CBI Holdings, Inc.) and Cadbury Limited dated August 25, 1988, is incorporated by reference from Exhibit 2(a) to the Corporation's Current Report on Form 8-K dated September 8, 1988.\nd. 364-Day Credit Agreement dated as of December 15, 1995 among Hershey Foods Corporation, the banks, financial institutions and other institutional lenders listed on the signature pages thereof, and Citibank, N.A. as administrative agent bank and Citicorp Securities, Inc. and BA Securities, Inc. as co- syndication agents, is incorporated by reference from Exhibit 10.1 to the Corporation's Current Report on Form 8-K dated January 29, 1996.\ne. Five-Year Credit Agreement dated as of December 15, 1995 among Hershey Foods Corporation, the banks, financial institutions and other institutional lenders listed on the signature pages thereof, and Citibank, N.A. as administrative agent bank and Citicorp Securities, Inc. and BA Securities, Inc. as co-syndication agents, is incorporated by reference from Exhibit 10.2 to the Corporation's Current Report on Form 8-K dated January 29, 1996.\nExecutive Compensation Plans\nf. The 1987 Key Employee Incentive Plan, as amended, is incorporated by reference from Exhibit 19(i) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\ng. Hershey Foods Corporation's Restated Supplemental Executive Retirement Plan is incorporated by reference from Exhibit 19(ii) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\nh. Hershey Foods Corporation's Non-Management Director Retirement Plan is incorporated by reference from Exhibit 19 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 29, 1992.\ni. Hershey Foods Corporation's Deferral Plan for Non-Management Directors is incorporated by reference from Exhibit 10 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\nj. A form of the Benefit Protection Agreements entered into between the Corporation and certain of its executive officers is incorporated by reference from Exhibit 10 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\nk. Hershey Foods Corporation's Deferred Compensation Plan is filed as Exhibit 10 hereto.\n(12) Computation of ratio of earnings to fixed charges statement\nA computation of ratio of earnings to fixed charges for the years ended December 31, 1995, 1994, 1993, 1992 and 1991 is filed as Exhibit 12 hereto.\n(13) Annual report to security holders\nThe Corporation's Consolidated Financial Statements and Management's Discussion and Analysis is included in the Appendix to the Proxy Statement and is filed as Exhibit 13 hereto.\n(21) Subsidiaries of the Registrant\nA list setting forth subsidiaries of the Corporation is filed as Exhibit 21 hereto.\nItem 14(b): Reports on Form 8-K\nA report on Form 8-K was filed on December 4, 1995, reporting that Hershey Chocolate U.S.A., a division of Hershey Foods Corporation, increased the wholesale price of its standard and king-size bar lines by approximately 11% effective December 4, 1995.\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.\nHERSHEY FOODS CORPORATION (Registrant)\nDate: March 13, 1996 By W. F. CHRIST (W. F. Christ, 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 Corporation and in the capacities and on the date indicated.\nSignature Title Date\nK. L. WOLFE Chief Executive Officer (K. L. Wolfe) and Director March 13, 1996\nW. F. CHRIST Chief Financial Officer Mrch 13, 1996 (W. F. Christ)\nD. W. TACKA Chief Accounting Officer March 13, 1996 (D.W. Tacka)\nJ. P. VIVIANO Director March 13, 1996 (J. P. Viviano)\nW. H. ALEXANDER Director March 13, 1996 (W. H. Alexander)\nH. O. BEAVER, JR. Director March 13, 1996 (H. O. Beaver, Jr.)\nR. H. CAMPBELL Director March 13, 1996 (R. H. Campbell)\nT. C. GRAHAM Director March 13, 1996 (T. C. Graham)\nB. GUITON HILL Director March 13, 1996 (B. Guiton Hill)\nSignature Title Date\nJ. C. JAMISON Director March 13, 1996 (J. C. Jamison)\nS. C. MOBLEY Director March 13, 1996 (S. C. Mobley)\nF. I. NEFF Director March 13, 1996 (F. I. Neff)\nJ. M. PIETRUSKI Director March 13, 1996 (J. M. Pietruski)\nV. A. SARNI Director March 13, 1996 (V. A. Sarni)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE\nTo Hershey Foods Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Hershey Foods Corporation's Proxy Statement for its 1996 Annual Meeting of Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 25, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14(a)(2) on page 9 is the responsibility of the Corporation'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\nNew York, New York January 25, 1996\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated January 25, 1996, included or incorporated by reference in this Form 10-K for the year ended December 31, 1995, into the Corporation's previously filed Registration Statements on Forms S-8 or S-3, (File No. 33-45431, File No. 33-45556 and File No. 33-51089).\nARTHUR ANDERSEN LLP\nNew York, New York March 13, 1996\n(a) Includes recoveries of amounts previously written off.\nHERSHEY FOODS CORPORATION ANNUAL REPORT ON FORM 10-K\nIndex to Exhibits\nExhibit No.\n10 -- Deferred Compensation Plan\n12 -- Computation of ratio of earnings to fixed charges statement\n13 -- Consolidated Financial Statements and Management's Discussion and Analysis\n21 -- Subsidiaries of the Registrant\n27 -- Financial Data Schedule for the period ended December 31, 1995 (Required for electronic filing only).","section_15":""}
{"filename":"806151_1995.txt","cik":"806151","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL OVERVIEW\nHorizon\/CMS Healthcare Corporation, a Delaware corporation (\"Horizon\" or the \"Company\"), was organized in 1986 and is a leading provider of specialty health care services and long-term care principally in the midwest, southwest, and northeast regions of the United States. The Company's strategy is to use its long-term or geriatric care and subacute care facilities as platforms to provide a continuum of post-acute care more typically delivered in the acute care hospital setting. This strategy will position the Company to take advantage of the increasing number of patients being discharged from hospitals who continue to require subacute and\/or long-term care as a result of cost containment measures implemented by private insurers through managed care programs and limitations on government reimbursement of hospital costs. These patients often cannot be effectively cared for in the home because of the complex monitoring and specialized medical treatment required. Because long-term or geriatric care facilities have lower capital and operating costs than acute care hospitals, the Company is able to offer these complex medical services at a significantly lower cost than acute care hospitals.\nIn response to current health care reform and ongoing changes in the health care marketplace, the Company implemented and continues to implement a strategy extending the continuum of services beyond traditional subacute care to create a post-acute health care delivery system in each geographic region served by the Company. Post-acute care is the provision of a continuum of care to patients for the twelve month period following discharge from an acute care hospital. Post-acute care services include subacute care, outpatient and home care, inpatient and outpatient rehabilitative and pharmacy services. The Company's integrated post-acute health care system is intended to provide continuity of care for its patients and enable payors to contract with one provider to provide virtually all of the patient's needs during the period following discharge from acute care facilities. To implement this strategy, the Company has focused on (a) continuing its development of specialty health care facilities such as its specialty hospitals, (b) developing geographic market concentration for its post-acute care services, and (c) expanding the range of related services it offers to patients.\nAt May 31, 1995, the Company owned, leased or managed 149 long-term care and specialty health care facilities containing 17,776 beds in 18 states. References herein to numbers of specialty health care facilities include those located in discrete areas within the physical structure of the Company's long-term care facilities.\nThe Company's long-term or geriatric care facilities provide routine basic patient services to geriatric and other patients with respect to daily living activities and general medical needs. Such basic patient services include daily dietary services, recreational activities, social services, housekeeping and laundry services, pharmaceutical and medical supplies and 24 hours-a-day access to registered nurses, licensed practical nurses and related services prescribed by the patient's physician.\nThe specialty health care services provided by the Company include subacute care, rehabilitation therapies (occupational, speech and physical therapies and treatment of traumatic head injury and other neurological impairments), institutional pharmacy services, Alzheimer's care, non-invasive medical diagnostic testing services, home respiratory care services and supplies, and clinical laboratory services. The Company's subacute care services include high acuity, multidisciplinary, complex medical care programs. Subacute care services also include dedicated programs for rehabilitative ventilator care, wound management, general rehabilitation, head trauma\/coma stimulation and infusion therapy. Subacute care services are provided through the Company's specialty hospitals and subacute care units. The Company provides Alzheimer's care through 26 units with 834 beds. The Company provides institutional pharmacy services to approximately 38,000 beds. The Company provides non-invasive medical diagnostic testing services such as echocardiography, peripheral venous and arterial imaging, holter monitoring and doppler scanning by way of mobile units and fixed location operations (generally in acute care hospitals) through a network of physicians and surgeons and also provides sleep diagnostic services. The Company's clinical laboratory provides body fluid testing to assist in detecting, diagnosing and monitoring diseases in the subacute and long-term care settings and currently provides services to approximately 9,000 beds. The Company's specialty health care services typically yield higher per bed charges and higher profit margins than traditional long-term care services.\nConsistent with the Company's strategy of developing one of the nation's leading providers of post-acute care, the Company acquired Continental Medical Systems, Inc. (\"CMS\") on July 10, 1995 by means of a merger of a wholly owned subsidiary of the Company with and into CMS, with CMS being the surviving corporation (the \"CMS Merger\"). Upon consummation of the CMS Merger, CMS became a wholly owned subsidiary of the Company. CMS is one the nation's largest providers of comprehensive inpatient and outpatient medical rehabilitative services. CMS has a significant clinical and market presence in each of the medical rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract rehabilitation therapies. CMS has developed and provides inpatient and outpatient rehabilitation programs and services for patients suffering from stroke and other neurological and cardiac disorders, orthopedic problems, head injuries, spinal cord injuries, work-related disabilities and multiple trauma. CMS's inpatient and outpatient rehabilitation programs and services are delivered to patients through a plan of treatment developed by an interdisciplinary team that includes physician specialists, therapists and other medical personnel, as determined by the individual patient's needs.\nCMS currently operates 37 free standing comprehensive medical rehabilitation hospitals with a total, as of June 30, 1995, consisting of 2,016 licensed acute rehabilitation beds located in 15 states. For the most part, these hospitals overlap geographically with the Company's long-term or geriatric care or specialty hospital\/subacute care facilities. Many of CMS's rehabilitation hospitals are operated through joint ventures with local general acute care hospitals, physicians and other investors. CMS's rehabilitation unit management group operates inpatient and outpatient rehabilitation programs within acute care hospitals and currently manages 12 rehabilitation units with more than 272 beds.\nCMS's comprehensive freestanding medical rehabilitation hospitals typically provide on-site outpatient services. As of June 30, 1995, CMS also provided outpatient services through 140 outpatient rehabilitation clinics, 102 of which are operated as satellites of CMS's inpatient rehabilitation hospitals. The remaining 38 outpatient clinics are operated through CMS's contract therapy subsidiaries.\nThrough its contract therapy subsidiaries, CMS provides physical, occupational, speech and respiratory therapy services on a contract basis to over 2,300 skilled nursing facilities, general acute care hospitals, schools, home health agencies, inpatient rehabilitation hospitals and outpatient clinics in 32 states.\nCMS provides physician locum tenens services to institutional providers and physician practice groups throughout the United States. \"Locum Tenens\" is a term used in the health care field to describe one physician covering for another. CMS also offers management and managed care services to independent physician associations, physicians, and outpatient rehabilitation providers under various contractual arrangements.\nManagement of the Company believes that the CMS Merger has created one of the nation's major post-acute care companies and one of the nation's largest specialty health care providers.\nINDUSTRY BACKGROUND\nThe post-acute industry, including subacute care and long-term care, encompasses a broad range of health care services for patients with medically complex needs who can be cared for outside of acute care hospitals. The Company believes that it is well positioned to capitalize on favorable industry trends, including increasing demand for long-term care and subacute care services, limited supply of new long-term care beds and consolidation within the industry.\nIn response to rapidly rising costs, governmental and private pay sources have adopted cost containment measures that encourage reduced length of stays in hospitals. These third party payors have implemented strong case management and utilization review procedures. In addition, traditional private insurers have begun to limit reimbursement to predetermined \"reasonable charges,\" while managed care organizations such as health maintenance organizations and preferred provider organizations are attempting to limit hospitalization costs by monitoring and reducing hospital utilization and by negotiating discounted rates for hospital services or fixed charges for procedures regardless of length of stay. As a result, average hospital stays have been shortened, with many patients being discharged despite a continuing need for specialty health care services or nursing care.\nThis trend will be amplified by the expected increase in the number of persons who will require long-term care services. According to the U.S. Bureau of the Census, approximately 1.4% of people 65 - 74 years of age received care in long-term care facilities in 1990, while 6.1% of people 75 - 84 years of age and 24.5% of people over age 85 received such care. The U.S. Bureau of the Census estimates that the U.S. population over age 75 will increase from approximately 13 million, or 5.2% of the population, in 1990 to approximately 17 million, or 6.1% of the population, by the year 2000. In particular, the segment of the U.S. population over 85 years of age, which comprises 45 - 50% of residents at long-\nterm care facilities nationwide, is projected to increase by more than 40%, from approximately 3 million, or 1.2% of the population, in 1990 to more than 4 million, or 1.6% of the population in 2000. The population over age 65 suffers from a greater incidence of chronic illnesses and disabilities than the rest of the population and currently accounts for more than two-thirds of total health care expenditures in the United States. As the number of Americans over age 65 increases, the need for long-term care services is also expected to increase.\nAdvances in medical technology have increased the life expectancy of a growing number of patients who require a high degree of care traditionally not available outside acute care hospitals. For such patients, home health care is not a viable alternative because of the complexity of medical services and equipment required. As a result, the Company believes that there is an increasing need for long-term care facilities that provide 24 hours-a-day supervision and specialty care at a significantly lower cost than traditional acute care and rehabilitation hospitals.\nRecently, the industry has been subject to competitive pressures that have resulted in a trend towards consolidation of smaller, local operators into larger, more established regional or national operators. The increasing complexity of medical services, growing regulatory and compliance requirements and increasingly complicated reimbursement systems have resulted in consolidation of operators who lack the sophisticated management information systems, operating efficiencies and financial resources to compete effectively.\nBUSINESS STRATEGY\nThe Company's business strategy emphasizes growth of its specialty health care services and long-term care operations and concentration of its operations in geographic regions. Specifically, the Company's strategy is to use its long-term or geriatric care and subacute care facilities as platforms to provide a continuum of post-acute care more typically delivered in the acute care hospital setting. This strategy will position the Company to take advantage of the increasing number of patients being discharged from hospitals who continue to require subacute and\/or long-term care as a result of cost containment measures implemented by private insurers through managed care programs and limitations on government reimbursement of hospital costs. These patients often cannot be effectively cared for in the home because of the complex monitoring and specialized medical treatment required. Because long-term or geriatric care facilities have lower capital and operating costs than acute care hospitals, the Company is able to offer these complex medical services at a significantly lower cost than acute care hospitals.\nIn response to current health care reform and ongoing changes in the health care marketplace, the Company continues to implement a strategy of extending the continuum of services beyond traditional subacute care to create an integrated post-acute health care delivery system in each geographic region served by the Company. The Company's integrated post-acute health care delivery system is intended to provide continuity of care for its patients and enable payors to contract with one provider to provide virtually all of the patient's needs during the year following discharge from acute care facilities and beyond, if necessary. To implement this strategy, the Company has focused on (a) continuing its development of specialty health care facilities such as its\nspecialty hospitals, (b) developing geographic market concentration for its post-acute care services, and (c) expanding the range of related services it offers to patients.\nEXPANSION THROUGH ACQUISITIONS. The Company intends to continue to expand its operations through the acquisition in select geographic areas of long-term care facilities and providers of specialty health care services. The acquisition of long-term care facilities provides further opportunities for expansion of the Company's higher margin specialty programs. See \"Acquisitions and Expansion.\"\nConsistent with the Company's strategy of developing one of the nation's leading providers of post-acute care, on July 10, 1995, the CMS Merger was consummated. CMS is one of the nation's largest providers of comprehensive inpatient and outpatient medical rehabilitative services. CMS has a significant clinical and market presence in each of the medical rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract rehabilitation therapies. CMS has developed and provides inpatient and outpatient rehabilitation programs and services for patients suffering from stroke and other neurological and cardiac disorders, orthopedic problems, head injuries, spinal cord injuries, work-related disabilities and multiple trauma. CMS's inpatient and outpatient rehabilitation programs and services are delivered to patients through a plan of treatment developed by an interdisciplinary team that includes physician specialists, therapists and other medical personnel, as determined by the individual patient's needs.\nManagement of the Company believes that the CMS Merger has created one of the nation's major post-acute care companies and one of the nation's largest specialty health care providers. The combined company has a substantial capability in a large array of post-acute care services; acute medical rehabilitation; outpatient rehabilitation; subacute care; long-term care; contract rehabilitation therapy; institutional pharmacy services; clinical laboratory services; medical diagnostic services; and home care services.\nManagement of the Company has begun implementation of its consolidation plan with CMS and believes that there are significant synergies to be realized, particularly through (a) revenue enhancement and cost savings from consolidation of contract therapy operations; (b) margin improvements from enhanced utilization of contract therapists; (c) the expansion of the Company's institutional pharmacy services into CMS facilities and new markets; (d) the consolidation of corporate overhead; (e) the potential to increase business through the ability to provide a full range of care to managed care providers who desire \"one stop shopping\"; (f) the ability to increase capacity and margins in rehabilitation hospitals by transferring patients to Company owned or operated subacute and long-term care facilities; (g) the potential to increase patient volume by expanding the continuum of care of each company on a stand-alone basis; and (h) the potential for improved buying power with respect to suppliers.\nREVENUE ENHANCEMENT THROUGH EXPANDED SPECIALTY SERVICES. The Company intends to continue to expand its specialty health care services at its facilities in order to improve profit margins, occupancy levels and payor mix achieved through these services.\nCONCENTRATION IN TARGETED GEOGRAPHIC AREAS. The Company concentrates its operations in clusters of operating units in selected geographic areas. The Company believes that concentrating its rehabilitation hospitals and long-term care facilities within selected geographic areas provides a platform to expand its specialty health care services. It also provides operating efficiencies, economies of scale and growth opportunities. These operating efficiencies enable the Company to reduce corporate overhead and to establish effective working relationships with the regulatory and legislative authorities in the states in which it operates. In addition, concentration of facilities enhances the development of stronger local referral sources through concentrated marketing efforts.\nLONG-TERM CARE FACILITIES\nThe Company's long-term care facilities provide routine basic patient services to geriatric and other patients with respect to daily living activities and general medical needs. Such basic patient services include daily dietary services, recreational activities, social services, housekeeping and laundry services, pharmaceutical and medical supplies and 24 hours-a-day access to registered nurses, licensed practical nurses and related services prescribed by the patient's physician. At May 31, 1995, the Company operated 133 long-term care facilities in 18 states.\nSubsequent to year end, on June 19, 1995 the Company announced plans to dispose of eight long-term care facilities. The decision to sell the facilities was based on both financial, regulatory and operational factors. The facilities to be sold are comprised of four neuro-behavioral centers, two chronic ventilator care facilities, one mild mental facility and one personal care center. The Company expects that each of the eight facilities will be disposed of during fiscal 1996.\nSPECIALTY HEALTH CARE SERVICES\nThe Company provides a variety of specialty health care services as described in more detail below. The Company believes that providing a broad range of specialty health care services and programs enables the Company to attract patients with more complex health care needs. These services typically generate higher profit margins to the Company than basic patient services.\nSUBACUTE CARE. The number of subacute and specialty hospital beds the Company operates has increased from 168 beds at the end of fiscal year 1993 to 1,331 at the end of fiscal 1994 and to 1,413 at the end of fiscal 1995. The Company provides subacute care to high acuity patients with medically complex conditions who require ongoing, multidisciplinary nursing and medical supervision and access to specialized equipment and services but who do not require many of the other services provided by an acute care hospital. Subacute care services are generally provided in a discrete area within the physical structure of a specialty hospital and are supervised by a separate medical staff employed by the Company. The Company operates one stand-alone specialty hospital. Such units also provide rehabilitative ventilator care, intravenous therapy and various forms of coma, pain and wound management. The Company believes that private insurance companies and other third party payors, including certain state Medicaid programs, recognize that treating patients requiring subacute care in specialty units such as those operated by the Company is a cost effective\nalternative to treatment in acute care hospitals. The Company believes that it can continue to offer subacute care at rates substantially below those typically charged by acute care hospitals for comparable services.\nAlthough subacute care units can be operated by the Company under its existing licenses, the Company may choose to operate them under specialty hospital licenses due to the higher reimbursement rates for services rendered under these licenses and the Company's belief that such licenses may enhance its marketing efforts to referral sources such as physicians, surgeons, managed care providers and hospital discharge planners. Ten of the Company's subacute care units are operated under specialty hospital licenses. Once a specialty hospital license has been obtained, the beds so licensed generally can no longer be used for patients who require only basic patient care.\nThe Company maintains a significant presence in the subacute care market. Specifically, the Company is a party to a number of contracts with commercial insurers and managed care providers and out-of-state special rate Medicaid provider agreements. The Company believes that these relationships will enable the Company to receive higher reimbursement rates and profit margins in the future. The CMS Merger further expands the Company's presence in the sub-acute segment of the post-acute care industry. CMS's 37 medical rehabilitation hospitals expand significantly the array of post-acute care services the Company can provide patients and third party payors.\nCONTRACT REHABILITATION THERAPIES. The Company provides a comprehensive range of rehabilitation therapies, including physical, occupational, respiratory and speech therapies in most of its long-term care facilities and through contracts with third parties. In addition, the Company has 14 facilities that provide comprehensive inpatient rehabilitation and skilled and intermediate nursing services to patients who have sustained traumatic head injuries or other neurological impairments. As of May 31, 1995, the Company provided comprehensive physical, occupational and speech therapy services through 498 contracts in 19 states, 120 of which are with Company-operated long-term care facilities and specialty hospitals, and 378 of which are with third party long-term care facilities, home health agencies, hospitals, outpatient clinics or school systems. The CMS Merger expands the Company's presence in the contract rehabilitation therapy marketplace, making the Company one of the nation's leading providers of these services.\nINSTITUTIONAL PHARMACY SERVICES. The Company has established a network of 22 regionally located pharmacies through which it provides a full range of prescription drugs and infusion therapy services, such as antibiotic therapy, pain management and chemotherapy, to facilities operated by the Company and by third parties. These pharmacy operations (certain of which are managed by third parties) enable the Company to generate revenues from services previously provided to the Company by third-party pharmacy vendors. The Company provides institutional pharmacy services in 17 states. The Company currently offers its pharmacy services to 96% of its facilities. Of the approximate 38,000 beds serviced by the Company's institutional pharmacies, 21,000 are located in facilities not operated by the Company.\nALZHEIMER'S LIVING CENTERS. The Company offers a specialized program for persons with Alzheimer's disease through its Alzheimer's Living Centers. At\nMay 31, 1995, this program had been instituted at 26 of the Company's long-term care facilities, with a total of 834 beds. Each Alzheimer's Living Center is located in a designated wing of a long-term care facility and is designed to address the problems of disorientation experienced by Alzheimer's patients and to help reduce stress and agitation resulting from a short attention span and hyperactivity. Each Alzheimer's Living Center employs a specially trained nursing staff and an activities director and engages a medical director with expertise in the treatment of Alzheimer's disease. The program also provides education and support to the patient's family.\nNON-INVASIVE MEDICAL DIAGNOSTICS. During fiscal 1994, the Company began providing noninvasive, portable and static diagnostic testing services for physicians and acute care hospitals. These services include cardiovascular (both cardiac imaging and vascular imaging), pelvic and abdominal testing services and sleep diagnostic services. The Company has recently expanded its diagnostic expertise and the diagnostic markets it serves through acquisitions. The Company now provides these diagnostic services in 12 states.\nCLINICAL LABORATORY. During fiscal 1993, the Company established a comprehensive clinical laboratory, which is centrally located in Dallas, Texas, to serve the long-term care industry. This laboratory has received a registration number in accordance with the Clinical Laboratory Improvement Act (\"CLIA\"), and has all necessary state regulatory approvals to conduct business in the states in which the Company currently operates. A CLIA registration number is required for clinical laboratories to receive reimbursement for charges to patients covered by Medicare and Medicaid. At May 31, 1995, the laboratory provided services to approximately 9,000 beds.\nThe clinical laboratory provides bodily fluid testing services to assist in detecting, diagnosing and monitoring diseases. These tests, performed as ordered by each patient's attending physician, include testing for complete blood count, blood chemistry testing, coagulation studies, urinalysis, microbiology tests and therapeutic drug level tests. Upon completion of these tests, the laboratory electronically communicates the results of such testing back to the applicable facility for inclusion on each patient's medical chart for review by the attending physician.\nThe following table sets forth the revenues for each of the Company's specialty health care services for the periods indicated:\nOn July 10, 1995, the Company consummated the CMS Merger, which is to be accounted for as a pooling of interests. CMS is one of the largest providers of comprehensive medical rehabilitation programs and services in the country with\na significant presence in each of the rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract therapy. CMS operates 37 freestanding rehablitation hospitals, provides outpatient rehabilitation services at more than 130 locations and manages 13 inpatient rehabilitation units for general acute care hospitals. These services are provided in 20 states. CMS also provides physician staffing services. Through its contract therapy operations, CMS provides physical, occupational, speech and respiratory therapy services on a contract basis to over 2,300 skilled nursing facilities, general acute care hospitals, schools, home health agencies, inpatient rehabilitation hospitals or outpatient clinics in 32 states.\nFACILITIES\nAt May 31, 1995, the Company operated 149 long-term care and specialty health care facilities in 18 states. Approximately 60% of the Company's facilities are subject to long-term operating leases, ranging from five to 15 years, that require the Company to pay all taxes, insurance and maintenance costs. Many of the leases contain at least one renewal option to extend the term for five to 15 years. The Company owns 48 of its facilities. The Company considers its properties to be in generally good operating condition and suitable for the purposes for which they are being used.\nThe following table summarizes by state certain information regarding the facilities operated and managed by the Company:\nOPERATIONS\nREGIONAL OPERATIONS. The Company's long-term care facilities are organized into four regions, each of which is supervised by a Vice President of Operations. For every six to twelve centers within each region, a District Director, Quality Assurance Nurse and Dietary Consultant are responsible for monitoring operations. Each facility operated by the Company is supervised by a licensed administrator and employs a Director of Nursing Services, who supervises a staff of registered nurses, licensed practical nurses and nurses' aides. A Medical Director supervises the medical management of all patients. Other personnel include dietary staff, housekeeping, laundry and maintenance staff, activities and social services staff and a business office staff. In addition, the Company's corporate and regional staffs provide services such as marketing assistance, training, quality assurance oversight, human resource management, reimbursement expertise, accounting, cash management, legal services and management support. Financial control is maintained through financial and accounting policies that are established at the corporate level for use at each facility. The Company has standardized operating procedures and monitors its centers to assure consistency of operations. The Company's financial reporting system enables it to monitor certain key financial data at each facility, such as payor mix, admissions and discharges, cash collections, net patient care revenues and staffing.\nThe Company's specialty health care operations are organized as follows.\nSUBACUTE CARE AND SPECIALTY HOSPITALS. The Company's subacute care and specialty hospital operations are divided into two geographic regions, each of which is supervised by a Director of Operations. Each of the subacute care facilities and\/or specialty hospitals is supervised by a licensed administrator and a governing board. Each of the subacute care facilities and specialty hospitals employs a Director of Nursing Services, who supervises a staff of registered nurses, licensed practical nurses and nurses' aides. A Medical Director and a staff of resident medical professionals supervise the medical management of all patients. As in the case of the Company's long-term care facilities, the Company's corporate and regional staffs provide services such as marketing assistance, training, quality assurance oversight, human resources management, legal services, and management support. The Company has standardized operating procedures and monitors its subacute care facilities and specialty hospitals to assure consistency and quality of operations.\nCONTRACT REHABILITATION THERAPIES. The Company's contract rehabilitation therapy operations are divided into six regional operational divisions, each of which is supervised by a Director of Operations. These regional divisions each recruit, hire, train and supervise the physical, occuptional and speech pathology therapists that provide the \"hands on\" therapy services to the Company's facilities and, to a greater extent, third parties. Each of the Directors of Operations is responsible not only for the productivity of the therapists employed by the\nCompany but also for the compliance with the Company's policies and procedures in billing for services rendered. As in the case of the Company's long-term care facilities, the Company's corporate and regional staffs provide a wide-array of support services to the Company's contract rehabilitation therapy subsidiaries. The Company believes its billing rates for contract rehabilitation therapies are both competitive and represent the price a \"prudent buyer\" would pay for such services.\nINSTITUTIONAL PHARMACY SERVICES. The Company's institutional pharmacy business is organized into geographic pharmacy distribution centers in each of the states where the Company provides these services. In each of the pharmacy distribution centers, the Company employs pharmacists to fill prescriptions ordered in each of the facilities with which the Company has contracted. Each of these pharmacy distribution centers also mix out and supply enteral and parenteral supplies as ordered in addition to all legally required pharmaceutical consulting services. These operations are supervised by a Vice President of Pharmacy Services. In addition, the regional managers recruit, hire, train and supervise the pharmacists employed by the Company. As in the case of the Company's other subsidiary operations, the Company's corporate staff provides a wide array of support services to the pharmacy subsidiaries.\nNON-INVASIVE MEDICAL DIAGNOSTICS. The Company's non-invasive medical diagnostic business is headquartered in Albuquerque, New Mexico and is divided into several geographic regions. Each of these regions is supervised by a regional supervisor, who recruits, hires, trains and supervises ultrasound technicians who work either in the Company's hospital-based operations or in the Company's mobile units. The Company also operates one of the largest physician training programs in the medical diagnostic industry. The Company has standardized operating procedures and monitors its technicians and staff to assure consistency and quality of operations.\nCLINICAL LABORATORY SERVICES. The Company's clinical laboratory operation is based in Dallas, Texas, which is operated by the Vice President of Operations for the clinical laboratory. A Medical Director supervises the testing of samples at the laboratory. When a facility physician orders lab testing for a patient, the necessary samples are drawn at the facility and shipped by overnight delivery service to the Company's clinical laboratory. The ordered tests are completed and the results are transmitted electronically back to the facility. As is the case for the Company's other services, the Company's corporate offices provide a wide array of support services to the Company's clinical laboratory.\nQUALITY ASSURANCE. The Company has developed a comprehensive quality assurance program intended to maintain a high standard of care with respect to all of the services it provides to patients. Under the Company's long-term and subacute care quality assurance program, the care and services provided at each facility are evaluated quarterly by a quality assurance team that reports directly to the Company's management and to the administrator of each facility.\nThe Company's long-term and subacute quality assurance program is comprised of a quality assurance checklist and a patient satisfaction survey and evaluation. The checklist, completed quarterly by the regional quality assurance nurses employed by the Company, provides for ongoing evaluation. Patient satisfaction is evaluated through patient satisfaction surveys. Patients and their\nfamilies are encouraged to recognize employees who demonstrate outstanding performance. Bonuses paid to facility administrators are dependent in part upon the rankings of their facility in such surveys. In order to assist patients and their families in resolving any concerns they may have, the Company has also established a resident advocacy program. The Company has also developed a specialized quality assurance program for its Alzheimer's living centers.\nEach of the Company's specialty health care subsidiaries has developed a comprehensive quality assurance program and system intended to maintain a high quality of care and\/or services to the Company's patients or customers.\nSOURCES OF REVENUES\nThe Company derives net patient care revenues principally from public funding through the Medicaid and Medicare programs and also from private pay patients and non-affiliated long-term care facilities.\nUnder the Medicare program and some state Medicaid programs, the Company's long-term care facilities are periodically paid in amounts designed to approximate the facilities' reimbursable costs or the applicable payment rate. Actual costs incurred are reported by each facility annually. Such cost reports are subject to audit, which may result in upward or downward adjustment for Medicare payments received. Most of the Company's Medicaid payments are prospective payments intended to approximate costs, and normally no retroactive adjustment is made to such payments. See \" -- Medicaid and Medicare\" and \"Regulation.\"\nThe Company's charges for private pay patients are established by the Company from time to time and the level of such charges is generally not subject to regulatory control. The Company classifies payments from individuals who pay directly for services without government assistance as private pay revenues. The private pay classification includes revenues from sources such as commercial insurers and health maintenance organizations. The Company bills private pay patients and rehabilitation therapy customers (or their insurer or health maintenance organization) on a monthly basis for services rendered. Such billings are due and payable upon receipt. The Company typically receives payments on a current basis from individuals and within 60 to 90 days of billing from commercial insurers and health maintenance organizations.\nOther revenue sources include revenues derived from institutional pharmacy services, rehabilitation therapy services provided to non-affiliates and Veterans Administration and Bureau of Indian Affairs contracts. The Company generally receives payments from such other sources within 60 to 90 days of billing.\nThe following table identifies the Company's revenues attributable to each of its revenue sources for the periods indicated below:\nChanges in the mix of the Company's patients among Medicaid, Medicare and private pay sources and with respect to different types of private pay sources can significantly affect the revenues and profitability of the Company's operations. There can be no assurance that payments under governmental and third party payor programs will remain at current levels or that the Company will continue to attract and retain private pay patients or maintain its current payor or revenue mix. In an attempt to reduce the federal budget deficit, there have been, and the Company expects there will continue to be, a number of proposals to limit Medicare and Medicaid reimbursement for long-term care services. The Company cannot at this time predict whether any of these pending proposals will be adopted or, if adopted and implemented, what effect such proposals would have on the Company.\nCOMPETITION\nThe Company's long-term care facilities principally compete for patients with other long-term care facilities and, to a lesser extent, with home health care providers and acute care hospitals. Construction of new long-term care facilities near the Company's facilities could adversely affect the Company's business. Many states require a Certificate of Need or impose similar restrictions before a new long-term care facility can be constructed or additional beds can be added to existing facilities.\nIn competing for patients, a facility's local reputation is of paramount importance. Referrals typically come from acute care hospitals, physicians, religious groups, other community organizations, health maintenance organizations and patients' families and friends. Members of a patient's family generally actively participate in selecting a long-term care facility. Other factors that affect a facility's ability to attract patients include the physical plant condition, the ability to identify and meet particular health care needs in the community, the rates charged for services, and the availability of personnel to provide the requisite care.\nCompetition for subacute care patients is increasing by virtue of market entry by numerous other care providers. These market entrants include acute care hospitals, rehabilitation hospitals and other specialty service providers. The Company believes that its subacute care facilities are characterized by a high level of acuity in patient care provided, which is one of the competitive factors that distinguish subacute care providers. Other important competitive factors\ninclude the reputation of the facility in the community, the services offered, the availability of qualified nurses, local physicians and hospital support, physical therapists and other personnel, the appearance of the facility and the cost of services.\nThe Company also faces competition in its other specialty health care lines of business (rehabilitation therapies, institutional pharmacy services, Alzheimer's care, noninvasive medical diagnostic services and clinical laboratory services), and the degree of competition varies depending on local market conditions. Competitive factors include nature and quality of the services offered, timeliness of delivery of services and availability of qualified personnel.\nA key element of the Company's strategy is to expand through the acquisition of long-term care facilities and related businesses. In making such acquisitions, the Company competes with other providers, some of which may have greater financial resources than the Company. Certain of these providers are operated by not-for-profit organizations and similar businesses that can finance capital expenditures on a tax-exempt basis or receive charitable contributions unavailable to the Company. There can be no assurance that suitable facilities can be located, that acquisitions can be consummated or that acquired facilities can be integrated successfully into the Company's operations.\nEMPLOYEES\nAs of May 31, 1995, the Company employed approximately 15,500 persons, and approximately 1,100 or 7.1% of the Company's employees in Ohio, Michigan, Wisconsin and Montana were covered by collective bargaining contracts. Of the 24 collective bargaining contracts covering the Company's employees, five will expire in calendar year 1995, five will expire in calendar year 1996, eight will expire in calendar year 1997, and six will expire in calendar year 1998. The Company believes it has had good relationships with the unions which represent its employees, but it cannot predict the effect of continued union representation or organizational activities on its future activities. The Company also believes that it has good relationships with its non-union employees.\nAlthough the Company believes it is able to employ sufficient personnel to staff its facilities adequately, a shortage of nurses in key geographic areas could affect the ability of the Company to attract and retain qualified professional health care personnel or could increase the Company's labor costs. The Company competes with other health care providers for both professional and non-professional employees and with non-health care providers for non-professional employees.\nACQUISITIONS AND EXPANSION\nSince its inception in mid-1986, the Company has expanded its operations through the acquisition of long-term care facilities as well as through the development of specialty hospitals and subacute care units. Factors considered by the Company in targeting long-term care facilities that are acquisition candidates include community demographics, the state's Medicaid program, the local referral base of physicians and hospitals, local labor costs, the availability of nursing personnel and the historical occupancy rates, reimbursement mix and physical condition of the particular facility.\nGrowth through acquisition entails certain risks in that acquired facilities could be subject to unanticipated business uncertainties or legal liabilities. The Company seeks to minimize these risks through investigation and evaluation of the facilities proposed to be acquired and through transaction structure and indemnification. The various risks associated with the implementation of the Company's growth strategies and uncertainties regarding the profitability of such strategies may adversely affect the Company's performance. The ability of the Company to acquire additional facilities depends upon its ability to obtain appropriate financing and personnel.\nMany of the Company's acquisitions have involved the leasing of facilities in order to reduce the amount of capital expenditures. The Company typically accomplishes this either through a direct lease of the facility from the owner or the purchase of the facility from the owner followed by a sale\/leaseback transaction in which the Company becomes the lessee.\nRECENT ACQUISITIONS\nPEOPLECARE HERITAGE GROUP. On July 29, 1994, the Company acquired the assets of peopleCARE Heritage Group (\"peopleCARE\"), a 13 facility long-term care company located in Texas. Consideration given for the acquisition included the issuance of 449,438 shares of the Company's common stock, valued at approximately $10.0 million, assumption of capital lease obligations of approximately $48.6 million for six facilities, and a cash payment of approximately $56.0 million for fee simple title to seven facilities.\nTHE FACILITIES. On January 1, 1995, the Company acquired in two separate transactions, 7 long-term care facilities located in Texas from Texas Health Enterprises, Inc. The Company paid $24.0 million in cash for fee simple title to two facilities and the transfer of operating leases for the five remaining facilities.\nDOCTORS HOSPITAL. On March 1, 1995, the Company acquired a 325 bed long-term care facility located in Texas. In connection with this acquisition, the Company issued 507,813 shares of the Company's common stock, valued at approximately $13.0 million.\nOTHER ACQUISITIONS. In addition to the recent acquisitions referred to above, the Company has completed various other acquisitions since June 1, 1994 involving the purchase of an aggregate of 881 long-term care beds, two rehabilitation providers, two sleep diagnostic clinics, two home respiratory providers, two medical diagnostic services companies and the management of 1,020 long-term care beds. In connection therewith, the Company paid $17.8 million in cash, issued 627,614 shares of the Company's common stock, valued at approximately $16.5 million, guaranteed approximately $6.7 million of lease obligations and became obligated to provide approximately $2.2 million of working capital with respect to certain managed facilities.\nSubsequent to fiscal year end, on June 19, 1995, the Company announced plans to dispose of eight long-term care facilities. Six of the facilities to be disposed of were among the 17 acquired in the merger with Greenery Rehabilitation Group, Inc. (\"Greenery\") during fiscal 1994. The decision to sell the facilities was based upon financial, regulatory and operational considerations.\nCMS MERGER\nAs previously discussed, the Company acquired CMS on July 10, 1995 by means of a merger of a wholly owned subsidiary of the Company with and into CMS, with CMS being the surviving corporation. Upon consummation of the CMS Merger, CMS became a wholly owned subsidiary of the Company. The CMS Merger will be accounted for as a pooling of interests. Under the terms of the merger agreement, each outstanding share of CMS's common stock was converted into .5397 of one share of the Company's common stock, resulting in the Company issuing approximately 20.9 million shares, valued at approximately $393.9 million, based on the closing price of the Company's common stock on July 10, 1995. Approximately 50.3 million shares of the Company's common stock were outstanding following the merger. Additionally, outstanding options to acquire shares of CMS's common stock were converted into options to acquire approximately 3.8 million shares of the Company's common stock.\nMEDICAID AND MEDICARE\nThe Medicaid program is a joint federal\/state medical assistance program for individuals who meet certain income and resource standards. Participating states administer their own Medicaid programs pursuant to state plans approved by the United States Department of Health and Human Services (the \"DHHS\"). Facilities participating in the Medicaid program are required to meet state licensing requirements, to be certified in accordance with state and federal regulations and to enter into contracts with the state to provide services at the rates established by the state. All long-term care facilities operated by the Company (other than its subacute care units and retirement housing facilities) are certified under the appropriate state Medicaid programs.\nAlthough all state Medicaid programs are subject to federal approval, the reimbursement methodologies and rates vary significantly from state to state. Reimbursement rates are typically determined by the state from \"cost reports\" filed annually by each facility, on a prospective or retrospective basis. Under a prospective system, per diem rates are established (generally on an annual basis) based upon certain historical costs of providing services, adjusted to reflect factors such as inflation and any additional services required to be performed. Retroactive adjustments, if any, are based on a recomputation of the applicable reimbursement rate following an audit of cost reports generally submitted at the end of each year. Reimbursable costs normally include the costs of providing health care services to patients, administrative and general costs, and the costs of property and equipment. Not all costs incurred are reimbursed, however, because of cost ceilings applicable to both operating and fixed costs. However, many state Medicaid programs include an incentive allowance for providers whose costs are less than the ceilings and who meet other requirements. A provider may not bill a Medicaid recipient for the portion of its costs for Medicaid-covered services that are not reimbursed by Medicaid. A provider may bill a Medicaid recipient for requested goods or services that are not covered by Medicaid. There can be no assurance that Medicaid reimbursement will be sufficient to cover actual costs incurred by the Company with respect to Medicaid services rendered.\nMedicare is a federal insurance program under the Social Security Act (\"SSA\") primarily for individuals age 65 and over and is supervised by the Health Care Financing Administration (\"HCFA\"), a division of DHHS. The Medicare program reimburses for skilled nursing services and rehabilitative care on the\nbasis of the reasonable cost of providing care and for covered specialty services on the basis of established charges. Like the various state Medicaid programs, the federal Medicare program is regulated and subject to change. With certain exceptions, Medicare is a retrospective cost-based reimbursement system for long-term and subacute care and acute long-term care hospital providers in which each facility receives an interim payment during the year, which is later adjusted upward or downward to reflect actual allowable direct and indirect costs of services (subject to certain cost ceilings) based on the submission of a cost report at the end of each year. Medicare reimbursement for services rendered to Medicare patients will generally cover the costs incurred by the Company in delivering such services. There can be no assurance, however, that Medicare reimbursement will be sufficient to cover actual costs incurred by the Company with respect to Medicare services rendered.\nSpecial regulations apply to Medicare reimbursement for rehabilitation therapy and institutional pharmacy services provided by the Company at Company operated facilities. In order for the Company to obtain reimbursement for more than merely its cost of services these Medicare regulations generally require, among other things, that (i) the Company's rehabilitation therapy and institutional pharmacy subsidiaries must each be a bona fide separate organization; (ii) a substantial part of the rehabilitation therapy services or institutional pharmacy services, as the case may be, of the relevant subsidiary must be transacted with non-affiliated entities, and there must be an open, competitive market for the relevant services; (iii) rehabilitation therapy services and institutional pharmacy services, as the case may be, must be commonly obtained by long-term and\/or subacute care facilities and\/or acute long-term care hospitals from other organizations and must not be a basic element of patient care ordinarily furnished directly to patients by such facilities and\/or hospitals; and (iv) the prices charged to the Company's long-term care facilities by the Company's rehabilitation therapy and institutional pharmacy subsidiaries must be in line with the charges for such services in the open market and no more than the prices charged by the Company's rehabilitation therapy and institutional pharmacy subsidiaries under comparable circumstances to non-affiliated long-term or subacute care facilities and\/ or acute long-term care hospitals. The Company believes that each of the foregoing requirements is satisfied with respect to its rehabilitation therapy and institutional pharmacy subsidiaries, and therefore the Company believes it satisfies the requirements of those regulations.\nIn April 1995, the HCFA issued a memorandum to its Medicare fiscal intermediaries (the \"Fiscal Intermediaries\") providing guidelines for assessing costs incurred by impatient providers (\"Care Providers\") relating to payment of occupational and speech language pathology services furnished under arrangements that include contracts between therapy providers and Care Providers. While not binding on the Fiscal Intermediaries, the HCFA memorandum suggested certain rates to the Fiscal Intermediaries to assist them in making annual \"prudent buyer\" assessments of speech and occupational therapy rates paid by Care Providers during the Fiscal Intermediary's reviews of the Care Providers' cost reports. The HCFA memorandum acknowledges that the rates noted in the memorandum are not absolute limits and should only be used by the Fiscal Intermediaries for comparative purposes. Following the issuance of the HCFA memorandum, meetings between industry representatives and the HCFA have been held concerning the merits of the HCFA memorandum. The HCFA has\nasked industry associations and groups to provide recommendations for inclusion in clarifying instructions to the Fiscal Intermediaries. In light of the fluid nature of the HCFA memorandum, the Company cannot predict what effect, if any, the HCFA memorandum will have on the Company or if the rates suggested in the HCFA memorandum will continue to be recommended by the HCFA. Additionally, the Company cannot determine at this time whether the rates suggested in the HCFA memorandum would be used by the HCFA as a basis for developing possible future regulations creating a salary equivalency based reimbursement system for speech and occupational therapy services. Although management of the Company has developed strategies to deal with potential future changes, there can be no assurance that future changes in the administration or interpretation of governmental health care programs will not have an adverse effect on the results of operations of the Company.\nREGULATION\nThe federal government and all states in which the Company operates regulate various aspects of the Company's business. The Company's long-term care, specialty hospital and subacute care facilities are subject to certain federal certification statutes and regulations and to state statutory and regulatory licensing requirements. In addition, long-term care facilities are subject to various local building codes and other ordinances, with which the Company believes it is in compliance.\nAll of the Company's long-term care facilities (other than its specialty hospitals and retirement housing facilities) are licensed under applicable state law and are certified or approved as providers under one or more of the Medicaid, Medicare or Veterans Administration programs. Each of the Company's specialty hospitals and certain of the Company's subacute care facilities are either accredited by, or are in the process of obtaining accreditation by, the Joint Commission on Accreditation of Healthcare Organizations. Each of the Company's specialty hospitals is licensed as such under applicable state law and is certified by Medicare as an acute long-term care hospital. Both initial and continuing qualification of a long-term and\/or subacute care facility to participate in such programs depend upon many factors, including accommodations, equipment, services, patient care, safety, personnel, physical environment and adequate policies, procedures and controls. Licensing, certification and other applicable standards vary from jurisdiction to jurisdiction and are revised periodically. To be certified as an acute long-term care hospital, the Company's specialty hospitals must satisfy certain conditions. These include an average length of stay for patients of greater than 25 days and, when the specialty hospital is located within another health care facility such as the Company's long-term care facilities, a separate governing body, a separate medical director, a separate medical staff, a separate administrator and separate self-sustained operating functions must be maintained.\nEffective October 1, 1990, the Omnibus Budget Reconciliation Act of 1987 (\"OBRA\") eliminated the different certification standards for \"skilled\" and \"intermediate care\" nursing facilities under the Medicaid program in favor of a single \"nursing facility\" standard. This standard requires, among other things, that the Company have at least one registered nurse on each day shift and one licensed nurse on each other shift and increases training requirements for\nnurses aides by requiring a minimum number of training hours and a certification test before a nurse's aide can commence work. States continue to be required to certify that nursing facilities provide \"skilled care\" in order to obtain Medicare reimbursement.\nIn late 1994, DHHS published the final new OBRA enforcement regulations in response to certain adverse judicial determinations concerning its previously issued state operations manual pertaining to survey procedures. Certain aspects of the new enforcement regulations became effective on July 1, 1995. The new enforcement regulations dictate to each state what such state's OBRA compliance plan must provide. Specifically, each state plan must contain the following remedies to be enforced against facilities that provide substandard care: (a) termination of the Medicaid provider agreement for the facility, (b) temporary management of the facility, (c) denial of payment for new admissions, (d) civil money penalties, (e) closure of the facility in emergency situations and transfer of the residents, and (f) state monitoring of the facility. In addition, each state is allowed to provide for certain alternative remedies provided the state can demonstrate to the satisfaction of the HCFA that these alternatives are effective in deterring non-compliance and in correcting deficiencies. These alternative remedies include directed plans of correction to bring the facility back into compliance and directed in-service training of facility employees. While many of these remedies for substandard care have existed in the past under prior regulations and procedures in each state, the new enforcement regulations substantially curtail a facility's ability to challenge the factual and\/or legal propriety of a survey or the deficiencies cited therein.\nThe Company believes that its facilities are in substantial compliance with the various Medicare and Medicaid regulatory requirements applicable to them. In the ordinary course of its business, however, the Company from time to time receives notices of deficiencies for failure to comply with various regulatory requirements. The Company reviews such notices to examine them for factual correctness and, based on such examination, either takes appropriate corrective action or challenges the propriety of the survey results and the deficiencies cited therein.\nIn most cases, the Company and the reviewing agency will agree upon the measure to be taken to bring the facility into compliance. In some cases or upon repeat violations, the reviewing agency has the authority to take various adverse actions against a facility, including the imposition of fines, temporary suspension of admission of new patients to the facility, suspension or decertification from participation in the Medicare or Medicaid programs and, in extreme circumstances, revocation of a facility's license. These actions would adversely affect a facility's ability to continue to operate, the ability of the Company to provide certain services, and eligibility to participate in the Medicare, Medicaid or Veterans Administration programs. Additionally, conviction of abusive or fraudulent behavior with respect to one facility could subject other facilities under common control or ownership to disqualification from participation in the Medicare and Medicaid programs. Certain of the Company's facilities have received notices in the past from state agencies that, as a result of certain alleged deficiencies, the agency was assessing a fine and\/or taking steps to decertify the facility from participation in the Medicare and Medicaid programs. In all cases during fiscal 1995, such cited deficiencies were remedied before any facilities were decertified,\nthe Company successfully appealed the appropriateness of the cited deficiency and such cited deficiencies were rescinded or the Company successfully negotiated an amicable resolution of any such decertification action and the facility remained certified for participation in the Medicare and\/or Medicaid programs. In addition, to date none of the Company's facilities has had its license revoked.\nThe SSA and DHHS regulations provide for exclusion of providers and related persons from participation in the Medicare and Medicaid programs if they have been convicted of a criminal offense related to the delivery of an item or service under either of these programs or if they have been convicted, under state or federal law, of a criminal offense relating to neglect or abuse of residents in connection with the delivery of a health care item or service. Further, individuals or entities and their affiliates may be excluded from the Medicaid and Medicare programs under certain circumstances including, but not limited to, conviction relating to fraud, license revocation or suspension, or filing claims for excessive charges or unnecessary services or failure to furnish services of adequate quality. Penalties for violation include imprisonment for up to five years, a fine of up to $25,000, or both. Further, the provider could also be excluded from the Medicaid and Medicare programs. In addition, Executive Order 12549 prohibits any corporation or facility from participating in federal contracts if it or its principals have been disbarred, suspended or are ineligible, or have been voluntarily excluded, from participating in federal contracts.\nAdditionally, the federal Medicare\/Medicaid Anti-Fraud and Abuse Amendments to the Social Security Act (the \"Anti-Kickback Law\") make it a criminal felony offense to knowingly and willfully offer, pay, solicit or receive remuneration in order to induce business for which reimbursement is provided under the Medicare or Medicaid programs. In addition to criminal penalties, including fines up to $25,000 and five years imprisonment per offense, violations of the Anti-Kickback Law or related federal laws can lead to civil monetary penalties and exclusion from the Medicare and Medicaid programs from which the Company receives substantial revenues. The Anti-Kickback Law has been broadly interpreted to make remuneration of any kind, including many types of business and financial arrangements among providers, such as joint ventures, space and equipment rentals, management and personal services contracts, and certain investment arrangements, illegal if any purpose of the remuneration or financial arrangement is to induce a referral.\nDHHS has promulgated regulations which describe certain arrangements that will be deemed to not constitute violations of the Anti-Kickback Law (the \"Safe Harbors\"). The Safe Harbors described in the regulations are narrow and do not cover a wide range of economic relationships that many hospitals, physicians and other health care providers consider to be legitimate business arrangements not prohibited by the statute. Because the regulations do not purport to comprehensively describe all lawful or unlawful economic arrangements or other relationships between health care providers and referral sources, hospitals and other health care providers having these arrangements or relationships may not be required to alter them in order to ensure compliance with the Anti-Kickback law. Failure to qualify for a Safe Harbor may, however, subject a particular arrangement or relationship to increased regulatory scrutiny. On September 21, 1993, DHHS published proposed regulations for comment in the Federal Register establishing additional Safe Harbors. As of August 16, 1995,\nsuch additional regulations have not been adopted. The Company cannot predict the final form these regulations will take or their effect, if any, on the Company's business. Since the passage of the Safe Harbors in July 1991, a number of \"Fraud Alerts\" have been distributed by DHHS setting forth certain practices that DHHS considers suspect under the Anti-Kickback Law. Additionally, on July 21, 1995, DHHS published a proposed rule aimed at clarifying the existing Safe Harbors. As of August 16, 1995, such rule has not been adopted. The Company cannot predict the final form such rule will take or its effect, if any, on the Company's business.\nIn August 1993, President Clinton signed the Omnibus Budget Reconciliation Act of 1993, which included certain amendments to Section 1877 of the SSA dealing with \"Physician Ownership of, and Referral to, Healthcare Entities,\" commonly known as the \"Stark Bill.\" The amendments, referred to as \"Stark II,\" significantly broadened the scope of prohibited physician self-referrals contained in the original Stark Bill, now commonly referred to as \"Stark I,\" to include, among others, referrals by physicians to entities with which the physician has a financial relationship and that provide physical and occupational therapy services that are reimbursable by Medicare or Medicaid. Specifically, Stark II expanded the original Stark I anti-referral prohibition from clinical laboratory services to a wide range of Medicare or Medicaid covered services referred to as \"designated services\" including, but not limited to, physical therapy, occupational therapy, radiology services, and inpatient and outpatient hospital services, subject to certain statutory exceptions to such referral prohibition. The type of financial relationships that can trigger the referral prohibition are broad and include ownership or investment interests, as well as compensation arrangements. Penalties for violating the law are severe, including denial of payment for services furnished pursuant to prohibited referrals, civil monetary penalties, and exclusion from the Medicare and Medicaid programs. Stark II prohibits referrals by physicians and also applies to financial relationships between family members of a physician and the entities to which the physician refers.\nStark II became effective on December 31, 1994 and contemplated the promulgation of regulations implementing the new provisions. As of August 16, 1995, no Stark II regulations have been published. In January 1995, the American Hospital Association and eleven other healthcare organizations wrote to the HCFA requesting a moratorium on Stark II sanctions until the date final regulations are promulgated. In January 1995, the HCFA denied such moratorium request while acknowledging the need for further advice and guidance regarding the Stark II statute and distributing a Program Memorandum to intermediaries and carriers setting forth general information and DHHS' enforcement plans for Stark II. Such memorandum stated the HCFA's intention, pending final Stark II regulations, to rely, for enforcement purposes, on the language of the Stark II statute. Additionally, the HCFA set forth its intentions to publish a final rule for comment in early 1995 covering Stark I and its plan to utilize such regulations, once final, in enforcing Stark II in those cases where interpretations of the law in the context of referrals for clinical lab services apply equally to situations involving referrals for designated services in Stark II. On August 14, 1995, Stark I final regulations were published for comment. The Company cannot predict the final form that such Stark I and\/or Stark II regulations will take or the effect that such regulations, and the interpretations thereof, will have on the Company.\nThe Company believes that its business practices and contractual arrangements generally satisfy the Anti-Kickback Law, Stark I, and Stark II requirements and proscriptions. See \"Item 3. Legal Proceedings.\" Both the Anti- Kickback Law and Stark II are broadly drafted, however, and their application is often uncertain. Since the inquiry under both laws is highly factual, it is not possible to predict how they may be applied to certain arrangements between the Company and other health care providers. Although the Company believes that its operations and practices are in compliance with the Anti-Kickback and Stark II laws, there can be no assurance that enforcement authorities will not assert that the Company, or one of its facilities, or certain transactions into which they have entered, has violated or is violating such Anti-Kickback or Stark II law, or that if any such assertions were made, that the Company would prevail, or whether any sanction imposed would have a material adverse effect on the operations of the Company. The Company intends to monitor regulations under, and interpretations of, the Stark II bill to determine whether any modifications to its operations will be necessary as a result of such final regulations or statute interpretations. Even the assertion of a violation of the Anti-Kickback Law, Stark II or similar laws could have a material adverse effect upon the Company.\nIn addition, from time to time, legislation is introduced or regulations are proposed at the federal and state levels that would further affect or restrict relationships and compensation or financial arrangements among health care providers. The Company cannot predict whether any proposed legislation or other legislation or regulations applicable to the Company will be adopted, the final form that any such legislation or regulations might take, or the effect that any such legislation or regulations might have on the Company.\nThe Company is also subject to various antitrust regulations. On September 17, 1994 the Department of Justice (the \"DOJ\") and the Federal Trade Commission (the \"FTC\") issued updated and expanded enforcement Policy Statements that provide insight into how the agencies enforce the antitrust laws with regard to joint ventures, networks and other joint activities in the health care industry. The 1994 Policy Statements provide insight to the DOJ's and FTC's analytical process regarding antitrust issues applicable to the health care industry and provide new guidelines applicable to transactions resulting from changes the health care industry is experiencing as hospitals explore new ways to cooperate with each other to provide quality, cost-effective services.\nOn May 3, 1995 President Clinton announced the creation of \"Operation Restore Trust.\" A joint federal\/state initiative, Operation Restore Trust as initially developed was to apply to nursing homes, home health agencies, and suppliers of medical equipment to these providers in the five states of New York, Florida, California, Illinois and Texas. On June 14, 1995, the Office of Inspector General (\"OIG\") of DHHS announced that the program has been expanded to hospices in those states as well.\nThe program is designed to focus audit and law enforcement efforts on geographic areas and provider types receiving large concentrations of Medicare and Medicaid dollars. According to DHHS statistics, the targeted states account for nearly 40% of all Medicare and Medicaid beneficiaries. Under Operation Restore Trust, the OIG and HCFA, along with the Administration on Aging, intend to undertake a variety of activities to address fraud and abuse by nursing\nhomes and home health providers. These activities will include financial audits, creation of a Fraud and Waste Report Hotline, and increased investigations and enforcement activity.\nOn June 12, 1995 the OIG of DHHS announced implementation of the Voluntary Disclosure Program (the \"VDP\") as part of Operation Restore Trust. Patterned after the disclosure program in place at the Department of Defense, the program is being implemented in pilot form in the five targeted states under Operation Restore Trust. It is intended to provide incentives for specified, qualifying providers and suppliers to come forward and voluntarily disclose instances of corporate wrongdoing affecting the Medicare and Medicaid programs. DHHS intends eventually to expand the program although there is some dispute as to whether the program will prove sufficient to elicit the desired disclosure.\nThe Company believes its operations and practices comply with these illegal remuneration and fraud and abuse provisions. If any of the Company's financial practices failed to comply with the fraud and antiremuneration or fraud and abuse laws, the Company could be materially adversely affected. The Company, however, is unable to predict the effect of future administrative or judicial interpretations of these laws, or whether other legislation or regulations on the federal or state level in any of these areas will be adopted, what form such legislation or regulations may take, or their impact on the Company. There can be no assurance that such laws will ultimately be interpreted in a manner consistent with the Company's practices.\nAs of May 31, 1995, 135 of the Company's long-term care facilities were certified to receive benefits provided under Medicare as skilled nursing facilities. As stated previously, to participate in the Medicare program, a facility must be licensed and certified as a provider of skilled nursing services. In areas where the demand for skilled nursing services is low or where the availability of the requisite registered nursing personnel is limited, the Company has opted not to seek such skilled licensure and certification. As of August 1, 1995, each of the Company's ten licensed specialty hospitals is certified to participate in the Medicare program as acute long-term care hospitals and complies with the certification standards enunciated previously.\nAll states in which the Company operates, other than California, Colorado, Texas, New Mexico and Kansas, have adopted Certificate of Need or similar laws that generally require that a state agency approve certain acquisitions and determine that a need exists prior to the addition of beds or services, the implementation of other changes, or the incurrence of certain capital expenditures. State approvals are generally issued for a specified maximum expenditure and require implementation of the proposal within a specified period of time. Failure to obtain the necessary state approval can result in the inability to provide the service, to operate the facility, to complete the acquisition, addition or other change, and can also result in the imposition of sanctions or adverse action on the facility's license and adverse reimbursement action.\nIn connection with Horizon's acquisition of Greenery in February 1994, the Massachusetts Department of Public Health (the \"Department\") deemed the Company to be neither suitable nor responsible in connection with its initial application to the Department for a license to acquire and operate the Massachusetts facilities then operated by Greenery, due in part to certain of Horizon's\nhistorical certification and decertification experiences in other states. Horizon appealed that determination. To resolve the matter, Horizon entered into an agreement with the Department under which the Department agreed, subject to compliance by Horizon with the terms of the agreement, to issue three successive six-month probationary licenses to Horizon for the acquisition and operation of those facilities and, during the 18-month duration of the agreement, Horizon agreed to commit the management of the patient care at the Massachusetts facilities to a management company owned and operated by a Horizon regional vice president. During the pendency of the agreement, Horizon derives substantially all of the financial benefits from the operation of these facilities. In addition, Horizon agreed not to file any application seeking to acquire or manage any other long-term care or assisted living facility in Massachusetts for the duration of the agreement.\nThe first of the probationary licenses contemplated under the agreement was issued on May 24, 1994 and the second was issued effective as of November 26, 1994. In May 1995, the Company filed its applications for renewal probationary licenses with the Department. In June 1995, the Department determined to issue renewal probationary licenses for four of the Massachusetts facilities and full licensure for three of the Massachusetts facilities. Horizon believes that its relationship with the Department has improved since the Company began operating in Massachusetts in February 1994. There is no assurance that the Company will be able, however, to obtain full licensure for the four Massachusetts facilities that remain subject to the probationary licenses and the agreement. Based in part on these regulatory concerns as well as financial and operational considerations, on June 19, 1995, the Company announced its intention to dispose of these four facilities in connection with the sales of a total of eight long-term care facilities. The sale of all eight facilities is expected to occur during fiscal 1996.\nBoth Houses of Congress have adopted a budget resolution or \"blueprint\" that is intended to control health care costs, improve access to medical services for uninsured individuals and balance the federal budget by the year 2002. At present, no budgetary reconciliation or appropriations have been approved by either House of Congress. However, certain members of Congress have introduced budget reconciliation proposals. These proposals have not yet been reported out of committee. These proposals include reduced rates of growth in the Medicare and Medicaid programs and proposals to block grant funds to the states to administer the Medicaid program. While these proposals do not, at this time, appear to affect the Company adversely, significant changes in reimbursement levels under Medicare or Medicaid and changes in applicable governmental regulations could affect the future results of operations of the Company. There can be no assurance that future legislation, health care or budgetary, will not have an adverse effect on the future results of operations of the Company.\nThe Company's contract rehabilitation therapy, institutional pharmacy and clinical laboratory businesses provide Medicare and Medicaid covered services and supplies to long-term and subacute care facilities and acute long-term care hospitals under arrangements with both facilities and\/or hospitals of the Company and non-affiliated facilities and\/or hospitals. Under these arrangements, the Company's rehabilitation therapy and institutional pharmacy subsidiaries bill and are paid by the facility and\/or hospitals for the services actually rendered\nand the details of billing the Medicare and Medicaid programs are handled directly by the facility and\/or hospitals. As a result, the Company's contract rehabilitation therapy business is not Medicare and Medicaid certified and does not enter into provider agreements with the Medicare and Medicaid programs. However, the Company's institutional pharmacy business is authorized to bill the Medicare program directly for parenteral and enteral services, which encompasses a narrow range of supplies, equipment and nutrients. The institutional pharmacy business is also authorized to bill the Medicaid program directly for prescription services related to Medicaid patients. In addition, the Company's home respiratory therapy, non-invasive medical diagnostic and sleep diagnostic business maintain Medicare and, in certain instances, Medicaid billing numbers and directly bill Medicare and\/or Medicaid for services rendered.\nINSURANCE\nThe Company maintains malpractice and public liability insurance in the amount of $1.8 million per occurrence with umbrella coverage in the amount of $20 million per occurrence. This policy, which is renewable by the carrier at the beginning of each policy period, was most recently renewed on June 1, 1995 for the policy period terminating on June 1, 1996. The Company believes that the insurance coverage that it maintains is adequate and customary in the long-term care industry. There can be no assurance, however, that such insurance will be adequate to cover the Company's liabilities or that the Company will be able to continue its present insurance coverage on satisfactory terms, if at all. To date, the Company has not been subject to a judgment or entered into a settlement agreement with respect to an insured liability claim that required out-of-pocket expenditures by the Company. The Company is self-insured with respect to the health insurance benefits made available to its employees. The Company is also self-insured with respect to its workers' compensation coverage in Nevada, New Mexico, Ohio, Oklahoma, Kansas and Montana. In Texas, the Company is a non-subscriber to the State's workers' compensation pool. The Company believes that it has adequate resources to cover any self-insured claims, and the Company maintains excess liability coverage to protect it against unusual claims in these areas. However, there can be no assurance that the Company will continue to have such resources available to it or that substantial claims will not be made against the Company.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are as follows:\nNeal M. Elliott, the Company's President, Chief Executive Officer and Chairman of the Board, has served in those capacities since July 1986. Mr. Elliott, a certified public accountant, worked for Price Waterhouse & Co. prior to joining The Hillhaven Corporation (\"Hillhaven\") as Controller in 1969. In 1970, Mr. Elliott became Vice President of Finance for Hillhaven and served as such until 1983. From 1983 to 1986, Mr. Elliott served as President of the long-term care group of National Medical Enterprises, Inc., a health care company then affiliated with Hillhaven. Mr. Elliott is a director of LTC Properties, Inc., a real estate investment trust which invests in health care related real estate.\nKlemett L. Belt, Jr., has served as Executive Vice President and a Director of the Company since July 1986. Mr. Belt also served as Chief Financial Officer and Treasurer of the Company from 1986 to September 1994. A certified public accountant, Mr. Belt served five years as an Assistant Regional Audit Director for the Department of Health, Education and Welfare. He was a Senior Manager for KPMG Peat Marwick from 1978 to 1983, when he joined Hillhaven as Vice President of Finance, a position he held from 1983 to July 1986.\nRobert A. Ortenzio has been an Executive Vice President and a Director of the Company since July 1995. He is also President and Chief Operating Officer of CMS, and has served in those capacities since May 1989 and April 1988, respectively. He joined CMS as a Senior Vice President in February 1986. Prior thereto, he was a Vice President of Rehab Hospital Services Corporation. Mr. Ortenzio is also a director of American Oncology Resources, Inc. and OccuSystems, Inc. Mr. Ortenzio is the son of Rocco A. Ortenzio, Vice-Chairman of the Board.\nCharles H. Gonzales, the Company's Senior Vice President -- Subsidiary Operations has served in such position since January 1992. He became a Director of the Company in January 1992. From September 1986 to January 1992,\nMr. Gonzales, a certified public accountant, served as Senior Vice President of Government Programs for the Company. From June 1984 to September 1986, Mr. Gonzales was National Director of Reimbursement for Hillhaven.\nMichael A. Jeffries, the Company's Senior Vice President of Operations, has served the Company in such position since June 1989. He became a Director of the Company in January 1992. Mr. Jeffries has 15 years of experience in the long-term health care industry. From 1984 to 1989, he served as Senior Vice President of Operations for the Central Division of Beverly Enterprises, Inc., an operator of long-term health care facilities. From 1983 to 1984 Mr. Jeffries, a certified public accountant, held the positions of Vice President of Operations and Assistant to the President of Beverly Enterprises, Inc.\nErnest A. Schofield, the Company's Senior Vice President, Treasurer, and Chief Financial Officer, has been with the Company since July 1987. From July 1987 to April 1988, he served as a reimbursement analyst for the Company, from April 1988 to May 1989, he served as Assistant Controller, from May 1989 to November 1990, he served as Vice President and Controller of the Company, and from November 1990 to August 1994 he served as Vice President -- Finance. He assumed his present position in September 1994. Prior to joining the Company, Mr. Schofield, a certified public accountant, held various positions in public accounting with Fox & Company and as a partner with Olivas & Company (certified public accounting firms).\nScot Sauder, the Company's Vice President of Legal Affairs, Secretary and General Counsel, has been with the Company since September 1993. From September 1993 to September 1994, he served as General Counsel to the Company. From September 1994 through July 1995, he served as Secretary and General Counsel to the Company. Prior to joining the Company, Mr. Sauder, an attorney licensed to practice in Texas and certain federal courts, was associated with Palmer & Palmer, P.C., and was a director of Geary, Glast & Middleton, P.C., and Smith & Underwood, P.C. (law firms).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSet forth below is certain information with respect to the Company's facilities at May 31, 1995:\nSee also the information included under the heading \"Facilities\" in Item 1 of Part I of this Annual Report on Form 10-K, which is incorporated by reference herein.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs previously disclosed by CMS, in late fall 1994, CMS learned of the DOJ investigations being handled by the United States Attorney's offices in Harrisburg, Pennsylvania and Sacramento, California. In this connection, representatives of the DOJ visited or contacted operating facilities and office locations of CMS for the purpose of interviewing certain of CMS's employees and reviewing certain documents. CMS has been cooperating in the investigation. The Company's management is not aware, however, of any company-wide practices of the type covered by the DOJ's inquiries or that are not in compliance with the rules and regulations applicable to CMS's operations. The Company cannot predict what effect, if any, these inquiries will have on the Company's business.\nThe Company is a party to litigation arising in the ordinary course of its business. Management does not believe the results of any such litigation, even if the outcome were to be unfavorable, would 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\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\nThe Company's common stock is listed on the New York Stock Exchange (the \"NYSE\") under the symbol \"HHC.\" The following table sets forth, for the periods indicated, the high and low sale price per share for the Company's common stock, as reported on the NYSE Composite Tape.\nThere were approximately 2,620 holders of record of the Company's common stock as of August 10, 1995.\nThe Company has not paid or declared any dividends on its common stock since its inception and anticipates that future earnings will be retained to finance the continuing development of its business. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, the success of the Company's business activities, regulatory and capital requirements, the general financial condition of the Company and general business conditions. The Company's credit facility restricts the payment of dividends. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" included in Item 7 of Part II of this Annual Report on Form 10-K, which is incorporated by reference herein.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected income statement and balance sheet data for the periods ended May 31, 1991 through May 31, 1995 have been derived from the\nCompany's Consolidated Financial Statements. The information set forth below is qualified by reference to and should be read in conjunction with the Consolidated Financial Statements and related notes thereto.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nThe Company adopted a strategic business plan in 1990 to increase its specialty health care services as a percent of operating revenues. The Company has pursued this strategy by acquiring long-term care facilities and integrating its specialty health care services into those facilities, by acquiring providers of specialty health care services, and by offering the Company's broad range of specialty health care services to third parties. As a result, the Company's operating revenues have grown from $105.7 million in fiscal 1990 to $639.1 million in fiscal 1995. Moreover, specialty health care services have grown from $17.4 million, or 16.5% of operating revenues in fiscal 1990 to $284.4 million, or 44.5% of operating revenues in fiscal 1995. The Company now provides a broad range of specialty health care services including subacute care, rehabilitation therapies, Alzheimer's care, institutional pharmacy services, non-invasive medical diagnostic and sleep diagnostic testing services and clinical laboratory services.\nAs previously discussed, the Company acquired CMS on July 10, 1995 by means of a merger of a wholly owned subsidiary of the Company with and into CMS, with CMS being the surviving corporation. Upon consummation of the CMS Merger, CMS became a wholly owned subsidiary of the Company. The CMS Merger will be accounted for as a pooling of interests. Under the terms of the merger agreement, each outstanding share of CMS's common stock was converted into .5397 of one share of the Company's common stock, resulting in the Company issuing approximately 20.9 million shares, valued at approximately $393.9 million based on the closing price of the Company's common stock on July 10, 1995. Approximately 50.3 million shares of the Company's common stock were outstanding following the CMS Merger. Additionally, outstanding options to acquire shares of CMS's common stock were converted into options to acquire approximately 3.8 million shares of the Company's common stock.\nThe Company's strategic business plan emphasizes operating and expanding its long-term care and specialty programs and services in regionally concentrated areas, including the midwest, southwest and northeast regions of the United States. The Company is expanding its specialty health care programs and services through the development of institutional pharmacies, acquisition and development of therapy companies and medical diagnostic companies and the conversion and renovation or acquisition of specialty hospitals. In turn, the acquisition of long-term care facilities in certain geographic areas has enhanced the Company's expansion of its specialty programs. Specifically, in certain geographic areas, the Company's long-term care presence is a platform from which it can vertically integrate its specialty health care programs and services.\nCMS is one of the nation's largest providers of comprehensive inpatient and outpatient medical rehabilitative services. CMS has a significant clinical and market presence in each of the medical rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract rehabilitation therapies. CMS operates 37 freestanding rehabilitation hospitals, provides outpatient rehabilitation services at more than 130 locations and manages 13 inpatient rehabilitation units for general acute care hospitals. These services are provided in 20 states. CMS also provides physician staffing services.\nThe CMS Merger will be accounted for as a pooling of interests and will require the restatement of all historical financial statements to combine the operations of the two companies. On a pro forma basis reflecting the CMS pooling combination and the disposal of the eight facilities previously discussed for the year ended May 31, 1995, total operating revenues would be $1.6 billion or approximately 2.4 times the Company's 1995 total operating revenues.\nThese growth objectives have been, and will continue to be, the basis of a strategic business plan that has resulted in net earnings of $31.2 million, $16.6 million and $7.7 million for the fiscal years ended May 31, 1995, 1994 and 1993, respectively, and $31.0 million for the year ended May 31, 1995, on a pro forma basis giving effect to the CMS Merger and the planned disposition of the eight facilities previously discussed.\nSee Note 13 of Notes to Consolidated Financial Statements included elsewhere herein for further discussion of the CMS Merger, the planned disposition of the eight long-term care facilities and pro forma combined financial information.\nRESULTS OF OPERATIONS\nThe following table sets forth certain statement of earnings data expressed as a percentage of total operating revenues:\nThe following table sets forth a summary of the Company's total operating revenues by type of service and the percentage of total operating revenues that each such service represented for each period indicated:\nThe following table sets forth the number of facilities operated by the Company at the end of each period indicated, the aggregate number of licensed beds contained in such facilities and average occupancy of such beds during the periods indicated:\nYEAR ENDED MAY 31, 1995 COMPARED TO YEAR ENDED MAY 31, 1994\nTotal operating revenues increased approximately $264.0 million or 70.4% for fiscal 1995 as compared with fiscal 1994. The majority of such increase is the result of the Company's expansion, both internally and through acquisition, since May 31, 1994. Greenery, which was acquired in February 1994, contributed $130.7 million of operating revenues in fiscal 1995 as compared to $46.2 million contributed during the three and one-half months Greenery was owned by the\nCompany in fiscal 1994. peopleCARE, which was acquired in July 1994, contributed $78.3 million of operating revenues in fiscal 1995. The Company added the operations of 13 long-term care facilities in such transaction. During fiscal 1995, the Company also completed other acquisitions resulting in the addition of approximately 4,000 long-term care beds, a skilled nursing center, two rehabilitation providers, two sleep diagnostic clinics, two home respiratory providers, and two medical diagnostic services companies. The Company also entered into managment contracts involving approximately 1,020 long-term care beds. An additional cause of the increase in revenues is increases in Medicare, Medicaid and private pay rates and increased utilization of higher margin specialty health care services. Revenues attributable to specialty health care services as a percentage of total operating revenues increased to 45% in fiscal 1995 from 38% in fiscal 1994. The average increase in rates per patient day across all pay types was approximately 8.8%. The increase in operating revenues attributable to such rate increases was approximately $37.2 million. The average occupancy of the Company's facilities remained essentially flat at 88% and as a consequence had little or no effect on operating revenues.\nRoutine expenses increased approximately $202.6 million or 67.3% in fiscal 1995 from $301.2 million in fiscal 1994. This increase is due primarily to the increase in the number of long-term care facilities, specialty hospitals and subacute care units operated by the Company, as well as the costs associated with the expansion of specialty health care services and programs.\nFacility lease expense, depreciation and amortization and other property expense increased approximately 60.5% for the same period. This increase is directly related to the increased number of facilities operated.\nInterest expense nearly tripled during this period. This increase is due primarily to the following factors: (i) an increase in the Company's average investment in owned facilities due in large part to the Greenery merger late in fiscal 1994 and the peopleCARE acquisition early in fiscal 1995, (ii) capital lease interest associated with the six peopleCARE leased facilities, (iii) assumption of $54.8 million of Greenery bonds late in fiscal 1994 and (iv) increased borrowings under the Company's then existing credit facility in connection with other facility acquisitions during fiscal 1995.\nAs a result of the foregoing factors, net earnings increased to $31.2 million or $1.16 per share for the year ended May 31, 1995. This compares to net earnings of $16.6 million or $.91 per share for fiscal 1994.\nYEAR ENDED MAY 31, 1994 COMPARED TO YEAR ENDED MAY 31, 1993\nTotal operating revenues increased approximately $142.9 million or 61.5% for fiscal 1994 as compared with fiscal 1993. The largest portion of such increase is the result of the Company's expansion, both internally and through acquisition, since May 31, 1993. Greenery, which was acquired in February 1994, contributed $46.2 million of operating revenues in fiscal 1994. At May 31, 1994 (without giving effect to the Greenery merger), the Company operated three more long-term care facilities, three more specialty hospitals and three more subacute care units than it did at May 31, 1993. As a result of the consummation of the Greenery merger in February 1994, the Company added the operations of 17 rehabilitation and skilled nursing facilities and three managed facilities.\nDuring fiscal 1994, the Company also expanded its institutional pharmacy services, its rehabilitation services in Ohio, Nevada and Texas, and its clinical laboratory services in Texas. An additional cause of the increase in revenues is increases in Medicare, Medicaid and private pay rates and increased utilization of higher margin specialty health care services. Revenues attributable to specialty health care services as a percentage of total operating revenues increased to 38% in fiscal 1994 from 27% in fiscal 1993. The average increase in rates per patient day across all pay types was approximately 9.7%. The increase in operating revenues attributable to such rate increases was approximately $18.8 million. The average occupancy of the Company's facilities remained essentially flat at 89%.\nRoutine expenses increased approximately $113.7 million or 60.6% in fiscal 1994 from $187.6 million in fiscal 1993. This increase is due primarily to the increase in the number of long-term care facilities, specialty hospitals and subacute care units operated by the Company, as well as the costs associated with the expansion of specialty health care services and programs. Greenery accounted for $37.9 million of such increase.\nFacility lease expense, depreciation and amortization and other property expense increased approximately 42.7% for the same period. This increase is directly related to the increased number of facilities operated. Of the total increase, Greenery accounted for approximately 20%.\nInterest expense increased approximately 46.8% during this period. This increase is related to draws under the Company's then-existing credit facility, and assumption of certain bonds and secured real property indebtedness in connection with facility acquisitions during fiscal 1994. Of the total increase, interest expense related to Greenery accounted for approximately 10%.\nAs a result of the foregoing factors, net earnings increased to $16.6 million or $.91 per share for the year ended May 31, 1994. This compares to net earnings of $7.7 million or $.62 per share for fiscal 1993. The Greenery merger, which was accounted for as a purchase, had no significant effect on the Company's results of operations for the year ended May 31, 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nOPERATIONS. At May 31, 1995, the Company's working capital was $153.0 million and included cash and cash equivalents of $20.4 million as compared with $65.1 million in working capital and $6.5 million in cash and cash equivalents at May 31, 1994. During the two years ended May 31, 1995 and 1994, the Company's operating activities used $27.7 million and $21.7 million of net cash, respectively, primarily as a result of increases in patient care and estimated Medicare and Medicaid settlements accounts receivable in each period. Patient care accounts receivable, net of allowances for doubtful accounts, increased $42.8 and $46.2 million during the fiscal years ended May 31, 1995 and 1994, respectively. Of the 1995 amount, $5.8 million was generated by the acquisition of peopleCARE. Of the 1994 amount, $16.2 million was acquired in the Greenery merger.\nEXPANSION PROGRAM. The net cash used by the Company's investing activities increased from $47.4 million in fiscal 1993 to $49.5 million in fiscal 1994 and\nto $138.4 million in fiscal 1995. The primary uses of cash from investing activities have been capital expenditures including, specifically, in fiscal 1994, the Greenery merger, and in fiscal 1995, the peopleCARE acquisition and other acquisitions. Capital expenditures were $53.4 million in fiscal 1993, $40.6 million in fiscal 1994, and $38.0 million in fiscal 1995. The principal purpose of the capital expenditures during each of these periods has been to fund the Company's internal and external expansion program. While capital expenditures during the three years ended May 31, 1995 aggregated $132.0 million, only $18.4 million was expended for maintenance of existing facilities. In addition, the Greenery merger consumed $7.8 million in cash in fiscal 1994. In fiscal 1995, the peopleCARE acquisition consumed $61.3 million in cash and other individually insignificant acquisitions consumed $37.1 million in cash.\nThe Company's expansion program requires funds: (i) to acquire assets and to expand and improve existing and newly acquired facilities; (ii) to discharge funded indebtedness assumed or otherwise acquired in connection with the acquisitions of facilities and properties; and (iii) to finance the increase in patient care and other accounts receivable resulting from acquisitions. The funds necessary to meet these requirements have been provided principally by the Company's financing activities and, to a lesser extent, from the sale of marketable securities and the sale of land, buildings and equipment. During the three years ended May 31, 1995, proceeds from the issuance of Company debt, net of debt repayments and repurchases, amounted to $91.2 million. In addition, the proceeds from the issuance of Common Stock totaled $184.0 million.\nSOURCES. At May 31, 1995, the available credit under the Company's then- existing credit facility was $133.4 million. To the extent that the Company's operations and expansion program require cash expenditures in excess of the amounts available to it under the Credit Facility (as defined below), management of the Company believes that the Company can obtain the necessary funds through other financing activities, including the issuance and sale of debt and equity securities in public and private markets. In addition, the Company anticipates that the previously discussed disposal of eight facilities will result in net cash proceeds of approximately $9.6 million.\nCREDIT FACILITY\nThe Company is the Borrower under a Credit Agreement dated July 6, 1995 (the \"Credit Facility\") with NationsBank of Texas, N.A., as Agent, and the lenders party thereto. The aggregate revolving credit commitment under the Credit Facility is $250 million, of which the Company had borrowed $105.1 million at July 31, 1995. Borrowings under the Credit Facility bear interest, payable monthly, at a rate equal to either, as selected by the Company, the Alternate Base Rate (as therein defined) of the Agent in effect from time to time, or the Adjusted London Inter-Bank Offer Rate plus 0.625% to 1.25% per annum, depending on the maintenance of specified financial ratios. The applicable interest rate at July 31, 1995 was 8.75% and 6.875% on the Alternate Base Rate and Adjusted London InterBank Offer Rate advances, respectively. In addition, borrowings thereunder mature in June 2000 and are secured by a pledge of the capital stock of all subsidiaries of the Company, other than subsidiaries of CMS. Under the terms of the Credit Facility, the Company is required to maintain certain financial ratios and is restricted in the payment of dividends to an amount which shall not exceed 25% of the Company's net income for the prior fiscal year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of Horizon\/CMS Healthcare Corporation:\nWe have audited the accompanying consolidated balance sheets of Horizon\/ CMS Healthcare Corporation (formerly, Horizon Healthcare Corporation) (a Delaware corporation) and subsidiaries as of May 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 May 31, 1995. These financial statements and 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 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 Horizon\/CMS Healthcare Corporation and subsidiaries as of May 31, 1995 and 1994, and the results of their operations and their cash flows for the three years in the period ended May 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 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\nAlbuquerque, New Mexico July 21, 1995\nHORIZON\/CMS HEALTHCARE CORPORATION CONSOLIDATED BALANCE SHEETS MAY 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these balance sheets.\nHORIZON\/CMS HEALTHCARE CORPORATION CONSOLIDATED BALANCE SHEETS (CONTINUED) MAY 31, 1995 AND 1994\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these balance sheets.\nHORIZON\/CMS HEALTHCARE CORPORATION\nCONSOLIDATED STATEMENTS OF EARNINGS\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these statements.\nHORIZON\/CMS HEALTHCARE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nHORIZON\/CMS HEALTHCARE CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF BUSINESS\nHorizon\/CMS Healthcare Corporation (formerly, Horizon Healthcare Corporation) and its subsidiaries (collectively, the Company) is a leading provider of long-term care and specialty health care services. The Company's long-term care facilities provide skilled nursing care and basic patient services with respect to daily living and general medical needs. The Company also provides specialty health care services to its long-term care facilities and outside parties. Such specialty health care services include licensed specialty hospital services and subacute units, rehabilitation and other therapies, institutional pharmacy services, Alzheimer's care, non-invasive medical diagnostic testing services, home respiratory care services and clinical laboratory services. Substantially all of these services are within the long-term care market and, accordingly, the Company operates within a single industry segment.\nSubsequent to year end, in connection with the merger of a wholly owned subsidiary of the Company with Continental Medical Systems, Inc. (CMS), the Company changed its name to Horizon\/CMS Healthcare Corporation (Note 13).\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nNET PATIENT CARE REVENUES\nNet patient care revenues are recorded at established billing rates or at the amount realizable under agreements with third-party payors, primarily Medicaid and Medicare. Revenues under third-party payor agreements in certain states are subject to examination and retroactive adjustments, and amounts realizable may change due to periodic changes in the regulatory environment. Provisions for estimated third-party payor settlements are provided in the period the related services are rendered. Differences between the amounts accrued and subsequent settlements are recorded in operations in the year of settlement.\nA significant portion of the Company's revenue is derived from patients under the Medicaid and Medicare programs. There have been and the Company expects that there will continue to be a number of proposals to limit Medicare and Medicaid reimbursement for long-term and rehabilitative care services. The Company cannot predict at this time whether any of these proposals will be adopted or, if adopted and implemented, what effect such proposals would have on the Company.\nCASH EQUIVALENTS\nFor purposes of the accompanying consolidated statements of cash flows, the Company considers its highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) DEPRECIATION\nBuildings and equipment are depreciated using the straight-line method over the estimated useful lives of the assets (buildings -- 40 years; equipment -- 3 to 10 years). Maintenance and repairs are charged to expense as incurred. Major renewals or improvements are capitalized.\nLEASE PURCHASE COSTS\nLease purchase costs represent amounts paid by the Company to obtain lease rights to long-term care facilities and are amortized over the initial and renewal terms of the leases expected to be renewed.\nGOODWILL\nGoodwill has resulted from various acquisitions made by the Company. All acquisitions were accounted for as purchases and the excess of the total acquisition cost over the fair value of the net assets acquired was recorded as goodwill. Goodwill is amortized on the straight-line basis over 40 years.\nThe Company maintains separate financial records for each of its acquired entities and performs periodic strategic and long-range planning for each entity. The Company evaluates its goodwill quarterly to determine potential impairment by comparing the carrying value to the undiscounted future cash flows of the related assets. The Company modifies the life or adjusts the value of its goodwill if any impairment is identified.\nOTHER INTANGIBLE ASSETS\nCosts incurred in obtaining long-term financing are amortized over the term of the related indebtedness using the effective interest method. Costs to initiate and implement therapy operations and new nursing or specialty units are amortized on a straight-line basis for periods up to five years.\nDEFERRED LEASE CREDIT\nThe deferred lease credit represents obligations for above market rate lease terms on operating leases recorded under purchase accounting. This credit is amortized over the terms of the related leases to yield level lease payments, net of discount accretion. In the event such facilities are converted from operating lease to ownership status, the related remaining deferred lease credit, if any, is eliminated in the recording of the related facility purchase.\nINCOME TAXES\nThe Company and certain of its subsidiaries file a consolidated Federal income tax return. On June 1, 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 Opinion No. 11) to an asset and liability approach. Previously, the Company deferred the past tax effects of\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) temporary 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 assets and liabilities.\nMARKET VALUE DISCLOSURES\nThe market value of all financial instruments approximates their carrying value unless indicated otherwise in the applicable notes to the consolidated financial statements.\nWORKERS' COMPENSATION\nWorkers' compensation coverage is effected through deductible insurance policies and qualified self insurance plans which vary by the states in which the Company operates. Provisions for estimated settlements are provided in the period of the related coverage and are determined on a case by case basis plus some amount for incurred but not reported claims. Differences between the amounts accrued and subsequent settlements are recorded in operations in the period of settlement.\nEARNINGS PER SHARE\nEarnings per share is calculated based upon the weighted-average number of common shares and common equivalent shares outstanding during each period. Common equivalent shares include stock purchase warrants and options. Earnings per common and common equivalent share is based upon 27,016,565 shares in 1995, 16,751,078 shares in 1994, and 11,711,911 shares in 1993. Earnings per common share-assuming full dilution is based upon 27,023,971 shares in 1995, 19,724,461 shares in 1994 and 16,275,875 shares in 1993, including the effect of the convertible subordinated notes.\nRECLASSIFICATIONS\nCertain amounts in the prior years' financial statements have been reclassified to conform to the 1995 presentation.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(2) NOTES RECEIVABLE Notes receivable consists of the following:\n(3) LAND, BUILDINGS AND EQUIPMENT Land, buildings and equipment owned and held under capital lease is stated at cost and consists of the following:\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(4) LONG-TERM DEBT Long-term debt consists of the following:\nOn March 16, 1995, the Company completed a $250,000 revolving credit loan agreement which replaced the revolving loan agreement outstanding at May 31, 1994. This credit agreement bears interest at either the Adjusted Corporate Base Rate plus up to .25% (9.0% at May 31, 1995) or at the Adjusted LIBOR rate plus 0.5 to 1.25% (7.0 to 7.0625% at May 31, 1995). The average interest rate on amounts outstanding under the credit agreement was 7.68% at May 31, 1995. The credit agreement: (a) requires the Company to maintain certain financial ratios, (b) restricts the Company's ability to enter into capital leases beyond certain specified amounts, (c) prohibits transactions with affiliates not at arm's length, (d) allows the Company to make only permitted investments, (e) restricts certain indebtedness, liens, dispositions of property and issuances of securities and (f) prohibits a change in control or a fundamental change in the business of the Company except under certain limited circumstances. The credit facility also restricts the payment of dividends by the Company to an amount which shall not exceed 25% of the Company's net income for the prior fiscal year, and any such payment is subject to continued compliance by the Company with the financial ratio covenants contained in the credit agreement. The credit agreement further provides that any event or occurrence that would have a material adverse effect on the Company's ability to repay the loans or to perform its obligations under the loan documents will constitute an event of default under the credit agreement. Certain subsidiaries of the Company have guaranteed the obligations of the Company under the credit agreement. The credit agreement expires on March 31, 1998 and is secured by a pledge of the stock of all subsidiaries of the Company and certain accounts receivable of the Company. The amount of such accounts receivable collateral was approximately $102.2 million at May 31, 1995.\nIn July 1995, in connection with the merger with CMS, the Company and CMS entered into a new facility that increased the amount available for borrowing to $485,000. The aggregate principal amount is divided between the Company and CMS in the amounts of $250,000 and $235,000, respectively. The terms\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) of the new facility are substantially consistent with those of the old facility except that accounts receivable are no longer required as collateral and the interest component has been revised. Under the new facility, interest is computed at a rate equal to either, as selected by the Company, the Alternate Base Rate or the Adjusted LIBOR Rate plus 0.625% to 1.25% per annum, depending on the maintenance of specified financial ratios. The Alternate Base Rate is equal to the greater of the prime rate or the federal funds effective rate plus .5%. The agreement expires in June 2000.\nThe approximate aggregate maturities of long-term debt are as follows:\n(5) CONVERTIBLE SUBORDINATED NOTES On February 14, 1992, the Company issued $57,500 of 6.75% convertible subordinated notes (the Notes) due February 1, 2002. The Notes were convertible at any time prior to maturity into shares of common stock of the Company at a conversion price of $12.00 per share, subject to adjustment in certain events. Interest on the Notes was payable semi-annually on each February 1 and August 1, commencing August 1, 1992. During the year ended May 31, 1992, the Company redeemed $3,230 of Notes at approximately 80% of par value, resulting in a gain of $475, net of allocable deferred financing costs of approximately $140. During the third quarter of 1994, the remaining $54,270 of Notes were converted into the Company's common stock at the conversion price stated above. In connection therewith, approximately $1,900 of deferred financing costs and $500 of conversion costs were offset against additional paid-in capital at the time of conversion.\nIn connection with the merger of Greenery Rehabilitation Group, Inc. (Greenery) into the Company (discussed in Note 7), the Company assumed the obligations under Greenery's 6.5% convertible subordinated notes and 8.75% convertible senior subordinated notes, par value of $26,631 and $28,150, respectively, at February 11, 1994. These obligations were recorded at their fair market value under purchase accounting, resulting in a discount on the 6.5% convertible subordinated notes of $2,663.\nThe 6.5% convertible subordinated notes are due June 2011 and are convertible into common stock of the Company at a price of $69.32 per share. These\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(5) CONVERTIBLE SUBORDINATED NOTES (CONTINUED) notes may be redeemed in whole or in part at 103.25% of par, plus accrued interest, declining annually to par on June 15, 1996. Commencing June 15, 1996, the Company is obligated to retire 5% of the issue amount annually to maturity.\nThe 8.75% convertible senior subordinated notes are due 2015 and are convertible into common stock of the Company at a price of $54.00 per share. The Company may redeem the notes, in whole or in part at 106.125% of par, plus accrued interest, declining annually to par on April 1, 2000. Commencing April 1, 2000, the Company is required to retire 5% of the original issue amount annually to maturity. The notes are senior to the 6.5% debentures, but will be subordinated to any future senior indebtedness.\nDuring the fourth quarter of fiscal 1994, the Company redeemed $15,520 of the 6.5% convertible subordinated notes and $7,244 of the 8.75% convertible senior subordinated notes. The Company recorded a gain of approximately $734, net of the write-off of $1,552 debt discount recorded under purchase accounting and income taxes of approximately $480.\nDuring 1995, the Company repurchased $4,800 of the 6.5% convertible subordinated notes and $506 of the 8.75% convertible senior subordinated notes. The Company recorded a gain of approximately $613, net of the write-off of $480 debt discount recorded under purchase accounting and income taxes of approximately $401.\nThe market value of the outstanding convertible subordinated notes at May 31, 1995 and 1994 was approximately $23,344 and $27,500, respectively. The market value is a function of both the conversion feature and the underlying debt instrument. It is impracticable to allocate the market value between these two components, however, the market value is not representative of the amounts that would be currently required to retire the debt obligation.\n(6) LEASE COMMITMENTS In connection with the acquisition of peopleCARE Heritage Group (peopleCARE) discussed in Note 7, the Company entered into a capital lease for six facilities. The lease expires October 2003. At May 31, 1995, the amount of land, buildings and equipment and related accumulated amortization recorded under this capital lease was as follows:\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(6) LEASE COMMITMENTS (CONTINUED) Amortization of assets held under this capital lease is included in depreciation and amortization expense. The present value of future minimum capital lease payments as of May 31, 1995 is as follows:\nThe Company also has noncancelable operating leases primarily for facilities and equipment. Certain leases provide for purchase and renewal options of 5 to 15 years, contingent rentals primarily based on operating revenues, and the escalation of lease payments coincident with increases in certain economic indexes. Contingent rent expense for the years ended May 31, 1995, 1994 and 1993 was approximately $1,433, $1,060 and $680, respectively.\nFuture minimum payments under noncancelable operating leases are as follows:\nThe Company is contingently liable for annual lease payments of approximately $2,570 for leases on facilities sold. In addition, the Company is contingently liable for annual lease payments of $6,200 for leases on managed facilities.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(6) LEASE COMMITMENTS (CONTINUED) The Company leases seven facilities from an affiliate of two directors of the Company. During fiscal 1995 a previously leased facility was purchased by the Company. The aggregate lease expense for these facilities for the years ended May 31, 1995, 1994 and 1993 was approximately $15,900, $5,501, and $903, respectively. Future minimum lease commitments related to these facilities are as follows:\nIn addition, the Company leases its corporate office space from certain officers and directors. The lease is classified as an operating lease and provides for minimum annual rents of $535. The lease expires on July 31, 2001.\n(7) FACILITY ACQUISITIONS During 1994 and 1995, the Company implemented its strategic business plan by leasing or acquiring long-term care facilities and related specialty services businesses in targeted geographic areas. The acquisitions have been recorded using the purchase method of accounting. The results of operations of the acquired companies are included in the Company's statements of earnings for the periods in which they were owned by the Company.\nIn February 1994, the Company completed its merger of Greenery into the Company. Pursuant to the merger, the Company issued approximately 2,050,000 shares of its common stock, valued at approximately $48,000, and assumed approximately $58,000 in debt for all of the outstanding shares of Greenery common stock. This merger added the operations of 17 rehabilitation and skilled nursing facilities and 3 managed facilities to the Company's operations. Subsequent to fiscal year end, on June 19, 1995, the Company announced plans to dispose of eight long-term care facilities. Six of the facilities to be disposed of were among the 17 acquired in the Greenery merger during fiscal 1994. The decision to sell the facilities was based upon financial, regulatory and operational considerations.\nThe Company had other acquisitions during fiscal 1994 that in the aggregate were insignificant.\nIn July 1994, the Company acquired peopleCARE, a 13 facility long-term care company located in Texas. Consideration given for the acquisition included\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(7) FACILITY ACQUISITIONS (CONTINUED) the issuance of approximately 449,000 shares of the Company's common stock, valued at approximately $10,000, assumption of capital lease obligations of approximately $48,600 for six facilities, and cash payment of approximately $56,000 for fee simple title to seven facilities. In addition, the Company had other individually insignificant acquisitions during fiscal 1995.\nThe following unaudited pro forma financial information reflects the combined results of operations for the years ended May 31, 1995 and 1994 as if the Greenery, peopleCARE and certain other individually insignificant acquisitions during fiscal 1995 and 1994 had been consummated on June 1, 1993:\nThe unaudited pro forma information is not necessarily indicative either of the results of operations that would have occurred had the acquisitions taken place at the beginning of fiscal 1994 or of future results of operations of the combined companies.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(8) INCOME TAXES On June 1, 1993, the Company adopted FAS109 through retroactive restatement of its financial statements from June 1, 1990. The restatement decreased 1993 net earnings by $67. FAS 109 requires an asset and liability approach for financial accounting and reporting of income taxes.\nThe provision for income taxes consists of the following:\nThe differences between the total tax expense from operations and the income tax expense using the Federal income tax rate (35 percent) were as follows:\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(8) INCOME TAXES (CONTINUED) The components of the net deferred tax assets and liabilities are as follows:\nAs the result of business combinations during the years ended May 31, 1995 and 1994, net deferred income tax assets of $4,238 and $14,724, respectively, and related valuation allowances of $0 and $3,051, respectively, were recorded.\nThe Company has regular tax net operating loss carry forwards of approximately $7,466 which are currently subject to separate return year limitations and expire in the years 2007 through 2008. In addition, the Company also has an alternative minimum tax credit carryforward of $205 which is available for utilization indefinitely.\n(9) CAPITAL STOCK\nCOMMON STOCK\nIn October 1993, the Company completed a common stock offering of 4,025,000 shares. Net proceeds of approximately $58,200 were used to repay outstanding debt under the revolving credit loan agreement and to fund acquisitions.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(9) CAPITAL STOCK (CONTINUED) As discussed in Note 5, the Company converted $54,270 of its 6.75% convertible subordinated notes into 4,522,500 shares of the Company's common stock during the third quarter of 1994 . The conversion price was $12 per share.\nAs discussed in Note 7, the Company issued 2,050,000 new shares of common stock during February 1994 in connection with the Greenery merger.\nIn addition, the Company acquired Advanced Cardiovascular Technology, Inc. (ACT), a non-invasive medical diagnostic company, in April 1994. In connection with this acquisition, the Company issued 163,976 new shares of common stock at $25 per share. The terms of the acquisition provide for the issuance of up to 204,985 additional shares of common stock if certain earning levels are achieved by March 31, 1997. Of these contingent shares, 160,000 were issued into escrow at closing and remained in escrow at May 31, 1995. This contingent consideration has not been recorded as of May 31, 1995.\nIn November and December 1994, the Company completed the sale of 5,558,790 shares of its common stock, including the sale of 643,333 shares held by certain stockholders. Net proceeds of approximately $119,600 were used to repay outstanding debt under the revolving credit loan agreement and to fund acquisitions.\nFinally, during 1995 the Company issued 1,776,924 shares of common stock in connection with certain acquisitions.\nPREFERRED STOCK\nThere are 500,000 shares of authorized but unissued shares of $.001 preferred stock. On September 12, 1994, the Board of Directors of the Company declared a dividend of one preferred share purchase right (a \"Right\") for each outstanding share of the Company's common stock held of record on September 22, 1994 and approved the further issuance of Rights with respect to all shares of the Company's common stock that are subsequently issued. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $.001 per share of the Company, at a price of $110 per one one-thousandth of a share, subject to adjustment. Until the occurrence of certain events, the Rights are not exercisable, will be evidenced by the certificates for the Company's common stock and will not be transferable apart from the Company's common stock.\nSTOCK PURCHASE WARRANTS\nThe Company had 100,000 stock purchase warrants outstanding at May 31, 1995 for the purchase of common shares. These warrants, priced at $2.50, were exercised subsequent to year end.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(9) CAPITAL STOCK (CONTINUED) STOCK BENEFIT PLANS\nThe Company has a nonqualified employee stock option plan and a directors' stock option plan that provide the Company the ability to grant to employees and outside directors the option to purchase shares of common stock of the Company at the market value of the stock at the option grant date. Accordingly, no compensation is recorded in the accompanying consolidated financial statements for the options granted.\nAll options granted under the employee plan and directors' plan expire ten years after grant, are non-transferable and are exercisable only during or immediately following the period the individual is employed by the Company or is a current member of the Board of Directors, subject to certain exceptions for death or disability. One-third of each option is exercisable on each of the first, second and third anniversary dates following the date of grant.\nThe following information is a summary of the stock option activity under the employee and directors' plans:\nThe Company also has an employee stock purchase plan (Plan). The Plan allows substantially all full-time employees to contribute up to five percent of their compensation for the purchase of the Company's common stock at 85 percent of market value at the date of purchase. For the year ended May 31, 1995, 16,352 shares of the Company's stock had been purchased under the Plan.\nIn addition and in connection with the Greenery merger, the Company issued to one of the Company's directors a five year option to purchase 125,000 shares of the Company's common stock at $17 per share. This option was exercised during 1995 and the shares, along with approximately 50,000 shares of additional common stock, were converted to treasury stock in consideration for reduction of amounts due to the Company under the terms of a note receivable.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(9) CAPITAL STOCK (CONTINUED) The total number of shares allocated, granted and outstanding pursuant to the Company's employee and directors' stock option plans and employee stock purchase plan together with other shares issued or allocated for issuance to employees and directors pursuant to option, incentive or similar plans, may not exceed 10 percent of the total number of shares authorized for issuance at the time of the allocation or grant.\n(10) EMPLOYEE BENEFITS In 1993, the Company established a deferred compensation plan for selected employees that work full-time and have been employed by the Company for more than one year. This plan, which is not required to be funded by the Company, allows eligible employees to defer portions of their current compensation up to 10%. The Company then matches up to 4% of the employee's deferred compensation. Employee contributions are vested immediately. Employer contributions vest on a graduated basis, with full vesting achieved at the end of six years. The Company contributed approximately $179, $124 and $39 to this plan for the years ended May 31, 1995, 1994 and 1993, respectively.\nThe Company also has a 401(k) savings plan available to substantially all employees who have been with the Company for more than six months. Employees may defer up to 20% of their salary, subject to the maximum permitted by law. The Company may, at its discretion, match a portion of the employee's contribution. Employee contributions are vested immediately. Employer contributions vest on a graduated basis, with full vesting achieved at the end of five years. The Company contributed approximately $306, $136 and $15 to this plan for the years ended May 31, 1995, 1994 and 1993, respectively.\nIn addition, the Company also has a profit-sharing plan to which it may make contributions at its discretion. The Company has not made any contributions to this plan. The Company may terminate any of the above plans at any time.\n(11) SUPPLEMENTARY INFORMATION RELATING TO CONSOLIDATED STATEMENTS OF CASH FLOWS For the purposes of the consolidated statements of cash flows, the following are considered non-cash items:\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(11) SUPPLEMENTARY INFORMATION RELATING TO CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nCash paid for interest for the years ended May 31, 1995, 1994 and 1993 was approximately $16,867, $5,650 and $4,387, respectively.\nCash paid for income taxes for the years ended May 31, 1995, 1994 and 1993 was approximately $17,562, $7,893 and $4,187, respectively.\n(12) COMMITMENTS\nLETTERS OF CREDIT\nThe Company was contingently liable for letters of credit aggregating $11,810 and $8,551 at May 31, 1995 and 1994, respectively. The letters of credit, which reduce the availability under the credit agreement, were used in lieu of lease deposits for facilities operated by the Company and for deposits under various workers' compensation programs.\nEMPLOYMENT AND CONSULTING AGREEMENTS\nUnder annual employment agreements with two of the officers\/stockholders, the Company is committed to pay minimum annual salaries totaling $775, subject to certain covenants. In addition, the employment agreements provide for annual retirement benefits and disability benefits equal to a maximum of 50 percent of each officer's base salary. The retirement benefits vest in equivalent increments over 10 years and the disability benefits terminate upon retirement or age 65. Further, an annual death benefit is payable to the surviving spouse or minor children equal to one-half of the vested retirement benefit at the time of the officer's death. Amounts recorded for the annual retirement and disability benefits have been included in other accrued liabilities in the accompanying consolidated financial statements.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(12) COMMITMENTS (CONTINUED) In addition and in connection with the Greenery merger, the Company has entered into a seven year consulting agreement with one of the Company's directors for which the Company has agreed to pay annual consulting fees of $175.\nLIFE INSURANCE PREMIUMS\nIn fiscal 1994, the Company agreed to fund life insurance premiums for two of its officers. As of May 31, 1995, such advances totaled approximately $1,162 and are reflected in other assets in the accompanying consolidated financial statements. These advances will be repaid to the Company by the officers' estates upon the earlier of cancellation of the policies or death of the officers.\nMANAGEMENT AGREEMENT\nIn connection with the Greenery merger, the Company has committed to manage three Connecticut facilities for an affiliate of two directors of the Company. The Company is committed to manage these facilities for up to five years, subject to the affiliate's right to terminate sooner at any time with 90 days notice.\nPURCHASE COMMITMENTS\nUnder the terms of one of the Company's facility lease agreements, the Company has the option to purchase the facility and the lessor has the option to require the Company to purchase the facility should the Company fail to exercise the purchase option for $5,500 at the end of the lease term (August 1, 1998).\nThe Company has purchased usage of a Cessna\/Citation III aircraft from AMI Aviation II, L.L.C., a Delaware limited liability company (\"AMI II\"). The Company's chief executive officer owns 99% of the membership interests of AMI II. Under the aircraft usage agreement, the Company will purchase a minimum of 20 hours usage per month for $45 per month for a five year period, and will pay certain amounts per hour for usage over 20 hours in a month plus a monthly maintenance reserve. The Company believes that the amounts payable under this agreement are comparable to those it would pay to other third party vendors of similar aircraft services.\n(13) SUBSEQUENT EVENTS\nCONTINENTAL MEDICAL MERGER\nOn July 6, 1995, the stockholders of the Company and CMS approved the merger of one of the Company's wholly-owned subsidiaries with CMS. Under the terms of the merger agreement, CMS stockholders received .5397 (\"The Exchange Rate\") of a share of the Company's common stock for each outstanding share of CMS's common stock. Accordingly, the Company issued approximately 20.9 million shares of its' common stock, valued at approximately $393.9 million based on the closing price of the Company's common stock on July 10, 1995, for all the outstanding shares of CMS's common stock. Additionally, outstanding\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(13) SUBSEQUENT EVENTS (CONTINUED) options to acquire CMS's common stock were converted at the Exchange Rate to options to acquire 3.8 million shares of the Company's common stock. CMS is one of the largest providers of comprehensive medical rehabilitation programs and services in the country with a significant presence in each of the rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract therapy. The merger qualifies as a tax-free reorganization and will be accounted for as a pooling of interests. Accordingly, historical financial data in future reports will be restated to include CMS. Supplemental unaudited pro forma data summarizing the combined results of operations of the Company and CMS as though the merger had occurred at the beginning of fiscal 1993 is as follows:\nThe above unaudited pro forma earnings statement information includes CMS information for the twelve months ended June 30, 1995, 1994 and 1993.\nRESTRUCTURING\nOn June 19, 1995, the Company announced that it plans to sell the assets and leasehold improvements at eight of its facilities. The Company anticipates that the intended dispositions will occur during fiscal 1996. The Company expects that it will record a $11,900 pre-tax charge during the first quarter of fiscal 1996 related to the disposal of the eight facilities. Among management's financial, regulatory and operational considerations in electing to dispose of these facilities was the fact that permanent licensure had not been obtained by the Company with respect to four of the facilities. Through these eight facilities, the Company provides services for neuro-behaviorally impaired patients, long-term chronic ventilator care patients, personal care patients and patients with mild mental disorders. These services are deemed by management of the Company to be inconsistent with the Company's emphasis on long-term rehabilitation services and its concentration on high acuity patient services.\nThe properties that are the subject of the planned dispositions, in the aggregate, incurred pre-tax net losses in fiscal years 1995, 1994 and 1993 of approximately $11,300, $1,200 and $0, respectively. Revenues for fiscal years 1995, 1994 and 1993 approximated $71,900, $29,200 and $5,300, respectively.\nHORIZON\/CMS HEALTHCARE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(14) QUARTERLY FINANCIAL DATA (UNAUDITED) The Company's unaudited quarterly financial information follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nFor information concerning 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:\nSee Index to Consolidated Financial Statements in Item 8 of this report.\n2. Financial Statement Schedule:\nThe following Schedule is filed herewith on the page indicated:\n3. Exhibits:\n(b) Reports on Form 8-K\nA Current Report on Form 8-K was filed on April 10, 1995 under \"Item 5. Other Events\" reporting that the Company entered into: (i) an Agreement and Plan of Merger, dated as of March 31, 1995, by and among the Company, CMS Merger Corporation, a wholly owned subsidiary of the Company, and CMS; (ii) a Stock Option Agreement, dated as of March 31, 1995, by and among the Company and CMS; and (iii) a Voting Agreement, dated as of March 31, 1995, between the Company and certain stockholders of CMS named therein.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 August, 1995.\nHORIZON\/CMS HEALTHCARE CORPORATION\nBy \/s\/ NEAL M. ELLIOTT\n----------------------------------------------------------------------- Neal M. Elliott 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. Each person whose individual signature appears below hereby authorizes Scot Sauder and Ernest A. Schofield or either of them, as attorneys-in-fact with full power of substitution, to execute in the name and on behalf of each person, individual, and in each capacity stated below, and to file, any and all amendments to this report.\nSCHEDULE II\nHORIZON\/CMS HEALTHCARE CORPORATION VALUATION AND QUALIFYING ACCOUNTS","section_15":""}
{"filename":"926897_1995.txt","cik":"926897","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION\nFirst SunAmerica Life Insurance Company (the \"Company\"), an indirect wholly owned subsidiary of SunAmerica Inc. (the \"Parent\"), is a stock life insurance company organized under the laws of New York. At September 30, 1995, the Company owned $163.2 million of assets.\nThe Company specializes in the sale of tax-deferred long-term savings products and investments. The Company markets fixed annuities and fee- generating variable annuities. Its annuity products are distributed through a broad spectrum of financial services distribution channels, including independent registered representatives of affiliated and unaffiliated broker-dealers; banks and other financial institutions; and independent general insurance agents.\nThe Company maintains its principal offices at 733 Third Avenue, 4th Floor, New York, New York 10017, telephone (800) 272-3007. The Company has no employees and employees of the Parent or its other subsidiaries perform various services for the Company. The Parent has approximately 1,300 employees, approximately 480 of whom perform services for the Company as well as for certain of its affiliates.\nLIFE INSURANCE OPERATIONS\nFounded in 1978 and licensed in the state of New York, the Company issues a portfolio of single premium fixed and flexible premium variable annuities. It has an \"A+\" (Superior) rating from industry analyst A.M. Best Company.\nBenefitting from continued strong demographic growth of the preretirement savings market, industry sales of tax-deferred savings products have represented, for a number of years, a significantly larger source of new premiums for the U.S. life insurance industry than have traditional life insurance products. Recognizing the growth potential of this market, the Company focuses its life insurance operations exclusively on the sale of annuities.\nBecause of its focus on annuity products, which generally have more contractholder transactions than traditional life insurance products, the Company utilizes computer-driven systems that employ optical disk imaging and artificial intelligence, in lieu of paper-intensive life insurance processing procedures. During 1995 the Company relocated its service support center from New York, New York to Los Angeles, California to consolidate operations with its affiliated life insurance companies. The Company believes its service support center and associated cost structure to be among the most competitive in the industry.\nThe Company markets its fixed and variable annuities through the following distribution channels: (i) independent registered representatives of SunAmerica Securities, Inc. and Royal Alliance Associates, Inc., which are indirect wholly owned subsidiaries of the Parent; (ii) approximately 190 other securities firms; (iii) banks and other financial institutions; and (iv) independent general insurance agents who specialize in selling fixed annuities and other single premium products. In addition, in June 1994, the Company entered into an exclusive agreement with The Chase Manhattan Bank, N.A. (\"Chase\") to develop variable annuity products for sale in the state of New York whose underlying funds will be managed by Chase. The institution will have the right to make these private label variable annuities available through its numerous retail branch networks and distribution channels within New York, beginning in December 1995. In addition, its new variable annuity product will also be available through a number of the broker-dealer and financial planning organizations that currently offer other investment products managed by Chase.\nFIXED ANNUITIES\nThe Company offers single premium deferred annuities that provide one or five-year fixed interest rate guarantees. Although the Company's contracts remain in force an average of seven to ten years, a majority (approximately 46% at September 30, 1995) reprice annually at discretionary rates determined by the Company. In repricing, the Company takes into account yield characteristics of its investment portfolio, annuity surrender assumptions and competitive industry pricing. Its fixed-rate annuity products offer many of the same features as conventional certificates of deposit from financial institutions, giving investors a choice of interest period and yield as well as additional advantages particularly applicable to retirement planning, such as tax-deferred accumulation and flexible payout options. The average new single premium fixed annuity contract sold by the Company amounted to approximately $32,000 in 1995.\nThe Company designs its fixed-rate products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its annuity obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed maturities. The Company's fixed-rate products incorporate surrender charges or other limitations on when contracts can be surrendered for cash to encourage persistency. Approximately 92% of the Company's fixed annuity reserves had surrender penalties or other restrictions at September 30, 1995.\nVARIABLE ANNUITIES\nThe Company's variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as fixed- rate account options. The Company earns fee income through the sale, administration and management of the variable account options of its variable annuity products. The Company also earns investment income on monies allocated to the fixed-rate account options of these products. Variable annuities offer retirement planning features and surrender charges similar to those offered by fixed annuities, but differ in that the annuity holder's rate of return is generally dependent upon the investment performance of the particular equity, fixed-income, money market or asset allocation fund selected by the contractholder. Because the investment risk is borne by the customer in all but the fixed-rate account options, these products require significantly less capital support than fixed annuities. The average new variable annuity contract sold by the Company amounted to approximately $38,000 in 1995.\nINVESTMENT OPERATIONS\nThe Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed maturities that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed maturities are priced over the yield curve and general competitive conditions within the industry. The Company manages all of its invested assets internally. Its portfolio strategy is designed to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.\nAs part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-maturity assets and liabilities under commonly used stress-test interest rate scenarios. Based on the results of these computer simulations, the investment portfolio has been constructed with a view to maintaining a desired investment spread between the yield on portfolio assets and the rate paid on its reserves under a variety of possible future interest rate scenarios.\nFor the years ended September 30, 1995, 1994 and 1993, the Company's yield on average invested assets was 7.59%, 6.54% and 6.17%, respectively, before net realized investment gains and losses, and it realized net investment spreads of 2.70%, 2.24% and 1.40%, respectively, on average invested assets. At September 30, 1995, the weighted average life of the Company's investments was approximately three and three-fourths years and the duration was slightly in excess of three years. Weighted average life is defined as the average time to receipt of all principal, incorporating the effects of scheduled amortization and expected prepayments, weighted by book value. Duration is a common measure for the price sensitivity of a fixed-income security or portfolio to changes in interest rates. It is the weighted average time to receipt of all expected cash flows, both principal and interest, including the effects of scheduled amortization and expected prepayments, in which the weight attached to each year of receipt is the proportion of the present value of cash to be received during that year to the total present value of the portfolio.\nThe Company's general investment philosophy is to hold fixed maturity assets for long-term investment. Thus, it does not have a trading portfolio. The Company carries the portion of its portfolio of bonds and notes that is available for sale (the \"Available for Sale Portfolio\") at estimated fair value. The remaining portion of its portfolio of bonds and notes is held for investment and is carried at amortized cost.\nThe following table summarizes the Company's investment portfolio at September 30, 1995:\nSUMMARY OF INVESTMENTS\nPercent Amortized of cost portfolio ------------ --------- (In thousands) Fixed maturities: Cash and short-term investments $ 6,382 5.2 % U.S. Government securities 39,990 32.6 Mortgage-backed securities 60,558 49.3 Other bonds and notes 10,966 8.9 Mortgage loans 4,733 3.9 ------------ --------- Total 122,629 99.9\nEquity securities 112 0.1 ------------ ---------- Total investments $ 122,741 100.0 % ============ ==========\nAt September 30, 1995, all bonds and notes, including those held for investment and the Available for Sale Portfolio (the \"Bond Portfolio\"), were rated by Standard & Poor's Corporation (\"S&P\"), Moody's Investors Service (\"Moody's\") or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners (\"NAIC\") and implemented by either the NAIC or the Company. At September 30, 1995, approximately $101.7 million (at amortized cost) was rated investment grade by one or both of these agencies or under the NAIC guidelines, including $100.5 million of U.S. Government\/agency securities and mortgage backed securities (\"MBSs\").\nAt September 30, 1995, the Bond Portfolio included $9.8 million (fair value, $8.4 million) of bonds not rated investment grade by S&P, Moody's or the NAIC. Based on their September 30, 1995 amortized cost, these non-investment- grade bonds accounted for 5.9% of the Company's total assets and 8.0% of its invested assets.\nMortgage loans aggregated $4.7 million at September 30, 1995 and consisted of 2 first mortgage loans collateralized by properties located in California. Both of these loans were multifamily residential loans to the same borrower.\nAt September 30, 1995, the amortized cost of all investments in default as to the payment of principal or interest totaled $0.7 million (fair value, $0.5 million), constituting 0.6% of total invested assets at amortized cost.\nFor more information concerning the Company's investments, including the risks inherent in such investments, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition and Liquidity.\"\nREGULATION\nThe Company is subject to regulation and supervision by the State of New York and the Insurance Commission of the State of New York. Insurance laws establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, regulating marketing and other trade practices, operating guaranty associations, licensing agents, approving policy forms, regulating certain premium rates, regulating insurance holding company systems, establishing reserve requirements, prescribing the form and content of required financial statements and reports, performing financial and other examinations, determining the reasonableness and adequacy of statutory capital and surplus, regulating the type and amount of investments permitted, limiting the amount of dividends that can be paid and the size of transactions that can be consummated without first obtaining regulatory approval and other related matters.\nDuring the last decade, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government and the NAIC. Various states have considered or enacted legislation that changes, and in many cases increases, the states' authority to regulate insurance companies. Legislation has been introduced from time to time in Congress that could result in the federal government assuming some role in the regulation of insurance companies. In recent years, the NAIC has approved and recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies. These initiatives include new investment reserve requirements, risk-based capital standards and restrictions on an insurance company's ability to pay dividends to its stockholders. The NAIC is also currently developing model laws to govern insurance company investments. Current proposals are still being debated and the Company is monitoring developments in this area and the effects any changes would have on the Company.\nCOMPETITION\nThe business conducted by the Company is highly competitive.\nThe Company competes with other life insurers, and also competes for customers' funds with a variety of investment products offered by financial services companies other than life insurance companies, such as banks, investment advisers, mutual fund companies and other financial institutions. Within the U.S. life insurance industry, there are approximately 125 companies that individually collect in excess of $150 million of annuity premiums annually. Certain of these companies and other life insurers with which the Company competes are significantly larger and have available to them much greater financial and other resources. The Company believes the primary competitive factors among life insurance companies for investment-oriented insurance products such as annuities include product flexibility, product pricing, innovation in product design, the claims-paying ability rating and the name recognition of the issuing company, the availability of distribution channels and service rendered to the customer before and after a contract is issued. Other factors affecting the annuity business include the benefits (including before-tax and after-tax investment returns) and guarantees provided to the customer and the commissions paid.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal office is in leased premises at 733 Third Avenue, 4th Floor New York, New York 10017. The Company, through an affiliate, also leases office space in Los Angeles, California and Torrance, California which is utilized for certain policy administration, recordkeeping and data processing functions.\nThe Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various kinds of litigation common to its business. These cases are in various stages of development and, based on reports of counsel, management believes that provisions made for potential losses are adequate and any further liabilities and costs will not have a material adverse impact 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 fiscal year 1995 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 EQUITY AND RELATED STOCKHOLDER MATTERS\nNot applicable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data of First SunAmerica Life Insurance Company 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, both of which are included elsewhere herein.\nITEM 6. SELECTED FINANCIAL DATA (continued)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following is management's discussion and analysis of financial condition and results of operations of First SunAmerica Life Insurance Company (the \"Company\") for the three years in the period ended September 30, 1995.\nRESULTS OF OPERATIONS\nINCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES totaled $0.5 million in 1995, compared with $1.1 million in 1994 and $0.9 million in 1993. The cumulative effect of the change in accounting for income taxes resulting from the 1994 implementation of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" amounted to a nonrecurring non-cash charge of $0.7 million. Accordingly, net income amounted to $0.4 million in 1994.\nPRETAX INCOME totaled $0.7 million in 1995 and $1.7 million in both 1994 and 1993. The $1.0 million decline in 1995 primarily resulted from net realized investment losses incurred, partially offset by an increase in net investment income.\nNET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest- bearing liabilities, increased to $2.8 million in 1995 from $1.9 million in 1994 and $1.2 million in 1993. These amounts represent net investment spreads of 2.70% on average invested assets (computed on a daily basis) of $103.2 million in 1995, 2.24% on average invested assets of $84.5 million in 1994 and 1.40% on average invested assets of $82.7 million in 1993. Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities was 1.69% in 1995, 1.13% in 1994 and 0.02% in 1993. Net investment income has increased over the three years due to both higher levels of average invested assets and an increase in the portfolio yield.\nInvestment income totaled $7.8 million in 1995, $5.5 million in 1994 and $5.1 million in 1993. Investment income increased in 1995 primarily as a result of an increase in investment yield on a higher level of average invested assets. The modest increase in investment income in 1994 over 1993 primarily resulted from an increase in overall portfolio yield as the Company reduced its average level of lower-yielding short-term investments. The yield on average invested assets increased to 7.59% in 1995 from 6.54% in 1994 and 6.17% in 1993. Over the last three fiscal years, the Company's quarterly investment yields on average invested assets have ranged from 5.85% to 7.81%; however, there can be no assurance that the Company will achieve similar yields in future periods.\nThe increased investment yield in 1995 reflects the higher interest rates prevailing during the latter half of 1994 and into fiscal 1995. In addition, the net cash provided by the Company's operating and financing activities and the cash flows from redemptions and maturities of securities in the Company's investment portfolio was invested in higher yielding instruments.\nTotal interest expense aggregated $5.0 million in 1995, $3.6 million in 1994 and $3.9 million in 1993. The average rate paid on fixed annuity contracts was 5.90% in 1995, compared with 5.41% in 1994 and 6.15% in 1993. Fixed annuity contracts averaged $85.5 million in 1995, compared with $67.2 million in 1994 and $64.1 million in 1993. The increase in the average rate paid on fixed annuities during 1995 primarily resulted from increased average crediting rates on the Company's new fixed annuity contracts relative to those issued in 1994 to maintain a generally competitive market rate in a higher interest rate environment. The decrease in the average rate paid on fixed annuities during 1994 was primarily due to a decline in prevailing interest rates that began during the latter half of fiscal 1992 and continued into the first half of fiscal 1994.\nNET REALIZED INVESTMENT LOSSES totaled $1.3 million in 1995, compared with net realized investment gains of $0.4 million in 1994 and $1.9 million in 1993, and represent 1.31%, 0.53% and 2.34%, respectively, of average invested assets. Net realized investment losses in 1995 include $1.2 million of net losses realized on $46.3 million of sales of mortgage backed securities (\"MBSs\") that were made primarily to maximize total return. Net gains in 1994 and 1993 are also related to sales of MBSs that were made primarily to maximize total return.\nVARIABLE ANNUITY FEES are based on the market value of assets supporting variable annuity contracts in separate accounts. Such fees totaled $0.4 million in both 1995 and 1994 and $0.2 million in 1993. Variable annuity fees have increased over the three years principally due to asset growth from the receipt of variable annuity premiums and, during 1995, from increased market values. Variable annuity assets averaged $27.8 million during 1995, $26.1 million during 1994 and $16.5 million during 1993. Variable annuity premiums, which exclude premiums allocated to the fixed accounts of variable annuity products, totaled $5.9 million in 1995, $5.7 million in 1994 and $14.5 million in 1993. The decline in premiums from 1993 to 1994 can be attributed, in part, to a heightened demand for fixed-rate investment options, including the fixed accounts of variable annuities. The Company has encountered increased competition in the variable annuity marketplace during 1995 and 1994 and anticipates that the market will remain highly competitive for the foreseeable future.\nSURRENDER CHARGES on fixed and variable annuities totaled $194,000 in 1995, compared with $367,000 in 1994 and $44,000 in 1993. Surrender charges generally are assessed on annuity withdrawals at declining rates during the first five to seven years of the contract. Withdrawal payments, which include surrenders and lump-sum annuity benefits, totaled $17.7 million in 1995, $12.9 million in 1994 and $2.9 million in 1993. These payments represent 16.93%, 15.04% and 3.85%, respectively, of average fixed and variable annuity reserves. Withdrawals include variable annuity payments from the separate accounts totaling $3.6 million in 1995, $2.4 million in 1994 and $0.4 million in 1993. Both fixed and variable annuity surrenders increased from the unusually low rates of prior years to more normal levels during 1994 and 1995, due to anticipated higher surrenders as the annuity block has matured. Management anticipates that withdrawal rates will remain relatively stable for the foreseeable future and the Company's investment portfolio has been structured to provide sufficient liquidity for anticipated withdrawals.\nGENERAL AND ADMINISTRATIVE EXPENSES totaled $1.1 million in 1995, compared with $1.0 million in 1994 and $1.1 million in 1993. General and administrative expenses remain closely controlled through a company-wide cost containment program and represent approximately 1% of average total assets.\nAMORTIZATION OF DEFERRED ACQUISITION COSTS increased during 1995 to $0.3 million primarily due to additional fixed and variable annuity sales and the subsequent amortization of related deferred commissions and other acquisition costs. There was no amortization in 1994 and $0.2 million in 1993. The decrease in amortization of deferred acquisition costs from 1993 to 1994 is primarily due to the decline in net realized investment gains which are included in gross profits for purposes of computing amortization.\nINCOME TAX EXPENSE totaled $0.2 million in 1995, $0.7 million in 1994 and $0.8 million in 1993, representing effective tax rates of 26% in 1995, 38% in 1994 and 49% in 1993. The higher tax rate in 1993 reflects the payment of state income taxes relating to net realized investment gains recorded in 1992. The lower tax rate in 1995 reflects a prior period state income tax benefit.\nFINANCIAL CONDITION AND LIQUIDITY\nSHAREHOLDER'S EQUITY increased by $2.0 million to $21.8 million at September 30, 1995 from $19.8 million at September 30, 1994, primarily as a result of the $1.5 million reduction of net unrealized losses on debt and equity securities available for sale charged directly to shareholders equity and net income of $0.5 million in 1995.\nTOTAL ASSETS increased by $49.1 million to $163.2 million at September 30, 1995 from $114.1 million at September 30, 1994, principally due to a $42.3 million increase in invested assets and a $6.4 million increase in the separate accounts for variable annuities.\nINVESTED ASSETS at year end totaled $121.2 million in 1995, compared with $78.9 million in 1994. This increase primarily resulted from sales of fixed annuity contracts which totaled $51.7 million in 1995, up from $7.8 million in 1994 and $9.1 million in 1993. The increase in fixed annuity premiums during 1995 reflects generally heightened demand for fixed-rate products in 1995 relative to the comparable 1994 periods. This heightened demand may be attributed, in part, to the increase in prevailing long-term interest rates that began during the latter half of the 1994 fiscal year and continued into the first quarter of fiscal 1995.\nThe Company manages all of its invested assets internally. The Company's general investment philosophy is to hold fixed maturity assets for long-term investment. Thus, it does not have a trading portfolio. The Company carries the portion of its portfolio of bonds and notes that is available for sale (the \"Available for Sale Portfolio\") at estimated fair value. The remaining portion of its portfolio of bonds and notes is held for investment and is carried at amortized cost.\nBONDS AND NOTES, including those held for investment and the Available for Sale Portfolio (the \"Bond Portfolio\"), at September 30, 1995, had an aggregate amortized cost that exceeded its fair value by $1.5 million (including net unrealized losses of $1.4 million on the Available for Sale Portfolio). The fair value of the Bond Portfolio was $5.9 million below its amortized cost at September 30, 1994 (including net unrealized losses of $5.7 million on the Available for Sale Portfolio). The decrease in net unrealized losses on the Bond Portfolio since September 30, 1994 principally reflects the lower relative prevailing interest rates at September 30, 1995 and their corresponding effect on the fair value of the Bond Portfolio.\nThe entire Bond Portfolio at September 30, 1995 was rated by Standard & Poor's Corporation (\"S&P\"), Moody's Investors Service (\"Moody's\") or under comparable statutory rating guidelines established by the National Association of Insurance Commissioners (\"NAIC\") and implemented by either the NAIC or the Company. At September 30, 1995, approximately $101.7 million (at amortized cost) was rated investment grade by one or both of these agencies or under the NAIC guidelines, including $100.5 million of U.S. government\/agency securities and MBSs.\nAt September 30, 1995, the Bond Portfolio included $9.8 million (fair value, $8.4 million) of bonds not rated investment grade by S&P, Moody's or the NAIC. Based on their September 30, 1995 amortized cost, these non-investment- grade bonds accounted for 5.9% of the Company's total assets and 8.0% of invested assets.\nNon-investment-grade securities generally provide higher yields and involve greater risks than investment-grade 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 securities. The Company intends that its holdings of such securities not exceed current levels, but its policies may change from time to time, including in connection with any possible acquisition. The Company had no material concentrations of non-investment-grade securities at September 30, 1995.\nThe table on the following page summarizes the Company's rated bonds by rating classification as of September 30, 1995.\nSummary of Rated Bonds (In thousands)\nMORTGAGE LOANS aggregated $4.7 million at September 30, 1995 and consisted of 2 first mortgage loans collateralized by properties located in California. Both of these loans were multifamily residential loans to the same borrower. At the time of their purchase by the Company, these mortgage loans had loan-to-value ratios of 75% or less. At September 30, 1995, neither loan was delinquent. No mortgage loans were foreclosed upon during fiscal years 1995, 1994 or 1993.\nASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed maturities that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed maturities are priced over the yield curve and general competitive conditions within the industry. Its portfolio strategy is designed to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.\nThe Company designs its fixed-rate products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its annuity obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed maturities. The Company's fixed-rate products incorporate surrender charges or other limitations on when contracts can be surrendered for cash to encourage persistency. Approximately 92% of the Company's fixed annuity reserves had surrender penalties or other restrictions at September 30, 1995.\nAs part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-maturity assets and liabilities under commonly used stress-test interest rate scenarios. Based on the results of these computer simulations, the investment portfolio has been constructed with a view to maintaining a desired investment spread between the yield on portfolio assets and the rate paid on its reserves under a variety of possible future interest rate scenarios. At September 30, 1995, the weighted average life of the Company's investments was approximately three and three- fourths years and the duration was slightly in excess of three years.\nThe Company also seeks to provide liquidity and enhance its spread income by using reverse repurchase agreements (\"Reverse Repos\"), and by investing in MBSs. Reverse Repos involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed upon price and are generally over-collateralized. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans.\nThere are risks associated with some of the techniques the Company uses to enhance its spread income and match its assets and liabilities. The primary risk associated with Reverse Repos is the risk associated with counterparty nonperformance. The Company believes, however, that the counterparties to its Reverse Repos are financially responsible and that the counterparty risk associated with those transactions is minimal. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase.\nINVESTED ASSETS EVALUATION routinely includes a review by the Company of its portfolio of debt securities. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying value of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of collateral (if any), compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral.\nThe carrying values of bonds that are determined to have declines in value that are other than temporary are reduced to net realizable value and no further accruals of interest are made. If needed, mortgage loan valuation allowances would be based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days.\nDEFAULTED INVESTMENTS, comprising all investments (at amortized cost) that are in default as to the payment of principal or interest, totaled $0.7 million (fair value, $0.5 million) at September 30, 1995. At September 30, 1995, defaulted investments constituted 0.6% of total invested assets at amortized cost. At September 30, 1994, there were no defaulted investments.\nSOURCES OF LIQUIDITY are readily available to the Company in the form of existing cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At September 30, 1995, approximately $60.5 million of the Company's Bond Portfolio had an aggregate unrealized gain of $0.6 million, while approximately $51.0 million of the Bond Portfolio had an aggregate unrealized loss of $2.1 million. In addition, the Company's investment portfolio also currently provides approximately $1.5 million of monthly cash flow from scheduled principal and interest payments.\nManagement is aware that prevailing market interest rates may shift significantly and has strategies in place to manage either an increase or decrease in prevailing rates. In a rising interest rate environment, the Company's average cost of funds would increase over time as it prices its new and renewing annuities to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company's substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market.\nIn a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed annuities. Should increased liquidity be required for withdrawals, the Company believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening that would be expected in the bond market.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's financial statements begin on page. 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\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe directors and principal officers of First SunAmerica Life Insurance Company (the \"Company\") as of December 8, 1995 are listed below, together with information as to their ages, dates of election and principal business occupation during the last five years (if other than their present business occupation).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nAll of the executive officers of the Company also serve as employees of SunAmerica Inc. or its affiliates and receive no compensation directly from the Company. Some of the officers also serve as officers of other companies affiliated with the Company. Allocations have been made as to each individual's time devoted to his or her duties as an executive officer of the Company.\nThe following table shows the cash compensation paid or earned, based on these allocations, to the chief executive officer and top four executive officers of the Company whose allocated compensation exceeds $100,000 and to all executive officers of the Company as a group for services rendered in all capacities in the Company during 1995:\nName of Individual or Capacities In Which Allocated Cash Number in Group Served Compensation --------------------- ------------------------- -------------- Eli Broad Chairman, Chief Executive $ 11,538 Officer and President Jay Wintrob Executive Vice President 7,212 James R. Belardi Senior Vice President 7,500 Gary W. Krat Senior Vice President 37,500 N. Scott Gillis Senior Vice President and Controller 8,904\nAll Executive Officers as a Group (12) $ 156,016 =========\nDirectors of the Company who are also employees of SunAmerica Inc. or its affiliates receive no compensation in addition to their compensation as employees of SunAmerica Inc. or its affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNo shares of the Company are owned by any executive officer or director. The Company is an indirect wholly-owned subsidiary of SunAmerica Inc. Except for Mr. Broad, the percentage of shares of SunAmerica Inc. beneficially owned by any director does not exceed one percent of the class outstanding. At November 30, 1995, Mr. Broad was the beneficial owner of 2,149,694 shares of Common Stock (approximately 4.7% of the class outstanding) and 8,857,081 shares of Class B Common Stock (approximately 86.5% of the class outstanding). Of the Common Stock, 250,659 shares represent restricted shares granted under the Company's employee stock plans as to which Mr. Broad has no investment power; 506,250 shares are held by a trust formed by Mr. Broad of which he is a beneficiary; and 1,344,234 shares represent employee stock options held by Mr. Broad which are or will become exercisable on or before February 2, 1996 and as to which he has no voting or investment power. Of the Class B Stock, 843,750 shares are held by a trust formed by Mr. Broad of which he is a beneficiary; 32,568 shares are held by a foundation of which Mr. Broad is a director and as to which he has shared voting and investment power; and 2,902,500 shares are registered in the name of a corporation as to which Mr. Broad exercises voting and investment power. At December 7, 1995, all directors and officers as a group beneficially owned 3,652,731 shares of Common Stock (approximately 8% of the class outstanding) and 8,857,081 shares of Class B Common Stock (approximately 86.5% of the class outstanding).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None.\nPART IV Item 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFinancial Statements and Financial Statement Schedules\nReference is made to the index set forth on page of this report.\nExhibits\nExhibit No Description - ------- 3(a) Declaration of intent and Charter dated November, 1978. 3(b) Certificate of Amendment of Charter dated February 1, 1988. 3(c) Certificate of Amendment of Charter dated January 26, 1989. 3(d) Certificate of Amendment of Charter dated March 1, 1989. 3(e) Bylaws dated December 20, 1978. 27 Financial Data Schedule\nReports on Form 8-K\nNo Current Report on Form 8-K was filed during the three months ended September 30, 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.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nBy\/s\/ SCOTT L. ROBINSON -------------------------------------- Scott L. Robinson Senior Vice President, Treasurer and Director December 8, 1995\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated:\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nPage(s)\nReport of Independent Accountants\nBalance Sheet as of September 30, 1995 and 1994\nIncome Statement for the years ended September 30, 1995, 1994 and 1993\nStatement of Cash Flows for the years ended September 30, 1995, 1994 and 1993 through\nNotes to Financial Statements through\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholder of First SunAmerica Life Insurance Company\nIn our opinion, the accompanying balance sheet and the related income statement and statement of cash flows present fairly, in all material respects, the financial position of First SunAmerica Life Insurance Company at 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. These financial 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 6, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in fiscal 1994.\nPrice Waterhouse LLP Los Angeles, California November 6, 1995\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nBALANCE SHEET\nThe accompanying notes are an integral part of these financial statements.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nINCOME STATEMENT\nThe accompanying notes are an integral part of these financial statements\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nSTATEMENT OF CASH FLOWS\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nSTATEMENT OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these financial statements\nFIRST SUNAMERICA LIFE INSURANCE COMPANY NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL: First SunAmerica Life Insurance Company (the \"Company\") is an indirect wholly owned subsidiary of SunAmerica Inc. (the \"Parent\"). Certain items have been reclassified to conform to the current year's presentation.\nINVESTMENTS: Cash and short-term investments primarily include cash, commercial paper, money market investments, repurchase agreements and short-term bank participations. All such investments are carried at cost plus accrued interest, which approximates fair value, have maturities of three months or less and are considered cash equivalents for purposes of reporting cash flows. Bonds and notes available for sale and common stocks are carried at aggregate fair value and changes in unrealized gains or losses, net of tax, are credited or charged directly to shareholder's equity. It is management's intent, and the Company has the ability, to hold the remainder of bonds and notes until maturity, and, therefore, these investments are carried at amortized cost. Bonds and notes, whether available for sale or held for investment, are reduced to estimated net realizable value when necessary for declines in value considered to be other than temporary. Estimates of net realizable value are subjective and actual realization will be dependent upon future events. Mortgage loans are carried at amortized unpaid balances, net of provisions for estimated losses. Realized gains and losses on the sale of investments are recognized in operations at the date of sale and are determined using the specific cost identification method. Premiums and discounts on investments are amortized to investment income using the interest method over the contractual lives of the investments.\nDEFERRED ACQUISITION COSTS: Policy acquisition costs are deferred and amortized, with interest, over the estimated lives of the contracts in relation to the present value of estimated gross profits, which are composed of net interest income, net realized investment gains and losses, variable annuity fees, surrender charges and direct administrative expenses. Deferred acquisition costs consist of commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business.\nAs debt and equity securities available for sale are carried at aggregate fair value, an adjustment is made to deferred acquisition costs equal to the change in amortization that would have been recorded if such securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. The change in this adjustment, net of tax, is included with the change in net unrealized gains or losses on debt and equity securities available for sale that is credited or charged directly to shareholder's equity. At September 30, 1995 and 1994, deferred acquisition costs have been increased by $200,000 and $2,100,000, respectively, for this adjustment.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nVARIABLE ANNUITY ASSETS AND LIABILITIES: The assets and liabilities resulting from the receipt of variable annuity premiums are segregated in separate accounts. The Company receives fees for assuming mortality and certain expense risks. Such fees are included in Variable Annuity Fee Income in the income statement.\nGOODWILL: Goodwill, amounting to $879,000 at September 30, 1995, is amortized by using the straight-line method over a period of 25 years and is included in Other Assets in the balance sheet.\nCONTRACTHOLDER RESERVES: Contractholder reserves for fixed annuity contracts are accounted for as investment-type contracts in accordance with Statement of Financial Accounting Standards No. 97, \"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments,\" and are recorded at accumulated value (premiums received, plus accrued interest, less withdrawals and assessed fees).\nFEE INCOME: Variable annuity fees are recognized in income as earned.\nINCOME TAXES: The Company is included in the consolidated federal income tax return of the Parent and files as a \"life insurance company\" under the provisions of the Internal Revenue Code of 1986. Income taxes have been calculated as if the Company filed a separate return. Effective October 1, 1993, deferred income tax assets and liabilities are recognized based on the difference between financial statement carrying amounts and income tax bases of assets and liabilities using enacted income tax rates and laws.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS\nThe amortized cost and estimated fair value of bonds and notes available for sale and held for investment by major category follow:\nEstimated Amortized fair cost value ------------- ------------- AT SEPTEMBER 30, 1995:\nAVAILABLE FOR SALE: Securities of the United States Government $ 37,693,000 $ 37,759,000 Mortgage-backed securities 60,558,000 60,367,000 Corporate bonds and notes 10,966,000 9,645,000 -------------- ------------- Total available for sale $ 109,217,000 $ 107,771,000 ============== ============= HELD FOR INVESTMENT: Securities of the United States Government $ 2,297,000 $ 2,289,000 ============== ============= AT SEPTEMBER 30, 1994:\nAVAILABLE FOR SALE: Securities of the United States Government $ 39,775,000 $ 36,398,000 Mortgage-backed securities 13,943,000 12,883,000 Corporate bonds and notes 8,048,000 6,785,000 -------------- ------------- Total available for sale $ 61,766,000 $ 56,066,000 ============== ============= HELD FOR INVESTMENT: Securities of the United States Government $ 2,301,000 $ 2,102,000 Corporate bonds and notes 1,013,000 1,015,000 -------------- ------------- Total held for investment $ 3,314,000 $ 3,117,000 ============== =============\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS (Continued)\nThe amortized cost and estimated fair value of bonds and notes available for sale and held for investment by contractual maturity, as of September 30, 1995, follow:\nEstimated Amortized fair cost value ------------- ------------- AVAILABLE FOR SALE: Due in one year or less $ --- $ --- Due after one year through five years --- --- Due after five years through ten years 10,966,000 9,645,000 Due after ten years 37,693,000 37,759,000 Mortgage-backed securities 60,558,000 60,367,000 ------------- ------------- Total available for sale $ 109,217,000 $ 107,771,000 ============= =============\nHELD FOR INVESTMENT: Due in one year or less $ --- $ --- Due after one year through five years --- --- Due after five years through ten years 2,297,000 2,289,000 Due after ten years --- --- Mortgage-backed securities --- --- ------------- ------------- Total held for investment $ 2,297,000 $ 2,289,000 ============= =============\nActual maturities of bonds and notes will differ from those shown above because of prepayments and redemptions.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS (Continued)\nGross unrealized gains and losses on bonds and notes available for sale and held for investment by major category follow:\nGross Gross unrealized unrealized gains losses ------------- ------------- AT SEPTEMBER 30, 1995:\nAVAILABLE FOR SALE: Securities of the United States Government $ 263,000 $ (197,000) Mortgage-backed securities 257,000 (448,000) Corporate bonds and notes 102,000 (1,423,000) ------------- ------------ Total available for sale $ 622,000 $ (2,068,000) ============= ============\nHELD FOR INVESTMENT: Securities of the United States Government $ 22,000 $ (30,000) ============= ============ AT SEPTEMBER 30, 1994:\nAVAILABLE FOR SALE: Securities of the United States Government $ --- $ (3,377,000) Mortgage-backed securities --- (1,060,000) Corporate bonds and notes 36,000 (1,299,000) ------------- ------------ Total available for sale $ 36,000 $ (5,736,000) ============= ============ HELD FOR INVESTMENT: Securities of the United States Government $ 8,000 $ (207,000) Corporate bonds and notes 2,000 --- ------------- ------------ Total held for investment $ 10,000 $ (207,000) ============= ============\nAt September 30, 1995, gross unrealized losses on equity securities aggregated $112,000 and gross unrealized gains aggregated $35,000.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS (Continued)\nGross realized investment gains and losses on sales of all types of investments are as follows:\nYears ended September 30, -------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Bonds and notes available for sale: Realized gains $ 423,000 $ 644,000 $ 2,157,000\nRealized losses (1,771,000) (199,000) (225,000) ------------ ------------ ------------ Total net realized investment gains (losses) $ (1,348,000)$ 445,000 $ 1,932,000 ============ ============ ============\nThe sources and related amounts of investment income are as follows:\nYears ended September 30, -------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Short-term investments $ 1,045,000 $ 685,000 $ 1,120,000 Bonds and notes 6,291,000 4,341,000 3,220,000 Mortgage loans 498,000 501,000 761,000 ------------ ------------ ------------\nTotal investment income $ 7,834,000 $ 5,527,000 $ 5,101,000 ============ ============ ============\nExpenses incurred to manage the investment portfolio amounted to $125,000 for the year ended September 30, 1995, $102,000 for the year ended September 30, 1994, and $84,000 for the year ended September 30, 1993 and are included in General and Administrative Expenses in the income statement.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS (Continued)\nThe carrying values of investments in any one entity or its affiliates exceeding 10% of the Company's shareholder's equity are as follows:\nSeptember 30, --------------- Short-term investments: Southern California Edison Commercial Paper $ 3,989,000 Mortgage loans: Hyman & Rose Shulman Family Trust 4,733,000 ===============\nAt September 30, 1995, bonds and notes included $9,768,000 (at amortized cost, with a fair value of $8,369,000) of investments not rated investment grade by either Standard & Poor's Corporation, Moody's Investors Service or under National Association of Insurance Commissioners' guidelines. The Company had no material concentrations of non-investment-grade assets at September 30, 1995.\nAt September 30, 1995, the amortized cost of investments in default as to the payment of principal or interest was $745,000 and the fair value was $500,000, all of which are unsecured non-investment-grade bonds.\nAt September 30, 1995, $257,000 of bonds, at amortized cost, were on deposit with regulatory authorities in accordance with statutory requirements.\n3. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following estimated fair value disclosures are limited to the reasonable estimates of the fair value of only the Company's financial instruments. The disclosures do not address the value of the Company's recognized and unrecognized nonfinancial assets (including equity investments) and liabilities or the value of anticipated future business. The Company does not plan to sell most of its assets or settle most of its liabilities at these estimated fair values.\nThe fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Selling expenses and potential taxes are not included. The estimated fair value amounts were determined using available market information, current pricing information and various valuation methodologies. If quoted market prices were not readily available for a financial instrument, management determined an estimated fair value. Accordingly, the estimates may not be indicative of the amounts the financial instruments could be exchanged for in a current or future market transaction.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n3. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCASH AND SHORT TERM INVESTMENTS: Carrying value is considered to be a reasonable estimate of fair value.\nBONDS AND NOTES: Fair value is based principally on independent pricing services, broker quotes and other independent information.\nMORTGAGE LOANS: Fair values are primarily determined by discounting future cash flows to the present at current market rates, using expected prepayment rates and further discounting for current market factors.\nVARIABLE ANNUITY ASSETS: Variable annuity assets are carried at the market value of the underlying securities.\nRESERVES FOR FIXED ANNUITY CONTRACTS: Deferred annuity contracts are assigned fair value equal to current net surrender value. Annuitized contracts are valued based on the present value of future cash flows at current pricing rates.\nVARIABLE ANNUITY LIABILITIES: Fair values of contracts in the accumulation phase are based on net surrender values. Fair values of contracts in the payout phase are based on the present value of future cash flows at assumed investment rates.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n3. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)\nThe estimated fair values of the Company's financial instruments at September 1995 and 1994, compared with their respective carrying values, are as follows:\n4. CONTINGENT LIABILITIES\nThe Company is involved in various kinds of litigation common to its business. These cases are in various stages of development and, based on reports of counsel, management believes that provisions made for potential losses are adequate and any further liabilities and costs will not have a material adverse impact upon the Company's financial position or results of operations.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n5. SHAREHOLDER'S EQUITY\nThe Company is authorized to issue 300 shares of its $10,000 par value Common Stock. At September 30, 1995, 1994 and 1993, 300 shares are outstanding.\nChanges in shareholder's equity are as follows:\nYears ended September 30, ---------------------------------------- 1995 1994 1993 ------------ ------------ ------------ RETAINED EARNINGS: Beginning balance $ 4,727,000 $ 4,370,000 $ 3,494,000 Net income 523,000 357,000 876,000 ------------ ------------ ------------ Ending balance $ 5,250,000 $ 4,727,000 $ 4,370,000 ============ ============ ============\nNET UNREALIZED GAINS (LOSSES) ON DEBT AND EQUITY SECURITIES AVAILABLE FOR SALE: Beginning balance $ (2,340,000) $ 1,331,000 $ --- Excess of market value over amortized cost on debt and equity securities available for sale --- --- 2,039,000 Change in net unrealized gains (losses) on debt and equity securities available for sale 4,177,000 (7,739,000) --- Change in adjustment to deferred acquisition costs (1,900,000) 2,100,000 --- Tax effect of net change (797,000) 1,968,000 (708,000) ------------ ------------ ------------ Ending balance $ (860,000) $ (2,340,000) $ 1,331,000 ============ ============ ============\nFor a life insurance company domiciled in the State of New York, no dividend may be distributed to any shareholder unless notice of the domestic insurer's intention to declare such dividend and the amount have been filed with the Superintendent of Insurance not less than 30 days in advance of such proposed declaration, nor if the Superintendent disapproves the distribution of the dividend within the 30-day period. No dividends were paid in fiscal years 1995, 1994 or 1993.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n5. SHAREHOLDER'S EQUITY (Continued)\nUnder statutory accounting principles utilized in filings with insurance regulatory authorities, the Company's net loss for the nine months ended September 30, 1995 was $1,755,000. The statutory net income for the year ended December 31, 1994 was $726,000 and for the year ended December 31, 1993 the statutory net loss was $597,000. The Company's statutory capital and surplus was $13,962,000 at September 30, 1995, $16,122,000 at December 31, 1994 and $15,623,000 at December 31, 1993.\n6. INCOME TAXES\nThe components of the provisions for income taxes on pretax income consist of the following:\nNet realized investment gains (losses) Operations Total ----------- ------------ ------------- 1995: Currently payable $ (592,000) $ 441,000 $ (151,000) Deferred (28,000) 361,000 333,000 ----------- ---------- -----------\nTotal income tax expense $ (620,000) $ 802,000 $ 182,000 =========== ========== =========== 1994: Currently payable $ 121,000 $ (854,000) $ (733,000) Deferred 65,000 1,323,000 1,388,000 ----------- ---------- -----------\nTotal income tax expense $ 186,000 $ 469,000 $ 655,000 =========== ========== =========== 1993: Currently payable $ 1,091,000 $ 642,000 $ 1,733,000 Deferred (46,000) (858,000) (904,000) ----------- ---------- -----------\nTotal income tax expense $ 1,045,000 $ (216,000) $ 829,000 =========== ========= ===========\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n6. INCOME TAXES (Continued)\nIncome taxes computed at the United States federal income tax rate of 35% for 1995 and 1994 and 34.75% for 1993 and income taxes provided differ as follows:\nYears ended September 30, ----------------------------- 1995 1994 1993 --------- --------- --------- Amount computed at statutory rate $ 247,000 $ 608,000 $ 592,000\nIncreases (decreases) resulting from: Amortization of differences between book and tax bases of net assets acquired 20,000 10,000 (20,000) State income taxes, net of federal tax benefit (86,000) 36,000 250,000\nOther, net 1,000 1,000 7,000 --------- --------- ---------\nTotal income tax expense $ 182,000 $ 655,000 $ 829,000 ========= ========= =========\nEffective October 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No.109, \"Accounting for Income Taxes.\" Accordingly, the cumulative effect of this change in accounting for income taxes was recorded during the quarter ended December 31, 1993 to decrease the asset for deferred income taxes by $725,000.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY\nNOTES TO FINANCIAL STATEMENTS\n6. INCOME TAXES (Continued)\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes. The significant components of the asset for deferred income taxes are as follows:\nSeptember 30, September 30, 1995 1994 ------------ ------------ Deferred tax liabilities: Investments $ (142,000) $ (45,000) Deferred acquisition costs (1,703,000) (1,026,000) Other (66,000) (41,000) ------------ ------------ Total deferred tax liabilities (1,911,000) (1,112,000) ============ ============ Deferred tax assets: Contractholder reserves 1,125,000 659,000 State income taxes 79,000 79,000 Net unrealized losses on certain debt and equity securities 463,000 1,260,000 ------------ ------------ Total deferred tax assets 1,667,000 1,998,000 ------------ ------------\nDeferred income tax asset (liability) $ (244,000) $ 886,000 ============ ============\n7. RELATED PARTY MATTERS\nThe Company pays commissions to two affiliated companies, Royal Alliance Associates, Inc. (\"Royal\") and SunAmerica Securities, Inc. These broker- dealers represent a significant portion of the Company's business, amounting to approximately 14.8%, 26.5% and 49.3% of premiums in 1995, 1994 and 1993, respectively. Commissions paid to these broker-dealers totaled $761,000 in 1995, $326,000 in 1994, and $733,000 in 1993. Occupancy and office services expenses paid to Royal totaled $113,000 for the year ended September 30, 1995, $122,000 for the year ended September 30, 1994 and $135,000 for the year ended September 30, 1993.\nThe Company purchases administrative, investment management, accounting, marketing and data processing services from SunAmerica Financial, Inc., whose purpose is to provide services to the SunAmerica companies. Amounts paid for such services totaled $722,000 for the year ended September 30, 1995, $706,000 for the year ended September 30, 1994 and $586,000 for the year ended September 30, 1993.\nDuring the year ended September 30, 1993, the Company sold to SunAmerica Life Insurance Company, its immediate parent, two mortgage loans for cash equal to their aggregate book value of $16,547,000.\nFIRST SUNAMERICA LIFE INSURANCE COMPANY LIST OF EXHIBITS FILED\nExhibit No Description ------- 3(a) Declaration of intent and Charter dated November, 1978. 3(b) Certificate of Amendment of Charter dated February 1, 1988. 3(c) Certificate of Amendment of Charter dated January 26, 1989. 3(d) Certificate of Amendment of Charter dated March 1, 1989. 3(e) Bylaws dated December 20, 1978. 27 Financial Data Schedule","section_15":""}
{"filename":"814430_1995.txt","cik":"814430","year":"1995","section_1":"Item 1. BUSINESS\nIntroduction\nIntelligent Electronics, Inc. (the \"Company\") provides information technology products, services and solutions to network integrators (the \"Network\"), and to large and small corporate customers, educational institutions and governmental agencies. The Company was founded in 1982 and is a Pennsylvania corporation. In March 1984, the Company commenced the wholesale distribution of microcomputers. As a leading supplier of premium brand technology products in the United States, the Company provides business solutions through innovative product management, sales demand generation programs and logistics services. As of January 28, 1995, the Network comprised more than 2,500 locations.\nThe Company's principal executive offices are located at 411 Eagleview Boulevard, Exton, Pennsylvania, 19341, telephone (610)458-5500. As used herein and unless otherwise required by the context, the \"Company\" shall mean Intelligent Electronics, Inc. and its wholly-owned subsidiaries.\nGeneral\nThe Company's revenues are derived principally from the distribution of microcomputer systems, workstations, networking and telecommunications equipment and software. In addition, in December 1994, the Company acquired certain assets of branch locations in five major-metropolitan cities from The Future Now, Inc. (\"FNOW\") to solidify its position in strategic corporate markets. These locations include Boston, New York City, Los Angeles, San Francisco and Baltimore\/Washington, D.C. The Company currently owns approximately 31.1% of the outstanding common stock of FNOW. On March 6, 1995, the Company signed a letter of intent to acquire all the remaining shares of FNOW, in a stock-for-stock merger transaction. Based on the exchange ratio set forth in the letter of intent, FNOW shareholders will receive .6588 shares of the Company's common stock in exchange for each share of FNOW. The transaction is subject to the completion of due diligence, the execution of a definitive agreement and other customary conditions and approvals, including approval by FNOW's shareholders. Assuming the completion of the FNOW merger, the FNOW acquisitions are intended to create a financially strong sales and service organization offering a range of sophisticated customer support and consulting services.\nThe Company provides distribution of microcomputers and related equipment to its customers through a business-to-business approach. Additionally, the Company provides product selection, technical support, cost-efficient marketing programs and promotions, configuration and marketing opportunities. The Company believes that it purchases the majority of the products distributed at the lowest published prices available and believes that its financial strength and purchasing power give it better access to constrained product lines. The Company consequently passes on to its customers a portion of the discount which it receives from vendors. This pricing, together with the Company's service offerings and ready access to expansive product inventories, generally enables its customers to purchase products from the Company at better terms than they could obtain directly from vendors and to effectively compete in the marketplace.\nThe Company sells products and provides certain services to its Network members, who are charged varying fees based on different levels of services which they select. The Company believes that its product pricing and its \"services-for-fees\" approach enhance the competitiveness of its Network and provide for an efficient allocation of support. In addition, the Company provides and is continuing to develop programs to enhance the competitiveness of its Network, such as marketing assistance, programs designed to enhance channel sales, product promotion, pre-shipment configuration, technical support and new product evaluation. Programs designed for specific members of the Network include a nationwide advanced systems program operated under the name \"Intelligent Systems Group\", which targets end-users with a regional or national presence and focuses primarily on high-end or technically advanced products, the ISG National Service Network, which assists members of the Network in servicing multi-location, regional or national accounts, the Minority Technical Alliance, which assists certain Network members in obtaining business from end-users seeking to purchase from minority-owned businesses and the Business Technology Centers program, which assists Network members in positioning themselves in the small business market.\nThe Company also offers financing programs, under which, for a fee, it extends up to thirty days credit to qualified end-users and certain Network members who purchase selected products. Under one such program, the Company, in partnership with Network members, provides products and extends credit directly to end-users who have been approved both by the Company and the Network member. This program frees up the existing credit line of the Network member. Also, certain members of the Network are receiving credit in order to facilitate their ability to purchase certain products from the Company and to allow the Company to compete with competitors who offer such credit terms. As these programs become more established and marketed, it is anticipated that they will facilitate incremental sales and profits, contribute gross margin, increase selling, general and administrative expenses, and increase accounts receivable. The Company may outsource some of the above financing programs which could slow the growth or reduce the level of accounts receivable.\nThe Company is currently upgrading its management information systems, as part of a project called IE 2000, including its financial accounting system, warehouse management systems, order-entry and purchasing systems and on-line customer access system. IE 2000 is designed to transform the Company to a process-driven model in order to facilitate continued growth and provide greater operating efficiencies. The Company's primary operations are Demand Generation (manages the Company's relationships with customers and vendors) and Demand Fulfillment (manages the delivery of products). The upgrading of the Company's processes and systems is expected to be completed by the end of fiscal 1996 and to cost approximately $40 million, including costs of approximately $8 million through January 28, 1995.\nNetwork Structure\nFranchise Agreements. Certain of the relationships between the Company and its Network are governed by franchise agreements. The first franchise agreement was signed in August 1984, and provided for the operation of a business center pursuant to a system developed by the Company under the tradename Todays Computers Business Centers (\"TCBC\"). At October 31, 1988, there were 175 centers in operation under the TCBC name. In December 1988, the Company acquired Entre Computer Centers, Inc. (\"Entre\"), which consisted of 180 franchised customers and company-owned centers. In August 1989, the Company acquired Connecting Point of America, Inc. (\"CPA\") which consisted of a network of 246 franchised customers.\nThe franchise agreements provide for the operation of a business center and the sale of microcomputer systems and related products and services as well as other advanced technology products under the Company's proprietary trademarks \"Todays Computers Business Centers\" and \"TCBC,\" or \"Entre Computer Centers\" or \"Connecting Point of America\". These agreements generally have an initial term of 10 years which may be renewed for an additional 10 years and provide that the franchisee will have the right to operate a franchise at a specific location. The franchisees generally sell products approved for sale which may be purchased from the Company. Some franchisees have agreed to purchase certain manufacturers' products only from the Company. The Company may terminate the franchise agreement, subject to termination requirements under state franchise laws, either upon the occurrence of certain specified events or upon 30 days' notice of certain defaults by the franchisee. Certain franchisees may terminate the agreement with or without cause, at any time upon 60 days' prior written notice to the Company. Franchisees operating under TCBC or Entre marks are subject to certain restrictions against competition following termination.\nThe Company also sells products to various members of the Network who do not sign franchise agreements and, therefore, are not entitled to conduct business under any of the Company's trademarks but are permitted to purchase certain products from the Company at competitive prices and terms.\nIn addition, members of the Network can participate in various supplemental programs offered by the Company and obtain the right to use other proprietary service marks of the Company including \"Intelligent Systems Group\" or \"ISG,\" \"Business Technology Centers\" or \"BTC,\" and \"Minority Technical Alliance\" or \"MTA.\"\nDuring the fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993, FNOW accounted for approximately 16%, 16% and 10%, respectively, of the Company's revenues from continuing operations. See Note 4 to the Company's Consolidated Financial Statements for the year ended January 28, 1995. The Company is not dependent for a material part of its business upon any other member of the Network, and the loss of any other Network member would not have a material adverse effect on the Company's financial condition.\nProducts\nThe Company currently markets technology products consisting of microcomputer systems, workstations, networking and telecommunications equipment and software. The Company's product acquisition staff selects products on the basis of overall quality, product image, technological capability, and business applications, as well as the pricing, discount, marketing and rebate programs offered by the manufacturer which enable the Company, and in turn the Network, to benefit from quantity purchasing economies. The Company currently distributes products of approximately 100 vendors, principally COMPAQ Computer Corporation (\"COMPAQ\"), Hewlett-Packard Company (\"Hewlett-Packard\"), Apple Computer, Inc. (\"Apple\"), International Business Machines Corporation (\"IBM\"), NEC Technologies, Inc., Toshiba America Information Systems, Inc., Microsoft Corporation, Epson America, Inc., Novell, Inc., Digital Equipment Corporation, American Telephone and Telegraph Company and Lotus Development Corporation.\nIn the past, certain vendors of the Company required resellers to purchase products from only one source. These vendors have changed their policy, allowing \"open sourcing,\" which permits resellers to purchase products from more than one source. As a result of open sourcing, competitive pricing pressures throughout the industry have intensified and customer loyalty has been reduced. In response to open sourcing and to enhance other services, the Company has broadened the selection of computer technology products stocked in its central warehouses. Products which the Company added to its existing assortment include advanced technology central processing units, an expanded offering of peripheral devices and certain software. Inventory levels increased in support of this enhanced product offering and higher sales volume. These lines typically require expanded inventory levels and a longer sell through cycle.\nThe Company's agreements with its major vendors permit it to purchase products from them for sale to Network members which are directly authorized by such vendors to sell products. In some cases, specific products from the major vendors may be sold to Network members which do not have specific authorization from the vendors. The vendor agreements are subject to termination by the vendors without cause on varying notice periods, and are subject to periodic renewals or re-authorization by the vendors. The termination or non-renewal of an agreement with a major vendor could have a material adverse effect on the Company.\nUnder the agreements with the vendors, products may be returned to vendors at restocking fees ranging up to 5%. The agreements generally provide for price adjustments for specified periods which protect the Company in the event of price reductions by the vendor. The Company administers certain vendors' price adjustment programs for the benefit of the Network. In 1994, the Company instituted a policy allowing members of the Network to return certain manufacturers' products, without a restocking fee, within fifteen days of purchase. After fifteen days, the Company charges restocking fees ranging up to 10%. In addition, the Company has favorable volume purchase agreements with major industry distributors, under which members of the Network may purchase items not supplied by the Company directly from the distributors at advantageous prices and terms.\nProducts from certain of these manufacturers comprised the following percentages of the Company's revenues during the years ended January 28, 1995, January 29, 1994 and January 30, 1993:\nCompetition\nCompetition in the microcomputer products market is intense, principally in the areas of price, breadth of product line, product availability and technical support and service. The Company and its Network compete with computer aggregators, distributors and retailers in the sale of its products. Additionally, several manufacturers have expanded their channels of distribution, pricing and product positioning and compete with the Company and its Network. The Company believes that the pricing and product availability offered to it by its vendors are at least as favorable as are offered to its competitors, which enables the Company and the Network to compete favorably with their competitors in terms of pricing and product availability. In addition, the Company develops customized value-add programs for its Network, including programs to develop channel markets, such as the market for advanced technology products, or to target certain end- users seeking to purchase products from minority-owned businesses, which enhance the competitiveness of the Network. The Company also provides technical support and service programs which it believes contribute favorably to the competitiveness of the Network.\nThe Company is also subject to competition from other aggregators in recruiting and retaining Network members, as well as competition from distributors in its efforts to sell products to the Network. The Company believes that its pricing and value-add programs and services allow it to compete effectively. Certain competitors may have greater financial resources than the Company.\nTrademarks and Service Marks\nThe service marks \"Todays Computers Business Centers,\" \"TCBC,\" \"Entre,\" \"Entre Computer Center,\" \"Connecting Point, \"Intelligent Systems Group,\" \"ISG,\" \"BTC Business Technology Center,\" \"Minority Business Alliance\" and the design of the Entre Computer Center logo are in use and (except for the logo) are currently registered or are in the process of registration in the United States Patent and Trademark Office by the Company. Although the marks are not otherwise registered with any states, the Company claims common law rights to the marks based on adoption and use. To the Company's knowledge, there are no pending interference, opposition or cancellation proceedings, or litigation, threatened or claimed, with respect to the marks in any jurisdiction. The Company holds no patents. Management believes that the Company's marks are valuable; however, the loss of use of any of the marks would not have a material adverse effect on the Company's business.\nGovernment Regulation\nThe Company is subject to Federal Trade Commission regulations governing disclosure requirements in the sale of franchises. The Company is also subject to a substantial number of United States and state laws regulating franchise operations. For the most part, such laws impose registration and disclosure requirements on the Company in the offer and sale of franchises and also regulate related advertisements. In certain states, there are substantive laws or regulations affecting the relationship between the Company and the franchisees, especially in the area of termination of the franchise agreement. The Company believes it is currently and has been in the past in substantial compliance with all such regulations.\nExecutive Officers of the Company\nThe executive officers of the Company are as follows:\nRichard D. Sanford has been the Company's Chairman and Chief Executive Officer since he founded the Company in May 1982.\nGregory A. Pratt joined the Company in March 1992 as Executive Vice President and was appointed President and Chief Operating Officer of the Company shortly thereafter. Prior to joining the Company, Mr. Pratt served as President of Atari Computer Corporation and Vice President of Finance and Chief Financial Officer of Atari Corporation. He also served on the Board of Directors of Atari Corporation and was a member of the Board's Executive Committee.\nRobert P. May joined the Company in November 1993 as Senior Vice President. Prior to joining the Company, Mr. May was a Senior Vice President of Federal Express Corporation and was President of Federal Express' Business Logistics Services Division. In his 20-year career with Federal Express, Mr. May served in a number of executive operations and corporate management positions.\nMark R. Briggs joined the Company as Vice President and Chief Financial Officer in March 1990 and became Vice President and Chief Operating Officer, Franchise Division (now Demand Generation) in December 1991. In February 1994, Mr. Briggs was elected Senior Vice President of the Company and Chief Executive Officer of Demand Generation. Prior to joining the Company, Mr. Briggs held various positions with Ingram-Micro D, Inc. (a distributor of microcomputer products), including Senior Vice President and Chief Financial Officer.\nTimothy D. Cook joined the Company as Senior Vice President - Fulfillment in October 1994. Prior to joining the Company, Mr. Cook held various positions at IBM since 1983, including Director of Brand Management and Site Services, and Director of North American Fulfillment for the IBM PC Company.\nEdward A. Meltzer became Chief Financial Officer in March 1992 and held the position of Treasurer of the Company from January 1989 to May 1993 and Vice President since August 1990. Mr. Meltzer served as Treasurer of Entre from January 1987 until its acquisition by the Company.\nStephanie D. Cohen was elected Vice President, Secretary and Treasurer in May 1993 and held the position of Vice President, Investor Relations of the Company from March 1991 to May 1993. Ms. Cohen joined the Company in 1987 as Controller, and served as Director, Investor Relations from March 1989 until March 1991.\nEmployees\nAs of January 28, 1995, the Company had 1,162 full-time employees. No employee is represented by a labor union and the Company believes that its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTY\nThe Company currently distributes products from four leased facilities in the United States. One distribution center is located in approximately 488,000 square feet of leased warehouse space in Memphis, Tennessee, under a lease which expires in February 2005. The remaining distribution centers are located in the Denver, Colorado area which total approximately 456,000 square feet of space under leases expiring no later than December 1995.\nThe Company leases approximately 31,000 square feet in Exton, Pennsylvania, primarily for its principal executive offices, the occupancy of which commenced in May 1989, for a term expiring in June 1997 and approximately 122,000 square feet in the Denver, Colorado area, primarily for its Demand Generation offices, under a lease expiring in December 2001. In addition, the Company leases facilities for its branch locations in five major metropolitan cities in the United States. The Company believes that its facilities are adequate for its present needs.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn December 1994, several purported class action lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania (Civil Action Nos. 94-3753, 94-CV-7410, 94-CV-7388, and 94-CV-7405) against the Company and certain directors and officers; these lawsuits have been consolidated with a class action lawsuit filed several years ago against the Company, certain directors and officers, and the Company's auditors (who are not named in the most recent complaint) in the United States District Court for the Eastern District of Pennsylvania (Civil Action No. 92-CV-1905). A purported derivative lawsuit was also filed in December 1994 in the Court of Common Pleas of Philadelphia County (No. 803) against the Company and certain of its directors and officers. These lawsuits allege violations of certain disclosure and related provisions of the federal securities laws and breach of fiduciary duties, including allegations relating to the Company's practices regarding vendor marketing funds, and seek damages in unspecified amounts as well as other monetary and equitable relief. In addition, the Company has been contacted by the Philadelphia office of the Securities and Exchange Commission regarding a preliminary, informal inquiry. The Company believes that all such allegations and lawsuits are without merit and intends to defend against them vigorously. While management of the Company, based on its investigation of these matters and consultations with counsel, believes resolution of these matters will not have a material adverse effect on the Company's financial position, the ultimate outcome of these matters cannot presently be determined.\nIn addition, the Company is involved in various litigation and arbitration matters in the ordinary course of business. The Company believes that it has meritorious defenses in and is vigorously defending against all such matters.\nDuring fiscal 1994, based in part on the advice of legal counsel, the Company established a reserve of $9 million in respect of all litigation and arbitration matters. Although the aggregate amount of the claims may exceed the amount of the reserve, management believes that the resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations in any subsequent period.\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 over-the-counter in the Nasdaq National Market (symbol INEL). As of March 31, 1995, there were 865 shareholders of record.\nSet forth below is the range of the high and low sale prices for the Company's common stock as reported by Nasdaq during each fiscal quarter within the two most recent fiscal years:\nQuarter ended High Low ---------------- -------- -------- January 28, 1995 $ 17 $ 7 1\/2 October 29, 1994 $ 18 1\/8 $ 13 7\/8 July 30, 1994 $ 23 1\/4 $ 13 5\/8 April 30, 1994 $ 27 3\/8 $ 18 1\/2 January 29, 1994 $ 28 $ 21 1\/8 October 30, 1993 $ 24 3\/8 $ 15 July 31, 1993 $ 16 1\/4 $ 12 1\/4 May 1, 1993 $ 15 3\/8 $ 12\nThe Company instituted a quarterly dividend of $0.08 per share in the second quarter of fiscal 1993. On June 1, 1993, the Company paid a one-time special cash dividend of $2.00 per share. In the second quarter of fiscal 1994, the quarterly dividend was increased to $0.10 per share.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Continuing Operations\nFiscal 1994 Compared to Fiscal 1993 - - - ----------------------------------- Revenues for the year ended January 28, 1995 (\"fiscal 1994\") were $3.2 billion compared to $2.6 billion for the year ended January 29, 1994 (\"fiscal 1993\"), representing an increase of 21%. The addition of new network integrators and continued demand from existing network integrators for premium brand name and advanced technology products were primarily responsible for the increase in revenues. However, the Company believes that operating inefficiencies caused by systems stresses and outages, discussed below, during the last half of fiscal 1994 caused a loss of potential sales.\nGross profit as a percentage of revenues decreased to 4.1% for fiscal 1994 compared to 4.4% for fiscal 1993. The decrease in gross margin percent is primarily attributable to intensified competitive pricing pressures as certain manufacturers expanded their distribution channels and the impact of management information systems stresses and outages, offset in part by the higher volume of revenues generated from higher margin advanced technology products and taking advantage of purchasing and early payment discount opportunities. The systems-related stresses and outages were caused by the cumulative effect of operating out of multiple warehouses, the addition of new vendors and SKU's and the expansion of on-line services to the Company's network integrators. This resulted in reduced customer service levels and unfavorably impacted gross margins as the Company reduced prices to customers, incurred inventory losses and incurred additional freight costs to expedite shipments. Although the Company does not expect the inventory-related losses to recur, it believes that the other factors adversely impacting gross margins are likely to continue for the foreseeable future.\nSelling, general and administrative expenses increased to $96.2 million (3.0% of revenues) for fiscal 1994 from $52.5 million (2.0% of revenues) for fiscal 1993. The increase was primarily due to costs to service the higher volume of revenues and to support new programs, vendors and SKU's; systems stresses and outages and related inefficiencies; a $9 million reserve for litigation and arbitration matters; and approximately $9 million of costs incurred in connection with the elimination of certain peripheral ventures noted below and the implementation of IE 2000, including costs associated with personnel reductions, closing and consolidating facilities, relocating personnel and consultant fees. IE 2000 is a project designed to transform the Company to a process-driven model. The Company expects future annualized cost savings of approximately $10 million as a result of IE 2000 together with the elimination of certain peripheral ventures. The Company expects costs associated with the transformation project and operating inefficiencies to continue through the middle of fiscal 1995.\nDuring fiscal 1994, the Company closed its cable television programming operation, discontinued its direct fulfillment agreement with a third-party and sold substantially all of its wireless telecommunications operation. In fiscal 1994 and fiscal 1993, revenues from these eliminated peripheral ventures were less than 1% of consolidated revenues and operating losses were $4.3 million and $1.3 million, respectively. These eliminations were substantially completed in the fourth quarter of fiscal 1994.\nInvestment and other income decreased from fiscal 1993 to fiscal 1994 primarily due to less investable cash as a result of the use of the Company's available cash for payment of common stock dividends and repurchases of its common stock. Interest expense increased as the Company used its available inventory financing arrangements to finance inventory purchases.\nDuring fiscal 1994, The Future Now, Inc. (\"FNOW\") announced the implementation of a company-wide restructuring, which included the closing and consolidation of duplicate facilities. For fiscal 1994, the Company recognized an after-tax loss of $13 million as its equity in FNOW's net loss compared to after-tax income of $1.7 million for fiscal 1993 (See Note 4 to the consolidated financial statements).\nThe Company's effective tax rate increased to 39.7% for fiscal 1994 compared to 38.2% for fiscal 1993. The impact of non-deductible goodwill amortization on lower pre-tax earnings, partially offset by a reduction in the Company's effective state tax rate, was primarily responsible for this increase.\nThe Company does not expect significant revenue growth in fiscal 1995 as it continues to concentrate on increasing product margins and upgrading systems. Gross profit and selling, general and administrative expenses are expected to increase both in amount and as a percentage of revenues if the Company's proposed acquisition of FNOW is completed (See Note 4).\nFiscal 1993 Compared to Fiscal 1992 - - - ----------------------------------- Revenues increased 31% to $2.6 billion in fiscal 1993 from $2 billion for the year ended January 30, 1993 (\"fiscal 1992\"). The increase was due primarily to the addition of new network members and increased revenues from existing members led by continued strong demand for premium computers and peripherals, despite the inability of certain manufacturers to supply certain products, offset in part by the sale of the Company Center Division (\"CCD\") in May and July 1992 (See Note 4).\nGross profit as a percentage of revenues for fiscal 1993 was 4.4% compared to 5.1% for fiscal 1992. This decline was primarily attributable to the sale of CCD which realized higher gross margins than the Company realizes on wholesale revenues and continued competitive pressures throughout the microcomputer industry. The Company reported fourth quarter gross margin percent of 4.6% as gross margin percent increased throughout fiscal 1993 as a result of taking advantage of purchasing opportunities and the introduction of new services and programs.\nSelling, general and administrative expenses decreased and as a percentage of revenues declined from 2.6% in fiscal 1992 to 2.0% in fiscal 1993. The elimination of costs related to CCD (which had proportionately higher operating costs than those associated with wholesale operations) in July 1992 accounted for most of the reduction, offset by cost increases to service the larger network, higher volume of revenues and new programs. These increases were at a lower rate than the growth in revenues causing the decline in selling, general and administrative expenses as a percentage of revenues.\nAmortization of intangibles decreased in fiscal 1993 compared to fiscal 1992 due to the elimination of goodwill included in CCD's net assets sold to FNOW.\nInvestment and other income was $5.1 million in fiscal 1993 compared to $0.5 million in fiscal 1992. This increase was due primarily to income earned on investing the proceeds from the sale of BizMart. Interest expense decreased primarily as a result of the early repayment of the Subordinated Notes in January and February 1993 and the reduced use of inventory financing.\nThe Company's equity interest in earnings of its affiliate increased to $1.7 million from $0.7 million. This increase was due to the inclusion of the Company's equity in FNOW's earnings for a full year and increased earnings by FNOW in fiscal 1993.\nThe effective tax rate for fiscal 1993 was 38.2% compared to 44.1% in fiscal 1992. Higher pre-tax earnings and tax-exempt investment income in fiscal 1993 and the impact of the incremental tax charge related to the sale of CCD in fiscal 1992, offset by a rise in the Company's effective state tax rate, were primarily responsible for the decrease.\nIncome from continuing operations for fiscal 1993 was $41.1 million compared to $22.1 million for fiscal 1992 due to the factors described above.\nResults of Discontinued Operation and Sale of BizMart\nAs discussed more fully in Note 3 to the consolidated financial statements, on June 19, 1991, the Company acquired BizMart, a national chain of office products supercenters, which operated in a separate industry segment from the Company's other subsidiaries. On March 4, 1993, the Company completed the sale of BizMart to OfficeMax, Inc. Accordingly, results of BizMart's operations are classified as a discontinued operation.\nDuring fiscal 1993, BizMart operations resulted in pre-tax losses totaling $3.5 million compared to pre-tax losses of $27.1 million in fiscal 1992. Contributing to such losses were adjustments to the carrying value of certain assets, including inventory repurchased from franchisees.\nLiquidity and Capital Resources\nThe Company has financed its growth to date from stock offerings, bank and subordinated borrowings, inventory financing and internally generated funds. The principal uses of its cash have been to fund its accounts receivable and inventory, make acquisitions, repurchase common stock and pay cash dividends.\nDuring fiscal 1994, cash generated from operating activities totaled $23.3 million compared to $8.2 million in fiscal 1993. At January 28, 1995, the Company had cash and cash equivalents of $69.0 million ($122.2 million at January 29, 1994) and marketable securities available for sale totaling $8.4 million ($61.1 million at January 29, 1994). Working capital totaled $31.9 million at January 28, 1995 compared to $105.3 million at January 29, 1994. This decrease is primarily a result of common stock repurchases and dividends during the year. New financing programs offered by the Company and its expanded selection and higher levels of inventory have increased working capital requirements. During fiscal 1994, days sales in accounts receivable averaged 4.5 days (1.9 days in fiscal 1993) and inventory turnover averaged 8.4 times (11.8 times in fiscal 1993). The increase in accounts receivable from January 29, 1994 to January 28, 1995 is due primarily to the acquisition of certain branch locations from FNOW and the extension of credit to the Company's network and end-users. The Company expects accounts receivable to increase as the Company continues to extend credit to its network and end- users. The Company may outsource some of its financing programs which could slow the growth or reduce the level of accounts receivable. The Company also has a $170 million financing agreement with a finance company. At January 28, 1995, the Company had $106.8 million available from this facility. On October 22, 1993, the Company executed a $20 million guarantee to an inventory finance company on behalf of FNOW. This guarantee remained in place at January 28, 1995.\nOn January 27, 1995, the Board of Directors declared a cash dividend of $0.10 per share to shareholders of record on February 15, 1995, which was paid on March 1, 1995. During fiscal 1994, the Company declared cash dividends totaling $0.38 per share.\nThe Board of Directors has authorized the repurchase, in open-market transactions, of up to 13.6 million shares of the Company's common stock. As of January 28, 1995, the Company had repurchased approximately 8.3 million shares at a cost of approximately $105.7 million, of which approximately 4.1 million shares were repurchased at a cost of approximately $48.5 million during fiscal 1994.\nThe Company's transformation project, IE 2000, is expected to be completed by the end of fiscal 1996 and is estimated to cost approximately $40 million, primarily due to upgrades in its management information systems, including costs of approximately $8 million through January 28, 1995.\nBased on the Company's current level of operations and capital expenditure requirements, management believes that the Company's cash and marketable securities, internally generated funds and available financing arrangements and opportunities will be sufficient to meet the Company's cash requirements for the foreseeable future.\nInflation and Seasonality\nThe Company believes that inflation has not had a material impact on its operations or liquidity to date. The Company's financial performance does not exhibit significant seasonality, although certain computer product lines follow a seasonal pattern with peaks occurring near the end of the calendar year.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of Intelligent Electronics, Inc. and its subsidiaries, listed in the index appearing under Item 14(a)(1) are filed as part of this annual report on Form 10-K.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors and Shareholders Intelligent Electronics, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 28 present fairly, in all material respects, the financial position of Intelligent Electronics, Inc. and its subsidiaries at January 28, 1995 and January 29, 1994 and the results of their operations and their cash flows for each of the three years in the period ended January 28, 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\nPhiladelphia, Pennsylvania April 12, 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.\nINTELLIGENT ELECTRONICS, INC. and Subsidiaries\nNotes to Consolidated Financial Statements\n(Dollars in thousands except share-related data)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness - - - -------- Intelligent Electronics, Inc. (the \"Company\") provides information technology products, services and solutions to its network of more than 2,500 integrators (\"Network\"), and to large and small corporate customers, educational institutions and governmental agencies. As a leading supplier of premium brand technology products in the United States, the Company provides business solutions to its customers through innovative product management, sales demand generation programs and logistics services. The principal products sold by the Company include microcomputer systems, workstations, networking and telecommunications equipment and software. On March 4, 1993, the Company sold BizMart, Inc. (\"BizMart\") and accordingly, BizMart is treated as a discontinued operation in the accompanying financial statements (See Note 3). Unless otherwise indicated, amounts and disclosures referred to herein relate to continuing operations.\nPrinciples of Consolidation - - - --------------------------- The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.\nDefinition of Fiscal Year - - - ------------------------- The fifty-two week periods ended January 28, 1995, January 29, 1994 and January 30, 1993 are referred to herein as \"fiscal 1994,\" \"fiscal 1993\" and \"fiscal 1992,\" respectively.\nCash, Cash Equivalents and Marketable Securities - - - ------------------------------------------------ Cash and cash equivalents comprise the Company's cash balances and short-term investments with an initial maturity of less than ninety days and include money-market funds, commercial paper and repurchase agreements. Short-term investments totaled $69,548 and $121,956 at January 28, 1995, and January 29, 1994, respectively. With respect to repurchase agreements, the Company requires specific assignment of securities as collateral for such investments, but does not take possession of the collateral. The carrying amount of cash, short-term investments and marketable securities approximates fair market value due to the short-term maturity of these instruments.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115 (\"FAS 115\"), Accounting for Certain Investments in Debt and Equity Securities, effective for fiscal years beginning after December 15, 1993. FAS 115 requires certain investments in debt and equity securities be classified into one of three categories: held- to-maturity, available-for-sale, or trading. The Company adopted FAS 115 on January 30, 1994. Adoption of this statement did not have a material effect on the financial position or results of operations of the Company; however, certain amounts in the January 29, 1994 Consolidated Balance Sheet have been reclassified for comparative purposes.\nInventory - - - --------- Inventory consists of microcomputers, related peripheral products and software, and is valued at the lower of cost (first-in, first-out) or market.\nProperty and Equipment - - - ---------------------- Property and equipment are carried at cost. The cost of additions and improvements is capitalized, while maintenance and repairs are charged to operations when incurred. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets (three to ten years). Leasehold improvements are amortized over the shorter of their useful lives or the remaining lease term. Leases meeting the capitalization requirements of FAS 13 are capitalized and depreciated over the lease term. Depreciation expense totaled $5,351 ($1,154 included in cost of goods sold), $4,558 ($783 included in cost of goods sold) and $3,680 for fiscal 1994, 1993 and 1992, respectively. Accumulated depreciation totaled $14,791 at January 28, 1995 and $14,872 at January 29, 1994.\nIE 2000 is a project designed to transform the Company to a process-driven model. Certain costs associated with IE 2000, including purchased software, outside consulting fees for custom software development and related incremental internal costs are being capitalized and will be amortized over the estimated useful life of the software. Approximately $8 million was capitalized pursuant to IE 2000 at January 28, 1995. The project is expected to be completed by the end of fiscal 1996.\nGoodwill - - - -------- Goodwill, resulting from acquisitions accounted for under the purchase method, is amortized using the straight-line method generally over a 20-year period.\nRevenue Recognition - - - ------------------- Revenue is recognized upon shipment of products or performance of services. Revenue from the granting of individual franchises is recognized when all significant obligations have been performed. Revenues and total operating costs related to company-owned centers were $9,897 and $10,197, respectively for fiscal 1994 (See Note 2), and $86,223 and $85,212, respectively, for fiscal 1992 (See Note 4). Funds received from vendors for marketing programs and product rebates are accounted for as revenue, a reduction of selling, general and administrative expenses or product cost according to the nature of the program.\nInvestment and Other Income - - - --------------------------- Investment income includes interest and dividend income and realized gains and losses on marketable securities. Total interest and dividend income was $4,062, $5,241 and $1,086 for fiscal 1994, fiscal 1993 and fiscal 1992, respectively.\nIncome Taxes - - - ------------ The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (\"FAS 109\"). Pursuant to FAS 109, deferred tax assets and liabilities are recorded for temporary differences which enter into the determination of taxable income in different periods for financial reporting and income tax purposes.\nEarnings Per Share - - - ------------------ Primary earnings per share is computed using the weighted average number of common shares and dilutive common share equivalents outstanding based on the average market price during the period. The amount of dilution is computed by application of the treasury stock method. Fully diluted earnings per share is computed in substantially the same manner, but includes the dilutive effect of all issuable shares, based on the market price at the end of the period, whether or not they are common share equivalents. Treasury stock transactions are recorded on their trade date and reduce weighted average shares outstanding from that date.\n(2) ACQUISITIONS\nOn December 30, 1994, the Company purchased certain assets of branch locations in five major-metropolitan cities from The Future Now, Inc. (\"FNOW\"), an equity affiliate, member of the Network and publicly traded company (See Note 4). The aggregate purchase price was approximately $39,101 and was accounted for by the purchase method. The aggregate purchase price was allocated to the assets and liabilities assumed based on their estimated fair market values as follows:\nAccounts receivable $ 23,000 Inventory 4,936 Property and equipment 2,714 Goodwill 8,838 Other assets 13 Other current liabilities (400) --------- Total purchase price $ 39,101 =========\nThese locations are operated by FNOW under a management agreement. The acquisition of these locations had no material effect on the consolidated results of operations in fiscal 1994.\n(3) DISCONTINUED OPERATION AND SALE OF BIZMART\nOn June 19, 1991, the Company acquired BizMart, a national chain of office products supercenters, for an aggregate purchase price of $195,796 including transaction costs. BizMart operations included the sale of traditional office products, microcomputers and related equipment. The Company accounted for the acquisition using the purchase method. On March 4, 1993, the Company sold BizMart to OfficeMax, Inc. (\"OfficeMax\") and received a cash payment totaling $275,236, including the purchase price, as defined, of $269,770 and repayment of other amounts, consisting principally of intercompany advances after November 28, 1992. The aggregate sale proceeds less the carrying value of net assets sold and costs related to the sale resulted in a gain before tax of $5,582. The effective tax rate for the sale of BizMart varies from the effective tax rate for the discontinued operation due to differences between the tax bases of assets sold and their amounts for financial reporting purposes.\nResults of BizMart's operations have been reported separately as a discontinued operation in the accompanying Consolidated Statement of Operations. BizMart's operating results excluded from continuing operations are summarized as follows:\nFiscal Fiscal 1993 1992 ---------- ----------- Net sales $ 60,193 $ 634,962 Costs and expenses 63,737 662,086 ---------- ----------- Loss before taxes (3,544) (27,124)\nIncome tax benefit (1,076) (6,964) ---------- ----------- Loss from discontinued operation $ (2,468) $ (20,160) ========== ===========\nBizMart was included in the consolidated federal and certain state income tax returns of the Company. For financial reporting purposes, income tax expense (benefit) was provided on a separate return basis except that the benefit of net operating losses was measured on a consolidated basis.\n(4) SALE OF COMPANY CENTER DIVISION AND INVESTMENTS IN AFFILIATES\nOn May 15, 1992, the Company sold certain assets of its Bellevue, WA center to Random Access, Inc. (\"RA\"), a member of the Network and publicly traded company. The consideration received consisted of $400 cash and 92,500 (as adjusted for a reverse two-for-one stock split on June 28,1993) newly issued unregistered shares representing approximately 1% of RA common stock. The Company accounts for its investment in RA common stock as available-for-sale in accordance with FAS 115, and accordingly, the carrying value is recorded at fair market value with changes in fair value recorded in shareholders' equity. At January 28, 1995, the aggregate market value, based on RA's quoted market price, of the Company's investment in RA was approximately $278.\nOn July 2, 1992, the Company sold substantially all of the remaining operations of its Company Center Division (\"CCD\") to FNOW. The consideration received by the Company consisted of 1,638,377 newly issued unregistered shares of FNOW valued at $16,589, or $10.12 per share, repayment of intercompany obligations ($27,850), warrants valued at $263 to purchase 184,498 shares of FNOW common stock at an average exercise price of $10.06 per share, and a cash payment of $1,940.\nThe aggregate sale proceeds from the above transactions less the carrying value of net assets sold and costs related to the sales resulted in a gain before tax of $43. An incremental tax charge of approximately $1,700, arising from differences between the tax bases of assets sold and their amounts for financial reporting purposes, is included in the Company's provision for income taxes for fiscal 1992.\nIn March 1993, FNOW completed a public offering which reduced the Company's equity interest in FNOW to 24.3%. In October 1993, the Company purchased an additional 681,447 newly issued unregistered shares of FNOW raising the Company's equity interest to 31.1%. The Company accounts for its investment in FNOW using the equity method. At January 28, 1995, the carrying value of the Company's investment in FNOW was approximately $17,852 and the aggregate market value, based on FNOW's quoted market price, was approximately $10,841, which management views as a temporary decline in value.\nSummarized financial information for FNOW is as follows:\nFiscal Fiscal 1994 1993 ---------- ---------- Current assets $ 181,377 $ 223,850 Non-current assets 48,000 66,709 Current liabilities 193,263 132,150 Non-current liabilities 2,825 80,649 Revenues 795,736 701,834 Gross profit 116,946 113,489 Net income (loss) (44,988) 9,303\nThe Company sells products to FNOW pursuant to a franchise agreement which expires in the year 2000. This agreement may be terminated by FNOW upon 90 days notice and payment of certain amounts. During fiscal 1994, 1993 and 1992, sales to FNOW approximated $506,000, $427,000 and $212,000, respectively, representing approximately 16%, 16% and 10%, respectively, of the Company's consolidated revenues from continuing operations.\nOn March 6, 1995, the Company signed a letter of intent to acquire all the remaining shares of FNOW, in a stock-for-stock merger transaction. Based on the exchange ratio set forth in the letter of intent, FNOW shareholders will receive .6588 shares of the Company's common stock in exchange for each share of FNOW. The transaction is subject to the completion of due diligence, the execution of a definitive agreement and other customary conditions and approvals, including approval by FNOW's shareholders.\n(5) CREDIT FACILITIES\nOn April 18, 1989, the Company issued to certain institutional investors Subordinated Notes in the aggregate principal amount of $30,000 and used net proceeds therefrom to reduce existing borrowings and for working capital purposes. Interest on the Subordinated Notes was payable quarterly at 13.25% per annum. On January 11, 1993 and February 24, 1993, the Company prepaid principal of $12,500 and $17,500, respectively, to retire the Subordinated Notes in full. Pursuant to terms outlined in the Subordinated Notes Agreement, the Company paid accrued interest and a prepayment premium totaling $4,454 in connection with the early repayment of the Subordinated Notes. The prepayment premium, together with unamortized deferred financing costs and loan discount are reflected as an extraordinary item, net of the related tax benefit, in the Consolidated Statement of Operations in fiscal 1992.\nThe Company and its subsidiaries have agreements with various lenders and other creditors to finance product purchases from vendors and for working capital requirements. Amounts outstanding for inventory financing are included in accounts payable on the Consolidated Balance Sheet. One such agreement with a finance company provides a total credit line of $170,000 for both inventory financing and general working capital requirements. Approximately, $106,800 and $23,200 were available under this credit line at January 28, 1995 and January 29, 1994, respectively. In connection with these arrangements, such creditors have a lien on all of the Company's assets at January 28, 1995. In addition, certain of these arrangements impose financial covenants relating to working capital, net worth, current ratio, liabilities to net worth and earnings.\n(6) LEASE OBLIGATIONS\nThe Company has noncancelable operating leases for offices, warehouse facilities, and equipment that expire over the next ten years. Most of the facilities' leases include renewal options and certain of the equipment leases have purchase options. Rent expense recorded for fiscal 1994, fiscal 1993 and fiscal 1992 amounted to $6,020, $3,836, and $3,947, respectively.\nFuture minimum lease payments under noncancelable operating leases are as follows:\nFiscal Year Amount ----------- -------- 1995 $ 6,258 1996 5,056 1997 4,450 1998 4,122 1999 4,122 Thereafter 12,979\nThe Company is guarantor of certain real estate leases of BizMart. OfficeMax has indemnified the Company against potential losses which may result pursuant to such guarantees.\n(7) CAPITAL STOCK\nOn April 18, 1989, in connection with the issuance of the Subordinated Notes (See Note 5), the Company granted warrants for the purchase of 1,200,000 shares of common stock at an exercise price of $4.75 per share, exercisable until April 30, 1995, subject to adjustment under certain circumstances. The value of these warrants ($1,090) was credited to paid-in capital and was charged to interest expense over the term of the loan. Shares of the Company's common stock have been issued pursuant to the exercise of 120,000 warrants during fiscal 1993, 40,000 warrants during fiscal 1992 and the remaining 1,040,000 warrants prior to fiscal 1992.\nThe Board of Directors of the Company has authorized the repurchase of up to 13.6 million shares, in open-market transactions, of its common stock. As of January 28, 1995, the Company has repurchased approximately 8.3 million shares at a cost of approximately $105,677.\nStock Options - - - ------------- The Company has a non-qualified stock option plan for employees and directors which permits the granting of options to purchase an aggregate of eight million shares of common stock to employees and directors of the Company. This plan is intended to provide an incentive for employees to maximize their efforts and enhance the success of the Company. Options are generally granted at option prices equivalent to fair market value on the date of grant. The options are generally exercisable commencing one year after the date of grant in five equal annual installments (unless otherwise provided in the grant) and expire six to ten years after the date of grant, subject to earlier termination and other rules relating to the cessation of employment.\nChanges in stock options are summarized as follows:\nNumber of Option price shares Range per share ---------- --------------- Balance outstanding February 1, 1992 4,956,400 $ 1.25-$15.50 Granted 450,000 $10.25-$24.25 Exercised (278,860) $ 1.25-$11.50 Canceled (891,240) $ 2.85-$24.25 ----------\nBalance outstanding January 30, 1993 4,236,300 $ 1.56-$15.50 Granted 1,014,100 $15.00-$24.88 Exercised (1,977,160) $ 1.56-$15.50 Canceled (666,300) $ 5.81-$17.00 ----------\nBalance outstanding January 29, 1994 2,606,940 $ 2.85-$24.88 Granted 945,300 $13.25-$24.00 Exercised (208,070) $ 2.85-$15.50 Canceled (233,780) $ 7.63-$24.00 --------- Balance outstanding January 28, 1995 3,110,390 $ 5.75-$24.88 =========\nAs of January 28, 1995, there were 972,858 options exercisable under the employee and director stock option plan at exercise prices ranging from $5.75 to $24.88 per share.\nOn February 25, 1995, the Board of Directors of the Company authorized the repricing of all outstanding options with exercise prices in excess of $13.25 per share to $13.25 per share. As of that date, 2,067,370 options were repriced, of which 345,158 were exercisable at January 28, 1995.\nThe Company also has a non-qualified stock option plan which permits the granting of options to purchase an aggregate of two million shares of common stock to franchisees of the Company. This plan is intended to reward franchisees' performance and commitment to the Company. Options are generally granted at option prices equivalent to fair market value on the date of grant. The options are generally exercisable commencing one year after the date of the grant in five equal annual installments. The options expire six years after the date of grant, subject to earlier termination and other rules relating to default under the terms of the franchise agreement. As of January 28, 1995, there were 141,635 options outstanding under this plan. Of this amount, 81,915 were exercisable at prices ranging from $5.81 to $14.75 per share.\nThe Company granted 200,000 options (100,000 each in May 1990 and May 1989) to an outside advisor to the Board of Directors of the Company with the same general terms and conditions as those in the non-qualified stock option plan for employees and directors. At January 28, 1995, 100,000 of these options were outstanding. In addition, 200,000 options were granted to an officer of BizMart in connection with the June 1991 acquisition, of which 50,000 were exercised on March 17, 1992 and 150,000 were exercised during fiscal 1993.\nAs of January 28, 1995, shares of common stock are reserved for issuance for the following purposes: Shares\nExercise of employee and director stock options 4,088,650 Exercise of franchisee stock options 1,933,435 Exercise of other stock options 100,000 --------- Total 6,122,085 =========\nIn April 1995, the Company's Board of Directors adopted the 1995 Long-Term Incentive Plan, subject to shareholder approval at the Annual Shareholders' Meeting to be held on or about June 8, 1995, permitting the grant of stock, stock-related and performance-based awards to employees and directors of the Company. A total of 5 million shares of the Company's common stock have been reserved for grant under the 1995 Long-Term Incentive Plan.\n8) INCOME TAXES\nThe provision for income taxes consists of the following:\nCurrent Deferred Total --------- -------- --------- Fiscal 1994 Federal $ 19,011 $ (5,923) $ 13,088 State 1,109 (344) 765 --------- -------- --------- Total $ 20,120 $ (6,267) $ 13,853 ========= ======== =========\nFiscal 1993 Federal $ 24,900 $ (2,916) $ 21,984 State 2,803 (344) 2,459 --------- -------- --------- Total $ 27,703 $ (3,260) $ 24,443 ========= ======== =========\nFiscal 1992 Federal $ 12,891 $ 3,191 $ 16,082 State 813 14 827 --------- -------- --------- Total $ 13,704 $ 3,205 $ 16,909 ========= ======== =========\nDeferred income tax balances, and the deferred component of the provision for income taxes, relate to the following cumulative temporary differences:\nJanuary 28, January 29, 1995 1994 ------------ ------------\nInventory $ 2,107 $ 1,879 Accounts receivable reserves 363 490 Acquisition and sale accruals 2,457 3,378 Employee benefits 851 834 Depreciation 592 537 Litigation and related contingencies 3,266 -- Other accruals 1,620 722 ------------ ------------ Deferred tax asset $ 11,256 $ 7,840 ============ ============\nDeferred gain on sale of CCD $ -- $ 989 Equity in earnings of affiliate -- 1,372 Other -- 429 ------------ ------------ Non-current deferred tax liability $ -- $ 2,790 ============ ============\nA reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:\nFiscal Fiscal Fiscal 1994 1993 1992 ----- ----- ----- Federal statutory rate 35.0% 35.0% 34.0% State income taxes, net of federal benefit 1.4 2.5 1.4 Amortization of intangibles 4.9 2.7 4.6 Basis difference from sale of CCD -- -- 4.6 Tax-exempt investment income (2.0) (2.1) -- Other 0.4 0.1 (0.5) ----- ----- ----- 39.7% 38.2% 44.1% ===== ===== =====\n(9) SUPPLEMENTAL CASH FLOW INFORMATION\nThe Company's non-cash investing and financing activities and cash payments for interest and income taxes were as follows:\nFiscal Fiscal Fiscal 1994 1993 1992 -------- -------- -------- Details of acquisitions: Fair value of assets acquired $ 39,501 -- -- Liabilities assumed 400 -- --\nDetails of other investing activities: Common stock and warrants received from sale of CCD -- -- $ 17,146\nDetails of other financing activities: Accrual for repurchase of common stock -- -- 9,090 Accrual of dividends declared 3,119 $ 2,809 --\nCash paid during the year for: Interest 1,518 767 10,099 Income taxes 19,865 22,833 11,559\n(10) MAJOR SUPPLIERS\nThe Company has authorized dealership or distributorship agreements with various manufacturers. Products from certain of these manufacturers comprised the following percentages of the Company's revenues during fiscal 1994, fiscal 1993 and fiscal 1992:\nFiscal Fiscal Fiscal 1994 1993 1992 ------- ------- ------- IBM Corp. 15% 15% 18% Compaq Computer Corp. 25% 25% 18% Apple Computer, Inc. 12% 18% 22% Hewlett-Packard Company 24% 22% 20%\n(11) EMPLOYEE BENEFIT PLAN\nThe Company has a 401(K) Tax Deferred Savings Plan (the \"Plan\") permitting eligible employees to defer a portion of their total compensation through contributions to the Plan. Until February 1992, the Company matched $0.50 for each dollar contributed by participants subject to certain limitations. Employer matching contributions were temporarily suspended during fiscal 1992 and were reinstated on February 1, 1993. The Company's contributions under the Plan for fiscal 1994, fiscal 1993 and fiscal 1992 were $426, $313 and $162, respectively.\n(12) COMMITMENTS\nThe Company and its subsidiaries have arrangements with five finance companies which provide inventory financing facilities for its Network. The Company monitors the financial stability of the finance companies and requires payment within two days of product shipment. If these arrangements are terminated, the Company would have to develop alternative financing arrangements. In conjunction with these arrangements, the Company has inventory repurchase agreements with the finance companies that would require it to repurchase certain inventory which might be repossessed from the Network by the finance companies. To date, such repurchases have been insignificant.\nOn October 22, 1993, the Company executed a $20 million guarantee to an inventory finance company on behalf of FNOW, which remained outstanding at January 28, 1995.\n(13) CONTINGENCIES\nIn December 1994, several purported class action lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania (Civil Action Nos. 94-3753, 94-CV-7410, 94-CV-7388, and 94-CV-7405) against the Company and certain directors and officers; these lawsuits have been consolidated with a class action lawsuit filed several years ago against the Company, certain directors and officers, and the Company's auditors (who are not named in the most recent complaint) in the United States District Court for the Eastern District of Pennsylvania (Civil Action No. 92-CV-1905). A purported derivative lawsuit was also filed in December 1994 in the Court of Common Pleas of Philadelphia County (No. 803) against the Company and certain of its directors and officers. These lawsuits allege violations of certain disclosure and related provisions of the federal securities laws and breach of fiduciary duties, including allegations relating to the Company's practices regarding vendor marketing funds, and seek damages in unspecified amounts as well as other monetary and equitable relief. In addition, the Company has been contacted by the Philadelphia office of the Securities and Exchange Commission regarding a preliminary, informal inquiry. The Company believes that all such allegations and lawsuits are without merit and intends to defend against them vigorously. While management of the Company, based on its investigation of these matters and consultations with counsel, believes resolution of these matters will not have a material adverse effect on the Company's financial position, the ultimate outcome of these matters cannot presently be determined.\nIn addition the Company is involved in various litigation and arbitration matters in the ordinary course of business. The Company believes that it has meritorious defenses in and is vigorously defending against all such matters.\nDuring fiscal 1994, based in part on the advice of legal counsel, the Company established a reserve of $9 million in respect of all litigation and arbitration matters. Although the aggregate amount of the claims may exceed the amount of the reserve, management believes that the resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations in any subsequent period.\n(14) QUARTERLY FINANCIAL DATA (unaudited)\nSelected quarterly financial data for fiscal 1994 and fiscal 1993, is as follows:\nThe sum of the quarterly net earnings per share amounts does not equal the annual amount reported, as per share amounts are computed independently for each quarter and for the full year based on respective weighted average common shares and share equivalents outstanding.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nThe information contained in the sections titled \"Election of Directors\" in the Proxy Statement for the Annual Shareholders' Meeting to be held on or about June 8, 1995 (the \"Proxy Statement\"), with respect to directors of the Company, and the information contained in the section titled \"Item 1. Business -Executive Officers of the Company\" in Part I of this Form 10-K, with respect to executive officers of the Company, are incorporated herein by reference in response to this item.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information contained in the section titled \"Executive Compensation\" in the Proxy Statement (other than the portion thereof contained under the headings \"Stock Performance Chart\" and \"Compensation and Stock Option Committee Report on Executive Compensation\"), with respect to executive compensation and the information contained in the section titled \"Director Compensation\" in the Proxy Statement with respect to Director compensation are incorporated herein by reference in response to this item.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained in the section titled \"Principal Shareholders and Holdings of Officers and Directors\" in the Proxy Statement, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference in response to this item.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained in the section titled \"Certain Relationships and Related Transactions\" in the Proxy Statement, with respect to certain relationships and related transactions, is incorporated herein by reference in response to this item.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report :\n(1) Financial statements:\nReport of Independent Accountants\nConsolidated Balance Sheet, January 28, 1995 and January 29, 1994\nConsolidated Statement of Operations, Years ended January 28, 1995, January 29, 1994 and January 30, 1993\nConsolidated Statement of Shareholders' Equity, Years ended January 28, 1995, January 29, 1994 and January 30, 1993\nConsolidated Statement of Cash Flows, Years ended January 28, 1995, January 29, 1994 and January 30, 1993\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedules:\nSchedule VIII - Valuation and Qualifying Accounts and Reserves\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(a) (3) Exhibits:\n* 3.1 Articles of Incorporation of the Company, as amended. (Exhibit 3.1 of the Company's Registration Statement No. 33-14436 filed on May 20, 1987 [the \"1987 Registration Statement\"].)\n* 3.2 Amendment to the Articles of Incorporation of the Company effective June 22, 1987. (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1987 [the \"1987 Form 10-K\"].)\n* 3.3 By-Laws of the Company. (Exhibit 3.3 to the 1987 Registration Statement.)\n* 3.4 Specimen Certificate of Common Stock, $.01 par value. (Exhibit 3.4 to the 1987 Registration Statement.)\n* 3.5 Amendments to By-Laws of the Company effective June 2, 1987. (Exhibit 3.5 to the 1987 Form 10-K.)\n* 3.6 Amendments to By-Laws of the Company effective March 28, 1990. (Exhibit 3.6 to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990 [the \"1990 Form 10-K\"].)\n* 3.7 Amendments to By-Laws of the Company effective July 4, 1990. (Exhibit 3.7 to the 1990 Form 10-K.)\n* 3.8 Articles of Amendment to the Articles of Incorporation of the Company filed on April 9, 1990. (Exhibit 3.8 to the 1990 Form 10-K.)\n*10.1 Amended and Restated Non-Qualified Stock Option Plan for Employees and Directors. (Exhibit 10.1 to the 1990 Form 10-K.) **\n*10.2 Amended and Restated Non-Qualified Stock Option Plan for Franchisees. (Exhibit 10.2 to the 1990 Form 10-K.)\n*10.3 IBM Personal Computer Agreement between the Company and IBM, as amended. (Exhibit 10.5 to the 1987 Registration Statement.)\n*10.4 COMPAQ Computer Corporation United States Central Purchase Agreement among the Company, TCBC and COMPAQ. (Exhibit 10.5 to the Company's Registration Statement No. 33-27573 filed on March 16, 1989 [the \"1989 Registration Statement\"].)\n*10.5 Lease Agreement dated January 20, 1989 between the Company and Hankin\/Crow Associates. (Exhibit 10.13 to the 1989 Registration Statement.)\n*10.6 IBM Personal Computer Agreement between Entre and IBM. (Exhibit 10.14 to the 1989 Registration Statement.)\n*10.7 COMPAQ Computer Corporation Central Purchase Agreement between Entre and COMPAQ. (Exhibit 10.15 to the 1989 Registration Statement.)\n*10.8 IBM Personal Computer Agreement between CPA and IBM. (Exhibit 10.24 to the 1989 Registration Statement.)\n*10.9 Dealer Sales Agreement between CPA and Apple. (Exhibit 10.25 to the 1989 Registration Statement.)\n*10.10 Addendum to Dealer Sales Agreement between CPA and IBM (and related documents). (Exhibit 10.29 to the 1989 Registration Statement.)\n*10.11 Agreement dated July 20, 1990 between the Company and Sun Microsystems, Inc. (Exhibit 10.33 to the 1990 Form 10-K.)\n*10.12 Agreement and Plan of Merger dated as of May 10, 1991 among the Company, IEI Acquisition Corp. (\"IEI\") and BizMart. (Exhibit (c)(1) to the Company's Schedule 14D-1 filed with the SEC on May 17, 1991 [the \"1991 Schedule 14D-1\"].)\n*10.13 Stock Purchase Agreement between Intelligent Electronics, Inc. and OfficeMax, Inc. dated December 3, 1992. (Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the Quarter ended October 31, 1992.)\n*10.14 Amendment to Addendum to Agreement for Wholesale Financing (Security Agreement) and Addendum to Addendum to Agreement for Wholesale Financing - Flexible Payment Plan dated January 25, 1994. (Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended January 29, 1994.)\n*10.15 Richard D. Sanford Deferred Compensation Agreement. (Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q for the Quarter ended July 30, 1994.) **\n10.16 Lease Agreement between Harbin Group, L.P. and the Company dated May 17, 1994.\n10.17 Lease Agreement between Quebec Court Joint Venture No. 2 and the Company dated June 3, 1995.\n10.18 Addendum to Addendum to Agreement for Wholesale Financing (Security Agreement) and Addendum to Addendum to Agreement for Wholesale Financing - Flexible Payment Plan dated January 26, 1995.\n10.19 Financial Statements for The Future Now, Inc. for the year ended December 31, 1994.\n11 Statement re: computation of per share earnings.\n21 Subsidiaries of the Company.\n23 Consent of Price Waterhouse LLP.\n23.1 Consent of KPMG Peat Marwick LLP.\n(b) Reports filed on Form 8-K during last fiscal quarter of 1994.\nThe Company filed a Current Report on Form 8-K dated January 5, 1995, relating to the acquisition of certain assets of branch locations in five major-metropolitan cities from The Future Now, Inc. __________________________________________ * Incorporated by reference\n** Management contract or compensatory plan or arrangement\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTELLIGENT ELECTRONICS, INC.\nDate: April 20, 1995 \/s\/Richard D. Sanford -------------------------------- Richard D. Sanford, Chief Executive Officer 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 and in the capacities and on the dates indicated.\nDate: April 20, 1995 \/s\/ Richard D. Sanford ----------------------------------- Richard D. Sanford, Chief Executive Officer and Chairman of the Board\nDate: April 20, 1995 \/s\/ Gregory A. Pratt ----------------------------------- Gregory A. Pratt, President Chief Operating Officer\nDate: April 20, 1995 \/s\/ Edward A. Meltzer ----------------------------------- Edward A. Meltzer, Chief Financial Officer, Vice President, Principal Accounting Officer\nDate: April 20, 1995 \/s\/ Arnold S. Hoffman ----------------------------------- Arnold S. Hoffman, Director\nDate: April 20, 1995 \/s\/ William L. Rulon-Miller ----------------------------------- William L. Rulon-Miller, Director\nDate: April 20, 1995 \/s\/ Barry M. Abelson ----------------------------------- Barry M. Abelson, Director\nDate: April 20, 1995 \/s\/ Roger J. Fritz ----------------------------------- Roger J. Fritz, Director\nDate: April 20, 1995 \/s\/ Robert P. May ----------------------------------- Robert P. May, Director\nDate: April 20, 1995 \/s\/ James M. Ciccarelli ----------------------------------- James M. Ciccarelli, Director\nDate: April 20, 1995 \/s\/ Alex A.C. Wilson ----------------------------------- Alex A.C. Wilson, Director","section_15":""}
{"filename":"717806_1995.txt","cik":"717806","year":"1995","section_1":"Item 1. Business.\nGeneral\nUnited Security Bancshares, Inc. (\"Bancshares\") is an Alabama corporation organized in 1984. Bancshares is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and it operates one banking subsidiary, United Security Bank (the \"Bank\").\nThe Bank has eight banking offices which are located in Thomasville, Coffeeville, Fulton, Gilbertown, Grove Hill, Butler, and Jackson, Alabama, and its market area includes portions of Clarke, Choctaw, Marengo, Sumter, Washington, and Wilcox Counties in Alabama, as well as Clarke, Lauderdale and Wayne Counties in Mississippi. The Bank conducts a general commercial banking business and offers banking services such as the receipt of demand, savings and time deposits, personal and commercial loans, credit card and safe deposit box services, and the purchase and sale of government securities.\nThe Bank encounters vigorous competition from 10 banks and one savings and loan association located in its service area for, among other things, new deposits, loans, savings deposits, certificates of deposit, interest-bearing transaction (NOW) accounts, and other banking and financial services.\nAs of December 31, 1995, the Bank had 90 full-time equivalent employees, and Bancshares had no employees, other than the officers of Bancshares who are indicated in Part III, Item 10 of this report.\nLegislation\nA regional reciprocal interstate banking bill permits Alabama banks to acquire banks located in 13 designated jurisdictions if such jurisdictions have adopted similar statutes. The 13 designated jurisdictions are Arkansas, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, West Virginia, and the District of Columbia, and all such jurisdictions have adopted varying forms of reciprocal statutes. The effect of this legislation is likely to increase competition within the State of Alabama among banking institutions located in Alabama and from banking institutions, many of which are larger than Bancshares, located in the area affected by the legislation.\nSupervision, Regulation and Governmental Policy\nBank Holding Company Regulation. As a registered bank holding company, Bancshares is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (\"Board of Governors\") under the Bank Holding Company Act of 1956, as amended. As a bank holding company, Bancshares is required to furnish the Board of Governors an annual report of its operations at the end of each fiscal year and to furnish such additional information as the Board of Governors may require pursuant to the Bank Holding Company Act. The Board of Governors may also make examinations of Bancshares.\nThe Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Board of Governors (i) before it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, such bank holding company will directly or indirectly own or control more than five percent of the voting shares of such bank; (ii) before it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of a bank; or (iii) before it may merge or consolidate with any other bank holding company. In reviewing a proposed acquisition, the Board of Governors considers financial, managerial and competitive aspects, and must take into consideration the future prospects of the companies and banks concerned and the convenience and needs of the community to be served. As part of its review, the Board of Governors concentrates on the pro forma capital position of the bank holding company and reviews the indebtedness to be incurred by a bank holding company in connection with the proposed acquisition to ensure that the bank holding company can service such indebtedness in a manner that does not adversely affect the capital requirements of the holding company or its subsidiaries. The Bank Holding Company Act further requires that consummation of approved acquisitions or mergers be delayed for a period of not less than 30 days following the date of such approval. During the 30 day period, complaining parties with respect to competitive issues may obtain a review of the Board of Governors' order granting its approval by filing a petition in the appropriate United States Court of Appeals petitioning that the order be set aside. The Board of Governors may not approve the acquisition by Bancshares of any voting shares of, or substantially all the assets of, any bank located outside Alabama unless such acquisition is specifically authorized by the statutes of the state in which the bank to be acquired is located.\nThe Bank Holding Company Act prohibits (with specific exceptions) Bancshares from engaging in nonbanking activities or from acquiring or retaining direct or indirect control of any company engaged in nonbanking activities. The Board of Governors by regulation or order may make exceptions for activities determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Board of Governors considers whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. For example, making, acquiring or servicing loans, leasing personal property, providing certain investment or financial advice, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions by the bank holding company and certain limited insurance underwriting activities have all been determined by regulations of the Board of Governors to be permissible activities. The Bank Holding Company Act does not place territorial limitations on permissible bank-related activities of bank holding companies. However, despite prior approval, the Board of Governors has the power to order a holding company or its subsidiaries to terminate any activity, or terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that holding company.\nFederal Reserve policy requires a bank holding company to act as a source of financial strength to each of its bank subsidiaries and to take measures, including possible loans to its subsidiaries in the form of capital notes or other instruments, to preserve and protect bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. However, any loans from the holding company to a subsidiary depository institution likely would be unsecured and subordinated to such institution's depositors and certain other creditors.\nBank Regulation. The Bank's deposits are insured by the Federal Deposit Insurance Corporation (\"FDIC\") to the extent provided by law. The major responsibility of the FDIC with respect to insured banks is to protect depositors as provided by law in the event a bank is closed without adequate provision having been made to pay claims of depositors. It also acts to prevent the development or continuation of unsafe or unsound banking practices. The FDIC is authorized to examine the Bank in order to determine its condition for insurance purposes. The FDIC must approve any merger or consolidation involving the Bank where the resulting bank is a state-chartered, non-Federal Reserve member bank. The Bank is not a member of the Federal Reserve System. The FDIC is also authorized to approve conversions, mergers, consolidations, and assumption of deposit liability transactions between insured and noninsured banks or institutions, and to prevent capital or surplus diminution in such transactions where the resulting, continuing or assumed bank is an insured bank that is not a member of the Federal Reserve System.\nSince the Bank is chartered under the laws of the State of Alabama, it is also subject to supervision and examination by the Alabama State Banking Department (\"Department\") and is subject to regulation by the Department of all areas of its operations. Alabama law and the regulations of the Department restrict the payment of dividends by state chartered banks. Under applicable law and regulations, cash dividends may not be paid without the approval of the Department if the total of all dividends declared by a bank in any calendar year exceeds the total of its net earnings of that year combined with the net retained earnings of the preceding two years, less any required transfers to surplus. Cash dividends in excess of 90% of the earnings of a bank may not be declared or paid at any time unless the surplus of such bank shall be equal to at least 20% of the bank's capital.\nIn accordance with regulatory restrictions, the Bank had at December 31, 1995, $7,441,820 of undistributed earnings included in consolidated retained earnings available for distribution to Bancshares as dividends without prior regulatory approval.\nSupervision, regulation and examination of banks by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of Bancshares common stock.\nOther Applicable Regulatory Provisions. Banks are also subject to the provisions of the Community Reinvestment Act of 1977, which require the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank's record in meeting the credit needs of the community serviced by the bank, including low and moderate-income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank that has applied to, among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution.\nIn August 1989, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\") was enacted. FIRREA, among other things, abolished the Federal Savings and Loan Insurance Corporation and established two new insurance funds under the jurisdiction of the Federal Deposit Insurance Corporation: the Savings Association Insurance Fund (the \"SAIF\") and the Bank Insurance Fund (\"BIF\"). The Bank's deposits are insured by the BIF. Effective January 1, 1996, the FDIC has adopted a new risk-based premium schedule of rates for annual insurance assessments paid by banks whose deposits are insured by the BIF. The new schedule will reduce assessments for all but the riskiest institutions. Under the new schedule, annual assessments range from $.00 to $.27 for every $100.00 of the Bank's assessment base (which is the sum of all demand and savings deposits plus accrued interest less unposted debits, pass through reserve balances, and other items) with a minimum assessment of $1,000.00 per institution per semi-annual period. The FDIC may adjust the assessment rates semiannually as necessary to maintain BIF reserves of at least 1.25% of total deposits insured ($1.25 per $100.00 of deposits insured) but cannot increase or decrease the rates by any more than 5 basis points (.05%) in the aggregate without opportunity for notice and comment.\nThe actual assessment rate applicable to a particular institution depends upon a risk assessment classification assigned to the institution by the FDIC. The FDIC will assign each financial institution to one of three capital groups--well capitalized, adequately capitalized, or undercapitalized, as defined in the regulations implementing the prompt corrective action provisions of FDICIA--and to one of three subgroups within a capital group on the basis of supervisory evaluations by the institution's primary federal, and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The Bank's current risk assessment classification is \"well-capitalized,\" for which the current assessment rate is $.04 per $100 of its assessment base. Legislation has been introduced in the House of Representatives that would merge the BIF with the SAIF to create a single federal insurance program for all depository institutions. This legislation, if passed, could impose a material increase in assessment rates for BIF insured institutions.\nFIRREA also imposes, with certain limited exceptions, a \"cross guarantee\" on the part of commonly-controlled depository institutions. Under this provision, if one depository institution's subsidiary of a multi-unit holding company fails or requires FDIC assistance, the FDIC may assess a commonly-controlled depository institution for the estimated losses suffered by the FDIC. Although the FDIC's claim is junior to the claims of nonaffiliated depositors, holders of secured liabilities, general creditors, and subordinated creditors, it is superior to the claims of shareholders.\nIn 1992, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted. FDICIA authorizes the Bank Insurance Fund (\"BIF\") to borrow up to $30 billion from the United States Treasury to be repaid by the banking industry through deposit insurance assessments. FDICIA required the federal banking agencies and the FDIC, as insurer, to take prompt action to resolve the problems of insured depository institutions. All depository institutions will be classified into one of five categories ranging from well-capitalized to critically undercapitalized. As an institution's capital level declines, it would become subject to increasing regulatory scrutiny and tighter restrictions. FDICIA further requires an increase in the frequency of \"fullscope, on-site\" examinations and expands the current audit requirements. In addition, federal banking agencies are mandated to review and prescribe uniform accounting standards that are at least as stringent as Generally Accepted Accounting Principles. FDICIA permits the merger or acquisition of any depository institutions with any other, provided that the transaction is approved by the resulting entity's appropriate federal banking agency. This would permit, for the first time, direct mergers between banks and thrift institutions.\nAmong other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" in respect of banks that do not meet minimum capital requirements, as defined by the regulations implementing FDICIA. If a depository institution fails to meet regulatory capital requirements, regulatory agencies can require submission and funding of a capital restoration plan by the institution to limit growth, require the raising of additional capital and, ultimately, require the appointment of a conservator or receiver for the institution. Under FDICIA, a bank holding company must guarantee that an undercapitalized subsidiary bank meets its capital restoration plan, subject to certain limitations.\nBecause of concerns relating to the competiveness and the safety and soundness of the industry, the Congress is considering, even after the enactment of FIRREA and FDICIA, a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. Among such bills are proposals to prohibit banks and bank holding companies from conducting certain types of activities, to subject banks to increased disclosure and reporting requirements, to eliminate the present restriction on interstate branching by banks, to alter the statutory separation of commercial and investment banking and to further expand the powers of banks, bank holding companies and competitors of banks.\nFederal law and regulations adopted by the Board of Governors and the FDIC (the \"Agencies\") require banks to define the geographic areas they serve and the services provided in these geographic areas. These agencies are required to consider compliance with these regulations and the services made available to geographic areas served in ruling on applications by banks for branches and other deposit facilities, relocation of banking offices and approval of mergers, consolidations, acquisitions of assets or assumptions of liabilities. The Board of Governors is also required to consider compliance with these regulations in ruling on applications under the Bank Holding Company Act for, among other things, the approval of the acquisition of shares of a bank.\nUnder federal law, restrictions are placed on extensions of credit by the Bank to insiders of Bancshares, to insiders of the Bank and to insiders of correspondent banks and on extensions of credit by such correspondent banks to insiders of Bancshares or the Bank.\nRecent legislation reduced substantially the limitations against branching by Alabama banks. Effective September 29, 1995, Alabama banks may establish a branch or office in any location within Alabama upon prior approval of the Superintendent of Banks. Alabama banks may also establish branches or offices in any other state, any territory of the United States, or any foreign country, provided that the branch or office is established in compliance with federal law and the law of the proposed location and is approved by the Alabama Superintendent of Banks. Under former law, Alabama banks could not establish a branch in any location other than its principal place of business, except as authorized by local laws or general laws of local application. This legislation is likely to increase competition within the State of Alabama among banking institutions located in Alabama and from banking institutions outside of Alabama, many of which are larger than Bancshares.\nDividend Restrictions. In addition to the Alabama statutory dividend restrictions discussed above under the caption \"Bank Regulation,\" federal banking regulators are authorized to prohibit banks and bank holding companies from paying dividends which would constitute an unsafe and unsound banking practice. The Board of Governors has indicated that it would generally be an unsafe and unsound practice to pay dividends except out of operating earnings.\nEffect of Governmental Policies. The earnings and business of Bancshares and the Bank are and will be affected by the policies of various regulatory authorities of the United States, especially the Board of Governors. Important functions of the Board of Governors, in addition to those enumerated above, are to regulate the supply of credit and to deal with general economic conditions within the United States. The instruments of monetary policy employed by the Board of Governors for these purposes influence in various ways the overall level of investments, loans, other extensions of credit and deposits, and the interest rates paid on liabilities and received on assets.\nIn view of the changing conditions in the national economy, in the money markets, in the federal government's fiscal policies and in the relationships of international currencies, as well as the effect of actions by the Board of Governors, no predictions can be made as to how these external variables, over which Bancshares' management has no control, may in the future affect possible interest rates, deposit levels, loan demand or the business and earnings of Bancshares and the Bank.\nCapital Adequacy Requirements. In July of 1988, the Basle Committee on Banking Regulations and Supervisory Practices (which included representatives of the United States and eleven other countries) issued proposals for the international convergence of capital measurement and capital standards for international banks. Each of the three agencies responsible for risk-based capital requirements, the Comptroller of the Currency (the \"Comptroller\"), the Board of Governors and the FDIC, have issued their final risk-based capital guidelines (the \"Capital Guidelines\").\nGenerally, the Capital Guidelines significantly revise the definition of capital and establish minimum capital standards in relation to assets and off-balance sheet exposures as adjusted for credit risks. Capital is classified into two tiers. The first tier (\"Tier I\") consists primarily of equity stock, as reduced by goodwill. The supplementary or second tier (\"Tier II\") consists of allowances for loan losses and other forms of capital, such as, among other things, specific types of preferred stock, mandatory convertible securities and term subordinated debt. Subordinated and intermediate-term preferred stock debt included in Tier II capital is limited to a maximum of 50 percent of Tier I capital. Also, Tier II capital cannot exceed 100 percent of Tier I capital, which places more emphasis on tangible equity than does the present primary capital test. The Capital Guidelines also assign risk-weightings to various types of bank assets to take into account different risks associated with different activities. Banks must have a capital to risk-weighted asset ratio of 8 percent, 4 percent of that amount to consist of Tier I capital.\nThe foregoing is a brief summary of certain statutes, rules and regulations affecting Bancshares and the Bank. Numerous other statutes and regulations have an impact on the operations of these entities.\nTax Considerations. The Revenue Reconciliation Act of 1993 (the \"Act\") revised the federal income tax provisions respecting the taxation of corporations by increasing the top marginal federal income tax rate from 34% to 35% beginning January 1, 1993.\nStatistical Information\nStatistical information concerning the business of Bancshares is set forth in Part II of this report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nBancshares owns no property and does not expect to own any. The business of Bancshares is conducted from the offices of the Bank.\nThe Bank has operated from its main office at 131 West Front Street since 1959. It is in a two-story building with approximately 17,000 square feet. During 1986, construction upon Bancshares' and the Bank's main offices at 131 West Front Street, Thomasville, was completed. Approximately 10,000 square feet of office space was added as a result of this construction.\nThe Bank operates seven branches in addition to its main office. The Highway 43 branch is located at the intersection of State Highway 43 and Nichol Avenue and is in a one-story brick building with approximately 3,500 square feet. The Coffeeville branch is located on Highway 84 in Coffeeville, approximately 33 miles from Thomasville, and it is in a one-story brick building of approximately 2,000 square feet. The Fulton branch is located on State Highway 178, approximately eight miles from Thomasville, in a one-story frame building of approximately 2,000 square feet. The Butler branch is located at 305 South Mulberry Street, Butler, Alabama in a one-story brick building of approximately 12,000 square feet. There are four drive-in teller facilities at this location. The Gilbertown branch, which consists of a one-story brick building of approximately 2,000 square feet, is located at the intersection of High Street and Highway 17 in Gilbertown, Alabama. There is one drive-in facility at this location. The Grove Hill branch is located at 131 Main Street in Grove Hill, Alabama. This branch is in a one-story brick building with approximately 2,700 square feet and two drive-in facilities. The Jackson Branch opened on November 19, 1990, and is located at the intersection of Highway 69 and College Avenue in Jackson, Alabama. The building is a one-story brick building of approximately 2,800 square feet with two drive-in facilities. All of the Bank's offices are owned in fee by the Bank without encumbrance.\nItem 3.","section_3":"Item 3. Pending Legal Proceedings.\nBancshares and the Bank, because of the nature of their businesses, are subject at various times to numerous legal actions, threatened or pending. In the opinion of Bancshares, based on review and consultation with legal counsel, the outcome of any litigation presently pending against Bancshares or the Bank will not have a material effect on Bancshares' consolidated financial statements or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nAt the 1995 Annual meeting of Bancshares, the shareholders of Bancshares approved an amendment to the Amended Articles of Incorporation of Bancshares increasing its authorized shares from 600,000 shares, with a par value of $.25 per share, to 2,400,000 shares, with a par value of $.01 per share and authorizing a split of each issued and outstanding share of Bancshares common stock into four shares of common stock, each with a par value of $.01 (the \"Stock Split\"). There are currently 2,202,060 shares of Bancshares common stock issued and 2,137,960 shares outstanding. As of December 31, 1995, there were approximately 564 shareholders of Bancshares.\nThe Bank is authorized by its Articles of Incorporation to issue 25,000 shares of common stock, par value $1.00 per share, all of which are outstanding. Bancshares is the only shareholder of the Bank.\nThere is no established public trading market for Bancshares common stock. Management of Bancshares is aware that from time to time Bancshares common stock is sold in private transactions. Management of Bancshares is aware of approximately 19 sales of Bancshares common stock since January 1, 1995 at prices ranging from $10.00 to $11.50 per share (adjusted for the stock split).\nBancshares has paid dividends on its common stock on a quarterly basis in the past three years. On December 21, 1993, Bancshares declared a ten percent stock dividend payable to shareholders of record on that date. As a result, Bancshares distributed 50,047 shares before January 31, 1994. The dividends retroactively adjusted for the 10% stock dividend in 1993 and the stock split are as follows:\nDividend paid on Common Stock Fiscal Year (per share)\n1993 $.3625 1994 $.42 1995 $.44\nAs a holding company, Bancshares, except under extraordinary circumstances, will not generate earnings of its own, but will rely solely on dividends paid to it by the Bank as the source of income to meet its expenses and pay dividends. Under normal circumstances, Bancshares' ability to pay dividends will depend entirely on the ability of the Bank to pay dividends to Bancshares.\nThe Bank is a state banking corporation and the payment of dividends by the Bank is governed by the Alabama Banking Code. The restrictions upon payment or dividends imposed by the Alabama Banking Code are described in Part II, Item 5 of Bancshares' Annual Report on Form 10-K for the year ended December 31, 1984, and such description is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Information.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of United Security Bancshares, Inc. (\"United Security\"), and should be read in conjunction with the Audited Financial Statements and Notes thereto included herein. United Security is the parent holding company of United Security Bank (the \"Bank\"), and it has no operations of consequence other than the ownership of its subsidiary. The emphasis of this discussion will be on the years 1995, 1994, and 1993. All yields presented and discussed herein are based on the cash basis and not on the tax-equivalent basis.\nAt December 31, 1995, United Security had consolidated assets of approximately $197.5 million and operated eight banking locations in a two-county area. These eight locations contributed over $3.6 million to consolidated net income in 1995. United Security Bank's sole business is banking; therefore, loans and investments are the principal source of income.\nThis discussion contains certain forward looking statements with respect to the financial condition, results of operation and business of United Security and the Bank related to, among other things:\n(A) trends or uncertainties which will impact future operating results, liquidity and capital resources, and the relationship between those trends or uncertainties and nonperforming loans and other loans;\n(B) the diversification of product production among timber related entities and the effect of that diversification on the Bank's concentration of loans to timber related entities;\n(C) the composition of United Security's derivative securities portfolio and its interest rate hedging strategies and volatility caused by uncertainty over the economy, inflation and future interest rate trends;\n(D) the effect of the market's perception of future inflation and real returns and the monetary policies of the Federal Reserve Board on short and long term interest rates; and\n(E) the effect of interest rate changes on liquidity and interest rate sensitivity management.\nThese forward looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, the following possibilities:\n(1) the perceived diversification in product production within the timber industry fails to protect the Bank from its concentration of loans to the timber industry as a result of, for example, the emergence of technological developments or market difficulties that affect the timber industry as a whole,\n(2) periods of lower interest rates accelerate the rate at which the underlying obligations of mortgage-backed securities and collateralized mortgage obligations are prepaid, thereby affecting the yield on such securities held by the Bank;\n(3) inflation grows at a greater-than-expected rate with a material adverse effect on interest rate spreads and the assumptions management of United Security has used in its interest rate hedging strategies and interest rate sensitivity gap strategies;\n(4) United Security encounters difficulty in integrating the operations of Brent Banking Company;\n(5) rising interest rates adversely affect the demand for the new consumer home equity line of credit to be introduced in 1996; and\n(6) general economic conditions, either nationally or in Alabama, are less favorable than expected.\nFinancial Condition\nUnited Security's financial condition depends primarily on the quality and nature of the Bank's assets, liabilities and capital structure, the quality of its personnel, and prevailing market and economic conditions.\nThe majority of the assets and liabilities of a financial institution are monetary and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets and inventories. Inflation has an important impact on the growth of total assets in the banking industry, resulting in the need to increase equity capital at rates greater than the applicable inflation rate in order to maintain an appropriate equity to asset ratio. Also, the category of other expenses tends to rise during periods of general inflation.\nManagement believes the most significant factor in producing quality financial results is the Bank's ability to react properly and timely to changes in interest rates. Management is attempting to maintain a balanced position between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations. The following table reflects the distribution of average assets, liabilities, and shareholders' equity for the three years ended December 31, 1995, 1994, and 1993.\nLoans and Allowances for Possible Loan Losses\nNet loans decreased in 1995 to $54,203,166, primarily as a result of several large lines of credit paying out or paying down in the fourth quarter. The total decrease in the loan portfolio amounted to $2.5 million or 4.46% of gross loans outstanding. Commercial loans decreased 1.64% to $34,107,901, and real estate loans decreased 5.64% to $16,267,120. Construction activity in the trade area tends to be predominantly commercial. During the year, the Bank has been able to secure some of the construction loan business in this area.\nConsumer installment loans continued to decline in 1995. The decrease of 17.11% in this area left $5,094,531 in total consumer installment loans outstanding on December 31, 1995. The Bank intends to market a new home equity line for consumer loans tied to our credit card program in the spring of 1996. This new product should help to retain some of the consumer loans and generate additional loans as well.\nAn allowance for loan losses is maintained by the Bank to provide for the coverage of potential losses in the loan portfolio. The level of this reserve is based on management's combined evaluation of the credit risk of each loan. A risk rating is assigned to each loan, and this rating is reviewed at least annually. In assigning risk, management takes into consideration the capacity of the borrower to repay the loan, the collateral value, recent loan loss experience, current economic conditions and other factors.\nThe Bank's loan policy requires immediate recognition of a loss if significant doubt exists as to the repayment of the principal balance of a loan. Consumer installment loans are generally recognized as losses if they become 90 days or more delinquent. The only exception to this policy occurs when the underlying value of the collateral or the customer's financial position makes a loss unlikely.\nA credit review of individual loans is conducted periodically by branch and by officer. Gross and net charge-offs in the current year are analyzed when determining the amount of the reserve. The current level of the allowance in relation to the total loans outstanding and to historical loss levels is included in this calculation.\nLoan officers and other personnel handling loan transactions undergo continuous training dedicated to improving the credit quality as well as the yield of the loan portfolio. United Security operates under a written loan policy which attempts to guide lending personnel in maintaining a consistent lending function. This policy is intended to aid loan officers and lending personnel in making sound credit decisions and to assure compliance with state and federal regulations. In addition, the intent of the loan policy is to provide lending officers with a guide to making loans which will provide an adequate return while providing services to the communities and trade areas in which we are located.\nThe balance of $778,391 in the allowance for loan loss account as of December 31, 1995, is considered by management to be adequate. The allowance is 1.40% of total loans.\nThe following table shows the Bank's loan distribution as of December 31, 1995, 1994, and 1993.\nThe amounts of total loans (excluding installment loans) outstanding at December 31, 1995, which, based on the remaining scheduled repayments of principal, are due in (1) one year or less, (2) more than one year but within five years, and (3) more than five years, are shown in the following table.\nVariable rate loans totaled approximately $11.1 million and are included in the one-year category.\nGross charge-offs for the year totaled $84,786. This is approximately equal to the gross charge-offs for 1994. The Bank was in a net recovered position for the year as recoveries on prior charge-offs exceeded current gross charge-offs by $6,391. Non-performing assets as a percentage of total loans and other real estate was .59% which is not a significant change from the previous year. Accruing loans past due 90 days or more at year-end increased from $79,000 in 1994 to $150,000 in 1995. These loans are reviewed closely by management and are allowed to continue accruing only because of underlying collateral values or due to the financial strength of the borrowers. If at any time management determines there may be a loss of interest or principal, these loans will be changed to non-accrual, and their asset value down graded.\nNOTE: The Bank had no loans considered to be impaired as defined by Statement of Financial Accounting Standards Number 114 \"Accounting by Creditors for Impairment of a Loan\" which was adopted in 1995.\nNon-Performing Assets\nThe following table presents information on non-performing loans and real estate acquired in settlement of loans.\nNon-performing loans and any other loans which have been classified for regulatory purposes do not represent or result from trends or uncertainties which will materially impact future operating results, liquidity, or capital resources. Management is not aware of information which would cause serious doubts as to the ability of borrowers to comply with present repayment terms. Total non-performing loans decreased during 1995 by 21% and represent only .59% of net loans. Non-performing loans continue to decline for several reasons. Through continuous training, our lending officers are directed by the Bank's conservative written loan policy to make loans within our trade area, to obtain adequate down payments on purchase-money transactions, and to lend within policy guidelines on other transactions. In addition, the Bank's loan review officer conducts an independent review of individual loans by branch and officer.\nUnited Security Bank discontinues the accrual of interest on a loan when management has reason to believe the financial condition of the borrower has deteriorated so that the collection of interest is in doubt. When a loan is placed on non-accrual, all unpaid accrued interest is reversed against current income unless the collateral securing the loan is sufficient to cover the accrued interest. Interest received on non-accrual loans is generally either applied against the principal or reported as interest income, according to management's judgement as to whether the borrower can ultimately repay the loan. A loan may be restored to accrual status if the obligation is brought current, performs in accordance with the contract for a reasonable period and if management determines that the repayment of the total debt is no longer in doubt.\nIt is the policy of United Security Bank to immediately charge-off as loss all amounts judged to be uncollectible. Management is aware that certain losses may exist in the loan portfolio which have not been specifically identified. The allowance for loan losses is established for this reason. The provision was $778,391 at year-end and represented 1.40% of total loans outstanding. Management believes this allowance is adequate to absorb any future loan losses.\nAllocation of Allowance for Possible Loan Losses\nThe following table shows an allocation of the allowance for possible loan losses for each of the three years.\nThe table above is based in part on the loan portfolio make-up, the Bank's internal risk evaluation, historical charge-offs, past-due loans, and non-accrual loans. Management considers this allocation as a guide and not restrictive to each category.\nNet charge-offs as shown in the \"Summary of Loan Loss Experience\" below indicates the trend for the past five years. Management does not anticipate charge-offs in 1996 to exceed the five-year average of $187,000.\nSummary of Loan Loss Experience\nThis table summarizes the Bank's loan loss experience for each of the five years indicated.\nNon-Accruing Loans\nSummarized below is information concerning the income on those loans with deferred interest or principal payments resulting from a deterioration in the financial condition of the borrower.\nTotal loans accounted for on a non-accrual basis decreased by $100,603 in 1995. Total non-accruing loans at year-end were $169,064. Lending officers and other personnel involved in the lending process receive ongoing training, and emphasis is placed on the quality of our loan portfolio. The Bank has no foreign loans. The Bank does not make loans on commercial property outside our market area. The Bank continues to be conservative in its lending directives.\nTimber Industry Concentration\nUnited Security Bank is located in Clarke and Choctaw Counties, Alabama. Our trade area, however, covers portions of six counties in Alabama and three counties in Mississippi and is in the heart of the timber producing area in the State of Alabama. Our neighboring counties of Marengo, Monroe, Washington, and Wilcox are all in the top ten counties in the State in timber production. We have several major paper mills in our trading area including Alabama River Paper, Boise Cascade, James River Corporation, and MacMillan Bloedel. In addition, there are several sawmills, lumber companies, and pole and piling producers. This table shows the dollar amount of loans made to timber and timber-related companies and to the principals and employees of those companies as of December 31, 1995. The amount of these loans decreased from $22 million in 1994 to $20 million in 1995, a decrease of 9.3%. Timber-related loans as a percentage of total gross loans decreased from 38.04% in 1994 to 36.10% in 1995. The Bank's concentration in the timber industry as of December 31, 1995, is shown below.\nTimber Total Percentage of Related Loans Gross Loans Total Loans\n$20,027,101 $55,469,552 36.10%\nManagement understands the concern for concentration of loans in timber and timber-related industries. However, we continue to feel these risks are reduced by the diversification of product production within these industries. Some of the mills and industries specialize in paper and pulp, some in lumber and plywood, some in poles and pilings, and others in wood and veneer. We do not feel that this concentration is excessive or that it represents a trend which might materially impact future earnings, liquidity, or capital resources of the Bank. Management does realize the Bank is heavily dependent on the economic health of the timber-related industries. The Bank continues to benefit from the area industries engaged in the growing, harvesting, processing and marketing of timber and timber-related products. The majority of the land in our trade area is used to grow pine and hardwood timber. Agricultural production loans make up less than 1% of the Bank's total loan portfolio.\nDeposits\nAverage total deposits have grown 14.9% during the last three years with a 3.2% increase in 1995. This growth can be attributed to the rate environment, product expansion, continued emphasis on quality service, and the Bank's safety and soundness.\nAverage non-interest bearing demand deposits have increased 31% over the last three years. The growth for 1995 was 5.4%. The ratio of average non-interest bearing deposits to average total deposits also increased in 1995 to 16% from 15.6% in 1994 and 14.2% in 1993. The growth of United Security's non-interest bearing demand deposits can be attributed in part to the Bank's product enhancements such as the introduction of image checking technology and 24-hour account accessibility. This increase in non-interest bearing deposits continues to contribute to the gross interest margin.\nAnother contributing factor in the growth in non-interest bearing demand deposits is the shift from interest bearing demand deposits the Bank experienced in 1995. Average interest-bearing demand deposits decreased 11.7% in 1995 and accounted for 16.5% of total average deposits for the year compared to 19.3% in 1994 and 19.4% in 1993. While some of these interest-bearing demand deposits moved to the non-interest bearing demand deposit accounts, it is clear that most transferred to time deposits.\nDuring the last three years, average time deposits increased 11.8%. This represents an increase of over $8.6 million. Average time deposits increased by 8.1% in 1995 compared to an increase of 3.3% in 1994 and .1% in 1993. Additionally, time deposits represented 57% of the total average deposits in 1995 compared to 54.4% in 1994 and 56.1% in 1993. This growth in time deposits coupled with the losses in interest-bearing demand deposits suggests that consumers were willing to sacrifice fund accessibility for a higher interest rate in 1995. This activity confirms the theory that the interest-bearing demand deposits were somewhat inflated in 1994 due to consumers waiting for rates to rise.\nAverage savings deposits have grown 26.4% since the end of 1992. This growth slowed in 1995 with a growth rate of 2.3%. The ratio of average savings to average total deposits, however, stayed consistent at 10.5% in 1995 compared to 10.6% in 1994 and 10% in 1993.\nUnited Security's deposit base remains the primary source of funding for the Bank. The average deposit base represented 75% of average liabilities and equity in 1995. As seen in the table on the following page, overall rates on these deposits increased to 3.84% in 1995 compared to 3.29% in 1994 and 3.36% in 1993. This rate increase reflects the rising rate environment in 1995 as well as the shift from interest-bearing demand accounts to the higher rates of certificates of deposits. Emphasis continues to be placed upon attracting consumer deposits. It is United Security's intent to expand its consumer deposit base in order to continue to fund asset growth through growth in both demand deposits and consumer certificates of deposits. This will be accomplished by remaining safe and sound, enhancing our products, and providing aggressive quality service.\nAverage Daily Amount of Deposits and Rates\nThe average daily amount of deposits and rates paid on such deposits is summarized for the periods in the following table.\nMaturities of Time Certificates of Deposits and Other Time Deposits of $100,000 or more outstanding at December 31, 1995, are summarized as follows:\nTime Other Certificates Time Maturities of Deposits Deposits Total\n(In Thousands of Dollars)\n3 Months or Less $ 3,463 $ 4,317 $ 7,780 Over 3 Through 6 Months 2,497 0 2,497 Over 6 Through 12 Months 856 0 856 Over 12 Months 7,111 0 7,111\nTotal $13,927 $ 4,317 $18,244\nInvestment Securities and Securities Available for Sale\nAt December 31, 1995, total securities were $129 million. All securities held were classified as available for sale.\nInvestment securities decreased $23.07 million with the election in July, 1995 to transfer the entire portfolio into available for sale.\nSecurities available for sale include Collateralized Mortgage Obligations (CMOs) of $100.45 million, other mortgage backed securities of $13.97 million, state, county and municipal securities of $13.43 million, and other securities of $1.1 million. The total securities portfolio increased $16.29 million or 14.45% from December 1994 to December 1995.\nAt December 1995, approximately $97.53 million in CMOs had floating interest rates which reprice monthly and $2.93 million had fixed interest rates.\nBecause of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been purchases of mortgage-backed obligations and collateralized mortgage obligations. The mortgage-backed obligations in which United Security invests represent an undivided interest in a pool of residential mortgages or may be collateralized by a pool of residential mortgages (\"mortgage-backed securities\"). Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying mortgages and any prepayments of principal due to prepayment, refinancing, or foreclosure of the underlying mortgages. Although maturities of the underlying mortgage loans may range up to 30 years, amortization and prepayments substantially shorten the effective maturities of mortgage-backed securities. Transactions in these securities have focused on the seven to ten year average life goal. Principal and interest payments also add significant liquidity to the balance sheet. In 1995, there was a continuing emphasis in Collateralized Mortgage Obligations (\"CMOs\"), all of which are collateralized by U.S. Government and Agency Mortgage Pools. The CMO market, in existence since 1983, was created to add liquidity to the mortgage-backed security (\"MBS\") market by furnishing better distribution of risk\/reward profiles. Since CMOs are derived from MBS pools, they are labeled mortgage derivatives.\nThe Federal Financial Institution Examination Council requires that all MBS derivatives be tested for suitability as an investment in the portfolio of financial institutions. These tests are run at purchase and periodically thereafter.\nFFIEC Policy Statement -- Derivative MBS Tests\nTests\n#1 -- Average Life Test\nExpected Average Life must be less than or equal to 10 years.\n#2 -- Average Life Sensitivity Test\nExtends by more than 4 years or shortens by more than 6 years for immediate Treasury curve shifts of +\/-300 basis points.\n#3 -- Price Sensitivity Test\nEstimated price changes by more than 17% for immediate Treasury curve shifts of +\/-300 basis points. (Price change measured from the offer, using constant spread to Treasury from Bid price.)\nThe FFIEC Policy Statement specifically exempts floating-rate CMOs from the average life and average life sensitivity tests (#1 and #2) if the instrument is uncapped at the time of purchase or on subsequent re-testing dates.\nSecurities that do not pass the applicable tests are designated \"high risk\". Institutions that hold high risk securities other than for trading may do so only to reduce interest rate risk.\nUnited Security held $30.93 million in securities which, at December 31, 1995, were designated high risk. $18.92 million of these securities were floating rate, and $10.18 million were inverse floating rate securities. These securities were purchased and\/or are being held to hedge certain areas of interest rate risk in the portfolio and balance sheet. There were unrealized losses in this portion of the portfolio at December 31, 1995 of $1.82 million. Despite these unrealized losses, the securities in this segment of the portfolio produced $2.76 million in interest income and positive total return for 1995.\nThe securities portfolio and its various components are monitored, and assessments are made regularly relative to United Security's exposure to high risk investments. Changes in the level of earnings and fair values of securities are generally attributable to fluctuations in interest rates as well as volatility caused by general uncertainty over the economy, inflation, and future interest rate trends. MBS and CMOs present some degree of additional risk in that mortgages collateralizing these securities can prepay, thereby affecting the yield of the securities and their carrying amounts. Such an occurrence is most likely in periods of low interest rates when borrowers refinance their mortgages, creating prepayments on their existing mortgages.\nThe composition of United Security's investment portfolio reflects United Security's investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of United Security's investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling United Security's interest rate position while at the same time producing adequate levels of interest income.\nFair market value of securities vary significantly as interest rates change. The gross unrealized gains and losses in the securities portfolio are not expected to have a material impact on future income, liquidity or other funding needs. There were unrealized gains (net of taxes) of $616,295 in the securities portfolio on December 31, 1995 versus net unrealized loss (net of taxes) of ($3,217,137) one year ago.\nUnited Security uses other off balance sheet derivative products for hedging purposes. These include interest rate swaps, caps, floors and options. The use and detail regarding these products are fully discussed under \"Liquidity and Interest Rate Sensitivity Management\" and in Note R in the \"Notes to Consolidated Financial Statements.\"\nReversing the 1994 trend, 1995 can be described as a year of falling interest rates. Interest rates declined over 200 basis points for all maturities of one year or longer. In addition, the yield curve flattened dramatically from a spread of approximately 200 basis points in December of 1994 to 87 basis points at December 31, 995. Short-term interest rates are generally influenced by the monetary policy stance of the Federal Reserve while longer term rates are determined by the market's perception of future inflation and real returns. The long end of the curve saw another year of consumer inflation below 3% and with mixed economic signals and slower growth the outlook is for lower inflation in the future. The year ahead should see the curve steepen, particularly with the Federal Reserve easing short-term rates. The risk of much slower growth, higher unemployment, declining production, and possible recessions in Europe and Japan continues to be greater than the risk of inflation. United Security will continue to invest in rate-sensitive securities which should have less price exposure to changes in interest rates. It is expected that there will be continued use of various on and off balance sheet techniques to manage interest rate risk in the securities portfolio.\nCondensed Portfolio Maturity Schedule\nDollar Portfolio Maturity Summary Amount Percentage\nMaturing in less than 1 year $ 0 0% Maturing in 1 to 5 years 1,185,835 0.92% Maturing in 5 to 10 years 1,108,523 0.86% Maturing in over 10 years 126,708,244 98.22%\nTotal $129,002,602 100.00%\nCondensed Portfolio Repricing Schedule\nDollar Portfolio Repricing Summary Amount Percentage\nRepricing in 30 days or less $ 97,559,848 75.63% Repricing in 31 to 90 days 1,138,200 0.88% Repricing in 91 days to 1 year 0 0.00% Repricing in 1 to 5 years 1,269,238 0.98% Repricing in 5 to 10 years 1,108,523 0.86% Repricing in over 10 years 27,926,793 21.65% Total $129,002,602 100.00%\nInvestment Securities Available for Sale Maturity Schedule\nSecurities Gains and Losses\nNon-interest income from securities transactions, trading account transactions, and associated option premium and off-balance sheet income was up slightly in 1995 compared to 1994 but significantly less than in 1993. The majority of the profits realized in 1995 were generated in options and other related transactions. Losses in the investment securities area were a result of a restructuring of the fixed-rate portion of the portfolio into floating rates or other fixed rates for greater future returns.\nThe table below shows the associated net gains or (losses) for the periods 1995, 1994, and 1993:\nLosses in 1995 from sales of investment securities were net of gains of $511,610. Volume of sales as well as other information on securities is further discussed in Note C to the \"Notes to Consolidated Financial Statements.\"\nInvestment Securities and Investment Securities Available for Sale\nThe following table sets forth the carrying value of investment securities at the dates indicated.\nThe maturities and weighted average yields of the investment securities available-for-sale at the end of 1995 are presented in the preceding table based on stated maturity. While the average stated maturity of the Mortgage-Backed Securities (excluding CMO's) was 25.80 years, the average life expected was 10.64 years. The average stated maturity of the CMO portion of the portfolio was 27.34 years, and the average expected life was 17.63 years. The average expected life of investment securities available for sale was 15.65 years with an average yield of 8.86 percent.\nShort-Term Borrowings\nPurchased funds can be used to satisfy daily funding needs, and when advantageous, for arbitrage. The following table shows information for the last three years regarding the Bank's short-term borrowings consisting of U.S. Treasury demand notes included in its Treasury, Tax, and Loan Account, securities sold under repurchase agreements, Federal Fund purchases (one day purchases), and other borrowings from the Federal Home Loan Bank.\nOther Short-Term Borrowings\n(In Thousands of Dollars) Year Ended December 31: 1995 $22,369 1994 $17,652 1993 $ 8,176\nWeighted Average Interest Rate at Year-End: 1995 5.82% 1994 5.90% 1993 2.19%\nMaximum Amount Outstanding at Any Month's End: 1995 $26,698 1994 $17,980 1993 $ 8,716\nAverage Amount Outstanding During the Year: 1995 $19,657 1994 $10,931 1993 $ 2,040\nWeighted Average Interest Rate During the Year: 1995 6.11% 1994 4.55% 1993 2.64%\nBalances in these accounts fluctuate dramatically on a day-to-day basis. Rates on these balances also fluctuate daily, but as you can see in the chart above, they generally depict the current interest rate environment.\nThe increase in short-term borrowings over the last two years can be attributed mainly to borrowings from the Federal Home Loan Bank of Atlanta which the Bank joined in 1992.\nShareholders' Equity\nUnited Security has always placed great emphasis on maintaining its strong capital base. At December 31, 1995, shareholders' equity totaled $25.2 million, or 12.8% of total assets compared to 10% and 11.6% for the same periods in 1994 and 1993, respectively. This level of equity assures United Security's shareholders, customers and regulators that United Security is financially sound and offers the ability to sustain an appropriate level of profitability and growth.\nOver the last three years shareholders' equity grew from $17.2 million at the beginning of 1993 to $25.2 million at the end of 1995. All of this growth was a result of internally generated retained earnings, with the exception of the market value adjustment made for the available for sale investments as required by Statement of Financial Accounting Standards No. 115. (See Note A of the \"Notes to Consolidated Financial Statements\" for additional information.) This accounting change, adopted in 1994, accounted for over half of the equity increase in 1995. The internal capital generation rate (net income less cash dividends as a percentage of average shareholders' equity) was 11.6% in 1995, down from 12.2% in 1994.\nAt United Security's annual meeting on April 25, 1995, the shareholders ratified a change in the par value of the Company's stock from $.25 to $.01 per share. Additionally, the shareholders approved an increase in the number of authorized shares from 600,000 shares to 2,400,000 shares in order for the Company to effect a four-for-one split of its stock payable to the shareholders of record on that date. This action had no effect on the total amount of shareholders' equity.\nUnited Security is required to comply with capital adequacy standards established by the banking regulatory agencies. Currently, the two basic measures of capital adequacy are the risk-based measure and the leverage measure.\nThe risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with a specified risk-weighting factor. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The banking regulatory agencies have adopted initiatives to begin considering interest rate risk in computing risk-based capital ratios. On December 14, 1994, the Federal Reserve Board adopted amendments to its risk based capital guidelines for state member banks and bank holding companies. Under the final rule, institutions are generally directed not to include the component of common stockholders equity created by SFAS 115 (net unrealized holding gains and losses on securities available for sale).\nThe minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits, and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles (\"Tier I Capital\"). The remainder (\"Tier II Capital\") may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt, and a limited amount of the allowance for loan losses. The sum of Tier I Capital and Tier II Capital is \"total risk-based capital\".\nThe banking regulatory agencies have also adopted regulations which supplement the risk-based guidelines to include a minimum leverage ratio of 3% of Tier I Capital to total assets less goodwill (the \"leverage ratio\"). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% or 2% higher than the minimum 3% level.\nThe following chart summarizes the applicable bank regulatory capital requirements. United Security's capital ratios at December 31, 1995, substantially exceeded all regulatory requirements.\nRisk-Based Capital Requirements\nTotal capital also has an important effect on the amount of FDIC insurance premiums paid. Lower capital ratios can cause the rates paid for FDIC insurance to increase. United Security plans to maintain the capital necessary to keep FDIC insurance rates at a minimum.\nUnited Security attempts to balance the return to shareholders through the payment of dividends with the need to maintain strong capital levels for future growth opportunities. Total cash dividends paid were $940,703 or $.44 per share compared to $.42 per share in 1994 and $.3625 per share in 1993. The total cash dividends represented a payout ratio of 26.02% in 1995 with a payout ratio of 27.84% and 24.36% in 1994 and 1993, respectively. This is the seventh consecutive year that United Security has increased cash dividends. The per share dividends are adjusted to reflect the four-for-one split authorized in 1995.\nRatio Analysis\nThe following table presents operating and capital ratios for each of the last three years.\nLiquidity and Interest Rate Sensitivity Management\nThe primary function of asset and liability management is to assure adequate liquidity and to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. Liquidity management involves the ability to meet day-to-day cash flow requirements of United Security's customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, United Security would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing during changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of such interest rate movements on the net interest margin.\nThe asset portion of the balance sheet provides liquidity primarily from loan principal payments and maturities and through sales, maturities, and payments from the investment portfolio. Other short-term investments, such as Federal Funds Sold, are additional sources of liquidity. Loans maturing or repricing in one year or less amounted to $28.63 million at December 31, 1995.\nInvestment securities maturing or repricing in the same time frame totaled $98.70 million or 76.51% of the investment portfolio at year-end 1995. In addition, principal payments on mortgage-backed securities totaled $2.82 million in 1995. For repricing purposes, $3.67 million in payments have been included in the one year or less categories in the Interest Rate Sensitivity Analysis, reflecting recent prepayment experience.\nThe liabilities portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts. Federal Funds purchased, securities sold under agreements to repurchase and short-term borrowings are additional sources of liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure.\nInterest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames during which the interest-bearing assets and liabilities are subject to changes in interest rates, either at replacement or maturity, during the life of the instruments. Sensitivity is measured as the difference between the volume of assets and the volume of liabilities in the current portfolio that are subject to repricing in future time periods. These differences are known as interest sensitivity gaps and are usually calculated for segments of time and on a cumulative basis.\nChanges in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly, while the timing of repricing for both the asset and the liability remains the same, thus affecting net interest income. It should be noted, therefore, that a matched interest-sensitive position by itself will not ensure maximum net interest income. Management continually evaluates the condition of the economy, the pattern of market interest rates, and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates.\nThe balance of cash and cash equivalents decreased at December 31, 1995, by $840,901. This decrease was the result of cash used in investing activities exceeding cash provided by operating and financing activities. Net income was the primary contributor from operating activities, while deposit growth was the main contributor to cash from financing activities. The primary sources of cash flows for United Security are earnings, proceeds from sales, payments and maturities of investment securities, and deposit growth, and short-term borrowings.\nProceeds from sales and maturities of investments have consistently been reinvested in the investment portfolio. Although the majority of the portfolio has stated maturities in excess of ten years, the entire portfolio consists of securities that are readily marketable and which are easily convertible into cash. However, management does not rely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment, etc. Instead, these activities are funded by cash flows from operating activities and increases in deposits and short-term borrowings. The proceeds from sales and maturities of investments have been used to purchase additional investments.\nUnited Security currently has long-term debt and short-term borrowings that on average represent 11.7 percent of total liabilities and equity.\nUnited Security's total deposits have shown steady growth each year since 1990. This growth occurred primarily in time deposits. All deposit functions experienced growth in 1995 except interest-bearing demand deposits. This increase in deposits has been used primarily to finance a portion of the increase in the investment securities portfolio.\nThe following table shows United Security's rate sensitive position at December 31, 1995, as measured by gap analysis (the difference between the earning asset and interest-bearing liability amounts eligible to be repriced to current market rates in subsequent periods).\nIn addition to the ongoing monitoring of interest-sensitive assets and liabilities, United Security enters into various interest rate contracts (\"interest rate protection contracts\") to help manage United Security's interest sensitivity. Such contracts generally have a fixed notional principal amount and include (i) interest rate swaps where United Security typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specified index, (ii) interest rate caps and floors purchased where United Security receives interest if the specified index falls below the floor rate or rises above the cap rate. All interest rate swaps represent end-user activities and are designed as hedges. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company's interest risk management program. The income or expense associated with interest rate swaps, caps and floors classified as hedges are ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized. A discussion of interest rate risks, credit risks and concentrations in off-balance sheet financial instruments is included in Note R of the \"Notes to Consolidated Financial Statements.\"\nIncome Taxes\nThe effective tax rate as a percentage of pre-tax income was 28.4% in 1995 compared to 26.5% and 30.0% in 1994 and 1993, respectively. These rates are lower than the maximum Federal statutory rate of 35% due primarily to tax exempt interest income and tax credits generated by investments in low income housing partnerships. The Company's taxable income was also only in the 34% tax bracket. The Company's effective tax rate should continue to be lower than the maximum Federal rates in future years.\nDeferred income taxes are reported for timing differences between items of income and expense reported in the financial statements and those reported for income tax purposes. Deferred taxes are computed in accordance with SFAS No. 109 \"Accounting for Income Taxes\" which was adopted in 1993.\nCommitments\nThe Bank maintains financial instruments with risk exposure not reflected in the Consolidated Financial Statements. These financial instruments are executed in the normal course of business to meet the financing needs of its customers and in connection with its investing and trading activities. These financial instruments include commitments to make loans, options written, standby letters of credit, and commitments to purchase securities for forward delivery.\nThe Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank applies the same credit policy in making these commitments that it uses for on-balance sheet items.\nCollateral obtained upon exercise of the commitment is determined based on management's credit evaluation of the borrower and may include accounts receivable, inventory, property, land, and other items. The Bank does not normally require collateral for standby letters of credit. As of December 31, 1995, the Bank had outstanding standby letters of credit and commitments to make loans of $1,352,853 and $28,329,347, respectively.\nFor options written and commitments to purchase securities for forward delivery, the contractual amounts reflect the extent of the Bank's involvement in various classes of financial instruments and does not represent exposure to credit loss. The Bank controls the credit risk of these instruments through credit approvals, limits, and monitoring procedures.\nOptions are contracts that allow the buyer of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from or to the seller or writer of the option. As a writer of options, the Bank is paid a premium at the outset and then bears the risk of an unfavorable change in the price of the financial instrument underlying the option. As of December 31, 1995, the Bank's options written totaled $2,000,000.\nCommitments to buy and sell securities for delayed delivery require the Bank to buy and sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in securities values and interest rates between the commitment and delivery dates. The Bank's commitments to buy and sell securities for delayed delivery as of December 31, 1995, totaled $1,268,500 and $3,900,100, respectively.\nThe Bank is prepared to fulfill the above commitments through scheduled maturities of loans and securities along with cash flows from operations, anticipated growth in deposits, and short-term borrowings.\nOperating Results\nNet Interest Income\nNet interest income is an effective measurement of how well management has matched interest-rate-sensitive assets and interest-bearing liabilities. The fluctuations in interest rates materially affect net interest income. The accompanying table analyzes these changes.\nNet interest income increased by $588,609 or 6.9% in 1995 compared to 14.5% and 8.6% increases in 1994 and 1993, respectively. Volume, rate, and yield changes contributed to the growth in net interest income. Average interest-earning assets increased by $15.1 million or 9.1% in 1995. This increase in interest-earning assets is partly offset by the volume increase of $10 million or 7.4% in average interest-bearing liabilities. Volume changes of equal amounts in interest-earning assets and interest-bearing liabilities generally increase net interest income because of the spread between the yield on loans and investments and the rates paid on interest-bearing deposits. In 1995, average interest-earning assets outgained average interest-bearing liabilities by $5.1 million.\nUnited Security's ability to produce net interest income is measured by a ratio called the interest margin. The interest margin is net interest income as a percent of average earning assets. The interest margin was 5.1% in 1995 compared to 5.2% and 5.1% in 1994 and 1993, respectively.\nInterest margins are affected by several factors, one of which is the relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities. This factor determines the effect that fluctuating interest rates will have on net interest income. Rate-sensitive earning assets and interest-bearing liabilities are those which can be repriced to current market rates within a relatively short time. United Security's objective in managing interest rate sensitivity is to achieve reasonable stability in the interest margin throughout interest rate cycles by maintaining the proper balance of rate sensitive assets and liabilities. For further analysis and discussion of interest rate sensitivity, refer to the preceding section entitled \"Liquidity and Interest Rate Sensitivity Management.\"\nAnother factor that affects the interest margin is the interest rate spread. The interest rate spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. This measurement gives a more accurate representation of the effect market interest rate movements have on interest rate-sensitive assets and liabilities. The average volume of the interest-bearing liabilities increased 7.4% in 1995, while the average rate of interest paid increased from 4.01% in 1994 to 4.83% in 1995, an increase of 82 basis points. Average interest-earning assets increased 9.1% in 1995, while the average yield increased from 8.48% in 1994 to 8.96% in 1995, an increase of 48 basis points. Net yield on average interest-earning assets, however, decreased only 13 basis points from 1994 to 1995.\nThe percentage of earning assets funded by interest-bearing liabilities also affects the Bank's interest margin. United Security's earning assets are funded by interest-bearing liabilities, non-interest-bearing demand deposits, and shareholders' equity. The net return on earning assets funded by non-interest-bearing demand deposits and shareholders' equity exceeds the net return on earning assets funded by interest-bearing liabilities. United Security maintains a relatively consistent percentage of earning assets funded by interest-bearing liabilities. In 1995, 80% of the Bank's average earning assets were funded by interest-bearing liabilities as opposed to 82% in 1994 and 81% in 1993. The earning assets funded by interest-bearing liabilities had a favorable effect on the net interest income.\nProvision for Possible Loan Losses\nThe provision for possible loan losses is an expense used to establish the allowance for possible loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of actual losses experienced during the year and management's judgment as to the adequacy of the allowance to absorb future losses. Net recoveries on prior charge-offs exceeded loans charged-off during the year 1995. As a result, no provision from current earnings was necessary to maintain the reserve for loan losses. For additional analysis and discussion of the allowance for loan losses, refer to the section entitled \"Loans and Allowance for Possible Loan Losses.\"\nNon-Interest Income\nNon-interest income consists of revenues generated from a broad range of financial services and activities including fee-based services and commissions earned through insurance sales and trading activities. In addition, gains and losses from the sale of investment portfolio securities and option transactions are included in non-interest income.\nFee income from service charges increased 1.2% in 1995 compared to a 2.8% decrease in 1994. The increase in service charge income resulted primarily from the introduction of the commercial demand deposit account analysis product. This product allows the Bank to evaluate and effectively price the commercial demand deposit account. Insurance premiums and commissions income continued to decline. This income originated primarily from the sale of credit life and accident and health insurance to consumer loan customers. The decline in insurance income resulted from declining volumes of credit life insurance written for customers, coupled with lower premium rates for the last four years. Insurance premiums and commissions income are not expected to increase due to the uncertainty in the credit life insurance market.\nOther non-interest income including safe deposit box fees, credit card fees, letters of credit fees and other customer charges increased to $128,113 in 1995 and accounted for 13.2% of non-interest income (excluding security related income) compared to 11.1% in 1994 and 13.3% in 1993.\nNon-recurring items of non-interest income include all the securities gains (losses) discussed previously. Investment securities had a total loss of $103,414 in 1995 compared to a $34,573 loss in 1994 and a $900,837 gain in 1993. The investment securities loss of $103,414 in 1995 was offset by a trading securities gain of $23,215 and an option income of $221,797 in 1995. The combination of these accounts yielded a net income of $141,598 in securities related non-interest income in 1995 compared to $93,130 in 1994, and $1,238,710 in 1993. Income generated in the area of securities gains and losses (which is also discussed under a separate category \"Securities Gains and Losses\") is dependent on many factors including investment portfolio strategies, interest rate changes, and the short, intermediate, and long-term outlook for the economy. The investment strategy in 1994 and 1995 was directed more toward interest income generated by the investment portfolio by restructuring the fixed-rate portion of the portfolio into floating rates or other fixed rates. This strategy will also enhance future earnings.\nUnited Security continues to search for new sources of non-interest income. These sources will come from innovative ways of performing banking services now as well as providing new services in the future.\nNon-Interest Expense\nNon-interest expenses consist primarily of four major categories: salaries and employee benefits, occupancy expense, furniture and equipment expense, and other expense. United Security Bank's non-interest expense remains relatively high when compared to other banks of similar size because United Security Bank operates eight banking offices. However, management's efforts to control these expenses continue to show positive results. United Security Bank's total non-interest expense as a percentage of average assets was 2.7%, 3.0%, and 3.2% in 1995, 1994, and 1993, respectively. The lower ratio of non-interest expenses to average assets in 1995 is due to a 8.6% increase in average assets while non-interest expenses were constant.\nThe control over non-interest expense growth was enhanced by the Bank's success in effectively utilizing human resource management to maximize productivity. Salaries and benefits increased 1.4% in 1995, decreased less than 1% in 1994, and increased 3.2% in 1993. The low growth in salaries and benefits expense is due to a reduction in full-time equivalent employees. At December 31, 1995, United Security had 90 full-time equivalent employees compared to 94 at December 31, 1994 and 96.5 in 1993. Assets per employee increased to $2.2 million in 1995 compared to $2 million in 1994 and $1.7 million in 1993. Deposits per employee also have steady improvements. In 1995, deposits per employee increased to $1.6 million from $1.5 million 1994 and $1.4 million in 1993. Improvements in these employee productivity measures resulted from effective utilization of human resources, investments in technology, and a concerted effort to carefully manage employee levels. Current levels of employment have been achieved through attrition.\nUnited Security sponsors an Employee Stock Ownership Plan with 401(k) provisions. Employee participation continues to increase; therefore, the Bank's matching contribution expense has increased. The contribution expense increased to $94,829 or 10.4% in 1995, $85,902 or 10% in 1994, and $78,075 or 6.6% in 1993.\nOccupancy expense includes depreciation, rents, utilities, maintenance, insurance, taxes, and other expenses associated with the eight buildings occupied by United Security as well as the vacant building adjacent to the Main Office. Occupancy expense decreased 2.5% in 1995, increased 1.2% in 1994, and decreased 3% in 1993.\nFurniture and equipment expense increased 3.9% in 1995, 2.9% in 1994, and 5.5% in 1993. During much of this three-year period, United Security made a significant investment in new check processing technology and in personal computer networking technology. While these investments will have a short-term impact on equipment depreciation expense, long-term cost savings are expected in the areas of employee productivity, stationery and supplies, postage, and communication expense. It is for this reason that expenditure in new banking technology will continue through 1996 and beyond.\nOther expense consists of stationery, printing supplies, advertising, postage, telephone, legal and other professional fees, other non-credit losses, and other insurance including deposit insurance, and other miscellaneous expenses. The success achieved in containing costs in this category of expenses is evidenced by the 3.6% decline in 1995, compared to the 5.5% increase in 1994 and the 9.5% decline in 1993. The decline in 1995 is directly attributed to the reduction in the FDIC insurance premium expense. The FDIC insurance expense declined by 36.9% in 1995 as a result of the risk-based assessment being reduced from $.23 per $100 of insured deposits to $.04 per $100. Additional savings are expected in this category in 1996 since the savings realized in 1995 was only for half of the year.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Data and Supplementary Data.\nINDEPENDENT AUDITOR'S REPORT\nBoard of Directors United Security Bancshares, Inc. Thomasville, Alabama\nWe have audited the accompanying consolidated statements of condition of United Security Bancshares, 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 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 misstatements. 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 United Security Bancshares, 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.\nSmith, Duke & Buckalew\nMobile, Alabama January 12, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote A -- Summary of Significant Accounting Policies\nDescription of Business\nUnited Security Bancshares, Inc. (the Company) and its subsidiary, United Security Bank (the Bank) provide commercial banking services to customers located primarily in Clarke, Choctaw, Marengo, Sumter, Washington, and Wilcox Counties in Alabama as well as Clarke, Lauderdale, and Wayne Counties in Mississippi.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank. All significant intercompany balances and transactions have been eliminated.\nCash and cash equivalents\nFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Federal funds are generally purchased and sold for one-day periods.\nSecurities\nSecurities are held in three portfolios; trading account securities, held to maturity securities, and securities available for sale. Trading account securities are stated at market value. Investment securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. With regard to investment securities held to maturity, management has the intent and ability to hold such securities until maturity. On January 1, 1994, the Company adopted Financial Accounting Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (\"FAS115\") which requires that investment securities available for sale be reported at fair value with any unrealized gains or losses excluded from earnings and reflected as a separate component of shareholders' equity. The adoption of FAS115 did not affect the Company's methodology for determining the carrying value of its trading account securities or its investment securities held to maturity. Additionally, FAS115 specifies accounting principles in regard to transfers among the three portfolios and the conditions that would permit such transfers. Investment securities available for sale are classified as such due to the fact that management may decide to sell certain securities prior to maturity for liquidity, tax planning or other valid business purposes. The adoption of FAS115 resulted in the addition of $266,972 to shareholders' equity at January 1, 1994, representing the tax-effected net unrealized gain on the Company's available for sale portfolio at that date. Subsequent increases and decreases in the net unrealized gain (loss) on the portfolio of securities available for sale will be reflected as adjustments to the carrying value of the portfolio and as adjustments to the component of shareholders' equity.\nInterest earned on investment securities held to maturity, investment securities available for sale, and trading account securities is included in interest income. Net gains and losses on the sale of investment securities held to maturity and investment securities available for sale, computed principally on the specific identification method, are shown separately in non-interest income in the consolidated statements of income.\nDerivative financial instruments\nAs part of the Company's overall interest rate risk management, the Company uses interest rate protection contracts consisting of interest rate swaps, caps and floors. Interest income or expense related to interest rate swaps, caps and floors is recorded over the life of the agreement as an adjustment to net interest income. The premiums paid for the caps and floors is included in other assets and are amortized straight-line over the life of the agreement. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized.\nLoans and interest income\nLoans are reported at the principal amounts outstanding less unearned income and the allowance for possible loan losses. Interest on commercial and real estate loans is accrued and credited to income based on the principal amount outstanding. Interest on installment loans is recognized using the interest method.\nThe accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.\nAllowance for possible loan losses\nThe allowance for possible loan losses is maintained at a level which, in management's judgement, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, historical trends, specific impaired loans, and economic conditions. Loans evaluated for impairment does not include smaller balance homogenous loans such as consumer installment and real estate mortgage loans. Larger balance loans which are classified as either doubtful or loss are evaluated for impairment and allowances are determined based on collateral values or the present value of estimated cash flows. Non-accrual loans are not considered impaired if the value of their underlying collateral indicates the performance of the loan under the original terms of the agreement. The Bank generally charges off on loans that become four months past due subject to evaluation of the collateral. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term.\nAmortization of Intangibles\nCore deposit intangibles are included in other assets and are amortized using the straight-line method over a period based on the life of the intangible which generally varies from 6 to 10 years. Impairment of these assets is evaluated annually by management based upon the existence of the deposits originally acquired.\nPremises and equipment\nPremises and equipment are stated at cost less accumulated depreciation. The provision for depreciation is computed using the straight-line and accelerated methods over the estimated useful lives of the assets.\nOther real estate\nReal estate acquired through foreclosure is valued at the lower of its fair market value or the recorded investment in the loan. If the fair value of the real estate is less than the Bank's recorded investment at the time of foreclosure, the write-down is charged to the allowance for possible loan losses. Subsequent declines in fair value are charged to other real estate expense.\nIncome taxes\nDeferred income taxes are reported for timing differences between items of income and expense reported in the consolidated financial statements and those reported for income tax purposes. The differences relate primarily to depreciation, provision for possible loan losses, and unrealized losses on trading securities. Deferred taxes are computed on the liability method as prescribed in SFAS No. 109 \"Accounting for Income Taxes\".\nTreasury Stock\nTreasury stock repurchases and sales are accounted for using the cost method.\nEarnings per share\nEarnings per share are calculated based on the weighted average number of shares outstanding during the period, after giving retroactive effect to a four-for-one stock split as explained in Note K.\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 previously reported amounts have been reclassified to conform with current presentation.\nNote B -- Restrictions on Cash and Due From Banks\nThe Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average reserve balance maintained was $3,215,232 in 1995 and $3,390,918 in 1994.\nNote C -- Investment Securities and Investment Securities Available for Sale\nThe adjusted cost and approximate market value of investment securities and investment securities available for sale at December 31, 1995 and 1994 are as follows:\nUnrealized gains and losses on investment securities and investment securities available for sale at December 31, 1995 and 1994 are as follows:\nThe maturity of the debt securities are presented in the following table:\nProceeds from sales of investment securities available for sale were $38,801,121 in 1995 and $39,234,730 in 1994. Gross gains realized on those sales were $511,610 in 1995 and $604,634 in 1994. Gross losses realized on those sales were $615,024 in 1995 and $638,937 in 1994.\nProceeds from sales of debt securities in the trading accounts were $19,197,227 in 1995 and $21,634,133 in 1994. Gross realized gains on those sales were $84,125 in 1995 and $156,382 in 1994. Gross realized losses on those sales were $60,910 in 1995 and $253,907 in 1994.\nInvestment securities with a carrying value of $37,085,102 and $36,241,000 at December 31, 1995 and 1994, respectively, were pledged to secure public deposits and for other purposes.\nSecurities transfers\nDuring 1995 and 1994, the Bank transferred securities from the held to maturity portfolio to the available for sale portfolio. The 1994 transfer was made due to conditions created by the rising rate environment. In July, 1995, the Bank decided to move all of their remaining held to maturity securities to available for sale to allow the Bank more flexibility in managing the portfolio. These transfers were made at market value in accordance with FAS115.\nNote D -- Loans\nAt December 31, 1995 and 1994, the composition of the loan portfolio was as follows:\nThe Bank grants commercial, real estate, and installment loans to customers primarily in Clarke, Choctaw, Marengo, Sumter, Washington, and Wilcox Counties in Alabama, as well as Clarke, Lauderdale, and Wayne Counties in Mississippi. Although the Bank has a diversified loan portfolio, the ability of a substantial number of the Bank's loan customers to honor their obligations is dependent upon the timber and timber-related industries. At December 31, 1995, approximately $20 million of the Bank's loan portfolio consisted of loans to customers in the timber and timber-related industries. This total includes loans of approximately $9.4 million to employees of those industries. Loans on which the accrual of interest has been discontinued amounted to $169,064 and $269,667 at December 31, 1995 and 1994, respectively. If interest on those loans had been accrued, such income would have approximated $22,727 and $52,585 for 1995 and 1994, respectively. Interest income actually recorded on those loans amounted to $10,407 and $44,378 for 1995 and 1994, respectively.\nNote E -- Allowance for Possible Loan Losses\nA summary of the transactions in the allowance for possible loan losses follows:\nAt December 31, 1995, the Bank had no loans considered to be impaired as defined by FAS114.\nNote F -- Premises and Equipment\nPremises and equipment are summarized as follows:\nDecember 31,\n1995 1994\nLand $ 372,554 $ 372,554 Premises 3,727,205 3,689,415 Furniture, fixtures and equipment 3,327,582 3,232,205\n7,427,341 7,294,174 Less accumulated depreciation 3,811,159 3,417,346\nTotal $3,616,182 $3,876,828\nDepreciation expense of $414,471, $437,505 and $415,799, was recorded in 1995, 1994, and 1993, respectively, on premises and equipment.\nNote G -- Investment in Limited Partnerships\nThe Bank has invested in four limited partnerships accounted for under the equity method. These partnerships develop real estate which qualify for Federal tax credits. The Bank's interest in these partnerships are as follows:\nThe assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages, and the Bank's carrying value approximates their underlying equity in the net assets of the partnerships. Market quotations are not available for any of the aforementioned partnerships.\nThe Bank has remaining cash commitments to these partnerships at December 31, 1995 in the amount of $1,270,000.\nNote H -- Other Real Estate\nOther real estate aggregated $2 and $55,003 at December 31, 1995 and 1994, respectively, and is included in other assets on the Consolidated Statements of Condition.\nNote I -- Short-Term Borrowings\nFederal funds purchased and securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Treasury tax and loan deposits are on demand. Other borrowed funds in the amounts of $22,000,000 and $9,500,000 at December 31, 1995 and 1994, respectively, consist of loans from the Federal Home Loan Bank. The cost of these borrowings during 1995 and 1994 varied from 3.20% to 6.40% and 3.06% to 6.50%, respectively. Investment securities are pledged to secure these borrowings.\nNote J -- Long-Term Debt\nLong-term debt consisted of the following at year-end:\nThe 6.5% note from Federal Home Loan Bank is due in equal monthly principal installments of $6,944.44 with a final installment due on February 2, 2005. This note is secured by investment securities pledged to the Federal Home Loan Bank.\nPrincipal payments required on long-term debt for each of the next five years is as follows:\n1996 $ 83,333 1997 83,333 1998 83,333 1999 83,333 2000 83,333 Thereafter 347,224\nNote K -- Change in Par Value and Stock Split\nAt the Company's annual meeting on April 25, 1995, the shareholders ratified a change in the par value of the Company's stock from $.25 to $.01 per share. Additionally, the shareholders also approved an increase in the number of authorized shares from 600,000 shares to 2,400,000 shares in order for the Company to effect a four-for-one split of its stock payable to shareholders of record on that date. All references in the accompanying financial statements to the average number of common shares and per share amounts for 1994 and 1993 have been restated to reflect the stock split.\nNote L -- Income Taxes\nFor the years ended December 31, 1995, 1994 and 1993, income tax expense attributable to income from operations consists of:\nIncome tax expense attributable to income from operations differed from the amount computed by applying the Federal statutory income tax rate to pretax earnings for the following reasons:\nThe sources of timing differences and the resulting net deferred income taxes were 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 presented below:\nThe Company believes that the deferred tax assets are recoverable.\nNote M -- Employee Benefit Plan\nThe Bank sponsors an Employee Stock Ownership Plan with 401(k) provisions. This plan covers substantially all employees and allows employees to contribute up to 15 percent of their compensation on a before-tax basis. The Bank may match employee contributions dollar for dollar up to five percent of an employee's compensation. Employees have the option to allocate some or all of their contributions and employer match towards the purchase of Company stock. The Bank made matching contributions totaling $94,829, $85,902 and $78,075 in 1995, 1994 and 1993, respectively. The ESOP held 34,720 and 34,068 shares as of December 31, 1995 and 1994, respectively as adjusted for the stock split explained in Note K.\nNote N -- Related Party Transactions\nThe Bank has granted loans to its executive officers and directors and their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than a normal risk of collectibility. The aggregate dollar amount of these loans was $1,957,884 and $2,134,580 at December 31, 1995 and 1994, respectively. During 1995, $687,050 of new loans were made, and repayments totaled $863,746. These parties also maintained deposits in the Bank of $3,396,092 at December 31, 1995.\nNote O -- Regulatory Matters\nDividends are paid by the Company from its assets which are mainly provided by dividends from the Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the State Superintendent of Banks is required to pay dividends in excess of the Bank's earnings retained in the current year plus retained net income of the two previous years. As of December 31, 1995, approximately $7,441,820 of the Bank's retained earnings were available for distribution without prior regulatory approval.\nThe Bank is also required to maintain minimum amounts of capital to total \"risk weighted\" assets, as defined by the banking regulators. The following chart summarizes a comparison of the bank's capital ratios for 1995 and 1994 with the minimum bank regulatory capital requirements.\nNote P -- Operating Leases\nThe Company leases data processing and other equipment under operating leases.\nThe following is a schedule by years of future minimum rental payments required under operating leases having initial or remaining noncancelable terms in excess of one year as of December 31, 1995:\nYear ending December 31, 1996 $ 83,973 1997 77,475 1998 31,379 1999 -0- 2000 -0-\nTotal minimum payments required $192,827\nTotal rental expense under all operating leases was $129,065, $131,280 and $153,304, in 1995, 1994 and 1993, respectively.\nNote Q -- Contingencies\nThe Company is a defendant in several lawsuits arising in the normal course of business. Legal counsel did not render an opinion as to the ultimate exposure of the Company in any of the lawsuits, however, management intends to vigorously defend these lawsuits and believes the ultimate outcome of these lawsuits will not have a material adverse effect on the financial position of the Company or will be covered by insurance.\nNote R -- Derivative Financial Instruments\nThe Bank is a party to derivative financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and in connection with its investing and trading activities. These financial instruments include commitments to make loans, options written, standby letters of credit, commitments to purchase or sell securities for forward delivery, interest rate caps and floors purchased, caps sold, and interest rate swaps.\nThe Bank's exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. For interest rate caps, floors, and swap transactions, options written, and commitments to purchase or sell securities for forward delivery, the contract or notional amounts do not represent exposure to credit loss. The Bank controls the credit risk of these instruments through credit approvals, limits and monitoring procedures. The Bank has credit risk on caps and floors for the carrying value plus the amount to replace such contracts in the event of counterparty default. The Bank is fully cross collateralized with counterparties on all interest rate swap agreements. At December 31, 1995, the Bank estimates its credit risk on purchased caps and floors in the event of total counterparty default to be $1,363,069. All of the Bank's financial instruments are held for risk management and not for trading purposes.\nAt December 31, 1995 and 1994, derivative financial instruments with off-balance sheet risk are summarized as follows:\nSince many commitments to make loans expire without being used, the amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined based on management's credit evaluation of the borrower and may include accounts receivable, inventory, property, land, and other items. The Bank does not normally require collateral for standby letters of credit.\nCommitments to purchase securities for delayed delivery require the Bank to purchase a specified security at a specified price for delivery on a specified date. Similarly, commitments to sell securities for delayed delivery require the Bank to sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in securities values and interest rates between the commitment and delivery dates.\nThe Bank's principal objective in holding derivative financial instruments is asset-liability management. The operations of the Bank are subject to a risk of interest rate fluctuations to the extent that there is a difference between the amount of the Bank's interest-earning assets and the amount of interest-bearing liabilities that mature or reprice in specified periods. The principal objective of the Bank's asset-liability management activities is to provide maximum levels of net interest income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Bank. To achieve that objective, the Bank uses a combination of derivative financial instruments, including interest rate swaps, caps, and floors. An interest rate swap is an agreement in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount with at least one stream based on a specified floating-rate index. Interest rate swaps are used by the Bank to effectively convert a portion of its floating rate securities to fixed rate securities except for one swap which is used to convert a fixed rate loan to prime. Interest rate caps and floors are option-like contracts that require the seller to pay the purchaser at specified future dates the amount, if any, by which a specified market interest rate exceeds the fixed cap rate or falls below the fixed floor rate, applied to a notional principal amount. The Bank uses interest rate caps to hedge against rising interest rates on the Bank's $22 million floating rate short-term borrowings. The remaining caps are used to un-cap a portion of the Bank's floating rate CMO portfolio which totals approximately $95 million at December 31, 1995. The Bank uses floors to protect CMO floaters against a decline in rates. The Bank sold a $10 million cap which matched a $10 million purchased cap to effectively raise the cap 100 basis points on a $10 million CMO floater which had been classified as \"high risk\" because rates were approaching the original cap rate. The cost of caps and floors are amortized straight-line over the life of these instruments. The income derived from these instruments is recorded on the accrual basis. The income and amortization from these instruments is recorded in net interest income and resulted in a reduction in net interest income of $42,895, $114,380, and $103,627 in 1995, 1994, and 1993, respectively.\nThe following table details various information regarding swaps, caps and floors used for purposes other than trading as of December 31, 1995.\nSwaps, caps and floors acquired for other than trading purposes are used to help reduce the risk of interest rate movements for specific categories of assets and liabilities. At December 31, 1995, such swaps, caps and floors were associated with the following asset or liability categories:\nIncome or expense on derivative financial instruments used to manage interest rate exposure is recorded on an accrual basis as an adjustment to the yield of the related interest-earning assets or interest-bearing liabilities over the periods covered by the contracts. If a derivative financial instrument that is used to manage interest rate risk is terminated early, any resulting gain or loss is deferred and amortized over the remaining periods originally covered by the derivative financial instrument.\nDeferred gains on early termination of interest rate swaps used to manage interest rate risk are $68,147, as of December 31, 1995. Those amounts are scheduled to be amortized into income in the following periods: $34,406 gain in 1996, $25,584 gain in 1997, $5,601 loss in 1998 and $13,758 gain in 1999.\nAll of the Bank's derivative financial instruments are over-the-counter instruments and are not exchange traded. Market values are obtained from the counterparties to each instrument. The Bank only uses other commercial banks as a counterparty to their derivative activity. The Bank performs stress tests and other models to assess risk exposure.\nNote S -- Fair Value of Financial Instruments\nFinancial Accounting Statement No. 107, Disclosures about Fair Value of Financial Instruments (\"FAS107\"), requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance. The Company has not undertaken any steps to value any intangibles, which is permitted by the provisions of FAS107.\nThe following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Cash and due from banks: Fair value equals the carrying value of such assets.\nFederal funds sold: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value. Investment securities available for sale: Fair values for investment securities are based on quoted market prices. Accrued interest receivable: Fair value equals the carrying value of these instruments.\nLoans: For variable rate loans, those repricing within six months fair values are based on carrying values. Fixed rate commercial loans, other installment loans, and certain real estate mortgage loans were valued using discounted cash flows. The discount rate used to determine the present value of these loans was based on interest rates currently being charged by the Bank on comparable loans as to credit risk and term.\nOff-balance-sheet instruments: Fair value of the Company's off-balance-sheet instruments (futures, forwards, swaps, caps, floors and options written) are based on quoted market prices. The Company's loan commitments are negotiated at current market rates and are relatively short-term in nature and, as a matter of policy, the Company generally makes commitments for fixed rate loans for relatively short periods of time, therefore, the estimated value of the Company's loan commitments approximates carrying amount.\nDemand and savings deposits: The fair values of demand deposits are, as required by FAS107, equal to the carrying value of such deposits. Demand deposits include noninteresting bearing demand deposits, savings accounts, NOW accounts and money market demand accounts.\nTime Deposits: The fair value of relatively short-term time deposits is equal to their carrying values. Discounted cash flows have been used to value long-term time deposits. The discount rate used is based on interest rates currently being offered by the Bank on comparable deposits as to amount and term.\nShort-term borrowings: These borrowings consist of floating rate borrowings from the Federal Home Loan Bank and the U.S. Treasury Tax and loan account. Due to the short-term nature of these borrowings, fair value approximate carrying value.\nFHLB long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company's current incremental borrowing rate for similar types of borrowing arrangements.\nNote T -- United Security Bancshares, Inc. (Parent Company Only)\nNote U -- Subsequent Events\nOn January 15, 1996, the Company signed an agreement to acquire all of the outstanding shares of Brent Banking Company for $7.05 million in cash. At December 31, 1995, Brent had assets of $36 million and equity of $4.7 million.\nNote V -- Accounting Standards Not Yet Adopted\nThe Company has not yet adopted the provisions of SFAS 121, however, the adoption of this standard is not expected to have a significant impact in the financial position of 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 called for in this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption \"Election of Directors,\" to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption \"Executive Compensation and Benefits,\" to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption \"Voting Securities and Principal Stockholders,\" to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption \"Certain Relationships and Related Transactions,\" to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the 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. Financial Statements\nReport of Independent Public Accountants.\nConsolidated Statements of Condition, December 31, 1995 and 1994.\nConsolidated Statements of Shareholders' Equity, December 31, 1995, 1994, and 1993.\nConsolidated Statements of Income, December 31, 1995, 1994, and 1993.\nConsolidated Statements of Cash Flows, December 31, 1995, 1994, and 1993.\nNotes to Consolidated Financial Statements.\n(a)2. Financial Statements Schedules\nIncluded in Part II of this report:\nThe financial statement schedules required to be included pursuant to this Item are not included herein because they are not applicable or the required information is shown in the financial statements or notes thereto, which are included at Part II, Item 8, of this report.\n(a)3. Exhibits\n(3)(a) Articles of Incorporation of Bancshares, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1987.\n(3)(b) Articles of Amendment to the Articles of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1992.\n(3)(c) Amended and Restated Articles of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the Quarter ended June 30, 1995.\n(3)(d) Bylaws of Bancshares, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1987.\n(10)(a) The United Security Bancshares, Inc. Employee Stock Ownership Plan, dated January 1, 1992, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1992.\n(10)(b) Employment Agreement dated November 1, 1995, between Bancshares and Jack M. Wainwright, III, incorporated by reference to Exhibit to Form 10-K for the year ended December 31, 1994.\n(10)(c) Form of Indemnification between Bancshares and its directors, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1994.\n(13) Bancshares' definitive proxy statement for 1995 annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year ended December 31, 1995, furnished for the information of the Commission.\n(22) List of Subsidiaries of Bancshares.\n(b) Reports on Form 8-K No report on Form 8-K was filed during the last quarter of the year ended December 31, 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.\nUNITED SECURITY BANCSHARES, INC.\nBy: \/s\/ Jack M. Wainwright, III March 19, 1996 Jack M. Wainwright, III Its 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":"847903_1995.txt","cik":"847903","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nThe operating subsidiaries of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and its wholly-owned subsidiary, RJR Nabisco, Inc. (\"RJRN\") (collectively the \"Registrants\"), comprise one of the largest tobacco and food companies in the world. In the United States, the tobacco business is conducted by R. J. Reynolds Tobacco Company (\"RJRT\"), the second largest manufacturer of cigarettes, and the packaged food business is conducted by Nabisco Holdings Corp. (\"Nabisco Holdings\") through its wholly-owned subsidiary, Nabisco, Inc. (\"Nabisco\"), the largest manufacturer and marketer of cookies and crackers. Outside the United States, the tobacco operations are conducted by R. J. Reynolds Tobacco International, Inc. and beginning on January 1, 1996, R.J. Reynolds International (collectively \"Reynolds International\"), and the food operations are conducted by Nabisco International, Inc. (\"Nabisco International\") and Nabisco Ltd (formerly Nabisco Brands Ltd). RJRT's and Reynolds International's tobacco products are sold around the world under a variety of brand names. Nabisco's food products are sold in the United States, Canada, Latin America, certain European countries and certain other international markets. For financial information with respect to RJRN's industry segments, lines of business and operations in various geographic locations, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 16 to the consolidated financial statements, and the related notes thereto, of RJRN Holdings and RJRN as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995 (the \"Consolidated Financial Statements\").\nRJRN Holdings was organized as a Delaware corporation in 1988 at the direction of Kohlberg Kravis Roberts & Co., L.P. (\"KKR\"), a Delaware limited partnership, to effect the acquisition of RJRN, which was completed on April 28, 1989 (the \"Acquisition\"). As a result of the Acquisition, RJRN became an indirect, wholly owned subsidiary of RJRN Holdings. After a series of holding company mergers completed on December 17, 1992, RJRN became a direct, wholly owned subsidiary of RJRN Holdings. The business of RJRN Holdings is conducted through RJRN.\nRJRN was incorporated as a holding company in 1970. RJRT can trace its origins back to its formation in 1875. Activities were confined to the tobacco industry until the 1960's, when diversification led to investments in transportation, energy and food. With the acquisition of Del Monte Corporation (\"Del Monte\") in 1979 (which was sold in 1989), RJRN began to concentrate its focus on consumer products. This strategy led to the acquisition of Nabisco Holdings Corp. (formerly Nabisco Brands, Inc.) in 1985.\nIn recent years subsidiaries of RJRN Holdings and RJRN have completed a number of acquisitions and have divested certain businesses. In 1995, these acquisitions included (i) certain trademark and other assets of Kraft Foods' U.S. and Canadian margarine and tablespreads business; (ii) certain trademarks and other assets of Primo Foods Limited, a Canadian manufacturer of dry pasta, canned tomatoes and pasta and pizza sauces; (iii) a 50% interest in Royal Beech-Nut (pty) Ltd., a South African subsidiary of Del Monte Royal Foods, Ltd; (iv) the assets of Avare and Gumz, two Brazilian milk product companies; (v) O.y. P.c. Rettig Ab, Finland's second largest tobacco company and (vi) a significant interest and management control of the Tanzania Tobacco Company. The 1995 divestitures included (i) the sale of the Ortega Mexican Food business and (ii) the sale of New York Style Bagel Chip business.\nIn 1994, acquisitions included (i) the KNOX gelatin brand; (ii) an approximately 99% interest in Establecimiento Modelo Terrabusi S.A., Argentina's second largest biscuit and pasta maker; (iii) a 76% interest in the Yelets tobacco processing plant in Russia; (iv) a controlling interest in a cigarette manufacturer in the Krasnodar region of southern Russia; and (v) a 90% interest in Shimkent Confectionery Enterprises and a site for a new cigarette factory in Kazakhstan.\nRJRN will continue to assess its businesses to evaluate their consistency with strategic objectives. Although RJRN may acquire and\/or divest additional businesses in the future, no other decisions have been made with respect to any such acquisitions or divestitures. RJRN Holdings' and RJRN's credit agreement, dated as of April 28, 1995, as amended (the \"1995 RJRN Credit Agreement\"), and credit agreement, dated as of April 28, 1995, as amended (the \"RJRN Commercial Paper Facility\" and, together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"), prohibit the sale of all or any substantial portion of certain assets of RJRN Holdings or its subsidiaries.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its initial borrowing under its credit agreement, dated as of December 6, 1994 (the \"1994 Nabisco Credit Agreement\"). RJRN owns 100% of the outstanding Class B Common Stock of Nabisco Holdings, which represents approximately 80.5% of the economic interest in Nabisco Holdings and approximately 97.6% of the total voting power of Nabisco Holdings' outstanding common stock. In connection with the offering, RJRN Holdings, RJRN and Nabisco Holdings entered into agreements to exchange certain services, to establish tax sharing arrangements and to provide RJRN with certain preemptive and registration rights with respect to Nabisco Holdings and Nabisco securities.\nIn 1995, RJRN and Nabisco engaged in a series of related transactions that were designed, among other things, to enable Nabisco to obtain long term debt financing independent of RJRN and to repay its intercompany debt to RJRN. Specifically, on April 28, 1995, Nabisco Holdings and Nabisco entered into a credit agreement with various financial institutions (as amended, the \"1995 Nabisco Credit Agreement\") to replace the 1994 Nabisco Credit Agreement. Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On June 5, 1995, RJRN and Nabisco consummated offers to exchange approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\"). As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN also obtained consents to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\").\nDuring 1994, the percentage voting power of RJRN Holdings held by partnerships affiliated with KKR (the \"KKR Partnerships\") decreased substantially and in 1995 the KKR Partnerships divested their remaining interests in RJRN Holdings voting securities primarily in connection with the acquisition of Borden, Inc. by certain of the KKR Partnerships.\n(b) Financial Information about Industry Segments\nDuring 1995, 1994 and 1993, RJRN's industry segments were tobacco and food.\nFor information relating to industry segments for the years ended December 31, 1995, 1994 and 1993, see Note 16 to the Consolidated Financial Statements.\n(c) Narrative Description of Business\nTOBACCO\nThe tobacco line of business is conducted by RJRT and Reynolds International, which manufacture, distribute and sell cigarettes. Cigarettes are manufactured in the United States by RJRT and in over 40 foreign countries and territories by Reynolds International and subsidiaries or licensees of RJRT and are sold throughout the United States and in more than 170 markets around the world. In 1995, approximately 58% of total tobacco segment net sales (after deducting excise taxes) and approximately 69% of total tobacco segment operating income (before amortization of trademarks and goodwill) were attributable to domestic tobacco operations.\nDOMESTIC TOBACCO OPERATIONS\nThe domestic tobacco business is conducted by RJRT which is the second largest cigarette manufacturer in the United States. RJRT's largest selling cigarette brands in the United States include WINSTON, DORAL, CAMEL, SALEM, MONARCH and VANTAGE. RJRT's other cigarette brands, including MORE, NOW, BEST VALUE, STERLING, MAGNA and CENTURY, are marketed to meet a variety of smoker preferences. All RJRT brands are marketed in a variety of styles. Based on data collected for RJRT by an independent market research firm, RJRT had an overall share of retail consumer cigarette sales during 1995 of 27%, a decrease of approximately 1 share point from 1994. During 1995, RJRT and the largest domestic cigarette manufacturer, Philip Morris Incorporated, together sold, on a shipment basis, approximately 72% of all cigarettes sold in the United States.\nIn November 1994, RJRT confirmed press reports that it was developing ECLIPSE, a cigarette that primarily heats rather than burns tobacco and thereby substantially reduces second-hand smoke. The cigarette remains under development and RJRT continues to assess a possible market introduction of an ECLIPSE cigarette.\nA primary long-term objective of RJRT is to increase earnings and cash flow through selective marketing investments in its key brands and continual improvements in its cost structure and operating efficiency. Marketing programs for full-price brands are designed to build brand awareness and add value to the brands by building brand loyalty among current adult smokers and attracting adult smokers of competitive brands. In 1995, these efforts included the continuation and refinement of conversion, continuity and relationship-building programs such as the CAMEL Genuine Taste Mission, the expanded regional introduction of the SALEM Preferred line extension and the introduction of a line of cigarette brands from a new operating unit, Moonlight Tobacco. RJRT believes it is essential to compete in all segments of the cigarette market, and accordingly it offers a range of lower-priced brands including DORAL, MONARCH and BEST VALUE, intended to appeal to more cost-conscious adult smokers. For a discussion on competition in the tobacco business, see \"Business--Tobacco-- Competition\" in this Item 1.\nRJRT's domestic manufacturing facilities, consisting principally of factories and leaf storage facilities, are located in or near Winston-Salem, North Carolina and are owned by RJRT. Cigarette production is conducted at the Tobaccoville cigarette manufacturing plant (approximately two million square feet) and the Whitaker Park cigarette manufacturing complex (approximately one and one-half million square feet). RJRT believes that its cigarette manufacturing facilities are among the most technologically advanced in the United States. RJRT also has significant research and development facilities in Winston-Salem, North Carolina.\nRJRT's cigarettes are sold in the United States primarily to chain stores, other large retail outlets and through distributors to other retail and wholesale outlets. Except for McLane Company, Inc., which represented approximately 13% of RJRT's sales, no RJRT customers accounted for more than 10% of sales for 1995. RJRT distributes its cigarettes primarily to public warehouses located throughout the United States that serve as local distribution centers for RJRT's customers.\nRJRT's products are sold to adult smokers primarily through retail outlets. RJRT employs a decentralized marketing strategy that permits its sales force to be flexible in responding to local market dynamics by designing individual in-store programs to fit varying consumption patterns. RJRT uses print media, billboards, point-of-sale displays and other methods of advertising. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States.\nINTERNATIONAL TOBACCO OPERATIONS\nReynolds International operates in over 170 markets around the world. Although overall foreign cigarette sales (excluding China, in which production data indicates an approximate 2% per annum growth rate) have increased at a rate of only 1% per annum in recent years, Reynolds International believes that the American Blend segment, in which Reynolds International primarily competes, is growing significantly faster. Although Reynolds International is the second largest of two international cigarette producers that have significant positions in the American Blend segment, its share of sales in this segment is approximately one-third of the share of Philip Morris International Inc., the largest American Blend producer.\nReynolds International has strong brand presence in Western Europe and is well established in its other key markets in the Middle East\/Africa, Asia and Canada. Reynolds International is aggressively pursuing development opportunities throughout the world.\nReynolds International markets nearly 100 brands of which WINSTON, CAMEL and SALEM, all American Blend cigarettes, are its international leaders. WINSTON, Reynolds International's largest selling international brand, has a significant presence in Puerto Rico and has particular strength in the Western Europe and Middle East\/Africa regions. CAMEL is sold in approximately 140 markets worldwide and is Reynolds International's second largest selling international brand. SALEM is the world's largest selling menthol cigarette and is particularly strong in Far East markets. Reynolds International also markets a number of local brands in various foreign markets. None of Reynolds International's customers accounted for more than 10% of sales in 1995.\nMore than 20% of Reynolds International's 1995 volume was U.S.-made product, with the remainder manufactured outside the U.S. Reynolds International brands are manufactured in owned or joint-venture facilities in 19 locations outside the United States, and through licensing agreements in about 20 other countries. Reynolds International owned or joint-venture manufacturing locations include Canada, the Canary Islands, China, the Czech Republic, Finland, Germany, Hong Kong, Hungary, Indonesia, Kazakhstan, Malaysia, Poland, Portugal, Romania, Russia, Switzerland, Tanzania, Turkey, Ukraine and Vietnam.\nCertain of Reynolds International's foreign operations are subject to local regulations that set import quotas, restrict financing flexibility, affect repatriation of earnings or assets and limit advertising. In recent years, certain trade barriers for cigarettes, particularly in Asia and Eastern Europe, have been liberalized. This may provide opportunities for all international cigarette manufacturers, including Reynolds International, to expand operations in such markets; however, there can be no assurance that the liberalizing trends will be maintained or extended or that Reynolds International will be successful in pursuing such opportunities.\nRAW MATERIALS\nIn its domestic production of cigarettes, RJRT primarily uses domestic burley and flue cured leaf tobaccos purchased at domestic auction. RJRT also purchases oriental tobaccos, grown primarily in Turkey and Greece, and certain other non-domestic tobaccos. Reynolds International uses a variety of tobacco leaf from both United States and international sources. RJRT and Reynolds International believe there is a sufficient supply of tobacco in the worldwide tobacco market to satisfy their current production requirements.\nTobacco leaf is an agricultural commodity subject in the United States to government production controls and price supports that can affect market prices substantially. The tobacco leaf price support program is subject to Congressional review and may be changed at any time. In addition, Congress enacted the Omnibus Budget Reconciliation Act of 1993, which assesses financial penalties against manufacturers if cigarettes produced in the United States do not contain at least 75% (by weight) domestically grown flue cured and burley tobaccos. In December 1994, Congress enacted the Uruguay Round Agreements Act to replace this domestic content requirement with a tariff rate quota system that keys tariffs to import volumes. The tariff rate quotas have been established by the United States with overseas tobacco producers and became effective on September 13, 1995. Compliance with domestic content restrictions increased raw material costs slightly in 1994 but these costs were down slightly in 1995 during the period when the domestic content requirement was not applicable.\nCOMPETITION\nGenerally, the markets in which RJRT and Reynolds International conduct their businesses are highly competitive, with a number of large participants. Competition is conducted on the basis of brand recognition, brand loyalty, quality and price. For most of RJRT's and Reynolds International's brands, substantial advertising and promotional expenditures are required to maintain or improve a brand's market position or to introduce a new brand. Anti-smoking groups have undertaken activities designed to inhibit cigarette sales, the form and content of cigarette advertising and the testing and introduction of new cigarette products.\nBecause television and radio advertising for cigarettes is prohibited in the United States and brand loyalty has tended to be higher in the cigarette industry than in other consumer product industries, established cigarette brands in the United States have a competitive advantage. RJRT has repositioned or introduced brands designed to appeal to adult smokers of the largest selling cigarette brand in the United States, but there can be no assurance that such efforts will be successful.\nIn addition, increased selling prices and taxes on cigarettes have resulted in additional price sensitivity of cigarettes at the consumer level and in a proliferation of discounted brands in the savings segment of the market. Generally, sales of cigarettes in the savings segment are not as profitable as those in other segments.\nLEGISLATION AND OTHER MATTERS AFFECTING THE CIGARETTE INDUSTRY\nThe advertising, sale and use of cigarettes has been under attack by government and health officials in the United States and in other countries for many years, principally due to claims that cigarette smoking is harmful to health. This attack has resulted in: a number of substantial restrictions on the marketing, advertising and use of cigarettes; diminishing social acceptability of smoking; and activities by anti-smoking groups designed to inhibit cigarette sales, the form and content of cigarette advertising and the testing and introduction of new cigarette products. Together with manufacturers' price increases in recent years and substantial increases in state and federal excise taxes on cigarettes, this has had and will likely continue to have an adverse effect on cigarette sales.\nCigarettes are subject to substantial excise taxes in the United States and to similar taxes in many foreign markets. The federal excise tax per pack of 20 cigarettes was last increased in January 1993 to its current rate of 24 cents per pack. In addition, all states and the District of Columbia impose excise taxes at levels ranging from a low of 2.5 cents to a high of 81.5 cents per pack of cigarettes. Increases in these state excise taxes could also have an adverse effect on cigarette sales. In 1994, five states enacted excise tax increases ranging from 7.5 cents to 50 cents per pack. In 1995, the cigarette excise tax in four states was increased by amounts which ranged from 5 cents to 24 cents per pack. In one state, a temporary 10 cent tax, scheduled to expire in 1995, was extended through 1997.\nIn January 1993, the U.S. Environmental Protection Agency (the \"EPA\") released a report on the respiratory effects of environmental tobacco smoke (\"ETS\") which concludes that ETS is a known\nhuman lung carcinogen in adults and in children causes increased respiratory tract disease and middle ear disorders and increases the severity and frequency of asthma. RJRT has joined other parties from the tobacco and distribution industries in a lawsuit against the EPA seeking a determination that the EPA did not have the statutory authority to regulate ETS, and that, given the current body of scientific evidence and the EPA's failure to follow its own guidelines in making the determination, the EPA's classification of ETS was arbitrary and capricious.\nIn February 1994, the Commissioner of the U.S. Food and Drug Administration (the \"FDA\"), which historically has refrained from asserting jurisdiction over cigarette products, stated that he intended to cause the FDA to work with the U.S. Congress to resolve the regulatory status of cigarettes under the Food, Drug and Cosmetic Act. During the second quarter of 1994, hearings were held in this regard, and RJRT and other members of the United States cigarette industry were asked to provide voluntarily certain documents and other information to Congress. In August 1995, the Commissioner of the FDA, with the support of the Clinton Administration, announced that he was asserting jurisdiction over cigarettes and certain other tobacco products and issued a notice and request for comments on proposed regulations. The proposed regulations would prohibit or impose stringent limits on a broad range of sales and marketing practices, including bans on sampling, sponsorship by brand name, and distribution of non-tobacco items carrying brand names. The FDA's proposed rule would also limit advertising in print and on billboards to black and white text, impose new labeling language, and require cigarette manufacturers to fund a $150 million-a-year campaign to discourage minors from using tobacco products. RJRT and other cigarette manufacturers have submitted responses to the proposed rules.\nThe purported purpose of the FDA's assertion of jurisdiction was to curb the use of tobacco products by underage youth. RJRT believes, however, that the assertion of jurisdiction and the scope of the proposed rules would materially restrict the availability of cigarettes and RJRT's ability to market its cigarette products to adult smokers. RJRT, together with the other four major domestic cigarette manufacturers and an advertising agency, filed suit on the day of the Commissioner's announcement in the U.S. District Court for the Middle District of North Carolina seeking to enjoin the FDA's assertion of jurisdiction (Coyne Beahm v. United States Food & Drug Administration). Similar suits have been filed in the same court by manufacturers of smokeless tobacco products, by operators of retail stores and by advertising interests. RJRT is unable to predict whether or when the FDA will adopt final rules asserting jurisdiction over cigarettes or the scope of such final rules if adopted, but such rules could have an adverse effect on cigarette sales and RJRT. It is also unable to predict the outcome of the litigation seeking to enjoin the FDA's rulemaking.\nIn March 1994, the U.S. Occupational Safety and Health Administration (\"OSHA\") announced proposed regulations that would restrict smoking in the workplace to designated smoking rooms that are separately exhausted to the outside. Although RJRT cannot predict the form or timing of any regulations that may be finally adopted by OSHA, if the proposed regulations are adopted, RJRT expects that many employers who have not already done so would prohibit smoking in the workplace rather than make expenditures necessary to establish designated smoking areas to accommodate smokers. RJRT submitted comments on the proposed regulations during the comment period which closed in February 1996. Because many employers currently do not permit smoking in the workplace, RJRT cannot predict the effect of any regulations that may be adopted, but incremental restrictions on smokers could have an adverse effect on cigarette sales and RJRT.\nIn July 1994, an amendment to a Florida statute became effective which allows the state of Florida to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action, and eliminates the comparative negligence and assumption of risk defenses. The Florida statute is being challenged on state and federal constitutional grounds in a\nlawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets, and National Association of Convenience Stores in June 1994. On June 26, 1995, the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the statute unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida supreme court accepted for direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether other states will enact similar legislation and whether lawsuits will be filed under these statutes or their outcome, if filed. A suit against the tobacco industry was filed under the Florida statute on February 21, 1995. See \"Business--Tobacco--Litigation Affecting the Cigarette Industry\" below in this Item 1.\nLegislation imposing various restrictions on public smoking has also been enacted in forty-eight states and many local jurisdictions, and many employers have initiated programs restricting or eliminating smoking in the workplace. Seventeen states have enacted legislation designating a portion of increased cigarette excise taxes to fund either anti-smoking programs, health care programs or cancer research. Federal law prohibits smoking on all domestic airline flights of six hours duration or less and the U.S. Interstate Commerce Commission has banned smoking on buses transporting passengers inter-state. Certain common carriers have imposed additional restrictions on passenger smoking.\nA number of foreign countries have also taken steps to discourage cigarette smoking, to restrict or prohibit cigarette advertising and promotion and to increase taxes on cigarettes. Such restrictions are, in some cases, more onerous than restrictions imposed in the United States. In June 1988, Canada enacted a ban on cigarette advertising, which was struck down on grounds of constitutionality by the Supreme Court of Canada in 1995.\nIn 1990, RJRT and other U.S. cigarette manufacturers, through The Tobacco Institute, announced a tobacco industry initiative to assist retailers in enforcing minimum age laws on the sale of cigarettes, to support the enactment of state laws requiring the adult supervision of cigarette vending machines in places frequented by minors, to seek the uniform establishment of 18 as the minimum age for the purchase of cigarettes in all states, to distribute informational materials to assist parents in combatting peer pressure on their children to smoke and to limit voluntarily certain cigarette advertising and promotional practices. In 1995, wholesalers, retailers and the tobacco industry including RJRT formed the Coalition for Responsible Tobacco Retailing and launched a new program (We Card) focused on stopping underage access to cigarettes. In 1992, the Alcohol, Drug Abuse and Mental Health Act was signed into law. This act requires states to adopt a minimum age of 18 for purchases of tobacco products and to establish a system to monitor, report and reduce the illegal sale of tobacco products to minors in order to continue receiving federal funding for mental health and drug abuse programs. In January, 1996, regulations implementing this legislation were announced by the Department of Health and Human Services.\nIn 1964, the Report of the Advisory Committee to the Surgeon General of the U.S. Public Health Service concluded that cigarette smoking was a health hazard of sufficient importance to warrant appropriate remedial action. Since 1966, federal law has required a warning statement on cigarette packaging. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States. Cigarette advertising in other media in the United States is required to include information with respect to the \"tar\" and nicotine yield content of cigarettes, as well as a warning statement.\nDuring the past three decades, various laws affecting the cigarette industry have been enacted. In 1984, Congress enacted the Comprehensive Smoking Education Act (the \"Smoking Education Act\"). Among other things, the Smoking Education Act: (i) establishes an interagency committee on smoking and health that is charged with carrying out a program to inform the public of any dangers to human health presented by cigarette smoking; (ii) requires a series of four health warnings to be printed on cigarette packages and advertising on a rotating basis; (iii) increases type size and area of the warning required in cigarette advertisements; and (iv) requires that cigarette manufacturers provide annually, on a confidential basis, a list of ingredients used in the manufacture of cigarettes to the Secretary of Health and Human Services. The warnings currently required on cigarette packages and advertisements (other than billboards) are as follows: (i) \"Surgeon General's Warning: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy\"; (ii) \"Surgeon General's Warning: Quitting Smoking Now Greatly Reduces Serious Risks To Your Health\"; (iii) \"Surgeon General's Warning: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth Weight\"; and (iv) \"Surgeon General's Warning: Cigarette Smoke Contains Carbon Monoxide.\" Similar warnings are required on outdoor billboards. In 1990, the Fire Safe Cigarette Act of 1990 was enacted, which directed the Consumer Product Safety Commission to conduct and oversee research begun under the direction of the Cigarette and Little Cigar Fire Safety Act of 1984 to assess the practicability of developing a performance standard to reduce cigarette ignition propensity. The Commission presented a final report to Congress in 1993 describing the results of the research. The Commission concluded that, while \"it is practicable to develop a performance standard to reduce cigarette ignition propensity, it is unclear that such a standard would effectively address the number of cigarette-ignited fires.\" The Commission further found that additional work would be required before the actual development of a performance standard. Nevertheless, the Commission reported that a test method developed by the National Institute of Standards and Technology was valid and reliable within reasonable limits and could be suitable for use in a performance standard. Although RJRT cannot predict whether further legislation on this subject may be enacted, some form of regulation of cigarettes based on their propensity to ignite soft furnishings may result.\nSince the initial report in 1964, the Secretary of Health, Education and Welfare (now the Secretary of Health and Human Services) and the Surgeon General have issued a number of other reports which purport to find the nicotine in cigarettes addictive and to link cigarette smoking and exposure to cigarette smoke with certain health hazards, including various types of cancer, coronary heart disease and chronic obstructive lung disease. These reports have recommended various governmental measures to reduce the incidence of smoking.\nIn addition to the foregoing, legislation and regulations potentially detrimental to the cigarette industry, generally relating to the taxation of cigarettes and regulation of advertising, labeling, promotion, sale and smoking of cigarettes, have been proposed from time to time at various levels of the federal government. During the last Congress, the Clinton administration and federal legislators introduced bills that would have significantly increased the federal excise tax on cigarettes, eliminated the deductibility of the cost of tobacco advertising, banned smoking in public buildings and on any scheduled airline flight, and given the Food and Drug Administration authority to reduce and eliminate nicotine in tobacco products. This legislation was not enacted.\nIt is not possible to determine what additional federal, state, local or foreign legislation or regulations relating to smoking or cigarettes will be enacted or to predict any resulting effect thereof on\nRJRT, Reynolds International or the cigarette industry generally, but such legislation or regulations could have an adverse effect on RJRT, Reynolds International or the cigarette industry generally.\nLITIGATION AFFECTING THE CIGARETTE INDUSTRY\nVarious legal actions, proceedings and claims are pending or may be instituted against RJRT or its affiliates or indemnitees, including those claiming that lung cancer and other diseases have resulted from the use of or exposure to RJRT's tobacco products. During 1995, 101 new actions were filed or served against RJRT and\/or its affiliates or indemnitees and 22 such actions were dismissed or otherwise resolved in favor of RJRT and\/or its affiliates or indemnitees without trial. A total of 132 such actions in the United States and two against RJRT's Canadian subsidiary were pending on December 31, 1995. As of February 16, 1996, 144 active cases were pending against RJRT and\/or its affiliates or indemnitees, 142 in the United States and two in Canada. The United States cases are in 22 states and are distributed as follows: 90 in Florida; 10 in Louisiana; 5 in Texas; 4 in each of Indiana, Kansas and Tennessee; 3 in each of Mississippi, California, Pennsylvania; 2 in each of Alabama, Colorado, Massachusetts and Minnesota; and one in each of Missouri, Nevada, New Hampshire, New Jersey, New York, North Carolina, Rhode Island, South Carolina and West Virginia. Of the 142 active cases in the United States, 116 are pending in state court and 26 in federal court.\nFive of the 142 active cases in the United States involve alleged non-smokers claiming injuries resulting from exposure to environmental tobacco smoke. Six cases, which are described more specifically below, purport to be class actions on behalf of thousands of individuals. Purported classes include individuals claiming to be addicted to cigarettes and flight attendants alleging personal injury from exposure to environmental tobacco smoke in their workplace. Four of the active cases were brought by state attorneys general seeking, inter alia, recovery of the cost of Medicare funds paid by their states for treatment of citizens allegedly suffering from tobacco related diseases or conditions. In addition, one case was brought by the State of Florida seeking similar rulings under a special state statute.\nThe plaintiffs in these actions seek recovery on a variety of legal theories, including strict liability in tort, design defect, negligence, breach of warranty, failure to warn, fraud, misrepresentation, unfair trade practices, conspiracy, unjust enrichment, indemnity and common law public nuisance. Punitive damages, often in amounts ranging into the hundreds of millions of dollars, are specifically pleaded in 20 cases in addition to compensatory and other damages. The defenses raised by RJRT and\/or its affiliates, where applicable, include preemption by the Federal Cigarette Labeling and Advertising Act, as amended (the \"Cigarette Act\") of some or all such claims arising after 1969; the lack of any defect in the product; assumption of the risk; comparative fault; lack of proximate cause; and statutes of limitations or repose. Juries have found for plaintiffs in two smoking and health cases in which RJRT was not a defendant, but in one such case, which has been appealed by both parties, no damages were awarded. The jury awarded plaintiffs $400,000 in the other such case, Cipollone v. Liggett Group, which award was overturned on appeal and the case was subsequently dismissed.\nOn June 24, 1992, the United States Supreme Court in Cipollone held that claims that tobacco companies failed to adequately warn of the risks of smoking after 1969 and claims that their advertising and promotional practices undermined the effect of warnings after that date were preempted by the Cigarette Act. The Supreme Court also held that claims of breach of express warranty, fraud, misrepresentation and conspiracy were not preempted. The Supreme Court's decision was announced through a plurality opinion, and further definition of how Cipollone will apply to other cases must await rulings in those cases.\nCertain legislation proposed in recent years in Congress, among other things, would eliminate any such preemptive effect on common law damage actions for personal injuries. RJRT is unable to predict whether such legislation will be enacted and, if so, in what form, or whether such legislation would be\nintended by Congress to apply retroactively. The passage of such legislation could increase the number of cases filed against cigarette manufacturers, including RJRT.\nSet forth below are descriptions of the class action lawsuits, a suit in which plaintiffs seek to act as private attorneys general, actions brought by state attorneys general in Massachusetts, Minnesota, Mississippi and West Virginia, an action brought by the State of Florida and pending investigations relating to RJRT's tobacco business.\nIn 1991, Broin v. Philip Morris Company, a purported class action against certain tobacco industry defendants, including RJRT, was brought by flight attendants claiming to represent a class of 60,000 individuals, alleging personal injury caused by exposure to environmental tobacco smoke in their workplace. In December 1994, the Florida state court certified a class consisting of \"all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from diseases and disorders caused by their exposure to secondhand cigarette smoke in airline cabins.\" The defendants appeal of this certification to the Florida Third District Court of Appeal was denied on January 3, 1995. A motion for rehearing has been filed.\nIn March 1994, Castano v. The American Tobacco Company, a purported class action, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT, seeking certification of a class action on behalf of all United States residents who allegedly are or claim to be addicted, or are the legal survivors of persons who allegedly were addicted, to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in their tobacco products to induce addiction in smokers. Plaintiffs' motion for certification of the class was granted in part on February 17, 1995. The district court certified core liability issues (fraud, negligence, breach of warranty, both express and implied, intentional tort, strict liability and consumer protection statutes), and punitive damages. Not certified were issues of injury-in-fact, proximate cause, reliance, affirmative defenses, and compensatory damages. In July 1995, the Fifth Circuit Court of Appeals agreed to hear defendants' appeal of this class certification. A decision is expected in 1996.\nIn March 1994, Lacey v. Lorillard Tobacco Company, a purported class action, was filed in Circuit Court, Fayette County, Alabama against three cigarette manufacturers, including RJRT. Plaintiff, who claims to represent all smokers who have smoked or are smoking cigarettes manufactured and sold by defendants in the state of Alabama, seeks compensatory and punitive damages not to exceed $48,500 per class member and injunctive relief arising from defendants' alleged failure to disclose additives used in their cigarettes. In April 1994, defendants removed the case to the United States District Court for the Northern District of Alabama.\nIn May 1994, Engle v. R.J. Reynolds Tobacco Company, was filed in Circuit Court, Eleventh Judicial District, Dade County, Florida against tobacco manufacturers, including RJRT, and other members of the industry, by plaintiffs who allege injury and purport to represent a class of all United States citizens and residents who claim to be addicted, or who claim to be legal survivors of persons who allegedly were addicted, to tobacco products. On October 28, 1994, a state court judge in Miami granted plaintiffs' motion to certify the class. The defendants appealed that ruling to the Florida Third District Court of Appeal which, on January 31, 1996, decided to certify a class limited to Florida citizens or residents. The defendants are considering seeking a rehearing.\nIn September 1994, Granier v. American Tobacco Company, a purported class action apparently patterned after the Castano case, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT. Plaintiffs seek certification of a class action on behalf of all residents of the United States who have used and purportedly became addicted to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in tobacco products for the purpose of addicting\nconsumers. By agreement of the parties, all action in this case is stayed pending determination of the motion for class certification in the Castano case.\nIn January 1995, a purported class action was filed in the Ontario Canada Court of Justice against RJR-MacDonald, Inc. and two other Canadian cigarette manufacturers. The lawsuit, then captioned Le Tourneau, v. Imperial Tobacco Company, seeks certification of a class of persons who have allegedly become addicted to the nicotine in cigarettes or who had such alleged addiction heightened or maintained through the use of cigarettes, and who have allegedly suffered loss, injury, and damage in consequence, together with persons with Family Law Act claims in respect to the claims of such allegedly addicted persons, and the estates of such allegedly addicted persons. Theories of recovery pleaded include negligence, strict liability, failure to warn, deceit, negligent misrepresentation, breach of implied warranty and conspiracy. The relief sought consists of damages of one million dollars for each of the three named plaintiffs, punitive damages, funding of nicotine addiction rehabilitation centers, interest and costs. On June 2, 1995, the plaintiffs, on consent, were granted leave to file an amended statement of claim to remove Le Tourneau as representative plaintiff and add two additional representative plaintiffs. The case is now captioned Caputo v. Imperial Tobacco Limited.\nIn June 1994, in Mangini v. R.J. Reynolds Tobacco Company, the California Supreme Court ruled that the plantiffs' claim that an RJRT advertising campaign constitutes unfair competition under the California Business and Professions Code was not preempted by the Cigarette Act. The plantiffs are acting as private attorneys general. This opinion allows the plaintiffs to pursue their lawsuit which had been dismissed at the trial court level. The defendants' Petition for Certiorari to the United States Supreme Court was denied in December 1994. The case has been remanded to the trial court.\nIn June 1994, in Moore v. The American Tobacco Company, RJRN and RJRT were named along with other industry members as defendants in an action brought by the Mississippi state attorney general on behalf of the state to recover state funds paid for health care and medical and other assistance to state citizens allegedly suffering from diseases and conditions allegedly related to tobacco use. This suit, which was brought in Chancery (non-jury) Court, Jackson County, Mississippi also seeks an injunction from \"promoting\" or \"aiding and abetting\" the sale of cigarettes to minors. Both actual and punitive damages are sought in unspecified amounts. Motions by the defendants to dismiss the case or to transfer it to circuit (jury) court were denied on February 21, 1995 and the case will proceed in Chancery Court. RJRN and other industry holding companies have been dismissed from the case.\nIn August 1994, RJRT and other U.S. cigarette manufacturers were named as defendants in an action instituted on behalf of the state of Minnesota and of Blue Cross and Blue Shield of Minnesota to recover the costs of medical expenses paid by the state and by Blue Cross\/Blue Shield that were incurred in the treatment of diseases allegedly caused by cigarette smoking. The suit, Minnesota v. Philip Morris, alleges consumer fraud, unlawful and deceptive trade practices, false advertising and restraint of trade, and it seeks injunctive relief and money damages, trebled for violations of the state antitrust law. Motions by the defendants to dismiss all claims of Blue Cross\/Blue Shield and certain substantive claims of the State of Minnesota, and by plaintiffs to strike certain of the defendants' defenses, were denied on May 19, 1995. An intermediate appeals court declined to hear the defendants' appeal from the ruling denying the motion to dismiss all claims of Blue Cross\/Blue Shield on the ground that it lacks standing to bring the action, but the Minnesota Supreme Court has agreed to do so. Oral argument was heard January 29, 1996 and a decision is pending.\nIn September 1994, the Attorney General of West Virginia filed suit against RJRT, RJRN and twenty-one additional defendants in state court in West Virginia. The lawsuit, McGraw v. American Tobacco Company, is similar to those previously filed in Mississippi and Minnesota. It seeks recovery for medical expenses incurred by the state in the treatment of diseases statistically associated with cigarette smoking and requests an injunction against the promotion and sale of cigarettes and tobacco products to minors. The lawsuit also seeks a declaration that the state of West Virginia, as plaintiff, is\nnot subject to the defenses of statute of repose, statute of limitations, contributory negligence, comparative negligence, or assumption of the risk. On May 3, 1995, the judge granted defendants' motion to dismiss eight of the ten causes of action pleaded. The defendants have filed motions to dismiss the remaining two counts. On October 20, 1995, at a hearing on the defendants' joint motion to prohibit prosecution of the action due to plaintiff's unlawful retention of counsel under a contingent fee arrangement, in a ruling from the bench, the contingent fee agreement between the West Virginia Attorney General and private attorneys preparing the case was held to be void on the grounds that the Attorney General has no constitutional, legislative, or statutory authority for entering into such an agreement.\nOn February 21, 1995, the state of Florida filed a suit under a special state statute against RJRT and RJRN, along with other industry members, their holding companies and other entities. The state is seeking Medicaid reimbursement under various theories of liability and injunctive relief to prevent the defendants from engaging in consumer fraud and to require that defendants: disclose and publish all research conducted directly or indirectly by the industry; fund a corrective public education campaign on the issues of smoking and health in Florida; prevent the distribution and sale of cigarettes to minors under the age of eighteen; fund clinical smoking cessation programs in the state of Florida; dissolve the Council for Tobacco Research and the Tobacco Institute or divest ownership, sponsorship, or membership in both; and disgorge all profits from sales of cigarettes in Florida. On defendants' motion, the case was stayed until July 7, 1995 and that stay has been extended pending appeals by the plaintiffs and the defendants in connection with the constitutional challenge to the Florida statute discussed above. See \"Business--Tobacco-- Legislation and Other Matters Affecting the Cigarette Industry\" in this Item 1.\nOn November 28, 1995, RJRT and other domestic cigarette manufacturers filed petitions for declaratory judgment in Massachusetts (Federal Court) and Texas (State Court, Austin Texas) as to potential Medicaid reimbursement suits that had been threatened by the Attorneys General of those states. On January 22, 1996, a similar petition for declaratory judgement was filed in Maryland (State Court).\nOn December 19, 1995, the Commonwealth of Massachusetts filed suit against cigarette manufacturers including RJRT and additional defendants including trade associations and wholesalers, seeking reimbursement of Medicaid and other costs incurred by the state in providing health care to citizens allegedly suffering from diseases or conditions purportedly caused by cigarette smoking. The complaint also seeks orders requiring the manufacturing defendants to disclose and disseminate prior research; fund a corrective campaign and smoking cessation program; disclose nicotine yields of their products; and pay restitution.\nRJRT understands that a grand jury investigation being conducted in the Eastern District of New York is examining possible violations of criminal law in connection with activities relating to the Council for Tobacco Research--USA, Inc., of which RJRT is a sponsor. RJRT is unable to predict the outcome of this investigation.\nRJRT received a civil investigative demand dated January 11, 1994 from the U.S. Department of Justice requesting broad documentary information from RJRT. Although the request appears to focus on tobacco industry activities in connection with product development efforts, it also requests general information concerning contacts with competitors. RJRT is unable to predict the outcome of this investigation.\n-------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or\nits affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nFOOD\nThe food line of business is conducted by operating subsidiaries of Nabisco Holdings. RJRN owns 100% of the outstanding Class B Common Stock of Nabisco Holdings, which represents approximately 80.5% of the economic interest in Nabisco Holdings and approximately 97.6% of the total voting power of Nabisco Holdings' outstanding common stock. Nabisco's businesses in the United States are comprised of the Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's companies (collectively, the \"Domestic Food Group\"). Nabisco's businesses outside the United States are conducted by Nabisco Ltd and Nabisco International (collectively, the \"International Food Group\"). Nabisco Ltd was recently shifted from the Domestic Food Group (formerly the North American Food Group) to the International Food Group.\nFood products are sold under trademarks owned or licensed by Nabisco and brand recognition is considered essential to their successful marketing. None of Nabisco's customers accounted for more than 10% of sales for 1995.\nDOMESTIC FOOD GROUP OPERATIONS\nNabisco Biscuit Company. Nabisco Biscuit Company is the largest manufacturer and marketer in the United States cookie and cracker industry with nine of the ten top selling brands, each of which had annual net sales of over $100 million in 1995. Overall, in 1995, Nabisco Biscuit had a 40.8% share of the domestic cookie category and a 55.3% share of the domestic cracker category, in the aggregate more than three times the share of its closest competitor. Leading Nabisco Biscuit cookie brands include OREO, CHIPS AHOY!, NEWTONS and SNACKWELL'S. Leading Nabisco Biscuit cracker brands include RITZ, PREMIUM, NABISCO HONEY MAID GRAHAMS, WHEAT THINS and TRISCUIT.\nOREO and CHIPS AHOY! are the two largest selling cookies in the United States. OREO, the leading sandwich cookie, is Nabisco Biscuit's largest selling cookie brand. Line extensions such as OREO DOUBLE STUF, FUDGE COVERED OREO and Reduced Fat OREO continue to increase the brand's appeal to targeted consumer groups. CHIPS AHOY! is the leader in the chocolate chip cookie segment with line extensions such as CHUNKY CHIPS AHOY! and CHEWY CHIPS AHOY! broadening its appeal and adding incremental sales.\nNEWTONS, the oldest Nabisco Biscuit cookie brand, is the fourth leading cookie brand in the United States. The introduction of FAT FREE FIG and APPLE NEWTONS in 1992, FAT FREE CRANBERRY, STRAWBERRY and RASPBERRY NEWTONS in 1993 and FAT FREE REDUCED CALORIE CRANBERRY and BLUEBERRY, as well as NEWTONS COBBLERS in 1995 have expanded the appeal of NEWTONS and added incremental sales.\nNabisco Biscuit's cracker business is led by RITZ, the largest selling cracker in the United States, as well as RITZ BITS, RITZ BITS SANDWICHES and REDUCED FAT RITZ successful product line extensions which, together with RITZ, accounted for 13.2% of cracker sales in the United States in 1995. In addition, PREMIUM, the oldest Nabisco cracker brand and the leader in the saltine cracker segment, is joined by NABISCO HONEY MAID GRAHAMS, WHEAT THINS and TRISCUIT to comprise, along with RITZ, five of the six largest selling cracker brands in the United States.\nIn 1992, Nabisco Biscuit became the leading manufacturer and marketer of no fat\/reduced fat cookies and crackers with the introduction of the SNACKWELL'S line, which is now the third largest cookie brand in the U.S. Nabisco Biscuit also acquired Stella D'oro, a leading producer of breadsticks, breakfast biscuits, specialty cakes, pastries and snacks. This line of specialty items gave Nabisco Biscuit access to new areas within supermarkets, further broadening Nabisco's cookie and cracker portfolio.\nNabisco Biscuit's other cookie and cracker brands, which include NUTTER BUTTER, NILLA WAFERS, BARNUM'S ANIMAL CRACKERS, BETTER CHEDDARS, HARVEST CRISPS, CHICKEN IN A BISKIT and CHEESE NIPS, compete in consumer niche segments. Many are the first or second largest selling brands in their respective segments.\nIn 1994, Nabisco entered the breakfast snack aisle with the launch of SNACKWELL'S cereal bars and granola bars and the repositioning of TOASTETTES toaster pastries.\nNabisco Biscuit's products are manufactured in 14 Nabisco Biscuit owned bakeries and in 16 facilities with which Nabisco Biscuit has production agreements. These facilities are located throughout the United States. Nabisco Biscuit is in the process of modernizing certain of its facilities. Nabisco Biscuit also operates a flour mill in Toledo, Ohio which supplies over 85% of its flour needs.\nNabisco Biscuit's products are sold to major grocery and other large retail chains through Nabisco Biscuit's direct store delivery system. The system is supported by a distribution network utilizing 10 major distribution warehouses and 129 shipping branches where shipments are consolidated for delivery to approximately 119,000 separate delivery points. Nabisco believes this sophisticated distribution and delivery system provides it with a significant service advantage over its competitors.\nSpecialty Products Company. The Specialty Products Company manufactures and markets a broad range of food products, with sauces and condiments, pet snacks, hot cereals and dry mix desserts representing the largest categories. Many of its products are first or second in their product categories. Well-known brand names include A.1. steak sauces, GREY POUPON mustards, MILK-BONE pet snacks, CREAM OF WHEAT hot cereals and ROYAL desserts. In September 1995, Specialty Products exited the Mexican food category, with the sale of its Ortega Mexican food business.\nSpecialty Products' primary entries in the sauce and condiment segments are A.1. and A.1. BOLD steak sauces, the leading lines of steak sauces, and GREY POUPON mustards, which include the leading Dijon mustard. Specialty Products also markets REGINA wine vinegar, the leader in its segment of the vinegar market.\nSpecialty Products is the second largest manufacturer of pet snacks in the United States with MILK-BONE dog biscuits. MILK-BONE products include MILK-BONE ORIGINAL BISCUITS, FLAVOR SNACKS, DOG TREATS and BUTCHER'S CHOICE.\nSpecialty Products participate in the dry mix dessert category with ROYAL and SNACKWELL'S brand gelatins and puddings. Specialty Products also participates in the non-dessert gelatin category with KNOX unflavored gelatins and has lines of regional products including COLLEGE INN broths, VERMONT MAID syrup, MY-T-FINE puddings, DAVIS baking powder and BRER RABBIT\nmolasses and syrup.\nNabisco, through the Specialty Products Company, manufactures hot cereals, participating in the cook-on-stove and mix-in-bowl segments of the category. CREAM OF WHEAT, the leading wheat-based hot cereal, and CREAM OF RICE participate in the cook-on-stove segment and eight varieties of INSTANT CREAM OF WHEAT participate in the mix-in-bowl segment. Quaker Oats Company is the most significant participant in the hot cereal category.\nSpecialty Products manufactures its products in four plants as well as in six facilities with which it has production agreements. Specialty Products sells to retail grocery chains through independent brokers and to drugstores, mass merchandisers and other major retail outlets through a direct sales force. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group.\nLifeSavers Company. The LifeSavers Company manufactures and markets non-chocolate candy and gum primarily for sale in the United States. LifeSavers' well-known brands include LIFE SAVERS candy, BREATH SAVERS sugar free mints, BUBBLE YUM bubble gum, FRUIT STRIPE gum, CARE*FREE sugarless gum, NOW & LATER fruit chewy taffy and GUMMI SAVERS fruit chewy candy. LIFE SAVERS is the largest selling non-chocolate candy brand in the United States, with a 1995 share of 4.9% of the non-chocolate candy category. BREATH SAVERS is the largest selling sugar free breath mint in the United States and BUBBLE YUM is the largest selling chunk bubble gum in the United States. LifeSavers' products are seasonally strongest in the fourth quarter.\nLifeSavers sells its products in the United States primarily to grocery stores, drug stores, mass merchandisers, convenience stores, membership club stores and food service, military and vending machine suppliers. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group. LifeSavers currently owns and operates four manufacturing facilities.\nPlanters Company. The Planters Company produces and\/or markets nuts and snacks largely for sale in the United States, primarily under the PLANTERS trademark. Planters is the clear leader in the packaged nut category, with a market share of seven times that of its nearest competitor. Planters' products are commodity oriented and are seasonally strongest in the fourth quarter.\nPlanters sells its products in the United States primarily to grocery stores, drug stores, mass merchandisers, convenience stores, membership club stores and food service, military and vending machine suppliers. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group. Planters currently owns and operates two manufacturing facilities.\nFood Service Company. The Food Service Company sells through non-grocery channels a variety of specially packaged food products of the Domestic Food Group, including cookies, crackers, hot cereals, sauces and condiments for the food service and vending machine industry. Food Service is also a leading regional supplier of premium frozen pies to in-store supermarket bakeries, wholesale clubs and food service accounts through Plush Pippin. The Food Service products are distributed by Nabisco's Sales & Integrated Logistics Group.\nFleischmann's Company. The Fleischmann's Company manufactures and markets various margarines and spreads as well as no-fat egg products and non-fat chocolate yogurt.\nFleischmann's is the second largest margarine producer in the United States. Fleischmann's participates in all segments of the margarine category, with the FLEISCHMANN'S, BLUE BONNET and MOVE OVER BUTTER brands. Fleischmann's Company strengthened its position in the margarine category in 1995, with the purchase of the Kraft margarine business which includes the PARKAY, TOUCH OF BUTTER and CHIFFON brands acquired from Kraft Foods, Inc. in October, 1995. Fleischmann's margarines are currently manufactured in two owned facilities and in six facilities\nwith which Fleischmann's has production agreements. Fleischmann's is the market leader in the healthy packaged egg category with EGG BEATERS and in 1995, introduced SNACKWELL'S Nonfat Chocolate Yogurt. Distribution for Fleischmann's is principally direct from plant to retailer warehouses through Nabisco's Sales & Integrated Logistics Group and with respect to the 1995 acquired products, for a temporary period through Kraft's distribution system.\nSales & Integrated Logistics Group. The Sales & Integrated Logistics Group handles sales and distribution for the Specialty Products, LifeSavers, Planters and Fleischmann's Companies and distribution for the Food Service Company. It sells to retail grocery chains through independent brokers and a direct sales force, and to drug stores, mass merchandisers and other major retail outlets through its direct sales force. The products are distributed from twenty-one distribution centers located throughout the United States.\nINTERNATIONAL FOOD GROUP OPERATIONS\nNabisco Ltd. Nabisco Ltd conducts Nabisco's Canadian operations through a biscuit division, a grocery division and a food service division. Excluding private label brands, the biscuit division produced nine of the top ten cookies and nine of the top ten crackers in Canada in 1995. Nabisco Ltd's cookie and cracker brands in Canada include OREO, CHIPS AHOY!, FUDGEE-O, PEEK FREANS, DAD'S, DAVID, PREMIUM PLUS, RITZ, TRISCUIT and STONED WHEAT THINS. These products are manufactured in five bakeries in Canada and are sold through a direct store delivery system, utilizing 11 sales offices and distribution centers and a combination of public and private carriers. Nabisco Ltd also markets a variety of single-serve cookies, crackers and salty snacks under such brand names as MINI OREO, RITZ BITS SANDWICHES and CRISPERS.\nNabisco Ltd's grocery division produces and markets canned fruits and vegetables, fruit juices and drinks and pet snacks. The grocery division is the leading canned fruit producer in Canada and is the second largest canned vegetable producer in Canada. Canned fruits, vegetables, soups and fruit juices and drinks are marketed under the DEL MONTE trademark, pursuant to a license from the Del Monte Corporation, and under the AYLMER trademark. The grocery division also markets MILK-BONE pet snacks and MAGIC baking powder, each a leading brand in Canada. Nabisco Ltd's grocery division operated six manufacturing facilities in 1995, five of which were devoted to canned products, principally fruits and vegetables, and one of which produced pet snacks. The grocery division's products are sold directly to retail chains and are distributed through five regional warehouses. In 1995, Nabisco Ltd acquired the PRIMO brand of dry pasta, canned tomatoes and other Italian food products which are manufactured in two facilities and sold and distributed by a direct store delivery system.\nIn 1995, Nabisco Ltd re-entered the margarine and tablespread business with its acquisition of the PARKAY, TOUCH OF BUTTER and CHIFFON brands from Kraft Canada Inc. These products are currently manufactured and distributed under agreements with Kraft Canada.\nNabisco Ltd's food service division sells a variety of specially packaged food products including cookies, crackers and canned fruits and vegetables as well as condiments to non-grocery outlets. The food service division has its own sales and marketing organization and sources product from Nabisco Ltd's other divisions.\nNabisco International. Nabisco International is a leading producer of biscuits, powdered dessert and drink mixes, baking powder, pasta, milk products and other grocery items, industrial yeast and bakery ingredients. Nabisco International also exports a variety of Domestic Food Group products to markets in Europe and Asia from the United States and is one of the largest multinational packaged food businesses in Latin America.\nNabisco International manufactures and markets biscuits and crackers under the NABISCO brand, yeast, baking powder and bakery ingredients under the FLEISCHMANN'S and ROYAL brands, desserts and drink mixes under the ROYAL brand, processed milk products under the GLORIA brand and canned fruits and vegetables under the DEL MONTE brand pursuant to a license from the Del Monte Corporation. Nabisco International's largest market is Brazil, where it operates 16 plants. Nabisco International is the market leader in powdered desserts in Spain and most of Latin America, in the yeast category in Brazil and certain other Latin American countries, in biscuits in Peru, Spain, Venezuela and Uruguay, and in canned vegetables in Venezuela. Nabisco International also maintains a strong position in the processed milk category in Brazil and expanded its market share through the 1995 acquisitions of Avare and Gumz. In Argentina, Nabisco International acquired 71% of Establecimiento Modelo Terrabusi S.A. in April 1994 and increased its interest in the Argentine biscuit and pasta company to approximately 99% in October and November 1994. Nabisco International has operations in 17 Latin American countries.\nNabisco International significantly increased its presence in Europe through its 1993 and 1994 100% acquisition of Royal Brands S.A. in Spain and Royal Brands Portugal. Nabisco International's products in Spain include biscuits marketed under the ARTIACH and MARBU trademarks, powdered dessert mixes marketed under the ROYAL trademark and various other foods, including canned meats and juices.\nNabisco International reentered the South African market through the acquisition of 50% of Royal Beech-Nut (Pty) Ltd., which it previously owned. Royal Beech-Nut markets baking powder and powdered dessert mixes under the ROYAL brand, chewing gum under the BEECHIES and CARE*FREE brands and candy under the LIFESAVERS and BEECH-NUT brands.\nNabisco International's grocery products are sold to retail outlets through its own sales forces and independent wholesalers and distributors. Industrial yeast and bakery products are sold to the bakery trade through Nabisco International's own sales forces and independent distributors.\nRAW MATERIALS\nVarious agricultural commodities constitute the principal raw materials used by Nabisco in its food businesses. These raw materials are purchased on the commodities market and through supplier contracts. Prices of agricultural commodities tend to fluctuate due to various seasonal, climatic and economic factors which generally also affect Nabisco's competitors. Nabisco believes that all of the raw materials for its products are in plentiful supply and are readily available from a variety of independent suppliers.\nCOMPETITION\nGenerally, the markets in which the Domestic Food Group and the International Food Group conduct their business are highly competitive. Competition consists of large domestic and international companies, local and regional firms and generic and private label products of food retailers. Competition is conducted on the basis of brand recognition, brand loyalty, quality and price. Substantial advertising and promotional expenditures are required to maintain or improve a brand's market position or to introduce a new product.\nThe trademarks under which the Domestic Food Group and the International Food Group market their products are generally registered in the United States and other countries in which such products are sold and are generally renewable indefinitely. Nabisco and certain of its subsidiaries have from time to time granted various parties exclusive licenses to use one or more of their trademarks in particular\nlocations. Nabisco does not believe that such licensing arrangements have a material effect on the conduct of its domestic or international business.\nOTHER MATTERS\nENVIRONMENTAL MATTERS\nThe U.S. Government and various state and local governments have enacted or adopted laws and regulations concerning protection of the environment. The regulations promulgated by the Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and will likely continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities.\nIn April 1995, RJRN Holdings was named a potentially responsible party (a \"PRP\") with certain third parties under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to a superfund site at which a former subsidiary of RJRN had operations. Certain subsidiaries of the Registrants have also been named as PRPs with third parties or may have indemnification obligations under CERCLA with respect to an additional thirteen sites.\nRJRN Holdings' subsidiaries have been engaged in a continuing program to assure compliance with U.S., state and local laws and regulations. Although it is difficult to identify precisely the portion of capital expenditures or other costs attributable to compliance with environmental laws and to estimate the cost of resolving these CERCLA matters, RJRN Holdings and RJRN do not expect such expenditures or other costs to have a material adverse effect on the financial condition of either RJRN Holdings or RJRN.\nEMPLOYEES\nAt December 31, 1995, RJRN Holdings together with its subsidiaries had approximately 76,000 full time employees. None of RJRT's operations are unionized. Most of the unionized workers at Nabisco's operations are represented under a national contract with the Bakery, Confection and Tobacco Workers Union, which was ratified in September 1992 and which will expire in September 1996. Other unions represent the employees of a number of Nabisco's operations and several of Reynolds International's operations are unionized. RJRN believes that its relations with these employees and with their unions are good.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\nFor information about foreign and domestic operations and export sales for the years 1993 through 1995, see \"Geographic Data\" in Note 16 to the Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFor information pertaining to the RJRN Holdings' and RJRN's assets by lines of business and geographic areas as of December 31, 1995 and 1994, see Note 16 to the Consolidated Financial Statements.\nFor information on properties, see Item 1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the fourth quarter of 1995, purported RJRN Holdings stockholders for themselves and derivatively for RJRN Holdings and Nabisco Holdings filed three putative class and derivative actions in the Court of Chancery of the State of Delaware in and for New Castle County against members of\nRJRN Holdings Board of Directors. The actions were consolidated in December 1995. The plaintiffs allege, among other things, that the individual defendants breached their fiduciary duty and wasted corporate assets by undertaking the Exchange Offer and Consent Solicitations completed by RJRN and Nabisco in June 1995 and by amending, in August 1995, RJRN Holdings By-Law provisions concerning the calling of shareholder meetings and procedures for shareholder action by written consent. The plaintiffs allege that management took these and other actions to wrongfully obstruct a spin-off of Nabisco, to enrich the defendants at the expense of RJRN Holdings, its shareholders and Nabisco Holdings and to entrench the defendants in the management and control of RJRN Holdings. RJRN Holdings believes that these allegations are without merit and is defending the consolidated action vigorously.\nFor information about other litigation and legal proceedings, see \"Business--Tobacco--Litigation Affecting the Cigarette Industry\" and \"Other Matters--Environmental Matters\" in Item 1.\n------------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or its affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn January, 1996, Brooke Group Ltd. commenced a solicitation of consents from the shareholders of RJRN Holdings to (i) a non-binding resolution seeking the immediate spin-off of the shares of Nabisco Holdings, and (ii) certain changes to the By-laws of RJRN Holdings which would allow holders of not less than 25% of its Common Stock to require a special meeting and would delete By- law provisions establishing certain administrative procedures for actions by written consent. The consent solicitation closed on February 15, 1996. A ministerial review of the validity of the consents by an independent inspector of elections had not been completed as of February 22, 1996. On February 20, 1996, however, Brooke Group Ltd. declared that it had received consents from holders of 50.4 percent of the voting stock with respect to a spin-off and 53.8 percent of such holders with respect to By-law changes.\nEXECUTIVE OFFICERS OF THE REGISTRANTS EXECUTIVE OFFICERS OF RJRN HOLDINGS\nThe executive officers of RJRN Holdings are Charles M. Harper (Chairman of the Board), Steven F. Goldstone (Chief Executive Officer and President), Gerald I. Angowitz (Senior Vice President, Human Resources and Administration), John J. Delucca (Senior Vice President and Treasurer), Robert S. Roath (Senior Vice President and Chief Financial Officer), Richard G. Russell (Senior Vice President and Controller), Robert F. Sharpe Jr. (Senior Vice President and General Counsel), and H. Colin McBride (Vice President, Assistant General Counsel and Secretary). Mr. Roath is married to Jo-Ann Ford who was, until December 31, 1995, Senior Vice President, Law and Secretary. The following table sets forth certain information regarding such officers.\nEXECUTIVE OFFICERS OF RJRN HOLDINGS OR ITS SUBSIDIARIES NOT LISTED ABOVE\nSet forth below are the names, ages, positions and offices held and a brief account of the business experience during the past five years of certain executive officers of RJRN Holdings or its subsidiaries, other than those listed above.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of RJRN Holdings, par value $.01 per share (the \"Common Stock\"), is listed and traded on the New York Stock Exchange (the \"NYSE\"). Since completion of the Acquisition there has been no public trading market for the common stock of RJRN.\nAs of January 31, 1996, there were approximately 65,000 record holders of the Common Stock. All of the common stock of RJRN is owned by RJRN Holdings. The Common Stock closing price on the NYSE for February 20, 1996 was $32 5\/8.\nThe following table sets forth, for the calendar periods indicated, the high and low sales prices per share for the Common Stock on the NYSE Composite Tape, as reported in the Wall Street Journal: HIGH LOW ---- --- 1995: First Quarter*.................................. $ 32 1\/2 $25 Second Quarter*................................. 31 1\/4 25 1\/4 Third Quarter................................... 33 1\/4 26 3\/8 Fourth Quarter.................................. 33 3\/8 27 7\/8\nHIGH LOW ---- --- 1994: First Quarter*.................................. $ 40 5\/8 $28 1\/8 Second Quarter*................................. 35 27 1\/2 Third Quarter*.................................. 35 5\/8 28 1\/8 Fourth Quarter*................................. 36 1\/4 26 9\/16\n- ------------\n* Adjusted to reflect a one-for-five reverse stock split\nThe Board of Directors of RJRN Holdings declared an initial quarterly cash dividend of $.375 per share payable on April 1, 1995. During 1995, RJRN Holdings continued to pay such a quarterly cash dividend on the Common Stock, adjusted to take into account the one-for-five reverse split of the Common Stock described below. Cash dividends paid by RJRN to RJRN Holdings are set forth in the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.\nThe operations of RJRN Holdings and RJRN are conducted through RJRN's subsidiaries and, therefore, RJRN Holdings and RJRN are dependent on the earnings and cash flow of RJRN's subsidiaries to satisfy their respective obligations and other cash needs. Certain Nabisco credit facilities limit the amount of dividends, distributions and advances by Nabisco Holdings and its subsidiaries to RJRN Holdings and its non-Nabisco subsidiaries. Moreover, the New RJRN Credit Agreements and certain policies adopted by the Board of Directors of RJRN Holdings limit the payment by RJRN Holdings of dividends on the Common Stock in excess of certain specific amounts. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Financial Condition\" and \"RJRN Holdings' Board of Directors Policies\" and Note 11 to the Consolidated Financial Statements. RJRN Holdings does not believe that the provisions of the New RJRN Credit Agreements or its adopted policies concerning distributions to stockholders will limit its ability to pay its anticipated quarterly dividends.\nA one-for-five reverse split of the Common Stock of RJRN Holdings was approved by its stockholders on April 12, 1995. The reverse stock split resulted in a dividend and earnings per share five times higher with a corresponding reduction in the number of shares outstanding.\nRJRN Holdings has indicated that, under normal circumstances, it does not plan to issue additional equity securities for purposes of balance sheet improvement.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") presented below as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995 was derived from the consolidated financial statements of RJRN Holdings (the \"Consolidated Financial Statements\"), which have been audited by Deloitte & Touche LLP, independent auditors. In addition, the consolidated financial data of RJRN Holdings presented below as of December 31, 1993, 1992 and 1991 and for each of the years in the two year period ended December 31, 1992 was derived from the audited consolidated financial statements of RJRN Holdings as of December 31, 1993, 1992 and 1991 and for the years ended December 31, 1992 and 1991, which are not presented herein. The data should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information included herein.\n(Footnotes on following page)\n(Footnotes from preceding page)\n- ------------\n(1) The 1995 amount includes approximately $49 million for the consolidation and relocation of the international tobacco headquarter's operations and certain of its sales facilities. The 1992 amount includes a gain of $98 million on the sale of the ready-to-eat cold cereal business.\n(2) The 1995 amount includes approximately $103 million for fees and expenses incurred in connection with certain debt refinancings by RJRN, Nabisco Holdings and Nabisco.\n(3) On September 21, 1995, RJR Nabisco Holdings Capital Trust I (the \"Trust\") exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The sole asset of the Trust is junior subordinated debentures of RJRN Holdings. Upon redemption of the junior subordinated debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The outstanding junior subordinated debentures have an aggregate principal amount of approximately $978 million and an annual interest rate of 10%.\n(4) On November 8, 1991, RJRN Holdings issued 52,500,000 shares of Series A Conversion Preferred Stock, par value $.01 per share (\"Series A Preferred Stock\"), and sold 210,000,000 $.835 depositary shares (the \"Series A Depositary Shares\"), each of which represented one-quarter of a share of Series A Preferred Stock. On May 6, 1994, RJRN Holdings issued 26,675,000 shares of Series C Conversion Preferred Stock, par value $.01 per share (the \"Series C Preferred Stock\"), and sold 266,750,000 Series C Depositary Shares (the \"Series C Depositary Shares\"), each of which represented one-tenth of a share of Series C Preferred Stock. On November 15, 1994, each outstanding Series A Depositary Share converted into one share of RJRN Holdings' Common Stock.\n(5) The loss before extraordinary item per common and common equivalent share reported for the year ended December 31, 1993 would have increased by $.82 per share if the weighted average number of shares of Series A Depositary Shares outstanding during the period had been excluded from the earnings per share calculation.\n(6) Working capital at December 31, 1994 included $1.35 billion of borrowings under the 1994 Nabisco Credit Agreement, a substantial portion of which was used in connection with the refinancing of certain debt. On January 26, 1995, such borrowings were substantially reduced through the application of approximately $1.2 billion of net proceeds received from the initial public offering of 51,750,000 shares of Nabisco Holdings' Class A Common Stock.\n(7) RJRN Holdings' stockholders' equity at December 31 of each year from 1995 to 1991 includes non-cash expenses related to accumulated trademark and goodwill amortization of $4.280 billion, $3.644 billion, $3.015 billion, $2.390 billion and $1.774 billion respectively.\nSee Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe operating subsidiaries of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and its wholly-owned subsidiary, RJR Nabisco, Inc. (\"RJRN\"), comprise one of the largest tobacco and food companies in the world. In the United States, the tobacco business is conducted by R. J. Reynolds Tobacco Company (\"RJRT\"), the second largest manufacturer of cigarettes, and the packaged food business is conducted by Nabisco Holdings Corp. (\"Nabisco Holdings\") through its wholly-owned subsidiary, Nabisco, Inc. (\"Nabisco\"), the largest manufacturer and marketer of cookies and crackers (the \"Domestic Food Group\"). Outside the United States, the tobacco operations are conducted by R.J. Reynolds Tobacco International, Inc. and beginning on January 1, 1996, R.J. Reynolds International (collectively \"Reynolds International\"), and the food operations are conducted by Nabisco International, Inc. and Nabisco Ltd (collectively, the \"International Food Group\").\nThe following is a discussion and analysis of the consolidated financial condition and results of operations of RJRN Holdings. The discussion and analysis should be read in connection with the consolidated financial statements and the related notes thereto of RJRN Holdings as of December 31, 1995 and 1994 and for each of the years in the three year period ended December 31, 1995 (the \"Consolidated Financial Statements\").\nRESULTS OF OPERATIONS\nSummarized financial data for RJRN Holdings is as follows:\n(Footnotes on following page)\nINDUSTRY SEGMENTS\nThe percentage contributions of each of RJRN Holdings' industry segments to net sales and operating company contribution during the last five years were as follows:\n- ------------\n(1) Operating company contribution represents operating income before amortization of trademarks and goodwill and exclusive of restructuring expenses. Restructuring expenses amounted to $154 million for 1995 (RJRT-$100 million, Reynolds International-$54 million) and $730 million for 1993 (RJRT-$355 million, Reynolds International-$189 million, Domestic Food Group-$132 million, International Food Group-$21 million and Headquarters-$33 million.)\n(2) Contributions by industry segments were computed without effects of Headquarters' expenses.\nTOBACCO\nThe tobacco business is conducted by RJRT and Reynolds International.\n1995 vs. 1994. The worldwide tobacco business reported net sales of $7.71 billion in 1995, an increase of 1% from the 1994 level of $7.67 billion. The net sales increase in 1995 resulted primarily from a higher proportion of domestic full price sales, higher selling prices worldwide and favorable foreign currency developments that more than offset the impact of an overall worldwide tobacco volume decline. Worldwide tobacco volume for 1995 decreased 2% from the prior year. Operating company contribution for the worldwide tobacco business of $2.06 billion in 1995 declined 6% from the 1994 level of $2.20 billion due to lower operating company contribution at both the domestic tobacco business and the international tobacco business. Operating income for the worldwide tobacco business in 1995 of $1.50 billion declined 17% from the 1994 level of $1.80 billion, reflecting the lower operating company contribution and a 1995 restructuring expense related to the domestic and international tobacco businesses of $100 million and $54 million, respectively.\nNet sales for RJRT amounted to $4.48 billion in 1995, a decline of 2% from the 1994 level of $4.57 billion. The decline in net sales in 1995 resulted primarily from an overall volume loss of 5% (approximately $320 million), partially offset by a higher proportion of full price sales (approximately $140 million) and higher selling prices in both the full price and savings segments (approximately $67 million). RJRT's volume declined slightly in the full price segment during 1995 despite an industry average increase of approximately 2% due to the pattern of wholesale purchases and the erosion of market share of certain brands during the first six months of 1995. However, RJRT's share of full price segment stablized during the third and fourth quarters of 1995. RJRT's volume in the savings segment declined by 13% during 1995 which exceeded industry average, reflecting an erosion of market share of certain brands in the segment due to RJRT's decision to be more selective in its participation in that segment. RJRT's full price volume as a percentage of total volume in 1995 and 1994 amounted to 63% and 60%, respectively. Comparable figures for the domestic cigarette market in 1995 and 1994 amounted to 70% and 67%, respectively.\nRJRT's operating company contribution was $1.42 billion in 1995, a 2% decline from the 1994 level of $1.45 billion, as lower manufacturing costs (approximately $67 million), the higher proportion\nof full price sales (approximately $118 million), reduced merchandising costs (approximately $13 million), lower administrative expenses (approximately $14 million) and higher selling prices (approximately $67 million) were more than offset by the decline in overall volume (approximately $196 million) and an increase in marketing expenses (approximately $97 million). RJRT's operating income was $954 million in 1995, a decline of 12% from the 1994 level of $1.09 billion. The decline in operating income for 1995 reflected the lower RJRT operating company contribution and a restructuring expense in 1995 of $100 million.\nReynolds International recorded net sales of $3.23 billion in 1995, an increase of 4% from the 1994 level of $3.10 billion. The increase in net sales for 1995 primarily resulted from favorable foreign currency developments (approximately $113 million) and higher pricing (approximately $42 million), offset in part by unfavorable mix (approximately $17 million). Overall volume increased by 1%. Reynolds International's operating company contribution of $643 million in 1995 decreased 15% from the 1994 level of $755 million primarily due to costs and expenses incurred in connection with the consolidation and relocation of its headquarter's operations and certain sales facilities (approximately $49 million), trade stock realignment (approximately $22 million), write-off of certain export receivables (approximately $16 million), higher administrative costs (approximately $19 million), higher promotional and selling expenses (approximately $25 million), higher manufacturing costs (approximately $13 million) and unfavorable mix (approximately $10 million), which were partially offset by higher pricing (approximately $42 million). The decline in operating income for 1995 reflected the lower Reynolds International operating company contribution and a restructuring expense in 1995 of $54 million.\n1994 vs. 1993. Despite declines in net sales for both the domestic and international tobacco businesses, the worldwide tobacco business reported profit gains for 1994. RJRT's net sales decline resulted principally from overall lower pricing and volume which more than offset the impact of a higher proportion of sales from full price brands. Reynolds International's net sales decline was primarily attributable to a reduction in trade inventory levels and price repositioning in Canada and Puerto Rico which more than offset higher selling prices and volume. Overall, net sales from the worldwide tobacco business amounted to $7.67 billion in 1994, a decline of 5% from the 1993 level of $8.08 billion. Worldwide volume for 1994 was flat compared to 1993. Operating company contribution for the worldwide tobacco business grew to $2.21 billion in 1994 from $1.82 billion in 1993, an increase of 21% that resulted from improved margins in both the domestic and international businesses. Operating income for the worldwide tobacco business rose to $1.80 billion in 1994, an increase of 108% from the 1993 level of $866 million, as a result of the increase in operating company contribution discussed above and the 1993 restructuring expense of $544 million.\nNet sales for RJRT amounted to $4.57 billion in 1994, a decrease of 8% from the 1993 level of $4.95 billion. The decrease primarily reflects the impact of industry-wide price reductions on full price brands (approximately $500 million) which went into effect during the second half of 1993, lower volume in the savings segment (approximately $60 million) primarily due to RJRT's decision to be more selective in its participation in that segment and lower volume in the full price segment (approximately $300 million) primarily due to increased competitor activities during the second half of 1994. These factors more than offset the impact of a higher proportion of sales from full price brands (approximately $400 million), higher selling prices in the savings segment (approximately $60 million) and higher selling prices in the full price segment during the fourth quarter of 1994 as compared to the fourth quarter of 1993 (approximately $40 million). RJRT's full price volume as a percentage of total volume amounted to 60% in 1994 versus 56% in 1993. RJRT's operating company contribution was $1.45 billion in 1994, a 24% increase from the 1993 level of $1.17 billion, as reduced promotional and selling expenses (approximately $650 million) more than offset the decline in net sales. RJRT's operating income was $1.09 billion in 1994, an increase of 140% from the 1993 level of $453 million. The increase in operating income for 1994 from the prior year reflects the increase in RJRT's operating company contribution discussed above and the 1993 restructuring expense of $355 million.\nReynolds International recorded net sales of $3.10 billion in 1994, a decrease of 1% from the 1993 level of $3.13 billion. The net sales decrease for 1994 primarily resulted from a reduction in trade\ninventory levels (approximately $75 million), repositioning of prices in Canada and Puerto Rico to enhance brand competitiveness (approximately $60 million), and unfavorable foreign exchange developments, primarily in Europe and the Middle East (approximately $30 million), which were offset in part by higher selling prices throughout Reynolds International's markets (approximately $70 million) and an increase in volume in certain regions (approximately $60 million). Reynolds International's operating company contribution rose to $755 million in 1994, an increase of 17% compared to the 1993 level of $644 million. The increase in operating company contribution for 1994 was due to lower product costs in all regions (approximately $100 million), reduced promotional expenses (approximately $70 million), the higher selling prices (approximately $70 million) and higher volume (approximately $15 million), which more than offset price repositioning in Canada and Puerto Rico (approximately $50 million), the reduction in trade inventories (approximately $30 million), higher operating expenses to support expansion of business activity primarily in Eastern Europe (approximately $30 million) and unfavorable foreign exchange developments (approximately $20 million). Reynolds International's operating income was $716 million in 1994, an increase of 73% from the 1993 level of $413 million. The increase in operating income reflects the increase in Reynolds International's operating company contribution discussed above and the 1993 restructuring expense of $189 million.\n1995 Governmental Activity\nCongress enacted legislation effective January 1, 1994 (the Omnibus Budget Reconciliation Act of 1993) that assesses financial penalties against manufacturers if cigarettes produced in the United States do not contain at least 75% (by weight) domestically grown flue cured and burley tobaccos. In December 1994, Congress enacted the Uruguay Round Agreements Act to replace this domestic content requirement with a tariff rate quota system that keys tariffs to import volumes. The tariff rate quotas have been established by the United States with overseas tobacco producers and became effective on September 13, 1995. Domestic content requirements and tariff rate quotas increased raw material costs slightly in 1994 but these costs were down slightly in 1995 during the period when the domestic content requirement was not applicable.\nIn February 1994, the Commissioner of the U.S. Food and Drug Administration (the \"FDA\"), which historically has refrained from asserting jurisdiction over cigarette products, stated that he intended to cause the FDA to work with the U.S. Congress to resolve the regulatory status of cigarettes under the Food, Drug and Cosmetic Act. During the second quarter of 1994, hearings were held in this regard, and RJRT and other members of the United States cigarette industry were asked to provide voluntarily certain documents and other information to Congress. In August 1995, the Commissioner of the FDA, with the support of the Clinton Administration, announced that he was asserting jurisdiction over cigarettes and certain other tobacco products and issued a notice and request for comments on proposed regulations. The proposed regulations would prohibit or impose stringent limits on a broad range of sales and marketing practices, including bans on sampling, sponsorship by brand name, and distribution of non-tobacco items carrying brand names. The FDA's proposed rule would also limit advertising in print and on billboards to black and white text, impose new labeling language, and require cigarette manufacturers to fund a $150 million-a-year campaign to discourage minors from using tobacco products. RJRT and other cigarette manufacturers have submitted responses to the proposed rules.\nThe purported purpose of the FDA's assertion of jurisdiction was to curb the use of tobacco products by underage youth. RJRT believes that the assertion of jurisdiction and the scope of the proposed rules would materially restrict the availability of cigarettes and RJRT's ability to market its cigarette products to adult smokers. RJRT, together with the other four major domestic cigarette manufacturers and an advertising agency, filed suit on the day of the Commissioner's announcement in the U.S. District Court for the Middle District of North Carolina seeking to enjoin the FDA's assertion of jurisdiction (Coyne Beahm v. United States Food & Drug Administration). Similar suits have been filed in the same court by manufacturers of smokeless tobacco products, by operators of retail stores and by advertising interests. RJRT is unable to predict whether the FDA will adopt final rules asserting\njurisdiction over cigarettes or the scope of such final rules, if adopted. It is also unable to predict the outcome of the litigation seeking to enjoin the FDA's rulemaking.\nIn March 1994, the U.S. Occupational Safety and Health Administration (\"OSHA\") announced proposed regulations that would restrict smoking in the workplace to designated smoking rooms that are separately exhausted to the outside. Although RJRT cannot predict the form or timing of any regulations that may be finally adopted by OSHA, if the proposed regulations are adopted, RJRT expects that many employers who have not already done so would prohibit smoking in the workplace rather than make expenditures necessary to establish designated smoking areas to accommodate smokers. RJRT submitted comments on the proposed regulations during the comment period which closed in February, 1996. Because many employers currently do not permit smoking in the workplace, RJRT cannot predict the effect of any regulations that may be adopted, but incremental restrictions on smokers could have an adverse effect on cigarette sales and RJRT.\nIn July 1994, an amendment to a Florida statute became effective which allows the state of Florida to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action and eliminates the comparative negligence and assumption of risk defenses. The Florida statute is being challenged on state and federal constitutional grounds in a lawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets, and National Association of Convenience Stores in June 1994. On June 26, 1995, the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the act unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida supreme court accepted for direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether other states will enact similar legislation and whether lawsuits will be filed under these statutes or their outcome, if filed. A suit against the tobacco industry under the Florida statute was filed on February 21, 1995.\nVarious states and local jurisdictions have enacted legislation imposing restrictions on public smoking, increasing excise taxes and designating a portion of the increased cigarette excise taxes to fund anti-smoking programs, health care programs or cancer research. Many employers have also initiated programs restricting or eliminating smoking in the workplace.\nIt is not possible to determine what additional federal, state or local legislation or regulations relating to smoking or cigarettes will be enacted or to predict any resulting effect thereof on RJRT, Reynolds International or the cigarette industry generally, but such legislation or regulations could have an adverse effect on RJRT, Reynolds International or the cigarette industry generally.\nFor a description of certain litigation affecting RJRT and its affiliates, see Item 1, \"Business-- Tobacco-- Litigation Affecting the Cigarette Industry\" and Note 12 to the Consolidated Financial Statements.\nFOOD\nThe food business is conducted by the Domestic Food Group and the International Food Group. The Domestic Food Group is comprised of the Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's companies.\n1995 vs. 1994. Nabisco Holdings reported net sales of $8.29 billion in 1995, an increase of 8% from the 1994 level of $7.70 billion, with the Domestic Food Group up 5% and the International Food Group up 15%. The Domestic Food Group's increase was primarily attributable to volume gains at\nNabisco Biscuit (approximately $228 million), reflecting new product introductions and product line extensions, volume gains at Food Service (approximately $37 million), volume gains at Fleischmann's (approximately $18 million) and the impact of the October, 1995 acquisition of the Parkay margarine brand (approximately $64 million), which were offset in part by volume declines at Planters (approximately $40 million) and the impact of the September, 1995 sale of the Ortega brand (approximately $39 million). The International Food Group's net sales increase for 1995 was primarily due to improved results in Brazil (approximately $120 million), reflecting a continuation of the country's economic recovery, the favorable impact of recent business acquisitions (approximately $112 million) and the favorable performance from businesses in Iberia, Canada and Venezuela (approximately $65 million), partially offset by lower net sales in Mexico (approximately $30 million) due to the devaluation of the peso.\nNabisco Holdings' operating company contribution was $1.13 billion in 1995, an increase of 2% from the 1994 level of $1.11 billion, with the International Food Group higher by 35% and the Domestic Food Group lower by 5%. The 1995 period includes a net pre-tax gain of $11 million from the sale of the Ortega Mexican food ($18 million gain) and New York Style Bagel Chip ($7 million loss) businesses, and the favorable impact of recent business acquisitions (approximately $18 million). Excluding these items and the results of operations from the business disposals in both years, Nabisco Holdings' operating company contribution was $14 million lower than the 1994 level, with the International Food Group higher by 32% and the Domestic Food Group lower by 8%. The Domestic Food Group's adjusted operating company contribution decrease for 1995 (approximately $70 million) reflects investment spending behind new product initiatives and intense competitive conditions in biscuits and nuts. The International Food Group's adjusted operating company contribution increase for 1995 (approximately $56 million) was primarily due to the profit impact of increased sales in Brazil, Iberia, Canada and Venezuela (approximately $34 million).\nNabisco Holdings' operating income was $902 million in 1995, an increase of 2% from the 1994 level of $887 million, as a result of the changes in operating company contribution discussed above.\n1994 vs. 1993. Nabisco Holdings reported net sales of $7.70 billion in 1994, an increase of 10% from the 1993 level of $7.03 billion, with the Domestic Food Group up 4% and the International Food Group up 28%. The Domestic Food Group's increase was primarily attributable to significant volume gains at Nabisco Biscuit, reflecting the success of new product introductions and product line extensions in the U.S. biscuit market (approximately $215 million) and volume increases from Specialty Products (approximately $13 million). The International Food Group's increase was primarily the result of the favorable impact of recent acquisitions (approximately $345 million) and improved business conditions in Brazil (approximately $70 million) as a result of its second-half 1994 economic recovery.\nNabisco Holdings' operating company contribution was $1.11 billion in 1994, an increase of 17% from the 1993 level of $949 million, with the Domestic Food Group up 15% and the International Food Group up 30%. The Domestic Food Group's increase for 1994 was primarily due to the increase in net sales (approximately $40 million) and savings from productivity programs (approximately $135 million), including previously established restructuring programs, which were offset in part by competitive pricing pressures (approximately $35 million) and the absence of a 1993 gain on the sale of certain assets (approximately $17 million). The International Food Group's increase in operating company contribution for 1994 was primarily due to recent acquisitions (approximately $40 million) and strong results in Canada (approximately $7 million), partially offset by unfavorable business results in Mexico (approximately $7 million). The devaluation of the Mexican peso was not material to earnings in 1994.\nNabisco Holdings' operating income was $887 million in 1994, an increase of 53% from the 1993 level of $578 million, as a result of the increase in operating company contribution discussed above and the 1993 restructuring expense of $153 million.\nRESTRUCTURING EXPENSE\nRJRN Holdings recorded a pre-tax restructuring expense of $154 million in the fourth quarter of 1995 ($104 million after tax) related to a program announced on October 13, 1995 to reorganize its worldwide tobacco operations. The 1995 restructuring program was primarily undertaken in order to streamline operations and improve profitability. The 1995 restructuring program was implemented in the latter part of 1995 and will be substantially completed during 1996. A significant portion of the 1995 restructuring program will be a cash expense. The major components of the 1995 restructuring program were workforce reductions totaling 1,260 employees (approximately $132 million), the rationalization and closing of facilities relating to the international tobacco operations (approximately $8 million) and equipment and lease abandonments at the domestic tobacco operations (approximately $14 million). At December 31, 1995, approximately $102 million of severance pay and benefits remained to be paid. Anticipated annual future cash savings from the plan are estimated to be in excess of approximately $70 million after tax.\nRJRN Holdings recorded a pre-tax restructuring expense of $730 million in the fourth quarter of 1993 ($467 million after tax) related to a program announced on December 7, 1993. The 1993 restructuring program was undertaken to respond to a changing consumer product business environment and to streamline operations and improve profitability. The 1993 program, which was implemented in the latter part of 1993 and substantially completed during 1995, consisted of workforce reductions, reassessment of raw material sourcing and production arrangements, contract termination costs, abandonment of leases and the rationalization and closing of manufacturing and sales facilities. Approximately 75% of the restructuring program required cash outlays. At December 31, 1995, approximately $21 million for severance pay and benefits remained to be paid.\nDuring 1994, a change in the estimated cost of the 1993 restructuring program resulted in a credit to income of $23 million related to changes in the number of workforce reductions and an increase in cost of $21 million associated with the rationalization and abandonment of manufacturing and sales facilities. The net adjustment during 1994 of the above changes was reflected in selling, advertising, administrative and general expenses.\nINTEREST AND DEBT EXPENSE\n1995 vs. 1994. RJRN and Nabisco manage interest rate exposure by adjusting their mix of floating rate debt and fixed rate debt. As part of managing such interest rate exposure, RJRN and Nabisco enter into various interest rate arrangements from time to time.\nFollowing adoption of a policy change in 1994, RJRN canceled all of its financial interest rate arrangements with optionality. During 1994, as part of its current strategy to manage interest rate exposure, RJRN effectively neutralized the effects of any future changes in market interest rates on the remainder of its outstanding interest rate swaps, options, caps and other financial instruments through the purchase of offsetting positions. Net unrealized gains and losses on the remaining interest rate instruments at the time such instruments were neutralized are being amortized as additional interest expense during 1995, 1996 and 1997 of approximately $39 million, $28 million and $5 million, respectively.\nDuring 1995, Nabisco began managing its own interest rate exposure. As part of managing its interest rate exposure, Nabisco entered into interest rate swaps and caps to effectively fix a portion of its interest rate exposure on its floating rate debt. The impact of these agreements was not significant.\nConsolidated interest and debt expense amounted to $899 million in 1995, a decrease of 16% from 1994. The decline is primarily due to refinancings completed during 1994 and repayments of debt with the proceeds from the issuances of preferred stock during 1994 and Nabisco Holdings Class A Common Stock during the first quarter of 1995. These factors more than offset the impact of higher market interest rates.\n1994 vs. 1993. Consolidated interest and debt expense of $1.06 billion in 1994 decreased 12% from 1993, primarily as a result of refinancings of debt during 1993 and 1994 and lower debt levels resulting primarily from the application of proceeds from the issuance of preferred stock. These factors more than offset the impact of higher market interest rates during 1994, including the effects thereof on RJRN's interest rate instruments described below.\nAs mentioned above, RJRN entered into interest rate arrangements to manage its interest rate exposure. The impact on interest expense from the utilization of interest rate instruments by RJRN in 1994 resulted in additional interest expense of $22 million, which includes $45 million associated with the written instruments. The impact of interest rate instrument utilization in 1993 included gains which lowered interest expense by approximately $70 million.\nOTHER INCOME (EXPENSE), NET\nConsolidated other income (expense), net for 1995 includes a pre-tax charge of approximately $103 million for fees and expenses incurred in connection with (i) the exchange of approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\") and (ii) the solicitation of consents by RJRN to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\"). The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nINCOME TAXES\nRJRN Holdings' provision for income taxes for 1993 was increased by $96 million as a result of the enactment of certain federal tax legislation during the third quarter of 1993 which increased federal corporate income tax rates to 35% from 34%, retroactively to January 1, 1993. The components of this increase to RJRN Holdings' provision for income taxes included an $86 million non-cash charge resulting primarily from the remeasurement of the balance of deferred federal income taxes at the date of enactment of the new federal tax legislation for the change in the income tax rates, and a $10 million charge resulting from the increase in current federal income taxes accrued for the change in the income tax rates and other effects of the new tax legislation. Also during 1993, RJRN Holdings' provision for income taxes was decreased by a $108 million credit primarily resulting from a change in the functional currency, for U.S. federal income tax purposes, relating to foreign branch operations.\nNET INCOME\n1995 vs. 1994. RJRN Holdings reported net income of $611 million in 1995, $92 million higher than the $519 million reported in 1994. The increase in net income for 1995 primarily reflects the impact in 1995 of lower interest and debt expense and a lower amount of loss from early extinguishment of debt which more than offset the impact in 1995 of lower operating company contribution, the domestic and international tobacco restructuring expenses, the fees and expenses incurred in connection with the Exchange Offers and the Consent Solicitations and the minority interest in income of Nabisco.\n1994 vs. 1993. RJRN Holdings' net income of $519 million in 1994 includes an after-tax extraordinary loss of $245 million related to the repurchase and redemption of debt during the year. Excluding the extraordinary loss in 1994, as well as a similar extraordinary item which resulted in a $142 million after-tax loss in 1993, RJRN Holdings would have reported net income of $764 million for\n1994, an increase of $767 million from 1993. The increase resulted primarily from the improvement in operating company contribution by both the Tobacco and Food operations, the impact of lower interest expense and the 1993 restructuring expense of $730 million, offset in part by a $65 million charge related to the realignment of Headquarters' functions at the holding company discussed below.\nDuring the fourth quarter of 1994, RJRN Holdings approved and adopted a plan to realign Headquarters' functions, transferring certain responsibilities to the operating companies and significantly streamlining the holding company. The plan reflected expectations of a lower level of financings and other activities at the holding company as RJRN Holdings concludes the post-LBO period. The costs and expenses associated with this decision resulted in a charge of approximately $65 million before tax, a significant portion of which was a cash expense. The majority of the charge was related to accrued employee termination benefits for the 25% of Headquarters' employees terminated (approximately $40 million). This cost was incurred pursuant to a continuing plan for employee termination benefits that provided for the payment of specified amounts of severance and benefits to terminated employees. The remainder of the charge (approximately $25 million) was related to the abandonment of leases of certain corporate office facilities as a result of the realignment and streamlining and the reduced need for office space. The plan was implemented in the first quarter of 1995 and was substantially completed during 1995. At December 31, 1995, approximately $14 million of severance pay and benefits remained to be paid.\nRJRN Holdings' net income (loss) applicable to its common stock for 1995, 1994 and 1993 of $501 million, $388 million and ($213) million, respectively, includes a deduction for preferred stock dividends of $110 million, $131 million and $68 million, respectively.\nIMPACT OF NEW 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 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. SFAS No. 121 requires that (i) 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 and (ii) long-lived assets and certain identifiable intangibles to be disposed of generally be reported at the lower of carrying amount or fair value less cost to sell. SFAS No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995. The adoption of the SFAS No. 121 is not expected to materially effect the financial position or results of operations of RJRN Holdings and RJRN.\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 financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 encourages all entities to adopt a fair value based method of accounting for stock-based compensation plans in which compensation cost is measured at the date the award is granted based on the value of the award and is recognized over the employee service period. However, SFAS No. 123 allows an entity to continue to use the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (\"APB No. 25\"), with proforma disclosures of net income and earnings per share as if the fair value based method had been applied. APB No. 25 requires compensation expense to be recognized over the employee service period based on the excess, if any, of the quoted marked price of the stock at the date the award is granted or other measurement date, as applicable, over an amount an employee must pay to acquire the stock. SFAS No. 123 is effective for financial statements for fiscal years beginning after December 15, 1995. RJRN Holdings and RJRN currently plan to continue to apply the methods prescribed by APB No. 25.\nLIQUIDITY AND FINANCIAL CONDITION\nDECEMBER 31, 1995\nNet cash flows from operating activities for 1995 were $1.67 billion, a decrease of $89 million from the 1994 level of $1.75 billion. The decrease in net cash flows from operating activities reflects lower income before extraordinary item which more than offsets the impact of lower working capital requirements and lower interest paid.\nThe components of net cash flows from operating activities are as follows:\nFree cash flow, another measure used by management to evaluate liquidity and financial condition and which represents cash available for the repayment of debt and certain other corporate purposes before the consideration of any debt and equity financing transactions, acquisition expenditures and divestiture proceeds, resulted in inflows of $348 million and $769 million for 1995 and 1994, respectively. The lower level of free cash flow in 1995 compared with 1994 primarily reflects lower operating company contribution, higher operating working capital requirements, capital expenditures, tax and dividend payments and the payment of fees and expenses for the Exchange Offers and the Consent Solicitations, which more than offset the impact of lower interest paid.\nThe components of free cash flow are as follows:\n- ------------\n* Operating cash flow, which is used internally to evaluate business performance, includes, in addition to net cash flows from (used in) operating activities as recorded in the Consolidated Statement of Cash Flows, proceeds from the sale of capital assets less capital expenditures, and is adjusted to exclude income taxes paid and items of a financial nature (such as interest paid, interest income, and other miscellaneous financial income or expense items).\n------------\nDuring 1995, RJRN Holdings, RJRN, Nabisco Holdings and Nabisco entered into a series of transactions designed to refinance long-term debt, lower debt levels, manage interest rate exposure and refinance certain preferred securities. At December 31, 1995, the effective interest rate on RJRN Holdings' consolidated long-term debt increased to 8.0% from 7.7% at December 31, 1994, primarily due to a lower proportion of consolidated indebtedness subject to floating interest rates and higher average market interest rates for 1995. Future effective interest rates may vary as a result of RJRN's and Nabisco's ongoing management of their respective interest rate exposure, changing market interest rates, refinancing activities and changes in the ratings assigned to RJRN's and Nabisco's debt securities by independent rating agencies. RJRN Holdings' total debt (notes payable and long-term debt, including current maturities) and total capital (total debt, obligations on redeemable preferred securities of subsidiary trust and total stockholders' equity) levels at December 31, 1995 amounted to approximately $9.8 billion and $21.1 billion, respectively, of which total debt and total capital were approximately $1.3 billion and $927 million lower, respectively, than the corresponding amounts at December 31, 1994. The lower debt and capital levels were primarily due to the application of approximately $1.2 billion of net proceeds from the Nabisco Holdings' initial public offering to repay debt. RJRN Holdings' ratio of total debt and obligations on redeemable preferred securities of subsidiary trust to total stockholders' equity at December 31, 1995 and 1994 was 1.0-to-1.\nRJRN's ratio of total debt to common equity was 0.8-to-1.0 at December 31, 1995 compared with 1.0-to-1 at December 31, 1994.\nCurrently, RJRN and its subsidiaries have four principal committed credit facilities. On April 28, 1995, RJRN Holdings and RJRN entered into a new $2.75 billion three year revolving bank credit agreement with various financial institutions (as amended, the \"1995 RJRN Credit Agreement\") and a new $750 million 364 day credit facility to support RJRN commercial paper (as amended, the \"RJRN Commercial Paper Facility,\" and together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"). Among other things, the New RJRN Credit Agreements were designed to remove restrictions on the ability of Nabisco Holdings and its subsidiaries to incur or prepay debt and allow RJRN to reduce the aggregate amount of commitments under its banking facilities from $6 billion to $3.5 billion by replacing its $5.0 billion revolving bank credit facility dated December 1, 1991 (as amended, the \"1991 RJRN Credit Agreement\"), and its $1.0 billion commercial paper facility dated as of April 5, 1993 (as amended and together with the 1991 RJRN Credit Agreement, the \"Old RJRN Credit Agreements\").\nOn April 28, 1995, Nabisco Holdings and Nabisco entered into a credit agreement with various financial institutions (as amended, the \"1995 Nabisco Credit Agreement\") to replace the credit agreement dated as of December 6, 1994 between Nabisco and various financial institutions (the \"1994 Nabisco Credit Agreement\"). Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On November 3, 1995, the 1995 Nabisco Credit Agreement was amended to, among other things, reduce the committed facility to $2.0 billion from $3.5 billion. Also on November 3, 1995, Nabisco Holdings and Nabisco entered into a 364 day credit facility (the \"Nabisco Commercial Paper Facility,\" and together with the 1995 Nabisco Credit Agreement, the \"1995 Nabisco Credit Agreements\") for $1.5 billion primarily to support the issuance of Nabisco commercial paper borrowings.\nThe 1995 RJRN Credit Agreement provides for the issuance of up to $800 million of irrevocable letters of credit. Availability is reduced by the aggregate amount of borrowings outstanding and letters of credit issued under the 1995 RJRN Credit Agreement and by the amount of outstanding RJRN commercial paper in excess of $750 million. At December 31, 1995, there were no borrowings outstanding and approximately $496 million stated amount of letters of credit issued under the 1995 RJRN Credit Agreement and approximately $224 million in RJRN commercial paper outstanding. Accordingly, the amount available under the 1995 RJRN Credit Agreement at December 31, 1995 was approximately $2.3 billion.\nThe RJRN Commercial Paper Facility provides a 364 day back-up line of credit to support RJRN commercial paper issuances of up to $750 million. Availability is reduced by an amount equal to the aggregate amount of outstanding RJRN commercial paper. At December 31, 1995, there was approximately $224 million of RJRN commercial paper outstanding, leaving approximately $526 million available under the facility to support the issuance of additional RJRN commercial paper.\nThe 1995 Nabisco Credit Agreement provides for the issuance of up to $300 million of irrevocable letters of credit. Availability is reduced by the aggregate amount of borrowings outstanding and letters of credit issued under the 1995 Nabisco Credit Agreement and by the amount of outstanding Nabisco commercial paper in excess of $1.5 billion. At December 31, 1995, there were no borrowings outstanding and no letters of credit issued under the 1995 Nabisco Credit Agreement and approximately $1.3 billion in Nabisco commercial paper outstanding. Accordingly, the amount available under the 1995 Nabisco Credit Agreement at December 31, 1995 was approximately $2.0 billion.\nThe Nabisco Commercial Paper Facility is a 364 day facility that primarily supports Nabisco commercial paper issuances of up to $1.5 billion. Availability is reduced by an amount equal to the aggregate amount of outstanding Nabisco commercial paper. At December 31, 1995, there was\napproximately $1.3 billion of Nabisco commercial paper outstanding, leaving approximately $200 million available under the facility to support the issuance of additional Nabisco commercial paper.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock, par value $.01 per share (\"Class A Common Stock\"), at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its borrowings under the 1994 Nabisco Credit Agreement. The completion of Nabisco Holdings' initial public offering and the corresponding reduction in RJRN's proportionate economic interest in Nabisco Holdings from 100% to approximately 80.5% resulted in an adjustment of approximately $401 million to the carrying amount of RJRN's investment in Nabisco Holdings. Such adjustment was reflected as additional paid-in capital by RJRN Holdings and RJRN.\nOn April 1, July 1 and October 1, 1995 and January 1, 1996, RJRN Holdings paid a quarterly dividend on its common stock, par value $.01 per share (the \"Common Stock\"), of $.375 per share. RJRN Holdings expects to continue to pay a quarterly cash dividend on the Common Stock equal to $.375 per share or $1.50 per share on an annualized basis. RJRN Holdings believes that its ability to pay these dividends will not be limited by the restrictions under the New RJRN Credit Agreements and the 1995 Nabisco Credit Agreements or by the policies of its Board of Directors described below.\nOn April 12, 1995, the stockholders of RJRN Holdings approved a one-for-five reverse stock split and the corresponding reduction in the number of authorized shares of Common Stock from 2,200,000,000 to 440,000,000. Accordingly, the rates at which shares of ESOP Convertible Preferred Stock, par value $.01 per share, and Series C Conversion Preferred Stock, par value $.01 per share, will convert into shares of Common Stock have been proportionately adjusted.\nOn June 5, 1995, RJRN and Nabisco consummated the Exchange Offers. As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN consummated the Consent Solicitations. The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nOn June 5, 1995, RJRN applied the approximately $2.3 billion that it received from Nabisco and Nabisco Holdings in repayment of the intercompany notes to repay a portion of its borrowings under the 1991 RJRN Credit Agreement. RJRN used an additional approximately $330 million of borrowings under the 1995 RJRN Credit Agreement to repay the balance of its obligations under the Old RJRN Credit Agreements and to pay certain expenses associated with the Exchange Offers, the Consent Solicitations and related transactions.\nOn June 28, 1995 Nabisco issued $400 million principal amount of 6.70% Notes Due 2002, $400 million principal amount of 6.85% Notes Due 2005 and $400 million principal amount of 7.55% Debentures Due 2015. On July 14, 1995, Nabisco issued $400 million principal amount of 7.05% Notes Due 2007. The net proceeds from the issuance of such debt securities were used to repay a portion of the borrowings under the 1995 Nabisco Credit Agreement.\nOn July 1 and October 1, 1995 and January 1, 1996, Nabisco Holdings paid a quarterly dividend on its common stock of $.1375 per share. Nabisco Holdings expects to continue to pay a quarterly cash\ndividend on its common stock equal to $.1375 per share or $.55 per share on an annualized basis (approximately $146 million). RJRN would receive approximately $117 million of the annualized Nabisco Holdings dividend.\nOn July 17, 1995, Nabisco redeemed its outstanding 8 5\/8% Sinking Fund Debentures Due March 15, 2017 at a price of $1,051.75 for each $1,000 principal amount of debentures, plus accrued interest. The aggregate redemption price and accrued interest on these debentures was approximately $442 million. The redemption resulted in an extraordinary loss of approximately $29 million ($16 million after tax and minority interest).\nOn July 24, 1995, RJRN issued $400 million aggregate principal amount of 8% Notes Due 2001 and $250 million aggregate principal amount of 8 3\/4% Notes Due 2007 under a $1.0 billion debt shelf registration statement filed during 1995. Approximately $352 million of debt securities remains unissued under the shelf as of December 31, 1995. The net proceeds from the issuance of these securities have been or will be used to repay borrowings under the 1995 RJRN Credit Agreement, to retire RJRN commercial paper and for general corporate purposes.\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its 10% Junior Subordinated Debentures due 2044 (the \"Junior Subordinated Debentures\") to a newly formed controlled affiliate, RJR Nabisco Holdings Capital Trust I (the \"Trust\"). The Trust, in turn, exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par value $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The sole asset of the Trust is the Junior Subordinated Debentures. Upon redemption of the Junior Subordinated Debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The transaction resulted in a charge of approximately $5 million to RJRN Holdings' paid in capital as the fair value of the Trust Preferred Securities issued exceeded the book carrying value of the retired Series B Preferred Stock.\nOn November 14, 1995, Nabisco filed a shelf registration statement with the Securities and Exchange Commission for $1.0 billion of debt.\nAt December 31, 1995, RJRN had outstanding interest rate instruments with a notional principal amount of $0, net.\nAt December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates occurring within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter.\nAt December 31, 1995, the aggregate amount of consolidated indebtedness subject to floating interest rates approximated $642 million. This represents a decrease of $3.7 billion from the year end 1994 level of $4.3 billion, primarily due to the application of approximately $1.2 billion of the net proceeds from the Nabisco Holdings' initial public offering to repay a portion of Nabisco's borrowing under the 1994 Nabisco Credit Agreement, Nabisco's interest rate instruments entered into during 1995 and the issuance of $1.6 billion of fixed rate debt by Nabisco and $650 million of fixed rate debt by RJRN to refinance bank and commercial paper borrowings.\nAs a result of the level of market interest rates at December 31, 1995 and 1994 compared with the interest rates associated with RJRN Holdings' consolidated debt obligations, the estimated fair value amounts of RJRN Holdings' long-term debt reflected in its Consolidated Balance Sheets is higher by $246 million and lower by $444 million than the carrying amounts (book values) of such debt at December 31, 1995 and 1994, respectively. For additional disclosures concerning the fair value of\nRJRN Holdings' consolidated indebtedness as well as the fair value of its interest rate arrangements at December 31, 1995 and 1994, see Notes 11 and 12 to the Consolidated Financial Statements.\nThe payment of dividends and the making of distributions by RJRN Holdings to its stockholders are subject to direct and indirect restrictions under certain financing agreements and debt instruments of RJRN Holdings and RJRN and their subsidiaries. The New RJRN Credit Agreements generally restrict cumulative common and preferred dividends and distributions by RJRN Holdings after April 28, 1995 to $1 billion, plus 50% of cumulative consolidated net income, as defined in the New RJRN Credit Agreements, after January 1, 1995, plus the aggregate cash proceeds of up to $250 million in any twelve month period from issuances of equity securities. The New RJRN Credit Agreements and certain other financing agreements also limit the ability of RJRN Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock, issue certain equity securities and engage in certain mergers or consolidations.\nAmong other things, the 1995 Nabisco Credit Agreements generally restrict common and preferred dividends and distributions after April 28, 1995 by Nabisco Holdings to its stockholders, including RJRN, to $300 million plus 50% of Nabisco Holdings' cumulative consolidated net income, as defined in the 1995 Nabisco Credit Agreements, after January 1, 1995. In general, loans and advances by Nabisco Holdings and its subsidiaries to RJRN are effectively subject to a $100 million limit and may only be extended to RJRN's foreign subsidaries. The 1995 Nabisco Credit Agreements also limit the ability of Nabisco Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock and engage in certain mergers or consolidations. These restrictions have not had and are not expected to have a material effect on the ability of Nabisco Holdings to pay its anticipated dividends, or on the ability of RJRN to meet its obligations.\nManagement of RJRN Holdings and its subsidiaries are continuing to review various strategic transactions, including but not limited to, acquisitions, divestitures, mergers and joint ventures. No assurance may be given that any such transactions will be announced or completed.\nRJRN Holdings has indicated that, under normal circumstances, it does not plan to issue additional equity securities for purposes of balance sheet improvement.\nCapital expenditures were $744 million, $670 million and $615 million for 1995, 1994 and 1993, respectively. The current level of expenditures planned for 1996 is expected to be in the range of approximately $700 million to $750 million (approximately 60% Food and 40% Tobacco), which will be funded primarily by cash flows from operating activities. Management expects that its capital expenditure program will continue at a level sufficient to support the strategic and operating needs of RJRN Holdings' operating subsidiaries.\nRJRN Holdings' subsidiaries have operations in many countries, utilizing many different functional currencies in its foreign subsidiaries and branches. Significant foreign currency net investments are located in Germany, Canada, Hong Kong, Brazil, Argentina and Spain. Changes in the strength of these countries' currencies relative to the U.S. dollar result in direct charges or credits to equity for non-hyperinflationary countries and direct charges or credits to the income statement for hyperinflationary countries. Translation gains or losses resulting from foreign-denominated borrowings that are accounted for as hedges of certain foreign currency net investments, also result in charges or credits to equity. RJRN Holdings' subsidiaries also have significant exposure to foreign exchange sale and purchase transactions in currencies other than its functional currency. The exposures include the U.S. dollar, German mark, Japanese yen, Swiss franc, Hong Kong dollar, Singapore dollar and cross-rate exposure among the French franc, British pound, Italian lira and the German mark. These exposures are managed to minimize the effects of foreign currency transactions on its cash flows.\nRJRN HOLDINGS' BOARD OF DIRECTORS POLICIES\nIn November 1994, the Board of Directors of RJRN Holdings adopted a policy stating that RJRN Holdings will limit, until December 31, 1998, the aggregate amount of cash dividends on its capital stock. Under this policy, during that period RJRN Holdings will not pay any extraordinary cash dividends and will limit the aggregate amount of its cash dividends, cash distributions and repurchases for cash of capital stock and subordinated debt to an amount equal to the sum of $500 million plus (i) 65% of RJRN Holdings' cumulative consolidated net income before extraordinary gains or losses and restructuring charges subsequent to December 31, 1994 and (ii) net cash proceeds of up to $250 million in any year from the sale of capital stock of RJRN Holdings or its subsidiaries (other than proceeds from the Nabisco Holdings initial public offering) to the extent used to repay, purchase or redeem debt or preferred stock.\nAlso in November 1994, the Board of Directors of RJRN Holdings adopted a policy providing that RJRN Holdings will not declare a dividend or distribution to its stockholders of the shares of capital stock of a subsidiary before December 31, 1996. RJRN Holdings has also adopted a policy setting forth its intention not to make such a distribution prior to December 31, 1998 if that distribution would cause the ratings of the senior indebtedness of RJRN to be reduced from investment grade to non-investment grade or if, after giving effect to such distribution, any publicly-held senior indebtedness of the distributed company would not be rated investment grade. The Board of Directors of RJRN Holdings is committed to effecting a spin-off of Nabisco Holdings at the appropriate time. There is no assurance that any such distribution will take place. Additional policies provide that an amount equal to the net cash proceeds from any issuance and sale of equity by RJRN Holdings or from any sale outside the ordinary course of business of material assets owned or used by subsidiaries in the tobacco business, in each case before December 31, 1998, will be used either to repay, purchase or redeem consolidated indebtedness or to acquire properties, assets or businesses to be used in existing or new lines of business and that an amount equal to the net cash proceeds of any secondary sale of shares of Nabisco Holdings before December 31, 1998 will be used to repay, purchase or redeem consolidated debt. No assurance can be given that RJRN Holdings will issue or sell any equity or sell any material assets outside the ordinary course of business.\nENVIRONMENTAL MATTERS\nThe U.S. Government and various state and local governments have enacted or adopted laws and regulations concerning protection of the environment. The regulations promulgated by the Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and will likely continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities.\nIn April 1995, RJRN Holdings was named a potentially responsible party (a \"PRP\") with certain third parties under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to a superfund site at which a former subsidiary of RJRN had operations. Certain subsidiaries of RJRN Holdings and RJRN have also been named as PRPs with third parties or may have indemnification obligations under CERCLA with respect to an additional thirteen sites.\nRJRN Holdings' and RJRN's subsidiaries have been engaged in a continuing program to assure compliance with U.S., state and local laws and regulations. Although it is difficult to identify precisely the portion of capital expenditures or other costs attributable to compliance with environmental laws and to estimate the cost of resolving these CERCLA matters, RJRN Holdings and RJRN do not expect such expenditures or other costs to have a material adverse effect on the financial condition of either RJRN Holdings or RJRN.\n-------------------------\nThe foregoing discussion in \"Management's Discussion and Analysis of Financial Condition 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, the effects on financial performance and future events, competitive pricing for products, success of new product innovations and acquisitions, local economic conditions and the effects of currency fluctuations in countries in which RJRN Holdings and its subsidiaries do business, domestic and foreign government regulation, ratings of RJRN Holdings' or its subsidiaries' securities and, in the case of the tobacco business, litigation. For additional information concerning factors affecting future events and policies and RJRN Holdings' performance, see Part I, Items 1 through 3 and Part II Item 5 of this report. 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nRefer to the Index to Financial Statements and Financial Statement Schedules on page 47 for the required 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 REGISTRANTS\nItem 10 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996. Reference is also made regarding the executive officers of the Registrants to \"Executive Officers of the Registrants\" following Item 4 of Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nItem 11 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem 12 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nItem 13 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 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, in the City of New York, State of New York on February 22, 1996.\nRJR NABISCO HOLDINGS CORP.\nBy: \/s\/ STEVEN F. GOLDSTONE ................................ (Steven F. Goldstone) 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 February 22, 1996.\nSIGNATURE TITLE --------- ----- \/s\/ CHARLES M. HARPER Chairman of the Board and ................................ Director (Charles M. Harper)\nPresident and Chief Executive \/s\/ STEVEN F. GOLDSTONE Officer (principal executive ................................ officer) (Steven F. Goldstone)\nSenior Vice President and Chief \/s\/ ROBERT S. ROATH Financial Officer (principal ................................ financial officer) (Robert S. Roath)\n\/s\/ RICHARD G. RUSSELL Senior Vice President and ................................ Controller (principal (Richard G. Russell) accounting officer)\n* Director ................................ (John T. Chain, Jr.)\n* Director ................................ (Julius L. Chambers)\n* Director ................................ (John L. Clendenin)\n* Director ................................ (H. John Greeniaus)\n* Director ................................ (Ray J. Groves)\n* Director ................................ (James W. Johnston)\n* Director ................................ (John G. Medlin, Jr.)\n* Director ................................ (Rozanne L. Ridgway)\n*By: \/s\/ ROBERT F. SHARPE, JR. ............................. (Robert F. Sharpe, Jr.) Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York on February 22, 1996.\nRJR NABISCO, INC.\nBy: \/s\/ STEVEN F. GOLDSTONE ................................ (Steven F. Goldstone) 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 February 22, 1996.\nSIGNATURE TITLE --------- ----- \/s\/ CHARLES M. HARPER Chairman of the Board and ................................ Director (Charles M. Harper)\nPresident and Chief Executive \/s\/ STEVEN F.GOLDSTONE Officer (principal executive ................................ officer) (Steven F. Goldstone)\nSenior Vice President and Chief \/s\/ ROBERT S. ROATH Financial Officer (principal ................................ financial officer) (Robert S. Roath)\n\/s\/ RICHARD G. RUSSELL Senior Vice President and ................................ Controller (principal (Richard G. Russell) accounting officer)\n* Director ................................ (John T. Chain, Jr.)\n* Director ................................ (Julius L. Chambers)\n* Director ................................ (John L. Clendenin)\n* Director ................................ (H. John Greeniaus)\n* Director ................................ (Ray J. Groves)\n* Director ................................ (James W. Johnston)\n* Director ................................ (John G. Medlin, Jr.)\n* Director ................................ (Rozanne L. Ridgway)\n*By: \/s\/ ROBERT F. SHARPE, JR. .............................. (Robert F. Sharpe, Jr.) Attorney-in-Fact\n[THIS PAGE INTENTIONALLY LEFT BLANK]\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nREPORT OF DELOITTE & TOUCHE LLP, INDEPENDENT AUDITORS\nRJR Nabisco Holdings Corp.: RJR Nabisco, Inc.:\nWe have audited the accompanying consolidated balance sheets of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and RJR Nabisco, Inc. (\"RJRN\") 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 schedules of RJRN Holdings and RJRN 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 accompanying index to financial statements and financial statement schedules. These financial statements and financial statement schedules are the responsibility of the companies' management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of RJRN Holdings and RJRN 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, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nNew York, New York January 29, 1996 (February 16, 1996 as to Note 12)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS)\n- ------------\n* The sole asset of the subsidiary trust is the junior subordinated debentures of RJRN Holdings. Upon redemption of the junior subordinated debentures, which have a final maturity of December 31, 2044, the preferred securities will be mandatorily redeemed. The outstanding junior subordinated debentures have an aggregate principal amount of approximately $978 million and an annual interest rate of 10%.\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThis Summary of Significant Accounting Policies is presented to assist in understanding the consolidated financial statements of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and RJR Nabisco, Inc. (\"RJRN\") (the \"Consolidated Financial Statements\") included in this report. These policies conform to generally accepted accounting principles.\nConsolidation\nConsolidated Financial Statements include the accounts of RJRN Holdings and RJRN and their subsidiaries.\nCash Equivalents\nCash equivalents include all short-term, highly liquid investments that are readily convertible to known amounts of cash and so near maturity (three months or less) that they present an insignificant risk of changes in value because of changes in interest rates.\nInventories\nInventories are stated at the lower of cost or market. Various methods are used for determining cost. The cost of U.S. tobacco inventories is determined principally under the LIFO method. The cost of remaining inventories is determined under the FIFO, specific lot and weighted average methods. In accordance with recognized trade practice, stocks of tobacco, which must be cured for more than one year, are classified as current assets.\nDepreciation\nProperty, plant and equipment are depreciated principally by the straight-line method over the estimated useful lives of the assets as follows: 13-25 years for land improvements, 20-50 years for buildings and leasehold improvements and 3-20 years for machinery and equipment.\nTrademarks and Goodwill\nValues assigned to trademarks are amortized on the straight-line method over a 40 year period. Goodwill is also amortized on the straight-line method over a 40 year period.\nIn evaluating the value and future benefits of trademarks and goodwill, the recoverability from operating income is measured. Under this approach, the carrying value of goodwill and trademarks would be reduced if it is probable that management's best estimate of future operating income before amortization of trademarks and goodwill from related operations, on an undiscounted basis, will be less than the carrying amount of trademarks and goodwill over the remaining amortization period.\nOther Income (Expense), Net\nInterest income, gains and losses on foreign currency transactions and other items of a financial nature are included in \"Other income (expense), net\".\nIncome Taxes\nIncome taxes are calculated for RJRN on a separate return basis.\nExcise Taxes\nExcise taxes are excluded from \"Net sales\" and \"Cost of products sold\".\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)\nReclassifications and Restatements\nCertain prior years' amounts have been reclassified to conform to the 1995 presentation. In addition, financial data of the prior years has been restated and financial data of the current year presented to give effect to the one-for-five reverse stock split discussed in Note 3 to the Consolidated Financial Statements.\nAdvertising\nAdvertising costs are generally expensed as incurred.\nInterest Rate Arrangements\nWhen interest rate swaps and purchased options and other interest rate arrangements effectively hedge interest rate exposures, the differential to be paid or received is accrued and recognized in interest expense and may change as market interest rates change. If an arrangement is terminated or effectively terminated prior to maturity, then the realized or unrealized gain or loss is effectively recognized over the remaining original life of the agreement if the hedged item remains outstanding, or immediately, if the underlying hedged instrument does not remain outstanding. If the arrangement is not terminated or effectively terminated prior to maturity, but the underlying hedged instrument is no longer outstanding, then the unrealized gain or loss on the related interest rate swap, option or other interest rate arrangement is recognized immediately. In addition, for written options and other financial instruments (or components thereof) having a risk profile substantially similar to written options, changes in market value result in the current recognition of any related gains or losses.\nForeign Currency Arrangements\nForward foreign exchange contracts and other hedging arrangements entered into generally mature at the time the hedged foreign currency transactions are settled. Gains or losses on forward foreign exchange transactions are determined by changes in market rates and are generally included at settlement in the basis of the underlying hedged transaction. To the extent that the underlying hedged foreign currency transaction does not occur, gains and losses are recognized immediately.\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 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. See Note 12 to the Consolidated Financial Statements for discussion of significant commitments and contingencies.\nNew 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 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. SFAS No. 121 requires that (i) 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\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)\ncarrying amount of an asset may not be recoverable and (ii) long-lived assets and certain identifiable intangibles to be disposed of generally be reported at the lower of carrying amount or fair value less cost to sell. SFAS No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995. The adoption of the SFAS No. 121 is not expected to materially effect the financial position or results of operations of RJRN Holdings and RJRN.\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 financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 encourages all entities to adopt a fair value based method of accounting for stock-based compensation plans in which compensation cost is measured at the date the award is granted based on the value of the award and is recognized over the employee service period. However, SFAS No. 123 allows an entity to continue to use the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (\"APB No. 25\"), with proforma disclosures of net income and earnings per share as if the fair value based method had been applied. APB No. 25 requires compensation expense to be recognized over the employee service period based on the excess, if any, of the quoted marked price of the stock at the date the award is granted or other measurement date, as applicable, over an amount an employee must pay to acquire the stock. SFAS No. 123 is effective for financial statements for fiscal years beginning after December 15, 1995. RJRN Holdings and RJRN currently plan to continue to apply the methods prescribed by APB No. 25.\nNOTE 2--OPERATIONS\nNet sales and cost of products sold exclude excise taxes of $3.832 billion, $3.578 billion and $3.757 billion for 1995, 1994 and 1993, respectively.\nConsolidated other income (expense), net for 1995 includes a pre-tax charge of approximately $103 million for fees and expenses incurred in connection with (i) the exchange of approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco, Inc. (\"Nabisco\") for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\") and (ii) the solicitation of consents by RJRN to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\"). The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nRJRN Holdings recorded a pre-tax restructuring expense of $154 million in the fourth quarter of 1995 ($104 million after tax) related to a program announced on October 13, 1995 to reorganize its worldwide tobacco operations. The 1995 restructuring program was primarily undertaken in order to streamline operations and improve profitability. The 1995 restructuring program was implemented in the latter part of 1995 and will be substantially completed during 1996. A significant portion of the 1995 restructuring program will be a cash expense. The major components of the 1995 restructuring program were work force reductions totaling 1,260 employees (approximately $132 million), the rationalization and closing of facilities relating to the international tobacco operations (approximately $8 million) and equipment and lease abandonments at the domestic tobacco operations (approximately\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2--OPERATIONS--(CONTINUED)\n$14 million). At December 31, 1995, approximately $102 million of severance pay and benefits remained to be paid. Anticipated annual future cash savings from the plan are estimated to be in excess of approximately $70 million after tax.\nDuring the fourth quarter of 1994, RJRN Holdings approved and adopted a plan to realign Headquarters' functions, transferring certain responsibilities to the operating companies and significantly streamlining the holding company. The plan reflected expectations of a lower level of financings and other activities at the holding company as RJRN Holdings concludes the post-LBO period. The costs and expenses associated with this decision resulted in a charge of approximately $65 million before tax, a significant portion of which was a cash expense. The majority of the charge was related to accrued employee termination benefits for the 25% of Headquarters' employees terminated (approximately $40 million). This cost was incurred pursuant to a continuing plan for employee termination benefits that provided for the payment of specified amounts of severance and benefits to terminated employees. The remainder of the charge (approximately $25 million) was related to the abandonment of leases of certain corporate office facilities as a result of the realignment and streamlining and the reduced need for office space. The plan was implemented in the first quarter of 1995 and was substantially completed during 1995. At December 31, 1995, approximately $14 million of severance pay and benefits remained to be paid.\nRJRN Holdings recorded a pre-tax restructuring expense of $730 million in the fourth quarter of 1993 ($467 million after tax) related to a program announced on December 7, 1993. The 1993 restructuring program was undertaken to respond to a changing consumer product business environment and to streamline operations and improve profitability. The 1993 program, which was implemented in the latter part of 1993 and substantially completed during 1995, consisted of workforce reductions, reassessment of raw material sourcing and production arrangements, contract termination costs, abandonment of leases and the rationalization and closing of manufacturing and sales facilities. Approximately 75% of the restructuring program required cash outlays. At December 31, 1995, approximately $21 million for severance pay and benefits remained to be paid.\nDuring 1994, a change in the estimated cost of the 1993 restructuring program resulted in a credit to income of $23 million related to changes in the number of workforce reductions and an increase in cost of $21 million associated with the rationalization and abandonment of manufacturing and sales facilities. The net adjustment during 1994 of the above changes was reflected in selling, advertising, administrative and general expenses.\nNOTE 3--EARNINGS PER SHARE\nEarnings per share is based on income applicable to the consolidated group, including the portion of income of Nabisco Holdings Corp. (\"Nabisco Holdings\") applicable to the consolidated group based on RJRN's approximately 80.5% economic ownership interest in Nabisco Holdings and Nabisco Holdings' primary earnings per share. Earnings per share is also based on the weighted average number of shares of RJRN Holdings' common stock, par value $.01 per share (the \"Common Stock\"), $.835 Depositary Shares (\"Series A Depositary Shares\") and Series C Depositary Shares (\"Series C Depositary Shares\") outstanding during the period and Common Stock assumed to be outstanding to reflect the effect of dilutive options. RJRN Holdings' other potentially dilutive securities are not included in the earnings per share calculation because the effect of excluding interest and dividends on such securities for the period would exceed the earnings allocable to the Common Stock into which such securities would be\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 3--EARNINGS PER SHARE--(CONTINUED)\nconverted. Accordingly, RJRN Holdings' earnings per share and fully diluted earnings per share are the same. The net loss per common and common equivalent share reported for the year ended December 31, 1993 would have increased by $.91 per share if the weighted average number of shares of Series A Depositary Shares outstanding during the period had been excluded from the earnings per share calculation.\nNet income per common and common equivalent share, including the average number of common and common equivalent shares outstanding, reflects a one-for-five reverse stock split approved by the RJRN Holdings' stockholders on April 12, 1995.\nNOTE 4--INCOME TAXES\nThe provision for income taxes consisted of the following:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nThe components of the deferred income tax liability disclosed on the Consolidated Balance Sheet at December 31, 1995 and 1994 included the following:\nPre-tax income (loss) for domestic and foreign operations is shown in the following table:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nThe differences between the provision for income taxes and income taxes computed at statutory U.S. federal income tax rates are explained as follows:\nAt December 31, 1995, there was $1.752 billion of accumulated and undistributed income of foreign subsidiaries. These earnings are intended by management to be reinvested abroad indefinitely. Accordingly, no applicable U.S. federal deferred income taxes or foreign withholding taxes have been provided nor is a determination of the amount of unrecognized U.S. federal deferred income taxes practicable.\nRJRN Holdings' provision for income taxes for 1993 was increased by $96 million as a result of the enactment of certain federal tax legislation during the third quarter of 1993 which increased federal corporate income tax rates to 35% from 34%, retroactively to January 1, 1993. The components of this increase to RJRN Holdings' provision for income taxes included an $86 million non-cash charge resulting primarily from the remeasurement of the balance of deferred federal income taxes at the date of enactment of the new federal tax legislation for the change in the income tax rates, and a $10 million charge resulting from the increase in current federal income taxes accrued for the change in the income tax rates and other effects of the new tax legislation. Also during 1993, RJRN Holdings' provision for income taxes was decreased by a $108 million credit primarily resulting from a change in the functional currency, for U.S. federal income tax purposes, relating to foreign branch operations.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nDuring 1993, $101 million of previously recognized deferred income tax benefits for operating loss carryforwards ($36 million), minimum tax credit carryforwards ($44 million) and other carryforward items ($21 million) were realized for federal tax purposes.\nNOTE 5--EXTRAORDINARY ITEM\nEarly extinguishment of debt resulted in the following extraordinary losses:\nSee Note 11 to the Consolidated Financial Statements for further discussion of early extinguishments of debt.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--SUPPLEMENTAL CASH FLOWS INFORMATION\nA reconciliation of net income (loss) to net cash flows from operating activities follows:\nCash payments for income taxes and interest were as follows:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--SUPPLEMENTAL CASH FLOWS INFORMATION--(CONTINUED)\nCash equivalents at December 31, 1995 and 1994, valued at cost (which approximates market value), totaled $115 million and $364 million, respectively, and consisted principally of domestic and Eurodollar time deposits and certificates of deposit.\nAt December 31, 1995 and 1994, cash of $17 million and $60 million, respectively, was held in escrow as collateral for letters of credit issued in connection with certain foreign currency debt.\nOn February 7, 1990, RJRN entered into an arrangement in which it agreed to sell for cash substantially all of its subsidiaries' domestic trade accounts receivable generated during a five-year period to a financial institution. Pursuant to amendments entered into in 1992, the length of the receivable program was extended an additional year. During 1995, the arrangement was further amended to October 1996 for only domestic trade accounts receivable generated by Nabisco. The accounts receivable have been and will continue to be sold with limited recourse at purchase prices reflecting the rate applicable to the cost to the financial institution of funding its purchases of accounts receivable and certain administrative costs. During 1995, 1994 and 1993, total proceeds of approximately $8.0 billion, $7.9 billion and $8.2 billion, respectively, were received in connection with this arrangement. The amount of total proceeds received applicable to Nabisco's domestic trade accounts receivable generated during 1995, 1994 and 1993 were approximately $5.5 billion, $5.3 billion and $4.9 billion, respectively. At December 31, 1995 and 1994, the accounts receivable balance has been reduced by approximately $418 million and $391 million, respectively, due to the receivables sold.\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE 7--INVENTORIES\nThe major classes of inventory are shown in the table below:\nAt December 31, 1995 and 1994, approximately $1.0 billion and $1.2 billion, respectively, of domestic tobacco inventories was valued under the LIFO method. The current cost of LIFO inventories at December 31, 1995 and 1994 was greater than the amount at which these inventories were carried on the Consolidated Balance Sheets by $146 million and $141 million, respectively.\nFor the years ended December 31, 1995, 1994 and 1993, net income was increased by $29 million, $10 million and $6 million, respectively, as a result of LIFO inventory liquidations. The LIFO liquidations resulted from programs to reduce leaf durations consistent with forecasts of future operating requirements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8--PROPERTY, PLANT AND EQUIPMENT\nComponents of property, plant and equipment were as follows:\nNOTE 9--NOTES PAYABLE\nNotes payable consisted of the following:\nWeighted average interest rate for notes payable consisted of the following:\nNOTE 10--ACCRUED LIABILITIES\nAccrued liabilities consisted of the following:\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE\nInterest and debt expense consisted of the following:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nLong-term debt consisted of the following:\n- ------------\n(1) The payment of debt through December 31, 2000 is due as follows (in millions): 1997--$61; 1998--$31; 1999--$1,944 and 2000--$1,319.\n(2) Nabisco maintains a revolving credit facility of $2.0 billion (as amended, the \"1995 Nabisco Credit Agreement\"), of which $2.0 billion is unused at December 31, 1995. Availability of the unused portion is reduced by the aggregate amount of letters of credit issued under the 1995 Nabisco Credit Agreement and by the amount of outstanding Nabisco commercial paper in excess of $1.5 billion. At December 31, 1995, there were no letters of credit issued under the 1995 Nabisco Credit Agreement. A commitment fee of .15% per annum is payable on the total facility.\n(3) Nabisco maintains a 364-day revolving credit facility primarily to support Nabisco commercial paper issuances of up to $1.5 billion (the \"Nabisco Commercial Paper Facility\"). Availability is reduced\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nby an amount equal to the aggregate amount of outstanding Nabisco commercial paper. A commitment fee of .1% per annum is payable on the total facility.\n(4) RJRN maintains a revolving credit facility of $2.75 billion (as amended, the \"1995 RJRN Credit Agreement\"), of which $2.75 billion was unused at December 31, 1995. Availability of the unused portion is reduced by $496 million for the extension of irrevocable letters of credit issued under the 1995 RJRN Credit Agreement and by the amount of outstanding RJRN commercial paper in excess of $750 million. A commitment fee of .225% per annum is payable on the total facility.\n(5) RJRN maintains a 364-day back-up line of credit to support RJRN commercial paper issuances of up to $750 million (as amended, the \"RJRN Commercial Paper Facility\"), which expires in April 1996. Availability is reduced by an amount equal to the aggregate amount of outstanding RJRN commercial paper. A commitment fee of .175% per annum is payable on the total facility.\n-------------------\nBased on RJRN's and Nabisco's intention and ability to continue to refinance, for more than one year, the amount of their respective commercial paper borrowings in the commercial paper market or with additional borrowings under their respective credit agreements, domestic commercial paper borrowings have been included under \"Long-term debt.\"\nDuring 1993, RJRN repurchased for approximately $1.0 billion in cash certain of its subordinated debentures consisting of $153 million aggregate principal amount of its 15% Payment-in-Kind Debentures due May 15, 2001 (the \"15% Subordinated Debentures\"), $82 million aggregate principal amount of its 13 1\/2% Subordinated Debentures due May 15, 2001 (the \"13 1\/2% Subordinated Debentures\") and $768 million aggregate principal amount (approximately $671 million accreted amount) of its Subordinated Discount Debentures due May 15, 2001 (the \"Subordinated Discount Debentures\"). The principal or accreted amounts of such debentures was refinanced from proceeds of debt securities maturing after 1998, including debt securities issued during 1993. The purchase of most of such amount had been temporarily funded with borrowings under RJRN's revolving credit facility (as amended, the \"1991 RJRN Credit Agreement\").\nThe remaining portion of a participation in an employee stock ownership plan established by RJRN Holdings (the \"ESOP\") was repurchased on January 15, 1993 for cash, plus accrued and unpaid interest thereon.\nRJRN Holdings redeemed on May 1, 1993, 100% of the aggregate principal amount of its outstanding Senior Converting Debentures due 2009 (the \"Converting Debentures\") at a price of $1,000 for each $1,000 principal amount of Converting Debentures, plus accrued and unpaid interest thereon, for the period from February 9, 1989 through April 30, 1993, of $937.54 for each $1,000 principal amount of Converting Debentures.\nDuring 1993, RJRN issued $750 million principal amount of 8% Notes due 2000, $500 million principal amount of 8 3\/4% Notes due 2005 and $500 million principal amount of 9 1\/4% Debentures due 2013. Also during 1993, RJRN issued medium-term notes maturing in the years 1995-1998 having an aggregate initial offering price of approximately $230 million. The net proceeds from the sale of these debt securities and the Series B Preferred Stock Offering (as hereinafter defined) were used for general corporate purposes, which included refinancings of indebtedness, working capital, capital expenditures, acquisitions and repurchases and redemptions of securities. Pending such uses, proceeds were used to repay indebtedness under the 1991 RJRN Credit Agreement or for short-term liquid investments.\nA portion of the net proceeds collected from the sale of RJRN Holdings' ready-to-eat cold cereal business during 1992 was used on February 5, 1993 to redeem $216 million principal amount of\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nRJRN's 9 3\/8% Sinking Fund Debentures due 2016 (the \"9 3\/8% Debenture\") at a price of $1,065.63 for each $1,000 principal amount of 9 3\/8% Debentures, plus accrued and unpaid interest thereon.\nOn May 15, 1994, RJRN redeemed substantially all of its approximately $2 billion in outstanding subordinated debentures. The subordinated debentures redeemed consisted of the Subordinated Discount Debentures, the 15% Subordinated Debentures and the 13 1\/2% Subordinated Debentures at redemption prices of 107 1\/2%, 107 1\/2% and 106 3\/4%, respectively, plus accrued interest. Approximately $1.2 billion principal or accreted amount of such debentures was refinanced with proceeds of debt securities maturing after 1998 that were issued during 1993. Such proceeds had been used to temporarily reduce indebtedness under the 1991 RJRN Credit Agreement. In addition, the redemption of such debentures was funded with approximately $900 million of net proceeds from the sale of 266,750,000 Series C Depositary Shares completed on May 6, 1994 in connection with the issuance of 26,675,000 shares of Series C Conversion Preferred Stock, par value $.01 per share (\"Series C Preferred Stock\").\nOn November 30, 1994, RJRN redeemed $1.5 billion of 10 1\/2% Senior Notes due 1998 (the \"10 1\/2% Senior Notes\"); $373.5 million of 8 3\/8% Sinking Fund Debentures due 2017 and approximately $24.8 million of 7 3\/8% Sinking Fund Debentures due 2001. On December 2, 1994, RJRN redeemed $100 million of the 13 1\/2% Subordinated Debentures. The redemption price for the 10 1\/2% Senior Notes was equal to $1,071 plus accrued interest for each $1,000 principal amount of notes. The redemption price for the 8 3\/8% Sinking Fund Debentures due 2017 was equal to $1,054.44 plus accrued interest for each $1,000 principal amount of debentures. The redemption price for the 7 3\/8% Sinking Fund Debentures due 2001 was equal to $1,005.60 plus accrued interest for each $1,000 principal amount of debentures. The redemption price for the 13 1\/2% Subordinated Debentures was equal to $1,067.50 plus accrued interest for each $1,000 principal amount of debentures. These redemptions were funded with borrowings under the 1991 RJRN Credit Agreement, internally generated cash flow, and, in the case of the 8 3\/8% Sinking Fund Debentures due 2017, proceeds from RJRN Holdings' Series C Preferred Stock Offering (as hereinafter defined).\nOn December 7, 1994, Nabisco borrowed $1.35 billion under its credit agreement dated as of December 6, 1994 (the \"1994 Nabisco Credit Agreement\") to repay a portion of Nabisco's intercompany indebtedness to RJRN. RJRN used the proceeds of the repayment to reduce borrowings under the 1991 RJRN Credit Agreement.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock, par value $.01 per share (\"Class A Common Stock\"), at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its borrowings under the 1994 Nabisco Credit Agreement.\nOn April 28, 1995, RJRN entered into the 1995 RJRN Credit Agreement and the RJRN Commercial Paper Facility (together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"). Among other things, the New RJRN Credit Agreements were designed to remove restrictions on the ability of Nabisco Holdings and its subsidiaries to incur or prepay debt and to allow RJRN to reduce the aggregate amount of commitments under its banking facilities from $6 billion to $3.5 billion by replacing its 1991 RJRN Credit Agreement and its $1.0 billion commercial paper\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nfacility dated as of April 5, 1993 (as amended and together with the 1991 RJRN Credit Agreement, the \"Old RJRN Credit Agreements\").\nOn April 28, 1995, Nabisco Holdings and Nabisco entered into the 1995 Nabisco Credit Agreement with various financial institutions to replace the 1994 Nabisco Credit Agreement. Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On November 3, 1995, the 1995 Nabisco Credit Agreement was amended to, among other things, reduce the committed facility to $2.0 billion from $3.5 billion. Also on November 3, 1995, Nabisco Holdings and Nabisco entered into a 364 day credit facility (the \"Nabisco Commercial Paper Facility\" and together with the 1995 Nabisco Credit Agreement, the \"1995 Nabisco Credit Agreements\") for $1.5 billion primarily to support the issuance of commercial paper borrowings.\nOn June 5, 1995, RJRN and Nabisco consummated the Exchange Offers. As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN consummated the Consent Solicitations. The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nOn June 5, 1995, RJRN applied the approximately $2.3 billion that it received from Nabisco and Nabisco Holdings in repayment of the intercompany notes to repay a portion of its borrowings under the 1991 RJRN Credit Agreement. RJRN used an additional approximately $330 million of borrowings under the 1995 RJRN Credit Agreement to repay the balance of its obligations under the Old RJRN Credit Agreements and to pay certain expenses associated with the Exchange Offers, the Consent Solicitations and the related transactions.\nOn June 28, 1995, Nabisco issued $400 million principal amount of 6.70% Notes Due 2002, $400 million principal amount of 6.85% Notes Due 2005 and $400 million principal amount of 7.55% Debentures Due 2015. On July 14, 1995, Nabisco issued $400 million principal amount of 7.05% Notes Due 2007. The net proceeds from the issuance of such debt securities were used to repay a portion of the borrowings under the 1995 Nabisco Credit Agreement.\nOn July 17, 1995, Nabisco redeemed its outstanding 8 5\/8% Sinking Fund Debentures Due March 15, 2017 at a price of $1,051.75 for each $1,000 principal amount of debentures, plus accrued interest. The aggregate redemption price and accrued interest on these debentures was approximately $442 million. The redemption resulted in an extraordinary loss of approximately $29 million ($16 million after tax and minority interest).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nOn July 24, 1995, RJRN issued $400 million aggregate principal amount of 8% Notes Due 2001 and $250 million aggregate principal amount of 8 3\/4% Notes Due 2007 under a $1.0 billion debt shelf registration statement. Approximately $352 million of debt securities remains unissued under the shelf as of December 31, 1995. The net proceeds from the issuance of these securities have been or will be used to repay borrowings under the 1995 RJRN Credit Agreement, to retire RJRN commercial paper and for general corporate purposes.\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its 10% Junior Subordinated Debentures due 2044 (the \"Junior Subordinated Debentures\") to a newly formed controlled affiliate, RJR Nabisco Holdings Capital Trust I (the \"Trust\"). The Trust, in turn, exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par value $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The transaction resulted in a charge of approximately $5 million to RJRN Holdings' paid-in capital as the fair value of the Trust Preferred Securities issued, which was the book carrying value assigned to these securities, exceeded the book carrying value of the retired Series B Preferred Stock. The difference between the assigned value of the Trust Preferred Securities and its redemption value will be amortized to interest expense over its term. The sole asset of the Trust is the Junior Subordinated Debentures. Upon maturity or redemption of the Junior Subordinated Debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The Junior Subordinated Debentures are redeemable at the option of RJRN Holdings, in whole or in part, on or after August 19, 1998, at a redemption price equivalent to $25 per Junior Subordinated Debenture to be redeemed, plus accrued and unpaid interest thereon, to the redemption date. Upon the repayment of the Junior Subordinated Debentures, whether at maturity, upon redemption or otherwise, the proceeds thereof will be promptly applied to redeem the Trust Preferred Securities. Holders of Trust Preferred Securities have no right to require the Trust to redeem the Trust Preferred Securities at the option of the holders. Cash distributions on the Trust Preferred Securities are cumulative at an annual rate of 10% of the liquidation amount of $25 per security and are payable quarterly in arrears, but only to the extent that interest payments are made on the Junior Subordinated Debentures. Cash distributions in arrears for more than one quarter will bear interest at 10% of the liquidation amount per security compounded quarterly.\nOn November 14, 1995, Nabisco filed a shelf registration statement with the Securities and Exchange Commission for $1.0 billion of debt.\nAt December 31, 1995, RJRN had outstanding interest rate instruments with a notional principal amount of $0, net. (See Note 12 to the Consolidated Financial Statements for additional disclosures regarding interest rate arrangements).\nAt December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates occurring within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter. (See Note 12 to the Consolidated Financial Statements for additional disclosures regarding interest rate arrangements).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nThe estimated fair value of RJRN Holdings' consolidated long-term debt as of December 31, 1995 and 1994 was approximately $10.1 billion and $10.7 billion, respectively, based on available market quotes, discounted cash flows and book values, as appropriate. The estimated fair value is higher by $246 million and lower by $444 million than the carrying amounts (book values) of RJRN Holdings' long-term debt at December 31, 1995 and 1994, respectively, as a result of the level of market interest rates at December 31, 1995 and 1994 compared with the interest rates associated with RJRN Holdings' debt obligations. Considerable judgment was required in interpreting market data to develop the estimates of fair value. In addition, the use of different market assumptions and\/or estimation methodologies may have had a material effect on the estimated fair value amounts. Accordingly, the estimated fair value of RJRN Holdings' consolidated long-term debt as of December 31, 1995 and 1994 is not necessarily indicative of the amounts that RJRN Holdings could realize in a current market exchange.\nThe payment of dividends and the making of distributions by RJRN Holdings to its stockholders are subject to direct and indirect restrictions under certain financing agreements and debt instruments of RJRN Holdings and RJRN and their subsidiaries. The New RJRN Credit Agreements generally restrict cumulative common and preferred dividends and distributions by RJRN Holdings after April 28, 1995 to $1 billion, plus 50% of cumulative consolidated net income, as defined in the New RJRN Credit Agreements, after January 1, 1995, plus the aggregate cash proceeds of up to $250 million in any twelve month period from issuances of equity securities. The New RJRN Credit Agreements and certain other financing agreements also limit the ability of RJRN Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock, issue certain equity securities and engage in certain mergers or consolidations.\nAmong other things, the 1995 Nabisco Credit Agreements generally restrict common and preferred dividends and distributions after April 28, 1995 by Nabisco Holdings to its stockholders, including RJRN, to $300 million plus 50% of Nabisco Holdings' cumulative consolidated net income, as defined in the 1995 Nabisco Credit Agreement, after January 1, 1995. In general, loans and advances by Nabisco Holdings and its subsidiaries to RJRN are effectively subject to a $100 million limit and may only be extended to RJRN's foreign subsidiaries. The 1995 Nabisco Credit Agreements also limit the ability of Nabisco Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock and engage in certain mergers or consolidations. These restrictions have not had and are not expected to have a material effect on the ability of Nabisco Holdings to pay its anticipated dividends, or on the ability of RJRN to meet its obligations.\nIn November 1994, the Board of Directors of RJRN Holdings adopted a policy stating that RJRN Holdings will limit, until December 31, 1998, the aggregate amount of cash dividends on its capital stock. Under this policy, during that period RJRN Holdings will not pay any extraordinary cash dividends and will limit the aggregate amount of its cash dividends, cash distributions and repurchases for cash of capital stock and subordinated debt to an amount equal to the sum of $500 million plus (i) 65% of RJRN Holdings' cumulative consolidated net income before extraordinary gains or losses and restructuring charges subsequent to December 31, 1994 and (ii) net cash proceeds of up to $250 million in any year from the sale of capital stock of RJRN Holdings or its subsidiaries (other than\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nproceeds from the Nabisco Holdings initial public offering) to the extent used to repay, purchase or redeem debt or preferred stock.\nAlso in November 1994, the Board of Directors of RJRN Holdings adopted a policy providing that RJRN Holdings will not declare a dividend or distribution to its stockholders of the shares of capital stock of a subsidiary before December 31, 1996. RJRN Holdings has also adopted a policy setting forth its intention not to make such a distribution prior to December 31, 1998 if that distribution would cause the ratings of the senior indebtedness of RJRN to be reduced from investment grade to non-investment grade or if, after giving effect to such distribution, any publicly-held senior indebtedness of the distributed company would not be rated investment grade. The Board of Directors of RJRN Holdings is committed to effecting a spin-off of Nabisco Holdings at the appropriate time. There is no assurance that any such distribution will take place. Additional policies provide that an amount equal to the net cash proceeds from any issuance and sale of equity by RJRN Holdings or from any sale outside the ordinary course of business of material assets owned or used by subsidiaries in the tobacco business, in each case before December 31, 1998, will be used either to repay, purchase or redeem consolidated indebtedness or to acquire properties, assets or businesses to be used in existing or new lines of business and that an amount equal to the net cash proceeds of any secondary sale of shares of Nabisco Holdings before December 31, 1998 will be used to repay, purchase or redeem consolidated debt. No assurance can be given that RJRN Holdings will issue or sell any equity or sell any material assets outside the ordinary course of business.\nNOTE 12--COMMITMENTS AND CONTINGENCIES\nTOBACCO-RELATED LITIGATION\nVarious legal actions, proceedings and claims are pending or may be instituted against R.J. Reynolds Tobacco Company (\"RJRT\") or its affiliates or indemnitees, including those claiming that lung cancer and other diseases have resulted from the use of or exposure to RJRT's tobacco products. During 1995, 101 new actions were filed or served against RJRT and\/or its affiliates or indemnitees and 22 such actions were dismissed or otherwise resolved in favor of RJRT and\/or its affiliates or indemnitees without trial. A total of 132 such actions in the United States and two against RJRT's Canadian subsidiary were pending on December 31, 1995. As of February 16, 1996, 144 active cases were pending against RJRT and\/or its affiliates or indemnitees, 142 in the United States and two in Canada. The United States cases are in 22 states and are distributed as follows: 90 in Florida; 10 in Louisiana; 5 in Texas; 4 in each of Indiana, Kansas and Tennessee; 3 in each of Mississippi, California and Pennsylvania; 2 in each of Alabama, Colorado, Massachusetts and Minnesota; and one in each of Missouri, Nevada, New Hampshire, New Jersey, New York, North Carolina, Rhode Island, South Carolina and West Virginia. Of the 142 active cases in the United States, 116 are pending in state court and 26 in federal court.\nFive of the 142 active cases in the United States involve alleged non-smokers claiming injuries resulting from exposure to environmental tobacco smoke. Six cases, which are described more specifically below, purport to be class actions on behalf of thousands of individuals. Purported classes include individuals claiming to be addicted to cigarettes and flight attendants alleging personal injury from exposure to environmental tobacco smoke in their workplace. Four of the active cases were brought by state attorneys general seeking, inter alia, recovery of the cost of Medicare funds paid by their states for\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\ntreatment of citizens allegedly suffering from tobacco related diseases or conditions. In addition, one case was brought by the State of Florida seeking similar rulings under a special state statute.\nThe plaintiffs in these actions seek recovery on a variety of legal theories, including strict liability in tort, design defect, negligence, breach of warranty, failure to warn, fraud, misrepresentation, unfair trade practices, conspiracy, unjust enrichment, indemnity and common law public nuisance. Punitive damages, often in amounts ranging into the hundreds of millions of dollars, are specifically pleaded in 20 cases in addition to compensatory and other damages. The defenses raised by RJRT and\/or its affiliates, where applicable, include preemption by the Cigarette Act of some or all such claims arising after 1969; the lack of any defect in the product; assumption of the risk; comparative fault; lack of proximate cause; and statutes of limitations or repose. Juries have found for plaintiffs in two smoking and health cases in which RJRT was not a defendant, but in one such case, which has been appealed by both parties, no damages were awarded. The jury awarded plaintiffs $400,000 in the other such case, Cipollone v. Liggett Group, Inc., which award was overturned on appeal and the case was subsequently dismissed.\nOn June 24, 1992, the United States Supreme Court in Cipollone held that claims that tobacco companies failed to adequately warn of the risks of smoking after 1969 and claims that their advertising and promotional practices undermined the effect of warnings after that date were preempted by the Cigarette Act. The Supreme Court also held that claims of breach of express warranty, fraud, misrepresentation and conspiracy were not preempted. The Supreme Court's decision was announced through a plurality opinion, and further definition of how Cipollone will apply to other cases must await rulings in those cases.\nCertain legislation proposed in recent years in Congress, among other things, would eliminate any such preemptive effect on common law damage actions for personal injuries. RJRT is unable to predict whether such legislation will be enacted and, if so, in what form, or whether such legislation would be intended by Congress to apply retroactively. The passage of such legislation could increase the number of cases filed against cigarette manufacturers, including RJRT.\nSet forth below are descriptions of the class action lawsuits, a suit in which plaintiffs seek to act as private attorneys general, actions brought by state attorneys general in Massachusetts, Minnesota, Mississippi and West Virginia, an action brought by the State of Florida and pending investigations relating to RJRT's tobacco business.\nIn 1991, Broin v. Philip Morris Company, a purported class action against certain tobacco industry defendants, including RJRT, was brought by flight attendants claiming to represent a class of 60,000 individuals, alleging personal injury caused by exposure to environmental tobacco smoke in their workplace. In December 1994, the Florida state court certified a class consisting of \"all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from diseases and disorders caused by their exposure to secondhand cigarette smoke in airline cabins.\" The defendants appeal of this certification to the Florida Third District Court of Appeal was denied on January 3, 1995. A motion for rehearing has been filed.\nIn March 1994, Castano v. The American Tobacco Company, a purported class action, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT, seeking certification of a class action on behalf of all United States\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nresidents who allegedly are or claim to be addicted, or are the legal survivors of persons who allegedly were addicted, to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in their tobacco products to induce addiction in smokers. Plaintiffs' motion for certification of the class was granted in part on February 17, 1995. The district court certified core liability issues (fraud, negligence, breach of warranty, both express and implied, intentional tort, strict liability and consumer protection statutes), and punitive damages. Not certified were issues of injury-in-fact, proximate cause, reliance, affirmative defenses, and compensatory damages. In July 1995, the Fifth Circuit Court of Appeals agreed to hear defendants, appeal of this class certification. A decision is expected in 1996.\nIn March 1994, Lacey v. Lorillard Tobacco Company, a purported class action, was filed in Circuit Court, Fayette County, Alabama against three cigarette manufacturers, including RJRT. Plaintiff, who claims to represent all smokers who have smoked or are smoking cigarettes manufactured and sold by defendants in the state of Alabama, seeks compensatory and punitive damages not to exceed $48,500 per class member and injunctive relief arising from defendants' alleged failure to disclose additives used in their cigarettes. In April 1994, defendants removed the case to the United States District Court for the Northern District of Alabama.\nIn May 1994, Engle v. R.J. Reynolds Tobacco Company, was filed in Circuit Court, Eleventh Judicial District, Dade County, Florida against tobacco manufacturers, including RJRT, and other members of the industry, by plaintiffs who allege injury and purport to represent a class of all United States citizens and residents who claim to be addicted, or who claim to be legal survivors of persons who allegedly were addicted, to tobacco products. On October 28, 1994, a state court judge in Miami granted plaintiffs' motion to certify the class. The defendants appealed that ruling to the Florida Third District Court of Appeal which, on January 31, 1996, decided to certify a class limited to Florida citizens or residents. The defendants are considering seeking a rehearing.\nIn September 1994, Granier v. American Tobacco Company, a purported class action apparently patterned after the Castano case, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT. Plaintiffs seek certification of a class action on behalf of all residents of the United States who have used and purportedly became addicted to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in tobacco products for the purpose of addicting consumers. By agreement of the parties, all action in this case is stayed pending determination of the motion for class certification in the Castano case.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nIn January 1995, a purported class action was filed in the Ontario Canada Court of Justice against RJR-MacDonald, Inc. and two other Canadian cigarette manufacturers. The lawsuit, then captioned Le Tourneau v. Imperial Tobacco Company seeks certification of a class of persons who have allegedly become addicted to the nicotine in cigarettes or who had such alleged addiction heightened or maintained through the use of cigarettes, and who have allegedly suffered loss, injury, and damage in consequence, together with persons with Family Law Act claims in respect to the claims of such allegedly addicted persons, and the estates of such allegedly addicted persons. Theories of recovery pleaded include negligence, strict liability, failure to warn, deceit, negligent misrepresentation, implied warranty and conspiracy. The relief sought consists of damages of one million dollars for each of the three named plaintiffs, punitive damages, funding of nicotine addiction rehabilitation centers, interest and costs. On June 2, 1995, the plaintiffs, on consent, were granted leave to file an amended statement of claim to remove Le Tourneau as representative plaintiff and add two additional representative plaintiffs. The case is now captioned Caputo v. Imperial Tobacco Limited.\nIn June 1994, in Mangini v. R.J. Reynolds Tobacco Company, the California Supreme Court ruled that the plantiffs' claim that an RJRT advertising campaign constitutes unfair competition under the California Business and Professions Code was not preempted by the Cigarette Act. The plantiffs are acting as private attorneys general. This opinion allows the plaintiffs to pursue their lawsuit which had been dismissed at the trial court level. The defendants' Petition for Certiorari to the United States Supreme Court was denied in December 1994. The case has been remanded to the trial court.\nIn June 1994, in Moore v. The American Tobacco Company, RJRN and RJRT were named along with other industry members as defendants in an action brought by the Mississippi state attorney general on behalf of the state to recover state funds paid for health care and medical and other assistance to state citizens allegedly suffering from diseases and conditions allegedly related to tobacco use. This suit, which was brought in Chancery (non-jury) Court, Jackson County, Mississippi also seeks an injunction from \"promoting\" or \"aiding and abetting\" the sale of cigarettes to minors. Both actual and punitive damages are sought in unspecified amounts. Motions by the defendants to dismiss the case or to transfer it to circuit (jury) court were denied on February 21, 1995 and the case will proceed in Chancery Court. RJRN and other industry holding companies have been dismissed from the case.\nIn August 1994, RJRT and other U.S. cigarette manufacturers were named as defendants in an action instituted on behalf of the state of Minnesota and of Blue Cross and Blue Shield of Minnesota to recover the costs of medical expenses paid by the state and by Blue Cross\/Blue Shield that were incurred in the treatment of diseases allegedly caused by cigarette smoking. The suit, Minnesota v. Philip Morris, alleges consumer fraud, unlawful and deceptive trade practices, false advertising and restraint of trade, and it seeks injunctive relief and money damages, trebled for violations of the state antitrust law. Motions by the defendants to dismiss all claims of Blue Cross\/Blue Shield and certain substantive claims of the State of Minnesota, and by plaintiffs to strike certain of the defendants' defenses, were denied on May 19, 1995. An intermediate appeals court declined to hear the defendants' appeal from the ruling denying the motion to dismiss all claims of Blue Cross\/Blue Shield on the ground that it lacks standing to bring the action, but the Minnesota Supreme Court has agreed to do so. Oral argument was heard January 29, 1996 and a decision is pending.\nIn September 1994, the Attorney General of West Virginia filed suit against RJRT, RJRN and twenty-one additional defendants in state court in West Virginia. The lawsuit, McGraw v. American\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nTobacco Company, is similar to those previously filed in Mississippi and Minnesota. It seeks recovery for medical expenses incurred by the state in the treatment of diseases statistically associated with cigarette smoking and requests an injunction against the promotion and sale of cigarettes and tobacco products to minors. The lawsuit also seeks a declaration that the state of West Virginia, as plaintiff, is not subject to the defenses of statute of repose, statute of limitations, contributory negligence, comparative negligence, or assumption of the risk. On May 3, 1995, the judge granted defendants' motion to dismiss eight of the ten causes of action pleaded. The defendants have filed motions to dismiss the remaining two counts. On October 20, 1995, at a hearing on the defendants' joint motion to prohibit prosecution of the action due to plaintiff's unlawful retention of counsel under a contingent fee arrangement, in a ruling from the bench, the contingent fee agreement between the West Virginia Attorney General and private attorneys preparing the case was held to be void on the grounds that the Attorney General has no constitutional, legislative, or statutory authority for entering into such an agreement.\nOn February 21, 1995, the state of Florida filed a suit against RJRT and RJRN, along with other industry members, their holding companies and other entities. The state is seeking Medicaid reimbursement under various theories of liability and injunctive relief to prevent the defendants from engaging in consumer fraud and to require that defendants: disclose and publish all research conducted directly or indirectly by the industry; fund a corrective public education campaign on the issues of smoking and health in Florida; prevent the distribution and sale of cigarettes to minors under the age of eighteen; fund clinical smoking cessation programs in the state of Florida; dissolve the Council for Tobacco Research and the Tobacco Institute or divest ownership, sponsorship, or membership in both; and disgorge all profits from sales of cigarettes in Florida. On defendants' motion, the case was stayed until July 7, 1995 and that stay has been extended pending appeals by the plaintiffs and the defendants in connection with the constitutional challenge to the Florida statute discussed below.\nThe suit by the state of Florida was brought under a statute which was amended effective July 1994 to allow the state to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action and eliminates the comparative negligence and assumption of risk defenses. The Florida statute was challenged on state and federal constitutional grounds in a lawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets and National Association of Convenience Stores in June 1994. On June 26, 1995 the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the statute unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida Supreme Court accepted for a direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which, on June 15, 1995, was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether legislation will be enacted in these states, whether other states will introduce and enact similar legislation, whether lawsuits will be filed under statutes, if enacted, or the outcome of any such lawsuits, if filed.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nOn November 28, 1995, RJRT and other domestic cigarette manufacturers filed petitions for declaratory judgment in Massachusetts (Federal Court) and Texas (State Court, Austin Texas) as to potential Medicaid reimbursement suits that had been threatened by the Attorneys General of those states. On January 22, 1996, a similar petition for declaratory judgement was filed in Maryland (State Court).\nOn December 19, 1995, the Commonwealth of Massachusetts filed suit against cigarette manufacturers including RJRT and additional defendants including trade associations and wholesalers, seeking reimbursement of Medicaid and other costs incurred by the state in providing health care to citizens allegedly suffering from diseases or conditions purportedly caused by cigarette smoking. The complaint also seeks orders requiring the manufacturing defendants to disclose and disseminate prior research; fund a corrective campaign and smoking cessation program; disclose nicotine yields of their products; and pay restitution.\nRJRT understands that a grand jury investigation being conducted in the Eastern District of New York is examining possible violations of criminal law in connection with activities relating to the Council for Tobacco Research--USA, Inc., of which RJRT is a sponsor. RJRT is unable to predict the outcome of this investigation.\nRJRT received a civil investigative demand dated January 11, 1994 from the U.S. Department of Justice requesting broad documentary information from RJRT. Although the request appears to focus on tobacco industry activities in connection with product development efforts, it also requests general information concerning contacts with competitors. RJRT is unable to predict the outcome of this investigation.\n-------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or its affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nCOMMITMENTS\nAt December 31, 1995, other commitments totalled approximately $777 million, principally for minimum operating lease commitments, the purchase of leaf tobacco inventories, the purchase of machinery and equipment and other contractual arrangements.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND SIGNIFICANT CONCENTRATIONS OF CREDIT RISK\nCertain financial instruments with off-balance sheet risk have been entered into by RJRN and Nabisco to manage their interest rate and foreign currency exposures.\nRJRN and Nabisco have each adopted policies to utilize interest rate instruments that will adjust the mix of floating rate debt and fixed rate debt on a one for one basis.\nInterest Rate Arrangements\nDuring 1995, Nabisco began managing its own interest rate exposure by adjusting its mix of floating rate debt and fixed rate debt. As part of managing its interest rate exposure, Nabisco entered into interest rate swaps and caps during 1995 to effectively fix a portion of its interest rate exposure on its floating rate debt. The impact of these arrangements was not significant. At December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter.\nRJRN also manages its interest rate exposure by adjusting its mix of floating rate debt and fixed rate debt. During 1994, RJRN cancelled all of its financial interest rate arrangments with optionality. Such cancelled instruments increased 1994 interest expense by $45 million. Also during 1994, as part of its current strategy to manage interest rate exposure, RJRN effectively neutralized the effects of any future changes in market interest rates on the remainder of its outstanding interest rate swaps, options, caps and other financial instruments through the purchase of offsetting positions. Net unrealized gains and losses on the remaining interest rate instruments at the time such instruments were neutralized are currently being amortized to interest expense through 1997. As a result of the 1994 activity, the net notional principal amount of outstanding interest rate instruments has been $0. The impact to interest expense from the utilization of interest rate instruments by RJRN has resulted in additional interest expense during 1995 and 1994 of approximately $39 million and $22 million (which included the $45 million stated above), respectively, and lower interest expense during 1993 of approximately $70 million. In addition, additional interest expense will be recorded during 1996 and 1997 of approximately $28 million and $5 million, respectively, in connection with the 1994 activity. At December 31, 1995, RJRN had outstanding interest rate swaps, options, caps and other interest rate arrangements with\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nfinancial institutions having a total gross notional principal amount of $2.8 billion and a net notional amount of $0. These arrangements entered into by RJRN mature as follows:\nForeign Currency Arrangements\nRJRN Holdings' subsidiaries have operations in many countries, utilizing many different functional currencies in its foreign subsidiaries and branches. Significant foreign currency net investments are located in Germany, Canada, Hong Kong, Brazil, Argentina and Spain. Changes in the strength of these countries' currencies relative to the U.S. dollar result in direct charges or credits to equity for non-hyperinflationary countries and direct charges or credits to the income statement for hyperinflationary countries. Translation gains or losses resulting from foreign-denominated borrowings that are accounted for as hedges of certain foreign currency net investments, also result in charges or credits to equity. RJRN Holdings' subsidiaries also have significant exposure to foreign exchange sale and purchase transactions in currencies other than its functional currency. The exposures include the U.S. dollar, German mark, Japanese yen, Swiss franc, Hong Kong dollar, Singapore dollar, Spanish peseta and cross-rate exposure among the French franc, British pound, Italian lira and the German mark. These exposures are managed to minimize the effects of foreign currency transactions on its cash flows.\nAt December 31, 1995 and 1994, RJRN had outstanding forward foreign exchange contracts with banks to purchase or sell an aggregate notional principal amount of $959 million and $713 million, respectively. The weighted average maturity of the arrangements outstanding at December 31, 1995 approximated four months. Such contracts were primarily entered into to hedge future commitments. The purpose of RJRN's foreign currency hedging activities is to protect RJRN from risk that the eventual dollar cash flows resulting from transactions with international parties will be adversely affected by changes in exchange rates.\nAt December 31, 1995 and 1994, Nabisco had outstanding forward foreign exchange contracts with banks to purchase or sell an aggregate notional principal amount of $142 million and $94 million, respectively. Such contracts were primarily entered into to hedge future commitments. The purpose of Nabisco's foreign currency hedging activities is to protect Nabisco from risk that the eventual dollar cash flows resulting from transactions with international parties will be adversely affected by changes in exchange rates.\nThe above interest rate and foreign currency arrangements entered into by RJRN and Nabisco involve, to varying degrees, elements of market risk as a result of potential changes in future interest and foreign currency exchange rates. To the extent that the financial instruments entered into remain outstanding as effective hedges of existing interest rate and foreign currency exposure, the impact of\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nsuch potential changes in future interest and foreign currency exchange rates on the financial instruments entered into would offset the related impact on the items being hedged. Also, RJRN and Nabisco may be exposed to credit losses in the event of non-performance by the counterparties to these financial instruments. However, RJRN and Nabisco continually monitor their positions and the credit ratings of their counterparties and therefore, do not anticipate any non-performance.\nThere are no significant concentrations of credit risk with any individual counterparties or groups of counterparties as a result of any financial instruments entered into including those financial instruments discussed above.\nSUMMARY FINANCIAL INSTRUMENTS FAIR VALUE INFORMATION\nAt December 31, 1995 and 1994, the carrying amounts and estimated fair values of financial instruments entered into by RJRN and Nabisco were as follows:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL\nThe changes in Common Stock and paid-in capital are shown as follows:\nAt December 31, 1995, RJRN Holdings' outstanding classes of capital stock consisted of the following: the Common Stock, the Series B Preferred Stock, the Series C Preferred Stock and the ESOP Convertible Preferred Stock, stated value of $16.00 per share and par value of $.01 per share (the \"ESOP Preferred Stock\"). In addition, RJRN Holdings had its Cumulative Convertible Preferred Stock, stated value of $25 per share and par value of $.01 per share (the \"Cumulative Convertible Preferred Stock\"), outstanding until the fourth quarter of 1993 and its Series A Conversion Preferred Stock, par value $.01 per share (the \"Series A Preferred Stock\"), outstanding until the fourth quarter of 1994. All of the classes of preferred stock of RJRN Holdings rank senior to the Common Stock as to dividends and preferences in liquidation. RJRN Holdings' charter authorized 150,000,000 preferred shares at December 31, 1995 and 1994.\nOn November 1, 1990, RJRN Holdings issued and\/or registered 72,032,000 shares of the Cumulative Convertible Preferred Stock. The Cumulative Convertible Preferred Stock paid cash dividends at a rate of 11.5% of stated value per annum, payable quarterly in arrears commencing January 15, 1991. The Cumulative Convertible Preferred Stock was convertible after May 1, 1991 into shares of Common Stock at a conversion price of $45 of stated value per share of Common Stock. Holders of the Cumulative Convertible Preferred Stock converted 379 shares of the stock into 210 shares of Common Stock during 1992 and another 123,523 shares into 68,595 shares of Common Stock during 1993. On December 6, 1993, the outstanding Cumulative Convertible Preferred Stock was redeemed at a redemption price of $27.0125 per share plus accrued and unpaid dividends.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nOn April 10, 1991, the ESOP borrowed $250 million from RJRN Holdings (the \"ESOP Loan\") to purchase 15,625,000 shares of ESOP Preferred Stock. The ESOP Loan, which was renegotiated in 1993, has a final maturity in 2006 and bears interest at the rate of 8.2% of its stated value per annum. At December 31, 1995, the ESOP Preferred Stock is convertible into 2,998,135 shares of Common Stock, subject to adjustment in certain events, and bears cumulative dividends at a rate of 7.8125% of stated value per annum at least until April 10, 1999, payable semi-annually in arrears commencing January 2, 1992, when, as and if declared by the board of directors of RJRN Holdings. The ESOP Preferred Stock is redeemable at the option of RJRN Holdings, in whole or in part, at any time on or after April 10, 1999, at an initial optional redemption price of $16.25 per share. The initial optional redemption price declines thereafter on an annual basis in the amount of $.125 a year to $16 per share on April 10, 2001, plus accrued and unpaid dividends. Holders of ESOP Preferred Stock have voting rights with respect to certain matters submitted to a vote of the holders of the Common Stock. Effective January 1, 1992, RJRN's matching contributions to eligible employees under its Capital Investment Plan are being made in the form of ESOP Preferred Stock. RJRN's matching contribution obligation in respect of each participating employee is equal to $.50 for every pre-tax dollar contributed by the employee, up to 6% of the employee's pay. The shares of ESOP Preferred Stock are allocated at either the floor value of $16 a share or the fair market value of one-fifth of a share of Common Stock, whichever is higher. During 1995, 1994 and 1993, approximately $23 million, $22 million and $29 million, respectively, was contributed to the ESOP by RJRN or RJRN Holdings and approximately $19 million, $19 million and $20 million, respectively, of ESOP dividends were used to service the ESOP's debt to RJRN Holdings.\nOn November 8, 1991, RJRN Holdings issued 52,500,000 shares of Series A Preferred Stock and sold 210,000,000 Series A Depositary Shares, each of which represented one-quarter of a share of Series A Preferred Stock. Each share of Series A Preferred Stock paid cash dividends at a rate of $3.34 per annum, payable quarterly in arrears commencing February 18, 1992. On November 15, 1994, the 210,000,000 Series A Depository Shares converted automatically into 42,000,000 shares of Common Stock.\nOn August 18, 1993, RJRN Holdings issued 50,000 shares of Series B Preferred Stock, and sold 50,000,000 Series B Depositary Shares at $25 per Series B Depositary Share ($1.25 billion) in connection with such issuance (the \"Series B Preferred Stock Offering\"). Each share of Series B Preferred Stock bears cumulative cash dividends at a rate of $2,312.50 per annum, or $2.3125 per Series B Depositary Share, and is payable quarterly in arrears commencing December 1, 1993. Each Series B Depositary Share represents .001 ownership interest in a share of Series B Preferred Stock of RJRN Holdings. At RJRN Holdings' option, on or after August 19, 1998, RJRN Holdings may redeem shares of the Series B Preferred Stock (and the Depositary will redeem the number of Series B Depositary Shares representing the shares of Series B Preferred Stock) at a redemption price equivalent to $25 per Series B Depositary Share plus accrued and unpaid dividends thereon. RJRN Holdings' ability to redeem the Series B Preferred Stock is subject to certain restrictions in its credit agreements. On September 21, 1995, RJRN Holdings retired approximately 76% of the outstanding Series B Preferred Stock in connection with the exchange of approximately $949 million amount of Trust Preferred Securities for 37,956,060 of the 50,000,000 Series B Depositary Shares. (See Note 11 to the Consolidated Financial Statements.)\nOn May 6, 1994, RJRN Holdings completed the issuance of 26,675,000 shares of Series C Preferred Stock in connection with the sale of 266,750,000 Series C Depositary Shares at $6.50 per\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\ndepositary share. Approximately $900 million of the net proceeds from the sale of the Series C Depositary Shares was applied to the redemption of RJRN's subordinated debentures on May 15, 1994. The remaining proceeds from the sale of the Series C Depositary Shares were used to repay indebtedness under the 1991 RJRN Credit Agreement and for short-term liquid investments until they were applied to redeem certain of RJRN's sinking fund debentures. Each share of Series C Preferred Stock bears cumulative cash dividends at a rate of $6.012 per annum, or $.6012 per Series C Depositary Share, payable quarterly in arrears. Each Series C Depositary Share represents a one-tenth ownership interest in a share of Series C Preferred Stock of RJRN Holdings. Each share of Series C Preferred Stock will mandatorily convert into two shares of Common Stock on May 15, 1997, subject to adjustment in certain events, plus accrued and unpaid dividends thereon. In addition, at RJRN Holdings' option, RJRN Holdings may redeem shares of the Series C Preferred Stock (and the Depositary will redeem the number of Series C Depositary Shares representing such shares of Series C Preferred Stock) at a redemption price to be paid in shares of Common Stock (or, following certain circumstances, other consideration), plus accrued and unpaid dividends. The optional redemption price declines from $112.286 per share by $.01656 per share on each day following May 6, 1994 to $95.246 per share on March 15, 1997 and is $94.25 thereafter.\nThe completion on January 26, 1995 of the Nabisco Holdings' initial public offering of 51,750,000 shares of its Class A Common Stock and the corresponding reduction in RJRN's proportionate economic interest in Nabisco Holdings from 100% to approximately 80.5% resulted in an adjustment of approximately $401 million to the carrying amount of RJRN's investment in Nabisco Holdings. Such adjustment was reflected as additional paid-in capital by RJRN Holdings and RJRN.\nOn April 1, July 1 and October 1, 1995 and January 1, 1996, RJRN Holdings paid a quarterly dividend on the Common Stock of $.375 per share. RJRN Holdings expects to continue to pay at least a quarterly cash dividend on the Common Stock equal to $.375 per share or $1.50 per share on an annualized basis.\nOn April 12, 1995, the stockholders of RJRN Holdings approved a one-for-five reverse stock split and the corresponding reduction in the number of authorized shares of Common Stock from 2,200,000,000 to 440,000,000. Accordingly, the rates at which shares of ESOP Preferred Stock and Series C Preferred Stock convert into shares of Common Stock were proportionately adjusted.\nOn July 1 and October 1, 1995 and January 1, 1996, Nabisco Holdings paid a quarterly dividend on its common stock of $.1375 per share. Nabisco Holdings expects to continue to pay a quarterly cash dividend on its common stock equal to at least $.1375 per share or $.55 per share on an annualized basis (approximately $146 million). RJRN would receive approximately $117 million of the annualized Nabisco Holdings dividend.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nThe changes in stock options are shown as follows:\nAt December 31, 1995, options were exercisable as to 3,437,549 shares, compared with 8,794,841 shares at December 31, 1994, and 4,003,608 shares at December 31, 1993. As of December 31, 1995, options for 7,374,069 shares of Common Stock were available for future grant.\nTo provide an incentive to attract and retain key employees responsible for the management and administration of the business affairs of RJRN Holdings and its subsidiaries, on June 15, 1989 the board of directors of RJRN Holdings adopted the Stock Option Plan for Directors and Key Employees of RJR Nabisco Holdings Corp. and Subsidiaries (the \"Stock Option Plan\") pursuant to which options to purchase Common Stock may be granted. On June 16, 1989, the Stock Option Plan was approved by the written consent of the holders of a majority of the Common Stock. Non-employee directors or key employees of RJRN Holdings or any subsidiary of RJRN Holdings are eligible to be granted options under the Stock Option Plan. A maximum of 6,000,000 shares of Common Stock (which may be adjusted in the event of certain capital changes) may be issued under the Stock Option Plan. The options to key employees granted under the Stock Option Plan generally vest over a three year period and the exercise price of such options is generally the fair market value of the Common Stock on the date of grant. On March 1, 1994, the Stock Option Plan was amended to satisfy the requirements of a nondiscretionary formula plan for stock option grants to directors. Each eligible director is, upon becoming a director, granted an option under the Stock Option Plan to purchase 6,000 shares of Common Stock. The options have an exercise price equal to the fair market value of the Common Stock on the date of grant. They cannot be exercised for six months following the date of grant but, thereafter, are exercisable for ten years from the date of grant. In addition, each eligible director receives an annual grant of stock options which is made on the date of the director's election or re-election to the Board of Directors. The annual grant is intended to deliver a predetermined value, and the number of shares of Common Stock subject to the option is determined based on an internal valuation methodology. In 1995 and 1994, each eligible director received a stock option to purchase 1,400 shares and 1,180 shares, respectively, of Common Stock. The annually granted stock options have a ten year term and vest over three years (33% on the first and second anniversaries of the date of grant and 34% on the third anniversary).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nOn August 1, 1990, the board of directors of RJRN Holdings adopted the 1990 Long Term Incentive Plan (the \"1990 LTIP\") which was approved on such date by the written consent of the holders of a majority of the Common Stock. The 1990 LTIP authorizes grants of incentive awards (\"Grants\") in the form of \"incentive stock options\" under Section 422 of the Internal Revenue Code, other stock options, stock appreciation rights, restricted stock, purchase stock, dividend equivalent rights, performance units, performance shares or other stock-based grants. Awards under the 1990 LTIP may be granted to key employees of, or other persons having a unique relationship to, RJRN Holdings and its subsidiaries. Directors who are not also employees of RJRN Holdings and its subsidiaries are ineligible for Grants. A maximum of 21,000,000 shares of Common Stock (which may be adjusted in the event of certain capital changes) may be issued under the 1990 LTIP pursuant to Grants. The 1990 LTIP also limits the amount of shares which may be issued pursuant to \"incentive stock options\" and the amount of shares subject to Grants which may be issued to any one participant. As of December 31, 1995, purchase stock, stock options other than incentive stock options, restricted stock, performance shares, performance units and other stock-based grants have been granted under the 1990 LTIP. The options granted before July 1, 1993 under the 1990 LTIP generally will vest over a three year period ending each December 31. Options granted on and after July 1, 1993, vest over a three year period beginning from the date of grant. The exercise prices of outstanding LTIP options are between $22.60 and $57.80 per share. On April 27, 1995, employees of RJRN, RJRT and R.J. Reynolds Tobacco International, Inc. (\"Reynolds International\") with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 100% of their outstanding LTIP and Stock Option Plan stock options (less the stock options permitted to be exchanged for Nabisco LTIP options, as described below) in exchange for a new grant of options under the LTIP. Options to purchase 8,389,656 shares of Common Stock were surrendered and 8,389,656 were reissued pursuant to this program. These options have an exercise price of $27.00 and are 100% vested but not exercisable for three years. On April 27, 1995 and on June 13, 1995, certain key employees were granted premium options to purchase shares of Common Stock. These options have an exercise price that is 10% above the fair market value on the date of the grant ($29.70 and $28.88, respectively) and vest over a three year period. In connection with the purchase stock grants awarded during 1995, 1994 and 1993, 16,529 shares, 0 shares and 124,444 shares, respectively, of Common Stock were purchased and options to purchase a specified number of shares were granted upon the optionee purchasing a stated dollar amount of Common Stock. In addition, an arrangement was made in 1995 to enable a purchaser to borrow on a secured basis from RJRN Holdings the price of the stock purchased. The current annual interest rate on the 1995 arrangement, which was set in December 1995 at the then applicable federal rate for long-term loans, is 6.26%. These borrowings plus accrued interest and taxes must generally be repaid within two years following termination of active employment. During 1995 and 1994, 30,000 shares and 884,100 shares, respectively, of Common Stock were awarded in connection with restricted stock grants made. These shares are subject to restrictions that will lapse 3 years from the date of grant (or earlier under certain circumstances). Other stock-based awards were made in 1995 and 1994 under the 1990 LTIP to individuals who previously acquired certain purchase stock under the 1990 LTIP. Under this program, such individuals receive grants of Common Stock or cash at the Company's election on either three or four annual grant dates beginning July 1994 and ending either July 1, 1996 or July 1, 1997. The fair market value of Common Stock to be awarded on each grant date is equal to the excess, if any, of (i) 33% or 25%, respectively, of the maximum amount the individual could have borrowed to acquire purchase stock, over (ii) the then fair market value of the same percentage of such individual's purchase stock. The grant is increased by the amount of presumed borrowing costs and the\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\namount necessary to hold the individual harmless from income taxes due as a result of the grant. No grant will be made on a grant date if, on such grant date, the amount determined under clause (ii) above equals or exceeds the amount determined in clause (i) above.\nIn connection with the initial public offering of shares of Nabisco Holdings in January 1995, the board of directors of Nabisco Holdings adopted the Nabisco Holdings Corp. 1994 Long Term Incentive Plan (the \"Nabisco LTIP\") which is substantially similar to the LTIP except that stock-based awards are denominated in shares of Class A Common Stock of Nabisco Holdings. On January 19, 1995, January 27, 1995 and March 31, 1995, employees of Nabisco with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 100% of their outstanding LTIP and the Stock Option Plan stock options in exchange for the grant of options under the Nabisco LTIP. Charles M. Harper, as chairman of the board of directors of Nabisco Holdings, was permitted to surrender 50% of his outstanding LTIP options on January 19, 1995 in exchange for Nabisco LTIP options. Options to purchase a total of 5,119,884 shares of Common Stock were surrendered pursuant to this program. Also on March 31, 1995 and for one employee on June 16, 1995, employees of RJRN with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 20% of their outstanding LTIP and Stock Option Plan stock options in exchange for the grant of options under the Nabisco LTIP. Options to purchase a total of 103,319 shares of Common Stock were surrendered pursuant to this program. Also on January 19, 1995, RJRN Holdings purchased one-half of Mr. Harper's restricted LTIP purchase shares (62,222 shares) at the then fair market value ($28.125 per share), and he used the proceeds to acquire similarly restricted shares of Class A Common Stock of Nabisco Holdings.\nNOTE 14--RETAINED EARNINGS AND CUMULATIVE TRANSLATION ADJUSTMENTS\nRetained earnings (accumulated deficit) at December 31, 1995, 1994 and 1993 includes non-cash expenses related to accumulated trademark and goodwill amortization of $4.280 billion, $3.644 billion and $3.015 billion, respectively.\nThe changes in cumulative translation adjustments are shown as follows:\nNOTE 15--RETIREMENT BENEFITS\nRJRN and its subsidiaries sponsor a number of non-contributory defined benefit pension plans covering most U.S. and certain foreign employees. Plans covering regular full-time employees in the tobacco operations as well as the majority of salaried employees in the corporate groups and food operations provide pension benefits that are based on credits, determined by age, earned throughout an employee's service and final average compensation before retirement. Plan benefits are offered as lump sum or annuity options. Plans covering hourly as well as certain salaried employees in the corporate groups and food operations\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nprovide pension benefits that are based on the employee's length of service and final average compensation before retirement. RJRN's policy is to fund the cost of current service benefits and past service cost over periods not exceeding 30 years to the extent that such costs are currently tax deductible. Additionally, RJRN and its subsidiaries participate in several (i) multi-employer plans, which provide benefits to certain union employees, and (ii) defined contribution plans, which provide benefits to certain employees in foreign countries. Employees in foreign countries who are not U.S. citizens are covered by various post-employment benefit arrangements, some of which are considered to be defined benefit plans for accounting purposes.\nA summary of the components of pension expense for RJRN-sponsored plans follows:\nThe principal plans used the following actuarial assumptions for accounting purposes:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nThe following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets at December 31, 1995 and 1994 for RJRN's defined benefit pension plans.\n- ------------\n(1) Of the net pension liability, $(292) million and $2 million were related to qualified plans at December 31, 1995 and 1994, respectively.\nAt December 31, 1995, approximately 97 percent of the plans' assets were invested in listed stocks and bonds and other highly liquid investments. The balance consisted of various income producing investments.\nIn addition to providing pension benefits, RJRN provides certain health care and life insurance benefits for retired employees and their dependents. Substantially all of its regular full-time employees, including certain employees in foreign countries, may become eligible for those benefits if they reach retirement age while working for RJRN. Effective January 1, 1992, RJRN adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS No. 106\"). Under SFAS No. 106, RJRN is required to accrue the costs for retirees' health and other postretirement benefits other than pensions and recognize the unfunded and unrecognized accumulated benefit obligation for these benefits. RJRN had previously accrued a liability for postretirement benefits other than pensions and as a result, SFAS No. 106 did not have a material impact on the financial statements of either RJRN Holdings or RJRN.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nNet postretirement health and life insurance benefit cost consisted of the following:\nRJRN's postretirement health and life insurance benefit plans currently are not funded. The status of the plans was as follows:\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8% in 1995 and 7% in 1996 gradually declining to 5% by the year 2000 and remaining at that level thereafter. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 and the aggregate of the service and interest cost components of the net postretirement benefit cost for the year then ended by approximately $54.5 million and $4.7 million, respectively.\nThe assumed discount rate used in determining the accumulated postretirement benefit obligation was 7% and 8.75% as of December 31, 1995 and 1994, respectively.\nEffective January 1, 1993, RJRN adopted Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (\"SFAS No. 112\"). Under SFAS No. 112, RJRN is required to accrue the costs for preretirement postemployment benefits provided to former or inactive employees and recognize an obligation for these benefits. The adoption of SFAS No. 112 did not have a material impact on the financial statements of either RJRN Holdings or RJRN.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--SEGMENT INFORMATION\nIndustry Segment Data\nRJRN is engaged principally in the manufacture, distribution and sale of tobacco products, cookies, crackers and other food products. Cigarettes are manufactured in the United States by RJRT and in over 40 foreign countries and territories by Reynolds International and subsidiaries or licensees of RJRT and are sold throughout the United States and in more than 170 markets around the world including Western Europe, the Middle East, Africa, Asia and Canada. RJRN, through its 80.5% owned subsidiary Nabisco Holdings, also manufactures and markets cookies, crackers, non-chocolate candy and gum products, nuts and snacks, various margarines and spreads and other specialty products under several brand names in the United States, Canada, Europe, Asia and Latin America. See the Management's Discussion and Analysis of Financial Condition and Results of Operations, appearing elsewhere herein, for further discussion of RJRN's operations. Summarized financial information for these operations is shown in the following tables.\n- ------------\n(1) Includes amortization of trademarks and goodwill for Tobacco and Food for the year ended December 31, 1995, of $409 million and $227 million, respectively; for the year ended December 31, 1994, of $404 million and $225 million, respectively; and for the year ended December 31, 1993, of $407 million and $218 million, respectively.\n(Footnotes continued on following page)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--SEGMENT INFORMATION--(CONTINUED)\n(Footnotes continued from preceding page) (2) The 1995 and 1993 amounts include the effects of a restructuring expense at Tobacco (1995-- $154 million; 1993--$544 million), Food (1993--$153 million) and Headquarters (1993--$33) (See Note 2 to the Consolidated Financial Statements).\n(3) Cash and cash equivalents for the domestic tobacco operations are included in Headquarters' assets.\nGeographic Data\nThe following tables show certain financial information relating to RJRN's continuing operations in various geographic areas.\n- ------------\n(1) Transfers between geographic areas (which consist principally of tobacco transferred principally from the United States to Europe) are generally made at fair market value.\n(2) The 1995 and 1993 amounts include the effects of restructuring expenses of $154 million and $730 million, respectively (see Note 2 to the Consolidated Financial Statements).\n(3) Includes amortization of trademarks and goodwill of $636 million, $629 million and $625 million for the 1995, 1994 and 1993 periods, respectively.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.\nThe food segment of RJRN Holdings is conducted through the operating subsidiaries of Nabisco Holdings. Nabisco Holdings' domestic operations consist of Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's Companies (the \"Domestic Food Group\"). Nabisco Holdings' operations outside the United States consists of Nabisco International, Inc. and Nabisco Ltd (collectively, the \"International Food Group\").\nConsolidated condensed financial information of Nabisco Holdings at December 31, 1995 and 1994, and for each of the years in the three year period ended December 31, 1995 is as follows:\nNABISCO HOLDINGS CORP. CONSOLIDATED CONDENSED STATEMENTS OF INCOME\n(DOLLARS IN MILLIONS)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.--(CONTINUED) CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW\n(DOLLARS IN MILLIONS)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.--(CONTINUED) CONSOLIDATED CONDENSED BALANCE SHEETS\n(DOLLARS IN MILLIONS)\n- --------------\n* The 1994 amounts for current and non-current maturities of long-term debt include intercompany indebtedness with RJRN or one of its subsidiaries of approximately $297 million and $3.8 billion, respectively.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 18--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a summary of the quarterly results of operations and per share data for RJRN Holdings for the quarterly periods of 1995 and 1994:\n(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\n- ------------\n(1) Earnings per share is computed independently for each of the periods presented; therefore, the sum of the earnings per share amounts for the quarters may not equal the total for the year.\n----------------------------\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-1\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-2\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-3\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION\nNOTE A--SUPPLEMENTAL CASH FLOWS INFORMATION\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE B--JUNIOR SUBORDINATED DEBENTURES\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its Junior Subordinated Debentures to the Trust. The Trust, in turn, exchanged approximately $949 million of its Trust Preferred Securities for 37,956,060 of the 50,000,000 Series B Depositary Shares outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of Series B Preferred Stock. RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. See Note 11 to the Consolidated Financial Statements for additional information regarding this transaction.\nThe obligations of RJRN Holdings under the Junior Subordinated Debentures are unsecured obligations and will be subordinate and junior in right of payment to all senior indebtedness of RJRN Holdings, but senior to all future stock issuances and to any future guarantee entered into by RJRN Holdings in respect of its capital stock. As of December 31, 1995, RJRN Holdings had no senior indebtedness other than its guarantee of RJRN's obligations under the New RJRN Credit Agreements. The payment of distributions out of moneys held by the Trust and payments on liquidation of the Trust and the redemption of Trust Preferred Securities are guaranteed by RJRN Holdings on a subordinated basis. RJRN Holdings' guarantee is subordinate and junior in right of payment to any senior indebtedness of RJRN Holdings and to the Junior Subordinated Debentures, and senior to all capital stock now or hereafter issued by RJRN Holdings and to any guarantee now or hereafter entered into by RJRN Holdings in respect of its capital stock.\nInterest on the Junior Subordinated Debentures is payable quarterly in arrears. RJRN Holdings has the right to extend the interest payment period under certain circumstances. RJRN Holdings has the right to redeem the Junior Subordinated Debentures, in whole or in part, on or after August 19, 1998, upon not less than 30 nor more than 60 days notice. Certain covenants of RJRN Holdings applicable to the Junior Subordinated Debentures limit the ability of RJRN Holdings to declare or pay any dividends on, or redeem, purchase, acquire or make a distribution or liquidation payment with respect to any of its common or preferred stock, or make any guarantee payment, if RJRN Holdings is in default of any of its payments or guarantees with respect to the Junior Subordinated Debentures.\nNOTE C--COMMITMENTS AND CONTINGENCIES\nRJRN Holdings has guaranteed the indebtedness of RJRN under the New RJRN Credit Agreements.\nFor disclosure of additional contingent liabilities, see Note 12 to the Consolidated Financial Statements.\nNOTE D--STOCKHOLDERS' EQUITY\nRJRN Holdings' stockholders approved a one-for-five reverse split of the Common Stock on April 12, 1995. For additional information, see Note 13 to the Consolidated Financial Statements.\nS-4\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-5\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-6\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-7\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION\nNOTE A--SUPPLEMENTAL CASH FLOWS INFORMATION\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE B--COMMITMENTS AND CONTINGENCIES\nFor disclosure of contingent liabilities, see Note 12 to the Consolidated Financial Statements.\nS-8\nSCHEDULE II\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS)\n- ------------\n(A) Miscellaneous adjustments. (B) Principally charges against the accounts. (C) Excludes valuation allowance accounts for deferred tax assets.\nS-9\nEXHIBIT INDEX\nEXHIBIT NO. - ---------\n- ---------------\n* Filed herewith.","section_15":""}
{"filename":"763660_1995.txt","cik":"763660","year":"1995","section_1":"ITEM 1. BUSINESS:\nRyland Acceptance Corporation Four (the \"Company\") was incorporated in Virginia on February 12, 1985 and is a wholly owned subsidiary of LPS Holdings Corporation (LPS) and an indirect, wholly owned subsidiary of The Ryland Group, Inc. (Ryland). Ryland is a diversified homebuilding and mortgage- finance company.\nThe Company was formed solely for the purpose of facilitating the long-term financing of mortgage loans. The Company issues collateralized mortgage- backed bonds (the \"bonds\") in series and uses the net proceeds from the sale of the bonds to: 1) purchase mortgage collateral from Ryland Mortgage Company (RMC), a wholly owned subsidiary of Ryland, 2) purchase mortgage collateral from other homebuilders or financial institutions and 3) fund loans secured by mortgage collateral to limited-purpose subsidiaries of homebuilders or financial institutions participating in the issuance of the bonds.\nThe Company has issued and recorded in the financial statements, 43 series of bonds with an initial principal amount of $4.34 billion as of December 31, 1995. In 1988, certain classes within 27 of the original 43 series of bonds with mortgage collateral of $516 million were sold to Resource Mortgage Capital, Inc., formerly RAC Mortgage Investment Corporation, a publicly held real estate investment trust. Also included in the sale were certain residual cash flows of various bond series. The related mortgage collateral and bond balances are not included in the financial statements as described below.\nIn addition, as of December 31, 1995, the Company has issued 56 series of bonds with an original principal balance of $12.03 billion under a program initiated during 1987 whereby the Company uses its shelf registration to issue bonds on behalf of other companies. These bonds and the associated mortgage collateral are excluded from the consolidated financial statements of the Company since the issuance of these bonds has been accounted for as a sale of the associated mortgage collateral in accordance with generally accepted accounting principles.\nDuring 1994, the Company acquired bonds of $12.8 million and the related collateral from another company. These bonds had previously been issued from the Company's shelf registration and accounted for as a sale under generally accepted accounting principles.\nIt is anticipated that regular payments under the terms of the mortgages, as well as early mortgage retirements, will reduce the number of mortgages and amount of bonds outstanding in future years. The Company does not anticipate the issuance of additional series of bonds.\nOn February 13, 1985, the Company filed an initial registration statement under the Securities Act of 1933 with the Securities and Exchange Commission (SEC), providing for the issuance of bonds in series. Registration statements have been filed as follows:\nAt December 31, 1995, the Company had $626.2 million of bonds remaining for issuance under a registration statement filed with the Securities and Exchange Commission. Bonds sold in private placements do not reduce the remaining issuance shelf. Since inception, the amount of bonds issued in private placements was $.9 million.\nThe bonds are secured by mortgage collateral which is comprised of GNMA certificates guaranteed by the Government National Mortgage Association, mortgage participation certificates issued by the Federal Home Loan Mortgage Corporation, guaranteed mortgage pass-through certificates issued by the Federal National Mortgage Association, other mortgage certificates issued by private companies, mortgage loans secured by first mortgages or deeds of trust and funds held by trustee (collectively, the \"mortgage collateral\"). The mortgage collateral is pledged to Bank of New York, (the \"Trustee\"), under an Indenture. The mortgage loans constituting the mortgage collateral are either insured by the Federal Housing Administration, partially insured by private mortgage insurance or partially guaranteed by the U.S. Veterans Administration. The bonds are not guaranteed or insured by Ryland, RMC, LPS or any other affiliated entities.\nCertain series of bonds are secured by mortgage collateral beneficially owned by a finance company. Pursuant to a funding agreement, the finance company pledges mortgage collateral and certain other collateral to the Company to secure a note receivable in an amount equal to the collateral value, as defined in the Indenture, of the pledged mortgage collateral and bearing interest generally at the weighted average interest rate of the applicable bond series. The Company assigns each funding agreement to the Trustee as security for the applicable bond series.\nEach series of bonds is secured by mortgage collateral with an aggregate collateral value of not less than the outstanding principal amount of the bonds of that series. Additionally, the bonds of a series may be further secured by one or more of the following: 1) cash or letters of credit to fund a buy-down fund for a series secured by one or more buy-down mortgage loans; 2) cash or letters of credit to fund a special reserve fund for certain series secured by mortgage loans; 3) mortgage pool insurance; 4) special hazard insurance; 5) mortgagor bankruptcy insurance; 6) master servicing agreement; 7) servicing agreements; 8) cash to fund other accounts and reserves; and 9) additional mortgage collateral.\nDuring 1991, RMC assumed the Company's obligation to maintain cash deposits with the Trustee for mortgagor bankruptcy risk associated with the mortgage collateral. At December 31, 1995 and 1994, cash deposits of $.2 million and $1.7 million, respectively, were maintained by RMC.\nThe Company competes in a national market with other private conduits, thrift institutions and financial firms. Economic conditions, interest rates, prepayment speeds, regulatory changes and market dynamics all influence the market for collateralized mortgage bonds.\nLEGEND:\n* These bonds are variable interest rate bonds. These bonds will bear interest at rates based upon the London Inter-bank Offered Rate, as specified in each Series Supplement to the Indenture between the Company and Bank of New York, as Trustee, dated February 1, 1985, as heretofore supplemented, amended and restated.\n** These classes of bonds represent REMIC residual interests and other classes for which varying interest rates as described in each Series' Supplement apply.\n*** These classes of bonds represent private placements of residual interests which have no stated interest rate.\n**** For purposes of this schedule only, the balances shown for these series have been reduced by the January 1, 1996 bond payment.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThe Company has 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:\nInformation in response to this Item is omitted pursuant to General Instruction J.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS:\nAll of the Company's outstanding common stock is owned by LPS. Accordingly, there is no market for its common stock. The Company did not pay any dividends to LPS with respect to its common stock in 1995. The Company paid $48 thousand in dividends to LPS with respect to its common stock in 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nInformation in response to this Item is omitted pursuant to General Instruction J.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nGENERAL\nThe consolidated financial statements and related notes should be read in conjunction with the following review.\nThe Company was formed on January 25, 1985 solely for the purpose of facilitating the long-term financing of mortgage loans through the issuance and sale of mortgage-backed bonds (the \"bonds\"). Since its inception, the Company has issued and recorded in the financial statements 43 series of bonds. The bond series shown in the financial statements represent obligations solely of the Company, and are secured by mortgage collateral originated by Ryland Mortgage Company (RMC), a wholly owned subsidiary of The Ryland Group, Inc. (Ryland), and by other entities. The bonds are not guaranteed or insured by Ryland, RMC, LPS Holdings Corporation or any other affiliated entities.\nThe Company issues bonds in series and uses the net proceeds from the sale of the bonds to: (1) purchase mortgage collateral from RMC, (2) purchase mortgage collateral from other homebuilders or financial institutions and (3) fund loans secured by mortgage collateral to limited-purpose subsidiaries of homebuilders or financial institutions participating in the issuance of the bonds. The bonds are structured such that the cash flows from the underlying mortgage collateral will be sufficient to satisfy the bond obligations. As of December 31, 1995, the Company had $626.2 million of collateralized mortgage bonds remaining for issuance under a registration statement filed with the Securities and Exchange Commission.\nIn addition, the Company uses its shelf registration to issue bonds on behalf of other companies. As of December 31, 1995, the Company had issued 56 series of bonds under these arrangements. These bonds and the associated mortgage collateral are excluded from the consolidated financial statements of the Company since the issuance of these bonds has been accounted for as a sale of the associated mortgage collateral in accordance with generally accepted accounting principles. The Company has relinquished all risks and rewards relating to the bonds payable and associated mortgage collateral. The Company has elected to treat 49 series of these bonds as real estate mortgage investment conduits for tax purposes. During the year ended December 31, 1995 and 1994, the Company did not issue any bonds.\nDuring 1994, the Company acquired bonds of $12.8 million and the related collateral from another company. These bonds had previously been issued from the Company's shelf registration and accounted for as a sale under generally accepted accounting principles.\nThe bonds were reduced during the year for payments and prepayments on the underlying mortgage collateral. A bond series or a class within certain series may be redeemed at par at the earlier of the date specified in the Indenture or when the outstanding collateral value of the mortgage securities securing the bond series or class is less than or equal to a specified percentage of the initial collateral value of such securities. During the year ended December 31, 1995, certain classes within each of 8 series totaling $58.1 million were redeemed. During the year ended December 31, 1994, certain classes within each of 17 series totaling $291.2 million were redeemed.\nRESULTS OF OPERATIONS\nFor the years ended December 31, 1995, 1994 and 1993, revenues consisted primarily of interest on mortgage collateral subject to the bond indebtedness and amortization of deferred items, and totalled $44,557, $58,142 and $104,366, respectively. The amount of revenues reported during each period depends primarily upon the amount of mortgage collateral outstanding during each such period, the related prepayment rates and the interest rates on such mortgage collateral. The Company's average net investment in mortgage collateral (excluding funds held by trustee) and the average effective rate of interest income are as follows (dollars in thousands):\nExpenses for the years ended December 31, 1995, 1994 and 1993 consisted primarily of interest on the Company's outstanding bonds and amortization of deferred costs, and totaled $44,546, $58,062 and $104,310, respectively. The amount of expenses reported during each period depends primarily upon the amount of bonds outstanding during each such period and the interest rates on such bonds. The Company's average debt outstanding and average cost of borrowings are as follows (dollars in thousands):\nThe bonds will decline over time in direct proportion to the decline in the mortgage collateral.\nNet cash flows that are generated based upon the differential between the interest rates of the bonds outstanding and the mortgage collateral are described as the net interest spreads. Excluding the impact of the amortization of deferred costs, the net interest spread of a bond generally is higher during the earlier years since bond classes with earlier stated maturities generally have lower interest rates than classes with later stated maturities. Because the weighted average interest rate of the bonds is lower during the earlier years and the interest rates on the underlying collateral are fixed, there is a greater net interest spread in the earlier years. The number of bonds issued by the Company in which a net interest spread is retained has decreased substantially since 1988.\nFINANCIAL CONDITION AND LIQUIDITY\nMortgage collateral held by the Company is pledged as collateral for the mortgage-backed bonds, the terms of which provide for the retirement of all bonds from the proceeds of the mortgage collateral. Cash flows from payments on the mortgage collateral, together with proceeds of reinvestment income earned on the mortgage collateral, are intended to provide cash sufficient to make all required payments of principal and interest on each outstanding series of bonds. The Company anticipates that it will require no additional funds to meet the obligation on its outstanding bonds.\nDuring 1991, RMC assumed the Company's obligation to maintain cash deposits with the Trustee for mortgagor bankruptcy risk associated with the mortgage collateral. At December 31, 1995 and 1994, cash deposits of $.2 million and $1.7 million were maintained by RMC.\nIt is anticipated that regular payments under the terms of the mortgages, as well as early mortgage retirements, will reduce the number of mortgages and amount of bonds outstanding in future years. The Company does not anticipate the issuance of additional series of bonds.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nAUDITED CONSOLIDATED FINANCIAL STATEMENTS\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995\nReport of Independent Auditors 26 Consolidated Balance Sheets 27 Consolidated Statements of Earnings 28 Consolidated Statements of Stockholder's Equity 29 Consolidated Statements of Cash Flows 30 Notes to Consolidated Financial Statements 31\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Ryland Acceptance Corporation Four\nWe have audited the accompanying consolidated balance sheets of Ryland Acceptance Corporation Four (a wholly owned subsidiary of LPS Holdings Corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholder's 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 Ryland Acceptance Corporation Four 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.\n\/s\/ Ernst & Young LLP ---------------------\nFebruary 5, 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\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Description of Business\nRyland Acceptance Corporation Four (the \"Company\") is a wholly owned subsidiary of LPS Holdings Corporation (LPS) and an indirect, wholly owned subsidiary of The Ryland Group, Inc. (Ryland). The Company was organized to facilitate the long-term financing of mortgage loans originated by Ryland Mortgage Company (RMC), a wholly owned subsidiary of Ryland, and other entities through the issuance and sale of mortgage-backed bonds.\nReclassifications\nCertain amounts previously reported have been reclassified to conform with the 1995 presentation.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, C.C. Holding Company and Brock Acceptance Corporation (BAC). All significant intercompany transactions and balances 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 inevitably will differ from those estimates, and such differences may be material to the financial statements.\nCollateral for Bonds Payable\nCollateral for bonds payable consists of mortgage-backed securities, mortgage loans receivable, notes receivable from participants, funds held by trustee and various types of insurance. Mortgage-backed securities consist primarily of GNMA certificates, FNMA mortgage pass-through certificates and FHLMC participation certificates. Mortgage loans receivable consists of loans collateralized by first mortgages or first deeds of trust on single family attached or detached houses.\nNotes receivable represent funding agreements with unaffiliated entities (the \"participants\") participating in the Company's bond programs. The Company issues bonds and lends proceeds to the participants in accordance with funding agreements. These funding agreements are fully collateralized by mortgage loans and mortgage-backed securities. The Company has assigned to the Trustee its interest in these funding agreements and the underlying loans and mortgage-backed securities as collateral for a corresponding amount of bonds. Principal and interest on the funding agreements are payable concurrently and at the same rate as such payments on the bonds.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nCollateral for Bonds Payable (Continued)\nFunds held by trustee represent payments on mortgage collateral and reinvestment earnings on such funds which have not been applied to pay principal and interest on the bonds. These funds are restricted to assure payment in accordance with the Trust Indenture (\"the Indenture\").\nThe mortgage collateral securing the bonds may include mortgage loans that are delinquent or non-performing, and real estate owned (\"REO\") properties. At December 31, 1995, Mortgage loans receivable and Notes receivable include 145 loans in the amount of $14.2 million that are delinquent, non-performing, or REO properties. At December 31, 1994, Mortgage loans receivable and Notes receivable include 153 loans in the amount of $16.6 million that are delinquent, non-performing, or REO properties. Reserves for these loans have not been established as any anticipated losses would be covered by primary mortgage insurance, hazard insurance, mortgagor bankruptcy insurance or mortgage pool insurance policies. Since the Company's inception, the Company has recovered $20.7 million from pool insurance which represents less than 1% of the initial total principal balance of mortgage loans. At December 31, 1995, $258.6 million or 93% of the initial pool insurance coverage remains available for future potential losses. Management believes that this coverage is adequate. As of December 31, 1995, the pool insurer has been rated AAA by a nationally recognized statistical rating agency.\nMortgage loans receivable acquired from an affiliate are valued at the affiliate's net carrying amount which is the lower of cost or market at the time of transfer.\nCollateral for bonds payable are reported net of loan origination discount points and purchase price discounts. These discounts are deferred as an adjustment to the carrying value of the related collateral for bonds payable and are amortized into interest income over their respective lives using the interest method adjusted currently for the effects of prepayments.\nDeferred Financing Costs\nFinancing costs incurred in connection with the issuance of bonds are capitalized and amortized over the respective lives of the bonds using the interest method adjusted currently for the effects of prepayments. These costs are included in other assets in the accompanying consolidated financial statements.\nBond Price Discounts\nPrice discounts incurred in connection with the issuance of bonds are deferred as an adjustment to the carrying value of the bonds and are amortized into interest expense over the lives of the bonds using the interest method adjusted currently for the effects of prepayments.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nIncome Taxes\nThe Company is included in the consolidated federal income tax return filed by Ryland. Consolidated income taxes are allocated to the Company using the separate return method. The Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109), effective January 1, 1993. Prior to the adoption of FAS 109, income taxes were accounted for in accordance with FAS 96. The impact of the adoption of FAS 109 was not material. Certain items of income and expense are included in one period for financial reporting purposes and another for income tax purposes. Deferred income taxes are provided in recognition of these differences.\nMortgage Backed Securities\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The Company adopted the provisions of the new standard for investments held as of or acquired after January 1, 1994.\nManagement determines the appropriate classification of mortgage backed securities at the time of purchase and reevaluates such designations as of each balance sheet date. The Company has classified its investments in mortgage-backed securities as held-to-maturity and available-for-sale. Securities classified as held-to-maturity are accounted for at amoritized cost. Securities classified as available-for-sale are measured at fair market value with market value changes, net of tax, reflected as a component of stockholder's equity. Because the Indentures prohibit liquidation of collateral for bonds payable, fair values cannot be realized unless the corresponding bonds payable are redeemed.\nIn November 1995, the Financial Accounting Standards Board issued Special Report No. 155-B, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\", as an aid in understanding and implementing Statement 115. The effect of adopting this implementation guidance as of December 31, 1995 has resulted in the reclassification of $45,825 of mortgage backed securities from the held-to- maturity classification to the available-for-sale classification. The related unrealized gain recorded in stockholder's equity totaled $1,213, net of deferred taxes of $808. Restatement of prior periods to reflect the effects of initially adopting this implementation guidance is not permitted.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nThe following is a summary of available-for sale and held-to-maturity securities as of:\nNOTE B--FAIR VALUES OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (FAS 107), requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet.\nFAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those fair values are significantly affected by the assumptions used, including the discount rate and estimates of cash flow. 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE B--FAIR VALUES OF FINANCIAL INSTRUMENTS - (CONTINUED)\nThe estimated fair values of the company's financial instruments are as follows:\nThe company used the following methods and assumptions in estmating fair values:\nCash: The carrying amounts of cash approximate fair values.\nMortgage-backed securities and mortgage loans receivable: Fair values are estimated using quoted market prices for similar certificates, loans or securities.\nNotes receivable: Fair values are based on quoted market prices for securities comparable to those that collateralize the notes receivable.\nFunds held by trustee: The carrying amounts of funds held by trustee approximate fair values.\nBonds payable: Fair values are based on quoted market prices of comparable securities.\nBecause the Indentures prohibit liquidation of collateral for bonds payable, fair values cannot be realized unless the corresponding bonds payable are redeemed. As more fully described in Note C, the bonds can be redeemed before maturity by the Company only under certain prescribed conditions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE C--BONDS PAYABLE\nBonds payable represent mortgage-backed bond series issued by the Company. Neither Ryland, nor any affiliated entities have guaranteed, nor are they otherwise obligated, with respect to these bond issues.\nAt December 31, 1995 and 1994, mortgage-backed bond series consisted of series with various classes maturing in the years 2006 through 2019. Payments are made on a periodic basis as a result of, and in amounts related to, corresponding payments received on the underlying mortgage collateral. Also, additional payments of the bonds may occur prior to maturity in accordance with certain provisions of the Indenture and related Series Supplements between the Company and the Trustee. At December 31, 1995 and 1994, the classes of each series of bonds bear interest at fixed rates ranging from 7.25% to 12.625%.\nDuring 1994, the Company acquired bonds of $12.8 million and the related collateral from another company. These bonds had previously been issued from the Company's shelf registration and accounted for as a sale under generally accepted accounting principles.\nUnder certain provisions of the Indenture, a bond series or a class within certain series may be redeemed at par prior to the stated maturity date. The redemption may take place at the earlier of specified dates or when the outstanding collateral value (as defined in the Indenture) of the mortgage securities securing the bond series or class is less than or equal to a specified percentage of its initial collateral value of such securities. Certain classes within each of 8 series totaling $58.1 million were redeemed in 1994 and certain classes within each of 17 series totaling $291.2 million were redeemed in 1994.\nThe Company uses its shelf registration to issue bonds on behalf of other companies. As of December 31, 1995, the Company had issued 56 series of bonds under these arrangements. These bonds and the associated mortgage collateral are excluded from the financial statements of the Company since these transactions have been accounted for as sales of the associated mortgage collateral in accordance with generally accepted accounting principles. The outstanding principal balance at December 31, 1995 and 1994, of bonds issued by the Company which is not included in the accompanying financial statements is $2 billion and $2.5 billion, respectively. During the years ended December 31, 1995 and 1994, the Company did not issue any bonds.\nAt December 31, 1995, the Company had $626.2 million of collateralized mortgage bonds remaining for issuance under a registration statement filed with the Securities and Exchange Commission.\nAlso included in bonds payable at December 31, 1995 and 1994 are funding notes payable totaling $.9 million and $1.0 million which represent BAC's participation in bond series issued by an unaffiliated entity.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE D--TRANSACTIONS WITH AFFILIATED COMPANIES\nThe Company records various intercompany transactions with affiliates and Ryland. These transactions include ongoing charges related to the outstanding bonds. The amount of these charges for the years ended December 31, 1995, 1994 and 1993 was $.2 million, $.4 million and $2.4 million, of which $.3 million, $.3 million, and $.5 million is recorded in interest revenue and ($.1) million, $.1 million and $1.9 million is recorded in other revenue, respectively.\nThe Company is charged a finance charge which is based on the average outstanding balance of advances made by Ryland and RMC. The amount of finance charge, which has been recorded in interest expense, is $.3 million, $.3 million and $.5 million for the years ended December 31, 1995, 1994 and 1993, respectively. Interest is calculated at approximate market rates. The carrying values of Due to affiliate were $3,209 and $3,911 at December 31, 1995 and 1994, respectively.\nIncluded in bonds payable are amounts which RMC holds totaling $72,704 and $80,887 at December 31, 1995 and 1994, respectively. Interest incurred on the bonds payable amounted to $7,380 and $9,254 in 1995 and 1994, respectively.\nAn affiliate performed the administration function through June 30, 1995 for the bonds issued under the Company's shelf registration statement. The affiliate was sold as of June 30, 1995 and continues to provide these functions as an unaffiliated entity. There were no payable balances related to administration fees to affiliated companies at December 31, 1995. Payable balances related to administration fees to affiliated companies were $155 at December 31, 1994.\nIn addition, an affiliate performs the loan servicing function for certain mortgage loans collateralizing the bonds. All fees and related expenses in connection with these services are recorded in the affiliates' financial statements.\nDuring 1991, RMC assumed the Company's obligation to maintain cash deposits with the Trustee for mortgagor bankruptcy risk associated with the mortgage collateral. At December 31, 1995 and 1994, cash deposits of $.2 million and $1.7 million were maintained by RMC.\nNOTE E--INCOME TAXES\nThe Company accounts for its income taxes under the liability method in accordance with Statement of Financial Accounting Standards No. 109 , \"Accounting for Income Taxes\" (FAS 109), effective January 1, 1993. Prior to the adoption of FAS 109, income taxes were accounted for in accordance with FAS 96. As both FAS 96 and 109 required the liability method, the adoption of FAS 109 did not have a material impact on the Company's financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE E--INCOME TAXES - (CONTINUED)\nUnder the liability method, the deferred tax liability (asset) is determined based on enacted tax rates and is subsequently adjusted for changes in tax rates. A change in the deferred tax liability (asset) results in a charge or credit to deferred tax expense. The Company's provision for income taxes for the years ended December 31, is summarized as follows:\nThe actual income tax rate differs from the statutory federal income tax rate as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRYLAND ACCEPTANCE CORPORATION FOUR AND SUBSIDIARIES\nDecember 31, 1995 (dollars in thousands)\nNOTE E--INCOME TAXES - (CONTINUED)\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and December 31, 1994 are as follows (in thousands):\nThe Company has determined that no valuation allowance for the deferred tax asset is required.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:\nInformation in response to this Item is omitted pursuant to General Instruction J.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nInformation in response to this Item is omitted pursuant to General Instruction J.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\nInformation in response to this Item is omitted pursuant to General Instruction J.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nInformation in response to this Item is omitted pursuant to General Instruction J.\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 following financial statements are included in Part II, Item 8:\nReport of Independent Auditors\nConsolidated Balance Sheets-December 31, 1995 and 1994\nConsolidated Statements of Earnings-Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Stockholder's 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) Consolidated Financial Statement Schedules.\nAll schedules have been omitted because they are either inapplicable or the required information has been given in the consolidated financial statements or the notes thereto.\n(A)(3) Exhibits.\n3.1 Articles of Incorporation of Ryland Acceptance Corporation Four (incorporated herein by reference to Exhibit to Company's Form 10, filed February 13, 1985).\n3.2 By-laws of Ryland Acceptance Corporation Four (incorporated herein by reference to Exhibit to Report on Form 8-K (File No. 0-13199) dated April 22, 1987, filed May 6, 1987).\n4.1 Indenture between Ryland Acceptance Corporation Four and S Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended March 31, 1985, filed May 10, 1985).\n4.2 Conformed copy of Series 1 Supplemental Indenture, dated as of April 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended March 31, 1985, filed May 10, 1985).\n4.3 Conformed copy of Series 2 Supplemental Indenture, dated as of June 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1985, filed August 12, 1985).\n4.4 Conformed copy of Series 3 Supplemental Indenture, dated as of August 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33-443, filed September 24, 1985).\n4.5 Conformed copy of Series 4 Supplemental Indenture, dated as of October 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended September 30, 1985, filed November 12, 1985).\n4.6 Conformed copy of Series 5 Supplemental Indenture, dated as of October 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended September 30, 1985, filed November 12, 1985).\n4.7 Conformed copy of Series 6 Supplemental Indenture, dated as of December 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n4.8 Conformed copy of Series 7 Supplemental Indenture, dated as of December 1, 1985, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n4.9 Amended and Restated Indenture for Series 8 Bonds and subsequent Series of Bonds, dated as of February 1, 1986 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0-13199) for period ended December 31, 1985, filed March 31, 1986).\n4.10 Conformed copy of Series 8 Supplemental Indenture, dated as of February 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the period ended December 31, 1985, filed March 31, 1986).\n4.11 Conformed copy of Series 9 Supplemental Indenture, dated as of February 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the period ended December 31, 1985, filed March 31, 1986).\n4.12 Conformed copy of Series 10 Supplemental Indenture, dated as of February 1, 1986, between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0-13199) for the period ended December 31, 1985, filed March 31, 1986).\n4.13 Conformed copy of Series 11 Supplemental Indenture, dated as of April 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended March 31, 1986, filed May 15, 1986).\n4.14 Conformed copy of Series 12 Supplemental Indenture, dated as of April 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended March 31, 1986, filed May 15, 1986).\n4.15 Conformed copy of Series 13 Supplemental Indenture, dated as of April 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended March 31, 1986, filed May 15, 1986).\n4.16 Conformed copy of Series 14 Supplemental Indenture, dated as of May 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1986, filed August 12, 1986).\n4.17 Conformed copy of Series 15 Supplemental Indenture, dated as of May 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1986, filed August 12, 1986).\n4.18 Conformed copy of Series 16 Supplemental Indenture, dated as of June 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended June 30, 1986, filed August 12, 1986).\n4.19 Conformed copy of Series 17 Supplemental Indenture, dated as of June 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended June 30, 1986, filed August 12, 1986).\n4.20 Conformed copy of Series 18 Supplemental Indenture, dated as of July 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended June 30, 1986, filed August 12, 1986).\n4.21 Conformed copy of Series 19 Supplemental Indenture, dated as of August 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 9191, filed September 30, 1986).\n4.22 Conformed copy of Series 20 Supplemental Indenture, dated as of September 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 9191, filed September 30, 1986).\n4.23 Conformed copy of Series 21 Supplemental Indenture, dated as of September 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 9191, filed September 30, 1986).\n4.24 Conformed copy of Series 22 Supplemental Indenture, dated as of September 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 9191, filed September 30, 1986).\n4.25 Conformed copy of Series 23 Supplemental Indenture, dated as of October 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended September 30, 1986, filed November 14, 1986).\n4.26 Conformed copy of Series 24 Supplemental Indenture, dated as of October 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended September 30, 1986, filed November 14, 1986).\n4.27 Conformed copy of Series 25 Supplemental Indenture, dated as of October 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended September 30, 1986, filed November 14, 1986).\n4.28 Conformed copy of Series 26 Supplemental Indenture, dated as of November 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.29 Conformed copy of Series 27 Supplemental Indenture, dated as of November 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.30 Conformed copy of Series 28 Supplemental Indenture, dated as of December 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.31 Supplemental Indenture, dated as of December 1, 1986, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33-11654, filed January 30, 1987).\n4.32 Conformed copy of Series 29 Supplemental Indenture, dated as of January 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.33 Conformed copy of Series 30 Supplemental Indenture, dated as of February 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.34 Conformed copy of Series 31 Supplemental Indenture, dated as of January 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.35 Conformed copy of Series 32 Supplemental Indenture, dated as of January 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 11654, filed January 30, 1987).\n4.36 Supplemental Indenture, dated as of January 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0-13199) for the period ended December 31, 1986, filed March 31, 1987).\n4.37 Conformed copy of Series 33 Supplemental Indenture, dated as of February 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the period ended December 31, 1986, filed March 31, 1987).\n4.38 Conformed copy of Series 34 Supplemental Indenture, dated as of February 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the period ended December 31, 1986, filed March 31, 1987).\n4.39 Conformed copy of Series 35 Supplemental Indenture, dated as of March 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 8-K (File No. 0- 13199) dated April 22, 1987, filed May 6, 1987).\n4.40 Conformed copy of Series 36 Supplemental Indenture, dated as of March 25, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 8-K (File No. 0- 13199) dated April 22, 1987, filed May 6, 1987).\n4.41 Conformed copy of Series 37 Supplemental Indenture, dated as of March 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 8-K (File No. 0- 13199) dated April 22, 1987, filed May 6, 1987).\n4.42 Conformed copy of Supplemental Indenture, dated as of April 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended March 31, 1987 filed May 15, 1987).\n4.43 Conformed copy of Series 38 Supplemental Indenture, dated as of April 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 8-K (File No. 0- 13199) dated April 22, 1987 filed May 6, 1987).\n4.44 (Reserved)\n4.45 Conformed copy of Series 40 Supplemental Indenture, dated as of May 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1987 filed August 15, 1987).\n4.46 Conformed copy of Series 41 Supplemental Indenture, dated as of May 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1987 filed August 15, 1987).\n4.47 Conformed copy of Series 42 Supplemental Indenture, dated as of May 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1987 filed August 15, 1987).\n4.48 Conformed copy of Series 43 Supplemental Indenture, dated as of June 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended June 30, 1987 filed August 15, 1987).\n4.49 Conformed copy of Series 44 Supplemental Indenture, dated as of June 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended June 30, 1987 filed August 15, 1987).\n4.50 Conformed copy of Series 45 Supplemental Indenture, dated as of July 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 15260, filed June 29, 1987).\n4.51 (Reserved)\n4.52 Conformed copy of Series 47 Supplemental Indenture, dated as of July 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement No. 33- 15260, filed June 29, 1987).\n4.53 (Reserved)\n4.54 Conformed copy of Series 49 Supplemental Indenture, dated as of August 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated August 27, 1987, filed October 15, 1987).\n4.55 Conformed copy of Series 50 Supplemental Indenture, dated as of September 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated August 27, 1987, filed October 15, 1987).\n4.56 Conformed copy of Series 51 Supplemental Indenture, dated as of September 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated August 27, 1987, filed October 15, 1987).\n4.57 Conformed copy of Series 52 Supplemental Indenture, dated as of September 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated August 27, 1987, filed October 15, 1987).\n4.58 Conformed copy of Series 53 Supplemental Indenture, dated as of October 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended September 30, 1987, filed November 13, 1987).\n4.59 Conformed copy of Series 54 Supplemental Indenture, dated as of October 1, 1987, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199) for the period ended September 30, 1987, filed November 13, 1987).\n4.60 Amended and Restated Indenture between Ryland Acceptance Corporation Four and Sovran Bank, N.A., as trustee, dated as of July 1, 1987 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0-13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.61 Conformed copy of Series 55 Supplemental Indenture, dated as of December 1, 1987 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.62 Conformed copy of Series 56 Supplemental Indenture, dated as of December 1, 1987 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.63 Conformed copy of Series 57 Supplemental Indenture, dated as of December 4, 1987 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.64 Conformed copy of Series 58 Supplemental Indenture, dated as of December 1, 1987 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.65 (Reserved)\n4.66 Conformed copy of Series 60 Supplemental Indenture, dated as of December 1, 1987 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-K (File No. 0- 13199) for the year ended December 31, 1987, filed March 30, 1988).\n4.67 Conformed copy of Series 61 Supplemental Indenture, dated as of February 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-21612), filed April 29, 1988).\n4.68 Conformed copy of Series 62 Supplemental Indenture, dated as of February 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-21612), filed April 29, 1988).\n4.69 Conformed copy of Series 63 Supplemental Indenture, dated as of March 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-21612), filed April 29, 1988).\n4.70 Conformed copy of Series 64 Supplemental Indenture, dated as of March 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-21612), filed April 29, 1988).\n4.71 (Reserved)\n4.72 (Reserved)\n4.73 Conformed copy of Series 67 Supplemental Indenture, dated as of April 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-21612), filed April 29, 1988).\n4.74 Conformed copy of Supplemental Indenture, dated as of March 1, 1988 for Series 11, 13, 14, 16, 17, 18, 19, 20, 21, 22, 23, 24, 26, 27, 28, 29, 30, 31, 34, 36, 41, 43, 45, 49 and 51 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended March 31, 1988, filed May 16, 1988).\n4.75 Conformed copy of Supplemental Indenture, dated as of March 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for the period ended March 31, 1988, filed May 16, 1988).\n4.76 Conformed copy of Series 68 Supplemental Indenture, dated as of April 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33-22561), filed June 16, 1988).\n4.77 Conformed copy of Series 69 Supplemental Indenture, dated as of May 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 22561), filed June 16, 1988).\n4.78 Conformed copy of Series 70 Supplemental Indenture, dated as of May 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 22561), filed June 16, 1988).\n4.79 Conformed copy of Series 71 Supplemental Indenture, dated as of May 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 22561), filed June 16, 1988).\n4.80 Conformed copy of Series 72 Supplemental Indenture, dated as of June 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 23346), filed July 27, 1988).\n4.81 Conformed copy of Series 73 Supplemental Indenture, dated as of June 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 23346), filed July 27, 1988).\n4.82 Conformed copy of Series 74 Supplemental Indenture, dated as of June 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Registration Statement (File No. 33- 23346), filed July 27, 1988).\n4.83 Conformed copy of Series 75 Supplemental Indenture, dated as of July 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199), for the period ended June 30, 1988 filed August 15, 1988).\n4.84 Conformed copy of Series 76 Supplemental Indenture, dated as of July 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199), for the period ended June 30, 1988 filed August 15, 1988).\n4.85 Conformed copy of Series 77 Supplemental Indenture, dated as of July 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0- 13199), for the period ended June 30, 1988 filed August 15, 1988).\n4.86 Conformed copy of Series 78 Supplemental Indenture, dated as of August 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated July 28, 1988 filed September 8, 1988).\n4.87 Conformed copy of Series 79 Supplemental Indenture, dated as of July 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated July 28, 1988 filed September 24, 1988).\n4.88 Conformed copy of Series 80 Supplemental Indenture, dated as of September 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated September 29, 1988 filed October 8, 1988).\n4.89 Conformed copy of Series 81 Supplemental Indenture, dated as of August 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated July 28, 1988 filed September 8, 1988).\n4.90 Conformed copy of Series 82 Supplemental Indenture, dated as of August 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated July 28, 1988 filed September 8, 1988).\n4.91 Conformed copy of Series 83 Supplemental Indenture, dated as of September 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated September 29, 1988 filed October 8, 1988).\n4.92 Conformed copy of Series 84 Supplemental Indenture, dated as of September 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K, (File No. 0-13199) dated September 29, 1988 filed October 8, 1988).\n4.93 Conformed copy of Series 85 Supplemental Indenture, dated as of October 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to the Registration Statement No. 33- 26428 filed January 9, 1989).\n4.94 Conformed copy of Series 86 Supplemental Indenture, dated as of December 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to the Registration Statement No. 33- 26428 filed January 9, 1989).\n4.95 Conformed copy of Series 87 Supplemental Indenture, dated as of December 1, 1988 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to the Registration Statement No. 33- 26428 filed January 9, 1989).\n4.96 Conformed copy of Series 88 Supplemental Indenture, dated as of December 1, 1988, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to the Registration Statement No. 33- 26428 filed January 9, 1989).\n4.97 Conformed copy of Series 89 Supplemental Indenture, dated as of January 1, 1989 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated January 26, 1989, filed February 10, 1989).\n4.98 Conformed copy of Series 90 Supplemental Indenture, dated as of January 1, 1989 to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated January 26, 1989, filed February 10, 1989).\n4.99 Conformed copy of Series 91 Supplemental Indenture, dated as of February 1, 1989, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated February 28, 1989, filed March 13, 1989).\n4.100 Conformed copy of Series 92 Supplemental Indenture, dated as of April 1, 1989, to Indenture between the Registrant and Sovran Bank, N.A., date February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated June 29, 1989, filed July 13, 1989).\n4.101 Conformed copy of Series 93 Supplemental Indenture, dated as of June 1, 1989, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated June 29, 1989, filed July 13, 1989).\n4.102 Conformed copy of Series 94 Supplemental Indenture, dated as of June 1, 1990, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated June 29, 1989, filed July 12, 1990).\n4.103 Conformed copy of Series 95 Supplemental Indenture, dated as of January 1, 1991, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated January 30, 1991, filed February 12, 1991).\n4.104 Conformed copy of Series 96 Supplemental Indenture, dated as of January 1, 1991, to Indenture between the Registrant and Sovran Bank, N.A., dated February 1, 1985 (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated January 30, 1991, filed February 12, 1991).\n4.105 Conformed copy of Series 97 Supplemental Indenture, dated as of April 30, 1991, to Indenture between the Registrant and Sovran Bank, N.A., dated April 1, 1991, (incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199), filed May 9, 1991).\n4.106 Form of Indenture between Registrant and NationsBank of Virginia, N.A., as Trustee (Incorporated herein by reference of Exhibit to Issuer's Post-Effective Amendment No. 1 to Registration Statement on Form S-11 (No. 33-39357), filed June 3, 1993).\n4.107 Form of Indenture between Registrant and Texas Commerce Bank National Association, as Trustee (Incorporated herein by reference to Exhibit to Issuer's Post-Effective Amendment No. 1 to Registration Statement on Form S-11 (No. 33-39357), filed June 3, 1993).\n4.108 Conformed Copy of Series 98 Supplemental Indenture between the Registrant and NationsBank of Virginia, N.A., as Trustee, dated as of September 1, 1993, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, as Amended and Restated as of July 1, 1987 (Incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199) dated September 30, 1993, filed October 12, 1993).\n4.109 Conformed Copy of Series 99 Supplemental Indenture between the Registrant and NationsBank of Virginia, N.A., dated as of October 1, 1993, to Indenture between the Registrant and Sovran Bank, N.A., as Trustee, as Amended and Restated as of July 1, 1987 (Incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199), filed November 12, 1993).\n4.110 Conformed Copy of Series 98 Series Second Supplement to Indenture, dated as of July 1, 1994, between the Registrant and NationsBank of Virginia, N.A., as Trustee (Incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199), dated June 1, 1994, filed April 19, 1995).\n4.111 Conformed Copy of Series 98 Series Third Supplement to Indenture, dated as of August 1, 1994, between Registrant and NationsBank of Virginia, N.A., as Trustee (Incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199), dated June 1, 1994, filed April 19, 1995).\n4.112 Conformed Copy of Series 99 Series Second Supplement to Indenture, dated as of July 1, 1994, between Registrant and NationsBank of Virginia, N.A., as Trustee (Incorporated herein by reference to Exhibit to Current Report on Form 8-K (File No. 0-13199), dated June 1, 1994, filed April 19, 1995).\n21.1 Subsidiaries of the Registrant:\nC. C. Holding Company was incorporated in Virginia on March 29, 1988 to acquire and hold mortgage collateral subject to the bond liability.\nBrock Acceptance Corporation was incorporated in Delaware on December 20, 1984 to acquire and hold mortgage collateral subject to the bond liability.\n24.1 Consent of Ernst & Young LLP, Independent Auditors.\n25.1 Power of Attorney of Directors of registrant.\n27.1 Financial Data Schedule (electronic filing only)\n99.1 Form of Guaranty Agreement with respect to Single-Family (level payment) Mortgage-Backed Certificates between Servicer and Government National Mortgage Association (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.2 Form of Guaranty Agreement with respect to Graduated Payment Mortgage-Backed Certificates between Servicer and Government National Mortgage Association (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.3 Form of Mortgage Participation Certificate Agreement Series 700 (March, 1983) (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.4 Federal National Mortgage Association Trust Indenture (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.5 Form of Funding Agreement (Incorporated herein by reference to Exhibit to Amendment No. 1 to Registration Statement No. 2- 95839, filed March 13, 1985) and Funding Note (Incorporated herein by reference to Exhibit to Report on Form 10-Q) (File No. 0-13199) for period ended June 30, 1985, filed August 12, 1985).\n99.6 Form of Servicing Agreement and Standard Provisions (Incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for period ended June 30, 1985, filed August 12, 1985).\n99.7 Form of Master Servicing Agreement (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18860, filed December 3, 1987).\n99.8 Form of Standard Terms to Master Servicing Agreement (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18860, filed December 3, 1987).\n99.9 Form of Performance Bond (Incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for period ended June 30, 1985, filed August 12, 1985).\n99.10 Form of Prospectus Supplement for Current Interest Bonds (Incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n99.11 Form of Prospectus Supplement for Capital Appreciation Bonds (Incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n99.12 Form of Primary Mortgage Insurance Policy (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.13 Form of Full Coverage Insurance Policy (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.14 Form of FHA Mortgage Insurance Certificate (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.15 Form of VA Loan Guaranty (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.16 Form of Pool Insurance Policy (Incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for period ended June 30, 1985, filed August 12, 1985).\n99.17 Form of Standard Hazard Insurance Policy (Incorporated herein by reference to Exhibit to Registration Statement No. 2-95839, filed February 13, 1985).\n99.18 Form of Special Hazard Insurance Policy (Incorporated herein by reference to Exhibit to Registrant's Report on Form 10-Q (File No. 0-13199) for period ended June 30, 1986, filed August 12, 1986).\n99.19 Form of Mortgagor Bankruptcy Bond (Incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for period ended June 30, 1985, filed August 12, 1985).\n99.20 Form of Surety Bond (Incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n99.21 Form of Escrow Agreement for Incomplete Mortgage Loan Files (Incorporated herein by reference to Exhibit to Registration Statement No. 33-1919, filed September 30, 1986).\n99.22 Form of Escrow Agreement for Missing Mortgage Certificates (Incorporated herein by reference to Exhibit to Registration Statement No. 33-1919, filed September 30, 1986).\n99.23 First Supplement to Standard Provisions to Servicing Agreement (Incorporated herein by reference to Exhibit to Report on Form 10-Q (File No. 0-13199) for period ended September 30, 1985, filed November 12, 1985).\n99.24 Second Supplement to Standard Provisions to Servicing Agreement (Incorporated herein by reference to Exhibit to Registration Statement No. 33-2757, filed January 16, 1986).\n99.25 Standard Provisions to Servicing Agreement, January, 1986 Edition (Incorporated herein by reference to Exhibit to Registrant's Annual Report on Form 10-K (File No. 0-13199) for the period ended December 31, 1985, filed March 31, 1986).\n99.26 First Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated February 1, 1986 (Incorporated herein by reference to Exhibit to Registrant's Annual Report on Form 10-K (File No. 0-13199) for the period ended December 31, 1985, filed March 31, 1986).\n99.27 Form of Prospectus Supplement for sale of single class Bonds with Redemption Fund (Incorporated herein by reference to Exhibit to Registration Statement No. 33-4691, filed April 9, 1986).\n99.28 Second Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated April 1, 1986 (Incorporated herein by reference to Exhibit to Registrant's Report on Form 10-Q (File No. 0-13199) for period ended March 31, 1986, filed May 15, 1986).\n99.29 Third Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated June 1, 1986 (Incorporated herein by reference to Exhibit to Registrant's Report on Form 10-Q (File No. 0-13199) for the period ended June 30, 1986, filed August 12, 1986).\n99.30 Fourth Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated September 1, 1986 (Incorporated herein by reference to Exhibit to Registration Statement No. 33-9191, filed September 30, 1986).\n99.31 Fifth Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated February 1, 1987 (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18098, filed October 23, 1987).\n99.32 Sixth Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated March 1, 1987 (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18098, filed October 23, 1987).\n99.33 Seventh Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated July 1, 1987 (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18098, filed October 23, 1987).\n99.34 Eighth Supplement to Standard Provisions to Servicing Agreement, January 1986 Edition, dated September 1, 1987 (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18098, filed October 23, 1987).\n99.35 First Supplement to Standard Terms to Master Servicing Agreement, dated October 1, 1987 (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-18860, filed December 3, 1987).\n99.36 Selected Provisions of the RAC Mortgage Investment Corporation Seller\/Servicer Guide (Incorporated herein by reference to Exhibit to Registrant's Report on Form 8-K (File No. 0-13199) dated and filed July 6, 1988).\n99.37 Form of Master Servicing Agreement among the Registrant, RAC Mortgage Investment Corporation, and Ryland Mortgage Company and Form of Standard Terms thereto (Incorporated herein by reference to Exhibit to Registrant's Report on Form 8-K (File No. 0-13199) dated and filed July 6, 1988).\n99.38 Form of Primary Mortgage Insurance Policy issued by PMI Mortgage Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33- 39357, filed March 1, 1991).\n99.39 Form of Primary Mortgage Insurance Company Policy issued by General Electric Mortgage Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-39357, filed March 1, 1991).\n99.40 Form of Primary Mortgage Insurance Policy issued by United Guaranty Residential Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-39357, filed March 1, 1991).\n99.41 Form of Pool Insurance Policy issued by PMI Mortgage Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-39357, filed March 1, 1991).\n99.42 Form of Pool Insurance Policy issued by General Electric Mortgage Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33- 39357, filed March 1, 1991).\n99.43 Form of Pool Insurance Policy issued by United Guaranty Residential Insurance Company (Incorporated herein by reference to Exhibit to Registrant's Registration Statement No. 33-39357, filed March 1, 1991).\n99.44 Standard Provisions to Servicing Agreement (February 1989 Edition) (Incorporated herein by reference to Exhibit to Ryland Mortgage Securities Corporation's Registration Statement on Form S-11 (No. 33-27345).\n99.45 Standard Provisions of the Saxon Mortgage Funding Corporation Seller\/Servicer Guide (December 1992 Edition) (Incorporated herein by reference to Exhibit to Saxon Mortgage Securities Corporation's Registration Statement on Form S-11 (No. 33- 57204).\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.\nRYLAND ACCEPTANCE CORPORATION FOUR\nBy: \/s\/ Michael C. Brown ------------------------------------ Michael C. Brown, Director\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\/ Michael C. Brown ------------------------------------ Michael C. Brown, Director\nDated: March 30, 1996\n\/s\/ Patricia S. Gloth ------------------------------------ Patricia S. Gloth, Vice-President, Financial Operations\nDated: March 30, 1996\nA Majority of the Board of Directors:\nBy: \/s\/ Michael C. Brown ------------------------------------ For Himself Michael C. Brown, and as Attorney-in-Fact\nDated: March 30, 1996\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OF REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT:\nPursuant to the Registrant's Trust Indenture, the Registrant must furnish all Holders of bonds of a series an Annual Report within 120 days of the Registrant's year end. The Annual Report to bondholders for the year ended December 31, 1995 will be furnished to the bondholders subsequent to the filing of this Annual report on Form 10-K. The Registrant does not provide its security holders with proxy statements or other proxy soliciting material.\nINDEX OF EXHIBITS:\nPAGE OF SEQUENTIALLY NUMBERED PAGES\n24.1 Consent of Ernst & Young LLP, Independent Auditors 60\n25.1 Power of Attorney of Directors of registrant 61\n27.1 Financial Data Schedule 62\nEXHIBIT 24.1\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-3 No. 33-39357) of Ryland Acceptance Corporation Four and in the related Prospectus of our report dated February 5, 1996, with respect to the consolidated financial statements of Ryland Acceptance Corporation Four included in this Annual Report (Form 10-K) for the year ended December 31, 1995.\n\/s\/ Ernst & Young LLP ---------------------\nBaltimore, Maryland March 27, 1996\nEXHIBIT 25.1\nRYLAND ACCEPTANCE CORPORATION FOUR\nPower of Attorney\nKNOW ALL MEN BY THESE PRESENTS that the undersigned directors and officers of Ryland Acceptance Corporation Four, a Maryland corporation, constitute and appoint Michael C. Brown as the true and lawful agent and attorney-in-fact of the undersigned with full power and authority in said agent and attorney-in- fact to sign for the undersigned in their respective names as directors and officers of Ryland Acceptance Corporation Four, the Annual Report on Form 10-K of Ryland Acceptance Corporation Four, for the fiscal year ended December 31, 1995, to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934. We hereby confirm all acts taken be such agent and attorney-in-fact as herein authorized.\nDated: March 30, 1996\nBy: ------------------------------------ Title: Michael C. Brown, Director","section_15":""}
{"filename":"34125_1995.txt","cik":"34125","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS\nSince January 1, 1995, there have been no developments in the Registrant's (hereinafter called \"F&M\" or the \"Company\") business other than the following:\nOn January 19, 1995, F&M Bank-Broadway was merged into F&M Bank-Massanutten.\nOn March 17, 1995, F&M acquired Farland Investment Management, Inc. (\"Farland\") through the exchange of 11,980 shares of F&M common stock.\nOn April 6, 1995, Bank of The Potomac (\"Potomac\"), Herndon, Virginia with assets of $54.3 million, became a wholly-owned subsidiary of F&M with a tax-free exchange of 872,187 shares of F&M common stock for all of the outstanding shares of Potomac. The share exchange of Potomac has been accounted for as a pooling of interests and, therefore, all financial statements have been restated to reflect the share exchange.\nOn April 11, 1995, F&M Bank-Winchester acquired from the County of Frederick property located at 9 Court Square, Winchester, Virginia consisting of land and buildings in exchange for 2 parking lots of equal value.\nOn April 21, 1995, F&M Bank-Winchester opened a full service branch bank at 1855 Senseny Road, Winchester, Virginia.\nOn June 17, 1995, F&M Bank-Peoples opened a full service branch bank at 760 Warrenton Road, Fredericksburg, Virginia.\nOn June 20, 1995, F&M Bank-Winchester opened a branch bank at 300 Westminister Canterbury Drive, Winchester, Virginia.\nOn October 20, 1995, F&M Bank-Martinsburg closed its branch bank located at 131 South Queen Street, Martinsburg, West Virginia, and converted it to an operations center.\nOn November 22, 1995, FB&T Financial Corporation (FB&T) and F&M announced that they entered into a Definitive Agreement and Plan of Reorganization, and related Plan of Share Exchange (collectively, the Merger Agreement). The transaction is subject to the approval of regulatory authorities and shareholders of FB&T. The proposed merger\nwill entitle the shareholders of FB&T to receive, in a tax-free exchange, shares of F&M common stock with an aggregate market value equal to $35.00, with cash being paid in lieu of issuing fractional shares. The market value of F&M common stock will be its average closing price as reported on the New York Stock Exchange for each of the ten trading days immediately preceding the closing date. As of December 31, 1995, FB&T's total assets were $243.1 million, total loans were $149.1 million, total deposits were $191.5 million and total shareholders' equity was $16.9 million. The merger will become effective during the first quarter 1996.\nOn December 12, 1995, F&M Bank-Massanutten opened a full service branch bank at the corner of Route 42 and American Legion Drive, Timberville, Virginia.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nF&M and its subsidiaries are engaged in only one industry segment, banking, the making of commercial and personal loans and similar credit transactions, and other activities closely related to banking.\n(c) NARRATIVE DESCRIPTION OF THE BUSINESS\nTHE COMPANY\nGENERAL\nF&M National Corporation is a multi-bank holding company headquartered in Winchester, Virginia. At December 31, 1995, F&M's eleven Subsidiary Banks operate 77 banking offices offering a full range of banking services principally to individuals and small and middle-market business in north, central and south Virginia including the Shenandoah Valley, and the eastern panhandle of West Virginia. At December 31, 1995, F&M had assets of $1.8 billion, deposits of $1.6 billion and shareholders' equity of $193.5 million.\nF&M was formed in 1969 to serve as the parent holding company of its then sole subsidiary bank, F&M Bank-Winchester, organized in 1902. Since its organization, F&M has acquired fourteen banks, which expanded its market area and increased market share in Virginia and West Virginia.\nThe following Table sets forth certain information concerning F&M and its operating subsidiaries as of December 31, 1995:\n(1) Includes Big Apple Mortgage and a general credit reporting agency. Also includes the 1993 purchase of substantially all of the assets and assumption of certain liabilities of Farmers and Merchants Bank of Hamilton(the \"Hamilton Bank\"). (2) Includes the acquisition in 1989 of The First National Bank of Broadway, Broadway, Virginia. (2) Includes the acquisition in 1986 of Virginia Capital Bank, Richmond, Virginia. (3) Includes the acquisition in 1990 of Peoples Bank of Central Virginia, Lovingston, Virginia.\nThe business strategy of F&M is to provide its customers with the financial sophistication and breadth of products of a regional bank, while retaining the local appeal and level of service of a community bank. F&M has maintained its community orientation by allowing the Subsidiary Banks latitude to tailor products and services to meet community and customer needs. While F&M has preserved the autonomy of its subsidiary Banks, it has established system-wide policies governing, amount other things, lending practices, credit analysis and approval procedures, as well as guidelines for deposit pricing and investment portfolio management. In addition, F&M has established a centralized loan review team that regularly performs a detailed, on-site review and analysis of each Subsidiary Bank's loan portfolio to ensure the consistent application\nof credit policies and procedures system-wide. An officer or representative of F&M serves on the board of directors of each Subsidiary Bank to monitor operations and to serve as a liaison to the Company.\nThe Subsidiary Banks are community-oriented and offer services customarily provided by full-service banks, including individual and commercial demand and time deposit accounts, commercial and consumer loans, residential mortgages, credit card services and safe deposit boxes. Lending is focused on individuals and small and middle-market businesses in the local market regions of the Subsidiary Banks. In addition, F&M Bank-Winchester, F&M Bank-Keyser, F&M Bank-Hallmark, and F&M Bank-Peoples operate trust departments offering a range of fiduciary services. At December 31, 1995, trust assets under management at these four banks totaled $308.5 million.\nF&M operates in six market regions: the Shenandoah Valley of Virginia; the eastern panhandle of West Virginia; Charlottesville\/ Albemarle County and surrounding areas; Greenville County in southside Virginia; suburban Richmond, primarily Henrico and Chesterfield Counties; the northern Virginia areas of Loudoun, Fairfax, and Prince William Counties and Stafford County, Warrenton and surrounding Fauquier County area. The more populous sectors within each of the six market regions experienced substantial population growth between 1980 and 1990, most of which exceeded 20% growth. At December 31, 1995, F&M operated 39 banking offices in the Shenandoah Valley from Winchester to Harrisonburg with deposits of $534.2 million; nine banking offices in the eastern panhandle of West Virginia with deposits of $242.1 million; seven banking offices in the Charlottesville\/Albemarle County area with deposits of $63.5 million; three banking offices in Emporia, Virginia, and surrounding Greenville County with deposits of $55.7 million; nine banking offices in suburban Richmond, Virginia, with deposits of $140.1 million; and six banking offices in Loudoun, Fairfax and Prince William Counties of northern Virginia with deposits of $164.7 million; and four offices in the city of Warrenton and Fauquier and Stafford Counties with deposits of $85.5 million. F&M's principal market is Winchester and the surrounding six Virginia counties where its lead bank, F&M Bank-Winchester, is the dominant financial institution in terms of deposit market share, with a 45% share of total deposits in Winchester, a 25% share of total deposits in surrounding Frederick County, a 27% share of total deposits in Warren County, and a 18% share of total deposits in Loudoun County. In Rockingham County, which has the largest population of any county or city in the Shenandoah Valley, F&M has a 19% deposit market share. In F&M's three-county West Virginia market, F&M has a 22% deposit market share in Jefferson County (which includes Charles Town), a 22% deposit market share in Berkeley County (which includes Martinsburg) and a 49% deposit market share in Mineral County (which includes Keyser). In Fairfax, Prince William, and Fauquier Counties (including Warrenton), F&M has 1%, 1%, and 17% of deposit market share. Although F&M's deposit market share in the Richmond and Charlottesville areas is small, F&M has positioned its banking offices in these two markets to increase deposit market share as a result of continued business and population growth in the suburban markets surrounding Richmond and Charlottesville.\nF&M has expanded its market area and increased its market share through both internal growth and strategic acquisitions. Since the beginning of 1988, F&M has acquired approximately $817.6 million in assets and approximately $725.1 million in deposits through ten bank acquisitions. Management believes there are additional opportunities to acquire financial institutions or to acquire assets and deposits that will allow F&M to enter adjacent markets or increase market share in existing markets. Management intends to pursue acquisition opportunities in strategic markets where its managerial, operational and capital resources will enhance the performance of acquired institutions.\nThe Subsidiary Banks have not experienced loan quality deterioration to the same extent as many other financial institutions, due to conservative underwriting standards and focused in-market lending practices. The purchase of assets of the Hamilton Bank increased nonperforming assets at September 18, 1993, by $27.9 million, of which, $21.3 million were nonaccrual loans and $6.6 million were foreclosed properties. At December 31, 1995, these Hamilton Bank nonaccrual loans and foreclosed properties have been reduced to $3.4 million and $4.6 million, respectively. At December 31, 1995, F&M had total nonperforming assets of approximately $23.9 million, representing 2.24% of period end loans and foreclosed properties. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset Quality.\"\nF&M also operates Big Apple Mortgage Co. Inc., which offers both fixed and adjustable rate residential mortgage loans and servicing . Big Apple Mortgage (also trading as F&M Mortgage Company) sells into the secondary market all the permanent mortgage loans it originates. Big Apple Mortgage purchases government insured 1-4 family FHA and VA loans which it may warehouse and sell when the market rates are attractive. At December 31, 1995, Big Apple Mortgage had $7.8 million in loans that it had committed to purchase, but had not settled upon and, in addition, $16.0 million residential loans were warehoused, available for sale.\nF&M's Articles of Incorporation and the Virginia Stock Corporation Act contain certain anti-takeover provisions, including (i) the Affiliated Transactions statue which places restrictions on any significant transaction between a publicly held Virginia corporation and any shareholder who owns more than 10% of any class of its outstanding shares, (ii) the Control Share Acquisitions statue which provides that a shareholder who purchases shares in any one of three statutory ranges (20%-33 1\/3%, 33 1\/3%-50%, and 50% or more of the outstanding shares) cannot vote those shares on any matter unless the acquisition of the additional shares has been approved by disinterested shareholders, and (iii) a super-majority provision in the Company's Articles of Incorporation that requires the affirmative vote of at least 80% of the outstanding voting shares on significant transactions, unless at least two-thirds of the Board of Directors then in office have approved the transaction.\nMARKET REGIONS\nThe market regions of F&M extend from the eastern panhandle of West Virginia southward to Virginia in Winchester, the surrounding Shenandoah Valley through Harrisonburg and Rockingham County and eastward to Loudoun, Fauquier, Stafford and Prince William counties, to the central Virginia markets of Charlottesville and Richmond, and southern Virginia market in Emporia and Greenville County. The following Table displays the market and population data for each of the market regions:\n* Represents less than 1% deposit market share NM = Not Meaningful.\n(1) In Virginia, certain cities are separate political entities and not part of the counties that surround them. The city of\nWinchester and Frederick County, the city of Harrisonburg and Rockingham County, the city of Charlottesville and Albemarle County, the city of Richmond and Henrico and Chesterfield Counties, and the city of Alexandria and Fairfax County are examples. The FDIC and OTS provide deposit data for each separately incorporated city.\n(2) Deposit data includes total bank and thrift deposits and is based on FDIC and OTS data as of June 30, 1995, which is the most recently available information.\nLENDING ACTIVITIES\nAll of the Subsidiary Banks offer both commercial and consumer loans, but lending activity is generally focused on consumers and small to middle market businesses within the Subsidiary Banks' respective market regions. Six of the Subsidiary Banks, F&M BankMassanutten, F&M Bank Blakeley, F&M Bank-Martinsburg, F&M BankKeyser, F&M Bank-Emporia, and F&M Bank-Peoples emphasize consumer lending with activities focused primarily on residential real estate and consumer lending. F&M Bank-Richmond, F&M Bank-Central Virginia, F&M Bank-Potomac and F&M Bank-Hallmark are based in larger markets where commercial loan demand is stronger and, as a result, their lending activities place a greater emphasis on small to medium sized business. F&M Bank-Winchester, because of its size and dominant position in its market, has a greater opportunity to appeal to larger commercial customers in addition to consumers.\nThe following table sets forth the composition of F&M's loan portfolio (by percentage) for the three years ended December 31, 1995:\n1995 1994 1993\nCommercial 12.8% 13.6% 11.2% Real estate construction 3.9 3.3 4.2 Real estate mortgage: Residential (1-4 family) 33.0 32.9 34.9 Home equity lines 5.2 5.5 4.8 Multifamily 1.9 1.9 1.8 Nonfarm, nonresidential(1) 28.4 26.8 26.5 Agricultural 1.6 1.7 1.7 Real estate mortgage Subtotal 70.1 68.8 69.7 Loans to individuals: Consumer 11.3 12.7 13.5 Credit card 1.9 1.6 1.4 Loans to individuals: Subtotal 13.2 14.3 14.9 Total loans 100.0% 100.0% 100.0% Total loans (dollars) $1,053,829 $1,009,223 $959,052\n(1) This category generally consists of commercial and industrial loans where real estate constitutes a source of collateral.\nApproximately 12.8% of F&M's loan portfolio at December 31, 1995, was comprised of commercial loans, which included loans secured by real estate shown in the Table above under the categories of multifamily, non-farm, non-residential and agricultural where real estate is among the sources of collateral securing the loan. The Subsidiary Banks offer a variety of commercial loans within their market regions, including revolving lines of credit, working capital loans, equipment financing loans, and letters of credit. Although the Subsidiary Banks typically look to the borrower's cash flow as the principal source of repayment for such loans, many of the loans within this category are secured by assets, such as accounts receivable, inventory and equipment. In addition, a number of commercial loans are secured by real estate used by such businesses and are generally personally guaranteed by the principals of the business. F&M's commercial loans generally bear a floating rate of interest tied to a system-wide prime rate set by F&M Bank-Winchester.\nF&M's residential real estate loan portfolio (including home equity lines) was 70.1% of its total loan portfolio at December 31, 1995. The residential mortgage loans made by the Subsidiary Banks and Big Apple Mortgage are made only for single family, owner-occupied residences within their respective market regions. The residential mortgage loans offered by the Subsidiary Banks are either adjustable rate loans or fixed rate loans with 20 to 30 year amortization schedules that mature with a balloon payment on the third or fifth year anniversary of the loan.\nBig Apple Mortgage offers both fixed and adjustable rate loans, while the Subsidiary Banks generally hold residential mortgage loans in their loan portfolios, Big Apple Mortgage (also trading as F&M Mortgage Company) sells into the secondary market all the permanent mortgage loans it originates. Big Apple Mortgage purchases government insured 1-4 family FHA and VA loans which it may warehouse and sell when the market rates are attractive. At December 31, 1995, Big Apple Mortgage had $7.8 million in loans that it had committed to purchase, but had not settled upon and $16.0 million residential loans were warehoused, available for sale.\nF&M's real estate construction portfolio historically has been a relatively small portion of the total loan portfolio. At December 31, 1995, construction loans were $40.7 million or 3.9% of the total loan portfolio. Of this amount, $22.0 million was originated by Big Apple Mortgage, all made to finance owner-occupied properties with permanent financing commitments in place. The Subsidiary Banks make a limited number of loans for acquisition, development and construction of residential real estate. F&M's construction loans, including its acquisition and development loans, generally bear a floating rate of interest and mature in one year or less. Loan underwriting standards for such loans generally limit the loan amount to 75% of the finished appraised value of the project. As a result of strict underwriting guidelines, F&M has experienced no charge-offs involving residential construction loans since 1987.\nLoans to individuals were 18.4% of F&M's total loan portfolio at December 31, 1995, if home equity lines were included. The\nSubsidiary Banks offer a wide variety of consumer loans, which include consumer loans, credit card loans, home equity lines and other secured and unsecured credit facilities. The performance of the consumer loan portfolio is directly tied to and dependent upon the general economic conditions in the Subsidiary Banks' respective market regions.\nCREDIT POLICIES AND PROCEDURES\nF&M has established system-wide guidelines governing, among other things, lending practices, credit analysis and approval procedures, and credit quality review. Within these guidelines, the Subsidiary Banks have latitude to tailor their loan products to meet the needs of the communities and specific customers. A holding company officer or representative serves on the Board of Directors of each Subsidiary Bank to monitor practices and to serve as the liaison with F&M.\nLOAN APPROVAL. F&M's loan approval policies provide for various levels of officer lending authority. When the aggregate outstanding loans to a single borrower exceed an individual officer's lending authority, the loan request must be approved by an officer with a higher lending limit or by the Subsidiary Bank's loan review committee. F&M has assigned a lending limit for each Subsidiary Bank. Loans that would result in a Subsidiary Bank exceeding its assigned limit must be approved first by the Subsidiary Bank's loan review committee and then by a central credit committee appointed by the holding company. The central credit committee consists of six senior officers of F&M Bank-Winchester and the Company, along with outside directors of either F&M Bank-Winchester or the Company, who rotate at the twice weekly meetings.\nAll loans to a particular borrower are reviewed each time the borrower requests a renewal or extension of any loan or requests an additional loan. All lines of credit are reviewed annually prior to renewal. These reviews are conducted by each Subsidiary Bank and, if necessary, by F&M's central credit committee.\nLOAN REVIEW. Each Subsidiary Bank has a formal loan review function which consists of a committee of bank officers that regularly reviews loans and assigns a classification, if required, based on current perceived credit risk. In addition, the holding company has a loan review team that performs a detailed on-site review and analysis of each Subsidiary Bank's portfolio on at least an annual basis to ensure the consistent application of system-wide policies and procedures. The holding company loan review team reviews all loans over an established principal amount for each Subsidiary Bank, which results in a review of 60% to 75% of the total principal amount of the Subsidiary Bank's loan portfolio. In addition, all lending relationships involving a classified loan are reviewed regardless of size. The holding company loan review team has the authority to classify any loan it determines is not satisfactory or to change the classification of a loan within F&M's loan grading system.\nAll classified loans are reviewed at least quarterly by F&M's senior officers and monthly by the Subsidiary Bank's boards of directors. All past due and nonaccrual loans are reviewed monthly by the Subsidiary Banks' boards of directors. As a matter of policy, the Subsidiary Banks place loans on nonaccrual status when management determines that the borrower can no longer service debt from current cash flows and\/or collateral liquidation. This generally occurs when a loan becomes 90 days past due as to principal and interest.\nALLOWANCE FOR LOAN LOSSES. Each Subsidiary Bank maintains its allowance for loan losses based on loss experience for each loan category over a period of years and adjusts the allowance for existing economic conditions as well as performance trends within specific areas, such as real estate. In addition, each Subsidiary Bank periodically reviews significant individual credits and adjusts the allowance when deemed necessary. The allowance also is increased to support projected loan growth.\nIMPAIRED LOANS\nOn January 1, 1995, F&M adopted FASB No. 114, \"Accounting by Creditors for Impairment of a Loan.\" This statement has been amended by FASB Statement No. 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.\" Statement 114, as amended, applies to all loans that are identified for evaluation, uncollateralized as well as collateralized, except for large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment. Homogeneous loans include residential mortgage, credit card and consumer installment loans. A loan is considered impaired when, based on current information and events, it is probable that F&M will be unable to collect all amounts due according to the contractual terms of the loan agreement. A delay of more than 90 days or a shortfall in amount of payments of more than 10% normally would require impairment recognition. However, a loan is not impaired during a period of delay in payment if F&M expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay.\nThe impairment of loans that have been separately identified for evaluation is to be measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment of those loans is to be based on the fair value for the collateral. Measurement of impairment for loans not meeting the above criteria would be under the aggregate collection experience method. Under this method, loans with similar risk characteristics are aggregated and historical data is used to determine the loan loss for the group. F&M measures the impairment of loans on a loan-by-loan basis.\nLoans are placed on nonaccrual when a loan is specifically determined to be impaired or when principal or interest is delinquent\nfor 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Cash payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses.\nAn impaired loan is charged-off when management determines that the prospect of recovery of the principal of the loan has significantly diminished.\nThe implementation of FASB 114 does not have a material impact on the credit risk of F&M. Information about impaired loans as of and for the period ended follows:\nImpaired loans for which an allowance has been provided $ 7,676,449 Impaired loans for which no allowance has been provided 3,029,014 Total impaired loans $ 10,705,463\nAllowance provided for impaired loans, included in the allowance for loan losses $ 1,400,961 Average balance in impaired loans $ 10,828,971 Interest income recognized $ 209,087\nImpaired loans by measurement method: Fair value of collateral method $ 9,076,463 Expected cash flow method 1,629,000 Aggregate collection experience method -- Total impaired loans $ 10,705,463\nDEPOSITS\nThe Subsidiary Banks offer a number of programs to consumers and to small and middle market businesses at interest rates consistent with local market conditions. The following Table sets forth the mix of depository accounts offered by the Subsidiary Banks as a percentage of total deposits at the dates indicated:\nDecember 31, 1995 1994 1993\nNoninterest-bearing demand 14.9% 15.5% 14.2% Interest checking 15.8 17.1 16.7 Savings accounts 11.7 14.1 14.6 Money market accounts 9.2 12.0 13.1 Time deposit accounts: Under $100,000 39.9 35.2 35.2 $100,000 and over 8.5 6.1 6.2 100.0% 100.0% 100.0%\nThe Subsidiary Banks control deposit flows primarily through pricing of deposits and, to a lesser extent, through promotional activities. The Subsidiary Banks establish deposit rates based on a variety of factors, including competitive conditions, liquidity needs and compliance with net interest margin requirements established by F&M for all Subsidiary Banks. As of December 31, 1995, the Subsidiary Banks had $135.1 million of certificates of deposit greater than $100,000, or 8.5% of total deposits. The Subsidiary Banks do not accept brokered deposits.\nNo material portion of the deposits of the Subsidiary Banks has been obtained from a single or a small group of customers, and the loss of any customer's deposits or a small group of customers' deposits would not have a material adverse effect on the business of any of the Subsidiary Banks. See \"Business-Market Regions\" for information regarding each Subsidiary Bank's deposit share and rank in its respective market.\nLIQUIDITY AND SENSITIVITY TO INTEREST RATES\nThe primary functions of asset\/liability management are to ensure adequate liquidity and maintain an appropriate balance between interest sensitive assets and interest-sensitive liabilities. Liquidity management involves the ability to meet the cash flow requirements of F&M's loan and deposit customers. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. F&M does not hedge its position with swaps, options or futures but instead maintains a highly liquid and short-term position in all of its earning assets and interest-bearing liabilities.\nIn order to meet its liquidity needs, F&M schedules the maturity of its investment securities according to its needs. The weighted-average life of the securities portfolio at the end of 1995 was 4 years 8 months which is indicative of F&M's investment philosophy of investing in U.S. Government securities with maturities between five and ten years. F&M views its securities portfolio primarily as a source of liquidity and safety, however, it may if the market is favorable, make changes in the available for sale portfolio to take advantage of changes in the yield curve. F&M views the total available for sale securities portfolio as a source of liquidity, whereas, liquidity in the held to maturity portfolio is limited to calls and maturities. The maturity ranges of the securities and the average taxable-equivalent yields as of December 31, 1995, are shown in the following Table.\nA cash reserve, consisting primarily of overnight investments such as Federal Funds, is also maintained to meet any contingencies and to provide additional capital, if needed.\nMost of F&M's loans are fixed-rate installment loans to consumers and mortgage loans whose maturities are generally longer than the deposits by which they are funded. A degree of interest-rate risk is incurred if the interest rate on deposits should rise before the loans mature. However, the substantial liquidity provided by the monthly repayments on these loans can be reinvested at higher rates that largely reduce the interest-rate risk. Home equity lines of credit have adjustable rates that are tied to the prime rate. Many of the loans not in the installment or mortgage categories have maturities of less than one year or have floating rates that may be adjusted periodically to reflect current market rates. These loans are summarized in the following Table:\nREMAINING MATURITIES OF SELECTED LOANS\nDecember 31, 1995 (Dollars in thousands) Commercial, Financial and Real estate- Agricultural Construction\nWithin 1 year $ 91,412 $38,527 Variable Rate: 1 to 5 years 1,678 202 After 5 years 190 -- Total 1,868 202\nFixed Rate: 1 to 5 years 33,340 1,994 After 5 years 8,588 -- Total 41,928 1,994 Total Maturities $135,208 $40,723\nF&M's asset\/liability committee is responsible for reviewing the Corporation's liquidity requirements and maximizing the Corporation's net interest income consistent with capital requirements, liquidity, interest rate and economic outlooks, competitive factors and customer needs. Liquidity requirements are also reviewed in detail for each of F&M's individual banks, however, overall asset\/liability management is performed on a consolidated basis to achieve a consistent and coordinated approach.\nOne of the tools F&M uses to determine its interest-rate risk is gap analysis. Gap analysis attempts to examine the volume of interest-rate sensitive assets minus interest-rate sensitive liabilities. The difference between the two is the interest sensitivity gap, which indicates how future changes in interest rates may affect net interest income. Regardless of whether interest rates are expected to increase or fall, the object is to maintain a gap position that will minimize any changes in net interest income. A negative gap exists when F&M has more interest-sensitive liabilities maturing within a certain time period than interest-sensitive assets. Under this scenario, if interest rates were to increase, it would tend to reduce net interest income. At December 31, 1995, F&M had a positive one year balance sheet gap of $98.0 million and a risk to interest margin (gap as a percentage of rate sensitive assets) of 5.85%.\nF&M attempts to control interest-rate risk according to its projected needs utilizing maturity and repricing reports. F&M also compares the Olson Model, a dynamic modeling process that projects the impact of different interest rate, loan and deposit growth scenarios over a 12-month period to its projected needs. A large part of F&M's loans and deposits comes from its retail base and does not automatically reprice on a contractual basis in reaction to changes in interest-rate levels. Accordingly, F&M has not experienced the earnings volatility indicated by its interest-sensitive gap position. F&M's net interest margin for 1993, 1994 and 1995 were 4.67%, 4.74% and 4.75%. Whether interest rates were high or low, F&M has been able to maintain adequate liquidity to provide for changes in interest rates and in loan and deposit demands.\nOTHER ACTIVITIES\nThe Subsidiary Banks offer a range of trust services. The Trust Department of F&M Bank-Winchester manages $188.9 million in assets in approximately 1,050 accounts, covering both personal trust activities and employee benefit plans. F&M Bank-Hallmark and F&M Bank-Peoples offer similar trust services and manage assets totaling $28.6 million and $82.8 million, respectively. F&M Bank-Keyser offers a range of trust services as well, managing approximately $8.3 million in assets. The other Subsidiary Banks do not operate trust departments, but are encouraged to offer their customers the opportunity to utilize trust services offered by F&M Bank-Winchester.\nCOMPETITION\nEach of the market regions in which the Company operates has a highly competitive banking market involving commercial banks and thrifts. Other competitors, including credit unions, consumer finance companies, insurance companies and money market mutual funds, compete with the Company for certain lending and deposit gathering services. In its Charlottesville\/Albemarle County, the northern Virginia, and suburban Richmond markets, the Company faces particularly intense competition from several state-wide and regional banking institutions which have substantial operations in those market regions. Management believes, however, that the Company enjoys certain competitive advantages in its principal market of Winchester, the surrounding northern Shenandoah Valley and Loudoun County where F&M Bank-Winchester is the largest financial institution headquartered in the area and the dominant bank in terms of deposit market share.\nCompetition among the various financial institutions is based on interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services, the convenience of banking facilities and, in connection with loans to larger borrowers, relative lending limits. Many of the financial organizations in competition with the Company have much greater financial resources, diversified markets, and branch networks than F&M and are able to offer similar services at varying costs with higher lending limits. With reciprocal interstate banking, the Company also faces the prospect of additional competitors entering its markets as well as additional competition in its efforts to acquire other financial institutions.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAll officers of the Company and its subsidiaries are elected annually to serve at the pleasure of the Board of Directors of the Company. The following table sets forth the names, offices and ages at February 29, 1995, of each of the executive officers of the Company and is included in conformity with Instruction 3 of Item 401(b) of Regulation S-K:\nFIRST NAME AGE ELECTED OFFICE\nW. M. Feltner 76 1970 Chairman and Chief Executive Officer of the Company; Chairman of Board, F&M Bank-Winchester\nJack R. Huyett 63 1992 President-Chief Administrative Officer of the Company\nF. Dixon Whitworth Jr. 51 1985 Executive Vice President of the Company\nAlfred B. Whitt 57 1991 Senior Vice President, Secretary, Senior Financial Officer of the Company and F&M Bank-Winchester\nBetty H. Carroll 58 1985 Senior Vice President of the Company; President, Chief Executive Officer, F&M Bank-Winchester\nBarbara H. Ward 50 1983 Treasurer of the Company; Senior Vice President of F&M Bank-Winchester\nMr. Feltner has been a senior executive officer of the Company since its inception in 1970.\nMr. Huyett joined the Company in November of 1988 at which time he was President and Chief Executive Officer of Blakeley Bank and Trust Company (now F&M Bank-Blakeley), a position he had held for 19 years. He was appointed President and Chief Administrative Officer of the Company July 1, 1992.\nF. Dixon Whitworth, Jr. Winchester, Virginia, joined the Company in August 1985, as President of the Suburban Bank, now F&M Bank-Richmond, and served as such until November, 1985, when he became Executive Vice President of the Company. Prior to joining the Company as President of The Suburban Bank in 1984, he had been employed as Executive Vice President of Southern Bank (now Jefferson National Bank), Richmond, Virginia for eleven years.\nMr. Whitt joined the Company in 1987 as Director of Human Resources, before which time he served as President of F&M Bank-Massanutten, Harrisonburg, Virginia, since its organization in 1973. In January of 1990, he was appointed Senior Financial Officer of the Company and Senior Financial Officer of F&M Bank-Winchester. In July of 1991, he was appointed Senior Vice President, Senior Financial Officer and Secretary of the Company and F&M Bank-Winchester.\nOn December 7, 1988, Mrs. Carroll was named Chief Executive Officer of F&M Bank-Winchester. Prior thereto, she had been President and Chief Administrative Officer of F&M Bank-Winchester since 1985, and had been Executive Vice President of that bank for eleven years before becoming President and Chief Administrative Officer.\nMrs. Ward was appointed Senior Vice President of F&M Bank-Winchester in March of 1992. Prior thereto, she was a Vice President of F&M Bank-Winchester since 1974. She has been Treasurer of the Company since 1983.\nSUPERVISION AND REGULATION\nThe Company and the Subsidiary Banks are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. The following is a brief summary of certain statues, rules and regulations affecting the Company and the Subsidiary Banks. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Subsidiary Banks. A change in applicable laws or regulations may have a material effect on the business and prospects of the Company.\nTHE COMPANY\nThe Company is registered as a bank holding company under the Bank Holding Company Act (\"BHCA\") and the Virginia Financial Institution Holding Company Act, and is therefore subject to regulation and examination by the Board of Governors of the Federal Reserve System (the \"Federal Reserve\") and the Virginia State Corporation Commission (the \"Virginia SCC\"). The Subsidiary Banks are subject to examination and regulation by the Virginia SCC and the West Virginia Board of Banking and Financial Institutions (the \"West Virginia Board of Banking\"). In addition, the Company and its Subsidiary Banks are subject to certain minimum capital standards established by the Federal Reserve and the FDIC.\nUnder the BHCA, the Company is required to secure the prior approval of the Federal Reserve before it can merge or consolidate with any other bank holding company, or acquire all or substantially all of the assets of any bank or acquire direct or indirect ownership or control of any voting shares of any bank that is not already majority owned by it if after such acquisition the Company would directly or indirectly own or control more than 5% of the voting shares of such bank. The BHCA also prohibits the Company from acquiring, directly or indirectly voting shares of, or interests in, or all or substantially all of the assets of, any bank located outside the State of Virginia unless the acquisition is specifically authorized by the laws of the state in which such bank is located, as discussed below.\nThe Company is prohibited under the BHCA, and regulations promulgated thereunder, from engaging in, and from acquiring direct or indirect ownership or control of more than 5% of voting shares of any company engaged in, nonbanking activities unless the Federal Reserve, 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. The Federal Reserve has by regulation determined that certain activities are closely related to banking within the meaning of the BHCA. These activities include, among others, operating a mortgage, finance, credit card or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for\ncertain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services.\nThe Company, as an affiliate of the Subsidiary Banks within the meaning of the Federal Reserve Act, is subject to certain restrictions under the Federal Reserve Act regarding transactions between a bank and companies with which it is affiliated. These provisions limit extensions of credit (including guarantees of loans) by the Subsidiary Banks to affiliates, investments in the stock or other securities of the Company by the Subsidiary Banks and the nature and amount of collateral that Subsidiary Banks may accept from any affiliate to secure loans extended to the affiliate. Further, under the Federal Reserve Act and the regulations promulgated thereunder, 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 any property or service.\nThe BHCA and the Change in Bank Control Act, together with regulations of the Federal Reserve, require that, depending on the particular circumstances, either Federal Reserve approval must be obtained or notice must be furnished to the Federal Reserve and not disapproved prior to any person or company acquiring \"control\" of a bank holding company, such as the Company, subject to exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended, or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption.\nFederal Reserve policy requires a bank holding company to act as a source of financial strength to each of its bank subsidiaries and to take certain measures to preserve and protect bank subsidiaries in situations where additional investments in a troubled bank subsidiary may not otherwise be warranted. Under the recently enacted Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), in order to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee up to certain maximum limits the compliance with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking regulator. See \"Recent Legislation and Regulatory Developments.\" In addition, if a bank holding company has more than one bank or thrift subsidiary, the bank holding company's other subsidiary depository institutions are responsible under a cross guarantee for any losses to the FDIC resulting from the failure of a depository institution subsidiary. Under these provisions, a bank holding company may be required to loan money to its depository institution subsidiaries in the form of capital notes or other instruments. However, any such loans likely would be unsecured and subordinated to such institution's depositors and certain other creditors.\nAll acquisitions, whether by an in-state or out-of-state acquirer, involving a Virginia bank or bank holding company require the prior approval of the Virginia SCC, in addition to approval by the appropriate federal regulatory authority. Similarly, the West Virginia Board of Banking must approve all acquisitions of a West Virginia bank or bank holding company.\nThe BHCA currently prohibits the Federal Reserve from approving an application from a bank holding company to acquire shares of a bank located outside the state in which the operations of the holding company's banking subsidiaries are principally conducted, unless such an acquisition is specifically authorized by statute of the state in which the bank whose shares are to be acquired is located. However, under recently enacted federal legislation, the restriction of interstate acquisitions will be abolished effective one year from enactment of such legislation, and thereafter bank holding companies from any state will be able to acquire banks and bank holding companies located in any other state, subject to certain conditions, including nationwide and state concentration limits. Banks also will be able to branch across state lines effective June 1, 1997 (unless state law would permit such intestate branching at an earlier date), provided certain condition are met, including that applicable state law must expressly permit such interstate branching. Virginia has adopted legislation that will permit branching across state lines effective July 1, 1995, provided there is reciprocity with the state in which the out-of-state bank is based.\nREGULATION OF SUBSIDIARY BANKS\nAll of the Subsidiary Banks are state-chartered institutions organized under either Virginia or West Virginia law. Eight of the Subsidiary Banks, F&M Bank-Winchester, F&M Bank-Massanutten, F&M Bank-Richmond, F&M Bank-Central Virginia, F&M Bank-Emporia, F&M BankHallmark, F&M Bank-Peoples, and F&M Bank-Potomac are Virginiachartered institutions regulated and examined by the Virginia SCC. F&M Bank-Blakeley, F&M Bank-Martinsburg and F&M Bank-Keyser are West Virginia-chartered institutions regulated and examined by the West Virginia Board of Banking.\nThe Subsidiary Banks are all members of the Federal Reserve System and are, therefore, supervised and examined by the Federal Reserve, their primary federal regulator. The Federal Reserve and the Virginia SCC or West Virginia Board of Banking, as appropriate, conduct regular examinations of the Subsidiary Banks, reviewing the adequacy of their allowance for loan losses, quality of loans and investments, propriety of management practices, compliance with laws and regulations and other aspects of operations. In addition to these regular examinations, the Subsidiary Banks must furnish the Federal Reserve with quarterly reports containing detailed financial statements and schedules. The FDIC, which provides deposit insurance, also has authority to examine and regulate the Subsidiary Banks.\nFederal and state banking laws and regulations govern all areas\nof the operations of the Subsidiary Banks, including maintenance of cash reserves, loans, mortgages maintenance of minimum capital, payment of dividends, and establishment of branch offices. Federal and state bank regulatory agencies also have the general authority to eliminate dividends paid by insured banks if such payment is deemed to constitute an unsafe and unsound practice. As their primary federal regulator, the Federal Reserve has authority to impose penalties, initiate civil administrative actions and take other steps to prevent the Subsidiary Banks from engaging in unsafe or unsound practices. In this regard, the Federal Reserve has adopted capital adequacy requirements applicable to its member banks.\nRECENT LEGISLATION AND REGULATORY DEVELOPMENTS\nOn December 19, 1991, FDICIA was enacted. Among other things, FDICIA provides increased funding for the FDIC's Bank Insurance Fund (\"BIF\") and expanded regulation of depository institutions and their affiliates, including parent holding companies. A significant portion of the additional BIF funding will be in the form of borrowings to be repaid by insurance premiums assessed on BIF members. These premium increases would be in addition to the increases in deposit premiums made during 1994. FDICIA provides for an increase in BIF's ratio of reserves to insured deposits to 1.25% within the next 15 years, also to be financed by insurance premiums. The result of these provisions could be a significant increase in the insurance assessment rate on deposits of BIF members over the next 15 years. FDICIA provides authority for special assessments against insured deposits and for the development of a system of assessing deposit insurance premiums based upon the financial institution's risk. FDIC announced in early 1995 that current projections indicate the BIF's ratio of reserves could reach the 1.25% requirement by the second quarter of 1996.\nOn September 15, 1992, the FDIC approved final regulations adopting the risk-related deposit insurance system that was proposed in May 1992. The new risk-related regulations, effective January 1, 1994, will initially result in an eight basis point spread between the highest and lowest deposit insurance premiums. The strongest institutions will continue to pay annual deposit insurance premiums of 0.23% and the weakest will pay 0.31%. Under the final riskrelated insurance regulations, each insured depository institution will be assigned to one of three categories, \"well capitalized,\" \"adequately capitalized\" or \"less than adequately capitalized\" as defined in regulations to be established pursuant to FDICIA by the Federal Reserve and the other federal bank regulatory agencies. These categories will be further subdivided into three subgroups based upon the FDIC's evaluations of the risk posed by the depository institution, based in part on examinations by the institution's primary federal and\/or state regulator. F&M's banks have received a \"1A\" risk classification rating for 1995, the highest possible rating and are paying the minimum premium of $2,000 per bank per year.\nAmong other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" in respect of banks that do not meet minimum capital requirements. FDICIA establishes five\ncapital tiers: \"well capitalized,\" \"adequately capitalized\", \"under capitalized\", \"significantly undercapitalized\", and \"critically undercapitalized\", to be further defined by federal regulations. A depository institution is \"well capitalized\" if it significantly exceeds the minimum level required by regulation for each relevant capital measure, \"adequately capitalized\" if it meets each such measure, \"undercapitalized\" if it fails to meet any such measure, \"significantly undercapitalized\" if it is significantly below any such measure, and \"critically undercapitalized\" if it fails to meet any critical capital level set forth in the regulations. The critical capital level must be a level of tangible equity capital equal to not less than 2.0% of total assets and not more than 65% of the minimum leverage ratio to be prescribed by regulation (except to the extent that 2.0% would be higher than such 65% level). An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. In order to be classified as a \"well capitalized institution\" under the proposed rules, the institution must have a total risk-based capital ratio of 10% and a leverage ratio of 5%.\nIf a depository institution fails to meet regulatory capital requirements, regulatory agencies can require submission and funding of a capital restoration plan by the institution, place limits on its activities, require the raising of additional capital, and, ultimately, require the appointment of a conservator or receiver for the institution. The obligation of a controlling bank holding company under FDICIA to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary's assets or the amount required to achieve regulatory capital adequacy requirements. If the controlling bank holding company fails to fulfill its obligations under FDICIA and files (or has filed against it) a petition under the Federal bankruptcy code, the FDIC's claim may be entitled to a priority in such bankruptcy proceeding over third party creditors of the bank holding company.\nAny institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market; in addition, \"pass through\" insurance coverage may not be available for certain employee benefit accounts. Under-capitalized depository institutions may be subject to growth limitations and are required to submit a capital restoration plan. The federal bank regulatory agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions, is likely to succeed in restoring the depository institutions's capital, and is guaranteed by the parent holding company. If a depository institution fails to submit an acceptable plan, it will be treated as if it were 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\nundercapitalized institutions are subject to appointment of a receiver or conservator.\nFDICIA contains numerous other provisions, including new reporting requirements, termination of the \"to big to fail\" doctrine except in special cases, limitations on the FDIC's payment of deposits at foreign branches, and revised regulatory standards for, among other things, real estate lending and capital adequacy.\nAn insured depository institution may not pay management fees to any person having control of the institution nor may an institution, except under certain circumstances and with prior regulatory approval, make any capital distribution if, after making such payment or distribution, the institution would be undercapitalized. FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts.\nOther legislative and regulatory proposals regarding changes in banking, and the regulation of bank thrifts and other financial institutions, are being considered by the executive branch of the Federal government, Congress and various state governments, including Virginia and West Virginia. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. It cannot be predicted whether any of these proposals will be adopted or, if adopted, how these proposals will affect the Company.\nCAPITAL ADEQUACY\nInformation on \"Capital Adequacy\" may be found under ITEM 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\", \"Capital Resources\".\nDIVIDENDS\nDividends from the Subsidiary Banks constitute the major source of funds for dividends to be paid by the Company. The amount of dividends payable by the Subsidiary Banks to the Company depends upon their earnings and capital position, and is limited by federal and state law, regulations and policy. The Federal Reserve has the general authority to limit dividends paid by the Subsidiary Banks and the Company if such payments are deemed to constitute an unsafe and unsound practice.\nAs state member banks subject to the regulations of the Federal Reserve, each Subsidiary Bank must obtain approval of the Federal Reserve for any dividend if the total of all dividends declared by the Subsidiary Bank in any calendar year would exceed the total of its net profits for such year, as defined by the Federal Reserve, plus its retained net profits for the preceding two years. In addition, each Subsidiary Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting current losses and bad debts. For this purpose, bad debts are\ngenerally defined to include the principal amount of all loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection.\nIn addition, Virginia law imposes restrictions on the ability of all banks chartered under Virginia law to pay dividends. Under Virginia law, no dividend may be declared or paid that would impair a bank's paid-in capital. The Virginia SCC also can limit the payment of dividends by any Virginia bank if it determines the limitation is in the public interest and is necessary to ensure the bank's financial soundness.\nUnder West Virginia law, a state bank may declare a dividend only from its undivided profits and, if the bank's surplus account is not greater than or equal to the par value of the bank's stock, the bank may not declare a dividend unless a portion of the bank's profits for the period for which dividends are declared is credited to the bank's surplus account. Also, a West Virginia-chartered bank must obtain the approval of the West Virginia Board of Banking prior to declaring a dividend if the total of all dividends paid by the bank in any calendar year exceeds the total of its profits for that year plus its undivided profits for the preceding two years. For further information about the Company's dividends, see Part II., Item 5., \"Market for Registrant's Common Equity and Related Stockholder Matters\".\nEMPLOYEES\nAt December 31, 1995, F&M had 865 full time and 169 part time employees. No employees are represented by any collective bargaining unit. F&M considers relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of F&M are located in the Yost Building at 38 Rouss Avenue, Winchester, Virginia, a two-story building built in 1784 and owned free of any encumbrances. The Company operates a total of 77 banking offices (68 in Virginia and 9 in West Virginia), 55 of which are owned by the Company or one of the Subsidiary Banks free of any encumbrances, and 22 of which are leased under agreements expiring at various dates, including renewal options, through 2008. The Company also owns additional office facilities for various of its lending, audit, accounting and data processing functions. Additional information regarding F&M's lease agreements may be found under ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, Note 14.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the ordinary course of its operations, the Company and the Subsidiary Banks are parties to various legal proceedings. Based on information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or 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.\nThe Company has not submitted any matters to its security holders since its Annual Meeting of Shareholders held April 25, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nOn December 28, 1994, the Company began trading its capital stock on the New York Stock Exchange under the symbol \"F M N\". Prior to December 28, 1994, the Company's common stock was traded in the over-the-counter market and quoted on the NASDAQ National Market System under the symbol \"FMNT\".\nThe following table sets forth the per share high and low last sale prices for the common stock of the Company as reported on the New York Stock Exchange and\/or the NASDAQ National Market System, and the cash dividends paid or declared per share on the Common Stock for the period indicated:\nPRICE RANGE CASH HIGH LOW DIVIDENDS\nFirst Quarter 17.25 15.38 0.140 Second Quarter 16.50 13.75 0.140 Third Quarter 16.75 14.25 0.140 Fourth Quarter 16.50 14.75 0.145\nFirst Quarter 16.50 15.57 0.145 Second Quarter 16.25 15.50 0.145 Third Quarter 17.37 16.00 0.145 Fourth Quarter 17.25 14.75 0.150\nFirst Quarter 17.12 15.75 0.150 Second Quarter 17.37 15.50 0.150 Third Quarter 18.12 15.62 0.150 Fourth Quarter 20.00 17.25 0.160\nAt December 31, 1995, there were 16,552,324 shares of Common Stock outstanding held by 7,821 holders of record.\nThe Company historically has paid cash dividends on a quarterly basis, together with a special cash dividend in the fourth quarter of each year depending upon the Company's performance that year. The Company in 1992 implemented a practice of eliminating the special cash dividend and instead increasing its regular fourth quarter dividend based on the Company's performance, with the intention of paying an equivalent amount for the first three quarters of each following year. The final determination of the timing, amount and payment of dividends on the Common Stock is at the discretion of the Board of Directors and will depend upon the earnings of the Company and its subsidiaries, principally the Subsidiary Banks, the financial condition of the Company and other factors, including general economic conditions and applicable governmental regulations and policies.\nThe Company or F&M Bank-Winchester has paid regular cash dividends for more than 50 consecutive years.\nThe Company is a legal entity separate and distinct from its subsidiaries, and its revenues depend primarily on the payment of dividends from the Subsidiary Banks. The Subsidiary Banks are subject to certain legal restrictions on the amount of dividends they are permitted to pay to the Company. At December 31, 1995, the Subsidiary Banks had available for distribution as dividends to the Company approximately $35.4 million.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL INFORMATION\nIncorporated herein by reference, as Exhibit 13, to page 1 of 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, as Exhibit 13, to pages 12 through 29 of the 1995 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated herein by reference, as Exhibit 13, to pages 30 through 50 of the 1994 Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGE 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\nITEM 12.","section_12":"ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction G(3), the information called for by Part III, Items 10. through 13., is incorporated herein by reference from the Company's definitive proxy statement, dated March 21, 1996, for the Company's Annual Meeting of Shareholders to be held April 23, 1996, which definitive proxy statement was filed with the Commission pursuant to Rule 14a-6 on March 20, 1996. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I under \"EXECUTIVE OFFICERS OF THE REGISTRANT\".\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following documents included in Part II of this report are incorporated by reference to the Company's 1995 Annual Report:\n(1) Financial Statements Page Report of Independent Certified Public Accountants 50 F&M National Corporation and Subsidiaries: Consolidated Balance Sheets at December 31, 1995 and 1994 30 Consolidated Statements of Income at December 31, 1995 and 1994 31 Consolidated Statements of Changes in Shareholders' Equity for years ended December 31, 1995, 1994 and 1993 32 Consolidated Statements in Cash Flows for the periods ended December 31, 1995, 1994 and 1993 33 Notes to Financial Statements 34\n(2) Financial Statement Schedules\nAll 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(3) Exhibits.\n(i) Registrant's Articles of Incorporation, as amended and adopted effective April 25, 1995, (filed herewith).\n(ii) Registrant's Bylaws, as amended and adopted effective December 13, 1995 (filed herewith).\n(10) Material Contracts.\n(i) Form of agreement between seventeen officers of the Registrant under the Registrant's Defined Benefit Deferred Compensation and Salary Continuation Plan (incorporated herein by reference to Exhibit 10(b) to Registration Statement #33-10696, filed on December 9, 1986).\n(ii) Registrant's 1982 Incentive and Non-Qualified Stock Option Plan, as amended (incorporated herein by reference to Exhibit 10(a) to Registration Statement #33-20165, filed on February 17, 1988).\n(iii) Registrant's Officers' Incentive Bonus Plan (incorporated herein by reference to Exhibit 28(i) to\nRegistration Statement #33-25867 filed on December 2, 1988).\n(iv) Registrant's 1992 Incentive and Non-Qualified Stock Option Plan (incorporated herein by reference to Exhibit 10(b) to Registration Statement #33-50902, filed on August 14, 1992).\n(v) Incorporated herein by reference is the Agreement and Plan of Reorganization and Plan of Merger dated November 22, 1995, between the Registrant and FB&T Financial Corporation, filed as Appendix I and Exhibit A, respectively, of the Proxy Statement and Prospectus which is part of Registration Statement No. 333-363 on Form S-4, January 22, 1996.\n(vi) The Registrant entered into Executive Severance Agreements with the following Executive Officers of the Registrant on December 1, 1995: Jack R. Huyett, Betty H. Carroll, Alfred B. Whitt, and F. Dixon Whitworth, Jr. (form of agreement filed herewith).\n(11) Statement re computation of per share earnings (filed herewith).\n(13) Portions of the 1995 Annual Report to Shareholders for the fiscal year ended December 31, 1995 (filed herewith).\n(21) Subsidiaries of the Registrant (filed herewith).\n(23) Consent of Yount, Hyde & Barbour, P. C., Certified Public Accountants (filed herewith).\n(27) Financial Data Schedule (filed herewith).\n(b) Reports on Form 8-K.\nDuring 1995, the Company filed the following reports:\n(i) January 11, 1995, under ITEM 5. to report the Registrant's Board granting authority to its management to purchase up to 250,000 shares of the Registrant's common stock on the open market for general corporate purposes.\n(ii) February 21, 1995, under ITEM 5. to report discontinuance and sale of the assets of four of the Registrant's non-bank subsidiaries.\n(iii) April 12, 1995, under ITEMS 2. and 7., to report the consummation of the merger of Bank of the Potomac with and into the Registrant.\n(iv) November 24, 1995, under ITEM 5. to report approval of a definitive agreement for the affiliation of FB&T Financial Corporation with and into the Registrant.\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, as of the 20th day of March, 1996:\nF&M NATIONAL CORPORATION Winchester, Virginia\n\/s\/ W. M. Feltner, 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 on the 20th day of March, 1996:\nSIGNATURE TITLE\n\/s\/ Chairman of the Board, Chief Executive W. M. FELTNER Officer, Director\n\/s\/ President, Chief Administrative Officer, JACK R. HUYETT Director\n\/s\/ Principal Accounting and Financial Officer, ALFRED B. WHITT Secretary\n\/s\/ FRANK ARMSTRONG, III Director\n\/s\/ JAMES L. BOWMAN Director\n\/s\/ BETTY H. CARROLL Director\n\/s\/ WILLIAM H. CLEMENT Director\n\/s\/ WILLIAM R. HARRIS Director\n\/s\/ L. DAVID HORNER, III Director\n\/s\/ WILLIAM A. JULIAS Director\n\/s\/ Director GEORGE L. ROMINE\n\/s\/ JOHN S. SCULLY, III Director\n\/s\/ J. D. SHOCKEY, JR. Director\n\/s\/ FRED G. WAYLAND, JR. Director\nC. RIDGELY WHITE Director\n\/s\/ F. DIXON WHITWORTH, JR. Director","section_15":""}
{"filename":"739460_1995.txt","cik":"739460","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCanyon Resources Corporation, a Delaware corporation (the Company or Canyon) is a Colorado-based company which was organized in 1979 to explore, acquire, develop, and mine precious metal and other mineral properties. The Company or Canyon is used herein to refer to all of the wholly-owned and majority-owned subsidiaries of Canyon Resources Corporation. Since 1986 the Company has been a reporting company and its securities have been traded on NASDAQ.\nThe Company is involved in all phases of the mining business from early stage exploration, exploration drilling, development drilling, feasibility studies and permitting, through construction, operation and final closure of mining projects.\nThe Company has gold and industrial mineral production operations in the western United States. The Company conducts exploration activities in the search for additional valuable mineral properties in the western United States, and in a number of areas throughout Latin America and Africa. The Company's exploration and development efforts emphasize precious metals (gold and silver) and industrial minerals.\nOnce acquired, mineral properties are evaluated by means of geologic mapping, rock sampling, and geochemical analyses. Properties having favorable geologic conditions and anomalous geochemical results usually warrant further exploration by the Company. In almost all cases, exploration or development drilling is required to further test the mineral potential of a property.\nProperties which have a demonstrated inventory of mineralized rock of a potentially economic nature are further evaluated by conducting various studies including calculation of tonnage and grade, metallurgical testing, development of a mine plan, environmental baseline studies and economic feasibility studies. If economics of a project are favorable, a plan of operations is developed and submitted to the required governmental agencies for review. Depending on the magnitude of the proposed project and its expected environmental impact, a vigorous environmental review may be required prior to issuance of permits for the construction of a mining operation.\nThe Company conducts a portion of its mineral exploration and development through joint ventures with other companies. The Company has also independently financed the acquisition of mineral properties and conducted exploration and drilling programs and implemented mine development and production from mineral properties in the western United States and exploration programs in Latin America and Africa. (See \"Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPRODUCTION PROPERTIES\nKENDALL MINING DISTRICT\nGeneral\nThe Kendall Mine near Lewistown, Montana, was developed as an operating open-pit, heap-leach gold mine in September 1988 under the management of the Kendall Venture, a joint venture between the Company and Addwest Gold, Inc. (Addwest). On January 26, 1990, the Company acquired all of the issued and outstanding common stock of Addwest and through its wholly-owned subsidiary, CR Kendall Corporation, became the operator and sole owner of the operating interest in the Kendall Mine.\nThrough 1995, the Kendall Mine operation leached gold and silver from crushed ore on a year-round basis. Mining and crushing of all remaining ore was completed in January 1995. Leaching of the remaining gold in the heap leach pads will continue through 1996.\nOperations\nThe Kendall Mining District is located approximately 20 miles north of Lewistown, Montana, and is accessible by paved U.S. highway and graded dirt roads. The property rights controlled by the Company include (i) approximately 253.61 acres in patented claims and fee land; (ii) mining leases on approximately 1,932 acres in 71 patented mining claims and fee land. The recovery facilities include a 1.6 million ton heap leach pad and a 9 million ton heap leach pad of crushed ore which are still undergoing leaching; process ponds for retention of barren and pregnant solutions, a 1,000 gpm carbon adsorption plant, a complete assay laboratory, and facilities for production of gold-silver dore bars.\nMining operations were terminated in January, 1995, with the exhaustion of the known orebodies. In 1995, a total of 21,500 tons of ore containing 1,354 ounces of gold and 24,000 tons of waste were mined. The Kendall Mine produced 16,624 ounces of gold and 7,429 ounces of silver during 1995. As of January 1, 1996, approximately 7,000 ounces of recoverable gold remained in the two leach pads. Cyanide-bearing solutions are applied to the crushed ore through a drip irrigation system that, during the winter, is buried within the heap. In general, gold production declines during the winter at the Kendall Mine, due to the lower temperatures and resulting slower dissolution rate of gold.\nIt is anticipated that approximately 7,000 ounces of gold will be produced in 1996. This lower production is due to cessation of new ore mining and crushing in January 1995. Gold production is expected to cease in 1997.\nFrom April 1988 through December 1993, a total of 1,090 drill holes totalling 332,619 feet were drilled in the Kendall Mining District. No drilling has been done since 1994. Drilling was conducted along a two mile long mineralized zone and resulted in the discovery or delineation of six separate deposits. All known targets warranting drilling have been tested and no further exploration work is planned for the Kendall Mining District.\nDuring 1995, the Company's capital expenditures at Kendall were approximately $0.17 million, primarily related to closure construction activities.\nStatistical production and financial data of the Kendall Mine for the period from 1991 through 1995 are shown on the following table.\n(1) Gold production net to Canyon after payment in kind of 5% royalty. (2) Includes royalty, severance taxes, overhead, and reclamation reserve. (3) Not meaningful, as active mining of new ore ceased in January, 1995. (4) Prior to provision for final site restoration of $1.1 million.\nEnvironmental Regulation & Reclamation\nThe Kendall Mine operates under permits issued by the Montana Department of Environmental Quality (DEQ), and other regulatory agencies. A life of mine permit was granted by these agencies on November 1, 1989. The Company recently completed a land exchange with the U.S. Bureau of Land Management (BLM). In the exchange, the Company received about 150 acres of BLM land within the Kendall Mine permit area in return for about 120 acres of patented mining claims outside the permit area. Because of this exchange, the BLM no longer manages any land within the permit area and no longer\nholds regulatory authority over the Kendall Mine. The Company has filed a final closure plan with the DEQ. This plan provides for enhanced closure measures not contemplated in the original permit. The DEQ approved the reclamation portion of the closure plans, and is reviewing the water quality and monitoring plans.\nThe Kendall Mine uses internal and external technical experts to monitor and insure environmental compliance. The Company believes the operation is currently in material compliance with all environmental and safety regulations.\nThe Montana Department of Environmental Quality requires that the Company maintain a $1,869,000 reclamation bond to ensure appropriate reclamation of the Kendall Mine. Reclamation has been ongoing throughout the life of the operation. Disturbed areas are contoured and topsoil is replaced and reseeded as soon as possible. During 1995, approximately 11 disturbed acres were reclaimed, an additional 16 acres were recontoured and prepared for reclamation, and no additional acres were disturbed.\nAs of the end of January 1995, all identified mineable ore reserves have been mined. Final reclamation will require recontouring of waste rock dumps, roads and other areas and redistribution of topsoil and reseeding of some disturbed areas. Reclamation of the heap will begin only when gold recovery by continued leaching becomes no longer profitable. Rinsing of the spent ore may require two or more years before final closure of the heap can begin. Bond release on the property will only take place once the regulatory agencies are satisfied that the mine has met all reclamation requirements. There is no assurance of agency satisfaction with mine closure.\nFERNLEY DIATOMITE PROPERTY\nThe industrial mineral activities of the Company are conducted through its wholly-owned subsidiary, CR Minerals Corporation. The Company produces and markets diatomite under the tradename of DiaFil and sells the product both by a distributor network as well as directly to customers. Diatomite or diatomaceous earth consists of siliceous skeletal remains of single cell aquatic plants. The unique properties of diatomite allow it to be used in a wide variety of applications. The main characteristics of diatomite that are important to its use in industrial products are unique structure, large surface area, high absorption of liquids, mild abrasive qualities, low bulk density, low thermal conductivity, chemical inertness, high silica content, and low impurities. Diatomite is used to manufacture a broad variety of industrial materials, such as paints, plastics, asphalt coatings, insecticides, fertilizers, and polishes. The Company has developed a wide range of diatomite products. These products are differentiated based on particle size distribution, which yields different physical properties.\nCR Minerals has established a distributor network in the United States, Canada, and throughout the world for assisting in the marketing of its diatomite. These distributors sell into the nonagricultural markets - paint, plastics, asphalt coatings, and other filler applications. Currently CR Minerals sells directly to agricultural users and wholesalers. CR Minerals maintains its administrative offices in Golden, Colorado. Sales orders are placed at this office and transferred to the Fernley production site in Nevada after scheduling the shipping date. Accounting, inventory control, transportation, and billing are handled in Golden.\nCR Minerals conducts mining and hauling with its own equipment and staff. The diatomaceous earth ore is mined from an open-pit and hauled by truck approximately 15 miles to the diatomite plant in Fernley, Nevada. Initially the diatomite is crushed to aggregate size, and then simultaneously milled and dried in a high volume stream of hot air. The dried diatomite is collected in cyclones for subsequent size classification by mechanical means or air classification. The coarser and denser accessory minerals are removed, and the diatomite particles can then be segregated by size fraction. Generally, the finer the size fraction, the higher the value. The processing facility has a capacity of 40,000 tons per year of processed diatomite and can load finished product in bulk rail cars, bulk bags, or standard 50 and 55 pound bags which can be shipped by rail, truck, and as ocean cargo. The processing facility has been in operation since the 1950's. Since acquisition in 1987, the Company has made capital improvements including additional air classification equipment, storage bins, and bulk bag loading facilities. Ample diatomite reserves exist for over 25 years production at near capacity rates.\nThe plant produces a natural diatomite product that is composed mainly of noncrystalline silica. DiaFil products typically contain less than 1% crystalline silica. Competitive calcined diatomite products contain up to 65% crystalline silica. Long-term exposure to crystalline silica is believed to cause pneumoconiosis or fibrotic lung disease. Recent work by the International Agency for Research on Cancer (IARC) of the World Health Organization has highlighted the link between cancer and crystalline silica. The Company believes that the low amount of crystalline silica in its DiaFil products is aiding in its marketing activities.\nThe Company's diatomite operations are subject to local, state and federal laws and regulations. These laws and regulations primarily apply to air quality and plant emissions resulting from mining, crushing, drying, size classification, and packaging operations. Pursuant to recently enacted Nevada statutes, the Company has submitted mining reclamation plans for three diatomite deposits. The Company currently mines diatomite from one of these deposits and a prior operator mined from the other two deposits. All of the deposits have been mined by previous operators under regulatory policies much different than those in existence today. The Company anticipates, but cannot guarantee, that the permits will be issued with full acknowledgement of the pre-law disturbance. Regulatory agencies have not issued mining permits for any of the three deposits, but have required the Company to post a reclamation assurance of $24,785 in connection with one of the applications. The Company anticipates that reclamation assurances will be required for the other applications at some time, possibly an additional $60,000.\nMining is currently being conducted on private land owned by the Company. Patent applications were filed in 1993 for claims that contain additional diatomite deposits. Patents have not yet been issued. The land on which the processing facility is located is leased from the Southern Pacific Railroad, but the facilities are owned by the Company. This lease expires in September 2007 and requires monthly payments of $1,050.\nDEVELOPMENT PROPERTIES\nBRIGGS PROJECT\nGeneral\nThe Briggs project, located on the west side of the Panamint Range, near Death Valley, California was acquired by the Company in 1990. It is 16 miles northeast of Trona and 35 miles northeast of Ridgecrest, in Inyo County, California. Access from Trona is by 33 miles of paved and graded gravel roads. The Company owns 100% of the Briggs project, subject to a 2% net smelter return royalty and an additional 2% net smelter return royalty on all gold production in excess of 400,000 ounces.\nBriggs' holdings include 809 unpatented mining claims, 67 mill site claims and 1 tunnel site claim that comprise an area of approximately 16,615 acres. The passage of the Desert Protection Act in 1994 removed all of the Company's holdings from Wilderness Study Areas. Most of Canyon's mining claims are now located on land prescribed for multiple use management by the U.S. Bureau of Land Management.\nFinancing\nOn December 6, 1995, CR Briggs, the Company's wholly owned subsidiary closed a $34 million credit facility for the construction of the Briggs Mine. See \"Item 1 - Business\" and \"Item 8 - Notes to Financial Statements\" for a description of the transaction.\nExploration and Development\nAt the turn of the century numerous small gold mines and prospects were active along the western slope of the Panamint Range, but all activity stopped by World War II. Since the resurgence of gold exploration in the western United States during the last 20 years, gold production in the Panamint Range resumed intermittently on a small scale from two high-grade deposits. Moreover, in the past several years, other companies have conducted drilling programs on mining claims either within the perimeter of the Briggs claim block or on its periphery.\nSignificant gold mineralization occurs within the Briggs claim block along a six-mile long trend that includes the Briggs, Cecil R, Jackson, and Gold Tooth prospects. In 1991, considerable drilling and exploration was conducted in each of these areas. Since 1991, drilling has been conducted only on the Briggs project. The Company plans to conduct further exploration, including drilling, on several of these targets in 1996.\nIn 1992 and 1993, diamond drilling within the Briggs orebody obtained core samples of gold ore for both metallurgical and crushing tests. Metallurgical testing conducted to date indicates that if the ore is crushed to less than 1\/4 inch, approximately 75-85% of the gold in the ore can be extracted by conventional cyanide heap leaching methods.\nThe Company completed a definitive Feasibility Study in February 1994. Roberts & Schaefer Company of Salt Lake City, Utah was retained to conduct a \"Fatal Flaw Review\" of all aspects of the Feasibility Study with the exception of ore reserves; mine plan; mining capital and operating costs; land status; permitting and environmental issues. Roberts & Schaefer Company also prepared the Executive Summary for the Feasibility Study. Mine Reserves Associates, Inc. of Wheat Ridge, Colorado, was retained to conduct the \"Fatal Flaw Review\" of the ore reserves, mine plan, and mining capital and operating costs. Remy and Thomas, Attorneys at Law, of Sacramento, California reviewed the environmental and permitting aspects of the Feasibility Study. Chamberlin & Associates of Littleton, Colorado provided an additional opinion on the gold recovery. The \"Fatal Flaw Reviews\" concluded that the Briggs Gold Project is technically and economically feasible.\nThrough the end of 1995, a total of 192,634 feet of drilling in 567 holes has been completed at Briggs for exploration, condemnation, metallurgical, and environmental purposes. The development drilling, on approximately 100 foot centers, has defined 805,000 ounces of gold, contained within 32.2 million tons of mineralized rock with an average grade of 0.025 ounce of gold per ton, using a cutoff grade of 0.01 ounce of gold per ton.\nThe Feasibility Study, augmented by an economic update in August of 1995, indicates that approximately 21.9 million tons of the Briggs deposit can be mined economically at a $375 gold price. The 21.9 million tons of mineable ore has an average grade of 0.030 ounce gold per ton, and contains 653,000 ounces of gold with a strip ratio of 1.7:1 (waste tons to ore tons).\nPatent application was made for the claims on the Briggs deposit during 1993, however no assurances can be made that patents will be issued.\nWith the completion of permitting and financing, construction of mine facilities began on December 16, 1995. The initial construction period will last approximately 7 months. Gold production will commence in the second half of 1996, after sufficient ore stacking and leaching to facilitate gold recovery has occurred.\nEnvironmental Regulation\nIn 1995 the U.S. Bureau of land Management (BLM) and Inyo County, as co-lead agencies, completed a joint Environmental Impact Statement\/Environmental Impact Report (EIS\/EIR) on the Briggs Project. Subsequently, those agencies, as well as several other agencies, issued permits to the Briggs project. Excepting permits issued by the air quality authority which require certain actions following project construction, the permits issued to date are adequate for all mine operations involving currently identified mineable reserves. A local environmental group, allied with the Timbisha Shoshone Indian Tribe, have initiated various actions in opposition to the Briggs permits. These actions are more fully described under \"Item 3","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFollowing the completion of the environmental review process for the permitting of the Briggs Project, the United States Department of the Interior, Bureau of Land Management (BLM) issued an approval of the Plan of Operations for the project on July 10, 1995. That approval was appealed to the Interior Board of Land Appeals within the Department of the Interior (IBLA) on August 10, 1995 by the Timbisha Shoshone Tribe of Death Valley, Madeline Esteves (a member of the Tribe), and the Desert Citizens Against Pollution (DCAP). The appeal alleges that BLM failed to adequately consult with the Tribe prior to taking its action and also alleges various technical errors in the environmental review process and requested a stay of the effectiveness of the approval pending resolution of the appeal. On August 29, 1995 the IBLA issued a temporary stay of the effectiveness of the Plan of Operations pending\nresolution of the request for stay included in the appeal. The Company has vigorously opposed this appeal through the filing of responsive briefs with the IBLA. In addition, the BLM has vigorously opposed the appeal through the filing of its own brief. The IBLA denied the request for stay and removed the temporary stay on October 23, 1995, stating that there was not a likelihood that the appellants would prevail on the merits of the appeal, thus allowing the Company to proceed with the development and operation of the project under the BLM Plan of Operations. The same appellants filed a Petition for Expedited Secretary's Review on November 14, 1995 with the office of the Secretary of the Interior requesting that the Secretary take jurisdiction of the proceeding and overrule the Interior Board of Land Appeals. On March 13, 1996, the Office of the Solicitor of the Interior on behalf of the Secretary issued a decision refusing to take jurisdiction with respect to the appeal. No final decision on the merits of the appeal has yet been rendered by the Interior Board of Land Appeals. Once the Interior Board of Land Appeals rules on the merits of the appeal, a further appeal by any of the parties to the proceeding can be filed in Federal Court. The Company believes that the appeal will be dismissed in the ordinary course of the appeals process as being without substantial merit or basis in law or fact.\nOn July 12, 1995, the Inyo County Planning Commission approved the Mine Reclamation Plan for the Briggs Project under applicable California law. This approval was appealed on July 26, 1995 to the Inyo County Board of Supervisors by the same appellants listed above in connection with the appeal to the IBLA. The Inyo County Board of Supervisors unanimously rejected the appeal and issued its decision on August 30, 1995. The appellants (hereafter \"Tribe\") appealed the decision of the Inyo County Board of Supervisors to the Superior Court of California in and for Inyo County on November 10, 1995 under a Petition for Writ of Mandate and Complaint for Injunctive Relief (\"Petition\") filed November 13, 1995 as No. 21419. Both the Company and Inyo County have answered the complaint and are vigorously defending the appeal.\nThe Petition alleged violations of the California Environmental Quality Act (hereinafter, \"CEQA\") and the Surface Mining and Reclamation Act (\"SMARA\"). The Tribe sought a Temporary Restraining Order from the Court on January 16, 1996. However, on January 17, the Inyo County Superior Court denied that request and set the matter for an Order to Show Cause regarding the issuance of a Preliminary Injunction on February 5, 1996.\nThe matter was heard on February 5, and, on February 16, 1996, the Court denied the Tribe's request for the issuance of a Preliminary Injunction. This matter will now proceed with briefing for a hearing before the Court on June 13, 1996. The Company believes that the matter will be dismissed as being without substantial merit or basis in law or fact.\nOn July 14, 1995, the Lahontan Regional Water Quality Control Board (\"Lahontan\") in California issued a Waste Discharge Order to the Company for the Briggs Project. On October 2, 1995, the same appellants identified above filed a petition with the California State Water Quality Control Board challenging certain of the findings and certain aspects of the Waste Discharge Order. In this petition, the appellants have not requested a stay and have not asked that the Waste Discharge Order be withdrawn or rescinded. Instead, they have petitioned to change various technical matters of the Waste Discharge Order and to have the financial assurance bond be increased. The Company and Lahontan are responding to this petition through the staff of the State Water Quality Control Board. The Company believes that the petition will be dismissed administratively through the staff consultation process without the necessity of a hearing before the entire board.\nThe Company has vigorously defended its position in each of the proceedings before the Interior Board of Land Appeals, the Inyo County Court and the Water Board, and believes that all of the claims of the Timbisha Shoshone Tribe and the local environmental group are without merit. No assurances can be given regarding the outcome of these actions or the effects those outcomes might have on the Company's ability to complete and operate the mine.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were brought to a vote of Security Holders in the last quarter of 1995.\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 the National Association of Securities Dealers Automated Quotation System (NASDAQ), National Market, under the symbol CYNR. The Company's common stock was first included on NASDAQ on February 9, 1986, following the completion of the Company's initial public offering and on the NASDAQ National Market on May 15, 1990. Canyon also has warrants that trade on the National Market under the symbol CYNRW. The following table reflects the high and low bid prices for the Company's common stock and warrants during the indicated periods:\nOn March 1, 1996 the high and low prices for the Company's common stock were $3.38 and $3.25, respectively. The high and low prices for the Company's warrants on March 1, 1996 were $0.28 and $0.25, respectively. These prices represent prices between dealers, do not include retail markups, markdowns, or commissions, and do not necessarily represent actual transactions. All price quotations were provided by NASDAQ.\nAs of March 1, 1996, there were approximately 1,359 holders of record of the Company's common stock. The number of shareholders of the Company who beneficially own shares in nominee or \"street\" name or through similar arrangements is estimated by the Company to be approximately 3,000. As of March 1, 1996, there were also 29 holders of record of trading warrants and 12 holders of unregistered warrants to purchase common stock.\nAs of March 1, 1996, there were outstanding; a) 25,943,459 shares of common stock; b) 4,118,632 warrants to purchase common stock; c) 2,128,500 employee and non-qualified stock options to purchase common stock; and d) 6,137,681 shares of common stock issuable upon conversion of debentures totalling $21.2 million.\nFor the foreseeable future, it is anticipated that the Company will use any earnings to finance its growth and that dividends will not be paid to shareholders. Further, pursuant to an agreement executed by the Company in favor of its wholly owned subsidiary, CR Briggs Corporation, in connection with a loan for the Briggs Project, the Company has agreed to maintain certain levels of working capital,\ntangible net worth, and leverage ratios which could restrict the payment of dividends where such payment would result in a failure to maintain such levels. Similarly, CR Briggs Corporation is prohibited from repaying the Company for advances or from paying dividends to the Company from the Briggs Project cash flow unless certain conditions relating to the financial performance of the Briggs Project are met.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected information regarding the Company's financial condition and results of operations over the past five years.\n(1) Includes asset writedowns of $14,075,400 for 1) Kendall Mine - $8,000,000; 2) Exploration Properties - $4,042,100; 3) Non-Compete Agreement - $2,033,300.\n(2) Gain on extinguishment of debt, net of taxes ($1,098,900) and credit equivalent to tax benefit from utilization of net operating loss carryforwards ($719,400).\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\nThe Company recorded a net loss of $6.1 million, or $0.24 per share, on revenues of $9.0 million in 1995, compared to a net loss of $0.3 million, or $0.01 per share, on revenues of $19.6 million in 1994. The 1995 results were principally impacted by lower gold production, a provision for final site restoration costs, and the writedown of remaining carrying values at the Kendall Mine.\nActive mining of new ore at Kendall ceased in January, 1995, with production of 16,624 ounces realized from continued leaching of all previously mined ore. As a result, substantially lower revenues of $9.0 million were realized during 1995, a 54% decrease from the $19.6 million in revenues during 1994. The Company sold 16,386 ounces of gold and 8,694 ounces of silver in 1995 at an average realized price of $386 per equivalent gold ounce. Comparable amounts in 1994 were 45,877 ounces of gold and 21,126 ounces of silver at an average price of $374 per equivalent gold ounce. The New York Commodity Exchange (COMEX) gold prices averaged $385 per ounce in 1995 and $384 per ounce in 1994. All ounces sold in 1995 were at spot prices, in contrast to sales in 1994 which included 18,300 ounces settled with spot deferred contracts averaging $351 per ounce and 6,393 ounces delivered against a gold loan monetized at $374.50 per ounce. As a result of the hedging program and gold deliveries in 1994, the Company recognized lower revenues of $755,900 relative to spot prices in effect on the settlement dates.\nCost of sales was $7.4 million in 1995 as compared to $12.3 million in 1994. Cost of sales per ounce at Kendall in 1995 increased to $362 as compared to $238 in 1994 due to the lower production levels associated with cessation of mining of new ore. Included in cost of sales for 1995 and 1994 are all direct and indirect costs of mining, crushing, processing and general and administrative expenses of the mine, including normal provisions for reclamation of $0.8 million for each year. In addition, the Company recorded a fourth quarter 1995 charge for remaining final site restoration at Kendall of $1.1 million as a consequence of reviewing and updating its anticipated scope of work to achieve mine closure.\nDepreciation, depletion, and amortization was lower during 1995 due principally to lower ounces sold from the Kendall Mine. Effective October 1, 1995, 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. SFAS 121 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Concurrent with adoption, the Company has determined that its carrying value for property and equipment at the Kendall Mine is not recoverable, due principally to the maturing life of the mine (remaining economic life of one year) and the level of site restoration costs anticipated during the next two to three years to achieve mine closure. As estimated cash outflows exceed estimated cash inflows, the Company has reduced the carrying value to zero and recorded a fourth quarter 1995 impairment of $296,000.\nSelling, general and administrative expenses were $3.4 million in 1995 as compared to $3.0 million in 1994. The increase was due primarily to increased corporate activity for business development and to increased diatomite sales and corresponding support levels.\nExploration costs expensed, almost entirely foreign related, decreased by $0.2 million to $1.0 million in 1995. During the current year, the Company closed its Mendoza, Argentina office and focused principally on opportunities in Brazil and Africa.\nAbandonments of $0.3 million in 1995 were in the ordinary course of business, and related principally to properties in Latin America.\nInterest income was marginally lower in 1995, as higher yields partially offset the effects of lower investible balances. Interest expense was lower in the current period as a gold loan was not outstanding for the full year. In addition, interest expense associated with the Company's debentures declined due to voluntary conversions of $725,000 principal during the year.\nThere was no current or deferred provision for income taxes during 1995 or 1994. The Company computes deferred taxes according to the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109). SFAS 109 requires deferred income taxes to be computed under the asset and liability method and to be adjusted to and maintained thereafter at statutory rates in effect when the taxes are expected to be paid. SFAS 109 also requires that a valuation allowance be provided if it is more likely than not that some portion or all of a deferred tax asset will not be realized. Although the Company maintains significant net deferred tax assets, principally in the form of operating loss carry-forwards, the Company did not record a deferred tax credit in either 1995 or 1994 due to an assessment of the \"more likely than not\" realization criteria required by SFAS 109.\nInflation did not have a material impact on operations in 1995 or 1994. Management of the Company does not anticipate that inflation will have a significant impact on continuing operations.\n1994 COMPARED TO 1993\nThe Company recorded a net loss of $0.3 million, or $0.01 per share, on revenues of $19.6 million in 1994, compared to net income of $0.9 million, or $0.04 per share, on revenues of $19.9 million in 1993. The 1994 results were adversely affected by higher interest expense and exploration costs, as compared to 1993.\nRevenues of $19.6 million were realized from the sale of gold, silver, and diatomite products during 1994, representing a 2% decrease from the $19.9 million in revenues during 1993. The Company sold 45,877 ounces of gold and 21,126 ounces of silver in 1994 at an average realized price of $374 per equivalent gold ounce. The New York Commodity Exchange (COMEX) gold price averaged $384 per ounce in 1994. Comparable amounts in 1993 were 51,113 ounces of gold and 29,633 ounces of silver at an average realized price of $353 per equivalent gold ounce and a COMEX average of $360 per ounce. As a condition of a gold loan secured in May 1993, the Company was required to hedge a portion of the Kendall Mine's future production to ensure adequate cash flow for repayment of the obligation. Accordingly, the Company entered into spot deferred contracts totalling 42,000 ounces of gold at prices ranging from $339 per ounce to $357 per ounce. During 1994, 18,300 ounces were settled at an average price of $351 per ounce. In addition, 6,393 ounces were delivered against the gold loan at a monetized price of $374.50 per ounce. During 1993, the Company settled 23,700 ounces at an average price of $343 per ounce and delivered 4,288 ounces against the gold loan. As a result of the hedging programs and gold loan deliveries, the Company recognized lower revenues of $755,900 and $580,600 in 1994 and 1993, respectively, relative to spot prices in effect on the settlement dates.\nCost of sales was $12.3 million in 1994 as compared to $12.5 million in 1993. Cost of sales per ounce at Kendall in 1994 was $238 as compared to $223 in 1993, representing a 7% increase. The higher unit costs were due principally to lower ore tons and ounces mined, and therefore lower production levels (-11%), and higher strip ratios of the ores mined. Included in cost of sales for 1994 and 1993 are all direct and indirect costs of mining, crushing, processing, and general and administrative expenses of the mine, including provisions for reclamation of $0.8 million and $0.4 million, respectively. The higher reclamation accrual in 1994 was due to a fourth quarter revision to the anticipated cost of final site restoration. Although higher metal prices were realized, lower production levels resulted in a decline of Kendall's operating earnings (defined as sales less cost of sales) to $6.2 million as compared to $6.7 million in the prior period.\nDepreciation, depletion and amortization was higher during 1994 than 1993 due principally to an increase in the capital base at Kendall and the resulting DD&A rate to $41 per ounce in 1994 from $35 per ounce in 1993. Other Company DD&A charges increased marginally in 1994 as well, due to current year capital additions.\nSelling, general and administrative expenses were $3.0 million in 1994 as compared to $2.1 million in 1993. The increase was due to: a) higher corporate costs of $0.4 million; b) increased diatomite sales and corresponding support levels ($0.2 million); and c) cost of establishing and maintaining an office in Mendoza, Argentina to support exploration activities ($0.3 million).\nExploration costs expensed in 1994 were $1.2 million as compared to $0.3 million in 1993 and reflect the commencement of a worldwide exploration effort. Foreign activity in 1994 totalled $1.1 million with a focus on exploration opportunities in Central and South America, Africa and the Pacific Rim. U.S. spending was a nominal $0.1 million in 1994.\nAbandonments in 1994 resulted in a nominal charge of $0.1 million as compared to $1.3 million in 1993. The prior year amount related principally to properties in the Moccasin and Judith Mountains in Montana.\nInterest income was higher in 1994 due to higher average cash balances. Interest expense was higher in the current period due to a full year of interest expense on the Company's $22.0 million, 6% interest, subordinated convertible debentures which were sold in June 1993. During 1994, $0.1 million of principal was converted to 29,900 shares of common stock.\nThere was no current provision for income taxes in 1994. The prior period amount was a credit of $35,800, reflecting an adjustment to the Company's 1992 estimate of its alternative minimum tax liability.\nInflation did not have a material impact on operations in 1994 or 1993.\nLIQUIDITY & CAPITAL RESOURCES\nSUMMARY:\nThe Company's cash and cash equivalents decreased $11.4 million during 1995 to $1.9 million at year end. The decrease was a result of cash outflows from operations of $2.4 million, $7.6 million of cash spent on investing activities, and $1.4 million of cash used in financing activities.\nOPERATING ACTIVITIES:\nOperations used $2.4 million of cash in 1995 in contrast to providing cash of $2.4 million and $5.2 million in 1994 and 1993, respectively. The decreasing trend is principally a result of declining production and sales of gold from the Kendall Mine, now in its final year (1996) of economic life.\nINVESTING ACTIVITIES:\nCapital expenditures in 1995 totaled $8.1 million. Major components included $5.5 million at Briggs, of which $1.6 million were financed by drawings under a loan facility; approximately $1.2 million for the Company's share of costs on the McDonald project, relating principally to permitting; $0.3 million at the Company's diatomite operations; $0.8 million on foreign exploration properties, with the remaining amount spent on miscellaneous projects.\nCapital expenditures in 1994 totalled $6.7 million. Major components included $3.4 million at the Briggs property, principally related to environmental, metallurgical and engineering work; $1.0 million for the Company's share of costs on the McDonald project which principally related to engineering and environmental analyses to support the Plan of Operations and commencement of the permitting process; $0.5 million at the Kendall Mine, principally to construct a carbon adsorption plant to process lower grade solutions expected with the cessation of new ore mining; $0.3 million at the Company's diatomite operations; with the remaining amount associated with miscellaneous exploration projects and corporate activities.\nCapital expenditures in 1993 totalled $7.6 million. Major components included $3.1 million at the Briggs property, principally related to environmental, metallurgical and engineering work; $2.0 million for the Company's share of costs on the McDonald project which principally related to hydrological, metallurgical and engineering work and to additional purchases of property within the area of interest; $1.1 million at the Kendall Mine, principally for final leach pad expansion; with the remaining amount associated with the Company's diatomite operations and miscellaneous exploration projects.\nFINANCING ACTIVITIES:\nOn December 6, 1995, the Company's wholly owned subsidiary, CR Briggs Corporation, secured a $34.0 million loan facility to finance the capital requirements of mine construction and working capital for its Briggs Mine in California. Costs of approximately $1.2 million incurred in connection with obtaining the facility will also be financed. The Company is guaranteeing the loan obligations of CR Briggs Corporation, and the loan facility is collateralized by a first mortgage lien on the property, non-leased assets of CR Briggs Corporation, and a pledge of the Company's stock in CR Briggs Corporation. The facility was provided by a syndication of three banks; Banque Paribas, Bayerische Vereinsbank AG, and NM Rothschild & Sons Ltd. and includes three tranches; a $25 million gold loan; a $5 million cash loan; and a $4 million cost overrun facility. The cost overrun facility is available only in the event of spending in excess of $30 million and an additional $2 million contribution by the Company. The Company has escrowed $2.0 million in connection with this requirement. The amount is included in other long-term assets on the Balance Sheet at December 31, 1995, as it is not contemplated to be available to the Company until 1997. On December 27, 1995 drawing commenced on the facility and $25.0 million principal in the form of a gold loan and $1.0 million principal as a dollar loan were drawn. At December 31, 1995, unspent proceeds of $23.3 million are included as restricted cash on the Company's balance sheet. The gold loan portion was monetized at $388.05 per ounce, or 64,425 ounces and carries an initial interest rate for 90 days of 5.32%. The dollar loan's initial interest rate for 90 days is 9.87%. Varying interest rate periods can be selected under the terms of the facility. Repayment terms\nrequire quarterly installments over six years, commencing in 1997 which include scheduled principal reductions and a varying cash sweep amount equal to 30% of free cash flow after primary debt service. Within three years of project completion (approximately 4 months beyond construction completion and start-up) an additional 70,000 ounces of recoverable reserves must be identified or 100% of excess cash flow after scheduled repayments will be applied as additional prepayments against the loan amounts. As a condition of the loan, a portion of the Briggs Mine's future production was hedged to ensure adequate cash flow for repayment of the obligation. Accordingly, fixed forward contracts totalling 186,600 ounces were entered into at prices ranging from $395 per ounce to $424 per ounce. In addition, put options on 21,600 ounces at a strike price of $380 per ounce were purchased. The put options were financed by the sale of call options on 10,800 ounces at a strike price of $403 per ounce. Approximately 41% of the Briggs Mine production from current reserves was hedged through forwards and put options as of December 31, 1995.\nIn connection with the issue of certain surety bonds in 1995 for the performance of reclamation obligations at the Kendall and Briggs Mines, a bank Letter of Credit has been provided in favor of the Surety as partial collateral for such bond obligations. The Letter of Credit, in the amount of $1,953,000, will expire no earlier than December 31, 1996, and at the bank's option, may be renewed for successive one-year periods. The Company has fully collateralized the Letter of Credit by depositing cash in the amount of $1,953,000 with the bank. The amount is included as restricted cash on the Company's balance sheet at December 31, 1995. Of the amount on deposit, $84,000 was funded in 1995 and $1,869,000 was funded in prior years in connection with a separate collateralized letter of credit for only the Kendall Mine.\nDuring 1995, in connection with a first year work commitment on an exploration property in Ethiopia, a bank Letter of Credit has been provided in favor of the Ministry of Mines and Energy, Federal Democratic Republic of Ethiopia. The Letter of Credit, in the amount of $500,000, will expire on January 6, 1997. The Company has fully collateralized the Letter of Credit by depositing cash in the amount of $500,000 with the bank. The amount is included in other non-current assets in the Company's balance sheet at December 31, 1995.\nDuring 1994, the Company fully repaid a previous gold loan by delivering 6,393 ounces to the lender. The initial loan amount of $4.0 million, secured in 1993, was monetized at $374.50 per ounce (10,681 ounces). The Company repaid 4,288 ounces on the loan during 1993. Because the gold price at the repayment dates was higher than the original monetized price in 1994, the Company recognized lower revenues and cash flow of $103,000 than it would have received if all gold were sold at spot market prices. During 1993, the gold price was lower than the original monetized price at the repayment dates and the Company recognized higher revenues and cash flow of $28,500 than it would have received if all gold were sold at spot market prices.\nIn August 1994, the Company exercised purchase options on its leased mining equipment at the Kendall Mine for $0.9 million and financed the purchase price over a three year period. Most of the equipment was transferred to the Briggs Mine in late 1995 to be utilized during the mine development phase, some equipment was disposed of during 1995, and some equipment will remain at Kendall during the final year of production and reclamation activity.\nOn June 2, 1993 the Company raised a total of $22.0 million ($20.5 million after financing costs) through the sale of subordinated debentures which are due June 1, 1998. Interest is payable semi-annually on December 1 and June 1 at the rate of 6% per annum. The debentures are convertible at the option of the holder any time prior to maturity into common stock at the rate of $3.45 per share. During 1995, $725,000 of principal was converted into 210,100 common shares of the Company. The Company,\nafter June 1, 1996, may redeem the debentures by issuing common stock at a rate of 94% of the then trading price of its common stock or by payment in cash at par. During 1995, the Company made interest payments of $1.3 million. On-going annual debt service costs will be comparable until any future conversions or redemptions.\nThe expiration date on the Company's 3,943,600 trading warrants and a private warrant to purchase 100,000 shares to purchase common stock (all at an exercise price of $3.50 per share) were extended at various times during 1995 and are currently scheduled to expire on April 12, 1996.\nAt December 31, 1995, the Company's debt consisted of the following: 1) $26.0 million Briggs loan; 2) $21.2 million convertible debentures; and 3) $0.4 million on a mining equipment loan.\nOUTLOOK:\nOperations\nMine development and construction of facilities at Briggs is expected to take approximately seven months. Financed expenditures for the period will total approximately $26 million. Gold production will commence in the second half of 1996, after sufficient ore stacking and leaching to facilitate gold recovery has occurred with production of approximately 19,000 ounces anticipated. Direct cash operating costs, after achieving design capacity, are expected in the range of $215-$225 per ounce during the fourth quarter of 1996 and approximately $230-$240 per ounce over the mine life.\nThe Company anticipates gold production from residual leaching at Kendall in 1996 of approximately 7,000 ounces at direct cash operating costs of approximately $330-340 per ounce. The Company expects to spend approximately $0.7 million on reclamation during 1996, and a further $2.0 million beyond 1996 through mine closure. The Company has fully accrued the expected reclamation costs as of December 31, 1995.\nDuring 1996, the Company expects to contribute approximately $1.8 million to fund its share of expenditures for the McDonald Project, principally relating to ongoing permitting and support activities. The permitting process will be rigorous and is expected to take a minimum of 30-36 months from the initial filing of the Plan of Operations in November 1994. The Company's overall exploration objectives in 1996 will be to seek quality joint venture partners for several of its foreign properties and focus internally on exploring and drilling within and adjacent to the Briggs claim block and select foreign properties, particularly in Brazil. These expenditures are expected to total $3.0 million.\nFinancing\nOn March 26, 1996, the Company completed a private placement in the amount of $12.1 million ($11.3 million net of expenses). The offering was completed at a price of $3.00 per unit which included one share of common stock (4,034,300 total shares) and one-half warrant (2,017,200 total warrants). Each whole warrant entitles the holder to purchase one share of common stock at an exercise price equal to $3.75 per share. The warrants expire on March 25, 1999. The Company intends to file a Registration Statement under the Securities and Exchange Act of 1933 in respect of the common shares, the warrants, and the common shares underlying the warrants and use its best efforts to cause such Registration Statement to become effective as soon as practical. In the event that the Registration Statement does not become effective on or before the 90th day following the completion of the private placement, each purchaser of units will be issued an additional 1\/10 of one common share and 1\/20 of one warrant for each unit purchased. The Company's planned use of proceeds are for exploring properties within and in proximity to the Briggs claim block, continuing to fund its share of\nexpenditures on the McDonald Project, exploration work on select foreign properties, particularly in Brazil, and for general corporate purposes. This financing is expected to adequately capitalize the Company for the next two years consistent with its present objectives.\nThe Company engages in an ongoing evaluation of opportunities in the mining business which may require other uses or additions of capital which cannot be predicted at this time. In addition, the Company, upon successful completion of the permitting process at the McDonald Project, will be required to fund its share of construction costs in order to maintain its present ownership level. The Company's share of these costs may exceed $50 million, which will require additional financing from external sources.\nGold Prices and Hedging\nThe Company's revenues, earnings and cash flow are strongly influenced by world gold prices, which fluctuate widely and over which the Company has no control. The Company's strategy is to provide an acceptable floor price for a portion of its production in order to meet minimum coverage ratios as required by loan facilities while providing participation in potentially higher prices. Production not subject to loan covenants has historically been sold at spot prices. The Company's hedging program for 1996 consists of forwards and put options with approximately 52% of estimated total production hedged at an average price of $394 per ounce. The risks of hedging include opportunity risk by limiting unilateral participation in upward prices; production risk associated with delivering physical ounces against a forward commitment; and credit risk associated with counterparties to the hedged transaction. The Company believes its production risk is minimal, and furthermore has the flexibility to selectively extend maturity dates, thereby postponing delivery against forward commitments. With regard to credit risk, the Company uses only creditworthy counterparties and does not anticipate non-performance by such counterparties.\nEnvironmental Regulation\nIn 1995, the Montana State Legislature passed legislation which streamlined the permitting process of new industrial projects by reorganizing the several state agencies that had jurisdiction over environmental permitting into one central agency, the new Department of Environmental Quality (DEQ). This agency will be responsible for acting on an application for a Hard Rock Mining Operating Permit in connection with a Plan of Operations filed by the Seven-Up Pete Joint Venture for the McDonald gold project. This permit, as well as several other local, state and federal permits, including a joint state and federal Environmental Impact Statement (EIS), will be required before permits can be issued. There are no assurances that all permits will be issued nor that, in the event they are issued, such issuances will be timely, nor that conditions contained in the permits will not be so onerous as to preclude construction and operation of the project.\nThe Kendall Mine in Montana operates under permits granted by the DEQ. The DEQ requires the Company to maintain a $1,869,000 Reclamation Bond to ensure appropriate reclamation. The Company has filed a final closure plan which provides for enhanced measures not contemplated in the original permit. The reclamation portion of the closure plan has been approved, however, the water quality and monitoring plans are still being reviewed. Release of bonding will only take place once the regulatory agencies are satisfied that all reclamation requirements have been met.\nThe U.S. Bureau of Land Management (BLM), Inyo County, the California Department of Conservation, and the Lahontan Regional Water Quality Control Board (Lahontan) have jointly required the Company to post a reclamation bond in the amount of $3,030,000 to ensure appropriate reclamation of the Briggs Mine. Additionally, the Company will be required by Lahontan to post a $1,010,000 bond to ensure adequate funds to mitigate any \"foreseeable release\" of pollutants to state waters at least 90 days prior to initiation of cyanide on the heap leach pads. Both bonds are subject to annual review and adjustment.\nBased upon current knowledge, the Company believes that it is in material compliance with all applicable environmental laws and regulations as currently promulgated. However, the exact nature of environmental control problems, if any, which the Company may encounter in the future cannot be predicted, primarily because of the increasing number, complexity and changing character of environmental requirements that may be enacted or of the standards being promulgated by federal and state authorities.\nFederal Legislation\nIn 1994, the United States Congress passed the California Desert Protection Act (CDPA), resolving surface management classifications for large portions of BLM managed lands in the desert areas of California. The passing of the CDPA released lands around the Briggs Mine for multiple use management, significantly reducing constraints on exploration and mine operations.\nNo congressional legislation was enacted in 1995 to modify the requirements applicable to mining claims on federal lands under the Mining Law of 1812. The timing and exact nature of any mining law changes cannot presently be predicted, however, the Company will continue its active role in industry efforts to work with Congress to achieve responsible changes to mining law. The Company is also continuing its present efforts to patent the Briggs and diatomite claims into private ownership in accordance with the provisions of currently applicable law.\nLegal Actions\nCertain actions are pending with respect to permits issued for the Briggs Mine in California. A local environmental group and the Timbisha Shoshone Tribe have; 1) appealed the Bureau of Land Management's decision to approve the Final Environmental Impact Statement and Plan of Operations; 2) petitioned the Superior Court of Inyo County alleging violations of the California Environmental Quality Act and the Surface Mining and Reclamation Act; and 3) filed a challenge to the issuance of Waste Discharge requirements by the Lahontan Regional Water Quality Board. The Company has vigorously defended its position in each of the proceedings and believes that all claims are without merit, however, there are no assurances regarding the outcome of these actions or the effects those outcomes might have on the Company's ability to complete and operate the mine.\nOther\nIn October, 1995, the Financial Accounting Standards Board (FASB) 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 employee options or similar equity instrument. SFAS 123 encourages, but does not require the method of accounting prescribed by the Statement, and\ndoes allow for an entity to continue to measure compensation cost as prescribed by APB Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. Entities electing to remain with APB 25 must make proforma disclosures of net income and earnings per share as if the fair value based method had been applied, effective for fiscal years beginning after December 15, 1995. The Company expects to continue to measure compensation cost under APB 25, subject to the proforma disclosure requirements of SFAS 123.\nFor the foreseeable future, it is anticipated that the Company will use any earnings to finance its growth and that dividends will not be paid to shareholders. Further, pursuant to an agreement executed by the Company in favor of its wholly owned subsidiary, CR Briggs Corporation, in connection with a loan for the Briggs Project, the Company has agreed to maintain certain levels of working capital, tangible net worth, and leverage ratios which could restrict the payment of dividends where such payment would result in a failure to maintain such levels. Similarly, CR Briggs Corporation is prohibited from repaying the Company for advances or from paying dividends to the Company from the Briggs Project cash flow unless certain conditions relating to the financial performance of the Briggs Project are met.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Stockholders of Canyon Resources Corporation:\nWe have audited the consolidated financial statements of Canyon Resources Corporation and Subsidiaries 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Canyon 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 Note 9 to the consolidated financial statements, the Company changed its method of accounting for impairment of long-lived assets, as required by Statement of Financial Accounting Standards No. 121, in 1995.\n\/s\/ Coopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P. Denver, Colorado\nMarch 27, 1996\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY For the years ended December 31, 1995, 1994, and 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED\nSupplemental disclosures of cash flow information:\n1. The Company paid $1,369,100, $1,453,500, and $891,400 of interest during 1995, 1994, and 1993, respectively.\n2. The Company paid no income taxes during 1995 and 1994, and $78,200 of income taxes during 1993.\nSupplemental schedule of noncash investing and financing activities:\n1. Capital lease obligations of $48,600, $55,600, and $62,100 were incurred for equipment in 1995, 1994, and 1993, resepectively.\n2. Debentures in the principal amount of $725,000 were converted into 210,100 shares of common stock during 1995 and $100,000 in principal were converted into 29,000 shares of common stock during 1994.\n3. The Company issued 61,500 shares of common stock which was valued at $100,000 in exchange for a joint venture interest during 1995 and issued 150,000 shares of common stock and warrants to purchase an additional 75,000 shares of common stock which was valued at $394,500 in exchange for a joint venture interest during 1993.\n4. During 1995, the Company transferred title to previously financed equipment back to the creditor for consideration equal to the unpaid balance of $56,500.\n5. Certain stock options were exercised and paid for by tendering shares otherwise issuable in lieu of cash payment. Fair market value of the shares tendered was $9,500, $254,600, and $265,100 during 1995, 1994, and 1993, respectively.\n6. The Company financed $899,900 of equipment purchases during 1994.\n7. The Company issued a warrant to purchase 200,000 shares of common stock which was valued at $167,400 during 1993.\n8. A note payable in the amount of $1,500,000 was converted into 789,500 shares of common stock during 1993.\nThe accompanying notes are an integral part of these consolidated financial statements.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. NATURE OF OPERATIONS:\nCanyon Resources Corporation (\"the Company\") is a United States based corporation involved in all phases of the mining business from exploration, permitting, developing, operating and final closure of mining projects. The Company has gold and industrial mineral production operations in the western United States and conducts exploration activities in search of additional mineral properties (emphasizing precious metals and industrial minerals) in the western United States and throughout Latin America and Africa. The principal market for the Company's precious metals products are European-based bullion trading concerns. The Company's industrial minerals products (diatomite) are differentiated based on particle size distribution and sold through a distributor network in the United States, Canada and internationally to the paint, plastics, asphalt coatings, and filler markets. Direct sales of diatomite are also made to agricultural markets as an insecticide.\n2. 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 reporting period. Actual results could differ from those estimates.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCONSOLIDATION: The consolidated financial statements of the Company include the accounts of Canyon and its wholly-owned subsidiaries: CR Kendall Corporation; CR Minerals Corporation; CR Briggs Corporation; CR Montana Corporation; CR International Corporation; Canyon Resources (Chile) S.A.; Canyon de Panama, S.A.; CR Brazil Corporation; and its 90% owned subsidiaries: Canyon Resources Venezuela, C.A.; Canyon Resources Africa Ltd.; and Canyon Resources Tanzania Limited. The Company applies equity accounting principles for its 40% ownership in Minera Hispaniola, S.A., a foreign corporation, and proportionately consolidates its interests in undivided interest joint ventures. All intercompany balances and transactions have been eliminated.\nCertain prior period items have been reclassified in the consolidated financial statements to conform with the current year presentation.\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents include amounts which are readily convertible into cash and which are not subject to significant risk from changes in interest rates. The Company maintained at December 31, 1995 and 1994, a significant portion of its cash in two financial institutions.\nRESTRICTED CASH: Cash held as collateral for letters of credit or in escrow for contingencies is classified based on the expected expiration of such facilities. Cash restricted to specific uses is classified based on the expected timing of such disbursements. See Note 7.\nINVENTORIES: Processed ores and metal-in-process are stated at the lower of average cost or market. Materials and supplies are stated at cost.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:\nDEFERRED MINING COSTS: The Company, in order to more closely match expenses and revenues, capitalizes costs of overburden removal that are in excess of the estimated average pit strip ratio over the pit life. When the actual strip ratio becomes less than the estimated average pit strip ratio, these costs are expensed.\nMINING CLAIMS AND LEASES: The Company's policy is to expense exploration costs incurred prior to identification of specific land areas of interest and to defer all costs directly associated with acquisition, exploration and development of specific properties until the land area of interest to which they relate is put into operation, sold or abandoned. Gains or losses resulting from the sale or abandonment of mining properties are included in operations. Proceeds from sales of properties and earn-in arrangements in which the Company has retained an economic interest are credited against property costs and no gain is recognized until all costs have been fully recovered.\nCosts associated with producing properties are charged to operations using the units-of-production method based on estimated recoverable reserves.\nPROPERTY AND EQUIPMENT: Gold production facilities and equipment are stated at cost and are depleted over the estimated production base of the related property. Diatomite production facilities and equipment are stated at cost and are depreciated using the straight-line method over estimated useful lives of three to forty years. Vehicles and office equipment are stated at cost and are depreciated using the straight-line method over estimated useful lives of three to five years. Maintenance and repairs are charged to expense as incurred. Gains or losses on dispositions are included in operations.\nThe Company has elected early adoption of 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 an impairment loss be recognized when the estimated future cash flows (undiscounted and without interest) expected to result from the use of an asset are less than the carrying amount of the asset. Measurement of an impairment loss is based on fair value of the asset if the asset is expected to be held and used.\nRECLAMATION: Costs are estimated based primarily upon environmental and regulatory requirements and are accrued and charged to expense over the expected economic life of the operation using the units of production method. The accrual for reclamation is classified based on the timing of expected expenditures.\nGOLD HEDGING: Gains or losses related to changes in values of hedging instruments are included in revenues when the related inventories are sold. The resulting cash flow is included in net cash provided by operating activities on the statements of cash flows.\nGOLD LOANS: Gold loans are monetized at the original proceeds amount and are recognized into revenue at the time of physical delivery of the metal. At any time that it is not probable that the timing and amount of production will be sufficient to repay the gold loan, or the cost of the production exceeds the market price of the gold, the gold loan is recorded at the higher of the original proceeds or the market value.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:\nDEFERRED FINANCING COSTS: Costs incurred to obtain debt financing are capitalized and amortized over the life of the debt facilities using the effective interest method.\nINTEREST CAPITALIZATION: Interest costs are capitalized as part of the historical cost of facilities and equipment, if material. Interest is not capitalized on properties in the exploration stage until a decision is made to develop the property and construct facilities, and all necessary permits and financing (if necessary) are in place.\nEARNINGS PER SHARE: Earnings per share are based on the weighted average number of common shares outstanding during 1995, 1994, and 1993. Common share equivalents were not included in 1995 and 1994 because their effect would be antidilutive. During 1993, common share equivalents were not included because they did not reduce per share amounts by more than 3%. Fully diluted earnings per share are reported if the calculation results in per share dilution greater than 3%.\n4. INVENTORIES:\nInventories consisted of the following at December 31:\n(a) Includes all direct and indirect costs of mining, crushing, processing and general and administrative expenses of the operation.\n5. INCOME TAXES:\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109). SFAS 109 requires deferred income taxes to be computed under the asset and liability method and to be adjusted to and maintained thereafter at statutory rates in effect when the taxes are expected to be paid. SFAS 109 also requires that a valuation allowance be provided if it is more likely than not that some portion or all of a deferred tax asset will not be realized. Although the Company has significant deferred tax assets, principally in the form of operating loss carryforwards, its ability to generate future taxable income to realize the benefit of these assets will depend primarily on bringing new mines into production. The market, capital, and environmental uncertainties associated with that growth requirement are considerable, resulting in the Company's conclusion that a full valuation allowance be provided, except to the extent that the benefit of operating loss carryforwards can be used to offset future reversals of existing deferred tax liabilities. As a result, adoption had no net cumulative effect on the results of operations. No changes occurred during 1995, 1994 and 1993 in the conclusions regarding the need for the valuation allowance. During 1995, 1994 and 1993, the change in the valuation allowance was $2,190,200, $1,474,300, and $52,100, respectively.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n5. INCOME TAXES, CONTINUED:\nDeferred tax assets and liabilities were comprised of the following at December 31, 1995 and December 31, 1994:\nThe provision for income taxes for the years ended December 31, 1995, 1994, and 1993 consists of the following:\nThe provision for income taxes differs from the amounts computed by applying the U.S. federal statutory rate as follows: 1995 1994 1993\nAt December 31, 1995, the Company had net operating loss carryforwards for regular tax purposes of approximately $37,186,200 and approximately $17,800,400 of net loss carryforwards available for the alternative minimum tax. The net loss carryforwards will expire from 1999 through 2009.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n5. INCOME TAXES, CONTINUED:\nAs a result of a merger in 1987, net operating loss carryforwards are limited by Section 382 of the Internal Revenue Tax Code to approximately $112,800 annually. As of December 31, 1995, the amount of remaining net operating loss carryforwards limited by Section 382 is $1,251,500.\n6. NOTES PAYABLE:\nNotes payable consisted of the following at:\n(a) On December 6, 1995, the Company's wholly owned subsidiary, CR Briggs Corporation, secured a $34.0 million loan facility to finance the capital requirements of mine construction and working capital for its Briggs Mine in California. The Company is guaranteeing the loan obligations of CR Briggs Corporation, and the loan facility is collateralized by a first mortgage lien on the property, non-leased assets of CR Briggs Corporation, and a pledge of the Company's stock in CR Briggs Corporation. The facility was provided by a syndication of three banks; Banque Paribas, Bayerische Vereinsbank AG, and NM Rothschild & Sons Ltd. and includes three tranches; a $25 million gold loan; a $5 million cash loan; and a $4 million cost overrun facility. The cost overrun facility is available only in the event of spending in excess of $30 million and an additional $2 million contribution by the Company. (See Note 7(d)). On December 27, 1995 drawing commenced on the facility and $25.0 million principal in the form of a gold loan and $1.0 million principal as a dollar loan were drawn. The gold loan portion was monetized at $388.05 per ounce, or 64,425 ounces and carries an initial interest rate for 90 days of 5.32%. The dollar loan's initial interest rate for 90 days is 9.87%. Varying interest rate periods can be selected under the terms of the facility. Repayment terms require quarterly installments over six years, commencing in 1997 which include scheduled principal reductions and a varying cash sweep amount equal to 30% of free cash flow (as defined) after primary debt service. After funding certain reserve accounts, if necessary, remaining cash flow is available to the Company, subject to further restrictive conditions. These restrictions include assertions of no potential or actual defaults at the time of transfer and to the frequency of such transfers. Within three years of project completion (approximately 4 months beyond construction completion and start-up) an additional 70,000 ounces of recoverable reserves must be identified or 100% of excess cash flow after scheduled repayments will be applied as additional prepayments against the loan amounts. As a condition of the loan, a portion of the Briggs Mine's future production was hedged to ensure adequate cash flow for repayment of the obligation. Accordingly, fixed forward contracts totalling 186,600 ounces were entered into at prices ranging from $395 per ounce to\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n6. NOTES PAYABLE, CONTINUED:\n$424 per ounce. In addition, put options on 21,600 ounces at a strike price of $380 per ounce were purchased. The put options were financed by the sale of call options on 10,800 ounces at a strike price of $403 per ounce. Approximately 41% of the Briggs Mine estimated production from current reserves was hedged through forwards and put options as of December 31, 1995. Upon the occurrence and during a default (as defined) the lenders may, by notice to CR Briggs Corporation, terminate the commitment and declare all amounts immediately due and payable. The Company (through project completion) and CR Briggs Corporation are also subject to cross-default provisions without the giving of notice in respect of other indebtedness and agreements which would cause such indebtedness to become due prior to its maturity.\n(b) On June 2, 1993, the Company sold $22.0 million of Subordinated Convertible Debentures which are due June 1, 1998. Expenses associated with the financing totalled $1.5 million. Interest is payable semi-annually on June 1 and December 1 at a rate of 6% per annum. Interest payments in 1995, 1994 and 1993 totalled $1,289,300, $1,317,000 and $656,300, respectively. The debentures are convertible at the option of the holder any time into common shares at the rate of $3.45 per share. During 1995, $725,000 of principal was converted into 210,100 shares of common stock. During 1994, $100,000 of principal was converted into 29,000 shares of common stock. After three years, the Company may redeem the debentures by issuing common stock at a rate equal to 94% of the then trading common stock price or by payment in cash at par. Upon the occurrence of certain events, principally relating to changes in control of the Company, each note holder has the right, at the holder's option, to require the Company to repurchase the notes for cash at par plus accrued interest to the repurchase date.\n(c) In August 1994, the Company exercised purchase options on its leased mining equipment at the Kendall Mine for $899,900. Caterpillar Financial Services subsequently agreed to finance the purchase price over a three year period at a fixed interest rate of 9.5%. During 1995, the Company paid $59,700 of interest and reduced the principal balance by $442,900, including a prepayment of $210,500 related to equipment which was sold because it was no longer needed. During 1994, the Company paid $14,100 of interest and reduced the principal balance by $57,600 in connection with the financing terms.\nMaturities of notes payable, excluding additional payments under the gold loan as more fully described in (a) above, are as follows for the next five years:\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n7. RESTRICTED CASH:\nRestricted cash consisted of the following at December 31:\n(a) In connection with the issue of certain bonds in 1995 for the performance of reclamation obligations at the Kendall and Briggs Mines, a bank Letter of Credit has been provided in favor of the Surety as partial collateral for such bond obligations. The Letter of Credit, in the amount of $1,953,000, will expire no earlier than December 31, 1996, and at the bank's option, may be renewed for successive one-year periods. The Company has fully collateralized the Letter of Credit by depositing cash in the amount of $1,953,000 with the bank. At December 31, 1994, cash held as collateral for a Letter of Credit related only to reclamation bonding requirements at the Kendall Mine.\n(b) In connection with a first year work commitment on an exploration property in Ethiopia, a bank Letter of Credit has been provided in favor of the Ministry of Mines and Energy, Federal Democratic Republic of Ethiopia. The Letter of Credit, in the amount of $500,000, will expire on January 6, 1997. The Company has fully collateralized the Letter of Credit by depositing cash in the amount of $500,000 with the bank.\n(c) As described in Note 6(a), the loan proceeds are restricted solely for the development of the Briggs Mine.\n(d) As a condition precedent to securing a loan facility (See Note 6(a)), the Company transferred $2.0 million to an escrow account to be held in reserve against construction cost overruns at the Briggs Mine. These funds, net of any cost overruns, will be returned to the Company upon final completion of an expansion phase of development, currently scheduled in 1997.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n8. MINING CLAIMS AND LEASES:\nThe carrying value of the Company's mining claims and leases consists of the following components at December 31, 1995 and 1994:\nFeasibility studies on the Briggs and McDonald properties indicate sufficient mineable reserves that, with subsequent development, would allow the Company to ultimately recover its carrying value at December 31, 1995. The results of exploration activities on the Company's exploration properties to date have not resulted in conclusions that the carrying value of these properties will or will not be recoverable by charges against income from future mining operations or sale of properties. The Company cannot presently determine the ultimate realizability of the carrying values of the exploration properties ($9,131,700 and $8,239,600 at December 31, 1995 and 1994, respectively) since the realization is dependent upon the discovery of reserves in commercial quantities and the subsequent development or sale of those reserves.\n9. ASSET IMPAIRMENT:\nEffective October 1, 1995, 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. SFAS 121 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Concurrent with adoption, the Company has determined that its carrying value for property and equipment at the Kendall Mine is not recoverable, due principally to the maturing life of the mine (remaining economic life of one year) and the level of site restoration costs anticipated during the next two to three years to achieve mine closure. As estimated cash outflows exceed estimated cash inflows, the Company has reduced the carrying value to zero, recorded a fourth quarter 1995 impairment of $296,000, and removed gross property and equipment costs and accumulated depreciation and depletion amounts from the Balance Sheet of $26,763,900 and $26,467,900, respectively, as of the adoption date.\n10. LEASE COMMITMENTS:\nThe Company has entered into various operating leases for office space and equipment, including a mining fleet at the Briggs Mine, and vehicles used in its operations. At December 31, 1995, future minimum lease payments extending beyond one year under noncancellable leases were as follows:\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n10. LEASE COMMITMENTS, CONTINUED:\nThe Company has also entered into various mining lease arrangements for purposes of exploring, and if warranted, developing and producing minerals from the underlying leasehold interests. The lease arrangements typically require advance royalty payments during the pre-production phase and a production royalty upon commencement of production, with previously advanced payments credited against the production royalties otherwise payable. Advance royalty commitments will vary each year as the Company adds or deletes properties. Currently, minimum advance royalty payments total approximately $152,300 annually.\nThe Company is also required to pay an annual rental fee to the federal government for any unpatented mining claims, mill or tunnel site claim on federally owned lands at the rate of $100 per mining claim. The Company's present inventory of claims would require approximately $134,100 in annual rental fees, however, this amount will vary as claims are added or dropped. The Company has submitted patent applications for its Briggs and diatomite claims, however, no assurances can be made that patents will be issued. The Company is also subject to rental fees to various other owners or lessors of mining claims. Currently, rental payments to these parties total approximately $124,000 annually.\nLease costs included in cost of goods sold for the years ended December 31, 1995, 1994 and 1993 were $85,600; $1,013,000 and $1,419,500, respectively. Rent expense included in selling, general and administrative expense of the Company for the years ended December 31, 1995, 1994 and 1993, was $121,200; $107,900; and $72,800, respectively.\nProperty and equipment includes equipment with a cost and accumulated amortization of $143,500 and $46,200, respectively, at December 31, 1995 and $330,600 and $234,300, respectively, at December 31, 1994 for leases that have been capitalized. Future minimum lease obligations under capital leases are as follows:\n11. COMMITMENTS AND CONTINGENCIES:\nCertain actions are pending with respect to permits issued for the Briggs Mine in California. A local environmental group and the Timbisha Shoshone Tribe have; 1) appealed the Bureau of Land Management's decision to approve the Final Environmental Impact Statement and Plan of Operations; 2) petitioned the Superior Court of Inyo County alleging violations of the California Environmental Quality Act and the Surface Mining and Reclamation Act; and 3) filed a challenge to the issuance of Waste Discharge requirements by the Lahontan Regional Water Quality Board. The Company has vigorously defended its position in each of the proceedings and believes that all claims are without merit.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n11. COMMITMENTS AND CONTINGENCIES, CONTINUED:\nBased upon current knowledge, the Company believes that it is in material compliance with environmental laws and regulations as currently promulgated. However, the exact nature of environmental control problems, if any, which the Company may encounter in the future cannot be predicted, primarily because of the increasing number, complexity and changing character of environmental requirements that may be enacted or of the standards being promulgated by federal, state, or foreign authorities.\n12. CERTAIN CONCENTRATIONS AND CONCENTRATIONS OF CREDIT RISK:\nThe Company sold its gold and silver production predominately to one customer during 1995, 1994 and 1993. Given the nature of the commodities being sold and because many other potential purchasers of gold and silver exist, it is not believed that loss of such customer would adversely affect the Company. Sales of diatomite were made to a diverse base of customers during 1995, 1994, and 1993.\nThe Company is subject to credit risk in connection with its price protection arrangements as outlined in Note 6(a) in the event of non-performance by its counterparties. The Company uses only highly-rated creditworthy counterparties, however, and does not anticipate non-performance.\nThe Company is subject to concentrations of credit risk in connection with maintaining its cash primarily in two financial institutions. The Company considers the institutions to be financially strong and does not consider the underlying risk to be significant. To date, these concentrations of credit risk have not had a significant effect on the Company's financial position or results of operations.\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe Company does not acquire, hold or issue financial instruments for trading purposes. The estimated fair values of the Company's financial instruments at December 31, 1995 and December 31, 1994, are as follows:\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED:\n(1) At December 31, 1994, it was not practicable for the Company to estimate fair value for its 40% ownership in an untraded foreign company carried at historic cost, the principal assets of which were exploration properties. During 1995, the shareholders of the foreign subsidiary entered into an option to purchase shares agreement with a third party, allowing the third party to acquire 100% ownership (subject to the shareholders retaining certain royalty rights) after certain work commitments and purchase obligations were fulfilled. At December 31, 1995, fair value was estimated based on the Company's share of expected discounted cash flows resulting from such agreement.\n(2) Long-term debt excludes the carrying and fair value amounts for the Company's gold loan (see Note 6(a)) because the commodity based loan does not meet the criteria established for inclusion as a financial instrument.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instrument:\nCASH AND CASH EQUIVALENTS: Carrying amounts approximate fair value based on the short-term maturity of those instruments.\nRESTRICTED CASH: Carrying amounts approximate fair value based on the short term maturity of those instruments.\nLONG-TERM INVESTMENTS: Fair value estimate based on expected discounted cash flows at a discount rate commensurate with the risk and contingent nature of future payments.\nLONG-TERM DEBT: Fair value estimate for convertible debentures based on quoted market prices. Fair value estimate for other long-term debt based on discounted cash flows using the Company's current rate of borrowing for a similar liability.\n14. STOCK OPTIONS:\nThe Company adopted an Incentive Stock Option Plan on April 12, 1982, as amended (the \"Plan\"), whereby options to purchase shares of the Company's common stock may be granted to employees of the Company, including those who are also directors of the Company, or subsidiary corporations in which the Company owns greater than a 50% interest. Exercise price for the options is at least equal to 100% of the market price of the Company's common stock at the date of grant for employees who own 10% or less of the total voting stock of the Company; and 110% of the market price of the Company's common stock at the date of grant for employees who own more than 10% of the Company's voting stock. Options become exercisable after the second anniversary of the date of the grant and can expire up to 10 years from the date of the grant.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n14. STOCK OPTIONS, CONTINUED:\nInformation on incentive stock option activity follows:\nAt December 31, 1995, the 1,965,500 shares under option are exercisable from January 1, 1996 through December 6, 2000 and 911,386 shares remain reserved for future issuance under the Plan.\nOn March 20, 1989, the Company's Board of Directors approved the adoption of a Non-Qualified Stock Option Plan (the \"Non-Qualified Plan\"). Under the Non-Qualified Plan, the Board of Directors may award stock options to consultants, directors and key employees of the Company, and its subsidiaries and affiliates, who are responsible for the Company's growth and profitability. The Non-Qualified Plan does not provide criteria for determining the number of options an individual shall be awarded, or the term of such options, but confers broad discretion on the Board of Directors to make these decisions. Total options granted under the Non-Qualified Plan may not have a term longer than 10 years or an exercise price less than 50 percent of the fair market value of the Company's common stock at the time the option is granted.\nBy vote of the Company's shareholders at the May 17, 1995 Annual Shareholders Meeting, the Company adopted a motion to award each non-employee Director options to purchase 10,000 shares of common stock each year during their tenure on the Board of Directors. Such stock option awards from the Non-Qualified Plan are made at an exercise price equal to the closing price of the Company's common stock one day prior to the Annual Shareholders Meeting. The non-employee Director grants are exercisable at any time between one and five years from the date of grant.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n14. STOCK OPTIONS, CONTINUED:\nInformation on non-qualified stock option activity follows:\nAt December 31, 1995, the 335,000 shares under option (all issued at 100% of fair market value) are exercisable from January 1, 1996 through May 16, 2000 and 273,357 shares remain reserved for future issuance under the Non-Qualified Plan. The Company has not recognized any compensation expense in connection with option grants under the Non-Qualified Plan as all grants were issued at fair market value.\nIn conjunction with the initial public offering of the Company's common stock, the Company issued options to purchase 55,000 shares of the Company's common stock at $2.00 per share to two members of the Company's Board of Directors. The options were exercised in 1994.\nIn October, 1995, the Financial Accounting Standards Board (FASB) 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 employee options or similar equity instrument. SFAS 123 encourages, but does not require the method of accounting prescribed by the Statement, and does allow for an entity to continue to measure compensation cost as prescribed by APB Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. Entities electing to remain with APB 25 must make proforma disclosures of net income and earnings per share as if the fair value based method had been applied, effective for fiscal years beginning after December 15, 1995. The Company expects to continue to measure compensation cost under APB 25, subject to the proforma disclosure requirements of SFAS 123.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n15. WARRANTS:\nAs a result of a private placement during January 1990, warrants to purchase 2,923,700 shares of $.01 par value common stock were sold. For each four shares of the Company's common stock purchased in the private placement, the purchaser received one warrant to purchase one share of the Company's common stock, at an exercise price of $3.50 per share. The warrants were initially scheduled to expire on December 31, 1994, however, the Company has extended the expiration date to April 12, 1996. No warrants have been exercised to date.\nAs a result of a private placement during March 1992, warrants to purchase 1,019,900 shares of $.01 par value common stock were sold. For each two shares of the Company's common stock purchased in the private placement, the purchaser received one warrant to purchase one share of the Company's common stock, at an exercise price of $3.50 per share. The warrants were initially scheduled to expire on December 31, 1994, however, the Company has extended the expiration date to April 12, 1996. No warrants have been exercised to date.\nA warrant to purchase 200,000 shares of common stock at an exercise price of $2.875 per share, exercisable until December 31, 1994, was issued in connection with a gold loan secured by the Company in May 1993. One-half of the warrant was subsequently exercised in October 1993. A replacement warrant was issued for the remaining 100,000 shares and, the Company has extended the scheduled expiration date to April 12, 1996.\nIn connection with the purchase of the Minex II parties' interests in May 1993 (see Note 17), warrants to purchase 75,000 shares of the Company's common stock were issued at an exercise price of $3.00 per share, exercisable until May 11, 1996. No warrants have been exercised to date.\n16. SITE RESTORATION COSTS:\nReclamation at the Kendall Mine is ongoing throughout the life of the operation. Approximately $1.5 million has been spent to date reclaiming disturbed areas by contouring, replacing topsoil and reseeding. As of the end of January 1995, all identifiable mineable ore reserves have been mined. Final reclamation will require recontouring of waste rock dumps, roads and other areas, and rinsing of the spent ore in the heaps. In the fourth quarter of 1995, the Company revised its anticipated scope of work for final reclamation and estimates total costs of approximately $4.2 million. As of December 1, 1995, the Company had accrued approximately $3.1 million of the total anticipated cost and, as a result of the revised estimate, recorded a charge of $1.1 million in the fourth quarter of 1995 to fully provide for remaining restoration costs as currently contemplated.\nThe Kendall Mine operates under permits granted by the Montana Department of Environmental Quality (DEQ). The DEQ requires the Company to maintain a $1,869,000 Reclamation Bond to ensure appropriate reclamation. The Company has filed a final closure plan which provides for enhanced measures not contemplated in the original permit. The reclamation portion of the closure plan has been approved, however, the water quality and monitoring plans are still being reviewed. If these plans are not approved as submitted, the current estimate of remaining closure costs could be impacted. Release of bonding will only take place once the regulatory agencies are satisfied that all reclamation requirements have been met.\nCANYON RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n16. SITE RESTORATION COSTS, CONTINUED:\nThe U.S. Bureau of Land Management (BLM), Inyo County, the California Department of Conservation, and the Lahontan Regional Water Quality Control Board (Lahontan) have jointly required the Company to post a reclamation bond in the amount of $3,030,000 to ensure appropriate reclamation of the Briggs Mine. Additionally, the Company will be required by Lahontan to post a $1,010,000 bond to ensure adequate funds to mitigate any \"foreseeable release\" of pollutants to state waters at least 90 days prior to initiation of cyanide on the heap leach pads. Both bonds are subject to annual review and adjustment.\n17. RELATED PARTY TRANSACTIONS:\nKeene Valley Minerals, a limited partnership, was a participant in the Canyon-Minex II Joint Venture. One of the Company's Directors is the sole general partner of a partnership which was a partner in Keene Valley Minerals. The participation of his partnership in this joint venture was on the same terms and conditions as were available to unaffiliated participants. Effective May 12, 1993, the Company acquired the Minex II parties' 38.25% interest in the venture by issuing 150,000 shares of common stock and warrants to purchase 75,000 shares of common stock at an exercise price of $3.00 per share, exercisable until May 11, 1996. The fair market value of the Company's common stock on the acquisition date was $2.38 per share. The principal assets acquired were the Mountain View, Rattlesnake and Judith Mountain properties. Keene Valley Minerals owned 22.5% of the Canyon-Minex II Joint Venture and had invested $750,000 in the venture as of May 12, 1993.\nIn January 1989, VenturesTrident II, L.P., one of the Company's major shareholders, loaned the Company $2,000,000 as part of a Stock Purchase and Loan Agreement. The Company paid $500,000 of the Debenture in early 1993. The remaining principal amount of $1.5 million was repaid on July 20, 1993 by the issuance of 789,473 fully paid and non-assessable common shares of the Company based upon a conversion rate of $1.90 per share. For the year ended December 31, 1993, interest expense on the Debenture was $77,700.\n18. UNAUDITED QUARTERLY FINANCIAL DATA:\nQuarterly financial information for the years ended December 31, 1995 and 1994 is summarized as follows:\nClimate conditions at the Kendall Mine in Montana curtail gold production during the winter months.\n19. SUBSEQUENT EVENT:\nOn March 26, 1996, the Company completed a private placement in the amount of $12.1 million ($11.3 million net of expenses). The offering was completed at a price of $3.00 per unit which included one share of common stock (4,034,300 total shares) and one-half warrant (2,017,200 total warrants). Each whole warrant entitles the holder to purchase one share of common stock at an exercise price equal to $3.75 per share. The warrants expire on March 25, 1999. The Company intends to file a Registration Statement under the Securities and Exchange Act of 1933 in respect of the common shares, the warrants, and the common shares underlying the warrants and use its best efforts to cause such Registration Statement to become effective as soon as practical. In the event that the Registration Statement does not become effective on or before the 90th day following the completion of the private placement, each purchaser of units will be issued an additional 1\/10 of one common share and 1\/20 of one warrant for each unit purchased.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no change in the Company's certified public accountants during the past two years. There has been no report on Form 8-K of a disagreement between the Company and its accountants on any matter of accounting principles or practices or financial statement disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOFFICERS AND DIRECTORS\nThe following table lists the names, ages, and positions of the executive officers and directors of the Company as of March 1, 1996. Directors are divided into classes, each of which is elected to serve for three years, with one class being elected each year. All officers have been appointed to serve until their successors are elected and qualified. Additional information regarding the business experience, length of time served in each capacity, and other matters relevant to each individual is set forth below the table.\nDR. RICHARD H. DE VOTO was a founder of the Company and has been a Director of the Company since its formation in 1979. Dr. De Voto served as President of the Company from September 1979 to April 1985, and became President again in April 1987. He is President of CR Montana Corporation, CR Briggs Corporation, and CR International Corporation, each wholly owned subsidiaries of the Company. Dr. De Voto is Professor Emeritus of Geology at the Colorado School of Mines, where he taught from 1966 to 1987. Dr. De Voto was a founder of the private Australian mining firm, Canyon Resources Proprietary Ltd., which later became Delta Gold N.L., a publicly listed company of which he was a Director from 1983 to 1989. From 1966 to 1979, he was a Vice President of Earth Sciences, Inc., a mineral exploration company, where he was involved in property acquisition and exploration and development ventures. Dr. De Voto also has worked in the petroleum business with Shell Oil and Mobil Oil. After graduating from Dartmouth College in 1956 with an A.B. Degree in Engineering Sciences, he received an M.Sc. Degree in Civil Engineering from Dartmouth in 1957 and a Doctor of Science Degree in Geology from the Colorado School of Mines in 1961. Dr. De Voto is a registered Professional Engineer in the State of Colorado.\nGARY C. HUBER was a founder of the Company and served as Secretary of the Company from inception through June 1986, as Treasurer from 1980 through December 1991, as Vice President from April 1985 to April 1987, and as Vice President-Finance since April 1987. He was elected as a Director of the Company in June 1985 and serves as President of CR Minerals Corporation, a wholly owned subsidiary of the Company. He was employed by Energy Reserves Group, Inc., an energy fuels company, as District Geologist from 1975 to 1977, where his responsibilities included exploration and development of several uranium\/vanadium mines in western Colorado. He graduated in 1973 from Fort Lewis College with a B.Sc. Degree in Geology and received a Ph.D in Geology with a minor in Mineral Economics from the Colorado School of Mines in 1979. Dr. Huber has been responsible for the financial operations of the Company since its inception and currently manages the Company's industrial minerals program.\nWILLIAM W. WALKER was a founder of the Company and served as its Vice President from 1979 to April 1985, and its President from April 1985 to April 1987. In April 1987, Mr. Walker became the Company's Vice President-Exploration. He was elected as a Director of the Company in June 1985 and serves as President of Canyon Resources Africa Ltd., the Company's African exploration subsidiary. Mr. Walker directs the Company's exploration programs and is responsible for joint venture activities and property farmouts. He has served as Division Geologist for Central and Southwest Fuels, Inc., a uranium and coal exploration company; as Vice President of Earth Sciences, Inc., a mineral exploration company; and as geologist for Climax Molybdenum Company (AMAX). Mr. Walker received a Professional Engineering Degree in Geological Engineering from the Colorado School of Mines in 1961.\nJOHN R. DANIO was appointed Vice President-Operations of the Company in September 1987, and has overall responsibility for the Company's mine development and production operations. Prior to joining the Company, he operated several open-pit gold mines and heap-leaching operations as Project Engineer and Mine Manager. Mr. Danio received a B.Sc. Degree in Mining Engineering from the Colorado School of Mines in 1973. He is a registered professional engineer in the States of Colorado and Nevada.\nGEORGE S. YOUNG was appointed Vice President - Law and Corporate Secretary of the Company in November, 1993. Mr. Young was most recently employed as President and Director of the Uruguayan and Argentinean affiliated companies of American Resource Corporation, Inc. during 1992 and 1993 and as Vice President and General Counsel of Alta Gold Co. from 1990-92. Mr. Young previously held various positions in the mining and resources industries including General Counsel of Bond International Gold, Inc. (1988-90), General Counsel and Acting General Manager of Intermountain Power Agency (1984-88), Legal Supervisor for the U.S. Minerals and Coal Division of Getty Oil Company (1981-84), and as a Metallurgical Engineer for Kennecott Copper Corporation (1975-76). Mr. Young has a B.S. degree in Metallurgical Engineering (1975) and a Law Degree (1979) from the University of Utah, and served as a law clerk to Judge Aldon J. Anderson in Utah Federal District Court (1979-80).\nRICHARD T. PHILLIPS was appointed Treasurer of the Company in December 1991. Initially joining the Company as Controller in July 1991, he is responsible for the Company's cash management, risk management, and financial reporting functions. From 1988 to 1991, Mr. Phillips served as Controller for Western Gold Exploration and Mining Company, a gold mining partnership between Minorco and Inspiration Resources Corporation. From 1975 to 1987, he was employed by subsidiaries of Inspiration Resources Corporation, a natural resources company, in various financial capacities including Director of Corporate Accounting. Mr. Phillips received a B.S. Degree in Business Administration from the University of Phoenix in 1984 and is a Certified Management Accountant.\nPAUL A. BAILLY has been a Director of the Company since February 1989. Pursuant to the provisions of a Stock Purchase and Loan Agreement between the Company and VenturesTrident II, L.P. (\"VT II\"), the Company is required to nominate a designee of VT II as a candidate for Director. Mr. Bailly is the designee of VT II. He is Chairman of Castle Group, Inc., the successor to Fulcrum Management, Inc. From 1984 through 1992, he served as President of Fulcrum Management, Inc., the managing company for two private U.S. venture capital funds, VenturesTrident L.P. and VenturesTrident II, L.P., which invest in precious metals companies and projects. He has previously served as President of Occidental Minerals Corporation and Bear Creek Mining, an exploration subsidiary of Kennecott Copper. Mr. Bailly received an M.S. Degree in Geology\/Mineralogy and a Geological Engineering Degree from the University of Nancy in France in 1948 and a Doctor of Science Degree in Geology from Stanford University in 1951. Mr. Bailly serves as Chairman of Dakota Mining Corporation (formerly MinVen Gold Corporation); Chairman of Golden Queen Mining Company, Ltd.; and Director of Golden Sitka Resources, Inc., Minven, Inc., and Olympic Mining Corporation.\nLELAND O. ERDAHL has been a Director of the Company since February 1986. He served as President and CEO of Stolar, Inc., a privately held service and communication supply company for the mining industry, from July 1987 to September 1991, and as President and CEO of Albuquerque Uranium Corporation, a privately held company engaged in the production and sale of uranium from November 1987 to January 1992. From October 1984 through October 1987, and from January 1992 to January 1995, Mr. Erdahl served as an independent management consultant. From 1970 through July 1984, he was employed by Ranchers' Exploration and Development Corporation, a mining company, in various capacities including Treasurer, Vice President-Finance, Senior Vice President, Executive Vice President, and, from 1982 to 1984, President. Mr. Erdahl holds a B.S. Degree in Business from the College of Santa Fe and is a Certified Public Accountant. Mr. Erdahl serves as a Director of Hecla Mining Company, Freeport McMoRan Copper & Gold Inc., Uranium Resources, Inc., and Original Sixteen to One Mine, Inc., all publicly held mineral resources companies, and as a trustee of a group of John Hancock Mutual Funds, all publicly held investment\nentities. Mr. Erdahl is also a Director of Santa Fe Ingredients Company of California, Inc. and Santa Fe Ingredients Company, Inc., private food processing companies.\nGEORGE W. HOLBROOK, JR. has been a Director of the Company since 1981. Since 1984, he has been the Managing Partner of Bradley Resources Company, a private investment company. Mr. Holbrook received a B.S. Degree in Mechanical Engineering from Cornell University in 1953. He is a Director of the Merrill Lynch Institutional Fund and other associated funds, Thoratec Laboratories and several private companies.\nFRANK M. MONNINGER has been a Director of the Company since September 1990. He is currently a consultant to the mining industry. From 1984 to 1988, he was Executive Vice President of Operations for Coeur D'Alene Mines Corporation, a publicly held mining company. From 1982 to 1984, Mr. Monninger was a consultant for San Francisco Mining Associates. From 1979 to 1982, he was the Vice President of Development and Operations for Occidental Minerals Corporation. In addition, Mr. Monninger has held positions of Vice President and General Manager for Inspiration Consolidated Copper Company, Manager of Mine and Plant Operations for Bechtel Corporation, Vice President of Anaconda Company, and President of the Montana Mining Division of Anaconda Company. Mr. Monninger received a Professional Degree in Metallurgical Engineering from the Colorado School of Mines in 1949 and an Honorary Degree of Metallurgical Engineering from Montana College of Mineral Science and Technology in 1973. He currently serves as Chairman of the Board of ISL Ventures, a Nevada corporation involved in in-situ leaching and precious metals lixiviants.\nWILLIAM C. PARKS has been a Director of the Company since February 1986. He is currently Executive Vice President and General Manager of R.A. Pearson Company, a privately held company engaged in the design and manufacture of packaging machinery. From August 1989 through December 1991, he was the President of United Management Company, a company involved in providing management consulting services to the mining, manufacturing, and transportation industries. From November 1987 through August 1989, he was Vice President of, through December 1991, a consultant to, and through February 1991, a Director of Artech Recovery Systems, Inc., a publicly held company engaged in the processing and extraction of metals from arsenic-bearing ores. From August 1983 through November 1987, he was President and Director of Nevex Gold Company, Inc., a publicly held mining company. Mr. Parks received his B.A. Degree in 1965 in Economics and English from Western Washington University. He currently serves as a Director of Advanced Recording Instruments, Inc., a manufacturer of on-board electronic recording equipment for the transportation industry.\nCHRISTOPHER M.T. THOMPSON has been a Director of the Company since September 1990. He is President of Castle Group, Inc., the successor to Fulcrum Management, Inc. From 1984 through 1992, he served as Executive Vice President and Chief Financial Officer for Fulcrum Management, Inc., the managing company for two private U.S. venture capital funds, VenturesTrident L.P. and VenturesTrident II, L.P., which invest in precious metals companies and projects. He is also a Director of EMGF Management Company which manages The Emerging Markets Gold Fund. Castle Group is by subcontract, manager of the Emerging Markets Gold Fund. From 1982 to 1983, he was Manager of New Business Development for Gulf Canada, Ltd. From 1978 to 1982, Mr. Thompson was a Partner, Director, and Mining Analyst for Gordon Securities Limited, a Canadian institutional brokerage firm. Mr. Thompson received a B.A. Law Degree from Rhodes University in 1969 and graduated with a M.Sc. from Bradford University in 1971. He currently serves as a Director of Golden Queen Mining Company, Ltd.; Golden Shamrock Mines, Ltd.; Minven, Inc.; Olympic Mining Corporation; Silver Standard Resources Inc.; and Santa Elina Gold Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item appears in the Company's Proxy Statement for the 1996 Annual Meeting to be filed within 120 days after the end of the fiscal year and is incorporated by reference in this Annual Report on Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe table on the next page sets forth information, as of March 1, 1996 with respect to beneficial ownership of the Company's common stock by each person known by the Company to be the beneficial owner of more than 5% of its outstanding common stock, by each director of the Company, by each named executive officer, and by all officers and directors of the Company as a group. Unless otherwise noted, each shareholder has sole investment and voting power over the shares owned.\n* Less than 1%\n(1) The general partner of VenturesTrident II, L.P. is Fulcrum Management Partners II, L.P., a Delaware limited partnership. Mr. Landon T. Clay and MinVen, Inc., a Delaware corporation are the two general partners of Fulcrum Management Partners II, L.P.\n(2) This number includes (i) 3,889,473 shares owned of record, and (ii) the right to acquire 650,000 shares of common stock upon the exercise of 650,000 warrants at an exercise price of $3.50 per share.\n(3) This number includes (i) 9,719 shares owned of record; (ii) 560,628 shares held by the Richard H. De Voto Trust No. 1; (iii) 351 shares held as Co-Trustee of Trust for his mother; (iv) an option to purchase 37,000 shares at an exercise price of $3.00 per share; (v) an option to purchase 50,000 shares at an exercise price of $1.63 per share; and (vi) an option to purchase 75,000 shares at an exercise price of $3.69 per share.\n(4) This number includes (i) 519,124 shares owned of record; (ii) two trusts of 15,000 shares each held by wife, Gwen D. Huber, as Trustee for two minor children; (iii) an option to purchase 50,000 shares at an exercise price of $3.00 per share; and (iv) an option to purchase 30,000 shares at an exercise price of $1.63 per share; and (v) an option to purchase 50,000 shares at an exercise price of $3.69 per share.\n(5) This number includes (i) 198,137 shares owned of record; (ii) an option to purchase 30,000 shares at an exercise price of $3.00 per share; and (iii) an option to purchase 35,000 shares at an exercise price of $3.69 per share.\n(6) Mr. Bailly is the Chairman of Castle Group, Inc., the management service company for VenturesTrident II, L.P. Mr. Bailly disclaims beneficial ownership of the shares held by VenturesTrident II, L.P.\n(7) This number includes an option to purchase 30,000 shares at an exercise price of $2.50 per share.\n(8) This number includes (i) 24,289 shares owned of record; (ii) an option to purchase 30,000 shares at an exercise price of $1.44 per share; and (iii) an option to purchase 10,000 shares at an exercise price of $2.19 per share.\n(9) This number includes (i) 5,000 shares owned of record; (ii) 694,946 shares owned of record by Bradley Securities Corporation of which Mr. Holbrook is the President and major shareholder; (iii) 167,629 shares owned by two partnerships in which Mr. Holbrook is a controlling partner; (iv) 80,000 shares owned of record by Bradley Resources Company, of which Mr. Holbrook is the Managing partner; (v) 20,000 shares of common stock issuable to Bradley Resources Company upon exercise of 20,000 warrants at an exercise price of $3.50 per share; (vi) 4,200 shares of common stock issuable to a partnership in which Mr. Holbrook is a controlling partner upon exercise of warrants at an exercise price of $3.00 per share; and (vii) an option to purchase 30,000 shares at an exercise price of $2.50 per share.\n(10) This number includes (i) an option to purchase 30,000 shares at an exercise price of $1.44 per share and (ii) an option to purchase 10,000 shares at an exercise price of $2.19 per share.\n(11) This number includes (i) 65,541 shares owned of record; (ii) 714 shares held by Mr. Parks as custodian for a minor child; (iii) an option to purchase 20,000 shares at an exercise price of $1.44 per share; and (iv) an option to purchase 30,000 shares at an exercise price of $3.19 per share.\n(12) Mr. Thompson is the President of Castle Group, Inc., the management service company for VenturesTrident II, L.P. Mr. Thompson disclaims beneficial ownership of the shares held by VenturesTrident II, L.P.\n(13) This number includes (i) an option to purchase 20,000 shares at an exercise price of $1.44 per share; and (ii) an option to purchase 30,000 shares at an exercise price of $3.19 per share.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nTRANSACTION WITH A DIRECTOR\nKeene Valley Minerals, a limited partnership, was a participant in the Canyon-Minex II Joint Venture. Mr. Holbrook is the sole general partner of a partnership which is a partner in Keene Valley Minerals. The participation of his partnership in this joint venture is on the same terms and conditions as were available to unaffiliated participants. Effective May 12, 1993, the Company acquired the Minex II parties' 38.25% interest in the venture by issuing 150,000 shares of common stock and warrants to purchase 75,000 shares of common stock at an exercise price of $3.00 per share, exercisable until May 11, 1996. The fair market value of the Company's common stock on the acquisition date was $2.38 per share. Keene Valley Minerals owned 22.5% of the Canyon-Minex II Joint Venture and had invested $750,000 in the venture as of May 12, 1993.\nTRANSACTIONS WITH VENTURESTRIDENT II, L.P.\nOn January 27, 1989, the Company entered into a Stock Purchase and Loan Agreement (the Agreement) with VenturesTrident II, L.P., a Delaware limited partnership (VT II). Pursuant to the Agreement, the Company (i) sold to VT II 1,000,000 shares of its $.01 par value common stock for $2,000,000; and (ii) accepted a $2,000,000 loan from VT II evidenced by a Variable Interest Secured, Recourse Convertible Debenture (the \"Debenture\").\nOn January 26, 1993, the Company and VT II agreed to amend certain provisions of the Debenture which included a two year extension of $1.5 million of the principal. The Company paid $500,000 of the Debenture in early 1993 and, on July 20, 1993, gave notice of intent to prepay the $1.5 million convertible debenture otherwise scheduled for payment on January 26, 1995. VT II elected to receive shares in lieu of cash as consideration for the repayment and was issued 789,473 fully paid and non-assessable shares of the Company's common stock.\nPursuant to the terms of the Agreement, and for so long as VT II owns more than 4% of the Company's issued and outstanding stock, the Company has agreed to nominate a designee of VT II as a candidate for Director of the Company. Mr. Paul A. Bailly, Chairman of Castle Group Inc., Manager of VT II, was elected by the Board as a Director of the Company, effective as of February 10, 1989, and has continued in that capacity henceforth. Mr. Bailly's present term as a Director is scheduled to expire in 1998. On September 18, 1991, the Board also elected Mr. Christopher M.T. Thompson, President of Castle Group, Inc., as a member of the Board. Mr. Thompson was re-elected by the Company's shareholders on June 17, 1993 to serve as a Director until 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements (included in Part II of this Report):\nReport of Independent Accountants'\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Operations - Years ended December 31, 1995, 1994, and 1993\nConsolidated Statement 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(b) There were no Form 8-K reports filed during the last quarter of the period covered by this report.\n(c) Exhibits, as required by Item 601 of Regulation S-K, are listed on pages 73 to 76. The exhibit numbers correspond to the numbers assigned in Item 601 of Regulation S-K.\nEXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.1 Certificate of Incorporation of the Company, as amended (2)\n3.1.1 Articles of Amendment to the Company's Certificate of Amendment as filed with the Delaware Secretary of State on January 23, 1990 (9)\n3.1.2 Executed Certificate of Designations, dated December 26, 1990, as filed with the Delaware Secretary of State on December 26, 1990 (11)\n3.2 Bylaws of the Company, as amended (2)\n4.1 Specimen Common Stock Certificate (1)\n4.2 Variable Interest, Secured, Resource Convertible Debenture (7)\n4.3 Specimen Warrant Certificate (10)\n4.4 Warrant Agreement dated January 26, 1990 by and between the Company and American Securities Transfer, Inc. (9)\n4.5 Stock and Warrant Purchase Agreement, dated December 26, 1990 among the Company, Kennecott Exploration Company, CR Briggs Corporation, CR Kendall Corporation, and CR Montana Corporation (11)\n4.6 Executed Common Stock Purchase Warrant, dated December 26, 1990 (11)\n4.7 Indenture dated June 2, 1993, between the Company and Bank of America Arizona, Trustee, with respect to $22,000,000, 6% Convertible Debentures due June 1, 1998 (15)\n4.8 Specimen 6% Convertible Subordinated Note (15)\n4.9* Specimen Warrant Certificate\n4.10* Warrant Agreement dated March 20, 1996 by and between the Company and American Securities Transfer, Inc.\n10.1 Canyon-Minex Joint Venture Agreement dated March 1, 1983, as amended, among the Company, Saranac Minerals, EMK Resources II, Black Hawk Resources Corporation, and Atlantic Associates (3)\n10.2 Office Building Lease, dated August 10, 1992, as amended, between Denver West Office Building No. 51 and the Company (14)\n10.3 Canyon-Minex Joint Venture and Meridian Minerals Company Agreement dated March 23, 1988 (4)\n10.4 Mining Venture Agreement between Recursos Canyon Dominicana, S.A. and Battle Mountain Gold Company dated June 28, 1988 (5)\n10.4.1 Letter Agreement dated February 16, 1992, among the Company, through its subsidiary Recursos Canyon Dominicana, S.A., and Battle Mountain Gold Company (14)\n10.5 Agreement between the Company, Meridian Minerals Company, and the Canyon-Minex Joint Venture dated December 27, 1988 (6)\n10.6 Stock Purchase and Loan Agreement between the Company and VenturesTrident II, L.P., dated January 27, 1989 (7)\n10.6.1 Amendment to Stock Purchase and Loan Agreement between the Company and VenturesTrident II, L.P., dated January 26, 1993 (14)\n10.7 Option to Purchase Agreement, dated July 14, 1989, by and between Addwest Gold, Inc. and Western Energy Company (8)\n10.8 Seven-Up Pete Venture Agreement between Addwest Gold, Inc. and Phelps Dodge Mining Company (8)\n10.9 Letter Agreement dated July 8, 1989 between Addwest Gold, Inc. and Phelps Dodge Mining Company (8)\n10.10 Purchase Agreement by and between the Company and Addington Resources, Inc. dated January 26, 1990 (9)\n10.11 Gold Loan Agreement by and between the Company and Bankers Trust Company dated January 26, 1990 (9)\n10.12 Net Smelter Return Royalty Deed from Addwest Gold, Inc. to Addington Resources, Inc. dated January 26, 1990 (9)\n10.13 Covenant Not to Compete between Addwest Gold, Inc. and Addington Resources, Inc. dated January 26, 1990 (9)\n10.14 Master Tax Lease between the Company and Caterpillar Financial Services Corporation dated June 15, 1990 (12)\n10.15 Judith Mountains Memorandum of Understanding between the Canyon-Minex II Joint Venture and Cominco American Resources, Inc. dated August 1, 1990 (12)\n10.16 Farm-In Agreement, effective December 1, 1990, among Kennecott Exploration Company, Canyon Resources Corporation, and CR Briggs Corporation (11)\n10.17 Consent, Subordination and Release Agreement, dated December 26, 1990, among Kennecott Exploration Company, Canyon Resources Corporation, CR Briggs Corporation, CR Kendall Corporation, and CR Montana Corporation (11)\n10.18 Amended and Restated Gold Loan and Letter of Credit Facility Agreement (without exhibits) by and between the Company and Mase Westpac Limited dated March 23, 1992 (13)\n10.19 Amendment No. 1 to Amended and Restated Gold Loan and Letter of Credit Facility Agreement by and between the Company and Mase Westpac Limited effective December 31, 1992 (14)\n10.20 Change of Control Agreements, dated December 6, 1991 between the Company and Richard H. De Voto, Gary C. Huber and William W. Walker (14)\n10.21 Amended and Restated Credit Facility Agreement dated May 26, 1993, among N M Rothschild & Sons Limited, Canyon Resources Corporation, CR Kendall Corporation, CR Briggs Corporation, CR Montana Corporation, and CR Minerals Corporation (15)\n10.22* Loan Agreement dated December 6, 1995 among CR Briggs Corporation as Borrower and Banque Paribas as Agent.\n10.23* Master Tax Lease dated December 27, 1995 between CR Briggs Corporation and Caterpillar Financial Services Corporation.\n11.1* Statement regarding computation of per share earnings\n22.1* Subsidiaries of the Registrant\n24.1* Consent of Coopers & Lybrand L.L.P.\n24.2* Consent of Davy International\n24.3* Consent of Roberts and Schaefer Company\n24.4* Consent of Mine Reserves Associates, Inc.\n24.5* Consent of Remy and Thomas\n24.6* Consent of Chamberlin & Associates\n27* Financial Data Schedule\n* Filed herewith\n- -------------------------------------------------------------------------------\n(1) Incorporated by reference from the Company's Registration Statement on Form 8-A as declared effective by the Securities and Exchange Commission on March 18, 1986.\n(2) Exhibits 3.1 and 3.2 are incorporated by reference from Exhibits 3.1 and 3.2, respectively, to the Company's Registration Statement on Form S-1 (File No. 33-19264) declared effective by the Securities and Exchange Commission on February 1, 1988.\n(3) Exhibit 10.1 is incorporated by reference from Exhibit 10.1 to the Company's Registration Statement on Form S-18 (File No. 2-99249-D) declared effective by the Securities and Exchange Commission on November 8, 1985.\n(4) Exhibit 10.3 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n(5) Exhibit 10.4 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(6) Exhibit 10.5 is incorporated by reference from the Company's Report on the Form 8-K filed with the Securities and Exchange Commission on January 4, 1989.\n(7) Exhibits 4.2 and 10.6 are incorporated by reference from Exhibits 1 and 2 of the Company's Report on Form 8-K filed with the Securities and Exchange Commission on January 27, 1989.\n(8) Exhibits 10.7, 10.8, and 10.9 are incorporated by reference from Exhibits 10.19, 10.20, and 10.21, respectively, to the Company's Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 1989.\n(9) Exhibits 3.1.1, 4.4, 10.10, 10.11, 10.12, and 10.13 are incorporated by reference from Exhibits 3.1, 4.1, 2.1, 10.1, 28.1, and 28.2, respectively, to the Company's Report on Form 8-K dated January 26, 1990.\n(10) Exhibit 4.3 is incorporated by referenced from Exhibit 4.3 to the Company's Registration Statement on Form S-2, effective August 13, 1990.\n(11) Exhibits 3.1.2, 4.5, 4.7, 10.16 and 10.17 are incorporated by reference from Exhibits 4, 3, 5, 1, and 2, respectively, of the Company's Report on Form 8-K filed with the Securities and Exchange Commission on December 26, 1990.\n(12) Exhibits 4.6, 10.14 and 10.15 are incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n(13) Exhibit 10.18 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(14) Exhibits 10.2, 10.4.1, 10.6.1, 10.19, and 10.20 are incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(15) Exhibits 4.7, 4.8, and 10.21 are incorporated by reference from Exhibits 4.3, 4.2, and 10.1, respectively, to the Company's report on Form 8-K dated May 26, 1993.\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 of the undersigned, thereunto duly authorized.\nCANYON RESOURCES CORPORATION\nDate: March 27, 1996 \/s\/ Richard H. De Voto ------------------------------------------ Richard H. De Voto Principal Executive Officer\nDate: March 27, 1996 \/s\/ Gary C. Huber ------------------------------------------ Gary C. Huber 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 Company and in the capacities and on the dates indicated.\nDate: March 27, 1996 \/s\/ Richard H. De Voto ------------------------------------------ Richard H. De Voto, Director\nDate: March 27, 1996 \/s\/ Gary C. Huber ------------------------------------------ Gary C. Huber, Director\nDate: March 27, 1996 \/s\/ William W. Walker ------------------------------------------ William W. Walker, Director\nDate: March 27, 1996 \/s\/ Paul A. Bailly ------------------------------------------ Paul A. Bailly, Director\nDate: March 27, 1996 \/s\/ Leland O.Erdahl ------------------------------------------ Leland O. Erdahl, Director\nDate: March 27, 1996 \/s\/ George W. Holbrook, Jr. ------------------------------------------ George W. Holbrook, Jr., Director\nDate: March 27, 1996 \/s\/ Frank M. Monninger ------------------------------------------ Frank M. Monninger, Director\nDate: March 27, 1996 \/s\/ William C. Parks ------------------------------------------ William C. Parks, Director\nDate: March 27, 1996 \/s\/ Christopher M.T. Thompson ------------------------------------------ Christopher M.T. Thompson, Director\nEXHIBIT INDEX\nNUMBER DESCRIPTION - ------- -----------\n3.1 Certificate of Incorporation of the Company, as amended (2)\n3.1.1 Articles of Amendment to the Company's Certificate of Amendment as filed with the Delaware Secretary of State on January 23, 1990 (9)\n3.1.2 Executed Certificate of Designations, dated December 26, 1990, as filed with the Delaware Secretary of State on December 26, 1990 (11)\n3.2 Bylaws of the Company, as amended (2)\n4.1 Specimen Common Stock Certificate (1)\n4.2 Variable Interest, Secured, Resource Convertible Debenture (7)\n4.3 Specimen Warrant Certificate (10)\n4.4 Warrant Agreement dated January 26, 1990 by and between the Company and American Securities Transfer, Inc. (9)\n4.5 Stock and Warrant Purchase Agreement, dated December 26, 1990 among the Company, Kennecott Exploration Company, CR Briggs Corporation, CR Kendall Corporation, and CR Montana Corporation (11)\n4.6 Executed Common Stock Purchase Warrant, dated December 26, 1990 (11)\n4.7 Indenture dated June 2, 1993, between the Company and Bank of America Arizona, Trustee, with respect to $22,000,000, 6% Convertible Debentures due June 1, 1998 (15)\n4.8 Specimen 6% Convertible Subordinated Note (15)\n4.9* Specimen Warrant Certificate\n4.10* Warrant Agreement dated March 20, 1996 by and between the Company and American Securities Transfer, Inc.\n10.1 Canyon-Minex Joint Venture Agreement dated March 1, 1983, as amended, among the Company, Saranac Minerals, EMK Resources II, Black Hawk Resources Corporation, and Atlantic Associates (3)\n10.2 Office Building Lease, dated August 10, 1992, as amended, between Denver West Office Building No. 51 and the Company (14)\n10.3 Canyon-Minex Joint Venture and Meridian Minerals Company Agreement dated March 23, 1988 (4)\n10.4 Mining Venture Agreement between Recursos Canyon Dominicana, S.A. and Battle Mountain Gold Company dated June 28, 1988 (5)\n10.4.1 Letter Agreement dated February 16, 1992, among the Company, through its subsidiary Recursos Canyon Dominicana, S.A., and Battle Mountain Gold Company (14)\n10.5 Agreement between the Company, Meridian Minerals Company, and the Canyon-Minex Joint Venture dated December 27, 1988 (6)\n10.6 Stock Purchase and Loan Agreement between the Company and VenturesTrident II, L.P., dated January 27, 1989 (7)\n10.6.1 Amendment to Stock Purchase and Loan Agreement between the Company and VenturesTrident II, L.P., dated January 26, 1993 (14)\n10.7 Option to Purchase Agreement, dated July 14, 1989, by and between Addwest Gold, Inc. and Western Energy Company (8)\n10.8 Seven-Up Pete Venture Agreement between Addwest Gold, Inc. and Phelps Dodge Mining Company (8)\n10.9 Letter Agreement dated July 8, 1989 between Addwest Gold, Inc. and Phelps Dodge Mining Company (8)\n10.10 Purchase Agreement by and between the Company and Addington Resources, Inc. dated January 26, 1990 (9)\n10.11 Gold Loan Agreement by and between the Company and Bankers Trust Company dated January 26, 1990 (9)\n10.12 Net Smelter Return Royalty Deed from Addwest Gold, Inc. to Addington Resources, Inc. dated January 26, 1990 (9)\n10.13 Covenant Not to Compete between Addwest Gold, Inc. and Addington Resources, Inc. dated January 26, 1990 (9)\n10.14 Master Tax Lease between the Company and Caterpillar Financial Services Corporation dated June 15, 1990 (12)\n10.15 Judith Mountains Memorandum of Understanding between the Canyon-Minex II Joint Venture and Cominco American Resources, Inc. dated August 1, 1990 (12)\n10.16 Farm-In Agreement, effective December 1, 1990, among Kennecott Exploration Company, Canyon Resources Corporation, and CR Briggs Corporation (11)\n10.17 Consent, Subordination and Release Agreement, dated December 26, 1990, among Kennecott Exploration Company, Canyon Resources Corporation, CR Briggs Corporation, CR Kendall Corporation, and CR Montana Corporation (11)\n10.18 Amended and Restated Gold Loan and Letter of Credit Facility Agreement (without exhibits) by and between the Company and Mase Westpac Limited dated March 23, 1992 (13)\n10.19 Amendment No. 1 to Amended and Restated Gold Loan and Letter of Credit Facility Agreement by and between the Company and Mase Westpac Limited effective December 31, 1992 (14)\n10.20 Change of Control Agreements, dated December 6, 1991 between the Company and Richard H. De Voto, Gary C. Huber and William W. Walker (14)\n10.21 Amended and Restated Credit Facility Agreement dated May 26, 1993, among N M Rothschild & Sons Limited, Canyon Resources Corporation, CR Kendall Corporation, CR Briggs Corporation, CR Montana Corporation, and CR Minerals Corporation (15)\n10.22* Loan Agreement dated December 6, 1995 among CR Briggs Corporation as Borrower and Banque Paribas as Agent.\n10.23* Master Tax Lease dated December 27, 1995 between CR Briggs Corporation and Caterpillar Financial Services Corporation.\n11.1* Statement regarding computation of per share earnings\n22.1* Subsidiaries of the Registrant\n24.1* Consent of Coopers & Lybrand L.L.P.\n24.2* Consent of Davy International\n24.3* Consent of Roberts and Schaefer Company\n24.4* Consent of Mine Reserves Associates, Inc.\n24.5* Consent of Remy and Thomas\n24.6* Consent of Chamberlin & Associates\n27* Financial Data Schedule\n* Filed herewith\n- -------------------------------------------------------------------------------\n(1) Incorporated by reference from the Company's Registration Statement on Form 8-A as declared effective by the Securities and Exchange Commission on March 18, 1986.\n(2) Exhibits 3.1 and 3.2 are incorporated by reference from Exhibits 3.1 and 3.2, respectively, to the Company's Registration Statement on Form S-1 (File No. 33-19264) declared effective by the Securities and Exchange Commission on February 1, 1988.\n(3) Exhibit 10.1 is incorporated by reference from Exhibit 10.1 to the Company's Registration Statement on Form S-18 (File No. 2-99249-D) declared effective by the Securities and Exchange Commission on November 8, 1985.\n(4) Exhibit 10.3 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n(5) Exhibit 10.4 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(6) Exhibit 10.5 is incorporated by reference from the Company's Report on the Form 8-K filed with the Securities and Exchange Commission on January 4, 1989.\n(7) Exhibits 4.2 and 10.6 are incorporated by reference from Exhibits 1 and 2 of the Company's Report on Form 8-K filed with the Securities and Exchange Commission on January 27, 1989.\n(8) Exhibits 10.7, 10.8, and 10.9 are incorporated by reference from Exhibits 10.19, 10.20, and 10.21, respectively, to the Company's Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 1989.\n(9) Exhibits 3.1.1, 4.4, 10.10, 10.11, 10.12, and 10.13 are incorporated by reference from Exhibits 3.1, 4.1, 2.1, 10.1, 28.1, and 28.2, respectively, to the Company's Report on Form 8-K dated January 26, 1990.\n(10) Exhibit 4.3 is incorporated by referenced from Exhibit 4.3 to the Company's Registration Statement on Form S-2, effective August 13, 1990.\n(11) Exhibits 3.1.2, 4.5, 4.7, 10.16 and 10.17 are incorporated by reference from Exhibits 4, 3, 5, 1, and 2, respectively, of the Company's Report on Form 8-K filed with the Securities and Exchange Commission on December 26, 1990.\n(12) Exhibits 4.6, 10.14 and 10.15 are incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n(13) Exhibit 10.18 is incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(14) Exhibits 10.2, 10.4.1, 10.6.1, 10.19, and 10.20 are incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(15) Exhibits 4.7, 4.8, and 10.21 are incorporated by reference from Exhibits 4.3, 4.2, and 10.1, respectively, to the Company's report on Form 8-K dated May 26, 1993.","section_15":""}
{"filename":"821509_1995.txt","cik":"821509","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Company is a leading designer, manufacturer and marketer of vehicle security systems including alarm and remote keyless entry systems. During the fiscal year ended December 31, 1995, the Company's principal business was the manufacture and sale of vehicle security systems and a limited number of home security systems. The Company's products are marketed and sold through automobile dealerships, independent retail specialty stores, automotive expediters and mass merchandisers.\nMARKET DESCRIPTION AND INDUSTRY OVERVIEW\nTheft of vehicles and vehicle contents is a widespread problem in the U.S. and most European countries. According to industry sources, in the United States, the theft of vehicles and vehicle contents, including repair and replacement costs, recovery costs, loss of productivity, etc., resulted in losses of approximately $7.5 billion in 1994 and the car theft rate in Germany, France and other affluent Western European countries was 13 per 1,000 vehicles, compared to 8 per 1,000 vehicles in the United States.\nTraditionally, vehicle security systems have been sold mainly in the aftermarket. However, automakers are beginning to offer vehicle security systems as installed options, either at the factory or at the dealership. Although most anti-theft devices are not offered as standard equipment on vehicles, the Company believes that the general trend is toward vehicle security systems that are either OEM-approved or installed on the assembly line.\nThe Company also believes that demand by European consumers for anti-theft devices is stimulated by rising insurance premiums and incentives offered by some European insurance companies for using vehicle security systems. These incentives are typically in the form of lower premiums for suitably equipped cars and lower claim payouts for those that are not. In certain European countries, automobiles above a specific monetary value cannot be insured against theft without an approved anti-theft system installed.\nThe Company believes that the foregoing factors will continue to increase both domestic and European demand for vehicle security systems and that it is in the process of positioning itself to take advantage of these growing global markets for vehicle security systems.\nBUSINESS STRATEGY\nKey elements of the Company's business strategy include the following:\n- Focus Sales Efforts to OEM customers.\nThe Company intends to focus its sales and marketing efforts toward the OEM market primarily through the following:\nAuto Brand Distribution to Dealers -- The Company presently markets its products to more than 9,000 automobile dealers in North America pursuant to private label purchase agreements with General Motors, Ford and Chrysler under the automakers' brand names including Mr. Goodwrench(TM), Ford Remote Systems(TM) and Mopar(TM), respectively, and it believes that additional growth opportunities are available through such dealers. The Company expects to pursue these opportunities by continuing to promote its sales to dealers through personal calls on dealers by the Company's sales staff, dealer education programs, seminars, product literature and manuals and on-site promotional items such as signs. To support such sales efforts, the Company intends to continue to offer technical support service and toll-free telephone lines to answer questions and help with problems.\nDirect Sales to Manufacturers for Factory Floor Installation -- The Company believes that there is potential for expanding its sales to OEMs for such items as remote keyless entry systems, basic alarm\nsystems and sensors. In light of increased consumer demand for systems offered in top-of-the-line models, OEMs are increasingly offering such systems. It is the Company's intent to capture a larger share of this market, which is currently supplied by more traditional OEM electronic suppliers such as TRW, Motorola and United Technologies. The Company's efforts in this regard currently consist of direct sales calls to automobile manufacturers by the Company's sales personnel and independent manufacturers representatives, and are focused on obtaining long-term supply contracts.\n- Continue Sales to Post-Delivery Market\nHistorically, the Company has successfully marketed to independent retailers and mass merchandisers. Currently, the Company sells to more than 1,200 independent retail specialty stores, automotive expediters, and mass merchandisers. The Company intends to continue its focus on this market.\n- Expand European Presence\nThe Company believes that it has significant growth opportunities both in the OEM and retail markets in Europe. Recognizing this, the Company acquired Europe Auto Equipement (EAE) as of January 1, 1994. The Company is currently concentrating its European sales efforts in France. Further expansion into other European markets is complicated by certain factors such as government approvals and insurance industry accreditation required to sell its products. In certain European countries, insurance industry certification of a vehicle security system is a prerequisite to obtaining theft insurance for most motor vehicles. The Company has received French and Belgian insurance industry accreditation for its electronic security systems, but to date has been unable to secure German insurance industry accreditation required to sell its products in Germany. European insurance industry standards are subject to change without notice; and, in 1994, significant changes in industry standards required the development and introduction of new products for 1995. The Company is currently seeking accreditation in several major European countries in an effort to take advantage of the growing market for vehicle security systems.\n- Enhance Engineering Capability\nIn order to stay competitive and deliver high quality, consumer-friendly vehicle security systems, the Company plans to continue to enhance its engineering and product testing capabilities. The Company believes that multiplexing systems planned for some top-of-the-line automobiles will allow more efficient access to a larger number of vehicle operations than present conventional wire harness electrical systems, and that the presence of these multiplexing systems will present potential growth opportunities for the Company over the next decade. The Company believes that it is favorably positioned to increase its business opportunities for interfacing with multiplexing systems because of the Company's reputation for technical innovation, quality, reliability and competitive pricing. See \"Engineering, Research and Development.\"\n- Shorten Product Development and Introduction Cycles\nThe Company believes that short product development cycles are essential to its success. Such cycles enable the Company to capitalize upon the higher margins that are associated with the introduction of new products and positions the Company to establish itself as a leader in its existing as well as its new markets. The Company's efforts in this area include simultaneous engineering which utilizes product teams from the engineering and manufacturing divisions of the Company whose function is to streamline product development and introduction cycles.\nPRODUCTS\nThe Company's vehicle security systems utilize low power radio frequency technology and are operated by remote micro-transmitters. Frequencies and the manufacture of transmitters and receivers used in the Company's remote systems are different in European countries than in the U.S. and are regulated separately in each country in which the Company does business.\nThe Company's vehicle security systems fall into two broad categories: alarm systems and remote keyless entry systems.\nAlarm Systems -- In general, the Company's alarm systems contain two major components: an immobilizer circuit and a siren. The immobilizer circuit prevents the automobile from being started unless the alarm system has been turned off. Each system automatically resets itself after the siren has been sounded for a predetermined period. Many of these systems allow the operator to choose between manually setting the alarm upon leaving the vehicle and having the alarm automatically set one minute after the keys are removed from the ignition switch. Various other components, such as hood locks and intrusion sensors, can generally be added to the alarm system.\nHistorically, most of the Company's sales have consisted of remote alarm systems, with a basic unit consisting of a remote micro-transmitter, which can be attached to the operator's keychain, and a control unit, which is located inside the automobile. The remote micro-transmitter is used to turn the alarm system on and off. This basic unit is typically sold as part of a system which is configured in various ways based upon the customer preferences and distribution channels.\nIn addition to remote alarm systems, the Company also produces digital and passive alarm systems which offer a lower level of protection. Digital systems, unlike remote systems, do not offer a way to turn the alarm system on and off from outside the vehicle. Instead, upon entering the vehicle, the operator has a fixed period of time to turn off the alarm system by entering the proper numerical sequence on a keypad. Passive alarm systems are much like digital systems, except that the operator only needs to insert the key in the ignition switch of the automobile to turn off the alarm.\nRemote Keyless Entry Systems -- The Company's remote keyless entry system enables the operator to use the remote micro-transmitter to lock and unlock the doors or open the trunk from outside the vehicle without having to use keys, to turn on the interior light to see if anyone is waiting inside the vehicle and to set off the siren in the event of a personal emergency.\nThe Company's vehicle security systems, most of which are now remote systems, include Code-Alarm(R), Chapman(R) and Anes(R) brands in the U.S. and Dragon, Jack-Code, Codalarme(R) and Euro-Alarm in Europe.\nThe Company's products are sold into two categories: pre-delivery and post-delivery. Pre-delivery includes those products sold in the OEM market for vehicle installation before delivery of a new vehicle to the purchaser through installation by the automaker or as a dealer-installed option or by an automotive expediter. Post-delivery includes those products which are installed on a vehicle already owned by the customer, generally through retail specialty stores and mass merchandisers.\n_______________\n(1) Pre-delivery includes sales to OEMs and expediters.\n(2) Post-delivery includes all other vehicle security system sales.\n(3) The Company acquired EAE and Code-Alarm Europe on January 1, 1994.\n(4) Includes contract manufacturing, home security systems and discontinued operations, including mechanical security devices.\nCUSTOMERS\nThe Company's primary OEM customers consist of General Motors, Ford, Peugeot, Chrysler, Volkswagen-Audi Group France, and Subaru. Historical sales by the Company to these customer groups and to other OEMs and expediters are set forth below.\nWith the exception of sales to dealers of General Motors and Ford, no single customer accounted for more than 10% of the Company's total net sales during the year ended December 31, 1995. Sales to General Motors and Ford accounted for 13.1% and 11.2%, respectively, of the Company's total net sales for the year ended December 31, 1995. Pursuant to its agreements with General Motors and Ford, the Company's direct sales personnel and independent manufacturer's representatives engaged by the Company call on, and solicit orders directly from, General Motors and Ford dealers. The Company views individual dealers as its customers.\nThe Company historically has placed and expects to continue to place a strong emphasis on its retail customers. The Company believes that accelerated growth in the OEM market for vehicle security systems offers the Company an opportunity to increase future sales and, therefore, its expansion into the OEM market, as well as its continued presence in the retail market, is important to the Company's future success. The increase in pre-delivery installation could have a detrimental effect on the retail market.\nThe following table shows the percentage of the Company's total net sales attributable to the OEM and retail market in both Europe and North America for the periods set forth below. This table does not include all other sales for the periods set forth below, which include contract manufacturing, home security systems and discontinued operations and sales to countries outside of North America and Europe:\nMARKETING\nSales of the Company's products to OEMs are made directly by the Company's sales and marketing personnel located at the Company's Madison Heights, Michigan headquarters and its European offices located in Paris, Brussels, Madrid and Birmingham, England. Through these sales and marketing offices, the Company services its OEM customers. These sales efforts are supported by a field force of 62 salespersons who call directly on dealers to explain and promote the ordering of the Company's products through the OEMs.\nIn promoting sales of vehicle security systems that require professional installation, the Company emphasizes dealer education programs, sales and installation seminars, product literature and technical manuals. Educational and marketing efforts are supplemented by direct mail campaigns, technical bulletins, advertising support, sales literature, newsletters, product displays and dealer signs.\nTo promote quality, customer satisfaction and relationships with dealers and installers, the Company maintains technical support and consumer support services and toll-free telephone lines to answer questions and to help solve problems with installation or operation of the Company's products.\nENGINEERING, RESEARCH AND DEVELOPMENT\nThe Company employs 20 full-time engineers and 31 full-time technicians in its engineering and research and development programs. This staff is divided into three main groups responsible for: (a) providing technical and support services to its customers, (b) improving manufacturing processes, and (c) developing new products. The Company's expenditures for engineering, research and development were approximately 3.4%, 3.7% and 4.9% of revenues in 1993, 1994 and 1995, respectively.\nThe Company conducts a variety of research and product development projects designed to achieve improvements in vehicle security systems through the development of new technologies. The Company's products include a number of innovative circuits and features developed by the Company. Past research and development efforts have produced consumer installable vehicle security systems that incorporate many of the features typically\nfound on more expensive professionally-installed systems, as well as the circuitry designed to prevent use of devices designed to search signals to deactivate its alarms.\nThe technological innovations of the Company's customers presents both challenges and opportunities for the Company. The Company's products must be advanced enough to efficiently interface with its customer's vehicles. One new innovation which has recently been introduced on certain high-end vehicles is the multiplexing system. The multiplexing system consists of a sophisticated computer processor located in the vehicle, connected to various electrical systems of the vehicle by a single wire, which allows simultaneous communication between multiple vehicle systems. As a result, the vehicle can accommodate more sophisticated operations and technologically complex accessories such as security systems. Multiplexing systems allow security systems more efficient access to a larger number of vehicle operations than do conventional wire harness electrical systems. The Company believes that the presence of multiplexing systems present potential growth opportunities for the Company over the next decade. The Company believes that it is positioned to increase its business opportunities for connecting its products to the multiplexing systems because of the Company's reputation for technical innovation, quality, reliability and competitive pricing.\nMANUFACTURING\nThe Company produces electronic products at facilities located in Madison Heights, Michigan and Georgetown, Texas. Automated and manual assembly methods are used to produce circuit boards, which are key components of many of the Company's products. The Company is expanding the use of automation in its manufacturing operations. The Company's electronic security systems are designed around the Company's manufacturing processes, which particularly emphasize surface mount technology (\"SMT\"). SMT is the automated manufacturing process used to place micro electronic components on printed circuit boards with a high level of accuracy and at high speed. The use of SMT enables the Company to design and manufacture products that are compact, portable and reliable and to achieve manufacturing efficiencies that result in lower costs.\nThe Company believes that it will have a competitive advantage as a result of its recent development and on-going construction of an on-premises test and validation laboratory and its lower labor costs for U.S. operations.\nWhile the Company currently does not manufacture its products in Europe, the Company does assemble some of its final products in Europe. At this time the Company is considering various alternatives for manufacturing its products overseas.\nThe Company attempts to fill its U.S. orders for vehicle security systems within 48 hours. Current U.S. product backlog, therefore, is not an important indicator of long-term sales trends. However, since European operations are currently supplied from U.S. manufacturing plants, additional inventory requirements necessary to achieve the 48-hour shipment goal have significantly increased working capital requirements and management attention to order and production planning.\nSUPPLIERS\nThe Company's products include a number of high-technology components that are currently sourced from only a few suppliers and, in some cases, a single supplier. The Company frequently requires large volumes of such components. If the Company's suppliers are unable to fulfill the Company's needs for such components, the Company may be unable to fill customer orders and its business and financial condition, including working capital and results of operations, may be materially and adversely affected. Since part of the Company's strategy is to shorten product development and introduction cycles, occasions may arise in the future where the Company's ability to produce products outpaces its suppliers' ability to supply components. There can be no assurance that the Company can continue to obtain adequate supplies or obtain such supplies at their historical cost levels. The Company has no guaranteed supply arrangements with any of its sole or limited source suppliers, does not maintain an extensive inventory of components, and customarily purchases sole or limited source components pursuant to purchase orders placed in the ordinary course of business. Moreover, the Company's suppliers may, from time to time, experience production shortfalls or interruptions which impair the supply of components to the Company.\nThere can be no assurance that such shortages will not occur in the future and adversely affect the Company's business and financial condition, including working capital, and results of operations.\nPRODUCT WARRANTY\nThe Company provides original purchasers of most vehicle security systems with a limited warranty. Scorpion(R) brand products have a one-year limited warranty and Anes(R) brand carries a limited two-year warranty. Dragon, Jack-Code and Codalarme(R) products sold in Europe have a limited one-year repair and replacement warranty. Warranties are customarily limited to replacement of defective parts to the original purchaser. The Company has several disputes pending with customers who claim that its home security and Intercept(TM) systems manufactured by the Company were faulty or inoperable.\nThe Company generally warrants contract manufactured products for 60 days. The warranty is limited to replacement of defective material or a price allowance at the Company's option.\nCOMPETITION\nAll markets in which the Company participates are highly competitive, and many current or prospective competitors, including several of the Company's significant OEM customers, are substantially larger and possess significantly greater financial, marketing and technical resources than the Company. An increase in factory-installed vehicle security systems or the introduction of other dealer-installed security systems and remote keyless entry systems by OEM customers or existing and potential competitors could have a material adverse effect on the Company.\nThere are a number of other well-known companies manufacturing and distributing electronic components for the automotive after-market which could become effective competitors should they choose to enter the vehicle security market. Many of these companies are much larger and better capitalized than the Company and have established distribution channels. While offshore producers of competing systems have not captured significant market share, these companies could also become significant competitors.\nCompeting manufacturers have developed vehicle recovery systems designed to locate stolen automobiles. Sales of other companies' automobile recovery systems could have a material adverse effect on sales of the Company's products. The Company also faces competition from certain mechanical devices such as The Club(TM).\nTRADEMARKS AND PATENTS\nThe Company markets its vehicle security systems under several registered trademarks. The Company also has patents and patent applications pending for certain of its products and components. The Company considers its trademarks, patents and patent applications to be valuable, and has defended, and intends to continue vigorously defending, its patented and proprietary technology from infringement or misappropriation. There can be no assurance that the Company's measures to protect its proprietary rights will deter or prevent unauthorized use of the Company's technology. Furthermore, the laws of certain countries may not protect the Company's proprietary rights to the same extent as do the laws of the United States. The Company has applied for patents on certain inventions in Europe; however, none of these patents has yet been granted nor is there any assurance that patents will be granted in the future. In addition, the Company may, from time to time, become subject to legal claims asserting that the Company has violated intellectual property rights of third parties. In the event a third party were to sustain a valid claim against the Company and in the event any required license were not available on commercially reasonable terms, the Company's business and financial condition, including working capital and results of operations, could be materially and adversely affected.\nREGULATION\nThe FCC regulates the assignment of frequencies for manufacture and sale of remote vehicle security systems and remote keyless entry systems in the U.S. The Company has received FCC authorization to manufacture\nand sell the devices it currently sells in the U.S. In Europe, similar government agencies in each country regulate the assignment of frequencies and the Company has generally been able to meet the applicable frequency requirements. However, because insurance industry accreditation of vehicle security systems is, in most European countries, a prerequisite to an automobile owner's ability to obtain vehicle theft coverage, the Company's ability to market its products in such countries is dependent upon obtaining such insurance industry approvals and certifications. The Company has received French and Belgian insurance industry accreditation to manufacture and sell electronic security systems. To date, the Company has been unable to secure German insurance industry accreditation required to sell its products in Germany. The Company is selling its products in Spain where no insurance industry certifications are required. European insurance industry accreditation standards are subject to change without notice; and, in 1994, significant changes in industry standards required the development and introduction of new products for 1995.\nThe Company's U.S. vehicle security systems are also affected by state insurance laws. The Company is aware of some states that mandate insurance discounts on comprehensive coverage for policyholders who have installed certain types of vehicle security systems. The Company is also aware of at least one state which provides additional discounts for policyholders who have installed vehicle recovery systems.\nThe loss of regulatory and insurance industry approvals or failure to obtain necessary authorizations in the future could have a material adverse effect on the Company.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 552 full-time persons. None of the Company's employees are represented by a labor union or other collective bargaining representative. The Company believes that relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following table sets forth certain information concerning the principal properties leased by the Company:\n______________ * Amounts payable under the lease are payable in local currencies and are subject to fluctuations in the exchange rates.\n** Terminable upon 3 months prior written notice by Company.\nManagement believes that the facilities presently occupied are adequate to meet the Company's requirements for the foreseeable future. All buildings and equipment are in good working condition.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nPATENT INFRINGEMENT LITIGATION\nCode Alarm, Inc. v. Electromotive Technology Corporation. Case No. 87-CV-74022-DT. On November of 1987, the Company filed a declaratory judgment action against Electromotive Technology Corporation (\"ETC\") in the United States District Court for the Eastern District of Michigan, Southern Division seeking a declaration that ETC's U.S. Patent No. 4,585,569 (\"the '569 Patent\"), describing and claiming a shock or motion sensor system, was invalid or not infringed by the Company. Subsequently, Directed Electronics (\"Directed\"), of Vista, California, acquired an interest in the '569 Patent and was made a party to the lawsuit. A judgment as to infringement liability was entered against the Company in 1993 based upon the Company's manufacture and sale of a shock sensor device. A bench trial was held on the issue of damages in 1994, but no ruling was made until June 16, 1995, when a judgment was awarded against the Company in the amount of $5.4 million for infringement (about $5.9 million when interest and other costs are included). The Company, after the liability decision was rendered, filed a notice of appeal of the decision and appealed the decision to the Court of Appeals for the Federal Circuit. After the notice of appeal was filed, it was discovered that ETC had failed to timely pay the first maintenance fee on April, 1990, required to maintain the '569 Patent with the U.S. Patent and Trademark Office (the \"Patent Office\"). Thus, the '569 Patent lapsed for a ten month period of time. The Company subsequently filed a motion with the United States District Court for the Eastern District of Michigan, Southern Division requesting certification for remand of the case for consideration of (1) the Company's intervening rights for the ten month lapse of the '569 Patent, (2) reconsideration of the award of enhanced damages for willful patent infringement and attorney fees in view of ETC's failure to notify the Company and the court of the lapse, and (3) an appeal of the Patent Office's decision to reinstate the '569 Patent. This motion was held moot following a granting of the Company's motion to dismiss its appeal of the judgment to the Court of the Appeals for the Federal Circuit, on January 3, 1996. The Company subsequently filed a motion with the United States District Court for the Eastern District of Michigan, to amend and reduce the judgment based upon the late payment of the maintenance fee and lapse of the '569 Patent. This motion was denied on March 7, 1996. The Company now intends to appeal this decision as well as the decision as to infringement damages. The Company has posted a letter of credit in lieu of an appeal bond in the amount of $5.9 million, representing the amount of the judgment, including interest. Both ETC and Directed are asserting patent infringement claims against two other shock sensor embodiments, one of which is the Company's principal shock sensor unit. Trial is scheduled to occur on this latest infringement matter on or about April 15, 1996. The Company has obtained various expert opinions concerning its potential infringement in this latest suit and, based upon these opinions, is of the belief that it will prevail in this action.\nMagnadyne Corporation v. Code Alarm, Inc. Case No. 96-60011. On January 17, 1996 Magnadyne Corporation filed, in the United States District Court for the Eastern District of Michigan, Southern Division, a complaint alleging that the Company infringes upon United States Patent Number 5,285,186 (\"the '186 Patent\"). The Company denied the infringement charges and has filed counter-claims, on February 6, 1996, for damages arising out of the assertion of the '186 Patent against the Company. This case remains in the early stages of discovery.\nCode Alarm, Inc. v. The United States International Trade Commission. Inv. No. 337-TA-355. On September 19, 1995 the United States Court of Appeals for the Federal Circuit affirmed the ITC Administrative Law Judge's holding of Invalidity of United States Patent Number 5,049,867, owned by the Company.\nCode Alarm, Inc. v. Magnadyne Corporation, Barry Carren, Do-It-Yourself-Security and James Compton, Civil Action No. 1-95 CV 0054 (CRR) filed March 21, 1995 in the United States District Court for the District of Columbia and Transferred on April 6, 1995 to the United States District Court for the Central District of California sitting in Los Angeles, California. The Company seeks damages for alleged infringement of United States Patent Number 4,740,775 (\"the '775 Patent) owned by the Company. A counterclaim has been filed alleging invalidity and non-infringement of the '775 Patent and seeking an injunction, legal fees and costs. This matter is set for trial on July 9, 1996 and remains in the early stages of discovery.\nCode Alarm, Inc. v. Sherwood, Inc., Inkel USA and Alfred J. Menozzi, Civil Action No. 95-4797 AWT filed on July 20, 1995 in the United States District Court for the Central District of California sitting in Los Angeles, California. The Company is seeking damages for alleged infringement of United States Patent Number 4,740,775 owned by the Company. The parties have reached a general settlement of all claims. Final details of the settlement remain to be finalized.\nDirected Electronics, Inc. v. Code Alarm, Case No. 95-0513S(CGA) is a declaratory judgment suit filed by Directed Electronics (\"Directed\") on April 18, 1995 in the United States District Court for the Southern District of California seeking a declaration that the plaintiff does not infringe upon United States Patent Number 4,740,775 (\"the '775 Patent\") and\/or that the '775 Patent is invalid and\/or unenforceable. The Company has counterclaimed seeking damages arising from Directed's infringement of the '775 Patent and has denied the invalidity and non-infringement\/unenforceability allegations. Although, this case remains in the early stages of discovery the Company has obtained an independent opinion of counsel that Directed is infringing the '775 Patent.\nCode Alarm, Inc. v. Directed Electronics, Daryl Issa, and A Class Tint and Alarm, Case No. A-95-CA-437 (JRN), filed by the Company on July 26, 1995 in the United States District Court, Western District of Texas, Austin Division, alleging damages arising from infringement of United States Patent Number 4,740,775. The case against Directed Electronics was transferred to the United States District Court for the Southern District of California on December 14, 1995. The case against the remaining parties was stayed.\nIn the matter of Certain Starter Kill Security Systems, Inv. No. 337-TA-379, On November 21, 1995 the United States International Trade Commission instituted, upon request of the Company, an investigation to determine whether products allegedly imported by Directed Electronics, Inc. of Vista, California from the Nutek Company of Taipei, Taiwan infringe United States Patent Number 4,740,775 owned by the Company. In addition to claims of patent infringement, the Company sought, in this action, to halt the importation and sale of the alleged infringing goods into the United States. On February 26, 1996, pursuant to Commission Rule 210.21, the Company filed a motion to terminate the investigation. On March 5, 1996, Administrative Law Judge Luckern issued a Final Initial Determination granting the Company's motion to terminate the investigation. On March 15, 1996, Directed filed a petition for review of the final initial determination and on March 22, 1996 both the Company and the ITC filed responses opposing Directed's petition for review. Resolution of Directed's petition for review is pending.\nACQUISITION-RELATED LITIGATION\nAureo Rivera Davila and Aureo E. Rivera v. Asset Conservation, Inc., Gabriel Guijarro Brunet, Iris Nieves DeGuijarro and their marital conjugalship, Chapman Industries Corporation, Chapman Products, Inc., Chapman Security Systems, Inc. and Code Alarm, Inc.. Case Number 90-2118 (SEC) United States District Court for the District of Puerto Rico. On January 19, 1990, Chapman Security Systems, Inc. (\"Chapman Security\"), a wholly owned subsidiary of the Company, purchased certain of the assets of Chapman Products, Inc. (\"Chapman Products\") from LaSalle National Bank, in a private sale in accordance with Section 9-504 of the Illinois Uniform Commercial Code. On August 17, 1990, Aureo Rivera Davila and Aureo E. Rivera (\"Plaintiffs\") filed a complaint against Asset Conservation, Inc. (a distributor of the now defunct Chapman Industries Corporation (\"Chapman Industries\"), Gabriel Guijarro Brunet and Iris Nieves DeGuijarro and their marital conjugalship, alleging infringement of United States Patent No. 3,548,373 (the \"373 Patent\"). Plaintiffs have a default judgment in the amount of about $19.4 million, in addition to interest, entered by the United States District Court for the Northern District of Illinois in 1990 against Chapman Industries Corporation for infringement of the '373 Patent. On March 16, 1995, the Plaintiffs added Chapman Products, the Company and its subsidiary, Chapman Security, as principal defendants in the case and are attempting to assert their default judgment against the Company and Chapman Security on a theory that the Company is the sole owner of Chapman Security and that the Company is a successor in interest to Chapman Industries. Plaintiffs also allege that the asset purchases by Chapman Products and then by Chapman Security were\nfraudulent conveyances. The Company has tendered defense of the complaint to LaSalle National Bank, which is providing for the defense of the fraudulent conveyance claims as well as certain of the successor liability claims brought by Plaintiffs under a reservation of rights against the Company and Chapman Security. This proceeding is in the early stages of discovery and is not expected to be resolved in the near future. On November 22, 1995, the Court issued an order to show cause why the case should not be remanded to the United States District Court for the Northern District of Illinois. Plaintiff's reply in this matter is due to be filed on or before March 27, 1996 and resolution of this issue should follow shortly thereafter. The size of this judgment (which, with interest, is currently estimated to be approximately $28.6 million), is so large that if it is enforced against the Company and Chapman Security, the likely award would exceed the Company's shareholders' equity.\nAsset Conservation, Inc. filed a third party complaint in the same case on June 16, 1992 against Chapman Industries, Chapman Products, the Company and Chapman Security alleging that they have a duty to indemnify Asset Conservation for all damages sustained by it in the litigation, based upon Asset Conservation's previous distributor and indemnification agreement with Chapman Industries, which Asset Conservation claims was assumed by Chapman Products and Chapman Security. On November 22, 1995 the third party complaint was dismissed, with prejudice, against all third party defendants, including the Company. The Plaintiffs are seeking reconsideration of the dismissal of the third party complaint.\nPRODUCT LITIGATION\nIntercept Security Corporation v. Code Alarm, Inc. and Rand Mueller. Case No. 95-40239. On July 19, 1995, Intercept Security Corporation, a Canadian distributor of the Company's home security systems (\"Intercept\"), filed suit in the United States District Court, for the Eastern District of Michigan, Southern Division, alleging that certain home security products manufactured and sold by the Company failed to perform in a manner consistent with the alleged representations of the Company. The complaint alleges that the Company committed fraud, misrepresentation, and breached an implied and an express warranty emanating from the sale of these goods to Intercept. On March 27, 1995, Intercept Security Corporation filed an amended complaint adding Rand Mueller to the suit and making the same allegations against Rand Mueller. The Company's provider of directors and officers liability insurance coverage has agreed to provide a defense for Rand Mueller, subject to a reservation of rights. The case remains in the early stages of discovery and the exposure, if any, to the Company or to Rand Mueller cannot be ascertained at this time.\nOTHER LITIGATION\nParasol Group, Ltd. v. Code Alarm, Inc. Case No. 95-4713-RSWL (Mc). On December 15, 1994, Parasol Group Filed, in the Superior Court for the County of Los Angeles, CA, a complaint seeking approximately $200,000 in damages for consulting services allegedly performed by Parasol's president, Nathan Sassover. On April 26, 1995, Parasol refiled the action in the United States District Court for the Central District of California. The Company denied the allegations and counterclaimed for damages including, without limitation, damages resulting from Parasol's fraud and misrepresentation. The case is presently in the early stages of discovery and the Company's liability, if any, cannot be determined.\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 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Common Stock has been traded on the NASDAQ Stock Market under the symbol \"CODL\" since October 19, 1987 and has been traded on the NASDAQ National Market since May 17, 1988.\nThe following table sets forth certain information about the price of the Common Stock which is based on the high and low sales prices for the Common Stock, as reported on the NASDAQ National Market:\nOn March 29, 1996, the last reported sale price of the Common Stock as reported on the NASDAQ National Market was $4 3\/8 per share. As of March 29, 1996, there were approximately 298 shareholders of record of the Company's Common Stock.\nUnder the terms of the credit agreement with its commercial bank, the Company may not purchase, redeem, retire, or otherwise acquire and shares of its Capital Stock, or make a commitment to do so, without the bank's prior written consent. See \"Managements' Discussion and Analysis of Financial Condition and Results of Operations\" and \"Note 4 to Financial Statements\".\nDIVIDEND POLICY\nHistorically, the Company has not paid any cash or other dividend. The Company does not expect to pay dividends in the foreseeable future but currently intends to retain any earnings to finance operations and to support future growth. Furthermore, the Company's bank credit facility agreement prohibits the payment of dividends. See \"Managements' Discussion and Analysis of Financial Condition and Results of Operations\" and \"Note 4 to Financial Statements\".\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected historical consolidated financial data shown below have been derived from the Company's audited consolidated financial statements for the years shown.\n(1) The results of operations includes patent infringement settlement costs in the amount of $4.4 million for the year ended December 31, 1994 and $1.82 million for the year ended December 31, 1995. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Legal Proceedings.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nThe Company is involved in a patent infringement suit involving a shock sensing device. The damage portion of the trial was completed in January 1995 and at December 31, 1994, the Company recorded an accrual for damages of approximately $4.2 million. In June 1995, the Company received information from the United States District Court that the damages would total $6.0 million. Accordingly, the Company recorded an additional accrual for damages of $1.8 million in 1995.\nThe following table sets forth, for the periods indicated, earnings data as a percentage of net sales of the Company:\nYear ended December 31, 1995 compared to the year ended December 31, 1994\nThe Company's consolidated net sales decreased $4.3 million or 5.9% to $69.2 million, for the year ended December 31, 1995 as compared to $73.5 million for the year end December 31, 1994. The decline is primarily due to the Company's decision to discontinue sales of Do-It-Yourself, mechanical and Vehicle Locator security products to mass merchandisers and independent dealers and to the transportation workers strike in France. The decline is partially offset by increases in OEM and expediter sales.\nFor the year ended December 31, 1995, consolidated gross profit decreased $3.2 million, or 11.4%, to $24.5 million as compared to $27.6 million for the year ended December 31, 1994. As a percentage of consolidated sales, gross profit decreased to 35.4% in 1995 from 37.6% in 1994. The decrease was primarily due to start up manufacturing problems with the Company's European parts production in the United States and a lower profit margin on sales in Europe. The Company expects to maintain the current gross profit margin in 1996 due to continued emphasis in OEM sales.\nConsolidated operating expenses decreased $121,000, or less than 1% in 1995 as compared to 1994. The decrease in consolidated operating expense was attributable to decreased sales and marketing expenses, partially offset by increases in engineering, product development costs and general and adminstrative costs. The Company expects to sustain decreases in sales and marketing expenses as a result of continued emphasis on OEM sales, but expects engineering, product development and general and adminstrative costs to remain relatively constant as a percentage of sales in 1996.\nAs a result of the foregoing, the Company had consolidated income from operations of $12,000 in the year ended December 31, 1995 compared to operating income of $3.0 million for the 1994 fiscal year.\nInterest expense increased $860,000 for the year ended December 31, 1995, or 133.3%, to $1.5 million as compared to $645,000 for the year ended December 31, 1994. Increases are attributable to higher interest rates and increased indebtedness associated mainly with the acquisition of European Auto Equipment and its operations.\nOther expenses for the year ended December 31, 1995 decreased $2.2 million to $2.3 million as compared to $4.5 million for the year ended December 31, 1994, exclusive of interest expense as discussed above. The $2.2 million decrease is primarily attributable to approximately $1.8 million in additional damages recorded in 1995 from a patent infringement suit as compared to $4.4 million in 1994.\nThe Company had an effective income tax rate of 28% on current operating income. Income taxes on foreign operations were approximately 33%. During 1995, the Company charged off state and foreign tax refunds determined to be uncollectable in the amount of $130,000.\nAs a result of the foregoing, the company incurred a net loss of $2.7 million, or $1.17 per share for the year ended December 31, 1995 compared to a net loss of $1.4 Million, or $0.58 per share for the year ended December 31, 1994.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nThe Company's consolidated net sales for 1994 increased $23.4 million, or 46.7%, to $73.5 million as compared to $50.1 million in 1993. Excluding the effect of acquisitions (EAE and the remaining interest in Code-Alarm Europe), consolidated net sales increased $5.9 million, or 11.8%, in 1994. The non-acquisition related sales increases resulted primarily from increases in expediters, retail and General Motors\/Ford sales volumes.\nThe Company's consolidated gross profit for 1994 increased $7.7 million, or 38.7%, to $27.6 million as compared to $19.9 million in 1993. Excluding the effect of acquisitions, consolidated gross profit for 1994 increased $1.4 million, or 7.0%. As a percentage of consolidated sales, gross profit decreased to 37.6% in 1994 from 39.8% in 1993. Such decreases were primarily due to launch costs associated with the introduction of the Euro Alarm in the fourth quarter of 1994.\nConsolidated operating expenses for 1994 increased $7.0 million, or 39.8%, to $24.6 million as compared to $17.6 million in 1993. Excluding the effect of acquisitions, consolidated operating expenses for 1994 increased $1.1 million, or 6.3%. Increases in consolidated operating expenses are attributable to acquisitions as well as other sales, marketing and product development efforts.\nAs a result of the foregoing, consolidated income from operations for 1994 increased $677,000, or 28.6%, to $3.1 million as compared to $2.4 million for 1993. The increase was due to the acquisition of EAE and increased volume through General Motors and Ford.\nInterest expense for 1994 increased $366,000, or 131.6%, to $645,000 as compared to $279,000 for 1993. The increase was due to increased interest rates, the acquisition of EAE and debt incurred in connection with the following items: (i) financing sales increases, (ii) the acquisition of an important patent and (iii) the Company's decision to repurchase stock held by two former directors at below market prices as of the date of repurchase.\nOther income (expense) for 1994 increased $4.9 million, or 2,210.4%, to an expense of $5.1 million as compared to an expense of $0.2 million for 1993. The increase was primarily due to $4.4 million of estimated costs associated with a judgment to be entered against the Company in the patent infringement lawsuit, Code-Alarm v. Electromotive Technologies Corporation. The amount recorded included the Company's estimate at\nthat time of damages, interest and legal fees to be awarded the Plaintiff, as well as expenses that the Company had already incurred, and estimated expenses that might be incurred in an appeal of the judgment.\nThe Company's effective income tax rate for the year ended 1994 was 34.0%.\nAs a result of the foregoing, the Company incurred a consolidated net loss of $1.4 million, or $0.58 per share, for the year ended December 31, 1994, compared to a net profit of $1.5 million, or $0.63 per share, for the year ended December 31, 1993. Excluding non-recurring expenses related to litigation, the Company earned a profit of $1.5 million or $0.64 per share for the year ended December 31, 1994.\nEFFECT OF INFLATION The Company does not believe that inflation has had a material impact on its operations over the past three years.\nLIQUIDITY AND CAPITAL RESOURCES The Company's consolidated working capital was $10.4 million at December 31, 1995 compared to $12.7 million at December 31, 1994, and $8.2 million at December 31, 1993. The current ratio (current assets divided by current liabilities) as of December 31, 1995 is 1.57 to 1, compared to 1.95 to 1 at December 31, 1994, and 2.2 to 1 at December 31, 1993.\nNet cash used in operating activities for the year ended December 31, 1995 was $573,000. The decrease in cash from prior years has been primarily due to increases in inventories, accrued expenses and other assets of $2.7 million, $1.3 million and $1.2 million, respectively. These increases are partially offset by an increase of $3.6 million in accounts payable for the year ended December 31, 1995 and an increase in the reserve for litigation of $2.1 million for the year ended December 31, 1995.\nIn May of 1995, the Company concluded a credit agreement with NBD Bank. Under the terms of this agreement, the Company has secured a $13.0 million revolving credit facility, $1.3 million in secured notes and $2.2 million in unsecured notes. The Company has used these facilities for operating capital and to provide financing for an appeal bond in the amount of $5.9 million for the patent infringement litigation. The Company's $13.0 million revolving credit agreement terminates May 23, 1997. On October 17, 1995, the credit agreement was amended to temporarily provide an additional $0.8 million under the revolving credit facility, available until February 29, 1996. On March 18, 1996, the agreement was amended to extend the additional $0.8 million to May 31, 1996. This indebtedness bears interest at the prime rate (8.25% as of March 18, 1996), or at the Company's option, at the LIBOR plus 1.5% to 2.5% for maturities ranging from one to six months (from 7.56% to 7.81% as of March 28, 1996). The credit facility is collateralized by substantially all of the assets of the Company and its domestic subsidiaries and the accounts receivable of its domestic and foreign subsidiaries. Furthermore, the Company's obligations under the credit facility have been guaranteed by all of its domestic subsidiaries and are subject to certain covenants including those listed above. The Company's existing bank credit facility contains covenants which require the Company and its subsidiaries to maintain a minimum working capital level, a specified current ratio, a minimum tangible net worth, a minimum ratio of total liabilities to tangible net worth, a specified fixed charges coverage ratio and limitations on indebtedness. As of December 31, 1995, the Company was not in compliance with the loan covenants, as amended. At the request of the Company, the bank amended the covenants enabling the Company to be in compliance as of December 31, 1995.\nOn April 12, 1995, NBD amended the loan agreement to place the Company in compliance with all covenants of the agreement as of December 31, 1995.\nAs of March 28, 1996, $ 900,000 of the $13.8 million revolving credit facility was unused and available. Under this revolving line of credit, $6.0 million was borrowed under the LIBOR option available to the Company at interest rates from 7.56% to 7.81%.\nThe Company historically has been involved in a number of legal disputes, many of which have resulted in litigation, both as plaintiff and as defendant, including a number of proceedings currently pending. The cost of legal proceedings and settlements of lawsuits involving the Company has been a principal cause of the Company's lack of profitability in 1994 and has had a substantial negative impact on the Company's results of operations in 1995. See Item 3 \"Legal Proceedings\".\nThe Company believes that internally generated funds, together with available credit facilities, are sufficient to meet expected levels of business activity and working capital needs of the Company for the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements, notes thereto and supplementary financial statement schedules with respect to this item are set forth in the Table of Contents to the Consolidated Financial Statements and Consolidated Financial Statement Schedules appearing on page 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.\nInformation with respect to this item may be found under the caption \"Directors, Nominees and Executive Officers\" of the Company's 1996 Proxy Statement and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation with respect to this item may be found under the captions \"Executive Compensation,\" \"Stock Option Plan\" and \"Directors' compensation\" of the Company's 1996 Proxy Statement and such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation with respect to this item may be found under the captions \"Security Ownership of Certain Beneficial Owners and Management' and \"Shareholder Agreement\" of the company's 1996 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 this item may be found under the caption \"Certain Transactions\" of the Company's 1996 Proxy Statement and such information is incorporated hereon by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The documents filed as a part of this report:\n1. Financial Statements:\nThe consolidated financial statements and notes thereto filed with this report are listed on page.\n2. Financial Statements Schedule:\nThe financial statement schedule filed with this report is listed on page.\n3. Exhibits:\n3.1 Restated Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-18, as amended, Registration No. 33-16991C (\"Form S-18\").\n3.2 Bylaws of the Company, as amended, incorporated by reference to Exhibit 3.2 to the Company's Form 10-K for the year ended December 31, 1990 (\"1990 Form 10-K\").\n9. Shareholder Agreement, as amended, incorporated by reference to Exhibit 9 to the Company's Form 10-K for the year ended December 31, 1989 (\"1989 Form 10-K\").\n10.2 Employment Agreement with Rand W. Mueller, as amended, incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1, as amended, Registration No. 33-31356 (\"Form S-1\"), as further amended by Amendment No. 2 to Employment Agreement incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1992 (\"September 1992 Form 10-Q\"). 10.3 1987 Stock Option Plan, incorporated by reference to Exhibit 10.3 to Form S-18, and amendment thereto, incorporated by reference to Exhibit 10.3 to the Company's Form 10-K for the year ending December 31, 1990 (\"1990 Form 10-K\").\n10.4 Indemnification Agreement with Rand W. Mueller, incorporated by reference to Exhibit 10.4 to Form S-18.\nThe Company has entered into the same form of agreement with the following directors and executive officers as of the dates indicated:\nMarshall J. Mueller May 29, 1987 Kenneth M. Mueller May 29, 1987 Jack C. Chilingirian May 29, 1987 William S. Pickett May 29, 1987 Alan H. Foster May 17, 1988 David L. Etienne March 16, 1990 Richard Wierzbicki July 16, 1990 Peter J. Stouffer March 22, 1991 Jack D. Rutherford May 21, 1991 Robert V. Wagner August 3, 1993 John G. Chupa December 9, 1994 Michael P. Schroeder March 24, 1995 John C. Moffat March 24, 1995 Dean Jones March 24, 1995\n10.6 Consulting and Non-Compete Agreement with David L. Skinner, incorporated by reference to Exhibit 10.6 to 1990 Form 10-K.\n10.7 Non-Compete Agreement with David L. Skinner and Shirley A. Skinner, incorporated by reference to Exhibit 10.9 to Form S-1.\n10.8 Mortgage Agreement with Rand W. Mueller, incorporated by reference to Exhibit 10.8 to the Company's Form 10-K for the year ending December 31, 1992 (\"1992 Form 10-K\").\n10.9 Consulting Agreement with Kenneth M. Mueller, incorporated by reference to Exhibit 10.9 to Form S-18.\n10.10 Lease of real property at 950 E. Whitcomb, Madison Heights, Michigan, incorporated by reference to Exhibit 10.10 to 1992 Form 10-K.\n10.11 Lease of real property at 300 Industrial Avenue, Georgetown, Texas, incorporated by reference to Exhibit 10.11 to the Company's Form 10-K for the year ended December 31, 1991 (\"1991 Form 10-K\").\n10.13 Lease of real property at 32, Rue Delizy, Pantin Cedex, France, incorporated by reference to Exhibit 10.13 to the Company's Form 10-K for the year ended December 31, 1994 (\"1994 Form 10-K\").\n10.14 Lease of real property at 16742 Burke Lane, Huntington Beach, California, incorporated by reference to Exhibit 14 to 1994 Form 10-K.\n10.19 General Motors Corporation contract, incorporated by reference to Exhibit 10.19 to Form S-1, as amended by amendments incorporated by reference to Exhibit 10.19 to 1994 Form 10-K.\n10.20 Ford Motor Corporation contract, incorporated by reference to Exhibit 10.20 to Form S-1, as amended by amendments incorporated by reference to Exhibit 10.21 to 1994 Form 10-K.\n10.21 Chrysler corporation contract, incorporated by reference to Exhibit 10.21 to Form S-1, as amended by amendments incorporated by reference to Exhibit 10.21 to 1994 Form 10-K.\n10.22 Purchase Agreement with Mitsubishi Motor Sales of America, Inc., incorporated by reference to Exhibit 10.22 to 1992 Form 10-K.\n10.23 Development Agreement by and between the City of Georgetown, Texas and Tessco Group, Inc. concerning redevelopment of real property at 300 Industrial Avenue, Georgetown, Texas, incorporated by reference to Exhibit 10.23 to 1991 Form 10-K. 10.27 Amended and Restated Loan Agreement with Comerica Bank as of March 31, 1991, incorporated by reference to Exhibit 10.27 to the Company's March 1991 Form 10-Q, as further amended by First and Second Amendments to Amended and Restated Loan Agreement with Comerica Bank as of March 31, 1991, incorporated by reference to Exhibit 10.27 to 1991 Form 10-K, as further amended by Third Amendment to Amended and Restated Loan Agreement with Comerica Bank as of March 31, 1991, incorporated by reference to Exhibit 10.27 to the Company's September 1992 10-Q, and as further amended by the Fourth Amendment to Amended and Restated Loan Agreement with Comerica Bank as of March 31, 1991, incorporated by reference to Exhibit 10.27 to 1992 Form 10-K.\n10.27.3 Ninth Amendment to Amended and Restated Loan Agreement with Comerica Bank as of March 31, 1991, incorporated by reference to Exhibit 10.27.3 to 1994 Form 10-K.\n10.28 Commitment Letter from NBD Bank, April 7, 1995, incorporated by reference to Exhibit 10.28 to 1994 Form 10-K; Loan Agreement with NBD Bank as of May 23, 1995 (\"NBD Loan Agreement\"), incorporated by reference to Exhibit 10.28 to the Company's Form 10-Q for the quarter ended June 30, 1995; and First Amendment dated June 30, 1995, Waiver Letter dated October 3, 1995, Second Amendment dated October 17, 1995 and Letter Agreeing to amend NBD Loan Agreement dated November 1, 1995, incorporated by reference to Exhibit 10.28 to the Company's Form 10-Q for the quarter ended September 30, 1995 (\"September 1995 Form 10-Q\").\n10.28.1* Third and Fourth Amendments to NBD Loan Agreement dated November 22, 1995 and March 18, 1996, respectively.\n10.28.2* Letter from NBD Bank dated April 12, 1996 amending NBD Loan Agreement.\n10.29 Purchase Agreement with Subaru of America, Inc., incorporated by reference to Exhibit 10.29 to the Company's September 1995 Form 10-Q.\n23* Consent of Deloitte & Touche LLP\n27* Financial Data Schedule\n* Attached as an Exhibit hereto. (b) There were no Reports on Form 8-K filed during the last quarter of the fiscal year ended December 31, 1995.\nCODE-ALARM, INC. AND SUBSIDIARIES CONTENTS\nPAGES ----- CONSOLIDATED FINANCIAL STATEMENTS OF CODE-ALARM, INC. AND SUBSIDIARIES:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.............\nCONSOLIDATED FINANCIAL STATEMENTS:\nBALANCE SHEETS .......................................\nSTATEMENTS OF OPERATIONS .............................\nSTATEMENTS OF SHAREHOLDERS' EQUITY ...................\nSTATEMENTS OF CASH FLOWS ............................. TO\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ........... TO\nFINANCIAL STATEMENT SCHEDULE:\nII. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES ..\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Code-Alarm, Inc.\nWe have audited the consolidated balance sheets of Code-Alarm, 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. 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 Corporation's management. Our responsibility is to express an opinion on the 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 Code-Alarm, 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. 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 herein.\nDeloitte & Touche LLP Detroit, Michigan April 12, 1996\nCODE-ALARM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS)\nCODE-ALARM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nCODE-ALARM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 (IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\nCODE-ALARM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)\n(Continued)\nCode-Alarm, Inc. and Subsidiaries Consolidated Statement of Cash Flows (IN THOUSANDS) (Continued)\nSUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES FOR 1994:\nDuring 1994, the Company entered into a $500,501 capital lease obligation for machinery and equipment.\nDuring 1995, the Company entered into capital lease obligations of approximately $386,000 for computer equipment and $247,000 for machinery and other capital equipment. Principal payments on these capital leases in 1995 were approximately $97,000 and $39,000 respectively. Also, during 1995, the Company exchanged inventory for a $413,000 note which may be used to reduce the cost of various goods and services received during the next five years.\nThe accompanying notes are an integral part of the consolidated financial statements.\n(End)\nCODE-ALARM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS OPERATIONS The Company designs, manufactures, imports and markets automobile and home security systems, keyless entry systems and related products. The Company is also a contract manufacturer of electronic cable, wire harness and printed circuit board assemblies.\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated.\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with an original maturity of three months or less at date of purchase to be cash equivalents.\nINVENTORIES Inventories are stated at the lower of cost or market. The cost of all inventories is determined on the first-in, first-out (\"FIFO\") method.\nPROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is being provided using the straight-line and accelerated methods over the estimated useful lives of the related assets. Upon retirement or disposal of property or equipment, the cost and accumulated depreciation are removed from the accounts, and any gain or loss is included in operations. Estimated useful lives are 5 years for furniture and fixtures and leasehold improvements and 3 to 5 years for machinery and equipment.\nINTANGIBLE ASSETS The excess of acquisition cost over net assets acquired (\"Goodwill\") is amortized on a straight-line basis over 40 years. The Company continually evaluates the realizability of Goodwill based upon expectations of estimated future cash flow and operating income. Impairment of Goodwill is recognized as a charge to operations when the estimated future cash flows are less than the carrying value of the Goodwill. Based upon its most recent analysis, the Company believes that no impairment of Goodwill exists at December 31, 1995. The costs of all other intangible assets, comprised primarily of covenants-not-to-compete, patents and trademarks, are amortized on a straight-line basis over their respective estimated useful lives, generally five years. Accumulated amortization of intangible assets amounted to approximately $1,643,000 and $ 1,685,000 at December 31, 1994 and December 31, 1995, respectively.\nREVENUE RECOGNITION Revenues are recognized from sales when the product is shipped. The Company provides an accrual for future product return and warranty costs based upon the prior years' sales and costs incurred. Accrued warranty costs amounted to approximately $300,000 and $150,000 at December 31, 1994 and 1995, respectively.\nRESEARCH AND DEVELOPMENT COSTS Expenditures for the research and development of new and improved products are charged to operations as incurred and aggregated approximately $358,000, $572,000 and $558,000 for the years ended December 31, 1993, 1994 and 1995 respectively.\nMANAGEMENT ESTIMATES The 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 contingent assets and liabilities at December 31, 1995 and 1994, and revenues and expenses during the three years in the period ended December 31, 1995. The actual results could differ from the estimates made in the preparation of the consolidated financial statements.\nEARNINGS PER COMMON SHARE Shares issuable under employee stock options were excluded from the computation of the weighted average number of common shares since they were either antidilutive or their dilutive effect was not significant.\nFOREIGN CURRENCY TRANSLATION The functional currency for the majority of the Company's foreign operations is the French franc. The translation from the franc 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 gains or losses, net of applicable deferred income taxes, resulting from translation are included in shareholders' equity, and gains or losses resulting from foreign currency transactions are included in the statement of operations.\n2. INVENTORIES Inventories consist of the following:\n3. PROPERTY AND EQUIPMENT Property and equipment is summarized by the following major classifications:\nDepreciation expense was approximately $1,064,000, $1,093,000 and $1,260,000 for the years ended December 31, 1993, 1994, and 1995 respectively.\nIn 1994 the Company had a loan agreement with Comerica Bank. The $7,500,000 revolving credit portion of the loan agreement was due June 30, 1997 and was collateralized by accounts receivable, inventory and property and equipment. At the Company's option, the interest rate was at Comerica Bank's prime rate (8.5% at December 31, 1994) or at fixed interest rates equal to the London Interbank Offered Rate (\"LIBOR\") plus 1% to 1.75% (7.75% at December 31, 1994). The Company also agreed to pay a commitment fee equal to three-eighths of one percent per annum on the difference between $6,000,000 and the outstanding balance.\nThis loan agreement was subject to covenants for maintenance of certain debt and cash flow ratios and minimum levels of current assets and tangible net worth. At December 31, 1994, the Company was not in compliance with certain covenants; however, Comerica Bank, at the Company's request, waived the covenant violations.\nTerm loans were payable in equal quarterly installments of $200,000 through 1999. At the Company's option, the interest rate was at the Comerica Bank's prime rate or at fixed interest rates ranging from 1% to 1.75% percent above LIBOR on a designated portion of the outstanding loan.\nIn May 1995 the above described loan agreement was replaced with a new credit arrangement with NBD Bank. The new credit arrangement provides for a $13 million secured revolving credit facility for working capital requirements, $1.3 million secured non-amortizing notes and $2.2 million unsecured four year term notes. The revolving credit facility expires in May 1997 and bears interest at NBD Bank's prime rate (8.50% at December 31, 1995) or at the Company's option at LIBOR plus 1.5% to 2.5% for maturities ranging from one to six months (from 8.187% to 8.429%, respectively, at December 31, 1995). On October 17, 1995 and March 18, 1996 amendments were added to the original loan agreement which temporarily provide an additional $750,000 under the revolving credit facility, until May 31, 1996. At December 31, 1995 a standby letter of credit in the amount of $5.9 million is outstanding under the revolving credit facility in conjunction with the appeal of the patent infringement settlement as discussed in Note 9.\nThe credit facility is subject to certain covenants and restrictions concerning certain debt and working capital ratios, minimum levels of tangible net worth, restrictions on the payment of dividends and purchases of fixed assets and is collateralized by substantially all the assets of the Company and its domestic subsidiaries. Total credit available under the arrangement is subject to a formula of accounts receivable, inventories and appraised value of property and equipment assets. As of December 31, 1995, the Company was in default with certain covenants. NBD Bank has amended the credit agreement. Such amendment will place the Company in compliance with the covenants.\nA foreign subsidiary of the Company has credit arrangements with three commercial banks representing working capital facilities totalling approximately $3.1 million, with interest rates ranging from 8% to 11.5%.\nThe mortgage note is payable to the City of Georgetown, Texas, in monthly installments of $4,401, including interest at 7% through January of 2005, and is collateralized by the leasehold improvements.\nThe recorded amounts of long term debt approximate fair value as of December 31, 1995.\nThe following table sets forth aggregate maturities of long-term debt (excluding capital lease obligations) at December 31, 1995:\nMinimum lease payments on capital lease obligations at December 31, 1995 are:\n5. COMMITMENTS\nLEASES The Company leases certain property and equipment under various operating leases through 2000.\nFuture minimum rental payments required for all noncancelable operating leases are as follows for the years ending December 31:\nRent expense under all operating leases was approximately $637,000, $769,000, and $915,000 for the years ended December 31, 1993, 1994 and 1995, respectively.\n6. CAPITAL STOCK\nSTOCK REPURCHASE The Company has repurchased and retired its common stock held by certain former directors in conjunction with their resignation from the Board of Directors. During the year ended December 31, 1993, the Company purchased and retired 20,000 shares for $140,000. During the year ended December 31, 1994, the Company purchased and retired 47,904 shares for $503,000 and 119,180 shares for $1,058,000. No repurchases of such shares were executed in 1995. All repurchases were made below the closing market price on the date of the purchase.\nSTOCK OPTION PLAN The Company has adopted a Stock Option Plan (\"Plan\") for its key employees and reserved 280,000 shares of common stock for issuance under the Plan. The Plan authorizes the Company to issue Incentive Stock Options and Non-Qualified Stock Options. The Company may grant such options concurrently with Stock Appreciation Rights, which entitle the Company to accept surrender of an option by paying the employee an amount equal to the increase in the price of the Company's common stock from the option date.\nIncentive Stock Options may be issued at a price not less than fair market value as of the grant date. For any employee holding more than 10 percent of the voting stock of the Company, the option price is 110 percent of fair market value at the grant date.\nNon-Qualified Stock Options may be issued at a price not less than 85 percent of fair market value at the grant date. Options are generally exercisable for a ten-year period; however, options granted to any employee holding more than 10 percent of the voting stock of the Company are exercisable over five years. No Non-Qualified Stock Options have been granted.\nThe following is a summary of Incentive Stock Options, with Stock Appreciation Rights, granted under the Plan:\nThese options and rights were issued at various prices ranging from $4.25 per share to $22.28 per share. At December 31, 1995, 77,625 options were exercisable at prices ranging from $4.25 to $22.28 per share.\n7. ACQUISITIONS\nEffective January 1, 1994, the Company purchased Europe Auto Equipement, S.A. (\"EAE\"), a French based distributor of vehicle security products. Consideration included $1.6 million and 50,000 shares of the Company's common stock. Also, effective January 1, 1994, the Company purchased Code-Alarm Europe, Ltd., a distributor of vehicle security products in the United Kingdom, for 40,000 shares of the Company's common stock.\nThese acquisitions were accounted for as purchases, with the results of their operations included from January 1, 1994. The fair value of assets acquired, including goodwill, was $8,766,000, and liabilities assumed totaled $6,389,000. Goodwill of $1,230,000 is being amortized over 40 years on a straight-line basis.\nThe pro forma results listed below are unaudited and reflect adjustments assuming the acquisition occurred January 1, 1993:\n(IN THOUSANDS)\n8. INCOME TAXES\nThe effective income tax rates differed from the statutory income tax rate due to the following:\nCurrent income tax expense for 1994 and 1995 includes $73,000 and $46,000 of foreign income taxes respectively. There were no foreign income taxes for 1993.\nDeferred tax assets and liabilities as of December 31 consisted of the following:\nThe Company does not provide United States income taxes on the undistributed earnings of foreign subsidiaries, as such earnings are intended to be reinvested in these operations. Accumulated undistributed earnings of the foreign subsidiaries are approximately $121,000 and $251,000, which would have resulted in federal income taxes of approximately $41,000 and $87,000 at December 31, 1994 and 1995, respectively.\n9. LITIGATION\nThe Company is involved in a patent infringement suit involving a shock sensing device. During 1993, the Company was found to be in violation of the patent. The damage portion of the trial was completed in January 1995 and at December 31, 1994, the Company recorded an accrual for damages, including interest and costs, of approximately $4.2 million. In June 1995 the Company received from the United States District Court information that the damages would total $6.0 million. Accordingly the Company has recorded an additional accrual for damages of $1.8 million in 1995. The Company believes that any amount paid will be paid after 1996, or it will be financed with long-term debt. The Company's reserve for litigation and litigation expense include this estimate of damages and incidental professional fees and costs.\nThe Company is involved in several legal proceedings following the Company's decision to aggressively defend its patent rights. The Company is asserting its patent rights against the defendants in these cases, and such defendants have made claims against the Company. The outcome of these cases cannot be reasonably estimated.\nThe Company, on March 16, 1995, was named as a defendant in an action pending since August 1990 to enforce a patent infringement default judgment rendered against certain predecessors in title to assets now owned by the Company which were purchased by the Company from a bank in January 1990. The amount of the judgment is $19.4 million, which with accumulated interest now has reached approximately $28.6 million. While the Company believes that it has meritorious defenses to the claims asserted in this lawsuit, there can be no assurance that the disposition of this matter will not have a material adverse effect on the Company's financial position, results of operation and liquidity. The ultimate outcome of this lawsuit cannot be determined at this time, and the Company is unable to estimate the range of possible loss, if any.\nVarious other legal actions and claims are pending or could be asserted against the Company. Litigation is subject to many uncertainties; the outcome of individual litigation matters is not predictable with assurance, and it is reasonably possible that some of these matters may be decided unfavorably to the Company. It is the opinion of management that the ultimate liability, if any, with respect to these matters will not materially affect the financial position, results of operations or liquidity of the Company.\n10. SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION\nThe Company operates primarily in one business segment -- vehicle security systems. This segment represents more than 90% of consolidated revenue, operating profit and identifiable assets. With the exception of sales to dealers of General Motors Corporation (\"GM\") and Ford Motor Company (\"Ford\"), no single customer accounted for more than 10 percent of revenue.\nWith the acquisition of EAE, effective January 1, 1994, the Company expanded its European distribution. Information about the Company's domestic and European operations is as follows:\nExport sales for 1993, 1994 and 1995 were not significant.\n11. CONCENTRATIONS OF RISK\nThe company's products include a number of high-technology components that are currently sourced from only a few suppliers and, in some cases, a single supplier. The Company frequently requires large volumes of such components. If the Company's suppliers are unable to fulfill the Company's needs for such components, the Company may be unable to fill customer orders and its business and financial condition, including working capital and results of operations, may be materially and adversely affected.\nCODE-ALARM, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nNote: (1) Write-off uncollectible accounts, 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.\nCODE-ALARM, INC. ----------------- (Registrant)\nDate: April 15, 1996 RAND W. MUELLER - --------------------- ------------------ RAND W. MUELLER 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.\nRAND W. MUELLER President (Chief April 15, 1996 - ------------------- Executive Officer) ------------------------- RAND W. MUELLER and Director\nROBERT V. WAGNER Vice President of April 15, 1996 - ------------------- Finance (Chief ------------------------- ROBERT V. WAGNER Financial Officer) Principal Accounting Officer April 15, 1996 ALAN H. FOSTER - ------------------- Director ------------------------- ALAN H. FOSTER\nApril , 1996\n- ------------------- Director ------------------------- KENNETH M. MUELLER\nApril , 1996\n- ------------------- Director ------------------------- MARSHALL J. MUELLER April , 1996\n- ------------------- Director ------------------------- WILLIAM S. PICKETT April 15, 1996 JACK D. RUTHERFORD - ------------------- Director ------------------------- JACK D. RUTHERFORD April 15, 1996 PETER J. STOUFFER - ------------------- Director ------------------------- PETER J. STOUFFER\nEXHIBIT INDEX\nExhibit Number Description Page - ------- --------------------------------------------------------------\n10.28.1* Third and Fourth Amendments to NBD Loan Agreement dated November 22, 1995 and March 18, 1996, respectively.\n10.28.2* Letter from NBD Bank dated April 12, 1996 amending NBD Loan Agreement.\n23* Consent of Deloitte & Touche LLP\n27* Financial Data Schedule.\n* attached as an Exhibit hereto.","section_15":""}
{"filename":"789791_1995.txt","cik":"789791","year":"1995","section_1":"ITEM 1. Business\nParker & Parsley 86-C, Ltd. (the \"Registrant\") is a limited partnership organized in 1986 under the laws of the State of Texas. The managing general partner is Parker & Parsley Development L.P. (\"PPDLP\"). PPDLP's general partner is Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"). The managing general partner during the year ended December 31, 1994 was Parker & Parsley Development Company (\"PPDC\"). PPDC was merged into PPDLP on January 1, 1995. See Item 12 (c).\nA Registration Statement, as amended, filed pursuant to the Securities Act of 1933, registering limited partnership interests aggregating $50,000,000 in a series of Texas limited partnerships formed under the Parker & Parsley 86 Development Drilling Program, was declared effective by the Securities and Exchange Commission on April 7, 1986. On December 30, 1986, the offering of limited partnership interests in the Registrant, the third partnership formed under such statement, was closed, with interests aggregating $19,317,000 being sold to 1,466 subscribers.\nThe Registrant engages primarily in oil and gas development and production and is not involved in any industry segment other than oil and gas. See \"Item 6. Selected Financial Data\" and \"Item 8. Financial Statements and Supplementary Data\" of this report for a summary of the Registrant's revenue, income and identifiable assets.\nThe principal markets during 1995 for the oil produced by the Registrant were refineries and oil transmission companies that have facilities near the Registrant's oil producing properties. The principal markets for the Registrant's gas were companies that have pipelines located near the Registrant's gas producing properties. Of the Registrant's oil and gas revenues for 1995, approximately 56%, 14% and 13% were attributable to sales made to Phibro Energy, Inc., Western Gas Resources, Inc. and GPM Gas Corporation, respectively.\nBecause of the demand for oil and gas, the Registrant does not believe that the termination of the sales of its products to any one customer would have a material adverse impact on its operations. The loss of a particular customer for gas may have an effect if that particular customer has the only gas pipeline located in the areas of the Registrant's gas producing properties. The Registrant believes, however, that the effect would be temporary, until alternative arrangements could be made.\nFederal and state regulation of oil and gas operations generally includes the fixing of maximum prices for regulated categories of natural gas, the imposition of maximum allowable production rates, the taxation of income and other items, and the protection of the environment. Although the Registrant believes that its business operations do not impair environmental quality and that its costs of complying with any applicable environmental regulations are not currently significant, the Registrant cannot predict what, if any, effect these environmental regulations may have on its current or future operations.\nThe Registrant does not have any employees of its own. PPUSA employs 623 persons, many of whom dedicated a part of their time to the conduct of the Registrant's business during the period for which this report is filed. The Registrant's managing general partner, PPDLP through PPUSA, supplies all management functions.\nNo material part of the Registrant's business is seasonal and the Registrant conducts no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Registrant's properties consist primarily of leasehold interests in properties on which oil and gas wells are located. Such property interests are often subject to landowner royalties, overriding royalties and other oil and gas leasehold interests.\nFractional working interests in developmental oil and gas prospects located primarily in the Spraberry Trend area of West Texas were acquired by the Registrant, resulting in the Registrant's participation in the drilling of 60 productive oil and gas wells. Two wells have been abandoned due to uneconomical operations; one in 1992 and one in 1995. At December 31, 1995, 58 wells were producing.\nFor information relating to the Registrant's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993, and changes in such quantities for the years then ended, see Note 7 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below. Such reserves have been estimated by the engineering staff of PPUSA with a review by an independent petroleum consultant.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Registrant is a party to material litigation which is described in Note 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\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\nAt March 8, 1996, the Registrant had 19,317 outstanding limited partnership interests held of record by 1,505 subscribers. There is no established public trading market for the limited partnership interests. Under the limited partnership agreement, PPDLP has made certain commitments to purchase partnership interests at a computed value.\nRevenues which, in the sole judgement of the managing general partner, are not required to meet the Registrant's obligations are distributed to the partners at least quarterly in accordance with the limited partnership agreement. During the years ended December 31, 1995 and 1994, distributions of $594,990 and $692,377, respectively, were made to the limited partners.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe following table sets forth selected financial data for the years ended December 31: 1995 1994 1993 1992 1991 ----------- ---------- ---------- ---------- ---------- Operating results: Oil and gas sales $ 1,423,091 $1,525,637 $1,972,283 $2,511,819 $2,790,268 ========== ========= ========= ========= ========= Litigation settle- ment, net $ - $ - $7,605,715 $ - $ - ========== ========= ========= ========= ========= Impairment of oil and gas properties $ 877,603 $ - $ - $ - $ - ========== ========= ========= ========= ========= Net income (loss) $(1,054,048) $ (8,694) $7,667,154 $ 213,293 $ 336,927 ========== ========= ========= ========= ========= Allocation of net income (loss): Managing general partner $ (10,540) $ (87) $ 76,627 $ 2,133 $ 4,142 ========== ========= ========= ========= ========= Limited partners $(1,043,508) $ (8,607) $7,590,527 $ 211,160 $ 332,785 ========== ========= ========= ========= ========= Limited partners' net income (loss) per limited part- nership interest $ (54.02) $ (.45) $ 392.95 $ 10.93 $ 17.23 ========== ========= ========= ========= ========= Limited partners' cash distributions per limited part- nership interest $ 30.80 $ 35.84 $ 410.60(a)$ 72.18 $ 84.15 ========== ========= ========= ========= ========= At year end: Total assets $ 4,413,551 $6,049,557 $6,768,125 $7,657,490 $8,862,658 - - --------------- ========== ========= ========= ========= ========= (a) Including litigation settlement per limited partnership interest of $360.95 in 1993. 4\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\nThe Registrant's 1995 oil and gas revenues decreased to $1,423,091 from $1,525,637 in 1994, a decrease of 7%. The decrease in revenues resulted from a 12% decline in barrels of oil produced and sold and a 10% decline in mcf of gas produced and sold, offset by an 8% increase in the average price received per barrel of oil. In 1995, 57,498 barrels of oil were sold compared to 65,208 in 1994, a decrease of 7,710 barrels. In 1995, 261,087 mcf of gas were sold compared to 289,443 in 1994, a decrease of 28,356 mcf. The decreases were primarily due to the decline characteristics of the Registrant's oil and gas properties. Because of these characteristics, management expects a certain amount of decline in production to continue in the future until the Registrant's economically recoverable reserves are fully depleted.(1)\nThe average price received per barrel of oil increased $1.25 from $15.94 in 1994 to $17.19 in 1995. The average price received per mcf of gas decreased from $1.68 in 1994 to $1.67 in 1995. The market price for oil and gas has been extremely volatile in the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.(1) The Registrant may therefore sell its future oil and gas production at average prices lower or higher than that received in 1995.(1)\nSalvage income of $4,257 was received during 1995 from the disposal of equipment on one fully depleted well. Salvage income from equipment disposals of $27,933 for 1994 consisted of equipment credits received of $210 on a well abandoned in a prior year and $27,723 received on one fully depleted well.\nTotal costs and expenses increased in 1995 to $2,489,655 as compared to $1,568,731 in 1994, an increase of $920,924, or 59%. The increase was primarily the result of the impairment of oil and gas properties, in addition to increases in abandoned property costs and loss on abandoned property, offset by decreases in production costs, depletion and general and administrative expenses (\"G&A\").\nProduction costs were $848,246 in 1995 and $901,212 in 1994, resulting in a $52,966 decrease, or 6%. The decrease was due to a decline in well repair and maintenance costs, offset by an increase in workover expense incurred in an effort to stimulate well production.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 7% from $45,769 in 1994 to $42,693 in 1995. The Registrant paid the managing general partner $34,427 in 1995 and $34,454 in 1994 for G&A incurred on behalf of the Registrant. G&A is allocated, in part, to the Registrant by the managing general partner. The Partnership agreement limits allocated G&A to 3% of gross oil and gas revenues. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of\nthe Registrant relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.(1)\nDepletion was $594,478 in 1995 compared to $621,750 in 1994. This represented a decrease of $27,272, or 4%. Depletion was computed property-by-property utilizing the unit-of-production method based upon the dominant mineral produced, generally oil. Oil production decreased 7,710 barrels in 1995 from 1994, while oil reserves of barrels were revised downward by 34,442 barrels, or 5%.\nA loss on abandoned property of $112,613 was recognized during 1995. This loss was the result of proceeds received of $32,091 from equipment salvage on abandoned property, less the write-off of remaining capitalized well costs of $144,704. Expenses incurred to plug and abandon one well totaled $14,022. There was no abandonment activity during 1994.\nEffective for the fourth quarter of 1995 the Registrant 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\") which requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, 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 of recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment is recognized based on the asset's fair value as determined for oil and gas properties by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of the natural gas price environment and the Registrant's expectation of future cash flows from its oil and gas properties at the time of review, the Registrant recognized a non-cash charge of $877,603 associated with the adoption of SFAS 121.\n1994 compared to 1993\nThe Registrant's 1994 oil and gas revenues decreased to $1,525,637 from $1,972,283 in 1993, a decrease of 23%. The decrease in revenues resulted from a 7% decrease in the average price received per barrel of oil, a 14% decrease in the average price received per mcf of gas, a 14% decrease in barrels of oil produced and sold and a 15% decrease in mcf of gas produced and sold. In 1994, 65,208 barrels of oil were sold compared to 76,016 in 1993, a decrease of 10,808 barrels. In 1994, 289,443 mcf of gas were sold compared to 340,453 in 1993, a decrease of 51,010 mcf. The decreases were primarily due to the decline characteristics of the Registrant's oil and gas properties.\nThe average price received per barrel of oil decreased $1.22 from $17.16 in 1993 to $15.94 in 1994. The average price received per mcf of gas decreased from $1.96 in 1993 to $1.68 in 1994.\nInterest income decreased to $6,467 in 1994 as compared to $21,103 for 1993. This decrease was due to interest earned on the litigation proceeds received in 1993 until it was disbursed to the limited partners.\nSalvage income from equipment disposals of $27,933 for 1994 consisted of equipment credits received of $210 on one well abandoned in a prior year and $27,723 received on one fully depleted well. Salvage income for 1993 consisted of equipment credits received of $27,579 on one previously productive oil and gas well, with expenses to abandon of $43,057.\nTotal costs and expenses decreased in 1994 to $1,568,731 as compared to $1,959,526 in 1993, a decrease of $390,795, or 20%. The decline was due to decreases in production costs, abandoned property costs, depletion and interest expense, offset by an increase in G&A.\nProduction costs were $901,212 in 1994 and $1,004,950 in 1993, resulting in a $103,738 decrease, or 10%. The decrease was due to declines in well repair, maintenance costs, workover expense and production and ad valorem taxes.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A increased, in aggregate, 2% from $44,842 in 1993 to $45,769 in 1994. The Registrant paid the managing general partner $34,454 in 1994 and $35,197 in 1993 for G&A incurred on behalf of the Registrant.\nDepletion was $621,750 in 1994 compared to $854,920 in 1993. This represented a decrease of $233,170, or 27%. Oil production decreased 10,808 barrels in 1994 from 1993, while oil reserves of barrels were revised downward by 61,421 barrels, or 7%.\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Registrant filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ-Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Registrant and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Registrant, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest, determined the general partner's portion of the funds and calculated any inter-partnership allocations. A distribution of $91,000,000 was made to the working interest owners, including the Registrant, on July 30, 1993. The limited partners received their distribution of $6,972,477, or $360.95 per limited partnership interest, in September 1993.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff partnerships, including the Registrant and others, alleging his entitlement to 12% of the settlement proceeds. Price's lawsuit\nclaim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Registrant and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court. On September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Registrant, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal of the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Registrant is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Registrant and other joint property owners for participating in the lawsuit pursuant to the joint operating agree ment. Litigation settlement proceeds received by the Registrant, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993. Interest charged on legal expenses paid on behalf of the Registrant by the managing general partner was $11,757 in 1993 and $29,277 in 1992.\nImpact of inflation and changing prices on sales and net income\nInflation impacts the fixed overhead rate charges of the lease operating expenses for the Registrant. During 1993, the annual change in the index of average weekly earnings of crude petroleum and gas production workers issued by the U.S. Department of Labor, Bureau of Labor Statistics, decreased by 1.1%. The 1994 annual change in average weekly earnings increased by 4.8% and was implemented April 1, 1994. The 1995 index (effective April 1, 1995) increased 4.4%. The impact of inflation for other lease operating expenses is small due to the current economic condition of the oil industry.\nThe oil and gas industry experienced volatility during the past decade because of the fluctuation of the supply of most fossil fuels relative to the demand for such products and other uncertainties in the world energy markets causing significant fluctuations in oil and gas prices. Since December 31, 1994, prices for oil production have fluctuated throughout the year. The price per barrel for oil production similar to the Registrant's ranged from approximately $16.00 to $19.00. For February 1996, the average price for the Registrant's oil was $18.00.\nPrices for natural gas are subject to ordinary seasonal fluctuations, and this volatility of natural gas prices may result in production being curtailed and, in some cases, wells being completely shut-in.(1)\nLiquidity and capital resources\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities decreased to $561,893 during the year ended December 31, 1995, a $24,499 decrease from the year ended December 31, 1994. The decrease was due to a decline in oil and gas sales and an increase in abandoned property costs, offset by declines in production costs. The decline in oil and gas sales was due to a decline in the barrels of oil and mcf of gas produced and sold, offset by an increase in the average price received per barrel of oil. The decline in production costs was due to less well repair and maintenance costs, offset by an increase in workover expense incurred in an effort to stimulate well production. The abandoned property costs increase was the result of the expense incurred to plug and abandon one well during 1995.\nNet Cash Provided by Investing Activities\nThe Registrant received $9,250 and $3,209 during 1995 and 1994, respectively, from the disposal of oil and gas equipment on various active properties.\nProceeds from salvage income on equipment disposals of $4,257 and $27,723 during 1995 and 1994, respectively, resulted from equipment credits received on fully depleted wells. The additional proceeds of $210 received in 1994 was from equipment credits received on a well abandoned in a prior year.\nProceeds of $32,091 were received from the salvage of equipment on one well abandoned during 1995.\nNet Cash Used in Financing Activities\nCash was sufficient in 1995 for distributions to the partners of $601,000 of which $594,990 was distributed to the limited partners and $6,010 to the managing general partner. In 1994, cash was sufficient for distributions to the partners of $699,372 of which $692,377 was distributed to the limited partners and $6,995 to the managing general partner.\nIt is expected that future net cash provided by operations will be sufficient for any capital expenditures and any distributions.(1) As the production from the properties declines, distributions are also expected to decrease.(1)\n- - ---------------\n(1) This statement is a forward looking statement that involves risks and uncertainties. Accordingly, no assurances can be given that the actual events and results will not be materially different than the anticipated results described in the forward looking statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Registrant's audited financial statements are included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nThe Registrant does not have any officers or directors. Under the limited partnership agreement, the Registrant's managing general partner, PPDLP, is granted the exclusive right and full authority to manage, control and administer the Registrant's business. PPUSA, the sole general partner of PPDLP, is a wholly-owned subsidiary of Parker & Parsley Petroleum Company (the \"Company\"), a publicly-traded corporation on the New York Stock Exchange.\nSet forth below are the names, ages and positions of the directors and executive officers of PPUSA. Directors of PPUSA are elected to serve until the next annual meeting of stockholders or until their successors are elected and qualified.\nAge at December 31, Name 1995 Position\nScott D. Sheffield 43 Chairman of the Board and Director\nJames D. Moring (a) 59 President, Chief Executive Officer and Director\nTimothy A. Leach 36 Executive Vice President and Director\nSteven L. Beal 36 Senior Vice President, Treasurer and Chief Financial Officer\nMark L. Withrow 48 Senior Vice President and Secretary\n- - --------------- (a) Mr. Moring retired from the Company and subsidiaries effective January 1, 1996. Mr. Sheffield assumed the positions of President and Chief Executive Officer of PPUSA effective January 1, 1996.\nScott D. Sheffield. Mr. Sheffield, a graduate of The University of Texas with a Bachelor of Science degree in Petroleum Engineering, has been the President and a Director of the Company since May 1990 and has been the Chairman of the Board and Chief Executive Officer since October 1990. Mr. Sheffield joined PPDC, the principal operating subsidiary of the Company, as a petroleum engineer in 1979. Mr. Sheffield served as Vice President - Engineering of PPDC from September 1981 until April 1985 when he was elected President and a Director of PPDC. In March 1989, Mr. Sheffield was elected Chairman of the Board and Chief Executive Officer of PPDC. On January 1, 1995, Mr. Sheffield resigned as President and Chief Executive Officer of PPUSA, but remained Chairman of the Board and a Director of PPUSA. On January 1, 1996, Mr. Sheffield reassumed the positions of President and Chief Executive Officer of PPUSA. Before joining PPDC, Mr. Sheffield was principally occupied for more than three years as a production and reservoir engineer for Amoco Production Company.\nJames D. Moring. Mr. Moring, a graduate of Texas Tech University with a Bachelor of Science degree in Petroleum Engineering has been a Director of the Company since October 1990 and was Senior Vice President - Operations of the Company from October 1990 until May 1993, when he was appointed Executive Vice President - Operations. Mr. Moring has been principally occupied since July 1982 as the supervisor of the drilling, completion, and production operations of PPDC and its affiliates and has served as an officer of PPDC since January 1983. Mr. Moring has been Senior Vice President - Operations and a Director of PPDC since June 1989 and in May 1993, Mr. Moring was appointed Executive Vice President - Operations. Mr. Moring was elected President and Director and appointed Chief Executive Officer of PPUSA on January 1, 1995. Effective January 1, 1996, Mr. Moring retired from the Company and subsidiaries. In the five years before joining PPDC, Mr. Moring was employed as a Division Operations Manager with Moran Exploration, Inc. and its predecessor.\nTimothy A. Leach. Mr. Leach, a graduate of Texas A&M University with a Bachelor of Science degree in Petroleum Engineering and the University of Texas of the Permian Basin with a Master of Business Administration degree, was elected Executive Vice President - Engineering of the Company on March 21, 1995. Mr. Leach had been serving as Senior Vice President Engineering since March 1993 and served as Vice President - Engineering of the Company from October 1990 to March 1993. Mr. Leach was elected Executive Vice President of PPUSA on December 1, 1995. He had joined PPDC as Vice President - Engineering in September 1989. Prior to joining PPDC, Mr. Leach was employed as Senior Vice President and Director of First City Texas - Midland, N.A.\nSteven L. Beal. Mr. Beal, a graduate of the University of Texas with a Bachelor of Business Administration degree in Accounting and a certified public accountant, was elected Senior Vice President - Finance of the Company in January 1995 and Chief Financial Officer of the Company on March 21, 1995. On January 1, 1995, Mr. Beal was elected Senior Vice President, Treasurer and Chief Financial Officer of PPUSA. Mr. Beal has been the Company's Chief Accounting Officer since November 1992 and been the Company's Treasurer since October 1990. Mr. Beal joined PPDC as Treasurer in March 1988 and was elected Vice President - Finance in October 1991. Prior to joining PPDC, Mr. Beal was employed as an audit manager of Price Waterhouse.\nMark L. Withrow. Mr. Withrow, a graduate of Abilene Christian University with Bachelor of Science degree in Accounting and Texas Tech University with a Juris Doctorate degree, was Vice President - General Counsel of the Company from February 1991 to January 1995, when he was appointed Senior Vice President - General Counsel, and has been the Company's Secretary since August 1992. On January 1, 1995, Mr. Withrow was elected Senior Vice President and Secretary of PPUSA. Mr. Withrow joined PPDC in January 1991. Prior to joining PPDC , Mr. Withrow was the managing partner of the law firm of Turpin, Smith, Dyer, Saxe & MacDonald, Midland, Texas.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Registrant does not have any directors or officers. Management of the Registrant is vested in PPDLP, the managing general partner. The Registrant\nparticipates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. Under the Program agreement, PPDLP pays approximately 10% of the Registrant's acquisition, drilling and completion costs and approximately 25% of its operating and general and administrative expenses. In return, PPDLP is allocated approximately 25% of the Registrant's revenues. See Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below for information regarding fees and reimbursements paid to the managing general partner or its affiliates by the Registrant.\nThe Registrant does not directly pay any salaries of the executive officers of PPUSA, but does pay a portion of PPUSA's general and administrative expenses of which these salaries are a part. See Note 6 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Beneficial owners of more than five percent\nThe Registrant is not aware of any person who beneficially owns 5% or more of the outstanding limited partnership interests of the Registrant. PPDLP owned 60 limited partner interests at January 1, 1996.\n(b) Security ownership of management\nThe Registrant does not have any officers or directors. The managing general partner of the Registrant, PPDLP, has the exclusive right and full authority to manage, control and administer the Registrant's business. Under the limited partnership agreement, limited partners holding a majority of the outstanding limited partnership interests have the right to take certain actions, including the removal of the managing general partner or any other general partner. The Registrant is not aware of any current arrangement or activity which may lead to such removal. The Registrant is not aware of any officer or director of PPUSA who beneficially owns limited partnership interests in the Registrant.\n(c) Changes in control\nOn January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of Parker & Parsley 86-C, Ltd., as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, which previously served as the managing general partner of the Registrant. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Registrant, including the development drilling program in which the Registrant participates.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nTransactions with the managing general partner or its affiliates\nPursuant to the limited partnership agreement, the Registrant had the following related party transactions with the managing general partner or its affiliates during the years ended December 31: 1995 1994 1993 --------- --------- ---------\nPayment of lease operating and supervision charges in accordance with standard industry operating agreements $ 351,625 $ 361,221 $ 392,060\nReimbursement of general and administrative expenses $ 34,427 $ 34,454 $ 35,197\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 58,340 $ 28,348 $ 25,383\nInterest expense charged on legal expenses paid on behalf of the Registrant by the managing general partner $ - $ - $ 11,757\nUnder the limited partnership agreement, the managing general partner pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Registrant's revenues. Also, see Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below, regarding the Registrant's participation with the managing general partner in oil and gas activities of the Program.\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 are filed as part of this annual report:\nIndependent Auditors' Report\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\n2. Financial statement schedules\nAll financial statement schedules have been omitted since the required information is in the financial statements or notes thereto, or is not applicable nor required.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits listed on the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.\nS I G N A T U R E S\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.\nPARKER & PARSLEY 86-C, LTD.\nDated: March 28, 1996 By: Parker & Parsley Development L.P., Managing General Partner\nBy: Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), General Partner\nBy: \/s\/ Scott D. Sheffield ------------------------------- Scott D. Sheffield, 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.\n\/s\/ Scott D. Sheffield President, Chairman of the Board, March 28, 1996 - - ------------------------- Chief Executive Officer and Scott D. Sheffield Director of PPUSA\n\/s\/ Timothy A. Leach Executive Vice President March 28, 1996 - - ------------------------- and Director of PPUSA Timothy A. Leach\n\/s\/ Steven L. Beal Senior Vice President, March 28, 1996 - - ------------------------- Treasurer and Chief Steven L. Beal Financial Officer of PPUSA\n\/s\/ Mark L. Withrow Senior Vice President and March 28, 1996 - - ------------------------- Secretary of PPUSA Mark L. Withrow\nINDEPENDENT AUDITORS' REPORT\nThe Partners Parker & Parsley 86-C, Ltd. (A Texas Limited Partnership):\nWe have audited the financial statements of Parker & Parsley 86-C, Ltd. as listed in the accompanying index under Item 14(a). 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 Parker & Parsley 86-C, Ltd. 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.\nAs discussed in Notes 2 and 3 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets and for long-lived assets to be disposed of in 1995 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\"\nKPMG Peat Marwick LLP\nMidland, Texas March 8, 1996\nPARKER & PARSLEY 86-C, LTD. (A Texas Limited Partnership)\nBALANCE SHEETS December 31\n1995 1994 ------------ ------------ ASSETS\nCurrent assets: Cash and cash equivalents, including interest bearing deposits of $73,587 in 1995 and $67,192 in 1994 $ 73,796 $ 67,305 Accounts receivable - oil and gas sales 151,051 164,132 ----------- -----------\nTotal current assets 224,847 231,437\nOil and gas properties - at cost, based on the successful efforts accounting method 15,562,115 15,864,179 Accumulated depletion (11,373,411) (10,046,059) ----------- -----------\nNet oil and gas properties 4,188,704 5,818,120 ----------- -----------\n$ 4,413,551 $ 6,049,557 =========== =========== LIABILITIES AND PARTNERS' CAPITAL\nCurrent liabilities: Accounts payable - affiliate $ 113,085 $ 94,043\nPartners' capital: Limited partners (19,317 interests) 4,258,769 5,897,267 Managing general partner 41,697 58,247 ----------- -----------\n4,300,466 5,955,514 ----------- ----------- $ 4,413,551 $ 6,049,557 =========== ===========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 86-C, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31\n1995 1994 1993 ----------- ---------- ----------\nRevenues: Oil and gas sales $ 1,423,091 $1,525,637 $1,972,283 Interest income 8,259 6,467 21,103 Salvage income from equipment disposals 4,257 27,933 27,579 Litigation settlement, net - - 7,605,715 ---------- --------- ---------\nTotal revenues 1,435,607 1,560,037 9,626,680\nCosts and expenses: Production costs 848,246 901,212 1,004,950 General and administrative expenses 42,693 45,769 44,842 Depletion 594,478 621,750 854,920 Impairment of oil and gas properties 877,603 - - Abandoned property costs 14,022 - 43,057 Loss on abandoned property 112,613 - - Interest expense - - 11,757 ---------- --------- ---------\nTotal costs and expenses 2,489,655 1,568,731 1,959,526 ---------- --------- ---------\nNet income (loss) $(1,054,048) $ (8,694) $7,667,154 ========== ========= =========\nAllocation of net income (loss): Managing general partner $ (10,540) $ (87) $ 76,627 ========== ========= =========\nLimited partners $(1,043,508) $ (8,607) $7,590,527 ========== ========= =========\nNet income (loss) per limited partnership interest $ (54.02) $ (.45) $ 392.95 ========== ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 86-C, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nManaging general Limited partner partners Total -------- ----------- -----------\nPartners' capital at January 1, 1993 $ 68,774 $ 6,939,255 $ 7,008,029\nDistributions (80,072) (7,931,531) (8,011,603)\nNet income 76,627 7,590,527 7,667,154 -------- ---------- ----------\nPartners' capital at December 31, 1993 65,329 6,598,251 6,663,580\nDistributions (6,995) (692,377) (699,372)\nNet loss (87) (8,607) (8,694) -------- ---------- ----------\nPartners' capital at December 31, 1994 58,247 5,897,267 5,955,514\nDistributions (6,010) (594,990) (601,000)\nNet loss (10,540) (1,043,508) (1,054,048) -------- ---------- ----------\nPartners' capital at December 31, 1995 $ 41,697 $ 4,258,769 $ 4,300,466 ======== ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 86-C, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31\n1995 1994 1993 ----------- --------- ----------- Cash flows from operating activities: Net income (loss) $(1,054,048) $ (8,694) $ 7,667,154 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depletion 594,478 621,750 854,920 Impairment of oil and gas properties 877,603 - - Salvage income from equipment disposals (4,257) (27,933) (27,579) Loss on abandoned property 112,613 - - Changes in assets and liabilities: Decrease in accounts receivable 13,081 14,568 51,439 Increase (decrease) in accounts payable 22,423 (13,299) (545,014) ---------- -------- ---------- Net cash provided by operating activities 561,893 586,392 8,000,920\nCash flows from investing activities: Proceeds from salvage income on equipment disposals 4,257 27,933 27,579 Proceeds from equipment salvage on abandoned property 32,091 - - Disposals of oil and gas properties 9,250 3,209 22,869 ---------- -------- ---------- Net cash provided by investing activities 45,598 31,142 50,448\nCash flows from financing activities: Cash distributions to partners (601,000) (699,372) (8,011,603) ---------- -------- ---------- Net increase (decrease) in cash and cash equivalents 6,491 (81,838) 39,765 Cash and cash equivalents at beginning of year 67,305 149,143 109,378 ---------- -------- ---------- Cash and cash equivalents at end of year $ 73,796 $ 67,305 $ 149,143 ========== ======== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 86-C, LTD. (A Texas Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNote 1. Organization and nature of operations\nParker & Parsley 86-C, Ltd. (the \"Partnership\") is a limited partnership organized in 1986 under the laws of the State of Texas.\nThe Partnership engages primarily in oil and gas development and production in Texas and is not involved in any industry segment other than oil and gas.\nNote 2. Summary of significant accounting policies\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\nImpairment of long-lived assets - Effective for the fourth quarter of 1995 the Partnership 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\"). Consequently, the Partnership reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows is less than the carrying amount of the assets. In this circumstance, the Partnership recognizes an impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset.\nThe Partnership accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less costs to sell once management has committed to a plan to dispose of the assets.\nOil and gas properties - The Partnership utilizes the successful efforts method of accounting for its oil and gas properties and equipment. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized while nonproductive exploration costs are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method on a property-by-property basis based on proved oil (dominant mineral) reserves as determined by the engineering staff of Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), the sole general partner of Parker & Parsley Development L.P. (\"PPDLP\"), the Partnership's managing general partner, and reviewed by independent petroleum consultants. The carrying amounts of properties sold or otherwise disposed of and the related allowances for depletion are eliminated from the accounts and any gain or loss is included in operations.\nPrior to the adoption of SFAS 121 in the fourth quarter, the Partnership's aggregate oil and gas properties were stated at cost not in excess of total estimated future net revenues and the estimated fair value of oil and gas assets not being depleted.\nUse of estimates in the preparation of financial statements - Preparation of the accompanying 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 reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNet income (loss) per limited partnership interest - The net income (loss) per limited partnership interest is calculated by using the number of outstanding limited partnership interests.\nIncome taxes - A Federal income tax provision has not been included in the financial statements as the income of the Partnership is included in the individual Federal income tax returns of the respective partners.\nStatements of cash flows - For purposes of reporting cash flows, cash and cash equivalents include depository accounts held by banks.\nGeneral and administrative expenses - General and administrative expenses are allocated in part to the Partnership by the managing general partner or its affiliates. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Partnership relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.\nEnvironmental - The Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nNote 3. Impairment of long-lived assets\nThe Partnership adopted SFAS 121 effective for the fourth quarter of 1995. SFAS 121 requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets to be disposed of are to be accounted for at the\nlower of carrying amount or fair value less cost to sell when management has committed to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 for fiscal years beginning after December 15, 1995.\nIn order to determine whether an impairment had occurred, the Partnership estimated the expected future cash flows of its oil and gas properties and compared such future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Partnership adjusted the carrying amount of those oil and gas properties to their fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result, the Partnership recognized a non-cash charge of $877,603 related to its oil and gas properties during the fourth quarter of 1995.\nAs of December 31, 1995, management had not committed to sell any Partnership asset.\nNote 4. Income taxes\nThe financial statement basis of the Partnership's net assets and liabilities was $2,185,447 greater than the tax basis at December 31, 1995.\nThe following is a reconciliation of net income (loss) per statements of operations with the net income per Federal income tax returns for the years ended December 31: 1995 1994 1993 ----------- -------- --------- Net income (loss) per statements of operations $(1,054,048) $ (8,694) $7,667,154 Depletion and depreciation provisions for tax reporting purposes under amounts for financial reporting purposes 567,874 298,329 234,308 Impairment of oil and gas properties for financial reporting purposes 877,603 - - Other 160,182 2,954 34,690 ---------- -------- --------- Net income per Federal income tax returns $ 551,611 $ 292,589 $7,936,152 ========== ======== =========\nNote 5. Oil and gas producing activities\nThe following is a summary of the costs incurred, whether capitalized or expensed, related to the Partnership's oil and gas producing activities for the years ended December 31: 1995 1994 1993 ---------- ---------- ---------- Development costs $ (34,957) $ (412) $ 20,286 ========= ========= =========\nCapitalized oil and gas properties consist of the following:\n1995 1994 1993 ------------ ------------ ----------- Proved properties: Property acquisition costs $ 698,973 $ 699,703 $ 699,703 Completed wells and equipment 14,863,142 15,164,476 15,164,888 ---------- ---------- ----------\n15,562,115 15,864,179 15,864,591 Accumulated depletion (11,373,411) (10,046,059) (9,424,309) ----------- ----------- ----------\nNet capitalized costs $ 4,188,704 $ 5,818,120 $ 6,440,282 =========== =========== ==========\nDuring 1995, the Partnership recognized a non-cash charge of $877,603 associated with the adoption of SFAS 121. See Note 3.\nNote 6. Related party transactions\nPursuant to the limited partnership agreement, the Partnership had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 351,625 $ 361,221 $ 392,060\nReimbursement of general and administrative expenses $ 34,427 $ 34,454 $ 35,197\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 58,340 $ 28,348 $ 25,383\nInterest expense charged on legal expenses paid on behalf of the Partnership by the managing general partner $ - $ - $ 11,757\nThe Partnership participates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. PPDLP and the Partnership are parties to the Program agreement.\nThe costs and revenues of the Program are allocated to PPDLP and the Partnership as follows: PPDLP (1) Partnership --------- ----------- Revenues: Proceeds from disposition of depreciable properties 9.09091% 90.90909% All other revenues 24.242425% 75.757575% Costs and expenses: Lease acquisition costs, drilling and completion costs and all other costs 9.09091% 90.90909% Operating costs, direct costs and general and administrative expenses 24.242425% 75.757575%\n(1) Excludes PPDLP's 1% general partner ownership which is allocated at the Partnership level and 60 limited partner interests owned by PPDLP.\nNote 7. Oil and gas information (unaudited)\nThe following table presents information relating to the Partnership's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities during the years then ended. All of the Partnership's reserves are proved and located within the United States. The Partnership's reserves are based on an evaluation prepared by the engineering staff of PPUSA and reviewed by an independent petroleum consultant, using criteria established by the Securities and Exchange Commission. Reserve value information is available to limited partners pursuant to the Partnership agreement and, therefore, is not presented. Oil (bbls) Gas (mcf) ---------- ---------- Net proved reserves at January 1, 1993 910,929 4,681,614 Revisions of estimates of January 1, 1993 29,967 786,021 Production (76,016) (340,453) ---------- ---------- Net proved reserves at December 31, 1993 864,880 5,127,182 Revisions of estimates of December 31, 1993 (61,421) (1,314,117) Production (65,208) (289,443) ---------- ---------- Net proved reserves at December 31, 1994 738,251 3,523,622 Revisions of estimates of December 31, 1994 (34,442) (108,877) Production (57,498) (261,087) ---------- ---------- Net proved reserves at December 31, 1995 646,311 3,153,658 ========== ==========\nThe estimated present value of future net revenues of proved reserves, calculated using December 31, 1995 prices of $19.35 per barrel of oil and $1.88 per mcf of gas, discounted at 10% was approximately $3,868,000 and undiscounted was $7,011,000 at December 31, 1995.\nThe Partnership emphasizes that reserve estimates are inherently imprecise and, accordingly, the estimates are expected to change as future information becomes available.\nNote 8. Major customers\nThe following table reflects the major customers of the Partnership's oil and gas sales during the years ended December 31:\n1995 1994 1993 ---- ---- ----\nPhibro Energy, Inc. 56% 55% 58% GPM Gas Corporation 13% 27% 25% Western Gas Resources Inc. 14% - -\nPPDLP is party to a long-term agreement pursuant to which PPDLP and affiliates are to sell to Phibro Energy, Inc. (\"Phibro\") substantially all crude oil (including condensate) which any of such entities has the right to market from time to time. On December 29, 1995, PPDLP and Phibro entered into a Memorandum to Agreement (\"Phibro MOA\") that cancels the prior crude oil purchase agreement between the parties and provides for adjusted terms effective December 1, 1995. The price to be paid for oil purchased under the Phibro MOA is to be competitive with prices paid by other substantial purchasers in the same area who are significant competitors of Phibro. The price to be paid for oil purchased under the Phibro MOA also includes a market-related bonus that may vary from month to month based upon spot oil prices at various commodity trade points. The term of the Phibro MOA is through June 30, 1998, and it may continue thereafter subject to termination rights afforded each party. Although Phibro was required to post a $16 million letter of credit in connection with purchases under the prior agreement, it is anticipated that this security requirement will be replaced by a $25 million payment guarantee by Phibro's parent company, Salomon Inc. Accounts receivable-oil and gas sales included $58,402 due from Phibro at December 31, 1995.\nNote 9. Contingencies\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Partnership filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ- Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Partnership and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Partnership, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest, determined the general partner's portion of the funds and calculated any inter-partnership allocations.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff partnerships, including the Partnership and others,\nalleging his entitlement to 12% of the settlement proceeds. Price's lawsuit claim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Partnership and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court.\nOn September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Partnership, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal of the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Partnership is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Partnership and other joint property owners for participating in the lawsuit pursuant to the joint operating agreement. Litigation settlement proceeds received by the Partnership, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993.\nA distribution of $91,000,000 was made to the working interest owners, including the Partnership, on July 30, 1993. The limited partners received their distribution of $6,972,477, or $360.95 per limited partnership interest, in September 1993. The allocation of the lawsuit settlement amount was based on the original verdict entered on October 26, 1990. The allocation to the working interest owners in each well (including the Partnership) was based on a ratio of the relative amount of damages due to overcharges for services and materials (\"Materials\") and damages for loss of past and future production (\"Production\"), each as determined in that initial judgment. Within the Partnership, damages for Materials were allocated between the partners based on their original sharing percentages for costs of acquiring and\/or drilling of wells. Similarly, damages related to Production were allocated to the partners in the Partnership based on their respective share of revenues from the subject wells (see Note 6).\nAs a condition of the purchase by Parker & Parsley Petroleum Company of Parker & Parsley Development Company (\"PPDC\"), which was merged into PPDLP on January 1, 1995 (see Note 10), from its former parent in May 1989, PPDC's interest in the lawsuit and subsequent settlement was retained by the former parent. Consequently, all of PPDC's share of the settlement related to its separately held interests in the wells and its partnership interests in the sponsored partnerships (except that portion allocable to interests acquired by PPDC after May 1989) was paid to the former parent.\nNote 10. Organization and operations\nThe Partnership was organized December 30, 1986 as a limited partnership under the Texas Uniform Limited Partnership Act for the purpose of acquiring and developing oil and gas properties. The following is a brief summary of the more significant provisions of the limited partnership agreement:\nManaging general partner - On January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of the Partnership as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, and which previously served as the managing general partner of the Partnership. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Partnership, including the development drilling program in which the Partnership participates. PPDLP has the power and authority to manage, control and administer all Program and Partnership affairs. Under the limited partnership agreement, the managing general partner pays 1% of the Partnership's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Partnership's revenues.\nLimited partner liability - The maximum amount of liability of any limited partner is the total contributions of such partner plus his share of any undistributed profits.\nInitial capital contributions - The limited partners entered into subscription agreements for aggregate capital contributions of $19,317,000. PPDLP is required to contribute amounts equal to 1% of initial Partnership capital less commission and offering expenses allocated to the limited partners and to contribute amounts necessary to pay costs and expenses allocated to it under the Partnership agreement to the extent its share of revenues does not cover such costs.\nPARKER & PARSLEY 86-C, LTD.\nINDEX TO EXHIBITS\nThe following documents are incorporated by reference in response to Item 14(c):\nExhibit No. Description Page\n3(a) Amended and Restated Certificate of - Limited Partnership of Parker & Parsley 86-C, Ltd.\n4(a) Agreement of Limited Partnership of - Parker & Parsley 86-C, Ltd.\n4(b) Form of Subscription Agreement and - Power of Attorney\n4(c) Specimen Certificate of Limited - Partnership Interest\n10(a) Operating Agreement -\n10(b) Exploration and Development Program - Agreement\n99.1 Mutual Release and Indemnity Agreement dated May 25, 1993 -","section_15":""}
{"filename":"352849_1995.txt","cik":"352849","year":"1995","section_1":"Item 1. Business\n(a) General development of business\nSEI II L.P. (the \"Partnership\" or the \"Registrant\") (formerly known as Shearson Equipment Investors - II) is a limited partnership organized April 6, 1981 under the Partnership Law of the State of New York to engage in the acquisition of various types of equipment and other property. The Partnership acquired, through direct forms of ownership, various types of equipment which do not incorporate high levels of technology and are therefore not likely to be subject to technological obsolescence.\nA Registration Statement on Form S-1, Registration No. 2-72177, filed with the Securities and Exchange Commission and relating to the public offering (the \"Offering\") of the limited partnership interests in the Partnership (the \"Interests\"), became effective on June 25, 1981, the date on which the Partnership's operations commenced. The Offering was completed as of October 2, 1981. As of that date, there were 3,614 Interests outstanding, (including 22 Interests purchased by the general partner and two Interests each purchased by the two initial limited partners) which represent aggregate capital contributions to the Partnership of $18,059,950.\nThe general partner of the Partnership is SEI II Equipment Inc. (the \"General Partner\") (formerly Shearson Equipment Management Corporation), a Delaware corporation which is an affiliate of Lehman Brothers Inc. (\"LB\"). Under the Partnership Agreement, the General Partner has exclusive authority to manage the operations and affairs of the Partnership and to make all decisions regarding the business of the Partnership; but the acquisition, sales, financing or refinancing of any item of equipment must be approved by a majority of the members of the investment committee, whose members are designated by the President of the General Partner. For a discussion of the investment committee, see Item 10. \"Directors and Executive Officers of the Registrant.\"\nAt December 31, 1982, the Partnership had completed the acquisition of its equipment portfolio. Equipment acquired by the Partnership is either operated by or on behalf of the Partnership under operating agreements.\nCommencing January 1, 1993, the General Partner engaged a new marine equipment operator, Midwest Marine Management Company (\"Midwest Marine\"), to manage the Partnership's barge fleet. The current management agreement with Midwest Marine expires December 31, 1996.\n(b) Financial information about industry segments\nAs of December 31, 1995, the Partnership's business consisted of one segment, the investment in a fleet of 25 covered hopper river barges. With the exception of such services as are provided by the Partnership to users of its equipment, the Partnership does not engage in sales of goods or services.\n(c) Narrative description of business\nSee Paragraphs (a) and (b) above and Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nEmployees\nThe Partnership has no employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nDuring the period ended December 31, 1982, the Partnership acquired various items of equipment which together constitute the Partnership's entire equipment portfolio. No equipment purchases were made subsequent to December 31, 1982, nor does the Partnership expect that it will acquire any additional equipment. All of the equipment has been pledged as collateral under the credit agreement described in Note 4 to the Partnership's financial statements. Commencing in 1987, the Partnership sold the following assets: two 2 offshore supply vessels, the drilling rig, and 82 railcars, with the proceeds being used to repay Partnership debt. The Partnership currently owns 25 covered river hopper barges which are engaged in the intercoastal waterway transportation of goods.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn March 1996, a purported class action, on behalf of all Limited Partners was brought against the Partnership, Lehman Brothers Inc., Smith Barney Holdings Inc., and a number of other limited partnerships in New York State Supreme Court. The complaint alleges claims of common fraud and deceit, negligent misrepresentation, breach of fiduciary duty and breach of implied covenant of good faith and fair dealing. The defendants intend to defend the action vigorously.\nItem 4.","section_4":"Item 4.\tSubmission of Matters to a Vote of Security Holders\nNo matters were submitted to the limited partners for a vote during the fourth quarter of the year for which this report is filed.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Limited Partnership Interests and Related Security Holder Matters\n(a) Market Price Information\nThe only outstanding or authorized securities of the Registrant are the Interests. There is no market for the Interests, nor is one expected to develop. The Partnership Agreement imposes substantial restrictions on the transfer of an Interest.\n(b) Holders\nThe number of holders of Interests as of December 31, 1995 was 1,439.\n(c) Cash Distributions per Interest\nTo the extent that funds are available and subject to the provisions of the Partnership Agreement, the Partnership will make cash distributions from operations to holders of Interests on a quarterly basis. Cash distributions from operations are made at the sole discretion of the General Partner. The Partnership Agreement prohibits the investment of cash available for distributions from operations in other than temporary money market investments or United States government securities. Cash distributions from operations are paid 99% to the limited partners and 1% to the General Partner and are distributed to each limited partner entitled to such distribution in the ratio in which the number of Interests owned by such limited partner bears to the total number of Interests issued, outstanding and held by limited partners entitled to such distribution.\nNo cash distributions have been made to the partners since the third quarter of 1982.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth below should be read in conjunction with the Partnership's financial statements and notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" also included herein.\nYears Ended December 31, 1995 1994 1993 1992 1991 Operating Revenues $2,892,077 $1,852,384 $1,710,410 $2,268,236 $2,060,383 Income (Loss) from operations 882,829 383,191 64,416 246,662 (28,543) Interest and Miscellaneous income 220,098 93,874 61,143 59,164 51,789 Other income - - - - 429,639 Interest expense (692,302) (547,495) (470,340) (489,937) (669,255) Net Income (Loss) 410,625 (70,430) (344,781) (184,111) (216,370) Net Income (Loss) Per Interest 112.48 (19.29) (94.45) (50.43) (59.27) Total Assets at Period-End 8,539,370 7,413,095 6,919,509 6,888,038 6,626,805 Long-term Debt at Period-End 7,839,000 7,839,000 7,839,000 7,839,000 7,839,000 Accrued interest expense due to affiliate 8,657,814 7,965,512 7,418,017 6,947,677 6,457,740\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n(a) Liquidity and Capital Resources\nOn May 30, 1986, the Partnership restructured its long-term debt. Buttonwood Leasing Corporation (the \"Purchaser\"), an affiliate of the General Partner, purchased from the Partnership's lenders the Promissory Note (the \"Note\") originally executed by the Partnership in favor of the lenders and which was dated December 9, 1981. Subsequent to the Note purchase, the Purchaser entered into an understanding with the Partnership on the following terms and conditions. First, the principal amount of the loan would remain the same. Second, interest would be charged on the outstanding principal amount of the Note at a rate equal to the prime rate charged by Bank America Illinois, formerly Continental Illinois National Bank, which was 8.75% at December 31, 1995, compared to 7.75% at December 31, 1994. No interest was paid relating to the Note for the twelve months ended December 31, 1995, and, as a result, the Partnership's accrued interest expense increased to $8,657,814 at December 31, 1995 , compared to $7,965,512 at December 31, 1994. As of December 31, 1995, the maturity date of the Note was extended to January 3, 1997, with all other terms and conditions of the Note remaining unchanged.\nDuring 1995, the Partnership's fleet of 25 covered hopper river barges continued to operate on the inland waterways of the United States, including the Ohio, Illinois and Mississippi Rivers. Conditions for barge traffic improved during 1995, as the record 1994 harvest translated into increased barge utilization rates in 1995. Increased foreign demand for U.S. crops, specifically corn and soybeans, also contributed to better operating conditions in 1995. Furthermore, the recent increase in the level of northbound traffic, which entails hauling cargo such as steel and fertilizer, has had a positive impact on barge utilization. Although the General Partner believes that the recent improvement in barge traffic has had a positive impact on the value of the Partnership's barge fleet, it is unlikely that the value of the barges will increase to an amount which is equal to or in excess of the Partnership's existing indebtedness.\nThe Partnership's cash and cash equivalents balance totalled $4,238,441 at December 31, 1995, which represents an increase over the balance of $2,931,466 at December 31, 1994. The increase is due to an increase in net cash flow from operating activities reflecting an increase in barge utilization. At December 31, 1995, the amount due from the Partnership's equipment manager was $673,652, compared to $522,083 at December 31, 1994. The increase is due to the timing of the distributions of net revenues from the equipment manager.\n(b) Results of Operations\n1995 versus 1994\nFor the year ended December 31, 1995, the Partnership generated net income of $410,625, compared to a net loss of $70,430 for the year ended December 31, 1994. The difference is primarily attributable to increased operating revenues.\nOperating revenues for the year ended December 31, 1995 totalled $2,892,077, compared to $1,852,384 for the year ended December 31, 1994. The increase is primarily attributable to an increase in barge utilization. The record harvest of soybeans in 1994 positively impacted revenue during 1995 as there was a greater quantity of goods to transport. Strong U.S. exports in 1995, also contributed to increased barge utilization. Furthermore, revenues were lower than usual in 1994 as a result of the 1993 floods which damaged crops and reduced utilization.\nInterest and miscellaneous income increased to $220,098 for the year ended December 31, 1995, compared to $93,874 for the year ended December 31, 1994. The increase is mainly due to an increase in interest income due to a higher cash balance invested and higher interest rates.\nOperating costs for the year ended December 31, 1995 were $1,454,871, compared to $949,093 for the year ended December 31, 1994. The increase is primarily attributable to increased towing costs as a result of greater utilization in 1995, and lower than normal towing costs for the first three quarters of 1994.\nInterest expense for the year ended December 31, 1995 totalled to $692,302 compared with $547,495 for the year ended December 31, 1994. The increase is due to an increase in the prime rate charged on the outstanding principal amount of the Note.\n1994 versus 1993\nFor the year ended December 31, 1994, the Partnership incurred a net loss of $70,430, compared to a net loss of $344,781 for the year ended December 31, 1993. The difference is attributable to increased operating revenues and decreased operating costs. Operating revenues for the year ended December 31, 1994 totalled $1,852,384, compared to $1,710,410 for the year ended December 31, 1993. The increase is primarily attributable to an increase in barge utilization as a result of a significant crop harvest during the third and fourth quarters of 1994.\nOperating costs for the year ended December 31, 1994 were $949,093, compared to $1,123,360 for the year ended December 31, 1993. The decrease is primarily attributable to a decrease in towing costs and costs incurred in 1993 due to the change in equipment managers which included repair costs of $29,389 and barge relocation costs of $42,547. Towing costs in the first two quarters of 1993 were approximately 50% of operating revenues. Commencing with the third quarter of 1993 and through the end of 1994, these costs averaged approximately 36% of operating revenues. The decline in towing costs is attributable to a decrease in towing rates due to intense competition among tow operators as a result of decreased barge traffic caused by the flooding in the Midwest in 1993. The residual effects of the flooding continued to impact barge traffic during the first and second quarter of 1994.\nInterest expense for the year ended December 31, 1994 increased to $547,495 from $470,340 at December 31, 1993 due to increases in the prime rate charged on the outstanding principal amount of the Note.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee item 14 \"Exhibits, Financial Statement Schedules, and Reports on Form 8-K\" for a listing of the financial statements filed with this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Partnership has no officers or directors and its affairs are managed by its General Partner, SEI II Equipment Inc. Decisions as to which items of equipment should be acquired, sold, financed or refinanced by the Partnership and whether such acquisitions should be direct or indirect, are made by an investment committee designated by the President of the General Partner. The investment committee has the right, power and authority to utilize the services of affiliates of the General Partner for assistance in evaluating the suitability of equipment for investment by the Partnership.\nCertain officers and directors of the General Partner are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of limited partnerships which have sought protection under the provisions of the federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own assets which have been adversely affected by the economic conditions in the markets in which that asset is located and, consequently, the partnerships sought protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nThe following is a brief description of the directors and executive officers of the General Partner:\n\tName\t\tOffice \tRocco Andriola\tPresident and Director Regina Hertl Vice President, Chief Financial Officer and Director \tMichael Marron\tVice President\nRocco F. Andriola, 37, is a Senior Vice President of Lehman Brothers in its Diversified Asset Group. Since joining Lehman Brothers in 1986, Mr. Andriola has been involved in a wide range of restructuring and asset management activities involving real estate and other direct investment transactions. From 1986-89, Mr. Andriola served as a Vice President in the Corporate Transactions Group of Shearson Lehman Brothers' office of the general counsel. Prior to joining Lehman Brothers, Mr. Andriola practiced corporate and securities law at Donovan Leisure Newton & Irvine in New York. Mr. Andriola received a B.A. degree from Fordham University, a J.D. degree from New York University School of Law, and an LL.M degree in Corporate Law from New York University's Graduate School of Law.\nRegina M. Hertl, 37, is a First Vice President of Lehman Brothers in its Diversified Asset Group and is responsible for the investment management of commercial and residential real estate, and a venture capital portfolio. From January 1988 through December 1988, Ms. Hertl was Vice President of the Real Estate Accounting Group within the Controller's Department of Shearson Lehman Brothers. From September 1986 through December 1987, she was an Assistant Vice President responsible for real estate accounting analysis within the Controller's Department at Shearson. From September 1981 to September 1986, Ms. Hertl was employed by the accounting firm of Coopers & Lybrand. Ms. Hertl, who is a Certified Public Accountant, graduated from Manhattan College in 1981 with a B.S. degree in Accounting.\nMichael Marron, 32, is a Vice President of Lehman Brothers and has been a member of the Diversified Asset Group since 1990 where he has actively managed and restructured a diverse portfolio of syndicated limited partnerships. Prior to joining Lehman Brothers, Mr. Marron was associated with Peat Marwick Mitchell & Co. serving in both its audit and tax divisions from 1985 to 1989. Mr. Marron received a B.S. degree from the State University of New York at Albany in 1985 and is a Certified Public Accountant.\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither of the General Partners nor any of their directors and officers received any compensation from the 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\n(a) Security ownership of certain beneficial owners\nNo person (including any \"group\" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) is known to the Partnership to be the beneficial owner of more than five percent of the outstanding Interests as of December 31, 1995.\n(b) Security ownership of management\nUnder the terms of the Limited Partnership Agreement, the Partnership's affairs are managed by the General Partner. The General Partner owns 22 interests. The General Partner also shares in the profits, losses and distributions of the Partnership.\n(c) Changes in Control\nNone.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to a Management Agreement dated June 25, 1981 between the Partnership and the General Partner, the General Partner is entitled to receive equipment management fees for services rendered in the management of equipment owned by the Partnership. The amount of the equipment management fees charged is the lesser of (i) the aggregate of amounts customarily charged by third parties for similar services or (ii) 5% of annual gross revenues. For the year ended December 31, 1995, equipment management fees aggregating $160,604 were expensed by the Partnership. Of this amount, $131,683 was due or paid by the Partnership to an independent, third-party operator, and $28,921 was earned by the General Partner. These fees were added to uncollected fees for prior years and, as of December 31, 1995, $671,201 remains to be paid to the General Partner. In accordance with the Partnership Agreement, the General Partner has deferred its rights to receive such fees until such time as the Partnersh ip is in a position to make cash distributions to all partners.\nThe General Partner is also entitled to receive, for services rendered, a Partnership management fee equal to 5% of cash distributions from operations. Such services relate to decision-making as to the terms of acquisitions and dispositions of equipment, selecting, retaining and supervising consultants, engineers, lenders and others, maintaining the books and records of the Partnership and otherwise generally managing the day-to-day operations of the Partnership. The Partnership management fees are payable at the same time as, but only if and when, cash distributions from operations are paid to the limited partners. Partnership management fees are in addition to all other fees, commissions or compensation paid or permitted to be paid to the General Partner or its affiliates. For the year ended December 31, 1995, no Partnership management fees were paid to the General Partner.\nFirst Data Investor Services Group, formerly The Shareholder Services Group, provides partnership accounting and investor relations services for the Registrant. Prior to May 1993, these services were provided by an affiliate of the General Partner. The Registrant's transfer agent and certain tax reporting services are provided by Service Data Corporation, an unaffiliated company. For additional information regarding fees paid and reimbursed to the General Partner or its affiliates during 1995, 1994 and 1993, see Note 4 to the Financial Statements in Item 14, \"Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) Financial statements:\n\tSEI II L.P.\nPage Number Report of Independent Public Accountants\n\tStatements of Financial Condition as of December 31, 1995 and 1994\n\tStatements of Partners' Deficit for the years ended December 31, 1995, 1994 and 1993 \t \tStatements of Operations \tfor the years ended December 31, 1995, 1994, and 1993\n\tStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\n(2) Financial Statement Schedules:\nNo schedules are presented because the information is not applicable or is included in the Financial Statements or the notes thereto.\n(3) Exhibits:\n3.1 Agreement of Limited Partnership dated June 25, 1981 (filed as Exhibit 3b to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).\n3.1 Certificate of Limited Partnership of the Partnership as filed in the office of the County Clerk of New York County on April 6, 1981(filed as Exhibit 3a to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).\n10.1 Acquisition Services Agreement between the Partnership and the General Partner dated June 25, 1981 (filed as Exhibit 12c to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).\n10.2 Management Agreement between the Partnership and the General Partner dated June 25, 1981 (filed as Exhibit 12d to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).\n10.3 Agreement for Financial Advisory Services between the Partnership and Shearson Leasing Corporation dated June 25, 1981 (filed as Exhibit 12e to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).\n\t27.0\tFinancial Data Schedule\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of the year for which this report is filed.\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.\n\t\tSEI II L.P.\n\t\tBY: \tSEI II EQUIPMENT INC. \t\t\tGeneral Partner\nDate: March 28, 1996\nBY: \/s\/ Rocco F. Andriola \t\tName:\tRocco F. Andriola \t\tTitle:\tPresident and Director\nDate: March 28, 1996\nBY: \/s\/ Regina Hertl Name: Regina Hertl Title: Vice President, Director and Chief Financial Officer\nDate: March 28, 1996\nBY: \/s\/ Michael T. Marron Name: Michael T. Marron Title: Vice President\nTo the Partners of SEI II L.P.:\nWe have audited the accompanying statements of financial condition of SEI II L.P. (a New York 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 SEI 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.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts February 6, 1996\nStatements of Financial Condition December 31, 1995 and 1994\nAssets 1995 1994\nEquipment $ 8,306,724 $ 8,306,724 Less-accumulated depreciation 4,679,447 4,347,178\nNet Equipment 3,627,277 3,959,546\nCash and cash equivalents 4,238,441 2,931,466 Due from equipment manager 673,652 522,083\nTotal Assets $ 8,539,370 $ 7,413,095\nLiabilities and Partners' Deficit\nLiabilities: Accounts payable and accrued expenses $ 30,628 $ 36,201 Accrued interest expense due to affiliate 8,657,814 7,965,512 Deferred interest payable to affiliate 512,854 512,854 Due to General Partner 671,201 642,280 Note payable to affiliate 7,839,000 7,839,000\nTotal Liabilities 17,711,497 16,995,847\nPartners' Deficit: General Partner (253,911) (258,017) Limited Partners (3,614 units outstanding) (8,918,216) (9,324,735)\nTotal Partners' Deficit (9,172,127) (9,582,752)\nTotal Liabilities and Partners' Deficit $ 8,539,370 $ 7,413,095\nStatements of Partners' Deficit For the years ended December 31, 1995, 1994 and 1993\nLimited General Partners Partner Total\nBalance at January 1, 1993 $(8,913,676) $ (253,865) $(9,167,541) Net Loss (341,333) (3,448) (344,781)\nBalance at December 31, 1993 (9,255,009) (257,313) (9,512,322) Net Loss (69,726) (704) (70,430)\nBalance at December 31, 1994 (9,324,735) (258,017) (9,582,752) Net Income 406,519 4,106 410,625\nBalance at December 31, 1995 $(8,918,216) $ (253,911) $(9,172,127)\nStatements of Operations For the years ended December 31, 1995, 1994 and 1993\nRevenues 1995 1994 1993\nOperating revenues $2,892,077 $1,852,384 $1,710,410\nOperating Expenses\nOperating costs 1,454,871 949,093 1,123,360 Depreciation 332,269 332,269 332,269 Professional and other expenses 44,660 48,422 49,722 Equipment management fee - Operators 131,683 105,558 100,088 General Partner 28,921 18,524 17,104 Insurance 16,844 15,327 23,451\nTotal Operating Expenses 2,009,248 1,469,193 1,645,994\nIncome from operations 882,829 383,191 64,416\nOther Income (Expense):\nInterest and miscellaneous income 220,098 93,874 61,143 Interest expense (692,302) (547,495) (470,340)\nTotal Other Expense (472,204) (453,621) (409,197)\nNet Income (Loss) $ 410,625 $ (70,430) $ (344,781)\nNet Income (Loss) Allocated:\nTo the General Partner $ 4,106 $ (704) $ (3,448) To the Limited Partners 406,519 (69,726) (341,333)\n$ 410,625 $ (70,430) $ (344,781)\nPer limited partnership unit (3,614 outstanding) $ 112.48 $ (19.29) $ (94.45)\nStatements of Cash Flows For the years ended December 31, 1995, 1994 and 1993\nCash Flows from Operating Activities: 1995 1994 1993\nNet income (loss) $ 410,625 $ (70,430) $ (344,781) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 332,269 332,269 332,269 Increase (decrease) in cash arising from changes in operating assets and liabilities: Due from equipment manager (151,569) (162,238) (359,845) Operating receivables, net - - 293,474 Prepaid expenses - - 8,103 Accounts payable and accrued expenses (5,573) (2,003) (111,192) Accrued interest expense due to affiliate 692,302 547,495 470,340 Due to General Partner 28,921 18,524 17,104\nNet cash provided by operating activities 1,306,975 663,617 305,472\nNet increase in cash and cash equivalents 1,306,975 663,617 305,472 Cash and cash equivalents at beginning of period 2,931,466 2,267,849 1,962,377\nCash and cash equivalents at end of period $4,238,441 $2,931,466 $2,267,849\nNotes to Financial Statements December 31, 1995, 1994 and 1993\n1. Organization of the Partnership The Partnership was organized under the Partnership Act of the State of New York on April 6, 1981. The term of the Partnership will continue through December 31, 2011, unless terminated and dissolved sooner pursuant to the Partnership Agreement.\nThe general partner is SEI II Equipment Inc. (the \"General Partner\") formerly Shearson Equipment Management Corp., an affiliate of Lehman Brothers Inc. On July 31, 1993, certain of Shearson Lehman Brothers Inc.'s domestic retail brokerage and management businesses were sold to Smith Barney, Harris Upham & Co. Inc. Included in the purchase was the name \"Shearson.\" Consequently, the General Partner's name was changed to SEI II Equipment Inc. to delete any reference to \"Shearson.\"\nThe Partnership's business consists of one segment, the investment in a fleet of 25 covered hopper river barges which are engaged in the intercoastal waterway transportation of goods. With the exception of such services as are provided by the Partnership to users of its equipment, the Partnership does not engage in the sales of goods or services.\nUpon formation of the Partnership, the General Partner contributed $1,000 and purchased 22 partner units for $100,650. The initial Limited Partners contributed $18,300 for four partner units. An additional 3,588 limited partnership units were then sold at a price of $5,000 per unit. The offering was completed as of October 2, 1981. As of that date, there were 3,614 interests outstanding, (including 22 interests purchased by the General Partner and two interests each purchased by the two initial limited partners) which represent aggregate capital contributions to the Partnership of $18,059,950.\nThe General Partner has entered into various agency agreements with independent equipment managers for the operation of the Partnership's equipment. The results of such operations are reported to the General Partner by the independent equipment managers and have been reflected in the accompanying financial statements.\n2. Significant Accounting Policies\nBasis of Accounting. The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. Revenues are recognized as earned and expenses are recorded as obligations are incurred.\nEquipment Manager. On January 1, 1993, the Partnership transferred management of its assets to a new equipment manager, Midwest Marine Management Company (\"Midwest Marine\"). The original equipment manager maintained individual balance sheets for each owner. Midwest Marine operates the barge fleet and provides for pooling of all owners' assets. Due to this pooling, the Partnership is entitled to a proportion of the pooled net revenues; therefore, as of December 31, 1993, the Partnership no longer records operating assets or liabilities other than the balance due from Midwest Marine.\nEquipment and Depreciation. The equipment balance at December 31, 1995 and 1994 consisted of 25 covered hopper river barges, stated at cost. Depreciation for financial reporting purposes is computed on a straight-line basis over the estimated useful lives of 25 years.\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 adopted FAS 121 in the fourth quarter of 1995. Based on current circumstances, the adoption of FAS 121 has no impact on the financial statements.\nCash Equivalents. Cash equivalents consist of short-term highly liquid investments with maturities of three months or less from the date of purchase. The carrying amount approximates fair value because of the short maturity of these investments.\nConcentration of Credit Risk. Financial instruments which potentially subject the Partnership to a concentration of credit risk principally consist of cash in excess of the financial institutions's insurance limits. The Partnership invests available cash with high credit quality financial institutions.\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.\nIncome Taxes. No provision for income taxes has been made in the accompanying financial statements since such taxes are the responsibility of the individual partners rather than that of the Partnership.\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. Partnership Allocations\nThe Partnership Agreement substantially provides for the following:\nDistribution of Partnership Funds. Net cash from operations shall be distributed at the discretion of the General Partner, 99% to the Limited Partners and 1% to the General Partner.\nCash from sales or refinancings shall be allocated and paid first to all partners until the amount of all distributions received by them equals their positive capital account balances. Any balance will be allocated to the Limited Partners until the cumulative amount of distributions made to them equals their Original Invested Capital plus a cumulative 10% per annum return as defined. Thereafter, cash will be distributed 85% to the Limited Partners and 15% to the General Partner. The cumulative amount of distributions to date does not exceed the required distributions as of December 31, 1995.\nCash distributions to the partners are presently prohibited by the amended credit agreement with the Partnership's lender (Note 4). No cash distributions have been made by the General Partner since the third quarter of 1982.\nAllocation of Income and Losses. All operating profits and losses and losses from sales or refinancings shall be allocated 1% to the General Partner and 99% to the Limited Partners. Profits from sales or refinancings shall be allocated to the General Partner based on the greater of either 1% of such profits or the amount distributable to the General Partner, as defined in the Partnership Agreement. Any remaining profits shall be allocated to the Limited Partners.\n4. Related Party Transactions\nGeneral Partner Fees. The Partnership Agreement specifies that the General Partner will receive (a) an equipment management fee in an amount that will not exceed 5% of the annual gross revenues of all equipment owned by the Partnership; (b) in the event the General Partner subcontracts to third parties for services to be rendered in the management of the equipment, any management fee paid to a third party will reduce the fee otherwise earned by the General Partner, but not below 1% of gross revenues. As of December 31, 1995, $671,201 in equipment management fees earned by the General Partner remains to be paid to the General Partner. In accordance with the Partnership Agreement, the General Partner has deferred its rights to receive such fees until such time as the Partnership is in a position to make cash distributions to all partners.\nCash and Cash Equivalents. Cash reflected on the Partnership's balance sheet at December 31, 1995 and 1994 was on deposit with an affiliate of the General Partner.\nLong-term Debt. On May 30, 1986, the Partnership restructured its long-term debt which had been in default since June 1985. Buttonwood Leasing Corporation (the \"Purchaser\"), which is an affiliated corporation of the General Partner, purchased from the Partnership's lenders (the \"Banks\") the Promissory Note dated December 9, 1981 (the \"Note\") originally executed by the Partnership in favor of the Banks. In consideration of the Purchaser purchasing the Note, the Banks issued releases in favor of the Partnership and the General Partner releasing each from any and all liability arising under the terms of the Note and from the loan documentation issued and executed in connection with the Note, with the exception that the Purchaser agreed to waive enforcement of certain financial covenants contained in the loan documentation, covenants of which the Partnership was not in compliance. Subsequent to the Note purchase, the Purchaser entered into an understanding with the Partnership on the fo lowing terms and conditions. First, the principal amount of the loan would remain the same. Second, interest would be charged on the outstanding principal amount of the Note at a rate equal to the prime rate charged by Bank America Illinois, formerly Continental Illinois National Bank, which was 8.75% at December 31, 1995, 7.75% at December 31, 1994 and 6.0% at December 31, 1993. Accrued and deferred interest is payable at maturity of the Note. As of December 31, 1995, the maturity date of the Note was extended until January 3, 1997.\nThe fair market value of the note is substantially less than its carrying amount. It is not practicable for the Partnership to estimate the fair value of this financial instrument as no quoted market price exists and the cost of obtaining an independent valuation appears excessive to the Partnership.\n5. Utilization of Equipment At December 31, 1995, the Partnership's equipment portfolio included 25 covered hopper river barges. The barges are carried on the Partnership's statement of financial condition at an aggregate net book value of $3,627,277.\n6. Litigation In March 1996, a purported class action, on behalf of all Limited Partners, was brought against the Partnership, Lehman Brothers Inc., Smith Barney Holdings Inc., and a number of other limited partnerships in New York State Supreme Court. The complaint alleges claims of common fraud and deceit, negligent misrepresentation, breach of fiduciary duty and breach of implied covenant of good faith and fair dealing. The defendants intend to defend the action vigorously.\n7. Reconciliation of Differences between Financial Statements and the Partnership's Tax Return\nNet income, as reported in 1995 $ 410,625 Adjustments- \tDepreciation differential between the Accelerated \t\tCost Recovery System (ACRS) and depreciation for financial reporting 332,269 Decrease in accrued operating expenses (5,573) Management fee expense 28,921 Increase in accrued interest expense due to affiliate 692,302\nTotal adjustments 1,047,919\nNet income per the Partnership's 1995 tax return $ 1,458,544\nNet income allocation:\nLimited Partners (3,614 interests) $ 1,443,959 General Partner 14,585\n$ 1,458,544\nPer Limited Partnership interest $ 399.55\nPartners' deficit, as reported December 31, 1995 $(9,172,127) Adjustments, as above 1,047,919 Adjustments, prior years 5,197,316 Syndication expenses 1,740,961\nPartners' deficit, per the Partnership's 1995 tax return $(1,185,931)\nThe partners' deficit reported on the Partnership's tax return is allocable to the partners as follows:\nLimited Partners (3,614 interests) $(1,372,938) General Partner 187,007\n$(1,185,931)\nThe Partnership's tax returns and the amounts of distributable Partnership income or loss are subject to examination by federal and state taxing authorities. In the event of an examination of the Partnership's tax return, the tax liability of the partners could be changed if an adjustment in the Partnership's income or loss is ultimately sustained by the taxing authorities.\nSchedule V - Property, Plant and Equipment for the Years Ended December 31, 1995, 1994 and 1993\nBalance at Other Balance at Beginning of Additions Charges End of Classification Period at Cost Retirements Add (Deduct) Period\n1993: Equipment $8,306,724 $ 0 $ 0 $ 0 $8,306,724\n1994: Equipment $8,306,724 $ 0 $ 0 $ 0 $8,306,724\n1995: Equipment $8,306,724 $ 0 $ 0 $ 0 $8,306,724\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment for the Years Ended December 31, 1995, 1994 and 1993\nBalance at Additions Other Balance at Beginning of Charged to Charges End of Classification Period Expense Retirements Add (Deduct) Period\n1993: Equipment $3,682,640 $332,269 $ 0 $ 0 $4,014,909\n1994: Equipment $4,014,909 $332,269 $ 0 $ 0 $4,347,178\n1995: Equipment $4,347,178 $332,269 $ 0 $ 0 $4,679,447","section_15":""}
{"filename":"789625_1995.txt","cik":"789625","year":"1995","section_1":"ITEM 1. BUSINESS\nMorgan Stanley Group Inc. (the \"Company\"*) is a holding company that, through its subsidiaries, provides a wide range of financial services on a global basis. Its businesses include securities underwriting, distribution and trading; merger, acquisition, restructuring, real estate, project finance and other corporate finance advisory activities; merchant banking and other principal investment activities; brokerage and research services; asset management; the trading of foreign exchange and commodities as well as derivatives on a broad range of asset categories, rates and indices; and global custody, securities clearance services and securities lending. These services are provided to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individual investors. The Company, which was formed in 1935, conducts business from its head office in New York City, international branches or representative offices in Beijing, Bombay, Frankfurt, Geneva, Hong Kong, Johannesburg, London, Luxembourg, Madrid, Melbourne, Milan, Montreal, Moscow, Osaka, Paris, Seoul, Shanghai, Singapore, Sydney, Taipei, Tokyo, Toronto and Zurich, and United States regional offices in Chicago, Los Angeles and San Francisco. At January 31, 1995, the Company employed 9,685 people.\nThe Company's business activities are highly integrated and constitute a single industry segment. Financial information concerning the Company for each of the three fiscal years ended January 31, 1995, January 31, 1994 and January 31, 1993, including the amount of total revenue contributed by classes of similar products or services that accounted for 10% or more of the Company's consolidated revenue in any one of those periods and information with respect to the Company's operations by geographic area, is set forth in the Consolidated Financial Statements and the Notes thereto in the 1994 Annual Report to Stockholders and is incorporated herein by reference.\nINVESTMENT BANKING\nThe Company is a leading international investment banking firm which provides advice to, and raises capital worldwide for, a broad group of domestic and international clients. The Company manages and participates in public offerings and private placements of debt, equity and other securities in the United States and international capital markets on behalf of United States and non-United States issuers. The Company is a leading underwriter of common stock, preferred stock, Preferred Equity Redemption Cumulative Stock (\"PERCS(R)\"), Performance Equity-linked Redemption Quarterly-pay Securities (\"PERQS(SM)\"), other equity-related securities, including American Depositary Receipts (\"ADRs\"), and taxable fixed income securities in the United States market and equity and taxable fixed income securities\n- ----------------------- * Unless the context otherwise requires, the term \"Company\" means Morgan Stanley Group Inc., and includes Morgan Stanley & Co. Incorporated (\"Morgan Stanley\"), Morgan Stanley & Co. International Limited and the other consolidated subsidiaries of Morgan Stanley Group Inc. Please note that in the 1994 Annual Report to Stockholders, which is incorporated by reference in part in this Form 10-K, the term \"Morgan Stanley\" is generally used to refer to the Company.\ndenominated in United States dollars and other currencies in international markets. The Company also underwrites tax exempt securities. In addition, the Company underwrites mortgage-related securities, including private pass-throughs and collateralized mortgage obligations (\"CMOs\"), and other asset-backed securities. The Company is active as an underwriter and distributor of commercial paper and other short-term and medium-term securities. The Company is also involved in tender offers, repurchase programs, consent solicitations, rights offerings and exchange offers on behalf of clients.\nThe Company provides corporate and institutional clients in the United States and internationally with a wide range of advisory services on key strategic matters such as mergers, acquisitions, joint ventures, privatizations, defenses, divestitures, spin-offs, restructurings, proxy mechanisms and leveraged buyouts as well as long-range financial planning. Other such services provided to clients include advice with respect to recapitalizations, dividend policy, valuations, foreign exchange exposures and financial risk management strategies. In addition, the Company provides advice and other services relating to project financings, lease transactions and the purchase, sale and financing of real estate. The Company may, from time to time, also provide financing or financing commitments in special situations to companies in connection with its investment banking activities.\nSALES, TRADING AND MARKET-MAKING ACTIVITIES\nThe Company provides a broad range of sales, trading and research services to investors worldwide and is an active dealer in fixed income, equity, foreign exchange and commodity products, including derivatives. In the United States, the Company ranks as one of the largest dealers in equity and fixed income securities. As a member of the major United States securities and commodities exchanges, as well as the major foreign exchanges, including the London and Tokyo Stock Exchanges, the Company conducts its sales and trading activities both as principal and as agent on behalf of a wide range of domestic and foreign institutional and, to a lesser extent, individual investors. The Company trades for its own account in equity and fixed income securities, foreign currencies, commodities and associated derivative products. The Company also provides financing to clients, including margin lending and other extensions of credit.\nThe Company's equity sales, trading and market-making activities cover domestic and foreign equity and equity-related securities (both exchange traded and over-the-counter (\"OTC\")), including ADRs, Optimised Portfolios as Listed Securities (OPALS(SM)) and restricted\/control stock; convertible debt and preferred securities, including PERCS(R), PERQS(SM) and warrants; equity index products and equity swaps; and international index arbitrage, equity repurchases and program and block trade execution. The Company borrows and lends equity securities. The Company also engages in the risk arbitrage business, which involves investing for the Company's own account in securities of companies involved in publicly announced corporate transactions in which the Company is not at the time of investment acting as adviser or agent.\nThe Company distributes and trades domestic and foreign debt securities, particularly corporate debt instruments, and preferred stock, offers investment strategies to\ninstitutional accounts, develops swap strategies for customers and assists corporations in their repurchase of debt. In addition, the Company trades a full range of money market instruments, including certificates of deposit, domestic and foreign bankers' acceptances, floating-rate certificates of deposit and floating-rate notes. The Company is an active dealer and market maker in mortgage-backed and other asset-backed securities and a broad range of long-term and short-term tax exempt securities. The Company is also involved in structuring debt securities with multiple risk\/return factors designed to suit investor objectives and repackaged asset vehicles (RAVs) through which investors can restructure asset portfolios to provide liquidity or recharacterize risk profiles.\nMorgan Stanley is one of 38 primary dealers of United States government securities currently recognized by the Federal Reserve Bank of New York. As such, it is among the firms with which the Federal Reserve conducts its open market operations and is required to submit bids in Treasury auctions, make secondary markets in United States government securities, provide the Federal Reserve Bank of New York with market information and maintain certain capital standards. Morgan Stanley is also a member of a number of selling groups responsible for the distribution of various issues of U.S. agency and other debt securities. As such, it is required to make secondary markets in these securities and to provide market information to the U.S. agency and instrumentality issuers. Morgan Stanley is also a member of the primary syndicate that issues German government bonds, a member of the Japanese government bond syndicate and a primary dealer in French and Italian government bonds. The Company also makes secondary markets in various foreign government bonds and other foreign currency denominated bonds issued in the Eurobond market and in the United States.\nThe Company's daily trading inventory positions in government, agency and instrumentality securities are financed substantially through the use of repurchase agreements. The Company also borrows and lends fixed income securities. In addition, the Company acts as an intermediary between borrowers and lenders of short-term funds utilizing repurchase and reverse repurchase agreements. At any given point in time, the Company may hold large positions in certain types of securities or commitments to purchase securities of a single issuer, sovereign governments and other entities, issuers located in a particular country or geographic area, public and private issuers involving developing countries or issuers engaged in a particular industry. For example, financial instruments owned by the Company include U.S. government and agency securities and securities issued by non-U.S. governments (principally France, Germany, Italy and Japan) which, in the aggregate, represented 19% of the Company's total assets at January 31, 1995 (positions in Japanese government securities amounted to approximately $7 billion, or 6% of total assets). In addition, a vast majority of all of the collateral held by the Company for resale agreements or bonds borrowed, which together represents 37% of the Company's total assets at January 31, 1995, consists of securities issued by the U.S. government, federal agencies or non-U.S. governments.\nThe Company makes markets and trades in Government National Mortgage Association (\"GNMA\") securities, Federal Home Loan Mortgage Corp. (\"FHLMC\") participation certificates and Federal National Mortgage Association (\"FNMA\") obligations. The Company enters into significant commitments, such as forward contracts, standby arrangements and futures and options contracts, for GNMA, FHLMC and FNMA securities. The Company also acts as an underwriter of and market-maker in mortgage-backed securities, CMOs and\nrelated instruments, and a market-maker in commercial, residential and real estate products. In this capacity, the Company carries certain related assets with reduced levels of liquidity; the carrying value of such assets approximated $1,193 million at January 31, 1995.\nThe Company also underwrites, trades, invests and makes markets in high-yield debt securities and emerging market loans and securitized instruments. \"High-yield\" refers to companies or sovereigns whose debt is rated as non-investment grade. High-yield debt securities, emerging market loans and securitized instruments held for sale by the Company are carried in the Company's Consolidated Statement of Financial Condition at their fair values. Trading gains and losses (inclusive of unrealized gains and losses) on high-yield debt securities and emerging market loans and securitized instruments are included as principal transaction revenues in the Company's Consolidated Statement of Income. At January 31, 1995, the aggregate net market value of high-yield debt securities and emerging market loans and securitized instruments held in inventory was $1,160 million (a substantial portion of which was subordinated debt), with not more than 8%, 12% and 11% of all such securities, loans and instruments attributable to any one issuer, industry or geographic region, respectively. For a discussion of the various risks associated with the Company's high-yield debt and emerging market loan activities and the Company's policies and procedures with respect to the management and monitoring of these risks, see \"Risk Management.\"\nThe Company also actively trades a number of foreign currencies on a spot and short-term forward basis with its customers, for its own account and to hedge its securities positions or liabilities. In connection with its market-making activities, the Company takes open positions in the foreign exchange market for its own account. The Company, on a more limited basis, enters into forward currency transactions as agent and principal for periods of up to seven years. The Company is a leading participant in currency futures trading at the International Monetary Market division of the Chicago Mercantile Exchange and is a leading dealer in OTC and exchange traded currency options on a worldwide basis. The Company also trades as principal in the spot, forward and futures markets in a variety of commodities, including precious metals (e.g., gold and silver), coffee, crude oil, oil products, natural gas and related energy products. The Company is an active market maker in swaps and OTC options on commodities such as metals, crude oil, oil products, natural gas and electricity and offers a range of hedging programs relating to production, consumption and reserve\/inventory management. The Company recently also became an electricity power marketer in the United States and received approval to be an associate member of the London Metals Exchange.\nThe Company actively offers to clients and trades for its own account a variety of financial instruments described as \"derivative products\" or \"derivatives.\" These products, some of which may be complex in structure, generally take the form of futures, forwards, options, swaps, caps, collars, floors, swap options and similar instruments which derive their value from underlying interest rates, foreign exchange rates or commodity or equity instruments and indices.* All of the Company's trading related business units use derivative products as\n- --------------------- * The Company does not include in this category certain securities and financial instruments that \"derive\" their values or contractually required cash flows from the price of some other security, asset, rate or index, such as mortgage-backed securities (although mortgage-backed swaps, options and forward contracts are included).\nan integral part of their respective trading strategies, and such products are used extensively to manage the market exposure that results from a variety of proprietary trading activities. In addition, as a dealer in certain derivative products, most notably interest rate and currency swaps, the Company enters into derivative contracts to meet a variety of risk management and other financial needs of its clients. Through the Company's Triple-A rated subsidiary (Morgan Stanley Derivative Products Inc.), which commenced operations in January 1994, the Company also enters into swap and related derivative transactions with certain clients seeking a Triple-A rated counterparty. For a detailed discussion of the Company's use of derivatives, see 1994 Annual Report to Stockholders, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Derivative Financial Instruments\" and \"Notes to Consolidated Financial Statements, Note 5.\"*\nDerivatives used in the Company's trading or dealing activities are recorded in its Consolidated Statement of Financial Condition at fair value (based on listed market prices or, if listed market prices are not available, based on other relevant factors, including dealer price quotations, time value and yield curve or volatility factors underlying the positions and price quotations for similar instruments traded in different markets), representing the cost of replacing these instruments.** Gains or losses (realized and unrealized) on derivatives are generally included on a net basis as principal transaction revenues in the Company's Consolidated Statement of Income. The total notional value of derivative trading contracts outstanding as of January 31, 1995 was $835 billion, which is an indication of the Company's degree of use of derivatives for trading purposes but is not representative of market or credit exposure. The Company's exposure to market risk relates to changes in interest rates, foreign currency exchange rates, or the fair value of the underlying financial instruments or commodities which may ultimately result in cash settlements which exceed the amounts currently recognized in the Company's Consolidated Statement of Financial Condition. The Company's credit exposure at any point in time is represented by the fair value of such instruments reported as assets which at January 31, 1995 was $8.6 billion. For a discussion of the various risks associated with the Company's derivative activities and the Company's policies and procedures with respect to the management and monitoring of these risks, see \"Risk Management.\"\nFrom time to time, the Company has organized, advised and managed certain funds that invest and trade in particular equity or debt securities, foreign currencies or\n- ----------------------------- * In addition, the Company also uses derivative products (primarily interest rate and currency swaps) to assist in asset and liability management and to reduce borrowing costs. Net revenues from derivatives used in the Company's own asset and liability management are recognized ratably over the term of the contract as an adjustment to interest expense. See 1994 Annual Report to Stockholders, \"Notes to Consolidated Financial Statements, Note 3.\"\n** Consistent with this treatment, financial instrument and commodity related derivative contracts are carried at net replacement cost as \"financial instruments owned\" and \"financial instruments sold, not yet purchased\" in the Company's Consolidated Statement of Financial Condition and are presented on a net-by-counterparty basis in cases where there is a legal right of set-off and the Company has obtained an enforceable netting agreement.\ncommodities and may continue to do so in the future. In connection with such activities, the Company has made and may continue to make investments for its own account in one or more of such funds.\nMERCHANT BANKING AND OTHER PRINCIPAL INVESTMENT ACTIVITIES\nThe Company also uses its capital and capital from funds under its management in a variety of activities that have been broadly described as merchant banking. Such activities include, among other things, making commitments to purchase, and making investments in, equity and debt securities in merger, acquisition, restructuring, private investment and leveraged capital transactions. Such activities also include investments in real estate assets, portfolios and operating companies. The Company is generally the general partner of, and an investor in, the funds which it sponsors.\nIn the merchant banking area, Morgan Stanley Capital Partners III, L.P. invests primarily in private equity or equity-related securities of companies in which the fund and its affiliates will have a controlling equity position. The Morgan Stanley Leveraged Equity Fund, L.P. and The Morgan Stanley Leveraged Equity Fund II, L.P. have invested in and provided financing for leveraged transactions and companies; these funds are no longer making new investments, but are actively managing existing investment portfolios.\nIn the venture capital area, Morgan Stanley Venture Capital Fund, II, L.P. invests primarily in private equity or equity-related securities of U.S. emerging growth companies, principally in the U.S. healthcare and information technology sectors. Morgan Stanley Research Ventures L.P. has invested in research and development projects, and Morgan Stanley Venture Capital Fund L.P. has made private equity investments in U.S. emerging growth companies in the healthcare and information technology sectors; these funds are no longer making new investments, but are actively managing existing investment portfolios.\nThe Morgan Stanley Real Estate Fund, L.P. and The Morgan Stanley Real Estate Fund II, L.P. invest primarily in real estate; the former fund is no longer making new investments but is actively managing its existing investment portfolio. Princes Gate Investors, L.P. assists the Company's clients by investing globally in special situation opportunities, generally in the form of minority equity positions which are short to medium term in duration.\nFrom time to time the Company may sponsor additional funds and commit to invest in such funds.\nEquity securities purchased in merchant banking and principal investment transactions (\"investments\") generally are held for appreciation, are not readily marketable and do not provide dividend income. As of January 31, 1995, the aggregate carrying value of the Company's investments (directly and indirectly through the above-referenced funds) in 83 privately held companies was $252 million and in 13 publicly held companies was $136 million. At January 31, 1995, the Company had aggregate commitments of approximately $223 million to make future investments in connection with its merchant banking and other principal investment activities. The Company's future commitments extend until January 1999.\nInvestments made in connection with merchant banking and other principal investment transactions initially are carried in the Company's Consolidated Statement of Financial Condition at their original cost. The carrying value of such equity securities is adjusted upward only when changes in the underlying market values are readily ascertainable, generally as evidenced by listed market prices or transactions which directly affect the value of such equity securities. Any such adjustment may occur a significant time after an investment in such equity securities has been made. Downward adjustments in such equity securities are made in the event that the Company determines that the eventual realizable value is less than the carrying value.\nFrom time to time, the Company provides loans, financing commitments or other extensions of credit, including on a subordinated and interim basis, to companies (which may otherwise be leveraged) associated with its merchant banking and other principal investment activities. Loans made in connection with such activities are carried at unpaid principal balances less any reserves for estimated losses. At January 31, 1995, there were no such loans or other extensions of credit outstanding.\nIt is not possible to determine whether or when the Company will realize the value of the investments, including any appreciation, dividends or other distributions thereon, since, among other things, such investments are generally subject to restrictions on such realization relating to the circumstances of particular transactions. Moreover, estimates of the eventual realizable value of the investments fluctuate significantly over time in light of business, market, economic and financial conditions generally or in relation to specific transactions or other factors, including the financial leverage involved in the underlying transactions. Thus, these estimates may at any given time differ from the carrying value of the investments. For a discussion of the various risks associated with the Company's merchant banking and other principal investment activities and the Company's policies and procedures with respect to the management and monitoring of these risks, see \"Risk Management.\"\nFor purposes of financial statement classification, merchant banking and other principal investment advice, underwriting, origination and commitment fees are included as investment banking revenues in the Company's Consolidated Statement of Income. Fees for funds under management by the Company are included in asset management and administration revenues. Investment gains and losses relating to, and distributions from, equity investments are included in principal transactions revenues.\nThe Company may also underwrite, trade, invest and make markets in the securities of issuers in which the Company or the funds have an investment. In addition, the Company may provide financial advisory services to, and have securities and commodity trading relationships with, these issuers.\nGLOBAL SECURITIES SERVICES\nThe Company provides a full range of securities services and information, including global custody, clearance, lending and settlement operations, foreign exchange, valuation services, cash management and margin lending. The Company's securities services operations support mutual funds, investment limited partnerships, insurance companies, banks,\nfoundations, endowments, family trusts, government agencies, public and private pension funds and broker-dealers. The Company acts as principal and agent in stock borrow and stock loan transactions in support of the Company's domestic and international trading and brokerage, asset management and clearing activities and as an intermediary between broker-dealers. Through its global securities services business, the Company has a network of agent banks in 60 countries. Morgan Stanley Capital International (MSCI(R)), the Company's global equity index and company data business, provides the global investment community with benchmark indices (including The World, EAFE(R) and Emerging Market Indices), a 25-year historical database and price and fundamental data covering 3,800 companies in 45 developed and emerging countries through a variety of print, electronic and software vendor-supported products. Through its global securities services business, the Company had approximately $90 billion in global assets under custody at January 31, 1995.\nASSET MANAGEMENT\nThrough Morgan Stanley Asset Management (\"MSAM\"), the Company provides global portfolio management to taxable and non-taxable institutions, domestic and foreign governments, pension funds, international organizations, mutual funds and individuals investing in United States and international equities and fixed income securities (including in emerging markets) and sponsors open and closed-end mutual funds. The Company also performs a broad range of fiduciary and named fiduciary services for pension funds and trusts. Through MSAM, the Company had approximately $49 billion in assets under management at January 31, 1995.\nRESEARCH\nThe Company is engaged in a wide range of research activities. The Company analyzes worldwide economic trends covering a broad range of industries and companies in the U.S. and internationally and produces publications and studies on the economy, financial markets, portfolio strategy, technical market analyses, industry developments and individual companies. The Company also provides analyses and forecasts relating to economic and monetary developments affecting matters such as interest rates, Federal Reserve open market operations, foreign currencies and securities and economic trends. Support for the sales and trading of fixed income securities is also provided in the form of quantitative and credit analyses and the development of research products that are distributed to the Company's clients. In addition, the Company provides analytical support and publishes reports on mortgage-related securities and the markets in which they are traded and does original research on valuation techniques.\nFINANCE, ADMINISTRATION AND OPERATIONS\nThe Company's finance, administration and operations departments include Information Technology, Firm Risk Management, Controllers, Treasury, Tax, Legal and Compliance, Office of Development, Facilities, General Services, and Security and Corporate Services. These departments support the Company's diverse global businesses through the processing of securities, foreign exchange and commodities transactions; receipt and delivery of funds and securities; safeguarding of customers' securities; internal financial controls,\nincluding management of global expenses, capital structure and funding; and ensuring compliance with regulatory and legal requirements. In addition, the Company has integrated recruitment, staffing, compensation and benefits, and career development and training initiatives to ensure that its human resources are aligned with strategic objectives. Certain of these areas also assist in the management and monitoring of the risks associated with the Company's business activities (see \"Risk Management\").\nCOMPETITION AND REGULATION\nThe Company encounters intense competition in all aspects of the financial services business and competes worldwide directly with other firms, both domestic and foreign, a significant number of which have greater capital and other resources. In addition to competition from firms traditionally engaged in the securities business, there has been increased competition from other sources, such as commercial banks, insurance companies and other companies offering financial services. As a result of pending legislative and regulatory initiatives in the United States to remove or relieve certain restrictions on commercial banks, it is anticipated that competition in some markets currently dominated by investment banks may increase in the near future. Such competition, among other things, affects the Company's ability to attract and retain highly skilled individuals.\nThe Company's business is, and the securities, commodities and financial services industries generally are, subject to extensive regulation in the United States at both the Federal and state levels. Various regulatory bodies are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of customers participating in those markets. Morgan Stanley is registered as a broker-dealer and an investment adviser with the Securities and Exchange Commission (\"SEC\") and in all 50 states, the District of Columbia and Puerto Rico and is a member of the National Association of Securities Dealers, Inc. (\"NASD\") and the New York Stock Exchange, Inc. (\"NYSE\"). The Company and certain other subsidiaries are registered as investment advisers with the SEC and in certain states. Broker-dealers are subject to regulation by state securities administrators in those states in which they conduct business. Broker-dealers are also subject to regulations that cover all aspects of the securities business, including sales and trading practices, use and safekeeping of customers' funds and securities, capital structure, record-keeping and the conduct of directors, officers and employees. The SEC, other governmental regulatory authorities, including state securities commissions, and self-regulatory organizations may institute administrative proceedings, which may result in censure, fine, the issuance of cease-and-desist orders, the suspension or expulsion of a broker-dealer or member, its officers or employees or other similar consequences. Additional legislation and regulations, including those relating to the activities of affiliates of broker-dealers, changes in rules promulgated by the SEC or other governmental regulatory authorities and self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules may directly affect the manner of operation and profitability of the Company.\nAs a futures commission merchant, Morgan Stanley is registered with the Commodity Futures Trading Commission (\"CFTC\") and its activities in the futures and options-on-futures markets are subject to regulation by the CFTC and various domestic boards of trade and other commodity exchanges. Certain subsidiaries of the Company are registered\nas commodity trading advisers and\/or commodity pool operators with the CFTC. The Company's futures and options-on-futures business is also regulated by the National Futures Association (\"NFA\"), a not-for-profit membership corporation, which has been designated a registered futures association by the CFTC and of which Morgan Stanley is a member.\nAs a broker-dealer, Morgan Stanley is subject to the SEC's temporary risk assessment rules which require, among other things, that a broker-dealer maintain and preserve certain information, describe risk management policies and procedures and report on the financial condition of certain affiliates whose financial and securities activities are reasonably likely to have a material impact on the financial and operational condition of the broker-dealer. As a futures commission merchant, Morgan Stanley is also subject to the first phase of the CFTC's risk assessment rules which have certain requirements similar to the SEC's rules and also require the reporting of certain \"trigger events\" when net capital is reduced by substantial amounts.\nThe Company is participating as a member of a select industry task force to formulate a framework for the voluntary oversight of OTC derivatives activities by the SEC and the CFTC. The task force has recently developed voluntary standards relating to reporting, capital, management controls and counterparty relationships.\nMargin lending by certain subsidiaries of the Company is subject to the margin rules of the Board of Governors of the Federal Reserve System and the NYSE. The Company's subsidiary that engages in custodial activities is subject to regulation by the New York State Banking Department.\nCertain of the Company's government securities activities are conducted through a subsidiary which is a member of the NASD and is registered as a government securities broker-dealer with the SEC and in certain states. The Department of the Treasury has promulgated regulations concerning, among other things, capital adequacy, custody and use of government securities and transfers and control of government securities subject to repurchase transactions. The rules of the Municipal Securities Rulemaking Board, which are enforced by the NASD, govern the municipal securities activities of the Company.\nCompanies in the merchant banking portfolio that are in certain regulated industries (e.g., insurance, public utilities or broadcasting) could subject the Company to additional regulation by virtue of the Company's affiliation with the funds that own equity interests in such companies or otherwise.\nThe Company's business is also subject to extensive regulation by various foreign governments, securities exchanges, central banks and regulatory bodies, especially in those jurisdictions in which the Company maintains an office. For example, the Company's business in the United Kingdom is regulated by the Securities and Futures Authority Limited, the Bank of England and the Investment Management Regulatory Organisation, and a number of exchanges, including the International Stock Exchange of the United Kingdom and the Republic of Ireland Limited and the London International Financial Futures and Options Exchange. The Bundesbank, the Bundesaufsichtsamt fur das Kreditwesen (the Federal German Banking Authority), the Bundesaufsichtsamt fur das Wertpapierhandel (the Federal German Securities\nAgency), the Frankfurt Stock Exchange and the Deutsche Terminboerse (the German Futures Exchange) regulate the Company's activities in the Federal Republic of Germany. The Company's business in Japan is subject to Japanese law applicable to foreign securities firms and related regulations of the Japanese Ministry of Finance and to the rules of the Bank of Japan and several Japanese securities and futures exchanges, including the Tokyo Stock Exchange, the Osaka Securities Exchange and the Tokyo International Financial Futures Exchange. The Monetary Authority of Singapore and the Singapore International Monetary Exchange regulate the Company's business in Singapore; and the Company's operations in Hong Kong are regulated by the Securities and Futures Commission of Hong Kong, the Stock Exchange of Hong Kong Ltd. and the Hong Kong Futures Exchange.\nAs registered broker-dealers and member firms of the NYSE, certain subsidiaries of the Company, including Morgan Stanley, are subject to the SEC's net capital rule, and as a futures commission merchant Morgan Stanley is subject to the net capital requirements of the CFTC and various commodity exchanges. Many non-U.S. securities exchanges and regulatory authorities also either have imposed or are considering imposing rules relating to capital requirements that apply to subsidiaries of the Company (such as rules to be promulgated in connection with the European Union Capital Adequacy Directive), including certain European subsidiaries that are considered banking organizations under local law. These rules, which specify minimum capital requirements, are designed to measure general financial integrity and liquidity and require that at least a minimum amount of assets be kept in relatively liquid form. Compliance with the capital requirements may limit those operations of the Company that require the intensive use of capital, such as underwriting, merchant banking and trading activities, and the financing of customer account balances, and also restricts the Company's ability to withdraw capital from its subsidiaries, which in turn may limit the Company's ability to pay dividends, repay debt or redeem or purchase shares of its outstanding capital stock. A change in such rules, or the imposition of new rules, affecting the scope, coverage, calculation or amount of capital requirements, or a significant operating loss or any unusually large charge against capital would adversely affect the ability of the Company to pay dividends or to expand or even maintain present levels of business.\nRISK MANAGEMENT*\nRisk is an inherent part of the Company's businesses and activities. The financial services business and its profitability are affected by many factors of a national and international nature, including economic and market conditions, broad trends in business and finance, legislation and regulation affecting the national and international financial communities, inflation, the availability of capital, the availability of credit and the level and volatility of interest rates and currency values. The extent to which the Company properly and effectively identifies, assesses, monitors and manages each of the various types of risks involved in its activities is critical to its success and profitability. The Company seeks to maintain a broad-based portfolio\n- ----------------------- * For a further discussion of the Company's risk management policies and procedures, see 1994 Annual Report to Stockholders, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Management\" and \"Notes to Consolidated Financial Statements, Note 5.\"\nof business activities to minimize the impact that volatility in any area or related areas may have on its net revenues as a whole. From an operational perspective, the Company seeks to actively manage the principal risks involved in each area of business activity: market risk, credit risk, operational risk and legal risk.\nRisk management at the Company is an integrated process with independent oversight which requires constant communication, judgment and knowledge of specialized products and markets. The Company's senior management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. The Company has developed a control infrastructure to monitor and manage each type of risk on a global basis throughout the Company. In addition, the Company has developed particular risk management policies and procedures for certain business activities including merchant banking and other principal investment activities, high-yield securities and derivative products. The Company's risk management policies and procedures are continually evolving to address the increasingly global nature of the financial services business as well as the continual development of sophisticated financial products with more varied and complex risk profiles.\nThe Company has developed a multi-tiered approach for monitoring and managing its risks. With respect to the Company's major trading businesses, senior division risk managers monitor positions and set the overall division risk profile within established limits, verify that position hedges are appropriate and well maintained, and report unusual market and position events. The base level of control is at the trading desks where desk risk managers and traders perform similar functions with respect to a product area or particular product. The Firm Risk Management Group has operational responsibility for reporting to senior management on the Company's exposure to risk. The Firm Risk Management Group consists of three departments that are all independent of the Company's business areas: the Market Risk and Exposure Management Department monitors certain divisional, geographic and product-line market risks; the Credit Department establishes and monitors counterparty exposure limits and collateral requirements to support counterparty contractual commitments; and the Internal Audit Department, which also reports to the Audit Committee of the Board of Directors, assesses the Company's operations and control environment through periodic examinations of business and operational areas. Other departments within the Company, which are independent of the Company's business areas, that are also actively involved in monitoring the Company's risk profile include the Controllers Department, the Operations Department and the Legal and Compliance Department.\nIn addition, the Company has certain standing committees, composed of a cross-section of the Company's senior officers from various disciplines, that are involved in managing and monitoring the risks associated with the Company's diverse businesses. The High-Yield Commitment Committee and Equity Commitment Committee determine whether the Company should participate in a transaction involving the underwriting or placement of high-yield or equity securities, respectively, where the Company's capital and reputation may be at risk and evaluate the potential revenues and risks involved with respect to a particular transaction. The Company's Finance and Risk Committee among other things establishes the overall funding, capital and credit policies of the Company, reviews the Company's performance relative to these\npolicies, allocates capital among business activities of the Company, monitors the availability of sources of financing, and oversees liquidity and interest rate sensitivity of the Company's asset and liability position.\nMarket risk refers to the risk that a change in the level of one or more market prices, rates, indices, volatilities, correlations or other market factors, such as liquidity, will result in losses for a specified position or portfolio. The Company manages the market risk associated with its trading activities on an individual product basis, on a divisional level and Company-wide. Specific risk limits are assigned to each trading area of the Company and trading desks within trading areas. These limits are reviewed periodically and are adjusted as required. The Company uses analytic and quantitative tools, such as option pricing and hedge models, to quantify market risk for comparison, by product, to specific internal risk limits and to assess the sensitivity of positions at risk to changes in market conditions. The Company also regularly uses a variety of measures to reduce and control the market risk associated with trading proprietary positions and making markets. Market-making positions are generally hedged (that is, covered by similar, offsetting positions). Hedges may be designed to remove all or part of a position's exposure to price or yield movements and are chosen using analytic tools similar to those used to determine the risk of the positions being hedged. The Company attempts to match the risk profiles of each portfolio of securities and any related hedges as closely as possible, and to accomplish this often uses futures, options or other derivative products. Exposures in proprietary positions are managed by customizing trades to respond to specific market movements, establishing limits and monitoring procedures and regularly marking positions to market.\nThe Company's exposure to credit risk arises from the possibility that a counterparty to a transaction might fail to perform under its contractual commitment, resulting in the Company incurring losses in liquidating or covering the position in the open market. All counterparties are reviewed on a regular basis to establish appropriate exposure limits for a variety of transactions. In certain cases, specific transactions are analyzed by the Credit Department to determine the amount of potential exposure that could arise, and the counterparty's credit is reviewed to determine whether it supports such exposure. In addition to the counterparty's credit status, the Credit Department analyzes market movements that could affect exposure levels. The Credit Department considers four main factors that may affect trades in determining trading limits: the settlement method; the time it will take for a trade to settle (i.e., the maturity of the trade); the volatility that could affect the value of the securities involved in the trade; and the size of the trade. In addition to determining trading limits, the Company actively manages the credit exposure relating to its trading activities by entering into master netting agreements when feasible; monitoring the creditworthiness of counterparties and the related trading limits on an ongoing basis and requesting additional collateral when deemed necessary; diversifying and limiting exposure to individual counterparties and geographic locations; and limiting the duration of exposure. In certain cases, the Company may also close out transactions or assign them to other counterparties when deemed necessary or appropriate to mitigate credit risk.\nOperational risk refers to the risk of human error and malfeasance or deficiencies in the Company's operating system. There is considerable fluctuation within each year and from year to year in the volume of business that the Company must process, clear and settle with the\ntrend toward increased transaction volume. The Company is exposed to operational risk from processing and settlement problems which may be especially acute in some non-U.S. markets, particularly emerging markets, and during periods of heavy trading volume in certain U.S. markets. The Company's advanced technology reduces transaction errors and costs by facilitating the Company's ability to communicate relevant information worldwide among business units within the Company, between the Company and its clients, and between the Company and the markets in which it participates. Through various management information systems, senior management has access to information to monitor principal positions and related funding activity. The Company's Controllers and Operations Departments monitor position, profit\/loss and balance sheet information on a daily basis through rigorous reconciliation procedures, and business unit profitability, position market prices and aged positions are also analyzed. The Company's Information Technology Department is regularly involved in automation efforts to improve operational monitoring and control procedures while the Internal Audit Department is responsible for the periodic review of the effectiveness of these procedures.\nLegal risk is risk of non-compliance with applicable legal and regulatory requirements and the risk that a counterparty's performance obligations will be unenforceable. The Company is generally subject to extensive regulation in the different jurisdictions in which it conducts its business (see \"Competition and Regulation\"). The Company has established legal standards and procedures on a world-wide basis that are designed to ensure compliance with all applicable statutory and regulatory requirements. The Company, principally through the Legal and Compliance Department, has also established procedures, such as the Company's Code of Conduct, to ensure that senior management's policies relating to conduct, ethics and business practices are followed. The Company also conducts education and training programs which emphasize protection of client interests and maintenance of the Company's reputation and global business franchise. The Company has established certain procedures to mitigate the risk that a counterparty's performance obligations will be unenforceable. The Company has also adopted certain procedures, which are generally product-specific and vary in accordance with risk profile and market practice, to determine counterparty authority and legal capacity, adequacy of legal documentation, the permissibility of the transaction under local law and whether applicable bankruptcy or insolvency laws limit or alter contractual remedies.\nPositions and commitments taken by the Company in connection with its merchant banking and other principal investment activities often may involve substantial amounts of capital and subject the Company to risk due to significant exposure to one issuer or business, and to market and credit risk. Additionally, the equity securities owned by the Company and the funds sponsored by the Company in connection with the Company's principal investment activities are generally not highly liquid. All proposed equity investments made by a fund sponsored by the Company are reviewed and approved by senior professionals in the department of the Company responsible for identifying and making such investments on behalf of such fund, and any proposed equity investments, loans, financing commitments or other extensions of credit by the Company to portfolio companies are reviewed and approved by senior management.* The Company analyzes projected operating cash flows of the prospective portfolio company's\n- --------------------------- * As previously indicated, there were no such loans, financing commitments or other extensions of credit outstanding at January 31, 1995.\nbusiness and projected returns on equity for the investment and their sensitivities to changes in economic assumptions, and reviews the prospective portfolio company's industry and its prospects as well as the portfolio company's relative position in the industry. With respect to any loans, financing commitments or other extensions of credit, the Company reviews the creditworthiness of the portfolio company, the availability to the company of financing generally, the likely overall financial return and the Company's available capital and funding sources. After any investment or loan, financing commitment or other extension of credit is made, the Company continually monitors the portfolio company's business plan and financial performance as well as overall trends in the portfolio company's industry.\nThe Company's trading and underwriting of high-yield debt securities and emerging market loans and securitized instruments also subjects the Company to market and credit risks. For example, securities held by the Company in connection with its high-yield trading activities typically rank subordinate to bank debt of the issuer and may rank subordinate to other debt of the issuer. The market for these securities has been, and may in the future continue to be, characterized by periods of illiquidity. The liquidity of any particular issue may be significantly better or worse than the overall liquidity of the high-yield market at any time, depending on the quality of the issuer, and during certain periods market quotations may not represent firm bids of dealers or prices of actual sales. In addition, the Company through its market-making and trading activities may be the sole or principal source of liquidity in certain issues and, as a result, may substantially affect the prices at which such issues trade. To mitigate the potential impact on the Company's operating results of the greater risk inherent in high-yield debt securities and emerging market loans and securitized instruments, the Company has in place policies to control total inventory positions in these securities and instruments. Additionally, the Company has in place specific credit policies to control exposures to individual emerging market counterparties.\nDerivatives facilitate risk transfer and enhance liquidity in the marketplace, and the origination and trading of derivatives have expanded significantly over the past decade. Derivative instruments have been utilized as efficient and cost effective tools that enable users to adjust risk profiles, such as interest rate, currency, or other market risks, or to take proprietary trading positions. Widespread acceptance of derivatives has contributed to the development of more complex OTC products structured for particular clients to address specific financing and risk management needs.* Derivative transactions may have both on- and off-balance sheet implications, depending on the nature of the contract, and the Company's use of derivative products may subject the Company to market and credit risks.** In times of market stress, sharp price or volatility movements may also reduce liquidity in certain derivatives positions, as well as in underlying non-derivative (cash) instruments. Credit risk in\n- ---------------------------- * As previously indicated, the Company also uses derivative products (primarily interest rate and currency swaps) to assist in asset and liability management and to reduce borrowing costs. The risks associated with derivatives activities in this context are managed in a manner consistent with the Company's overall risk management policies.\n** It should be noted, however, that in many cases derivatives serve to reduce, rather than increase, the Company's exposure to losses from market, credit and other risks.\nthe context of OTC derivative transactions relates to the potential for a counterparty to default on its contract and is represented by the replacement cost of all contracts in a gain position (after considering the effects of master netting agreements where applicable) rather than by the gross notional or contractual values. The risks associated with derivative products, including credit and market risks, are managed in a manner consistent with the Company's overall risk management policies. The Company's exposure to changes in interest rates, foreign currencies and other factors is managed on an individual product basis, generally by entering into offsetting or other positions in a variety of financial instruments and derivative products. The Company manages its credit exposure to derivative products by entering into master netting agreements when feasible, monitoring the creditworthiness of counterparties on an ongoing basis and requesting initial and\/or additional collateral when deemed necessary, diversifying and limiting exposure to individual counterparties, and limiting the duration of exposure. In addition, with respect to certain exchange-listed derivatives, the Company has in place agreements with customers that permit the Company to close out positions or require additional collateral (and in many cases require excess collateral) if certain events occur. In certain instances, the Company may also limit the types of derivative products that may be traded in a particular account.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located at 1251 Avenue of the Americas, New York, New York, and occupy 612,255 square feet under a lease expiring in 1998. The Company also leases space at various other locations in Manhattan under leases expiring between 1996 and 2002 and aggregating approximately 504,447 square feet. In addition, the Company leases space in Brooklyn, New York, aggregating approximately 383,112 square feet under a lease expiring in 2013.\nDuring 1995, the Company will relocate approximately 4,100 of its New York City employees from existing leased space at 1221 and 1251 Avenue of the Americas to space in its buildings at 1585 Broadway and 750 Seventh Avenue, which were purchased in fiscal 1993 and fiscal 1994, respectively. The Company plans to occupy approximately 980,500 square feet at 1585 Broadway, which will become the Company's New York headquarters, and approximately 342,000 square feet of space at 750 Seventh Avenue. The total investment in these two buildings will aggregate approximately $700 million and will be capitalized and depreciated over the useful lives of the individual assets comprising the investment.\nDuring fiscal 1994, the Company recognized a pre-tax charge of $59 million ($39 million after tax). The charge was in connection with the Company's pending move to the purchased New York City facilities and to new office space in Tokyo. The charge specifically covers the Company's termination of certain leased office space and the write-off of remaining leasehold improvements in both cities.\nThe Company's London headquarters are located at 25 Cabot Square, Canary Wharf (approximately three miles east of the City of London), and occupy approximately 475,000 square feet of a 500,000 square foot building (the \"Building\") constructed by the Company. The Company owns the ground lease obligation and has a 999-year lease plus an option to acquire the freehold interest in the land and the Building. The Company recently\nleased approximately 350,000 square feet at 20 Cabot Square, Canary Wharf, under a lease arrangement expiring in 2020.\nMost of the Company's other offices are located in leased premises, the leases for which expire at various dates through 2011. Facilities owned or occupied by the Company and its subsidiaries are believed to be adequate for the purposes for which they are currently used and are well maintained.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in the following litigation matters.\nI. State of West Virginia v. Morgan Stanley & Co. Incorporated. On October 24, 1989, the State of West Virginia (the \"State\") commenced an action in the Circuit Court of Kanawha County, West Virginia against Morgan Stanley, County NatWest Government Securities, Inc., County NatWest, Inc., Salomon Brothers Inc, Greenwich Capital Markets, Inc. and Goldman, Sachs & Co., alleging that the defendants had induced the State, through its Board of Investments and the office of the State Treasurer, to engage in unsuitable and speculative investment activity in the State's Consolidated Fund. The complaint alleged that, as a result of this activity, the Consolidated Fund suffered significant losses. As against Morgan Stanley, the complaint alleged damages in excess of $79 million. All of the other defendants settled with the State.\nOn March 15, 1992, the court orally granted partial summary judgment for the State on certain of its claims. The trial began on March 30, 1992 and concluded on May 8, 1992. On May 6, 1992, the court directed a verdict of approximately $32.6 million against Morgan Stanley on the State's ultra vires claim. On May 8, 1992, the jury awarded approximately $4.9 million in damages against Morgan Stanley on the State's constructive fraud claim, but found that Morgan Stanley had not engaged in actual fraud. On October 13, 1993, the court entered a judgment in the action awarding the State the total amount of $56.8 million, inclusive of pre-judgment interest, and ordering that post-judgment interest accrue on that sum at the statutory rate of 10% per annum until the judgment is paid. On January 12, 1994, the court denied Morgan Stanley's motion for judgment notwithstanding the verdict or, alternatively, for a new trial. The court granted Morgan Stanley's motion for a stay pending appeal. On May 9, 1994, Morgan Stanley filed a petition for appeal, which was granted by the Supreme Court of Appeals of West Virginia on June 29, 1994. Following oral argument on January 18, 1995, the Supreme Court of Appeals entered an order on January 20, 1995 directing the Circuit Court to prepare written findings of fact and conclusions of law clarifying the basis of its ruling. That decision was issued on March 3, 1995. Reargument of the appeal before the Supreme Court of Appeals is currently scheduled for May 10, 1995.\nII. Taxable Municipal Bond Litigation. Between April and October 1990, 16 purported class action complaints were filed in various federal and state courts alleging claims relating to eight offerings of taxable municipal bonds by eight different issuers in 1986. On November 27, 1990, the federal Judicial Panel on Multi-district Litigation transferred all of the actions to the United States District Court for the Eastern District of Louisiana for consolidated pretrial proceedings.\nOn May 3, 1991, eight amended and consolidated complaints (the \"Amended and Consolidated Complaints\") were filed in connection with the proceedings arising out of eight different bond offerings (the \"Eight Offerings\"). In addition, a single Racketeer Influenced and Corrupt Organizations Act (\"RICO\") complaint was filed on May 3, 1991, which addressed all of the Eight Offerings. The Amended and Consolidated Complaints and the RICO complaint, like the previously filed complaints, alleged that the defendants fraudulently informed investors that the proceeds of the Eight Offerings would be used to fund low cost, public interest loans. According to the Amended and Consolidated Complaints, the money was instead invested in guaranteed investment contracts (\"GICs\") issued by Executive Life Insurance Company (\"Executive Life\") as part of a purported scheme on the part of Drexel Burnham Lambert Incorporated (\"Drexel\") and Executive Life to use the underwriting of municipal bonds to permit Executive Life to invest in high risk junk bonds through Drexel. (Due to its bankruptcy filing, Drexel was not named as a defendant in any of the Amended and Consolidated Complaints.) Following the deterioration of the high yield bond market, the ratings of Executive Life and the GIC-backed bonds were downgraded, and the resulting decline in the value of the bonds is alleged to have caused losses to the members of the purported plaintiff classes. The plaintiff class in each of the actions purportedly consists of all persons who purchased the bonds at issue prior to and including April 9, 1990. The Amended and Consolidated Complaints generally alleged violations of section 10(b) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), and rule 10b-5 promulgated thereunder, section 80a of the Investment Company Act of 1940 (the \"Investment Company Act\"), section 80b-3 of the Investment Advisers Act of 1940 (the \"Advisers Act\") and common law and\/or statutory fraud, and sought actual and punitive damages in unspecified amounts, rescission, declaratory relief, interest, costs and attorneys' fees. The RICO complaint alleged violations of section 1962(c) and (d) of Title 18 and sought compensatory and treble damages in unspecified amounts, injunctive relief, disgorgement, interest, costs, and attorneys' fees. Morgan Stanley was named as a defendant in seven of the eight Amended and Consolidated Complaints and in the RICO complaint. The master caption of the multi-district proceeding is In re Taxable Municipal Bond Securities Litigation. The seven actions naming Morgan Stanley as a defendant are: Farm Bureau Federation, et al. v. The Board of County Commissioners of Adams County, Colorado, et al.; Washington National Life Insurance Company of New York, et al. v. Morgan Stanley & Co. Incorporated, et al.; First National Bank, et al. v. Louisiana Housing Finance Agency, et al.; Associated Kellogg Bank, et al. v. Louisiana Agricultural Finance Authority, et al.; Bloomfield State Bank, et al. v. Louisiana Agricultural Finance Authority, et al.; Virgin, et al. v. Health, Educational and Housing Facility Board of the City of Memphis, Tennessee, et al.; and Farm Bureau Town & Country Insurance Company of Missouri, et al. v. El Paso Housing Finance Corporation, et al.\nOn June 3, 1992, the court dismissed plaintiffs' claims under the Investment Company Act and the Advisers Act. On November 1, 1993, certain of the defendants in the various actions filed cross-claims to preserve their various claims for contribution, credit or offset. In connection with the RICO action, all of the plaintiffs except Washington National Life Insurance Company and Washington National Life Insurance Company of New York withdrew their RICO claims without prejudice. Thereafter, on December 13, 1993, the court granted defendants' motion for summary judgment on the Washington National plaintiffs' RICO claims, and denied the Washington National plaintiffs' motion for leave to file an amended RICO\ncomplaint. On February 2, 1994, the court entered an order imposing sanctions on counsel for the Washington National plaintiffs.\nThe parties reached an agreement to settle the various actions in which Morgan Stanley was named as a defendant, and the settlement was approved by the court on February 1, 1995. A fairness hearing on the proposed settlement is scheduled for July 31, 1995.\nIII. Lundy, et al. v. Morgan Stanley & Co. Inc. On September 28, 1990, a purported class action complaint was filed in the United States District Court for the Northern District of California, purportedly on behalf of all persons who purchased 12.40% Debentures due 1997 (the \"Debentures\") of Imperial Corporation of America (\"ICA\") between January 9, 1987 and July 1, 1990. Morgan Stanley and Drexel Burnham Lambert Incorporated (\"Drexel\") were the underwriters for the initial offering of $100 million of the Debentures. On February 28, 1990, ICA filed for protection under Chapter 11 of the Federal Bankruptcy Code, and on July 1, 1990 defaulted on the payment of interest on the Debentures. The complaint alleged that the Debentures were issued in order to facilitate ICA's continuing investment in high yield junk bonds through Drexel, and that, with Morgan Stanley's knowledge, the prospectus issued in connection with the Debentures was materially false and omitted to state material information. The complaint asserted claims under section 10(b) of the Exchange Act and rule 10b-5 promulgated thereunder, and for fraud, negligence, negligent misrepresentation and false advertising, and sought rescission, compensatory and punitive damages in unspecified amounts, disgorgement of profits and compensation, costs and attorneys' fees. On February 25, 1991, the court certified the plaintiff class. On January 25, 1993, Morgan Stanley filed a motion for summary judgment. On October 21, 1993, the court entered a preliminary order approving an agreement, subject to certain contingencies, to settle the action.\nIV. Katell, et al. v. Morgan Stanley Group, Inc., et al. On November 6, 1991, a complaint was filed in the Court of Chancery of the State of Delaware for New Castle County against the Company, Morgan Stanley, two Morgan Stanley employees, Morgan Stanley Leveraged Capital Fund, Inc., Morgan Stanley Leveraged Equity Fund, L.P. (\"MSLEF\"), CIGNA Corp., CIGNA Capital Advisors, Inc., CIGNA Leveraged Capital Fund, Inc., SIBV\/MS Holdings, Inc., Jefferson Smurfit Corp., Container Corporation of America (\"CCA\"), Silgan Holdings Inc. and Silgan Corporation (\"Silgan\"). The complaint, filed on behalf of two limited partners in MSLEF, alleged breaches of fiduciary duties, willful misconduct, gross negligence and breach of contract in connection with the purchase and sale of MSLEF's interests in CCA and Silgan. The complaint alleged damages in excess of $32.9 million and sought compensatory damages in an unspecified amount, together with interest. On February 17, 1992, plaintiffs filed an amended complaint, adding derivative claims and seeking an accounting. On January 14, 1993, the court dismissed plaintiffs' individual claims, co-investor claims, right of first refusal claims and aiding and abetting claims, but did not dismiss plaintiffs' derivative claims regarding the CCA and Silgan sale prices. On September 27, 1993, the court granted defendants' motion to stay the action pending a report by a special litigation committee. On April 15, 1994, the special litigation committee filed its report together with a motion to dismiss the action. On March 28, 1995, the court heard oral argument on the motion to dismiss. A decision is pending.\nA related action, captioned Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund II, L.P., et al., was commenced on February 18, 1992 in the Court of Chancery\nof the State of Delaware for New Castle County against Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\"), Morgan Stanley Leveraged Equity Fund II, Inc. and the Company. The complaint alleged that plaintiff, a limited partner in MSLEF II, was improperly excluded from MSLEF II investment opportunities in retaliation for its participation in the Katell litigation described above. The complaint asserted claims for breach of fiduciary duty, breach of the MSLEF II Partnership Agreement and breach of an implied covenant of good faith and fair dealing. The complaint sought damages in an unspecified amount, interest, injunctive relief, specific performance of the Partnership Agreement and an accounting. On July 28, 1992, the court granted defendants' motion for judgment on the pleadings. On June 1, 1993, the Delaware Supreme Court reversed and remanded the action for further proceedings. Discovery is proceeding.\nV. Atwood, et al. v. Burlington Industries Equity, Inc., et al. On June 3, 1992, a purported class action complaint was filed against Burlington Industries Equity, Inc. (\"Burlington\"), the Company, and seven officers and\/or directors of Burlington, two of whom are Morgan Stanley employees. NationsBank Trust Company was subsequently added as a defendant. The plaintiff class purportedly consists of all participants in and beneficiaries of Burlington's Employee Stock Ownership Plan (\"ESOP\"). The complaint alleged that defendants violated the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"), and breached various fiduciary duties purportedly owed to plaintiffs in connection with the ESOP's August 1989 purchase of certain Burlington voting stock at $37.80 per share. The complaint alleged that defendants thereafter caused Burlington to engage in a series of transactions which decreased significantly the value of the ESOP's investment in Burlington stock. The complaint sought compensatory and punitive damages in unspecified amounts, rescission of the ESOP's August 1989 purchase of Burlington stock, removal of all defendants as ESOP fiduciaries under the ERISA statute, pre- and post-judgment interest, costs and attorneys' fees. The action is pending in the United States District Court for the Middle District of North Carolina.\nOn August 3, 1994, the court granted in part and denied in part defendants' motion to dismiss the action. On February 13, 1995, the court granted plaintiffs' motion for class certification. Discovery is proceeding.\nVI. Hedged-Investments Litigation. On August 6, 1993, a purported class action complaint captioned Bruce W. Higley, D.D.S., M.S., P.A. Defined Benefit Annuity Plan v. Donahue, et al. was filed in the District Court for the City and County of Denver, Colorado purportedly on behalf of all persons and entities who invested, directly or indirectly, in certain investment partnerships or entities organized and\/or managed by James D. Donahue (\"Donahue\"). Donahue was the founder and president of Hedged-Investments Associates, Inc. (\"HIA\"), through which Donahue conducted the options trading at issue in the action. HIA, in turn, was allegedly the general partner of several limited partnerships. The trading at issue occurred through accounts held at Morgan Stanley, Kidder, Peabody & Co. Incorporated (\"Kidder\"), and Prudential Securities Incorporated (\"Prudential\"). The action was brought against Donahue, Morgan Stanley, Kidder, Prudential, and individual employees at each of those firms. The complaint alleged that despite representations made to investors that the trading would be based on a \"scientific\" approach, would be fully hedged, and would yield a predictable return, Donahue, in conspiracy with and aided and abetted by the other defendants, in reality engaged in risky trading strategies while operating a \"Ponzi scheme,\" which caused investors\nto suffer substantial losses. As against the brokerage firms, the complaint asserted state law causes of action for violating and aiding and abetting violations of state securities laws, fraud and aiding and abetting fraud, aiding and abetting Donahue's breach of fiduciary duty, theft by deception, civil conspiracy, and aiding and abetting conversion. The complaint also asserted causes of action under the Colorado Organized Crime Control Act. The complaint sought rescissory and compensatory damages in unspecified amounts, treble damages, costs and attorneys' fees.\nRelated litigation against Morgan Stanley and the other defendants is pending in the same court. That litigation includes an action by HIA's bankruptcy trustee and a competing class action brought on behalf of essentially the same class of investors alleged to be represented in Higley. On March 10, 1994, the court certified a plaintiff class in Higley and the competing class action. The court denied various motions to dismiss.\nAn agreement has been reached to settle Higley and the competing class action. On March 3, 1995, the proposed settlement was filed for court approval. A fairness hearing is scheduled for April 28, 1995.\nThe settlement described above, upon final approval by the court, will result in the dismissal of all related litigation against Morgan Stanley except for the action filed by the bankruptcy trustee for HIA and certain related partnerships, captioned Sender v. Kidder, Peabody & Co. Incorporated, et al. On November 17, 1994, the court in Sender vacated an earlier order that had dismissed the only claim asserted by the trustee against Morgan Stanley. Discovery in the Sender action is proceeding, and the trial is scheduled to begin on January 29, 1996.\nVII. First Tokyo Index Trust Limited v. Morgan Stanley Trust Company and Morgan Stanley International. On September 30, 1993, First Tokyo Index Trust Limited (\"First Tokyo\") commenced an action in the High Court of Justice, Chancery Division, London, against Morgan Stanley Trust Company (\"MSTC\") and Morgan Stanley International (\"MSI\"). MSTC was the custodian for First Tokyo's assets, and MSI engaged in certain transactions concerning those assets. First Tokyo asserted claims for breach of contract, negligence, breach of trust, breach of fiduciary duty, conversion and constructive trust, and sought the return of certain assets remaining in the First Tokyo custodial account with MSTC, compensatory damages in an unspecified amount, interest, costs and an accounting. On December 31, 1993, MSTC and MSI filed their defenses, as well as claims for contribution and\/or indemnity against various individuals and entities. The parties subsequently amended their respective pleadings. On May 12, 1994, the court granted in part and denied in part plaintiff s motion to strike certain of the defenses asserted by the defendants. The defenses were subsequently amended and re-served. On November 10, 1994, the court granted MSTC and MSI's application to add Coopers & Lybrand as a third-party defendant, and to assert claims for contribution and\/or indemnity against Coopers & Lybrand. Discovery is proceeding.\nVIII. The National Commercial Bank v. Morgan Stanley Asset Management, Inc., et al. On May 2, 1994, a complaint was filed in the United States District Court for the Southern District of New York by The National Commercial Bank (\"NCB\") against Morgan Stanley Asset Management Inc. (\"MSAM\") and certain MSAM employees. The complaint alleges that NCB\nestablished a managed account at MSAM in or about February 1993 to trade United States Treasury securities and that in August 1993 that account suffered substantial losses. The complaint alleges violations of sections 10(b) and 20(a) of the Exchange Act and rule 10b-5 promulgated thereunder, common law fraud, common law constructive fraud, breach of fiduciary duty, breach of contract, negligence and negligent misrepresentation, and seeks compensatory damages in excess of $39 million, punitive damages in an unspecified amount, costs, attorneys' fees and interest. On June 28, 1994, defendants filed answers to the complaint. On July 13, 1994, defendants filed third-party complaints against two employees of NCB, asserting claims over and for contribution and indemnity in the event defendants are determined to be liable to NCB. Discovery is proceeding.\nIX. NASDAQ Antitrust Litigation. On December 16, 1994, a consolidated amended complaint was filed in the United States District Court for the Southern District of New York against a total of 33 defendants, including Morgan Stanley. The consolidated amended complaint alleges that Morgan Stanley and other participants and market makers on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") engaged in a conspiracy to fix the \"spread\" between bid and asked prices for securities traded on the NASDAQ in violation of Section 1 of the Sherman Act. The plaintiff class is alleged to include persons throughout the United States who are customers of the defendants or their affiliates and who purchased or sold securities on the NASDAQ during the period from May 1, 1989 through May 27, 1994. Plaintiffs are alleged to have been damaged in that they paid more for securities purchased on the NASDAQ, or received less for securities sold, than they would have but for the alleged conspiracy. The consolidated amended complaint seeks compensatory damages, treble damages, declaratory and injunctive relief, attorneys' fees and costs. Judgment against each of the defendants is sought on a joint and several basis. On February 2, 1995, Morgan Stanley and the other named defendants filed a motion to dismiss.\nIn addition to the federal court litigation, on May 27, 1994, a purported class action complaint captioned Abel, et al. v. Merrill Lynch & Co., et al. was filed in California Superior Court, San Diego County, against Morgan Stanley and 12 other participants and market makers on the NASDAQ. The complaint raised substantially the same allegations as the federal court litigation, on behalf of a purported class of persons in California who purchased or sold securities on the NASDAQ. On April 5, 1995, by agreement of the parties and by order of the Court, this matter was dismissed without prejudice, and the relevant statutes of limitation tolled pending termination of the federal actions.\nX. Other. In addition to the matters described above, the Company, including Morgan Stanley, has been named from time to time as a defendant in various legal actions, including arbitrations, arising in connection with its activities as a global diversified financial services institution, certain of which include large claims for punitive damages. The Company, including Morgan Stanley, is also involved, from time to time, in investigations and proceedings by governmental and self-regulatory agencies.\nIn view of the inherent difficulty of predicting the outcome of such matters, particularly in cases such as some of those described above in which substantial damages are sought, the Company cannot state what the eventual outcome of pending matters will be. The Company is contesting the allegations made in each pending matter and believes, based on\ncurrent knowledge and after consultation with counsel, that the outcome of such matters will not have a material adverse effect on the Company's Consolidated Financial Statements incorporated by reference herein.\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 January 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table provides certain information about each of the Registrant's executive officers on January 31, 1995:\n- -------------------------- * Mr. Matschullat will not stand for re-election as a Director of the Registrant at the 1995 Annual Meeting of and will resign from the Company effective July 1995.\nAll directors hold office until the next annual meeting of stockholders and until their respective successors have been duly elected and qualified. Officers serve at the discretion of the Board of Directors. There are no family relationships among any directors or executive officers.\nMr. Fisher has served as Chairman of the Board of Directors of the Registrant and Morgan Stanley since January 1991. From January 1984 through December 1990, he served as President of the Registrant and Morgan Stanley. He has been a director and a Managing Director of the Registrant since July 1975 and a director and a Managing Director of Morgan Stanley since July 1970. He has also been a member of the Registrant's Executive Committee since March 1986 and its chairman since May 1991. He was a partner of Morgan Stanley & Co. from July 1970 through June 1975.\nMr. Mack has been President of the Registrant and Morgan Stanley since June 1993. He has been a director and a Managing Director of the Registrant since December 1987 and was a director and a Managing Director of the Registrant from January 1979 until March 1986. Mr. Mack has been a director and a Managing Director of Morgan Stanley since January 1979. He has also been a member of the Registrant's Executive Committee since December 1987.\nMr. Biggs has been a director and a Managing Director of the Registrant since May 1991 and a director and Managing Director of Morgan Stanley since July 1973. He was a director and a Managing Director of the Registrant from July 1975 to March 1986. He has also been a member of the Registrant's Executive Committee since May 1991. He was a partner of Morgan Stanley & Co. from June 1973 through June 1975.\nMr. Karches has been a director and a Managing Director of the Registrant since February 1994 and a director and a Managing Director of Morgan Stanley since January 1985. He has also been a member of the Registrant's Executive Committee since February 1994.\nMr. Matschullat has been a director and a Managing Director of the Registrant since July 1992 and a Managing Director of Morgan Stanley since February 1986. He has been a director of Morgan Stanley from February 1986 to September 1991 and since January 1992. He has also been a member of the Registrant's Executive Committee since July 1992.\nSir David Walker has been a director of the Registrant since November 1994, a director of Morgan Stanley since February 1995 and a Managing Director of Morgan Stanley since November 1994. He has also been a member of the Registrant's Executive Committee\nsince November 1994. Before joining the Company, Sir David was a Deputy Chairman of Lloyds Bank in England. From 1988 to 1992 he was Chairman of the Securities and Investments Board, the British authority that regulates the securities markets.\nMr. Clark has been the General Counsel and Secretary of the Registrant and Morgan Stanley since February 1993. Since February 1993 he has been a director and a Managing Director of Morgan Stanley. Before joining the Company, Mr. Clark was a partner of Davis Polk & Wardwell, a New York law firm.\nMr. Duff has been the Chief Financial Officer of the Registrant and Morgan Stanley since February 1994. He has been a Managing Director of Morgan Stanley since February 1993 and a Principal of Morgan Stanley from January 1991 to February 1993. From January 1989 to January 1991 he was a Vice President of Morgan Stanley.\nMr. Hintz has been the Treasurer of the Registrant and Morgan Stanley since January 1992. He has been a Managing Director of Morgan Stanley since February 1993. From January 1989 to February 1993 he was a Principal of Morgan Stanley.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation relating to the principal market in which the Registrant's Common Stock is traded, the high and low sales prices per share for each full quarterly period within the two most recent fiscal years, the approximate number of holders of record of Common Stock and the frequency and amount of any cash dividends declared for the two most recent fiscal years is set forth under the caption \"Quarterly Results\" on page 77 of the Registrant's 1994 Annual Report to Stockholders and such information is hereby incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data for the Registrant and its subsidiaries for each of the last five fiscal years is set forth under the same caption on page 2 of the 1994 Annual Report to Stockholders. Such information is hereby incorporated herein by reference and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto contained on pages 46 to 77 of such 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 set forth under the same caption on pages 33 to 44 of the 1994 Annual Report to Stockholders. Such information is hereby incorporated herein by reference and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto contained on pages 46 to 77 of such Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Registrant and its subsidiaries, together with the Notes thereto and the Report of Independent Auditors thereon, are contained in the 1994 Annual Report to Stockholders on pages 45 to 77 and such information is hereby incorporated herein by reference, including the information appearing under the caption \"Quarterly Results\" on page 77 of such Annual Report.\nThe Statement of Financial Condition at December 31, 1994 and 1993 for the Morgan Stanley U.K. Group Profit Sharing Scheme (the \"Plan\"), the Statement of Changes in Plan Equity for the Years Ended December 31, 1994, 1993 and 1992 together with the Notes thereon and the Report of Independent Chartered Accountants appear as Exhibit 99.\nITEM 9.","section_9":"ITEM 9. CHANGES IN 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 relating to Directors and Nominees of the Registrant is set forth under the caption \"Election of Directors\" on pages 3 and 4 of the Proxy Statement of the Registrant for its 1995 Annual Meeting of Stockholders and such information is hereby incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is set forth under the captions \"Board of Directors Meetings, Committees and Fees\" on page 5, \"Compensation of Executive Officers\" on pages 10 to 14 and \"Compensation Committee Interlocks and Insider Participation\" on page 19 of the Proxy Statement of the Registrant for its 1995 Annual Meeting of Stockholders and such information is hereby incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation relating to security ownership of management and certain beneficial owners is set forth under the captions \"Stock Ownership of Management\" and \"Principal Stockholders\" on pages 6 and 7, respectively, of the Proxy Statement of the Registrant for its 1995 Annual Meeting of Stockholders and such information is hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is set forth under the caption \"Interest of Management in Certain Transactions\" on page 9 of the Proxy Statement\nof the Registrant for its 1995 Annual Meeting of Stockholders and such information is hereby incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this Report:\n1 Financial Statements\nThe financial statements required to be filed hereunder are listed on page hereof.\n2 Financial Statement Schedules\nThe financial statement schedules required to be filed hereunder are listed on page hereof.\n3 Exhibits\nCertain of the following exhibits, as indicated parenthetically, were previously filed as exhibits to registration statements filed by the Registrant under the Securities Act of 1933 or to reports or registration statements filed by the Registrant under the Exchange Act, respectively, and are hereby incorporated by reference to such statements or reports.\n3.1 Restated Certificate of Incorporation of the Company, as amended to date (Registration Statement on Form S-3 (No. 33-57833)).\n3.2* By-Laws of the Company, as amended to date.\n4.1 Restated Certificate of Incorporation of the Company, as amended to date (see Exhibit 3.1).\n4.2 Stockholders' Agreement dated February 14, 1986, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.3 Subordinated Indenture dated as of April 15, 1989 between the Company and The First National Bank of Chicago, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n- ----------------------------- * Filed herewith.\n4.4 First Supplemental Subordinated Indenture dated as of May 15, 1991 between the Company and The First National Bank of Chicago, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.5 Senior Indenture dated as of April 15, 1989 between the Company and Chemical Bank, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.6 First Supplemental Senior Indenture dated as of May 15, 1991 between the Company and Chemical Bank, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.7 Subordinated Indenture dated as of November 15, 1993 among Morgan Stanley Finance plc, the Company, as guarantor, and Chemical Bank, as trustee (Current Report on Form 8-K dated December 1, 1993).\n4.8 Voting Agreement dated March 5, 1991 among the Company, State Street Bank and Trust Company and Other Persons Signing Similar Voting Agreements (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.9 Instruments defining the Rights of Security Holders, Including Indentures - In addition to Exhibits 4.1 through 4.8 herein, pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, the Registrant hereby undertakes to furnish to the Securities and Exchange Commission upon request copies of the instruments defining the rights of holders of long-term debt securities of the Registrant and its subsidiaries, none of which instruments authorizes the issuance of an amount of securities that exceeds 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.\n10.1+ Form of Agreement under the Morgan Stanley & Co. Incorporated Owners' and Select Earners' Plan (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.2+ Form of Agreement under the Morgan Stanley Group Inc. Officers' and Select Earners' Plan (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\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).\n10.3+ Morgan Stanley & Co. Incorporated Excess Benefit Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.4+ Morgan Stanley & Co. Incorporated Supplemental Executive Retirement Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.5+ Morgan Stanley Group Inc. 1986 Stock Option Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.6+ Morgan Stanley Group Inc. Performance Unit Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.7+ Morgan Stanley Group Inc. Deferred Compensation Plan for Outside Directors, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.8+ Morgan Stanley Group Inc. 1988 Equity Incentive Compensation Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.9+ Morgan Stanley Group Inc. 1988 Capital Accumulation Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.10+ Form of Deferred Compensation Agreement under the Pre-Tax Incentive Program (Annual Report on Form 10-K for the fiscal year ended January 31, 1994).\n10.11 Trust Agreement dated March 5, 1991 between the Company and State Street Bank and Trust Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.12 Lease Agreement dated as of July 5, 1972 between Morgan Stanley & Co. Incorporated and Standard Oil Company, as amended (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.13 Agreement of Lease dated May 13, 1986 between Morgan Stanley & Co. Incorporated and Forest City Pierrepont Associates, as\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).\namended (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.14 Agreement of Sublease between McGraw Hill, Inc. and Morgan Stanley & Co. Incorporated, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.15 Lease dated January 22, 1993 between Rock-McGraw, Inc., Landlord, to Morgan Stanley & Co. Incorporated, Tenant (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.16 999 Year Lease dated November 5, 1993 among Canary Wharf Investments Limited, Canary Wharf Management Limited, Canary Wharf Limited, Morgan Stanley UK Holdings PLC and the Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1994; confidential treatment has been granted for a portion of this exhibit).\n10.17 Option Agreement dated November 5, 1993 among Canary Wharf Investments Limited, 25 Cabot Square Limited and the Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1994).\n10.18* Agreement of Lease dated February 10, 1995 among Canary Wharf Limited, Morgan Stanley UK Group and the Company.\n10.19 Sale-Purchase Agreement dated as of August 11, 1993 between 1585 Broadway Associates and the Company (Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 1993).\n10.20 Sale-Purchase Agreement dated as of April 28, 1994 between 750 Seventh Avenue Associates, L.P. and Morgan Stanley 750 Building Corp. (Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 1994).\n11* Statement Re: Computation of Earnings Per Share.\n12* Statement Re: Computation of Ratio of Earnings to Fixed Charges and Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.\n- -------------------------- * Filed herewith.\n13* The following portions of the Company's 1994 Annual Report to Stockholders, which are incorporated by reference in this Annual Report on Form 10-K, are filed as an Exhibit:\n13.1 \"Quarterly Results\" (page 77).\n13.2 \"Selected Financial Data\" (page 2).\n13.3 \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (pages 33 to 44).\n13.4 Consolidated Financial Statements of the Company and its subsidiaries, together with the Notes thereto and the Report of Independent Auditors thereon (pages 45 to 77).\n21* Subsidiaries of the Company.\n23.1* Consent of Ernst & Young.\n23.2* Consent of Ernst & Young with respect to the Financial Statements for the fiscal year ended December 31, 1994 for the Morgan Stanley U.K. Group Profit Sharing Scheme.\n24 Powers of Attorney (included on signature page).\n27* Financial Data Schedule.\n99* Financial Statements for the fiscal year ended December 31, 1994 for the Morgan Stanley U.K. Group Profit Sharing Scheme.\n- ----------------------- * Filed herewith.\n(b) A Current Report on Form 8-K, dated November 16, 1994, was filed with the Securities and Exchange Commission in connection with the announcement of the Company's third quarter financial results and declaration of a quarterly cash dividend.\nA Current Report on Form 8-K, dated December 8, 1994, was filed with the Securities and Exchange Commission in connection with the discussions by the Company and S.G. Warburg Group plc of the possibility of combining their businesses.\nA Current Report on Form 8-K, dated December 15, 1994, was filed with the Securities and Exchange Commission in connection with the termination of merger discussions between the Company and S.G. Warburg Group plc.\nA Current Report on Form 8-K, dated January 19, 1995, was filed with the Securities and Exchange Commission in connection with expected earnings for the fiscal quarter ending January 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 April 26, 1995.\nMORGAN STANLEY GROUP INC.\nBy \/s\/ Richard B. Fisher ------------------------------- Richard B. Fisher Chairman of the Board of Directors\nPOWER OF ATTORNEY\nWe, the undersigned directors and executive officers of Morgan Stanley Group Inc., hereby severally constitute Jonathan M. Clark, Philip N. Duff and Ralph L. Pellecchio, and each of them singly, our true and lawful attorneys with full power to them and each of them to sign for us, and in our names in the capacities indicated below, any and all amendments to the Annual Report on Form 10-K filed with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys to any and all amendments to said Annual Report on Form 10-K.\nPURSUANT TO THE REQUIREMENTS OF THE 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 OF APRIL, 1995.\nMORGAN STANLEY GROUP INC. AND FINANCIAL STATEMENT SCHEDULES ITEMS (14)(a)(l) AND (14)(a)(2)\nSCHEDULE III MORGAN STANLEY GROUP INC. (PARENT COMPANY ONLY)\nCONDENSED STATEMENT OF FINANCIAL CONDITION JANUARY 31, 1995 AND JANUARY 31, 1994\n(IN THOUSANDS, EXCEPT SHARE DATA)\nSee Notes to Condensed Financial Statements.\nSCHEDULE III\nMORGAN STANLEY GROUP INC. (PARENT COMPANY ONLY)\nCONDENSED STATEMENT OF INCOME FOR THE YEARS ENDED JANUARY 31, 1995, JANUARY 31, 1994, AND JANUARY 31, 1993\n(IN THOUSANDS, EXCEPT SHARE DATA)\n- --------------- (1) Amounts shown are used to calculate primary earnings per share.\nSee Notes to Condensed Financial Statements.\nSCHEDULE III MORGAN STANLEY GROUP INC. (PARENT COMPANY ONLY)\nCONDENSED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED JANUARY 31, 1995, JANUARY 31, 1994, AND JANUARY 31, 1993\n(IN THOUSANDS, EXCEPT SHARE DATA)\nSee Notes to Condensed Financial Statements.\nSCHEDULE III\nMORGAN STANLEY GROUP INC. (PARENT COMPANY ONLY)\nNOTES TO CONDENSED FINANCIAL STATEMENTS\n1. General\nThe condensed financial statements of Morgan Stanley Group Inc. (the \"Company\") should be read in conjunction with the consolidated financial statements of Morgan Stanley Group Inc. and Subsidiaries and the notes thereto.\n2. Transactions with subsidiaries\nThe Company has transactions with its subsidiaries determined on an agreed-upon basis and has guaranteed certain unsecured lines of credit and contractual obligations of its subsidiaries.\nEXHIBIT INDEX\nEXHIBIT NO. EXHIBIT ----------- -------\n3.1 Restated Certificate of Incorporation of the Company, as amended to date (Registration Statement on Form S-3 (No. 33-57833)).\n3.2* By-Laws of the Company, as amended to date.\n4.1 Restated Certificate of Incorporation of the Company, as amended to date (see Exhibit 3.1).\n4.2 Stockholders' Agreement dated February 14, 1986, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.3 Subordinated Indenture dated as of April 15, 1989 between the Company and The First National Bank of Chicago, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.4 First Supplemental Subordinated Indenture dated as of May 15, 1991 between the Company and The First National Bank of Chicago, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.5 Senior Indenture dated as of April 15, 1989 between the Company and Chemical Bank, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.6 First Supplemental Senior Indenture dated as of May 15, 1991 between the Company and Chemical Bank, as trustee (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.7 Subordinated Indenture dated as of November 15, 1993 among Morgan Stanley Finance plc, the Company, as guarantor, and Chemical Bank, as trustee (Current Report on Form 8-K dated December 1, 1993).\n4.8 Voting Agreement dated March 5, 1991 among the Company, State Street Bank and Trust Company and Other Persons Signing Similar Voting Agreements (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n- --------------- * Filed herewith.\nEXHIBIT NO. EXHIBIT ----------- -------\n4.9 Instruments defining the Rights of Security Holders, Including Indentures - In addition to Exhibits 4.1 through 4.8 herein, pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, the Registrant hereby undertakes to furnish to the Securities and Exchange Commission upon request copies of the instruments defining the rights of holders of long-term debt securities of the Registrant and its subsidiaries, none of which instruments authorizes the issuance of an amount of securities that exceeds 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.\n10.1+ Form of Agreement under the Morgan Stanley & Co. Incorporated Owners' and Select Earners' Plan (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.2+ Form of Agreement under the Morgan Stanley Group Inc. Officers' and Select Earners' Plan (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.3+ Morgan Stanley & Co. Incorporated Excess Benefit Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.4+ Morgan Stanley & Co. Incorporated Supplemental Executive Retirement Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.5+ Morgan Stanley Group Inc. 1986 Stock Option Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.6+ Morgan Stanley Group Inc. Performance Unit Plan, as amended and restated to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\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).\nEXHIBIT NO. EXHIBIT ----------- -------\n10.7+ Morgan Stanley Group Inc. Deferred Compensation Plan for Outside Directors, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.8+ Morgan Stanley Group Inc. 1988 Equity Incentive Compensation Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.9+ Morgan Stanley Group Inc. 1988 Capital Accumulation Plan, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.10+ Form of Deferred Compensation Agreement under the Pre-Tax Incentive Program (Annual Report on Form 10-K for the fiscal year ended January 31, 1994).\n10.11 Trust Agreement dated March 5, 1991 between the Company and State Street Bank and Trust Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.12 Lease Agreement dated as of July 5, 1972 between Morgan Stanley & Co. Incorporated and Standard Oil Company, as amended (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.13 Agreement of Lease dated May 13, 1986 between Morgan Stanley & Co. Incorporated and Forest City Pierrepont Associates, as amended (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.14 Agreement of Sublease between McGraw Hill, Inc. and Morgan Stanley & Co. Incorporated, as amended to date (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n10.15 Lease dated January 22, 1993 between Rock-McGraw, Inc., Landlord, to Morgan Stanley & Co. Incorporated, Tenant (Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\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).\nEXHIBIT NO. EXHIBIT ----------- -------\n10.16 999 Year Lease dated November 5, 1993 among Canary Wharf Investments Limited, Canary Wharf Management Limited, Canary Wharf Limited, Morgan Stanley UK Holdings PLC and the Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1994; confidential treatment has been granted for a portion of this exhibit).\n10.17 Option Agreement dated November 5, 1993 among Canary Wharf Investments Limited, 25 Cabot Square Limited and the Company (Annual Report on Form 10-K for the fiscal year ended January 31, 1994).\n10.18* Agreement of Lease dated February 10, 1995 among Canary Wharf Limited, Morgan Stanley UK Group and the Company.\n10.19 Sale-Purchase Agreement dated as of August 11, 1993 between 1585 Broadway Associates and the Company (Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 1993).\n10.20 Sale-Purchase Agreement dated as of April 28, 1994 between 750 Seventh Avenue Associates, L.P. and Morgan Stanley 750 Building Corp. (Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 1994).\n11* Statement Re: Computation of Earnings Per Share.\n12* Statement Re: Computation of Ratio of Earnings to Fixed Charges and Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.\n- --------------- * Filed herewith.\nEXHIBIT NO. EXHIBIT ----------- -------\n13* The following portions of the Company's 1994 Annual Report to Stockholders, which are incorporated by reference in this Annual Report on Form 10-K, are filed as an Exhibit:\n13.1 \"Quarterly Results\" (page 77).\n13.2 \"Selected Financial Data\" (page 2).\n13.3 \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (pages 33 to 44).\n13.4 Consolidated Financial Statements of the Company and its subsidiaries, together with the Notes thereto and the Report of Independent Auditors thereon (pages 45 to 77).\n21* Subsidiaries of the Company.\n23.1* Consent of Ernst & Young.\n23.2* Consent of Ernst & Young with respect to the Financial Statements for the fiscal year ended December 31, 1994 for the Morgan Stanley U.K. Group Profit Sharing Scheme.\n24 Powers of Attorney (included on signature page).\n27* Financial Data Schedule.\n99* Financial Statements for the fiscal year ended December 31, 1994 for the Morgan Stanley U.K. Group Profit Sharing Scheme.\n- --------------- * Filed herewith.","section_15":""}
{"filename":"95626_1995.txt","cik":"95626","year":"1995","section_1":"Item 1. BUSINESS.\nGeneral - -------\nSunbase Asia, Inc., a Nevada corporation (the \"Company,\" which term shall include, when the context so requires, its subsidiaries and affiliates), is engaged in the design, manufacture and distribution of a broad range of bearing products in the People's Republic of China (\"China\" or the \"PRC\"), the United States (\"US\"), Europe, Asia, South America and Africa. The Company's subsidiary in China, Harbin Bearing Company, Ltd. (\"Harbin Bearing\"), employs approximately 13,000 personnel. Harbin Bearing is the largest precision bearing manufacturer and the third largest bearing manufacturer overall in China. Harbin Bearing produces a wide variety of precision and commercial-grade, rolling-element bearings in sizes ranging from 10mm to 1000mm (internal diameter). Rolling-element bearings use small metal balls or cylinders to facilitate rotation with minimal friction and are typically used in vehicles, aircraft, appliances, machine tools, general machinery and virtually any product that contains rotating or revolving parts.\nOn January 16, 1996 (effective December 29, 1995), the Company acquired Southwest Products Company (\"Southwest Products\"), an engineering- intensive company that produces precision spherical bearings for US, European and Asian aerospace and high tech commercial applications and the US military. Precision bearings are bearings that are produced to more exacting dimensional tolerances and to higher performance characteristics than standard commercial bearings. The manufacturing process for precision bearings generally requires the labor of highly-skilled machinists and the use of sophisticated machine tools. Southwest Products recently established a joint venture company in Shanghai, China (the \"Shanghai Joint Venture\") that will begin production in 1996 of a line of precision grade, high-profit-margin spherical bearings primarily for distribution to international aircraft original equipment manufacturers (OEMs) that have major \"offset\" commitments to purchase made-in- China parts.\nOver 90% of Harbin Bearing's sales are made to the OEM and replacement markets in China. Based on low production costs in China and the on-going world-wide demand for bearings, management has been increasing Harbin Bearing's efficiency and production output with the intent of creating a substantial export business to complement the Company's strong domestic position in the Chinese markets. Historically, Harbin Bearing export sales have been made through trade intermediaries and by receiving customer orders that are placed directly to its offices in China. Southwest Products will provide engineering and technical support, and will market and distribute Harbin Bearing products internationally, focusing on exports of the products to the US. In addition, Southwest Products will assist Harbin Bearing in implementing US manufacturing methods, improving quality control procedures and in developing new products at Harbin Bearing's facilities in China.\nThe Company's overall plan is to combine the management style, technology, quality control and production methods found in the West with low- cost Chinese manufacturing capacity so as to become a major international designer, manufacturer and distributor of bearing products.\nThe following diagram shows the corporate structure of the Company and its affiliated entities.\n[CHART APPEARS HERE]\nHARBIN BEARING\nHarbin Bearing presently produces a wide range of bearings, ranging from 10mm to 1000mm (internal diameter). Harbin Bearing specializes in the manufacture of precision bearings and has the capability of manufacturing more than 5,000 of the approximately 6,000 different specifications of bearings that are available in China today. Harbin Bearing produces seven major types of bearings: deep-groove ball bearings, self-aligning ball bearings, cylindrical rolling bearings, angular-contact ball bearings, tapered rolling bearings, thrust ball bearings and linear-motion ball bearings. Each of such bearings are manufactured in micro, small, medium and large sizes. In 1995, deep-groove bearings comprised approximately 75% of Harbin Bearing's sales in units, and approximately 43% of sales in revenue.\nBased on increasing demand and profit opportunities, Harbin Bearing increased its production of all sizes and grades of cylindrical rolling bearings and angular-contact ball bearings, (particularly in medium sizes and precision grades). In order to enhance the profitability for deep-groove ball bearings, Harbin Bearing has shifted its production mix of such bearings by increasing its production of medium-sized deep-groove ball bearings (especially in precision grades). The shift in production to medium-sized and precision grade bearings has enabled Harbin Bearing to expand its customer base, improve its profit margins, and meet the demand of many of its existing PRC customers for a full line of bearings. In addition, Harbin Bearing plans to increase its production of high-speed angular-contact and precision angular-contact ball bearings and to generally improve the quality of its non-precision bearings so they meet ISO standards.\nHarbin Bearing has recently expanded its product line to include self- aligning roller bearings. Self-aligning roller bearings are used predominantly in mining and extraction machinery. Management believes that based on the PRC government's policy of developing its mining and extraction industry, the demand for self-aligning roller bearings will likely remain strong in the near future.\nHarbin Bearing has also recently expanded its product line to include railway freight car bearings (Harbin Bearing is currently the leading supplier of railway passenger car bearings in China). Management believes that demand for railway freight car bearings is growing rapidly and that demand for such bearings will remain strong. Pursuant to the Strategic Plan, Harbin Bearing has installed certain equipment which has enabled Harbin Bearing to commence the production of railway freight car bearings and increase its production of railway passenger car bearings.\nMarketing - ---------\nThe major end-users of Harbin Bearing's products are manufacturers of electrical machinery, machine tools, mining and extraction machinery, automobiles, motorcycles, household appliances and aircraft and aerospace equipment. In 1995, approximately 32% of Harbin Bearing's sales were made to OEMs in the machinery, transportation and electrical equipment\nindustries representing, respectively, approximately 28%, 30% and 35% of its total sales to OEMs. The remaining 7% of sales were made to miscellaneous categories of OEM customers. Approximately 68% of Harbin Bearing's sales in 1995 were made to distributors.\nHarbin Bearing has 18 sales offices in major cities in China, including Beijing, Shanghai and Guangzhou. All sales are coordinated through Harbin Bearing's headquarters in Harbin, including sales to local distributors and transportation industries, overseas agents, and domestic import and export companies. Harbin Bearing's sales force consists of 152 sales personnel and 288 support personnel who are responsible for product promotion, marketing, aftermarket services and technical support. Harbin Bearing sells its bearings in China and abroad under the \"HRB\" trademark.\nHarbin Bearing's products are considered to be the highest grade inside of China and medium-grade in world-wide markets. Harbin Bearing's pricing is considered to be very competitive in the international market. In 1994, the US was Harbin Bearing's largest export market, accounting for approximately 60% of total export sales. It is the Company's intention to increase Harbin Bearing's export sales to the US, Europe and certain developing countries in South America and Southeast Asia.\nHarbin Bearing delivers its bearings by rail (approximately 80% of Harbin Bearing's domestic deliveries are made by rail), truck, ocean freight and air freight. Harbin Bearing leases trucks from Harbin Precision Machinery Manufacturing Company which are used mostly for short-haul deliveries. See ITEM 13, \"CERTAIN RELATIONSHIPS AND TRANSACTIONS.\" Bearings which are exported are generally shipped by ocean freight.\nChinese Bearing Industry - ------------------------\nBased on the Ministry of Machinery & Industry's 1993 Annual Report, China's aggregate domestic demand for bearings in 1995 was expected to be approximately 900 million units, representing an average annual increase of approximately 17% based on China's aggregate demand of 560 million units in 1992. Prior to 1989, under China's planned economy, the production, pricing and sales of bearings were fixed by the Chinese government. Beginning in 1988, demand for bearings exceeded the available supply, particularly for small and medium-sized bearings. Beginning in 1989, in connection with the implementation of economic reform measures undertaken by the Chinese government, production quotas and raw material subsidies were abolished. By 1991, competition among manufacturers of low-quality, small and medium-sized bearings had increased. This competition created an excess supply of such bearings and resulted in a decrease of profit margins. In July 1992, all price controls on bearing prices were removed. Even though supply still generally exceeds demand for small and medium-sized bearings in the low end market, demand continues to be strong for higher-quality small and medium-sized bearings used in the automobile, motorcycle, agricultural, electrical appliance and machinery industries. Overall, demand for bearings used in large agricultural machinery, mineral and extraction machinery and electric generating equipment, and demand for precision, special-purpose, large and extra-large-sized bearings continued to grow through 1995.\nCompetition - -----------\nChinese Competition\nHarbin Bearing's main competitors can be separated into three principal groups: (i) two nationwide domestic bearing manufacturers with wide product lines; (ii) small bearing production facilities which compete on a local basis by manufacturing small-sized, commodity-type bearings; and (iii) foreign bearing manufacturers. Harbin Bearing, Wafangdian Bearing Factory and Luoyang Bearing Factory are the three largest bearing manufacturers in China, based on 1994 sales. The combined sales revenues of these three manufacturers accounted for 30% of the US $1.09 billion of total sales revenue of China's bearing industry (figures are approximate). By comparison, the aggregate sales revenue of the fourth, fifth and sixth largest Chinese bearing manufacturers accounted for only approximately 9.5% of the total sales revenue of China's bearing industry. Wafangdian Bearing Factory does not produce high-precision aerospace- quality rolling-element bearings, a market in which Harbin Bearing has a 70% domestic share (the remaining 30% market share is split among Luoyang Bearing Factory and Hongshan Bearing Factory). Luoyang Bearing Factory and Wafangdian Bearing Factory produce nine of the ten classified types of bearings in China in a full range of sizes. Wafangdian Bearing Factory, like Harbin Bearing, produces a full line of rolling-element bearings, but it does not produce a full series of sizes of bearings for the majority of its product line. Luoyang Bearing Factory only produces large-size rolling-element bearings. In addition to the manufacturers described above, there are approximately 270 other manufacturers of ball bearings in China, including a number of small bearing factories in China, located mainly in the coastal and southeastern provinces, that were established after 1988 when demand for small-sized bearings greatly exceeded the available supply. The bearings manufactured by these small factories are generally of lower quality and are used mostly as replacement bearings in the electrical appliance and agricultural equipment industry.\nHarbin Bearing's other significant domestic competitors are mostly manufacturers that specialize in certain types of bearings, such as Hongshan Bearing Factory and Shanghai Micro Bearing Factory. Hongshan Bearing Factory, located in Guizhou, produces mainly lower-rated precision bearings. Shanghai Micro Bearing Factory produces almost exclusively small-sized deep-groove ball bearings.\nChinese Competition from Imports\nForeign bearing manufacturers are able to supply types and grades of bearings which are not available from Chinese domestic suppliers, particularly precision bearings of the highest durability and quality. Imported foreign bearings are generally higher in quality than Chinese-manufactured bearings, but are also priced higher due to China's low production costs and the assessment on imported bearings of a 15% or 20% import tariff. The 15% import tariff applies to bearings imported from countries that have established a tax treaty with China and the 20% import tariff applies to imports from other countries. Some foreign bearing manufacturers have established bearing manufacturing facilities in China, typically through joint ventures with\nlocal bearing manufacturers. Such ventures, if successful, would likely increase competition for Harbin Bearing in the higher-quality and precision- bearing market segments.\nCompetition in International Markets\nIn the international bearing markets, Harbin Bearing's main competitors are Eastern European manufacturers and manufacturers located in China. To a lesser extent, Harbin Bearing also competes with large international bearing manufacturers such as SKF, FAG and NTN. Management believes that the assistance of Southwest Products in implementing US manufacturing methods and quality control procedures and in developing new products, Harbin Bearing's general competitive position will be substantially improved. In addition, Harbin Bearing will be able to compete in market segments that demand products with higher precision levels and will more effectively penetrate those market segments that utilize commodity-type bearings.\nLeading industrial countries such as the US, Japan and countries in Europe impose import tariffs on bearings. For example, the US import tariff for bearings is 9% for ball bearings and 5% for cylindrical bearings.\nRaw Materials - -------------\nThe principal raw materials used by Harbin Bearing to manufacture bearings are carbon steel and stainless steel rod, wire and tubing. These steels are specialized alloys designed for hardness, durability and resistance to rust. A small amount of copper and aluminum tubing and rods are also used to produce seals, cages and other ancillary bearing components. Harbin Bearing sources most of its bearing steel directly from four domestic mills located in Heilongjiang Province, Liaoning Province and Shanghai. Harbin Bearing imported less than 1% of its raw materials in 1995.\nIn January 1993, the Chinese government lifted price controls on steel products and, as a result, the price of bearing steel in 1993 increased by more than 35.2% based on 1992 prices. The price of bearing steel in China is now approximately the same as the international price of bearing steel and has remained at approximately US $660.00 per ton since the end of 1993. Harbin Bearing believes that its sources of bearing steel are stable and, consistent with industry practice in China, has not entered into any long-term supply contracts for bearing steel. Harbin Bearing generally maintains a raw material inventory sufficient for approximately one-and-a-half months of production. Railroad tracks leading directly to two of Harbin Bearing's raw material warehouses are used exclusively to transport raw materials, such as bearing steel, to Harbin Bearing.\nIn the future, Harbin Bearing intends to purchase bearing steel from South Korea and other countries. South Korean steel is price-competitive and is much higher quality than most Chinese steel. Accordingly, the use of South Korean steel will improve the quality of\nHarbin Bearing's products while reducing the amount of products that are scrapped due to the use of lower-quality steel.\nWorkforce - ---------\nAs of January 16, 1996, Harbin Bearing employs approximately 13,000 full-time personnel in the following areas: executive and administrative (658), sales and service (507), manufacturing and production (11,492), and research and development (319). Management believes that in general, its employee relations are good. Harbin Bearing has recently begun to enter into employment contracts with all of its employees. The use of such employment contracts is an example of the steps Harbin Bearing is taking to raise its workforce productivity and efficiency.\nHarbin Bearing has begun to revise its compensation system to provide incentives to employees by linking productivity with compensation. Part of the revised compensation system was instituted in May 1994, and governs the wages of production employees. Depending on actual productivity, which is determined according to unit output and standard labor hours, a production employee may be paid more or less than the average wage. Harbin Bearing has also revised its compensation system with respect to its sales personnel. Harbin Bearing sets a monthly sales target for each sales office and each salesman. If the target is reached, the sales personnel will receive a bonus in addition to basic wages and allowances. In 1995, the total labor cost of Harbin Bearing comprised approximately 15% of total production costs.\nThe Harbin Municipal Government promulgated regulations that were effective January 1994, which provide for the establishment of a pension fund program to which both employer and employee must contribute. Harbin Bearing is required to contribute a monthly amount equivalent to 20% of its employees' aggregate monthly income, and each employee is required to contribute a monthly amount that is equivalent to 2% of such employees' monthly income.\nAll of the employees of Harbin Bearing are members of a trade union. To date, Harbin Bearing has not been subject to any strikes or other significant labor disputes and is not a party to any collective bargaining agreements.\nHarbin Bearing presently recruits graduates of the Harbin Bearing Technical Institute and universities all over China and provides ongoing training for its management and production employees in the form of a series of training seminars.\nSOUTHWEST PRODUCTS COMPANY\nSouthwest Products, located at a 55,000 square foot facility in Irwindale, California, designs, engineers and manufactures custom, short-order spherical bearing products, such as high-precision spherical bearings, rod-end bearings, bushings and push-pull controls, for aerospace and high tech commercial applications. Southwest Products employs 58 full-time\npersonnel in the following areas: executive and administrative (5); sales and service (5); manufacturing (35) and engineering, research and development (13). The average length of employee tenure at Southwest Products is in excess of eight years.\nSouthwest Products specializes in the design and manufacture of spherical bearings for use in extremely demanding and flight-critical applications. Such bearings meet unique load and tolerance requirements and are known as \"Specials.\" Southwest Products produces small orders of custom bearings, the sales price of which typically includes the cost of product design, engineering and development. Southwest Products is respected worldwide for its ability to engineer and produce precision bearings, which are used in the Space Shuttle, commercial jet aircraft (Boeing and McDonnell Douglas), military aircraft (including the B-2 Stealth Bomber, Stealthfighter,,, C-17 and), submarines, (Los Angeles Class, Ohio Class, Seawolf and Centurion), and nuclear power plants. Southwest Products' bearings are used by Northrop Grumman, Lockheed Martin, NASA, all US military services, Mitsubishi Heavy Industries, Korean Heavy Industries (Hanjun), Fluor Daniel, General Electric, Westinghouse, General Dynamics, Textron Marine, Ingalls Shipbuilding and Newport News Shipbuilding. Southwest Products' bearings have been used by NASA in all manned space programs since the launch of Mercury and are used in most NASA orbiters, including Viking, Magellan and Galileo.\nSouthwest Products has operated continuously since it was established in 1945. The assets of Southwest Products were purchased during a Chapter 11 bankruptcy proceeding in 1991 by an investment group led by James McN. Stancill, a distinguished author and professor of finance at the University of Southern California. The investment group developed a plan for Southwest Products pursuant to which it would increase its production and sales of higher-volume standard spherical bearings. Standard spherical bearings rely on technology that is similar to the technology used to produce Specials, but require less sophisticated design and manufacturing methods. Standards are produced and used in substantially greater volume than Specials, and price and delivery are the primary competitive factors. Generally, Standards are ordered in large quantities for delivery over a number of years, whereas Specials are usually ordered in very small quantities. Typically, Standards sell for about $25 per unit while Specials sell for over $150 per unit. Certain Specials sell for $25,000 per unit or more.\nTo facilitate its entrance into the Standards market, Southwest Products has been developing its production capacity for standard spherical bearings at the Shanghai Southwest Bearing Company, Ltd. Joint Venture (\"Shanghai Joint Venture\") and has contributed to the Shanghai Joint Venture certain proprietary technology, engineering assistance, technical support, training and plant management. The Shanghai Joint Venture partner has contributed the plant (which is now operational), equipment and general labor force. Upon completion of the transfer of certain technology (expected to be completed by May of 1996), Southwest Products will have a 28% interest in the Shanghai Joint Venture and the exclusive right to purchase up to 100% of the Shanghai Joint Venture's production, with the exclusive rights to distribute all of the Shanghai Joint Venture's products that are exported from China. Southwest Products also has the right to appoint the General Manager, manage the day-to-day operations and establish the long-term plans of the Shanghai Joint Venture. Southwest Products has commenced the training of the Shanghai\nJoint Venture workforce and has completed the production of product prototypes. Qualification testing to ensure that the products of the Shanghai Joint Venture meet US Navy standards has begun, and commercial production is expected to commence in the fall of 1996. See \"Shanghai Joint Venture.\"\nSouthwest Products' Proprietary Technology - ------------------------------------------\nSouthwest Products manufactures both metal-on-metal bearings and self- lubricating bearings, based on Southwest Products' design and on OEM specifications. Self-lubricating bearings are lined with either Dyflon or Kentlon, which are both proprietary liner systems of Southwest Products. Kentlon is qualified by the United States Navy to Mil-B-81820, Mil-B-81934 and Mil-B-81935. It is used in military aircraft, tanks, ground support equipment, commercial aircraft, space vehicles, launch and payload systems and in the oil refinery, automotive and heavy manufacturing industries. Dyflon is one of only two liner systems in existence that is moldable and machineable that also performs successfully when fully submersed in water. Accordingly, in addition to the uses described above for Kentlon, Dyflon-lined parts are used in submarines, surface ships and nuclear power plants.\nAlthough Southwest Products has federally registered its trademarks \"Dyflon\" and \"Kentlon,\" Southwest Products has chosen not to patent its various technologies because the specific formulae and methods for manufacturing Dyflon and Kentlon would then become a matter of public record.\nSHANGHAI JOINT VENTURE\nIn 1991, principals of Southwest Products met with principals of Hong Xing Bearing Company (\"HXBC\") to discuss the establishment of a joint venture between Southwest Products and HXBC that would manufacture standard spherical bearings in Shanghai, PRC. Such a joint venture would assist Southwest Products in effectively penetrating the Standards market by improving Southwest Products' international cost competitiveness.\nIn late 1992, Southwest Products and HXBC signed a Technology Transfer Agreement pursuant to which Southwest Products licenses technology to the Shanghai Joint Venture and manages the Shanghai Joint Venture's manufacturing activities. Because the types of bearings covered by the Technology Transfer Agreement are restricted commodities covered by the US Export Administration Regulations Commerce Control List, the transfer of technology relating to such bearings was subject to Southwest Products receiving from the United States Department of Commerce a Validated Export License (\"License\"), which permits the technology to be transferred by Southwest Products to the PRC. The License was issued in February 1994 after being reviewed and approved by the US Department of Defense. To management's knowledge, Southwest Products is the only company in the US to possess such a license.\nImmediately following the issuance of the License, Southwest Products and HXBC entered into a Joint Venture Agreement, thereby forming the Shanghai Southwest Bearing\nCompany, Ltd. Joint Venture, the main objective of which is to manufacture standard spherical bearings primarily for sale outside the PRC. The transfer of technology commenced in mid-1994 and the formal training by Southwest Products of Chinese manufacturing personnel commenced in March 1995. The Shanghai Joint Venture will employ 57 personnel in the following areas: executive, management and administration (5), sales and service (2), manufacturing (40), product quality and control (8), and engineering and research and development (2). The Shanghai Joint Venture ordered new machinery and equipment for its facility in mid-1994, most of which is already installed. The Shanghai Joint Venture is located at a new 35,000 square foot facility and has the option to expand its operation into an additional 50,000 square feet. The qualification of the Shanghai Joint Venture's bearing prototypes by the United States Navy to the Navy's Mil-B-81820, Mil-B-81934 and Mil-B-81935 standards will enable the Shanghai Joint Venture to sell such bearings to substantially all international users of such bearings. The worldwide annual market for bearings employing Mil- B-81820 qualified liners is in excess of $400,000,000. Southwest Products will supervise all aspects of the qualification process and anticipates that such bearing prototypes will be qualified by summer 1996.\nAt present, the Boeing Commercial Airplane Group, McDonnell Douglas Corporation and Airbus Industries have \"offset\" agreements with the PRC under which these OEMs have committed to purchase equipment and parts from Chinese producers for use on commercial aircraft as an \"offset\" to China's substantial purchases of jet aircraft. Due to shortages of high-quality Chinese-made aircraft parts, these OEMs have not been able to purchase a sufficient volume of products from China at competitive prices to satisfy their purchase requirements under the offset program. Although the Shanghai Joint Venture cannot sell its products to these OEMs until the product prototypes have been qualified by the US Navy, management and Boeing and McDonnell Douglas have engaged in preliminary discussions regarding purchase of the Shanghai Joint Venture's products which, management believes, will likely lead to sales of such products to these OEMs.\nOPERATING IN CHINA ------------------\nBecause the production operations of the Company are based to a substantial extent in China, the Company (through Harbin Bearing and the Shanghai Joint Venture) is subject to rules and restrictions governing China's legal and economic system as well as general economic and political conditions in that country. These include the following:\nPOLITICAL AND ECONOMIC MATTERS. Under its current leadership, the Chinese government has been pursuing economic reform policies, which include the encouragement of private economic activity and greater economic decentralization. There can be no assurance, however, that the Chinese government will continue to pursue such policies, or that such policies will be successful if pursued. Changes in policies made by the Chinese government may result in new laws, regulations, or the interpretation thereof, confiscatory taxation, restrictions on imports, currency devaluations or the expropriation of private enterprise which may, in turn, adversely affect the Company. Furthermore, business operations in China can become subject to the risk of nationalization, which could result in the total loss of investments in China. Finally, economic\ndevelopment may be limited by the imposition of austerity measures intended to reduce inflation, the inadequate development of an infrastructure, and the potential unavailability of adequate power and water, transportation, communication networks, raw materials and parts.\nLEGAL SYSTEM. The PRC's legal system is a civil law system based on written statutes. Unlike the common law system in the United States, decided legal cases in the PRC have little value as precedents. Furthermore, the PRC does not have a well-developed body of laws governing foreign investment enterprises. Definitive regulations and policies with respect to such matters as the permissible percentage of foreign investment and permissible rates of equity returns have not yet been published, statements regarding these evolving policies have been conflicting, and any such policies, as administered, are likely to be subject to broad interpretation and modification, perhaps on a case-by-case basis. As the legal system in the PRC develops with respect to such new forms of enterprise, foreign investors may be adversely affected by new laws, changes in existing laws (or interpretation thereof) and the preemption of provincial or local laws by national laws. Some of the Company's operations in China are subject to administrative review and approval by various national and local agencies of the PRC government. Although management believes that the Company's operations are currently in compliance with applicable administrative requirements, there is no assurance that administrative approvals, when necessary or advisable, will be forthcoming. In addition, although China has promulgated an administrative law permitting appeal to the courts with respect to certain administrative actions, this law appears largely untested in the context of administrative approvals.\nINFLATION\/ECONOMIC POLICIES. In recent years, the Chinese economy has experienced periods of rapid growth and high rates of inflation, which have, from time to time, led to the adoption by the PRC government of various corrective measures designed to regulate growth and contain inflation. In 1995, China's overall inflation rate was estimated to be 14.8%, compared to 21.4% in 1994 and 13.2% in 1993. High inflation has in the past and may in the future cause the PRC government to impose controls on prices, or to take other action which could inhibit economic activity in China, which in turn could affect demand for the Company's products. The Company carefully monitors the effects of inflation on its performance in China, and Harbin Bearing is usually able to increase its selling prices to shift a portion of its inflated costs to its customers. The price of bearing steel, the major raw material used by Harbin Bearing, remained fairly stable during 1994 and 1995 and the only major impact of inflation on Harbin Bearing's costs was on the cost of labor (due to the rising level of compensation of Harbin Bearing's employees). Due to economies of scale and improved control of Harbin Bearing's production costs, management believes that an increased inflation rate would have a favorable impact on its market position, as smaller bearing manufacturers in China would have greater difficulties in dealing with the effects of increasing inflation.\nFOREIGN CURRENCY EXCHANGE. The Renminbi (\"Rmb\"), the currency of China, is not a freely convertible currency. Both conversion of Rmb into foreign currencies and the remittance of Rmb abroad are subject to PRC government approval. The Company earns the majority of its revenues, and incurs the majority of its costs, in Rmb. Prior to January 1, 1994, Rmb that were earned within the PRC were not freely convertible into foreign currencies except with government\npermission, at rates determined in place at swap centers, where the exchange rates often differed substantially from the official rates quoted by the People's Bank of China (the \"PBOC\"). On January 1, 1994, the official exchange rate was abolished pursuant to a Notice (the \"PBOC Notice\") of the PBOC and a new managed floating rate system was implemented. This new rate system effectively replaced the dual exchange rate system with a unitary exchange rate system. All future foreign currency exchange transactions are to be conducted through a unified interbank foreign exchange trading market based upon rates set by the PBOC. According to the PBOC Notice, enterprises operating in the PRC may no longer sell their products in the PRC for foreign currency; all sales of goods and services in the PRC must now be priced and paid for in Rmb. Domestic enterprises are required to sell all of their foreign exchange revenues to the authorized foreign exchange banks in the PRC and may obtain foreign currency for expenditures only upon SAEC approval. However, Sino-foreign equity joint ventures, such as the Shanghai Joint Venture, as foreign investment enterprises, are not required to sell their foreign exchange revenues to such banks. Although the China Foreign Exchange Center and the new rate system were fully established as of April 1994, as of May 1, 1996, the swap centers have remained in existence.\nVOLATILITY OF EXCHANGE RATES. The January 1, 1994 establishment of the unitary exchange rate system produced a significant devaluation of the Rmb, resulting in the US Dollar-Rmb exchange rate increasing from $1.00 to Rmb 5.7 to approximately $1.00 to Rmb 8.7. The US Dollar-Rmb exchange rate has been relatively stable since January 1, 1994 and the exchange rate quoted by the PBOC on December 31, 1995 was $1.00 to Rmb 8.32. However, the US Dollar-Rmb exchange rate may vary in the future and, as in 1993, the US Dollar-Rmb exchange rate could become volatile. Any devaluation of the Rmb against the US Dollar will have an adverse effect upon the US Dollar equivalent of the Company's net income and will increase the effective cost of any foreign currency expenses and liabilities, including any distributions to the shareholders of the Company which are to be made in US Dollars. Currently, the Company is unable to hedge its US Dollar-Rmb exchange rate exposure in China because neither the PBOC nor any other financial institution authorized to engage in foreign currency transactions offers forward exchange contracts with respect to Rmb.\nORGANIZATION OF THE COMPANY ---------------------------\nHarbin Bearing was the successor to the manufacturing operations of Harbin Bearing General Factory (the \"Bearing Factory\"), a Chinese state-owned enterprise established in 1950. Harbin Bearing was established in 1993 as a joint stock limited company. Pursuant to an agreement between the Bearing Factory and Harbin Bearing, the bearing manufacturing and sales business together with certain assets and liabilities of the Bearing Factory were transferred to Harbin Bearing (the \"Restructuring\"). Certain other assets and liabilities were transferred to Harbin Precision Machinery Manufacturing Company (\"Harbin Precision\") and certain ancillary operations were transferred to Harbin Bearing Holdings Company (\"Harbin Holdings\"). Harbin Holdings and Harbin Precision were and are affiliates of the Harbin Municipal Government.\nAs part of the Restructuring, Sunbase International (Holdings) Ltd. (\"Sunbase International\"), a Hong Kong corporation, through a series of affiliated entities, acquired an effective ownership interest in Harbin Bearing of 51.4%. Substantially all of the remaining interests in Harbin Bearing were and continue to be owned by the employees of Harbin Bearing (approximately 15%) and Harbin Holdings. After the acquisition of the controlling interest in Harbin Bearing, Sunbase International implemented various programs to strengthen the business and operations of Harbin Bearing. These programs resulted in a shift in product mix to larger, higher margin bearings which, in turn, increased profitability. The work force was reduced approximately 25% with minimal negative effects on production. Incentive-based pay programs and western-style accounting and reporting systems were implemented to further strengthen and improve Harbin Bearing's business and operations.\nIn December 1994, the Company (which was then called Pan American Industries, Inc.) acquired a 51.4% effective interest in Harbin Bearing by issuing to Asean Capital Limited (\"Asean Capital\") newly issued shares representing a controlling interest in the Company. Asean Capital was, and is, owned 90% by Sunbase International and 10% by an unrelated company, New China Hong Kong Capital Ltd. (\"New China Hong Kong\"). See ITEM 13, \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nHarbin Bearing - --------------\nHarbin Bearing operates twelve finished product plants and seventeen auxiliary plants. With the exception of a finished product plant in Wucangzian, all of the Company's plants are located in four plant compounds in Harbin. Harbin Bearing plans to relocate the Wucangzian finished product plant, now located approximately 260 kilometers from the main site, to a new facility currently under construction approximately 17 kilometers from the main site. The Company believes the costs associated with the relocation to be approximately RMB 27 million.\nThe Harbin branch office of the State Asset Administration Bureau has granted Harbin Holdings the right to use the properties where Harbin Bearing's production and other facilities, which include the Wucangzian finished product plant and the four plant compounds. The site is approximately 540,000 km\/(2)\/ of which production facilities occupy approximately 290,000 km\/(2)\/ square meters. Harbin Holdings has entered into a lease agreement with the Company for use of its buildings for five years. See Item 13, \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nSouthwest Products - ------------------\nSouthwest Products leases a 55,000 square foot facility in Irwindale, California on a month to month basis at a monthly rent of $14,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to, nor is any of its property subject to, any pending legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of the 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 STOCKHOLDER MATTERS.\nCommencing on February 9, 1996, the Company's Common Stock began trading on the National Market of NASDAQ under the symbol ASIA. Prior thereto, the Common Stock was listed for trading on the NASDAQ's Electronic Bulletin Board (the \"Bulletin Board\") and on the Pink Sheets.\nThe following tables set forth the high and low closing prices of the Company's Common Stock on NASDAQ or the Bulletin Board. Such prices reflect prices between dealers in securities and do not include any retail markup, markdown or commission and may not necessarily represent actual transactions. There was no established trading market for the Company's Common Stock during fiscal 1994.\nThe approximate number of record security holders of the Common Stock at March 15, 1996 was 1,700.\nThe Company has paid no cash dividends on its Common Stock and has no present intention of paying cash dividends in the foreseeable future. It is the present policy of the Board of Directors to retain all earnings to provide for the growth of the Company. Payment of cash dividends in the future will depend upon, among other things, future cash flow and requirements for capital improvements.\nApplicable Chinese laws and regulations provide that a joint stock company (such as Harbin Bearing) cannot distribute its after-tax earnings and profits made in a fiscal year unless\nthe losses of the previous years have been made up and certain funds retained. A joint stock company is required by applicable Company Law to reserve 10% of its after-tax earnings and profits as the mandatory retained fund and 5% of its after-tax earnings and profits as the public welfare fund. The joint stock company does not have to reserve for the mandatory retained fund if the amount of such fund has reached 50% of the company's registered capital. For 1994, Harbin Bearing contributed 10% and 5%, respectively, of after-tax profits as determined under Chinese accounting principles for such purposes. Distributions of dividends by Harbin Bearing to its shareholders are required to be in proportion to each shareholder's percentage interest in the Harbin Bearing.\nAll distributions by Harbin Bearing will be paid to its shareholders of record, which include the joint venture partners. Applicable Chinese laws and regulations require that, before a Sino-foreign equity joint venture (such as the joint venture partners) distributes dividends, it must: (1) satisfy all tax liabilities; (2) provide for losses in previous years; and (3) make allocations of capital to its official surplus accumulation fund and public welfare fund. The Company indirectly owns 99% and 99.9% of the two joint venture partners and, therefore, approximately 1.1% of distributions received by such partners will be paid to the Chinese parties of these joint ventures.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data (expressed in thousands) have been derived from the audited financial statements of Harbin Bearing General Factory for the year ended December 31, 1993 and the audited financial statements of the Company for the years ended December 31, 1994 and 1995. All U.S. dollar amounts have been converted from Renminbi based on the exchange rate on December 31, 1995 of $1.00 US to each RMB 8.32 as quoted at the People's Bank of China. Due to the reorganization of the Harbin Bearing General Factory on January 1, 1994, the 1993 financial information was prepared on a pro-forma basis as if the acquisition of China Bearing and Harbin Bearing had occurred on January 1, 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOVERVIEW - --------\nThe Company owns, through various subsidiaries and joint venture interests, a 51.4% indirect ownership in Harbin Bearing, which develops and manufactures bearings in China and sells bearings in China as well as western countries, including the United States.\nThe Company produces seven types of bearings: deep groove ball bearings, self-aligning bearings, cylindrical roller bearings, angular contact ball bearings, tapered roller bearings, thrust bearings and linear-motion ball bearings, with a focus on medium and large sized bearings which have a relatively higher profit margin. During the year, 92 new bearing products were introduced. These new bearing products are mainly medium and large sized self- aligning ball bearings and angular contact ball bearings which are used for motor vehicles and machine-tools applications, respectively.\nThe Company raised the selling price of all bearing products effective July 1, 1995 by an average of 3-5% in order to cover increasing costs, as compared to July 1, 1994 when there was a sales price increase of 5-8%.\nIn the last quarter of 1995, the Company changed its marketing strategy by shifting smaller OEM accounts to designated distributors in order to reduce marketing costs and credit risks.\nEffective December 29, 1995, the Company acquired Southwest Products Company (\"Southwest Products\") which is a small but strategically-positioned, engineering-intensive company that produces precision spherical bearings for US, European and Asian aerospace and high tech commercial applications and the US military. Southwest Products recently established a joint venture company in Shanghai, China (the \"Shanghai Joint Venture\") that is expected to begin production in the second half of 1996 of a line of precision-grade, high-profit- margin spherical bearings primarily for distribution to international aircraft original equipment manufacturers (\"OEMs\") that have major \"offset\" commitments to purchase made-in-China parts. The acquisition of Southwest Products has been treated as a business combination and is accounted for under the purchase method of accounting. However, since the acquisition was deemed to have been consummated on December 29, 1995, the results of Southwest Products have not been consolidated into the Company and will be included in the Company's consolidated results of operations from January 1, 1996. The assets and liabilities of Southwest Products have been incorporated into the consolidated balance sheet of the Group at December 31, 1995.\nAfter acquiring Southwest Products, the management of the Company has developed a Strategic Plan to foster future growth. The Strategic Plan has three main objectives:\n1. To increase export sales of Harbin Bearing's products in the US by selling its products through Southwest Products' distribution network, and by changing its export product mix to meet the demands of the international marketplace.\n2. To transfer US manufacturing and product development expertise and technology from Southwest Products to Harbin Bearing to increase production, efficiency and product quality.\n3. To achieve rapid growth of the Shanghai Joint Venture by targeting customers with \"offset\" commitments to purchase made-in-China parts.\nUnless specifically stated, all amounts in this Management's Discussion and Analysis are in thousands (RMB000).\nRESULTS OF OPERATIONS - ---------------------\nRESULTS FOR 1995 COMPARED TO 1994\nNET SALES - ---------\nNet sales decreased by RMB 47,483 or 6.6% in 1995 as compared to 1994. The decrease was mainly due to the change in the Company's marketing strategy in order to further enhance its credit control on sales in the last quarter of 1995 whereby a contracted sales order was entered into with a major distributor, which is a related party beneficially owned by the Harbin Municipal Government. Delivery was not made in respect of this transaction at December 31, 1995 and thus this sale was not recognized in the Financial Statements. However, in anticipation of this transaction, the Company reduced the delivery of its products to other customers. As a result of the aforementioned contracted sales order in the last quarter of 1995, the net reported sales in the last quarter of 1995 was RMB 21,289.\nThroughout 1995, the Company continued to adjust its product mix by shifting from small and medium sized bearings to higher margin medium and large sized bearings in order to improve profitability and to cope with the growth in market demand on these new products.\nGROSS PROFIT - ------------\nGross profit increased by RMB 12,994 or 4.7% in 1995 as compared to 1994. Gross profit as a percentage of revenue increased from 38.6% in 1994 to 43.3% in 1995. The increase in gross profit was mainly attributable to the effect of the sales mix change to higher-margin products, the improved operational efficiency and a reduction in purchase price of major raw materials.\nIn previous quarters in 1995, cost of sales was calculated with reference to the average gross profit ratio for 1994, being 38.6% on revenue. The average gross profit ratio for 1995 of 43.3% on revenue was computed from actual results throughout the year after taking into account various year-end closing inventory adjustments such as a write-back of obsolete inventories sold during the year which amounted to RMB 15,805 and adjustment to reflect under absorption of labor and overhead of approximately RMB 4,700. The gross profit margin for 1995 would have been only 39.2% on revenue if no account was taken of the year end adjustments on closing inventories.\nSELLING EXPENSES - ----------------\nSelling expenses decreased by RMB 1,529 or 7.5% in 1995 as compared to 1994. The decrease was in line with the decrease in sales this year. Selling expenses as a percentage of revenue has remained constant at a rate of 2.8%.\nGENERAL AND ADMINISTRATIVE EXPENSES - -----------------------------------\nGeneral and Administrative expenses increased by RMB 19,313 or 25.8% in 1995 as compared to 1994. General and Administrative expenses as a percentage of revenues increased from 10.4% to 14.0%. The increase in General and Administrative expenses was mainly attributable to:\na. An increase in staff wages and welfare costs of RMB 7,550 as a result of increments given to the staff this year.\nb. There was a loss of RMB 4,829 on disposal of fixed assets as compared to a gain on disposal of fixed assets of RMB 1,087 in 1994.\nc. A cash discount of RMB 6,490 was granted in 1995 for incentives to customers for early settlement of debt in order to accelerate the cash collection. In 1995, an additional bad debt provision of RMB 2,627 was provided (1994: RMB 11,300) on certain aged debt.\nd. An increase in management fee of RMB 1,716 payable to Harbin Bearing Holdings Company as a result of a 10% inflation adjustment.\ne. An increase in insurance premium paid of RMB 1,979 on the increase in assets.\nINTEREST EXPENSE - ----------------\nInterest Expense increased by RMB 5,725 or 13.4% in 1995 as compared to 1994. The increase was attributable to interest expense of 8% related to a US$ 5,000 promissory note issued on December 30, 1994 and to a 1.3% increase in interest rate on increased amounts of short-term bank loans effective July 1, 1995.\nREORGANIZATION EXPENSES - -----------------------\nThere was no similar charges in 1995 of the one time reorganization expenses in 1994 which were incurred in connection with the acquisition of China Bearing Holdings Limited.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nOPERATING ACTIVITIES - --------------------\nThe Company utilized cash in operating activities of RMB 39,057 in 1995 as compared to RMB 86,312 used in operating activities in 1994. The decrease in cash used in operating activities was mainly due to net improvements in cash settlements from accounts receivable. The Company continues to strengthen the enforcement of credit controls and the acceleration of cash collections.\nAs of December 31, 1995, the Company's working capital had increased to RMB 306,288 as compared to RMB 247,990 at December 31, 1994. The Company's current ratio was 1.42:1 as of December 31, 1995 as compared to 1.38:1 at December 31, 1994.\nINVESTING ACTIVITIES - --------------------\nAs of December 31, 1995, the Company had outstanding capital expenditure commitments of RMB 46,027 (December 31, 1994: RMB 91,500). These capital commitments are expected to be funded through December 1996.\nTotal capital expenditure for 1995 were RMB 92,571 and were mainly for construction of new plant, buildings and renovating existing facilities and equipment. They were financed primarily by internally generated funds and short-term and long-term bank loans (see below).\nFINANCING ACTIVITIES - --------------------\nThe Company relies on both short-term and long-term bank loans from Chinese banks to support its operating and capital requirements. Short-term bank loans have terms ranging from three months to six months, and are reviewed on a revolving basis. During the year of 1995, new short-term bank loans (after deducting repayment of previous loans) totaled RMB 49,735. The net proceeds from short-term bank loans in 1995 were mainly utilized to fund capital expansion projects.\nLong-term bank loans have terms ranging from 2 to 4 years and are utilized for funding capital expansion projects. During the year 1995, new long-term bank loans after deducting repayment of previous loans totaled RMB 42,246.\nThe Company believes that it will be able to continue to maintain and expand its bank borrowings under existing terms and conditions. The Company believes that cash flow from operations, combined with cash and bank balances and bank borrowings, will provide sufficient cash flow to finance internal growth, capital projects and debt service requirements for the foreseeable future.\nEFFECT OF INFLATION - -------------------\nIn China, the general inflation rate continued to be in excess of 10% during the year 1995 but it is expected that the Chinese government will continue to make substantial efforts to curb inflation over the near term. During the last quarter of 1995, the inflation growth rate has begun to slow down.\nThe Company constantly monitors the effects of inflation. In general, the Company is able to raise its selling prices to shift a portion of the inflated costs to the customers. The price of the major raw material used by the Company (bearing steel) remained fairly stable during 1994 and 1995. The major impact of inflation on cost was from labor costs due to\nincreases in employees wages. However, the improved operational efficiency, as reflected by the increased gross profit ratio during the year of 1995, managed to offset the effects of inflation.\nRESULTS FOR ACTUAL 1994 COMPARED TO PROFORMA 1993\nThe above pro forma results for the year ended December 31, 1993 were prepared on the basis as if the reorganization of Harbin Bearing General Factory and the acquisition of China Bearing and the Company had occurred on January 1, 1993 which are extracted from the Unaudited Proforma Consolidated Statement of Income for the year ended December 31, 1993 after giving effect to the proforma adjustments described in further detail in the aforesaid Proforma Financial Statements.\nThe proforma results of operations have been prepared for comparative purposes only and do not purport to indicate the results of operation which would actually have incurred had the acquisition been in effect on January 1, 1993 or which may occur in the future.\nSALES - -----\nSales increased by RMB 8,422 or 1.2% in 1994 compared to 1993. The increase in sales was mainly due to general sales price increases.\nGROSS PROFIT - ------------\nGross profit increased by 12.3% or RMB 30,341 in 1994 compared to 1993. Gross profit as a percentage of revenue increased to 38.6% in 1994 from 34.8% in 1993, primarily due to the slight increase in general sales price and the effect of the sales mix change to higher margin products and the change in VAT system in China effective January 1, 1994.\nSELLING EXPENSES - ----------------\nSelling expenses increased by 38.6% or RMB 5,706 in 1994 compared to 1993 which was mainly due to an increase in government taxes of RMB 7,651. This was offset by a decrease in transportation expenses of RMB 1,500 in 1994 compared to 1993 as a result of the passing of its transportation costs directly to certain customers arising from the introduction of the new VAT system in China.\nGENERAL AND ADMINISTRATION EXPENSES - -----------------------------------\nGeneral and Administrative expenses decreased by 2.2% or RMB 1,685 in 1994 compared to 1993. General and Administrative expenses as a percentage of revenues decreased from 10.7% to 10.4%. Although there was a large decrease in the bad debt provision of RMB 17,000, this decrease was however largely offset by a one-time formation expense of RMB 2,637 and special compensation payments to workers for early retirement totalling RMB 7,243 in 1994. This was offset by having no gain on disposal of fixed assets, whereas a gain was recorded in 1993 for RMB 4,700.\nINTEREST EXPENSE - ----------------\nInterest expense increased 5.1% or RMB 2,083 in 1994 compared to 1993 which was mainly due to an increase in interest rates during 1994.\nREORGANIZATION EXPENSES - -----------------------\nOn a proforma basis, the one time reorganization expenses in connection with the acquisition of China Bearing Holdings Limited were assumed to be incurred on January 1, 1993.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Company's overall cash position decreased by RMB 101,000 in 1994 from 1993. The cash used in operating activities decreased from RMB 87,500 in 1993 to RMB 86,300 in 1994. The cash was mainly used to finance accounts receivable. In 1994, cash used in investing activities amounted to RMB 153,000 compared to RMB 26,000 in 1993. The increase was attributable to the investment in new equipment and construction of a new plant in order to cope with the future expansion. Cash from financing activities was decreased from RMB 266,500 in 1993 to RMB 138,300 in 1994. In 1994, the cash received was mainly in the form of loans to finance working capital and capital projects whereas in 1993, the cash from financing was mainly arising from equity financing for the joint venture and employees' stock comprised RMB 300,000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and exhibits are listed at Item 14 \"Exhibits, Financial Statement Schedules and Reports on Form 8-K\".\nCertain unaudited quarterly financial information is set forth in the following table:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot Applicable.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nA. Directors ---------\nThe Board of Directors of the Company is comprised of only one class. The Company's current directors are listed below. The Directors are elected to serve until the following annual shareholders' meeting.\nB. Executive Officers ------------------\nThe Company's current executive officers are listed below. Executive officers are elected to serve until the following annual meeting of the Company's Board of Directors:\nGUNTER GAO, CHAIRMAN AND DIRECTOR, 40. Mr. Gao, a Hong Kong businessman who has extensive business experience in China, is the Chairman of the Board and a principal of Sunbase International, which indirectly owns a controlling position in Sunbase Asia. Sunbase International has various industrial holdings in China, in industries such as aviation, transportation, cement,\nsteel and retail. Mr. Gao is also the Chairman of the Board of Sunbase Asia. Mr. Gao is responsible for the general strategy of the Company and maintains overall control of the Company's operations. Mr. Gao is actively and directly involved in all operational and strategic issues that require his experience and expertise in handling a wide variety of Chinese business transactions. During the 1980s, Mr. Gao engaged in trading and investment activities in industries such as food, timber, real estate, coal and textiles. Based on his success in these activities and with the support of several banks in China, Mr. Gao has turned Sunbase International into a leading China industrial company. Mr. Gao is currently a member of China's congress, known as the People's Political Consultative Conference. Mr. Gao is the youngest member of the congress and is widely respected for his contributions to the country's development. Mr. Gao's strong reputation in China has enabled Sunbase International to engage in and complete many difficult transactions, including acquiring a majority interest in Harbin Bearing and obtaining a license to create an airline in China. Now known as Northern Swan Airlines, this airline enjoys international prominence and the financial support of the Bank of China and the People's Construction Bank of China. Mr. Gao serves as a Senior Economic Advisor to several Chinese municipal and provincial governments, including the governments of Tianjin, Hebei, Xinjiang and Harbin. In addition, Mr. Gao is the deputy director of the Sino- Foreign Entrepreneurs Cooperative Committee.\nBILLY KAN, DIRECTOR, 43. Mr. Kan has been a director of Sunbase Asia since the beginning of 1996. In his capacity at Sunbase International, Mr. Kan reports directly to its Board of Directors and serves as the communications and support link in various parts of the world. Mr. Kan holds a Bachelor of Science Degree from the University of East Anglia, a United Kingdom university, and is a member of The Institute of Chartered Accountants in England & Wales as well as the Hong Kong Society of Accountants. Prior to joining Sunbase International, Mr. Kan held many directorships and senior management positions in a wide range of professions and industries including banking, retailing, manufacturing, property, investment and corporate consulting.\nWILLIAM MCKAY, CHIEF EXECUTIVE OFFICER, PRESIDENT AND DIRECTOR, 41. Mr. McKay has recently been elected as the Chief Executive Officer, President and a Director of Sunbase Asia, and has been a Director and President of Southwest Products since 1991. Prior to becoming President of Southwest Products, he was Southwest Products' General Manager since 1986. Mr. McKay has substantial experience in conducting business with China, and is very familiar with Sino- American joint venture law and policies. Mr. McKay was instrumental in establishing the joint venture between Southwest Products and Shanghai Hong Xing Bearing Factory. Mr. McKay is responsible for the day-to-day operations of, and the long-term planning for, the Company in the areas of product development, marketing, financing and general operations. Prior to jointing Southwest Products, Mr. McKay practiced law, specializing in the areas of business and real estate. Mr. McKay holds a Juris Doctorate Degree, Masters in Business Administration and Bachelor of Arts degree with a major in History and minor in International Relations from the University of Southern California.\n(ROGER) LI YUEN FAI, GROUP FINANCIAL CONTROLLER, CHIEF FINANCIAL OFFICER, VICE- PRESIDENT AND DIRECTOR, 35. Mr. Li has been the Group Financial Controller of Sunbase International since\n1994. He has been the Chief Financial Officer and a Director of Sunbase Asia since 1995 and has recently been elected as the Vice-President of Sunbase Asia. From 1990 to 1991 he was compliance manager of Hong Kong Securities Clearing Company Limited. Mr. Li was employed by Coopers & Lybrand in Hong Kong from 1980 to 1990 (his most recent position was audit manager) and was a partner in a Hong Kong accounting firm from 1992 to 1993.\nLINDA YANG, DIRECTOR, 35. Ms. Yang has been the Executive Director and a principal of Sunbase International since 1989. Ms. Yang was a co-founder of Sunbase International, has extensive experience in China business operations and holds a degree from a Chinese university. She is the wife of Gunter Gao.\n(FRANCO) HO CHO HING, DIRECTOR, 43. Mr. Ho has been a Director of the New China Hong Kong Group since 1993, and a Director of Sunbase Asia since 1995. Mr. Ho is also a registered investment advisor with the Securities and Futures Commission in Hong Kong. Mr. Ho held executive positions with Trenomics Securities Limited (1981 to 1983), Shun Loong Bear Stearns Asia Limited (1985 to 1988) and Best Securities Company (1991 to 1993).\nKEY MANAGEMENT\nMR. MA JI BO, GENERAL MANAGER, 57. Mr. Ma is the General Manager of Harbin Bearing and is responsible for the day-to-day operations of Harbin Bearing as well as strategic planning in the areas of marketing, product development and general operations. Mr. Ma has made significant contributions relating to the design and manufacture of a broad range of Harbin Bearing's products. Mr. Ma has been awarded various provincial and national Chinese awards for scientific and technological progress in the Chinese bearing industry and holds a degree in rocket science from Northwest China Engineering University.\nMR. MEI HAI YOU, DEPUTY GENERAL MANAGER, 59. Mr. Mei is the Deputy General Manager of Harbin Bearing where he has been employed for 35 years. Mr. Mei is the head of Harbin Bearing's manufacturing operations and has extensive experience in the fields of research and development, product development and manufacturing engineering. Mr. Mei is the author of a number of works on mechanical engineering and bearings and holds a degree in mechanical engineering from Harbin Polytechnic University.\nMR. ZHANG ZHENG BIN, DEPUTY GENERAL MANAGER, 50. Mr. Zhang has been employed by Harbin Bearing as Deputy General Manager of Sales and Marketing for 10 years. Mr. Zhang has extensive contacts in the Chinese engineering community and has proven very effective at penetrating existing markets and developing new markets for Harbin Bearing. Mr. Zhang holds a degree in engineering from Harbin Polytechnic University.\n(DICKENS) CHANG SHING YAM, ASSISTANT MANAGER AND CHIEF ACCOUNTING OFFICER, 29. Since 1994, Mr. Chang has been the Assistant Manager of Finance of Sunbase International and has been the Chief Accounting Officer of Sunbase Asia since 1995. Mr. Chang was employed by\nthe international accounting firm of Ernst & Young in Hong Kong from 1989 to 1994, most recently as audit manager.\nTODD STOCKBAUER, FINANCE MANAGER, 33. Mr. Stockbauer has been employed as the Finance Manager of Southwest Products since 1991 and directs its financial and administrative operations. Prior to 1991, he was employed in the public accounting sector, specializing in bankruptcy, litigation support and business turnarounds. Mr. Stockbauer holds a Bachelor of Arts degree in business and economics from the University of California at Santa Barbara with an emphasis in accounting, and is a Certified Public Accountant in the State of California.\nERNST RENEZEDER, DIRECTOR OF MANUFACTURING, 59. Mr. Renezeder has been the Director of Manufacturing at Southwest Products since 1992. Mr. Renezeder has over 24 years experience in manufacturing, engineering, management, and product research and development. Mr. Renezeder holds a Bachelor of Science degree in Molding and Foundry, which is equivalent to a Bachelor of Science in manufacturing engineering with an emphasis in mechanical engineering.\nJOHN LEONIAK, CHIEF ENGINEER, 59. Mr. Leoniak has been the Chief Engineer at Southwest Products since 1991. As Chief Engineer, Mr. Leoniak supervises Southwest Products' engineering and research and development. Prior to joining Southwest Products, Mr. Leoniak was employed by Grumman Aircraft Systems as the head of its Landing Gear, Armament, Carrier Suitability and Survivability Group. Mr. Leoniak has contributed to the writing of various US Navy manufacturing specifications, including MIL-B-8942, MIL-B-81820, MIL-B-81819 and MIL-STD-1599. Mr. Leoniak holds a Bachelor of Science in mechanical engineering from the Polytechnic Institute of Brooklyn.\nPETER WANG, QUALITY CONTROL MANAGER, 35. Mr. Wang has been the Quality Control Manager of Southwest Products since 1993 where he supervises the Quality Control and Inspection Departments. Prior to joining Southwest Products, Mr. Wang held positions as a mechanical engineer and a senior quality engineer. Mr. Wang has extensive experience in quality and statistical process control, is fluent in Mandarin and holds a Master of Science degree in mechanical engineering from North Carolina A&T State University and a Bachelor of Science degree in physics from Lenoir Rhyne College.\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT - -------------------------------------------------\nBased solely on a review of Forms 3 and 4 and amendments thereto furnished to the Company during its most recent fiscal year and certain written representations, no persons who were either a director, officer, beneficial owner of more than 10% of the Company's common stock, failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nMANAGEMENT COMPENSATION\nNo compensation was earned by or awarded to any of the Company's officers or directors in 1995. In 1995, in connection with a Management and Services Agreement between China Bearing Holdings Limited and Sunbase International, Sunbase International provided to the Company and its affiliates office space and equipment, administrative services and the services of Mr. Gao and other employees of Sunbase International (such as Ms. Yang, Mr. Li and Mr. Chang). In consideration of the provision of such services, China Bearing Holdings Limited paid Sunbase International a total of US $30,000 plus certain out-of-pocket expenses such as travel and entertainment. See ITEM 13 \"CERTAIN RELATIONSHIPS AND TRANSACTIONS.\" Based on the foregoing, no executive officer of the Company received compensation of US $100,000 or more from the Company.\nSTOCK OPTION PLAN\nOn January 2, 1996, the Company's Board of Directors adopted the 1995 Sunbase Asia, Inc. Stock Option Plan (the \"Plan\"). The Plan permits the grant of options to purchase an aggregate of up to 2,500,000 Shares of the Common Stock of the Company. Under the Plan, incentive stock options and non-qualified stock options may be issued. Eligible participants under the Plan are those individuals and entities that the stock option committee of the Company (the \"Committee\") in its discretion determines should be awarded such incentives given the best interests of the Company; provided, however, that incentive stock options may only be granted to employees of the Company and its affiliates. The Committee has the power to determine the price, terms and vesting schedule of the options granted, subject to the express provisions of the Plan. All incentive stock options will have option exercise prices per option share not less than the fair market value of a share of the Common Stock on the date the option is granted, except that in the case of incentive stock options granted to any person possessing more than 10% of the total combined voting power of all classes of stock of the Company or any affiliate of the Company, the price shall not be less than 110% of such fair market value. The Plan terminates on the earlier of that date on which no additional shares of Common Stock are available for issuance under the Plan or January 2, 2006.\nIn connection with an employment agreement entered into by and between the Company and William R. McKay on January 16, 1996, and pursuant to the Plan, the Company\ngranted Mr. McKay the option to purchase an aggregate of up to 800,000 shares of Common Stock of the Company. The option is intended by the Company and Mr. McKay to be, and will be treated as, an incentive stock option. The options granted to Mr. McKay vest at the rate of 160,000 shares per each full year of Mr. McKay's employment under the Agreement. Mr. McKay may exercise the options that have vested and purchase shares of the Common Stock of the Company at the following prices:\nAll unexercised options will expire on that date which is six years after the date on which such options have vested.\nEMPLOYMENT AGREEMENT\nOn January 16, 1996, Sunbase Asia and Southwest Products entered into an employment agreement with William R. McKay (the \"Agreement\") pursuant to which Mr. McKay is employed to serve as President and Chief Executive Officer of Southwest Products and as President and Chief Executive Officer of Sunbase Asia. Under the terms of the Agreement, Mr. McKay will be paid an annual base salary of $285,000. The base salary may be increased or decreased (to a minimum of $225,000), based upon an annual review of Mr. McKay's performance. In addition to the base salary, the Board of Directors of Sunbase Asia may, at its sole discretion, pay Mr. McKay a bonus for any particular year of his employment. On January 16, 1996, in connection with the execution of the Agreement, Sunbase Asia, Southwest Products and Mr. McKay entered into a Confidentiality and Non- Competition Agreement pursuant to which Mr. McKay agrees to keep certain information of Sunbase Asia, Southwest Products and their affiliates confidential, and is prohibited from competing with Sunbase Asia, Southwest Products and their affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth, as of March 15, 1996, the stock ownership of all persons known to own beneficially five percent (5%) or more of the equity securities of the Company, and all directors and officers of the Company and its affiliates, individually and as a group. Each person has sole voting and investment power over the shares indicated, except as noted.\n_________________________ * less than 1 percent\n(1) As used in this table, \"beneficial ownership\" means the sole or shared power to vote, or to direct the voting of, a security, or the sole or share investment power with respect to a security (i.e., the power to dispose of, or to direct the disposition of a security).\n(2) Based on 15,980,063 shares of Common Stock outstanding on a fully-diluted basis calculated as follows: (a) 11,700,063 shares outstanding; (b) 3,600,000 shares issuable upon conversion of the Series A Preferred Stock and (c) 680,000 shares issuable upon conversion of the Series B Preferred Stock.\n(3) Includes 10,111,000 outstanding shares of Common Stock and 3,600,000 shares of Common Stock issuable upon conversion of the Series A Preferred Stock.\n(4) Includes 10,111,000 voting rights held by way of Asean Capital's ownership of 10,111,000 shares of Common Stock and 18,000,000 voting rights held by way of Asean Capital's ownership of 36 shares of the Series A Preferred Stock.\n(5) Includes shares of Sunbase Common Stock and Preferred Stock beneficially owned by Gunter Gao and Linda Yang, husband and wife, by way of the ownership by each of Mr. Gao and Ms. Yang of 50% of the capital stock of Sunbase International, which in turn owns 90% of the capital stock of Asean Capital. Each of Ms. Yang and Mr. Gao disclaims beneficial ownership of the shares held by the other, although their ownership has been aggregated for purposes of this table.\n(6) Does not include 800,000 shares of Common Stock issuable upon exercise of the stock options granted to Mr. McKay. See \"Stock Option Plan.\"\n(7) Consists of 10,111,000 outstanding shares of Common Stock and 3,600,000 shares of Common Stock issuable upon conversion of the Series A Preferred Stock owned by Asean Capital, of which Sunbase International owns 90%.\n(8) Consists of shares beneficially owned by Gunter Gao and Linda Yang.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nAs discussed above (See ITEM 1 \"BUSINESS ORGANIZATION OF THE COMPANY\"), an effective 51.4% in Harbin Bearing was acquired at the end of 1993 by then affiliates of Sunbase International. This was accomplished by the acquisition by China Bearing Holdings Limited (\"China Bearing\") of China International Bearing (Holdings) Limited (\"China International\"). China International was incorporated to act as the holding company of two Sino-foreign joint venture companies which in turn were formed to acquire in the aggregate a 51.6% interest in Harbin Bearing. China International has a 99.9% equity interest in one of the joint venture companies and a 99% equity interest in the other, which in turn hold a 41.6% and 10% interest, respectively, in Harbin Bearing (See, \"Organizational Chart\"). The aggregate cash consideration contributed by the joint venture companies was Rmb 232.1 million which was principally financed by an interest free loan from Sunbase International to China International (the \"Sunbase Loan\"). China International in turn made equity contributions and loans to the two joint venture companies.\nIn April 1994, New China Hong Kong acquired from Sunbase International 10% of the outstanding stock of China Bearing and 10% of the Sunbase Loan. The Sunbase Loan was later assigned to China Bearing, and China Bearing assumed the Sunbase Loan for a consideration of the same amount payable to it by China International. The obligations under the Sunbase Loan were extinguished by Sunbase International and New China Hong Kong, and the amount thereof was treated as a contribution of cash to China Bearing and credited to its contributed surplus account. Thereafter, the shares of China Bearing owned by Sunbase International and New China Hong Kong were transferred to Asean Capital, in which Sunbase International and New China Hong Kong own 90% and 10%, respectively. As set forth above, in December 1994, Asean Capital transferred all of its interest in China Bearing to the Company.\nPursuant to a Management Services Agreement between Sunbase International and China Bearing dated January 1, 1994, Sunbase International agreed to provide China Bearing and its affiliates, including the Company, advice and consultation, including strategic management, business planning and development services, accounting and financial service, human resource service, sales and marketing service and such additional services as may be agreed upon for an annual fee of US $30,000. China Bearing is also obligated to reimburse Sunbase International for its direct out-of-pocket costs incurred in providing the management services. The Agreement's term was two years and it expired on December 31, 1995.\nHarbin Bearing and Harbin Precision have entered into leases (the \"Ancillary Transport Equipment Lease\" and the \"Manufacturing Machinery Lease\"), covering all equipment and assets of the Bearing Factory relating to the bearing operations which were not contributed to the Company in the Restructuring. The Leases cover cars, trucks, machinery and equipment used in manufacturing, office administration and power generation and provide for total annual payments of US $3,267,000. At the expiration of the two Leases in December 31, 1998 and December 31, 2001, respectively, Harbin Bearing has the right to either renew the Leases or acquire the equipment.\nHarbin Bearing and Harbin Holdings have entered into a lease covering plants and buildings used in Harbin Bearing business which were not contributed to Harbin Bearing in the Restructuring (the \"Plant Lease\"). The Plant Lease provides for annual rent payments of US $451,000. At the expiration of the lease on December 31, 1998, Harbin Bearing has the right to extend the lease at market rent for another five years.\nHarbin Holdings and Harbin Bearing have entered into a lease providing for the use of land by Harbin Bearing at US $301,000 per annum.\nAs a result of the Restructuring, Harbin Holdings owns the rights to the trademark \"HRB.\" Pursuant to an exclusive and perpetual trademark license agreement, Harbin Holdings has granted Harbin Bearing the exclusive and perpetual right to use the \"HRB\" trademark on its products and marketing materials. The royalty on the trademark license agreement is 0.5% of annual sales from 1994 to 2003 and 0.3% from 2004 to 2013.\nPursuant to the Restructuring, Harbin Holdings assumed responsibilities of the pension payments of all employees of the Bearing Factory who retired or left the Bearing Factory prior to the Restructuring. Harbin Bearing and Harbin Holdings have entered into an agreement (the \"Pension Agreement\") relating to pension arrangements after the Restructuring. The Pension Agreement provides that Harbin Bearing may satisfy the statutory requirement to pay an amount equal to 20% of annual wages to the municipal government to fund future pension obligations of its existing employees, by making such payments to Harbin Holdings as representative of the municipal government of Harbin, and Harbin Holdings agrees to be responsible for all pension obligations to employees of Harbin Bearing who retire or leave after the Restructuring.\nSubsequent to December 31, 1993, Harbin Bearing and Harbin Holdings entered into a management and administrative services agreement. The agreement provides for the payment by Harbin Bearing of an annual fee of Rmb 17,160,000 (approximately US $2,049,000) in connection with services for medical, heating, education and other staff-related benefits provided by Harbin Holdings for a term of three years. The costs of these services were previously fully paid by the Bearing Factory and have now been superseded by the above agreement. The fees are subject to an annual 10% inflation adjustment.\nAgreements were also entered into by Harbin Bearing with the two joint venture holding companies of Harbin Bearing in respect of general management services to be provided by the joint venture companies from January 1, 1994 to December 31, 1995 at an annual fee of Rmb 150,000 (US $18,000) payable to each of the joint venture companies.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following financial statements and exhibits are filed with and as a part of this Report.\n_____________ (1) Filed with the Company's Form 8-K, dated December 22, 1994 and incorporated herein. (2) Filed with the Company's Form 8-K\/A, dated December 22, 1994 and incorporated by reference herein. (3) Filed with the Company's Form 10-K dated March 3, 1995 and incorporated by reference herein.\n22 The Company's subsidiaries are:\n______________ (b) No Reports on Form 8-K were filed during or related to the last quarter of 1995.\nSIGNATURES ----------\nIn accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSunbase Asia, Inc.\nDate: May 3, 1996 By: \/s\/ William McKay ------------------------ William McKay, 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: May 3, 1996 By: \/s\/ Gunter Gao ------------------------ Gunter Gao, Chairman\nDate: May 3, 1996 By: \/s\/ Billy Kan ------------------------ Billy Kan, Director\nDate: May 3, 1996 By: \/s\/ William McKay ------------------------ William McKay, Chief Executive Officer, President and Director\nDate: May 3, 1996 By: \/s\/ Roger Li ------------------------ (Roger) Li Yuen Fai, Vice President and Chief Financial Officer and Director\nDate: May 3, 1996 By: \/s\/ Linda Yang ------------------------ Linda Yang, Director\nDate: May 3, 1996 By: \/s\/ Franco Ho Cho Hing ------------------------ (Franco) Ho Cho Hing, Director\nDate: May 3, 1996 By: \/s\/ Dickens Chang ------------------------ (Dickens) Change Shing Yam, Chief Accounting Officer\nFinancial Statements\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nERNST & YOUNG HONG KONG\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Shareholders Sunbase Asia, Inc.\nWe have audited the accompanying consolidated balance sheets of Sunbase Asia, Inc. and its subsidiaries as of December 31, 1995 and 1994 and the related statements of income, cash flows and changes in shareholders' equity for each of the years in the two-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 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.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunbase Asia, Inc. and its subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and cash flows for each of the years in the two-year period ended December 31, 1995, in conformity with accounting principles generally accepted in the United States of America.\nERNST & YOUNG\nHong Kong April 5, 1996\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1995\n(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)\nContinued on next page\nThe accompanying notes form an integral part of these consolidated financial statements\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1995 (continued)\n(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)\nThe accompanying notes form an integral part of these consolidated financial statements\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995\n(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES AND PER SHARE DATA)\nThe accompanying notes form an integral part of these consolidated financial statements\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995\n(AMOUNTS IN THOUSANDS)\n(Continued on next page)\nThe accompanying notes form an integral part of these consolidated financial statements.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995 (continued)\n(AMOUNTS IN THOUSANDS)\nThe accompanying notes form an integral part of these consolidated financial statements.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1995\n(AMOUNTS IN THOUSANDS)\nThe accompanying notes form an integral part of these consolidated financial statements.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, unless otherwise stated and except number of shares and per share data)\n1. ORGANIZATION AND PRINCIPAL ACTIVITIES\nSunbase Asia, Inc. (\"the Company\") entered into a share exchange agreement (\"Share Exchange Agreement\") with Asean Capital Limited (\"Asean Capital\") on December 2, 1994. Pursuant to the agreement and certain subsequent changes thereto, as agreed between the Company and Asean Capital, and further to a board resolution of the Company on March 31, 1995, the Company issued 10,261,000 common stock shares, 36 shares of Series A convertible preferred stock and a US$5 million secured promissory note to Asean Capital in exchange for the entire issued share capital of China Bearing Holdings Limited (\"China Bearing\").\nThe Series A convertible preferred stock is convertible at the option of the holder at a conversion rate of 100,000 common stock shares per Series A share. As preferred shares, they also carry 500,000 votes per share and are entitled to the same dividend as the common stock shareholders on the basis as if the preferred shares had been converted to common stock shares at the conversion rate as noted above.\nThe total number of common stock shares outstanding subsequent to this arrangement was 11,700,063. For the purpose of these financial statements, the Share Exchange Agreement and all subsequent amendments thereto were deemed to be effected as of December 31, 1993.\nThis transaction has been treated as a recapitalization of China Bearing with China Bearing as the acquirer (reverse acquisition). The historical financial statements prior to December 2, 1994 are those of China Bearing.\nChina Bearing is a holding company which was establishing to acquire a 100% interest in China International Bearing (Holdings) Company Limited (\"China International\"), a company then wholly-owned by Sunbase International (Holdings) Limited (\"Sunbase International\"), at a nominal consideration of HK$0.002 on March 8, 1994. China International was incorporated in Hong Kong on June 23, 1993 to act as the holding company of Harbin Xinhengli Development Co. Ltd. (\"Harbin Xinhengli\") and Harbin Sunbase Development Co. Ltd. (\"Harbin Sunbase\"), Sino-foreign equity joint ventures in the People's Republic of China (\"China\" or the \"PRC\") established on September 18, 1993 and January 28, 1993, respectively, and to acquire, in aggregate, a 51.6% interest in Harbin Bearing Company Limited (\"Harbin Bearing\"). China International has a 99.9% equity interest in Harbin Xinhengli and a 99.0% equity interest in Harbin Sunbase, which hold 41.6% and 10.0%, equity interests in Harbin Bearing. The aggregate cash consideration contributed by Harbin Xinhengli and Harbin Sunbase to Harbin Bearing was RMB 232.1 million for the acquisitions of the 51.6% interest in Harbin Bearing.\nHarbin Bearing is the successor to the manufacturing operations of Harbin Bearing General Factory (the \"Predecessor\" or \"Bearing Factory\"), a Chinese state-owned enterprise established in 1950. In connection with the restructuring of the Predecessor, Harbin Bearing was established on December 28, 1993 as a joint stock limited company under the Trial Measures on Share Companies and the Opinion on the Standardization of Joint Stock Companies promulgated by the State Council of China.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, unless otherwise stated and except number of shares and per share data)\n1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)\nPursuant to an agreement between the Predecessor and Harbin Bearing, the ball bearing manufacturing and sales businesses, together with certain assets and liabilities, were transferred to Harbin Bearing. Certain other assets and liabilities relating to the bearing business were transferred to Harbin Precision Machinery Manufacturing Company (\"Harbin Precision\"), and certain ancillary operations, businesses, facilities used to provide community services to employees of the factory and their families in Harbin were transferred to Harbin Bearing Holdings Company (\"Harbin Holdings\").\nHowever, certain assets such as accounts receivable and construction in progress and certain liabilities such as the long term bank loan were not transferred to Harbin Bearing. Harbin Bearing will account for all new sales and subsequent collections effective from January 1, 1994 and assist the Predecessor in the collection of its outstanding accounts receivable prior to the reorganization. This service will be provided at no cost.\nHarbin Holdings is a separately established enterprise controlled by and under the administration of the Harbin Municipal Government and the industrial oversight of the Machine Bureau. Harbin Precision is wholly-owned by Harbin Holdings. Harbin Holdings received 33.3% of the new shares of Harbin Bearing in consideration for the net assets transferred thereto from the Predecessor.\nDetails of the equity capital of Harbin Bearing are as follows:\nThe assets acquired and the liabilities assumed by Harbin Bearing from the Predecessor were revalued on December 31, 1993 at the then respective fair values which included certain fixed assets revalued by the State Administration of Assets Bureau. The book value of the net assets so transferred was RMB 150,000. After giving effect to the principal adjustments in conformity with accounting principles generally accepted in the United States of America (\"U.S. GAAP\") as explained in Note 2 below, the fair value of the net assets transferred to Harbin Bearing from the Predecessor was RMB 173,118. The total fair value of the net assets of Harbin Bearing after taking into account the cash received from the other investors totalled RMB 473,118.\nChina International completed its acquisition of an effective interest of 51.4% interest in Harbin Bearing through Harbin Xinhengli and Harbin Sunbase on December 28, 1993. Harbin Holdings together with\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, unless otherwise stated and except number of shares and per share data)\n1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)\nsome individual investors retained 48.4% and the remaining 0.2% which was held by the joint venture partners of Harbin Xinhengli and Harbin Sunbase.\nThe following unaudited pro forma information for the years ended December 31, 1994 and 1993 has been prepared on the basis as if the acquisition of China Bearing and Harbin Bearing had occurred on January 1, 1993.\nThe pro forma results for the year ended December 31, 1994 presented below are prepared after giving effect to the following pro forma adjustments:\n(a) Interest expense in respect of the US$5 million secured promissory note issued pursuant to the restructuring as detailed above; and\n(b) reversal of the reorganization expenses which had already been reflected in the pro forma results for the year ended December 31, 1993 on the basis as if the reorganization was completed on January 1, 1993.\nThe pro forma results of operations have been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the acquisitions been in effect on January 1, 1993 or which may occur in the future.\nOn December 29, 1995, the Company entered into a reorganization agreement (\"Reorganization Agreement\") with Southwest Products Company (\"Southwest\") and the shareholders of Southwest for the acquisition of 100% of the issued common stock of Southwest.\nPursuant to the Reorganization Agreement, a wholly-owned subsidiary of the Company was incorporated for the purpose of merging with Southwest pursuant to a separate merger agreement. In connection with the merger, the Company issued an aggregate of 6,800 shares of Series B convertible preferred stock (\"Series B stock\") to the then shareholders of Southwest or their designates. At the option of the Series B stockholders, the stock may be redeemed at US$500 per Series B share by the Company from the proceeds of the next permanent equity offering, the net proceeds of which will be designated for such redemption. Any shares not so redeemed will automatically be converted into common stock shares at the rate of 100 common stock shares per Series B stock. If the aforesaid public offering or the redemption are\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, unless otherwise stated and except number of shares and per share data)\n1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)\nnot effected within two years from date of issue of the Series B stock, the stock will automatically be converted into common stock at the rate of 100 common stock shares per Series B stock. As preferred shares, the shares carry 100 votes per share and are entitled to the same dividend as the common shareholders on the basis as if the preferred shares had been converted to common stock shares at the conversion rate as noted above.\nThis transaction has been treated as a business combination and is accounted for under the purchase method of accounting. However, since the acquisition was consummated on December 31, 1995, the results of Southwest for the year then ended have not been consolidated into the Company but will accrue to the Company from January 1, 1996.\nSouthwest is a manufacturer of spherical bearings and supplies its products to the aerospace, commercial aviation and other industries around the world. Its major customers are in the United States of America. Southwest also has an interest in a Shanghai Joint Venture. As a result of a lack of information available with respect to the financial condition of the Shanghai Joint Venture, management of the Company was unable to determine the fair value of the 28% equity interest in the Shanghai Joint Venture owned by Southwest. Accordingly, the Company did not allocate any portion of the Southwest purchase consideration to the investment in the Shanghai Joint Venture at December 31, 1995. The Company is attempting to obtain additional information, and to the extent that such additional information is obtained during 1996, the Company may subsequently determine to reallocate a portion of the purchase consideration to the investment in the Shanghai Joint Venture, with a commensurate reduction to goodwill. Such reallocation, if it occurs, would not have a material effect on the consolidated results of operations or financial position of the Company.\nThe following unaudited pro forma information for the years ended December 31, 1995 and 1994 are prepared on the basis as if the acquisition of Southwest and China Bearing by the Company had occurred on January 1, 1994. The unaudited pro forma information for the year ended December 31, 1994 is presented after taking into account the effect of the following pro forma adjustments in respect of the acquisition of China Bearing and Southwest by the Company:\n(a) interest expense in respect of the US$5 million secured promissory note issued pursuant to the restructuring of the Company for the acquisition of China Bearing;\n(b) reversal of the reorganization expenses incurred for the aforesaid restructuring as if the reorganization were completed on January 1, 1993; and\n(c) amortization of goodwill and the effect of the increment of fair values on assets arising from acquisition of Southwest.\nThe following pro forma financial information has been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, unless otherwise stated and except number of shares and per share data)\n1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)\nacquisitions and the reorganization been in effect on January 1, 1994 or which may occur in the future.\n2. BASIS OF PRESENTATION\nThe Company's first operating subsidiary, Harbin Bearing, was formed on December 28, 1993 and commenced operations on January 1, 1994. Accordingly, no consolidated statements of income and cash flows were prepared for the year ended December 31, 1993.\nThese consolidated financial statements incorporate the results of operations of the Company and its subsidiaries (hereinafter referred to as the \"Group\") on the basis that the Group with all its present components had been so constituted during the two-year period ended December 31, 1995, except for Southwest, the acquisition of which was completed on December 31, 1995. These financial statements include the fair value of the net assets of Southwest at December 31, 1995. All material intra group transactions and balances have been eliminated on consolidation.\nThe consolidated financial statements were prepared in accordance with U.S. GAAP. This basis of accounting differs from that used in the statutory and management accounts of Harbin Bearing which were prepared in accordance with the accounting principles and the relevant financial regulations applicable to joint stock enterprises as established by the Ministry of Finance of China (\"PRC GAAP\").\nThe principal adjustments made to conform the statutory accounts of Harbin Bearing to U.S. GAAP included the following:\n. Revenue recognition;\n. Provision for doubtful accounts receivable;\n. Provision for inventory obsolescence;\n. Valuation of inventories;\n. Accounting of assets financed under capital leases as assets of the Company together with the corresponding liabilities; and\n. Deferred taxation.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n2. BASIS OF PRESENTATION (Continued)\nThe financial information has been prepared in Renminbi (RMB), the national currency of China. Solely for the convenience of the reader, certain elements of these financial statements have been translated into United States dollars prevailing at the People's Bank of China on December 31, 1995 which was US$1.00 = RMB8.32. No representation is made that the Renminbi amounts could have been, or could be, converted into United States dollars at that rate or any other certain rate on December 31, 1995.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Cash and bank balances\nCash and bank balances include cash on hand and demand deposits with banks with an original maturity of three months or less. None of the Group's cash is restricted as to withdrawal or use.\n(b) Inventories\nInventories are stated at the lower of cost, on a first-in, first- out basis, or market. Work-in-progress and finished goods include direct materials, direct labor and an attributable proportion of production overheads.\n(c) Fixed assets and depreciation\nProperty, machinery and equipment are stated at cost less accumulated depreciation. Depreciation of property, machinery and equipment is computed using the straight-line method over the assets' estimated useful lives. The estimated useful lives of property, machinery and equipment are as follows:\nBuildings 20 years\nMachinery and equipment 8-10 years\nMotor vehicles 3 years\nFurniture, fixtures and office equipment 5 years\n(d) Construction in progress\nConstruction in progress represents factory buildings, plant and machinery and other fixed assets under construction and is stated at cost. Cost comprises direct costs of construction as well as interest charges on borrowed funds. Capitalization of interest charges ceases when an asset is ready for its intended use. Construction in progress is transferred to fixed assets upon commissioning when it is capable of producing saleable output on a commercial basis, notwithstanding any delays in the issue of the relevant commissioning certificates by the appropriate PRC authorities.\nNo depreciation is provided on construction in progress until the asset is completed and put into productive use.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\n(e) Income taxes\nThe income taxes reflect the accounting standards in Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\".\n(f) Foreign currency translation\nForeign currency transactions are translated into Renminbi at the applicable floating rates of exchange quoted by the People's Bank of China, prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi using the applicable exchange rates prevailing at the balance sheet date.\nThe Company's share capital is denominated in United States Dollars and the reporting currency is Renminbi. For financial reporting purposes the United States Dollars share capital amounts have been translated into Renminbi at the applicable rates prevailing on the dates of receipt.\n(g) Capital leases\nLeases that transfer substantially all the rewards and risks of ownership of assets to the Group, other than legal title, are accounted for as capital leases. At the inception of a capital lease, the cost of the leased asset is capitalized at the present value of the minimum lease payments and recorded together with the obligation, excluding the interest element, to reflect the purchase and financing. Assets held under capital leases are included in fixed assets and depreciated over the estimated useful lives of the assets. The finance costs of such leases are charged to the profit and loss account so as to provide a constant periodic rate over the lease terms.\nLeases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Rentals applicable to such operating leases are charged to the profit and loss account on the straight-line basis over the lease terms.\n(h) Goodwill\nGoodwill represents the excess of the consideration paid for the purchase of a subsidiary over the fair value of the net assets of businesses acquired and are being amortized over a 15-year period. The carrying value of goodwill is assessed on an ongoing basis. The measurement of possible impairment is based primarily on the ability to recover the balance of the goodwill from expected future operating cash flows on an undiscounted basis of the entity acquired. If the review indicates goodwill may be impaired, the carrying value of the goodwill is reduced.\n(i) Use of estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nestimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\n4. INCOME TAXES\nSunbase Asia, Inc. was incorporated in the State of Nevada in the United States of America. The Company is subject to U.S. federal tax on its income. Nevada does not impose any tax on corporations organized under its laws.\nSouthwest was incorporated in the State of California in the United States of America and is subject to U.S. federal tax on its income.\nChina Bearing was incorporated under the laws of Bermuda and, under current Bermudan law, is not subject to tax on income or on capital gains. China Bearing has received an undertaking from the Ministry of Finance of Bermuda pursuant to the provisions of the Exempted Undertakings Tax Protection Act, 1966, as amended, that in the event that Bermuda enacts any legislation imposing tax computed on profits or income, including any dividend or capital gains withholding tax, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to China Bearing or to any of its operations or the shares, debentures or other obligations of China Bearing, until March 28, 2016. This undertaking is not to be construed so as to (i) prevent the application of any such tax or duty to such persons as are ordinarily resident in Bermuda; or (ii) prevent the application of any tax payable in accordance with the provision of the Land Tax Act, 1967 or otherwise payable in relation to any land leased to China Bearing in Bermuda.\nChina International was incorporated under the Hong Kong Companies Ordinance and under the current Hong Kong tax law, any income arising in and deriving from businesses carried on in Hong Kong will be subject to tax. No tax will be charged on dividends received and capital gains earned.\nHarbin Xinhengli and Harbin Sunbase are subject to Chinese income taxes at the applicable tax rates of 30% for Sino-foreign equity joint venture enterprises. Dividend income received is exempt from any Chinese income taxes.\nThe applicable tax rate for joint stock limited enterprises in China is 33% which is levied on the taxable income as reported in the statutory accounts adjusted for taxation in accordance with the relevant income tax laws applicable to joint stock limited enterprises. Harbin Bearing, being a joint stock limited company registered in the Special Economic and Technological Development Zone in the Municipal City of Harbin, will normally be subject to a maximum income tax rate of 20%. Pursuant to the same income tax basis applicable to the Special Economic and Technological Development Zone, Harbin Bearing has been designated a high technology production enterprise and is entitled to a special income tax rate of 15%.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n4. INCOME TAXES (Continued)\nThe Company has undertaken not to require China Bearing to make any distribution of dividends and the directors of Harbin Xinhengli and Harbin Sunbase have decided not to distribute any dividend income related to income earned for the year received from Harbin Bearing outside of China. As a result, deferred income taxes have not been accrued in the financial statements in respect of income distributions. The determination of the amount of the unrecognized deferred tax liability for temporary differences related to such investments in foreign subsidiaries is not practicable.\nThe reconciliation of the effective income tax rates based on income before income taxes stated in the consolidated statement of income to the statutory income tax rate in China applicable to the Company's only operating subsidiary is as follows:\n5. ACCOUNTS RECEIVABLE\nAccounts receivable comprise:\nThe accounts receivable of the Predecessor were not transferred to Harbin Bearing as part of the reorganization on formation of Harbin Bearing on December 28, 1993. However, Harbin Bearing will account for new sales and subsequent collections effective from January 1, 1994 and assist the Predecessor in the collection of its accounts receivable prior to the reorganization.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n6. INVENTORIES\nInventories comprise:\n7. FIXED ASSETS\nTotal amount of interest capitalized during the year and included in the above fixed assets are RMB 10,411 (1994: RMB 1,334).\nThe Group's buildings are located in PRC and the land on which the Group's buildings are situated is State-owned.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n7. FIXED ASSETS (Continued)\nThe gross amounts of assets recorded under capital leases and the accumulated depreciation thereon are analyzed as follows:\n8. DEFERRED ASSET\nThis represents the deemed VAT receivable arising from the introduction of the new PRC VAT system on January 1, 1994. This asset was calculated and accounted for in accordance with governmental directions by applying the 14% VAT rate to certain inventory values as at December 31, 1993, with the effect of reducing the value of certain opening inventory of Harbin Bearing as at January 1, 1994 by the same amount. A detailed directive regarding the utilization of the deferred VAT receivable was issued in May 1995 by the Ministry of Finance and the State General Tax Bureau pursuant to which the Group will be permitted to offset the balance of RMB38,860 against its VAT payable within a period of five years starting from January 1, 1995. Accordingly, a discount has been applied using Harbin Bearing's average rate of borrowing over the estimated period of recovery.\n9. LONG TERM INVESTMENTS\nLong term investments are stated at cost and represent investments in treasury bonds issued by the Chinese Government. The investments bear interest ranging from 3% to 8% per annum and are redeemable on maturity or otherwise prior thereto as advised by the government.\nThe long term investments were pledged as one element of the security to the Group's bankers to secure a short term bank loan of RMB 418.4 million which was utilized to the extent of RMB 358 million. Other collateral includes the Group's fixed assets of RMB 137,782 and a third party guarantee from Harbin Holdings.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n10. GOODWILL\nThe goodwill arises as a result of the acquisition of Southwest on December 31, 1995. Nor amortization was provided during the year as the acquisition was completed on December 31, 1995.\n11. SHORT TERM BANK LOANS\nThe short term bank loans bear interest at a weighted average rate of 14% and 11% per annum for the years ended December 31, 1995 and 1994, respectively, and are repayable within one year.\n12. NOTES PAYABLE\nIncluded in the total amount was an amount of RMB 11,627 which represents a long term note payable to a bank. The Group is in the process of refinancing the note and accordingly the amount has been classified under current liabilities.\n13. OBLIGATIONS AND COMMITMENTS\n(a) Obligations under capital leases\nHarbin Bearing leases machinery and equipment, furniture, fixtures and office equipment and motor vehicles from Harbin Precision, a company wholly-owned by Harbin Holdings, a separately established enterprise under the supervision and control of the Machine Bureau, which received 33.3% of the new shares of Harbin Bearing. These leases are accounted for as capital leases which have lease terms ranging from five years to eight years.\nThe lease obligations for the machinery and equipment, furniture, fixtures and office equipment and motor vehicles have an implicit annual interest rate at 8.46%. The scheduled future minimum lease payments as of December 31, 1995 were as follows:\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n13. OBLIGATIONS AND COMMITMENTS(Continued)\nThe lease rentals incurred during the year amounted to RMB27,183 (1994: RMB27,183), out of which RMB 11,310 (1994: RMB12,593) was the interest portion.\n(b) Other commitments\nAs of December 31, 1995, the Group had outstanding commitment for capital expenditure of RMB 46,027 (US$5,532) (1994: RMB 91,500 (US$10,919)) and outstanding operating lease commitments expiring in 1998 in respect of buildings of approximately RMB 11,254 (US$ 1,353) (1994: RMB 15,004 (US$1,790)).\n14. OTHER LOANS\nThe loans are due to the employees of Harbin Bearing, are unsecured and bear interest at 15% per annum. The loans, together with the accumulated interest, were repaid in full subsequent to December 31, 1995.\n15. SECURED PROMISSORY NOTE\nThe secured promissory note (the \"Note\") was issued to Asean Capital Limited in connection with the Share Exchange Agreement as detailed in Note 1 and is secured by a continuing security interest in and to all of the Company's title and interest in the outstanding capital stock of China Bearing. The carrying value of the net assets of China Bearing represents all the consolidated net assets of the Company before taking into account the carrying value of the Note, the consolidated net assets of Southwest of RMB 16,144 and the goodwill arising on acquisition of Southwest of RMB 12,144.\nThe Note is denominated in United States dollars, is repayable in full in United States dollars on December 31, 1996 and bears interest at 8% per annum.\n16. LONG TERM BANK LOANS\nThe long term bank loans are principally loans borrowed to finance the construction in progress. The loans bear interest ranging from 3.7% to 9.25% per annum and are not repayable within one year.\n17. NUMBER OF SHARES\/EARNINGS PER SHARE\nAs detailed in Note 1 to the financial statements, the Company issued new shares in consideration for the acquisition of its interest in Southwest. The earnings per common stock share for the years ended December 31, 1994 and 1995, which excludes the results of Southwest, is calculated using the common stock and common stock equivalents, after assuming that all convertible preferred stocks except those issued in\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n17. NUMBER OF SHARES\/EARNINGS PER SHARE (Continued)\nconnection with the acquisition of Southwest, have been converted into common stock, as if these shares had been outstanding throughout all periods presented. The pro forma earnings per common share for the years ended December 31, 1994 and 1995, which includes the results of Southwest, as stated in Note 1, is calculated by including all the convertible preferred stocks.\n18. FOREIGN CURRENCY EXCHANGE\nThe Chinese government imposes control over its foreign currency. Renminbi, the official currency in China, is not freely convertible. Prior to December 31, 1993, all foreign exchange transactions involving Renminbi had to be undertaken either through the Bank of China or other institutions authorized to buy and sell foreign exchange or at a swap center. The exchange rates used for transactions through the Bank of China and other authorized banks were set by the government from time to time whereas the exchange rates available at a swap center were determined largely by supply and demand.\nOn January 1, 1994, the People's Bank of China introduced a managed floating exchange rate system based on the market supply and demand and proposed to establish a unified foreign exchange inter-bank market amongst designated banks. In place of the official rate and the swap centre rate, the People's Bank of China publishes a daily exchange rate for Renminbi based on the previous day's dealings in the inter-bank market. It is expected that swap centres will be phased out in due course.\nHowever, the unification of exchange rates does not imply the full convertibility of Renminbi into United States dollars or other foreign currencies. Payment for imported materials and the remittance of earnings outside of China are subject to the availability of foreign currency which is dependent on the foreign currency denominated earnings of the entity or allocated to the Company by the government at official exchange rates or otherwise arranged through a swap center with government approval. Approval for exchange at the exchange centre is granted to enterprises in China for valid reasons such as purchases of imported goods and the remittance of earnings. While conversion of Renminbi into United States dollars or other foreign currencies can generally be effected at the exchange centre, there is no guarantee that it can be effected at all times.\n19. CONTRIBUTED SURPLUS\nAs part of the reorganization of Sunbase Asia, Inc. on December 2, 1994 as detailed in Note 1 above, the entire share capital and contributed surplus of China Bearing were acquired by Sunbase Asia, Inc. The consideration for the shares in China Bearing on the basis that the reorganization took place on December 31, 1993 was as follows:\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n19. CONTRIBUTED SURPLUS (Continued)\nThe net assets of China Bearing were allocated first to the legal paid up capital at the par value of US$0.001 per share of 11,700,063 shares. The amount of net assets allocated to the convertible preferred stock was based on the total equivalent common shares attributable to the preferred stock. The remaining net assets were allocated to the contributed surplus. As more fully explained in note 21, reorganization expenses of RMB 7,307 were credited to contributed surplus pursuant to the Share Exchange Agreement in 1994.\n20. DISTRIBUTIONS OF PROFIT AND APPROPRIATIONS TO RESERVES\nAccording to the relevant laws and regulations for joint stock limited enterprises and Harbin Bearing's articles of association, the distribution of profit by Harbin Bearing is based on the profits as reported in the statutory accounts after the following allocations and appropriations:\n(a) making up any accumulated losses;\n(b) transferring 10% of its profit after taxation, measured under PRC accounting standards, to the statutory surplus reserve;\n(c) transferring 5% to 10% of its profit after taxation, measured under PRC accounting standards, to a collective welfare fund; and\n(d) transferring a certain amount of its profit after taxation measured under PRC accounting standards to a discretionary surplus reserve.\nThe following appropriations were made and are further described below:\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n20. DISTRIBUTIONS OF PROFIT AND APPROPRIATIONS TO RESERVES (Continued)\nThe collective welfare fund must be used for capital expenditure on staff welfare facilities and cannot be used to finance staff welfare expenses. Such facilities for staff were and are owned by Harbin Bearing.\nThe distributable retained earnings of the Group as of December 31, 1995, after taking into account of the above restrictions and appropriations and based on the PRC statutory accounts of Harbin Bearing, amounted to RMB 73,591.\n21. REORGANIZATION EXPENSES\nThe amount represents expenses related to the cost of the minority- owned 1,439,063 common stock (the \"Shares\") valued at the pro-rated net asset value of the Company on December 2, 1994, which approximated the fair value, pursuant to the Share Exchange Agreement detailed in Note 1, after accounting for relevant discounts relating to minority interest and the trading restrictions of the Shares. The value assigned to these shares is considered a cost of the restructuring of the Company and is charged to income and credited to contributed surplus. The proforma earnings per common stock for the year ended December 31, 1994 after excluding such non- recurring reorganization expenses is RMB 3.85.\n22. NOTE TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS\nPurchase of a subsidiary\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS\nDuring the year, the Group had transactions with several related parties. The major related party transactions are summarized as follows and described in further detail below:\n(a) Significant sales to related companies\nHarbin Bearing made sales of RMB 42,855 (1994: RMB 46,578) and RMB 40,257 (1994: RMB 7,832) to Harbin Bearing Import & Export Company (\"HBIE\") and Xin Dadi Mechanical and Electrical Equipment Company (\"Xin Dadi\"), related companies owned by the Harbin Municipal Government, respectively, during the current year. As at December 31, 1995, the amounts of trade receivables from HBIE and Xin Dadi included under due from related companies were RMB 65,520 (1994: RMB 54,496) and RMB Nil (1994: RMB 9,164), respectively. An amount due to Xin Dadi is included in due to related companies as at December 31, 1995 at RMB 105,171, representing advance payment received in respect of future sales.\n(b) Leases of equipment\nHarbin Bearing has entered into an eight year lease agreement with Harbin Precision to lease machinery and equipment and a five year lease agreement with Harbin Precision to lease motor vehicles, furniture, fixtures and equipment related to the business at an initial annual rental of RMB 25,927 (US$3,116) and RMB 1,256 (US$151), respectively, from January 1, 1994 to December 31, 2001 and from January 1, 1994 to December 31, 1998, respectively.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS (Continued)\n(c) Leases of Buildings\nOptions to extend the leases and to purchase the leased assets have been granted to Harbin Bearing upon expiring of the initial leases. All these leases are treated as capital leases.\nHarbin Bearing has entered into a five year lease agreement with Harbin Precision to lease buildings related to the operation of Harbin Bearing with effect from January 1, 1994 at an initial annual rental of RMB 3,751 (US$451). The initial lease will expire on December 31, 1998 and Harbin Bearing has been granted an option to extend the lease at market rent for another five years. This lease is treated as an operating lease.\n(d) Land use rights\nThe municipal government has allocated to Harbin Holdings the right to use the parcels of land on which Harbin Bearing's operations are conducted. Harbin Holdings has agreed to lease the land on which the main factory is situated to Harbin Bearing in return for an initial annual rental of RMB 2,508 (US$301) effective from January 1, 1994 subject to future adjustments in accordance with changes in government fees.\n(e) Management and administrative services agreements\nIn 1994, Harbin Bearing and Harbin Holdings entered into a management and administrative services agreement. The agreement provides for the payment by Harbin Bearing of an annual fee of RMB 18,876 (US$2,269) (1994: RMB 17,160) in connection with services for medical, heating, education and other staff-related benefits provided by Harbin Holdings for a term of three years. The fees are subject to an annual 10% inflation adjustment. The costs of these services were previously fully paid by the Predecessor and have now been superseded by the above agreement.\nAgreements were also entered into by Harbin Bearing with Harbin Xinhengli and Harbin Sunbase, respectively, in respect of general management services to be provided by the joint ventures from January 1, 1994 to December 31, 1995 at an annual fee of RMB 150 (US$18) payable to each of the joint ventures.\nAn agreement was entered into between China Bearing and Sunbase International, a majority shareholder of the Company, in respect of general management and administrative services at an annual fee of RMB 250 (US$30). In addition, China Bearing is to reimburse Sunbase International for administrative services rendered on behalf of China Bearing at cost. No additional administrative services were rendered by Sunbase International in the current year.\n(f) Trademark license\nPursuant to a trademark license agreement, Harbin Holdings has granted Harbin Bearing the right to use the \"HRB\" trademark. Harbin Bearing is required to pay a royalty cost calculated on\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n23. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS (Continued)\n(f) Trademark license (Continued)\nan annual basis at 0.5% of the net sales of Harbin Bearing effective from January 1, 1994 to December 31, 2003 and at 0.3% of the net sales from January 1, 2004 to December 31, 2013. The trademark license can be transferred to Harbin Bearing thereafter upon mutual agreement between the two parties subject to the relevant laws in China.\nThe trademark royalty paid by Harbin Bearing during the current year amounted to RMB 3,362 (1994: RMB 3,599).\n(g) Pension and retirement plan\nPursuant to an agreement on December 31, 1993, Harbin Bearing will make an annual payment to Harbin Holdings as its contribution to the pension scheme for all staff retiring after December 28, 1993. Such annual payment should be made based on the standard contribution as required by government regulations calculated at 20% of salary. Harbin Holdings is then responsible for the entire pension payment to staff who have retired after December 28, 1993. Harbin Holdings has undertaken to bear all pension payments to staff who have retired before December 28, 1993. This agreement will only be effective on the condition that no compulsory rules and regulations are implemented in the future such that Harbin Bearing has to be directly responsible for any pension payments.\nThe contribution to the pension scheme made by Harbin Bearing in the current year amounted to RMB 18,394 (1994: RMB 16,769).\nManagement expects that the arrangements detailed in (b), (c) and (d) above will be renewed after the initial contract term.\nAs described further in Note 1, the Company, in consideration for the purchase of its interest in China Bearing, exchanged common stock shares, preferred shares and assumed vendor financing from Asean Capital Limited. The vendor financing provided from Asean Capital is in the form of US$5,000 secured promissory note secured on the shares of China Bearing (see Note 15).\nA significant portion of the business undertaken by Harbin Bearing during the year has been effected with State-owned enterprises in China and on such terms as determined by the relevant Chinese authorities.\n24. FINANCIAL INSTRUMENTS\nThe carrying amount of the Company's cash and bank balances approximates their fair value because of the short maturity of those instruments. The carrying amounts of the Company's borrowings approximate their fair value based on the borrowing rates currently available for borrowings with similar terms and average maturities.\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n25. SEGMENT DATA\nThe Company operates mainly in the ball bearing industry in China, consequently, no segment reporting disclosures are required.\n26. CONCENTRATION OF RISK\nConcentration of credit risk:\nFinancial instruments that potentially subject the Group to a significant concentration of credit risk consist principally of cash deposits, trade receivables and amounts due from related companies.\n(a) Cash deposits\nThe Group places its cash deposits with various PRC State-owned financial institutions.\n(b) Trade receivables\nThe Company manufactures and sells general and precision ball bearings in diversified industries in China. The Company has long standing relationships with most of its customers and generally does not require collateral. There is no concentration of receivables in any one specific industry except for the outstanding receivable balance with a distributor, HBIE, which has a receivable balance of RMB 65,520 as at December 31, 1995.\nCurrent vulnerability due to certain concentrations:\nThe Group's operating assets and primary source of income and cash flow is its interest in its subsidiary in the PRC. The value of the Group's interest in this subsidiary may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for the past 17 years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC's political, economic and social life. There is also no guarantee that the PRC government's pursuit of economic reforms will be consistent or effective.\n27. SUBSEQUENT EVENT\nOn January 2, 1996, the Company's board of directors adopted a stock option plan (the \"Plan\"). The Plan permits the directors to grant options to purchase an aggregate of up to 2,500,000 shares of the common stock of the Company. All incentive stock options will have option exercise prices per option share not less than the fair market value of a share of the common stock on the date the option is granted, except that in the case of incentive stock options granted to any person possessing more than 10% of the total combined voting power of all classes of stock of the Company or any\nSUNBASE ASIA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(Amounts in thousands, except number of shares and per share data)\n27. SUBSEQUENT EVENT (Continued)\naffiliate of the Company, the price shall not be less than 110% of such fair market value. The Plan terminates on the earlier of the date on which no additional shares of common stock are available for issuance under the Plan or January 2, 2006.","section_15":""}
{"filename":"811156_1995.txt","cik":"811156","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nCMS Energy\nCMS Energy, incorporated in Michigan in 1987, is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving all of Michigan's Lower Peninsula, is the largest subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: oil and gas exploration and production; development and operation of independent power production facilities; marketing gas to utility, commercial and industrial customers; and transmission, storage and processing of natural gas. CMS Energy is exempt from registration under PUHCA, see Item 3. LEGAL PROCEEDINGS.\nCMS Energy had consolidated operating revenue in 1995 of $3.9 billion which was derived approximately 59 percent from its electric utility operations, approximately 31 percent from its gas utility operations, approximately 5 percent from gas transmission, storage and marketing, approximately 3 percent from oil and gas exploration and production activities and approximately 2 percent from independent power production and other non-utility activities. Consumers' consolidated operations in the electric and gas utility businesses account for the major share of CMS Energy's total assets, revenue and income. The unconsolidated share of non-utility electric generation and gas transmission and storage revenue for 1995 was $523 million.\nConsumers\nConsumers was incorporated in Michigan in 1968 and is the successor to a corporation of the same name which was organized in Maine in 1910 and which did business in Michigan from 1915 to 1968.\nConsumers is a public utility serving gas or electricity to almost 6 million of Michigan's 9.5 million residents in all 68 counties in Michigan's Lower Peninsula. Industries in Consumers' service area include automotive, metal, chemical, food and wood products and a diversified group of other industries. Consumers had consolidated operating revenue in 1995 of $3.5 billion which was derived approximately 65 percent from its electric business, approximately 34 percent from its gas business and approximately 1 percent from its nonutility business. Consumers' rates and certain other aspects of its business are subject to the jurisdiction of the MPSC and FERC.\nBUSINESS SEGMENTS\nCMS Energy and Consumers Financial Information\nFor information with respect to operating revenue, net operating income, assets and liabilities attributable to all of CMS Energy's business segments, refer to its Consolidated Financial Statements and Notes to Consolidated Financial Statements for the year ended December 31, 1995, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFor information with respect to the operating revenue, net operating income, assets and liabilities attributable only to Consumers' business segments, refer to its Consolidated Financial Statements and Notes to Consolidated Financial Statements for the year ended December 31, 1995, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCMS Energy and Consumers Principal Operations\nCMS Energy conducts its principal operations through the following five business segments: electric utility operations; gas utility operations; oil and gas exploration and production operations; independent power production; and gas marketing, transmission, storage and processing. Consumers conducts CMS Energy's regulated electric and gas utility operations.\nConsumers Electric Utility Operations\nConsumers generates, purchases, transmits and distributes electricity and renders electric service in 62 of the 68 counties in the Lower Peninsula of Michigan. Principal cities served include Battle Creek, Flint, Grand Rapids, Jackson, Kalamazoo, Muskegon, Saginaw and Wyoming. Consumers had approximately 1.6 million electric customers at December 31, 1995. Total electric sales in 1995 were a record 35.5 billion kWh, a 3 percent increase from the 1994 levels which included a 4.2 percent increase in system sales to Consumers' ultimate customers. Electric operating revenue in 1995 was $2.3 billion, an increase of 4 percent from 1994. A peak demand of 7,158 MW was achieved in August 1995, representing an increase of 10.1 percent from the peak achieved in 1994, predominantly as a result of improved industrial sales. Consumers' reserve margin was approximately 3 percent in 1995 and 14.6 percent in 1994, and 8 percent in 1995 and 15 percent in 1994, based on actual and weather adjusted peaks, respectively.\nIncluding Ludington, in which Consumers has a 51 percent ownership and capacity entitlement, Consumers owns and operates 28 electric generating plants with an aggregate net demonstrated capability available to Consumers in 1995 under summer conditions, of 6,256 MW. In 1995, Consumers purchased approximately 1,485 MW of net capacity from independent power producers and cogenerators, the most significant being the MCV Facility, which amounted to approximately 22 percent of Consumers' total system requirements. See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nCHARACTER OF OWNERSHIP\nThe principal properties of CMS Energy and its subsidiaries are owned in fee, except that most electric lines and gas mains are located, pursuant to easements and other rights, in public roads or on land owned by others. The statements under this item as to ownership of properties are made without regard to tax and assessment liens, judgments, easements, rights of way, contracts, reservations, exceptions, conditions, immaterial liens and encumbrances, and other outstanding rights. None of these outstanding rights impairs the usefulness of such properties.\nSubstantially all of Consumers' properties are subject to the lien of its First Mortgage Bond Indenture. Substantially all properties of the subsidiaries of CMS Generation that own interests in operating plants are subject to liens of creditors of the respective subsidiaries. Properties of certain CMS Gas Transmission subsidiaries are also subject to liens of creditors of the respective subsidiaries.\nCONSUMERS ELECTRIC UTILITY PROPERTIES\nConsumers' electric generating system consists of five fossil-fueled plants, two nuclear plants, one pumped storage hydroelectric facility, seven gas combustion turbine plants and 13 hydroelectric plants.\nConsumers' electric transmission and distribution lines owned and in service are as follows:\nStructure Sub-Surface (Miles) (Miles)\nTransmission 345,000 volt 1,137 - 138,000 volt 3,265 4 120,000 volt 20 - 46,000 volt 4,095 9 23,000 volt 30 7 ------ ----- Total transmission 8,547 20\nDistribution (2,400-24,900 volt) 51,341 5,276 ------ ----- Total transmission and distribution 59,888 5,296 ====== =====\nConsumers owns substations having an aggregate transformer capacity of 37,847,720 kilovoltamperes.\nCONSUMERS GAS UTILITY PROPERTIES\nConsumers' gas distribution and transmission system consists of 21,690 miles of distribution mains and 1,078 miles of transmission lines throughout the Lower Peninsula of Michigan. Consumers owns and operates six compressor stations with a total of 130,170 installed horsepower.\nConsumers' gas storage fields, listed below, have an aggregate certified storage capacity of 242.2 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nOverisel Allegan and Ottawa Counties 64.0 Salem Allegan and Ottawa Counties 35.0 Ira St Clair County 7.5 Lenox Macomb County 3.5 Ray Macomb County 66.0 Northville Oakland, Washtenaw and Wayne Counties 25.8 Puttygut St Clair County 16.6 Four Corners St Clair County 3.8 Swan Creek St Clair County .6 Hessen St Clair County 18.0 Lyon - 34 Oakland County 1.4\nMichigan Gas Storage owns and operates two compressor stations with a total of 46,600 installed horsepower. Its transmission system consists of 548 miles of pipelines within the Lower Peninsula of Michigan.\nMichigan Gas Storage's gas storage fields, listed below, have an aggregate certified storage capacity of 117 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nWinterfield Osceola and Clare Counties 75.0 Cranberry Lake Clare and Missaukee Counties 30.0 Riverside Missaukee County 12.0\nConsumers' gas properties also include the Marysville gas reforming plant, located in Marysville, Michigan. Huron and PanCanadian Petroleum Company are partners in a partnership to use the expanded capacity of the underground caverns at the Marysville plant for commercial storage of liquid hydrocarbons. In addition, Consumers and PanCanadian Petroleum Company are partners in a partnership to use certain hydrocarbon fractionation facilities at the plant.\nCMS ENERGY OIL AND GAS EXPLORATION AND PRODUCTION PROPERTIES\nNet oil and gas production by CMS NOMECO for the years 1993 through 1995 is shown in the following table.\nThousands of barrels of oil and millions of cubic feet of gas, except for reserves\n1995 1994 1993\nOil and condensate (a) 4,267 2,025 1,716 Natural gas (a) 26,348 20,546 18,487 Plant products (a) 226 193 186 Average daily production (b) Oil 16.1 7.1 5.6 Gas 84.9 69.3 62.3\nReserves to annual production ratio Oil (MMbbls) 14.9 26.1 19.1 Gas (bcf) 10.8 11.3 10.9\n(a) Revenue interest to CMS NOMECO (b) CMS NOMECO working interest (includes CMS NOMECO's share of royalties)\nThe following table shows CMS NOMECO's estimated proved reserves of oil and gas for the years 1993 through 1995.\nThe following table shows CMS NOMECO's undeveloped net acres of oil and gas leasehold interests at December 31.\nNet Acres 1995 1994\nMichigan 143,243 85,372 Louisiana (a) 17,408 30,418 North Dakota 15,586 5,099 Texas (a) 11,458 7,823 Indiana 7,014 2,518 Ohio 4,494 2,201 Other states 4,335 1,908 --------- --------- Total Domestic 203,538 135,339 --------- --------- Yemen 401,897 401,897 Venezuela 230,175 234,002 Equatorial Guinea 113,947 47,330 Tunisia 67,891 - Ecuador 66,430 69,160 Colombia 42,571 85,217 Congo 17,981 - Papua New Guinea - 63,220 New Zealand - 602 --------- --------- Total International 940,892 901,428 --------- --------- Total 1,144,430 1,036,767 ========= =========\n(a) Includes offshore acreage.\nCONSUMERS OTHER PROPERTIES\nCMS Midland owns a 49 percent interest in the MCV Partnership which was formed to construct and operate the MCV Facility. The MCV Facility has been sold to five owner trusts and leased back to the MCV Partnership. CMS Holdings is a limited partner in the FMLP, which is a beneficiary of one of these trusts. CMS Holdings' indirect beneficial interest in the MCV Facility is 35 percent.\nConsumers owns fee title to 1,140 acres of land in the City and Township of Midland, Midland County, Michigan, occupied by the MCV Facility. The land is leased to the owners of the MCV Facility by five separate leases, each leasing an undivided interest and in the aggregate totaling 100 percent, for an initial term ending December 31, 2035 with possible renewal terms to June 15, 2090.\nConsumers owns or leases three principal General Office buildings in Jackson, Michigan and 55 field offices at various locations in Michigan's Lower Peninsula. Of these, two General Office buildings and eleven field offices are leased. Also owned are miscellaneous parcels of real estate not now used in utility operations.\nCMS ENERGY OTHER PROPERTIES\nThe following table shows CMS Generation's interests in independent power plants at December 31, 1995.\nLocation Ownership Capacity Interest (%) (MW) Wood Fueled Chateaugay, New York 50.0 20 Grayling Township, Michigan 50.0 39 Imperial Valley, California 48.0 15 Lyonsdale, New York 50.0 19 New Bern, North Carolina 50.0 45 Stratton, Maine 30.0 40 Susanville, California 50.0 36\nFossil Fueled Cebu Island, Philippines (two plants) 32.5 135 Filer City, Michigan 50.0 60 Lakewood, New Jersey 45.0 236 Little Falls, New York 50.0 4 Mendoza Province, Argentina 51.0 422 Oklahoma City, Oklahoma 8.8 110 Solvay, New York 37.5 80\nTire Fueled Sterling, Connecticut 50.0 31\nHydro Generation Benton, Maine 50.0 4 Canton, New York 50.0 8 Copenhagen, New York 50.0 3 Corinth, New York 12.5 58 Limay River, Argentina (two plants) 17.2 1,320 Little Falls, New York 1.0 13 Lyons Falls, New York 50.0 3 Petersburg, Virginia 55.5 3 Port Leyden, New York 12.5 6\nWind Generation Altamont Pass, California 22.7 30 Montezuma, California 8.5 72\nDuring the year, CMS Generation sold substantially all of its 18.6 percent interest in a consortium which owns an 88 percent interest in a 650 MW fossil-fueled plant in San Nicolas, Argentina; and its 50 percent interest in a 5 MW hydroelectric power plant in Bath, New York.\nCMS Gas Transmission owns a 75 percent interest in a general partnership which owns and operates a 25-mile, 16-inch natural gas transmission pipeline in Jackson and Ingham Counties, Michigan; owns a 24 percent limited partnership interest in the Saginaw Bay Area Limited Partnership which owns 125 miles of 10-inch and 16-inch natural gas transmission pipeline in north-central Michigan; owns a 44 percent limited partnership interest in a partnership that owns certain pipelines of 20 and 12 miles interconnected to the Saginaw Bay Area Limited Partnership facilities; owns natural gas treating plants in Otsego County, Michigan; owns 41 miles of gas transmission pipeline in Otsego and Montmorency Counties, Michigan; and owns a 25 percent general partnership interest in TGN, which owns and operates 2,600 miles of pipelines that provide natural gas transmission service to the northern and central parts of Argentina.\nIn late 1995, CMS Gas Transmission completed construction and commenced operations of the Bluewater Pipeline, a 3.1 mile pipeline from an interconnection with Consumers natural gas transmission system to an interconnection with an existing pipeline at the St. Clair River, south of Port Huron, Michigan.\nCMS Gas Transmission is currently developing the Grands Lacs Market Center. Located in southeastern Michigan, this site was selected as a North American natural gas market center which will provide natural gas storage services, peaking storage, wheeling, parking and other related natural gas services to both buyers and sellers.\nIn January 1996, CMS Gas Transmission acquired Petal Gas Storage Company, a natural gas storage facility located in Forrest County, Mississippi. The salt dome storage cavern provides up to 3.2 bcf per day of ten day storage service and has the capability of being refilled in 20 days.\nThrough an ownership interest in Nitrotec Corporation, a proprietary gas technology company acquired in January 1996, CMS Gas Transmission currently has two helium recovery plants under construction in Kansas. One helium recovery plant was placed in service in October 1995.\nCMS Energy, through certain subsidiaries, owns a 50 percent interest in Bay Harbor Limited Liability Company, a resort development in Emmet County, Michigan, owns 6,000 acres of undeveloped land in Benzie and Manistee Counties, Michigan, and owns 53 acres of undeveloped land in Muskegon County, Michigan.\nCONSUMERS CAPITAL EXPENDITURES\nCapital expenditures during 1995 for Consumers and its subsidiaries totaled $445 million for capital additions and $9 million for DSM programs. These capital additions include $33 million for environmental protection additions and $31 million for capital leases of nuclear fuel and other assets. Of the $445 million, $320 million was incurred for electric utility additions and $125 million for gas utility additions. The electric and gas utility additions include an attributed portion of capital expenditures common to both businesses.\nIn 1996, capital expenditures are estimated to be $428 million for capital additions and $7 million for DSM programs. These capital addition estimates include $39 million related to environmental protection additions and $44 million related to capital leases of nuclear fuel and other assets. Of the $428 million, $304 million will be incurred for electric utility additions and $124 million for gas utility additions. The estimated electric and gas utility additions include an attributed portion of anticipated capital expenditures common to both businesses.\nCMS ENERGY CAPITAL EXPENDITURES\nCapital expenditures during 1995 for CMS Energy and its subsidiaries totaled $1.0 billion for capital additions and $9 million for DSM programs. These capital additions include $33 million for environmental protection additions and $31 million for capital leases of nuclear fuel and other assets. Of the $1.0 billion, $445 million was incurred by Consumers as discussed above. The remaining $599 million in capital additions include $168 million for oil and gas exploration and development, $239 million for independent power production, $178 million for natural gas transmission, storage and marketing and $14 million for other capital expenditures.\nIn 1996, capital expenditures are estimated to be $849 million for capital additions and $7 million for DSM programs. This capital addition estimate includes $39 million related to environmental protection additions and $44 million related to capital leases of nuclear fuel and other assets. Of the $849 million, $428 million will be incurred by Consumers as discussed above. The remaining $421 million in capital additions will be incurred as follows: $120 million for oil and gas exploration and development, $189 million for independent power production, and $112 million for natural gas transmission, storage and marketing.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nConsumers and some of its subsidiaries and affiliates are parties to certain routine lawsuits and administrative proceedings incidental to their businesses involving, for example, claims for personal injury and property damage, contractual matters, income taxes, and rates and licensing. Reference is made to the Notes to the Consolidated Financial Statements included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters.\nThe Attorney General, ABATE, and the MPSC staff typically intervene in MPSC proceedings concerning Consumers. Unless otherwise noted below, these parties have intervened in such proceedings. For many years, almost every significant MPSC order affecting Consumers has been appealed. Appeals from such MPSC orders are pending in the Michigan Court of Appeals and the Michigan Supreme Court. Consumers is vigorously pursuing these matters. Under Michigan civil procedure, parties may file a claim of appeal with the Michigan Court of Appeals which serves as a notice of appeal. The grounds on which the appeal is being made are not finally set forth until a later date when the parties file their briefs.\nRATE CASE PROCEEDINGS\nAppeal of MPSC Orders Related to the Abandoned Midland Nuclear Plant Investment\nIn November 1983, Consumers filed an electric rate case with the MPSC which sought recovery of its investment in the abandoned portion of the Midland nuclear plant. This case was separated into two phases in September 1984: a financial stabilization phase, MPSC Case No. U-7830, Step 3A, and a prudence phase, MPSC Case No. U-7830, Step 3B. Numerous orders were issued in these cases, including one issued in 1985 in the financial stabilization phase which contained certain conditions to Consumers' receiving financial stabilization rate relief.\nOn May 7, 1991, the MPSC issued final orders in both Step 3A and Step 3B proceedings. In Step 3B, the MPSC ruled, among other things, that Consumers could recover approximately $760 million of its $2.1 billion of abandoned Midland investment. In Step 3A, the MPSC reviewed Consumers' compliance with the financial stabilization order conditions. Consumers, as well as the Attorney General and ABATE, among others, filed applications for rehearing with the MPSC of the May 7 Orders in Step 3A and Step 3B which were all denied by the MPSC. Several parties, including Consumers, appealed the MPSC determinations in these orders to the Court of Appeals. Regarding the Step 3B order, the Attorney General and ABATE primarily disagreed with the standard used by the MPSC to determine the amount of investment that is recoverable by Consumers from its electric customers, contending that recovery should not be allowed for utility assets that have not been placed in service. Consumers disagreed with the date the MPSC determined it would have been prudent for Consumers to abandon construction of the Midland nuclear facility and the reduction in recoverable investment that resulted from this determination. In the Step 3A appeal, the Attorney General and ABATE contended that Consumers did not fully comply with the financial stabilization orders. In separate decisions, the Court of Appeals has affirmed the MPSC determinations in Step 3A and Step 3B. ABATE, the Attorney General and Consumers filed applications for leave to appeal the Court of Appeals decision in Step 3B with the Michigan Supreme Court. In October 1995, the Michigan Supreme Court denied all applications for leave to appeal the Court of Appeals' decision relating to the Step 3B order. In May 1995, ABATE filed an application with the Michigan Supreme Court for leave to appeal the Court of Appeals' affirmation of the MPSC's determinations in Step 3A.\n1993 ELECTRIC RATE CASE\nOn May 10, 1994, the MPSC issued a final order in this case which increased annual electric revenues by $58 million, or about 2.8 percent, and approved an allowed rate of return on common equity of 11.75 percent. The rate increase is effective for service rendered on and after May 11, 1994. In August 1994, the MPSC denied petitions for rehearing filed by Consumers and the Attorney General. The Attorney General has appealed the MPSC order to the Court of Appeals arguing that the MPSC cannot require Consumers to spend money on DSM programs and that a modified interruptible rate authorized by the MPSC is unlawful because it permits Consumers to negotiate rates, for certain customers, within a specified range.\n1994 ELECTRIC RATE PROCEEDINGS\nIn November 1994, Consumers filed a request with the MPSC which could have increased its retail electric rates in a range from $104 million to $140 million, depending upon the ratemaking treatment afforded sales losses to competition and the treatment of the 325 MW of MCV Facility contract capacity above 915 MW. The request included a proposed increase in Consumers' authorized rate of return on equity to 13 percent from the current 11.75 percent, recognition of increased expenditures related to continuing construction activities and capital additions aimed at maintaining and improving system reliability and increases in financing costs. The filing addressed the ratemaking effect of jurisdictional sales losses by assuming adoption of a proposed special nonjurisdictional rate to large, qualifying industrial customers as requested by Consumers in an earlier June 1994 filing with the MPSC. An alternative approach presented would use the MCV Facility contract capacity above 915 MW for jurisdictional electric customers and offer discounted jurisdictional tariffs. Consumers had also requested that the MPSC eliminate the rate subsidization of residential rates in a two-step adjustment. In addition, Consumers proposed to eliminate all DSM expenditures after April 1995 and further requested MPSC approval to recover costs associated with the proposed settlement of the proceedings concerning the operation of Ludington. During this case, the MPSC issued an order stating that the remaining 325 MW of MCV Facility capacity will be considered only as part of a competitive capacity solicitation, and not as part of the electric rate case. In November 1995, the MPSC granted Consumers' petition for rehearing of this order, and the issue is pending in the settlement discussed below.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that, if approved by the MPSC, would resolve several outstanding regulatory issues currently before the MPSC in three separate proceedings, one of which was the 1994 electric rate case. In mid- September, the MPSC issued an order creating a consolidated proceeding to consider the proposed settlement agreement. Hearings on the proposed settlement agreement are continuing. Approval of the proposed settlement agreement could: provide for cost recovery of the remaining 325 MW of contract capacity from the MCV Facility; result in recovery of Consumers' regulatory assets related to power purchase agreements which have been terminated; introduce provisions for incentive ratemaking; resolve the pending special competitive services and depreciation rate cases; implement a limited direct access program under which it would be possible for Consumers to deliver power from qualified third party power suppliers to qualified retail customers; enable Consumers to negotiate rates for certain large industrial customers; and accelerate recovery of nuclear plant investment. The MPSC issued a partial order in the electric rate case, as described below, and under the current schedule, the MPSC should decide the remaining issues by mid-1996. Consumers cannot predict whether the entire settlement will be approved by the MPSC.\nOn February 5, 1996, the MPSC issued a partial final order in the electric rate case. In that order, the MPSC authorized Consumers to increase its electric retail rates and charges by approximately $46 million; authorized a return on common equity of 12.25 percent; reduced the subsidization of residential customers by industrial and large commercial customers taking service at primary voltage in a two-step process, which will increase residential rates by 3.9 percent for services rendered on and after February 6, 1996 and increase residential rates by another 3.9 percent for services rendered on and after December 1, 1996; and approved the Ludington settlement and the recovery of costs related to the Ludington settlement.\nREQUEST FOR APPROVAL OF A COMPETITIVE TARIFF FOR CERTAIN INDUSTRIAL CUSTOMERS\nIn January 1995, the MPSC dismissed a filing made by Consumers, seeking approval of a plan to offer competitive, special rates to certain large qualifying customers. Consumers had proposed to offer the new rates to customers using high amounts of electricity that have expressed an intention to or are capable of terminating purchases of electricity from Consumers and have the ability to acquire energy from alternative sources. Consumers subsequently filed a new, simplified proposal with the MPSC which would allow Consumers a certain level of rate-pricing flexibility and allow the use of the MCV Facility contract capacity above the level currently authorized by the MPSC to respond to customers' alternative energy options. Some of the intervenors in this proceeding filed motions to dismiss this case contesting the MPSC's jurisdiction to authorize the type of rates proposed. In May 1995, the MPSC issued an order stating that it has legal authority to approve a range of rates under which Consumers could negotiate prices with customers that have competitive energy alternatives. All parties have filed briefs and reply briefs in this proceeding. See 1994 Electric Rate Proceedings, for information concerning a proposed settlement agreement relating to this case, including treatment of the remaining 325 MW of MCV Facility contract capacity addressed in this case.\n1994 GAS RATE CASE FILING\nConsumers filed a general gas rate case in December 1994. Consumers' final position in this case requested an increase in its gas rates of $6.7 million annually and a 12.25 percent return on equity. Consumers' request incorporated, among other things, cost increases, including costs for postretirement benefits and costs related to the investigation and remediation of Consumers' former manufactured gas plant sites.\nThe MPSC issued a final order in this case in March 1996. In this order the MPSC reduced Consumers' general gas rates by $11.7 million annually, based on a return on common equity of 11.6 percent. Consumers was authorized to recover the gas utility portion of its postretirement benefit costs over a period of 16 years. The order also authorized Consumers to defer environmental cleanup costs relating to its former manufactured gas plant sites for amortization over a ten-year period beginning with the year following incurrence. Rate recognition of amortization expense will not begin until after a prudence review in a general rate case. The prudence review will include consideration of Consumers' attempts to minimize it's exposure and obtain reimbursement from third parties. In this rate order, the MPSC authorized Consumers current recovery of approximately $1 million a year, based upon an historical five-year average of such environmental clean up expenses. Carrying costs will be earned on balances included in rate base at the authorized pre-tax rate of return.\nMCV - RELATED PROCEEDINGS\nIn March 1993, the MPSC approved, with modifications, a contested settlement agreement among Consumers, the MPSC staff and 10 independent cogenerators which resolved certain regulatory issues and allowed Consumers to recover from electric customers a substantial portion of the cost of 915 MW of contract capacity from the MCV Facility. After their requests for rehearing were denied by the MPSC, ABATE and the Attorney General appealed the orders approving the settlement to the Court of Appeals. Briefs have been filed and oral argument held before the Court of Appeals where the appeals await decision. In the meantime, the MPSC has been implementing the settlement in PSCR plan and reconciliation cases for 1993, 1994 and subsequent years. However, various parties dissatisfied with such implementation, including Consumers, have appealed the MPSC orders in these cases. In February 1996, the Court of Appeals affirmed the MPSC's order in the 1993 PSCR plan case which implemented the Settlement Order based upon projected data for 1993. Consumers had not appealed that implementation order, but ABATE had. The other appeals remain pending before the Court of Appeals at various stages of the appellate process.\nCMS ENERGY'S EXEMPTION UNDER PUHCA\nCMS Energy is exempt from registration under PUHCA. In December 1991, the Attorney General and the MMCG filed a request with the SEC for the revocation of CMS Energy's exemption. In January 1992, CMS Energy responded to the revocation request affirming its position that it is entitled to the exemption. In April 1992, the MPSC filed a statement with the SEC that recommended that the SEC impose certain conditions on CMS Energy's exemption. CMS Energy is vigorously contesting the revocation request and believes it will maintain the exemption. There has been no action taken by the SEC on this matter.\nIn June 1995, the SEC released a staff report that recommended legislative options to Congress: 1) repeal PUHCA and strengthen the ability of the FERC and state regulators to obtain books and records, conduct audits and review affiliate transactions; 2) repeal PUHCA, without condition; or 3) amend PUHCA to give the SEC broader exemptive authority. The SEC staff supported option 1 because it would achieve the benefits of unconditional repeal, while preserving the ability of states to protect consumers. In October 1995, a bill was introduced in the U. S. Senate to transfer oversight of public utility holding companies from the SEC to FERC.\nLUDINGTON PUMPED STORAGE PLANT\nIn October 1994, Consumers, Detroit Edison, the Attorney General, the DNR and certain other parties signed an agreement in principle designed to resolve all legal issues associated with fish mortality at Ludington. The definitive settlement documents were thereafter filed with the appropriate Michigan Courts and State and federal agencies. On January 23, 1996, the FERC approved the settlement agreement. On February 5, 1996, the MPSC approved the settlement agreement and the recovery of costs associated with the settlement agreement. The settlement allows for the continued operation of the plant through the end of its FERC license and requires Consumers and Detroit Edison to continue using a seasonal barrier net as well as monitoring new technology which may further reduce fish loss at the plant. It requires Consumers to develop and improve recreational areas and convey undeveloped land to the State of Michigan and the Great Lakes Fishery Trust (with an original cost of $9 million and a fair market value in excess of $20 million), make an initial payment of approximately $3 million and incur approximately $1 million of expenditures related to recreational improvements. Future annual payments of approximately $1 million are also anticipated over the next 24 years and are intended to enhance the fishery resources of the Great Lakes. The settlement resolves two lawsuits filed by the Attorney General in 1986 and 1987 on behalf of the State of Michigan in the Circuit Court of Ingham County which sought damages from Consumers and Detroit Edison for injuries to fishery resources because of the operation of the Ludington plant and the revocation of the plant's bottom-lands lease.\nSTRAY VOLTAGE LAWSUITS\nConsumers has a number of lawsuits relating to so-called stray voltage, which results when small electrical currents present in grounded electric systems are diverted from their intended path. Claimants contend that stray voltage affects farm animal behavior, reducing the productivity of their livestock operations. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers' system. On October 27, 1993, a complaint seeking certification as a class action suit was filed against Consumers in a local circuit court. The complaint alleged that in excess of a billion dollars of damages, primarily related to lost production by certain livestock owned by the purported class, were being incurred as a result of stray voltage from electricity being supplied by Consumers. Consumers believed the allegations to be without merit and vigorously opposed the certification of the class and this suit. On March 11, 1994, the court decided to deny class certification for this complaint and to dismiss, subject to refiling as separate suits, the October lawsuit with respect to all but one of the named plaintiffs. On April 4, 1994, the plaintiffs appealed the court's denial of class certification in this matter to the Court of Appeals. The Court of Appeals on its own motion issued an order which decided that since the lead case in the class action suit had not been dismissed, the trial court's decision to deny class certification was an interlocutory order and therefore not ripe for appeal. The Court of Appeals order also found that the trial court's decision that the other named plaintiffs had been misjoined was final and ripe for appeal. This issue had not been raised in the plaintiffs' appeal or brief. Consumers and plaintiffs have now addressed both issues in their briefs filed with the Court of Appeals. This matter is pending before the Court of Appeals. A number of individuals who would have been part of the class action have refiled their claims as separate lawsuits. On February 14, 1996, Consumers had 33 separate stray voltage cases pending for trial, down from 83 pending at year-end 1994.\nRETAIL WHEELING PROCEEDINGS\nIn April 1994, the MPSC issued an Opinion and Interim Order which approved the framework for a five-year experimental retail wheeling program for Consumers and Detroit Edison, and remanded the case to the ALJ to determine appropriate rates and charges. The MPSC stated that the purpose of the experiment is to gather and evaluate information regarding whether retail wheeling is in the public interest and should occur on a permanent basis. The experimental program will commence with each utility's next solicitation of additional supply side resources. In June 1995, the MPSC issued an order that set rates and charges for retail delivery service under the experiment. In September 1995, the MPSC denied Consumers' and ABATE's petitions for rehearing of this order. Consumers, ABATE and Dow have filed claims of appeal of the MPSC's order with the Court of Appeals, joining Detroit Edison and the Attorney General who had previously appealed. The Court of Appeals subsequently consolidated the appellate cases of these parties.\nWHOLESALE WHEELING PROCEEDINGS\nConsumers has an approved open-access interconnection service schedule on file with the FERC for wholesale wheeling transactions. In 1992, Consumers also filed a separate but complementary open-access transmission tariff that would make both firm and non-firm transmission service available to eligible power generators, including investor-owned utilities, facilities that meet the ownership and technical requirements under PURPA, independent power producers, and municipal and cooperative utilities. The FERC accepted the filing, effective May 2, 1992, subject to refund, and ordered a hearing before an ALJ. In September 1993, the ALJ issued an initial decision that would compel reductions of the tariff rates ranging from 25 percent to 65 percent. On November 1, 1993, Consumers filed exceptions with the FERC, which are still pending, seeking reversal of the rate reductions proposed in the ALJ's initial decision. As of January 1, 1996, the amount of firm transmission service currently subject to the tariff is 29 MW. For discussion of a notice of rulemaking by the FERC relating to changes in the wholesale electric industry, see Item 1. BUSINESS. CONSUMERS AND CMS ENERGY COMPETITION - Electric Competition.\nHIGHLAND TOWNSHIP FRANCHISE PROCEEDING\nMichCon obtained a revocable franchise in 1956 to provide natural gas service to Highland Township, Michigan. In 1962, Consumers secured an irrevocable 30 year franchise to provide natural gas service to Highland Township. Neither franchise was exclusive. Although MichCon's franchise for service in Highland Township expired in 1986 and was not renewed, MichCon continued service to customers in Highland Township. Consumers secured a revocable renewal franchise for Highland Township in 1992.\nThereafter, in 1992, Consumers filed suit to enjoin MichCon from expanding its gas service to new customers in Highland Township. The Circuit Court of Oakland County, Michigan denied MichCon's motion for summary disposition and granted Consumers' petition for an injunction. MichCon subsequently transferred its remaining rights and interest in Highland Township to Consumers, ceased doing business there and appealed the Circuit Court decision with the Court of Appeals. In August 1995, the Court of Appeals refused to decide the issue addressed by the Circuit Court (namely whether MichCon, as a holdover utility without any franchise, could continue to lawfully do business in a township) because the Court of Appeals concluded that Consumers' 1992 revocable renewal franchise was invalid since it was not confirmed by a vote of the Highland Township electorate as the Court determined was required by the Public Utility Franchise Act. Prior to this decision, the commonly held interpretation of the Public Utility Franchise Act was that a vote of the electorate was only required for irrevocable franchises, not revocable franchises such as that held by Consumers in this case. The Michigan Court of Appeals reversed the Circuit Court decision and remanded the case to the Circuit Court for entry of summary disposition in MichCon's favor - - - even though the only franchise MichCon had ever possessed was revocable, and thus under the Court of Appeals' decision, invalid. Although the Court of Appeals specifically stated in its opinion that continuing to provide utility service without a valid franchise was not necessarily unlawful, Consumers currently has over 800 revocable franchises which could be affected should the Court of Appeals order remain in place. Consumers' motion for reconsideration and for a stay of the Court of Appeals' decision was denied. In December 1995, Consumers filed an application with the Michigan Supreme Court for leave to appeal the Court of Appeals' decision.\nINTRASTATE GAS SUPPLIER CONTRACT PRICING DISPUTE\nOn October 25, 1995, the MPSC issued an opinion and order in a proceeding that had been initiated by Consumers regarding a gas contract pricing dispute under three gas supply contracts. The MPSC found that a pricing mechanism like the one at issue, that operates within definite ceiling and floor prices, is a definite pricing provision within the meaning of the state statutes and was properly implemented to reduce gas prices without the prior approval of the MPSC. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals.\nPrior to the issuance of the MPSC's order, the intrastate gas producers involved in this MPSC proceeding filed a complaint against Consumers in Kent County Circuit Court alleging breach of contract. On Consumers' motion, the court dismissed the lawsuit. The gas suppliers subsequently filed a petition for rehearing with the court where the matter is still pending.\nMPSC CASE NO U-10029 - INTRASTATE GAS SUPPLY\nOn February 8, 1993, the MPSC issued an order granting Consumers' request to lower the price to be paid to one of its intrastate gas suppliers, North Michigan, who then filed an appeal with the Court of Appeals. In June 1995, the Court of Appeals affirmed the MPSC's decision and North Michigan's motion for reconsideration was denied in August 1995. In September 1995, North Michigan filed an application with the Michigan Supreme Court for leave to appeal the Court of Appeals' order.\nCollateral suits claiming relief based on a theory of breach of contract, among other things, were filed by the producers in the Grand Traverse County Circuit Court and in the Clinton County Circuit Court, which was subsequently transferred to Jackson County Circuit Court. The dismissals of the Grand Traverse County Circuit Court suit and the Jackson County Circuit Court suit have been appealed by the producers to the Court of Appeals.\nENVIRONMENTAL MATTERS\nConsumers is subject to various federal, state and local laws and regulations relating to the environment. Consumers has been named as a party to several actions involving environmental issues. However, based on its present knowledge and subject to future legal and factual developments, CMS Energy and Consumers believe that it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition. See Item 1. BUSINESS. CONSUMERS AND CMS ENERGY ENVIRONMENTAL COMPLIANCE.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nCMS ENERGY\nNone in the fourth quarter of 1995 for CMS Energy.\nCONSUMERS\nNone in the fourth quarter of 1995 for Consumers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR CMS ENERGY'S AND CONSUMERS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nCMS Energy\nMarket prices for CMS Energy's common stock and related security holder matters are contained herein in Item 8, CMS Energy's Quarterly Financial and Common Stock Information, which is incorporated by reference herein. Number of common shareholders at February 29, 1996 was 89,167.\nConsumers\nConsumers' common stock is privately held by its parent, CMS Energy, and does not trade in the public market. In May 1995, Consumers paid $70 million in cash dividends on its common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nCMS Energy\nSelected financial information is contained in Item 8, CMS Energy's Selected Financial Information which is incorporated by reference herein.\nConsumers\nSelected financial information is contained in Item 8, Consumers' Selected Financial Information which is incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nCMS Energy\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, CMS Energy's Management's Discussion and Analysis which is incorporated by reference herein.\nConsumers\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, Consumers' Management's Discussion and Analysis which is incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Financial Statements:\nCMS Energy Page\nSelected Financial Information 51 Management's Discussion and Analysis 53 Consolidated Statements of Income 64 Consolidated Statements of Cash Flows 65 Consolidated Balance Sheets 66 Consolidated Statements of Preferred Stock 68 Consolidated Statements of Common Stockholders' Equity 69 Notes to Consolidated Financial Statements 70 Report of Independent Public Accountants 94 Quarterly Financial and Common Stock Information 95\nConsumers Page\nSelected Financial Information 98 Management's Discussion and Analysis 99 Consolidated Statements of Income 108 Consolidated Statements of Cash Flows 109 Consolidated Balance Sheets 110 Consolidated Statements of Long-Term Debt 112 Consolidated Statements of Preferred Stock 113 Consolidated Statements of Common Stockholder's Equity 114 Notes to Consolidated Financial Statements 115 Report of Independent Public Accountants 136 Quarterly Financial Information 137\n(This page intentionally left blank)\nCMS Energy Corporation\n1995 Financial Statements\nCMS Energy Corporation Management's Discussion and Analysis\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses, including oil and gas exploration and production, development and operation of independent power production facilities, electric and gas marketing services to utility, commercial and industrial customers, and storage and transmission of natural gas.\nConsolidated Earnings\nConsolidated net income for 1995 totaled $204 million comprised of $201 million of net income attributable to CMS Energy Common Stock or $2.27 per share compared to net income of $179 million or $2.09 per share in 1994 and net income of $155 million or $1.90 per share in 1993. Net income attributable to Class G Common Stock totaled $3 million or $.38 per share in 1995. The improved net income for 1995 reflects increased utility electric sales and utility gas deliveries, increased electric utility revenue as a result of the May 1994 rate increase, reversal of losses previously recorded for gas utility contingencies (see Note 4), improved operating results from Consumers' interest in the MCV Facility, and the continuing growth of the international businesses. For further information, see the Electric and Gas Utility Results of Operations sections and the individual international results of operations sections. The increased 1994 net income over the 1993 period reflects a significant increase in utility electric sales, the impact of the 1994 electric rate increase, recognition of incentive revenue related to DSM programs, the favorable resolution of a previously recorded gas cost contingency, and the growth of international businesses.\nCash Position, Financing and Investing\nCMS Energy's primary ongoing source of operating cash is dividends from its subsidiaries. In 1995, CMS Energy received a $70 million dividend from Consumers compared to $176 million in 1994. This decrease represents Consumers temporarily suspending its common dividends to CMS Energy in lieu of CMS Energy making a direct equity infusion of cash into Consumers. In 1996, Consumers plans to resume common stock dividend payments to CMS Energy.\nCMS Energy's consolidated cash from operations is derived mainly from Consumers' sale and transportation of natural gas, its generation, transmission, and sale of electricity and CMS NOMECO's sale of oil and natural gas. Consolidated cash from operations during 1995 increased $70 million from the 1994 level primarily from higher sales of electricity and gas, lower gas inventories, timing of cash payments related to its utility operations, CMS NOMECO's increased sale of oil and natural gas and the growth of the international businesses partially offset by Consumers' higher power purchases from the MCV Partnership. CMS Energy primarily uses this operating cash to expand its international businesses, maintain its electric and gas utility systems, retire portions of its long-term securities and pay dividends.\nFinancing Activities: Net cash provided by financing activities in 1995 increased $163 million from 1994, primarily reflecting the issuance of Class G Common Stock and increased long-term debt. Net cash provided by financing activities in 1994 increased by $214 million primarily reflecting the issuance of Consumers preferred stock.\nIn January 1994, CMS Energy filed a shelf-registration statement with the SEC for the issuance and sale of up to $250 million of GTNs. As of December 31, 1995, CMS Energy had issued approximately $221 million of GTNs with a weighted average interest rate of 7.7 percent.\nIn the third quarter 1995, CMS Energy received net proceeds of approximately $123 million from the issuance of 7.52 million shares of Class G Common Stock at a price to the public of $17.75 per share, initially representing 23.50 percent of the common stockholder's equity value attributed to the Consumers Gas Group. All of the proceeds from this sale will fund the capital programs and be used for general corporate purposes of CMS Energy. Initially, such proceeds were used to repay a portion of CMS Energy's indebtedness under the Credit Facility, none of which was attributable to the Consumers Gas Group. In 1995, CMS Energy issued approximately $90 million of CMS Energy Common Stock in conjunction with the acquisitions of Terra and Walter.\nIn January 1995, CMS Generation entered into a one-year $118 million bridge credit facility for the acquisition of HYDRA-CO of which approximately $109 million remained outstanding as of December 31, 1995. In January 1996, CMS Generation refinanced the bridge credit facility into a $110 million, five-year term loan.\nDuring 1995, CMS Energy paid $80 million in cash dividends to holders of CMS Energy Common Stock compared to $67 million in 1994. The $13 million increase reflects an annual increase of $.12 per share to $.96 per share, commencing third quarter 1995. CMS Energy also paid $4 million in cash dividends to holders of Class G Common Stock. Dividends on preferred stock increased to $28 million in 1995, reflecting Consumers' issuance of additional preferred stock in 1994.\nIn October 1995, CMS NOMECO filed a registration statement with the SEC for an initial public offering of not more than 20 percent of CMS NOMECO common stock. CMS Energy will continue to evaluate market conditions for a possible future offering of CMS NOMECO common stock.\nIn November 1995, CMS Energy amended the terms of its $400 million Unsecured Credit Facility, increased the amount to $450 million and extended the termination date to June 30, 1998. CMS Energy also entered into a $125 million, seven-year Term Loan Agreement. As of December 31, 1995, $118 million and $125 million remains outstanding for the Unsecured Credit Facility and Term Loan Agreement, respectively.\nInvesting Activities: Net cash used in investing activities in 1995 increased $307 million from 1994, primarily reflecting the acquisitions of TGN and HYDRA-CO. Capital expenditures, including assets placed under capital lease (see Note 17), deferred DSM costs, investment in international subsidiaries and common stock issued for acquisitions totaled $1,053 million in 1995 as compared to $672 million in 1994 and $768 in 1993. Capital expenditures for 1995 include approximately $200 million for acquisitions which commenced in 1994 but did not close until 1995. CMS Energy's expenditures for its utility, independent power production, oil and gas exploration and production, and gas transmission and marketing business segments were $454 million, $239 million, $168 million and $178 million, respectively.\nFinancing and Investing Outlook: CMS Energy estimates that capital expenditures, including new lease commitments, and investments in partnerships and unconsolidated subsidiaries, will total approximately $2.4 billion over the next three years.\nIn Millions Years Ended December 31 1996 1997 1998 - ----------------------- ---- ---- ---- Electric utility $311 $285 $295 Gas utility 124 110 105 Oil and gas exploration and production 120 135 150 Independent power production 189 175 150 Natural gas transmission, storage and marketing 112 70 50 ---- ---- ---- $856 $775 $750 ===== ===== ===== CMS Energy is required to redeem or retire approximately $1,266 million of long-term debt over the three-year period ending December 1998. Cash provided by operating activities is expected to satisfy a substantial portion of these capital expenditures and debt retirements. In January 1996, Consumers issued and sold 4 million shares of Trust Originated Preferred Securities with net proceeds totaling $96 million (see Note 8). CMS Energy will continue to evaluate the capital markets in 1996 as a source of financing its subsidiaries' investing activities and required debt retirements.\nConsumers has several available, unsecured, committed lines of credit totaling $145 million and a $425 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1996. Consumers uses short-term borrowings to finance working capital and gas in storage, and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. At December 31, 1995 and 1994, receivables sold totaled $295 million and $275 million, respectively.\nElectric Utility Results of Operations\nPretax Operating Income Change Compared to Prior Year\nIn Millions 1995\/1994 1994\/1993 --------- --------- Sales $ 59 $ 33 Rate increase and other regulatory issues 9 38 O&M, general taxes and depreciation (38) (25) ---- ---- Total change $ 30 $ 46 ==== ====\nElectric Sales: Total electric sales in 1995 were a record 35.5 billion kWh, a 3.0 percent increase from the 1994 level as a result of economic growth and warmer summer temperatures. The increase in total electric sales included a 4.2 percent increase in sales to Consumers' ultimate customers, with fairly consistent increases in the residential, commercial, and industrial sectors. The increase was partially offset by a decrease in certain sales to other utilities.\nTotal electric sales in 1994 were 34.5 billion kWh, a 5.2 percent increase from the 1993 level, which included a 4.2 percent increase in system sales to Consumers' ultimate customers.\nPower Costs: Power costs for 1995 totaled $970 million, a $20 million increase from the corresponding 1994 period, primarily reflecting increased purchased power costs due to higher sales levels. Power costs for 1994 totaled $950 million, a $42 million increase as compared to 1993 which reflects increased kWh production at Consumers' generating plants and greater power purchases from outside sources to meet increased sales demand.\nOperating Expenses: Electric operation and maintenance expense for 1995 compared to 1994 increased $13 million, which included $9 million of additional postretirement benefit costs and increased expenditures to improve electric system reliability. Electric depreciation for 1995 compared to 1994 increased $15 million, reflecting additional property and equipment. Electric general taxes increased $11 million in 1995 compared to 1994, reflecting millage rate increases and additional capital investments in property and equipment.\nElectric Utility Issues\nPower Purchases from the MCV Partnership: Consumers' annual obligation to purchase contract capacity from the MCV Partnership increased 108 MW in 1995 to 1,240 MW. In 1993, the MPSC issued the Settlement Order that have allowed Consumers to recover substantially all payments for 915 MW of contract capacity purchased from the MCV Partnership. ABATE and the Attorney General have appealed the Settlement Order to the Court of Appeals. The market for the remaining 325 MW of contract capacity was assessed at the end of 1992. This assessment, along with the Settlement Order, resulted in Consumers recognizing a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. Additional losses may occur if actual future experience materially differs from the 1992 estimates. As anticipated in 1992, Consumers continues to experience cash underrecoveries associated with the Settlement Order. These after-tax cash underrecoveries totaled $90 million, $61 million and $59 million in 1995, 1994 and 1993, respectively. Estimated future after-tax cash underrecoveries, and possible losses for 1996 and the next four years are shown in the table below.\nAfter-tax, In Millions 1996 1997 1998 1999 2000 ---- ---- ---- ---- ----\nEstimated cash underrecoveries $56 $55 $ 8 $ 9 $ 7\nPossible additional under- recoveries and losses (a) $20 $22 $72 $72 $74\n(a) If unable to sell any capacity above the MPSC's 1993 authorized level.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that would potentially resolve several issues in three pending proceedings, including cost recovery for the 325 MW of MCV Facility capacity above the MPSC's currently authorized level. For further information regarding the settlement, see Note 4.\nIn 1994 and 1995, Consumers terminated power purchase agreements with the developers of a proposed 65 MW coal-fired cogeneration facility and a proposed 44 MW wood and chipped-tire plant. To replace this capacity, 109 MW of less expensive contract capacity from the MCV Facility which Consumers is currently not authorized to recover from retail customers would be used. For further information, see Note 4.\nElectric Rate Proceedings: Consumers filed a request with the MPSC in late 1994 to increase its retail electric rates. In early 1996, the MPSC granted Consumers authority to increase its annual electric retail rates by $46 million. This partial final order did not address cost recovery related to the 325 MW of MCV Facility contract capacity above 915 MW. The MPSC stated that this matter would be addressed in connection with its consideration of the proposed settlement agreement discussed below.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that, if approved by the MPSC, would resolve several outstanding regulatory issues. One of these issues, Consumers' electric rate case, was addressed, in part, by the order discussed above. If fully adopted, the settlement agreement would resolve Consumers' depreciation and special competitive service cases (discussed below) and cost recovery of 325 MW of uncommitted MCV Facility capacity. Consumers expects a final order in the spring of 1996. For more information regarding the electric rate order and the settlement, see Note 4.\nIn 1995, Consumers filed a request with the MPSC, seeking approval to increase its traditional depreciation expense by $21 million and reallocate certain portions of its utility plant from production to transmission, resulting in a $28 million decrease. If both aspects of the request are approved, the net result would be a decrease in electric depreciation expense of $7 million for ratemaking purposes. The MPSC staff's filing in this case did not support Consumers' requested increase in depreciation expense, but instead proposed a decrease of $24 million. The MPSC staff also did not support the reallocation of plant investment as proposed by Consumers but suggested several alternatives which could partially address this issue. In September 1995, the ALJ issued a proposal for decision that essentially supported the MPSC staff's position regarding depreciation expense and recommended that the MPSC reject both Consumers' and the MPSC staff's positions regarding the reallocation of Consumers' depreciation reserve and plant investment. This case is currently part of the proposed settlement discussed above.\nSpecial Rates: Consumers currently has a request before the MPSC that, if approved, would allow Consumers a certain level of rate-pricing flexibility to respond to customers' alternative energy options. This request has been consolidated into the settlement proceeding discussed above.\nElectric Conservation Efforts: In June 1995, the MPSC issued an order that authorized Consumers to discontinue future DSM program expenditures and cease all new programs. For further information, see Note 4.\nElectric Environmental Matters: The 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nThe Michigan Natural Resources and Environmental Protection Act (formerly the Michigan Environmental Response Act) was substantially amended in June 1995. The Michigan law bears similarities to the federal Superfund law. The purpose of the 1995 amendments was generally to encourage development of industrial sites and to remove liability from some parties who were not responsible for activities causing contamination. Consumers expects that it will ultimately incur costs at a number of sites. Consumers believes costs incurred for both investigation and required remedial actions are properly recoverable in rates.\nConsumers is a so-called \"potentially responsible party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on current information, management believes it is unlikely that Consumers' liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position, liquidity or results of operations. For further information regarding electric environmental matters, see Note 14.\nElectric Outlook\nCompetition: Consumers currently expects approximately 2 percent average annual growth in electric system sales over the next five years.\nConsumers continues to be affected by the developing competitive market for electricity. The primary sources of competition include: the installation of cogeneration or other self-generation facilities by Consumers' larger industrial customers; the formation of municipal utilities which would displace retail service by Consumers to an entire community; and competition from neighboring utilities which offer flexible rate arrangements designed to encourage movement to their respective service areas. Consumers continues to work toward retaining its current retail service customers.\nIn an effort to meet the challenge of competition, Consumers has signed long-term sales contracts with some of its largest industrial customers, including its largest customer, General Motors Corporation. Under the General Motors contract, Consumers will serve certain facilities at least five years and other facilities at least 10 years in exchange for competitively discounted electric rates. Certain facilities will have the option of taking retail wheeling service (if available) after the first three years of the contract. The MPSC approved this contract in 1995.\nAs part of an order issued in early 1996, the MPSC significantly reduced the rate subsidization of residential customers by industrial and large commercial customers. In addition to offering electric rates that are competitive with other energy providers, Consumers is pursuing other strategies to retain its \"at-risk\" customers. These strategies include: minimizing outages for each customer, promptly responding to customer inquiries, and providing consulting services to help customers use energy efficiently.\nIn 1994, the MPSC approved a framework for a five-year experimental retail wheeling program for Consumers and Detroit Edison. Under the experiment, up to 60 MW of Consumers' additional load requirements could be met by retail wheeling. The program becomes effective upon Consumers' next solicitation for capacity. In June 1995, the MPSC issued an order that set rates and charges for retail delivery service under the experiment. Consumers, ABATE and Dow filed claims of appeal of the MPSC's retail wheeling orders. The Court of Appeals subsequently consolidated these appeals with those previously filed by Detroit Edison and the Attorney General. Consumers does not expect this short-term experiment to have a material impact on its financial position, liquidity or results of operations.\nIn March 1995, the FERC issued a NOPR and a supplemental NOPR that propose changes in the wholesale electric industry. Among the most significant proposals is a requirement that utilities provide open access to the domestic interstate transmission grid. The FERC's final rules are expected to be announced in the spring of 1996. Consumers is unable to predict the terms of these rules. However, management believes that Consumers is well-positioned to conform to open access as it has been voluntarily providing this transmission service since 1992.\nThe Governor of the State of Michigan has proposed that the MPSC review the existing statutory and regulatory framework governing Michigan utilities in light of increasing competition in the utility industry and recommend appropriate revisions. At this time, no proceedings have been initiated at the MPSC on this matter and no new legislation has been introduced.\nChanges in the competitive environment facing regulated utilities may eventually lead to the discontinuance of SFAS 71, which allows the deferral of certain costs and the recording of regulatory assets. Management has evaluated Consumers' current regulatory position and believes it continues to support the recognition of Consumers' $779 million of electric-related regulatory assets. If changes in the industry were to lead to Consumers discontinuing the application of SFAS 71, for all or part of its business, Consumers may be required to write-off the portion of any regulatory asset for which no regulatory assurance of recovery continued to exist. Consumers does not believe that there is any current evidence that supports the write-off of any of its electric- related regulatory assets. For further information regarding SFAS 71 and Consumers' regulatory assets, see Notes 2 and 19.\nNuclear Matters: In July 1995, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report recognized improved performance at the plant, specifically in the areas of Engineering and Plant Operations. In the report, the NRC noted areas which continue to require management's attention, but also recognized the development and implementation of plans for corrective action designed to address previously identified weak areas. The report noted that performance in the areas of Maintenance and Plant Support was good and remained unchanged.\nConsumers' on-site storage pool for spent nuclear fuel at Palisades is at capacity. Consequently, Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary on-site storage. In 1996, Consumers plans to unload and replace one of the casks where a minor flaw has been detected. For further information, see Note 15.\nThe Low-Level Radioactive Waste Policy Act encourages the respective states, individually or in cooperation with each other, to be responsible for the disposal of low-level radioactive waste. Currently, a low-level waste site does not exist in Michigan and Consumers has been storing low- level waste at its nuclear plant sites. Consumers began shipping its low- level waste to a site in South Carolina during 1995 and plans to have all its currently stored low-level waste removed from the plant sites by the end of 1996.\nConsumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated \"pressurized thermal shock\" events during its remaining license life. Analysis of recent data from testing of similar materials indicates that the Palisades reactor vessel can be safely operated through late 1999. Consumers is developing plans to anneal the reactor vessel in 1998 at an estimated cost of $20 million to $30 million. This repair would allow for operation of the plant to the end of its license life in the year 2007. Consumers cannot predict whether the studies being conducted as a part of the development plans will support a future decision to anneal.\nAt the SEC staff's request, the FASB is reviewing the accounting for closure and removal costs for long-lived assets, including decommissioning. The current electric utility industry accounting practices of recording the cost of removal as a component of depreciation could be changed. The FASB's tentative decision includes recognition of the cost of closure and removal obligation as a liability based on discounted future cash flows with the offset recorded as part of the cost of the plant asset.\nStray Voltage: Consumers has experienced a number of lawsuits relating to the effect of so-called stray voltage on certain livestock. At December 31, 1995, Consumers had 30 separate stray voltage lawsuits awaiting trial court action, down from 83 lawsuits at December 31, 1994. CMS Energy believes that the resolution of these lawsuits will not have a material impact on its financial position or results of operations.\nGas Utility Results of Operations\nPretax Operating Income Change Compared to Prior Year\nIn Millions 1995\/1994 1994\/1993 --------- --------- Sales $ 12 $ (3) Regulatory recovery of gas cost 19 10 O&M, general taxes and depreciation (15) (19) ---- ---- Total change $ 16 $(12) ==== ====\nGas Deliveries: Gas sales in 1995 totaled 254 bcf, a 5.2 percent increase from 1994 levels, and total system deliveries, excluding transport to the MCV Facility, increased 6.5 percent from 1994. On a weather-adjusted basis, total system deliveries increased 4.1 percent, reflecting significant growth. In 1994, total system deliveries, excluding transport to the MCV Facility, were 314 bcf, a slight decrease from 1993 deliveries.\nCost of Gas Sold: The cost of gas sold for 1995 increased $9 million from the 1994 level, as a result of increased deliveries. The increased costs reflect the reversal of a $23 million gas supplier loss contingency.\nOperating Expenses: Gas operation and maintenance expense increased $12 million, reflecting an $8 million gas inventory loss. Gas depreciation for 1995 compared to 1994 increased $7 million, reflecting additional capital investment in property and equipment.\nGas Utility Issues\nGas Rates: In December 1994, Consumers filed a request with the MPSC to increase Consumers' annual gas rates. The requested increase totaling $7 million reflected increased expenditures, including those associated with postretirement benefits, and a 12.25 percent return on equity. The MPSC staff recommended a $13 million rate decrease. In November 1995, the ALJ issued a proposal for decision that essentially adopted the MPSC staff's position. In early 1996, the MPSC issued a final order in this case, decreasing Consumers' annual gas rates by $11.7 million. For further information regarding this case, see Note 4.\nConsumers entered into a special natural gas transportation contract with one of its transportation customers in response to the customer's proposal to by-pass Consumers' system in favor of a competitive alternative. The contract provides for discounted gas transportation rates in an effort to induce the customer to remain on Consumers' system. In February 1995, the MPSC approved the contract but stated that the revenue shortfall created by the difference between the contract's discounted rate and the floor price of one of Consumers' MPSC authorized gas transportation rates must be borne by Consumers' shareholders. In March 1995, Consumers filed an appeal with the Court of Appeals claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional.\nGCR Matters: In October 1995, the MPSC issued an order regarding a $44 million (excluding any interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order supports its position that the producers' theories are without merit and intends to vigorously oppose any claims they may raise but cannot predict the outcome of this issue.\nGas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Data available to Consumers and its continued internal review of these former manufactured gas plant sites have resulted in an estimate for all costs related to investigation and remedial action of between $48 million and $112 million. These estimates are based on undiscounted 1995 costs. At December 31, 1995, Consumers has accrued a liability for $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and regulatory requirements, could impact the estimate of remedial action costs for the sites.\nConsumers requested recovery and deferral of certain investigation and remedial action costs in its gas rate case filed in December 1994. Consumers believes that remedial action costs are recoverable in rates and is continuing discussions with certain insurance companies regarding coverage for some or all of the costs which may be incurred for these sites. For further information, see Note 14.\nGas Outlook\nConsumers currently anticipates gas deliveries to grow approximately 2 percent per year (excluding transportation to the MCV Facility and off- system deliveries) over the next five years, primarily due to a steadily growing customer base. Additionally, Consumers has several strategies which will support increased load requirements in the future. These strategies include increased efforts to promote natural gas to both current and potential customers that are using other fuels for space and water heating. The emerging use of natural gas vehicles also provides Consumers with sales growth opportunities. In addition, as air quality standards continue to become more stringent, management believes that greater opportunities exist for converting industrial boiler load and other processes to natural gas. Consumers also plans additional capital expenditures to construct new gas mains that are expected to expand Consumers' system.\nIn 1995, Consumers purchased approximately 80 percent of its required gas supply under long-term contracts, and the balance on the spot market. Consumers estimates that approximately 35 percent of its gas purchases will be under long-term contracts in future years as current contracts expire. Consumers also has transmission contracts totaling approximately 90 percent of its supply requirements. The expiration dates of the transmission contracts range from 1997 to 2004.\nIn 1995, the Low Income Home Energy Assistance Program provided approximately $71 million in heating assistance to about 400,000 Michigan households, with approximately 18 percent of funds going to Consumers' customers. In late 1995, federal legislative approval provided Michigan residents with approximately $60 million of funding for 1996. Consumers cannot predict what level of funding will be approved for 1997.\nIn January 1996, the MPSC issued a Notice of legislative-type hearings to be held in 1996, to assess whether it is appropriate to allow all natural gas customers access to gas transportation service. The MPSC notice designated all eight local distribution companies whose rates are regulated by the MPSC as parties to this proceeding.\nUnder SFAS 71, Consumers is allowed to defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its $276 million of regulatory assets (see Note 19) related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs.\nOil and Gas Exploration and Production\nPretax Operating Income: 1995 pretax operating income increased $22 million from 1994, primarily due to higher sales volumes and oil sales prices, income attributable to the acquisitions of Walter and Terra and increased gains from the assignment of gas supply contracts, partially offset by lower average market prices for gas. 1994 pretax operating income increased $5 million from 1993, reflecting higher gas sales volumes, lower international write-offs, and the gain from the disposition of a gas supply contract, partially offset by lower average market prices for oil and gas.\nCapital Expenditures: In February 1995, CMS NOMECO closed on the acquisition of Walter for approximately $49 million, consisting of approximately $27 million of CMS Energy Common Stock and $22 million in both cash and assumed debt. The Walter acquisition added proved reserves of approximately 20 million barrels of oil.\nIn August 1995, CMS NOMECO acquired Terra with approximately $63 million of CMS Energy Common Stock. The Terra acquisition added approximately 96 bcf of proved gas reserves.\nOther capital expenditures for 1995 approximated $84 million, primarily for development of existing oil and gas reserves.\nIndependent Power Production\nPretax Operating Income: 1995 pretax operating income increased $25 million, primarily reflecting higher capacity sales by the MCV Partnership, as well as additional equity earnings by CMS Generation subsidiaries primarily due to the HYDRA-CO acquisition. 1994 pretax operating income increased $16 million from 1993, primarily reflecting additional electric generating capacity.\nCapital Expenditures: In January 1995, CMS Generation completed its acquisition of HYDRA-CO for $153 million, net of $54 million cash. CMS Generation acquired 224 MW of net generating capacity and also assumed shared construction management responsibility for a 60 MW diesel-fueled plant under construction in Jamaica, scheduled to go into service in the fourth quarter of 1996.\nOther capital expenditures for 1995 totaled approximately $86 million related to expanding ownership in existing facilities and investments in new facilities.\nNatural Gas Transmission, Storage and Marketing\nPretax Operating Income: 1995 pretax operating income increased $5 million over 1994, reflecting growth from new pipeline investments and the continued growth of existing projects and gas marketed to end-users. 1994 pretax operating income increased $2 million over 1993, reflecting earnings growth from gas pipeline and storage projects and gas marketed to end-users. In 1995, 101 bcf of natural gas was marketed compared to 66 bcf and 60 bcf in 1994 and 1993, respectively.\nCapital Expenditures: In July 1995, CMS Gas Transmission acquired a 25 percent ownership interest in TGN for $136 million. TGN, which had 1995 revenues of approximately $150 million, owns and operates 2,600 miles of pipelines that provide natural gas transmission service to the northern and central parts of Argentina, with almost one bcf per day of existing pipeline capacity.\nCMS Gas Transmission, through an ownership interest in Nitrotec Corporation, a proprietary gas technology company acquired in January 1996, currently has two helium recovery plants under construction, with the first plant scheduled to be in service in the first quarter of 1996. The total estimated cost for these two plants, located in Kansas, is $8.2 million. One helium recovery plant was placed in service in October 1995. Nitrotec Corporation has also started construction on a $5.2 million nitrogen rejection facility in Texas.\nIn January 1996, CMS Gas Transmission signed a letter of intent to transfer its 50 percent ownership interest to its partner, MHP Corporation, in the Moss Bluff Gas Storage System, a salt cavern storage facility on the Gulf Coast of Texas and MHP Corporation will transfer its 50 percent ownership interest to CMS Gas Transmission in the Grand Lacs Limited Partnership, a marketing center for natural gas. CMS Gas Transmission will also receive approximately $26 million.\nIn January 1996, CMS Gas Transmission acquired Petal Gas Storage Company, a natural gas storage facility located in Forrest County, Mississippi. The salt dome storage cavern provides up to 3.2 bcf per day of 10-day storage service and has the capability of being refilled in 20 days.\nOther capital expenditures in 1995 totaled approximately $42 million for acquisitions, expansion of existing facilities and construction of new facilities.\nOther\nNew Accounting Standard: In 1995, the FASB issued SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which is effective for 1996. CMS Energy does not expect the application of this statement to have a material impact on its financial position, liquidity or results of operations. For further information, see Note 2.\nCMS Energy Corporation Notes to Consolidated Financial Statements\n1: Corporate Structure\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry. Enterprises is engaged in several domestic and international energy-related businesses, including oil and gas exploration and production, development and operation of independent power production facilities, electric and gas marketing services to utility, commercial and industrial customers, and storage and transmission of natural gas.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation: The consolidated financial statements include CMS Energy, Consumers and Enterprises and their wholly owned subsidiaries. The financial statements are prepared in conformity with generally accepted accounting principles and include the use of management's estimates. CMS Energy uses the equity method of accounting for investments in companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating income. For the years ended December 31, 1995, 1994 and 1993, undistributed equity earnings were $53 million, $25 million and $9 million, respectively.\nAccretion Income and Expense: In 1991, the MPSC ordered that Consumers could recover a portion of its abandoned Midland investment over a 10-year period, but did not allow Consumers to earn a return on that amount. Consumers reduced the recoverable investment to the present value of the future recoveries. During the recovery period, the unrecovered asset is adjusted to its present value. This adjustment is reflected as accretion income. Conversely, Consumers recorded a loss in 1992 for the present value of its estimated future underrecoveries of power costs resulting from purchases from the MCV Partnership (see Note 3), and now recognizes accretion expense annually to reflect the time value of money on the recorded loss.\nGas Inventory: Consumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion: Property repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. The composite depreciation rate for electric utility property was 3.5 percent for 1995, 3.5 percent for 1994 and 3.4 percent for 1993. The composite rate for gas utility plant was 4.3 percent for 1995, 4.2 percent for 1994 and 4.4 percent for 1993. The composite rate for Consumers' other plant and property was 4.9 percent for 1995 and 4.7 percent for 1994 and 1993.\nCMS NOMECO, a wholly owned subsidiary of Enterprises, follows the full-cost method of accounting and, accordingly, capitalizes its exploration and development costs, including the cost of non-productive drilling and surrendered acreage, on a country-by-country basis. The capitalized costs in each cost center are being amortized on an overall units-of-production method based on total estimated proved oil and gas reserves. Other depreciable property of CMS Energy and its subsidiaries is amortized over its estimated useful life.\nNew Accounting Standard: During 1995, the Financial Accounting Standards Board issued SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement, which is effective for 1996 financial statements, requires that an asset be reviewed for impairment whenever events indicate that its carrying amount may not be recoverable. The statement also requires that a loss be recognized whenever a portion of an asset's cost is excluded from a rate- regulated company's rate base. CMS Energy does not expect the application of this statement to have a material impact on its financial position or results of operations.\nNuclear Fuel Cost: Consumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities. However, in 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. In 1995, federal legislation was introduced to clarify the DOE's obligation to accept spent nuclear fuel and direct the DOE to establish an integrated spent fuel management system that includes designing and constructing an interim storage facility in Nevada. For fuel used after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers them through electric rates and remits to the DOE quarterly. Consumers elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983, until the spent fuel is delivered to the DOE, which was originally scheduled to occur in 1998. At December 31, 1995, Consumers has recorded a liability to the DOE of $100 million, including interest. Consumers recovered through electric rates the amount of this liability, excluding a portion of interest.\nNuclear Plant Decommissioning: Consumers collects approximately $45 million annually from its electric customers to decommission its two nuclear plants. On March 1, 1995, Consumers filed updated decommissioning information with the MPSC which estimated decommissioning costs for Big Rock and Palisades to be $303 million and $524 million (in 1995 dollars), respectively. The estimated decommissioning costs increased from previous estimates principally due to the unavailability of low- and high-level radioactive waste disposal facilities. Amounts collected from electric retail customers and deposited in trusts (including trust earnings) are credited to accumulated depreciation. To meet NRC decommissioning requirements, Consumers prepared site-specific decommissioning cost estimates for Big Rock and Palisades, assuming that each plant site will eventually be restored to conform with the adjacent landscape, and that all contaminated equipment will be disassembled and disposed of in a licensed burial facility. After the plants are retired, Consumers plans to maintain the facilities in protective storage until radioactive waste disposal facilities are available. As a result, the majority of decommissioning costs will be incurred several years after each plant's NRC operating license expires. When Big Rock's and Palisades' NRC licenses expire in 2000 and 2007, respectively, the trust funds are estimated to have accumulated to $257 million and $686 million, respectively. It is estimated that at the time the plants are fully decommissioned (in the years 2030 for Big Rock and 2046 for Palisades), the trust funds will have provided $1 billion for Big Rock and $2.1 billion for Palisades including trust earnings over this decommissioning period. Based on this plan, Consumers believes that the current decommissioning surcharge will be sufficient to provide for decommissioning of its nuclear plants. At December 31, 1995, Consumers had an investment in nuclear decommissioning trust funds of $304 million.\nReclassifications: CMS Energy has reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect the net income for the years presented.\nRelated-Party Transactions: In 1995, 1994 and 1993, Consumers purchased $53 million, $48 million and $52 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Affiliates of CMS Energy sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $26 million, $22 million and $27 million for 1995, 1994 and 1993, respectively. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 20. Other related-party transactions are immaterial.\nRevenue and Fuel Costs: Consumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until it bills or refunds these differences to customers following an MPSC order.\nUtility Regulation: Consumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther: For significant accounting policies regarding income taxes, see Note 5; for pensions and other postretirement benefits, see Note 12; and for cash equivalents, see Note 17.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to The Dow Chemical Company. Consumers, through its subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds through the FMLP a 35 percent lessor interest in the MCV Facility.\nPower Purchases from the MCV Partnership: Consumers' annual obligation for purchase of contract capacity from the MCV Partnership under a 35-year PPA increased 108 MW to its maximum amount of 1,240 MW in 1995. In 1993, the MPSC issued the Settlement Order that has allowed Consumers to recover substantially all of the payments for its ongoing purchase of 915 MW of contract capacity. ABATE and the Attorney General have appealed the Settlement Order to the Court of Appeals. Under the Settlement Order, capacity and energy purchases from the MCV Partnership above the 915 MW level can be utilized to satisfy customers' power needs but the MPSC will determine the levels of recovery from retail customers at a later date. The Settlement Order also provides Consumers the right to remarket to third parties the remaining contract capacity. The MCV Partnership did not object to the Settlement Order.\nThe PPA provides that Consumers is to pay the MCV Partnership a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge which is based primarily on Consumers' average cost of coal consumed. The Settlement Order permits Consumers to recover capacity charges averaging 3.62 cents per kWh for 915 MW of capacity, the fixed energy charge and the prescribed energy charges associated with the scheduled deliveries within certain hourly availability limits, whether or not those deliveries are scheduled on an economic basis. For all energy delivered on an economic basis above the availability limits to 915 MW, Consumers has been allowed to recover 1\/2 cent per kWh capacity payment in addition to the variable energy charge.\nIn 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss was based, in part, on management's assessment of the future availability of the MCV Facility, and the effect of the future power market on the amount, timing and price at which various increments of the capacity, above the MPSC authorized level, could be resold. Additional losses may occur if actual future experience materially differs from the 1992 estimates. As anticipated in 1992, Consumers continues to experience cash underrecoveries associated with the Settlement Order. If Consumers is unable to sell any capacity above the 1993 MPSC-authorized level, future additional after-tax losses and after- tax cash underrecoveries would be incurred. Consumers' estimates of its future after-tax cash underrecoveries, and possible losses for 1996 and the next four years are shown in the table below.\nAfter-tax, In Millions 1996 1997 1998 1999 2000 ---- ---- ---- ---- ----\nEstimated cash underrecoveries $56 $55 $ 8 $ 9 $ 7\nPossible additional under- recoveries and losses (a) $20 $22 $72 $72 $74\n(a) If unable to sell any capacity above the MPSC's 1993 authorized level.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that would potentially resolve several issues in three pending proceedings, including cost recovery for the 325 MW of MCV Facility capacity above the MPSC's currently authorized level. For further information regarding this proposed settlement, see Note 4.\nAt December 31, 1995 and 1994, the after-tax present value of the Settlement Order liability totaled $202 million and $272 million, respectively. The reduction in the liability since December 31, 1994, reflects after-tax cash underrecoveries of $90 million, partially offset by after-tax accretion expense of $20 million. The undiscounted after-tax amount associated with the liability totaled $607 million at December 31, 1995.\nIn 1994 and 1995, Consumers paid $44 million to terminate power purchase agreements with the developers of two proposed independent power projects totaling 109 MW. As part of the proposed settlement reached with the MPSC staff (see Note 4), Consumers is seeking MPSC approval to utilize less- expensive contract capacity from the MCV Facility which Consumers is currently not authorized to recover from retail customers. Cost recovery for this contract capacity would start in late 1996. Even if Consumers is not allowed to substitute MCV Facility capacity for the capacity to be provided under the terminated agreements, Consumers believes that the MPSC would approve recovery of the buyout costs due to the significant customer savings resulting from the terminated power purchase agreements. As a result, Consumers has recorded a regulatory asset of $44 million.\nPSCR Matters Related to Power Purchases from the MCV Partnership: As part of the 1993 and 1994 plan case orders, the MPSC confirmed the recovery of certain costs related to power purchases from the MCV Partnership. ABATE or the Attorney General has appealed these plan case orders to the Court of Appeals.\nAs part of its decision in the 1993 PSCR reconciliation case issued February 23, 1995, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership, and instead assumed recovery of those costs from wholesale customers and reduced recovery from retail customers. Consumers believes this is contrary to the terms of the Settlement Order and has appealed the February 23 order on this issue.\n4: Rate Matters\nElectric Rate Proceedings: In late 1994, Consumers filed a request with the MPSC to increase its retail electric rates. The request included provisions for ratemaking treatment of expected sales losses to competition and the treatment of the 325 MW of MCV Facility contract capacity above 915 MW. Consumers also requested that the MPSC eliminate subsidization of residential rates in a two-step adjustment.\nEarly in 1996, the MPSC issued a partial final order in this case, granting Consumers a $46 million annual increase in its electric retail rates. This order authorized a 12.25 percent return on equity as compared to the previously approved 11.75 percent, approved recovery of certain costs associated with a proposed settlement related to the Ludington plant (see Note 14), and significantly reduced (in a two-step adjustment) the subsidization of residential customers by industrial and large commercial customers. As a result, residential customers were allocated approximately $31 million of the $46 million increase.\nThis order did not address cost recovery related to the 325 MW of MCV Facility contract capacity above 915 MW. The MPSC stated that this matter would be addressed in connection with its consideration of the proposed settlement agreement discussed below.\nConsumers also has a separate request before the MPSC to offer competitive special rates to certain large qualifying customers. In addition, Consumers filed a request with the MPSC, seeking to adjust its depreciation rates and to reallocate certain portions of its electric production plant to transmission accounts. If approved, this would result in a net decrease in depreciation expense of $7 million for ratemaking purposes. For further information regarding these requests, see the Electric Rate Proceedings and Special Rates discussions in the Management's Discussion and Analysis.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that, if approved by the MPSC, would resolve several outstanding regulatory issues currently before the MPSC in separate proceedings. Some of these issues were preliminarily addressed in early 1996 when the MPSC issued an order in Consumers' electric rate case (see above). If fully adopted, the settlement agreement would: provide for cost recovery of the 325 MW of uncommitted MCV Facility capacity; implement provisions for incentive ratemaking; resolve the special competitive services and depreciation rate cases; implement a limited direct access program; and accelerate recovery of nuclear plant investment. Consumers expects a final order in the spring of 1996.\nElectric DSM: In June 1995, the MPSC authorized Consumers to discontinue future DSM program expenditures and cease all new programs. Consumers is deferring and amortizing past program costs ($68 million at December 31, 1995) over the period these costs are being recovered from customers in accordance with an MPSC accounting order.\nGas Rates: As part of an agreement approved by the MPSC, Consumers filed a gas rate case in December 1994. The request, among other things, incorporated cost increases, including costs for postretirement benefits and costs related to Consumers' former manufactured gas plant sites and proposed a 12.25 percent rate of return on equity, instead of the current 13.25 percent. Consumers had requested a $7 million increase in its annual gas rates. The MPSC staff recommended a $13 million rate decrease, which included a lower rate base, a lower return on common equity, a revised capital structure and a lower operating cost forecast than Consumers had projected. In November 1995, the ALJ issued a proposal for decision that essentially adopted the MPSC staff's position. In early 1996, the MPSC issued a final order in this case, decreasing Consumers' annual gas rates by $11.7 million and authorized an 11.6 percent return on equity.\nGCR Matters: In 1993, the MPSC issued a ruling favorable to Consumers regarding a gas pricing disagreement between Consumers and certain intrastate producers. In 1995, management concluded that the intrastate producers' pending appeals of the MPSC order would not be successful and accordingly reversed $23 million (pretax) of a previously accrued loss. The MPSC ruling was affirmed by the Court of Appeals in June 1995. The producers have petitioned the Michigan Supreme Court for review.\nIn October 1995, the MPSC issued an order regarding a $44 million (excluding any interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order supports its position that the producers' theories are without merit and intends to vigorously oppose any claims they may raise but cannot predict the outcome of this issue.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on CMS Energy's or Consumers' financial position or results of operations.\n5: Income Taxes\nCMS Energy and its subsidiaries (including Consumers) file a consolidated federal income tax return. Income taxes are generally allocated based on each subsidiary's separate taxable income. CMS Energy and Consumers practice full deferred tax accounting for temporary differences.\nCMS Energy uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1995 1994 1993 - ----------------------- ---- ---- ----\nCurrent federal income taxes $ 43 $ 36 $ 19 Deferred income taxes 85 66 67 Deferred income taxes - tax rate change - - (1) Deferred ITC, net (10) (10) (10) ---- ---- ---- $118 $ 92 $ 75 ==== ==== ====\nOperating $130 $103 $ 81 Other (12) (11) (6) ---- ---- ---- $118 $ 92 $ 75 ==== ==== ====\nThe principal components of CMS Energy's deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1995 1994\nProperty $ (603) $ (601) Unconsolidated investments (266) (246) Postretirement benefits (Note 12) (173) (177) Abandoned Midland project (46) (51) Employee benefit obligations (includes postretirement benefits of $175 and $174) (Note 12) 204 203 Power purchases - settlement (Note 3) 112 146 AMT carryforward 161 154 ITC carryforward (expires 2005) 23 37 Other (28) (13) ------- ------- $ (616) $ (548) ======= =======\nGross deferred tax liabilities $(1,698) $(1,659) Gross deferred tax assets 1,082 1,111 ------- ------- $ (616) $ (548) ======= =======\nThe actual income tax expense differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1995 1994 1993 - ----------------------- ----- ----- -----\nNet income before preferred dividends $232 $203 $166 Income tax expense 118 92 75 ----- ----- -----\n350 295 241 Statutory federal income tax rate x 35% x 35% x 35% ----- ----- -----\nExpected income tax expense 123 103 84 Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 5 Differences in book and tax depreciation not previously deferred 6 7 5 ITC amortization (10) (10) (10) Nonconventional Fuel Tax Credit (13) (8) (6) Other, net 7 (5) (3) ----- ----- ----- $118 $ 92 $ 75 ===== ===== =====\n6: Short-Term Financings\nConsumers has FERC authorization to issue or guarantee up to $900 million of short-term debt through December 31, 1996. Consumers has an unsecured $425 million facility and unsecured, committed lines of credit aggregating $145 million that are used to finance seasonal working capital requirements. At December 31, 1995, $238 million and $103 million were outstanding under these facilities at weighted average interest rates of 6.4 percent and 6.9 percent, respectively. Consumers has an established $500 million trade receivables purchase and sale program. At December 31, 1995 and 1994, receivables sold under the agreement totaled $295 million and $275 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold.\n7: Long-Term Debt\nAt December 31, 1995 and 1994, long term debt consists of the following:\n(a) Represents the weighted average interest rate during 1995.\nThe scheduled maturities of long-term debt and improvement fund obligations are as follows: $161 million in 1996, $325 million in 1997, $803 million in 1998, $716 million in 1999 and $10 million in 2000.\nCMS Energy\nIn January 1994, CMS Energy filed a shelf-registration statement with the SEC permitting the issuance and sale of up to $250 million of GTNs. The GTNs are offered from time to time on terms determined at the time of sale.\nIn 1994, CMS Energy refinanced its $220 million Secured Revolving Credit Facility dated November 30, 1992 with the Unsecured Credit Facility and extended the termination date to June 30, 1997. In November 1995, CMS Energy amended the terms of its $400 million Unsecured Credit Facility, increased the amount to $450 million and extended the termination date to June 30, 1998. CMS Energy also entered into a $125 million, seven-year Term Loan Agreement dated November 21, 1995.\nConsumers\nFirst Mortgage Bonds: Consumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, its Articles and the need for regulatory approvals in compliance with appropriate federal law.\nLong-Term Bank Debt: During 1994, Consumers entered into a $400 million unsecured, variable rate, five-year term loan and subsequently used the proceeds to refinance certain long-term bank debt. In 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on $250 million of its long-term bank debt. The swap agreement hedges the variable rate exposure associated with Consumers' long-term bank debt. The swap agreement began to decrease in February 1995 and will terminate by May 1996. At December 31, 1995, the amount of the swap totaled $94 million at 5.4 percent. The swap agreement had the effect of decreasing the weighted average interest rate to 6.3 percent from 6.6 percent for the 12-month period ended December 31, 1995.\nOther: Consumers' long-term PCRBs are secured by irrevocable letters of credit or first mortgage bonds.\nCMS NOMECO\nCMS NOMECO's existing Revolving Line of Credit, which converts to term loans maturing from November 1996 through November 1999, was increased from $110 million at December 31, 1994 to $140 million at December 31, 1995.\nSenior serial notes amounting to $28 million, with a weighted average interest rate of 9.40 percent, were repaid in full on August 10, 1995. In connection with this early extinguishment of debt, CMS NOMECO incurred a $1.5 million prepayment premium. The notes were retired with available proceeds from the bank credit line.\nCMS Generation\nIn January 1995, CMS Generation, entered into a one-year $118 million bridge credit facility for the acquisition of HYDRA-CO Enterprises, Inc. of which approximately $109 million remained outstanding as of December 31, 1995. In January, 1996, CMS Generation refinanced this bridge facility with a $110 million, five-year term loan.\n8: Capitalization\nCMS Energy\nCapital Stock: During 1995, CMS Energy amended its Articles of Incorporation and authorized a new class of common stock of CMS Energy, designated Class G Common Stock, which reflects the separate performance of Consumers Gas Group. The pre-existing CMS Energy Common Stock continues to be outstanding and reflects the performance of all of the businesses of CMS Energy and its subsidiaries, including the business of the Consumers Gas Group, except for the interest in the Consumers Gas Group attributable to the outstanding shares of the Class G Common Stock. The filing of the restated Articles of Incorporation with the Michigan Department of Commerce increased the number of authorized shares of capital stock from 255 million shares to 320 million shares, consisting of 250 million shares of CMS Energy Common Stock, par value $.01 per share, 60 million shares of Class G Common Stock, no par value, and 10 million shares of Preferred Stock, par value $.01 per share.\nCMS Energy filed a shelf-registration statement with the SEC on February 15, 1995 covering the issuance of up to $200 million of securities encompassing Common Stock, Preferred Stock of CMS Energy or of a special purpose affiliate of CMS Energy, and\/or unsecured debt of CMS Energy. CMS Energy continually evaluates the capital markets and may offer such securities from time to time, at terms to be determined at or prior to the time of the sale. In the third quarter 1995, CMS Energy received net proceeds of approximately $123 million from the issuance of 7.52 million shares of Class G Common Stock at a price to the public of $17.75 per share, initially representing 23.50 percent of the common stockholder's equity value attributed to the Consumers Gas Group. All of the proceeds will fund the capital programs and be used for general corporate purposes of CMS Energy. Initially, such proceeds were used to repay a portion of CMS Energy's indebtedness under the Credit Facility, none of which is attributable to the Consumers Gas Group. The issuance of additional shares, during 1995, increased the common stockholder's equity value attributable to the Consumers Gas Group represented by the outstanding shares of Class G Common Stock, to 23.73 percent as of December 31, 1995.\nOther: Under its most restrictive borrowing arrangement at December 31, 1995, none of CMS Energy's net income was restricted for payment of common dividends.\nConsumers\nCapital Stock: During 1995, the MPSC issued an order authorizing Consumers to issue and sell up to $300 million of intermediate and\/or long-term debt and $100 million of preferred stock or subordinate debentures. In January 1996, 4 million shares of 8.36 percent Trust Originated Preferred Securities were issued and sold through a business trust wholly owned by Consumers. The trust was formed for the sole purpose of issuing preferred securities and the only asset of the trust is $103 million of 8.36 percent unsecured subordinated deferrable interest notes issued by Consumers. The obligations of Consumers with respect to the preferred securities under the notes that mature in 2015, the indenture under which the notes will be issued, Consumers' guarantee of the preferred securities and the Declaration of Trust, taken together, constitute a full and unconditional guarantee by Consumers of the trust's obligations under the Trust Originated Preferred Securities. Net proceeds from the sale totaled $96 million.\nOther: Under the provisions of its Articles at December 31, 1995, Consumers had $197 million of unrestricted retained earnings available to pay common dividends.\nCMS NOMECO\nIn February 1995, CMS Energy acquired Walter, a Houston-based independent oil company, for approximately $49 million, consisting of approximately $27 million of CMS Energy Common Stock and $22 million in cash and assumed debt. Walter was merged with a wholly owned subsidiary of CMS NOMECO.\nIn August 1995, CMS Energy acquired 100 percent of the common stock of Terra, a gas exploration company, located in Traverse City, Michigan for approximately $63 million. Terra has become a wholly owned subsidiary of CMS NOMECO.\nIn October 1995, CMS NOMECO filed a registration statement with the SEC for an initial public offering of not more than 20 percent of CMS NOMECO common stock. CMS Energy will continue to evaluate market conditions for a possible future offering of CMS NOMECO common stock.\n9: Earnings Per Share and Dividends\nEarnings per share attributable to Common Stock, for the year ended December 31, 1995 reflect the performance of the Consumers Gas Group since initial issuance of Class G Common Stock during the third quarter of 1995. The Class G Common Stock participates in earnings and dividends from the issue date. The allocation of earnings (loss) attributable to each class of common stock and the related amounts per share are computed by considering the weighted average number of shares outstanding.\nEarnings (loss) attributable to outstanding Class G Common Stock are equal to Consumers Gas Group net income (loss) multiplied by a fraction, the numerator is the weighted average number of Outstanding Shares during the period and the denominator represents the weighted average number of Outstanding Shares and Retained Interest Shares during the period. The earnings attributable to Class G Common Stock on a per share basis, for the year ended December 31, 1995, are based on 23.45 percent of the income of the Consumers Gas Group since the initial issuance.\nEarnings per share for Class G Common Stock are omitted from the statements of income for the years ended December 31, 1994 and 1993, since the Class G Common Stock was not part of the equity structure of CMS Energy. For purpose of analysis, following are pro forma data for the years ended December 31, 1995 and 1994 which give effect to the issuance and sale of 7.52 million shares of Class G Common Stock (representing 23.50 percent of the equity attributable to the Consumers Gas Group) on January 1, 1994.\nIn Millions, Except Per Share Amounts Pro Forma Pro Forma Years Ended December 31, 1995 1994 - ------------------------ ----- -----\nNet Income $ 204 $ 179\nNet Income attributable to CMS Energy Common Stock $ 189 $ 167\nNet Income attributable to outstanding Class G Common Stock $ 15 $ 12\nAverage shares outstanding: CMS Energy Common Stock 88.810 85.888 Class G Common Stock 7.536 7.520\nEarnings per share attributable to CMS Energy Common Stock $2.14 $1.94\nEarnings per share attributable to outstanding Class G Common Stock $1.93 $1.66\nHolders of Class G Common Stock have no direct rights in the equity or assets of the Consumers Gas Group, but rather have rights in the equity and assets of CMS Energy as a whole. In the sole discretion of the Board of Directors, dividends may be paid exclusively to the holders of Class G Common Stock, exclusively to the holders of CMS Energy Common Stock, or to the holders of both classes in equal or unequal amounts. The Board of Directors has stated its intention to declare and pay dividends on the CMS Energy Common Stock based primarily on the earnings and financial condition of CMS Energy. Dividends on the Class G Common Stock are paid at the discretion of the Board of Directors based primarily upon the earnings and financial condition of the Consumers Gas Group, and to a lesser extent, CMS Energy as a whole. It is the Board of Directors' current intention that the declaration or payment of dividends with respect to the Class G Common Stock will not be reduced, suspended or eliminated as a result of factors arising out of or relating to the electric utility business or the international businesses of CMS Energy unless such factors also require, in the Board of Directors' sole discretion, the omission of the declaration or reduction in payment of dividends on both the CMS Energy Common Stock and the Class G Common Stock.\nThe Board of Directors declared a dividend on CMS Energy Common Stock of $.21 per share for the first and second quarters and $.24 per share for the third and fourth quarters of 1995. A dividend on Class G Common Stock of $.28 per share was declared by the Board of Directors for the third and fourth quarters of 1995.\n10: Financial Instruments\nThe carrying amounts of cash, short-term investments and current liabilities approximate their fair values due to their short-term nature. The estimated fair values of long-term investments are based on quoted market prices or, in the absence of specific market prices, on quoted market prices of similar investments or other valuation techniques. The carrying amounts of all long-term investments in financial instruments approximate fair value.\nThe carrying amount of long-term debt was $2.9 billion and $2.7 billion at December 31, 1995 and 1994, respectively, and the fair value was $3.0 billion and $2.6 billion on those dates. Although the current fair value of the long-term debt may differ from the current carrying amount, settlement of the reported debt is generally not expected until maturity.\nThe fair values of CMS Energy's off-balance-sheet financial instruments are based on the amounts estimated to terminate or settle the instruments. At December 31, 1995, the fair value of CMS Energy's interest rate swap agreements was $16 million, representing the amount that CMS Energy would pay to terminate the agreements. At December 31, 1994, CMS Energy would have received $5 million to terminate the agreements. Guarantees and letters of credit were $148 million and $123 million at December 31, 1995 and 1994, respectively.\nIn 1994, CMS Energy adopted SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, which did not materially impact CMS Energy's financial position or results of operations.\n11: Executive Incentive Compensation\nUnder CMS Energy's Performance Incentive Stock Plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. During 1995, shareholders approved amendments to the CMS Energy Performance Incentive Stock Plan. The amendments authorized awards under the plan consisting of any class of common stock of CMS Energy and established performance based business criteria for certain plan awards. The amendments also increased the number of shares reserved for award to not more than 3 percent of each class of CMS Energy common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. At December 31, 1995, awards of up to 1,174,388 shares of CMS Energy Common Stock and 211,634 shares of Class G Common Stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan. At December 31, 1995, 475,447 shares of the 517,447 restricted shares outstanding are subject to performance objectives.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, expired in September 1995.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted under the Performance Incentive Stock Plan and options granted under both plans follows.\nRestricted Stock Options ------------ ---------------- Number Number Price CMS Energy Common Stock of Shares of Shares per Share - ----------------------- ---------- ---------- --------- Outstanding at January 1, 1993 323,266 1,435,091 $7.13 - $34.25 Granted 132,000 249,000 $25.13 - $26.25 Exercised or Issued (54,938) (152,125) $ 7.13 - $21.13 Canceled (84,141) (33,000) $20.50 - $33.88 ------- ------- --------------\nOutstanding at December 31, 1993 316,187 1,498,966 $ 7.13 - $34.25 Granted 133,500 273,000 $21.25 - $22.38 Exercised or Issued (39,361) (158,300) $7.13 - $22.00 Canceled (79,970) (123,000) $26.25 - $33.88 ------- ------- --------------\nOutstanding at December 31, 1994 330,356 1,490,666 $ 7.13 - $34.25 Granted 253,337 304,000 $23.25 - $34.25 Exercised or Issued (43,939) (147,666) $7.13 - $22.00 Canceled (22,307) (55,000) $20.50 - $34.25 ------- ------- --------------\nOutstanding at December 31, 1995 517,447 1,592,000 $13.00 - $34.25 ======= ========== ============== During 1995, 6,924 restricted shares and 10,000 options of Class G Common Stock were granted at a price of $17.88.\n12: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions: CMS Energy and its subsidiaries adopted SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions, effective as of the beginning of 1992 and Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates (see Note 19). CMS Energy's international subsidiaries expensed their accumulated transition obligation liability. The amount of such transition obligation is not material to the presentation of the consolidated financial statements or significant to CMS Energy's total transition obligation. Both the MPSC and FERC have generally allowed recovery of SFAS 106 costs. In May 1994, the MPSC authorized recovery of the electric utility portion of these costs over 18 years. During 1995, the FERC granted Consumers a waiver of a three-year filing requirement for cost recovery with respect to its wholesale electric business, which at December 31, 1995, had recorded a regulatory asset and liability of $7 million. In early 1996, the MPSC approved recovery of the gas utility portion of these costs over 16 years. CMS Energy funds the benefits using external Voluntary Employee Beneficiary Associations, a legal entity, established under guidelines of the Internal Revenue Code, through which the company can provide certain benefits for its employees or retirees. Funding of the health care benefits coincides with Consumers' recovery in rates. A portion of the life insurance benefits have previously been funded.\nRetiree health care costs at December 31, 1995, are based on the assumption that costs would increase 9.5 percent in 1996, then decrease gradually to 6 percent in 2004 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year's estimated health care cost assumption would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $80 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1995 by $9 million.\nYears Ended December 31 1995 1994 1993 - ----------------------- ----- ----- -----\nWeighted average discount rate 7.50% 8.00% 7.25% Expected long-term rate of return on plan assets 7.00% 7.00% 8.50%\nNet postretirement benefit costs for the health care benefits and life insurance benefits consisted of: In Millions Years Ended December 31 1995 1994 1993 - ----------------------- ---- ---- ---- Service cost $ 11 $ 13 $ 13 Interest cost 40 41 38 Actual return on assets (4) - - Net amortization and deferral 1 - - ---- ---- ----\nNet postretirement benefit costs $ 48 $ 54 $ 51 ==== ==== ====\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1995 1994 ---- ---- Actuarial present value of estimated benefits Retirees $ 331 $ 338 Eligible for retirement 46 44 Active (upon retirement) 200 170 ------ ------ Accumulated postretirement benefit obligation 577 552 Plan assets (primarily stocks, bonds and money market investments) at fair value 78 36 ------ ------ Accumulated postretirement benefit obligation in excess of plan assets (499) (516) Unrecognized net loss from experience different than assumed 1 4 ------ ------ Recorded liability $ (498) $ (512) ====== ======\nCMS Energy's postretirement health care plan is partially funded; the accumulated postretirement benefit obligation for that plan is $562 million and $536 million at December 31, 1995 and 1994, respectively.\nSERP: Certain management employees qualify to participate in the SERP. SERP benefits, which are based on an employee's years of service and earnings as defined in the SERP, are paid from a trust established and funded in 1988. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in consolidated assets. At December 31, 1995 and 1994, trust assets at cost (which approximates market) were $28 million and $19 million, respectively, and were classified as other non-current assets.\nDefined Benefit Pension Plan: A trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan was fully funded, no contributions were made in 1993 and 1994. A contribution of $9 million was made in 1995.\nYears Ended December 31 1995 1994 1993 - ----------------------- ----- ----- ----- Discount rate 7.50% 8.00% 7.25% Rate of compensation increase 4.50% 4.50% 4.50% Expected long-term rate of return on assets 9.25% 9.25% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1995 1994 1993 - ----------------------- ----- ----- -----\nService cost $ 23 $ 24 $ 19 Interest cost 56 51 50 Actual return on plan assets (168) 21 (92) Net amortization and deferral 103 (85) 34 ------ ------ ------ Net periodic pension cost $ 14 $ 11 $ 11 ====== ====== ======\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP 1995 1994 1995 1994 - --------------------------------------------------------------------------- Actuarial present value of estimated benefits Vested $496 $421 $ 20 $ 17 Non-vested 74 61 1 - ---- ---- ---- ---- Accumulated benefit obligation 570 482 21 17 Provision for future pay increases 183 154 13 11 ---- ---- ---- ---- Projected benefit obligation 753 636 34 28 Plan assets (primarily stocks and bonds, including $104 in 1995 and $79 in 1994 in common stock of CMS Energy) at fair value 779 637 - - ---- ---- ---- ---- Projected benefit obligation less than (in excess of) plan assets 26 1 (34) (28) Unrecognized net (gain) loss from experience different than assumed (69) (35) 7 5 Unrecognized prior service cost 43 40 2 2 Unrecognized net transition (asset) obligation (32) (39) - 1 ----- ----- ----- ----- Recorded liability $(32) $(33) $(25) $(20) ===== ===== ===== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\n13: Leases\nCMS Energy, Consumers, and Enterprises lease various assets, including vehicles, rail cars, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement is scheduled to expire in November 1997 and provides for additional one-year extensions upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $65 million as of December 31, 1995. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under CMS Energy's non-cancelable leases at December 31, 1995, were:\nIn Millions Capital Operating Leases Leases\n1996 $ 55 $ 7 1997 56 7 1998 17 6 1999 14 4 2000 13 3 2001 and thereafter 24 18 ----- ----- Total minimum lease payments 179 $45 Less imputed interest 27 ===== -----\nPresent value of net minimum lease payments 152 Less current portion 46 ----- Non-current portion $106 =====\nConsumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1995, 1994 and 1993, were $11 million, $10 million and $10 million, respectively.\nCapital lease expenses for the years ended December 31, 1995, 1994 and 1993 were $46 million, $43 million and $34 million, respectively. Included in these amounts for the years ended 1995, 1994 and 1993 are nuclear fuel lease expenses of $25 million, $21 million and $13 million, respectively.\n14: Commitments, Contingencies and Other\nLudington Pumped Storage Plant: Early in 1996, the FERC and MPSC approved the recovery of costs associated with a settlement designed to resolve all legal issues related to fish mortality at Ludington. Consumers, Detroit Edison, the Attorney General, the DNR and certain other parties agreed to the terms of the settlement in 1994. Approval of the settlement requires Consumers to transfer certain land to the State of Michigan and the Great Lakes Fishery Trust, make certain recreational improvements, and incur future annual payments of approximately $1 million (over 24 years) to improve fishery resources. The settlement resolves two lawsuits filed by the Attorney General in 1986 and 1987 on behalf of the State of Michigan.\nEnvironmental Matters: Consumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Superfund liability is joint and several and along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based upon past negotiations, Consumers estimates its total liability for the significant sites will average less than 4 percent of the estimated total site remediation costs, and such liability is expected to be less than $9 million. At December 31, 1995, Consumers has accrued a liability for its estimated losses.\nThe Michigan Natural Resources and Environmental Protection Act (formerly the Michigan Environmental Response Act) was substantially amended in June 1995. The Michigan law bears similarities to the federal Superfund law. The purpose of the 1995 amendments was generally to encourage development of industrial sites and to remove liability from some parties who were not responsible for activities causing contamination. Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest.\nConsumers has prepared plans for remedial investigation\/feasibility studies for several of these sites. Three of the four plans submitted by Consumers have been approved by the DNR or the Michigan Department of Environmental Quality (a new department succeeding to some of the former jurisdiction of the DNR). The findings for the first remedial investigation indicate that the expenditures for remedial action at this site are likely to be minimal. However, Consumers does not believe that a single site is representative of all of the sites. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $112 million. These estimates are based on undiscounted 1995 costs. At December 31, 1995, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and legal and regulatory requirements, could impact the estimate of remedial action costs for the sites.\nConsumers requested recovery and deferral of certain investigation and remedial action costs in its gas rate case filed in 1994. In early 1996, the MPSC issued an order in this case which authorized Consumers to defer costs and amortize them over 10 years. The amount of authorized annual recovery totaled $1 million. Consumers is continuing discussions with certain insurance companies regarding coverage for some or all of the costs which may be incurred for these sites.\nThe Clean Air Act contains provisions that limit emissions of sulfur dioxide and nitrogen oxides and require emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. The Clean Air Act's provisions required Consumers to make capital expenditures totaling $25 million to install equipment at certain generating units. Consumers estimates capital expenditures for in-process and possible modifications at other coal-fired units to be an additional $50 million by the year 2000. Final acid rain program nitrogen oxide regulations specifying the limits applicable to the other coal-fired units are expected to be issued in 1996. Management believes that Consumers' annual operating costs will not be materially affected.\nCapital Expenditures: CMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries and new lease commitments, of $856 million for 1996, $775 million for 1997 and $750 million for 1998.\nCommitments for Coal and Gas Supplies: Consumers has entered into coal supply contracts with various suppliers for its coal-fired generating stations. These contracts have expiration dates that range from 1997 to 2004. Consumers contracts for approximately 60 - 70 percent of its annual coal requirements which in 1995 totaled $233 million (72 percent was under long-term contracts). Consumers supplements its long-term contracts with spot-market purchases to fulfill its coal needs.\nConsumers has entered into gas supply contracts with various suppliers for its natural gas business. These contracts have expiration dates that range from 1996 to 2003. In 1995, Consumers' gas requirements totaled $694 million (80 percent was under long-term contracts). In the future, Consumers expects that approximately 35 percent of its annual gas requirements will be under long-term contracts. Consumers supplements its long-term contracts with spot-market purchases to fulfill its gas needs.\nOther: As of December 31, 1995, CMS Energy and Enterprises have guaranteed up to $62 million in contingent obligations of unconsolidated affiliates of Enterprises' subsidiaries.\nCMS NOMECO periodically enters into oil and gas price hedging arrangements to mitigate its exposure to price fluctuations on the sale of crude oil and natural gas. These arrangements limit potential gains\/losses from any future decrease\/increase in the spot prices. As of December 31, 1994, CMS NOMECO was party to gas price collar contracts on 7.3 bcf of gas for the delivery months of January through December 1995 at prices ranging from $2.05 to $2.35 per MMBtu. As of December 31, 1995, CMS NOMECO also has contracts on 7.4 bcf of gas for the delivery months of January through May 1996 at prices ranging from $1.89 to $2.18 per MMBtu. These hedging arrangements are accounted for as hedges; accordingly, any changes in market value and gains or losses from settlements are deferred and recognized at such time as the hedged transaction is completed. As of December 31, 1994 and December 31, 1995, the fair values of these hedge arrangements were not materially different than the book value.\nCMS NOMECO also has one arrangement which is used to fix the prices that CMS NOMECO will pay to supply gas for the years 2001 - 2006 by purchasing the economic equivalent of 10,000 MMBtu per day at a fixed, escalated price starting at $2.82 per MMBtu in 2001. The settlement periods are each a one-year period ending December 31, 2001 through 2006 on 3.65 MMBtu. If the \"floating price,\" essentially the then current Gulf Coast spot price, for a period is higher than the \"fixed price,\" the seller pays CMS NOMECO the difference, and vice versa. If a party's exposure at any time exceeds $2 million, that party is required to obtain a letter of credit in favor of the other party for the excess over $2 million and up to $10 million. At December 31, 1995, a letter of credit was not required.\nConsumers has experienced a number of lawsuits filed against it relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the grounding of the customer's service. At December 31, 1995, Consumers had 30 separate stray voltage lawsuits awaiting trial court action, down from 83 lawsuits at December 31, 1994.\nIn addition to the matters disclosed in these notes, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on CMS Energy's financial position or results of operations.\n15: Nuclear Matters\nIn 1993, the NRC approved the design of the spent fuel dry storage casks now being used by Consumers at Palisades. In order to address concerns raised subsequent to the initial cask loading, Consumers and the NRC each analyzed the effects of seismic and other natural hazards on the support pad on which the casks are placed, and confirmed that the pad location is acceptable to support the casks. As of December 31, 1995, Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades.\nIn 1996, Consumers plans to unload and replace one of the loaded casks. In a review of the cask manufacturer's quality assurance program, Consumers detected indications of minor flaws in welds in the steel liner of one of the loaded casks. Although the cask continues to safely store spent fuel and there is no requirement for its replacement, Consumers has nevertheless decided to remove the spent fuel and insert it in another cask. Consumers has examined radiographs for all of its casks and has found all other welds acceptable. Certain parties, including the Attorney General, have petitioned the NRC to suspend Consumers' general license to store spent fuel, claiming that Consumers' cask unloading procedure does not satisfy NRC regulations. The NRC staff is reviewing the petitions.\nThe Low-Level Radioactive Waste Policy Act encourages the respective states, individually or in cooperation with each other, to be responsible for the disposal of low-level radioactive waste. Currently, a low-level waste site does not exist in Michigan and Consumers has been storing low- level waste at its nuclear plant sites. Consumers began shipping its low- level waste to a site in South Carolina during 1995 and plans to have all its currently stored low-level waste removed from the plant sites by the end of 1996.\nConsumers maintains insurance coverage against property damage, debris removal, personal injury liability and other risks that are present at its nuclear generating facilities. This insurance includes coverage for replacement power costs for the major portion of prolonged accidental outages for 12 months after a 21 week exclusion with reduced coverage to approximately 80 percent for two additional years. If certain loss events occur at its own or other nuclear plants similarly insured, Consumers could be required to pay maximum assessments of: $30 million in any one year to NML and NEIL; $79 million per event under the nuclear liability secondary financial protection program, limited to $10 million per event in any one year; and $6 million in the event of nuclear workers claiming bodily injury from radiation exposure. Consumers considers the possibility of these assessments to be remote.\nUnder its NML and NEIL policies, Consumers may be entitled to cash distributions following the discontinued operation of its nuclear facilities. The amount of any distribution would be determined by NML and NEIL and would be based, in part, on their overall underwriting experience.\nAs an NRC licensee, Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated \"pressurized thermal shock\" events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Analysis of recent data from testing of similar materials indicates that the Palisades reactor vessel can be safely operated through late 1999. In April 1995, Consumers received a Safety Evaluation Report from the NRC concurring with this evaluation and requesting submittal of an action plan to provide for operation of the plant beyond 1999. Consumers is developing plans to anneal the reactor vessel in 1998 at an estimated cost of $20 million to $30 million. This repair would allow for operation of the plant to the end of its license life in the year 2007. Consumers cannot predict whether the studies being conducted as part of the development plans will support a future decision to anneal.\n16: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for the jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1995 1994 - ----------- ----- ----- Net investment Ludington - 51% $116 $119 Campbell Unit 3 - 93.3% 332 337 Transmission lines - various 33 31\nAccumulated depreciation Ludington $ 81 $ 76 Campbell Unit 3 238 224 Transmission lines 14 11\n17: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1995 1994 1993 ----- ----- ----- Cash transactions Interest paid (net of amounts capitalized) $207 $162 $193 Income taxes paid (net of refunds) 34 36 32\nNon-cash transactions Nuclear fuel placed under capital lease $ 26 $ 21 $ 28 Other assets placed under capital leases 5 15 30 Common Stock issued to acquire companies 90 - - Assumption of debt 20 - - Capital leases refinanced 21 - 42\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1995 1994 1993 ----- ----- -----\nSale of receivables, net $ 20 $(10) $ 60 Accounts receivable (80) (15) 22 Accrued revenue (24) 20 (48) Inventories 43 (4) (32) Accounts payable 112 26 (31) Accrued refunds (3) (3) (49) Other current assets and liabilities, net 30 4 (4) Non-current deferred amounts, net (9) (6) (6) ----- ----- ----- $ 89 $ 12 $(88) ===== ===== =====\n18: Reportable Segments\nCMS Energy operates principally in the following five business segments: electric utility, gas utility, oil and gas exploration and production, independent power production, and natural gas transmission, storage and marketing.\nThe Consolidated Statements of Income show operating revenue and pretax operating income by business segment. Other segment information follows:\nIn Millions Years Ended December 31 1995 1994 1993 - ----------------------- ----- ----- ----- Depreciation, depletion and amortization Electric utility $ 272 $ 257 $ 241 Gas utility 83 76 73 Oil and gas exploration and production 52 41 45 Independent power production 4 2 2 Natural gas transmission, storage and marketing 3 2 1 Other 2 1 2 ------- ------- ------- $ 416 $ 379 $ 364 ======= ======= =======\nIdentifiable assets Electric utility (a) $4,522 $4,364 $4,100 Gas utility (a) 1,690 1,673 1,628 Oil and gas exploration and production 660 469 398 Independent power production 840 536 488 Natural gas transmission, storage and marketing 303 109 75 Other 128 227 275 ------- ------- ------- $8,143 $7,378 $6,964 ======= ======= =======\nCapital expenditures (b) Electric utility $ 328 $ 358 $ 403 Gas utility 126 134 158 Oil and gas exploration and production (c) 168 115 83 Independent power production 239 29 110 Natural gas transmission, storage and marketing 178 31 14 Other 14 5 - ------ ------ ------ $1,053 $ 672 $ 768 ====== ====== ======\n(a) Amounts include an attributed portion of Consumers' other common assets to both the electric and gas utility businesses.\n(b) Includes capital leases for nuclear fuel and other assets and electric DSM costs (see Statement of Cash Flows). Amounts also include an attributed portion of Consumers' capital expenditures for plant and equipment common to both the electric and gas utility businesses.\n(c) Includes common stock issued for acquisitions.\n19: Effects of the Ratemaking Process\nThe following regulatory assets (liabilities) which include both current and non-current amounts, are reflected in the Consolidated Balance Sheets. These assets represent probable future revenue to Consumers associated with certain incurred costs as these costs are recovered through the ratemaking process.\nIn Millions December 31 1995 1994 - ------------ ----- ----- Postretirement benefits (Note 12) $ 487 $ 503 Income taxes (Note 5) 176 189 Abandoned Midland project 131 147 DSM - deferred costs (Note 4) 68 71 Trunkline settlement 55 85 Manufactured gas plant sites (Note 14) 47 47 Power purchase contracts (Note 3) 44 30 Uranium enrichment facility 25 25 Other 22 31 ------ ------\nTotal regulatory assets $1,055 $1,128 ====== ======\nIncome taxes (Note 5) $ (220) $ (205) DSM - deferred revenue (25) (21) Other (1) - ------ ------\nTotal regulatory liabilities $ (246) $ (226) ====== ======\nAt December 31, 1995, approximately $778 million of Consumers' regulatory assets are being recovered through rates being charged to customers over periods of up to 17 years. Consumers anticipates MPSC approval for recovery of the remaining amounts.\n20: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1995 obligation to purchase electric capacity from the MCV Partnership was approximately 16 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership follows:\nStatements of Income In Millions Years Ended December 31 1995 1994 1993 - ----------------------- ----- ----- -----\nOperating revenue (a) $ 618 $ 579 $ 548 Operating expenses 386 378 362 ------ ------ ------\nOperating income 232 201 186 Other expense, net 171 183 189 ------ ------ ------ Net income (loss) $ 61 $ 18 $ (3) ====== ====== ====== Balance Sheets In Millions December 31 1995 1994 - ------------ ---- ----\nAssets Current assets (b) $ 263 $ 206 Property, plant and equipment, net 1,948 2,012 Other assets 156 154 ------ ------ $2,367 $2,372 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 225 $ 218 Long-term debt and other non-current liabilities (c) 2,008 2,081 Partners' equity (d) 134 73 ------ ------ $2,367 $2,372 ====== ======\n(a) Revenue from Consumers totaled $571 million, $534 million and $505 million for 1995, 1994 and 1993, respectively.\n(b) At December 31, 1995 and 1994, $48 million was receivable from Consumers.\n(c) FMLP is the sole beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP. At December 31, 1995 and 1994, lease obligations of $1.6 billion and $1.7 billion, respectively, were owed to the owner trust. CMS Holdings' share of the interest and principal portion for the 1995 lease payments was $66 million and $23 million, respectively, and for the 1994 lease payments was $68 million and $14 million, respectively. The lease payments service $1.1 billion and $1.2 billion in non-recourse debt outstanding as of December 31, 1995 and 1994, respectively, of the owner-trust. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1995 and 1994, the owner-trust made debt payments (including interest) of $192 million and $175 million, respectively.\n(d) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of preferred stock of CMS ENERGY CORPORATION (a Michigan corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 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 CMS Energy 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\nDetroit, Michigan, January 26, 1996.\nConsumers Power Company\n1995 Financial Statements\n(This page intentionally left blank)\nConsumers Power Company Management's Discussion and Analysis\nConsumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry.\nConsolidated Earnings\nConsolidated net income after dividends on preferred stock totaled $227 million in 1995, compared to net income of $202 million and $187 million in 1994 and 1993, respectively. The improved net income for 1995 reflects increased electric sales and gas deliveries, increased electric revenue as a result of the May 1994 rate increase, reversal of losses previously recorded for gas contingencies (see Note 4), and improved operating results from Consumers' interest in the MCV Facility. For further information, see the Electric and Gas Utility Results of Operations sections. The increased 1994 net income over the 1993 period reflects a significant increase in electric sales, the impact of the 1994 electric rate increase, recognition of incentive revenue related to DSM programs, and the favorable resolution of a previously recorded gas cost contingency.\nCash Position, Financing and Investing\nCash from operations is derived from the sale and transportation of natural gas and the generation, transmission, and sale of electricity. Cash from operations during 1995 increased $44 million from the 1994 level primarily from higher sales of electricity and gas, lower gas inventories and timing of cash payments related to its operations partially offset by higher power purchases from the MCV Partnership. Consumers primarily uses this operating cash to maintain its electric and gas systems and retire portions of its long-term debt and pay dividends.\nFinancing Activities: Net cash used in financing activities in 1995 increased $76 million from 1994, reflecting no new stock or debt issuances during 1995. This change also reflects a $100 million equity investment from CMS Energy during 1994. During 1995, Consumers declared $70 million in common stock dividends. This represents a decrease from 1994 as Consumers temporarily suspended its common dividends in lieu of CMS Energy making a direct equity infusion of cash into Consumers. In 1996, Consumers plans to resume common stock dividend payments to CMS Energy. Dividends on preferred stock increased to $28 million in 1995, reflecting the issuance of additional preferred stock in 1994.\nInvesting Activities: Net cash used in investing activities in 1995 decreased $9 million from 1994, primarily reflecting decreased capital expenditures. Capital expenditures, including assets placed under capital lease (see Note 15) and deferred DSM costs, totaled $454 million in 1995 as compared to $492 million in 1994 and $561 million in 1993. These amounts primarily represent capital investments in Consumers' electric and gas utility business units.\nFinancing and Investing Outlook: Consumers estimates that capital expenditures, including new lease commitments, related to its electric and gas utility operations will total approximately $1.2 billion over the next three years.\nIn Millions Years Ended December 31 1996 1997 1998 ----- ----- ----- Consumers Construction $389 $368 $340 Nuclear fuel lease 34 5 41 Capital leases other than nuclear fuel 10 19 16 Michigan Gas Storage 2 3 3 ----- ----- ----- $435 $395 $400 ===== ===== =====\nConsumers is required to redeem or retire $726 million of long-term debt over the three-year period ending December 1998. Cash provided by operating activities is expected to satisfy a substantial portion of these capital expenditures and debt retirements. Additionally, Consumers will continue to evaluate the capital markets as a source of financing its investing activities and required debt retirements.\nConsumers has several available, unsecured, committed lines of credit totaling $145 million and a $425 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1996. Consumers uses short-term borrowings to finance working capital and gas in storage, and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. At December 31, 1995 and 1994, receivables sold totaled $295 million and $275 million, respectively.\nAt December 31, 1995, Consumers' capital structure consisted of approximately 36 percent common equity, 8 percent preferred stock, and 56 percent long- and short-term debt (including capital leases and notes payable). Consumers is continuing its efforts to improve the percentages of common and preferred equity on its balance sheet. In January 1996, Consumers issued and sold, through a business trust, 4 million shares of Trust Originated Preferred Securities with net proceeds totaling $96 million (see Note 7). Consumers also expects to improve the equity portion of its capital structure through accumulated earnings and controlled capital expenditures.\nElectric Utility Results of Operations\nElectric Pretax Operating Income: During 1995, electric pretax operating income increased $30 million compared to 1994, reflecting significantly higher electric kWh sales (see Electric Sales section) and the impact of the May 1994 electric rate increase, which included the recovery of higher postretirement benefit costs. The increase was partially offset by higher depreciation, general taxes, and electric operation expenses during 1995, which included $9 million of additional postretirement benefit costs, along with the impact of $11 million of DSM incentive revenue during 1994.\nThe 1994 increase of $46 million over the 1993 level reflects increased electric sales, partially offset by higher depreciation and electric operation expenses. Other factors contributing to the 1994 increase were the impact of the May 1994 electric rate increase and the recognition of 1994 DSM incentive revenue.\nIn Millions Impact on Pretax Operating Income Change Compared to Prior Year\n1995\/1994 1994\/1993 --------- --------- Sales $59 $ 33 Rate increase and other regulatory issues 9 38 O&M, general taxes and depreciation (38) (25) ----- ----- Total change $30 $46 ===== =====\nElectric Sales: Total electric sales in 1995 were a record 35.5 billion kWh, a 3.0 percent increase from the 1994 level as a result of economic growth and warmer summer temperatures. The increase in total electric sales included a 4.2 percent increase in sales to Consumers' ultimate customers, with fairly consistent increases in the residential, commercial, and industrial sectors. The increase was partially offset by a decrease in certain sales to other utilities.\nTotal electric sales in 1994 were 34.5 billion kWh, a 5.2 percent increase from the 1993 level, which included a 4.2 percent increase in system sales to Consumers' ultimate customers.\nPower Costs: Power costs for 1995 totaled $970 million, a $20 million increase from the corresponding 1994 period, primarily reflecting increased purchased power costs due to higher sales levels. Power costs for 1994 totaled $950 million, a $42 million increase as compared to 1993 which reflects increased kWh production at Consumers' generating plants and greater power purchases from outside sources to meet increased sales demand.\nOperating Expenses: Electric operation and maintenance expense for 1995 compared to 1994 increased $13 million, which included $9 million of additional postretirement benefit costs and increased expenditures to improve electric system reliability. Electric depreciation for 1995 compared to 1994 increased $15 million, reflecting additional property and equipment. Electric general taxes increased $11 million in 1995 compared to 1994, reflecting millage rate increases and additional capital investments in property and equipment.\nElectric Utility Issues\nPower Purchases from the MCV Partnership: Consumers' annual obligation to purchase contract capacity from the MCV Partnership increased 108 MW in 1995 to 1,240 MW. In 1993, the MPSC issued the Settlement Order that has allowed Consumers to recover substantially all payments for 915 MW of contract capacity purchased from the MCV Partnership. ABATE and the Attorney General have appealed the Settlement Order to the Court of Appeals. The market for the remaining 325 MW of contract capacity was assessed at the end of 1992. This assessment, along with the Settlement Order, resulted in Consumers recognizing a loss for the present value of the estimated future underrecoveries of power purchases from the MCV Partnership. Additional losses may occur if actual future experience materially differs from the 1992 estimates. As anticipated in 1992, Consumers continues to experience cash underrecoveries associated with the Settlement Order. These after-tax cash underrecoveries totaled $90 million, $61 million and $59 million in 1995, 1994 and 1993, respectively. Estimated future after-tax cash underrecoveries, and possible losses for 1996 and the next four years are shown in the table below.\nAfter-tax, In Millions 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- Estimated cash underrecoveries $56 $55 $ 8 $ 9 $ 7\nPossible additional underrecoveries and losses (a) 20 22 72 72 74\n(a) If unable to sell any capacity above the MPSC's 1993 authorized level.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that would potentially resolve several issues in three pending proceedings, including cost recovery for the 325 MW of MCV Facility capacity above the MPSC's currently authorized level. For further information regarding the settlement, see Note 4.\nIn 1994 and 1995, Consumers terminated power purchase agreements with the developers of a proposed 65 MW coal-fired cogeneration facility and a proposed 44 MW wood and chipped-tire plant. To replace this capacity, 109 MW of less expensive contract capacity from the MCV Facility which Consumers is currently not authorized to recover from retail customers would be used. For further information, see Note 3.\nElectric Rate Proceedings: Consumers filed a request with the MPSC in late 1994 to increase its retail electric rates. In early 1996, the MPSC granted Consumers authority to increase its annual electric retail rates by $46 million. This partial final order did not address cost recovery related to the 325 MW of MCV Facility contract capacity above 915 MW. The MPSC stated that this matter would be addressed in connection with its consideration of the proposed settlement agreement discussed below.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that, if approved by the MPSC, would resolve several outstanding regulatory issues. One of these issues, Consumers' electric rate case, was addressed, in part, by the order discussed above. If fully adopted, the settlement agreement would resolve Consumers' depreciation and special competitive service cases (discussed below) and cost recovery of 325 MW of uncommitted MCV Facility capacity. Consumers expects a final order in the spring of 1996. For more information regarding the electric rate order and the settlement, see Note 4.\nIn 1995, Consumers filed a request with the MPSC, seeking approval to increase its traditional depreciation expense by $21 million and reallocate certain portions of its utility plant from production to transmission, resulting in a $28 million decrease. If both aspects of the request are approved, the net result would be a decrease in electric depreciation expense of $7 million for ratemaking purposes. The MPSC staff's filing in this case did not support Consumers' requested increase in depreciation expense, but instead proposed a decrease of $24 million. The MPSC staff also did not support the reallocation of plant investment as proposed by Consumers but suggested several alternatives which could partially address this issue. In September 1995, the ALJ issued a proposal for decision that essentially supported the MPSC staff's position regarding depreciation expense and recommended that the MPSC reject both Consumers' and the MPSC staff's positions regarding the reallocation of Consumers' depreciation reserve and plant investment. This case is currently part of the proposed settlement discussed above.\nSpecial Rates: Consumers currently has a request before the MPSC that, if approved, would allow Consumers a certain level of rate-pricing flexibility to respond to customers' alternative energy options. This request has been consolidated into the settlement proceeding discussed above.\nElectric Conservation Efforts: In June 1995, the MPSC issued an order that authorized Consumers to discontinue future DSM program expenditures and cease all new programs. For further information, see Note 4.\nElectric Capital Expenditures: Consumers estimates capital expenditures, including new lease commitments, related to its electric utility operations of $311 million for 1996, $285 million for 1997 and $295 million for 1998. These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas utility businesses.\nElectric Environmental Matters: The 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nThe Michigan Natural Resources and Environmental Protection Act (formerly the Michigan Environmental Response Act) was substantially amended in June 1995. The Michigan law bears similarities to the federal Superfund law. The purpose of the 1995 amendments was generally to encourage development of industrial sites and to remove liability from some parties who were not responsible for activities causing contamination. Consumers expects that it will ultimately incur costs at a number of sites. Consumers believes costs incurred for both investigation and required remedial actions are properly recoverable in rates.\nConsumers is a so-called \"potentially responsible party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on current information, management believes it is unlikely that Consumers' liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position, liquidity or results of operations. For further information regarding electric environmental matters, see Note 12.\nElectric Outlook\nCompetition: Consumers currently expects approximately 2 percent average annual growth in electric system sales over the next five years.\nConsumers continues to be affected by the developing competitive market for electricity. The primary sources of competition include: the installation of cogeneration or other self-generation facilities by Consumers' larger industrial customers; the formation of municipal utilities which would displace retail service by Consumers to an entire community; and competition from neighboring utilities which offer flexible rate arrangements designed to encourage movement to their respective service areas. Consumers continues to work toward retaining its current retail service customers.\nIn an effort to meet the challenge of competition, Consumers has signed long-term sales contracts with some of its largest industrial customers, including its largest customer, General Motors Corporation. Under the General Motors contract, Consumers will serve certain facilities at least five years and other facilities at least 10 years in exchange for competitively discounted electric rates. Certain facilities will have the option of taking retail wheeling service (if available) after the first three years of the contract. The MPSC approved this contract in 1995.\nAs part of an order issued in early 1996, the MPSC significantly reduced the rate subsidization of residential customers by industrial and large commercial customers. In addition to offering electric rates that are competitive with other energy providers, Consumers is pursuing other strategies to retain its \"at-risk\" customers. These strategies include: minimizing outages for each customer, promptly responding to customer inquiries, and providing consulting services to help customers use energy efficiently.\nIn 1994, the MPSC approved a framework for a five-year experimental retail wheeling program for Consumers and Detroit Edison. Under the experiment, up to 60 MW of Consumers' additional load requirements could be met by retail wheeling. The program becomes effective upon Consumers' next solicitation for capacity. In June 1995, the MPSC issued an order that set rates and charges for retail delivery service under the experiment. Consumers, ABATE and The Dow Chemical Company filed claims of appeal of the MPSC's retail wheeling orders. The Court of Appeals subsequently consolidated these appeals with those previously filed by Detroit Edison and the Attorney General. Consumers does not expect this short-term experiment to have a material impact on its financial position, liquidity or results of operations.\nIn March 1995, the FERC issued a NOPR and a supplemental NOPR that propose changes in the wholesale electric industry. Among the most significant proposals is a requirement that utilities provide open access to the domestic interstate transmission grid. The FERC's final rules are expected to be announced in the spring of 1996. Consumers is unable to predict the terms of these rules. However, management believes that Consumers is well-positioned to conform to open access as it has been voluntarily providing this transmission service since 1992.\nThe Governor of the State of Michigan has proposed that the MPSC review the existing statutory and regulatory framework governing Michigan utilities in light of increasing competition in the utility industry and recommend appropriate revisions. At this time, no proceedings have been initiated at the MPSC on this matter and no new legislation has been introduced.\nChanges in the competitive environment facing regulated utilities may eventually lead to the discontinuance of SFAS 71, which allows the deferral of certain costs and the recording of regulatory assets. Management has evaluated Consumers' current regulatory position and believes it continues to support the recognition of Consumers' $779 million of electric-related regulatory assets. If changes in the industry were to lead to Consumers discontinuing the application of SFAS 71, for all or part of its business, Consumers may be required to write-off the portion of any regulatory asset for which no regulatory assurance of recovery continued to exist. Consumers does not believe that there is any current evidence that supports the write-off of any of its electric- related regulatory assets. For further information regarding SFAS 71 and Consumers' regulatory assets, see Notes 2 and 18.\nNuclear Matters: In July 1995, the NRC issued its Systematic Assessment of Licensee Performance report for Palisades. The report recognized improved performance at the plant, specifically in the areas of Engineering and Plant Operations. In the report, the NRC noted areas which continue to require management's attention, but also recognized the development and implementation of plans for corrective action designed to address previously identified weak areas. The report noted that performance in the areas of Maintenance and Plant Support was good and remained unchanged.\nConsumers' on-site storage pool for spent nuclear fuel at Palisades is at capacity. Consequently, Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary on-site storage. In 1996, Consumers plans to unload and replace one of the casks where a minor flaw has been detected. For further information, see Note 13.\nThe Low-Level Radioactive Waste Policy Act encourages the respective states, individually or in cooperation with each other, to be responsible for the disposal of low-level radioactive waste. Currently, a low-level waste site does not exist in Michigan and Consumers has been storing low- level waste at its nuclear plant sites. Consumers began shipping its low- level waste to a site in South Carolina during 1995 and plans to have all its currently stored low-level waste removed from the plant sites by the end of 1996.\nConsumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated \"pressurized thermal shock\" events during its remaining license life. Analysis of recent data from testing of similar materials indicates that the Palisades reactor vessel can be safely operated through late 1999. Consumers is developing plans to anneal the reactor vessel in 1998 at an estimated cost of $20 million to $30 million. This repair would allow for operation of the plant to the end of its license life in the year 2007. Consumers cannot predict whether the studies being conducted as a part of the development plans will support a future decision to anneal.\nAt the SEC staff's request, the FASB is reviewing the accounting for closure and removal costs for long-lived assets, including decommissioning. The current electric utility industry accounting practices of recording the cost of removal as a component of depreciation could be changed. The FASB's tentative decision includes recognition of the cost of closure and removal obligation as a liability based on discounted future cash flows with the offset recorded as part of the cost of the plant asset.\nStray Voltage: Consumers has experienced a number of lawsuits relating to the effect of so-called stray voltage on certain livestock. At December 31, 1995, Consumers had 30 separate stray voltage lawsuits awaiting trial court action, down from 83 lawsuits at December 31, 1994. Consumers believes that the resolution of these lawsuits will not have a material impact on its financial position or results of operations.\nGas Utility Results of Operations\nGas Pretax Operating Income: For 1995, gas pretax operating income increased $16 million compared to 1994, reflecting higher gas deliveries (see Gas Deliveries section), and the reversal of losses previously recorded for gas contingencies (see Note 4). Partially offsetting this increase were higher depreciation and gas operation expenses. For 1994, gas pretax operating income decreased $11 million compared to 1993, reflecting slightly lower gas sales and higher depreciation and gas operation and maintenance expenses, partially offset by the favorable resolution of a previously recorded gas cost contingency.\nIn Millions Impact on Pretax Operating Income\nChange Compared to Prior Year 1995\/1994 1994\/1993 --------- --------- Sales $12 $(3) Regulatory recovery of gas cost 19 10 O&M, general taxes and depreciation (15) (18) ----- ----- Total change $16 $(11) ===== =====\nGas Deliveries: Gas sales in 1995 totaled 254 bcf, a 5.2 percent increase from 1994 levels, and total system deliveries, excluding transport to the MCV Facility, increased 6.5 percent from 1994. On a weather-adjusted basis, total system deliveries increased 4.1 percent, reflecting significant growth. In 1994, total system deliveries, excluding transport to the MCV Facility, were 314 bcf, a slight decrease from 1993 deliveries.\nCost of Gas Sold: The cost of gas sold for 1995 increased $9 million from the 1994 level, as a result of increased deliveries. The increased costs reflect the reversal of a $23 million gas supplier loss contingency.\nOperating Expenses: Gas operation and maintenance expense increased $12 million, reflecting an $8 million gas inventory loss. Gas depreciation for 1995 compared to 1994 increased $7 million, reflecting additional capital investment in property and equipment.\nGas Utility Issues\nGas Rates: In December 1994, Consumers filed a request with the MPSC to increase Consumers' annual gas rates. The requested increase totaling $7 million reflected increased expenditures, including those associated with postretirement benefits, and a 12.25 percent return on equity. The MPSC staff recommended a $13 million rate decrease. In November 1995, the ALJ issued a proposal for decision that essentially adopted the MPSC staff's position. In early 1996, the MPSC issued a final order in this case, decreasing Consumers' annual gas rates by $11.7 million. For further information regarding this case, see Note 4.\nConsumers entered into a special natural gas transportation contract with one of its transportation customers in response to the customer's proposal to by-pass Consumers' system in favor of a competitive alternative. The contract provides for discounted gas transportation rates in an effort to induce the customer to remain on Consumers' system. In February 1995, the MPSC approved the contract but stated that the revenue shortfall created by the difference between the contract's discounted rate and the floor price of one of Consumers' MPSC authorized gas transportation rates must be borne by Consumers' shareholders. In March 1995, Consumers filed an appeal with the Court of Appeals claiming that the MPSC decision denies Consumers the opportunity to earn its authorized rate of return and is therefore unconstitutional.\nGCR Matters: In October 1995, the MPSC issued an order regarding a $44 million (excluding any interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order supports its position that the producers' theories are without merit and intends to vigorously oppose any claims they may raise but cannot predict the outcome of this issue.\nGas Capital Expenditures: Consumers estimates capital expenditures, including new lease commitments, related to its gas utility operations of $124 million for 1996, $110 million for 1997 and $105 million for 1998. These amounts include an attributed portion of Consumers' anticipated capital expenditures for plant and equipment common to both the electric and gas utility businesses.\nGas Environmental Matters: Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some that formerly housed manufactured gas plant facilities. Data available to Consumers and its continued internal review of these former manufactured gas plant sites have resulted in an estimate for all costs related to investigation and remedial action of between $48 million and $112 million. These estimates are based on undiscounted 1995 costs. At December 31, 1995, Consumers has accrued a liability for $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and regulatory requirements, could impact the estimate of remedial action costs for the sites.\nConsumers requested recovery and deferral of certain investigation and remedial action costs in its gas rate case filed in December 1994. Consumers believes that remedial action costs are recoverable in rates and is continuing discussions with certain insurance companies regarding coverage for some or all of the costs which may be incurred for these sites. For further information, see Note 12.\nGas Outlook\nConsumers currently anticipates gas deliveries to grow approximately 2 percent per year (excluding transportation to the MCV Facility and off- system deliveries) over the next five years, primarily due to a steadily growing customer base. Additionally, Consumers has several strategies which will support increased load requirements in the future. These strategies include increased efforts to promote natural gas to both current and potential customers that are using other fuels for space and water heating. The emerging use of natural gas vehicles also provides Consumers with sales growth opportunities. In addition, as air quality standards continue to become more stringent, management believes that greater opportunities exist for converting industrial boiler load and other processes to natural gas. Consumers also plans additional capital expenditures to construct new gas mains that are expected to expand Consumers' system.\nIn 1995, Consumers purchased approximately 80 percent of its required gas supply under long-term contracts, and the balance on the spot market. Consumers estimates that approximately 35 percent of its gas purchases will be under long-term contracts in future years as current contracts expire. Consumers also has transmission contracts totaling approximately 90 percent of its supply requirements. The expiration dates of the transmission contracts range from 1997 to 2004.\nIn 1995, the Low Income Home Energy Assistance Program provided approximately $71 million in heating assistance to about 400,000 Michigan households, with approximately 18 percent of funds going to Consumers' customers. In late 1995, federal legislative approval provided Michigan residents with approximately $60 million of funding for 1996. Consumers cannot predict what level of funding will be approved for 1997.\nIn January 1996, the MPSC issued a Notice of legislative-type hearings to be held in 1996, to assess whether it is appropriate to allow all natural gas customers access to gas transportation service. The MPSC notice designated all eight local distribution companies whose rates are regulated by the MPSC as parties to this proceeding.\nUnder SFAS 71, Consumers is allowed to defer certain costs to the future and record regulatory assets, based on the recoverability of those costs through the MPSC's approval. Consumers has evaluated its $276 million of regulatory assets (see Note 18) related to its gas business, and believes that sufficient regulatory assurance exists to provide for the recovery of these deferred costs.\nOther\nNew Accounting Standard: In 1995, the FASB issued SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which is effective for 1996. Consumers does not expect the application of this statement to have a material impact on its financial position, liquidity or results of operations. For further information, see Note 2.\nConsumers Power Company Notes to Consolidated Financial Statements\n1: Corporate Structure\nConsumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation: The consolidated financial statements include Consumers and its wholly owned subsidiaries. The financial statements are prepared in conformity with generally accepted accounting principles and include the use of management's estimates. Consumers uses the equity method of accounting for investments in its companies and partnerships where it has more than a 20 percent but less than a majority ownership interest.\nAccretion Income and Expense: In 1991, the MPSC ordered that Consumers could recover a portion of its abandoned Midland investment over a 10-year period, but did not allow Consumers to earn a return on that amount. Consumers reduced the recoverable investment to the present value of the future recoveries. During the recovery period, the unrecovered asset is adjusted to its present value. This adjustment is reflected as accretion income. Conversely, Consumers recorded a loss in 1992 for the present value of its estimated future underrecoveries of power costs resulting from purchases from the MCV Partnership (see Note 3), and now recognizes accretion expense annually to reflect the time value of money on the recorded loss.\nGas Inventory: Consumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion: Property repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. The composite depreciation rate for electric utility property was 3.5 percent for 1995, 3.5 percent for 1994 and 3.4 percent for 1993. The composite rate for gas utility plant was 4.3 percent for 1995, 4.2 percent for 1994 and 4.4 percent for 1993. The composite rate for other plant and property was 4.9 percent for 1995 and 4.7 percent for 1994 and 1993.\nNew Accounting Standard: During 1995, the FASB issued SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement, which is effective for 1996 financial statements, requires that an asset be reviewed for impairment whenever events indicate that its carrying amount may not be recoverable. The statement also requires that a loss be recognized whenever a portion of an asset's cost is excluded from a rate-regulated company's rate base. Consumers does not expect the application of this statement to have a material impact on its financial position or results of operations.\nNuclear Fuel Cost: Consumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities. However, in 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. In 1995, federal legislation was introduced to clarify the DOE's obligation to accept spent nuclear fuel and direct the DOE to establish an integrated spent fuel management system that includes designing and constructing an interim storage facility in Nevada. For fuel used after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers them through electric rates and remits to the DOE quarterly. Consumers elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983, until the spent fuel is delivered to the DOE, which was originally scheduled to occur in 1998. At December 31, 1995, Consumers has recorded a liability to the DOE of $100 million, including interest. Consumers recovered through electric rates the amount of this liability, excluding a portion of interest.\nNuclear Plant Decommissioning: Consumers collects approximately $45 million annually from its electric customers to decommission its two nuclear plants. On March 1, 1995, Consumers filed updated decommissioning information with the MPSC which estimated decommissioning costs for Big Rock and Palisades to be $303 million and $524 million (in 1995 dollars), respectively. The estimated decommissioning costs increased from previous estimates principally due to the unavailability of low- and high-level radioactive waste disposal facilities. Amounts collected from electric retail customers and deposited in trusts (including trust earnings) are credited to accumulated depreciation. To meet NRC decommissioning requirements, Consumers prepared site-specific decommissioning cost estimates for Big Rock and Palisades, assuming that each plant site will eventually be restored to conform with the adjacent landscape, and that all contaminated equipment will be disassembled and disposed of in a licensed burial facility. After the plants are retired, Consumers plans to maintain the facilities in protective storage until radioactive waste disposal facilities are available. As a result, the majority of decommissioning costs will be incurred several years after each plant's NRC operating license expires. When Big Rock's and Palisades' NRC licenses expire in 2000 and 2007, respectively, the trust funds are estimated to have accumulated $257 million and $686 million, respectively. It is estimated that at the time the plants are fully decommissioned (in the years 2030 for Big Rock and 2046 for Palisades), the trust funds will have provided $1 billion for Big Rock and $2.1 billion for Palisades including trust earnings over this decommissioning period. Based on this plan, Consumers believes that the current decommissioning surcharge will be sufficient to provide for decommissioning of its nuclear plants. At December 31, 1995, Consumers had an investment in nuclear decommissioning trust funds of $304 million.\nReclassifications: Consumers has reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect net income for the years presented.\nRevenue and Fuel Costs: Consumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until it bills or refunds these differences to customers following an MPSC order.\nUtility Regulation: Consumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther: For significant accounting policies regarding income taxes, see Note 5; for pensions and other postretirement benefits, see Note 10; and for cash equivalents, see Note 15.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990 and to supply electricity and steam to The Dow Chemical Company. Consumers, through its subsidiaries, holds the following assets related to the MCV Partnership and MCV Facility: 1) CMS Midland owns a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings holds through the FMLP a 35 percent lessor interest in the MCV Facility.\nPower Purchases from the MCV Partnership: Consumers' annual obligation for purchase of contract capacity from the MCV Partnership under the PPA increased 108 MW to its maximum amount of 1,240 MW in 1995. In 1993, the MPSC issued the Settlement Order that has allowed Consumers to recover substantially all of the payments for its ongoing purchase of 915 MW of contract capacity. ABATE and the Attorney General have appealed the Settlement Order to the Court of Appeals. Under the Settlement Order, capacity and energy purchases from the MCV Partnership above the 915 MW level can be utilized to satisfy customers' power needs but the MPSC will determine the levels of recovery from retail customers at a later date. The Settlement Order also provides Consumers the right to remarket to third parties the remaining contract capacity. The MCV Partnership did not object to the Settlement Order.\nThe PPA provides that Consumers is to pay the MCV Partnership a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge which is based primarily on Consumers' average cost of coal consumed. The Settlement Order permits Consumers to recover capacity charges averaging 3.62 cents per kWh for 915 MW of capacity, the fixed energy charge and the prescribed energy charges associated with the scheduled deliveries within certain hourly availability limits, whether or not those deliveries are scheduled on an economic basis. For all energy delivered on an economic basis above the availability limits to 915 MW, Consumers has been allowed to recover 1\/2 cent per kWh capacity payment in addition to the variable energy charge.\nIn 1992, Consumers recognized a loss for the present value of the estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss was based, in part, on management's assessment of the future availability of the MCV Facility, and the effect of the future power market on the amount, timing and price at which various increments of the capacity, above the MPSC authorized level, could be resold. Additional losses may occur if actual future experience materially differs from the 1992 estimates. As anticipated in 1992, Consumers continues to experience cash underrecoveries associated with the Settlement Order. If Consumers is unable to sell any capacity above the 1993 MPSC-authorized level, future additional after-tax losses and after- tax cash underrecoveries would be incurred. Consumers' estimates of its future after-tax cash underrecoveries, and possible losses for 1996 and the next four years are shown in the table below.\nAfter-tax, In Millions 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- Estimated cash underrecoveries $56 $55 $ 8 $ 9 $ 7\nPossible additional underrecoveries and losses (a) 20 22 72 72 74\n(a) If unable to sell any capacity above the MPSC's 1993 authorized level.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that would potentially resolve several issues in three pending proceedings, including cost recovery for the 325 MW of MCV Facility capacity above the MPSC's currently authorized level. For further information regarding this proposed settlement, see Note 4.\nAt December 31, 1995 and 1994, the after-tax present value of the Settlement Order liability totaled $202 million and $272 million, respectively. The reduction in the liability since December 31, 1994, reflects after-tax cash underrecoveries of $90 million, partially offset by after-tax accretion expense of $20 million. The undiscounted after-tax amount associated with the liability totaled $607 million at December 31, 1995.\nIn 1994 and 1995, Consumers paid $44 million to terminate power purchase agreements with the developers of two proposed independent power projects totaling 109 MW. As part of the proposed settlement reached with the MPSC staff (see Note 4), Consumers is seeking MPSC approval to utilize less- expensive contract capacity from the MCV Facility which Consumers is currently not authorized to recover from retail customers. Cost recovery for this contract capacity would start in late 1996. Even if Consumers is not allowed to substitute MCV Facility capacity for the capacity to be provided under the terminated agreements, Consumers believes that the MPSC would approve recovery of the buyout costs due to the significant customer savings resulting from the terminated power purchase agreements. As a result, Consumers has recorded a regulatory asset of $44 million.\nPSCR Matters Related to Power Purchases from the MCV Partnership: As part of the 1993 and 1994 plan case orders, the MPSC confirmed the recovery of certain costs related to power purchases from the MCV Partnership. ABATE or the Attorney General has appealed these plan case orders to the Court of Appeals.\nAs part of its decision in the 1993 PSCR reconciliation case issued February 23, 1995, the MPSC disallowed a portion of the costs related to purchases from the MCV Partnership, and instead assumed recovery of those costs from wholesale customers and reduced recovery from retail customers. Consumers believes this is contrary to the terms of the Settlement Order and has appealed the February 23 order on this issue.\n4: Rate Matters\nElectric Rate Proceedings: In late 1994, Consumers filed a request with the MPSC to increase its retail electric rates. The request included provisions for ratemaking treatment of expected sales losses to competition and the treatment of the 325 MW of MCV Facility contract capacity above 915 MW. Consumers also requested that the MPSC eliminate subsidization of residential rates in a two-step adjustment.\nEarly in 1996, the MPSC issued a partial final order in this case, granting Consumers a $46 million annual increase in its electric retail rates. This order authorized a 12.25 percent return on equity as compared to the previously approved 11.75 percent, approved recovery of certain costs associated with a proposed settlement related to the Ludington plant (see Note 12), and significantly reduced (in a two-step adjustment) the subsidization of residential customers by industrial and large commercial customers. As a result, residential customers were allocated approximately $31 million of the $46 million increase.\nThis order did not address cost recovery related to the 325 MW of MCV Facility contract capacity above 915 MW. The MPSC stated that this matter would be addressed in connection with its consideration of the proposed settlement agreement discussed below.\nConsumers also has a separate request before the MPSC to offer competitive special rates to certain large qualifying customers. In addition, Consumers filed a request with the MPSC, seeking to adjust its depreciation rates and to reallocate certain portions of its electric production plant to transmission accounts. If approved, this would result in a net decrease in depreciation expense of $7 million for ratemaking purposes. For further information regarding these requests, see the Electric Rate Proceedings and Special Rates discussions in the Management's Discussion and Analysis.\nIn September 1995, Consumers and the MPSC staff reached a proposed settlement agreement that, if approved by the MPSC, would resolve several outstanding regulatory issues currently before the MPSC in separate proceedings. Some of these issues were preliminarily addressed in early 1996 when the MPSC issued an order in Consumers' electric rate case (see above). If fully adopted, the settlement agreement would: provide for cost recovery of the 325 MW of uncommitted MCV Facility capacity; implement provisions for incentive ratemaking; resolve the special competitive services and depreciation rate cases; implement a limited direct access program; and accelerate recovery of nuclear plant investment. Consumers expects a final order in the spring of 1996.\nElectric DSM: In June 1995, the MPSC authorized Consumers to discontinue future DSM program expenditures and cease all new programs. Consumers is deferring and amortizing past program costs ($68 million at December 31, 1995) over the period these costs are being recovered from customers in accordance with an MPSC accounting order.\nGas Rates: As part of an agreement approved by the MPSC, Consumers filed a gas rate case in December 1994. The request, among other things, incorporated cost increases, including costs for postretirement benefits and costs related to Consumers' former manufactured gas plant sites and proposed a 12.25 percent rate of return on equity, instead of the current 13.25 percent. Consumers had requested a $7 million increase in its annual gas rates. The MPSC staff recommended a $13 million rate decrease, which included a lower rate base, a lower return on common equity, a revised capital structure and a lower operating cost forecast than Consumers had projected. In November 1995, the ALJ issued a proposal for decision that essentially adopted the MPSC staff's position. In early 1996, the MPSC issued a final order in this case, decreasing Consumers' annual gas rates by $11.7 million and authorizing an 11.6 percent return on equity.\nGCR Matters: In 1993, the MPSC issued a ruling favorable to Consumers regarding a gas pricing disagreement between Consumers and certain intrastate producers. In 1995, management concluded that the intrastate producers' pending appeals of the MPSC order would not be successful and accordingly reversed $23 million (pretax) of a previously accrued loss. The MPSC ruling was affirmed by the Court of Appeals in June 1995. The producers have petitioned the Michigan Supreme Court for review.\nIn October 1995, the MPSC issued an order regarding a $44 million (excluding any interest) gas supply contract pricing dispute between Consumers and certain intrastate producers. The order stated that Consumers was not obligated to seek prior approval of market-based pricing provisions that were implemented under the contracts in question. The producers subsequently filed a claim of appeal of the MPSC order with the Court of Appeals. Consumers believes the MPSC order supports its position that the producers' theories are without merit and intends to vigorously oppose any claims they may raise but cannot predict the outcome of this issue.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on Consumers' financial position or results of operations.\n5: Income Taxes\nConsumers and its subsidiaries file a consolidated federal income tax return with CMS Energy. Income taxes are generally allocated based on each company's separate taxable income. Consumers does not have an accrued federal income tax benefit from CMS Energy for 1995, but had a $33 million benefit as of December 31, 1994. Consumers practices full deferred tax accounting for all temporary differences as authorized by the MPSC.\nConsumers uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1995 1994 1993 - ----------------------- ----- ----- ----- Current federal income taxes $ 76 $ 51 $ 41 Deferred income taxes 67 67 61 Deferred income taxes - tax rate change - - (2) Deferred ITC, net (10) (10) (9) ----- ----- ----- $ 133 $ 108 $ 91 ===== ===== =====\nOperating $ 145 $ 120 $ 105 Other (12) (12) (14) ----- ----- ----- $ 133 $ 108 $ 91 ===== ===== =====\nThe principal components of Consumers' deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1995 1994 ------- ------- Property $ (539) $ (535) Unconsolidated investments (245) (236) Postretirement benefits (Note 10) (173) (177) Abandoned Midland project (46) (51) Employee benefit obligations (includes postretirement benefits of $173 and $172) (Note 10) 200 200 Power purchases - settlement (Note 3) 112 146 AMT carryforward 94 89 ITC carryforward (expires 2005) 23 37 Other (5) (6) ------- ------- $ (579) $ (533) ======= =======\nGross deferred tax liabilities $(1,388) $(1,388) Gross deferred tax assets 809 855 ------- ------- $ (579) $ (533) ======= =======\nThe actual income tax expense differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1995 1994 1993 ----- ----- ----- Net income $ 255 $ 226 $ 198 Income tax expense 133 108 91 ----- ----- ----- 388 334 289 Statutory federal income tax rate x 35% x 35% x 35% ----- ----- ----- Expected income tax expense 136 117 101 Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 5 Differences in book and tax depreciation not previously deferred 6 7 6 ITC amortization (10) (10) (10) Affiliated companies' dividends (6) (6) (6) Other, net 2 (5) (5) ----- ----- ----- $ 133 $ 108 $ 91 ===== ===== =====\n6: Short-Term Financings\nConsumers has FERC authorization to issue or guarantee up to $900 million of short-term debt through December 31, 1996. Consumers has an unsecured $425 million facility and unsecured, committed lines of credit aggregating $145 million that are used to finance seasonal working capital requirements. At December 31, 1995, $238 million and $103 million were outstanding under these facilities at weighted average interest rates of 6.4 percent and 6.9 percent, respectively. Consumers has an established $500 million trade receivables purchase and sale program. At December 31, 1995 and 1994, receivables sold under the agreement totaled $295 million and $275 million, respectively. Accounts receivable and accrued revenue in the Consolidated Balance Sheets have been reduced to reflect receivables sold.\n7: Capitalization\nCapital Stock: During 1995, the MPSC issued an order authorizing Consumers to issue and sell up to $300 million of intermediate and\/or long-term debt and $100 million of preferred stock or subordinate debentures. In January 1996, 4 million shares of 8.36 percent Trust Originated Preferred Securities were issued and sold through a business trust wholly-owned by Consumers. The trust was formed for the sole purpose of issuing preferred securities and the only asset of the trust is $103 million of 8.36 percent unsecured subordinated deferrable interest notes issued by Consumers. The obligations of Consumers with respect to the preferred securities under the notes that mature in 2015, the indenture under which the notes will be issued, Consumers' guarantee of the preferred securities and the Declaration of Trust, taken together, constitute a full and unconditional guarantee by Consumers of the trust's obligations under the Trust Originated Preferred Securities. Net proceeds from the sale totaled $96 million.\nFirst Mortgage Bonds: Consumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, its Articles and the need for regulatory approvals in compliance with appropriate federal law.\nLong-Term Bank Debt: During 1994, Consumers entered into a $400 million unsecured, variable rate, five-year term loan and subsequently used the proceeds to refinance certain long-term bank debt. At December 31, 1995, the loan carried a weighted average interest rate of 6.2 percent. In 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on $250 million of its long-term bank debt. The swap agreement hedges the variable rate exposure associated with Consumers' long-term bank debt. The swap agreement began to decrease in February 1995 and will terminate by May 1996. At December 31, 1995, the amount of the swap totaled $94 million at 5.4 percent. The swap agreement had the effect of decreasing the weighted average interest rate to 6.3 percent from 6.6 percent for the 12-month period ended December 31, 1995.\nOther: Consumers has a total of $131 million of long-term pollution control revenue bonds outstanding (secured by irrevocable letters of credit or first mortgage bonds) with a weighted average interest rate of 5.9 percent as of December 31, 1995.\nUnder the provisions of its Articles at December 31, 1995, Consumers had $197 million of unrestricted retained earnings available to pay common dividends.\n8: Financial Instruments\nThe carrying amounts of cash, short-term investments and current liabilities approximate their fair values due to their short-term nature. The estimated fair values of long-term investments are based on quoted market prices or, in the absence of specific market prices, on quoted market prices of similar investments or other valuation techniques. The carrying amounts of all long-term investments, except as shown below, approximate fair value.\n(a) Consumers classifies its unrealized gains and losses on nuclear decommissioning investments in accumulated depreciation.\nThe carrying amount of long-term debt was $1.9 billion and $2.0 billion at December 31, 1995 and 1994, respectively, and the fair value, as calculated by debt-pricing specialists, was $1.9 billion on those dates. Although the current fair value of the long-term debt may differ from the current carrying amount, settlement of the reported debt is generally not expected until maturity. For held-to-maturity securities, see Note 17.\n9: Executive Incentive Compensation\nConsumers participates in CMS Energy's Performance Incentive Stock Plan. Under the plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. During 1995, shareholders approved amendments to the CMS Energy Performance Incentive Stock Plan. The amendments authorized awards under the plan consisting of any class of common stock of CMS Energy and established performance-based business criteria for certain plan awards. The amendments also increased the number of shares reserved for award to not more than 3 percent of each class of CMS Energy's common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. At December 31, 1995, awards of up to 1,174,388 shares of CMS Energy Common Stock and 211,634 shares of Class G Common Stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan. At December 31, 1995, 249,053 shares of the 269,053 restricted shares outstanding are subject to performance objectives.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, expired in September 1995.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted to Consumers' key employees under the Performance Incentive Stock Plan and options granted under both plans follows.\nRestricted Stock Options ---------- --------------- Number Number Price CMS Energy Common Stock of Shares of Shares per Share --------- --------- --------------- Outstanding at January 1, 1993 206,863 922,108 $ 7.13 - $34.25 Granted 83,775 142,550 $26.25 - $26.25 Exercised or Issued (33,325) (112,625) $ 7.13 - $21.13 Canceled (57,188) (33,000) $20.50 - $33.88 -------- -------- --------------- Outstanding at December 31, 1993 200,125 919,033 $ 7.13 - $34.25 Granted 72,250 145,500 $22.00 - $22.00 Exercised or Issued (22,510) (138,650) $ 7.13 - $22.00 Canceled (60,087) (123,000) $26.25 - $33.88 -------- -------- --------------- Outstanding at December 31, 1994 189,778 802,883 $ 7.13 - $34.25 Granted 123,615 147,200 $24.75 - $34.25 Exercised or Issued (27,533) (93,333) $ 7.13 - $22.00 Canceled (16,807) (51,000) $20.50 - $34.25 -------- -------- --------------- Outstanding at December 31, 1995 269,053 805,750 $13.00 - $34.25 ======== ======== ===============\nDuring 1995, 6,924 restricted shares and 10,000 options of Class G Common Stock were granted at a price of $17.88.\n10: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions: Consumers adopted SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions, effective as of the beginning of 1992 and recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates (see Note 18). Both the MPSC and FERC have generally allowed recovery of SFAS 106 costs. In May 1994, the MPSC authorized recovery of the electric utility portion of these costs over 18 years. During 1995, the FERC granted Consumers a waiver of a three-year filing requirement for cost recovery with respect to its wholesale electric business, which at December 31, 1995, had recorded a regulatory asset and liability of $7 million. In early 1996, the MPSC approved recovery of the gas utility portion of these costs over 16 years. Consumers funds the benefits using external Voluntary Employee Beneficiary Associations. Funding of the health care benefits coincides with Consumers' recovery in rates. A portion of the life insurance benefits have previously been funded.\nRetiree health care costs at December 31, 1995, are based on the assumption that costs would increase 9.5 percent in 1996, then decrease gradually to 6 percent in 2004 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year's estimated health care cost assumption would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $79 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1995 by $8 million.\nYears Ended December 31 1995 1994 1993 ----- ----- ----- Weighted average discount rate 7.50% 8.00% 7.25% Expected long-term rate of return on plan assets 7.00% 7.00% 8.50%\nNet postretirement benefit costs for the health care benefits and life insurance benefits consisted of:\nIn Millions Years Ended December 31 1995 1994 1993 ----- ----- ----- Service cost $ 11 $ 13 $ 13 Interest cost 39 40 38 Actual return on assets (4) - - Net amortization and deferral 1 - - ----- ----- ----- Net postretirement benefit costs $ 47 $ 53 $ 51 ===== ===== =====\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1995 1994 ------ ------ Actuarial present value of estimated benefits Retirees $ 329 $ 336 Eligible for retirement 45 43 Active (upon retirement) 195 166 ------ ------ Accumulated postretirement benefit obligation 569 545 Plan assets (primarily stocks, bonds and money market investments) at fair value 76 35 ------ ----- Accumulated postretirement benefit obligation in excess of plan assets (493) (510) Unrecognized net (gain) loss from experience different than assumed (1) 2 ------ ------ Recorded liability $ (494) $ (508) ====== ======\nConsumers' postretirement health care plan is partially funded; the accumulated postretirement benefit obligation for that plan is $554 million and $530 million at December 31, 1995 and 1994, respectively.\nSupplemental Executive Retirement Plan: Certain management employees qualify to participate in the SERP. SERP benefits, which are based on an employee's years of service and earnings as defined in the SERP, are paid from a trust established and funded in 1988. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in consolidated assets. At December 31, 1995 and 1994, trust assets at cost (which approximates market) were $19 million and $14 million, respectively, and were classified as other noncurrent assets.\nDefined Benefit Pension Plan: A trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan was fully funded, no contributions were made in 1993 and 1994. A contribution of $9 million was made in 1995. Amounts presented below for the Pension Plan include minor amounts for employees of CMS Energy and non-utility affiliates which were not distinguishable from the plan's total assets.\nYears Ended December 31 1995 1994 1993 ----- ----- ----- Discount rate 7.50% 8.00% 7.25% Rate of compensation increase 4.50% 4.50% 4.50% Expected long-term rate of return on assets 9.25% 9.25% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1995 1994 1993 ----- ----- ----- Service cost $ 22 $ 23 $ 19 Interest cost 54 50 49 Actual return on plan assets (168) 21 (92) Net amortization and deferral 103 (85) 34 ----- ----- ----- Net periodic pension cost $ 11 $ 9 $ 10 ===== ===== =====\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP ------------ ------------ 1995 1994 1995 1994 ----- ----- ----- ----- Actuarial present value of estimated benefits Vested $ 496 $ 421 $ 12 $ 13 Non-vested 74 61 - - ----- ----- ----- ----- Accumulated benefit obligation 570 482 12 13 Provision for future pay increases 183 154 7 6 ----- ----- ----- ----- Projected benefit obligation 753 636 19 19 Plan assets (primarily stocks and bonds, including $104 in 1995 and $79 in 1994 in common stock of CMS Energy) at fair value 779 637 - - ----- ----- ----- ----- Projected benefit obligation less than (in excess of) plan assets 26 1 (19) (19) Unrecognized net (gain) loss from experience different than assumed (69) (35) 2 3 Unrecognized prior service cost 43 40 1 1 Unrecognized net transition (asset) obligation (32) (39) - 1 ----- ----- ----- ----- Recorded liability $ (32) $ (33) $ (16) $ (14) ===== ===== ===== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\n11: Leases\nConsumers leases various assets, including vehicles, rail cars, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement is scheduled to expire in November 1997 and provides for additional one-year extensions upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $65 million as of December 31, 1995. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under Consumers' non-cancelable leases at December 31, 1995, were:\nIn Millions Capital Operating Leases Leases\n1996 $ 53 $ 3 1997 55 3 1998 16 2 1999 14 2 2000 12 2 2001 and thereafter 24 17 ----- ----- Total minimum lease payments 174 $ 29 Less imputed interest 25 ===== ----- Present value of net minimum lease payments 149 Less current portion 45 ----- Non-current portion $ 104 =====\nConsumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1995, 1994 and 1993, were $7 million, 8 million and $8 million, respectively.\nCapital lease expenses for the years ended December 31, 1995, 1994 and 1993 were $45 million, $40 million and $32 million, respectively. Included in these amounts for the years ended 1995, 1994 and 1993, are nuclear fuel lease expenses of $25 million, $21 million and $13 million, respectively.\n12: Commitments and Contingencies\nLudington Pumped Storage Plant: Early in 1996, the FERC and MPSC approved the recovery of costs associated with a settlement designed to resolve all legal issues related to fish mortality at Ludington. Consumers, Detroit Edison, the Attorney General, the DNR and certain other parties agreed to the terms of the settlement in 1994. Approval of the settlement requires Consumers to transfer certain land to the State of Michigan and the Great Lakes Fishery Trust, make certain recreational improvements, and incur future annual payments of approximately $1 million (over 24 years) to improve fishery resources. The settlement resolves two lawsuits filed by the Attorney General in 1986 and 1987 on behalf of the State of Michigan.\nEnvironmental Matters: Consumers is a so-called \"potentially responsible party\" at several sites being administered under Superfund. Superfund liability is joint and several and along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based upon past negotiations, Consumers estimates its total liability for the significant sites will average less than 4 percent of the estimated total site remediation costs, and such liability is expected to be less than $9 million. At December 31, 1995, Consumers has accrued a liability for its estimated losses.\nThe Michigan Natural Resources and Environmental Protection Act (formerly the Michigan Environmental Response Act) was substantially amended in June 1995. The Michigan law bears similarities to the federal Superfund law. The purpose of the 1995 amendments was generally to encourage development of industrial sites and to remove liability from some parties who were not responsible for activities causing contamination. Consumers expects that it will ultimately incur investigation and remedial action costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest.\nConsumers has prepared plans for remedial investigation\/feasibility studies for several of these sites. Three of the four plans submitted by Consumers have been approved by the DNR or the Michigan Department of Environmental Quality (a new department succeeding to some of the former jurisdiction of the DNR). The findings for the first remedial investigation indicate that the expenditures for remedial action at this site are likely to be minimal. However, Consumers does not believe that a single site is representative of all of the sites. Data available to Consumers and its continued internal review have resulted in an estimate for all costs related to investigation and remedial action for all 23 sites of between $48 million and $112 million. These estimates are based on undiscounted 1995 costs. At December 31, 1995, Consumers has accrued a liability of $48 million and has established a regulatory asset for approximately the same amount. Any significant change in assumptions such as remediation technique, nature and extent of contamination and legal and regulatory requirements, could impact the estimate of remedial action costs for the sites.\nConsumers requested recovery and deferral of certain investigation and remedial action costs in its gas rate case filed in 1994. In early 1996, the MPSC issued an order in this case which authorized Consumers to defer costs and amortize them over 10 years. The amount of authorized annual recovery totaled $1 million. Consumers is continuing discussions with certain insurance companies regarding coverage for some or all of the costs which may be incurred for these sites.\nThe federal Clean Air Act contains provisions that limit emissions of sulfur dioxide and nitrogen oxides and require emissions monitoring. Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. The Clean Air Act's provisions required Consumers to make capital expenditures totaling $25 million to install equipment at certain generating units. Consumers estimates capital expenditures for in-process and possible modifications at other coal-fired units to be an additional $50 million by the year 2000. Final acid rain program nitrogen oxide regulations specifying the limits applicable to the other coal-fired units are expected to be issued in 1996. Management believes that Consumers' annual operating costs will not be materially affected.\nCapital Expenditures: Consumers estimates capital expenditures, including new lease commitments, of $435 million for 1996, $395 million for 1997 and $400 million for 1998.\nCommitments for Coal and Gas Supplies: Consumers has entered into coal supply contracts with various suppliers for its coal-fired generating stations. These contracts have expiration dates that range from 1997 to 2004. Consumers contracts for approximately 60 - 70 percent of its annual coal requirements which in 1995 totaled $233 million (72 percent was under long-term contracts). Consumers supplements its long-term contracts with spot-market purchases to fulfill its coal needs.\nConsumers has entered into gas supply contracts with various suppliers for its natural gas business. These contracts have expiration dates that range from 1996 to 2003. In 1995, Consumers' gas requirements totaled $694 million (80 percent was under long-term contracts). In the future, Consumers expects that approximately 35 percent of its annual gas requirements will be under long-term contracts as current contracts expire. Consumers supplements its long-term contracts with spot-market purchases to fulfill its gas needs.\nOther: Consumers has experienced a number of lawsuits filed against it relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electrical systems are diverted from their intended path. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the grounding of the customer's service. At December 31, 1995, Consumers had 30 separate stray voltage lawsuits awaiting trial court action, down from 83 lawsuits at December 31, 1994.\nIn addition to the matters disclosed in these notes, Consumers and certain of its subsidiaries are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on Consumers' financial position or results of operations.\n13: Nuclear Matters\nIn 1993, the NRC approved the design of the spent fuel dry storage casks now being used by Consumers at Palisades. In order to address concerns raised subsequent to the initial cask loading, Consumers and the NRC each analyzed the effects of seismic and other natural hazards on the support pad on which the casks are placed, and confirmed that the pad location is acceptable to support the casks. As of December 31, 1995, Consumers had loaded 13 dry storage casks with spent nuclear fuel at Palisades.\nIn 1996, Consumers plans to unload and replace one of the loaded casks. In a review of the cask manufacturer's quality assurance program, Consumers detected indications of minor flaws in welds in the steel liner of one of the loaded casks. Although the cask continues to safely store spent fuel and there is no requirement for its replacement, Consumers has nevertheless decided to remove the spent fuel and insert it in another cask. Consumers has examined radiographs for all of its casks and has found all other welds acceptable. Certain parties, including the Attorney General, have petitioned the NRC to suspend Consumers' general license to store spent fuel, claiming that Consumers' cask unloading procedure does not satisfy NRC regulations. The NRC staff is reviewing the petitions.\nThe Low-Level Radioactive Waste Policy Act encourages the respective states, individually or in cooperation with each other, to be responsible for the disposal of low-level radioactive waste. Currently, a low-level waste site does not exist in Michigan and Consumers has been storing low- level waste at its nuclear plant sites. Consumers began shipping its low- level waste to a site in South Carolina during 1995 and plans to have all its currently stored low-level waste removed from the plant sites by the end of 1996.\nConsumers maintains insurance coverage against property damage, debris removal, personal injury liability and other risks that are present at its nuclear generating facilities. This insurance includes coverage for replacement power costs for the major portion of prolonged accidental outages for 12 months after a 21 week exclusion with reduced coverage to approximately 80 percent for two additional years. If certain loss events occur at its own or other nuclear plants similarly insured, Consumers could be required to pay maximum assessments of: $30 million in any one year to NML and NEIL; $79 million per event under the nuclear liability secondary financial protection program, limited to $10 million per event in any one year; and $6 million in the event of nuclear workers claiming bodily injury from radiation exposure. Consumers considers the possibility of these assessments to be remote.\nUnder its NML and NEIL policies, Consumers may be entitled to cash distributions following the discontinued operation of its nuclear facilities. The amount of any distribution would be determined by NML and NEIL and would be based, in part, on their overall underwriting experience.\nAs an NRC licensee, Consumers is required to make certain calculations and report to the NRC about the continuing ability of the Palisades reactor vessel to withstand postulated \"pressurized thermal shock\" events during its remaining license life, in light of the embrittlement of reactor vessel materials over time due to operation in a radioactive environment. Analysis of recent data from testing of similar materials indicates that the Palisades reactor vessel can be safely operated through late 1999. In April 1995, Consumers received a Safety Evaluation Report from the NRC concurring with this evaluation and requesting submittal of an action plan to provide for operation of the plant beyond 1999. Consumers is developing plans to anneal the reactor vessel in 1998 at an estimated cost of $20 million to $30 million. This repair would allow for operation of the plant to the end of its license life in the year 2007. Consumers cannot predict whether the studies being conducted as part of the development plans will support a future decision to anneal.\n14: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for the jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1995 1994 ----- ----- Net investment Ludington - 51% $116 $119 Campbell Unit 3 - 93.3% 332 337 Transmission lines - various 33 31\nAccumulated depreciation Ludington $ 81 $ 76 Campbell Unit 3 238 224 Transmission lines 14 11\n15: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1995 1994 1993 ----- ----- ----- Cash transactions Interest paid (net of amounts capitalized) $158 $147 $177 Income taxes paid (net of refunds) 43 34 90\nNon-cash transactions Nuclear fuel placed under capital lease $ 26 $ 21 $ 28 Other assets placed under capital leases 5 15 30 Capital leases refinanced 21 - 42\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1995 1994 1993 ----- ----- ----- Sale of receivables, net $ 20 $ (10) $ 60 Accounts receivable (55) (4) 19 Accrued revenue 1 24 (48) Inventories 54 (5) (32) Accounts payable 48 19 (25) Accrued refunds (4) (3) (48) Other current assets and liabilities, net 28 12 (45) Non-current deferred amounts, net (8) (9) (7) ------ ------ ------ $ 84 $ 24 $(126) ====== ====== ======\n16: Reportable Segments\nThe Consolidated Statements of Income show operating revenue and pretax operating income by segments. These amounts include earnings from investments accounted for by the equity method of $38 million, $16 million and $6 million for 1995, 1994 and 1993, respectively. Other segment information follows:\nIn Millions Years Ended December 31 1995 1994 1993 ------ ------ ------ Depreciation, depletion and amortization Electric $ 272 $ 257 $ 241 Gas 83 76 73 Other 2 2 2 ------ ------ ------ $ 357 $ 335 $ 316 ====== ====== ======\nIdentifiable assets Electric (a) $ 4,522 $ 4,364 $ 4,100 Gas (a) 1,690 1,673 1,628 Other 742 772 823 ------ ------ ------ $ 6,954 $ 6,809 $ 6,551 ======= ====== ======\nCapital expenditures (b) Electric $ 328 $ 358 $ 403 Gas 126 134 158 ------ ------ ------ $ 454 $ 492 $ 561 ====== ====== ======\n(a) Amounts include an attributed portion of Consumers' other common assets to both the electric and gas utility businesses.\n(b) Includes capital leases for nuclear fuel and other assets and electric DSM costs (see Statement of Cash Flows). Amounts also include an attributed portion of Consumers' capital expenditures for plant and equipment common to both the electric and gas utility businesses.\n17: Related-Party Transactions\nConsumers has an investment of $250 million in 10 shares of Enterprises' preferred stock. Beginning in 1997, a five-year redemption program of $50 million per year will commence. In addition, Consumers has an investment in approximately 3 million shares of CMS Energy Common Stock with a fair value totaling $88 million (see Note 8) at December 31, 1995. As a result of these two investments, Consumers received dividends on affiliates' common and preferred stock totaling $17 million in 1995 and 1994 and $16 million in 1993. CMS Midland, a wholly owned subsidiary of Consumers, holds a $10 million short-term note from Consumers, in satisfaction of a covenant related to CMS Midland's general partnership interest in the MCV Partnership.\nConsumers purchases a portion of its gas from an affiliate, CMS NOMECO Oil & Gas Co. The amounts of purchases for the years ended 1995, 1994 and 1993 were $19 million, $1 million and $3 million, respectively. In 1995, 1994 and 1993, Consumers purchased $53 million, $48 million and $52 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Consumers and its subsidiaries sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $13 million for 1995, $13 million for 1994 and $14 million for 1993. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 19. Other related-party transactions are immaterial.\n18: Effects of the Ratemaking Process\nThe following regulatory assets (liabilities) which include both current and non-current amounts, are reflected in the Consolidated Balance Sheets. These assets represent probable future revenue to Consumers associated with certain incurred costs as these costs are recovered through the ratemaking process.\nIn Millions December 31 1995 1994 ------ ------ Postretirement benefits (Note 10) $ 487 $ 503 Income taxes (Note 5) 176 189 Abandoned Midland project 131 147 DSM - deferred costs (Note 4) 68 71 Trunkline settlement 55 85 Manufactured gas plant sites (Note 12) 47 47 Power purchase contracts (Note 3) 44 30 Uranium enrichment facility 25 25 Other 22 31 ------ ------ Total regulatory assets $1,055 $1,128 ====== ======\nIncome taxes (Note 5) $ (220) $ (205) DSM - deferred revenue (25) (21) Other (1) - ------ ------ Total regulatory liabilities $ (246) $ (226) ====== ======\nAt December 31, 1995, approximately $778 million of Consumers' regulatory assets are being recovered through rates being charged to customers over periods of up to 17 years. Consumers anticipates MPSC approval for recovery of the remaining amounts.\n19: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1995 obligation to purchase electric capacity from the MCV Partnership was approximately 16 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership follows:\nStatements of Income In Millions Years Ended December 31 1995 1994 1993 ----- ----- ----- Operating revenue (a) $ 618 $ 579 $ 548 Operating expenses 386 378 362 ----- ----- ----- Operating income 232 201 186 Other expense, net 171 183 189 ----- ----- ----- Net income (loss) $ 61 $ 18 $ (3) ===== ===== =====\nBalance Sheets In Millions December 31 1995 1994\nAssets Current assets (b) $ 263 $ 206 Property, plant and equipment, net 1,948 2,012 Other assets 156 154 ------ ------ $2,367 $2,372 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 225 $ 218 Long-term debt and other non-current liabilities (c) 2,008 2,081 Partners' equity (d) 134 73 ------ ------\n$2,367 $2,372 ====== ====== (a) Revenue from Consumers totaled $571 million, $534 million and $505 million for 1995, 1994 and 1993, respectively.\n(b) At December 31, 1995 and 1994, $48 million was receivable from Consumers.\n(c) FMLP is the sole beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP. At December 31, 1995 and 1994, lease obligations of $1.6 billion and $1.7 billion, respectively, were owed to the owner trust. CMS Holdings' share of the interest and principal portion for the 1995 lease payments was $66 million and $23 million, respectively, and for the 1994 lease payments was $68 million and $14 million, respectively. The lease payments service $1.1 billion and $1.2 billion in non-recourse debt outstanding as of December 31, 1995 and 1994, respectively, of the owner-trust. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1995 and 1994, the owner-trust made debt payments (including interest) of $192 million and $175 million, respectively.\n(d) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of long-term debt and preferred stock of CONSUMERS POWER COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy Corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumers Power Company and subsidiaries as of December 31, 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\nDetroit, Michigan, January 26, 1996.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nCMS Energy\nNone for CMS Energy.\nConsumers\nNone for Consumers.\nPART III (ITEMS 10., 11., 12. and 13.) CMS Energy\nCMS Energy's definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.","section_9A":"","section_9B":"","section_10":"Item 10.\nConsumers\nConsumers' definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.\nPART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent Reports dated January 10, 1995, February 2, 1995, September 11, 1995 and February 23, 1996 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent Reports dated January 10, 1995, February 2, 1995, September 11, 1995 and January 18, 1996 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Restated Articles of Incorporation of CMS Energy Corporation. (Designated in CMS Energy Corporation's Form S-4 dated June 6, 1995, File No. 33-60007, as Exhibit (3)(i).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1994, File No. 1-9513, as Exhibit 3(b).)\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1994, File No. 1-5611, as Exhibit 3(c).)\n(3)(d) - Copy of By-Laws of Consumers Power Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1994, File No. 1-5611, as Exhibit 3(d).)\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No. 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind\/Dated as of File Reference Exhibit ------------------- ---------------- -------\n65th 02\/15\/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 67th 11\/15\/89 Reg No 33-31866 (4)(d) 68th 06\/15\/93 Reg No 33-41126 (4)(c) 69th 09\/15\/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) - Indenture dated as of January 1, 1996 between Consumers Power Company and The Bank of New York, as Trustee.\nFirst Supplemental Indenture dated as of January 18, 1996 between Consumers Power Company and The Bank of New York, as Trustee.\n(4)(c) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(4)(d) (CMS ONLY) - Indenture between CMS Energy Corporation and Chase Manhattan Bank (National Association), as Trustee, dated as of January 15, 1994. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4a).)\nFirst Supplemental Indenture dated as of January 20, 1994 between CMS Energy Corporation and Chase Manhattan Bank (National Association), as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4b).)\n(5)-(9) - Not applicable.\n(10)(a) (CMS ONLY) - Credit Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Managers, all as defined therein, and the Exhibits thereto. (Designated in CMS Energy's Form S-4 Registration Statement filed January 12, 1996, File No. 33-60007, as Exhibit 4(ii).)\n(10)(b) (CMS ONLY) - Term Loan Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Managers, all as defined therein, and the Exhibits thereto. (Designated in CMS Energy's Form S-4 Registration Statement filed January 12, 1996, File No. 33-60007, as Exhibit 4(ii)(A).)\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No. 1-5611, as Exhibit (10)(i).)\n(10)(e) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No. 1-5611, as Exhibit (10)(f).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(g) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(f).)\n(10)(h) - Employment Agreement dated March 25, 1992 between Consumers Power Company, CMS Energy Corporation and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(j) (CMS ONLY) - Employment Agreement dated January 12, 1996 between CMS Energy Corporation and Rodger A. Kershner.\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No. 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form S-8 Registration Statement filed August 4, 1995, File No. 33-61595, as Exhibit (4)(d).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1993, File No. 1-9513, as Exhibit (10)(m).)\n(10)(n) - CMS Energy Corporation and Consumers Power Company Annual Executive Incentive Compensation Plan effective January 1, 1986, as amended January 1995.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1993, File No. 1-5611, as Exhibit (10)(o).)\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No. 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No. 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.13.)\nAmendment No. 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No. 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.5.)\nAmendment No. 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.6.)\nAmendment No. 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.7.)\nAmendment No. 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U-10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).)\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24)(a) - Power of Attorney for CMS Energy Corporation.\n(24)(b) - Power of Attorney for Consumers Power Company.\n(25)-(26) - Not applicable.\n(27)(a) - Financial Data Schedule UT for CMS Energy Corporation.\n(27)(b) - Financial Data Schedule UT for Consumers Power Company.\n(28) - Not applicable\n(99) - CMS Energy: Consumers Gas Group Financials\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nPage\nSchedule II Valuation and Qualifying Accounts and Reserves 1995, 1994 and 1993: CMS Energy Corporation 147 Consumers Power Company 148\nReport of Independent Public Accountants CMS Energy Corporation 149 Consumers Power Company 150\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1995 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 1996. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a) is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDetroit, Michigan, January 26, 1996.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1995 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 1996. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a) is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDetroit, Michigan, January 26, 1996.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of March 1996.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. --------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 14th day of March 1996.\nSignature Title\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director --------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer: Senior Vice President, Chief Financial Officer A M Wright and Treasurer --------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nSenior Vice President, Controller P. D. Hopper and Chief Accounting Officer --------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nJames J. Duderstadt* Director --------------------------- James J. Duderstadt\nK R Flaherty* Director --------------------------- Kathleen R. Flaherty\nVictor J. Fryling* Director --------------------------- Victor J. Fryling\nEarl D. Holton* Director --------------------------- Earl D. Holton\nLois A. Lund* Director --------------------------- Lois A. Lund\nFrank H. Merlotti* Director --------------------------- Frank H. Merlotti\nMichael G. Morris* Director --------------------------- Michael G. Morris\nW. U. Parfet* Director --------------------------- William U. Parfet\nPercy A. Pierre* Director --------------------------- Percy A. Pierre\nK. Whipple* Director --------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director --------------------------- John B. Yasinsky\n* By Thomas A. McNish --------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of March 1996.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 14th day of March 1996.\nSignature Title\n(i) Principal executive officer: President, Chief Executive Officer Michael G. Morris and Director --------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer --------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller --------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nJames J. Duderstadt* Director --------------------------- James J. Duderstadt\nK R Flaherty* Director --------------------------- Kathleen R. Flaherty\nVictor J. Fryling* Director --------------------------- Victor J. Fryling\nEarl D. Holton* Director --------------------------- Earl D. Holton\nLois A. Lund* Director --------------------------- Lois A. Lund\nWilliam T. McCormick, Jr.* Director --------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director --------------------------- Frank H. Merlotti\nW. U. Parfet* Director --------------------------- William U. Parfet\nPercy A. Pierre* Director --------------------------- Percy A. Pierre\nK. Whipple* Director --------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director --------------------------- John B. Yasinsky\n*By Thomas A. McNish --------------------------- Thomas A. McNish, Attorney-in-Fact","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent Reports dated January 10, 1995, February 2, 1995, September 11, 1995 and February 23, 1996 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent Reports dated January 10, 1995, February 2, 1995, September 11, 1995 and January 18, 1996 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Restated Articles of Incorporation of CMS Energy Corporation. (Designated in CMS Energy Corporation's Form S-4 dated June 6, 1995, File No. 33-60007, as Exhibit (3)(i).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1994, File No. 1-9513, as Exhibit 3(b).)\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1994, File No. 1-5611, as Exhibit 3(c).)\n(3)(d) - Copy of By-Laws of Consumers Power Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1994, File No. 1-5611, as Exhibit 3(d).)\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No. 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind\/Dated as of File Reference Exhibit ------------------- ---------------- -------\n65th 02\/15\/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 67th 11\/15\/89 Reg No 33-31866 (4)(d) 68th 06\/15\/93 Reg No 33-41126 (4)(c) 69th 09\/15\/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) - Indenture dated as of January 1, 1996 between Consumers Power Company and The Bank of New York, as Trustee.\nFirst Supplemental Indenture dated as of January 18, 1996 between Consumers Power Company and The Bank of New York, as Trustee.\n(4)(c) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(4)(d) (CMS ONLY) - Indenture between CMS Energy Corporation and Chase Manhattan Bank (National Association), as Trustee, dated as of January 15, 1994. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4a).)\nFirst Supplemental Indenture dated as of January 20, 1994 between CMS Energy Corporation and Chase Manhattan Bank (National Association), as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4b).)\n(5)-(9) - Not applicable.\n(10)(a) (CMS ONLY) - Credit Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Managers, all as defined therein, and the Exhibits thereto. (Designated in CMS Energy's Form S-4 Registration Statement filed January 12, 1996, File No. 33-60007, as Exhibit 4(ii).)\n(10)(b) (CMS ONLY) - Term Loan Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Managers, all as defined therein, and the Exhibits thereto. (Designated in CMS Energy's Form S-4 Registration Statement filed January 12, 1996, File No. 33-60007, as Exhibit 4(ii)(A).)\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No. 1-5611, as Exhibit (10)(i).)\n(10)(e) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No. 1-5611, as Exhibit (10)(f).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(g) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(f).)\n(10)(h) - Employment Agreement dated March 25, 1992 between Consumers Power Company, CMS Energy Corporation and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(j) (CMS ONLY) - Employment Agreement dated January 12, 1996 between CMS Energy Corporation and Rodger A. Kershner.\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No. 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form S-8 Registration Statement filed August 4, 1995, File No. 33-61595, as Exhibit (4)(d).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1993, File No. 1-9513, as Exhibit (10)(m).)\n(10)(n) - CMS Energy Corporation and Consumers Power Company Annual Executive Incentive Compensation Plan effective January 1, 1986, as amended January 1995.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1993, File No. 1-5611, as Exhibit (10)(o).)\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No. 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No. 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No. 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 4.13.)\nAmendment No. 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No. 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.5.)\nAmendment No. 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.6.)\nAmendment No. 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.7.)\nAmendment No. 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No. 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U-10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).)\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24)(a) - Power of Attorney for CMS Energy Corporation.\n(24)(b) - Power of Attorney for Consumers Power Company.\n(25)-(26) - Not applicable.\n(27)(a) - Financial Data Schedule UT for CMS Energy Corporation.\n(27)(b) - Financial Data Schedule UT for Consumers Power Company.\n(28) - Not applicable\n(99) - CMS Energy: Consumers Gas Group Financials\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nPage\nSchedule II Valuation and Qualifying Accounts and Reserves 1995, 1994 and 1993: CMS Energy Corporation 147 Consumers Power Company 148\nReport of Independent Public Accountants CMS Energy Corporation 149 Consumers Power Company 150\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1995 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 1996. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a) is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDetroit, Michigan, January 26, 1996.\nARTHUR ANDERSEN LLP\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1995 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 1996. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a) is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDetroit, Michigan, January 26, 1996.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of March 1996.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. --------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 14th day of March 1996.\nSignature Title\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director --------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer: Senior Vice President, Chief Financial Officer A M Wright and Treasurer --------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nSenior Vice President, Controller P. D. Hopper and Chief Accounting Officer --------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nJames J. Duderstadt* Director --------------------------- James J. Duderstadt\nK R Flaherty* Director --------------------------- Kathleen R. Flaherty\nVictor J. Fryling* Director --------------------------- Victor J. Fryling\nEarl D. Holton* Director --------------------------- Earl D. Holton\nLois A. Lund* Director --------------------------- Lois A. Lund\nFrank H. Merlotti* Director --------------------------- Frank H. Merlotti\nMichael G. Morris* Director --------------------------- Michael G. Morris\nW. U. Parfet* Director --------------------------- William U. Parfet\nPercy A. Pierre* Director --------------------------- Percy A. Pierre\nK. Whipple* Director --------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director --------------------------- John B. Yasinsky\n* By Thomas A. McNish --------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of March 1996.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 14th day of March 1996.\nSignature Title\n(i) Principal executive officer: President, Chief Executive Officer Michael G. Morris and Director --------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer --------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller --------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nJames J. Duderstadt* Director --------------------------- James J. Duderstadt\nK R Flaherty* Director --------------------------- Kathleen R. Flaherty\nVictor J. Fryling* Director --------------------------- Victor J. Fryling\nEarl D. Holton* Director --------------------------- Earl D. Holton\nLois A. Lund* Director --------------------------- Lois A. Lund\nWilliam T. McCormick, Jr.* Director --------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director --------------------------- Frank H. Merlotti\nW. U. Parfet* Director --------------------------- William U. Parfet\nPercy A. Pierre* Director --------------------------- Percy A. Pierre\nK. Whipple* Director --------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director --------------------------- John B. Yasinsky\n*By Thomas A. McNish --------------------------- Thomas A. McNish, Attorney-in-Fact","section_15":""}
{"filename":"709804_1995.txt","cik":"709804","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nAdaptec is a leading supplier of input\/output (I\/O) hardware and software (referred to by the Company as IOware solutions) used to eliminate performance bottlenecks between a microcomputer's central processing unit (CPU) and its peripheral devices, such as hard disk, optical and tape storage devices, and network file servers. The Company's IOware products include board-based I\/O solutions using extensive proprietary software and proprietary very large scale integration (VLSI) integrated circuits (ICs). The Company's host adapter products are based on the Small Computer Systems Interface (SCSI) standard, which interfaces with all standard microcomputer architectures. The Company's IC products include single chip disk controllers for SCSI, AT and PCMCIA hard disk drives and single chip SCSI host adapters.\nBACKGROUND\nThe market for high-performance microcomputers and related products, which are typically used in multiuser and multitasking environments, has continued to grow more rapidly than the overall microcomputer market in recent years. A key factor driving this growth has been the development of increasingly sophisticated software for applications such as networking, transaction processing, high resolution graphics and multimedia. These application developments have resulted in the need for increased data transmission rates between CPUs and peripherals to alleviate I\/O bottlenecks which would limit the overall performance of microcomputer systems. The Company addresses these needs with products that significantly enhance and optimize overall microcomputer system performance, particularly in complex operating environments, involving sophisticated applications and multiple peripherals.\nMARKET OVERVIEW\nThe Company provides value-added IOware solutions to the personal computing, enterprise computing and mass storage markets. The Company believes that technical leadership, product innovation, marketing expertise and brand name recognition allow it to compete favorably in these markets.\nDesktop and portable personal computers are used in a number of environments including business, home and travel. Operating systems for computing have historically been text-based and single-tasking such as MS-DOS. During the past several years Graphical User Interfaces (GUIs) such as Microsoft's Windows, have increasingly been shipped by Original Equipment Manufacturers (OEMs) as standard in most desktop and portable computers. Additionally, many desktop and portable personal computers are being configured with a more diverse set of peripherals, such as CD-ROM, Tape, Write Once Read Many (WORM), CD ROM Recordable (CDR) and Digital Audio Tape (DAT) drives, either at the time of purchase or after the original equipment sale. When this occurs, ease of installation and configuration are of great importance to the end user, giving products that provide this capability a significant competitive advantage.\nThe enterprise computing market is characterized by increasingly more sophisticated and I\/O-intensive applications, such as network management software, and distributed multimedia and business applications. During the past several years, these applications have been migrating from minicomputers to client\/server environments. These applications typically require a file server to be configured with multiple peripherals such as WORM, CD-ROM and DAT drives, together with hard disk subsystems that provide security and data integrity capabilities such as Redundant Array of Inexpensive Disks (RAID). Successful implementation of such mission critical systems requires significant knowledge of networking software and I\/O subsystems.\nVirtually every microcomputer is shipped with inexpensive mass storage devices which are required to store vast amounts of information and data. Such devices include CD-ROM, tape drives and most commonly rigid or hard disk drives. Non-hard disk devices are increasingly used in addition to a hard disk and often have SCSI interfaces. Common uses for non-hard disk SCSI devices include data backup and archiving for tape drives and storage needed for multimedia programs where video, text, graphics and sound are stored on a\nCD-ROM or CDR. Hard disk drives are usually part of a standard desktop, portable or networked microcomputer configuration, and generally are used to store operating systems, user applications and data files. Most hard disk drives are shipped with either an AT or a SCSI interface and have relatively fast data access and transfer capabilities. Cost per megabyte of storage and performance characteristics such as average seek time, data transfer rate and spindle rotational speed continue to be critical to success in the disk drive market.\nPRODUCTS\nThe Company's IOware products are designed and manufactured using a core set of technologies and resources. The Company's semiconductor technology design center develops products for all markets the Company serves. The Company utilizes a process called concurrent engineering, in which manufacturing, marketing and engineering work together early in the development cycle, to decrease the \"time to volume\" of product shipments.\nBoard-based I\/O Solutions\nThe Company's board-based I\/O solutions are designed to support business, technical and multimedia applications in the personal and enterprise computing markets. The Company's single chip host adapters are the principal component of these products. These ICs, together with the Company's extensive array of software products, provide customers the most comprehensive board-based I\/O solutions available in the markets it serves. The Company provides bus mastering, multitasking host adapters that manage all I\/O processing activity, thereby freeing the CPU to focus most of its power on task processing. The Company also provides non-bus mastering host adapters which provide standardized SCSI connectivity between the CPU and its peripherals. The Company's board-based I\/O solutions are capable of interfacing with most major microcomputer architectures, including PCI, VESA, ISA, EISA and Micro Channel. Demand for the Company's board-based I\/O solutions has increased with the continued adoption of SCSI as the high-performance I\/O standard in personal computing. Additionally, demand is being driven by the increased use of file servers where SCSI usage approaches 100%. To meet this increased demand, the Company continues to develop and market I\/Oware solutions meeting specific OEM requirements and turnkey kits for the distributor channels. These kits include a SCSI host adapter and related software, that enable end-users to connect SCSI peripherals to their microcomputer system.\nTo facilitate the use of SCSI in microcomputer systems, the Company developed Advanced SCSI Programming Interface (ASPI), an operating system-level interface allowing seamless connectivity between SCSI host adapters and operating systems. ASPI enables users to integrate high-performance SCSI peripherals with microcomputers using popular operating systems, such as DOS, NetWare, OS\/2 and UNIX. Additionally, ASPI supports the current release of Microsoft Windows operating environment; the Company has also been working with Microsoft to ensure that ASPI will support Windows 95. The Company is engaged in strategic relationships with leading operating system vendors, such as IBM, Microsoft and Novell, resulting in joint development projects to embed the Company's software within their operating systems. In addition, the Company has developed several software utilities such as Adaptec EZ-SCSI and SCSISelect products, which simplify connecting a SCSI host adapter and peripherals to a microcomputer system.\nIntegrated Circuits\nThe Company develops proprietary integrated circuits for use in mass storage devices and microcomputer systems and for use in its own board-based SCSI host adapters. Adaptec's proprietary integrated circuits provide innovative solutions for managing complex I\/O functions in high-performance microcomputer and storage applications. Working closely with customers, the Company provides complete solutions that include sophisticated integrated circuits, with related firmware and software, to optimize overall subsystem design. In addition, the Company seeks to establish its proprietary integrated circuits as industry standards, thereby increasing market acceptance by new customers.\nThe Company's current IC products include SCSI, PCMCIA and AT programmable storage controllers and single-chip SCSI host adapters. All of the Company's IC products are developed using advanced design technologies to meet market requirements for higher levels of physical integration, increased functionality and performance. The Company's programmable SCSI and AT storage controllers are typically configured to address specific customer requirements in the mass storage market and are used primarily in high capacity hard disk drives. The Company's SCSI host adapter integrated circuits incorporate similar technology and are used by system manufacturers to embed SCSI on the system motherboard and by multifunction card companies to provide a SCSI interface.\nRESEARCH AND DEVELOPMENT\nThe Company believes research and development is fundamental to its success, especially in integrated circuit design and software development. The development of proprietary integrated circuits that support multiple architectures and peripheral devices requires a combination of engineering disciplines. In addition, extensive knowledge of computer and subsystem architectures, expertise in the design of high-speed digital integrated circuits and knowledge of operating system software is essential. The integration of these specialized disciplines has enabled the Company to address more comprehensively the needs of the I\/O microcomputer industry.\nThe Company continues to leverage its technical expertise and product innovation capabilities to address applications requiring the management and high-speed transmission of microcomputer system data. Among the products under development are higher performance host adapters for microcomputers using PCI and ISA architectures, more highly integrated and functionally robust integrated circuits and software support for additional operating systems. While SCSI solutions currently remain the core of the Company's business, in fiscal 1995 the Company broadened its development efforts to include asynchronous transfer mode (ATM), RAID, Serial I\/O, and infrared technologies.\nApproximately 22% of the Company's employees are engaged in research and development. In fiscal 1995, 1994 and 1993, the Company spent approximately $60.8 million, $40.0 million, and $26.3 million respectively, for research and development.\nMARKETING AND CUSTOMERS\nThe Company sells its products through both OEM and distributor channels and packages these products to meet the specific requirements of system integrators and end users. The Company works closely with its OEM customers on the design of current and next generation products that incorporate the Company's SCSI host adapters and integrated circuits. The Company provides its OEM customers with extensive applications and system design support. The Company also sells host adapters to end users through major computer product distributors. The Company believes it has successfully positioned itself as a leading supplier of SCSI-based solutions in both OEM and distributor channels.\nThe Company focuses its worldwide marketing efforts on major OEM customers and major distributors through its direct sales force located in the United States and major industrial centers in Europe and the Far East. The Company also makes selective use of sales representatives on a worldwide basis. OEM customers include Conner Peripherals, Digital Equipment Corporation, Dell Computer Corporation, Fujitsu, Hewlett-Packard Company, IBM Corporation, Intel Corporation, Maxtor Corporation, NEC Technologies, Samsung, Seagate Technology, Siemens and Toshiba America. Distribution customers include, Actebis, Anthem Electronics, Gates\/Arrow, Globelle, Ingram Micro, Merisel, Nissho, and Tech Data. In fiscal 1995 and fiscal 1994 no customer accounted for more than 10% of the Company's net revenues. In fiscal 1993, Apple Computer, Inc. accounted for 16% of the Company's net revenues, substantially all of which was derived from the sale of the Company's discontinued laser printer controllers, and Maxtor accounted for approximately 10% of the Company's net revenues.\nThe Company emphasizes solution-oriented customer support as a key element of its marketing strategy and maintains technical applications groups in the field as well as at the Company's headquarters. Support provided by these groups includes assisting current and prospective customers in the use of the Company's products, writing application notes and conducting seminars for use by system designers. The systems-level expertise and software experience of the Company's engineering staff are also available to customers with\nparticularly difficult I\/O design problems. A high level of customer support is also maintained through technical support hotlines, electronic bulletin boards and dial-in-fax capability.\nInternational net revenues accounted for approximately 62%, 58% and 50% of net revenues in fiscal 1995, 1994, and 1993, respectively. Sales of the Company's products internationally are subject to certain risks common to all export activities, such as governmental regulation and the risk of imposition of tariffs or other trade barriers. Sales to customers are primarily denominated in U.S. dollars. As a result, the Company believes its corresponding foreign currency risk is minimal.\nBACKLOG\nThe Company's backlog was approximately $65.6 million and $61.7 million at March 31, 1995 and March 31, 1994, respectively. These backlog figures include only orders scheduled for shipment within six months, of which the majority are scheduled for delivery within 90 days.\nIn the past, the Company has experienced delays in receipt of expected purchase orders, and in some cases purchase orders have been rescheduled or canceled due to changes in customer requirements. These changes may occur even after the Company has been notified of design wins or has executed purchase agreements with customers. The Company's customers may cancel or delay purchase orders for a variety of reasons, including rescheduling of new product introductions and changes in inventory policies and forecasted demand. Accordingly, the Company's backlog as of any particular date may not be indicative of the Company's actual sales for any succeeding fiscal period.\nThe demand for the Company's products is strongly related to the demand for high-performance microcomputers. This segment of the microcomputer industry is continuing to experience significant growth due to migration of minicomputer applications to microcomputers and the implementation of more complex business applications. Should these rates of growth decline, the Company's revenues and income may be adversely affected by a decrease in demand for the Company's products, and pricing pressures could increase from both competitors and customers.\nCOMPETITION\nIn the personal and enterprise computing markets, the Company's principal competitors are small, privately-held host adapter companies. The Company's competitive strategy is to leverage its technical leadership and concentrate on the most technology-intensive solutions. To address the competitive nature of the business the Company designs advanced features into its products, with particular emphasis on data transfer rates, software-defined features and compatibility with major operating systems and most peripherals. The Company believes that it obtains a significant competitive advantage by supplying its customers with a comprehensive array of I\/O solutions ranging from connectivity products for the personal computing market to high performance products for enterprise-wide computing and networked environments. In addition, technical leadership, product innovation, marketing expertise, and brand awareness successfully position the Company in these markets.\nThe Company's principal competitor in the mass storage market is Cirrus Logic, Inc. The Company believes that its competitive strengths in the mass storage market include its ability to obtain major design wins as the result of its systems level expertise, integrated circuit design capability and substantial experience in I\/O applications. The Company believes the principal competitive factors in design wins are performance, product features, price, quality and technical and administrative support. Based on these factors, the Company believes it has, in the past, successfully competed for design wins.\nThe markets for the Company's products are highly competitive and are characterized by rapid technological advances, frequent new product introductions and evolving industry standards. The Company's competitors continue to introduce products with improved performance characteristics and its customers continue to develop new applications. The Company will have to continue to develop and market appropriate products to remain competitive. While the Company continues to devote significant resources to research and development, there can be no assurance that such efforts will be successful or that the Company will develop and introduce new technology and products in a timely manner. In addition, while relatively few competitors offer a full range of IOware solutions, additional domestic and foreign manufacturers may increase their presence in, and the resources devoted to, these markets.\nMANUFACTURING\nIn August 1988, the Company opened its Singapore manufacturing facility for the production and testing of high volume host adapter products. The Singapore facility has earned ISO 9002 certification, a stringent quality standard that has become a requirement for doing business globally. During fiscal 1995, the Company purchased a fifth and sixth surface mount manufacturing line to support its continued growth. In addition, the Company completed the move of its IC production test facility to Singapore. This move affords the Company lower costs, shorter manufacturing cycle times, and improved service to customers.\nThe Company's products make extensive use of standard logic, printed circuit boards and static random access memory supplied by several outside sources. An extended shortage or a major increase in the market prices of these components could have an adverse affect on the Company's business. In addition, foreign manufacturing is also subject to certain risks, including changes of governmental policies, transportation delays and interruptions and the imposition of tariffs and import and export controls. Currency exchange fluctuations could increase the cost of components manufactured abroad, although non-dollar denominated purchases do not currently represent a significant portion of the Company's purchases. In addition, there is no assurance that the Company will achieve its product cost objectives.\nAll semiconductor wafers used to manufacture the Company's products are processed to its specification by outside suppliers. The Company believes that its current wafer volume and manufacturing technology requirements do not justify owning and operating a fabrication facility. The Company's reliance on third party semiconductor manufacturers involves several risks, including the absence of guaranteed capacity, the possible unavailability of or delays in obtaining access to certain process technologies, and the absence of control over wafer delivery schedules, manufacturing yields and production costs. To reduce these risks, in fiscal 1994 the Company entered into a deposit and supply agreement with Taiwan Semiconductor Manufacturing Co., Ltd. Under this agreement, the Company is entitled to guaranteed sub micron wafer foundry capacity through June 1997 and as of March 31, 1995 is committed to $44.6 million of purchases over the remaining term of the contract. The Company has made available to the supplier advances aggregating $14.7 million to secure the supply of silicon wafers pursuant to this agreement. The advances are repayable at the expiration of the supply agreement and the supplier has provided an irrevocable standby letter of credit to the Company in an equal amount to guarantee the repayment of amounts made available by the Company.\nPATENTS AND LICENSES\nThe Company believes that patents are of less significance in its industry than such factors as innovative skills, technological expertise and marketing abilities. However, the Company encourages its engineers to document patentable inventions, and has applied for and continues to apply for patents both in the United States and in foreign countries when it deems it to be advantageous to do so. There can be no assurance that patents will be issued or that any patent issued will provide significant protection or could be successfully defended.\nAs is the case with many companies in the electronics industry, it may be desirable in the future for the Company to obtain technology licenses from other companies. The Company has occasionally received notices of claimed infringement of intellectual property rights and may receive additional such claims in the future. The Company evaluates all such claims and, if necessary, will seek to obtain appropriate licenses. There can be no assurance that any such licenses, if required, will be available on acceptable terms.\nEMPLOYEES\nAt March 31, 1995, the Company had 1,697 employees, including 379 in engineering, 871 in manufacturing (including 748 at its Singapore facility), 67 in customer technical support, 119 in marketing, 116 in sales, and 145 in finance and administration. The Company's continued success will depend in large measure on its ability to attract and retain highly skilled employees who are in great demand. None of the Company's employees is represented by a labor union.\nFOREIGN AND DOMESTIC OPERATIONS\nIncorporated by reference from information under the caption \"Segment Information\" on Pages 45 and 46 of the Annual Report to Shareholders for the fiscal year ended March 31, 1995.\nFACTORS AFFECTING STOCK PRICE\nFactors such as technological innovations or new product introductions by Adaptec, its competitors or its customers may have a significant impact on the market price of Adaptec's Common Stock. In addition, quarter-to-quarter fluctuations in the Company's results of operations, caused by changes in customer demand, changes in the microcomputer and peripherals markets, or other factors, may have a significant impact on the market price of the Company's Common Stock. These conditions, as well as factors which generally affect the market for stocks of high technology companies, could cause the price of the Company's stock to fluctuate substantially over short periods.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following sets forth certain information with respect to the executive officers of the Company, and their ages, as of March 31, 1995.\nExecutive officers serve at the pleasure of the Board of Directors of the Company. There are no family relationships between any directors or executive officers of the Company.\nMr. Adler has served as Chief Executive Officer since December 1986, and as a Director since February 1986. Mr. Adler served as Chief Operating Officer from May 1985 to December 1986 and President from May 1985 to July 1992.\nMr. Saviers has served as President and Chief Operating Officer of the Company since August 1992. Mr. Saviers was also appointed a member of the Board of Directors at that time. Prior to that time, Mr. Saviers held several senior level management positions in his 24 year tenure with Digital Equipment Corporation, and most recently served as Vice President of Digital's personal computer systems and peripherals operations.\nMr. Bowman has served as Vice President of Administration since December 1990 and from September 1988 to December 1990, was Director of Administration.\nMr. Brauns has served as Vice President of Sales since February 1994. From March 1993 to January 1994, he served as Director of Sales. Between April 1991 and February 1993 Mr. Brauns held the position of Vice President of Marketing and General Manager at Librex Computer Systems, Inc. From June 1987 to March 1991, he held a number of management positions at Wyse Technologies, Inc.\nMr. Brown has served as Corporate Controller and Principal Accounting Officer since May 1994. From July of 1988 to April of 1994 he served in various financial roles with the Company, the most recent as Operations Accounting Controller.\nMr. Hamm has served as Vice President and General Manager since February 1994, after serving as Vice President of Sales from December 1990 to February 1994. Between February 1988 and August 1990, Mr. Hamm served as Director of Original Equipment Sales and held other various sales management positions at Western Digital Corporation.\nMr. Hansen, a certified public accountant, has served as Vice President of Finance and Chief Financial Officer since January 1988, after serving as Corporate Controller from March 1985 to December 1987 and Director of Accounting from March 1984 to March 1985.\nMr. Kazarian has served as Vice President of Operations since May 1990. Before joining Adaptec, he served as Executive Vice President and Chief Operating Officer at Rugged Digital Systems from January 1988 to April 1990.\nMr. O'Meara has served as a Vice President since July 1992 and as Treasurer since April 1989. Between May 1988 and April 1989, Mr. O'Meara served as the Company's Director of Financial Planning.\nMr. Sundaresh has served as Vice President and General Manager since February 1994. From March of 1993 until January of 1994 he served as Director of Marketing. From 1991 to 1993 he served as Director of PC Marketing at Hyundai Electronics America. From 1983 to 1991, Mr. Sundaresh held several marketing management positions at Hewlett-Packard Company.\nMr. Massey has served as Secretary since November 1989. For more than the last five years, Mr. Massey has been a practicing lawyer and a member of Wilson, Sonsini, Goodrich & Rosati, Professional Corporation, a law firm and general outside counsel to the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns six buildings (approximately 375,000 square feet) in Milpitas, California. Five buildings are used by the Company for corporate offices, research, manufacturing, marketing and sales. The sixth building, consisting of office and warehouse facilities, (approximately 101,000 square feet) is currently leased to third parties. The Company leases a facility in Boulder, Colorado (47,000 square feet) to support technical design efforts and sales.\nAdaptec Manufacturing Singapore is located in two leased facilities (approximately 103,000 square feet). The two buildings are used by the Company for research, manufacturing and sales. The Company also leases seven sales offices in the United States, and one sales office each in Brussels, Belgium; Munich, Germany; Bretonneux, France; Fleet, England; Singapore; and Tokyo, Japan. The Company believes its existing facilities and equipment are well maintained and in good operating condition and believes its manufacturing facilities, together with the use of independent manufacturers where required or desirable, will be sufficient to meet its anticipated manufacturing needs through fiscal 1996. The Company's future facilities requirements will depend upon the Company's business and, the Company believes additional space, if required, may be obtained on reasonable terms.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nA class action lawsuit alleging federal securities law violations and negligent misrepresentation was filed against the Company, its directors, and certain of its officers in February, 1991. That action was settled by letter agreement on July 29, 1993. The Company has made all payments required under the terms of the letter agreement. On March 7, 1995, the Court issued an Order preliminarily approving the class action settlement. Notice of the settlement has been given to class members. Final approval of the class action settlement is pending final order from the Court.\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.\nIncorporated by reference from the information under the caption \"Common Stock Prices and Dividends\" on page 48 of the Annual Report to Shareholders for the fiscal year ended March 31, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nIncorporated by reference from the information under the caption \"Selected Financial Data\" on page 48 of the Annual Report to Shareholders for the fiscal year ended March 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 information under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" from pages 31 through 34 of the Annual Report to Shareholders for the fiscal year ended March 31, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nConsolidated financial statements of Adaptec, Inc. at March 31, 1995 and 1994 and for each of the three years in the period ended March 31, 1995 and the independent accountants' report thereon are incorporated by reference from pages 35 through 47 of the Annual Report to Shareholders for the fiscal year ended March 31, 1995. The financial statements of Adaptec, Inc. as of and for the two years ended March 31, 1994 were audited by other independent accountants as indicated in the previously mentioned independent accountants' report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe change in accountants during fiscal 1995 was reported of Forms 8-K filed May 4, 1994 and June 23, 1994. Additionally, Form 8-K\/A-2 dated July 11,1994 was filed amending the original Form 8-K filed on May 4, 1994.\nOn May 3, 1994, the Company dismissed Arthur Andersen LLP as its auditors. This decision was recommended by management and approved by the Audit Committee of the Board of Directors. The Company believes there were no disagreements with Arthur Andersen LLP within the meaning of Instruction 4 of Item 304 of Regulation S-K for the fiscal years ended March 31, 1993 or 1994, or with respect to the subsequent period ended May 3, 1994.\nDuring the fiscal years ended March 31, 1993 and 1994 and through May 3, 1994 there were no reportable events (as defined in Item 304 of Regulation S-K) with Arthur Andersen LLP.\nA letter from Arthur Andersen LLP addressed to the Securities and Exchange Commission is included as an exhibit to this Form 10-K and incorporated by reference from the aforementioned Form 8-K\/A-2 dated July 11, 1994. This letter states that the firm agrees with the statements made by the Company pursuant to Item 304 of Regulation S-K.\nThe Company appointed Price Waterhouse LLP as its independent accountants on June 21, 1994. This appointment is included in the Company's Form 8-K filed June 23, 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 Adaptec is incorporated by reference from the information under the captions \"Election of Directors -- Nominees\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held, August 24, 1995 (the \"Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nIncorporated by reference from the information under the caption \"Executive Compensation and Other Matters\" and \"Election of Directors, Certain Relationships and Related Transactions\" in the Company's Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nIncorporated by reference from the information under the caption; \"Election of Directors -- Security Ownership of Management\" in the Company's Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIncorporated by reference from the information under the caption \"Election of Directors, Certain Relationships and Related Transactions\" in the Company's Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nThe following Consolidated Financial Statements of Adaptec, Inc. and the Report of Independent Public Accountants, as listed under (a)(1) below, are incorporated herein by reference to the Registrant's Annual Report to Shareholders for the year ended March 31, 1995.\n(a)(1) Financial Statements:\n(2) All schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n(3) Exhibits included herein (numbered in accordance with Item 601 of Regulation S-K):\n- ---------------\n(1) Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the year ended March 31, 1994.\n(2) Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the year ended March 31, 1993.\n(3) Incorporated by reference to Exhibit A filed with the Registrant's Registration Statement Number 0-15071 on Form 8-A on May 11, 1989 and to Exhibit 1.1 to Form 8 Amendments No. 1, No. 2 and No. 3 thereto as filed June 5, 1990, April 8, 1992 and July 20, 1992, respectively.\n(4) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1990.\n(5) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1987.\n(6) Incorporated by reference to Exhibit 10.15 filed in response to Item 16(a) \"Exhibits\", of the Registrant's Registration Statement on Form S-1 and Amendment No. 1 and Amendment No. 2 thereto (file No. 33-5519), which became effective on June 11, 1986.\n(7) Confidential treatment granted by order effective June 11, 1986 and extended by orders dated August 12, 1992 through June 30, 1995.\n(8) Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1992.\n(9) Incorporated by reference to Exhibit 4.2 to Form S-8 as filed October 26, 1994.\n(10) Incorporated by reference to Exhibit 16 to Form 8-K\/A-2 dated July 11, 1994.\n(11) Incorporated by reference from the information under the caption \"Corporate Information\" included in the Annual Report to Shareholders for the fiscal year ended March 31, 1995.\n* Designates management contracts or compensatory plan arrangements required to be filed as an exhibit pursuant to item 14(c) of this report on Form 10-K.\n** Confidential treatment has been requested for portions of this agreement.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the fourth quarter.\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-85652) of Adaptec, Inc. of our report dated April 20, 1995 appearing on page 47 of the Annual Report to Shareholders which is incorporated by reference in this Annual Report on Form 10-K.\nPRICE WATERHOUSE, LLP\n--------------------------------------\nSan Jose, California June 23, 1995\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statements File No. 33-36353, No. 33-36352, No. 33-32071, No. 33-25237, No. 33-19125, No. 33-19124, No. 33-8846 and No.33-68630.\n\/s\/ ARTHUR ANDERSEN LLP\n-------------------------------------- Arthur Andersen LLP\nSan Jose, California June 23, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Adaptec, Inc.:\nWe have audited the consolidated balance sheet of Adaptec, Inc. (a California corporation) and subsidiaries as of March 31, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended March 31, 1994 and 1993 (incorporated by reference 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 Adaptec, Inc. and subsidiaries as of March 31, 1994, and the results of their operations and their cash flows for the years ended March 31, 1994 and 1993 in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP\n-------------------------------------- Arthur Andersen LLP\nSan Jose, California April 25, 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.\nADAPTEC, INC.\nDate: June 23, 1995 \/s\/ JOHN G. ADLER\n-------------------------------------- John G. Adler Chairman of the Board of Directors, Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints John G. Adler and Paul G. Hansen, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.","section_15":""}
{"filename":"72903_1995.txt","cik":"72903","year":"1995","section_1":"Item 1 - Business\nNorthern States Power Company (the Company) was incorporated in 1909 under the laws of Minnesota. Its executive offices are located at 414 Nicollet Mall, Minneapolis, Minnesota 55401. (Phone 612-330-5500). The Company has two significant subsidiaries, Northern States Power Company, a Wisconsin corporation (the Wisconsin Company) and NRG Energy, Inc. (NRG), a Delaware corporation; and several other subsidiaries, including Cenergy, Inc. (which changed its name to Cenerprise, Inc. effective Jan. 1, 1996), a Minnesota corporation, and Viking Gas Transmission Company, a Delaware corporation (Viking). (See \"Gas Utility Operations - Viking Gas Transmission Company\" and \"Non-Regulated Subsidiaries\" herein for further discussion of these subsidiaries.) The Company and its subsidiaries collectively are referred to herein as NSP.\nNSP is predominantly an operating public utility engaged in the generation, transmission and distribution of electricity throughout an approximately 49,000 square mile service area and the transportation and distribution of natural gas in approximately 156 communities within this area. Viking is a regulated natural gas transmission company that operates a 500-mile interstate natural gas pipeline. NRG manages several non-regulated energy subsidiaries.\nThe Company serves customers in Minnesota, North Dakota and South Dakota. The Wisconsin Company serves customers in Wisconsin and Michigan. Of the approximately 3 million people served by the Company and the Wisconsin Company, the majority are concentrated in the Minneapolis-St. Paul metropolitan area. In 1995, about 63 percent of NSP's electric retail revenue was derived from sales in the Minneapolis-St. Paul metropolitan area and about 55 percent of retail gas revenue came from sales in the St. Paul metropolitan area. (For business segment information, see Note 16 of Notes to Financial Statements under Item 8.)\nNSP's utility businesses are currently experiencing some of the challenges common to regulated electric and gas utility companies, namely, increasing competition for customers, increasing pressure to control costs, uncertainties in regulatory processes and increasing costs of compliance with environmental laws and regulations. In addition, there are uncertainties related to permanent disposal of used nuclear fuel. (See Management's Discussion and Analysis under Item 7, Notes 14 and 15 of Notes to Financial Statements under Item 8 and \"Electric Utility Operations - Capability and Demand and Nuclear Power Plants - Licensing, Operation and Waste Disposal,\" herein, for further discussion of this matter.)\nPROPOSED MERGER WITH WISCONSIN ENERGY CORPORATION\nDescription of the Merger Transaction\nAs initially announced in the Company's Current Report on Form 8-K dated April 28, 1995 and filed on May 3, 1995 (the Company's 4\/28\/95 8-K), NSP, Wisconsin Energy Corporation, a Wisconsin corporation (WEC), Northern Power Wisconsin Corp., a Wisconsin corporation and wholly-owned subsidiary of NSP (New NSP) and WEC Sub Corp., a Wisconsin corporation and wholly owned subsidiary of WEC (WEC Sub), have entered into an Amended and Restated Agreement and Plan of Merger, dated as of April 28, 1995, as amended and restated as of July 26, 1995 (the Merger Agreement), which provides for a strategic business combination involving NSP and WEC in a \"merger-of-equals\" transaction (the Merger Transaction). The Merger Transaction, which was approved by the respective Boards of Directors and shareholders of the constituent companies, is expected to close shortly after all of the conditions to the consummation of the Merger Transaction, including obtaining applicable regulatory approvals, are met or waived. The goal of the Company and WEC is to receive approvals from all regulatory authorities by the end of 1996; however, some regulatory authorities have not established a timetable for their decisions. Therefore, timing of the approvals necessary to complete the Merger Transaction is not known at this time. See discussion of the regulatory proceedings under the caption \"Utility Regulation and Revenues - Rate Matters by Jurisdiction\" herein. (See additional discussion of the Merger Transaction under Item 7, Management's Discussion and Analysis, under Item 8, Note 18 of Notes to Financial Statements and pro forma financial statements included in exhibits listed in Item 14.)\nIn the Merger Transaction, the holding company of the combined enterprise will be registered under the Public Utility Holding Company Act of 1935, as amended. The holding company will be named Primergy Corporation (Primergy) and will be the parent company of both NSP (which, for regulatory reasons, will reincorporate in Wisconsin) and of WEC's principal utility subsidiary, Wisconsin Electric Power Company (WEPCO), which will be renamed \"Wisconsin Energy Company.\" Wisconsin Energy Company will include the operations of WEC's other current utility subsidiary, Wisconsin Natural Gas Company, which was merged into WEPCO effective Jan. 1, 1996. It is anticipated that, following the Merger Transaction, except for certain gas distribution properties transferred to the Company, the Wisconsin Company will be merged into Wisconsin Energy Company.\nIncorporated herein as exhibits by reference are the Merger Agreement, filed as an exhibit to New NSP's registration statement on Form S-4, and the press release issued in connection therewith and the related Stock Option Agreements (defined below) filed as exhibits to the Company's 4\/28\/95 8-K. The descriptions of the Merger Agreement and the Stock Option Agreements set forth herein do not purport to be complete and are qualified in their entirety by the provisions of the Merger Agreement and the Stock Option Agreements, as the case may be, and the other exhibits filed with the Company's 4\/28\/95 8-K.\nUnder the terms of the Merger Agreement, the Company will be merged with and into New NSP and immediately thereafter WEC Sub will be merged with and into New NSP, with New NSP being the surviving corporation. Each outstanding share of the Company's common stock, par value $2.50 per share (NSP Common Stock), will be canceled and converted into the right to receive 1.626 shares of common stock, par value $.01 per share, of Primergy (Primergy Common Stock). The outstanding shares of WEC common stock, par value $.01 per share (WEC Common Stock), will remain outstanding, unchanged, as shares of Primergy Common Stock. As of the date of the Merger Agreement, (April 28, 1995) the Company had 67.3 million common shares outstanding and WEC had 109.4 million common shares outstanding. Based on such capitalization, the Merger Transaction would result in the common shareholders of the Company receiving 50 percent of the common stock equity of Primergy and the common shareholders of WEC owning the other 50 percent of the common stock equity of Primergy. Each outstanding share of the Company's cumulative preferred stock, par value $100.00 per share, will be canceled and converted into the right to receive one share of cumulative preferred stock, par value $100.00 per share, of New NSP with identical rights (including dividend rights) and designations. WEPCO's outstanding preferred stock will remain outstanding and be unchanged in the Merger Transaction.\nIt is anticipated that Primergy will adopt the Company's dividend payment level adjusted for the exchange ratio. The Company currently pays $2.70 per share annually, and WEC's annual dividend rate is currently $1.47 per share. Based on the 1.626 stock exchange ratio and the Company's current dividend rate, the pro forma dividend rate for Primergy Common Stock would be $1.66 per share as of Dec. 31, 1995. However, the amount, declaration, and timing of dividends on Primergy Common Stock will be a business decision to be made by the Primergy Board of Directors from time to time based upon the results of operations and financial condition of Primergy and its subsidiaries and such other business considerations as the Primergy Board considers relevant in accordance with applicable laws.\nMerger Consummation Conditions\nThe Merger Transaction is subject to customary closing conditions, including, without limitation, the receipt of all necessary governmental approvals and the making of all necessary governmental filings, including approvals of state utility regulators in Wisconsin, Minnesota and certain other states, the approval of the Federal Energy Regulatory Commission (FERC), the Securities and Exchange Commission (SEC), the Nuclear Regulatory Commission (NRC), and the filing of the requisite notification with the Federal Trade Commission and the Department of Justice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the expiration of the applicable waiting period thereunder. (See discussion of the utility regulation proceedings under the caption \"Utility Regulation and Revenues - Rate Matters by Jurisdiction\" herein.) The Merger Transaction is also subject to receipt of assurances from the parties' independent accountants that the Merger Transaction will qualify as a pooling of interests for accounting purposes under generally accepted accounting principles. In addition, the consummation of the Merger Transaction is conditioned upon the approval for listing of such shares on the New York Stock Exchange.\nDuring 1995, in addition to shareholder and Board of Directors approval, the Company and WEC took the following steps toward fulfilling the conditions to closing:\n- Registration statements filed by WEC and the Company with the SEC with respect to the Primergy Common Stock to be issued in the Merger Transaction and New NSP Preferred Stock became effective.\n- NSP and WEC received a ruling from the Internal Revenue Service indicating that the proposed merger transactions would qualify as independent tax-free reorganizations under applicable tax law.\n- NSP and WEC filed for regulatory approval of the Merger Transaction with the FERC and state commissions. (See \"Utility Regulation and Revenues - Rate Matters by Jurisdiction\", herein, for further discussion of the status of these filings.)\n- The Company filed for the NRC approval of the transfer of nuclear operating licenses from the Company to New NSP.\nDuring 1996 NSP and WEC expect to make the following filings as part of the regulatory approval process for the Merger Transaction:\n- NSP and WEC will file for SEC approval of the registration of Primergy under the Public Utility Holding Company Act of 1935, as amended, including a decision on possible divestiture of the existing gas operations and certain non-regulated businesses.\n- Notification under the Hart-Scott-Rodino Antitrust Act of 1976, as amended, is expected to be filed in the second quarter of 1996 with the Department of Justice and Federal Trade Commission.\nThe Merger Agreement\nThe Merger Agreement contains certain covenants of the parties pending the consummation of the Merger Transaction. Generally, the parties must carry on their businesses in the or- dinary course consistent with past practice, may not increase dividends on common stock beyond specified levels, and may not issue capital stock beyond certain limits. The Merger Agreement also contains restrictions on, among other things, charter and bylaw amendments, capital expenditures, acquisitions, dispositions, incurrence of indebtedness, certain increases in employee compensation and benefits, and affiliate transactions.\nIn accordance with the Merger Agreement, upon the consummation of the Merger Transaction, James J. Howard, Chairman, President, and Chief Executive Officer of the Company will initially serve as the Chairman and Chief Executive Officer of Primergy for a minimum of 16 months after the effectiveness of the Merger Transaction and will thereafter serve only as Chairman of the Board of Primergy for a minimum of two years. Also, Richard A. Abdoo, Chairman, President and Chief Executive Officer of WEC shall initially hold the positions of Vice Chairman of the Board, President and Chief Operating Officer of Primergy and thereafter shall be entitled to hold the additional position of Chief Executive Officer when Mr. Howard ceases to be Chief Executive Officer. Mr. Abdoo will assume the position of Chairman when Mr. Howard ceases to be Chairman.\nThe Merger Agreement may be terminated under certain circumstances, including (1) by mutual consent of the parties; (2) by any party if the Merger Transaction is not consummated by April 30, 1997 (provided, however, that such termination date shall be extended to Oct. 31, 1997 if all conditions to closing the Merger Transaction, other than the receipt of certain consents and\/or statutory approvals by any of the parties, have been satisfied by April 30, 1997); (3) by any party if either NSP's or WEC's shareholders vote against the Merger Transaction or if any state or federal law or court order prohibits the Merger Transaction; (4) by a non-breaching party if there exist breaches of any representations or warranties contained in the Merger Agreement as of the date thereof which breaches, individually or in the aggregate, would result in a material adverse effect on the breaching party and which is not cured within 20 days after notice; (5) by a non-breaching party if there occur breaches of specified covenants or material breaches of any covenant or agreement which are not cured within 20 days after notice; (6) by either party if the Board of Directors of the other party shall withdraw or adversely modify its recommendation of the Merger Transaction or shall approve any competing transaction; or (7) by either party, under certain circumstances, as a result of a third-party tender offer or business combination proposal which such party's board of directors determines in good faith that their fiduciary duties require be accepted, after the other party has first been given an opportunity to make concessions and adjustments in the terms of the Merger Agreement. In addition, the Merger Agreement provides for the payment of certain termination fees by one party to the other in the event of a willful breach or acceptance of a third-party tender offer or business combination.\nConcurrently with the Merger Agreement, the parties have entered into reciprocal stock option agreements (the Stock Option Agreements) each granting the other an irrevocable option to purchase up to that number of shares of common stock of the other company which equals 19.9 percent of the number of shares of common stock of the other company outstanding on April 28, 1995 at an exercise price of $44.075 per share, in the case of NSP Common Stock, or $27.675 per share, in the case of WEC Common Stock, under certain circumstances if the Merger Agree- ment becomes terminable by one party as a result of the other party's breach or as a result of the other party becoming the subject of a third-party proposal for a business combination. Any party whose option becomes exercisable (the Exercising Party) may request the other party to repurchase from it all or any portion of the Exercising Party's option at the price specified in the Stock Option Agreements.\nResults of the Merger Transaction\nA preliminary estimate indicates that the Merger Transaction will result in net savings of approximately $2.0 billion in costs over 10 years. It is anticipated that the synergies created by the Merger Transaction will allow the companies to implement a modest reduction in electric and gas retail rates as described below followed by a rate freeze for electric and gas retail customers. This rate plan is currently being considered by various regulatory agencies.\nThe Company has proposed an average retail electric rate reduction of 1.5 percent and a four-year rate freeze in its retail jurisdictions. The electric rate reduction of 1.5 percent would be implemented as soon as reasonably possible following the receipt of the necessary approvals and closing of the Merger Transaction. This proposed rate reduction is made in conjunction with the proposal to recover deferred Merger Transaction costs and costs incurred to achieve merger savings through amortization over the same period. Customers will also receive directly the benefit of any fuel savings through the electric fuel adjustment clause mechanism.\nThe Company has proposed a two-year freeze for retail natural gas rates in its Minnesota jurisdiction and a 1.25 percent rate reduction along with a four-year freeze in its North Dakota jurisdiction. In addition, 38 percent of the Company's net gas savings available in 1997 are forecasted to be in the purchased cost of gas and would be reflected in customer rates automatically through the purchased gas adjustment clause mechanism. The remaining benefits will support the rate freeze, as well as offset a portion of the rising gas utility costs other than the purchased cost of gas in that time period.\nThe total savings identified as a result of the Merger Transaction represent aggressive goals which the Company and WEC intend to achieve, but the rate freeze will result in some risk to the shareholders if the anticipated cost savings are not realized. There is uncertainty regarding the timing and levels of the savings and costs associated with the Merger Transaction. The Company's proposal to unilaterally reduce rates and institute a rate freeze is designed to shield customers from these uncertainties. This proposal permits customers the opportunity to immediately begin realizing benefits of the Merger Transaction notwithstanding these uncertainties. Further, the four-year rate freeze permits the companies a reasonable time period to implement the changes necessary to achieve the contemplated savings.\nThe commitment not to increase electric rates does not prohibit tariff amendments and rate design changes which would not increase electric net income during the moratorium. NSP also proposes to continue to apply the Conservation Investment Program Annual Tracker Mechanism to recover conservation program costs. Finally, as part of this proposal, Primergy's operating utility subsidiaries will work with regulatory commissions to develop a plan for managing merger benefits for the year 2001 and beyond. The Company recognizes that during the four-year rate freeze period, it may experience certain significant but uncontrollable events which necessitate rate changes. Accordingly, as part of the rate plan proposal, the Company has identified certain events (large increases in taxes and government-mandated costs, and extraordinary events) which it believes should be excepted from the rate freeze. The exceptions are necessary in order to protect the Company from major cost increases or events which are beyond its control. The Company proposes that for these uncontrollable events it be allowed to file with the Commission during the rate freeze period for recovery of the costs related to these events.\nBoth NSP and WEC recognize that the divestiture of their existing gas operations and certain non-utility operations is a possibility under the new registered holding company structure, but have been working with the SEC to retain such businesses. Based on prior decisions and other actions by the SEC, the retention of both the gas and non-regulated businesses seems possible after consummation of the Merger Transaction. If divestiture is ultimately required, the SEC has historically allowed companies sufficient time to accomplish divestitures in a manner that protects shareholder value.\nUTILITY REGULATION AND REVENUES\nGeneral\nRetail sales rates, services and other aspects of the Company's operations are subject to the jurisdiction of the Minnesota Public Utilities Commission (MPUC), the North Dakota Public Service Commission (NDPSC), and the South Dakota Public Utilities Commission (SDPUC) within their respective states. The MPUC also possesses regulatory authority over aspects of the Company's financial activities including security issuances, property transfers when the asset value is in excess of $100,000, mergers with other utilities, and transactions between the regulated Company and affiliates. In addition, the MPUC reviews and approves the Company's electric resource plans and gas supply plans for meeting customers' future energy needs. The Wisconsin Company is subject to regulation of similar scope by the Public Service Commission of Wisconsin (PSCW) and the Michigan Public Service Commission (MPSC). In addition, each of the state commissions certifies the need for new generating plants and transmission lines of designated capacities to be located within the respective states before the facilities may be sited and built.\nWholesale rates for electric energy sold in interstate commerce, wheeling rates for energy transmission in interstate commerce, the wholesale gas transportation rates of Viking, and certain other activities of the Company, the Wisconsin Company and Viking are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). NSP also is subject to the jurisdiction of other federal, state and local agencies in many of its activities. (See \"Environmental Matters\" herein.)\nThe Minnesota Environmental Quality Board (MEQB) is empowered to select and designate sites for new power plants with a capacity of 50 megawatts (Mw) or more, wind energy conversion plants with a capacity of 5 Mw or more, and routes for transmission lines with a capacity of 200 kilovolts (Kv) or more, as well as evaluate such sites and routes for environmental compatibility. The MEQB may designate sites or routes from those proposed by power suppliers or those developed by the MEQB. No such power plant or transmission line may be constructed in Minnesota except on a site or route designated by the MEQB.\nNSP is unable to predict the impact on its operating results from the future regulatory activities of any of the above agencies. To the best of its ability, NSP works to understand and comply with all rules and regulations issued by the various agencies.\nRevenues\nNSP's financial results depend, in part, on its ability to obtain adequate and timely rate relief from the various regulatory bodies, its ability to control costs and the success of its non-regulated activities. NSP's 1995 utility operating revenues, excluding intersystem non-firm electric sales to other utilities of $90 million and miscellaneous revenues of $60 million, were subject to regulatory jurisdiction as follows:\nPercent Authorized Return on Common of Total Equity @ Dec. 31, 1995 Revenues (Electric Electric Gas & Gas) Retail: Minnesota Public Utilities Commission 11.47% 11.47% 74.1% Public Service Commission of Wisconsin 11.4** 11.4** 14.7 North Dakota Public Service Commission 11.50 14.0 5.1 South Dakota Public Utilities Commission * 3.1 Michigan Public Service Commission 12.25 14.5 0.6\nSales for Resale - Wholesale, Viking Gas and Interstate Transmission: Federal Energy Regulatory Commission * * 2.4\nTotal 100.0%\n* Settlement proceeding, based upon revenue levels granted with no specified return. ** Return authorized for 1996 is 11.3 percent.\nGeneral Rate Filings\nGeneral rate increases (other than fuel and resource adjustment rate changes) requested and granted in previous years from various jurisdictions were as follows (note that 1992, 1993, 1994 and 1995 amounts represent annual increases (decreases) effective in those years, while 1991 increases represent annual increases requested in that year even if effective in a subsequent year):\nAnnual Increase\/(Decrease) Year Requested Granted (Millions of dollars)\n1991 118.7 68.0 1992 ----- ---- 1993 166.6 101.5 1994 (1.0) (1.0) 1995 (0.8) (0.8)\nThe following table summarizes the status of general rate increases (decreases) for rates effective in 1995.\nAnnual Increase\/(Decrease) Requested Granted Status (Millions of dollars) Electric North Dakota-Retail* (0.8) (0.8) Order Issued (May 10, 1995) Gas 0.0 0.0 Total 1995 Rate Programs (0.8) (0.8)\n* Does not include a refund to residential customers of approximately $1.5 million for the period Jan. 1, 1994, through June 1, 1994.\nRatemaking Principles in Minnesota and Wisconsin\nSince the MPUC assumed jurisdiction of Minnesota electric and gas rates in 1975, several significant regulatory precedents have evolved. The MPUC accepts the use of a forecast test year that corresponds to the period when rates are put into effect and allows collection of interim rates subject to refund. The use of a forecast test year and interim rates minimizes regulatory lag.\nThe MPUC must order interim rates within 60 days of a rate case filing. Minnesota statutes allow interim rates to be set using (1) updated expense and rate base items similar to those previously allowed, and (2) a return on equity equal to that granted in the last MPUC order for the utility. The MPUC must make a determination on the application within 10 months after filing. If the final determination does not permit the full amount of the interim rates, the utility must refund the excess revenue collected, with interest. To the extent final rates exceed interim rates, the final rates become effective at the time of the order and retroactive recovery of the difference is not permitted. Generally, the Company may not increase its rates more frequently than every 12 months.\nMinnesota law allows Construction Work in Progress (CWIP) in a utility's rate base instead of recording Allowance for Funds Used During Construction (AFC) in revenue requirements for rate proceedings. The MPUC has exercised this option to a limited extent so that cash earnings are allowed on small and short-term projects that do not qualify for AFC. (For the Company's policy regarding the recording of AFC, see Note 1 of Notes to Financial Statements under Item 8.)\nThe PSCW has a biennial filing requirement for processing rate cases and monitoring utilities' rates. By June 1 of each odd-numbered year, the Wisconsin Company must submit filings for calendar test years beginning the following January 1. The filing procedure and subsequent review generally allow the PSCW sufficient time to issue an order effective with the start of the test year.\nThe PSCW reviews each utility's cash position to determine if a current return on CWIP will be allowed. The PSCW will allow either a return on CWIP or capitalization of AFC at the adjusted overall cost of capital. The Wisconsin Company currently capitalizes AFC on production and transmission CWIP at the FERC formula rate and on all other CWIP at the adjusted overall cost of capital.\nFuel and Purchased Gas Adjustment Clauses in Effect\nThe Company's retail electric rate schedules, and most of the Wisconsin Company's wholesale rate schedules, provide for adjustments to billings and revenues for changes in the cost of fuel and purchased energy. Although the lag in implementing the billing adjustment is approximately 60 days, an estimate of the adjustment is recorded in unbilled revenue in the month costs are incurred. The Company's wholesale electric sales customers remaining with NSP do not have a fuel clause provision in their contracts. In lieu of fuel clause recovery, the contracts instead provide a fixed rate with an escalation factor. The Wisconsin Company calculates the wholesale electric fuel adjustment factor for the current month based on estimated fuel costs for that month. The estimated fuel cost is adjusted to actual the following month.\nIn September 1995, the MPUC approved a variance of Minnesota fuel adjustment clause rules to specifically allow for the inclusion of total wind purchase power costs and biomass related energy costs in the fuel adjustment clause. The Company must request approval for renewal of this variance annually. The Company is obligated by legislative mandate to purchase 425 Mw of wind generated energy and 125 Mw of farm-grown closed-loop bio-mass generated energy by 2002.\nThe Wisconsin Company's automatic retail electric fuel adjustment clause for Wisconsin customers was eliminated effective in 1986. The clause was replaced by a limited-issue filing procedure. Under the procedure, the Wisconsin Company may elect to file or be required to file for a change in rates (limited to the fuel issue) following an annual deviation in fuel costs of 2 percent or more. The adjustment approved is calculated on an annual basis, but applied prospectively. Effective Jan. 1, 1996, the fuel costs that are monitored include certain fuel costs including demand costs for sales and purchased power, which had been excluded prior to that date.\nGas rate schedules for the Company and the Wisconsin Company include a purchased gas adjustment (PGA) clause that provides for rate adjustments for changes in the current unit cost of purchased gas compared to the last costs included in rates.\nBy September 1 of each year, the Company is required by Minnesota statute to submit to the MPUC an annual report of the Purchased Gas Adjustments (PGA) for each customer class by month for the previous year commencing July 1 and ending June 30. The report verifies whether the utility is calculating the adjustments properly and implementing them in a timely manner. In addition, the MPUC review includes an analysis of procurement policies, cost-minimizing efforts, rule variances in effect or requested, retail transportation gas volumes, independent auditors' reports, and the impact of market forces on gas costs for the coming year. The MPUC has the authority to disallow certain costs if it deems the utility was not prudent in its gas procurement activities. The MPUC allowed full recovery of gas costs in response to the June 30, 1994, filing. The MPUC's determination regarding the filing for the year ended June 30, 1995, is pending.\nIn August 1995, the MPUC initiated an investigation - -- an industry-wide proceeding which will be open to participation from any interested party -- to examine whether the PGA mechanism is still appropriate for gas utilities based on the recent changes in the competitive environment in the gas utility industry and the authorization of performance-based gas purchasing regulation. The MPUC requested comments on the continued need for the PGA mechanism. The Company has filed comments supporting the continued use of the PGA, but urging the use of performance-based PGA mechanisms. An MPUC decision on the matter is pending.\nThe PSCW scheduled a generic hearing in March 1996 to consider an incentive-based gas cost recovery adjustment clause to replace the current purchased gas cost recovery adjustment clause. The incentive-based mechanism would allow recovery of fluctuations in gas costs based on an index, such as the spot market price. The new method would allow the Wisconsin Company to absorb the additional charge or benefit related to any difference between actual gas costs incurred and the index used for recovery. A PSCW decision is pending.\nThe Wisconsin Company's gas and retail electric rate schedules for Michigan customers include Gas Cost Recovery Factors and Power Supply Cost Recovery Factors, which are based on 12 month projections. After each 12 month period, a reconciliation is submitted whereby over-collections are refunded and any under-collections are collected from the customers.\nViking is a transportation-only interstate pipeline and provides no sales services. As a result, Viking terminated its PGA clause effective Nov. 1, 1993. Natural gas fuel for compressor station operations is provided in-kind by transportation service customers.\nResource Adjustment Clauses in Effect\nIn October 1994, the Company filed with the MPUC a petition for a miscellaneous rate change approving the implementation of an annual recovery mechanism for deferred electric conservation and energy management program expenditures. On Feb. 23, 1995, the MPUC voted to approve recovery of $41 million under a new electric rate adjustment clause for the period May 1995 through June 1996. Thereafter, the Company would be required to request a new cost recovery level annually. This decision allows for accelerated recovery of conservation and energy management program expenditures which is desirable because it lessens the risk for future stranded costs resulting from electric industry restructuring. Beginning in May 1995, a 2.45 percent surcharge to customer's bills appeared as a line item entitled \"resource adjustment.\" A similar rate adjustment clause was approved for an annual recovery rate of $3.7 million in deferred and current gas conservation and energy management program expenditures beginning with November 1995 billings. In January 1996, a number of changes to the Company's regulatory deferral and amortization practices for Minnesota electric conservation program expenditures were approved. These changes allow the Company to expense rather than amortize new conservation expenditures beginning in 1996 and to increase its recovery of electric margins lost due to conservation activity. In addition, the Company received approval for 1996 and 1997 conservation expenditures at levels lower than 1995. On April 1, 1996, the Company expects to file for annual changes to the Minnesota electric conservation rate adjustment clause, incorporating the changes in January 1996, with an effective period of July 1, 1996, through June 30, 1997. These conservation cost recovery changes are intended to avoid a significant delay between the time when costs are incurred and their recovery in rates.\nRate Matters by Jurisdiction\nMinnesota Public Utilities Commission (MPUC)\nIn 1991, the Minnesota legislature passed a law which granted the MPUC discretionary authority to approve a rate adjustment clause for changes in certain costs (including property taxes, fees and permits) incurred by Minnesota public utilities. In addition, the MPUC may approve a utility's use of the rate adjustment clause for billing customers if certain conservation expenditure levels are met. During 1995, the Company filed with the MPUC a request to make use of the rate adjustment clause to recover increased property tax costs from its retail gas customers in Minnesota. The MPUC denied the Company's request. No additional request to make use of the rate adjustment clause for the Company's electric or gas customers is currently pending with the MPUC.\nIn October 1994, as part of a response to 1994 Minnesota legislation related to fuel storage at the Prairie Island nuclear plant, the Company filed a miscellaneous rate change proposal with the MPUC which reflects a 50 percent discount on the first 300 kilowatt hours (Kwh) consumed each month by qualified low-income residential customers. In December 1994 the MPUC approved the Company filing. As a result, the Low Income Discount Rate became effective beginning with the October 1994 billing month for qualifying customers, with rate adjustments designed to recover from other customers the costs of the discount becoming effective Jan. 4, 1995. The ruling also eliminated the Conservation Rate Break and restructured the rates between customer classes, but did not significantly change overall revenue levels.\nApproximately 35,000 of the Company's customers received assistance totaling more than $5 million from federally funded Low Income Household Energy Assistance Programs (LIHEAP) operated by the state of Minnesota in 1995. Other states served by NSP have similar programs. The federal LIHEAP program is currently facing significant opposition in securing funding to continue operations. Qualification for the Company's Low Income Discount Rate is based on eligibility for LIHEAP. The state of Minnesota would continue to certify eligibility even if LIHEAP is not funded. Management believes reductions in federal funding for LIHEAP exceeding 30 percent may result in an increase in the Company's uncollectible accounts for customers who cannot obtain other sources of assistance.\nGas utilities in Minnesota are also required to file for a change in gas supply contract levels to meet peak demand, to redistribute demand costs among classes, or exchange one form of demand for another. The Company filed in October 1995 to increase its demand entitlements due to projected increases in firm customer count, to increase the Minnesota jurisdictional allocation of total demand entitlements, effective Nov. 1, 1995, and to recover the demand entitlement costs associated with the increase in transportation and storage levels in its monthly PGA's. The MPUC approved this filing on March 7, 1996.\nIn April 1995, the MPUC opened up the rulemaking process to amend, repeal, or replace existing rules governing customer service standards for gas and electric utilities. The MPUC solicited comments from interested parties in June 1995. The MPUC formed an advisory task force in August 1995 representing interests from electric and gas utilities, low and fixed income consumer advocate groups, other state of Minnesota agencies and other various rate payer classes. Certain parties are proposing changes to the MPUC customer service rules that have the potential to increase the Company's costs associated with managing and collecting customer accounts. Examples of proposed changes are provisions to require NSP to have a signed contract for service, restrict collection of past-due bills to only the party(s) named on the bill, and to prohibit the Company from collecting a deposit for utility service from a low-income customer. The ultimate outcome of the rulemaking process is unknown at this time.\nOn Aug. 4, 1995 the Company filed for MPUC approval of the Merger Transaction with WEC. The Company proposed a rate plan which would reduce electric rates by 1.5 percent starting Jan. 1, 1997, or after receipt of all regulatory approvals and a four-year rate freeze thereafter, except for certain uncontrollable events. The rate plan was modified in March 1996 to also provide for a two-year freeze in gas rates. The proposed rate plan also included a request for deferred accounting and rate recovery of the costs associated with the Merger Transaction. Initial comments from the Department of Public Service, which recommended that the MPUC approve the Merger Transaction, and other interested parties were filed on Jan. 16, 1996. The Company's reply comments were filed on March 1, 1996. The MPUC's decision on the Merger Transaction approval filing is expected in the third or fourth quarter of 1996.\nNo general rate filings are anticipated in Minnesota in 1996.\nNorth Dakota Public Service Commission (NDPSC)\nIn August 1994, the Company applied to the NDPSC for an annualized electric rate reduction of $3.6 million to reflect a correction in cost allocations to the North Dakota jurisdiction. In November 1994, the NDPSC approved the Company's request to make refunds to customers, effectively implementing the reduction as of June 1, 1994. These refunds were accrued in 1994 and paid in February 1995. In May 1995, the NDPSC approved a refund to residential customers of approximately $1.5 million for the period Jan. 1, 1994 through June 1, 1994 to reflect corrections to cost allocations for that period. This refund was accrued in 1994 and paid in June 1995. Also,the NDPSC approved an annualized rate reduction of $750,000 for North Dakota commercial and industrial electric customers, which was effective prospectively from June 1, 1995.\nOn Aug. 4, 1995, the Company filed for NDPSC approval of the Merger Transaction with WEC. The Company proposed a rate plan which would reduce electric rates by 1.5 percent on Jan. 1, 1997, or after the close of the Merger Transaction, and implement a four-year rate freeze thereafter, with certain exceptions. A 1.25 percent rate reduction and a four-year rate freeze in gas rates was also proposed. Public hearings on the Merger Transaction were held in Minot, Grand Forks and Fargo, North Dakota in November and December 1995. A technical hearing was held in March 1996. The NDPSC's decision is expected on the Merger Transaction approval filing later in 1996.\nAt a hearing in December 1995, the NDPSC approved the phase-out of the use of deferred accounting for conservation program costs. Effective retroactively to Jan. 1, 1995, the Company will expense conservation program costs related to North Dakota operations in the year the costs are incurred. This change increased expenses by $1.7 million in 1995 and is expected to increase 1996 expenses by a similar amount. Costs incurred prior to 1995 will continue to be amortized in jurisdictional expenses.\nOn Jan. 17, 1996, the Company filed a plan with the NDPSC for a $485,000 annual reduction in base gas rates in North Dakota. This plan responds to a NDPSC staff audit of gas earnings for this jurisdiction for the years 1991 to 1995. The Company also proposed to adjust its base cost of gas to more current levels and make modifications to its PGA and annual gas cost true-up mechanism. The changes are proposed to be effective prospective from the date of the NDPSC order approving the plan. NDPSC action is pending. This reduction would be in addition to the merger-related gas rate reductions.\nNo other general rate filings are anticipated in North Dakota in 1996.\nSouth Dakota Public Utilities Commission (SDPUC)\nThere were no general rate filings in South Dakota in 1995. On Sept. 8, 1995, the SDPUC determined that it did not have jurisdiction to approve or deny the Merger Transaction with WEC. However, a rate filing to reflect merger savings in electric rates is expected on or around the time of the consummation of the Merger Transaction. No other general rate filings are anticipated in South Dakota in 1996.\nPublic Service Commission of Wisconsin (PSCW)\nOn June 1, 1995, the Wisconsin Company filed with the PSCW for a $2.7 million increase, or 3.6 percent, in natural gas rates and no change in electric rates to be effective Jan. 1, 1996. On Oct. 6, 1995, the PSCW ordered a $4.8 million decrease, or approximately 1.7 percent on an annual basis, in the Wisconsin Company's retail electric rates. The new rates took effect Jan. 1, 1996. On Dec. 21, 1995, the PSCW ordered a $2.5 million increase, or approximately 3.4 percent on an annual basis, in the Wisconsin Company's retail gas rates and a return on common equity of 11.3 percent to be effective Jan. 1, 1996.\nThe Wisconsin Company and WEC filed for approval of the Merger Transaction on Aug. 4, 1995. WEC requested deferred accounting treatment and rate recovery of costs associated with the proposed merger. Rate plans were filed that proposed a 1.5 percent annual retail electric rate reduction and a $4.2 million annual reduction in gas rates (of which $.2 million relates to the Wisconsin Company) at the time of the merger and four-year rate freezes thereafter with certain exceptions. On March 15, 1996, the Wisconsin Company filed full stand-alone rate cases for a 1997 test year on an unmerged basis. This special filing was requested by the PSCW to set a baseline cost for evaluating savings associated with the Merger Transaction. The Wisconsin Company filing described revenue deficiencies for both electric and gas utilities, however no rate increases were requested. The Wisconsin Company intends to attempt to manage its cost levels to avoid such rate increases. On March 18, 1996, the Wisconsin Company filed testimony and exhibits supporting the original Aug. 4, 1995 Merger Transaction filing. Technical hearings on the merger are expected in July 1996. The PSCW's decision on the merger approval filing is expected in the fourth quarter of 1996.\nThe Wisconsin Company is scheduled to file a general rate case in June 1997, for rates effective in 1998, as required by the PSCW biennial filing requirement.\nMichigan Public Service Commission (MPSC)\nThe Wisconsin Company and WEC filed for MPSC approval of the Merger Transaction on Aug. 4, 1995. Electric and gas rate plans were filed that proposed a rate reduction and a four-year rate freeze. The MPSC's decision on the Merger Transaction is expected in the first half of 1996.\nElectric Transmission Tariffs and Settlement (FERC)\nIn 1990, NSP filed a transmission services tariff for certain transmission customers. New rates were effective under the filing, subject to refund, for the period Dec. 29, 1990, through Oct. 31, 1994. NSP has recorded an estimated liability at Dec. 31, 1995, for potential transmission rate refunds under this tariff based on the FERC order dated Sept. 21, 1993. On Feb. 5, 1996, the FERC denied NSP's request for rehearing and required NSP to submit a refund compliance filing in the amount of $1.7 million. This refund amount is approximately the same as estimated liabilities recorded.\nIn March 1994, NSP filed a revised open access transmission tariff with the FERC. On May 25, 1994, the FERC accepted the filing, with the new rates effective Nov. 1, 1994, subject to refund. The FERC also ruled the tariff would be subject to the requirement that NSP offer transmission service using terms and conditions comparable to its own use of the system. On April 11, 1995, an Offer of Settlement (the Settlement) was entered into by a majority of the parties involved in this proceeding. The settlement agreement includes a transmission tariff that complies with the FERC transmission pricing policy which calls for comparability of service and pricing, network service, and unbundling of ancillary charges such as scheduling and load following. On May 25, 1995, the Administrative Law Judge (ALJ) issued to the FERC a Certification of Contested Order of Settlement. Although there are no genuine issues of material fact and all parties support certification of the Settlement, the ALJ stated the Settlement is contested since FERC Staff and Electric Clearinghouse list numerous provisions that need to be modified in response to the issuance of proposed rulemaking referred to as the Mega NOPR. (See discussion and definition of Mega-NOPR below.) The ALJ further stated the Settlement is not affected by the issuance of the Mega-NOPR, even though the FERC in the Mega-NOPR stated that any settlement approved prior to the issuance of the Final Rule will be made subject to the outcome of the final rule. The FERC approved the Settlement on Feb. 14, 1996, subject to the outcome of the final rule, in 1996. The revenue effect on the Company is an increase of approximately $200,000 per year. The new tariff allows NSP to comply with transmission pricing provisions of open access transmission requirements of the Energy Policy Act of 1992.\nOpen Access Transmission Proceedings (FERC)\nIn March 1995, the FERC issued a Notice of Proposed Rulemaking on Open Access Non-Discriminatory Transmission Services and a Supplemental Notice of Proposed Rulemaking on Stranded Investment (together called the \"Mega-NOPR\"); and a proposal to require Real-Time Information Networks (RIN).\nThe stated purpose for the Mega-NOPR is to create a vigorous wholesale electric market by requiring transmission providers to offer open access to their transmission systems. The FERC is proposing to require utilities to unbundle power sales from transmission. This \"unbundling service\" requirement would apply only to new requirements contracts and new coordination trade contracts. The FERC did not require utilities to divest or separate their generation businesses from their transmission businesses. The FERC also proposes to not disrupt any existing power or transmission contracts.\nThe Mega-NOPR would apply to all utilities under the FERC's jurisdiction and would require each utility to file individual tariffs. The FERC also seeks to require non- jurisdictional transmission providing entities (such as municipals and cooperatives) to offer open access by including a reciprocity clause in their individual tariffs, so that those who take service from a FERC jurisdictional utility must offer the open access. The rule will be implemented in two stages. In the first stage, generic pro forma tariffs rates would take effect under financial data filed with the FERC on Form 1. In the second stage, utilities and their customers could file to modify the tariffs and rates within the limits of non- discriminatory open access. A Procedural Order which was concurrently issued with the Mega-NOPR grandfathers NSP's transmission tariff into the second stage.\nThe Mega-NOPR would require transmission providers to offer network, point-to-point and ancillary services. Ancillary services would include scheduling and dispatching, load following,imbalance resolution, reactive power support and system protection.\nIn the Mega-NOPR, the FERC further clarified its guidelines for utilities to recover stranded investment costs due to facilitation of open access to a competitive market. The FERC stated that it recognized the vital link between the prior stranded cost proposal issued in 1994 and the open access initiative. In the Mega-NOPR, the FERC has proposed a \"backstop\" position, whereby it will only entertain stranded cost filings when a state regulatory commission does not have authority under state law to address stranded costs at the time retail wheeling (which is the transmission to retail customers of power generated by a third party, in competition with supplies from the host utility) takes place. The Mega-NOPR also provides that the FERC will entertain utilities' requests for stranded-cost recovery even after a state has addressed the case. However, if a state commission has authority to act, but does not do so, a utility may not seek recovery from the FERC.\nWith regard to the RIN proposal, FERC is considering requiring that each public utility create an electronic bulletin board to ensure that potential purchasers of transmission services have access to information to enable them to obtain open access transmission services on a non-discriminatory basis from the public utility. The proposed RIN would include a wide range of information such as: availability of transmission services (including ancillary services); rates; hourly transfer capacities; hourly amounts scheduled; transmission and unit outages; load flow data; and transaction specific information on all requests for transmission service, including requests by transmission owner's wholesale power marketing department.\nIn its response to the RIN and Mega NOPR proposals, NSP filed comments which indicated support for FERC's open access objective and for FERC's position that it should be a backstop for the recovery of stranded costs. NSP also asserted that its open access transmission tariffs filed in 1994 comply with the spirit of the Mega-NOPR.\nProposed Merger Approval Proceedings (FERC)\nOn July 10, 1995, the Company and WEC filed an application and supporting testimony with the FERC seeking approval of the Merger Transaction to form Primergy Corporation. The filing consisted of the merger application, the proposed joint transmission tariff, and an amendment to the Company's Interchange Agreement with the Wisconsin Company. On Sept. 11, 1995, several parties, who had previously filed for intervenor status in the FERC Merger Transaction approval application filing, filed interventions and protests. On Oct. 10, 1995, the Company and WEC replied to petitions for intervention and requests for hearings. On or about Oct. 25, 1995, intervenors filed responses to the Company and WEC's reply. On Nov. 9, 1995, the Company and WEC filed a response to the intervenors reply comments. Additional intervenor comments were filed on Nov. 22, 1995. The Company has met all previously stated FERC criteria for merger approvals.\nThe issues raised by intervenors with respect to the merger application at the FERC are primarily related to two areas: the impact on competition and the nature of the cost savings. The Company has settled with several intervenors and is continuing to meet with interested parties in the FERC proceeding, seeking resolution of the intervenor issues.\nOn Jan. 31, 1996, the FERC issued a ruling which put the merger approval filing on an accelerated schedule. The FERC set only one of six merger issues raised by intervenors to a hearing. The FERC ordered a hearing regarding the effect of the proposed merger on bulk power competition. The FERC commissioners ordered the judge's initial decision by Aug. 30, 1996, and briefs on exception by Sept. 30, 1996. In March 1996, the PSCW requested that the FERC broaden the scope of the merger application hearing to evaluate whether the proposed merger will impair effective state oversight of retail rates. While the Company expects the FERC's decision on the merger approval filing in the fourth quarter of 1996, the approval process may extend beyond 1996.\nIn February 1996, the Company and WEC agreed to freeze wholesale rates for four years subsequent to the Merger Transaction.\nIntervenors argue that competition will be adversely affected because the Company and WEC will constrain the transmission system at the interconnections between the NSP system and a group of upper Wisconsin and northern Michigan utilities, allowing the Company and WEC to increase the price they charge for energy. In response to the intervenor concerns, the Company and WEC have committed to make whatever changes are required by FERC in its open access proceeding to ensure the appropriate level of access is achieved. The Company and WEC have filed to expand the capacity of the interconnections and further expansion is being pursued. When the interface is constrained, any economic energy sales that the Company and WEC make into the upper Wisconsin and northern Michigan utilities will be at incremental cost. The Company and WEC will waive their AES (native load) and Mid-Continent Area Power Pool (MAPP) line loading relief procedure priorities for internal and economy transactions through the interface. To the extent that a regional transmission operator has not been established by the time of the merger, the Company and WEC are willing to establish an unaffiliated entity as an Independent Tariff Administrator that will schedule transmission use and otherwise ensure that transmission is provided on a nondiscriminatory basis. (See discussion of the negotiations to convert MAPP to a Regional Transmission Group at the \"Electric Utility Operations - Capability and Demand\" section herein.)\nOther Wholesale Rate Proceedings (FERC)\nIn December 1993, the Company, in compliance with a FERC order in the Central Maine case requiring that the FERC approve all interstate, inter-utility contracts, filed over 300 such contracts with the FERC for review. The FERC established 76 separate dockets for review. Absent FERC acceptance, the contracts could have been declared null and void, possibly resulting in full refunds for all amounts paid. The FERC has accepted each of the 76 dockets with little or no change. The Company completed full resolution of the Central Maine compliance filings in 1995.\nELECTRIC UTILITY OPERATIONS\nCompetition\nNSP's electric sales are subject to competition in some areas from municipally owned systems, rural cooperatives and, in certain respects, other private utilities and independent power producers. Electric service also increasingly competes with other forms of energy. The degree of competition may vary from time to time, depending on relative costs and supplies of other forms of energy. Although NSP cannot predict the extent to which its future business may be affected by supply, relative cost or promotion of other electricity or energy suppliers, NSP believes that it will be in a position to compete effectively.\nIn October 1992, the President signed into law the Energy Policy Act of 1992 (Energy Act). The Energy Act amends the Public Utility Holding Company Act of 1935 (1935 Act) and the Federal Power Act. Among many other provisions, the Energy Act is designed to promote competition in the development of wholesale power generation in the electric utility industry. It exempts a new class of independent power producers from regulation under the 1935 Act. The Energy Act also allows the FERC to order wholesale \"wheeling\" by public utilities to provide utility and non-utility generators access to public utility transmission facilities. The provision allows the FERC to set prices for wheeling, which will allow utilities to recover certain costs. The costs would be recovered from the companies receiving the services, rather than the utilities' retail customers. The market-based power agreement filings with the FERC and the Mega-NOPR issued by the FERC (as discussed in \"Utility Regulation and Revenues,\" herein) reflect the trend toward increasing transmission access under the Energy Act. The FERC Mega-NOPR seeks to standardize the terms, conditions and rate development approaches to ensure fundamental principles underlie open access tariffs. NSP shares the FERC view that such tariffs are a necessary step to support functional unbundling of generation and transmission and the evolution of a competitive electric power market place. NSP's tariff filed in 1994 and settled in 1995, preceded the FERC's pro-forma tariff and provided significant input to its development. The final rules the FERC will issue as a result of the Mega-NOPR are expected to be aligned with the pro-forma tariff. The use of pro-forma tariffs in merger filings enables the FERC to separate and exclude open access transmission from other issues in the Primergy merger docket. This treatment was requested in the Primergy merger filing that included the pro-forma tariff. The Energy Act's ultimate impact on NSP cannot be predicted at this time.\nNSP had municipal wholesale revenues from sales of electricity of approximately $44 million in 1995 and approximately $57 million in 1994. The trend of increased competition has resulted in changes in the negotiation of contracts with municipal wholesale customers. In the past several years, these customers have begun to evaluate a variety of energy sources to provide their power supply. While the full impact of competition on this part of NSP's business is unknown at this time, the following changes have occurred.\nIn 1990, 16 of the Company's 19 municipal wholesale customers in Minnesota began reviewing their long-term power supply options. Eight customers created a joint action group, the Minnesota Municipal Power Agency (MMPA), to serve their future power supply needs. An additional wholesale customer became an associate member of the MMPA. In 1992, these nine municipal customers notified the Company of their intent to terminate their power supply agreements with the Company effective July 1995 or July 1996. In July 1995, seven of these nine customers took power supply service from MMPA and are now transmission only customers of the Company. The loss of these seven customers in 1995 resulted in a revenue decrease of approximately $12 million from 1994 levels. The two other wholesale customers will terminate their power supply service with the Company in July 1996 and are expected to become wheeling customers of the Company. These two customers provided revenues of $3.6 million in 1995. These nine customers affiliated with MMPA are expected to provide estimated annual wheeling revenues of nearly $3 million.\nOf the remaining 10 municipal wholesale customers of the Company, nine have full requirements contracts with terms expiring in the years 1999 through 2005, with three- to four- year cancellation notice provisions. The other customer became a member of Central Minnesota Municipal Power Agency (CMMPA) in 1995. CMMPA currently has seven members and the Company has provided the energy requirements to CMMPA since it was formed in 1992. The Company recently won a bid to continue supplying energy to CMMPA for six years beginning in March 1996. In addition, during 1995, the Company signed contracts with three other municipals to provide energy and some capacity for terms ranging from five to 10 years, beginning in the years 1995 through 1998. The annual revenues from these three contracts are estimated to be approximately $1 million.\nThe Wisconsin Company had 10 wholesale customers at Dec. 31, 1995, with revenues of approximately $18 million in 1995. In 1995, the Wisconsin Company offered its wholesale customers discounts from the FERC authorized rate. Seven of the 10 municipal customers elected to renew or extend their contracts to receive these discounts. As part of the settlement agreement between NSP, WEC and the Wisconsin intervenors in the Merger Transaction approval filing, the cities of Medford and Rice Lake have a five year power supply agreement. For the first year the two cities receive discounted full requirements service, for the remaining four years, they receive service at a negotiated, fixed rate. Upon completion of the term, NSP will have no further obligation to service these two customers. The other customer did not elect to sign a new contract, but continues with its existing contract. Due to these changes, 1996 revenues are estimated to decrease from 1995 revenues by approximately $0.6 million.\nIn 1993, the Company signed an electric power agreement with Michigan's Upper Peninsula Power Company with service beginning in 1998. (See Management's Discussion and Analysis under Item 7 for more discussion.)\nIn addition, with the development of the electric industry competition, the Company has experienced an increase in requests for the use of its transmission system. A large portion of these requests can be identified as due to the increase in FERC approved power marketers. In 1995, the Company filed 23 transmission service agreements for FERC approval, including 10 with power marketers. The annual transmission revenue in 1995 from this activity was immaterial. However, in 1996 revenues are expected to increase due to growth of power market activity in this region. Competition from FERC approved power marketers is expected to increase. As of Dec. 31, 1995, power marketers had filed 175 applications with the FERC and 151 of the applications had been approved by the FERC including 24 from utility affiliates (one of which is Cenergy). For the year 1995, power marketers in the United States made transactions of 26 million megawatt hours. The ultimate impact on NSP's sales and purchases of power, and NSP's power marketing revenue (from Cenergy activity) due to power marketing activity is not determinable.\nMany states are currently considering retail competition. Regulators in Minnesota, Wisconsin and North Dakota are currently considering what actions they should take regarding electric industry competition. In 1994, the PSCW asked each utility in the state for comments regarding retail competition. In response to the request, the Wisconsin Company filed the following recommendations: (i) competition should be phased in for retail markets by customer classes, with all customers having choice of supplier by 2001, (ii) the generation segment of the industry should be deregulated by 2001, (iii) prudent stranded costs should be recovered prior to the advent of retail wheeling and (iv) utilities and other competitors should have a level playing field for issues such as obligation to serve, eminent domain, requirements for demand side management, funding of social programs, opening of retail markets to competition and other issues. Also, as an outcome of the responses to the PSCW, a task force was formed by the PSCW to analyze the industry restructuring necessary in the state of Wisconsin. In 1995, the PSCW voted to adopt an electric utility restructuring plan which includes a 32-step phase-in of retail wheeling by the year 2001. A key component of the plan is to provide the protections necessary to ensure that consumers are not harmed in an increasingly competitive environment. One component of the plan is to have an independent system operator to control transmission access.\nIn Minnesota, regulators have developed draft principles for electric industry restructuring to provide a framework from which to proceed. One of the principles supports an open transmission system and the establishment of a robust wholesale competitive market. At this time, Minnesota regulators have not established definitive timelines for industry restructuring or changes. NSP believes the transition to a more competitive electric industry is inevitable and beneficial for all consumers. NSP supports an orderly and efficient transition to an open, fair and competitive energy market for all customers and suppliers. The timing of regulatory actions and their impact on NSP cannot be predicted and may be significant.\nMichigan also has a retail wheeling experiment, which is currently being challenged in court. The experiment is limited to its two largest utilities and customers larger than $50 million. The Wisconsin Company's customers are not included in this experiment.\nThe Company is facing potential competition from a retail customer's proposed cogeneration project. Koch Refining Co. (Koch), the Company's largest customer which provides approximately $30 million in annual revenues to NSP, proposes to build a cogeneration plant that would burn petroleum coke, a refinery byproduct, to produce between 180 and 250 Mw of electricity. This would be enough supply for Koch's own use plus an additional 80 to 150 Mw to be sold on the wholesale market. Koch is requesting a legislative exemption from Minnesota personal property tax for its plant. While NSP supports the reduction of taxes on generating facilities, it believes any reduction should be applied to all generating facilities so that there are no unfair tax advantages available to some generators. This project has several implications for NSP: 1) Koch could become a competitor as it seeks markets for its excess capacity; 2) Koch's capacity would also represent a potential power source for NSP; and 3) Koch's plan represents a potential loss of a large retail customer. The project's anticipated three-year lead time will allow NSP to respond appropriately.\nNSP has proposed to fill future needs for new generation through competitive bid solicitations. The use of competitive bidding to select future generation sources allows the Company to take advantage of the developing competition in this sector of the industry. The Company's proposal, which has been approved by both the MPUC and the PSCW, allows NRG to bid in response to Company solicitations for proposals. The Company is also seeking permission from the MPUC to include its own generation construction department as a bidder in the competitive process.\nRetail competition represents yet another development of a competitive electric industry. Management plans to continue its ongoing efforts to be a low-cost supplier of electricity and an active participant in the more competitive market for electricity expected as a result of the Energy Act. NSP will continue to work with regulators to complete the tariff and infrastructure that will support an electric competitive environment. The proposed merger with WEC is a key strategy in ensuring competitive prices and high-quality services for customers. Additional actions the Company is pursuing to position itself for the competitive environment include: creative partnership solutions with strategic customers including communities; focusing on the unique needs of national account customers; competitive pricing alternatives; improved reliability; implementation of service guarantees; ease of customer access including 24 hour, 7 days\/week operation; substantial customer convenience and flexibility improvements via a new Customer Service System which includes appointment scheduling upon first contact, improved outage call response, and a wide array of new billing options; and centralization of common services and aggressive cost management. In addition, NSP will compete for service outside its traditional service area. This process has begun via NSP's Cenergy subsidiary.\nCapability and Demand\nAssuming normal weather, NSP expects its 1996 summer peak demand to be 7,326 Mw. NSP's 1996 summer capability is estimated to be 8,843 Mw, (net of contract sales) including 1,153 Mw (including reserves) of contracted purchases from the Manitoba Hydro-Electric Board, a Canadian Crown Corporation (Manitoba Hydro) and 899 Mw of other contracted purchases. The estimate assumes 7,731 Mw of thermal generating capability and 1,440 Mw of hydro and wind generating capability. Of the total summer capability, NSP has committed 328 Mw for sales to other utilities. Of the estimated net capability, including the interconnection with Manitoba Hydro, 30 percent has been installed during the last 10 years.\nNSP's 1995 maximum demand of 7,519 Mw occurred on July 13, 1995. Resources available at that time included 7,100 Mw of Company-owned capability and 1,910 Mw of purchased capability net of contracted sales. Due to the MAPP's penalty for reserve margin shortfalls and to be prepared for weather uncertainty at the lowest potential cost, NSP carried a reserve margin for 1995 of 20 percent. The minimum reserve margin requirement as determined by the members of the MAPP, of which NSP is a member, is 15 percent. In March 1996, the members of MAPP approved a proposal to convert MAPP into a Regional Transmission Group (RTG). This proposal will now be submitted to the FERC for approval before April 1, 1996. By converting MAPP to an RTG, members will have more input into transmission access within other member's territories. This is one of the proposals in response to intervenor concerns in the FERC regulatory approval proceeding of the Company's proposed merger with WEC. (See \"Utility Regulation and Revenues - Rate Matters by Jurisdiction\" herein for more information and Note 15 of Notes to Financial Statements under Item 8 for more discussion of power agreement commitments.)\nThe Company is continuing an extensive performance- based transmission and distribution reliability program. This program includes preventative maintenance on transmission and distribution power lines, improvements to existing equipment and implementation of new technology. The program focuses on the leading causes of outages consisting of lightning, trees and underground cable and also concentrates on reducing the number of human-error outages. In 1995, the reliability program resulted in a reduction in the number of outages to the Company's feeders, which had been the most likely to experience an outage, from 600 in 1994 to 425 in 1995. The outage count on the one feeder most likely to experience an outage was reduced from 24 in 1994 to 12 in 1995. Reliability goals for 1996 have already been formulated, and include emphasis on reliability- focused maintenance programs, improved restoration processes, and improved customer communication\/access.\nIn 1994, NSP signed a long term power purchase contract for 245 Mw of annual capacity for 30 years. The purchase will be from a natural gas-fired combined cycle facility that NSP can dispatch as system requirements dictate. NSP expects the facility to be available in May 1997.\nThe Company filed an electric resource plan with the MPUC on July 3, 1995. The plan shows how the Company intends to meet the increased energy needs of its electric customers and includes an approximate schedule of the timing of resources to meet such needs. The plan contains: conservation programs to reduce the Company's peak demand and conserve overall electricity use; economic purchases of power; and programs for maintaining reliability of existing plants. It also includes an approximate schedule of the timing of such resource needs. The plan does not anticipate the need for additional base-load generating plants during the balance of this century and assumes that all existing generating facilities will continue operating through their license period or useful life. The plan also assumes that modifications will be made to the Monticello nuclear generating facility to increase its capacity by 46 Mw by 1997.\nThe following resource needs were included in the resource plan. The plan does not specify the precise technology to meet these needs, but does suggest energy source options.\nCumulative Mw Resource Needs By Type vs. Base of 1995\n1998 2002 2006 2010\nRenewables* 200 (40) 525 (212) 525 (212) 525 (212) Peak 0-71 63-505 415-822 415-1,067 Intermediate 0-148 0-581 579-734 579-889 Base 0 0 247-1,253 927-2,176 Demand Side Management 512 968 1,348 1,657 Total 552-771 1,243-2,266 2,801-4,369 3,790-6,001\n* Includes the Prairie Island legislation mandate of an additional 400 Mw of wind generation and 125 Mw of biomass generation. The amounts shown in parentheses are the estimated MAPP accredited capacity values at the time of system peak demand. The MAPP accreditation procedure for wind is intended to measure wind generation's contribution to system reliability at the time of system peak demand. Because wind generation is a variable resource the accredited capacity is less than the installed capacity.\nThe resource plan proposes to satisfy the above resource needs through a combination of the following options:\nSources of Energy to Meet Needs\n- Continued operation of existing generation facilities. - Demand reduction of an additional 1,400 Mw by 2010 through conservation and load management. - 425 Mw of wind generation in service by 2002. - 125 Mw of biomass generation in service by 2002. - Acquisition of competitively priced resources to meet changing needs, i.e. competitive bidding.\nThe Company intends to seek competitive bids in 1996 for the following resources: 100 Mw of wind generation; 75 Mw of biomass generation; 100 Mw of peaking generation; 200 Mw of intermediate generation and 600 Mw of baseload generation. If the Koch Refining Co. proposed cogeneration project is built, as discussed previously, the Company's resource plan and bidding schedules might be affected.\nIn connection with the approval of used nuclear fuel storage facilities at the Company's Prairie Island generation plant, legislation was enacted in 1994 which established certain resource commitments, as discussed in Note 15 to the Financial Statements under Item 8 and \"Electric Utility Operations - Nuclear Power Plants - Licensing, Operation and Waste Disposal,\" herein. The Company has taken steps to comply with the requirements of these resource commitments. Twenty-five Mw of third party wind generation has been fully operational since May 1, 1994. With respect to the additional 100 Mw of wind energy to be under contract by the end of 1996, the Company has obtained a site designation from the Minnesota Environmental Quality Board (MEQB), and selected Zond Systems, Inc. to supply the wind energy. The Company must now secure wind rights from an unsuccessful bidder, which has indicated it will not voluntarily transfer the wind rights. The Company has commenced litigation to expedite resolution of the wind rights dispute. Siting and design activities are proceeding while wind rights acquisition efforts continue. The Company also used a competitive bid solicitation to acquire 50 Mw of farm-grown closed-loop biomass generation. An independent evaluator reviewed proposals from bidders regarding this 50 Mw of farm- grown closed-loop biomass generation and made a recommendation to the Company in January 1996. On March 7, 1996, the Company submitted a filing with the MPUC rejecting all bids primarily due to price concerns. The Minnesota Legislature is considering several bills which could affect the existing biomass resource commitment. In order to include any legislative changes, the Company is deferring its decision on future biomass generation plans until after the expected close of the current Minnesota legislative session in April 1996. The Company's construction commitments disclosed in \"Capital Spending and Financing\", herein, include the known effects of the 1994 Prairie Island legislation. The impact of the legislation on power purchase commitments is not yet determinable.\nMinnesota utilities are required under a 1993 Minnesota law to use values established by the MPUC, which assign a range of environmental costs with each method of electricity generation that is not part of the price of electricity, when evaluating and selecting generation resource options. These values are known as environmental externalities. NSP, along with several other parties, is currently participating in a proceeding initiated by the MPUC to establish final externality values. An order from this proceeding is not expected until mid-1996. Pending the outcome of this proceeding, utilities are required to use interim externality values which were set by the MPUC in early 1994. The critical issue and uncertainty for NSP is the extent to which the use of these externality values will cause NSP to select higher priced generation resources and increase NSP's cost to provide electricity. The value assigned to the carbon dioxide factor will most likely have the greatest impact on NSP in terms of costs added for new coal or gas-fired plants. The high end of the range of interim externality values add about 1.75 cents per kwh to a typical new coal plant and about .65 cents per kwh to a natural gas-fired plant. The carbon dioxide value comprises about 80 percent to 90 percent of these amounts. NSP will be affected in 1996 when it issues a Request for Proposal for peak, intermediate and base plants. Depending on the values established and how they are applied, externalities could significantly affect resources available to NSP to meet future demands for electricity.\nNSP continues to implement various Demand Side Management (DSM) programs designed to improve load factor and reduce NSP's power production cost and system peak demands, thus reducing or delaying the need for additional investment in new generation and transmission facilities. NSP currently offers a broad range of DSM programs to all customer sectors, including information programs, rebate and financing programs, and rate incentive programs. These programs are designed to respond to customer needs and focus on increasing NSP's value of service that, over the long term, will help its customer base become more stable, energy efficient and competitive. During 1995, NSP's programs reduced system peak demand by approximately 202 Mw. Since 1986, NSP's DSM programs have achieved 1,224 Mw of summer peak demand reduction, which is equivalent to 16 percent of its 1995 summer peak demand. In its 1995 Resource Plan and Conservation Improvement Program (CIP) Filings with the MPUC and the Minnesota Department of Public Service respectively, the Company proposed to reduce its DSM expenditures from approximately 3.5 percent of revenues in 1995 to 2.2 percent of revenues by 1997. The corresponding long-term energy savings goals would be reduced by approximately 50 percent, while the long-term demand savings goals would be reduced by approximately 25 percent. The CIP filing was approved with modification, requiring the Company to spend 2.8 percent and 2.6 percent of its annual revenues on DSM in 1996 and 1997, respectively. A decision on the long-term energy savings goal in the resource plan is anticipated later in 1996.\nIn 1994, the MPUC increased the Company's cost recovery and incentives for DSM by allowing recovery of a portion of the lost margins due to DSM impacts on electric revenues. This lost margin recovery, subject to annual review by the MPUC, was approximately $7 million in 1995 and $3 million in 1994. In addition, the MPUC allowed the Company to earn $5 million in 1995 and $4 million in 1994 for DSM investment returns through an incentive program that rewards the attainment of specified conservation goals.\nEnergy Sources\nFor the year ended Dec. 31, 1995, 45 percent of NSP's Kwh requirements was obtained from coal generation and 30 percent was obtained from nuclear generation. Purchased and interchange energy provided 21 percent, including 15 percent from Manitoba Hydro; NSP's hydro and other fuels provided the remaining 4 percent. The fuel resources for NSP's generation based on Kwh were coal (57 percent), nuclear (38 percent), renewable and other fuels (5 percent).\nThe following is a summary of NSP's electric power output in millions of Kwh for the past three years:\n1995 1994 1993\nThermal plants 33,802 32,710 33,130 Hydro plants 1,049 922 1,001 Purchased and interchange 9,189 9,054 8,541 Total 44,040 42,686 42,672\nMany of NSP's power purchases from other utilities are coordinated through the regional power organization MAPP, pursuant to an agreement dated March 31, 1972, with amendments filed in 1994. NSP is one of 58 members in MAPP consisting of eight investor-owned systems, eight generation and transmission cooperatives, three public power districts, eight municipal systems, the Department of Energy's Western Area Power Administration and 30 Associate Participants. The MAPP agreement provides for the members to coordinate the installation and operation of generating plants and transmission line facilities. The terms and conditions of the MAPP agreement and transactions between MAPP members are subject to the jurisdiction of the FERC. The 1972 MAPP agreement, as amended, was accepted for filing by the FERC on Dec. 15, 1994.\nFuel Supply and Costs\nCoal and nuclear fuel will continue to dominate NSP's regulated utility fuel requirements for generating electricity. It is expected that approximately 97 percent of NSP's fuel requirements, on a Btu basis, will be provided by these two fuels over the next several years, leaving 3 percent of NSP's annual fuel requirements for generation to be provided by other fuels (including natural gas, oil, refuse derived fuel, waste materials, renewable sources and wood). The actual fuel mix for 1995 and the estimated fuel mix for 1996 and 1997 are as follows:\nFuel Use on Btu Basis (Est) (Est) 1995 1996 1997\nCoal 57.9% 59.9% 59.7% Nuclear 39.0% 36.8% 36.6% Other 3.1% 3.3% 3.7%\nThe Company normally maintains between 20 and 50 days of coal inventory depending on the plant site. The Company has long-term contracts providing for the delivery of up to 100 percent of its 1996 coal requirements. Coal delivery may be subject to short-term interruptions or reductions due to transportation problems, weather and availability of equipment.\nThe Company expects that more than 98 percent of the coal it burns in 1996 will have a sulfur content of less than 1 percent. The Company has contracts with three Montana coal suppliers (Westmoreland Resources, Decker Coal Company, and Big Sky Coal Company) and four Wyoming suppliers (Rochelle Coal Company, Antelope Coal Company, Kerr-McGee Coal and Black Thunder Coal Company) for a maximum total of 65 million tons of low-sulfur coal for the next 5 years. These arrangements are sufficient to meet the requirements of existing coal-fired plants. They also permit the Company to purchase additional coal when such purchase would improve fuel economics and operations. The Company has options from suppliers for over 100 million tons of coal with a sulfur content of less than 1 percent that could be available for future generating needs. The plants in the Minneapolis-St. Paul area are about 800 miles from the mines in Montana and 1,000 miles from the mines in Wyoming. Coal delivered by rail provides the Company with an economical source of fuel.\nThe estimated coal requirements of the Company at its major coal-fired generating plants for the periods indicated and the coal supply for such requirements are as follows:\nState Sulfur Dioxide Emission Maximum Amount Contract Approximate Limit Annual Covered by Expiration Sulfur Pounds Per Plant Demand Contract Date Content(%)(2) MBTU* Input (Tons) (Tons)\nBlack Dog 1,200,000 1,200,000 (1) 0.5 1.3(3) High Bridge 800,000 800,000 (1) 0.5 3.0 Allen S. King 2,000,000 2,000,000 (1) 0.9 1.6 Riverside 1,300,000 1,300,000 (1) 0.7 2.5(4) Sherco 8,000,000 8,000,000 (1) 0.5 0.9(5) 13,300,000 13,300,000(6)\n*MBTU = Million British Thermal Units\nNotes:\n(1) Contract expiration dates vary between 1996 and 2005 for western coal, which can provide up to 100 percent of the required fuel supply for the designated generating unit. Spot market purchases of other western coal, and other fuels will provide the remaining fuel requirements when such purchases would improve fuel economics. The Company is also burning petroleum coke as a source of fuel.\n(2) This percentage represents the average blended sulfur content of the combination of fuels typically burned at each plant.\n(3) The Black Dog Fluidized Bed (Unit 2) SO2 limit is 1.2 lb\/MBTU.\n(4) The SO2 limitation at Riverside Unit 8 is 2.5 lb\/MBTU. The limitation for units 6 and 7 is currently 0.9 lb SO2\/MBTU.\n(5) The SO2 limitation at Units 1 and 2 is 70 percent removal of SO2 input and a maximum emission rate of 0.96 lb SO2\/MBTU averaged over 90 days. The SO2 limitation at Unit 3 is 70 percent removal of SO2 input and a maximum emission rate of 0.60 lb SO2\/MBTU averaged over 30 days. The use of lime and\/or limestone in the plant's scrubbers may be necessary to achieve these limits.\n(6) Annual requirements are expected to range from 11.0 to 13.3 million.\nThe Company's current fuel oil inventory is adequate to meet anticipated 1996 requirements. Additional oil may be provided through spot purchases from two local refineries and other domestic sources.\nTo operate the Company's nuclear generating plants, the Company secures contracts for uranium concentrates, uranium conversion, uranium enrichment and fuel fabrication. The contract strategy involves a portfolio of spot, medium and long- term contracts for uranium, conversion and enrichment. Current contracts are flexible and cover between 70 percent and 100 percent of uranium, conversion and enrichment requirements through the year 1997. These contracts expire at varying times between 1997 and 2005. The overlapping nature of contract commitments will allow the Company to maintain 70 percent to 100 percent coverage beyond 1997, if appropriate. The Company expects sufficient uranium, conversion and enrichment to be available for the total fuel requirements of its nuclear generating plants. Fuel fabrication is 100 percent committed through the year 2003. The Company expects the unit cost of fuel to produce electricity with these nuclear facilities will be lower than the comparable cost of fuel to produce electricity with any other currently available fuel sources for the sustained operation of a generation facility. The cost of nuclear fuel, including disposal, is recovered in the customer price of the electricity sold by the Company.\nThe Company's average electric fuel costs for the past three years are shown below:\nFuel Costs * Per Million Btu Year Ended December 31 1993 1994 1995\nCoal** $ 1.12 $ 1.13 $1.11 Nuclear*** .41 .47 .48 Composite All Fuels .87 .89 .87\n* Fuel adjustment clauses in its electric rate schedules or statutory provisions enable NSP to adjust for fuel cost changes. (See \"Utility Regulation and Revenues - Fuel and Purchased Gas Adjustment Clauses\" under Item 1.)\n** Includes refuse-derived fuel and wood.\n*** See Note 1 to the Financial Statements under Item 8 for an explanation of the Company's nuclear fuel amortization policies.\nNuclear Power Plants - Licensing, Operation and Waste Disposal\nThe Company operates two nuclear generating plants: the single unit, 539 Mw Monticello Nuclear Generating Plant and the Prairie Island Nuclear Generating Plant with two units totaling 1,025 Mw. The Monticello Plant received its 40-year operating license from the Nuclear Regulatory Commission (NRC) on Sept. 8, 1970, and commenced operation on June 30, 1971. Prairie Island Units 1 and 2 received their 40-year operating licenses on Aug. 9, 1973, and Oct. 29, 1974, respectively, and commenced operation on Dec. 16, 1973, and Dec. 21, 1974, respectively.\nIn its most recent ratings of Company nuclear facilities, the NRC rated the overall performance of both the Prairie Island and Monticello Plants as excellent. On a scale of 1 to 3 (1 being the highest), the plants both rate at 1.25, which is the average of ratings in the areas of plant operations, maintenance, engineering, and plant support. These ratings of the NRC's Systematic Assessment of Licensee Performance (SALP) place the plants in the top quarter of the 18 plants located in the Midwest.\nThe Prairie Island and Monticello nuclear plants currently hold the Institute of Nuclear Power Operations' (INPO) top rating for plant operations and training. The Company is one of only three utilities in the nation to achieve INPO's top rating simultaneously at all of its nuclear plants.\nThe Company previously operated the Pathfinder Plant near Sioux Falls, SD as a nuclear plant from 1964 until 1967, after which it was converted to an oil and gas-fired peaking plant. The nuclear portions were placed in a safe storage condition in 1971, and the Company began decommissioning in 1990. Most of the plant's nuclear material, which was contained in the reactor building and fuel handling building, was removed during 1991. Decommissioning activities cost approximately $13 million and have been expensed. A few millicuries of residual contamination remain in the operating plant.\nOperating nuclear power plants produce gaseous, liquid and solid radioactive wastes. The discharge and handling of such wastes are controlled by federal regulation. For commercial nuclear power plants, high-level radioactive waste includes used nuclear fuel. Low-level radioactive wastes are produced from other activities at a nuclear plant. They consist principally of demineralizer resins, paper, protective clothing, rags, tools and equipment that have become contaminated through use in the plant.\nA 1980 federal law places responsibility on each state for disposal of its low-level radioactive waste. The law encourages states to form regional agreements or compacts to dispose of regionally generated waste. Minnesota is a member of the Midwest Interstate Low-Level Radioactive Waste Compact Commission. Following the expulsion of Michigan from the Midwest Compact in 1991 for failing to make progress, Ohio was designated the host state. The Ohio legislature in 1995 passed amendments to the Midwest Compact agreement and established procedures for the siting of a compact facility. Other member states must pass the compact amendments. Wisconsin passed the amendments at the end of 1995. Minnesota will seek passage in the 1996 legislative session. Following acceptance of the compact amendments within each member state, Congress is expected to ratify the compact amendments by 1999. Ohio is progressing with development of the low-level radioactive waste disposal facility and expects to complete construction in 2005. The development costs will be paid by the generators of low- level radioactive waste within the compact. Currently, the Barnwell facility, located in South Carolina, has been given authorization by South Carolina to accept low-level radioactive waste and the Midwest Compact has authorized its generators to use the Barnwell facility from July 1, 1995, through June 30, 1996. The use of the Barnwell facility is expected to be reauthorized on an annual basis through 2005.\nThe federal government has the responsibility to dispose of or permanently store domestic used nuclear fuel and other high-level radioactive wastes. The Nuclear Waste Policy Act of 1982 requires the Department of Energy (DOE) to implement a program for nuclear waste management including the siting, licensing, construction and operation of repositories for domestically produced used nuclear fuel from civilian nuclear power reactors and other high-level radioactive wastes. The Company has contracted with the DOE for the future disposal of used nuclear fuel. The DOE is currently charging a quarterly disposal fee based on nuclear electric generation sold. This fee ranges from approximately $10 million to $12 million per year, which NSP recovers from its customers in cost-of-energy rate adjustments. In 1985, NSP paid the DOE a one-time fee of $95 million for fuel used prior to April 7, 1983. None of the Company's used nuclear fuel has been accepted by the DOE for disposal due to the unavailability of a planned federal fuel storage facility. The Company, along with a group of other utilities, has commenced litigation against the DOE to ensure that the federal facility will be available as contracted. (See Item 3 - Legal Proceedings.) In addition, because of the DOE's inadequate progress to provide a permanent repository and its recent disavowal of its obligation, the Minnesota Department of Public Service is investigating whether continued payments to fund the DOE's permanent disposal is prudent use of ratepayer dollars. The outcome of this investigation is unknown at this time.\nThe DOE has stated in statute and by contract that a permanent storage or disposal facility would be ready to accept used nuclear fuel by 1998. However, indications from the DOE are that a permanent federal facility will not be ready to accept used nuclear fuel from utilities until approximately 2010. NSP, with regulatory and legislative approval, has been providing its own temporary on-site storage facilities at its Monticello and Prairie Island nuclear plants. In 1979, the Company began expanding the used nuclear fuel storage facilities at its Monticello Plant by replacement of the racks in the storage pool. Also, in 1987, the Company completed the shipment of 1,058 spent fuel assemblies from the Monticello Plant to a General Electric storage facility in Morris, Illinois. As a result, the Monticello plant does not expect to run out of storage capacity prior to the end of its current operating license in 2010. The on-site storage pool for used nuclear fuel at the Company's Prairie Island Nuclear Generating Plant (Prairie Island) was filled during refueling in June 1994, so adequate space for a subsequent refueling was no longer available. In anticipation of this, the Company, in 1989, proposed construction of a temporary on-site dry cask storage facility for used nuclear fuel at Prairie Island. The Minnesota Legislature (Legislature) considered the dry cask storage issue during its 1994 legislative session as required by a Minnesota Court of Appeals ruling in June 1993.\nIn May 1994, the Governor of the State of Minnesota (Governor) signed into law a bill passed by the Legislature. The law authorizes the Company to install 17 dry casks at Prairie Island, each capable of holding 40 spent fuel assemblies (approximately one-half year's used fuel) which should provide storage capacity to allow operation until at least 2003 and 2004 for units 1 and 2 respectively, if the Company satisfies certain requirements. The Company executed an agreement with the Governor concerning the renewable energy and alternative siting commitments contained in the new law. The law authorized immediately the installation of the first increment of five casks, three of which have been loaded on site as of Dec. 31, 1995. The second increment of four casks would be authorized in 1996 if the Minnesota Environmental Quality Board (MEQB) finds that by Dec. 31, 1996: (i) the Company has applied to the NRC for an alternative site license for an off-site temporary nuclear fuel storage facility in Goodhue County (but not on the Prairie Island Nuclear generating site), (ii) the Company has used good faith in locating and building the alternative site, and (iii) 100 Mw of wind generation is operational, under construction or under contract. The final increment of eight casks would be available unless prior to June 1, 1999, the Legislature specifically revokes the authorization for the final eight casks or if an alternative storage site is not operational or under construction, or the Company fails to meet certain renewable energy commitments, including the increased use of wind power and biomass generation facilities by Dec. 31, 1998.\nThe Company continues to make substantial progress toward fulfilling the commitments necessary to secure the use of casks six through nine. On Aug. 17, 1995, the MEQB accepted the Company's application for a site certificate outlining two alternative sites for the alternate spent nuclear fuel storage facility in Goodhue County. The MEQB has begun the 12 to 18 month public siting process to examine these sites and any others that may be proposed. The Company expects to file its application with the NRC by October 1996. In 1995, the Company took steps for its wind and biomass resource commitments as discussed under the caption \"Electric Utility Operations- Capability and Demand\", herein. Other commitments resulting from the legislation include a low-income discount for electric customers, additional required conservation improvement expenditures and various study and reporting requirements to a legislative electric energy task force. In January 1995, the MPUC approved the Company's low-income discount programs in accordance with the statute. The Company has implemented programs to begin meeting the other legislative commitments. (See \"Electric Utility Operations - Capability and Demand\", herein and Notes 14 and 15 of Notes to Financial Statements under Item 8 for further discussion of this matter.)\nTo address the issue of continued temporary storage of used nuclear fuel until the DOE provides for permanent storage or disposal, the Company is leading a consortium working with the Mescalero Apache Tribe to establish a private facility for interim storage of used nuclear fuel on the Tribe's reservation in New Mexico. A core group of more than 20 United States nuclear utilities has agreed to support the construction and operation of the interim storage site. Work on the project is underway in several areas, including environmental assessment, facility design, and drafting of the detailed contracts that will govern the construction and operation of the site. An architect engineering firm and an environmental contractor have been retained to perform the environmental and licensing activities. The consortium is currently scheduled to submit a license application for the facility to the Nuclear Regulatory Commission (NRC) in December 1996. The spent fuel storage facility is expected to be operational and able to accept the first shipment of used nuclear fuel by mid-2002. However, due to pending regulatory and governmental approval uncertainty, it is possible that this interim storage may be delayed or not available at all.\nIn January 1995, the Company received a notice of violation from the United States Nuclear Regulatory Commission (NRC). The notice was regarding an inspection of the quality assurance programs for the spent nuclear fuel storage containers to be used at the Prairie Island Nuclear Generating Plant. On Feb. 1, 1995, the NRC supplemented the notice, stating, \"...the staff has no reason to conclude that the casks could not perform their intended safety functions adequately.\" On March 21, 1995, the NRC reviewed NSP's responses and concluded that the Company's corrective actions associated with the violation were acceptable, and that no further actions with respect to the violations identified in the January 1995 Inspection Report are required prior to cask use.\nOn Dec. 28, 1995, the Company received another notice of violation from the NRC. This notice was regarding an improperly positioned valve at the Monticello Nuclear Generating Plant which violated NRC requirements. The valve had been mispositioned since returning to power from the last refueling outage on Oct. 23, 1994. This violation was categorized as a Severity Level III problem. A base civil penalty in the amount of $50,000 is considered for a Severity Level III problem. However, due to Monticello's good past performance and the initiation of immediate corrective actions upon determination of the mispositioned valve, the NRC decided to waive the civil penalty. The Company is continuing follow-up with the NRC to implement any further corrective actions necessary.\nA revision to NSP's 1993 nuclear decommissioning study and nuclear plant depreciation capital recovery request was filed with the MPUC and approved in 1994 for the Company's nuclear power plants. Although management expects to operate the Prairie Island plant units through the end of their useful lives, the approved capital recovery would allow for the plant to be fully depreciated, including the accrual and recovery of decommissioning costs by 2008, about six years earlier than the end of its licensed life. The approved cost recovery period has been reduced because of the uncertainty regarding used fuel storage.\nDuring the past several years, the NRC has issued a number of regulations, bulletins and orders that require analyses, modification and additional equipment at commercial nuclear power plants. The Company has spent approximately $530 million since 1971, and approximately $1 million, $6 million and $11 million for 1995, 1994 and 1993, respectively, under such requirements. The Company expects to expend a minimal amount for currently required NRC analyses, modification and additional equipment. The NRC is engaged in various ongoing studies and rulemaking activities that may impose additional requirements upon commercial nuclear power plants. Management is unable to predict any new requirements or their impact on the Company's facilities and operations.\nSee Note 14 to the Financial Statements under Item 8 for further discussion of nuclear fuel disposal issues and information on decommissioning of the Company's nuclear facilities. Also, see Note 15 to the Financial Statements under Item 8 for a discussion of the Company's nuclear insurance and potential liabilities under the Price-Anderson liability provisions of the Atomic Energy Act of 1954.\nElectric Operating Statistics\nThe following table summarizes the revenues, sales and customers from NSP's electric transmission and distribution business:\nGAS UTILITY OPERATIONS\nCompetition\nNSP provides retail gas service in portions of eastern North Dakota and northwestern Minnesota, the eastern portions of the Twin Cities metro area, and other regional centers in Minnesota (Mankato, St. Cloud and Winona) and Wisconsin (Eau Claire, La Crosse and Ashland). NSP is directly connected to four interstate natural gas pipelines serving these regions: Northern Natural Gas Company (Northern), Viking, Williston Basin Interstate Pipeline Company (Williston) and Great Lakes Transmission Limited Partnership (Great Lakes). Approximately 90 percent of NSP's retail gas customers are served from the Northern pipeline system.\nDuring 1992 and 1993, the FERC issued a series of orders (together called Order 636) that addressed interstate natural gas pipeline restructuring. This restructuring required all interstate pipelines, including those serving NSP, to \"unbundle\" each of the services they provide: sales, transportation, storage and ancillary services. To comply with Order 636, NSP executed new pipeline transportation service and gas supply agreements effective Nov. 1, 1993, as discussed below. While these new agreements create a new form of contractual obligation, NSP believes the new agreements provide flexibility to respond to future changes in the retail natural gas market. NSP expects its financial risk under the new transportation agreements to be no greater than the risk faced under the previous long-term full requirements gas supply contracts with interstate pipelines.\nThe implementation of Order 636 applies additional competitive pressure on all local distribution companies (LDCs) including NSP, to keep gas supply and transmission prices for their large customers competitive because of the alternatives now available to these customers. Like gas LDCs, these customers now have expanded ability to buy gas directly from suppliers and arrange pipeline and LDC transportation service. NSP has provided unbundled transportation service since 1987. Transportation service does not currently have an adverse effect on earnings because NSP's sales and transportation rates have been designed to make NSP economically indifferent to sales or transportation of gas. However, some transportation customers may have greater opportunities or incentives to physically bypass the LDC distribution system. NSP has arranged its gas supply and transportation portfolio in anticipation that it may be required to terminate its retail merchant sales function. Overall, NSP believes Order 636 has enhanced its ability to remain competitive and allowed it to increase certain of its margins by providing an increased selection of services to its customers.\nOrder 636 allows interstate pipelines to negotiate with customers to recover up to 100 percent of prudently incurred \"transition costs\" (i.e., stranded costs) attributable to Order 636 restructuring. Recoverable transition costs can include \"buy down\" and \"buy out\" costs for remaining gas supply and upstream pipeline transportation agreements, unrecovered deferred gas purchase costs, and the cost to dispose of regulated assets no longer needed because of the termination of the merchant function (e.g., financial losses on the sale of regulated gathering or storage facilities).\nNSP's primary gas supplier, Northern, is in the process of determining the final amount of transition costs to be passed on to customers as a result of Order 636 restructuring. Northern's restructuring settlement provided for the assignment of a significant portion of Northern's gas supply and upstream contract obligations. This solution was beneficial because Northern's customers contracted directly for obligations, rather than paying to buy out of those obligations and then contracting with the same gas suppliers and pipelines to replace the merchant function. The total transition costs recoverable for the remaining unassigned agreements is limited to $78 million. In addition, Northern may seek transition cost recovery for certain other costs, subject to prudency review. Northern's total Order 636 transition costs, to be passed on to all of its customers, are estimated to be approximately $100 million. Northern will recover the prudent transition costs by amortizing the amount over a period of several years, and including the amortized costs as a component of its transportation charges. NSP estimates that it will be responsible for less than $11 million of Northern's transition costs, spread over a period of approximately five years, which began Nov. 1, 1993. To date, NSP's regulatory commissions have approved recovery of restructuring charges in retail gas rates. NSP has no significant Order 636 transition cost responsibilities to its other pipeline suppliers.\nThe gas services available to NSP's customers were enhanced beginning in 1993 through the acquisitions of Viking in June 1993 and the assets of a gas marketing business by a new NSP subsidiary, Cenergy, Inc., in October 1993. See the Non- Regulated Subsidiaries section herein for further discussion of Cenergy. See further discussion of Viking below.\nNSP's gas utility took advantage of opportunities to expand into new service territory during 1995. NSP extended service to approximately 1,600 customers in 8 new communities. In addition to exploring new growth opportunities, NSP is also focusing on conversion of potential customers who are located near NSP's gas mains but are not hooked up to receive the service. NSP estimates there are approximately 28,000 potential customers that fall into this category.\nThe most recent large gas expansion project occurred in Crow Wing and Cass counties in north central Minnesota. Outside the St Paul-Minneapolis area, these counties are experiencing the fastest growth of all counties in Minnesota. The project included laying approximately 550 miles of pipeline in 11 of the cities in the Brainerd Lakes area. The project's net capitalized investment cost was approximately $23 million. Construction began in 1994. The MPUC approved a \"new town\" rate surcharge for customers in this area to support NSP's capital investment in the project. The surcharge will be in effect for up to 15 years.\nThe Company's gas operation has organized a non- utility service offering individuals service contracts on a variety of home appliances. Working in partnership with local independent service contractors, NSP Advantage Service offers 24 hour appliance repair service. Depending on the level of service contracted, Advantage Service customers have coverage to help avoid the expense and inconvenience of unexpected appliance repairs. This service is being offered to individuals within NSP's service territory.\nCapability and Demand\nNSP categorizes its gas supply requirements as firm (primarily for space heating customers) or interruptible (commercial\/industrial customers with an alternate energy supply). NSP's maximum daily sendout (firm and interruptible) of 659,800 MMBtu for 1995 occurred on Jan. 3, 1995.\nNSP's primary gas supply sources are purchases of third-party gas which are delivered under gas transportation service agreements with interstate pipelines. These agreements provide for firm deliverable pipeline capacity of approximately 557,810 MMBtu\/day. In addition, NSP has contracted with four providers of underground natural gas storage services to meet the heating season and peak day requirements of NSP gas customers. Using storage reduces the need for firm pipeline capacity. These storage agreements provide NSP storage for approximately 19 percent of annual and 31 percent of peak daily firm requirements. NSP also owns and operates two liquified natural gas (LNG) plants with a storage capacity of 2.53 Bcf equivalent and four propane-air plants with a storage capacity of 1.42 Bcf equivalent to help meet the peak requirements of its firm residential, commercial and industrial customers. These peak shaving facilities have production capacity equivalent to 242,300 Mcf of natural gas per day, or approximately 34 percent of peak day firm requirements. NSP's LNG and propane-air plants provide a cost-effective alternative to annual fixed pipeline transportation charges to meet the \"needle peaks\" caused by firm space heating demand on extremely cold winter days and can be used to minimize daily imbalance fees on interstate pipelines.\nThe cost of gas supply, transportation service and storage service is recovered through the PGA rate adjustment mechanism. The average cost of gas and propane held in inventory for the latest test year is allowed in rate base by the MPUC and the PSCW.\nA number of NSP's interruptible industrial customers purchase their natural gas requirements directly from producers or brokers for transportation and delivery through NSP's distribution system. The transportation rates have been designed to make NSP economically indifferent as to whether NSP sells and transports gas or only transports gas.\nGas Supply and Costs\nAs a result of Order 636 restructuring, NSP's natural gas supply commitments have been unbundled from its gas transportation and storage commitments. NSP's gas utility actively seeks gas supply, transportation and storage alternatives to yield a diversified portfolio that provides increased flexibility, decreased interruption and financial risk, and economical rates. This diversification involves numerous domestic and Canadian supply sources, varied contract lengths, and transportation contracts with seven natural gas pipelines.\nAmong other things, Order 636 provides for the use of the \"straight fixed\/variable\" rate design that allows pipelines to recover all their fixed costs through demand charges. NSP has firm gas transportation contracts with the following seven pipelines. The contracts expire in various years from 1996 through 2013.\nNorthern Natural Gas Company Great Lakes Transmission Limited Partnership Williston Basin Interstate Pipeline Co. Northern Border Pipeline Company Viking Gas Transmission Company ANR Pipeline Company TransCanada Gas Pipeline Ltd.\nThe agreements with Great Lakes, Northern Border, ANR and TransCanada provide for firm transportation service upstream of Northern Natural and Viking, allowing competition among suppliers at supply pooling points, minimizing commodity gas costs.\nIn addition to these fixed transportation charge obligations, NSP has entered into firm gas supply agreements that provide for the payment of monthly or annual reservation charges irrespective of the volume of gas purchased. The total annual obligation is approximately $34.4 million. These agreements are beneficial because they allow NSP to purchase the gas commodity at a high load factor at rates below the prevailing market price reducing the total cost per Mcf.\nNSP has certain gas supply and transportation agreements, which include obligations for the purchase and\/or delivery of specified volumes of gas, or to make payments in lieu thereof. At Dec. 31, 1995, NSP was committed to approximately $511.8 million in such obligations under these contracts, over the remaining contract terms, which range from the years 1996-2013. These obligations include some of the effects of contract revisions made to comply with Order 636. NSP has negotiated \"market out\" clauses in its new supply agreements, which reduce NSP's purchase obligations if NSP no longer provides merchant gas service.\nNSP purchases firm gas supply from a total of approximately 20 domestic and Canadian suppliers under contracts with durations of one year to 10 years. NSP purchases no more than 20 percent of its total daily supply from any single supplier. This diversity of suppliers and contract lengths allows NSP to maintain competition from suppliers and minimize supply costs. NSP's objective is to be able to terminate its retail merchant sales function, if either demanded by the marketplace or mandated by regulatory agencies, with no financial cost to NSP.\nThe state utility commissions in Minnesota, North Dakota, Wisconsin and Michigan allowed NSP to fully recover the costs of these restructured services through purchased gas adjustments to customer rates.\nIn July 1995, the FERC issued an order on remand in the 1991 and 1992 general rate cases filed by Great Lakes Gas Transmission Limited Partnership, one of NSP's transportation suppliers. The primary issue in the cases involved whether Great Lakes must use \"incremental\" or \"rolled in\" pricing for approximately $900 million of pipeline capacity expansion costs. The FERC had initially ruled that Great Lakes' rates should be designed to collect the incremental cost of the new facilities only from the new customers of the expansion project. On remand from the United States Circuit Court of Appeals, FERC reversed its previous order and ruled Great Lakes could include the expansion costs in rates for all transportation customers. The reversal increases NSP's costs for transportation service by approximately $1.1 million annually; the Company and the Wisconsin Company are recovering this increase through the PGA clause. However, the FERC also ruled Great Lakes could collect the higher rates from non-expansion customers retroactive to Nov. 1, 1991. This surcharge for NSP is expected to be approximately $2.8 million. NSP will seek PGA recovery of the surcharges if they are billed. In addition, NSP and numerous other parties have requested rehearing of the July 1995 remand order. A final FERC decision is pending.\nOn March 1, 1995, Northern Natural Gas filed for FERC approval to implement a general increase in its rates for transportation and other services. Northern implemented the increased rates on Jan. 1, 1996, subject to refund. The rate change is expected to increase the Company's costs by approximately $5.9 million annually. The Company and the Wisconsin Company are recovering this increase through the PGA clause. The FERC hearings are scheduled for August 1996.\nPurchases of gas supply or services by the Company from the Wisconsin Company, its Viking pipeline affiliate and its Cenergy gas marketing affiliate are subject to approval by the MPUC. The MPUC has approved all the Company's transportation contracts with Viking and a spot gas purchase agreement with Cenergy. In September 1995, the MPUC approved a settlement authorizing a gas supply management agreement between the Company's gas utility and generating business units. In January 1996, the MPUC approved a three-month capacity release agreement between the Company and the Wisconsin Company, which allowed gas and pipeline capacity sales between the two companies in 1996.\nThe following table summarizes the average cost per MMBtu of gas purchased for resale by NSP's regulated retail gas distribution business, which excludes Viking and Cenergy:\nThe Company Wisconsin Company\n1992 $2.71 $2.80 1993 $3.11 $3.02 1994 $2.59 $3.13 1995 $2.29 $2.78\nViking Gas Transmission Company\nIn June 1993, the Company acquired 100 percent of the stock of Viking Gas Transmission Company (Viking) from Tenneco Gas, a unit of Tenneco Inc., in Houston, Texas. Viking, which is now a wholly owned subsidiary of the Company, owns and operates a 500-mile interstate natural gas pipeline serving portions of Minnesota, Wisconsin and North Dakota with a capacity of approximately 400 million cubic feet per day. The Viking pipeline currently serves 10 percent of NSP's gas distribution system needs. Viking currently operates exclusively as a transporter of natural gas for third-party shippers under authority granted by the FERC. Rates for Viking's transportation services are regulated by FERC. In addition to revenue derived from FERC-approved rates, which are reported in Operating Revenues, Viking is receiving intercompany revenues from the Company and the Wisconsin Company for jurisdictional allocations of the acquisition adjustment paid by NSP (in excess of Tenneco's pipeline carrying value) to acquire Viking. The Company is not recovering this cost in retail gas rates in Minnesota, but is recovering this cost in North Dakota. The Wisconsin Company is recovering this cost in its retail gas rates.\nIn October 1995, Viking filed an application with the FERC for authorization to install 13.5 miles of pipeline looping in northwestern Minnesota to increase Viking's capacity by approximately 19,400 million cubic feet per day. The total expected cost is approximately $8.4 million, with a proposed in- service date of November 1996. This would be Viking's first mainline capacity expansion since the 1960s. This capacity is for four expansion customers: two municipal gas utilities already served by Viking, Perham and Randall, Minn.; and two large industrial customers, American Crystal Sugar and ProGold, LLC. Viking may have further expansion opportunities in 1997. The FERC authorization of the application is pending. A decision is expected in April 1996.\nIn 1995, the Viking pipeline experienced a leak which may be attributable to stress corrosion cracking (SCC). Permanent repairs were made to correct the problem without impacting service to customers. Viking is reviewing current industry practices and is developing plans to minimize the possibility of future SCC problems. This was the first occurrence since the line went in service in the early 1960s.\nGas Operating Statistics\nThe following table summarizes the revenue, sales and customers from NSP's regulated gas businesses:\nNON-REGULATED SUBSIDIARIES NRG Energy, Inc.\nNRG Energy, Inc. (NRG) is the Company's subsidiary that develops, builds, acquires, owns and operates several non- regulated energy-related businesses. It was incorporated in Delaware on May 29, 1992, and assumed ownership of the assets of NRG Group, Inc., including its subsidiary companies. NRG businesses generated 1995 operating revenues of $64 million and had assets of $452 million at Dec. 31, 1995.\nNRG conducts business through various subsidiaries, including: NRG International, Inc.; Graystone Corporation; Scoria Incorporated; San Joaquin Valley Energy I, Inc.; San Joaquin Valley Energy IV, Inc.; NRG Energy Jackson Valley I, Inc.; NRG Energy Jackson Valley II, Inc.; NEO Corporation; NRG Energy Center, Inc; NRG Sunnyside Inc. and NRG Operating Services, Inc.\nOperating Businesses\nIn December 1993, NRG, through a wholly owned foreign subsidiary, agreed to acquire a 33 percent interest in the coal mining, power generation and associated operations of Mitteldeutsche Braunkohlengesellschaft mbh (MIBRAG), located south of Leipzig, Germany. MIBRAG is a German corporation formed by the German government to hold two open-cast brown coal (lignite) mining operations, a lease on an additional mine, the associated mining rights and rights to future mining reserves, two small industrial power plants and a circulating fluidized bed power plant, a district heating system and coal briquetting and dust production facilities. Under the acquisition agreement, Morrison Knudsen Corporation and PowerGen plc also each acquired a 33 percent interest in MIBRAG, while the German government retained a one-percent interest in MIBRAG. The investor partners began operating MIBRAG effective Jan. 1, 1994, and the legal closing occurred Aug. 11, 1994.\nIn December 1993, NRG, through a wholly owned foreign subsidiary, acquired a 50 percent interest in a German corporation, Saale Energie GmbH (Saale). Saale owns a 400 Mw share of a 960 Mw power plant currently under construction in Schkopau, Germany, which is near Leipzig. PowerGen plc of the United Kingdom acquired the remaining 50 percent interest in Saale. Saale was formed to acquire a 41.1 percent interest in the power plant. VEBA Kraftwerke Ruhr AG of Gelsenkirchen, Germany (VKR), is the builder of the Schkopau plant. VKR owns the remaining 58.9 percent interest in the power plant and will operate the plant. The plant will be fired by brown coal (lignite) mined by MIBRAG under a long-term contract. Saale has a long-term power sales agreement for its 400 Mw share of the Schkopau facility with VEAG of Berlin, Germany, the company that controls the high-voltage transmission of electricity in the former East Germany. The first 425 Mw unit of the plant began test operations in January 1996 and the second 425 Mw unit is expected to commence commercial operation in July 1996. The 110 Mw turbine began commercial operations in February 1996. Through Dec. 31, 1995, NRG had invested approximately $31 million to acquire its interest in Saale including capitalized development costs. NRG's future equity commitment to Saale through 1996 is expected to be no more than $25 million.\nIn March 1994, NRG, through wholly owned foreign subsidiaries, acquired a 37.5 percent interest in the Gladstone Power Station, a 1680 Mw coal-fired plant in Gladstone, Queensland, Australia from the Queensland Electricity Commission. Other members of the unincorporated joint venture, including Comalco Limited of Australia (Comalco), acquired the remaining interest. A large portion of the electricity generated by the station is sold to Comalco for use in its aluminum smelter, pursuant to long-term power purchase agreements. NRG, through an Australian subsidiary, operates the Gladstone plant.\nIn 1994, NRG signed a Joint Development Agreement with Advanced Combustion Technologies, Inc. (ACT) with respect to the acquisition, upgrading, expansion and development of Energy Center Kladno (\"Kladno\") in Kladno, Czech Republic. NRG and ACT jointly have acquired a 36.5 percent interest in Kladno, which owns and operates an existing coal-fired power and thermal energy generation facility that can supply 28 Mw of electrical energy to an industrial complex and to the local electric distribution company and 150 megawatts thermal-equivalent steam and heated water to a district heating system and thermal energy to an industrial complex. Kladno also owns certain ancillary utility assets. The acquisition of the existing facility is the first phase of a development project that would include upgrading the existing plant and would explore developing a new power generation facility with up to 240 Mw of coal-fired generation and up to 100 Mw of gas-fired generation depending on the ongoing analysis of the alternatives. The new facility would supply back-up steam to the district heating system and sell electricity to STE, the principal regional electric distribution company in Prague, via an existing 23 kilometer transmission line owned by Kladno.\nNRG operates two refuse-derived fuel (RDF) processing plants and an ash disposal site in Minnesota. The ownership of one plant was transferred by the Company to NRG at the end of 1993. NRG manages the operation of the other RDF plant, of which the Company owns 85 percent, and of the ash disposal site. The Company and NRG are currently negotiating a new operation and maintenance agreement for approval by the MPUC. In 1995, workers at the RDF plants processed more than 750,000 tons of municipal solid waste into approximately 660,000 tons of RDF that was burned at two NSP power plants and at a power plant owned by United Power Association.\nNRG also owns and operates three steam lines in Minnesota that provide steam from the Company's power plants to the Waldorf Corporation, the Andersen Corporation and the Minnesota Correctional Facility in Stillwater.\nDuring 1993, the Company formed NEO Corporation (NEO), a wholly owned subsidiary, to develop small power generation facilities in the United States. During 1994, the ownership of NEO was transferred by the Company to NRG. NEO owns a 50 percent interest in Minnesota Methane LLC. Minnesota Methane LLC is developing small scale waste to energy facilities utilizing landfill gas. In December 1994, NEO acquired a 50 percent ownership in STS HydroPower Limited, an independent power producer with 21 Mw of hydroelectric facilities throughout the United States. STS HydroPower Limited currently is successfully operating 11 hydroelectric facilities across the United States and four generating plants that use renewable landfill gas as fuel. Minnesota Methane LLC is pursuing 10 additional landfill gas projects.\nNRG, through wholly owned subsidiaries, owns 45 percent of the San Joaquin Valley Energy Partnerships (SJVEP), which own four power plants located near Fresno, California with a total capacity of 55 megawatts. Through February 1995, the plants operated under long-term Standard Offer 4 (SO4) power sales contracts with Pacific Gas and Electric (PG&E) which expire in 2017. On February 28, 1995, PG&E reached basic agreements with SJVEP to acquire the SO4 contracts. The negotiated agreements will result in cost savings for PG&E customers as well as economic benefits for SJVEP. Under the terms of the agreements, PG&E has been released from its contractual obligation to purchase power generated by SJVEP. Proceeds received from PG&E under the agreements were used to repay SJVEP debt obligations and recover investments in the facilities. SJVEP continues to own and maintain the facilities and to evaluate opportunities to market power without the prior costs incurred for plant depreciation and interest on debt. All regulatory approvals for the agreements were received in the second quarter of 1995. NRG's share of the pretax gain realized by SJVEP from this transaction, which was recorded in June 1995, was approximately $30 million (26 cents per share after tax). Approximately $12 million in settlement distributions were paid to NRG from SJVEP in 1995, and additional distributions are expected in 1996.\nNRG, through wholly owned subsidiaries, owns 50 percent of the Jackson Valley Energy partnership, which owns and operates a 16 Mw cogeneration power plant near Sacramento, California. The plant had a long-term power sales agreement with Pacific Gas & Electric through 2014. On April 1, 1995, Jackson Valley Energy Partners reached an agreement with PG&E regarding the idling of the Jackson Valley plant near Sacramento. Under this agreement, which is similar to the SJVEP agreement, the plant will remain idle until May 1, 1997, and will then restart and sell power to PG&E under a new long term agreement. No gain or cash distribution has resulted or is expected from this transaction.\nNRG, through a wholly owned subsidiary, purchased the assets of the Minneapolis Energy Center (MEC), a downtown Minneapolis district heating and cooling system in August 1993. The system utilizes steam and chilled water generating facilities to heat and cool buildings for 86 heating and 29 cooling customers. The primary assets include the main plant, with 800,000 lbs\/hour of steam capacity and 22,000 tons\/hour of chilled water capacity, two satellite plants, two standby plants, six miles of steam lines and two miles of chilled water distribution lines. Existing long-term contracts with MEC customers remained in effect under NRG's ownership. During 1995, MEC negotiated contracts with two new customers for 25,000 lbs\/hour of steam and 2,400 tons\/hour of chilled water.\nOn August 1, 1995, NRG closed on the acquisition of a 49 percent limited partnership interest in the partnerships holding the operating assets of the district and heating and cooling systems in Pittsburgh and San Francisco. The interest was acquired from Thermal Ventures, Inc., which will continue to operate these systems. Current annual revenue of the San Francisco thermal system is approximately $9 million, and the annual steam sales volumes are approximately 700 million pounds. The San Francisco thermal system provides service to more than 200 buildings. The Pittsburgh thermal system currently has $8 million of annual revenue and provides annual steam sales volumes of 300 million pounds, and chilled water sales volumes of 21 million ton-hours to 24 customers.\nIn December 1994, NRG, through a wholly owned subsidiary, purchased a 50 percent ownership interest in Sunnyside Cogeneration Associates (SCA), a Utah joint venture (partnership), which owns and operates a 58 Mw waste coal plant in Utah. The waste coal plant is currently being operated by a partnership that is 50 percent owned by an NRG affiliate.\nScoria Incorporated and Western SynCoal Co., a subsidiary of Montana Power Co., completed construction in January 1992 of a demonstration coal conversion plant designed to improve the heating value of coal by removing moisture, sulfur and ash. The plant, located in Montana, began commercial operation in August 1993. NRG's net capitalized investment in the Scoria coal project was written down by $3.5 million in 1994 and $5 million in 1995 to reflect reductions in the expected future operating cash flows from the project. NRG continues to evaluate the recoverability of its remaining investment of approximately $2.5 million in the Scoria project.\nNew Business Development\nNRG is pursuing several energy-related investment opportunities, including those discussed below, and continues to evaluate other opportunities as they arise. Potential capital requirements for these opportunities are discussed in the \"Capital Spending and Financing\" section.\nOn November 17, 1995, NRG through a wholly owned subsidiary, entered into an agreement with the Aetna Life Insurance Company to acquire a 50 percent interest in Capital District Energy Center Cogeneration Associates, a joint venture general partnership which owns and operates a 56 Mw, natural gas-fired, cogeneration facility located in Hartford, Connecticut. The closing of the transaction is conditioned upon receipt of third party consents.\nEarly in 1996, NRG was negotiating the purchase of a 42 percent interest in O'Brien Environmental Energy, Inc. (O'Brien) from bankruptcy. The remaining 58 percent interest will be held by shareholders of O'Brien and will be publicly traded. O'Brien has interests in eight domestic operating power generation facilities with aggregate capacity of approximately 230 megawatts, and in one 150-megawatt facility in the contract stage of development. O'Brien's principal operating projects have an aggregate capacity of 183 Mw and include: (a) the 52 Mw Newark Boxboard Project (which is owned 100 percent by a wholly owned subsidiary of O'Brien), a gas-fired cogeneration facility that sells electricity to Jersey Central Power and Light Company (JCP&L) and steam to Newark Boxboard Company; (b) the 122 Mw E.I. du Pont Parlin Project (which is owned 100 percent by a wholly owned subsidiary of O'Brien), a gas-fired cogeneration facility that sells electricity to JCP&L and steam to E.I. du Pont de Nemours and Company; and (c) four biogas projects in Pennsylvania and California with total power generation capacity of 9.2 Mw. In addition, at Dec. 31, 1995, O'Brien had a 50 percent interest in the 150 Mw Grays Ferry Project, a proposed cogeneration project that would, upon successful development, sell electricity to Philadelphia Electric Company and district heating steam to Trigen Philadelphia Energy Corporation (TPEC). As a result of the purchase of O'Brien, approximately $107 million would be made available to O'Brien creditors by NRG. See additional discussion of commitments for the O'Brien acquisition in Note 15 to Financial Statements under Item 8.\nA joint venture between NRG and Transfield, an Australian infrastructure contractor, signed an 18-year power purchase agreement and an acquisition agreement with the Queensland Transmission and Supply Corporation for the acquisition and refurbishment of the 189 Mw Collinsville coal- fired power generation facility in Queensland, Australia. If successful in the acquisition of this project, NRG would own a 50 percent interest and operate the facility. Transfield would perform the facility refurbishment and environmental remediation under a fixed price turnkey contract and would perform facility maintenance under a subcontract with NRG.\nIn July 1993, NRG, together with the International Finance Corporation (an affiliate of the World Bank), CMS Energy Corporation (the parent company of Consumers Power Company) and Corporation Andina de Fomento (CAF) formed the Scudder Latin American Trust for Independent Power (Scudder), an investment fund which is intended to invest in the development of new power plants and privatization of existing power plants in Latin America and the Caribbean. The fund has retained Scudder Stevens & Clark, Inc. as its investment manager. The fund commenced its investment development efforts in September 1993. Each of the four investors has committed $25 million which the fund is seeking to invest over the five year period 1994 - 1998. The fund has commenced private placement activities to obtain additional investors in the fund, particularly other utility affiliates and institutional investors. Scudder holds investments in two power generation facilities in Latin America and one in the Caribbean. As of Dec. 31, 1995, NRG has invested $9 million in Scudder for equity interests ranging from 7.7 percent to 10.3 percent.\nGraystone Corporation, with several other companies, continues with permitting plans to build the first privately owned uranium enrichment plant in the United States. Construction of the Louisiana plant, which would provide fuel for the nuclear power industry, could begin in the next few years. Because of the uncertainty surrounding the ultimate successful operation of this plant, NRG wrote off its $1.5 million investment in Graystone during 1994.\nCenergy, Inc.\nNSP's non-regulated wholly owned subsidiary, Cenergy, Inc. (which changed its name to Cenerprise, Inc. effective Jan. 1, 1996) commenced operations in October 1993 through the acquisition from bankruptcy of selected assets of Centran Corporation, a natural gas marketing company. Cenergy, in addition to marketing natural gas, provides customized value- added energy services to customers, both inside NSP service territory and on a national basis. Cenergy offers customers many energy products and services including: utility billing analysis, end-use gas marketing, risk management, construction, energy services consulting and administrative services. The MPUC has approved an affiliate transaction contract, whereby Cenergy may make natural gas sales at market based rates (determined by competitive bids) to NSP for resale to retail gas customers.\nIn December 1994, the FERC approved Cenergy's application to sell electric power (except electricity generated by NSP) in the United States, giving NSP an opportunity to enter the increasingly deregulated and competitive electric market. Cenergy was one of the first utility affiliates to obtain this approval from the FERC. NSP is allowing open access to its electric transmission lines by other electric power providers throughout North America. Cenergy's initiative to buy and sell deregulated electricity is consistent with NSP's objective to embrace competition, which will benefit NSP customers and shareholders.\nIn 1995, Cenergy and Atlantic Energy Enterprises (AEE) established Atlantic CNRG Services LLC (Atlantic CNRG). Cenergy and AEE each own 50 percent of the new venture that will develop new and expanded natural gas and electric energy products and services, primarily in the northeast United States. On Feb. 1, 1996, Atlantic CNRG acquired the natural gas marketing assets of Interstate Gas Marketing (IGM). IGM, which has offices in Scranton and Pittsburgh, Pennsylvania, markets natural gas to customers in the northeastern United States.\nOn Sept. 1, 1995, a non-regulated subsidiary of NSP was merged with Kansas City-based Energy Masters Corporation (EMC) resulting in the Company's acquisition of an 80 percent ownership interest in EMC. The Company subsequently assigned its interest in EMC to Cenergy. Cenergy has the option to acquire the remaining 20 percent of EMC in three years. EMC has offices in seven states nationwide and specializes in energy efficiency improvement services for commercial, industrial and institutional customers. For its fiscal year ended Oct. 31, 1994 (the latest EMC fiscal year prior to acquisition), EMC, with more than 60 employees, had operating revenues of $5.9 million. EMC will continue to operate as a separate legal entity, as a subsidiary of Cenergy.\nOn Nov. 15, 1995, Cenergy and its partners sold their oil and gas leasehold interest in approximately 1,000 acres to TransTexas Gas Co. for $5 million. Cenergy purchased the property, located in Zapata County, Texas, in July 1994. Earlier in 1995 Cenergy redirected its oil and natural gas unit to focus on financing flowing production rather than engaging in exploratory and development drilling ventures. The sale of the Zapata County leases is the first step in shifting production area business to more closely follow its corporate energy service focus. The pretax gain recognized in 1995 from the sale of these leases, net of valuation adjustments for investments in remaining oil and gas properties held by Cenergy was approximately $1.1 million.\nEloigne Company\nIn 1993, the Company established Eloigne Company (Eloigne), to identify and develop affordable housing investment opportunities. Eloigne's principal business is the acquisition of a broadly diversified portfolio of rental housing projects which qualify for low income housing tax credits under current federal tax law. As of Dec. 31, 1995, approximately $38.5 million had been invested in Eloigne projects, including $13.3 million in wholly owned properties (at net book value) and $25.2 million in equity interests in jointly-owned projects. These investments and related working capital requirements have been financed with $25.3 million of equity capital (including undistributed earnings) and $20.7 million of long-term debt (including current maturities). Completed projects as of Dec. 31, 1995, are expected to generate tax credits of $45.6 million over the 10-year period 1996-2005. Tax credits recognized in 1995 as a result of these investments were approximately $3.0 million. A proposed \"phase-out\" of these tax credits is currently under consideration by the United States Congress. The proposal would sunset the low-income housing tax credit allocation after Dec. 31, 1997. Projects with credits allocated prior to that date would continue to generate tax credits over the remainder of the 10-year credit period allowed.\nNon-Regulated Business Information\n(Thousands of dollars, except per share data) 1995 1994 1993 Operating Results Operating Revenues $313 082 $241 827 $90 531 Operating Expenses (1) (327 894) (241 480) (81 480) Equity in earnings of unconsolidated affiliates: Earnings from operations (2) 28 055 31 595 2 695 Gains from contract terminations 29 850 9 685 Other income (deductions)---net 6 518 1 843 1 040 Interest expense (9 879) (7 975) (3 146) Income taxes (2) (6 119) (2 591) (3 548) Net income $ 33 613 $ 32 904 $ 6 092\nContribution of Non-regulated Businesses to NSP Earnings per Share NRG Energy, Inc. $0.46 $0.44 $0.04 Eloigne Company 0.02 0.02 0.00 Cenergy, Inc. (Cenerprise, Inc., effective Jan. 1, 1996) (0.02) 0.00 0.00 Other (3) 0.04 0.03 0.05 Total $0.50 $0.49 $0.09\n(Thousands of dollars) 1995 1994\nEquity Investment by Non-regulated Businesses in Unconsolidated Projects at Dec. 31 (Including undistributed earnings and capitalized development costs)\nAustralian projects $81 885 $75 108 German projects 87 699 55 337 Other international projects 14 920 4 013 Affordable housing projects (U.S.) 25 211 7 148 Other U.S. projects 54 276 36 152\nTotal Equity Investment in Unconsolidated Non-regulated Projects $263 991 $177 758\nAdditional Equity Invested in Consolidated Non-regulated Businesses 115 276 104 011\nTotal Net Assets of Non-regulated Businesses $379 267 $281 769\nSignificant Unconsolidated Non-Regulated Projects at Dec. 31, 1995\nENVIRONMENTAL MATTERS\nNSP's policy is to proactively prevent adverse environmental impacts by regularly monitoring operations to ensure the environment is not adversely affected, and take timely corrective actions where past practices have had a negative impact on the environment. Significant resources are dedicated to environmental training, monitoring and compliance matters. NSP strives to maintain compliance with all applicable environmental laws.\nIn general, NSP has been experiencing a trend toward increasing environmental monitoring and compliance costs, which has caused and may continue to cause slightly higher operating expenses and capital expenditures. The Company has spent approximately $700 million on capitalized environmental improvements to new and existing facilities since 1968. NSP expects to incur approximately $20 million in capital expenditures and approximately $28 million in operating expenses for compliance with environmental regulations in 1996. The precise timing and amount of future environmental costs are currently unknown. (For further discussion of environmental costs, see \"Environmental Matters\" under Management's Discussion and Analysis of Financial Condition and Results of Operations under Item 7, and Note 15 to the Financial Statements under Item 8.)\nPermits\nNSP is required to seek renewals of environmental operating permits for its facilities at least every five years. NSP believes that it is in compliance, in all material respects, with environmental permitting requirements.\nWaste Disposal\nUsed nuclear fuel storage and disposal issues are discussed in \"Electric Utility Operations - Nuclear Power Plants - - Licensing, Operation and Waste Disposal and Capability and Demand,\" herein, in Management's Discussion and Analysis under Item 7 and in Notes 14 and 15 of Notes to Financial Statements under Item 8.\nThe Company and NRG have contractual commitments to convert municipal solid waste to boiler fuel and burn the fuel to generate electricity. NRG owns and\/or operates two resource recovery plants that produce RDF from the waste. The RDF is burned at the Company's Red Wing and Wilmarth plants in the Company's service area, the French Island plant in the Wisconsin Company's service area, and the Elk River plant owned by United Power Association. Processing and burning RDF provides an additional economical source of electric capacity and energy, which is beneficial to NSP's electric customers. The Company's commitment to this program enables counties to meet state- mandated goals to reduce the amount of solid waste now going to landfills. In addition, the program provides for increased materials recovery and increased use of municipal solid waste as an energy source.\nNSP has met or exceeded the removal and disposal requirements for polychlorinated biphenyl (PCB) equipment as required by state and federal regulations. NSP has removed nearly all known PCB capacitors from its distribution system. NSP also has removed nearly all known network PCB transformers and equipment in power plants containing PCBs. NSP continues to test and dispose of PCB-contaminated mineral oil and equipment in accordance with regulations. PCB-contaminated mineral oil is detoxified and reused or burned for energy recovery at permitted facilities. Any future cleanup or remediation costs associated with past PCB disposal practices is unknown at this time.\nAir Emissions Control And Monitoring\nIn 1994, the U.S. Environmental Protection Agency (EPA) proposed new air emission guidelines for municipal waste combustors. These proposed guidelines were finalized in December 1995. The Minnesota Pollution Control Agency has indicated its plans to update Minnesota state waste combustor rules to meet or be more restrictive than the final federal guidelines. The June 1997 effective date for the state waste combustor rules is expected to be extended due to the issuance of the new federal combustor rules. To meet the new federal and state requirement, the Company must install additional pollution control and monitoring equipment at the Red Wing plant and additional monitoring equipment at the Wilmarth plant. The Company is evaluating equipment to meet the requirements. The required equipment may cost between $6 million and $10 million.\nThe Clean Air Act, including the Amendments of 1990, (the \"Clean Air Act\") calls for reductions in emissions of sulfur dioxide and nitrogen oxides from electric generating plants. These reductions, which will be phased in, began in 1995. The majority of the rules implementing this complex legislation are finalized. No additional capital expenditures are anticipated to comply with the sulfur dioxide emission limits of the Clean Air Act. NSP has expended significant amounts over the years to reduce sulfur dioxide emissions at its plants. Based on revisions to the sulfur dioxide portion of the program, NSP's emission allowance allocations for the years 1995-1999 were dramatically reduced from prior rulemaking. The Company's Sherburne County Generating Plant (Sherco) unit 2 Low Nox Burner Technology was upgraded in 1994 to further reduce its emissions of nitrogen oxides. It is expected that approximately $7 million will be spent on a similar upgrade at Sherco unit 1 in 1998. Other expenditures may be necessary upon the EPA's finalization of remaining rules. Capital expenditures will be required for opacity compliance in 1996-2000 at certain facilities as discussed below.\nAs a part of its Clean Air Act compliance effort, the Company is testing a type of air quality control device called a wet electrostatic precipitator at the Sherco generating plant. The equipment was installed in 1995 inside one of the existing scrubber modules. Testing, anticipated to be completed in 1996, will determine the equipment's operational requirements and ability to reduce particulate emissions and opacity. The equipment is being examined as one option to lower opacity from Sherco units 1 and 2, as required by the EPA. Until testing is completed, it is unknown whether the equipment will result in full compliance with air quality standards, however, testing results to date have been favorable. Total costs for equipment to reduce particulate emissions and opacity range from $90 million for the equipment being tested to approximately $300 million for other technology options. As of Dec. 31, 1995, approximately $3 million of these costs had already been incurred and capitalized.\nThe Company has conducted testing for air toxics at its major facilities and shared these results with state and federal agencies. The Company also conducted research on ways to reduce mercury emissions. This information has also been shared with state and federal agencies. The Clean Air Act requires the EPA to look at issuing rules for air toxic emissions from electric utilities. A report is expected from the EPA to Congress in 1996. There is continued interest at the Minnesota Legislature to pass legislation restricting emissions of air toxics in the state. The Company cannot predict what impact these rules will have if passed.\nOn March 11, 1996, the Company received a Notice of Violation from the Wisconsin Department of Natural Resources (WDNR) stating that emissions from the Wisconsin Company's French Island facility had exceeded allowable levels for dioxin. The WDNR has requested a written response from the Wisconsin Company no later than April 15, 1996, setting forth the Wisconsin Company's plans for bringing the emissions levels back into compliance. The Wisconsin Company is currently investigating this matter to determine the cause of this unexpected event. At this time, the Wisconsin Company is unable to predict whether any fines will be imposed by the WDNR against the Company or what further corrective action may be required. The Wisconsin Company does not believe any fines, if levied, or corrective actions, if required, will have a material adverse effect on NSP's financial condition or results of operations.\nWater Quality Monitoring\nIn compliance with federal and state laws and state regulatory permit requirements, and also in conformance with the Company's corporate environmental policy, the Company has installed environmental monitoring systems at all coal and RDF ash landfills and coal stockpiles to assess and monitor the impact of these facilities on the quality of ground and surface waters. Degradation of water quality in the state is prohibited by law and requires remedial action for restoration to an agreed upon acceptable clean-up level. The cost of overall water quality monitoring is not material in relation to NSP's operating results.\nSite Remediation\nThrough the end of 1995, the Company had been designated by the EPA or state environmental agencies as a \"potentially responsible party\" (PRP) for 12 waste disposal sites to which the Company allegedly sent hazardous materials. Under applicable law, the Company, along with each PRP, could be held jointly and severally liable for the total site remediation costs. Those costs have been estimated between $123 and $126 million for all 12 PRP sites. In the event additional remediation is necessary or unexpected costs are incurred, the amount could be in excess of $126 million. The Company is not aware of the other parties inability to pay, nor does it know if responsibility for any of the sites is disputed by any party.\nSettlement with the EPA, state environmental agencies and other PRPs has been reached for eight of these waste disposal sites for reimbursement of the past costs and expected future costs of remedial action. By reaching early settlement, the Company avoided litigation costs, increased costs of investigation and remediation and possible penalties that could have resulted and substantially increased the Company's allocation. For the four remaining sites, neither the amount of cleanup costs nor the final method of their allocation among all designated PRP's has been determined. However, the current estimate of the Company's share of future remediation costs for all four sites is approximately $1.0 million, which has been recorded as a liability at Dec. 31, 1995.\nUntil final settlement, neither the amount of cleanup costs nor the final method of their allocation among all designated PRPs can be determined. While it is not feasible to determine the precise outcome of these matters, amounts accrued represent the best current estimate of the Company's future liability for the cleanup costs of these sites. It is the Company's practice to vigorously pursue and, if necessary, litigate with insurers to recover costs. Through litigation, the Company has recovered from other PRPs a portion of the remedial costs paid to date. Management also believes that costs incurred in connection with the sites, which are not recovered from insurance carriers or other parties, may be recoverable in future ratemaking.\nBoth the Company and the Wisconsin Company have received notices for requests for information concerning groundwater contamination at a landfill site in Wisconsin. While neither the Company nor the Wisconsin Company have been named PRP's, both companies voluntarily joined a group of other parties to address the contamination at this site. This site is included in the description of the 12 Company sites described above. In addition, the administrator of a group of PRP's has notified the Wisconsin Company that it might be responsible for cleanup of a solid and hazardous waste landfill site. The Wisconsin Company contends that it did not dispose of hazardous wastes in the subject landfill during the time period in question. Because neither the amount of cleanup costs nor the final method of their allocation among all designated PRP's has been determined, it is not feasible to predict the outcome of the matter at this time.\nOn March 2, 1995, the WDNR notified the Wisconsin Company that it is a PRP at a creosote\/coal tar contamination site in Ashland, Wisconsin. At this time, the WDNR has determined that the Wisconsin Company is the only PRP at this site. The site has three distinct portions - the Wisconsin Company portion of the site, the Kreher Park portion of the site and the Chequamegon Bay (of Lake Superior) portion of the site. The Wisconsin Company portion of the site, formerly a coal gas plant site, is Wisconsin Company property. The Kreher Park portion of the site is adjacent to the Wisconsin Company site and is not owned by the Wisconsin Company. The Chequamegon Bay portion of the site is adjacent to the Kreher Park portion of the site and is not owned by the Wisconsin Company. The Wisconsin Company is discussing its potential involvement in the Kreher Park and Chequamegon Bay portions of the site with the WDNR and the City of Ashland.\nOn Feb. 19, 1996, the Wisconsin Company received a draft report from the WDNR's consultant of the results of a remediation action options feasibility study for the Kreher Park portion of the Ashland site. The draft report contains a number of remediation options which were scored by the consultant across a variety of parameters. Two options scored the most technologically and economically feasible and one of those is the lowest cost option for remediation at the Kreher Park portion of the site. The draft report estimates that this option, which would involve capping the property and some limited groundwater treatment, would cost approximately $6.0 million. Currently, the WDNR is conducting an investigation in Chequamegon Bay adjacent to Kreher Park to determine the extent of contamination in the bay. The WDNR has informed the Wisconsin Company that it will not choose or proceed with any remediation options on any portion of the Ashland site until the completion of the Chequamegon Bay investigation in the second half of 1996. Until more information is known concerning the extent of remediation required by the WDNR, the remediation method selected and the related costs, the various parties involved and the extent of the Wisconsin Company's responsibility, if any, for sharing the costs, the ultimate cost to the Wisconsin Company and the expected timing of any payments related to the Ashland site is not determinable. At Dec. 31, 1995, the Wisconsin Company had recorded an estimated liability of $900,000 for future remediation costs at this site and had incurred approximately $400,000 in actual expenditures.\nThe Company is continuing to investigate 15 properties either presently or previously owned by the Company which were, at one time, sites of gas manufacturing or storage plants, or coal gas pipelines. The purpose of this investigation is to determine if waste materials are present, if such materials constitute an environmental or health risk, if the Company has any responsibility for remedial action and if recovery under the Company's insurance policies can contribute to any remediation costs. The Company has commenced remediation efforts at five of the 15 sites. One of the active sites has been completed, while the remaining four are in various stages of remediation. Monitoring continues at the completed site. In addition, the Company has been notified that two other sites will require remediation, and a study will be initiated in 1996 to determine the cost and method of clean up. Clean up is expected to begin in 1997. The total cost of remediation of these sites is expected to be approximately $13 million, including $6.7 million which has been paid to date. As for the eight inactive sites, no liability has been recorded for remediation or investigation because the present land use at each of these sites does not warrant a response action. Management believes costs incurred in connection with the sites that are not recovered from insurance carriers or other parties may be allowable costs for future ratemaking purposes. In 1994 the Company received MPUC approval of deferred accounting for certain investigation and remediation expenses associated with four active gas sites. The ultimate rate treatment of any costs deferred will be determined in the Company's future general gas rate cases. (See Note 15 of Notes to the Financial Statements under Item 8 for further discussion of this matter.)\nNSP has not developed any specific site restoration and exit plans for its fossil fuel plants, hydroelectric plants or substation sites as it currently intends to operate at these sites indefinitely. NSP intends to treat any future costs incurred related to decommissioning and restoration of its non- nuclear power plants and substation sites, where operation may extend indefinitely, as a capitalized removal cost of retirement in utility plant. Depreciation expense levels currently recovered in rates include a provision for an estimate of removal costs (based on historical experience).\nContingencies\nElectric and magnetic fields (sometimes referred to as EMF) surround electric wires and conductors of electricity such as electrical tools, household wiring, appliances, electric distribution lines, electric substations and high-voltage electric transmission lines. NSP owns and operates many of these types of facilities. Some studies have found statistical associations between surrogates of EMF and some forms of cancer. The nation's electric utilities, including NSP, have participated in the sponsorship of more than $50 million in research to determine the possible health effects of EMF. Through its participation with the Electric Power Research Institute and the EMF Research and Public Information Dissemination Program, sponsored by the National Institute of Environmental Health Sciences and the U.S. Department of Energy, NSP will continue its investigation and research with regard to possible health effects posed by exposure to EMF. No litigation has been commenced or claims asserted against NSP for adverse health effects related to EMF. However, several immaterial claims have been asserted against NSP for diminution of property values due to EMF. No litigation has commenced or is expected from these claims.\nBoth regulatory requirements and environmental technology change rapidly. Accordingly, NSP cannot presently estimate the extent to which it may be required by law, in the future, to make additional capital expenditures or to incur additional operating expenses for environmental purposes. NSP also cannot predict whether future environmental regulations might result in significant reductions in generating capacity or efficiency or otherwise affect NSP's income, operations or facilities.\nCAPITAL SPENDING AND FINANCING\nNSP's capital spending program is designed to assure that there will be adequate generating and distribution capacity to meet the future electric and gas needs of its utility service area, and to fund investments in non-regulated businesses. NSP continually reassesses needs and, when necessary, appropriate changes are made in the capital expenditure program.\nTotal NSP capital expenditures (including allowance for funds used during construction and excluding business acquisitions and equity investments in non-regulated projects) totaled $401 million in 1995, compared to $409 million in 1994 and $362 million in 1993. These capital expenditures include gross additions to utility property of $386 million, $387 million and $357 million, (excluding Viking property acquired in 1993) for years ended 1995, 1994 and 1993, respectively. Internally generated funds could have provided approximately 85 percent of all capital expenditures for 1995, 69 percent for 1994 and 99 percent for 1993.\nNSP's utility capital expenditures (including allowance for funds used during construction) are estimated to be $410 million for 1996 and $1.9 billion for the five years ended Dec. 31, 2000. Included in NSP's projected utility capital expenditures is $50 million in 1996 and $250 million during the five years ended Dec. 31, 2000, for nuclear fuel for NSP's three existing nuclear units. The remaining capital expenditures through 2000 are for many utility projects, none of which are extraordinarily large relative to the total capital expenditure program. Internally generated funds from utility operations are expected to equal approximately 90 percent of the 1996 utility capital expenditures and approximately 100 percent of the 1996-2000 utility capital expenditures. Internally generated funds from all operations are expected to equal approximately 75 percent and 90 percent respectively, of NSP's total capital requirements (including equity investments in non- regulated projects as discussed below) anticipated for 1996 and the five-year period 1996-2000. The foregoing estimates of utility capital expenditures and internally generated funds may be subject to substantial changes due to unforeseen factors, such as changed economic conditions, competitive conditions, resource planning, new government regulations, changed tax laws and rate regulation.\nIn addition to capital expenditures, NSP invested $54 million in 1995, $137 million in 1994 and $184 million in 1993 for interests in existing and additional non-regulated businesses and Viking. Investments in 1993 included business acquisitions of $159 million. (See \"Gas Utility Operations - Viking Gas Transmission Company\" and \"Non-Regulated Subsidiaries\" herein.) NSP and its subsidiaries continue to evaluate opportunities to enhance its competitive position and shareholder returns through strategic acquisitions of existing businesses. Long-term financing may be required for any such future acquisitions that NSP (including its subsidiaries) consummates.\nAlthough they may vary depending on the success, timing, level of involvement in planned and future projects and other unforeseen factors, potential capital requirements for investments in existing and additional non-regulated projects are estimated to be $140 million in 1996 and $550 million for the five-year period 1996-2000. The majority of these non- regulated capital requirements relate to equity investments (excluding costs financed by project debt) in NRG's projects, as discussed previously and include commitments for certain NRG investments, as discussed in Note 15 of Notes to the Financial Statements under Item 8. The remainder consists mainly of affordable housing investments by Eloigne Company. Equity investments by NRG and Eloigne would be funded through their own internally generated funds, equity investments by NSP, or long- term debt issued by the subsidiary. Such equity investments by NSP are expected to be financed on a long-term basis through NSP's internally generated funds or through NSP's issuance of common stock.\nEMPLOYEES AND EMPLOYEE BENEFITS\nAt year end 1995 the total number of full- and part-time employees of NSP was approximately 7,505. Of this number approximately 2,900 employees are represented by five local IBEW labor unions under a three year collective bargaining agreement expiring Dec. 31, 1996.\nRecent changes to NSP's employee and retiree benefits, which support NSP's goal of providing market-based benefits, include:\nActive nonbargaining medical premium increases: A cost sharing strategy for medical benefits for nonbargaining employees was implemented in 1994. The strategy consisted of adjusting the employee contribution portion of total medical costs to 10 percent in 1994 and 20 percent in 1995 and 1996.\nRetiree medical premium increases: Retiree medical premiums were increased in 1994 for existing and future retirees. For existing qualifying retirees, pension benefits have been increased to offset some of the premium increase. For future retirees, a six-year cost-sharing strategy was implemented with retirees paying 15 percent of the total cost of health care in 1994, increasing gradually each year to a total of 40 percent in 1999.\n401(k) changes: NSP currently offers eligible employees a 401(k) Retirement Savings Plan. In 1994, NSP began matching employees' pre-tax 401(k) contribution for a total of $2.6 million. NSP's matching contributions were $3.7 million in 1995, based on matching up to $700 per year for each nonbargaining employee and up to $500 per year for each bargaining employee. In 1996, NSP's annual match will increase to $900 for nonbargaining employees. Under the terms of the bargaining agreement implemented in 1994, NSP's annual match for bargaining employees will increase to $600 in 1996.\nWage increases: Under a market-based pay structure implemented for nonbargaining employees in 1994, NSP uses salary surveys that indicate how local and regional companies pay their employees for comparable positions. In January 1995, nonbargaining employees received an average wage scale increase of 3.5 percent, while bargaining employees received a 2 percent base wage increase and 1.5 percent lump sum payment. In January 1996, nonbargaining employees received an average wage scale increase of 4 percent, while bargaining employees received a 4 percent base wage increase.\nEXECUTIVE OFFICERS *\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nThe Company's major electric generating facilities consist of the following:\nNSP's electric generating facilities provided 79 percent of its Kwh requirements in 1995. The current generating facilities are expected to be adequate base load sources of electric energy until 2003-2006, as detailed in the Company's electric resource plan filed with the MPUC in 1995. All of NSP's major generating stations are located in Minnesota on land owned by the Company.\nIn late 1995, NSP converted three of its older, less efficient generating units from an intermediate load status to peaking plant operations. This change is expected to save approximately $3 million annually. The Company's 47 Mw Minnesota Valley generating plant in Granite Falls and the 65 Mw Black Dog Unit 1 in Burnsville will be dispatched as peaking units and fired on 100 percent natural gas. Black Dog Unit 2, with capacity of approximately 100 Mw, will also be dispatched as a peaking unit but will continue to be fired on coal.\nAt Dec. 31, 1995, NSP had transmission and distribution lines as follows:\nVoltage Length (Pole Miles)\n500Kv 265 345Kv 733 230Kv 283 161Kv 339 115Kv 1,650 Less than 115 Kv 31,509\nNSP also has approximately 300 transmission and distribution substations with capacities greater than 10,000 kilovoltamperes (Kva) and approximately 270 with capacities less than 10,000 Kva.\nManitoba Hydro, Minnesota Power Company and the Company completed the construction of a 500-Kv transmission interconnection between Winnipeg, Manitoba, Canada, and the Minneapolis-St Paul, Minnesota, area in May 1980. NSP has a contract with Manitoba Hydro-Electric Board for 500 Mw of firm power utilizing this transmission line. In addition, the Company is interconnected with Manitoba Hydro through a 230 Kv transmission line completed in 1970. In May of 1995 a project was completed to increase the Manitoba-US transmission interconnection by a nominal 400 Mw, to 1900 Mw. This project was undertaken as part of a contract where NSP and Manitoba Hydro have established an additional 150 Mw of seasonal power exchange. (Also, see Note 15 of Notes to Financial Statements under Item 8.)\nThe electric delivery system utilization has increased during recent years due to better analytical methods and enhanced Energy Management System monitoring and control capability. This increased utilization has been achieved while continuing to operate within reliability parameters established by MAPP and North American Electric Reliability Council (NERC).\nIn April 1995, a plan was completed to determine electric delivery system upgrades required to accommodate load growth expected in the Minneapolis\/St. Paul geographic area through 2010. The results indicated load growth at a rate of approximately 2 percent per year. To accommodate the load growth, portions of the 69 Kv transmission, especially located on the outskirts of the Twin Cities, will be reconductored and operated at 115 Kv; distribution development in these areas will largely be at 34.5 Kv. By reconductoring on existing right-of- ways and increasing distribution voltage, the requirements for new right-of-ways and substation sites are minimized as compared with other alternatives for serving the load growth.\nThe natural gas properties of NSP include about 8,060 miles of natural gas transmission and distribution mains. NSP natural gas mains include approximately 116 miles with a capacity in excess of 275 pounds per square inch (psi) and approximately 7,944 miles with a capacity of less than 275 psi. In addition, Viking owns a 500-mile interstate natural gas pipeline serving portions of Minnesota, Wisconsin and North Dakota.\nVirtually all of the utility plant of the Company and the Wisconsin Company are subject to the lien of their first mortgage bond indentures pursuant to which they have issued first mortgage bonds.\nItem 3","section_3":"Item 3 - Legal Proceedings\nIn the normal course of business, various lawsuits and claims have arisen against NSP. Management, after consultation with legal counsel, has recorded an estimate of the probable cost of settlement or other disposition for such matters.\nOn July 22, 1993, a natural gas explosion occurred on the Company's distribution system in St. Paul, MN. Seventeen lawsuits have been filed against the Company in regard to the explosion, including one suit with multiple plaintiffs. In April 1995, the National Transportation Safety Board concluded the City of St. Paul contractors were largely responsible for the natural gas explosion. The report found little, if any, fault with the actions taken by or conduct of the Company. A trial to decide civil liability and the parties responsible for the explosion has been scheduled for February 1997, with the damages portion of the trial scheduled for six months thereafter.\nIn February 1996, the Company and Westinghouse Electric Corp. (Westinghouse) reached a settlement in principle of a lawsuit which the Company had filed against Westinghouse related to steam generators installed at the Company's Prairie Island plant. The parties have agreed to keep the specific terms of the settlement confidential. The Company expects to share all of the benefits of the settlement with its customers.\nOn June 20, 1994, the Company and 13 other major utilities filed a lawsuit against the Department of Energy (DOE) in an attempt to clarify the DOE's obligation to accept spent nuclear fuel beginning in 1998. The suit was filed in the U.S. Court of Appeals, Washington, D.C. The primary purpose of the lawsuit is to insure that the Company and its customers receive timely storage of used nuclear fuel in accordance with the terms of the Company's contract with the DOE. The lawsuit was argued before the United States Circuit Court of Appeals for the District of Columbia on Jan. 17, 1996, and a decision is expected in three to six months from the time of argument.\nThe Federal Energy Regulatory Commission (FERC) made a favorable decision for the Company regarding its Sherco unit 3 transmission contracts with the Southern Minnesota Municipal Power Agency (SMMPA). A hearing judge had previously issued several rulings in favor of the Company, but had refused to find SMMPA obligated to pay for any transmission service since deliveries had commenced on November 1, 1987. FERC reversed and ordered SMMPA to pay for the 172 megawatts (MW) of transmission service in an amount determined by applying NSP's filed wheeling rate. It is anticipated that SMMPA will appeal. NSP will ask FERC to reconsider its decision as to the total transmission service SMMPA is responsible for because NSP believes SMMPA owes for 56 Mw more than FERC allowed. Until the appeal and reconsideration processes are complete, the ultimate impact of this decision on NSP's results of operation and financial condition are not determinable.\nFor a discussion of environmental proceedings, see \"Environmental Matters\" under Item 1, incorporated herein by reference. For a discussion of proceedings involving NSP's utility rates, see \"Utility Regulation and Revenues\" under Item 1, incorporated herein by reference.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders\nNone\nPART II Item 5","section_5":"Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters\nQuarterly Stock Data\nThe Company's common stock is listed on the New York Stock Exchange (NYSE), Chicago Stock Exchange (CHX) and the Pacific Stock Exchange (PSE). Following are the reported high and low sales prices based on the NYSE Composite Transactions for the quarters of 1995 and 1994 and the dividends declared per share during those quarters:\nThe Company's Restated Articles of Incorporation and First Mortgage Bond Trust Indenture provide for certain restrictions on the payment of cash dividends on common stock. At Dec. 31, 1995, the payment of cash dividends on common stock was not restricted except as described in Note 5 to the Financial Statements under Item 8.\nFor a discussion of the anticipated dividend payment level of Primergy, see \"Proposed Merger with Wisconsin Energy Corporation\" under Item 1, incorporated herein by reference.\n1995 1994 1993 1992 1991 Shareholders of record at year-end 83 902 85 263 86 404 72 525 72 704\nBook value per share at year-end $29.74 $28.35 $27.32 $25.91 $25.21\nShareholders of record as of March 15, 1996 were 83,517.\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\nNorthern States Power Company, a Minnesota corporation (the Company), has two significant subsidiaries, Northern States Power Company, a Wisconsin corporation (the Wisconsin Company), and NRG Energy, Inc., a Delaware corporation (NRG). The Company also has several other subsidiaries, including Viking Gas Transmission Company (Viking) and Cenergy, Inc., (Cenergy). The Company and its subsidiaries collectively are referred to herein as NSP.\nFINANCIAL RESULTS AND OBJECTIVES\n1994 Financial Results\nNSP's 1995 earnings per share were $3.91, an increase of 45 cents, or 13.0 percent, over the $3.46 earned in 1994. The effects of sales growth in the core electric and gas utility businesses, favorable weather and reduced operating and maintenance costs more than offset higher costs for depreciation, tax and interest expenses. This provided a regulated utility earnings increase of 44 cents, or 14.8 percent, from 1994. In 1995, non-regulated businesses contributed earnings of 50 cents, up 1 cent, or 2.0 percent, from 1994 earnings. Investor returns also were enhanced in 1995 by an increase in the common dividend rate, as discussed below.\nNSP remained financially strong in 1995, as evidenced by continued high operating cash flows and interest coverage. NSP maintained its first mortgage bond ratings with all rating agencies during 1995. NSP bonds are rated double A by all rating agencies except Moody's Investors Services (Moody's). Moody's downgraded NSP's first mortgage bond ratings in May 1994 to A1 based on its interpretation of provisions of a Minnesota law enacted in 1994 regarding the used fuel storage project for the Prairie Island nuclear generating plant. (See discussion of this legislation in Notes 14 and 15 to the Financial Statements.) In 1995, Moody's placed the Company's ratings on credit review for possible upgrade based on anticipated cost savings from the proposed merger with Wisconsin Energy Corporation, which is discussed later.\nTotal Return\nTotal return to investors is measured by dividends plus stock price appreciation. NSP's common dividend rate increased by more than 2 percent and its stock price increased by 11.6 percent in 1995. For the most recent 15-, 10- and five-year periods, the total return on NSP common stock averaged 18.1 percent, 12.7 percent and 13.8 percent per year, respectively. For the same periods, the total return for the Standard & Poor's (S&P) composite stock index for 500 industrial companies averaged 14.8 percent, 14.8 percent and 16.5 percent per year, respectively.\nFinancial Objectives\nNSP's financial objectives are:\n- To provide investor returns in the top one-fourth of the utility industry as measured by a three-year average return on equity. NSP's average return on common equity for the three years ending in 1995 was 12.5 percent. Based on a three-year average, this return was below the top one-fourth of the industry, which was approximately 13.0 percent, but above the median three-year industry average of approximately 11.6 percent.\n- To increase dividends on a regular basis and maintain a long-term average payout ratio in the range of 65 to 75 percent. The objective payout ratio is based on long-term earnings expectations. In June 1995, NSP's annualized common dividend rate was increased by 6 cents per share, or 2.3 percent, from $2.64 to $2.70. The dividend payout ratio was 69 percent in 1995, within the objective range.\n- To maintain continued financial strength with a double A bond rating. The Company's first mortgage bonds continued to be rated AA- by S&P, AA- by Duff & Phelps, Inc. and AA by Fitch Investors Service, Inc. Since May 1994, Moody's has rated NSP's first mortgage bonds A1 based on its interpretations of a Minnesota law enacted in 1994 regarding the used fuel storage project for the Prairie Island nuclear generating plant. First mortgage bonds issued by the Wisconsin Company carry comparable ratings. NSP's pretax interest coverage ratio, based on income without Allowance for Funds Used During Construction (AFC), was 3.8 in 1995. A capital structure consisting of 48.4 percent common equity at year-end 1995, including both regulated and non-regulated operations, contributes to NSP's financial flexibility and strength.\n- To provide at least 20 percent of NSP earnings from NRG businesses by the year 2000. NRG expects to meet this goal through growing profitability of existing businesses and the addition of new businesses. Businesses owned or managed by NRG provided 12.4 percent of NSP's earnings in 1995 and 13.5 percent in 1994.\n- To maintain long-term average annual earnings growth of 5 percent from ongoing operations, as described below. Excluding the non-recurring items discussed later under Factors Affecting Results of Operations, NSP achieved earnings per share growth of 7.0 percent in 1995 over 1994 and an average annual growth of 10.5 percent since 1993.\n1995 1994 1993 Total earnings per share $3.91 $3.46 $3.02 Less earnings from non-recurring items 0.22 0.01 Earnings from ongoing operations $3.69 $3.45 $3.02\nTotal earnings per share increased 13.0 percent in 1995 over 1994.\nBusiness Strategies\nNSP's management is proactive in shaping the new business environment in which it will be operating. In April 1995, the Company and Wisconsin Energy Corporation (WEC) entered into a definitive agreement that provides for a strategic business combination in a \"merger-of-equals\" transaction to operate as Primergy Corporation (Primergy), as discussed further under Factors Affecting Results of Operations. Both companies' management teams view this transaction as creating a combined enterprise well-positioned for an increasingly competitive energy industry environment. The goal of the merger is to achieve continued competitive energy rates over the long term for the companies' respective customers and to enhance value for the shareholders of both companies. In addition to this merger strategy, management's business strategies include:\n- Focusing on the core energy business. The electric utility industry is becoming more complex as customers, as well as utilities and federal and state regulators, promote competition. To remain successful in this more complex environment, NSP will maintain its focus on its core energy-related activities.\n- Providing reliable, low-cost, environmentally responsible energy. Whether energy is produced or purchased through NSP's regulated utility or its non-regulated businesses, three general concepts provide a focus for its energy businesses: reliable energy, low-cost energy and environmentally responsible energy.\n- Responding to customer needs. Customers will have an increasing number of options for meeting their energy needs, and there will be competition among energy companies for the privilege of serving those customers. NSP will work with its customers to develop innovative products and services that benefit both customers and NSP.\n- Increasing non-regulated investments and earnings. Non- regulated businesses will be an important part of NSP's future. Deregulation in the utility industry is expected to provide new investment opportunities in non-regulated businesses. Participation in these opportunities is expected to improve NSP's total profitability.\nRESULTS OF OPERATIONS AND LIQUIDITY AND CAPITAL RESOURCES\nThe following discussion and analysis by management focuses on those factors that had a material effect on NSP's financial condition and results of operations during 1995 and 1994. It should be read in conjunction with the accompanying Financial Statements and Notes thereto. Trends and contingencies of a material nature are discussed to the extent known and considered relevant. Material changes in balance sheet items are discussed below and in the accompanying Notes to Financial Statements. The discussion and analysis and the related financial statements do not reflect the impact of the Company's proposed merger with WEC except for pro forma information included in Note 18 to the Financial Statements.\nRESULTS OF OPERATIONS\n1995 Compared with 1994 and 1993\nNSP's 1995 earnings per share were $3.91, up 45 cents from the $3.46 earned in 1994 and up 89 cents from the $3.02 earned in 1993. Regulated utility businesses generated earnings per share of $3.41 in 1995, $2.97 in 1994 and $2.93 in 1993. Non-regulated businesses generated earnings per share of 50 cents in 1995, 49 cents in 1994 and 9 cents in 1993. The results of the regulated utility businesses and the non-regulated businesses are discussed in more detail later. In addition to the revenue and expense changes, earnings per share have been affected by an increasing average number of common and equivalent shares outstanding. Common and equivalent shares increased in 1995 and 1994 due mainly to stock issuances for the Company's dividend reinvestment and stock ownership plans.\nUtility Operating Results\nElectric Revenues Sales to retail customers, which account for more than 90 percent of NSP's electric revenue, increased 4.2 percent in 1995 and 3.9 percent in 1994. Retail revenues were favorably affected by sales growth, weather and increased cost recovery for conservation expenditures. During 1995, NSP added 18,297 retail electric customers, a 1.3 percent increase. Total sales of electricity increased 2.9 percent in 1995 and decreased 0.2 percent in 1994. Warmer-than-normal summer weather in 1995 contributed to sales growth compared with 1994, which had a cooler-than-normal summer.\nOn a weather-adjusted basis, sales to retail customers increased an estimated 2.4 percent in 1995 and 3.4 percent in 1994. Retail sales growth for 1996 is estimated to be 0.8 percent over 1995, or 1.9 percent on a weather-adjusted basis.\nSales to other utilities increased 1.0 percent in 1995 after decreasing 21.6 percent in 1994. The 1994 decrease from 1993 largely was due to unusually high demand in 1993 from utilities in flood-stricken Midwestern states.\nThe table below summarizes the principal reasons for the electric revenue changes during the past two years:\n(Millions of dollars) 1995 vs. 1994 1994 vs. 1993 Retail sales growth (excluding weather impacts) $ 46 $ 56 Estimated impact of weather on retail sales volume 42 8 Sales to other utilities 1 (20) Wholesale sales (13) 7 Conservation cost recovery 19 2 Fuel adjustment clause recovery (7) 23 Other rate changes (2) 15 Energy management discounts and other (10) 1 Total revenue increase $ 76 $ 92\nNSP's electric rates are adjusted for changes in fuel and purchased energy costs from amounts currently included in approved base rates through fuel adjustment clauses in all jurisdictions, except as noted below for Wisconsin. While the lag in implementing these billing adjustments is approximately 60 days, an estimate of the adjustments is recorded in unbilled revenue in the month in which costs are incurred. In Wisconsin, the biennial retail rate review process considers changes in electric fuel and purchased energy costs in lieu of a fuel adjustment clause.\nIn 1995, a new rate adjustment clause was approved. It accelerated recovery of deferred electric conservation and energy management program costs in the Company's Minnesota jurisdiction. This adjustment clause helps reduce the need for filing a general rate increase request for recovery of increases in conservation expenditures. The Company is required to request a new cost recovery level annually. In January 1996, a number of changes to the Company's regulatory deferral and amortization practices for Minnesota conservation program expenditures were approved. These changes allow the Company to expense rather than amortize new conservation expenditures beginning in 1996 and to increase its recovery of electric margins lost due to conservation activity. In addition, the Company received approval for 1996 and 1997 conservation expenditures at levels lower than 1995. On April 1, 1996, the Company expects to file for annual changes to the Minnesota conservation rate adjustment clause with an effective period of July 1, 1996, through June 30, 1997. Revenues in 1996 are expected to increase by an estimated $17 million, compared with 1995, due to the effects of the rate recovery changes for conservation programs in 1995 and 1996. These revenue increases will be largely offset by a corresponding increase in conservation expenses.\nElectric Production Expenses Fuel expense for electric generation increased $4.5 million, or 1.4 percent, in 1995 compared with an increase of $5.6 million, or 1.8 percent, in 1994. The 1995 increase was primarily attributable to an increase in output from NSP's generating plants, resulting from increased sales and fewer scheduled plant maintenance outages. Although output from NSP's generating plants declined slightly in 1994 because of more scheduled fossil plant maintenance outages, fuel expenses were higher in 1994 because of the higher cost of nuclear fuel per megawatt-hour due to increased payments to the U.S. Department of Energy (DOE) for decommissioning and decontamination of the DOE's uranium enrichment facilities and nuclear fuel disposal costs. In addition, the costs of fossil fuel were higher in 1994 because of fewer coal purchases at the lowest contractual prices due to lower fossil plant output.\nPurchased power costs decreased $5.2 million, or 2.1 percent, in 1995 after increasing $41.1 million, or 19.7 percent, in 1994. The decrease in 1995 was primarily due to lower average market prices and less energy purchased. The level of purchases declined due to fewer scheduled plant maintenance outages in 1995. The increase in 1994 primarily was due to additional demand expenses of $21 million for the full-year impact of capacity charges from the power purchase agreements with the Manitoba Hydro-Electric Board (MH), which went into effect in May 1993, as discussed in Note 15 to the Financial Statements. In addition to demand expenses, purchased power costs increased from 1993 due to higher average market prices and increased purchases because of more plant maintenance outages in 1994.\nGas Revenues The majority of NSP's retail gas sales are categorized as firm (primarily space heating customers) and interruptible (commercial\/industrial customers with an alternate energy supply). Firm sales in 1995 increased 6.8 percent compared with 1994 sales, while firm sales in 1994 decreased 5.4 percent compared with 1993 sales. The 1995 increase primarily is due to increased sales of natural gas resulting from 16,680 additional new firm gas customers, a 4.1 percent increase, and slightly more favorable weather in 1995. The 1994 decrease was due largely to warm weather in the last quarter of 1994.\nOn a weather-adjusted basis, firm sales are estimated to have increased 4.6 percent in 1995 and decreased 0.7 percent in 1994. Firm gas sales in 1996 are estimated to increase by 2.6 percent relative to 1995, a 3.6 percent increase on a weather- adjusted basis.\nInterruptible sales of gas increased 15.7 percent in 1995 and 4.4 percent in 1994. The 1995 increase is the result of favorable gas market prices that caused large interruptible customers with alternate fuel sources to use more natural gas. Other gas deliveries increased 46.1 percent primarily due to additional gas sales to off-system customers. Other gas deliveries increased 65.7 percent in 1994 due to gas sales to off-system customers. Viking wholesale transmission deliveries increased 1.1 percent in 1995. These wholesale deliveries increased 74.3 percent in 1994 due to a full year of Viking activity.\nThe table below summarizes the principal reasons for the gas revenue changes during the past two years.\n(Millions of dollars) 1995 vs 1994 1994 vs 1993 Sales growth (excluding weather impacts) $26 $0 Estimated impact of weather on firm sales volume 7 (8) Sales to off-system customers 2 14 Purchased gas adjustment clause recovery (26) (24) Rate changes and other (3) 4 Viking Gas (acquired in June 1993) 5\nTotal revenue increase (decrease) $6 $(9)\nNSP's retail gas rates are adjusted for changes in purchased gas costs from amounts currently included in approved base rates through purchased gas adjustment clauses in all jurisdictions. Effective November 1995, a new rate adjustment clause was approved that accelerated recovery of deferred gas conservation and energy management program costs in the Company's Minnesota jurisdiction, similar to the retail electric rate clause discussed previously. The Company estimates it will receive an additional $2.7 million in revenues from this new rate mechanism in 1996 compared with 1995. This increased recovery will result in a corresponding increase in conservation expenses.\nCost of Gas Purchased and Transported The cost of gas purchased and transported decreased $7.1 million, or 2.7 percent, in 1995 primarily due to a 12.6 percent decline in the per unit cost of purchased gas, partially offset by higher sendout volumes due to increased sales and off-system deliveries. The lower cost of purchased gas reflects continuing favorable market pricing, while the higher gas sendout reflects sales growth in 1995 and higher gas sales to off-system customers. The cost of gas associated with off-system sales was $14.3 million in 1995 and $12.7 million in 1994. The cost of gas purchased and transported decreased $18.6 million, or 6.6 percent, in 1994. The decrease reflects lower gas prices and cost recovery adjustments, partially offset by higher sendout volumes primarily for gas sales to off-system customers. The average cost per unit of NSP- owned gas sold in 1994 was 8.4 percent lower than it was in 1993, mainly due to lower market prices for gas.\nOther Operation, Maintenance and Administrative and General These expenses, in total, decreased by $9.1 million, or 1.4 percent, in 1995 compared with an increase of $26.0 million, or 4.0 percent, in 1994. The 1995 decrease is largely due to fewer employees, fewer scheduled plant maintenance outages, lower property insurance premiums and a one-time charge in 1994 for postemployment benefits. Partially offsetting these decreases were higher employee benefit costs, and higher electric line maintenance costs, mostly for tree trimming and heat-related repairs. The 1994 increase resulted primarily from higher postretirement health care costs, including amounts deferred from 1993, and higher postemployment costs as discussed in Note 2 to the Financial Statements. (See Note 12 to the Financial Statements for a summary of administrative and general expenses.)\nConservation and Energy Management Expenses in 1995 were higher than in 1994 primarily due to higher amortization levels of deferred conservation program costs, consistent with cost recovery under new electric and gas rate adjustment clauses in the Company's Minnesota jurisdiction effective May 1, 1995, and Nov. 1, 1995, respectively. The deferred costs being amortized are higher due to increased customer participation in NSP's conservation and energy management programs.\nDepreciation and Amortization The increases in 1995 and 1994 reflect higher levels of depreciable plant.\nProperty and General Taxes Property and general taxes increased in 1995 and 1994 primarily due to property additions and higher property tax rates.\nUtility Income Taxes The variations in income taxes primarily are attributable to fluctuations in taxable income. (See Note 9 to the Financial Statements for a detailed reconciliation of the statutory tax rate to NSP's effective tax rate.)\nNon-operating Items Related to Utility Businesses\nAllowance for Funds Used During Construction (AFC) The differences in AFC for the reported periods are attributable to varying levels of construction work in progress and changing AFC rates associated with various levels of short-term borrowings to fund construction. In addition, returns allowed on deferred costs for conservation and energy management programs increased AFC-equity by $2.6 million and $2.0 million in 1995 and 1994, respectively, and increased AFC-debt by the amounts of $1.5 million and $0.9 million in 1995 and 1994, respectively.\nOther Income (Expense) Note 12 to the Financial Statements lists the components of Other Income (Deductions)- Net reported on the Consolidated Statements of Income. Other than the operating revenues and expenses of non-regulated businesses, as discussed in the next section, non-operating income (net of expense items and associated income taxes) related to utility businesses increased $5.6 million in 1995 and decreased $2.4 million in 1994. The 1995 increase primarily is due to higher expense levels in 1994 for environmental and regulatory contingencies, and public and governmental affairs costs related to the Prairie Island fuel storage issue. These were partly offset by lower interest income associated with the Company's settlement of federal income tax disputes in 1995. The 1994 decrease primarily is due to higher expenses for environmental and regulatory contingencies, and higher public and governmental affairs expenses associated with the Prairie Island fuel storage issue, partially offset by interest income associated with the Company's settlement of federal income tax disputes.\nInterest Charges (Before AFC) Interest costs recognized for NSP's utility businesses, including amounts capitalized to reflect the financing costs of construction activities, were $123.4 million in 1995, $107.1 million in 1994 and $110.4 million in 1993. The 1995 increase is largely due to long-term debt issues in 1995 and 1994 (net of retirements) and higher short-term interest rates, which affect commercial paper borrowings and variable rate long-term debt. The 1994 decrease reflects the impact of refinancing several higher-rate long-term debt issues in 1993 and 1994. These interest savings were partially offset by interest on higher short-term debt balances and Viking debt (issued late in 1993). The average short-term debt balance was $208.7 million in 1995, $204.5 million in 1994 and $77.0 million in 1993.\nPreferred Dividends Dividends on the Company's preferred stock decreased in 1994 primarily due to redemption of the $7.84 Series Cumulative Preferred Stock in October 1993.\nNon-regulated Business Results\nNSP's non-regulated operations include many diversified businesses, such as independent power production, gas marketing, industrial heating and cooling, and energy-related refuse- derived fuel (RDF) production. NSP also has investments in affordable housing projects and several income-producing properties. The following discusses NSP's diversified business results in the aggregate.\nOperating Revenues and Expenses The net results of non-regulated businesses that are consolidated are reported in Other Income (Deductions)-Net on the Consolidated Statements of Income. (Note 12 to the Financial Statements lists the individual components of this line item.) Non-regulated operating revenues increased $71.3 million, or 29 percent, in 1995, and $151.3 million, or 167 percent, in 1994. The 1995 increase was largely due to increased gas marketing sales by Cenergy. The 1994 increase was mainly due to the impact of Cenergy gas marketing and NRG industrial heating and cooling businesses acquired in 1993. Non- regulated operating expenses increased in 1995 primarily due to higher gas costs associated with Cenergy gas sales and higher project development expenses by NRG on pending projects. Non- regulated operating expenses increased in 1994 consistent with revenue increases resulting from 1993 acquisitions. In addition, such expenses increased in 1994 due to fewer project development costs being capitalized on pending projects in 1994 compared with 1993, and project write-downs. Non-regulated operating expenses include charges of $5.0 million in 1995 and $5.0 million in 1994 for previously capitalized development and investment costs to reflect a decrease in the expected future cash flows of certain energy projects.\nEquity in Operating Earnings NSP has a less-than-majority equity interest in many non-regulated projects, as discussed in Note 3 to the Financial Statements. Consequently, a large portion of NSP's non-regulated earnings is reported as Equity in Earnings of Unconsolidated Affiliates on the Consolidated Statements of Income. The 1995 decrease in equity in project operating earnings is due to lower earnings from an NRG cogeneration project contract that was terminated in 1995 and other domestic projects, somewhat offset by higher earnings from NRG international energy projects (one of which did not provide earnings prior to the second quarter of 1994). The 1994 increase in equity in project operating earnings primarily is due to new international energy projects in which NRG entered during 1994 (as discussed in Note 3 to the Financial Statements), and more profitable operations of other energy projects in which NRG had been an investor for several years.\nEquity in Gains From Contract Terminations In June 1995, after receiving final regulatory approvals, a power sales contract between a California energy project, in which NRG is a 45 percent investor, and an unaffiliated utility company was terminated. A pretax gain of approximately $30 million was recognized by NRG for its share of the termination settlement. In 1994, a Michigan cogeneration project, in which NRG was a 50 percent investor, received a payment from an unaffiliated utility company as compensation for the termination of an energy purchase agreement. A pretax gain of $9.7 million was recognized by NRG for its share of the contract termination settlement, net of project investment costs.\nOther Income (Expense) Other than the operating revenues and expenses of non-regulated businesses, as discussed above, non- operating income (net of expense items) related to non-regulated businesses increased $4.7 million in 1995 and increased $0.8 million in 1994. The 1995 increase primarily is due to a gain on the sale of Cenergy oil and gas properties, higher income from cash investments, and an adjustment to the 1994 contract termination gain recorded by NRG.\nInterest Expense Interest charges on the Consolidated Statements of Income include interest and amortization expenses related to non-regulated businesses. The expenses were $9.9 million in 1995, $8.0 million in 1994 and $3.1 million in 1993. The increase in 1995 mainly is due to the issuance of long-term debt on new affordable housing projects by Eloigne Company, a wholly owned subsidiary of the Company. The increase in 1994 relates primarily to non-utility long-term debt issued to finance the 1993 acquisitions of NRG's industrial heating and cooling business (Minneapolis Energy Center), a gas marketing business now operated by Cenergy, and 1994 investments in affordable housing projects by Eloigne Company. In addition, during 1994 and late 1993, United Power & Land and First Midwest Auto Park, wholly owned subsidiaries of the Company, issued long-term debt secured by non-regulated properties and lowered NSP's equity investment in these subsidiaries.\nIncome Taxes The Consolidated Statements of Income include income tax expense related to non-regulated businesses of $6.1 million in 1995, $2.6 million in 1994 and $3.5 million in 1993. The increase in 1995 mainly is due to a gain from an NRG energy contract termination, as discussed previously, somewhat offset by higher income tax credits from Eloigne Company's affordable housing projects. The decrease in 1994 mainly is due to higher income tax credits from affordable housing projects and energy tax credits related to an NRG project, somewhat offset by higher taxes due to higher operating earnings, as discussed above. The effective tax rate in 1995 and 1994 is substantially less than the U.S. federal tax rate mainly due to the tax treatment of income from unconsolidated international affiliates, and energy and affordable housing tax credits, as shown in Note 9 to the Financial Statements.\nFactors Affecting Results of Operations\nNSP's results of operations during 1995, 1994 and 1993 were primarily dependent upon the operations of the Company's and Wisconsin Company's utility businesses consisting of the generation, transmission, distribution and sale of electricity and the distribution, transportation and sale of natural gas. NSP's utility revenues depend on customer usage, which varies with weather conditions, general business conditions, the state of the economy and the cost of energy services. Various regulatory agencies approve the prices for electric and gas service within their respective jurisdictions. In addition, NSP's non-regulated businesses are contributing significantly to NSP's earnings. The historical and future trends of NSP's operating results have been and are expected to be affected by the following factors:\nProposed Merger On April 28, 1995, the Company and WEC entered into an Agreement and Plan of Merger that provides for a business combination of NSP and WEC in a \"merger-of-equals\" transaction. As a result of the mergers contemplated by the merger agreement, Primergy will become the holding company for the regulated operations of both the Company and the utility subsidiary of WEC. The business combination is intended to be tax-free for income tax purposes, and accounted for as a \"pooling of interests.\" On Sept. 13, 1995, more than 95 percent of the respective shareholders of the Company and WEC voting approved the merger plan at their respective shareholder meetings. Under the proposed business combination, shareholders of the Company would receive 1.626 shares of Primergy common stock for each share of the Company's common stock owned at the time of the merger.\nAfter the merger is completed, a transition to a new organization would begin. Anticipated cost savings of the new organization (compared with the continued independent operation of NSP and WEC) are estimated to be $2 billion over a 10-year period, net of transaction costs (about $30 million) and costs to achieve the merger savings (about $122 million). It is anticipated that the proposed merger will allow the companies to implement a modest reduction in electric retail rates and a four-year rate freeze for electric retail customers. In addition, the companies agreed to provide a four-year freeze in wholesale rates. After the merger, the regulated businesses of NSP and WEC would continue to operate as utility subsidiaries of Primergy, which would be registered under the Public Utility Holding Company Act of 1935 (PUHCA), as amended, and some of the Company's subsidiaries would be transferred to direct Primergy ownership. Except for certain gas distribution properties transferred to the Company, the Wisconsin Company will become part of the regulated business of WEC. Although NSP and WEC are working to avoid divestitures, the PUHCA may require the merged entity to divest certain of its gas utility and\/or non-regulated operations. Also, regulatory authorities may require the restructuring of transmission system operations or administration. NSP currently cannot determine if such divestitures or restructuring would be required. In addition, Wisconsin state law limits the total assets of non-utility affiliates of Primergy. This could affect the growth of non- regulated operations.\nThe agreement to merge is subject to a number of conditions, including approval by applicable regulatory authorities. During 1995, NSP and WEC received a ruling from the Internal Revenue Service indicating that the proposed successive merger transactions would not prevent treatment of the business combination as a tax-free reorganization under applicable tax law if each transaction independently qualified. During 1995, NSP and WEC submitted filings to the Federal Energy Regulatory Commission (FERC), applicable state regulatory commissions and other governmental authorities seeking approval of the proposed merger to form Primergy. The FERC has put the merger application on an accelerated schedule, ordering the administrative law judge's initial decision by Aug. 30, 1996, and briefs on exception by Sept. 30, 1996, which makes possible a FERC ruling on the merger application by the end of 1996. Although the goal of NSP and WEC is to receive approvals from all regulatory authorities by the end of 1996, some regulatory authorities have not established a timetable for their decision. Therefore, the timing of the approvals necessary to complete the merger is not known at this time. The state filings included a request for deferred accounting treatment and rate recovery of costs incurred associated with the proposed merger. At Dec. 31, 1995, $13.9 million of costs associated with the proposed merger had been deferred as a component of Intangible and Other Assets. In February 1996, the appropriate committees of the Minnesota Legislature passed legislation that would affect merger approval for electric utilities. The bill, if passed into law, would provide for certain binding commitments regarding minimum levels of staffing and investment for electric service.\nIn addition to the regulatory and other governmental approvals of the proposed merger, certain NSP financial and other agreements may be construed to require that, in the case of a change in ownership (such as the proposed merger), the other party to the agreement must consent to the change or waive the requirement. Agreements with such provisions at Dec. 31, 1995, include $101.7 million of long-term debt, operating lease agreements with annual payments of $1.3 million in 1996 and a $10 million credit line agreement, under which there were no borrowings at Dec. 31, 1995. Although neither consents nor waivers from the other parties have yet been obtained, NSP will seek to obtain them prior to the completion of the merger. (See further discussion of the proposed business combination in Note 18 to the Financial Statements.)\nRegulation NSP's utility rates are approved by the FERC, the Minnesota Public Utilities Commission (MPUC), the North Dakota Public Service Commission, the Public Service Commission of Wisconsin (PSCW), the Michigan Public Service Commission and the South Dakota Public Utilities Commission. Rates are designed to recover plant investment and operating costs and an allowed return on investment, using an annual period upon which rate case filings are based. NSP requests changes in rates for utility services as needed through filings with the governing commissions. The rates charged to retail customers in Wisconsin are reviewed and adjusted biennially. Because comprehensive rate changes are not requested annually in Minnesota, NSP's primary jurisdiction, changes in operating costs can affect NSP's earnings, shareholders' equity and other financial results. Except for Wisconsin electric operations, NSP's rate schedules provide for cost-of-energy and resource adjustments to billings and revenues for changes in the cost of fuel for electric generation, purchased energy, purchased gas, and conservation and energy management program costs. For Wisconsin electric operations, the biennial retail rate review process considers changes in electric fuel and purchased energy costs in lieu of a cost-of-energy adjustment clause. In addition to changes in operating costs, other factors affecting rate filings are sales growth, conservation and demand-side management efforts and the cost of capital.\nCompetition The Energy Policy Act of 1992 (the Act) was a catalyst for comprehensive and significant changes in the operation of electric utilities, including increased competition. The Act's reform of the PUHCA promotes creation of wholesale non-utility power generators and authorizes the FERC to require utilities to provide wholesale transmission services to third parties. The legislation allows utilities and non- regulated companies to build, own and operate power plants nationally and internationally without being subject to restrictions that previously applied to utilities under the PUHCA. Management believes this legislation will promote the continued trend of increased competition in the electric energy markets. NSP management plans to continue its efforts to be a competitively priced supplier of electricity and an active participant in the competitive market for electricity. The proposed merger with WEC is a key strategic initiative designed to facilitate NSP's effective competition in the future energy marketplace.\nIn March 1995, the FERC issued a Notice of Proposed Rulemaking on Open Access Non-discriminatory Transmission Services and a Supplemental Notice of Proposed Rulemaking on Stranded Investment (together called the Mega-NOPR). The Mega- NOPR is intended to create a vigorous wholesale electric market by requiring transmission providers to offer open access to their transmission systems. The FERC is proposing to require utilities to unbundle power sales from transmission. This \"unbundled service\" requirement would apply only to new requirements contracts and new coordination trade contracts. The Mega-NOPR would apply to all utilities under the FERC's jurisdiction and would require each utility to file individual tariffs. The FERC also seeks to require non-jurisdictional transmission-providing entities (such as municipals and cooperatives) to offer open access by including a reciprocity clause in their individual tariffs so that those who take service from a FERC jurisdictional utility must also offer open access. Concurrently with the Mega-NOPR, the FERC issued a proposal for a Real-Time Information Network intended to facilitate open access by requiring all public utilities to create an electronic bulletin board of information regarding their transmission system services, availability and rates. Also in the Mega-NOPR, the FERC proposed to consider cases involving stranded costs resulting from open access (a) when a state regulatory commission does not have authority under state law to address such costs at the time retail wheeling (which is the transmission to retail customers of power generated by a third party, in competition with supplies from the host utility) takes place, and (b) after a state commission has addressed such costs. In response to the FERC's proposals, NSP filed comments with the FERC that supported the Mega-NOPR's open access initiative and asserted NSP's intent that open access transmission tariffs filed in 1994 comply with the spirit of the Mega-NOPR. NSP expects the impact of any rulemaking such as the Mega-NOPR to be consistent with its efforts to be a competitively priced supplier of electricity and an active participant in the competitive market for electricity.\nWith the development of electric industry competition, the Company has experienced an increase in requests for the use of its transmission system. A large portion of these requests is due to the increase in FERC-approved power marketers. In 1995, the Company filed 23 transmission service agreements for FERC approval, including 10 with power marketers. While the annual transmission revenue in 1995 from this activity was immaterial, it is expected that 1996 revenues will increase due to the growth of power marketing activity in this region.\nIn response to the developing electric industry competition, Cenergy applied for and was granted permission by the FERC to market electricity (except electricity generated by NSP) in the United States, effective Dec. 1, 1994. Cenergy was one of the first affiliates of an electric utility to obtain this approval from the FERC.\nSome states are considering proposals to increase competition in the supply of electricity. In response to a proposal in 1994 by its regulator in Wisconsin, NSP outlined the transitional steps necessary to create an open and fair competitive electric market. NSP's position is that all customers should be able to choose their electric supplier by 2001, and that generation also should be deregulated by 2001. NSP proposes that utilities retain operational control of their transmission and distribution systems, and that utilities should be permitted to recover the cost of investments made under traditional regulation. Regulators in Minnesota and Wisconsin are currently considering what actions they should take regarding electric industry competition. In Wisconsin, regulators developed a plan for a phased approach. They voted to adopt a restructuring plan, which includes a 32-step phase-in of retail wheeling by the year 2001. A key component of the plan is to provide the protections necessary to ensure that consumers are not harmed in an increasingly competitive environment. One component of the plan is to have an independent system operator control transmission access. In Minnesota, regulators have developed draft principles to provide a framework for electric industry restructuring. They have not established definitive timelines for industry restructuring or changes. One of the principles supports an open transmission system and establishing a robust wholesale competitive market. NSP believes the transition to a more competitive electric industry is inevitable and beneficial for all consumers. NSP supports an orderly and efficient transition to an open, fair and competitive energy market for all customers and suppliers. The timing of regulatory actions and their impact on NSP cannot be predicted and may be significant.\nDuring 1992 and 1993, the FERC issued a series of orders (together called Order 636) addressing interstate natural gas pipeline service restructuring. This restructuring \"unbundled\" each of the services (sales, transportation, storage and ancillary services) traditionally provided by gas pipeline companies. Interstate pipelines have been allowed to recover from their customers 100 percent of prudently incurred transition costs attributable to Order 636 restructuring. Under service agreements that went into effect Nov. 1, 1993, NSP estimates that it will be responsible for less than $11 million of transition costs over a five-year period beginning on that date. To date, NSP's regulatory commissions have approved recovery of these restructuring charges in retail gas rates through the purchased gas adjustment. NSP does not believe Order 636 has materially affected its cost of gas supply. NSP's acquisitions of Viking and Cenergy in 1993 have enhanced its ability to participate in the more competitive gas transportation business. In implementing Order 636, Viking incurred no transition costs.\nCustomer Cogeneration Koch Refining Co. (Koch), the Company's largest customer which provides approximately $30 million in annual revenues to NSP, proposes to build a cogeneration plant to burn petroleum coke, a refinery byproduct, to produce between 180 and 250 megawatts of electricity. This would be enough supply for Koch's own use plus an additional 80 to 150 megawatts to be sold on the wholesale market. Koch is requesting a legislative exemption from Minnesota property tax for its plant. While NSP supports the reduction of taxes on generating facilities, it believes any reduction should be applied to all generating facilities so that there are no unfair tax advantages available to some generators. This project has several implications for NSP: 1) Koch could become a competitor as it seeks markets for its excess capacity; 2) Koch's capacity would also represent a potential power source for NSP; and 3) Koch's plan represents a potential loss of a large retail customer. The project's anticipated three-year lead time will allow NSP to respond appropriately.\nWholesale Customers NSP had wholesale revenues from sales of electricity of approximately $44 million in 1995 and approximately $57 million in 1994. The trend of increased competition, as previously discussed, has resulted in significant changes in the negotiation of contracts with wholesale customers. In the past several years, these customers have begun to evaluate a variety of energy sources to provide their power supply. While the full impact of these changes is unknown at this time, the following changes have been identified.\nIn 1992, nine of the Company's municipal wholesale electric customers notified the Company of their intent to terminate their power supply agreements with the Company, effective July 1995 or July 1996. The loss of seven of these customers in July 1995 resulted in a revenue decrease of approximately $12 million from 1994 levels. The other two customers, who are expected to terminate their power agreements in July 1996, provided revenues of $3.6 million in 1995. These nine customers are expected to become wheeling customers providing estimated annual revenues of nearly $3 million. NSP's remaining 19 municipal wholesale electric customers are under contracts with terms expiring in the years 1999 through 2008.\nDuring 1993, the Company signed an electric power agreement to provide Michigan's Upper Peninsula Power Company (UPPCO) with up to 150 megawatts of baseload service, peaking service options and load regulation service options for 20 years from January 1998 through December 2017. Load regulation service is designed to change the level of power delivery during each hour to match UPPCO's load requirements. UPPCO has nominated 50 megawatts of baseload and five megawatts of winter season peaking power purchases from NSP beginning Jan. 1, 1998. The annual revenue for 1998 is projected to be approximately $11 million to $14 million. The interchange agreement between UPPCO and NSP for this sale was accepted by the FERC. The Michigan Public Utilities Commission also must approve the transaction.\nRate Changes As discussed previously under Utility Operating Results, filings for rate changes in 1995 had an immaterial impact on financial results. No significant general rate filings in any of NSP's utility jurisdictions are expected for 1996. However, the Company has proposed rate changes in connection with requested approvals of its proposed business combination with WEC, as discussed previously.\nUsed Nuclear Fuel Storage and Disposal In 1994, NSP received legislative authorization from the State of Minnesota for dry cask fuel storage facilities at the Company's Prairie Island nuclear generating facility. As a condition of this authorization, the Minnesota Legislature established several resource commitments for the Company, including wind and biomass generation sources, as well as other requirements. In addition, the Company and other utilities filed a lawsuit against the DOE in 1994 to compel the DOE to fulfill its statutory and contractual obligations to store and dispose of used nuclear fuel as required by the Nuclear Waste Policy Act of 1982. Also, the Company is leading a consortium to establish a private facility for interim storage of used nuclear fuel, the outcome of which is uncertain at this time. (See Notes 14 and 15 to the Financial Statements for more information.)\nEnvironmental Matters NSP incurs several types of environmental costs, including nuclear plant decommissioning, storage and ultimate disposal of used nuclear fuel, disposal of hazardous materials and wastes, remediation of contaminated sites and monitoring of discharges into the environment. Because of the continuing trend toward greater environmental awareness and increasingly stringent regulation, NSP has been experiencing a trend toward increasing environmental costs. This trend has caused, and may continue to cause, slightly higher operating expenses and capital expenditures for environmental compliance. In addition to nuclear decommissioning and used nuclear fuel disposal expenses (as discussed in Note 14 to the Financial Statements), costs charged to NSP's operating expenses for environmental monitoring and disposal of hazardous materials and wastes in 1995 were approximately $26 million and are expected to increase to an average annual amount of approximately $30 million for the five-year period 1996-2000. However, the precise timing and amount of environmental costs, including those for site remediation and disposal of hazardous materials, are currently unknown. In each of the years, 1995, 1994 and 1993, the Company spent about $15 million for capital expenditures on environmental improvements at its utility facilities. In 1996, the Company expects to incur approximately $20 million in capital expenditures for compliance with environmental regulations and approximately $180 million for the five-year period 1996-2000. These capital expenditure amounts include the costs of constructing used nuclear fuel storage casks. (See Notes 14 and 15 to the Financial Statements for further discussion of these and other environmental contingencies that could affect NSP.)\nWeather NSP's earnings can be significantly affected by unusual weather. In 1995, unusual weather, mainly a hot summer, increased earnings over a normal year by an estimated 21 cents per share. Mild weather, mainly cool summers, reduced earnings from a normal year by an estimated 13 cents per share in 1994 and 18 cents per share in 1993. The effect of weather is considered part of NSP's ongoing business operations.\nAcquisitions In 1994, NRG acquired ownership interests in three significant international energy projects (listed in Note 3 to the Financial Statements). NSP also made three other strategically important business acquisitions in 1993, including an interstate natural gas pipeline (Viking), an energy services marketing business (Cenergy) and a steam heating and chilled water cooling system business (Minneapolis Energy Center, now an NRG subsidiary). NSP continues to evaluate opportunities to enhance its competitive position and shareholder returns through strategic business acquisitions.\nImpact of Non-regulated Investments NSP's net income includes after-tax earnings of $33.6 million, or 50 cents per share, from all of its non-regulated businesses in 1995 and $32.9 million, or 49 cents per share, in 1994. As discussed previously, NRG acquired equity interests in three significant energy projects in 1994. NSP expects to continue investing significant amounts in non-regulated projects, including domestic and international power production projects through NRG, as described under Future Financing Requirements. Depending on the success and timing of involvement in these projects, NSP's goal is for NRG earnings to increase in the future to contribute at least 20 percent of NSP's earnings by the year 2000. The non-regulated projects in which NRG has invested carry a higher level of risk than NSP's traditional utility businesses. Current and future investments in non-regulated projects are subject to uncertainties prior to final legal closing, and continuing operations are subject to foreign government actions, foreign economic and currency risks, partnership actions, competition, operating risks, dependence on certain suppliers and customers, domestic and foreign environmental and energy regulations, or all of these items. Most of NRG's current project investments consist of minority interests, and a substantial portion of future investments may take the form of minority interests, which limits NRG's ability to control the development or operation of the projects. In addition, significant expenses may be incurred for potential projects pursued by NRG that may never materialize. The operating results of NSP's non-regulated businesses in 1995 and 1994 may not necessarily be indicative of future operating results.\nAccounting Changes The Financial Accounting Standards Board (FASB) has issued two new accounting standards that become effective in 1996. Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets, establishes standards for measuring and recognizing asset impairments. SFAS No. 123, Accounting for Stock-Based Compensation, provides an optional accounting method for compensation from stock option and other stock award programs that NSP does not intend to use. NSP does not expect the adoption of these new accounting standards to have a material impact on its results of operations or financial condition. However, the principles of SFAS No. 121 will be followed to measure the effects of any stranded investments that could arise from the Act, the FERC's Mega-NOPR proposal or other competitive business developments.\nThe FASB also has proposed new accounting standards expected to go into effect in 1997. The standards would require the full accrual of nuclear plant decommissioning and certain other site exit obligations. Material adjustments to NSP's balance sheet could occur under the FASB's proposal. However, the effects of regulation are expected to minimize or eliminate any impact on operating expenses and earnings from this future accounting change. (For further discussion of the expected impact of this change, see Note 14 to the Financial Statements.)\nUse of Derivatives Through its non-regulated subsidiaries, NSP uses derivative financial instruments to hedge the risks of fluctuations in foreign currencies and natural gas prices. Also, to hedge the interest rate risk associated with fixed rate debt in a declining interest rate environment, NSP uses interest rate swap agreements to convert fixed rate debt to variable rate debt. (See Notes 1 and 11 to the Financial Statements for further discussion of NSP's financial instruments and derivatives.)\nNon-recurring Items NSP's earnings for 1995 include two significant unusual or infrequently occurring items. As discussed in the Non-regulated Business Results section, NRG recognized a pretax gain of approximately $30 million (26 cents per share) from a power sales contract termination settlement. Partially offsetting this gain was an asset impairment write- down of $5 million before taxes (4 cents per share) for a non- regulated domestic energy project.\nNSP's 1994 earnings also included several significant unusual or infrequently occurring items. Although their net effect was an earnings increase of only 1 cent per share, individually significant non-recurring items included a gain on termination of a non-regulated cogeneration contract, interest income from the settlement of a federal income tax dispute, a charge for pre-1994 postemployment costs associated with adopting SFAS No. 112, and asset impairment write-downs for certain non-regulated energy projects.\nInflation Historically, certain operating costs, mainly labor and property taxes, have been affected by inflation. Also, inflation has tended to increase the replacement cost of operating facilities, which has increased depreciation expense when replacement facilities are constructed. However, several significant expense items, including fuel costs, income taxes and interest expense have been less sensitive to inflation. Overall, inflation at the levels currently being experienced is not expected to materially affect NSP's prices to customers or returns to shareholders.\nLIQUIDITY AND CAPITAL RESOURCES\n1995 Financing Requirements NSP's need for capital funds is primarily related to the construction of plant and equipment to meet the needs of electric and gas utility customers and to fund equity commitments or other investments in non-regulated businesses. Total NSP utility capital expenditures (including AFC) were $386 million in 1995. Of that amount, $318 million related to replacements and improvements of NSP's electric system and nuclear fuel, and $37 million involved construction of natural gas distribution facilities. NSP companies invested $71 million in non-regulated projects and property in 1995. NRG primarily invested in existing projects. In 1995, Cenergy became a majority investor (80 percent) in Energy Masters Corporation, a firm specializing in energy efficiency improvement services for commercial, industrial and institutional customers. The investment is accounted for on a consolidated basis. Eloigne Company invested in affordable housing projects, including wholly owned and limited partnership ventures.\n1995 Financing Activity During 1995, NSP's primary sources of capital included internally generated funds, long-term debt, short-term debt and common stock issuances, as discussed below. The allocation of financing requirements between these capital options is based on the relative cost of each option, regulatory restrictions and the constraints of NSP's long-range capital structure objectives. During 1995, NSP continued to meet its long-range regulated capital structure objective of 45-50 percent common equity and 42-50 percent debt.\nFunds generated internally from operating cash flows in 1995 remained sufficient to meet working capital needs, debt service, dividend payout requirements and non-regulated investment commitments, as well as fund a significant portion of construction expenditures. The pretax interest coverage ratio, excluding AFC, was 3.8 in 1995 and 3.9 in 1994. These ratios met NSP's objective range of 3.5-5.0 for interest coverage. Internally generated funds could have provided financing for 85 percent of NSP's total capital expenditures for 1995 and 72 percent of the $1.9 billion in capital expenditures incurred for the five-year period 1991-1995.\nNSP had approximately $216 million in short-term borrowings outstanding as of Dec. 31, 1995. Throughout 1995, short-term borrowings were used to finance a portion of utility capital expenditures and provide for other NSP cash needs.\nIn 1995, the Company issued $250 million of first mortgage bonds to refinance higher-cost debt issues and reduce short-term debt levels. Eloigne Company also issued approximately $12.5 million of long-term debt to finance affordable housing project investments.\nDuring 1995, the Company issued new shares of common stock under various stock plans, including 536,360 new shares under the Employee Stock Ownership Plan (ESOP), 527,671 new shares under the Dividend Reinvestment and Stock Purchase Plan (DRSPP), and 63,780 new shares under the Executive Long-Term Incentive Award Stock Plan. In addition, the Company issued common stock in connection with a non-regulated business acquisition. At Dec. 31, 1995, the total number of common shares outstanding was 68,175,934.\nNSP's equity investments in non-regulated projects during 1995 were financed through internally generated funds. Project financing requirements, in excess of equity contributions from investors, were satisfied with project debt. Project debt associated with many of NSP's non-regulated investments is not reflected in NSP's balance sheet because the equity method of accounting is used for such investments. (See Note 3 to the Financial Statements.)\nIn January 1996, NRG issued $125 million of 7.625 percent unsecured Senior Notes maturing in 2006 to support equity requirements for projects currently under way and in development. The Senior Notes were assigned ratings of BBB- by S&P's Rating Group and Baa3 by Moody's.\nFuture Financing Requirements Utility financing requirements for 1996-2000 may be affected in varying degrees by numerous factors, including load growth, changes in capital expenditure levels, rate changes allowed by regulatory agencies, new legislation, market entry of competing electric power generators, changes in environmental regulations and other regulatory requirements. NSP currently estimates that its utility capital expenditures will be $410 million in 1996 and $1.9 billion for the five-year period 1996-2000. Of the 1996 amount, approximately $345 million is scheduled for utility electric facilities and approximately $45 million for natural gas facilities including Viking. In addition to utility capital expenditures, expected financing requirements for the 1996-2000 period include approximately $480 million to retire long-term debt and meet first mortgage bond sinking fund requirements.\nThrough its subsidiaries, NSP expects to invest significant amounts in non-regulated projects in the future. Financing requirements for non-regulated project investments may vary depending on the success, timing and level of involvement in projects currently under consideration. NSP's potential capital requirements for non-regulated projects and property are estimated to be approximately $140 million in 1996 and approximately $550 million for the five-year period 1996-2000. These amounts include commitments for NRG investments, as discussed in Note 15 to the Financial Statements, and Eloigne Company investments of up to $13 million annually in 1996-2000 for affordable housing projects. Eloigne Company expects to finance approximately 65 percent of these investments in affordable housing projects with equity and approximately 35 percent with long-term debt. In addition to investments in non- regulated projects, NSP continues to evaluate opportunities to enhance shareholder returns and achieve long-term financial objectives through acquisitions of existing businesses. Long- term financing may be required for such investments.\nThe Company also will have future financing requirements for the portion of nuclear plant decommissioning costs not funded externally. Based on the most recent decommissioning study, these amounts are anticipated to be approximately $363 million, and are expected to be paid during the years 2010 to 2022.\nFuture Sources of Financing NSP expects to obtain external capital for future financing requirements by periodically issuing long-term debt, short-term debt, common stock and preferred stock as needed to maintain desired capitalization ratios. Over the long-term, NSP's equity investments in non- regulated projects are expected to be financed through internally generated funds or the Company's issuance of common stock. Financing requirements for the non-regulated projects, in excess of equity contributions from investors, are expected to be fulfilled through project or subsidiary debt. Decommissioning expenses not funded by an external trust are expected to be financed through a combination of internally generated funds, long-term debt and common stock. The extent of external financing to be required for nuclear decommissioning costs, as discussed above, is unknown at this time.\nNSP's ability to finance its utility construction program at a reasonable cost and to provide for other capital needs depends on its ability to meet investors' return expectations. Financing flexibility is enhanced by providing working capital needs and a high percentage of total capital requirements from internal sources, and having the ability to issue long-term securities and obtain short-term credit. NSP expects to maintain adequate access to securities markets in 1996. Access to securities markets at a reasonable cost is determined in large part by credit quality. The Company's first mortgage bonds are rated AA- by Standard & Poor's Corporation, A1 by Moody's Investors Service, Inc. (Moody's), AA- by Duff & Phelps, Inc., and AA by Fitch Investors Service, Inc. Ratings for the Wisconsin Company's first mortgage bonds are generally comparable. These ratings reflect the views of such organizations, and an explanation of the significance of these ratings may be obtained from each agency. In May 1994, Moody's downgraded the Company's first mortgage bond ratings to A1 based on its interpretation of provisions of a Minnesota law enacted in 1994 for used nuclear fuel storage at the Prairie Island generating plant. (The other three rating agencies reaffirmed their ratings of the Company's bonds after considering the potential impact of the legislation on NSP.) As discussed in Notes 14 and 15 to the Financial Statements, the legislation requires the Company to increase its use of renewable energy sources such as wind and biomass power. Moody's has indicated that it believes these sources of power are considerably more costly than the power currently generated and that NSP's electric production costs will increase materially over current levels. NSP acknowledges that electric production costs may increase as a result of the Prairie Island legislation. In 1995, Moody's placed the Company's ratings on credit review for possible upgrade based on anticipated cost savings from the proposed merger with WEC, which was discussed previously.\nThe Company's and the Wisconsin Company's first mortgage indentures limit the amount of first mortgage bonds that may be issued. The MPUC and the PSCW have jurisdiction over securities issuance. At Dec. 31, 1995, with an assumed interest rate of 7.0 percent, the Company could have issued about $2.5 billion of additional first mortgage bonds under its indenture, and the Wisconsin Company could have issued about $356 million of additional first mortgage bonds under its indenture.\nThe Company filed a shelf registration for first mortgage bonds with the Securities and Exchange Commission (SEC) in October 1995. Depending on capital market conditions, the Company expects to issue the $300 million of registered, but unissued, bonds over the next several years to raise additional capital or redeem outstanding securities. In addition, depending on market conditions, the Wisconsin Company may issue up to $65 million in first mortgage bonds to redeem outstanding securities or raise additional capital.\nThe Company's Board of Directors has approved short-term borrowing levels up to 10 percent of capitalization. The Company has received regulatory approval for up to $445 million in short-term borrowing levels and plans to keep its credit lines at or above its average level of commercial paper borrowings. Commercial banks presently provide credit lines of approximately $265 million to the Company and an additional $17 million to subsidiaries of the Company. These credit lines make short-term financing available in the form of bank loans.\nThe Company's Articles of Incorporation authorize the maximum amount of preferred stock that may be issued. Under these provisions, the Company could have issued all $460 million of its remaining authorized, but unissued, preferred stock at Dec. 31, 1995, and remained in compliance with all interest and dividend coverage requirements.\nThe level of common stock authorized under the Company's Articles of Incorporation is 160 million shares. In January 1996, the Company filed a registration statement with the SEC to provide for the sale of up to 1.6 million additional shares of new common stock under the Company's Dividend Reinvestment and Stock Purchase Plan (DRSPP) and Executive Long-Term Incentive Award Stock Plan. The Company may issue new shares or purchase shares on the open market for its stock-based plans. (See Note 5 to the Financial Statements for discussion of stock awards outstanding.) The Company plans to issue new shares for its DRSPP, ESOP and Executive Long-Term Incentive Award Stock plans in 1996. While no general public stock offerings are currently anticipated in 1996, such offerings may be necessary to fund significant equity investments in non-regulated projects should they occur.\nInternally generated funds from utility operations are expected to equal approximately 90 percent of anticipated utility capital expenditures for 1996 and approximately 100 percent of the $1.9 billion in anticipated utility capital expenditures for the five-year period 1996-2000. Internally generated funds from all operations are expected to equal approximately 75 percent and 90 percent, respectively, of the anticipated total capital expenditures for 1996 and the five- year period 1996-2000. Because NSP intends to reinvest foreign cash flows in non-U.S. operations, the equity income from international investments currently does not provide operating cash available for U.S. cash requirements such as payment of dividends, domestic capital expenditures and domestic debt service. Through NRG, NSP intends to pursue a diverse portfolio of foreign energy projects with varying levels of cash flows, income and foreign taxation to allow maximum flexibility of foreign cash flows.\nThe merger agreement, as previously discussed, provides for restrictions on certain transactions by both the Company and WEC, including the issuance of debt and equity securities. While the Company currently does not plan to enter into transactions that would not comply with these restrictions, circumstances may arise to make such transactions necessary. Under such circumstances, the Company and WEC would need to mutually agree to amend the merger agreement.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nSee Item 14(a)-1 in Part IV for index of financial statements included herein.\nSee Note 17 of Notes to Financial Statements for summarized quarterly financial data.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders of Northern States Power Company:\nIn our opinion, the accompanying consolidated balance sheet and statement of capitalization and the related consolidated statements of income, of common stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Northern States Power Company, a Minnesota corporation, and its subsidiaries at Dec. 31, 1995, and the results of their operations and their cash flows for the year 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 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. The consolidated financial statements of the Company and its subsidiaries for the years ended Dec. 31, 1994 and 1993 were audited by other independent accountants whose report dated Feb. 8, 1995 expressed an unqualified opinion on those statements and included an explanatory paragraph related to a change in method of accounting for postretirement health care costs in 1993.\n(Price Waterhouse LLP)\nPRICE WATERHOUSE LLP Minneapolis, Minnesota February 5, 1996 INDEPENDENT AUDITORS' REPORT\nTo the Shareholders of Northern States Power Company:\nWe have audited the accompanying consolidated balance sheet and statement of capitalization of Northern States Power Company (Minnesota) and its subsidiaries (the Companies) as of December 31, 1994, and the related consolidated statements of income, changes in common stockholders' equity, and cash flows for each of the two years in the period ended December 31, 1994, listed in the accompanying table of contents in Item 14(a)1. These consolidated financial statements and financial statement schedules are the responsibility of the Companies' management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the 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.\nAs discussed in Note 2 to the financial statements, the Companies changed their method of accounting for postretirement health care costs in 1993.\n(Deloitte & Touche LLP)\nDELOITTE & TOUCHE LLP Minneapolis, Minnesota February 8, 1995\nNOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nSystem of Accounts Northern States Power Company, a Minnesota corporation (the Company), is predominantly a regulated public utility serving customers in Minnesota, North Dakota and South Dakota. Northern States Power Company, a Wisconsin corporation (the Wisconsin Company), a wholly owned subsidiary of the Company, is a regulated public utility serving customers in Wisconsin and Michigan. Another wholly owned subsidiary, Viking Gas Transmission Company (Viking), is a regulated natural gas transmission company that operates a 500-mile interstate natural gas pipeline. Consequently, the Company, the Wisconsin Company and Viking maintain accounting records in accordance with either the uniform system of accounts prescribed by the Federal Energy Regulatory Commission (FERC) or those prescribed by state regulatory commissions, whose systems are the same in all material respects.\nPrinciples of Consolidation The consolidated financial statements include all material companies in which NSP holds a controlling financial interest, including: the Wisconsin Company; NRG Energy, Inc. (NRG); Viking; Cenergy, Inc. (Cenergy), which changed its name to Cenerprise, Inc. effective Jan. 1, 1996; and Eloigne Company. As discussed in Note 3, NSP has investments in partnerships, joint ventures and projects for which the equity method of accounting is applied. Earnings from equity in international investments are recorded net of foreign income taxes. All significant intercompany transactions and balances have been eliminated in consolidation except for intercompany and intersegment profits for sales among the electric and gas utility businesses of the Company, the Wisconsin Company and Viking, which are allowed in utility rates. The Company and its subsidiaries collectively are referred to herein as NSP.\nRevenues Revenues are recognized based on products and services provided to customers each month. Because utility customer meters are read and billed on a cycle basis, unbilled revenues (and related energy costs) are estimated and recorded for services provided from the monthly meter-reading dates to month- end.\nThe Company's rate schedules, applicable to substantially all of its utility customers, include cost-of-energy adjustment clauses, under which rates are adjusted to reflect changes in average costs of fuels, purchased energy and gas purchased for resale. The Company's rate schedules in Minnesota also include a rate adjustment clause, which is to be adjusted annually, to reflect changes in recovery of electric and gas deferred conservation program costs. As ordered by its primary regulator, Wisconsin Company retail rate schedules include a cost-of-energy adjustment clause for purchased gas but not for electric fuel and purchased energy. The biennial retail rate review process for Wisconsin electric operations considers changes in electric fuel and purchased energy costs in lieu of a cost-of-energy adjustment.\nUtility Plant and Retirements Utility plant is stated at original cost. The cost of additions to utility plant includes contracted work, direct labor and materials, allocable overhead costs and allowance for funds used during construction. The cost of units of property retired, plus net removal cost, is charged to the accumulated provision for depreciation and amortization. Maintenance and replacement of items determined to be less than units of property are charged to operating expenses.\nAllowance for Funds Used During Construction (AFC) AFC, a non- cash item, is computed by applying a composite pretax rate, representing the cost of capital used to finance utility construction activities, to qualified Construction Work in Progress (CWIP). The AFC rate was 6.0 percent in 1995, 5.0 percent in 1994 and 7.4 percent in 1993. The amount of AFC capitalized as a construction cost in CWIP is credited to other income (for equity capital) and interest charges (for debt capital). AFC amounts capitalized in CWIP are included in rate base for establishing utility service rates. In addition to construction-related amounts, AFC is also recorded to reflect returns on capital used to finance conservation programs.\nDepreciation For financial reporting purposes, depreciation is computed by applying the straight-line method over the estimated useful lives of various property classes. The Company files with the Minnesota Public Utilities Commission (MPUC) an annual review of remaining lives for electric and gas production properties. The most recent studies, as approved by the MPUC, recommended a decrease of approximately $0.2 million and an increase of approximately $0.5 million for the 1995 and 1994 annual depreciation accruals, respectively.\nEvery five years, the Company also must file an average service life filing for transmission, distribution and general properties. The most recent filings approved by the MPUC were in 1994 for general plant and in 1993 for all other facilities. Depreciation provisions, as a percentage of the average balance of depreciable utility property in service, were 3.64 percent in 1995, 3.55 percent in 1994 and 3.47 percent in 1993.\nDecommissioning As discussed in Note 14, NSP currently is recording the future costs of decommissioning the Company's nuclear generating plants through annual depreciation accruals. The provision for the estimated decommissioning costs has been calculated using an annuity approach designed to provide for full expense accrual (with full rate recovery) of the future decommissioning costs, including reclamation and removal, over the estimated operating lives of the Company's nuclear plants. The Financial Accounting Standards Board (FASB) has proposed new accounting standards expected to go into effect in 1997. The standards would require the full accrual of nuclear plant decommissioning and certain other site exit obligations beginning in 1997. (See Note 14 for more discussion of this proposed standard.)\nNuclear Fuel Expense The original cost of nuclear fuel is amortized to fuel expense based on energy expended. Nuclear fuel expense also includes assessments from the U.S. Department of Energy (DOE) for costs of future fuel disposal and DOE facility decommissioning, as discussed in Note 14.\nEnvironmental Costs Accruals for environmental costs are recognized when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. When a single estimate of the liability cannot be determined, the low end of the estimated range is recorded. Costs are charged to expense or deferred as a regulatory asset based on expected recovery in future rates, if they relate to the remediation of conditions caused by past operations, or if they are not expected to mitigate or prevent contamination from future operations. Where environmental expenditures relate to facilities currently in use, such as pollution control equipment, the costs may be capitalized and depreciated over the future service periods. Estimated remediation costs are recorded at undiscounted amounts, independent of any insurance or rate recovery, based on prior experience, assessments and current technology. Accrued obligations are regularly adjusted as environmental assessments and estimates are revised, and remediation efforts proceed. For sites where NSP has been designated as one of several potentially responsible parties, the amount accrued represents NSP's estimated share of the cost. NSP intends to treat any future costs incurred related to decommissioning and restoration of its non-nuclear power plants and substation sites, where operation may extend indefinitely, as a capitalized removal cost of retirement in utility plant. Depreciation expense levels currently recovered in rates include a provision for an estimate of removal costs (based on historical experience).\nIncome Taxes NSP records income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109--- Accounting for Income Taxes. Under the liability method required by SFAS No. 109, income taxes are deferred for all temporary differences between pretax financial and taxable income and between the book and tax bases of assets and liabilities. Deferred taxes are recorded using the tax rates scheduled by law to be in effect when the temporary differences reverse. Due to the effects of regulation, current income tax expense is provided for the reversal of some temporary differences previously accounted for by the flow-through method. Also, regulation has created certain regulatory assets and liabilities related to income taxes, as summarized in Note 10. NSP's policy for income taxes related to international operations is discussed in Note 9.\nInvestment tax credits are deferred and amortized over the estimated lives of the related property.\nForeign Currency Translation The local currencies are generally the functional currency of NSP's foreign operations. Foreign currency denominated assets and liabilities are translated at end-of-period rates of exchange. The resulting currency translation adjustments are accumulated and reported as a separate component of stockholders' equity. Income, expense and cash flows are translated at weighted-average rates of exchange for the period.\nExchange gains and losses that result from foreign currency transactions (e.g. converting cash distributions made in one currency to another) are included in the results of operations as a component of equity in earnings of unconsolidated affiliates. Through Dec. 31, 1995, NSP had not experienced any material translation gains or losses from foreign currency transactions that have occurred since the respective foreign investment dates.\nDerivative Financial Instruments NSP's policy is to hedge foreign currency denominated investments as they are made to preserve their U.S. dollar value, where appropriate hedging instruments are available. NRG has entered into currency hedging transactions through the use of forward foreign currency exchange agreements. Gains and losses on these agreements offset the effect of foreign currency exchange rate fluctuations on the valuation of the investments underlying the hedges. Hedging gains and losses, net of income tax effects, are reported with other currency translation adjustments as a separate component of stockholders' equity. NRG is not hedging currency translation adjustments related to future operating results. NSP does not speculate in foreign currencies. A second derivative arrangement is the use of natural gas futures contracts by Cenergy to manage the risk of gas price fluctuations. The cost or benefit of natural gas futures contracts is recorded when related sales commitments are fulfilled as a component of Cenergy's non- regulated operating expenses. NSP does not speculate in natural gas futures. A third derivative instrument used by NSP is interest rate swaps that convert fixed rate debt to variable rate debt. The cost or benefit of the interest rate swap agreements is recorded as a component of interest expense. None of these three derivative financial instruments is reflected on NSP's balance sheet.\nUse of Estimates In recording transactions and balances resulting from business operations, NSP uses estimates based on the best information available. Estimates are used for such items as plant depreciable lives, tax provisions, uncollectible accounts, environmental loss contingencies, unbilled revenues and actuarially determined benefit costs. As better information becomes available (or actual amounts are determinable), the recorded estimates are revised. Consequently, operating results can be affected by revisions to prior accounting estimates. Recent changes in interest rates have resulted in changes to actuarial assumptions used in the benefit cost calculations for postretirement benefits. Also, the depreciable lives of certain plant assets are reviewed and, if appropriate, revised each year, as discussed previously. (See Notes 8, 14 and 15 for more information on the effects of these changes in estimates.)\nCash Equivalents NSP considers investments in certain debt instruments (primarily commercial paper) with an original maturity to NSP of three months or less at the time of purchase to be cash equivalents.\nRegulatory Deferrals As regulated utilities, the Company, the Wisconsin Company and Viking account for certain income and expense items under the provisions of SFAS No. 71---Accounting for the Effects of Regulation. In doing so, certain costs that would otherwise be charged to expense are deferred as regulatory assets based on expected recovery from customers in future rates. Likewise, certain credits that otherwise would be reflected as income are deferred as regulatory liabilities based on expected flowback to customers in future rates. Management's expected recovery of deferred costs and expected flowback of deferred credits are generally based on specific ratemaking decisions or precedent for each item. Regulatory assets and liabilities are amortized consistent with ratemaking treatment established by regulators. Note 10 describes the nature and amounts of these regulatory deferrals.\nOther Assets The purchase of various non-regulated entities from 1993-1995 at a price exceeding the underlying fair value of net assets acquired resulted in recorded goodwill of $20.3 million ($19.0 million net of accumulated amortization) at Dec. 31, 1995. This goodwill and other intangible assets acquired are being amortized using the straight-line method over periods of 15 to 30 years. NSP periodically evaluates the recovery of goodwill based on an analysis of estimated undiscounted future cash flows.\nIntangible and other assets also include deferred financing costs (net of amortization) of approximately $11.8 million at Dec. 31, 1995. These costs are being amortized over the remaining maturity period of the related debt.\nReclassifications Certain reclassifications have been made to the 1994 and 1993 financial statements to conform with the 1995 presentation. These reclassifications had no effect on net income or earnings per share.\n2. Accounting Changes\nPostemployment Benefits Effective Jan. 1, 1994, NSP adopted the provisions of SFAS No. 112---Employers' Accounting for Postemployment Benefits. This standard required the accrual of certain postemployment costs, such as injury compensation and severance, that are payable in the future. The Company's pre- 1994 liability of approximately $9.4 million (8 cents per share) was expensed in 1994.\nPostretirement Benefits As discussed in Note 8, NSP changed its accounting for postretirement medical and death benefits in 1993. Due to rate recovery of the expense increases, the change had an immaterial effect on net income. Of the 1993 cost increases due to adoption of SFAS No. 106, about $12 million was deferred to be amortized over rate recovery periods in 1994- 1996. In 1994, administrative and general expenses increased by approximately $16 million due to the full recognition of accrued SFAS No. 106 costs, including amounts deferred from 1993.\n3. Investments Accounted for by the Equity Method\nThrough its non-regulated subsidiaries, NSP has investments in various international and domestic energy projects and domestic affordable housing and real estate projects. The equity method of accounting is applied to such investments in affiliates, which include joint ventures and partnerships, because the ownership structure prevents NSP from exercising a controlling influence over operating and financial policies of the projects. Under this method, equity in the pretax income or losses of domestic partnerships and in the net income or losses of international projects is reflected as Equity in Earnings of Unconsolidated Affiliates. A summary of NSP's significant equity-method investments is as follows:\nInvestments in the MIBRAG and Gladstone projects in 1994 resulted in an increase in the equity in earnings from unconsolidated affiliates of approximately $26 million in 1994.\nSummarized Financial Information of Unconsolidated Affiliates Summarized financial information for these projects, including interests owned by NSP and other parties, was as follows (as of and for the years ended Dec. 31, 1995 and 1994):\nFinancial Position (Millions of dollars) 1995 1994 Current Assets $ 762.1 $ 514.9 Other Assets 2 631.9 1 593.8 Total Assets $3 394.0 $2 108.7\nCurrent Liabilities $ 295.5 $ 159.6 Other Liabilities 2 290.2 1 480.0 Equity 808.3 469.1 Total Liabilities and Equity $3 394.0 $2 108.7\nNSP's Equity Investment in Unconsolidated Affiliates $266.0 $179.1\nResults of Operations (Millions of dollars)\n1995 1994\nOperating Revenues $790.2 $778.4 Operating Income $154.2 $128.8 Net Income $160.2 $117.0\n4. Cumulative Preferred Stock\nThe Company has two series of adjustable rate preferred stock. The dividend rates are calculated quarterly and are based on prevailing rates of certain taxable government debt securities indices. At Dec. 31, 1995, the annualized dividend rates were $5.50 for both series A and series B.\nAt Dec. 31, 1995, the various preferred stock series were callable at prices per share ranging from $102.00 to $103.75, plus accrued dividends. In 1993, the Company redeemed all 350,000 shares of its $7.84 series Cumulative Preferred Stock at $103.12 per share.\n5. Common Stock and Incentive Stock Plans\nThe Company's Articles of Incorporation and First Mortgage Indenture provide for certain restrictions on the payment of cash dividends on common stock. At Dec. 31, 1995, the Company could have paid, without restrictions, additional cash dividends of more than $1 billion on common stock.\nNSP has an Executive Long-Term Incentive Award Stock Plan that permits granting non-qualified stock options. The options currently granted may be exercised one year from the date of grant and are exercisable thereafter for up to nine years. The plan also allows certain employees to receive restricted stock and other performance awards. Performance awards are valued in dollars, but paid in shares based on the market price at the time of payment. Transactions under the various incentive stock programs, which may result in the issuance of new shares, were as follows:\nStock Awards (Thousands of shares) 1995 1994 1993 Outstanding Jan. 1 782.4 537.1 528.7 Options granted 278.0 304.0 196.9 Other stock awards .2 9.5 Options and awards exercised (63.8) (42.6) (174.3) Options and awards forfeited (6.5) (16.1) (22.2) Other (.1) (.2) (1.5) Outstanding at Dec. 31 990.0 782.4 537.1\nOption price ranges: Unexercised at Dec. 31 $33.25-$45.50 $33.25-$43.50 $33.25-$43.50 Exercised during the year $33.25-$43.50 $33.25-$43.50 $33.25-$40.94\nUsing the treasury stock method of accounting for outstanding stock options, the weighted average number of shares of common stock outstanding for the calculation of primary earnings per share includes any dilutive effects of stock options and other stock awards as common stock equivalents. The differences between shares used for primary and fully diluted earnings per share were not material.\n6. Short-Term Borrowings\nNSP has approximately $282 million of commercial bank credit lines under commitment fee arrangements. These credit lines make short-term financing available in the form of bank loans and support for commercial paper sales. There were no borrowings against these credit lines at Dec. 31, 1995, and approximately $3.6 million of such borrowings, with interest payable at 9.75 percent, at Dec. 31, 1994. However, $9.6 million in letters of credit were outstanding, which reduced the available credit lines at Dec. 31, 1995.\nAt Dec. 31, 1995 and 1994, the Company had $215.6 million and $234.8 million, respectively, in short-term commercial paper borrowings outstanding. The weighted average interest rates on all short-term borrowings as of Dec. 31, 1995, and Dec. 31, 1994, were 5.7 percent and 6.1 percent, respectively.\n7. Long-Term Debt\nThe annual sinking-fund requirements of the Company's and the Wisconsin Company's First Mortgage Indentures are the amounts necessary to redeem 1 percent of the highest principal amount of each series of first mortgage bonds at any time outstanding, excluding those series issued for pollution control and resource recovery financings, and excluding certain other series totaling $990 million. The Company may, and has, applied property additions in lieu of cash payments on all series, as permitted by its First Mortgage Indenture. The Wisconsin Company also may apply property additions in lieu of cash on all series as permitted by its First Mortgage Indenture. Except for minor exclusions, all real and personal property of the Company and the Wisconsin Company is subject to the liens of the first mortgage indentures. Other debt securities are secured by a lien on the related real or personal property, as indicated on the Consolidated Statements of Capitalization.\nThe Company's First Mortgage Bonds Series due March 1, 2011, and the City of Becker Pollution Control Revenue Bonds Series due March 1, 2019, and Sept. 1, 2019, have variable interest rates, which currently change at various periods up to 270 days, based on prevailing rates for certain commercial paper securities or similar issues. The interest rates applicable to these issues averaged 5.2 percent, 3.7 percent and 3.8 percent, respectively, at Dec. 31, 1995. The 2011 series bonds are redeemable upon seven days notice at the option of the bondholder. The Company also is potentially liable for repayment of the 2019 Series Becker Bonds when the bonds are tendered, which occurs each time the variable interest rates change. The principal amount of all three series of these variable rate bonds outstanding represents potential short-term obligations and, therefore, is reported under current liabilities on the balance sheet.\nMaturities and sinking-fund requirements on long-term debt are: 1996, $25,760,000; 1997, $111,553,000; 1998, $14,457,000; 1999, $210,909,000; and 2000, $115,982,000.\n8. Benefit Plans and Other Postretirement Benefits\nNSP offers the following benefit plans to its benefit employees, of whom approximately 43 percent are represented by five local labor unions under a collective-bargaining agreement, which expires Dec. 31, 1996.\nPension Benefits NSP has a non-contributory, defined benefit pension plan that covers substantially all employees. Benefits are based on a combination of years of service, the employee's highest average pay for 48 consecutive months and Social Security benefits.\nIt is the Company's policy to fully fund the actuarially determined pension costs recognized for ratemaking purposes, subject to the limitations under applicable employee benefit and tax laws. Plan assets principally consist of common stock of public companies, corporate bonds and U.S. government securities. The funded status of NSP's pension plan as of Dec. 31 is as follows:\n(Thousands of dollars) 1995 1994 Actuarial present value of benefit obligation: Vested $686 403 $571 254 Non-vested 155 177 120 420\nAccumulated benefit obligation $841 580 $691 674\nProjected benefit obligation $1 039 981 $836 957 Plan assets at fair value 1 456 530 1 165 584 Plan assets in excess of projected benefit obligation (416 549) (328 627) Unrecognized prior service cost (20 805) (21 538) Unrecognized net actuarial gain 452 699 370 289 Unrecognized net transitional asset 615 691 Net pension liability recorded $15 960 $20 815\nFor regulatory purposes, the Company's pension expense is determined and recorded under the aggregate-cost method. As required by SFAS No. 87---Employers' Accounting for Pensions, the difference between the pension costs recorded for ratemaking purposes and the amounts determined under SFAS No. 87 is recorded as a regulatory liability on the balance sheet. Net annual periodic pension cost includes the following components:\n(Thousands of dollars) 1995 1994 1993\nService cost-benefits earned during the period $24 499 $27 536 $25 015 Interest cost on projected benefit obligation 69 742 65 107 71 075 Actual return on assets (344 837) (12 668) (152 019) Net amortization and deferral 240 458 (82 114) 66 299\nNet periodic pension cost determined under SFAS No. 87 (10 138) (2 139) 10 370 Additional costs recognized due to actions of regulators 10 454 3 922 5 117 Net periodic pension cost recognized for ratemaking $316 $1 783 $15 487\nThe weighted average discount rate used in determining the actuarial present value of the projected obligation was 7 percent in 1995 and 8 percent in 1994. The rate of increase in future compensation levels used in determining the actuarial present value of the projected obligation was 5 percent in 1995 and 1994. The assumed long-term rate of return on assets used for cost determinations under SFAS No. 87 was 9 percent for 1995 and 8 percent for 1994 and 1993. Assumption changes decreased 1995 pension costs (determined under SFAS No. 87) by approximately $21.5 million. Assumption changes are expected to increase 1996 pension costs (determined under SFAS No. 87) by approximately $13.6 million. Because the Company's pension expense is determined under the aggregate-cost method (not SFAS No. 87) for regulatory and financial reporting purposes, the effects of regulation prevent the majority of these assumption changes from affecting earnings.\nPostretirement Health Care NSP has a contributory health and welfare benefit plan that provides health care and death benefits to substantially all employees after their retirement. The plan is intended to provide for sharing the costs of retiree health care between NSP and retirees. For employees retiring after Jan. 1, 1994, a six-year cost-sharing strategy was implemented with retirees paying 15 percent of the total cost of health care in 1994, increasing to a total of 40 percent in 1999.\nEffective Jan. 1, 1993, NSP adopted the provisions of SFAS No. 106---Employers' Accounting for Postretirement Benefits Other Than Pensions. SFAS No. 106 requires the actuarially determined obligation for postretirement health care and death benefits to be fully accrued by the date employees attain full eligibility for such benefits, which is generally when they reach retirement age. This is a significant change from NSP's pre-1993 policy of recognizing benefit costs on a cash basis after retirement. In conjunction with the adoption of SFAS No. 106, NSP elected to amortize on a straight-line basis over 20 years the unrecognized accumulated postretirement benefit obligation (APBO) of $215.6 million for current and future retirees. This obligation considered 1994 plan design changes, including Medicare integration, increased retiree cost sharing and managed indemnity measures not in effect in 1993.\nBefore 1993, NSP funded payments for retiree benefits internally. While NSP generally prefers to continue using internal funding of benefits paid and accrued, significant levels of external funding, including the use of tax-advantaged trusts, have been required by NSP's regulators, as discussed below. Plan assets held in such trusts as of Dec. 31, 1995, consisted of investments in equity mutual funds and cash equivalents. The funded status of NSP's health care plan as of Dec. 31 is as follows:\n(Millions of dollars) 1995 1994\nAPBO: Retirees $145.8 $132.2 Fully eligible plan participants 24.4 21.5 Other active plan participants 116.8 79.4 Total APBO 287.0 233.1 Plan assets at fair value 11.6 8.0 APBO in excess of plan assets 275.4 225.1 Unrecognized net actuarial gain (loss) (40.4) 2.3 Unrecognized transition obligation (183.2) (194.0) Net benefit obligation recorded $51.8 $ 33.4\nThe assumed health care cost trend rates used in measuring the APBO at Dec. 31, 1995 and 1994, respectively, were 10.4 and 11.0 percent for those under age 65, and 7.3 and 7.5 percent for those over age 65. The assumed cost trend rates are expected to decrease each year until they reach 5.5 percent for both age groups in the year 2004, after which they are assumed to remain constant. A 1 percent increase in the assumed health care cost trend rate for each year would increase the APBO by approximately 15 percent as of Dec. 31, 1995. Service and interest cost components of the net periodic postretirement cost would increase by approximately 17 percent with a similar 1 percent increase in the assumed health care cost trend rate. The assumed discount rate used in determining the APBO was 7 percent for Dec. 31, 1995, 8 percent for Dec. 31, 1994, and 7 percent for Dec. 31, 1993, compounded annually. The assumed long-term rate of return on assets used for cost determinations under SFAS No. 106 was 8 percent for 1995 and 1994. Assumption changes decreased 1994 costs by approximately $2.1 million and decreased 1995 costs by approximately $2.0 million. The effect of the changes in 1996 is expected to be a cost increase of approximately $2.1 million.\nThe net annual periodic postretirement benefit cost recorded consists of the following components:\n(Millions of dollars) 1995 1994 1993\nService cost-benefits earned during the year $5.2 $5.0 $4.4 Interest cost (on service cost and APBO) 19.2 16.1 17.5 Actual return on assets (1.0) (.2) (.1) Amortization of transition obligation 10.8 10.8 10.8 Net amortization and deferral 0.4 (.3) .1 Net periodic postretirement health care cost under SFAS No. 106 34.6 31.4 32.7 Costs recognized (deferred) due to actions of regulators 4.0 4.1 (12.1) Net periodic postretirement health care cost recognized for ratemaking $38.6 $35.5 $20.6\nRegulators for NSP's retail and wholesale customers in Minnesota, Wisconsin and North Dakota have allowed full recovery of increased benefit costs under SFAS No. 106, effective in 1993. Increased 1993 accrual costs for Minnesota retail customers are being amortized over the years 1994 through 1996, consistent with approved rate recovery. External funding was required by Minnesota and Wisconsin retail regulators to the extent it is tax advantaged; funding began for Wisconsin in 1993 and must begin by the next general rate filing for Minnesota. For wholesale ratemaking, the FERC has required external funding for all benefits paid and accrued under SFAS No. 106.\nESOP NSP has a leveraged Employee Stock Ownership Plan (ESOP) that covers substantially all employees. Employer contributions to this non-contributory, defined contribution plan are generally made to the extent NSP realizes a tax savings on its income statement from dividends paid on certain shares held by the ESOP. Contributions to the ESOP in 1995, 1994 and 1993, which represent compensation expense, were $5,059,000, $5,695,000 and $6,281,000, respectively. ESOP contributions have no material effect on NSP earnings because the contributions (net of tax) are essentially offset by the tax savings provided by the dividends paid on ESOP shares. Leveraged shares held by the ESOP are allocated to participants when dividends on stock held by the plan are used to repay ESOP loans. NSP's ESOP held 5.7 million and 5.4 million shares of the Company's common stock as of Dec. 31, 1995 and 1994, respectively. An average of 221,066 and 111,845 uncommitted leveraged ESOP shares were excluded from earnings-per-share calculations in 1995 and 1994, respectively. The fair value of NSP's leveraged ESOP shares approximated cost at Dec. 31, 1995.\n401(k) NSP has a contributory, defined contribution Retirement Savings Plan, which complies with section 401(k) of the Internal Revenue Code and covers substantially all employees. Since 1994, NSP has been matching specified amounts of employee contributions to this plan. NSP's matching contributions were $3.7 million in 1995 and $2.6 million in 1994.\n9. Income Taxes\nTotal income tax expense from operations differs from the amount computed by applying the statutory federal income tax rate to income before income tax expense. The reasons for the difference are as follows:\n1995 1994 1993\nFederal statutory rate 35.0 % 35.0 % 35.0 % Increases (decreases) in tax from: State income taxes, net of federal income tax benefit 5.1 % 5.9 % 6.1 % Tax credits recognized (3.4)% (3.5)% (2.8)% Equity income from unconsolidated international affiliates (2.5)% (2.5)% 0.0 % Regulatory differences - utility plant items 1.0 % 0.5 % 1.3 % Other---net 0.4 % (0.7)% (1.4)%\nEffective income tax rate 35.6 % 34.7 % 38.2 %\n(Thousands of dollars)\nIncome taxes are comprised of the following expense (benefit) items: Included in utility operating expenses: Current federal tax expense $137 011 $108 652 $92 099 Current state tax expense 33 359 34 823 25 787 Deferred federal tax expense (12 019) (3 450) 15 010 Deferred state tax expense (2 396) (1 606) 4 431 Deferred investment tax credits (8 807) (9 191) (8 981) Total 147 148 129 228 128 346 Included in other income (expense): Current federal tax expense 5 481 3 959 7 853 Current state tax expense 1 629 923 2 289 Current foreign tax expense 233 219 Current federal tax credits (5 292) (3 548) (321) Deferred federal tax expense 2 646 (835) (6 736) Deferred state tax expense 693 (209) (449) Deferred investment tax credits (310) (310) (242) Total 5 080 199 2 394\nTotal income tax expense $152 228 $129 427 $130 740\nIncome before income taxes includes net foreign equity income of $32.3 and $25.9 million in 1995 and 1994, respectively. NSP's management intends to reinvest the earnings of foreign operations indefinitely. Accordingly, U.S. income taxes and foreign withholding taxes have not been provided on the earnings of foreign subsidiary companies. The cumulative amount of undistributed earnings of foreign subsidiaries upon which no U.S. income taxes or foreign withholding taxes have been provided is approximately $61.6 million at Dec. 31, 1995. The additional U.S. income tax and foreign withholding tax on the unremitted foreign earnings, if repatriated, would be offset in whole or in part by foreign tax credits. Thus, it is impracticable to estimate the amount of tax that might be payable.\nThe components of NSP's net deferred tax liability (current and non-current portions) at Dec. 31 were:\n(Thousands of dollars) 1995 1994\nDeferred tax liabilities: Differences between book and tax bases of property $866 784 $843 872 Regulatory assets 124 910 120 329 Tax benefit transfer leases 59 579 76 775 Other 13 338 7 854 Total deferred tax liabilities $1 064 611 $1 048 830\nDeferred tax assets: Regulatory liabilities $96 935 $80 383 Deferred investment tax credits 61 911 65 812 Deferred compensation, vacation and other accrued liabilities not currently deductible 57 209 50 572 Other 22 658 18 110 Total deferred tax assets $238 713 $214 877 Net deferred tax liability $825 898 $833 953\n10. Regulatory Assets and Liabilities\nThe following summarizes the individual components of unamortized regulatory assets and liabilities shown on the Consolidated Balance Sheets at Dec. 31:\nAmortization (Thousands of dollars) Period 1995 1994\nAFC recorded in plant on a net-of-tax basis* Plant Lives $146 662 $155 102 Conservation and energy management programs* Up to 10 Years 98 570 76 902 Losses on reacquired debt Term of New Debt 63 209 52 514 Environmental costs Up to 15 Years 45 018 47 779 Deferred postretirement benefit costs 3-15 Years 5 568 9 930 Unrecovered purchased gas costs 1-2 Years 5 932 7 601 State commission accounting adjustments* Plant Lives 7 221 5 544 Other Various 2 032 2 204 Total regulatory assets $374 212 $357 576\nExcess deferred income taxes collected from customers $83 066 $75 277 Investment tax credit deferrals 104 371 110 831 Unrealized gains from decommissioning investments 26 374 1 412 Pension costs 21 508 11 054 Fuel costs and other 7 468 1 943 Total regulatory liabilities $242 787 $200 517\n* Earns a return on investment in the ratemaking process.\n11. Financial Instruments\nFair Values The estimated Dec. 31 fair values of NSP's recorded financial instruments are as follows:\n1995 1994 Carrying Fair Carrying Fair (Thousands of dollars) Amount Value Amount Value\nCash, cash equivalents and short-term investments $28 943 $28 943 $41 947 $41 947 Long-term decommissioning investments $203 625 $203 625 $145 467 $145 467 Long-term debt, including current portion $1 709 646 $1 781 066 $1 621 060 $1 540 595\nFor cash, cash equivalents and short-term investments, the carrying amount approximates fair value because of the short maturity of those instruments. The fair values of the Company's long-term investments in an external nuclear decommissioning fund are estimated based on quoted market prices for those or similar investments. The fair value of NSP's long-term debt is estimated based on the quoted market prices for the same or similar issues, or the current rates offered to NSP for debt of the same remaining maturities.\nDerivatives NRG has entered into six forward foreign currency exchange contracts with counterparties to hedge exposure to currency fluctuations to the extent permissible by hedge accounting requirements. Pursuant to these contracts, transactions have been executed that are designed to protect the economic value in U.S. dollars of NRG's equity investments and retained earnings, denominated in Australian dollars and German deutsche marks (DM). NRG's forward foreign currency exchange contracts, in the notional amount of $119 million, hedge approximately $123 million of foreign currency denominated assets, and in the notional amount of $47 million, hedge approximately $64 million of foreign currency denominated retained earnings at Dec. 31, 1995. Because the effects of both currency translation adjustments to foreign investments and currency hedge instrument gains and losses are recorded on a net basis in stockholders' equity (not earnings), the impact of significant changes in currency exchange rates on these items would have an immaterial effect on NSP's financial condition and results of operations. The contracts required cash collateral balances of $5.9 million at Dec. 31, 1995, which are reflected as other current assets on NSP's balance sheet. The contracts terminate in 1998 through 2005 and require foreign currency interest payments by either party during each year of the contract. If the contracts had been terminated at Dec. 31, 1995, $5.2 million would have been payable by NRG for currency exchange rate changes to date. Management believes NRG's exposure to credit risk due to non- performance by the counterparties to its forward exchange contracts is not significant, based on the investment grade rating of the counterparties.\nCenergy has entered into natural gas futures contracts in the notional amount of $11.3 million at Dec. 31, 1995. The original contract terms range from one month to three years. The contracts are intended to mitigate risk from fluctuations in the price of natural gas that will be required to satisfy sales commitments for future deliveries to customers in excess of Cenergy's natural gas reserves. Cenergy's futures contracts hedge $11.5 million in anticipated natural gas sales in 1996-1997. Margin balances of $2.3 million at Dec. 31, 1995, were maintained on deposit with brokers and recorded as cash and cash equivalents on NSP's balance sheet. The counterparties to the futures contracts are the New York Mercantile Exchange and major gas pipeline operators. Management believes that the risk of non-performance by these counterparties is not significant. If the contracts had been terminated at Dec. 31, 1995, $0.6 million would have been payable to Cenergy for natural gas price fluctuations to date.\nNSP has three interest rate swap agreements with notional amounts totalling $320 million. These swaps were entered into in conjunction with first mortgage bonds. As summarized below, these agreements effectively convert the interest costs of these debt issues from fixed to variable rates based on six-month London Interbank Offered Rates (LIBOR), with the rates changing semiannually. Net Effective Notional Amount Term of Interest Cost Series (millions of dollars) Swap Agreement at Dec. 31, 1995\n5 7\/8% Series due Oct. 1, 1997 $100 Maturity 5.94% 5 1\/2% Series due Feb. 1, 1999 $200 Maturity 5.36% 7 1\/4% Series due March 1, 2023 $ 20 March 1, 1998 8.03%\nMarket risks associated with these agreements result from short-term interest rate fluctuations. Credit risk related to non- performance of the counterparties is not deemed significant, but would result in NSP terminating the swap transaction and recognizing a gain or loss, depending on the fair market value of the swap. The interest rate swaps serve to hedge the interest rate risk associated with fixed rate debt in a declining interest rate environment. This hedge is produced by the tendency for changes in the fair market value of the swap to be offset by changes in the present value of the liability attributable to the fixed rate debt issued in conjunction with the interest rate swaps. If the interest rate swaps had been discontinued on Dec. 31, 1995, the present value benefit to NSP would have been $2.8 million, which is partially offset by an increase in the present value of the related debt of $0.9 million above carrying value.\nLetters of Credit NSP uses letters of credit to provide financial guarantees for certain operating obligations, including NSP workers' compensation benefits and ash disposal site costs, and Cenergy natural gas purchases. At Dec. 31, 1995, letters of credit of $46.7 million were outstanding. Generally, the letters of credit have terms of one year and are automatically renewed, unless prior written notice of cancellation is provided to NSP and the beneficiary by the issuing bank. The contract amounts of these letters of credit approximate their fair value and are subject to fees competitively determined in the marketplace.\n12. Detail of Certain Income and Expense Items\nAdministrative and general (A&G) expense for utility operations consists of the following:\n(Thousands of dollars) 1995 1994 1993\nA&G salaries and wages $48 437 $49 726 $51 601 Postretirement medical and injury compensation benefits 34 112 41 901 14 995 Other benefits---all utility employees 47 167 38 792 51 860 Information technology, facilities and administrative support 31 863 29 751 30 504 Insurance and claims 13 969 16 771 16 165 Other 10 599 11 055 11 492\nTotal $186 147 $187 996 $176 617\nOther income (deductions)---net consist of the following:\n(Thousands of dollars) 1995 1994 1993 Non-regulated operations: Operating revenues and sales $313 082 $241 827 $90 531 Operating expenses 327 894* 241 480* 81 480 Pretax operating income** (14 812) 347 9 051 Interest and investment income 11 953 10 839 4 522 Charitable contributions (5 314) (5 037) (4 752) Environmental and regulatory contingencies 1 027 (4 568) (100) Other---net (excluding income taxes) (829) (5 267) (739) Total---net income (expense) $ (7 975) $ (3 686) $ 7 982\n*Includes non-regulated energy project write-downs of $5.0 million in 1995 and $5.0 million in 1994. **See Non-Regulated Subsidiaries-Non-Regulated Business Information under Item 1.\n13. Joint Plant Ownership\nThe Company is a participant in a jointly owned 855-megawatt coal- fired electric generating unit, Sherburne County generating station unit No. 3 (Sherco 3), which began commercial operation Nov. 1, 1987. Undivided interests in Sherco 3 have been financed and are owned by the Company (59 percent) and Southern Minnesota Municipal Power Agency (41 percent). The Company is the operating agent under the joint ownership agreement. The Company's share of related expenses for Sherco 3 since commercial operations began are included in Utility Operating Expenses. The Company's share of the gross cost recorded in Utility Plant at Dec. 31, 1995 and 1994, was $585,625,000 and $585,783,000, respectively. The corresponding accumulated provisions for depreciation were $150,022,000 and $132,092,000.\n14. Nuclear Obligations\nFuel Disposal NSP is responsible for the temporary storage of used nuclear fuel from the Company's nuclear generating plants. Under a contract with the Company, the DOE is obligated to assume the responsibility for permanent storage or disposal of NSP's used nuclear fuel. The Company has been funding its portion of the DOE's permanent disposal program since 1981. Funding took place through an internal sinking fund until 1983, when the DOE began assessing fuel disposal fees under the Nuclear Waste Policy Act of 1982 based on a charge of 0.1 cent per kilowatt-hour sold to customers from nuclear generation. The cumulative amount of such assessments from the DOE to NSP through Dec. 31, 1995, is $230.8 million. Currently, it is not determinable if the amount and method of the DOE's assessments to all utilities will be sufficient to fully fund the DOE's permanent storage or disposal facility.\nThe DOE has stated in statute and by contract that a permanent storage or disposal facility would be ready to accept used nuclear fuel by 1998. Accordingly, NSP has been providing, with regulatory and legislative approval, its own temporary on-site storage facilities at its Monticello and Prairie Island nuclear plants, with a capacity sufficient for used fuel from the plants until at least that date. Recent indications from the DOE are that a permanent federal facility will not be ready to accept used fuel from utilities until approximately 2010. In 1994, the Company and 13 other major utilities filed a lawsuit against the DOE in an attempt to clarify the DOE's obligation to accept spent nuclear fuel beginning in 1998. The primary purpose of the lawsuit is to insure the Company and its customers receive timely storage of used nuclear fuel. The lawsuit was argued before the United States Circuit Court of Appeals for the District of Columbia on Jan. 17, 1996 and a decision is expected in three to six months from the time of argument. In 1995, the DOE published its \"Final Interpretations of Nuclear Waste Acceptance Issues\" in the Federal Register. In this notice, the DOE concluded that it has neither an unconditional obligation to accept spent nuclear fuel by 1998 nor any authority to provide interim storage. Because of the DOE's inadequate progress to provide a permanent repository and its disavowal of its obligation, the Minnesota Department of Public Service is investigating whether continued payments to fund the DOE's permanent disposal program is prudent use of ratepayer money. The outcome of this investigation is unknown at this time. In the meantime, NSP is investigating all of its alternatives for used fuel storage until a DOE facility is available. When on-site temporary storage at NSP's nuclear plants reaches approved capacity, the Company could seek interim storage at a contracted private facility. The Company received Minnesota legislative approval in 1994 for additional on-site storage facilities at its Prairie Island plant, provided the Company satisfies certain requirements. Seventeen dry cask containers, each of which can store approximately one-half year's used fuel, can become available as follows: five immediately in 1994; four more in 1996 if an application for an alternative storage site is filed, an effort to locate such a site is made and 100 megawatts of wind generation is available or contracted for construction; and the final eight in 1999, unless the specified alternative site is not operational or under construction, certain resource commitments are not met, or the Minnesota Legislature revokes its approval. (See additional discussion of legislative commitments in Note 15.) NSP has loaded used fuel into three of the dry cask containers as of Dec. 31, 1995. With the dry cask storage facilities approved in 1994 for the Prairie Island nuclear generating plant, the Company believes it has adequate storage capacity to continue operation of its nuclear plants until at least 2002 and 2003 for Prairie Island Units 1 and 2, respectively. The Monticello nuclear plant has storage capacity to continue operations until 2010. Storage availability to permit operation beyond these dates is not assured at this time.\nTwo alternatives to on-site storage of used fuel are currently under consideration. As discussed in Note 15, the Company is investigating alternative sites in Goodhue County, Minnesota, for interim used nuclear fuel storage. Also, the Company is leading a consortium working with the Mescalero Apache Tribe to establish a private facility for interim storage of used nuclear fuel on the Tribe's reservation in New Mexico. A core group of more than 20 United States nuclear utilities has agreed to support the construction and operation of the Mescalaro interim storage site. Work on the project is under way in several areas, including environmental assessment, facility design and drafting the detailed contracts that will govern the construction and operation of the site. An architect engineering firm and an environmental contractor have been retained to perform the environmental and licensing activities. The consortium is currently scheduled to submit a license application for the facility to the Nuclear Regulatory Commission (NRC) in December 1996. The spent fuel storage facility is expected to be operational and able to accept the first shipment of used nuclear fuel by mid-2002. However, due to pending regulatory and governmental approval uncertainty, it is possible that this interim storage may be delayed or not available.\nFuel expense includes DOE fuel disposal assessments of $12.3 million, $10.6 million and $8.7 million for 1995, 1994 and 1993, respectively. Disposal expenses reflect reductions of $0.7 million in 1994 and $2.6 million in 1993 due to a change in the DOE's basis of charging customers, retroactive to 1983. Nuclear fuel expenses in 1995, 1994 and 1993 also include about $5 million, $5 million and $1 million, respectively, for payments to the DOE for the decommissioning and decontamination of the DOE's uranium enrichment facilities. The DOE's initial assessment of $46 million to the Company was recorded in 1993. This assessment will be payable in annual installments from 1993-2008 and each installment is being amortized to expense on a monthly basis in the 12 months following each payment. The most recent installment paid in 1995 was $3.7 million; future installments are subject to inflation adjustments under DOE rules. The Company is obtaining rate recovery of these DOE assessments through the cost-of-energy adjustment clause as the assessments are amortized. Accordingly, the unamortized assessment of $44 million at Dec. 31, 1995, has been deferred as a regulatory asset and is reported under the caption Environmental Costs in Note 10.\nPlant Decommissioning Decommissioning of all Company nuclear facilities is planned for the years 2010-2022, using the prompt dismantlement method. The Company is currently following industry practice by ratably accruing the costs for decommissioning over the approved cost recovery period and including the accruals in Utility Plant---Accumulated Depreciation, as discussed in Note 1. Consequently, the total decommissioning cost obligation and corresponding asset currently are not recorded in NSP's financial statements. The FASB has proposed new accounting standards which, if approved as expected in 1996, would require the full accrual of nuclear plant decommissioning and certain other site exit obligations beginning in 1997. If NSP were to adopt the proposed accounting, beginning in 1997 an estimated total discounted decommissioning obligation of $610 million would be recorded as a liability, with the corresponding costs capitalized as a plant asset and depreciated over the operating life of the plant. The obligation calculation methodology proposed by the FASB is slightly different from the ratemaking methodology that derives the decommissioning accruals currently being recovered in rates (as discussed below). The Company has not yet determined the potential impact of the FASB's proposed changes in the accounting for site exit obligations other than nuclear decommissioning (such as costs of removal). However, the ultimate decommissioning and site exit costs to be accrued are the same under both methods and, accordingly, the effects of regulation are expected to minimize or eliminate any impact on operating expenses and results of operations from this future accounting change.\nConsistent with cost recovery in utility customer rates, the Company records annual decommissioning accruals based on periodic site-specific cost studies and a presumed level of dedicated funding. Cost studies quantify decommissioning costs in current dollars. Since the costs are expected to be paid in 2010-2022, funding presumes that current costs will escalate in the future at a rate of 4.5 percent per year. The total estimated decommissioning costs that will ultimately be paid, net of income earned by external trust funds, is currently being accrued using an annuity approach over the approved plant recovery period. This annuity approach uses the assumed rate of return on funding, which is currently 6 percent (net of tax) for external funding and approximately 8 percent (net of tax) for internal funding.\nThe total obligation for decommissioning currently is expected to be funded approximately 82 percent by external funds and 18 percent by internal funds, as approved by the MPUC. Rate recovery of internal funding began in 1971 through depreciation rates for removal expense, and was changed to a sinking fund recovery in 1981. Contributions to the external fund started in 1990 and are expected to continue until plant decommissioning begins. Costs not funded by external trust contributions and related earnings will be funded through internally generated funds and issuance of Company debt or stock. The assets held in trusts as of Dec. 31, 1995, primarily consisted of investments in tax-exempt municipal bonds, common stock of public companies and U.S. government securities.\nThe following table summarizes the funded status of the decommissioning obligation at Dec. 31, 1995, under the method currently in use.\n(Millions of dollars) 1995\nDecommissioning cost estimate from most recent study (1993 dollars) $750.8 Effect of escalating costs to payment date (at 4.5% per year) 1 094.0 Estimated future decommissioning costs (undiscounted) $1 844.8 Estimated decommissioning cost obligation escalated to current dollars $ 819.9 External trust fund assets at fair value 203.6 Decommissioning obligation in excess of assets currently held in external trust $ 616.3\nDecommissioning expenses recognized include the following components:\n(Millions of dollars) 1995 1994 1993\nAnnual decommissioning cost accrual reported as depreciation expense: Externally funded $33.2 $33.2 $28.4 Internally funded (including interest costs) 1.2 1.1 14.5 Interest cost on externally funded decommissioning obligation 6.0 3.5 3.7 Earnings from external trust funds---net (6.0) (3.5) (3.7) Current year decommissioning accruals---net $34.4 $34.3 $42.9\nAt Dec. 31, 1995, the Company has recorded and recovered in rates cumulative decommissioning accruals of $381 million; $177 million has been deposited into external trust funds for such accruals. The Company believes future decommissioning cost accruals will continue to be recovered in customer rates. Decommissioning and interest accruals are included with the accumulated provision for depreciation on the balance sheet. Interest costs and trust earnings associated with externally funded obligations are reported in Other Income and Expense on the income statement.\nA revision to NSP's 1993 nuclear decommissioning study and nuclear plant depreciation capital recovery request was filed with the MPUC and approved in 1994. Although management expects to operate the Prairie Island units through the end of their licensed lives, the approved capital recovery would allow for the plant to be fully depreciated, including the accrual and recovery of decommissioning costs in 2008, about six years earlier than the end of its licensed life. The approved recovery period for Prairie Island has been reduced because of the uncertainty regarding used fuel storage. The updated nuclear decommissioning study resulted in a decrease in annual cost accruals for decommissioning due to a reduction in decommissioning cost estimates as well as the shortened recovery period. The combined impact of the request as approved, including the shorter depreciation period and lower decommissioning costs, was a net decrease of about $800,000 in annual depreciation and decommissioning expenses, beginning in 1994.\n15. Commitments and Contingent Liabilities\nLegislative Resource Commitments In 1994, the Minnesota Legislature established several energy resource and other commitments for NSP to fulfill to obtain the Prairie Island temporary nuclear fuel storage facility approval, as discussed in Note 14. The additional resource commitments, which can be built, purchased or (in the case of biomass generation) converted, can be summarized as follows:\nPower Type Megawatts Deadline\nWind 100 (1) (Additional) 12\/31\/96 (3) Wind 225 (Cumulative) 12\/31\/98 (4) Biomass 50 (Additional) 12\/31\/98 (5) Wind 200 (Additional) 12\/31\/02 Biomass 75 (Additional) 12\/31\/02 Wind 400 (2) (Additional) 12\/31\/02\n(1) In addition to 25 megawatts of wind generation currently installed (2) If required by least-cost planning and resource planning (3) Power purchase contract awarded to Zond Systems, Inc. (4) Power purchase bids to be received mid-1996 (5) Power purchase bid decision expected in March 1996\nThe Company has taken steps to comply with the requirements of these resource commitments. Twenty-five megawatts of third party wind generation has been fully operational since May 1, 1994. With respect to the additional 100 megawatts of wind energy to be under contract by the end of 1996, the Company has obtained a site designation from the Minnesota Environmental Quality Board (MEQB), and selected Zond Systems, Inc. to supply the wind energy. The Company must now secure wind rights for the site from an unsuccessful bidder, which has indicated it will not voluntarily transfer the wind rights. The Company has commenced litigation to expedite resolution of the wind rights dispute. Siting and design activities are proceeding while wind rights acquisition efforts continue. An independent evaluator also reviewed proposals from bidders regarding 50 megawatts of farm-grown closed-loop biomass generation and made a recommendation to the Company in January 1996, with a final decision to be made in early 1996. On Jan. 22, 1996, the Company notified the MPUC that due to the price of the various bids and other factors, the Company intended to reject each of the bids. Since legislation may be proposed to change various elements of the biomass mandate, the Company proposed to delay its report detailing the Company's decision and its proposal to meet the statutory mandate until later in 1996.\nOther commitments established by the Legislature include applying for, locating and licensing an alternative used fuel storage site, a low-income discount for electric customers, additional required conservation improvement expenditures and various study and reporting requirements to a legislative electric energy task force formed in 1994. In January 1995, the MPUC approved the Company's low-income discount programs in accordance with the statute. In July 1995, the Company filed documents with the MEQB outlining two alternative Goodhue County sites to be considered for the development of an interim used nuclear fuel storage facility, as the Minnesota Legislature required. The MEQB has begun a 12- to 18-month public process to examine these sites and any others that may be proposed. The Company has implemented programs to begin meeting the other legislative commitments. The Company's capital commitments disclosed below include the known effects of the 1994 Prairie Island legislation. The impact of the legislation on power purchase commitments and other operating expenses is not yet determinable.\nCapital Commitments NSP estimates utility capital expenditures, including acquisitions of nuclear fuel, will be $410 million in 1996 and $1.9 billion for 1996-2000. There also are contractual commitments for the disposal of used nuclear fuel. (See Note 14.)\nNRG is contractually committed to additional equity investments in an existing German energy project. Such commitments are for approximately DM 33 million in 1996. The 1996 commitment would be approximately $23 million, based on exchange rates in effect at Dec. 31, 1995. In addition, NRG is contractually committed to additional equity investments of $17 million in the Scudder Latin American Trust for Independent Power Energy Projects, as of Dec. 31, 1995.\nNRG is in the final stages of purchasing a 42 percent interest in O'Brien Environmental Energy, Inc. (O'Brien) from bankruptcy. In connection with its bid for O'Brien, on Jan. 3, 1996, NRG obtained a $100 million letter of credit from a bank, which is secured by a pledge of various NRG assets. NRG delivered the letter of credit to O'Brien on Jan. 18, 1996, to secure its obligation to complete its proposed investment in O'Brien. In January 1996, the United States Bankruptcy Court for the District of New Jersey confirmed the Chapter 11 Plan of Reorganization for O'Brien proposed by NRG and other interested parties. O'Brien has interests in eight domestic operating power generation facilities with aggregate capacity of approximately 230 megawatts, and in one 150-megawatt facility in the contract stage of development. As a result of the purchase, approximately $107 million would be made available to O'Brien's creditors by NRG. At least $81 million of the total made available to the creditors would be provided by NRG as follows: (i) a $28 million equity investment by NRG for its 42 percent interest in O'Brien; (ii) a $7.5 million investment by NRG for all of O'Brien's interest in certain biogas projects; and (iii) a $45 million unsecured loan from NRG to O'Brien. NRG currently is negotiating with an unaffiliated lender to refinance O'Brien's Newark Boxboard project in the amount of $56 million, of which approximately $26 million would be applied for distribution to O'Brien's creditors in reduction of NRG's approximately $107 million obligation. If this financing is not obtained concurrently with the closing of the O'Brien transaction, NRG would be obligated to make a $26 million loan to O'Brien after its reorganization.\nLeases Rentals under operating leases were approximately $26.9 million, $24.0 million and $27.5 million for 1995, 1994 and 1993, respectively. Future commitments under these leases generally decline from current levels.\nFuel Contracts NSP has contracts providing for the purchase and delivery of a significant portion of its current coal, nuclear fuel and natural gas requirements. These contracts, which expire in various years between 1996 and 2013, require minimum contractual purchases and deliveries of fuel, and additional payments for the rights to purchase coal in the future. In total, NSP is committed to the minimum purchase of approximately $529 million of coal, $26 million of nuclear fuel and $512 million of natural gas and related transportation, or to make payments in lieu thereof, under these contracts. In addition, NSP is required to pay additional amounts depending on actual quantities shipped under these agreements. As a result of FERC Order 636, NSP has been very active in developing a mix of gas supply, transportation and storage contracts designed to meet its needs for retail gas sales. The contracts are with several suppliers and for various periods of time. Because NSP has other sources of fuel available and suppliers are expected to continue to provide reliable fuel supplies, risk of loss from non- performance under these contracts is not considered significant. In addition, NSP's risk of loss (in the form of increased costs) from market price changes in fuel is mitigated through the cost-of- energy adjustment provision of the ratemaking process, which provides for recovery of nearly all fuel costs.\nPower Agreements The Company has executed several agreements with the Manitoba Hydro-Electric Board (MH) for hydroelectricity. A summary of the agreements is as follows:\nYears Megawatts\nParticipation Power Purchase 1996-2005 500 Seasonal Participation Power Purchase 1996 250 Seasonal Peaking Power Purchase 1996 200 Seasonal Diversity Exchanges: Summer exchanges from MH 1996-2014 150 1997-2016 200 Winter exchanges to MH 1996-2014 150 1996-2015 200 2015-2017 400\n2018 200\nThe cost of the 500-megawatt participation power purchase commitment is based on 80 percent of the costs of owning and operating the Company's Sherco 3 generating plant (adjusted to 1993 dollars). The total estimated future annual capacity costs for all MH agreements is projected to be approximately $65 million. However, the Company and MH have consented to arbitration to finalize interpretations of specific contractual factors relating to the 500-megawatt participation agreement. These commitments to MH, which represent about 22 percent of MH's output capability in 1996, account for approximately 13 percent of NSP's 1996 electric system capability. The risk of loss from non-performance by MH is not considered significant, and the risk of loss from market price changes is mitigated through cost-of-energy rate adjustments.\nThe Company has an agreement with Minnkota Power Cooperative (MPC) for the purchase of summer season capacity and energy. From 1996 through 2001, the Company will buy 150 megawatts of summer season capacity for $12.4 million annually. From 2002 through 2015, the Company will purchase 100 megawatts of capacity for $10.0 million annually. Under the agreement, energy will be priced against the cost of fuel consumed per megawatt-hour at the Coyote Generating Station in North Dakota. The Company also has three seasonal (summer) purchase power agreements with MPC, Minnesota Power and Mid American Energy Company for the purchase of 388 megawatts in 1996, including reserves. The annual cost of this capacity will be approximately $4 million.\nThe Company has agreements with several non-regulated power producers to purchase electric capacity and associated energy. The 1996 cost of these commitments for non-regulated installed capacity is approximately $20 million for 115 megawatts. This annual cost will increase to approximately $37 million-$44 million for 1997- 2018 and then decrease to approximately $25 million-$29 million for 2019-2027 due to the expiration of existing agreements and an additional agreement for the purchase of 245 to 262 megawatts.\nNuclear Insurance The Company's public liability for claims resulting from any nuclear incident is limited to $8.9 billion under the 1988 Price-Anderson amendment to the Atomic Energy Act of 1954. The Company has secured $200 million of coverage for its public liability exposure with a pool of insurance companies. The remaining $8.7 billion of exposure is funded by the Secondary Financial Protection Program, available from assessments by the federal government in case of a nuclear accident. The Company is subject to assessments of up to $79.3 million for each of its three licensed reactors to be applied for public liability arising from a nuclear incident at any licensed nuclear facility in the United States. The maximum funding requirement is $10 million per reactor during any one year.\nThe Company purchases insurance for property damage and site decontamination cleanup costs with coverage limits of $2.0 billion for each of the Company's two nuclear plant sites. The coverage consists of $500 million from Nuclear Mutual Limited (NML) and $1.5 billion from Nuclear Electric Insurance Limited (NEIL).\nNEIL also provides business interruption insurance coverage, including the cost of replacement power obtained during certain prolonged accidental outages of nuclear generating units. Premiums billed to NSP from NML and NEIL are expensed over the policy term. All companies insured with NML and NEIL are subject to retrospective premium adjustments if losses exceed accumulated reserve funds. Capital has been accumulated in the reserve funds of NML and NEIL to the extent that the Company would have no exposure for retrospective premium assessments in case of a single incident under the business interruption and the property damage insurance coverages. However, in each calendar year, the Company could be subject to maximum assessments of approximately $4.9 million (five times the amount of its annual premium) and $36.8 million (generally 7.5 times the amount of its annual premium) if losses exceed accumulated reserve funds under the business interruption and property damage coverages, respectively.\nEnvironmental Contingencies Other long-term liabilities include an accrual of $42 million, and other current liabilities include an accrual of $6 million at Dec. 31, 1995, for estimated costs associated with environmental remediation. Approximately $37 million of the long-term liability and $4 million of the current liability relate to a DOE assessment for decommissioning of a federal uranium enrichment facility, as discussed in Note 14. Other estimates have been recorded for expected environmental costs associated with manufactured gas plant sites formerly used by the Company and other waste disposal sites, as discussed below.\nThese environmental liabilities do not include accruals recorded (and collected from customers in rates) for future nuclear fuel disposal costs or decommissioning costs related to the Company's nuclear generating plants. (See Note 14 for further discussion.)\nThe Environmental Protection Agency (EPA) or state environmental agencies have designated the Company as a \"potentially responsible party\" (PRP) for 12 waste disposal sites to which the Company allegedly sent hazardous materials. Under applicable law, the Company, along with each PRP, could be held jointly and severally liable for the total remediation costs of all 12 sites, which are currently estimated between $123 million and $126 million. If additional remediation is necessary or unexpected costs are incurred, the amount could be in excess of $126 million. The Company is not aware of the other parties' inability to pay, nor does it know if responsibility for any of the sites is disputed by any party. The Company's share of the costs associated with these 12 sites is approximately $2.5 million. Of this amount, about $1.5 million already has been paid in connection with eight of the 12 sites for which the Company has settled with the EPA and other PRPs. For the remaining four sites, neither the amount of remediation costs nor the final method of their allocation among all designated PRPs has been determined. However, the Company has recorded an estimate of approximately $1 million for future costs for all four sites, with the estimated payment dates not determinable at this time. While it is not feasible to determine the outcome of these matters, amounts accrued represent the best current estimate of the Company's future liability for the remediation costs of these sites. It is the Company's practice to vigorously pursue and, if necessary, litigate with insurers to recover incurred remediation costs whenever possible. Through litigation, the Company has recovered from other PRPs a portion of the remediation costs paid to date. Management believes costs incurred in connection with the sites, which are not recovered from insurance carriers or other parties, should be allowed recovery in future ratemaking. Until the Company is identified as a PRP, it is not possible for the Company to predict the timing or amount of any costs associated with cleanup sites other than those discussed above.\nThe Wisconsin Company potentially may be involved in the cleanup and remediation at three sites. One site is a solid and hazardous waste landfill site in Eau Claire, Wis. The Wisconsin Company contends that it did not dispose of hazardous wastes in the subject landfill during the time period in question. Because neither the amount of cleanup costs nor the final method of their allocation among all designated PRPs has been determined, it is not feasible to predict the outcome of this matter at this time. The second site, in Ashland, Wis., contains creosote\/coal tar contamination. In 1995, the Wisconsin Department of Natural Resources (WDNR) notified the Wisconsin Company that it is a PRP at this site. At this time, the WDNR has determined that the Wisconsin Company is the only PRP at this site. The site has three distinct portions - the Wisconsin Company portion of the site, the Kreher Park portion of the site and the Chequamegon Bay (of Lake Superior) portion of the site. The Wisconsin Company portion of the site, formerly a coal gas plant site, is Wisconsin Company property. The Kreher Park portion of the site is adjacent to the Wisconsin Company site and is not owned by the Wisconsin Company. The Chequamegon Bay portion of the site is adjacent to the Kreher Park portion of the site and is not owned by the Wisconsin Company. The Wisconsin Company is discussing its potential involvement in the Kreher Park and Chequamegon Bay portions of the site with the WDNR and the City of Ashland. At Dec. 31, 1995, the Wisconsin Company had recorded an estimated liability of $900,000 for future remediation costs at the Ashland site and had incurred approximately $400,000 in actual expenditures. Investigations are under way to determine the Wisconsin Company's responsibility as well as that of predecessor companies contributing to the contamination existing at the Ashland site. The investigation also should determine the extent and source of the contamination and potential methods for remediation. (See subsequent event section below.) An estimate of cleanup and remediation costs at the Eau Claire site and any further costs at the Ashland site and the extent of the Wisconsin Company's responsibility, if any, for sharing such costs are not known at this time. The third site is a landfill site in Hudson, Wis., which is one of the 12 waste disposal sites discussed previously.\nThe Company also is continuing to investigate 15 properties, either presently or previously owned by the Company, which were at one time sites of gas manufacturing, gas storage plants or gas pipelines. The purpose of this investigation is to determine if waste materials are present, if such materials constitute an environmental or health risk, if the Company has any responsibility for remedial action and if recovery under the Company's insurance policies can contribute to any remediation costs. Of the 15 gas sites under investigation, the Company already has remediated one site and is actively taking remedial action at four of the sites. In addition, the Company has been notified that two other sites eventually will require remediation, and a study will be initiated in 1996 to determine the cost and method of cleanup. Cleanup is expected to begin in 1997. The Company has paid $6.7 million to date on these seven active sites. The one remediated site continues to be monitored. The Company has recorded an estimated liability for future costs at the other six active sites of approximately $6.1 million, with payment expected over the next 10 years. This estimate is based on prior experience and includes investigation, remediation and litigation costs. As for the eight inactive sites, no liability has been recorded for remediation or investigation because the present land use at each of these sites does not warrant a response action. While it is not feasible to determine the precise outcome of all of these matters, the accruals recorded represent the current best estimate of the costs of any required cleanup or remedial actions at these former gas operating sites. Management also believes that incurred costs, which are not recovered from insurance carriers or other parties, should be allowed recovery in future ratemaking. During 1994, the Company's gas utility received approval for deferred accounting for certain gas remediation costs incurred at four active sites, with final rate treatment of such costs to be determined in future general gas rate cases.\nThe Clean Air Act, including the Amendments of 1990 (the Clean Air Act), calls for reductions in emissions of sulfur dioxide and nitrogen oxides from electric generating plants. These reductions, which will be phased in, began in 1995. The majority of the rules implementing this complex legislation have been finalized. No additional capital expenditures are anticipated to comply with the sulfur dioxide emission limits of the Clean Air Act. NSP has expended significant amounts over the years to reduce sulfur dioxide emissions at its plants. Based on revisions to the sulfur dioxide portion of the program, NSP's emission allowance allocations for the years 1995-1999 were dramatically reduced. The Company's capital expenditures include some costs for ensuring compliance with the Clean Air Act's other emission requirements; other expenditures may be necessary upon EPA's finalization of remaining rules. Because NSP is only beginning to implement some provisions of the Clean Air Act, its overall financial impact is unknown at this time. Capital expenditures for opacity compliance, which began in 1995 at certain facilities, are considered in the capital expenditure commitments disclosed previously. NSP plans to seek recovery of these expenditures in future rate proceedings.\nSeveral of NSP's operating facilities have asbestos-containing material, which represents a potential health hazard to people who come in contact with it. Governmental regulations specify the required timing and nature of disposal of asbestos-containing materials. Under such requirements, asbestos not readily accessible to the environment need not be removed until the facilities containing the material are demolished. NSP estimates its future asbestos removal costs will approximate $43 million. Most of these costs will not need to be incurred until current operating facilities are demolished, and will be included in the costs of removal for the facilities.\nEnvironmental liabilities are subject to considerable uncertainties that affect NSP's ability to estimate its share of the ultimate costs of remediation and pollution control efforts. Such uncertainties involve the nature and extent of site contamination, the extent of required cleanup efforts, varying costs of alternative cleanup methods and pollution control technologies, changes in environmental remediation and pollution control requirements, the potential effect of technological improvements, the number and financial strength of other potentially responsible parties at multi-party sites and the identification of new environmental cleanup sites. NSP has recorded and\/or disclosed its best estimate of expected future environmental costs and obligations, as discussed previously.\nLegal Claims In the normal course of business, NSP is a party to routine claims and litigation arising from prior and current operations. NSP is actively defending these matters and has recorded an estimate of the probable cost of settlement or other disposition. In July 1993, a natural gas explosion occurred on the Company's distribution system in St. Paul, Minn. Total damages are estimated to exceed $1 million. The Company has a self-insured retention deductible of $1 million, with general liability coverage of $150 million, which includes coverage for all injuries and damages. Seventeen lawsuits have been filed, including one suit with multiple plaintiffs. In April 1995, the National Transportation Safety Board found little, if any, fault with the Company's actions or conduct. A trial to decide civil liability and the parties responsible for the explosion has been scheduled for February 1997, with the damages portion of the trial scheduled for six months thereafter. The ultimate costs to the Company are unknown at this time.\nSubsequent Event (Unaudited) On Feb. 19, 1996, the Wisconsin Company received from the WDNR's consultant a draft report of the results of a remediation action options feasibility study for the Kreher Park portion of the Ashland site discussed previously. The draft report contains a number of remediation options which were scored by the consultant across a variety of parameters. Two options scored the most technologically and economically feasible and one of those is the lowest cost option for remediation at the Kreher Park portion of the site. The draft report estimates that this option, which would involve capping the property and some limited groundwater treatment, would cost approximately $6.0 million. Currently, the WDNR is conducting an investigation in Chequamegon Bay adjacent to Kreher Park to determine the extent of contamination in the bay. The WDNR has informed the Wisconsin Company that it will not choose or proceed with any remediation options on any portion of the Ashland site until completion of the Chequamegon Bay investigation in the second half of 1996. Until more information is known concerning the extent of remediation required by the WDNR, the remediation method selected and the related costs, the various parties involved and the extent of the Wisconsin Company's responsibility, if any, for sharing the costs, the ultimate cost to the Wisconsin Company and the expected timing of any payments related to the Ashland site is not determinable.\n16. Segment Information\nYear Ended Dec. 31 (Thousands of dollars) 1995 1994 1993\nUtility operating income before income taxes Electric $444 687 $399 185 $393 758 Gas 48 340 38 361 38 474 Total operating income before income taxes $493 027 $437 546 $432 232\nUtility depreciation and amortization Electric $266 231 $252 322 $245 200 Gas 23 953 21 479 19 317 Total depreciation and amortization $290 184 $273 801 $264 517\nUtility capital expenditures Electric utility $317 750 $303 896 $284 239 Gas utility 37 215 60 183 36 312 Common utility 31 057 22 947 36 285 Total utility capital expenditures $386 022 $387 026 $356 836\nIdentifiable assets Electric utility $4 751 650 $4 634 511 $4 543 286 Gas utility 600 738 556 975 521 595 Total identifiable assets 5 352 388 5 191 486 5 064 881 Other corporate assets * 876 197 758 246 522 837 Total assets $6 228 585 $5 949 732 $5 587 718\n* Includes equity investments of $185 million in 1995 and $134 million in 1994 in non-regulated energy projects outside of the United States.\n* An expense of $8.7 million ($5.1 million net of tax), or 8 cents per share, was recognized to write off the unamortized deferred costs associated with adopting SFAS No. 112 (See Note 2.) Such costs had initially been deferred based on a preliminary decision to request amortization through rates over future periods.\n18. Merger Agreement with Wisconsin Energy Corporation\nAs previously reported in the Company's Current Report on Form 8-K, dated April 28, 1995, and filed on May 3, 1995, and Quarterly Reports on Form 10-Q, the Company and Wisconsin Energy Corporation (WEC) have entered into an Agreement and Plan of Merger (Merger Agreement), which provides for a strategic business combination involving the Company and WEC in a \"merger-of-equals\" transaction (the Transaction). See further discussion of the transaction in the Management's Discussion and Analysis, Factors Affecting Results of Operations-Proposed Merger section.\nPrimergy Corporation (Primergy), which will be registered under the Public Utility Holding Company Act of 1935, as amended, will be the parent company of both the Company (which, for regulatory reasons, will reincorporate in Wisconsin) and WEC's current principal utility subsidiary, Wisconsin Electric Power Company, which will be renamed \"Wisconsin Energy Company.\" It is anticipated that, following the Transaction, except for certain gas distribution properties transferred to the Company, the Wisconsin Company will be merged into Wisconsin Energy Company and that some of the Company's other subsidiaries will become direct Primergy subsidiaries.\nAs noted above, pursuant to the Transaction, NSP will reincorporate in Wisconsin. This reincorporation will be accomplished by the merger of the Company into a new company, Northern Power Wisconsin Corporation (New NSP), with New NSP being the surviving corporation and succeeding to the business of the Company as an operating public utility. Following such merger, a new WEC subsidiary, WEC Sub Corporation (WEC Sub), will be merged with and into New NSP, with New NSP being the surviving corporation and becoming a subsidiary of Primergy. Both New NSP and WEC Sub were created to effect the Transaction and will not have any significant operations, assets or liabilities prior to such mergers. After the Transaction is completed, current common stockholders of the Company will own shares of Primergy common stock, and current bondholders and preferred stockholders of the Company will become investors in New NSP.\nSUMMARIZED PRO FORMA FINANCIAL INFORMATION (UNAUDITED)\nThe following summary of unaudited pro forma financial information reflects the adjustment of the historical consolidated balance sheets and statements of income of NSP and WEC to give effect to the Transaction to form Primergy and a new subsidiary structure. The unaudited pro forma balance sheet information gives effect to the Transaction as if it had occurred on Dec. 31, 1995. The unaudited pro forma income statement information gives effect to the Transaction as if it had occurred on Jan. 1, 1995. This pro forma information was prepared from the historical consolidated financial statements of NSP and WEC on the basis of accounting for the Transaction as a pooling of interests and should be read in conjunction with such historical consolidated financial statements and related notes thereto of NSP and WEC. The following information is not necessarily indicative of the financial position or operating results that would have occurred had the Transaction been consummated on the dates, for which the Transaction is being given effect, nor is it necessarily indicative of future Primergy operating results or financial position.\nPrimergy Information The following summarized Primergy pro forma financial information reflects the combination of the historical financial statements of NSP and WEC after giving effect to the Transaction to form Primergy. A $141 million pro forma adjustment has been made to conform the presentations of noncurrent deferred income taxes in the summarized pro forma combined balance sheet information as a net liability. The pro forma combined earnings per common share reflect pro forma adjustments to average common shares outstanding in accordance with the stock conversion provisions of the Merger Agreement.\nPro Forma Primergy Pro Forma Financial Information NSP WEC Combined (Millions of dollars, except per share amounts)\nAs of Dec. 31, 1995: Utility Plant---Net $4 310 $2 911 $7 221 Current Assets 705 531 1 236 Other Assets 1 214 1 119 2 192 Total Assets $6 229 $4 561 $10 649\nCommon Stockholders' Equity $2 028 $1 871 $3 899 Preferred Stockholders' Equity 240 30 270 Long-Term Debt 1 542 1 368 2 910 Total Capitalization 3 810 3 269 7 079 Current Liabilities 992 436 1 428 Other Liabilities 1 427 856 2 142 Total Equity & Liabilities $6 229 $4 561 $10 649\nFor the Year Ended Dec. 31, 1995: Utility Operating Revenues $2 569 $1 770 $4 339 Utility Operating Income $346 $329 $675 Net Income, after Preferred Dividend Requirements $263 $234 $497 Earnings per Common Share: As reported $3.91 $2.13 Using NSP Equivalent Shares* $3.69 Using Primergy Shares $2.27\n* Represents the pro forma equivalent of one share of NSP Common Stock calculated by multiplying the pro forma information by the conversion ratio of 1.626 shares of Primergy Common Stock for each share of NSP Common Stock.\nNew NSP Information The following summarized New NSP pro forma financial information reflects the adjustment of the historical financial statements of NSP to give effect to the Transaction, including the merger of the Wisconsin Company into Wisconsin Energy Company and the transfer of ownership of all of the other current NSP subsidiaries to Primergy. The transfer of certain Wisconsin Company gas distribution properties to New NSP, which is anticipated as part of the merger, has not been reflected in the pro forma amounts due to immateriality.\nMerger Divestitures, Pro Forma New NSP Pro Forma Financial Information NSP Net New NSP (Millions of dollars)\nAs of Dec. 31, 1995: Utility Plant---Net $4 310 ($692) $3 618 Current Assets 705 (170) 535 Other Assets 1 214 (531) 683 Total Assets $6 229 ($1 393) $4 836\nCommon Stockholders' Equity $2 028 ($706) $1 322 Preferred Stockholders' Equity 240 240 Long-Term Debt 1 542 (356) 1 186 Total Capitalization 3 810 (1 062) 2 748 Current Liabilities 992 (139) 853 Other Liabilities 1 427 (192) 1 235 Total Equity & Liabilities $6 229 ($1 393) $4 836\nFor the Year Ended Dec. 31, 1995: Utility Operating Revenues $2 569 ($213) $2 356 Utility Operating Income $346 ($62) $284 Net Income, after Preferred Dividend Requirements $263 ($73) $190\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nDuring 1995 there were no disagreements with the Company's independent public accountants on accounting procedures or accounting and financial disclosures. As discussed in the Company's Current Report on Form 8-K filed Dec. 16, 1994, on Dec. 14, 1994, the Company's Board of Directors approved the appointment of the accounting firm of Price Waterhouse LLP as independent accountants for the Registrant beginning in fiscal year 1995, subject to ratification by the shareholders. On Sept. 13, 1995, the Company's shareholders ratified the appointment of Price Waterhouse LLP as the Company's independent accountants for 1995.\nPART III Item 10","section_9A":"","section_9B":"","section_10":"Item 10 - Directors and Executive Officers of the Registrant\nInformation required under this Item with respect to directors is set forth in the Registrant's 1996 Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996, on pages 3 through 6 under the caption \"Election of Directors,\" which is incorporated herein by reference. Information with respect to Executive Officers is included under the caption \"Executive Officers\" in Item 1 of this report, and is incorporated herein by reference.\nItem 11","section_11":"Item 11 - Executive Compensation\nInformation required under this Item is set forth in the Registrant's 1996 Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996, on pages 7 through 17 under the caption \"Compensation of Executive Officers,\" which is incorporated herein by reference.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management\nInformation required under this item is set forth in the Registrant's 1996 Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996, on page 6 under the caption \"Share Ownership of Directors, Nominees and Named Executive Officers,\" which is incorporated herein by reference.\nItem 13","section_13":"Item 13 - Certain Relationships and Related Transactions\nInformation required under this Item is set forth in the Registrant's 1996 Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996, on pages 3 through 4 under the captions \"Class I - Nominees for Terms expiring in 1999,\" \"Class II - Nominee for Term expiring in 1997,\" \"Class II - - Directors Whose Terms Expire in 1997,\" \"Class III - Directors Whose Terms Expire in 1998,\" which is incorporated herein by reference.\nPART IV Item 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 2. Financial Statement Schedules\nSchedules are omitted because of the absence of the conditions under which they are required or because the information required is included in the financial statements or the notes.\n(a) 3. Exhibits\n* Indicates incorporation by reference\n2.01* Amended and Restated Agreement and Plan of Merger, dated as of April 28, 1995, as amended and restated as of July 26, 1995, by and among Northern States Power Company, Wisconsin Energy Corporation, Northern Power Wisconsin Corp. and WEC Sub. Corp. (Exhibit (2)-1 to Northern Power Wisconsin Corp.'s Registration Statement on Form S-4 filed on Aug. 7, 1995, File No. 33- 61619-01).\n2.02* WEC Stock Option Agreement, dated as of April 28, 1995, by and among Northern States Power Company and Wisconsin Energy Corporation (Exhibit (2)-2 to Form 8-K dated April 28, 1995, File No. 1- 3034).\n2.03* NSP Stock Option Agreement, dated as of April 28, 1995, by and among Wisconsin Energy Corporation and Northern States Power Company (Exhibit (2)-3 to Form 8-K dated April 28, 1995, File No. 1-3034).\n2.04* Committees of the Board of Directors of Primergy Corporation, Exhibit 7.13 to the Agreement and Plan of Merger (Exhibit (2)-4 to Form 8-K dated April 28, 1995, File No. 1-3034).\n2.05* Form of Employment Agreement of James J. Howard, Exhibit 7.15.1 to the Agreement and Plan of Merger (Exhibit (2)-5 to Form 8-K dated April 28, 1995, File No. 1-3034).\n2.06* Form of Employment Agreement with Richard A. Abdoo, Exhibit 7.15.2 to the Agreement and Plan of Merger (Exhibit (2)-6 to Form 8-K dated April 28, 1995, File No. 1-3034).\n2.07* Form of Amended and Restated Articles of Incorporation of Northern Power Wisconsin Corp., Exhibit 7.20 (b) to the Agreement and Plan of Merger (Exhibit (2)-7 to Form 8-K dated April 28, 1995, File No. 1-3034).\n2.08* Form of NSP Senior Executive Severance Policy, Exhibit 7.10 (a) to the Amended and Restated Agreement and Plan of Merger, dated as of April 28, 1995, as amended and restated as of July 26, 1995, by and among Northern States Power Company, Wisconsin Energy Corporation, Northern Power Wisconsin Corp. and WEC Sub. Corp. (Exhibit (2) - 1 to Northern Power Wisconsin Corp.'s Registration on Form S-4 filed Aug. 7, 1995, File No. 33-61619-01).\n3.01* Restated Articles of Incorporation of the Company and Amendments, effective as of April 2, 1992. (Exhibit 3.01 to Form 10-Q for the quarter ended March 31, 1992, File No. 1-3034).\n3.02* Bylaws of the Company as amended Jan. 22, 1992. (Exhibit 3.02 to Form 10-K for the year 1991, File No. 1-3034).\n4.01* Trust Indenture, dated Feb. 1, 1937, from the Company to Harris Trust and Savings Bank, as Trustee. (Exhibit B-7 to File No. 2-5290).\n4.02* Supplemental and Restated Trust Indenture, dated May 1, 1988, from the Company to Harris Trust and Savings Bank, as Trustee. (Exhibit 4.02 to Form 10-K for the year 1988, File No. 1-3034).\nSupplemental Indenture between the Company and said Trustee, supplemental to Exhibit 4.01, dated as follows:\n4.03* Jun. 1, 1942 (Exhibit B-8 to File No. 2-97667).\n4.04* Feb. 1, 1944 (Exhibit B-9 to File No. 2-5290).\n4.05* Oct. 1, 1945 (Exhibit 7.09 to File No. 2-5924).\n4.06* Jul. 1, 1948 (Exhibit 7.05 to File No. 2-7549).\n4.07* Aug. 1, 1949 (Exhibit 7.06 to File No. 2-8047).\n4.08* Jun. 1, 1952 (Exhibit 4.08 to File No. 2-9631).\n4.09* Oct. 1, 1954 (Exhibit 4.10 to File No. 2-12216).\n4.10* Sep. 1, 1956 (Exhibit 2.09 to File No. 2-13463).\n4.11* Aug. 1, 1957 (Exhibit 2.10 to File No. 2-14156).\n4.12* Jul. 1, 1958 (Exhibit 4.12 to File No. 2-15220).\n4.13* Dec. 1, 1960 (Exhibit 2.12 to File No. 2-18355).\n4.14* Aug. 1, 1961 (Exhibit 2.13 to File No. 2-20282).\n4.15* Jun. 1, 1962 (Exhibit 2.14 to File No. 2-21601).\n4.16* Sep. 1, 1963 (Exhibit 4.16 to File No. 2-22476).\n4.17* Aug. 1, 1966 (Exhibit 2.16 to File No. 2-26338).\n4.18* Jun. 1, 1967 (Exhibit 2.17 to File No. 2-27117).\n4.19* Oct. 1, 1967 (Exhibit 2.01R to File No. 2-28447).\n4.20* May 1, 1968 (Exhibit 2.01S to File No. 2-34250).\n4.21* Oct. 1, 1969 (Exhibit 2.01T to File No. 2-36693).\n4.22* Feb. 1, 1971 (Exhibit 2.01U to File No. 2-39144).\n4.23* May 1, 1971 (Exhibit 2.01V to File No. 2-39815).\n4.24* Feb. 1, 1972 (Exhibit 2.01W to File No. 2-42598).\n4.25* Jan. 1, 1973 (Exhibit 2.01X to File No. 2-46434).\n4.26* Jan. 1, 1974 (Exhibit 2.01Y to File No. 2-53235).\n4.27* Sep. 1, 1974 (Exhibit 2.01Z to File No. 2-53235).\n4.28* Apr. 1, 1975 (Exhibit 4.01AA to File No. 2-71259).\n4.29* May 1, 1975 (Exhibit 4.01BB to File No. 2-71259).\n4.30* Mar. 1, 1976 (Exhibit 4.01CC to File No. 2-71259).\n4.31* Jun. 1, 1981 (Exhibit 4.01DD to File No. 2-71259).\n4.32* Dec. 1, 1981 (Exhibit 4.01EE to File No. 2-83364).\n4.33* May 1, 1983 (Exhibit 4.01FF to File No. 2-97667).\n4.34* Dec. 1, 1983 (Exhibit 4.01GG to File No. 2-97667).\n4.35* Sep. 1, 1984 (Exhibit 4.01HH to File No. 2-97667).\n4.36* Dec. 1, 1984 (Exhibit 4.01II to File No. 2-97667).\n4.37* May 1, 1985 (Exhibit 4.36 to Form 10-K for the year 1985, File No. 1-3034).\n4.38* Sep. 1, 1985 (Exhibit 4.37 to Form 10-K for the year 1985, File No. 1-3034).\n4.39* Jul. 1, 1989 (Exhibit 4.01 to Form 8-K dated July 7, 1989, File No. 1-3034).\n4.40* Jun. 1, 1990 (Exhibit 4.01 to Form 8-K dated June 1, 1990, File No. 1-3034).\n4.41* Oct. 1, 1992 (Exhibit 4.01 to Form 8-K dated Oct. 13, 1992, File No. 1-3034).\n4.42* April 1, 1993 (Exhibit 4.01 to Form 8-K dated March 30, 1993, File No. 1-3034).\n4.43* Dec. 1, 1993 (Exhibit 4.01 to Form 8-K dated Dec. 7, 1993, File No. 1-3034).\n4.44* Feb. 1, 1994 (Exhibit 4.01 to Form 8-K dated Feb. 10, 1994, File No. 1-3034).\n4.45* Oct. 1, 1994 (Exhibit 4.01 to Form 8-K dated Oct. 5, 1994, File No. 1-3034).\n4.46* Jun. 1, 1995 (Exhibit 4.01 to Form 8-K dated June 28, 1995, File No. 1-3034).\n4.47* Trust Indenture, dated April 1, 1947, from the Wisconsin Company to Firstar Trust Company (formerly First Wisconsin Trust Company), as Trustee. (Exhibit 7.01 to File No. 2-6982).\nSupplemental Indentures between the Wisconsin Company and said Trustee, supplemental to Exhibit 4.45 dated as follows:\n4.48* Mar. 1, 1949 (Exhibit 7.02 to File No. 2-7825).\n4.49* Jun. 1, 1957 (Exhibit 2.13 to File No. 2-13463).\n4.50* Aug. 1, 1964 (Exhibit 4.20 to File No. 2-23726).\n4.51* Dec. 1, 1969 (Exhibit 2.03E to File No. 2-36693).\n4.52* Sep. 1, 1973 (Exhibit 2.01F to File No. 2-48805).\n4.53* Feb. 1, 1982 (Exhibit 4.01G to File No. 2-76146).\n4.54* Mar. 1, 1982 (Exhibit 4.39 to Form 10-K for the year 1982, File No. 10-3140).\n4.55* Jun. 1, 1986 (Exhibit 4.01I to File No. 33-6269).\n4.56* Mar. 1, 1988 (Exhibit 4.01J to File No. 33-20415).\n4.57* Supplemental and Restated Trust Indenture dated March 1, 1991, from the Wisconsin Company to Firstar Trust Company (formerly First Wisconsin Trust Company), as Trustee. (Exhibit 4.01K to File No. 33-39831)\n4.58* Apr. 1, 1991 (Exhibit 4.01L to File No. 33-39831).\n4.59* Mar. 1, 1993 (Exhibit 4.01 to Form 8-K dated March 4, 1993, File No. 10-3140).\n4.60* Oct. 1, 1993 (Exhibit 4.01 to Form 8-K dated September 21, 1993, File No. 10-3140).\n4.61* NSP Employee Stock Ownership Plan. (Exhibit 4.60 to Form 10-K for the year 1994, File No. 1-3034).\n10.01* Mid-continent Area Power Pool (MAPP) Agreement, dated March 31, 1972, with amendments in 1994, between the local power suppliers in the North Central States area. (Exhibit 10.01 to Form 10-K for the year 1994, File No. 1-3034).\n10.02* Facilities agreement, dated July 21, 1976, between the Company and the Manitoba Hydro- Electric Board relating to the interconnection of the 500 Kv Line. (Exhibit 5.06I to File No. 2-54310).\n10.03* Transactions agreement, dated July 21, 1976, between the Company and the Manitoba Hydro- Electric Board relating to the interconnection of the 500 Kv Line. (Exhibit 5.06J to File No. 2-54310).\n10.04* Coordinating agreement, dated July 21, 1976, between the Company and the Manitoba Hydro- Electric Board relating to the interconnection of the 500 Kv Line. (Exhibit 5.06K to File No. 2-54310).\n10.05* Ownership and Operating Agreement, dated March 11, 1982, between the Company, Southern Minnesota Municipal Power Agency and United Minnesota Municipal Power Agency concerning Sherburne County Generating Unit No. 3. (Exhibit 10.01 to Form 10-Q for the quarter ended Sept. 30, 1994, File No. 1-3034).\n10.06* Transmission agreement, dated April 27, 1982, and Supplement No. 1, dated July 20, 1982, between the Company and Southern Minnesota Municipal Power Agency. (Exhibit 10.02 to Form 10-Q for the quarter ended Sept. 30, 1994, File No. 1-3034).\n10.07* Power agreement, dated June 14, 1984, between the Company and the Manitoba Hydro-Electric Board, extending the agreement scheduled to terminate on April 30, 1993, to April 30, 2005. (Exhibit 10.03 to Form 10-Q for the quarter ended Sept. 30, 1994, File No. 1-3034).\n10.08* Power Agreement, dated August 1988, between the Company and Minnkota Power Company. (Exhibit 10.08 to Form 10-K for the year 1988, File No. 1-3034).\n10.09* Energy Supply Agreement, dated Oct. 26, 1993, between the Company and Liberty Paper, Inc. (LPI), relating to the supply of steam and electricity to the LPI container-board facility in Becker, MN. (Exhibit 10.09 to Form 10-K for the year 1993, File No. 1-3034).\nExecutive Compensation Arrangements and Benefit Plans Covering Executive Officers\n10.10* Executive Long-Term Incentive Award Stock Plan. (Exhibit 10.10 to Form 10-K for 1988, File No. 1-3034).\n10.11* Terms and Conditions of Employment - James J Howard, President and Chief Executive Officer, effective Feb. 1, 1987, as amended. (Agreement filed as Exhibit 10.11 to Form 10-K for the year 1986, File No. 1-3034, Acknowledgement of Amendment to Terms and Conditions of Employment of James J. Howard filed as Exhibit 10.01 to Form 10-Q for the quarter ended June 30, 1995, File No. 1-3034).\n10.12* NSP Severance Plan. (Exhibit 10.12 to Form 10-K for the year 1994, File No. 1-3034).\n10.13* NSP Deferred Compensation Plan amended effective Jan. 1, 1993. (Exhibit 10.16 to Form 10-K for the year 1993, File No. 1-3034).\n10.14 Annual Executive Incentive Plan for 1996.\n12.01 Statement of Computation of Ratio of Earnings to Fixed Charges.\n16.01* Independent Auditors' Letter re: Change in Certifying Accountant (Exhibit 16.01 to Form 8-K dated Dec. 13, 1994, File No. 1-3034).\n21.01 Subsidiaries of the Registrant.\n23.01 Consent of Independent Accountants - Price Waterhouse LLP, Minneapolis, MN.\n23.02 Independent Auditor's Consent - Deloitte & Touche LLP.\n23.03 Consent of Independent Accountants - Price Waterhouse LLP, Milwaukee, WI.\n27.01 Financial Data Schedule.\n99.01* Press Release, dated May 1, 1995, of NSP (Exhibit (99)-1 to Form 8-K dated April 28, 1995, File No. 1-3034).\n99.02 Unaudited Pro Forma Combined Condensed Balance Sheets for Primergy Corporation at Dec. 31, 1995 and Unaudited Pro Forma Combined Condensed Statements of Income for the three years ended Dec. 31, 1995.\n99.03 Unaudited Pro Forma Condensed Balance Sheet for New NSP at Dec. 31, 1995 and Unaudited Pro Forma Condensed Statements of Income for the three years ended Dec. 31, 1995.\n99.04* Audited Financial Statements of Wisconsin Energy Corporation. (Item 8 of Wisconsin Energy Corporation's Annual Report on Form 10-K for the fiscal year ended Dec. 31, 1995, File No. 1- 9057).\n(b) Reports on Form 8-K. The following reports on Form 8-K were filed either during the three months ended Dec. 31, 1995, or between Dec. 31, 1995 and the date of this report.\nJan. 18, 1996 (Filed Jan. 18, 1996) - Item 5. Other Events. Re: Release of 1995 financial results of NRG Energy, Inc., a wholly owned subsidiary of the Company.\nMarch 1, 1996 (Filed March 1, 1996) - Item 5. Other Events. Re: Disclosure of new category of electric commercial and industrial customers, and electric and gas operating statistics for 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 annual report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTHERN STATES POWER COMPANY\nMarch 27, 1996 (E J McIntyre) E J McIntyre Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\n(James J Howard) (E J McIntyre) James J Howard E J McIntyre Chairman of the Board, President Vice President and Chief and Chief Executive Officer Financial Officer (Principal (Principal Executive Officer) Financial Officer\n(Roger D Sandeen) (H Lyman Bretting) Roger D Sandeen H Lyman Bretting Vice President, Controller and Chief Director Information Officer (Principal Accounting Officer)\n(David A Christensen) (W John Driscoll) David A Christensen W John Driscoll Director Director\n(Dale L Haakenstad) (Allen F Jacobson) Dale L Haakenstad Allen F Jacobson Director Director\n(Richard M Kovacevich) (Douglas W Leatherdale) Richard M Kovacevich Douglas W Leatherdale Director Director\n(John E Pearson) (G M Pieschel) John E Pearson G M Pieschel Director Director\n(Margaret R Preska) (A Patricia Sampson) Margaret R Preska A Patricia Sampson Director Director\nEXHIBIT INDEX\nMethod of Exhibit Filing No. Description\nDT 10.14 Annual Executive Incentive Plan for 1996\nDT 12.01 Statement of Computation of Ratio of Earnings to Fixed Charges\nDT 21.01 Subsidiaries of the Registrant\nDT 23.01 Consent of Independent Accountants - Price Waterhouse LLP, Minneapolis, MN\nDT 23.02 Independent Auditor's Consent - Deloitte & Touche LLP\nDT 23.03 Consent of Independent Accountants - Price Waterhouse LLP, Milwaukee, WI\nDT 27.01 Financial Data Schedule\nDT 99.02 Unaudited Pro Forma Combined Condensed Balance Sheets for Primergy Corporation at Dec. 31, 1995 and Unaudited Pro Forma Combined Condensed Statements of Income for the three years ended Dec. 31, 1995\nDT 99.03 Unaudited Pro Forma Condensed Balance Sheet for New NSP at Dec. 31, 1995 and Unaudited Pro Forma Condensed Statements of Income for the three years ended Dec. 31, 1995\nDT = Filed electronically with this direct transmission.","section_15":""}
{"filename":"352510_1995.txt","cik":"352510","year":"1995","section_1":"ITEM 1 BUSINESS\nGeneral Development of Business\nNorth Fork Bancorporation, Inc. (the \"Registrant\") with its executive headquarters located in Melville, New York, is a bank holding company organized under the laws of the State of Delaware in 1980 and registered under the Bank Holding Company Act of 1956, as amended. The Registrant's primary subsidiary, North Fork Bank, operates forty-nine retail banking facilities throughout Suffolk, Nassau, Queens, Westchester and Rockland Counties, New York.\nDuring 1995, North Fork Bank entered into definitive merger agreements to acquire the domestic commercial banking business of Extebank with approximately $387 million in assets and $348 million in deposits for $47 million in cash. Extebank operated seven retail banking facilities in Suffolk County and one in Manhattan, New York. Additionally, North Fork Bank entered into an Asset Purchase and Sale Agreement with First Nationwide Bank to acquire their ten Long Island branches with approximately $600 million in deposits at a deposit premium of 6.35% (see \"Note 2 -- Mergers and Acquisitions\" (pages 24-25) of the Registrant's 1995 Annual Report for a more detailed discussion). Both of these in-market acquisitions closed during the first quarter of 1996.\nOn July 3, 1995, the Bank consummated its purchase of Great Neck Bancorp, the parent company of Bank of Great Neck, a Long Island based commercial bank (\"Great Neck\"). Great Neck with net assets of $91 million, including $49.4 million in net loans and $90.3 million in deposits, was merged into North Fork Bank.\nOn November 30, 1994, Metro Bancshares Inc. (\"Metro\"), the parent company of Bayside Federal Savings Bank (\"Bayside\") was merged with and into the Registrant. Simultaneously, Bayside (with approximately $1.0 billion in assets, $.9 billion in deposits and $83.5 million in stockholders equity, operating through thirteen branch locations in Queens, Nassau and Suffolk Counties, New York) was merged with and into the Bank. The merger was accounted for as a pooling-of-interests, and accordingly, the Registrant's consolidated financial statements include the consolidated results of Metro.\nNorth Fork Bank is the result of the October 1, 1992 merger of the Registrant's banking subsidiaries, The North Fork Bank & Trust Company (\"Bank & Trust\") and Southold Savings Bank (\"Southold\"). Bank & Trust was merged into Southold; Southold then converted its charter from that of a state savings bank to a state commercial bank and changed its name to North Fork Bank.\nPrior to 1988, the Registrant's principal asset was Bank & Trust and its business consisted primarily of the ownership and operation of Bank & Trust. On August 1, 1988, the Registrant completed the acquisition of Southold, a New York State chartered savings bank. Southold expanded its branch network through the June 28, 1991 acquisition of Eastchester Financial Corporation, (\"Eastchester\"). Eastchester's primary asset was Eastchester Savings Bank, a $500.8 million savings bank which operated through seven branch locations in Westchester and Rockland Counties, New York. Immediately upon consummation of the acquisition. Eastchester was dissolved and its operations consolidated into those of Southold.\nAdditionally, the Registrant and the Bank have nine active non-bank subsidiaries, none of which accounted for a significant portion of the Registrant's consolidated assets, nor contributed significantly to the Registrant's consolidated results of operations, at and for the year ended December 31, 1995.\nDESCRIPTION OF BUSINESS\nThe Registrant, through its bank subsidiary, provides a variety of banking and financial services to middle market and small business organizations, local governmental units, and retail customers in the metropolitan New York area. The Bank's major competitors across the entire line of its products and services are local branches of large money-center banks headquartered in New York City and other banks headquartered in New York State. Additionally, the Bank competes with other independent commercial banks in its marketplace for loans and deposits; with local savings and loan associations and savings banks for deposits and mortgage loans; with credit unions for deposits and consumer loans; with insurance companies and money market funds for deposits; and with local consumer finance organizations and the financing affiliates of consumer goods manufacturers for consumer loans, especially automobile manufacturers. In setting rate structures for the Bank's loan and deposit products, management refers to a wide variety of financial information and indices, including the rates charged or paid by the major money-center banks, both locally and in the commercial centers, and the rates fixed periodically by smaller, local competitors.\nThe Registrant and the Bank, in their normal course of business, are subject to various regulatory statutes and guidelines. Additional information is set forth under the caption \"Capital\" (pages 13-14) in Management's Discussion and Analysis of the Registrant's 1995 Annual Report to Shareholders included as Exhibit 13 herewith and incorporated herein by reference.\nAs of December 31, 1995, the Registrant and its consolidated subsidiaries had approximately 814 full-time equivalent employees.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nDuring 1995, the Registrant entered into a long-term lease for a portion of a four-story office building located at 275 Broad Hollow Road, Melville, New York. At December 31, 1995, the Registrant occupied 48,125 square feet which represents approximately 42% of the building's rentable space. This additional space was necessitated by the Registrant's recent acquisitions which expanded its presence in the metropolitan New York area, specifically, Queens and Nassau Counties. This facility now serves as the Registrant's administrative headquarters, and includes its lending, retail banking, trust and investment management services divisions and its recently relocated Melville branch.\nThe Registrant maintains its operations center and mortgage origination and administration offices in a 28,300 square foot facility owned by the bank, located at 9025 Main Road, Mattituck, New York.\nThe Bank owns twenty-six (26) buildings and occupies thirty-four (34) other facilities under various lease arrangements expiring at various times through 2014 (see \"Note 14 - Other Commitments and Contingent Liabilities(b) Lease Commitments\" (page 39)) of the Registrant's 1995 Annual Report to Shareholders included as Exhibit 13 herewith and incorporated herein by reference). All but six of these buildings and facilities are utilized by the Bank to provide banking and related financial services either as bank branches or as limited banking facilities (principally stand-alone ATM locations). Of the six not used for retail banking, two are owned facilities used by the data processing, loan servicing and operations departments of the Bank. The remaining space is leased to either accommodate additional office space or has been vacated and subleased as a result of relocating certain departments to 275 Broad Hollow Road, Melville. The premises occupied or leased by the Registrant and its subsidiaries are considered to be well located and suitably equipped to serve as banking and related financial services facilities.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nInformation required by this item is set forth under the caption \"Note 14 -- Other Commitments and Contingent Liabilities -- (c) Other Matters\" (page 39), in the Registrant's 1995 Annual Report to Shareholders included herein as Exhibit 13 and incorporated herein by reference.\nITEM 4","section_4":"ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to security holders for vote during the fourth quarter of 1995.\nITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT\nThe name, age, position and business experience during the past five years of each of the executive officers of the Registrant as of December 31, 1995, are presented in the following table. The officers are elected annually by the Board of Directors.\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 under the symbol NFB. As of March 15, 1996, there were approximately 5,551 shareholders of record of the Registrant's common stock.\nDuring 1995, the Registrant declared dividends of $.125 per share for the first and second quarters, respectively, and $.15 per share for the third and fourth quarter, respectively. During 1994, the Registrant declared dividends of $.075 per share for the first and second quarters, respectively, and $.10 per share for the third and fourth quarters, respectively (dividends declared are exclusive of dividends declared by Metro prior to merger).\nFor additional information regarding dividends and restrictions thereon, and market price information, refer to the \"Selected Financial Data\" (page 1), the \"Liquidity\" section of Management's Discussion and Analysis (pages 9-10), the \"Selected Statistical Data\" (page 16), \"Note 8 - Long Term Borrowings\" (page 29), and \"Note 13 - Regulatory Matters\" (page 37) of the Registrant's 1995 Annual Report to Shareholders included herewith as Exhibit 13 and incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nThe information required by this item is set forth in \"Selected Financial Data\" (page 1) of the Registrant's 1995 Annual Report to Shareholders included herewith as Exhibit 13 and 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 Management's Discussion and Analysis, (pages 3-15) of the Registrant's 1995 Annual Report to Shareholders included herewith as Exhibit 13 and incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following information is set forth in the Registrant's 1995 Annual Report to Shareholders included herewith as Exhibit 13 and incorporated herein by reference:\nUnaudited Consolidated Quarterly Financial Information (page 16); the Consolidated Financial Statements (pages 17-21); the Notes to the Consolidated Financial Statements (pages 22-41); the Independent Auditors' Report (page 42); and the Report of Management (page 43).\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes in or disagreements with accountants on accounting and financial disclosure as defined by Item 304 of Regulation S-K.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item is set forth under the caption \"Election of Directors and Information with Respect to Directors and Officers\" (pages 2-6) in the Registrant's Definitive Proxy Statement for its Annual Meeting of Stockholders to be held April 23, 1996, which is incorporated herein by reference, and in Part I 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 is set forth under the captions \"Compensation of Directors\" (pages 6 - 7), \"Executive Compensation\" (pages 8-19), and \"Retirement Plans\" (pages 19-20) in the Registrant's Definitive Proxy Statement for its Annual Meeting of Stockholder's to be held April 23, 1996, which is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is set forth under the caption \"Certain Beneficial Ownership\" and \"Nominees for Director and Directors Continuing in Office\" (pages 2-6) in the Registrant's Definitive Proxy Statement for its Annual Meeting of Stockholder's to be held April 23, 1996, which is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is set forth under the caption \"Transactions with Directors, Executive Officers and Associated Persons\" (page 20) in the Registrant's Definitive Proxy Statement for its Annual Meeting of Stockholders to be held April 23, 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\n(a) The consolidated financial statements, including notes thereto, and financial schedules of the Registrant, required in response to this item is set forth in response to Part II, Item 8 of this Annual Report are incorporated herein by reference in the Registrant's 1995 Annual Report to Shareholders filed herewith as Exhibit 13.\n1. Financial Statements Page # Consolidated Statements of Income 17 Consolidated Balance Sheets 18 Consolidated Statements of Cash Flows 19-20 Consolidated Statements of Changes 21 in Stockholders' Equity Notes to Consolidated Financial Statements 22-41 Report of Independent Public Accountants 42\n2. Financial Statement Schedules\nSchedules to the consolidated financial statements required by Article 9 of Regulation S-X and all other schedules to the consolidated financial statements of the Registrant have been omitted because they are either not required, are not applicable or are included in the consolidated financial statements or notes thereto, which is incorporated herein by reference.\n3. Exhibits\nThe exhibits listed on the Exhibit Index page of this Annual Report are incorporated by reference or filed herewith as required by Item 601 of Regulation S-K (each management contract or compensatory plan or arrangement listed therein is identified).\n(b) Current Reports on Form 8-K\nThe Registrant has not filed any reports on Form 8-K during the last quarter of the year ended December 31, 1995. Pursuant to the requirements of Section 13 or 15(d) of this Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTH FORK BANCORPORATION, INC.\nBY: \/s\/ John A. Kanas ------------------------------------- JOHN A. KANAS President and Chief Executive Officer\nDated: March 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 date indicated.\nSignature Title Date\n\/s\/ John A. Kanas Director, President, March 26, 1996 - - ------------------------- Chief Executive Officer, John A. Kanas and Chairman of the Board (Principal Executive Officer)\n\/s\/ Daniel M. Healy Executive Vice President and March 26, 1996 - - ------------------------- Chief Financial Officer Daniel M. Healy (Principal Accounting Officer)\n\/s\/ John Bohlsen Director March 26, 1996 - - ------------------------- Vice Chairman of the Board John Bohlsen\n\/s\/ Malcolm J. Delaney Director March 26, 1996 - - ------------------------- Malcolm J. Delaney\n\/s\/ Allan C. Dickerson Director March 26, 1996 - - ------------------------- Allan C. Dickerson\n\/s\/ Lloyd A. Gerard Director March 26, 1996 - - ------------------------- Lloyd A. Gerard\n\/s\/ James F. Reeve Director March 26, 1996 - - ------------------------- James F. Reeve\n\/s\/ James H. Rich, Jr. Director March 26, 1996 - - ------------------------- James H. Rich, Jr.\n\/s\/ George H. Rowsom Director March 26, 1996 - - ------------------------- George H. Rowsom\n\/s\/ Raymond W. Terry, Jr. Director March 26, 1996 - - ------------------------- Raymond W. Terry, Jr.\n\/s\/ Dr. Kurt R. Schmeller Director March 26, 1996 - - ------------------------- Dr. Kurt R. Schmeller\nEXHIBIT INDEX\nEXHIBIT INDEX (continued)\nEXHIBIT INDEX (continued)\n(a) Management Contract or Compensatory Plan arrangement.","section_15":""}
{"filename":"729533_1995.txt","cik":"729533","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nHadco Corporation (the \"Company\" or \"HADCO\") is a leading independent manufacturer of high density double-sided and complex multilayer printed circuits and backplane assemblies used in the computer, telecommunications and industrial automation industries, including process control systems, automotive electronics and electronic instrumentation. The Company's customers include large, medium and small original equipment manufacturers (\"OEM\") of electronic systems, as well as independent sub-contract manufacturers. HADCO is a Massachusetts corporation organized in 1966. The Company is headquartered in Salem, New Hampshire and operates facilities in New Hampshire, New York and California.\nINDUSTRY OVERVIEW\nHADCO's business is the provision of electronic interconnect solutions, primarily printed circuits. Printed circuits are the base used to interconnect the microprocessors, integrated circuits, capacitors, resistors, and other components critical to the operation of electronic equipment. Printed circuits are generally made of rigid fiberglass, rigid paper or thin flexible plastic. The Company manufactures primarily rigid fiberglass printed circuits.\nIn recent years, the trend in the electronics industry has generally been toward increasing the speed and performance of components, while reducing their size. This advancement in component technology has driven the change in printed circuit design to higher density printed circuits. Surface Mount Technology (\"SMT\") and multilayer circuits provide some of the solutions to these density requirements. Within SMT technology, new component attachment methods have been developed. Tape Automate Bonding (TAB), Ball Grid Array (BGA) and other component attachment technologies provide electronic equipment producers with a more cost effective solution to attaching components to a printed circuit. These attachment strategies continue to drive increased density in printed circuit design and production. HADCO has invested in the advanced engineering systems and process equipment needed to meet these density requirements.\nThe increased technology requirements and high cost of development and advancement within the printed circuit industry have created a trend toward turning the OEM away from internal circuit board production, and towards independent board producers that can effectively manage the high cost of printed circuit development and advancement. Based on industry sources, the domestic market for all printed circuits in 1995 was approximately $6.6 billion. Industry analysts estimate that in 1995, approximately 85% of the domestic printed circuit market was served by independent manufacturers such as HADCO, with the remaining 15% being served by captive manufacturing facilities operated by certain OEMs.\nDEFINITION OF PRODUCTS AND SERVICES\nThe Company provides products and services to meet the multilayer and high density needs of its customers. In fiscal 1995, approximately 67% of the Company's printed circuit net sales were for high density products with two or three conductive tracks between plated through-holes with centers 100 mils apart, as compared to 63% in 1994 and 62% in 1993. Net sales of multilayer, as opposed to double sided, printed circuits accounted for 94%, 93%, and 91% of the Company's printed circuit net sales in fiscal 1995, 1994 and 1993, respectively.\nIn order to fully support the needs of the Company's customers, HADCO offers a number of complementary processes and capabilities that span the period of product conception through delivery to the customer.\nThe Company supports its customers in the computer aided design for the physical design and layout of printed circuits. The Company cooperates with customers in the design of their products in order to assure that their design specifications will be compatible with the Company's manufacturing processes. The Company also gains a better understanding of the future requirements of OEMs. This cooperative process shortens the time in transition from the development of the prototype design to volume manufacturing and facilitates the delivery of high quality products on time to customer premises. These results are important benefits to the Company's customers since many of their products have increasingly shorter economic lives.\nThe Company offers solutions to support customer needs in the prototyping product development stage or small volume production through its Tech Center facilities in New Hampshire and California. Prototype development at these facilities has included: embedded discrete components, multilayer boards of up to 34 layers, Multichip Modules (MCM-L), Single Chip Carriers (SCC), planar magnetics and new high performance substrates. The Tech Centers also support new attachment strategies such as Tape Automated Bonding (TAB), Chip-on-Board (COB), Flip Chip and Direct Chip Attach (DCA). In combining the design of a printed circuit with manufacturing of the prototype, HADCO has reduced the length of design\/manufacture cycle. By working with customers at the design and prototype stage, management believes that the Company has a greater likelihood of securing a preferred vendor status when customers begin commercial manufacturing of new products.\nThe Company operates two facilities, located in New York and New Hampshire, designed to support medium and high volume printed circuit production. Customers often demand a quick transition from prototype to volume production. Creating an effective product development transition from prototype to volume production is a difficult challenge in today's market. While many competitors can supply prototypes, as HADCO does through its Tech Centers, relatively few independent manufacturers can provide complex multilayer printed circuits in the volume that HADCO's larger facilities can provide. During 1995, volume manufacturing expanded production space in Derry, N.H. by 30,000 square feet and in Owego, N.Y. by 18,000 square feet, in order to accommodate higher capacities, broader product offerings and higher layer count.\nThe Value Added Manufacturing division of HADCO directly supports customers in the backplane and card cage assembly market. During 1995, the Value Added Manufacturing division expanded production space from 15,000 to 40,000 square feet, and added an additional SMT assembly with specialized capabilities in order to meet customer requirements. The Company believes that its Value Added Manufacturing division provides its customers with a strategic advantage by shortening the period of design through the manufacturing and assembly of backplane and card cage products (collectively referred to herein as \"value added assembly\").\nMARKETS AND MARKETING\nThe Company's strategy is to broaden and diversify the market it serves. The Company supplies printed circuits and value added assemblies to a diverse customer base in the computer, telecommunications, instrumentation, including medical and industrial automation, and automotive industries. Contract assembly, referenced in the table below, represents a segment which may encompass several different industries. Within the computer segment, the Company's customers include leaders in the notebook, advanced peripheral devices and workstation markets as well as leaders in the minicomputer and mainframe markets.\nThe Company's high percentage of net sales to the computer industry reflects the fact that dense multilayer printed circuits are routinely used in products such as mini- and micro-computers, computer workstations and computer peripheral equipment. Consumer products generally incorporate low-density double-sided boards. The Company does not manufacture printed circuits of this type.\nHADCO has an Advanced Packaging Design Group, whose purpose is to identify, develop and market new technologies that are highly beneficial to our customers and position HADCO as a unique source for these solutions. Process design changes and refinements required for volume production are identified and implemented prior to production of the orders. Many times this development is done with customers and alliance partners to ensure accurate and timely results. The group focuses on the continued densification of electronic packaging, as well as the evaluation of new high performance materials. The group also assists in marketing efforts by hosting the Regional Technology Symposiums, which present HADCO technical capabilities and industry technical trends to customers.\nHADCO's comprehensive product offerings are a key marketing strategy for the Company. By offering a full spectrum of integrated processes and capabilities including printed circuit design assistance, prototype and preproduction fabrication, medium and high volume fabrication, as well as value added assembly, HADCO can help its customers cut time-to-market schedules. In addition, by working with products from the design stage, HADCO can enhance the manufacturability during volume production.\nThe Company markets its products through its own sales and marketing organization and independent manufacturers' representatives. As of October 28, 1995, the Company employed 90 sales and marketing employees, of which 39 are direct sales representatives at 8 locations. The Company is also represented by 15 independent manufacturers' representatives at 22 locations in North America, Europe, Mexico, Asia, Australia and the Middle East. Regional direct sales offices are located in the states of California, Georgia, Minnesota, New Hampshire, Pennsylvania, Arizona and Texas, and the Province of Ontario, Canada. The Company's marketing organization consists of a vice president in charge of sales and marketing, 9 regional sales managers, a support staff of sales engineers and technical service personnel responsible for technical liaison and problem solving, development of product and market opportunities, market research and marketing communications.\nThe Company currently exports a very small percentage of its products.\nCUSTOMERS\nThe Company supplied more than 382 customers during fiscal 1995, and 307 customers in fiscal 1994. The Company attempts to market its products to customers who currently have or have the potential to obtain significant market shares in their respective industries. The following list sets forth the Company's largest customers during fiscal 1995:\nDuring fiscal 1995, 1994 and 1993, no customer accounted for more than 7%, 7% and 6%, respectively, of HADCO's consolidated net sales. The Company's five largest customers accounted for 28%, 28% and 25% of HADCO's consolidated net sales during fiscal 1995, 1994 and 1993, respectively.\nHADCO continues its efforts to decrease its dependence upon the computer market by seeking new customers in different markets, particularly those that require complex state-of-the-art printed circuits or whose needs closely match the capabilities of the Company.\nMANUFACTURING\nThree processes are used in the United States to manufacture electronic interconnect circuits. In the subtractive process, the conductive paths are formed by etching copper from the laminated board. In the additive process, conductive lines are formed by an electroless deposition of copper onto the board. In the discrete wiring process, patterns of insulated copper wire are laid down by numerically controlled machines. The subtractive process is the most common process used in the production of printed circuits made in the United States. HADCO exclusively uses the subtractive process to manufacture high density multilayer and double-sided rigid fiberglass printed circuits.\nThe need for high volume production of dense multilayer and double-sided printed circuits has transformed HADCO's segment of the electrical interconnect industry into one that increasingly requires complex manufacturing processes, necessitating high levels of capital investment and high technology materials, production processes and product design capabilities. The Company has invested in the production technology to manufacture large volumes of dense multilayer printed circuits utilizing surface mount technology. The Company employs numerous advanced manufacturing techniques and systems which include: Computer Aided Manufacturing (CAM) systems, Computer Integrated Manufacturing (CIM) systems, numerically controlled drilling and routing, dry-film imaging, multi-purpose metals plating, high volume surface coating, dual access electrical testing, automated optical inspection, and high volume photoimageable solder mask processing. These techniques enable HADCO to manufacture complex printed circuits of consistent quality in high volume on a timely basis.\nMATERIALS\nMultilayer blanks, mass lamination and pin lamination are primary materials in the production of high density, complex printed circuits. The mass laminating facility in Derry produces inner layer blanks. The Hudson facility is dedicated to the production of high density multilayer blanks. The Owego operations have vacuum pin lamination capabilities for higher layer count multilayer blanks.\nAlthough materials that are essential to the Company's business have been available in the open market, various segments of the industry have recently experienced shortages of certain materials. Although the Company believes its relationship with its suppliers is strong, there can be no assurance that it will not be adversely affected by such shortages.\nCOMPETITION\nThe domestic market for printed circuits is highly competitive and fragmented. HADCO believes its major competitors are the larger independent producers and captive producers world-wide, which also manufacture multilayer, high density printed circuits. Many of the captives are part of large national or multi-national companies. The major captive printed circuit producers include IBM, AT&T and other large electronic equipment manufacturers. During periods of recession in the electronics industry, any competitive advantages of the Company in the areas of quick turn-around manufacturing and responsive customer service may be of reduced importance to electronics OEMs, who may become more price sensitive. In addition, captive interconnect product manufacturers may seek orders in the open market to fill excess capacity, thereby increasing price competition.\nThe number of companies engaged in the volume production of high density, multilayer printed circuits is considerably smaller than the number of companies manufacturing other types of printed circuits. High density multilayer boards involve a high level of material and process technology, and therefore, are more complex to manufacture than less complex printed circuits.\nThe demand for printed circuits has continued to be partially offset, during the past several years, by the development of smaller, more powerful electronic components requiring less printed circuit board area. The Company continues to emphasize high density multilayer circuits, particularly surface mount applications that support smaller, more powerful electronic components.\nHADCO competes on the basis of product quality, timeliness of delivery, price, customer technical support and the capability to produce complex circuits in prototype, preproduction and high volume.\nPRODUCT PROTECTION\nThe Company does not have any patent protection of significance. The Company believes that its accumulated experience with respect to materials and process technology is important to its operation.\nBACKLOG\nAs of October 28, 1995, the Company's released backlog was $70.5 million, as compared with $37.7 million as of October 29, 1994. The Company anticipates manufacturing and delivering approximately 80% of such backlog during the first quarter of fiscal 1996. The Company's business is not seasonal. Released backlog consists of orders for which artwork has been received, a delivery date has been scheduled and the Company\nEMPLOYEES\nThe Company believes that its employee relations are excellent. The employees are not represented by a union, and the Company has never experienced any labor problems resulting in a work stoppage. As of October 28, 1995, the Company had 2,346 employees, as compared to 1,999 as of October 29, 1994.\nENVIRONMENTAL\nWaste treatment and disposal are major considerations for printed circuit manufacturers. The Company uses chemicals in the manufacture of its products that are classified by the Environmental Protection Agency (EPA) as hazardous substances. The Company is aware of certain chemicals that exist in the ground at certain of its facilities. The Company has notified various governmental agencies and continues to work with them to monitor and resolve these matters. The Company believes that the resolution of these matters will not have a material adverse effect on the Company. During March 1995, the Company received a Record Of Decision (ROD) from the New York State Department of Environmental Conservation (NYSDEC), regarding soil and groundwater contamination at its Owego, New York facility. Based on a Remedial Investigation and Feasibility Study (RIFS) for apparent on-site contamination at that facility and a Focused Feasibility Study (FFS), each prepared by environmental consultants of the Company, the NYSDEC has approved a remediation program of groundwater withdrawal and treatment and iterative soil flushing. The cost, based upon the FFS, to implement this remediation is estimated to be $4.6 million, and is expected to be expended as follows: $300,000 for capital equipment and $4.3 million for operation and maintenance costs which will be incurred and expended over the estimated life of the program of 30 years. NYSDEC has requested that the Company consider taking additional samples from a wetland area near the Company's Owego facility. Analytical reports of earlier sediment samples indicated the presence of certain inorganics. There can be no assurance that the Company and\/or other third parties will not be required to conduct additional investigations and remediation at that location, the costs of which are currently indeterminable due to the numerous variables described in the second sentence of the penultimate paragraph of this \"Environmental\" section.\nFrom 1974 to 1980, the Company operated a printed circuit manufacturing facility in Florida as a lessee of property that is now the subject of a pending lawsuit (\"the Florida Lawsuit\") and investigation by the Florida Department of Environmental Regulation (FDER). On June 9, 1992, the Company entered into a Cooperating Parties Agreement in which it and Gould, Inc., another prior lessee of the site have agreed to fund certain assessment and feasibility study activities at the site, and an environmental consultant has been retained to perform such activities. The cost of such activities is not expected to be material to the Company. In addition to the Cooperating Parties Agreement, Hadco and others are participating in alternative dispute resolution regarding the site with an independent mediator. In connection with the mediation, in February 1992 the FDER presented computer-generated estimates of remedial costs, for activities expected to be spread over a number of years, that ranged from approximately $3.3 million to $9.7 million. Mediation sessions were conducted in March 1992 but have been suspended during the ongoing assessment and feasibility activities. Management believes it is likely that it will participate in implementing a continuing remedial program for the site, the costs of which are currently unknown. However, based on information currently known by the Company, management does not expect these costs to have a material adverse effect on the Company. In June 1995, Hadco was named a third-party defendant in the Florida Lawsuit. See Item 3, \"Legal Proceedings,\" for information relating to this lawsuit.\nThe Company is planning the installation of a groundwater extraction system at its Derry, New Hampshire facility to address certain groundwater contamination. Because of the uncertainty regarding both the quantity of contaminants beneath the building at the site and the long-term effectiveness of the groundwater migration control system the Company proposes to install, it is not possible to make a reliable estimate of the length of time remedial activity will have to be performed. However, it is anticipated that the groundwater extraction system will be operated for at least 30 years. There can be no assurance that the Company will not be required to conduct additional investigations and remediation relating to the Derry facility. The total costs of such groundwater extraction system and of conducting any additional investigations and remediation relating to the Derry facility are not fully determinable due to the numerous variables described in the penultimate paragraph of this \"Environmental\" section.\nThe Company accrues estimated costs associated with known environmental matters, when such costs can be reasonably estimated. The cost estimates relating to future environmental clean-up are subject to numerous variables, the effects of which can be difficult to measure, including the stage of the environmental investigations, the nature of potential remedies, possible joint and several liability, the magnitude of possible contamination, the difficulty of determining future liability, the time over which remediation might occur, and the possible effects of changing laws and regulations. Management believes the ultimate disposition of above known environmental matters will not have a material adverse effect upon the liquidity, capital resources, business or consolidated financial position of the Company. However, one or more of such environmental matters could have a significant negative impact on the Company's consolidated financial results for a particular reporting period. See Item 7, \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" and footnote 7 of Notes to Consolidated Financial Statements.\nThe Company does plan further capital expenditures during fiscal 1996 to further reduce air emissions and reduce waste generation. See discussion under Item 2, \"Properties,\" concerning the Company's capital expenditures for environmental control facilities. Also see Item 3, \"Legal Proceedings,\" relating to lawsuits regarding environmental matters.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe administrative and corporate offices in Salem, New Hampshire are located in two separate facilities. Both facilities are covered by leases that expire in March 1996, with options to extend until March 2002. The lease for the Value Added Manufacturing facility expires in March 2000, with options to extend until March 2006. The lease for the Salem Prototype Service Center expires in 1999, with an option of the Company to extend until 2004. The Hudson operation is located in two separate facilities. Both leases expire in 1997 with options to extend until 2000. The lease on the Derry property, consisting of warehouse and high volume finishing production space, runs until January 1998, with options to extend until January 2001. The Watsonville lease runs until December 1996 and has one three-year option remaining.\nThe Company owns approximately 6 acres of land in Salem, New Hampshire, approximately 5 acres of land in Derry, New Hampshire, and approximately 4.4 acres in Owego, New York, which could be used for future expansion.\nIn fiscal 1995, the Company's capital expenditures relating to its environmental control facilities and equipment totaled approximately $257,887. The Company estimates that it will make capital expenditures with respect to its environmental control facilities and equipment of approximately $550,000 and $700,000 in fiscal 1996 and 1997, respectively.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is one of thirty-three entities which have been named as potentially responsible parties in a lawsuit pending in the federal district court of New Hampshire concerning environmental conditions at the Auburn Road, Londonderry, New Hampshire landfill site. Local, state and federal entities and certain other\nparties to the litigation seek contribution for past costs, totaling approximately $20 million, allegedly incurred to assess and remediate the Auburn Road site. These parties also allege that future monitoring will be required. In addition, the EPA contends that future remediation actions may be required. The Company is contesting liability.\nIn connection with the \"Florida Lawsuit\" (as described in the second paragraph under \"Environmental\" above) pending in the Circuit Court for Broward County, Florida, Hadco and Gould, Inc., another prior lessee of the site of the printed circuit manufacturing facility in Florida, each was served with a third-party complaint in June 1995, as third-party defendants in such pending Florida Lawsuit by a party who had previously been named as a defendant when the Florida Lawsuit was commenced in 1993 by the FDER. The Florida Lawsuit seeks damages relating to environmental pollution and FDER costs and expenses, civil penalties, and declaratory and injunctive relief to require the parties to complete assessment and remediation of soil and ground water contamination. The other parties include alleged owners of the property and Fleet Credit Corporation, a secured lender to a prior lessee of the property.\nThe future costs in connection with the lawsuits described in the two immediately preceding paragraphs are currently indeterminable due to such factors as the unknown timing and extent of any future remedial actions which may be required, the extent of any liability of the Company and of other potentially responsible parties, and the financial resources of the other potentially responsible parties.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote to the Company's security holders during the fourth quarter of the fiscal year ended October 28, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company has never declared or paid a cash dividend on its Common Stock, and it is anticipated that the Company will continue to retain its earnings for use in its business and not pay cash dividends. Declaration of dividends is within the discretion of the Company's Board of Directors, which will review such dividend policy from time to time. The Company's lines of credit currently contain certain cash flow requirements that may have the effect of limiting the Company's ability to pay dividends in the future. See Note 5 of Notes to Consolidated Financial Statements.\nAs of December 20, 1995, there were 401 holders of record of the Common Stock of the Company.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nRESULTS OF OPERATIONS\nYears Ended October 28, 1995 and October 29, 1994\nNet sales during 1995 increased 19.7% over the same period in 1994. The change was due to an 8.2% increase in the volume of production and shipments and a shift in product mix to higher layer, higher density products, as compared to fiscal 1994. Average pricing per unit increased 3.1% compared to the same period a year ago. The Company believes that the potential exists for excess capacity in the industry, which could have an adverse impact on future pricing.\nThe gross profit margin increased from 19.8% in 1994 to 24.3% in 1995. The increase is a direct result of higher volume of shipments, an increase in the technology level of product mix, improved pricing and improvements in operating efficiencies. Continued productivity improvements have lead to increased unit\nvolume and lower unit costs. The Company believes that the potential exists for the shortage of materials in the industry, which could have an adverse impact on future unit costs.\nSelling, general and administrative (\"SG&A\") expenses, as a percent of net sales, decreased to 11.5% during fiscal 1995 from 12.4% during fiscal 1994, due to increased revenue. SG&A expenses increased from $27.5 million in 1994 to $30.6 million in 1995, as a result of increased variable costs directly attributable to increased net sales and charges for environmental related matters. Included in SG&A expenses are charges for actual expenditures and accruals, based on estimates, for environmental matters. During fiscal 1995 and 1994, the Company made, and charged to SG&A expenses, actual payments of approximately $1,111,000 and $1,040,000 respectively, for environmental matters. In 1995 and 1994, the Company also accrued and charged to SG&A expenses of approximately $2,740,000 and $2,100,000, respectively, as cost estimates relating to known environmental matters. To the extent and in amounts HADCO believes circumstances warrant, it will continue to accrue and charge to SG&A expenses cost estimates relating to environmental matters. Management believes the ultimate disposition of known environmental matters will not have a material adverse effect upon the liquidity, capital resources, business or consolidated financial position of the Company. However, one or more of such environmental matters could have a significant negative impact on the Company's consolidated financial results for a particular reporting period. See Item 1, \"Environmental,\" Item 3, \"Legal Proceedings,\" and footnote 7 of Notes to Consolidated Financial Statements.\nIn 1995, interest income increased as a result of higher rates of return earned on investments, and higher cash balances available for investment.\nInterest expense decreased in 1995 from 1994 due to decreased average debt balances during the year.\nYears Ended October 29, 1994 and October 30, 1993\nNet sales during 1994 increased 16.9% as a result of a higher volume of shipments and a shift in product mix to higher layer count, higher density products. In 1994, the Company continued to experience general pressure on pricing for all products resulting from continued excess capacity in the industry, and the increase in net sales was affected by a decline in pricing.\nThe gross profit margin increased in 1994 from the 1993 level due to higher volume of shipments and an increase in the technology level of product mix. The shift in product mix, improvements in operating efficiencies and lower material costs partially offset the general pressure on pricing due to market conditions.\nSG&A expenses, as a percent of net sales, increased to 12.4% versus 11.4% in 1993. This resulted from increased variable costs directly attributable to the increased net sales and charges for environmental related matters. SG&A expenses increased from $21.7 million in 1993 to $27.5 million, primarily as a result of increased selling expenses due to higher net sales and compensation related expenses and environmental related matters. Included in SG&A expenses are charges for actual expenditures and accruals, based on estimates, for environmental matters. During fiscal 1994 and 1993, the Company made, and charged to SG&A expenses, actual payments of approximately $1,040,000 and $320,000, respectively, for environmental matters. In 1994 and 1993, the Company also accrued and charged to SG&A expenses approximately $2,100,000 and $1,000,000, respectively, as cost estimates relating to known environmental matters.\nIn 1994, interest income increased as a result of higher rates of return earned on investments, and higher cash balances available for investment.\nInterest expense decreased in 1994 from 1993 due to decreased average debt balances during the year.\nINCOME TAXES\nThe annual effective income tax rate for 1995 was 39.0%, which is less than the current combined federal and state statutory rates. This difference is caused primarily by tax advantaged investments and the tax benefits of a foreign sales corporation.\nLIQUIDITY AND CAPITAL RESOURCES\nIn 1995, the Company's financing requirements were satisfied principally from cash flows from operations. These funds were sufficient to meet increased working capital needs, capital expenditures amounting to approximately $28.9 million and debt and lease payments of approximately $4.7 million.\nAt October 28, 1995, the Company had working capital of $41,043,000 and a current ratio of 1.78 compared to working capital of $31,829,000 and a current ratio of 1.80 at October 29, 1994. Cash, cash equivalents and short-term investments at October 28, 1995 were $36,474,000, an increase of $4,911,000 from $31,563,000 at October 29, 1994.\nAt October 28, 1995, the Company had available credit lines of $25,000,000 under its unsecured revolving credit and term loan agreements with two banks. The unused portion of these credit lines at October 28, 1995 was $25,000,000.\nAt October 28, 1995, the Company also had a lease line of credit of $5,000,000. The unused portion of this line of credit at October 28, 1995 was $4,188,000.\nThe Company has commitments to purchase approximately $15,000,000 of manufacturing equipment. The majority of these commitments are expected to be completed by the end of fiscal 1996.\nThe Company believes its existing working capital and borrowing capacity, coupled with the funds generated from the Company's operations, will be sufficient to fund its anticipated working capital, capital expenditure and debt payment requirements in fiscal 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's Consolidated Financial Statements and the Report of Independent Public Accountants thereon are presented in the following pages. The Consolidated Financial Statements filed in Item 8 are as follows:\nReport of Independent Public Accountants.\nConsolidated Statements of Income for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nConsolidated Balance Sheets as of October 28, 1995 and October 29, 1994.\nConsolidated Statements of Stockholders' Investment for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nConsolidated Statements of Cash Flows for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nNotes to Consolidated Financial Statements.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of HADCO CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Hadco Corporation (a Massachusetts corporation) and subsidiaries as of October 28, 1995 and October 29, 1994, and the related consolidated statements of income, stockholders' investment and cash flows for each of the three years in the period ended 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.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hadco Corporation and subsidiaries as of October 28, 1995 and October 29, 1994, and the results of their operations and their cash flows for each of the three years in the period ended October 28, 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)(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 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 November 15, 1995 (except for the matter discussed in Note 8 for which the date is November 29, 1995)\nHADCO CORPORATION AND SUBSIDIARIES\nThe accompanying notes are an integral part of these consolidated financial statements.\nHADCO CORPORATION AND SUBSIDIARIES\nThe accompanying notes are an integral part of these consolidated financial statements.\nHADCO CORPORATION AND SUBSIDIARIES\nThe accompanying notes are an integral part of these consolidated financial statements.\nHADCO CORPORATION AND SUBSIDIARIES\nThe accompanying notes are an integral part of these consolidated financial statements.\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 28, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nHadco Corporation (the \"Company\") is engaged primarily in the manufacture and sale of printed circuits, backplanes and related products. The consolidated financial statements reflect the application of certain accounting policies as described in this note and elsewhere in the accompanying notes to consolidated financial statements.\nPrinciples 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.\nManagement 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.\nCash Equivalents and Short-term Investments\nThe Company considers all highly liquid investment instruments purchased with a maturity of three months or less to be cash equivalents. Short-term investments are carried at cost, which approximates market, and have maturities of less than one year.\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective October 30, 1994, the beginning of fiscal year 1995.\nThe Company classifies its investments in corporate and government debt securities as held-to-maturity given the Company's intent and ability to hold the securities to maturity. In accordance with the statement, held-to-maturity securities are carried at amortized cost.\nIn October 1994, the Financial Accounting Standards Board issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" which is effective for fiscal years ending after December 15, 1994. As of October 28, 1995, the Company had no financial instruments requiring disclosure under SFAS No. 119.\nConcentration of Credit Risk\nSFAS No. 105, \"Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk,\" requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that subject the Company to credit risk\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)\nconsist primarily of trade accounts receivable. As of October 28, 1995, there were no significant off-balance-sheet risks which would have a material or adverse effect on the financial condition or net worth of the Company.\nDuring December 1994, the American Institute of Certified Public Accountants (AICPA) issued SOP 94-6, Disclosure of Certain Significant Risks and Uncertainties Summary, which is effective for fiscal years ending after December 15, 1995. During 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. During 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 does not expect the adoption of these standards to have a material effect on its financial position or results of operations.\nDepreciation and Amortization of Property, Plant and Equipment\nNet Income per Common and Common Equivalent Share\nNet income per common and common equivalent share was computed based on the weighted average number of common and common equivalent shares outstanding during each year. Common equivalent shares include outstanding stock options. Fully diluted net income per share has not been separately presented as it would not be materially different from net income per share as presented.\nRevenue Recognition\nThe Company recognizes revenue at the time products are shipped.\n2. INVENTORIES\nThe work-in-process inventories consist of materials, labor and manufacturing overhead.\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n4. INCOME TAXES\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes.\"\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n4. INCOME TAXES -- (CONTINUED)\nDue to the uncertainty surrounding the actual value of the favorable tax benefits relating to deferred compensation from stock options, the Company has recorded a valuation allowance of approximately $290,000 and $330,000 as of October 28, 1995 and October 29, 1994. The reduction of this allowance for the year ending October 28, 1995 is a result of the decrease in the deferred tax asset relating to deferred compensation.\n5. LINES OF CREDIT\nOn June 30, 1993, the Company amended its existing unsecured Revolving Credit and Term Loan Agreement with a bank. The agreement provides for up to $15,000,000 in revolving credit until June 30, 1996, when the unpaid balance is to be paid in equal quarterly installments over four years. During the revolving credit period, on each June 30, the Company may elect early four year amortization of any portion of the unpaid balance. The Company can designate the rate of interest at either the Eurodollar Rate plus 1% (1.25% during the term loan period), or the bank's Base Rate. As of October 28, 1995, no amounts were outstanding under this line of credit. This line expires in fiscal 1996.\nAdditionally, on June 30, 1993, the Company entered into a Revolving Credit and Term Loan Agreement with another bank. This agreement provides for up to $10,000,000 in revolving credit until June 30, 1996, when the unpaid balance will be paid in equal quarterly installments over four years. During the revolving credit period, the Company may elect early four year amortization of any portion of the unpaid balance. The\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n5. LINES OF CREDIT -- (CONTINUED)\nCompany can designate the rate of interest at either the Eurodollar Rate plus 1% (1.25% during the term loan period), or the bank's Base Rate. As of October 28, 1995, no amounts were outstanding under this line of credit. This line expires in 1996.\nAdditionally, the Company has a line of credit of $5,000,000 which is used for equipment financing from a leasing company. Use of this line is subject to, among other things, the approval by the leasing company of the equipment to be leased. At October 28, 1995, the unused portion of this line was approximately $4,188,000. This line expires during fiscal 1996.\nThe Company's lines of credit place several restrictions on the Company, including limitations on mergers, acquisitions and sales of a substantial portion of its assets, as well as certain limitations on liens, guarantees, additional borrowings and investments. These loan agreements also contain provisions pertaining to the maintenance by the Company of certain levels of consolidated tangible net worth, consolidated net income, operating cash flow, debt to worth ratio, quick ratio, and various other financial ratios during the term of the loan.\n6. LONG-TERM DEBT\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n7. COMMITMENTS AND CONTINGENCIES\nCapital Leases\nOperating Leases\nTotal rental expense of approximately $1,447,000, $1,317,000 and $1,221,000 was incurred for the fiscal years ended October 1995, 1994 and 1993, respectively.\nThese operating leases include office and manufacturing space leased from a partnership in which the Chairman of the Board and a former executive officer and director of the Company have an interest. Two of the leases are for terms of five years, and expire in March 1996 with options to extend until March 2002. The remaining lease expires in March 2000 with options to extend until 2006. For the fiscal years ended October 1995, 1994 and 1993, the related rental expense was approximately $479,000, $571,000 and $528,000, respectively.\nEnvironmental Matters\nDuring March 1995, the Company received a Record Of Decision (ROD) from the New York State Department of Environmental Conservation (NYSDEC), regarding soil and groundwater contamination at its Owego, New York facility. Based on a Remedial Investigation and Feasibility Study (RIFS) for apparent on-site contamination at that facility and a Focused Feasibility Study (FFS), each prepared by environmental consultants of the Company, the NYSDEC has approved a remediation program of groundwater withdrawal and treatment and iterative soil flushing. The cost, based upon the FFS, to implement this remediation is estimated to be $4.6 million, and is expected to be expended as follows: $300,000 for capital equipment and $4.3 million for operation and maintenance costs which will be incurred and expended over the estimated life of the program of 30 years. NYSDEC has requested that the Company consider taking additional samples\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n7. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)\nfrom a wetland area near the Company's Owego facility. Analytical reports of earlier sediment samples indicated the presence of certain inorganics. There can be no assurance that the Company and\/or other third parties will not be required to conduct additional investigations and remediation at that location, the costs of which are currently indeterminable due to the numerous variables described in the second sentence of the fifth paragraph of this \"Environmental Matters\" section.\nFrom 1974 to 1980, the Company operated a printed circuit manufacturing facility in Florida as a lessee of property that is now the subject of a pending lawsuit (\"the Florida Lawsuit\") and investigation by the Florida Department of Environmental Regulation (FDER). On June 9, 1992, the Company entered into a Cooperating Parties Agreement in which it and Gould, Inc., another prior lessee of the site, have agreed to fund certain assessment and feasibility study activities at the site, and an environmental consultant has been retained to perform such activities. The cost of such activities is not expected to be material to the Company. In addition to the Cooperating Parties Agreement, Hadco and others are participating in alternative dispute resolution regarding the site with an independent mediator. In connection with the mediation, in February 1992 the FDER presented computer-generated estimates of remedial costs, for activities expected to be spread over a number of years, that ranged from approximately $3.3 million to $9.7 million. Mediation sessions were conducted in March 1992 but have been suspended during the ongoing assessment and feasibility activities. Management believes it is likely that it will participate in implementing a continuing remedial program for the site, the costs of which are currently unknown. However, based on information currently known by the Company, management does not expect these costs to have a material adverse effect on the Company. Also see the penultimate paragraph of this \"Environmental Matters\" section relating to the Company's having been named as a third-party defendant in the Florida Lawsuit.\nThe Company is planning the installation of a groundwater extraction system at its Derry, New Hampshire facility to address certain groundwater contamination. Because of the uncertainty regarding both the quantity of contaminants beneath the building at the site and the long-term effectiveness of the groundwater migration control system the Company proposes to install, it is not possible to make a reliable estimate of the length of time remedial activity will have to be performed. However, it is anticipated that the groundwater extraction system will be operated for at least 30 years. There can be no assurance that the Company will not be required to conduct additional investigations and remediation relating to the Derry facility. The total costs of such groundwater extraction system and of conducting any additional investigations and remediation relating to the Derry facility are not fully determinable due to the numerous variables described in the fifth paragraph of this \"Environmental Matters\" section.\nIncluded in selling, general and administrative (\"SG&A\") expenses are charges for actual expenditures and accruals, based on estimates, for environmental matters. During fiscal 1995 and 1994, the Company made, and charged to SG&A expenses, actual payments of approximately $1,111,000 and $1,040,000, respectively, for environmental matters. In 1995 and 1994, the Company also accrued and charged to SG&A expenses approximately $2,740,000 and $2,100,000, respectively, as cost estimates for environmental matters.\nThe Company accrues estimated costs associated with known environmental matters, when such costs can be reasonably estimated. The cost estimates relating to future environmental clean-up are subject to numerous variables, the effects of which can be difficult to measure, including the stage of the environmental investigations, the nature of potential remedies, possible joint and several liability, the magnitude of possible contamination, the difficulty of determining future liability, the time over which remediation might occur, and the possible effects of changing laws and regulations. The total reserve for environmental matters currently identified by the Company amounted to $8.2 million and $5.5 million at October 28, 1995 and October 29, 1994, respectively. The current portion of these costs as of October 28, 1995 and October 29, 1994, amounted to approximately $900,000 and $873,000, respectively, and is included in \"Other accrued expenses.\" The long-term portion of these costs amounted to approximately $7.3 million and $4.6 million as of October 28, 1995\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n7. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)\nand October 29, 1994, respectively, and is reported under the caption \"Other Long-term Liabilities.\" Based upon its assessment at the current time, management estimates the cost of ultimate disposition of the above known environmental matters to range from approximately $7.0 million to $12.0 million, and is expected to be spread over a number of years. Management believes the ultimate disposition of the above known environmental matters will not have a material adverse effect upon the liquidity, capital resources, business or consolidated financial position of the Company. However, one or more of such environmental matters could have a significant negative impact on the Company's consolidated financial results for a particular reporting period.\nThe Company is one of thirty-three entities which have been named as potentially responsible parties in a lawsuit pending in the federal district court of New Hampshire concerning environmental conditions at the Auburn Road, Londonderry, New Hampshire landfill site. Local, state and federal entities and certain other parties to the litigation seek contribution for past costs, totalling approximately $20 million, allegedly incurred to assess and remediate the Auburn Road site. These parties also allege that future monitoring will be required. In addition, the EPA contends that future remediation actions may be required. The Company is contesting liability.\nIn connection with the \"Florida Lawsuit\" (as described in the second paragraph of this \"Environmental Matters\" section), pending in the Circuit Court of Broward County, Florida, Hadco and Gould, Inc., another prior lessee of the site of the printed circuit manufacturing facility in Florida, each was served with a third-party complaint in June 1995, as third-party defendants in such pending Florida Lawsuit by a party who had previously been named as a defendant when the Florida Lawsuit was commenced in 1993 by the FDER. The Florida Lawsuit seeks damages relating to environmental pollution and FDER costs and expenses, civil penalties, and declaratory and injunctive relief to require the parties to complete assessment and remediation of soil and groundwater contamination. The other parties include alleged owners of the property and Fleet Credit Corporation, a secured lender to a prior lessee of the property.\nThe future costs in connection with the lawsuits described in the two immediately preceding paragraphs are currently indeterminable due to such factors as the unknown timing and extent of any future remedial actions which may be required, the extent of any liability of the Company and of other potentially responsible parties, and the financial resources of the other potentially responsible parties.\nPurchase Commitments\nThe Company has commitments to purchase approximately $15,000,000 of manufacturing equipment. The majority of these commitments are expected to be completed by the end of fiscal 1996.\n8. STOCKHOLDERS' INVESTMENT\nCommon Stock\nIn September 1994, the Board of Directors authorized the purchase of up to $1,500,000 of its shares of common stock in the open market in calendar 1994. As of October 29, 1994, a total of 28,000 shares of common stock were purchased and retired at an average price of $7.75 per share. During the first quarter of fiscal 1995, an additional 113,800 shares were purchased and retired at an average price of $8.96 per share. The program expired in December 31, 1994.\nAlso in September of 1994, the Board of Directors authorized the purchase and retirement of 100,000 shares of common stock from Horace H. Irvine II, Chairman of the Board of Directors of the Company, for a purchase price of $7.50 per share, and the purchase and retirement of an additional 200,000 shares of common stock from certain trusts created in the past by Mr. Irvine, also for a purchase price of $7.50 per share.\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n8. STOCKHOLDERS' INVESTMENT -- (CONTINUED)\nStock Options\nThe Company has the following nonqualified stock option plans:\nDecember 1985 Plan and December 1986 Plan -- The options under these plans are exercisable immediately, and have various vesting periods up to ten years according to each individual option agreement with an expiration date no later than ten years and ninety days from the date of grant. Upon termination of employment under certain circumstances, the Company may, at its option, repurchase the exercised but unvested shares at the original purchase price.\nDecember 1987 Plan -- The options under this plan become exercisable according to each option agreement and expire no later than June 30, 1997.\nSeptember 1990 Plan -- This plan provides for the granting of options at a price equal to the fair market value at the date of the grant. The options become exercisable according to each option agreement and expire no later than ten years from the date of grant.\nDecember 1991 Director Plan -- This plan provides for the granting of options to purchase up to 150,000 shares of common stock at a price equal to the fair market value at the date of grant. These options are exercisable ratably over a four-year period and expire no later than seven years from the date of grant.\nNovember 1995 Plan -- This plan was adopted by the Board of Directors on November 29, 1995, subject to approval by the shareholders in February 1996. This plan provides for the granting of options to purchase up to 1,000,000 shares of common stock at a price equal to the fair value at the date of the grant. The options become exercisable according to each option agreement and expire no later than ten years from the date of grant.\nOn November 29, 1995, the Board of Directors voted to increase the number of shares of common stock authorized from 25,000,000 to 100,000,000, subject to shareholder approval on February 28, 1996.\nHADCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OCTOBER 28, 1995\n8. STOCKHOLDERS' INVESTMENT -- (CONTINUED)\nThe Company had reserved, as of October 28, 1995, a total of 1,645,356 shares of common stock for issuance under the nonqualified stock option plans listed in the above chart. During fiscal 1995, 1994 and 1993, approximately $287,000, $360,000, and $390,000, respectively, were charged against income as compensation expense associated with these options.\nThe Company adopted a Stockholder Rights Plan in August 1995 pursuant to which the Company declared the distribution of one Common Stock Purchase Right (\"Right\") for each share of outstanding common stock. Under certain conditions, each Right may be exercised for one share of common stock at an exercise price of $130, subject to adjustment. Under circumstances defined in the Stockholder Rights Plan, the Rights entitle holders to purchase stock having a value of twice the exercise price of the Rights. Until they become exercisable, the Rights are not transferable apart from the common stock. The Rights may be redeemed by the Company at any time prior to the occurrence of certain events at $.01 per Right. The Stockholder Rights Plan will expire on September 11, 2005, unless the Rights are earlier redeemed by the Company.\n9. RETIREMENT PLAN\nThe Hadco Corporation Retirement Plan (the \"Plan\"), as amended, covers all employees with at least six months of continuous service (as defined). Annual profit sharing contributions are determined at the discretion of the Board of Directors but cannot exceed the amount allowable for federal income tax purposes. The Company made profit sharing contributions of $2,285,000, $1,074,000 and $877,000 to the Plan for the years ended October 1995, 1994 and 1993, respectively.\nThe Plan permits participants to elect to have contributions made to the Plan in the form of reductions in salary under Section 401(k) of the Internal Revenue Code subject to limitations set out in the Plan. Under the Plan, the Company will match employee contributions up to a set percentage. Employee contributions become vested when made, and Company contributions become vested at the rate of 33 1\/3% for each year of service with the Company. The Company matched employee contributions in the amount of approximately $600,000, $500,000 and $460,000 during fiscal 1995, 1994 and 1993, respectively.\n10. QUARTERLY RESULTS (UNAUDITED)\nThe following summarized unaudited results of operations for the fiscal quarters in the years ended October 1995 and 1994 have been accounted for using generally accepted accounting principles for interim reporting purposes and include adjustments (consisting of normal recurring adjustments) that the Company considers necessary for the fair presentation of results for these interim periods.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable\nPART III\nAnything herein to the contrary not withstanding, in no event whatsoever are the sections entitled \"Stock Performance Graph\" and \"Compensation Committee and Stock Option Committee Report on Executive Compensation\" to be incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Stockholders to be held on February 28, 1996.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain information 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 Stockholders to be held on February 28, 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 October 28, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCertain information relating to remuneration 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 Stockholders to be held on February 28, 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 October 28, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nCertain information 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 Stockholders to be held on February 28, 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 October 28, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain information 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 Stockholders to be held on February 28, 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 October 28, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A)1. FINANCIAL STATEMENTS:\nThe following consolidated financial statements are included in Item 8:\nReport of Independent Public Accountants.\nConsolidated Statements of Income for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nConsolidated Balance Sheets as of October 28, 1995 and October 29, 1994.\nConsolidated Statements of Stockholders' Investment for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nConsolidated Statements of Cash Flows for the years ended October 28, 1995, October 29, 1994 and October 30, 1993.\nNotes to Consolidated Financial Statements.\n2. FINANCIAL STATEMENT SCHEDULES:\nThe following consolidated financial statement schedules are included in Item 14(b):\nSCHEDULES\nII -- Valuation and Qualifying Accounts.\nSchedules other than those listed above has been omitted since they are either not required or the information is otherwise included.\n(B) REPORTS ON FORM 8-K\nA report on Form 8-K dated August 22, 1995 was filed by the Company, reporting the adoption of a Stockholder Rights Plan.\n(C) EXHIBITS\nThe Company hereby files as part of this Form 10-K the exhibits listed in Item 14(a)(3) above. Exhibits which are incorporated herein by reference can be inspected and copied at the public reference facilities maintained by the Commission, 450 Fifth Street, N.W., Room 1024, Washington, D.C., and at the Commission's regional offices at 219 South Dearborn Street, Room 1204, Chicago, Illinois; 26 Federal Plaza, Room 1102, New York, New York and 5757 Wilshire Boulevard, Suite 1710, Los Angeles, California. Copies of such material can also be obtained from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates.\n(D) FINANCIAL STATEMENT SCHEDULES\nThe Company hereby files as part of this Form 10-K in Item 14(b) attached hereto the consolidated financial statement schedules listed in 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.\nHADCO CORPORATION\nANDREW E. LIETZ By: ................................ ANDREW E. LIETZ, PRESIDENT CHIEF EXECUTIVE OFFICER AND DIRECTOR\nDated: December 20, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nS-1\nEXHIBIT INDEX","section_15":""}
{"filename":"70684_1995.txt","cik":"70684","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General\nLife Insurance Operations\nNational Western Life Insurance Company (hereinafter referred to as \"National Western\", \"Company\", or \"Registrant\") is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. National Western also accepts applications from and issues policies to residents of several Central and South American countries. Such policies are accepted and issued in the United States. During 1995, the Company recorded approximately $403 million in premium revenues, universal life, and investment annuity contract deposits. New life insurance issued during 1995 approximated $1.2 billion and the total amount in force at year-end 1995 was $7.9 billion. As of December 31, 1995, the Company had total consolidated assets of approximately $2.96 billion.\nCompetition: The life insurance business is highly competitive and National Western competes with over 1,700 stock and mutual companies. Best's Agents Guide To Life Insurance Companies, an authoritative life insurance publication, lists companies by total admitted assets and life insurance in force. As of December 31, 1994, the most recent date for which information is available, National Western ranked 145 in total admitted assets and 227 in life insurance in force among approximately 1,700 life insurance companies domiciled in the United States.\nLife insurance companies compete not only on product design and price, but increasingly on policyowner service and marketing and sales efforts. National Western believes that its products, premium rates, policyowner service, and marketing efforts are generally competitive with those of other life insurance companies selling similar types of insurance. Mutual insurance companies may have certain competitive advantages over stock companies in that the policies written by them are participating policies and their profits inure to the benefit of their policyholders. The Company no longer writes participating policies, and such policies represent only 1% of the Company's life insurance in force at December 31, 1995.\nIn addition to competition within the life insurance industry, National Western and other insurance companies face competition from other industries. In recent years, there has been increased interest in the banking industry to directly market annuities. In fact, in January, 1995, the U.S. Supreme Court ruled that national banks may compete with insurance companies in the sale of annuities. Such regulation changes could result in increased competition for National Western and the life insurance industry.\nCompetition also arises from different investment and product choices. Annuities are often used as long-term, tax deferred investment vehicles and in retirement planning. As a result, other investment types can be competitive products to annuities. For example, the recent growth and popularity of mutual funds has attracted large amounts of investment funds over the past several years, particularly during periods of declining market interest rates. Many mutual funds also allow tax deferred features through individual retirement accounts, 401(k) plans, and other qualified methods.\nAgents and Employees: National Western has 230 full-time employees at its principal executive office. Its insurance operations are conducted primarily through broker-agents, which numbered 8,330 at December 31, 1995. The agency operations are supervised by Senior Vice Presidents of domestic and international marketing. The Company's agents are independent contractors who are compensated on a commission basis. General agents receive overriding first year and renewal commissions on business written by agents under their supervision.\nTypes of Insurance Written: National Western offers a broad portfolio of individual whole life and term life insurance plans, endowments, and annuities, including standard supplementary riders. The Company does not market group life insurance but does offer group annuities. In recent years the majority of the business written has been individual flexible premium and single premium annuities and universal life products. Except for a small employee health plan and a small number of existing individual accident and health policies, primarily in Florida, the Company does not write any new policies in the accident and health markets. A distribution of the Company's direct premium revenues and deposits by type of product is provided below:\nThe underwriting policy of the Company is to require medical examination of applicants for ordinary insurance in excess of certain prescribed limits. These limits are graduated according to the age of the applicant and the amount of insurance desired. The Company has no maximum for issuance of life insurance on any one life. However, the Company's general policy is to reinsure that portion of any risk in excess of $150,000 on the life of any one individual. Effective January 1, 1996, the Company has raised this reinsurance level to $200,000 per individual. Also, following general industry practice, policies are issued on substandard risks.\nGeographical Distribution of Business: For the year 1995, insurance and annuity policies held by residents of the State of Texas accounted for 17% of premium revenues, universal life, and investment annuity contract deposits from direct business, while policies held by residents of California, Pennsylvania, and Michigan accounted for approximately 8%, 7%, and 6%, respectively. All other states of the United States accounted for 48% of premium revenues and deposits from direct business. The remaining 14% of premium revenues and deposits were derived from the Company's policies issued to foreign nationals, primarily all of which was for individual life insurance. A distribution of the Company's direct premium revenues and deposits by domestic and international markets is provided below:\nApproximately 74% of the life insurance face amount issued by the Company during 1995 was written through international insurance brokers acting as independent contractors. Foreign business is solicited by various independent brokers, primarily in Central and South America, and forwarded to the United States for acceptance and issuance. The Company maintains strict controls on the business it accepts from such foreign independent brokers, as well as its underwriting procedures for such business. Except for a small block of business, a currency clause is included in each foreign policy stating that premium and claim \"dollars\" refer to lawful currency of the United States. Traditional and universal life products are sold in the international market to individuals in upper socioeconomic classes. By marketing exclusively to this group, sales typically produce a higher average policy size, strong persistency, and claims experience similar to that in the United States.\nInvestments: State insurance statutes prescribe the nature, quality, an percentage of the various types of investments which may be made by insurance companies and generally permit investments in qualified state, municipal, federal, and foreign government obligations, corporate bonds, preferred and common stock, real estate, and real estate first lien mortgages where the value of the underlying real estate exceeds the amount of the mortgage lien by certain required percentages.\nThe following table shows investment results for insurance operations for the periods indicated:\nThe following table shows the percentage distribution of insurance operation investments:\nRegulation: The Company is subject to regulation by the supervisory agency of each state or other jurisdiction in which it is licensed to do business. These agencies have broad administrative powers, including the granting and revocation of licenses to transact business, the licensing of agents, the approval of policy forms, the form and content of mandatory financial statements, capital, surplus, and reserve requirements, as well as the previously mentioned regulation of the types of investments which may be made. The Company is required to file detailed financial reports with each state or jurisdiction in which it is licensed, and its books and records are subject to examination by each. In accordance with the insurance laws of the various states in which the Company is licensed and the rules and practices of the National Association of Insurance Commissioners, examination of the Company's records routinely takes place every three to five years. These examinations are supervised by the Company's domiciliary state, with representatives from other states participating. The most recent examination of National Western was completed in 1994 and covered the six-year period ended December 31, 1992. The states of Colorado and Delaware participated. A final report disclosing the examination results was received by the Company in March, 1995. The report contained no adjustments or issues which would have a significant, negative impact on the operations of the Company.\nRegulations that affect the Company and the insurance industry are often the result of efforts by the National Association of Insurance Commissioners (NAIC). The NAIC is an association of state insurance commissioners, regulators and support staff that acts as a coordinating body for the state insurance regulatory process. Recently, increased scrutiny has been placed upon the insurance regulatory framework, and certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies. The NAIC and state insurance regulators periodically re-examine existing laws and regulations, and recently have been specifically focusing on insurance company investments and solvency issues, statutory policy reserves, reinsurance, risk-based capital guidelines, and codification of prescribed statutory accounting principles.\nOf particular importance, in 1993 the NAIC established new risk-based capital (RBC) requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset\/liability matching issues; and (iv) other business risks. The Company has calculated its RBC level and has determined that its capital and surplus is significantly in excess of the threshold requirements.\nThe RBC regulation developed by the NAIC is an example of its involvement in the regulatory process. New regulations are routinely published by the NAIC as model acts or model laws. The NAIC encourages adoption of these model acts by all states to provide uniformity and consistency among state insurance regulations.\nDiscontinued Brokerage Operations\nGeneral: The Westcap Corporation (Westcap), a wholly owned subsidiary of the Company, was a brokerage firm headquartered in Houston, Texas. Prior to July 17, 1995, Westcap provided investment products and financial services to a nationwide customer base. Its wholly owned subsidiaries include Westcap Securities Investment, Inc. (Westcap Investment), Westcap Securities Management, Inc. (Westcap Management), and Westcap Mortgage Company (Westcap Mortgage). Westcap Investment and Westcap Management own 100% of the partnership interests in Westcap Securities, L.P. (Westcap L.P.). Westcap L.P. was primarily a dealer in municipal and corporate bonds and collateralized mortgage obligations and a secondary market dealer in obligations issued or guaranteed by the U.S. government or its agencies. The limited partnership was subject to regulation by the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers.\nPlan to Cease Brokerage Operations: Effective July 17, 1995, The Westcap Corporation and subsidiaries discontinued all sales and trading activities in its Houston, Texas, office. At that time, Westcap continued its corporate operations and small sales operations in its New Jersey office. However, in September, 1995, Westcap approved a plan to close the remaining sales office in New Jersey and to cease all brokerage operations.\nAs more fully described in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, declines in both sales revenues and earnings were the principal reasons for ceasing brokerage operations. The declines resulted primarily from adverse bond market conditions and adverse publicity about litigation. As a result of Westcap's decision to cease brokerage operations, the brokerage segment is now reported as discontinued operations throughout this report and in the accompanying financial statements.\nIn anticipation of an Order Instituting Public Administrative Proceedings, Making Findings and Imposing Remedial Sanctions (Order) being entered pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 by the Securities and Exchange Commission (Commission), on February 8, 1996, Westcap L.P. submitted an offer of settlement to the Commission whereby it consented, without admitting or denying the findings in the Order, to the entry of an Order of the Commission making findings, revoking Westcap L.P.'s registration with the Commission, and requiring payment to the Commission of (i) $445,341 disgorgement, (ii) prejudgement interest of $83,879, and (iii) civil penalty of $300,000. Such an Order was entered by the Commission on February 14, 1996. In compliance with the Order, Westcap L.P. made payment to the Commission of $829,220 on March 5, 1996.\n(b) Financial Information About Industry Segments\nA summary of financial information for the Company's two industry segments follows:\n(c) Narrative Description of Business\nIncluded in Item 1.(a).\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nIncluded in Item 1.(a).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases approximately 72,000 square feet of office space in Austin, Texas, for $477,600 per year plus taxes, insurance, maintenance, and other operating costs. This lease expires in 2000.\nThe Company's brokerage subsidiary, The Westcap Corporation, leases its office facilities in Houston, Texas, under a lease which terminates in 1997. The total leased space is approximately 4,200 square feet. The annual lease costs will be approximately $74,000 and $35,000 in 1996 and 1997, respectively.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn March 28, 1994, the Community College District No. 508, County of Cook and State of Illinois (The City Colleges) filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, against National Western Life Insurance Company (the Company) and subsidiaries of The Westcap Corporation. The suit seeks rescission of securities purchase transactions by The City Colleges from Westcap between September 9, 1993 and November 3, 1993, alleged compensatory damages, punitive damages, injunctive relief, declaratory relief, fees, and costs. National Western is named as a \"controlling person\" of the Westcap defendants. On February 1, 1995, the complaint was amended to add a RICO count for treble damages and claims under the Texas securities and consumer fraud laws, and to add additional defendants. Westcap and the Company are of the opinions that Westcap has adequate documentation to validate all such securities purchase transactions by The City Colleges, and that Westcap and the Company each have adequate defenses to the litigation. Although the alleged damages would be material to the Company's and Westcap's financial positions, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. A judicial ruling favorable to Westcap has been made requiring resolution of the suit against Westcap through binding arbitration. The lawsuit against the Company was suspended pending determination of the arbitration proceeding against Westcap. Arbitration proceedings are currently set to begin in August, 1996.\nOn February 1, 1995, the San Antonio River Authority (SARA) filed a complaint in the 285th Judicial District Court, Bexar County, Texas, against Kenneth William Katzen (Katzen), Westcap Securities, L.P., The Westcap Corporation (Westcap), and National Western Life Insurance Company (the Company). The suit alleges that Katzen and Westcap sold mortgage-backed security derivatives to SARA and misrepresented these securities to SARA. The suit alleges violations of the Federal Securities Act, Texas Securities Act, Deceptive Trade Practices Act, breach of fiduciary duty, fraud, negligence, breach of contract, and seeks attorney's fees. The Company is named as a \"controlling person\" of the Westcap defendants. Westcap and the Company are of the opinions that Westcap has adequate documentation to validate all securities purchases by SARA and that the Company and Westcap have adequate defenses to such suit. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company and Westcap have denied all allegations and the parties have initiated discovery. The case is set for trial on April 8, 1996.\nOn June 9, 1995, Charles McCutcheon, as Sheriff of Palm Beach County, Florida, served The Westcap Corporation, Westcap Securities, Inc., Westcap Government Securities, Inc., individual officers and directors of the Westcap entities, and National Western Life Insurance Company as defendants with a complaint filed in the U.S. District Court for the Southern District of Florida. The Complaint alleges that the Westcap entities improperly sold certain derivative securities to the Plaintiff and did not disclose the high risk of these securities to the Plaintiff, who suffered financial losses from the investments. The Company is sued as a \"controlling person\" of Westcap, and it is alleged that the Company is responsible and liable for the alleged wrongful conduct of Westcap. The suit seeks rescission of the investment transactions, alleged damages, punitive and exemplary damages, attorneys' fees, and injunction. On October 13, 1995, the U.S. District Judge ordered arbitration of Plaintiff's claims against the Westcap entities and stayed all proceedings pending outcome of the arbitration. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company and Westcap deny the allegations and believe they each have adequate defenses to such suit.\nOn July 5, 1995, San Patricio County, Texas, filed suit in the District Court of San Patricio County, Texas, against National Western Life Insurance Company (the Company) and its chief executive officer, Robert L. Moody. The suit arises from derivative investments purchased by San Patricio County from Westcap Securities, L.P. or Westcap Government Securities, Inc., affiliates of The Westcap Corporation, a wholly owned subsidiary of the Company. The suit alleges that the Westcap affiliates were controlled by the Company and Mr. Moody and that they are responsible for the alleged wrongful acts of the Westcap affiliates in selling the securities to the Plaintiff. Plaintiff alleges that the Westcap affiliates violated duties and responsibilities owed to the Plaintiff related to its investment recommendations and the decisions made by Plaintiff, and alleges that the Plaintiff was financially damaged by such actions of Westcap. The suit seeks rescission of the investment transactions and actual and punitive damages of unspecified amounts. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company believes that it has adequate defenses to such suit and denies the allegations. The parties have initiated discovery.\nOn September 13, 1995, Michigan South Central Power Agency filed a complaint in The United States District Court for the Western District of Michigan against Westcap Securities Investment, Inc., Westcap Securities, L.P., Westcap Securities Management, Inc., The Westcap Corporation, National Western Life Insurance Company (the Company), and others. The suit alleges that salesmen of Westcap sold mortgage-backed securities to the Plaintiff and misrepresented these securities in violation of Federal and state securities laws and common law. The Company is named as a \"controlling person\" of the Westcap defendants. Westcap and the Company are of the opinions that they have adequate defenses to the suit. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from the suit cannot be made at this time. The Company and Westcap deny all allegations.\nThe Westcap Corporation and Westcap Securities, L.P. are also defendants in several other pending lawsuits which have arisen in the ordinary course of its business. Westcap Securities, L.P. has also been notified of several arbitration claims filed with the National Association of Securities Dealers. After reviewing the lawsuits and arbitration filings with outside counsel, management believes it has adequate defenses to each of the claims.\nAlthough the alleged damages for all of the above-described suits and arbitration claims would be material to the financial positions of the Company and The Westcap Corporation, a reasonable estimate of actual losses which may result from any of these claims cannot be made at this time. Accordingly, no provision for any liability that may result from these actions has been recognized in the consolidated financial statements.\nNo other legal proceedings presently pending by or against the Company or its subsidiaries are described, because management believes the outcome of such litigation should not have a material adverse effect on the financial position of the Company or its subsidiaries taken as a whole.\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 STOCKHOLDER MATTERS\n(a) Market Information\nThe principal market on which the common stock of the Company is traded is The Nasdaq Stock Market under the symbol NWLIA. The high and low sales prices for the common stock for each quarter during the last two years are shown in the following table:\n(b) Equity Security Holders\nThe number of stockholders of record on December 31, 1995, was as follows:\n(c) Dividends\nThe Company has never paid cash dividends on its common stock. Payment of dividends is within the discretion of the Company's Board of Directors and will depend on factors such as earnings, capital requirements, and the operating and financial condition of the Company. Presently, the Company's capital requirements are such that it intends to follow a policy of retaining any earnings in order to finance the development of business and to meet increased regulatory requirements for capital.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following five-year financial summary includes comparative amounts taken from the audited financial statements. The results have been reclassified to reflect The Westcap Corporation as discontinued brokerage operations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nNational Western Life Insurance Company is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. It also accepts applications from and issues policies to residents of Central and South American countries. These policies are accepted and issued in the United States and accounted for approximately 14% of the Company's total premium revenues, universal life, and investment annuity contract deposits in 1995. The primary products marketed by the Company are its universal life and single and flexible premium annuity products.\nIn addition to the life insurance business, the Company has a brokerage operations segment through its wholly owned subsidiary, The Westcap Corporation. However, during 1995 The Westcap Corporation closed its sales offices and approved a plan to cease all brokerage operations. Accordingly, the brokerage segment is now reported as discontinued operations throughout this report and in the accompanying financial statements.\nINVESTMENTS IN DEBT AND EQUITY SECURITIES\nInvestment Philosophy\nThe Company's investment philosophy is to maintain a diversified portfolio of investment grade debt and equity securities that provide adequate liquidity to meet policyholder obligations and other cash needs. The prevailing strategy within this philosophy is the intent to hold investments in debt securities to maturity. However, the Company manages its portfolio, which entails monitoring and reacting to all components which affect changes in the price, value, or credit rating of investments in debt and equity securities.\nInvestments in debt and equity securities are classified and reported into the following categories: held to maturity, available for sale, and trading. The reporting category chosen for the Company's securities investments depends on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset\/liability management strategy. At December 31, 1995, approximately 26% of the Company's total debt and equity securities, based on fair values, were classified as securities available for sale. These holdings provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs.\nSecurities the Company purchases with the intent to hold to maturity are classified as securities held to maturity. Because the Company has strong cash flows and matches expected maturities of assets and liabilities, the Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary. However, certain situations may change the Company's intent to hold a particular security to maturity, the most notable of which is a deterioration in the issuer's creditworthiness. Accordingly, a security may be sold to avoid a further decline in realizable value when there has been a significant change in the credit risk of the issuer. Securities that are held for current resale are classified as trading securities, as the intent is to sell them, producing a trading profit. The Company does not maintain a portfolio of trading securities.\nSecurities that are not classified as either held to maturity or trading securities are reported as securities available for sale. These securities may be sold if market or other measurement factors change unexpectedly after the securities were acquired. For example, opportunities arise when factors change that allow the Company to improve the performance and credit quality of the investment portfolio by replacing an existing security with an alternative security while still maintaining an appropriate matching of expected maturities of assets and liabilities. Examples of such improvements are as follows: improving the yield earned on invested assets, improving the credit quality, changing the duration of the portfolio, and selling securities in advance of anticipated calls or other prepayments. Securities available for sale are reported in the Company's financial statements at fair value. Any unrealized gains or losses resulting from changes in the fair value of the securities are reflected as a component of stockholders' equity.\nAs an integral part of its investment philosophy, the Company performs an ongoing process of monitoring the creditworthiness of issuers within the investment portfolio. In addition, review procedures are performed on securities that have had significant declines in fair value. The Company's objective in these circumstances is to determine if the decline in fair value is due to changing market expectations regarding inflation and general interest rates or other factors.\nAdditional review procedures are performed on those fair value declines which are caused by factors other than market expectations regarding inflation and general interest rates. Specific conditions of the issuer and its ability to comply with all terms of the instrument are considered in the evaluation of the realizable value of the investment. Information reviewed in making this evaluation would include the recent operational results and financial position of the issuer, information about its industry, recent press releases, and other available data. If evidence does not exist to support a realizable value equal to or greater than the carrying value of the investment, such decline in fair value is determined to be other than temporary, and the carrying amount is reduced to its net realizable value. The amount of the reduction is reported as a realized loss.\nThe Company's overall conservative investment philosophy is reflected in the allocation of investments of its insurance operations which is detailed below as of December 31, 1995 and 1994. The Company emphasizes debt securities, with smaller holdings in mortgage loans and real estate than industry averages.\nPortfolio Analysis\nAt December 31, 1995, securities held to maturity totaled $1.643 billion, or 62.6% of total invested assets. The fair value of these securities was $1.726 billion, which reflects gross unrealized gains of $83 million. The unrealized gains within this portfolio result from decreases in market interest rates during 1995. The unrealized gains have no effect on the Company's financial statements, as securities held to maturity are recorded at amortized cost.\nSecurities available for sale totaled $601 million at December 31, 1995, or 22.9% of total invested assets. Equity securities, which are included in securities available for sale, continue to be a small component of the Company's total investment portfolio totaling only $26 million. Securities available for sale are reported in the accompanying financial statements at fair value, with changes in values reported as a separate component of stockholders' equity. Net unrealized gains, net of adjustments for deferred policy acquisition costs and Federal income taxes, on securities in the available for sale category at December 31, 1995, totaled $12 million and are reflected as a component of stockholders' equity.\nAs described in the notes in the accompanying financial statements, on July 31, 1994, the Company transferred securities with fair values totaling $805 million from securities available for sale to securities held to maturity. On December 29, 1995, the Company made additional transfers totaling $156 million to the held to maturity category from securities available for sale. The lower holdings of securities available for sale significantly reduces the Company's exposure to equity volatility while still providing securities for liquidity and asset\/liability management purposes. The transfers to held to maturity in 1994 and 1995 resulted in locking in net unrealized gains which require subsequent amortization and had the following effects on stockholders' equity:\nOn December 29, 1995, the Company also transferred securities totaling $284 million to the available for sale category from securities held to maturity. This transfer resulted in an increase to stockholder's equity of $4,266,000 as of December 31, 1995, net of effects of deferred policy acquisition costs and taxes. This transfer was made to restructure the Company's portfolio to provide increased flexibility for both portfolio and asset\/liability management. Accounting principles typically do not allow transfers from the held to maturity category to the available for sale category except under certain prescribed circumstances. However, in 1995 the Financial Accounting Standards Board permitted a one-time reassessment by companies of their securities classifications and allowed transfers out of the held to maturity category without regard to the prescribed circumstances. The reassessment and any resulting transfers had to be completed by December 31, 1995.\nThe Company maintains a diversified debt securities portfolio which consists of various types of fixed income securities including primarily U.S. government, public utilities, corporate, and mortgage-backed securities. Investments in mortgage-backed securities include U.S. government and private issue mortgage-backed pass-through securities as well as collateralized mortgage obligations (CMOs). As of December 31, 1995 and 1994, the Company's debt securities portfolio consisted of the following mix of securities based on amortized cost:\nThe amortized cost and estimated fair values of investments in debt securities 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.\nBecause expected maturities of securities may differ from contractual maturities due to prepayments and calls, the Company takes steps to manage and minimize such risks. In previous years, the Company has experienced increased calls, particularly in the public utilities portfolio. As a result, the Company has been increasing its holdings in noncallable corporate securities. Corporate holdings as a percentage of the entire portfolio increased from 32.5% in 1994 to 40.3% in 1995.\nThe Company's holdings of mortgage-backed securities are also subject to prepayment risk, as well as extension risk. Both of these risks are addressed by specific portfolio management strategies. The Company substantially reduced both prepayment and extension risks by investing primarily in collateralized mortgage obligations which have more predictable cash flow patterns than pass-through securities. These securities, known as planned amortization class I (PAC I) CMOs, are designed to amortize in a more predictable manner than other CMO classes or pass-throughs. Using this strategy, the Company can more effectively manage and reduce prepayment and extension risks, thereby helping to maintain the appropriate matching of the Company's assets and liabilities.\nPAC I CMOs now account for approximately 90% of the total CMO portfolio as of December 31, 1995. The CMOs that the Company purchases are modeled and subjected to detailed, comprehensive analysis by the Company's investment staff before any investment decision is made. The overall structure of the entire CMO is evaluated, and an average life sensitivity analysis is performed on the individual tranche being considered for purchase under increasing and decreasing interest rate scenarios. This analysis provides information used in selecting securities that fit appropriately within the Company's investment philosophy and asset\/liability management parameters. The Company's investment mix between mortgage-backed securities and other fixed income securities helps effectively balance prepayment, extension, and credit risks.\nIn addition to managing prepayment, extension, and call risks, the Company continues to concentrate on improving the credit quality of its investments in debt securities. Much attention is often placed on a company's holdings of below investment grade debt securities, as these securities generally have greater default risk than higher rated corporate debt. These issuers usually have high levels of indebtedness and are more sensitive to adverse industry or economic conditions than are investment grade issuers. The Company's small holdings of below investment grade debt securities are summarized as follows:\nThe level of investments in debt securities which are in default as to principal or interest payments is indicative of the Company's minimal holdings of below investment grade debt securities. At December 31, 1995 and 1994, securities with principal balances totaling $3,575,000 and $2,415,000 were in default and on non-accrual status.\nThe Company's commitment to high-quality investments in debt securities is also reflected by the portfolio average rating of \"Aa,\" which is high quality. Allocation of investments in debt securities classified in accordance with the highest rating by a nationally recognized statistical rating organization as of December 31, 1995, is provided below. If securities were not rated by one of these organizations, the equivalent classification as assigned by the National Association of Insurance Commissioners was used.\nMORTGAGE LOANS AND REAL ESTATE\nInvestment Philosophy\nIn general, the Company seeks loans on high quality, income producing properties such as shopping centers, freestanding retail stores, office buildings, industrial and sales or service facilities, selected apartment buildings, motels, and health care facilities. The location of these loans is typically in growth areas that offer a potential for property value appreciation. These growth areas are found primarily in major metropolitan areas, but occasionally in selected smaller communities. The Company currently seeks loans ranging from $500,000 to $11,000,000, with terms ranging from three to twenty-five years, at interest rates dictated by the marketplace.\nThe Company seeks to minimize the credit and default risk in its mortgage loan portfolio through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are often guaranteed by the lessee, in which case the Company approves the loan based on the credit strength of the lessee. This approach, implemented in 1991, has significantly improved the quality of the Company's mortgage loan portfolio and reduced defaults.\nThe Company's level of mortgage loan originations declined in 1995 to approximately $18 million. This is in comparison to originations totaling $30 million and $33 million in 1994 and 1993, respectively. Market conditions in 1995 included a decreasing interest rate environment and increasing competition. As a result, mortgage loan originations declined in 1995, as the Company has maintained its strict underwriting policies and its commitment to quality loans.\nThe Company's direct investments in real estate are not a significant portion of its total investment portfolio, and the majority of real estate owned was acquired through mortgage loan foreclosures. However, the Company is also currently participating in several real estate joint ventures and limited partnerships. The joint ventures and partnerships invest primarily in income-producing retail properties. While not a significant portion of the Company's investment portfolio, these investments have produced favorable returns to date. The Company has no current plans to significantly increase its investments in real estate in the foreseeable future.\nPortfolio Analysis\nThe Company held net investments in mortgage loans totaling $191,674,000 and $189,632,000, or 7.3% and 8.1% of total invested assets, at December 31, 1995 and 1994. The loans are real estate mortgages, substantially all of which are related to commercial properties and developments and have fixed interest rates.\nThe diversification of the mortgage loan portfolio by geographic region of the United States and by property type as of December 31, 1995 and 1994, was as follows:\nAs of December 31, 1995, the allowance for possible losses on mortgage loans was $5,668,000. Additions to the allowance totaling $307,000 were recognized as realized losses on investments in the Company's 1994 financial statements. No additions were made in 1995. Management believes that the allowance for possible losses is adequate. However, while management uses available information to recognize losses, future additions to the allowance may be necessary based on changes in economic conditions, particularly in the West South Central region which includes Texas, Louisiana, Oklahoma, and Arkansas, as this area contains the highest concentrations of the Company's mortgage loans.\nThe Company currently places all loans past due three months or more on non-accrual status, thus recognizing no interest income on the loans. At December 31, 1995 and 1994, the Company had approximately $202,000 and $2,292,000, respectively, of mortgage loan principal balances on non-accrual status. In addition to the non-accrual loans, the Company had mortgage loan principal balances with restructured terms totaling approximately $13,355,000 and $13,123,000 at December 31, 1995 and 1994, respectively. For the years ended December 31, 1995 and 1994, the reductions in interest income due to non-accrual and restructured mortgage loans were not significant.\nThe contractual maturities of mortgage loans at December 31, 1995, are as follows:\nThe Company owns real estate that was acquired through foreclosure and through direct investment totaling approximately $19,066,000 and $17,766,000 at December 31, 1995 and 1994, respectively. This small concentration of properties represents less than one percent of the Company's entire investment portfolio. The real estate holdings consist primarily of income-producing properties which are being operated by the Company. The Company recognized operating income on these properties of approximately $404,000 for the year ended December 31, 1995, and operating losses of approximately $62,000 for the year ended December 31, 1994. The Company does not anticipate significant changes in these operating results in the near future.\nThe Company monitors the conditions and market values of these properties on a regular basis. Realized losses recognized due to declines in values of properties totaled $882,000 and $318,000 for the years ended December 31, 1995 and 1994, respectively. The Company makes repairs and capital improvements to keep the properties in good condition and will continue this maintenance as needed.\nRESULTS OF OPERATIONS\nSummary of Consolidated Operations\nA summary of operating results, net of taxes, for the years ended December 31, 1995, 1994, and 1993 is provided below:\nSignificant changes and fluctuations in income and expense items between years are described in detail for insurance and brokerage operations as follows:\nInsurance Operations\nInsurance Operations Net Earnings: Earnings from insurance operations for the year ended December 31, 1995, were $37,203,000 compared to $36,115,000 for 1994. However, 1995 earnings include a $5.7 million tax benefit resulting from the Company's subsidiary brokerage losses. Earnings for 1994 include a comparable $2.9 million tax benefit. The tax benefits were recognized in accordance with the Company's tax allocation agreement with its subsidiaries. Excluding the tax benefits, earnings from insurance operations for 1995 were down $1.7 million from 1994 due primarily to higher life insurance benefit claims and other policy and contract related expenses. The higher claims and policy related expenses were partially offset by lower insurance operating expenses relating to state guaranty association assessments.\nLife and Annuity Premiums: This revenue category represents the premiums on traditional type products. However, sales in most of the Company's markets currently consist of non-traditional types such as universal life and investment annuities. The Company's current plans are to continue to focus the majority of its product development and marketing efforts on universal life and investment annuities. As a result, no significant growth is anticipated for these premiums in the near future.\nUniversal Life and Investment Annuity Contract Revenues: These revenues are from the Company's non-traditional products, which are universal life and investment annuities. Revenues from these types of products consist of policy charges for the cost of insurance, policy administration fees, and surrender charges assessed during the period. These revenues decreased from $67.8 million in 1993 to $64.7 million in 1994 and then increased to $69.8 million in 1995. More specifically, cost of insurance, policy administration fees, and other related revenues have steadily increased each year due to continued sales of non-traditional products which continue to increase the Company's policies in force. However, surrender charge revenues were significantly higher in 1993 due to increased policy surrenders. This accounts for the majority of the decrease in universal life and investment annuity contract revenues in 1994. Overall revenues were up in 1995 due to increases in cost of insurance and other related revenues as previously described, even though surrender charge revenues were not up significantly from 1994 and remained substantially below 1993 levels.\nActual universal life and investment annuity deposits collected for the years ended December 31, 1995, 1994, and 1993 are detailed below. Deposits collected on these non-traditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.\nPrior to 1993, most of the Company's investment annuity production was from the sale of two-tier annuity products. However, in the third quarter of 1992, the Company discontinued sales of all two-tier annuities due to declines in sales and certain regulatory issues concerning two-tier products. The Company has continued to collect additional premiums on existing two-tier annuities, which accounts for the majority of the deposits for investment annuities in 1993. The vast majority of the two-tier annuities were sold by a single independent marketing organization.\nSubsequent to discontinuing the two-tier annuity sales, the Company set goals to not only develop new annuity products to replace the lost two-tier production, but to diversify and strengthen distribution channels to avoid dependence on its primary independent marketing organization. The Company achieved this by developing new annuity products in 1994 and by contracting new marketing organizations with extensive experience, financial resources, and success in marketing annuities. The combination of new products, primarily a single premium deferred annuity, and new marketing organizations started to produce results in the latter half of 1994 as annuity production began to increase significantly. This increased production has continued into 1995 with annuity deposits increasing from $158 million in 1994 to $310 million in 1995, reflecting a 97% increase.\nThe majority of the Company's universal life insurance production is from the international market, primarily Central and South American countries. The Company has seen increased competition in the Central and South American market in recent years causing production growth to slow. However, the Company has been accepting policies from foreign nationals for almost thirty years and has developed strong relationships with carefully selected brokers in the foreign countries. This experience and strong broker relations have enabled the Company to meet the increased competition with new product enhancements and marketing efforts. Such efforts have resulted in increased universal life production once again in 1995. Deposits for universal life for both international and domestic markets are up 5.7% in 1995 from $64.8 million in 1994 to $68.5 million in 1995.\nNet Investment Income: During 1995, net investment income increased 6.2% from 1994 while total invested assets increased 12.0% for the same period. The increase in invested assets was primarily due to the increased annuity production as previously described. The growth in net investment income lagged the growth in invested assets for several reasons. Interest rates declined significantly throughout 1995, resulting in investments in lower yielding securities. Also, net investment income was up significantly in 1994 due to yield and amortization adjustments on mortgage-backed securities as more fully described below. There were no significant corresponding adjustments in 1995.\nNet investment income increased 5.4% from $180.3 million in 1993 to $190.0 million in 1994. Net investment income was up primarily due to yield and amortization adjustments on mortgage-backed securities and increases in invested assets. The yield and amortization adjustments were made 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.\" The adjustments are made to reflect changes in mortgage-backed securities prepayment levels, caused by changes in market interest rates, which affect average lives, yields, and amortization periods of the securities.\nOther Income: The Company received proceeds from lawsuit settlements totaling $1,050,000 in 1993 which has been reflected in other income. In 1984, certain employee participants in the Company's \"Builders, Contractors, and Employees Retirement Trust and Pension Plan\" (the Plan) and other plaintiffs filed a civil lawsuit against the Company and other defendants with respect to various Plan matters, all as previously disclosed in the Company's annual reports on Form 10-K. The Company settled the lawsuit in 1991 with payments to the Internal Revenue Service and participants in the Plan. Subsequent to this settlement, the Company filed suit against the law firm which assisted in the development of the Plan. The Company also filed suit, for recovery of damages incurred, against an insurance company providing liability coverage for trustees of the Plan. Both suits were settled, with the Company receiving the proceeds as described above.\nAlso, as previously disclosed in the Company's annual reports on Form 10-K, the Company was a defendant in a lawsuit seeking recovery of certain values of life insurance policies pledged as collateral for debentures totaling $8,000,000. In early 1991, a court ruled that the collateral assignment was not enforceable. As a result, the Company recorded a loss of $8,000,000 in 1990, as the debentures were no longer deemed collateralized by the insurance policies and their market value was zero due to the insolvency of the issuer. The Company appealed the court ruling and also recorded a corresponding $8,000,000 liability for the potential payment of this claim. The Company had been accruing an additional liability for interest on this $8,000,000 balance. This lawsuit was settled in September, 1993, resulting in an $11,500,000 payment by the Company. The Company's total accrued liability for this claim exceeded the payment by approximately $670,000 which has been reflected as other income in 1993. The Company also received proceeds from a settlement totaling $955,000 for recovery of damages incurred related to this lawsuit. These settlement proceeds have been reflected as other income in 1994.\nRealized Gains and Losses on Investments: The Company recorded realized losses totaling $2.4 million in 1995 compared to realized gains of $1.6 million and $3.2 million in 1994 and 1993, respectively. The losses in 1995 were primarily from sales of investments in debt securities, the majority of which were from the Company's remaining investments in principal exchange rate linked securities. The Company made the decision to realize these losses to obtain tax benefits related to the losses which were scheduled to expire on December 31, 1995. The gains and losses in 1995, 1994, and 1993 are net of write-downs on real estate and mortgage loans totaling $882,000, $625,000, and $3,360,000, respectively. The 1993 gains are also net of write-downs for permanent impairments on investments in debt securities totaling $6,329,000.\nLife and Other Policy Benefits: Expenses in 1995 and 1993 were significantly higher at $39.8 million and $36.3 million than 1994 expenses which totaled only $32.1 million. The significant fluctuation in expenses is due to higher life insurance benefit claims and high policy surrenders on traditional insurance products in both 1995 and 1993. Life insurance benefit claims, which accounted for the majority of the fluctuation, totaled $24.6 million, $19.1 million, and $21.3 million in 1995, 1994, and 1993, respectively. The 1995 and 1993 expenses were abnormally high due to adverse claims experience. Throughout the Company's history, it has experienced both periods of higher and lower benefit claims in comparison to Company averages. Years 1995 and 1993 reflect such periods, as benefits were significantly higher. Such deviations are not uncommon in the life insurance industry and, over extended periods of time, tend to be offset by periods of more favorable claims experience.\nAmortization of Deferred Policy Acquisition Costs: This expense item represents the amortization of the costs of acquiring or producing new business, which consists primarily of agents' commissions. The majority of such costs are amortized in direct relation to the anticipated future gross profits of the applicable blocks of business. Amortization is also impacted by the level of policy surrenders. Amortization for 1995, 1994, and 1993 has been relatively consistent at $33.7 million, $32.1 million, and $33.2 million, respectively. The higher amortization in 1995 and 1993 correlates to increased policy surrenders in those years.\nUniversal Life and Investment Annuity Contract Interest: Prior to 1995, interest expense declined steadily as amounts totaled $129.1 million, $130.9 million, and $135.8 million for 1994, 1993, and 1992, respectively. This decline was due to the lowering of credited interest rates on most universal life and investment annuity products throughout these years. Additional interest costs related to increasing business was not significant, as the policy liabilities remained relatively constant over those years. However, in the latter part of 1994, annuity production began to increase significantly, which continued through 1995. This increase in annuity deposits resulted in corresponding increases in policy liabilities and significantly higher interest costs in 1995. Also, the Company's new annuity products typically credit significantly higher interest rates in the first policy year, again resulting in higher 1995 interest costs.\nThe Company closely monitors its credited interest rates, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. Rates are established or adjusted after careful consideration and evaluation of these factors against established objectives.\nOther Insurance Operating Expenses: These expenses totaled $27.1 million, $29.4 million, and $29.0 million for 1995, 1994, and 1993, respectively. Although these expenses are relatively comparable between years, these amounts include significant expenses for guaranty association assessments.\nNational Western Life Insurance Company is subject to state guaranty association assessments in all states in which it is licensed to do business. These associations generally guarantee certain levels of benefits payable to resident policyholders of insolvent insurance companies. Most states allow premium tax credits for all or a portion of such assessments, thereby allowing potential recovery of these payments over a period of years. However, several states do not allow such credits. In December, 1995 and 1994, the National Organization of Life and Health Insurance Guaranty Associations published revised assessment data on nationwide life and health insurance company insolvencies. Based on this information, the Company revised its estimates for assessment liabilities relating to such insolvencies. The Company will continue to monitor and revise its estimates for assessments as additional information becomes available, which could result in additional expense charges. Other insurance operating expenses related to state guaranty association assessments totaled $2,371,000, $4,869,000, and $4,583,000 for the years ended December 31, 1995, 1994, and 1993, respectively. The lower assessment expenses in 1995 are the primary reason for the lower overall insurance operating expenses for the same period.\nDiscontinued Brokerage Operations\nEffective July 17, 1995, The Westcap Corporation, a wholly owned brokerage subsidiary of National Western Life Insurance Company, discontinued all sales and trading activities in its Houston, Texas, office. At that time, The Westcap Corporation (Westcap) continued its corporate operations and small sales operations in its New Jersey office. However, in September, 1995, Westcap approved a plan to close the remaining sales office in New Jersey and to cease all brokerage operations.\nDeclines in both sales revenues and earnings were the principal reasons for ceasing operations. Increasing market interest rates and resulting adverse bond market conditions during 1994 and 1995 compared to previous years had a negative impact on the entire bond brokerage industry. These conditions, coupled with adverse publicity about litigation related to sales of collateralized mortgage obligation (CMO) products, led to the declines in sales and earnings. The publicity surrounding these claims made it extremely difficult to keep Westcap's customer base and sales force in place. Additionally, because much publicity characterizes CMOs as derivatives, adverse publicity about derivatives impacted the market for CMOs and decreased Westcap's prospects for future sales.\nIn connection with the plan to cease brokerage operations, Westcap's assets are being carried at their estimated fair value, and its liabilities include estimated costs to dispose of assets and estimated future costs to cease operations. As a result of the plan and in accordance with generally accepted accounting principles, the assets and liabilities of Westcap have been reclassified in the accompanying consolidated balance sheets to separately identify them as assets and liabilities of the discontinued operations.\nIn previous years, Westcap has contributed significantly to the consolidated earnings of National Western Life Insurance Company. However, more recently, brokerage operations have produced losses due to the reasons cited above. A summary of net earnings and losses from brokerage operations since 1992 is provided below.\nLosses from the discontinued brokerage operations have been reflected separately from continuing operations of the Company in the accompanying consolidated financial statements. The 1995 losses disclosed above include estimated future operating losses as well as estimated costs to cease brokerage operations totaling $6,381,000 and have resulted in the complete write-off of the Company's investment in Westcap on a consolidated basis.\nConsolidated Federal Income Taxes\nFederal Income Taxes: Federal income taxes for 1995 on earnings from continuing operations reflect an effective tax rate of 23%. The 1995 taxes are lower than the expected statutory rate of 35% due to a $5.7 million tax benefit resulting from the Company's subsidiary brokerage losses. Correspondingly, losses on discontinued operations for 1995 totaling $16,350,000 do not include any tax benefits relating to the brokerage subsidiary. This tax reporting treatment is in accordance with the Company's tax allocation agreement with its subsidiaries. However, on a consolidated basis, the Federal income taxes reflect the expected effective tax rate of 35% for 1995.\nFederal income taxes for 1994 on earnings from continuing operations also reflect a low effective tax rate, as such taxes also include a tax benefit totaling $2.9 million resulting from the Company's subsidiary brokerage losses. Losses on discontinued operations for 1994 totaling $2,936,000 include Federal income taxes of $2,983,000. Again, the tax reporting treatment is in accordance with the tax allocation agreement previously described, and on a consolidated basis, Federal income taxes reflect an effective tax rate of 35% for 1994.\nThe Federal corporate tax rate was increased from 34% to 35% beginning in 1993. The total increase in 1993 Federal income taxes resulting from the change in rates was approximately $1,018,000.\nCumulative Effect of Change in Accounting for Income Taxes: In February, 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires 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 SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nThe Company adopted SFAS No. 109 effective January 1, 1993. The cumulative effect of this change in accounting for income taxes of $5,520,000 was determined as of January 1, 1993, and is reported separately in the statement of earnings for the year ended December 31, 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity\nThe liquidity requirements of the Company are met primarily by funds provided from operations. Premium deposits and revenues, investment income, and investment maturities are the primary sources of funds, while investment purchases and policy benefits are the primary uses of funds. Primary sources of liquidity to meet cash needs are the Company's securities available for sale portfolio, net cash provided by operations, and bank line of credit. The Company's investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. The Company may also borrow up to $60 million on its bank line of credit for short-term cash needs.\nA primary liquidity concern for the Company's life insurance operations is the risk of early policyholder withdrawals. Consequently, the Company closely evaluates and manages the risk of early surrenders or withdrawals. The Company includes provisions within annuity and universal life insurance policies, such as surrender charges, that help limit early withdrawals. The Company also prepares cash flow projections and performs cash flow tests under various market interest rate scenarios to assist in evaluating liquidity needs and adequacy. The Company currently expects available liquidity sources and future cash flows to be adequate to meet the demand for funds.\nIn the past, cash flows from the Company's insurance operations have been more than adequate to meet current needs. Cash flows from operating activities were $99 million, $117 million, and $136 million in 1995, 1994, and 1993, respectively. Lower earnings from brokerage operations is the primary reason for the decrease in cash flows in 1995 and 1994. Additionally, net cash flows from the Company's deposit product operations, which includes universal life and investment annuity products, totaled $99 million in 1995. These operations incurred net cash outflows in 1994 and 1993 totaling $17 million and $99 million, respectively. The increase in cash flows in 1995 is due to increased annuity production as previously described in \"Results of Operations.\" The Company expects this increased annuity production will continue through 1996, thereby enhancing cash flows.\nThe Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $69 million, $133 million, and $486 million in 1995, 1994, and 1993, respectively. The Company again expects significant cash flows from these sources in 1996 at levels similar to 1995 and 1994.\nCapital Resources\nThe Company relies on stockholders' equity for its capital resources, as there has been no long-term debt outstanding in 1995 or recent years. The Company does not anticipate the need for any long-term debt in the near future. There are also no current or anticipated material commitments for capital expenditures in 1996.\nStockholders' equity totaled $312 million at December 31, 1995, reflecting an increase of $37 million from 1994. The increase in capital is primarily from net earnings of $19 million and the change in net unrealized gains on investment securities totaling $17 million in 1995. The decrease in market interest rates during 1995 resulted in the significant increase in unrealized gains. Book value per share at December 31, 1995, was $89.36, reflecting a 13% increase for the year.\nCHANGES IN ACCOUNTING PRINCIPLES\nIn January, 1995, the FASB issued SFAS No. 120, \"Accounting and Reporting by Mutual Life Insurance Enterprises and by Insurance Enterprises for Certain Long-Duration Participating Contracts.\" Also, the AICPA has established accounting for certain participating life insurance contracts of mutual life insurance enterprises in its Statement of Position (SOP) 95-1, \"Accounting for Certain Insurance Activities of Mutual Life Insurance Enterprises,\" that should be applied to those contracts that meet the conditions in this statement. This statement also permits stock life insurance enterprises to apply the provisions of the SOP to participating life insurance contracts that meet certain conditions. SFAS No. 120 is effective for financial statements issued for fiscal years beginning after December 15, 1995. Due to the Company's small level of participating life insurance contracts, this statement will have no significant effects on the Company's financial statements.\nThe FASB issued SFAS No. 121, \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,\" in March, 1995. 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. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. 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 costs to sell.\nThe Company's real estate investments are the only significant assets that will be subject to this statement. As the Company already records foreclosed real estate at the lower of cost or fair value less estimated costs to sell, the implementation of this statement will not have a significant effect on the Company's financial statements. The statement will be implemented in the first quarter of 1996.\nIn October, 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. It defines 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 plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Entities electing to continue applying the accounting methods in Opinion 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.\nUnder the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. For stock options, fair value is determined using an option pricing model that takes into account various information and assumptions regarding the Company's stock and options. 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 an employee must pay to acquire the stock.\nThe Company anticipates that it will continue to apply the accounting methods prescribed by Opinion 25 for its existing stock and incentive plan. Therefore, the implementation of this statement will not affect the Company's results of operations. However, as required by this statement, disclosure information will be provided in the Company' financial statements reflecting costs that would have been recorded under the fair value based method. The statement will be implemented in 1996.\nCURRENT REGULATORY ISSUES\nActuarial Guideline 33\nIn December, 1995, the National Association of Insurance Commissioners adopted for statutory accounting practices Actuarial Guideline 33, previously referred to as Actuarial Guideline GGG. This reserve guideline, which has not been adopted by any states at this time, helps define the minimum reserves for policies with multiple benefit streams, such as two-tier annuities.\nAs of December 31, 1995, the Company's statutory reserving practices for two-tier annuities follow an agreement reached in 1993 with its state of domicile, Colorado. This agreement requires the Company to phase-in a different reserve basis by the end of 1996. The agreement states the acceptable difference between the target reserve and the statutory reserve held by the Company will meet the following schedule:\nThe Company has met the above scheduled difference for December 31, 1995. However, in 1995, the Company entered into discussions with the Colorado Division of Insurance (the Division) to implement Actuarial Guideline 33 and to phase it in over a three-year period as allowed by the guideline. In January, 1996, the Division approved the proposal for this three-year phase-in. The effect on the Company's statutory financial statements will not be significant, since the previous agreement with the Division was similar to the final guideline. Also, the guideline does not affect the Company's policy reserves which are prepared under generally accepted accounting principles as reported in the accompanying consolidated financial statements.\nRisk Based Capital Requirements\nIn 1993, the National Association of Insurance Commissioners (NAIC) established new risk-based capital (RBC) requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset\/liability matching issues; and (iv) other business risks.\nThere continues to be some public pressure for insurance companies to publish their RBC ratios or levels. However, the legality of publishing such information is uncertain. The American Institute of Certified Public Accountants (AICPA) released an exposure draft of a Statement of Position (SOP) which included requirements that insurance companies disclose certain information about their RBC levels. This requirement was deleted from the final SOP version due to questions raised about the legality of such disclosures. Instead, the AICPA decided to consider a separate SOP at a later date on RBC disclosures, after the legal issues are resolved. Due to these unanswered legal issues, the Company has chosen not to publish its RBC ratios or levels. However, the Company's current statutory capital and surplus is significantly in excess of the threshold RBC requirements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is reported in Attachment A beginning on page ____. See Index to Financial Statements and Schedules on page ___ for a list of financial information included in Attachment A.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in auditors or disagreements with auditors which are reportable pursuant to Item 304 of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\n(a) Identification of Directors\nThe following information as of January 31, 1996, is furnished with respect to each director. All terms expire in June of 1996.\nFamily relationships among the directors are: Mr. Robert Moody and Mr. McLeod are brothers-in-law and Mr. Robert Moody is the father of Ms. Frances Moody, Mr. Ross Moody, and Mr. Russell Moody.\n(b) Identification of Executive Officers\nThe following is a list of the Company's executive officers, their ages, and their positions and offices as of January 31, 1996.\n(c) Identification of Certain Significant Employees\nNone.\n(d) Family Relationships\nThere are no family relationships among the officers listed except that Mr. Robert Moody is the father of Mr. Ross Moody. There are no arrangements or understandings pursuant to which any officer was elected. All officers hold office for one year and until their successors are elected and qualified, unless otherwise specified by the Board of Directors.\n(e) Business Experience\nAll of the executive officers listed above have served in various executive capacities with the Company for more than five years, with the exception of the following:\nMr. Ross Moody was a corporate financial analyst with Drexel Burnham Lambert from 1986 to 1987 and was a graduate student at the Harvard Business School from 1987 to 1989. He also served as Director of Administrative Services for American National Insurance Company from 1989 to 1991.\nMr. Facey was Superintendent, Marketing, for Northern Life Assurance Company of Canada from 1973-1985. From 1985-1987, he was Assistant Vice President, Marketing and Actuarial Services for Gerling Global Life Insurance Company in Toronto, Canada, and from 1987 until March, 1992 was Director of Actuarial Services for Variable Annuity Life Insurance Company of Houston, Texas.\nMr. Pickering was Agency Vice President of the Western Division with Integon Life Insurance Company from 1981 to 1987. From 1987 to 1990, he served as Regional Vice President of United Pacific Life Insurance Company. In 1990, he began work for Conseco\/Western National Life Insurance Company as Vice President Marketing until May, 1994.\nMs. Scheuer was a Management Consultant for Deloitte, Haskins & Sells from 1983-1984. From 1984-1988, she was Senior Financial Analyst with the Texas Public Utility Commission. From 1988 until August, 1992, she was the Fixed Income Portfolio Manager for the Texas Permanent School Fund.\nMr. Antonowich was Regional Vice President of Security Life of Denver Insurance Company from 1982 to 1991. From 1991 to December, 1993, he was Vice President, Marketing, of Guarantee Mutual Life Company, and from 1994 to June, 1995, he was Senior Vice President, Sales, of Lamar Life Insurance Company.\nMr. Kasch was Staff Accountant with Arthur Young & Company from 1984-1985. From 1985 until January, 1991, he was Senior Accountant and Audit Manager for KPMG Peat Marwick.\nMr. Payne was staff attorney with the Kansas Insurance Department from 1972 to 1975. From 1975-1983, he was Vice President, Secretary & General Counsel for Lone Star Life Insurance Company; from 1983-1990, he was Vice President, Secretary and General Counsel for Reserve Life Insurance Company; from 1990-1991 he was President and CEO of Great Republic Insurance Company; and from 1991-1993 he was Vice President - Government Relations for United American Insurance Company. From 1993 until October, 1994, he was in private practice in Dallas, Texas.\nMr. Steger was Assistant Vice President-Chief Underwriter of Tower Life, San Antonio, Texas from 1971 until December, 1991.\n(f) Involvement in Certain Legal Proceedings\nThere are no events pending, or during the last five years, under any bankruptcy act, criminal proceedings, judgments, or injunctions material to the evaluation of the ability and integrity of any director or executive officer except as described below:\nIn January, 1994, a United States District Court Judge vacated and withdrew the judgment which had been entered in Case No. H-86-4269, W. Steve Smith, Trustee vs. Shearn Moody, Jr., et al, United States District Court for the Southern District of Texas. The Judge also dismissed the case with prejudice. The judgment had been entered against Robert L. Moody and The Moody National Bank of Galveston, of which he was Chairman of the Board. Robert L. Moody is also Chairman of the Board of National Western Life Insurance Company. The case arose out of complex bankruptcy and related proceedings involving Robert L. Moody's brother, Shearn Moody, Jr. Subsequently, a global settlement of Shearn Moody, Jr.'s bankruptcy and related legal proceedings was reached and executed. As part of the global settlement, the Bankruptcy Trustee recommended, and other interested parties agreed not to oppose or object to, the Judge's vacating and withdrawing the judgment and dismissing the case with prejudice. This case and settlement did not involve the Company and had no effect on its financial statements.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n(b) Summary Compensation Table\nNotes to Summary Compensation Table:\n(A) Salary includes directors' fees from National Western Life Insurance Company and its subsidiaries.\n(B) Bonuses include the following:\n(1) Stock Bonus Plan - During 1993 the Company implemented a one-time stock bonus plan for all officers of the Company. Class A common stock restricted shares totaling 13,496 were granted to officers based on their individual performance and contribution to the Company. The shares are subject to vesting requirements as reflected in the following schedule:\nThe resulting compensation from the vesting of shares has been included in the applicable year in the bonus column. All of the 13,496 shares that were granted have been issued and are outstanding as of December 31, 1995.\n(2) Westcap Bonuses - Ross R. Moody and Charles D. Milos, Jr., are directors of the Company's brokerage subsidiary, The Westcap Corporation. The directors received bonuses for such services in 1993.\n(3) Other Bonuses - Employment and performance related bonuses are occasionally granted. Arthur W. Pickering received such bonuses in 1995 and 1994 and Robert L. Busby, III received such bonuses in 1994.\n(C) Restricted stock awards include common stock shares that were granted as part of the stock bonus plan described in (1) above but had not vested as of December 31, 1993. Restricted stock holdings at December 31, 1993, for all officers totaled 6,666 shares with a market value of $296,637. Restricted stock holdings for the named executive officers were as follows at December 31, 1993:\nOf the remaining 6,666 unvested shares at December 31, 1993, 3,146 and 3,520 of such shares vested on December 31, 1995 and 1994, respectively, and are reflected as bonuses in those years.\n(D) Represents stock options granted under the National Western Life Insurance Company 1995 Stock and Incentive Plan.\n(E) All other compensation includes primarily employer contributions made to the Company's 401(k) Plan and Non-Qualified Deferred Compensation Plan on behalf of the employee.\n(c) Option\/SAR Grants Table\nDuring 1995 the Company adopted the National Western Life Insurance Company 1995 Stock and Incentive Plan (the Plan). The Plan is effective as of April 21, 1995, and will terminate on April 20, 2005, unless terminated earlier by the Board of Directors. The number of shares of Class A, $1.00 par value, common stock which may be issued under the Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 300,000. These shares may be authorized and unissued shares or treasury shares.\nAll of the employees of the Company and its subsidiaries are eligible to participate in the Plan. In addition, directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Non-employee directors, including members of the Compensation and Stock Option Committee, are eligible for non-discretionary stock options. On May 19, 1995, the Committee approved the issuance of 52,500 non-qualified stock options to selected officers of the Company. The Committee also granted 7,000 non-qualified, non-discretionary stock options to non-employee Company directors. The stock options begin to vest following three full years of service to the Company after date of grant, with 20% of the options to vest at the beginning of the fourth year of service, and with 20% thereof to vest at the beginning of each of the next four years of service. The exercise price of the stock options was set at the fair market value of the common stock on the date of grant, May 19, 1995, which was $38.125 per share.\nStock options granted to the named executive officers during 1995 are as follows:\n(d) Aggregated Option\/SAR Exercises and Fiscal Year-End Option\/SAR Value Table\nNone.\n(e) Long-Term Incentive Plan Awards Table\nNone.\n(f) Defined Benefit or Actuarial Plan Disclosure\nThe Company currently has two employee defined benefit plans for the benefit of its employees and officers. A brief description and formulas by which benefits are determined for each of the plans are detailed as follows:\nQualified Defined Benefit Plan - This plan covers all full-time employees and officers of the Company and provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act.\nAnnual pension benefits for those employees who became eligible participants prior to January 1, 1991, are calculated as the sum of the following:\n(1) 50% of the participant's final 5-year average annual compensation at December 31, 1990, less 50% of their primary social security benefit determined at December 31, 1990; this net amount is then prorated for less than 15 years of benefit service at normal retirement date. This result is multiplied by a fraction which is the participant's years of benefit service at December 31, 1990, divided by the participant's years of benefit service at normal retirement date.\n(2) 1.5% of the participant's compensation earned during each year of benefit service after December 31, 1990.\nAnnual pension benefits for those employees who become eligible participants on or subsequent to January 1, 1991, are calculated as 1.5% of their compensation earned during each year of benefit service.\nNon-Qualified Defined Benefit Plan - This plan covers those officers in the position of senior vice president or above and other employees who have been designated by the President of the Company as being in the class of persons who are eligible to participate in the plan. This plan also provides benefits based on the participants' years of service and compensation. However, no minimum funding standards are required.\nThe benefit to be paid pursuant to this Plan to a Participant who retires at his normal retirement date shall be equal to (a) less (b) less (c) where:\n(a) is the benefit which would have been payable at the participant's normal retirement date under the terms of the Qualified Defined Benefit Plan as of December 31, 1990, as if that Plan had continued without change, and,\n(b) is the benefit which actually becomes payable under the terms of the Qualified Defined Benefit Plan at the participant's normal retirement date, and,\n(c) is the actuarially equivalent life annuity which may be provided by an accumulation of 2% of the participant's compensation for each year of service on or after January 1, 1991, accumulated at an assumed interest rate of 8.5% to his normal retirement date.\nIn no event will the benefit be greater than the benefit which would have been payable at normal retirement date under the terms of the Qualified Defined Benefit Plan as of December 31, 1990, as if that plan had continued without change.\nThe estimated annual benefits payable to the named executive officers upon retirement, at normal retirement age, for the Company's defined benefit plans are as follows:\n(g) Compensation of Directors\nAll directors of the Company currently receive $12,000 a year and $500 for each board meeting attended. They are also reimbursed for actual travel expenses incurred in performing services as directors. An additional $500 is paid for each committee meeting attended. However, a director attending multiple meetings on the same day receives only one meeting fee. The amounts paid pursuant to these arrangements are included in the summary compensation table under Item 11(b). The directors and their dependents are also insured under the Company's group insurance program.\nDuring 1995 the Company adopted the National Western Life Insurance Company 1995 Stock and Incentive Plan ( the Plan), as more fully described in Item 11(c). Directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Non-employee directors, including members of the Compensation and Stock Option Committee, are eligible for non-discretionary stock options. On May 19, 1995, the Committee approved the issuance of 7,000 non-qualified, non-discretionary stock options to non-employee Company directors, with each such director receiving 1,000 stock options. Directors who are also employees of the Company were granted stock options as disclosed in the table in Item 11(c).\nDirectors of the Company's subsidiary, NWL Investments, Inc., receive $250 annually. Directors' fees for the Company's subsidiary, The Westcap Corporation, have been suspended indefinitely. No fees were paid in 1995.\n(h) Employment Contracts and Termination of Employment and Change-in-Control Arrangements\nNone.\n(i) Report on Repricing of Options\/SARs\nNone.\n(j) Compensation Committee Interlocks and Insider Participation\nThe Company's Board of Directors determines and approves executive compensation. Mr. Robert Moody, Mr. Ross Moody, and Mr. Milos serve as directors and also serve as officers and employees of the Company. The Donner Company, 100% owned by Mr. Dummer, who is a director of National Western Life Insurance Company, was paid $60,474 in 1995 pursuant to an agreement between The Donner Company and a reinsurance intermediary relating to a reinsurance contract between the Company and certain life insurance reinsurers. No compensation committee interlocks exist with other unaffiliated companies.\n(k) Board Compensation Committee Report on Executive Compensation\nThe Company's Board of Directors performs the functions of an executive compensation committee. The Board is responsible for developing and administering the policies that determine executive compensation.\nExecutive compensation, including that of the chief executive officer, is comprised primarily of a base salary. The salary is adjusted annually based on a performance review of the individual as well as the performance of the Company as a whole. The president and chief executive officer make recommendations annually to the Board of Directors regarding such salary adjustments. The review encompasses the following factors:\n- - contributions to the Company's short and long-term strategic goals, including financial goals such as Company revenues and earnings\n- - achievement of specific goals within the individual's realm of responsibility\n- - development of management and employees within the Company\n- - performance of leadership within the industry\nThe policies discussed above are reviewed periodically by the Board of Directors to ensure the support of the Company's overall business strategy and to attract and retain key executives.\nA separate Compensation and Stock Option Committee, comprised of outside, independent directors, determines compensation for the three highest paid Company executives. The committee also performs various projects relating to executive compensaion at the request of the Board of Directors. Those directors serving on the committee include the following:\nArthur O. Dummer Harry L. Edwards E. J. Pederson\nThe policies used by the Compensation and Stock Option Committee in determining compensation are similar to those described above for all other Company executives.\n(1) Performance Graph\nThe following graph compares the change in the Company's cumulative total stockholder return on its common stock with the NASDAQ - U.S. Companies Index and the NASDAQ Insurance Stock Index. The graph assumes that the value of the investment in the Company's common stock and each index was $100 at December 31, 1990, and that all dividends were reinvested.\nFor the purpose of this electronic filing, the graph has been filed separately under the Securities and Exchange Commission filing Form SE dated March 29, 1996. The coordinates of the graph are as follows:\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners\nSet forth below is certain financial information concerning persons who are known by the Company to own beneficially more than 5% of any class of the Company's common stock on December 31, 1995:\n(b) Security Ownership of Management\nThe following table sets forth as of December 31, 1995, information concerning the beneficial ownership of the Company's common stock by all directors, named officers, and all directors and officers of the Company as a group:\n(c) Changes in Control\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Transactions with Management and Others\nThe Donner Company, 100% owned by Mr. Arthur Dummer, who is a director of National Western Life Insurance Company, was paid $60,474 in 1995 pursuant to an agreement between The Donner Company and a reinsurance intermediary relating to a reinsurance contract between the Company and certain life insurance reinsurers.\n(b) Certain Business Relationships\nNone.\n(c) Indebtedness of Management\nSeal Fleet, Inc.\nThe Company holds a corporate note for $500,000 which was originally issued by Oceanographic and Seismic Services, Inc. (Oceanographic). Oceanographic was later merged into Seal Fleet, Inc. The original note was renewed in 1976 and is a 20-year debenture due in August, 1996, with interest of 8% annually.\nThe Company also holds a corporate note for $2,168,232 issued in 1990 by Seal (GP), Inc., which is a subsidiary of Seal Fleet, Inc. The note is due in June, 2000, with interest of 12% payable monthly and is secured by first preferred ship mortgages. The note was modified during 1992 reducing the interest rate from 12% to 10%. However, the additional 2% interest will be payable upon maturity of the note.\nSeal Fleet, Inc., has two classes of stock outstanding, Class A and B. The Class B shares elect a majority of the Board of Directors of Seal Fleet, Inc. All of the Class B shares and 212,655 (9%) of the Class A shares of Seal Fleet, Inc., are owned by the Three R Trust, Galveston, Texas. This Trust was created by Robert L. Moody as Settlor for the benefit of his children. Three of his children, Mr. Ross R. Moody, Mr. Russell S. Moody, and Ms. Frances A. Moody are beneficiaries of the Three R Trust and are also directors of National Western Life Insurance Company. The Trustee of the Trust is Irwin M. Herz, Jr., of Galveston, Texas. Mr. Herz personally owns 10,932 (.5%) shares of the Class A stock of Seal Fleet, Inc. Mr. Herz is a lawyer representing the Company, Mr. Moody, and several of Mr. Moody's affiliated interests. Through its Trustee, Mr. Herz, the Three R Trust is considered to be the controlling stockholder of Seal Fleet, Inc. Louis Pauls, Jr., and Russell S. Moody, directors of the Company, are also directors of Seal Fleet, Inc.\nSeal Fleet, Inc., and its subsidiaries own, operate, or lease supply and equipment boats for off-shore oil and gas well drilling rigs. The consolidated audited financial statements of Seal Fleet, Inc., and its subsidiaries for the fiscal year ending December 31, 1995, reflected total assets of $10,394,000, net losses of $116,000, and negative stockholders' equity of $3,621,000.\nGal-Tex Hotel Corporation\nThe Company also holds three mortgage loans issued to Gal-Tex Hotel Corporation, which is owned 50% by the Libbie Shearn Moody Trust and 50% by The Moody Foundation. The first mortgage loan in the amount of $3,040,000 was issued in 1988, will mature in May of 1998, and pays interest of 10.5%. The loan is secured by property consisting of a hotel located in Kingsport, Tennessee. The second mortgage loan in the amount of $8,796,000 was issued in 1994, will mature in October of 2004, and pays interest of 8.75%. The loan is secured by property consisting of a hotel located in Houston, Texas. The third mortgage loan in the amount of $2,000,000 was issued in 1995, will mature in January of 2006, and pays interest of 9%. The loan is secured by property consisting of a hotel located in Woodstock, Virginia.\nThe Company is the beneficial owner of a life interest (1\/8 share), previously owned by Mr. Robert L. Moody, in the trust estate of Libbie Shearn Moody. The trustee of this estate is The Moody National Bank of Galveston. The Moody Foundation is a private charitable foundation governed by a Board of Trustees of three members. Mr. Robert L. Moody and Mr. Ross R. Moody are members of the Board of Trustees.\n(d) Transactions with Promoters\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\nSee Attachment A, Index to Financial Statements and Schedules, on page ______ for a list of financial statements included in this report.\n(a) 2. Listing of Financial Statement Schedules\nSee Attachment A, Index to Financial Statements and Schedules, on page ____ for a list of financial statement schedules included in this report.\nAll other schedules are omitted because they are not applicable, not required or because the information required by the schedule is included elsewhere in the financial statements or notes.\n(a) 3. Listing of Exhibits\nExhibit 3(a) - Restated Articles of Incorporation of National Western Life Insurance Company dated April 10, 1968 (filed on page _____ of this report).\nExhibit 3(b) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated July 29, 1971 (filed on page ____ of this report).\nExhibit 3(c) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated May 10, 1976 (filed on page ____ of this report).\nExhibit 3(d) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated April 28, 1978 (filed on page ____ of this report).\nExhibit 3(e) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated May 1, 1979 (filed on page ____ of this report).\nExhibit 3(f) - Bylaws of National Western Life Insurance Company as amended through April 24, 1987 (filed on page ____ of this report).\nExhibit 10(a) - National Western Life Insurance Company Non-Qualified Defined Benefit Plan dated July 26, 1991 (filed on page ____ of this report).\nExhibit 10(b) - National Western Life Insurance Company Officers' Stock Bonus Plan effective December 31, 1992 (incorporated by reference to the Company's Form S-8 registration dated January 27, 1994).\nExhibit 10(c) - National Western Life Insurance Company Non-Qualified Deferred Compensation Plan, as amended and restated, dated March 27, 1995 (filed on Page _____ of this report).\nExhibit 10(d) - First Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective July 1, 1995 (filed on page _____ of this report).\nExhibit 10(e) - National Western Life Insurance Company 1995 Stock and Incentive Plan (filed on page _____ of this report).\nExhibit 21 - Subsidiaries of the Registrant (filed on page _____ of this report).\nExhibit 27 - Financial Data Schedule (filed electronically pursuant to Regulation S-K).\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\nExhibits required by Regulation S-K are listed as to location in the Listing of Exhibits in Item 14(a)3 above. Exhibits not referred to have been omitted as inapplicable or not required.\n(d) Financial Statement Schedules\nThe financial statement schedules required by Regulation S-K are listed as to location in Attachment A, Index to Financial Statements and Schedules, on page ____ of this report.\nATTACHMENT A\nIndex to Financial Statements and Schedules\nPage\nIndependent Auditors' Report\nConsolidated Balance Sheets, December 31, 1995 and 1994\nConsolidated Statements of Earnings 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\nSchedule I - Summary of Investments Other Than Investments in Related Parties, December 31, 1995\nSchedule V - Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994, and 1993\nAll other schedules are omitted because they are not applicable, not required or because the information required by the schedule is included elsewhere in the financial statements or notes.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders National Western Life Insurance Company Austin, Texas\nWe have audited the consolidated financial statements of National Western Life Insurance Company and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Western 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 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 3, the Company changed its method of accounting for investments in debt and equity securities in 1994 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As discussed in Note 5, the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of SFAS No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick LLP\nAustin, Texas March 1, 1996\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (In thousands)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (In thousands except per share amounts)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS For the Years Ended December 31, 1995, 1994, and 1993 (In thousands except per share amounts)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS, CONTINUED For the Years Ended December 31, 1995, 1994, and 1993 (In thousands except per share amounts)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994, and 1993 (In thousands)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994, and 1993 (In thousands)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED For the Years Ended December 31, 1995, 1994, and 1993 (In thousands)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) Principles of Consolidation - The accompanying consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly owned subsidiaries (the Company), The Westcap Corporation, NWL Investments, Inc., NWL Properties, Inc., NWL 806 Main, Inc., and Commercial Adjusters, Inc. Commercial Adjusters, Inc., was dissolved in October, 1994, and all remaining assets and liabilities were assumed by National Western Life Insurance Company. The Westcap Corporation ceased brokerage operations during 1995 and, as a result, is reflected as discontinued operations in the accompanying financial statements. All significant intercorporate transactions and accounts have been eliminated in consolidation.\n(B) Basis of Presentation - The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates included in the accompanying financial statements include (1) contingent liabilities related to litigation, (2) recoverability of deferred policy acquisition costs, (3) estimated losses related to discontinued operations, and (4) valuation allowances for mortgage loans.\nNational Western Life Insurance Company also files financial statements with insurance regulatory authorities which are prepared on the basis of statutory accounting practices which are significantly different from financial statements prepared in accordance with generally accepted accounting principles. These differences are described in detail in the statutory information section of this note.\n(C) Investments - Investments in debt securities the Company purchases with the intent to hold to maturity are classified as securities held to maturity. The Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary.\nInvestments in debt and equity securities that are not classified as securities held to maturity are reported as securities available for sale. Securities available for sale are reported in the accompanying financial statements at individual fair value. Any valuation changes resulting from changes in the fair value of the securities are reflected as a component of stockholders' equity. These unrealized gains or losses in stockholders' equity are reported net of taxes and adjustments to deferred policy acquisition costs.\nTransfers of securities between categories are recorded at fair value at the date of transfer. Unrealized holding gains or losses associated with transfers of securities held to maturity to securities available for sale are recorded as a separate component of stockholders' equity. The unrealized holding gains or losses included as a separate component of equity for securities transferred from available for sale to held to maturity are maintained and amortized into earnings over the remaining life of the security as an adjustment to yield in a manner consistent with the amortization or accretion of premium or discount on the associated security.\nPremiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Realized gains and losses for securities available for sale and securities held to maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold. For securities available for sale or securities held to maturity, a decline in the fair value below cost that is deemed other than temporary is charged to earnings, resulting in the establishment of a new cost basis for the security.\nMortgage loans and other long-term investments are stated at cost, less unamortized discounts and allowances for possible losses. Policy loans are stated at their aggregate unpaid balances. Real estate acquired by foreclosure is stated at the lower of cost or fair value less estimated costs to sell.\n(D) Cash Equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with a maturity at date of purchase of three months or less to be cash equivalents.\n(E) Insurance Revenues and Expenses - Premiums on traditional life insurance products are recognized as revenues as they become due or, for short duration contracts, over the contract periods. Benefits and expenses are matched with premiums in arriving at profits by providing for policy benefits over the lives of the policies and by amortizing acquisition costs over the premium-paying periods of the policies. For universal life and investment annuity contracts, revenues consist of policy charges for the cost of insurance, policy administration, and surrender charges assessed during the period. Expenses for these policies include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. The related deferred policy acquisition costs are amortized in relation to the present value of expected gross profits on the policies.\n(F) Federal Income Taxes - Federal income taxes are accounted for under the asset and liability method. 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 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. A valuation allowance for deferred tax assets is provided if all or some portion of the deferred tax asset may not be realized. An increase or decrease in a valuation allowance that results from a change in circumstances that affects the realizability of the related deferred tax asset is included in income.\n(G) Depreciation of Property, Equipment, and Leasehold Improvements - Depreciation is based on the estimated useful lives of the assets and is calculated on the straight-line and accelerated methods. Leasehold improvements are amortized over the lesser of the economic useful life of the improvement or the term of the lease.\n(H) Earnings Per Share - Earnings per share of common stock are based on the weighted average number of such shares outstanding during each year. The weighted average shares outstanding were 3,488,205 and 3,484,682, and 3,481,233 for the years ended December 31, 1995, 1994, and 1993, respectively.\n(I) Classification - Certain reclassifications have been made to the prior years to conform to the reporting categories used in 1995. The most significant of these reclassifications relate to The Westcap Corporation and its discontinued brokerage operations. All assets, liabilities, results of operations, and cash flows of The Westcap Corporation for 1994 and 1993 have been reclassified and reported separately as discontinued operations in the accompanying financial statements.\n(J) Statutory Information - National Western Life Insurance Company, domiciled in Colorado, prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the Colorado Division of Insurance. 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. 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 will likely change, to some extent, prescribed statutory accounting practices and may result in changes to the accounting practices that insurance companies use to prepare their statutory financial statements. The following are major differences between generally accepted accounting principles and prescribed or permitted statutory accounting practices.\n1. The Company accounts for universal life and investment annuity contracts based on the provisions of Statement of Financial Accounting Standards (SFAS) No. 97, \"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.\" The basic effect of the statement with respect to certain long-duration contracts is that deposits for universal life and investment annuity contracts are not reflected as revenues, and surrenders and certain other benefit payments are not reflected as expenses. However, statutory accounting practices do reflect such items as revenues and expenses.\n2. Commissions and certain expenses related to policy issuance and underwriting, all of which generally vary with and are related to the production of new business, have been deferred. For traditional products, these costs are being amortized over the premium-paying period of the related policies in proportion to the ratio of the premium earned to the total premium revenue anticipated, using the same assumptions as to interest, mortality, and withdrawals as were used in calculating the liability for future policy benefits. For universal life and investment annuity contracts, these costs are amortized in relation to the present value of expected gross profits on these policies. The Company evaluates the recoverability of deferred policy acquisition costs on an annual basis. In this evaluation, the Company considers estimated future gross profits or future premiums, as applicable for the type of contract. The Company also considers expected mortality, interest earned and credited rates, persistency, and expenses. Statutory accounting practices require commissions and related costs to be expensed as incurred.\nA summary of information relative to deferred policy acquisition costs and premiums and deposits follows:\n3. Under generally accepted accounting principles, the liability for future policy benefits on traditional products has been calculated by the net level method using assumptions as to future mortality (based on the 1965-1970 and 1975-1980 Select and Ultimate mortality tables), interest ranging from 4% to 8%, and withdrawals based on Company experience. For universal life and investment annuity contracts, the liability for future policy benefits represents the account balance.\n4. Deferred Federal income taxes are provided for temporary differences which are recognized in the financial statements in a different period than for Federal income tax purposes. Deferred taxes are not recognized in statutory accounting practices. Also, for statutory accounting purposes, the Company has recorded Federal income tax receivables as permitted by the Colorado Division of Insurance. The Federal income tax receivables related to subsidiary losses have been recorded directly to surplus and were not recorded in results of operations. Prescribed statutory accounting practices do not address the accounting for tax receivables.\n5. For statutory accounting purposes, debt securities are recorded at amortized cost, except for securities in or near default which are reported at market value.\n6. Investments in subsidiaries are recorded at admitted asset value for statutory purposes, whereas the financial statements of the subsidiaries have been consolidated with those of the Company under generally accepted accounting principles.\n7. The asset valuation reserve and interest maintenance reserve, which are investment valuation reserves prescribed by statutory accounting practices, have been eliminated, as they are not required under generally accepted accounting principles.\n8. The recorded value of the life interest in the Libbie Shearn Moody Trust (the Trust) is reported at its initial valuation, net of accumulated amortization. The initial valuation was based on the assumption that the Trust would provide certain income to the Company at an assumed interest rate and is being amortized over 53 years, the life expectancy of Mr. Robert L. Moody at the date he contributed the life interest to the Company. For statutory accounting purposes, the life interest has been valued at $26,400,000, which was computed as the present value of the estimated future income to be received from the Trust. However, this amount is being amortized to a valuation of $12,774,000 over a seven-year period in accordance with Colorado Division of Insurance permitted accounting requirements. Prescribed statutory accounting practices provide no accounting guidance for such asset. The statutory admitted value of this life interest at December 31, 1995, is $20,561,000 in comparison to a carrying value of $5,206,000 in the accompanying consolidated financial statements.\nReconciliations of statutory stockholders' equity, as included in the annual statements filed with the Colorado Division of Insurance, to the respective amounts as reported in the accompanying consolidated financial statements prepared under generally accepted accounting principles are as follows:\nReconciliations of statutory net earnings, as included in the annual statements filed with the Colorado Division of Insurance, to the respective amounts as reported in the accompanying consolidated financial statements prepared under generally accepted accounting principles are as follows:\n(2) DEPOSITS WITH REGULATORY AUTHORITIES\nThe following assets were on deposit with state and other regulatory authorities as required by law at the end of each year:\n(3) INVESTMENTS\n(A) Investment Income\nThe major components of net investment income are as follows:\nInvestments of the following amounts were non-income producing for the preceding twelve months:\nAs of December 31, 1995 and 1994, investments in debt securities and mortgage loans with principal balances totaling $3,778,000 and $8,314,000 were on non-accrual status. During 1995, 1994, and 1993, reductions in interest income associated with non-performing investments in debt securities and mortgage loans were as follows:\n(B) Investment Concentrations\nConcentrations of credit risk arising from mortgage loans exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Company does not have a significant exposure to any individual customer or counterparty. The major concentrations of mortgage loan credit risk for the Company arise by geographic location in the United States and by property type as detailed below.\nThe Company held in its investment portfolio below investment grade debt securities totaling $14,244,000 and $31,861,000 at December 31, 1995 and 1994, respectively. This represents approximately 0.5% and 1.4% of total invested assets. These below investment grade debt securities often have common characteristics in that they are usually unsecured and are often subordinated to other creditors of the borrower or issuer. Additionally, the issuers of the below investment grade debt securities usually have high levels of indebtedness and are more sensitive to adverse economic conditions.\nAt December 31, 1995 and 1994, the Company held $4,966,000 and $8,948,000 of residual interests in collateralized mortgage obligations (CMOs) in its investment portfolio. Investments in residual interests of CMOs are securities that entitle the Company to the excess cash flows arising from the difference between the cash flows required to make principal and interest payments on the related CMOs and the actual cash flows received on the underlying U.S. agency collateral included in the CMO portfolios. Total cash flows to be received by the Company from the residual interests could differ from the projected cash flows resulting in changes in yield or losses if prepayments vary from projections on the collateral underlying the CMOs.\nAt December 31, 1995 and 1994, the Company had real estate totaling $19,066,000 and $17,766,000, net of estimated selling costs, which is reflected in other long-term investments in the accompanying financial statements.\nThe Company had no investments in any entity, except for U.S. government agency securities, in excess of 10% of stockholders' equity at December 31, 1995.\n(C) Investment Gains and Losses\nThe table below presents realized gains and losses and increases or decreases in unrealized gains on investments:\nThe tables below present amortized cost and fair values of securities held to maturity and securities available for sale at December 31, 1995:\nThe tables below present amortized cost and fair values of securities held to maturity and securities available for sale at December 31, 1994:\nThe amortized cost and fair values of investments in debt securities 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.\nProceeds from sales of securities available for sale during 1995 and 1994 totaled $44,440,000 and $9,114,000, respectively. Gross gains of $1,153,000 and $654,000 and gross losses of $3,752,000 and $1,535,000 were realized on those sales during 1995 and 1994, respectively. Proceeds from sales of investments in debt securities during 1993 were $77,869,000. Gross gains of $12,966,000 and gross losses of $1,283,000 were realized on those sales, respectively. The Company uses the specific identification method in computing realized gains and losses.\nThe Company sold three held to maturity securities during 1995 due to significant credit deterioration of the issuing companies. Amortized cost of the securities sold totaled $10,727,000, and realized losses of $68,000 were recognized on the sales.\n(D) Changes in Accounting Principles\nIn May, 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities as previously described in note 1. The Company adopted SFAS No. 115 effective January 1, 1994. Upon adoption, approximately 60% of the Company's insurance operations debt securities were reported as securities available for sale, with the remainder classified as securities held to maturity. The Company's relatively small holdings of equity securities were also reported as securities available for sale.\nUpon adoption of the new statement, certain related balance sheet accounts, deferred Federal income taxes payable and deferred policy acquisition costs, were adjusted as if the unrealized gains on the securities classified as available for sale had actually been realized. For the Company's universal life and investment annuity contracts, deferred policy acquisition costs are amortized in relation to the present value of expected gross profits on these policies. Accordingly, under SFAS No. 115, deferred policy acquisition costs are adjusted for the impact on estimated gross profits of net unrealized gains and losses on securities. The implementation of the new statement had no effect on net earnings of the Company. However, stockholders' equity was adjusted as follows as of January 1, 1994:\nAt July 31, 1994, the Company transferred debt securities with fair values totaling $805 million from securities available for sale to securities held to maturity. On December 29, 1995, the Company made additional transfers totaling $156 million to the held to maturity category from securities available for sale. The lower holdings of securities available for sale significantly reduces the Company's exposure to equity volatility while still providing securities for liquidity and asset\/liability management purposes. The transfers of securities were recorded at fair values in accordance with SFAS No. 115. This statement requires that the unrealized holding gain or loss at the date of the transfer continue to be reported in a separate component of stockholders' equity but shall be amortized over the remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount. The amortization of an unrealized holding gain or loss reported in equity will offset or mitigate the effect on interest income of the amortization of the premium or discount for the held-to-maturity securities. The transfer of securities from available for sale to held to maturity had no effect on net earnings of the Company. However, stockholders' equity was adjusted as follows:\nAlso on December 29, 1995, the Company transferred securities totaling $284 million to the available for sale category from securities held to maturity. This transfer resulted in an increase to stockholder's equity of $4,266,000 as of December 31, 1995, net of effects of deferred policy acquisition costs and taxes. This transfer was made to restructure the Company's portfolio to provide increased flexibility for both portfolio and asset\/liability management. Accounting principles typically do not allow transfers from the held to maturity category to the available for sale category except under certain prescribed circumstances. However, in 1995 the Financial Accounting Standards Board permitted a one-time reassessment by companies of their securities classifications and allowed transfers out of the held to maturity category without regard to the prescribed circumstances. The reassessment and any resulting transfers had to be completed by December 31, 1995.\nNet unrealized gains (losses) on investment securities included in stockholders' equity at December 31, 1995 and 1994 are as follows:\nThe Financial Accounting Standards Board (FASB) issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" in May, 1993. In October, 1994, the FASB also issued SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" which amends SFAS No. 114. These statements address the accounting by creditors for impairment of certain loans and related financial statement disclosures.\nThe Company adopted both SFAS No. 114 and No. 118 effective January 1, 1995. As the Company was already providing for impairment of loans through an allowance for possible losses, the implementation of this statement had no significant effect on the Company's results of operations or stockholders' equity. However, additional disclosures are required by these statements which are provided below.\nAs of December 31, 1995 and 1994, impaired mortgage loans were as follows:\nFor the years ended December 31, 1995 and 1994, average investments in impaired mortgage loans were $234,000 and $997,000, respectively. Interest income recognized on impaired loans during the years ended December 31, 1995 and 1994, was not significant. Impaired loans are typically placed on non-accrual status and no interest income is recognized. However, if cash is received on the impaired loan, it is applied to principal and interest on past due payments, beginning with the most delinquent payment. Detailed below are the changes in the allowance for mortgage loan losses for the years ended December 31, 1995 and 1994.\nIn March, 1995, the FASB issued SFAS No. 121, \"Accounting for 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. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. 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 costs to sell.\nThe Company's real estate investments are the only significant assets that will be subject to this statement. As the Company already records foreclosed real estate at the lower of cost or fair value less estimated costs to sell, the implementation of this statement will not have a significant effect on the Company's financial statements. The statement will be implemented in the first quarter of 1996.\n(4) REINSURANCE\nThe Company is party to several reinsurance agreements. The Company's general policy is to reinsure that portion of any risk in excess of $150,000 on the life of any one individual. Total life insurance in force was $7.94 billion and $7.71 billion at December 31, 1995 and 1994, respectively. Of these amounts, life insurance in force totaling $1.27 billion and $1.05 billion was ceded to reinsurance companies, primarily on a yearly renewable term basis, at December 31, 1995 and 1994, respectively.\nIn accordance with the reinsurance contracts, reinsurance receivables including amounts related to claims incurred but not reported and liabilities for future policy benefits totaled $5,646,000 and $6,480,000 at December 31, 1995 and 1994, respectively. Premium revenues were reduced by $7,420,000, $6,040,000, and $7,450,000 for reinsurance premiums incurred during 1995, 1994, and 1993, respectively. Benefit expenses were reduced by $5,812,000, $3,295,000, and $6,943,000 for reinsurance recoveries during 1995, 1994, and 1993, respectively. A contingent liability exists with respect to reinsurance, as the Company remains liable if the reinsurance companies are unable to meet their obligations under the existing agreements.\n(5) FEDERAL INCOME TAXES\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which requires an asset and liability method of accounting. The cumulative effect of this change in accounting for income taxes of $5,520,000 was determined as of January 1, 1993, and is reported separately in the consolidated statement of earnings for the year ended December 31, 1993.\nTotal Federal income taxes were allocated as follows:\nThe provisions for Federal income taxes attributable to income from continuing operations vary from amounts computed by applying the statutory income tax rate to earnings before Federal income taxes. The reasons for the differences, and the tax effects thereof, are as follows:\nThe significant components of deferred income tax expense (benefit) attributable to earnings from continuing operations for the years ended December 31, 1995, 1994, and 1993, are 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, 1994, and 1993, are presented below:\nThere was no valuation allowance for deferred tax assets at December 31, 1995 and 1994. 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. 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 that the Company will realize the benefits of these deductible differences.\nPrior to the Tax Reform Act of 1984 (1984 Act), a portion of a life insurance company's income was not subject to tax until it was distributed to stockholders, at which time it was taxed at the regular corporate tax rate. In accordance with the 1984 Act, this income, referred to as policyholders' surplus, would not increase, yet any amounts distributed would be taxable at the regular corporate rate. The balance of this account as of December 31, 1995, is approximately $2,446,000. No provision for income taxes has been made on this untaxed income, as management is of the opinion that no distribution to stockholders will be made from policyholders' surplus in the foreseeable future. Should the balance in the policyholders' surplus account at December 31, 1995, become taxable, the Federal income taxes computed at present rates would be approximately $856,000.\nThe Company files a consolidated Federal income tax return with its subsidiaries. Allocation of the consolidated tax liability is based on separate return calculations pursuant to the \"wait-and-see\" method as described in sections 1.1552-1(a)(2) and 1.1502-33(d)(2)(i) of the current Treasury Regulations. Under this method, consolidated group members are not given current credit for net losses until future net taxable income is generated to realize such credits. In accordance with this consolidated tax sharing agreement, tax benefits resulting from discontinued brokerage operation losses totaling $5,669,000 and $2,864,000 for 1995 and 1994 were included in earnings from continuing operations.\n(6) TRANSACTIONS WITH CONTROLLING STOCKHOLDER AND AFFILIATES\n(A) Life Interest in Libbie Shearn Moody Trust\nThe Company is the beneficial owner of a life interest (1\/8 share), in the trust estate of Libbie Shearn Moody which was previously owned by Mr. Robert L. Moody, Chairman of the Board of Directors of the Company. The Company has issued term insurance policies on the life of Mr. Robert L. Moody which are reinsured through agreements with unaffiliated insurance companies. The Company is the beneficiary of these policies for an amount equal to the statutory admitted value of the Trust, which was $20,561,000 at December 31, 1995. The excess of $27,000,000 face amount of the reinsured policies over the statutory admitted value of the Trust has been assigned to Mr. Robert L. Moody. The recorded net asset values in the accompanying consolidated financial statements for the Company's life interest in the Trust are as follows:\nIncome from the Trust and related expenses reflected in the accompanying consolidated statements of earnings are summarized as follows:\n(B) Common Stock\nMr. Robert L. Moody, Chairman of the Board of Directors, owns 198,074 of the total outstanding shares of the Company's Class B common stock and 1,160,896 of the Class A common stock.\nHolders of the Company's Class A common stock elect one-third of the Board of Directors of the Company, and holders of the Class B common stock elect the remainder. Any cash or in-kind dividends paid on each share of Class B common stock shall be only one-half of the cash or in-kind dividends paid on each share of Class A common stock. Also, in the event of liquidation of the Company, the Class A stockholders shall first receive the par value of their shares; then the Class B stockholders shall receive the par value of their shares; and the remaining net assets of the Company shall be divided between the stockholders of both Class A and Class B common stock, based on the number of shares held.\n(7) PENSION PLANS\nThe Company has a qualified noncontributory pension plan covering substantially all full-time employees. The plan provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act. A summary of plan information is as follows:\nPension costs (credits) include the following components:\nThe following sets forth the plan's funded status and related amounts recognized in the Company's balance sheet as of:\nThe discount rate used in determining the actuarial present value of the projected benefit obligations was 7.0% for 1995 and 8.75% for 1994. The projected increase in future compensation levels was based on a rate of 5.0% and 6.0% for 1995 and 1994, respectively. The projected long-term rate of return on plan assets was 8.5% for 1995 and 1994.\nThe Company also has a non-qualified defined benefit plan primarily for senior officers. The plan provides benefits based on the participants' years of service and compensation. No minimum funding standards are required. However, at the option of the Company, contributions may be funded into the National Western Life Insurance Company Non-Qualified Plans Trust. There are currently no plan assets in the trust. A summary of plan information is as follows:\nPension costs include the following components:\nThe following sets forth the plan's funded status and related amounts recognized in the Company's balance sheet as of:\nThe discount rate used in determining the actuarial present value of the projected benefit obligations was 7.0% for 1995 and 8.75% for 1994. The projected increase in future compensation levels was based on a rate of 5.0% and 6.0% for 1995 and 1994, respectively.\nIn addition to the defined benefit plans, the Company has a qualified 401(k) plan for substantially all full-time employees and a non-qualified deferred compensation plan primarily for senior officers. The Company makes annual contributions to the 401(k) plan of two percent of each employee's compensation. Additional Company matching contributions of up to two percent of each employee's compensation are also made each year based on the employee's personal level of salary deferrals to the plan. All Company contributions are subject to a vesting schedule based on the employee's years of service. For the years ended December 31, 1995 and 1994, Company contributions totaled $201,000 and $198,000.\nThe non-qualified deferred compensation plan was established to allow eligible employees to defer the payment of a percentage of their compensation and to provide for additional Company contributions. Company contributions are subject to a vesting schedule based on the employee's years of service. For the years ended December 31, 1995 and 1994, Company contributions totaled $55,000 and $45,000, respectively.\n(8) SHORT-TERM BORROWINGS\nThe Company has available a $60 million bank line of credit primarily for cash management purposes relating to investment transactions. The Company is required to maintain a collateral security deposit in trust with the bank equal to 120% of any outstanding liability. The Company had no outstanding liabilities or collateral security deposits with the bank at December 31, 1995 and 1994. The average interest rate on borrowings for the year ended December 31, 1994 was 4.45%. The Company had no borrowings on the line of credit during 1995.\n(9) COMMITMENTS AND CONTINGENCIES\n(A) Current Regulatory Issues\nIn December, 1995, the National Association of Insurance Commissioners adopted for statutory accounting practices Actuarial Guideline 33, previously referred to as Actuarial Guideline GGG. This reserve guideline, which has not been adopted by any states at this time, helps define the minimum reserves for policies with multiple benefit streams, such as two-tier annuities.\nAs of December 31, 1995, the Company's statutory reserving practices for two-tier annuities follow an agreement reached in 1993 with its state of domicile, Colorado. This agreement requires the Company to phase-in a different reserve basis by the end of 1996. The agreement states the acceptable difference between the target reserve and the statutory reserve held by the Company will meet the following schedule:\nThe Company has met the above scheduled difference for December 31, 1995. However, in 1995, the Company entered into discussions with the Colorado Division of Insurance (the Division) to implement Actuarial Guideline 33 and to phase it in over a three-year period as allowed by the guideline. In January, 1996, the Division approved the proposal for this three-year phase-in. The effect on the Company's statutory financial statements will not be significant, since the previous agreement with the Division was similar to the final guideline. Also, the guideline does not affect the Company's policy reserves which are prepared under generally accepted accounting principles as reported in the accompanying consolidated financial statements.\n(B) Legal Proceedings\nOn March 28, 1994, the Community College District No. 508, County of Cook and State of Illinois (The City Colleges) filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, against National Western Life Insurance Company (the Company) and subsidiaries of The Westcap Corporation. The suit seeks rescission of securities purchase transactions by The City Colleges from Westcap between September 9, 1993 and November 3, 1993, alleged compensatory damages, punitive damages, injunctive relief, declaratory relief, fees, and costs. National Western is named as a \"controlling person\" of the Westcap defendants. On February 1, 1995, the complaint was amended to add a RICO count for treble damages and claims under the Texas securities and consumer fraud laws, and to add additional defendants. Westcap and the Company are of the opinions that Westcap has adequate documentation to validate all such securities purchase transactions by The City Colleges, and that Westcap and the Company each have adequate defenses to the litigation. Although the alleged damages would be material to the Company's and Westcap's financial positions, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. A judicial ruling favorable to Westcap has been made requiring resolution of the suit against Westcap through binding arbitration. The lawsuit against the Company was suspended pending determination of the arbitration proceeding against Westcap. Arbitration proceedings are currently set to begin in August, 1996.\nOn February 1, 1995, the San Antonio River Authority (SARA) filed a complaint in the 285th Judicial District Court, Bexar County, Texas, against Kenneth William Katzen (Katzen), Westcap Securities, L.P., The Westcap Corporation (Westcap), and National Western Life Insurance Company (the Company). The suit alleges that Katzen and Westcap sold mortgage-backed security derivatives to SARA and misrepresented these securities to SARA. The suit alleges violations of the Federal Securities Act, Texas Securities Act, Deceptive Trade Practices Act, breach of fiduciary duty, fraud, negligence, breach of contract, and seeks attorney's fees. The Company is named as a \"controlling person\" of the Westcap defendants. Westcap and the Company are of the opinions that Westcap has adequate documentation to validate all securities purchases by SARA and that the Company and Westcap have adequate defenses to such suit. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company and Westcap have denied all allegations and the parties have initiated discovery. The case is set for trial on April 8, 1996.\nOn June 9, 1995, Charles McCutcheon, as Sheriff of Palm Beach County, Florida, served The Westcap Corporation, Westcap Securities, Inc., Westcap Government Securities, Inc., individual officers and directors of the Westcap entities, and National Western Life Insurance Company as defendants with a complaint filed in the U.S. District Court for the Southern District of Florida. The Complaint alleges that the Westcap entities improperly sold certain derivative securities to the Plaintiff and did not disclose the high risk of these securities to the Plaintiff, who suffered financial losses from the investments. The Company is sued as a \"controlling person\" of Westcap, and it is alleged that the Company is responsible and liable for the alleged wrongful conduct of Westcap. The suit seeks rescission of the investments, alleged damages, punitive and exemplary damages, attorneys' fees, and injunction. On October 13, 1995, the U.S. District Judge ordered arbitration of Plaintiff's claims against the Westcap entities and stayed all proceedings pending outcome of the arbitration. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company and Westcap deny the allegations and believe they each have adequate defenses to such suit.\nOn July 5, 1995, San Patricio County, Texas, filed suit in the District Court of San Patricio County, Texas, against National Western Life Insurance Company (the Company) and its chief executive officer, Robert L. Moody. The suit arises from derivative investments purchased by San Patricio County from Westcap Securities, L.P. or Westcap Government Securities, Inc., affiliates of The Westcap Corporation, a wholly owned subsidiary of the Company. The suit alleges that the Westcap affiliates were controlled by the Company and Mr. Moody and that they are responsible for the alleged wrongful acts of the Westcap affiliates in selling the securities to the Plaintiff. Plaintiff alleges that the Westcap affiliates violated duties and responsibilities owed to the Plaintiff related to its investment recommendations and the decisions made by Plaintiff, and alleges that the Plaintiff was financially damaged by such actions of Westcap. The suit seeks rescission of the investments and actual and punitive damages of unspecified amounts. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from this suit cannot be made at this time. The Company believes that it has adequate defenses to such suit and denies the allegations. The parties have initiated discovery.\nOn September 13, 1995, Michigan South Central Power Agency filed a complaint in The United States District Court for the Western District of Michigan against Westcap Securities Investment, Inc., Westcap Securities, L.P., Westcap Securities Management, Inc., The Westcap Corporation, National Western Life Insurance Company (the Company), and others. The suit alleges that salesmen of Westcap sold mortgage-backed securities to the Plaintiff and misrepresented these securities in violation of Federal and state securities laws and common law. The Company is named as a \"controlling person\" of the Westcap defendants. Westcap and the Company are of the opinions that they have adequate defenses to the suit. Although the alleged damages would be material to Westcap's financial condition, a reasonable estimate of any actual losses which may result from the suit cannot be made at this time. The Company and Westcap deny all allegations.\nThe Westcap Corporation and Westcap Securities, L.P. are also defendants in several other pending lawsuits which have arisen in the ordinary course of its business. Westcap Securities, L.P. has also been notified of several arbitration claims filed with the National Association of Securities Dealers. After reviewing the lawsuits and arbitration filings with outside counsel, management believes it has adequate defenses to each of the claims.\nAlthough the alleged damages for all of the above-described suits and arbitration claims would be material to the financial positions of the Company and The Westcap Corporation, a reasonable estimate of actual losses which may result from any of these claims cannot be made at this time. Accordingly, no provision for any liability that may result from these actions has been recognized in the consolidated financial statements.\nNational Western Life Insurance Company is also currently a defendant in several other lawsuits, substantially all of which are in the normal course of business. In the opinion of management, the liability, if any, which may rise from these lawsuits would not have a material adverse effect on the Company's financial condition. The Company settled several lawsuits during 1994 and 1993. Other income totaling $955,000 and $1,720,000 from these settlements has been reflected in the accompanying statements of earnings for the years ended December 31, 1994 and 1993, respectively.\n(C) Financial Instruments\nIn order to meet the financing needs of its customers in the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments are commitments to extend credit which involve elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet.\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 is represented by the contractual amounts, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company controls the credit risk of these transactions through credit approvals, limits, and monitoring procedures.\nThe Company had commitments to extend credit relating to mortgage loans totaling $211,000 at December 31, 1995. Commitments to extend credit are legally binding agreements to lend to a customer that generally have fixed expiration dates or other termination clauses and may require payment of a fee. These commitments do not necessarily represent future liquidity requirements, as some of the commitments could expire without being drawn upon. The Company evaluates each customer's creditworthiness on a case-by-case basis. The Company also had commitments to purchase investment securities totaling $4,710,000 at December 31, 1995.\n(D) Guaranty Association Assessments\nNational Western Life Insurance Company is subject to state guaranty association assessments in all states in which it is licensed to do business. These associations generally guarantee certain levels of benefits payable to resident policyholders of insolvent insurance companies. Many states allow premium tax credits for all or a portion of such assessments, thereby allowing potential recovery of these payments over a period of years. However, several states do not allow such credits.\nThe Company estimates its liabilities for guaranty association assessments by using the latest information available from the National Organization of Life and Health Insurance Guaranty Associations. The Company will continue to monitor and revise its estimates for assessments as additional information becomes available which could result in changes to the estimated liabilities. Other insurance operating expenses related to state guaranty association assessments totaled $2,371,000, $4,869,000, and $4,583,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\n(10) STOCKHOLDERS' EQUITY\n(A) Dividend Restrictions\nThe Company is restricted by state insurance laws as to dividend amounts which may be paid to stockholders without prior approval from the Colorado Division of Insurance. The restrictions are based on statutory earnings and surplus levels of the Company. The maximum dividend payment which may be made without prior approval in 1996 is $28,992,000. The Company has never paid cash dividends on its common stock, as it follows a policy of retaining any earnings in order to finance the development of business and to meet increased regulatory requirements for capital.\n(B) Regulatory Capital Requirements\nThe Colorado Division of Insurance imposes minimum risk-based capital requirements on insurance companies that were developed by the National Association of Insurance Commissioners (NAIC). The formulas for determining the amount of risk-based capital (RBC) specify various weighting factors that are applied to statutory 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 to its authorized control level RBC, 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 Company's current statutory capital and surplus is significantly in excess of the threshold RBC requirements.\n(C) Stock Bonus Plan\nDuring 1993 the Company implemented a one-time stock bonus plan for all officers of the Company. Class A common stock restricted shares totaling 13,496 were granted to officers based on their individual performance and contribution to the Company. The shares are subject to vesting requirements as reflected in the following schedule:\nAll of the 13,496 shares that were granted have been issued and are outstanding as of December 31, 1995.\n(D) Stock and Incentive Plan\nDuring 1995 the Company adopted the National Western Life Insurance Company 1995 Stock and Incentive Plan (the Plan). The Plan provides for the grant of any or all of the following types of awards to eligible employees: (1) stock options, including incentive stock options and non-qualified stock options; (2) stock appreciation rights, in tandem with stock options or freestanding; (3) restricted stock; (4) incentive awards; and (5) performance awards.\nThe Plan is effective as of April 21, 1995, and will terminate on April 20, 2005, unless terminated earlier by the Board of Directors. The number of shares of Class A, $1.00 par value, common stock which may be issued under the Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 300,000. These shares may be authorized and unissued shares or treasury shares.\nAll of the employees of the Company and its subsidiaries are eligible to participate in the Plan. In addition, directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Non-employee directors, including members of the Compensation and Stock Option Committee, are eligible for non-discretionary stock options. On May 19, 1995, the Committee approved the issuance of 52,500 non-qualified stock options to selected officers of the Company. The Committee also granted 7,000 non-qualified, non-discretionary stock options to non-employee Company directors. The stock options begin to vest following three full years of service to the Company after date of grant, with 20% of the options to vest at the beginning of the fourth year of service, and with 20% thereof to vest at the beginning of each of the next four years of service. The exercise price of the stock options was set at the fair market value of the common stock on the date of grant, May 19, 1995, which was $38.125 per share.\nIn October, 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. It defines 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 plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Entities electing to continue applying the accounting methods in Opinion 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.\nUnder 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, which is usually the vesting period. For stock options, fair value is determined using an option pricing model that takes into account various information and assumptions regarding the Company's stock and options. 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 an employee must pay to acquire the stock.\nThe Company anticipates that it will continue to apply the accounting methods prescribed by Opinion 25 for its existing stock and incentive plan. Therefore, the implementation of this statement will not affect the Company's results of operations. However, as required by this statement, disclosure information will be provided in the Company's financial statements reflecting costs that would have been recorded under the fair value based method. The statement will be implemented in 1996.\n(11) FOREIGN SALES AND SIGNIFICANT AGENCY RELATIONSHIPS\nTotal direct premium revenues and universal life and annuity contract deposits related to insurance written in foreign countries, primarily Central and South America, were approximately $57,407,000, $53,846,000, and $57,450,000, for the years ended December 31, 1995, 1994, and 1993, respectively.\nA significant portion of the Company's universal life and investment annuity contracts are written through one agency. Such business accounted for approximately 11%, 20%, and 44% of total direct premium revenues and universal life and investment annuity contract deposits for 1995, 1994, and 1993, respectively.\n(12) SEGMENT INFORMATION\nA summary of financial information for the Company's two industry segments follows:\n(13) UNAUDITED QUARTERLY FINANCIAL DATA\nQuarterly results of operations are summarized as follows:\nThe fourth quarter net earnings in 1995 reflect the following significant items:\nContinuing Operations: Earnings from insurance operations, excluding net realized gains and losses on investments, for the quarter ended December 31, 1995, were $8,345,000 compared to $8,311,000 for the fourth quarter of 1994. However, fourth quarter 1994 earnings included a $2.9 million tax benefit resulting from the Company's subsidiary brokerage losses, whereas 1995 fourth quarter earnings do not include such a benefit because the total 1995 tax benefit had been recognized as of September 30, 1995. The tax benefit was recognized in accordance with the Company's tax allocation agreement with its subsidiaries. Excluding the tax benefit, 1995 fourth quarter earnings were up $2.9 million over the comparable 1994 quarter. Contributing to the increased earnings were insurance revenues, excluding realized gains and losses on investments, which were up $6,482,000, or 9.4%, from the 1994 fourth quarter. The increase in revenues was offset somewhat by higher life insurance benefit claims and other policy and contract related expenses.\nDiscontinued Operations: Third quarter 1995 losses from discontinued brokerage operations included estimated future operating losses, as well as estimated costs to cease brokerage operations, and resulted in the complete write-off of the Company's investment in Westcap on a consolidated basis. Accordingly, no earnings or losses were reported for the discontinued operations for the fourth quarter of 1995, as the investment in Westcap was previously written-off and there have been no significant changes in estimated costs to close the brokerage operations.\nThe fourth quarter net earnings in 1994 reflect the following significant items:\nContinuing Operations: Other insurance operating expenses were up significantly, as fourth quarter 1994 expenses included a charge of $2,636,000, net of taxes, or $0.76 per share, for state guaranty fund assessments relating to insolvent insurance companies.\nDiscontinued Operations: Fourth quarter 1994 net losses from the Company's discontinued brokerage operations, The Westcap Corporation, totaled $3,968,000, or $1.13 per share, compared to net earnings of $7,309,000, or $2.10 per share, for the fourth quarter of 1993. Volatile bond market conditions due to increasing market interest rates was the major factor for lower production, coupled with adverse publicity about litigation which led to the decline in sales and earnings.\n(14) FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\nInvestment securities: Fair values for investments in debt and equity securities are based on quoted market prices, where available. For securities not actively traded, fair values are estimated using values obtained from various independent pricing services and the Securities Valuation Office of the National Association of Insurance Commissioners. In the cases where prices are unavailable from these sources, prices are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments.\nCash and short-term investments: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.\nMortgage loans: The fair value of performing mortgage loans is estimated by discounting scheduled cash flows through the scheduled maturities of the loans, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Fair value for significant nonperforming loans is based on recent internal or external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.\nPolicy loans: The fair value for policy loans is calculated by discounting estimated cash flows using U.S. Treasury bill rates as of December 31, 1995 and 1994. The estimated cash flows include assumptions as to whether such loans will be repaid by the policyholders or settled upon payment of death or surrender benefits on the underlying insurance contracts. As a result, these assumptions incorporate both Company experience and mortality assumptions associated with such contracts.\nLife interest in Libbie Shearn Moody Trust: The fair value of the life interest is estimated based on assumptions as to future dividends from the Trust over the life expectancy of Mr. Robert L. Moody. These estimated cash flows were discounted at a rate consistent with uncertainties relating to the amount and timing of future cash distributions. However, the Company has limited the fair value to the statutory admitted value of the Trust, as this is the maximum amount to be received by the Company in the event of Mr. Moody's premature death.\nAssets of discontinued operations: These assets consist of cash, trading securities, and securities purchased under agreements to resell. Trading securities are based on quoted market prices. The carrying amount and fair value of securities purchased under agreements to resell are the amounts at which the securities will be subsequently resold as specified in the respective agreements.\nInvestment and supplemental contracts: Fair value of the Company's liabilities for deferred investment annuity contracts is estimated to be the cash surrender value of each contract. The cash surrender value represents the policyholder's account balance less applicable surrender charges. The fair value of liabilities for immediate investment annuity contracts and supplemental contracts with and without life contingencies is estimated by discounting estimated cash flows using U.S. Treasury bill rates as of December 31, 1995 and 1994.\nFair value for the Company's insurance contracts other than investment contracts is not required to be disclosed. This includes the Company's traditional and universal life products. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance and investment contracts.\nLiabilities of discontinued operations: These liabilities consist of short-term borrowings, securities sold not yet purchased, and securities sold under agreements to repurchase. The carrying amount of the Company's borrowings approximates its fair value due to the short duration of the borrowing periods. Securities sold not yet purchased are carried at fair values determined in the same manner as investment securities described above. The carrying amounts and fair values of securities sold under agreements to repurchase are the amounts at which the securities will be subsequently repurchased as specified in the respective agreements.\nThe carrying amounts and fair values of the Company's financial instruments are as follows:\nFair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. 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. Because no market exists for a portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\n(15) DISCONTINUED BROKERAGE OPERATIONS\n(A) Plan to Cease Brokerage Operations\nEffective July 17, 1995, The Westcap Corporation (Westcap), a wholly owned brokerage subsidiary of National Western Life Insurance Company, discontinued all sales and trading activities in its Houston, Texas, office. In September, 1995, Westcap approved a plan to close its remaining sales office in New Jersey and to cease all brokerage operations.\nIn connection with the plan, as of December 31, 1995, Westcap's assets are being carried at their estimated fair value, and its liabilities include estimated costs to dispose of assets and estimated future costs to cease operations. These estimated costs consist primarily of operating and legal expenses based on a reasonable time period to cease operations. The preparation of Westcap's 1995 financial statements required assumptions by management that included assumptions regarding the fair value of assets and expenses to be incurred. Variations between these assumptions and actual results could result in a change in the estimated fair value of assets recorded in Westcap's 1995 financial statements. However, management believes that, based on information currently available, any differences in recoveries on its assets in the future from the existing carrying values thereof will not have a material effect on the financial statements.\nAs a result of the plan and in accordance with generally accepted accounting principles, the assets and liabilities of Westcap have been reclassified in the accompanying consolidated balance sheets to separately identify them as assets and liabilities of the discontinued operations. Earnings and losses from the discontinued brokerage operations have also been reflected separately from continuing operations of the Company in the accompanying consolidated financial statements. The 1995 losses from discontinued operations include estimated future operating losses as well as estimated costs to cease brokerage operations totaling $6,381,000 and have resulted in the complete write-off of National Western Life Insurance Company's investment in Westcap on a consolidated basis.\n(B) Summary Financial Statements and Significant Disclosures\nA summary of Westcap's financial statements for the years ended September 30, 1995, 1994, and 1993 is provided below. Westcap's fiscal year-end is September 30. Although reported in detail below, these assets and liabilities have been aggregated and reported as assets and liabilities of discontinued operations in the accompanying financial statements. Likewise, all revenues and expenses have been netted and reported separately in the accompanying financial statements as earnings or losses from discontinued operations.\nThe following disclosures refer to the assets, liabilities, and operations items of Westcap as detailed above.\nSignificant Accounting Policies: Trading securities are carried at fair value. Unrealized gains and losses on trading securities are included in revenues.\nSecurities purchased under agreements to resell and securities sold under agreements to repurchase are treated as financing transactions, collateralized by negotiable securities, and carried at the amounts at which the securities will be subsequently resold or repurchased as specified in the respective agreements.\nReceivables from and payables to customers and brokers and dealers represent the contract value of securities which have not been delivered or received as of settlement date. The receivables from customers and brokers and dealers are collateralized by securities held by or due to subsidiaries of The Westcap Corporation.\nSecurities transactions and related revenues and expenses, except trading profits, are recorded on a settlement date basis. Trading profits are recorded on a trade date basis. Other revenues and expenses related to securities transactions executed but not yet settled as of year-end were not material to the financial position and results of operations of Westcap.\nCapital Requirements: The Westcap Corporation conducted its brokerage operations through a limited partnership, Westcap Securities, L.P. (Westcap L.P.). Westcap L.P. was subject to the Securities and Exchange Commission's Uniform Net Capital Rule (Rule 15c3-1), which required the maintenance of minimum net capital. The limited partnership elected to be subject to the Alternative Net Capital requirement which required the partnership to, at all times, maintain net capital equal to the greater of $250,000 or 2% of aggregate debit items computed in accordance with the formula for the determination of Reserve Requirements for Brokers and Dealers. At September 30, 1995, Westcap L.P. had a net capital deficit of $1,499,000 which was $1,749,000 below its required net capital of $250,000.\nIn anticipation of an Order Instituting Public Administrative Proceedings, Making Findings and Imposing Remedial Sanctions (Order) being entered pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 by the Securities and Exchange Commission (Commission), on February 8, 1996, Westcap L.P. submitted an offer of settlement to the Commission whereby it consented, without admitting or denying the findings in the Order, to the entry of an Order of the Commission making findings, revoking Westcap L.P.'s registration with the Commission, and requiring payment to the Commission of (i) $445,341 disgorgement, (ii) prejudgement interest of $83,879, and (iii) civil penalty of $300,000. Such an Order was entered by the Commission on February 14, 1996. In compliance with the Order, Westcap L.P. made payment to the Commission of $829,220 on March 5, 1996.\nShort-Term Borrowings: Certain subsidiaries of The Westcap Corporation have arrangements with a financial institution whereby the institution performs clearing functions for all securities transactions with customers and brokers and dealers. These arrangements include revolving line of credit agreements which bear interest at variable rates based on Federal funds rates and are due on demand. Borrowings under these arrangements are guaranteed by Westcap and collateralized by trading securities and certain customers' and brokers' and dealers' unpaid securities, which at September 30, 1994, had aggregate market values of approximately $35,354,000. There were no short-term borrowings outstanding at September 30, 1995. The average interest rates on borrowings for the years ended September 30, 1995 and 1994, were 6.26% and 4.60%, respectively.\nSecurities Purchased under Agreements to Resell and Securities Sold under Agreements to Repurchase: At September 30, 1994, securities purchased under agreements to resell by Westcap were collateralized by U.S. Government and agencies' securities with market values of approximately $152,753,000. These agreements had maturity dates ranging from one to ninety days and weighted average interest rates of 4.2%. There were no securities purchased under agreement to resell at September 30, 1995. During the years ended September 30, 1995 and 1994, the maximum month-end balance of outstanding agreements was $136,906,000 and $270,854,000, and the average amount of outstanding agreements was $68,876,000 and $197,327,000, respectively. Risks arise from the possible inability of counterparties to meet the terms of their agreements and from movements in securities' values.\nAt September 30, 1994, securities sold under agreements to repurchase by Westcap were collateralized by U.S. Government and agencies' securities with market values of approximately $93,025,000. These agreements had maturity dates ranging from one to ninety days and weighted average interest rates of 4.8%. There were no securities sold under agreements to repurchase at September 30, 1995. During the years ended September 30, 1995 and 1994, the maximum month-end balance of outstanding agreements was $125,864,000 and $245,564,000, and the average amount of outstanding agreements was $54,322,000 and $169,187,000, respectively.\nWhen-Issued and Forward Contracts: In the normal course of business, Westcap entered into when-issued and forward contracts principally related to mortgage-backed and U.S. Government securities issues. These contracts are for delayed delivery of securities in which the seller agrees to make delivery at a specified future date of a specified instrument, at a specified price. These securities issues may have settlement dates ranging from several weeks to several months after trade date. Revenues and expenses related to such contracts are recognized on settlement date. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities values and interest rates. At September 30, 1994, the approximate amount of unsettled when-issued and forward purchase and sale contracts were $73,009,000 and $73,431,000, respectively. These contracts principally related to obligations of the U.S. Government and its agencies. There were no unsettled when-issued and forward purchase and sale contracts at September 30, 1995.\nDuring the year ended September 30, 1994, Westcap adopted the provisions of SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" which requires disclosure of certain fair value information regarding derivative financial instruments. During 1994, the average fair value of when-issued purchase and sale contracts were approximately $4,789,000 and $2,602,000, respectively. At September 30, 1994, the fair value of when-issued and forward purchase and sale contracts were approximately $68,146,000 and $68,632,000, respectively. For the year ended September 30, 1994, Westcap recognized a net gain of approximately $12,079,000 from such transactions. There were no significant transactions during 1995 in when-issued purchase and sale contracts.\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1995 (In thousands)\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE I, CONTINUED SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1995 (In thousands)\nNotes to Schedule I\n(1) Fixed maturity bonds are shown at amortized cost, mortgage loans are shown at unpaid principal balances before allowances for possible losses of $5,668,000, and real estate is stated at cost before allowances for possible losses of $2,152,000. The following investments in related parties have been excluded: fixed maturity bonds - $2,418,000 and mortgage loans - $13,836,000.\n(2) Real estate acquired by foreclosure included in other long-term investments totaled approximately $6,260,000.\nNATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE V VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1995, 1994, and 1993 (In thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL WESTERN LIFE INSURANCE COMPANY (Registrant)\n\/S\/ Robert L. Moody \/S\/ Ross R. Moody By: Robert L. Moody By: Ross R. Moody Chairman of the Board, Chief President, Chief Operating Executive Officer, Director Officer, Director\n\/S\/ Robert L. Busby, III By: Robert L. Busby, III Senior Vice President - Chief Administrative Officer, Chief Financial Officer and Treasurer\nMarch 28, 1996 Date\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\/ Arthur O. Dummer Arthur O. Dummer, Frances A. Moody, Director Director\n\/S\/ Harry L. Edwards Harry L. Edwards, Russell S. Moody, Director Director\n\/S\/ E. Douglas McLeod \/S\/ Louis E. Pauls, Jr. E. Douglas McLeod, Louis E. Pauls, Jr., Director Director\n\/S\/ Charles D. Milos, Jr. Charles D. Milos, Jr., E. J. Pederson, Director Director\nMarch 28, 1996 Date","section_15":""}
{"filename":"825541_1995.txt","cik":"825541","year":"1995","section_1":"Item 1. Business\nGeneral\nSilgan Corporation (the \"Company\" or \"Silgan\") 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, the Company'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. The Company 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.\nThe Company is a Delaware corporation formed in August 1987 as a holding company to acquire interests in various packaging manufacturers. Prior to 1987, the Company did not engage in any business. In June 1989, the Company became a wholly owned subsidiary of Silgan Holdings Inc. (\"Holdings\"), a Delaware corporation whose principal asset is all of the outstanding common stock of the Company. See \"Company History\" below.\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 the Company'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\nThe Company was organized in August 1987 as a holding company to acquire interests in various packaging manufacturers. On August 31, 1987, the Company, 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, the Company, 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, the Company 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 the Company. On June 30, 1989, Silgan Acquisition, Inc. (\"Acquisition\"), a wholly owned subsidiary of Holdings, merged with and into the Company, and the Company 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, Silgan and Holdings 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, the Company 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\nSilgan's and Holdings' 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 Silgan and Holdings, the court dismissed all claims against Silgan and Holdings 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 Silgan and Holdings 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 Silgan's 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 Silgan'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............ 45\nPART IV .................................................................... 48 Item 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K..................................... 48\n-i-","section_15":""}
{"filename":"711389_1995.txt","cik":"711389","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nHutton\/ConAm Realty Investors 3 (the \"Registrant\" or the \"Partnership\") is a California limited partnership formed on July 14, 1983, of which RI 3-4 Real Estate Services Inc. (\"RI 3-4 Services,\" formerly Hutton Real Estate Services VIII, Inc.), a Delaware corporation, and ConAm Property Services IV, Ltd., a California limited partnership (\"ConAm Services\"), are the general partners (together, the \"General Partners\").\nCommencing March 31, 1983, the Registrant began offering through E.F. Hutton & Company Inc., an affiliate of the Registrant, up to a maximum of 80,000 units of limited partnership interest (the \"Units\") at $500 per Unit. Investors who purchased the Units (the \"Limited Partners\") are not required to make any additional capital contributions. The Units were registered under the Securities Act of 1933, as amended, under Registration Statement No. 2-80991, which Registration Statement was declared effective on March 31, 1983. The offering of Units was terminated on July 14, 1983. Upon termination of the offering, the Registrant had accepted subscriptions for 80,000 Units for an aggregate of $40,000,000.\n(b) Narrative Description of Business\nThe Registrant is engaged in the business of acquiring, operating and holding for investment multifamily residential properties which by virtue of their location and design and the nature of the local real estate market have the potential for long-term capital appreciation and generation of current income. All of the proceeds available for investment in real estate were originally invested in three residential apartment properties and two joint ventures, each of which owns a specified property. Funds held as a working capital reserve are invested in bank certificates of deposit, unaffiliated money market funds or other highly liquid short-term investments where there is appropriate safety of principal in accordance with the Registrant's investment objectives and policies.\nThe Registrant's principal investment objectives with respect to its interests in real property are:\n(1)\tcapital appreciation;\n(2) distribution of net cash from operations attributable to rental income; and\n(3)\tpreservation and protection of capital.\nDistribution of net cash from operations will be the Registrant's objective during its operational phase, while preservation and appreciation of capital continues to be the Registrant's longer term objectives. The attainment of the Registrant's investment objectives will depend on many factors, including future economic conditions in the United States as a whole and, in particular, in the localities in which the Registrant's properties are located, especially with regard to achievement of capital appreciation.\nFrom time to time the Registrant expects to sell its real property interests taking into consideration such factors as the amount of appreciation in value, if any, to be realized and the possible risks of continued ownership. In consideration of these factors and improving market conditions, over the next several years, the General Partners have commenced marketing certain of the properties for sale. No property will be sold, financed or refinanced by the Registrant without the agreement of both General Partners. Proceeds from any future sale, financing or refinancing of properties will not be reinvested and may be distributed to the Limited Partners and General Partners (sometimes referred to together herein as the \"Partners\"), so that the Registrant will, in effect, be self-liquidating. If deemed necessary, the Registrant may retain a portion of the proceeds from any sale, financing or refinancing as capital reserves. As partial payment for properties sold, the Registrant may receive purchase money obligations secured by mortgages or deeds of trust. In such cases, the amount of such obligations will not be included in Net Proceeds From Sale or Refinancing (distributable to the Partners) until and only to the extent the obligations are realized in cash, sold or otherwise liquidated.\nOriginally, the Registrant acquired five residential apartment complexes (collectively, the \"Properties\") either directly or through investments in joint ventures. As of November 30, 1995, the Registrant had interests in the Properties as follows: (1) Autumn Heights, a 140-unit apartment complex, located in Colorado Springs, Colorado; (2) Skyline Village, a 168-unit apartment complex, located in Tucson, Arizona; and (3) Ponte Vedra Beach Village II, a 124-unit apartment complex, located in Ponte Vedra Beach, Florida. Country Place Village II was sold on July 20, 1995, for $3,890,000 to an institutional buyer, which is unaffiliated with the Partnership. The selling price was determined by arm's length negotiations between the Partnership and the buyer. The Partnership received net proceeds of $3,832,290. The fifth property in which the Registrant had an interest, Bernardo Point Apartments in San Diego, California, was sold on December 20, 1990. See Item 2, \"Properties,\" and Note 4 , \"Real Estate Investments,\" of the Notes to Consolidated Financial Statements incorporated herein by reference to the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995 filed as an exhibit under Item 14 for further information on each of the Properties. Reference is made to Item 7 of this report for a more detailed discussion of the Country Place Village II sale.\nThe Registrant's mortgage loan secured by Autumn Heights was refinanced in January 1994 and will mature in January 2001. See Note 5, \"Mortgages Payable,\" of the Notes to the Consolidated Financial Statements for additional information concerning the Registrant's current mortgage indebtedness. See Item 7 of this report for discussion of the Autumn Heights refinancing.\nCompetition\nThe Registrant's real property investments are subject to competition from similar types of properties in the vicinities in which they are located and such competition has increased since the Registrant's investment in the Properties due principally to the addition of newly constructed apartment complexes offering increased residential and recreational amenities. The investment properties have also been subject to competition from condominiums and single-family properties especially during periods of low mortgage interest rates. The Registrant competes with other real estate owners and developers in the rental and leasing of its Properties by offering competitive rental rates and, if necessary, leasing incentives. Such competition may affect the occupancy levels and revenues of the Properties. The occupancy levels at the properties in Arizona and Florida reflect some seasonality, which is typical in the markets. In some cases, the Registrant may compete with other properties owned by partnerships affiliated with either General Partner of the Registrant.\nFor a discussion of current market conditions in each of the areas where the Partnership's Properties are located, see Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nBelow is a description of the Registrant's Properties and a discussion of current market conditions in each of the areas where the Properties are located. For information on the purchase of the Properties, reference is made to Note 4 to the Consolidated Financial Statements in the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995, which is filed as an exhibit under Item 14. Appraised values of the Partnership's real estate investments are incorporated by reference to the Partnership's Annual Report to Unitholders. Average occupancy rates at each property are incorporated by reference to Item 7.\nAutumn Heights - Colorado Springs, Colorado. The 140-unit Autumn Heights complex is situated in southwest Colorado Springs, approximately sixty miles south of Denver. Colorado Springs has rebounded from its economic difficulties and overbuilding experienced in the mid-to-late 1980s, and market conditions for multifamily housing improved considerably. As of the third quarter of 1995, average occupancy was 98% in Colorado Springs overall and 99% in the Southwest submarket where the property is located. The strong market conditions have also resulted in significant increases in rental rates. As a result of the pent-up demand for multifamily housing, development of new apartment complexes has increased. There are over 900 units currently under construction in Colorado Springs, with an additional 1,800 units in various stages of the permitting process. Given the area's growing population and strong economy, this new supply is expected only to have minimal impact on the multifamily market. However, continuing construction at thi space could lead to softness in the market in the future.\nPonte Vedra Beach Village II - Ponte Vedra Beach, Florida This 124-unit property is located in an oceanside residential area south of Jacksonville, Florida. The Ponte Vedra Beach area has experienced notable population growth and limited new construction in recent years, resulting in strong occupancy for area apartment complexes. A local survey of the Ponte Vedra Beach area reported an average apartment occupancy rate of 95% in the fourth quarter of fiscal 1995. The use of rental concessions in the market is virtually non-existent. Given the strong market conditions, several apartment projects are in the planning or construction phase. In July 1995, construction of phase one of a new development containing 240 units was completed. Phase two of this project, which will contain an additional 178 units, is expected to be completed by the end of 1996. A separate project containing 252 units is to be built in the Ponte Vedra area and a project with an additional 200 to 300 units is awaiting permits to begin construction. All this construction is expected to intensify competition in the Ponte Vedra area market.\nSkyline Village - Tucson, Arizona. This 168-unit complex is situated in the northern portion of the Tucson metropolitan area near the foothills of the Santa Catalina mountains. Skyline Village competes with a number of apartment complexes and condominium developments within the Tucson area. Tucson's economy began to weaken as population and job growth slowed during 1995. Despite the economic slowdown, construction of multifamily properties has increased significantly. As of the third quarter of 1995, 1,123 units were under construction in the Catalina Foothills submarket with an additional 656 units not yet begun. These units are being added to the 7,226 completed units in the market. There are an additional seven projects planned for the Catalina Foothills market although all of these projects may not proceed to constructions. In addition, the multifamily market has been unfavorably impacted by a decline in interest rates which has made home ownership a viable alternative for renters. As a result, vacancy rate s are beginning to rise and increases in rental rates are moderating. A local survey of metropolitan Tucson conducted in the fourth quarter of fiscal 1995 showed an average occupancy rate of 92% among multifamily properties with five or more units, down from 96% at the same period in 1994. However, the economy and population continue to grow at a rapid pace which will lessen the impact.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Registrant is not 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 November 30, 1995, no matter was submitted to a vote of Unitholders through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for Partnership's Limited Partnership Units and Related Security Holder Matters\nAs of November 30, 1995, the number of Unitholders of record was 3,972.\nNo established public trading market exists for the Units, and it is not anticipated that such a market will develop in the future.\nDistributions of Net Cash From Operations, when made, are paid on a quarterly basis, with distributions generally occurring approximately 45 days after the end of each quarter. Such distributions have been made primarily from net operating income with respect to the Registrant's investment in the Properties and from interest on short-term investments, and partially from excess cash reserves. Information on cash distributions paid by the Partnership for the past two fiscal years is incorporated by reference to the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995, which is filed as an exhibit under Item 14. The level of future distributions will be evaluated on a quarterly basis and will depend on the Partnership's operating results and future cash needs.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated by reference to the Partnership's Annual Report to Unitholders for the year ended November 30, 1995, which is filed as an exhibit under Item 14.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nAt November 30, 1995, the Partnership had cash and cash equivalents of $1,060,348, which were invested in unaffiliated money market funds. The $3,152,800 decrease from November 30, 1994 is due primarily to cash distributions to the partners and mortgage principal payments in excess of proceeds from the sale of Country Place Village II, and cash provided by operating activities. The Partnership also maintains a restricted cash balance, which totaled $61,141 at November 30, 1995, representing real estate tax escrows required under the terms of the Autumn Heights and Skyline Village loans. The Partnership expects sufficient cash to be generated from operations to meet its current operating expenses.\nOn July 20, 1995, the Partnership sold Country Place Village II for $3,890,000 to an institutional buyer. The Partnership received net proceeds of $3,832,290. On August 22, 1995, the General Partners made a special distribution of $4,000,000 or $50 per Unit from proceeds resulting from the sale and a portion of the Partnership's cash reserves. This distribution represents a return of investors original capital and includes sales proceeds held in reserve from the Bernardo Point sale. As a result of the sale of Country Place Village II, security deposits payable declined to $109,876 at November 30, 1995 from $161,667 at November 30, 1994.\nMortgages payable declined from $11,598,519 at November 30, 1994 to $8,564,859 at November 31, 1995 primarily due to a June 29, 1995 payment in the amount of $2,925,099, representing principal and interest, from cash reserves to fully satisfy the Partnership's mortgage obligation on Country Place Village II, plus amortization of the outstanding balance on the Skyline Village and Autumn Heights mortgages.\nOn January 6, 1994, the Partnership refinanced its mortgage collateralized by the Autumn Heights property. The replacement financing has a term of seven years and bears interest at an annual rate of 8%, requiring monthly installments of principal and interest. Proceeds from the new financing were used to pay off the existing mortgage balance of $4,411,215. The funds in excess of the maturing loan balance, approximately $1 million, were added to the Partnership's cash reserve. As a result of the completion of the Autumn Heights refinancing, the General Partners declared a special distribution in the amount of $2,400,000 or $30 per unit which was paid on January 27, 1994. This distribution represents a return of investors' original capital related to the proceeds from the sale of the Bernardo Point property. See Note 4, \"Real Estate Investments,\" of Notes to the Consolidated Financial Statements for a discussion of such sale.\nDuring the remainder of 1996, the General Partners intend to implement an extensive improvement program to upgrade the properties. This program, which includes roof repairs at all three properties and asphalt repairs at Autumn Heights and Ponte Vedra Beach II, is intended to maintain each property's position within their respective markets, which are growing increasingly competitive with the addition of newly-constructed apartment properties. This is particularly true in the Tucson and Jacksonville markets where Skyline Village and Ponte Vedra Beach Village II, respectively, are located. It is also hoped that these improvements will allow for greater increases in rental rates, thereby improving each property's revenue and value, and making them better positioned for eventual sale. It is anticipated that cash from reserves may be required to fund a portion of the distributions during 1996 as a result of the capital expenditures required.\nResults of Operations\n1995 versus 1994 Partnership operations for the year ended November 30, 1995 resulted in net income of $85,405 compared with $17,509 in fiscal 1994. Excluding the $83,992 loss recognized on the sale of Country Place Village II, income from operations for the fiscal year ended November 30, 1995 was $169,397 as compared to $17,509 in fiscal 1994. The increases in net income and income from operations for the year ended November 30, 1995 are due primarily to reductions in interest expense and depreciation and amortization attributable to the sale of Country Place Village II. Net cash provided by operating activities was $1,184,714 for the fiscal year ended November 30, 1995 virtually unchanged from $1,196,687 in fiscal 1994.\nRental income for the year ended November 30, 1995 was $4,027,970 compared with $4,146,674 in fiscal 1994. The decrease reflects the sale of Country Place Village II in July 1995, partially offset by increases in rental income at the three remaining properties, particularly Autumn Heights, due to increased rental rates. Interest income totalled $174,780 for the fiscal year ended November 30, 1995 compared to $151,152 in fiscal 1994. The increase is the result of the Partnership earning higher interest rates on its invested cash in 1995 compared to 1994.\nProperty operating expenses were $1,912,816 for the year ended November 30, 1995, virtually unchanged from $1,936,098 for fiscal 1994 as decreases in operating expenses at Country Place Village II and Autumn Heights were offset by higher repairs and maintenance expenses at Skyline Village. Depreciation and amortization was lower in fiscal 1995 compared to fiscal 1994 due to the July 1995 sale of Country Place Village II. Interest expense also declined due to the June 1995 repayment of the Country Place Village II mortgage.\n1994 versus 1993 Partnership operations for the year ended November 30, 1994 resulted in net income of $17,509 compared with $2,707 in fiscal 1993. The increase in net income for the year ended November 30, 1994 is due primarily to an increase in rental income, partially offset by an increase in property operating expenses. Net cash provided by operating activities was $1,196,687 for the fiscal year ended November 30, 1994 virtually unchanged from $1,153,670 in fiscal 1994.\nRental income for the year ended November 30, 1994 was $4,146,674 compared with $3,893,009 in fiscal 1993. The increase reflects increased rental income at all four of the Partnership's properties during fiscal 1994, particularly Autumn Heights and Skyline Village, due primarily to increased rental rates.\nProperty operating expenses were $1,936,098 for the year ended November 30, 1994, compared with $1,697,471 for fiscal 1993. The increase is due primarily to the painting of the exterior building and landscaping expenditures for Autumn Heights and asphalt repairs and carpet replacements performed at Skyline Village.\nThe average occupancy levels at each of the properties for the years ended November 30, 1995, 1994 and 1993 were as follows:\nTwelve Months Ended November 30, Property 1995 1994 1993 Autumn Heights 96% 96% 98% Ponte Vedra Beach Village II 93% 95% 95% Skyline Village 94% 96% 97% \t\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIncorporated by reference to the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995, which is filed as an exhibit under Item 14. Supplementary Data is incorporated by reference to to of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Registrant has no officers or directors. RI 3-4 Services and ConAm Services, the co-General Partners of the Registrant, jointly manage and control the affairs of the Registrant and have general responsibility and authority in all matters affecting its business.\nRI 3-4 Services\nRI 3-4 Services (formerly Hutton Real Estate Services VIII, Inc.) is a Delaware corporation formed on August 2, 1982, as a wholly-owned subsidiary of LB I Group Inc. (formerly the E.F. Hutton Group Inc., the \"Hutton Group\"). The Hutton Group is now a wholly-owned subsidiary of Lehman Brothers Inc. (\"Lehman\"). See the section captioned, \"Certain Matters Involving Affiliates of RI 3-4 Services,\" below for a description of the Hutton Group's acquisition by Shearson Lehman Brothers, Inc. (\"Shearson\") and the subsequent sale of certain of Shearson's domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"), which resulted in a change in the general partner's name.\nCertain officers and directors of RI 3-4 Services are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought the protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure. The names and positions held by the directors and executive officers of RI 3-4 Services are set forth below. There are no family relationships between any officers or directors.\nName Office\n\t\tPaul L. Abbott\t\tDirector, President, Chief Financial \t\t\t\t\tOfficer and Chief Executive Officer Donald E. Petrow Vice President \t\tKate Hobson\t\tVice President\nPaul L. Abbott, 50, is a Managing Director of Lehman. Mr. Abbott joined Lehman in August 1988, and is responsible for investment management of residential, commercial and retail real estate. Prior to joining Lehman, 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.\nDonald E. Petrow, 39, is a First Vice President of Lehman Brothers Inc. Since March 1989, he has been responsible for the investment management and restructuring of various investment portfolios, including but not limited to, federal insured mortgages, tax exempt bonds, multifamily and commercial real estate. From November 1981 to February 1989, Mr. Petrow, as Vice President of Lehman, was involved in investment banking activities relating to partnership finance and acquisitions. Prior to joining Lehman, Mr. Petrow was employed in accounting and equipment leasing firms. Mr. Petrow holds a B.S. Degree in accounting from Saint Peters College and an M.B.A in Finance from Pace University.\nKate Hobson, 29, is an Assistant Vice President of Lehman and has been a member of the Diversified Asset Group since 1992. Prior to joining Lehman, Ms. Hobson was associated with Cushman & Wakefield serving as a real estate accountant from 1990 to 1992. Prior to that, Ms. Hobson was employed by Cambridge Systematics, Inc. as a junior land planner. Ms. Hobson received a B.A. degree in sociology from Boston University in 1988.\nConAm Services\nConAm Services is a California limited partnership organized on August 30, 1982. The sole general partner of ConAm Services is Continental American Development, Inc. (\"ConAm Development\"). The names and positions held by the directors and executive officers of ConAm Development are set forth below. There are no family relationships between any officers or directors.\nName Office\nDaniel J. Epstein President and Director \t\tE. Scott Dupree\t\tVice President\/Director Robert J. Svatos Vice President\/Director \t\tRalph W. Tilley\t\tVice President J. Bradley Forrester Vice President\nDaniel J. Epstein, 56, has been the President and a Director of ConAm Development and ConAm Management (or its predecessor firm) and a general partner of Continental American Properties, Ltd. (\"ConAm\"), an affiliate of ConAm Services, since their inception. Prior to that time Mr. Epstein was Vice President and a Director of American Housing Guild, which he joined in 1969. At American Housing Guild, he was responsible for the formation of the Multi-Family Division and directed its development and property management activities. Mr. Epstein holds a Bachelor of Science degree in Engineering from the University of Southern California.\nE. Scott Dupree, 45, is a Vice President and general counsel of ConAm Management responsible for negotiation, documentation, review and closing of acquisition, sale and financing proposals. Mr. Dupree also acts as principal legal advisor on general legal matters ranging from issues and contracts involving the management company to supervision of litigation and employment issues. Prior to joining ConAm Management in 1985, he was corporate counsel to Trusthouse Forte, Inc., a major international hotel and restaurant corporation. Mr. Dupree holds a B.A. from United States International University and a Juris Doctorate degree from the University of San Diego.\nRobert J. Svatos, 37, is a Vice President and is the Chief Financial Officer of ConAm Management. His responsibilities include the accounting, treasury and data processing functions of the organization. Prior to joining ConAm Management in 1988, he was the Chief Financial Officer for AmeriStar Financial Corporation, a nationwide mortgage banking firm. Mr. Svatos holds an M.B.A. in Finance from the University of San Diego and a Bachelor's of Science degree in Accounting from the University of Illinois. He is a Certified Public Accountant.\nRalph W. Tilley, 41, is a Vice President and Treasurer of ConAm Management. He is responsible for the financial aspects of syndications and acquisitions, the company's asset management portfolio and risk management activities. Prior to joining ConAm Management in 1980, he was a senior accountant with KPMG Peat Marwick, specializing in real estate. He holds a Bachelor's of Science degree in Accounting from San Diego State University and is a Certified Public Accountant.\nJ. Bradley Forrester, 38, currently serves as a Senior Vice President of ConAm Management Corporation. He is responsible for property acquisition and disposition on a nationwide basis. Additionally, he is involved with the company's real estate development activities. Prior to joining ConAm, Mr. Forrester served as Senior Vice President - Commercial Real Estate for First Nationwide Bank in San Francisco, where he was responsible for a $2 billion problem asset portfolio including bank-owned real estate and non-performing commercial real estate loans. His past experience includes significant involvement in real estate development and finance, property acquisitions and dispositions and owner's representation matters. Prior to entering the real estate profession, he worked for KPMG Peat Marwick in Dallas, Texas. Mr. Forrester holds a Bachelor of Science degree in Accounting from Louisiana State University. He received his CPA certification in the State of Texas.\nCertain Matters Involving Affiliates of RI 3-4 Services\nOn July 31, 1993, Shearson sold certain of its domestic retail brokerage and asset management businesses to Smith Barney. Subsequent to the sale, Shearson changed its name to \"Lehman Brothers Inc.\" The transaction did not affect the ownership of the Partnership's General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, the Hutton Real Estate Services general partner changed its name to \"RI 3-4 Real Estate Services Inc.\", and the Hutton Group changed its name to \"LB I Group Inc.\" to delete any reference to \"Hutton.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither of the General Partners nor any of their directors or executive officers received any compensation from the Registrant. See Item 13 of this report for a description of certain costs of the General Partners and their affiliates reimbursed by the Registrant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of November 30, 1995, no person was known by the Registrant to be the beneficial owner of more than five percent of the Units of the Registrant. Neither of the General Partners nor any of their executive officers or directors owns any Units.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nRI 3-4 Services and ConAm Services each received $44,444 as its allocable share of Net Cash From Operations with respect to the fiscal year ended November 30, 1995. Pursuant to the Certificate and Agreement of Limited Partnership of the Registrant, for the fiscal year ended November 30, 1995, $16,100 of Registrant's net income was allocated to the General Partners ($7,910 to RI 3-4 Services and $8,190 to ConAm Services). For a description of the share of Net Cash From Operations and the allocation of income and loss to which the General Partners are entitled, reference is made to the material contained on pages 43-45 of the Prospectus of the Registrant dated March 31, 1983 (the \"Prospectus\"), contained in Registrant's Registration No. 2-80991, under the section captioned \"Profits and Losses and Cash Distributions,\" which section is incorporated herein by reference thereto.\nPursuant to property management arrangements with the Registrant, ConAm Management has assumed direct responsibility for day-to-day management of the Properties owned by the Registrant or its joint ventures. It is the responsibility of ConAm Management to select resident managers and to monitor their performance. ConAm Management's services also include the supervision of leasing, rent collection, maintenance, budgeting, employment of personnel, payment of operating expenses, and related services. For such services, ConAm Management is entitled to receive a management fee as described on pages 33 and 34 of the Prospectus under the caption \"Investment Objectives and Policies - Management of Properties,\" which description is herein incorporated by reference. A summary of property management fees earned by ConAm Management during the past three fiscal years is incorporated herein by reference to Note 6, \"Transactions with Related Parties,\" of Notes to Consolidated Financial Statements , included in the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995.\nPursuant to Section 12(g) of Registrant's Certificate and Agreement of Limited Partnership, the General Partners may be reimbursed by the Registrant for certain of their costs as described on page 16 of the Prospectus, which description is incorporated herein by reference thereto. First Data Investor Services Group provides partnership accounting and investor relations services for the Registrant. Prior to May 1993, these services were provided by an affiliate of a general partner. The Registrant's transfer agent and certain tax reporting services are provided by Service Data Corporation. Both First Data Investor Services Group and Service Data Corporation are unaffiliated companies. A summary of amounts paid to the General Partners or their affiliates during the past three years is incorporated by reference to Note 6, \"Transactions with Related Parties,\" of Notes to Consolidated Financial Statements, included in the Partnership's Annual Report to Unitholders for the fiscal year e nded November 30, 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K\n\t(a)(1)\tFinancial Statements: Page\nConsolidated Balance Sheets - November 30, 1995 and 1994 (1)\nConsolidated Statements of Operations - For the years ended November 30, 1995, 1994 and 1993 (1)\nConsolidated Statements of Partners' Capital (Deficit) - For the years ended November 30, 1995, 1994 and 1993 (1)\nConsolidated Statements of Cash Flows - For the years ended November 30, 1995, 1994 and 1993 (1)\nNotes to Consolidated Financial Statements (1)\nReport of Independent Accountants (1) \t \t(a)(2)\tFinancial Statement Schedule:\nSchedule III - Real Estate and Accumulated Depreciation\nReport of Independent Accountants\n(1) Incorporated by reference to the Partnership's Annual Report to Unitholders for the fiscal year ended November 30, 1995, filed as Exhibit 13 under Item 14.\n\t(a)(3)\tExhibits:\n(4)(A) Certificate and Agreement of Limited Partnership (included as, and incorporated herein by reference to, Exhibit A to the Prospectus of Registrant dated March 31, 1983, contained in Amendment No. 1 to Registration Statement No. 2-80991, of Registrant filed March 29, 1983 (the \"Registration Statement\").\n(B) Subscription Agreement and Signature Page (included as, and incorporated herein by reference to, Exhibit 3.1 to Amendment No. 1 to the Registration Statement).\n(10)(A) Purchase Agreement relating to Autumn Heights, between the Registrant and Highland Properties, Inc., and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit (10)(A) to the Registrant's Annual Report on Form 10-K filed February 28, 1985 for the fiscal year ended November 30, 1984 (the \"1984 Annual Report\")).\n(B) Purchase Agreement relating to Skyline Village, between the Registrant and Epoch Properties, Inc., and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit (10)(C) to the Registrant's Annual Report on Form 10-K filed February 28, 1984 for the fiscal year ended November 30, 1983).\n(C) Purchase Agreement relating to Country Place Village II, between the Registrant and Epoch Properties, Inc. and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit (10)(C) to the 1984 Annual Report).\n(D) Purchase Agreement relating to Ponte Vedra Beach Village II, between the Registrant and Epoch Properties, Inc., and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit (10)(A) to the Quarterly Report).\n(E) Loan Documents: Promissory Note and Deed of Trust, Assignment of Rents and Security Agreement with respect to the mortgaging of Skyline Village dated December 20, 1991 (included as, and incorporated herein by reference to, Exhibit 10(K) to the Registrant's 1991 Annual Report on Form 10-K filed on February 27, 1992).\n(F) Settlement Agreement by and among the Managing Joint Venturers and the Epoch Joint Venturers dated July 1, 1992 (included as, and incorporated herein by reference to, Exhibit 10.1 to the Registrant's Quarterly Report on From 10-Q filed on October 14, 1992).\n(G) Amended and Restated Agreement of Limited Partnership of Skyline Village Joint Venture Limited Partnership dated as of July 1, 1992 (included as, and incorporated herein by reference to, Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q filed on October 14, 1992).\n(H) Amended and Restated Agreement of General Partnership of Country Place Village II Joint Venture dated as of July 1, 1992 (included as, and incorporated herein by reference to, Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q filed on October 14, 1992).\n(I) Loan Documents: Promissory Note and Assignment of Rents and Leases with respect to the refinancing of Autumn Heights, between Registrant and John Hancock Life Insurance Company (included as, and incorporated herein by reference to, Exhibit 10-J to the Registrant's 1993 Annual Report on Form 10-K filed on March 30, 1994).\n(J) Property Management Agreement between Registrant and Con Am Management Corporation for the Ponte Vedra Beach Village II property (included as, and incorporated herein by reference to, Exhibit 10(L) to the Registrant's 1993 Annual Report on Form 10-K filed on March 30, 1994).\n(K) Property Management Agreement between Registrant and Con Am Management Corporation for the Skyline Village property (included as, and incorporated herein by reference to, Exhibit 10(M) to the Registrant's 1993 Annual Report on Form 10-K filed on March 30, 1994).\n(L) Property Management Agreement between Registrant and ConAm Colorado, Inc. for the Autumn Heights property (included as, and incorporated herein by reference to, Exhibit 10(N) to the Registrant's 1993 Annual Report on Form 10-K filed on March 30, 1994).\n(13) Annual Report to Unitholders for the fiscal year ended November 30, 1995.\n(22) List of Subsidiaries - Joint Ventures (included as, and incorporated herein by reference to, Exhibit 22 to the Registrant's 1991 Annual Report on Form 10-K filed on February 27, 1992 for the fiscal year ended November 30, 1991).\n(27) Financial Data Schedule.\n(99) Portions of Prospectus of Registrant dated March 31, 1983 (included as, and incorporated herein by reference to, Exhibit 28 to the Registrant's Annual Report on Form 10-K filed on February 28, 1988 for the fiscal year ended November 30, 1987).\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed in 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.\nDated: February 28, 1996 HUTTON\/CONAM REALTY INVESTORS 3\nBY: RI 3-4 Real Estate Services, Inc. General Partner\nBY: \/S\/ Paul L. Abbott Name: Paul L. Abbott Title: Director, President, Chief Executive Officer and Chief Financial Officer\nBY: ConAm Property Services IV, Ltd. General Partner\nBY: Continental American Development, Inc. General Partner\nBY: \/S\/ Daniel J. Epstein Name: Daniel J. Epstein Title: President, Director and Principal Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capabilities and on the dates indicated.\nRI 3-4 REAL ESTATE SERVICES, INC. A General Partner\nDate: February 28, 1996 BY: \/S\/ Paul L. Abbott Paul L. Abbott Director, President, Chief Executive Officer and Chief Financial Officer\nDate: February 28, 1996 BY: \/S\/ Donald E. Petrow Donald E. Petrow Vice President\nDate: February 28, 1996 BY: \/S\/ Kate Hobson Kate Hobson Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nCONAM PROPERTY SERVICES IV, LTD. A General Partner\nBy: Continental American Development,Inc. General Partner\nDate: February 28, 1996 BY: \/S\/ Daniel J. Epstein Daniel J. Epstein Director, President and Principal Executive Officer\nDate: February 28, 1996 BY: \/S\/ E. Scott Dupree E. Scott Dupree Vice President\/Director\nDate: February 28, 1996 BY: \/S\/ Robert J. Svatos Robert J. Svatos Vice President\/Director\nDate: February 28, 1996 BY: \/S\/ Ralph W. Tilley Ralph W. Tilley Vice President\nDate: February 28, 1996 BY: \/S\/ J. Bradley Forrester Vice President\nExhibit 13\nHUTTON\/CONAM REALTY INVESTORS 3\n1995 ANNUAL REPORT\nHutton\/ConAm Realty Investors 3 is a California limited partnership formed in 1983 to acquire, operate and hold for investment multifamily housing properties. At November 30, 1995, the Partnership's portfolio consisted of three apartment properties. Provided below is a comparison of average occupancy levels for the years ended November 30, 1995 and 1994.\nAverage Occupancy Property Location 1995 1994 __________________________________________________________________________ Autumn Heights Colorado Springs, Colorado 96% 96% Ponte Vedra Beach Village II Ponte Vedra Beach, Florida 93% 95% Skyline Village Tucson, Arizona 94% 96% __________________________________________________________________________\nAdministrative Inquiries Performance Inquiries\/Form 10-Ks Address Changes\/Transfers First Data Investor Services Group Service Data Corporation P.O. Box 1527 2424 South 130th Circle Boston, Massachusetts 02104-1527 Omaha, Nebraska 68144 Attn: Financial Communications 800-223-3464 (select option 1) 800-223-3464 (select option 2)\nContents\n1 Message to Investors 2 Performance Summary 3 Financial Highlights 4 Consolidated Financial Statements 7 Notes to Consolidated Financial Statements 13 Report of Independent Accountants 14 Net Asset Valuation\nMESSAGE TO INVESTORS\nPresented for your review is the 1995 Annual Report for Hutton\/ConAm Realty Investors 3. In this report, we review Partnership operations and discuss general market conditions affecting the Partnership's properties. We have also included a performance summary which addresses operating results at each of the properties and financial highlights for the year.\nCountry Place Village II Sale The most significant event during 1995 was the sale of Country Place Village II on July 20, 1995 to an unaffiliated institutional buyer. The Partnership received net sale proceeds of $3,832,290. The loan secured by Country Place Village II, in the amount of $2,925,099, including principal and interest, matured on July 1, 1995. Since the sale closed subsequent to this date, the Partnership's cash reserves were used to repay the loan.\nCash Distributions The Partnership paid cash distributions totaling $60 per Unit for the year ended November 30, 1995, including the fourth quarter distribution of $2.50 per Unit, which was credited to your brokerage account or sent directly to you on January 16, 1996. This amount also includes the special return of capital distribution of $50 per Unit which was paid on August 22, 1995 and resulted primarily from the sale of Country Place Village II. Since inception, the Partnership has paid distributions totalling $392.50 per original $500 Unit, including $250 per Unit in return of capital payments. The level of future distributions will be evaluated on a quarterly basis and will depend on the Partnership's operating results and future cash needs. It is anticipated that cash from reserves may be required to fund a portion of the distributions during 1996 as a result of the capital expenditures required at two of the Partnership's properties which are discussed in this report.\nOperations Overview The solid recovery of multifamily housing in most regions of the country began to level off during 1995. New construction intensified competition in many areas with building permits for multifamily units up almost 22% in 1995 compared to 1994 levels. In addition, falling interest rates induced many renters to purchase homes. Despite these trends, strong population and job growth in the areas where the Partnership's properties are located helped strengthen multifamily housing, and brought about improved performance at the Partnership's properties. All three properties sustained average occupancy rates for the year at or above 93% and recorded higher average rental income from the prior year.\nDuring 1996, we intend to implement an extensive improvement program to upgrade the properties. This program, which includes roof repairs at all three properties and asphalt repairs at Autumn Heights and Ponte Vedra Beach II, is intended to maintain each properties' position within their respective markets, which are growing increasingly competitive with the addition of newly-constructed apartment properties. This is particularly true in the Tucson and Jacksonville markets where Skyline Village and Ponte Vedra Beach Village II, respectively, are located. It is also hoped that these improvements will allow for greater increases in rental rates, thereby improving each property's revenue and ultimately their sales value. Updates on the improvements at each property will be included in future correspondence.\nSummary During 1996, we will continue to seek to maintain high occupancy levels, implement rental rate increases as conditions permit, and make capital improvements to upgrade the properties. We will keep you apprised of significant developments affecting your investment in future reports.\nVery truly yours, \t \/s\/ Paul L. Abbott \/s\/ Daniel J. Epstein President President RI 3-4 Real Estate Services, Inc. Continental American Development Inc., General Partner of ConAm Property Services IV, Ltd. February 28, 1996\nPERFORMANCE SUMMARY\nAutumn Heights - Colorado Springs, Colorado\nThis 140-unit complex maintained an average occupancy rate of 96% during fiscal 1995. As of the third quarter of 1995, average occupancy was 98% in Colorado Springs overall and 99% in the Southwest submarket where the property is located. The tight market conditions have also resulted in significant increases in rental rates. A particularly successful strategy at Autumn Heights is the leasing of certain units to corporate tenants at premium rates to provide short-term housing for executive transfers. This program, coupled with higher rental rates, resulted in an 8% increase in rental revenue during 1995. Property improvements completed during the year included the repaving of the driveway and replacement of the roof on one building. As a result of the pent-up demand for multifamily housing, development of new apartment complexes has increased. There are over 900 units currently under construction in Colorado Springs, with an additional 1,800 units in various stages of the permit ting process. Given the area's growing population and strong economy, this new supply is expected only to have minimal impact on the multifamily market. However, continuing construction at this pace could lead to softness in the market in the future.\nPonte Vedra Beach Village II - Ponte Vedra Beach, Florida\nPonte Vedra Beach Village II contains 124 units and maintained an average occupancy level of 93% during fiscal 1995. The property's occupancy rate has remained consistently at or above 93% for the past four years. Rental rate increases during 1995 on renewal units led to a modest rise in rental income. Property improvements in 1995 primarily consisted of roof repairs and the replacement of carpet and tile. A local survey of the Ponte Vedra Beach area reported an average apartment occupancy rate of 95% in the fourth quarter of fiscal 1995. The use of rental concessions in the market is virtually non-existent. Given the strong market conditions, several apartment projects are in the planning or construction phase. This construction is expected to intensify competition in the Ponte Vedra area market.\nSkyline Village - Tucson, Arizona\nSkyline Village, a 168-unit complex located in the Foothills region of Tucson, achieved an average occupancy rate of 94% during fiscal 1995, in line with local area averages. Rental income increased 2%, reflecting modest rental rate increases and the lack of rental concessions. Improvements at the property included carpet replacement in selected units and repairs to parking areas and roofs. The property continued to perform well despite intensifying competition in the metro Tucson area brought on by new construction. As of the third quarter of 1995, 1,123 units were under construction in the Foothills submarket with an additional 656 units not yet begun. There are an additional seven projects planned for the Foothills market although all of these projects may not proceed to construction. Competition for tenants is also increasing as many renters take advantage of low interest rates on mortgages and purchase homes. As a result, the area's vacancy rate reached 8% by fiscal year-end 1995, its highest level since 1990. However, the economy and population continue to grow at a rapid pace which will lessen the impact of this competition.\nFINANCIAL HIGHLIGHTS\nSelected Financial Data\nFor the Periods Ended November 30, (dollars in thousands, except per Unit data)\n1995 1994 1993 1992 1991 ____________________________________________________________________________\nTotal Revenue $ 4,203 $ 4,298 $ 4,033 $ 3,864 $ 3,982\nGain (loss) on Sale of Property (84) 0 0 0 8,451\nNet Income (Loss) 85 18 3 (454) (78)\nNet Cash Provided by Operating Activities 1,185 1,197 1,154 943 632\nLong-term Obligations at Year End 8,565 11,599 10,636 10,733 7,469\nTotal Assets at Year End 19,650 27,614 30,184 30,888 29,440\nNet Income (Loss) per Limited Partnership Unit (80,000 Units) .87 .20 .03 (5.61) 104.68\nDistributions per Limited Partnership Unit (80,000 Units) 10.00 14.00 8.00 6.00 6.00\nSpecial Distributions per Limited Partnership Unit (80,000 Units) 50.00 30.00 0.00 10.00 97.00\nTotal revenue decreased slightly from fiscal 1994 to fiscal 1995, primarily due to the July 1995 sale of Country Place Village II. This was offset partially by increased rental income at the Partnership's three remaining properties, particularly Autumn Heights.\nThe increase in net income is due primarily to reductions in depreciation and amortization and interest expense. Depreciation and amortization was lower in fiscal 1995 due to the sale of Country Place Village II and interest expense declined due to the June 1995 repayment of the Country Place Village II mortgage.\nCash Distributions Per Limited Partnership Unit \t 1995 1994 - - -------------------------------------------------------------- Special Distributions* $ 50.00 $ 30.00 First Quarter 2.50 3.50 Second Quarter 2.50 3.50 Third Quarter 2.50 3.50 Fourth Quarter 2.50 3.50\nTotal $ 60.00 $ 44.00\n* On August 22, 1995, the Partnership paid a special cash distribution totalling $50 per Unit, reflecting net proceeds received from the sale of Country Place Village II and the remaining proceeds from the sale of Bernardo Point in 1990. On January 27, 1994, the Partnership made a special distribution of $30 per Unit, representing proceeds reserved from the sale of Bernardo Point.\nCONSOLIDATED FINANCIAL STATEMENTS\nConsolidated Balance Sheets November 30, 1995 and 1994\nAssets 1995 1994 - - ---------------------------------------------------------------------- Investments in real estate: Land $ 5,817,668 $ 7,220,465 Buildings and improvements 22,164,580 26,508,961 ---------- ---------- 27,982,248 33,729,426 Less accumulated depreciation (9,645,010) (10,629,776) ---------- ---------- 18,337,238 23,099,650 Cash and cash equivalents 1,060,348 4,213,148 Restricted cash 61,141 57,980 Other assets, net of accumulated amortization of $120,176 in 1995 and $77,160 in 1994 191,114 242,868 ---------- ---------- Total Assets $19,649,841 $27,613,646 ========== ==========\nLiabilities and Partners' Capital\nLiabilities: Mortgages payable $ 8,564,859 $11,598,519 Distribution payable 222,222 311,111 Accounts payable and accrued expenses 149,215 137,709 Due to general partners and affiliates 40,519 38,007 Security deposits 109,876 161,667 --------- ---------- Total Liabilities 9,086,691 12,247,013\nPartners' Capital (Deficit): General Partners (846,302) (773,514) Limited Partners 11,409,452 16,140,147 ---------- ---------- Total Partners' Capital 10,563,150 15,366,633 ---------- ---------- Total Liabilities and Partners' Capital $19,649,841 $27,613,646 ========== ==========\nConsolidated Statements of Partners' Capital (Deficit) For the years ended November 30, 1995, 1994 and 1993\nGeneral Limited Partners Partners Total - - -------------------------------------------------------------------------- Balance at December 1, 1992 $ (579,981) $ 20,281,953 $ 19,701,972 Net income 271 2,436 2,707 Cash distributions (71,111) (640,000) (711,111) ------- ---------- ---------- Balance at November 30, 1993 (650,821) 19,644,389 18,993,568 Net income 1,751 15,758 17,509 Cash distributions (124,444) (3,520,000) (3,644,444) ------- ---------- ---------- Balance at November 30, 1994 (773,514) 16,140,147 15,366,633 Net income 16,100 69,305 85,405 Cash distributions (88,888) (4,800,000) (4,888,888) ------- ---------- ---------- Balance at November 30, 1995 $ (846,302) $ 11,409,452 $ 10,563,150 ======= ========== ==========\nConsolidated Statements of Operations For the years ended November 30, 1995, 1994 and 1993\nIncome 1995 1994 1993 - - ------------------------------------------------------------------------------ Rental $ 4,027,970 $ 4,146,674 $ 3,893,009 Interest 174,780 151,152 140,236 --------- --------- --------- Total Income 4,202,750 4,297,826 4,033,245 --------- --------- --------- Expenses\nProperty operating 1,912,816 1,936,098 1,697,471 Depreciation and amortization 1,047,513 1,137,125 1,113,965 Interest 929,646 1,066,185 1,077,518 General and administrative 143,378 140,909 141,584 --------- --------- --------- Total Expenses 4,033,353 4,280,317 4,030,538 --------- --------- --------- Income from operations 169,397 17,509 2,707\nLoss on sale of property (83,992) 0 0 --------- --------- --------- Net Income $ 85,405 $ 17,509 $ 2,707 ========= ========= ========= Net Income Allocated:\nTo the General Partners $ 16,100 $ 1,751 $ 271 To the Limited Partners 69,305 15,758 2,436 --------- --------- --------- $ 85,405 $ 17,509 $ 2,707 ========= ========= ========= Per Limited Partnership Unit: (80,000 outstanding)\nIncome from operations $1.91 $.20 $.03 Loss on sale of property (1.04) 0 0 --------- --------- --------- Net Income $ .87 $.20 $.03 --------- --------- ---------\nConsolidated Statements of Cash Flows For the years ended November 30, 1995, 1994 and 1993\nCash Flows from Operating Activities: 1995 1994 1993 - - ------------------------------------------------------------------------------- Net income $ 85,405 $ 17,509 $ 2,707 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,047,513 1,137,125 1,113,965 Loss on sale of property 83,992 0 0 Increase (decrease) in cash arising from changes in operating assets and liabilities: Fundings to restricted cash (152,988) (143,834) (132,417) Release of restricted cash to property operations 149,827 140,968 141,397 Other assets 8,738 39,838 15,195 Accounts payable and accrued expenses 11,506 (15,447) 13,242 Due to general partners and affiliates 2,512 2,467 (3,162) Security deposits (51,791) 18,061 2,743 --------- --------- --------- Net cash provided by operating activities 1,184,714 1,196,687 1,153,670 --------- --------- --------- Cash Flows from Investing Activities:\nNet proceeds from sale of property 3,832,290 0 0 Additions to real estate (158,367) (146,029) (8,872) --------- --------- --------- Net cash provided by (used for) investing activities 3,673,923 (146,029) (8,872) --------- --------- --------- Cash Flows from Financing Activities:\nMortgage borrowings 0 5,500,000 0 Mortgage principal payments (3,033,660) (4,537,574) (97,328) Distributions (4,977,777) (3,555,555) (622,222) Mortgage fees 0 (74,496) (94,569) Refund of deposit on mortgage refinancing 0 55,000 0 Deposit on mortgage refinancing 0 0 (55,000) IRS Section 444 deposit 0 0 295,192 --------- --------- --------- Net cash used for financing activities (8,011,437) (2,612,625) (573,927) --------- --------- --------- Net increase (decrease) in cash and cash equivalents (3,152,800) (1,561,967) 570,871 Cash and cash equivalents at beginning of period 4,213,148 5,775,115 5,204,244 --------- --------- --------- Cash and cash equivalents at end of period $ 1,060,348 $4,213,148 $ 5,775,115 ========= ========= =========\nSupplemental Disclosure of Cash Flow Information:\nCash paid during the period for interest $ 929,646 $1,066,185 $ 1,077,518\nCash refunded during the period for taxes IRS Section 444 deposit $ 0 $ 0 $ (295,192)\nNotes to the Consolidated Financial Statements For the years ended November 30, 1995, 1994 and 1993\n1. Organization Hutton\/ConAm Realty Investors 3 (the \"Partnership\") was organized as a limited partnership under the laws of the State of California pursuant to a Certificate and Agreement of Limited Partnership (the \"Partnership Agreement\") dated July 14, 1983. The Partnership was formed for the purpose of acquiring and operating certain types of residential real estate. The general partners of the Partnership are RI 3-4 Real Estate Services, Inc., an affiliate of Lehman Brothers, Inc. (see below), and ConAm Property Services IV, Ltd., an affiliate of Continental American Properties, Ltd. (the \"General Partners\"). The Partnership will continue until December 31, 2010 unless sooner terminated pursuant to the terms of the Partnership Agreement.\nOn July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. (\"Lehman Brothers\"). The transaction did not affect the ownership of the General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, effective October 8, 1993, the Hutton Real Estate Services VIII, Inc. General Partner changed its name to \"RI 3-4 Real Estate Services, Inc.\"\n2. Significant Accounting Policies\nFinancial Statements The consolidated financial statements include the accounts of the Partnership and its affiliated ventures. The effect of transactions between the Partnership and its ventures have been eliminated in consolidation.\nReal Estate Investments Real estate investments are recorded at cost less accumulated depreciation and include the initial purchase price of the property, legal fees, acquisition and closing costs.\nLeases are accounted for under the operating method. Under this method, revenue is recognized as rentals are earned and expenses (including depreciation) are charged to operations when incurred. Leases are generally for terms of one year or less.\nDepreciation is computed using the straight-line method based upon the estimated useful lives of the properties. Maintenance and repairs are charged to operations as incurred. Significant betterments and improvements are capitalized and depreciated over their estimated useful lives.\nFor assets sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income for the period.\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 fiscal quarter of 1995. Based on current circumstances, the adoption had no impact on the financial statements.\nOther Assets - Included in other assets are mortgage costs incurred in connection with obtaining financing on the Partnership's properties. Such costs are amortized over the initial term of the applicable loan.\nOffering Costs - Costs relating to the sale of limited partnership units were deferred during the offering period and charged to the limited partners' capital accounts upon the consummation of the public offering.\nIncome Taxes - No provision for income taxes has been made in the financial statements since income, losses and tax credits are passed through to the individual partners.\nCash and Cash Equivalents - Cash and cash equivalents consist of highly liquid short-term investments with maturities of three months or less from date of issuance. Cash and cash equivalents include security deposits of $32,096 and $65,837 at November 30, 1995 and 1994, respectively, the use of which is restricted under certain state statutes.\nConcentration of Credit Risk - Financial instruments which potentially subject the Partnership to a concentration of credit risk principally consist of cash and cash equivalents in excess of the financial institution's insurance limits. The Partnership invests available cash with high credit quality financial institutions.\nRestricted Cash - Restricted cash consists of escrows for real estate taxes as required by the first mortgage lender in the amount of $61,141 and $57,980 at November 30, 1995 and 1994, 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 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. The Partnership Agreement The Partnership Agreement provides that net cash from operations, as defined, will be distributed quarterly, 90% to the limited partners and 10% to the General Partners.\nNet loss for any fiscal year will be allocated 99% to the limited partners and 1% to the General Partners. Net income for any fiscal year will generally be allocated 90% to the limited partners and 10% to the General Partners.\nNet proceeds from sales or refinancing will be distributed 100% to the limited partners until each limited partner has received an amount equal to his adjusted capital value (as defined) and an annual, cumulative 7% return thereon. The balance, if any, will be distributed 85% to the limited partners and 15% to the general partners. Generally, all gain from sales will be allocated in the same manner as net proceeds from sales or refinancing.\n4. Real Estate Investments The Partnership has three residential apartment complexes acquired either directly or through investments in joint ventures as follows:\nDate Purchase Property Name Units Location Acquired Price - - ---------------------------------------------------------------------------- Autumn Heights 140 Colorado Springs, CO 1\/25\/85 $ 9,234,438\nSkyline Village 168 Tucson, AZ 3\/20\/85 10,388,068\nPonte Vedra Beach Village II 124 Jacksonville, FL 8\/22\/85 6,547,829\nOn December 20, 1990, Bernardo Point was sold to an unaffiliated party. The gross sales price of $19,915,000, paid in cash, was determined based upon current market values of comparable properties in the region. After paying off the first mortgage loan of $7,400,000 and related closing costs, the Partnership received net cash proceeds of $12,275,200. Gain on sale for financial statement purposes in the fiscal year ended November 30, 1991 was $8,450,578 and was allocated to the limited partners in accordance with the Partnership Agreement. The General Partners distributed $7,760,000 of the net sales proceeds amount while the remaining balance of approximately $4,515,000 was utilized to repay the Skyline Village mortgage loan in June 1991.\nOn July 20, 1995, the Partnership sold Country Place Village II (the \"Property\") for $3,890,000 to an institutional buyer (the \"Buyer\"), which is unaffiliated with the Partnership. The selling price was determined by arm's length negotiations between the Partnership and the Buyer. The Partnership received net proceeds of $3,832,290. The transaction resulted in a loss on sale for the Property of $83,992 which was allocated in accordance with the Partnership Agreement. On August 22, 1995, the General Partners paid a special distribution of $4,000,000 to the limited partners. The special distribution was comprised of a portion of the net proceeds from the sale of the Property and Partnership's cash reserves.\nSkyline Village and Country Place Village II were acquired through joint ventures with an unaffiliated developer. To each venture, the Partnership assigned its rights to acquire the above properties and contributed cash equal to the purchase price of the properties. The developer did not make an initial capital contribution to these ventures. In the case of Country Place Village II, the Joint Venture form was retained. The Partnership has entered into an amended and restated Agreement of General Partnership, dated as of July 1, 1992 with its two corporate General Partners, RI 3-4 Real Estate Services, Inc. and ConAm Property Services IV, Ltd. In the case of Skyline Village, the joint venture has been converted to a limited partnership. The Partnership has entered into an amended and restated Agreement of Limited Partnership, dated as of July 1, 1992 with its two corporate General Partners, RI 3-4 Real Estate Services, Inc. and ConAm Property Services IV, Ltd., as General Partners, and the Partnership as the sole limited partner. There has been no interruption in either management or operating activities of the Partnership as a result of the settlement.\nThe initial joint venture agreements of Skyline Village and Country Place Village II substantially provided that:\na. Net cash from operations will be distributed 100% to the Partnership until it has received an annual, non-cumulative 12% return on its adjusted capital contribution. Any remaining balance will be distributed 60% to the Partnership and 40% to the co-venturer.\nb. Net income of the joint ventures will be allocated to the Partnership and the co-venturer basically in accordance with the distribution of net cash from operations. Generally, all depreciation and losses will be allocated to the Partnership.\nc. Net proceeds from a sale or refinancing will be distributed 100% to the Partnership until it has received an annual, cumulative 12% return on its adjusted capital contribution and an amount equal to 120% of its adjusted capital contribution. Distributions will then be made 75% to the Partnership and 25% to the co-venturer until the Partnership has received an amount equal to 120% of its adjusted capital contribution. Any remaining balance will be distributed 50% to the Partnership and 50% to the co-venturer.\nThe amended limited partnership and general partnership agreements of Skyline Village and Country Place Village II substantially provide that:\na. Available cash from operations will be distributed 100% to the Partnership until it has received an annual, non-cumulative preferred return of $675,000 and $450,000, respectively. Any remaining balance will be distributed 99% to the Partnership and 1% to the corporate General Partners.\nb. Net income will be allocated first, proportionately to partners with negative capital accounts, as defined, until such capital accounts have been increased to zero then, to the Partnership up to the amount of any payments made on account of its preferred return and thereafter, 99% to the Partnership and 1% to the corporate General Partners. All net losses will be allocated first, to the partners with positive capital accounts, as defined, until such accounts have been reduced to zero and then 99% to the Partnership and 1% to the corporate General Partners.\nc. Income from a sale will be allocated first, to the Partnership until the Partnership's capital accounts, as defined, are equal to the fair market value of the ventures' assets at the date of the amendment. Then, any remaining balance will be allocated 99% to the Partnership and 1% to the corporate General Partners. Net proceeds from a sale or refinancing will be distributed first to the partners with the positive capital account balance, as defined; thereafter, 99% to the Partnership and 1% to the corporate General Partners.\n5. Mortgages Payable\nThe Partnership's first mortgage loans are comprised as follows:\nAutumn Heights - On October 9, 1985, the Partnership obtained a first mortgage loan of $4,600,000 collateralized by a deed of trust encumbering Autumn Heights. The loan had an initial term of five years and bore interest at an annual rate of 11% with monthly payments of interest only for the first two years. The loan was extended in 1990 for an additional three years bearing interest at an annual rate of 10.00%. The remaining balance of $4,422,269 matured November 1, 1993. A regular monthly mortgage payment was made on November 30, 1993 resulting in a principal balance of $4,411,215 at November 30, 1993. The General Partners submitted a financing application to the existing lender, John Hancock Life Insurance Company (\"John Hancock\"), along with a refundable good faith deposit equal to 2% of the new loan balance of $5.5 million; 1% of the deposit was refundable and 1% represented John Hancock's financing fee. John Hancock issued a loan commitment dated May 28, 1993.\nOn January 6, 1994, the Partnership obtained replacement financing from John Hancock. Total proceeds of $5,500,000 were received and are collateralized by a Deed of Trust, Security Agreement and Fixture Filing with Assignment of Rents Agreement encumbering the property. The loan is for a term of seven years and bears interest at an annual rate of 8% requiring monthly installments of principal and interest based on a 25 year amortization schedule. The loan requires monthly real estate tax escrow fundings. The proceeds in excess of the maturing loan balance, approximately $1 million, were added to the Partnership's cash reserve. Annual maturities for principal will be $83,894 in fiscal year 1996, $90,857 in fiscal year 1997, $98,399 in fiscal year 1998, $106,566 in fiscal year 1999, $115,411 in fiscal year 2000 and $4,861,576 thereafter.\nSkyline Village - On December 20, 1991, the venture obtained a first mortgage loan of $3,350,000 collateralized by a deed of trust, the land and the improvements, and an assignment of rents and security encumbering Skyline Village. The loan is for a term of seven years and bears interest at an annual rate of 10.125% requiring monthly installments of principal and interest. Annual maturities for principal will be $46,122 in fiscal year 1996, $51,014 in fiscal year 1997, $56,426 in fiscal year 1998, and $3,054,594 in fiscal year 1999.\nOn May 27, 1992 the General Partners made a special cash distribution to the limited partners with a portion of the mortgage loan proceeds. On January 27, 1994, the General Partners made an additional special cash distribution to the limited partners from the remaining mortgage loan proceeds.\nCountry Place Village II - On July 15, 1985, the venture obtained a first mortgage loan of $3,000,000 collateralized by a mortgage encumbering Country Place Village II. The loan had an initial term of five years and bore interest at an annual rate of 12.5% with monthly interest payments only. The loan was extended in 1990 for an additional five years bearing interest at an annual rate of 10.15% with monthly principal and interest payments. The mortgage matured in July 1995, with the remaining principal of $2,900,075 due. On June 29, 1995, the Partnership paid $2,925,099, representing principal and interest, from cash reserves to fully satisfy its mortgage obligation on Country Place Village II.\nAnnual maturities of mortgage notes principal at November 30, over the next five fiscal years are as follows:\nYear Amount\n1996 $ 130,016 1997 141,871 1998 154,825 1999 3,161,160 2000 115,411 \tThereafter\t4,861,576 --------- $ 8,564,859 =========\n6. Transactions with Related Parties\nThe following is a summary of fees earned and reimbursable expenses for the years ended November 30, 1995, 1994 and 1993, and the unpaid portion at November 30, 1995:\nUnpaid at November 30, Earned 1995 1995 1994 1993 - - ---------------------------------------------------------------------------- Reimbursement of: Administrative salaries and expenses $ 25,509 $ 53,415 $ 39,251 $ 51,164 Out-of-pocket expenses 0 3,105 1,434 2,854 Property operating salaries 0 258,010 280,845 274,314\nProperty management fees 15,010 203,107 207,193 194,835 ------ ------- ------- ------- $ 40,519 $517,637 $528,723 $523,167 ====== ======= ======= =======\nThe above amounts have been paid and\/or accrued to the general partners and affiliates as follows:\nUnpaid at November 30, Earned 1995 1995 1994 1993 - - ----------------------------------------------------------------------------- RI 3-4 Real Estate Services, Inc. $ 25,509 $ 56,520 $ 40,685 $ 54,018\nConAm and affiliates 15,010 461,117 488,038 469,149 ------ ------- ------- ------- $ 40,519 $517,637 $528,723 $523,167 ====== ======= ======= =======\n7. Reconciliation of Financial Statement and Tax Information\nThe following is a reconciliation of net income for financial statement purposes to net income (loss) for federal income tax purposes for the years ended November 30, 1995, 1994 and 1993:\n1995 1994 1993 - - ----------------------------------------------------------------------------- Net income per financial statements $ 85,405 $ 17,509 $ 2,707\nDepreciation deducted for tax purposes in excess of depreciation expense per financial statements (117,445) (182,687) (182,688)\nTax basis gain on sale in excess of GAAP loss on sale 852,564 0 0\nTax basis joint venture net income (loss) in excess of GAAP basis joint venture net loss (74,889) (172,232) (170,796)\nOther 3,951 (949) (1,587) ------- ------- ------- Taxable net income (loss) $ 749,586 $ (338,359) $ (352,364) ======= ======= =======\nThe following is a reconciliation of partners' capital for financial statement purposes to partners' capital for federal income tax purposes as of November 30, 1995, 1994 and 1993:\n1995 1994 1993\nPartners' capital per financial statements $10,563,150 $15,366,633 $18,993,568\nAdjustment for cumulative difference between tax basis net income (loss) and net income per financial statements (3,225,297) (3,889,478) (3,533,610) --------- ---------- ---------- Partners' capital per tax return $7,337,853 $11,477,155 $15,459,958 ========= ========== ==========\n8. Distributions Paid\nCash distributions, per the consolidated statements of partners' capital (deficit), are recorded on the accrual basis, which recognizes specific record dates for payments within each fiscal year; the consolidated statements of cash flows recognize actual cash distributions paid during the fiscal year. The following table discloses the annual amounts as presented on the consolidated financial statements:\nDistributions Distributions Payable Distributions Distributions Payable Beginning of Year: Declared: Paid: November 30: - - --------------------------------------------------------------------------- 1995 $ 311,111 $ 4,888,888 $ 4,977,777 $ 222,222 1994 222,222 3,644,444 3,555,555 311,111 1993 133,333 711,111 622,222 222,222\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Hutton\/ConAm Realty Investors 3:\nWe have audited the consolidated balance sheets of Hutton\/ConAm Realty Investors 3, a California limited partnership, and Consolidated Ventures as of November 30, 1995 and 1994 and the related consolidated statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended November 30, 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hutton\/ConAm Realty Investors 3, a California limited partnership, and Consolidated Ventures as of November 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 November 30, 1995 in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nHartford, Connecticut February 1, 1996\nNET ASSET VALUATION\nComparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $250 Unit at November 30, 1995 (Unaudited)\nAcquisition Cost (Purchase Price Partnership's Plus General Share of Partners' November 30, Acquisition 1995 Appraised Property Date of Acquisition Fees) Value (1) - - -------------------------------------------------------------------------- Autumn Heights 01-25-85 $ 9,687,174 $ 10,300,000 Skyline Village 03-20-85 10,838,195 8,000,000 Ponte Vedra Beach Village II 08-22-85 6,869,917 5,600,000 ---------- ---------- Total Appraised Value as of November 30, 1995 $ 27,395,286 $ 23,900,000 ---------- ---------- Cash and cash equivalents 1,121,489 Other assets 10,176 ---------- 25,031,665 Less: Total liabilities (9,086,691) ---------- Partnership Net Asset Value (2) $ 15,944,974 ========== Net Asset Value Allocated: Limited Partners $ 15,944,974 General Partners 0 ---------- $ 15,944,974 ========== Net Asset Value Per Unit (80,000 units outstanding) $199.31 =======\n(1) This represents the Partnership's share of the November 30, 1995 Appraised Values which were determined by an independent property appraisal firm.\n(2) The Net Asset Value assumes a hypothetical sale at November 30, 1995 of all the Partnership's properties at a price based upon their value as a rental property as determined by an independent property appraisal firm, and the distribution of the proceeds of such sale, combined with the Partnership's cash after liquidation of the Partnership's liabilities, to the Partners.\nLimited Partners should note that appraisals are only estimates of current value and actual values realizable upon sale may be significantly different. A significant factor in establishing an appraised value is the actual selling price for properties which the appraiser believes are comparable. In addition, the appraised value does not reflect the actual costs which would be incurred in selling the properties. As a result of these factors and the illiquid nature of an investment in Units of the Partnership, the variation between the appraised value of the Partnership's properties and the price at which Units of the Partnership could be sold is likely to be significant. Fiduciaries of Limited Partners which are subject to ERISA or other provisions of law requiring valuations of Units should consider all relevant factors, including, but not limited to Net Asset Value per Unit, in determining the fair market value of the investment in the Partnership for such purposes.\nHUTTON\/CONAM REALTY INVESTORS 3 Schedule III Real Estate and Accumulated Depreciation\nNovember 30, 1995\nCost Capitalized Subsequent Initial Cost to Partnership To Acquisition --------------------------- -------------- Land, Buildings and Buildings and Description Encumbrances Land Improvements Improvements - - ------------------------------------------------------------------------------- Residential Property: Partnership Owned:\nAutumn Heights Colorado Springs, CO $ 5,356,703 $ 1,581,000 $ 8,123,598 $ 196,009\nPonte Vedra Beach Village II Jacksonville, FL 0 788,000 6,138,289 130,175 --------- --------- ---------- ------- 5,356,703 2,369,000 14,261,887 326,184\nConsolidated Ventures: Skyline Village Tucson, AZ 3,208,156 3,410,000 7,510,205 104,972 --------- --------- ---------- ------- $ 8,564,859 $ 5,779,000 $21,772,092 $ 431,156 ========= ========= ========== =======\nHUTTON\/CONAM REALTY INVESTORS 3 Schedule III - Real Estate and Accumulated Depreciation (continued)\nNovember 30, 1995\nGross Amount at Which Carried at Close of Period -------------------------------------- Buildings and Accumulated Description Land Improvements Total Depreciation - - ------------------------------------------------------------------------------- Residential Property: Partnership Owned:\nAutumn Heights Colorado Springs, CO $ 1,589,840 $ 8,310,767 $ 9,900,607 $ 3,654,182\nPonte Vedra Beach Village II Jacksonville, FL 789,882 6,266,582 7,056,464 2,627,647 --------- ---------- ---------- --------- 2,379,722 14,577,349 16,957,071 6,281,829\nConsolidated Ventures: Skyline Village Tucson, AZ 3,437,946 7,587,231 11,025,177 3,363,181 --------- ---------- ---------- --------- $ 5,817,668 $ 22,164,580 $27,982,248 $ 9,645,010 ========= ========== ========== ========= (1) (2)\nHUTTON\/CONAM REALTY INVESTORS 3 Schedule III - Real Estate and Accumulated Depreciation (continued)\nNovember 30, 1995\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed - - -------------------------------------------------------------------------- Residential Property: Partnership Owned:\nAutumn Heights Colorado Springs, CO 1983-1985 01\/25\/85 (3)\nPonte Vedra Beach Village II Jacksonville, FL 1984-1985 08\/22\/85 (3)\nConsolidated Ventures: Skyline Village Tucson, AZ 1984-1985 03\/20\/85 (3)\n(1) The aggregate cost for both financial reporting and Federal income tax purposes is $27,982,248.\n(2) The amount of accumulated depreciation for Federal income tax purposes is $16,816,451.\n(3) Buildings and improvements - 25 years; personal property - 10 years.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended November 30, 1995, 1994 and 1993:\nReal Estate Investments: 1995 1994 1993 -------------------------------------------- Beginning of year $ 33,729,426 $ 33,583,397 $ 33,574,525 Acquisitions 158,367 146,029 8,872 Dispositions (5,905,545) 0 0 --------- ---------- ---------- End of year $ 27,982,248 $ 33,729,426 $ 33,583,397 ========== ========== ==========\nAccumulated Depreciation:\nBeginning of year $ 10,629,776 $ 9,533,654 $ 8,438,736 Dispositions (1,989,263) 0 0 Depreciation expense 1,004,497 1,096,122 1,094,918 ---------- ---------- --------- End of year $ 9,645,010 $ 10,629,776 $ 9,533,654 ========== ========== =========\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of Hutton\/ConAm Realty Investors 3, a California limited partnership, and Consolidated Ventures has been incorporated by reference in this Form 10-K from the Annual Report to unitholders of Hutton\/ConAm Realty Investors 3 for the year ended November 30, 1995. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nHartford, Connecticut February 1, 1996","section_15":""}
{"filename":"318870_1995.txt","cik":"318870","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nIndependent Bankshares, Inc., a Texas corporation (the \"Company\"), is a multi-bank holding company that, at December 31, 1995, owned 100% of Independent Financial Corp. (\"Independent Financial\"), which, in turn, owned 100% of First State Bank, National Association, Abilene, Texas (\"First State, N.A., Abilene\") and First State Bank, National Association, Odessa, Texas (\"First State, N.A., Odessa\"). First State, N.A., Abilene and First State, N.A., Odessa are collectively referred to as the \"Banks.\"\nEffective November 1, 1994, two of the Company's then existing subsidiary banks, The First National Bank in Stamford, Stamford, Texas (\"First National\"), and The Winters State Bank, Winters, Texas (\"Winters State\"), were merged with and into First State, N.A. Abilene. As a result of the merger, the offices of First National and Winters State became branches of First State, N.A. Abilene. Additionally, First State, N.A., Abilene has two separate branch office locations in Abilene, Texas. First State, N.A. Odessa has two branches in Odessa, Texas.\nThe Company's primary activities are to assist the Banks in the management and coordination of their financial resources and to provide capital, business development, long range planning and public relations for the Banks. Each of the Banks operates under the day-to-day management of its own officers and board of directors and formulates its own policies with respect to banking matters.\nAt December 31, 1995, the Company had, on a consolidated basis, total assets of $180,344,000, total deposits of $164,704,000, total loans, net of unearned income, of $81,927,000 and total stockholders' equity of $13,818,000.\nThe Banks\nThe Company conducts substantially all of its business through the Banks, both of which are located in the West Texas area. Each of the Banks is an established franchise with a significant presence in their respective service areas. First State, N.A., Abilene was chartered in 1982 and was the third largest commercial bank headquartered in Abilene, Texas, in terms of total assets at December 31, 1995. First State, N.A., Odessa was chartered in 1983 and was the fourth largest commercial bank headquartered in Odessa, Texas, in terms of total assets at December 31, 1995. The deposits of the Banks are insured by the Federal Deposit Insurance Corporation (the \"FDIC\") to the maximum extent provided by law.\nThe following table sets forth certain selected information with respect to the Banks at December 31, 1995:\nAlthough each Bank operates under the management of its own directors and officers, the Banks participate as a group in providing various financial services and extensions of credit, which increases the ability of each Bank to provide such services to customers who might otherwise be required to seek banking services from larger banks. The principal services provided by the Banks are as follows:\nThe Company\nGeneral\nThe Company is a bank holding company under the Bank Holding Company Act of 1956, as amended (\"BHCA\"), and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). Federal law subjects bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and policies.\nScope of Permissible Activities\n\"Closely Related\" to Banking. The BHCA prohibits a bank holding company, with certain limited exceptions, from acquiring direct or indirect ownership or control of any voting shares of any company that is not a bank or from engaging in any activities other than those of banking, managing or controlling banks and certain other subsidiaries, or furnishing services to or performing services for its banking subsidiaries. One principal exception to these prohibitions allows the acquisition of interests in companies whose activities are found by the Federal Reserve Board, by order or regulation, to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. Some of the activities that have been determined by regulation to be closely related to banking are making or servicing loans, performing certain data processing services, acting as an investment or financial advisor to certain investment trusts and investment companies and providing certain securities brokerage services. In approving acquisitions by the Company of entities engaged in banking-related activities, the Federal Reserve Board would consider a number of factors, including the expected benefits to the public, such as greater convenience and increased competition or gains in efficiency, which would be weighed against the risk of potential negative effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board may also differentiate between activities commenced de novo and activities commenced through the acquisition of a going concern. The Company has no current plans to form or acquire any non-banking subsidiaries.\nSecurities Activities. The Federal Reserve Board has approved applications by bank holding companies to engage, through nonbank subsidiaries, in certain securities-related activities (underwriting of municipal revenue bonds, commercial paper, consumer-receivable-related securities and one-to-four family mortgage-backed securities), provided that the subsidiaries would not be \"principally engaged\" in such activities for purposes of Section 20 of the Glass-Steagall Act. In very limited situations, holding companies may be able to use such subsidiaries to underwrite and deal in corporate debt and equity securities. Bills have been introduced in both the U.S. Senate and House of Representatives that could, if enacted, remove many of the restraints imposed by the Glass-Steagall Act.\nSafe and Sound Banking Practices. Bank holding companies are not permitted to engage in unsafe or unsound banking practices. For example, the Federal Reserve Board's Regulation Y requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve Board may oppose the transaction if it would constitute an unsafe or unsound practice or would violate any law or regulation. Additionally, a holding company may not impair the financial soundness of a subsidiary bank by causing it to make funds available to nonbanking subsidiaries or their customers when such a transaction would not be prudent. The Federal Reserve Board may exercise several administrative remedies including cease-and-desist powers over parent holding companies and nonbanking subsidiaries when the actions of such companies would constitute a serious threat to the safety, soundness or stability of a subsidiary bank.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") expanded the Federal Reserve Board's authority to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe and unsound banking practices or that constitute violations of laws or regulations. FIRREA authorizes the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantee against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets or take other appropriate action as determined by the ordering agency.\nFIRREA increased the amount of civil money penalties that the Federal Reserve Board may assess for certain activities conducted on a knowing and reckless basis, if those activities cause a substantial loss to a depository institution. The penalties may reach as much as $1,000,000 per day. FIRREA also expanded the scope of individuals and entities or \"institution-affiliated parties\" against which such penalties may be assessed. In addition, FIRREA contains a \"cross-guarantee\" provision that makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred, or reasonably anticipated to be incurred, in connection with the failure of an affiliated insured depository institution. The FDIC must present its claim within two years of incurring such loss and may require either immediate or installment payments.\nAnti-Tying Restrictions. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to certain other services offered by a holding company or its affiliates.\nAnnual Reporting; Examination\nThe Company is required to file quarterly and annual reports with the Federal Reserve Bank of Dallas (the \"Federal Reserve Bank\") and such additional information as the Federal Reserve Bank may require pursuant to the BHCA. The Federal Reserve Bank may examine a bank holding company or any of its subsidiaries and charge the examined institution for the cost of such an examination. The Company is also subject to reporting and disclosure requirements under state and federal securities laws.\nCapital Adequacy Requirements\nStandards. The Federal Reserve Board monitors the capital adequacy of bank holding companies. The Federal Reserve Board has adopted a system using a combination of risk-based guidelines and leverage ratios to evaluate the capital adequacy of bank holding companies. Under the risk-based capital guidelines, each category of assets is assigned a different risk weight, 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 to them the appropriate risk weight. In addition, the guidelines define the capital components. Total capital is defined as the sum of \"Tier 1\" and \"Tier 2\" capital elements, with \"Tier 2\" being limited to 100% of \"Tier 1.\" For bank holding companies, \"Tier 1\" capital includes, with certain restrictions, common stockholders' equity and qualifying perpetual noncumulative preferred stock and minority interests in consolidated subsidiaries. \"Tier 2\" capital includes, with certain limitations, certain other preferred stock, as well as qualifying debt instruments and all or part of the allowance for possible loan losses.\nThe guidelines require a minimum ratio of qualifying total capital to risk-weighted assets of 8.0% (of which at least 4.0% is required to be in the form of \"Tier 1\" capital elements). At December 31, 1995, the Company's ratios of \"Tier 1\" and total capital to risk-weighted assets were 15.23% and 16.08%, respectively. At such date, both ratios exceeded regulatory minimums.\nIn addition to the risk-based capital guidelines, the Federal Reserve 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 quarterly average total assets. The leverage ratio adopted by the federal banking agencies requires a minimum 3.0% \"Tier 1\" capital to adjusted quarterly average total assets ratio for top regulatory- rated banking organizations. All other institutions are expected to maintain a leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31, 1995, was 7.65% and exceeded the regulatory minimum.\nConsequences of Capital Deficiencies. A bank holding company that fails to meet the applicable capital standards will be at a disadvantage. For example, Federal Reserve Board policy discourages the payment of dividends by a bank holding company from borrowed funds as well as payments that would adversely affect capital adequacy. Failure to meet the capital guidelines may result in institution by the Federal Reserve Board of appropriate supervisory or enforcement actions.\nImposition of Liability for Undercapitalized Subsidiaries\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") became effective at various times through January 1994. FDICIA requires bank regulators to take \"prompt corrective action\" to resolve problems associated with insured depository institutions. In the event an institution becomes \"undercapitalized,\" it must submit a capital restoration plan. The capital restoration plan will not be accepted by applicable regulators unless each company \"having control of\" the undercapitalized institution \"guarantees\" the subsidiary's compliance with the capital restoration plan until it becomes \"adequately capitalized.\" The Company has control of the Banks for purposes of this statute.\nUnder FDICIA, the aggregate liability of all companies controlling a particular institution is generally limited to the lesser of 5% of the institution's assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDICIA grants greater powers to regulatory authorities in situations where an institution becomes \"significantly\" or \"critically\" undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution may be required to obtain prior Federal Reserve Board approval of proposed dividends or could be required to consent to a merger or to divest the troubled institution or other affiliates.\nAcquisitions by Bank Holding Companies\nFederal Reserve Board Approval. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or 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 approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. The Attorney General of the United States may, within 30 days after approval of an acquisition by the Federal Reserve Board, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts.\nInterstate Acquisitions. Currently, the Federal Reserve Board will only allow the acquisition by a bank holding company of an interest in any bank located in another state if the statutory laws of the state in which the target bank is located expressly authorize such acquisition. The Texas Banking Code permits, in certain circumstances, out-of-state bank holding companies to acquire certain existing banks and bank holding companies in Texas. However, Congress has enacted and the President has signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"Interstate Act\"), which permits, commencing one year after enactment, bank holding companies 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 subject to interstate acquisition by out-of-state bank holding companies. The minimum age of local banks subject to interstate acquisition is limited to a maximum of five years.\nMergers of Banks and Thrifts. FDICIA eased restrictions on cross-industry mergers. Members of the Bank Insurance Fund (\"BIF\") and the Savings Association Insurance Fund are generally allowed to merge, assume each other's deposits, and transfer assets in exchange for an assumption of deposit liabilities. A formula applies to treat insurance assessments relating to acquired deposits as if they were still insured through the acquired institution's insurance fund. The transaction must be approved by the appropriate federal banking regulator. In considering such approval, the regulators take into account applicable capital requirements, certain interstate banking restrictions and other factors.\nAcquisitions of Troubled Institutions. The Competitive Equality Banking Act of 1987 (\"CEBA\") amended the Federal Deposit Insurance Act and certain other statutes to provide federal regulatory agencies with expanded authority to deal with troubled institutions. Among other things, CEBA expanded the ability of out-of-state holding companies to acquire certain financial institutions that are in danger of closing and permits the FDIC, in certain circumstances, to establish a \"bridge bank\" to assume the deposits or liabilities of one or more closed banks or to perform certain other functions.\nThe Banks\nGeneral\nThe Banks are national banking associations organized under the National Bank Act of 1864, as amended (the \"National Bank Act\"), and are subject to regulatory supervision and examination by the Office of the Comptroller of the Currency (the \"Comptroller\"). Pursuant to such regulation, the Banks are subject to special restrictions, supervisory requirements and potential enforcement actions.\nPermissible Activities for National Banks\nNational Bank Powers. The National Bank Act delineates the rights, privileges and powers of national banks and defines the activities in which national banks may engage. National banks are authorized to engage in the following: make, arrange, purchase or sell loans or extensions of credit secured by liens on interests in real estate; purchase, hold and convey real estate under certain conditions; offer certain trust services to the public; deal in investment securities in certain circumstances; and, more broadly, engage in the \"business of banking\" and activities that are \"incidental\" to banking. Specifically, the following are a few of the activities deemed incidental to the business of banking: the borrowing and lending of money; receiving deposits, including deposits of public funds; holding or selling stock or other property acquired in connection with security on a loan; discounting and negotiating evidences of debt; acting as guarantor, if the bank has a \"substantial interest in the performance of the transaction\"; issuing letters of credit to or on behalf of its customers; operating a safe deposit business; providing check guarantee plans; issuing credit cards; operating a loan production office; selling loans under repurchase agreements; selling money orders at offices other than bank branches; providing consulting services to banks; and verifying and collecting checks.\nIn general, statutory restrictions on the activities of banks are aimed at protecting the safety and soundness of such depository institutions. Many of the statutory restrictions limit the participation of national banks in the securities and insurance product markets. These restrictions do not now affect the Banks, because the Banks are not presently involved in the types of transactions covered by the restrictions.\nBranching\nNational banks may establish a branch anywhere in Texas provided that the branch is approved in advance by the Comptroller, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. Federal law places limitations on the ability of national banks, such as the Banks, to branch across state lines.\nRestrictions on Transactions With Affiliates\nCertain provisions of FDICIA applicable to the Banks enhance safeguards against insider abuse by recodifying current law restricting transactions among related parties. One set of restrictions is found in Section 23A of the Federal Reserve Act, which affects loans to and investments in \"affiliates\" of the Banks. The term \"affiliates\" include the Company and any of its subsidiaries. Section 23A imposes limits on the amount of such transactions and also requires certain levels of collateral for such loans. In addition, Section 23A limits the amount of advances to third parties that are collateralized by the securities or obligations of the Company or its subsidiaries.\nAnother set of restrictions is found in Section 23B of the Federal Reserve Act. Among other things, Section 23B requires that certain transactions between each Bank and its affiliates must be on terms substantially the same, or at least as favorable to the subject Bank, 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 Bank and its affiliates must be on terms and under circumstances, including credit underwriting standards and procedures, that in good faith would be offered to or would apply to nonaffiliated companies. Each Bank is also subject to certain prohibitions against advertising that suggests that the Bank is responsible for the obligations of its affiliates.\nThe restrictions on loans to insiders contained in the Federal Reserve Act and Regulation O now apply to all insured institutions and their subsidiaries and holding companies. The aggregate amount of an institution's loans to insiders is limited to the amount of its unimpaired capital and surplus, unless the FDIC determines that a lesser amount is appropriate. Each Bank may pay, on behalf of any executive officer or director, an amount exceeding funds on deposit in that individual's personal account only if there is a written, preauthorized, interest-bearing extension of credit specifying a method of repayment and a written preauthorized transfer of funds from another account of the executive officer or director at that Bank. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.\nInterest Rate Limits and Lending Regulations\nThe Banks are subject to various state and federal statutes relating to the extension of credit and the making of loans. The maximum legal rate of interest that the Banks may charge on a loan depends on a variety of factors such as the type of borrower, purpose of the loan, amount of the loan and date the loan is made. There are several different state and federal statutes that set maximum legal rates of interest for various lending situations. If a loan qualifies under more than one statute, the lending institutions may charge the highest rate for which the loan is eligible.\nLoans made by banks located in Texas are subject to numerous other federal and state laws and regulations, including truth-in-lending statutes, the Texas Consumer Credit Code, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act. These laws provide remedies to the borrower and penalties to the lender for failure of the lender to comply with such laws. The scope and requirements of these laws and regulations have expanded in recent years, and claims by borrowers under these laws and regulations may increase.\nRestrictions on Subsidiary Bank Dividends\nDividends payable by the Banks to Independent Financial are restricted under the National Bank Act. The Banks' ability to pay dividends is further restricted by the requirement that they maintain adequate levels of capital in accordance with capital adequacy guidelines promulgated from time to time by the Comptroller. See \"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - Dividend Policy.\" Moreover, the prompt corrective provisions of FDICIA and implementing regulations prohibit a bank from paying a dividend if, following the payment, the bank would be in any of the three capital categories for undercapitalized institutions. See \"Capital Adequacy Requirements\" below.\nExaminations\nThe Comptroller periodically examines and evaluates national banks. Based upon such evaluations, the Comptroller may revalue certain assets of an institution and require that it establish specific reserves to compensate for the difference between the regulatory-determined value and the book value of such assets. The Comptroller is authorized to assess the institution an annual fee based upon deposits for, among other things, the costs of conducting the examinations.\nCapital Adequacy Requirements\nFDICIA, among other things, substantially revised existing statutory capital standards, restricted certain powers of state banks, gave regulators the authority to limit officer and director compensation and required holding companies to guarantee the capital compliance of their banks in certain instances. Among other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" with respect to banks that do not meet minimum capital requirements. FDICIA established five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized,\" as defined by regulations adopted by the Federal Reserve Board, the FDIC and the other federal depository institution regulatory agencies. A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to meet any critical capital level set forth in the regulations. The critical capital level must\nbe a level of tangible equity capital equal to the greater of 2% of total tangible assets or 65% of the minimum leverage ratio to be prescribed by regulation. An 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. At December 31, 1995, each of the Banks was well capitalized.\nBanks with capital ratios below the required minimum are subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.\nCorrective Measures for Capital Deficiencies\nFDICIA requires the federal banking regulators to take \"prompt corrective action\" with respect to capital-deficient institutions with the overall goal to reduce losses to the depository insurance fund. In addition to requiring the submission of a capital restoration plan (as discussed above), FDICIA contains broad restrictions on certain activities of undercapitalized institutions involving asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.\nAs an institution's capital decreases, the FDIC's powers and scrutiny become greater. A significantly under-capitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. Under proposed regulations, an institution will be considered critically undercapitalized if its tangible equity to assets ratio falls below 2%. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator.\nReal Estate Lending Evaluations and Appraisal Requirements\nFDICIA required the federal banking regulators to adopt uniform standards for evaluations by the regulators of loans collateralized by real estate or made to finance improvements to real estate. In formulating the standards, the banking agencies were required to take into consideration the risk posed to the insurance funds by real estate loans, the need for safe and sound operation of insured depository institutions and the availability of credit. FDICIA also prohibits the regulators from adversely evaluating a real estate loan or investment solely on the grounds that the investment involves commercial, residential or industrial property, unless the safety and soundness of an institution may be affected.\nThe federal agencies adopted a number of regulatory standards with regard to real estate lending. These standards require banking institutions to establish and maintain written internal real estate lending policies. These policies must not only be consistent with safe and sound banking practices, but must also be appropriate to the size of the institution and the nature and scope of its operations. The policies must establish loan portfolio diversification standards, prudent underwriting standards, including clear and measurable loan-to-value limits (although such limits should not exceed specific supervisory limits), loan administration procedures and comprehensive documentation, approval and reporting requirements to ensure compliance with these policies. Additionally, the institution's policies must be reviewed and approved by that institution's Board of Directors on at least an annual basis and such policies must be continually monitored by the institutions to ensure compatibility with current market conditions. In addition, banks are required to secure appraisals for real estate-collateralized loans with a transaction value of $250,000 or more.\nDeposit Insurance Assessments\nFDICIA required the FDIC to establish a risk-based deposit insurance premium schedule. The risk-based assessment system is used to calculate a depository institution's semi-annual deposit insurance assessment based upon the designated reserve ratio for the deposit insurance fund and the probability and extent to which the deposit insurance fund will incur a loss with respect to this institution. In addition, the FDIC can impose special assessments to cover the cost of borrowings from the U.S. Treasury, the Federal Financing Bank and BIF member banks.\nOn September 15, 1992, the FDIC issued a rule revising its assessment regulations from the existing flat-rate system for deposit insurance assessments (or \"premiums\") to a new, risk-based assessment system. This system became effective for the assessment period beginning January 1, 1993. Under this system, each depository institution will be placed in one of nine assessment categories based on certain capital and supervisory measures. Institutions assigned to higher-risk categories -- that is, institutions that pose a greater risk of loss to their respective deposit insurance funds -- pay assessments at higher rates than would institutions that pose a lower risk. The Banks were assessed a weighted average premium of $0.1073 per $100 of deposits for the year ended December 31, 1995.\nCommunity Reinvestment Act\nThe Community Reinvestment Act of 1977 (\"CRA\") and the regulations issued by the Comptroller to implement that law are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide for regulatory assessment of a bank's record in meeting the needs of its service area when considering applications to establish branches, merger applications and applications to acquire the assets and assume the liabilities of another bank. FIRREA requires federal banking agencies to make public a rating of a bank's performance under the CRA. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The bank regulatory agencies in 1995 adopted final regulations implementing the CRA. These regulations affect extensive changes to the existing procedures for determining compliance with the CRA and the full effect of these new regulations cannot be determined at this time.\nInstability of Regulatory Structure\nOther legislative and regulatory proposals regarding changes in banking, and regulations of banks, thrifts and other financial institutions, are being considered by the executive branch of the federal government, Congress and various state governments, including Texas. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. The Company cannot predict accurately whether any of these proposals will be adopted or, if adopted, how these proposals will affect the Company or the Banks.\nExpanding Enforcement Authority\nOne of the major additional burdens imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC are possessed of extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and other holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The regulatory agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers.\nEffect on Economic Environment\nThe policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. Government securities, control of borrowings at the \"discount window,\" changes in the discount rate on member bank borrowings, changes in reserve requirements against member bank deposits and against certain borrowings by banks and their affiliates and the placing of limits on interest rates that member banks may pay on time and savings deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The Company cannot predict the nature of future monetary policies and the effect of such policies on the business and earnings of the Company and the Banks.\nEmployees\nAt March 18, 1996, the Company and the Banks had 97 full-time equivalent employees. Employees are provided with employee benefits, such as an employee stock ownership\/401(k) plan and life, health and long-term disability insurance plans. The Company considers the relationship of the Banks with their employees to be excellent.\nCompetition\nThe activities in which the Company and the Banks engage are highly competitive. Each activity engaged in and the geographic market served involves competition with other banks and savings and loan associations as well as with nonbanking financial institutions and nonfinancial enterprises. In Texas, savings and loan associations and banks are allowed to establish statewide branch offices. The Banks actively compete with other banks in their efforts to obtain deposits and make loans, in the scope and type of services offered, in interest rates paid on time deposits and charged on loans and in other aspects of banking. In addition to competing with other commercial banks within and without their primary service areas, the Banks compete with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, factors, certain governmental agencies, credit card organizations and other enterprises. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds. The Banks also compete with suppliers of equipment in providing equipment financing.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAt December 31, 1995, the Company occupied approximately 600 square feet of space for its corporate offices at 547 Chestnut Street, Abilene, Texas. The Central Branch of First State, N.A., Abilene occupies approximately 8,000 square feet at this same facility. The following table sets forth, at December 31, 1995, certain information with respect to the banking premises owned or leased by the Company and the Banks. The Company considers such premises adequate for its needs and the needs of the Banks.\nThe Banks own or lease certain additional tracts of land for parking, drive-in facilities and for future expansion or construction of new premises. Aggregate annual rentals of the Company and the Banks for all leased premises during the year ended December 31, 1995, were $46,000. This amount represents rentals paid for the lease of land by the Wylie Branch of First State, N.A., Abilene and of banking premises by the Winwood Branch of First State, N.A., Odessa.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n1. In Jon F. Bergstrom, et. al. v. First United Trust Company, et. al. and Morton J Adels, et. al. v. The First State Bank of Abilene, et. al., Civil Action No. H-87-2757 (Consolidated with Civil Action No. H-88-764) brought in the United States District Court for the Southern District of Texas (Houston Division,), the plaintiffs asserted various causes of action which sought to impose liability on the Company and certain of the former officers and directors of First State Bank, N.A., Abilene as a result of the purchase of the stock of the failed bank, First State Bank of Saginaw. Each of the 25 plaintiffs sought actual damages in the amount of $55,000. The plaintiffs additionally claimed violations of the Racketeer Influenced and Corrupt Organizations Act (18 U.S.C. Section 1961 et. seq.) which imposes treble damages. The court in this case granted the Company's motion for summary judgment and on March 10, 1995, rendered a final judgment in favor of the defendants.\n2. Security State Bank, Big Spring, Texas, filed a lawsuit (Security State Bank, Big Spring, Texas v. First State Bank, N.A. d\/b\/a First State Bank of Wylie, N.A, Independent Bankshares, Inc. and Bryan Stephenson, Individually - Cause No. 42475-A) on April 2, 1991, in the 157th Judicial District Court of Taylor County, Texas, against First State, N.A., Abilene, the Company and its President, Bryan W. Stephenson, as a result of collection efforts regarding a loan that was participated to the plaintiff. First State, N.A., Abilene, released certain guarantors of the loan upon partial payment of their guaranties based, in part, upon information as to the value of the primary collateral, namely, the stock of First Comanche Bankshares, a bank holding company. Shortly after the foreclosure on First Comanche Bankshares stock, the Texas Department of Banking closed the bank subsidiary of First Comanche Bankshares. Security State Bank, Big Spring, as a participant in the loan, asserts that First State, N.A., Abilene negligently and\/or fraudulently handled the loan participation. Security State Bank, Big Spring, has also asserted causes of action for tortious interference, breach of fiduciary duty, negligent misrepresentation and breach of contract. The plaintiff's interest in the loan participation was approximately $287,140 in principal amount. The Company is vigorously contesting all of the aforementioned claims and\/or causes of action related to this litigation and considers the lawsuit to be without merit.\n3. First State, N.A., Abilene f\/k\/a First State Bank of Wylie, N.A. as successor in interest of The First State Bank of Abilene, a former bank subsidiary of the Company (\"FSB Abilene\") filed a lawsuit on April 22, 1992, against O. B. Stephens, Jr. (First State Bank, N.A. f\/k\/a First State Bank of Wylie, N.A. v. O. B. Stephens, Jr., Cause No. 42849-A) in State District Court in Taylor County, Texas, on a promissory note in the approximate principal amount of $355,960, made by Mr. Stephens. First State, N.A., Abilene sought actual damages of $310,425 plus interest and attorneys' fees from Mr. Stephens. Although First State, N.A., Abilene is the current holder of the note, another bank owns a 45.5% participation interest in the loan and the underlying note.\nIn connection with this lawsuit, Mr. Stephens has filed a general and specific denial and has asserted certain affirmative defenses and counterclaims including misrepresentation, fraud and bad faith. The plaintiff claims, among other things, that FSB- Abilene agreed to offset the amount owing under the promissory note with amounts allegedly due plaintiff under an offset agreement. Mr. Stephens seeks actual damages in an amount not less than $1,000,000, punitive damages in amount not less than three times actual damages, prejudgment and post judgment interest and attorneys fees and costs.\nFirst State, N.A., Abilene is vigorously contesting the affirmative defenses and counterclaims asserted by Mr. Stephens and considers Mr. Stephens' affirmative defenses and counterclaims to be without merit. First State, N.A., Abilene has filed a motion for Partial Summary Judgment with regard to the various affirmative defenses and counterclaims made by Mr. Stephens. This case was originally set for trial in February 1996, but has been continued by the court upon a motion by Mr. Stephens.\n4. In 1985, a former subsidiary bank of the Company foreclosed on the stock of Texas Bank & Trust Company, Sweetwater, Texas (\"TB&T-Sweetwater\"), which became a repossessed asset of the former subsidiary. TB&T-Sweetwater subsequently failed, resulting in a legal action being brought in federal court against the thirteen TB&T-Sweetwater directors by the FDIC. In September 1993, nine former directors of TB&T-Sweetwater (the \"Outside Directors\") settled with the FDIC for an aggregate of $60,000. All the former directors of TB&T-Sweetwater requested that the Company reimburse them for their expenses and settlement costs incurred by them in their defense of the FDIC litigation. This request was based on their interpretation of certain indemnification provisions contained in the Company's Articles of Incorporation.\nIn January 1994, the Company filed a declaratory judgment action in state district court to petition the court to rule on certain matters that would have precluded indemnification. Certain of the directors filed counterclaims against the Company asserting their right to be indemnified. A hearing occurred in July 1994, and the court issued an order in September 1994, denying the Company's petition and upholding the individuals' counterclaims.\nIn December 1994, a settlement was entered into between the FDIC, one Outside Director and the three management directors of TB&T-Sweetwater who were also management directors of the Company (the \"Inside Directors\"), with the Inside Directors paying the FDIC a total of $450,000. As a result of the two settlements and indemnification requests, the Outside Directors claimed indemnification in the amount of approximately $467,000 and the Inside Directors claimed indemnification in the amount of approximately $900,000. In 1994, the Company accrued $900,000 for the potential reimbursement of the $1,367,000 in claims.\nOn March 7, 1995, the Company agreed to settle the indemnification requests of the Inside Directors for $450,000 in cash and by delivery of three promissory notes in the aggregate principal amount of $350,000. These notes are payable in three equal annual installments over three years and bear interest at 6% per annum. In April and May 1995, the Company consummated this settlement with the Inside Directors by paying them an aggregate of $450,000 and delivering such promissory notes to them. In May and June 1995, the Company settled with the Outside Directors by paying them an aggregate of $252,000 in cash.\nThe Company is involved in various other litigation proceedings incidental to the ordinary course of business. In the opinion of management, however, the ultimate liability, if any, resulting from such other litigation would not be material in relation to the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of the fiscal year, no matter was submitted by the Company to a vote of its shareholders 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\nMarket Information\nSince September 12, 1995, the Company's Common Stock has traded on the American Stock Exchange (the \"AMEX\") under the symbol \"IBK.\" Prior to September 12, 1995, the Common Stock was quoted on Nasdaq's Small-Cap Market system under the symbol \"IBKS.\" The following table sets forth the high and low sales prices from January 1, 1994, through March 18, 1996, for the Common Stock as reported by the AMEX and by Nasdaq Small-Cap Market, as the case may be, and the amount of dividends per share, adjusted for the 33- 1\/3% stock dividend paid to stockholders in May 1995. All quotations represent prices between dealers, without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.\nShareholders\nAccording to the records of the Company's transfer agent, there were approximately 1,268 holders of record of the Common Stock at December 31, 1995.\nDividend Policy\nThe Company. Until 1994, the Company had not paid any cash dividends on its Common Stock since 1985. In May 1994, the Company reinstituted the payment of a $.03 per share cash dividend and has paid such cash dividend through February 1996. The Company's ability to pay cash dividends is restricted by the requirement that it maintain a certain level of capital in accordance with regulatory guidelines promulgated by the Federal Reserve Board. See \"ITEM 1. BUSINESS - Supervision and Regulation - The Company - - Capital Adequacy Requirements.\"\nThe Company's loan agreement with the Amarillo Bank provides that the Company must obtain the prior written consent of the Amarillo Bank prior to paying cash dividends on the Common Stock if the indebtedness to the Amarillo Bank is $1,000,000 or more. Any future financing agreement may contain restrictions on dividends.\nHolders of the Series C Cumulative Convertible Preferred Stock (\"Series C Preferred Stock\") are entitled to receive, if, as and when declared by the Company's Board of Directors, out of funds legally available therefor, in preference to the holders of Common Stock and any other stock ranking junior to the Series C Preferred Stock in respect of dividends, quarterly cumulative cash dividends at the annual rate of $4.20 per share. The aggregate annual dividend payment on the 16,436 shares of the Series C Preferred Stock outstanding at December 31, 1995, is approximately $69,000. If earnings and cash flow from ordinary operations of the Company are not sufficient to enable it to pay the full amount of the dividend on the Series C Preferred Stock, the Company may cumulate all or a portion of the annual dividend. The Company can cause the mandatory conversion of the Series C Preferred Stock into Common Stock beginning in December 1997. In March 1995, 100 shares of Series C Preferred Stock were converted to 1,838 shares of Common Stock, adjusted for the 33 1\/3% stock dividend paid in May 1995, and in October 1995, 132 shares of Series C Preferred Stock were converted into 2,425 shares of Common Stock. The Series C Preferred Stock is the Company's only outstanding preferred issue.\nThe Company may not, among other things, declare or pay any cash dividend in respect of the Common Stock or any stock junior to the Series C Preferred Stock with respect to dividends or liquidation rights unless, on the date of payment, all accumulated dividends in respect of the Series C Preferred Stock are paid or set aside. Furthermore, the Company may not declare or pay any dividends in respect of the Common Stock or purchase, redeem or otherwise acquire shares of Common Stock if, on the record date for such payment, or on the date of such purchase, redemption or acquisition, such action would cause stockholders' equity (including mandatorily\nredeemable preferred stock) of the Company, as reported in the most recent quarterly or annual financial statements filed by the Company with the Securities and Exchange Commission, to be less than an amount equal to the sum of (i) 140% of the number of then outstanding shares of Series C Preferred Stock multiplied by its liquidation value and (ii) 140% of the number of then outstanding shares of any stock ranking senior as to dividends to the Series C Preferred Stock multiplied by the liquidation value of such senior stock. Dividend payments on any other stock junior to the Series C Preferred Stock with respect to dividends or liquidation rights are similarly limited.\nThe Federal Reserve Board has a policy prohibiting bank holding companies from paying dividends on common stock except out of current earnings. The Federal Reserve Board has asserted that this policy, originally only applicable to common stock, also limits dividends on preferred stocks. As expanded, the Federal Reserve Board policy would limit dividends on the Series C Preferred Stock to an amount equal to current earnings. To date, the Company's earnings have been sufficient to cover dividends on the Common Stock and the Series C Preferred Stock.\nThe Board of Directors presently intends to continue the payment of a small cash dividend on the Common Stock. The amount and timing of any future dividend payments, however, will be determined by the Board of Directors and will depend upon a number of factors, including the extent of funds legally available therefor, dividend requirements of the Series C Preferred Stock, and the earnings, business prospects, acquisition opportunities, cash needs, financial condition, regulatory and capital requirements of the Company and the Banks and provisions of existing and future loan agreements.\nThe Banks. The funds used by the Company to meet its operational expenses and debt service obligations, to maintain the necessary level of capital for itself and the Banks and to pay cash dividends on the Common Stock and the Series C Preferred Stock will be derived primarily from dividends, management fees and tax liabilities paid to the Company by the Banks. See \"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity.\" The ability of the Banks to pay dividends is restricted by (i) the requirement that the Banks maintain an adequate level of capital in accordance with regulatory guidelines and (ii) statute.\nThe FDIC requires insured banks, such as the Banks, to maintain certain minimum capital ratios. The FDIC is permitted to require higher ratios if it believes that the financial condition and operations of a particular bank mandates such a higher ratio. The Comptroller has substantially similar requirements. See \"ITEM 1. BUSINESS - Supervision and Regulation - The Banks - Capital Adequacy Requirements\" and \"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Capital Resources.\"\nThe National Bank Act provides that, prior to declaring a dividend, a bank must transfer to its surplus account an amount equal to or greater than 10% of the net profits earned by the bank since its last dividend was declared, unless such transfer would increase the surplus of the bank to an amount greater than the bank's stated capital. Moreover, the approval of the Comptroller is required for any dividend to a bank holding company by a national bank if the total of all dividends, including the proposed dividend, declared by the bank in any calendar year exceeds the total of its net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus. In addition, the prompt corrective provisions of FDICIA and implementing regulations prohibit a bank from paying a dividend if, following the payment, the bank would be in any of the three capital categories for undercapitalized institutions. See \"ITEM 1. BUSINESS - Supervision and Regulation - - The Banks - Capital Adequacy Requirements.\"\nIn 1995, First State, N.A., Odessa was restricted in the payment of dividends without prior regulatory approval through September, 1995. First State, N.A., Odessa was restricted during this period because of the statute that prohibits dividends by banks with negative retained earnings.\nDividends paid by the Banks to Independent Financial and by Independent Financial to the Company totaled $700,000 and $905,000, respectively, during 1995. At December 31, 1995, there were approximately $1,208,000 in dividends available for payment to Independent Financial by the Banks without regulatory approval.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated herein by reference from page 31 of the Company's 1995 Annual Report to Shareholders under the caption \"Selected Consolidated Financial Information.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is incorporated herein by reference from pages 33 through 55, inclusive, of the Company'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 information required by this item is incorporated herein by reference from pages 9 through 30, inclusive, of the Company's 1995 Annual Report to Shareholders under the captions \"Report of Coopers & Lybrand, L.L.P., Independent Auditors,\" \"Consolidated Balance Sheets,\" \"Consolidated Income Statements,\" \"Consolidated Statements of Changes in Stockholders' Equity,\" \"Consolidated Statements of Cash Flows,\" \"Notes to Consolidated Financial Statements\" and \"Quarterly Data (Unaudited).\"\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required for by this item is incorporated herein by reference from pages 6 through 9, inclusive, of the Company's definitive proxy statement to be filed pursuant to Regulation 14A with the Securities and Exchange Commission relating to its Annual Meeting of Shareholders to be held April 30, 1996 (the \"Definitive Proxy Statement\"), under the respective captions \"Item 1. Election of Directors\" and \"Executive Officers.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference from pages 9 and 10 of the Company's Definitive Proxy Statement under the caption \"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 from pages 2 through 5, inclusive, of the Company's Definitive Proxy Statement under the caption \"Voting Securities and Principal Shareholders.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference from pages 10 and 11 of the Company's Definitive Proxy Statement under the caption \"Executive Compensation - Transactions with Management.\"\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 following Consolidated Financial Statements of the Company included in PART II of this report are incorporated by reference from the Company's Annual Report to Shareholders for the year ended December 31, 1995, furnished to the Securities and Exchange Commission pursuant to Rule 14a-3(b):\nPage Reference of Item Annual Report\nReport of Coopers & Lybrand, L.L.P., Independent Auditors 9\nConsolidated Balance Sheets as of December 31, 1995 and 1994 10\nConsolidated Income Statements for the three years ended December 31, 1995 11-12\nConsolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1995 13\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995 14\nNotes to Consolidated Financial Statements 15-30\n2. Financial Statement Schedules\nReport of Ernst & Young, L.L.P., predecessor accountant\nAll 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 Company's Consolidated Financial Statements or notes thereto.\n[Letterhead]\nBoard of Directors and Shareholders Independent Bankshares, Inc.\nWe have audited the accompanying consolidated statements of income, changes in stockholders' equity and cash flows of Independent Bankshares, Inc. (the Company) 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 financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Independent Bankshares, Inc. 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 methods of accounting for income taxes and changed its method of accounting for certain investments in debt and equity securities.\n\/s\/ Ernest & Young LLP\nJanuary 31, 1994\n3. Exhibits\nThe exhibits listed below 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 document, such document is identified in parenthesis. See the Index of Exhibits included with the exhibits filed as part of this report.\nNo. Description\n3.1 Restated Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n3.2 Bylaws of Independent Bankshares, Inc., as amended (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n10.1 Form of Nonqualified Option Agreement (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n10.2 Loan Agreement (Renewal) dated as of April 15, 1993, by and among Independent Bankshares, Inc. and The First National Bank of Amarillo and related Term Note dated April 15, 1993, and Security Agreement dated September 8, 1993 (Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993); Revolving Credit Note dated April 15, 1995 (filed herewith)\n10.3 Master Equipment Lease Agreement, dated December 24, 1992, between Independent Bankshares, Inc. and NCR Credit Corporation, Amendment to Master Equipment Lease Agreement dated concurrently therewith, and related form of Schedule and Commencement Certificate (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.4 Asset Purchase and Account Assumption Agreement dated March 4, 1996, between the Company and Coastal Banc ssb (filed herewith)\n13.1 Annual Report to Shareholders for the year ended December 31, 1995 (filed herewith)\n21.1 Subsidiaries of Independent Bankshares, Inc. (Exhibit 21.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n23.1 Consent of Coopers & Lybrand, L.L.P. (filed herewith)\n23.2 Consent of Ernst & Young, L.L.P. (filed herewith)\n27.1 Financial Data Schedule (filed herewith)\n(b) Current Reports on Form 8-K.\nThe Company did not file any Current Reports on Form 8-K in the fourth quarter of 1995 or in the first quarter of 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.\nINDEPENDENT BANKSHARES, INC.\nBy: \/s\/ Bryan W. Stephenson Bryan W. Stephenson, 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 below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Bryan W. Stephenson President, March 28, 1996 Bryan W. Stephenson Chief Executive Officer and Director\n\/s\/ Randal N. Crosswhite Senior Vice March 28, 1996 Randal N. Crosswhite President, Chief Financial Officer, Corporate Secretary and Director\n________________________ Director March 28, 1996 Lee Caldwell\n\/s\/ Mrs. Wm. R. (Amber) Cree Director March 28, 1996 Mrs. Wm. R. (Amber) Cree\n\/s\/ Louis S. Gee Director March 28, 1996 Louis S. Gee\n\/s\/ Marshal M. Kellar Director March 28, 1996 Marshal M. Kellar\n\/s\/ Tommy McAlister Director March 28, 1996 Tommy McAlister\n\/s\/ Scott L. Taliaferro Director March 28, 1996 Scott L. Taliaferro\n\/s\/ James D. Webster, M.D. Director March 28, 1996 James D. Webster, M.D.\n\/s\/ C. G. Whitten Director March 28, 1996 C. G. Whitten\n\/s\/ John A. Wright Director March 28, 1996 John A. Wright\nINDEX TO EXHIBITS Exhibit Number Description\n3.1 Restated Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n3.2 Bylaws of Independent Bankshares, Inc., as amended (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n10.1 Form of Nonqualified Option Agreement (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n10.2 Loan Agreement (Renewal) dated as of April 15, 1993, by and among Independent Bankshares, Inc. and The First National Bank of Amarillo and related Term Note dated April 15, 1993, and Security Agreement dated September 8, 1993 (Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993); Revolving Credit Note dated April 15, 1995 (filed herewith)\n10.3 Master Equipment Lease Agreement, dated December 24, 1992, between Independent Bankshares, Inc. and NCR Credit Corporation, Amendment to Master Equipment Lease Agreement dated concurrently therewith, and related form of Schedule and Commencement Certificate (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.4 Asset Purchase and Account Assumption Agreement dated March 4, 1996 between the Company and Coastal Banc ssb (filed herewith)\n13.1 Annual Report to Shareholders for the year ended December 31, 1995 (filed herewith)\n21.1 Subsidiaries of Independent Bankshares, Inc. (Exhibit 21.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)\n23.1 Consent of Coopers & Lybrand, L.L.P. (filed herewith)\n23.2 Consent of Ernst & Young, L.L.P. (filed herewith)\n27.1 Financial Data Schedule (filed herewith)","section_15":""}
{"filename":"757549_1995.txt","cik":"757549","year":"1995","section_1":"ITEM 1. BUSINESS\nThe primary business of Krupp Institutional Mortgage Fund Limited Partnership (the \"Partnership\") is making loans evidenced by non-recourse participating promissory notes (\"Participating Notes\"), collateralized by mortgages on improved, income producing real properties and a Collateral Pledge Agreement dated February 20, 1985. See Note C to Financial Statements included in Appendix A of this report. The loans have been made to Krupp Equity Limited Partnership (\"KELP\"), which has the same general partners as the Partnership, under a master loan agreement (the \"Master Loan Agreement\"). The Partnership considers itself to be engaged in only one industry segment, namely real estate mortgage lending to KELP.\nKELP's properties began experiencing cash flow difficulties and, beginning with the payment due April 1, 1991, KELP has not been able to fully pay the required quarterly interest payments. The terms of the Master Loan Agreement, which is currently in default, require KELP to pay the Partnership basic interest at a rate of 10% per annum on the Participating Notes.\nThe General Partners determined in 1991 not to exercise the Partnership's foreclosure remedies under the Master Loan Agreement as a result of KELP's default because the severely depressed state of the real estate market in much of the U.S. made it unlikely that KELP would be able to dispose of its properties at other than very unattractive prices at that time. Thus, the General Partners believed that it was in the Partnership's best interest to continue to permit KELP to hold the properties and attempt to increase cash flows.\nAs a result of KELP's difficulties: 1) KELP has remitted to the Partnership all cash flow generated by the properties after operating and administrative expenses and senior mortgage obligations (\"KELP Cash Flow\") and the Partnership has not exercised its foreclosure rights under the Master Loan Agreements with respect to KELP's defaults; 2) interest and late charges on the Partnership's Participating Notes have continued to accrue although reserved against; 3) since 1991, as a consequence of the default, the management agent of KELP's properties (an affiliate of its general partners) has continued to serve even though it is not receiving any payment of property management fees.\nAs a result of management's annual assessment of the carrying value of the Participating Notes, which is based on the fair value of underlying properties considering such factors as tenant turnover, current and prospective occupancy levels, the current market competition and assumptions on potential proceeds that might be received upon sale, the General Partner of KELP determined that the carrying value of its investments exceeded its net realizable value. As of December 31, 1995, KELP has reduced the carrying value of its real estate by $5,986,000. Accordingly, the Partnership has recorded a cumulative provision for credit losses of $16,524,000, against the outstanding mortgage note receivable balance of $28,319,943, on its related mortgage loans.\nSince 1991, many segments of the U.S. real estate market have begun to\nrecover. However, in the General Partners' judgment, the properties held by KELP have not materially increased in value over this period. The General Partners' current plan is to continue not to exercise the Partnership's foreclosure rights under the Master Loan Agreement, although they intend to carefully monitor the operations of each property and the state of the market in which each property is located. At such time as the Partnership believes the disposition of a property by KELP would produce an attractive level of proceeds to the Partnership under the Master Loan Agreement, the General Partners will take appropriate steps on behalf of the Partnership to require a sale by KELP or commence foreclosure proceedings with respect to such property. By proceeding in this fashion the General Partners are seeking to avoid a disposition of the portfolio at \"forced liquidation\" prices.\nThe General Partners estimate that this disposition process, which has been ongoing through 1995 and earlier, could take several years. Limited Partners should note that the deferral of property dispositions defers significant tax liabilities of all Partners. It also defers the due date on certain notes totalling $2,790,388 issued by the partners of KELP, which have been pledged to the Partnership under a Collateral Pledge Agreement. See Note D to the Financial Statements included in Appendix A of this report.\nAs a result of the above mentioned disposition activities, subsequent to year end KELP sold Village Green Apartments to an unaffiliated third party for $5,200,000. As a result of the Village Green sale, the Partnership will receive all available net cash proceeds from KELP. Additionally, KELP has entered into a purchase and sale agreement with an unaffiliated buyer for the purchase of North Salado Village Shopping Center at a contracted sale price of $7,350,000. For details of each transaction see Note D to the Financial Statements included in Appendix A of this report.\nAs of December 31, 1995, the Partnership did not employ any personnel.\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.\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 SECURITY STOCKHOLDER MATTERS\nThe transfer of Units is subject to certain limitations contained in the Partnership Agreement. There is no public market for the Units and it is not anticipated that any such public market will develop.\nThe number of Limited Partners as of December 31, 1995 was approximately\n3,300.\nThe Partnership made the following distributions to its Partners during the fiscal year ended December 31, 1995 and 1994:\nOne of the objectives of the Partnership is to generate cash available for quarterly distribution. However, there is no assurance that future cash flows from KELP will be available for quarterly distributions.\nAs a result of the financial condition of the KELP properties and the reduction in the debt service payments made by KELP to the Partnership, the Partnership has made quarterly distributions at rates that fluctuate from .25% to .625% of the invested proceeds.\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 Notes thereto, which are included in Items 7 and 8 (Appendix A) of this report, respectively.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nCurrently, the Partnership has sufficient liquidity to meet its operating needs. The most significant capital need is distributions to investors. However, distributions are currently dependent on cash flow received from KELP's interest payments on the Participating Notes based upon the cash flow of the underlying properties.\nKELP's properties have not generated cash flow sufficient to meet the terms of their existing obligations. The retail centers have historically suffered from an economic downturn in retail sales beginning in the late 1980s. Recently, the properties have maintained a consistent level of operating cash flow. The partners of KELP have made cumulative capital contributions of approximately $4,673,000 to cover prior operating deficits and have arranged for certain short-term borrowings. Additionally, the affiliated management agent has not received payment of management fees since 1991. The General Partners of the Partnership have not commenced foreclosure proceedings because, as described in Item 1 above, they have determined that there are advantages to allowing KELP to continue to own the properties.\nOn October 20, 1995, the partners of KELP refinanced the first mortgage note payable of North Salado Shopping Center for $2,972,130. The terms of the new mortgage require monthly principal and interest payments of $31,612 at a rate of 9.25% per annum. The new mortgage note matures November 15, 2009. The new mortgage may be prepaid without penalty until November 15, 1996, if the property is sold to an unaffiliated third party. Previously, the mortgage note payable for North Salado required monthly payments of $32,241, consisting of principal and interest at the rate of 10.625% per annum.\nOn March 5, 1996, KELP sold Village Green Apartments to an unaffiliated third party for $5,200,000. The buyer assumed the principal outstanding on the first mortgage note payable on the property of $4,633,989, as of the date of sale, which was netted against sales proceeds. KELP will remit to KIMF available sale proceeds, net of closing costs, of approximately $400,000.\nThe partners of KELP have entered into a purchase and sale agreement with an unaffiliated buyer for North Salado Village Shopping Center. The contracted price for the property is $7,350,000 and the sale is expected to take place during the second quarter of 1996. At December 31, 1995, the property is subject to first and second mortgages of $2,954,660 and $7,513,000, respectably.\nOperations\n1995 Compared to 1994\nTotal revenues decreased approximately $192,000 primarily from a decrease in cash flow from the underlying KELP mortgages. The decrease in cash flows was impacted by the sale of NOC Mall in 1994. The decrease in interest income on mortgage notes receivable was partly offset by an increase in interest income earned on cash and cash equivalents.\nTotal expenses, net of a provision for credit losses in 1994 of $4,500,000, decreased $57,000. The decrease is due to management's efforts to control all operating costs.\n1994 Compared to 1993\nTotal revenues increased as a result of additional income earned from the Partnership's first mortgage interest investment as a first lien holder of Northeast Plaza, as well as cash flows generated by KELP's properties. Upon KELP's sale of NOC Mall, the Partnership recorded interest income of approximately $83,000 for the release of the property as collateral for the additional Participating Notes. Expenses include a provision for losses recorded in 1994 of $4,500,000 on the Participating Notes based on the current estimated value of the collateral.\nDistributable Cash from Operations\nDistributable Cash from Operations of $765,000, $899,000 and $607,000, as defined by Section 5.01 of the Partnership Agreement, is equivalent to the net income before the provision for credit losses on the Participating Notes for the fiscal years ended December 31, 1995, 1994 and 1993, respectively.\nKELP's Results of Operations\nThe average occupancy percentages for KELP's properties for the fiscal years ended 1995, 1994, 1993, 1992 and 1991 for residential and commercial properties are as follows:\nThe following table presents an analysis of KELP Cash Flow for purposes of determining required cash flow payments on the participating notes for the years ended December 31, 1995, 1994 and 1993:\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A to this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. PART 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 directors and executive officers of The Krupp Corporation, which is a General Partner of both the Partnership and The Krupp Company Limited Partnership-III, the other General Partner of the Partnership, is as follows:\nName and Age The Krupp Corporation\nDouglas Krupp (49) Co-Chairman of the Board George Krupp (51) Co-Chairman of the Board Laurence Gerber (39) President Robert A. Barrows (38) Senior Vice President and Corporate Controller\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, healthcare facility ownership and the management of the Company. 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 approximately 3,400 are responsible for the more than $4 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 is Chairman of the Board and a Director of Berkshire Realty Company, Inc. (NYSE-BRI). George Krupp is Douglas Krupp's brother.\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 approximately 3,400 are responsible for more than $4 billion under management for institutional and individual clients. Mr. Krupp attended the University of Pennsylvania and Harvard University. Mr. Krupp also serves as Chairman of the Board and Trustee of Krupp Government Income Trust and as Chairman of the Board and Trustee of 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 Chief Executive Officer of Berkshire Realty Company, Inc. (NYSE-BRI) and President and Trustee of Krupp Government Income Trust and President and Trustee of Krupp Government Income Trust II.\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 of record owned, or was known by the General Partners to own, beneficially more than 5% of the Partnership's 30,059 outstanding Units. On that date the General Partners and their affiliates owned 10 Units (.03% of the total outstanding) of the Partnership in addition to their General Partner Interests. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership does not have any directors, executive officers or nominees for election as director. Additionally, as of December 31, 1995 no person of record owned, or was known by the General Partners to own, beneficially more than 5% of the Partnership s outstanding Units.\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 included under Item 8, Appendix A on page of this report.\n2. Financial Statement Schedules - All schedules are omitted as they are not applicable, not required or the information is provided in the financial statements or the notes thereto.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable Exhibits required under Item 601 of Regulation S-K:\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended Limited Partnership Agreement dated as of February 14, 1985 [Exhibit A to Prospectus included in Registrant's Registration Statement on Form S-11 dated\nFebruary 15, 1985 (File No. 2-94392)].*\n(4.2) Amended Certificate of Limited Partnership filed with the Massachusetts Secretary of State on December 13, 1985. [Exhibit 4.2 to Registrant's Report on Form 10-K for the year ended October 31, 1985 (File No. 2- 94392)].*\n(10) Material contracts:\n(10.1) The form of Master Loan Agreement (including the form of Participating Note and Collateral Pledge Agreement) between the Partnership and Krupp Equity Limited Partnership (\"KELP\") [Exhibit C to Prospectus included in Registrant's Registration Statement on Form S-11 dated February 15, 1985 (File No. 2-94392)].*\n(10.2) Revised basic form of Mortgage to secure payment of the Loans under the Master Loan Agreement [Exhibit 10.3(a) included in Registrant's Registration Statement on Form S-11 dated February 15, 1985 (File No. 2-94392)].*\n(10.3) Revised form of Promissory Note as executed by the partners of KELP and pledged under the Collateral Pledge Agreement to secure payment of Loans under the Master Loan Agreement. [Exhibit 10.4(b) included in Registrant's Registration Statement on Form S-11 dated February 15, 1985 (File No. 2-94392)].*\nNorth Salado Village Shopping Center II\n(10.4) Promissory Note of KELP dated September 12, 1985, payable to the Partnership. [Exhibit 1 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\n(10.5) Deed of Trust, Security Agreement and Financing Statement, dated September 12, 1985, from KELP to the Partnership. [Exhibit 2 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\nNorth Salado Village Shopping Center I\n(10.6) Promissory Note of KELP, dated September 12, 1985, payable to the Partnership and Related Allonge dated September 24, 1985. [Exhibit 3 to Registrant's Report dated September 12, 1985 (File No. 2-94392)].*\n(10.7) Deed of Trust, Security Agreement and Financing Statement, dated September 12, 1985, from KELP to the Partnership. [Exhibit 4 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\nNortheast Plaza Shopping Center\n(10.8) Promissory Note of KELP, dated September 12, 1985, payable to the Partnership. [Exhibit 5 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\n(10.9) Collateral Mortgage and Collateral Chattel Mortgage Note from KELP dated September 12, 1985. [Exhibit 6 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\n(10.10) Act of Collateral Mortgage and Collateral Chattel Mortgage by KELP in favor of the Partnership dated September 12, 1985. [Exhibit 7 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].*\n(10.11) Act of Pledge and Pawn of Collateral Mortgage and Collateral Chattel Mortgage Note dated September 12, 1985 between KELP and the Partnership. [Exhibit 8 to Registrant's Report on Form 8-K dated September 12, 1985 (File No. 2-94392)].* (10.12) Modification of promissory note dated August 31, 1993 by and between the Partnership and KELP.*\nVillage Green Apartments\n(10.13) Promissory Note of KELP dated December 18, 1985, payable to the Partnership. [Exhibit 1 to Registrant's Report on Form 8-K dated December 19, 1985 (File No. 2-94392)].* (10.14) Mortgage, Security Agreement and Financing Statement dated December 18, 1985 between KELP and the Partnership. [Exhibit 2 to Registrant's Report on Form 8-K dated December 19, 1985 (File No. 2-94392)].*\nBell Plaza Shopping Center\n(10.15) Promissory Note of KELP, dated June 2, 1987, payable to the Partnership [Exhibit 1 to Registrant's Report on Form 8-K dated June 2, 1987 (File No. 0-14378)].*\n(10.16) Mortgage dated June 2, 1987, from KELP to the Partnership. [Exhibit 2 to Registrant's Report on Form 8-K dated June 2, 1987 (File No. 0-14378)].*\n*Incorporated by reference.\n(c) 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, on 21st day of March, 1996.\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nBy: The Krupp Corporation, a General Partner\nBy: \/s\/Douglas Krupp Douglas Krupp, Co-Chairman (Principal Executive Officer) and Director of The Krupp Corporation\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the 21st day of March, 1995.\nSignatures Titles\n\/s\/Douglas Krupp Co-Chairman (Principal Executive Officer) and Douglas Krupp Director of The Krupp Corporation, a General Partner.\n\/s\/George Krupp Co-Chairman (Principal Executive Officer) and George Krupp Director of The Krupp Corporation, a General Partner.\n\/s\/Laurence Gerber President of The Krupp Corporation, a General Laurence Gerber Partner.\n\/s\/Robert A. Barrows Sr. Vice President and Corporate Controller of\nRobert A. Barrows The Krupp Corporation (a General Partner of the Registrant)\nAPPENDIX A\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS ITEM 8 OF FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1995\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nReport of Independent Accountants\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' 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 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 Institutional Mortgage Fund Limited Partnership:\nWe have audited the financial statements of Krupp Institutional Mortgage Fund Limited Partnership (the \"Partnership\") listed in the index on page 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.\nAs discussed in Note E, the Partnership has recorded a loan loss reserve of $16,524,000 and a reserve for uncollectible interest of $9,755,416, based on management's estimate of the value of the properties which serve as collateral for the mortgage notes receivable. As is the case with all real estate, the ultimate value of such properties can only be determined in a negotiation between buyer and seller.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Krupp Institutional 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.\nBoston, Massachusetts COOPERS & LYBRAND, L.L.P. March 26, 1996\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSTITUTIONAL MORTGAGE FUND LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nA. Organization\nKrupp Institutional Mortgage Fund Limited Partnership (the \"Partnership\") was formed on November 15, 1984 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Partnership was formed for the purpose of making participating mortgage loans (\"the Participating Notes\") to Krupp Equity Limited Partnership (\"KELP\"), in the amount of up to 95% of the proceeds of the offering of units of limited partner interest (the \"Units\") (see Note D). The Partnership terminates on December 31, 2013 unless earlier terminated upon the occurrence of certain events as set forth in the Partnership Agreement.\nThe Partnership issued all of the General Partner Interests to The Krupp Corporation (\"Krupp Corp.\") and The Krupp Company Limited Partnership-III (\"Krupp Co.-III\"), in exchange for capital contributions aggregating $1,000. The General Partners made additional capital contributions of $4,207,560 which equals fourteen percent of the capital contributions of the Investor Limited Partners. The Partnership used these capital contributions to pay costs incurred in connection with its organization and the public offering of Units.\nOn February 21, 1985 the Partnership, commenced the marketing and sale of the Units for $1,000 per Unit. The public offering was closed on December 5, 1985, at which time 30,059 Units had been sold.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (see Note I).\nRisks and Uncertainties\nThe Partnership invests its cash primarily in deposits and money market funds with commercial banks. The Partnership has not experienced any losses to date on its invested cash.\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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\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. Cash equivalents are recorded at cost, which approximates current market value.\nProvisions for Credit Losses and Accrued Interest Reserves\nIn accordance with Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\", and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\", the Partnership has implemented polices and practices for assessing impairment of its mortgage loans and the recognition of income on impaired loans.\nMortgage notes receivable are recorded at the lower of cost or estimated net realizable value. The estimated net realizable value of the mortgage loans is based on current market estimates of the underlying properties held as collateral considering such factors as tenant turnover, current and prospective occupancy levels, the current market competition and assumptions on potential proceeds that might be received upon sale. Given the uncertainty of real estate valuation in the current market, these market estimates could differ from the ultimate value obtained from a sale of such properties (see Note E).\nThe Partnership recognizes interest income on its impaired loans based on the expected cash flow payments to be received from KELP. Cash flow payments are determined to be all cash flow generated by the properties after operating and administrative expenses and senior mortgage obligations. Unpaid interest and late charges are being accrued and reserved against.\nIncome Taxes\nThe Partnership is not liable for federal or state income taxes as Partnership income or loss is allocated to the partners for income tax purposes. In the event that the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and such examination results in a change in the Partnership's taxable income or loss, the change will be reported to the partners.\nC. Mortgage Notes Receivable\nThe Partnership made loans to KELP, an affiliate of the Partnership, as provided under the Master Loan Agreement and Collateral Pledge Agreement (the \"Agreements\"). Under the terms of the Master Loan Agreement, basic interest accrued at a rate of 7.6% per annum and was payable quarterly, in arrears, on the unpaid principal balance of the Participating Notes which were due on December 31, 1992, however, the Partnership had the option to extend the maturity date to December 29, 1995.\nKELP's properties began experiencing cash flow deficiencies and, beginning with the payment due April 1, 1991, KELP has not been able to fully pay the required quarterly interest payments.\nThe terms of the Master Loan Agreement required KELP to pay the Partnership adjusted basic interest at a rate of 10% per annum, which accrued and was payable quarterly, in arrears, on the unpaid principal balance of the Participating Notes. The Participating Notes have matured.\nMortgage Notes Receivable consist of the following as of December 31, 1995 and 1994:\nNortheast Plaza Shopping Center (\"Northeast Plaza\")\nNortheast Plaza is an 89,115 square foot shopping plaza located in Baton Rouge, Louisiana. On September 12, 1985, the Partnership loaned KELP $6,000,000 collateralized by a second mortgage on the Northeast Plaza and the Collateral Pledge Agreement.\nThe non-recourse first mortgage of $994,873, collateralized by Northeast Plaza, matured in 1993. KELP had been unable to resolve refinancing issues with the original lender, and was also unable to find other financing sources even though its debt service payments were current. Therefore, in 1994, the General Partners used a portion of working capital reserves to purchase the first mortgage note in order to preserve the Partnership's\nequity in the underlying property. By its action, the Partnership became the first lien holder of the property. In addition, the Partnership earns 10% from its first mortgage interest investment versus 4% to 6% earned on the working capital reserve balance.\nThe maturity date of the note was extended to December 29, 1995 as evidenced by the modification of the promissory note dated August 31, 1993. The note requires monthly payments of $10,135 consisting of principal and interest at the rate of 10% per annum based on a 25 year amortization schedule. The non- recourse first mortgage note had a balance of $936,993 and $963,453 at December 31, 1995 and 1994, respectively.\nNorth Salado Village Shopping Center I (\"North Salado I\")\nNorth Salado I is an 84,108 square foot shopping center located in San Antonio, Texas. In 1985, the Partnership loaned KELP $1,453,000 and in 1990 the Partnership loaned to KELP an additional $60,000. These loans are collateralized by a second mortgage evidenced by a deed of trust and security agreement on North Salado I and the Collateral Pledge Agreement.\nNorth Salado Village Shopping Center II (\"North Salado II\") North Salado II is a 74,470 square foot shopping center adjacent to North Salado I located in San Antonio, Texas. On September 12, 1985, the Partnership loaned KELP $6,000,000 collateralized by a first mortgage evidenced by a deed of trust and security agreement on North Salado II and the Collateral Pledge Agreement.\nVillage Green Apartments (\"Village Green\")\nVillage Green is a 200-unit garden apartments complex located in Baldwinsville, New York. On December 19, 1985 and July 9, 1986, the Partnership loaned KELP $1,800,000 and $102,750, respectively, collateralized by a second mortgage and security agreement on Village Green and the Collateral Pledge Agreement.\nBell Plaza Shopping Center (\"Bell\")\nBell is a 43,400 square foot shopping center located in Oak Lawn, Illinois, a suburb of Chicago. On June 2, 1987, the Partnership loaned KELP $5,300,000 collateralized by a first mortgage evidenced by a deed of trust on Bell and the Collateral Pledge Agreement.\nThe average outstanding balance of the mortgage notes receivable was $28,333,173, $28,358,379 and $28,374,089 at December 31, 1995, 1994 and 1993, respectively.\nThe carrying value of the above mentioned mortgage notes receivable approximates fair value.\nSubsequent to year end KELP sold Village Green Apartments to an unaffiliated third party for $5,200,000. Additionally, KELP has entered into a purchase and sale agreement with an unaffiliated buyer\nfor the purchase of North Salado Village Shopping Center at a contracted sale price of $7,350,000 (see Note D).\nD. Krupp Equity Limited Partnership\nKELP was formed on January 3, 1985 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. KELP terminates on December 31, 2005, unless earlier terminated upon the occurrence of certain events as set forth in its partnership agreement. KELP issued all of the General Partner Interests to two General Partners, Krupp Corp. and Krupp Co.-III, and issued all of the Limited Partner Interests to Krupp Co.-III. KELP received capital contributions from the two General Partners, Krupp Corp. and Krupp Co-III, totalling $480,000 which consisted of $204,000 in cash and $276,000 in promissory notes. KELP also received $6,984,086 of Limited Partner capital contributions from Krupp Co.-III consisting of cash, the assumption of a notepayable to an affiliate in the amount of $1,550,013, and promissory notes in the amount of $2,514,388. These promissory notes, totalling $2,790,388, are pledged as additional collateral for the Participating Notes under the Master Loan Agreement and the Collateral Pledge Agreement.\nThe purpose of KELP is to acquire, manage, operate and sell real estate and personal property; and to borrow funds from the Partnership and other sources to finance the acquisition, management and operation of real estate and personal property related thereto. Condensed financial statements of KELP are as follows:\n(1) On October 31, 1995, the Partnership refinanced the first\nmortgage note payable of North Salado Shopping Center for $2,972,130. The terms of the new mortgage require monthly principal and interest payments of $31,612 at a rate of 9.25% per annum. The new mortgage note matures on November 15, 2009. The new mortgage may be prepaid without penalty until November 15, 1996 if the property is sold to an unaffiliated third party. However, if the property is not sold, the mortgage note will be subject to a prepayment penalty at the greater of 1) one percent of the outstanding principal balance at the time of prepayment, or 2) the sum of the present value of the amount of principal and interest payments due on the note from the date of prepayment to the maturity date based on U.S. Treasury Note or Bond yields as reported in the Wall Street Journal and, the present value of the amount of principal and interest of the note due on the maturity date, less the outstanding principal balance of the note at the day of prepayment. The Partnership incurred closing costs related to the refinancing of $97,281.\n(2) On March 5, 1996, KELP sold Village Green Apartments to an unaffiliated third party for $5,200,000. The sales agreement required the buyer to assume the first mortgage note payable on the property of $4,633,989. KELP will remit available sale proceeds to KIMF.\nThe partners of KELP have entered into a purchase and sale agreement with an unaffiliated buyer for the purchase of North Salado Village Shopping Center. The contracted price of the property is $7,350,000. The sale is expected to be consummated during the second quarter of 1996.\n(3) During the fourth quarter of 1995, the General Partners of KELP determined that the carrying value of its retail properties exceeded its net realizable value which resulted in an additional valuation adjustment of $586,000 which was charged against earnings. To date the General Partners have recorded a cumulative property valuation provision of $5,986,000.\nIt is expected that KELP will continue to be unable to pay its stated debt service obligation to KIMF. The general partners of KELP have attempted to mitigate the cash flow issues in the following ways: 1) the general partners or the limited partner of KELP have funded certain prior deficits through capital Contributions; 2) the general partners of KELP have arranged for borrowings to cover certain prior deficits; 3) KELP has remitted to the Partnership all available cash flow from the properties; and 4) the management agent for the properties (an affiliate of the general partners of KELP) has continued to serve even though it is not receiving payment of property management fees. KELP will continue to monitor expenses and implement rent increases as market conditions permit in order to increase cash flow from the properties.\nE. Provision for Credit Losses and Accrued Interest Reserves\nThe General Partners of the Partnership have recorded a cumulative provision for credit losses of $16,524,000 on its mortgage notes receivable. Additionally, the Partnership has recorded cumulative provisions for uncollectible interest of $9,755,416 and $7,584,144 as of December 31, 1995 and 1994, respectively. These cumulative provisions are booked against the carrying value of the assets in order to reflect management's current estimates of the underlying property values which, given the inherent uncertainty of real estate valuation in the current market, could differ from the ultimate value obtained upon sale of such properties.\nF. Cash and Cash Equivalents\nCash and cash equivalents at December 31, 1995 and 1994 consisted of the following:\nCommercial paper and certificates of deposit at December 31, 1995 represents corporate issues complying with Section 3.04 of the Partnership Agreement maturing in the first quarter of 1996 with yields of 5.79% to 5.88% per annum.\nG. Partners' Equity\nNet profits or net losses from Partnership operations, excluding Additional Interest on the Participating Notes, shall be determined as of the end of each fiscal year, and are allocated ninety-nine percent (99%) to the class of Limited Partners and one percent (1%) to the class of General Partners.\nNet profits, net losses and Distributable Cash from Operations, as defined by Section 5.01 of the Partnerships Agreement, allocated to the Limited Partners have been apportioned among the Limited Partners in the ratio to which the number of Units owned by each of them bears to the total number of Units owned by all of them. The interest of the class of General Partners in net profits, net losses and distributions of Distributable Cash from Operations and Surplus Funds, as defined, has been allocated proportionately among the General Partners according to their respective invested capital.\nDistributable Cash from Operations shall be distributed ninety-nine percent (99%) to the class of Limited Partners and one percent (1%) to the class of General Partners. Surplus Funds received by the Partnership, as defined in the Partnership Agreement, are to be allocated differently than that described above.\nAs of December 31, 1995, the following cumulative Partner contributions and allocations were made since inception of the Partnership:\nH. Related Party Transactions\nThe Partnership reimburses affiliates of the General Partners for certain expenses incurred in connection with the activities of the Partnership, including; communications, bookkeeping and clerical work necessary in maintaining relations with Limited Partners, and accounting, tax and computer services necessary for the maintenance of the books and records of the Partnership.\nI. Federal Income Taxes\nThe reconciliations of the net income(loss) reported in the accompanying Statement of Operations with the net income(loss) reported in the Partnership's federal income tax return for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe allocation of net income for federal income tax purposes for 1995 is as follows:\nAt December 31, 1995, the carrying values of the Partnership's assets and liabilities for federal income tax purposes were $37,150,659 and $12,952, respectively.","section_15":""}
{"filename":"276189_1995.txt","cik":"276189","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS - ------ -----------------\nThe information required by Item 3 is incorporated herein by reference to Note 13 - Contingencies of ----------------------- \"Notes to Consolidated Financial Statements\" included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1995.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------ --------------------------------------------------- No matters were submitted to a vote of stockholders during the fourth quarter of 1995.\nExecutive Officers of the Registrant - ------------------------------------\nThe following is a listing of the executive officers of the Company, none of whom has a family relationship with directors or other executive officers:\nJohn W. McConnell, age 54, President and Chief Executive Officer since 1991; President and Chief Operating Officer from 1990 to 1991; Senior Vice President and Chief Financial Officer from 1986 to 1990.\nMarcel J. Dumeny, age 45, Senior Vice President and General Counsel since 1989; Senior Vice President\/Law and Development from 1987 to 1989.\nClay G. Gring, Sr., age 64, Senior Vice President\/Chief Operating Officer since January 23, 1996; Senior Vice President\/Leisure Products Group from 1991 to January 23, 1996. Self-employed from 1984 to 1991 specializing in the development and management of real estate properties, including resort communities and hospitality related properties.\nRobert W. Howeth, age 48, Senior Vice President, Chief Financial Officer and Treasurer since 1993; Senior Vice President and Treasurer from 1992 to 1993; Senior Vice President\/Planning and Administration from 1990 to 1992; Vice President and Treasurer from 1988 to 1990.\nJoe T. Gunter, age 54, Senior Vice President since 1989; Senior Vice President and Special Counsel from 1984 to 1989.\nMorris E. Meacham, age 57, Vice President of Special Projects since 1994; Executive Vice President from 1990 to 1994; Senior Vice President and Chief Operating Officer\/Leisure Products Group from 1986 to 1990.\nWilliam G. Sell, age 42, Vice President and Controller (Chief Accounting Officer) since 1988.\nPART II -------\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED - ------ ------------------------------------------------ STOCKHOLDER MATTERS -------------------\nInformation required by Item 5 is incorporated herein by reference to Common Stock Prices included in ------------------- the Registrant's Annual Report to Stockholders for the year ended December 31, 1995.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA - ------ ----------------------- Information required by Item 6 is incorporated herein by reference to Financial Highlights included in -------------------- the Registrant's Annual Report to Stockholders 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 -----------------------------------\nInformation required by Item 7 is incorporated herein by reference to Management's Discussion and --------------------------- Analysis of Financial Condition and Results of ---------------------------------------------- Operations included in the Registrant's Annual Report ---------- to Stockholders for the year ended December 31, 1995.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------ ------------------------------------------- Financial statements and supplementary data required by Item 8 are set forth below in Item 14(a), Index to Financial Statements. -----------------------------\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON - ------ ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURE ----------------------------------\nNone\nPART III -------- Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------- -------------------------------------------------- (a) Identification of Directors ---------------------------\nThis item is incorporated herein by reference to Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders.\n(b) Identification of Executive Officers ------------------------------------\nIn accordance with Regulation S-K Item 401(b), Instruction 3, the information required by Item 10(b) concerning the Company's executive officers is furnished in a separate item captioned Executive --------- Officers of the Registrant in Part I above. -------------------------- (c) Compliance with Section 16(a) of the Exchange Act -------------------------------------------------\nThis item is incorporated by reference to Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION - ------- ---------------------- This item is incorporated by reference to Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND - ------- --------------------------------------------------- MANAGEMENT ---------- This item is incorporated by reference to Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ----------------------------------------------\nThis item is incorporated by reference to Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders.\nPART IV -------\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - ------- ------------------------------------------------------- FORM 8-K -------- (a)(1) Index to Financial Statements: -----------------------------\nThe following consolidated financial statements and Report of Ernst & Young LLP, Independent Auditors, included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1995 are incorporated herein by reference:\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Earnings - 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 - December 31, 1995\n(2) The following financial statement schedule should be read in conjunction with the consolidated financial statements included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1995:\nSchedule II - Valuation and Qualifying Accounts\nFinancial statement schedules not included herein have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n(3) Exhibits required by this item are listed on the Exhibit Index attached to this report and hereby incorporated by reference.\n(b) Reports on Form 8-K Filed in the Fourth Quarter -----------------------------------------------\nNone\n(c) Exhibits -------- The Exhibit Index attached to this report is hereby incorporated by reference.\n(d) Financial Statement Schedules -----------------------------\nFollowing is the schedule as referenced in the Index to Financial Statements included in Item 14(a) ----------------------------- above.\n(a) Uncollectible loans receivable written-off, net of recoveries. (b) Represents the refinement of prior year estimates of certain deferred tax assets. (c) Utilization of pre-confirmation income tax attributes credited to paid-in capital. (d) Includes $334 which is included in \"Savings and loan operations\" in the 1993 Consolidated Statement of Earnings. (e) Includes $2,248 transferred to net liabilities of assets held for sale and $4,959 of uncollectible loans receivable written-off, net of recoveries. (f) Includes $3,016 utilization of pre- confirmation income tax attributes credited to paid-in capital. Other deductions represent the refinement of prior year estimates of certain deferred tax assets, including net operating loss carryforwards and tax credits subject to the limitations of Internal Revenue Code Section 382.\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 duly authorized.\nFAIRFIELD COMMUNITIES, INC.\nDate: March 11, 1996 By \/s\/ J.W. McConnell ---------------------------------- J.W. McConnell, 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 on the dates indicated:\nDate: March 11, 1996 By \/s\/ Russell A. Belinsky* ------------------------------------ Russell A. Belinsky, Director\nDate: March 11, 1996 By \/s\/ Ernest D. Bennett, III* ------------------------------------ Ernest D. Bennett, III, Director\nDate: March 11, 1996 By \/s\/ Daryl J. Butcher* ------------------------------------ Daryl J. Butcher, Director\nDate: March 11, 1996 By \/s\/ Philip L. Herrington* ------------------------------------ Philip L. Herrington, Director\nDate: March 11, 1996 By \/s\/ Ronald Langley* ------------------------------------ Ronald Langley, Director\nDate: March 11, 1996 By \/s\/ William C. Scott* ------------------------------------ William C. Scott, Director\nDate: March 11, 1996 By \/s\/ J. W. McConnell ----------------------------------- J. W. McConnell, Director, President and Chief Executive Officer\nDate: March 11, 1996 By \/s\/ Robert W. Howeth ------------------------------------ Robert W. Howeth, Senior Vice President, Chief Financial Officer and Treasurer\nDate: March 11, 1996 By \/s\/ William G. Sell ------------------------------------- William G. Sell, Vice President\/Controller (Chief Accounting Officer)\nDate: March 11, 1996 *By \/s\/ J. W. McConnell ------------------------------------- J. W. McConnell, Attorney-in-Fact\nFAIRFIELD COMMUNITIES, INC. EXHIBIT INDEX ------------- Exhibit Number - -------\n3(a) Second Amended and Restated Certificate of Incorporation of the Registrant, effective September 1, 1992 (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n3(b) Second Amended and Restated Bylaws of the Registrant, dated November 18, 1994 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n4.1 Supplemented and Restated Indenture between the Registrant, Fairfield River Ridge, Inc., Fairfield St. Croix, Inc. and IBJ Schroder Bank & Trust Company, as Trustee, and Houlihan Lokey Howard & Zukin, as Ombudsman, dated September 1, 1992, related to the Senior Subordinated Secured Notes (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n4.2 First Supplemental Indenture to the Supplemented and Restated Indenture referenced in 4.1 above, dated September 1, 1992 (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n4.3 Second Supplemental Indenture to the Supplemented and Restated Indenture referenced in 4.1 above, dated September 1, 1992 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n4.4 Third Supplemental Indenture to the Supplemented and Restated Indenture referenced in 4.1 above, dated March 18, 1993 (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 and incorporated herein by reference)\n4.5 Certificate of Designation, Preferences, and Rights of Series A Junior Participating Preferred Stock, dated September 1, 1992 (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n10.1 Amended and Restated Revolving Credit and Term Loan Agreement, dated September 28, 1993, by and between the Registrant, Fairfield Myrtle Beach, Inc., Suntree Development Company, Fairfield Acceptance Corporation (\"FAC\") and The First National Bank of Boston (\"FNBB\") (previously filed with the Registrant's Current Report on Form 8-K dated October 1, 1993 and incorporated herein by reference)\n10.2 First Amendment to Amended and Restated Revolving Credit Agreement, referenced in 10.1 above, dated May 13, 1994 (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference)\n10.3 Second Amendment to Amended and Restated Revolving Credit Agreement, referenced in 10.1 above, dated December 9, 1994 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\nExhibit Number - ------\n10.4 Third Amendment to Amended and Restated Revolving Credit Agreement, referenced in 10.1 above, dated December 19, 1994 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.5 Fourth Amendment to Amended and Restated Revolving Credit Agreement referenced in 10.1 above, dated November 20, 1995 (attached)\n10.6 Fifth Amendment to Amended and Restated Revolving Credit Agreement referenced in 10.1 above, dated January 25, 1996 (attached)\n10.7 Stock Purchase Agreement, dated April 5, 1994, between the Registrant and Security Capital Bancorp (previously filed with the Registrant's Current Report on Form 8-K dated April 14, 1994 and incorporated herein by reference)\n10.8 Limited Partnership Agreement, dated March 3, 1981, between Harbour Ridge, Inc., Fairfield River Ridge, Inc. and Harbour Ridge Investments, Inc. forming the limited partnership of Harbour Ridge, Ltd. (previously filed with the Registrant's Registration Statement on Form S-7 No. 2-75301 effective February 11, 1982 and incorporated herein by reference)\n10.9 Sugar Island Associates, Ltd. Amended Limited Partnership Agreement, dated October 17, 1984 (previously filed with the Registrant's current Report on Form 8-K dated October 25, 1984 and incorporated herein by reference)\n10.10 Rights Agreement, dated September 1, 1992, between Registrant and Society National Bank, as Rights Agent (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n10.11 Amendment to Rights Agreement, referenced in 10.10 above, dated September 20, 1994 (previously filed with the Registrant's Form 8-A\/A dated November 1, 1994 and incorporated herein by reference)\n10.12 Fourth Amended and Restated Title Clearing Agreement between the Registrant, FAC, Lawyers Title Insurance Corporation, FNBB individually and in various capacities as agent and trustee, First Bank National Association, First Commercial Trust Company, N.A., First American Trust Company, N.A. and First Federal, dated September 1, 1992 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n10.13 Promissory Note and Security Agreement, each dated June 30, 1994, between the Registrant and VM Investors Partnership (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference)\n10.14 Second Amended and Restated Title Clearing Agreement between the Registrant, FAC, Colorado Land Title Company, FNBB, First Bank National Association, First Commercial Trust Company, N.A. and First Federal, dated September 1, 1992 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\nExhibit Number - -------\n10.15 Westwinds Third Amended and Restated Title Clearing Agreement between the Registrant, FAC, Fairfield Myrtle Beach, Inc., Lawyers Title Insurance Corporation, FNBB, and Resort Funding, Inc., dated November 15, 1992 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n10.16 Third Amended and Restated Revolving Credit Agreement between FAC and FNBB, dated September 28, 1993 (previously filed with Registrant's Current Report on Form 8-K dated October 1, 1993 and incorporated herein by reference)\n10.17 First Amendment to Third Amended and Restated Revolving Credit Agreement, referenced in 10.16 above, dated December 9, 1994 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.18 Second Amendment to Third Amended and Restated Revolving Credit Agreement, referenced in 10.16 above, dated December 19, 1994 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.19 Pledge and Servicing Agreement between Fairfield Funding Corporation (\"FFC\"), FAC, First Commercial Trust Company, N.A. and Texas Commerce Trust Company, N.A., dated September 28, 1993 (previously filed with Registrant's Current Report on Form 8-K filed October 1, 1993 and incorporated herein by reference)\n10.20 Receivable Purchase Agreement, dated September 28, 1993, between the Registrant, FAC, and FFC (previously filed with the Registrant's Current Report on Form 8-K filed October 1, 1993 and incorporated herein by reference)\n10.21 Third Amended and Restated Operating Agreement, dated December 9, 1994, between the Registrant and FAC (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.22 Appointment and Acceptance Agreement, dated March 3, 1994, between the Registrant and FNBB appointing FNBB as successor Rights Agent (previously filed with the Registrant's Annual Report on Form 10-K\/A for the year ended December 31, 1993 and incorporated herein by reference)\n10.23 Credit Agreement, dated March 28, 1995, among the Registrant, Fairfield Capital Corporation (\"FCC\"), FAC, Triple-A One Funding Corporation and Capital Markets Assurance Corporation as Administrative Agent and Collateral Agent (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference)\n10.24 Receivables Purchase Agreement dated March 28, 1995 among the Registrant, FAC, and FCC (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference)\nExhibit Number - ------\nCOMPENSATORY PLANS OR ARRANGEMENTS\n10.25 Form of Warrant Agreement between the Registrant and directors of the Registrant (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 and incorporated herein by reference)\n10.26 Registrant's Savings\/Profit Sharing Plan, as amended, effective January 1, 1995 (previously filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.27 Amendment Number Two to Registrant's Savings\/Profit Sharing Plan referenced in 10.26 above, effective January 1, 1996 (attached)\n10.28 Employment Agreement, dated September 20, 1991, by and between the Registrant and Mr. John W. McConnell (previously filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference)\n10.29 Employment Contract, effective January 1, 1994, by and between the Registrant and Mr. Morris E. Meacham (previously filed with Registrant's Annual Report on Form 10-K\/A for the year ended December 31, 1993 and incorporated herein by reference)\n10.30 Employment Agreement, dated September 20, 1991, by and between the Registrant and Mr. Marcel J. Dumeny (previously filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference)\n10.31 Form of Amendment No. One to Employment Agreements between Registrant and certain officers (previously filed with Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n10.32 Form of Warrant Agreement between Registrant and certain officers and executives of the Registrant (previously filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 and incorporated herein by reference)\n10.33 Registrant's First Amended and Restated 1992 Warrant Plan (previously filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 and incorporated herein by reference)\n10.34 Form of Indemnification Agreement between the Registrant and certain officers and directors of the Registrant (previously filed with the Registrant's Current Report on Form 8-K dated September 1, 1992 and incorporated herein by reference)\n10.35 Form of Severance Agreement between the Registrant and certain officers of the Registrant (previously filed with Registrant's Annual Report on Form 10-K\/A for the year ended December 31, 1993 and incorporated herein by reference)\n10.36 Registrant's Excess Benefit Plan, adopted February 1, 1994 (previously filed with the Registrants Annual Report on Form 10-K\/A for the year ended December 31, 1993 and incorporated herein by reference)\n10.37 First Amendment to Excess Benefit Plan, adopted May 11, 1995 (previously filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference)\nExhibit Number - ------\n10.38 Registrant's Key Employee Retirement Plan, adopted January 1, 1994 (previously filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 and incorporated herein by reference)\n10.39 First Amendment to Key Employee Retirement Plan, adopted May 11, 1995 (previously filed with Registrant's Quarterly Report on Form 10- Q for the quarter ended June 30, 1995 and incorporated herein by reference)\n11 Computation of earnings per share (attached)\n13 Portions of Registrant's Annual Report to Stockholders for the year ended December 31, 1995 which are incorporated herein by reference: Fairfield Property Portfolio; Common Stock Prices; Financial Highlights; Management's Discussion and Analysis of Financial Condition and Results of Operations; Report of Ernst & Young LLP, Independent Auditors; Consolidated Balance Sheets; Consolidated Statements of Earnings; Consolidated Statements of Stockholders' Equity; Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements (attached)\n21 Subsidiaries of the Registrant (attached)\n23 Consent of Ernst & Young LLP, Independent Auditors (attached)\n24 Powers of Attorney (attached)\n27 Financial Data Schedule (attached)\n99 Ombudsman Report for the period ending December 31, 1995 related to the Registrant's Senior Subordinated Secured Notes. Fairfield Communities, Inc. (the \"Company\") has issued its 10% Senior Subordinated Secured Notes (the \"FCI Notes\") pursuant to the Supplemented and Restated Indenture, dated as of September 1, 1992, as amended (the \"Restated Indenture\"), among the Company, as issuer, Fairfield St. Croix, Inc. and Fairfield River Ridge, Inc., as guarantors, IBJ Schroder Bank & Trust Company, as trustee (the \"Trustee\"), and Houlihan Lokey Howard & Zukin, as ombudsman (the \"Ombudsman\"). The Ombudsman, which was designated by the committee representing the holders of the notes for which the FCI Notes were exchanged in the Company's reorganization proceedings, as part of its duties under the Restated Indenture, is to report periodically concerning the collateral securing the FCI Notes and other matters (the \"Ombudsman's Reports\"). The Ombudsman's Reports are not prepared at the direction of, or in concert with, the Company and are delivered by the Ombudsman to the Trustee for distribution to each holder of record of the FCI Notes. However, because the Ombudsman's Reports are being distributed to the record holders of the FCI Notes and the contents of the Ombudsman's Reports may be of interest to other persons, including potential purchasers of the FCI Notes, the Company is filing herewith, as Exhibit 99, a copy of the Ombudsman's Report dated February 8, 1996, for the period ending December 31, 1995. The Company is not obligated to file such reports and may discontinue filing such reports in the future without notice to any person. (attached)","section_15":""}
{"filename":"7314_1995.txt","cik":"7314","year":"1995","section_1":"ITEM 1. BUSINESS.\nNorAm Energy Corp. (the \"Company\") was incorporated in 1928 under the laws of the State of Delaware and is principally engaged in the distribution and transmission of natural gas including gathering, marketing and storage of natural gas. The revenue, operating profit and identifiable assets of the Company's natural gas segment exceed 90% of the respective totals for the Company. Accordingly, the Company is not required to report on a \"segment\" basis, although the Company is organized into, and the following business description focuses on, the five operating units described below. Previously, the Company segregated its business activities into \"Natural Gas Distribution\" and \"Natural Gas Pipeline\" when reporting results of operations. In recognition of changes within the natural gas industry and the manner in which the Company manages its portfolio of businesses, the Company has further broken down its results of operations into (1) Natural Gas Distribution; (2) Interstate Pipelines; (3) Wholesale Energy Marketing; (4) Retail Energy Marketing; and (5) Natural Gas Gathering. The business units now referred to as Interstate Pipelines, Wholesale Energy Marketing and Natural Gas Gathering have also been referred to from time to time as the NorAm Trading and Transportation Group or the Trading and Transportation Group. The business unit referred to herein as Retail Energy Marketing includes a number of activities previously conducted as part of Natural Gas Distribution. Set forth below is the Operating Income (Loss) by the five Business Units described above as well as Corporate. Following that table is a reconciliation of operating income reported in accordance with the current organizational breakdown with operating income reported in accordance with the previous organizational breakdown.\nOPERATING INCOME (LOSS) BY BUSINESS UNIT(1)\n(1) To the extent practicable, prior year results of operations have been reclassified to conform to the current business unit presentation, although such results are not necessarily indicative of the results which would have been achieved had the revised business unit structure been in effect during those periods. In general, transactions among business units are recorded at market prices and material affiliate transactions within business units have been eliminated.\n(2) Included with \"Interstate Pipelines\" in 1993.\n(3) Includes amortization of goodwill, see Note 1 of Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders.\n(4) See \"Interstate Pipelines\" following.\n(5) In December 1993, the Company completed a comprehensive settlement agreement (\"the Settlement\") with certain subsidiaries of Samson Investment Company, terminating or modifying a number of outstanding contractual arrangements. The Settlement resulted in a $34.2 million pre-tax charge to earnings, set forth in the Company's Statement of Consolidated Income for 1993 as \"Contract Termination Charge\".\nOPERATING INCOME (LOSS) BY BUSINESS UNIT RECONCILIATION TO PREVIOUS FORMAT (MILLIONS OF DOLLARS)\nSee the separate discussions for each Business Unit for operating revenue and throughput information.\nThe Company also is evaluating opportunities for international investment, and the Company's efforts thus far have focused on opportunities emerging in Latin America due to privatization initiatives currently underway in a number of countries, as well as broad-based efforts to encourage international investment.\nSince the Company's December 31, 1992 sale of its oil and gas exploration and production business, the Company's operations principally have been rate regulated. The operations of the Natural Gas Distribution and Interstate Pipelines business units are subject to rate regulation, while the operations of Wholesale Energy Marketing, Retail Energy Marketing and Natural Gas Gathering are not generally subject to direct regulation as to the rates which may be charged.\nNATURAL GAS DISTRIBUTION.\nThe Company's natural gas distribution business is conducted through its three divisions, Arkla, Entex and Minnegasco, and their affiliates. Historically, the Company's Natural Gas Distribution business included substantially all the activities conducted by these three divisions. In recognition of the fact that certain of these activities are not subject to traditional cost-of-service rate regulation and, as such, have different risk profiles and return potentials, and in order to concentrate its similarly-targeted marketing efforts in a single business unit, certain large-volume marketing activities, including the provision of services to a number of customers previously reported with \"Natural Gas Distribution\", have been aggregated and separately reported as \"Retail Energy Marketing\". Thus, Natural Gas Distribution, as presently constituted consists principally of natural gas sales to and natural gas transportation for residential, commercial and a limited number of industrial customers, substantially all of which are located behind the \"city gate\" and subject to traditional cost-of-service rate regulation.\nArkla provides service in approximately 613 communities in the states of Arkansas, Louisiana, Oklahoma and Texas. The largest communities served by Arkla are the metropolitan areas of Little Rock, Arkansas, and Shreveport, Louisiana. In 1995, approximately 73% of Arkla's total throughput was composed of sales of gas at retail and approximately 27% was attributable to transportation services. For the same period, in excess of 95% of Arkla's supplies were obtained from NorAm Gas Transmission Company (\"NGT\") and Mississippi River Transmission Corporation (\"MRT\"), or through transportation agreements with NorAm Energy Services, Inc. (\"NES\"). In September of 1994, Arkla and NGT, respectively, completed the sale of its Kansas distribution properties and certain related pipeline assets of NGT, located in Kansas, to UtiliCorp United Inc. (\"UtiliCorp\", an affiliate of Peoples Natural Gas) for approximately $23 million in cash. This sale terminated the Company's distribution operations in Kansas.\nEntex provides service in approximately 502 communities in the states of Texas, Louisiana and Mississippi. The largest community served by Entex is the metropolitan area of Houston, Texas. In 1995, approximately 95% of Entex's total throughput was composed of sales of gas at retail and approximately 5% was attributable to transportation services. For the same period, Entex's principal suppliers of gas were Enron Capital & Trade Resources, MidCon Texas Pipeline Co., Koch Gateway Pipeline Company, and certain affiliates of each such company. No other supplier accounted for more than 10% of Entex's purchases.\nDuring 1995, Minnegasco provided service in approximately 243 communities in Minnesota. The largest community served by Minnegasco is Minneapolis, Minnesota and its suburbs. In 1995, approximately 92% of Minnegasco's total throughput was composed of sales of gas at retail and approximately 8% was attributable to transportation services. For the same period, Minnegasco's principal pipeline service providers were Northern Natural Gas Company, Viking Gas Transmission Company, Minnesota Intrastate Pipeline and Natural Gas Pipeline Company of America. For the same period, Minnegasco's principal suppliers of gas were Pan Alberta Gas, NES, Coastal Gas Marketing and Western Gas Marketing. No other supplier of natural gas accounted for more than 10% of Minnegasco's purchases. In February 1993, Minnegasco completed the sale of its Nebraska distribution system to UtiliCorp for\n$75.3 million in cash plus an additional payment of $17.8 million for net working capital transferred. In August of 1993, Minnegasco completed the exchange of its South Dakota distribution properties plus $38 million in cash for the Minnesota distribution properties of Midwest Gas, a division of Midwest Power System Inc. (\"Midwest\"). The UtiliCorp and Midwest transactions terminated Minnegasco's distribution operations outside of Minnesota.\nThe following table summarizes by state the number of communities and the estimated number of customers served by the Company as of December 31, 1995:\nSERVICE AREA COMMUNITIES NUMBER OF LOCATIONS SERVED CUSTOMERS ------------ ----------- ---------\nTexas 365 1,203,712\nMinnesota 243 626,556\nArkansas 383 425,423\nLouisiana 179 262,480\nMississippi 91 118,520\nOklahoma 97 114,794 ----- --------- 1,358 2,751,485 ===== =========\nThe following table summarizes the estimated number of customers served by each of the divisions as of December 31, 1995 and 1994:\nDECEMBER 31, ------------ CUSTOMERS BY DIVISION 1995 1994 --------------------- --------- ---------\nEntex 1,394,292 1,375,393 Arkla 730,637 721,185 Minnegasco 626,556 612,254 --------- ---------\nTotal 2,751,485 2,708,832 ========= =========\nThe Company's approximately 54,982 linear miles of gas distribution mains vary in size from one-half inch to 24 inches. Generally, in each of the cities, towns and rural areas it serves, the Company owns the underground gas mains and service lines, metering and regulating equipment located on customers' premises, and the district regulating equipment necessary for pressure maintenance. With a few exceptions, the measuring stations at which the Company receives gas from its suppliers are owned, operated and maintained by others, and the distribution facilities of the Company begin at the outlet of the measuring equipment. These facilities include odorizing equipment usually located on the land owned by suppliers and district regulator installations, in most cases located on small parcels of land which are leased or owned by the Company.\nConsolidated revenue, throughput and customer data of the distribution divisions are as follows:\nNATURAL GAS DISTRIBUTION\nIn almost all of the communities in which it provides service, the city or other relevant governmental body has granted the Company a franchise to serve, and its service is subject to the terms and conditions of the franchise. In most instances the Company's franchise is not exclusive. The rates at which the Company provides service at retail to its residential and commercial customers are, in all instances, subject to regulation by the relevant state public service commissions and, in Texas, also by municipalities. The services provided by the Company to its industrial customers are largely unregulated in Texas and Louisiana, and are subject to regulatory supervision of differing degrees in each of the other states. See \"Regulation.\"\nINTERSTATE PIPELINES.\nThe Company's interstate natural gas pipeline business (collectively referred to as \"Pipeline\") is conducted principally through NGT and MRT, two wholly-owned subsidiaries of the Company together with certain subsidiaries and affiliates. The Company's natural gas gathering activities subsequent to 1993 and wholesale energy marketing activities for all periods, previously included with Pipeline, are now separately discussed, see \"Wholesale Energy Marketing\" and \"Natural Gas Gathering\" elsewhere herein.\nIn March 1993, the Company transferred assets, liabilities and service obligations of Arkla Energy Resources, formerly a division of the Company, into a then newly-formed wholly-owned subsidiary of the Company, now called NGT, pursuant to an order from the Federal Energy Regulatory Commission (\"FERC\") approving the transfer. As a result of this transfer of assets, liabilities and service obligations, the FERC now has sole jurisdiction over NGT's interstate pipeline business, including transportation services and certain of NGT's transactions with affiliates of the Company, which historically were subject to both FERC and state regulatory oversight. See \"Regulation.\"\nOn June 30, 1993, the Company completed the sale of its intrastate pipeline business as conducted by Louisiana Intrastate Gas Corporation and its subsidiaries, LIG Chemical Company, LIG Liquids Corporation and Tuscaloosa Pipeline (the \"LIG Group\"), to a subsidiary of Equitable Resources, Inc. (\"Equitable\") for $191 million in cash. The Company agreed to indemnify Equitable against certain exposures, for which the Company has established reserves equal to anticipated claims under the indemnity. The Company acquired the LIG Group in July of 1989. The LIG Group operated a natural gas pipeline system located wholly within Louisiana.\nIn February 1996, Pipeline announced a reorganization plan which resulted in the elimination of a total of approximately 275 positions at NGT and MRT. The reorganization plan is intended to allow Pipeline to operate more efficiently, improving its ability to compete in its market areas. The Company expects to record a first-quarter 1996 charge of less than $20 million associated with the reorganization plan, which amount is expected to be substantially offset by the associated cost savings during 1996.\nNGT owns and operates a natural gas pipeline system located in portions of Arkansas, Louisiana, Mississippi, Missouri, Kansas, Oklahoma, Tennessee and Texas. As described above under \"Natural Gas Distribution\", effective September 30, 1994, NGT sold to UtiliCorp certain of its pipeline assets in Kansas. At December 31, 1995 the NGT system consisted of approximately 6,400 miles of transmission lines. The NGT pipeline system extends generally in an easterly direction from the Anadarko Basin area of the Texas Panhandle and western Oklahoma through the Arkoma Basin area of eastern Oklahoma and Arkansas to the Mississippi River. Additional pipelines extend from east Texas to north Louisiana and central Arkansas, and from the mainline system in Oklahoma and Arkansas to south central Kansas and southwest Missouri. In its system, NGT operates various compressor facilities related to its gas transmission business. NGT's peak day gas handled during the 1995\/96 heating season was approximately 2.40 billion cubic feet (\"Bcf\"). NGT , on behalf of various shippers, transports and delivers gas to distributors for resale for ultimate public consumption, to industrial customers for their own use and consumption, and to third party pipeline interconnects located in the states of Arkansas, Kansas, Louisiana, Mississippi, Missouri, Oklahoma, Tennessee and Texas. In 1995 NGT's throughput totaled 630.1 million MMBtu. Approximately 17% of the total throughput was attributable to services provided to Arkla, and 17% was attributable to gas marketed by NES to other parties. No other customer or supplier accounted for more than 10% of NGT's throughput.\nThe MRT system consists of approximately 2,200 miles of pipeline serving principally the greater St. Louis area in Missouri and Illinois. This pipeline system includes the \"Main Line System,\" the \"East Line,\" and the \"West Line.\" The Main Line System includes three transmission lines extending approximately 435 miles from Perryville, Louisiana, to the greater St. Louis area. The East Line, also a main transmission line, extends approximately 94 miles from southwestern Illinois to St. Louis. The West Line extends approximately 140 miles from east Texas to Perryville, Louisiana. The system also incudes various other branch, lateral, transmission and gathering lines and compressor stations. During 1995, MRT's throughput totaled 395.1 million MMBtu. Approximately half of MRT's total 1995 volumes were delivered to its traditional markets along its system in Missouri, Illinois and Arkansas with the remaining volumes delivered to off-system customers. MRT's peak day deliveries during the 1995\/96 heating season to its traditional market area customers were approximately one million MMBtu. MRT's largest customer is Laclede Gas Company, which serves metropolitan St. Louis and to which MRT provides service under several long-term firm transportation and storage agreements and an agency agreement. The FERC has jurisdiction over MRT with regard to its interstate pipeline business. See \"Regulation.\"\nThe Company owns and operates seven gas storage fields. Four storage fields are associated with NGT's pipeline and have a combined maximum deliverability of approximately 665 million cubic feet (\"mmcf\") per day and a working gas capacity of approximately 22.8 Bcf. NGT also owns a 1\/12 interest in Koch Gateway Pipeline Company's Bistineau storage field which provides an additional 100 mmcf per day of deliverability and additional working gas capacity of 8 Bcf. The two largest NGT storage fields are located in Oklahoma: the Ada field - capable of delivering approximately 330 mmcf per day, and the Chiles Dome field - capable of delivering 265 mmcf per day. The other NGT storage fields, Ruston and Collinson, are located near Ruston, La. and Winfield, Kansas. However, the Collinson storage field is scheduled for abandonment in 1996. Three storage fields are associated with MRT's pipeline and have a maximum aggregate deliverability of approximately 580 mmcf per\nday and a working gas capacity of approximately 31 Bcf. Most of MRT's storage capacity is located in two fields in north central Louisiana, near Ruston. MRT's other storage field is located at St. Jacob, Illinois off of MRT's East Line. During 1995, all of MRT's storage capacity was subscribed on a firm basis by its customers, who had contracted for the capacity as a result of MRT's FERC Order 636 restructuring proceeding.\nAs stated above, the Company sold the LIG Group to a subsidiary of Equitable Resources in June, 1993. As a result, LIG's results of operations have been excluded from the following data, although this disposition did not qualify for presentation as \"discontinued operations\" in the Company's Consolidated Financial Statements. LIG's operating income was $5.6 million for the six months ended June 30, 1993 and total throughput for the same period was 103.4 million MMBtu.\nConsolidated throughput and revenue data for Pipeline is as follows:\n(1) When sold volumes are also transported by Pipeline, the throughput statistics will include the same physical volumes in both the sales and transportation categories, requiring an elimination to prevent the overstatement of actual total throughput. No elimination is made for volumes of 196.6 million MMBtu, 145.8 million MMBtu and 158.2 million MMBtu in 1995, 1994 and 1993, respectively, which were transported on both the NGT and MRT systems.\nDuring the 1980s, the Company, as most other pipelines, was compelled to resolve a number of significant disputes with its suppliers under contracts which allegedly required the Company to take or, if not taken pay for, quantities of gas in excess of its available sales markets and\/or at prices generally above the levels required by such markets. These disputes, generally referred to as \"take-or-pay\" claims, have been resolved in a number of ways, including both buy-out\/buy-downs and payments for gas in advance of its delivery. In the third quarter of 1989, the Company recorded a pre-tax Special Charge of $269 million related\nto these claims. The amount shown as \"Gas Purchased in Advance of Delivery\" in the Company's Consolidated Balance Sheet and the component of \"Investments and Other Assets\" bearing the same caption (See Note 1 of Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders) represents, in substantial part, amounts paid to suppliers in conjunction with the above referenced settlements. These prepayments for gas were made at varying prices but have been reduced to their estimated net realizable value (which approximates fair value) and, to the extent that the Company is unable to realize at least this amount through sale of the gas as delivered over the life of these agreements, its earnings will be adversely affected, although such impact is not expected to be material.\nIn addition, the Company's Consolidated Balance Sheet includes an accrual representing its estimate of the amount it will be required to pay in settlement of all remaining claims, including those not yet asserted. While the vast majority of such claims have been settled, the Company is committed, under certain of these settlements, to make additional payments, expects that other such claims may be asserted and that amounts may be expended in settlement of such claims. The Company currently expects that the amount of such settlements if any, in excess of existing reserves will not be material.\nThe Company is committed under certain agreements to purchase certain quantities of gas in the future. At December 31, 1995, the Company had the following gas take commitments under its agreements which are not variable- market-based priced:\nAt December 31, 1995, the Company had the following gas take commitments under its agreements which are variable-market-based priced, valued using an average spot price over the delivery period of approximately $2.13\/MMBtu:\n* Includes approximately 45.4 million MMBtu of gas subject to 3 - 6 month term purchase agreements at NES which, in general, are matched with sale agreements with similar terms.\nIn order to mitigate the risk from market fluctuations in the price of natural gas and transportation during the terms of these commitments, the Company enters into futures contracts, swaps and options, (see Notes 1 and 8 of Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders). In no case are these derivatives held for trading purposes. To the extent that the Company expects that these commitments will result in losses over the contract term, the Company has established reserves equal to such expected losses.\nWHOLESALE ENERGY MARKETING.\nThe Company's marketing of natural gas and risk management services to natural gas resellers and certain large volume industrial consumers is principally conducted by NES, together with certain affiliates. NES, previously reported as a part of Pipeline, historically has operated primarily in those states served by the NGT and MRT systems but recently has had significant sales in various other states as it seeks to extend its activities throughout North America. In addition, in recent periods, NES has begun to market electricity in wholesale markets.\nNES markets gas under daily, baseload and term agreements which include either market sensitive or fixed pricing provisions. Fixed priced sales or purchase contracts are hedged using gas futures contracts or other derivative financial instruments. See Notes 1 and 8 of Notes to the Company's Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders. NES gas supplies are purchased from others on both a daily and term basis. Most gas supplies are purchased based on market sensitive pricing. Gas sales for 1995 were approximately 513 million MMBtu of which approximately 85.2% was to unaffiliated parties. Customers are located both on the NGT system and other pipelines. Gas is transported to customers using both firm and interruptible transportation. Sales and services provided by NES are generally not subject to any form of rate regulation.\nRETAIL ENERGY MARKETING.\nThe Company's marketing of natural gas and related services to those industrial and commercial customers located behind the \"city gate\" of local gas distribution companies but not utilizing traditional \"bundled\" utility service, as well as certain industrial customers served by third-party pipelines on which the Company holds capacity, is principally carried out by NorAm Energy Management, Inc., together with certain affiliates (collectively, \"NEM\"). Certain of NEM's activities, while not subject to traditional cost-of-service rate determination, are subject to the jurisdiction of various regulatory bodies as to the allocation of joint costs between such activities and certain of the company's regulated activities. This recently-formed business unit includes a number of activities previously included with Distribution (see \"Natural Gas Distribution\" elsewhere herein) and will execute the Company's plan for serving these markets more coherently and effectively. NEM had sales to five chemical facilities, operated by its largest customer and owned by a total of five customers, which collectively represented approximately 38.3 Bcf (22.6%), 11.9 Bcf (10.2%) and 7.0 Bcf(8.6%) of NEM's total gas sales volumes of 169.7 Bcf, 116.6 Bcf and 81.7 Bcf in 1995, 1994 and 1993, respectively.\nNATURAL GAS GATHERING.\nOn February 1, 1995, pursuant to a \"spindown\" order from the FERC, the Company transferred the natural gas gathering assets of NGT into the Company's wholly-owned subsidiary, NorAm Field Services Corp. (\"NFS\"). These assets consist principally of approximately 3,500 miles of gathering pipelines which collect gas from more than 200 separate systems located in major producing fields in Oklahoma, Louisiana, Arkansas and Texas. NFS is not generally subject to cost-of-service regulation, although the spindown order required that it offer to continue any pre-existing gathering services generally under the terms of NGT's tariff, including the applicable stated maximum gathering rate of $0.1417 per MMBtu for a two-year period (the \"Default Contract\"), except to the extent that separate terms and conditions have been negotiated. While various parties, including NFS, have appealed certain of the FERC's findings and the case is pending before the D.C. Circuit Court of Appeals, if the Default Contract provisions are not reversed in the interim, NFS will be unable to realize the full market value for certain of its services until February 1, 1997. The Company expects that efforts will be made in certain states to enact legislation to regulate gathering rates and services but the Company currently expects that any such efforts will be successful only to the extent of providing for complaint-type proceedings alleging undue discrimination or similar \"light-handed\" regulatory approaches. Natural Gas Gathering also includes Arkla Chemical Company which performs gas processing, liquids extraction and marketing activities, generally in conjunction with certain of NFS's gathering activities. In the future, the majority of NFS's gas processing activities will\nbe conducted by Waskom Gas Processing Company, a joint venture of NFS and NGC Corp. (an affiliate of Natural Gas Clearinghouse).\nMARKET FACTORS.\nThe Company's business is generally affected by a number of market factors, including competition, seasonality and the general economic climate. Increasingly, the activities of the Company's Interstate Pipelines, Wholesale Energy Marketing and Retail Energy Marketing units are most significantly affected by national trends in these areas. On the other hand, the results of the Company's Natural Gas Distribution units continue to be influenced most significantly by local trends in these factors.\nHistorically, competition in the sale and transportation of natural gas was limited due to the pervasive nature of the regulation of the industry and the long-term nature of the service obligations assumed by its participants. As a result, the Company's results of operations were largely affected by local factors, including the effects of local regulation. Over the past few years, however, regulatory and economic developments have significantly reduced the influence of such factors, particularly with respect to the Company's Interstate Pipelines, Wholesale Energy Marketing and Retail Energy Marketing operations. At the federal level, regulations governing natural gas transmission and marketing have been redesigned in order to promote intense competition between natural gas transporters and marketers. From an economic perspective, in recent years the energy industry, including the natural gas industry, has been characterized by a surplus of product deliverability (and, in the case of natural gas transportation in certain locations during certain seasons, a surplus of capacity), which also has increased the level of competition.\nCurrently, the Company generally faces competition in all aspects of its operations, both from other companies engaged in the natural gas business and from companies providing other energy products. This has an effect both on the quantity of the services sold by the Company and the prices it receives. At all levels of the industry in which the Company is engaged, competition generally occurs on the basis of price, the ability to meet individual customer requirements, access to supplies and markets and reliability. In the current environment, the ability of the Company to respond to this competition is tied directly to its ability to maintain operational flexibility, achieve low operating costs and maintain continued access to reliable sources of competitively priced gas and a broad range of gas markets.\nThese developments have had the effect of increasing the number of competitors and competitive options faced by the Company. As a consequence, changes in the market for natural gas and gas transportation services at the national level increasingly influence the demand and prices paid for the natural gas and gas transportation services offered by the Company. Additionally, to the extent that the customers served by those units are relatively large volume customers using gas to meet industrial or electric power generation requirements, the Company faces significant competition from fuel oil, waste products used as a source of fuel for the generation of process heat or steam, energy conservation products, and, with respect to electric generation customers, low cost energy available to such customers from other electric generators.\nLargely as a result of increasing competition, the Company discontinued the application of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"SFAS 71\") to NGT's transactions and balances in 1992, see Note 1 of Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders. These trends in competition are expected to continue, although not necessarily at the same rate as in the past.\nThe Company's distribution units also face competition. As with customers served by the Company's transmission and marketing units, over the last few years the Company's small industrial and large commercial customers served through its distribution units increasingly have been the target of other companies engaged in the natural gas business seeking to sell gas directly or transport third-party gas to customers currently served through the Company's distribution units. In some cases, these other companies seek to provide such service through newly constructed facilities, thereby bypassing the facilities installed by the Company to serve such customers. The Company has met such competition by adopting new programs which, in some instances, have provided its competitors with access to its sales customers, but through the use of the Company's facilities. The Company also faces competition with respect to such customers from fuel oil, electricity, energy conservation products, and in certain instances, liquified petroleum gas.\nWhile with certain limited exceptions, the Company currently is not in direct competition with any other distributors of natural gas with respect to its existing small commercial and residential customers, the Company nevertheless faces significant competition for such customers from electric utilities and providers of energy conservation products. Moreover, while the Company currently holds franchises in almost all of the communities which it serves, such franchises generally are not by their terms exclusive and competition has been experienced in certain instances as the Company has sought to extend service from existing service areas to geographically adjacent areas.\nIn addition to competition, the Company's business is also affected at all levels by the seasonality of weather and general economic conditions. Because one of the significant markets for natural gas is use in space heating, demand for natural gas and gas transportation services is generally seasonal in nature. The Company has obtained rate design changes in its regulated businesses which generally have reduced the sensitivity of the Company's earnings to changes in natural gas consumption prompted by seasonal weather patterns. Additionally, in recent years, the Company's transmission and marketing units have increased the volume of their off-season sales by expanding their markets to include additional industrial users of gas, gas-fired electric generators, and customers seeking gas in the summer to fill storage. Even with increased summer demand, however, the price of natural gas and gas transportation services continues to be seasonal in nature, with prices generally significantly lower in the summer than in winter. While the Company's distribution units also have sought to increase the level of their off-season sales, the opportunity to do so within their historic service areas is limited.\nGeneral economic conditions also significantly influence the demand for gas. The national demand for gas has increased in recent years and currently is expected to continue to increase in future years. This, in turn, at certain times and in certain market segments has influenced the price for natural gas and gas transportation services. However, this increased\ndemand for gas is somewhat tied to the overall state of economic activity and there can be no assurance that current levels of demand will continue or that, if they continue, they will necessarily have a significant effect on the price of or demand for the Company's products or services. From the perspective of the Company's local distribution units, the economic conditions prevailing in the Company's historic service areas continue to have a significant effect on the results of their operations. Unlike the Company's transmission and marketing units, the local distribution units are not readily able to redirect their activities to other markets when the demand for gas in their local service areas declines. In recent years, the level of economic activity in the areas served by these units has remained relatively stable.\nREGULATION.\nThe Company's business operations are significantly affected by regulation. This regulation occurs at all levels -- federal, state and local - -- and has the effect, among other things, of: (i) requiring that the Company seek and obtain certain approvals before it may undertake certain acts, (ii) regulating the level of rates which the Company may charge for certain of its services and products, and (iii) imposing certain conditions on the Company's conduct of its business.\nThe Company is significantly affected by the regulations of the FERC. FERC Order 636 is currently the subject of an appeal to the U.S. Court of Appeals, D.C. Circuit. Until such time as this appeal is resolved, there will continue to be some uncertainty in the natural gas industry respecting the full effect of FERC Order 636.\nThe changes to the industry brought about by FERC Order 636 also have affected and will continue to affect the business environment in which the Company's local distribution units operate in those geographical areas where gas supplies are delivered on interstate pipelines. The impact is less pronounced in the case of Entex, where a significant portion of supplies are delivered on intrastate pipelines. FERC Order 636 has increased, and in some cases likely will continue to increase, the number and diversity of potential suppliers and products available to meet the supply needs of each unit. In addition, the requirement that pipelines \"unbundle\" their services permits the Company's distribution units to avoid the purchase -- and, thus, the cost -- of services which they do not require. On the other hand, the elimination of the right of local distribution companies to require service from interstate pipelines in the absence of a contract will expose local distributors to an increased risk of supply disruption and the potential for increased review from some state regulatory agencies. In addition, the ability of holders of firm transportation capacity entitlements to assign their capacity rights to other parties, coupled with the ability of those holders to change the points at which that capacity is used, likely will increase the competitive pressures faced by local distributors. This is because such provisions will expand the incentives for and capabilities of third parties to build new facilities from nearby pipelines which bypass the existing facilities of the incumbent local distributors.\nUnder FERC Order 636, the Company's distribution units have incurred increased costs as a result of the recovery by their pipeline suppliers through their rates of those pipelines' FERC Order 636-related \"transition costs\". In some cases, the recovery of\ntransition costs remains unresolved. In addition, the ratemaking provisions of FERC Order 636 have increased the fixed costs incurred by distribution companies in reserving firm transportation capacity on their pipeline suppliers. While the Company's distribution units generally expect to be able to recover all of these increased costs in their retail rates, the resulting increases may adversely affect their competitive posture relative to alternate fuels and suppliers.\nAs described below, the Company is involved in several significant proceedings before the FERC.\nIn one such set of proceedings, NGT and MRT appealed the FERC's approval of NGT's and MRT's proposal to sell approximately 250 MMcf per day of capacity in certain NGT and MRT facilities to ANR Pipeline Company (\"ANR\"). The FERC had approved the parties' agreements (the \"Agreement\") but had also imposed conditions inconsistent with the Agreement. In 1995, the parties renegotiated and resolved their outstanding issues. The Federal Trade Commission, which also had to approve the sale, modified its Consent Decree on April 5, 1995, to delete the requirement that NorAm, through NGT and MRT, divest certain facilities by sale to ANR. In accordance with a March 1, 1995 Supplemental Agreement between the parties, effective June 1, 1995, all prior agreements between the parties were superseded or terminated except for amendment of and continuation of certain existing transportation arrangements between the parties. NGT and MRT subsequently dismissed their appeals and withdrew their FERC application to consummate the transaction.\nAs circumstances warrant, both NGT and MRT regularly seek authorization from the FERC for changes in their rates. In August 1994, NGT filed at the FERC for a $42.5 million annual rate increase, which case was subsequently accepted for filing with rates that became effective in February 1995 subject to refund. On January 22, 1996, the FERC affirmed a settlement of this proceeding making the settlement rates effective February, 1995. The settlement did not result in any refund in excess of amounts previously reserved.\nIn February, 1995, MRT filed an application with the FERC to install new compressors at its Biggers and Tuckerman Compressor Stations, and to abandon a segment of its Main Line No. 1. These changes will help modernize MRT's facilities, and will help MRT meet future, and increasingly stricter, air emission standards. MRT received FERC approval for the installation and abandonment in September, 1995.\nAt the state and local level, the primary effect of regulation of the Company relates to the rates charged by the Company's various distribution units for the services they provide to their customers. These services generally include both gas transportation and gas sale services. During 1995 Minnegasco and Arkla obtained increases in their local rates from the appropriate Minnesota and Arkansas regulatory agencies. Entex engaged in no major rate initiatives during 1995, although it was granted a total of approximately $2.3 million in annual rate increases from three of the larger cities it serves and received increases in several other jurisdictions pursuant to annual cost-of-service adjustment filings.\nOn October 24, 1994 the Minnesota Public Utilities Commission (\"MPUC\") issued its order in the rate case filed by Minnegasco in November 1993. The order allowed Minnegasco a rate increase of $7.1 million, compared to $22.7 million requested, and $14.6 million allowed\nin interim rates. In addition, Minnegasco was allowed to reduce its interim rate refund for unrecovered conservation improvement program (\"CIP\") costs and $.3 million of unrecovered prior rate case costs. To the extent certain unrecovered CIP costs are used to reduce the interim rate refund, the allowed revenue may be reduced. Minnegasco asked for reconsideration on certain issues in the MPUC's decision. On April 4, 1995, the MPUC issued an order upholding its original decision. In July 1995, Minnegasco issued an interim rate refund for the amount of interim rates collected in excess of the final rate increase of $7.1 million, including interest. Currently Minnegasco has an appeal pending before the Minnesota Supreme Court of certain portions of the MPUC's order in its 1993 rate case as well as prior MPUC decisions (1) providing that a portion of the cost of responding to certain gas leak calls not be allowed in rates and (2) that Minnegasco's non-regulated appliance sales and service operations must pay the regulated operations an amount for the use of Minnegasco's name, image and reputation.\nOn August 11, 1995, Minnegasco filed for a $24.3 million annual rate increase in Minnesota. In October 1995, the MPUC accepted the filing and issued an order allowing Minnegasco to collect $17.8 million in interim rates. Hearings were held before an Administrative Law Judge in January 1996; the Judge's recommended decision is expected in April. The MPUC is expected to issue its final decision in June 1996.\nAlso in August 1995, Minnegasco filed a performance-based or incentive regulation plan for its procurement of natural gas. The costs of natural gas have historically been flowed through to customers on a dollar-for-dollar basis. Under Minnegasco's plan, it would be able to receive a reward or penalty of up to $7 million annually based on its performance in procuring natural gas. In January 1996, Minnegasco entered into a settlement with two state agencies which recommends approval of the plan. The plan is currently pending review by the MPUC, which is expected to render its decision in the second quarter of 1996.\nIn March 1995, an order was issued by the Arkansas Public Service Commission (the \"APSC\") approving a settlement among Arkla, the APSC and certain of Arkla's customers which provided for (1) an annual rate increase of approximately $7 million and (2) an agreement by Arkla not to file another rate application in Arkansas before June 1996. In December 1995, an APSC order was issued authorizing implementation of a Weather Normalization Adjustment (the \"WNA\") to be effective for a two-year pilot period beginning January 1, 1996. The WNA provides that, from November to April of each year, Arkla's Arkansas customer bills will be adjusted by 75% of any variation from normal weather. Also during 1995, Arkla received annual increases totaling $0.9 million pursuant to annual cost of service adjustment filings in other jurisdictions.\nIn addition to regulation of the Company's distribution rates, state and local regulatory bodies also issue the franchises and certificates of public convenience and necessity which govern most services provided by the Company at retail.\nRegulations at both the federal and state levels also have other effects on the competitive environment in which the Company operates. Historically, the regulatory regimes applicable at both the federal and state level restricted the amount of facilities which could be installed to serve a given customer. Customarily, these regulations did not allow for the construction of \"duplicate\" facilities by a second supplier to a given customer if the customer\nalready was being adequately served by its existing supplier. Since the mid-1980's, however, these regulatory restrictions gradually have been eroded and other companies competing for the sale or transportation of gas to customers presently served or capable of being served through facilities owned by the Company have been permitted to use existing facilities owned by others or to construct new facilities, thereby entirely bypassing the Company's facilities. In certain instances, these proposals require the advance approval of various regulatory bodies before they may be implemented. In the past, certain such proposals have been approved and, when approved and implemented, have resulted in reductions in the level of services provided by the Company to its customers. In other situations, proposals to bypass facilities owned by the Company have not been approved. The Company is not able at present to predict either the outcome of any current or future proceedings or the effect, if any, which they ultimately may have on the Company.\nCertain business activities of the Company in the United States are subject to existing federal, state and local laws and regulations governing environmental quality and pollution control.\nOn October 24, 1994, the United States Environmental Protection Agency advised the Company that MRT and a number of other companies have been named under federal law as potentially responsible parties for a landfill site in West Memphis, Arkansas and may be required to share in the cost of remediation of this site. However, considering the information currently known about the site and the involvement of MRT, the Company does not believe that this matter will have a material adverse effect on the financial position, results of operations or cash flows of the Company.\nOn December 18, 1995, the Louisiana Department of Environmental Quality advised the Company, that the Company, through one of its subsidiaries, and together with several other unaffiliated entities, have been named under state law as potentially responsible parties with respect to a hazardous substance site in Shreveport, Louisiana and may be required to share in the remediation costs, if any, of the site. However, considering the information currently known about the site and the involvement of the Company and its subsidiaries with respect to the site, the Company does not believe that the matter will have a material adverse effect on the financial position, results of operations or cash flows of the Company.\nWith the acquisition of Diversified Energies, Inc. (\"DEI\") in November 1990, the Company acquired Minnegasco, a natural gas distribution company headquartered in Minneapolis, Minnesota, which owns or is otherwise associated with a number of sites where manufactured gas plants (\"MGPs\") were previously operated.\nFrom the late 1800s to 1960, Minnegasco and its predecessors manufactured gas at a site in Minnesota, located in Minneapolis near the Mississippi River (the \"Minneapolis Site\"), which site is on Minnesota's Permanent List of Environmental Priorities. Minnegasco\nis working with the Minnesota Pollution Control Agency to implement an appropriate response action. There are six other former MGP sites in Minnesota in the service territory in which Minnegasco operated at December 31, 1995. Of these six sites, Minnegasco believes that two were neither owned nor operated by Minnegasco, two were owned at one time by Minnegasco but were operated by others and are currently owned by others, one is presently owned by Minnegasco but was operated by others and one was operated by Minnegasco for a short period and is now owned by others. Minnegasco believes it has no liability with respect to the sites neither owned nor operated by Minnegasco.\nAt December 31, 1995, the Company has estimated a range of $20 million to $177 million for possible remediation of the Minnesota sites. The low end of the range was determined using only those sites presently owned or known to have been operated by the Company, assuming the Company's proposed remediation methods. The upper end of the range was determined using the sites once owned by the Company, whether or not operated by the Company, using more costly remediation methods. The cost estimates for the Minneapolis Site are based on studies of that site. The remediation costs for other sites are based on industry average costs for remediation of sites of similar size. The actual remediation costs will be dependent upon the number of sites remediated, the participation of other potentially responsible parties, if any, and the remediation methods used.\nIn its 1993 rate case, Minnegasco was allowed $2.1 million annually to recover amortization of previously deferred and ongoing clean-up costs. Any amounts in excess of $2.1 million annually were deferred for future recovery. In its 1995 rate case, Minnegasco asked that the annual allowed recovery be increased to approximately $7 million and that such costs be subject to a true-up mechanism whereby any over or under recovered amounts, net of certain insurance recoveries, be deferred until the next rate case. Such accounting was implemented effective October 1, 1995 pending final approval in the existing rate case. At December 31, 1995 and 1994, the Company had net deferred expenses of $2.3 million and $0.2 million respectively. At December 31, 1995 and 1994, the Company had recorded a liability of $45.2 million and $40.1 million, respectively, to cover the cost of remediation. The Company expects that the majority of its accrual as of December 31, 1995 will be expended within the next five years. In accordance with the provisions of SFAS 71, a regulatory asset has been recorded equal to the liability accrued. The Company believes the difference between any cash expenditure for these costs and the amounts recovered in rates during any year will not be material to the Company's overall cash requirements. The Company is pursuing recovery of its costs from insurers.\nIn addition to the Minnesota MGP sites described above, the Company's distribution divisions are investigating the possibility that the Company or predecessor companies may be or may have been associated with other MGP sites in the service territories of the distribution divisions. At the present time, the Company is aware of some plant sites in addition to the Minnesota sites and is investigating certain other locations. While the Company's evaluation of these other MGP sites is in its preliminary stages, it is likely that some compliance costs will be identified and become subject to reasonable quantification. To the extent that such potential costs are quantified, as with the Minnesota remediation costs for MGP described herein, the Company expects to provide an appropriate accrual and seek recovery for such remediation costs through all appropriate means, including regulatory relief.\nIn addition, the Company, as well as other similar firms in the industry, is investigating the possibility that it may elect or be required to perform remediation of various sites where meters containing mercury were disposed of improperly, or where mercury from such meters may have leaked or been disposed of improperly. While the Company's evaluation of this issue is in its preliminary stages, it is likely that compliance costs will be identified and become subject to reasonable quantification.\nTo the extent that potential environmental compliance costs are quantified within a range, the Company establishes reserves equal to the most likely level of costs within the range and adjusts such accruals as better information becomes available. If justified by circumstances within the Company's businesses subject to SFAS 71, corresponding regulatory assets are set up in anticipation of recovery through the ratemaking process. At December 31, 1995 and 1994, the Company had recorded a liability of $3.3 million (with a maximum estimated exposure of approximately $18 million) for environmental matters in addition to those described above with an offsetting regulatory asset.\nWhile the nature of environmental contingencies makes complete evaluation impracticable, the Company currently is aware of no other environmental matter which could reasonably be expected to have a material impact on the results of operations, financial position or cash flows of the Company.\nOther legislative proposals affecting the industry have been and may be introduced before the Congress and state legislatures, and the FERC and various state agencies currently have under consideration various policies and proposals, in addition to those discussed above, that may affect the natural gas industry. It is not possible to predict what actions, if any, the Congress, the FERC or the states will take on these matters, or the effect any such legislation, policies, or proposals may have on the activities of the Company.\nMERGERS, ACQUISITIONS AND DISPOSITIONS.\nAll levels of the natural gas industry -- transmission and marketing, distribution, and exploration and production -- have undergone a number of acquisitions, divestitures and combinations in recent years, and the Company has been a party to several such transactions, including, as previously described, the sale of Arkla's Kansas distribution properties and certain of NGT's Kansas pipeline assets in September 1994, the exchange of Minnegasco's South Dakota distribution properties in August of 1993, the sale of the LIG Group in June of 1993 and the sale of Minnegasco's Nebraska distribution properties in February 1993, and as described more fully below, the sale of the Company's exploration and production business in December 1992, the sale of Dyco Petroleum and the acquisition of The Hunter Company in 1991, its merger with DEI, the parent company of Minnegasco in 1990, its acquisition of the LIG Group in 1989 and its merger with Entex in 1988. The Company reviews possible transactions from time to time and may engage in other business combinations in the future that are not specifically described herein.\nOn December 31, 1992, the Company completed the sale of the stock of Arkla Exploration Company (\"AEC\") to Seagull for approximately $397 million in cash (including\n$7.3 million removed from AEC just prior to closing). This sale terminated the Company's activities in the exploration and production business and, accordingly in 1992, the Company reclassified the results of operations of AEC to discontinued operations.\nThe Company previously conducted operations in the radio communications business through E. F. Johnson and the energy measurement business through EnScan, Inc. (\"EnScan\") which were acquired in conjunction with the merger with DEI. In early 1992, EnScan merged with Itron, Inc. (\"Itron\") of Spokane, Washington, of which, the Company owned at March 1, 1996, common stock representing ownership of approximately 12.3% of the combined enterprise, which is managed by Itron. In December 1994 and January 1995 the Company sold a total of 480,000 shares of Itron common stock in a public offering, resulting in the reduction of the Company's stock ownership percentage of Itron common stock from 18.5% to the current 12.3%. Based on price quotations on the NASDAQ, the market value of the Company's interest at December 31, 1995 was approximately $50.7 million and had increased to approximately $65.4 million at March 1, 1996. While there are other ways in which the Company can monetize its investment in the Itron shares, in general, the market for the Itron shares on the NASDAQ is not sufficiently liquid to allow the company to dispose of a significant portion of its investment in a single transaction without accepting a significant discount from the quoted price. It is currently the Company's intention to dispose of its investment in the combined enterprise over the next several years at times to be determined principally by economic factors in the markets available for the sale or exchange of such interests. In July 1992, the Company sold the stock of Johnson for total consideration of approximately $40 million, receiving cash proceeds of approximately $15 million at closing and retaining an investment currently valued at approximately $5 million.\nIn addition to the EnScan and Johnson transactions described above, during recent years, the Company has disposed of substantially all of its non-gas related businesses, including, in late 1992 the sale of the principal assets of Arkla Products Company, which was originally sold as a part of the 1984 sale of Arkla Industries and conducted operations for the Company in the gas grill manufacturing business after it was reacquired by the Company due to Preway Inc.'s default on certain revenue bonds for which the Company was secondarily liable. Prior to its merger with the Company in 1988, Entex similarly disposed of substantially all of its non-gas related assets. For a further discussion of certain of these matters, see Note 1 of Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report to Stockholders incorporated herein by reference.\nEMPLOYEES.\nThe Company employs approximately 6,703 persons and has retirement plans for the majority of its employees and maintains contributory group life, medical, dental and disability insurance plans for its employees as well as certain other benefit plans for its retirees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company is of the opinion that it has generally satisfactory title to the properties owned and used in its businesses, subject to the liens for current taxes, liens incident to minor encumbrances, and easements and restrictions which do not materially detract from the value of such property or the interests therein or the use of such properties in its businesses. See \"Natural Gas Distribution\" and Natural Gas Pipeline\".\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn August 6, 1993, the Company, its former subsidiary, Arkla Exploration Company (\"AEC\") and Arkoma Production Company, a subsidiary of AEC, were named as defendants in a lawsuit filed in the Circuit Court of Independence County, Arkansas. On September 20, 1994, the Circuit Court entered an order granting the Company's motion to dismiss. On October 23, 1995, the Supreme Court of Arkansas affirmed the Circuit Court's order granting the Company's motion to dismiss.\nOn October 24, 1994, the United States Environmental Protection Agency advised the Company that MRT and a number of other companies have been named under federal law as potentially responsible parties for a landfill site in West Memphis, Arkansas and may be required to share in the cost of remediation of this site. However, considering the information currently known about the site and the involvement of MRT, the Company does not believe that this matter will have a material adverse effect on the financial position, results of operations or cash flows of the Company.\nOn December 18, 1995, the Louisiana Department of Environmental Quality advised the Company, that the Company, through one of its subsidiaries, along with several other unaffiliated entities have been named under state law as potentially responsible parties with respect to a hazardous substance site in Shreveport, Louisiana and may be required to share in the remediation cost of the site, if any are incurred. However, considering the information currently known about the site and the involvement of the Company and its subsidiaries with respect to the site, the Company does not believe that the matter will have a material adverse effect on the financial position, results of operations or cash flows of the Company.\nREGULATION S-K, ITEM 401(b). EXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth certain information concerning the \"executive officers\" of the Company (as defined by the Securities and Exchange Commission) as of March 15, 1996:\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe information required hereunder applicable to market, number of security holders and dividend history is shown on page 53 of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data required hereunder is included on page 34 of the 1995 Annual Report to Stockholders, which data is incorporated herein by reference. For information, if any, concerning accounting changes, business combinations or dispositions of business operations that materially affect the comparability of the information reflected in selected financial data, see Notes to Consolidated Financial Statements on pages 58 through 70 of the 1995 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe required information is included on pages 34 through 53 of the 1995 Annual Report to Stockholders, which pages are 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 auditor's reports are set forth on pages 54 through 71 of the 1995 Annual Report to Stockholders, which pages are incorporated herein by reference.\nStatement of Consolidated Income for the years ended December 31, 1995, 1994, and 1993.\nConsolidated Balance Sheet as of December 31, 1995 and 1994.\nStatement of Consolidated Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nStatement of Consolidated Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Accountants.\nThe required supplementary data concerning quarterly results of operations is set forth on page 72 of the 1995 Annual Report to Stockholders, which page is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nThe information appearing under the caption \"Election of Directors And Beneficial Ownership of Common Stock For Officers and Directors\" set forth in the Company's definitive proxy statement, for the Annual Meeting of Stockholders to be held on May 14, 1996, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 (the \"1934 Act\") is incorporated herein by reference. See also \"Regulation S-K, Item 401(b)\" appearing in Part I of this Annual Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under the caption \"Executive Compensation\" set forth in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 14, 1996, to be filed pursuant to Regulation 14A under the 1934 Act 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 \"Voting\" and \"Election of Directors And Beneficial Ownership of Common Stock For Officers and Directors\" set forth in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 14, 1996 to be filed pursuant to Regulation 14A under the 1934 Act is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under the captions \"Compensation Committee Interlocks and Insider Participation\" and \"Executive Compensation\" set forth in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 14, 1996 to be filed pursuant to Regulation 14A under the 1934 Act is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS\nIncluded under Item 8 are the following financial statements:\nStatement of Consolidated Income for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Balance Sheet as of December 31, 1995 and 1994.\nStatement of Consolidated Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nStatement of Consolidated Cash Flows 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 Page ----\nReport of Independent Accountants 33 Schedule II - Valuation and Qualifying Accounts 34\nAll other schedules for which provision is made in applicable regulations of the Securities and Exchange Commission have been omitted because the information is disclosed in the Consolidated Financial Statements or because such schedules are not required or are not applicable.\n(b)(3) EXHIBITS\n* (Asterisk indicates exhibits incorporated by reference herein). Pursuant to Item 601(b)(4)(iii), the Company agrees to furnish to the Commission upon request a copy of any instrument with respect to long-term debt not exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis.\n(b) REPORTS ON FORM 8-K FILED DURING THE LAST QUARTER OF THE PERIOD COVERED BY THIS REPORT\nReport on Form 8-K, dated November 2, 1995 - Third Quarter Earnings Release\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors and Stockholders NorAm Energy Corp.:\nOur report on the consolidated financial statements of NorAm Energy Corp. and Subsidiaries has been incorporated by reference in this Form 10-K from page 71 of the 1995 Annual Report to Stockholders of NorAm Energy Corp. and Subsidiaries. In connection with our audits of such consolidated 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 financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nHouston, Texas March 25, 1996\nNORAM ENERGY CORP. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (In thousands of dollars)\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.\nNORAM ENERGY CORP. (Registrant)\nBy \/s\/ T. Milton Honea -----------------------------------\n(T. Milton Honea) Chairman of the Board, President and Chief Executive Officer\nBy \/s\/ Michael B. Bracy -----------------------------------\n(Michael B. Bracy) Executive Vice President (Principal Financial Officer)\nBy \/s\/ Jack W. Ellis, II --------------------------------------\n(Jack W. Ellis, II) Vice President and Corporate Controller (Principal Accounting 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 Registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 The portions of the Annual Report to Stockholders for the year ended December 31, 1995 incorporated by reference into this Form 10-K.\n21 Subsidiaries of the Company.\n23 Consent of Coopers & Lybrand L.L.P.\n24 Powers of Attorney from each Director of NorAm Energy Corp. whose signature is affixed to this Form 10-K.\n27 Financial Data Schedule","section_15":""}
{"filename":"713095_1995.txt","cik":"713095","year":"1995","section_1":"Item 1 - Business\nOrganization\nFarmers Capital Bank Corporation (\"the Registrant\") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and was organized on October 28, 1982, under the laws of the Commonwealth of Kentucky. Its subsidiaries provide a wide range of banking and bank-related services to customers throughout Kentucky. The bank subsidiaries owned by the Registrant are Farmers Bank & Capital Trust Company (\"Farmers Bank\"), Frankfort, Kentucky; United Bank & Trust Co. (\"United Bank\"), Versailles, Kentucky; Lawrenceburg National Bank (\"Lawrenceburg Bank\"), Lawrenceburg, Kentucky; First Citizens Bank, Hardin County, Incorporated (\"First Citizens Bank\"), Elizabethtown, Kentucky; Farmers Bank and Trust Company (\"Farmers Georgetown Bank\"), Georgetown, Kentucky; and Horse Cave State Bank (\"Horse Cave Bank\"), Horse Cave Kentucky. The Registrant also owns two non-bank subsidiaries; FCB Services, Inc. (\"FCB Services\"), Frankfort, Kentucky and Farmers Capital Insurance Company (\"Farmers Insurance\"), Frankfort, Kentucky. As of December 31, 1995, the Registrant has $906 million in consolidated assets.\nFarmers Bank, originally organized in 1850, is a state chartered bank engaged in a wide range of commercial and personal banking activities, which include accepting savings, time and demand deposits; making secured and unsecured loans to corporations, individuals and others; providing cash management services to corporate and individual customers; issuing letters of credit; renting safe deposit boxes; and providing funds transfer services. The bank's lending activities include making commercial, construction, mortgage and personal loans and lines of credit. The bank serves as an agent in providing credit card loans. It acts as trustee of personal trusts, as executor of estates, as trustee for employee benefit trusts, as registrar, transfer agent and paying agent for bond issues. Farmers Bank also acts as registrar, transfer agent and paying agent for the Registrant's stock issue. Farmers Bank is the general depository for the Commonwealth of Kentucky and has been for more than 70 years.\nFarmers Bank is the largest bank in Franklin County. It conducts business in its principal office and four branches within Frankfort, the capital of Kentucky. Franklin County is a diverse community, including government, commerce, finance, industry, medicine, education and agriculture. The bank also serves many individuals and corporations throughout Central Kentucky. On December 31, 1995, it had total assets of $425 million, including loans of $244 million. On the same date, total deposits were $353 million and shareholders' equity totaled $36 million.\nFarmers Bank has three subsidiaries: Farmers Bank Realty Company (\"Realty\"); Money One Credit of Kentucky, Inc. (\"Money One\"); and Leasing One Corporation (\"Leasing One\"). Farmers Bank, Realty and Money One, Inc. own a partnership - - Money One Credit Company (\"MOCC\"). Farmers Bank also participates in a joint venture - Frankfort ATM, Ltd. (\"ATM\").\nRealty was incorporated in 1978 for the purpose of owning certain real estate used by the Registrant and Farmers Bank in the ordinary course of business. Realty had total assets of $3.6 million on December 31, 1995.\nMoney One was incorporated in 1989 and until January 1, 1993, was a direct subsidiary of the Registrant. It manages the consumer finance company, MOCC. At December 31, 1995 it had $1.2 million in assets.\nMOCC was established on June 1, 1994. It is a partnership engaged in consumer lending activities under Chapter 288 of the Kentucky Revised Statutes. As stated earlier, the partners include Farmers Bank, Realty and Money One. MOCC has fourteen offices throughout Kentucky. At December 31, 1995 it had total assets of $15.0 million.\nLeasing One was incorporated in August, 1993 to operate as a commercial equipment leasing company. It is located in Frankfort, but conducts business in Ohio, Indiana, Tennessee and Kentucky. At year end it had total assets of $11.3 million.\nA fourth subsidiary, Farmers Financial Services Corporation (\"FFSC\"), was in existence for the first three quarters of 1995. FFSC was incorporated in 1985 in order to enter into a partnership with several other banks to form a statewide electronic network. The partnership, known as \"Transaction Services Company\", supported an automated teller machine network (Quest) with machines throughout Kentucky and Indiana as well as point-of-sale terminals in retail stores. With the termination of the \"Quest\" network, the partnership known as \"Transaction Services Company\" was also terminated. As a result, FFSC was dissolved as of September 27, 1995.\nFarmers Bank has a 50% interest in ATM, a joint venture for the purpose of ownership of automatic teller machines in the Frankfort area. State National Bank, a Frankfort bank not otherwise associated with the Registrant, also has a 50% interest in ATM.\nOn February 15, 1985, the Registrant acquired United Bank, a state chartered bank originally organized in 1880. It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business in its principal office and two branches in Woodford County, Kentucky. United Bank is the second largest bank in Woodford County with total assets of $100 million and total deposits of $89 million at December 31, 1995.\nOn June 28, 1985, the Registrant acquired Lawrenceburg Bank, a national chartered bank originally organized in 1885. It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business in its principal office and one branch in Anderson County, Kentucky. Lawrenceburg Bank is the largest bank in Anderson County with total assets of $93 million and total deposits of $84 million at December 31, 1995.\nOn March 31, 1986, the Registrant acquired First Citizens Bank, a state chartered bank originally organized in 1964. It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business in its principal office and four branches in Hardin County, Kentucky. First Citizens Bank is the largest bank in Hardin County with total assets of $108 million and total deposits of $89 million at December 31, 1995.\nOn June 30, 1986, the Registrant acquired Farmers Georgetown Bank, a state chartered bank originally organized in 1850. It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business in its principal office and three branches in Scott County, Kentucky. Farmers Georgetown Bank is the largest bank in Scott County with total assets of $113 million and total deposits of $100 million at December 31, 1995.\nOn June 15, 1987, the Registrant acquired Horse Cave Bank, a state chartered bank originally organized in 1926. It is engaged in a general banking business providing full service banking to individuals, businesses and governmental customers. It conducts business in its principal office and one branch in Hart County, Kentucky. Horse Cave Bank is the largest bank in Hart County with total assets of $75 million and total deposits of $65 million at December 31, 1995.\nSubsidiary banks make first and second residential mortgages secured by the real estate not exceeding 90% loan to value. Commercial real estate loans are made in the low to moderate range, secured by the real estate not exceeding 80% loan to value. Other commercial loans are asset based loans secured by equipment and lines of credit secured by receivables. Secured and unsecured consumer loans generally are made for automobiles and other motor vehicles. In most cases loans are restricted to the subsidiaries' general market area.\nThe consumer finance subsidiary makes secured and unsecured installment loans for various purposes. The leasing subsidiary makes secured equipment leases to commercial and municipal entities in Kentucky, Indiana, Ohio and Tennessee.\nFCB Services, organized in 1992, provides data processing services and support for the Registrant and its subsidiaries. It is located in Frankfort, Kentucky. During 1994, FCB Services began performing data processing services for nonaffiliated banks.\nFarmers Insurance was organized in 1988 to engage in insurance activities permitted to the Registrant by federal and state law. This corporation has had no activity to date.\nSupervision and Regulation\nThe Registrant, as a registered bank holding company, is restricted to those activities permissible under the Bank Holding Company Act of 1956, as amended, and is subject to actions of the Board of Governors of the Federal Reserve System thereunder. It is required to file various reports with the Federal Reserve Board, and is subject to examination by the Board.\nThe Registrant's state bank subsidiaries are subject to state banking law and to regulation and periodic examinations by the Kentucky Department of Financial Institutions. Lawrenceburg Bank, a national bank, is subject to similar regulation and supervision by the Comptroller of the Currency under the National Bank Act and the Federal Reserve System under the Federal Reserve Act.\nDeposits of the Registrant's subsidiary banks are insured by the Federal Deposit Insurance Corporation Bank Insurance Fund, which subjects the banks to regulation and examination under the provisions of the Federal Deposit Insurance Act.\nThe operations of the Registrant and its subsidiary banks also are affected by other banking legislation and policies and practices of various regulatory authorities. Such legislation and policies include statutory maximum rates on some loans, reserve requirements, domestic monetary and fiscal policy, and limitations on the kinds of services which may be offered.\nThe Bank Holding Company Act formerly prohibited the Federal Reserve Board from approving an application from a bank holding company to acquire shares of another bank across its own state lines. However, effective September 1995, new legislation abolished those restrictions and now allows bank holding companies to acquire shares of out of state banks, subject to certain conditions. Currently, the Company has no plans to purchase shares of an out of state bank.\nThe Financial Reform, Recovery and Enforcement Act of 1989 (FIRREA) provides that a holding company's controlled insured depository institutions are liable for any loss incurred by the Federal Deposit Insurance Corporation in connection with the default of or any FDIC assisted transaction involving an affiliated insured bank.\nUnder the Federal Deposit Insurance Corporation Improvement Act (\"FDICIA\"), the FDIC was required to establish a risk-based assessment system for insured depository institutions which became effective January 1, 1994. The FDIC has adopted a risk-based deposit insurance assessment system under which 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.\nUnder FDICIA, the federal banking regulators are required to take prompt corrective action if an institution fails to satisfy certain minimum capital requirements, including a leverage limit, a risk-based capital requirement, and any other measure deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees that would cause the institution to become undercapitalized.\nThe purpose of the Community Reinvestment Act (CRA) is to encourage banks to respond to the credit needs of the communities they serve, including low and moderate income neighborhoods. CRA states that banks should accomplish this while still preserving the flexibility needed for safe and sound operations. It is designed to increase the bank's sensitivity to investment opportunities which will benefit the community. Of the Company's six subsidiary banks, two have an outstanding CRA rating and four have a satisfactory rating.\nCompetition\nThe Corporation and its subsidiaries compete for banking business with various types of businesses other than commercial banks and savings and loan associations. These include, but are not limited to, credit unions, mortgage lenders, finance companies, insurance companies, stock and bond brokers, financial planning firms, and department stores which compete for one or more lines of banking business. The banks also compete for commercial and retail business not only with banks in Central Kentucky, but with banking organizations from Ohio, Indiana, Tennessee and Pennsylvania which have banking subsidiaries located in Kentucky and may possess greater resources than the Corporation.\nThe primary areas of competition pertain to quality of services, interest rates and fees.\nThe business of the Registrant is not dependent upon any one customer or on a few customers, and the loss of any one or a few customers would not have a materially adverse effect on the Registrant.\nNo material portion of the business of the Registrant is seasonal. No material portion of the business of the Registrant is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government, though certain contracts are subject to such renegotiation or termination.\nThe Registrant is not engaged in operations in foreign countries.\nEmployees\nAs of December 31, 1995, the Registrant and its subsidiaries had 494 full-time equivalent employees. Employees are provided with a variety of employee benefits. A retirement plan, a profit-sharing (401K) plan, group life insurance, hospitalization, dental and major medical insurance are available to eligible personnel. The employees are not represented by a union. Management and employee relations are good.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nAll of the Registrant's properties are owned or leased by the Banks or their subsidiaries.\nFarmers Bank and its subsidiary, Realty, currently own or lease nine buildings. Farmers Bank operates five branches, two of which it owns and three of which it leases. United Bank owns its two branch offices and approximately 52% of a condominiumized building which houses its main office. Lawrenceburg Bank owns its main office and its branch office. First Citizens Bank owns its main office and two of its four branches. The other two branch locations of First Citizens Bank are leased facilities, one of which being located in a grocery store. Farmers Georgetown Bank owns its main office, another branch in downtown Georgetown and one in Stamping Ground, Kentucky. Farmers Georgetown Bank's third branch is located in a leased facility. Horse Cave Bank owns the building where it is headquartered. In the first quarter of 1991, Horse Cave Bank opened a branch in leased facilities in Munfordville, Kentucky.\nMoney One operates out of fourteen leased offices in fourteen cities within Kentucky.\nItem 3","section_3":"Item 3 - Legal Proceedings\nFarmers was named, on September 10, 1992, as a defendant in Case No. 92CI05734 in Jefferson Circuit Court, Louisville, Kentucky, Earl H. Shilling et al. v. Farmers Bank & Capital Trust Company. The named plaintiffs purported to represent a class consisting of all present and former owners of the County of Jefferson, Kentucky Nursing Home Refunding Revenue Bonds (Filson Care Home Project) Series 1986A (the \"Series A Bonds\") and County of Jefferson, Kentucky Nursing Home Improvement Bonds (Filson Care Home Project) Series 1986B (the \"Series B Bonds\") (collectively the \"Bonds\"). The plaintiffs alleged that the class which they purported to represent has been damaged in the approximate amount of $2,000,000 through the reduction in value of the Bonds and the collateral security therefore, and through the loss of interest on the Bonds since June 1, 1989, as a result of alleged negligence, breach of trust, and breach of fiduciary duty on the part of Farmers Bank in its capacity as indenture trustee for the Bonds. A subsequent amendment to the complaint further alleges that Farmers Bank conspired with and aided and abetted the former management of the Filson Care Home in its misappropriation of the nursing home's revenues and assets to the detriment of the Bondholders and in order to unlawfully secure and benefit Farmers Bank. The amendment seeks unspecified punitive damages against Farmers Bank. On July 6, 1993, the Circuit Court denied the plaintiff's motion to certify the case as a class action on behalf of all present and former owners of the Bonds. Under that ruling, the action may be maintained only with respect to the individual claims of the named plaintiffs and any other Bondholders whom the court might allow to join in the action with respect to their own individual claims. Since the denial of class certifications, the complaint has been amended twice to join additional Bondholders as plaintiffs. The 42 existing plaintiffs claim to hold Bonds having an aggregate face value of $470,000. The case is presently in the process of discovery. Farmers Bank believes that the claims of the plaintiffs are unfounded and totally without merit, and Farmers Bank intends to vigorously contest any further proceedings in the case.\nTwo of the original named plaintiffs in the case before the Circuit Court filed a similar action, Earl H. Schilling et al v. Farmers Bank & Capital Trust Company, on July 7, 1992 in the United State District Court for the Western District of Kentucky at Louisville, Case No. C- 920399 L-M. That action has been dismissed without prejudice on the grounds that the plaintiffs did not appear to be able to establish federal jurisdiction.\nOn November 27, 1995, one of the Registrant's subsidiaries, Farmers Bank & Capital Trust Co. (\"Farmers Bank\") filed suit in the Circuit Court for Franklin County, Kentucky against Travel Professionals of Frankfort, Inc. and Travel Professionals of Scott County, Inc. (the \"TPI Companies\") to collect five (5) loans totaling approximately $1,158,572 plus interests, costs and attorney's fees. In addition to the TPI Companies, other named defendants were Charles O. Bush, Sr., a director of the bank (by virtue of certain guarantees) and two of his children, Charles O. Bush, Jr. and Karen Wilhelm and their respective spouses, Sandra Bush and David Wilhelm, (collectively, the \"Bush Family Members\"). In addition, Ray Godbey and Virginia Godbey, officers of the Corporation were joined as defendants. Each of the defendants has filed an answer and counterclaim denying liability to Farmers Bank and asserting various claims for damages against the Bank. The Registrant believes that the defenses and claims asserted by the defendants are without merit and Farmers Bank has denied any liability to the defendants. The litigation presently is in the discovery phase and is being vigorously defended. It is anticipated that Farmers Bank will amend its complaint to assert additional claims against the defendants in this case.\nThe Registrant's Georgetown, Kentucky affiliate, Farmers Georgetown Bank, and its Executive Vice President, have been named defendants in a civil action brought on August 1, 1994 by a loan customer of the Bank, in which the customer alleges (1) fraud, (2) breach of good faith and fair dealing, (3) disclosure of false credit information (defamation) and (4) outrageous conduct. As earlier reported, the initial amount in controversy for the first three counts was unspecified. The amount originally sought as punitive damages for outrageous conduct was $10,000,000. By order of the Scott County Circuit Court, Georgetown, Kentucky, the plaintiffs were recently required to quantify the amounts in controversy. For the count of fraud the plaintiffs seek $50,000; for the count of breach of good faith and fair dealing the plaintiff seeks $12,900,000; for the count of defamation the plaintiffs seek $14,800,000 plus an estimated $75,000 in legal costs. Further the amount now sought as punitive damages is $21,000,000.\nThe conduct complained about in counts 1 and 2 involves former officers of Farmers Georgetown Bank. The Bank at this time has had the opportunity to examine those former officers knowledge of the events alleged to have taken place and believes there is no merit to the allegations. The Farmers Georgetown Bank also believes that there is no merit to the allegations in counts 3 and 4 and intends to vigorously defend all claims.\nThe case has been set for trial in both November 1995 and February 1996, but has been recently continued once again. It is anticipated that the case will go to trial in either September 1996 or in the alternative November 1996. With respect to the issue of the count of defamation, the court at one point, granted the defendants a summary judgement, but has agreed to reconsider that action at some later time. Management believes the previously mentioned actions are without merit, that in certain instances its actions or omissions were pursuant to the advice of counsel, or that the ultimate liability, if any, resulting from one or more of the claims will not materially affect the Registrant's consolidated financial position, although resolution in any year or quarter could be material for that period.\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 Stock and Related Shareholders' Matters\nThe Registrant's stock is traded in the National Association of Security Dealers Automated Quotation System (NASDAQ) National Market System and the sales prices shown below are as reported by the National Association of Securities Dealers under the NASDAQ symbol: FFKT. The amount of dividends per share declared by the Registrant during the last two calendar years is also included below:\nDividends Stock Prices High Low Declared\n4th Quarter, 1995 $43.50 $37.00 $0.36 3rd Quarter, 1995 39.50 33.00 0.33 2nd Quarter, 1995 37.00 32.50 0.33 1st Quarter, 1995 38.00 35.50 0.33\n4th Quarter, 1994 $40.50 $36.50 $0.33 3rd Quarter, 1994 41.00 36.88 0.30 2nd Quarter, 1994 43.00 37.00 0.30 1st Quarter, 1994 39.50 33.00 0.30\nAs of January 1, 1996, there were 818 shareholders of record. This figure does not include individual participants in security position listings.\nPayment of dividends by the Registrant's subsidiary banks is subject to certain regulatory restrictions as set forth in national and state banking laws and regulations. At December 31, 1995, combined retained earnings of the subsidiary banks were approximately $38,401,026 of which $4,519,000 was available for the payment of dividends in 1996 without obtaining prior approval from bank regulatory agencies.\nStock Transfer Agent and Registrar:\nFarmers Bank & Capital Trust Co. P.O. Box 309 Frankfort, Kentucky 40602\nThe Registrant offers shareholders automatic reinvestment of dividends in shares of stock at the market price without fees or commissions. For a description of the plan and an authorization card, contact the Registrar above.\nNASDAQ Market Makers:\nJ.J.B. Hilliard, W.L. Lyons, Inc. Herzog, Heine, Geduld, Inc. Phone: 502\/588-8400 or Phone: 800\/221-3600 800\/444-1854\nJ.C. Bradford and Co., Inc. PaineWebber Incorporated Louisville 502\/589-7760 or Phone: 800\/222-1448 800\/752-6093 Lexington 606\/255-7353 or 800\/522-7353\nItem 6","section_6":"Item 6 - Selected Financial Highlights\nDecember 31 (In thousands, except per share data)\n1995 1994 1993 1992 1991\nNet interest income $ 39,146 $ 36,164 $ 32,844 $ 32,338 $ 28,869\nNet income 10,389 10,250 10,804 6,317 4,261\nNet income per share 2.69 2.65 2.79 1.63 1.10\nTotal assets 906,113 851,703 794,269 820,991 926,248\nLong term debt 3,886 4,865 2,695 159 None\nDividends declared per share 1.35 1.23 1.11 1.08 1.08\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\nOperating Results\nFarmers Capital Bank Corporation (the \"Company\") finished 1995 with net income of $10.4 million, or $2.69 per share, up from $10.25 million, or $2.65 per share reported for 1994. This increase was realized even though the Company benefited during the second quarter of 1994 from a significant nonrecurring recovery of prior year losses amounting to $503 thousand after tax. Adjusting for the nonrecurring recovery, 1995 net income is $642 thousand, or 6.6% higher than net income for 1994. The performance ratios also increased after adjusting for the nonrecurring recovery. Return on assets increased 4.3% from 1.16% to 1.21%. Return on equity increased 2.1% from 9.99% to 10.20%.\nThe two items having the most beneficial impact on the Company during 1995 were the increase in net interest margin and the much publicized reduction in the FDIC insurance premium.\nInterest Income\nTotal interest income, on a tax equivalent basis was $68.7 million, up $9.4 million, or 15.9% from 1994. Interest on taxable investment securities was up $1.8 million, or 29.8% from 1994. The yield was 5.8%, up from 4.8% in the previous year. Interest on nontaxable investment securities was stable at $3.4 million while the yield dropped 19 basis points to 6.6%. Interest on federal funds sold and securities purchased under agreement to resell was $3.0 million, up $644 thousand or 26.9%. The yield was up, due to rate, 160 basis points to 5.9%. Interest on loans was $54.4 million, up $7.0 million, or 14.9% over 1994. The yield was up 80 basis points to 10.0%.\nThe increase in loan and taxable investment securities interest was due primarily to changes in rates. The decline in nontaxable investment security interest was also due to rate. The yield on total earning assets increased from 8.0% to 8.8%. This was accomplished by increased loan volumes and by moving balances from lower yielding asset categories to higher earning loans.\nInterest Expense\nTotal interest expense was $28.1 million, up $6.5 million, or 30.2%. Interest expense on interest bearing demand deposits was up $537 thousand, or 8.0% from 1994 due to the rate variance. Interest paid on savings accounts was $1.7 million, an increase of $91 thousand while the rate paid increased 30 basis points to 3.2% in 1995.\nThe largest interest expense impact came from those on time deposits which had increases in both rate and volume. Interest expense on time deposits increased $5.5 million, or 46.3% while the rate increased 125 basis points to 5.6%. Interest paid on securities sold under agreement to repurchase was $1.6 million, up $375 thousand, or 31.0% due to rate. The rate paid on total interest bearing liabilities was 4.36%, an increase of 85 basis points.\nNet interest income is the most significant component of the Company's earnings. Net interest income is the excess of the interest income earned on assets over the interest paid for funds to support those assets. The following table represents the major components of interest earning assets and interest bearing liabilities on a tax equivalent basis (TE) where tax exempt income is adjusted upward by an amount equivalent to the federal income taxes that would have been paid if the income had been fully taxable (assuming a 34% tax rate).\n1 Income and yield stated at a fully tax equivalent basis (TE), using a 34% tax rate. 2 Loan balances include principal balances on non-accrual loans. 3 Loan fees included in interest income amounted to $1,781,000, $1,731,000 and $1,302,000 in 1995, 1994 and 1993, respectively.\nNet interest income (TE) increased $2.9 million during 1995 to $40.6 million. The change in the spread between rates earned and paid and the net interest margin are summarized below:\n1995 1994 % change\nSpread between rates earned and paid 4.45% 4.45% Net interest margin 5.21% 5.06% 3%\nThe following table is an analysis of the change in net interest income and the attributable factors.\n1 Income stated at fully tax equivalent basis using a 34% tax rate. 2 The changes which are not solely due to rate or volume are allocated on a percentage basis, using the absolute values of rate and volume variances as a basis for allocation.\nAs the table indicates, the $2.9 million increase for 1995 in net interest income (TE) is nearly equally attributed to rate and volume variance.\nAsset Quality\nThe provision for loan losses represents charges made to earnings to maintain an adequate Allowance. Each subsidiary determines its level for the Allowance and maintains it at an amount believed to be sufficient to absorb possible losses that may be experienced in the credit portfolio. The following factors are used in establishing an appropriate Allowance:\nA careful assessment of the financial condition of individual borrowers\nA realistic determination of the value and adequacy of underlying collateral\nA thorough review of historical loss experience\nThe condition of the local economy\nA comprehensive analysis of the levels and trends of loan categories\nA review of delinquent and criticized loans\nThe provision for loan losses increased $1.6 million compared to 1994. The Company had net charge-offs of $4.1 million compared to $1.8 million the prior year. The Allowance was 1.56% of net loans, down from 1.67% at the end of 1994. Management feels the current reserve is adequate to cover any potential future losses within the loan portfolio. Management also continues to emphasize collection efforts and evaluation of risks within the portfolio.\nSeveral loans to one borrower (an entity controlled by relatives of a director), totaling $1.4 million were charged off during 1995. Remaining loans with this borrower have been addressed in determining the current amount of reserve necessary to cover potential future losses.\nThe table below summarizes the loan loss experience for the past five years.\nYear Ended December 31, (In thousands) 1995 1994 1993 1992 1991\nAverage loans net of unearned income $540,632 $511,492 $467,738 $473,271 $482,355\nBalance of allowance for loan losses at beginning of period $ 8,889 $ 8,547 $ 8,261 $ 7,917 $ 7,947 Loans charged off: Commercial, financial and agricultural 2,390 741 1,826 2,427 2,126 Real estate 118 416 638 611 2,213 Installment loans to individuals 2,376 1,467 1,483 1,233 1,460\nTotal loans charged off 4,884 2,624 3,947 4,271 5,799\nRecoveries of loans previously charged off: Commercial, financial and agricultural 192 193 343 651 329 Real estate 146 230 5,409 371 354 Installment loans to individuals 402 418 507 357 268\nTotal recoveries 740 841 6,259 1,379 951\nNet loans charged off\/ (recovered) 4,144 1,783 (2,312) 2,892 4,848 Additions to allowance charged (credited) to expense 3,727 2,125 (2,026) 3,236 4,818\nBalance at end of period $ 8,472 $ 8,889 $ 8,547 $ 8,261 $ 7,917\nRatio of net charge offs (recoveries) during period to average loans, net of unearned income .77% .35% (.49)% .61% 1.01%\nNoninterest Income\nNoninterest income for 1995 totaled $11.9 million. Compared with 1994, noninterest income increased $384 thousand; however, after considering that in 1994 noninterest income was inflated by a $758 thousand nonrecurring recovery, the actual increase is $1.1 million. The majority of the improvement came from increased nonsufficient funds and overdraft fees. Trust income, totalling $1.2 million was unchanged from the previous year. The rest of the increase was made up from various unrelated service charges and fees.\nNoninterest Expense\nNoninterest expense, excluding the provision for loan losses, increased $1.5 million, or 4.9% to $32.6 million despite the significant reduction in FDIC insurance premiums. FDIC premiums decreased $686 thousand, or 45.4% and will be even lower in 1996. The premium rate declined during the third quarter of 1995 from $.23 per $100 to $.04 per $100. No premium will be collected in the first six months of 1996 before returning to the $.04 per $100 rate.\nSalaries and benefits were up $835 thousand, or 5.2% to $16.8 million. The full time equivalent number of employees did not change during the last year; the increase is due to rising health insurance premiums. Management has addressed rising health insurance costs by adopting a self-insured medical plan effective January 1, 1996. It is anticipated that the new self-funded plan will help control rising costs. Occupancy expense is up $163 thousand, or 8.2% and equipment expense is up $158 thousand, or 6.2%.\nOther noninterest expense is up $1.1 million, a 14.4% increase to $9.1 million. Expense related to other real estate owned is $292 thousand. The rest of the increase in other noninterest expense consists of various unrelated service charges, and operating expenses.\nIncome Tax\nIncome tax expense increased $108 thousand or 2.5% which correlates to the increase in income before tax. The effective tax rate for 1995 was 29.6%, up 20 basis points from last year.\nFinancial Condition\nOn December 31, 1995 assets were $906 million, an increase of $54 million or 6.4% from year end 1994. Average assets for 1995 increased $23 million, or 2.7% to $862 million. Earning assets, primarily loans and investments, averaged $779 million, up $34 million or 4.6%.\nLoans\nAverage loans increased $29 million, or 5.7% in 1995 to $541 million and represented 69.4% of total earning assets, up 7 basis points from 1994. The average yield on the entire loan portfolio was 10.05% in 1995 compared to 9.25% in 1994.\nOn average, real estate mortgage loans are up $15.6 million, or 5.7%, direct lease financing is up $8.7 million, or 86.7% while the other categories experienced nominal fluctuations. Leasing One, our commercial leasing subsidiary, has now completed its second full year of operations and will continue to provide increased volume in the near future. The outlook for increased volumes of other types of loans is not as favorable.\nThe composition of the loan portfolio is summarized in the table below:\nThe following table indicates the amount of loans (excluding real estate mortgages, consumer loans and direct lease financing) outstanding at December 31, 1995, which, based on remaining scheduled repayments of principal, are due in the periods indicated.\nMaturing Within After One But After (In thousands) One Year Within Five Years Five Years Total\nCommercial, financial and agricultural $ 92,699 $20,585 $1,128 $114,412 Real estate - Construction 23,354 3,002 24 26,380\nTotal $116,053 $23,587 $1,152 $140,792\nThe table below shows the amount of loans (excluding real estate mortgages, consumer loans and direct lease financing) outstanding at December 31, 1995, which are due after one year classified according to sensitivity to changes in interest rates.\nInterest Sensitivity Fixed Variable (In thousands) Rate Rate\nDue after one but within five years $23,240 $347 Due after five years 1,090 62\n$24,330 $409\nTemporary Investments\nFederal funds sold and securities purchased under agreement to resell are the primary components of temporary investments. These funds help in the management of liquidity and interest rate sensitivity. In 1995, temporary investments averaged $52 million, a decrease of $4.3 million, or 7.7% from year end 1994. Temporary investment funds are reallocated as loan demand presents the opportunity.\nInvestment Securities\nThe majority of the investment security portfolio is comprised of U.S. Treasury securities, Federal agency securities, tax-exempt securities, and mortgage-backed securities. Total investment securities were $227 million on December 31, 1995 an increase of $34 million, or 17.6% from year end 1994.\nObligations of other U.S. Government agencies are currently providing the best opportunities. New funds and the reinvestment of called or matured securities are typically being used to acquire agency bonds without lowering the current level of tax free obligations. Obligations of states and political subdivisions are the primary means of managing the Company's tax position. The alternative minimum tax is not expected to impact our ability to acquire tax free obligations in the near future as they become available at an attractive yield.\nAvailable for sale securities and held to maturity securities were $106 million and $121 million, respectively. Total investment securities averaged $187 million, an increase of $9.6 million, or 5.4% from year end 1994. Net unrealized losses, net of tax effect, on available for sale securities, was $826 thousand on December 31, 1995.\nThe following table summarizes the carrying values of investment securities on December 31, 1994 and 1995. The investment securities are divided into available for sale and held to maturity securities. Available for sale securities are carried at the estimated fair value and held to maturity securities are carried at amortized cost.\n1995 1994\nAvailable Held to Available Held to December 31, (In thousands) for sale maturity for sale maturity\nU.S. Treasury securities $ 16,668 $ 15,994 $ 8,745 $ 45,559 Obligations of other U.S. Government agencies 77,624 34,732 55,855 18,192 Obligations of states and political subdivisions 54,696 51,095 Mortgage-backed securities 10,251 13,151 4,819 5,131 Other securities 1,390 2,418 3,047 500\nTotal $105,933 $120,991 $72,466 $120,477\nDuring 1993, investment securities were carried at amortized cost. The following table summarizes the carrying values on December 31, 1993.\nDecember 31, (In thousands) 1993\nU.S. Treasury securities $ 67,355 Obligations of other U.S. Government agencies 68,529 Obligations of states and political subdivisions 46,081 Mortgage-backed securities 5,792 Other securities 1,109\nTotal $188,866\nThe following is an analysis of the maturity distribution and weighted average interest rates of investment securities at December 31, 1995. For purposes of this analysis, available for sale securities are stated at fair value and held to maturity securities are valued at amortized cost.\nThe calculation of the weighted average interest rates for each category is based on the weighted average costs of the securities. The weighted average tax rates on exempt state and political subdivisions is computed on a taxable equivalent basis using a 34% tax rate.\nDeposits\nOn December 31, 1995, deposits totaled $755 million, an increase of $58 million, or 8.3% from year end 1994. Deposits averaged $722 million, an increase of $22 million, or 3.1% from 1994.\nDuring 1995 the total average interest bearing deposits increased $33 million, or 5.7% to $611 million while average noninterest bearing deposits decreased $11 million, or 8.8% to $111 million. On average, interest bearing demand deposits make up 34.1% of the total deposit base and have fluctuated less than 1% from last year. Average savings accounts have declined 4.4% to a total of $53 million.\nThe primary increase in the deposit base has been with time deposits. Average time deposits have increased $37 million, or 13.4% to $312 million due to the creation of a new flexible rate certificate of deposit product (\"FlexSaver\") introduced during the fourth quarter of 1994. The increase is the result of both new deposits and the migration of existing accounts into the FlexSaver.\nThe decline in noninterest bearing deposits can be attributed to the introduction of the FlexSaver and the unpredictable fluctuation in activity from the Commonwealth of Kentucky deposits. Farmers Bank & Capital Trust Co., a subsidiary of the Company, is the general depository for the Commonwealth of Kentucky and has been for more than 70 years.\nA summary of average balances and rates paid on deposits follows:\n1995 1994 1993\nAverage Average Average Average Average Average (In thousands) Balance Rate Balance Rate Balance Rate\nNoninterest demand deposits $110,759 0.00% $121,492 0.00% $110,721 0.00% Interest bearing demand deposits 245,926 2.96 247,554 2.72 221,086 2.73 Savings deposits 53,417 3.19 55,853 2.89 55,697 2.83 Time deposits 311,668 5.55 274,812 4.30 295,883 4.44\n$721,770 $699,711 $683,387\nMaturities of time deposits of $100,000 or more outstanding at December 31, 1995 are summarized as follows:\nTime Deposits (In thousands) >$100,000\n3 months or less $13,286 Over 3 through 6 months 13,632 Over 6 through 12 months 15,506 Over 12 months 16,217\n$58,641\nShort-term Borrowings\nSecurities sold under agreement to repurchase: (In thousands) 1995 1994 1993\nAmount outstanding at year-end $34,638 $43,525 $22,372 Maximum outstanding at any month-end 55,929 43,525 36,058 Average outstanding 28,889 33,348 30,590 Weighted average prime rate during the year 8.83% 7.14% 6.00% Weighted average interest rate at year-end 5.48 3.63 2.89\nSuch borrowings are generally on an overnight basis.\nNonperforming Assets\nNonperforming assets decreased $1.9 million, or 21.7% to $7.0 million at year end 1995. As a percentage of loans and other real estate owned, nonperforming assets were 1.3% in 1995, 1.7% in 1994, 1.6% in 1993, 3.7% in 1992, and 4.7% in 1991. Since 1991, nonperforming assets have decreased $15.9 million, or 69.6%. The largest reductions have been in other real estate owned and restructured loans. This trend is the result of management's continued efforts to improve the quality of the loan portfolio. The Company's loan policy includes strict guidelines for approving and monitoring loans. The table below is a five year summary of nonperforming assets.\nYear Ended December 31, (In thousands) 1995 1994 1993 1992 1991\nLoans accounted for on non-accrual basis $2,897 $ 3,913 $ 1,565 $ 3,981 $ 5,479 Loans contractually past due ninety days or more 1,713 1,056 1,402 2,730 3,275 Restructured loans 1,571 3,538 3,734 5,266 5,247 Other real estate owned 776 380 1,169 5,541 8,865\nTotal nonperforming assets $6,957 $ 8,887 $ 7,870 $17,518 $22,866\nLiquidity and Interest Rate Sensitivity\nThe liquidity of the Company is dependent on the receipt of dividends from its subsidiary banks (see Note 17 to the financial statements). Management expects that in the aggregate, its subsidiary banks will continue to have the ability to dividend adequate funds to the Company.\nThe Company's objective as it relates to liquidity is to insure that subsidiary banks have funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability. In order to maintain a proper level of liquidity, the banks have several sources of funds available on a daily basis which can be used for liquidity purposes. Those sources of funds are:\nThe banks' core deposits consisting of both business and non-business deposits\nCash flow generated by repayment of loan principal and interest\nFederal funds purchased and securities sold under agreements to repurchase\nFor the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet. This process allows for an orderly flow of funds over an extended period of time.\nInterest Rate Sensitivity\nIn that it is extremely difficult to accurately predict interest rate movements, it is management's intention to maintain the cumulative interest sensitivity gap at the one year time frame between plus or minus 10% as a percent of total assets. The gap position may be managed by (1) purchasing investment securities with a maturity date within the desired time frame, (2) offering interest rate incentives to encourage loan customers to choose the desired maturity, and (3) offer interest rate incentives to encourage deposit customers to choose the desired maturity.\nThe following chart illustrates interest rate sensitivity at December 31, 1995 for various time periods. The purpose of this GAP chart is to measure interest rate risk utilizing the repricing intervals of the interest sensitive assets and liabilities. Rising interest rates are likely to increase net interest income in a positive GAP position while falling interest rates are beneficial in a negative GAP position. The Company has a negative GAP position through three months, but then shifts to a nearly neutral GAP position at twelve months. This positioning is due to management's anticipated economic outlook and other competitive factors.\nAfter Three After Months But One Year But Within Within Twelve Within Five After (In millions) Three Months Months Years Five Years Total\nInterest earning assets: Investment securities $ 81.1 $ 28.4 $ 89.8 $ 27.6 $226.9 Federal funds sold 68.4 68.4 Loans, net of unearned income 218.7 167.1 147.2 10.1 543.1\nTotal $368.2 $195.5 $237.0 $ 37.7 $838.4 Percentage of total interest earning assets 43.9% 23.3% 28.3% 4.5% 100.0%\nRate sensitive sources of funds used to finance interest earning assets: Interest bearing deposits $379.5 $141.4 $119.5 $ 5.0 $645.4 Other borrowed funds 34.5 1.0 3.0 38.5\nTotal $414.0 $141.4 $120.5 $ 8.0 $683.9 Percent of total rate sensitive sources of funds 60.5% 20.7% 17.6% 1.2% 100.0%\nInterest sensitivity gap (45.8) 54.1 116.5 29.7 154.5\nCumulative interest sensitivity gap (45.8) 8.3 124.8 154.5\nInterest sensitive assets to interest sensitive liabilities .89:1 1.38:1 1.97:1 4.71:1 1.23:1\nCumulative ratio of interest sensitive asset to interest sensitive liabilities .89:1 1.01:1 1.18:1 1.23:1\nEffects of Inflation\nSince most of the assets and liabilities are monetary in nature, inflation has a minor effect on banking concerns. Personnel costs, occupancy expenses and equipment costs all tend to reflect the inflation rate as measured by the consumer price index. The Company continues to attempt to offset such increases by raising noninterest income fees.\nShareholders' Equity\nShareholders equity was $105 million on December 31, 1995, increasing $4.9 million, or 4.9% from year end 1994. Dividends of $5.2 million were declared during 1995. The Company's Board of Directors approved a 9.1% increase in the quarterly dividend rate in the fourth quarter of 1995 from $.33 per share to $.36 per share. The Company's capital ratios as of December 31, 1995 and the regulatory minimums are as follows:\nFarmers Capital Regulatory Bank Corporation Minimum\nTier 1 risk based 18.29% 4.00%\nTotal risk based 19.54 8.00\nLeverage 11.73 3.00\nThe capital ratios of all the subsidiary banks, on an individual basis, were well in excess of the applicable minimum regulatory capital ratio requirements at December 31, 1995.\nThe table below is an analysis of dividend payout ratios and equity to asset ratios for five years.\nDecember 31, 1995 1994 1993 1992 1991\nPercentage of dividends declared to net income 50.24% 46.40% 39.78% 66.26% 98.18%\nPercentage of average shareholders' equity to average total assets 11.81 11.57 11.22 10.85 10.64\nShareholder Information\nAs of January 1, 1996, there were 818 shareholders of record. This figure does not include individual participants in security position listings.\nStock Prices\nFarmers Capital Bank Corporation's stock is traded in the National Association of Security Dealers Automated Quotation System (NASDAQ) National Market System, with sales prices reported by the National Association of Securities Dealers, under the NASDAQ symbol: FFKT. The table below is an analysis of the stock prices and dividends declared for 1995 and 1994.\nStock Prices Dividends High Low Declared\nFourth Quarter $43.50 $37.00 $0.36 Third Quarter 39.50 33.00 0.33 Second Quarter 37.00 32.80 0.33 First Quarter 38.00 35.50 0.33\nFourth Quarter $40.50 $36.50 $0.33 Third Quarter 41.00 36.88 0.30 Second Quarter 43.00 37.00 0.30 First Quarter 39.50 33.00 0.30\nDividends declared per share increased $.12, or 9.8% and $.12 or 10.8%, for the years 1995 and 1994, respectively.\nAccounting Requirements\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.\" 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 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 no be recoverable. If the sum of the expected future cash flows resulting from an asset's use and disposition is less than the carrying amount of the asset, an impairment loss is recognized.\nThis Statement if effective for fiscal years beginning after December 15, 1995. The Company does not expect the implementation of this Statement to have a material effect on the financial statements.\nIn May 1995, the FASB issued SFAS No. 122 \"Accounting for Mortgage Servicing Rights\". This Statement amends FASB Statement No. 65, \"Accounting for Certain Mortgage Banking Activities\", to require that a mortgage banking enterprise recognize as separate assets rights to service mortgage loans for others, however those servicing rights are acquired. The total cost of the mortgage loans should be allocated between the mortgage servicing rights and the loans based on their relative fair values if it is practicable to estimate those fair values. If not, the entire cost should be allocated to the mortgage loans.\nThis Statement applies prospectively in fiscal years beginning after December 15, 1995. The Company does not expect the implementation of this Statement to have a material affect on the financial statements.\nIn October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\". The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. This Statement also applies to transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.\nThe accounting requirements of this Statement are effective for transactions entered into in fiscal years that begin after December 15, 1995. The Company does not expect this Statement to have an effect on the financial statements in that the Company is not involved with any stock-based employee compensation plans or transactions to acquire goods or services from nonemployees in exchange for equity.\n1994 Compared with 1993\nNet income was $10.25 million in 1994 compared to $10.8 million in 1993, a decrease of $550 thousand, or 5.0%. Net income per share decreased to $2.65 from $2.79, or 5.0%. The decrease resulted from three nonrecurring events: (1)nonrecurring recovery of prior year losses increased 1994 net income by $503 thousand; (2) settlement of a bond claim increased 1993 net income by $3.5 million; (3) adoption of SFAS No. 109 \"Accounting for Income Taxes\" increased 1993 net income by $380 thousand. Adjusting each year for these items, net income would increase 40.7% to $9.7 million or $2.52 per share in 1994, from $6.9 million or $1.79 per share in 1993. Also after adjustment, return on average assets and average equity would increase to 1.16% and 9.99% in 1994 compared to 0.85% and 7.58% in 1993.\nNet interest income on a tax equivalent basis increased 11% to $37.7 million. The growth was due to the $31.0 million increase in average earning assets. The spread between rates earned and paid and the net interest margin both increased in 1994 to 4.45% and 5.06%, respectively compared to 4.19% and 4.73% in 1993.\nNoninterest income increased $876 thousand, or 8.2% in 1994. The majority of the increase can be attributed to the $758 thousand nonrecurring recovery of prior year losses. Third party brokerage income, service charges and fees and trust income contributed to the remaining part of the increase.\nNoninterest expense increased $1.0 million to $31.1 million in 1994. Salaries and benefits, the largest component, increased $793 thousand. Occupancy expenses were up $56 thousand and equipment expenses were down $113 thousand. FDIC insurance premiums were down $61 thousand. Other real estate expenses decreased $97 thousand.\nIncome tax expense was $4.3 million in 1994, a decrease of $802 thousand from 1993, which correlates to the decrease in income before taxes and the higher percentage of tax free income. The effective tax rate for 1994 was 29.4% compared to 32.7% in 1993.\nOn December 31, 1994, the allowance for loan losses totaled $8.9 million, or 1.7% of loans, net of unearned, down slightly from 1993. The provision for loan losses increased $4.2 million in 1994, which can be directly attributed to the bond claim settlement received in 1993. Nonperforming assets increased $1.0 million, or 12.9% in 1994 although they have otherwise steadily decreased over the previous four years.\nAverage assets, average earning assets, average loans, and average deposits increased between 1994 and 1993 by 3.5%, 4.3%, 9.4% and 2.4% respectively.\nStockholders' equity was $100.1 million on December 31, 1994, an increase of $5 million, or 5.2% from 1993.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nReport of Independent Accountants\nTo the Board of Directors and Shareholders Farmers Capital Bank Corporation\nWe have audited the accompanying consolidated balance sheets of Farmers Capital Bank 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 consolidated financial position of Farmers Capital Bank 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.\nAs discussed in Note 5 to the consolidated financial statements, in 1995 the Company changed its method of accounting for impaired loans. Also, as discussed in Notes 3, 10, and 12 to the consolidated financial statements, in 1994, the Company changed its method of accounting for certain investments in debt and equity securities and in 1993 the Company changed its method of accounting for income taxes and other postretirement benefits.\nCoopers & Lybrand L.L.P.\nLouisville, Kentucky January 16, 1996\nConsolidated Balance Sheets\nDecember 31, (In thousands, except share figures) 1995 1994\nAssets Cash and cash equivalents: Cash and due from banks $ 41,126 $ 56,304 Interest bearing deposits in other banks 688 577 Federal funds sold and securities purchased under agreement to resell 68,370 43,670\nTotal cash and cash equivalents 110,184 100,551 Investment securities: Available for sale 105,933 72,466 Held to maturity 120,991 120,477 Loans 554,942 544,566 Less: Allowance for loan losses (8,472) (8,889) Unearned income (11,762) (11,376)\nLoans, net 534,708 524,301 Bank premises and equipment 19,916 20,588 Interest receivable 7,889 6,778 Deferred income taxes 1,363 1,867 Other assets 5,129 4,675\nTotal Assets $906,113 $851,703\nLiabilities Deposits: Noninterest bearing $109,490 $103,933 Interest bearing 645,371 592,762\nTotal deposits 754,861 696,695 Other borrowed funds 38,524 48,392 Dividends payable 1,392 1,276 Interest payable 2,370 1,715 Other liabilities 4,037 3,561\nTotal liabilities 801,184 751,639\nCommitments and contingencies Shareholders' equity Common stock, par value $.25 per share, 4,804,000 shares authorized; 3,866,382 shares issued and outstanding at December 31, 1995 and 1994 967 967 Capital surplus 9,094 9,094 Retained earnings 95,694 90,524 Net unrealized loss on securities available for sale, net of tax (826) (521)\nTotal shareholders' equity 104,929 100,064\nTotal liabilities and shareholders' equity $906,113 $851,703\nThe accompanying notes are an integral part of the consolidated financial statements.\nConsolidated Statements of Income\nFor the years ended December 31, (In thousands, except per share data) 1995 1994 1993\nInterest income Interest and fees on loans $ 53,965 $ 46,951 $ 43,291 Interest on investment securities: Taxable 7,923 6,106 7,539 Nontaxable 2,331 2,295 1,510 Interest on deposits in other banks 116 122 37 Interest on federal funds sold and securities purchased under agreement to resell 2,926 2,276 2,235\nTotal interest income 67,261 57,750 54,612\nInterest expense Interest on deposits 26,274 20,171 20,737 Interest on other borrowed funds 1,841 1,415 1,031\nTotal interest expense 28,115 21,586 21,768\nNet interest income 39,146 36,164 32,844 Provision (credit) for loan losses 3,727 2,125 (2,026)\nNet interest income after provision (credit) for loan losses 35,419 34,039 34,870\nNoninterest income Service charges and fees on deposits 5,425 4,743 4,615 Trust income 1,176 1,202 1,157 Other 5,314 5,586 4,883\nTotal noninterest income 11,915 11,531 10,655\nNoninterest expense Salaries and employee benefits 16,788 15,953 15,160 Occupancy expenses, net 2,154 1,991 1,935 Equipment expenses 2,712 2,554 2,667 Bank shares tax 1,000 1,097 1,011 Deposit insurance expense 826 1,512 1,573 Other 9,093 7,949 7,689\nTotal noninterest expense 32,573 31,056 30,035\nIncome before income taxes and cumulative effect of change in accounting principle 14,761 14,514 15,490 Income tax expense 4,372 4,264 5,066\nIncome before cumulative effect of change in accounting principle 10,389 10,250 10,424 Cumulative effect of change in accounting principle 380\nNet income $10,389 $ 10,250 $ 10,804\nPer common share: Income before cumulative effect of change in accounting principle $ 2.69 $ 2.65 $ 2.69 Cumulative effect of change in accounting principle .10\nNet income $ 2.69 $ 2.65 $ 2.79\nWeighted average shares outstanding 3,866 3,866 3,866\nThe accompanying notes are an integral part of the consolidated financial statements.\nConsolidated Statements of Changes in Shareholders' Equity\nFor the years ended December 31, 1995, 1994 and 1993 (In thousands, except per share data) Net Unrealized Gain(Loss) on Total Common Capital Retained Securities Shareholders' Stock Surplus Earnings Available for Sale Equity\nBalance at January 1, 1993 $967 $9,094 $78,518 $88,579 Cash dividends declared (4,292) (4,292) Net income 10,804 10,804\nBalance at December 31, 1993 967 9,094 85,030 95,091 Cumulative effect of net unrealized gain on securities available for sale, net of tax $182 182 Cash dividends declared, $1.23 per share (4,756) (4,756) Net income 10,250 10,250 Net unrealized loss on securities available for sale, net of tax (703) (703)\nBalance at December 31, 1994 967 9,094 90,524 (521) 100,064\nCash dividends declared, $1.35 per share (5,219) (5,219) Net income 10,389 10,389 Net unrealized loss on securities available for sale, net of tax (305) (305)\nBalance at December 31, 1995 $ 967 $ 9,094 $95,694 $(826) $104,929\nThe accompanying notes are an integral part of the consolidated financial statements.\nConsolidated Statements of Cash Flows\nFor the Years Ended December 31, (In thousands) 1995 1994 1993\nCash flows from operating activities: Net income $ 10,389 $ 10,250 $ 10,804 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,634 2,553 2,775 Net amortization of investment security premiums and discounts: Available for sale (818) 117 Held to maturity 238 326 Carried at amortized cost 893 Provision (credit) for loan losses 3,727 2,125 (2,026) Loans originated for sale (14,730) (3,840) (5,035) Sale of loans 14,730 3,840 5,035 Deferred income tax expense (benefit) 732 (18) (430) Loss on sale of fixed assets 32 19 Investment security (gains) losses: Available for sale 74 Carried at amortized cost (4) Changes in: Interest receivable (1,111) (358) 408 Other assets (1,078) 785 4,265 Interest payable 655 240 (477) Other liabilities 476 589 (4,040)\nNet cash provided by operating activities 15,844 16,715 12,187\nCash flows from investing activities: Proceeds from maturities of investment securities: Available for sale 84,897 73,841 Held to maturity 51,855 21,609 Carried at amortized cost 84,743 Proceeds from sales of investment securities: Available for sale 11,603 Carried at amortized cost 7,989 Purchases of investment securities: Available for sale (118,004) (77,005) Held to maturity (52,607) (35,431) Carried at amortized cost (121,643) Net increase in loans (14,134) (53,336) (16,851) Purchases of bank premises and equipmen (1,413) (921) (1,649) Proceeds from sale of equipment 6 16\nNet cash used in investing activities (49,406) (59,634) (47,395)\nCash flows from financing activities: Net increase (decrease) in deposits 58,166 39,262 (27,096) Dividends paid (5,103) (4,640) (4,176) Net increase (decrease) in other borrowed funds (9,868) 11,064 (1,737)\nNet cash provided by (used in) financing activities 43,195 45,686 (33,009)\nNet change in cash and cash equivalents 9,633 2,767 (68,217) Cash and cash equivalents at beginning of year 100,551 97,784 166,001\nCash and cash equivalents at end of year $110,184 $100,551 $ 97,784\nSupplemental disclosures: Cash paid during the year for: Interest $ 27,460 $ 21,346 $ 22,245 Income taxes 3,730 4,255 5,337 Cash dividend declared and unpaid 1,392 1,276 1,160\nThe accompanying notes are an integral part of the consolidated financial statements.\n1. Summary of Significant Accounting Policies The accounting and reporting policies of Farmers Capital Bank Corporation and Subsidiaries conform to generally accepted accounting principles and general practices applicable to the banking industry. The more significant accounting policies are summarized below:\nBasis of Presentation and Organization: The consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the \"Company\"), a bank holding company, and its subsidiaries, including its principal subsidiary, Farmers Bank & Capital Trust Company. All significant intercompany transactions and accounts have been eliminated in consolidation.\nThe Company is predominantly engaged in the business of receiving deposits from and making real estate, commercial and consumer loans to businesses and consumers in central Kentucky.\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 financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly effect the Company's net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the financial statements.\nReclassifications: Certain amounts in the accompanying consolidated financial statements presented for prior years have been reclassified to conform with the 1995 presentation. These reclassifications do not affect net income or shareholders' equity as previously reported.\nCash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing demand deposits in other banks, federal funds sold and securities purchased under agreements to resell. Generally, federal funds sold and securities purchased under agreements to resell are purchased and sold for one-day periods.\nInvestment Securities: All investments in debt securities and all investments in equity securities that have readily determinable fair values are classified into three categories. Securities that management has positive intent and ability to hold until maturity are classified as held to maturity. Securities that are bought and held specifically for the purpose of selling them in the near term are classified as trading securities. All other securities are classified as available for sale. Securities are designated as available for sale if management intends to use such securities in its asset\/liability management strategy and therefore such securities may be sold in response to changes in interest rates and prepayment risk. Securities classified as trading and available for sale are carried at market value. Unrealized holding gains and losses for trading securities are included in current income. Unrealized holding gains and losses for available for sale securities are reported net as a separate component of stockholders' equity until realized. Investments classified as held to maturity are carried at amortized cost. Realized gains and losses on any sales of securities are computed on the basis of specific identification of the adjusted cost of each security and are included in noninterest income.\nLoans: Loans are stated at the principal amount outstanding. Interest income on loans is recognized using the interest method based on loan principal amounts outstanding during the period. Accrual of interest is adjusted or discontinued on a loan when, in the opinion of management, its collection becomes doubtful.\nProvision for Loan Losses: The provision for loan losses charged to operating expenses is an amount that is sufficient to maintain the allowance for loan losses at an adequate level based on management's best estimate of possible future loan losses. Management's determination of the adequacy of the allowance is based on such considerations as the current condition and volume of the Company's loan portfolios, economic conditions within the Company's service areas, review of specific problem loans, and any other factors influencing the collectibility of the loan portfolios.\nOther Real Estate: Other real estate owned and held for sale included with other assets on the accompanying consolidated balance sheets includes properties acquired by the Company through actual loan foreclosures. Other real estate owned is carried at lower of cost or fair value less estimated costs to sell. Fair value is the amount that the Company could reasonably expect to receive in a current sale between a willing buyer and a willing seller, other than in a forced or liquidation sale. Fair value of assets are measured by their market value based on comparable sales. Any reduction to fair value from the fair value recorded at the time of acquisition is accounted for as a valuation reserve.\nBank Premises and Equipment: Bank premises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily on the straight-line method over the estimated useful lives for furniture, equipment and buildings. Leasehold improvements are amortized over the shorter of the estimated useful lives or terms of the related leases on the straight-line method. Maintenance, repairs and minor improvements are charged to operating expenses as incurred and major improvements are capitalized. The cost of assets sold or retired and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in income.\nEarnings Per Share: Earnings per share is calculated on the basis of the weighted average number of common shares outstanding.\n2. Restrictions on Cash and Due From Banks Included in cash and due from banks are certain noninterest bearing deposits that are held at the Federal Reserve Bank and correspondent banks in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The total average balances maintained in accordance with such requirements as of December 31, 1995 and 1994 were $8,988,000 and $6,449,000, respectively.\n3. Investment 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.\" SFAS No. 115 requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and available for sale securities. Investments categorized as available for sale had an estimated fair value in excess of carrying value of $276,000 at January 1, 1994, and had the effect of increasing stockholders' equity by $182,000 (net of tax effect of $94,000). There was no impact on the Company's consolidated net income as a result of the adoption of SFAS No. 115.\nThe following summarizes the amortized cost and estimated fair values of the securities portfolio at December 31, 1995. The summary is divided into available for sale and held to maturity securities.\nDecember 31, 1995 Gross Gross Estimated (In thousands) Amortized Unrealized Unrealized Fair Available for Sale Cost Gains Losses Value\nU.S. Treasury $ 16,609 $ 70 $ 11 $ 16,668 Obligations of U.S. Government agencies 78,992 52 1,420 77,624 Mortgage-backed securities 10,210 41 10,251 Other securities 1,372 18 1,390\nTotal securities - available for sale $107,183 $181 $1,431 $105,933\nHeld to Maturity\nU.S. Treasury $ 15,994 $ 79 $ 6 $ 16,067 Obligations of U.S. Government agencies 34,732 192 176 34,748 Obligations of states and political subdivisions 54,696 721 256 55,161 Mortgage-backed securities 13,151 214 31 13,334 Other securities 2,418 24 8 2,434\nTotal securities - held to maturity $120,991 $1,230 $477 $121,744\nThe following summarizes the amortized cost and estimated fair values of the securities portfolio at December 31, 1994.\nDecember 31, 1994 Gross Gross Estimated (In thousands) Amortized Unrealized Unrealized Fair Available for Sale Cost Gains Losses Value\nU.S. Treasury $ 8,991 $ 246 $ 8,745 Obligations of U.S. Government agencies 56,308 $ 1 454 55,855 Mortgage-backed securities 4,910 91 4,819 Other securities 3,046 1 3,047\nTotal securities - available for sale $73,255 $ 2 $ 791 $72,466\nHeld to Maturity\nU.S. Treasury $ 45,559 $ 2 $ 699 $44,862 Obligations of U.S. Government agencies 18,192 1,045 17,147 Obligations of states and political subdivisions 51,095 333 1,835 49,593 Mortgage-backed securities 5,131 228 4,903 Other securities 500 10 490\nTotal securities - held to maturity $120,477 $335 $3,817 $116,995\nThe amortized cost and estimated fair value of the securities portfolio at December 31, 1995, by contractual maturity, are shown below. The summary is divided into available for sale and held to maturity securities.\nAvailable for Sale Held to Maturity\nDecember 31, 1995 Amortized Estimated Amortized Estimated (In thousands) Cost Fair Value Cost Fair Value\nDue in one year or less $ 46,430 $ 46,415 $ 29,203 $ 29,208 Due after one year through five years 57,277 56,017 65,387 65,854 Due after five years through ten years 194 195 24,466 24,730 Due after ten years 3,282 3,306 1,935 1,952\n$107,183 $105,933 $120,991 $121,744\nProceeds from sales and maturities of investments in debt securities during 1995, 1994 and 1993 were $136,752,000, $107,053,000 and $92,732,000, respectively. Gross gains of $2,000, $3,000 and $48,000 and gross losses of $0, $77,000 and $44,000 for 1995, 1994 and 1993, respectively, were realized on those sales and maturities.\nThe amortized cost and estimated fair value of investment securities which were pledged as collateral for public deposits, treasury deposits, trust funds, customer repurchase agreements, and other purposes as required by law at December 31, 1995 and 1994 are shown below. The securities are divided into available for sale and held to maturity.\n1995 1994\nAvailable Held to Available Held to December 31, (In thousands) for sale maturity for sale maturity\nAmortized cost $51,077 $67,903 $31,224 $80,557 Estimated fair value 50,217 68,496 30,673 78,104\n4. Loans Major classifications of loans are summarized as follows:\nDecember 31, (In thousands) 1995 1994\nCommercial, financial and agricultural $114,412 $115,068 Real estate - construction 26,380 28,755 Real estate - mortgage 292,913 279,264 Consumer loans 99,571 107,450 Lease financing 21,666 14,029\nTotal loans 554,942 544,566 Less unearned income (11,762) (11,376)\nTotal loans, net of unearned income $543,180 $533,190\nLoans to directors, executive officers, principal shareholders, including loans to affiliated companies of which directors, executive officers and principal shareholders are principal owners, and loans to members of the immediate family of such persons, were approximately $12,602,000 and $14,908,000 at December 31, 1995 and 1994, respectively. An analysis of the activity with respect to these loans follows:\n(In thousands)\nBalance, December 31, 1994 $14,908 Additions, including loans now meeting disclosure requirements 12,077 Amounts collected, including loans no longer meeting disclosure requirements (12,965) Amounts charged off related to director loans (1,418)\nBalance, December 31, 1995 $12,602\n5. Allowance for Loan Losses On January 1, 1995, the Company implemented 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\" which amends SFAS No. 114. The two Statements address the following:\n1. The accounting by creditors for impairment of a loan.\n2. The accounting by creditors for loans that are restructured in a troubled debt restructuring involving a modification of terms of a receivable.\n3. The elimination of the categories of loans classified as in-substance foreclosures.\nSFAS No. 114 requires the measurement of impaired loans based on the present value of expected future cash flows using the loan's effective interest rate or, as a practical expedient, it may be measured on the fair market value of the loan if the loan is collateral dependent. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. If the measure of the impaired loan is less than the recorded investment, an impairment will be recognized by creating a valuation allowance with a corresponding charge to the provision for loan loss. The adoption of SFAS No. 114 did not result in additional provisions for loan losses or changes in previously reported net earnings due to the fact that the Company's existing methods of measuring loan impairment are consistent with the methods prescribed by the Statement.\nSFAS No. 114 does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment. The Company has identified these loans as credit card loans and home mortgages, and all other loans less than $500,000.\nThe factors considered by management in determining if a loan is impaired include, but are not limited to, the following: length of delinquency, past history with the borrower, financial condition of the borrower, ability of the borrower to repay the debt based upon cash flow information, intentions of the borrower, and value of the collateral. Impairment is not necessarily determined by a minimum delay in payment. A minimum delay in payment is when the exact terms of the loan agreement have not been met by the borrower; however, the Company believes that contractual interest and principal payments will still be received These loans are considered non-accrual loans because the timing of interest payments is unknown; however, it is still likely that interest will be received. Payments received while a loan is on non-accrual status are applied against principal only.\nAll of the loans of the Company to which SFAS No. 114 applies are classified as commercial loans. Due to the size of the Company and the few loans that meet the criteria for application of SFAS No. 114, no further risk classification is necessary. On December 31, 1995, the recorded investment in loans for which impairment has been recognized in accordance with the SFAS No. 114 total $2.0 million and the total allowance related to such loans was $785 thousand. Of the $2.0 million recorded investment, $1.1 million was measured using the present value of future cash flows method and $.9 million was measured using the fair value of collateral method. The recorded investment averaged $2.6 million for the year ended December 31, 1995. The amount of interest earned on these loans during 1995 was $113 thousand. If the Company had used a cash-based method of accounting for the interest on these loans, the interest earned would have been $114 thousand.\nThe Company's charge-off policy for impaired loans does not differ from the charge-off policy for loans outside the definition of SFAS No. 114. Loans that are delinquent in excess of 120 days are charged-off unless there is a valid reason for the delinquency and the borrower continues to maintain a satisfactory financial standing and\/or the collateral securing the debt is of such value that any loss appears to be unlikely.\nAn analysis of the allowance for loan losses follows:\nYear Ended December 31, 1995 1994 1993 (In thousands) Regular SFAS 114 Total Regular Regular Allowance Allowance Allowance Allowance Allowance\nBalance, beginning of year $ 8,889 None $ 8,889 $ 8,547 $ 8,261 Provisions (credit) for loan losses 3,727 3,727 2,125 (2,026) Recoveries 740 740 841 6,259 Loans charged off (3,666) $(1,218) (4,884) (2,624) (3,947) Amount transferred to SFAS 114 allowance (2,003) (2,003) Amount transferred from regular allowance 2,003 2,003\nBalance, end of year $7,687 $ 785 $8,472 $ 8,889 $ 8,547\nThe following is an estimate of the breakdown of the allowance for loan losses by type for the date indicated:\nYear Ended December 31, (In thousands) 1995 1994\nCommercial, financial and agricultural $4,138 $6,427 Real estate 1,928 1,027 Installment loans to individuals 2,176 1,264 Direct leasing financing 230 171\nTotal $8,472 $8,889\n6. Nonperforming Assets\n(In thousands) 1995 1994 1993\nNon-accrual loans $2,897 $ 3,913 $ 1,565 Loans past due 90 days or more 1,713 1,056 1,402 Restructured loans 1,571 3,538 3,734\nTotal nonperforming loan balances at December 31, 6,181 8,507 6,701 Other real estate owned 776 380 1,169\nTotal nonperforming assets at December 31, $6,957 $ 8,887 $ 7,870\nNonperforming loans as a percentage of loans - net of unearned interest 1.1% 1.6% 1.4% Nonperforming assets as a percentage of loans and other real estate owned 1.3% 1.7% 1.6% Interest income that would have been recognized under original terms for the year on nonperforming loans $ 731 $ 576 $ 698 Amount of interest income recognized for the year on nonperforming loans $ 133 $ 117 $ 431\n7. Bank Premises and Equipment Bank premises and equipment consist of the following:\nDecember 31, (In thousands) 1995 1994\nLand, building and leasehold improvement $22,566 $21,769 Furniture and equipment 17,919 17,616\n40,485 39,385 Less accumulated depreciation and amortization 20,569 18,797\n$19,916 $20,588\nDepreciation and amortization of bank premises and equipment was $2,082,000, $1,973,000 and $2,197,000 in 1995, 1994 and 1993, respectively.\n8. Interest Bearing Deposits Time deposits of $100,000 or more at December 31, 1995 and 1994 were $58,641,000 and $54,951,000, respectively.\n9. Other Borrowed Funds Other borrowed funds are comprised primarily of securities sold under agreement to repurchase with balances of $34,638,000 and $43,525,000 at December 31, 1995 and 1994, respectively. The weighted average interest rates for 1995 and 1994 were 5.48% and 3.63%, respectively.\n10. Income Taxes In February 1992, the Financial Accounting Standards Board (FASB) issued SFAS No. 109, \"Accounting for Income Taxes\". The Statement requires a change from the deferred method to the asset and liability method of computing deferred income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences on future years of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities.\nEffective January 1, 1993, the Company adopted the Statement. The cumulative effect of this adoption was an increase in net income of $380,000 ($.10 per share).\nThe components of income tax expense are as follows:\n(In thousands) 1995 1994 1993\nCurrently payable $ 3,640 $ 4,282 $ 5,116 Deferred income taxes 732 (18) (50)\n$ 4,372 $ 4,264 $ 5,066\nAn analysis of the difference between the effective income tax rates and the statutory federal income tax rate follows:\n(In thousands) 1995 1994 1993\nFederal statutory rate 35.0% 35.0% 34.0% Changes from statutory rates resulting from: Tax exempt interest (7.4) (7.0) (4.3) Nondeductible interest to carry municipal obligations .9 .7 .4 Amortization of intangibles 1.2 1.3 1.2 Other, net (.1) (.6) 1.4\n29.6% 29.4% 32.7%\nThe tax effects of the significant temporary differences which comprise deferred tax assets and liabilities at December 31, 1995 and 1994 follows:\n1995 1994\nAssets: Loan loss reserve $3,000 $3,022 Deferred directors' fees 145 125 Postretirement benefit obligation 257 164 Investment securities 425 268 Other 260 224\n4,087 3,803 Liabilities: Depreciation 1,643 1,589 Deferred loan fees 228 125 Lease financing operations 752 163 Other 101 59\n2,724 1,936\nNet assets $1,363 $1,867\n11. Retirement Plans The Company maintains a defined contribution-money purchase pension plan which covers substantially all employees. The Company's contributions under the plan are based upon a percentage of covered employees' salaries.\nThe Company has established a stock bonus\/employee stock ownership plan for the benefit of substantially all employees of the Company. The Company's contributions under the plan are based upon a percentage of covered employees' salaries, and are paid at the discretion of the Board of Directors of the Company. The Company contributes cash to the plan and Company shares are purchased with the cash in the open market. Cash contributed to the plan was $0, $100,265 and $0 respectively for the years ended December 31, 1995, 1994 and 1993. No stock was contributed to the plan for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company has also established a profit-sharing (401K) plan which covers substantially all employees. The Company will match all eligible employee contributions up to 4% of the participant's compensation. The Company may, at the discretion of the Board, contribute an additional amount based upon a percentage of covered employees' salaries.\nThe total retirement plans' expense for 1995, 1994 and 1993 was $857,000, $820,000, and $741,000, respectively.\n12. Postretirement Benefits The Company provides lifetime medical and dental benefits for certain eligible retired employees. Only employees meeting the eligibility requirements as of December 31, 1989 will be eligible for such benefits upon retirement. The entire cost of these benefits is paid for by the Company as incurred and totaled $131,000, $86,000 and $104,000, respectively, for the years ended December 31, 1995, 1994 and 1993. The plan is unfunded.\nIn December of 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which requires that all such benefits be accounted for on an accrual basis rather than the prevalent cash basis. Management determined that the accumulated postretirement benefit obligation at January 1, 1993 was approximately $2,029,000. Management implemented this statement in the first quarter of 1993 and is amortizing the transition obligation over 20 years.\nThe following table sets forth the plan's status reconciled with the amount shown in the Company's balance sheets at December 31, 1995 and 1994.\n(In thousands) 1995 1994\nAccumulated postretirement benefit obligation Retirees and dependents $3,367 $2,065 Fully eligible active plan participants 671 545 Other active plan participants 684 513\nTotal accumulated postretirement benefit obligation 4,722 3,123 Unrecognized net loss (1,768) (266) Unamortized transition obligation (1,725) (1,826) Unrecognized prior service cost (551) (594)\nAccrued postretirement benefit cost $ 678 $ 437\nThe components of the net periodic postretirement benefit cost at December 31, 1995 and 1994 are as follows:\n(In thousands) 1995 1994\nService cost $ 19 $ 20 Interest on accumulated benefit obligation 243 213 Amortization of transition obligation and other 144 147\nTotal $ 406 $ 380\nMajor assumptions: Discount rate 7.0% 8.0%\nFor measurement purposes, a 13% annual rate of increase in the per capita cost of covered health care benefits for those below the age of 65 and 11% for those over 65 was assumed. The rate was assumed to decrease gradually to 6% by 2012 and remain at that level thereafter. The health care cost trend rate assumption has a significant affect on the amounts reported.\nIf the health care cost trend rate were to increase 1%, the service and interest cost would be $296,000 and the accumulated benefit obligation would be $5,328,000.\n13. Leases The Company leases certain of its branch sites and certain banking equipment under operating leases. All of the branch site leases have renewal options of varying lengths and terms. The aggregate minimum rental commitments under these leases are not material.\n14. 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. The financial instruments include commitments to extend credit and standby letters of credit.\nThese financial 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 these instruments reflect the extent of involvement the Company has in particular classes of financial 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 the 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. Total commitments to extend credit at December 31, 1995, were $79,609,000. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, marketable securities, inventory, property, plant and equipment, residential real estate, and income producing commercial properties.\nStandby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The credit risk involved in using letters of credit is essentially the same as that received when extending credit to customers. The Company had approximately $4,652,000 in irrevocable letters of credit outstanding at December 31, 1995.\n15. Concentration of Credit Risk The Company's bank subsidiaries actively engage in lending, primarily in home counties and adjacent areas. Collateral is received to support these loans when deemed necessary. The more significant categories of collateral include cash on deposit with the Company's banks, marketable securities, income producing property, home mortgages, and consumer durables. Loans outstanding, commitments to make loans, and letters of credit range across a large number of industries and individuals. The obligations are significantly diverse and reflect no material concentration in one or more areas.\n16. Contingencies The Company's bank subsidiaries are defendants in legal actions arising from normal business activities. Management believes these actions are without merit, that in certain instances its actions or omissions were pursuant to the advice of counsel, or that the ultimate liability, if any, resulting from them will not materially affect the Company's consolidated financial position, although resolution in any year or quarter could be material for that period.\n17. Dividend Limitations Payment of dividends by the Company's subsidiary banks is subject to certain regulatory restrictions as set forth in national and state banking laws and regulations. At December 31, 1995, combined retained earnings of the subsidiary banks were approximately $38,401,000 of which $4,519,000 is available for the payment of dividends in 1996 without obtaining prior approval from bank regulatory agencies.\n18. Bond Claim During 1991, First Citizens Bank, Hardin County (the \"Bank\"), a subsidiary of the Company, filed a bond claim for $6,800,000 with its bonding company to recover loan losses incurred in 1990 resulting from an apparent scheme to defraud the Bank. The original losses were recorded as loan losses. After exhaustive efforts to settle the claim with the bonding company, the Bank initiated litigation during the first quarter of 1992 against the bonding company. During the third quarter of 1993, the Company reached a settlement in the amount of $5,279,000, which was accounted for as a loan loss recovery. Loan loss recoveries result in an increase in the allowance for loan losses (\"Allowance\"). The Allowance was subsequently adjusted to the amount necessary, as determined by management, to absorb possible future losses on the total loans currently outstanding. The adjustment resulted in a reduction in the provision for loan losses to the extent that the provision for the year was negative.\n19. Effect of Implementing SFAS No. 116 In June 1993, the FASB issued SFAS No. 116 \"Accounting for Contributions Received and Contributions Made\". This Statement required that contributions made, including unconditional promises to give, be recognized as expenses in the period made at their fair values. This Statement is effective for fiscal years beginning after December 15, 1994. The Company implemented this Statement on January 1, 1995 with no impact on the financial statements.\n20. Effect of Implementing SFAS No. 121 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.\" 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 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. If the sum of the expected future cash flows resulting from an asset's use and disposition is less than the carrying amount of the asset, an impairment loss is recognized.\nThis Statement is effective for fiscal years beginning after December 15, 1995. The Company does not expect the implementation of this Statement to have a material effect on the financial statements.\n21. Effect of Implementing SFAS No. 122 In May 1995, the FASB issued SFAS No. 122 \"Accounting for Mortgage Servicing Rights\". This Statement amends FASB Statement No. 65, \"Accounting for Certain Mortgage Banking Activities\", to require that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others, however those servicing rights are acquired. The total cost of the mortgage loans should be allocated between the mortgage servicing rights and the loans based on their relative fair values if it is practicable to estimate those fair values. If not, the entire cost should be allocated to the mortgage loans.\nThis Statement applies prospectively in fiscal years beginning after December 15, 1995. The Company does not expect the implementation of this Statement to have a material affect on the financial statements.\n22. Effect of Implementing SFAS No. 123 In October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\". The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. This Statement also applies to transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.\nThe accounting requirements of this Statement are effective for transactions entered into in fiscal years that begin after December 15, 1995. The Company does not expect this Statement to have an effect on the financial statements in that the Company is not involved with any stock-based employee compensation plans or transactions to acquire goods or services from nonemployees in exchange for equity.\n23. Disclosures About Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.\nCash and Cash Equivalents: The carrying amount is a reasonable estimate of fair value.\nInvestment Securities: For marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, 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.\nLoan Receivables: For variable rate loans that reprice frequently with no significant change in credit risk, fair values are based upon carrying amounts.\nFor certain homogeneous categories of loans, such as credit card receivables, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using a discount rate that has been adjusted for credit risk and the remaining maturities.\nDeposit Liabilities: The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The carrying amount for variable rate and fixed maturity money market accounts and certificates of deposit approximates fair value at the reporting date. The fair value of fixed rate and fixed maturity certificates of deposit is estimated using a discounted cash flow method that applies interest rates currently offered for certificates of deposit with similar remaining maturities.\nCommitments to Extend Credit and Standby Letters of Credit: Pricing of these financial instruments is based on the credit quality and relationship, fees, interest rates, probability of funding, compensating balance, and other covenants or requirements. Loan commitments generally have fixed expiration dates, variable interest rates and contain termination and other clauses which provide for relief from funding in the event there is a significant deterioration in the credit quality of the customer. Many loan commitments are expected to, and typically do, expire without being drawn upon. The rates and terms of the Company's commitments to lend, and standby letters of credit are competitive with others in the various markets in which the Company operates. There are no unamortized fees relating to these financial instruments, as such the carrying value and market value are both zero.\nOther Borrowed Funds: The fair value of other borrowed funds is estimated using rates currently available for debt with similar terms and remaining maturities.\nThe estimated fair values of the Company's financial instruments are as follows:\n1995 1994\nDecember 31, Carrying Fair Carrying Fair (In thousands) Amount Value Amount Value\nAssets: Cash and cash equivalents $110,184 $110,184 $100,551 $100,551 Investments securities: Available for sale 105,933 105,933 72,466 72,466 Held to maturity 120,991 121,744 120,477 116,995 Loans, net 534,708 528,749 524,301 518,356\nLiabilities: Deposits 754,861 757,771 697,377 695,348 Other borrowed funds 38,524 37,362 47,710 46,489\n24. Quarterly Financial Data Quarters Ended 1995 Unaudited (In thousands, except per share data) March 31, June 30, Sept. 30, Dec. 31,\nInterest income $16,148 $16,596 $16,972 $17,545 Interest expense 6,584 6,988 7,162 7,381\nNet interest income 9,564 9,608 9,810 10,164 Provision for loan losses 713 1,048 945 1,021\nNet interest income after provision for loan losses 8,851 8,560 8,865 9,143 Other income 2,562 3,213 3,008 3,132 Other expense 8,057 8,667 7,727 8,122\nIncome before income taxes 3,356 3,106 4,146 4,153 Income tax 1,011 920 1,272 1,169\nNet income $ 2,345 $ 2,186 $ 2,874 $ 2,984\nNet income per common share $ 0.61 $ 0.57 $ 0.74 $ 0.77\nWeighted average shares outstanding 3,866 3,866 3,866 3,866\nQuarters Ended 1994 Unaudited (In thousands, except per share data) March 31, June 30, Sept. 30, Dec. 31,\nInterest income $13,354 $13,863 $14,765 $15,768 Interest expense 5,035 5,104 5,546 5,901\nNet interest income 8,319 8,759 9,219 9,867 Provision for loan losses 646 419 498 562\nNet interest income after provision for loan losses 7,673 8,340 8,721 9,305 Other income 2,495 3,342 2,799 2,895 Other expense 7,501 7,478 7,883 8,194\nIncome before income taxes 2,667 4,204 3,637 4,006 Income tax 797 1,260 1,059 1,148\nNet Income $ 1,870 $ 2,944 $ 2,578 $ 2,858\nNet income per common share $ 0.48 $ 0.76 $ 0.67 $ 0.74\nWeighted average shares outstanding 3,866 3,866 3,866 3,866\n25. Parent Company Financial Statements\nCondensed Balance Sheets\nDecember 31, (In thousands) 1995 1994\nAssets Cash on deposit with subsidiaries $ 24,598 $ 21,969 Investment in subsidiaries 81,349 78,577 Other assets 1,581 1,723\nTotal assets $107,528 $102,269\nLiabilities Dividends payable $ 1,392 $ 1,276 Other liabilities 1,207 929\nTotal liabilities 2,599 2,205\nShareholders' Equity Common stock 967 967 Capital surplus 9,094 9,094 Retained earnings 95,694 90,524 Net unrealized loss on securities available for sale, net of tax (826) (521)\nTotal shareholders' equity 104,929 100,064\nTotal liabilities and shareholders' equity $107,528 $102,269\n25. Parent Company Financial Statements (cont.)\nCondensed Statements of Income\nDecember 31, (In thousands) 1995 1994 1993\nIncome Dividends from subsidiaries $ 7,756 $ 24,090 $ 4,038 Interest income 101 72 48 Other income 724 740 388\nTotal income 8,581 24,902 4,474 Expense Other expense 1,556 1,526 1,579\nTotal expense 1,556 1,526 1,579\nIncome before income tax benefit, cumulative effect of change in accounting principle and equity in income of subsidiaries less amounts distributed to parent 7,025 23,376 2,895 Income tax benefit 288 154 378\nIncome before cumulative effect of change in accounting principle and equity in income of subsidiaries less amounts distributed to parent 7,313 23,530 3,273 Cumulative effect of change ccounting principle 1,237\nIncome before equity in income of subsidiaries less amounts distributed to parent 7,313 23,530 4,510 Equity in income of subsidiaries less amounts distributed to parent 3,076 (13,280) 6,294\nNet income $ 10,389 $ 10,250 $ 10,804\n25. Parent Company Financial Statements (cont.)\nCondensed Statements of Cash Flows\nDecember 31, (In thousands) 1995 1994 1993\nCash flows from operating activities: Net income $ 10,389 $ 10,250 $ 10,804 Adjustments to reconcile net income to net cash provided by operating activities: Equity in income of subsidiaries less amounts distributed to parent (3,076) 13,280 (6,294) Deferred income tax expense (benefit) 3 22 (1,237) Change in other assets and liabilities, net 417 526 (723)\nNet cash provided by operating activities 7,733 24,078 2,550\nCash flows from financing activities: Cash dividends (5,104) (4,640) (4,176)\nNet cash used in financing activities (5,104) (4,640) (4,176)\nNet increase (decrease) in cash and cash equivalents 2,629 19,438 (1,626) Cash and cash equivalents at beginning of year 21,969 2,531 4,157\nCash and cash equivalents at end of year $ 24,598 $ 21,969 $ 2,531\nSupplemental disclosures: Cash paid during the year for: Income taxes $ 3,730 $ 4,255 $ 5,337 Cash dividend declared and unpaid 1,392 1,276 1,160\nPART II\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere have been no disagreements with or changes in accountants during the three month period ended December 31, 1995.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 - Directors and Executive Officers of the Registrant\nPositions and Years of Service Offices With With the Executive Officer Age Registrant Registrant\nCharles S. Boyd 54 Director 1, President 32* and CEO\nJames H. Childers 53 Executive Vice President 26* Director 2\nAdditional information required by Item 10 is hereby incorporated by reference from the Registrant's definitive proxy statement in connection with its annual meeting of shareholders scheduled for May 14, 1996 which will be filed with the Commission in April 1996 pursuant to Regulation 14A.\n* Includes years of service with the Registrant and Farmers Bank & Capital Trust Co.\n1 Also a director of Farmers Bank, Horse Cave Bank, Farmers Georgetown Bank, United Bank, Lawrenceburg Bank, First Citizens Bank, FCB Services and Money One.\n2 A director of Farmers Georgetown Bank.\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 11 through 13 is hereby incorporated by reference from the Registrant's definitive proxy statement in connection with its annual meeting of shareholders scheduled for May 14, 1996 which will be filed with the Commission in April, 1996 pursuant to Regulation 14A.\nPART IV\nItem 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) List of documents and exhibits\n1 & 2 Financial Statements and Schedules Reference (page)\nReport of Independent Accountants 28\nConsolidated Balance Sheets at December 31, 1995 and 1994 29\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993 30\nConsolidated Statements of Changes in Stockholders Equity for the years ended December 31, 1995, 1994 and 1993 31\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 32\nNotes to the Consolidated Financial Statements 33 - 49\nAll schedules are omitted for the reason they are not required, or are not applicable, or the required information is disclosed elsewhere in the financial statements and related notes thereto.\n3. Exhibits:\n21. Subsidiaries of the Registrant\n27. Financial Data Schedule\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed by the Registrant during the three month period ended December 31, 1995.\n(c) Exhibits\nSee list of exhibits set forth on page 54.\n(d) Separate Financial Statements and 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.\nFARMERS CAPITAL BANK CORPORATION\nBy: Charles S. Boyd Charles Scott Boyd President and Chief Executive Officer\nDate: 3\/21\/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.\nCharles S. Boyd President, Chief Executive Charles Scott Boyd Officer and Director (principal executive officer of the Registrant) 3\/21\/96\nChairman John Poage Stewart\nMichael Meagher Sullivan Director 3\/21\/96 Michael Meagher Sullivan\nDirector Joseph Charles Yagel\nWarner Underwood Hines Director 3\/22\/96 Warner Underwood Hines\nDirector John James Hopkins II\nJ.D. Sutterlin Director 3\/21\/96 John Douglas Sutterlin\nWilliam Ray Sykes Director 3\/21\/96 William Ray Sykes\nDirector Charles Owen Bush\nE. Bruce Dungan Director 3\/22\/96 Ellwood Bruce Dungan\nC. Douglas Carpenter Vice President and CFO 3\/21\/96 Cecil Douglas Carpenter (principal financial and accounting officer)\nFARMERS CAPITAL BANK CORPORATION INDEX OF EXHIBITS\n21. Subsidiaries of the Registrant\n27. Financial Data Schedule\nEXHIBIT 21 Subsidiaries of the Registrant\nThe following table provides a listing of the direct and indirect operating subsidiaries of the Registrant, the percent of voting stock held by the Registrant as of December 31, 1995 and the jurisdiction or organization in which each subsidiary was incorporated or organized.\nPercentage of Voting Jurisdiction Stock held by Subsidiaries of the Registrant of Organization Registrant\nFarmers Bank & Capital Trust Co. Kentucky 100%\nUnited Bank & Trust Company Kentucky 100%\nFirst Citizens Bank, Hardin County, Inc. Kentucky 100%\nLawrenceburg National Bank Kentucky 100%\nFarmers Bank and Trust Company Kentucky 100%\nHorse Cave State Bank Kentucky 100%\nFCB Services, Incorporated Kentucky 100%\nFarmers Capital Insurance Company 1 Kentucky 100%\nFarmers Bank Realty Company 2 Kentucky\nFrankfort ATM Ltd. 3 Kentucky\nMoney One Credit of Kentucky. Inc. 2 Kentucky\nMoney One Credit Company 4 Kentucky\nLeasing One Corporation 2 Kentucky\n1 Dormant company, no activity to date.\n2 A wholly-owned subsidiary of Farmers Bank & Capital Trust Company.\n3 A fifty (50%) percent owned joint venture of Farmers Bank & Capital Trust Company.\n4 A partnership of which ninety-eight (98%) is owned by Farmers Bank & Capital Trust Company, one (1%) percent is owned by Money One Credit of Kentucky, Inc. and one (1%) percent is owned by Farmers Bank Realty Company.","section_15":""}
{"filename":"23666_1995.txt","cik":"23666","year":"1995","section_1":"Item 1. Business\n(A) GENERAL DEVELOPMENT OF BUSINESS\nSara Lee Corporation (\"Sara Lee\") is a global manufacturer and marketer of high-quality, brand-name products for consumers throughout the world. It was incorporated in Baltimore, Maryland in 1939 as the C.D. Kenney Company and adopted its current name in 1985.\nIn fiscal 1995, the main focus of Sara Lee's two industry segments, Packaged Foods and Packaged Consumer Products, was to continue to build brand equity and improve returns. These objectives were pursued through the introduction of new products, the expansion of existing products into new markets, and a significant commitment to marketing support in order to build leadership brands. In fiscal 1995, Sara Lee spent nearly $1.7 billion to retain and grow the equity its brands have with customers, and to support its stable of value-added, high-margin products. This amount represents an increase of 11.8% over fiscal 1994.\nDuring fiscal 1995, Sara Lee continued to implement its worldwide restructuring program, which was announced in the latter part of fiscal 1994. As part of the restructuring, 42 manufacturing and distribution facilities were closed and 6,029 employees were terminated during fiscal 1995. Sara Lee anticipates that the restructuring will be substantially completed by the close of calendar year 1996.\nSARA LEE PACKAGED FOODS SARA LEE PACKAGED MEATS AND BAKERY\nSara Lee Packaged Meats continued to introduce new food products during fiscal 1995, with an emphasis on \"better-for-you\" products and convenience foods. Several Sara Lee meat brands introduced no-fat or reduced-fat products in fiscal 1995, including Ball Park Fat Free Classics, Kahn's Fat Free Franks and Bryan Fat Free Juicy Jumbos. Jimmy Dean Foods introduced Tastefuls! packaged meals, consisting of two small submarine sandwiches, potato chips and cookies.\nIn fiscal 1995, Sara Lee pursued its objectives of building brands and increasing business outside the United States through its acquisition of Imperial Meats Group, Belgium's largest packaged meats producer. The company's Imperial, Cornby, and Marcassou brands are sold in Belgium, France, Germany and the Netherlands.\nSara Lee Bakery introduced, and\/or expanded its distribution of, a number of new products. In fiscal 1995, Sara Lee added a collection of sweet goods to its fresh-baked line, including Danish, pound cakes, iced cakes, muffins, doughnuts, cookies and pies. Sara Lee Chocolate Chip Cheesecake, Strawberry Swirl Pound Cake, Breakfast Quick Breads, several flavors of reduced-fat, no-sugar-added fruit pies and reduced-fat muffins were new frozen product introductions. In addition, Sara Lee Bakery's foodservice unit introduced a variety of mini-muffins and homestyle cakes.\nSara Lee Foodservice's business, PYA\/Monarch, strengthened its position as the leading foodservice distributor in the southeastern United States and the third-largest full-line foodservice company in the nation with the acquisition of the remaining outstanding shares of Virginia-based Consolidated Foodservice Companies.\nSARA LEE COFFEE AND GROCERY\nDuring fiscal 1995, the Coffee and Grocery line of business introduced new items to meet growing consumer demand for premium and specialty products, including Marcilla Mocca coffee in Spain, an assortment of roasted coffees under the Moccona label in Australia, and Merrild Gourmet coffee, sold as whole beans that are ground at the point of sale, in Denmark. For the out-of-the-home market, Superior Coffee introduced an Instant Cappuccino beverage. The Cafitesse system of coffee serving equipment was introduced in Europe, and Piazza D'Oro espresso was introduced in Australia. Sara Lee also acquired an interest in the Bravo coffee company in Greece in fiscal 1995.\nGreen coffee costs fluctuated severely during fiscal 1995, principally due to unfavorable weather conditions and economic and social instability in several coffee-producing nations. In Brazil, for example, two frosts in a single winter season -- the first such occurrence on record -- were followed by severe drought. These extraordinary events in the green coffee market led to higher retail prices and reduced consumption in fiscal 1995. Sara Lee's retail coffee operations managed price changes on a market-by-market basis in an effort to protect margins and profits. Modest declines in market share were reported in the Netherlands, Belgium, Denmark, the Czech Republic and the United Kingdom for fiscal 1995, while market share remained stable in France and Australia, and improved slightly in Spain and Hungary. Primarily due to the effect of high green coffee costs on consumer buying habits, unit volumes for retail and out-of-home roasted coffee were down 8% for fiscal 1995, excluding the effect of acquisitions.\nNew tea products were launched during the fiscal year. In the Netherlands, major product introductions under the Pickwick brand were Pickwick Framboos fruit tea and Pickwick Seasons variety packs. Pickwick Regelli breakfast tea was introduced in Hungary. To supply growing Russian and Eastern European markets, capacity was expanded at Pickwick's Budapest production facility.\nSARA LEE PACKAGED CONSUMER PRODUCTS\nSARA LEE PERSONAL PRODUCTS\nSara Lee Intimates introduced new features and products and increased the profitability of its bra, panty and shapewear business in fiscal 1995. North American manufacturing operations faced capacity constraints primarily as a result of the national introduction of the Wonderbra brand in fiscal 1995. Playtex launched a minimizer bra with comfort straps for full-busted women in fiscal 1995. In Europe, Sara Lee introduced a line of coordinating bras and panties under the Liabel brand in Italy.\nSara Lee formed the Sara Lee Bodywear Group in fiscal 1995 to manufacture and market exercise wear and activewear under the Champion Jogbra, Body Force and Hanes Her Way names. The group also acquired the license for Spalding Bodywear and will market sports-inspired bodywear under the Spalding name.\nSara Lee Accessories opened 17 new Coach retail stores in the United States, including a flagship location in New York City. The major new Coach product introduction of 1995 was the Sonoma Collection, a line of nubuc and natural grain leather handbags, backpacks, wallets and belts. Mark Cross, a premium leather goods company, reintroduced its handbags, business cases and executive accessories into department stores, and resumed its catalog business. Also in fiscal 1995, Aris Isotoner expanded its line of slippers. Aris Isotoner posted weak results in fiscal 1995, due in part to warmer than normal winter temperatures.\nSara Lee Knit Products focused on value-added products and cost-effective manufacturing and sourcing in fiscal 1995. In the U.S. women's and girls' panties category, Hanes Her Way and other Sara Lee brands increased their leading market position. The increase in Sara Lee's share of the girls' panties market was partially a result of increased distribution and new licensed character agreements. In fiscal 1995, Hanes underwear was introduced in Brazil and Venezuela.\nIn fiscal 1995, Sara Lee Knit Products became the master licensee to manufacture sports apparel bearing the Spalding name. Hanes Licensed Products, which markets licensed college and professional sportswear, was negatively affected by labor strikes in professional sports. In the retail fleece business, Sara Lee reduced excess capacity.\nFor all apparel categories, Sara Lee began to capitalize on its unique partnership agreement with the 1996 Olympic Games -- the first agreement of its kind to combine Games sponsorship, product licensing and U.S. Team outfitting. An agreement with Warner Brothers and the United States Olympic Committee led to the introduction of Warner Brothers' familiar Looney Tunes characters on Hanes T-shirts to be used in creative apparel relating to the Olympics.\nSara Lee Hosiery continued to respond to changing market forces in the hosiery area during fiscal 1995 through the introduction of shaping and toning products, new colors and textures, increased durability and special occasion hosiery. The global market for sheer hosiery continued to exhibit weakness, and unit volumes fell 7% as Sara Lee eliminated low-margin items from its product line. However, profits for Sara Lee's worldwide sheer hosiery business increased. In the United States, Sara Lee Hosiery continued to decrease production capacity and improve inventory flow to maximize efficiencies, returns and profitability. In Europe, Sara Lee continued to reduce manufacturing overhead and excess sheer hosiery capacity.\nL'eggs launched Smooth Silhouettes, a Body Contouring product in fiscal 1995. Hanes introduced its own Body Contouring product, Smooth Illusions, in fiscal 1995, with strong advertising support and a \"tag\" line of \"Liposuction without surgery.\" Under its licensed designer brand Donna Karan, Sara Lee introduced The Nudes hosiery, an ultrasheer product offering colors to complement a wide array of skin tones. In Mexico, Sara Lee introduced Hanes Her Way hosiery in fiscal 1995. In Europe, Sara Lee introduced several new hosiery products under the Dim brand, including Teint de Soleil, extra-sheer hosiery for warm weather, and Ventre Plat, the first hosiery with tummy control to be introduced in Europe. Pretty Polly introduced Legworks hosiery, which offers thigh and tummy control, in the United Kingdom.\nIn fiscal 1995, Sara Lee introduced the Silk Reflections Casual collection of tights, trouser socks and casual socks in North America, contributing to strong growth in unit and dollar sales of tights and opaque legwear.\nSARA LEE HOUSEHOLD AND PERSONAL CARE\nSara Lee Household and Personal Care continued to grow through the introduction of new products and entry into new markets. Geographic expansion of Sara Lee's shoe care business continued in fiscal 1995, with the introduction of Kiwi products in China, Mexico and Hungary. Also in fiscal 1995, Sara Lee acquired the rights to market Brylcreem products for men in Indonesia.\nSanex Sun Care tanning lotions and sunblockers were introduced in the Netherlands during the fiscal year. Also in the Netherlands, Sanex toothpaste debuted. In Spain, the Sanex brand was extended to a line of new shaving creams and aftershaves under the Sanex for Men label. Duschdas Milk & Silk bath and shower foam was introduced in Germany, while Badedas for Kids soap was launched in the Netherlands. The Ambi-Pur electrical diffuser air freshener, introduced in five European markets in fiscal 1994, was extended to Belgium, the United Kingdom and Hungary. The Ambi-Pur Neutraliser air freshener debuted in the Netherlands and Italy. In the oral care line, Prodent Sensitive and Prodent Baking Soda toothpastes were made available in the Netherlands.\nSara Lee's Direct Selling business in Mexico, House of Fuller, suffered the negative impact of the peso's devaluation on sales in Mexico. House of Fuller has nevertheless expanded its product offerings, particularly in the area of apparel products and, in fiscal 1995, House of Fuller began selling Playtex intimate apparel.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nSara Lee's businesses are classified into two industry segments: Sara Lee Packaged Foods and Sara Lee Packaged Consumer Products. The financial information about Sara Lee's industry segments can be found on page of this Report.\n(C) NARRATIVE DESCRIPTION OF BUSINESS\nSARA LEE PACKAGED FOODS\nSara Lee's Packaged Foods segment is comprised of Sara Lee Packaged Meats and Bakery, and Sara Lee Coffee and Grocery.\nSARA LEE PACKAGED MEATS AND BAKERY\nSara Lee Packaged Meats processes and sells pork, poultry and beef products to supermarkets, warehouse clubs, national chains and institutions throughout the United States, Europe and Mexico. Sales are transacted through Sara Lee's own sales force, brokers and institutional buyers. Some of the more prominent brands in the United States within this category include Ball Park, Best's Kosher, Bryan, Hillshire Farm, Hygrade, Jimmy Dean, Kahn's, Mr. Turkey, Sara Lee and Sinai 48. Sara Lee's more prominent European brands include Stegemann in the Netherlands, Argal in Spain and Nobre in Portugal. Sara Lee has a 49.9% interest in AXA Alimentos, S.A. de C.V., which owns Kir Alimentos S.A. de C.V., a leading processed meats company in Mexico. In fiscal 1995, Sara Lee acquired Imperial Meats Group, Belgium's largest packaged meats producer. The company's Imperial, Cornby and Marcassou brands are sold in Belgium, France, Germany and the Netherlands.\nThe products offered by this line of business include smoked sausage, bacon, hot dogs, breakfast sausage, breakfast sandwiches, premium deli and luncheon meats, ham, turkey, and packaged lunch combinations. The ingredients -- pork, turkey and beef -- are purchased by Sara Lee from a variety of sources. The prices of these raw materials fluctuate, depending primarily on supply and demand. Because of the range of sources from which these raw materials are available, Sara Lee believes that it will continue to have access to adequate supplies.\nThe Packaged Meats category is highly competitive, with an emphasis on product quality, price, advertising and promotion, and customer service. Sara Lee's competitors include international, national, regional and local companies. The Packaged Meats category has accounted for 10% or more of Sara Lee's consolidated revenues during the past three fiscal years. Sara Lee believes it is one of the three industry leaders in the United States.\nMost of Sara Lee's Packaged Meats operations are regulated by the U.S. Department of Agriculture, whose focus is the quality, sanitation and safety of meat products, and, to some extent, by state and local government agencies. Sara Lee's Packaged Meats operations in Europe and Mexico are regulated by local authorities.\nSara Lee Bakery produces a wide variety of fresh and frozen baked and specialty items. Its core products are pies, cheesecakes, pound cakes and Danish. These products are sold through supermarkets, foodservice distributors, bakery-deli and direct channels throughout the United States, United Kingdom, France, Mexico, Australia and numerous Asia-Pacific countries. Sales are transacted through Sara Lee's sales force and independent wholesalers and distributors. The key ingredients for these products -- butter, milk, sugar, fruits, eggs and flour -- are purchased from suppliers at prices that are subject to such influences as supply and demand, weather, and government price controls. Because of the number of sources from which such raw materials are generally available, Sara Lee believes it will continue to have access to adequate supplies.\nCompetition in this category is keen, with a large number of participants. Sara Lee seeks to maintain and enhance a leading position in the industry through marketing efforts that are designed to reinforce and build brand recognition, and through superior customer service.\nIn the United States, Sara Lee Bakery products are subject to regulation by the Food and Drug Administration, the federal agency charged with, among other things, enforcing laws pertaining to food processing, content and labeling, and to a lesser extent, by state and local government agencies.\nSara Lee Foodservice's business is conducted principally under the PYA\/Monarch name. With the acquisition of the remaining outstanding shares of Virginia-based Consolidated Foodservice Companies in fiscal 1995, PYA\/Monarch strengthened its position as the leading foodservice distributor in the southeastern United States and became the third largest full-line foodservice company in the nation. This business distributes dry, refrigerated and frozen foods, paper supplies and foodservice equipment to institutional and commercial foodservice customers.\nThe institutional foodservice distribution industry is highly competitive, with price and service being the major means by which Sara Lee Foodservice competes. This line of business generates lower margins on sales dollars than Sara Lee's other businesses.\nSARA LEE COFFEE AND GROCERY\nSara Lee believes it is one of the top four coffee roasters in the world, and one of the top three in the European market. It has a significant presence in such countries as the Netherlands, Belgium, France, Denmark, Spain and Australia, and has established positions in Central and Eastern Europe through acquisitions and expanded sales efforts. While Douwe Egberts is its European flagship brand, its other premium European coffee brands include Maison du Cafe, Marcilla, and Merrild. Sara Lee's Pickwick brand, an important brand in the European tea market, is expanding its current lines in an effort to appeal to younger consumers and is entering the Russian and Eastern European markets.\nThis is a very competitive business with the other participants consisting primarily of other large multi-national companies. Sara Lee seeks to maintain a competitive edge by offering its customers superior quality and value.\nSara Lee is also a significant competitor in the out-of-home coffee service business. Its Douwe Egberts Coffee Systems business provides coffee and dispensing equipment in Europe, while its Superior Coffee and Foods business provides similar products and services in the United States.\nThe significant cost item in the production of coffee products is the price of green coffee, which varies depending on such factors as weather (which affects the quality and quantity of available supplies), consumer demand, the political climate in the producing nations, unilateral pricing policies of producing nations, speculation on the commodities market, and the relative valuations and fluctuations of the currencies of producer versus consumer countries. These factors also generally affect Sara Lee's competitors. At the end of fiscal 1994, and the beginning of fiscal 1995, Brazil, the world's largest coffee producer, suffered two major frosts, followed by a drought, that negatively affected crop output in fiscal 1995. Uncertainty over the availability of supplies resulted in extreme volatility in the price of green coffee in fiscal 1995, leading to the highest prices in recent years. Sara Lee anticipates that green coffee prices will continue to be affected due to uncertainty over the availability of future supplies. Sara Lee has and expects to continue to offset the negative effect of price increases through careful inventory management, cost cutting, and higher prices for its coffee products. Primarily due to the effect of higher green coffee costs on consumer buying habits, unit volumes for retail and out-of-home roasted coffee were down 8% for fiscal 1995, excluding the effect of acquisitions.\nThe Sara Lee Coffee and Grocery line of business also manufactures rice products under the Lassie brand in the Netherlands, and snack and nut products under the Duyvis, Felix and Benenuts brands in the Netherlands, Belgium and France, respectively.\nThe Sara Lee Coffee and Grocery business has accounted for 10% or more of Sara Lee's consolidated revenues during the past three fiscal years.\nSARA LEE PACKAGED CONSUMER PRODUCTS\nSara Lee's Packaged Consumer Products segment is divided into two lines of business: Personal Products and Household and Personal Care.\nSARA LEE PERSONAL PRODUCTS\nThe Personal Products line of business, which is headquartered in Winston-Salem, North Carolina, includes the Intimates, Accessories, Knit Products and Hosiery business groups.\nSara Lee Intimates' business includes bras, panties and shapewear. These are manufactured and distributed under such labels as Bali, Hanes Her Way, Playtex, WonderBra and Daisyfresh in North America, and Playtex and Dim in Europe. Sara Lee holds a leading position in the Mexican bra market through its Playtex and Hanes Her Way brand and continued to build market share in Canada during fiscal 1995 through its Playtex, Wonderbra, Daisyfresh and Hanes Her Way brands.\nDistribution channels for intimate apparel range from department and specialty stores for such premium brands as Bali, and some Playtex products, to warehouse clubs and mass-merchandise outlets for some of the value-priced brands. Sales are effected through Sara Lee's sales force.\nThe intimate apparel market is a competitive one based on consumer brand loyalty. Sara Lee endeavors to maintain its competitive edge through marketing and promotional efforts, and by offering consumers value through a superior combination of quality and price.\nSara Lee Accessories' business involves the manufacture and marketing of premium leather products through its Coach division, under the Coach and Mark Cross brands, and the manufacture and marketing of men's and women's gloves, slippers and knitwear through its Aris Isotoner division under the Aris and Isotoner brands. Aris Isotoner products are sold primarily to department stores, while Coach and Mark Cross products are sold through department stores, catalog sales and Sara Lee stores. Coach and Mark Cross now operate approximately 120 stores in the United States.\nSara Lee Knit Products' business involves the manufacture and distribution of men's, women's and children's underwear and activewear (T-shirts, fleecewear and other jersey products for casualwear) in North America, South and Central America, Europe and the Asia-Pacific countries. These products are sold through Sara Lee's sales force to department stores, mass merchandisers, discount chains and the screen print trade. Principal brands in this category include Champion, Hanes, Hanes Her Way and Rinbros in North America, and Abanderado, Princesa, Champion, Hanes and Dim in Europe. Sara Lee believes that it has the leading market share in the women's and girls' panties category in the United States, the second largest share in the heavily branded category of men's and boys' underwear in the United States, and the leading position in men's and boys' underwear in Mexico.\nActivewear is marketed under Sara Lee's Hanes and Champion lines. In addition to targeting the public activewear market, Champion also manufactures and markets authentic uniforms and practicewear for professional and amateur athletic teams, including such organizations as the National Basketball Association, the National Football League, the Olympics and a number of major university sports teams.\nThe principal raw material in this product category is cotton. Sara Lee currently believes it has access to an adequate supply of cotton from a variety of sources.\nThe knit products business is highly competitive, with products relying on brand recognition, quality, price and loyalty. Sara Lee competes by offering superior value, utilizing its megabranding strategy -- marketing various products through common packaging, promotion and advertising, increased marketing activity, and low-cost sourcing. The Knit Products business has accounted for 10% or more of Sara Lee's consolidated revenues during each of the past three fiscal years.\nSara Lee Hosiery is the market leader in hosiery markets in North America, Western Europe, Australia, New Zealand and South Africa. It also continues to establish operations in various Asia-Pacific countries, placing it in a strategic position to capitalize on developing markets in that area. The European hosiery business is somewhat seasonal in nature in contrast to the domestic business.\nHosiery products consist of a wide variety of branded, packaged consumer products, including pantyhose, stockings, combination panty and pantyhose garments, tights, knee-highs and socks, many of which are available in both sheer and opaque styles. These products are sold domestically under such brand names as Hanes, L'eggs, Donna Karan and DKNY (the last two being licensed), and abroad under such labels as Dim, Pretty Polly, Elbeo, Nur Die, Bellinda, Filodoro, Philippe Matignon and Omero. Sara Lee is the largest sock manufacturer in the United States.\nHosiery products are sold by Sara Lee's sales force in channels ranging from department and specialty stores (for premium brands such as Hanes, Donna Karan and DKNY in the United States, and Dim abroad), to supermarkets, warehouse clubs, discount chains and convenience stores for brands like L'eggs and some Dim products aimed at the price-conscious consumer. Hosiery products are also distributed through catalog sales and Sara Lee stores. The hosiery business has accounted for 10% or more of Sara Lee's consolidated revenues during each of the past three fiscal years.\nThe hosiery business is very competitive in both the United States and Europe. In the United States, Sara Lee's major competitors are other hosiery companies, and the primary methods of competition are quality, value, function, and, with respect to L'eggs products, service and distribution. In Europe, where most of Sara\nLee's competitors are small companies who compete in the unbranded sector of the market, the primary focus is on quality.\nRaw materials -- nylon, spandex, and cotton -- for the products in this category are readily available to Sara Lee from a variety of sources.\nHOUSEHOLD AND PERSONAL CARE\nSara Lee's Household and Personal Care line of business includes three primary core categories: shoe care -- led by a worldwide line of Kiwi products; body care items -- led by the Sanex brand, but also including Duschdas and Badedas and baby care products sold under the Zwitsal, Fissan and Proderm names; and insecticides -- sold internationally under the Catch, Bloom, Vapona and Ridsect brand names. Ambi-Pur air fresheners, Zendium and Prodent oral care products, and Biotex and Neutral specialty detergents are also important categories for Sara Lee.\nSara Lee Direct Selling distributes a wide range of products -- cosmetics, fragrances, toiletries, personal products and jewelry -- through a network of independent sales representatives. This method of reaching the consumer has been particularly successful at the House of Fuller business in Mexico, the House of Sara Lee businesses in Indonesia and the Philippines, and the Avroy Shlain business in South Africa. While this segment is very fragmented, Sara Lee believes it has an important position in many product lines in those countries in which it competes.\nTRADEMARKS\nSara Lee is the owner of over 30,000 trademark registrations and applications in over 140 countries. Sara Lee's trademarks are among its most valuable assets as it pursues its strategy of building brands globally.\nCUSTOMERS\nNone of Sara Lee's business segments or lines of business is dependent upon a single customer or a small number of customers, the loss of whom would have a material adverse effect on Sara Lee's consolidated operations. Sara Lee considers major mass retailers and supermarket chains in both the United States and Europe to be significant customers across one or more product categories, and it has developed specific approaches to working with individual customers.\nENVIRONMENTAL MATTERS\nSara Lee is subject to a number of federal, state and local statutes, rules, regulations and ordinances in the United States and other countries relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment (\"Environmental Laws\").\nWhile Sara Lee expects to make capital and other expenditures in compliance with Environmental Laws, it does not anticipate that such compliance will have a material adverse effect on its capital expenditures, earnings or competitive position. Sara Lee has implemented a program to monitor compliance with Environmental Laws and is continually examining its methods of operation and product packaging to reduce its use of natural resources.\nEMPLOYEES\nSara Lee has approximately 149,000 employees worldwide.\n(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nSara Lee's foreign operations are conducted primarily through wholly- or partially-owned subsidiaries incorporated outside the United States. The foreign operations of the Packaged Meats line of business within the Packaged Foods segment are conducted through Sara Lee Processed Meats (Europe) B.V., while the Sara Lee Bakery business includes Kitchens of Sara Lee U.K. Ltd. and Kitchens of Sara Lee (Australia) Pty. Ltd. The Coffee and Grocery line of business within the Packaged Foods segment is conducted by a number of\nsubsidiaries, principally European, including Douwe Egberts Nederland B.V., Douwe Egberts France S.A., Douwe Egberts Espana S.A., Merrild Kaffe A\/S, Douwe Egberts N.V., Compack Douwe Egberts Rt., Harris\/DE Pty. Ltd., Balirny Douwe Egberts A.S. and Douwe Egberts Coffee Systems Nederland B.V.\nThe Personal Products line of business within the Packaged Consumer Products segment includes numerous foreign businesses, including Dim S.A., Grupo Sans S. A., Sara Lee Personal Products (Australia) Pty. Ltd., Pretty Polly Ltd., Vatter GmbH, the Filodoro Group, Manufacturas Mallorca, S.A. de C.V., Rinbros, S.A. de C.V., and a 60% interest in Maglificio Bellia S.p.A.\nThe Household and Personal Care line of business within the Packaged Consumer Products segment is composed of subsidiaries in over forty countries. The principal subsidiaries are Kiwi Brands Pty. Ltd., Kiwi France S.A., Kortman Intradal B.V., A\/S Blumoller, Sara Lee\/DE Espana S.A., Sara Lee Household and Personal Care U.K. Ltd., and Sara Lee\/DE Italy S.p.A.\nThe financial information about foreign and domestic operations can be found on page of this Report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nSara Lee operates 289 food processing and consumer product manufacturing plants, each containing more than 20,000 square feet in building area, in 27 states and 35 foreign countries. Sara Lee owns 221 and leases 68 of these plants. It also operates 135 warehouses containing more than 20,000 square feet in building area in 18 states and 20 foreign countries. Of these warehouses, 57 are owned and 78 are leased. The following table identifies the plants and warehouses presently owned or leased by Sara Lee that contain at least 250,000 square feet in building area.\n- --------------- * These facilities are leased; the remainder are owned by Sara Lee.\n** Facilities have been closed as part of 1994 restructuring and are awaiting sale. See pages through of this Report for a description of the restructuring.\n*** Facilities have been closed and are awaiting sale.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn September 1994, Sara Lee and the State of Wisconsin stipulated and agreed that (i) Sara Lee would pay $200,000 into an escrow fund established at the conclusion of the bankruptcy proceedings of Peck Foods Corporation (\"Peck\"), a former subsidiary of Sara Lee sold in 1988, in connection with certain allegations that Peck had violated hazardous spill remediation laws, and (ii) judgment in the amount of $218,400, including a penalty assessment, would be entered against Sara Lee in connection with certain allegations that Peck had illegally discharged wastewater in violation of water pollution control laws. The current owners of Peck have reimbursed Sara Lee for approximately $318,000 of these costs.\nIn addition to the foregoing, Sara Lee is a party to several pending legal proceedings and claims, and environmental actions by governmental agencies. Although the outcome of such items cannot be determined with certainty, Sara Lee's General Counsel and management are of the opinion that the final outcomes should not have a material adverse effect on Sara Lee's results of operations or financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot Applicable.\nEXECUTIVE OFFICERS OF SARA LEE\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 Stockholders to be held on October 26, 1995 (the \"Proxy Statement\").\nThe following is a list of names and ages of all current executive officers of Sara Lee indicating positions and offices with Sara Lee held by each such person. All such persons have been elected by, and hold office at the pleasure of, the Board of Directors. No person other than those listed below has been chosen to become an executive officer of Sara Lee.\n- --------------- * Mr. Heid and Mr. Meysman assumed the duties of executive officers (as defined in Rule 3b-7 under the Securities Exchange Act of 1934, as amended) of Sara Lee as of September 26, 1995.\nThere are no family relationships between any of the above-named executive officers and directors.\nEach of the executive officers listed above has served Sara Lee or its subsidiaries in various executive capacities for the past five years except Donald J. Franceschini, Joseph E. Heid and Janet Langford Kelly.\nPrior to his election, Mr. Franceschini served in various executive capacities at Playtex Apparel, Inc. prior to its acquisition by Sara Lee. Before joining Sara Lee in December 1992, Mr. Heid was President of Guiness America, Inc., a marketer and producer of distilled beverages. Ms. Kelly was a partner in the Chicago office of Sidley & Austin from June 1991 until her election and prior thereto was an associate at Sidley & Austin.\nPART II\nItem 5.","section_5":"Item 5. Market for Sara Lee's Common Equity and Related Stockholder Matters.\nSara Lee's securities are traded on the exchanges listed on the cover page of this Form 10-K Report. As of September 1, 1995, Sara Lee had approximately 93,200 holders of record of its Common Stock. Information about the high and low sales prices for each full quarterly period and the amount of cash dividends declared on Sara Lee's Common Stock during the past three fiscal years is set forth on page of this Report.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe requisite financial information for Sara Lee for the five fiscal years ending July 1, 1995, is set forth on pages and of this Report. Such information should be read in conjunction with the consolidated Financial Statements and related Notes to Financial Statements on pages through of this Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThis discussion and analysis of financial condition and results of operations should be read in conjunction with the General Development of Business on pages 1 through 3, Narrative Description of Business on pages 3 through 7, and the consolidated Financial Statements and related Notes to Financial Statements on pages through of this Report.\nRESULTS OF OPERATIONS\nNet sales increased 14.1% to $17.7 billion in 1995, from $15.5 billion in 1994, and $14.6 billion in 1993. The increase in 1995 was due to higher unit volumes and improved product mix, as well as the strengthening of foreign currencies relative to the U.S. dollar and business acquisitions. Business acquisitions and unit volume growth, offset in part by the weakening of foreign currencies relative to the U.S. dollar, were the primary contributing factors in the 1994 increase. Excluding the effects of foreign currencies and acquisitions and dispositions, sales dollars increased 6% in 1995 and 3% in 1994.\nThe gross profit margin was 37.8% in 1995, compared with 37.6% in 1994 and 38.0% in 1993. Improved margins in the corporation's Personal Products and Packaged Meats and Bakery operations, offset in part by lower Coffee and Grocery margins, generated the increase in 1995. The decrease in 1994 was attributable to margin declines in the European hosiery and knit products businesses, offset in part by improved margins in the Household and Personal Care and Packaged Meats and Bakery operations.\nOn June 6, 1994, the corporation announced a restructuring of its worldwide operations that will ultimately result in the closure of 94 manufacturing and distribution facilities and the severance of 9,900 employees. This restructuring reduced 1994 operating income (pretax earnings before interest and corporate expenses), net income and primary earnings per share by $732 million, $495 million and $1.03, respectively. The 1994 operating income included charges for restructuring as follows: Personal Products -- $630 million; Household and Personal Care -- $55 million; Coffee and Grocery -- $25 million; and Packaged Meats and Bakery -- $22 million.\nOf the total provision of $732 million, non-cash charges of $304 million represent the excess of the net book value of plants to be closed and businesses to be sold over the estimated sales proceeds. The balance of the restructuring provision primarily represents cash outflows. During fiscal 1995, cash payments totaled $173 million. Restructuring actions are expected to be substantially completed by the close of 1996 and the corporation expects to fund the remaining costs of the plan from internal sources and available borrowings.\nDuring 1995, 42 manufacturing and distribution facilities were closed and 6,029 employees terminated. Operating costs were lowered in 1995 by $89 million, primarily as a result of lower plant overhead and labor costs. The corporation expects the restructuring plan to generate increasing savings in subsequent years, growing to an annual savings of approximately $250 million in 1998. Savings from the planned actions will be\nused for both business-building initiatives and profit improvement. The restructuring reserve is analyzed in greater detail in the Restructuring Provision note to the financial statements on pages and.\nOperating income, excluding the restructuring charge, increased 18.5% in the Packaged Foods segment, while the Packaged Consumer Products segment increased 15.6% from 1994 results. The increase in the Packaged Foods segment is primarily attributable to business acquisitions, the strengthening of foreign currencies relative to the U.S. dollar and cost controls. The increased results in the Packaged Consumer Products segment were primarily attributable to the improved profitability of the worldwide hosiery, knit products and intimates businesses. Business acquisitions and the strengthening of foreign currencies relative to the U.S. dollar also contributed to the improved results of the Packaged Consumer Products segment. Excluding the restructuring charge and the effects of acquisitions and fluctuations in foreign exchange rates, operating income increased 7% in 1995, and in 1994 was virtually unchanged from 1993.\nNet interest expense was $185 million in 1995, compared with $145 million in 1994 and $82 million in 1993. The 1995 increase was largely due to higher interest rates, while the increase in 1994 interest expense was a result of increased financing needs for acquisitions and capital expenditures.\nUnallocated corporate expenses are costs not directly attributable to specific segment operations. Unallocated corporate expenses were $192 million in 1995, $98 million in 1994 and $143 million in 1993. Unallocated corporate expenses in 1995 were negatively impacted by the costs of hedging foreign currency movements and expenses associated with minority interests in subsidiaries. In 1993, unallocated corporate expenses were greater than in 1994 because of costs of hedging foreign currency movements and higher administrative expenses.\nThe effective tax rate was 34.1% in 1995, 39.9% in 1994 and 34.9% in 1993. Excluding the impact of unusual items in 1994, the effective tax rate was 35.0%. The reduction of the tax rate from 35.0% in 1994 to 34.1% in 1995 was primarily due to increased earnings in certain foreign jurisdictions that have lower tax rates than the United States.\nIn fiscal 1994, the corporation adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The cumulative effect of this mandated accounting change was a one-time charge of $35 million, or $.07 per share.\nExcluding the effects of the 1994 restructuring charge and the cumulative effect of the accounting change, 1995 net income increased 10.3% to $804 million, and earnings per share increased 10.2% to $1.62. In 1994, net income decreased 71.8% to $199 million and primary earnings per share decreased 73.6% to $.37. Excluding the effects of the restructuring charge and the cumulative effect of the accounting change, net income and primary earnings per share in 1994 increased 3.5% and 5.0%, respectively.\nDuring 1995, the corporation acquired several companies for an aggregate purchase price of $168 million in cash. The principal acquisitions were in the Packaged Meats and Bakery segment, and included the remaining outstanding shares of Consolidated Foodservice Companies, a domestic foodservice distribution business, and the Imperial Meats Group, a European manufacturer and distributor of processed meats.\nDuring 1994, the corporation acquired several companies for an aggregate purchase price of $412 million in cash. The principal acquisitions were the European personal care businesses of SmithKline Beecham (Household and Personal Care), Kiwi Brands (Pty.) Ltd. and subsidiaries (Household and Personal Care and Personal Products), and Maglificio Bellia S.p.A. (Personal Products).\nDuring 1993, the corporation acquired several companies for an aggregate purchase price of $352 million in cash and the issuance of common stock having a market value of $69 million. The principal acquisitions were BP Nutrition's Consumer Food Group (Packaged Meats and Bakery) and the Filodoro Group (Personal Products).\nThese transactions are discussed in greater detail in the Acquisitions and Divestments note to the financial statements on page.\nDuring the past three years, the general rate of inflation has averaged 2%. Additionally, approximately 35% of the corporation's inventories are valued on the last-in, first-out basis. As a result, much of the current cost of production is reflected in operating results and not retained as a component of inventory.\nFINANCIAL POSITION\nNet cash provided from operating activities was $1.4 billion in 1995 as compared to $839 million in 1994. The favorable 1995 results were due to improved gross margins, operating efficiencies resulting in part from the 1994 restructuring, and improved working capital management. Net cash provided from operating activities in 1994 was approximately the same as in 1993.\nNet cash used in investment activities was $517 million in 1995, $937 million in 1994 and $967 million in 1993. Lower capital expenditures and business acquisition costs were the primary reasons for the reduced 1995 cash use. Capital expenditures were $480 million in 1995, $628 million in 1994 and $728 million in 1993. A significant portion of these expenditures was for the reduction of manufacturing and distribution costs, and for expansion of capacity to meet internal growth. The corporation expects fiscal 1996 capital expenditures to approximate $600 million. The 1996 expenditures will be funded from internal sources and available borrowing capacity. The corporation retains substantial flexibility to adjust its spending levels in order to act upon other opportunities, including business acquisitions.\nDuring 1995, cash of $853 million was used for financing activities, primarily to repay $459 million of debt and pay dividends of $358 million. During 1994, cash of $42 million was used in financing activities. In 1994, a domestic subsidiary of the corporation issued $200 million of equity securities, the proceeds of which were used to purchase shares of the corporation's common stock. During 1993, cash of $248 million was provided from financing activities, primarily through the utilization of available short-term debt capacity. As of July 1, 1995, the total-debt-to-total-capital ratio decreased to 33.8% from 38.9% at July 2, 1994. The current capital structure is within the corporation's objective of maintaining a total-debt-to-total-capital ratio of no more than 40% over time, and provides sufficient financial flexibility to pursue business opportunities.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated Financial Statements and related Notes to Financial Statements of Sara Lee identified in the Index to Financial Statements appearing under Item 14, Exhibits, Financial Statement Schedules and Reports on Form 8-K, 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 Sara Lee.\nFor information with respect to the executive officers of Sara Lee, see \"Executive Officers of Sara Lee\" on page 11 of this Report. For information with respect to the directors of Sara Lee, see \"Election of Directors\" on pages 2 through 8 of the Proxy Statement, which is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information set forth in the Proxy Statement on pages 11 through 19, under the caption \"Executive Compensation,\" and on pages 19 through 21, under the caption \"Retirement Plans,\" is incorporated herein by reference; provided, however, that the Report of the Compensation and Employee Benefits Committee on Executive Compensation and the Performance Graph contained therein is specifically excluded and shall not be deemed so incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) No person or \"group\" (as that term is used in Section 3(d)(3) of the Securities Exchange Act of 1934) is known by Sara Lee to beneficially own more than 5% of any class of Sara Lee's voting securities, except that, as of September 1, 1995, State Street Bank & Trust Company of Boston, as trustee (\"Trustee\") of the Sara Lee Corporation Employee Stock Ownership Plan (\"ESOP\"), held in trust 4,514,427 shares (100% of the outstanding shares) of Sara Lee's Employee Stock Ownership Plan Convertible Preferred Stock (\"ESOP Stock\"), of which 1,168,043 shares (25.87%) were allocated to participant accounts and 3,346,384 shares (74.13%) were unallocated shares, and 9,517 shares of Sara Lee Common Stock (less than 1% of the outstanding shares of Common Stock), all of which were allocated to participant accounts. Each ESOP participant is entitled to direct the Trustee how to vote the shares allocated to such participant's account, as well as a proportionate share of unallocated or unvoted shares. The ESOP Stock votes as a class with the Common Stock and each share of ESOP Stock is entitled to 5.133 votes. Each share of ESOP Stock is convertible into four shares of Sara Lee Common Stock.\n(b) Security ownership by management as outlined on page 9 of the Proxy Statement under the caption \"Ownership of Common Stock and ESOP Stock by Directors, Nominees and Executive Officers\" is incorporated herein by reference.\n(c) There are no arrangements known to Sara Lee the operation of which may at a subsequent date result in a change in control of Sara Lee.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nDuring fiscal 1995, Sara Lee paid fees for legal services performed by the law firm of Sidley & Austin, to which Newton N. Minow is counsel, and the law firm of Akin, Gump, Strauss, Hauer & Feld, L.L.P., of which Vernon E. Jordan, Jr. is a senior partner. Sara Lee paid fees for investment banking services to The First National Bank of Chicago, of which Richard L. Thomas is Chairman of the Board and Chief Executive Officer. Each of the above individuals is a director of Sara Lee.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, Sara Lee Corporation has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSeptember 29, 1995\nSARA LEE CORPORATION\nBy: \/s\/ JANET LANGFORD KELLY\n---------------------------------- Janet Langford Kelly Senior Vice President, Secretary and General Counsel\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 Sara Lee Corporation and in the capacities indicated on September 29, 1995.\n*By Janet Langford Kelly as Attorney-in-Fact pursuant to Powers of Attorney executed by the directors listed above, which Powers of Attorney have been filed with the Securities and Exchange Commission.\n\/s\/ JANET LANGFORD KELLY\n------------------------------------ Janet Langford Kelly As Attorney-in-Fact\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders, SARA LEE CORPORATION:\nWe have audited the accompanying consolidated balance sheets of SARA LEE CORPORATION (a Maryland corporation) AND SUBSIDIARIES as of July 1, 1995, July 2, 1994, and July 3, 1993, and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three years in the period ended July 1, 1995. 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 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 Sara Lee Corporation and Subsidiaries as of July 1, 1995, July 2, 1994, and July 3, 1993, and the results of their operations and their cash flows for each of the three years in the period ended July 1, 1995 in conformity with generally accepted accounting principles.\nAs explained in the Notes to Financial Statements, the Corporation adopted the requirements of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective July 4, 1993.\n\/s\/ Arthur Andersen LLP\nChicago, Illinois, July 31, 1995.\nSARA LEE CORPORATION AND SUBSIDIARIES\nFINANCIAL SUMMARY\nThe Notes to Financial Statements should be read in conjunction with the Financial Summary.\nSARA LEE CORPORATION AND SUBSIDIARIES\nFINANCIAL SUMMARY\nThe Notes to Financial Statements should be read in conjunction with the Financial Summary.\nSARA LEE CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nSARA LEE CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying Notes to Financial Statements are an integral part of these balance sheets.\nSARA LEE CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying Notes to Financial Statements are an integral part of these balance sheets.\nSARA LEE CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nSARA LEE CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n(dollars in millions except per share data)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements include all majority-owned subsidiaries. All significant intercompany transactions of consolidated subsidiaries are eliminated. Acquisitions recorded as purchases are included in the income statement from the date of acquisition.\nINVESTMENTS IN ASSOCIATED COMPANIES\nInvestments in associated companies consist of minority positions in several companies whose activities are similar to those of the corporation's operating divisions. The equity method of accounting is used when the corporation's ownership exceeds 20% and it exercises significant influence over the investee. Other minority positions are recorded at cost.\nFISCAL YEAR\nThe corporation's fiscal year ends on the Saturday closest to June 30. Fiscal 1995 and 1994 were 52-week years, while 1993 was a 53-week year. Unless otherwise stated, references to years relate to fiscal years.\nINTANGIBLE ASSETS\nThe excess of cost over the fair market value of tangible net assets and trademarks of acquired businesses is amortized on a straight-line basis over the periods of expected benefit, which range from 10 years to 40 years. Accumulated amortization of intangible assets amounted to $710 at July 1, 1995, $572 at July 2, 1994 and $457 at July 3, 1993.\nSubsequent to its acquisition, the corporation continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of an intangible asset may warrant revision or that the remaining balance of an intangible asset may not be recoverable. When factors indicate that an intangible asset should be evaluated for possible impairment, the corporation uses an estimate of the related business' undiscounted future cash flows over the remaining life of the asset in measuring whether the intangible asset is recoverable.\nINVENTORY VALUATION\nInventories are valued at the lower of cost (in 1995, approximately 35% at last-in, first-out [LIFO] and the remainder at first-in, first-out [FIFO]) or market. Inventories recorded at LIFO were approximately $18 at July 1, 1995, $24 at July 2, 1994 and $38 at July 3, 1993, lower than if they had been valued at FIFO. Inventory cost includes material and conversion costs.\nPROPERTY\nProperty is stated at cost, and depreciation is computed using principally the straight-line method at annual rates of 2% to 20% for buildings and improvements, and 4% to 33% for machinery and equipment. Additions and improvements that substantially extend the useful life of a particular asset and interest costs incurred during the construction period of major properties are capitalized. Repair and maintenance costs are charged to expense. Upon sale, the cost and related accumulated depreciation are removed from the accounts.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nFOREIGN OPERATIONS\nForeign currency-denominated assets and liabilities are translated into U.S. dollars at the exchange rates existing at the balance sheet date. Translation adjustments resulting from fluctuations in the exchange rates are recorded as a separate component of common stockholders' equity. Income and expense items are translated at the average exchange rates during the respective periods.\nFINANCIAL INSTRUMENTS\nThe corporation uses financial instruments in its management of foreign currency and interest rate exposures. Financial instruments are not held or issued for trading purposes. Non-U.S. dollar financing transactions generally are effective as hedges of long-term investments or intercompany loans in the corresponding currency. Foreign currency gains and losses on the hedges of long-term investments are recorded as foreign currency translation adjustments included in stockholders' equity. Gains and losses related to hedges of intercompany loans offset the gains and losses on intercompany loans and are recorded in net income. Interest rate exchange agreements are effective at modifying the corporation's interest rate exposures. Net interest is accrued as either interest receivable or payable with the offset recorded in interest expense. The company also uses short-term forward exchange contracts for hedging purposes. Realized and unrealized gains and losses on these instruments are deferred and recorded in the carrying amount of the related hedged asset, liability or firm commitment.\nNET INCOME PER COMMON SHARE\nPrimary net income per common share is based on the average number of common shares outstanding and common share equivalents and net income reduced for preferred dividends, net of the tax benefits related to the ESOP convertible preferred stock dividends. The fully diluted net income per share calculation assumes conversion of the ESOP convertible preferred stock into common stock and further adjusts net income for the additional ESOP compensation expense, net of tax benefits, resulting from the assumed replacement of the ESOP convertible preferred stock dividends with common stock dividends.\nINCOME TAXES\nIncome taxes are provided on the income reported in the financial statements, regardless of when such taxes are payable. U.S. income taxes are provided on undistributed earnings of foreign subsidiaries that are intended to be remitted to the corporation. If the permanently reinvested earnings of foreign subsidiaries were remitted, the U.S. income taxes due under current tax law would not be material.\nADVERTISING\nThe costs of advertising are generally expensed in the year in which the advertising first takes place.\nCOMMON STOCK\nUnder the corporation's stock option plans, executive employees may be granted options to purchase common stock at the market value on the date of grant. Under the corporation's nonqualified stock option plans, an active employee will receive a replacement stock option equal to the number of shares surrendered upon a stock-for-stock exercise. The exercise price of the replacement option will be 100% of the market value at the date of exercise of the original option and will remain exercisable for the remaining term of the original option.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nAt July 1, 1995, 3,428,746 common shares were available for granting; options had been granted on 15,947,144 shares at prices ranging from $8.30 to $31.94 per share. During 1995, options on 4,798,160 shares were granted at prices ranging from $19.63 to $28.68; options for 1,403,375 shares were exercised at prices ranging from $5.38 to $28.07; and options for 466,051 shares expired or were canceled. Options exercisable at year-end were: 1995-10,111,475; 1994-9,548,858; and 1993-10,425,115.\nEmployees may purchase up to twenty-five thousand dollars market value of common stock annually at 85% of the market value. At July 1, 1995, 10,044,613 shares of common stock were available for issuance under this stock purchase plan.\nThe corporation has restricted stock plans that provide for awards of common stock to executive employees, subject to forfeiture if employment terminates prior to the end of prescribed periods. The market value of shares awarded under the plans is recorded as unearned compensation. The unearned amounts are amortized to compensation expense over the periods the restrictions lapse.\nEffective December 1, 1992, the corporation declared a two-for-one stock split in the form of a 100% stock dividend.\nChanges in outstanding common shares for the past three years were:\nPREFERRED STOCK\nSix series of 500 shares each of nonvoting auction preferred stock are outstanding. Dividends are cumulative and are determined every 49 days through specific auction procedures.\nThe convertible preferred stock sold to the corporation's Employee Stock Ownership Plan (ESOP) is redeemable at the option of the corporation at any time after December 15, 2001. Each share is currently convertible into four shares of the corporation's common stock and is entitled to 5.133 votes. This stock has a 7.5% annual dividend rate, payable semiannually, and has a liquidation value of $72.50 plus accrued but unpaid dividends. The purchase of the preferred stock by the ESOP was funded with notes guaranteed by the corporation. The loan is included in long-term debt and is offset in the corporation's Consolidated Balance Sheets under the caption Unearned Deferred Compensation. Each year, the corporation makes contributions that, with the dividends on the preferred stock held by the ESOP, will be used to pay loan interest and principal. Shares are allocated to participants based upon the ratio of the current year's debt service to the sum of the total principal and interest payments over the life of the loan. Plan expense is recognized in accordance with methods prescribed by the FASB.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nESOP-related expenses amounted to $12 in 1995, $11 in 1994, and $11 in 1993. Payments to the ESOP were $38 in 1995, $38 in 1994 and $35 in 1993. Principal and interest payments by the ESOP amounted to $12 and $26 in 1995, $11 and $27 in 1994, and $7 and $28 in 1993.\nThe corporation has a Preferred Stock Purchase Rights Plan. The Rights are exercisable 10 days after certain events involving the acquisition of 20% or more of the corporation's outstanding common stock or the commencement of a tender or exchange offer for at least 25% of the common stock. Upon the occurrence of such an event, each Right, unless redeemed by the board of directors, entitles the holder to receive common stock equal to twice the exercise price of the Right. The exercise price is $140 multiplied by the number of preferred shares held. There are 3,000,000 shares of preferred stock reserved for issuance upon exercise of the Rights.\nThe corporation redeemed for cash its cumulative convertible adjustable preferred stock on July 26, 1993 for $30.\nMINORITY INTEREST IN SUBSIDIARIES\nMinority interest in subsidiaries primarily consists of preferred equity securities issued by subsidiaries of the corporation. No gain or loss was recognized as a result of the issuance of these securities and the corporation owned substantially all of the voting equity of the subsidiaries both before and after the transactions.\nIn 1994, a domestic subsidiary of the corporation issued $200 of preferred equity securities. The securities provide the holder a rate of return based upon a specified inter-bank borrowing rate, are redeemable in 1998 and may be called at any time by the subsidiary. The subsidiary has the option of redeeming the securities with either cash, debt or equity of the corporation. The subsidiary used the cash proceeds received to purchase the common stock of the corporation on the open market.\nMinority interest in subsidiaries also includes $295 of preferred equity securities issued by a wholly owned foreign subsidiary of the corporation. The securities provide a rate of return based upon specified inter-bank borrowing rates. The securities are redeemable in 1997 in exchange for common shares of the issuer, which may then be put to the corporation for preferred stock. The subsidiary may call the securities at any time.\nACQUISITIONS AND DIVESTMENTS\nDuring 1995, the corporation acquired several companies for an aggregate purchase price of $168 in cash. The principal acquisitions were the remaining outstanding shares of the Consolidated Foodservice Companies, a domestic foodservice distribution business, and the Imperial Meats Group, a European manufacturer and distributor of processed meats.\nDuring 1994, the corporation acquired several companies for an aggregate purchase price of $412 in cash. The principal acquisitions were the European personal care businesses of SmithKline Beecham; Kiwi Brands (Pty.) Ltd. and subsidiaries, a group of South African companies that manufacture and market personal care products and hosiery; and Maglificio Bellia S.p.A., a manufacturer and marketer of intimate apparel in Italy.\nDuring 1993, the corporation acquired several companies for an aggregate purchase price of $352 in cash and the issuance of 1,924,411 shares of common stock having a market value of $69. The principal acquisitions were BP Nutrition's Consumer Food Group, a manufacturer and marketer of packaged meat products in Europe, and the Filodoro Group, a manufacturer and marketer of hosiery in Italy.\nNo material divestments were made during the last three years.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nFINANCIAL INSTRUMENTS AND RISK MANAGEMENT\nINTEREST RATE AND CURRENCY SWAPS\nTo manage interest rate and foreign exchange risk and to lower its cost of borrowing, the corporation has entered into interest rate and currency swaps. The currency swaps effectively hedge long-term Dutch guilder-and Swiss franc-denominated investments and French franc-denominated intercompany loans. The weighted average maturities of interest rate and currency swaps as of July 1, 1995 were 2.6 years and 1.2 years, respectively.\nFORWARD EXCHANGE CONTRACTS\nThe corporation uses forward exchange contracts to reduce the effect of fluctuating foreign currencies on short-term foreign currency-denominated intercompany transactions, firm third-party product sourcing commitments and other known foreign currency exposures.\nThe table below summarizes by major currency the contractual amounts of the corporation's forward exchange contracts in U.S. dollars. The bought amounts represent the net U.S. dollar equivalent of commitments to purchase foreign currencies, and the sold amounts represent the net U.S. dollar equivalent of commitments to sell foreign currencies. The foreign currency amounts have been translated into a U.S. dollar\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nequivalent value using the exchange rate at the reporting date. Forward exchange contracts mature at the anticipated cash requirement date of the hedged transaction, generally within one year.\nAt July 1, 1995, the deferred unrealized gains and losses on forward exchange contracts were not material to the financial position of the corporation.\nCONCENTRATIONS OF CREDIT RISK\nA large number of major international financial institutions are counterparties to the corporation's financial instruments. The corporation enters into financial instrument agreements only with those counterparties meeting very stringent credit standards, limiting the amount of agreements or contracts it enters into with any one party and, where legally available, executing master netting agreements. These positions are continuously monitored. While the corporation may be exposed to credit losses in the event of nonperformance by these counterparties, it does not anticipate losses, because of these control procedures.\nTrade accounts receivable due from highly leveraged customers were $49 at July 1, 1995, $52 at July 2, 1994 and $41 at July 3, 1993. The financial position of these businesses has been considered in determining allowances for doubtful accounts.\nGUARANTEES\nThe corporation had third-party guarantees outstanding, aggregating approximately $31 at July 1, 1995, $28 at July 2, 1994 and $22 at July 3, 1993. These guarantees relate primarily to financial arrangements to support various suppliers of the corporation, and are secured by the inventory and fixed assets of suppliers.\nFAIR VALUES\nThe carrying amounts of cash and equivalents, trade receivables, notes payable, accounts payable, and auction preferred shares approximated fair value as of July 1, 1995, July 2, 1994 and July 3, 1993. The fair values of the remaining financial instruments recognized on the Consolidated Balance Sheets of the corporation at the respective year-end were:\nThe fair value of the corporation's long-term debt, including the current portion, is estimated using discounted cash flows based on the corporation's current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the ESOP preferred shares is based upon the contracted conversion into the corporation's common stock.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nThe fair value of the corporation's interest rate swaps, currency swaps, and forward exchange contracts approximate their carrying value in the financial statements as of July 1, 1995, July 2, 1994 and July 3, 1993. The fair value of these instruments was not material to the financial position of the corporation.\nLONG-TERM DEBT\nThe ESOP debt is guaranteed by the corporation.\nThe zero coupon notes are net of unamortized discounts of $110 in 1995, $112 in 1994 and $113 in 1993. Principal payments of $19 and $105 are due in 2014 and 2015, respectively.\nPayments required on long-term debt during the years ending in 1996 through 2000 are $221, $132, $419, $86 and $241, respectively.\nThe corporation made cash interest payments of $236, $203, and $161 in 1995, 1994 and 1993, respectively.\nRental expense under operating leases amounted to approximately $222 in 1995, $207 in 1994 and $182 in 1993. Future minimum annual fixed rentals required during the years ending in 1996 through 2000 under noncancelable operating leases having an original term of more than one year are $113, $95, $81, $68 and $62, respectively. The aggregate obligation subsequent to 2000 is $137.\nThe corporation is contingently liable for long-term leases on properties operated by others. The minimum annual rentals under these leases average approximately $5 for the years ending in 1996-2000 and $2 in 2001-2005. Amounts thereafter are not material.\nCREDIT FACILITIES\nThe corporation has numerous credit facilities available, including revolving credit agreements totaling $1,920 that had an annual fee of 0.07% as of July 1, 1995. These agreements support commercial paper\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nborrowings. Subsequent to July 1, 1995 the corporation reduced its revolving credit facility to $1,635 in anticipation of lower borrowing needs. Selected data on the corporation's short-term obligations follow:\nCONTINGENCIES\nThe corporation is a party to several pending legal proceedings and claims, and environmental actions by governmental agencies. Although the outcome of such items cannot be determined with certainty, the corporation's general counsel and management are of the opinion that the final outcome should not have a material effect on the corporation's results of operations or financial position.\nRESTRUCTURING PROVISION\nThe composition of the corporation's restructuring reserves is as follows:\nIn the fourth quarter of 1994, the corporation provided for the cost of restructuring its worldwide operations, which will result in the closure of 94 manufacturing and distribution facilities and the severance of 9,900 employees. The restructuring provision reduced 1994 income before income taxes, net income and net\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nincome per common share by $732, $495 and $1.03, respectively. As of July 2, 1994, no material actions contemplated in the restructuring plan had taken place.\nDuring 1995, 42 manufacturing and distribution facilities were closed and 6,029 employees terminated. Operating costs were lowered in 1995 by $89, primarily as a result of lower plant overhead and labor costs. The corporation expects the restructuring plan to generate increasing savings in subsequent years, growing to an annual savings of approximately $250 in 1998. Savings from the planned actions will be used both for business-building initiatives and profit improvement. As of July 1, 1995, $166 of the remaining reserves were classified as current liabilities and $76 as noncurrent.\nRETIREMENT PLANS\nThe corporation has noncontributory defined benefit plans covering certain of its domestic employees. The benefits under these plans are primarily based on years of service and compensation levels. The plans are funded in conformity with the requirements of applicable government regulations. The plans' assets consist principally of marketable equity securities, corporate and government debt securities and real estate.\nThe corporation's foreign subsidiaries have plans for employees consistent with local practices.\nThe corporation also sponsors defined contribution pension plans at several of its subsidiaries. Contributions are determined as a percent of each covered employee's salary.\nCertain employees are covered by union-sponsored, collectively bargained, multi-employer pension plans. Contributions are determined in accordance with the provisions of negotiated labor contracts and generally are based on the number of hours worked.\nThe annual pension expense for all plans was:\nThe components of the defined benefit plan expenses were:\nThe increase in the 1995 defined benefit plan expense is primarily attributable to lower asset returns, the strengthening of foreign currencies relative to the U.S. dollar, and benefit increases in certain foreign plans.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nThe status of defined benefit plans at the respective year-end was:\nWeighted average rates used in determining net pension expense and related obligations for defined benefit plans were:\nThe corporation adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (SFAS 106), for its domestic retiree benefit plans in 1994. Under SFAS 106, the corporation accrues the estimated cost of retiree health care and life insurance benefits during the employees' active service periods. The corporation's previous method of accounting for postretirement benefits other than pensions was similar to that required by SFAS 106, and as of the start of 1994, the accumulated benefit obligation for domestic employees had been accrued.\nThe corporation provides health care and life insurance benefits to certain domestic retired employees, their covered dependents and beneficiaries. Generally, employees who have attained age 55 and who have rendered 10 years of service are eligible for these postretirement benefits. Certain retirees are required to contribute to plans in order to maintain coverage. The components of the expense for these plans were:\nThe domestic postretirement benefit expense was $18 in 1993.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nThe status of domestic postretirement benefit plans at the respective year-end was:\nActuarial assumptions used to determine the accumulated postretirement benefit obligation include a discount rate of 7.75% for 1995 and 1994. The assumed health care cost trend rate was 14% for 1995, decreasing to 7% by the year 2002 and remaining at that level thereafter. These trend rates reflect the corporation's prior experience and management's expectation that future rates will decline. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of July 1, 1995 by 10% and the post-retirement benefit expense for 1995 by 12%.\nEmployees outside the United States are covered principally by government-sponsored plans, and the cost of company-provided plans is not material. The corporation is required to adopt SFAS 106 for its plans outside the United States in 1996.\nINCOME TAXES\nEffective July 4, 1993, the corporation adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). The cumulative effect as of July 4, 1993 of adopting SFAS 109 was a one-time charge of $35, or $.07 per share, primarily due to adjusting deferred taxes from historical to current rates. Financial statements for years prior to 1994 have not been restated to reflect the adoption of this standard.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nThe provisions for income taxes computed by applying the U.S. statutory rate to income before taxes as reconciled to the actual provisions were:\nCurrent and deferred tax provisions were:\nFollowing are the components of the deferred tax provisions occurring as a result of transactions being reported in different years for financial and tax reporting:\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nThe deferred tax (assets) liabilities at the respective year-end were as follows:\nINDUSTRY SEGMENT INFORMATION\nThe corporation's business segments are described in the Narrative Description of Business on pages 3 through 7.\nIndustry segment sales and operating income applicable to businesses sold prior to July 1, 1995 were not material.\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nGEOGRAPHIC AREA INFORMATION\nSARA LEE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(dollars in millions except per share data)\nQUARTERLY FINANCIAL DATA (unaudited)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Management of SARA LEE CORPORATION:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Sara Lee Corporation included in this Form 10-K, and have issued our report thereon dated July 31, 1995. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The supplemental schedule II is the responsibility of the Corporation'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 supplemental 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\/s\/ Arthur Andersen LLP\nChicago, Illinois, July 31, 1995.\nSCHEDULE II\nSARA LEE CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JULY 3, 1993, JULY 2, 1994, AND JULY 1, 1995 (IN MILLIONS)\nEXHIBIT INDEX","section_15":""}
{"filename":"810999_1995.txt","cik":"810999","year":"1995","section_1":"ITEM 1. Business\nParker & Parsley 87-A, Ltd. (the \"Registrant\") is a limited partnership organized in 1987 under the laws of the State of Texas. The managing general partner is Parker & Parsley Development L.P. (\"PPDLP\"). PPDLP's general partner is Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"). The managing general partner during the year ended December 31, 1994 was Parker & Parsley Development Company (\"PPDC\"). PPDC was merged into PPDLP on January 1, 1995. See Item 12 (c).\nA Registration Statement, as amended, filed pursuant to the Securities Act of 1933, registering limited partnership interests aggregating $40,000,000 in a series of Texas limited partnerships formed under the Parker & Parsley 87 Development Drilling Program, was declared effective by the Securities and Exchange Commission on April 28, 1987. On August 20, 1987, the offering of limited partnership interests in the Registrant, the first partnership formed under such registration statement, was closed, with interests aggregating $28,811,000 being sold to 2,264 subscribers.\nThe Registrant engages primarily in oil and gas development and production and is not involved in any industry segment other than oil and gas. See \"Item 6. Selected Financial Data\" and \"Item 8. Financial Statements and Supplementary Data\" of this report for a summary of the Registrant's revenue, income and identifiable assets.\nThe principal markets during 1995 for the oil produced by the Registrant were refineries and oil transmission companies that have facilities near the Registrant's oil producing properties. The principal markets for the Registrant's gas were companies that have pipelines located near the Registrant's gas producing properties. Of the Registrant's oil and gas revenues for 1995, approximately 58% and 15% were attributable to sales made to Phibro Energy, Inc. and Western Gas Resources, Inc., respectively.\nBecause of the demand for oil and gas, the Registrant does not believe that the termination of the sales of its products to any one customer would have a material adverse impact on its operations. The loss of a particular customer for gas may have an effect if that particular customer has the only gas pipeline located in the areas of the Registrant's gas producing properties. The Registrant believes, however, that the effect would be temporary, until alternative arrangements could be made.\nFederal and state regulation of oil and gas operations generally includes the fixing of maximum prices for regulated categories of natural gas, the imposition of maximum allowable production rates, the taxation of income and other items, and the protection of the environment. Although the Registrant believes that its business operations do not impair environmental quality and that its costs of complying with any applicable environmental regulations are not currently significant, the Registrant cannot predict what, if any, effect these environmental regulations may have on its current or future operations.\nThe Registrant does not have any employees of its own. PPUSA employs 623 persons, many of whom dedicated a part of their time to the conduct of the Registrant's business during the period for which this report is filed. The Registrant's managing general partner, PPDLP through PPUSA, supplies all management functions.\nNo material part of the Registrant's business is seasonal and the Registrant conducts no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Registrant's properties consist primarily of leasehold interests in properties on which oil and gas wells are located. Such property interests are often subject to landowner royalties, overriding royalties and other oil and gas leasehold interests.\nFractional working interests in developmental oil and gas prospects located primarily in the Spraberry Trend area of West Texas and Colorado were acquired by the Registrant, resulting in the Registrant's participation in the drilling of 96 oil and gas wells, with two wells completed as dry holes. One uneconomical well was plugged and abandoned and six wells were sold during 1995. At December 31, 1995, 87 wells were producing.\nFor information relating to the Registrant's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993, and changes in such quantities for the years then ended, see Note 7 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below. Such reserves have been estimated by the engineering staff of PPUSA with a review by an independent petroleum consultant.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Registrant is a party to material litigation which is described in Note 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\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\nAt March 8, 1996, the Registrant had 28,811 outstanding limited partnership interests held of record by 2,325 subscribers. There is no established public trading market for the limited partnership interests. Under the limited partnership agreement, PPDLP has made certain commit ments to purchase partnership interests at a computed value.\nRevenues which, in the sole judgement of the managing general partner, are not required to meet the Registrant's obligations are distributed to the partners at least quarterly in accordance with the limited partnership agreement. During the years ended December 31, 1995 and 1994, distributions of $1,006,255 and $999,660, respectively, were made to the limited partners.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe following table sets forth selected financial data for the years ended December 31: 1995 1994 1993 1992 1991 ---------- ---------- ---------- ----------- ---------- Operating results: Oil and gas sales $2,338,478 $2,402,964 $ 3,120,078 $ 3,770,395 $4,334,762 ========= ========= ========== ========== ========= Litigation settle- ment, net $ - $ - $ 9,065,723 $ - $ - ========= ========= ========== ========== ========= Impairment of oil and gas properties$ 922,203 $ - $ - $ - $ - ========= ========= ========== ========== ========= Net income (loss) $ (955,234) $ (10,326) $ 8,763,729 $ 394,419 $ 490,079 ========= ========= ========== ========== ========= Allocation of net income (loss): Managing general partner $ (9,553) $ (103) $ 87,584 $ 4,712 $ 6,054 ========= ========= ========== ========== ========= Limited partners $ (945,681) $ (10,223) $ 8,676,145 $ 389,707 $ 484,025 ========= ========= ========== ========== ========= Limited partners' net income (loss) per limited part- nership interest $ (32.82) $ (.35) $ 301.14 $ 13.53 $ 16.80 ========= ========= ========== ========== ========= Limited partners' cash distributions per limited part- nership interest $ 34.93 $ 34.70 $ 339.32(a)$ 71.15 $ 96.90 ========= ========= ========== ========== ========= At year end: Total assets $6,973,611 $8,966,767 $10,049,155 $11,832,077 $13,746,491 - --------------- ========= ========= ========== ========== ========== (a) Including litigation settlement per limited partnership interest of $286.62 in 1993. 4\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\nThe Registrant's 1995 oil and gas revenues decreased to $2,338,478 from $2,402,964 in 1994, a decrease of 3%. The decrease in revenues resulted from a 13% decline in barrels of oil produced and sold, offset by a 4% increase in mcf of gas produced and sold and increases in the average prices received per barrel of oil and mcf of gas. In 1995, 101,238 barrels of oil were sold compared to 115,931 in 1994, a decrease of 14,693 barrels. In 1995, 365,173 mcf of gas were sold compared to 352,692 in 1994, an increase of 12,481 mcf. The decrease in oil production was primarily due to the decline characteristics of the Registrant's oil and gas properties. The increase in gas production was the result of operational changes on several wells. Management expects a certain amount of decline in production in the future until the Registrant's economically recoverable reserves are fully depleted.(1)\nThe average price received per barrel of oil increased $1.26, or 8%, from $15.84 in 1994 to $17.17 in 1995, while the average price received per mcf of gas increased from $1.61 in 1994 to $1.66 in 1995. The market price received for oil and gas has been extremely volatile in the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.(1) The Registrant may therefore sell its future oil and gas production at average prices lower or higher than that received in 1995.(1)\nA gain on sale of assets of $36,708 resulted from the sale of six oil and gas wells during 1995. The gain was the net result of proceeds received of $148,022 less the write-off of remaining capitalized well costs of $111,314.\nSalvage income from equipment disposals of $922 received during 1995 was derived from equipment credits received on one fully depleted well.\nInterest income increased to $19,373 in 1995 from $10,477 in 1994, or $8,896. This increase was the result of proceeds received from the sale of six oil and gas wells during 1995.\nTotal costs and expenses increased in 1995 to $3,350,715 as compared to $2,436,349 in 1994, an increase of $914,366, or 38%. The increase was attributable to increases in impairment of oil and gas properties, loss on abandoned properties and abandoned property expense, offset by declines in production costs, general and administrative expenses (\"G&A\") and depletion.\nProduction costs were $1,192,526 in 1995 and $1,348,673 in 1994, resulting in a $156,147 decrease, or 12%. This decrease was due to reductions in well repair, maintenance and workover costs.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate,\n2% from $72,128 in 1994 to $70,886 in 1995. The Registrant paid the managing general partner $58,516 in 1995 and $55,851 in 1994 for G&A incurred on behalf of the Registrant. G&A is allocated, in part, to the Registrant by the managing general partner. The Partnership agreement limits allocated G&A to 3% of gross oil and gas revenues. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Registrant relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.(1)\nDepletion was $935,628 in 1995 compared to $1,015,548 in 1994. This represented a decrease of $79,920, or 8%. Depletion was computed property-by-property utilizing the unit-of-production method based upon the dominant mineral produced, generally oil. Oil production decreased 14,693 barrels in 1995 from 1994, while oil reserves of barrels were revised upward by 42,523 barrels, or 4%, and six wells were sold representing oil reserves of 29,026 barrels.\nEffective for the fourth quarter of 1995 the Registrant 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\") which requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, 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 of recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment is recognized based on the asset's fair value as determined for oil and gas properties by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of the natural gas price environment and the Registrant's expectation of future cash flows from its oil and gas properties at the time of review, the Registrant recognized a non-cash charge of $922,203 associated with the adoption of SFAS 121.\nA loss of $203,788 on abandoned property was the net result of proceeds received of $12,962 from the salvage of equipment on one well abandoned during 1995, less the write-off of remaining capitalized well costs of $216,750. Costs associated with the plugging and abandonment of this well totaled $25,684. There was no abandonment activity during 1994.\n1994 compared to 1993\nThe Registrant's 1994 oil and gas revenues decreased to $2,402,964 from $3,120,078 in 1993, a decrease of 23%. The decrease in revenues resulted from a 14% decrease in barrels of oil produced and sold, an 8% decrease in the average price received per barrel of oil, a 14% decrease in mcf of gas produced and sold and a 17% decrease in the average price received per mcf of gas. In 1994, 115,931 barrels of oil were sold compared to 135,434 in 1993, a decrease of 19,503 barrels. In 1994, 352,692 mcf of gas were sold compared to 410,709 in 1993, a decrease of 58,017 mcf. The decreases in production volumes were primarily due to the decline characteristics of the Registrant's oil and gas properties.\nThe average price received per barrel of oil decreased $1.30 from $17.14 in 1993 to $15.84 in 1994, while the average price received per mcf of gas decreased from $1.95 in 1993 to $1.61 in 1994.\nInterest income decreased to $10,477 in 1994 as compared to $27,342 for 1993. This decrease was due to interest earned on the litigation proceeds received in 1993 until it was disbursed to the limited partners in September 1993.\nSalvage income from equipment disposals of $12,582 received during 1994 was derived from equipment credits received on two fully depleted wells.\nTotal costs and expenses decreased in 1994 to $2,436,349 as compared to $3,449,414 in 1993, a decrease of $1,013,065, or 29%. The decrease was the result of a decline in production costs, G&A, depletion and interest expense.\nProduction costs were $1,348,673 in 1994 and $1,625,307 in 1993, resulting in a $276,634 decrease, or 17%. This decrease was due to declines in well repair, maintenance and workover costs and ad valorem and production taxes due to the decline in oil and gas sales.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 23% from $93,679 in 1993 to $72,128 in 1994. The Registrant paid the managing general partner $55,851 in 1994 and $79,978 in 1993 for G&A incurred on behalf of the Registrant.\nDepletion was $1,015,548 in 1994 compared to $1,715,305 in 1993. This represented a decrease of $699,757, or 41%. Oil production decreased 19,503 barrels in 1994 from 1993, while oil reserves of barrels were revised downward by 58,830 barrels, or 4%.\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Registrant filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ-Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Registrant and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Registrant, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest, determined the general partner's portion of the funds and calculated any inter-partnership allocations. A distribution of $91,000,000 was made to the working interest owners, including the Registrant, on July 30, 1993. The limited partners received their distribution of $8,257,794, or $286.62 per limited partnership interest, in September 1993.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff\npartnerships, including the Registrant and others, alleging his entitlement to 12% of the settlement proceeds. Price's lawsuit claim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Registrant and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court.\nOn September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Registrant, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal of the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Registrant is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Registrant and other joint property owners for participating in the lawsuit pursuant to the joint operating agree ment. Litigation settlement proceeds received by the Registrant, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993. Interest charged on legal expenses paid on behalf of the Registrant by the managing general partner was $15,123 in 1993 and $37,711 in 1992.\nImpact of inflation and changing prices on sales and net income\nInflation impacts the fixed overhead rate charges of the lease operating expenses for the Registrant. During 1993, the annual change in the index of average weekly earnings of crude petroleum and gas production workers issued by the U.S. Department of Labor, Bureau of Labor Statistics, decreased by 1.1%. The 1994 annual change in average weekly earnings increased by 4.8%. The 1995 index (effective April 1, 1995) increased 4.4%. The impact of inflation for other lease operating expenses is small due to the current economic condition of the oil industry.\nThe oil and gas industry experienced volatility during the past decade because of the fluctuation of the supply of most fossil fuels relative to the demand for such products and other uncertainties in the world energy markets causing significant fluctuations in oil and gas prices. Since December 31, 1994, prices for oil production have fluctuated throughout the year. The price per barrel for oil production similar to the Registrant's ranged from approximately $16.00 to $19.00. For February 1996, the average price for the Registrant's oil was approximately $18.00.\nPrices for natural gas are subject to ordinary seasonal fluctuations, and this volatility of natural gas prices may result in production being curtailed and, in some cases, wells being completely shut-in.(1)\nLiquidity and capital resources\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities increased to $1,040,485 during the year ended December 31, 1995, a $115,446 increase from the year ended December 31, 1994. The increase was primarily due to a decline in production costs, offset by a decline in oil and gas sales and an increase in abandoned property costs. Production costs decreased due to less well repair, maintenance and workover costs. The decline in oil and gas sales was due to the decrease in barrels of oil produced and sold. Abandoned property costs increased due to the plugging and abandonment of one uneconomical well during 1995, as compared to no abandonment activity during 1994.\nNet Cash Provided by (Used in) Investing Activities\nThe Registrant received $24,409 during 1995 from the disposal of oil and gas equipment on active properties, as compared to $27,343 in expenditures in 1994 related to repair and maintenance activity on several oil and gas properties.\nProceeds of $12,962 were received from the salvage of equipment on one well plugged and abandoned during 1995. Proceeds from salvage income of $922 and $12,582 during 1995 and 1994, respectively, was attributable to equipment credits received on fully depleted properties.\nThe Registrant received $148,022 in proceeds from the sale of six oil and gas wells during 1995.\nNet Cash Used in Financing Activities\nCash was sufficient in 1995 for distributions to the partners of $1,016,419 of which $1,006,255 was distributed to the limited partners and $10,164 to the managing general partner. In 1994, cash was sufficient for distributions to the partners of $1,009,759 of which $999,660 was distributed to the limited partners and $10,099 to the managing general partner.\nIt is expected that future net cash provided by operations will be sufficient for any capital expenditures and any distributions.(1) As the production from the properties declines, distributions are also expected to decrease.(1)\n- ---------------\n(1) This statement is a forward looking statement that involves risks and uncertainties. Accordingly, no assurances can be given that the actual events and results will not be materially different than the anticipated results described in the forward looking statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Registrant's audited financial statements are included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nThe Registrant does not have any officers or directors. Under the limited partnership agreement, the Registrant's managing general partner, PPDLP, is granted the exclusive right and full authority to manage, control and administer the Registrant's business. PPUSA, the sole general partner of PPDLP, is a wholly-owned subsidiary of Parker & Parsley Petroleum Company (the \"Company\"), a publicly-traded corporation on the New York Stock Exchange.\nSet forth below are the names, ages and positions of the directors and executive officers of PPUSA. Directors of PPUSA are elected to serve until the next annual meeting of stockholders or until their successors are elected and qualified.\nAge at December 31, Name 1995 Position\nScott D. Sheffield 43 Chairman of the Board and Director\nJames D. Moring (a) 59 President, Chief Executive Officer and Director\nTimothy A. Leach 36 Executive Vice President and Director\nSteven L. Beal 36 Senior Vice President, Treasurer and Chief Financial Officer\nMark L. Withrow 48 Senior Vice President and Secretary\n- ---------------\n(a) Mr. Moring retired from the Company and subsidiaries effective January 1, 1996. Mr. Sheffield assumed the positions of President and Chief Executive Officer of PPUSA effective January 1, 1996.\nScott D. Sheffield. Mr. Sheffield, a graduate of The University of Texas with a Bachelor of Science degree in Petroleum Engineering, has been the President and a Director of the Company since May 1990 and has been the Chairman of the Board and Chief Executive Officer since October 1990. Mr. Sheffield joined PPDC, the principal operating subsidiary of the Company, as a petroleum engineer in 1979. Mr. Sheffield served as Vice President - Engineering of PPDC from September 1981 until April 1985 when he was elected President and a Director of PPDC. In March 1989, Mr. Sheffield was elected Chairman of the Board and Chief Executive Officer of PPDC. On January 1, 1995, Mr. Sheffield resigned as President and Chief Executive Officer of PPUSA, but remained Chairman of the Board and a Director of PPUSA. On January 1, 1996, Mr. Sheffield reassumed the positions of President and Chief Executive Officer of PPUSA. Before joining PPDC, Mr. Sheffield was principally occupied for more than three years as a production and reservoir engineer for Amoco Production Company.\nJames D. Moring. Mr. Moring, a graduate of Texas Tech University with a Bachelor of Science degree in Petroleum Engineering has been a Director of the Company since October 1990 and was Senior Vice President - Operations of the Company from October 1990 until May 1993, when he was appointed Executive Vice President - Operations. Mr. Moring has been principally occupied since July 1982 as the supervisor of the drilling, completion, and production operations of PPDC and its affiliates and has served as an officer of PPDC since January 1983. Mr. Moring has been Senior Vice President - Operations and a Director of PPDC since June 1989 and in May 1993, Mr. Moring was appointed Executive Vice President - Operations. Mr. Moring was elected President and Director and appointed Chief Executive Officer of PPUSA on January 1, 1995. Effective January 1, 1996, Mr. Moring retired from the Company and subsidiaries. In the five years before joining PPDC, Mr. Moring was employed as a Division Operations Manager with Moran Exploration, Inc. and its predecessor.\nTimothy A. Leach. Mr. Leach, a graduate of Texas A&M University with a Bachelor of Science degree in Petroleum Engineering and the University of Texas of the Permian Basin with a Master of Business Administration degree, was elected Executive Vice President - Engineering of the Company on March 21, 1995. Mr. Leach had been serving as Senior Vice President Engineering since March 1993 and served as Vice President - Engineering of the Company from October 1990 to March 1993. Mr. Leach was elected Executive Vice President of PPUSA on December 1, 1995. He had joined PPDC as Vice President - Engineering in September 1989. Prior to joining PPDC, Mr. Leach was employed as Senior Vice President and Director of First City Texas - Midland, N.A.\nSteven L. Beal. Mr. Beal, a graduate of the University of Texas with a Bachelor of Business Administration degree in Accounting and a certified public accountant, was elected Senior Vice President - Finance of the Company in January 1995 and Chief Financial Officer of the Company on March 21, 1995. On January 1, 1995, Mr. Beal was elected Senior Vice President, Treasurer and Chief Financial Officer of PPUSA. Mr. Beal has been the Company's Chief Accounting Officer since November 1992 and been the Company's Treasurer since October 1990. Mr. Beal joined PPDC as Treasurer in March 1988 and was elected Vice President - Finance in October 1991. Prior to joining PPDC, Mr. Beal was employed as an audit manager of Price Waterhouse.\nMark L. Withrow. Mr. Withrow, a graduate of Abilene Christian University with Bachelor of Science degree in Accounting and Texas Tech University with a Juris Doctorate degree, was Vice President - General Counsel of the Company from February 1991 to January 1995, when he was appointed Senior Vice President - General Counsel, and has been the Company's Secretary since August 1992. On January 1, 1995, Mr. Withrow was elected Senior Vice President and Secretary of PPUSA. Mr. Withrow joined PPDC in January 1991. Prior to joining PPDC , Mr. Withrow was the managing partner of the law firm of Turpin, Smith, Dyer, Saxe & MacDonald, Midland, Texas.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Registrant does not have any directors or officers. Management of the Registrant is vested in PPDLP, the managing general partner. The Registrant participates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. Under the Program agreement, PPDLP pays approximately 10% of the Registrant's acquisition, drilling and completion costs and approximately 25% of its operating and general and administrative expenses. In return, PPDLP is allocated approximately 25% of the Registrant's revenues. See Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below for information regarding fees and reimbursements paid to the managing general partner or its affiliates by the Registrant.\nThe Registrant does not directly pay any salaries of the executive officers of PPUSA, but does pay a portion of PPUSA's general and administrative expenses of which these salaries are a part. See Note 6 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Beneficial owners of more than five percent\nThe Registrant is not aware of any person who beneficially owns 5% or more of the outstanding limited partnership interests of the Registrant. PPDLP owned 175 limited partner interests at January 1, 1996.\n(b) Security ownership of management\nThe Registrant does not have any officers or directors. The managing general partner of the Registrant, PPDLP, has the exclusive right and full authority to manage, control and administer the Registrant's business. Under the limited partnership agreement, limited partners holding a majority of the outstanding limited partnership interests have the right to take certain actions, including the removal of the managing general partner or any other general partner. The Registrant is not aware of any current arrangement or activity which may lead to such removal. The Registrant is not aware of any officer or director of PPUSA who beneficially owns limited partnership interests in the Registrant.\n(c) Changes in control\nOn January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of Parker & Parsley 87-A, Ltd., as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, which previously served as the managing general partner of the Registrant. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Registrant, including the development drilling program in which the Registrant participates.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nTransactions with the managing general partner or its affiliates\nPursuant to the limited partnership agreement, the Registrant had the following related party transactions with the managing general partner or its affiliates during the years ended December 31: 1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 471,166 $ 490,225 $ 527,544\nReimbursement of general and administrative expenses $ 58,516 $ 55,851 $ 79,978\nPurchase of oil and gas properties and related equipment, at predecessor cost $ - $ 9,593 $ 7,610\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 27,120 $ - $ -\nInterest expense charged on legal expenses paid on behalf of the Registrant by the managing general partner $ - $ - $ 15,123\nUnder the limited partnership agreement, the managing general partner pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Registrant's revenues. Also, see Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below, regarding the Registrant's participation with the managing general partner in oil and gas activities of the Program.\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 are filed as part of this annual report:\nIndependent Auditors' Report\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\n2. Financial statement schedules.\nAll financial statement schedules have been omitted since the required information is in the financial statements or notes thereto, or is not applicable nor required.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits listed on the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.\nS I G N A T U R E S\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.\nPARKER & PARSLEY 87-A, LTD.\nDated: March 25, 1996 By: Parker & Parsley Development L.P., Managing General Partner\nBy: Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), General Partner\nBy: \/s\/ Scott D. Sheffield ------------------------------ Scott D. Sheffield, 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.\n\/s\/ Scott D. Sheffield President, Chairman of the Board, March 25, 1996 - ------------------------- Chief Executive Officer and Scott D. Sheffield Director of PPUSA\n\/s\/ Timothy A. Leach Executive Vice President and March 25, 1996 - ------------------------- Director of PPUSA Timothy A. Leach\n\/s\/ Steven L. Beal Senior Vice President, Treasurer March 25, 1996 - ------------------------- and Chief Financial Officer Steven L. Beal of PPUSA\n\/s\/ Mark L. Withrow Senior Vice President and March 25, 1996 - ------------------------- Secretary of PPUSA Mark L. Withrow\nINDEPENDENT AUDITORS' REPORT\nThe Partners Parker & Parsley 87-A, Ltd. (A Texas Limited Partnership):\nWe have audited the financial statements of Parker & Parsley 87-A, Ltd. as listed in the accompanying index under Item 14(a). 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 Parker & Parsley 87-A, Ltd. 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.\nAs discussed in Notes 2 and 3 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets and for long-lived assets to be disposed of in 1995 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\"\nKPMG Peat Marwick LLP\nMidland, Texas March 8, 1996\nPARKER & PARSLEY 87-A, LTD. (A Texas Limited Partnership)\nBALANCE SHEETS December 31\n1995 1994 ------------ ------------ ASSETS\nCurrent assets: Cash and cash equivalents, including interest bearing deposits of $340,340 in 1995 and $142,195 in 1994 $ 353,019 $ 142,638 Accounts receivable - oil and gas sales 261,155 271,715 ----------- -----------\nTotal current assets 614,174 414,353\nOil and gas properties - at cost, based on the successful efforts accounting method 22,340,532 23,456,669 Accumulated depletion (15,981,095) (14,904,255) ----------- -----------\nNet oil and gas properties 6,359,437 8,552,414 ----------- -----------\n$ 6,973,611 $ 8,966,767 =========== =========== LIABILITIES AND PARTNERS' CAPITAL\nCurrent liabilities: Accounts payable - affiliate $ 138,353 $ 159,856\nPartners' capital: Limited partners (28,811 interests) 6,766,910 8,718,846 Managing general partner 68,348 88,065 ----------- -----------\n6,835,258 8,806,911 ----------- -----------\n$ 6,973,611 $ 8,966,767 =========== ===========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 87-A, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31\n1995 1994 1993 ---------- ---------- -----------\nRevenues: Oil and gas sales $2,338,478 $2,402,964 $ 3,120,078 Interest income 19,373 10,477 27,342 Salvage income from equipment disposals 922 12,582 - Gain on sale of assets 36,708 - - Litigation settlement, net - - 9,065,723 --------- --------- ----------\nTotal revenues 2,395,481 2,426,023 12,213,143\nCosts and expenses: Production costs 1,192,526 1,348,673 1,625,307 General and administrative expenses 70,886 72,128 93,679 Depletion 935,628 1,015,548 1,715,305 Impairment of oil and gas properties 922,203 - - Loss on abandoned property 203,788 - - Abandoned property costs 25,684 - - Interest expense - - 15,123 --------- --------- ----------\nTotal costs and expenses 3,350,715 2,436,349 3,449,414 --------- --------- ----------\nNet income (loss) $ (955,234) $ (10,326) $ 8,763,729 ========= ========= ==========\nAllocation of net income (loss): Managing general partner $ (9,553) $ (103) $ 87,584 ========= ========= ==========\nLimited partners $ (945,681) $ (10,223) $ 8,676,145 ========= ========= ==========\nNet income (loss) per limited partnership interest $ (32.82) $ (.35) $ 301.14 ========= ========= ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 87-A, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nManaging general Limited partner partners Total --------- ----------- -----------\nPartners' capital at January 1, 1993 $ 109,378 $10,828,655 $10,938,033\nDistributions (98,695) (9,776,071) (9,874,766)\nNet income 87,584 8,676,145 8,763,729 -------- ---------- ----------\nPartners' capital at December 31, 1993 98,267 9,728,729 9,826,996\nDistributions (10,099) (999,660) (1,009,759)\nNet loss (103) (10,223) (10,326) -------- ---------- ----------\nPartners' capital at December 31, 1994 88,065 8,718,846 8,806,911\nDistributions (10,164) (1,006,255) (1,016,419)\nNet loss (9,553) (945,681) (955,234) -------- ---------- ----------\nPartners' capital at December 31, 1995 $ 68,348 $ 6,766,910 $ 6,835,258 ======== ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 87-A, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31\n1995 1994 1993 ----------- ----------- ----------- Cash flows from operating activities: Net income (loss) $ (955,234) $ (10,326) $ 8,763,729 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depletion 935,628 1,015,548 1,715,305 Impairment of oil and gas properties 922,203 - - Salvage income from equipment disposals (922) (12,582) - Gain on sale of assets (36,708) - - Loss on abandoned property 203,788 - - Changes in assets and liabilities: (Increase) decrease in accounts receivable 10,560 (16,090) 85,078 Decrease in accounts payable (38,830) (51,511) (674,047) ---------- ---------- ---------- Net cash provided by operating activities 1,040,485 925,039 9,890,065 Cash flows from investing activities: (Additions) deletions to oil and gas properties 24,409 (27,343) (26,639) Proceeds from equipment salvage on abandoned property 12,962 - - Proceeds from salvage income on equipment disposals 922 12,582 - Proceeds from sale of assets 148,022 - - ---------- ---------- ---------- Net cash provided by (used in) investing activities 186,315 (14,761) (26,639) Cash flows from financing activities: Cash distributions to partners (1,016,419) (1,009,759) (9,874,766) ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents 210,381 (99,481) (11,340) Cash and cash equivalents at beginning of year 142,638 242,119 253,459 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 353,019 $ 142,638 $ 242,119 ========== ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 87-A, LTD. (A Texas Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNote 1. Organization and nature of operations\nParker & Parsley 87-A, Ltd. (the \"Partnership\") is a limited partnership organized in 1987 under the laws of the State of Texas.\nThe Partnership engages primarily in oil and gas development and production in the Spraberry Trend area of West Texas and Colorado and is not involved in any industry segment other than oil and gas.\nNote 2. Summary of significant accounting policies\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\nImpairment of long-lived assets - Effective for the fourth quarter of 1995 the Partnership 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\"). Consequently, the Partnership reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows is less than the carrying amount of the assets. In this circumstance, the Partnership recognizes an impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset.\nThe Partnership accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less costs to sell once management has committed to a plan to dispose of the assets.\nOil and gas properties - The Partnership utilizes the successful efforts method of accounting for its oil and gas properties and equipment. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized while nonproductive exploration costs are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method on a property-by-property basis based on proved oil (dominant mineral) reserves as determined by the engineering staff of Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), the sole general partner of Parker & Parsley Development L.P. (\"PPDLP\"), the Partnership's managing general partner, and reviewed by independent petroleum consultants. The carrying amounts of properties sold or otherwise disposed of and the related allowances for depletion are eliminated from the accounts and any gain or loss is included in operations.\nPrior to the adoption of SFAS 121 in the fourth quarter, the Partnership's aggregate oil and gas properties were stated at cost not in excess of total estimated future net revenues and the estimated fair value of oil and gas assets not being depleted.\nUse of estimates in the preparation of financial statements - Preparation of the accompanying 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 reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNet income (loss) per limited partnership interest - The net income (loss) per limited partnership interest is calculated by using the number of outstanding limited partnership interests.\nIncome taxes - A Federal income tax provision has not been included in the financial statements as the income of the Partnership is included in the individual Federal income tax returns of the respective partners.\nStatements of cash flows - For purposes of reporting cash flows, cash and cash equivalents include depository accounts held by banks.\nGeneral and administrative expenses - General and administrative expenses are allocated in part to the Partnership by the managing general partner or its affiliates. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Partnership relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.\nEnvironmental - The Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nNote 3. Impairment of long-lived assets\nThe Partnership adopted SFAS 121 effective for the fourth quarter of 1995. SFAS 121 requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be\nrecoverable. Long-lived assets to be disposed of are to be accounted for at the lower of carrying amount or fair value less cost to sell when management has committed to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 for fiscal years beginning after December 15, 1995.\nIn order to determine whether an impairment had occurred, the Partnership estimated the expected future cash flows of its oil and gas properties and compared such future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Partnership adjusted the carrying amount of those oil and gas properties to their fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result, the Partnership recognized a non-cash charge of $922,203 related to its oil and gas properties during the fourth quarter of 1995.\nAs of December 31, 1995, management had not committed to sell any Partnership assets.\nNote 4. Income taxes\nThe financial statement basis of the Partnership's net assets and liabilities was $3,479,611 greater than the tax basis at December 31, 1995.\nThe following is a reconciliation of net income (loss) per statements of operations with the net income per Federal income tax returns for the years ended December 31:\n1995 1994 1993 ---------- --------- ----------\nNet income (loss) per statements of operations $ (955,234) $ (10,326) $8,763,729 Intangible development costs capitalized for financial reporting purposes and expensed for tax reporting purposes - - (388) Depletion and depreciation provisions for tax reporting purposes under amounts for financial reporting purposes 741,976 299,885 817,950 Impairment of oil and gas properties for financial reporting purposes 922,203 - - Other, net 346,989 (6,347) 7,919 --------- --------- ---------\nNet income per Federal income tax returns $1,055,934 $ 283,212 $9,589,210 ========= ========= =========\nNote 5. Oil and gas producing activities\nThe following is a summary of the costs incurred, whether capitalized or expensed, related to the Partnership's oil and gas producing activities for the years ended December 31: 1995 1994 1993 ---------- ---------- ---------- Development costs $ 4,719 $ 16,551 $ 28,801 ========= ========= =========\nCapitalized oil and gas properties consist of the following: 1995 1994 1993 ----------- ----------- ----------- Proved properties: Property acquisition costs $ 1,070,384 $ 1,128,242 $ 1,128,242 Completed wells and equipment 21,270,148 22,328,427 22,311,876 ---------- ---------- ---------- 22,340,532 23,456,669 23,440,118 Accumulated depletion (15,981,095) (14,904,255) (13,888,707) ---------- ---------- ---------- Net capitalized costs $ 6,359,437 $ 8,552,414 $ 9,551,411 ========== ========== ==========\nDuring 1995, the Partnership recognized a non-cash charge against oil and gas properties of $922,203 associated with the adoption of SFAS 121. See Note 3.\nNote 6. Related party transactions\nPursuant to the limited partnership agreement, the Partnership had the following related party transactions with the managing general partner or its affiliates during the years ended December 31: 1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 471,166 $ 490,225 $ 527,544\nReimbursement of general and administrative expenses $ 58,516 $ 55,851 $ 79,978\nPurchase of oil and gas properties and related equipment, at predecessor cost $ - $ 9,593 $ 7,610\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 27,120 $ - $ -\nInterest expense charged on legal expenses paid on behalf of the Partnership by the managing general partner $ - $ - $ 15,123\nThe Partnership participates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. PPDLP, Parker & Parsley 87-A Conv., L.P. and the Partnership (the \"Partnerships\") are parties to the Program agreement.\nThe costs and revenues of the Program are allocated to PPDLP and the Partnerships as follows: PPDLP (1) Partnerships(2) --------- --------------- Revenues: Proceeds from disposition of depreciable properties 9.09091% 90.90909% All other revenues 24.242425% 75.757575%\nCosts and expenses: Lease acquisition costs, drilling and completion costs and all other costs 9.09091% 90.90909% Operating costs, direct costs and general and administrative expenses 24.242425% 75.757575%\n(1) Excludes PPDLP's 1% general partner ownership which is allocated at the Partnership level and 175 limited partner interests owned by PPDLP.\n(2) The allocation between the Partnership and Parker & Parsley 87-A Conv., L.P. is 88.19604% and 11.80396%, respectively.\nNote 7. Oil and gas information (unaudited)\nThe following table presents information relating to the Partnership's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities during the years then ended. All of the Partnership's reserves are proved and located within the United States. The Partnership's reserves are based on an evaluation prepared by the engineering staff of PPUSA and reviewed by an independent petroleum consultant, using criteria established by the Securities and Exchange Commission. Reserve value information is available to limited partners pursuant to the Partnership agreement and, therefore, is not presented. Oil (bbls) Gas (mcf) --------- --------- Net proved reserves at January 1, 1993 1,632,733 5,401,706 Revisions of estimates of January 1, 1993 (138,880) 160,286 Production (135,434) (410,709) --------- --------- Net proved reserves at December 31, 1993 1,358,419 5,151,283 Revisions of estimates of December 31, 1993 (58,830) (311,295) Production (115,931) (352,692) --------- --------- Net proved reserves at December 31, 1994 1,183,658 4,487,296 Revisions of estimates of December 31, 1994 42,523 (176,997) Sale of production in place (29,026) - Production (101,238) (365,173) --------- --------- Net proved reserves at December 31, 1995 1,095,917 3,945,126 ========= =========\nThe estimated present value of future net revenues of proved reserves, calculated using December 31, 1995 prices of $19.36 per barrel of oil and $1.81 per mcf of gas, discounted at 10% was approximately $6,062,000 and undiscounted was $10,785,000 at December 31, 1995.\nThe Partnership emphasizes that reserve estimates are inherently imprecise and, accordingly, the estimates are expected to change as future information becomes available.\nNote 8. Major customers\nThe following table reflects the major customers of the Partnership's oil and gas sales during the years ended December 31: 1995 1994 1993 ---- ---- ---- GPM Gas Corporation - 17% 15% Phibro Energy, Inc. 58% 57% 60% Western Gas Resources, Inc. 15% - -\nPPDLP is party to a long-term agreement pursuant to which PPDLP and affiliates are to sell to Phibro Energy, Inc. (\"Phibro\") substantially all crude oil (including condensate) which any of such entities has the right to market from time to time. On December 29, 1995, PPDLP and Phibro entered into a Memorandum of Agreement (\"Phibro MOA\") that cancels the prior crude oil purchase agreement between the parties and provides for adjusted terms effective December 1, 1995. The price to be paid for oil purchased under the Phibro MOA is to be competitive with prices paid by other substantial purchasers in the same area who are significant competitors of Phibro. The price to be paid for oil purchased under the Phibro MOA also includes a market-related bonus that may vary from month to month based upon spot oil prices at various commodity trade points. The term of the Phibro MOA is through June 30, 1998, and it may continue thereafter subject to termination rights afforded each party. Although Phibro was required to post a $16 million letter of credit in connection with purchases under the prior agreement, it is anticipated that this security requirement will be replaced by a $25 million payment guarantee by Phibro's parent company, Salomon Inc. Accounts receivable-oil and gas sales included $104,780 due from Phibro at December 31, 1995.\nNote 9. Contingencies\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Partnership filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ- Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Partnership and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Partnership, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest,\ndetermined the general partner's portion of the funds and calculated any inter- partnership allocations.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff partnerships, including the Partnership and others, alleging his entitlement to 12% of the settlement proceeds. Price's lawsuit claim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Partnership and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court.\nOn September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Partnership, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal of the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Partnership is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Partnership and other joint property owners for participating in the lawsuit pursuant to the joint operating agreement. Litigation settlement proceeds received by the Partnership, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993.\nA distribution of $91,000,000 was made to the working interest owners, including the Partnership, on July 30, 1993. The limited partners received their distribution of $8,257,794, or $286.62 per limited partnership interest, in September 1993. The allocation of the lawsuit settlement amount was based on the original verdict entered on October 26, 1990. The allocation to the working interest owners in each well (including the Partnership) was based on a ratio of the relative amount of damages due to overcharges for services and materials (\"Materials\") and damages for loss of past and future production (\"Production\"), each as determined in that initial judgment. Within the Partnership, damages for Materials were allocated between the partners based on their original sharing percentages for costs of acquiring and\/or drilling of wells. Similarly, damages related to Production were allocated to the partners in the Partnership based on their respective share of revenues from the subject wells (see Note 6).\nAs a condition of the purchase by Parker & Parsley Petroleum Company of Parker & Parsley Development Company (\"PPDC\"), which was merged into PPDLP on January 1, 1995 (see Note 10), from its former parent in May 1989, PPDC's interest in the lawsuit and subsequent settlement was retained by the former parent. Consequently, all of PPDC's share of the settlement related to its\nseparately held interests in the wells and its partnership interests in the sponsored partnerships (except that portion allocable to interests acquired by PPDC after May 1989) was paid to the former parent.\nNote 10. Organization and operations\nThe Partnership was organized August 20, 1987 as a limited partnership under the Texas Uniform Limited Partnership Act for the purpose of acquiring and developing oil and gas properties. The following is a brief summary of the more significant provisions of the limited partnership agreement:\nManaging general partner - On January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of the Partnership as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, and which previously served as the managing general partner of the Partnership. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Partnership, including the development drilling program in which the Partnership participates. PPDLP has the power and authority to manage, control and administer all Program and Partnership affairs. Under the limited partnership agreement, the managing general partner pays 1% of the Partnership's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Partnership's revenues.\nLimited partner liability - The maximum amount of liability of any limited partner is the total contributions of such partner plus his share of any undistributed profits.\nInitial capital contributions - The limited partners entered into subscription agreements for aggregate capital contributions of $28,811,000. PPDLP is required to contribute amounts equal to 1% of initial Partnership capital less commission and offering expenses allocated to the limited partners and to contribute amounts necessary to pay costs and expenses allocated to it under the Partnership agreement to the extent its share of revenues does not cover such costs.\nPARKER & PARSLEY 87-A, LTD.\nINDEX TO EXHIBITS\nThe following documents are incorporated by reference in response to Item 14(c):\nExhibit No. Description Page\n4(a) Certificate and Agreement of Limited - Partnership of Parker & Parsley 87-A, Ltd.\n4(b) Form of Subscription Agreement and - Power of Attorney\n4(c) Specimen Certificate of Limited - Partnership Interest\n10(a) Operating Agreement -\n10(b) Exploration and Development Program - Agreement\n99.1 Mutual Release and Indemnity Agreement dated May 25, 1993 -","section_15":""}
{"filename":"79879_1995.txt","cik":"79879","year":"1995","section_1":"ITEM 1. BUSINESS\nPPG Industries Inc., incorporated in Pennsylvania in 1883, is comprised of three basic business segments: coatings and resins, glass and chemicals. Within these business segments, PPG has followed a careful program of directing its resources of people, capital and technology in selected areas where it enjoys positions of leadership. Primary areas in which resources have been focused are automotive original, refinish, industrial and architectural coatings; flat glass, automotive original and replacement glass, aircraft transparencies, continuous-strand fiber glass, and chlor-alkali and specialty chemicals. Each of the business segments in which PPG is engaged is highly competitive. However, the broad diversification of product lines and worldwide markets served tend to minimize the impact on total sales and earnings of changes in demand for a particular product line. Reference is made to \"Business Segment Information\" on pages 26 and 27 of the Annual Report to Shareholders, which is incorporated herein by reference, for financial information relating to business segments.\nCOATINGS AND RESINS\nPPG is a major manufacturer of protective and decorative coatings. The coatings industry is highly competitive and consists of a few large firms with global presence, and many smaller firms serving local or regional markets. PPG competes in its primary markets with the world's largest coatings companies, most of which have operations in North America and Europe. Product development, innovation, quality and customer service have been stressed by PPG and have been significant factors in developing an important supplier position.\nThe coatings business involves the supply of protective and decorative finishes for automotive original equipment, appliances, industrial equipment, and packaging; factory finished aluminum extrusions and coils for architectural uses, and other industrial and consumer products. In addition to supplying finishes to the automotive original equipment market, PPG supplies automotive refinishes to the aftermarket which are primarily sold through distributors. In the automotive original and industrial portions of the coatings business, PPG sells directly to a variety of manufacturing companies. Product performance, technology, quality and customer service are major competitive factors. The automotive original and industrial coatings are formulated specifically for the customer's needs and application methods. PPG also manufactures adhesives and sealants for the automotive industry and metal pretreatments for automotive and industrial applications.\nThe architectural finishes business consists primarily of coatings used by painting and maintenance contractors and by consumers for decoration and maintenance. PPG's products are sold through independent distributors, paint dealers, mass merchandisers and home centers. Price, quality and service are key competitive factors in the architectural finishes market.\nCoatings and resins' principal production facilities are concentrated in North America and Europe. North American production facilities consist of fourteen plants in the United States, one in Canada and two in Mexico. The three largest facilities are the Cleveland, OH plant, which primarily produces automotive original coatings; the Oak Creek, WI plant, which produces automotive original and other industrial coatings; and the Delaware, OH plant, which primarily produces automotive refinishes and certain industrial coatings. Outside North America, PPG operates three plants in Spain; two plants in Italy, and one plant each in China, England, France, Germany and Portugal. These plants produce a variety of industrial coatings. PPG owns a 60 percent interest in a sales operation in Hong Kong, 50 percent interests in operations in South Korea and Japan, and minority interests in operations in Taiwan and Brazil. Additionally, coatings and resins operates ten service centers in the United States and two each in Canada and Mexico to provide just-in-time delivery and service to selected automotive assembly plants. Nineteen training centers in the United States, six in Europe, five in Asia and one in Canada are in operation. These centers provide training for automotive aftermarket refinish customers. Also, four automotive original application centers that provide testing facilities for customer paint processes and new products are in operation. The average number of persons employed by the coatings and resins segment during 1995 was 10,100.\nGLASS\nPPG is one of the major producers of flat glass, fabricated glass and continuous-strand fiber glass in the world. PPG's major markets are automotive original equipment, automotive replacement, residential and commercial construction, aircraft transparencies, the furniture, marine and electronics industries and other markets. Most glass products are sold directly to manufacturing and construction companies, although in some instances products are sold directly to independent distributors and through PPG distribution outlets. Fiber glass products are sold directly to manufacturing companies and independent distributors. PPG manufactures flat glass by the float process and fiber glass by the continuous filament process.\nThe bases for competition are price, quality, technology, cost and customer service. The Company competes with six other major producers of flat glass, six other major producers of fabricated glass and two other major producers of fiber glass throughout the world.\nPPG's principal glass production facilities are concentrated in North America and Europe. Fourteen plants\noperate in the United States, of which six produce flat glass, five produce automotive glass, two produce fiber glass products and one produces aircraft transparencies. A third plant is expected to begin producing fiber glass products in March 1996. There are three plants in Canada, two of which produce automotive glass and one produces flat glass. Four plants operate in Italy; one manufactures automotive and flat glass, one produces automotive glass, one produces flat glass, and another produces aircraft transparencies. Three plants are located in France; one plant manufactures automotive and flat glass and two plants produce automotive glass. One plant in England and one plant in the Netherlands produce fiber glass. PPG owns equity interests in operations in Canada, France, the Netherlands, the People's Republic of China, Taiwan, the United States and Venezuela and a majority interest in a glass distribution company in Japan. Additionally, glass has four satellite operations that provide limited manufacturing and just-in-time service to selected automotive customer locations. The average number of persons employed by the glass segment during 1995 was 15,700.\nCHEMICALS\nPPG is a major producer of chlor-alkali and specialty chemicals. The primary chlor-alkali products are chlorine, caustic soda, vinyl chloride monomer, chlorinated solvents and chlorinated benzenes. Most of these products are sold directly to manufacturing companies in the chemical processing, rubber and plastics, paper, minerals and metals, and water treatment industries. The primary specialty chemical products are Transitions(registered trademark) optical products; silica based compounds for the tire, shoe and battery separator businesses; surfactants for food emulsification, sugar processing and personal care products; CR-39 monomer for optical plastics; and phosgene derivatives for the pharmaceutical, herbicide and fuel additives businesses.\nPPG competes with six other major producers of chlor-alkali products. Price, product availability, product quality and customer service are the key competitive factors. In the specialty chemicals area, PPG's market share varies greatly by business; product performance and technical service are the most critical competitive factors.\nPPG's chemical production facilities consist of nine plants in North America, two plants each in Taiwan and the People's Republic of China, and one each in Australia, France, Ireland and the Netherlands. The two largest facilities, located in Lake Charles, LA and in Natrium, WV, primarily produce chlor-alkali products. PPG owns equity interests in operations in Japan, Thailand and the United States. The average number of persons employed by the chemicals segment during 1995 was 4,600.\nBUSINESS DIVESTED--BIOMEDICAL SYSTEMS DIVISION\nThe Company's Biomedical Systems Division was a manufacturer, supplier and servicer of integrated medical systems for human health care on a worldwide basis.\nA decision was made in the fourth quarter of 1993 to divest the Biomedical Systems Division. The sale of the medical electronics portion of this business was completed by the end of the third quarter of 1994. With the sale of the sensors business in January 1995, the divestiture of the Biomedical Systems Division was completed.\nRAW MATERIALS\nThe effective management of raw materials is important to PPG's continued success. The Company's most significant raw materials are sand, soda ash, energy, polyvinyl butyral and boron containing minerals in the glass segment; titanium dioxide and epoxy resins in the coatings and resins segment, and energy and ethylene in the chemicals segment. Most of the raw materials used in production are purchased from outside sources, and the Company has made, and will continue to make, supply arrangements to meet the planned operating requirements for the future. For the significant raw material requirements identified above, and other material, there is more than one source of supply.\nRESEARCH AND DEVELOPMENT\nResearch and development costs, including depreciation of research facilities, during 1995, 1994 and 1993 were $252 million, $233 million and $218 million, respectively. Research and development facilities are maintained for each business segment. Each of the facilities conducts research and development involving new and improved products and processes, and additional process and product development work is undertaken at many of the Company's manufacturing plants. PPG owns and operates eight research and development facilities in the United States and Europe.\nPATENTS\nPPG considers patent protection to be important from an overall standpoint. The Company's business segments are not materially dependent upon any single patent or group of related patents. PPG received $27 million, $25 million and $25 million from royalties and the sale of technical know-how during the years 1995, 1994 and 1993, respectively.\nBACKLOG\nIn general, PPG does not manufacture its products against a backlog of orders; production and inventory levels are geared primarily to projections of future demand and the level of incoming orders.\nNON-U.S. OPERATIONS\nAlthough PPG has a significant investment in non-U.S. operations, based upon the extent and location of investments, management believes that the risk associated with its international operations is not significantly greater than domestic operations.\nEMPLOYEES\nThe average number of persons employed worldwide by PPG during 1995 was 31,200.\nENVIRONMENTAL MATTERS\nLike other companies, PPG is subject to the existing and evolving standards relating to the protection of the environment. Capital expenditures for environmental control projects were $25 million, $19 million and $29 million in 1995, 1994 and 1993, respectively. It is expected that expenditures for such projects in 1996 will approximate $40 million with similar amounts of annual expenditures expected in the near future. Although future capital expenditures are difficult to estimate accurately because of constantly changing regulatory standards, it can be anticipated that environmental control standards will become increasingly stringent and costly.\nPPG is negotiating with various government agencies concerning 72 National Priority List (\"NPL\") and various other cleanup sites. While PPG is not generally a major contributor of wastes to these sites, each potentially responsible party or contributor may face agency assertions of joint and several liability. Generally, however, a final allocation of costs is made based on relative contributions of wastes to the site. There is a wide range of cost estimates for cleanup of these sites, due largely to uncertainties as to the nature and extent of their condition and the methods which may have to be employed for their remediation. Additionally, remediation projects have been or may be undertaken at certain of the Company's current and former plant sites. The Company has established reserves for those sites where it is probable a liability exists and the amount can be reasonably estimated. As of Dec. 31, 1995 and 1994, PPG had reserves for environmental contingencies totaling $100 million and $90 million, respectively. Charges against income for environmental remediation costs totaled $49 million in 1995, $36 million in 1994 and $23 million in 1993.\nThe Company's experience to date regarding environmental matters leads PPG to believe that it will have continuing expenditures for compliance with provisions regulating the protection of the environment and for present and future remediation efforts at waste and plant sites. However, management anticipates that such expenditures, which will occur over an extended period of time, will not result in future annual charges against income that are significantly greater than those recorded in 1995. It is possible, however, that technological, regulatory and enforcement developments, the results of environmental studies and other factors could alter this expectation. In management's opinion, the Company operates in an environmentally sound manner, is well positioned, relative to environmental matters, within the industries in which it operates and the outcome of these environmental matters will not have a material adverse effect on PPG's financial position or liquidity. See Environmental Matters in Management's Discussion and Analysis for additional information related to environmental matters.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee \"Item 1. Business\" for information on PPG's production and fabrication facilities.\nGenerally, the Company's plants are suitable and adequate for the purposes for which they are intended, and overall have sufficient capacity to conduct business in the upcoming year.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSecurities and Exchange Commission regulations require the disclosure of any environmental legal proceeding in which a governmental authority is a party and which may reasonably be expected to involve monetary sanctions in excess of $100,000. In this regard, on November 14, 1991, the Company received a penalty notice from the Louisiana Department of Environmental Quality (DEQ) proposing a penalty of $1,236,000 for alleged violations of hazardous waste regulations relating to the Company's investigation of groundwater contamination at the Company's Lake Charles, LA plant. The Company and DEQ reached a settlement of this matter which resulted in a payment by PPG of $200,000.\nSeparately, the Company has voluntarily entered into an agreement with the EPA to participate in the EPA's Toxic Substances Control Act Section 8(e) Compliance Audit Program (the \"Program\"). Under the Program the Company conducted a self-audit. On October 28, 1992, the Company submitted the first of two final reports pursuant to the Program. Based on this submission, the Company would pay $522,000 in stipulated penalties. To the Company's knowledge, the EPA has not yet reviewed the report or issued any order as a result of the report. Under the Program, the EPA has agreed that the combined potential civil penalties for both final reports of the Company will not exceed $1,000,000.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Mr. Dempsey was Senior Vice President of WMX Technologies, Inc., and Chairman of Chemical Waste Management, Inc., prior to his present position. (b) Mr. LeBoeuf was Executive Vice President, Vice President, Coatings and Resins and Vice President, Finance prior to his present position. (c) Mr. Archinaco was Vice President, Glass, Vice President, Automotive and Aircraft Products and Vice President, Automotive OEM Products prior to his present position. (d) Mr. Crane was Vice President, Human Resources prior to his present position. (e) Mr. Duncan was Group Vice President, Glass prior to his present position. (f) Dr. Heinze was Group Vice President, Chemicals of the Company and was President of the Chemicals Division of BASF (U.S.) prior to his present position. (g) Mr. Hernandez was Vice President, Finance, Vice President and Controller and Controller prior to his present position. (h) Mr. Pollock was Vice President, Coatings and Resins and Vice President, Automotive Products prior to his present position. (i) Mr. Zoghby was Vice President and General Counsel prior to his present position.\nThe executive officers of the Company are elected annually in April by the Board of Directors.\nPART II\nInformation with respect to the following Items can be found on the indicated pages of the Annual Report to Shareholders and is incorporated herein by reference.\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 information required by Item 10 regarding Directors is contained under the caption \"Election of Directors\" in the Registrant's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders (the \"Proxy Statement\") 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, which information under such caption is incorporated herein by reference.\nThe information required by Item 10 regarding Executive Officers is set forth in Part I of this report under the caption \"Executive Officers of the Registrant.\"\nThe information required by Item 405 of Regulation S-K is included under the caption \"Section 16(a) Reporting\" in the Proxy Statement which information under such caption is incorporated herein by reference.\nITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is contained under the captions \"Compensation of Executive Officers\" and \"Election of Directors--Compensation of Directors\" in the Proxy Statement which information under such captions is incorporated herein by reference.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 is contained under the caption \"Voting Securities\" in the Proxy Statement which information under such caption is incorporated herein by reference.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is contained under the caption \"Election of Directors--Other Transactions\" in the Proxy Statement which information under such caption is incorporated herein by reference.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Independent Auditors' Report (see Part II, 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":"","section_15":""}
{"filename":"813762_1995.txt","cik":"813762","year":"1995","section_1":"Item 1. Business.\nIntroduction\nAmerican Real Estate Partners, L.P. (\"AREP\") was formed in Delaware on February 17, 1987. Pursuant to an exchange offer (the \"Exchange Offer\") which was consummated on July 1, 1987, AREP acquired the real estate and other assets, subject to the liabilities, of thirteen limited partnerships (the \"Predecessor Partnerships\"). The Predecessor Partnerships acquired such assets between 1972 and 1985. A registration statement on Form S-4 relating to the Exchange Offer (Registration No. 33-13943) was filed with the Securities and Exchange Commission (the \"SEC\") and declared effective May 18, 1987.\nAREP's general partner is American Property Investors, Inc. (the \"General Partner\"), a Delaware corporation which is wholly owned by Carl C. Icahn (\"Icahn\"). The General Partner's principal business address is 100 South Bedford Road, Mt. Kisco, New York 10549, and its telephone number is (914) 242-7700. AREP's business is conducted through a subsidiary limited partnership, American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), in which AREP owns a 99% limited partnership interest. The General Partner also acts as the general partner for the Subsidiary. The General Partner has a 1% general partnership interest in each of AREP and the Subsidiary. References to AREP herein include the Subsidiary, unless the context otherwise requires.\nOn March 30, 1995, AREP completed a rights offering (the \"Rights Offering\"), pursuant to which it raised approximately $107,600,000, net of related expenses. In addition, in connection therewith the General Partner contributed $2,206,242 in accordance with the terms of the Partnership's Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\"). Pursuant to the terms of the Rights Offering, holders of depositary units representing limited partner interests (the \"Depositary Units\") on the record date received one transferable subscription right (each a \"Right\") for each seven Depositary Units held. Each Right was exercisable for a combination of securities consisting of six Depositary Units and one 5% cumulative pay-in-kind redeemable preferred unit representing a limited partner interest (the \"Preferred Units\"). High Coast Limited Partnership, a Delaware limited partnership which is controlled by Icahn, acted as guarantor of the offering (the \"Guarantor\"). The Guarantor exercised certain subscription rights and an over-subscription privilege pursuant to which it acquired a total of 10,324,128 additional Depositary Units and 1,720,688 Preferred Units; as a result, the Rights Offering was fully subscribed. 1,975,640 Rights were issued in the offering, of which 418,307 were exercised. 190,554 Depositary Units and 31,759 Preferred Units were subscribed for through the exercise of the Over-Subscription Privilege by Rights Holders other than the Guarantor. As of March 20, 1996, Icahn, through the Guarantor, beneficially owned approximately 50.6% of the Depositary Units then outstanding and approximately 88.2% of the Preferred Units then outstanding, giving effect to the Rights Offering. A registration statement on Form S-3 relating to the Rights Offering (Registration No. 33-54767) was filed with the SEC and declared effective February 23, 1995. See \"Business -- Rights Offering\" and Item 12 -- \"Security Ownership of Certain Beneficial Owners and Management.\"\nI-1 Description of Business\nAREP is in the business of acquiring and managing real estate and activities related thereto. Such acquisitions may be accomplished by purchasing assets outright or by acquiring securities of entities which hold significant real estate related assets. Historically, the properties owned by AREP have been primarily office, retail, industrial, residential and hotel properties. Most of the real estate assets currently owned by AREP were acquired from the Predecessor Partnerships and such assets generally are net-leased to single, corporate tenants. As of March 7, 1996, AREP owned 238 separate real estate assets primarily consisting of fee and leasehold interests in 35 states. As discussed below, AREP is seeking to make new investments to take advantage of investment opportunities it believes exist in the real estate market to further diversify its portfolio and to mitigate against lease expirations.\nFor each of the years ended December 31, 1995, 1994 and 1993, no single real estate asset or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of AREP. However, at December 31, 1995, 1994 and 1993, Portland General Electric Company (\"PGEC\") occupied a property (the \"PGEC Property\") which represented more than 10% of AREP's total real estate assets. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of March 7, 1996, AREP owned 238 separate real estate assets (primarily consisting of fee and leasehold interests and, to a limited extent, interests in real estate mortgages) in 35 states. These properties are generally net-leased to single corporate tenants. Approximately\nI-14 97% of AREP's properties are currently net-leased. See Note 8 to the Financial Statements contained herein for information on mortgages payable.\nThe following table summarizes the type, number per type and average net effective rent per square foot of AREP's properties:\n- -------------- (1) Based on net-lease rentals.\nThe following table summarizes the number of AREP's properties in each region specified below:\nFrom January 1, 1995 through March 7, 1996, AREP sold or otherwise disposed of 15 properties. In connection with such sales and dispositions, AREP received an aggregate of approximately $21,000,000 in cash, net of amounts utilized to satisfy mortgage indebtedness which encumbered such properties. As of December 31, 1995, AREP owned seven properties that were being actively marketed for sale. The aggregate net realizable value of such properties is estimated to be approximately $1,983,000.\nI-15 On February 1, 1995, the Penske Corp. exercised its purchase option on three properties leased from AREP, two located in New Jersey and one located in New York. The selling price was approximately $4,535,000 and a gain of approximately $1,003,000 was recognized in the year ended December 31, 1995. Each property was encumbered by first and second mortgages which totalled approximately $1,152,000 and which were paid from the sales proceeds.\nOn March 24, 1995, AREP sold a property located in Taylor, Michigan which is tenanted by Pace Membership Warehouse, Inc. The sales price was $9,300,000 and a gain of approximately $3,307,000 was recognized in the year ended December 31, 1995. The property was encumbered by a nonrecourse mortgage payable of approximately $4,346,000, which the purchaser assumed.\nOn May 18, 1995, AREP purchased approximately 248 acres of partially improved land located in Armonk, New York. The purchase price was approximately $3,044,000. AREP intends to construct approximately 45 to 50 single-family detached luxury homes subject to subdivision and other required approvals. No material development costs have yet been incurred.\nOn June 28, 1995, General Signal Technology Corporation, a tenant of a property located in Andover, Massachusetts, exercised its rights under the lease to purchase the property. The selling price was approximately $19,808,000, and a loss of approximately $125,000 was recognized in the year ended December 31, 1995. The property was encumbered by two nonrecourse mortgages payable, which totalled approximately $10,670,000 and were paid from the sales proceeds.\nFor each of the years ended December 31, 1995, 1994 and 1993, no single real estate asset or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of AREP. However, at December 31, 1995, 1994 and 1993, PGEC occupied a property, which represented more than 10% of AREP's total real estate assets. PGEC is an electric utility engaged in the generation, purchase, transmission, distribution and sale of electricity, whose shares are traded on the NYSE.\nThe PGEC Property is an office complex consisting of three buildings containing an aggregate of approximately 803,000 square feet on an approximate 2.7 acre parcel of land located in Portland, Oregon. A Predecessor Partnership originally purchased the PGEC Property on September 11, 1978 for a price of approximately $57,143,000.\nThe PGEC Property is subject to two underlying mortgages, which in the aggregate as of December 31, 1995, had an outstanding principal balance of $35,534,172. The first mortgage bears interest at 8.5% per annum, provides for aggregate annual debt service of $2,856,960 and matures on October 1, 2002, at which time a balloon payment of $19,304,091 will be due and payable. By its terms, this mortgage is prepayable at any time subject to certain restrictions. The second mortgage bears interest at 10% per annum, provides for interest-only payments during its term (an aggregate of $1,000,000 per annum) and matures in October 1996, at which time a balloon payment of $10,000,000 will be due and payable. By its terms, this second\nI-16 mortgage was not prepayable until September 1989, and then only with a 6% penalty, which penalty decreases by .5% each year thereafter.\nThe PGEC Property is net-leased to a wholly owned subsidiary of PGEC for forty years, with two ten-year and one five-year renewal options. The annual rental is $5,137,309 until 2003, $4,973,098 until 2018 and $2,486,549 during each renewal option. PGEC has guaranteed the performance of its subsidiary's obligations under the lease. The lessee has an option to purchase the PGEC Property in September of 2003, 2008, 2013 and 2018 at a price equal to the fair market value of the PGEC Property determined in accordance with the lease and is required to make a rejectable offer to purchase the PGEC Property in September 2018 for a price of $15,000,000. A rejection of such offer will have no effect on the lease obligations or the renewal and purchase options.\nIn June 1994, AREP entered into two joint ventures with unaffiliated co-venturers for the purpose of developing luxury garden apartment complexes. See Item 1 -- \"Business -- Recent Acquisitions\" above.\nAREP's most significant acquisition in 1993 was the purchase of two non-performing mortgage loans for a combined price of $13,000,000. AREP foreclosed on these loans in 1993 and 1994, and now holds title to the underlying properties. On July 25, 1994, AREP obtained financing on these two properties. See Item 1 -- \"Business -- Financing Activities.\"\nAREP is continuing to seek opportunities to refinance upon favorable terms and sell certain of its properties to generate proceeds for future investments, in addition to the proceeds from the Rights Offering. In the current real estate environment, management continues to seek to improve the long-term value of AREP's portfolio by, among other means, using its available cash and reinvesting capital transaction proceeds to maximize capital appreciation and diversification of the portfolio. AREP believes that the continuing weakness in the real estate market presents opportunities to acquire significantly undervalued properties, including commercial properties, residential development projects, land parcels for the future development of residential and commercial properties, non-performing loans and securities of entities which own, manage or develop significant real estate assets, including limited partnership units and securities issued by real estate investment trusts, which will enhance AREP's portfolio and its return on investments. In selecting investments, AREP intends to focus on assets that it believes are undervalued in the current real estate market, such as development properties, non-performing loans and securities of companies with significant real estate assets, which the General Partner believes have the potential to diversify and enhance the long-term value of AREP's portfolio. AREP also may acquire real estate operating and development companies which may enhance its ability to develop and manage properties it acquires as well as its ability to reduce the operating expenses related to investments which require active management. The cash flow generated by an asset will be a consideration, but AREP may acquire assets that are not generating positive cash flow. While this may impact cash flow in the near term and there can be no assurance that any asset acquired by AREP will increase in value or generate positive cash flow, management intends to focus on assets that it believes may provide opportunities for long-term growth and diversification of its portfolio.\nI-17 Item 3.","section_3":"Item 3. Legal Proceedings.\nUnitholder Litigation\nIn August 1994, three class action complaints against AREP were filed with the Delaware Court of Chancery, New Castle County, in connection with the Rights Offering, Allan Haymes, I.R.A. v. American Real Estate Partners, L.P., American Property Investors, Inc. and Carl C. Icahn and Steven Yavers v. American Real Estate Partners, L.P., American Property Investors, Inc. and Carl C. Icahn and Wilbert Schoomer v. American Real Estate Partners, L.P., American Property Investors, Inc. and Carl C. Icahn (the \"Complaints\"). The Complaints were consolidated. The Complaints claimed defendants breached fiduciary and common law duties owed to plaintiffs and plaintiffs' class by self dealing and failing to disclose all relevant facts regarding the Rights Offering, and sought declaratory and injunctive relief declaring the action was properly maintainable as a class action, declaring the defendants breached their fiduciary and other duties, enjoining the Rights Offering, ordering defendants to account for all damages suffered by the class for alleged acts and transactions and awarding further relief as the court deemed appropriate. On April 7, 1995, defendants moved to dismiss the consolidated complaint as moot. Only July 28, 1995, the parties submitted a stipulation of dismissal agreeing to dismiss the action as moot. The plaintiffs have reserved their right to make application to the Court for fees and expenses. On August 3, 1995, the Court signed an order dismissing the plaintiffs' claims with prejudice as moot. The Court retained jurisdiction with respect to any application filed by the plaintiffs for fees and expenses.\nDefaulted Mortgage Receivable\nAs of December 31, 1995, AREP held a mortgage note receivable in the principal amount of approximately $97,000 which is in default. The mortgage encumbers one property together with a collateral assignment of ground lease and rent. The property is tenanted by Gino's. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of this property. The tenant remained current in its lease obligations. See Note 14 to the Financial Statements contained herein.\nProperty Litigation\nSimultaneously with the acquisition of property in East Syracuse, New York, AREP entered into a general construction contract (the \"GC Agreement\") pursuant to which the seller was required to construct the property for a guaranteed maximum amount of $2,327,802. However, the construction of the BJ's Warehouse Store was subject to delays and the seller did not meet all of its construction obligations under the GC Agreement and failed to cure such defaults. AREP sent a notice, dated February 19, 1993, terminating the GC Agreement. AREP contacted the surety of the GC Agreement to make a claim pursuant to the terms of the surety bond but was unsuccessful. AREP has determined at this point that it will not pursue any potential claims that it may have against the surety, because after due inquiry, it believes that such claims will not be able to be satisfied. Additionally, in connection with certain alleged\nI-18 agreements between related entities and principals of the seller, and a brokerage company, the broker filed an action for a commission in the amount of $250,000 plus additional damages of $500,000. AREP served an answer denying any liability and served a cross-claim on the seller and its principals, based upon representations in the contract of sale that no commissions were due to this broker. AREP did not agree to assume the obligation to pay such commission and is defending such action; discovery is proceeding in the matter. Furthermore, another broker has instituted an action against AREP and certain other co-defendants regarding a $224,500 brokerage claim with respect to such property, as well as punitive damages of $1,000,000; this action was settled in January 1995 with dismissal of the action with prejudice and with a reservation of AREP's rights against its co-defendants.\nEnvironmental Litigation\nOn September 16, 1991, AREP brought suit against Alco Standard Corporation and its affiliates, a former tenant of an industrial facility located in Rome, Georgia whose lease expired in October 1990. The action was brought against the defendants in the United States District Court for the Northern District of Georgia, Rome Division, for reimbursement of costs that could be incurred for clean-up of hazardous materials on the site and certain deferred maintenance. In July 1994, this litigation was settled and the property was sold for $525,000. A gain of approximately $100,000 was recognized in the year ended December 31, 1994. In addition, Alco reimbursed AREP for $150,000 of expenses incurred and indemnified AREP against any future liability in connection with any site contamination.\nLockheed, a tenant of AREP's leasehold property in Palo Alto, California, has entered into a consent decree with the California Department of Toxic Substances (\"CDTS\") to undertake certain environmental remediation at this property. Lockheed has estimated that the environmental remediation costs may be up to approximately $14,000,000. In a non-binding determination by CDTS, Lockheed was found responsible for approximately 75% of such costs and the balance was allocated to other parties. AREP was allocated no responsibility for any such costs.\nLockheed has served a notice that it may exercise its statutory right to have its liability reassessed in a binding arbitration proceeding. In this notice of arbitration, Lockheed stated that it will attempt to have allocated to AREP and to AREP's ground-lessor (which may claim a right of indemnity against AREP) approximately 9% and 17%, respectively, of the total remediation costs. AREP believes that it has no liability for any of such costs and, in any proceeding in which such liability is asserted against AREP, AREP intends to contest such liability vigorously. In the event any of such liability is allocated to AREP, AREP intends to seek indemnification for any such liability from Lockheed in accordance with its lease. In April 1995 Lockheed began ground water remediation at the leasehold property.\nOn December 11, 1995, Panos Sklavenitis commenced an action against the Subsidiary and others related to a shopping center that he purchased from a successor-in-interest to AREP. The action was brought in the United States District Court for the Central District of California, for reimbursement of the cost of remediating certain environmental contamination that appears\nI-19 to have been caused by a dry cleaner that was a tenant at the property; the amount of damages sought have not yet been quantified. Mr. Sklavenitis is suing the parties who are in the chain of ownership, as well as the dry cleaner and its predecessor. AREP believes that it has no liability for any such costs and intends to vigorously contest the action. In the event any liability under the suit is allocated to AREP, AREP will seek indemnification for such monies from Federated Department Stores, Inc., Ralph's Grocery Company and Los Coyotes Associates and the other owners in the chain of title.\nBankruptcies\nAREP is aware that 14 of its present and former tenants have been or are currently involved in some type of bankruptcy or reorganization. Of AREP's 14 present and former tenants involved in bankruptcy proceedings or reorganization, nine have rejected their leases, affecting 28 properties, all of which have been vacated. See also Notes 7, 14 and 18 to the Financial Statements contained herein and \"Business - Bankruptcies and Defaults\" which describe various tenant and mortgagor bankruptcies for which AREP has filed claims.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nI-20 PART II\nItem 5.","section_5":"Item 5. Market for AREP's Common Equity and Related Security Holder Matters.\nMarket Information\nAREP's Depositary Units are traded on the NYSE under the symbol \"ACP.\" Trading on the NYSE commenced July 23, 1987, and the range of high and low market prices for the Depositary Units on the New York Stock Exchange Composite Tape (as reported by The Wall Street Journal) from January 1, 1994 through December 31, 1995 is as follows:\nOn March 20, 1996, the last sales price of the Depositary Units, as reported by the New York Stock Exchange Composite Tape (as reported by The Wall Street Journal) was $8.875.\nAs of March 20, 1996, there were approximately 22,000 record holders of the Depositary Units.\nSince January 1, 1994, AREP has made no cash distributions with respect to the Depositary Units.\nDistributions\nAfter evaluating the contingencies facing AREP, its anticipated cash flows, liquidity needs, maturing debt obligations and capital expenditure requirements, the Board of Directors of the General Partner reduced the quarterly distributions in 1993 from $.25 to $.125 per quarter. This reduction permitted management to continue to establish reserves for AREP's maturing debt obligations and other contingencies. In 1994 the General Partner determined that it was necessary for AREP to conserve cash and increase reserves from time to time in order to meet capital expenditures and maturing debt obligations and no distributions were made to Unitholders in 1994 or 1995.\nOn December 4, 1995, the Board of Directors of the General Partner announced that no distribution for the fiscal quarter ended December 31, 1995 would be made and that no\nII-1 distributions are expected to be made in 1996. In making its announcement, AREP noted it plans to continue to apply available Partnership operating cash flow toward its operations, repayment of maturing indebtedness, tenant requirements and other capital expenditures and creation of cash reserves for Partnership contingencies, including environmental matters and scheduled lease expirations. As previously reported, by the end of the year 2000, net leases representing approximately 26% of AREP's net annual rentals from its portfolio will be due for renewal, and by the end of the year 2002, 40% of such rentals will be due for renewal. Another factor that AREP took into consideration was that net leases representing approximately 30% of AREP's net annual rentals from its portfolio are with tenants in the retail sector, some of which are currently experiencing cash flow difficulties and restructurings. In addition, AREP noted that net operating cash flow in 1995 was break-even, after payment of approximately $23,900,000 of periodic principal payments and maturing debt obligations, including an $11.3 million principal payment made in May 1995 on its Senior Unsecured Debt, capital expenditures and the creation of cash reserves for its obligations. In making its announcement, AREP stated that it expects to reconsider distribution issues for 1997. See Item 7 -- \"Management's Discussion and Analysis of the Financial Condition and Results of Operations -- Capital Resources and Liquidity.\" A substantial portion of the proceeds from the Rights Offering and its available cash will be used to fund the acquisition of additional properties by AREP, which the General Partner believes have the potential to diversify and enhance the long-term value of AREP's investment portfolio.\nPursuant to the terms of the Preferred Units, on April 1, 1996, AREP will distribute to holders of record of Preferred Units as of March 15, 1996, additional Preferred Units at the rate of $.50 per Preferred Unit (which is equal to a rate of 5% of the liquidation preference thereof). The total number of additional Preferred Units anticipated to be distributed by AREP on April 1, 1996 is approximately 98,782.\nEach Depositary Unitholder will be taxed on the Unitholder's allocable share of AREP's taxable income and gains and, with respect to Preferred Unitholders, accrued guaranteed payments, whether or not any cash is distributed to the Unitholder.\nRepurchase of Depositary Units\nAREP announced in 1987 its intention to purchase up to 1,000,000 Depositary Units. On June 16, 1993, AREP increased the amount of shares authorized to be repurchased to 1,250,000 Depositary Units. As of March 8, 1996, AREP had purchased 1,037,200 Depositary Units at an aggregate cost of approximately $11,184,000. Management has not been acquiring Depositary Units for AREP, although AREP may from time to time acquire additional Depositary Units. Under the terms of the Note Agreements for the Senior Unsecured Debt, distributions and the amounts used to repurchase Depositary Units cannot exceed net cash flow, as defined therein, plus $15,000,000. See Item 7 -- \"Management's Discussion and Analysis of the Financial Condition and Results of Operations -- Capital Resources and Liquidity.\" To date this restriction has not impaired the ability of AREP to make distributions.\nII-2\nItem 6.","section_6":"Item 6. Selected Financial Data.\n* To the extent financial information pertaining to AREP is reflected, such information is consolidated for AREP and its Subsidiary.\nII-3 Item 7.","section_7":"Item 7. Management's Discussion and Analysis of the Financial Condition and Results of Operations.\nGeneral\nHistorically, substantially all of AREP's real estate assets have been net-leased to single corporate tenants under long-term leases. With certain exceptions, these tenants are required to pay all expenses relating to the leased property and therefore AREP is not typically responsible for payment of expenses, such as maintenance, utilities, taxes and insurance associated with such properties. AREP has experienced an increase in its property expenses in recent years, due principally to tenant bankruptcies and defaults as well as the acquisition of operating properties, although such expenses decreased in 1995 in comparison to 1994 as discussed below under \"-Results of Operations\".\nEconomic conditions in recent years led the General Partner to reexamine from time to time AREP's cash needs and investment opportunities. Tenant defaults and lease expirations caused rental revenues to decrease and property management and certain operating expenses to increase and led to expenditures to re-let. In addition, the availability of acceptable financing to refinance maturing debt obligations including AREP's Senior Unsecured Debt became increasingly scarce. Consequently, the General Partner determined it was necessary to conserve cash and establish reserves from time to time. As a result, there was insufficient cash flow from operations to pay distributions to unitholders and such distributions were reduced and finally suspended. As discussed below, AREP's investment strategy is to apply its capital transaction proceeds and Rights Offering proceeds, including interest earned thereon, toward its investment purposes.\nBy the end of the year 2000, net leases representing approximately 26% of AREP's net annual rentals from its portfolio will be due for renewal, and by the end of the year 2002, net leases representing approximately 40% of AREP's net annual rentals will be due for renewal. Since most of AREP's properties are net-leased to single, corporate tenants, it is expected that it may be difficult and time-consuming to re-lease or sell those properties that existing tenants decline to re-let or purchase and AREP may be required to incur expenditures to renovate such properties for new tenants. In addition, AREP may become responsible for the payment of certain operating expenses, including maintenance, utilities, taxes, insurance and environmental compliance costs associated with such properties, which are presently the responsibility of the tenant. As a result, AREP could experience an adverse impact on net cash flow from such properties.\nAs a consequence of the foregoing, AREP decided to raise funds through the Rights Offering to increase its assets available for investment, take advantage of real estate investment opportunities, further diversify its portfolio and mitigate against the impact of potential lease expirations. The Rights Offering was successfully completed during April 1995 and net proceeds of approximately $107.6 million were raised for investment purposes. In order to enhance AREP's investment portfolio (and ultimately its asset values and cash flow prospects), AREP is seeking to acquire investments in undervalued properties, including commercial properties, residential development projects, land parcels for the future development of\nII-4 residential and commercial properties, non-performing loans and securities of entities which own, manage or develop significant real estate assets, including limited partnership units and securities issued by real estate investment trusts. Such assets may not be generating positive cash flow in the near term; however, the General Partner believes that the acquisition of properties requiring some degree of management or development activity have the greatest potential for growth, both in terms of capital appreciation and the generation of cash flow. These types of investments may involve debt restructuring, capital improvements and active asset management and by their nature as under-performing assets may not be readily financeable. As such, they require AREP to maintain a strong capital base.\nExpenses relating to environmental clean-up have not had a material effect on the earnings, capital expenditures, or competitive position of AREP. Management believes that substantially all such costs would be the responsibility of the tenants pursuant to lease terms. While most tenants have assumed responsibility for the environmental conditions existing on their leased property, there can be no assurance that AREP will not be deemed to be a responsible party or that the tenant will bear the costs of remediation. Also, as AREP acquires more operating properties, its exposure to environmental clean-up costs may increase. AREP completed Phase I Environmental Site Assessments of certain of its properties by third-party consultants. Based on the results of these Phase I Environmental Site Assessments, the environmental consultant has recommended that limited Phase II Environmental Site Investigations be conducted. AREP has notified each of the tenants of the respective sites of the environmental consultant's findings. If such tenants do not arrange for further investigations, or remediations, if required, AREP may determine to undertake the same at its own cost. If the tenants fail to perform responsibilities under their leases referred to above, based solely upon the consultant's estimates resulting from its Phase I Environmental Site Assessments referred to above, it is presently estimated that AREP's exposure could amount to $3-4 million, however, as no Phase II Environmental Site Assessments have been conducted by the consultants, there can be no accurate estimation of the need for or extent of any required remediation, or the costs thereof. In addition, AREP is planning Phase I Environmental Site Assessments for approximately 100 more net leased properties during 1996 and 1997. Phase I Environmental Site Assessments will also be performed in connection with new acquisitions and with such property refinancings as AREP may deem necessary and appropriate.\nResults of Operations\nCalendar Year 1995 Compared to Calendar Year 1994. Gross revenues increased by approximately $8,370,000, or 13.6%, during calendar year 1995 as compared to calendar year 1994. This increase reflects approximate increases of $6,715,000, or 466.8%, in other interest income, $2,655,000 in other income, $980,000, or 11.1%, in hotel operating income, and $558,000, or 2.9%, in rental income, partially offset by a decrease of approximately $2,538,000, or 7.9%, in financing lease income. The increase in other interest income is primarily due to an increase in AREP's short-term cash investments as a result of the Rights Offering proceeds and the investment in the Facility Agreement. The increase in other income is primarily due to the settlement of the Chipwich and Be-Mac bankruptcy claims. The hotel operating revenues were generated by two hotels formerly leased to Integra. AREP has been\nII-5 operating these hotel properties through a third-party management company since August 7, 1992. The increase in rental income is primarily due to increased rents at the two apartment complexes in Lexington, Kentucky and the new apartment complex in Alabama, partially offset by the loss of rents due to property sales. The decrease in financing lease income is primarily attributable to normal lease amortization and property sales.\nExpenses decreased by approximately $2,886,000, or 6.9%, during calendar year 1995 compared to calendar year 1994. This decrease reflects decreases of approximately $3,122,000, or 13.7%, in interest expense, $586,000, or 13.3%, in property expenses and $185,000, or 6.7%, in general and administrative expenses, partially offset by increases of approximately $630,000, or 8.9%, in hotel operating expenses and $377,000, or 7.6%, in depreciation and amortization expense.\nThe decrease in interest expense is primarily attributable to normal loan amortization and reductions due to repayments of maturing balloon debt obligations, including the Senior Unsecured Debt, certain loan refinancings, as well as the sale of encumbered properties. The decrease in property expenses is primarily attributable to decreases in certain operating property expenses and environmental review expenses. The hotel expenses were generated from the hotels mentioned previously.\nEarnings before property transactions increased during the calendar year 1995 by approximately $11,256,000, or 57.5%, from calendar year 1994 primarily due to increased interest income earned on the Rights Offering proceeds, other income from the settlement of bankruptcy claims and decreased interest expense due to refinancings and repayments of maturing debt obligations, partially offset by a decrease in financing lease income.\nGain on property transactions increased by approximately $918,000 during the calendar year 1995 as compared to calendar year 1994, due to differences in the size and number of transactions.\nDuring calendar year 1995, AREP recorded a provision for loss on real estate of approximately $769,000 as compared to $582,000 in 1994.\nNet earnings for the calendar year 1995 increased by approximately $11,987,000, or 51.7%, as compared to net earnings for the calendar year 1994. This increase was primarily attributable to the increase in other interest income, other income from the settlement of bankruptcy claims and decreased interest expense, partially offset by a decrease in financing lease income.\nCalendar Year 1994 Compared to Calendar Year 1993. Gross revenues increased by approximately $1,394,000, or 2.3%, during calendar year 1994 as compared to calendar year 1993. This increase reflects approximate increases of $3,393,000, or 21.6%, in rental income and $405,000, or 4.8%, in hotel operating income, partially offset by decreases of approximately $861,000, or 2.6%, in financing lease income, $571,000, or 28.4%, in other interest income, and $972,000, or 84.1%, in other income. The increase in rental income is primarily attributable to the two apartment complexes in Lexington, Kentucky acquired in 1993, increases\nII-6 in rents from a property formerly occupied by Amdura and rents received from BJ's Warehouse Store. The hotel operating revenues were generated by two hotels formerly leased to Integra. AREP has been operating these hotel properties through a third-party management company since August 7, 1992. The decrease in financing lease income is primarily attributable to normal amortization of financing leases partially offset by increased income from the Toy's \"R\" Us properties reacquired as a result of foreclosure on defaulted purchase money mortgages. The decrease in other interest income is primarily attributable to less interest received on defaulted purchase money mortgages and payments of balloon balances due. The decrease in other income related primarily to the settlement of the Days Inn bankruptcy claim, most of which was recognized in 1993.\nExpenses increased by approximately $196,000, or .5%, during calendar year 1994 compared to calendar year 1993. This increase reflects increases of approximately $1,833,000, or 71.1%, in property expenses, $600,000, or 13.8%, in depreciation and amortization and $336,000, or 13.7%, in general and administrative expenses, offset by decreases of approximately $2,392,000, or 9.5%, in interest expense and $181,000, or 2.5%, in hotel operating expenses. The increase in property expenses is primarily attributable to costs associated with the newly acquired operating properties mentioned previously, as well as the former Days Inn and Amdura properties now operated by the Company. The decrease in interest expense is primarily attributable to normal loan amortization and reductions due to certain loan refinancings and the repayments of maturing balloon debt obligations, including the Senior Unsecured Debt.\nEarnings before property transactions increased during the calendar year 1994 by approximately $1,198,000, or 6.5%, from calendar year 1993.\nGain on property transactions decreased by approximately $586,000 during the calendar year 1994 as compared to calendar year 1993, due to differences in the size and number of transactions.\nDuring calendar year 1994, AREP recorded a provision for loss on real estate of $582,000 as compared to $462,000 in 1993.\nNet earnings for the calendar year 1994 increased by approximately $492,000, or 2.2%, as compared to net earnings for the calendar year 1993. This increase is attributable to the approximate $1,198,000 increase in earnings before property transactions, offset by the decrease in gain on sales of real estate and the increase in provision for loss on real estate.\nCapital Resources and Liquidity\nGenerally, the cash needs of AREP for day-to-day operations have been satisfied from cash flow generated from current operations. In recent years, AREP has applied a larger portion of its cash flow to the repayment of maturing debt obligations. Cash flow from day-to-day operations represents net cash provided by operating activities (excluding working capital changes and non-recurring other income) plus principal payments received on financing leases\nII-7 as well as principal receipts on mortgages receivable reduced by periodic principal payments on mortgage debt.\nAREP may not be able to re-let certain of its properties at current rentals. As previously discussed, net leases representing approximately 40% of AREP's net annual rentals will be due for renewal by the end of the year 2002. In 1995, seventeen leases covering twenty-six properties and representing approximately $996,000 in annual rentals expired. Sixteen of these twenty-six properties originally representing approximately $653,000 in annual rental income have been or will be re-let or renewed for approximately $662,000 in annual rentals. Three properties, with an approximate annual rental income of $137,000, are currently being marketed for sale or lease. Seven properties with annual rentals of approximately $206,000 were sold in 1995.\nIn 1996, 22 leases covering 22 properties and representing approximately $2,413,000 in annual rentals are scheduled to expire. Seven of these 22 leases originally representing approximately $1,102,000 in annual rental income have been or will be re-let or renewed for approximately $1,109,000 in annual rentals. Such renewals are generally for a term of five years. Six leases, with an approximate annual rental income of $822,000, will be marketed for sale or lease when the current lease terms expire. Tenants occupying two of the properties with approximate annual rental income of $358,000 have elected to exercise their purchase options and the renewal status of the remaining seven properties representing approximately $131,000 in annual rental income is uncertain as of the date hereof.\nAfter evaluating the contingencies facing AREP, its anticipated cash flows, liquidity needs, maturing debt obligations and capital expenditure requirements, the Board of Directors of the General Partner reduced the quarterly distributions in 1993 from $.25 to $.125 per quarter. This reduction permitted management to continue to establish reserves for AREP's maturing debt obligations and other contingencies. In 1994 the General Partner determined that it was necessary for AREP to conserve cash and increase reserves from time to time in order to meet capital expenditures and maturing debt obligations and no distributions were made to Unitholders in 1994 or 1995.\nOn December 4, 1995, the Board of Directors of the General Partner announced that no distribution for the fiscal quarter ended December 31, 1995 would be made and that no distributions on its Depositary Units are expected to be made in 1996. In making its announcement, AREP noted it plans to continue to apply available Partnership operating cash flow toward its operations, repayment of maturing indebtedness, tenant requirements and other capital expenditures and creation of cash reserves for Partnership contingencies including environmental matters and scheduled lease expirations. As previously reported, by the end of the year 2000, net leases representing approximately 26% of AREP's net annual rentals will be due for renewal, and by the end of the year 2002, 40% of such rentals will be due for renewal. Another factor that AREP took into consideration was that net leases representing approximately 30% of AREP's annual rentals from its portfolio are with tenants in the retail sector, some of which are currently experiencing cash flow difficulties and restructurings. In addition, AREP noted that net operating cash flow in 1995 was break-even, after payment of approximately $23,900,000 of periodic principal payments and maturing debt obligations, including an $11.3\nII-8 million principal payment made in May 1995 on its Senior Unsecured Debt, capital expenditures and the creation of cash reserves for its obligations. In making its announcement, AREP stated that it expects to reconsider distribution issues for 1997.\nThere were no distributions due to Unitholders for the year ended December 31, 1995. Distributions paid during December 31, 1995 totalled approximately $105,000, representing distributions due to Unitholders who exchanged their limited partner interests during 1995. There were no distributions due to Unitholders for the year ended December 31, 1994. Distributions paid during 1994 totalled approximately $1.9 million, representing distributions due to Unitholders for the fourth quarter of 1993 and to Unitholders who exchanged their limited partner interests during 1994. Distributions due to Unitholders for the year ended December 31, 1993 were approximately $7,100,000. Distributions paid during 1993 totalled approximately $9,300,000, representing distributions due to Unitholders for the fourth quarter of 1992, the first three quarters of 1993 and to Unitholders who exchanged their limited partner interests during 1993.\nDuring the year ended December 31, 1995, AREP generated approximately $26,900,000 in cash flow from day-to-day operations which excludes approximately $4.6 million in interest earned on the Rights Offering proceeds which will be retained for future acquisitions. In addition, approximately $2.8 million of non-recurring income, including approximately $2 million from the Chipwich bankruptcy settlement, was recorded. During 1994, AREP generated approximately $22,000,000 in cash flow from day-to-day operations and approximately $200,000 from the Days Inn bankruptcy settlement.\nCapital expenditures for real estate, excluding new acquisitions, were approximately $2,100,000 during 1995. During 1994, such expenditures totalled approximately $2,300,000. During 1993, such expenditures totalled approximately $2,500,000.\nDuring 1995, approximately $14.9 million of balloon mortgages were repaid out of AREP's cash flow, including the scheduled payment due on AREP's Senior Unsecured Debt. During 1994, approximately $16.7 million of balloon mortgages were repaid out of the AREP's cash flow, including the scheduled payment due on the AREP's Senior Unsecured Debt. In addition to payments due under AREP's Senior Unsecured Debt, approximately $19,000,000 and $5,500,000 of maturing balloon mortgages are due in 1996 and 1997, respectively, and during the period 1998 through 1999 approximately $12,000,000 in maturing mortgages come due. AREP will seek to refinance a portion of these maturing mortgages, although it does not expect to be able to refinance all of them and may be required to repay them from cash flow and increase reserves from time to time, thereby reducing cash flow otherwise available for other uses.\nDuring 1995, net cash flow after payment of maturing debt obligations and capital expenditures but before creation of cash reserves was approximately $10 million, excluding non-recurring income and interest earned on the Rights Offering proceeds which will be retained for acquisitions. After the creation of such reserves net cash flow for 1995 was approximately break-even. AREP's operating cash reserves are approximately $23 million at December 31, 1995 which are being retained to meet maturing debt obligations, capitalized expenditures for\nII-9 real estate and certain contingencies facing AREP. AREP from time to time may increase its cash reserves to meet its maturing debt obligations, tenant requirements and other capital expenditures and to guard against scheduled lease expirations and other contingencies including environmental matters. Rights Offering proceeds and related interest income are being retained for investment in undervalued assets including commercial properties, residential development projects, land parcels for the development of residential and commercial properties, non-performing loans and securities of entities which own, manage or develop significant real estate assets, including limited partnership units and securities issued by real estate investment trusts. In addition to using its available cash to make these types of investments, AREP intends to sell some of its existing portfolio properties and use such proceeds to reinvest in such undervalued assets. These types of investments may involve debt restructuring, capital improvements and active asset management and by their nature as underperforming assets may not be readily financeable and may not generate immediate positive cash flow. As such, they require AREP to maintain a strong capital base both to react quickly to these market opportunities as well as to allow AREP to rework the assets to enhance their turnaround performance.\nAREP also has significant maturing debt requirements under the Note Agreements. As of December 31, 1995, AREP has $33,923,329 of Senior Unsecured Debt outstanding. Pursuant to the Note Agreements, AREP is required to make semi-annual interest payments and annual principal payments. The interest rate charged on the Senior Unsecured Debt is 9.6% per annum. Under the terms of the Note Agreements, AREP deferred and capitalized 2% annually of its interest payment through May 1993. In May 1994 and 1995, AREP repaid $10 million and $11.3 million, respectively, of its outstanding Senior Unsecured Debt under the Note Agreements and principal payments of approximately $11,308,000 are due annually from 1996 through the final payment date of May 27, 1998. As of December 31, 1995, AREP was in compliance with the terms of the Note Agreements.\nThe Note Agreements contain certain covenants restricting the activities of AREP. Under the Note Agreements, AREP must maintain a specified level of net annual rentals from unencumbered properties (as defined in the Note Agreements) and is restricted, in certain respects, in its ability to create liens and incur debts. Investment by AREP in certain types of assets that may be regarded as non-income producing, such as land or non-performing loans, is restricted under the Note Agreements. The holders of the Senior Unsecured Debt have agreed, however, to waive this restriction with respect to any capital raised by AREP in the Rights Offering.\nThe Note Agreements contain certain prepayment penalties which AREP would be required to pay if it extinguishes any portion of the outstanding principal prior to its annual due date. The Note Agreements require that such prepayment consist of 100% of the principal amount to be prepaid plus a premium based on a formula described therein. As of March 8, 1996, the premium required in order to prepay the Note Agreement in full would have been approximately $2,745,000. Subject to negotiating favorable terms AREP may prepay in full the Senior Unsecured Debt. Prepayment would release the Company from certain covenants which restrict its operating and investment activities, including, among others, covenants relating to the level of net annual rentals from unencumbered properties and the ability to create liens and\nII-10 incur additional debt. To date, the Partnership has been unable to negotiate favorable terms for such prepayment.\nSales proceeds from the sale or disposal of portfolio properties totalled approximately $21 million in 1995. During 1994, sales proceeds totalled approximately $12.6 million, including $1.4 million of net proceeds from a balloon payment of a mortgage receivable. During 1995, AREP received $9.8 million of mortgage proceeds from the financing of its two apartment complexes located in Lexington, Kentucky. In addition, approximately $8.8 million of mortgage financing was obtained by the Alabama joint venture. AREP intends to use property sales, financing and refinancing proceeds for new investments. In addition, AREP successfully completed its Rights Offering in April 1995 and net proceeds of approximately $107.6 million were raised for investment purposes.\nAREP entered into two joint ventures with unaffiliated co-venturers in June 1994 for the purpose of developing luxury garden apartment complexes in Hoover, Alabama, and Cary, North Carolina. In the year ended December 31, 1994, AREP invested approximately $5,500,000 in these joint ventures. During 1995, AREP invested approximately an additional $400,000. In May 1995, AREP acquired approximately 248 acres of land for approximately $3,044,000. AREP intends to develop and construct 45 to 50 single-family detached luxury homes on this land. In August 1995, AREP invested approximately $7.1 million by purchasing a portion of an unsecured Senior Term Facility Agreement. The borrower is Queens Moat Houses P.L.C., which is a United Kingdom based hotel operator with properties located in various countries in Europe.\nAREP's cash and cash equivalents increased by approximately $147.6 million during 1995, primarily due to Rights Offering proceeds, and the interest earned thereon, of $115.4 million, sales proceeds, net of property acquisitions and investments, of approximately $11 million and financing proceeds of approximately $10 million. These funds are being retained for investment in undervalued assets including commercial properties, residential development projects, land parcels, non-performing loans and securities of companies which own significant real estate assets. In addition, approximately $10 million of additional cash reserves were created.\nII-11\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nINDEPENDENT AUDITORS' REPORT\nThe Partners American Real Estate Partners, L.P:\nWe have audited the accompanying consolidated balance sheets of American Real Estate Partners, L.P. and subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in partners' 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 1995 financial statement schedule as listed in the Index at Item 14 (a) 2. These consolidated financial statements and the financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Real Estate Partners, L.P. and subsidiary as of December 31, 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\nNew York, New York March 7, 1996\nII-12\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 and 1994 - --------------------------------------------------------------------------------\n(Continued)\nII-13 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 and 1994 (Continued) - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nII-14 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nII-15 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nII-16 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n(Continued)\nII-17 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nII-18 AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 and 1993 - --------------------------------------------------------------------------------\n1. ORGANIZATION AND BASIS OF PRESENTATION\nOn July 1, 1987, American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), in connection with an exchange offer (the \"Exchange\"), entered into merger agreements with American Real Estate Partners, L.P. (the \"Company\") and each of American Property Investors, L.P., American Property Investors II, L.P., American Property Investors III, L.P., American Property Investors IV, L.P., American Property Investors V, L.P., American Property Investors VI, L.P., American Property Investors VII, L.P., American Property Investors VIII, L.P., American Property Investors IX, L.P., American Property Investors X, L.P., American Property Investors XI, L.P., American Property Investors 82, L.P. and American Property Investors 83, L.P. (collectively, the \"Predecessor Partnerships\"), pursuant to which the Subsidiary acquired all the assets, subject to the liabilities (known and unknown) of the Predecessor Partnerships.\nThe limited partners of the Predecessor Partnerships received limited partner interests in the Subsidiary. The number of such limited partner interests received by a limited partner was determined based upon his percentage ownership interest in the Predecessor Partnerships, the value of the Predecessor Partnerships' net assets and the number of limited partner interests allocable to the Predecessor Partnerships' general partners and their affiliates. The limited partner interests in the Subsidiary were contributed to the Company in exchange for limited partner interests therein. Limited partnership interests were allocable to the Predecessor Partnerships' general partners and their affiliates as a result of their rights: (i) to receive a portion of the cash flow of the Predecessor Partnerships by virtue of their ownership of interests in such partnerships and their entitlement to receive management fees and nonaccountable expense reimbursements and (ii) to share in the proceeds from the sale or liquidation of the assets of the Predecessor Partnerships and to receive real estate commissions with respect to the sale of properties by the Predecessor Partnerships. These rights of the Predecessor Partnerships' general partners and their affiliates were valued in connection with the Exchange. As a result of such valuation, and the assignment of the interests receivable by the corporate affiliates to American Property Investors, Inc. (the \"General Partner\"), an aggregate of 1,254,280 units and a 1% general partner interest in the Company were issued to the General Partner and 5,679 units were issued to noncorporate affiliates of the Predecessor Partnerships' general partners. In addition, the General Partner also received a 1% general partner interest in the Subsidiary.\nBy virtue of the Exchange, the Subsidiary owns the assets, subject to the liabilities, of the Predecessor Partnerships. The Company owns a 99% limited partner interest in the Subsidiary. The General Partner owns a 1% general partner interest in both the Subsidiary and the Company representing an aggregate 1.99% general partner interest in the Company and the Subsidiary.\nThe participation in the transaction by a Predecessor Partnership was conditioned upon obtaining the approval of a majority-in-interest of the limited partners in such Predecessor Partnership. Such approvals were obtained with respect to each of the Predecessor Partnerships prior to July 1, 1987.\nII-19 During 1989, Integrated Resources, Inc. (\"Integrated\"), the former parent of the General Partner, experienced serious financial difficulties and, on February 13, 1990, it filed in the Bankruptcy Court for the Southern District of New York a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code (the \"Filing\"). The General Partner was a separate entity and neither the General Partner nor any other subsidiary of Integrated was included in the Filing.\nOn September 13, 1990, in connection with its voluntary petition for reorganization pursuant to Chapter 11 of the Bankruptcy Code, Integrated entered into an agreement whereby it agreed to sell all of its stock in the General Partner to Meadowstar Holding Company, Inc. (\"Meadowstar\"). Neither the Company nor the General Partner was a party to such agreement. The sale of the stock of the General Partner to Meadowstar was approved by the Bankruptcy Court on October 22, 1990. On November 15, 1990, pursuant to the terms of the Acquisition Agreement, Meadowstar purchased all of the outstanding shares of Common Stock of the General Partner. In May 1993, Carl C. Icahn acquired all of Meadowstar's interest in the General Partner. See Note 10 pertaining to the Rights Offering consummated in March 1995.\n2. SIGNIFICANT ACCOUNTING POLICIES\nFinancial Statements and Principles of Consolidation - The consolidated financial statements are prepared on the accrual basis of accounting and include only those assets, liabilities and results of operations which relate to the Company and the Subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation.\nRegistration Costs, Expenses of the Exchange and Rights Offering Expenses - Registration costs of the Predecessor Partnerships were charged against partners' equity upon the closing of the public offerings in accordance with prevalent industry practice. Expenses of the Exchange were charged against partners' equity upon consummation of the Exchange. Rights Offering Expenses were charged against partners' equity upon consummation of the Right's Offering.\nNet Earnings and Distributions Per Limited Partnership Unit - For financial reporting purposes, the weighted average number of depositary units and equivalent units outstanding and subscribed for assumed outstanding for the year ended December 31, 1995 was 27,467,194. For the years ended December 31, 1994 and 1993 the weighted average number of depositary units assumed outstanding was 13,812,800 and 13,889,667, respectively. There were no distributions in 1995 or 1994. Distributions were $.50 per unit in 1993.\nUnit Option Plan - The Company adopted a Nonqualified Unit Option Plan (the \"Plan\") in 1987, which was further amended in 1989, under which options to purchase an aggregate of 1,416,910 depositary Units may be granted to officers and key employees of the General Partner and the Company who provide services to the Company. To date, no options have been granted under the Plan.\nCash and Cash Equivalents - The Company considers short-term investments, which are highly liquid with original maturities of three months or less from date of issuance, to be cash equivalents.\nIncluded in cash and cash equivalents at December 31, 1995 and 1994 are investments in government backed securities of approximately $164,130,000 and $17,155,000, respectively.\nIncome Taxes - No provision has been made for Federal, state or local income taxes since the Company is a partnership and, accordingly, such taxes are the responsibility of the partners.\nII-20 Leases - The Company leases to others substantially all its real property under long-term net leases and accounts for these leases in accordance with the provisions of Financial Accounting Standards Board Statement No. 13, \"Accounting for Leases,\" as amended. This Statement sets forth specific criteria for determining whether a lease is to be accounted for as a financing lease or operating lease.\na. Financing Method - Under this method, minimum lease payments to be received plus the estimated value of the property at the end of the lease are considered the gross investment in the lease. Unearned income, representing the difference between gross investment and actual cost of the leased property, is amortized to income over the lease term so as to produce a constant periodic rate of return on the net investment in the lease.\nb. Operating Method - Under this method, revenue is recognized as rentals become due and expenses (including depreciation) are charged to operations as incurred.\nProperties - Properties, other than those accounted for under the financing method, are carried at cost less accumulated depreciation unless declines in the values of the properties are considered other than temporary.\nFor each of the years ended December 31, 1995, 1994 and 1993 no individual real estate or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of the Company. At December 31, 1994 and 1993, Portland General Electric Company occupied a property, consisting of corporate offices, which represented more than 10% of the Company's total assets.\nDepreciation - Depreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years. When properties are sold or otherwise disposed of, the cost and accumulated depreciation are removed from the property account and the accumulated depreciation account, and any gain or loss on such sale or disposal is generally credited or charged to income (see Note 7).\nDebt Placement Costs - Debt placement costs are amortized on a straight-line basis over the term of the respective indebtedness.\nUse of Estimates - Management of the Partnership 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 financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\nAssets Held for Sale - Assets held for sale are carried at the lower of cost or net realizable value.\nAccounting by Creditors for Impairment of a Loan - On January 1, 1995, SFAS No. 114, Accounting by Creditors for Impairment of a Loan (\"Statement 114\"), as amended by SFAS 118, Accounting by Creditors for Impairment of a Loan - Income Recognition Disclosures, was adopted by the Company. In accordance with these standards, if it is probable that based upon current information that a creditor will be unable to collect all amounts due according to the contractual terms of a loan agreement, the asset is considered \"impaired\". Reserves are established against impaired loans in amounts equal to the difference between the recorded investment in the asset and either the present value of the cash flows expected to be received, or the fair value of the underlying collateral if foreclosure is deemed probable or if the loan is considered collateral dependent. The adoption of Statement 114 and 118 had no impact on net income.\nII-21 Impact of New Accounting Standards Issued, But Not Yet Adopted Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of (\"Statement 121\")\nStatement 121, which was issued in March 1995 , and requires that long-lived assets and certain identifiable intangibles, and goodwill related to those assets to be held and used and long-lived assets and certain identifiable intangibles to be disposed of, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.\nStatement 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. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than that carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss in not recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset.\nThis Statement generally 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.\nStatement 121 is effective for fiscal years beginning after December 15, 1995, applied prospectively. Statement 121 is not expected to have a material effect on the Company's financial condition or results of operations.\n3. CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES\na. The General Partner and its affiliates may realize substantial fees, commissions and other income from transactions involving the purchase, operation, management, financing and sale of the Partnership's properties, subject to certain limitations relating to properties acquired from the Predecessor Partnerships in the Exchange. Some of such amounts may be paid regardless of the overall profitability of the Partnership and whether any distributions have been made to Unitholders. As new properties are acquired, developed, constructed, operated, leased, financed and sold, the General Partner or its affiliates may perform acquisition functions, development and construction oversight and other land development services, property management and leasing services, either on a day-to-day basis or on an asset management basis, and other services and be entitled to fees and reimbursement of expenses relating thereto, including the Reinvestment Incentive Fee, property management fees, real estate brokerage and leasing commissions, fees for financing either provided or arranged by the General Partner and its affiliates, development fees, general contracting fees and construction management fees. The terms of any transactions between the Company and the General Partner or its affiliates must be fair and reasonable to the Company and customary to the industry.\nReinvestment incentive fees as payment for services rendered in connection with the acquisition of properties from July 1, 1987 through July 1, 1997 were 1% of the purchase price for the first five years and are 1\/2% for the second five years.\nReinvestment incentive fees are only payable on an annual basis if the sum of (x), the sales price of all Predecessor Partnerships' properties (net of associated debt which encumbered such properties at the consummation of the Exchange) sold through the end of such year, and (y), the appraised value of all Predecessor Partnerships' properties which have been financed or refinanced (and not subsequently sold), net of the amount of\nII-22 any refinanced debt, through the end of such year determined at the time of such financings or refinancings, exceeds the aggregate values assigned to such Predecessor Partnerships' properties for purposes of the Exchange. If the subordination provisions are not satisfied in any year, payment of reinvestment incentive fees for such year will be deferred. At the end of each year, a new determination will be made with respect to subordination requirements (reflecting all sales, financings and refinancings from the consummation of the Exchange through the end of such year) in order to ascertain whether reinvestment incentive fees for that year and for any prior year, which have been deferred, may be paid.\nFrom the commencement of the Exchange through December 31, 1995 the Company (i) sold or disposed of an aggregate of 140 properties of the Predecessor Partnerships for an aggregate of approximately $69,123,000, net of associated indebtedness which encumbered such properties at the consummation of the Exchange and (ii) refinanced 25 Predecessor Partnership properties with an aggregate appraised value, net of the amount of the refinanced debt, of approximately $44,431,000 for a sum total of approximately $113,554,000. Aggregate appraised values attributable to such properties for purposes of the Exchange were approximately $105,039,000. Sixteen properties have been acquired since the commencement of the exchange, including two joint ventures entered into in 1994, for aggregate purchase prices of approximately $58,000,000. Reinvestment incentive fees of approximately $354,000 have previously been paid to the General Partner, and approximately $113,000 and $15,000 are payable to the General Partner for the 1994 and 1995 acquisitions, respectively.\nb. The Company and certain affiliates of its General Partner entered into an agreement with the third-party landlord of its leased executive office space. The agreement provided for the Company and these affiliates to relocate their offices to an adjacent building also owned by the landlord which relocation occurred in September 1995. In accordance with the agreement, the Company entered into a lease, expiring in 2001, for 7,920 square feet of office space, at an annual rental of approximately $153,000. The Company has sublet to certain affiliates 3,205 square feet at an annual rental of approximately $62,000, resulting in a net annual rental of approximately $91,000. The prior lease, which was terminated, provided for approximately 6,900 square feet at an annual rental of $155,000. During the year ended December 31, 1995, the affiliates reimbursed the Company approximately $15,000 for rent in connection with the new lease.\nIn addition, the Company and an affiliate received a lease termination fee of $350,000 which has been allocated $175,000 to the Company and $175,000 to the affiliates. Such allocations and terms of the sublease were approved by the Audit Committee of the Board of Directors of the General Partner.\nc. The Company was reimbursed by an affiliate of the General Partner for payroll and certain overhead expenses related to certain employees of the Company who provided services on a part-time basis in the amount of approximately $86,000 for the year ended December 31, 1995. Such reimbursements were approved by the Audit Committee of the Board of Directors of the General Partner.\n4. REAL ESTATE LEASED TO OTHERS ACCOUNTED FOR UNDER THE FINANCING METHOD\nReal estate leased to others accounted for under the financing method is summarized as follows:\nII-23\nII-24 The following is a summary of the anticipated future receipts of the minimum lease payments receivable at December 31, 1995:\nAt December 31, 1995, approximately $213,771,000 of the net investment in financing leases was pledged to collateralize the payment of nonrecourse mortgages payable.\n5. REAL ESTATE LEASED TO OTHERS ACCOUNTED FOR UNDER THE OPERATING METHOD\nReal estate leased to others accounted for under the operating method is summarized as follows:\nAs of December 31, 1995 and 1994, accumulated depreciation on the hotel operating properties (not included above) amounted to approximately $2,321,000 and $1,499,000, respectively (see Note 7).\nThe following is a summary of the anticipated future receipts of minimum lease payments under noncancelable leases at December 31, 1995:\nAt December 31, 1995, approximately $95,147,000 of real estate leased to others was pledged to collateralize the payment of nonrecourse mortgages payable.\nII-25 6. MORTGAGES AND NOTE RECEIVABLE (See Note 2)\n(a) See Note 14a.\n(b) 5.75% is paid currently and 3.25% is deferred. The principal and deferred interest is payable in monthly installments from March 1999 until November 2005.\n(c) 4.5% is paid currently and 4.5% is deferred until maturity.\n(d) Payments are $46,931 through November 1, 1996 and $54,276 through September 1, 2001.\n(e) Interest only will accrue until December 1, 2010; commencing January 1, 2011, monthly payments of $39,035 will be due, which will self-amortize the outstanding principal and current and deferred interest, with the final payment due December 1, 2019. Increased rentals on the property, if any, during the renewal term of the underlying lease will be applied against accrued interest and then the outstanding principal.\n(f) On January 16, 1992, the purchase money mortgage was amended. The maturity date was extended to November 1994 and the monthly payments decreased to $27,800 commencing February 1, 1992. Under the terms of the amendment, the maturity date has been further extended to February 1997 to coincide with Easco's renewal of its lease for an additional ten years.\n(g) On August 15, 1995, the Company invested approximately $7.1 million in a note receivable by purchasing a portion (approximately 1.85%) of an unsecured Senior Term Facility Agreement (\"Facility Agreement\"). The borrower is Queens Moat Houses P.L.C. (\"Queens Moat\") and certain subsidiaries. Queens Moat is a United Kingdom based hotel operator with properties in the U.K., Germany, Netherlands, France and Belgium. The Company purchased its participation portion from Lazard Freres & Co. LLC, defined as a Priority Lender in the Facility Agreement, at 71.75% of the face amount of the Company's pro rata portion of the Facility Agreement's outstanding senior advances on the acquisition date. The Facility Agreement's advances are denominated in Pounds Sterling, Deutsche Marks, Dutch Guilders, Belgian Francs and French Francs. The discount at acquisition date, based on the then existing spot rate, was approximately $2.8 million. The Facility Agreement matures December 31, 2000 and bears interest at LIBOR (London Interbank Offered Rate) plus 1.75% per annum for the relevant currencies. Interest will accrue from July 1, 1995 to June 30, 1996 which will then be\nII-26 due and payable to the Company. Subsequent to June 30, 1996 interest periods and payments can vary from one month to two, three or six months at the discretion of the borrower. There are scheduled payments of the advances over the term of the loan. In addition, repayments are required when certain underlying assets are sold. During the year ended December 31, 1995, these repayments totalled approximately $102,000.\nThe discount at acquisition date will be amortized on a straight-line basis over the term of the Facility Agreement. For the year ended December 31, 1995, approximately $225,000 of discount was amortized. In accordance with accounting policy, foreign exchange gains and losses will be recorded each quarter based on the prevailing exchange rates at each balance sheet data. Foreign exchange gains of approximately $158,000 have been recognized and are included in \"Other Income\" for the year ended December 31, 1995.\nThe Company has generally not recognized any profit in connection with the property sales in which the above purchase money mortgages receivable were taken back. Such profits are being deferred and will be recognized when the principal balances on the purchase money mortgages are received since profit recognition was not allowed under generally accepted accounting principles at the time of sale.\n7. SIGNIFICANT PROPERTY TRANSACTIONS\nInformation on significant property transactions during the three-year period ended December 31, 1995 is as follows:\na. On March 27, 1991, The Public Building Commission of Chicago (\"Public Building Commission\") commenced a condemnation proceeding against a property leased by The TJX Companies, Inc. The condemnation proceeding was settled on March 12, 1993 when the Company received approximately $4,305,000 from the tenant who purchased the property in accordance with their lease obligations. A net gain of approximately $1,575,000 was recognized on this transaction in the year ended December 31, 1993.\nb. On September 16, 1991, the Company brought suit against Alco Standard Corporation and its affiliates, a former tenant of an industrial facility locate in Rome, Georgia whose lease expired in October 1990. The action was brought against the defendants in the United States District Court Northern District of Georgia, Rome Division for reimbursement of costs that could be incurred for clean-up of hazardous materials on the site and certain deferred maintenance. In July 1994, this litigation was settled and the property was sold for $525,000. A gain of approximately $100,000 was recognized in the year ended December 31, 1994. In addition, Alco reimbursed the Company for $150,000 of expenses incurred and indemnified the Company against any future liability in connection with any site contamination. The expense reimbursement has been included in \"Property expenses\" in the financial statements for the year ended December 31, 1994.\nc. On September 27, 1991, Days Inn of America, Inc. (\"Days Inn\") a tenant of a property owned by the Company, located in Atlanta, Georgia, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The tenant, by order of the Bankruptcy Court, rejected the lease effective July 31, 1992. The Company submitted a claim to the Bankruptcy Court and in August 1993, it reached a settlement of this claim against Days Inn, now known as Buckhead America Corporation (\"Buckhead\"). As a result, the Company has received cash in the amounts of approximately $104,000, $184,000 and $730,000 in the years ended December 31, 1995, 1994 and 1993, respectively. In addition, stock in Buckhead valued at approximately $28,000 and $305,000 was received in the years ended December 31, 1995 and 1993, respectively. The total of the above amounts of approximately $132,000, $184,000 and\nII-27 $1,035,000 have been included in \"Other income\" for the years ended December 31, 1995, 1994 and 1993, respectively. The Buckhead stock received in 1993 was disposed of in 1994 with a nominal gain.\nEffective August 1, 1992, the Company engaged a management company to perform on-site and supervisory and management services. The lease rejection has adversely impacted operating cash flow by approximately $110,000 per month. In addition, the Company expects to incur costs of approximately $2,600,000, as leases are executed to renovate, build-out and re-lease the property.\nd. On July 14, 1992, Integra, a Hotel and Restaurant Company (\"Integra\"), which leased two hotel properties located in Miami, Florida and Phoenix, Arizona filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Bankruptcy Code. The tenant's petition, previously filed with the Bankruptcy Court, to reject the aforementioned leases, was approved on August 7, 1992, and the Company assumed operation of the properties on that date. The Company has submitted a claim to the Bankruptcy Court.\nAt December 31, 1995, the property located in Miami Florida has a carrying value of approximately $5,475,000 and is unencumbered by any mortgages. This property is subject to a ground lease. Based on current conditions, management believes the carrying value of the Miami property is reasonably stated.\nAt December 31, 1995, the property located in Phoenix, Arizona has a carrying value of approximately $7,888,000 and is encumbered by a nonrecourse mortgage payable of approximately $3,255,000. This mortgage was refinanced during the year ended December 31, 1994 (see Note 8e). Based on current conditions, the management believes the carrying value of the Phoenix property is reasonably stated.\nDuring the year ended December 31, 1993, the Company completed major renovations at the Miami and Phoenix Holiday Inns with capital expenditures totaling approximately $1,700,000 and $400,000, respectively. In connection with these renovations, approximately $250,000 of nonrecurring maintenance expenses were incurred at the Miami location. These expenses were included in hotel operating expenses for the year ended December 31, 1993. During the year ended December 31, 1995, additional capital expenditures of approximately $162,000 and $368,000 were incurred at the Miami and Phoenix Holiday Inn's, respectively. During the year ended December 31, 1994 approximately $190,000 and $240,000 were incurred at the Miami and Phoenix properties, respectively.\nThe Company entered into a management agreement for the operation of the hotels with a national management organization. Since August 7, 1992, the hotels have been classified as Hotel Operating Properties and their revenues and expenses separately disclosed in the Consolidated Statements of Earnings. Net hotel operations (hotel operating revenues less hotel operating expenses) totalled approximately $2,131,000, $1,781,000 and $1,195,000 for the years ended December 31, 1995, 1994 and 1993, respectively. This was approximately $29,000, $379,000 and $965,000 less than the rent would have been from the rejected leases for the years then ended, respectively. Hotel operating expenses include all expenses except for approximately $822,000, $776,000 and $509,000 of depreciation and $339,000, $456,000 and $742,000 of interest expense for the years ended December 31, 1995, 1994 and 1993, respectively. These amounts are included in their respective captions in the Consolidated Statements of Earnings. The results for the year ended December 31, 1995 are not necessarily indicative of future operating results.\ne. On July 31, 1992, Chipwich, Inc. (\"Chipwich\"), parent of Peltz Food Corporation, a tenant in a property owned by the Company filed a voluntary petition for reorganization\nII-28 pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. Chipwich then filed a motion for rejection of the lease and, pursuant to an order of the Bankruptcy Court, the lease was rejected on September 29, 1992. There was a guarantor of the lease and the Company settled its claim against the guarantor.\nIn 1995, the guarantor paid the company $2,200,000 in full satisfaction of its leasehold obligation which, net of related costs, resulted in approximately $2,034,000 of \"Other income\" in the year ended December 31, 1995. The company reclassified this property to \"Property held for sale\" and reduced its carrying value to net realizable value by recording a provision for loss on real estate of $611,552 in the year ended December 31, 1995.\nf. During 1992, leases on two properties formerly tenanted by Petrolane, Inc. located in Belle Chasse, LA and Nisku, Alberta, Canada, expired and were re-let at rents substantially less than the previous leases. As a result, the Company previously recorded provisions for loss on real estate in the year ended December 31, 1992. In addition, after further evaluation and review, the Company believed the Belle Chasse property's carrying value at June 30, 1994 to exceed the recoverable value in the amount of $237,000. As a result, the Company recorded a provision for loss on real estate in the amount of $237,000 for the year ended December 31, 1994.\nIn September 1995, the Company sold the property located in Belle Chasse, LA to the current tenant pursuant to a purchase option for $575,000. A gain of approximately $116,000 was recorded in the year ended December 31, 1995. In December 1995, the properly located in Nisku, Alberta, Canada was sold to the current tenant for a sale price of approximately $730,000. A gain of approximately $6,000 was recorded in the year ended December 31, 1995.\ng. On December 9, 1991, Stop N Go Markets of Texas, Inc. (National Convenience Stores, Inc.) filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Bankruptcy Code. The tenant, who previously leased twenty-three locations, filed a motion with the Bankruptcy Court to assume four leases and reject the remaining leases. Pursuant to a stipulation by the Bankruptcy Court on February 4, 1993, the tenant's motion was approved effective as of August 31, 1992. On March 19, 1993, the Company filed a proof of claim with the Bankruptcy Court. In November 1993, the Company received stock of the debtor valued at approximately $123,000 in partial settlement of its claim. This total has been included in \"Other income\" for the year ended December 31, 1993. In April of 1995 and May of 1994 additional stock of the debtor was received. The total value of the stock at December 31, 1995 of $120,000 is based on the lower of cost or market. In January 1996, the entire NCS stock was sold pursuant to a tender offer for proceeds totaling $364,500. A gain of approximately $245,000 will be recognized in the three months ending March 31, 1996.\nIn 1994, all four of the leased locations were sold. The remaining nineteen properties, whose rents totaled approximately $217,000 per year, were actively marketed for sale by the Company. During the years ended December 31, 1994 and 1993, the Company sold ten and nine of these locations, respectively. A nominal gain was recognized on the disposal of all twenty-three properties.\nh. On November 2, 1992, the Company purchased approximately fifteen acres of land in East Syracuse, New York for approximately $3,500,000 and contracted to build a 116,000 square foot BJ's Warehouse Store (\"BJ's\") upon the site. The Company has entered into a twenty year lease with Waban, Inc. (\"Waban\"), the parent company of BJ's Warehouse Club. Construction was substantially completed on May 22, 1993 and Waban took possession of the premises, which is situated on approximately ten acres of land, and\nII-29 commenced rental payments on that date. The lease provides for an initial annual net rental of $659,262 with CPI increases every five years, not to exceed 8.77%. Under the lease, Waban is responsible for any required structural repairs. Of the remaining five acres of adjacent land approximately 3.6 acres is available for future development by the Company.\nSimultaneously with the acquisition of the property, the Company entered into a general construction contract with the seller (the \"GC Agreement\") pursuant to which the seller (the \"Seller\") was required to construct BJ's in accordance with the terms and conditions of the lease for a guaranteed maximum amount of $2,327,802. However, the construction of BJ's was subject to delays and the Seller did not meet all of its construction obligations under the GC Agreement and failed to cure such defaults. The Company sent a notice, dated February 19, 1993, terminating the GC Agreement and assumed the construction obligations. The Company contacted the surety of the GC Agreement pertaining to the site work. The surety was not responsive to the Company. The Company has determined at this point to not pursue any potential claims it may have because after further investigation, it believes such claims will not be able to be satisfied.\nAt December 31, 1995, the BJ's land, including related improvements, cost a total of approximately $4,877,000 and the building cost a total of approximately $3,421,000. The carrying value of this property at December 31, 1995 is approximately $8,016,000 and is encumbered by a nonrecourse mortgage payable of approximately $3,813,000. The adjacent land available for future development, including related improvements, cost a total of approximately $1,244,000. Approximately $210,000 of interest was capitalized during the year ended December 31, 1993.\nA reinvestment incentive fee was paid in 1994 to the General Partner of approximately $45,000 pertaining to this acquisition and development.\nThe Company received permanent financing of $4,000,000 on the BJ's parcel and improvements in October 1993. (see Note 8a).\nII-30 i. At December 31, 1992, the Company owned fifteen properties tenanted by Nationsbank, formerly NCNB National Bank of South Carolina. The leases on fourteen of these properties expired in December 1992 and one expired in March 1993; however, nine leases were extended to March 1993 in connection with an executed agreement (the \"Agreement\") entered into between the Company and the tenant to purchase and\/or lease any one or more of ten locations, including the property whose lease expired in March 1993. The tenant elected to purchase four and lease six properties in accordance with the Agreement. The four properties which were sold on March 26, 1993 had a carrying value of approximately $4,357,000 and were unencumbered by any mortgage at December 31, 1992. Since the contracted selling price of approximately $5,300,000 exceeded the carrying value, the Company believed the assets were fairly stated. The six leased locations were re-let at an annual rental of approximately $214,000, a reduction of approximately $196,000 from the previous rent. As a result, the Company wrote the properties down by incurring a provision for loss on real estate for the year ended December 31, 1992. At December 31, 1995, these properties have a carrying value of approximately $2,031,000 and are unencumbered by any mortgage.\nOf the remaining five properties whose leases were not extended, one was sold on January 20, 1993. Another property, whose carrying value at December 31, 1992 was $357,000 was written down by incurring a provision for loss on real estate in the amount of $182,000 in the three months ended March 31, 1993 and subsequently sold on April 15, 1993. The other three properties were sold during the year ended December 31, 1994.\nj. On January 26, 1993, Be-Mac Transport Company, Inc. (\"Be-Mac\"), a tenant in a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. Be-Mac then filed a motion for rejection of the lease and, pursuant to an order of the Bankruptcy Court, the lease was rejected on February 24, 1993. There was a guarantor of the lease and the Company settled its unsecured proof of claim filed by the Company for $377,000 in May 1995. As a result, approximately $331,000, net of related costs, of \"Other income\" was recognized in the year ended December 31, 1995. Based on the purchase option price contained in the rejected lease, the Company wrote the property down by incurring a provision for loss on real estate in the amount of $196,000 in the year ended December 31, 1993. At December 31, 1995, the property has a carrying value of $927,000 and is unencumbered by any mortgage. The Company re-let the property effective March 1, 1994 at an annual rental of $120,000.\nk. On July 31, 1993, the Company held a nonrecourse mortgage in the amount of approximately $3,456,000 secured by four properties tenanted by Toys \"R\" Us, Inc. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of such properties. The tenant remained current in its obligations under the lease. The terms of the mortgage called for a balloon payment of approximately $3,456,000 on January 1, 1993 which was not received. The Company reacquired these properties in satisfaction of such mortgage and as of August 1, 1993 real estate with a carrying value of approximately $5,883,000 and a nonrecourse mortgage payable with a balance of approximately $2,904,000 were recorded. No gain or loss resulted upon foreclosure because the estimated fair value of the properties exceeded their carrying value. These properties have a carrying value of approximately $5,734,000 and are encumbered by a nonrecourse mortgage payable of approximately $3,235,000 at December 31, 1995. See Note 8d concerning the mortgage refinancing in 1994.\nII-31 l. On December 31, 1992, the Company held four nonrecourse wrap-around mortgages in the amount of approximately $7,689,000 secured by four properties tenanted by The Wickes Corp. The mortgages had been taken back by a Predecessor Partnership in connection with the sale of such properties. The tenant remained current in its obligations under the lease. However, the Company did not receive monthly debt service payments on these mortgages from the purchaser. Additionally, the terms of mortgages called for balloon payments of approximately $7,689,000 on January 1, 1993 which were not received. However, the tenant had previously purchased one property from the debtor and in January 1993, the tenant paid the balloon mortgage due on the property net of the underlying first mortgage, which it assumed. A gain of approximately $1,371,000 was recognized on this transaction in the year ended December 31, 1993.\nIn addition, the debtor paid the balloon mortgage due on one property, net of the underlying first mortgage in August of 1993. A gain of approximately $784,000 was recognized in the year ended December 31, 1993.\nIn January 1994, the debtor paid the balloon mortgage due, net of the underlying first mortgage, on one Wickes property and a gain of approximately $1,238,000 was recognized in the year ended December 31, 1994. In addition, the Company foreclosed on the remaining Wickes property in January 1994 and real estate with a carrying value of approximately $643,000 was recorded in the year ended December 31, 1994. No gain or loss was incurred upon foreclosure because the estimated fair value of the property is equal to its carrying value. The mortgage balance on this remaining property is approximately $538,000 at December 31, 1995.\nm. On June 17, 1993, the Company purchased two non-performing mortgage loans for a combined price of $13,000,000. Each loan was collateralized by a residential apartment complex located in Lexington, Kentucky. The face value of the non-performing loans was approximately $21,188,000.\nThe first non-performing loan, purchased for $6,990,000, was collateralized by a 396 unit multi-family complex. The Company foreclosed on this property (\"Stoney Falls\"), and received the deed on October 11, 1993. The Company has entered into a management agreement for the operation of this property with a national management organization which began operating the property effective September 1, 1993. Subsequent to the acquisition, the Company received distributions from the receiver and cash flow from the property pertaining to the period prior to formal foreclosure, net of expenditures incurred by the Company, which have been applied as a reduction to the initial cost of the loan. This net cash flow, subsequent to the acquisition, totalled approximately $94,000. During the year ended December 31, 1994, the Company completed major renovations which totalled approximately $1,360,000. In connection with these renovations, approximately $350,000 of non recurring maintenance expenses where incurred. These expenses are included in \"Property expenses\" for the year ended December 31, 1994. During the year ended December 31, 1995, approximately $267,000 of capital expenditures were incurred. This asset has a carrying value of approximately $8,132,000 and is encumbered by a nonrecourse mortgage payable of approximately $5,438,000 at December 31, 1995.\nThe second non-performing loan, purchased for $6,010,000, is collateralized by a 232 unit apartment complex. Foreclosure proceedings were initiated in April 1993 resulting in the debtor filing for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The Company executed an agreement with the borrower, which was approved by the Bankruptcy Court, and foreclosed on this property (\"Stoney Brooke\") and received the deed on February 11, 1994. Subsequent to the acquisition, the Company received distributions from the seller of the note and began to receive cash flow\nII-32 from the property pertaining to the period prior to formal foreclosure, net of expenditures incurred by the Company, which have been applied as a reduction to the initial cost of the loan. This cash flow, net of expenditures incurred by the Company, totalled approximately $735,000. This property at December 31, 1995 has a carrying value of approximately $5,130,000 and is encumbered by a nonrecourse mortgage payable of approximately $4,449,000.\nA reinvestment incentive fee of approximately $65,000 was paid to the General Partner in 1994. (See Note 3).\nSee Note 8f in connection with the mortgage financing of these two properties in 1994.\nn. In March 1994, the Company foreclosed on the property tenanted by Webcraft Technologies and KSS Transportation. As a result, real estate with a carrying value of approximately $626,000 was recorded in the year ended December 31, 1994. No gain or loss was incurred upon foreclosure because the estimated fair value of the property is believed to exceed its carrying value.\nII-33 o. In June 1994, the Company sold a property to the tenant, Lockheed Sanders, Inc. The property, which was located in Plainfield, N.J., was subject to a purchase option which was exercised. The selling price was $5,625,000 and a gain of approximately $1,961,000 was recognized in the year ended December 31, 1994. The property was unencumbered by any mortgage.\np. The Company entered into two joint ventures in June 1994 with unaffiliated co-venturers for the purpose of developing luxury garden apartment complexes. Both of these joint ventures have been consolidated in the accompanying financial statements.\n1. The first joint venture, formed as an Alabama Limited Liability Company, developed a 240 unit multi-family project situated on approximately twenty acres, currently owned by the joint venture, located in Hoover, Alabama, a suburb of Birmingham. The Company, which owns a seventy percent (70%) majority interest in the joint venture, contributed $1,750,000 in June 1994 and the co-venturer contributed $250,000. As of December 31, 1995 and 1994 approximately $220,000 and $250,000, respectively, representing the minority interest of the co-venturer has been included in \"Accounts payable, accrued expenses, and other liabilities\" in the accompanying financial statements. Distributions will be made in proportion to ownership interests. The co-venturer will be credited with $500,000 of additional capital in lieu of receiving a general contractor's fee. Permanent financing has been obtained by the joint venture in the amount of $8,860,000 of which $360,000 is guaranteed by the co-venturer and personally by its principals. The Company funded approximately $140,000 of $200,000 of approved additional improvements with the co-venturer funding the balance. The complex was completed in September 1995, and all rental units were available for occupancy. As of February 1996, approximately 83% of the units are leased. The development totalled approximately $10,889,000, including the acquisition of land valued at approximately $1,138,000. An affiliate of the Company's co-venturer is managing the property.\nFor the year ended December 31, 1995, net rental operations resulted in a loss of approximately $301,000, including approximately $289,000 of depreciation and amortization, before consideration of the co-venturer's minority interest in such loss of approximately $90,000.\nA reinvestment incentive fee of approximately $38,000 is due the general partner upon completion of the project (see Note 3).\n2. The second joint venture, a Delaware limited partnership, is developing a 288 unit multi-family project situated on approximately thirty-three acres in Cary, North Carolina (Raleigh-Durham area). The Company, which owns a ninety percent (90%) majority interest in the partnership, has contributed approximately $4,022,000 as of December 31, 1995 and is a limited partner. The Company has fulfilled its contribution obligation. The co-venturer is the general partner and has a limited partner interest. The Company is entitled to a cumulative annual preferred return of 12% on its investment before cash distributions are made in proportion to ownership interests. Construction financing has been obtained by the joint venture in the amount of $12,205,000 and is guaranteed by the joint venture general partner and personally by its principals. The development costs are expected to total approximately $16,100,000. As of December 31, 1995, approximately $12,216,000 of development costs have been incurred of which approximately $6,988,000 represents completed rental units, including the acquisition of land valued at $1,600,000. Construction loan funding at December 31, 1995 was\nII-34 approximately $7,834,000. The first units were available for occupancy in October 1995 and project completion is scheduled for July 1996. As of March 1996, approximately 29% of the rental units are leased. An affiliate of the Company's co-venturer is managing the property.\nFor the year ended December 31, 1995, net rental operations resulted in a loss of approximately $115,000, including approximately $87,000 of depreciation and amortization.\nA reinvestment incentive fee of approximately $70,000 will be due the Company's general partner upon completion of the project (see Note 3).\nq. On February 1, 1995, the Penske Corp. exercised its purchase option on three properties leased from the Company (two in New Jersey and one in New York). The selling price was approximately $4,535,000 and a gain of approximately $1,003,000 was recognized in the year ended December 31, 1995. Each property was encumbered by first and second mortgages which totalled approximately $1,152,000 and which were paid from the sales proceeds.\nr. On March 24, 1995, the Company sold the property tenanted by Pace Membership Warehouse, Inc. in Taylor, Michigan. The selling price was $9,300,000 and a gain of approximately $3,307,000 was recognized in the year ended December 31, 1995. The property was encumbered by a nonrecourse mortgage payable of approximately $4,346,000 which the purchaser assumed.\ns. On May 18, 1995, the Company purchased approximately 248 acres of partially improved land located in Armonk, New York. The purchase price was approximately $3,044,000. The Company intends to construct approximately 45 to 50 single-family detached luxury homes subject to subdivision and other required approvals. No material development costs have yet been incurred.\nA reinvestment incentive fee of approximately $15,000 is payable to the Company's general partner (see Note 3).\nt. On June 28, 1995, General Signal Technology Corporation, a tenant of a property located in Andover, Massachusetts exercised its rights under the lease to purchase the property. The selling price was approximately $19,808,000 and a loss of approximately $125,000 was recognized in the year ended December 31, 1995. The property was encumbered by two nonrecourse mortgages payable which totalled approximately $10,670,000 and were paid from the sales proceeds.\nII-35 8. MORTGAGES PAYABLE\nAt December 31, 1995, mortgages payable, all of which are nonrecourse to the Company, are summarized as follows:\nThe following is a summary of the anticipated future principal payments of the mortgages:\na. On October 18, 1993, the Company obtained permanent financing on the BJ's property in East Syracuse, New York. The nonrecourse loan is in the principal amount of $4,000,000, bears interest at 8.25% per annum, and matures October 31, 1998 at which time the Company has the option to extend the loan for one to five years, providing certain conditions are met. The monthly debt service is approximately $34,000. Debt placement costs of approximately $156,000 have been incurred.\nb. On December 13, 1993, the Company prepaid a mortgage with an outstanding balance of $3,038,346 that encumbered a property tenanted by the Lockheed Corporation, located in Burbank, CA. This mortgage was scheduled to mature on February 1, 1996 and bore interest at 16%. Prepayment penalties of approximately $91,000 were incurred.\nc. On December 22, 1993, the Company refinanced a nonrecourse mortgage loan which had an outstanding principal balance of approximately $7,613,000. This mortgage encumbered a property tenanted by Super Foods Services, Inc. It was scheduled to mature on October 1, 2010 and bore interest at 11.076%. The new mortgage loan which is self-liquidating is in the principal amount of $7,650,000, bears interest at 8.25% per annum, and matures August 1, 2010. Debt placement costs of approximately $333,000 and prepayment penalties of approximately $76,000 were incurred. The new annual debt service of approximately $846,000 reflects a decrease of $156,000 and initial interest savings of approximately $215,000 in 1994.\nII-36 d. On March 4, 1994, the Company paid off one nonrecourse mortgage loan and refinanced two nonrecourse mortgage loans that encumbered a total of seven properties tenanted by Toys \"R\" Us. The loan paid off, which encumbered one property, had an outstanding principal balance of approximately $616,000, bore interest at 10.375%, and was callable at the lender's option in 1994. The two loans refinanced had outstanding principal balances of approximately $1,550,000 and $2,863,000, bore interest at 9.25% and 9.55%, were self-liquidating, and were callable at the lender's option in 1995 and 1996, respectively. The two new mortgage loans, in the principal amounts of approximately $1,464,000 and $3,636,000, bear interest at 7.08%, are self-liquidating and mature January 15, 2012. Debt placement costs of approximately $226,000 have been incurred. The new annual debt service of approximately $532,000 reflects a decrease of approximately $89,000.\ne. A balloon payment of approximately $6,266,000 was originally due June 1, 1994 on a nonrecourse mortgage which encumbered the Holiday Inn in Phoenix, Arizona; however, the Company paid off approximately $2,966,000 on that date and was granted an extension on the remaining balance. The interest rate was 10.75%. On June 27, 1994 the Company refinanced the remaining balance with a nonrecourse mortgage loan in the amount of $3,300,000. The new mortgage loan matures July 27, 1999, bears interest at 10.35% and has a balloon payment due at maturity of approximately $3,120,000. Debt placement costs of approximately $143,000 were incurred. The new annual debt service is approximately $370,000.\nf. On July 25, 1994 the Company obtained financing on the two apartment complexes located in Lexington, Kentucky. The two nonrecourse mortgage loans in the amount of $5,500,000 and $4,500,000 for Stoney Falls and Stoney Brooke Apartments, respectively, bear interest at 8.375% and mature in ten years when balloon payments totaling approximately $8,150,000 will be due. Under the terms of the loans, $100,000 was initially funded on each loan with the balance funded in January 1995. Debt placement costs of approximately $250,000 have been incurred. Annual debt service on the two loans is approximately $956,000.\ng. On December 9 and 23, 1994, the Company prepaid the first and second mortgages, respectively, with aggregate outstanding balances of approximately $3,364,000 which encumbered a property tenanted by Chomerics, Inc. located in Woburn, Massachusetts. The first and second mortgages were scheduled to mature August 1, 2011 and February 1, 2005, respectively, and both bore interest at 13.875%. The first mortgage was callable August 1, 1996.\n9. SENIOR INDEBTEDNESS\nOn May 27, 1988, the Company closed a $50,000,000, 10-year senior unsecured debt financing. The notes bear interest at 9.6%, payable semiannually, 2% of which may be deferred and added to the principal at the Company's option during the first five years. During 1993 $546,842 was added to the principal of the note. In May 1994 and 1995, the Company repaid $10,000,000 and approximately $11,308,000 of the outstanding principal balance of the notes, respectively. The Company is required to make principal repayments of approximately $11,308,000 in each of the years 1996 through 1998.\nThe note agreements also place limitations on the Company with respect to, among other things, additional debt and the use of proceeds from property sales. In addition, distributions and the amounts used to purchase partnership interests cannot exceed cash flow, as defined in the agreements, plus $15,000,000. The Company is also required to maintain, among other things, specified levels of (i) net annual rentals, as defined in the agreements, on properties\nII-37 unencumbered by mortgage financing and (ii) net cash flow.\n10. RIGHTS OFFERING\nA registration statement relating to the Rights Offering was filed with the Securities and Exchange Commission and declared effective February 23, 1995.\nOn March 1, 1995, the Company issued to record holders of its Depositary Units one transferable subscription right (a \"Right\"), for each seven Depositary Units of the Company held on February 24, 1995, the record date. The Rights entitled the holders thereof (the \"Rights Holders\") to acquire during the subscription period at a subscription price of $55, six Depositary Units and one 5% cumulative pay-in-kind redeemable preferred unit representing a limited partner interest (\"Preferred Units\"). The subscription period commenced on March 1, 1995 and expired at the close of business on March 30, 1995.\nThe Preferred Units have certain rights and designations, generally as follows. Each Preferred Unit will have a liquidation preference of $10.00 and will entitle the holder thereof to receive distributions thereon, payable solely in additional Preferred Units, at the rate of $.50 per Preferred Unit per annum (which is equal to a rate of 5% of the liquidation preference thereof), payable annually on March 31 of each year (each, a \"Payment Date\"), commencing March 31, 1996. On any Payment Date commencing with the Payment Date on March 31, 2000, the Company with the approval of the Audit Committee of the Board of Directors of the General Partner may opt to redeem all, but not less than all, of the Preferred Units for a price, payable either in all cash or by issuance of additional Depositary Units, equal to the liquidation preference of the Preferred Units, plus any accrued but unpaid distributions thereon. On March 31, 2010, the Company must redeem all, but not less than all, of the Preferred Units on the same terms as any optional redemption.\n1,975,640 Rights were issued in the Rights Offering of which 418,307 were exercised. 190,554 Depositary Units and 31, 759 Preferred Units were subscribed for through the exercise of the Over-Subscription Privilege by Rights Holders other than High Coast Limited Partnership (\"High Coast\"), a Delaware limited partnership.\nHigh Coast acted as guarantor for the Rights Offering and is an affiliate of Carl C. Icahn, (\"Icahn\"), the Chairman of American Property Investors, Inc., (\"API\"), the general partner of the Company. API is also the general partner of the guarantor and the two limited partners are affiliates of and are controlled by Icahn. Pursuant to its subscription guaranty, High Coast oversubscribed for a total of 9,343,998 Depositary Units and 1,557,333 Preferred Units. As a result, the Rights Offering was fully subscribed. The proceeds received by the Company, after deduction of expenses of approximately $1.1 million incurred by the Company in connection with the Rights Offering, were approximately $107.6 million.\nIn addition, in accordance with the terms of the Company's and its subsidiary's partnership agreements, API was required to contribute $2,206,242 in order to maintain its aggregate 1.99% general partnership interest.\nOn April 12, 1995, the Company received $108,660,200, the gross proceeds of the Rights Offering, from its subscription agent and $2,206,242 from API. The Company issued 1,975,640 Preferred Units and an additional 11,853,840 Depositary Units. Trading in the Preferred Units commenced March 31, 1995 on the New York Stock Exchange (\"NYSE\") under the symbol \"ACP PR\". The Depositary Units trade on the NYSE under the symbol \"ACP\".\nAs of March 6, 1996, High Coast owns 1,741,688 Preferred Units and 12,991,312 Depositary\nII-38 Units.\n11. EARNINGS PER SHARE\nNet earnings per limited partnership unit and equivalent partnership units are computed using the weighted average number of units and equivalent units outstanding during the period. The earnings per share calculation for the year ended December 31, 1995 assumes the Depositary and Preferred Units subscribed for in the Rights Offering were outstanding at the beginning of the year. Also, with respect to the year ended December 31, 1995 calculation, net income has been increased by approximately $2,100,000 in accordance with the modified treasury stock method. The dilutive effect of preferred units and the pro rata quarterly portion of the annual pay-in-kind distribution to preferred Unitholders have been included in the earnings per share calculation, as calculated under the effective yield method, as equivalent depositary units (see Note 10).\n12. RECONCILIATION OF NET EARNINGS PER FINANCIAL STATEMENTS TO TAX REPORTING\nII-39\n13. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER UNIT DATA)\nNet earnings per unit is computed separately for each period and, therefore, the sum of such quarterly per unit amounts may differ from the total for the year.\n(1) Includes the issuance of additional Partnership units and equivalent units in 1995.\n14. COMMITMENTS AND CONTINGENCIES\na. On December 31, 1995, the Company held a mortgage note receivable in the principal amount of $96,938. The mortgage encumbers one property together with a collateral assignment of the ground lease and rent. The property is tenanted by Gino's. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of this property and seven other properties. The tenant has remained current in its lease obligations.\nThe terms of the mortgage called for a balloon payment of $1,100,000 on January 1, 1992 which was not received. On January 9, 1992, the Company gave written notice of default to Sheldon Lowe and Joseph T. Comras, the mortgagors and the current owners at that date of the eight properties. As of December 31, 1995, the Company has commenced\nII-40 foreclosure action on the Gino's property which is located in Pennsylvania. The Company foreclosed on the property in Michigan on October 7, 1993 and real estate with carrying value of approximately $70,000 was recorded in the year ended December 31, 1993. On February 25, 1994 the Company foreclosed on the previously encumbered property formerly tenanted by Lionel Leisure located in Pennsylvania. In September 1994, this property was sold and no gain or loss was incurred upon disposition. In October 1994, the Company foreclosed on two properties located in Massachusetts and real estate with a carrying value of approximately $102,000 was recorded in the year ended December 31, 1994. During the year ended December 31, 1995, the Company completed foreclosure actions on three properties (one in Pennsylvania and two in New Jersey), tenanted by Gino's and Foodarama. As a result, real estate with a carrying value of approximately $256,000 was recorded. No gain or loss was incurred or is anticipated upon foreclosure because the estimated fair value of the properties exceeds their carrying value.\nb. Lockheed Missile and Space Company, Inc. (\"Lockheed\"), a tenant of the Company's leasehold property in Palo Alto, California, has entered into a consent decree with the California Department of Toxic Substances Control (\"CDTS\") to undertake certain environmental remediation at this property. Lockheed has estimated that the environmental remediation costs may be up to approximately $14,000,000. In a non-binding determination by the CDTS, Lockheed was found responsible for approximately 75% of such costs and the balance was allocated to other parties. The Company was allocated no responsibility for any such costs.\nLockheed has served a notice that it may exercise its statutory right to have its liability reassessed in a binding arbitration proceeding. In connection with this notice, Lockheed has stated that it will attempt to have allocated to the Company and to the Company's ground-lessor (which may claim a right of indemnity against the Company) approximately 9% and 17%, respectively, of the total remediation costs. The Company believes that it has no liability for any of such costs, and in any proceeding in which such liability is asserted against it, the Company will vigorously contest such liability. In the event any of such liability is allocated to the Company, it will seek indemnification from Lockheed in accordance with its lease.\nc. On January 25, 1995, the Grand Union Company, a tenant leasing eight properties owned by the Company, filed a prepackaged voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. These eight properties' annual rentals total approximately $1,450,000 (including two properties which are sublet, representing approximately $58,000 in annual rentals). The tenant is current in its obligations under the lease. The tenant rejected the lease on one property located in Waterford, NY effective July 31, 1995 by order of the Bankruptcy Court on June 6, 1995. The annual rent for this property was approximately $103,000. The Company is now actively marketing this property for sale and believes the property's carrying value of $1,057,149 at December 31, 1995 to exceed its estimated net realizable value by $157,149, for which a provision for loss on real estate was recorded in the year then ended.\nIn June 1995, the tenant emerged from Bankruptcy. The tenant affirmed five of the seven remaining leases and allowed the two sub-let property's leases to remain in effect. At December 31, 1995, the carrying value of these seven properties is approximately $11,203,000. One of these properties is encumbered by a nonrecourse mortgage payable of approximately $4,672,000. The Company has filed a proof of claim with the Bankruptcy Court for the rejected lease.\nII-41 d. On June 23, 1995, Bradlees Stores, Inc., a tenant leasing four properties owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The annual rentals for these four properties is approximately $1,320,000. The tenant is current in its obligations under the leases. The tenant has not yet determined whether it will exercise its right to reject or affirm the leases which will require an order of the Bankruptcy Court. There are existing assignors who are still obligated to fulfill all of the terms and conditions of the leases.\nAt December 31, 1995, the carrying value of these four properties is approximately $7,537,000. Two of the properties are encumbered by nonrecourse mortgages payable of approximately $2,031,000.\ne. On September 18, 1995, Caldor Corp., a tenant in a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The annual rental for this property is approximately $248,000. The tenant is current in its obligations under the lease with the exception of approximately $12,000 of prepetition rent. The tenant has not yet determined whether it will exercise its right to reject or affirm the leases which will require an order of the Bankruptcy Court. At December 31, 1995, the property has a carrying value of approximately $2,005,000 and is unencumbered by any mortgage.\n15. PROPERTY HELD FOR SALE\nAt December 31, 1995, the Company owned seven properties that were being actively marketed for sale. At December 31, 1995, these properties have been stated at the lower of their carrying value or net realizable value. The aggregate value of the properties is estimated to be approximately $1,983,000, after incurring a provision for loss on real estate in the amount of $157,149 in the year ended December 31, 1995 (see Note 14c). At December 31, 1994, the aggregate value of the properties was estimated to be approximately $413,000 after incurring a provision for loss on real estate in the amount of approximately $85,000 in the year then ended.\n16. FAIR VALUE OF FINANCIAL INSTRUMENTS\nCash and Cash Equivalents, Accounts Receivable, Construction Loans Payable, Mortgages Payable and Accounts Payable and Accrued Expenses\nThe carrying amount of cash and cash equivalents, accounts receivable, construction loans payable, mortgages payable and accounts payable and accrued expenses are carried at cost, which approximates their fair value.\nMortgages Receivable\nThe fair values of the mortgages receivable past due, in process of foreclosure, or for which foreclosure proceedings are pending, are based on the discounted cash flows of the underlying lease. The fair values of the mortgages receivable satisfied subsequent to year end are based on the amount of the net proceeds received.\nThe fair values of the mortgages receivable which are current are based on the discounted cash flows of their respective payment streams.\nThe approximate estimated fair values of the mortgages receivable held as of December 31, 1995 are summarized as follows:\nII-42\nThe net investment at December 31, 1995 is equal to the carrying amount of the mortgage receivable less any deferred income recorded.\nSenior Indebtedness\nThe approximate fair value and carrying value of the Company's senior indebtedness at December 31, 1995 is $34,106,000 and $33,923,000, respectively. The estimated fair value is based on the amount of future cash flows associated with the instrument discounted using the rate at which the Company believes it could currently replace the senior indebtedness.\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.\n17. DISTRIBUTIONS PAYABLE\nDistributions payable represent amounts accrued and unpaid due to non-consenting investors (\"Non-consents\"). Non-consents are those investors who have not yet exchanged their limited partnership interest in the various Predecessor Partnerships for limited partnership units of American Real Estate Partners, L.P.\n18. SUBSEQUENT EVENTS\na. On January 10, 1996, Rickel Home Centers, Inc., a tenant leasing a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. This property's annual rental totals approximately $90,000. The tenant has not yet determined whether it will exercise its right to reject or affirm the lease which will require an order of the Bankruptcy Court. The tenant is current in its obligations under the lease.\nb. On January 11, 1996, Forte Hotels, Inc. (\"Forte\") a\/k\/a Travelodge, a tenant in a property owned by the Company entered into a Lease Termination and Mutual Release Agreement (\"Agreement\"). This Agreement terminated the lease, which was due to expire on June 30, 1996, effective January 17, 1996 and required Forte to pay the Company $2,800,000 in consideration of the early lease termination and certain deferred maintenance items. In addition, this property was encumbered by two mortgages. The first mortgage with a principal balance of approximately $84,000 was paid off on January 18, 1996. The\nII-43 second mortgage with a principal balance of approximately $231,000 was paid off March 1, 1996.\nAs a result of the above settlement and mortgage payoffs, the Company will recognize \"Other income\" of approximately $2,700,000, net of related costs, in the quarter ended March 31, 1996. The carrying value of this property at December 31, 1995 is approximately $762,000. The Company believes that the carrying value of the asset is fairly stated at December 31, 1995.\nII-44 Item 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nII-45 PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of AREP.\nThe names, offices held and the ages of the directors and executive officers of the General Partner are as follows:\nCarl C. Icahn has been Chairman of the Board of the General Partner since November 15, 1990. He is also President and a Director of Starfire Holding Corporation (formerly Icahn Holding Corporation), a Delaware corporation (\"SHC\") and Chairman of the Board and a Director of various of SHC's subsidiaries, including ACF Industries, Inc., a New Jersey corporation (\"ACF\"). SHC is primarily engaged in the business of holding, either directly or through subsidiaries, a majority of the common stock of ACF and its address is 100 South Bedford Road, Mount Kisco, New York 10549. Mr. Icahn has also been Chairman of the Board of Directors of ACF since October 29, 1984 and a Director of ACF since June 29, 1984. ACF is a railroad freight and tank car leasing, sales and manufacturing company. He has also been Chairman of the Board of Directors and President of Icahn & Co., Inc. since 1968. Icahn & Co., Inc. is a registered broker-dealer and a member of the National Association of Securities Dealers. In 1979, Mr. Icahn acquired control and presently serves as Chairman of the Board of Directors of Bayswater Realty & Capital Corp., which is a real estate investment and development company. ACF, Icahn & Co., Inc. and Bayswater Realty & Capital Corp. are deemed to be directly or indirectly owned and controlled by Carl C. Icahn. Mr. Icahn was Chief Executive Officer and Member of the Office of the Chairman of Trans World Airlines, Inc. (\"TWA\") from November 8, 1988 to January 8, 1993; Chairman of the Board of Directors of TWA from January 3, 1986 to January 8, 1993 and Director of TWA from September 27, 1985 to January 8, 1993. Mr. Icahn also has substantial equity interests in and controls various partnerships and corporations which invest in publicly traded securities.\nAlfred D. Kingsley has served as Director of the General Partner since November 15, 1990. He was also Vice Chairman of the Board of Directors of TWA from February 1, 1989\nIII-1 to January 8, 1993 and a Member of the Office of the Chairman from November 8, 1988 to January 8, 1993. Mr. Kingsley was a Director of TWA from September 27, 1985 to January 8, 1993. He also was a Director and Executive Officer and Director of Research at Icahn & Co., Inc. and related entities from 1968 until December 1994. He also has been Vice Chairman of the Board of Directors of ACF since October 29, 1984 and a Director of ACF since June 29, 1984. Mr. Kingsley has also been a Senior Managing Director of Greenway Partners, L.P. since May 1993, which invests in publicly traded securities.\nMark H. Rachesky, M.D. has served as Director of the General Partner since November 15, 1990 and as Vice President since November 29, 1990. Beginning February 1990, Dr. Rachesky acted as a senior investment advisor to Carl C. Icahn and his affiliated companies and shortly thereafter, he became their chief investment officer. Dr. Rachesky is also the sole Managing Director of Starfire Holding Corporation, which is responsible for substantially all of Mr. Icahn's investment activities. Dr. Rachesky has been a director of Samsonite Corporation since June 1993, and is also a director of Culligan Water Technologies, Inc. since its spin-off from Samsonite in August 1995. From August 1993, Dr. Rachesky has served as a director of Cadus Pharmaceutical Corporation. From June 1987 to February 1990, Dr. Rachesky was employed by an affiliate of the Robert M. Bass Group, Inc. where he was involved in financing and investment activity. Dr. Rachesky is a graduate of the Stanford University School of Medicine and School of Business.\nWilliam A. Leidesdorf has served as Director of the General Partner since March 26, 1991. Since April 1995, Mr. Leidesdorf has acted as an independent real estate investment banker. From January 1, 1994 through April 1995, Mr. Leidesdorf was Managing Director of RFG Financial, Inc., a commercial mortgage company. From September 30, 1991 to December 31, 1993, Mr. Leidesdorf was Senior Vice President of Palmieri Asset Management Group. From May 1, 1990 to September 30, 1991, Mr. Leidesdorf was Senior Vice President of Lowe Associates, Inc., a real estate development company, where he was involved in the acquisition of real estate and the asset management workout and disposition of business areas. He also acted as the Northeast Regional Director for Lowe Associates, Inc. From June 1985 to January 30, 1990, Mr. Leidesdorf was Senior Vice President and stockholder of Eastdil Realty, Inc., a real estate company, where he was involved in the asset management workout, disposition of business and financing areas. During the interim period from January 30, 1990 through May 1, 1990, Mr. Leidesdorf was an independent contractor for Eastdil Realty, Inc. on real estate matters.\nJack G. Wasserman has served as a Director of the General Partner since December 3, 1993. Mr. Wasserman is an attorney and a member of the New York State Bar and has been with the New York based law firm of Wasserman, Schneider & Babb since 1966, where he is currently a senior partner.\nJohn P. Saldarelli has served as Vice President, Secretary and Treasurer of the General Partner since March 18, 1991. Mr. Saldarelli was also President of Bayswater Realty Brokerage Corp. from June 1987 until November 19, 1993 and Vice President of Bayswater Realty & Capital Corp. from September 1979 until April 15, 1993, both of which are deemed to be directly or indirectly owned and controlled by Carl C. Icahn.\nIII-2 William Leidesdorf and Jack G. Wasserman are on the Audit Committee of the Board of Directors of the General Partner.\nEach of Messrs. Icahn and Kingsley served on the Board of Directors of TWA. On January 31, 1992, TWA filed a petition for bankruptcy in the U.S. Bankruptcy Court in Delaware, seeking reorganization under Chapter 11 of the Bankruptcy Code. In connection therewith, the Pension Benefit Guaranty Corporation asserted that there existed in the TWA defined benefit plans an underfunding deficiency, and that if the Plans were terminated, TWA and all members of the controlled group of which TWA was a member, including the General Partner, would be liable, jointly and severally, for approximately $1.2 billion. On January 8, 1993, TWA, the Pension Benefit Guaranty Corporation, Mr. Icahn and the members of the controlled group, among others, settled all claims and potential claims which they had against each other.\nEach executive officer and director will hold office until the next annual meeting of the General Partner and until his or her successor is elected and qualified. Effective June 15, 1993, directors who are not employed by AREP or certain affiliates, receive fees of $3,000 for attendance at each quarterly meeting of the Board of Directors. Mr. Kingsley, Mr. Leidesdorf and Mr. Wasserman each received $12,000 for attendance at meetings in 1995.\nEach of the executive officers of the General Partner performs services for other affiliates of the General Partner.\nThere are no family relationships between or among any of the directors and\/or executive officers of the General Partner.\nIf distributions (which are payable in kind) are not made to the holders of Preferred Units on any two Payment Dates (which need not be consecutive), the holders of more than 50% of all outstanding Preferred Units, including the General Partner and its affiliates, voting as a class, will be entitled to appoint two nominees for the Board of Directors of the General Partner. Holders of Preferred Units owning at least 10% of all outstanding Preferred Units, including the General Partner and its affiliates to the extent that they are holders of Preferred Units, may call a meeting of the holders of Preferred Units to elect such nominees. Once elected, the nominees will be appointed to the Board of Directors of the General Partner by Icahn. As directors, the nominees will, in addition to their other duties as directors, be specifically charged with reviewing all future distributions to the holders of the Preferred Units. Such additional directors shall serve until the full distributions accumulated on all outstanding Preferred Units have been declared and paid or set apart for payment. If and when all accumulated distributions on the Preferred Units have been declared and paid or set aside for payment in full, the holders of Preferred Units shall be divested of the special voting rights provided by the failure to pay such distributions, subject to revesting in the event of each and every subsequent default. Upon termination of such special voting rights attributable to all holders of Preferred Units with respect to payment of distributions, the term of office of each director nominated by the holders of Preferred Units (the \"Preferred Unit Directors\") pursuant to such special voting rights shall terminate and the number of directors constituting the entire Board of Directors shall be reduced by the number of Preferred Unit Directors. The holders of the Preferred Units have no other\nIII-3 rights to participate in the management of AREP and are not entitled to vote on any matters submitted to a vote of the holders of Depositary Units.\nFiling of Reports\nTo the best of AREP's knowledge, no director, executive officer or beneficial owner of more than 10% of AREP's Depositary Units failed to file on a timely basis reports required by Section 16(a) of the Securities Exchange Act of 1934, as amended, during the year ended December 31, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation. (1)\nThe following table sets forth information in respect of the compensation of the Chief Executive Officer and each of the other four most highly compensated executive officers of AREP for services in all capacities to AREP for the fiscal years ended December 31, 1995, 1994 and 1993. (2)\nSUMMARY COMPENSATION TABLE Annual Compensation\n- --------------------\n(1) Pursuant to applicable regulations, certain columns of the Summary Compensation Table and each of the remaining tables have been omitted, as there has been no compensation awarded to, earned by or paid to any of the named executive officers by AREP or by the General Partner, which was subsequently reimbursed by AREP, required to be reported in those columns or tables.\n(2) Carl C. Icahn, the Chief Executive Officer, received no compensation as such for the periods indicated. In addition, other than John P. Saldarelli, no other executive officer received compensation in excess of $100,000 from AREP for the applicable period.\n(3) On March 18, 1991, Mr. Saldarelli was elected Vice President, Secretary and Treasurer of the General Partner. Mr. Saldarelli devotes substantially all of his time to the performance of services for AREP and the General Partner. The other executive officers and directors of the General Partner devote only a portion of their time to performance of services for AREP.\nIII-4 AREP has adopted a Nonqualified Unit Option Plan (the \"Plan\") pursuant to which options to purchase an aggregate of 1,416,910 Depositary Units at an option price equal to the market price on the date of grant may be granted to officers and key employees of the General Partner and AREP who provide services to AREP. To date, no options have been granted under the Plan.\nIn February 1993, AREP adopted a 401K plan pursuant to which AREP will make a matching contribution to an employee's individual plan account in the amount of one-third (1\/3) of the first six (6%) percent of gross salary contributed by the employee.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nAs discussed below, effective February 22, 1995 the General Partner and its affiliates contributed all of their Depositary Units to the Guarantor in exchange for a general partner interest in the Guarantor. As a result, as of February 22, 1995, the Guarantor owned 1,365,768 Depositary Units, or approximately 9.89% of the Depositary Units then outstanding, prior to giving effect to the Rights Offering. There were no outstanding Preferred Units on that date. After giving effect to the Rights Offering, the Guarantor owned 11,689,896 Depositary Units, or approximately 45.6% of the Depositary Units then outstanding, and 1,720,688 Preferred Units, or 87.1% of the Preferred Units then outstanding. The foregoing is exclusive of a 1.99% ownership interest in AREP which the General Partner held by virtue of its 1% General Partner interest in each of AREP and the Subsidiary. In addition, the Guarantor received certain registration rights with respect to its Depositary Units and Preferred Units for providing the subscription guaranty but was not otherwise compensated. Prior to May 1993, Icahn's ownership of the General Partner was through his affiliate, Meadowstar Holding Company, Inc. (\"Meadowstar\"). Meadowstar had originally purchased all of the outstanding shares of common stock of (i) the General Partner and (ii) API Nominee Corp., a Delaware corporation (\"Nominee\"), pursuant to an Acquisition Agreement, dated as of September 13, 1990 (the \"Acquisition Agreement\") between Meadowstar and Integrated Resources, Inc. In May 1993, Icahn purchased all of the outstanding shares of the General Partner from Meadowstar. As a result, Icahn became the beneficial owner of the 1,254,280 Depositary Units owned by the General Partner. Icahn may also be deemed to be the beneficial owner of the 148,962 Depositary Units owned of record by Nominee (the Units owned by Nominee are Depositary Units of holders who have not yet exchanged their limited partner interests) which, in accordance with state law are in the process of being turned over to the relevant state authorities as unclaimed property; however, Icahn disclaims such beneficial ownership. During the fiscal year ended December 31, 1995, the Guarantor acquired 810,416 Depositary Units in open market purchases. As a result of these purchases and subsequent purchases in 1996 to date and after giving effect to the Rights Offering, as of March 20, 1996, the Guarantor owns 12,991,312 Depositary Units, or approximately 50.6% of the outstanding Depositary Units and 1,741,688 Preferred Units or approximately 88.2% of the outstanding Preferred Units.\nThe affirmative vote of Unitholders holding more than 75% of the total number of all Units then outstanding, including Depositary Units held by the General Partner and its\nIII-5 affiliates, is required to remove the General Partner. Thus, since Icahn, through the Guarantor, holds approximately 50.6% of the Depositary Units outstanding after giving effect to the Rights Offering and subsequent purchases to date, the General Partner will not be able to be removed pursuant to the terms of the Partnership Agreement without Icahn's consent. Moreover, under the Partnership Agreement, the affirmative vote of the General Partner and Unitholders owning more than 50% of the total number of all outstanding Depositary Units then held by Unitholders, including the Guarantor, is required to approve, among other things, selling or otherwise disposing of all or substantially all of AREP's assets in a single sale or in a related series of multiple sales, dissolving AREP or electing to continue AREP in certain instances, electing a successor general partner, making certain amendments to the Partnership Agreement or causing AREP, in its capacity as sole limited partner of the Subsidiary, to consent to certain proposals submitted for the approval of the limited partners of the Subsidiary. Accordingly, as the Guarantor holds in excess of 50% of the Depositary Units outstanding, Icahn, through the Guarantor, will have effective control over such approval rights.\nAs of March 20, 1996, to the best knowledge of AREP, Wellington Management Company, a Massachusetts corporation, who filed a Schedule 13-G on January 26, 1996, owns 1,526,546 Depositary Units, or approximately 5.95% of the outstanding Depositary Units.\nThe following table provides information, as of March 20, 1996, as to the beneficial ownership of the Depositary Units and Preferred Units of AREP for each director of the General Partner, and all directors and executive officers of the General Partner as a group.\n- --------------- (1) Carl C. Icahn, through the Guarantor, is the beneficial owner of the 12,991,312 Depositary Units set forth above and may also be deemed to be the beneficial owner of the 148,962 Depositary Units owned of record by API Nominee Corp., which in accordance with state law are in the process of being turned over to the relevant state authorities as unclaimed property; however, Mr. Icahn disclaims such beneficial ownership. The foregoing is exclusive of a 1.99% ownership interest in AREP which the General Partner holds by virtue of its 1% General Partner interest in each of AREP and the Subsidiary, but inclusive of the Depositary Units the Guarantor acquired through the Rights Offering. Furthermore, pursuant to a registration rights agreement entered into by the Guarantor in connection with the Rights Offering, AREP has agreed to pay any expenses incurred in connection with two demand and unlimited piggy-back registrations requested by the Guarantor.\nIII-6 Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nRelated Transactions with the General Partner and its Affiliates\nFor the year ended December 31, 1995, AREP made no payments with respect to the Depositary Units owned by the General Partner. However, in 1995 the General Partner was allocated $699,597 of the income of AREP as a result of its 1.99% general partner interest in AREP.\nIn May 1995, AREP and an affiliate of the General Partner (\"Affiliate\") entered into an agreement with the third-party landlord of its leased executive office space. The agreement provided for AREP and the Affiliate to relocate their offices to an adjacent building also owned by the landlord which relocation occurred in September 1995. In accordance with the agreement, AREP entered into a lease, expiring in 2001, for 7,920 square feet of office space, at an annual rental of approximately $153,000. AREP has sublet to certain affiliates of the General Partner 3,205 square feet at an annual rental of approximately $62,000, resulting in a net annual rental of approximately $91,000. Affiliates of the General Partner reimbursed AREP for approximately $15,000 in rent paid by AREP on its behalf during 1995 in connection with the new lease. The prior lease, which was terminated, provided for approximately 6,900 square feet at an annual rental of $155,000 to AREP. In addition, AREP and the Affiliate received a lease termination fee of $350,000 allocated $175,000 to AREP and $175,000 to the Lessor. Such allocations and the terms of the sublease were reviewed and approved by the Audit Committee of the Board of Directors of the General Partner.\nProperty Management and Other Related Transactions\nThe General Partner and its affiliates benefited from the Rights Offering because, in their capacity as Exercising Rights Holders, they were entitled to the same right to increase their investment in AREP as other Unitholders, including acquiring additional Depositary Units. The Guarantor also received certain registration rights with respect to its Depositary Units and Preferred Units for providing the Subscription Guaranty.\nThe General Partner and its affiliates may receive fees in connection with the acquisition, sale, financing, development and management of new properties acquired by AREP. As development and other new properties are acquired, developed, constructed, operated, leased and financed, the General Partner or its affiliates may perform acquisition functions, including the review, verification and analysis of data and documentation with respect to potential acquisitions, and perform development and construction oversight and other land development services, property management and leasing services, either on a day-to-day basis or on an asset management basis, and may perform other services and be entitled to fees and reimbursement of expenses relating thereto, provided the terms of such transactions are fair and reasonable to AREP in accordance with AREP Agreement and customary to the industry. It is not possible to state precisely what role, if any, the General Partner or any of its affiliates may have in the acquisition, development or management of any new investments. Consequently, it is not\nIII-7 possible to state the amount of the income, fees or commissions the General Partner or its affiliates might be paid in connection with the investment of the Rights Offering proceeds since the amount thereof is dependent upon the specific circumstances of each investment, including the nature of the services provided, the location of the investment and the amount customarily paid in such locality for such services. However, Unitholders may expect that, subject to the specific circumstances surrounding each transaction and the overall fairness and reasonableness thereof to AREP, the fees charged by the General Partner and its affiliates for the services described below generally will be within the ranges set forth below:\n- Property Management and Asset Management Services. To the extent that AREP acquires any properties requiring active management (e.g., operating properties that are not net leased) or asset management services, including on site services, it may enter into management or other arrangements with the General Partner or its affiliates. Generally, it is contemplated that under property management arrangements, the entity managing the property would receive a property management fee (generally 3% to 6% of gross rentals for direct management, depending upon the location) and under asset management arrangements, the entity managing the asset would receive an asset management fee (generally .5% to 1% of the appraised value of the asset for asset management services, depending upon the location) in payment for its services and reimbursement for costs incurred.\n- Brokerage and Leasing Commissions. AREP also may pay affiliates of the General Partner real estate brokerage and leasing commissions (which generally may range from 2% to 6% of the purchase price or rentals depending on location; this range may be somewhat higher for problem properties or lesser-valued properties).\n- Lending Arrangements. The General Partner or its affiliates may lend money to, or arrange loans for, AREP. Fees payable to the General Partner or its affiliates in connection with such activities include mortgage brokerage fees (generally .5% to 3% of the loan amount), mortgage origination fees (generally .5% to 1.5% of the loan amount) and loan servicing fees (generally .10% to .12% of the loan amount), as well as interest on any amounts loaned by the General Partner or its affiliates to AREP.\n- Development and Construction Services. The General Partner or its affiliates may also receive fees for development services, generally 1% to 4% of development costs, and general contracting services or construction management services, generally 4% to 6% of construction costs.\n- Reinvestment Incentive Fees. Subject to the limitations described below, the General Partner is entitled to receive a reinvestment incentive fee (a \"Reinvestment Incentive Fee\") for performing acquisition services equal to a percentage of the purchase price (whether paid in cash, Depositary Units, other securities and\/or with mortgage financing) of properties (other than Predecessor Properties) acquired from July 1, 1987 through July 1, 1997. This percentage is 1% for the first five years and 1\/2% for the second five years. Although a Reinvestment Incentive Fee accrues each time a property is acquired, Reinvestment Incentive Fees are only payable on an annual basis, within 45 days after the end of each calendar year, if the following subordination provisions are satisfied. Reinvestment Incentive Fees accrued in any year will\nIII-8 only be payable if the sum of (x) the sales price of all Predecessor Properties (net of associated debt which encumbered these Properties at the consummation of the Exchange) sold through the end of that year and (y) the appraised value of all Predecessor Properties which have been financed or refinanced (and not subsequently sold), net of the amount of any refinanced debt through the end of that year determined at the time of such financings or refinancings, exceeds the aggregate values assigned to those Predecessor Properties for purposes of the Exchange. If the subordination provisions are not satisfied in any year, payment of Reinvestment Incentive Fees for that year will be deferred. At the end of each year a new determination will be made with respect to subordination requirements (reflecting all sales, financings and refinancings from the consummation of the Exchange through the end of that year) in order to ascertain whether Reinvestment Incentive Fees may be payable irrespective of whether distributions have been made or are projected to be made to Unitholders. Through December 31, 1995, an aggregate of (i) 140 Predecessor Properties were sold or disposed of for an aggregate amount of approximately $69,123,000 net of associated indebtedness which encumbered these Properties at the consummation of the Exchange, and (ii) 25 Predecessor Properties were refinanced at an aggregate appraised value, net of the amount of the refinanced debt, of approximately $44,431,000 for a sum total of approximately $113,554,000. Aggregate appraised values attributable to these Predecessor Properties for purposes of the Exchange were approximately $105,039,000. Accordingly, through December 31, 1995, AREP satisfied the subordination requirements detailed above.\nAREP may also enter into other transactions with the General Partner and its affiliates, including, without limitation, buying and selling properties and borrowing and lending funds from or to the General Partner or its affiliates, joint venture developments and issuing securities to the General Partner or its affiliates in exchange for, among other things, assets that they now own or may acquire in the future, provided the terms of such transactions are fair and reasonable to AREP. The General Partner is also entitled to reimbursement by AREP for all allocable direct and indirect overhead expenses (including, but not limited to, salaries and rent) incurred in connection with the conduct of AREP's business.\nIn addition, employees of AREP may, from time to time, provide services to affiliates of the General Partner, with AREP being reimbursed therefor. Reimbursement to AREP by such affiliates in respect of such services is subject to review and approval by the Audit Committee of the Board of Directors of the General Partner. In 1995 such amounts were approximately $86,000, which reimbursement was approved by the Audit Committee of the General Partner.\nThe Audit Committee of the Board of Directors of the General Partner meets on an annual basis, or more often if necessary, to review any conflicts of interest which may arise, including the payment by AREP of any fees to the General Partner or any of its affiliates. The General Partner and its affiliates may not receive duplicative fees.\nIII-9 Nonqualified Unit Option Plan\nAREP has adopted the Plan, under which options to purchase an aggregate of 1,416,910 Depositary Units may be granted to officers and key employees of the General Partner and AREP who provides services to AREP. To date, no options have been granted under the Plan. See Item 11 - \"Executive Compensation.\"\nIII-10 Part 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 American Real Estate Partners, L.P. are included in Part II, Item 8:\nAll other Financial Statement schedules have been omitted because the required financial information is not applicable or the information is shown in the Financial Statements or Notes thereto.\n(a)(3) Exhibits:\nIV-1\nIV-2\nIV-3\n(b) Reports on Form 8-K:\n(1) AREP filed a Current Report on Form 8-K (the \"Form 8-K\") with the Securities and Exchange Commission on March 16, 1995. Pursuant to Item 5 of the Form 8-K, AREP released its earnings for the fourth quarter and fiscal year ended December 31, 1995 and also announced that no distribution would be made for the fiscal quarter ending March 31, 1996.\n(2) AREP filed a Current Report on Form 8-K (the \"Form 8-K\") with the Securities and Exchange Commission on December 4, 1995. Pursuant to Item 5 of the Form 8-K, AREP announced that no distribution would be made for the fourth quarter of 1995 and that no distributions are expected to be made in 1996.\nIV-4\nAMERICAN REAL ESTATE PARTNERS, LP a limited partnership Schedule III ------------\nREAL ESTATE OWNED AND REVENUES EARNED ------------- -------------- --------------\nIV-5 AMERICAN REAL ESTATE PARTNERS, LP a limited partnership Schedule III ------------ REAL ESTATE OWNED AND REVENUES EARNED ------------- -------------- --------------\nIV-6 AMERICAN REAL ESTATE PARTNERS, LP a limited partnership Schedule III ------------ REAL ESTATE OWNED AND REVENUES EARNED ------------- -------------- --------------\nIV-7 AMERICAN REAL ESTATE PARTNERS, LP a limited partnership Schedule III ------------ REAL ESTATE OWNED AND REVENUES EARNED ------------ -------------- ---------\nIV-8 AMERICAN REAL ESTATE PARTNER, LP a limited partnership Schedule III ------------ REAL ESTATE OWNED REVENUES EARNED ------------- ------------ -----------\nIV-9 AMERICAN REAL ESTATE PARTNERS, LP a limited partnership Schedule III ------------ REAL ESTATE OWNED AND REVENUES EARNED --------------- -------------- ----------\n(1) Amount shown includes hotel operating properties.\n(2) The Company owns a 70% interest in the joint venture which owns this property.\n(3) The Company owns a 90% interest in the joint venture which owns this property.\nIV-10\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1995\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\n3. The aggregate cost of real estate owned for Federal income tax purposes is $376,471,538.\n(Continued)\nIV-11\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1995\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\n(Continued)\nIV-12\nSchedule III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1994\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\n3. The aggregate cost of real estate owned for Federal income tax purposes is $402,624,341.\n(Continued)\nIV-13\nSchedule III Page 8.1\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1994\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\n(Continued)\nIV-14\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1993\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nThe aggregate cost of real estate owned for Federal income tax purposes is $398,245,532.\n(Continued)\nIV-15\nSCHEDULE III PAGE 9.1\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1993\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\n(Continued)\nIV-16 Schedule III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1995 - -------------------------------------------------------------------------------\n(Continued)\nIV-17 Schedule III Page 10.1\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND RESERVE FOR DEPRECIATION BY STATE (ACCOUNTED FOR UNDER THE OPERATING METHOD) DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation ----- --------------- ------------ [S] [C] [C] Alabama $ 11,459,096 $ 265,568 Arizona 9,028,875 1,141,233 California 13,574,684 3,861,125 Connecticut 1,549,805 1,070,864 Florida 13,772,389 5,122,422 Georgia 7,750,258 797,977 Illinois 8,850,494 3,065,734 Indiana 8,635,584 2,954,479 Kansas 460,490 - Kentucky 14,851,240 1,052,938 Louisiana 11,313,683 2,479,819 Maryland 1,864,304 565,688 Massachusetts 2,916,915 1,429,333 Michigan 12,649,448 2,865,957 Minnesota 8,023,299 1,722,126 Missouri 1,946,471 323,448 New Jersey 4,437,341 1,489,539 New York 23,410,097 4,944,535 North Carolina 8,580,112 1,120,666 Ohio 3,635,082 357,702 Oregon 298,451 - Pennsylvania 10,386,463 6,045,388 South Carolina 3,101,170 907,373 Tennessee 335,367 205,951 Texas 4,302,872 2,810,501 Virginia 1,986,638 975,491 Washington 4,190,631 1,830,477 ------------ -----------\n$ 193,311,259 $ 49,406,334 ============ ===========\n(Continued)\nIV-18\nSchedule III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1994 - --------------------------------------------------------------------------------\n(Continued)\nIV-19 Schedule III Page 11.1\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED AND RESERVE FOR DEPRECIATION BY STATE (ACCOUNTED FOR UNDER THE OPERATING METHOD) DECEMBER 31, 1994 - --------------------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation ----- --------------- ------------ [S] [C] [C] Alabama $ 1,707,913 $ - Arizona 8,661,230 780,739 California 13,574,684 3,702,517 Connecticut 1,549,805 1,027,553 Florida 14,474,746 5,007,024 Georgia 8,219,782 612,349 Illinois 8,849,567 2,836,885 Indiana 8,635,584 2,645,196 Kansas 460,490 - Kentucky 14,470,363 691,180 Louisiana 12,638,536 2,975,581 Maryland 1,864,304 518,658 Massachusetts 2,916,915 1,349,837 Michigan 19,225,223 3,394,696 Minnesota 7,072,018 1,474,020 Missouri 1,946,471 289,549 New Jersey 4,293,403 1,471,681 New York 22,393,357 5,858,402 North Carolina 3,191,685 1,030,096 Ohio 3,635,192 299,308 Oregon 298,451 - Pennsylvania 10,273,909 5,843,239 South Carolina 3,101,170 857,047 Tennessee 335,368 196,998 Texas 4,302,872 2,730,561 Virginia 1,986,638 948,210 Washington 4,190,632 1,337,294 Canada 1,057,300 356,102 ------------ -----------\n$ 185,327,608 $ 48,234,722 ============ ===========\n(Continued)\nIV-20\nSchedule III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1993 - --------------------------------------------------------------------------------\n(Continued)\nIV-21 Schedule III Page 12.1\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY\nREAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1993 - --------------------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation ----- --------------- ------------ [S] [C] [C] Alabama $ 736,694 $ 87,325 Arizona 8,419,901 432,415 California 12,931,574 3,463,370 Connecticut 1,549,805 965,696 Florida 14,636,201 4,438,112 Georgia 9,238,378 1,029,031 Illinois 8,850,494 2,604,653 Indiana 8,635,584 2,410,912 Kansas 460,490 - Kentucky 7,860,177 389,534 Louisiana 13,125,806 2,884,385 Maryland 1,238,325 474,818 Massachusetts 2,814,867 1,270,340 Michigan 19,225,223 3,044,807 Minnesota 6,776,010 1,243,786 Missouri 2,335,344 455,296 New Jersey 4,293,403 1,434,545 New York 21,711,796 5,430,334 North Carolina 1,591,685 1,008,960 Ohio 3,876,312 351,221 Oregon 298,451 - Pennsylvania 10,274,362 5,531,108 South Carolina 3,101,170 806,722 Tennessee 449,753 248,129 Texas 4,384,018 2,650,621 Virginia 1,986,638 920,929 Washington 4,190,632 1,129,111 Canada 1,057,300 334,624 ------------ -----------\n$ 176,050,393 $ 45,040,784 ============ ===========\nIV-22 SIGNATURES\nPursuant to the requirements of Section 13 or 15(a) of the Securities Exchange Act of 1934, AREP has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 31st day of March, 1996.\nAMERICAN REAL ESTATE PARTNERS, L.P.\nBy: AMERICAN PROPERTY INVESTORS, INC. General Partner\nBy: \/s\/ Carl C. Icahn --------------------------------- Carl C. Icahn Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of AREP and in the capacities and on the dates indicated.\nEXHIBIT INDEX -------------\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"102710_1995.txt","cik":"102710","year":"1995","section_1":"Item 1 Business\nValley Resources, Inc. (the \"Corporation\") is a holding company organized in 1979 and incorporated in the State of Rhode Island. The Corporation has six wholly-owned active subsidiaries: Valley Gas Company (\"Valley Gas\") and Bristol & Warren Gas Company (\"Bristol\")--regulated natural gas distribution companies; Valley Appliance and Merchandising Company (\"VAMCO\")--a merchandising and appliance rental company; Valley Propane, Inc. (\"Valley Propane\") and The New England Gas Company (\"New England Gas\")--retail propane companies; and Morris Merchants, Inc. (d\/b\/a \"The Walter F. Morris Company\")--a wholesale distributor of franchised lines in plumbing and heating contractor supply and other energy related business.\nThe headquarters for the Corporation and the sales and service offices of Valley Gas, VAMCO and Valley Propane are located in Cumberland, Rhode Island. Morris Merchants, Inc.'s sales and warehouse facilities are located in Canton, Massachusetts. The operation center of Bristol and New England Gas is located in Bristol, Rhode Island.\nBristol, acquired by the Corporation on April 1, 1992, was incorporated in the State of Rhode Island in 1953 to distribute natural gas to customers in Bristol & Warren, Rhode Island. New England Gas, also acquired by the Corporation in April 1992, was incorporated in the State of Rhode Island in 1992. New England Gas markets propane at retail in Rhode Island.\nEffective September 1995, all propane sales and service will be consolidated into a single operation under the name Valley Propane. The New England Gas Company became inactive.\nFinancial information about industry segments appearing on page 28 of the Annual Report to Stockholders for the year ended August 31, 1995 is incorporated herein by reference.\nThe Corporation does not expect any material effects on its business as a result of compliance with environmental regulations.\nThe Corporation and its subsidiaries had 237 employees at August 31, 1995, of which 60 were covered by a collective bargaining agreement with the Utility Workers Union of America, AFL-CIO, Local No. 472 expiring March 31, 1997 and 8 were covered by a collective bargaining agreement with the Service Employee International Union, AFL-CIO, Local No. 134 expiring May 31, 1996.\nUtility Operations\nGas Sales and Transportation\nThe Corporation's utility operations are conducted through Valley Gas and Bristol (the \"utilities\"). They had an average of 60,698 customers during the twelve months ended August 31, 1995, of which approximately 91% were residential and 9% were commercial and industrial.\nThe utilities provide natural gas service to residential, commercial and industrial customers. Valley Gas' service territory is approximately 92 square miles located in the Blackstone Valley region in northeastern Rhode Island with a population of approximately 250,000. Bristol's service territory is approximately 15 square miles in eastern Rhode Island with a population of approximately 35,000.\nThe following table shows the distribution of gas sold during the years since 1991 in millions of cubic feet (\"MMcf\"):\nFirm customers of the utilities use gas for cooking, heating, water heating, drying and commercial\/industrial processing. Certain industrial customers use additional gas in the summer months when it is available at lower prices. These customers are subject to having their service interrupted at the discretion of the utilities with very little notice. This use is classified as seasonal use. As discussed further below, the margin on the Valley Gas seasonal use is passed through the Purchased Gas Price Adjustment (\"PGPA\") to lower the cost of gas to all categories of firm customers.\nThe primary source of utility revenues is firm use customers under tariffs which are designed to recover a base cost of gas, administrative and operating expenses and provide sufficient return to cover interest and profit. Valley Gas also services dual fuel, interruptible and transportation customers under rates approved by the Rhode Island Public Utilities Commission (\"RIPUC\"). Additionally, Valley Gas services two cogeneration customers (one firm use customer and the other a firm off-peak transportation customer) under separate contract rates that were individually approved by the RIPUC. Bristol also has approved interruptible tariffs.\nThe utilities tariffs include a PGPA which allows an adjustment of rates charged to customers in order to recover all changes in gas costs from stipulated base gas costs. The PGPA provides for an annual reconciliation of total gas costs billed with the actual cost of gas incurred. Any excess or deficiency in amounts collected as compared to costs incurred is deferred and either reduces the PGPA or is billed to customers over subsequent periods. All margins from Valley Gas interruptible customers are returned to firm customers through the workings of the PGPA. Effective with the new rate structure approved by the RIPUC, (see \"Rates and Regulation\"), Bristol will return all seasonal margins through the PGPA.\nThe utility revenues of Valley Gas include a surcharge on firm gas consumption to collect a portion of the costs to fund postretirement medical and life insurance benefits above the pay-as-you-go costs included in base tariffs. The surcharge was authorized by the RIPUC in a generic rate proceeding and are being phased in over a ten-year period which commenced September 1, 1993. Effective November 1995, the current year funding of postretirement medical and life insurance benefits will be included in base tariffs. Any funding shortages from the first two years of the phase-in will be recovered through a surcharge in the last seven years.\nThe prices of alternative sources of energy impact the interruptible and dual fuel markets. The utilities serve these customers in the nonpeak periods of the year or when competitively priced gas supplies are available. These customers are subject to service discontinuance on short notice as system firm requirements may demand. Prices for these customers are based on the price of the customers' alternative fuel. In order to mitigate the volatility of earnings from interruptible and dual fuel sales Valley Gas rolls into the PGPA the margin earned on these interruptible sales and all margins in excess of $1 per thousand cubic feet (\"Mcf\") of gas sold to dual fuel customers. This margin credit reduces rates to the Company's firm customers. This means of margin treatment\nalleviates the negative impact that swings in sales can have on earnings in the highly competitive industrial interruptible market.\nRates and Regulation\nThe utilities are subject to regulation by the RIPUC with respect to rates, adequacy of service, issuance of securities, accounting and other matters.\nOn January 19, 1995, Valley Gas and Bristol filed revised tariffs with the RIPUC to consolidate their rate structure and to increase their combined annual revenues. On October 18, 1995, the RIPUC authorized the companies to adjust their tariffs to collect $1.2 million or 2.0%. These rates became effective November 21, 1995.\nGas Supply and Storage\nThe Federal Energy Regulatory Commission (\"FERC\") in 1992 issued its order No. 636, the primary purpose of which was to promote competition in the natural gas industry by requiring all interstate pipelines to separate or \"unbundle\" their all-encompassing firm gas sales service to public utilities into its five component parts: production, sales, aggregation, storage and transportation.\nAs a result, local utility companies converted from firm pipeline sales to firm pipeline transportation, and began purchasing their gas directly from producers and marketers in a highly competitive free marketplace. In order to facilitate the procurement of this supply, Valley Gas became a charter member of the Mansfield Consortium (the \"Consortium\"). The Consortium is a group of five New England gas distribution companies which purchases natural gas from producers and marketers based upon the combined demand and marketpower of its members. The Consortium members believe that the most significant benefits to its firm sales customers are reduced gas costs and enhanced security of supply.\nTennessee Gas Pipeline Company is the major natural gas transporter for Valley Gas under long-term contracts. Bristol's principal gas transporters are Algonquin Gas Transmission Company and Texas Eastern Transmission Corporation. The utilities purchase natural gas from several suppliers on a long-term firm basis, as well as on the spot market whenever available. Valley Gas has entered into firm contracts with four domestic and two Canadian suppliers for the purchase of 21,402 dekatherms per day; Bristol has contracted for 3,000 dekatherms per day.\nValley Gas is an investor in Boundary Gas, Inc. and a customer of Alberta Northeast, Limited, both of which were founded by groups of gas distribution companies in the northeast to import gas from Canada.\nSupplementing their firm and spot gas supplies, the utilities have contracted for firm long-term availability and delivery of underground storage gas. Both utilities store natural gas with Consolidated Natural Gas Company and National Fuel Gas Supply Corporation. Natural gas is injected into storage facilities in Pennsylvania and New York during the non-winter months when supply and pipeline capacity exceed customer demand, and this gas is used in the cold weather months when customer demand is high.\nIn addition to gas delivered by the interstate pipelines, both utilities have on-site storage facilities for liquid propane gas (\"LPG\"). Valley Gas also has on-site storage for liquefied natural gas (\"LNG\"), and both utilities backhaul LNG from Distrigas of Massachusetts Corporation. The LPG and LNG from storage are vaporized into the companies' distribution systems during periods of peak demand. Valley Gas also leases additional space for LNG from Algonquin LNG, Inc. in Providence, Rhode Island. Valley Gas' contract with a transportation customer allows Valley to access up to 527 Mcf per hour of additional natural gas supply during periods of peak demand.\nCompetition and Marketing\nThe primary competition faced by the utilities is from other energy sources, primarily heating oil. The principal considerations affecting a customer's selection among competing energy sources include price, equipment cost, reliability, ease of delivery and service. In addition, the type of equipment already installed in businesses and residences significantly affects the customer's choice of energy. However, where previously installed equipment is not an issue, households in recent years have consistently preferred the installation of gas heat. For example, Valley Gas' statistics indicate that approximately 90% of the new homes built on or near Valley Gas' service mains in recent years have selected gas as their energy source.\nThe utilities are pursuing new markets believed to have the potential to provide both growth and\/or lessen sales sensitivity to weather: industrial processing, cogeneration, natural gas vehicles and conversions from oil to gas.\nValley Gas received approval from the RIPUC for two rates which promote economic development in its service territory. These rates provide incentives for companies that add industrial processing load, make a substantial investment in new natural gas equipment and hire additional employees.\nThe cogeneration market is addressed through sales contacts with customers who have applications suitable to use waste heat through the cogeneration process. Valley Gas established rate tariffs to specifically address the requirements of the cogeneration market. In addition, Valley Gas has a 50 kilowatt demonstration facility at its Cumberland location which provides electricity for computer facilities and hot water requirements.\nValley Gas installed a compressed natural gas (\"CNG \") fueling station at its Cumberland headquarters. The use of natural gas in vehicles will be promoted through conversion of its own fleet and the CNG rate approved by the RIPUC.\nThe focus of the residential marketing department to increase conversions from oil to natural gas is in the installations of conversion burners and a continuous effort in the replacement market of housing developments that did not choose natural gas. Additional efforts are spent to convert homes with inactive natural gas service.\nSeasonality\nThe bulk of firm sales are made during the months of November through March. As a result, the highest levels of earnings and cash flow are generated from the quarters ending in February and May. The bulk of the capital expenditure programs are undertaken during the months of May through October, causing cash flow to be at its lowest during the quarters ending in November and August.\nShort-term borrowing requirements vary according to the seasonal nature of sales and expense activities of the utilities, creating greater need for short-term borrowings during periods when internally generated funds are not sufficient to cover all capital and operating requirements, particularly in the summer and fall. Short-term borrowings utilized for construction expenditures generally are replaced by permanent financing when it becomes economical and practical to do so and where appropriate to maintain an acceptable relationship between borrowed and equity resources.\nGas Distribution System\nValley Gas' distribution system consists of approximately 900 miles of gas mains and service lines. Bristol's gas distribution system consists of approximately 100 miles of gas mains. The aggregate maximum daily quantity of gas that may be distributed through the utilities from its own facilities and under existing supply and transportation contracts is approximately 100 MMcf, and the maximum daily gas sendouts for all sales customers of the utilities during the last five fiscal years were 66 MMcf in 1995, 77 MMcf in 1994, 69 MMcf in 1993, 67 MMcf in 1992, and 55 MMcf in 1991.\nAppliance Contract Sales and Rentals\nThe Corporation conducts appliance, contract sales and rentals through its subsidiaries VAMCO and Morris Merchants. VAMCO's revenues are generated through retail appliance sales, service contract sales and through the rental of gas-fired appliances. Morris Merchants sells at wholesale gas- and oil-fired equipment and plumbing and heating supplies.\nMorris Merchants has contracts for the distribution of certain lines that it wholesales. At this time the Corporation has no reason to believe it will lose any of its existing lines. Morris Merchants is not dependent on any one of the existing lines.\nPropane Operations\nThe propane operations are conducted through Valley Propane and New England Gas. Both companies sell, at retail, liquid propane gas to residential and commercial customers in Rhode Island and nearby Massachusetts. At August 31, 1995, the propane companies had 2,310 customers. Valley Propane also supplies propane to holding customers of Valley Gas; these customers are serviced by Valley Propane until Valley Gas can connect mains and service lines. The propane subsidiaries are also impacted by weather, as a large percentage of their customers use propane as a primary source of heat. Valley Propane and New England Gas increase and decrease the selling price of their gas depending upon supply and competition.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties\n1595 Mendon Road, Cumberland, Rhode Island Office, Sales, and Service Center\nThis location comprises the headquarters, sales and service operation of the Corporation, Valley Gas, VAMCO and Valley Propane; and includes accounting, billing, credit, engineering, garage, maintenance, service, storeroom and construction. The facilities are considered suitable and adequate for the Corporation.\n425 Turnpike Street Canton, Massachusetts Office and Warehouse Facilities\nMorris Merchants, Inc. conducts its business at this leased warehouse and office building in Canton, MA. Its business does not require any special facilities and, therefore, its leased facilities are not significant to its operation. The total lease payments are less than 1 percent of corporate assets. Walter F. Morris, previously a member of the Board of Directors, owns 50 percent of a corporation which leases warehouse and office facilities to Morris Merchants, Inc., a subsidiary of the Corporation, at an annual rental of $153,300.\nScott Road, Cumberland, Rhode Island LNG Storage Plant Propane Storage Plant\nThis facility is used for the storage of LNG and propane used in the peak-shaving operations of Valley Gas. Its daily delivery capacity of LNG and LPG is 1,500 Mcf's and 12,000 Mcf's, respectively. Facility improvements which will be completed during the fall of fiscal 1996 will double the delivery capacity for LNG.\n25 Gooding Avenue Bristol, Rhode Island Office, Sales and Service Center\nThis leased location comprises the office, sales and service operation of Bristol and New England Gas and includes construction, credit, engineering, garage, maintenance, service, and storeroom. The leased facilities are not significant to its operations and the total lease payments are less than 1 percent of corporate assets. In December 1995, Bristol will relocate its operations to a newly constructed facility at 100 Broad Common Road, Bristol, Rhode Island. The new facility will comprise the office, sales and service operation which include construction, credit, garage, service and storeroom.\nBrown Street Warren, Rhode Island Propane Storage\nThis facility is used for the storage of propane used in peak-shaving operations of Bristol. Its daily delivery capacity of LPG is 1,600 Mcf's.\nThe Corporation believes its storage facilities are adequate to meet the needs of the utilities for the foreseeable future.\nAll of the storage facilities are owned. All Valley Gas properties, except leased property, are held in fee.\nSee item 1 for discussion of gas supply.\nItem 3","section_3":"Item 3 Legal Proceedings\nThere were no material legal proceedings pending to which the registrant or any of its subsidiaries is a party, or of which any of their property is the subject, except two claims that were asserted against Valley Gas Company as referred to in Note H, page 27, of the 1995 Annual Report to Stockholders which is incorporated by reference.\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 position of all the executive officers of the registrant on October 15, 1995 are listed below together with their business experience during the past five years. All officers of Valley Resources, Inc. are elected or appointed annually by the board of directors at the directors' first meeting following the Annual Meeting of Stockholders.\nBusiness Experience Name Age Position During Last Five Years\nAlfred P. Degen 48 President and President since July Chief Executive 1994 and Chief Executive Officer Officer since March 1995; Executive Vice President- Acting President of Philadelphia Gas Works prior to July 1994.\nKenneth W. Hogan 50 Senior Vice President, Senior Vice President Chief Financial Officer since July 1994; Vice and Secretary President since August 1984; Chief Financial Officer since December 1994 and Secretary since April 1977.\nPART II\nItem 5","section_5":"Item 5 Market for the Registrant's Securities and Related Stockholder Matters\nCommon stock market prices, number of common stockholders, dividends declared and dividend restrictions appearing on pages 14 and 23 of the Annual Report to Stockholders for the fiscal year ended August 31, 1995 are incorporated herein by reference. The common stock of Valley Resources, Inc. is listed on the American Stock Exchange under the symbol VR.\nItem 6","section_6":"Item 6 Selected Financial Data\nThe selected financial data (Summary of Consolidated Operations) appearing on page 34 of the Annual Report to Stockholders for the fiscal year ended August 31, 1995 is incorporated herein by reference.\nItem 7","section_7":"Item 7 Management's Discussion and Analysis\nManagement's discussion and analysis of the results of operations, liquidity and capital resources appearing on pages 30 through 33 of the Annual Report to Stockholders for the fiscal year ended August 31, 1995 are incorporated herein by reference.\nItem 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplementary Data\nThe following consolidated financial statements of the registrant and its subsidiaries appearing on pages 16 through 29 in the Annual Report to Stockholders for the fiscal year ended August 31, 1995 are incorporated herein by reference:\nConsolidated Statements of Earnings for each of the three years in the period ended August 31, 1995\nConsolidated Balance Sheets - August 31, 1995 and 1994\nConsolidated Statements of Cash Flows for each of the three years in the period ended August 31, 1995\nConsolidated Statements of Changes in Common Stock Equity for each of the three years in the period ended August 31, 1995\nConsolidated Statements of Capitalization - August 31, 1995 and 1994\nNotes to Consolidated Financial Statements\nReport of Independent Certified Public Accountants\nItem 9","section_9":"Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors and Executive Officers of the Registrant\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.\nInformation regarding the directors of the registrant appearing on pages 2 through 6 of the Proxy Statement filed with the Securities and Exchange Commission on November 7, 1995 is incorporated herein by reference.\nBased solely upon a review of copies of Forms 3, 4 and 5 furnished to the Corporation pursuant to Rule 16a-3(e), the Corporation believes that each of the Corporation's directors, officers and beneficial owners of more than 10% of any class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 (the \"Exchange Act\") have timely filed all reports required by Section 16(a) of the Exchange Act during the most recent two fiscal years.\nItem 11","section_11":"Item 11 Executive Compensation\nInformation regarding management compensation appearing on pages 7 through 11 of the Proxy Statement filed with the Securities and Exchange Commission on November 7, 1995 is incorporated herein by reference.\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management\nInformation regarding the beneficial owners of more than 5 percent of the outstanding Common Stock of the Corporation, being the only class of equity security issued and outstanding, and the security ownership of management appearing on pages 1 and 2 of the Proxy Statement filed with the Securities and Exchange Commission on November 7, 1995 is incorporated herein by reference.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14","section_14":"Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. The following consolidated financial statements of Valley Resources, Inc. and subsidiaries appearing on pages 16 through 29 in the Annual Report to Stockholders for the year ended August 31, 1995 are incorporated by reference in Item 8:\nConsolidated Statements of Earnings for each of the three years in the period ended August 31, 1995\nConsolidated Balance Sheets - August 31, 1995 and 1994\nConsolidated Statements of Cash Flows for each of the three years in the period ended August 31, 1995\nConsolidated Statements of Changes in Common Stock Equity for each of the three years in the period ended August 31, 1995\nConsolidated Statements of Capitalization - August 31, 1995 and 1994\nNotes to Consolidated Financial Statements\nReport of Independent Certified Public Accountants\n(a) 2. Consolidated Financial Schedule\nSchedule VIII - Valuation and Qualifying Accounts\nSchedules I, II, III, IV, V, VI, VII, IX, X, XI, XII, XIII and XIV are either inapplicable or not required or the required information is shown in the financial statements or notes thereto under the instructions and have been omitted.\nReport of Independent Certified Public Accountants on Consolidated Financial Schedule\n(a) 3. Exhibits\n3. Articles of Incorporation and Bylaws (Exhibit 3 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1988 is incorporated herein by reference.)\n4. Indenture of First Mortgage dated as of December 15, 1992 between Valley Gas Company, Valley Resources, Inc. as guarantor and State Street Bank and Trust Company, Trustee (Exhibit 4 to the Corporation's Annual Report on Form 10-K for the year-ended August 31, 1993 is hereby incorporated by reference.)\n10. Compensation Contracts or Arrangements\n10. (a) Valley Gas Company Supplemental Retirement Plan (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1989 is hereby incorporated by reference.)\n10. (b) Valley Resources, Inc. 1988 Executive Incentive Plan (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1989 is hereby incorporated by reference.)\n10. (c) Termination agreement between Valley Resources, Inc. and Kenneth W. Hogan (Exhibit 10 to the Corporation's Registration Statement on Form S-2 (File No. 2-99315) is hereby incorporated by reference.)\n10. (d) Valley Resources, Inc. Directors Retirement Plan. (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1992 is hereby incorporated by reference.)\n10. (e) Termination agreement dated June 21, 1995 between Valley Resources, Inc. and Alfred P. Degen.\n10. Other Material Contracts\n10. (f) Firm Storage Service Transportation contract between Valley Gas and Tennessee Gas Pipeline Company, dated December 15, 1985 (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1986 is hereby incorporated by reference.)\n10. (g) Storage Service Agreement dated July 3, 1985 between Valley Gas Company and Consolidated Gas Transmission Corporation (Exhibit 10 to the Corporation's Registration Statement on Form S-2 (File No. 2-99315) is hereby incorporated by reference.)\n10. (h) Underground Storage Service Agreement dated October 3, 1984 between Valley Gas Company and Penn-York Energy Corporation (Exhibit 10 to the Corporation's Registration Statement on Form S-2 (File No. 2-99315) is hereby incorporated by reference.)\n10. (i) Underground storage service agreement dated August 19, 1983 between Valley Gas Company and Penn-York Energy Corporation (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1983 is hereby incorporated by reference.\n10. (j) Service agreement for storage of LNG dated June 30, 1982 between Valley Gas Company and Algonquin LNG, Inc. (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1982 is hereby incorporated by reference.)\n10. (k) Contract for the purchase of natural gas dated March 1, 1981, between Valley Gas Company and Tennessee Gas Pipeline Company (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1981 is hereby incorporated by reference.)\n10. (l) Storage Service Transportation contract dated May 15, 1981, between Valley Gas Company and Tennessee Gas Pipeline Company (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1981 is hereby incorporated by reference.)\n10. (m) Storage Service Transportation contract dated May 26, 1981, between Valley Gas Company and Tennessee Gas Pipeline Company (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1981 is hereby incorporated by reference.)\n10. (n) Storage Service Agreement dated February 18, 1980, between Valley Gas Company and Consolidated Gas Supply Corporation (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1981 is hereby incorporated by reference.)\n10. (o) Loan Agreement dated July 18, 1991 between Valley Resources, Inc. and Fleet National Bank (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1991 is hereby incorporated by reference.)\n10. (p) Gas Sales Agreement dated June 15, 1992 between Aquila Energy Marketing Corporation and Valley Gas Company. (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1992 is incorporated herein by reference.)\n10. (q) Gas Sales Agreement dated June 8, 1992 between Natural Gas Clearinghouse and Valley Gas Company. (Exhibit 10 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1992 is incorporated herein by reference).\n13. Annual Report to Stockholders.\n21. Subsidiaries of the Registrant. (Exhibit 21 to the Corporation's Annual Report on Form 10-K for the year ended August 31, 1993 is incorporated herein by reference.)\n23. Consent of Grant Thornton LLP.\n27. Financial Data Schedule.\n(b) Form 8-K was not required to be filed for 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.\nVALLEY RESOURCES, INC. AND SUBSIDIARIES\nDate: November 27, 1995 By S\\K. W. Hogan Kenneth W. Hogan Senior Vice President, Chief Financial Officer & Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: November 27, 1995 S\/A. P. Degen Alfred P. Degen, President and Chief Executive Officer\nDate: November 27, 1995 S\\K. W. Hogan Kenneth W. Hogan, Senior Vice President, Chief Financial Officer & Secretary\nDate: November 27, 1995 S\\E. N. Agresti Ernest N. Agresti, Director\nDate: November 27, 1995 Melvin G. Alperin, Director\nDate: November 27, 1995 C. Hamilton Davison, Director\nDate: November 27, 1995 S\\D. A. DeAngelis Don A. DeAngelis, Director\nDate: November 27, 1995 James M. Dillon, Director\nDate: November 27, 1995 S\\J. K. Farnum Jonathan K. Farnum, Director\nDate: November 27, 1995 S\\J. F. Guthrie, Jr. John F. Guthrie, Jr., Director\nDate: November 27, 1995 Eleanor M. McMahon, Director\nVALLEY RESOURCES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nSCHEDULE VIII\nFiscal Years Ended August 31, 1995, 1994 and 1993\nReport of Independent Certified Public Accountants on Consolidated Financial Schedule\nTo the Shareholders of Valley Resources, Inc.\nIn connection with our audit of the consolidated financial statements of Valley Resources, Inc. and subsidiaries referred to in our report dated September 22, 1995 (except for Note G, as to which the date is October 18, 1995), which is included in the Annual Report to Stockholders and incorporated by reference in Part II of this form, we have also examined the schedule listed in the index at Part IV, Item 14(a)2. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nGRANT THORNTON LLP\nBoston, Massachusetts September 22, 1995 (Except for Note G, as to which date is October 18, 1995)","section_15":""}
{"filename":"811714_1995.txt","cik":"811714","year":"1995","section_1":"ITEM 1. BUSINESS\nOsborn Communications Corporation (the 'Company') was organized in 1984 and is a broadcasting company primarily engaged in the operation of radio stations in medium and small markets throughout the United States. In conjunction with several of its radio stations, the Company promotes country music festivals and concerts through Company-owned entertainment properties. The Company also distributes programmed music, primarily Muzak, through exclusive franchises in Florida and Georgia, and provides cable television entertainment and\/or interactive educational services to hospitals throughout the United States.\nAt December 31, 1995, the Company owned sixteen radio stations (eleven FM and five AM) in medium-sized and small markets, primarily in the eastern United States. These stations feature a variety of music formats of which country music is the most prevalent. The Company also owns four programmed music and sound equipment distributorships, a concert hall and certain country music shows and festivals, and a hospital cable television company. In addition, the Company has a 50% non-voting ownership interest (without control) of an FM radio station in San Carlos Park\/Ft. Myers, Florida, a 25% ownership interest in Fairmont Communications Corporation ('Fairmont'), and an economic interest in Northstar Television Group, Inc. ('Northstar') (see Fairmont and Northstar Management Agreements).\nThe Company derives revenue from broadcasting and related businesses, programmed music and sound equipment distribution, and hospital cable television. The gross revenue contributed by each is as follows:\nSince its inception, the Company has used a variety of sources, including bank and institutional borrowings, sales of common stock to private investors and to the public, the sale of publicly-traded notes, and seller financing to finance its acquisitions. The Company has used leverage to maximize the potential returns on its investments.\nIn August 1995, the Company entered into a credit facility of $56.0 million with Society National Bank (the 'Credit Facility'). The Credit Facility consists of a $46.0 million revolving credit facility and a $10.0 million facility which may be used for acquisitions. The initial drawdown of $44.5 million, along with the Company's internally generated funds, was used to repay loans totalling $50.0 million, at 101% of par value under the Company's outstanding debt facilities and to pay transaction costs.\nIn July 1994, the Company effected a 1-for-2 reverse stock split. All share data contained in Part I of this Annual Report on Form 10-K reflect the reverse stock split.\nAcquisitions and Dispositions. The Company has made numerous acquisitions and dispositions, primarily of radio stations. The acquisitions and dispositions for 1995 and 1994 are more fully described in Part II, Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations.\nBROADCASTING\nRadio Operating Strategy. The Company's operating strategy is designed to capitalize on competitive dynamics unique to medium and small radio markets. Typically, these markets are characterized by lower revenues and fewer competitors than large markets. In addition, because of the greater revenue potential in larger markets, the Company believes medium and small markets tend to attract small, local operators, rather than experienced, large market broadcasting companies with sizable station portfolios and significant capital. As a result, medium and small markets tend to be\ndominated by a few stations targeting the most profitable demographic segments. In markets where the Company operates the leading stations, its operating strategy is designed to maintain ratings dominance and enhance profitability through a combination of an aggressive sales effort, strict cost control and, in more competitive markets, audience research to ensure that programming appeals to the preferences of its target demographic groups. By contrast, in markets in which the Company has acquired a station that is not the market leader, its operating strategy relies primarily on management's extensive operating experience to achieve increased market share and profitability. This strategy is implemented by focusing on profitable demographic niches within the market through appealing formats and aggressive promotional campaigns. The Company has successfully utilized these strategies in medium and small markets throughout the United States over the past decade.\nProgramming is central to the Company's operating strategy because format determines the demographics of the station's listeners and, in part, the station's market share. These factors, in turn, largely determine the perceived value of commercial air time to advertisers. The Company operates in each of its radio markets with a format that has the potential either to capture a dominant position in the most commercially desirable segment of listener demographics (adults age 25-54) or to obtain a dominant position with regard to a profitable market niche. The Company's stations are programmed in a variety of formats, the most prevalent of which is country music, that both attracts audiences in those demographics desirable to advertisers and accommodates relatively large amounts of advertising.\nThe Company emphasizes programming instead of high profile, highly compensated personalities to attract audience share as a lower cost, lower risk strategy. The costs of on-air programming are relatively inexpensive because a large portion of the Company's programming is music produced by record companies, and the royalties payable to copyright holders are fixed at a relatively low percentage of revenues. In addition, several stations broadcast network originated programs and receive compensation in return for providing airtime for which the network can solicit advertising.\nThe Company believes that the listening public's awareness of a station is crucial and that focused promotional spending is directly related to a station's success in adding and retaining new listeners. Management's goal is for the Company to be the most marketing oriented competitor in each of its markets, and its promotions are designed to attract and secure the largest share of listeners in its targeted demographic group. A key factor in the Company's marketing strategy is multimedia promotions. For example, the Company's stations sponsor contests through direct mail to listeners with key demographics, thereby promoting both the station and the advertisers included in the mailer. The Company's mobile units occasionally broadcast live at high traffic retail centers frequented by its targeted listeners, such as shopping malls. Promotions of this type are cost effective for the Company because advertisers generally provide prizes and contract for additional advertising time on the Company's stations. The Company also capitalizes on cross-promotional opportunities with its other businesses, such as its country music entertainment properties in Wheeling, West Virginia.\nPricing strategy and inventory management are critical aspects of the Company's radio station management. The Company seeks to maximize revenues by continually monitoring inventory (i.e., available advertising time) and demand. As available advertising time is sold, station general managers are able to increase rates for remaining time. General managers also are able to react quickly to a shift in demand between national and local advertising by directing sales efforts to the appropriate markets.\nIntegral to the Company's pricing strategy is strong decentralized local management. Local management is responsible for day-to-day operations of the station while corporate management is responsible for long range strategic planning and resource allocation. Local management is also responsible for building a sales team capable of turning the station's audience rankings into revenues. Members of the Company's sales force are encouraged to forge strong relationships with local advertisers.\nAdvertising Sales. The Company's primary source of revenue is the sale of broadcasting time for local, regional and national advertising. The Company believes that radio is one of the most efficient, cost-effective means for advertisers to reach specific demographic groups. The station's format, and in some cases the content of specific programs, enable the potential advertiser to determine which demographic groups its advertising will reach. Advertising rates are based upon a program's popularity among the listeners an advertiser wishes to attract (as measured principally by periodic Arbitron rating\nsurveys that quantify the number of listeners tuned to the station at various times), the number of advertisers competing for the available time, the size and demographic makeup of the market served by the station and the availability of alternative advertising media in the market area. Rates are the highest during morning and evening drive-time hours.\nAdvertising time on the Company's radio stations is sold locally by each station's sales staff, and nationally by sales representatives employed by firms specializing in radio advertising sales on a national level. These national sales representatives obtain advertising principally from advertising agencies located outside the Company's markets and receive commissions based on the revenues from the advertising obtained. Each station's sales staff directly solicits advertising from local advertising agencies and businesses. The local sales staff is also compensated on a commission basis. Most advertising contracts are short-term, generally running for only a few weeks. The Company determines the number of advertisements broadcast per hour that can maximize revenue without jeopardizing listening levels. Although the number of advertisements broadcast during a given time period may vary, the total number of advertisements broadcast on a particular station generally does not vary significantly from year to year.\nMarketing and Promotion. For each station, the Company develops and pursues a marketing strategy designed to attract and secure the largest share of listeners within its targeted demographic group.\nA radio station's listenership and competitive position in a market is measured principally through periodic ratings surveys conducted by Arbitron. Ratings provide a quantitative measure of a station's audience size and are used by most advertisers in considering advertising with a station and by the Company to track audience growth, establish advertising rates and adjust programming.\nEach of the Company's stations makes its own marketing and promotional determinations regarding the best method to reach its targeted audience. From time to time, stations in more competitive markets conduct qualitative research regarding the specific preferences of such station's target audience. The station relies on the research to create and conduct marketing and promotional campaigns, utilizing such media as direct mail, telemarketing and outdoor advertising.\nAcquisition Strategy. The Company seeks to acquire radio stations located in medium and small markets with positive operating cash flow and competitive technical facilities. The Company looks for properties selling at reasonable multiples of operating cash flow that have not been managed aggressively. To maximize management and operational efficiency, higher priority is given to potential acquisitions of properties in proximity to existing areas of operation. The Company has primarily focused on the southeastern United States as an area of primary interest, given the region's economic and demographic growth potential, although it considers potential acquisitions in all regions of the United States.\nAs a result of revisions to its rules mandated by the Telecommunications Act of 1996, the Federal Communications Commission ('FCC') now permits a company to own, depending on the number of stations in a particular market, a maximum of between five and eight stations in the same geographic market (see Federal Regulation of Broadcasting). The Company intends to seek the acquisition of additional radio stations in markets in which it has an existing station or multiple stations in other markets. The Company believes that ownership of multiple stations in a market achieves significant savings through consolidation of administrative, engineering and management expenses and has the potential for increasing revenues. By acquiring an additional station in a given market, the Company can improve its market share and capture a larger share of the prime advertising time available for sale in that market while minimizing the possibility of direct format competition. In addition, ownership of multiple stations in a market would allow the Company to capitalize on its market expertise and existing relationships with advertisers, consequently lowering the Company's acquisition risk. In addition, the Company would be at a competitive disadvantage if its competitors acquire multiple stations in markets in which the Company operates.\nThe Company has focused on medium and small markets because generally there has been less competition to acquire broadcasting properties in those markets, which has meant that relative acquisition costs have been lower than in large markets. The Company believes that medium and small\nmarkets offer a reasonable rate of return on well-managed properties and that generally there is less competition for advertising revenues within such markets. Although the Company intends to continue to focus on medium and small markets, it has considered, and expects to consider, acquisition opportunities for radio stations in large markets.\nLocal Marketing Agreements. The Company has entered into certain local marketing agreements ('LMAs') whereby it provides programming to a station owned by a third party and pays a monthly fee for the right to air such programming. The Company receives the right to solicit advertising and to receive payments from the advertisers. In addition, the Company has entered into certain other LMAs whereby a third party provides programming to a station owned by the Company and pays a monthly fee for the right to air such programming. The third party receives the right to solicit advertising and to receive payments from the advertisers. The LMAs that the Company is a party to are more fully described in Note 4 to the consolidated financial statements contained in Part II, Item 8 -- Financial Statements and Supplementary Data.\nTelevision. In December 1995, the Company entered into an option agreement with Allbritton Communications Company for the sale of television station WJSU-TV, Anniston, Alabama, and an associated 10-year LMA. This transaction is more fully described in Part II, Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations. The Company has no other television stations and has no current intention to own and operate broadcast television properties in the future.\nBroadcasting Properties. The following table sets forth markets, frequencies, transmitter power and other station details of the Company's radio broadcasting properties:\n- ------------\n(1) Many AM radio stations are licensed to operate at a reduced power during nighttime broadcasting hours; where applicable, both power ratings are shown.\n(2) Metro Market Rank is based on determination by Arbitron of the market's number of persons aged 12 years and over.\n(3) Renewal application pending.\n(4) The Company has a 50% non-voting ownership interest in WDRR-FM.\n(5) The sales of the Jacksonville, Florida and Syracuse, New York radio stations were closed in January and February of 1996, respectively.\n(6) WKII-AM has been operating pursuant to Special Temporary Authority issued to it by the FCC.\n* These markets are not assigned a Metro Market Rank by Arbitron.\nBROADCAST-RELATED BUSINESSES\nThe Company's broadcast-related businesses provide extensive marketing and promotional opportunities for its nearby radio stations. In Wheeling, West Virginia, the Company enhances and capitalizes on its ratings dominance in country music by the integration of its stations with its country music-related entertainment businesses. The Company-owned Capitol Music Hall is a 2,500 seat theater that hosts approximately 100 music, comedy and dramatic performances each year, including Jamboree USA, a live country music concert and radio program heard weekly throughout the northeastern United States featuring such country music stars as John Michael Montgomery, Trisha Yearwood, Alan Jackson and Lorrie Morgan. Each July, the Company stages Jamboree in the Hills, an outdoor festival featuring\n20 or more country music stars held on a 200 acre site owned by the Company outside of Wheeling. This four day event attracts tens of thousands of country music fans each year from throughout the United States and Canada. Past performers at Jamboree in the Hills include Vince Gill, Loretta Lynn, Brooks & Dunn, Tim McGraw, and Travis Tritt. Jamboree in the Hills won the Country Music Association's 1991 award for Festival of the Year and was featured in a one-hour special on The Nashville Network in 1992.\nBesides Jamboree USA, the Capitol Music Hall also hosts, among other events, musical acts other than country, comedians, dramatic presentations and symphonies. Attendance varies based upon the popularity of each particular event. The Company also promotes shows in the 7,500 seat Wheeling Civic Center and has begun promoting shows in markets outside of Wheeling.\nPROGRAMMED MUSIC\nThe Company distributes programmed music, primarily Muzak, in the Atlanta, Macon and Albany, Georgia and Ft. Myers, Florida markets. As the exclusive Muzak franchisee in these markets, the Company provides subscribers with commercial-free Muzak programming ranging from traditional background music to newer formats including country and soft rock, and sells, leases and installs the equipment required to receive the programming via satellite and other media.\nThe franchisor, Muzak L.P., provides the programming, and the Company remits to Muzak a fee based upon the gross revenues from Muzak service. The Company, and not the franchisor, is the owner of the contracts with the individual users of the Muzak programming. These contracts generally have five-year terms with an automatic renewal provision. In most cases, the Company owns the equipment at the customers' sites and charges a lease fee for its use.\nAs part of its programmed music business, the Company also designs, sells and installs sound, closed-circuit video and security systems and equipment in locations such as offices, schools, hospitals, shopping malls and stadiums. Examples of such systems include shopping mall paging, public address, closed-circuit video, and fire\/security systems. In addition, the Company is an authorized distributor of the Rauland-Borg line of communications equipment for schools and hospitals in various markets. The Company believes the sale and installation of such sound equipment will continue to be an area of increasing growth in revenues for the Company.\nOSBORN HEALTHCARE\nOsborn Healthcare was started by the Company in 1988 and offers a range of education and entertainment services to hospitals. Osborn Healthcare operates The Patient Network in 9 hospitals in the southeastern United States. The Patient Network is a proprietary closed-circuit television system offering patients premium cable television services such as movies, news and sports. Separately, the Company distributes fully automated On-Demand Video systems, which provide educational videos to physicians, patients and hospital staff. The Company also offers The Automated Testing System, which is linked to On-Demand Video and is proprietary software that allows viewer interaction with the educational videos. These systems permit physicians to inform patients about medical procedures via video with follow-up interactive question and answer sessions. The Company is exploring expanded applications for these systems. In addition, Osborn Healthcare distributes cable television programming via satellite to 45 hospitals.\nThe sources of the movies shown by Osborn Healthcare are film distributors licensed by major movie studios and the sources of The Patient Network's programming are major cable networks and film distributors. Osborn Healthcare generally pays a subscription fee based upon the number of beds in each of the hospitals serviced.\nEMPLOYEES\nAt December 31, 1995, the Company had approximately 288 full-time employees, of whom 7 employees were on the corporate staff, and the balance were employed at the operating subsidiary level in connection with the operation and management of the Company's properties. One employee of the\nprogrammed music franchise in Atlanta is a union member. The Company believes its relations with its employees are good.\nCOMPETITION\nRadio. Radio is a highly competitive business. The Company's radio stations compete with radio stations in their respective market areas, as well as with other advertising media such as newspapers, television, cable television, magazines, outdoor advertising, transit advertising and direct mail marketing. Competition within the radio broadcasting industry occurs primarily in individual market areas, so that a station in one market generally does not compete with stations in other markets for local advertising, although it does compete indirectly for national advertising. In addition to management experience, factors material to competitive position include a station's audience rank in its market, authorized power, quality of equipment, location of transmitter, assigned frequency, audience characteristics, local program acceptance and the number and characteristics of other stations in the market area.\nTechnological advances may have an impact on the competitive radio broadcasting environment. Several companies have begun offering radio programming by cable to subscribers of cable television. In addition, the FCC has allocated spectrum for, and various companies have sought authorization to provide, the direct transmission of radio programming to listeners via satellite. The FCC is also considering permitting the broadcast of terrestrial digital radio programming. The effect that these technological advances will have on the Company's operations is uncertain.\nIn 1996, the FCC, in response to the Telecommunications Act of 1996, relaxed its rules regarding ownership by one entity of multiple radio stations in the same market. The effect that these changes will have on the Company's business is unclear. However, to the extent that the Company can purchase additional stations or enter into LMAs in markets where it has existing stations, the Company's stations may have a competitive advantage in their markets; conversely, the Company's stations may be at a competitive disadvantage to the extent other broadcasters in their markets purchase additional stations or enter into LMAs.\nBroadcast-Related Businesses. The Company's broadcast-related businesses generally compete regionally for audiences with other live concerts and sports and entertainment events as well as other media such as films, broadcast and cable television, videocassettes and radio. Competition for talent may come from national or regional sources and is primarily from other concert venues.\nProgrammed Music. The Company's competition in the programmed music markets is the ready availability of low-cost, nonprogrammed music, such as regular radio broadcasts, audio cassettes and compact discs as well as competing programmed music services. The Company competes in the sale and installation of sound systems with numerous other sources of such equipment, including both local and national distributors.\nHospital Cable Television. Competition for viewers for the Company's hospital cable television service comes from broadcast television. The cable television operations compete nationally for hospitals with a small number of companies involved in supplying cable programming to hospitals, local cable distributors and with companies which sell or lease television equipment to hospitals. In addition, many hospitals choose to provide their own television entertainment and education services.\nFEDERAL REGULATION OF BROADCASTING\nIntroduction. Radio broadcasting is subject to regulation by the FCC under the Communications Act of 1934, as amended (the 'Communications Act'). Under the Communications Act, the FCC, among other things, assigns frequency bands for broadcasting, determines the frequencies, location and power of stations, issues, renews, revokes and modifies station licenses, regulates equipment used by stations, and adopts and implements regulations and policies which directly or indirectly affect the ownership, operations and employment practices of broadcasting stations. In particular, the Communications Act prohibits the assignment of a broadcasting license or the transfer of control of a corporation holding a broadcasting license without prior approval of the FCC. In addition, modification of the facilities of television and radio stations is subject to FCC approval. The Telecommunications Act of\n1996 (the '1996 Act'), which was signed into law in February 1996, amended the Communications Act in several key respects.\nLicense Renewal. As a result of amendments to the Communications Act brought about through the 1996 Act, the FCC must grant the renewal application filed on behalf of a station if it finds that, during the preceding term of that station's license, the station has served the public interest, convenience, and necessity; there have been no serious violations by the licensee of the Communications Act or the rules and regulations of the FCC; and there have been no other violations by the licensee of the Communications Act or the rules and regulations of the FCC which, taken together, would constitute a pattern of abuse. If the FCC is unable to make such findings with respect to the station, it can grant the station's renewal application, but on terms and conditions that the FCC considers to be appropriate, or, the FCC can, after providing the licensee with notice and an opportunity for hearing, and if the FCC determines that no mitigating factors justify the imposition of a lesser sanction, deny the renewal application. The terms and conditions that could be imposed by the FCC in granting the renewal include requiring the payment of a forfeiture, requiring the licensee to make periodic reports to the FCC or granting the renewal for a period of time less than a normal license term. Only upon the issuance of an order denying the renewal application may the FCC accept and consider applications specifying the channel or broadcasting facilities of the former licensee, whereas, prior to the amendments brought about by the 1996 Act, a license was subject to competing applications being filed whenever the license was due for renewal. In making its determination as to whether the licensee's renewal application can be granted, the FCC may consider facts brought to its attention by parties filing petitions seeking denial of the renewal application.\nAlso as a result of the 1996 Act, the FCC now has the authority to renew a broadcast station license for a maximum term of eight years. Previously, the Communications Act permitted the FCC to grant broadcast station license renewals for a maximum term of seven years. The FCC has announced that it intends to initiate a rulemaking in March 1996 looking toward the adoption of rules consistent with the renewal term prescribed by the 1996 Act, and that it intends to adopt such rules in the third quarter of 1996.\nOwnership Matters. As a result of the 1996 Act, the FCC revised its ownership rule effective March 15, 1996, to remove the national limit on the number of stations that any one entity may own or in which that entity may have an attributable interest. The FCC also revised its ownership rule so as to provide that (a) in a radio market with 45 or more commercial radio stations, a party may own, operate, or control up to 8 commercial radio stations, not more than 5 of which may be in the same service (i.e., AM or FM); (b) in a radio market with between 30 and 44 (inclusive) commercial radio stations, a party may own, operate, or control up to 7 commercial radio stations, not more than 4 of which may be in the same service; (c) in a radio market with between 15 and 29 (inclusive) commercial radio stations, a party may own, operate, or control up to 6 commercial radio stations, not more than 4 of which may be in the same service; and (d) in a radio market with 14 or fewer commercial radio stations, a party may own, operate, or control up to 5 commercial radio stations, not more than 3 of which are in the same service, except that the party may not own, operate, or control more than 50 percent of the stations in such market.\nParties subject to the multiple ownership rules include officers, directors, and holders of 5% or more of the voting stock of broadcasting companies. Holders of debt and non-voting stock, however, are not subject to the multiple ownership rules. Passive investments of less than 10% of the voting stock of a broadcasting company held by certain categories of financial institutions are also not recognized for purposes of these rules.\nThe multiple ownership rules could preclude the Company from acquiring radio or TV stations in areas where its officers, directors, or stockholders have such an interest.\nUnder the Communications Act, as amended by the 1996 Act, no FCC license may be granted to any alien, to a corporation organized under the laws of a foreign government, or to any corporation of which more than 20% of its capital stock is owned of record or voted (i) by aliens or their representatives, (ii) by a foreign government or representative thereof, or (iii) by any corporation organized under the laws of a foreign country (collectively, 'Aliens'). In addition, no one corporation may hold the capital stock of another corporation owning broadcast licenses if more than 25% of the\ncapital stock of such parent corporation is owned of record or voted by Aliens or is subject to control by Aliens, unless specific FCC authorization is obtained.\nThe Company's Restated Certificate of Incorporation and By-Laws authorize the Board of Directors to prohibit ownership, voting, or transfer of its capital stock which would cause the Company to violate the Communications Act or FCC regulations.\nLocal Marketing Agreements. A number of broadcasting stations, including several of the Company's stations, have entered into what have commonly been referred to as 'Time Brokerage Agreements', 'Local Marketing Agreements', or 'LMAs'. While these agreements may take varying forms, under a typical LMA, separately-owned and licensed radio stations agree to enter into cooperative arrangements, subject to compliance with the requirements of antitrust laws and with the FCC's rules and policies. Under these types of arrangements, separately-owned stations could agree to function cooperatively in terms of programming, advertising sales, etc., subject to the licensee of each station maintaining independent control over the programming and station operations of its own station. One typical type of LMA is a programming agreement among two separately-owned radio stations serving a common service area, whereby the licensee of one station programs substantial portions of the broadcast day on the other licensee's station, subject to ultimate editorial and other controls being exercised by the latter licensee, and sells advertising time during such program segments.\nThe FCC has held that such agreements are not contrary to the Communications Act, or the FCC's policies, provided that the licensee of the station which is being substantially programmed by another entity maintains complete responsibility for and control over operations of its broadcast station and assures compliance with applicable FCC rules and policies.\nThe FCC's rules provide that a station brokering time on another station serving the same market may be considered to have an attributable ownership interest in the brokered station for purposes of the multiple ownership rules. As a result, under the rules, a broadcast station will not be permitted to program more than 15% of the broadcast time, on a weekly basis, of another local station which it could not own under the multiple ownership rules. The FCC's rules also prohibit a broadcast licensee from simulcasting more than 25% of its programming on another station in the same broadcast service (i.e., AM\/AM or FM\/FM) whether it owns the stations or through a time brokerage or LMA arrangement, where the brokered and brokering stations serve substantially the same geographic area.\nProposed Changes. The Congress and the FCC have under consideration, and 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 and ownership of the Company and its radio and television broadcast properties. Such matters include, for example, the license renewal process; proposals to impose spectrum use or other governmentally imposed fees upon licensees; proposals to place limitations on the amount of commercial matter that television stations can carry; proposals to change rules relating to political broadcasting; proposals to increase the benchmarks or thresholds for attributing ownership interest in broadcast media; proposals to require certain types of programming; proposals to restrict the use of LMAs and certain types of marketing arrangements; technical and frequency allocation matters, including those relative to the implementation of digital audio broadcasting on both a satellite and terrestrial basis; proposals to initiate a new high definition television service; proposals to restrict or prohibit the advertising of beer, wine and other alcoholic beverages or to limit the tax deductibility of such advertisements; and changes to broadcast technical requirements. The Company cannot predict what other changes might be considered in the future, nor can it judge in advance what impact, if any, such changes might have on its business.\nThe foregoing is only a brief summary of certain provisions of the Communications Act and FCC regulations. The Communications Act and FCC regulations may be amended from time to time. The Company cannot predict whether any such legislation will be enacted or whether new or amended FCC regulations will be adopted, or the effect of any changes on the Company. For further information, reference should be made to the Communications Act, FCC regulations, and Public Notices issued by the FCC.\nOther Matters. Construction projects such as broadcasting towers are subject to state and local construction and environmental laws and regulations and may require governmental permits.\nBroadcasting towers also must comply with regulations issued by the Federal Aviation Administration ('FAA') and must receive FAA approval before construction.\nOTHER TRANSACTIONS\nFairmont and Northstar Management Agreements. The Company currently owns 25% of the stock of Fairmont Communications Corporation. Fairmont is managed by the Company pursuant to a management agreement. In August 1992, Fairmont filed for protection from its creditors under Chapter 11 of the U.S. Bankruptcy Code. In September 1993, Fairmont emerged from Chapter 11 upon approval by the bankruptcy court of a plan of reorganization (the 'Plan'). The Plan provides for the sale of Fairmont's assets, distribution of proceeds in accordance with the Plan, and subsequent liquidation of Fairmont. All of Fairmont's stations were sold by the second quarter of 1994. The Company will continue to manage Fairmont pursuant to the management agreement which expires upon the liquidation of Fairmont, which is expected in 1996. For managing Fairmont, the Company receives an annual fee of $125,000, plus reimbursement of out-of-pocket expenses and allocated overhead costs. In 1994, the Company received additional management fees of $728,000 related to the sale of Fairmont's stations. The Company also earned distributions of $0.4 million and $2.3 million in 1995 and 1994, respectively, classified as other income in the consolidated financial statements, determined by the amounts realized by Fairmont from sales of its assets.\nThe Company held a 32% interest in Northstar Television Group, Inc. and managed Northstar's four television stations pursuant to a management agreement in return for reimbursement of out-of-pocket expenses and allocated overhead costs. In 1994, Northstar's creditors and equity investors reached an agreement with respect to restructuring Northstar's highly leveraged capital structure pursuant to which, among other things, the Company received a portion of accrued and unpaid management fees and retains an economic interest. The Company's management agreement with Northstar terminated following the restructuring. In January 1995, three of Northstar's four television stations were sold and the Company received a distribution of $1.6 million, classified as other income in the consolidated financial statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters are located in Greenwich, Connecticut. The Company leases offices in Greenwich pursuant to a lease terminating in May 1999.\nThe types of properties required to support each of the Company's radio stations include offices, studios, and transmitter and antenna sites. The Company and certain subsidiaries lease the following properties: Ft. Myers, Florida, radio station and Muzak offices leased pursuant to leases terminating September 2005 and June 1999, respectively; Tampa sound equipment distribution offices leased pursuant to lease terminating March 2000; Atlanta Muzak offices leased pursuant to lease terminating October 2001; Asheville, North Carolina, FM broadcasting tower site leased pursuant to lease terminating October 1996; Dayton, Ohio, offices leased pursuant to lease expiring March 1999; Greenwich, Connecticut, offices leased pursuant to lease terminating May 1999; Daytona Beach\/Palatka, Florida, offices and tower site leased pursuant to leases terminating May 1999 and December 2014, respectively; Nashville, Tennessee, offices leased pursuant to lease terminating October 1999; Raleigh, North Carolina, offices leased pursuant to lease expiring December 1999; Atlantic City, New Jersey, broadcasting tower site and offices leased pursuant to leases expiring December 1999 and December 2001, respectively; and Wheeling, West Virginia, FM broadcasting tower site leased pursuant to lease terminating February 2002. The Company owns the remaining broadcasting equipment and offices, studios and broadcasting towers. The Company believes that its facilities are adequate and suitable for their present uses.\nAll of the Company's properties are subject to encumbrances as security for certain of the Company's borrowings. All of the stock in the subsidiaries holding such properties has also been pledged as security for certain of the Company's borrowings. See Notes 6 and 7 to the consolidated financial statements contained in Part II, Item 8 -- Financial Statements and Supplementary Data.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any lawsuit or any legal proceeding that, in the opinion of management, is likely to have a material adverse impact 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 stockholders of the Company in the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the name, age, present position with the Company and a brief past five-year employment history of each executive officer of the Company.\nFrank D. Osborn has been President and Chief Executive Officer of the Company since the Company's formation in September 1984 and was its Treasurer until August 1989. From 1983-1985, Mr. Osborn was Senior Vice President\/Radio for Price Communications Corporation, a diversified communications corporation. From 1981-1983, Mr. Osborn served as Vice President and General Manager of WYNY, NBC's New York FM radio station, and was Vice President of Finance and Administration of NBC Radio from 1977-1981. Mr. Osborn serves as Chairman of the Board and Chief Executive Officer of Fairmont Communications Corporation, and is a Director of Northstar Television Group, Inc. Mr. Osborn is married to the niece of Edward G. Nelson, a Director of the Company. Fairmont filed a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code on August 28, 1992 and emerged from Chapter 11 in September 1993.\nThomas S. Douglas joined the Company in January 1994, and became Senior Vice President -- Finance and Treasurer in March 1994. For the previous two years, he was an investment banking advisor to the Czech Ministry of Privatization in Prague, the Czech Republic in association with Deloitte & Touche and the Bank Przemyslowo-Handlowy, Crakow, Poland in association with KPMG Peat Marwick. From 1983 to 1991, he was a Director, Investment Banking, at Prudential Securities Incorporated, New York, New York.\nW. Charles Hillebrand has served as Senior Vice President -- Muzak since joining the Company in 1986. In February 1993, Mr. Hillebrand was appointed President of the Company's wholly-owned subsidiaries which own and operate its programmed music businesses.\nMichael F. Mangan, a certified public accountant, has served as Vice President -- Controller since rejoining the Company in April 1994 and as Secretary since June 1994. From July 1992 through April 1994, he was Assistant Controller of PolyGram Holding, Inc. He previously served as the Company's Controller from 1989 through June 1992, and as Assistant Controller from 1987 through 1989.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is traded on the NASDAQ National Market System under the symbol OSBN. Common stockholders of record at December 31, 1995 numbered approximately 135, but the Company believes that the number of beneficial owners is approximately 1,000, including those whose shares are held in nominee or 'street' names.\nMarket prices have been adjusted to reflect (to the nearest eighth) the 1-for-2 reverse stock split on July 11, 1994.\nTo date, the Company has not paid cash dividends on its common stock. Under the terms of certain of the Company's debt agreements, the Company may not declare or pay any dividend on, or make any distribution to the holders of, any shares of capital stock of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- ------------\n(1) Reflects the acquisitions and dispositions described in Note 3 to the consolidated financial statements, as well as acquisitions and dispositions occurring in previous years.\n(2) Per share data adjusted to reflect the 1-for-2 reverse stock split on July 11, 1994.\n(3) Operating cash flow is defined as operating income before depreciation, amortization and corporate expenses.\n(4) EBITDA is defined as operating income before depreciation and amortization.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe primary source of the Company's broadcasting revenues is the sale of air time on its radio stations for advertising. The Company's most significant operating expenses are employee salaries and commissions, programming expenses and advertising and promotional expenses. The Company strives to control these expenses by working closely with station management.\nThe Company's revenues are affected primarily by the advertising rates its radio stations charge. These rates are in large part based on a station's ability to attract audiences in the demographic groups targeted by its advertisers, as measured periodically by Arbitron. Because audience ratings in local markets are crucial to a station's financial success, the Company endeavors to develop strong listener loyalty.\nThe number of advertisements that can be broadcast without jeopardizing listening levels (and the resulting ratings) is limited in part by the format of a particular station. The Company's stations strive to maximize revenue by constantly managing the number of commercials available for sale and adjusting prices based upon local market conditions.\nThe Company's advertising contracts are generally short-term. The Company generates most of its revenue from local advertising, which is sold primarily by a station's sales staff. To generate national advertising sales, the Company engages independent advertising sales representatives that specialize in national sales for each of its stations. The Company's operating results in any period may be affected by the incurrence of advertising and promotion expenses that do not necessarily produce commensurate revenues until the impact of the advertising and promotion is realized in future periods.\nThe performance of a broadcasting company is customarily measured by its ability to generate operating cash flow. Operating cash flow is defined as operating income before depreciation, amortization and corporate expenses. Although operating cash flow is not a measure of performance calculated in accordance with Generally Accepted Accounting Principles ('GAAP'), the Company believes that operating cash flow is useful to investors because it is accepted by the radio broadcasting industry as a generally recognized measure of performance and is used by securities analysts who report publicly on the performance of broadcasting companies. Operating cash flow should not be considered in isolation or as a substitute for net income, cash flows from operating activities and consolidated income or cash flow statement data prepared in accordance with GAAP, or as a measure of the Company's profitability or liquidity.\nFINANCIAL ADVISOR\nIn November 1994, the Company engaged an investment banking firm as its financial advisor to assist the Company in evaluating its options to increase shareholder value. As a result of this process, the Company has decided to dispose of broadcasting properties in Syracuse, New York and Anniston, Alabama. The engagement of the financial advisor ended in January 1996.\nTELECOMMUNICATIONS ACT OF 1996\nThe Telecommunications Act of 1996 (the '1996 Act'), which was signed into law in February 1996, impacts the Company's operations in several respects. The 1996 Act, among other things, directs the Federal Communications Commission ('FCC') to modify its ownership rules to eliminate the limits on the number of radio stations one entity may own nationally and to make the limits on the number of radio stations one entity may own in a single market less restrictive. Under the 1996 Act, depending on the number of radio stations in a particular market, one entity may own a maximum of between five and eight radio stations in a market, except that an entity may not own more than 50% of the stations in such market. The 1996 Act directed the FCC to conduct a rulemaking to reevaluate existing limitations on the number of television stations that a person or entity may own, operate or control, or have a cognizable interest in within the same television market. In addition, the FCC has the authority to grant\nbroadcast license terms for a maximum term of eight years (previously seven years). Additionally, the provisions of the 1996 Act strengthen the license renewal expectancy for a license holder.\nACQUISITIONS AND DISPOSITIONS\nGiven the less restrictive regulatory environment, the Company intends to own multiple radio stations in certain of its markets in order to attain a more dominant position in the respective market. If the Company determines that opportunities to acquire additional stations in a particular market are not satisfactory, it may dispose of its stations in such market. The Company also intends to pursue the acquisition of multiple stations in other markets.\nConsistent with its strategy of owning multiple stations in a market or leaving markets where opportunities to acquire additional stations are not satisfactory, the Company has entered into several transactions for the acquisition or disposition of broadcast properties in 1995 and early 1996. Each of these transactions is more fully described in Notes 3 and 13 to the consolidated financial statements.\nIn August 1995, the Company agreed to acquire substantially all the assets of radio stations WKII-AM\/WEEJ-FM, Port Charlotte, Florida for $2.85 million, subject to FCC approval and license renewal. In the event that the Company is able to relocate WEEJ-FM's broadcast antenna to the Company's Pine Island, Florida tower in order to better serve the Port Charlotte\/Ft. Myers market, additional consideration of $750,000 will be paid. The Company intends to combine these stations with its existing operations in the Ft. Myers market. The transaction is expected to close in April 1996.\nIn January 1996, the Company agreed to acquire substantially all the assets of radio station duopoly KNAX-FM\/KRBT-FM, Fresno, California for consideration consisting of $6.0 million plus 120,000 shares of the Company's common stock. The FCC has consented to this transaction which is expected to close in 1996.\nIn January 1996, the Company agreed to acquire substantially all the assets of radio station WHLX-FM, Wheeling, West Virginia for $0.8 million and in February 1996, agreed to acquire substantially all assets of radio stations WKWK-AM\/FM, also in Wheeling, for $2.7 million. Both acquisitions are subject to FCC approval. The Company believes that these acquisitions will further strengthen its dominant position in the Wheeling market.\nPending the closing of these acquisitions, the Port Charlotte and Fresno stations are managed by the Company pursuant to local marketing agreements. The Company also intends to enter into a local marketing agreement to manage radio stations WKWK-AM\/FM in Wheeling.\nThe Company has determined that attractive acquisition opportunities did not exist in certain of its markets and in 1995 and early 1996 agreed to sell certain broadcast properties.\nIn September 1995, the Company agreed to sell substantially all the assets of radio stations WNDR-AM\/WNTQ-FM, Syracuse, New York for $12.5 million. The transaction closed in February 1996. Since September 1995 and pending the closing of the transaction, the stations were managed by the purchaser pursuant to a local marketing agreement.\nIn September 1995, the Company agreed to sell substantially all the assets of radio stations WWRD-FM, Jacksonville, Florida\/Brunswick, Georgia and WFKS-FM, Daytona Beach\/Palatka, Florida, as well as the Company's 50% interest in the broadcast tower serving WWRD-FM for total consideration of $6.5 million. The sale of WWRD-FM closed in January 1996. The closing of the WFKS-FM transaction is expected in 1996. Pending the closing of the transactions, the stations have been managed by the purchaser pursuant to local marketing agreements.\nIn February 1996, the Company agreed to sell substantially all the assets of radio station WAYV-FM, Atlantic City, New Jersey for $3.1 million, subject to FCC approval. Pending the closing of the transaction, which is expected in 1996, the purchaser is managing the station pursuant to a local marketing agreement. The station was acquired by the Company in March 1994 for consideration of $2.5 million.\nIn February 1996, the Company entered into an agreement to sell substantially all the assets of radio station WFXK-FM, Raleigh\/Tarboro, North Carolina for $5.9 million, subject to FCC approval.\nPending the closing of the transaction, which is expected in 1996, the station will continue to be operated by the purchaser pursuant to a local marketing agreement.\nIn December 1995, the Company entered into an option agreement with Allbritton Communications Company for the sale of television station WJSU-TV, Anniston, Alabama, and an associated 10-year local marketing agreement. In consideration for the option, the Company received a nonrefundable cash payment of $10.0 million. Because the cash proceeds from the option are nonrefundable, the Company accounted for the economic substance of the transaction as if a sale of substantially all the assets of the station had occurred. Accordingly, a gain of approximately $8.1 million was recorded. In addition, upon the exercise of the option and the necessary FCC consent, the Company will receive an additional cash payment of $2.0 million. If the necessary approvals to relocate the station's broadcast transmitter to a new location to maximize broadcast coverage are received, the Company will receive additional cash payments of up to $7.0 million. WJSU-TV was the Company's only television station and it does not intend to acquire additional broadcast television stations in the foreseeable future.\n1994 ACQUISITIONS\nIn June 1994, the Company acquired substantially all the assets of three FM and one AM radio stations for $20.0 million plus transaction costs. The acquisition included radio stations WWNC-AM\/WKSF-FM, Asheville, North Carolina; WOLZ-FM, Ft. Myers, Florida; and WFKS-FM, Daytona Beach\/Palatka, Florida. In August 1994, the Company, through a wholly-owned subsidiary, acquired substantially all the assets of radio stations WAAX-AM\/WQEN-FM, Gadsden, Alabama for $1.75 million plus transaction costs. The seller of the six stations has agreed not to own or operate radio stations in these markets for a period of three years. The Gadsden market is adjacent to the Anniston market, in which the Company owned its television station. In August 1995, the Company was granted a waiver of the FCC's regulations prohibiting ownership of radio and television stations in the same market. Pending the FCC's ruling on the waiver application, the Gadsden stations were placed in a trust which operated the stations on the Company's behalf.\nThe Asheville, Ft. Myers, Daytona Beach\/Palatka, Gadsden and Atlantic City acquisitions have been accounted for using the purchase method of accounting. Accordingly, the purchase price of each acquisition has been allocated to the assets based upon their fair values at the date of acquisition. The results of operations of the properties are included in the Company's consolidated results of operations from the respective dates of acquisition for properties acquired and until the date of disposition for properties disposed. Prior to the grant of the waiver of the FCC's cross-ownership regulations, the Gadsden acquisition was accounted for using the equity method of accounting. Accordingly, prior year financial statements have been reclassified to reflect the consolidation of the Gadsden radio stations.\nDue to the acquisitions, dispositions, and local marketing agreements, the results of operations from period to period are not comparable and are not necessarily indicative of future results. The effects of these acquisitions and dispositions on 1996 revenue, operating cash flow and net income are dependent on the timing of the closing of each transaction. In general, it is expected that the net result will be a reduction of net revenue and operating cash flow in 1996 as compared to 1995 because acquired properties will be included for a partial year whereas divested properties will not be included for a majority of the year. The reduction in operating cash flow is expected to be more than offset by the reduction in interest expense due to the expected reduced borrowings.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 VS. 1994\nNet revenues of $39.1 million in 1995 represent a 13% increase from 1994 net revenues of $34.6 million. The increase is primarily attributable to the radio stations acquired in 1994, as well as improved operations at the Company's Asheville and Gadsden radio stations and its Georgia and Florida programmed music franchises. For businesses owned and operated for a comparable period in 1995 and 1994, net revenues increased 3%. For broadcasting and related businesses operated for a comparable period, net revenues of $23.4 million in 1995 were basically flat compared to 1994. This is attributable to reductions in net revenues for the Syracuse and Daytona Beach\/Palatka radio stations which have been\nsubject to local marketing agreements since September 1995 pending disposition in 1996, and the Anniston television station which benefited in 1994 from significant political advertising, offset by increased revenues by the Company's other broadcasting properties. Net revenues for the programmed music division increased 13%, from $8.3 million in 1994 to $9.4 million in 1995. The increase reflects the growth of sound equipment sales in Georgia and Florida.\nTotal operating expenses increased 11%, from $33.3 million in 1994 to $36.9 million in 1995. The increase is primarily attributable to the radio stations acquired in 1994, offset by expense reductions at the Syracuse and Daytona Beach\/Palatka radio stations, which have been subject to local marketing agreements since September 1995. For businesses owned and operated for a comparable period in 1995 and 1994, operating expenses increased 2%. The increase in operating expenses for comparable properties reflects the increased level of business at the Company's broadcasting and programmed music operations, partially offset by the expense reductions at the Syracuse and Daytona Beach\/Palatka radio stations. The decrease in corporate expenses is primarily due to nonrecurring costs incurred in 1994, totalling approximately $0.5 million, primarily relating to the relocation of the Company's corporate headquarters from New York City to Greenwich, Connecticut, severance costs, the installation of new management for the hospital cable television business, and certain costs relating to the 1994 refinancing.\nOperating cash flow increased 7%, to $9.7 million in 1995 from $9.1 million in 1994. The increase is attributable to a full year of operations for the radio stations acquired in 1994, as well as stronger results for the Asheville and Gadsden radio stations and the programmed music franchises. For businesses owned and operated for a comparable period in 1995 and 1994, operating cash flow increased 4%. The increase in operating cash flow for comparable properties primarily reflects the strong performance by the Asheville and Gadsden radio stations and the growth of the sound equipment business in Georgia and Florida, partially offset by the Syracuse radio stations.\nOperating income increased 68% to $2.2 million in 1995, from $1.3 million in 1994. Results in 1995 include distributions totalling $1.9 million, classified as other income, from Northstar Television Group ('Northstar') and Fairmont Communications Corporation ('Fairmont') relating to the sale of Northstar's television stations and Fairmont's radio stations, while results in 1994 include a distribution of $2.3 million relating to the sale of Fairmont's radio stations (see Management Agreements). Interest expense increased 19%, to $5.2 million in 1995 from $4.4 million in 1994 due to the increased level of debt outstanding following the 1994 acquisitions. Interest expense in 1995 and 1994 includes $0.3 million and $0.2 million, respectively, of non-cash interest attributable to warrant and deferred financing cost amortization. Included in results in 1995 is the gain on the sale of the Anniston station of $8.1 million. Included in 1995 and 1994 results are extraordinary losses on the early extinguishment of debt of $3.9 million and $0.4 million, respectively. Net income of $2.7 million, or $0.50 per share in 1995 compares to a net loss of $1.6 million, or $0.29 per share in 1994.\nYEAR ENDED DECEMBER 31, 1994 VS. 1993\nNet revenues of $34.6 million in 1994 represent a 26% increase from 1993 net revenues of $27.4 million. The increase is primarily attributable to the radio stations acquired in 1994, as well as improved operations at the Company's other businesses. For businesses owned and operated for a comparable period in 1994 and 1993, net revenues increased 10%. For broadcasting and related businesses operated for a comparable period, net revenues increased 8%, to $19.9 million in 1994 from $18.4 million in 1993. The increase primarily reflects strong performance by the Company's Anniston television station, as well as certain other broadcasting properties. Net revenues for the programmed music division increased from $7.2 million in 1993 to $8.3 million in 1994, which represents a 15% increase. The increase reflects the growth of sound equipment sales in Georgia and Florida. Net revenues in 1994 include management fee revenue of $0.7 million relating to the sale of Fairmont Communications Corporation's radio stations (see Management Agreements).\nTotal operating expenses increased 23%, from $27.0 million in 1993 to $33.3 million in 1994. The increase is primarily attributable to the radio stations acquired in 1994. For businesses owned and operated for a comparable period in 1994 and 1993, operating expenses increased 6%. The increase in operating expenses for comparable properties reflects the increased level of business at the Company's broadcasting and programmed music operations, partially offset by the local marketing agreement\nentered into by radio station WING-FM, Dayton in 1993 and reductions in expenses at certain of the Company's broadcasting properties. The increase in corporate expenses is primarily due to nonrecurring costs totalling approximately $0.5 million primarily relating to the relocation of the Company's corporate headquarters from New York City to Greenwich, Connecticut, severance costs, the installation of new management for the hospital cable television business, and certain costs relating to the 1994 refinancing.\nOperating cash flow increased 48%, to $9.1 million in 1994 from $6.2 million in 1993. The increase is attributable to improved results at the businesses owned for a comparable period and the radio stations acquired in 1994. For businesses owned and operated for a comparable period in 1994 and 1993, operating cash flow increased 33%. The increase in operating cash flow for comparable properties primarily reflects the strong performance by the Anniston television station, the Wheeling radio and entertainment businesses and the growth of the sound equipment business in Georgia. These increases also reflect increased operating cash flow attributable to the local marketing agreement at the Company's Dayton radio station.\nOperating income of $1.3 million in 1994 compares to $0.4 million in 1993. Other income (expense) in 1994 includes a $2.3 million distribution from Fairmont relating to the sale of all of Fairmont's radio stations, partially offset by a charge of $0.4 million relating to the registration statement filed by the Company in March 1994 and withdrawn in July 1994. Interest expense increased 62%, to $4.4 million in 1994 from $2.7 million in 1993. The increase in interest expense is due to the increased level of debt outstanding following the 1994 acquisitions. Interest expense in 1994 includes $0.2 million of non-cash interest attributable to warrant and deferred financing cost amortization. The net loss in 1994 of $1.6 million includes a tax provision of $0.3 million, while the net loss of $2.2 million in 1993 includes a tax provision of $0.2 million. Included in 1994's results is an extraordinary loss on the early extinguishment of debt of $0.4 million.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS FROM OPERATING ACTIVITIES\nIn 1995 and 1994, net cash provided by operating activities totalled $1.9 million and $2.8 million, respectively (see Results of Operations.)\nCASH FLOWS FROM INVESTING ACTIVITIES\nDuring 1995, the Company received cash distributions relating to the sale of Northstar's and Fairmont's broadcasting properties totalling $4.2 million, of which $2.3 million related to income accrued in 1994.\nIn June and August 1994, the Company acquired six radio stations for an aggregate of $21.8 million plus transaction costs and in 1995 the Company entered into an option agreement for $10.0 million to sell its television station (see Acquisitions and Dispositions).\nDuring 1995 and 1994, the Company received $1.6 million and $0.3 million, respectively, representing the remaining principal from a note issued in 1988 by the purchaser of the Company's Toledo, Ohio radio station and programmed music franchise.\nIn December 1995, the Company paid $260,000 in exchange for the interest held by outside investors in Osborn Healthcare Communications, Inc. ('Osborn Healthcare'), thereby increasing its ownership to 100%. Osborn Healthcare provides cable television services to hospitals.\nIn addition to debt service requirements, the Company's remaining liquidity demands will primarily be for capital expenditures and to meet working capital needs. The Company made capital expenditures of $1.3 million and $0.9 million in 1995 and 1994, respectively. These expenditures are primarily attributable to the addition of new customers by its programmed music franchises and upgrades to technical facilities at several of the broadcasting properties, including those acquired in 1994. For 1996, the Company expects to make capital expenditures for its existing properties totalling $0.9 million and will make capital expenditures for the properties acquired in 1996 as needed.\nCASH FLOWS FROM FINANCING ACTIVITIES\nIn August 1995, the Company entered into a credit facility of $56.0 million with Society National Bank. The facility consists of a $46.0 million revolving credit facility and a $10.0 million facility which may be used for acquisitions. The initial drawdown of $44.5 million, along with the Company's internally generated funds, was used to repay all outstanding indebtedness, totalling $50.0 million, at 101% of par value under the Company's existing debt facilities and to pay transaction costs.\nIn June 1994, the Company entered into loan agreements totalling $50.0 million with World Subordinated Debt Partners, L.P., an affiliate of Citicorp Mezzanine Investment Fund ('CMIF'). The proceeds were used to fund the 1994 acquisitions, except the Atlantic City acquisition (see Acquisitions and Dispositions); to repay certain of the Company's existing debt; to redeem the Company's 13.875% senior subordinated notes of $10.7 million at 101% of par value; to pay transaction costs; and to provide funds for general corporate purposes. As partial consideration for making the loans, CMIF received a warrant to purchase 1,014,193 shares of the Company's common stock at $7.00 per share. The warrant is exercisable for a 10-year period. The CMIF loans were repaid in August 1995, primarily with the proceeds from the Society National Bank credit facility. Along with the repayment of debt, the Company was able to cancel purchase rights with respect to 676,162 warrant shares of the 1,014,193 warrant shares issued with the CMIF loans.\nLONG-TERM DEBT\nLong-term debt to total capitalization decreased between December 31, 1994 and December 31, 1995 from 73% to 69% (see Cash Flows from Financing Activities). Based on transactions announced to date, the Company anticipates a net reduction in the ratio of long-term debt to total capitalization following the closing of the acquisitions and dispositions described above (see Acquisitions and Dispositions).\nWORKING CAPITAL\nAt December 31, 1995 and 1994, cash and cash equivalents totalled $13.0 million and $6.4 million, respectively. Working capital increased $3.9 million, from $8.3 million to $12.2 million during 1995. The change in working capital is primarily attributable to the results of operations (see Cash Flows from Operating Activities) and the proceeds from the Anniston transaction.\nAssuming no deterioration in the economic climate, the Company believes the funds generated from its existing operations are adequate to service its debt and to meet all other existing obligations in the normal course of business, and will continue to be adequate for the foreseeable future. The Company believes that the funds available under its existing credit facility, combined with the expected proceeds from the Syracuse, Jacksonville, Daytona Beach\/Palatka, and Raleigh dispositions, will be sufficient to fund the Port Charlotte, Fresno, and Wheeling acquisitions. In 1996, 1997, 1998, and 1999 through 2001, $2.7 million, $4.1 million, $5.4 million, and $35.0 million respectively, of the Company's long-term debt principal is scheduled to be repaid. The Company anticipates that the 1996 amount will be repaid from the proceeds of the sale of the Atlantic City radio station. Such indebtedness is secured by the stock and assets of Atlantic City and is otherwise nonrecourse to the Company and its other assets. There can be no assurance that funds generated from operations will be sufficient to meet these obligations in full at maturity and refinancing and\/or asset sales may be necessary. There can be no assurance as to the Company's ability to refinance this debt or sell assets on acceptable terms.\nIt is not possible to ascertain the effect on the Company's liquidity that would result from potential future acquisitions, dispositions or debt repurchases. The Company expects to evaluate all viable forms of financing when examining potential future acquisitions or its capital structure. This could take the form of, among other things, additional sales of stock or notes, bank and\/or institutional borrowings, or seller financing, as well as internally generated funds.\nMANAGEMENT AGREEMENTS\nThe Company currently owns 25% of the stock of Fairmont Communications Corporation. Fairmont is managed by the Company pursuant to a management agreement, for which the Company\nreceives a management fee of $125,000 plus reimbursement of out-of-pocket expenses and allocated overhead costs. In August 1992, Fairmont filed for protection from its creditors under Chapter 11 of the U.S. Bankruptcy Code. In September 1993, Fairmont emerged from Chapter 11 upon approval by the bankruptcy court of a plan of reorganization (the 'Plan'). The Plan provides for the sale of Fairmont's assets, distribution of proceeds in accordance with the Plan, and subsequent liquidation of Fairmont. All of Fairmont's stations were sold by 1994. The Company will continue to manage Fairmont pursuant to the management agreement which expires upon the liquidation of Fairmont, which is expected in 1996. In addition to its management fees, the Company received distributions of $0.4 million and $2.3 million in 1995 and 1994, respectively, relating to the sale of Fairmont's radio stations.\nThe Company held a 32% interest in Northstar Television Group, Inc. and managed Northstar's four television stations pursuant to a management agreement in return for a management fee plus reimbursement of out-of-pocket expenses and allocated overhead costs. In 1994, Northstar's creditors and equity investors reached an agreement with respect to restructuring Northstar's highly leveraged capital structure pursuant to which, among other things, the Company received a portion of accrued and unpaid management fees and retains an economic interest. The Company's management agreement with Northstar terminated following the restructuring. In January 1995, three of Northstar's four television stations were sold and the Company received a distribution of $1.6 million.\nOSBORN HEALTHCARE\nThe Company's credit facility limits the amount of additional investment the Company may make in Osborn Healthcare to $2.0 million, of which $0.4 million was made in 1995. The Company believes that this limitation will not significantly impact the operation of the business in 1996.\nSEASONALITY\nFor broadcasting properties, the first quarter is expected to reflect the lowest revenues and net income of the year, while the fourth quarter historically has had the highest revenues and net income. This is due in part to increases in retail advertising in the fall in preparation for the holiday season, with a subsequent reduction of retail advertising after the holidays.\nThe Company's entertainment properties are expected to reflect the lowest revenues and net operating results of the year in the first quarter due to the planned scheduling of the most popular performers during the peak spring, summer and fall seasons. Also, the Company's country music festival, Jamboree in the Hills, takes place in the third quarter of each year.\nEFFECTS OF INFLATION\nThe Company believes the relatively moderate rates of inflation over the past three years have not had a significant impact on the profitability of the Company. In general, the Company believes the effects of inflation are offset through increases in advertising rates.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nOSBORN COMMUNICATIONS CORPORATION CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee accompanying notes.\nOSBORN COMMUNICATIONS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nOSBORN COMMUNICATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nOSBORN COMMUNICATIONS CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\nNOTE 1 -- NATURE OF BUSINESS AND ORGANIZATION\nOsborn Communications Corporation (the 'Company') is engaged in the operation of radio, television, programmed music, cable television and other communications properties throughout the United States.\nNOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES\nA. Basis of presentation -- The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany items and transactions have been eliminated. Investments in affiliated companies are accounted for using the equity method. Prior years' amounts have been reclassified to conform with the current year's presentation.\nB. Depreciation -- Property, plant and equipment are recorded at cost and depreciated 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.\nC. Intangible assets -- Intangible assets include $2.5 million for 1995 and $3.0 million for 1994 for agreements not to compete relating to certain transactions described in Note 3, and $3.4 million for 1995 and 1994 assigned to Muzak customer contracts acquired in 1990 and 1986, which are being amortized over their estimated useful lives. Deferred financing costs of $1.2 million for 1995 and $1.9 million for 1994 are being amortized over the term of the related debt on a straight-line basis, which approximates the interest method. The remainder, in the amount of $48.6 million for 1995 and $49.3 million for 1994, represents the excess of acquisition cost over the amounts assigned to other assets acquired in the Company's acquisitions, and is being amortized on a straight-line basis principally over a 40-year period.\nIt is the Company's policy to account for goodwill and all other intangible assets at the lower of amortized cost or estimated realizable value. As part of an ongoing review of the valuation and amortization of intangible assets of the Company and its subsidiaries, management assesses the carrying value of the intangible assets if facts and circumstances suggest that there may be impairment. If this review indicates that the intangibles will not be recoverable as determined by a non-discounted cash flow analysis of the operating assets over the remaining amortization period, the carrying value of the intangible assets would be reduced to estimated realizable value.\nThe 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' in March 1995, which establishes standards for the recognition and measurement of impairment losses on long-lived assets, certain identifiable intangible assets, and goodwill. The requirements of SFAS No.121 will be effective for the Company's financial statements beginning in 1996. The Company does not believe that the implementation of SFAS No. 121 will have a material effect on its financial statements.\nD. Barter transactions -- Revenue from barter transactions (advertising provided in exchange for goods and services) is recognized as income when advertisements are broadcast, and merchandise or services received are charged to expense (or capitalized as appropriate) when received or used.\nE. Minority interest -- In December 1995, the Company paid $260,000 in exchange for the interest held by outside investors in Osborn Healthcare Communications, Inc. ('Osborn Healthcare'), thereby increasing its ownership to 100%. Osborn Healthcare provides cable television services to hospitals.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nF. Revenue -- Broadcast revenue is presented net of advertising commissions and representative fees of $2,326,000, $2,089,000 and $1,417,000 in 1995, 1994 and 1993, respectively.\nG. Per share data -- Primary earnings per common share for 1995 is based on the net income for the year divided by the weighted average number of common and common equivalent shares. Common stock equivalents consist of stock options and warrants (see Notes 11 and 12). Shares issuable upon the exercise of all common stock equivalents and other potentially dilutive securities are not included in the computations for 1994 and 1993 since their effect is not dilutive.\nH. Cash equivalents -- Cash equivalents consist of short-term, highly liquid investments which are readily convertible into cash and have an original maturity of three months or less when purchased.\nI. Inventory -- Inventories, consisting of merchandise for the Company's entertainment properties, sound equipment held for resale by the Company's Muzak franchises and equipment held for resale by the Company's healthcare cable business, are valued at the lower of cost or market using the first-in, first-out method.\nJ. Risks and Uncertainties -- The preparation of financial statements in conformity with generally accepted accounting principles requires the Company 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 reported period. Actual results may differ from those estimates.\nNOTE 3 -- ACQUISITIONS AND DISPOSITIONS\nAt December 31, 1995 the Company owned and operated eleven FM and five AM radio stations, four programmed music and sound equipment distributorships, a hospital cable television company and certain entertainment properties.\n1995:\nIn December 1995, the Company entered into an option agreement with Allbritton Communications Company for the sale of television station WJSU-TV, Anniston, Alabama, and an associated 10-year local marketing agreement. In consideration for the option, the Company received a nonrefundable cash payment of $10.0 million. Because the cash proceeds from the option are nonrefundable, the Company accounted for the economic substance of the transaction as if a sale of substantially all the assets of the station had occurred. Accordingly, a gain of approximately $8.1 million was recorded. In addition, upon the exercise of the option and the necessary FCC consent, the Company will receive an additional cash payment of $2.0 million. If the necessary approvals to relocate the station's broadcast transmitter to maximize broadcast coverage of the facility are received, the Company will receive additional cash payments of up to $7.0 million.\nIn August 1995, the Company agreed to acquire substantially all the assets of radio stations WKII-AM\/WEEJ-FM, Port Charlotte, Florida from Kneller Broadcasting of Charlotte County, Inc. ('Kneller') for $2.85 million, subject to Federal Communications Commission ('FCC') approval and license renewal. In the event that the Company is able to relocate WEEJ-FM's broadcast antenna to the Company's Pine Island, Florida tower in order to better serve the Port Charlotte\/Ft. Myers market, additional consideration of $750,000 will be paid. Pending the closing of the transaction, which is expected in April 1996, the stations are managed by the Company pursuant to a local marketing agreement.\nIn September 1995, the Company agreed to sell substantially all the assets of radio stations WNDR-AM\/WNTQ-FM, Syracuse, New York to Pilot Communications L.L.C. ('Pilot') for $12.5 million, subject to FCC approval. Pending the closing of the transaction, which occurred in February\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\n1996, the stations were managed by the purchaser pursuant to a local marketing agreement (see Note 13).\nIn September 1995, the Company agreed to sell substantially all the assets of radio stations WWRD-FM, Jacksonville, Florida\/Brunswick, Georgia and WFKS-FM, Daytona Beach\/Palatka, Florida, as well as the Company's 50% interest in the broadcast tower serving WWRD-FM to Renda Broadcasting Corporation ('Renda') for total consideration of $6.5 million. The closing of the transactions is subject to FCC approval. The sale of WWRD-FM closed in January 1996 (see Note 13) and the sale of WFKS-FM is expected to close in 1996. Pending the closing of the transactions, the stations have been managed by the purchaser pursuant to local marketing agreements.\n1994:\nIn June 1994, the Company acquired substantially all the assets of three FM and one AM radio stations for $20.0 million plus transaction costs. The acquisition included radio stations WWNC-AM\/WKSF-FM, Asheville, North Carolina; WOLZ-FM, Ft. Myers, Florida; and WFKS-FM, Daytona Beach\/Palatka, Florida. In August 1994, the Company acquired substantially all the assets of radio stations WAAX-AM\/WQEN-FM, Gadsden, Alabama for $1.75 million plus transaction costs. The seller of the six stations has agreed not to own or operate radio stations in these markets for a period of three years. The Gadsden market is adjacent to the Anniston market, in which the Company owned its television station. In August 1995, the Company was granted a waiver of the FCC's regulations prohibiting ownership of radio and television stations in the same market. Pending the FCC's ruling on the waiver application, the Gadsden stations were placed in a trust which operated the stations on the Company's behalf.\nIn March 1994, the Company, through a wholly-owned subsidiary, acquired radio station WAYV-FM, Atlantic City, New Jersey, for consideration of approximately $2.5 million (see Note 6.) In February 1996, the Company entered into an agreement to sell substantially all the assets of radio station WAYV-FM, Atlantic City, New Jersey to Equity Communications, L.P. for $3.1 million, subject to FCC approval. Pending the closing of the transaction, which is expected in 1996, the purchaser is managing the stations pursuant to a local marketing agreement.\nAll of the acquisitions have been accounted for using the purchase method of accounting. Accordingly, the purchase price of each acquisition has been allocated to the assets based upon their fair values at the date of acquisition. The results of operations of the properties acquired are included in the Company's consolidated results of operations from the respective dates of acquisition and until the date of disposition for properties disposed. Prior to the grant of the waiver of the FCC's cross-ownership regulations, the Gadsden acquisition was accounted for using the equity method of accounting. Accordingly, prior year financial statements have been reclassified to reflect the consolidation of the Gadsden radio stations.\nOTHER INVESTMENTS:\nIn 1989, the Company acquired, for $620,000, a 50% non-voting ownership interest (without control) in a corporation that owns and operates radio station WDRR-FM, San Carlos Park, Florida. The station became operational in September 1995. The Company's net investment is included in investment in affiliated companies on the consolidated balance sheet.\nIn 1989, the Company acquired a 32% ownership interest in Northstar Television Group, Inc. ('Northstar') for $329,000. From Northstar's inception through May 1994, the Company managed Northstar's four television stations for an annual fee of up to $250,000, plus reimbursement of out-of-pocket expenses and allocated overhead costs. In 1994, as a result of a proposed restructuring of Northstar, the Company agreed, as payment for prior services rendered, to receive an immediate\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\npayment of $250,000, another payment of $250,000 within two years, and the retention of an economic interest. The Company's management agreement terminated following the restructuring. In 1995, three of Northstar's four television stations were sold and the Company received a distribution of $1.6 million, classified as other income in the consolidated statement of operations, plus accrued management fees of $250,000.\nIn 1987, the Company acquired 25% of the stock of Fairmont Communications Corporation ('Fairmont') for $500,000. Fairmont owned seven radio stations in four large and medium sized markets. In August 1992, Fairmont filed for protection from its creditors under Chapter 11 of the U.S. Bankruptcy Code. In September 1993, Fairmont emerged from Chapter 11 upon approval by the bankruptcy court of a plan of reorganization (the 'Plan'). The Plan provided for the sale of Fairmont's assets, distribution of the proceeds in accordance with the Plan, and subsequent liquidation of Fairmont. All of Fairmont's stations were sold by the second quarter of 1994. The Company will continue to manage Fairmont pursuant to a management agreement which expires upon the liquidation of Fairmont, which is expected in 1996. For managing Fairmont, the Company receives an annual fee of $125,000, plus reimbursement of out-of-pocket expenses and allocated overhead costs. In 1994, the Company received additional management fees of $728,000 related to the sale of Fairmont's stations. The Company also earned distributions of $0.4 million and $2.3 million in 1995 and 1994, respectively, classified as other income and distribution receivable in the consolidated financial statements, determined by the amounts realized by Fairmont from sales of its assets.\nNOTE 4 -- LOCAL MARKETING AGREEMENTS\nThe Company has entered into certain local marketing agreements ('LMAs') whereby it provides programming to a station owned by a third party and pays a monthly fee for the right to air such programming. The Company receives the right to solicit advertising and to receive payments from the advertisers.\nIn September 1995, the Company entered into an LMA with Kneller to manage Kneller's radio stations WKII-AM\/WEEJ-FM, Port Charlotte, Florida pending the acquisition of the stations (see Note 3).\nIn January 1996, the Company entered into an LMA with EBE Communications Limited Partnership and EBE Broadcasting, L.P. ('EBE') to manage EBE's radio stations KNAX-FM\/KRBT-FM, Fresno, California pending the acquisition of the stations (see Note 13).\nIn addition, the Company has entered into certain other LMAs whereby a third party provides programming to a station owned by the Company and pays a monthly fee for the right to air such programming. The third party receives the right to solicit advertising and to receive payments from the advertisers.\nIn September 1995, the Company entered into LMAs with Renda to manage radio stations WWRD-FM, Jacksonville, Florida\/Brunswick, Georgia and WFKS-FM, Daytona Beach\/Palatka, Florida pending the disposition of the stations (see Note 3).\nIn September 1995, the Company entered into an LMA with Pilot to manage radio stations WNDR-AM\/WNTQ-FM, Syracuse, New York pending the disposition of the stations (see Note 3).\nIn 1993, the Company entered into a five-year LMA with Great Trails Broadcasting Corporation ('Great Trails') to manage the Company's radio station WING-FM, Dayton\/Springfield, Ohio. Great Trails has the option to purchase the station at escalating prices throughout the term of the LMA.\nIn 1992, the Company entered into a five-year LMA with Pinnacle Broadcasting Company, Inc. ('Pinnacle') to manage the Company's radio station WFXK-FM, Raleigh\/Tarboro, North Carolina. In\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nFebruary 1996, the Company agreed to sell substantially all the assets of the station to Pinnacle (see Note 13).\nNOTE 5 -- PRO FORMA FINANCIAL INFORMATION (UNAUDITED)\nThe unaudited pro forma information for the year ended December 31, 1995 assumes that the Anniston, Syracuse and Jacksonville\/Brunswick dispositions, as described in Note 3, had occurred on January 1, 1995. The unaudited pro forma information for the year ended December 31, 1994 assumes that the Anniston, Syracuse and Jacksonville\/Brunswick dispositions and Atlantic City, Asheville, Ft. Myers, Daytona Beach\/Palatka, and Gadsden acquisitions, as described in Note 3, the CMIF credit agreement, as described in Note 6, and reverse stock split, as described in Note 12, had occurred on January 1, 1994. The pro forma information is not necessarily indicative either of the results of operations that would have occurred had these transactions been made at the beginning of the period, or of future results of operations.\nNet assets of properties to be disposed in Syracuse, Anniston, Jacksonville\/Brunsick, Daytona Beach, Raleigh\/Tarboro and Atlantic City aggregated $17.6 million at December 31, 1995, consisting of current assets of $0.8 million, net property, plant and equipment of $4.1 million, and net intangible assets of $12.7 million.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nNOTE 6 -- LONG-TERM DEBT\nA summary of long-term debt as of December 31, 1995 and 1994 is as follows:\n- ------------\n(A) In August 1995, the Company entered into a credit facility of $56.0 million with Society National Bank (the 'Credit Facility'). The Credit Facility consists of a $46.0 million revolving credit facility and a $10.0 million facility which may be used for acquisitions. The initial drawdown of $44.5 million, along with the Company's internally generated funds, was used to repay existing loans totalling $50.0 million and pay transaction costs. The Credit Facility contains covenants which require, among other things, that the Company and its subsidiaries (excluding Atlantic City Broadcasting Corp.) maintain certain financial levels, principally with respect to EBITDA and\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nleverage ratios, and limit the amount of capital expenditures. The Credit Facility also restricts the payment of cash dividends. The Credit Facility is collateralized by pledges of the tangible and intangible assets of the Company and its subsidiaries (excluding Atlantic City Broadcasting Corp.), as well as the stock of those subsidiaries. At December 31, 1995, the Company has additional availability under the revolving credit facility and the acquisition facility of $1.5 million and $10.0 million, respectively. The Company pays an annual commitment fee of 0.5% of the unused commitment.\n(B) In June 1994, the Company entered into two loan agreements totalling $50.0 million with World Subordinated Debt Partners, L.P., an affiliate of Citicorp Mezzanine Investment Fund ('CMIF'). As part of the consideration for making the loans, the lender was given a warrant to purchase 1,014,193 shares of the Company's common stock at $7.00 per share (see Note 12.) The net proceeds from the loans were used to fund the acquisitions of radio stations and to repay certain of the Company's other debt, resulting in an extraordinary loss on the early extinguishment of debt of $436,000 in 1994. The loans were repaid in August 1995, primarily using the proceeds from the Credit Facility. Along with the repayment of debt, the Company was able to cancel purchase rights with respect to 676,162 warrant shares of the 1,014,193 warrant shares issued with the previous loans.\nAs a result of the repayment of the CMIF loans, the Company recorded an extraordinary loss on the early extinguishment of debt of approximately $3.9 million in 1995. The extraordinary loss is primarily due to non-cash charges from the write-off of deferred financing costs and debt discount.\n(C) The term loan and revolving loan contain covenants with respect to the Company's wholly-owned subsidiary, Atlantic City Broadcasting Corp. which, among other things, restrict cash distributions to the Company and limit the amount of annual capital expenditures. The revolving loan converted to a term loan in March 1995. These loans are collateralized by pledges of the tangible and intangible assets and stock of Atlantic City Broadcasting Corp., and is otherwise nonrecourse to the Company and its other assets. The Company and the lender have agreed to sell substantially all the assets of Atlantic City Broadcasting Corp., and accordingly, the debt is classified as short term. All proceeds of the proposed sale are expected to be used to fund transaction costs and repay the debt (see Note 13). The assets of Atlantic City Broadcasting Corporation were acquired in March 1994 for consideration of approximately $2.5 million, consisting of the assumption of debt.\n------------------------\nAt December 31, 1995, the aggregate amounts of long-term debt due during the next five years are as follows:\nThe fair value of the debt approximates net book value.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nNOTE 7 -- PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31, consists of the following:\nAt December 31, 1995, all property, plant and equipment is pledged as collateral for the debt disclosed in Note 6.\nNOTE 8 -- INCOME TAXES\nAt December 31, 1995, the Company has consolidated net operating loss carryforwards for income tax purposes of $33.9 million that expire in years 2002 through 2010. Of the total net operating loss carryforwards, $11.0 million may be used only to offset future income of the Company's subsidiary, Osborn Entertainment Enterprises Corporation. For financial reporting purposes, a valuation allowance of $9.1 million has been recognized to offset the deferred tax asset related to carryforwards.\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:\nThe 1995 provision for income taxes consists entirely of state and local taxes, of which $535,000 is current and $241,000 is deferred. The 1994 provision consists entirely of state and local taxes, of which $114,000 is current and $175,000 is deferred. The 1993 provision consists entirely of current state and local taxes.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nThe reconciliation of income tax computed at the U.S. federal statutory tax rate to income tax expense is as follows:\nNOTE 9 -- COMMITMENTS\nThe Company leases office space, vehicles and office equipment. Rental expense amounted to $994,000, $768,000 and $710,000 in 1995, 1994 and 1993, respectively.\nThe minimum aggregate annual rentals under noncancellable operating leases are payable as follows:\nNOTE 10 -- EMPLOYEE BENEFIT PLANS\nThe Company sponsors a profit sharing plan which qualifies under Section 401(k) of the Internal Revenue Code. The plan is available to all full-time employees with at least one year of employment with the Company. All eligible employees may elect to contribute a portion of their compensation to the profit sharing plan, subject to Internal Revenue Code limitations. In December 1994, the Company adopted a non-qualified deferred compensation plan available to certain management employees.\nNOTE 11 -- STOCK OPTION PLAN\nThe Company's Incentive Stock Option Plan provides for the granting to officers and key employees of incentive and non-qualified stock options to purchase the Company's voting common stock as defined under current tax laws. Incentive stock options are exercisable at a price equal to the fair market value, as defined, on the date of grant, for a maximum 10-year period from the date of grant. Non-qualified stock options may be granted at an exercise price equal to at least 85% of the fair market value on the date of grant, for a maximum 11-year period from the date of grant. The exercise prices of all options granted in 1995, 1994 and 1993 were the fair market values at the date of grant.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nThe following table summarizes the plan's transactions for the years ended December 31, 1995, 1994 and 1993:\nThe Financial Accounting Standards Board issued SFAS No. 123, 'Accounting for Stock Based Compensation' in October 1995, which establishes financial accounting and reporting standards for stock based employee compensation plans including stock purchase plans, stock options, restricted stock, and stock appreciation rights. The Company has elected to continue accounting for stock based compensation under Accounting Principles Board Opinion No. 25. The disclosure requirements of SFAS No. 123 will be effective for the Company's financial statements beginning in 1996. The Company does not believe that the implementation of SFAS No. 123 will have a material effect on its financial statements.\nNOTE 12 -- STOCKHOLDERS' EQUITY\nIn January 1995, the Company repurchased and subsequently retired 107,059 unregistered shares of its common stock which were held by an institution, totalling approximately $642,000. In December 1994, the Company repurchased and subsequently retired 17,843 shares of its common stock at $6.00 per share, totalling approximately $107,000.\nIn June 1994, the Company entered into two credit agreements totalling $50.0 million with CMIF (see Note 6.) As partial consideration for making the loans, CMIF received a warrant to purchase 1,014,193 shares (after giving effect to the reverse stock split described below) of the Company's common stock at $7.00 per share. The warrant is exercisable for a 10-year period. Under the terms of the warrant agreement, in the event that the CMIF loans were repaid by December 31, 1995, purchase rights with respect to 676,162 warrant shares will be cancelled. The loans were repaid in August 1995 and, accordingly, the purchase rights with respect to 676,162 warrant shares were cancelled.\nOn July 11, 1994, the Company effected a 1-for-2 reverse stock split for shareholders of record on that date. Cash was paid in lieu of fractional shares. All per share amounts in the consolidated statement of operations reflect the reverse stock split.\nNOTE 13 -- SUBSEQUENT EVENTS (UNAUDITED)\nIn January 1996, the Company entered into an agreement to acquire substantially all assets of radio stations KNAX-FM\/KRBT-FM, Fresno, California from EBE Broadcasting, L.P., subject to FCC approval. Consideration for the acquisition consists of $6.0 million plus 120,000 shares of the Company's common stock. Pending the closing of the transaction, which is expected in 1996, the Company is managing the stations pursuant to a local marketing agreement.\nIn January 1996, the Company entered into an agreement to acquire substantially all the assets of radio station WHLX-FM, Wheeling, West Virginia from Bethlehem Radio, Inc. for $0.8 million, subject to FCC approval. The transaction is expected to close in 1996.\nOSBORN COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DECEMBER 31, 1995\nIn February 1996, the Company entered into an agreement to acquire substantially all the assets of radio stations WKWK-AM\/FM, Wheeling, West Virginia from WKWK Radio, Inc. for $2.7 million, subject to FCC approval. Pending the closing of the transaction, which is expected in 1996, the Company intends to enter into a local marketing agreement to manage the stations as soon as FCC regulations permit.\nIn January 1996, the Company sold substantially all the assets of radio station WWRD-FM, Jacksonville, Florida\/Brunswick, Georgia to Renda Broadcasting Corp. for $2.5 million. This transaction resulted in a pre-tax gain of approximately $0.8 million (see Note 3).\nIn February 1996, the Company sold substantially all the assets of radio stations WNDR-AM\/WNTQ-FM, Syracuse, New York to Pilot Communications, L.L.C. for $12.5 million. This transaction resulted in a pre-tax gain of approximately $6.0 million (see Note 3).\nIn February 1996, the Company entered into an agreement to sell substantially all the assets of radio station WFXK-FM, Raleigh\/Tarboro, North Carolina to Pinnacle Broadcasting Corporation for $5.9 million, subject to FCC approval. Pending the closing of the transaction, which is expected in 1996, the purchaser is continuing to manage the station pursuant to a local marketing agreement (see Note 4).\nIn February 1996, the Company entered into an agreement to sell substantially all the assets of radio station WAYV-FM, Atlantic City, New Jersey to Equity Communications, L.P. for $3.1 million, subject to FCC approval. Pending the closing of the transaction, which is expected in 1996, the purchaser is managing the stations pursuant to a local marketing agreement.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders OSBORN COMMUNICATIONS CORPORATION\nWe have audited the accompanying consolidated balance sheets of Osborn Communications Corporation 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. 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 by management, as 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 Osborn Communications 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, present fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nNew York, New York February 16, 1996\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information required by this item is not 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 relating to Directors of the Company is included in the Company's definitive proxy statement for the annual meeting of shareholders to be held on May 22, l996 and is incorporated herein by reference. The information required by this item relating to the executive officers of the Company is included in Part I of this report on page 12.\nAll directors hold office until the next annual meeting of the shareholders of the Company and until their successors are elected and qualified. Officers are elected by the Board of Directors and serve at the pleasure of the Board, except that Mr. Osborn serves as President pursuant to a contract expiring December 1996, as discussed in Part III, Item 11","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is included in the Company's definitive proxy statement for the annual meeting of shareholders to be held on May 22, l996 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 definitive proxy statement for the annual meeting of shareholders to be held on May 22, l996 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 definitive proxy statement for the annual meeting of shareholders to be held on May 22, l996 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) The following consolidated financial statements of Osborn Communications Corporation and subsidiaries are filed as a part of this report:\nConsolidated Financial Statements\nConsolidated Balance Sheets as of December 31, l995 and l994\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 Statement of Changes in Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Auditors\n(a)(2) The following Financial Statement Schedule for the years ended December 31, 1995, 1994 and 1993 is filed as Exhibit 99(a) as part of this annual report on Form 10-K.\nSchedule II -- Valuation and qualifying accounts\nAll other schedules have been omitted because the information is not applicable or is not material or because the information required is included in the consolidated financial statements or the notes thereto.\n(a)(3) Exhibits\nThe exhibits listed in the accompanying index to exhibits on page 41 are filed as part of this annual report on Form 10-K.\n(b) Reports on Form 8-K for the quarter ended December 31, l995: None\nSIGNATURES\nPursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOSBORN COMMUNICATIONS CORPORATION (Registrant)\nBy: \/s\/ FRANK D. OSBORN ................................... FRANK D. OSBORN PRESIDENT AND CHIEF EXECUTIVE OFFICER\nMarch 25, 1996\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:\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-30820) pertaining to the Osborn Communications Corporation 1987 Incentive Stock Plan, as Amended, and in the related Prospectus, of our report dated February 16, 1996 with respect to the consolidated financal statements and the financial statement schedule included in this Annual Report (Form 10K) of Osborn Communications Corporation.\nERNST & YOUNG LLP\nNew York, New York March 25, 1996\nINDEX TO EXHIBITS ITEM 14(A)3.\n(table continued on next page)\n(table continued from previous page)\n(table continued on next page)\n(table continued from previous page)\n(table continued on next page)\n(table continued from previous page)\n- ------------ * Indicates a management contract or compensatory plan or arrangement.\nOSBORN COMMUNICATIONS CORPORATION 130 Mason Street Greenwich, Connecticut 06830 Telephone (203) 629-0905 Fax (203) 629-1749\nDIRECTORS Brownlee O. Currey, Jr. H. Anthony Ittleson Edward G. Nelson Frank D. Osborn William G. Spears Robert K. Zelle\nOFFICERS Frank D. Osborn President and Chief Executive Officer\nThomas S. Douglas Senior Vice President\/Finance and Treasurer\nMichael F. Mangan Vice President\/Controller and Secretary\nRADIO Larry A. Anderson Vice President\/General Manager Radio and Entertainment Wheeling, West Virginia\nRobert E. Vandine Station Manager Radio Stations WWVA-AM\/WOVK-FM Wheeling, West Virginia\nMark Bass Vice President\/General Manager Radio Stations WAAX-AM\/WQEN-FM Gadsden, Alabama\nDonald Boyles Senior Vice President -- Southwest Florida\/General Manager Radio Stations WKII-AM*\/WOLZ-FM\/ WEEJ-FM*\nLynn Golub General Manager Radio Station WFKS-FM Daytona Beach, Florida\nDonald P. Hodges Vice President\/General Manager Radio Stations WTJS-AM\/WTNV-FM Jackson, Tennessee\nWilliam R. McMartin Vice President\/General Manager Radio Stations WWNC-AM\/WKSF-FM Asheville, North Carolina\nChris Pacheco Vice President\/General Manager Radio Stations KNAX\/KRBT-FM* Fresno, California\nJohn Rae General Manager Radio Station WFXK-FM Raleigh\/Tarboro, North Carolina\nRuth Ray President\/General Manager Radio Station WDRR-FM** Fort Myers\/San Carlos Park, Florida\nJohn Soller Group Director of Engineering General Manager Radio Station WING-FM Dayton\/Springfield, Ohio\nJoan Taylor General Manager Radio Station WAYV-FM Atlantic City, New Jersey\nMUZAK'r'\/OSBORN SOUND & COMMUNICATIONS W. Charles Hillebrand President\nPeter P. Longley Vice President\nKenneth R. Maas General Manager Tampa, Florida\nMark A. Rupert General Manager Fort Myers, Florida\nDominique Martin General Manager Albany, Georgia\nHEALTHCARE COMMUNICATIONS John F. McLane President Nashville, Tennessee\nCORPORATE COUNSEL Paul, Weiss, Rifkind, Wharton & Garrison 1285 Avenue of the Americas New York, New York 10019\nFCC COUNSEL Haley, Bader & Potts 4350 Fairfax Drive Arlington, Virginia 22203\nAUDITORS Ernst & Young, LLP 787 Seventh Avenue New York, New York 10019\nSTOCK TRANSFER AGENT American Stock Transfer & Trust Co. 40 Wall Street New York, New York 10005\nCOMMON STOCK The Company's common stock is listed on the NASDAQ National Market System and trades under the symbol OSBN. - ------------ * Operating under an LMA pending acquisition ** The Company has a 50% non-voting ownership interest in WDRR-FM","section_15":""}
{"filename":"729502_1995.txt","cik":"729502","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral: ------- First Financial Bancorp (the \"Company\") was incorporated under the laws of the State of California on May 13, 1982, and operates principally as a bank holding company for its wholly owned subsidiary, Bank of Lodi, N.A. (the \"Bank\"). The Company is registered under the Bank Holding Company Act of 1956, as amended. The Bank is the sole subsidiary of the Company and its principal source of income. The Company also owns the office building where the Bank's Lodi Branch and administrative offices are located as well as the land upon which the Bank's Woodbridge Branch is located. The Company receives income from the Bank and other parties from leases associated with these properties. All references herein to the \"Company\" include the Bank, unless the context otherwise requires.\nThe Bank: -------- The Bank was organized on May 13, 1982 as a national banking association. The application to organize the Bank was accepted for filing by the Comptroller of the Currency (OCC) on September 8, 1981, and preliminary approval was granted on March 27, 1982. On July 18, 1983 the Bank received from the Comptroller a Certificate of Authority to Commence the Business of Banking.\nThe Bank's main office is located at 701 South Ham Lane, Lodi, California, with branch offices in Woodbridge and Lockeford California. The Bank's primary service area, from which the Bank attracts 95% of its business, is the city of Lodi and the surrounding area. This area is estimated to have a population approaching 70,000 persons, with a median annual family income of approximately $30,000. The area includes residential developments, neighborhood shopping centers, business and professional offices and manufacturing and agricultural concerns.\nBank Services: ------------- The Bank offers a wide range of commercial banking services to individuals and business concerns located in and around its primary service area. These services include personal and business checking and savings accounts (including interest-bearing negotiable order of withdrawal (\"NOW\") accounts and\/or accounts combining checking and savings accounts with automatic transfers), and time certificates of deposit. The Bank also offers extended banking hours at its drive-through window, night depository and bank-by-mail services, and travelers' checks (issued by an independent entity). The Bank issues MasterCard credit cards and acts as a merchant depository for cardholder drafts under both VISA and MasterCard. In addition, it provides note and collection services and direct deposit of social security and other government checks.\nThe Bank engages in a full complement of lending activities, including commercial, SBA, residential mortgage, consumer\/installment, and short-term real estate loans, with particular emphasis on short and medium-term obligations. Commercial lending activities are directed principally towards businesses whose demand for funds falls within the Bank's lending limit, such as small to medium-sized professional firms, retail and wholesale outlets and manufacturing and agricultural concerns. Consumer lending is oriented primarily to the needs of the Bank's customers, with an emphasis on automobile financing and leasing. Consumer loans also include loans for boats, home improvements, debt consolidation, and other personal needs. Real estate loans include short-term \"swing\" loans and construction loans. Residential mortgages are generally sold into the secondary market for these loans. Small Business Administration (SBA) loans are made available to small to medium-sized businesses.\nSources of Business ------------------- Management seeks to obtain sufficient market penetration through the full range of services described above and through the personal solicitation of the Bank's officers, directors and shareholders. All officers are responsible for making regular calls on potential customers to solicit business and on existing customers to obtain referrals. Promotional efforts are directed toward individuals and small to medium-sized businesses. The Bank's customers are able in their dealings with the Bank to be served by bankers who have commercial loan experience, lending authority, and the time to serve their banking needs quickly and competently. Bankers are assigned to customers and not transferred from office to office as in many major chain or regional banks. In order to expedite decisions on lending transactions, the Bank's loan committee meets on a regular basis and is available where immediate authorization is important to the customer.\nThe risk of non-payment (or deferred payment) of loans is inherent in commercial banking. Furthermore, the Bank's marketing focus on small to medium-sized businesses may involve certain lending risks not inherent in loans to larger companies. Smaller\ncompanies generally have shorter operating histories, less sophisticated internal record keeping and financial planning capabilities, and greater debt-to-equity ratios. Management of the Bank carefully evaluates all loan applicants and attempts to minimize its credit risk through the use of thorough loan application and approval procedures.\nConsistent with the need to maintain liquidity, management of the Bank seeks to invest the largest portion of the Bank's assets in loans of the types described above. Loans are generally limited to less than 75% of deposits and capital funds. The Bank's surplus funds are invested in the investment portfolio, made up of both taxable and non-taxable debt securities of the U.S. government, U.S. government agencies, states, and municipalities. On a day to day basis, surplus funds are invested in federal funds and other short-term money market instruments.\nCompetition: ----------- The banking business in California generally, and in the northern portion of San Joaquin County where the Bank is located, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks with branch office networks and other operating affiliations throughout the State. The Bank competes for deposits and loans with these banks, as well as with savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies and other lending institutions. Among the advantages certain of these institutions have over the Bank are their ability (i) to finance extensive advertising campaigns, (ii) to allocate a substantial portion of their investment assets in securities with higher yields (not available to the Bank if its investments are to be diversified) and (iii) to make funds available for loans in geographic regions with the greatest demand. In competing for deposits, the Bank is subject to the same regulations with respect to interest rate limitations on time deposits as other depository institutions. See \"Supervision and Regulation\" below.\nMany of the major commercial banks operating in the Bank's service area offer certain services, such as international banking and trust services, which are not offered directly by the Bank, and such banks, by virtue of their greater capitalization, have substantially higher lending limits than the Bank. In addition, other entities, both public and private, seeking to raise capital through the issuance and sale of debt and equity securities compete with the Bank for the acquisition of funds for deposit.\nIn order to compete with other financial institutions in its primary service area, the Bank relies principally on local promotional activities, personal contacts by its officers, directors, employees and shareholders, extended hours and specialized services. The Bank's promotional activities emphasize the advantages of dealing with a locally-owned and headquartered institution sensitive to the particular needs of the community. The Bank also assists customers in obtaining loans in excess of the Bank's lending limit or services not offered by the Bank by arranging such loans or services in participation with or through its correspondent banks.\nThe State Bank Parity Act, effective January 1, 1996, eliminates certain existing disparities between California state chartered banks and national banking associations, such as the Bank, by authorizing the California Superintendent of Banks (the \"Superintendent\") to address such disparities through a streamlined rulemaking process.\nEmployees: --------- As of December 31, 1995, the Company employed 65 full-time equivalent employees, including three executive officers. Management believes that the Company's relationship with its employees is good.\nSUPERVISION AND REGULATION\nThe Company ----------- The common stock of the Company is subject to the registration requirements of the Securities Act of 1933, as amended, and the qualification requirements of the California Corporate Securities Law of 1968, as amended. The Bank's common stock, however, is exempt from such requirements. The Company is also subject to the periodic reporting requirements of Section 15(d) of the Securities Exchange Act of 1934, as amended, which include, but are not limited to, annual, quarterly and other current reports with the Securities and Exchange Commission.\nThe Company is a bank holding company registered under the Bank Holding Company Act of 1956 (the \"Act\") and is subject to supervision by the Board of Governors of the Federal Reserve System (the \"Board\"). As a bank holding company, the Company must file with the Board quarterly reports, annual reports, and such other additional information as the Board may require pursuant to the Act. The Board may also make examinations of the Company and its subsidiaries.\nThe Act requires prior approval of the Board for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares, or substantially all the assets, of any bank, or for a merger or consolidation by a bank holding company with any other bank holding company. The Act also prohibits the acquisition by a bank holding company or any of its subsidiaries of voting shares, or substantially all the assets, of any bank located in a state other than the state in which the operations of the bank holding company's banking subsidiaries are principally conducted, unless the statutes of the state in which the bank to be acquired is located expressly authorize such acquisition.\nWith certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to, or performing services for, its authorized subsidiaries. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities that the Board has determined to be so closely related to banking or to managing or controlling banks as to be properly incident thereto. In making such a determination, the Board is required to consider whether the performance of such activities 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 undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Board is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern.\nAdditional statutory provisions prohibit a holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit, sale or lease of property or furnishing of services. Thus, a subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or service from or to such bank other than a loan, discount, deposit or trust service; or (ii) the customer must obtain or provide some additional credit, property or service from or to the company or any other subsidiary of the company; or (iii) the customer may not obtain some other credit, property to service from competitors, except reasonable requirements to assure soundness of the credit extended. These anti-tying restrictions also apply to bank holding companies and their non-bank subsidiaries as if they were banks.\nThe Company's ability to pay cash dividends is subject to restrictions set forth in the California General Corporation Law. See Item 5 below for further information regarding the payment of cash dividends by the Company and the Bank.\nThe Company is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Superintendent. Regulations have not yet been proposed or adopted to implement the Superintendent's powers under this statute.\nThe Bank: -------- The Bank, as a national banking association whose accounts are insured by the Federal Deposit Insurance Corporation (the \"FDIC\") up to the maximum legal limits and is subject to regulation, supervision, and regular examination by the OCC. The Bank is a member of the Federal Reserve System, and, as such, is subject to certain provisions of the Federal Reserve Act and regulations issued by the Board. The Bank is also subject to applicable provisions of California law, insofar as they are not in conflict with, or preempted by, federal law. The regulations of these various agencies govern most aspects of the Bank's business, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and location of branch offices.\nOfficers: -------- In addition to the directors and executive officers listed in the Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 1996, which is incorporated herein by reference in Part III of this report, Leon Zimmerman, age 53, is President and Chief Executive Officer of the Bank and of the Company; David M. Philipp, age 33, is Executive Vice- President, Chief Financial Officer and Secretary of the Bank, and Senior Vice-President, Chief Financial Officer and Secretary of the Company; and Richard K. Helton, age 46, is Senior Vice President and Chief Credit Officer of the Bank.\nPrior to joining the Bank in April, 1990, Mr. Zimmerman was a general contractor building moderately priced homes and earlier served as Vice- President-Loan Administrator for Bank of Salinas. Mr. Zimmerman has nearly 30 years of banking experience at various levels of responsibility with institutions in the San Joaquin Valley. Mr. Zimmerman was promoted from Executive Vice\nPresident and Chief Credit Officer of the Bank to President and Chief Executive Officer of the Bank effective August 25, 1994. He was promoted from Executive Vice President of the Company to President and Chief Executive Officer of the Company effective August 24, 1995.\nPrior to joining the Company and the Bank in April, 1992, Mr. Philipp was the Budget Director and Financial Analyst for Merksamer Jewelers, Inc., at that time the eighth largest jewelry retailer in the United States, headquartered in Sacramento, California. Prior to joining Merksamer Jewelers, Inc., Mr. Philipp was a Supervising Senior Accountant in the audit department of the Sacramento office of KPMG Peat Marwick. While at KPMG Peat Marwick, Mr. Philipp specialized in providing audit and accounting services to financial institution, agribusiness, and broadcasting clients. Mr. Philipp is a CPA and holds a Bachelor of Science in Business Administration, Accountancy from California State University.\nPrior to joining the Bank in 1995, Mr. Helton was Senior Vice President and Credit Administrator with Central Sierra Bank. Prior to joining Central Sierra Bank in 1984, Mr. Helton was Vice President and Senior Credit Officer for Bay Area Bank (1981-1984) and he served in various positions with First Interstate Bank of California from 1973 until 1981.\nRecent Legislation and Regulations Affecting Banking: ---------------------------------------------------- From time to time, new laws are enacted which increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of bank holding companies, banks and other financial institutions are frequently made in Congress, in the California legislature and before various bank holding company and bank regulatory agencies. The likelihood of any major changes and the impact such changes might have are impossible to predict. Certain significant recently proposed or enacted laws and regulations are discussed below.\nINTERSTATE BANKING. Since 1986, California has permitted California banks and bank holding companies to be acquired by banking organizations based in other states on a \"reciprocal\" basis (i.e., provided the other state's laws permit California banking organizations to acquire banking organizations in that state on substantially the same terms and conditions applicable to local banking organizations). Some increase in merger and acquisition activity among California and out-of-state banking organizations has occurred as a result of this law, as well as increased competition for loans and deposits.\nThe federal Riegle-Neal Interstate Banking and Branching Efficiency Act, enacted late in 1994, authorizes the Board, generally without regard to conflicting requirements of state law, after one year from the date of enactment (i.e. after September 29, 1995) to approve interstate acquisitions of entire banks or branches by adequately capitalized and managed bank holding companies, and (after June 1, 1997) authorizes the other federal banking agencies to approve similar acquisitions by banks unless (prior to that date) states enact laws specifically prohibiting such acquisitions. States also may \"opt in\" to this authority at an earlier date if they enact laws specifically permitting such acquisitions. The law forbids the federal banking agencies from approving any interstate acquisition under authority of the law which would result in a concentration of deposits greater than 10% of total United States deposits or 30% of total deposits in the state in which the acquired bank or branch is located. The law also authorizes the appropriate federal agency after 18 months from the date of enactment (i.e. after March 29, 1996) to approve the consolidation of banks located in different states but operated by the same bank holding company.\nThe new law contains several provisions designed to impose Community Reinvestment Act standards (see discussion of the Community Reinvestment Act, or \"CRA,\" below) upon interstate banking operations authorized by the law. A separate CRA analysis must be done for each state in which a multi- state banking operation approved under the law exists, and the federal banking agencies are required to adopt regulations which (after June 1, 1997) will prevent interstate branching authority from being used primarily as a means of deposit production. Such regulations will require the appropriate federal agency of an out-of-state bank or bank holding company, whenever it determines that such bank's level of lending in the host state relative to the deposits which it holds in the host state is less than one- half the average of the total loans relative to total deposits in the host state for banks whose home state is the host state, to review such bank's operations in the host state in order to determine whether it is meeting the credit needs of the host state communities in which it operates. If the agency reaches a negative conclusion, it is authorized to order the closure of the host state branches of the out-of-state bank. Finally, the law requires that banks which determine to close branches located in low or moderate income areas acquired under the law must notify their customers how to write to the appropriate federal agency to complain about the closing. The agency, if it determines that any such complaint is not frivolous, must convene a meeting of concerned organizations and individuals to explore the feasibility of putting in place adequate alternative sources of banking services for the affected communities. This provision, the law states, is not intended to affect the ability of a bank to close a branch.\nThe Caldera, Weggeland and Killea California Interstate Banking and Branching Act of 1995, effective October 2, 1995, amends the California Financial Code to, among other matters, regulate the operations of state banks to eliminate conflicts with, and to implement the, Riegle-Neal Act described above. The Caldera Act includes (i) an election to permit early interstate merger transactions; (ii) a prohibition against interstate branching through the acquisition of a branch business unit located in California without acquisition of the whole business unit of the California bank; and (iii) a prohibition against interstate branching through de novo establishment of California branch offices. The Caldera Act mandates that initial entry into California by an out-of-state institution be accomplished by acquisition of or merger with an existing whole bank which has been in existence for at least five years.\nCAPITAL REQUIREMENTS. Beginning in 1989, the federal bank regulatory agencies have imposed upon all FDIC-insured financial institutions a variable system of risk-based capital requirements which replaced the former system of uniform minimum capital requirements and is designed to make capital requirements more sensitive to asset risk and off-balance sheet exposure.\nUnder the risk-based capital guidelines, the Bank is required to maintain capital equal to at least 8 percent of its assets, weighted by risk. Assets and off-balance sheet items are categorized by the guidelines according to risk, and certain assets considered to present less risk than others permit maintenance of capital at less than the 8 percent ratio. For example, most home mortgage loans are placed in a 50 percent risk category and therefore require maintenance of capital equal to 4 percent of such loans, while commercial loans are placed in a 100 percent risk category and therefore require maintenance of capital equal to 8 percent of such loans.\nThe guidelines establish two categories of qualifying capital: Tier 1 capital comprising core capital elements, and Tier 2 comprising supplementary capital requirements. At least one-half of the required capital must be maintained in the form of Tier 1 capital. For the Bank, Tier l capital includes only common stockholders' equity and retained earnings, but qualifying perpetual preferred stock would also be included without limit if the Bank were to issue such stock. Tier 2 capital includes, among other items, limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of reserves for loan and lease losses.\nThe Bank also is required to maintain a minimum leverage ratio of 3 percent Tier 1 capital to total assets (the \"leverage ratio\"). The leverage ratio constitutes a minimum requirement for well-run banking organizations. Other banking organizations (including those experiencing or anticipating significant growth) are required to maintain a minimum leverage ratio ranging generally from 4 to 5 percent.\nThe minimum leverage standard in conjunction with the risk-based capital ratio now constitutes the basis for determining the capital adequacy of all national banking associations, but overall capital assessments by bank regulators include analysis of such additional factors as interest rate exposure, liquidity, earnings, and portfolio quality and concentrations. In addition, the federal banking agencies have proposed to incorporate an interest-rate risk component (interest rate risk is the risk that changes in market interest rates might adversely affect a bank's financial condition) into the guidelines, with the goal of ensuring that institutions with high levels of interest-rate risk have sufficient capital to cover their exposures.\nAs of December 31, 1995, the Bank's total risk-based capital ratio was approximately 15.1% percent and its leverage ratio was approximately 9.0% percent. The Bank does not presently expect that compliance with the risk- based capital guidelines or minimum leverage requirements will have a materially adverse effect on its business in the reasonably foreseeable future.\nAs required by the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), the federal financial institution agencies solicited comments in September 1993 on a method of incorporating an interest rate risk component into the current risk-based capital guidelines, with the goal of ensuring that institutions with high levels of interest rate risk have sufficient capital to cover their exposures. Interest rate risk is the risk that changes in market interest rate might adversely affect a bank's financial condition. Under the proposal, intearest rate risk exposures would be quantified by weighing assets, liabilities and off- balance sheet items by risk factors which approximate sensitivity to interest rate fluctuations. As proposed, institutions identified as having an interest rate risk exposure greater than a defined threshold would be required to allocate additional capital to support this higher risk. Higher individual capital allocations could be required by the bank regulators based on supervisory concerns. The agencies adopted a final rule effective September 1, 1995 which is substantially similar to the proposed rule, except that the final rule does not establish (1) a measurement framework for assessing the level of a bank's interest rate exposure; nor (2) a minimum level of exposure above which a bank will be required to hold additional capital for interest rate risk if it has a significant exposure or a weak interest rate risk management process. The agencies also solicited comments on and are continuing their analysis of a proposed policy statement which would establish a framework to measure and monitor interest rate exposure.\nDEPOSIT INSURANCE ASSESSMENTS. The Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") directed the FDIC to establish two separate financial industry deposit insurance funds, the Bank Insurance Fund (\"BIF\") and the Savings Association Insurance Fund (\"SAIF\"), and required that deposit insurance premiums be increased in order to restore deposit insurance funds depleted due to the high level of deposit insurance payouts. FDICIA also requires that, once the BIF or SAIF are restored to a required level of funding, the FDIC reset deposit insurance rates for the fund at levels sufficient to maintain the fund at the required level.\nIn 1992, the FDIC adopted a recapitalization schedule for the BIF and established a risk-based deposit insurance assessment system to replace the uniform assessment rate system previously applicable to BIF members. The regulation requires each insured bank to be assigned to one of three capital groups and one of three supervisory subgroups within each capital group, based upon financial data reported by each bank and supervisory evaluations by the bank's primary federal regulatory agency. The three capital groups are substantially similar to the capital groupings under the Prompt Corrective Action Regulations described below, except that the bottom three categories are grouped together as \"Undercapitalized.\" The three subgroup categories distinguish banks which are financially sound, have weaknesses, or pose a substantial probability of loss to the BIF. During 1994, the assessment rates ranged from $0.23 to $0.31 per $100 of deposits across the capital group and supervisory subgroup framework.\nIn late 1994 and early 1995, the FDIC proposed two significant changes to the deposit insurance assessment system to (i) redefine the deposit assessment base which has been defined to equal an institution's total domestic deposits, plus or minus certain adjustments, but without significantly impacting total industry-wide assessments (although significant changes in assessments of individual institutions may occur) and (ii) establish a new assessment rate schedule, using the present group and subgroup categories, but with assessment rates varying from $0.04 to $0.31 per $100 of deposits, resulting in a spread between the minimum and maximum rates of $0.27 rather than the present $0.08.\nOn August 8, 1995, the FDIC voted to reduce the deposit insurance assessment rates to a range from $0.04 to $0.31 per $100 of deposits and subsequently, on November 14, 1995, the FDIC voted again to further reduce the assessment rates to a range from $0.00 to $0.27 per $100 of deposits, subject to a minimum $2,000 annual assessment for all institutions regardless of classification within the capital group and supervisory subgroup as follows:\nThe above assessment rates are effective for the first semiannual assessment period of 1996. Based upon the above risk-based assessment rate schedule, the Company's and the Bank's current capital ratios, the Bank's current level of deposits, and assuming no change in the assessment rate applicable to the Bank during 1996, the Company estimates that its annual noninterest expense attributed to assessments will decrease by approximately $101,000 during 1996.\nPROMPT CORRECTIVE ACTION. Pursuant also to FDICIA, the Board, FDIC, and the Comptroller in 1992 adopted a system of Prompt Corrective Action Regulations (the \"PCA Regulations\") based upon the system of risk-based capital described above. The PCA Regulations establish five capital categories in descending order (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), assignment to which depends upon the institution's total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio. For example, a well capitalized bank must have total risk-based capital not less than 10% and a leverage ratio of 5% or higher, while an undercapitalized institution is one with total risk-based capital less than 8% and a leverage ratio below 3%. Regulatory authorities may assign a well-capitalized, adequately capitalized or undercapitalized bank to the next lower capitalization category if such bank is in an unsafe or unsound condition or has engaged in unsafe or unsound activities.\nThe PCA Regulations establish procedures for classifying institutions within the capital categories, for filing and reviewing capital restoration plans required to be developed by all undercapitalized institutions, and for issuing directives by the regulatory agencies. Institutions classified in one of the three undercapitalized categories are subject to certain mandatory and discretionary supervisory actions, which include increased monitoring and review, implementation of capital restoration plans, asset growth restrictions, limitations upon expansion and new business activities, requirements to augment capital, restrictions upon deposit gathering and interest rates, replacement of senior executive officers and directors, and requiring divestiture or sale of the institution. Any institution classified as \"critically undercapitalized\" must be placed in conservatorship or receivership within 90 days unless some other course of action is warranted, and are also subject to other mandatory restrictions on their activities and operations.\nFDICIA contains numerous other provisions which affect or may affect the Bank, such as (1) the requirement that the regulatory agencies promulgate certain standards of \"safety and soundness\" applicable in such areas as asset quality and earnings, employee compensation and stock valuation, and (2) the requirement that an insured institution provide at least 90 days' written notice to the FDIC and its customers prior to closing any branch office. Implementation of the various provisions of FDICIA is subject to the adoption of regulations by the various federal banking agencies and to certain phase-in periods.\nCOMMUNITY REINVESTMENT ACT. In October 1994, the federal financial institution regulatory agencies jointly proposed a comprehensive revision of their regulations implementing the Community Reinvestment Act (\"CRA\"), enacted in 1977 to promote lending by financial institutions to individuals and businesses located in low and moderate income areas. In May 1995, the proposed CRA regulations were published in final form effective as of July 1, 1995. The revised regulations included transitional phase-in provisions which generally require mandatory compliance not later than July 1, 1997, although earlier voluntary compliance is permissible.\nUnder the former CRA regulations, compliance was evaluated by an assessment of the institution's methods for determining, and efforts to meet, the credit needs of such borrowers. This system was highly criticized by depository institutions and their trade groups as subjective, inconsistent and burdensome, and by consumer representatives for its alleged failure to aggressively penalize poor CRA performance by financial institutions. The revised CRA regulations emphasize an assessment of actual performance rather than of the procedures followed by a bank, to evaluate compliance with the CRA. Overall CRA compliance continues to be rated across a four- point scale from \"outstanding\" to \"substantial noncompliance,\" and continues to be a factor in review of applications to merge, establish new branches or form bank holding companies. In addition, any bank rated in \"substantial noncompliance\" with the revised CRA regulations may be subject to enforcement proceedings.\nThe regulations provide that \"small banks,\" which are defined to include any independent bank with total assets of less than $250 million, are to be evaluated by means of a so-called \"streamlined assessment method\" unless such a bank elects to be evaluated by one of the other methods provided in the regulations. The differences between the evaluation methods may be summarized as follows:\n(1) The \"streamlined assessment method\" presumptively applicable to small banks requires that a bank's CRA compliance be evaluated pursuant to five \"assessment criteria,\" including its (i) loan-to-deposit ratio (as adjusted for seasonal variations and other lending-related activities, such as sales to the secondary market or community development lending), (ii) percentage of loans and other lending-related activities in the bank's service area(s), (iii) distribution of loans and other lending-related activities among borrowers of different income levels, given the demographic characteristics of its service area(s), (iv) geographic distribution of loans and other lending-related activities within its service area(s), and (v) record of response to written complaints, if any, about its CRA performance.\n(2) The \"lending, investments and service tests method\" is applicable to all banks larger than $250 million which are not wholesale or limited purpose banks and do not elect to be evaluated by the \"strategic plan assessment method.\" Central to this method is the requirement that such banks collect and report to their primary federal banking regulators detailed information regarding home mortgage, small business and farm and community development loans which is then used to evaluate CRA compliance. At a bank's option, data regarding consumer loans and any other loan distribution it may choose to provide also may be collected and reported.\nUsing such data, the Board will evaluate a bank's (i) lending performance according to the geographic distribution of its loans, the characteristics of its borrowers, the number and complexity of its community development loans, the innovativeness or flexibility of its lending practices to meet low and moderate income credit needs and, at the bank's election, lending by affiliates or through consortia or third-parties in which the bank has an investment interest; (ii) investment performance by measure of the bank's\n\"qualified investments,\" that is, the extent to which the bank's investments, deposits, membership shares in a credit union, or grants primarily benefit low or moderate income individuals and small businesses and farms, address affordable housing or other needs not met by the private market, or assist any minority or women-owned depository institution by donating, selling on favorable terms or providing on a rent-free basis any branch of the bank located in a predominantly minority neighborhood; and (iii) service performance by evaluating the demographic distribution of the bank's branches and ATMs, its record of opening and closing them, the availability of alternative retail delivery systems (such as telephone banking, banking by mail or at work, and mobile facilities) in low and moderate income geographies and to low and moderate income individuals, and (given the characteristics of the bank's service areas and the its capacity and constraints) the extent to which the bank provides \"community development services\" (services which primarily benefit low and moderate income individuals or small farms and businesses or address affordable housing needs not met by the private market) and their innovativeness and responsiveness.\n(3) Wholesale or limited purpose banks which do not make home mortgage, small farm or business or consumer loans to retail customers may elect, subject to agency approval of their status, to be evaluated by the \"community development test method,\" which assesses the number and amount of the bank's community development loans, qualified investments and community development services and their innovativeness and complexity.\n(4) Any bank may request to be evaluated by the \"strategic plan assessment method\" by submitting a strategic plan which the Board approves. Such a plan must involve public participation in its preparation, and contain measurable goals for meeting low and moderate income credit needs through lending, investments and provision of services. Such plans generally would be evaluated by the Board by measuring strategic plan goals against standards similar to those which would be applied in evaluating a bank according to the \"lending, investments and service tests method.\"\nThe federal financial institution regulatory agencies jointly issued a final rule, effective as of January 1, 1996, to make certain technical corrections to the revised CRA regulations. Among other matters, the rule clarifies the transition from the form CRA regulations to the revised CRA regulations by confirming that when an institution either voluntarily or mandatorily becomes subject to the performance tests and standards of the revised regulations, the institution must comply with all of the requirements of the revised regulations and is no longer subject to the provisions of the former CRA regulations.\nThe Bank has a current rating of \"satisfactory\" CRA compliance, and believes that it would not have received any lower rating if the regulations had been in effect when the Bank was last examined for CRA compliance in April, 1994.\nSTATISTICAL INFORMATION\nThe following selected information should be read in conjunction with the Company's entire consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference into Items 7 and 8 herein.\nFIRST FINANCIAL BANCORP AND SUBSIDIARY\nANALYSIS OF NET INTEREST EARNINGS\nANALYSIS OF CHANGES IN INTEREST INCOME & EXPENSE\nChanges not solely attributable to volume or rate have been allocated to the rate component.\nINTEREST RATE SENSITIVITY\nThe interest rate gaps reported in the table arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not be reflective of the Company's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the above analysis, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. Actual payment patterns may differ from contractual payment patterns.\nINVESTMENT PORTFOLIO\n(a) The yields on tax-exempt obligations have not been computed on a tax- equivalent basis.\nLOAN PORTFOLIO\nTypes of Loans\nMaturities and Sensitivity to Changes in Interest Rates (in thousands)\nScheduled repayments are reported in the maturity category in which the payments are due.\nThe company's nonaccrual policy is discussed in note 1(c) to the consolidated financial statements.\nInterest income recorded on these loans was approximately $13,000, $14,000, $22,000, $43,000 and $25,000 in 1995, 1994, 1993, 1992 and 1991, respectively.\nInterest income foregone or reversed on these loans was approximately $161,000, $74,000, $57,000, $142,000 and $137,000 in 1995, 1994, 1993, 1992 and 1991, respectively.\nSUMMARY OF LOAN LOSS EXPERIENCE\nAnalysis of the Allowance for Loan Losses (in thousands)\nFootnote 1(g) to the consolidated financial statement discusses the factors used in determining the provision for loan losses and the adequacy of the allowance for loan losses.\nALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS)\nDEPOSITS\nAverage amount and average rate paid on deposits (in thousands)\nMATURITIES OF TIME DEPOSITS OF $100,000 OR MORE AT DECEMBER 31 (IN THOUSANDS):\nRETURN ON AVERAGE EQUITY AND ASSETS\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns a 0.861 acre lot located at the corner of Ham Lane and Tokay Street, Lodi, California. In 1990, the Company completed construction of a 34,000 square foot, tri-level commercial building for the main branch and administrative offices of the Company and the Bank on this lot. The Company and the Bank use approximately 75% of the leasable space in the building and the remaining area is either leased or available for lease as office space to other tenants. The Bank has multi-year leases at market rates for a total of 17,400 square feet and one other tenant has leased 1,922 square feet for a five year period with renewal options. All lease payments to the Company are tied to changes in the Consumer Price Index and are adjusted on an annual basis. This expansion has enabled the Bank to better serve its customers with more teller windows, four drive- through lanes and expanded safe deposit box capacity.\nThe Bank assumed a ground lease on 1.7 acres of land at 19000 North Highway 88, Lockeford, California. The building previously occupying the Lodi site was moved to Lockeford, California, and has become the permanent branch office of the Bank at that location. A temporary office was opened by the Bank on January 8, 1990 at this location in a 1,100 square foot building. The permanent office was opened on April 1, 1991. The temporary office, along with a portion of the permanent building, are leased by the Bank to two tenants.\nThe Company also owns a 10,000 square foot lot located on Lower Sacramento Road in the unincorporated San Joaquin County community of Woodbridge, California. The entire parcel has been leased to the Bank on a long term basis at market rates. The Bank has constructed, furnished and equipped a 1,437 square foot branch office on the parcel and commenced operations of the Woodbridge Branch on December 15, 1986.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Bank, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or the Bank is a party, and none of the above persons has a material interest adverse to the Company or the Bank.\nNeither the Company nor the Bank is a party to any pending legal or administrative proceeding (other than ordinary routine litigation incidental to the Company's or the Bank's business) and no such proceedings are known to be contemplated.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this item is contained under the caption \"MARKET PRICE OF COMPANY'S STOCK\" at page 9 of the Company's 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\nThe information required by this item is contained under the caption \"SELECTED FINANCIAL DATA\" at page 10 of the Company's 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\nThe information required by this item is contained under the caption \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" at page 1 of the Company's 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 See Item 14(a) herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable\nPART III ITEMS 10, 11, 12 AND 13.\nThe information required by these items is contained at pages 2 through 9 of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 1996, and is incorporated herein by reference. The definitive Proxy Statement will be filed with the Commission within 120 days after the close of the Company's fiscal year pursuant to Regulation 14A of the Securities Exchange Act of 1934.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nPAGE REFERENCE TO ANNUAL (A) FINANCIAL STATEMENTS AND SCHEDULES REPORT TO SHAREHOLDERS*\nIndependent Auditors' Report 11 Consolidated Balance Sheets as of December 31, 1995 and 1994. 12 Consolidated Statements of Income Years Ended 1995, 1994, and 1993 14 Consolidated Statements of Stockholders' Equity Years Ended 1995, 1994, and 1993 13 Consolidated Statements of Cash Flows Years Ended 1995, 1994, and 1993 15 Notes to Consolidated Financial Statements 16 ---------- *The pages of the Company's Annual Report to Shareholders for the year ended December 31, 1995 listed above, are incorporated herein by reference in response to Item 8 of this report.\n(B) REPORTS ON FORM 8-K\nOn November 3, 1995, the Company filed a Current Report on Form 8-K regarding its press release of the same date, reporting the Company's results of operations for the quarter ended September 30, 1995, and the declaration of a cash dividend of $.05 per share, payable November 30, 1995.\n(C) EXHIBITS Exhibit No. Description\n11 Statement re computation of earnings per share is incorporated herein by reference to page 24 of the Company's Annual Report to Shareholders for the year ended December 31, 1995.\n13 First Financial Bancorp 1995 Annual Report to Shareholders - portions which have been incorporated by reference herein are filed with this report, and portions which have not been incorporated herein are provided for information purposes only.\n23 Consent of Experts\n(D) FINANCIAL STATEMENT SCHEDULES\nNo financial statement schedules are included in this report on the basis that they are either inapplicable or the information required to be set forth therein is contained in the financial statements incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 29th day of March, 1996.\nFIRST FINANCIAL BANCORP\n\/s\/ LEON J. ZIMMERMAN --------------------------- Leon J. Zimmerman (President & Chief Executive Officer)\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nCAPACITY DATE -------- ----\n\/s\/ BOZANT KATZAKIAN Director and Chairman March 29, 1996 - -------------------------- of the Board Bozant Katzakian\n\/s\/ ANGELO J. ANAGNOS Director March 29, 1996 - -------------------------- Angelo J. Anagnos\n\/s\/ RAYMOND H. COLDANI Director March 29, 1996 - -------------------------- Raymond H. Coldani\n\/s\/ BENJAMIN R. GOEHRING Director March 29 1996 - -------------------------- Benjamin R. Goehring\n\/s\/ MICHAEL D. RAMSEY Director March 29, 1996 - -------------------------- Michael D. Ramsey\n\/s\/ FRANK M. SASAKI Director March 29, 1996 - -------------------------- Frank M. Sasaki\n\/s\/ WELDON D. SCHUMACHER Director March 29, 1996 - -------------------------- Weldon D. Schumacher\n\/s\/ DENNIS SWANSON Director March 29, 1996 - -------------------------- Dennis Swanson\n\/s\/ DAVID M. PHILIPP Senior Vice President, March 29, 1996 - -------------------------- Chief Financial Officer David M. Philipp and Secretary (Principal Financial and Accounting Officer)\nINDEX TO EXHIBITS\nExhibit Page - ------- ----\n11 Statement re computation of earnings per share is incorporated herein by reference to page 24 of theCompany's Annual Report to Shareholders for the year ended December 31, 1995.\n13 First Financial Bancorp 1995 Annual Report to Shareholders - 27 portions which have been incorporated by reference herein are filed with this report, and portions which have not been incorporated herein are provided for information purposes only.\n23 Consent of Experts 59","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.\nPAGE REFERENCE TO ANNUAL (A) FINANCIAL STATEMENTS AND SCHEDULES REPORT TO SHAREHOLDERS*\nIndependent Auditors' Report 11 Consolidated Balance Sheets as of December 31, 1995 and 1994. 12 Consolidated Statements of Income Years Ended 1995, 1994, and 1993 14 Consolidated Statements of Stockholders' Equity Years Ended 1995, 1994, and 1993 13 Consolidated Statements of Cash Flows Years Ended 1995, 1994, and 1993 15 Notes to Consolidated Financial Statements 16 ---------- *The pages of the Company's Annual Report to Shareholders for the year ended December 31, 1995 listed above, are incorporated herein by reference in response to Item 8 of this report.\n(B) REPORTS ON FORM 8-K\nOn November 3, 1995, the Company filed a Current Report on Form 8-K regarding its press release of the same date, reporting the Company's results of operations for the quarter ended September 30, 1995, and the declaration of a cash dividend of $.05 per share, payable November 30, 1995.\n(C) EXHIBITS Exhibit No. Description\n11 Statement re computation of earnings per share is incorporated herein by reference to page 24 of the Company's Annual Report to Shareholders for the year ended December 31, 1995.\n13 First Financial Bancorp 1995 Annual Report to Shareholders - portions which have been incorporated by reference herein are filed with this report, and portions which have not been incorporated herein are provided for information purposes only.\n23 Consent of Experts\n(D) FINANCIAL STATEMENT SCHEDULES\nNo financial statement schedules are included in this report on the basis that they are either inapplicable or the information required to be set forth therein is contained in the financial statements incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 29th day of March, 1996.\nFIRST FINANCIAL BANCORP\n\/s\/ LEON J. ZIMMERMAN --------------------------- Leon J. Zimmerman (President & Chief Executive Officer)\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nCAPACITY DATE -------- ----\n\/s\/ BOZANT KATZAKIAN Director and Chairman March 29, 1996 - -------------------------- of the Board Bozant Katzakian\n\/s\/ ANGELO J. ANAGNOS Director March 29, 1996 - -------------------------- Angelo J. Anagnos\n\/s\/ RAYMOND H. COLDANI Director March 29, 1996 - -------------------------- Raymond H. Coldani\n\/s\/ BENJAMIN R. GOEHRING Director March 29 1996 - -------------------------- Benjamin R. Goehring\n\/s\/ MICHAEL D. RAMSEY Director March 29, 1996 - -------------------------- Michael D. Ramsey\n\/s\/ FRANK M. SASAKI Director March 29, 1996 - -------------------------- Frank M. Sasaki\n\/s\/ WELDON D. SCHUMACHER Director March 29, 1996 - -------------------------- Weldon D. Schumacher\n\/s\/ DENNIS SWANSON Director March 29, 1996 - -------------------------- Dennis Swanson\n\/s\/ DAVID M. PHILIPP Senior Vice President, March 29, 1996 - -------------------------- Chief Financial Officer David M. Philipp and Secretary (Principal Financial and Accounting Officer)\nINDEX TO EXHIBITS\nExhibit Page - ------- ----\n11 Statement re computation of earnings per share is incorporated herein by reference to page 24 of theCompany's Annual Report to Shareholders for the year ended December 31, 1995.\n13 First Financial Bancorp 1995 Annual Report to Shareholders - 27 portions which have been incorporated by reference herein are filed with this report, and portions which have not been incorporated herein are provided for information purposes only.\n23 Consent of Experts 59","section_15":""}
{"filename":"825881_1995.txt","cik":"825881","year":"1995","section_1":"Item 1. Business\nGeneral\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (the \"Partnership\" or \"Registrant\") was organized as a Delaware limited partnership on November 30, 1987. The offering of limited partnership interests began March 31, 1988, minimum capital requirements were met July 6, 1988, and the offering concluded March 31, 1989. The Partnership has no subsidiaries.\nThe Partnership has expended its capital and acquired interests in producing oil and gas properties. After such acquisitions, the Partnership has produced and marketed the crude oil and natural gas produced from such properties. In most cases, the Partnership purchased working interests in oil and gas properties, with an occasional purchase of a royalty or overriding royalty interest. The Partnership purchased either all or part of the rights and obligations under various oil and gas leases.\nThe principal executive offices of the Partnership are located at 407 N. Big Spring, Suite 300, Midland, Texas, 79701. The managing general partner of the Partnership, Southwest Royalties, Inc. (the \"Managing General Partner\") and its staff of 160 individuals, together with certain independent consultants used on an \"as needed\" basis, perform various services on behalf of the Partnership, including the selection of oil and gas properties and the marketing of production from such properties. H. H. Wommack, III, a stockholder, director, President and Treasurer of the Managing General Partner, is also a general partner. The Partnership has no employees.\nPrincipal Products, Marketing and Distribution\nThe Partnership has acquired and holds working interests in oil and gas properties located in New Mexico and Texas. All activities of the Partnership are confined to the continental United States. All oil and gas produced from these properties is sold to unrelated third parties in the oil and gas business.\nThe revenues generated from the Partnership's oil and gas activities are dependent upon the current market for oil and gas. With some periodic exceptions, since the early 1980's, there has been a worldwide oversupply of oil and gas; therefore, market prices have declined significantly. In the latter part of 1990 and early 1991, the Persian Gulf crisis resulted in a short period of increased oil prices, with such prices again falling following the cessation of hostilities. The prices received by the Partnership for its oil and gas production depend upon numerous factors beyond the Partnership's control, including competition, economic, political and regulatory developments and competitive energy sources, and make it particularly difficult to estimate future prices of oil and natural gas.\nFor the last few years, the natural gas industry in the United States has been affected generally by a decline in demand for natural gas, a surplus in available natural gas, and enhanced delivery capability causing a general deterioration in natural gas prices.\nFollowing is a table of the ratios of revenues received from oil and gas production for the last three years:\nOil Gas\n1995 84% 16% 1994 80% 20% 1993 79% 21%\nAs the table indicates, the majority of the Partnership's revenue is from its oil production; therefore, Partnership revenues will be highly dependent upon the future prices and demands for oil.\nSeasonality of Business\nAlthough the demand for natural gas is highly seasonal, with higher demand in the colder winter months and in very hot summer months, the Partnership has been able to sell all of its natural gas, either through contracts in place or on the spot market at the then prevailing spot market price. As a result, the volumes sold by the Partnership have not fluctuated materially with the change of season.\nCustomer Dependence\nNo material portion of the Partnership's business is dependent on a single purchaser, or a very few purchasers, the loss of one of which would have a material adverse impact on the Partnership. Two purchasers accounted for 66% of the Partnership's total oil and gas production during 1995: Scurlock Permian Corporation and Mobil Corporation purchased 48% and 18%, respectively. Two purchasers accounted for 59% of the Partnership's total oil and gas production during 1994: Scurlock Permian Corporation and Mobil Corporation purchased 41% and 18%, respectively. Two purchasers accounted for 57% of the Partnership's total oil and gas production during 1993: Scurlock Permian Corporation and Mobil Corporation purchased 39% and 18%, respectively. In the event any of these purchasers were to discontinue purchasing the Partnership's production, the Managing General Partner believes that a substitute purchaser or purchasers could be located without undue delay. No other purchaser accounted for an amount equal to or greater than 10% of the Partnership's sales of oil and gas production.\nCompetition\nBecause the Partnership has utilized all of its funds available for the acquisition of interests in producing oil and gas properties, it is not subject to competition from other oil and gas property purchasers. See Item 2, Properties.\nFactors that may adversely affect the Partnership include delays in completing arrangements for the sale of production, availability of a market for production, rising operating costs of producing oil and gas and complying with applicable water and air pollution control statutes, increasing costs and difficulties of transportation, and marketing of competitive fuels. Moreover, domestic oil and gas must compete with imported oil and gas and with coal, atomic energy, hydroelectric power and other forms of energy.\nRegulation\nOil and Gas Production - The production and sale of oil and gas is subject to federal and state governmental regulation in several respects, such as existing price controls on natural gas and possible price controls on crude oil, regulation of oil and gas production by state and local governmental agencies, pollution and environmental controls and various other direct and indirect regulation. Many jurisdictions have periodically imposed limitations on oil and gas production by restricting the rate of flow for oil and gas wells below their actual capacity to produce and by imposing acreage limitations for the drilling of wells. The federal government has the power to permit increases in the amount of oil imported from other countries and to impose pollution control measures.\nVarious aspects of the Partnership's oil and gas activities are regulated by administrative agencies under statutory provisions of the states where such activities are conducted and by certain agencies of the federal government for operations on Federal leases. Moreover, certain prices at which the Partnership may sell its natural gas production are controlled by the Natural Gas Policy Act of 1978, the Natural Gas Wellhead Decontrol Act of 1989 and the regulations promulgated by the Federal Energy Regulatory Commission.\nEnvironmental - The Partnership's oil and gas activities are subject to extensive federal, state and local laws and regulations governing the generation, storage, handling, emission, transportation and discharge of materials into the environment. Governmental authorities have the power to enforce compliance with their regulations, and violations carry substantial penalties. This regulatory burden on the oil and gas industry increases its cost of doing business and consequently affects its profitability. The Managing General Partner is unable to predict what, if any, effect compliance will have on the Partnership.\nIndustry Regulations and Guidelines - Certain industry regulations and guidelines apply to the registration, qualification and operation of oil and gas programs in the form of limited partnerships. The Partnership is subject to these guidelines which regulate and restrict transactions between the Managing General Partner and the Partnership. The Partnership will comply with these guidelines and the Managing General Partner does not anticipate that compliance will have a material adverse affect on Partnership operations.\nPartnership Employees\nThe Partnership has no employees; however, the Managing General Partner has a staff of geologists, engineers, accountants, landmen and clerical staff who engage in Partnership activities and operations and perform additional services for the Partnership as needed. In addition to the Managing General Partner's staff, the Partnership engages independent consultants such as petroleum engineers and geologists as needed. As of December 31, 1995, there were 160 individuals directly employed by the Managing General Partner in various capacities.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nIn determining whether an interest in a particular producing property was to be acquired, the Managing General Partner considered such criteria as estimated oil and gas reserves, estimated cash flow from the sale of production, present and future prices of oil and gas, the extent of undeveloped and unproved reserves, the potential for secondary, tertiary and other enhanced recovery projects and the availability of markets.\nAs of December 31, 1995, the Partnership possessed an interest in oil and gas properties located in Winkler, Ward, Hockley, Reagan, Nolan, Pecos, Garza, Reeves, Yoakum, Glasscock, Midland, Martin, Borden, Stonewall, Schleicher, Dawson, Howard, Cochran, Mitchell, Coke, Upton, Runnels, Crockett and Crane Counties of Texas; Eddy, Chaves and Lea Counties of New Mexico. These properties consist of various interests in approximately 158 wells and units.\nDue to the Partnership's objective of maintaining current operations without engaging in the drilling of any developmental or exploratory wells, or additional acquisitions of producing properties, there has not been any significant changes in properties during 1995, 1994 and 1993.\nUpon a determination by Management that they were either not profitable to own or Management received an offer that exceeded the leases reserves, the following leases were sold.\nDuring 1995, five leases were sold for approximately $84,500. The XIT Unit was sold effective March 1995, the Exxon Fee was sold effective July 1995 and the Cunningham, Johnson and Bolin Wallis were sold effective November 1995.\nDuring 1994, there were no properties sold.\nDuring 1993, four leases were sold for approximately $84,700. The J.S. Todd leases were sold effective March 1993, the Murphy was sold effective April 1993 and the Ft. Chadbourne Unit was sold effective July 1993.\nSignificant Properties\nThe following table reflects the significant properties in which the Partnership has an interest:\nDate Purchased No. of Proved Reserves* Name and Location and Interest Wells Oil (bbls) Gas (mcf)\nMobil Acquisition 4\/89 at 5% 17 125,949 204,996 Ward and Reeves to 50% working Counties, Texas interest\nNorth American 3\/89 at 50% 3 146,922 - Royalties working Yoakum County, interest Texas\nRamsey\/Sell 3\/89 at 11% 7 141,184 140,713 Acquisition to 51% Winkler County, working Texas interest\n*The reserve estimates were prepared as of January 1, 1996, by Donald R. Creamer, P.E., an independent certified petroleum engineer, in accordance with the rules and regulations of the SEC. The calculation of reserves is a function, among other things, of oil and gas prices and extraction costs. The fluctuation of such prices or costs would have a corresponding effect on reserve estimates. The oil price used in the preparation of the reserve report as of January 1, 1996, was $17.89, which was the posted price at December 31, 1995, adjusted by the Partnership's average oil price, with the price of gas being the contract price for each respective lease. As also discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, oil prices were subject to frequent changes in 1995.\nThe evaluation of oil and gas properties is not an exact science and inevitably involves a significant degree of uncertainty, particularly with respect to the quantity of oil or gas that any given property is capable of producing. Estimates of oil and gas reserves are based on available geological and engineering data, the extent and quality of which may vary in each case and, in certain instances, may prove to be inaccurate. Consequently, properties may be depleted more rapidly than the geological and engineering data have indicated. Unanticipated depletion, if it occurs, will result in lower reserves than previously estimated; thus an ultimately lower return for the Partnership. Basic changes in past reserve estimates occur annually. As new data is gathered during the subsequent year, the engineer must revise his earlier estimates. A year of new information, which is pertinent to the estimation of future recoverable volumes, is available during the subsequent year evaluation. In applying industry standards and procedures, the new data may cause the previous estimates to be revised. This revision may increase or decrease the earlier estimated volumes. Pertinent information gathered during the year may include actual production and decline rates, production from offset wells drilled to the same geologic formation, increased or decreased water production, workovers, and changes in lifting costs, among others. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered.\nThe Partnership has reserves which are classified as proved developed producing, proved developed non-producing, proved undeveloped and probable. All of the proved reserves are included in the engineering reports which evaluate the Partnership's present reserves. Probable reserves are not included in the reserve evaluation, and are less certain than proved reserves but can be estimated with a degree of certainty sufficient to indicate they are more likely to be recovered than not.\nBecause the Partnership does not engage in drilling activities, the development of proved undeveloped reserves is conducted pursuant to farm-out arrangements with the Managing General Partner or unrelated third parties. Generally, the Partnership retains a carried interest such as an overriding royalty interest under the terms of a farm-out, or receives cash.\nThe Partnership or the owners of properties in which the Partnership owns an interest can engage in workover projects or supplementary recovery projects, for example, to extract behind the pipe reserves which qualify as proved developed non-producing reserves. See Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\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 matter was submitted to a vote of security holders during the fourth quarter of 1995 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\nMarket Information\nLimited partnership interests, or units, in the Partnership were initially offered and sold for a price of $500. Limited partner units are not traded on any exchange and there is no public or organized trading market for them. The Managing General Partner has become aware of certain limited and sporadic transfers of units between limited partners and third parties, but has no verifiable information regarding the prices at which such units have been transferred. Further, a transferee may not become a substitute limited partner without the consent of the Managing General Partner.\nAfter completion of the Partnership's first full fiscal year of operations and each year thereafter, the Managing General Partner has offered and will continue to offer to purchase each limited partner's interest in the Partnership, at a price based on tangible assets of the Partnership, plus the present value of the future net revenues of proved oil and gas properties, minus liabilities with a risk factor discount of up to one-third which may be implemented in the sole discretion of the Managing General Partner. However, the Managing General Partner's obligation to purchase limited partner units is limited to an expenditure of an amount not in excess of 10% of the total limited partner units initially subscribed for by limited partners. In 1995, 257 limited partner units were tendered to and purchased by the Managing General Partner at an average base price of $128.62 per unit. In 1994, 44 limited partner units were tendered to and purchased by the Managing General Partner at an average base price of $73.37 per unit. In 1993, 183 limited partner units were tendered to and purchased by the Managing General Partner at an average base price of $149.40 per unit.\nNumber of Limited Partner Interest Holders\nAs of December 31, 1995, there were 630 holders of limited partner units in the Partnership.\nDistributions\nPursuant to Article IV, Section 4.01 of the Partnership's Certificate and Agreement of Limited Partnership \"Net Cash Flow\" is distributed to the partners on a monthly basis. \"Net Cash Flow\" is defined as \"the cash generated by the Partnership's investments in producing oil and gas properties, less (i) General and Administrative Costs, (ii) Operating Costs, and (iii) any reserves necessary to meet current and anticipated needs of the Partnership, as determined in the sole discretion of the Managing General Partner.\"\nDuring 1995, twelve monthly distributions were made totaling $429,924, with $391,224 distributed to the limited partners and $38,700 distributed to the general partners. For the year ended December 31, 1995, distributions of $28.77 per limited partner unit were made, based on 13,596 limited partner units outstanding. During 1994, twelve monthly distributions were made totaling $278,000, with $250,200 distributed to the limited partners and $27,800 distributed to the general partners. For the year ended December 31, 1994, distributions of $18.40 per limited partner unit were made, based on 13,596 limited partner units outstanding. During 1993, twelve monthly distributions were made totaling $595,732, with $542,012 distributed to the limited partners and $53,720 distributed to the general partners. For the year ended December 31, 1993, distributions of $39.87 per limited partner unit were made, based on 13,596 limited partner units outstanding.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data for the years ended December 31, 1995, 1994, 1993, 1992 and 1991 should be read in conjunction with the financial statements included in Item 8:\nYear ended December 31, ----------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Revenues $ 1,511,905 1,332,582 1,567,894 2,241,436 2,949,708\nNet income (loss) 259,472 111,820 (942,312) 55,643 269,370\nPartners' share of net income (loss):\nGeneral partners 41,647 29,582 35,298 61,979 103,052\nLimited partners 217,825 82,238 (977,610) (6,336) 166,318\nLimited partners' net income (loss) per unit 16.02 6.05 (71.90) (.47) 12.23\nLimited partners' cash distributions per unit 28.77 18.40 39.87 67.08 75.89\nTotal assets $ 1,762,282 1,935,208 2,099,330 3,636,600 4,572,607\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGeneral\nThe Partnership was formed to acquire interests in producing oil and gas properties, to produce and market crude oil and natural gas produced from such properties and to distribute any net proceeds from operations to the general and limited partners. Net revenues from producing oil and gas properties are not reinvested in other revenue producing assets except to the extent that producing facilities and wells are reworked or where methods are employed to improve or enable more efficient recovery of oil and gas reserves. The economic life of the Partnership thus depends on the period over which the Partnership's oil and gas reserves are economically recoverable.\nIncreases or decreases in Partnership revenues and, therefore, distributions to partners will depend primarily on changes in the prices received for production, changes in volumes of production sold, lease operating expenses, enhanced recovery projects, offset drilling activities pursuant to farm-out arrangements and on the depletion of wells. Since wells deplete over time, production can generally be expected to decline from year to year.\nWell operating costs and general and administrative costs usually decrease with production declines; however, these costs may not decrease proportionately. Net income available for distribution to the limited partners is therefore expected to fluctuate in later years based on these factors.\nResults of Operations\nA. General Comparison of the Years Ended December 31, 1995 and 1994\nThe following table provides certain information regarding performance factors for the years ended December 31, 1995 and 1994:\nYear Ended Percentage December 31, Increase 1995 1994 (Decrease) ---- ---- ---------- Average price per barrel of oil $ 16.90 15.65 8% Average price per mcf of gas $ 2.02 2.03 - Oil production in barrels 75,400 68,200 11% Gas production in mcf 116,400 129,800 (10%) Gross oil and gas revenue $ 1,509,663 1,330,535 13% Net oil and gas revenue $ 526,123 409,764 28% Partnership distributions $ 429,924 278,000 55% Limited partner distributions $ 391,224 250,200 56% Per unit distribution to limited partners $ 28.77 18.40 56% Number of limited partner units 13,596 13,596\nRevenues:\nThe Partnership's oil and gas revenues increased to $1,509,663 from $1,330,535 for the years ended December 31, 1995 and 1994, respectively, an increase of 13%. The principal factors affecting the comparison of the years ended December 31, 1995 and 1994 are as follows:\n1. The average price for a barrel of oil received by the Partnership increased during the year ended December 31, 1995 as compared to the year ended December 31, 1994 by 8%, or $1.25 per barrel, resulting in an increase of approximately $85,300 in revenue. Oil sales represented 84% of total oil and gas sales during the year ended December 31, 1995 as compared to 80% during the year ended December 31, 1994.\nThe average price for an mcf of gas received by the Partnership decreased during the same period by less than 1%, resulting in a decrease of approximately $1,300 in revenue.\nThe net total increase in revenue due to the change in prices received from oil and gas production is approximately $84,000. The market price for oil and gas has been extremely volatile over the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.\n2. Oil production increased approximately 7,200 barrels or 11% during the year ended December 31, 1995 as compared to the year ended December 31, 1994, resulting in an increase of approximately $121,700 in revenue.\nGas production decreased approximately 13,400 mcf or 10% during the same period, resulting in a decrease of approximately $27,100 in revenue.\nThe net total increase in revenue due to the change in production is approximately $94,600. The increase is a result of successful workovers.\nCosts and Expenses:\nTotal costs and expenses increased to $1,252,433 from $1,220,762 for the years ended December 31, 1995 and 1994, respectively, an increase of 3%. The increase is the result of an increase in production costs, offset by a decrease in general and administrative expense and depletion.\n1. Lease operating costs and production taxes were 7% higher, or approximately $62,800 more during the year ended December 31, 1995 as compared to the year ended December 31, 1994. The increase is a result of workover costs incurred in 1995.\n2. General and administrative costs consists of independent accounting and engineering fees, computer services, postage, and Managing General Partner personnel costs. General and administrative costs decreased 4% or approximately $4,100 during the year ended December 31, 1995 as compared to the year ended December 31, 1994.\n3. Depletion expense decreased to $157,000 for the year ended December 31, 1995 from $184,000 for the same period in 1994. This represents a decrease of 15%. Depletion is calculated using the gross revenue method of amortization based on a percentage of current period gross revenues to total future gross oil and gas revenues, as estimated by the Partnership's independent petroleum consultants. Although oil and gas revenues increased for the year ended December 31, 1995 as compared to the year ended December 31, 1994, the decrease in depletion expense is the result of the change in oil prices since 1994.\nB. General Comparison of the Years Ended December 31, 1994 and 1993\nThe following table provides certain information regarding performance factors for the years ended December 31, 1994 and 1993:\nYear Ended Percentage December 31, Increase 1994 1993 (Decrease) ---- ---- ---------- Average price per barrel of oil $ 15.65 16.14 (3%) Average price per mcf of gas $ 2.03 2.25 (10%) Oil production in barrels 68,200 76,900* (11%) Gas production in mcf 129,800 144,100* (10%) Gross oil and gas revenue $ 1,330,535 1,565,659 (15%) Net oil and gas revenue $ 409,764 468,110 (12%) Partnership distributions $ 278,000 595,732 (53%) Limited partner distributions $ 250,200 542,012 (54%) Per unit distribution to limited partners $ 18.40 39.87 (54%) Number of limited partner units 13,596 13,596\n*In the Form 10-K, for the year ended December 31, 1993, the oil and gas production volumes were calculated by rounding to the nearest 1,000 barrels or mcf, respectively. In the Form 10-K, for the year ended December 31, 1994, the oil and gas production volumes were calculated by rounding to the nearest 100 barrels or mcf, respectively.\nRevenues:\nThe Partnership's oil and gas revenues decreased to $1,330,535 from $1,565,659 for the years ended December 31, 1994 and 1993, respectively, a decrease of 15%. The principal factors affecting the comparison of the years ended December 31, 1994 and 1993 are as follows:\n1. The average price for a barrel of oil received by the Partnership decreased during the year ended December 31, 1994 as compared to the year ended December 31, 1993 by 3%, or $.49 per barrel, resulting in a decrease of approximately $37,700 in revenue. Oil sales represented 80% of total oil and gas sales during the year ended December 31, 1994 as compared to 79% during the year ended December 31, 1993.\nThe average price for an mcf of gas received by the Partnership decreased during the same period by 10%, or $.22 per mcf, resulting in a decrease of approximately $31,700 in revenue.\nThe total decrease in revenue due to the change in prices received from oil and gas production is approximately $69,400. The market price for oil and gas has been extremely volatile over the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.\n2. Oil production decreased approximately 8,700 barrels or 11% during the year ended December 31, 1994 as compared to the year ended December 31, 1993, resulting in a decrease of approximately $136,200 in revenue.\nGas production decreased approximately 14,300 mcf or 10% during the same period, resulting in a decrease of approximately $29,000 in revenue.\nThe total decrease in revenue due to the change in production is approximately $165,200. The decrease in production is attributable to eleven properties which experienced mechanical or downhole problems during the year ended 1994. Management has made, or is in the process of making, the necessary repairs on eight of the above mentioned properties and is currently evaluating the economic feasibility of repairing the remaining properties. Management expects this decline in production to level out to a more normal rate of decline and expects a certain amount of decline in production to continue in the future until the partnership's economically recoverable reserves are fully depleted.\nCosts and Expenses:\nTotal costs and expenses decreased to $1,220,762 from $2,510,206 for the years ended December 31, 1994 and 1993, respectively, a decrease of 51%. The decrease is the result of a decrease in production costs, general and administrative expense and depletion.\n1. Lease operating costs and production taxes were 16% lower, or approximately $176,800 less during the year ended December 31, 1994 as compared to the year ended December 31, 1993. The decrease is a result primarily of mechanical, equipment and downhole repairs made to several properties during the year ended 1993. The decrease is also attributed to four property sales made during 1993 which had some lease operating expenses associated with these properties during 1993.\n2. General and administrative costs consists of independent accounting and engineering fees, computer services, postage, and Managing General Partner personnel costs. General and administrative decreased 1% or approximately $1,400 during the year ended December 31, 1994 as compared to the year ended December 31, 1993.\n3. Depletion expense decreased to $184,000 for the year ended December 31, 1994 from $552,000 for the same period in 1993. This represents a decrease of 67%. Depletion is calculated using the gross revenue method of amortization based on a percentage of current period gross revenues to total future gross oil and gas revenues, as estimated by the Partnership's independent petroleum consultants. Consequently, depletion will usually fluctuate in direct relation to oil and gas revenues. As noted above, oil and gas revenues declined due to a decline in oil and gas prices and production for the year ended December 31, 1994 as compared to the same period for 1993.\nC. Revenue and Distribution Comparison\nPartnership net income or (loss) for the years ended December 31, 1995, 1994, and 1993 was $259,472, $111,820, and ($942,312), respectively. Excluding the effects of depreciation, depletion and amortization, net income for the years ended December 31, 1995, 1994, and 1993 would have been $416,472, $295,820, and $352,973, respectively. Correspondingly, Partnership distributions for the years ended December 31, 1995, 1994, and 1993 were $429,924, $278,000, and $595,732, respectively. These differences are indicative of the changes in oil and gas prices, production and properties during 1995, 1994 and 1993.\nThe sources for the 1995 distributions of $429,924 were oil and gas operations of approximately $389,800 and property sales of approximately $88,500, offset by additions to oil and gas properties of approximately $47,400, resulting in excess cash for contingencies or subsequent distributions. The sources for the 1994 distributions of $278,000 were oil and gas operations of approximately $301,200, offset by additions to oil and gas properties of approximately $1,700, resulting in excess cash for contingencies or subsequent distributions. The sources of the 1993 distributions of $595,732 were oil and gas operations of approximately $419,600 and property sales of approximately $158,400, offset by additions to oil and gas properties of approximately $12,800, with the balance from available cash on hand at the beginning of the period.\nTotal distributions during the year ended December 31, 1995 were $429,924 of which $391,224 was distributed to the limited partners and $38,700 to the general partners. The per unit distribution to limited partners during the same period was $28.77. Total distributions during the year ended December 31, 1994 were $278,000 of which $250,200 was distributed to the limited partners and $27,800 to the general partners. The per unit distribution to limited partners during the same period was $18.40. Total distributions during the year ended 1993 were $595,732 of which $542,012 was distributed to the limited partners and $53,720 to the general partners. The per unit distribution to limited partners during the same period was $39.87.\nSince inception of the Partnership, cumulative monthly cash distributions of $5,576,939 have been made to the partners. As of December 31, 1995, $5,057,818 or $372.01 per limited partner unit, has been distributed to the limited partners, representing a 74% return of the capital contributed.\nLiquidity and Capital Resources\nThe primary source of cash is from operations, the receipt of income from interests in oil and gas properties. The Partnership knows of no material change, nor does it anticipate any such change.\nCash flows provided by operating activities were approximately $389,800 in 1995, compared to approximately $301,200 in 1994 and approximately $419,600 in 1993. The primary source of the 1995 cash flow from operating activities was profitable operations.\nCash flows provided by or (used in) investing activities were approximately $41,100 in 1995, compared to approximately ($1,700) in 1994 and approximately $145,600 in 1993. The principal source of the 1995 cash flow from investing activities was the sale of oil and gas properties, offset by additions to oil and gas properties.\nCash flows used in financing activities were approximately $429,600 in 1995, compared to approximately $278,000 in 1994 and approximately $595,600 in 1993. The only use in financing activities was the distributions to partners.\nAs of December 31, 1995, the Partnership had approximately $185,000 in working capital. The Managing General Partner knows of no unusual contractual commitments and believes the revenue generated from operations are adequate to meet the needs of the Partnership.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage\nReport of Independent Accountants. . . . . . . . . . . . . . . . . . . .19\nBalance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20\nStatements of Operations . . . . . . . . . . . . . . . . . . . . . . . .21\nStatement of Changes in Partners' Equity . . . . . . . . . . . . . . . .22\nStatements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . .23\nNotes to Financial Statements. . . . . . . . . . . . . . . . . . . . . .25\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners Southwest Oil & Gas Income Fund VIII-A, L.P. Midland, Texas\nWe have audited the accompanying balance sheets of Southwest Oil & Gas Income Fund VIII-A, L.P. as of December 31, 1995 and 1994, and the related statements of operations, 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, the financial statements referred to above present fairly, in all material respects, the financial position of Southwest Oil & Gas Income Fund VIII-A, 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.\nJOSEPH DECOSIMO AND COMPANY A Tennessee Registered Limited Liability Partnership\nChattanooga, Tennessee March 20, 1996\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership) Balance Sheets December 31, 1995 and 1994\n1995 1994 ---- ----\nAssets\nCurrent assets: Cash and cash equivalents $ 38,356 37,115 Receivable from Managing General Partner 147,157 120,250 --------- --------- Total current assets 185,513 157,365 --------- ---------\nOil and gas properties - using the full-cost method of accounting 5,501,878 5,545,952 Less accumulated depreciation, depletion and amortization 3,925,109 3,768,109 --------- --------- Net oil and gas properties 1,576,769 1,777,843 --------- --------- $ 1,762,282 1,935,208 ========= =========\nLiabilities and Partners' Equity\nCurrent liabilities: Accounts payable $ - 2,768 Distribution payable 536 242 --------- --------- Total current liabilities 536 3,010 --------- --------- Partners' equity: General partners 18,943 15,996 Limited partners 1,742,803 1,916,202 --------- --------- Total partners' equity 1,761,746 1,932,198 --------- --------- $ 1,762,282 1,935,208 ========= =========\nThe accompanying notes are an integral part of these financial statements.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership) Statements of Operations Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nRevenues\nOil and gas revenue $ 1,509,663 1,330,535 1,565,659 Interest 2,242 2,047 2,235 --------- --------- --------- 1,511,905 1,332,582 1,567,894 --------- --------- --------- Expenses\nProduction 983,540 920,771 1,097,549 General and administrative 111,893 115,991 117,372 Depreciation, depletion and amortization 157,000 184,000 576,964 Provision for impairment of oil and gas properties - - 718,321 --------- --------- --------- 1,252,433 1,220,762 2,510,206 --------- --------- --------- Net income (loss) $ 259,472 111,820 (942,312) ========= ========= ========= Net income (loss) allocated to:\nManaging General Partner $ 37,482 26,624 31,768 ========= ========= ========= General partner $ 4,165 2,958 3,530 ========= ========= ========= Limited partners $ 217,825 82,238 (977,610) ========= ========= ========= Per limited partner unit $ 16.02 6.05 (71.90) ========= ========= =========\nThe accompanying notes are an integral part of these financial statements.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership) Statement of Changes in Partners' Equity Years ended December 31, 1995, 1994 and 1993\nGeneral Limited Partners Partners Total -------- -------- -----\nBalance at December 31, 1992 $ 32,636 3,603,786 3,636,422\nNet income (loss) 35,298 (977,610) (942,312)\nDistributions (53,720) (542,012) (595,732) ------ --------- --------- Balance at December 31, 1993 14,214 2,084,164 2,098,378\nNet income 29,582 82,238 111,820\nDistributions (27,800) (250,200) (278,000) ------ --------- --------- Balance at December 31, 1994 15,996 1,916,202 1,932,198\nNet income 41,647 217,825 259,472\nDistributions (38,700) (391,224) (429,924) ------ --------- --------- Balance at December 31, 1995 $ 18,943 1,742,803 1,761,746 ====== ========= =========\nThe accompanying notes are an integral part of these financial statements.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership) Statements of Cash Flows Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities:\nCash received from oil and gas sales $ 1,488,831 1,343,043 1,664,659 Cash paid to suppliers (1,101,276) (1,043,861) (1,247,269) Interest received 2,242 2,047 2,235 --------- --------- --------- Net cash provided by operating activities 389,797 301,229 419,625 --------- --------- --------- Cash flows from investing activities:\nAdditions to oil and gas properties (47,449) (1,737) (12,775) Sale of oil and gas properties 88,523 - 158,379 --------- --------- --------- Net cash provided by (used in) investing activities 41,074 (1,737) 145,604 --------- --------- --------- Cash flows used in financing activities:\nDistributions to partners (429,630) (278,045) (595,623) --------- --------- --------- Net increase (decrease) in cash 1,241 21,447 (30,394)\nCash and cash equivalents: Beginning of year 37,115 15,668 46,062 --------- --------- --------- End of year $ 38,356 37,115 15,668 ========= ========= =========\n(continued)\nThe accompanying notes are an integral part of these financial statements.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership) Statements of Cash Flows, continued Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nReconciliation of net income (loss) to net cash provided by operating activities:\nNet income (loss) $ 259,472 111,820 (942,312)\nAdjustments to reconcile net income (loss) to net cash provided by operating activities:\nDepreciation, depletion and amortization 157,000 184,000 576,964 (Increase) decrease in receivables (20,873) 12,508 99,000 Decrease in payables (5,802) (7,099) (32,348) Provision for impairment of oil and gas properties - - 718,321 ------- ------- ------- Net cash provided by operating activities $ 389,797 301,229 419,625 ======= ======= =======\nSupplemental schedule of noncash investing and financing activities:\nSale of oil and gas property included in receivable from Managing General Partner $ 3,000 - -\nThe accompanying notes are an integral part of these financial statements.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\n1. Summary of Significant Accounting Policies\nOil and Gas Properties\nOil and gas properties are accounted for at cost under the full-cost method. Under this method, all productive and nonproductive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized. Gain or loss on the sale of oil and gas properties is not recognized unless significant oil and gas reserves are involved.\nThe Partnership's policy for depreciation, depletion and amortization of oil and gas properties is computed over their remaining useful life using the units of revenue method based on dollars of future gross revenue attributable to proved oil and gas reserves.\nUnder the future gross revenue method, the Partnership computes the provision by multiplying the total unamortized cost of oil and gas properties by an overall rate determined by dividing (a) oil and gas revenues during the period by (b) the total future gross oil and gas revenues as estimated by the Partnership's independent petroleum consultants. It is reasonably possible that those estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both could be changed significantly in the near term due to the potential fluctuation of oil and gas prices or production. The depletion estimate would also be affected by this change.\nShould the net capitalized costs exceed the estimated present value of oil and gas reserves, discounted at 10%, such excess costs would be charged to current expense. As of December 31, 1995 and 1994, the net capitalized costs did not exceed the estimated present value of oil and gas reserves. In 1993, the Partnership reduced the net capitalized costs of oil and gas properties by $718,321. This write-down had the effect of reducing net income, but did not affect cash flow or partner distributions.\nEstimates and Uncertainties\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.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\nSyndication Costs\nSyndication costs are accounted for as a reduction of partnership equity.\nEnvironmental Costs\nThe Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on 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. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nGas Balancing\nThe Partnership utilizes the sales method of accounting for over\/under deliveries of gas. Under this method, the Partnership records revenues based on the payments it has received for sales from its purchasers. As of December 31, 1995, 1994 and 1993, the Partnership was overproduced by approximately 59, 60, and 60 mcf, respectively.\nIncome Taxes\nNo provision for income taxes is reflected in these financial statements, since the tax effects of the Partnership's income or loss are passed through to the individual partners.\nIn accordance with the requirements of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes, the Partnership's tax basis in its oil and gas properties at December 31, 1995 and 1994 is $203,903 and $257,768 more, respectively, than that shown on the accompanying Balance Sheets in accordance with generally accepted accounting principles.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\nCash and Cash Equivalents\nFor 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. The Partnership maintains its cash at one financial institution.\nNumber of Limited Partner Units\nAs of December 31, 1995, 1994 and 1993, there were 13,596 limited partner units outstanding.\n2. Organization\nSouthwest Oil & Gas Income Fund VIII-A, L.P. was organized under the laws of the state of Delaware on November 30, 1987, for the purpose of acquiring producing oil and gas properties and to produce and market crude oil and natural gas produced from such properties for a term of 50 years, unless terminated at an earlier date as provided for in the Partnership Agreement. The Partnership sells its oil and gas production to a variety of purchasers with the prices it receives being dependent upon the oil and gas economy. Southwest Royalties, Inc. serves as the Managing General Partner and H. H. Wommack, III, as the individual general partner. Revenues, costs and expenses are allocated as follows:\nLimited General Partners Partners -------- -------- Interest income on capital contributions 100% - Oil and gas sales 90% 10% All other revenues 90% 10% Organization and offering costs (1) 100% - Amortization of organization costs 100% - Syndication costs 100% - Property acquisition costs 100% - Gain\/loss on property disposition 90% 10% Operating and administrative costs (2) 90% 10% Depreciation, depletion and amortization of oil and gas properties 100% - All other costs 90% 10%\n(1) All organization costs in excess of 3% of initial capital contributions will be paid by the Managing General Partner and will be treated as a capital contribution. The Partnership paid the Managing General Partner an amount equal to 3% of initial capital contributions for such organization costs.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\n2. Organization - continued\n(2) Administrative costs in any year which exceed 2% of capital contributions shall be paid by the Managing General Partner and will be treated as a capital contribution.\n3. Oil and Gas Properties\nCosts incurred in connection with the Partnership's oil and gas producing activities for the years ended December 31, 1995, 1994 and 1993 are as follows:\n1995 1994 1993 ---- ---- ----\nDevelopment costs $ 47,449 1,737 12,775 ======= ======= ======= Depreciation, depletion and amortization $ 157,000 184,000 576,964 ======= ======= ======= Impairment of oil and gas properties $ - - 718,321 ======= ======= =======\nAll of the Partnership's properties were proved when acquired.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\n4. Commitments and Contingent Liabilities\nThe Partnership is subject to various federal, state and local environmental laws and regulations which establish standards and requirements for protection of the environment. The Partnership cannot predict the future impact of such standards and requirements, which are subject to change and can have retroactive effectiveness. The Partnership continues to monitor the status of these laws and regulations.\nAs of December 31, 1995, the Partnership has not been fined, cited or notified of any environmental violations and management is not aware of any unasserted violations which would have a material adverse effect upon capital expenditures, earnings or the competitive position in the oil and gas industry. However, the Managing General Partner does recognize by the very nature of its business, material costs could be incurred in the near term to bring the Partnership into total compliance. The amount of such future expenditures is not reliably determinable due to several factors, including the unknown magnitude of possible contaminations, the unknown timing and extent of the corrective actions which may be required, the determination of the Partnership's liability in proportion to other responsible parties and the extent to which such expenditures are recoverable from insurance or indemnifications from prior owners of Partnership's properties.\n5. Related Party Transactions\nA significant portion of the oil and gas properties in which the Partnership has an interest are operated by and purchased from the Managing General Partner. As is usual in the industry and as provided for in the operating agreement for each respective oil and gas property in which the Partnership has an interest, the operator is paid an amount for administrative overhead attributable to operating such properties, with such amounts to Southwest Royalties, Inc. as operator approximating $130,000, $133,000, and $141,000 for the years ended December 31, 1995, 1994 and 1993, respectively. In addition, the Managing General Partner and certain officers and employees may have an interest in some of the properties that the Partnership also participates.\nCertain subsidiaries of the Managing General Partner perform various oil field services for properties in which the Partnership owns an interest. Such services aggregated approximately $26,000, $31,000, and $75,000 for the years ended December 31, 1995, 1994 and 1993, respectively, and the Managing General Partner believes that these costs are comparable to similar charges paid by the Partnership to unrelated third parties.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\n5. Related Party Transactions - continued\nSouthwest Royalties, Inc., the Managing General Partner, was paid $98,400 during 1995, 1994 and 1993 as an administrative fee for indirect general and administrative overhead expenses.\nAmounts due from Southwest Royalties, Inc. as of December 31, 1995 and 1994 totaled $147,157 and $120,250, respectively, all of which is from oil and gas production which is distributed to the Partnership subsequent to the end of the year.\nIn addition, a director and officer of the Managing General Partner is a partner in a law firm, with such firm providing legal services to the Partnership approximating none, $200, and $1,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n6. Major Customers\nTwo customers purchased 48% and 18% of the Partnership's oil and gas production during 1995. Two customers purchased 41% and 18% of the Partnership's oil and gas production during 1994. During 1993, two customers purchased 39% and 18% of the Partnership's oil and gas production.\nSouthwest Oil & Gas Income Fund VIII-A, L.P. (a Delaware limited partnership)\nNotes to Financial Statements\n7. Estimated Oil and Gas Reserves (unaudited)\nThe Partnership's interest in proved oil and gas reserves is as follows:\nOil (bbls) Gas (mcf) ---------- --------- Proved developed and undeveloped reserves -\nJanuary 1, 1993 682,000 1,049,000\nRevisions of previous estimates (167,000) 3,000 Production (77,000) (144,000) ------- --------- December 31, 1993 438,000 908,000\nRevisions of previous estimates 303,000 145,000 Production (68,000) (130,000) ------- --------- December 31, 1994 673,000 923,000\nRevisions of previous estimates 100,000 269,000 Production (75,000) (116,000) Sale of minerals in place (13,000) (5,000) ------- --------- December 31, 1995 685,000 1,071,000 ======= =========\nProved developed reserves -\nDecember 31, 1993 374,000 860,000 ======= ========= December 31, 1994 585,000 832,000 ======= ========= December 31, 1995 620,000 973,000 ======= =========\nAll of the Partnership's reserves are located within the continental United States.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nManagement of the Partnership is provided by Southwest Royalties, Inc., as Managing General Partner. The names, ages, offices, positions and length of service of the directors and executive officers of Southwest Royalties, Inc. are set forth below. Each director and executive officer serves for a term of one year. The present directors of the Managing General Partner have served in their capacity since the Company's formation in 1983.\nName Age Position - -------------------- --- ------------------------------------- H. H. Wommack, III 40 Chairman of the Board, President, Chief Executive Officer, Treasurer and Director\nH. Allen Corey 40 Secretary and Director\nBill E. Coggin 41 Vice President and Chief Financial Officer\nRichard E. Masterson 43 Vice President, Exploration and Acquisitions\nJon P. Tate 38 Vice President, Land and Assistant Secretary\nRussell K. Hall 39 Vice President, Acquisitions and Exploitation Manager\nR. Douglas Keathley 40 Vice President, Operations\nH. H. Wommack, III, is Chairman of the Board, President, Chief Executive Officer, Treasurer, principal stockholder and a director of the Managing General Partner, and has served as its President since the Company's organization in August, 1983. Prior to the formation of the Company, Mr. Wommack was a self-employed independent oil producer engaged in the purchase and sale of royalty and working interests in oil and gas leases, and the drilling of exploratory and developmental oil and gas wells. Mr. Wommack holds a J.D. degree from the University of Texas from which he graduated in 1980, and a B.A. from the University of North Carolina in 1977.\nH. Allen Corey, Secretary and a director of the Managing General Partner, has served as its Secretary since its inception. Mr. Corey is an attorney and is engaged in the private practice of law with the firm of Miller & Martin, Chattanooga, Tennessee, of which he is a partner, since 1981; except for a period of five months in which Mr. Corey served as President of Southwest Associated Securities, Inc., formerly a subsidiary of Southwest Royalties, Inc. Mr. Corey received his J.D. degree from Vanderbilt University Law School and a B.A. from the University of North Carolina.\nBill E. Coggin, Vice President and Chief Financial Officer, has been with the Managing General Partner since 1985. Mr. Coggin was Controller for Rod Ric Corporation of Midland, Texas, an oil and gas drilling company, during the latter part of 1984. He was Controller for C.F. Lawrence & Associates, Inc., an independent oil and gas operator also of Midland, Texas during the early part of 1984. Mr. Coggin taught public school for four years prior to his business experience. Mr. Coggin received a B.S. in Education and a B.B.A. in Accounting from Angelo State University.\nRichard E. Masterson, Vice President, Exploration and Acquisitions, first became associated with the Managing General Partner as a geological consultant in 1985. He was employed as a petroleum geologist by Grand Banks Energy (1980-1985), Monsanto (1977-1980) and Texaco, Inc. (1974-1976) prior to joining the Managing General Partner. Mr. Masterson is a member of the Society of Economic Paleontologists and Mineralogists and the West Texas Geological Society. Mr. Masterson received his B.A. degree in Geology from Trinity University.\nJon P. Tate, Vice President, Land and Assistant Secretary, assumed his responsibilities with the Managing General Partner in 1989. Prior to joining the Managing General Partner, Mr. Tate was employed by C.F. Lawrence & Associates, Inc., an independent oil and gas company, as Land Manager from 1981 through 1989. Mr. Tate is a member of the Permian Basin Landman's Association and received his B.B.S. degree from Hardin-Simmons University.\nRussell K. Hall, Vice President, Acquisitions and Exploitation Manager, assumed his responsibilities with the Managing General Partner on May 1, 1995. Prior to joining the Managing General Partner, Mr. Hall was employed by NationsBank of Texas, N.A. as a petroleum engineer and vice president, specializing in the Permian Basin (1981-1995) and for Amoco Production Company as a reservoir engineer (1979-1981). Mr. Hall received his B.S. in mechanical engineering in 1978 from the University of Oklahoma.\nR. Douglas Keathley, Vice President, Operations, assumed his responsibilities with the Managing General Partner as a Production Engineer in October, 1992. Prior to joining the Managing General Partner, Mr. Keathley was employed for four (4) years by ARCO Oil & Gas Company as senior drilling engineer working in all phases of well production (1988-1992), eight (8) years by Reading & Bates Petroleum Company as senior petroleum engineer responsible for drilling (1980-1988) and two (2) years by Tenneco Oil Company as drilling engineer responsible for all phases of drilling (1978-1980). Mr. Keathley received his B.S. in Petroleum Engineering in 1977 from the University of Oklahoma.\nKey Employees\nAccounting and Administrative Officer - Debbie A. Brock, age 43, assumed her position with the Managing General Partner in 1991. Prior to joining the Managing General Partner, Ms. Brock was employed with Western Container Corporation as Accounting Manager (1982-1990), Synthetic Industries (Texas), Inc. as Accounting Manager (1976-1982) and held various accounting positions in the manufacturing industry (1971-1975). Ms. Brock received a B.B.A. from the University of Houston.\nController - Robert A. Langford, age 46, assumed his responsibilities with the Managing General Partner in 1992. Mr. Langford received his B.B.A. degree in Accounting in 1975 from the University of Central Arkansas. Prior to joining the Managing General Partner, Mr. Langford was employed with Forest Oil Corporation as Corporate Coordinator, Regional Coordinator, Accounting Manager. He held various other positions from 1982-1992 and 1976-1980 and was Assistant Controller of National Oil Company from 1980-1982.\nFinancial Reporting Manager - Bryan Dixon, C.P.A., age 29, assumed his responsibilities with the Managing General Partner in 1992. Mr. Dixon received his B.B.A. degree in Accounting in 1988 from Texas Tech University in Lubbock, Texas. Prior to joining the Managing General Partner, Mr. Dixon was employed as a Senior Auditor with Johnson, Miller & Company from 1991- 1992 and Audit Supervisor for Texas Tech University and the Texas Tech University Health Sciences Center from 1988-1991.\nProduction Superintendent - Steve C. Garner, age 54, assumed his responsibilities with the Managing General Partner as Production Superintendent in July, 1989. Prior to joining the Managing General Partner, Mr. Garner was employed 16 years by Shell Oil Company working in all phases of oil field production as operations foreman, one and one-half years with Petroleum Corporation of Delaware as Production Superintendent, six years as an independent engineering consultant, and one year with Citation Oil & Gas Corp. as a workover, completion and production foreman. Mr. Garner has worked extensively in the Permian Basin oil field for the last 25 years.\nTax Manager - Carolyn Cookson, age 39, assumed her position with the Managing General Partner in April, 1989. Prior to joining the Managing General Partner, Ms. Cookson was employed as Director of Taxes at C.F. Lawrence & Associates, Inc. from 1983 to 1989, and worked in public accounting at McCleskey, Cook & Green, P.C. from 1981 to 1983 and Deanna Brady, C.P.A. from 1980 to 1981. She is a member of the Permian Basin Chapter of the Petroleum Accountants' Society, and serves on its Board of Directors and is liaison to the Tax Committee. Ms. Cookson received a B.B.A. in accounting from New Mexico State University.\nVice President, Marketing - Steve J. Person, age 37, joined the Managing General Partner in 1989. Prior to joining the Managing General Partner, Mr. Person served as Vice President of Marketing for CRI, Inc., and was associated with Capital Financial Group and Dean Witter (1983). He received a B.B.A. from Baylor University in 1982 and an M.D.A. from Houston Baptist University in 1987.\nInvestor Relations Manager - Sandra K. Flournoy, age 49, came to Southwest Royalties, Inc. in 1988 from Parker & Parsley Petroleum, where she was Assistant Manager of Investor Services and Broker\/Dealer Relations for two years. Prior to that, Ms. Flournoy was Administrative Assistant to the Superintendent at Greenwood ISD for four years.\nIn certain instances, the Managing General Partner will engage professional petroleum consultants and other independent contractors, including engineers and geologists in connection with property acquisitions, geological and geophysical analysis, and reservoir engineering. The Managing General Partner believes that, in addition to its own \"in-house\" staff, the utilization of such consultants and independent contractors in specific instances and on an \"as-needed\" basis allows for greater flexibility and greater opportunity to perform its oil and gas activities more economically and effectively.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Partnership does not have any directors or executive officers. The executive officers of the Managing General Partner do not receive any cash compensation, bonuses, deferred compensation or compensation pursuant to any type of plan, from the Partnership. The Managing General Partner received $98,400 during 1995, 1994 and 1993 as an annual administrative fee.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThere are no limited partners who own of record, or are known by the Managing General Partner to beneficially own, more than five percent of the Partnership's limited partnership interests.\nThe Managing General Partner owns a nine percent interest in the Partnership as a general partner. Through repurchase offers to the limited partners, the Managing General Partner also owns 583 limited partner units, a 4.3% limited partner interest. The Managing General Partner total percentage interest ownership in the Partnership is 12.9%.\nNo officer or director of the Managing General Partner owns Units in the Partnership. H. H. Wommack, III, as the individual general partner of the Partnership, owns a one percent interest in the Partnership as a general partner. The officers and directors of the Managing General Partner are considered beneficial owners of the limited partner units acquired by the Managing General Partner by virtue of their status as such. A list of beneficial owners of limited partner units, acquired by the Managing General Partner, is as follows:\nAmount and Nature of Percent Name and Address of Beneficial of Title of Class Beneficial Owner Ownership Class - ------------------- --------------------------- --------------- ------- Limited Partnership Southwest Royalties, Inc. Directly Owns 4.3% Interest Managing General Partner 583 Units 407 N. Big Spring Street Midland, TX 79701\nLimited Partnership H. H. Wommack, III Indirectly Owns 4.3% Interest Chairman of the Board, 583 Units President, CEO, Treasurer and Director of Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nLimited Partnership H. Allen Corey Indirectly Owns 4.3% Interest Secretary and Director of 583 Units Southwest Royalties, Inc., the Managing General Partner 1000 Volunteer Bldg. Chattanooga, TN 37402-2289\nLimited Partnership Bill E. Coggin Indirectly Owns 4.3% Interest Vice President and CFO of 583 Units Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nLimited Partnership Richard E. Masterson Indirectly Owns 4.3% Interest Vice President, Exploration 583 Units and Acquisitions of Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nLimited Partnership Jon P. Tate Indirectly Owns 4.3% Interest Vice President, Land and 583 Units Assistant Secretary of Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nAmount and Nature of Percent Name and Address of Beneficial of Title of Class Beneficial Owner Ownership Class - ------------------- --------------------------- --------------- ------- Limited Partnership Russell K. Hall Indirectly Owns 4.3% Interest Vice President, 583 Units Acquisitions and Exploitation Manager of Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nLimited Partnership R. Douglas Keathley Indirectly Owns 4.3% Interest Vice President, 583 Units Operations of Southwest Royalties, Inc., the Managing General Partner 407 N. Big Spring Street Midland, TX 79701\nThere are no arrangements known to the Managing General Partner which may at a subsequent date result in a change of control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIn 1995, the Managing General Partner received $98,400 as an administrative fee. This amount is part of the general and administrative expenses incurred by the Partnership.\nIn some instances the Managing General Partner and certain officers and employees may be working interest owners in an oil and gas property in which the Partnership also has a working interest. Certain properties in which the Partnership has an interest are operated by the Managing General Partner, who was paid approximately $130,000 for administrative overhead attributable to operating such properties during 1995.\nCertain subsidiaries of the Managing General Partner perform various oilfield services for properties in which the Partnership owns an interest. Such services aggregated approximately $26,000 for the year ended December 31, 1995.\nIn the opinion of management, the terms of the above transaction are similar to ones with 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:\nIncluded in Part II of this report --\nReport of Independent Accountants Balance Sheets Statements of Operations Statement of Changes in Partners' Equity Statements of Cash Flows Notes to Financial Statements\n(a)(2) Schedules I through XIII are omitted because they are not applicable, or because the required information is shown in the financial statements or the notes thereto.\n(a)(3) Exhibits:\nExhibit 4(a): Certificate of Limited Partnership of Southwest Oil & Gas Income Fund VIII-A, L.P., dated November 30, 1987. (Incor- porated by reference from Partnership's S-1 Registration Statement File Number 33-18847 effective March 31, 1988.)\nExhibit 4(b): Agreement of Limited Partnership of Southwest Oil & Gas Income Fund VIII-A, L.P. dated July 6, 1988. (Incorporated by reference from Partnership's Form 10-K for the fiscal year ended December 31, 1988.)\n(b) No report on Form 8-K was filed during the last quarter of the period covered by this report.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSouthwest Oil & Gas Income Fund VIII-A, L.P., a Delaware limited partnership\nBy: Southwest Royalties, Inc., Managing General Partner\nBy: \/s\/ H. H. Wommack, III ----------------------------- H. H. Wommack, III, President\nDate: March 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 Partnership and in the capacities and on the dates indicated.\nBy: \/s\/ H. H. Wommack, III ----------------------------------- H. H. Wommack, III, Chairman of the Board, President, Chief Executive Officer, Treasurer and Director\nDate: March 26, 1996\nBy: \/s\/ H. Allen Corey ----------------------------- H. Allen Corey, Secretary and Director\nDate: March 26, 1996","section_15":""}
{"filename":"91767_1995.txt","cik":"91767","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------------------\nThe main plant and corporate offices are located in Hartsville, South Carolina. The Company has 181 branch or manufacturing operations in the United States, 25 in Canada and 73 in 27 other international countries.\nInformation about the Company's manufacturing operations by segment follows:\nThe Company believes that its properties are suitable and adequate for current needs and that the total productive capacity is adequately utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -------------------------\nIn the normal course of business, the Company is a party to various legal proceedings incidental to its business and is subject to a variety of environmental and pollution control laws and regulations in all jurisdictions in which it operates. On May 3, 1994, a civil action was filed against the Company in the United States District Court for the District of Massachusetts by Integrated Bagging Systems Corporation and BPI Packaging Technologies, Inc. for alleged patent infringement. The suit also seeks to have a patent owned by the Company declared invalid. There were no new developments in this matter during 1995, and the Company believes this lawsuit is without merit. The Company continues to vigorously defend its position and expects to prevail.\nAlthough the level of future expenditures for legal and environmental matters is impossible to determine with any degree of probability, it is management's opinion that such costs, when finally determined, will not have a material adverse effect on the consolidated financial position, liquidity or results of operation, of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -----------------------------------------------------------\nNone.\nI-6\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - ------------------------------------------------------------------------- MATTERS - -------\nMarket and Market Prices of Common Stock\nThe Company's common stock began trading on the New York Stock Exchange (NYSE) March 8, 1995, under the stock symbol \"SON\". Prior to that date, the common stock was traded on the NASDAQ National Market System. The Comparative Highlights in the 1995 Annual Report to Shareholders (Exhibit 13 of this report) shows, by quarter, the high and low price on the NASDAQ market for the period January 1, 1994 through March 7, 1995, and the NYSE for the period March 8, 1995 through December 31, 1995, and is hereby incorporated by reference herein.\nApproximate Number of Security Holders\nThere were approximately 33,000 shareholder accounts as of March 3, 1996.\nDividends\nInformation required is included in the Comparative Highlights in the 1995 Annual Report to Shareholders, and is hereby incorporated by reference herein.\nOn April 19, 1995, the Board of Directors declared a five percent stock dividend for all shareholders, and of record May 19, 1995, to be distributed on June 9, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -------------------------------\nThe Selected Eleven-Year Financial Data in the 1995 Annual Report to Shareholders provides the required data, and is hereby incorporated by reference herein.\nII-1\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS - ---------------------\nThe information presented under Management's Discussion and Analysis of the 1995 Annual Report to Shareholders is hereby incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ---------------------------------------------------\nConsolidated Financial Statements\nThe consolidated financial statements, notes to consolidated financial statements and the report of Certified Public Accountants for the Company included in the 1995 Annual Report to Shareholders are hereby incorporated by reference herein.\nSupplementary Financial Data\nThe information set forth under \"Comparative Highlights\" in the 1995 Annual Report to Shareholders is hereby incorporated by reference herein.\nII-2\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Directors of Sonoco Products Company:\nOur report on the consolidated financial statements of Sonoco Products Company has been incorporated by reference in this Form 10-K from page 45 of the 1995 Annual Report to Shareholders of Sonoco Products Company. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the exhibit index of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic fianancial 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.\nCharlotte, North Carolina January 31, 1996\nII-3\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ----------------------------------------------------------------------- FINANCIAL DISCLOSURE - --------------------\nNone.\nII-4\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -----------------------------------------------------------\nIdentification of Directors\nInformation about the Directors of the Company and Compliance with the Securities Exchange Act of 1934 is shown on pages 4 through 10 and page 27, respectively, of the Definitive Proxy Statement (included as Exhibit 99-1 of this report) and is hereby incorporated by reference herein.\nIdentification of Executive Officers\nIII-1\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT, CONTINUED - -----------------------------------------------------------\nIII-2\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT, CONTINUED - -----------------------------------------------------------\nFamily Relationships ---------------------\nC. W. Coker and F. L. H. Coker are brothers and the first cousins of J. L. Coker and P. C. Coggeshall, Jr.\nIII-3\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------------------------------\nExecutive Compensation, as discussed on pages 14 - 16 and pages 18 - 23 of the Proxy Statement, included as Exhibit 99-1 of this report, is hereby incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -----------------------------------------------------------------------\nThe security ownership of management as shown on pages 12 - 13 of the Proxy Statement, Exhibit 99-1 of this report, is hereby incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------\nTransactions with management as shown on pages 23 - 24 of the Proxy Statement, included as Exhibit 99-1 of this report, is hereby incorporated by reference herein.\nIII-4\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------\nData incorporated by reference from the 1995 Annual Report to Shareholders (included as Exhibit 13 of this report):\nComparative Highlights (Selected Quarterly Financial Data)\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nSelected Eleven-Year Financial Data\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 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\nShareholder Information (Selected Financial Data)\nData submitted herewith:\nReport of Independent Accountants (included under Item 8)\nIV-1\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - --------------------------------------------------------------- FORM 8-K, CONTINUED - --------\nFinancial Statement Schedule:\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not required, are not applicable or the required information is given in the financial statements or notes thereto.\nExhibits:\n* Incorporated by reference to the Registrant's Form S-3 (filed October 4, 1993, File No. 33-50503, and June 6, 1991, File No. 33-40538).\nIV-2\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - --------------------------------------------------------------- FORM 8-K, CONTINUED - --------\nReports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the fourth quarter of 1995.\nIV-3\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS)\n(1) Includes amounts written off, translation adjustments and payments.\nIV-4\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 27th day of March 1996.\nSONOCO PRODUCTS COMPANY\n\/s\/ C. W. Coker ---------------------------- C. W. Coker Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following person on behalf of the Registrant and in the capacities indicated on this 27th day of March 1996.\n\/s\/ F. T. Hill, Jr. ------------------------------- F. T. Hill, Jr. Chief Financial Officer (and Principal Accounting Officer)\nIV-5\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nSIGNATURES, CONTINUED - ----------\n\/s\/ C. W. Coker Chief Executive Officer and - ----------------------------- Director C. W. Coker\n\/s\/ P. C. Browning President, Chief Operating Officer and - ----------------------------- Director P. C. Browning\n\/s\/ L. Benatar Senior Vice President and - ----------------------------- Director L. Benatar\n\/s\/ C. J. Bradshaw Director - ----------------------------- C. J. Bradshaw\n\/s\/ R. J. Brown Director - ----------------------------- R. J. Brown\n\/s\/ F. L. H. Coker Director - ----------------------------- F. L. H. Coker\nDirector - ----------------------------- J. L. Coker\n\/s\/ T. C. Coxe, III Director - ----------------------------- T. C. Coxe, III\n\/s\/ A. T. Dickson Director - ----------------------------- A. T. Dickson\n\/s\/ R. E. Elberson Director - ----------------------------- R. E. Elberson\n\/s\/ J. C. Fort Director - ----------------------------- J. C. Fort\n\/s\/ P. Fulton Director - ----------------------------- P. Fulton\n\/s\/ B. L. M. Kasriel Director - ----------------------------- B. L. M. Kasriel\nDirector - ----------------------------- R. C. King, Jr.\n\/s\/ E. H. Lawton, Jr. Director - ----------------------------- E. H. Lawton, Jr.\n\/s\/ H. L. McColl, Jr. Director - ----------------------------- H. L. McColl, Jr.\n\/s\/ E. C. Wall, Jr. Director - ----------------------------- E. C. Wall, Jr.\n\/s\/ Dona Davis Young Director - ------------------------------ Dona Davis Young\nIV-6\nSONOCO PRODUCTS COMPANY AND CONSOLIDATED SUBSIDIARIES\nEXHBIT INDEX\n*Incorporated by reference to the Registrant's Form S-3 (filed October 4, 1993, File No. 33-50503, and June 6, 1991, file No. 33-40538).","section_15":""}
{"filename":"822663_1995.txt","cik":"822663","year":"1995","section_1":"Item 1. Business\nIntroduction\nJean Philippe Fragrances, Inc. was organized under the laws of the State of Delaware in May 1985, maintains it executive offices at 551 Fifth Avenue, New York, New York 10176 and its telephone number is 212-983-2640. Unless the context otherwise indicates, the term \"Jean Philippe\" refers to the parent company, Jean Philippe Fragrances, Inc., and the term the \"Company\" refers to Jean Philippe Fragrances, Inc. and its consolidated majority-owned direct and indirect subsidiaries, Inter Parfums Holdings, S.A. (\"IP Holdings\"), Inter Parfums, S.A. (\"Inter Parfums\"), Inter Parfums Trademarks, S.A. (formerly Jean Desprez, S.A.) and Inter Parfums Cosmetiques (formerly Jean Desprez, S.A.); and the Company's wholly-owned subsidiaries, Elite Parfums, Ltd. (\"Elite\") and Jean Philippe Fragrances do Brasil, Ltda. (\"Jean Philippe Brasil\"), a limited liability company.\nThe Company is a manufacturer and distributor of fragrances and cosmetics in the following niche markets: domestic and international brand name and licensed fragrances, alternative designer fragrances and mass market cosmetics.\nThe Company is the owner of the Intimate(Registered), Parfums Molyneux(Registered) and Parfums Weil(Registered) fragrance lines, and Aziza(Registered), a hypo-allergenic line of eye cosmetics; is the exclusive licensee in the United States and Puerto Rico for Cutex(Registered) nail care (excluding nail polish remover) and lip products; and is world-wide licensee, manufacturer and distributor of the Burberrys(Registered), Ombre Rose(Registered) and Regine's(Registered) fragrance lines, the Jordache(Registered) line of fragrances and cosmetics and Chaz(Registered) fragrances for men.\nInter Parfums markets its own line of moderately priced fragrances and certain licensed or brand name fragrances in approximately sixty (60) countries worldwide.\nThe Company has in the past acquired, and may in the future seek to acquire, one (1) or more companies or divisions of companies in the fragrance or related business, or fragrance product lines or related products. Any and all discussions had by management to date have been at the inquiry, pre-negotiation level only, and no assurances can be given that: (i) management will pursue any transaction should a company, business, division, or product line become available; (ii) or if pursued, that any transaction will be consummated; or (iii) if consummated, that such transaction will increase the Company's earnings.\nProducts and Selection\n-Alternative Designer Fragrances\nThe Company produces and markets several lines of fragrances which it\nsells at a substantial discount from the high image, high retail cost brand name counterparts. Prior to producing and marketing a new alternative designer product, management of the Company looks for the existence of certain factors with respect to a particular designer fragrance: (i) high retail cost, (ii) substantial expenditure of advertising dollars and (iii) selective distribution. Management is of the opinion that the presence of all three (3) factors gives a reasonable degree of market presence for such designer fragrance. Management then seeks to create a similar scent which, together with creative packaging and steeply discounted prices, will create what the Company intends will be an appealing fragrance to be sold to mass market merchandisers and drug store chains at substantial discounts from the higher cost brand name fragrance.\nThe Company's alternative designer fragrances are similar in scent to highly advertised designer fragrances that have been established in the retail market at a high retail price. These products are produced in the United States, and are intended to have an upscale image without a high retail price. The Company's alternative designer fragrances, which typically sell for under $5.00 at the retail level, are substantially discounted from the high cost of designer fragrances, which range from $30.00 to $200.00.\nSome of the alternative designer fragrances currently produced and marketed by the Company include: Fleur de Paris(Trademark), Radiance(Trademark), Elite 2(Trademark), Flight(Trademark), Dakota(Trademark), Memphis(Registered), Snow Silk(Registered), Duo(Trademark), Sexation(Trademark) and Gold by Jean Philippe(Registered).\nAdditionally, the Company markets complementary alternative designer fragrance products such as deodorant sticks, roll on deodorants and body sprays. New products are intended to be developed in accordance with market feasibility and demand. Management of the Company believes that demand for new alternative designer fragrances may be created when participants in the designer fragrance industry launch promotional campaigns for new products.\n-Brand Name and Licensed Fragrances\nThe Parfums Weil and Parfums Molyneux world-wide family of trademarks were acquired in February 1994 by Inter Parfums, and cover a variety of moderately priced fragrance lines for distribution to perfumeries, and the fragrance lines are distributed in over thirty (30) countries world-wide. Parfums Molyneux, formed in 1927, has established a classic line of fragrances including Captain and Quartz, with representation in all major markets world-wide. Parfums Weil has enjoyed a similar history dating back to the early 1900's with its first production of a range of original perfumes presented in exquisite Baccarat bottles. Through the years the fragrance lines were modernized and expanded, and today include the trademarks Bambou, Antilope and Kipling, among others. Quartz by Molyneux has achieved wide acceptance in Central and South America. As a result, Inter Parfums will introduce a new fragrance, Quartz for men, in 1996. During 1995, Inter Parfums launched Fluer de Weil, a new fragrance developed by Inter Parfums following the trend of light floral notes associated with the Weil brand. Initial results for this new fragrance have been promising.\nIn March 1994 the Company acquired from Revlon Consumer Products Corporation (\"Revlon\") the world-wide trademarks for the Intimate fragrance\nline, and entered into a 99 year royalty free license agreement with Revlon for the use of the trademark Chaz in connection with men's fragrances, deodorants and body sprays.\nThe Intimate and Chaz brands cover a variety of moderately priced fragrances for mass market distribution, and are currently distributed in a number of countries throughout the world. The Intimate product line has been available for over forty (40) years and has gained a reputation for quality and value with women over forty (40) years of age.\nIn July 1993 Inter Parfums acquired the exclusive world-wide license for Burberrys fragrances in accordance with the terms of a License Agreement entered into among Burberrys Limited as licensor, Inter Parfums as licensee and Jean Philippe as the guarantor of Inter Parfums obligations thereunder (the \"Burberrys License Agreement\"). The Burberrys License Agreement expires on December 31, 2003, subject to certain minimum sales requirements and royalty payments. In 1995 Inter Parfums completely redesigned all products under the Burberry's brand name, which achieved successful distribution in more than twenty (20) countries around the world.\nIn July 1993 Inter Parfums acquired the exclusive world-wide license for Ombre Rose fragrances as well as other fragrances to be developed by Inter Parfums in accordance with the terms of a License Agreement entered into between Jean-Charles Brosseau S.A. as licensor and Inter Parfums as licensee (the \"Brosseau License Agreement\"). The Brosseau License Agreement is for a term of ten (10) years, subject to certain minimum sales requirements and royalty payments. The Ombre Rose line, with its classically designed bottle, continues to enjoy wide acceptance in the Far East and the United States.\nIn addition, Inter Parfums acquired all of the then existing world-wide distribution rights for Ombre Rose fragrances, which had previously been granted to two (2) affiliated companies based in Miami, Florida, subject to continuing in effect certain sub-distribution agreements outside of the United States in accordance with their respective terms. As part of such transaction, Inter Parfums granted exclusive distribution rights in the United States, Canada and Puerto Rico to Fragrance Marketing Group, Inc., an affiliate of the former distributors of Ombre Rose, for the same term of the Brosseau License Agreement, subject to certain minimum purchase requirements. Jean Philippe has guaranteed the obligations of Inter Parfums under such agreements.\nIn January 1990 the Company obtained the exclusive right to use the trademark Jordache(Registered) from Jordache Enterprises, Inc. (\"Jordache\") in connection with the manufacturing, marketing and distribution of fragrances and cosmetics in the United States. The Company also received the license to manufacture, market and distribute fragrances and cosmetics in various territories abroad, which territories are to become exclusive in nature upon the commencement of substantial bona fide sales in each such territory. The initial term of the license was for five and a half (5-1\/2) years and ended on June 30, 1995. In addition the license agreement provides the Company with the right to renew the license for ten (10) annual renewal terms, subject to certain minimum sales and royalty payment requirements. In the first quarter of both fiscal 1995 and 1996, the Company elected to renew the Jordache license for the next annual period. Since obtaining the right to use the Jordache trademark, the Company has created and produced, and presently\nmarkets, a Jordache(Registered) product line, which consists of a collection of moderately priced fragrances and cosmetics (lipstick and nail polish) geared to the youth market.\nIn February 1989 the Company became the exclusive world wide distributor for a new fragrance called Regine's, which is sold internationally in approximately sixty (60) countries. The Regine's fragrance was developed by Inter Parfums, the first original fragrance to be created and marketed by the Company. Inter Parfums markets Regine's, Zoa(Trademark) and Jimmy'z (the Regine's men's fragrance) outside the United States and Canada.\nIn March 1996, the Company, through its indirect, majority-held subsidiary, Parfums Jean Desprez, S.A. and its wholly-owned subsidiary, Jean Desprez, S.A., sold to Parlux Fragrances, Inc. all of the trademarks and related intellectual property rights, equipment, ancillary assets and inventory of the Bal`a Versailles and Revolution `a Versailles lines, among others. In addition, Parfums Jean Desprez and Jean Desprez on behalf of themselves and their parent and affiliated corporations, agreed not to create alternative designer fragrances with similar packaging to the Bal`a Versailles and Revolution `a Versailles, lines. The aggregate consideration paid by the purchaser was $4.95 million (which included $1.8 million of inventory at cost), payable $1.575 million in cash at closing and $3.375 million in installments over a nine (9) month period without interest. Inter Parfums, the parent of Parfums Jean Desprez, paid approximately $3.1 million in excess of the tangible assets of the companies acquired, for the outstanding capital stock of Parfums Jean Desprez in July 1994.\n-International Fragrances\nInter Parfums creates, produces and markets its proprietary line of fragrances designed to appear expensive, with attractive bottling and packaging, but sold in the middle market. Typical proprietary fragrances sold by Inter Parfums retail between U.S.$10.00 to $15.00.\nMass Market Cosmetics\nOn August 1, 1994 Jean Philippe entered into a license agreement with Chesebrough-Pond's, Inc. for the exclusive rights to manufacture and market Cutex(Registered) nail care (excluding nail polish remover) and lip color products in the United States and Puerto Rico (the \"Cutex License\"). The Cutex License provides for an initial term of seven (7) years together with three (3) annual renewal periods, and either party may cancel the agreement if certain minimum annual sales levels are not achieved. The Cutex License also provides for the payment of royalties based upon net sales and minimum annual royalty payments.\nThe Cutex License contemplates certain minimum sales levels over the life of the agreement, which would constitute a material increase over the Company's recent level of net sales. However, sales of Cutex products have been substantially below that set forth in the Cutex License, and product returns have been substantially higher than anticipated. As a result of disappointing sales in the Cutex lip color line, the Company decided to discontinue production\nof the line in October 1995. As a result, the Company has taken a nonrecurring charge aggregating $2.2 million, before taxes, in the fourth quarter of 1995. (See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operation\"). This charge represents a writedown of current lip product inventory and the effect of potential customer returns or markdowns which may be required on lip products in 1996. The discontinued lip color line did not contribute to net sales in 1995 as customer returns exceeded new product shipments.\nFurther, the Company and the licensor of Cutex have agreed to a reduction in the minimum annual royalties payable under the Cutex License. The Company believes that such relief along with the discontinuance of the lip color line will enable the Company to direct all Cutex marketing efforts and resources to building upon the core nail care business for which Cutex is famous.\nIn February 1996 the Company relaunched the Aziza(Registered) brand hypo-allergenic line of eye cosmetics through mass market distribution. The new Aziza line was completely modernized and includes thirty-six (36) of the historically most popular and best selling mascaras, eyeliners and eyeshadows. The Company acquired the world-wide rights to the brand name Aziza in June 1994 from Chesebrough-Pond's USA, Unilever N.V. and various affiliates of Unilever N.V. for nominal consideration.\nAlso in the mass market cosmetics category, the Company has created, produced and markets a Jordache(Registered) line of cosmetics (lipstick and nail polish), which is geared to the youth segment of such market.\nThe Company's Cutex nail care, Jordache cosmetic and Aziza lines are presently distributed in approximately 20,000 mass market outlets.\nProduction and Supply\nA substantial portion of the Company's products are produced by the Company either in the United States or France. Although the Company does not own a factory or production plant, it acts as a general contractor, and supervises each stage of production from the creation of the fragrance, design and creation of the bottle, dispenser or container, filling of same, packing and shipping, all as performed by various subcontractors. Management believes that its relationships with such subcontractors are good, and that there are sufficient alternatives should one or more subcontractors become unavailable.\nInventory\nThe Company purchases its raw materials and component parts from suppliers based upon internal estimates of anticipated need for finished goods, which enables the Company to meet its production requirements for finished goods. The Company generally delivers customer orders within seventy-two (72) hours of their receipt.\nSales and Marketing\nThe broad array of Company product lines permits the Company to market fragrances and cosmetics to all levels of distribution -- the alternative designer fragrances, Cutex and Jordache cosmetics at mass market, the Inter\nParfums proprietary line at the moderately priced level and the Company's brand name and licensed designer fragrances at the high end.\nThe Company markets its alternative designer fragrances and personal care products and its Cutex and Jordache product lines through in-house sales executives to mass merchandisers, major drugstore chains, supermarket chains, \"specialty store chains\" (multiple outlets of accessories, jewelry and clothing), and wholesalers. The Company's alternative designer products are presently being sold in approximately 18,000 retail outlets, and the Cutex, Aziza and Jordache product lines are presently being sold in approximately 20,000 retail outlets.\nIn addition, the Company has established an electronic ordering system, or Electronic Data Interface (\"EDI\"), which permits the Company to receive orders for products via computer modem, as opposed to hard copy purchase orders, from certain major retailers. Management believes that EDI facilitates the receipt and processing of customer orders.\nMass market merchandisers and major drug chains are the most established markets for all of Jean Philippe's product lines, and are the traditional points of distribution for them. The ultimate market for this business segment is the general public. Some of the mass market merchandisers, major drug store chains and supermarket chains which are presently carrying the Company's products include: Walmart, KMart, Walgreen's, Revco, Rite Aid, Winn Dixie, CVS, Publix, and Thrifty Drugs.\nAnother market for the Company's products consists of distributors and wholesalers, which service independent stores. Often, the trends in this business segment mirror those of major drug store chains and mass market retailers. The Company uses the same marketing strategy of providing quality products coupled with flexible programs (i.e., discounts, extended payment terms) in order to compete with other alternative fragrance companies.\nDuring fiscal years ended December 31, 1995, 1994 and 1993, no customer accounted for ten percent (10%) or more of sales on a consolidated basis.\nForeign Sales and Marketing\nMarketing and sales of the Company's brand name and licensed designer fragrance line are conducted through independent distributors, in-house executives and international agents and importing companies and such products are sold in approximately sixty (60) countries world-wide. Generally, marketing and advertising are subject to approval of the respective licensors. Advertising for the Company's designer fragrance lines appear in high fashion magazines and to a lesser extent on television in France and the Middle East.\nInter Parfums maintains its own in-house sales force with executives who are generally responsible for marketing the Inter Parfums designer fragrance lines in specific territories. In France, the Inter Parfums designer fragrance lines are sold in approximately 1000 perfumeries.\nInter Parfums markets its middle market proprietary fragrances to wholesalers in France, and to distributors and importers predominantly in the Middle East, Far East, Central America and South America through in-house sales\nexecutives.\nIn October 1995 the Company commenced marketing its alternative designer fragrance and Jordache lines through a newly formed limited liability company organized in Brazil, Jean Philippe Brasil.\nSee Note \"J\" to the Consolidated Financial Statements for information regarding the Company's operations by geographic areas.\nProduct Liability\nThe Company maintains product liability coverage in an amount of $3,000,000, which it believes is adequate to cover substantially all of the exposure it may have with respect to its products. The Company has never been the subject of any material product liability claims.\nCompetition\nThe market for fragrances and beauty related products is highly competitive and sensitive to changing consumer preferences and demands. At the present time, management is aware of approximately five (5) established companies which market similar alternative designer fragrances. The Company believes that the quality of its fragrance products, as well as its ability to quickly and efficiently develop and distribute new products, will enable it to continue to effectively compete with these companies.\nThe market for name brand and budget color cosmetics is highly competitive, with several major cosmetic companies marketing similar products, many with substantial financial resources and national marketing campaigns. The Company has experienced competitive pressures in this market, and it may be difficult for the Company to significantly increase the market share of its brands against this competition. However, management believes that brand recognition of its Cutex, Aziza and Jordache lines, together with the quality and competitive pricing of its products, should enable it to compete with these companies.\nHowever, especially in the area of high priced, original designer fragrances, there are products which are better known than the products produced for or distributed by the Company. There are also many companies which are substantially larger and more diversified, and which have substantially greater financial and marketing resources than the Company, as well as greater name recognition, and the ability to develop and market products competitive with those distributed by the Company. For these reasons, it may be particularly difficult for the Company to successfully increase market share in the high priced, original designer fragrance market.\nGovernment Regulation\nA fragrance is a \"cosmetic\" as that term is defined under the Federal Food, Drug and Cosmetics Act (\"FDC Act\"), and must comply with the labeling requirements of the FDC Act, the Fair Packaging and Labeling Act, and the regulations thereunder. Certain of the Company's Cutex brand color cosmetic products contain menthol, and are also classified as a \"drug,\" as the categories of cosmetic and drug are not mutually exclusive. Additional regulatory\nrequirements for such products include additional labeling requirements, registration of manufacturer and semi-annual update of drug list.\nThe Company's fragrances are subject to approval of the Bureau of Alcohol, Tobacco and Firearms as the result of the use of specially denatured alcohol. To date the Company has not experienced any difficulties in obtaining such approval.\nTrademarks\nIn the United States the Company's registered trademarks include Intimate, Aziza, Beverly, Fire by Jean Philippe(Registered), Fashion Mood(Registered), Snow Silk(Registered) and Memphis(Registered). In addition, the Company has various trademark applications pending. In addition, under various license agreements the Company has the right to use the registered trademark Cutex in the United States and Puerto Rico, and the registered trademarks, Burberrys, Ombre Rose, Chaz, Regine's and Jordache both in the United States and abroad.\nOutside of the United States and Canada, the Company owns the following registered trademarks: Intimate, Aziza, the Parfums Molyneux family of trademarks, including Captain, Quartz and Lord, and the Parfums Weil family of trademarks, including Bambou, Antilope and Kipling. See \"Business-Products and Selection\".\nEmployees\nAs of March 15, 1996 Jean Philippe had eighty-three (83) full-time domestic employees. Of these, seventeen (17) were engaged in sales activities, and sixty-six (66) in administrative and marketing activities.\nAs of March 15, 1996 Inter Parfums and its foreign subsidiaries had forty-five (45) full-time employees. Of these, fourteen (14) were engaged in sales activities, and thirty-one (31) in administrative and marketing activities.\nThe Company believes that its relationships with its employees are satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's domestic offices are located in approximately 12,000 square feet of office space at 551 Fifth Avenue, New York, New York. These premises are leased for a five (5) year term ending in April 1997, at a monthly rental of approximately $17,000, which is subject to escalations.\nThe offices of Inter Parfums and the Company's other French subsidiaries are located at 4 Rond Point Des Champs Elysees, Paris, France, in approximately 6,000 square feet of leased office space pursuant to two (2) leases. The first lease, for approximately 4,000 square feet, expires in September 1996, with an annual rental of 775,000 French francs (or approximately $155,000) for such period. Inter Parfums has options to renew for two (2) additional three (3) year periods, with annual rental commencing at 800,000 French francs (approximately $160,000). Rent is subject to escalations. The second lease, for approximately\n2,000 square feet, is for a term which expires in March 1997, with annual rentals of 410,650, 439,300 and 458,400 French francs (approximately $83,300, $87,900 and $91,000 for the three (3) year period. Inter Parfums has options to renew for two (2) additional three (3) year periods, with annual rental commencing at 477,500 French francs (or approximately $95,500). Rent is subject to escalations.\nManagement of the Company is of the belief that the Company's executive office facilities are satisfactory for its present needs and those for the foreseeable future.\nOn October 25, 1995, the Company took occupancy of its new 145,000 square foot distribution center at 60 Stults Road in Dayton, New Jersey. The premises have been leased by the Company for an eight (8) year term and require monthly rental payments of $57,000, aggregating $684,000 per annum. In connection therewith, the Company has expended approximately $1.0 million in equipment and improvements and incurred moving expenses of approximately $50,000 in the fourth quarter of 1995. Management of the Company is of the belief that the Company's distribution center is satisfactory for its present needs and those for the foreseeable future.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere is no material litigation pending or, to the knowledge of the Company, threatened to which the property of the Company is subject or to which the Company may be a party.\nItem 4.","section_4":"Item 4. Submissions 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, $.001 par value per share (\"Common Stock\") is traded on The Nasdaq Stock Market under the symbols \"JEAN\". The following table sets forth in dollars, the range of high and low closing prices for the past two (2) fiscal years for the Company's Common Stock.\nFiscal 1995 High Closing Price Low Closing Price Fourth Quarter $10.50 $ 8.13 Third Quarter $11.75 $10.63 Second Quarter $10.88 $ 8.75 First Quarter $ 9.00 $ 7.31\nFiscal 1994 High Closing Price Low Closing Price Fourth Quarter $ 9.00 $ 6.88 Third Quarter $11.00 $ 8.63 Second Quarter $11.88 $ 9.88 First Quarter $12.75 $ 9.75\nAs of March 1, 1996, the number of record holders (brokers and broker's nominees, etc.) of the Company's Common Stock was 133. Management believes that there are approximately 2400 beneficial owners of the Company's Common Stock.\nDividends\nJean Philippe has not paid cash dividends since inception and management of the Company does not foresee Jean Philippe paying cash dividends in the foreseeable future as earned surplus is to be retained as working capital for anticipated growth. The revolving credit agreement with the Company's primary institutional lender generally prohibits the payment of cash dividends in excess of fifty (50%) percent of the Company's net income.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data have been derived from the Company's financial statements, and should be read in conjunction with such financial statements, including the footnotes relating thereto, referred to in Item 8 of this Form 10-K.\n- ----------------------- 1 Includes a net gain of $3.3 million or $.32 per share, $221,000 or $.02 per share, $645,000 or $.06 per share for the years ended December 31, 1995, 1994 and 1993, respectively, resulting from the sale of common stock of a subsidiary.\n2 Includes a nonrecurring charge, net of taxes, of $1.3 million or $.13 per share, relating to the discontinuance of a product line.\nItem 7.","section_7":"Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operation\nThe Company's long-term business strategy of building core volume and profitability, developing products in new categories, exploring strategic acquisition opportunities, and pursuing expansion in international markets, has enabled the Company to report another record year for growth in sales. However, current year earnings excluding the gain on sale of stock of subsidiary, reflect the obstacles encountered in bringing the newly acquired Cutex nail care and lip\ncolor lines to the profitability levels originally anticipated. As discussed in more detail below, current earnings reflect a nonrecurring charge of $2.2 million, before taxes, relating to the discontinuance of the Cutex lip color line in October 1995.\n1995 as Compared to 1994\nNet sales increased 25% to $93.7 million, as compared to $75.1 million in 1994. This increase reflects the Company's ability to integrate new product lines with existing product offerings. Sales generated by the Company's domestic operations increased 19%. Such growth is the result of the August 1994 acquisition of the Cutex nail care and lip color line, and the continued growth in the core Alternative Designer Fragrance lines.\nNet sales generated by Cutex product lines increased $5.3 million over 1994 net sales. This increase was well below original expectations as the result of excessive product returns caused in part from the required change in the Uniform Product Code from that of Chesebrough-Ponds and disappointing sales of the lip color line.\nIn October 1995 the Company decided to discontinue production of the lip color line and as a result, has taken a nonrecurring charge aggregating $2.2 million, before taxes, in the fourth quarter of 1995. This charge represents a writedown of current lip product inventory and the effect of potential customer returns or markdowns which may be required on lip products in 1996. The discontinued lip color line did not contribute to net sales in 1995 as customer returns exceeded new product shipments.\nAs a result of the issues relating to the Cutex product lines, the Company and the licensor have agreed to a reduction of the minimum royalties payable under the Cutex license. The Company believes that such relief along with the discontinuance of the lip color line will enable the Company to direct all Cutex marketing efforts and resources to building upon the core nail care business for which Cutex is famous.\nSales by the Company's foreign subsidiaries increased 36%; at comparable foreign currency exchange rates, sales by the Company's foreign subsidiaries increased 22%. Such increase reflects new product introductions under the Ombre Rose and Burberrys labels and initial sales by Jean Philippe Brasil, the Company's recently organized Brazilian subsidiary, which commenced operations in October 1995.\nThe Company continues to focus its sales efforts on development of new product categories for sale to our expanding customer base. The February 1996 relaunch of the Aziza(Registered) hypo allergenic eye cosmetic line is well under way.\nGross profit margin was 48% in both 1995 and 1994. Ordinarily, increased sales of Cutex products would have enabled the Company to improve overall gross margin. However, with the excessive customer returns experienced in 1995, markdowns and inventory writedowns of returned products were necessary. In addition, gross margin has been negatively impacted from incremental closeout sales of discontinued or returned product at reduced prices. While in the ordinary course of business the Company closes out such inventory, management\nhad taken an increased initiative to reduce excess inventory to improve the Company's cash flow and in preparation of moving to our new distribution center in Dayton NJ. The Company's business lines, excluding Cutex, generated a 46% gross margin in both 1995 and 1994.\nSelling, general and administrative expenses represented 35% of net sales in 1995 as compared to 32% in 1994. The increase is primarily the result of promotion and advertising expenses required for the Cutex product lines and reflect the fact that sales of the Cutex color lines have been below original expectations. Management is taking the steps it deems necessary to bring these product lines to an acceptable profitability level. In addition, most licensed product lines call for royalties to be paid based on sales volume and some require minimum advertising expenditures.\nInterest expense increased to $1.1 million in 1995 from $0.8 million in 1994. The Company uses its available credit lines, as needed, to finance its working capital needs.\nThe Company realized a gain on foreign currency aggregating $197,000 in 1995 as compared to a loss of $161,000 in 1994. The Company, on occasion enters into foreign currency forward exchange contracts as a hedge for short-term intercompany borrowings.\nThe Company recognized a net gain on sale of stock of a subsidiary aggregating $3.3 million in 1995 and $0.2 million in 1994. The 1995 gain resulted primarily from the public offering by Inter Parfums, in France, of 308,000 shares of its common stock. The 1994 gain also resulted from the sale of common stock by Inter Parfums. Such sales of shares has been accounted for as a gain on sale of stock of a subsidiary and is not part of a broader corporate reorganization contemplated by the Company. Although additional shares may be issued in the future, the Company has no plans to spin-off its subsidiary nor to repurchase the shares previously issued. (See Liquidity and Financial Resources).\nThe Company's effective income tax rate was 26% in 1995 and 37% in 1994. Both the 1995 and 1994 tax rates were favorably impacted as deferred taxes were not required to be provided on the gain on sale of stock by Inter Parfums. Excluding such gain the Company's effective tax rate was 35% in 1995 and 37% in 1994.\nNet income for the year ended December 31, 1995 increased 24% to $9.0 million compared to $7.3 million for the year ended December 31, 1994. Results for 1995 include a nonrecurring charge of $1.3 million, on an after tax basis, relating to the discontinuance of the lip color line. Results also include a net gain from the sale of common stock of a subsidiary of $3.3 million in 1995 and $0.2 million in 1994. Excluding the nonrecurring charge and such gains, net income was $7.1 million or $0.68 per share in 1995 and in 1994.\nThe weighted average number of shares outstanding was 10,438,896 in 1995 and 10,454,555 in 1994.\n1994 as Compared to 1993\nNet sales increased 26% to $75.1 million, as compared to $59.5 million\nin 1993. The results for 1994 reflect the Company's success in integrating new product lines with pre existing product offerings, and creating greater opportunities to serve the needs of its customers. Sales generated by the Company's domestic operations increased 12%. Such growth reflects the positive impact of the recently acquired Cutex lip and nail product line and the negative impact of store closings of one of the Company's larger customers.\nSales by the Company's foreign subsidiaries increased 62%; at comparable foreign currency exchange rates, sales by the Company's foreign subsidiaries increased 59%. Such increase reflects contributions from the Ombre Rose and Burberrys license agreements as well as the Parfums Molyneux and Parfums Weil fragrance lines.\nIn connection with the Company's recent acquisitions and license agreements, the Company has restructured its retail sales force and has added additional experienced salespeople. The Company's primary efforts are now focused on capitalizing on its expanding list of customer relationships. With efficient product development and a strong national sales force, the Company can now offer to all of its customers, its growing collection of fragrance, personal care and color cosmetic products.\nGross profit margin for 1994 increased to 48% of sales from 45% in 1993. The Company's decision to purchase certain raw materials and component parts for its domestic operations at lower domestic prices continued to benefit the Company's gross margin throughout 1994. In addition, initial sales of Cutex products have enabled the Company to further improve its gross margin; without such sales gross profit margin would have been 46%.\nSelling, general and administrative expenses represented 32% of net sales in 1994 as compared to 27% and 1993. The increase is primarily the result of expenses incurred in connection with the restructuring of the Company's sales force and the transition of all of the Company's new product lines into its existing domestic and international business operations. In addition, most licensed product lines call for royalties to be paid based on sales volume and some require minimum advertising expenditures.\nInterest expense increased to $803,000 in 1994 from $619,000 in 1993.The Company uses its available credit lines, as needed, to finance its working capital needs.\nIn 1994, as a result of the decline of the U.S. dollar relative to the French franc, the Company incurred a loss on foreign currency of $161,000 as compared to a gain of $179,000 in 1993. The Company, on occasion enters into foreign currency forward exchange contracts as a hedge for short-term intercompany borrowings. No material hedge transactions were entered into during 1994.\nGain on sale of stock of subsidiary aggregated $221,000 in 1994 as compared to a gain of $645,000 1993. The 1993 gain resulted from the issuance by Inter Parfums of 7.65% of its common stock. In 1994, an additional 10,000 shares were sold to enable the stock of Inter Parfums to commence trading in the over-the-counter stock market in Paris, and 11,536 shares were issued pursuant to the conversion terms of Inter Parfum's long-term debt. These issuances of shares by Inter Parfums have been accounted for as a gain on sale of stock of\nsubsidiary; the issuances are not part of a broader corporate reorganization contemplated by the Company. Although additional shares may be issued in the future the Company has no plans to spin-off its subsidiary nor repurchase the shares previously issued.\nThe Company's effective income tax rate increased to 37.1% in 1994 from 36.8% in 1993. Both 1994 and 1993 were favorably impacted as deferred taxes were not required to be provided on the gain from issuance of common stock by Inter Parfums.\nNet income for the year ended December 31, 1994 was $7.3 million compared to $7.1 million for the year ended December 31, 1993. Results for the year include a net gain from the sale of common stock of a subsidiary of $221,000 or $0.02 per share in 1994 and $645,000 or $0.06 per share in 1993. Excluding such gain, net income increased 9.3% to $7.1 million or $0.68 per share compared to $6.5 million or $0.64 per share for the year ended December 31, 1993.\nThe weighted average number of shares outstanding increased 3% to 10,454,555 in 1994 from 10,132,628 in 1993. This increase is primarily the result of the issuance of common stock in connection with the February 1994 acquisition of Parfums Molyneux and Parfums Weil.\nLiquidity and Financial Resources\nThe Company's financial position continues to show solid strength as a result of profitable operating results. At December 31, 1995, working capital aggregated $41.4 million and the Company had cash and cash equivalents aggregating $14.2 million. The Company's Board of Directors has authorized the repurchase of up to 1,000,000 shares of the Company's common stock and as of December 31, 1995, 324,305 shares had been purchased at an average price per share of $8.91. Through February 1996 an additional 138,000 shares were purchased at an average price per share of $7.85.\nIn November 1995, the Company's majority owned subsidiary, Inter Parfums sold to the public in France 308,000 shares of its capital stock at 130 French francs per share. Net proceeds of such offering aggregated 36.5 million French francs ($7.6 million U.S.). In connection with such offering, Inter Parfums Holding (\"Holding\"), a wholly-owned subsidiary of the Company and direct parent of Inter Parfums, exercised its right to convert a portion of its convertible debt into 250,000 shares of capital stock of Inter Parfums at 80 French francs per share.\nAs a result of such offering and related debt to equity conversions, the interest of the Company in Inter Parfums, as held by Holding, was reduced from 90.64% to 76.72%.\nThe Company's short-term financing requirements are expected to be met by available cash at December 31, 1995, cash generated by operations and short-term credit lines provided by domestic and foreign banks. The principal credit facility for 1996 is a $12.0 million unsecured revolving line of credit provided by a domestic commercial bank. Borrowings under the domestic revolving line of credit are due on demand and bear interest at the bank's prime lending rate.\nManagement of the Company believes that funds generated from operations, supplemented by its available credit facilities, will provide it with sufficient resources to meet all present and reasonably foreseeable future operating needs.\nOperating activities provided $2.8 million of net cash in 1995 as compared to $2.1 million in 1994. As the Company continues to monitor and improve its procedures with respect to collection of outstanding receivables and closely monitor inventory levels, the Company anticipates continued improvement in cash flow. Current inventory levels reflect the necessary quantities to support the upcoming selling season and new product introductions.\nOn October 25, 1995, the Company took occupancy of its new 145,000 square foot distribution center at 60 Stults Road in Dayton NJ. The premises have been leased by the Company for an eight year term and require monthly rental payments of $57,000, aggregating $684,000 per annum. In connection therewith, the Company has invested approximately $0.7 million in equipment and improvements and expects to invest an additional $0.3 million in 1996.\nInflation rates in the U.S. and foreign countries in which the Company operates have not had a significant impact on operating results for the year ended December 31, 1995.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe required financial statements commence on page.\nSupplementary Data\nItem 9.","section_9":"Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure\nNot applicable.\n- -------------------------------\n1 Includes a net gain of $3.3 million or $.32 per share resulting from the sale of common stock of a subsidiary.\n2 Includes a nonrecurring charge, net of taxes, of $1.3 million or $.13 per share, relating to the discontinuance of a product line.\n3 Includes a net gain of $113,000 or $.01 per share resulting from the sale of common stock of a subsidiary.\n4 Includes a net gain of $108,000 or $.01 per share from the sale of common stock of a subsidiary.\n5 Includes a net gain of $221,000 or $.01 per share from the sale of common stock of a subsidiary\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Executive Officers And Directors Of Registrant\nAs of March 1, 1996, the executive officers and directors of the Company were as follows:\nName Position\nJean Madar Chairman of the Board and Director General of Inter Parfums\nPhilippe Benacin Vice Chairman of the Board, President and President of Inter Parfums\nRussell Greenberg Director, Executive Vice President and Chief Financial Officer\nFrancois Heilbronn Director\nJoseph A. Caccamo Director\nBruce Elbilia Executive Vice President\nWayne C. Hamerling Executive Vice President\nTerrence H. Augenbraun Executive Vice President\nJaime Resnik Executive Vice President\nThe directors will serve until the next annual meeting of stockholders and thereafter until their successors shall have been elected and qualified. With the exception of Mr. Benacin, the officers are elected annually by the directors and serve at the discretion of the board of directors. See \"Item 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth a summary of all compensation awarded to, earned by or paid to, the Company's Chief Executive Officer and each of the four (4) most highly compensated executive officers of the Company whose compensation exceeded $100,000 per annum for services rendered in all capacities to the Company and its subsidiaries during fiscal years ended December 31, 1995, December 31, 1994 and December 31, 1993:\nSUMMARY COMPENSATION TABLE\n- --------\n(1) As of December 31, 1995, Mr. Madar held 2,768,049 restricted shares of Common Stock, with an aggregate value of $22,490,398 based upon the closing price of the Company's Common Stock as reported by the Nasdaq Stock Market, National Market system, of $8.125 on December 29, 1995.\n(2) Consists of lodging expenses.\n(3) Consists of noncash compensation attributable to the difference between the exercise price and the value of certain restricted shares of Common Stock acquired upon the exercise of stock options.\n(4) Mr. Benacin was elected President of the Company in January 1994. Compensation figures for Mr. Benacin are approximate, as he is paid in French francs, and conversion into U.S. dollars was made at the average exchange rates prevailing during the respective periods. As of December 31, 1995, Mr. Benacin held 2,318,049 restricted shares of Common Stock, with an aggregate value of $18,834,148 based upon the closing price of the Company's Common Stock as reported by the Nasdaq Stock Market, National Market system, of $8.125 on December 29, 1995.\n(5) Consists of noncash compensation of $650,000 attributable to the difference between the exercise price and the value of certain restricted shares of Common Stock acquired upon the exercise of stock options; approximately $2,400 for automobile expenses and $28,800 for lodging expenses.\n(6) Consists of approximately $2,170 for automobile expenses and $26,035 for lodging expenses.\n(7) Consists of approximately $8,300 for automobile expenses and $25,800 in lodging expenses.\n(8) As of December 31, 1995, Mr. Elbilia held 20,000 restricted shares of Common Stock, with an aggregate value of $162,500 based upon the closing price of the Company's Common Stock as reported by the Nasdaq Stock Market, National Market system, of $8.125 on December 29, 1995.\n(9) Consists of selling commissions.\n(10) Consists of selling commissions.\n(11) Consists of selling commissions equal to $22,159; and noncash compensation of $718,095 attributable to the difference between the exercise price and the value of certain restricted shares of Common Stock acquired upon the exercise of stock options.\n(SUMMARY COMPENSATION TABLE CONTINUED)\n- ---------- (1) As of December 31, 1995, Mr. Augenbraun held 1,334 restricted shares of Common Stock, with an aggregate value of $10,839 based upon the closing price of the Company's Common Stock as reported by the Nasdaq Stock Market, National Market system, of $8.125 on December 29, 1995.\n(2) Consists of selling commissions.\n(3) Consists of selling commissions.\n(4) As of December 31, 1995, Mr. Hamerling held 30,000 restricted shares of Common Stock, with an aggregate value of $243,750 based upon the closing price of the Company's Common Stock as reported by the Nasdaq Stock Market, National Market system, of $8.125 on December 29, 1995.\n(5) Consists of selling commissions equal to $82,160 and noncash compensation of $4,814 equal to the value of personal use of a Company leased automobile.\n(6) Consists of selling commissions equal to $62,749 and noncash compensation of $3,357 equal to the value of personal use of a Company leased automobile.\n(7) Consists of selling commissions equal to $41,784; and noncash compensation of $11,000 equal to the value of personal use of a Company leased automobile.\nThe following table sets forth certain information relating to stock option grants during Fiscal 1995 to the Company's Chief Executive Officer and each of the four (4) most highly compensated executive officers of the Company whose compensation exceeded $100,000 per annum for services rendered in all capacities to the Company and its subsidiaries during fiscal year ended December 31, 1995:\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table sets forth certain information relating to option exercises effected during Fiscal 1994, and the value of options held as of such date by each of the four (4) most highly compensated executive officers of the Company whose compensation exceeded $100,000 per annum for services rendered in all capacities to the Company and its subsidiaries during fiscal year ended December 31, 1995:\nAGGREGATE OPTION EXERCISES FOR FISCAL 1995 AND YEAR END OPTION VALUES\n- ---------- (1) Total value of unexercised options is based upon the fair market value of the Common Stock as reported by the Nasdaq Stock Market of $8.125 on December 29, 1995.\n(2) Value realized in dollars is based upon the difference between the fair market value of the Common Stock on the date of exercise, and the exercise price of the option.\nEmployment Agreements\nAs part of the acquisition by the Company of the controlling interest in Inter Parfums in 1991, the Company entered into an employment agreement with Philippe Benacin. The agreement provides that Mr. Benacin will be employed as Vice Chairman of the Board and President and Chief Executive Officer of IP Holdings and its subsidiary, Inter Parfums. The initial term expired on September 2, 1992, and has subsequently been automatically renewed for additional annual periods. The agreement provides for automatic annual renewal terms, unless either party terminates the agreement upon 120 days notice. Mr. Benacin is entitled to receive an annual salary is 600,000ff (approximately US$ 120,000) together with 5,000ff per month (approximately US$1,000) for lodging expenses, both of which are subject to increases in the discretion of the Board of Directors. In addition he is to receive a nonaccountable expense allowance of 1,200ff (approximately US$ 240) per week and reimbursement for all out-of-pocket expenses associated with the acquisition, operation and maintenance of an automobile. The agreement also provides for indemnification and a covenant not to compete for one (1) year after termination of employment.\nCompensation of Directors\nMr. Caccamo receives $500 for each board meeting at which he participates.\nOn January 14, 1994, the Board of Directors of the Company adopted, subject to the approval of its stockholders, the 1994 Nonemployee Stock Option\nPlan (the \"1994 Plan\"). The purpose of the 1994 Plan is to assist the Company in attracting and retaining key directors who are responsible for continuing growth and success of the Company. The 1994 Plan was approved by the stockholders of the Company on July 8, 1994.\nThe 1994 Plan provides for the grant of nonqualified stock options to nonemployee directors to purchase an aggregate of 25,000 shares of Common Stock.\nOptions to purchase 1,000 shares are granted on each February 1st to all nonemployee directors for as long as each is a nonemployee director on such date, except for Joseph A. Caccamo, who is granted options to purchase 4,000 shares. Further, options to purchase 1,000 shares are to be granted to persons who become nonemployee directors at the time they become nonemployee directors. The exercise price of all options granted or to be granted under the 1994 Plan is to be equal to the fair market value of the Company's Common Stock on the date of grant, and the term of each option shall be for a five (5) year period, subject to earlier termination as set forth in the 1994 Plan.\nOn February 1, 1996, in accordance with the terms of the 1994 Plan, options to purchase 1,000 shares were granted on such date to Francois Heilbronn, and 4,000 shares to nonemployee director, Joseph A. Caccamo, all at the exercise price of $8.0625 per share, the fair market value on the date of grant.\nItem 12.","section_12":"Item 12. Security Ownership Of Certain Beneficial Owners And Management\nThe following table sets forth information, as of March 25, 1996 with respect to the beneficial ownership of the Company's Common Stock by (a) each person known by the Company to be the beneficial owner of more than five percent (5%) of the Company's outstanding Common Stock, (b) the executive officers and directors of the Company and (c) the directors and officers of the Company as a group:\nName and Address Amount of Approximate of Beneficial Owner Beneficial Percent of Class Ownership(1)\nJean Madar 3,363,736(2) 31.7% c\/o Inter Parfums, S.A. 4, Rond Point Des Champs Elysees 75008 Paris, France\nPhilippe Benacin 2,931,736(3) 27.6% c\/o Inter Parfums, S.A. 4, Rond Point Des Champs Elysees 75008 Paris, France\nRussell Greenberg 33,000(4) Less than 1% c\/o Jean Philippe Fragrances, Inc. 551 Fifth Avenue New York, NY 10176\nFrancois Heilbronn 8,500(5) Less than 1% 12 Rue Pierre Leroux 75007 Paris, France\n- ---------- (1) All shares of Common Stock are directly held unless otherwise stated.\n(2) Consists of 2,768,049 shares held directly and options to purchase 595,687 shares of Common Stock.\n(3) Consists of 2,318,049 shares held directly and options to purchase 613,687 shares of Common Stock.\n(4) Consists of options to purchase shares of Common Stock.\n(5) Consists of 4,500 shares held directly and options to purchase 4,000 shares of Common Stock.\n(Beneficial Ownership Table Continued) Name and Address Amount of Approximate Percent of Beneficial Owner Beneficial of Class Ownership Bruce Elbilia 54,000(1) Less than 1% c\/o Jean Philippe Fragrances, Inc. 551 Fifth Avenue New York, NY 10176\nWayne C. Hamerling 66,000(2) Less than 1% c\/o Jean Philippe Fragrances, Inc. 551 Fifth Avenue New York, NY 10176\nJoseph A. Caccamo 18,500(3) Less than 1% 666 Third Avenue--18th Fl. New York, NY 10017\nTerrence H. Augenbraun 24,334(4) Less than 1% c\/o Jean Philippe Fragrances, Inc. 551 Fifth Avenue New York, NY 10176\nJaime Resnik 20,500(5) Less than 1% c\/o Jean Philippe Fragrances, Inc. 551 Fifth Avenue New York, NY 10176\nFMR Corp., Fidelity Management 605,000(6) 6.0% & Research Company and Fidelity Low-Priced Stock Fund 82 Devonshire Street, Boston, MA 02109\nAll Directors and Officers 6,520,306(7) 57.2% as a Group (9 Persons)\n- ----------\n(1) Consists of 18,000 shares held directly and options to purchase 36,000 shares of Common Stock.\n(2) Consists of 30,000 shares held directly and options to purchase 36,000 shares of Common Stock.\n(3) Consists of options to purchase shares of Common Stock.\n(4) Consists of 1,334 shares held directly and options to purchase 23,000 shares of Common Stock\n(5) Consists of options to purchase shares of Common Stock.\n(6) Information is derived forth in a Schedule 13G dated February 14, 1996 of Fidelity Management & Research Company (\"Fidelity\"), a wholly-owned subsidiary of FMR Corp., FMR Corp. and Fidelity Low-Price Stock Fund (\"Fidelity Fund\"). Fidelity is a registered investment advisor to various investment companies, including Fidelity Fund, which is listed as a beneficial owner. Edward C. Johnson, 3rd, and members of his family are control persons of FMR and therefore also listed as beneficial owners of the 605,000 shares of common stock or the Company.\n(7) Consists of 5,139,932 shares held directly and options to purchase 1,380,374 shares of Common Stock.\nItem 13.","section_13":"Item 13. Certain Relationships And Related Party Transactions\nTransactions with French Subsidiaries\nIn July 1994 the Company, through its subsidiary, Inter Parfums, acquired the outstanding capital stock of Parfums Jean Desprez, and its wholly-owned subsidiary, Jean Desprez, S.A. for approximately $3.1 million in excess of the tangible assets of the companies acquired.\nThe acquisition was funded by Jean Philippe, and is being carried as an advance to its direct French subsidiary, IP Holding, and is due and payable on July 12, 1999, together with interest at seven percent (7%) per annum on the unpaid principal balance, payable quarterly in arrears, to the date of payment of the principal balance. IP Holding has in turn advanced such funds to Inter Parfums, which are repayable to IP Holding in ten (10) years together with interest at seven percent (7%) per annum. In addition, subject to compliance with applicable French regulatory requirements, the advance is convertible at the option of IP Holding into additional shares of common stock of Inter Parfums at the rate of 86 French francs per share.\nSubsequent to the closing of the sale of the Bal`a Versailles and Revolution `a Versailles assets in March 1996 (see Item 1, \"Business-Products and Selection-Brand Name and Licensed Products\"), IP Holdings intends to repay\nthe sum of $1.575 million to Jean Philippe Fragrances in partial satisfaction of the aforementioned loan.\nIn connection with the acquisitions by Inter Parfums of the world-wide rights under the Burberrys License Agreement and the Brosseau License Agreement, Jean Philippe guaranteed the obligations of Inter Parfums under the Burberrys License Agreement and the distribution agreement for Ombre Rose fragrances.\nJean Philippe and Elite have guaranteed the obligations of IP Holdings and Inter Parfums to Republic National Bank of New York (France).\nLoans to Directors\nIn February 1996 the Company made a short term loan in the sum of $400,000 to Jean Madar, the Chairman of the Board, together with interest at the rate of five (5%) percent per annum, and the principal amount of such loan was repaid in two (2) weeks. Interest of $770 is paid in April 1996.\nOn August 20, 1996 the Company made a bridge loan in the amount of $175,000 to Russell Greenberg, the Chief Financial Officer and a Director, in connection with the sale of his residence and purchase of a new residence, with interest at the rate of four (4%) percent per annum. The sum of $145,000 was repaid four (4) days later. The balance of the loan is repayable $400 per month and prepayable out of the proceeds of any sale of shares of Common Stock of the Company by Mr. Greenberg.\nRepurchase of Shares from Officers and Directors\nIn August 1995 Philippe Benacin, the President and a Director, exercised a nonqualified stock option to purchase 75,000 shares at $1.33 per share. In connection with the Company's stock repurchase program, the Company purchased such shares at $10.00 per share, which was below the market value at the time of the sale.\nIn April 1995 the Company, in connection with the Company's stock repurchase program, purchased from Joseph A. Caccamo, the principal of the general counsel to the Company and a Director, 1,005 shares at $8.625 per share, the fair market value at the time of such sale.\nIn September 1995 Mr. Caccamo exercised nonqualified stock options to purchase 5,000 shares at $7.75 per share and 4,000 shares at $7.6875. In connection with the Company's stock repurchase program, the Company purchased such shares at $10.25 per share and $10.1875 per share, respectively, which was below the fair market value at the time of such sales.\nRemuneration of Counsel\nJoseph A. Caccamo, a director of the Company, is the principal of Joseph A. Caccamo Attorney at Law, P.C., general counsel to the Company. Mr. Caccamo's firm was paid $107,223 in legal fees and for reimbursement of disbursements incurred on behalf of the Company during Fiscal 1995, and presently receives a monthly retainer of $7,250 together with reimbursement for expenses. In addition, his firm is of counsel to the law firm of Robson &\nMiller, LLP, which received an aggregate of fees and disbursements equal to $34,570 during Fiscal 1995.\nOn February 1, 1996 in accordance with the terms of the 1994 Plan, Mr. Caccamo was granted an option with a term of five (5) years to purchase 4,000 shares at $8.0625 per share, the fair market value at the time of grant. In addition, Mr. Caccamo receives $500 for each board meeting at which he participates.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K\n(a)(1) Financial Statements annexed hereto Page No.\nReports of Independent Auditors-\nConsolidated Balance Sheets as at December 31, 1995 and December 31, 1994\nConsolidated Statements of Income for the Years ended December 31, 1995, December 31, 1994 and December 31, 1993\nConsolidated Statements of Changes in Shareholders' Equity for the Years ended December 31, 1995, December 31, 1994 and December 31, 1993\nConsolidated Statements of Cash Flows for the Years ended December 31, 1995, December 31, 1994 and December 31, 1993\nNotes to Financial Statements\n(a)(2) Financial Statement Schedules annexed hereto:\nSchedule II - Valuation and Qualifying Accounts and Reserves S-1\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 consolidated financial statements.\n(a)(3) Exhibits\nThe following documents heretofore filed by the Company with the Securities and Exchange Commission (the \"Commission\") are hereby incorporated by reference from the Company's Registration Statement on Form S-18, file no. 33-17139-NY:\nExhibit No. and Description\n3.1 Restated Certificate of Incorporation\n4.2 Common Stock Certificate Specimen\n4.4 1987 Stock Option Plan\nThe following document heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987:\nExhibit No. and Description\n3.2 By-laws, as amended\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - January 18, 1990), as follows:\nExhibit No. and Description\n10.13 License Agreement between the Company and Jordache dated January 18, 1990 (as no. 10.1 therein).\n10.15 Letter of Indemnification from Jordache to the Company dated January 18, 1990 (as no. 10.3 therein)\n10.16 Letter Agreement from Jordache to the Company regarding foreign license rights dated January 18, 1990 (as no. 10.4 therein).\nThe following documents heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990:\nExhibit No. and Description\n3.1(a) Certificate of Amendment of the Restated Certificate of Incorporation\n10.20 Stock Option Agreement between the Company and Philippe Benacin dated August 31, 1990.\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 29, 1991), as follows:\nExhibit No. and Description\n10.24 Agreement and Plan or Reorganization dated July 29, 1991 among the Company, Jean Madar and Philippe Benacin (as No. 10.1 therein)\nThe following document heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991:\nExhibit No. and Description\n10.25 Employment Agreement between the Company and Philippe Benacin dated July 29, 1991\nThe following documents heretofore filed with the Commission is incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-48811):\nExhibit No. and Description\n10.26 Lease for portion of 15th Floor, 551 Fifth Avenue, New York, New York\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992:\nExhibit No. and Description\n3.1(b) Amendment to the Company's Restated Certificate of Incorporation, as amended, dated July 31, 1992\n4.9 1992 Stock Option Plan\n4.10 Amendment to 1992 Stock Option Plan\n4.11 1993 Stock Option Plan\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-63330):\nExhibit No. and Description\n4.12 Form of Warrant Agreement between Bear, Stearns & Co. Inc. and Jean Philippe Fragrances, Inc.\n10.29 Form of Purchase Agreement\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 15, 1993), as follows:\nExhibit No. and Description\n10.30 License Agreement dated July 15, 1993, among Burberrys Limited, Inter Parfums, S.A. and Jean Philippe Fragrances, Inc.1\n10.31 License Agreement dated May 7, 1993, between Jean-Charles Brosseau, S.A. and Inter Parfums, S.A. (original in French)1\n10.32 License Agreement dated May 7, 1993, between Jean-Charles Brosseau, S.A. and Inter Parfums, S.A.(translation of French into English)1\n10.33 Agreement dated July 14, 1993, between Alfin, Inc. and Inter Parfums, S.A.1\n10.34 Agreement dated July 16, 1993 among Inter Parfums, S.A., Jean Philippe Fragrances, Inc., C&C Beauty Sales, Inc. and Parfico, Inc.\n10.35 Distribution Agreement dated July 16, 1993 among Inter Parfums, S.A., Jean Philippe Fragrances, Inc. and Fragrance Marketing Group, Inc.1\n- ------------------\n1Filed in excised form, as confidentiality is being sought for certain portions thereof.\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - February 28, 1994), as follows:\nExhibit No. and Description\n10.36 Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Molyneux)\n10.37 Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Weil)\n10.38 Agreement (Acquisition) among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Cosmetiques et Parfums de France, S.A. dated February 18, 1994\n10.39 Noncompetition Agreement among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994\n10.40 Commission Agreement among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994\n10.41 Convention between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re inventory purchase)\n10.42 Convention de Nantissement among Cosmetiques et Parfums de France, S.A., Cosmetiques et Parfums de France-I.D., S.A., Sodipe S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. dated February 18, 1994 (re security agreement)\n10.43 Convention among Cosmetiques et Parfums de France-I.D., S.A., Cosmetiques et Parfums de France,S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994 (re French regulatory requirements)\n10.44 Acquisition Agreement among Jean Philippe Fragrances, Inc., Revlon Consumer Products Corporation and Revlon Suisse, S.A. dated March 2, 1994\n10.45 License Agreement among Jean Philippe Fragrances, Inc., Revlon Consumer Products Corporation and Revlon Suisse, S.A. dated March 2, 1994\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Form 8 Amendment no. 1 (dated March 14, 1994) to the Current Report on Form 8-K (date of event - February 28, 1994), as follows:\nExhibit No. and Description\n10.46. English translation of exhibit no. 10.36, Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Molyneux)\n10.47. English translation of exhibit no. 10.37, Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Weil)\n10.48. English translation of exhibit no. 10.41, Convention between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re inventory purchase)\n10.49. English translation of exhibit no. 10.42, Convention de Nantissement among Cosmetiques et Parfums de France, S.A., Cosmetiques et Parfums de France-I.D., S.A., Sodipe S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. dated February 18, 1994 (re security agreement)\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Form 8 Amendment no. 2 (dated March 21, 1994) to the Current Report on Form 8-K (date of event - February 28, 1994), as follows:\nExhibit No. and Description\n10.50. English translation of exhibit no. 10.43, Convention among Cosmetiques et Parfums de France-I.D., S.A., Cosmetiques et Parfums de France, S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994 (re French regulatory requirements)\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993:\nExhibit No. and Description\n3.1(c) Amendment to the Company's Restated Certificate of Incorporation, as amended, dated July 9, 1993\n3.3 Articles of Incorporation of Inter Parfums Holding, S.A.\n3.3.1 English Translation of Exhibit no. 3.3, Articles of Incorporation of Inter Parfums Holding, S.A.\n3.4 Articles of Incorporation of Inter Parfums, S.A.\n3.4.1 English Translation of Exhibit no. 3.4, Articles of Incorporation of Inter Parfums, S.A.\n4.14 Warrant no. 108 registered in the name of Ladenburg, Thalmann & Co., Inc. dated February 2, 1994\n4.15 1994 Nonemployee Director Stock Option Plan\n10.51 Traite D'Apport Partiel D'Actif dated July 30, 1993 (Reorganization\nAgreement between Inter Parfums, S.A. and Selective Industrie, S.A.)\n10.51.1 English translation of Exhibit no. 10.51, Traite D'Apport Partiel D'Actif dated July 30, 1993 (Reorganization Agreement between Inter Parfums, S.A. and Selective Industrie, S.A.)\n10.52 Lease for portion of 4, Rond Point Des Champs Des Elysees dated September 30, 1993\n10.52.1 English translation of Exhibit no. 10.52, Lease for portion of 4, Rond Point Des Champs Des Elysees dated September 30, 1993\n10.53 Lease for portion of 4, Rond Point Des Champs Des Elysees dated March 2, 1994\n10.53.1 English translation of Exhibit no. 10.53, Lease for portion of 4, Rond Point Des Champs Des Elysees dated March 2, 1994\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - May 31, 1994), as follows:\nExhibit No. and Description\n10.55 License Agreement between Chesebrough-Pond's, Inc. and Jean Philippe Fragrances, Inc. dated May 31, 1994 2, listed as no. 10.51 therein.\n10.56 Asset Purchase Agreement between Conopco, Inc. and Jean Philippe Fragrances, Inc. dated May 31, 1994, listed as no. 10.52 therein.\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 15, 1994), as follows:\nExhibit No. and Description\n10.57 Revolving Credit Agreement dated July 15, 1994 among Republic National Bank of New York, Jean Philippe Fragrances, Inc. and Elite Parfums, Ltd., listed as no. 10.54 therein.\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Form 8 Amendment no. 1 (dated August 8, 1994) to the Current Report on Form 8-K (date of event - July 13, 1994), as follows:\nExhibit No. and Description\n10.58. Engagements de Garanties among Zanimob Enterprise Limited, Jacomo France and Inter Parfums, S.A. dated July 12, 1994, listed as no. 10.53 therein.\n10.58.1 English translation of exhibit no. 10.53, Engagements de Garanties among Zanimob Enterprise Limited, Jacomo France and Inter Parfums, S.A. dated July 12, 1994, listed as no. 10.53.1 therein.\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994:\n4.15 1994 Nonemployee Director Supplemental Stock Option Plan\n10.59 Modification of Lease Agreement dated June 17, 1994 between Metropolitan Life Insurance Company and Jean Philippe Fragrances, Inc.\n_______________________ 2Filed in excised form as confidential treatment has been granted for certain provisions thereof.\nThe following exhibits are filed herewith:\nExhibit No. and Description\n10.60 Guaranty and Security Agreement of Jean Philippe Fragrances, Inc. and Elite Parfums, Ltd. to Republic National Bank of New York (France) dated July 19, 1995\n10.61 Lease for 60 Stults Road, South Brunswick, NJ between Forsgate Industrial Complex, a limited partnership, and Jean Philippe Fragrances, Inc. dated July 10, 1995\n10.62 Intellectual Property Purchase Agreement between Parlux Fragrances, Inc. and Parfums Jean Desprez, S.A. dated March 12, 1996\n10.63 Inventory Purchase Agreement between Parlux Fragrances, Inc. and Jean Desprez, S.A. dated March 12, 1996\n11 Statement re: Computation of Earnings Per Share\n21 List of Subsidiaries\n(b) Reports on Form 8-K:\nNo Current Reports on Form 8-K were filed during the fourth quarter of Fiscal 1995.\nRichard A. Eisner & Company, LLP Accountants and Consultants\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Shareholders Jean Philippe Fragrances, Inc. New York, New York\nWe have audited the accompanying consolidated balance sheets of Jean Philippe Fragrances, Inc. and subsidiaries as at December 31, 1995 and December 31, 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 financial 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 Inter Parfums Holdings, S.A. and subsidiaries, consolidated subsidiaries of the Company, which statements include total assets, net sales and net income constituting 53%, 38% and 51% of the related consolidated totals for 1995 and 47%, 36% and 13% for 1994 and 30%, 28% and 28% for 1993. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts for Inter Parfums Holdings, S.A. and subsidiaries, 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 the other auditors, the consolidated financial statements enumerated above present fairly, in all material respects, the consolidated financial position of Jean Philippe Fragrances, Inc. and subsidiaries at December 31, 1995 and December 31, 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.\nOur audits referred to above included Schedule II for each of the years in the three-year period ended December 31, 1995. In our opinion, such schedule presents fairly the information set forth therein in accordance with the applicable accounting regulation of the Securities and Exchange Commission.\nRichard A. Eisner & Company, LLP\nNew York, New York March 19, 1996\nWith respect to accounts for foreign subsidiaries March 27, 1996\nINDEPENDENT AUDITOR'S REPORT\nINTER PARFUMS HOLDING AND SUBSIDIARIES\nWe have audited the consolidated balance sheets of Inter Parfums Holding and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, retained earnings 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 Inter Parmfums Holding and subsidiaries 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.\nCABINET CAUVIN, ANGLEYS, SAINT-PIERRE INTERNATIONAL\nParis, France March 27, 1996\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (in thousands except share and per share data)\nDecember 31, ------------------- A S S E T S 1995 1994 ----------- ------- -------\nCurrent assets: Cash and cash equivalents. . . . . . . . . . . . . $14,204 $ 5,275 Accounts receivable, net of allowances of $4,208\nand $2,823 in 1995 and 1994, respectively (Note F) . . . . . . . . . . . . . . . . . . . . 22,884 19,876 Inventories (Notes A and C). . . . . . . . . . . . 26,093 24,641 Receivables, other . . . . . . . . . . . . . . . . 970 1,936 Other. . . . . . . . . . . . . . . . . . . . . . . 987 1,786 Deferred tax benefit (Note K). . . . . . . . . . . 2,401 992 -------- -------\nTotal current assets. . . . . . . . . . . . 67,539 54,506\nEquipment and leasehold improvements, net (Notes A and D). . . . . . . . . . . . . . . . . . 1,970 1,202\nOther assets. . . . . . . . . . . . . . . . . . . . . 1,314 584\nDeferred tax benefit (Note K) . . . . . . . . . . . . 582 732\nTrademarks and licenses, net (Notes A and E). . . . . 12,596 12,427 -------- -------\nT O T A L . . . . . . . . . . . . . . . . . $84,001 $69,451 ======== =======\nLIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------\nCurrent liabilities: Loans payable, banks (Note F). . . . . . . . . . . $ 9,922 $ 6,681 Current portion of long-term debt. . . . . . . . . 187 Accounts payable . . . . . . . . . . . . . . . . . 15,012 14,647 Income taxes payable . . . . . . . . . . . . . . . 1,242 1,765 -------- -------\nTotal current liabilities . . . . . . . . . 26,176 23,280 -------- -------\nLong-term debt, less current portion (Note G) . . . . 596 862 -------- -------\nMinority interest . . . . . . . . . . . . . . . . . . 5,253 796 -------- -------\nCommitments (Note H)\nShareholders' equity (Note I): Preferred stock, $.001 par value; authorized 1,000,000 shares; none issued Common stock, $.001 par value; authorized 30,000,000 shares; outstanding 10,009,981 and 10,242,786 shares in 1995 and 1994, respectively . . . . . . . . . . . . . . . . . . 10 10 Additional paid-in capital . . . . . . . . . . . . 20,610 20,408 Retained earnings. . . . . . . . . . . . . . . . . 32,565 23,527 Foreign currency translation adjustment. . . . . . 1,681 568\nTreasury stock, at cost 810,503 and 486,198 shares in 1995 and 1994, respectively. . . . . . (2,890) -------- -------\nTotal shareholders' equity. . . . . . . . . 51,976 44,513 -------- -------\nT O T A L . . . . . . . . . . . . . . . . . $84,001 $69,451 ======== =======\nThe accompanying notes are an integral part of these financial statements.\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (in thousands except share and per share data)\nYear Ended December 31, --------------------------------------- 1995 1994 1993 -------- ------- ------- Net sales . . . . . . . . . . . . $93,669 $75,079 $59,546\nCost of sales . . . . . . . . . . 48,703 39,036 32,964 -------- -------- -------\nGross margin. . . . . . . . . . . 44,966 36,043 26,582\nSelling, general and administrative . . . . . . . . 32,990 23,773 15,814\nLoss on product discontinuance. . 2,229 -------- -------- ------- Income from operations. . . . . . 9,747 12,270 10,768 -------- -------- -------\nOther charges (income): Interest . . . . . . . . . . . 1,148 803 619 (Gain) loss on foreign currency . . . . . . . . . . (197) 161 (178) Interest (income). . . . . . . (274) (152) (269) (Gain) on sale of stock of subsidiary . . . . . . . . . (3,310) (221) (644) -------- -------- --------\n(2,633) 591 (472) -------- -------- --------\nIncome before income taxes. . . . 12,380 11,679 11,240\nIncome taxes. . . . . . . . . . . 3,188 4,330 4,137 -------- -------- -------\nIncome before minority interest . 9,192 7,349 7,103\nMinority interest in net income of consolidated subsidiary . . 154 74 4 -------- -------- -------\nNET INCOME. . . . . . . . . . . . $ 9,038 $ 7,275 $ 7,099 ======== ======== =======\nNet income per share. . . . . . . $0.87 $0.70 $0.70 ====== ====== =====\nWeighted average number of common and common equivalent shares outstanding. . . . . . . . . . 10,438,896 10,454,555 10,132,628 =========== =========== ==========\nThe accompanying notes are an integral part of these financial statements.\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands except share and per share data)\nThe accompanying notes are an integral part of these financial statements.\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands except share and per share data)\nThe accompanying notes are an integral part of these financial statements.\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE A) - The Company and its Significant Accounting Policies:\n[1] Business of the Company:\nThe Company is a manufacturer and distributor of domestic and international brand name and licensed fragrances, alternative designer fragrances and mass market cosmetics.\n[2] Basis of preparation:\nThe consolidated financial statements include the accounts of Jean Philippe Fragrances, Inc. (\"JPF\") and its domestic and foreign subsidiaries (the \"Company\"). 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 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] Foreign currency translation:\nFor foreign subsidiaries that operate in a foreign currency, assets and liabilities are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Gains and losses from translation adjustments are accumulated in a separate component of shareholders' equity. In instances where the financial statements of foreign entities are remeasured into their functional currency (U.S. dollars), the remeasurement adjustment is recorded in operations.\n[4] Cash equivalents:\nAll highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents.\n[5] Inventories:\nInventories are stated at the lower of cost (first-in, first-out) or market.\n[6] Equipment and leasehold improvements:\nEquipment and leasehold improvements are stated at cost. Depreciation and amortization are provided using the straight-line method and the declining balance method over the estimated useful asset lives for equipment and the\nshorter of the lease term or estimated useful asset lives for leasehold improvements.\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE A) - The Company and its Significant Accounting Policies: (continued)\n[7] Trademarks and licenses:\nTrademarks are stated at cost and are amortized by the straight-line method over twenty years. The cost of licenses acquired is being amortized by the straight-line method over the term of the license, approximately seven to ten years.\nThe Company reviews trademarks and licenses for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.\n[8] Revenue recognition:\nRevenue is recognized upon shipment of merchandise. Allowances are established for estimated returns.\n[9] Issuance of common stock of subsidiary:\nThe Company's share of the proceeds in excess of the carrying amount of the portion of the Company's investment sold is reflected as a gain in the consolidated income statement.\n[10] Per share data:\nNet income per share is based on the weighted average number of common and common equivalent shares outstanding during each year. Common equivalent shares, which consist of unissued shares under options and warrants, are included in the computation when the results are dilutive.\n(NOTE B) - Loss on Product Discontinuance:\nAs a result of disppointing sales of the Cutex lip color line, the Company decided to discontinue prodcution of the line in October 1995. As a result, the Company has taken a nonrecurring charge aggregating $2.2 million, before taxes, in the fourth quarter of 1995. This charge represents a writedown of current lip product inventory and the effect of potential customer returns or markdowns of lip products expected in 1996. The discontinued lip color line did not contribute to net sales in 1995 as customer returns exceeded new product shipments.\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE B) - Loss on Product Discontinuance: (continued)\nAs a result of this issue, among others, relating to the Cutex product lines, the Company and the licensor have agreed to a reduction of the minimum royalties payable under the Cutex license. The Company believes that such relief, along with the discontinuance of the lip color line, will enable the Company to direct all Cutex marketing efforts and resources to building upon the core nail care business for which Cutex is famous.\n(NOTE C) - Inventories:\nDecember 31, ------------------- 1995 1994 ------- ------- Raw materials and component parts. . . . . . . . . . . . . $10,982 $10,537 Finished goods. . . . . . . . . . 15,111 14,104 ------- -------\nT o t a l . . . . . . . $26,093 $24,641\n(NOTE D) - Equipment and Leasehold Improvements:\nDecember 31, ------------------- 1995 1994 ------- ------- Equipment . . . . . . . . . . . . $3,308 $ 2,275 Leasehold improvements. . . . . . 727 405 ------- ------- 4,035 2,680 Less accumulated depreciation and amortization . . . . . . . 2,065 1,478 ------- ------- T o t a l . . . . . . . $1,970 $ 1,202 ======= =======\n(NOTE E) - Trademarks and Licenses:\nDecember 31, ------------------- 1995 1994 ------- -------\nTrademarks. . . . . . . . . . . . $11,015 $10,032 Licenses. . . . . . . . . . . . . 3,246 3,008 ------- ------- 14,261 13,040\nLess accumulated amortization . . 1,665 613 ------- ------- T o t a l . . . . . . . $12,596 $12,427 ======= ======= (continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE F) - Loans Payable - Banks:\nDecember 31, ------------------- 1995 1994 ------- -------\nBorrowings under a $12,000 unsecured revolving line of credit. Principal is due on demand bearing interest at the bank's prime rate or 1.75% above the LIBOR rate. . . . . . . . . . . . . . . . $ 2,600 $ 3,000\nBorrowings by the Company's foreign subsidiaries under a $4,000 credit facility whereby accounts receivable are sold with recourse and accounted for as a loan and bearing interest at 0.8% above the PIBOR rate (5.5% at December 31, 1995). . . . . . . . . . . . 2,530 996\nBorrowings by the Company's foreign subsidiaries under several bank overdraft facilities bearing interest at 1.0% above the PIBOR rate. . . . . . . 4,792 1,374\nOther borrowings by the Company's foreign subsidiaries. . . . . . . . . . . 1,311 ------- ------- T o t a l. . . . . . . . . . . . . $ 9,922 $ 6,681 ======= =======\n(NOTE G) - Long-Term Debt:\nBorrowings by the Company's foreign subsidiary of $596 is due in 2004, or the loan may be converted into shares of the Company's foreign subsidiary at approximately $15 per share. Interest is payable quarterly at 7% per annum.\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE H) - Commitments:\n[1] Leases:\nThe Company leases its office and warehouse facilities under operating leases expiring through 2003. Rental expense amounted to $730 in 1995, $442 in 1994 and $362 in 1993. Minimum future rental payments are as follows:\n1996. . . . . . . . . . . . $1,307 1997. . . . . . . . . . . . 1,180 1998. . . . . . . . . . . . 1,127 1999. . . . . . . . . . . . 684 2000. . . . . . . . . . . . 684 Thereafter. . . . . . . . . 1,926 ------ T o t a l . . . . $6,908 ====== [2] License agreements:\nIn January 1990, the Company entered into a license agreement with Jordache Enterprises, Inc. (\"Jordache\"). In connection therewith, the Company acquired the exclusive license to use the Jordache trademark in connection with fragrances and cosmetics in the United States and various territories abroad. The license, which expired June 30, 1995, permits ten annual renewals at the Company's option, subject to certain minimum sales requirements and royalty payments. The Company has exercised its option to renew for the year ended June 30, 1996.\nOn July 15, 1993, the Company entered into a license agreement with Burberrys Limited. In connection therewith, the Company obtained the exclusive world-wide rights for the manufacturing and distribution of Burberrys' fragrances. The license agreement expires December 31, 2003, subject to certain minimum sales requirements and royalty payments.\nOn July 16, 1993, the Company entered into an exclusive, ten-year, world-wide license with Jean Charles Brosseau S.A. for Ombre Rose fragrances, subject to certain minimum sales requirements and royalty payments.\nOn May 31, 1994 the Company entered into a license agreement with Chesebrough-Pond's USA for the United States and Puerto Rican rights to manufacture and market Cutex nail care and lip color products, excluding nail polish remover. The license is for a term of ten years, including renewal periods, and is subject to certain minimum sales and royalty payments.\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE H) - Commitments:\n[2] License agreements: (continued)\nMinimum future royalty payments due pursuant to license agreements are as follows:\n1996. . . . . . . . . . . . $ 2,166 1997. . . . . . . . . . . . 2,156 1998. . . . . . . . . . . . 2,077 1999. . . . . . . . . . . . 2,122 2000. . . . . . . . . . . . 2,192 Thereafter. . . . . . . . . 3,590 ------- T o t a l . . . . $14,303 =======\n(NOTE I) - Shareholders' Equity:\n[1] Issuance of common stock of subsidiary:\nIn December 1993, Inter Parfums, S.A., a consolidated subsidiary of the Company, sold 100,000 shares of its common stock at 70 French francs per share aggregating 7 million French francs or approximately $1.2 million. The shares were sold in a private placement transaction to unaffiliated French institutional investors.\nIn 1994, 10,000 shares were sold to enable the stock of Inter Parfums, S.A. to commence trading on the over-the-counter Paris Stock Exchange, and 11,536 shares were issued pursuant to the conversion terms of the Company's long-term debt.\nIn November 1995, Inter Parfums, S.A. completed a public offering of 308,000 shares of its common stock at 130 French francs per share. Net proceeds of such offering aggregated 36.5 million French francs or approximately $7.6 million. In connection with such offering, Inter Parfums Holdings, S.A. (\"Holdings\"), a wholly-owned subsidiary of the Company and direct parent of Inter Parfums, S.A. exercised its right to convert a portion of its convertible debt into 250,000 shares of capital stock of Inter Parfums, S.A. at 80 French francs per share. As a result of such issuances in 1995, the percentage ownership of Inter Parfums, S.A. was reduced from 90.64% to 76.72%.\nThe Company's share of the offering, sale or conversion proceeds in excess of the carrying amount of the portion of the Company's investment sold is reflected as a gain in the consolidated income statement. Deferred taxes have not been provided because application of available tax savings strategies would eliminate taxes on this transaction.\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE I) - Shareholders' Equity: (continued)\n[2] Stock option plans:\nThe Company maintains a stock option program for key employees and executives and a separate program for nonemployee directors. The plans provide for the granting of both nonqualified and incentive options. Options granted under the plans are exercisable for a period of up to ten years from the date of grant.\nA summary of option transactions during the year ended December 31, 1995 is presented below:\nIncentive Nonqualified Stock Options Stock Options Shares under option - beginning ------------- ------------- of year. . . . . . . . . . . 31,500 1,248,974\nOptions granted . . . . . . . . 313,150\nOptions exercised at prices ranging from $3.83 to $7.75. (6,000) (10,500)\nOptions cancelled . . . . . . . (35,250) ------ --------- Shares under option - end of year (1) . . . . . . . . . . 25,500 1,516,374 ====== ========= Exercise price. . . . . . . . . $3.83 to $4.22 $6.67 to $12.00 ============== =============== Options available for grant . . 162,600 177,100 ======= ======= (1) All of which are exercisable.\nIn addition, the Company has outstanding options not pursuant to any plan. Options for 75,000 shares were exercised during 1995 at $1.33 per share and 1,000 remain outstanding at an exercise price of $12.00.\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE J) - Geographic Areas:\nInformation on the Company's operations by geographical areas is as follows:\nYear Ended December 31, ------------------------------------ 1995 1994 1993 -------- -------- -------- Net sales: United States. . $ 57,382 $ 48,377 $ 43,103 Europe . . . . . 38,451 30,672 20,661 South America. . 693 Eliminations . . (2,857) (3,970) (4,218) -------- -------- -------- T o t a l. . . $ 93,669 $ 75,079 $ 59,546 ======== ======== ======== Net income: United States. . $ 4,256 $ 6,297 $ 5,139 Europe . . . . . 4,619 1,295 1,960 South America. . 107 Eliminations . . 56 (317) -------- -------- -------- T o t a l. . . $ 9,038 $ 7,275 $ 7,099 ======== ======== ======== Total assets: United States. . $ 50,767 $ 49,625 $ 37,362 Europe . . . . . 44,522 32,518 15,134 South America. . 900 Eliminations . . (12,188) (12,692) (2,587) -------- -------- -------- T o t a l. . . $ 84,001 $ 69,451 $ 49,909 ======== ======== ======== United States export sales were approximately $6,400, $5,700 and $5,100 for the years ended December 31, 1995, 1994 and 1993, respectively.\n(NOTE K) - Income Taxes:\nThe components of income before income taxes consist of the following:\nYear Ended December 31, ------------------------------------ 1995 1994 1993 -------- -------- -------- U.S. operations . . $ 6,802 $ 10,244 $ 8,480 Foreign operations. 5,483 1,951 2,760 Eliminations. . . . 95 (516)\n-------- -------- --------\nT o t a l. . . $ 12,380 $ 11,679 $ 11,240 ======== ======== ========\n(continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE K) - Income Taxes: (continued)\nThe provision for current and deferred income tax expense consists of the following:\nYear Ended December 31, ------------------------------------ 1995 1994 1993 -------- -------- -------- Current: Federal . . . . . $2,627 $3,434 $2,762 State and local . 618 919 746 Foreign . . . . . 316 180 915 ------ ------ ------ T o t a l . . . $3,561 $4,533 $4,423 ====== ====== ====== Deferred: Federal . . . . . $ (555) $ (338) $ (175) State and local . (143) (69) 8 Foreign . . . . . 325 204 (119) ------ ------ ------ T o t a l . . . . $ (373) $ (203) $ (286) ====== ====== ======\nDeferred taxes are provided principally for valuation reserves, and certain other expenses that are recognized in different years for financial reporting and income tax purposes. At December 31, 1995, the deferred tax assets consists of approximately $2,400 relating to reserves and other expenses which are not currently deductible for tax purposes and approximately $581 relating to available foreign net operating loss carryforwards.\nDifferences between the United States federal statutory income tax rate and the effective income tax rate were as follows:\nYear Ended December 31, --------------------- 1995 1994 1993 ----- ----- ----- Statutory rates. . . . . . . . 34.0% 34.0% 34.0% State and local taxes, net of federal benefit . . . . . . 2.5 4.8 4.4 Nontaxable gain on sale of stock of subsidiary . . . . (9.2) Other. . . . . . . . . . . . . (1.6) (1.7) (1.6) ----- ----- ----- Effective rates. . . . . . . . 25.7% 37.1% 36.8% ===== ===== ===== (continued)\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS (in thousands except share and per share data)\n(NOTE L) - Subsequent Event:\nOn March 19, 1996, the Company sold the trademarks of the Bal `a Versailles and Revolution' a Versailles lines. The aggregate sales price was $4.95 million which includes $1.8 million of inventory at cost.\n(continued)\nSCHEDULE II\nJEAN PHILIPPE FRAGRANCES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)\n(a) Write off of bad debts and sales returns.\nThe accompanying notes are an integral part of these 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.\nJEAN PHILIPPE FRAGRANCES, INC.\nBy: \/s\/ Philippe Benacin -------------------- Philippe Benacin, 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 the Registrant and in the capacities and on the dates indicated:\nSignature Title Date\n\/s\/ Jean Madar - -------------- Jean Madar Chairman of the March 26, 1996 Board of Directors\n\/s\/ Philippe Benacin - -------------------- Philippe Benacin Chief Executive Officer March 27, 1996 and Director\n\/s\/ Russell Greenberg - --------------------- Chief Financial and March 26, 1996 Russell Greenberg Accounting Officer and Director\n\/s\/ Francois Heilbronn - ---------------------- Director March 27, 1996 Francois Heilbronn\n\/s\/ Joseph A. Caccamo - --------------------- Director March 26, 1996 Joseph A. Caccamo\nUNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\nEXHIBIT INDEX TO REPORT ON FORM 10-K (Mark one) \/X\/ Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1995 or\n\/ \/ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _______ to ______.\nCommission File No. 0-16469\nJEAN PHILIPPE FRAGRANCES, INC. (Exact name of registrant as specified in its charter)\nDelaware 13-3275609 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)\n551 Fifth Avenue, New York, New York 10176 (Address of Principal Executive Offices) (Zip Code)\nRegistrant's telephone number, including area code: (212) 983-2640. ------------------------------------------------------------\nThe following documents heretofore filed by the Company with the Securities and Exchange Commission (the \"Commission\") are hereby incorporated by reference from the Company's Registration Statement on Form S-18, file no. 33-17139-NY:\nExhibit No. and Description\n3.1 Restated Certificate of Incorporation\n4.2 Common Stock Certificate Specimen\n4.4 1987 Stock Option Plan\nThe following document heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987:\nExhibit No. and Description\n3.2 By-laws, as amended\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - January 18, 1990), as follows:\nExhibit No. and Description\n10.13 License Agreement between the Company and Jordache dated January 18, 1990 (as no. 10.1 therein).\n10.15 Letter of Indemnification from Jordache to the Company dated January 18, 1990 (as no. 10.3 therein)\n10.16 Letter Agreement from Jordache to the Company regarding foreign license rights dated January 18, 1990 (as no. 10.4 therein).\nThe following documents heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990:\nExhibit No. and Description\n3.1(a) Certificate of Amendment of the Restated Certificate of Incorporation\n10.20 Stock Option Agreement between the Company and Philippe Benacin dated August 31, 1990.\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 29, 1991), as follows:\nExhibit No. and Description\n10.24 Agreement and Plan or Reorganization dated July 29, 1991 among the Company, Jean Madar and Philippe Benacin (as No. 10.1 therein)\nThe following document heretofore filed with the Commission is incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991:\nExhibit No. and Description\n10.25 Employment Agreement between the Company and Philippe Benacin dated July 29, 1991\nThe following documents heretofore filed with the Commission is incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-48811):\nExhibit No. and Description\n10.26 Lease for portion of 15th Floor, 551 Fifth Avenue, New York, New York\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992:\nExhibit No. and Description\n3.1(b) Amendment to the Company's Restated Certificate of Incorporation, as amended, dated July 31, 1992\n4.9 1992 Stock Option Plan\n4.10 Amendment to 1992 Stock Option Plan\n4.11 1993 Stock Option Plan\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-63330):\nExhibit No. and Description\n4.12 Form of Warrant Agreement between Bear, Stearns & Co. Inc. and Jean Philippe Fragrances, Inc.\n10.29 Form of Purchase Agreement\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 15, 1993), as follows:\nExhibit No. and Description\n10.30 License Agreement dated July 15, 1993, among Burberrys Limited, Inter Parfums, S.A. and Jean Philippe Fragrances, Inc.1\n10.31 License Agreement dated May 7, 1993, between Jean-Charles Brosseau, S.A. and Inter Parfums, S.A. (original in French)1\n10.32 License Agreement dated May 7, 1993, between Jean-Charles Brosseau, S.A. and Inter Parfums, S.A.(translation of French into English)1\n10.33 Agreement dated July 14, 1993, between Alfin, Inc. and Inter Parfums, S.A.1\n10.34 Agreement dated July 16, 1993 among Inter Parfums, S.A., Jean Philippe Fragrances, Inc., C&C Beauty Sales, Inc. and Parfico, Inc.\n10.35 Distribution Agreement dated July 16, 1993 among Inter Parfums, S.A., Jean Philippe Fragrances, Inc. and Fragrance Marketing Group, Inc.(1)\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - February 28, 1994), as follows:\n- -------- 1 Filed in excised form, as confidentiality is being sought for certain portions thereof.\nExhibit No. and Description\n10.36 Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Molyneux)\n10.37 Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Weil)\n10.38 Agreement (Acquisition) among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Cosmetiques et Parfums de France, S.A. dated February 18, 1994\n10.39 Noncompetition Agreement among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994\n10.40 Commission Agreement among Jean Philippe Fragrances, Inc., Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994\n10.41 Convention between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re inventory purchase)\n10.42 Convention de Nantissement among Cosmetiques et Parfums de France, S.A., Cosmetiques et Parfums de France-I.D., S.A., Sodipe S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. dated February 18, 1994 (re security agreement)\n10.43 Convention among Cosmetiques et Parfums de France-I.D., S.A., Cosmetiques et Parfums de France, S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994 (re French regulatory requirements)\n10.44 Acquisition Agreement among Jean Philippe Fragrances, Inc., Revlon Consumer Products Corporation and Revlon Suisse, S.A. dated March 2, 1994\n10.45 License Agreement among Jean Philippe Fragrances, Inc., Revlon Consumer Products Corporation and Revlon Suisse, S.A. dated March 2, 1994\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Form 8 Amendment no. 1 (dated March 14, 1994) to the Current Report on Form 8-K (date of event - February 28, 1994), as follows:\nExhibit No. and Description\n10.46. English translation of exhibit no. 10.36, Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Molyneux)\n10.47. English translation of exhibit no. 10.37, Cession D'Elements Partiels de Fonds de Commerce between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re: Parfums Weil)\n10.48. English translation of exhibit no. 10.41, Convention between Inter Parfums, S.A. and Cosmetiques et Parfums de France-I.D., S.A. dated February 18, 1994 (re inventory purchase)\n10.49. English translation of exhibit no. 10.42, Convention de Nantissement among Cosmetiques et Parfums de France, S.A., Cosmetiques et Parfums de France-I.D., S.A., Sodipe S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. dated February 18, 1994 (re security agreement)\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Form 8 Amendment no. 2 (dated March 21, 1994) to the Current Report on Form 8-K (date of event - February 28, 1994), as follows:\nExhibit No. and Description\n10.50. English translation of exhibit no. 10.43, Convention among Cosmetiques et Parfums de France-I.D., S.A., Cosmetiques et Parfums de France, S.A., Jean Philippe Fragrances, Inc. and Inter Parfums, S.A. and Sodipe S.A. dated February 18, 1994 (re French regulatory requirements)\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993:\nExhibit No. and Description\n3.1(c) Amendment to the Company's Restated Certificate of Incorporation, as amended, dated July 9, 1993\n3.3 Articles of Incorporation of Inter Parfums Holding, S.A.\n3.3.1 English Translation of Exhibit no. 3.3, Articles of Incorporation of Inter Parfums Holding, S.A.\n3.4 Articles of Incorporation of Inter Parfums, S.A.\n3.4.1 English Translation of Exhibit no. 3.4, Articles of Incorporation of Inter Parfums, S.A.\n4.14 Warrant no. 108 registered in the name of Ladenburg, Thalmann & Co., Inc. dated February 2, 1994\n4.15 1994 Nonemployee Director Stock Option Plan\n10.51 Traite D'Apport Partiel D'Actif dated July 30, 1993 (Reorganization Agreement between Inter Parfums, S.A. and Selective Industrie, S.A.)\n10.51.1 English translation of Exhibit no. 10.51, Traite D'Apport Partiel D'Actif dated July 30, 1993 (Reorganization Agreement between Inter Parfums, S.A. and Selective Industrie, S.A.)\n10.52 Lease for portion of 4, Rond Point Des Champs Des Elysees dated September 30, 1993\n10.52.1 English translation of Exhibit no. 10.52, Lease for portion of 4, Rond Point Des Champs Des Elysees dated September 30, 1993\n10.53 Lease for portion of 4, Rond Point Des Champs Des Elysees dated March 2, 1994\n10.53.1 English translation of Exhibit no. 10.53, Lease for portion of 4, Rond Point Des Champs Des Elysees dated March 2, 1994\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - May 31, 1994), as follows:\nExhibit No. and Description\n10.55 License Agreement between Chesebrough-Pond's, Inc. and Jean Philippe Fragrances, Inc. dated May 31, 1994(2), listed as no. 10.51 therein.\n10.56 Asset Purchase Agreement between Conopco, Inc. and Jean Philippe Fragrances, Inc. dated May 31, 1994, listed as no. 10.52 therein.\n- ------------------ (2) Filed in excised form as confidential treatment has been granted for certain provisions thereof.\nThe following document heretofore filed with the Commission is incorporated herein by reference to the Company's Current Report on Form 8-K (date of event - July 15, 1994), as follows:\nExhibit No. and Description\n10.57 Revolving Credit Agreement dated July 15, 1994 among Republic National Bank of New York, Jean Philippe Fragrances, Inc. and Elite Parfums, Ltd., listed as no. 10.54 therein.\nThe following documents heretofore filed with the Commission are incorporated herein by reference to the Company's Form 8 Amendment no. 1 (dated August 8, 1994) to the Current Report on Form 8-K (date of event - July 13, 1994), as follows:\nExhibit No. and Description\n10.58. Engagements de Garanties among Zanimob Enterprise Limited, Jacomo France and Inter Parfums, S.A. dated July 12, 1994, listed as no. 10.53 therein.\n10.58.1 English translation of exhibit no. 10.53, Engagements de Garanties among Zanimob Enterprise Limited, Jacomo France and Inter Parfums, S.A.\ndated July 12, 1994, listed as no. 10.53.1 therein.\nThe following documents heretofore filed with the Commission are incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994:\n4.15 1994 Nonemployee Director Supplemental Stock Option Plan\n10.59 Modification of Lease Agreement dated June 17, 1994 between Metropolitan Life Insurance Company and Jean Philippe Fragrances, Inc.\nThe following exhibits are filed herewith:\nExhibit No. and Description\n10.60 Guaranty and Security Agreement of Jean Philippe Fragrances, Inc. and Elite Parfums, Ltd. to Republic National Bank of New York (France) dated July 19, 1995\n10.61 Lease for 60 Stults Road, South Brunswick, NJ between Forsgate Industrial Complex, a limited partnership, and Jean Philippe Fragrances, Inc. dated July 10, 1995\n10.62 Intellectual Property Purchase Agreement between Parlux Fragrances, Inc. and Parfums Jean Desprez, S.A. dated March 12, 1996\n10.63 Inventory Purchase Agreement between Parlux Fragrances, Inc. and Jean Desprez, S.A. dated March 12, 1996\n11 Statement re: Computation of Earnings Per Share\n21 List of Subsidiaries","section_15":""}
{"filename":"809017_1995.txt","cik":"809017","year":"1995","section_1":"ITEM 1. Business\nParker & Parsley Producing Properties 87-B, Ltd. (the \"Registrant\") is a limited partnership organized in 1987 under the laws of the state of Texas. The managing general partner is Parker & Parsley Development L.P. (\"PPDLP\"). PPDLP's general partner is Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"). The managing general partner during the year ended December 31, 1994 was Parker & Parsley Development Company (\"PPDC\"). PPDC was merged into PPDLP on January 1, 1995. See Item 12 (c).\nA Registration Statement, as amended, filed pursuant to the Securities Act of 1933, registering limited partnership interests aggregating $30,000,000 in a series of Texas limited partnerships formed under the Parker & Parsley Producing Properties Program-I, was declared effective by the Securities and Exchange Commission on February 20, 1987. On December 28, 1987, the offering of limited partnership interests in the Registrant, the second partnership formed under such statement, was closed, with interests aggregating $6,095,500 being sold to 573 subscribers.\nThe Registrant's primary business plan and objectives are to purchase producing oil and gas properties and distribute the cash flow from operations to its partners. The Registrant is not involved in any industry segment other than oil and gas. See \"Item 6. Selected Financial Data\" and \"Item 8. Financial Statements and Supplementary Data\" of this report for a summary of the Registrant's revenue, income and identifiable assets.\nThe principal markets during 1995 for the oil produced by the Registrant were refineries and oil transmission companies that have facilities near the Registrant's oil producing properties. The principal markets for the Registrant's gas were companies that have pipelines located near the Registrant's gas producing properties. Of the Registrant's oil and gas revenues for 1995, approximately 66% was attributable to sales made to Phibro Energy, Inc.\nBecause of the demand for oil and gas, the Registrant does not believe that the termination of the sales of its products to any one customer would have a material adverse impact on its operations. The loss of a particular customer for gas may have an effect if that particular customer has the only gas pipeline located in the areas of the Registrant's gas producing properties. The Registrant believes, however, that the effect would be temporary, until alternative arrangements could be made.\nFederal and state regulation of oil and gas operations generally includes the fixing of maximum prices for regulated categories of natural gas, the imposition of maximum allowable production rates, the taxation of income and other items and the protection of the environment. Although the Registrant believes that its business operations do not impair environmental quality and that its costs of complying with any applicable environmental regulations are not currently significant, the Registrant cannot predict what, if any, effect these environmental regulations may have on its current or future operations.\nThe Registrant does not have any employees of its own. PPUSA employs 623 persons, many of whom dedicated a part of their time to the conduct of the Registrant's business during the period for which this report is filed. The Registrant's managing general partner, PPDLP through PPUSA, supplies all management functions\nNo material part of the Registrant's business is seasonal and the Registrant conducts no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Registrant's properties consist primarily of leasehold interests in properties on which oil and gas wells are located. Such property interests are often subject to landowner royalties, overriding royalties and other oil and gas leasehold interests.\nThe Registrant completed seven purchases of producing properties. These acquisitions involved the purchase of working interests in 54 properties of which all are operated by the managing general partner. The Registrant also participated in the drilling of two oil and gas wells during 1988 which were completed as producers. Additionally, the Registrant purchased 15 overriding royalty interests effective January 1, 1990 and two additional overriding royalty interests during 1991. Seventeen uneconomical wells have been abandoned; one well in 1989, two wells in 1991, two wells in 1992, six in 1993, three wells in 1994 and three wells in 1995.\nFor information relating to the Registrant's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities for the years then ended, see Note 7 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below. Such reserves have been estimated by the engineering staff of PPUSA with a review by an independent petroleum consultant.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Registrant is not aware of any material legal proceedings (other than routine litigation in the ordinary course of the Registrant's business) to which it is a party or to which its property is 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 during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters\nAt March 8, 1996, the Registrant had 12,191 outstanding limited partnership interests held of record by 600 subscribers. There is no established public trading market for the limited partner ship interests. Under the limited partnership agreement, PPDLP has made certain commitments to purchase partnership interests at a computed value.\nRevenues which, in the sole judgement of the managing general partner, are not required to meet the Registrant's obligations are distributed to the partners at least quarterly in accordance with the limited partnership agreement. During the years ended December 31, 1995 and 1994, $353,613 and $266,567, respectively, of such revenue-related distributions were made to the limited partners.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe following table sets forth selected financial data for the years ended December 31: 1995 1994 1993 1992 1991 ---------- ---------- ---------- ---------- ---------- Operating results: Oil and gas sales $ 921,034 $ 907,637 $1,045,994 $1,242,244 $1,584,138 ========= ========= ========= ========= ========= Impairment of oil and gas properties $ 104,960 $ - $ - $ - $ - ========= ========= ========= ========= ========= Net income (loss) $ 157,736 $ (166,914) $ (112,198) $ (31,728) $ 122,694 ========= ========= ========= ========= ========= Allocation of net income (loss): Managing general partner $ 1,578 $ (1,669) $ (1,122) $ 49 $ 1,594 ========= ========= ========= ========= ========= Limited partners $ 156,158 $ (165,245) $ (111,076) $ (31,777) $ 121,100 ========= ========= ========= ========= ========= Limited partners' net income (loss) per limited part- nership interest $ 12.81 $ (13.55) $ (9.11) $ (2.61) $ 9.93 ========= ========= ========= ========= ========= Limited partners' cash distributions per limited part- nership interest $ 29.01 $ 21.87 $ 39.35 $ 52.16 $ 83.23 ========= ========= ========= ========= ========= At year end: Total assets $1,958,507 $2,158,522 $2,594,125 $3,190,822 $3,864,733 ========= ========= ========= ========= =========\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of operations\nThe Registrant's 1995 oil and gas revenues increased to $921,034 from $907,637 in 1994. The increase in revenues was the net result of an increase in the average price received per barrel of oil produced and sold, offset by a slight decline in barrels of oil produced and sold, a 6% decline in mcf of gas produced and sold and a decrease in the average price received per mcf of gas. In 1995, 43,188 barrels of oil were sold compared to 43,656 in 1994, a decrease of 468 barrels. In 1995, 108,168 mcf of gas were sold compared to 115,012 in 1994, a decrease of 6,844 mcf. Because of the decline characteristics of the Registrant's oil and gas properties, management expects a certain amount of decline in production to continue in the future until the Registrant's economically recoverable reserves are fully depleted.(1)\nThe average price received per barrel of oil increased $1.21, or 8%, from $15.90 in 1994 to $17.11 in 1995, while the average price received per mcf of gas decreased from $1.86 in 1994 to $1.68 in 1995. The market price for oil and gas has been extremely volatile in the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.(1) The Registrant may therefore sell its future oil and gas production at average prices lower or higher than that received in 1995.(1)\nSalvage income received from equipment disposals of $1,660 during 1995 was derived from equipment credits received on wells that were plugged and abandoned in prior years, as compared to $7,747 in equipment credits received on prior year abandonments during 1994. A loss on abandoned property of $4,769 was recognized during 1995. This loss was the result of $1,165 in proceeds received from equipment salvage on two abandoned wells, less the write-off of remaining capitalized well costs of $5,934. During 1994, a gain of $12,493 resulted from proceeds received from equipment salvage on two fully depleted abandoned wells. Expenses incurred to plug and abandon these properties decreased from $22,674 in 1994 to $8,153 in 1995.\nTotal costs and expenses decreased in 1995 to $771,512 as compared to $1,099,693 in 1994, a decrease of $328,181, or 30%. The decrease was attributable to declines in production costs, abandoned property costs and depletion, offset by increases in loss on abandoned properties, general and administration expenses (\"G&A\") and the impairment of oil and gas properties.\nProduction costs were $471,114 in 1995 and $556,124 in 1994, resulting in an $85,010 decrease, or 15%. The decrease was the result of a reduction in well repair and maintenance costs.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A increased, in aggregate, from $27,229 in 1994 to $27,631 in 1995. The Registrant paid the managing general partner $23,322 in 1995 and $19,388 in 1994 for G&A incurred on behalf of the Registrant. G&A is allocated, in part, to the Registrant by the managing general partner. The Partnership agreement limits allocated G&A to 2% of the initial contributions of the limited partners during the year of activation and the following calendar year. During each of the years\nthe year of activation and the following calendar year. During each of the years following such two-year period, allocated G&A will not exceed 3% of the gross oil and gas revenues. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Registrant relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.(1)\nDepletion was $154,885 in 1995 compared to $493,666 in 1994, a decrease of $338,781, or 69%. This decrease was the result of several properties being fully depleted in 1994. These properties reached their economic limit due to the downward revision of oil reserves during 1994. Depletion was computed property-by-property utilizing the unit-of-production method based upon the dominant mineral produced, generally oil. Oil production decreased 468 barrels in 1995 from 1994, while oil reserves of barrels were revised upward by 83,282 barrels, or 19%.\nEffective for the fourth quarter of 1995 the Registrant 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\") which requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, 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 of recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment is recognized based on the asset's fair value as determined for oil and gas properties by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of the natural gas price environment and the Registrant's expectation of future cash flows from its oil and gas properties at the time of review, the Registrant recognized a non-cash charge of $104,960 associated with the adoption of SFAS 121.\n1994 compared to 1993\nThe Registrant's 1994 oil and gas revenues decreased to $907,637 from $1,045,994 in 1993, a decrease of 13%. The decrease in revenues resulted from a 4% decline in barrels of oil produced and sold, a 12% decline in mcf of gas produced and sold and decreases in the average price received per barrel of oil and mcf of gas. In 1994, 43,656 barrels of oil were sold compared to 45,679 in 1993, a decrease of 2,023 barrels. In 1994, 115,012 mcf of gas were sold compared to 130,491 in 1993, a decrease of 15,479 mcf. The production declines were the result of the decline characteristics of the Registrant's oil and gas properties.\nThe average price received per barrel of oil decreased $1.17 from $17.07 in 1993 to $15.90 in 1994, while the average price received per mcf of gas decreased from $2.04 in 1993 to $1.86 in 1994.\nTotal costs and expenses decreased in 1994 to $1,099,693 as compared to $1,182,414 in 1993, a decrease of $82,721, or 7%. The decrease was attributable\nto declines in production costs, G&A and abandoned property costs, offset by an increase in depletion.\nProduction costs were $556,124 in 1994 and $719,600 in 1993, resulting in a $163,476 decrease, or 23%. Decreases in well repair and down-hole maintenance and in workover costs were attributable to the decline in production costs.\nSalvage income from equipment disposals of $7,747 during 1994 was derived from equipment credits received on wells that were plugged and abandoned in prior years, as compared to no equipment credits received on prior year abandonments during 1993. Gains on abandoned properties of $12,493 and $16,649 were recognized during 1994 and 1993, respectively. These gains were the result of proceeds received from equipment salvage on two fully depleted abandoned wells in 1994 and six fully depleted abandoned wells in 1993. Accordingly, expenses incurred to plug and abandon these properties decreased from $58,228 in 1993 to $22,674 in 1994.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 13% from $31,378 in 1993 to $27,229 in 1994. The Registrant paid the managing general partner $19,388 in 1994 and $24,527 in 1993 for G&A incurred on behalf of the Registrant.\nDepletion was $493,666 in 1994 compared to $373,208 in 1993, an increase of $120,458, or 32%. This increase was the result of several properties being fully depleted in 1994. These properties reached their economic limit due to the downward revision of oil reserves during 1994. Oil production decreased 2,023 barrels in 1994 from 1993, while oil reserves of barrels were revised downward by 55,250 barrels, or 10%.\nImpact of inflation and changing prices on sales and net income\nInflation impacts the fixed overhead rate charges of the lease operating expenses for the Registrant. During 1993, the annual change in the index of average weekly earnings of crude petroleum and gas production workers issued by the U.S. Department of Labor, Bureau of Labor Statistics, decreased by 1.1%. The 1994 annual change in average weekly earnings increased by 4.8%. The 1995 index (effective April 1, 1995) increased 4.4%. The impact of inflation for other lease operating expenses is small due to the current economic condition of the oil industry.\nThe oil and gas industry experienced volatility during the past decade because of the fluctuation of the supply of most fossil fuels relative to the demand for such products and other uncertainties in the world energy markets causing significant fluctuations in oil and gas prices. Since December 31, 1994, prices for oil production have fluctuated throughout the year. The price per barrel for oil production similar to the Registrant's ranged from approximately $16.00 to $19.00. For February 1996, the average price for the Registrant's oil was approximately $18.00.\nPrices for natural gas are subject to ordinary seasonal fluctuations, and this volatility of natural gas prices may result in production being curtailed and, in some cases, wells being completely shut-in.(1)\nLiquidity and capital resources\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities increased to $476,380 during the year ended December 31, 1995, a $240,769 increase from the year ended December 31, 1994. The increase was due to an increase in oil and gas sales and reductions in production costs, abandoned property costs and G&A. The increase in oil and gas sales was primarily attributable to higher average prices received per barrel of oil produced and sold. The reduced production costs reflected lower well repair and downhole maintenance costs. The decline in abandoned property costs was attributable to a smaller working interest in the three wells abandoned in 1995 as compared to the three wells abandoned in 1994. G&A decreased due to less direct expense allocated by the managing general partner.\nNet Cash Provided by (Used in) Investing Activities\nThe Registrant's investing activities during 1995 included $26,426 for expenditures related to repair and maintenance activity on several oil and gas properties, as compared to $121,915 during 1994.\nThe Registrant received $1,155 and $7,349 during 1995 and 1994, respectively, from the salvage of equipment on abandoned properties. Equipment disposals on active properties yielded proceeds of $5,713 and $7,747 during 1995 and 1994, respectively.\nNet Cash Used in Financing Activities\nCash was sufficient in 1995 for distributions to the partners of $357,751 of which $353,613 was distributed to the limited partners and $4,138 to the managing general partner. In 1994, cash was sufficient for distributions to the partners of $268,689 of which $266,567 was distributed to the limited partners and $2,122 to the managing general partner.\nIt is expected that future net cash provided by operations will be sufficient for any capital expenditures and any distributions.(1) As the production from the properties declines, distributions are also expected to decrease.(1)\n- ---------------\n(1) This statement is a forward looking statement that involves risks and uncertainties. Accordingly, no assurances can be given that the actual events and results will not be materially different than the anticipated results described in the forward looking statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Registrant's audited financial statements are included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nThe Registrant does not have any officers or directors. Under the limited partnership agreement, the Registrant's managing general partner, PPDLP, is granted the exclusive right and full authority to manage, control and administer the Registrant's business. PPUSA, the sole general partner of PPDLP, is a wholly-owned subsidiary of Parker & Parsley Petroleum Company (the \"Company\"), a publicly-traded corporation on the New York Stock Exchange.\nSet forth below are the names, ages and positions of the directors and executive officers of PPUSA. Directors of PPUSA are elected to serve until the next annual meeting of stockholders or until their successors are elected and qualified.\nAge at December 31, Name 1995 Position\nScott D. Sheffield 43 Chairman of the Board and Director\nJames D. Moring (a) 59 President, Chief Executive Officer and Director\nTimothy A. Leach 36 Executive Vice President and Director\nSteven L. Beal 36 Senior Vice President, Treasurer and Chief Financial Officer\nMark L. Withrow 48 Senior Vice President and Secretary\n- ---------------\n(a) Mr. Moring retired from the Company and subsidiaries effective January 1, 1996. Mr. Sheffield assumed the positions of President and Chief Executive Officer of PPUSA effective January 1, 1996.\nScott D. Sheffield. Mr. Sheffield, a graduate of The University of Texas with a Bachelor of Science degree in Petroleum Engineering, has been the President and a Director of the Company since May 1990 and has been the Chairman of the Board and Chief Executive Officer since October 1990. Mr. Sheffield joined PPDC, the principal operating subsidiary of the Company, as a petroleum engineer in 1979. Mr. Sheffield served as Vice President - Engineering of PPDC from September 1981 until April 1985 when he was elected President and a Director of PPDC. In March 1989, Mr. Sheffield was elected Chairman of the Board and Chief Executive Officer of PPDC. On January 1, 1995, Mr. Sheffield resigned as President and Chief Executive Officer of PPUSA, but remained Chairman of the Board and a Director of PPUSA. On January 1, 1996, Mr. Sheffield reassumed the positions of President and Chief Executive Officer of PPUSA. Before joining PPDC, Mr. Sheffield was principally occupied for more than three years as a production and reservoir engineer for Amoco Production Company.\nJames D. Moring. Mr. Moring, a graduate of Texas Tech University with a Bachelor of Science degree in Petroleum Engineering has been a Director of the Company since October 1990 and was Senior Vice President - Operations of the Company from October 1990 until May 1993, when he was appointed Executive Vice President - Operations. Mr. Moring has been principally occupied since July 1982 as the supervisor of the drilling, completion, and production operations of PPDC and its affiliates and has served as an officer of PPDC since January 1983. Mr. Moring has been Senior Vice President - Operations and a Director of PPDC since June 1989 and in May 1993, Mr. Moring was appointed Executive Vice President - Operations. Mr. Moring was elected President and Director and appointed Chief Executive Officer of PPUSA on January 1, 1995. Effective January 1, 1996, Mr. Moring retired from the Company and subsidiaries. In the five years before joining PPDC, Mr. Moring was employed as a Division Operations Manager with Moran Exploration, Inc. and its predecessor.\nTimothy A. Leach. Mr. Leach, a graduate of Texas A&M University with a Bachelor of Science degree in Petroleum Engineering and the University of Texas of the Permian Basin with a Master of Business Administration degree, was elected Executive Vice President - Engineering of the Company on March 21, 1995. Mr. Leach had been serving as Senior Vice President Engineering since March 1993 and served as Vice President - Engineering of the Company from October 1990 to March 1993. Mr. Leach was elected Executive Vice President of PPUSA on December 1, 1995. He had joined PPDC as Vice President - Engineering in September 1989. Prior to joining PPDC, Mr. Leach was employed as Senior Vice President and Director of First City Texas - Midland, N.A.\nSteven L. Beal. Mr. Beal, a graduate of the University of Texas with a Bachelor of Business Administration degree in Accounting and a certified public accountant, was elected Senior Vice President - Finance of the Company in January 1995 and Chief Financial Officer of the Company on March 21, 1995. On January 1, 1995, Mr. Beal was elected Senior Vice President, Treasurer and Chief Financial Officer of PPUSA. Mr. Beal has been the Company's Chief Accounting Officer since November 1992 and been the Company's Treasurer since October 1990. Mr. Beal joined PPDC as Treasurer in March 1988 and was elected Vice President - Finance in October 1991. Prior to joining PPDC, Mr. Beal was employed as an audit manager of Price Waterhouse.\nMark L. Withrow. Mr. Withrow, a graduate of Abilene Christian University with Bachelor of Science degree in Accounting and Texas Tech University with a Juris Doctorate degree, was Vice President - General Counsel of the Company from February 1991 to January 1995, when he was appointed Senior Vice President - General Counsel, and has been the Company's Secretary since August 1992. On January 1, 1995, Mr. Withrow was elected Senior Vice President and Secretary of PPUSA. Mr. Withrow joined PPDC in January 1991. Prior to joining PPDC , Mr. Withrow was the managing partner of the law firm of Turpin, Smith, Dyer, Saxe & MacDonald, Midland, Texas.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Registrant does not have any directors or officers. Management of the Registrant is vested in PPDLP, the managing general partner. The Registrant\nparticipates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. Under the limited partnership agreement, PPDLP pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, PPDLP is allocated 1% of the Registrant's revenues. See Notes 6 and 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below for information regarding fees and reimbursements paid to the managing general partner or its affiliates by the Registrant.\nThe Registrant does not directly pay any salaries of the executive officers of PPUSA, but does pay a portion of PPUSA's general and administrative expenses of which these salaries are a part. See Note 6 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Beneficial owners of more than five percent\nThe Registrant is not aware of any person who beneficially owns 5% or more of the outstanding limited partnership interests of the Registrant. PPDLP owned 196 limited partner interests at January 1, 1996.\n(b) Security ownership of management\nThe Registrant does not have any officers or directors. The managing general partner of the Registrant, PPDLP, has the exclusive right and full authority to manage, control and administer the Registrant's business. Under the limited partnership agreement, limited partners holding a majority of the outstanding limited partnership interests have the right to take certain actions, including the removal of the managing general partner or any other general partner. The Registrant is not aware of any current arrangement or activity which may lead to such removal. The Registrant is not aware of any officer or director of PPUSA who beneficially owns limited partnership interests in the Registrant.\n(c) Changes in control\nOn January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of Parker & Parsley Producing Properties 87-B, Ltd., as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, which previously served as the managing general partner of the Registrant. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Registrant.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nTransactions with the managing general partner or its affiliates\nPursuant to the limited partnership agreement, the Registrant had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 153,156 $ 178,054 $ 203,041\nReimbursement of general and administrative expenses $ 23,322 $ 19,388 $ 24,527\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 6,498 $ 18,684 $ 30,239\nUnder the limited partnership agreement, the managing general partner pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Registrant's revenues. Also, see Notes 6 and 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below, regarding the Registrant's participation with the managing general partner in oil and gas activities of the Program.\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 are filed as part of this annual report:\nIndependent Auditors' Report\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\n2. Financial statement schedules\nAll financial statement schedules have been omitted since the required information is in the financial statements or notes thereto, or is not applicable nor required.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits listed on the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.\nS I G N A T U R E S\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.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD.\nDated: March 29, 1996 By: Parker & Parsley Development L.P., Managing General Partner\nBy: Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), General Partner\nBy: \/s\/ Scott D. Sheffield ------------------------------- Scott D. Sheffield, 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.\n\/s\/ Scott D. Sheffield President, Chairman of the Board, March 29, 1996 - ------------------------- Chief Executive Officer and Scott D. Sheffield Director of PPUSA\n\/s\/ Timothy A. Leach Executive Vice President March 29, 1996 - ------------------------- and Director of PPUSA Timothy A. Leach\n\/s\/ Steven L. Beal Senior Vice President, March 29, 1996 - ------------------------- Treasurer and Chief Steven L. Beal Financial Officer of PPUSA\n\/s\/ Mark L. Withrow Senior Vice President and March 29, 1996 - ------------------------- Secretary of PPUSA Mark L. Withrow\nINDEPENDENT AUDITORS' REPORT\nThe Partners Parker & Parsley Producing Properties 87-B, Ltd. (A Texas Limited Partnership):\nWe have audited the financial statements of Parker & Parsley Producing Properties 87-B, Ltd. as listed in the accompanying index under Item 14(a). 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 Parker & Parsley Producing Properties 87-B, Ltd. 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.\nAs discussed in Notes 2 and 3 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets and for long-lived assets to be disposed of in 1995 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\"\nKPMG Peat Marwick LLP\nMidland, Texas March 8, 1996\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD. (A Texas Limited Partnership)\nBALANCE SHEETS December 31\n1995 1994 ----------- ----------- ASSETS\nCurrent assets: Cash and cash equivalents, all interest bearing deposits $ 135,981 $ 36,910 Accounts receivable - affiliate 43,366 82,820 ---------- ---------- Total current assets 179,347 119,730\nOil and gas properties - at cost, based on the successful efforts accounting method 4,897,763 4,902,973 Accumulated depletion (3,118,603) (2,864,181) ---------- ----------\nNet oil and gas properties 1,779,160 2,038,792 ---------- ----------\n$ 1,958,507 $ 2,158,522 ========== =========== PARTNERS' CAPITAL\nPartners' capital: Limited partners (12,191 interests) $ 1,939,382 $ 2,136,837 Managing general partner 19,125 21,685 ---------- ----------\n$ 1,958,507 $ 2,158,522 ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31\n1995 1994 1993 ---------- ---------- ---------- Revenues: Oil and gas sales $ 921,034 $ 907,637 $1,045,994 Interest income 6,554 4,902 7,573 Gain on abandoned properties - 12,493 16,649 Salvage income from equipment disposals 1,660 7,747 - --------- --------- ---------\nTotal revenues 929,248 932,779 1,070,216\nCosts and expenses: Production costs 471,114 556,124 719,600 Abandoned property costs 8,153 22,674 58,228 Loss on abandoned properties 4,769 - - General and administrative expenses 27,631 27,229 31,378 Depletion 154,885 493,666 373,208 Impairment of oil and gas properties 104,960 - - --------- --------- ---------\nTotal costs and expenses 771,512 1,099,693 1,182,414 --------- --------- ---------\nNet income (loss) $ 157,736 $ (166,914) $ (112,198) ========= ========= =========\nAllocation of net income (loss): Managing general partner $ 1,578 $ (1,669) $ (1,122) ========= ========= =========\nLimited partners $ 156,158 $ (165,245) $ (111,076) ========= ========= =========\nNet income (loss) per limited partnership interest $ 12.81 $ (13.55) $ (9.11) ========= ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nManaging general Limited partner partners Total --------- ---------- ----------\nPartners' capital at January 1, 1993 $ 31,383 $3,159,439 $3,190,822\nDistributions (4,785) (479,714) (484,499)\nNet loss (1,122) (111,076) (112,198) -------- --------- ---------\nPartners' capital at December 31, 1993 25,476 2,568,649 2,594,125\nDistributions (2,122) (266,567) (268,689)\nNet loss (1,669) (165,245) (166,914) -------- --------- ---------\nPartners' capital at December 31, 1994 21,685 2,136,837 2,158,522\nDistributions (4,138) (353,613) (357,751)\nNet income 1,578 156,158 157,736 -------- --------- ---------\nPartners' capital at December 31, 1995 $ 19,125 $1,939,382 $1,958,507 ======== ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31\n1995 1994 1993 --------- --------- --------- Cash flows from operating activities: Net income (loss) $ 157,736 $(166,914) $(112,198) Adjustments to reconcile net income (loss) to net cash provided by operating activities: (Gain) loss on abandoned properties 4,769 (12,493) (16,649) Salvage income from equipment disposals (1,660) (7,747) - Depletion 154,885 493,666 373,208 Impairment of oil and gas properties 104,960 - - Changes in assets: (Increase) decrease in accounts receivable 55,690 (70,901) 68,642 -------- -------- -------- Net cash provided by operating activities 476,380 235,611 313,003\nCash flows from investing activities:\n(Additions) disposals of oil and gas equipment (26,426) (121,915) 7,028 Proceeds from salvage income on equipment disposals 5,713 7,747 - Proceeds from equipment salvage on abandoned properties 1,155 7,349 16,649 -------- -------- -------- Net cash provided by (used in) investing activities (19,558) (106,819) 23,677\nCash flows from financing activities: Cash distributions to partners (357,751) (268,689) (484,499) -------- -------- -------- Net increase (decrease) in cash and cash equivalents 99,071 (139,897) (147,819) Cash and cash equivalents at beginning of year 36,910 176,807 324,626 -------- -------- -------- Cash and cash equivalents at end of year $ 135,981 $ 36,910 $ 176,807 ======== ======== ========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD. (A Texas Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNote 1. Organization and nature of operations\nParker & Parsley Producing Properties 87-B, Ltd. (the \"Partnership\") is a limited partnership organized in 1987 under the laws of the State of Texas.\nThe Partnership engages primarily in oil and gas production in Texas and is not involved in any industry segment other than oil and gas.\nNote 2. Summary of significant accounting policies\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\nImpairment of long-lived assets - Effective for the fourth quarter of 1995 the Partnership 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\"). Consequently, the Partnership reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows is less than the carrying amount of the assets. In this circumstance, the Partnership recognizes an impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset.\nThe Partnership accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less costs to sell once management has committed to a plan to dispose of the assets.\nOil and gas properties - The Partnership utilizes the successful efforts method of accounting for its oil and gas properties and equipment. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized while nonproductive exploration costs are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method on a property-by-property basis based on proved oil (dominant mineral) reserves as determined by the engineering staff of Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), the sole general partner of Parker & Parsley Development L.P. (\"PPDLP\"), the Partnership's managing general partner, and reviewed by independent petroleum consultants. The carrying amounts of properties sold or otherwise disposed of and the related allowances for depletion are eliminated from the accounts and any gain or loss is included in operations.\nPrior to the adoption of SFAS 121 in the fourth quarter, the Partnership's aggregate oil and gas properties were stated at cost not in excess of total\nestimated future net revenues and the estimated fair value of oil and gas assets not being depleted.\nUse of estimates in the preparation of financial statements - Preparation of the accompanying 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 reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nOrganization costs - Organization costs are capitalized and amortized on the straight-line method over 60 months.\nNet income (loss) per limited partnership interest - The net income (loss) per limited partnership interest is calculated by using the number of outstanding limited partnership interests.\nIncome taxes - A Federal income tax provision (credit) has not been included in the financial statements as the income (loss) of the Partnership is included in the individual Federal income tax returns of the respective partners.\nStatements of cash flows - For purposes of reporting cash flows, cash and cash equivalents include depository accounts held by banks.\nGeneral and administrative expenses - General and administrative expenses are allocated in part to the Partnership by the managing general partner or its affiliates. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Partnership relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.\nEnvironmental - The Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nNote 3. Impairment of long-lived assets\nThe Partnership adopted SFAS 121 effective for the fourth quarter of 1995. SFAS 121 requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be\nrecoverable. Long-lived assets to be disposed of are to be accounted for at the lower of carrying amount or fair value less cost to sell when management has committed to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 for fiscal years beginning after December 15, 1995.\nIn order to determine whether an impairment had occurred, the Partnership estimated the expected future cash flows of its oil and gas properties and compared such future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Partnership adjusted the carrying amount of those oil and gas properties to their fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result, the Partnership recognized a non-cash charge of $104,960 related to its oil and gas properties during the fourth quarter of 1995.\nAs of December 31, 1995, management had not committed to sell any Partnership assets.\nNote 4. Income taxes\nThe financial statement basis of the Partnership's net assets and liabilities was $599,645 less than the tax basis at December 31, 1995.\nThe following is a reconciliation of net income (loss) per statements of operations with the net income (loss) per Federal income tax returns for the years ended December 31: 1995 1994 1993 --------- --------- --------- Net income (loss) per statements of operations $ 157,736 $(166,914) $(112,198) Intangible development costs capitalized for financial reporting purposes and expensed for tax reporting purposes (623) (110,435) - Depletion and depreciation provisions for tax reporting purposes (over) under amounts for financial reporting purposes (23,603) 241,597 (6,698) Impairment of oil and gas properties for financial reporting purposes 104,960 - - Abandoned property costs for tax reporting purposes over amounts for financial reporting purposes - (13,094) (33,127) Accrued expense for financial reporting purposes under amounts for tax reporting purposes - - (9,736) Other, net 535 4,631 11,286 -------- -------- -------- Net income (loss) per Federal income tax returns $ 239,005 $ (44,215) $(150,473) ======== ======== ========\nNote 5. Oil and gas producing activities\nThe following is a summary of the costs incurred, whether capitalized or expensed, related to the Partnership's oil and gas producing activities for the years ended December 31: 1995 1994 1993 --------- ---------- --------- Property acquisition costs $ 10,852 $ 21,844 $ 28,834 ======== ========= ======== Development costs $ 623 $ 127,068 $ - ======== ========= ========\nCapitalized oil and gas properties consist of the following:\n1995 1994 1993 ----------- ----------- ----------- Proved properties: Property acquisition costs $ 3,354,752 $ 3,360,585 $ 3,396,794 Completed wells and equipment 1,543,011 1,542,388 1,415,320 ---------- ---------- ---------- 4,897,763 4,902,973 4,812,114 Accumulated depletion (3,118,603) (2,864,181) (2,426,135) ---------- ---------- ---------- Net capitalized costs $ 1,779,160 $ 2,038,792 $ 2,385,979 ========== ========== ==========\nDuring 1995, the Partnership recognized a non-cash charge against oil and gas properties of $104,960 associated with the adoption of SFAS 121. See Note 3.\nNote 6. Related party transactions\nPursuant to the limited partnership agreement, the Partnership had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 153,156 $ 178,054 $ 203,041\nReimbursement of general and administrative expenses $ 23,322 $ 19,388 $ 24,527\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 6,498 $ 18,684 $ 30,239\nThe Partnership participates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. PPDLP, P&P Producing Properties 87-B Employees (\"EMPL\") and the Partnership are parties to the Program agreement. EMPL is a general partnership organized for the benefit of certain employees of PPUSA.\nThe costs and revenues of the Program are allocated to PPDLP, EMPL and the Partnership as follows: PPDLP (1) and EMPL Partnership ----------- ----------- Revenues: Revenues from oil and gas production, proceeds from sales of producing properties and all other revenues: Before payout 4.040405% 95.959595% After payout 19.191920% 80.808080% Costs and expenses: Property acquisition costs, operating costs, general and administrative expenses and other costs: Before payout 4.040405% 95.959595% After payout 19.191920% 80.808080%\n(1) Excludes PPDLP's 1% general partner ownership which is allocated at the Partnership level and 196 limited partner interests owned by PPDLP.\nNote 7. Oil and gas information (unaudited)\nThe following table presents information relating to the Partnership's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities during the years then ended. All of the Partnership's reserves are proved and located within the United States. The Partnership's reserves are based on an evaluation prepared by the engineering staff of PPUSA and reviewed by an independent petroleum consultant, using criteria established by the Securities and Exchange Commission. Reserve value information is available to limited partners pursuant to the Partnership agreement and, therefore, is not presented. Oil (bbls) Gas (mcf) ---------- ---------- Net proved reserves at January 1, 1993 572,446 1,830,081 Revisions of estimates of January 1, 1993 11,077 (19,069) Production (45,679) (130,491) ---------- ---------- Net proved reserves at December 31, 1993 537,844 1,680,521 Revisions of estimates of December 31, 1993 (55,250) (62,621) Production (43,656) (115,012) ---------- ---------- Net proved reserves at December 31, 1994 438,938 1,502,888 Revisions of estimates of December 31, 1994 83,282 411,623 Production (43,188) (108,168) ---------- ---------- Net proved reserves at December 31, 1995 479,032 1,806,343 ========== ==========\nThe estimated present value of future net revenues of proved reserves, calculated using December 31, 1995 prices of $19.35 per barrel of oil and $1.90 per mcf of gas, discounted at 10% was approximately $2,816,000 and undiscounted was $5,451,000 at December 31, 1995.\nThe Partnership emphasizes that reserve estimates are inherently imprecise and, accordingly, the estimates are expected to change as future information becomes available.\nNote 8. Major customers\nThe following table reflects the major customers of the Partnership's oil and gas sales during the years ended December 31:\n1995 1994 1993 ---- ---- ----\nPhibro Energy, Inc. 66% 62% 60% GPM Gas Corporation - 15% 11% Western Gas Resources, Inc. - 10% 10% Phillips Petroleum Company - - 10%\nPPDLP is party to a long-term agreement pursuant to which PPDLP and affiliates are to sell to Phibro Energy, Inc. (\"Phibro\") substantially all crude oil (including condensate) which any of such entities has the right to market from time to time. On December 29, 1995, PPDLP and Phibro entered into a Memorandum of Agreement (\"Phibro MOA\") that cancels the prior crude oil purchase agreement between the parties and provides for adjusted terms effective December 1, 1995. The price to be paid for oil purchased under the Phibro MOA is to be competitive with prices paid by other substantial purchasers in the same area who are significant competitors of Phibro. The price to be paid for oil purchased under the Phibro MOA also includes a market-related bonus that may vary from month to month based upon spot oil prices at various commodity trade points. The term of the Phibro MOA is through June 30, 1998, and it may continue thereafter subject to termination rights afforded each party. Although Phibro was required to post a $16 million letter of credit in connection with purchases under the prior agreement, it is anticipated that this security requirement will be replaced by a $25 million payment guarantee by Phibro's parent company, Salomon Inc.\nNote 9. Organization and operations\nThe Partnership was organized December 28, 1987 as a limited partnership under the Texas Uniform Limited Partnership Act for the purpose of acquiring producing properties. The following is a brief summary of the more significant provisions of the limited partnership agreement:\nManaging general partner - On January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of the Partnership as a result of the merger into it of Parker & Parsley Development Company (\"PPDC\"), a Delaware corporation, and an affiliate of PPDLP and the Company, and which previously served as the managing general partner of the Partnership. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Partnership, including the development drilling program in which the Partnership participates. PPDLP has the power and authority to manage, control and administer all Partnership affairs. Under the limited partnership agreement, the managing general partner pays 1% of the\nPartnership's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Partnership's revenues.\nLimited partner liability - The maximum amount of liability of any limited partner is the total contributions of such partner plus his share of any undistributed profits.\nInitial capital contributions - The limited partners entered into subscription agreements for aggregate capital contributions of $6,095,500. PPDLP is required to contribute amounts equal to 1% of initial Partnership capital less commission and offering expenses allocated to the limited partners and to contribute amounts necessary to pay costs and expenses allocated to it under the Partnership agreement to the extent its share of revenues does not cover such costs.\nPARKER & PARSLEY PRODUCING PROPERTIES 87-B, LTD.\nINDEX TO EXHIBITS\nThe following documents are incorporated by reference in response to Item 14(c):\nExhibit No. Description Page\n4(a) Agreement of Limited Partnership of - Parker & Parsley Producing Properties 87-B, Ltd.\n4(b) Form of Subscription Agreement and - Power of Attorney\n4(c) Specimen Certificate of Limited Partnership - Interest\n10(a) Operating Agreement -\n10(b) Exploration and Development Program - Agreement","section_15":""}
{"filename":"316297_1995.txt","cik":"316297","year":"1995","section_1":"ITEM 1.\nBusiness\n(a) General Development of Business\nSuper 8 Motels Northwest I is a Washington limited partnership (the \"Partnership\") which was formed to invest in and operate two \"economy\" motels located in the state of Washington (the \"Motels\"). The Partnership operates the Motels as a franchise of Super 8 Motels, Inc., the national franchiser of the \"Super 8\" tradename. The General Partner of the Partnership is Gerald L. Whitcomb.\nThe Partnership was formed in March 1980. The Limited Partnership Units of the Partnership (the \"Units\") were offered and sold by selected broker-dealers on a best efforts basis in the states of Washington, Oregon, Montana, Idaho and Alaska.\nThe Partnership's total offering of $6,000,000 (6,000 Units at $1,000 each) was fully subscribed and the offering closed in February 1982.\n(b) Financial Information About Industry Segments.\nNot applicable as the registrant operates in a single industry (motels) and within that industry only in the economy motel category. For financial information generally, see \"Financial Statements.\"\n(c) Narrative Description of Business.\nThe motel properties were developed and are being operated as economy motels in the locations indicated below. Both properties are franchisees of the national \"Super 8\" motel chain. The economy motel concept provides for a clean, comfortable average-size motel room that has all the basic amenities required by the traveling public at a price lower than that of most surrounding motel properties of equal quality.\nAll guest rooms are equipped with direct-dial telephone, color television and tub\/shower combination, and are fully carpeted, sound proofed and insulated. Guests are allowed to use major national credit cards and cash checks with V.I.P. Club membership. Vending machines are also available.\nEach property has interior hallways, a lobby with a manager's office, an employee lounge, an in-house laundry and a manager's apartment. No restaurants are located on either property.\nThe 120-room Super 8 Motel at Sea-Tac is located near the Seattle\/Tacoma International Airport and provides additional special services to the traveling public: long parking privileges, airport courtesy telephone, and free limousine transportation to and from the airport.\nThe 90-room Super 8 Motel at Federal Way provides a special parking area for commercial trucks, guest laundry facilities and a travelers lounge. Adjacent to the property are two family style restaurants owned and operated by non affiliated companies.\nBoth motels historically experience seasonal fluctuations in occupancy, the low point occurring in the winter months and peaking in late summer.\nThe motels provide full or part-time employment for approximately 39 people (Sea-Tac 22, Federal Way 17).\n(d) Financial Information About Foreign and Domestic Operations and Export Sales.\nThe Partnership operates only in one geographic area, the Puget Sound region of Washington State. For financial information generally, see \"Financial Statements.\"\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2\nProperties\n(a) Location and General Characteristics.\nThe Partnership owns two parcels of real property, both purchased during the year ended December 31, 1981. The Sea-Tac property is located at 192nd Street at Old Highway 99 in King County, Washington. Construction commenced on the Sea-Tac parcel in August 1981 and it opened in March 1982. The Federal Way property is located at 348th Street and 16th Avenue in Federal Way, King County, Washington. Construction commenced on the Federal Way property in March 1982 and was completed in September 1982.\nBoth motels are of frame construction with stucco exteriors, tile roofs and have full fire alarm system. Heating and cooling is by individual room through the wall heat pumps.\nThe approximate size of the buildings is as follows:\nBoth motels underwent major renovations in 1987 at an approximate total cost of $328,000. An approximately $1,000,000 renovation of the Sea-Tac property commenced in February 1995, with one-half of the property closed for a substantial period of time. The Sea-Tac renovation was completed in February, 1996. During the course of renovating the Sea-Tac property, an abandoned residential oil tank was discovered as was other petroleum products located underneath the building. Upon discovery of these items, the Partnership immediately engaged an environmental consulting firm as well as legal counsel and both the tank and the soils which were found to contain unsuitable levels of petroleum products were removed from the site and properly disposed of.\nBoth motels are in operation as economy motels. For utilization of these properties see Item 7.\nSee Item 1 (c) for further information on each property.\nITEM 3","section_3":"ITEM 3\nLegal Proceeding\nThe Partnership is not party to any material legal proceedings. ITEM 4","section_4":"ITEM 4\nSubmission 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 Units are owned by approximately 1,050 investors.\nThere is no established public trading market for the units and no significant transactions in units between a willing buyer and a willing seller have occurred since the original offering of limited partnership units. Because of this, the Partnership is unable to determine a fair market value for the units.\nDistributions of cash to the Limited Partners made during 1995 totaled $600,000. Distributions of cash to the Limited Partners during 1994 and 1993 were $600,000 for each year.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data*\n*In filings prior to the year ended December 31, 1994, with the United States Securities and Exchange Commission (the \"SEC\"), and in the Partnership's prior years' financial statements, the Partnership did not accrue unpaid property management fees due to the uncertainty of payment. During the year ended December 31, 1994, the Partnership changed its method of accounting for such fees and the above information was restated for 1993, 1992, and 1991 to account for such fees so that Net Income, Long Term Debt and Net Income Per Unit was revised to accrue the expense when incurred and reflect the associated liability on the balance sheet.\n**Net of amortization and depreciation\nDetailed financial data is provided in the form of audited Financial Statements as of December 31, 1995 and 1994 and for each of the three years ended December 31, 1995, 1994 and 1993. These statements show the results of operations, changes in partners' equity, cash flows and additional financial disclosures.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nAt December 31, 1995, the Partnership's current assets exceeded its current liabilities by $48,802 which was $76,030 less than the difference between current assets and current liabilities on December 31, 1994. This drop is largely attributable to the funds the Partnership expended in renovating its Sea-Tac property (see the discussion below), and the loss of available rooms during the renovation. Further, as in the recent past, because the months of January, February, and March are the slowest season of occupancy, the Partnership must carefully manage its cash during those months. Nevertheless, the Partnership was able to make a distribution to its limited partners on January 31, 1996, of $150,000.\nThe interest rate on the Partnership's primary mortgage was 7.5% in 1995 and 1994. This adjustable rate loan provides for an interest rate adjustment each January determined as the lesser of 1% per annum, or an amount equal to the monthly median cost of funds index for FSLIC insured savings and loan associations plus 3.75% per annum. The rate in effect for 1996 is 8.5% per annum.\nThe interest rate on the long term loan funding the Sea-Tac renovation is variable, based on the lender's prime rate plus 1% per annum and is payable in interest only payments through March 31, 1996. The bank's prime rate of interest at December 31, 1995, was 8.5% per annum.\nAt December 31, 1995, both the Sea-Tac and Federal Way properties completed their thirteenth full years of operation. Comparative operational statistics follow:\n*\"Gross Room Rate\" is defined as total room revenue divided by total rooms sold.\nThe Sea-Tac motel renovation contributed to the significant decrease in rooms rented at the property. The number of rented rooms for the partnership decreased from 46,138 during 1994 to 43,594 in 1995, a decrease of 2,544 rooms. The slight increase in the gross room rate was not enough to offset the drop in occupancy caused by the Sea-Tac renovation. Total revenues of the Partnership decreased $96,232 from $2,415,274 in 1994 to $2,319,042 in 1995.\nNet income of the Partnership decreased by $650,953 in 1995 from the prior year, from $783,376 for the year ended December 31, 1994 to $132,423 for the year ended December 31, 1995. Increases in direct operating expenses and fixed charges, coupled with decreased revenues, largely contributed to the decrease in net income of the Partnership.\nDirect operating expenses increased to $444,939 as a result of the increase in maintenance, repairs and supplies due to the renovation of the Sea-Tac location. Indirect operating expenses grew by $14,336, primarily as a result in increases in advertising and promotion, insurance, and other expenses.\nIncreases in professional services and administrative fees resulted in a $47,292 rise in administrative and general costs during 1995 when compared to 1994.\nThe $48,679 increase in fixed charges resulted from increases in depreciation and interest expense.\nOn February 16, 1993, the Board of Directors of Super 8 Motels, Inc., the Partnership's franchiser, announced an agreement to sell the company to Hospitality Franchise Systems, Inc. The sale was consummated in 1993. Hospitality Franchise Systems, Inc., the world's largest franchiser of hotel rooms, is a publicly-held company whose stock is traded on the New York Stock Exchange under the symbol \"HFS.\" The company has more than 4,400 franchised Super 8 Motels, Days Inn, Howard Johnson, Ramada and other motel brands with over 300,000 rooms in the United States, Canada, Mexico, India, and Europe.\nHFS operates its franchise business in a manner that respects the separate identity of each brand. They maintain separate marketing campaigns, additional general franchise services, and separate reservation systems and \"800\" numbers. Having over 4,200 properties worldwide provides enormous opportunities in marketing, purchasing, and technology. This transaction made available to Super 8 franchisees HFS's operational, marketing, and franchise sales experience.\nNationwide the Super 8 motel chain continues to grow, increasing the name familiarity of the chain.\nThe Super 8 \"Superline\" national reservation system and \"VIP Club\" (approximately 3,000,000 members) continue to be improved.\nPrior to 1985, the Partnership had been accruing, as an expense and as a liability, the Motels' property management fees. Even though the obligation to pay those fees exists, the terms of the partnership agreement of the Partnership did not allow them to be paid until such time as the limited partners have received a cumulative annual 10% return on their adjusted capital investment. In previous filings with the United States Securities and Exchange Commission (the \"SEC\"), and in the Partnership's prior years' financial statements, the Partnership's accounting policy regarding these fees was to expense them when paid (instead of when earned) and to not accrue unpaid property management fees as a liability on the face of the balance sheet.\nIn 1994, the Partnership changed its accounting policy for property management fees to reflect, on the Partnership's income statement, the expense when the obligation to pay the fee was incurred and to accrue the corresponding liability on the face of the Partnership's balance sheet. Thus, the financial information contained in this report conforms with that reporting position. Currently, previously incurred but unpaid management fees total approximately $605,000. Attention is directed to Note 7 in the Partnership's Financial Statements, for a discussion of property management fees. Additionally, see the discussion in Part II, Item 6, \"Selected Financial Data\" of this report.\nITEM 8","section_7A":"","section_8":"ITEM 8 Financial Statements\nSee Independent Auditors Report and Financial Statements, pages 2 through 14, for financial statements incorporated herein by reference; and Item 14 for a list of the Financial Statement Schedules filed as a part of this report. ITEM 9","section_9":"ITEM 9 Disagreements on Accounting and Financial Disclosure\nNone. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.\nDirectors and Executive Officers of the Registrant\nThe sole General Partner of the Partnership is Gerald L. Whitcomb.\nGerald L. Whitcomb, age 52, was educated at the University of Nebraska with majors in economics and business finance and obtained a JD. in Law. He practiced law in Shelton, Washington from 1969 to 1979. Since 1979, he has been involved in the management of the Peninsula Group, Inc., (formerly known as Super 8 Motels Northwest, Inc.) and its affiliates. -\nMr. Whitcomb is the principal organizer and stockholder of The Peninsula Group Incorporated and its subsidiaries, one of which was the General Partner of Shelton Super 8 Motel Associates. Mr. Whitcomb is the general partner of Super 8 Motels Northwest II, a limited partnership whose limited partnership units were registered under the Securities Act of 1933. He is also a partner in Super 8 Motel Developers, which is General Partner of Super 8 Motels of Lacey Associates, the General Partner of Super 8 Motels Northwest I, Juneau Motel Associates, Anchorage Motel Associates and Peninsula Motel Associates, all Washington limited partnerships. Mr. Whitcomb is the Managing Partner of Tongass Motel Associates, an Alaska general partnership, Mr. Whitcomb is partner in Peninsula Properties Partnership, a Washington partnership.\nDue to a change in management of the Partnership's General Partner's offices where the individual responsible for ensuring that appropriate filings are made with the SEC, some recently required filings on Forms 3, 4 or 5 appear not to have been timely made. The Partnership is working closely with its counsel to promptly rectify any such delinquent filings.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe General Partner received no salary or bonus compensation from the Partnership during fiscal year ended December 31, 1995. See Item 13.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nThe General Partner, together with family members, owns twelve of the Limited Partnership Units in addition to his General Partner Interest. See Note 3 of Notes to the \"Financial Statements\" for a discussion of distributions and allocations of profits and losses.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nSee the Notes to the Partnership's Financial Statements.\nA portion of Note 6 relating to property management fees payable to an affiliate of the general partner follows:\n\"Payment of property management fees is subordinated to receipt by the limited partners of a cumulative, pre-tax return on their adjusted capital investment of 10% per annum. This I0% was achieved as of June 30, 1992. Effective July 1, 1992 the Partnership began paying monthly the current management fees. Prior to December 31, 1992, the Partnership then determined, based upon working capital needs of Northwest I, that the first six months of 1992 and all of 1991 management fees were to be paid. Management fees paid during 1992 were $124,403 for 1992 and $111,973 for 1991. Management fees paid during 1993 were $115,480 for 1993. Management fees paid during 1994 were $119,617 for 1994 and $115,594 for 1990. Management fees paid during 1995 were $115,938 for 1995.\" PART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on form 8-K\nExhibits incorporated by reference\n1.2 Subscription Agreement (which is filed as Exhibit B to the Prospectus).\n3.1 Certificate and Agreement of Limited Partnership of the Registrant (which is filed as Exhibit \"A\" to the Prospectus).\n6.1 Opinion of Counsel to the Partnership.\nExhibits filed herewith. Financial Statements of the Registrant for the years ended December 31, 1995, 1994 and 1993. Financial Statements include: Report of Independent Public Accountants Balance Sheet Statement of Income Statement of Changes in Partners' Equity Statement of Cash Flows Notes to Financial Statements\nJanuary, 1996 Partnership newsletter mailed to limited partners.\nThere were no reports filed on Form 8-K during 1995.\nFinancial Data Schedule for the year ended December 31, 1995 SIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:\nGerald L. Whitcomb March 28, 1996 - - --------------------- ---------------------- GERALD L. WHITCOMB Date General Partner SUPER 8 MOTELS NORTHWEST I\nINDEPENDENT AUDITOR'S REPORT AND FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994, AND 1993 CONTENTS\nINDEPENDENT AUDITOR'S REPORT\nTo the General and Limited Partners Super 8 Motels Northwest I\nWe have audited the accompanying balance sheets of Super 8 Motels Northwest I as of December 31, 1995 and 1994, and the related statements of income, changes in partners' equity, and cash flows for the three 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 Super 8 Motels Northwest I as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the three years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs described in Note 7, the accompanying financial statements for the year ended December 31, 1993, have been restated to reflect the accrual of property management fees.\nMOSS ADAMS LLP\nTacoma, Washington February 5, 1996\n- 1 - SUPER 8 MOTELS NORTHWEST I BALANCE SHEET\nASSETS\nThe accompanying notes are an integral part of these financial statements.\n- 2 - SUPER 8 MOTELS NORTHWEST I BALANCE SHEET\nLIABILITIES AND PARTNERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\n- 3 - SUPER 8 MOTELS NORTHWEST I STATEMENT OF INCOME\nThe accompanying notes are an integral part of these financial statements.\n- 4 - SUPER 8 MOTELS NORTHWEST I STATEMENT OF CHANGES IN PARTNERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\n- 5 - SUPER 8 MOTELS NORTHWEST I STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\n- 6 - SUPER 8 MOTELS NORTHWEST I STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\n- 7 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 1 - PARTNERSHIP OPERATIONS\nDESCRIPTION OF BUSINESS - SUPER 8 MOTELS NORTHWEST I IS A WASHINGTON LIMITED PARTNERSHIP. THE PARTNERSHIP OWNS AND OPERATES TWO MOTELS: ONE IN FEDERAL WAY, WASHINGTON, AND ONE IN THE VICINITY OF THE SEATTLE-TACOMA INTERNATIONAL AIRPORT.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Cash Equivalents - Cash equivalents are investments with maturity at date of purchase of three months or less.\n(b) Inventory - Inventory consists of various operating supplies which have been valued at cost.\n(c) Property, Equipment, and Depreciation - Property and equipment are stated at cost and are dep eciated using straight-line and accelerated methods over estimated useful lives as follows:\n(d) Franchise Fees - Initial franchise fees are stated at cost and are being amortized over 20 years using the straight-line method.\n(e) Income Taxes - No provision has been made in the accompanying financial statements for federal or state income taxes as taxable income or loss of the partnership is allocated to and included in the taxable income of the partners. See Note 5 for additional discussion.\n(f) Income per Limited Partnership Unit - Net income per limited partnership unit is computed by dividing the limited partners' share of net income by the limited partners' units outstanding for each year.\n- 8 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\n(g) Accrued Vacation - It is the partnership's policy to expense vacation pay as paid rather than as earned as required by generally accepted accounting principles. The effect upon the financial statements is not significant.\n(h) Concentration of Credit Risk - The partnership has bank deposits in excess of federal deposit insurance limits. The partnership's management does not anticipate any adverse effect on its financial position resulting from the credit risk.\n(i) Use 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.\n(j) Loan Fees - Loan fees in connection with financing for remodeling the Sea-Tac motel are amortized over a five-year period.\nNOTE 3 - DISTRIBUTIONS AND ALLOCATIONS OF PROFITS AND LOSSES\nDistributions - Under the partnership agreement, on a quarterly basis, the general partner determines the amount, if any, of cash available for distribution and distributes cash as follows:\n- 1% to the general partner and 99% to the limited partners until the limited partners have received a cumulative pretax return on their adjusted capital investment equal to 10% per year through the end of the partnership year for which the distribution is being made, then\n- Payment of the unpaid balance of property management fees (see Note 6), then\n- Any remaining cash will be allocated 15% to the general partner and 85% to the limited partners.\nProfit and Losses - Profits and losses are allocated 1% to the general partner and 99% to the limited partners until the limited partners' have received a cumulative pretax return of 10% per year on their adjusted capital investment; and thereafter, 15% to the general partner and 85% to the limited partners. At the years ended December 31, 1995, 1994, and 1993, the limited partners received a cumulative pretax return of 10% and the partnership's net income for these years has been allocated 15% to the general partner and 85% to the limited partners.\n- 9 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 4 - LONG-TERM DEBT\nLong-term debt at December 31, 1995 and 1994, consisted of the following:\n- 10 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 4 - LONG-TERM DEBT (CONTINUED)\nBased on the December 31, 1995, interest rate, principal payments required on these notes during each of the next five years and thereafter are as follows:\nNOTE 5 - INCOME TAXES\nThe cost of certain assets and the amount of certain expenses reported for federal income tax purposes are different from the amounts reported under generally accepted accounting principles in the accompanying financial statements. The differences arise primarily from:\n(a) Depreciating land improvements and buildings for financial reporting purposes sing the straight-line method over a 30 year life, and for federal income tax purposes using the straight-line method over 15, 18, or 31.5 year lives.\n(b) Depreciating furniture and equipment for financial reporting purposes using the straight-line method over a five year life, and for federal income tax purposes using the accelerated cost recovery method or the modified accelerated cost recovery method over a five or a seven year life.\n(c) Deducting sales tax incurred prior to 1987 on property and equipment acquisitions as an expense for federal income tax purposes and capitalizing it for financial reporting purposes.\n(d) Amortizing capitalized interest for federal income tax purposes using a ten year life and for financial reporting purposes amortizing it over the lifeof the building.\n- 11 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 5 - INCOME TAXES (CONTINUED)\nFollowing is a reconciliation of net income for financial reporting purposes to net income for federal income tax reporting purposes for the years ended December 31, 1995, 1994, and 1993:\nNOTE 6 - RELATED-PARTY TRANSACTIONS\nTransactions between the partnership and the general partner, Gerald L. Whitcomb, and between the partnership and affiliates of the general partner are as follows:\nThe partnership has a management agreement with an affiliate of the general partner to employ the affiliate for a period of 20 years as manager of the motels owned by the partnership. The agreement provides for payment of a property management fee to the affiliate equal to 5% of the partnership's gross revenues from motel operations in addition to reimbursement of certain out-of-pocket cost incurred by the affiliate in connection with management of the property. The 5% base fees are property management fees. The reimbursements of out-of-pocket costs are recorded as administrative service fees.\n- 12 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 6 - RELATED-PARTY TRANSACTIONS (CONTINUED)\nPayment of property management fees is subordinated to receipt by the limited partners of a cumulative, pretax return on their adjusted capital investment of 10% per annum. This 10% was achieved as of June 30, 1992. Effective July 1, 1992, management began paying monthly the current management fees. Prior to December 31, 1992, management then determined, based upon working capital needs of Northwest I, that the first six months of 1992 and all of 1991 management fees were to be paid. Management fees paid during 1992 were $124,403 for 1992 and $111,973 for 1991. Management fees paid during 1993 were $115,480 for 1993. Management fees paid during 1994 were $119,617 for 1994 and $115,594 for 1990.\nManagement fees paid during 1995 were $115,938 for 1995.\nHowever, since the partnership agreement states that the management fees are to be paid out of operational cash flow, after paying the 10% return to limited partners, no payment for management fees relating to 1990 and before has been made. These unpaid management fees totaling $605,348 will be paid only when sufficient operational cash flow is experienced. In 1994 all management fees were accrued with restatement of prior years' information. See Note 7 for further discussion.\nNOTE 7 - PRIOR-PERIOD ADJUSTMENT\nAs discussed in the last two paragraphs of Note 6, management did not previously accrue unpaid property management fees because management then believed that such fees were not probable of payment. In 1994 the partnership adopted the accrual method of accounting for unpaid property management fees. Accordingly, the accompanying December 31, 1993, financial statements were restated.\nA summary of the effect of this restatement on the 1993 financial statements is as follows:\n- 13 - SUPER 8 MOTELS NORTHWEST I NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\nNOTE 8 - COMMITMENT\n(a) Franchise Agreement - The partnership has purchased franchise rights to provide motel services to the general public using a system commonly known as Super 8 Motels. An initial franchise fee of $15,000 was paid for each motel and the partnership is committed to pay additional fees equal to 4% of gross room revenue for the 20 year term of the agreement. The franchise agreement with Super 8 Motels, Inc. to pay 1% of gross room revenue to the national advertising fund was terminated December 31, 1995.\n(b) Lease Commitments - The partnership has an operating lease for equipment at the Sea-Tac motel. The term of the operating lease is 3.5 years.\nMinimum lease payments based on current rents are as follows:\nNOTE 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS\nCash and Cash Equivalents - The carrying amount approximates fair value because of the short-term maturity of those instruments.\nLong-Term Debt - The carrying amounts of the partnership's borrowings under its long-term revolving credit agreement and notes payable approximate fair value.\n- 14 -","section_15":""}
{"filename":"357020_1995.txt","cik":"357020","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nLTX designs, manufactures and markets automatic test equipment for the semiconductor industry that is used to test digital, linear and mixed signal (a combination of digital and linear) integrated circuits (\"ICs\") and discrete semiconductor components. The Company currently offers three lines of test systems: digital test systems, which test digital ICs, including microprocessors and microcontrollers; linear\/mixed signal test systems, which test a wide range of linear and mixed signal ICs; and discrete component test systems, which test small signal and high power semiconductor components. The Company also sells service and applications support for its test systems. The semiconductors tested by the Company's systems are widely used in the computer, communications, automotive and consumer electronics industries. The Company markets its products worldwide to both manufacturers and users of digital, linear and mixed signal ICs and discrete semiconductor components.\nINDUSTRY BACKGROUND\nAll semiconductor manufacturers use semiconductor test equipment (\"STE\") in the design and manufacture of ICs. During design, STE is used for design verification, characterization, qualification and failure analysis of ICs. During manufacture, STE is used during wafer probing to select usable ICs and after packaging to classify ICs by performance characteristics and to assure conformance with quality standards. Typically, all ICs are tested two or more times during the manufacturing process. In addition, certain large electronic equipment manufacturers employ STE for incoming inspection and for further classification of ICs.\nDemand for STE is driven by overall business expansion in the semiconductor industry and advances in semiconductor technology. When demand for semiconductors increases, semiconductor manufacturers will often purchase STE to meet their growing capacity requirements. Advances in semiconductor technology have allowed for increasingly complex semiconductor devices with improved performance, lower cost and greater reliability than earlier generations of devices. As a result, the use of semiconductors has proliferated across many industries, particularly in applications for the computer, communications, automotive and consumer electronics industries. In turn, semiconductor manufacturers are demanding STE that is faster, more versatile, more accurate, more productive and easier to program and maintain.\nAccording to industry sources, worldwide sales of STE totaled approximately $2.3 billion in 1994. Sales of STE for testing of digital, linear and mixed signal ICs and discrete components, which are the markets in which the Company participates, accounted for approximately $1.5 billion of this total. STE for testing of memory ICs accounted for the balance. Worldwide semiconductor shipments increased by approximately 29% and 32% in 1993 and 1994, respectively, and by approximately 45% in the first six months of 1995 over the comparable 1994 period. Worldwide shipments of STE increased by approximately 37% in 1994.\nPrices of STE systems generally increase as their capabilities increase. The acquisition of STE represents a significant investment on the part of the Company's customers, who typically consider both the capital and long term operating costs of the test system in the acquisition process. Factors that can vary from one test system to another, and thereby affect the total cost of testing, include:\nSpeed. A test system that offers faster test times or that is able to test more than one device at a time is able to test a greater number of devices over its product life, thus increasing the system's efficiency and reducing the customer's cost of testing.\nAccuracy. Superior accuracy improves the yield of the semiconductor production process because it reduces the number of good devices that are improperly rejected and permits the selection of a higher number of premium devices.\nEfficiency. Greater efficiency in test program preparation, loading and debugging leads to faster time to market for newly-designed semiconductors.\nSoftware. Test system operating software which is easier to use and more powerful reduces the amount of engineering resources needed to develop test programs and operate test systems.\nReliability. A test system that operates with minimal downtime allows the customer's production and engineering work to proceed without frequent intervention and provides more cost-effective operation.\nSystem Architecture. Test system architecture that is modular extends the product life of a test system because the system can be adapted to meet the customer's new requirements while largely retaining compatibility with existing test programs.\nCustomer Support. Customer specific applications programs, worldwide service and customer training contribute to the efficient use of STE and minimize the customer's cost of testing.\nCOMPANY STRATEGY\nLTX's objective is to be the leading supplier of STE in the markets in which it participates. The key elements of the Company's strategy are as follows:\nFocus on Leading-Edge Devices\nThe Company's test systems are designed to meet the design and production test requirements of leading-edge digital, linear and mixed signal ICs and discrete components. Testing of these devices requires high performance test systems. The Company believes that only STE manufacturers with sophisticated technological ability are able to compete effectively in this sector of the STE market. Moreover, the Company believes that by focusing on testing advanced devices, it is able to gain valuable insight into future market opportunities.\nDevelop Adaptable Test Systems\nThe Company designs its test systems so that they may be adapted and improved to meet its customers' future needs. This philosophy is reflected in the modular architecture of many of the Company's products, which permits both capacity additions and upgrading of performance as the Company develops new modular options and associated software. When possible, the Company also seeks to enable its customers to bridge different generations of the Company's products. For example, the Company's enVision software has been designed to operate on its new Delta Series products, as well as on its Master Series products.\nProvide Application Specific Solutions\nThe Company is committed to providing complete test solutions to its customers by having a substantial group of engineers strategically located at customer support centers throughout the world. By actively participating in the application of its test systems, the Company is able to learn more about requirements for new devices and to improve the design of future test systems. LTX also believes that its participation in the application of its test systems enables its customers to get devices to market more rapidly and builds stronger ties with these customers.\nLeverage Worldwide Presence\nThe semiconductor business is a worldwide industry, with well-established manufacturers in the United States, Europe and the Far East. The Company has nine offices in the United States, and in Europe maintains sales and support offices in the United Kingdom, France, Italy and Germany. In recent years, an increasing portion of semiconductor test and assembly operations has been conducted in the Pacific Rim by manufacturers based in the United States and Europe, as well as by local manufacturers. LTX has established sales and support offices in Korea, Taiwan and Singapore to focus on the specific needs of the markets within the Pacific Rim. In addition, through a majority-owned subsidiary, the Company provides sales and support services at three locations in Japan. The Company believes that this network of sales and support centers improves its ability to sell and support its products to the world's major semiconductor manufacturers.\nExecute Strategic Alliances in Japan\nThe Japanese semiconductor industry represents the second largest market in the world for STE. In Japan, the Company encounters significant competition from local STE manufacturers. In fiscal 1990, the Company strengthened its resources and presence in Japan by forming a joint venture with Sumitomo Metal Industries, Ltd. (\"SMI\") through which the Company currently sells and services its products in Japan. In addition, in fiscal 1993, the Company entered into a development, manufacturing and marketing agreement with Ando, a Japanese STE manufacturer and majority owned subsidiary of NEC, relating to the Delta 50, a new digital test system that the Company introduced in fiscal 1994. The Company believes that its alliance with Ando will better enable it to penetrate the Japanese digital production STE market. Moreover, since the Delta 50 is compatible with other Delta Series machines, the Company believes that sales of Delta 50 test systems to key Japanese semiconductor manufacturers will increase the Company's opportunities to sell other Delta Series test systems to these same manufacturers. In fiscal 1995, the Company entered into a development, manufacturing and marketing agreement with Asia Electronics, Inc. (\"Asia\"), a Japanese STE manufacturer which is 50% owned by Toshiba Corporation (\"Toshiba\"), relating to a new discrete component test system for testing integrated power modules that the Company plans to introduce in 1996. The Company believes that its alliance with Asia will increase LTX's penetration of the market for discrete component test systems in Japan.\nEmphasize Quality and Reliability\nThe Company's People Driven Quality (PDQ) Program is designed to continually improve all of its processes and increase the satisfaction of its customers. The Company believes that this program will lead to: more efficient and timely performance in engineering projects; improvement in manufacturing costs through the reduction of defective products and manufacturing cycle time; better on-time delivery performance; and greater reliability of its test systems.\nPRODUCTS AND MARKETS\nProduct Overview\nThe Company offers products in three broad product categories:\n- Systems that are used to test linear and mixed signal devices, which include the Synchro Series and Ninety;\n- Systems that are used to test digital devices, which include the Delta Series and Master Series, and enVision test development software; and\n- Discrete component test systems, marketed as the iPTest product line.\nSince its inception, the Company has shipped over $1.8 billion of products, including approximately $1.2 billion of linear\/mixed signal test systems and approximately $600 million of digital test systems. In fiscal 1995, sales of linear\/mixed signal test systems, digital test systems and discrete component test systems represented approximately 57%, 28% and 3%, respectively, of total net sales of the Company with service revenues representing 12%.\nThe Company's test systems are used by semiconductor manufacturers for design verification, characterization, qualification and failure analysis of ICs. In addition, certain large electronic equipment manufacturers use the Company's test systems for incoming inspection and for further classification of ICs. All of the Company's test systems are comprised of multiple computer-controlled instruments which send signals to a device under test and measure the responses of that device to classify the device by performance characteristics and to ensure conformance with quality standards. The Company's test system instrumentation is controlled by operating system software which is developed by the Company. The Company also develops and sells test programs for specific devices and offers software packages for use by semiconductor manufacturers for test simulation in engineering design and test program generation, data collection and statistical analysis in manufacturing.\nLinear and Mixed Signal ICs\nLinear ICs are used in almost every electronic application. Physical occurrences, such as sound, images, temperature, pressure, speed, acceleration, position and rotation, consist of continuously varying information. Linear ICs are used to amplify, filter and shape this information. Mixed signal ICs convert the signals from linear ICs into digital signals that can be processed by a computer. Mixed signal devices also convert processed digital information into a linear form to control physical phenomena or to improve sound and images.\nLinear and mixed signal ICs are widely used in automobiles, appliances, personal computers, telephones, personal communication products and home entertainment products such as video cassette recorders, cameras, compact disc players and video games. The complexity and density of these ICs have increased rapidly over the past several years, as the demand for portable, battery-operated products has required IC manufacturers to integrate more functions on each chip and reduce size and power consumption. These technological advances have resulted in increased demand for higher performance linear\/mixed signal test systems.\nDigital ICs\nDigital ICs include microprocessors, microcontrollers, programmable DSPs (digital signal processing), microperipherals and logic\/ASIC (application specific IC) devices. These ICs are used for computing, controlling and calculating functions, and are at the heart of most electronic products. The most well known of these devices is the microprocessor, which is the enabler of personal computer technology. Microcontrollers, however, are much more broadly used in automobiles, appliances, home entertainment products and many other electronic products which utilize electronic control functions. According to industry statistics, fewer than 200 million microprocessors were manufactured worldwide during 1994, while more than 2.5 billion microcontrollers were manufactured that year. The unit growth alone from 1993 to 1994 in microcontrollers shipped was approximately double the total production for microprocessors in 1994. Microprocessors can cost hundreds or even thousands of dollars, while microcontrollers typically cost tens of dollars. However, testing of microcontrollers can be as complex as microprocessors and requires high performance test systems.\nLINEAR\/MIXED SIGNAL PRODUCTS\nLTX offers two product lines for testing linear\/mixed signal ICs, the Synchro Series and Ninety, introduced in 1990 and 1986, respectively.\nSynchro Series\nThe Synchro is the latest generation of the Company's linear\/mixed signal test systems. Synchro test systems are designed for high throughput testing of linear devices and for testing mixed signal devices that require high digital pattern rates and high digital pin counts along with analog signal generation and measurement requirements. The Synchro features DSP(digital signal processor) - per-pin architecture which allows for concurrent control of both linear and digital resources at each pin of the IC under test. This design permits the generation of test signals and measurements on many device pins at the same time, producing faster test times on high pin count ICs. The Synchro systems are modular in design which enables customers to add new options to their systems in the future. This allows customers to increase the capability of their Synchro system to meet their new test requirements. Since its introduction, the Company has significantly upgraded the performance and capabilities of the Synchro through the introduction of new hardware and software.\nThe Synchro Series includes the Synchro II, Synchro Plus and Synchro ProductionPAC test systems:\nSynchro II. The configuration of the Synchro II test system is flexible. This permits LTX customers to choose from a wide array of options to meet the test requirements of a broad range of linear\/mixed signal devices.\nSynchro Plus. The Synchro Plus test system is configured with SuperSpeed Data Pins which can test mixed signal devices at data rates of up to 400 MHz. The Synchro Plus system addresses the test requirements of new, high speed devices used in applications such as disk drives for personal computers and advanced ATM(Asynchronous Transfer Mode) interface boards used to support the development of the information superhighway.\nSynchro ProductionPAC. The Synchro ProductionPAC test systems are lower cost, smaller footprint, specifically focused configurations that address the production requirements of high volume, low cost mixed signal devices. The RFPAC system is configured to test devices used in the rapidly expanding wireless communications market. The PowerPAC addresses \"smart\" power devices that are being increasingly used in automobiles and consumer electronics. The TelePAC addresses commodity ICs used in telecommunications. The ConverterPAC is focused on devices used in multimedia applications.\nAll Synchro Series test systems are fully compatible in hardware, software and specification. Current prices range from approximately $400,000 for a Synchro ProductionPAC system to approximately $2,000,000 for a high pin count Synchro Plus system.\nNinety\nThe Ninety system is an improved version of the LTX77, the Company's first linear\/mixed signal test system introduced in 1977. Although the Synchro has largely superseded the Ninety, the Company continues to manufacture the Ninety, primarily for customers who are already using the Ninety or LTX77 systems and desire to expand capacity. Many of the Ninety or LTX77 systems the Company has previously sold are currently still in use. In the past, the Company has upgraded the performance and capabilities of the Ninety system through the introduction of new hardware and software. As with the Synchro, a wide array of options are available. The current prices for a Ninety system range from approximately $200,000 to approximately $700,000, depending on the system configuration.\nSoftware Tools\nThe Company offers software for test program generation and debugging in manufacturing, called Device Tool, with its Synchro test systems. The Company also offers data collection and statistical analysis software, called dataVision. This software is test system independent and provides customers with solutions for integrated yield management in manufacturing and engineering device characterization. Device Tool typically sells for approximately $25,000 and dataVision typically sells for approximately $100,000.\nDIGITAL PRODUCTS\nLTX offers two product lines for testing digital ICs, the Delta Series and Master Series, which are marketed under the Trillium name. The Delta Series and Master Series product lines are based on a resource-per-pin architecture which allows for a complete set of the test system's key features (timing generators, waveform formatting and pattern memory) for each pin channel of the test system. The Company believes that this architecture provides for faster, simpler characterization and engineering debugging of new ICs, better system timing accuracy, and simplified interfacing with computer-aided design systems. The Company's enVision test development software is sold with both the Delta Series and Master Series product lines.\nDelta Series\nThe Company's new line of digital test systems, the Delta Series, includes the Delta 50, Delta\/ST and the Delta 100. Introduced in 1994, the Delta 50 was designed to meet the production test requirements of newer high volume, lower cost devices such as microcontrollers. The Delta 50 has a compact design and is capable of testing 512 pins at data rates of up to 50 MHz or 256 pins at data rates of up to 100 MHz. The Delta\/ST, introduced in 1995, incorporates Synchro mixed signal technology with Delta Series digital technology to address the test requirements of a new generation of devices with high performance analog signal interfaces to complex digital functions. These new devices are enabling the development of powerful, yet low cost consumer electronic products in areas such as multimedia and portable communications. The Delta 100, also introduced in 1994, was designed to test high performance microprocessors and the ICs that make up the chip sets that are used with them. The Delta 100 can test up to 512 pins at data rates of up to 100 MHz with timing accuracy of 150 pico seconds. The Delta 50, Delta\/ST, and Delta 100 operate with the Company's enVision software providing customers with compatibility among these systems. The current prices for the Delta Series test systems range from approximately $500,000 for a low pin count Delta 50 to approximately $4,000,000 for a high pin count Delta 100.\nIn fiscal 1993, the Company entered into a development, manufacturing and marketing agreement with Ando, a Japanese STE manufacturer and majority owned subsidiary of NEC, relating to the Delta 50. The Company has developed the Delta 50 in conjunction with Ando and has granted Ando exclusive rights to manufacture the Delta 50 in Japan. The Company has retained exclusive rights to manufacture the Delta 50 outside of Japan. Ando has the exclusive right to sell the Delta 50 in Japan and the Company has exclusive marketing rights for the rest of the world, with certain exceptions in each case. In connection with this agreement, the Company has received a payment of $6.5 million from Ando and will receive royalty payments on sales of the Delta 50 by Ando. In July 1994, the Company amended its development agreement with Ando to allow for further development enhancements to the Delta 50.\nMaster Series\nThe Master Series product line includes the Deltamaster and Micromaster test systems, which are enhanced versions of the Company's original digital test system. The Deltamaster, introduced in 1990, is a high-performance system with the capability of testing up to 256 pins at data rates of up to 80 MHz. The Micromaster, introduced in 1987, is a lower-priced system that can test up to 256 pins at data rates of up to 40 MHz. The Micromaster is device interface and software compatible with the Deltamaster. Although the Delta Series product line is expected to eventually replace the Master Series, the Company will continue to sell the Master Series test systems, primarily to customers who are already using these systems and desire to expand capacity. The current prices for the Master Series range from approximately $400,000 for a low pin count Micromaster to approximately $2,000,000 for a high pin count Deltamaster.\nenVision\nIn fiscal 1993, the Company completed the development of its new object-oriented enVision programming software for use on all its digital test systems. In earlier generation software languages, programming commands made direct reference to the hardware of the test system, which required the user to have a detailed knowledge of the system's hardware. In contrast, this detailed knowledge is not required when using enVision, thereby allowing the programmer to focus attention on refining the test program for the specific IC under test. Thus, the Company has designed enVision to be more device oriented than tester oriented. enVision permits a user to test multiple devices at the same time, significantly improving the throughput of the Company's digital test systems. enVision is an integral feature of the Delta Series product line and can be purchased by customers of the Master Series product line. The current price for enVision is approximately $15,000 per workstation.\nDISCRETE PRODUCTS\nThe Company's iPTest systems are used to test discrete semiconductor components, such as diodes, small signal transistors and power transistors, as well as arrays of these components. These discrete components are used in every area of electronics. For example, diodes are used in consumer, industrial and automotive applications; small signal transistors are used in consumer electronics, such as hearing aids and portable radios; and power transistors are used in audio amplifiers, radios and televisions. iPTest systems are also capable of accurately measuring the characteristics of transient voltage suppression components, which are widely used to protect personal computers and telecommunications products from harmful voltage spikes or surges.\nThe Company expects that arrays of discrete components, such as multi-device modules, will replace transistors in electric motor control and will permit a wider use of semiconductors in extremely high power applications, such as air conditioners, domestic appliances, electric locomotives and automobiles. These arrays of discrete components are mostly constructed from high power transistors of IGBT (insulated gate bipolar transistor) technology. In 1995, the Company introduced new options to its iPTest systems for high volume production testing of these discrete power components. The Company believes that these newer components may become the most significant market for discrete component test systems. In 1995, the Company entered into a development, manufacturing and marketing agreement with Asia, a Japanese STE manufacturer which is 50% owned by Toshiba, relating to a new discrete component test system.\nPrices of iPTest systems currently range from approximately $100,000 to approximately $700,000, depending on the system configuration and testing specifications.\nSERVICE\nThe Company considers service to be an important aspect of its business. The Company's worldwide service organization is capable of performing installations and all necessary maintenance of test systems sold by the Company, including routine servicing of components manufactured by third parties. The Company includes a one-year parts and three-month labor warranty on test systems or options designed and manufactured by the Company, and a three-month labor warranty on components that have been purchased\nfrom other manufacturers and incorporated into the Company's test systems. The Company also provides training on the maintenance and operation of test systems sold to its customers.\nThe Company offers a wide range of service contracts which gives its customers flexibility to select the maintenance program best suited to their needs. Customers may purchase service contracts which extend maintenance beyond the initial warranty provided by the Company with the sale of its test systems. Many customers enter into annual or multiple-year service contracts over the life of the equipment. The pricing of contracts is based upon the level of service provided to the customer and the time period of the service contract. As the installed base of LTX test systems has grown, service revenues have been increasing on an annual basis. The Company believes that service revenues should be less affected by the cyclicality of the semiconductor industry than sales of test equipment. The Company maintains 22 service centers around the world.\nSALES AND DISTRIBUTION\nThe Company sells its products primarily through its worldwide sales organization. In Japan, the Company sells, services and supports its products through its joint venture with SMI, except that Ando has the right to manufacture and sell the Delta 50 to certain customers in Japan and to sell the Delta 100 to these customers. The Company will share with its SMI joint venture specified portions of the royalties to be paid by Ando on any sales by it of the Delta 50 and of the revenues received on the Delta 100. In the future, Asia will be selling the Company's iPTest systems to certain customers in Japan. The Company uses a small number of independent sales representatives in certain other regions of the world.\nCUSTOMERS\nThe Company's customers include many of the world's leading semiconductor manufacturers. The Company's major customers in fiscal 1995 included:\nSales to these major customers accounted for approximately 60% of net sales in fiscal 1995. Sales to Philips accounted for approximately 17% of net sales in fiscal 1995. No single customer accounted for 10% or more of net sales in fiscal 1994. Sales to Intel accounted for approximately 16% of net sales in fiscal 1993.\nGEOGRAPHIC SALES\nThe following table sets forth the Company's net sales by geographic area as a percentage of total net sales for each of the Company's last three fiscal years:\nSales to customers outside the United States are subject to risks, including the imposition of governmental controls, the need to comply with a wide variety of foreign and United States export laws, political and economic instability, trade restrictions, changes in tariffs and taxes, longer payment cycles typically associated with international sales, and the greater difficulty of administering business overseas as well as general economic conditions. For information about the Company's foreign operations and export sales see Note 10 of Notes to the Company's Consolidated Financial Statements.\nENGINEERING AND PRODUCT DEVELOPMENT\nThe STE market is characterized by rapid technological change and new product introductions, as well as advancing industry standards. The Company's ability to remain competitive in the digital, linear and mixed signal IC and discrete component markets will depend upon its ability to successfully enhance existing test systems and develop new generations of test systems and to introduce these new products on a timely and cost-effective basis. Accordingly, the Company devotes a significant portion of its personnel and financial resources to engineering and product development programs and seeks to maintain close relationships with its customers in order to be responsive to their product needs. The Company's expenditures for engineering and product development were $19.7 million, $19.6 million and $19.8 million during fiscal 1993, 1994 and 1995, respectively.\nThe Company's engineering strategy is to develop its test systems in an evolutionary manner so that they may be progressively upgraded. This approach preserves its customers' substantial investments in test programs, and, in general, maintains market acceptance for the Company's test systems. In order to implement this strategy, the Company works closely with its customers to define new product features and to identify emerging applications for its products.\nMANUFACTURING AND SUPPLY\nLTX's principal manufacturing operations consist of component parts assembly, final assembly and testing at its manufacturing facilities in Westwood, Massachusetts and San Jose, California. Over the past year, the Company has significantly increased its outsourcing of certain subassemblies to contract manufacturers. The Company uses standard components and prefabricated parts manufactured to the Company's specifications. Most of the components for the Company's products are available from a number of different suppliers; however, certain components are purchased from a single supplier. Although LTX believes that all single-source components currently are available in adequate amounts, there can be no assurance that shortages will not develop in the future. Any disruption or termination of supply of certain single-source components could have an adverse effect on the Company's business and results of operations.\nCOMPETITION\nThe STE industry is highly competitive, with many other domestic and foreign companies participating in the markets for each of the Company's products. The Company's major competitors in the market for digital test systems are Schlumberger Limited, Teradyne, Inc. and Credence Systems Corporation, except in Japan where the Company's major competitor is Advantest Corporation (an affiliate of Fujitsu Limited). The Company's principal competitor for linear\/mixed signal test systems is Teradyne, Inc., except in Japan where the Company's major competitor is Yokogawa Electric Works. The Company's principal competitor for discrete component test systems is Tesec, Ltd. Most of the Company's major competitors are also suppliers of other types of automatic test equipment and have significantly greater financial and other resources than the Company.\nThe Company principally competes on the basis of performance, cost of test, reliability, customer service, applications support, price and ability to deliver its products on a timely basis. Although the Company believes that it competes favorably with respect to each of these factors, new product introductions by the Company's competitors could cause a decline in sales or loss of market acceptance of the Company's existing products. In addition, increased competitive pressure could lead to intensified price-based competition, resulting in lower prices and adversely affecting the Company's business and results of operations.\nBACKLOG\nAt July 31, 1995, the Company's backlog of unfilled orders for all products and services was approximately $98.4 million, compared with approximately $71.8 million at July 31, 1994. The Company expects to deliver approximately 92% of its July 31, 1995 backlog in fiscal 1996. While backlog is calculated on the basis of firm orders, no assurance can be given that customers will purchase the equipment subject to such\norders. As a result, the Company's backlog at a particular date is not necessarily indicative of actual sales for any succeeding period.\nPROPRIETARY RIGHTS\nThe development of the Company's products is largely based on proprietary information. The Company relies upon a combination of contract provisions, copyright, trademark and trade secret laws to protect its proprietary rights in products. It also has a policy of seeking patents on technology considered of particular strategic importance. Although the Company believes that the copyrights, trademarks and patents it owns are of value, the Company believes that they will not determine the Company's success, which depends principally upon its engineering, manufacturing, marketing and service skills. However, the Company intends to protect its rights when, in its view, these rights are infringed upon.\nThe Company licenses some software programs from third party developers and incorporates them in the Company's products. Generally, such agreements grant to the Company non-exclusive licenses with respect to the subject program and terminate only upon a material breach by the Company. The Company believes that such licenses are generally available on commercial terms from a number of licensors.\nThe use of patents to protect hardware and software has increased in the STE industry. The Company has at times been notified of claims that it may be infringing patents issued to others. Although there are no pending actions against the Company regarding any patents, no assurance can be given that infringement claims by third parties will not have a material adverse effect on the Company's business and results of operations. As to any claims asserted against the Company, the Company may seek or be required to obtain a license under the third party's intellectual property rights. There can be no assurance, however, that a license will be available under reasonable terms or at all. In addition, the Company could decide to resort to litigation to challenge such claims or a third party could resort to litigation to enforce such claims. Such litigation could be expensive and time consuming and could materially adversely affect the Company's business and results of operations.\nExecutive officers are chosen by and serve at the discretion of the Board of Directors of the Company.\nRoger W. Blethen was elected a President of the Company in February 1994. Mr. Blethen has been a Director since 1980 and had been a Senior Vice President of the Company from 1985 until February 1994. Mr. Blethen was a founder of LTX and has served in a number of senior management positions with the Company since its formation in 1976.\nMartin S. Francis was elected a President of the Company in February 1994. Mr. Francis has been a Director since 1991 and had been a Senior Vice President of the Company from 1991 until 1994. Prior to 1991, Mr. Francis had held senior management positions in the Company's European and Japanese operations from the time that he joined LTX in 1982.\nJohn J. Arcari has been Chief Financial Officer and Treasurer of the Company since 1987. He had been Controller of LTX since joining the Company in 1981. Prior to joining LTX, Mr. Arcari spent ten years with the public accounting firm of Price Waterhouse as a certified public accountant.\nKenneth E. Daub was appointed a Senior Vice President of the Company in 1991 and is responsible for North American and Pacific Rim sales. From the time he joined the Company in 1987 until 1991, Mr. Daub\nserved as Vice President responsible for North American Sales. Prior to joining the Company in 1987, Mr. Daub held various senior positions with Schlumberger Limited.\nAt July 31, 1995, the Company had a total of 944 employees, including 238 in engineering and product development, 185 in service and customer support, 323 in manufacturing and 198 in sales, marketing and administration. Many of the Company's employees are highly skilled, and the Company believes its future success will depend in large part on its ability to attract and retain such employees. None of the Company's employees are represented by a labor union, and the Company has experienced no work stoppages. The Company believes that its employee relations are excellent.\nENVIRONMENTAL AFFAIRS\nThe Company's manufacturing facilities are subject to numerous laws and regulations designed to protect the environment. The Company does not anticipate that compliance with these laws and regulations will have a material effect on its capital expenditures, earnings or competitive position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAll of the Company's facilities are leased. The Company maintains its headquarters in Westwood, Massachusetts, where corporate administration, sales and customer support and manufacturing and engineering for its linear\/mixed signal products are located. In May 1995, the Company subleased a 208,000 square foot facility at this location for a ten year term. The Company's lease of this facility expires in 2010. The Company is currently consolidating its operations into an adjacent 167,000 square foot facility. The lease of that facility expires in 2007. Manufacturing and engineering for the Company's digital products are located in a 70,000 square foot facility in San Jose, California. The lease of this facility expires in 1999. The Company also leases seven sales and customer support offices at various locations in the United States totaling approximately 40,000 square feet.\nThe Company's European headquarters is located in Woking, United Kingdom. The Company also maintains sales and support offices in facilities at four other locations in Europe. The manufacturing and engineering facilities for the Company's iPTest systems are located in Guildford, United Kingdom. The Company also maintains sales and support offices in six locations in the Far East. Office space leased in Europe and the Far East totals approximately 100,000 square feet.\nThe headquarters of LTX Co., Ltd., the Company's joint venture with SMI, is located in Kawasaki, Japan. The joint venture also leases additional offices in four other locations in Japan. Office space leased in Japan totals approximately 15,000 square feet.\nThe Company believes that its existing facilities are adequate to meet its current and foreseeable future requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has no material pending legal proceedings other than routine litigation relating to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of stockholders during the fourth quarter of fiscal 1995.\nPART II\nThe Company has never declared or paid cash dividends on the shares of Common Stock and does not anticipate paying any cash dividends on the shares of Common Stock in the foreseeable future. The Company currently intends to retain future earnings to fund the development and growth of its business. Moreover, the Company's credit agreement with a bank contains certain covenants which prohibit the payment of cash dividends by the Company.\nAs of September 13, 1995, there were 1,208 stockholders of record.\nITEM 7.","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nLTX designs, manufactures and markets automatic test equipment for the semiconductor industry. The Company sells and supports its products worldwide to both manufacturers and users of semiconductor components. LTX has been selling equipment to test linear\/mixed signal ICs since 1977 and digital ICs since 1985. The Company's business is largely dependent upon the capital expenditures of semiconductor manufacturers. The semiconductor industry is highly cyclical and has historically experienced recurring periods of oversupply, which often have had a severely detrimental effect on such industry's demand for test equipment. As a result of these and other factors, the Company incurred losses in fiscal years 1992, 1993 and 1994.\nThe Company has recently taken certain steps to attempt to mitigate the effect on its business of the cyclical nature of the semiconductor industry. In February 1994, the Company initiated a major restructuring program, including a reorganization of senior management. This restructuring program lowered the Company's break-even level of sales and aligned management responsibilities and objectives along the Company's product lines. The Company consolidated operations in Massachusetts and California, implemented a workforce reduction of approximately 100 employees and eliminated several levels of management. Largely as a result of these actions, quarterly operating expense levels were reduced $2.1 million in the second half of fiscal 1994. In addition, product reliability and product cost reduction programs were initiated to improve the Company's gross margins.\nIn fiscal 1995, the Company began delivering its Delta Series digital test systems and its Synchro ProductionPAC mixed signal test system. The Delta 50 and Delta\/ST systems were developed to meet the test requirements of newer high volume, lower cost devices such as microcontrollers. The Synchro Production PAC systems are lower cost, focused configurations aimed at the production requirements of a variety of new mixed signal devices. In July 1994, the Company strengthened its relationship with Ando Electric Company Ltd. (\"Ando\"), a Japanese STE manufacturer and majority-owned subsidiary of Nippon Electric Corporation, Ltd. (NEC). The Company received $20.0 million from Ando under a term loan agreement that extends through July 2001. In fiscal 1993, the Company entered into a development, manufacturing and marketing agreement with Ando relating to the Delta 50.\nSince the second quarter of fiscal 1994, the Company's operating results have improved significantly. The Company returned to profitability in the first quarter of fiscal 1995 and had net income of $10.7 million in fiscal 1995. The Company has substantially increased its backlog position, while increasing quarterly sales from $38.1 million in the second quarter of fiscal 1994 to $59.9 million in the fourth quarter of fiscal 1995. With the higher level of backlog, the Company has been able to manufacture and deliver its test systems more evenly within a quarter. Largely as a result of this, the Company generated $19.5 million in net cash flow from operations in fiscal 1995.\nFiscal 1995 Compared to Fiscal 1994\nStrong semiconductor industry conditions during fiscal 1995 resulted in a significant increase in demand for the Company's test systems. Orders for the Company's products and services were $236.9 million in fiscal 1995 as compared to $197.9 million in fiscal 1994, an increase of approximately 20%. In the fourth quarter of fiscal 1995, the Company achieved a record order level of $83.7 million. Orders for the Company's linear and mixed signal test systems remained at a high level in fiscal 1995, increasing 11% over fiscal 1994, while orders for the Company's digital products increased 41% year-to-year. As a result, the Company's backlog of unfilled orders for products and services was $98.4 million at July 31, 1995 as compared to $71.8 million at July 31, 1994.\nNet sales were $210.3 million in fiscal 1995 as compared to $168.3 million in fiscal 1994, an increase of approximately 25%. Sales of the Company's linear and mixed signal test systems were about 40% higher in fiscal 1995 as compared to fiscal 1994. Sales of the Company's digital test systems in fiscal 1995 were slightly higher than fiscal 1994. In the fourth quarter of fiscal 1995, sales of the Company's digital test systems were almost 50% higher than the fourth quarter of fiscal 1994. Service revenues were $25.1 million in fiscal 1995 as compared to $22.7 million in fiscal 1994.\nThe gross profit margin was 35.0% of net sales in fiscal 1995 as compared to 28.4% in fiscal 1994. The improvement in the gross profit margin was largely a result of proportionately lower fixed manufacturing costs on the higher level of shipments and higher average selling prices. In fiscal 1994, the gross profit margin was reduced by 2.1% as a result of a $3.5 million provision for excess inventories.\nEngineering and product development expenses were $19.8 million, or 9.4% of net sales, in fiscal 1995, as compared to $19.6 million, or 11.6% of net sales, in fiscal 1994. Engineering and product development expenses have remained approximately equal year-to-year reflecting the Company's continuing development efforts, particularly for its Delta Series and Synchro product lines.\nSelling, general and administrative expenses were $39.0 million, or 18.5% of net sales, in fiscal 1995, as compared to $42.3 million, or 25.1% of net sales, in fiscal 1994. The decrease in selling, general and administrative expenses of $3.3 million was largely a result of the Company's cost reduction and restructuring measures initiated in fiscal 1994, which included a workforce reduction and consolidation of facilities.\nNet interest expense was $3.8 million in fiscal 1995 as compared to $3.9 million in fiscal 1994. In July 1995, the Company's 13 1\/2% Convertible Subordinated Debentures Due 2011 were converted into 2,241,000 shares of Common Stock, reducing interest expense in the fourth quarter of fiscal 1995. In addition, lower average bank borrowings reduced interest expense in fiscal 1995 as compared to fiscal 1994. This reduction in interest expense was largely offset by an increase in interest due to a long-term loan the Company received in July 1994.\nThe tax provision of $0.4 million in fiscal 1995 reflected certain state and foreign tax provisions. The Company is in a net operating loss carryforward position in most tax jurisdictions. There was no tax provision in fiscal 1994 due to the net operating loss for the year.\nThe Company's Japanese subsidiary's results of operations were break-even in fiscal 1995. In fiscal 1994, the minority partner's share of the Company's Japanese subsidiary's net loss was $1.0 million.\nThe Company had net income of $10.7 million, or $0.36 per share, in fiscal 1995, as compared to a net loss of $31.3 million, or $1.23 per share, in fiscal 1994. The net loss in fiscal 1994 included a restructuring charge of $14.4 million and a provision for excess inventories of $3.5 million. The Company's operating results improved sequentially during fiscal 1995, beginning with net income of $0.8 million in the first quarter and ending with net income of $5.1 million in the fourth quarter. The quarterly improvement in the Company's results reflected the increasing level of sales, higher gross profit margin and reduction of operating expenses as a percentage of net sales.\nFiscal 1994 Compared to Fiscal 1993\nNet sales were $168.3 million in fiscal 1994 as compared to $172.9 million in fiscal 1993, a decrease of approximately 3%. Sales of the Company's linear and mixed signal products increased by over 30% in fiscal 1994 as compared to fiscal 1993, and service revenues increased by over 20% year-to-year. However, this improvement was offset by a reduction of over 30% in sales of the Company's digital product line in fiscal 1994 as compared to fiscal 1993. The decline in shipments of the Company's digital product line was due to lower demand from customers, particularly in North America, for testing microprocessors and other personal computer-related devices.\nThe gross profit margin was 28.4% of net sales in fiscal 1994 as compared to 34.4% in fiscal 1993. In the second quarter of fiscal 1994, the Company recorded a $3.5 million provision for excess inventories primarily as a result of lower than anticipated shipment levels in the first half of fiscal 1994. This provision lowered the gross profit margin by 2.1% of net sales in fiscal 1994. In fiscal 1993, the gross profit margin was increased by 2.6% as a result of a $6.5 million payment made by Ando under the terms of a development contract that was included in product sales. There was no similar contract revenue in fiscal 1994. The gross profit margin in fiscal 1994 was also adversely affected by proportionately higher fixed manufacturing costs on lower digital product sales and by lower average selling prices for the Company's digital products.\nEngineering and product development expenses were $19.6 million, or 11.6% of net sales, in fiscal 1994 as compared to $19.7 million, or 11.5% of net sales, in fiscal 1993. Engineering expenses in both fiscal 1994 and fiscal 1993 included significant development costs for the Company's new generation of digital products, the Delta Series, as well as enhancements to the mixed signal product line.\nIn March 1994, the Company announced a major restructuring program. The restructuring consisted of a consolidation of facilities, primarily involving the Company's leased facilities in Westwood, Massachusetts, and a workforce reduction of approximately 100 employees. As a result of those decisions, the Company took a $14.4 million restructuring charge to its second quarter results of operations. The restructuring charge largely related to the Company's plan to eliminate excess leased facilities and included amounts for severance payments and outplacement benefits for terminated employees. Largely as a result of the restructuring,\nengineering and product development expenses and selling, general and administrative expenses, combined, were $2.1 million lower in the fourth quarter of fiscal 1994 as compared to the second quarter of fiscal 1994.\nSelling, general and administrative expenses were $42.3 million, or 25.1% of net sales, in fiscal 1994 as compared to $42.5 million, or 24.6% of net sales, in fiscal 1993. The decrease of $0.2 million was due to a translation loss of $1.5 million in fiscal 1993, which was partially offset by personnel additions and higher costs for sales activities in the first half of fiscal 1994.\nNet interest expense was $3.9 million in fiscal 1994 as compared to $4.0 million in fiscal 1993. A decrease in interest expense in fiscal 1994 as a result of the conversion of the Company's 10 1\/2% Convertible Subordinated Debentures Due 2010 into Common Stock in July 1993 was largely offset by an increase in interest expense on higher average bank borrowings in fiscal 1994.\nThe Company's Japanese subsidiary had a net loss in fiscal 1994 and fiscal 1993. The minority interest in net loss of subsidiary represents the minority partner's share of the Company's Japanese subsidiary's loss in both years. The net loss in fiscal 1994 was reduced substantially from the prior fiscal year primarily as a result of an increase in sales and gross margin in fiscal 1994 over fiscal 1993.\nThere was no tax provision in fiscal 1994 or fiscal 1993 due to the net loss in both years.\nThe Company had a net loss of $31.3 million in fiscal 1994 as compared to a net loss of $4.3 million in fiscal 1993. The Company reported a net loss of $1.6 million in the first quarter of fiscal 1994 and a net loss of $24.0 million in the second quarter of fiscal 1994, including the restructuring charge of $14.4 million and a provision for excess inventories of $3.5 million. The Company reduced its net loss to $4.3 million in the third quarter of fiscal 1994 and to $1.4 million in the fourth quarter of fiscal 1994 as a result of a combination of lower operating expenses from the restructuring effort initiated in March 1994 and an increase in the Company's shipment level and gross profit margin.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and equivalents were $29.2 million at July 31, 1995 as compared to $17.2 million at July 31, 1994. The increase in cash and equivalents of $12.0 million was a result of $19.5 million of net cash provided by operating activities, $10.2 million of net cash used for property and equipment expenditures, $2.3 million of net cash provided by financing activities and $0.4 million of net cash provided by the effect of exchange rate changes.\nThe positive net cash flow from operating activities was primarily a result of the net income for the fiscal year, before non-cash depreciation charges. Although sales in the fourth quarter of fiscal 1995 were approximately 40% higher than the fourth quarter of the prior year, accounts receivable were $0.5 million lower year-to-year. The decrease in accounts receivable reflected the Company's ability to ship more evenly within a fiscal quarter and achieve a higher level of collections on those shipments within the fiscal quarter. Inventories increased $4.4 million during fiscal 1995 to meet the higher sales levels and to allow for more even shipments during the year. The increase in accounts payable of $6.0 million during fiscal 1995 relates to the higher level of inventory purchases during the period. At July 31, 1995, the Company had received $3.3 million in advance payments from customers for systems to be delivered in fiscal 1996. At July 31, 1995, the Company had a restructuring reserve of $6.1 million remaining to cover the estimated future cash flows relating primarily to excess leased facilities. Cash outflows during fiscal 1995 were $4.8 million for excess leased facilities and $0.8 million for severance payments. At July 31, 1995, the Company had working capital of $62.2 million and a ratio of current assets to current liabilities of 2.2 to 1.0.\nAdditions to property and equipment were $10.2 million during fiscal 1995 and were slightly higher than depreciation charges of $9.7 million. Equipment additions during fiscal 1995 were primarily for use in product development and customer support activities. The Company anticipates that expenditures for property and equipment in fiscal 1996 will be approximately $14.0 million.\nThe Company's Japanese subsidiary had bank borrowings of $8.5 million at July 31, 1995 as compared to $6.9 million at July 31, 1994. The Company had no borrowings outstanding under its domestic bank line at July 31, 1995 or July 31, 1994.\nIn July 1995, the Company's 13 1\/2% Convertible Subordinated Debentures Due 2011 were converted into 2,241,000 shares of Common Stock. The outstanding principal amount of $15.7 million of Debentures was converted at the conversion price of $7.00 per share. As a result, long-term debt was reduced by $13.1 million for the book value of the Debentures and stockholders' equity was increased by $12.1 million.\nManagement believes that the Company has sufficient cash resources to meet at least its fiscal 1996 needs. These resources include existing cash balances, borrowing availability under domestic and Japanese bank lines and future cash flows from operations, together with the proceeds from a proposed public offering of Common Stock by the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of LTX Corporation:\nWe have audited the accompanying consolidated balance sheet of LTX Corporation and subsidiaries as of July 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 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 financial statements referred to above present fairly, in all material respects, the financial position of LTX Corporation and subsidiaries as of July 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP Boston, Massachusetts September 8, 1995\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report, included in this Form 10-K, into LTX Corporation's previously filed registration statements on Form S-8 (File No. 2-77475, File No. 2-90698, File No. 33-7018, File No. 33-14179, File No. 33-32140, File No. 33-32141, File No. 33-33614, File No. 33-38675, File No. 33-51683, File No. 33-51685, File No. 33-57457 and File No. 33-57459) and on Form S-3 (File No. 33-62125).\nARTHUR ANDERSEN LLP Boston, Massachusetts September 19, 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.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned domestic subsidiaries and wholly-owned and majority-owned foreign subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nMinority interest in net loss of subsidiary represents the minority shareholder's proportionate share of the results of operations of the Company's majority-owned Japanese subsidiary (see Note 12).\nForeign Currency Translation\nThe financial statements of the Company's foreign subsidiaries are translated in accordance with Statement of Financial Accounting Standards No. 52. The Company's functional currency is the U.S. dollar. Accordingly, the Company's foreign subsidiaries translate monetary assets and liabilities at year-end exchange rates while nonmonetary items are translated at historical rates. Income and expense accounts are translated at the average rates in effect during the year, except for sales, cost of sales and depreciation which are primarily translated at historical rates. Net realized and unrealized gains and losses resulting from foreign currency remeasurement and transaction gains and losses, which have not been significant in the past three fiscal years, are included in the results of operations.\nCash Equivalents\nCash equivalents consist of short-term investments with maturity dates of one month or less and which are readily convertible into cash. The Consolidated Statement of Cash Flows for fiscal year 1993 and fiscal year 1994 has been reclassified to conform with the current year's presentation.\nInventories\nInventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method, and include materials, labor and manufacturing overhead.\nProperty and Equipment\nProperty and equipment is recorded at cost. The Company provides for depreciation and amortization on the straight-line method. Charges are made to operating expenses in amounts which are sufficient to amortize the cost of the assets over their estimated useful lives.\nRevenue Recognition\nRevenue from product sales is recognized at the time of shipment. Service revenues are recognized over the applicable contractual periods or as services are performed. Revenues from engineering contracts are recognized over the contract period on a percentage of completion basis.\nWarranty Costs\nWarranty costs incurred by the Company during the three years ended July 31, 1995 were not significant. Future warranty costs are not expected to be significant, and therefore, the Company has not provided any warranty reserves.\nEngineering and Product Development Costs\nThe Company expenses all engineering, research and development costs as incurred. Expenses subject to capitalization in accordance with the Statement of Financial Accounting Standards No. 86, relating to certain software development costs, were insignificant.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncome Taxes\nThe Company adopted Statement of Financial Accounting Standards No. 109 in fiscal 1994. The change in accounting principles was not material to the results of operations for the year ended July 31, 1993.\nDeferred income taxes are recorded for temporary differences between the financial reporting and tax basis of assets and liabilities. Research and development tax credits are recognized for financial reporting purposes to the extent they can be used to reduce the tax provision. The Company has not provided for federal income taxes on the cumulative undistributed earnings of its foreign subsidiaries in the past since it reinvested those earnings. At July 31, 1995, the Company's foreign subsidiaries had accumulated deficits.\nNet Income (Loss) per Share\nPrimary and fully diluted earnings per share are based on the weighted average number of shares of common stock and common stock equivalents (shares issuable under stock option plans and warrants) outstanding. None of the Company's Convertible Subordinated Debentures are common stock equivalents. Net loss per share is based on the weighted average number of shares of common stock outstanding only, as the inclusion of common stock equivalents would be anti-dilutive.\n4. NOTES PAYABLE\nThe Company's Japanese subsidiary had borrowings outstanding of $8,457,000 at July 31, 1995 under demand bank lines of credit. Borrowings of $7,662,000, at the local prime rate plus 1\/4%, are guaranteed by the Company's minority partner in Japan, and borrowings of $795,000, at the local prime rate plus 1 1\/8%, under a $2,273,000 demand bank line, are guaranteed by the Company. At July 31, 1994, the Company's Japanese subsidiary had borrowings outstanding of $6,870,000 under demand bank lines of credit.\nThe Company had no borrowings outstanding under a $5,000,000 domestic bank line at July 31, 1995 and July 31, 1994. This line of credit matures in December 1995 and bears interest at the bank's prime rate plus\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n1%. Borrowing availability under the line is on a formula basis and borrowings are secured by accounts receivable and inventories. The line of credit has financial covenants which largely relate to results of operations and a minimum level of liquidity.\nIn July 1994, the Company received $20,000,000 from Ando Electric Co., Ltd. of Japan (\"Ando\") under a long-term loan agreement which extends through July 2001. The loan bears interest at 8%, which is payable semi-annually and has semi-annual principal payments of $2,000,000 beginning in January 1997. The loan is secured by the Company's inventories and capital equipment and is subordinated in right of payment to senior indebtedness of the Company. In connection with this loan agreement, the Company issued to Ando a warrant to purchase up to 2,000,000 shares of common stock during the term of the loan agreement (See Note 8). The Company also expanded its existing license and development agreement with Ando to allow for further joint development of the Company's Delta 50 technology. Proceeds from the loan were used to repay domestic bank borrowings and to finance working capital requirements.\nIn July 1995, the Company's 13 1\/2% Convertible Subordinated Debentures Due 2011 were converted into 2,240,581 shares of common stock. The outstanding principal amount of $15,693,000 of Debentures was converted at the conversion price of $7.00 per share. On the conversion date, the Debentures had a book value of $13,149,000, which included the remaining unamortized original issue discount of $2,544,000.\nOn April 25, 1986, the Company issued and sold at par $35,000,000 of 7 1\/4% Convertible Subordinated Debentures Due 2011. A total of $7,308,000 of the original issue of $35,000,000 of 7 1\/4% Convertible Subordinated Debentures remain outstanding on July 31, 1995. The debentures are subordinated in right of payment to senior indebtedness and are convertible by the holders into common stock at $18 per share at any time prior to redemption or maturity. The debentures are redeemable at the Company's option at any time, in whole or in part, at 100% of the principal amount. Annual sinking fund payments of $366,000 are required beginning April 15, 1996. Interest is payable semi-annually on April 15 and October 15.\nOn July 30, 1993 Sumitomo Metal Industries, Ltd. of Japan converted its $6,375,000 10 1\/2% Convertible Subordinated Debenture Due 2010 into 1,500,000 shares of common stock of the Company. The Company had issued the debenture to Sumitomo Metal Industries, Ltd. in May 1990 (see Note 12).\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n7. INCOME TAXES\nAt July 31, 1995 the Company had, for tax purposes, $2,330,000 of federal tax credits available for carryforward, which expire in fiscal years 2000 through 2004. In addition, the Company had, for tax purposes, a federal net operating loss carryforward available of $30,500,000 which expires in fiscal years 2007 through 2010.\nThe tax provision of $372,000 in fiscal 1995 consisted of $50,000 in currently payable state income taxes and $322,000 in currently payable foreign income taxes.\nDeferred tax assets and liabilities as of July 31, 1994 have been reclassified to reflect the tax returns as actually filed. The valuation allowance relates to uncertainty surrounding the realization of the deferred tax assets, principally the tax loss carryforwards.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n8. STOCKHOLDERS' EQUITY\nAuthorized Shares\nAt the Company's Annual Meeting of Stockholders in December 1993, the stockholders approved an increase in the Company's authorized common stock from 50,000,000 shares to 100,000,000 shares.\nStock Option Plans\nThe Company has two stock option plans: the 1990 Stock Option Plan (\"1990 Plan\") and the 1995 LTX (Europe) Ltd. Approved Stock Option Plan (\"U.K. Plan\").\nThe 1990 Plan and the U.K. Plan provide for the granting of options to employees to purchase shares of common stock at not less than 100% of the fair market value on the date of grant. The 1990 Plan also provides for the granting of options to key employees, directors and advisors of the Company to purchase shares of common stock at prices to be determined by the Board of Directors. Compensation expense relating to shares granted under this plan at less than fair market value has been charged to operations over the applicable vesting period. Options under both plans are exercisable over vesting periods which are typically three-years beginning one year from the date of grant. In December 1994, the stockholders of the Company approved an increase to the number of shares of common stock that may be granted under the 1990 Plan, through October 2000, from 1,500,000 shares to 2,700,000 shares. At July 31, 1995, options to purchase 1,374,143 shares had been granted, and 1,325,857 shares were subject to future grant under the 1990 Plan. At July 31, 1995, 100,000 shares were subject to future grant under the U.K. Plan.\nThe following table summarizes stock option activity for the three years ended July 31, 1995:\nOf the total options outstanding at July 31, 1995, 1,135,014 shares were exercisable.\nWarrants\nIn July 1994, in connection with a term loan agreement, the Company issued to Ando Electric Co., Ltd. a warrant to purchase up to 2,000,000 shares of common stock, at the fair market value of $2.31 per share, during the term of the loan agreement (see Note 5). At July 31, 1995, the total warrant was outstanding.\nEmployees' Stock Purchase Plan\nIn December 1993, the stockholders of the Company approved the adoption of the 1993 Employees' Stock Purchase Plan, which replaced the 1983 Employees' Stock Purchase Plan which expired in December 1993. Under this plan, eligible employees may contribute up to 15% of their annual compensation for the purchase of common stock of the Company up to $25,000 of fair market value of the stock per calendar year. The plan limits the number of shares which can be issued for any semi-annual plan period to 150,000 shares\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nand, over the term of the plan, the Company may issue up to 600,000 shares. Under the plan, 299,708 shares were issued in fiscal 1995 and 19,520 shares were available for future issuance under this plan at July 31, 1995.\nRights Agreement\nThe Board of Directors of the Company adopted a Rights Agreement, dated as of May 11, 1989, between the Company and The First National Bank of Boston, as rights agent, and in connection therewith, distributed one common share purchase right for each outstanding share of common stock. The rights will become exercisable only if a person or group acquires 20% or more of the Company's common stock or announces a tender offer that would result in ownership of 30% or more of the common stock. Initially, each right will entitle a stockholder to buy one share of common stock of the Company at a purchase price of $30.00 per share, subject to significant adjustment depending upon the occurrence thereafter of certain events. Before any person or group has acquired 20% or more of the common stock of the Company, the rights are redeemable by the Board of Directors at $0.01 per right. The rights will expire on May 11, 1999, unless redeemed by the Company prior to that date.\n9. RETIREMENT PLAN\nThe Company's retirement plan provides for an annual discretionary contribution by the Company from current or accumulated profits of an amount not to exceed 5% of the eligible compensation of the participants in the plan. Amounts are allocated to the accounts of the participants based on their compensation and years of service and are subject to certain vesting provisions. No contributions were made in the past three fiscal years. Eligible employees may also make voluntary contributions to the plan through a salary reduction contract up to the statutory limit or 15% of their annual compensation. Beginning in October 1995, the Company will begin matching, up to certain prescribed limits, employees' voluntary contributions to the plan.\n10. GEOGRAPHIC AREA INFORMATION\nThe Company's operations by geographic segment for the three years ended July 31, 1995 are summarized as follows:\nTransfer prices on products sold to foreign subsidiaries are intended to produce profit margins that correspond to the subsidiary's sale and support efforts.\nTotal rental expense for fiscal 1993, 1994 and 1995 was $10,822,000, $9,849,000 and $9,611,000, respectively.\nAs a result of the Company's restructuring in fiscal 1994, certain excess leased facilities have been sub-leased. At July 31, 1995, the Company had accrued $1,159,000, which is included in restructuring charges on the accompanying balance sheet, relating to the lease commitments on these facilities.\n12. JOINT VENTURE AGREEMENT\nIn May 1990, the Company completed a joint venture agreement with Sumitomo Metal Industries, Ltd. (\"SMI\") of Japan to manufacture, sell and support the Company's semiconductor test equipment products in Japan. Under this agreement, the Company owns 50.5% of the shares of its Japanese subsidiary and 49.5% are owned by SMI.\nAt July 31, 1995, other assets include a minority interest receivable from SMI of $2,320,000 which arose as a result of cumulative losses of the Company's Japanese subsidiary allocable to SMI, exceeding SMI's investment in the Company's subsidiary. The Company believes this asset is fully realizable from SMI due to SMI's guarantee of a portion of the Company's Japanese subsidiary's bank lines of credit.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEMS 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT EXECUTIVE COMPENSATION SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under these Items is included in Item 1. of Part I of this report and in the Proxy Statement for the Annual Meeting of Stockholders to be held on December 13, 1995, under the headings \"Certain Stockholders,\" \"Election of Directors,\" and \"Compensation of Executives,\" which information is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year, July 31, 1995.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. FINANCIAL STATEMENTS\nThe following consolidated financial statements of LTX Corporation are included in response to Item 8:\nReport of Independent Public Accountants Consolidated Balance Sheet -- July 31, 1994 and 1995 Consolidated Statement of Operations for the years ended July 31, 1993, 1994 and 1995 Consolidated Statement of Stockholders' Equity for the years ended July 31, 1993, 1994 and 1995 Consolidated Statement of Cash Flows for the years ended July 31, 1993, 1994 and 1995 Notes to the Consolidated Financial Statements\n(B) 2. SCHEDULES\nSeparate financial statements of LTX Corporation (parent only) have been omitted since they are not required.\nAll other schedules have been omitted since they are not required, not applicable or the information is included in the financial statements or notes thereto.\n(A) 3. EXHIBITS\nCertain of the exhibits listed hereunder have previously been filed with the Commission as exhibits to the Company's Registration Statement No. 2-75470 on Form S-1 filed December 23, 1981, as amended (the 1981 Registration Statement); to the Company's Registration Statement No. 2-94218 on Form S-1 filed November 8, 1984, as amended (the 1984 Registration Statement); to the Company's Registration Statement No. 33-35401 on Form S-4 filed June 26, 1990, as amended (the 1990 Registration Statement No. 1); to the Company's Registration Statement No. 33-39610 on Form S-3 filed June 10, 1991, as amended (the 1991 Registration Statement No. 1); to the Company's Amendment No. 1 to Registration Statement No. 33-62125 on Form S-3 filed September 11, 1995 (the 1995 Registration Statement No. 1); to the Company's Form 8A\/A filed September 30, 1993 amending the Company's Registration Statement on Form 8-A filed November 24, 1982 (the 1993 8A\/A); to the Company's Current Report on Form 8-K, filed May 11, 1989; or the Company's Annual Reports on Form 10-K for one of the years ended July 31, 1994, 1993, 1992, 1991,\n1990, 1989, 1988, 1987, 1986, 1985, 1984 and 1983 and are hereby incorporated by reference. The location of each document so incorporated by reference is noted parenthetically.\nPursuant to Item 601 of Regulation S-K, certain instruments with respect to long-term debt not exceeding 10% of the total assets of the Company and its subsidiaries on a consolidated basis are not filed herewith. The Company hereby agrees to furnish to the Commission a copy of each such instrument upon request.\nITEM 14(B). REPORTS ON FORM 8-K\nThe Company did not file any reports on Form 8-K during the fourth quarter of fiscal 1995.\nThe subsidiaries listed are all included in the consolidated financial statements of the Company.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLTX CORPORATION\n\/S\/ ROGER W. BLETHEN \/S\/ MARTIN S. FRANCIS By ................................. ROGER W. BLETHEN DIRECTOR AND PRESIDENT MARTIN S. FRANCIS DIRECTOR AND PRESIDENT September 19, 1995","section_15":""}
{"filename":"805647_1995.txt","cik":"805647","year":"1995","section_1":"ITEM 1 - BUSINESS\nGENERAL\nFinancial Institutions Insurance Group, Ltd. (the \"Registrant\") is an insurance holding company which, through its subsidiaries, underwrites insurance and reinsurance. The principal lines of business include professional liability, directors and officers liability, property catastrophe reinsurance and other lines of property and casualty reinsurance.\nThe Registrant conducts its business by operating an insurance company and managing insurance and reinsurance assumptions through two underwriting agencies.\nThe First Reinsurance Company of Hartford (\"First Re\") is the largest subsidiary. Incorporated in 1911, First Re was the first reinsurance company formed in the United States. First Re is domiciled in the State of Connecticut and currently maintains direct licenses in 20 states. First Re has reinsurance authorities in an additional 14 states. A second insurance company, Financial Institutions Insurance Fund, Incorporated (\"FIIF\"), was sold in the third quarter of 1994, after all of its business and unrestricted net assets were transferred to First Re.\nThe principal underwriting activity of the group is managed by a wholly-owned subsidiary, Oakley Underwriting Agency, Inc. (\"Oakley\"). Formed in 1993, Oakley underwrites directors and officers liability insurance and professional liability insurance coverages on behalf of First Re and Virginia Surety Company, Inc. (\"VSC\"). VSC is an unaffiliated insurance company that maintains an underwriting contract with Oakley.\nOakley produces its business through independent insurance agents and brokers. In 1994, Oakley became the major source of premium revenue for the Registrant, providing 78.5% of the net written premium revenue and 66.1% of the earned premium revenue. In 1995 Oakley premiums increased to 88.3% and 84.4% respectively of the Registrant's total net written and earned premium.\nFirst Re provides reinsurance behind VSC on the Oakley produced premium. The agreement with VSC permits First Re to retain approximately 70.0% of the gross premium revenue paid by the insureds. The remaining 30.0% of the premium is ceded to approximately 15 other reinsurance companies. First Re assumes a maximum net exposure of $500,000 per risk under the current reinsurance program that expires April 1, 1996.\nThe non-Oakley reinsurance activities of First Re depend on agreements (\"reinsurance treaties\") that have been entered into with non-affiliated ceding insurance companies that market and underwrite policies of insurance. First Re has entered into reinsurance treaties whereby companies cede a portion of their premiums, commissions and related incurred losses to First Re.\nThese agreements consist of both quota share and excess of loss treaties with the ceding companies. The principal distinction between these two types of agreements is that in quota-share treaties, the reinsurer usually takes a pro rata portion of the risk and receives that pro rata portion of the premium revenues. Under the excess of loss treaty, for a specified rate, a portion of the liability is assumed in excess of a specific retention and up to the agreed reinsurance limit.\nThe treaties are usually for a one year duration and cover policies attaching during that period. The policies covered by the agreements are normally for a one year term. Most of the premiums written in 1995 were for quota share treaties. These treaties with ceding companies were the primary source of non-investment related income during 1995. The loss of revenues from any one treaty or cedant would not affect the Registrant's ability to remain a going concern.\nGENERAL (CONTINUED)\nFirst Re recognizes premium revenues according to the terms of the reinsurance treaties and the insurance contracts it issues. Premiums assumed under the terms of quota share treaties are earned by the cedant on a pro rata basis, whereas premiums assumed on excess of loss treaties are calculated by applying the respective rate and participation percentages to the subject premiums. In both kinds of treaties, the premiums earned are based on the terms and the periods of the underlying insurance contracts.\nIn addition, First Re exercises the right to periodically review ceding companies' records to evaluate their compliance with such matters as premium accounting, underwriting standards and claims handling. Reports on the performance of the ceding companies are reviewed by the Registrant's affiliates.\nAt year end, the Registrant's subsidiaries had 25 full-time employees and 7 part-time employees and maintained offices in Chicago, Illinois and Avon, Connecticut.\nPRODUCTS AND COMPETITORS\nOakley operates as an insurance underwriting agency, writing professional liability and directors and officers liability insurance policies under contracts with First Re and VSC. The producers of this business are both retail and wholesale insurance brokers who represent the insureds. Oakley underwrites, issues and maintains the policies on behalf of First Re and VSC. First Re assumes a portion (approximately 70.0%) of the gross written premium that VSC cedes to its reinsurers after deductions for acquisition costs. In 1995, 40.6% of the premiums written through the Oakley operation were written directly for First Re. First Re, when acting as the insurer, shares the same reinsurance protections as are arranged for VSC. The Oakley operation gives First Re a larger degree of control over the risk selection at reduced commission terms than it could expect as a quota-share reinsurer.\nA directors and officers liability policy indemnifies its directors and officers for claims made against the directors and officers for wrongful acts. The policy is written on a claims made basis and provides coverage to insureds, not for profit entities, public entities, and educational entities. The professional liability policy provides selected lines of business with insurance for errors and omissions in the conduct of the insureds professional activities. The majority of the professional liability business written covers lawyers, architects and engineers, consultants and insurance agents. These policies are also written on a claims made basis.\nFirst Re also operates as a reinsurer in the intermediary segment of the reinsurance market. Business is produced by non-affiliated reinsurance intermediaries (brokers) who represent various ceding companies in the purchase of quota-share and excess of loss reinsurance.\nFirst Re assumes various lines of property and casualty reinsurance. These exposures are typically less than 10.0% of any one reinsurance program. The property exposures are excess of loss and quota share coverages. The liability lines are professional liability, directors and officers liability, municipal liability and auto exposures. First Re competes with other reinsurance companies within the intermediary market and with direct marketing reinsurers. A direct market reinsurer does not use intermediaries, but instead markets its reinsurance through an employed production staff.\nFactors that affect First Re's ability to compete in the insurance and reinsurance marketplace are: (1) approval by various state regulatory authorities, brokers, reinsurance intermediaries and ceding companies which would enable other companies to transact business with First Re, (2) First Re's \"A-\" rating by A.M. Best Company, the traditional rating agency for the reinsurance (insurance) industry, and (3) the size of the surplus of First Re.\nThe agreement structured between Oakley and VSC allows Oakley to utilize a company that has in place the filings necessary to compete in the current marketplace until First Re can gain its own approvals by various state insurance departments. VSC is rated A+ (Superior) by A.M. Best Company. There is no one dominant company that can be identified as a major competitor of First Re. The insurance industry is a competitive marketplace where no one insurer or reinsurer dominates the industry.\nPRODUCTS AND COMPETITORS (CONTINUED)\nThe competitive marketplace for products changes with cycles in the insurance industry. At any given time there are a number of insurance carriers competing for professional liability, property-casualty reinsurance programs, and directors and officers liability insurance. Over the last three years, First Re has reduced its dependence on VSC production by expanding First Re's ability to write insurance business and by expanding into new lines of reinsurance from other insurance companies. It is management's intent to continue to build the Oakley\/First Re facilities. See further discussion under \"Customers.\"\nFor further discussion of these products and their inherent risks, see the General Business section of the Management Discussion and Analysis, Item 7 on page 9.\nLICENSING AND REGULATION\nInsurance and reinsurance companies must comply with laws and regulations of the jurisdictions in which they do business. These regulations are designed to ensure financial solvency of insurance and reinsurance companies and to require fair and adequate service for policyholders. The regulations are enforced in the United States and certain other countries through the granting and revoking of licenses to do business. Licensing of agents, monitoring of trade practices, policy form approval, maximum premium and commission rates, investment parameters, underwriting limitations, minimum reserve and capital requirements, transactions with affiliates, dividend limitations, changes in control and a variety of other financial and non-financial components of an insurance company's business are also regulated under the various regulatory jurisdictions. These regulations and procedures are administered by individual state insurance departments by means of regular reporting procedures and periodic examinations. The quarterly and annual financial reports to the regulators in the various states utilize accounting principles (statutory accounting principles), which are different from the generally accepted accounting principles used in stockholder reports. The statutory accounting principles, in keeping with the intent to assure policyholder protection, are primarily based on a solvency concept, while generally accepted accounting principles are based on a going concern concept. The Registrant believes that more, rather than less, regulation is likely in the future.\nIn particular, the National Association of Insurance Commissioners (\"NAIC\") has adopted systems of assessing risk based capital and establishing statutory capital requirements based on levels of risk assumed by insurance companies. Based on the formulas adopted by the NAIC in 1994, the capital of First Re exceeds required levels by a significant margin. The Registrant does not foresee any regulatory impediments to its planned operations.\nCUSTOMERS\nThe Registrant's principal source of revenue, other than that which it derives from its investment portfolio, is now produced by Oakley. The Oakley business has increased from 16.5% in 1993 to 66.4% in 1994, and to 84.4% in 1995, of the total premiums earned. The other reinsurance business provided 15.3%, 23.0% and 27.0% in 1995, 1994, and 1993 respectively of premiums earned. These are the two main components of the Registrant's current business.\nThe VSC financial institutions blanket bond and directors and officers sources of business, were approximately 0.2%, 10.5% and 54.3%, of the premiums earned in 1995, 1994, and 1993 respectively.\nOakley markets its products through a network of producers who represent the insureds. Approximately 50 independent producers account for 90% of the Oakley business. Additionally, the Oakley staff visits producers, advertises in trade publications and participates in industry seminars and conferences to promote its products and further its relationships with the producers.\nFirst Re is continuing to develop its insurance and reinsurance sources of income as opportunities present themselves.\nMANAGEMENT\nThe following table sets forth, with respect to each director or executive officer, his or her age and position with the Registrant.\n* Age as of December 31, 1995\nJohn A. Dore, Lonnie L. Steffen, Robert E. Wendt and Lana J. Braddock have entered into employment agreements with certain subsidiaries of the Registrant in the forms filed as exhibits 10(f) and 10(g) to the Registrant's Form 10-K for the year ended 12\/31\/90.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES No properties are owned by the Registrant that are material to its business.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS There are no material legal proceedings. All pending legal proceedings are incidental to the normal course of the insurance business of First Re.\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\nEffective January 19, 1993, the Registrant's common stock began trading on The NASDAQ Stock Market, under the symbol FIRE. During 1995 and 1994, the Registrant's stock traded at adjusted prices ranging from a high of $14.48 to a low of $7.99.\nDuring 1995, trades occurred at the following prices:\nDuring 1994, trades occurred at the following prices:\nAs of December 31, 1995, there were approximately 325 holders of record of the Registrant's common stock.\nThe Registrant had 707,300 shares retained as treasury stock at December 31, 1995. The Board of Directors of the Registrant have reviewed proposals for future utilization of these shares. A limited number of shares has been made available to the directors and officers of the Registrant. (See Note I of the Notes To Consolidated Financial Statements.)\nAt its December 10, 1993 board meeting, the Registrant declared a 2 for 1 split of the common stock to be effected by a distribution on February 24, 1994 of one fully paid and non-assessable share of common stock for each share of stock outstanding to stockholders of record on January 20, 1994. At the June 7, 1995 meeting of the Board of Directors, a 20% stock dividend was declared payable on August 24, 1995 to stockholders of record on July 27, 1995. At the December 6, 1995 board meeting, the Registrant declared another 20% stock dividend payable February 22, 1996 to stockholders of record on January 25, 1996. Information set forth herein has been adjusted to reflect the stock split and dividends.\nThe Registrant intends to retain a substantial portion of its earnings to finance future growth and, until 1990, had not paid any cash dividends. The Registrant declared or paid the following cash and common stock dividends in 1994 and 1995 to holders of record of outstanding shares of common stock:\nITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (CONTINUED)\nIn declaring the most recent dividend, the Registrant considered its current financial condition with special attention to current income and retained earnings and the Stockholder Dividend Policy approved by the Board of Directors at a meeting on December 12, 1990 (the \"Dividend Policy\"). In considering the Dividend Policy, the Board gave effect to the Dividend Policy's guidelines that the amount available for the current year's cash distribution would be in the range of 15-25% of the previous year's net income, provided the net income of the most recent two quarters was at least 90% of the respective quarters a year earlier. There is no assurance that dividends will continue to be considered with reference to the guidelines described above, and the Registrant's Stockholder Dividend Policy is at all times subject to change at the discretion of the Board of Directors. See also Note E to the Notes to Consolidated Financial Statements.\nITEM 6","section_6":"ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA FINANCIAL INSTITUTIONS INSURANCE GROUP, LTD.\n(**) As of 12\/10\/93 a 2-for-1 stock split to shareholders of record on January 20, 1994 was recorded.\nAs of 6\/7\/95 a 20% stock dividend was declared payable to stockholders of record on July 27, 1995.\nAs of 12\/6\/95 a 20% stock dividend was declared payable to stockholders of record on January 26, 1996.\nEarnings per share were restated to reflect the stock dividend dilution.\n(*) As of 12\/6\/95 $.075 of dividends were declared payable to stockholders of record on January 26, 1996 and were accrued by FIIG as part of the other liabilities.\nThe accompanying notes are an integral part of these financial statements.\nCertain balance sheet amounts have been reclassified for prior years to conform with 1995 presentations.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL BUSINESS\nThe profitability of the property-casualty business is dependent on competitive influences, the efficiency and costs of operations, investment results between the time premiums are collected and losses are paid, the level of ultimate losses paid, and the ability to estimate each of these factors in setting premium rates. Investment results are dependent on the selection of investment vehicles, the ability to project ultimate loss payments, and the timing of the loss payments. Ultimate loss payments are dependent on the types of coverages provided, results of litigation, the geographic areas of the country covered and the quality of underwriting.\nThe major product lines the Registrant reinsures are professional liability, directors & officers (\"D&O\") liability, other reinsurance lines, and run-off reinsurance exposures acquired in the First Re acquisition. These product lines and their unique risk characteristics are discussed below.\nOAKLEY PROFESSIONAL LIABILITY COVERAGES\nOakley was formed in April 1993 to underwrite professional liability and D&O coverages. The underlying business had been managed by an experienced staff and established systems at VSC. Oakley agreed to hire certain staff from VSC and entered into an arrangement that compensates VSC for its costs with an override related to the renewal of policies and the use of VSC as the issuing carrier until First Re can gain the necessary approvals to insure these coverages. The exclusive portion of the contract with VSC was extended until September 1996. In 1995 84.4% of First Re's premiums earned came from Oakley, up from 66.1% in 1994 and 16.5% in 1993.\nASSUMED REINSURANCE\nSince 1991, First Re has expanded its reinsurance business by writing participating coverages brokered by reinsurance intermediaries. As a result of these efforts, First Re has been able to increase existing business lines in casualty, professional liability and property catastrophe. These exposures are typically less than $500,000 per insured exposure of each reinsurance program ceded and have different risk characteristics from the Registrant's insurance program.\nThe property exposures are significant natural disaster coverages where First Re reinsures the insureds losses in excess of underlying retentions and reinsured coverages. The losses on this class are reported and settled in a shorter time frame than First Re's traditional business. Catastrophe losses are sporadic, difficult to predict and vary depending on the cedent's underwriting exposures.\nBecause of the sporadic nature of the insured catastrophes, in any one year the losses incurred can exceed the premiums for that year. The underwriters for this class typically attempt to recoup this shortfall of premiums in excess of losses over a period of time.\nThe professional liability and casualty reinsurance components of this business are typically claims-made policies that reimburse injured third parties or defend insureds for wrongful acts.\nAt December 31, 1995, 1994 and 1993 these programs accounted for 15.3%, 23.0% and 27.0% respectively of First Re's earned premium.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nFINANCIAL INSTITUTIONS REINSURANCE\nThe Registrant was originally formed to support reinsurance of financial institutions blanket bond and directors and officers liability insurance coverages. First Re reinsured two companies, Virginia Surety Company, Inc. and Dearborn Insurance Company (\"DIC\"), both affiliates of Aon Corporation (\"Aon\"). Effective July 1, 1993, VSC withdrew from the market for these coverages.\nThe financial institutions reinsurance was approximately 0.2%, 10.5% and 54.3%, of the premiums earned in 1995, 1994, and 1993 respectively. All of the policies expired by June 30, 1994.\nFirst Re continues to reserve and pay claims on these lines of business.\nBLANKET BOND COVERAGE (\"BOND\")\nThe Bond policy issued by VSC\/DIC, which was marketed by Aon affiliates and in part reinsured by First Re, is based on a Surety Association of America standard form. This program was terminated when VSC withdrew from the market on July 1, 1993. The policy provides for indemnification of the insured financial institution for any losses discovered during the period of coverage.\nBonds policies issued as a result of the treaties had limits up to $5,000,000, of which First Re reinsured 50% of the first $500,000 limit and 11% of the limits between $500,000 and $5,000,000.\nDIRECTORS AND OFFICERS LIABILITY COVERAGES\nThe D&O liability coverages issued by VSC\/DIC and other ceding companies, and reinsured in part by First Re, is a Directors and Officers and Company Indemnity Policy form (\"Policy\"). The policy was marketed by Aon Corporation affiliates until the program terminated July 1, 1993, when VSC withdrew from the market for this coverage.\nPolicies issued from this treaty coverage had limits up to $3,000,000, of which First Re reinsured $600,000 (in 1993) and amounts up to $1,000,000 in earlier years.\nCLAIMS INCURRED AND RESERVES\nThe reinsurance contracts generally have customary clauses which bind First Re to pay its share of claims and claim settlement costs. First Re reviews and monitors all aspects of the reinsurance relationships based on the monthly or quarterly reports it receives as part of the contract terms.\nOakley claims are adjusted by an affiliate of Aon for VSC, First Re and its reinsurers. The claims are typically reported to the insured's broker who in turn reports them to Oakley or VSC. VSC reports the claims to reinsurers as per terms of the reinsurance agreements in place. Some of the claims reported will be notification of an incident or potential claim that will ultimately be closed without payment or indemnity. Legal counsel is assigned to significant claims.\nFirst Re establishes reserves for its loss and loss adjustment expense liabilities. These liabilities consist of accruals for reported claims and estimates for incurred but not reported claims (\"IBNR\"). First Re utilizes ceding company actuarial reports, industry experience, independent legal counsel and its own experience to establish IBNR reserves.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCLAIMS INCURRED AND RESERVES (CONTINUED)\nThe following table outlines the respective reserve components and their balances at December 31, 1994 and at quarterly intervals through the period to December 31, 1995:\nFirst Re regularly monitors the relative proportions of its gross reserves to ensure that they are adequate. In the event such reserves are deemed to be either redundant or deficient, adjustments are made at the time of such determination. Such adjustments were recorded as reductions in losses and loss adjustment expenses in the consolidated income statement for 1995, 1994 and 1993 in the amounts of $4,883,000, $3,352,436, and $1,648,000, respectively.\nManagement considers First Re's gross and net reserves to be adequate to support the level of premiums previously written.\nLIQUIDITY & CASH FLOWS\nThe extended development period on claims permits First Re to invest the reserves from the associated premiums and then realize investment income. Such extended periods may also cause temporary and possibly significant pressure on liquidity due to unanticipated requests for claim payments.\nThe Registrant engages the firms of Asset Allocation and Management Company (\"AAM\") and Otter Creek Management, Inc. (\"OCM\") to provide investment portfolio management services under the Board of Directors' approved guidelines, which in turn are conformed to the insurance laws of Connecticut. The investment portfolio remains at investment grade quality. No investment in a single security or issuer exceeds 5.0% of the total investment portfolio. OCM began managing $5,000,000 of the portfolio January 1, 1994 and the portfolio had a market value of approximately $6,700,000 at December 31, 1995. OCM is controlled by a director of the Registrant who manages portfolios for a variety of clients seeking investments in certain segments of the market that are perceived as undervalued. In January 1995, the Registrant invested $1,000,000 in PSCO Partners Limited Partnership (\"PSCO\"), a limited partnership, that invests in publicly held financial services stocks. The partnership is recorded as part of the common stock investments of the Registrant.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY & CASH FLOWS(CONTINUED)\nThe Registrant's investment portfolio has been structured such that the average expected maturity of the portfolio is approximately three and one half years. The length of time needed to settle claims from contracts or policies is influenced by the type of coverage involved, the complexity of the individual loss occurrence and the early determination of ultimate liability. Management believes that it has positioned the Registrant's investment portfolio to ensure that it can meet its obligations without adverse deviation from its current investment objectives. It is also believed that the Registrant's current investment policies permit it to continue to take advantage of favorable changes that might occur in the investment marketplace. The Registrant has also reduced exposure to duration risk and maintains an investment grade portfolio with an average credit rating of \"A\" as determined by Moodys.\nAt January 1, 1994, First Re had capital loss carryforwards of approximately $404,000, which were utilized in 1994 to offset taxes due on the realized capital gains of $570,231. Approximately $778,000 of the $1,275,142 gains recorded in 1993 were free of taxes paid, due to the utilization of capital loss carryforwards. The capital gains realized in 1995 were fully taxed.\nAs part of its revised investment policy, the Registrant elected, beginning in 1991, to segregate its securities held for investment from those which are held for trading. Fixed maturities held for investment were carried at amortized cost, because the Registrant had the ability and intent to hold such investments to maturity. As of December 31, 1993, the Registrant adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 allows the Registrant to classify its portfolio of fixed maturities and equity securities as available for sale and to report them at market value. The market value of the non-redeemable preferred equities at December 31, 1995 was $6,091,931. Fixed maturities held for sale had a market value of $58,834,592 as of December 31, 1995. Common stocks had an aggregate market value of $4,148,237 at December 31, 1995.\nThe unrealized gain or loss on these securities in the held for sale portfolio is recorded directly to stockholders' equity less the applicable capital gains tax. The unrealized gain net of taxes on these securities was $1,542,730 at December 31, 1995. Short-term investments are carried at the lower of amortized cost or market value, which was $6,110,072 and $4,673,778, as of December 31, 1995 and 1994 respectively.\nThe Registrant believes that it will not have to sell invested assets to meet its obligations ahead of their scheduled maturities. There are no equity investments with an unrealized loss position that represent a permanent impairment to the Registrant's fixed capital structure.\nCash balances at year end were $3,782,536 in 1995 as compared to $3,251,227 in 1994.\nCash flow provided from operations was $5,368,018 in 1995 as compared to $2,933,553 in 1994 and $1,014,343 in 1993. Investing activities used cash in the amount of $4,413,500 in 1995 and $3,981,220 in 1994 as compared to a contribution of $3,266,013 in 1993.\nFinancing activities used cash amounting to $423,209, $564,822 and $517,825 in 1995, 1994 and 1993 respectively. Receipt of shareholder loans and proceeds from stock options totaling $270,754 offset an increase in stockholder dividends of $129,141 in 1995. Payment of cash dividends was the sole financing activity in 1994 and 1993.\nThe Oakley operations of the Registrant generated most of the cash increase from operations in 1995 and 1994. Oakley collects premiums from producers and invests them in short-term investments until settlement with the issuing company (VSC or First Re) is required. Oakley invests these funds in short-term investments that are matched to quarterly settlement dates. First Re, as a reinsurer and an insurer, receives its contractual portion of these funds and invests them in fixed income securities that match the anticipated loss payout term. Oakley completed its second full year of operation in 1995.\nIn 1993, operating activities included the release of funds held by VSC which provided $14,101,348 of cash. A decrease of $607,932 related to the utilization of other assets, and accrued liabilities provided additional cash in 1994. Purchases of fixed maturities held for trading in 1993 totaled $16,727,247. These purchases were the principal use of the cash.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY & CASH FLOWS(CONTINUED)\nInvesting activities in 1995 reflect a net use of cash totaling $4,413,500 compared to $3,981,220 in 1994. The Registrant increased its short-term investments $1,437,064 to fund the contractual settlement requirements of Oakley. It also invested $1,000,000 in an investment partnership (PSCO) in January 1995. PSCO invests in publicly traded financial services company common stocks and this investment is carried as part of common stocks. The year end value of PSCO was $1,379,000.\nSales of fixed term investments and other securities were completed in 1993 and 1994 as part of a strategy to utilize all of a long term capital loss carryforward that would have expired on December 31, 1994. The realized gains of $570,231 were utilized in the remaining balance of that capital loss carryforward. The investing activity in 1993 was also directed at utilizing the long term capital loss and investing for the highest after tax total return possible.\nThe Registrant feels it has sufficient liquidity to enable it to carry out its planned operations.\nCAPITAL RESOURCES\nPrior to risk based capital standards, general convention in the insurance industry established an informal guideline ratio of premiums to capital that was deemed appropriate. Typically, this ratio provided that written premiums be no greater than three times the capital and surplus of First Re. For the current year, First Re has an average ratio of $.34 of premium written for each $1.00 of its capital and surplus. On the basis of these results, management believes that it has available insurance capacity to increase its writings should the opportunity present itself.\nPayments of future cash dividends are reviewed and voted on at regularly scheduled Board of Directors' meetings of the Registrant and its subsidiaries. In declaring the most recent dividend, the Registrant considered its current financial condition with special attention to current income and retained earnings, and its Stockholder Dividend Policy. These decisions, further, are based upon the subsidiaries' performance, taking into account regulatory restrictions on the payment of dividends by such subsidiaries, which are discussed in more detail in the footnotes to the financial statements.\nIn September 1994, the Registrant made a formal offer to acquire, in a cash transaction, AmerInst Insurance Group, Inc. (\"AIIG\"), a publicly held reinsurer of accountants professional liability insurance. This offer was rejected by the AmerInst board as being insufficient. The Registrant increased its offer to purchase AIIG in January, 1995 and this offer too was rejected as being insufficient.\nThe Registrant announced in March, 1995 plans to repurchase up to three million dollars of its common stock in open market purchases, but to date has not acquired any stock through this program.\nManagement considers the Registrant's capitalization and net reserves to be adequate to meet current operating and financing needs. The Registrant is unaware of any other trends or uncertainties that have had, or it reasonably expects will have, a material effect on its liquidity, and capital resources or operations.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS\nThe Registrant's financial position and results of operations are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on the Registrant. Additionally, re-evaluations of the Registrant's loss reserves could result in an increase or decrease in these reserves and a corresponding adjustment to earnings. The historical results of operations are not necessarily indicative of future results.\nThe Registrant has replaced its financial institutions' reinsurance business with Oakley's professional liability and D&O policies and other reinsurance writings that may not match the historical experience the Registrant recorded on its financial institutions' business. Oakley is an insurance underwriter who can write a broad range of professional liability and D&O policies produced by the marketing efforts of insurance producers. This underwriting will likely cost less in commission expense but will increase operating costs as the risk analysis is performed by company staff for each submission for an insurance policy. The other assumed reinsurance writings will depend on First Re's ability to participate in the brokered reinsurance market.\nNet income per share in 1995 amounted to $1.30 as compared to $1.13 for 1994. This represents an increase of 15.0% for the year. In 1994, earnings per share were 14.1% higher than 1993 ($1.13 vs $.99). Earnings per share are calculated on a primary basis and have been adjusted to reflect the 20.0% stock dividends declared in June 1995 and December 1995.\nNet income in 1995 is 15.6% higher than 1994 ($4,321,799 vs $3,738,818) and 1994 was 16.4% higher than 1993 ($3,738,818 vs $3,211,945).\nThe major factors influencing performance are:\n1. NET INVESTMENT INCOME AND NET REALIZED CAPITAL GAINS\nNet investment income and net realized gains on investments in 1995 increased by 36.3% to $5,244,382 from $ 3,848,095. Capital gains increased $623,549 due to improvement in the stock and bond markets. Investment income increased principally due to increased investment funds from underwriting operations. Net investment income and net realized gains on investments in 1994 decreased from 1993 by 18.9% from $4,745,344 to $3,848,095. This decrease is attributable to reduced capital gains and lower short-term interest rates that were available in the first six months of 1994.\nThe pre-tax average yields on mean invested assets for the years 1995 and 1994 were 5.5% and 5.1%, respectively. Improvement in short term rates was the major reason for the increase in yield.\nThe Registrant's investments at December 31, 1995 had an unrealized after-tax gain of $1,542,730 as compared to a loss of $1,562,822 at December 31, 1994. In 1994, the Registrant utilized the $404,000 remaining unrealized capital loss carry forward from December 31, 1993 to offset taxes that would otherwise be paid on its capital gains.\nUncertainty exists about the future direction of investment yields and realization of capital gains, making forecasts regarding future interest income difficult.\n2. PREMIUMS EARNED AND COMMISSION EXPENSES\nPremiums earned increased 45.2% in 1995 (to $11,356,083) as compared to a 5.2% growth in 1994 (to $7,819,784) as First Re continued its expansion into other reinsurance lines and finished its second full year of the Oakley operation (the 1993 results reflected nine months of Oakley). These increases offset the loss of revenue from the financial institutions program due to the withdrawal of VSC as an underwriter of this coverage in the third quarter of 1993. The financial institutions' program represented less than 0.2% of total earned premium in 1995, as compared to 10.5% in 1994 and 54.3% in 1993.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\n2. PREMIUMS EARNED AND COMMISSION EXPENSES(CONTINUED)\nThe Oakley operation produced professional liability and D&O net written premiums of approximately $12,500,000 for 1995, $7,038,954 for 1994 and $3,256,991 in the last three quarters of 1993. The increase was due to an increase in gross written premiums and to a change in participation of the underlying risk premium (gross premium) from approximately 37.0% to 47.0% in the second quarter of 1994 and to 70.0% in the second quarter of 1995.\nCommission expense increased 70.3% to $3,042,719 in 1995. The 1995 commissions paid include contractual contingent commissions of $416,000 on financial institutions' business for the prior underwriting year results. The remainder of the 1995 commission expense increase relates to the increase in premiums written.\nCommissions paid relate directly to premiums written as they follow contractually set rates. The Oakley premiums have a lower commission rate due to the use of ceded reinsurance programs. The average commission rate on Oakley production is approximately 24.0%, as contrasted to 29.0% on the discontinued financial institution business. The Registrant expects to lower its commission rate as the Oakley premiums become an even larger proportion of the total writings. The Registrant's premium writings for all sources of business in 1995, 1994 and 1993 were approximately $14,140,000, $8,962,000 and $7,425,000 respectively.\nThe Registrant believes that in the current environment, a conservative underwriting philosophy is warranted. The Registrant, however, will take advantage of opportunities which provide a reasonable return. It seeks to make an underwriting profit on all lines and will withdraw from opportunities that do not provide a reasonable return.\n3. OTHER INCOME\nOther income decreased 25.0% to $556,941 in 1995 from 1994. Other income increased 27.5% to $742,546 in 1994 from 1993. The 1995 amount includes amortization of the excess of acquired net assets over cost related to the First Re purchase of $455,000 and the remainder is brokerage income from the company's financial institution division of its Oakley subsidiary. This division was terminated in the second quarter of 1995. The 1994 amount includes amortization of the excess of acquired net assets over cost related to the First Re purchase of $466,465 and the remainder is from management fees related to First Re Management Company, Inc. activities and brokerage income from the Oakley operation.\n4. LOSSES AND LOSS ADJUSTMENT EXPENSES\nLoss and loss adjustment expenses incurred in 1995 were $4,843,484. This is $2,230,090 or 85.3% greater than 1994. The year 1994 losses incurred were $2,310,268 or 46.9% less than in 1993. These changes vary in direct relation to the volume of business underwritten for the subject year, the type of business written, and the development of actual claims incurred for both the subject year and re-estimations of prior year claims.\nThe incurred relationship between paid losses and reserves in the current and prior periods is explained in Note K to the financial statements.\nFavorable development in underlying claim settlements on the VSC financial institutions' business created a favorable re-estimation of liabilities related to claims that had been charged to prior year income statements. The reduction in estimated ultimate losses on this and other non renewed programs for the underwriting years 1988-1990 recorded in the 1995 income statement was approximately $3,469,000. For 1994 these coverages represented 96.7% or approximately $2,585,000 of the incurred claims and 36.3% or $1,771,442 for 1993. The company continues to monitor these claims carefully and continually re-estimates its ultimate losses based on evaluation of each underlying case and advice from outside counsel and ceding companies' actuaries. The Registrant believes its reserves are adequate to cover the remaining exposures in its financial institutions' business.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\n4. LOSSES AND LOSS ADJUSTMENT EXPENSES(CONTINUED)\nThe other reinsurance had incurred losses of approximately $1,167,000 in 1995 as compared to approximately $500,800 in 1994 and $2,022,000 in 1993. The 1994 losses reflected favorable re-estimations of approximately $1,100,000 related to property exposures on expired reinsurance contracts. The Registrant records these reserves at values reported by the ceding companies plus estimates for additional development.\nOakley loss estimates are recorded using a combination of the prior underwriting history, industry experience and management judgment. Oakley losses were $7,145,864 in 1995, $4,705,129 in 1994 and $1,052,453 in 1993. The estimated ultimate losses are approximately 80.9% of the Oakley inception to date earned premiums. The increase in the estimated ultimate losses on these classes were due to the increase in premium revenues and its' related exposure.\nTotal losses incurred are shown in aggregate terms in the consolidated statements of income in the financial statements. Losses are such that First Re is not required to record premium deficiency reserves.\n5. OTHER OPERATING AND MANAGEMENT EXPENSES\nA portion of the expenses of the Registrant are fixed and do not vary directly in relation to the volume of operating activity.\nThe operating and management expenses increased 6.2 % to $3,683,860 in 1995 from 1994. The increase in general expenses relates to the increase in premium revenues and the related expenses on Oakley business as compared to other reinsurance that had been written by First Re. The operating and management expenses increased 20.2 % to $3,467,801 in 1994 from 1993. This was due to the full year of costs involving Oakley, which required more staff and the corresponding expenses including additional office space.\n6. TAXES\nThe Registrant incurred taxes of $1,265,544, $803,748, and $68,160 for the years ended December 31, 1995, 1994 and 1993 respectively on net income before taxes and cumulative effect of changes in accounting principles. The increase in the tax provision from 1994 to 1995 is primarily due to the favorable re-estimations of loss reserves as described more fully in Paragraph 4 above. This contributed a higher proportion of fully taxable income to the total income.\nThe effective tax rate was 22.7%, 17.7% and 2.4% for 1995, 1994 and 1993 respectively. The increase from 1993 to 1994 was primarily due to the full recognition of the capital loss carry forward in 1993 due to the adoption of FASB 109. The increase in the rate from 1994 to 1995 is the result of a lower proportion of tax advantaged investment income to the total investment income.\n7. REGULATORY ENVIRONMENT\nThe reinsurance (and insurance) industry is continually being scrutinized by the Executive and Legislative branches of government, as well as by other regulatory agencies for dividend paying ability and solvency.\nCurrent statutes require prior approval by the Connecticut Insurance Commissioner for any dividend distributions during a twelve-month period that are in excess of the greater of (a) 10% of an insurer's surplus, or (b) net income measured as of the preceding December 31. This will not have any material effect on First Re's dividend paying ability.\nThe NAIC has established a new set of measurements for risk based capital (\"RBC\") requirements on 1994 financial statements. The tests correlate the risk and uncertainty of the underwriting exposure with the quality of the assets. Based on the RBC formulas adopted by the NAIC, capital of First Re exceeded the required levels of capital. The Registrant does not foresee any negative results of this requirement.\nThe Registrant will continue to monitor developments and respond as necessary to the changing environment. Without an appropriate response, actions of regulatory authorities could adversely affect the operations of the Registrant.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\n7. REGULATORY ENVIRONMENT(CONTINUED)\nThe NAIC is currently conducting a project to codify statutory accounting principles. The codification is not expected to be final until 1997. At this time the impact on the financial statements of the Registrant cannot be determined.\n8. RECENT DEVELOPMENTS\nThe Registrant executed a letter agreement dated as of February 17, 1996 with John A. Dore, and Castle Harlan Partners II, L.P. (\"CHP II\") pursuant to which CHP II and John Dore have jointly proposed to acquire the Registrant at a cash price of $16.00 per share (after giving effect to the 20% stock dividend payable on February 22, 1996). The proposal is subject to negotiation and execution of a definitive purchase agreement, regulatory approval, and other customary closing conditions. The proposal is not conditioned upon receipt of financing.\nThe Registrant has agreed to deal exclusively with CHP II and Mr. Dore for a period of 45 days. The agreement provides under certain circumstances for the payment of a cash fee in the amount of $3,500,000 to CHP II in the event the Registrant executes an agreement with a third party involving a merger or other business combination or sale of a substantial portion of the assets or stock of the Registrant within one year. The discussion of the terms of the agreement is qualified in its entirety by reference to the agreement, a copy of which is attached hereto as an exhibit.\n9. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF\nThis annual report contains forward looking statements that involve risks and uncertainties, including but not limited to the following: premium revenues, commissions and other expenses are dependent on rates charged by insurers, which are subject to fluctuation; the property and casualty insurance industry continues to experience a soft market; continued low interest rates will reduce income earned on invested funds; changes in the performance of financial markets will affect investment earnings; the insurance and reinsurance businesses are extremely competitive; and the general level of economic activity can have a substantial impact on the Registrant's business production. Accordingly, actual results may differ materially from those set forth in the forward looking statements. Attention is also directed to other risk factors set forth in documents filed by the Registrant with the Securities and Exchange Commission.\n[Coopers & Lybrand LOGO]\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors Financial Institutions Insurance Group, Ltd.:\nWe have audited the consolidated balance sheets of Financial Institutions Insurance Group, Ltd. 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 financial statement schedules of Financial Institutions Insurance Group, Ltd. listed in Item 14 (a) 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 consolidated financial position of Financial Institutions Insurance Group, Ltd. 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 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 A to the consolidated financial statements, the Company changed its method of accounting for income taxes and accounting and reporting for debt and equity securities in 1993.\nHartford, Connecticut March 28, 1996\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. CONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these financial statements.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES\nTHE REGISTRANT\nFinancial Institutions Insurance Group, Ltd. (\"the Registrant\") is an insurance holding company, which through its subsidiaries underwrites insurance and reinsurance. The principal lines of business include professional liability, directors and officers liability, fidelity, property catastrophe reinsurance and other lines of property and casualty reinsurance.\nThe Registrant conducts its business by owning and operating an insurance company and underwriting insurance and reinsurance assumptions through two wholly owned underwriting agencies.\nThe First Reinsurance Company of Hartford (\"First Re\") is the insurance company. First Re is domiciled in the State of Connecticut and maintains direct licenses in 20 states. First Re has reinsurance authorities in an additional 14 states. A second insurance company, Financial Institutions Insurance Fund, Incorporated (\"FIIF\"), was sold at book value plus legal fees in the third quarter of 1994, after all of the liabilities and the net unrestricted assets were transferred to First Re during 1993 and 1994.\nThe Registrant's primary business from its inception in 1986 through July 1, 1993 was reinsurance of Directors and Officers liability and Blanket Bond coverage for banks and savings institutions that were insured by an unaffiliated insurer, Virginia Surety Company (\"VSC\"). These reinsurance contracts were assumed by FIIF.\nOn August 23, 1991, FIIF completed the acquisition of all the outstanding common stock of JBR Holdings, Inc. (\"JBR\") and its wholly-owned subsidiary, The First Reinsurance Company of Hartford. JBR's only operation is as the holding company for First Re.\nFirst Re had stopped writing new business in April 1990, was running-off its discontinued underwriting operations and commuting, where possible, its underwriting liabilities since that time. The run-off of this book of business has continued since the acquisition and has been combined with the Registrant's primary business. Liabilities on contracts issued prior to November, 1987 were assumed by the former owners of First Re.\nIn 1992 the Registrant formed an underwriting management company, First Re Management Company \"FRM\" and began to write reinsurance through the reinsurance intermediary market. FRM typically assumed for First Re 5.0% or less of a company's reinsurance exposure on terms set by the reinsurance market. The premiums are typically related to property catastrophe coverages, professional liability and other liability coverages.\nOn April 1, 1993, the Registrant acquired the renewal rights from VSC for a book of professional liability and non-financial institutions directors and officers liability insurance and further entered into a management agreement pursuant to which the Registrant will perform underwriting and administrative services with respect to such business. The Registrant organized a wholly-owned subsidiary, Oakley Underwriting Agency, Inc. (\"Oakley\"), to act as an underwriting management company and hired staff involved with this program from VSC to underwrite these lines of business. First Re assumes, as reinsurance, a portion of the premiums and liabilities from these programs. First Re also issues direct insurance policies in Oakley and reinsures them with non-affiliated reinsurers.\nNearly all of the premiums written by the Registrant are produced by Oakley. Should changes be made to the Oakley program, the revenues of the Registrant could change significantly. In addition, the Registrant writes reinsurance for catastrophe coverage. The Registrant believes its portfolio is well-diversified so that any catastrophic event would not have a material impact on its financial position.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) BASIS OF PRESENTATION\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include the accounts, after inter-company eliminations, of the Registrant and its subsidiaries, JBR, First Re, FIIF (through September 21, 1994), FRM, Oakley, and F\/I Insurance Agency(\"F\/I Agency\"), Incorporated (collectively \"the Registrant\").\nRECOGNITION OF EARNED PREMIUM AND RELATED ACQUISITION COSTS\nPremiums are recognized as revenue over the term of the related reinsurance contracts or policies and are net of deductions for retrocessions to other reinsurers. Unearned premium reserves are established for the unexpired portion of policy premiums.\nAcquisition costs, which consist primarily of commissions, are deferred and amortized pro rata over the contract periods in which the related premiums are earned. Future investment income attributable to related premiums is taken into account in measuring the carrying value of this asset. All other acquisition expenses are charged to operations as incurred.\nCEDED REINSURANCE\nCeded reinsurance premiums, commissions, expense reimbursements, and reserves related to ceded reinsurance business are accounted for on a basis consistent with that used in accounting for the assumed business. Premiums ceded to other companies have been reported as a reduction of premium income. Loss and loss adjustment expense payments ceded to other companies have been reported as a reduction of those items. A provision for doubtful or uncollectable reinsurance ceded of approximately $171,000 is recorded net of ceded reinsurance recoverable.\nINCOME TAXES\nThe provision for federal and state income taxes gives effect to permanent differences between income before taxes and taxable income. Deferred income taxes are provided for certain transactions which are reported in different periods for financial reporting than for income tax purposes. The deferred federal income tax asset is recognized to the extent that 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.\nStatement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" was adopted by the Registrant during the first quarter of 1993 retroactive to January 1, 1993. SFAS No. 109 establishes an asset and liability approach for financial reporting of income taxes. The adoption of SFAS No. 109 resulted in a one time increase to earnings of $192,515 or $0.08 per share, in the first quarter of 1993. This increase in earnings was principally due to the recognition of a portion of previously unrecognized deferred tax assets.\nEXCESS OF ACQUIRED NET ASSETS OVER COST\nThe excess of acquired net assets over cost relating to the acquisition of First Re during 1991, is being amortized on a straight-line basis over a seven year period, which is the estimated time period over which the purchased liabilities will be settled. The amortization is recorded as other income in the consolidated statement of income.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nINVESTMENTS\nAt December 31, 1993, the Registrant adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The Registrant classified its entire portfolio of fixed maturities and equity securities as available for sale and reported them at market value. The unrealized gain or loss on the securities is recorded directly to stockholders' equity, less the applicable capital gains tax. The adoption of SFAS No. 115 had an immaterial effect on the unrealized capital gains of the Registrant, because most of the portfolio had been marked to market prior to December 31, 1993 as part of the trading portfolio. During 1993, before the adoption of SFAS No. 115, the Registrant's fixed maturities portfolio was segregated into two classifications: securities held for trading and securities held for investment. All securities held for trading were previously reported at estimated market values, whereas the securities held for investment were reported at amortized cost.\nNon-redeemable preferred equities are carried at estimated market value in 1995 and 1994. The Registrant reports short-term investments at amortized cost, which approximates current market value. Realized gains and losses on investments are determined on the basis of specific identification. The Registrant classifies its portfolio as available for sale, as it has the ability but not the intent to hold these securities to maturity.\nLOSS AND LOSS ADJUSTMENT EXPENSE RESERVES\nAs most of the Registrant's business is written on a claims-made form of coverage, the liability for unpaid losses and loss adjustment expenses consists of an aggregation of the estimated liability for incurred losses and loss adjustment expenses on claims that are known to the Registrant as of the reporting date and an aggregate estimate of the liability for losses and loss adjustment expenses incurred, but not reported to the Registrant, as of the same date. Although such reserves are based on estimates, management believes that the recorded reserves for loss and loss adjustment expenses are adequate in the aggregate to cover the ultimate resolution of reported and incurred but not reported claims. These estimates are continually reviewed, and any required adjustments are reflected in current operations.\nThe Registrant's estimates are developed from its own experience using independent actuarial analysis and advice from its ceding reinsurers. Additionally, the Registrant uses available industry information on similar lines of insurance coverage to establish its reserves. The Registrant believes that the combined liability reflected in the accompanying consolidated financial statements is a reasonable estimate of unpaid losses and loss adjustment expenses (See Note K).\nSTATEMENTS OF CASH FLOWS\nCash equivalents include short term, highly liquid investments that are readily convertible to known amounts of cash.\nDue to the nature of the Registrant's operations, none of the short-term investments are considered to be cash equivalents for purposes of the statements of cash flows. Restricted cash is also not considered to be cash for the statements of cash flows, as such cash is not available for general corporate purposes.\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. Certain balances in the prior years' financial statements have been reclassified to conform to current presentation.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE B - INVESTMENTS AND INVESTMENT INCOME\nEffective December 31, 1993, the Registrant adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The Registrant classified its entire portfolio of fixed maturities and equity securities as available for sale and reported them at market value. During 1993, before the adoption of SFAS No. 115, the Registrant's portfolio was segregated into two classifications: securities held for trading and securities held for investment. All securities held for trading were previously reported at estimated market values, whereas the securities held for investment were reported at amortized cost. The investment portfolio consisted of securities for which the Registrant had the intention and ability to hold until maturity. The trading portfolio arose primarily because investment assets exceed the amounts needed to match against liabilities, and because the Registrant intended to generate realized gains so the tax benefits of capital loss carry forwards obtained through the purchase of JBR could be realized.\nRealized investment gains and losses for the years ended December 31, 1995, 1994 and 1993 are summarized as follows:\nThe proceeds from the sale of investments held for sale were $39,071,486 and $21,866,175 during 1995 and 1994 respectively.\nThe proceeds from the sale of investment account securities were $2,719,755, in 1993.\nNet purchases and sales activity related to fixed maturities held for trading are reflected in the operating activities section of the consolidated statement of cash flows.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE B INVESTMENTS AND INVESTMENT INCOME (CONTINUED)\nThe carrying values of investments held for sale at market value at December 31, 1995 and 1994 are summarized below.\nIncluded in the above, at December 31, 1995, are mortgage backed securities with a market value of $12,292,889 and amortized cost of $12,116,499. The gross unrealized gains and losses are $183,335 and $6,945 respectively.\nHELD FOR SALE AT MARKET VALUE AT DECEMBER 31, 1994\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE B INVESTMENTS AND INVESTMENT INCOME (CONTINUED)\nINVESTMENT MATURITIES\nThe amortized cost and estimated market value of fixed income 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.\nRESTRICTIONS ON SECURITIES AND ASSETS\nFirst Re has certain invested assets on deposit with state insurance regulatory authorities at December 31, 1995, with an amortized cost of $2,189,091. These deposits are required to maintain the licenses and allow the writing of insurance and reinsurance in those states. Market value of these securities is $2,236,000.\nSome of First Re's existing contracts require letters of credit in the amount of the premium paid to be held by the reinsured. First Re collateralized the letter of credit with a U.S. treasury bond totaling approximately $351,000 and has collateralized these with an interest bearing investment of approximately the same amount.\nDuring 1992, First Re drew down a letter of credit from a reinsurer for approximately $3,200,000 in response to the reinsurer's financial condition. The current $2,601,312 balance of restricted cash and funds withheld from reinsurers represents the projected ultimate reinsurance recoverable due to First Re based on expected loss development. On a quarterly basis, the restricted cash is reduced by the amount of losses paid by the Registrant on behalf of the reinsurer, and the remaining balance is not available for general use.\nPrior to December 1993, there was an agreement between the principal ceding companies, VSC and First Re, which called for funds to be held by VSC. During the fourth quarter of 1993, the Registrant negotiated the release of these funds by establishing a trust agreement between First Re and VSC. The trust, which is the property of First Re, has been funded with securities with a current estimated market value of approximately $6,606,000 and $13,768,000 for 1995 and 1994 respectively which is included as investments in the consolidated balance sheet. Investments must be maintained in the trust until certain reinsurance assumed obligations are settled.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE C - INCOME TAXES\nA reconciliation of the expected federal income tax on income before tax expense using the 34% statutory rate to the provision for income taxes is as follows:\nThe net deferred tax asset comprised the tax effects of the temporary differences relating to the following assets and liabilities:\nThe net deferred tax asset comprised the tax effects of the temporary differences relating to the following assets and liabilities:\nThe Registrant files a consolidated federal income tax return. The Registrant had available a capital loss carryforward of approximately $404,000 as of January 1, 1994, which resulted from former activities of JBR. The loss carryforward is less than the annual limitation prescribed by the Internal Revenue Code and was fully utilized during 1994.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE C INCOME TAXES (CONTINUED)\nUpon adoption of SFAS No. 109, a valuation allowance of $192,675 was established to reduce the net deferred tax asset to an amount that, based on all available evidence, would more likely than not be realized. During 1993, this allowance was reduced, allowing full recognition of the deferred tax asset as there were unrealized gains on investments in the balance sheet against which the tax deduction giving rise to the asset could be taken.\nThe valuation allowance established in 1994 is with respect to the tax effect of the unrealized losses on equity securities. There was no valuation allowance established on the tax effect of the fixed maturities in 1994 because, although they were held for sale, management would hold them until maturity to avoid non-deductible losses.\nActual income tax payments made amounted to approximately $2,000,000, $692,000 and $500,000 in 1995, 1994 and 1993, respectively.\nNOTE D - REINSURANCE CEDED\nFirst Re had immaterial amounts of ceded premiums earned and incurred losses and loss adjustment expenses for the year ended 1993 as related to the 1987-1993 underwriting years. For the years ended 1995 and 1994, the following shedule shows the components of First Res' underwriting results.\nAt December 31, 1995, $4,181,349 represented reinsurance recoverable related to the reserves. First Re is liable to pay the claims even if this is not collected from the reinsurers who are liable under their ceded contracts. The ceded contracts allow First Re to collateralize the reinsurance recoverable to a certain extent with letters of credit and other collateral balances. Accordingly, First Re has received collateral of approximately $1,441,000 which came from a formerly affiliated insurance company in the form of a letter of credit from Citibank of New York. In addition, as discussed in Note B, First Re has restricted cash of $2,601,312, which is drawn upon to pay losses on behalf of a former affiliated reinsurer.\nThe Registrant released its former affiliated reinsurer of its reinsurance obligation on February 7, 1996, to reduce handling costs and agreed to release $1,340,000 of the funds held and retain $1,261,314 of funds.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE E - DIVIDENDS FROM SUBSIDIARY\nThe State of Connecticut, under the statutes and regulations that govern the operations and affairs of insurance companies that are domiciled in the state, impose a restriction on the amount of dividends that can be paid by First Re to the Registrant without prior regulatory approval. The maximum amount of dividends that may be paid by First Re without prior regulatory approval, is limited to the greater of 10% of statutory surplus (stockholders' equity determined on a statutory basis) or 100% of net income for the preceding fiscal year. There is also a further limitation to earned surplus. Dividends exceeding these limitations require regulatory approval. The maximum dividends that could be paid in 1996 by First Re is equal to 10% of the company's surplus or $4,226,588.\nNOTE F - RECONCILIATION OF NET INCOME AND STOCKHOLDERS' EQUITY\nThe following reconciles the consolidated statutory net income and stockholders' equity of FIIG and its subsidiaries, determined in accordance with accounting practices prescribed or permitted by the Insurance Department of the State of Connecticut, with such amounts determined in conformity with generally accepted accounting principles (GAAP):\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE F - RECONCILIATION OF NET INCOME AND STOCKHOLDERS' EQUITY (CONTINUED)\nNOTE G - LEASE COMMITMENTS\nIn June 1993, the Registrant entered into a lease for office space in Chicago with an annual rent of approximately $112,000. The lease is due to terminate on May 31, 1996. On a month to month basis, the Registrant also leases space in Avon, Connecticut to service the run-off operation that it assumed in conjunction with the purchase of JBR and First Re. The annual cost of this is approximately $40,000.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE H - PENSIONS, EMPLOYEE BENEFIT OBLIGATIONS\nThe Registrant has a 401 (k) retirement savings plan which commenced in 1992. All employees are eligible to participate in the plan after completing six months of service. Participants may make contributions on a pre-tax basis of up to 15% of annual compensation subject to IRS limitations. The Registrant matches 50% of the employee's contribution (up to 6%). The Registrant's contributions were approximately $111,000, $120,000, and $95,000 in 1995, 1994 and 1993, respectively.\nThe Registrant has no other significant pension or other post-retirement programs in place for the benefit of its employees as of December 31, 1995.\nNOTE I - STOCK OPTIONS AND STOCK GRANTS\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" SFAS No. 123 is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 introduces a preferable fair value-based method of accounting for stock-based compensation. SFAS No. 123 encourages, but does not require, companies to recognize compensaton expense for grants of stock, stock options, and other equity instruments to employees based on the new fair value accounting rules. The Company intends to continue applying the existing accounting rules contained in Accounting Principles Board Opinion No. 25, \" Accounting for Stock Issued to Employees,\" and disclose net income and earnings per share on a pro forma basis, based on the new fair value methodology.\nMr. Dore received a loan from the Registrant in 1991 in the amount of $150,000 in order to finance the purchase of 43,200 shares of common stock from the Registrant at a price of $3.48 per share. Mr. Dore purchased the 43,200 shares from the Registrant on January 2, 1991, and executed a Promissory Note in the amount of $150,000 payable to the Registrant. The Promissory Note provided that payment of the amounts due thereunder was secured by the 43,200 shares so purchased by Mr. Dore. The principal amount bore interest at a rate equal to the average yield on five year Treasury obligations, and interest was due and payable annually. The $150,000 principal amount plus accrued interest was paid in full by Mr. Dore in 1995.\nThe Board of Directors in 1990 approved plans for stock options and stock grants for certain key officers, directors, and employees.\nAt December 31, 1995, stock options for an adjusted total of 310,896 shares were outstanding with exercise prices ranging from $3.13-$10.70 per share. Of this total, 180,504 stock options were exercisable. During 1995 there were 23,600 stock options exercised for a total of $120,754. During 1995, stock options for an adjusted total of 51,120 shares were granted with market values $9.20 and $12.32.\nIn addition, at December 31, 1995, the Registrant had allocated for future grants a total of 3,600 shares after adjusting for the stock dividend. The Registrant granted in 1994 and issued in 1995, 7,200 shares with a market value of $9.20 and in addition the Registrant granted in 1994 and 1995 7,776 shares and issued during 1995 15,552 with a market value of $12.32 per share.\nNOTE J - STOCK SPLIT AND STOCK DIVIDENDS\nAt the December 10, 1993 Board of Directors' Meeting, the Registrant declared a split of the common stock to be effected by a distribution on February 24, 1994 of one fully paid and non-assessable share of common stock for each share of stock outstanding with shareholders of record on January 20, 1994. The Registrant submitted to its shareholders at the June 1994 annual meeting a proposal to increase its authorized shares of stock from 3,000,000 to 6,000,000 which was approved.\nAt the June 7, 1995 meeting of the Board of Directors, a 20% stock dividend was declared payable on August 24, 1995 to stockholders of record on July 27, 1995. At the December 6, 1995 board meeting, the Registrant declared another 20% stock dividend payable February 22, 1996 to stockholders of record on January 25, 1996. Information set forth herein has been adjusted to reflect the stock split and dividends.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE K - REINSURANCE RISK\nWhen a reinsured company reports a claim, the Registrant establishes a reserve equal to that report. It also evaluates the circumstance of that claim based on the judgment of management and reserving practices for the type of business, it establishes additional case reserves sufficient to settle the estimated ultimate liability given the current information. In many cases, several years may elapse between the reporting of a claim and its final settlement. These estimates are difficult to quantify, as the outcome may depend on multi-party litigation and other factors not readily predictable.\nThe Federal Deposit Insurance Corporation the success of to The Resolution Trust Corporation can be a party to claims in the discontinued financial institution business which tends to lengthen the claims settlement period. The other reinsurance exposures typically would involve property catastrophe events which tend to be more easily quantified, as the claims would likely be notified quickly, and they do not usually involve litigation.\nThe Registrant, with the help of consulting actuaries and the advice from its reinsured companies, establishes incurred but not reported \"IBNR\" reserves in addition to the reserves reported by the reinsureds. These reserves are estimates based on company and industry data that estimate claims that may occur against the policy coverage. Reserves are estimates involving actuarial and statistical projections of the ultimate settlement and administration of claims, based on facts and circumstances then known, predictions of future events, estimates of future trends in severity and other variable factors such as new concepts of liability. Future revisions of the estimated claims liability have occurred and are likely to continue to occur. These revisions are recorded on the statement of income in the period in which they occur. The following table displays the effect of those revisions for 1995, 1994, and 1993.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE K - REINSURANCE RISK (CONTINUED)\nIncluded in the table on the prior page are reserves with respect to contracts on programs no longer renewed. While this business is not a separate segment or operation, the loss behavior patterns are unique. While no premium is currently being earned on these programs, the continual adjustment of reserves on this business is charged to current operations and has had a material effect on net income. The following table displays the changes in those reserves in 1995 and 1994:\nNOTE L - SUBSEQUENT EVENTS\nOn February 19, 1996 the Registrants entered into a letter agreement to be sold to a new company to be formed by Castle Harlan Partners II and John Dore, the President of the Registrant. This event will not have a material effect on the affairs of the Registrant.\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.\nDIRECTORS\nW. DEAN CANNON, JR. Director since 1986\nW. Dean Cannon, Jr. served as President of the California League of Savings Institutions from 1973 until his retirement on December 31, 1991.\nAge: 66 Term to Expire in 1998\nWILLIAM B. O'CONNELL Director since 1986\nWilliam B. O'Connell is the Vice Chairman of the Registrant, The First Reinsurance Company of Hartford and First Re Management Company, Inc. Mr. O'Connell also serves as a member of the board of directors of Fairfield Savings Bank, F.S.B. in Long Grove, Illinois. For two years prior to his retirement in November, 1989, Mr. O'Connell served as Chairman of the Board of Directors of Advance America Funds, Inc., Asset Management Fund for Savings Institutions, Inc., USL Management Services, Inc., U.S. League Investment Services, Inc., U.S. League Securities, Inc., U.S. League Government Securities, Inc., U.S. League Assets Management, Inc., U.S. League Trust Company and U.S. League Administrative Services, Inc. For nine years prior thereto, Mr. O'Connell served as President and Chief Executive Officer of the United States League of Savings Institutions (\"U.S. League\").\nAge: 72 Term to Expire in 1998\nJOHN B. ZELLARS Director since 1986\nJohn B. Zellars is Chairman of the Executive Committee of the Registrant. He currently serves as a member of the Board of Directors of Douglas Federal Savings Bank; Greater Georgia Life Insurance Co. and Blue Cross\/Blue Shield of Georgia. Mr. Zellars previously served as a member of the Board of Directors of the Federal Home Loan Bank of Atlanta, and in 1989, retired as Chairman of the Board of Georgia Federal Bank in Atlanta, Georgia. Mr. Zellars, a past Chairman of the U.S. League, also has served as President and Chief Executive Officer of Georgia Federal Bank, a director of Asset Management Fund for Savings Institutions, Inc. and as Chairman of the Board of the Federal Asset Disposition Association. He has also served as a Director of Fuqua Industries, Inc.; Director of Southern Floridabanc Federal Savings and Loan, Boca Raton, Florida; and senior Chairman and CEO of Lamar Savings Association, Austin Texas; and Director of Beach Federal Savings and Loan Association, Boynton Beach, Florida.\nAge: 71 Term to Expire in 1998\nR. KEITH LONG Director since 1991\nR. Keith Long is Chairman of the Board of the Registrant. He has been engaged principally in private investments since January, 1991. For more than five years prior thereto, Mr. Long was employed as a principal in the capital markets division of Morgan Stanley & Co.\nAge: 47 Term to Expire in 1998\nJOHN A. DORE Director since 1990\nJohn A. Dore has served as a member of the Board of Directors and as President and Chief Executive Officer of the Registrant since October 1, 1990. In addition, Mr. Dore serves as President and Chief Executive Officer of The First Reinsurance Company of Hartford, First Re Management Company, Inc., F\/I Insurance Agency, and Oakley Underwriting Agency, Inc., a wholly-owned subsidiary of the Registrant. Prior to joining the Registrant, beginning in 1987, Mr. Dore served as President and Chief Operating Officer of Virginia Surety Company\/Dearborn Insurance Company. From 1983 to 1986, Mr. Dore was President and Chief Executive Officer of Chicago Underwriting Group, Inc.\nAge: 44 Term to Expire in 1997\nGERALD J. LEVY Director since 1986\nGerald J. Levy has served for more than five years as Chairman of the Board and Chief Executive Officer of Guaranty Bank, Milwaukee, Wisconsin. Mr. Levy also serves as a director of FISERV, Asset Management Fund for Financial Institutions, Inc. and Republic Mortgage Insurance Company. Mr. Levy, who is a past Chairman of the U.S. League, also has served as a director of Advance America Funds, Inc., the Federal Asset Disposition Association, and as a member of the Advisory Committee of the Federal Home Loan Mortgage Corporation.\nAge: 63 Term to Expire in 1997\nHERSCHEL ROSENTHAL Director since 1986\nHerschel Rosenthal currently is President of Donalga, Inc. a commercial construction development company in Florida. Mr. Rosenthal previously served as President of Flagler Federal Savings and Loan Association of Miami from 1976 until his retirement effective January 31, 1992. Mr. Rosenthal also served as a director of Flagler Federal Savings and Loan Association.\nAge: 68 Term to Expire in 1997\nJOHN P. DIESEL Director since 1995\nJohn P. Diesel served as President and a member of the Board of Directors of Tenneco, Inc. (\"Tenneco\") from 1979 until his retirement in 1991. Mr. Diesel joined Tenneco in 1972 as President of Newport News Shipbuilding and became Chairman and Chief Executive Officer of that company in 1973. Prior to joining Tenneco, Mr. Diesel acquired more than 20 years experience in manufacturing, corporate management and consulting through employment with McQuay Norris Mfg., Booz Allen and Hamilton and A.O. Smith Corporation. Mr. Diesel currently serves as a member of the Board of Directors of the Aluminum Corporation of America, Brunswick Corporation and Telepad Corporation.\nAge: 69 Term to Expire in 1997\nDALE C. BOTTOM Director since 1986\nDale C. Bottom served as Secretary General of the International Union of Housing Finance Institutions from 1992 through 1995, and as President and Chief Executive Officer of the Institute of Financial Education from 1967 through 1992. Mr. Bottom previously was Executive Vice President of the U.S. League, and between 1985 and 1988 served as the U.S. League's Chief Financial Officer. Mr. Bottom served as Vice President and Chief Financial Officer of the Registrant from 1986 until his resignation in September, 1991.\nAge: 62 Term to Expire in 1996\nRICHARD P. ACKERMAN Director since 1995\nRichard P. Ackerman is a partner in the law firm of Goodkind, Labaton, Rudoff & Sucharow, LLP, New York, New York, and serves on the Executive Committee of that firm. Mr. Ackerman received his law degree from New York University in 1973.\nAge: 48 Term to Expire in 1996\nJOE C. MORRIS Director since 1986\nJoe C. Morris currently serves as Senior Vice President of First Bank, F.S.B. in Overland Park, Kansas. Mr. Morris was Director of Government Affairs at Metropolitan Financial Corporation, Overland Park, Kansas from 1993 to 1994, and formerly Chief Executive Officer and Chairman of the Board of Directors of Western Financial Corporation, a savings and loan holding company, and Columbia Savings Association, F.A., Emporia, Kansas. In addition, Mr. Morris previously served as President of Columbia Savings Association, Emporia, Kansas. Mr. Morris also is a past Chairman of the U.S. League. He formerly served as a director of both Asset Management Fund for Savings Institutions, Inc. and Advance America Funds, Inc.\nAge: 56 Term to Expire in 1996\nTHAD WOODARD Director since 1986\nThad Woodard has served as President of the Community Bankers Association of North Carolina (formerly the North Carolina Alliance of Community Financial Institutions) since 1978.\nAge: 50 Term to Expire in 1996\nEXECUTIVE OFFICERS OF THE REGISTRANT\nIn addition to serving as directors of the Registrant, R. Keith Long served as Chairman of the Board of Directors of the Registrant, John A. Dore as President and Chief Executive Officer and William B. O'Connell as Vice Chairman of the Board of Directors. Additional information about the foregoing officers is included herein under \"Directors.\" Other officers of the Registrant are as set forth below:\nLONNIE L. STEFFEN Executive Vice President, Chief Financial Officer and Treasurer since 1991\nLonnie L. Steffen has served as Executive Vice President, Chief Financial Officer and Treasurer of the Registrant since September, 1991. Prior thereto, beginning in 1986, Mr. Steffen served as Executive Vice President of First Re. Mr. Steffen currently serves as Executive Vice President, Chief Financial Officer and Treasurer of FRM, First Re and Oakley, and Executive Vice President and Chief Financial Officer of F\/I Agency. Mr. Steffen also is a member of the Boards of Directors of First Re and Oakley.\nAge: 46 One Year Term to Expire in 1996\nROBERT E. WENDT Senior Vice President since 1989\nRobert E. Wendt, Senior Vice President of the Registrant, is also Senior Vice President of FRM and First Re, as well as Senior Vice President and Director of both F\/I Agency and Oakley. For the five years prior to joining the Registrant in 1988, Mr. Wendt was employed by CNA Insurance Companies as Underwriting Manager, Senior Manager of Commercial Lines Underwriting, and as Senior Manager of Underwriting.\nAge: 48 One Year Term to Expire in 1996\nDANIEL S. KONAR Assistant Vice President since 1991; Controller and Assistant Treasurer since 1990\nDaniel S. Konar has served as Controller of the Registrant since January, 1990, Assistant Treasurer of the Registrant since September, 1990, and Assistant Vice President of the Registrant since June, 1991. In addition, Mr. Konar serves as Assistant Vice President, Assistant Treasurer and Controller of FRM, First Re and Oakley, and as Treasurer of F\/I Agency. For the five years prior to 1990, Mr. Konar served as a reinsurance consultant with the CNA Insurance Companies.\nAge: 44 One Year Term to Expire in 1996\nLANA J. BRADDOCK Secretary since 1991\nLana J. Braddock has served as Secretary of the Registrant and First Re since September, 1991, and also serves as Secretary of F\/I Agency, FRM and Oakley. Ms. Braddock previously served as Assistant Secretary of the Registrant. Ms. Braddock has been an office manager and assistant to the President of the Registrant since February, 1990. Prior thereto, beginning in 1987, Ms. Braddock served as business manager for Internal Medicine Associates in Chicago, Illinois.\nAge: 53 One Year Term to Expire in 1996\nITEM 11 - EXECUTIVE COMPENSATION.\nSUMMARY COMPENSATION TABLE\nThe following table sets forth certain information regarding the compensation paid by the Registrant to or for the account of the Chief Executive Officer and each of the other most highly compensated executive officers of the Registrant for services rendered in all capacities during each of the Registrant's fiscal years ended December 31, 1995, 1994 and 1993. All share and per share amounts, including amounts for prior periods, have been adjusted to reflect the 20 percent stock dividends payable on August 24, 1995 and February 22, 1996.\n(1) The Executive Committee annually determines whether to award cash bonuses to officers and other key employees of the Registrant based on operating income and a performance assessment of the participant. Awards are recommended subject to approval of such awards by the Board of Directors. (2) Number of shares of Common Stock subject to options granted during the year indicated under the Registrant's Stock Option Plan described in more detail below.\n(3) Supplemental and matching contributions made by the Registrant's wholly-owned subsidiary, FRM, pursuant to its Thrift Plan (\"401(k) Plan\"). Pursuant to the terms of the 401(k) Plan, an employee who has completed at least six months service may save, through payroll deductions, up to 15 percent of the employee's monthly wages or salary, with the total contribution not to exceed amounts permissible under the Internal Revenue Code. An amount equal to 50 percent of the employee's savings is contributed to the employee's 401(k) account, to the extent such savings do not exceed 6 percent of monthly wages or salary. In addition, a supplemental annual contribution in the amount of six percent of each employee's salary is made to the employee's account. 4) Shares awarded pursuant to the provisions of Mr. Dore's Employment Agreement dated October 1, 1990. Subject to his continuing employment, the agreement gave Mr. Dore the right to receive a total of 28,800 shares of Common Stock in increments over the periods January 1, 1992 through January 1,1996 as follows:\nJanuary 1, 1992 3,600 Shares January 1, 1993 7,200 Shares January 1, 1994 7,200 Shares January 1, 1995 7,200 Shares January 1, 1996 3,600 Shares\nThe closing market price per share of the Registrant's stock at December 31, 1995 was $13.54. The aggregate value of Mr. Dore's stock awards at December 31, 1995 was therefore equal to $341,205 ($13.54 x 25,200 shares). Dividends are paid on the shares of Common Stock actually held by Mr. Dore in the same manner as all shares of the Registrant's Common Stock. No dividends are paid on shares to be received at future dates.\nEMPLOYEE STOCK OPTIONS\nA Stock Option Plan has been adopted by the Board of Directors of the Registrant. The purpose of the Stock Option Plan is to provide key employees with a proprietary interest in the Registrant and thereby develop in them a stronger incentive to devote maximum effort to the continued success and growth of the Registrant. Only salaried officers and other salaried key employees of the Registrant who are in a position to affect materially the profitability and growth of the Registrant are eligible to receive options under the Stock Option Plan.\nThe members of the Executive Committee who are not full-time salaried officers (the \"Committee\") administer the Stock Option Plan and are responsible for determining: the individuals who will receive options; the number of options to be granted and the number of shares subject to each option; and the terms and conditions of the options, including when exercisable, the price, and payment terms.\nThe Stock Option Plan provides that the shares of common stock of the Registrant made subject to the options may not exceed in the aggregate 310,896.\nThe purchase price per share of common stock subject to an option will be fixed by the Committee but will not be less than the fair market value per share of common stock on the date the option is granted. The date an option first is exercisable will not be more than 12 years after the date the option is granted, and the date the option expires will not be more than five years after the date the option first is exercisable. In the event of certain structural changes or a change-in-control, options not yet exercisable will become immediately exercisable.\nOPTION GRANTS IN LAST FISCAL YEAR\nThe following table sets forth certain information regarding options to purchase shares of Common Stock granted to the executive officers of the Registrant named in the Summary Compensation Table during the Registrant's 1995 fiscal year:\n(1) All options were granted on March 8, 1995 under the Registrant's Stock Option Plan. Beginning March 8, 1996, annually, upon the anniversary of the date of grant of the options, one-fifth of the options granted become vested and exercisable for a period of five years. (2) The option exercise price is equal to the fair market value per share of Common Stock on the date of grant.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table sets forth certain information regarding the number and value of unexercised options to purchase shares of Common Stock held at the end of the Registrant's 1995 fiscal year by the executive officers of the Registrant named in the Summary Compensation Table. No options were exercised by such persons during the Registrant's 1995 fiscal year.\n(1) Value of unexercised in-the-money options is equal to the difference between the fair market value per share of Common Stock at December 31, 1995 and the option exercise price per share multiplied by the number of shares subject to such options. (2) Indicates options exercisable at December 31, 1995.\nEMPLOYMENT AGREEMENTS\nJohn A. Dore has entered into an Employment Agreement dated October 1, 1990 pursuant to which Mr. Dore was employed as President and Chief Executive Officer of the Registrant and certain affiliates. The Employment Agreement provides for an annual base salary of $175,000, which salary may be increased in conjunction with annual reviews of executive compensation. The Employment Agreement is terminable by either party on the last day of any month with 60 days prior written notice. Subject to his continuing employment, the Agreement gave Mr. Dore the right to receive as additional compensation a total of 28,800 shares of the common stock of the Registrant over the period January 1, 1992 through January 1, 1996.\nRobert E. Wendt has entered into an Employment Agreement dated February 1, 1991. Mr. Wendt's Employment Agreement provides for an annual base salary of $88,500. Lonnie L. Steffen entered into an Employment Agreement dated August 23, 1991 providing for an annual base salary of $166,000. Salaries may be increased in conjunction with annual reviews of executive compensation. The Employment Agreements are terminable by either party on the last day of any month with 60 days prior written notice.\nTERMINATION ARRANGEMENTS\nThe Employment Agreements give John A. Dore, Robert E. Wendt and Lonnie L. Steffen (collectively, the \"Executives\") certain rights upon the termination of employment, including a termination following specified structural changes or a change-in-control of the Registrant.\nIf employment is terminated under certain specific circumstances, including a change in control, the Executive may continue to receive monthly payments of his salary for up to 12 months, and in the case of Mr. Dore, for up to 36 months.\nIf, under certain limited circumstances, including a change in control, and subject to certain conditions, an Executive's employment is terminated, the Executive may be paid for each share of the common stock of the Registrant that is subject to any unexercised option to purchase granted to the Executive by the Registrant. In such case, the Executive would receive an amount equal to the difference between the exercise price and fair market value for the share of stock.\nIn addition, if Mr. Dore terminates his employment or is terminated under certain specific circumstances, including a change in control, for a period of seven months following such termination Mr. Dore will have the right to require the Registrant to repurchase for cash at $3.47 per share all shares of the common stock of the Registrant obtained pursuant to his Employment Agreement.\nDIRECTORS' COMPENSATION\nIn March, 1995, the Board of Directors adopted an Amended Directors' Incentive Plan (the \"Amended Plan\") for the directors of the Registrant and its subsidiaries. Pursuant to the Amended Plan, each director receives an annual cash fee of $5,000 for service on the boards of the Registrant's subsidiaries, as well as a $1,000 cash fee for each directors' meeting attended. Directors receive a cash fee of $500 for attendance at committee meetings, and the chairman of a committee receives an additional fee of $250.\nDirectors are permitted to elect to receive shares of Common Stock (\"Incentive Shares\") in lieu of cash fees. The directors of the Registrant also receive an option to purchase 1,000 shares of Common Stock (\"Incentive Option\") annually. The purchase price per share of common stock subject to an Incentive Option is the fair market value per share of common stock on the date the Incentive Option is granted.\nThe Chairman of the Board and the Chairman of the Executive Committee are entitled to an annual cash fee of $10,000. The Chairman of the Board has agreed to forego all compensation. The directors also are reimbursed for their expenses incurred in connection with meetings. No compensation is paid for telephonic meetings.\nPrior to the effectiveness of the Amended Plan on July 1, 1995, each director received an annual cash fee of $3,000 for service on the Registrant's board and $3,000 for service on the board of FRM, as well as a $500 cash fee for each director's meeting attended. In addition, each director received 200 shares of Common Stock for each meeting of the Board of Directors of the Company and its subsidiaries attended in person.\nThe Amended Plan is administered by the members of the Executive Committee of the Board of Directors who are not full-time salaried officers. The administrators of the Plan do not have discretion as to the selection of the directors to whom the awards may be granted. All of the non-employee directors, with the exception of the Chairman of the Board, participate in the Plan.\nThe total number of securities subject to the Plan, including both Incentive Shares and Incentive Options, is 252,000. The Plan provides that it will terminate on July 1, 1996.\nAs of January 31, 1996, the following options have been granted to the directors:\n* Retired as director July 1, 1995.\n1. Options for 7,200 shares exercised in July, 1995.\n2. Options for 7,200 shares exercised in January, 1995.\n3. Options for 5,760 shares exercised in April, 1995.\n4. Options for 7,200 shares exercised in May, 1995.\nExcept as reported herein, no other payments are made to the directors of the Registrant for their services as directors of the Registrant.\nITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nPRINCIPAL HOLDERS OF THE REGISTRANT'S VOTING SECURITIES\nAs of January 31, 1996 the following persons or entities were known by the Registrant to be beneficial owners of 5 percent or more of the Registrant's Common Shares:\n1. Calculated for each beneficial owner on the basis of shares outstanding at January 31, 1996, plus shares subject to options exercisable by such beneficial owner within 60 days of January 31, 1996.\n2. Owned directly by a limited partnership, the general partner of which is a corporation owned by Mr. Long.\n3. Mr. Long also holds options to purchase 7,200 shares of the Registrant's Common Stock as described under \"Remuneration and Other Transactions with Management - Directors' Compensation.\"\n4. Schedule 13D dated June 26, 1992 filed with the Securities and Exchange Commission reported ownership of 192,096 Common Shares. The Registrant's records indicate an additional 4,054 shares subsequently were acquired.\n5. As reported in an Amendment to Schedule 13D dated March 8, 1995 filed with the Securities and Exchange Commission. David G. Booth is the spouse of Jane Marvel Garnett.\n6. As reported in a Schedule 13D dated December 16, 1994 filed with the Securities and Exchange Commission.\n7. 6,336 Shares of Common Stock are owned directly by the children of Mr. Dore, and 67,658 shares of Common Stock are owned directly by the spouse of Mr. Dore.\n8. Mr. Dore also holds options (currently exercisable or exercisable within 60 days of January 31, 1996) to acquire 59,040 shares of Common Stock.\n9. As reported in a Form 4 dated September 6, 1995 filed with the Securities and Exchange Commission.\nThe amount and nature of beneficial ownership of Common Shares by the directors and executive officers of the Registrant as of January 31, 1996 is set forth below:\n(*) Less than one percent.\n1. The directors also hold certain options to purchase shares of the Registrant's Common Stock as described above under \"Directors' Compensation.\"\n2. Calculated for each beneficial owner on the basis of shares outstanding at January 31, 1996, plus shares subject to options exercisable by such beneficial owner within 60 days of January 31, 1996.\n3. 6,336 shares of Common Stock are owned directly by the children of Mr. Dore and 67,658 shares of Common Stock are owned directly by the spouse of Mr. Dore.\n4. Owned directly by a limited partnership, the general partner of which is a corporation owned by Mr. Long.\n5. Owned directly by a trust of which Mr. Morris is trustee.\n6. Owned directly by the estate of the spouse of the person whose ownership is reported.\n7. Owned directly by the spouse of the person whose ownership is reported.\n8. Owned directly by the children of Mr. Steffen. Mr. Steffen also holds options (currently exercisable or exercisable within 60 days of January 31, 1996) to purchase 23,760 shares of Common Stock.\n9. Owned directly by the spouse of the person whose ownership is reported. Mr. Wendt also holds options (currently exercisable or exercisable within 60 days of January 31, 1996) to purchase 3,312 shares of Common Stock.\nAs used herein, \"beneficially owned\" means the sole or shared power to vote or direct the voting of a security and\/or sole or shared investment power with respect to a security (i.e., the power to dispose or direct the disposition of a security). Unless otherwise indicated, the nominees and all directors and executive officers as a group have sole voting and sole investment power over the shares listed.\nThe present directors and named executive officers of the Registrant as a group (14 individuals including the above named directors) owned beneficially 777,932 Common Shares, or 27.9 percent of the outstanding Common Shares at January 31, 1996 including in such calculation options for Common Shares exercisable within 60 days of January 31, 1996.\nSee \"Recent Developments\" under Item 7 above.\nITEM - 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nLOAN\nMr. Dore received a loan from the Registrant in 1991 in the amount of $150,000 in order to finance the purchase of 43,200 shares of common stock from the Registrant at a price of $3.48 per share. Mr. Dore purchased the 43,200 shares from the Registrant on January 2, 1991, and executed a Promissory Note in the amount of $150,000 payable to the Registrant. The Promissory Note provided that payment of the amounts due thereunder was secured by the 43,200 shares so purchased by Mr. Dore. The principal amount bore interest at a rate equal to the average yield on five year Treasury obligations, and interest was due and payable annually. The $150,000 principal amount plus accrued interest was paid in full by Mr. Dore in 1995.\nCASTLE HARLAN LETTER AGREEMENT\nSee \"Recent Developments\" under Item 7.\nLONG AGREEMENT\nOn April 19, 1995, Mr. Long submitted a written request to the Registrant to inspect and make copies of a list of the names and addresses of the Registrant's stockholders. Mr. Long indicated that he intended to solicit proxies in support of a slate of directors proposed by him in opposition to the slate of directors proposed by management.\nAt a special meeting of the Board of Directors of the Registrant on April 21, 1995, an agreement with Mr. Long was approved pursuant to which: (i) Henry Drewitz and Edmond Shanahan retired from the Board of Directors of the Registrant and its subsidiaries effective July 1, 1995; (ii) the Board of Directors of the Registrant and its subsidiaries filled the vacancies created by such resignations with two nominees of Mr. Long, John P. Diesel and Richard P. Ackerman; (iii) Mr. Long was nominated to be Chairman of the Board of the Registrant and its subsidiaries, with Mr. Zellars to remain as Chairman of the Executive Committee of the Registrant and its subsidiaries, and Mr. O'Connell to remain as Vice-Chairman of the Registrant and its subsidiaries; and (iv) Mr. Long withdrew his request for a stockholders' list and voted his shares in favor of the slate of director nominees proposed by management.\nINDEMNITY AGREEMENTS\nIn December 1991, the Board of Directors of the Registrant authorized an updated form of Indemnity Agreement between the Registrant and its directors and officers and the directors and officers of its subsidiaries. Pursuant to the Indemnity Agreements, and in order to induce continued service by its directors and officers, the Registrant agrees to indemnify the directors and officers for certain claims against such persons arising solely out of their positions as directors and officers of the Registrant or its subsidiaries. Indemnity Agreements have been executed by each of the directors as well as by the officers of the Registrant set forth herein under \"Executive Officers of the Registrant.\"\nOTTER CREEK AGREEMENT\nEffective in January 1994, FRH, a subsidiary of the Registrant, has entered into an Investment Management Agreement with Otter Creek Management, Inc. (\"OCM\"). Director R. Keith Long is President and sole stockholder of OCM. Pursuant to the terms of the Investment Management Agreement, FRH has designated OCM as investment manager of funds in the amount of $7,000,000. OCM is required to obtain the specific approval of FRH prior to making any investments. OCM receives as compensation an annual fee equal to one percent of the market value of assets under management.\nASAP ARRANGEMENT\nThe Board of Directors of First Re in September, 1993 approved an arrangement pursuant to which First Re will share in the revenues from the sale of certain software products by Annual Statement Automated Products, Inc. (\"ASAP\"). Mr. Steffen, Chief Financial Officer of the Registrant and First Re, is founder and 45 percent owner of ASAP. In consideration of First Re's involvement in the enhancement of a general ledger software package for the preparation of annual statements, ASAP and First Re agreed to split any profits resulting from the sale of the package. Amounts to be received by First Re on an annual basis pursuant to the arrangement cannot be predicted at this time, but are not expected to be material in amount.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPART IV\nITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) The following consolidated financial statements of Financial Institutions Insurance Group, Ltd. are included in Item 8:","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\n(b)(iv) Amendment to the bylaws of Registrant -incorporated by reference to exhibit 3(b)(iv) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(b)(v) Amendment to the bylaws of Registrant -incorporated by reference to exhibit 3(b)(v) to the Registrant's Form 10-K for the year ended December 31, 1991.\n(b)(vi) Amendment to the bylaws of Registrant -incorporated by reference to exhibit 3(b)(vi) to the Registrant's Form 10-K for the year ended December 31, 1992.\n(b)(vii) Amendment to the bylaws of Registrant adopted March 8, 1995 incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1994.\n(b)(viii) Amendment to bylaws of the Registrant adopted June 7, 1995.\n(10)(a) Agreement dated April 1, 1991 between FIIF and Asset Allocation & Management Company and Agreement dated April 1, 1991 between FIIF and AAM Advisors, Inc. - incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1991.\n(b) Form of Employment Agreement between the Registrant's subsidiary and certain key officers - incorporated by reference to exhibit 10(f) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(c) Employment Agreement between FIIF and John A. Dore dated October 1, 1990 - incorporated by reference to exhibit 10(g) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(d) Stock Option Plan of the Registrant dated February 18, 1991 - incorporated by reference to exhibit 10(h) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(e) Form of Option Agreement - incorporated by reference to exhibit 10(i) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(f) Directors' Incentive Plan of the Registrant adopted September 10, 1990 - incorporated by reference to exhibit 10(j) to the Registrant's Form 10-K for the year ended December 31, 1990.\n(g) Amended Directors' Incentive Plan of the Registrant adopted March 12, 1991 -incorporated by reference to exhibit (a)(ii) to the Registrant's Form 10-Q for the quarter ended March 31, 1991.\n(h) Amended Directors' Incentive Plan of the Registrant adopted March 8, 1995 incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1994.\n(i) Agreement dated June 13, 1991 between the Registrant and Mr. R. Keith Long - incorporated by reference to the Registrant's Form 8-K dated June 13, 1991.\n(j) Form of Indemnity Agreement between the Registrant and directors and officers of the Registrant and its subsidiaries incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1991.\n(k) Investment management agreement dated January 1, 1994, between First Re and Otter Creek Management, Inc., incorporated by reference to exhibit 10(j) to the Registrant's Form 10-K For the year ended December 31, 1993.\nITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\n(l) Letter agreement dated as of February 17, 1996 among the Registrant, Castle Harlan Partners II, L.P., and John A. Dore.\n(21)(a) List of subsidiaries of the Registrant.\n(28) Information from reports furnished to state insurance regulatory authorities.\n(b) Reports on Form 8-K: Current Report on Form 8-K dated December 28, 1995 reporting the revocation of an offer by R. Keith Long to acquire the Registrant.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. SCHEDULE II CONDENSED BALANCE SHEETS (PARENT COMPANY) - -------------------------------------------------------------------------\nThe notes to the consolidated financial statements beginning on Page 23 are an integral part of these financial statements\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. SCHEDULE II CONDENSED STATEMENTS OF INCOME (PARENT COMPANY) - --------------------------------------------------------------------------------\nThe notes to the consolidated financial statements beginning on Page 23 are an integral part of these financial statements\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD. SCHEDULE II CONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY) - ------------------------------------------------------------------------------\nThe notes to the consolidated financial statements beginning on Page 23 are an integral part of these 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, as of the 30th day of March, 1996.\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD.\nR. Keith Long\nBy R. Keith Long Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and as of the dates indicated.\nINDEX OF EXHIBITS\nEXHIBIT\n(i) Information from reports furnished to state insurance regulatory authorities A (page 58 - 59)\n(ii) List of Subsidiaries B (page 60)\n(iii) Amendment to Article III, Section 8 of the bylaws of Financial Institutions Insurance Group, LTD. C (page 61 - 69)\n(iv) Letter agreement among Castle Harlan Partners II, L.P., John A. Dore and the Registrant dated as of February 17, 1996. D (page 70 - 71)\nEXHIBIT A\nRESERVES\nLoss reserves are estimates at a given point in time of what insurers expect to pay claimants, based on facts and circumstances then known, and it can be expected that the ultimate liability in each case will differ from such estimates. During the loss settlement period, additional facts regarding individual claims may become known and, consequently, it becomes necessary to refine and adjust the estimates of liability.\nThe Registrant maintains reserves for the eventual payment of losses and loss adjustment expenses with respect to both reported and unreported claims. Loss adjustment expense reserves are intended to cover the ultimate costs of settling all losses, including investigation and litigation costs from such losses. The amount of loss reserves for reported losses is primarily based upon a case-by-case evaluation of the type of risk involved and knowledge of the circumstances surrounding each claim and the claims and loss adjustment expense reserves are determined on the basis of historical information by line of insurance. Inflation is implicitly provided for in the reserving function through analysis of cost trends and reviews of historical reserving results. Reserves are closely monitored and are recomputed periodically using new information on reported claims and a variety of statistical techniques.\nThe following table sets forth a reconciliation of beginning and ending loss and loss adjustment expense reserves for each of the years shown. The table shows the amounts of the gross liability for 1987 through 1995 and its related payments and the reestimations of the reserves. The Registrant previously reported this information on a net reserve basis and has elected to conform to the current SEC guidelines on a historical basis.\nNote: The 1991 year reflects an increase in reserves due to the acquisition of First Re by the Registrants wholly-owned subsidiary FIIF. This is consistent with the treatment of the acquisition for all previously filed reports. The top line of the table shows the combined reserves at the balance sheet date for each of the indicated periods. The amount of the reserves represents the estimated amount of losses and LAE arising in all prior years that are unpaid at the balance sheet date, including IBNR reserves. The upper portion of the table shows the reestimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual periods. The cumulative redundancy (deficiency) represents the aggregate change in the estimates over all prior years. It should be noted that the table presents a \"run off\" of balance sheet reserves rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years (dollars in thousands):\nEXHIBIT A (CONTINUED) - ---------------------\nRESERVES (CONTINUED) - -------------------\nEXHIBIT OF GROSS LOSS RESERVE CUMULATIVE DEVELOPMENT (000 omitted)\nEXHIBIT B\nLIST OF SUBSIDIARIES\nCompany Name: Financial Institutions Insurance Group, Ltd. Tax ID#: 36-3468795 State of Incorporation: DE\nParent of\nCompany Name: First Re Management Company, Inc. Tax ID#: 36-3800158 State of Incorporation: IL\nCompany Name: Oakley Underwriting Agency, Inc. Tax ID#: 36-3876758 State of Incorporation: IL\nCompany Name: F\/I Insurance Agency, Inc. Tax ID#: 36-3714022 State of Incorporation: IL\nCompany Name: JBR Holdings, Inc. Tax ID#: 13-3385142 State of Incorporation: DE\nParent of\nCompany Name: The First Reinsurance Company of Hartford Tax ID#: 42-6052413 State of Incorporation: CT\nEXHIBIT C\nAMENDMENT TO ARTICLE III, SECTION 8\nBY-LAWS OF FINANCIAL INSTITUTIONS INSURANCE GROUP, LTD.\nARTICLE I\nOffices\nSection 1. The registered office shall be in the City of Wilmington, County of New Castle, State of Delaware.\nSection 2. The corporation may also have offices at such other places both within and without the State of Delaware as the board of directors may from time to time determine or the business of the corporation may require.\nARTICLE II\nMeetings of Stockholders\nSection 1. Annual meetings of stockholders for the election of directors and for such other business as may be stated in the notice of the meeting shall be held at such place, either within or without the State of Delaware, and at such time and date as the board of directors, by resolution, shall determine and as set forth in the notice of the meeting. In the event the board of directors fails to so determine the time, date and place of meeting, the annual meeting of stockholders shall be held at the offices of the corporation in Wilmington, Delaware on the second Thursday in May of each year at 10:00 A.M.\nIf the date of the annual meeting shall fall upon a legal holiday, the meeting shall be held on the next succeeding business day. At each annual meeting, the stockholders entitled to vote shall elect by a majority of the shares of stock having voting power present in person or represented by proxy directors of the first, second or third class, as the case may be, and the stockholders may transact such other corporate business as shall be stated in the notice of the meeting.\nSection 2. Meetings of stockholders for any purpose other than the election of directors may be held at such time and place, within or without the State of Delaware, as shall be stated in the notice of the meeting.\nSection 3. Written notice of the annual meeting stating the place, date and hour of the meeting shall be given to each stockholder entitled to vote at such meeting at his address as it appears on the records of the corporation, not less than ten nor more than sixty days before the date of the meeting.\nSection 4. The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present.\nSection 5. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the certificate of incorporation, may be called by the president or secretary or by resolution of the directors, but shall not be called at the request of the stockholders.\nSection 6. Written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called, shall be given not less than ten nor more than sixty days before the date of the meeting, to each stockholder entitled to vote at such meeting.\nSection 7. 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 stockholders for the transaction of business except as otherwise provided by statute, by the certificate of incorporation, or by these by-laws. 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 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 at the meeting as originally notified. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.\nSection 8. 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 certificate of incorporation of these by-laws, a different vote is required in which case such express provision shall govern and control the decision of such question.\nSection 9. Unless otherwise provided in the certificate of incorporation, each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder, but no proxy shall be voted on after three years from its date, unless the proxy provides for a longer period.\nSection 10. Except as otherwise provided by the certificate of incorporation, whenever the vote of stockholders at a meeting thereof is required or permitted to be taken for or in connection with any corporate action, by any provision of the General Corporation Law of the State of Delaware, or of the certificate of incorporation or of these by-laws, the meeting and vote of stockholders may be dispensed with if all of the stockholders who would have been entitled to vote upon the action if such meeting were held shall consent in writing to such corporate action being taken.\nARTICLE III\nDirectors\nSection 1. The number of directors shall be twelve (12). The directors shall be elected at the annual 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 or until his earlier resignation or removal. Directors need not be stockholders.\nSection 2. Any director, member of a committee or other officer may resign at any time. Such resignation shall be made in writing, and shall take effect at the time specified therein, and if no time be specified, at the time of its receipt by the president or secretary. The acceptance of a resignation shall not be necessary to make it effective.\nSection 3. If the office of any director, member of a committee or other officer becomes vacant, the remaining directors in office, though less than a quorum, by a majority vote may appoint any qualified person to fill such vacancy, who shall hold office for the unexpired term and until his successor shall be duly chosen.\nSection 4. Any director or directors may be removed for cause at any time by the affirmative vote of the holders of a majority of all the shares of stock outstanding and entitled to vote, at a special meeting of the stockholders called for that purpose and the vacancies thus created may be filled, at the meeting held for the purpose of removal, by a majority of the shares of stock having voting power present in person or represented by proxy.\nSection 5. The number of directors may be increased by amendment of these by-laws by the affirmative vote of a majority of the directors, 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 made in the manner provided by statute.\nNomination of Directors\nSection 6. Nominations for election to the board of directors may be made by the board of directors or by any stockholder of the corporation entitled to vote for the election of directors.\nSection 7. It shall be the duty of the board of directors to nominate directors by or on behalf of the existing management. Such nominations shall be made at a meeting of the board of directors prior to submission of preliminary proxy material on behalf of the existing management for the annual or special meeting at which the election is to take place.\nSection 8. (a) Nominations of persons for election to the board of directors of the corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (1) by or at the direction of the board of directors as set forth above, or (2) by any stockholder of record of the corporation who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 8.\n(b) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (2) of paragraph (a) of this Section, the stockholder must have given timely notice thereof in writing to the President of the corporation. To be timely, a stockholder's notice shall be delivered to the President at the principal executive offices of the corporation not less than sixty (60) days nor more than ninety (90) days prior to the first anniversary of the preceding year's annual meeting; provided, further, in the event that the date of the annual meeting is advanced by more than thirty (30) days or delayed by more than sixty (60) days from such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the 90th day prior to such annual meeting and not later than the close of business on the later of the 60th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made. Such stockholder's notice shall set forth: (1) as to each person whom the stockholder proposes to nominate for election or reelection as a director (i) the name, age, business address and residence address of each such person, (ii) the principal occupation or employment of such person, (iii) the class and number of shares of the corporation that are beneficially owned by each such person, (iv) such other information relating to such person as would be required to be disclosed by the federal securities laws and the rules and regulations promulgated thereunder in respect of an individual nominated as a director of the corporation and for whom proxies are solicited by the board of directors of the corporation (including without limitation such person's written consent to being named in the proxy statement as a nominee and serving as a director if elected), (v) to the extent known to the notifying stockholder, the total number of shares of capital stock of the corporation that will be voted for each proposed nominee; (2) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting; and (3) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation's books, and of such beneficial owner, (ii) the class and number of shares of the corporation that are owned beneficially and of record by such stockholder and such beneficial owner and (iii) a description of all arrangements or understandings between such stockholder or beneficial owner and any other person or persons (including their names) in connection with such nomination or business and any material interest of such stockholder or beneficial owner in such nomination or business.\n(c) Notwithstanding anything in the second sentence of paragraph (b) of this Section to the contrary, in the event that the number of directors to be elected to the board of directors of the corporation is increased and there is no public announcement naming all of the nominees for director or specifying the size of the increased board of directors made by the corporation at least (70) days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice required by this Section shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the President at the principal executive offices of the corporation not later than the close of business on the 10th day following the day on which such public announcement is first made by the corporation.\n(d) Only such persons who are nominated in accordance with the procedures set forth in this Section shall be eligible to serve as directors and only such business shall be conducted at an annual meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section. The President of the corporation shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made in accordance with the procedures set forth in this Section and, if any proposed nomination or business is not in compliance with these by-laws, to declare that such defective proposed business or nomination shall be disregarded.\n(e) For the purposes of this Section, \"public announcement\" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or a comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act.\n(f) Notwithstanding the foregoing provisions of this Section, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section. Nothing in this Section shall be deemed to affect any rights of stockholders to request inclusion of proposals in the corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act.\nSection 9. In the event that the board of directors has not acted as provided in Section 7 of this Article, or in the event of the death or refusal to serve of a nominee named pursuant to Section 7 of this Article, nominations may be made from the floor.\nSection 10. Nominations not made as herein provided may, in his discretion, be disregarded by the chairman of the meeting and, upon his instructions, the tellers of election may disregard all votes cast for any person not nominated as herein provided.\nMeetings of the Board of Directors\nSection 11. The board of directors of the corporation may hold meetings, both regular and special, either within or without the State of Delaware.\nSection 12. The first meeting of each newly elected board of directors may be held immediately following the adjournment of the annual meeting of the stockholders at the same place as such annual meeting and no notice of such meeting shall be necessary to the newly elected directors in order legally to constitute the meeting, provided a quorum shall be present. In the event such meeting is not held at such time and place, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the board of directors, or as shall be specified in a written waiver signed by all of the directors.\nSection 13. 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.\nSection 14. Special meetings of the board may be called by the president on at least two days' notice to each director, either personally or by mail or by telegram. Special meetings shall be called by the president or secretary in like manner and on like notice on the written request of two or more directors stating the purpose or purposes for which such meeting is requested. A meeting of the board of directors or any committee thereof by conference telephone or similar communication equipment by means of which all of the members of the board or committee participating may hear one another shall not require notice if a quorum of the board or committee are participating.\nSection 15. At all meetings of the board a majority of the then duly elected directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the board of directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation or by these by-laws. 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 16. 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 17. The board of directors shall exercise all of the powers of the corporation except such as are by statute or by the certificate of incorporation of the corporation or by these by-laws conferred upon or reserved to the stockholders.\nCommittees of Directors\nSection 18. 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. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution or in the by-laws of the corporation, 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.\nSection 19. Each committee shall keep regular minutes of its meetings and shall file such minutes and all written consents executed by its members with the secretary of the corporation.\nCompensation of Directors\nSection 20. Directors shall not receive a stated salary for their services as directors or as members of committees, but by resolution of the board, a fixed fee and expenses of attendance may be allowed for attendance at each meeting. Nothing herein contained shall be construed to preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.\nARTICLE IV\nNotices\nSection 1. Whenever, under the provisions of statute or of the certificate of incorporation or of these by-laws, notice is required to be given to any director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such director or stockholder, at his address as its appears on the records of the corporation, with postage thereon prepaid, and such notice shall be deemed to have been given on the day of such mailing. Notice to directors may also be given by telegram.\nSection 2. Whenever any notice is required to be given under the provisions of statute 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 to the notice.\nARTICLE V\nOfficers\nSection 1. 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 may also choose a chairman of the board of directors, a vice chairman, a chief executive officer, a chief financial officer and one or more vice-presidents, assistant vice-presidents, 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. The chairman and vice chairman of the board of directors shall be chosen from the members of the board of directors. None of the officers of the corporation need be directors.\nSection 2. The board of directors at its first meeting after each annual meeting of stockholders shall choose a president, a secretary, a treasurer and such other officers as the board of directors shall deem desirable.\nSection 3. The board of directors may appoint such other officers and agents as it shall deem necessary who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be provided for in these by-laws determined from time to time by the board.\nSection 4. The salaries of all officers of the corporation shall be fixed by the board of directors.\nSection 5. The officers of the corporation shall hold office until their successors are chosen and qualify or until their earlier resignation or removal. Any officer elected or appointed by the board of directors may be removed at any time by the affirmative vote of a majority of the board of directors. Any vacancy occurring in any office of the corporation shall be filled by the board of directors.\nThe Chairman of the Board\nSection 6. The chairman of the board of directors and in his absence the vice chairman, if either be elected, shall preside at all meetings of the board of directors and he shall have and perform such other duties as from time to time may be assigned to him by the board of directors.\nThe President\nSection 7. The president shall have the general powers and duties of supervision and management usually vested in the office of president of a corporation. He shall preside at all meetings of the stockholders if present thereat, and in the absence or non-election of the chairman and vice chairman of the board of directors, at all meetings of the board of directors, and shall have general supervision, direction and control of the business of the corporation. Except as the board of directors shall authorize the execution thereof in some other manner, he shall execute bonds, mortgages and other contracts in behalf of the corporation, and shall cause the seal to be affixed to any instrument requiring it and when so affixed the seal shall be attested by the signature of the secretary or the treasurer or an assistant secretary or an assistant treasurer.\nThe Chief Executive Officer\nSection 8. The chief executive officer shall under the general direction and supervision of the board of directors have general and active supervision over the formulation and implementation of corporation policy and over the business and affairs of the corporation and shall perform such other duties as may from time to time be prescribed by the board of directors or these by-laws.\nThe Chief Financial Officer\nSection 9. The chief financial officer shall assist the president and chief executive officer in the administration of the corporation's business and shall perform such other duties as may from time to time be prescribed by the board of directors or these by-laws.\nThe Vice Presidents\nSection 10. Each vice-president shall have such powers and shall perform such duties as shall be assigned to him by the directors.\nThe Treasurer\nSection 11. The treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate account of receipts and disbursements in books belonging to the corporation. He shall deposit all moneys and other valuables in the name and to the credit of the corporation in such depositories as may be designated by the board of directors.\nThe treasurer shall disburse the funds of the corporation as may be ordered by the board of directors, or the president, taking proper vouchers for such disbursements. He shall render to the president and the board of directors at the regular meetings of the board of directors, or whenever they may request it, an account of all his transactions as treasurer and of the financial condition of the corporation. If required by the board of directors, he shall give the corporation a bond for the faithful discharge of his duties in such amount and with such surety as the board shall prescribe.\nThe Secretary\nSection 12. The secretary shall give, or cause to be given, notice of all meetings of stockholders and directors, and all other notices required by law or by these by-laws, and in case of his absence or refusal or neglect so to do, any such notice may be given by any person thereunto directed by the president or by the directors upon whose request the meeting is called as provided in these by-laws. He shall record all the proceedings of the meetings of the corporation and of the directors in a book to be kept for that purpose, and shall perform such other duties as may be assigned to him by the directors or the president. He shall have the custody of the seal of the corporation and shall affix the same to all instruments requiring it, when authorized by the directors or the president, and attest the same.\nThe Assistant Treasurers and Assistant Secretaries\nSection 13. Assistant treasurers and assistant secretaries, if any, shall be elected and shall have such powers and shall perform such duties as shall be assigned to them, respectively, by the directors.\nARTICLE VI\nCertificates of Stock\nSection 1. Every holder of stock in the corporation shall be entitled to have a certificate, signed by, or in the name of the corporation by (a) the chairman or vice chairman of the board of directors, the president or a vice-president, and (b) 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. If the corporation shall be authorized to issue more than one class of stock or more than one series of any class, the designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and\/or rights shall be set forth in full or summarized on the face or back of the certificate which the corporation shall issue to represent such class or series of stock provided that, except as otherwise provided in the Corporation Law of Delaware in lieu of the foregoing requirements there may be set forth on the face or back of the certificate which the corporation shall issue to represent such class or series of stock a statement that the corporation will furnish without charge to each stockholder who so requests the designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and\/or rights.\nSection 2. Where a certificate is countersigned (a) by a transfer agent other than the corporation or its employee, or (b) by a registrar other than the corporation or its employee, any other signatures on the certificate may be 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. Subject to the foregoing, certificates for stock of the corporation shall be in such form as the board of directors may from time to time prescribe.\nLost Certificates\nSection 4. The board of directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of the fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the board of directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and\/or to give the corporation a bond in such sum as it may direct, not exceeding double the value of the stock, to indemnify the corporation against any claim that may be made against it or its transfer agent or registrar on account of the alleged loss of any such certificate, or the issuance of any such new certificate.\nTransfers of Stock\nSection 5. Upon surrender to the corporation of the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books.\nFixing Record Date\nSection 6. In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the board of directors may fix, in advance, a record date, which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting.\nRegistered Stockholders\nSection 7. 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 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\nIndemnification\nSection 1. It is mandatory that the corporation indemnify to the full extent provided in Article Tenth and Article Eleventh of the corporation's certificate of incorporation and under the Delaware Corporation Law any director, officer, employee or agent of the corporation or any person serving at the request of the corporation as a director, officer, employee or agent of another enterprise against expenses, judgments, fines and amounts paid in settlement.\nARTICLE VIII\nGeneral Provisions\nDividends\nSection 1. Dividends upon the capital stock of the corporation, subject to the provisions of the certificate of incorporation, if any, may be declared by the board of directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the certificate of incorporation. In the event dividends are declared, stock transfer books will not be closed but a record date will be set by the corporation, upon which date the transfer agent will take a record of all stockholders entitled to the dividend without actually closing the transfer books.\nSection 2. Before payment of any dividend, there may be set aside out of any funds of the corporation available for dividends such sum or sums as the directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for such other purpose as the directors shall think conducive to the interest of the corporation, and the directors may modify or abolish any such reserve in the manner in which it was created.\nAnnual Statement\nSection 3. The board of directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the corporation.\nChecks\nSection 4. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the board of directors may from time to time designate.\nFiscal Year\nSection 5. The fiscal year of the corporation shall commence on the first day of January and end on the last day of December unless and until the board of directors shall adopt a different fiscal year by resolution duly adopted.\nSeal\nSection 6. The corporate seal shall have inscribed thereon the name of the corporation 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 IX\nAmendments\nSection 1. Except as otherwise may be provided by the certificate of incorporation, these by-laws may be altered, amended or repealed, or new by-laws may be made at any annual meeting of the stockholders or at any special meeting thereof if notice of the proposed alteration or repeal of the by-law or by-laws to be made be contained in the notice of such special meeting, by the affirmative vote of a majority of the stock issued and outstanding and entitled to vote thereat, or by the affirmative vote of a majority of the board of directors at any regular meeting of the board of directors or at any special meeting thereof if notice of the proposed alteration or repeal of the by-law or by-laws to be made be contained in the notice of such meeting.\nEXHIBIT D\nLETTER AGREEMENT\nFebruary 17, 1996\nFinancial Institutions Insurance Group, Ltd. 300 Delaware Avenue Suite 1704 Wilmington, Delaware 19801-1612\nAttention: Board of Directors\nRe: Financial Institutions Insurance Group, Ltd.\nGentlemen:\nWe are pleased to submit to you this proposal by Castle Harlan Partners II, L.P. (\"CHP II\") and John A. Dore to acquire, through a new corporation to be organized and owned by them, Financial Institutions Insurance Group, Ltd. (\"FIIG\"), at a price of $16 per share of outstanding FIIG Common Stock (the \"Per Share Purchase Price\") after giving effect to the announced split and dividend. We would also pay, with respect to each outstanding option to purchase FIIG Common Stock, the excess of the Per Share Purchase Price over the exercise price of such option.\nThis proposal is subject to negotiation and finalization of a definitive purchase agreement. CHP II is a $250 million private equity investment limited partnership. Castle Harlan, Inc., as investment manager for CHP II, has the discretion, without the need for additional approval, to direct CHP II's investments. Accordingly, the definitive purchase agreement would not be conditioned upon financing. Consummation of such acquisition would only be subject to receipt of any regulatory approvals and other customary conditions to closing for a transaction of this type. The definitive purchase agreement will contain such other terms as are customary for a transaction of this type and as the parties may agree.\nFollowing execution of the enclosed counterpart of this letter by FIIG, during the period ending 5:00 p.m. New York City time on March 4, 1996 (or such later date as may be 13 days following such execution) (the \"Due Diligence Period\"), FIIG agrees that it shall not, directly or indirectly, solicit any acquisition proposal, or cooperate with, furnish or cause to be furnished any information concerning the business, financial condition, properties or assets of FIIG to, or continue or enter into any discussion, negotiation, agreement or understanding concerning any acquisition proposal with, any person making any acquisition proposal. For a period of 32 days following the expiration of the Due Diligence Period, FIIG further agrees that it shall not, directly or indirectly, solicit any acquisition proposal, or cooperate with, furnish or cause to be furnished any information concerning the business, financial condition, properties or assets of FIIG to, or continue or enter into any discussion, negotiation, agreement or understanding concerning any acquisition proposal with, any person making any acquisition proposal, except that FIIG shall be permitted to consider and negotiate any unsolicited acquisition proposal, furnish information to and enter into an acquisition agreement with a third party if the Board of Directors of FIIG determines in good faith, based upon a written opinion of outside counsel, that its fiduciary duties require it to do so. The provisions of this paragraph shall expire at 5:00 p.m. New York City time on the date which is 45 days following the date of execution of the enclosed counterpart of this letter by FIIG, unless a definitive purchase agreement with CHP II or its affiliates is executed and delivered on or before that date, or such later date as the parties may agree. As used in this paragraph, \"acquisition proposal\" shall mean any proposal, offer or indication of interest for a merger or other business combination or joint venture involving FIIG or for the acquisition of a substantial portion of the assets or the stock of FIIG.\nAs we have discussed, we are prepared to commence a confirmatory due diligence review of FIIG on February 21, 1996 to confirm that all public information concerning FIIG is correct in all material respects and that there are no material omissions in such information. CHP II is prepared to move expeditiously and begin immediately the process of negotiating a definitive purchase agreement, and you and we agree, subject to the fiduciary duties of the directors of FIIG referred to in the prior paragraph, to use our mutual best efforts to execute and consummate such agreement as promptly as possible. Upon the satisfactory conclusion of our due diligence review (which shall be completed within the Due Diligence Period), we will deliver written confirmation to FIIG that such review was satisfactory, and this proposal, the definitive agreement and the Per Share Purchase Price shall thereafter not be subject to any due diligence contingencies.\nIn the event that FIIG enters into an agreement involving a merger or other business combination or joint venture involving FIIG or for the acquisition of a substantial portion of the assets or the stock of FIIG with a third party (other than with CHP II or its affiliates), within one year of the date hereof, FIIG shall be obligated, upon such execution, (i) to reimburse us for our out-of-pocket fees and expenses in connection with the transactions contemplated hereby in an amount not to exceed $100,000, a written itemization of which shall be delivered to FIIG; and (ii) to pay to CHP II a cash fee of $3,500,000. Upon payment of any such amount, FIIG shall have no further liability or obligation whatsoever to CHP II. The provisions of this paragraph shall be of no force and effect and no payment shall be made to CHP II if: (i) at any time CHP II lowers the Per Share Purchase Price below $16.00; (ii) a transaction with CHP II is not consummated due to the failure by CHP II to satisfy the terms and conditions of this agreement or the definitive agreement; (iii) CHP II for any reason (other than due to the failure by FIIG to satisfy the terms and conditions of this agreement or the definitive agreement) determines not to pursue the transaction with FIIG; (iv) any regulatory approval required for such transaction is not obtained; or (v) the written confirmation of satisfactory completion of due diligence is not received by 5:00 p.m. New York City time on the last day of the Due Diligence Period.\nIf the foregoing is acceptable to you, please sign the attached enclosed counterpart of this letter in the space provided and return the counterpart to CHP II no later than 5:00 p.m. New York City time, February 20, 1996.\nVery truly yours,\nCastle Harlan Partners II, L.P. By: Castle Harlan, Inc., as Investment Manager\nBy: \/s\/ Jeffrey M. Siegal ------------------------------------ Jeffrey M. Siegal, Managing Director\n\/s\/ John A. Dore -------------------- John A. Dore\nACCEPTED AS OF February __, 1996:\nFINANCIAL INSTITUTIONS INSURANCE GROUP, LTD.\nBy: \/s\/ R. Keith Long 2\/19\/96 ------------------------------------------- Title:","section_15":""}
{"filename":"798085_1995.txt","cik":"798085","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL INFORMATION\nThe Registrant, US Facilities Corporation (the \"Company\"), is a Delaware holding company formed in 1982 which, through its subsidiaries, operates as a specialty insurance group. The Company's two principal operating units are USBenefits Insurance Services, Inc. (\"USBenefits\") and USF RE INSURANCE COMPANY (\"USF RE\"). USBenefits underwrites, manages and markets medical stop- loss coverage nationwide for The Continental Insurance Company (\"Continental\"), one of the CNA Insurance Companies (\"CNA\"), an unaffiliated insurance company, in exchange for management fees. Medical stop-loss insurance protects self-insured employers against the risk of exposure to excessive losses by limiting their liability to a predetermined amount. Self- insured plans permit employers to design employee benefit coverages structured to meet their specific needs, allow employers to exercise more control over their health insurance costs, and provide health coverages that might not otherwise be available. USBenefits also markets other employee benefit related products on behalf of several national life insurance companies.\nUSF RE is a property\/casualty reinsurance company whose primary business is the reinsurance of 50% of the medical stop-loss coverage underwritten by USBenefits for Continental and the reinsurance of property\/casualty accounts produced by independent sources. Its subsidiary, USF Insurance Company (\"USFIC\"), writes excess and surplus lines insurance on a direct basis.\nFINANCIAL INFORMATION RELATING TO BUSINESS SEGMENTS\nThe Company's operations are classified into two business segments: (1) medical stop-loss and employee benefit products (which include the revenues from commissions and fees of the Company, and from reinsurance of 50% of its medical stop-loss business); and (2) property\/casualty reinsurance and insurance underwriting. The medical stop-loss and employee benefits segment produced 73%, 80% and 81%, and the property\/casualty segment produced 26%, 20% and 18% of the Company's consolidated revenues for 1995, 1994 and 1993, respectively.\nSee \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" and also \"Note 9 of Notes to CONSOLIDATED FINANCIAL STATEMENTS,\" incorporated herein by reference from the Company's 1995 Annual Report to Stockholders under Items 7 and 8 hereof, respectively.\nMEDICAL STOP-LOSS AND EMPLOYEE BENEFIT PRODUCTS\nGENERAL\nSince 1980, USBenefits has had a mutually exclusive agreement to underwrite and manage medical stop-loss coverage for Continental. Such agreement provides that USBenefits is responsible for designing medical stop-loss products, marketing the products, underwriting risks, collecting premiums, administering coverage agreements, investigating and settling claims and making claim payments within specified limits. While USBenefits participates in the setting of rates and underwriting standards, which are the ultimate responsibility of Continental, it does not insure any risks in its role as underwriting manager; all insurance risks are borne by Continental and its reinsurers, including USF RE. See \"BUSINESS--MEDICAL STOP-LOSS AND EMPLOYEE BENEFIT PRODUCTS--MEDICAL STOP-LOSS REINSURANCE\" herein.\nUnder its current management agreement with Continental, USBenefits is paid management fees for its services which are a percentage of premiums collected. The management agreement may be terminated by either party at any December 31 upon 90 days prior notice, and can also be terminated upon the occurrence of certain events. The management agreement provides that during its term and for a period ranging from 12 to 18 months following termination, Continental will not solicit or take away USBenefits' accounts or production sources, and\nthat upon termination USBenefits has the right to the expirations and renewals of the medical stop-loss business. The Company believes that these provisions permit USBenefits to move the medical stop-loss business to another insurance company if its relationship with Continental were to terminate. Alternatively, USBenefits could write medical stop-loss coverage on a direct basis through its affiliate, USF RE, which is currently licensed to issue such coverage in 44 states and the District of Columbia.\nUSBenefits also markets various employee benefit insurance products on behalf of several large national life insurance companies. Other than Continental, no one insurance company, third party administrator (\"TPA\") or insurance producer accounts for 10% or more of USBenefits' revenues.\nIn mid-1992 the Company began development of a medical bill review business. During 1995 the Company determined that the medical bill review business was no longer viable and terminated its operations in May. Consolidated pre-tax results for 1995, 1994 and 1993 include losses from this bill review operation of $1,156,000, $1,136,000 and $1,492,000, respectively.\nMARKETING\nUSBenefits markets and distributes its medical stop-loss products through a network of TPAs, insurance agents, brokers and consultants (collectively \"Producers\"). Producers have non-exclusive arrangements with USBenefits that enable them to submit requests for stop-loss coverage quotations on behalf of their self-insured clients. Continental may pay a fee or commission to Producers for placing the coverage, the amount of which is based on a percentage of the premium written and is negotiated on a case-by-case basis. Additionally, USBenefits may pay an annual production bonus to Producers based on the amount of new business and rate of retention of accounts during the calendar year. USBenefits markets its products to a variety of employers, which includes both large and small employee groups.\nPRODUCTS\nMedical Stop-Loss. USBenefits offers two types of medical stop-loss products: specific excess and aggregate excess. Employers can elect to purchase specific excess coverage only, or a combination of specific and aggregate coverage. USBenefits does not offer aggregate coverage separately. Generally, self-insured employers purchase a combination of specific and aggregate medical stop-loss coverage in order to minimize their exposure.\nMedical stop-loss coverage is written on a basic form which can be customized to meet the employer's individual needs and ability to retain risk. Medical stop-loss coverage indemnifies only the employer for its obligations under its self-insured plan of medical benefits; no plan participant or beneficiary is covered by the Continental medical stop-loss policy.\nProvider Capitation. In 1994 USBenefits commenced the marketing, underwriting and managing of a provider capitation product on behalf of Continental. This product limits the exposure which providers of medical services incur when they enter into capitated fee arrangements; it protects these providers from excessive losses that can arise when expenses exceed a predetermined level. Continental pays USBenefits management fees for its services, which are a percentage of premiums collected.\nUNDERWRITING MANAGEMENT\nUnder its agreement with Continental, USBenefits, with the assistance of USF RE, provides the services necessary to underwrite and service the medical stop-loss business, including, but not limited to: (i) selecting TPAs and Producers; (ii) accepting medical stop-loss risks and issuing coverage agreements on behalf of Continental within mutually agreed upon underwriting and pricing guidelines; and (iii) processing employers' claims for reimbursement under medical stop-loss agreements on behalf of Continental.\nMEDICAL STOP-LOSS REINSURANCE\nUSF RE reinsures a portion of the medical stop-loss business and the provider capitation business underwritten by USBenefits. Under the reinsurance agreement with Continental, USF RE is responsible for 50% of Continental's liability under such contracts issued through USBenefits. Continental's liability under medical stop-loss contracts varies per account, but in no event can exceed $2,000,000 lifetime per individual self-insured plan participant or $2,000,000 in the aggregate per agreement year for each self- insured employer account. Continental's liability under provider capitation contracts generally is limited to a maximum of $1,000,000 per individual participant and up to a maximum of $5,000,000 for all participants. In addition, USF RE is responsible for a proportionate share of loss adjustment expenses and any liability incurred by Continental for extra-contractual or punitive damages.\nThe amount of premium ceded by Continental to USF RE under the reinsurance agreement is equal to a proportionate share of the original gross premiums written by Continental, less a ceding commission paid by USF RE to Continental which covers Continental's costs of acquiring and servicing such business.\nPROPERTY\/CASUALTY UNDERWRITING\nGENERAL\nUSF RE underwrites property\/casualty reinsurance which it secures from numerous reinsurance intermediaries and directly from unaffiliated insurance companies. USF RE is licensed to write various lines of insurance in 46 states and the District of Columbia. USF RE and USFIC share a pooled A- (Excellent) rating from A.M. Best Company (\"A.M. Best\"), which reflects A.M. Best's evaluation that these companies have exhibited \"excellent overall performance\" and have \"a strong ability to meet obligations to their policyholders over a long period of time.\" During the third quarter of 1995, USF RE ceased writing plate glass insurance, which accounted for 3%, 5% and 5%, of USF RE's premium earned in 1995, 1994 and 1993, respectively.\nPROPERTY\/CASUALTY REINSURANCE\nGross reinsurance premiums written by the Company's property\/casualty segment were $50,915,000 in 1995, an increase of 42% as compared to 1994 premiums written of $35,760,000, which was an increase of 38% over $25,952,000 in premiums written during 1993. The ceding companies of one client organization accounted for a total for 27%, 17% and 13% of gross premiums written in the property\/casualty segment in 1995, 1994 and 1993, respectively.\nGeneral. USF RE offers a variety of reinsurance coverages in selected property\/casualty lines. In general, reinsurance coverage is provided on the basis of the underwriter's evaluation of the acceptability of the risk to be assumed, the adequacy of the premium, the potential exposure of the line of business to be underwritten, the quality of the primary insurers' operations and the ceding commission. USF RE's property\/casualty premiums are generated from writing facultative and treaty reinsurance. Facultative is the reinsurance of one account at a time, while reinsurance treaties cover a portion of all policies written by another insurer in a particular risk category.\nProduct Lines. USF RE concentrates its casualty writings on three principal lines: general liability, commercial automobile liability and products liability. USF RE provides casualty reinsurance for primary as well as excess policies, with the majority of its writings in low excess layers. USF RE provides a broad range of reinsurance coverages for most types of property exposures, subject to adequate underwriting information and proper rates and forms. All Risk and Difference in Conditions coverages represent the majority of property premiums written; other coverages include fire and extended coverage, as well as allied lines and inland marine.\nRetrocessions. USF RE has entered into retrocession (reinsurance) agreements which mitigate USF RE's exposure to losses and therefore allow it to increase the limits it can offer on each property\/casualty account. Under its current catastrophe retrocession arrangements, USF RE purchases approximately 95% of $24,500,000\nof catastrophic protection in excess of a retention of $3,500,000 covering property facultative and surplus lines losses. Within this cover, USF RE has $6,500,000 of catastrophic protection in excess of the same retention of $3,500,000 covering property treaty losses. Management believes this coverage is adequate to protect the Company from excessive catastrophic losses.\nUSF RE evaluates the financial condition of potential retrocessionaires to determine whether to cede retrocessional coverage to such companies. USF RE's retrocession agreements are placed with unaffiliated companies which management believes to be financially secure and experienced in this type of business. Reinsurance recoverables are monitored continually, and any retrocessionaire not qualified in USF RE's state of domicile, Massachusetts, is requested to post security in the amount of its estimated liability to USF RE.\nSurplus Lines. USFIC, a Pennsylvania domiciled insurance company, is eligible to offer surplus lines coverages in 29 states and the District of Columbia and is also licensed as an admitted insurer in New York and Florida. Since acquiring USFIC, USF RE has increased USFIC's policyholders' surplus to over $15,000,000 at December 31, 1995. USFIC's business consists primarily of writing commercial property\/casualty coverages on a surplus lines basis. USFIC's operations contributed 13%, 8% and 4% of the property\/casualty underwriting segment's premiums earned in 1995, 1994 and 1993, respectively.\nSTATUTORY FINANCIAL INFORMATION\nCOMBINED RATIO\nThe combined ratio is the traditional indicator of the potential underwriting profitability of an insurance company's business. It reflects the percentage of losses and loss adjustment expenses incurred to earned premiums (the \"loss ratio\") plus the percentage of production and servicing expenses to net written premiums (the \"underwriting expense ratio\"). The table below sets forth USF RE's consolidated loss ratio, underwriting expense ratio and combined ratio determined in accordance with statutory accounting practices (\"SAP\") for the years indicated. Management believes that USF RE's combined ratio is generally better than the combined ratio for the reinsurance industry as a whole and is well within the requirements of regulatory agencies.\nLOSS AND LOSS ADJUSTMENT EXPENSE RESERVES\nInsurance and reinsurance companies are required to maintain reserves for losses and loss adjustment expenses (\"LAE\") which are intended to cover the ultimate cost of settling all losses incurred and unpaid, including an estimate of those not yet reported to the insurer, in order to properly match the expected losses incurred to the related earned premium.\nReserves for medical stop-loss reinsurance are established on the basis of the most widely used techniques for determining loss reserves for this line of business, such as trended cost per covered person and loss payment pattern analysis. Property\/casualty loss reserves are determined by customary industry methods of evaluating reported claims on the basis of the type of loss involved, knowledge of the circumstances surrounding the claim, policy provisions relating to the type of loss, and by estimating the cost of unreported claims on the basis of statistical information for occurrences which have not yet been reported to the carrier.\nReserves are adjusted from time to time based on monitoring by the insurer. USF RE conducts, on a quarterly basis, an in-depth analysis of its incurred but not reported losses and bulk reserves relative to recent experience and trends, and adjusts such reserves upward or downward as necessary to maintain the reserves at a\nlevel which USF RE deems to be sufficient to provide for all claims incurred through the reporting date. Such reserves are regularly reviewed by USF RE's independent actuary and auditors.\nLoss reserve estimates are not precise because they are based on predictions of future events, as well as other variable factors, including changes in the legal system which can affect the results of litigated claims. Reserves for losses and LAE are estimates only. It is possible that an insurer's ultimate liability may be greater or less than such estimates. At USF RE, no explicit provisions are made for inflation, but inflationary trends are considered when setting reserves. USF RE does not discount its reserves to their present value. USF RE has no known pre-1986 environmental or asbestos exposures.\nThe loss settlement period for certain types of insurance claims, such as casualty reinsurance, may be many years, and during such time it often becomes necessary to adjust the estimate of liability on a claim either upward or downward. In the last few years various factors (including escalation of repair costs, the size and unpredictability of jury awards and inflation) have necessitated periodic upward adjustments in reserves by most property\/casualty insurers, including USF RE. In addition, USF RE's relatively recent entry into the assumed casualty reinsurance business in 1987 contributes to the level of uncertainty associated with USF RE's estimates for loss and LAE reserves. Due to USF RE's size, should any future adjustments of its reserves become necessary, such adjustments could have a proportionately greater impact upon its reported earnings and surplus than they would have upon the earnings and surplus of a much larger insurance company.\nLAE reserves are intended to cover the ultimate cost of investigating and settling all losses. LAE reserves are estimated throughout each year based on historical data and factors similar to those used in estimating loss reserves, and are adjusted from time to time as management deems appropriate.\nIn 1987, USF RE established a liability for uncollectible reinsurance related to adverse development in its discontinued general liability and special multiple peril (\"GL\/SMP\") liability lines of business to recognize that certain amounts would not be recoverable from a former reinsurer. Under generally accepted accounting principles (\"GAAP\"), that provision was recorded as additional loss and LAE reserves, and has been adjusted periodically as claims develop. USF RE has not experienced any other material unrecoverable reinsurance.\nIn 1992 the Company adopted the Statement of Financial Accounting Standards (\"SFAS\") No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,\" which changes certain GAAP accounting presentation by insurance enterprises for reinsurance transactions. Under SFAS No. 113, insurance receivables, such as ceded loss and LAE reserves, are required to be reported as assets rather than reductions of gross liabilities.\nThe following table reconciles USF RE's consolidated reserve for losses and LAE from SAP to amounts based on GAAP:\nExcept for the foregoing, there is no difference in USF RE's reserves for losses and LAE whether determined in accordance with GAAP or SAP.\nThe table set forth below provides a reconciliation of beginning and ending consolidated statutory liability balances as of December 31, 1995, 1994 and 1993. Management will continue to evaluate and monitor reserves on all of its businesses, and management believes that USF RE's consolidated reserves at December 31, 1995 are adequate to cover the ultimate cost of settlement of all losses incurred through that date.\nThe table on the following page presents the development of USF RE's consolidated statutory balance sheet liability for losses and LAE for 1983 through 1995. The top line of the table shows the estimated liability for unpaid losses and LAE recorded at December 31 for each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported.\nThe upper 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. The material increase in loss reserves beginning in 1986 is primarily attributable to USF RE's commencement of and, thereafter, significant growth in its reinsurance business. The cumulative redundancy or deficiency represents the total change in reserves from the original balance sheet date to December 31, 1995, and is a measure of the accuracy of the original estimate. The significant deficiencies shown for years 1983 through 1987 are related to the aforementioned discontinued GL\/SMP lines of business. Such increases related to losses incurred in 1983 through 1984, and therefore affect reserve amounts in all years from 1983 through 1995.\nThe lower portion of the table on the following page shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year, and a reconciliation of the gross and net amounts for the latest two years.\nINVESTMENTS\nInvestment income is an important source of revenue for the Company. The return on its investment portfolio has a significant bearing on the Company's results of operations. Funds of the Company's insurance company subsidiaries available for investment arise from their capital and surplus, as well as from the difference in timing between the receipt of premiums and the payment of claims. Investment income is also generated from investments in short-term securities of the premiums received and held in trust by USBenefits pending payment to Continental and other insurance carriers and from investment of commissions and fees received by USBenefits. In the fourth quarters of 1994 and 1995, the Company contributed $20,000,000 and $10,500,000, respectively, to USF RE, bringing its policyholders' surplus to over $100,000,000 at December 31, 1995.\nThe Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective as of January 1, 1994. This pronouncement deals with the manner in which fixed maturity securities are valued in financial statements. For further information, see \"Note 1 of Notes to CONSOLIDATED FINANCIAL STATEMENTS,\" incorporated by reference from the Company's Annual Report to Stockholders under Item 8 herein.\nThe Company's investment policy is determined in accordance with guidelines established by the Investment Committee of the Company's Board of Directors, subject to state regulatory restrictions on the nature and extent of investments of insurance companies. Generally speaking, the Company's policy is to acquire investment grade bonds with maturities timed to meet the liquidity needs of the business, a limited amount of high-grade equity securities, certificates of deposit and short-term securities. This policy is substantially more restrictive than applicable insurance laws or regulations, because such laws and regulations permit some investment in high-yield bonds, stocks, real estate, and other vehicles which may have substantially more volatility and risk than USF RE's investments. At year-end 1995, approximately 99% of the fixed income portfolio was invested in securities rated A or better, with maturity dates ranging from 1-30 years. Short-term investments are comprised of bank certificates of deposit, tax-exempt auction rate preferred stocks which are redeemable at par value every 7-270 days, and tax- exempt money market funds. For further information, see \"Note 2 of Notes to CONSOLIDATED FINANCIAL STATEMENTS,\" incorporated by reference from the Company's Annual Report to Stockholders under Item 8 herein.\nCOMPETITION\nThe insurance and reinsurance industries are highly competitive and consist of a large number of companies, many of which have financial resources, employees, facilities and experience substantially in excess of those of the Company.\nMEDICAL STOP-LOSS\nThe medical stop-loss business is highly competitive and involves a diversified field of participants from small, start-up operations to large, well-established organizations such as USBenefits. In recent years there has been significant growth in the number of medical stop-loss providers. Currently the Company believes that there are over 200 providers of medical stop-loss coverage, as compared to approximately 120 providers in 1990. Based on its over-15 years of experience in the medical stop-loss business, the Company believes that it is the largest single issuer of medical stop-loss coverage in the United States. However, other large and established companies offer medical stop-loss products and services similar to those offered by USBenefits, and have large, well-established sales forces and ample resources at their disposal.\nUSBenefits currently relies primarily on its long-standing relationships with independent TPAs as a source of business, as well as newer relationships with insurance agents, brokers and consultants. USBenefits must compete for its business by offering competitively priced products, providing high quality, timely services and paying commissions which are competitive. USBenefits believes that the financial strength of Continental and its A- (Excellent) rating from A.M. Best are positive factors in USBenefits' competitive position.\nPROPERTY\/CASUALTY REINSURANCE\nCompetition in the reinsurance business is based on many factors, including a reinsurer's perceived overall financial strength, premiums charged, A.M. Best rating, services offered, claims handling, experience in the lines of business written and the number of jurisdictions in which a reinsurer is authorized to do business.\nThe reinsurance market has two basic segments: reinsurers that primarily obtain their business directly from ceding insurance companies, and those that primarily obtain business through reinsurance intermediaries. USF RE obtains the majority of its property\/casualty business through reinsurance intermediaries. USF RE's competition in this field includes numerous major international and domestic insurance and reinsurance companies and underwriting syndicates. Management believes that while USF RE's competitive position may have historically been negatively affected by its relatively small surplus and the lack of an A.M. Best rating, as a result of the increase of its surplus to over $100,000,000 and the A- (Excellent) rating from A.M. Best, USF RE's competitive position has been improved.\nThe reinsurance marketplace has been and continues to be highly competitive. Due to losses caused by various natural disasters during the latter half of 1992 and continuing through 1995, both demand and rates for some segments of property reinsurance increased. This has caused a certain amount of relaxation in the competitive environment in this line of business. However, the overall reinsurance marketplace for property\/casualty coverage continues to be highly competitive.\nSURPLUS LINES\nThe surplus lines insurance business has many participants, including small companies such as USFIC and large, well-established organizations which create a highly competitive environment. Competition in the surplus lines area involves the same factors and considerations as with any insurance operation: the financial strength of the carrier, the premiums charged, the A.M. Best rating, the services offered, the timeliness of claims handling, experience in the lines of business written, relationships with brokers and the number of jurisdictions in which the carrier is authorized to do business. Based both upon an evaluation of such factors and because of USFIC's focus on specialized areas of the business, such as smaller commercial property and casualty accounts and other multiple-account programs in certain states, management believes that USFIC will be able to continue to grow in this field.\nREGULATION\nGENERAL\nInsurance and reinsurance companies are subject to primary regulation and supervision by the insurance departments of their states of domicile, as well as by agencies of other states where they are licensed or authorized to transact business. Such regulation and supervision is designed primarily to protect policyholders, not stockholders. Although the extent of such regulation varies from state to state, in general the insurance laws of states provide such supervisory agencies with broad administrative powers. These powers include the granting and revocation of licenses to transact business, the licensing of agents, the approval of policy forms and rates, the determination of reserve requirements, the monitoring of financial stability, the form and content of required financial statements, and the type and character of investments. Further, the National Association of Insurance Commissioners (\"NAIC\") has proposed a variety of model laws and regulations affecting insurance companies generally, including laws and regulations relating to solvency standards for all insurance companies. Certain of these model laws and regulations have been adopted by various states and others are being considered for adoption.\nUSF RE and USFIC are required to file detailed annual financial and other reports with the appropriate insurance regulatory agency in each state in which they are admitted or authorized to do business. Their business and accounts are subject to examination by such agencies at any time, and the laws of Massachusetts and Pennsylvania and other states require periodic examination of USF RE and USFIC. USF RE was examined by\nthe Division of Insurance of the Commonwealth of Massachusetts during 1993 for the four-year period ended December 31, 1992. USFIC was examined by the Insurance Department of the Commonwealth of Pennsylvania during 1993 for the three-year period ended December 31, 1992. The final reports of these examinations did not indicate any concerns of a material nature or which were significant to USF RE's or USFIC's surplus as regards policyholders.\nPROPERTY\/CASUALTY\nHistorically the property\/casualty reinsurance business has not been subject to extensive regulation. However, reinsurance is now under closer scrutiny by state agencies, as evidenced by the recent promulgation by the NAIC of several model laws and regulations. Additionally, legislative initiatives are being considered at the federal level to regulate the solvency of insurance and reinsurance companies. Management expects this trend toward greater regulation of the insurance and reinsurance industries to continue. At this time management cannot anticipate what impact, if any, such regulation would have on the Company's operations.\nUSFIC is required by state laws governing surplus lines to be eligible to write business as a surplus lines insurer in each state in which its products are sold. Eligibility is based on a number of considerations, including size, financial condition, experience in the insurer's state of domicile, expertise of management and plan of operations. The writing of surplus lines is constrained by laws that require that the business can be written in a state only if coverage for the risk is not available from an insurer admitted in such state. Furthermore, the business can only be written through a licensed excess and surplus lines broker.\nMEDICAL STOP-LOSS\nHistorically medical stop-loss coverage had not been subject to the high degree of regulation characteristic of the fully-insured group health business. State regulation of self-insured plans is preempted by the Employee Retirement Income Security Act of 1974 (\"ERISA\"). However, as medical stop- loss has grown in importance, states have attempted to circumvent ERISA's preemption by seeking to assert their regulatory authority over insurance companies writing medical stop-loss coverages and related service providers, such as USBenefits. States have now taken legislative or regulatory action to regulate policy and rate filings for this line of business. The Company and Continental have filed policies and rates as required by the applicable state laws.\nThe NAIC has adopted a model Managing General Agents Law, the substance of which has been enacted in 49 states and the District of Columbia. This model law requires the licensing of managing general agents that perform certain functions on behalf of insurance companies, such as underwriting, together with claims settlement and payment. It also imposes certain requirements with respect to the content of agreements between insurance companies and managing general agents. USBenefits is licensed or registered as a managing general agent or third party administrator in various states where such licensing or registration is required. It is also licensed directly, or through one or more of its employees, in 42 states as a property\/casualty insurance agent and in 47 states as an accident and health insurance agent.\nSTATE INSURANCE HOLDING COMPANY LAWS\nThe Company, its stockholders, and its insurance company subsidiaries are subject to the Insurance Holding Company Acts of the Commonwealth of Massachusetts where USF RE is domiciled, the State of California where USF RE is deemed to be \"commercially domiciled\" and the Commonwealth of Pennsylvania where USFIC is domiciled. Generally, these Insurance Holding Company Acts prohibit any person from acquiring \"control\" of a domestic insurer, or of a company controlling a domestic insurer, without prior approval of the insurance commissioner of such insurer's state of domicile. Control is presumed to exist through ownership or the right to acquire 10% or more of the stock of the insurer; but this presumption may be rebutted. These Insurance Holding Company Acts require holding companies and their insurance subsidiaries to register and file on a regular basis reports which include information concerning their capital structure, ownership and financial condition. Certain transactions between members of the holding company group are subject to fairness and\nreasonableness standards, and notice of such transactions must be given to the Commissioners of Insurance of Massachusetts and Pennsylvania 30 days prior to entering into such transactions, during which time the Commissioners of these states may indicate their disapproval. Further, the California Holding Company Act requires approval of material transactions of an extraordinary type.\nThe amount of dividends which USF RE is permitted to pay the Company is limited by the insurance laws of Massachusetts and California. USF RE must give notice to the Massachusetts and California Insurance Commissioners of all dividends and other distributions to stockholders within five business days after they are declared, and may not pay such dividends until ten business days after receipt by both Commissioners of the required notices. Following such dividends or distributions, USF RE's surplus to policyholders must be reasonable in relation to its outstanding liabilities and adequate to its financial needs. In addition, USF RE may not pay any \"extraordinary\" dividend or distribution until 30 days after the Massachusetts and California Insurance Commissioners have received notice of such dividend or distribution, and until both Commissioners have either (i) not disapproved such payment within such 30-day period, or (ii) approved such payment within such 30-day period. For 1996, the amount which may be paid in dividends by USF RE without prior regulatory approval is $10,057,000. The amount of dividends which USFIC may pay to USF RE is subject to similar restrictions under the laws of Pennsylvania. Since being acquired by the Company, neither USF RE nor USFIC has paid any dividends.\nLEGISLATIVE AND REGULATORY DEVELOPMENTS\nFederal healthcare legislation, which was extensively considered but not adopted by Congress during 1994, was again taken up by the Congress during 1995. As with prior efforts, such legislation concerns government regulation and control of the financing and delivery of healthcare. Among the items being considered are proposals concerning the scope of the present preemptive provisions of ERISA. Some of these proposals would reinforce the ERISA preemption of state regulation of self-insured plans, while others would permit states the authority to regulate specific aspects of self-insured plans.\nOver the past several years various states have been initiating their own healthcare reforms. With respect to the self-insured market, many of these actions have focused primarily on the small group health insurance market, generally plans with 50 employees or less. Other state efforts include attempts to regulate self-insured plans indirectly by regulating companies providing stop-loss coverage. Such efforts include prescribing policy terms and establishing minimum attachment points; i.e., the amount of risk an employer retains for itself. The Company believes these state initiatives have not had, and are not expected to have, a significant effect on its medical stop-loss business.\nIn addition, the NAIC proposed in September 1995 a model act that would regulate medical stop-loss policies. The principal feature of the model act is a recommendation that stop-loss policies contain a minimum specific attachment point of $20,000. In order to be effective in any state, the NAIC model act would have to be adopted by legislative action in such state. To management's knowledge, no state has adopted the model act as of year end 1995. Management does not believes that all states will adopt the model act, and that of those states that may, some will adopt specific attachment point requirements lower than the $20,000 level recommended by the model act. Furthermore, based upon recent court decisions, the Company believes that if adopted by a state, the model act will continue to be challenged on the basis that it is preempted by ERISA. Accordingly, at this time the Company believes that the proposed model act will not have a significant effect on its medical stop-loss business.\nThe Company cannot predict at this time the extent to which the federal or state legislative or regulatory initiatives discussed above will be adopted, or the extent of the impact they would have on the Company's business. Management believes, however, that changes to the healthcare system which ultimately may be adopted will continue to recognize employers' self-insurance of healthcare benefits as a viable and cost effective method of financing healthcare. Accordingly, management believes that there will be a continuing need for medical stop-loss products and that such products will remain a source of revenues to the Company.\nSome of the statements included within this Item 1. and in Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as in the Consolidated Financial Statements and related Notes may be considered to be forward looking statements (as that term is defined in the Private Securities Litigation Reform Act of 1995), and which are subject to certain risks and uncertainties. Among those factors which could cause the actual results to differ materially from those suggested by such statements are the following: catastrophe losses in the Company's insurance lines or a material aggregation of losses; changes in federal or state law affecting an employer's ability to self-insure; the availability of adequate retrocessional insurance coverage at appropriate prices; stock and bond market volatility; the effects of competitive market pressures within the stop-loss or property\/casualty marketplaces; the effect of changes required by generally accepted accounting practices or statutory accounting practices; and other risks which are described from time to time in the Company's filings with the Securities and Exchange Commission.\nEMPLOYEES\nAs of March 21, 1996, the Company had 148 full-time employees. No employees are represented by labor unions, and management considers its employee relations to be excellent.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are:\nAll executive officers except Messrs. Cargile and Singer have been employed by the Company for more than five years. There are no family relationships among any of the executive officers of the Company. There have been no events under bankruptcy or insolvency laws, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any executive officer during the past five years.\nThe following information is provided for Messrs. Cargile and Singer:\nMr. Cargile joined the Company in December 1991 as a Senior Vice President, was appointed President and Chief Operating Officer in August 1994, Chief Executive Officer in March 1995 and Chairman of the Board in April 1995. Prior to joining the Company he was employed by Reinsurance Facilities Corporation for seventeen years and had served since 1984 as its President and Chief Executive Officer. Mr. Cargile was employed by International Facultative Company prior to commencing his employment with Reinsurance Facilities Corporation and has served on the Board of Directors of a number of companies engaged in the reinsurance business.\nMr. Singer has served as a director of the Company since its founding and also serves as a director of a number of the Company's subsidiaries. Commencing in the early 1970s Mr. Singer had been a securities broker-dealer in Chicago, Illinois, including acting as the President of his own company. From 1983 to November 30, 1991 he served in the capacity of financial consultant to the Company. On December 1, 1991, Mr. Singer was employed by the Company in the position of Executive Vice President.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of the Company and its subsidiaries are located in 40,281 square feet of leased office space at 650 Town Center Drive, Costa Mesa, California. The lease on this facility was extended as of October 1, 1995 through March 31, 2007, with a five-year option to extend. Additional offices are maintained in leased premises in Chicago, Illinois; Philadelphia, Pennsylvania; Atlanta, Georgia; Tulsa, Oklahoma; and Phoenix, Arizona.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFrom time to time the Company is a party to legal proceedings incidental to its business, none of which individually or in the aggregate is considered by the Company to be material to its 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 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\nDuring fiscal year 1995 the Company paid four quarterly cash dividends of $.05 per share. No cash dividends were paid during fiscal year 1994. In addition, material appearing under the captions \"STOCKHOLDER INFORMATION\" and \"STOCK PRICE INFORMATION\" in the 1995 Annual Report to Stockholders of US Facilities Corporation (the \"Annual Report\") is hereby incorporated by this reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nMaterial appearing under the caption \"SELECTED FINANCIAL DATA\" in the Company's Annual Report is hereby incorporated by this reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nMaterial appearing under the caption \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" in the Company's Annual Report is hereby incorporated by this reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nMaterial appearing under the captions \"REPORT ON CONSOLIDATED FINANCIAL STATEMENTS,\" and \"INDEPENDENT AUDITORS' REPORT\" and contained in the Company's CONSOLIDATED FINANCIAL STATEMENTS and Notes thereto in the Company's Annual Report are hereby incorporated by this reference.\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 regarding directors and executive officers of the Registrant as required by Items 401 and 405 of Regulation S-K is set forth in Part I of this report under the caption \"EXECUTIVE OFFICERS OF THE COMPANY\" and under the caption \"ELECTION OF DIRECTORS\" in the Company's definitive Proxy Statement for the Company's 1996 Annual Meeting of Stockholders scheduled to be held on May 22, 1996, and which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1995 (the \"Proxy Statement\"), and is hereby incorporated by this reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 402 of Regulation S-K is set forth under the caption \"COMPENSATION OF EXECUTIVE OFFICERS\" in the Company's Proxy Statement, and is hereby incorporated by this 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 set forth under the captions \"SECURITY OWNERSHIP OF MANAGEMENT\" and \"SECURITY OWNERSHIP OF CERTAIN OTHER STOCKHOLDERS\" in the Company's Proxy Statement, and is hereby incorporated by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information regarding certain relationships and related transactions as required by Item 404 of Regulation S-K is set forth in the Company's Proxy Statement under the captions \"COMPENSATION OF EXECUTIVE OFFICERS\" and \"RELATED TRANSACTIONS,\" and is hereby incorporated by this reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Form 10-K:\n(i) The following is a list of financial statements, together with reports thereon, filed as part of this Form 10-K, all of which have been incorporated herein by reference to the material in the Company's Annual Report as described under Item 8 of this Form 10-K:\nReport on Consolidated Financial Statements Consolidated Income Statements--Years ended December 31, 1995, 1994 and Consolidated Balance Sheets--December 31, 1995 and 1994 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 Independent Auditors' Report\n(ii) The following is a list of financial statement schedules filed with this Form 10-K:\nIndex to Schedules Independent Auditors' Report Schedule I--Summary of Investments Schedule II--Condensed Financial Information of Registrant Schedule III--Supplementary Insurance Information Schedule IV--Reinsurance\nAll other schedules to the Consolidated Financial Statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n(iii) The following is a list of exhibits required to be filed as part of this Form 10-K by Item 601 of Regulation S-K:\n2. None.\n3.1, 4.1 Restated Certificate of Incorporation, as amended, as presently in effect. Filed as Exhibits 3.1 and 3.1.1 to the Company's Form S-1 Registration Statement declared effective by the Securities and Exchange Commission (\"Commission\") on October 31, 1986 (the \"S-1 Registration Statement\"), and incorporated herein by this reference; and as Exhibit 3 to the Company's Current Report on Form 8-K dated May 24, 1990, and incorporated herein by this reference.\n3.2, 4.2 Bylaws of the Company, as amended, as presently in effect. Filed as Exhibit 4.2 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n4.3 Common Stock Certificate of the Company. Filed as Exhibit 4.1 to the Company's S-1 Registration Statement, and incorporated herein by this reference.\n4.4 Rights Agreement. Filed as Exhibit 2 to the Company's Current Report on Form 8-K dated May 24, 1990, and incorporated herein by this reference.\n4.5 First Amendment to Rights Agreement. Filed as Exhibit 1 to the Company's Current Report on Form 8-K dated January 16, 1992, and incorporated herein by this reference.\n4.6 Second Amendment to Rights Agreement. Filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated April 29, 1994, and incorporated herein by this reference.\n4.7 Third Amendment to Rights Agreement. Filed on October 3, 1995, as Exhibit 4 to the Company's Current Report on Form 8-K dated September 28, 1995, and incorporated herein by this reference.\n9 None.\n10 Material Contracts.\n10.2(iii) Settlement Agreement and General Release between George Kadonada and the Company dated March 10, 1995. Filed as Exhibit 10.2 to the Company's March 31, 1995 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.3 Employment Agreement dated December 1, 1991 between the Company and Howard S. Singer. Filed as Exhibit 10.3 to Company's Annual Report on Form 10-K for the year ended December 31, 1991 (\"1991 Form 10-K\"), and incorporated herein by this reference.\n10.3(i) Amendment No. 1 to Employment Agreement between the Company and Howard S. Singer effective as of August 4, 1994. Filed as Exhibit 10.4 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.4 Agreement of Employment between the Company and David L. Cargile dated August 4, 1994. Filed as Exhibit 10.2 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.4(i)* Amendment to Agreement of Employment between the Company and David L. Cargile dated July 21, 1995, with exhibits thereto.\n10.9 Stock Option Agreement dated May 23, 1991 between the Company and H.S. Singer Company, Inc. Filed as Exhibit 10.7(ii) to the Company's Form S-2 Registration Statement declared effective by the Commission on December 4, 1991 (the \"S-2 Registration Statement\"), and incorporated herein by this reference.\n10.10 Stock Option Agreement dated September 16, 1991 between the Company and H.S. Singer Company, Inc. Filed as Exhibit 10.7(iii) to the Company's S-2 Registration Statement, and incorporated herein by this reference.\n10.11 Stock Option Agreement dated December 18, 1991 between the Company and H.S. Singer Company, Inc. Filed as Exhibit 10.10 to Company's 1991 Form 10-K, and incorporated herein by this reference.\n10.12 Consulting Agreement dated June 24, 1991 between US Benefits, Inc. and L. Steven Medgyesy. Filed as Exhibit 10.9 to the Company's S-2 Registration Statement, and incorporated herein by this reference.\n10.14 Severance Agreement dated May 24, 1994 between the Company and David L. Cargile. Filed as Exhibit 10.3 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.14(i) Severance Agreement dated May 24, 1994 between the Company and Howard S. Singer. Filed as Exhibit 10.2 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.14(ii) Severance Agreement dated May 24, 1994 between the Company and John T. Grush. Filed as Exhibit 10.4 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference. - -------- * Describes a document being filed with this Annual Report on Form 10-K for year ended December 31, 1995.\n10.14(iii) Severance Agreement dated May 24, 1994 between the Company and Mark Burke. Filed as Exhibit 10.5 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.14(iv) Severance Agreement dated May 24, 1994 between the Company and Jose A. Velasco. Filed as Exhibit 10.6 to the Company's June 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.14(v)* Severance Agreement dated May 24, 1994 between the Company and Craig J. Kelbel.\n10.15 Lease Agreement dated May 28, 1985 between Center Tower Associates and US Benefits, Inc. Filed As Exhibit 10.13 to the Company's S-1 Registration Statement, and incorporated herein by this reference.\n10.16 First Amendment dated November 24, 1986 to Lease Agreement between Center Tower Associates and the Company as assignee of US Benefits, Inc. Filed as Exhibit 10.26 to the Company's S-2 Registration Statement, and incorporated herein by this reference.\n10.17 Second Amendment dated July 8, 1992 to Lease Agreement between Center Tower Associates and the Company. Filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (\"1992 Form 10-K\"), and incorporated herein by this reference.\n10.18 Third Amendment dated May 4, 1993 to Lease Agreement between Center Tower Associates and the Company. Filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (\"1993 Form 10-K\"), and incorporated herein by this reference.\n10.18(i)* Fourth and Fifth Amendments dated August 29, 1994 and October 1, 1995, respectively, to Lease Agreement between Center Tower Associates and the Company.\n10.19 Management Agreement No. 1 dated October 3, 1994 (with Addendums) between The Continental Insurance Company and USBenefits Insurance Services, Inc. Filed as Exhibit 10.1 to the Company's September 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by this reference.\n10.19(i)* Additional Addendums to Management Agreement No. 1 between The Continental Insurance Company and USBenefits Insurance Services, Inc.\n10.20 Quota Share Retrocession Agreement, as amended, dated July 11, 1986 between The Continental Insurance Company, as successor to Harbor Insurance Company by assumption, and USF RE INSURANCE COMPANY. Filed as Exhibit 10.47 to the Company's S-2 Registration Statement, and incorporated herein by this reference.\n10.21 Amendment dated January 16, 1991 to Quota Share Retrocession Agreement between The Continental Insurance Company and USF RE INSURANCE COMPANY. Filed as Exhibit 10.21 to the Company's 1993 Form 10-K, and incorporated herein by this reference.\n10.21(i) Amendment dated October 3, 1994 to Quota Share Retrocession Agreement between The Continental Insurance Company and USF RE INSURANCE COMPANY. Filed as Exhibit 10.21(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (\"1994 Form 10-K\"), and incorporated herein by this reference.\n10.22 US Facilities Corporation 1988 Employee Stock Plan. Filed as Exhibit A to the Company's Proxy Statement for the May 25, 1988 Annual Meeting of Stockholders, and incorporated herein by this reference.\n10.23 US Facilities Corporation 1991 Employee Stock Option Plan. Filed as Exhibit A to the Company's Proxy Statement for the May 23, 1991 Annual Meeting of Stockholders, and incorporated herein by this reference. - -------- * Describes a document being filed with this Annual Report on Form 10-K for year ended December 31, 1995.\n10.23(i) US Facilities Corporation Amended 1991 Employee Stock Option Plan. Filed as Exhibit A to the Company's Proxy Statement for the May 24, 1995 Annual Meeting of Stockholders, and incorporated herein by this reference.\n10.24 US Facilities Corporation 1988 Directors Stock Option Plan. Filed as Exhibit B to the Company's Proxy Statement for the May 25, 1988 Annual Meeting of Stockholders, and incorporated herein by this reference.\n10.24(i) US Facilities Corporation 1991 Directors Stock Option Plan Amended and Restated as of December 18, 1991. Filed as Exhibit 10.27 to Company's 1991 Form 10-K, and incorporated herein by this reference.\n10.26* Amended US Facilities Corporation Incentive Compensation Program, as in effect for 1995.\n11* The US Facilities Corporation and Subsidiaries Computation of Earnings Per Share.\n12 None.\n13* US Facilities Corporation 1995 Annual Report to Stockholders (filed with the Commission only to the extent it is specifically incorporated by reference in this 1995 Form 10-K).\n16 None.\n18 None.\n21* Subsidiaries of US Facilities Corporation.\n22 None.\n23* Independent Auditors' Consent dated March 26, 1996.\n24 None.\n27* Financial Data Schedules.\n28* Schedule P of 1995 Combined Annual Statement of USF RE INSURANCE COMPANY and USF Insurance Company filed with the Divisions of Insurance of the Commonwealths of Massachusetts and Pennsylvania.\n99 None.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1995. - -------- * Describes a document being filed with this Annual Report on Form 10-K for year ended December 31, 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.\nDate: March 26, 1996 US FACILITIES CORPORATION\nBy \/s\/ David L. Cargile ----------------------------------- David L. Cargile 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 Company and in the capacities and on the dates indicated.\nINDEX TO SCHEDULES\nIndependent Auditors' Report\nINDEPENDENT AUDITORS' REPORT\nUnder date of February 6, 1996, we reported on the consolidated balance sheets of US Facilities Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated income statements, statements of 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 audited the related consolidated financial statement schedules as listed in the accompanying index. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statement schedules based on our audits.\nIn our opinion, such schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for investments in 1994 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\nKPMG PEAT MARWICK LLP\nLos Angeles, California February 6, 1996\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nSCHEDULE I--SUMMARY OF INVESTMENTS\nDECEMBER 31, 1995\n- -------- (1) Cost represents the amortized cost of investments to the Company. Value represents current market value. Amount at which investments are shown on the balance sheet represents current market value as required by SFAS No. 115.\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nSCHEDULE II--CONDENSED INCOME STATEMENTS\nUS FACILITIES CORPORATION (PARENT COMPANY ONLY)\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nSCHEDULE II--CONDENSED BALANCE SHEETS\nUS FACILITIES CORPORATION (PARENT COMPANY ONLY)\nASSETS\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nUS FACILITIES CORPORATION (PARENT COMPANY ONLY)\nSCHEDULE II--CONDENSED STATEMENTS OF CASH FLOWS\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nSCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION\nUS FACILITIES CORPORATION AND SUBSIDIARIES\nSCHEDULE IV--REINSURANCE\nUSF RE INSURANCE COMPANY AND SUBSIDIARY (WHOLLY-OWNED SUBSIDIARIES OF US FACILITIES CORPORATION)","section_15":""}
{"filename":"1008540_1995.txt","cik":"1008540","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNo material legal proceedings are pending other than routine litigation incidental to the business of the Company. The company believes that such proceedings will not have any material adverse effect on it or its operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to shareholders during the last quarter of the fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a)The principal market for the Certificates is the over the counter market.\n(b)As of March 15, 1996 there were:\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.\nNot applicable.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND FORM 8-K.\n(a)The Annual Statement of compliance and Independent Accountant's Annual Servicing Report are not due until November 1, 1996.\n(b)Reports on Form 8-K.\n(c) 3.1 *,** Articles of Incorporation\n3.2 *,** By-Laws\n4.1 ** Pooling and Servicing Agreement, including form of Certificates\n4.2 * Form of Limited Guarantee\n* Previously filed pursuant to Registration Statement on form S-3 (Commission file number 33-80304) and incorporated by reference thereto.\n** Previously filed pursuant to form 8-K, dated August 28, 1995, and incorporated by reference 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, in the City of Knoxville, State of Tennessee, on March 15, 1996.\nVanderbilt Mortgage and Finance, Inc.\nBy:\/s\/ Kevin C. Clayton Kevin C. Clayton 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.","section_15":""}
{"filename":"30822_1995.txt","cik":"30822","year":"1995","section_1":"Item 1. Business 4\n2. Properties 111\n3. Legal Proceedings 122\n4. Submission of Matters to a Vote of Security Holders\n4A. Executive Officers of the Registrant 122\nPart II 5. Market for Registrant's Common Equity and Related Stockholder Matters 133\n6. Selected Financial Data 133\n7. Management's Discussion and Analysis of Financial Condition and Results of Operations 133\n8. Financial Statements and Supplementary Data 133\n9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 144\nPart III 10. Directors and Executive Officers of the Registrant\n11. Executive Compensation 155\n12. Security Ownership of Certain Beneficial Owners and Management 155\n13. Certain Relationships and Related Transactions\nPart IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 166\nPART I\nItem 1. Business\nDynamics Research Corporation (referred to herein as \"DRC\" or the \"Company\") was organized in 1955 under the laws of the Commonwealth of Massachusetts.\nThe Company is principally engaged in providing a broad range of technical services including informationcomputer-based systems development and operation, engineering, and management support services to organizations of the United States Department of Defense (DoD), other agencies of the U.S. Government and commercial companies. The Company also designs, and manufactures and sells digital instruments and precision componentsproducts and measurement devices,that are often used as components in computer- controlled systems.\nThe Company's products and services fall within the following broad categories:\nInformation systems development and operation Engineering and management support services Digital instruments and components\nThe following sections describe each of these business areas and related major programs and products.\nInformation Systems Development and Operation\nDRC maintains a multi-vendor data processing environment with professionals who provides systems analysis and programming support primarily to government customers. The Company designs, develops, installs, operates, and maintains custom-engineered data systems. Systems developed by DRC gather information electronically from various sources, organize the data and store it in large databases. The Company's systems enable customers to track product location and configuration, and perform detailed reliability, maintainability, quality assurance, vendor qualification and cost analyses. The Company has developed systems for transit vehicles, missiles, submarines, surface ships, land warfare weapons, and aircraft.\nThe Company's major DoD information systems programs are sometimes referred to as logistics information systems. These systems are essentially product management information systems and involve inventory requirements and control, maintenance and repair, warranty analysis, supply, distribution and other functions critical to effective and economical support of system hardware and software throughout the system's life.\nUnder contract with the U.S. Air Force, the Company has designed, developed, implemented and operates TICARRS (Tactical Interim CAMS and REMIS Reporting System) for the aircraft. The TICARRS databases accept data entries and requests from numerous Air Force user organizations worldwide. The TICARRS databases are continuously expanded and provide, upon request by the Air Force user organizations worldwide, a variety of operational reports. Data include results from worldwide flight operations and maintenance activities. While remote computer terminals and communications interfaces are an integral part of the system, the host computer facility and its associated databases are located at a Company facility where system operations are supported around the clock.\nBased on TICARRS, DRC developed a Smart Data System (SDS) for the F- 117A Stealth Fighter Program by special request of the U.S. Air Force. It was used in the Persian Gulf to support Operation Desert Storm. The SDS is an on-line interactive aircraft maintenance data reporting and analysis system supporting operational, staff, depot and contractor organizations.\nFor nearly thirty years, the Company has assisted the U.S. Navy's Fleet Ballistic Missile program office in the design, development, and operation of inertial systems. The Company has extensive experience with the Polaris, Poseidon, and Trident missile guidance systems and submarine inertial navigation systems. The Company develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in those systems. These databases track detailed information on thousands of component parts comprising the systems. This information is used by the customer for a wide range of operating management tasks and decision making.\nAlso for the U.S. Navy, the Company provides independent analysis and monitoring of submarine-based inertial guidance systems and electronic modules. The Company's support capabilities include its Inertial Instrument Test Laboratory, which is equipped for full-scale performance testing of navigational quality inertial instruments.\nWeapon Systems Management Information System (WSMIS) is a primary Air Force decision support tool for assessing the impacts of logistics status on potential wartime capabilities. WSMIS computes inventory requirements and purchasing needs for high-tech, high-cost aircraft spare parts to meet aircraft availability requirements. WSMIS also controls repair, manufacturing and distribution schedules to meet customer demands. WSMIS assesses the \"health\" and capability of the Air Force's weapon systems to meet wartime objectives. DRC served as the overall functional integrator of WSMIS and the developer of certain WSMIS modules. Currently, the Company continues to provides operational support for the system as well as software development modifications and other changes.\nDuring 1994, DRC completed work as subcontractor under the U.S. Air Force Aircraft Mishap Prevention (AMP) Program. The Company developed a new system to facilitate aircraft accident analysis. The system helps analysts systematically identify safeguards, corrective actions, and countermeasures to reduce the number and impact of human factors that contribute to aircraft mishaps.\nCritical to the development of information systems is the Company's software development process and related tools. The Company's approach to mission-critical software stresses principles of continuous software quality evaluation and increased visibility throughout the software development life cycle. The Company uses commercially available software development tools and internally developed tools to meet the needs of software acquisition managers and developers.\nThe Company has also developed computer-based tools thatwhich evaluate the quality of software programs and determine how well they adhere to predetermined standards. One of these tools, AdaMAT, is licensed to both government and commercial customers as a tool for an Ada software engineering environment. The Company designed this static code analyzer for use with the Ada programming language. AdaMAT helps Ada users and managers of Ada development efforts adhere to specific programming practices and program development goals during coding, testing, and maintenance of the software. by AdaMAT allowings visibility into the quality of the code at any given point in time. AdaMAT incorporates a hierarchy of software metrics including management-related concerns such as reliability, portability, maintainability; and software-related concerns such as code simplicity, modularity, and self-descriptiveness.\nEngineering and Management Support Services\nUnder various DoD contracts, the Company has performed a variety of services for its U.S. Government customers to assist them in the planning and managing of their large system development programs. This business area utilizes a wide range of technical and management skills of Company personnel to plan, analyze, design, test, support, train, maintain, and dispose of a variety of complex physical systems. Systems include radar, C3I, missile, aircraft, information, software, munitions, and soldier protective gear.\nThe Company provides support at all stages of a system's life. In response to emerging requirements, the Company helps customersclients define, develop, and initiate new programs. The Company also helps customersclients obtainreceive program approval, conduct strategic planning, and evaluate proposals from industry. After prime contract awards, the Company helps clients monitor contractor activities, evaluate progress, and measure performance against program requirements.\nUnder the umbrella of the U.S. Air Force Technical and Engineering Management Support (TEMS) and System Design and Analysis Support (SDAS) contracts, the Company has supported, among others, the following programs out of the Air Force Electronic Systems Center at Hanscom Air Force Base in Massachusetts:\no Milstar o Airborne Warning and Control System (AWACS) o Joint Surveillance Target Attack Radar System (JSTARS) o Mission Planning Systems o Cheyenne Mountain Upgrade o U.S. Transportation Command\/Air Mobility Command Support o PEACE SHIELD Air Defense System o Airborne Battlefield Command and Control Center o Over-the-Horizon Radar o Theater Battle Management Core Systems (TBMCS)\nDRC served as a prime contractor under the TEMS program from 1984 to 1993. During 1993, the Air Force recompeted the TEMS program and awarded contracts to eight contractors, including several small and \"disadvantaged\" businesses. DRC was a subcontractor on one of the winning teams, and has been subsequently added as a subcontractor to several of the other winning bidders. In addition, in January 1996, the Company acquired the Massachusetts-based operations of Support Systems Associates, Inc. The acquired assets included a prime contract to provide support services under the TEMS program.As a result, DRC has retained substantially all the tasks it had previously performed as a prime contractor, although. As discussed in the Company's third and fourth quarter reports during 1993, financial results have been adversely affected by the reduced hourly rates available as a subcontractor.. To favorably position itself for future TEMS programs as a prime contractor with the Air Force Electronic Systems Center (ESC), the Company acquired a Massachusetts based business of Support Systems Associates, Incorporated (SSAI) in January 1996. \"The acquisition of the Massachusetts based operations of Support Systems Associates, Inc. (SSAI) in January, 1996 is a major accomplishment in our effort to strengthen the Air Force management support services portion of our Systems Division. The combination of our existing business base and resources with the SSAI contrctual vehicles enhances our competitiveness in this important business area.\"\nIn February 1995, the U.S. Air Force awarded to the Company a 5-year contract (one year plus four option years), valued depending on customer task ordering at up to $23.7 million. Under the contract, DRC will provide technical and engineering services to the U.S. Air Force Air Logistics Center at Tinker AFB, Oklahoma. Initial tasking under the new contract included orders to provide independent test and evaluation services of certain avionics and software under the Air Force B-1B aircraft program. DRC has been supporting the B-1B programthis program office since 1990.\nIn November 1993, the Defense Information Systems Agency (DISA) awarded its Defense Enterprise Integration Services (DEIS) contract, an estimated $900 million, five- year program, to six competitors. DRC is a member of the winning Computer Sciences Corporation team. DEIS is an indefinite order, indefinite quantity program that may be a vehicle for a wide variety of tasks which DRC will perform for DISA and related agencies. In particular, DRC brings its experience in Business Process Re-Engineering (BPR), as well as systems development, integration and migration, to the DEIS program.\nIn particular, DRC brings its experience in Business Process Re-Engineering (BPR), as well as systems development, integration and migration, to the DEIS program.\nThe Company is also supporting the DoD in the area of acquisition logistics. DRC technical staff helpassist the customers to plan and manage the implementation of program requirements throughout all phases of the acquisition process. From 1987 to present the Company has provided services to the Ballistic Missile Defense Organization (BMDO) that include operating and support considerations during the early conceptual phases of the BMDO program. In 1995, the Company received a five-year contract (one year plus four option years) to provide logistics modeling and analysis for the U.S. Air Force Air Staff, with a potential value depending upon tasking of up to $6.9 million. The Company also received a $400,000 contract from the Federal Aviation Administration for a radar performance monitoring and analysis system and a $600,000 contract for logistics modeling support for the DoD's Joint Advanced Strike Technology program. From 1987 to present the Company has provided acquisition logistics services to the Ballistic Missile Defense Organization (BMDO). In February 1995, the Company received a $0.7 million contract to provide logistics modeling support for the Joint Advanced Strike Technology program. Also in February 1995, an indefinite quantity contract was awarded to the Company to provide logistics support to the Air Staff.\nThe Company combines its expertise in the weapon system acquisition process with expertise in systems analysis, design, training and simulation, and human factors to perform human-systems integration and force analysis. DRC has been provideding force analysis support to the Army Research Laboratory since 1987. Force Analysis activities are focused on developing tools that support analysis of soldier and system effectiveness, identify and assess force improvement options (doctrine, training, leader development, organization, and material), and ensure that soldier considerations are addressed in force improvements. In 1995, DRC won a $22.5 million 5-year contract from the U.S. Army Research Laboratory to providewhich builds on the Company's capabilities providing analysis, system development and support in several functional areas, including assessment of manpower, personnel and training issues, analysis of soldier systems performance, and integration of methods and databases for use by system designers. Under the Company's previouscurrent contract, begun in 1991, DRC developed a set of automated manpower and personnel integration analysis tools that are used to analyze system cost versus performance to help maintain optimal system performance at an affordable price. DRC also developed methods for analyzing training requirements to promote standardized training across the military services. In addition, DRC developed advanced crew coordination training methods for the Army aviation community designed to help reduce aviation mishaps. from the U.S. Army Research Laboratory which singA follow-on to the current contract is presently under evaluation with award expected during the first half of 1995.\nThrough its human-systems integration efforts, the Company helps the military benefit through improved performance and effectiveness, by matching soldiers to the tasks they must perform; cost and resource savings, by making soldiers more effective and by automating tasks; and more effective system design, by documenting relationships of design options to eventual performance.\nHARDMAN III, a suite of microcomputer-based tools developed by DRC, estimates a weapon system's manpower and training requirements, calculating manpower requirements by military specialty, skill level, pay grade, and maintenance level for every unit within a specified force structure. This suite of tools also allows analysts to locate and distribute system-level requirements to lower-level tasks with consistency; estimate and set required parameters for personnel quality constraints that affect job performance; and evaluate contractor designs on the basis of performance requirements, available maintenance support, and operator crew sizes. The training model estimates a weapon system's total course costs, costs per graduate, instructor requirements, and training man-day requirements. The HARDMAN software has been used on over fifteen Army weapon systems. , including the APACHE helicopter, and can produce manpower requirements for the Active Army, Reserves, and National Guard components.\nDRC is a subcontractor to Loral Federal Systems for the Close Combat Tactical Trainer program (CCTT). CCTT will simulate Army tank and mechanized infantry units from vehicle crews to the battalion level. CCTT will use distributed, interactive simulation technology to provide a \"virtual\" training environment. DRC will conduct all manpower and personnel integration activities such as training, human factors engineering, system safety, health hazards, and survivability, and will develop modules of software for CCTT that generate tactical exercises and that assess unit performance.\nDRC has been supporting the B-1B Program Office since 1990. We provide independent, third party test and evaluation services to ensure the proper installation and implementation of avionics and software modifications. In 1994, the Company received an award to continue these services through the Government's 1995 fiscal year. DRC staff in offices in Oklahoma City, Oklahoma and Andover, Massachusetts support this program.\n, insert proven technology into the design of new and existing Air Force systems and processes resulting in improvements to life-cycle cost, productivity, efficiency, reliability, maintainability, supportability and survivability provide technical and engineering services DRC staff in offices in Oklahoma City, Oklahoma and Andover, Massachusetts support this program.\nThe Company's Test Equipment Division provides a variety of research, engineering, and manufacturing services in support of the U.S. Navy, including test equipment services for the Trident submarine's inertial gyroscopes, accelerometers, and other components. Also for the Navy, the Company has developed an automated system used for the design, simulation, synthesis, analysis, and verification of integrated circuits, printed circuit boards, and entire electronic systems.\nDuring 1994, the Company's Systems and Test Divisions competitively bid and won an Air Force contract to produce a test system for secure tactical communications devices. Company systems engineers are responsible for the integration of commercially available components with sophisticated software supplied by a subcontractor. The system operates with a DEC Alpha workstation. Future system sales depend on system performance capabilities as well as cost and customer budget factors.\nDuring 1995, DRC was awarded two major prime contracts awards as a result of a concerted multi-year effort to serve Federal agencies other than DoD., traditionally our principal customer. successful in accomplishing its plans to penetrate the non-DoD information technology business by being awarded two prime contracts: the The first award was fromwith the U.S. Department of the Treasury to provide information technology support services to the Internal Revenue Service and other Treasury departments. The contract is for one year plus four one-year options with an aggregate ceiling of $200 million. The contract may be used for a broad range of information system development, acquisition support, and other management services. The Treasury made multiple awards and expects the best technical and management performing contractors to obtain the highest level of tasking over the life of the program. The secondAlso was with award, from the General Services Administration,, permits DRC to provide a broad range of information technology services including software management, communications systems support, satellite communications systems, acquisition support, and system engineering under the GSA's Federal Systems Integration and Management program (FEDSIM). This contract may serve as a vehicle for services to the GSA as well as other Federal agencies. The amount of revenue that DRC may achieve under this contract is uncertain. The FEDSIM program is for $840 million over 5 years among eight winning teams.\nDigital Instruments and Precision Components\nThe Company operates two units that produce digital instuments and precision components manufactured products for commercial markets, the Encoder Division and the Metrigraphics Division. The Encoder Division designs, manufactures and markets a line of digital encoders used to sense position in a wide range of equipment. These products use optical techniques to convert motion to digital signals that can then be used to control the speed and position of devices such as machine tools, computer peripherals, robotics arms and medical equipment.\nBeginning in late 1992 and continuing through 1993, the Company invested in a specialized production line and produced a line of encoders for an automotive industry manufacturing customer. This line of encoders is designed into a fuel pump and is used to control fuel flow and reduce emissions. Manufacturing on the line commenced in 1993, and became fullywas fully operational infor 1994 and has continued through 1995, contributing sales of approximately $5 million in 1995. The continuation of this business throughout 1995 and beyond depends on follow-on orders on mutually satisfactory terms and conditions, end user demand for the vehicles equipped with the system and other factors.\nThe Metrigraphics Division uses photolithographic processes to manufacture optical discs, scales and reticles thatwhich are used for precision measurement. Metrigraphics also uses various metals deposition processes, including electroplating and electroforming, to produce a variety of precision components. Products include printheads and oriface plates used in electronic printers.\nUsing a process called electroforming, DRC manufactures precision components used in inkjet cartridges. During 1995, the Metrigraphics DivisionDRC received a $10 million order to produce these components. The order is for delivery in 1996. In December 1995, the Company leased 27,000 square feet in Wilmington, Massachusetts to provide space for a second electroform production facility. Approximately $5 million has been committed for the purchase of production equipment for the new facility, $1.9 million of which was incurred in 1995.and is the largest commercial order ever received by DRC. Uu,. manufactures precision components used in inkjet cartridges. DRC has been investing capital funds during 1995 to increase electroform production capacity, and has recently committed to an additional $3.0 million capital expansion program to meet customer requirements.committed to a $2.4 million capital expansion program to meet customer requirements.\nThe customers for both of these dDivisionsproducts are primarily manufacturingOEM companies which integrate the Company's components into their equipment. Encoder and Metrigraphics engineers work closely with customer engineers to design and develop prototypes to meet customer product requirements. Repeat orders for these customer-designed components are a significant factorelement of sales. High quality standards and competitive unit costs are critical aspects of this business.\nUnited States Government Contracts\nContracts for the Company's defense services are obtained by marketing and technical personnel employed by the Company. The Company's other products are sold by sales personnel employed by the Company and sales representatives.\nDuring 1995, the Company's revenues from contracts with the DoDDepartment of Defense, either as prime contractor or subcontractor, accounted for approximately 78% of the Company's total revenues. The Company's government contracts can fall into one of three categories: (1) fixed price, (2) time and materials, andor (3) cost plus fixed fee. Under a fixed price contract, the customer pays an agreed upon price for the Company's services or products, and the Company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the Company incurs actual costs below anticipated costs on these contracts, the Company could realize greater profits. Under a time and materials contract, the government pays the Company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a certain profit margin. Under a cost plus fixed fee contract, the government reimburses the Company for its allowable expenses and allowable costs and pays a negotiated fee. In 1995, approximately xx56% of the Company's government contracts revenue was under fixed price or time and material contracts, while approximately xx44% of revenue was under costs plus fixed fee contracts.\nDuring 1995, the Company's U.S. Government business consisted of approximately 135 separate contracts on 60xx different programs. The Company's contracts with the government are generally subject to termination at the convenience of the government; however, the Company would be reimbursed for its allowable costs to the time of termination and would be paid a proportionate amount of the stipulated profit attributable to the work actually performed. Although government contracts may extend for several years, they are generally funded on an annual basis and are subject to reduction or cancellation in the event of changes in government requirements or budgetary concerns. If the U.S. Government significantly curtails expenditures for research, development and consulting activities, such curtailment might have an adverse impact on the Company's sales and earnings.\nBacklog\nAt December 30, 1995, the Company's backlog of unfilled orders was approximately $61,284,000 compared with $43,679,000 at December 31, 1994. The Company expects that substantially all of its backlog on December 30, 1995 will be filled during itsthe fiscal year ending December 28, 1996. The bBacklog at December 30, 1995 consisted of funded amounts under contracts. Backlog at December 30, 1995 included $xx25,528xxx,000xxx of unfunded amounts under ongoing programs which were contractually committed by the procuring Government agency. The Company has a number of multi-year contracts with agencies of the U.S. Government on which actual funding generally occurs on an annual basis. The Company's business does not have seasonal characteristics but a portion of its funded backlog is based on annual purchase contracts, and the amount of funded backlog as of any date can be affected by the timing of order receipts and deliveries thereunder. Competition\nThe Company competes with both domestic and foreign firms, including larger diversified companies and smaller specialized firms. The U.S. Government's own in-house capabilities are also, in effect, competitors of the Company becausesince various agencies perform certain types of services which might otherwise be performed by the Company. The principal competitive factors for dDefense sServices are price, performance, technical competence and reliability. In addition, in the our commercial business, the Company also competes with other manufacturers of encoders, electroform vendors and photolithographic suppliers of precision measurement scales. The principal competitive factors effecting the precision components manufacturing business are price, product quality and custom engineering to meet customer system requirements.\nResearch and Development\nThe Company expended approximately $1,949,000 (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 30, 1995, as compared to expenditures of $224,000 during 1994 and $2,007,000 during 1993.\nRaw Materials\nRaw materials and components are purchased from a large number of independent sources and are generally available in sufficient quantities to meet current requirements.\nEnvironmental Matters\nCompliance with federal, state and local provisions relating to the protection of the environment has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company.\nEmployees\nAt December 30, 1995, the Company had approximately 1,249 employees.\nProprietary Information\nPatents, trademarks and copyrights are not materially important to the business of the Company. The United States Government has certain proprietary rights in processes and data developed by the Company in its performance of government contracts.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases offices and other facilities, totaling approximately 231,000170,000 square feet, which are utilized for its defense services, manufacturing and warehousing operations as well as its marketing and engineering offices. The Company has manufacturing and office space in Wilmington, Massachusetts under threetwo leases totaling 11385,000 square feet, expiring in 20001995, with options to the year 20050. The remaining leased facilities consist of offices in 242 locations across the United States. The Company owns aits 135,000 square foot facility in Andover, Massachusetts. This building was purchased in 1993 and is utilized for its defense service operations and corporate administrative offices.\nThe Company's total rental cost for 1995 was $1,636,000.\nThe Company believes its properties are adequate for its present needs. See Note 7 to the Consolidated Financial Statements included in the Company's 1995 Annual Report to Shareholders for a description of the Company's lease obligations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone.The information set forth in the last paragraph of Note 7 to the Consolidated Financial Statements included in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference. The complaint described therein, filed in the United States District Court for Massachusetts by the United States Government, was dismissed in connection with a settlement agreement entered into by the Company in April 1994.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nItem 4A. Executive Officers of the Registrant\nThe following is a list of the names and ages of the executive officers of the Company indicating all positions and offices held by each person and each person's principal occupations or employment during the past five years. The executive officers were elected by the Board of Directors and will hold office until the next annual election of officers and their successors are elected and qualified, or until their earlier resignation or removal by the Board of Directors. There are no family relationships between any executive officers and directors.\nYears of Age Service Position\nJohn S. Anderegg, Jr. 72 41 Chairman\nAlbert Rand 69 36President and Chief Executive Officer\nJohn L. Wilkinson 56 14 Vice President, Human Resources\nDouglas R. Potter 45 2 Vice President of Finance, Chief Financial Officer\nEach of the persons named above has served in the position indicated for more than five years, with the exception of Douglas R. Potter. Mr. Potter was appointed Vice President of Finance and Chief Financial Officer in November 1993. Previously hHe was Vice President, Treasurer, and Chief Financial Officer of SofTech, Inc. of Waltham, Massachusetts fromsince 1990 to 1993. and Corporate Controller from 1985 to 1990.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe common stock of Dynamics Research Corporation is traded on the National Market System of the National Association of Securities Dealers, Inc., Automated Quotation System (NASDAQ - NMS) under the symbol DRCO.\nThe high and low bid prices for the quarters in 1994 and 1995 and the number of holders of record of the Company's common stock are described in the Company's Annual Report to Shareholders for 1995 under the caption \"Stock Prices\" and \"Number of Shareholders,\" and such information is incorporated herein by reference.\nIn September 1984, the Board of Directors indicated its intention not to declare cash dividends to preserve cash for the future growth and development of the Company. The Company did not declare any cash dividends betweenduringbetween 1984 and 19954 and does not anticipate doing so for the foreseeableforseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe section entitled, \"Five Year Summary of Selected Financial Data\" in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe section entitled, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following financial statements are filed as part of this Annual Report:\nReport of Independent Public Accountants\nConsolidated Balance Sheets at December 30, 1995, December 31, 1994 and December 25, 1993\nConsolidated Statements of Operations for the three years ended December 30, 1995\nConsolidated Statements of Shareholders' Investment for the three years ended December 30, 1995\nConsolidated Statements of Cash Flows for the three years ended December 30, 1995\nNotes to Consolidated Financial Statements\n(The consolidated financial statements and related notes listed above are incorporated by reference to the Company's Annual Report to Shareholders for the year 1995.)\nReport of Independent Public Accountants on Schedules to Consolidated Financial Statements\nSchedule VIII - Valuation and Qualifying Accounts for the three years ended December 30, 1995\nThe foregoing schedule is included as part of Item 14 of this Annual Report on Form 10-K\nAll other financial statements and schedules have been omitted because the information required to be submitted has been included in the financial statements and related notes or they are either not applicable or not required under the rules of Regulation S-X.\nQuarterly financial data presented on page 13, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 26-28, of the Company's Annual Report to Shareholders for the year 1995, are also incorporated herein by reference. With the exception of the portions listed in the above index, the Annual Report referred to above is not to be deemed filed as part of the financial statements.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation with respect to Directors of the Registrant in the section entitled \"Election of Directors\" in the Company's definitive proxy Statement for the 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995, is incorporated herein by reference.\nInformation relating to the Executive Officers of the Company is included in Item 4A of Part I of this Form 10K.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation called for by this item is incorporated by reference from the section entitled \"Compensation and Related Matters\" in the Company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation called for by this item is incorporated by reference from the sections entitled \"Common Stock Ownership of Certain Beneficial Owners and Management\" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot applicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) and (2) Financial Statements and Schedules - See Item 8.\n(a) (3) Exhibits. The exhibits thatwhich are filed with this Form 10- K or thatwhich are incorporated herein by reference are set forth in the Exhibit Index, which appears in Part IV of this report on pages 240 and 251.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by the Company during the last quarter of fiscal 19954.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES TO CONSOLIDATED FINANCIAL STATEMENTS\nTo Dynamics Research Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Dynamics Research Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 16, 19965. Our audit was 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. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts, February 126, 19965\nIMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS\nThe following factors, among others, could cause the Company's actual results and performance to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by or on behalf of the Company from time to time.\nUncertainties as to Department of Defense and Other Federal Agency Budgets\nThe Company has historically derived a substantial portion of its revenue from contracts and subcontracts with the Government, and currently more than 78% of the Company's revenue is derived from the Department of Defense business. Over the past several years, the Company's defense business has been adversely affected by significant changes in defense spending. Overall U.S. defense budgets have been declining, and the effects of this general decline and attendant increased competition within the consolidating defense industry is expected to continue over the next several years. Funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. These factors, among others, have reduced the Company's revenue and operating margins on its defense contracts in recent fiscal periods. The Company anticipates that competition in all defense-related areas will continue to be intense and that, accordingly, there will be continued significant competition when the Company's defense contracts are rebid and continued significant competitive pressure to lower prices, which may reduce profitability in this area of the Company's business. Any reduction in the level or profitability of the Company's defense business, if not offset by new commercial business or other business with the federal government, will adversely affect the Company's business, financial condition and results of operations.\nA significant portion of the Company's Government contracts are renewable on an annual basis, or are subject to the exercise of contractual options. Also, multi-year contracts often require funding actions by the Government on an annual or more frequent basis. As a result, the Company's business could experience material adverse consequences should the Government budget not include funds required to sustain the programs under which DRC operates.\nGovernment Contracting Risks\nA significant portion of the Company's Government contracts are of a time and materials nature, with fixed hourly rates that are intended to cover salaries, benefits, other indirect costs of operating the business and profit. The pricing of such contracts is based upon estimates of future costs and assumptions as to the aggregate volume of business that the Company will perform in a certain business division or other relevant unit. For long term contracts, the Company must estimate the costs necessary to complete the defined statement of work and recognize revenues or losses in accordance with such estimates. However, actual costs may vary materially from the estimates made from time to time, necessitating adjustments to reported revenue and net income. Underestimates of the costs associated with a project would adversely affect the Company's overall profitability and could have a material adverse effect on the Company's business, financial condition and results of operations.\nThe Government's awards of contracts are subject to regulations and procedures that permit formal protests by losing bidders. Such protests may result in significant delays in the commencement of expected contractual effort, or the reversal of a previous award decision, which could have a material adverse effect on the Company's business, financial condition and results of operations.\nBecause of the complexity and scheduling of contracting with the Government, from time to time costs are incurred in advance of contractual funding by the Government. In some circumstances, such costs may not be recovered in whole or in part under subsequent Government contractual actions. Failure to collect such amounts may have material adverse consequences on the Company's business, financial condition and results of operations.\nCosts incurred in connection with Government contracts are generally subject to after-the-fact audits. Such audits may result in material disallowances, which could have an adverse effect on the Company's business, financial condition and results of operations.\nA substantial portion of the Company's Government contracting business is as a subcontractor. In such circumstances, the Company generally bears the risk that the prime contractor will meet its performance obligations to the Government under the prime contract and that the prime contractor will have the financial capability to pay the Company amounts due under the subcontract. The inability of a prime contractor to perform or make required payments could have a material adverse effect on the Company's business, financial condition and results of operations.\nThe Government has the right to terminate contracts for convenience. In such a termination, the Company would generally recover costs incurred to termination, costs required to be incurred in connection with the termination, and a portion of the fee earned commensurate with the work performed to termination. However, significant adverse effects on the Company's indirect cost pools may not be recoverable in connection with a termination for convenience.\nDependence or Key Personnel\nThe Company is dependent on its key technical personnel. In addition, certain technical contributors may have specific knowledge and experience related to various Government customer operations that would be difficult to replace in a timely fashion. The loss of the services of key personnel could have a material adverse effect on the Company's ability to perform required services under certain contracts, or to retain such business after the expiration of the current contract, or to win new business where certain personnel have been identified as key personnel in the proposal, any of which could have a material adverse effect on the Company's business, financial condition and results of operations.\nCompetition\nThe Government contracting business is subject to intense competition, both technical and pricing, from numerous companies, many of which have significantly greater financial, technical and marketing resources than the Company.\nCompetition in the market for the Company's commercial products is also intense. There is a significant lead time for developing such business, and it involves significant capital investment including development of prototypes and investment in manufacturing equipment. The Company's precision products business has a number of competitors, many of which have significantly greater financial, technical and marketing resources than the Company.\nRisks Associates with New Markets and New Products\nIn its efforts to enter new markets, including Government agencies other than the Department of Defense and commercial markets, the Company faces significant competition from other companies that have prior experience with such potential customers as well as significantly greater financial, technical and marketing resources than the Company. As a result, the Company's efforts to enter such new markets may be unsuccessful or may not achieve the level of success sought by the Company.\nThe Company has announced software products for commercial markets. There is no assurance that the Company's software products will meet with market acceptance or that the Company will be able to compete in the development and distribution of such products with competitors that have significantly greater resources and experience.\nConcentration of Customers\nWithin the Department of Defense, individual services and program offices account for a significant portion of the Company's Government business. Two customers account for a significant portion of the revenue of the Company's commercial manufacturing divisions. No assurance can be provided that any of these customers will continue as such or will continue at current levels. A decrease in orders from these customers would have an adverse effect on the Company's profitability, and the loss of any large customer could have a material adverse effect on the Company's business, financial condition and results of operations.\nRisk of Product Claims\nThe Company's precision manufactured products are generally designed to operate as important components of complex systems or products, and defects in DRC products could cause the customer's product or systems to fail or perform below expectations. Like other manufacturing companies, the Company may be subject to claims for alleged performance issues relating to its products. There can be no assurance any such claims, if made, will not have a material adverse effect on the Company's business, financial conditions or results of operations.\nRisk of Economic Events Effecting the Company's Business Segments\nCertain of the Company's precision products are components of commercial products. Factors that affect the production and demand for such products, including economic events, competition, technological change and productions stoppages, could adversely affect demand for the Company's products. Certain of the Company's products are incorporated into capital equipment, such as machine tools and other automated production equipment, used in the manufacture of other products. As a result, this portion of the Company's business may be subject to fluctuations in the manufacturing sector of the overall economy. An economic recession could have a material adverse effect on the rate of orders received by the commercial divisions. Significantly lower production volumes resulting in under-utilization of the Company's manufacturing would adversely impact the Company's profitability.\nTechnological Change\nThe Company's knowledge base and skills in the Government contracting area are sophisticated and involve areas in which there have been and are expected to be significant technological change. There is no assurance that the Company will continue to be able to offer services that satisfy its customers' requirements at a competitive price. Many of the Company's products are incorporated into sophisticated machinery, equipment or electronic systems. Technological changes may be incorporated into competitor's products that may adversely affect the market for the Company's products. Further, there can be no assurance that the Company's research and product development efforts will be successful and result in new or improved products that may be required to sustain the Company's market position.\nUncertainty of Future Financing\nAlthough the Company has no immediate plans to raise additional capital, it may in the future need to raise additional funds through public or private debt or equity financings. There can be no assurance that any such funding will be available or of the terms or timing of any such funding.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the 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\nDYNAMICS RESEARCH CORPORATION\nby: \/s\/ Albert Rand Albert Rand, President (Principal Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 25th of March, 1996.\n\/s\/ Albert Rand Albert Rand Director, President, Chief Executive Officer\n\/s\/ Douglas R. Potter Douglas R. Potter Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ John S. Anderegg, Jr. John S. Anderegg, Jr. Director, Chairman\n\/s\/ Francis J. Aguilar Dr. Francis J. Aguilar Director\n\/s\/ Thomas J. Troup Thomas J. Troup Director\n\/s\/ James P. Mullins Gen. James P.Mullins Director\nSCHEDULE VIII\nDYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 30, 1995\n(in thousands of dollars)\nALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS\nBalance, December 26, 1992 $356 Additions charged to expense 63 Write-off of uncollectible accounts, net (1)\nBalance, December 25, 1993 $418 Additions charged to expense 222 Write-off of uncollectible accounts, net (54)\nBalance, December 31, 1994 $586 NetAdditions recoveries charged to expense (2) Write-off of uncollectible accounts, net (182)\nBalance, December 30, 1995 $402\nEXHIBIT INDEX\n3.0 Certificate of Incorporation and By-Laws.\n3.1 Restated Articles of Organization dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6\/13\/87)\n3.2 By-Laws dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6\/13\/87)\n4.0 Instruments defining the rights of security holders, including indentures.\n4.1 Common stock included in Exhibit 3.1 through 3.2.\n4.2 Preferred stock included in Exhibit 3.1 through 3.2.\n4.3 Rights Agreement dated as of July 14, 1988 (\"Rights Agreement\") between the Company and American Stock Transfer & Trust Company, as Rights Agent.* (Incorporated by reference to the Registrant's Form 8-K on July 14, 1988)\n4.4 Rights Agreement Amendment No. 1 dated as of September 6, 1989.* (Incorporated by reference to the Registrant's Form 8-K on September 12, 1989)\n10.0 Material Contracts\n10.1 Amended 1983 Stock Option Plan. dated January 14, 1987 (Incorporated by reference to the Registrant's Form 10-K for the year ended 12\/27\/87) Plan terminated during 1993.*\n10.2 1993 Equity Incentive Plan. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6\/12\/93)\n10.3 1995 Stock Option Plan for non-employee directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12\/31\/94)\n10.42 Form of Dynamics Research Corporation Indemnification Agreement for Directors as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12\/28\/91)*\n10.53 Form of Dynamics Research Corporation Severance Agreement for Messrs. Anderegg and Rand as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12\/28\/91)*\n10.64 Dynamics Research Corporation Deferred Compensation Plan for Non-Employee Directors as of October 22, 1991. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12\/28\/91)*\n10.75 Mortgage Aagreement dated February 5, 1993 on the Andover office building as referred above between Dynamics Research Corporation and ABN AMRO Bank, N.V., Boston branch of a Connecticut corporation. (Incorporated by reference to the Registrant's Form 8-K on May 5, 1993)\n10.6 1993 Equity Incentive Plan dated April 27, 1993. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6\/12\/93)*\n10.7 1995 Stock Option Plan for non-employee directors filed herewith.*\n13.0 Annual Report to security holders, Form 10-Q or quarterly reports to security holders.\n13.1 The Company's Annual Report to Shareholders for the year ended December 30, 1995 filed herewith with the exception of the information incorporated by reference in parts I, II and IV of this Form 10-K is not deemed to be filed as part of this report.\n23.0 Consents of experts and counscel\n23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 26XX, 1996 filed herewith.\n99.0 Important Factors Regarding Forward-Looking Statements.\n* Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"774624_1995.txt","cik":"774624","year":"1995","section_1":"Item 1. Business\nALLIED Group, Inc. (the Company) was incorporated in 1971 as an Iowa corporation and operates as a regional insurance holding company headquartered in Des Moines, Iowa. At year-end 1995, The ALLIED Group Employee Stock Ownership Trust owned 26.9% of the outstanding voting stock of the Company. ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 18% of the voting stock of the Company. The Company has two reportable business segments: property-casualty insurance and excess & surplus lines insurance. Property-casualty insurance was the most significant segment in 1995, accounting for 85.4% of consolidated revenues. The Company's segment information is contained in note 18 of Notes to Consolidated Financial Statements.\nProperty-casualty Insurance\nThe Company's property-casualty segment operates through three subsidiaries: AMCO Insurance Company (AMCO), ALLIED Property and Casualty Insurance Company (ALLIED Property and Casualty), and Depositors Insurance Company (Depositors), which underwrite personal lines (primarily automobile and homeowners) and small commercial lines. The property-casualty segment operates exclusively in the United States; primarily in the central and western states. The segment and ALLIED Mutual pool their property-casualty business. See notes 4 and 6 of Notes to Consolidated Financial Statements and \"Business-Relationship with ALLIED Mutual-Pooling Agreement.\"\nA.M. Best has assigned a rating of A+ (superior) to each of the Company's property-casualty subsidiaries and to ALLIED Mutual for 1995 with respect to their financial strength and their ability to meet policyholder and other contractual obligations based on the review of the pool's 1994 statutory results and operating performance.\nThe profitability of the property-casualty segment is affected by many factors, including industry price competition, the severity and frequency of weather-related claims, the adequacy of prior-year estimates of loss and loss settlement expense reserves, court decisions that define the extent of coverage and the compensation awarded for injuries and losses, insurance laws and regulations, fluctuations in the financial markets, interest rates, reinsurance costs, and general business and economic conditions.\nThe Company pursues a strategy of growth in personal lines of insurance, which it sells predominantly in central and western United States, primarily through a system of more than 2,100 independent agencies, a growing number of which represent the property-casualty subsidiaries of the Company on an exclusive basis for their personal lines of insurance. For the year ended December 31, 1995, 65.7% of the property-casualty subsidiaries' net earned premiums were attributable to personal lines of insurance. While the majority of the Company's revenues are attributable to personal lines, the Company also writes commercial lines of insurance for small businesses through such agents. Because the Company's primary focus, and primary market served by its independent agency force, is personal lines of insurance and because the Company perceives the risks to be greater in commercial lines, the Company has been conservative in the types of commercial risks it underwrites and in the pricing therefor. Historically, this has resulted in the Company writing less commercial business than it might otherwise have if it adopted a more aggressive strategy in commercial lines. It has also resulted in a lower combined ratio for the commercial lines compared with its core personal lines business.\nThe property-casualty segment markets its products through three distribution systems: independent agencies, exclusive agencies, and direct response marketing. Generally, AMCO writes, through independent agencies, personal and commercial property-casualty insurance lines, consisting primarily of private passenger automobile and homeowners, with lesser emphasis on special multiple peril, workers' compensation, inland marine, and other miscellaneous lines of business. ALLIED Property and Casualty generally writes personal lines insurance products through agents who sell ALLIED Property and Casualty personal lines exclusively, and Depositors generally writes personal lines through a direct mail and telemarketing agency, ALLIED Group Insurance Marketing Company, an affiliate of ALLIED Mutual.\nNeither the insurance subsidiaries in the property-casualty segment nor ALLIED Mutual appoint managing general agents, and each retains all underwriting, claims, and reinsurance authority. While the insurers provide contractual binding authority to most agents, such authority is subject to express limitations on the nature, type, and extent of each risk. With respect to the ability of the agents to bind the insurers, the insurers have no right to reject any contracts entered into by the agents even if the agent exceeds the express limitations; however, such instances occur infrequently, and constitute no material financial risk to the Company.\nThe pooling agreement provides that ALLIED Mutual, ALLIED Property and Casualty, and Depositors cede to AMCO (pool administrator) premiums, losses, allocated loss settlement expenses, commissions, premium taxes, service charge income, and dividends to policyholders and assume from AMCO an amount of this pooled property-casualty business equal to their participation in the pooling agreement. ALLIED Mutual's crop hail business is not pooled. AMCO pays certain underwriting expenses, unallocated loss settlement expenses, and premium collection expenses for all of the pool participants and receives a fee equal to a specified percentage of premiums as well as a contingent fee based on the attainment of certain combined ratios from each of the pool participants.\nThe pooling arrangement provides ALLIED Mutual, ALLIED Property and Casualty, and Depositors more predictable expense levels by limiting such expenses to a specified percentage of their premiums. AMCO has opportunities to profit from the efficient administration of such underwriting, loss settlement, and premium collection activities and to provide similar services to nonaffiliated insurance companies in the future. The property-casualty segment's participation in the pool in 1995, 1994, and 1993 was 64%. As of December 31, 1995, the statutory capital and surplus of ALLIED Mutual and AMCO was $229,848,488 and $196,568,115, respectively.\nThe following table sets forth statutory basis and generally accepted accounting principles (GAAP) basis information for the Company's property-casualty subsidiaries for the years indicated.\nThe underwriting experience of the pool is indicated by the statutory combined ratio, a measure of underwriting profitability which excludes investment income and income taxes. Generally, a ratio below 100 indicates underwriting profitability and a ratio exceeding 100 indicates an underwriting loss. The following table sets forth the net earned premiums and the statutory combined ratios (after policyholder dividends) by line of insurance business for the property-casualty segment for the years indicated.\nThe following table sets forth the components of the statutory combined ratio and wind and hail loss information for the Company's property-casualty segment for the years indicated.\nWind and hail losses are calculated by adding together all claims with a cause of loss from wind or hail and then deducting the related reinsurance recoveries. The information provides an indication of how weather-related losses impact the property-casualty segment's operating results for the years presented. Losses not resulting from either wind or hail are excluded from these calculations.\nThe following table sets forth premium information and agency counts for the property-casualty pool (including ALLIED Mutual) for the years indicated.\nThe following table sets forth the geographic percentage distribution of property-casualty pool (including ALLIED Mutual) direct written premiums for the years indicated.\n*Includes all other states, none of which accounted for more than 2% in 1995.\nExcess & Surplus Lines\nWestern Heritage Insurance Company (Western Heritage) is an excess & surplus lines insurance subsidiary, which primarily underwrites commercial lines. A.M. Best has assigned a rating of A- (excellent) to Western Heritage for 1995 based on the review of their 1994 statutory results and operating performance.\nFor 1995, Western Heritage's net earned premiums were 74.3% specialty commercial casualty, 9% commercial property, 14.3% commercial transportation, and 2.4% personal lines coverages. Specialty commercial casualty lines include general liability, multiple peril, and product liability coverages for special events, such as concerts, fairs, exhibitions, and parades as well as coverages for merchants and artisan contractors. Specialty commercial property lines include\ncoverages for buildings that are older, in higher risk locations, or vacant; agricultural and contractor equipment; and protection against vandalism. Commercial transportation coverages include liability, physical damage, and garagekeepers insurance written for used car dealers and repair shops. The personal lines consist primarily of basic property coverages for dwellings.\nWestern Heritage agents are accorded contractual binding authority for risks which meet the insurer's written underwriting guidelines and rules. Western Heritage appoints no managing general agents, however, and retains all underwriting, claims, and reinsurance authority. With respect to the ability of the agents to bind Western Heritage, Western Heritage has no right to reject any contracts entered into by the agents.\nThe following table sets forth statutory and GAAP basis information for the excess & surplus lines segment for the years indicated.\nThe following table sets forth the net earned premiums and statutory combined ratios of the commercial casualty, commercial property, commercial transportation, and personal lines written by Western Heritage for the years indicated.\nThe following table sets forth the geographic percentage distribution of excess & surplus lines direct written premiums for the years indicated.\n*Includes all other states, none of which accounted for more than 2% in 1995.\nReinsurance\nThe Company's insurance subsidiaries follow the industry practice of reinsuring a portion of their insured risks, paying to the reinsurer a portion of the premiums received on all policies. Insurance is ceded principally to reduce the net liability on individual risks and to protect against catastrophic losses. The basic reinsurance treaties benefiting the parties to the pooling agreement insure risks in excess of specific amounts. Except for crop-hail reinsurance, all reinsurance is obtained by the pool participants directly and the pool administrator does not have any additional or special reinsurance arrangements other than as a pool participant. The financial stability of each participating reinsurer is independently monitored by the pool participants and by their reinsurance intermediaries.\nThe property-casualty pool participants and Western Heritage purchase coverage from nonaffiliated reinsurers in the ordinary course of their businesses. See \"Business-Relationship with ALLIED Mutual-Other Relationships\" for the ALLIED Mutual and American Re-Insurance Company property catastrophe reinsurance agreement. The insurers monitor the availability of replacement coverages in the reinsurance market, and the Company believes that replacement coverages from financially responsible reinsurers are available and accordingly does not deem its existing reinsurance arrangements to be material.\nWith the exception of Western Heritage, all retentions discussed in this section are for the entire pool. The property-casualty subsidiaries of the Company are allocated a portion of the stated pool retentions based upon their respective pool participation percentage.\nThe parties to the pooling agreement are covered by a property treaty which provides per risk property reinsurance in excess of a retention of $500,000 to a maximum limit of $5,000,000 per risk. Such parties are also covered by a property treaty that provides coverage on a facultative basis in excess of a retention of $5,000,000 to a maximum limit of $15,000,000.\nThe pool participants purchase property catastrophe reinsurance from a large number of reinsurers each of which provides a relatively small percentage of the total cover. For 1995, the pool liability limit of the cover is 90% of $100,000,000 with retention of $10,000,000. A reinstatement agreement exists allowing purchases of reinsurance for an additional catastrophe occurring in the same year. See \"Business-Relationship with ALLIED Mutual for affiliated reinsurance relationships.\" In 1996 the pool increased its maximum property catastrophe coverage to 90% of $120,000,000.\nThe pool's retention for most casualty risks is $375,000, with a reinsurance limit of $1,000,000 per occurrence. Other treaties provide reinsurance for each workers' compensation loss over $375,000 and up to $5,000,000. Catastrophe workers' compensation treaties increase the reinsurance to $35,000,000.\nWestern Heritage, which is not a participant in the property-casualty pool, purchases reinsurance on property risks covering 75% of the risk in excess of $50,000 to a maximum of $1,000,000, which is the largest property risk insured. Western Heritage also purchases casualty reinsurance in excess of $200,000 to a maximum of $1,000,000, the largest casualty risk insured. Western Heritage does not write workers' compensation or primary auto coverage.\nAlthough reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. As of December 31, 1995, there were no past due amounts from reinsurers. Historically, the Company has had no adverse collection experience with its reinsurers.\nLosses and Loss Settlement Expense Reserves\nIn many cases, several years 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 unpaid losses, the insurance subsidiaries establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. The insurance subsidiaries do not discount loss reserves for financial statement purposes.\nWhen a claim is reported, a case reserve for the estimated amount of the ultimate payment is established. The estimate reflects an informed judgment based on general corporate reserving practices and the Company's experience and knowledge regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not yet reported to the insurer and the overall adequacy of case reserves. The insurance subsidiaries also establish reserves representing the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process.\nAs part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as known and anticipated legal developments, changes in social attitudes, inflation, and economic conditions. This process relies on the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate basis for predicting future events. Reserve amounts are necessarily based on management's informed estimates, and as other data becomes available and is reviewed, these estimates and judgments are revised, resulting in increases or decreases to existing reserves.\nWhile the methods for setting the reserve structure are well tested, some assumptions about loss patterns have changed. In particular, recent higher jury verdicts and judicial decisions which expand coverage to new theories of liability have increased the demands against the loss and loss settlement expense reserves of the insurance subsidiaries. Not only have anticipated claims increased in severity, but unanticipated claims have arisen. In establishing reserves, management considers exposure the Company may have to environmental claims. Because reported claim activity levels are minimal and the emphasis of the Company's property-casualty business is primarily on personal lines and small commercial business, management believes exposure to material liability on environmental claims to be remote as of December 31, 1995. The Company continues to monitor legal developments as they relate to the Company's exposure to environmental claims.\nThe following table presents the development of losses and loss settlement expense reserves for 1985 to 1994 for the pool (which includes ALLIED Mutual) and Western Heritage. The top line of the table shows the estimated reserve for losses and loss settlement expenses at the balance sheet date for each of the indicated years. These figures represent the estimated amount of losses and loss settlement expenses, net of reinsurance recoverables, for claims arising in the current and all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported. The lower portion of the table shows the re-estimated amount of net reserves as a percentage of the previously recorded net reserves based on experience as of the end of each succeeding year. The re-estimated reserves change as more information becomes known about the frequency and severity of claims for individual years.\n(1) Shown as a percentage of reserves for losses and loss settlement expenses. (2) Shown as a percentage of gross reserves, reinsurance recoverables and net reserves.\nThe cumulative redundancy or deficiency represents the aggregate change in the estimates over all prior years. It should be emphasized that the table presents a run-off of balance sheet reserves rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years.\nThe following table reconciles the reserves for losses and loss settlement expenses from the previous table to the amount shown on the Company's consolidated balance sheets.\nThe next table sets forth a reconciliation of beginning and ending GAAP reserves for losses and loss settlement expenses for the years indicated, net of reinsurance recoverables. The table includes property-casualty and excess & surplus lines insurance loss and loss settlement expense reserves. Developments for losses and loss settlement expenses on prior years is immaterial to the Company's consolidated financial statements taken as a whole.\n* As of January 1, 1993, the property-casualty subsidiaries' underwriting accounts were adjusted to reflect their increased participation in the pool. The property-casualty subsidiaries received cash and securities for the transfer of reserves from ALLIED Mutual as of January 1, 1993. There was no income statement effect from this transaction as the amount received was offset by the increase in the reserves. However, since the reserves transferred were necessarily based upon estimates, subsequent changes in the estimates are reflected in current operating results.\nNoninsurance Operations\nThe investment services segment of the Company is comprised of ALLIED Group Mortgage Company (ALLIED Mortgage) and, through October 29, 1993, Dougherty Dawkins, Inc. and subsidiaries (Dougherty Dawkins). Dougherty Dawkins was sold October 29, 1993 and the results of operations through the closing date are reflected in the Company's consolidated financial statements. See note 7 of Notes to Consolidated Financial Statements.\nALLIED Mortgage purchases, originates, and services single-family residential mortgages. It acquires mortgage servicing rights from savings and loan associations, banks, other mortgage companies, the Resolution Trust Corporation, and other financial institutions. The market in which ALLIED Mortgage originates mortgages is primarily Polk County, Iowa, which includes the Des Moines area. ALLIED Mortgage purchases and services mortgages on a nationwide basis. See \"Business--Competition.\"\nALLIED Mortgage began operations in 1987, and by year-end 1995, its servicing portfolio included 54,533 mortgages for a total value of $3 billion. ALLIED Mortgage is an approved seller-servicer of mortgages guaranteed by Government National Mortgage Association, Federal National Mortgage Association, and Federal Home Loan Mortgage Corporation. See \"Business--Regulation.\" Working capital requirements are managed through short-term financing with commercial banks. See note 8 of Notes to Consolidated Financial Statements.\nThe Company's data processing services segment is comprised of ALLIED Group Information Systems, Inc. (AGIS) and The Freedom Group, Inc. (Freedom), which have a line of property-casualty and life insurance software products and data processing services which are marketed under the name \"Freedom Group\" to affiliated and nonaffiliated insurance companies. AGIS provides management information services to the property-casualty subsidiaries, ALLIED Mutual, ALLIED Life Insurance Company (ALLIED Life), the Company, and other company subsidiaries. See \"Business--Relationship with ALLIED Mutual.\" These services include the processing of policies and claims, billing, rating, statistical and regulatory reporting, and recordkeeping. AGIS also provides automated systems to the property-casualty segment's agency force. The majority of the segment's revenues and operating profits came from affiliated companies.\nThrough its direct sales force, AGIS licenses property-casualty insurance software to property-casualty insurance companies generally on a national basis. AGIS also provides certain consulting services and software maintenance services. On a nationwide basis, Freedom licenses statutory accounting insurance software to property-casualty and life insurance companies on primarily a direct sales basis.\nInvestments\nThe Company uses its investments to generate the majority of its operating profit and provide liquidity. Investments in fixed maturities are classified as available for sale. See note 1--\"Investments\" of Notes to Consolidated Financial Statements. The Company's invested assets are managed by Conning & Company, subject to restrictions on permissible investments under applicable state insurance codes and the Company's investment policies. Those policies require that the fixed maturity portfolio be invested primarily in debt obligations rated \"BBB\" (investment grade) or higher by Standard & Poor's Corporation (Standard & Poor's) or a recognized equivalent at the time the security is acquired by the Company. The policy also states that equity securities are to be of United States and Canadian Corporations listed on established exchanges or publicly traded in the over-the-counter market. Preferred stock is to be comprised primarily of issues rated at least A3\/A- by Standard & Poor's Corporation or Moody's. The Company monitors the investment quality of the fixed maturity portfolio subsequent to acquisition by reviewing on a quarterly basis the current debt ratings assigned to each of the securities in the fixed maturity portfolio.\nFixed income securities comprised 97.7% of the Company's invested assets, 98.1% of those had an \"BBB\" rating from Standard & Poor's (or the equivalent from Moody's) at December 31, 1995. The portfolio contain no real estate or mortgage loans. At December 31, 1995, less than $300,000 of the Company's fixed maturities were rated less than investment grade securities. At year-end 1995, the Company held $14,439,351 of nonrated securities. Evaluation of the issuers' rating and ratings for the issuers' other securities supports management's view that the nonrated securities are investment grade. At December 31, 1995, the fair value of the Company's fixed maturity portfolio was $27.8 million over amortized cost.\nAs of December 31, 1995, the Company held collateralized mortgage obligation (CMO) investments with a carrying and fair value of $77,671,819. Substantially all of the Company's CMO investments are in planned amortization class bonds or sequential pay bonds with anticipated durations of approximately 3.8 years at December 31, 1995. The Company has not invested in the more volatile types of CMO products such as companion or accrual (Z-bond) tranches. All of the Company's CMO investments have an active secondary market; accordingly, their effect on the Company's liquidity does not differ from that of other fixed income investments.\nThe carrying values of all the Company's investments in fixed maturities are reviewed on an ongoing basis. If this review indicates a decline in fair value below cost is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a specific write-down is taken. Such reductions in carrying value are recognized as realized losses and charged to income.\nThe table below shows the classifications of the Company's investments at December 31, 1995.\n(1) All such securities are backed by the full faith and credit of the United States Government.\nThe following table sets forth the composition of the Company's fixed maturity investments by rating at December 31, 1995.\n(1) Ratings are assigned primarily by Standard & Poor's with remaining ratings assigned by Moody's and converted to the equivalent Standard & Poor's ratings.\nThe following table sets forth contractual maturities in the fixed maturity and short-term investment portfolios at December 31, 1995. 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.\nInvestment results of the Company for each year in the three years ended December 31, 1995 are shown in the following table.\n(1) Represents total invested assets on an average quarterly basis. The beginning of the period balance for 1993 has been adjusted to reflect the effects of the changes in the pooling agreement.\n(2) Investment income is net of investment expenses and does not include realized investment gains or losses or provision for income taxes.\n(3) Assuming an effective tax rate of 35%.\nCompetition\nThe insurance industry is highly competitive. The Company's insurance subsidiaries compete with numerous insurance companies, many of which are substantially larger and have considerably greater financial resources. Because the Company's insurance subsidiaries operate through independent agents and such agents represent more than one company, they face competition within each agency. The Company's insurance subsidiaries compete by underwriting criteria, pricing, automation, service, and product design. The Company believes that its management information systems and procedures for selecting and rating risks accord it a competitive advantage.\nCompetition in the excess & surplus lines market stiffened in recent years as standard market capacity increased and prices decreased. Western Heritage competes in its chosen market (approximately 40 states in the Midwest, West, and South) with numerous insurers on the basis of service, price, and financial strength.\nALLIED Mortgage, in originating residential mortgages in central Iowa and servicing residential mortgages nationally, competes through competitive pricing and service. Nationally, ALLIED Mortgage is a small-sized company servicing mortgages with remaining principal balances aggregating $3 billion at December 31, 1995. The largest competitors service in excess of $126 billion of mortgages. With greater capital and greater efficiencies, the larger companies have an advantage in originating and purchasing mortgages to obtain the servicing rights. ALLIED Mortgage has access to capital due to its association with the Company and competes in the purchase of servicing on the basis of price and in mortgage originations on the basis of price and quality of service.\nRegulation\nThe Company's insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they transact business under statutes which delegate regulatory, supervisory, and administrative powers to state insurance commissioners. Such regulation is designed generally to protect policyholders rather than investors and relates to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and examination of the affairs of insurance companies, which includes periodic market conduct and financial examinations by the regulatory authorities; annual and other reports, prepared on a statutory accounting basis, required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses and loss settlement expenses; and requirements regarding numerous other matters. In general, the Company's insurance subsidiaries must file all rates for insurance directly underwritten with the insurance department of each state in which they operate; reinsurance generally is not subject to rate regulation. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect their solvency. Iowa, the jurisdiction of incorporation of all of the Company's insurance subsidiaries (except Western Heritage), requires that dividends be paid only out of statutory unassigned\nsurplus and requires prior regulatory approval for the payment of any dividend which exceeds the greater of either 10% of the insurer's policyholders' surplus as of the preceding December 31 or statutory net income of the preceding calendar year. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations-Regulations\" and note 13 of Notes to Consolidated Financial Statements for additional discussion of dividend limitations. AMCO and ALLIED Property and Casualty are also commercially domiciled insurers within the State of California and subject to regulation (including limitations on dividend payments) as California domiciled insurers by the California Insurance Commissioner. The amounts available for distributions as dividends from Western Heritage are limited by Arizona law, state of jurisdiction, to statutory unassigned surplus and requires prior regulatory approval for the payment of any dividends which exceed the lesser of 10% of the policyholders' surplus as of the preceding December 31 or net investment income of the preceding calendar year.\nCalifornia was the source of approximately 25% of the pool's direct written premiums for the past ten years. Proposition 103, approved by California voters in 1988, provides for a rollback of rates on premiums collected in calendar year 1989 to the extent that the insurer's return on equity for each Proposition 103 line exceeded 10%. Since it was passed, Proposition 103 has been the subject of a number of legal and regulatory proceedings for the purpose of clarifying the scope and extent of insurers' rollback obligations. Management of the Company continues to believe that the insurance subsidiaries will not be liable for any material rollback of premiums.\nThe Company is also subject to statutes governing insurance holding company systems in various jurisdictions. Typically, such statutes require the Company periodically to file information with the state insurance regulatory authority, including information concerning its capital structure, ownership, financial condition and general business operations. Under the terms of applicable state statutes, any person or entity desiring to acquire more than a specified percentage (commonly 10%) of the Company's outstanding voting securities is required first to obtain approval from the applicable state insurance regulators. Chapter 521A of the Iowa Code relating to holding companies, to which the Company is subject, requires disclosure of transactions between the Company and its insurance subsidiaries or between an insurer and another subsidiary, that such transactions satisfy certain standards, including that they be fair, equitable, and reasonable and that certain material transactions be specifically non-disapproved by the Iowa Insurance Division. Further, prior approval by the Iowa Insurance Division is required of affiliated sales, purchases, exchanges, loans or extensions of credit, guarantees, or investments, any of which involve 5% or more of the insurer's admitted assets as of the preceding December 31st.\nUnder insolvency or guaranty fund laws in most states in which the Company's insurance subsidiaries and ALLIED Mutual operate, insurers doing business in those states can be assessed, up to prescribed limits, for losses incurred by policyholders as a result of the insolvency of other insurance companies. The amounts and timing of such assessments are beyond the control of the Company and generally have an adverse impact on the Company's earnings. Additionally, the Company is required to participate in various mandatory pools or underwriting associations in amounts related to the amount of the Company's direct writings in the applicable state.\nRecently, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government, and the National Association of Insurance Commissioners (NAIC). Various states have considered or enacted legislation which changes, and in many cases increases, the state's authority to regulate insurance companies. The NAIC has recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies. Two of these initiatives include risk based capital standards and a model investment law.\nThe NAIC's risk based capital (RBC) requirements were adopted by the NAIC in 1993 and require property-casualty insurance companies to calculate and report information under the RBC formula. It is anticipated that the Iowa legislature will enact the NAIC's proposal into law in 1996. The RBC formula uses the statutory financial statements to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums, and unearned premium) risk. Based on the subsidiaries' statutory financial statements and interpretation of the RBC formula, management believes capital levels are sufficient to support the level of risk inherent in Company operations and are in excess of any amount which would require regulator action.\nThe NAIC's model legislation to govern insurance company investments is in development. An exposure draft was released in December of 1995 and a model law may be adopted by the NAIC in 1996. The effect of adoption by the Iowa legislature is not expected to be a significant to the Company.\nThe mortgage banking subsidiary is subject to the rules and regulations of, and examination by, the United States Department of Housing and Urban Development, Federal National Mortgage Association (FNMA), and Government National Mortgage Association (GNMA) with respect to originating, processing, selling, and servicing mortgage loans. These rules and regulations, among other things, prohibit discrimination, provide for inspection and appraisals of properties, require credit reports on prospective borrowers, and sometimes fix maximum interest rates, fees, and loan amounts. GNMA requires the maintenance of specified amounts of net worth that vary with the amount of GNMA mortgage-backed securities issued by ALLIED Mortgage. There are also various state laws affecting mortgage banking operations.\nRelationship with ALLIED Mutual\nThe Company is operated as a part of the ALLIED Group of insurance companies. ALLIED Mutual has operated as a mutual property-casualty insurance company since 1929. In 1971, it organized the Company as a wholly owned subsidiary and transferred to it certain assets, including the stock of AMCO, which had operated as a subsidiary of ALLIED Mutual since 1959. In 1985, the Company effected an initial public offering which then resulted in public ownership of approximately 22% of its common stock. As of December 31, 1995, ALLIED Mutual controlled 18% of the voting stock of the Company.\nThe operations of the Company and its subsidiaries are interrelated with the operations of ALLIED Mutual. The Company and ALLIED Mutual share common executive officers, and three directors of the Company are also directors of ALLIED Mutual.\nFor the year ended December 31, 1995, ALLIED Mutual reported, in accordance with Statutory Accounting Principles, net income of $12,162,049, a statutory combined ratio of 104.5, and assets and surplus at December 31, 1995 of $498,568,711 and $229,848,488, respectively. As of December 31, 1995, ALLIED Mutual's invested assets were $453,311,143. Invested assets included a fixed maturity portfolio of $338,971,484 (at amortized cost), of which over 95.3% was rated \"BBB\" or higher by Standard & Poor's or a recognized equivalent rating agency. Invested assets also included $72,071,431 in equity investments in affiliates (which includes the Company, ALLIED Life Financial Corporation (ALFC), which is a 52% owned subsidiary of ALLIED Mutual, and AID Finance Services, Inc.). ALLIED Mutual files its statutory-basis financial reports with the state insurance departments in the territories in which it operates.\nThe Company and ALLIED Mutual formalized their relationship by entering into an Intercompany Operating Agreement, a Stock Rights Agreement, and a Pooling Agreement.\nIntercompany Operating Agreement\nThe Company, ALLIED Mutual, ALFC, and each of their respective subsidiaries are parties to an Intercompany Operating Agreement providing for the sharing of employees, office space, agency forces, data processing, and other services and facilities. The Company and its subsidiaries receive from and pay to ALLIED Mutual and its subsidiaries fees and cost reimbursements for the employees, services, and facilities provided. In determining the allocated costs to the companies, each provider of the various services (e.g., ALLIED Mutual leases office facilities, AGIS provides data processing, etc.) attempts to set fees on a basis consistent with that which would apply in an arm's length transaction with nonaffiliates. However, there can be no assurance that the actual rates charged reflect those which would be obtained if the Company and ALLIED Mutual were not affiliated and had agreed upon rates following arm's length negotiation. See \"Relationship with ALLIED Mutual-Pooling Agreement\" for a discussion of changes that impact expense sharing arrangements between ALLIED Mutual and the Company.\nThe Company leases to ALLIED Mutual and certain of its subsidiaries all of the employees utilized in their operations for a fee and reimbursement of personnel costs based on certain allocation methods. The Company is obligated to provide the entire requirements for employees of ALLIED Mutual and certain of its subsidiaries, but ALLIED Mutual reserves the right to hire employees independently rather than leasing them from the Company. In 1995, 1994, and 1993, ALLIED Mutual and its subsidiaries paid the Company approximately $2,489,390, $2,414,504, and $3,204,386, respectively, for leased employees, substantially all of which represented cost reimbursement.\nThe Intercompany Operating Agreement also provides for the leasing by ALLIED Mutual to the Company of substantially all of the office space utilized by the Company. ALLIED Mutual and the Company share agency forces as well as other services and facilities. The Intercompany Operating Agreement contains a covenant not to compete that binds each of the Company, ALLIED Mutual, and ALFC not to engage in a business that competes with the products or markets of any other party or such party's subsidiaries for the term of the Intercompany Operating Agreement and five years thereafter. The Intercompany Operating Agreement can be terminated by ALLIED Mutual, ALFC, or the Company after December 31, 2004 upon two years prior notice.\nIn addition, ALLIED Mutual, the Company, and ALFC have certain rights under the Intercompany Operating Agreement, the Pooling Agreement, and the Management Information Services Agreement in the event a nonaffiliated party acquires the ownership of 50% or more of the voting stock of the Company or ALFC. If such an event were to occur, ALLIED Mutual, the Company, or ALFC, as the case may be, has the right to (i) terminate all three of the Intercompany Operating Agreement, the Pooling Agreement, and the Management Information Services Agreement upon six months notice (ii) extend the term of all three such agreements for up to ten additional years beyond December 31, 2004, upon six months notice, or (iii) allow such agreements to continue in effect.\nStock Rights Agreement\nThe Company and ALLIED Mutual are parties to a Stock Rights Agreement, which grants certain rights to, and imposes certain restrictions on, ALLIED Mutual in respect of its holdings of the Company's common and preferred stock. This Agreement expires in 2005.\nPursuant to the Stock Rights Agreement, ALLIED Mutual is entitled to nominate, and the Company is required to use its best efforts to cause the election or retention of, a number of members of the Company's Board of Directors in proportion to ALLIED Mutual's percentage ownership of the total number of shares of the Company's voting stock outstanding at the time of nomination. In addition, the Company is required to elect to its Executive Committee at least one Company director who has been nominated by ALLIED Mutual but who is not an officer or employee of ALLIED Mutual. The Stock Rights Agreement also restricts the ability of ALLIED Mutual to grant proxies and solicit other shareholders of the Company. Under the Stock Rights Agreement, ALLIED Mutual is prohibited from initiating or accepting a tender offer for shares of the Company's common stock except under certain conditions. The Company has a right of first refusal with respect to any sale by ALLIED Mutual of the Company's common stock, subject to certain exceptions, including a distribution of such stock to the public in a registered public offering or sale pursuant to Rule 144. ALLIED Mutual has incidental registration rights and three demand registration rights with respect to the Company's common and 6-3\/4% Series preferred stock it owns.\nThe limitations on ALLIED Mutual's ability to initiate, or tender shares, in a tender offer as well as the limitations on its ability to grant proxies and solicit other shareholders of the Company terminate upon a consolidation or merger of the Company with another corporation in which the Company is not the surviving corporation, a sale of substantially all of its assets, or the holding, by any person other than ALLIED Mutual, of 50% or more of the voting securities of the Company then outstanding. The Agreement will be suspended for so long as ALLIED Mutual holds less than 10% of the outstanding common stock and 6-3\/4% Series preferred stock of the Company.\nPooling Agreement\nThe Pooling Agreement provides that ALLIED Mutual, ALLIED Property and Casualty, and Depositors cede to AMCO premiums, losses, allocated loss settlement expenses, commissions, premium taxes, service charge income, and dividends to policyholders and assume from AMCO an amount of this pooled property-casualty business equal to their participation in the Pooling Agreement. ALLIED Mutual's crop hail business is not pooled. AMCO pays certain underwriting expenses, unallocated loss settlement expenses, and premium collection expenses for all of the pool participants and receives a fee equal to a specified percentage of premiums as well as a contingent fee based on the attainment of certain combined ratios from each of the pool participants. AMCO charges each of the other pool participants 12.85% of written premiums for underwriting services, 7.25% of earned premiums for unallocated loss settlement expenses, and 0.75% of earned premiums for premium collection services. AMCO received pool administrative fees\nof $55,721,043, $50,449,437, and $44,920,376 from ALLIED Mutual in 1995, 1994, and 1993, respectively. The administrative fees are subject to renegotiation during the term of the pooling agreement upon five years notice.\nThe pooling agreement provides ALLIED Mutual, ALLIED Property and Casualty, and Depositors more predictable expense levels by limiting such expenses to a specified percentage of their premiums in lieu of the prior arrangement, where such expenses were allocated based on the pool participation percentages. These arrangements give AMCO opportunities to profit from the efficient administration of such underwriting, loss settlement, and premium collection activities and to provide similar services to nonaffiliated insurance companies in the future.\nChanges to the Pooling Agreement must be approved by the Coordinating Committee. The term of the Pooling Agreement extends to 2004 after which time it can be terminated by either party on five years' notice. The Pooling Agreement may also be terminated or extended by ALLIED Mutual upon the occurrence of certain events. See \"Relationship with ALLIED Mutual-Intercompany Operating Agreement.\"\nThe Coordinating Committee\nUnder the Intercompany Operating Agreement, the Company, ALLIED Mutual, and ALFC have formed a Coordinating Committee comprised of two independent directors of the Company, two directors of ALLIED Mutual, and two independent directors of ALFC, none of whom serve on other ALLIED boards. All disputes arising under the Intercompany Operating Agreement as well as other intercompany agreements are to be submitted to the Coordinating Committee for resolution. Decisions of this Coordinating Committee must be unanimous and are binding on the parties. Historically, all issues that have been submitted to the Coordinating Committee have been resolved by the Committee. The Company anticipates that any future issues would be similarly resolved. If an issue is not resolved by the Coordinating Committee, it will be submitted to arbitration. In such arbitration, each party to the dispute selects one arbitrator, and if such dispute involves only two parties, such arbitrators select a third arbitrator.\nOther Relationships\nALLIED Mutual has participated with American Re-Insurance Company in a property catastrophe reinsurance agreement to cover the property-casualty segment's share of pooled losses. In 1995, 1994, and 1993, ALLIED Mutual's and American Re-Insurance Company's respective participation in the reinsurance agreement were 90% and 10% and covered the property-casualty segment's share of pooled losses up to $5,000,000 in excess of $5,000,000. See notes 4 and 6 of Notes to Consolidated Financial Statements for additional information concerning transactions between the Company and ALLIED Mutual.\nEmployees\nAt December 31, 1995, the Company was the direct employer of personnel for all subsidiaries of the Company and of ALLIED Mutual and its subsidiaries other than ALFC, employing 2,243 persons. None of the Company's employees are members of a collective bargaining unit. Management believes that its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe majority of the real property occupied by the Company and its subsidiaries are owned or leased by ALLIED Mutual. A portion of the costs of the properties is paid by the Company and its subsidiaries. See \"Relationship with ALLIED Mutual-Intercompany Operating Agreement.\" Management considers the properties to be adequate for its needs. The primary properties owned by ALLIED Mutual are the home office in Des Moines, Iowa, a data processing facility and claims center in Urbandale, Iowa, and regional offices in Denver, Colorado and Lincoln, Nebraska. The Santa Rosa, California regional office building is leased by ALLIED Mutual. The Company and its subsidiaries lease office space in Des Moines and Cedar Rapids, Iowa, Minneapolis, Minnesota, Lincoln, Nebraska, and Scottsdale, Arizona.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company and its subsidiaries are party to various lawsuits arising in the normal course of business. The Company and its subsidiaries believe the resolution of these lawsuits will not have a material adverse effect on their financial condition or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Securities Holders\nNo matters were submitted during the fourth quarter of 1995 to a vote of holders of ALLIED Group, Inc. stock.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholders' Matters\nThe Company's common stock trades on The Nasdaq Stock Market under the symbol ALGR. As of December 31, 1995, there were 1,026 stockholders of record. The following table shows the high and low market prices and dividends paid per share for each calendar quarter for the two most recent years.\nThere are certain regulatory restrictions relating to the payment of dividends (see note 13 of Notes to Consolidated Financial Statements). It is the present intention of the Board of Directors to declare quarterly cash dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related footnotes included elsewhere herein.\nALLIED Group, Inc. (the Company) is a regional insurance holding company. As of December 31, 1995, The ALLIED Group Employee Stock Ownership Trust (ESOP Trust) owned 26.9% of the outstanding stock. ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 18% of the voting stock of the Company.\nThe operating results of the property-casualty insurance industry are subject to significant fluctuations from quarter to quarter and from year to year due to the effect of competition on pricing, the frequency and severity of losses incurred in connection with weather-related and catastrophic events, general economic conditions, and other factors such as changes in tax laws and the regulatory environment.\n1995 COMPARED TO 1994\nConsolidated revenues for 1995 were $552.8 million, up 8.9% over the $507.4 million reported for 1994. Excluding realized in gains, revenues grew 9.5% for 1995. The increase occurred primarily because of the 10.4% growth in earned premiums.\nIncome before income taxes was up 10.7% to $73.8 million from $66.7 million for 1994 primarily because of revenue growth and improved underwriting margins for the property-casualty segment. The property-casualty segment was the dominant contributor to operating income with an increase of $9.7 million.\nNet income for the year ended December 31, 1995 was up 10% to $52.4 million, raising fully diluted earnings per share to $3.52 from $3.19. Fully diluted earnings per share before net realized investment gains were $3.50 for 1995 compared with $3.05. Book value per share increased to $24.23 from $19.68.\nProperty-casualty\nRevenues for the property-casualty segment increased to $472 million from $431.1 million for 1994. Direct earned premiums for the segment were $435.2 million for 1995 compared with $383.5 million one year earlier. Earned premiums increased 10.1% to $425.8 million from $386.7 million. The increase resulted primarily from growth in insurance exposure as well as a larger average premium per policy.\nPooled net written premiums (including ALLIED Mutual) totaled $692.6 million, a 9.4% increase over 1994 production. The average premium per policy for personal lines was up 3.4% to $586 while the policy count grew 6.5%. The average premium per policy for commercial lines increased 2% to $1,086, and policy count was up 5.3%. Earned premiums for the property-casualty segment were 65.7% personal lines and 34.3% commercial lines. The business mix for 1994 was 65.4% personal and 34.6% commercial lines.\nIncome before income taxes increased to $63.9 million from $54.2 million primarily as a result of lower underwriting expenses in 1995 and an increase in earned premiums. Investment income was $39.1 million compared with $35.3 million. The pretax yield on invested assets was 6.4%, down from 6.6% one year earlier. Realized investment gains were $236,000 compared with $3 million. Realized investment gains for 1994 included $2.6 million from the sale of the segment's 20% interest in a savings and loan holding company. Other income increased to $6.9 million from $6.1 million in 1994.\nThe statutory combined ratio (after policyholder dividends) improved to 95.7 from the 97.1 reported in 1994. Improvement was attributed primarily to a 1.3-point decrease in the underwriting expense ratio. The decrease was the result of the Company's continuing efforts to improve efficiency and productivity. Wind and hail losses for 1995 increased to $28.7 million from $24.4 million in 1994. The impact of wind and hail losses on the statutory combined ratio was 6.7 points for the year ended December 31, 1995 and 6.3 points for 1994. The underwriting gain (on a generally accepted accounting principles basis) was $17.7 million compared with $9.8 million for 1994. On a fully diluted basis, the impact of wind and hail losses on the results of operations was $1.35 per share versus $1.15 in 1994.\nThe personal auto statutory combined ratio improved to 96.5 for 1995 from 97.4 last year. The improvement was due to a 1.4-point decrease in the underwriting expense ratio that more than offset the increase in the loss and loss settlement expense ratio. The statutory combined ratio for the homeowners line was 99.2 compared with 107.4 for 1994. The impact of wind and hail losses on the homeowners combined ratio increased slightly to 21.7 points from 21.5 points. Results for the homeowners line were favorably affected by better pricing in 1995. Overall, the personal lines statutory combined ratio improved to 97.2 in 1995 from 99.8 in 1994. The statutory combined ratio for commercial lines increased to 92.7 from 92.0 for the previous year.\nExcess & Surplus Lines\nEarned premiums increased to $29.7 million for 1995 from $25.8 million for 1994. Net written premiums increased 13.2% to $30.6 million from $27 million. Direct earned premiums were $37.2 million compared with $32.3 million. As of December 31, 1995, the segment's book of business was comprised of 2.4% personal lines and 97.6% commercial lines. For 1994, the business mix was 2.8% personal and 97.2% commercial lines.\nThe statutory combined ratio (after policyholder dividends) was 102.2, which produced an underwriting loss (on a generally accepted accounting principles basis) of $855,000. The statutory combined ratio of 99.9 for 1994 resulted in an underwriting loss of $218,000. The 1995 combined ratio increased primarily because of a 20.4% increase in losses and loss settlement expenses (3.4-points on the combined ratio).\nIncome before income taxes for 1995 decreased 3.2% to $4.8 million from $5 million. The decrease was primarily due to poor loss development. Realized investment losses were $136,000 compared with losses of $24,000 for 1994. Investment income increased 11.2% to $5.8 million from $5.2 million. Investment income increased because a larger average balance of invested assets more than offset a 10 basis-point decline in the pretax yield from last year's 6.8%. Invested assets rose 21.2% from the previous year-end to $96.4 million at December 31, 1995.\nNoninsurance Operations\nRevenues for ALLIED Group Mortgage Company (ALLIED Mortgage) decreased in 1995 to $17.9 million from $18.3 million in 1994. Growth in revenues was adversely affected by a decrease in interest income due to a decline in the average balance of mortgage loans held for sale in 1995. The mortgage servicing portfolio was $3 billion at year-end 1995 and 1994. Income before income taxes for ALLIED Mortgage was up 13.8% to $4.5 million from $4 million for 1994. The increase was primarily the result of lower operating expenses.\nRevenues for the data processing operations decreased 6% to $48.6 million from $51.8 million in 1994. The operations reported a pretax loss of $618,000 for 1995 and a pretax profit of $3.9 million the previous year. The 1995 decreases were primarily the result of a reduction in revenues generated from the affiliated property-casualty segment. Fees for processing and product maintenance services were lowered during the year to more closely approximate cost for providing such services to that segment's companies.\nInvestments and Investment Income\nThe investment policy for the Company's insurance segments requires that the fixed maturity portfolio be invested primarily in debt obligations rated investment grade (BBB) or higher by Standard & Poor's Corporation or a recognized equivalent at the time of acquisition. The policy also states that equity securities are to be of United States and Canadian corporations listed on\nestablished exchanges or publicly traded in the over-the-counter market. Preferred stock is to be comprised primarily of issues rated at least A3\/A- by Standard & Poor's Corporation or Moody's. At December 31, 1995 the Company's investment portfolio consisted almost exclusively of fixed income securities; 98.1% were rated investment securities or higher. The portfolios contained no real estate or mortgage loans.\nInvested assets were up 17.7% to $772.3 million from $655.9 million at year-end 1994. Fixed maturities at amortized cost increased 11.2%. In 1995, the Company reclassified all fixed maturities in held to maturity to available for sale. Therefore, all fixed maturities were marked to market at December 31, 1995. See Investments section in note 1 of Notes to Consolidated Financial Statements.\nConsolidated investment income increased 15% to $47.2 million from $41.1 million in 1994. The increase was due primarily to a larger average balance of invested assets. The tax-equivalent yield was down in 1995 to 7.8% compared with 7.9% one year earlier. The aftertax yield for 1995 and 1994 was 5.1%.\nAt December 31, 1995, the Company held collateralized mortgage obligation (CMO) investments with a carrying and fair value of $77.7 million. The Company's investments in CMOs as of December 31, 1994 had a carrying value of $59.6 million (fair value of $57 million). Substantially all of the Company's CMO investments are in planned amortization class bonds or sequential pay bonds with anticipated durations of approximately five years at the time of acquisition. The Company has not invested in the more volatile types of CMO products such as companion or accrual (Z-bond) tranches. All of the Company's CMO investments have an active secondary market; accordingly, their effect on the Company's liquidity does not differ from that of other fixed income investments.\nIncome Taxes\nThe Company's effective income tax rate was 29.1% compared with 28.6% for 1994. The income tax expense for 1995 rose to $21.5 million from $19.1 million due to higher operating income and a smaller percentage of tax-exempt investment income.\n1994 COMPARED TO 1993\nConsolidated revenues for 1994 were $507.4 million, up 5.2% over the $482.4 million reported for 1993. Though earned premiums grew 12% in 1994, the percentage increase in revenues was constrained by the sale of the Company's investment banking and asset management subsidiary in October of 1993.\nIncome before income taxes was up 17.5% to $66.7 million from $56.8 million for 1993 primarily because of improved underwriting results for the property-casualty segment. The segment's operating income increased $13.3 million.\nNet income for the year ended December 31, 1994 was up 19.3% to $47.6 million, raising fully diluted earnings per share to $3.19 from $2.61. Fully diluted earnings per share before net realized investment gains were $3.05 compared with $2.55. Book value per share increased to $19.68 from $17.98.\nProperty-casualty\nRevenues for the property-casualty segment increased to $431.1 million from $384.6 million for 1993. Direct earned premiums for the segment were $383.5 million for 1994 compared with $328.5 million one year earlier. Earned premiums increased 12.3% to $386.7 million from $344.3 million. The increase resulted primarily from growth in insurance exposure and a larger average premium per policy.\nPooled net written premiums (including ALLIED Mutual) totaled $632.8 million, an 11.3 % increase over 1993 production. The average premium per policy for personal lines was up 3.8% to $567 while the policy count grew 8%. The average premium per policy for commercial lines increased 4.5% to $1,065, and policy count was up 4.8%. Earned premiums for the property-casualty segment were 65.4% personal lines and 34.6% commercial lines. The business mix for 1993 was 65.5% personal and 34.5% commercial.\nIncome before income taxes increased to $54.2 million from $40.9 million as a result of the first statutory underwriting profit in seven years. Investment income was $35.3 million compared with $33.5 million. The pretax yield on invested assets was 6.6%, down from 7% due to a larger investment in tax-exempt securities. Realized investment gains were $3 million compared with $1.3 million; the increase was from the sale of the segment's 20% interest in a savings and loan holding company in 1994 for $9.4 million. The pretax gain of $2.6 million from the sale generated an aftertax gain on a fully diluted basis of $0.13 per share. Other income increased to $6.1 million from $5.5 million in 1993.\nThe statutory combined ratio (after policyholder dividends) improved to 97.1 from the 99.3 reported in 1993. Improvement was attributed to a 1.2-point decrease in the underwriting expense ratio and a 1-point decrease in the loss and loss settlement expense ratio. The decreases were the result of the Company's continuing efforts to improve efficiency and productivity. Wind and hail losses for 1994 increased to $24.4 million from $18.7 million in 1993; their impact on the combined ratio worsened to 6.3 points from 5.4 points for 1993. The underwriting gain (on a generally accepted accounting principles basis) was $9.8 million compared with a gain of $611,000 for 1993. On a fully diluted basis, wind and hail losses increased $0.26 per share to $1.15 in 1994.\nThe personal auto statutory combined ratio improved to 97.4 for 1994 from 98.3. The improvement was due to a 10.6% growth in earned premiums that outpaced the increase in losses and loss settlement expenses. The statutory combined ratio for the homeowners line was 107.4 compared with 109.1 for 1993. The impact of the wind and hail losses on the homeowners combined ratio increased to 21.5 points from 17.9 points, but the increase was offset by lower loss settlement and underwriting expenses. Overall, the personal lines statutory combined ratio improved to 99.8 in 1994 from 100.8 in 1993. The statutory combined ratio for commercial lines improved to 92.0 from 96.3.\nExcess & Surplus Lines\nEarned premiums increased 7.4% to $25.8 million for 1994 from $24 million. Net written premiums increased 8.6% to $27 million from $24.9 million. Direct earned premiums were $32.3 million compared with $30 million. As of December 31, 1994, the segment's book of business was comprised of 2.8% personal lines and 97.2% commercial lines. For 1993, the business mix was 3.5% personal and 96.5% commercial.\nThe statutory combined ratio (after policyholder dividends) was 99.9, which produced an underwriting loss (on a generally accepted accounting principles basis) of $218,000. The statutory combined ratio of 96.1 for 1993 resulted in an underwriting gain of $647,000. The 1994 combined ratio worsened primarily because of a 16.4% increase in incurred losses resulting from higher than anticipated one unusually large claim; the loss and loss settlement expense ratio increased 2.5 points.\nIncome before income taxes for 1994 decreased 11% to $5 million from $5.6 million for 1993. Realized investment losses were $24,000 compared with gains of $103,000. Investment income increased 7.7% to $5.2 million from $4.9 million because a larger average balance of invested assets more than offset the decline in the pretax yield to 6.8% from 7.2%. Invested assets rose 6% from the previous year-end to $79.6 million at December 31, 1994.\nNoninsurance Operations\nRevenues for ALLIED Mortgage decreased slightly in 1994 to $18.3 million from $18.4 million in 1993, adversely affected by a sharp decrease in marketing revenues in an interest rate environment that experienced rising rates throughout the year. In 1993, falling interest rates provided the market with an abundance of mortgage loans to be purchased or originated at below-market prices and allowed the mortgage loans to be sold on the secondary market at a premium. The stability in revenues in 1994 was attributed primarily to an increase in servicing fees that offset the decline in marketing revenues. The mortgage servicing portfolio grew 19.3% to $3 billion from $2.5 billion at year-end 1993.\nIncome before income taxes for ALLIED Mortgage was up 16.5% to $4 million from $3.4 million for 1993. The increase was primarily the result of fewer servicing rights being written off due to the reduction in refinancing activities in 1994. During 1993, lower interest rates increased the amount of servicing rights being expensed as the underlying mortgages were repaid or refinanced.\nRevenues increased 6.8% for the data processing operations to $51.8 million from $48.4 million in 1993. Income before income taxes decreased 16.8% to $3.9 million in 1994 from $4.6 million. The decrease occurred because the growth in operating expenses outpaced the increase in revenues. Higher operating expenses were the result of expensing direct development costs.\nInvestments and Investment Income\nInvested assets were up 8.1% to $655.9 million from $606.5 million at year-end 1993. The investment portfolios consisted of 99.6% investment grade securities at December 31, 1994. The fair value of the Company's investment in fixed maturities held to maturity was $13.2 million below amortized cost compared with an excess of $18.8 million at December 31, 1993.\nConsolidated investment income increased 5.2% to $41.1 million from $39 million for 1993. The Company's pretax rate of return on invested assets was down to 6.5% from the previous year's 7.1%. The aftertax yield for 1994 was 5.1% compared with 5.4%.\nAs of December 31, 1994, the Company held collateralized mortgage obligation (CMO) investments with a carrying value of $59.6 million (fair value of $57 million). The Company's investments in CMOs as of December 31, 1993 had a carrying value of $104 million (fair value of $105.6 million).\nIncome Taxes\nThe Company's effective income tax rate was 28.6% compared with 29.7% for 1993. The increased tax-exempt income in 1994 was primarily responsible for the change in the effective tax rate. The income tax expense for 1994 rose to $19.1 million from $16.8 million due to higher operating income.\nREGULATIONS\nThe NAIC's risk based capital (RBC) requirements were adopted by the NAIC in 1993 and call for property-casualty insurance companies to calculate and report information under the RBC formula. It is anticipated the Iowa legislature will enact the NAIC's proposal into law in 1996. The RBC formula uses the statutory financial statements to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums, and unearned premiums) risk. The subsidiaries' statutory financial statements and counsel's interpretation of the RBC formula lead management to believe capital levels are sufficient to support the level of risk inherent in Company operations and are in excess of the minimums required.\nThe NAIC's model legislation to govern insurance company investments is in development. An exposure draft was released in December of 1995, and the model investment law may be adopted by the NAIC in 1996. The effect of the adoption by the Iowa legislature is not expected to be significant to the Company.\nCalifornia has been the source of approximately 25% of the pool's direct written premiums for the past ten years. Proposition 103, approved by California voters in 1988, provides for a rollback of rates on premiums collected in calendar year 1989 to the extent that the insurer's return on equity for each Proposition 103 line exceeded 10%. Since it was passed, Proposition 103 has been the subject of a number of legal and regulatory proceedings for the purpose of clarifying the scope and extent of insurers' rollback obligations. Management of the Company continues to believe that the insurance subsidiaries will not be liable for any material rollback of premiums.\nLIQUIDITY AND CAPITAL RESOURCES\nSubstantial cash inflows are generated from premiums, pool administration fees, investment income, and proceeds from maturities of portfolio investments. The principal outflows of cash are payments of claims, commissions, premiums taxes, operating expenses, income taxes, and the purchase of fixed maturities and equity securities. In developing its strategy, the Company establishes a level\nof cash and highly liquid short- and intermediate-term securities that, combined with expected cash flow, is believed adequate to meet anticipated short-term and long-term payment obligations.\nIn 1995, operating activities generated cash flows of $97.9 million; in 1994, the total was $85.5 million; in 1993, the total was $91.6 million (including $25.8 million from the 1993 change in the pool participation percentage and pool administration). For each year, the primary source of funds was premium growth in the Company's property-casualty insurance operations. Proceeds from the sale of 1.6 million shares of common stock in the first quarter of 1993 accounted for the majority of the $38.1 million generated from financing activities during 1993.\nIn each of the years, funds generated from operating activities were used primarily to purchase investment grade fixed securities, accounting for the majority of cash used in investing activities. The net cash used in investing activities in 1995, 1994, and 1993 was $88.8 million, $69.5 million, and $128.8 million, respectively. In 1993, additional funds were generated from financing activities and were used primarily to purchase investment grade fixed maturities. In 1995, 1994, and 1993, the Company paid dividends of $13.5 million, $12.7 million, and $11.8 million, respectively.\nIn 1994, the Company also used funds to repurchase $6.4 million of common stock. On February 11, 1994, the Company's Board of Directors approved a plan to repurchase up to 250,000 shares of the Company's common stock on the open market. The 250,000 shares were repurchased at an average cost of $25.44 per share. The repurchase program was completed during November of 1994.\nOn December 14, 1994, the Company's Board of Directors approved the repurchase of an additional 250,000 shares of the Company's common stock on the open market. Through December 31, 1995, the Company had not repurchased any shares under this program.\nManagement anticipates that short-term and long-term capital expenditures, cash dividends, and operating cash needs will be met from existing capital and internally generated funds. In 1994, additional funds of $9.4 million were generated from the sale of the 20% interest in a savings and loan holding company. As of December 31, 1995, the Company and its subsidiaries had no material commitments for capital expenditures. Future debt and stock issuance will be considered as additional capital needs arise. The method of funding will depend upon financial market conditions.\nThe Company's mortgage banking subsidiary, ALLIED Mortgage, has separate credit agreements to support its operations. Short-term and long-term notes payable to nonaffiliated companies are used by ALLIED Mortgage to finance its mortgage loans held for sale, to purchase servicing rights, and to purchase short-term investments. These notes payable are not guaranteed by the Company. At December 31, 1995, ALLIED Mortgage had short-term borrowings of $22.5 million, which are to be repaid through the subsequent sale of securities inventory. The amount of short-term borrowings fluctuates daily depending on the level of inventory being financed. Long-term borrowings amounted to $13.5 million to be repaid over the next nine years. See note 8 of Notes to Consolidated Financial Statements. In the normal course of its business, ALLIED Mortgage also makes commitments to buy and sell securities that may result in credit and market risk in the event the counterparty is unable to fulfill its obligation. See note 14 of Notes to Consolidated Financial Statements.\nHistorically, the Company's insurance subsidiaries have generated sufficient funds from operations to pay their claims. While the property-casualty and excess & surplus lines insurance companies have maintained adequate investment liquidity, they have in the past required additional capital contributions to support premium growth. Industry and regulatory guidelines suggest that a property-casualty insurer's annual net written premiums should not exceed approximately 300% of statutory surplus. At December 31, 1995, the property-casualty and excess & surplus lines segments' net written premiums were 171% and 110% of their statutory surplus, respectively. On February 18, 1993, 1.6 million shares of common stock were sold to the public at $24.67 per share; the Company used the net proceeds to contribute $36.1 million to the property-casualty subsidiaries and improve overall liquidity.\nThe Company relies primarily on dividends from its insurance subsidiaries to pay preferred and common stock dividends to Company stockholders. State insurance regulations restrict the maximum amount of dividends the property-casualty subsidiaries can pay without prior regulatory approval. The maximum dividend that the subsidiaries may pay without prior approval of the insurance authorities is the greater of either 10% of the subsidiary's statutory capital\nstock and surplus as of the preceding December 31 or net income of the preceding calendar year. In 1996 the maximum amount legally available for distribution to the Company without prior approval is $44.1 million.\nThe excess & surplus lines subsidiary is domiciled in Arizona and operates under Arizona state laws. The maximum amount available for distribution as dividends from the excess & surplus lines subsidiary is limited to the lesser of 10% of stockholders' surplus as of the preceding December 31 or net investment income of the pre year. The excess & surplus lines segment could pay $2.8 million in 1996 without prior notice to the insurance commissioner. The Company anticipates that the excess & surplus lines segment will not pay dividends in 1996.\nDuring 1995, the Company received dividend payments of $12 million from the property-casualty subsidiaries and $974,000 from noninsurance subsidiaries. During 1994 and 1993, the property-casualty subsidiaries made dividend payments of $7.8 million and $7.7 million, respectively, to the Company; noninsurance subsidiaries paid dividends of $1.1 million and $440,000, respectively.\nDividend payments to common stockholders totaled $6.3 million for the year ended December 31, 1995, up from $5.4 million and $4.4 million in 1994 and 1993, respectively. In 1995, 1994, and 1993, the Company paid dividends of $3.7 million, $3.8 million, and $3.9 million, respectively, on the ESOP Series. In each year, the Company paid dividends of $3.5 million on the 6-3\/4% Series preferred stock.\nAt its March 5, 1996 meeting, the Board of Directors approved a first-quarter 1996 common stock dividend of $0.22 per share for payment to holders of record on March 26. The dividend is $0.05 (29.4%) higher than the amount paid in the fourth quarter of 1995.\nOn March 7, 1996, the ESOP Trust converted its shares of the ESOP Series to approximately 4.4 million shares of common stock. The conversion increased the number of shares outstanding to 13.9 million. Paying the first-quarter 1996 common stock dividends on the new shares of common stock held by the ESOP Trust will increase the Company's dividend payments in the first quarter by $675,000. If the $0.22 rate is approved by the Board each quarter of 1996, the annual dividend payments will rise $939,000 as a result of the conversion of the ESOP Series share to common stock. The impact is greatest in the first quarter because the ESOP Trust will receive the full first-quarter dividend in addition to the ESOP Series dividend for the two months prior to the conversion.\nIn 1990, the ESOP Trust issued notes totaling $35 million (ESOP obligations) to acquire ESOP Series preferred stock for the Company's Employee Stock Ownership Plan (ESOP). In March 1995, the ESOP Trust refinanced its notes with a Term Credit Agreement and Guaranty (Agreement) with two separate commercial banks. The Company guaranteed the ESOP Trust's obligations under the Agreement. See note 9 of Notes to Consolidated Financial Statements. At December 31, 1995, the balance of the obligations was $26.3 million. Company contributions plus dividends on the ESOP Series preferred stock are used by the ESOP Trust to service the ESOP obligations. Dividends and payments for the employee lease fees from its subsidiaries are used by the Company to fund the amounts paid to the ESOP Trust. The Company made contributions to the ESOP Trust of $733,000 in 1995, $35,000 in 1994, and $54,000 in 1993. The Company paid dividends of $2.8 million in 1995, 1994, and 1993, which were used for such debt service. In connection with its ESOP guarantee of ESOP obligations, the Company is required to maintain minimum stockholders' equity and to comply with certain other financial covenants. See notes 9 and 15 of Notes to Consolidated Financial Statements.\nInsurance premiums are established before the amount of losses and loss settlement expenses, or the extent to which inflation may affect such expenses, is known. Consequently, the Company attempts to anticipate the impact of inflation in establishing premiums. Inflation is implicitly considered in the determination of reserves for losses and loss settlement expenses since portions of the reserves are expected to be paid over extended periods of time. The importance of continually reviewing reserves is even more pronounced in periods of extreme inflation.\nTHIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nManagement's Representation\nThe management of ALLIED Group, Inc. is responsible for the integrity and fair presentation of the consolidated financial statements, related notes, and all other information presented herein. The statements were prepared in accordance with generally accepted accounting principles and include amounts that are based on management's best estimates and judgements.\nManagement maintains a system of internal control designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, the prevention and detection of fraudulent financial reporting, and the appropriate division of responsibility. In addition, the Company's internal audit department systematically reviews these controls, evaluates their adequacy and effectiveness, and reports thereon. Management has considered internal audit recommendations and those of KPMG Peat Marwick LLP and has in its opinion responded appropriately to those recommendations. Management believes that as of December 31,1995 the Company's system of internal control is adequate to accomplish the objectives discussed herein.\nThe Company's financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The audit was conducted in accordance with generally accepted auditing standards, which included a consideration of the Company's system of internal control to the extent necessary to form an independent opinion on the financial statements prepared by management.\nThe audit committee of the Board of Directors, composed solely of outside directors, oversees management's discharge of its financial reporting responsibilities. The committee meets periodically with management, internal auditors, and representatives of KPMG Peat Marwick LLP to discuss auditing, financial reporting and internal control matters. Both internal and independent auditors have access to the audit committee without management's presence.\nJamie H. Shaffer President (Financial)\nIndependent Auditors' Report\nThe Board of Directors and Stockholders ALLIED Group, Inc.\nWe have audited the accompanying consolidated balance sheets of ALLIED Group, 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 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 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 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 ALLIED 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 note 1 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for investments in fixed maturities in 1993.\nKPMG Peat Marwick LLP\nDes Moines, Iowa February 2, 1996 except for note 20, which is as of March 7, 1996\nALLIED Group, Inc. and Subsidiaries Consolidated Balance Sheets (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nSee accompanying Notes to Consolidated Financial Statements.\nALLIED Group, Inc. and Subsidiaries Consolidated Statements of Income (in thousands, except per share data)\nSee accompanying Notes to Consolidated Financial Statements.\nALLIED Group, Inc. and Subsidiaries Statements of Stockholders' Equity (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nALLIED Group, Inc. and Subsidiaries Statements of Cash Flows (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nALLIED Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (dollars in thousands, except per share data)\n(1) Summary Of Significant Accounting Policies\nPrinciples of Consolidation and Basis of Presentation\nThe accompanying consolidated financial statements include the accounts of ALLIED Group, Inc. (the Company) and its property-casualty, excess & surplus lines, and noninsurance subsidiaries on a consolidated basis.\nThe Company's property-casualty segment operates through three subsidiaries: AMCO Insurance Company (AMCO), ALLIED Property and Casualty Insurance Company (ALLIED Property and Casualty), and Depositors Insurance Company (Depositors), which underwrite personal lines (primarily automobile and homeowners) and small commercial lines. The property-casualty segment operates exclusively in the United States and primarily in central and western states. Iowa and California accounted for 23.3% and 24%, respectively, of 1995 direct written premiums. The property-casualty segment markets its products through three distribution systems: independent agencies, exclusive agencies, and direct response. The property-casualty segment accounted for 85.4% of 1995 consolidated revenues.\nWestern Heritage Insurance Company (Western Heritage) is the excess & surplus lines subsidiary, which primarily underwrites commercial lines. The excess & surplus lines segment operates exclusively in the United States. In 1995 the segment accounted for 6.4% of consolidated revenues.\nThe noninsurance subsidiaries are ALLIED Group Mortgage Company (ALLIED Mortgage), Dougherty Dawkins, Inc. and subsidiaries (Dougherty Dawkins) through October 29, 1993, ALLIED Group Information Systems, Inc. (AGIS), The Freedom Group, Inc. (Freedom Group), Midwest Printing Services, Ltd., ALLIED Group Leasing Corporation, and ALLIED General Agency Company.\nAt year-end 1995 the ALLIED Group Employee Stock Ownership Trust (ESOP Trust) owned 26.9% of the outstanding voting stock of the Company. ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 18% of the voting stock of the Company.\nThe consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities. The preparation of the 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. All significant intercompany balances and transactions have been eliminated. Certain amounts in the financial statements for prior years have been reclassified to conform to the current year's presentation.\nInvestments\nIn compliance with Statement of Financial Accounting Standards (SFAS) 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" investments in fixed maturities where there is the positive intent and ability to hold to maturity are classified as held to maturity and carried at cost adjusted for amortization of premium or discount. Amortization of premiums and discounts on mortgage-backed securities incorporates a prepayment assumption to estimate the securities' expected lives. Except for declines that are other than temporary, changes in fair value are not reflected in the financial statements. Investments in fixed maturities that may be sold prior to maturity and are not bought and\nheld principally for the purpose of selling in the near term are segregated into an available for sale portfolio and are carried at fair value. Unrealized appreciation and depreciation of securities classified as available for sale are excluded from income and reported as a separate component of stockholders' equity net of deferred income taxes.\nIn conjunction with the adoption of SFAS 115 on December 31, 1993, the Company reclassified certain securities totaling $199,618 to securities available for sale from securities held to maturity. The reclassification increased stockholders' equity by $5,883 net of deferred income taxes.\nIn November of 1995, the Financial Accounting Standards Board (FASB) issued an implementation guide entitled, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities,\" which included transition guidelines that permitted the Company to reassess the appropriateness of its classification of all securities held at November 30, 1995; reassessment was to be completed no later than December 31, 1995. Prior to the deadline, the Company reclassified $359,409 of securities held to maturity to securities available for sale. The reclassification increased unrealized appreciation of investments by $7,727 net of deferred income taxes.\nThe carrying values of all investments in fixed maturities are reviewed on an ongoing basis. If this review indicates that a decline in fair value below cost is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a specific write-down is taken. Such reductions in carrying value are recognized as realized losses and charged to income. Realized gains and losses on disposition of investments are based on specific identification of the investments sold.\nEquity securities are carried at fair value with any unrealized appreciation and depreciation reported net of deferred income taxes as a separate component of stockholders' equity. All short-term investments are recorded at cost, which approximates fair value. Other investments are reported using the equity method. Other investments at December 31, 1995 and 1994 included a 20% ownership in Black Hawk Holding Company (Black Hawk), an abstract and title holding company.\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are used to hedge against well defined market and interest rate risks. The Company has entered into an interest rate swap agreement to reduce its exposure to interest rate risk associated with its guarantee of ESOP obligations. ALLIED Mortgage enters into futures, options, and cash markets to limit its exposure to market risk on mortgage loans held for sale.\nProperty-casualty and Excess & Surplus Lines\nPremiums are recognized as revenue ratably over the terms of the respective policies. Unearned premiums are calculated on the monthly pro rata basis. Amounts paid for ceded reinsurance premiums are reported as prepaid reinsurance premiums and amortized over the remaining contract period in proportion to the amount of insurance protection provided. Premiums receivable from policyholders and agents are recorded at cost less an allowance for doubtful accounts.\nPolicy acquisition costs such as commissions, premium taxes, and certain other underwriting and agency expenses that vary with and are directly related to the production of business have been deferred. Such deferred policy acquisition costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisitions costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss settlement expenses, and certain other costs expected to be incurred as the premium is earned.\nLiabilities for losses are based upon case-basis estimates of reported losses, estimates of unreported losses based upon prior experience adjusted for current trends, and estimates of losses expected to be paid under assumed reinsurance\ncontracts. Liabilities for loss settlement expenses are provided by estimating expenses expected to be incurred in settling the claims provided for in the loss reserve. Changes in estimates are reflected in current operating results (note 5).\nCeded reinsurance amounts with unaffiliated reinsurers relating to reinsurance receivables for paid and unpaid losses and loss settlement expenses and prepaid reinsurance are reported on the balance sheets on a gross basis. Amounts ceded to ALLIED Mutual relating to the affiliated reinsurance pooling agreement and the property catastrophe reinsurance agreement have not been grossed up because the contracts provide that receivables and payables may be offset upon settlement.\nThe liabilities for losses and loss settlement expenses are considered adequate to cover the ultimate cost of losses and claims incurred to date net of estimated salvage and subrogation recoverable. Since the provisions are necessarily based on estimates, the ultimate liability may be more or less than such provisions.\nNoninsurance Operations\nMortgage loans held for sale by ALLIED Mortage are reported at the lower of cost or fair value on an aggregate basis. The fair value calculation includes consideration of all open positions, outstanding commitments from investors, related fees paid, and unrealized gains and losses from open options and financial futures contracts. Loan origination fees and certain direct costs related to loan origination are deferred and recognized at the time the related loans are sold. In the normal course of business, ALLIED Mortgage protects its position in mortgages by taking positions in options, futures, and cash markets. Market risk exists in the event of fluctuations in market prices on the unhedged portions of mortgage loans held for sale and outstanding commitments.\nEffective January 1, 1995, ALLIED Mortgage adopted SFAS 122, \"Accounting for Mortgage Servicing Rights, an Amendment of FASB Statement No. 65.\" Accordingly, ALLIED Mortgage recognizes as separate assets the rights to service mortgage loans for others, whether acquired through purchases or loan originations. Capitalized mortgage servicing rights are assessed periodically for impairment based on the fair value of those rights. ALLIED Mortgage stratifies its mortgage servicing portfolio on the basis of certain risk characteristics, including loan type and note rate, and determines fair value based upon the present value of estimated future cash flows. Impairment is recognized through a valuation allowance for each impaired stratum. The total valuation allowance for capitalized mortgage servicing rights was $1,368 as of December 31, 1995. The fair value of capitalized mortgage servicing rights as of December 31, 1995 was approximately $40,186. Capitalized mortgage servicing rights are amoritzed over twelve years using the straight-line method, which management believes approximates the realization of the related net servicing income. Amortization of servicing rights for the years ended December 31, 1995, 1994, and 1993 was $4,728, $3,507, and $6,033, respectively. The adoption of SFAS 122 did not have a material effect on the financial statements. Prior to adoption of SFAS 122, the Company capitalized only the costs related to purchased mortgage servicing rights.\nDepreciation and Amortization\nEquipment and software are included in other assets at cost less accumulated depreciation and amortization. For financial reporting purposes, depreciation and amortization are provided primarily on the straight-line basis over the estimated useful lives of the assets, ranging from two to seven years. Accelerated depreciation methods are utilized for income tax purposes.\nRetirement Plan Costs\nThe amount of compensation cost related to The ALLIED Group Employee Stock Ownership Plan (ESOP) is based on the cost of the shares allocated to participants plus interest expense incurred related to the debt of the ESOP reduced by dividends paid used to service the ESOP's debt (the shares allocated\nmethod). The income tax benefit for the tax deductibility of dividends paid on unallocated shares of the ESOP available for debt service is included as a direct addition to retained earnings.\nStock-based Compensation\nThe FASB issued SFAS 123, \"Accounting for Stock-Based Compensation,\" in October of 1995. SFAS 123 specifies a fair value method of accounting for stock-based compensation plans and recognizes compensation cost over the vesting period of the option granted. An entity is permitted to determine its net income by continuing to apply Opinion 25, \"Accounting for Stock Issued to Employees,\" but must comply with the disclosure requirements of SFAS 123. SFAS 123 is required to be adopted for fiscal years beginning after December 15, 1995. The Company will adopt the disclosure requirements of SFAS 123 for the year ended December 31, 1996 but will continue to account for stock-based compensation plans under Opinion 25.\nIncome Taxes\nDeferred income taxes reflect the impact of temporary differences between the tax basis of assets and liabilities and the reported amounts of those assets and liabilities for financial reporting purposes. 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. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted.\nEarnings per Share\nPrimary earnings per share calculations are computed after net income is reduced by the amount of dividends paid on the Company's preferred stock and divided by the weighted average of common stock and common stock equivalents outstanding during the period. Securities that are in substance equivalent to common stock (primarily stock options) are referred to as common stock equivalents.\nFully diluted earnings per share calculations are based on the weighted average number of shares of common stock and common stock equivalents outstanding for a period and the assumed conversion of the ESOP Series convertible preferred stock into common stock. Net income is reduced by dividends on the 6-3\/4% Series preferred stock and by the additional costs for the ESOP resulting from the assumed replacement of the convertible preferred stock dividends with common stock dividends net of the related income taxes.\nCash Flows\nFor purposes of reporting cash flows, changes in notes payable issued by ALLIED Mortgage to purchase mortgage loans held for sale are included in cash flows from operating activities.\n(2) Fair Value of Financial Instruments\nThe estimated fair value amounts have been determined by using available market information and appropriate valuation methods. The estimates presented herein are not necessarily indicative of the amounts that would be realized in a current market exchange, and the use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe following methods and assumptions were used in estimating the fair value disclosures for financial instruments:\nFixed maturities (available for sale and held to maturity)--The estimated fair value is based upon the quoted market prices for the same or similar issues or from independent pricing services (note 3).\nEquity securities--The estimated fair value is based upon the quoted market prices where available or from independent pricing services (note 3).\nShort-term investments--Due to their short-term nature, their carrying amount approximates fair value.\nMortgage loans held for sale--The fair value is estimated using quoted market prices and includes commitments to extend credit and forward sales commitments (note 14).\nExcess servicing rights--The fair value represents the present value of estimated future servicing revenues in excess of normal servicing revenues over the assumed life of the servicing portfolio.\nNotes payable to affiliates and nonaffiliates--Due to the short maturity of the short-term notes payable, carrying value approximates fair value. The fair value of the long-term notes payable is estimated using current rates available for similar issues (notes 4 and 8).\nGuarantee of ESOP obligations--Due to its floating interest rate, the guarantee approximates its fair value (note 9).\nInterest rate swap agreement (derivative)--The fair value reflects the estimated amount the Company would pay to terminate the contract at year-end, thereby taking into account the current unrealized gains or losses of the open contract. Dealer quotes are available for the Company's derivative (note 9).\nOther financial instruments--Due to their short-term nature, their carrying amount approximates fair value.\nThe following table presents the carrying value and estimated fair value of the financial instruments at December 31, 1995 and 1994.\nThe estimated fair values presented herein are based on pertinent information available to management as of December 31, 1995 and 1994. 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 those dates; current estimates of fair value may differ significantly from the amounts presented herein.\n(3) Investments\nFollowing is a schedule of amortized costs and estimated fair values of investments in fixed maturities and equity securities as of December 31, 1995 and 1994. The estimated fair values for fixed maturities and equity securities are based on quoted market prices for the same or similar issues or from independent pricing services.\nThe table below presents the amortized cost and estimated fair value of fixed maturities at December 31, 1995 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.\nThe following table presents for the years ended December 31, 1995, 1994, and 1993 the gross realized gains and losses by portfolio included in the proceeds from calls, principal reductions, and sales of fixed maturities.\nThere were no sales or transfers from the held to maturity portfolio in 1995 and 1993. For the year ended December 31, 1994, gross realized losses of the held to maturity portfolio included a realized loss of $195 on the sale of an investment. The investment had an amortized cost of $4,937 and was disposed of due to the significant downgrade of the issuer's credit rating in 1994. Additionally, the Company sold from the held to maturity portfolio an investment with an amortized cost of $1,001 for a realized loss of $10. There were no transfers in 1994.\nAs required by law, fixed maturities and short-term investments were on deposit with various insurance regulatory authorities at December 31, 1995 and 1994 amounting to $10,487 and $10,583, respectively.\nAs of December 31, 1995 and 1994, there were no investments that were non-income producing for the previous twelve months.\nA summary of net investment income for the years ended December 31, 1995, 1994, and 1993 follows:\nA summary of net realized investment gains (losses) and net changes in unrealized appreciation (depreciation) of investments for the years ended December 31, 1995, 1994, and 1993 follows:\n(4) Transactions With Affiliates\nThe property-casualty segment and ALLIED Mutual participate in a reinsurance pooling agreement. The pooling agreement provides that AMCO (pool administrator) assumes from the pool participants premiums, losses, allocated loss settlement expenses, commissions, premium taxes, service charge income, and dividends to policyholders. Then the pool participants assume from AMCO an amount of this pooled property-casualty business equal to their participation in the pooling agreement. AMCO pays certain underwriting expenses, unallocated loss settlement expenses, and premium collection expenses for all of the pool participants and receives a fee equal to a specified percentage of premiums as well as a contingent fee based on the attainment of certain combined ratios from each of the pool participants. AMCO charges each of the participants 12.85% of written premiums for underwriting services, 7.25% of earned premiums for unallocated loss settlement expenses, and 0.75% of earned premiums for premium collection services. The administrative fees are subject to renegotiation during the term of the agreement upon at least five years' notice. AMCO received pool administrative fees of $55,721, $50,449, and $44,920 from ALLIED Mutual in 1995, 1994, and 1993, respectively. The term of the pooling agreement extends to December 31, 2004, after which it can be terminated by participating parties upon five years' notice. All changes to the pooling agreement must be approved by the coordinating committee of the Board of Directors.\nThe reinsurance pooling agreement was amended January 1, 1993 to increase the property-casualty segment's participation to 64% from 60% in 1992. ALLIED Mutual transferred cash of $16,240 to the property-casualty segment to fund the additional net underwriting liabilities assumed. The pooling agreement was also amended January 1, 1993 to change the pool administrator from ALLIED Mutual to AMCO. As a result of becoming pool administrator, AMCO assumed $9,538 in certain underwriting liabilities and received a corresponding amount of cash from ALLIED Mutual. See note 6 for discussion of reinsurance transactions between the Company's property-casualty subsidiaries and ALLIED Mutual.\nPursuant to the terms of the Intercompany Operating Agreement, the Company leases employees to its subsidiaries and ALLIED Mutual and certain of its subsidiaries. Each company that leases employees is charged a fee based upon costs incurred for salaries, related benefits, taxes, and expenses associated with the employees it leases. The Company received revenues of $2,490, $2,415, and $3,204 for employees leased to affiliates for the years ended December 31, 1995, 1994, and 1993, respectively, which are included in income from affiliates and in eliminations and other under segment information.\nThe Intercompany Operating Agreement between the Company and ALLIED Mutual also provides for the continued availability of office space, marketing services, agency forces, and computer and other facilities. Expenses are charged to the Company based on specific identification or, if undeterminable, the expenses are allocated on the basis of cost and time studies that are updated annually. The agreement extends through December 31, 2004, after which it may be terminated on two years' notice given after December 31, 2002 by either ALLIED Mutual or the Company.\nIncluded in income from affiliates are revenues of $2,795, $2,322, and $2,274 relating to data processing services provided by AGIS to ALLIED Mutual and its subsidiaries for the years ended December 31, 1995, 1994, and 1993, respectively.\nALLIED Mutual participates with a nonaffiliated reinsurance company in a property catastrophe reinsurance agreement to cover the property-casualty segment's share of pooled losses. In 1995, 1994, and 1993, the coverage was $5,000 in excess of $5,000. ALLIED Mutual's and the reinsurance company's respective participation in such agreement was 90% and 10% in 1995, 1994, and 1993. Related premiums paid by the property-casualty segment to ALLIED Mutual were $2,330 in 1995, $1,866 in 1994, and $1,478 in 1993. There were recoveries of $2,586, $2,217, and $1,400 from ALLIED Mutual in 1995, 1994, and 1993, respectively.\nAll expenses incurred on the Company's behalf by its affiliates have been reflected in the accompanying financial statements. Management believes the costs incurred by its affiliates and allocated to the Company are reasonable and would not be materially different than if they had been incurred from a nonaffiliated third party. The aforementioned transactions result in intercompany balances that are created during the normal course of business and are settled on a monthly basis.\nThe Company and its affiliates deposit their excess cash into a short-term investment fund. The fund was established to concentrate short-term cash in a single account to maximize yield. AID Finance Services, Inc., a wholly owned subsidiary of ALLIED Mutual, is the administrator of the fund. At December 31, 1995 and 1994, the Company had $7,773 and $4,021, respectively, invested in the fund. The Company also had several unsecured notes payable to the fund at December 31, 1995 totaling $3,500. Interest rates ranged from 5.9% to 8.8%, and the notes mature in January of 1996. At December 31, 1994 the Company had two unsecured notes payable to the investment fund totaling $2,000.\nThe Company paid interest to affiliates of $127, $123, and $484 in 1995, 1994, and 1993, respectively.\n(5) Losses and Loss Settlement Expenses\nThe following table sets forth the reconciliation of beginning and ending reserves for losses and loss settlement expenses for the years indicated. Reinsurance recoverables on unpaid losses and loss settlement expenses are included on the consolidated balance sheets within reinsurance receivables for losses and loss settlement expenses. The following table includes property-casualty and excess & surplus lines losses and loss settlement expense reserves.\nThe reserving process relies on the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate basis for predicting future events. Reserve amounts are necessarily based on management's informed estimates; as other data becomes available and is reviewed, these estimates and judgments are revised, resulting in increases and decreases to existing reserves. As a result of changes in estimates of insured\nevents in prior years, the provision for losses and loss settlement expenses increased $1,984 in 1995 and decreased $1,630 and $3,854 in 1994 and 1993, respectively. Development for losses and loss settlement expenses on prior years is immaterial to the financial statements taken as a whole.\nAs of January 1, 1993, the property-casualty subsidiaries' underwriting accounts were adjusted to reflect their increased participation in the pool. The property-casualty subsidiaries received cash and securities for the transfer of reserves from ALLIED Mutual as of January 1, 1993. There was no income statement effect from this transaction as the amount received was offset by the increase in the reserves. Because the reserves transferred were necessarily based upon estimates, subsequent changes in the estimates are reflected in current operating results.\nIn establishing reserves, management considers exposure the Company may have to environmental claims. Because reported claim activity levels are minimal and the emphasis of the Company's property-casualty business is primarily on personal lines and small commercial business, management believes exposure to material liability on such claims to be remote as of December 31, 1995. The Company continues to monitor legal developments as they relate to the Company's exposure to environmental claims.\n(6) Reinsurance\nThe property-casualty and excess & surplus lines subsidiaries cede insurance to other insurers in the ordinary course of business for the purpose of limiting their maximum loss exposure through diversification of their risks. See note 4 for discussion of reinsurance contracts with ALLIED Mutual. Reinsurance contracts do not relieve the Company from its obligations to policyholders as the primary insurer. 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. As of December 31, 1995, reinsurance receivables and prepaid reinsurance premiums associated with three nonaffiliated reinsurers aggregated approximately $14,675, which represented a significant portion of the total prepaid reinsurance premiums and reinsurance receivables for losses and loss settlement expenses. The property-casualty subsidiaries also assume insurance as members of various pools and associations.\nThe effect of reinsurance on premiums written and earned and losses and loss settlement expenses incurred for the years ended December 31, 1995, 1994, and 1993 was as follows:\n(7) Dispositions\nOn June 1, 1994, the Company completed the sale of its investment in MidAmerica Financial Corporation (MidAmerica) for $9,395. The 20% interest in MidAmerica was acquired for investment purposes and was reported in other investments. The pretax gain of $2,646 is included in realized investment gains for 1994 in the consolidated statements of income.\nOn October 29, 1993, the Company completed the sale of its investment banking and asset management subsidiary, Dougherty Dawkins, for $14,304. The results of operations through the closing date are reflected in the Company's consolidated income statements. The pretax loss on this transaction was $894 and is included in other expenses in the consolidated statements of income.\n(8) Notes Payable to Nonaffiliates\nThe short-term notes payable to nonaffiliated companies include line of credit agreements used by ALLIED Mortgage primarily to finance its mortgage loans held for sale. At December 31, 1995 and 1994, ALLIED Mortgage had borrowed $22,465 and $24,361, respectively, under the terms of mortgage loan warehousing agreements with three different commercial banks; the agreements expires in April and May of 1996. Under the terms of the agreements, ALLIED Mortgage can borrow up to the lesser of $67,000 or 98% of the mortgage credit borrowing base, which includes related sublines. At December 31, 1995, the outstanding borrowings of ALLIED Mortgage under these line of credit agreements were secured by mortgage loans held for sale of $13,673, mortgage servicing rights on loans with a principal balance of $2,796,696, and foreclosure loans of $3,904. Interest rates applicable to these borrowing arrangements vary with the level of investable deposits maintained at the respective commercial banks.\nDuring 1993, ALLIED Mortgage entered into an agreement with a life insurance company for $15,000 of 8.4% senior secured notes due September 1, 2004. The notes are secured by mortgage servicing rights and are payable in equal annual installments of $1,500 every September 1; interest is payable semiannually. At December 31, 1995 and 1994, the outstanding balance was $13,500 and $15,000, respectively.\nThe Federal Home Loan Bank of Des Moines provides a $3,000 committed credit facility through a line of credit agreement with AMCO that expires March 6, 1996. Interest on any outstanding borrowings is payable at an annual rate equal to the federal funds unsecured rate for federal reserve member banks. The Company had no outstanding balance as of December 31, 1995. At December 31, 1994, there was an outstanding balance of $2,180.\nThe Company paid interest to nonaffiliates of $1,569, $2,249, and $2,442 in 1995, 1994, and 1993, respectively.\n(9) Guarantee of ESOP Obligations\nOn July 12, 1990, the ESOP Trust issued Remarketed Floating Rate Notes (FRN) totaling $35,000 with a final maturity of July 12, 2005. The proceeds from the FRN were used to acquire Series A ESOP Convertible Preferred Stock. Effective March 13, 1995, the ESOP Trust refinanced its $28,150 of FRN under the terms of a Term Credit Agreement and Guaranty (Credit Agreement) with two separate commercial banks. The loans mature July 12, 2005, and interest rates applicable to the borrowings are adjusted at the beginning of each interest period. The interest periods may be one, three, or six months at the discretion of the ESOP Trust.\nThe Company has guaranteed on an unsecured basis the ESOP Trust's reimbursement obligations under the Credit Agreement. The Company's guarantee has been recorded in the consolidated balance sheets as a liability under the caption, \"Guarantee of ESOP obligations.\" At December 31, 1995 and 1994, the Company had an outstanding guarantee of principal of $26,270 and $28,150, respectively. The Company contributions to the ESOP Trust plus dividends on leveraged shares held by the ESOP Trust are used to meet interest and principal payments on the notes. As principal payments are made, the recorded ESOP guarantee is reduced.\nThe interest rate on the Credit Agreement resets at the beginning of each interest period, and the ESOP Trust's interest expense is included as a component of the Company's ESOP expense. The Company is party to an interest rate swap agreement with a broker-dealer to reduce the financial statement impact of fluctuations in the Credit Agreement interest rate. The interest rate swap transactions generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying principal amount. As of December 31, 1995, the amount of principal covered under the swap agreement was $19,760 with a fixed interest rate of 7.4%. The amount of principal covered under the swap agreement reduces over time; the final swap maturity date is December 12, 1997. During 1995, the actual Credit Agreement interest rate ranged from 6% to 6.8%. During 1994 and 1993, the actual FRN interest rates ranged from 2.9% to 6.3% and 2.8% to 3.3%, respectively. Though nonperformance of the broker-dealer is not expected, the Company is exposed to credit loss should such an event occur.\nThe Credit Agreement includes various financial and operating covenants with which the Company must comply. The covenants include the maintenance of certain contractual relationships with ALLIED Mutual, continued ownership of certain subsidiaries, limitations on the issuance of security interests in certain assets, maintenance of various financial ratios, and minimum net equity requirements.\n(10) Preferred Stock\nThe Company is authorized to issue 7,500,000 shares of preferred stock without par value. The preferred stock may be issued from time to time by the Board of Directors in one or more series with such dividend rights, conversion rights, voting rights, redemption provisions, liquidation preferences, and other rights and restrictions as the Board of Directors may determine.\n6-3\/4% Series\nThe 6-3\/4% Series preferred stock (6-3\/4% Series), issued to ALLIED Mutual at a value of $28.50 per share, is perpetual, nonconvertible, voting, and cumulative with respect to dividends. The 6-3\/4% Series has no preemptive rights and is not registered or traded. Upon any transfer by ALLIED Mutual, the 6-3\/4% Series is callable under certain conditions and becomes nonvoting. It ranks on a parity with the ESOP Series. Each share of the 6-3\/4% Series has 1-1\/2 votes. The annual dividend rate is 6-3\/4% of the liquidation preference of $28.50 ($1.92 per share) and is payable quarterly.\nThe Company entered into a Stock Rights Agreement with ALLIED Mutual to grant both parties certain rights in terms of registration, transfer, voting, board nominations, and other matters. Pursuant to the Stock Rights Agreement executed July 5, 1990, ALLIED Mutual is entitled to nominate for election to the Company's Board of Directors a number of director nominees that most closely approximates the same percentage of the total number of members of the Company's Board of Directors as is equal to ALLIED Mutual's percentage ownership of the total number of shares of Company voting stock.\nESOP Series\nAs of December 31, 1995, a commercial bank acting on behalf of the ESOP participants as the trustee for the ESOP Trust (Trustee) was the holder of 2,992,710 shares of ESOP Convertible Preferred Stock that had been issued in series (collectively, ESOP Series). In 1995, the ESOP Trust purchased 13,426 shares of Series D for $54.00 per share. In 1994 the ESOP Trust purchased 22,223 shares of ESOP Series for $37.12 per share: 9,247 shares of Series C and 12,976 shares of Series D.\nThe Trustee is entitled to vote the ESOP Series on all matters submitted to a vote of the holders of the common stock of the Company, voting together with the holders of common stock and the 6-3\/4% Series as one class. The ESOP Trust generally provides that each ESOP participant is entitled to direct the Trustee how to vote (or whether to tender or exchange) the shares of ESOP Series allocated to the participant's account. Each share of the ESOP Series is convertible into 1-1\/2 shares of common stock and has 1-1\/2 votes, subject to antidilution adjustments.\nThe ESOP Series ranks senior to the common stock as to the payment of dividends and has an annual dividend of $1.20 per share paid on a monthly basis. In the event of a liquidation of the Company, the Trustee of the ESOP Series is entitled to receive $15 per share plus accrued dividends prior to any distribution to the holders of common stock.\nThe ESOP Series is redeemable at the option of the Company any time after three years from issuance and under specified circumstances prior thereto. The redemption price is $15 per share plus a premium in the first ten years after issuance that reduces in equal annual increments from 8% in the first year to 0% in the eleventh year. The Company, solely at its discretion, has the option to issue common stock, cash, or a combination thereof for any redemption price. Upon notice of redemption, the Trustee, acting in its fiduciary capacity, may elect to convert the ESOP Series to common stock prior to redemption.\nThe ESOP Series has no preemptive rights and is not registered or traded. Upon any transfer by the Trustee, the ESOP Series is automatically converted into shares of the Company's common stock. See note 20 for discussion of the conversion of ESOP Series to common stock subsequent to year-end 1995.\n(11) Common Stock\nThe Company has reserved 750,000 shares of common stock for issuance under the ALLIED Group, Inc. Employee Stock Purchase Plan (ESPP). The ESPP is available to full-time employees who meet minimum age and service requirements. The participants in the ESPP purchase Company common stock on a monthly basis and pay 85% of the fair market value of the shares issued under the plan. During 1995, 26,498 shares were issued at a weighted average price per share of $24.59. During 1994 and 1993, 27,603 and 70,203 shares were issued at a weighted average price of $22.36 and $22.62, respectively. At December 31, 1995, 282,490 shares were available for issuance.\nThe Company has reserved 1,350,000 shares of common stock to be issued through the ALLIED Group, Inc. Dividend Reinvestment and Stock Purchase Plan. Any stockholder of record may participate in the plan and have cash dividends reinvested in additional shares of Company common stock. The plan also provides for optional cash payments. Shares of common stock purchased under the plan may be either original issue shares or open market shares, such determination to be made at the discretion of the Company. The number of shares purchased by the plan participants is based upon fair market value on the dividend payment date. During 1995, 42,705 shares, puchased on the open market, were issued at a weighted average price per share of $30.01. During 1994 and 1993, 50,305 and 35,043 shares were issued at the weighted average prices per share of $26.06 and $27.39, respectively. At December 31, 1995, 626,941 shares were available for issuance.\nThe Company has reserved 375,000 shares of common stock for issuance under the ALLIED Group, Inc. Outside Director Stock Purchase Plan. Under the plan, participants pay 85% of the fair value of the shares issued and the remainder is paid proportionally by the Company and\/or the other companies within the ALLIED Group to which the director fees were allocated. Only nonemployee directors of the Company and its affiliates may participate in this plan. Shares of common stock may be purchased only on the purchase dates: the last business day of June and December. During 1995, 4,197 shares were issued at a weighted average price per share of $31.75. During 1994 and 1993, 5,231 and 4,530 shares were issued at a weighted average price of $24.85 and $24.98, respectively. At December 31, 1995, 355,816 shares were available for issuance.\nThe Company has reserved 250,000 shares of common stock for issuance under the ALLIED Life Employee Stock Purchase Plan. The Company receives fair market value for the shares issued under the plan. During 1995, 2,005 shares were issued at a weighted average price per share of $28.76. During 1994 and 1993, 309 and 47 shares were issued at a weighted average price per share of $26.30 and $26.44, respectively. At December 31, 1995, 247,639 shares were available for issuance.\nThe Company awarded 13,311 shares of restricted stock to key employees, and 406 of such shares were cancelled in 1995. The restricted shares were awarded under the ALLIED Group, Inc. Long-Term Management Incentive Plan (note 12).\nDuring 1994, the Company repurchased and cancelled 250,000 shares of its common stock on the open market at an average cost of $25.44 per share. The repurchase was approved by the Board of Directors in the first quarter of 1994, implemented pursuant to Rule 10b-18 under the Securities Exchange Act of 1934, and completed on November 17, 1994.\nOn December 14, 1994, the Company's Board of Directors approved a plan to repurchase 250,000 shares of the Company's common stock on the open market also pursuant to Rule 10b-18. The actual number of shares repurchased is dependent upon market conditions, and the plan may be suspended at the Company's discretion. The Company has no present intention to cause its shares to be delisted or deregistered as a result of this repurchase program. The Company did not repurchase any shares under this plan through December 31, 1995.\nDuring 1995, 1994, and 1993, 174,960, 110,956, and 94,124 ESOP Series shares were converted to 262,440, 166,434, and 141,186 shares of common stock, respectively. The Company has reserved 5,950,524 shares of common stock for conversion of the ESOP Series.\nOn February 18, 1993, 2,587,500 shares of common stock were sold to the public at $24.67 per share. The Company received $37,600 in proceeds (net of underwriting discount and expenses) from the sale of 1,612,500 shares. The remaining 975,000 shares were sold by ALLIED Mutual.\nThe dividend rate per common share was $0.68, $0.60, and $0.51 for 1995, 1994, and 1993, respectively.\n(12) Long-Term Incentive Plans\nThe ALLIED Group, Inc. Restated and Amended Stock Option Plan (Option Plan) and the ALLIED Group, Inc. Nonqualified Stock Option Plan (Nonqualified Plan) had 675,000 and 225,000 shares of common stock, respectively, reserved for issuance to certain key employees of ALLIED Group, Inc. and subsidiaries. Both plans are nonqualified stock option plans as defined by the Internal Revenue Code. The period for granting options under these plans expired on August 5, 1995. During 1995, 30,000 and 40,000 options were granted under the Option Plan and the Nonqualified Plan, respectively, at an exercise price of $27.50 per share. The options expire ten years after the date of grant. During 1995, 33,135 shares were deregistered under the Nonqualified Plan.\nThe Company deregistered 103,955 shares under the ALLIED Group Executive Equity Incentive Plan (Equity Plan) during 1994. The Company had reserved 525,000 shares of common stock for issuance under the terms of the Equity Plan. The Equity Plan is a nonqualified stock option plan as defined by the Internal Revenue Code, with eligibility granted only to certain key employees of the Company and its affiliated companies. The optionees pay $0.67 of the per share option price upon exercise; the balance of the exercise price is paid by the company that leases the employee. At December 31, 1995, 14,460 options were outstanding and exercisable under the Equity Plan. There are no shares available to grant any additional options under the Equity Plan, and the options currently outstanding expire on December 31, 1997.\nUnder the Freedom Group Incentive Plan (Freedom Plan), the Company had reserved 270,000 shares of authorized but unissued common stock. The Freedom Plan is a nonqualified stock option plan as defined by the Internal Revenue Code. Three key employees were granted options to purchase up to 270,000 shares of the Company's common stock. The optionees pay $0.67 of the per share option price upon exercise; the balance of the exercise price is to be paid by Freedom Group. On April 30, 1993, the participants were vested in 54,000 stock options and the remaining 216,000 unvested shares were deregistered. At year-end 1995, 18,000 vested options remained unexercised.\nDuring 1994, the Company reserved 600,000 shares of common stock for issuance to key employees of the Company and its affiliates under the ALLIED Group, Inc. Long-Term Management Incentive Plan (Incentive Plan). Under the Incentive Plan,\nshares of common stock are available for grant until December 31, 2003 as incentive and nonqualified stock options (collectively, Options), stock appreciation rights (SARs), and restricted stock. The Options, SARs, and restricted stock were issued to vest two years after the grant date at a rate of 25% per year and expire ten years after the date of grant. Options, SARs, and restricted stock prices are based upon the fair market value as of the date of grant. During 1995, 60,000 Options and 7,667 SARs were granted at $27.63 per share. At December 31, 1995, 452,522 shares were available for award under the Incentive Plan.\nA summary of the status of the Company's stock option plans as of December 31, 1995, 1994, and 1993 and changes during the years ending on those dates is presented below:\nThe issuance of SARs and restricted stock under the Incentive Plan reduces the number of Options available for future issuance. During 1995, 13,311 shares of restricted stock were awarded at $27.38 per share, and 406 restricted shares were cancelled. At December 31, 1995, 12,671 restricted shares were outstanding. The following table shows SAR activity for the years ended December 31, 1995 and 1994:\n(13) Retained Earnings\nRetained earnings of the property-casualty and excess & surplus lines subsidiaries available for distribution as dividends are limited by law to the amount of statutory unassigned surplus as of the date the dividend is authorized or paid. The maximum dividend the property-casualty subsidiaries may pay without prior approval of the state of Iowa (state of domicile) insurance regulatory authorities is the greater of either 10% of the property-casualty statutory capital stock and surplus as of the preceding December 31 or statutory net income of the preceding calendar year. The amount legally available for distribution from the property-casualty segment in 1996 to the Company without regulatory approval is $44,121. The maximum dividend the excess & surplus lines subsidiary may pay without prior approval of the state of Arizona (state of domicile) insurance regulatory authorities is the lesser of either 10% of the statutory capital stock and surplus as of the preceding year or net investment income of the preceding year. The maximum amount legally available for distribution in 1996 without regulatory approval is $2,777.\nThe following table includes selected information for the Company's insurance subsidiaries as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities:\n(14) Commitments and Contingent Liabilities\nThe Company leases data processing equipment and certain office facilities under operating leases expiring in various years through 2003. Rental expense amounted to $2,587, $3,845, and $3,817 for the years ended December 31, 1995, 1994, and 1993, respectively. For each of the next five years and in the aggregate as of December 31, 1995, these are the minimum future rental payments under noncancellable operating leases having remaining terms in excess of one year:\nIn the normal course of business, ALLIED Mortgage grants mortgage loan commitments to borrowers, subject to normal loan underwriting standards. As of December 31, 1995, ALLIED Mortgage had granted loan commitments of approximately $39,500, including floating rate commitments of $12,600. To hedge loan commitments, ALLIED Mortgage may enter into options, futures, or cash delivery\ncontracts. As of December 31, 1995, ALLIED Mortgage had commitments to sell mortgage securities totaling approximately $27,000 and no outstanding options. In connection with these commitments to buy and sell mortgages, ALLIED Mortgage is exposed to credit risk in the event the counterparty is unable to fulfill its contractual obligations.\nAlthough loans serviced for others are not on the accompanying balance sheets, ALLIED Mortgage does have credit risk associated with the mortgage servicing portfolio. As the loan servicer, ALLIED Mortgage is required to process delinquent loans through the foreclosure process, thereby incurring certain direct expenses which generally are, but may not be, reimbursed. At December 31, 1995, ALLIED Mortgage had sold loans totaling approximately $20,500 while retaining recourse risk. ALLIED Mortgage established allowances for losses in connection with these various risks, which totaled $1,476 and $1,495 at December 31, 1995 and 1994, respectively. These allowances are included in other liabilities on the accompanying balance sheets.\nCalifornia was the source of 24% of the pool's direct written premiums in 1995. Proposition 103, approved by California voters in 1988, provides for a rollback of rates on premiums collected in calendar year 1989 to the extent that the insurer's return on equity for each Proposition 103 line exceeded 10%. Since it was passed, Proposition 103 has been the subject of a number of legal and regulatory proceedings for the purpose of clarifying the scope and extent of insurers' rollback obligations. Management of the Company continues to believe that the insurance subsidiaries will not be liable for any material rollback of premiums.\nThe Company is party to various lawsuits arising in the normal course of business. Management believes the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations.\n(15) Employee Retirement Plan\nThe ESOP established by ALLIED Group, Inc. covers all of its employees who meet age and service requirements. Shares of ESOP Series preferred stock are allocated annually to each employee's account pursuant to a formula and held in trust until the employee's termination, retirement, or death. As shares of ESOP Series preferred stock are allocated to participants, the cost of such shares is expensed and deducted from \"Unearned compensation related to ESOP\" included in stockholders' equity.\nThe Company's ESOP expense was $2,682 in 1995, $1,780 in 1994, and $1,529 in 1993. Of those respective amounts, $65, $30, and $37 were included in the employee lease fee received from affiliates pursuant to the terms of the Intercompany Operating Agreement for the years ended December 31, 1995, 1994, and 1993, respectively.\nDuring 1995, 1994, and 1993, the ESOP Trust received $2,782, $2,782, and $2,783, respectively, from dividends on the ESOP Series used to service debt on the ESOP obligations and to purchase stock for participants. ALLIED Group, Inc. made ESOP contributions of $733 in 1995, $35 in 1994, and $54 in 1993. Interest incurred on the ESOP debt, which is included as a component of ESOP expense, was $1,831, $1,225, and $918 in 1995, 1994, and 1993, respectively. The ESOP shares as of December 31, 1995 and 1994 were as follows:\n(16) Other Postretirement Benefit Plan\nIn addition to the ESOP, the Company sponsors a health care plan that provides postretirement medical benefits to full-time employees who meet age and service requirements. The plan is contributory with retiree contributions adjusted annually, and it contains other cost-sharing features such as deductibles and coinsurance. The Company's policy is to fund the cost of medical benefits in amounts determined at the discretion of management.\nThe following table presents the plan's postretirement benefit obligations as of December 31, 1995 and 1994 reconciled with the plan's funded status and the amount recognized in the Company's consolidated balance sheets:\nA 7.5% weighted average discount rate was used to determine the accumulated postretirement benefit obligation at December 31, 1995 and 1994.\nNet periodic postretirement benefit cost for the years ended December 31, 1995, 1994, and 1993 included the following:\nFor measurement purposes, a 9% annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was assumed for 1996; the rate was assumed to decrease in equal annual increments to 5% by the year 2000 and to remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by approximately $430 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by approximately $40.\n(17) Income Taxes\nTotal income taxes for the years ended December 31, 1995, 1994, and 1993 were allocated as follows:\nThe tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 relate to the following:\nSince adoption of SFAS 109 on January 1, 1993, there has not been a valuation allowance for deferred income tax assets. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will 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 primarily tax planning strategies and the scheduled reversal of deferred tax liabilities in making this assessment and believes it is more likely than not the Company ultimately will realize the benefits of the deductible differences recognized at December 31, 1995.\nThe actual income tax expense for the years ended December 31, 1995, 1994, and 1993 differed from the expected tax expense (computed by applying the federal corporate tax rate of 35% to income before income taxes). The difference was primarily a result of investment income exempt from federal income tax, which decreased tax expense by $4,504, $4,630, and $3,445 in 1995, 1994, and 1993, respectively.\nIncluded in income tax expense is state income tax expense of $402, $456, and $956 for the years ended December 31, 1995, 1994, and 1993, respectively. The Company paid federal and state income taxes of $19,117, $16,702, and $14,525 in 1995, 1994, and 1993, respectively.\nThe IRS is currently examining the 1992 income tax return. Any proposed adjustments are not expected to have a material impact on the Company's financial condition or results of operations.\n(18) Segment Information\nThe Company's operations include two major segments: property-casualty and excess & surplus lines. Their principal products, services, revenues, income before income taxes, assets, depreciation and amortization, and capital expenditures are identified by segment.\nProperty-casualty--Predominantly private passenger automobile, homeowners, and small commercial lines of insurance.\nExcess & surplus lines--Primarily commercial casualty and commercial property lines of insurance coverages that standard insurers are unable or unwilling to provide.\nEliminations and other--Eliminations between segments plus other noninsurance operations not reported as segments (including investment services, data processing, and employee lease fees from affiliates).\n(1) Including realized investment gains or losses.\n(2) Including the results of Dougherty Dawkins' operations through the sale date of October 29, 1993. Its results are also reflected in the Company's consolidated income statements. The loss on the sale is reported in eliminations and other.\n(19) Unaudited Interim Financial Information\nCaution should be exercised in comparing the results of consecutive quarters.\n(20) Subsequent Event\nOn March 7, 1996, the ESOP Trust converted all of its shares of ESOP Series to 4,402,797 shares of common stock. The conversion increased the number of common shares outstanding to approximately 13,949,000 shares.\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 under the caption \"Directors and Executive Officers\" in the 1996 Proxy Statement is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information under the caption \"Compensation of Executive Officers\" in the 1996 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 Directors and Executive Officers\" in the 1996 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 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) List of Financial Statements and Schedules.\nForm 10-K Page(s) ---------\n1. Financial Statements.\nIndependent Auditors' Report. 31\nConsolidated Balance Sheets as of December 31, 1995 and 1994. 32 to 33\nConsolidated Statements of Income for the Years ended December 31, 1995, 1994 and 1993. 34\nStatements of Stockholders' Equity for the Years ended December 31, 1995, 1994 and 1993. 35\nConsolidated Statements of Cash Flows for the Years ended December 31, 1995, 1994 and 1993. 36\nNotes to Consolidated Financial Statements. 37 to 59\n2. Schedules.\nReport of Independent Auditors on Schedules. 68\nI - Summary of Investments-Other Than Investments in Related Parties. 69\nII - Condensed Financial Information of Registrant 70 to 73\nIII - Supplementary Insurance Information. 74\nIV - Reinsurance. 75\nVI - Supplemental Information. 76\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.\n3. Executive Compensation Plans and Arrangements.\nLong-term Management Incentive Compensation Plan for 1991 (Incorporated by reference to Exhibit 10.3 to the Company's September 30, 1993 Form 10-Q on file with the Commission), Exhibit 10.3.\nLong-term Management Incentive Compensation Plan for 1992 (Incorporated by reference to Exhibit 10.4 to the Company's September 30, 1993 Form 10-Q on file with the Commission), Exhibit 10.4.\nShort-term and Long-term Management Incentive Compensation Plans for 1993 (Incorporated by reference to Exhibit 10.5 to the Company's September 30, 1993 Form 10-Q on file with the Commission), Exhibit 10.5.\nALLIED Group, Inc. Restated and Amended Stock Option Plan (Incorporated by reference to Exhibit 10.19 to the Company's December 31, 1992 Form 10-K on file with the Commission), Exhibit 10.18.\nALLIED Group, Inc. Nonqualified Stock Option Plan (Incorporated by reference to Exhibit 10.20 to the Company's December 31, 1992 Form 10-K on file with the Commission), Exhibit 10.19.\nALLIED Group, Inc. Outside Director Stock Purchase Plan (Incorporated by reference to Exhibit 10.21 to the Company's December 31, 1992 Form 10-K on file with the Commission), Exhibit 10.20.\nALLIED Group, Inc. Executive Equity Incentive Plan (Incorporated by reference to Exhibit 10.22 to the Company's December 31, 1992 Form 10-K on file with the Commission), Exhibit 10.21.\nThe ALLIED Group Employee Stock Ownership Plan, Amended and Restated, dated September 27, 1994 (Incorporated by reference to Exhibit 10.27 to the Company's September 30, 1994 Form 10-Q on file with the Commission), Exhibit 10.27.\nFirst Amendment to The ALLIED Group Employee Stock Ownership Plan, dated March 7, 1995 (Incorporated by reference to Exhibit 10.50 to the Company's March 31, 1995 Form 10-Q on file with the Commission), 10.29.\nSecond Amendment to The ALLIED Group Employee Stock Ownership Plan, dated May 15, 1995 (Incorporated by reference to Exhibit 10.51 to the Company's June 30, 1995 Form 10-Q on file with the Commission), 10.30.\nALLIED Group Mortgage Company Nonqualified Stock Option Plan (Incorporated by reference to Exhibit 10.28 of the Company's Registration Statement on Form S-3 filed with the Commission on February 2, 1993, Registration No. 33-55714), Exhibit 10.35.\nShort-term Management Incentive Plans for 1993 (Incorporated by reference to Exhibit 10.39 to the Company's December 31, 1993 Form 10-K on file with the Commission), Exhibit 10.39.\nALLIED Group Short Term Management Incentive Plan for 1994 (Incorporated by reference to Exhibit 10.40 to the Company's June 30, 1994 Form 10-Q on file with the Commission), Exhibit 10.40.\nALLIED Group, Inc. Long-Term Management Incentive Plan (Incorporated by reference to Exhibit 10.42 to the Company's March 31, 1994 Form 10-Q on file with the Commission), Exhibit 10.42.\nConsulting Agreement between John E. Evans and ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation (Incorporated by reference to Exhibit 10.48 to the Company's December 31, 1994 Form 10-K on file with the Commission), Exhibit 10.48.\nALLIED Group Short Term Management Incentive Plan for 1995 (Incorporated by reference to Exhibit 10.49 to the Company's December 31, 1994 Form 10-K on file with the Commission), Exhibit 10.49.\nALLIED Group Short Term Management Incentive Plan for 1996, Exhibit 10.52.\n(b) Reports on Form 8-K.\nNone.\n(c) Exhibits.\nNOTE: See \"Index to Exhibits\" on page number 78, which discloses the specific page numbers for the exhibits included in this Form 10-K.\n2. Plan of acquisition, reorganization, arrangement, liquidation or succession.\n2.2 Stock Rights Agreement between ALLIED Mutual Insurance Company and ALLIED Group, Inc. dated July 5, 1990 (Incorporated by reference to Exhibit 2.4 to the Company's July 1, 1990 Form 8-K on file with the Commission).\n2.3 First Amendment to Stock Rights Agreement between ALLIED Mutual Insurance Company and ALLIED Group, Inc. (Incorporated by reference to Exhibit 2.5 to the Company's September 30, 1992 Form 10-Q on file with the Commission).\n3. Articles of incorporation and bylaws.\n3.1 Amended and Restated Articles of Incorporation of the Company as of December 22, 1989 (Incorporated by reference to Exhibit 3.1 to the Company's December 31, 1989 Form 10-K on file with the Commission).\n3.2 Articles of Amendment dated May 26, 1993 of the Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3.10 of the Company's June 30, 1993 From 10-Q on file with the Commission).\n3.3 Bylaws of the Company as of July 9, 1991 (Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-2 filed with the Commission on July 9, 1991, Registration No. 33-40995).\n3.4 Amendment to Bylaws of the Company as of March 3, 1992 (Incorporated by reference to Exhibit 3.6 to Company's December 31, 1992 Form 10-K on file with the Commission).\n3.5 Amendment to Bylaws of the Company as of October 14, 1993 (Incorporated by reference to Exhibit 3.5 to Company's December 31, 1993 Form 10-K on file with the Commission).\n3.6 Certificate of Designations, defining the rights of holders of Series A ESOP Convertible Preferred Stock of ALLIED Group, Inc. (Incorporated by reference to Exhibit 4.1 to the Company's July 1, 1990 Form 8-K on file with the Commission).\n3.7 Certificate of Designations, defining the rights of holders of Series B ESOP Convertible Preferred Stock of ALLIED Group, Inc. (Incorporated by reference to Exhibit 4.3 to the Company's December 31, 1990 Form 10-K on file with the Commission).\n3.9 Certificate of Designations, defining the rights of holders of 6-3\/4% Series Preferred Stock of ALLIED Group, Inc. (Incorporated by reference to Exhibit 3.7 to Company's November 2, 1992 Form 8-K on file with the Commission).\n3.10 Certificate of Designations, defining the rights of holders of Series D ESOP Convertible Preferred Stock of ALLIED Group, Inc. (Incorporated by reference to Exhibit 3.8 to the Company's Registration Statement on Form S-3 filed with the Commission on February 2, 1993, Registration No. 33-55714).\n3.11 Articles of Correction for the Certificate of Designations defining the rights of holders of Series D ESOP Convertible Preferred Stock of ALLIED Group, Inc. (Incorporated by reference to Exhibit 3.9 to the Company's Registration Statement on Form S-3 filed with the Commission on February 9, 1993, Registration No. 33-55714).\n3.12 Amendment to Bylaws of the Company as of December 14, 1994, (Incorporated by reference to Exhibit 3.12 to the Company's December 31, 1994 Form 10-K on file with the Commission).\n4. Instruments defining the rights of security holders including indentures.\n4.6 Stock Purchase Agreement between ALLIED Group, Inc. and State Street Bank and Trust Company, dated December 31, 1993 (Incorporated by reference to Exhibit 4.6 of the Company's December 31, 1993 Form 10-K on file with the Commission).\n4.7 Agreement between ALLIED Group, Inc. and State Street Bank and Trust Company, dated March 7, 1996.\n4.8 Stock Purchase Agreement between ALLIED Group, Inc. and State Street Bank and Trust Company dated December 30, 1994.\n4.9 Stock Purchase Agreement between ALLIED Group, Inc. and State Street Bank and Trust Company dated December 29, 1995.\n10. Material contracts.\n10.3 Long-term Management Incentive Compensation Plan for 1991 (Incorporated by reference to Exhibit 10.3 to the Company's September 30, 1993 Form 10-Q on file with the Commission).\n10.4 Long-term Management Incentive Compensation Plan for 1992 (Incorporated by reference to Exhibit 10.4 to the Company's September 30, 1993 Form 10-Q on file with the Commission).\n10.5 Short-term and Long-term Management Incentive Compensation Plans for 1993 (Incorporated by reference to Exhibit 10.5 to the Company's September 30, 1993 Form 10-Q on file with the Commission).\n10.7 Amended and Restated Management Information Services Agreement between ALLIED Group Information Systems, Inc. and certain of its affiliated companies.\n10.10 Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and certain of its affiliated companies (Incorporated by reference to Exhibit 10.7 to the Company's December 31, 1989 Form 10-K on file with the Commission).\n10.11 Amendment to Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and certain of its affiliated companies as of March 28, 1990 (Incorporated by reference to Exhibit 10.11 to the Company's March 31, 1990 Form 10-Q on file with the Commission).\n10.12 Amendment to Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and the Company's property-casualty insurance subsidiaries (Incorporated by reference to Exhibit 10.19 to the Company's December 31, 1991 Form 10-K on file with the Commission).\n10.13 Fourth Amendment to Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and the Company's property-casualty insurance subsidiaries (Incorporated by reference to Exhibit 10.33 to the Company's September 30, 1992 Form 10-Q on file with the Commission).\n10.14 Second Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and the Company's property-casualty insurance subsidiaries (Incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-3 filed with the Commission on December 15, 1992, Registration No. 33-55714).\n10.15 First Amendment to the Second Amended and Restated Reinsurance Pooling Agreement between ALLIED Mutual Insurance Company and the Company's property-casualty insurance subsidiaries (Incorporated by reference to Exhibit 10.43 to the Company's March 31, 1993 Form 10-Q on file with the Commission).\n10.16 Amended and Restated ALLIED Group Intercompany Operating Agreement between the Company and its affiliated companies dated August 25, 1993 and amendment thereto dated November 1, 1993 (Incorporated by reference to Exhibit 10.14 to the Company's September 30, 1993 Form 10-Q on file with the Commission).\n10.17 ALLIED Group, Inc. Federal Income Tax Sharing Agreement.\n10.18 ALLIED Group, Inc. Restated and Amended Stock Option Plan (Incorporated by reference to Exhibit 10.19 to the Company's December 31, 1992 Form 10-K on file with the Commission).\n10.19 ALLIED Group, Inc. Nonqualified Stock Option Plan (Incorporated by reference to Exhibit 10.20 to the Company's December 31, 1992 Form 10-K on file with the Commission).\n10.20 ALLIED Group, Inc. Outside Director Stock Purchase Plan (Incorporated by reference to Exhibit 10.21 to the Company's December 31, 1992 Form 10-K on file with the Commission).\n10.21 ALLIED Group, Inc. Executive Equity Incentive Plan (Incorporated by reference to Exhibit 10.22 to the Company's December 31, 1992 Form 10-K on file with the Commission).\n10.22 Agency Agreement between ALLIED Group Insurance Marketing Company and Depositors Insurance Company, AMCO Insurance Company, and ALLIED Property and Casualty Insurance Company (Incorporated by reference to Exhibit 10.17 to the Company's December 31, 1991 Form 10-K on file with the Commission).\n10.27 The ALLIED Group Employee Stock Ownership Plan, Amended and Restated, dated September 27, 1994 (Incorporated by reference to Exhibit 10.27 to the Company's September 30, 1994 Form 10-Q on file with the Commission).\n10.28 The ALLIED Group Employee Stock Ownership Trust (Incorporated by reference to Exhibit 10.27 to the Company's March 31, 1991 Form 10-Q on file with the Commission).\n10.29 First Amendment to The ALLIED Group Employee Stock Ownership Plan, dated March 7, 1995 (Incorporated by reference to Exhibit 10.50 to the Company's March 31, 1995 Form 10-Q on file with the Commission).\n10.30 Second Amendment to The ALLIED Group Employee Stock Ownership Plan, dated May 15,1995 (Incorporated by reference to Exhibit 10.51 to the Company's June 30, 1995 Form 10-Q on file with the Commission).\n10.32 Term Credit Agreement and Guaranty between ALLIED Group, Inc., ALLIED Group Employee Ownership Trust, Bank of Montreal, and Norwest Bank Iowa, N.A. (Incorporated by reference to Exhibit 10.29 to the Company's March 31, 1995 Form 10-Q on file with the Commission).\n10.33 First Amendment to the Term Credit Agreement and Guaranty, dated October 12, 1995. (Incorporated by reference to Exhibit 10.30 to the Company's September 30, 1995 Form 10-Q on file with the Commission).\n10.35 ALLIED Group Mortgage Company Nonqualified Stock Option Plan (Incorporated by reference to Exhibit 10.28 of the Company's Registration Statement on Form S-3 filed with the Commission on February 2, 1993, Registration No. 33-55714).\n10.37 Stock Purchase Agreement between ALLIED Group, Inc. and Michael E. Dougherty and Dougherty Dawkins, Inc. (Incorporated by reference to Exhibit 10.38 to the Company's June 30, 1993 Form 10-Q on file with the Commission).\n10.38 The ALLIED Group Marketing Agreement between the Company's property-casualty subsidiaries and certain of its affiliated companies dated August 25, 1993 and amendment thereto dated November 1, 1993 (Incorporated by reference to Exhibit 10.39 to the Companies September 30, 1993 Form 10-Q on file with the Commission).\n10.39 Short-term Management Incentive Plan for 1993 (Incorporated by reference to Exhibit 10.39 to the Company's December 31, 1993 Form 10-K on file with the Commission).\n10.40 ALLIED Group Short Term Management Incentive Plan for 1994 (Incorporated by reference to Exhibit 10.40 to the Company's June 30, 1994 Form 10-Q on file with the Commission).\n10.42 ALLIED Group, Inc. Long-Term Management Incentive Plan (Incorporated by reference to Exhibit 10.42 to the Company's March 31, 1994 Form 10-Q on file with the Commission).\n10.44 Second Amendment to Amended and Restated ALLIED Group Intercompany Operating Agreement dated May 16, 1994 (Incorporated by reference to Exhibit 10.42 to the Company's June 30, 1994 Form 10-Q on file with the Commission).\n10.45 Second Amendment to the ALLIED Group Marketing Agreement between the Company's property-casualty subsidiaries and certain of its affiliated companies, dated August 25, 1994 (Incorporated by reference to Exhibit 10.45 to the Company's September 30, 1994 Form 10-Q on file with the Commission).\n10.46 Third Amendment to Amended and Restated ALLIED Group Intercompany Operating Agreement (Incorporated by reference to Exhibit 10.46 to the Company's December 31, 1994 Form 10-K on file with the Commission).\n10.47 Second Amendment to Amended and Restated Reinsurance Pooling Agreement (Incorporated by reference to Exhibit 10.47 to the Company's December 31, 1994 Form 10-K on file with the Commission).\n10.48 Consulting Agreement between John E. Evans and ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation (Incorporated by reference to Exhibit 10.48 to the Company's December 31, 1994 Form 10-K on file with the Commission).\n10.49 ALLIED Group Short Term Management Incentive Plan for 1995 (Incorporated by reference to Exhibit 10.49 to the Company's December 31, 1994 Form 10-K on file with the Commission).\n10.50 Intercompany Cash Concentration Fund Agreement, dated April 24, 1995 (Incorporated by reference to Exhibit 10.52 to the Company's June 30, 1995 Form 10-Q on file with the Commission)\n10.51 Amendment to the Nonqualified Stock Option Plan, dated October 20, 1995 (Incorporated by reference to Exhibit 10.53 to the Company's September 30, 1995 Form 10-Q on file with the Commission).\n10.52 ALLIED Group Short Term Management Incentive Plan for 1996.\n10.53 Property Special Catastrophe Excess Contract.\n11. Statement re computation of per share earnings.\n21. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n27. Financial Data Schedule\n28P. Information from Reports Furnished to State Insurance Regulatory Authorities.\n(d) Financial Statements required by Regulation S-X which are excluded from the Annual Report to Stockholders by Rule 14a-3(b)(1).\nNone.\nREPORT OF INDEPENDENT AUDITORS ON SCHEDULES\nThe Board of Directors and Stockholders ALLIED Group, Inc.:\nUnder date of February 2, 1996 we reported on the consolidated balance sheets of ALLIED Group, 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 years in the three-year period ended December 31, 1995, as contained in the 1995 Annual Report. As reported in Note 1 to the consolidated financial statements, the Company changed its method of accounting for investments in 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedules listed in Part IV, 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.\nKPMG Peat Marwick LLP\nDes Moines, Iowa February 2, 1996\nALLIED Group, Inc. and Subsidiaries SCHEDULE I SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1995\nALLIED Group, Inc. and Subsidiaries SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS December 31, 1995 and 1994\nSee accompanying Notes to Condensed Financial Statements\nALLIED Group, Inc. and Subsidiaries SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENTS OF INCOME Years ended December 31, 1995, 1994, and 1993\nSee accompanying Notes to Condensed Financial Statements.\nALLIED Group, Inc. and Subsidiaries SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994, and 1993\nSee accompanying Notes to Condensed Financial Statements.\nALLIED Group, Inc. and Subsidiaries SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) NOTES TO CONDENSED FINANCIAL STATEMENTS\nThe accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of ALLIED Group, Inc. and its subsidiaries.\n(1) The Company's investment in subsidiaries, undistributed earnings of subsidiaries, and dividends received from subsidiaries are shown by segment below:\nALLIED Group, Inc. and Subsidiaries\nSCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION\nYears ended December 31, 1995, 1994, and 1993\nALLIED Group, Inc. and Subsidiaries SCHEDULE IV REINSURANCE Years ended December 31, 1995, 1994, and 1993\n(1) See note 6 of Notes to Consolidated Financial Statements for additional information on amounts assumed from ALLIED Mutual Insurance Company in accordance with the affiliated reinsurance pooling agreement.\nALLIED Group, Inc. and Subsidiaries SCHEDULE VI SUPPLEMENTAL INFORMATION Years ended December 31, 1995, 1994, and 1993\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nALLIED Group, Inc. (Registrant)\nDate: March 5, 1996 By \/s\/ Jamie H. Shaffer ------------------------------------- Jamie H. Shaffer (Principal Financial Officer and Principal Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on the dates indicated.\nALLIED Group, Inc. and Subsidiaries\nINDEX TO EXHIBITS","section_15":""}
{"filename":"350745_1995.txt","cik":"350745","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 November 7, 1980. The General Partners of Registrant are W.P. Carey & Co., Inc. (the \"Corporate General Partner\" or \"W.P. Carey\") and William Polk Carey (the \"Individual General Partner\"). The Corporate General Partner, the Individual General Partner and\/or affiliates 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 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 7 - a California limited partnership (\"CPA(R):7\"), 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\"), 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\"). Registrant has a management agreement with Carey Corporate 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 July 31, 1981, as supplemented by Supplements dated December 9, 1981, January 8, 1982 and February 10, 1982, filed pursuant to Rules 424(b) and 424(c) 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 only one industry segment which consists of the investment in and the leasing of industrial and commercial real estate. See Selected Financial Data in Item 6 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 Properties in Item 2.","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings. -----------------\nOn April 1, 1993, New Valley Corporation, (\"New Valley\"), a tenant of a property owned by Registrant and formerly a tenant of two other of Registrant's properties, filed a petition of voluntary bankruptcy seeking reorganization under Chapter 11 of the United States Bankruptcy Code. In connection with the filings, Registrant and Corporate Property Associates 2, which together own the properties as tenants-in-common, filed a bankruptcy claim in the amount of $6,766,904. New Valley is contesting the claims and Registrant and New Valley are now in litigation regarding this claim. The matter is expected to go to trial in May of 1996. No prediction regarding the outcome of this litigation can be made at this time.\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 22 of Registrant's Annual Report contained in Appendix A.\nItem 6.","section_6":"Item 6. Selected Financial Data. ------------------------ Selected 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.\nManagement'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. Financial Statements and Supplementary Data. --------------------------------------------\nThe following financial statements and supplementary data are hereby incorporated by reference to pages 5 to 18 of Registrant's Annual Report contained in Appendix A:\n(i) Report of Independent Accountants. (ii) Balance Sheets as of December 31, 1994 and 1995. (iii) Statements of Income for the years ended December 31, 1993, 1994 and 1995. (iv) Statements of Partners' Capital for the years ended December 31, 1993, 1994 and 1995. (v) Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995. (vi) Notes to Financial Statements.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. ----------------------------------------------------- NONE\n- 6 -\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. ---------------------------------------------------\nRegistrant has no officers or directors. The executive officers and directors 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- 7 -\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 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.\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- 8 -\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.\nItem 11.","section_11":"Item 11. Executive Compensation. -----------------------\nUnder the Amended Agreement of Limited Partnership of Registrant (the \"Agreement\"), 1.9% 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 and the Individual General Partner received $89,725 and $84,722 respectively, from Registrant as their share of Distributable Cash From Operations during the year ended December 31 1995. As owner of 200 Limited Partnership Units, the Corporate General Partner received cash distributions of $38,024 ($190.12 per Unit) 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 or any other affiliate of Registrant during the year ended December 31, 1995. Although Registrant is authorized to pay the Individual General Partner a fee of up to $15,000 in any year beginning after December 31, 1980, no fee will be paid so long as Mr. Carey is the Individual General Partner and no fee may be paid to any successor Individual General Partner appointed by Mr. Carey pursuant to the Agreement.\nIn the future, the Corporate General Partner will continue to receive 1.9% of Distributable Cash From Operations, the Individual General Partner will continue 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 the past. For a description of the subordinated interest of the Corporate General Partner and the Individual General Partner in Cash From Sales and Cash From Financing, reference is made to the materials contained in the Prospectus under the heading MANAGEMENT COMPENSATION.\n- 9 -\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 of Registrant.\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, W. P. Carey & Co., Inc., owned 200 Limited Partnership Units of Registrant. William Polk Carey, the sole 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 Financial Statements contained 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 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- 10 -\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 filed as a part of this Report:\nReport of Independent Accountants.\nBalance Sheets, December 31, 1994 and 1995.\nStatements of Income for the years ended December 31, 1993, 1994 and 1995.\nStatements of Partners' Capital for the years ended December 31, 1993, 1994 and 1995.\nStatements of Cash Flows for the years ended December 31, 1993, 1994 and 1995.\nNotes to Financial Statements.\nThe financial statements are hereby incorporated by reference to pages 7 to 18 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. Notes to Schedule III.\nSchedule III and notes thereto are hereby incorporated by reference to pages 19 to 20 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 Financial Statements, including the Notes thereto, or because the conditions requiring their filing do not exist.\n- 11 -\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- 12 -\n- 13 -\n- 14 -\n(b) Reports on Form 8-K -------------------\nDuring the quarter ended December 31, 1995 the Registrant was not required to file any reports on Form 8-K.\n- 15 -\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the 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 3 (a California limited partnership)\nBY: W. P. CAREY & CO., INC.\n04\/08\/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: W. P. CAREY & CO., 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 8, 1996 Dr. Lawrence R. Klein Chairman of the Economic Policy Committee and Director\nMadelon DeVoe Talley Vice Chairman of the Board of Directors and Director\n04\/08\/96 BY: \/s\/ Claude Fernandez -------------- --- --------------------- Date Claude Fernandez Executive Vice President and Chief Administrative Officer (Principal Financial Officer)\n04\/08\/96 BY: \/s\/ Michael D. Roberts -------------- --- ----------------------- Date Michael D. Roberts First Vice President and Controller (Principal Accounting Officer)\n- 16 -\nAPPENDIX A TO FORM 10-K\nCORPORATE PROPERTY ASSOCIATES 3 (A CALIFORNIA LIMITED PARTNERSHIP)\n1995 ANNUAL REPORT\nSELECTED FINANCIAL DATA - --------------------------------------------------------------------------------\n(In thousands except per unit amounts)\n(1) 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. (2) Include special distributions of $50 and $120 in 1992 and 1995, respectively, per Limited Partnership Unit. (3) Represents mortgage obligations due after more than one year.\nMANAGEMENT'S DISCUSSION AND ANALYSIS - --------------------------------------------------------------------------------\nResults of Operations ---------------------\nNet income for the year ended December 31, 1995 increased by $12,761,000 as compared with net income for the year ended December 31, 1994, primarily due to the successful settlement of litigation with the Leslie Fay Company (\"Leslie Fay\") which accounted for $11,499,000 of the increase to net income. Excluding the effect of Leslie Fay, other nonrecurring income of $225,000 and writedowns of properties to net realizable value in 1995 and 1994 of $146,000 and $697,000, respectively, the Partnership would have reflected an increase in net income of $485,000. The increase in income, as adjusted, was due to decreases in interest and property expenses and an increase in other interest income and was partially offset by a decrease in lease revenues. The decrease in interest expense resulted from the $1,320,000 prepayment of mortgage loans on properties leased or formerly leased to New Valley Corporation (\"New Valley\") in the first quarter of 1995 and the prepayment of the mortgage loan on the Gibson Greetings, Inc. (\"Gibson\") properties in November 1995 in connection with the restructuring of the Gibson lease. The decrease in property expenses was due to the costs incurred in 1994 in connection with the Partnership's assessment of its liquidity alternatives which included environmental reviews and property valuations. Other interest income increased as the result of the receipt of a lump sum cash payment of $5,000,000 received upon resolution of the dispute with Leslie Fay and invested in money market funds, before being distributed to partners through a special distribution. The decrease in lease revenues was due to the termination of the New Valley lease on the Reno, Nevada property in December 1994 and the modification and restructuring of the Gibson lease as described below. The substantial increase in cash flow provided from operations was primarily due to the receipt of lump sum payments of $13,732,000 relating to Gibson and Leslie Fay.\nThe Partnership realized a net gain of $11,499,000 upon settlement of a dispute with Leslie Fay, described in Note 10 to the Financial Statements. Proceeds from the settlement amount to $18,900,000, of which $13,081,000 had been collected prior to 1995. Pursuant to the settlement, Leslie Fay was released from all obligations under the lease, relinquished all claims to the property and vacated the facility. In connection with the settlement, the Partnership incurred a $7,400,000 writeoff on the property to its net realizable value, unencumbered by the lease. The Leslie Fay property was purchased by the Partnership for $9,400,000 in 1982. The vacant property was subsequently sold to a third party in January 1996 and, in connection with the sale, the Partnership recognized an additional writeoff of $146,000 to net realizable value in 1995. Total proceeds from the settlement of the Leslie Fay dispute and the sale of the property amount to approximately $20,900,000. In addition, as more fully described in Note 11 to the Financial Statements, the Partnership received $8,723,000 ($8,150,941, net of costs) in connection with consenting to a modification of the Gibson lease. The Partnership severed one of three properties from the Gibson master lease, modified the master lease for the remaining two properties and entered into a new lease with Cleo, Inc. (\"Cleo\"), a new lessee, for the severed property. Annual gross revenues will decrease as a result of the lease modification; however, net cash flow will increase as a result of the retirement of the Gibson mortgage which was paid off with proceeds from the lump sum payment. For financial reporting purposes, income from this transaction has been deferred and will be recognized over the remaining terms of the Gibson and Cleo leases.\nNet income for the year ended December 31, 1994 increased by $286,000 to $3,215,000 as compared with net income for the year ended December 31, 1993. In addition, cash provided from operations for 1994 increased by $260,000 to $4,647,000 as compared with 1993. The increase in net income was primarily due to the noncash charges of $1,302,000 in 1993 for the writedown on the Partnership property in Moorestown, New Jersey as compared with the noncash charge of $697,000 in 1994 on the writedown of the Partnership's property in Reno, Nevada. Excluding the effect of the writedowns, income would have decreased by $319,000 in 1994 as compared with 1993. Such a decrease would have resulted from the increase in property expenses and a decrease on other interest income due to the Leslie Fay litigation and bankruptcy proceedings and related interest incurred on the Leslie Fay installments.\nNet income and cash flow provided by operating activities may be affected by the uncertainty related to the Hughes Markets, Inc. (\"Hughes\") lease. The lease with Hughes for a dairy processing plant in Los Angeles, California is currently scheduled to expire in April 1996. The Partnership and Hughes have entered into negotiations for a two-year lease extension; however, there can be no assurance that such an extension will be executed. The Partnership is in the process of remarketing the property in the event that Hughes vacates. The Partnership's share of annual rent from the Hughes lease is currently $305,000. If the property were vacated, the Partnership estimates that annual carrying costs for insurance, real estate taxes and maintenance and security would be approximately $100,000. The Partnership's share of annual carrying charges on the vacant property in Reno, Nevada is currently $80,000. The Partnership is continuing its efforts to remarket the Reno property for either lease or sale.\nIn May 1996, the Partnership is scheduled to start receiving rent of $188,000 per year from its lease with Sports & Recreation, Inc. (\"Sports & Recreation\") on the Moorestown, New Jersey property. Sports & Recreation is in the process of retrofitting the Moorestown property for use as a retail store. Annual rentals on the two Gibson properties and the Cleo property which had formerly been leased to Gibson are $2,367,000 and $1,145,000, respectively. Prior to the modification of the Gibson lease, the Partnership's annual rentals from the property were $5,962,000. Although annual revenues from these properties will be reduced by $2,450,000, the Partnership had been paying annual debt service of $2,510,000 on the Gibson mortgage loan. As the result of the prepayment of the mortgage loan, annual cash flow from the Gibson and Cleo properties will reflect an increase of $60,000 in spite of the reduction in rental income. The Gibson mortgage loan had been scheduled to mature with a balloon payment of $12,582,000 in 1996 and the Partnership would have attempted to refinance the loan at that time. It is possible that the Partnership would have realized a reduction in debt service on any refinancing. Prior to the restructuring, Gibson represented approximately 80% of lease revenues. If the Hughes lease is extended, Gibson's share of lease revenues will decrease to approximately 50% of lease revenues, thereby reducing the Partnership's exposure to any adverse changes in the financial condition of Gibson. By entering into the lease with Cleo, the Partnership has achieved greater diversification.\nBecause of the long-term nature of the Partnership's net leases, inflation and changes in prices have not unfavorably affected the Partnership's net income or had an impact on the continuing operations of the Partnership's properties. The leases with Gibson, New Valley, Sports & Recreation and AT&T Corporation (\"AT&T\") provide periodic fixed rent increases and the lease with Cleo provides for periodic rent increases based on formulas indexed to increases in the Consumer Price Index. No rental increases are scheduled to occur until 1997, when an increase is scheduled on the AT&T lease.\nFinancial Condition -------------------\nExcept for the vacant property in Reno, Nevada, all of the Partnerships properties are leased to corporate tenants under net leases by which tenants are generally required to pay all operating expenses relating to the leased properties. The Partnership depends on a relatively stable operating cash flow from its net leases to meet operating expenses and fund quarterly distributions to partners. During 1995, the Partnership significantly modified its capital structure by liquidating all of its mortgage debt. At the beginning of the year, the Partnership had a remaining mortgage obligation at the beginning of the year of approximately $15,600,000. In addition, the Company paid a special distribution of $8,000,000 (resulting in a $120 return of capital per Limited Partnership Unit as defined in the Partnership Agreement). As a result, the Partnership's cash balances decreased from $8,851,000 to $1,158,000.\nCash provided from operating activities of $12,918,000 was sufficient to pay distributions to partners of $4,722,000 and scheduled mortgage installment payments of $1,113,000. Approximately $8,151,000 of the cash provided from operations resulted from nonrecurring lump sum payments, net of the related costs. Future operating cash flows are subject to various uncertainties described herein and the ability to sustain or increase the distribution rate is subject to the outcome of the uncertainty related to the Hughes property.\nCash flow generated from operating and investing activities has generally exceeded distributions paid. Distributions paid per Limited Partnership Unit in 1993 and 1994 exceeded net income per Limited Partnership Unit by $24.91 and $21.40 in 1993 and 1994, respectively. This is because the Partnership evaluates its projection of cash flows in determining the distribution rate. Net income is reduced by charges such as depreciation, amortization and property writedowns which do not impact cash flows.\nThe Partnership's financing activities in 1995 included paying off all of the Partnership's remaining mortgage balances and paying a special distribution to partners of $8,000,000 as well as paying quarterly distributions to partners of $4,722,000. As a result of these activities, the Partnership significantly reduced its cash reserves. Since the inception of the Partnership, special distributions of $250 per Unit have been paid representing a return of 50% of the original cost of a Unit. Accordingly, the amount of quarterly distributions per Unit can be expected to decrease even though the distribution rate on adjusted capital, as defined in the Partnership Agreement, may continue to increase. The Corporate General Partner advanced a loan of $2,300,000 to help retire the Gibson mortgage loan. The loan is a demand note and it is anticipated that the note will be repaid from future operating cash flow. Since December 31, 1995, the Partnership has repaid $1,500,000 of the advance. The Partnership has ample unused borrowing capacity because all of its properties are unleveraged; however, no financings are currently being contemplated.\nThe Partnership's sole investing activity for the periods presented in the financial statements consisted of the receipt of purchase installments and settlement payments from Leslie Fay. Pursuant to its lease with Sports and Recreation, the Partnership has an obligation to reimburse Sports and Recreation for certain retrofitting costs which are currently estimated to be $458,000. It is currently anticipated that such costs will be funded from operating cash flow. In the event that there are insufficient cash reserves, the Partnership could seek an additional advance from the Corporate General Partner or borrow on its unleveraged properties.\nIn connection with the termination of the Moorestown and Reno leases, the Partnership expects to receive a bankruptcy settlement; however, the amount of such settlement cannot be estimated and no amounts that the Partnership may ultimately receive have been recorded in the accompanying financial statements.\nCleo has an option to purchase its property which is exercisable at any time with at least six months notice.\nAll of the Partnership's properties are subject to environmental statutes and regulations regarding the discharge of hazardous materials and related remediation obligations. All but two of the Partnership's properties are currently leased to corporate tenants. The Partnership generally structures a lease to require the tenant to comply with all laws. In addition, substantially all of the Partnership's net leases include provisions which require tenants to indemnify the Partnership from all liabilities and losses related to their operations at the leased properties. If the Partnership undertakes to clean up or remediate any of its properties, the General Partners believe that in most cases the Partnership will be entitled to reimbursement from tenants for such costs. In the event that the Partnership absorbs a portion of such costs because of a tenant's failure to fulfill its obligations (or because a property currently has no tenant), the General Partners believe such expenditures will not have a material adverse effect on the Partnership's financial condition, liquidity or results of operations.\nIn 1994, the Partnership voluntarily conducted Phase II environmental reviews of certain of its properties based on the results of Phase I environmental reviews conducted in 1993. The Partnership believes, based on the results of such reviews, that its properties are in substantial compliance with Federal and state environmental statutes and regulations. Portions of certain properties have been documented as having a limited degree of contamination, principally in connection with either leakage from underground storage tanks or surface spills from facility activities. For those conditions which were identified, the Partnership advised the affected tenant of the Phase II findings and of its obligation to perform required remediation.\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.\nREPORT of INDEPENDENT ACCOUNTANTS\nTo the Partners of Corporate Property Associates 3:\nWe have audited the accompanying balance sheets of Corporate Property Associates 3 (a California limited partnership) as of December 31, 1994 and 1995, and the related 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 19 to 20 of this Annual Report. 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 financial position of Corporate Property Associates 3 (a California limited partnership) 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. In addition, in our opinion, the 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.\nNEW YORK, NEW YORK March 29, 1996\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nBALANCE SHEETS December 31, 1994 and 1995\nThe accompanying notes are an integral part of the financial statements.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nSTATEMENTS of INCOME\nFor the years ended December 31, 1993, 1994 and 1995\nThe accompanying notes are an integral part of the financial statements.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nSTATEMENTS of PARTNERS' CAPITAL\nFor the years ended December 31, 1993, 1994 and 1995\n(a) Based on 66,000 Units issued and outstanding during all periods.\nThe accompanying notes are an integral part of the financial statements.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nSTATEMENTS of CASH FLOWS For the years ended December 31, 1993, 1994 and 1995\nThe accompanying notes are an integral part of the financial statements.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies: ------------------------------------------- Real Estate Leased to Others: ---------------------------- Real 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. The leases are accounted for under 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.\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.\nSubstantially all of the Partnership's leases provide for either scheduled rent increases or periodic rent increases based on formulas indexed to increases in the Consumer Price Index (\"CPI\").\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 Held for Sale: - --------------------------\nReal estate held for sale is accounted for at the lower of cost or fair value less costs to sell.\nDepreciation: - -------------\nDepreciation is computed using the straight-line method over the estimated useful lives of components of the property, which range from 5 to 36 years.\nCash Equivalents: - ----------------- Corporate Property Associates 3 (the \"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\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nPartnership's cash and cash equivalents at December 31, 1994 and 1995 were held in the custody of two financial institutions.\nOther Assets: - -------------\nIncluded in other assets at December 31, 1994 are costs incurred in connection with mortgage note refinancings which are amortized on a straight-line basis over the terms of the mortgages.\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.\n2. Partnership Agreement: ----------------------\nThe Partnership was organized on November 7, 1980 under the 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 200 Limited Partnership Units in connection with the Partnership's public offering. The Partnership will terminate on December 31, 2018, 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 2% (.1% to the Individual General Partner, William P. Carey, and 1.9% to the Corporate General Partner, W. P. Carey & Co., Inc. (\"W.P. Carey\") and the Limited Partners are allocated 98% of the profits and losses as well as distributions of distributable cash from operations, as defined. The partners are also entitled to receive net proceeds from the sale of the Partnership properties as defined in the Agreement. An affiliate of the General Partners may be entitled to incentive fees during the liquidation stage of the Partnership. A division of W.P. Carey is engaged in the real estate brokerage business. The Partnership may sell properties through the division and pay subordinated real estate commissions as provided in the Agreement. The division could ultimately earn a real estate commission of up to $675,477 with respect to the sales of properties, which amounts will be retained by the Partnership unless the subordination provisions of the Agreement are satisfied.\n3. Transactions with Related Parties: ----------------------------------\nUnder the Agreement, a division of W.P. Carey is also entitled to receive a property management fee and reimbursement of certain expenses incurred in connection with the Partnership's operations. Property management fee in 1995 includes the effects of certain transactions described in Notes 10 and 11. General and administrative expense reimbursements consist primarily of the actual cost of personnel needed in providing administrative services necessary to the operation of the Partnership. Property management fee and general and administrative expense reimbursements are summarized as follows:\nDuring 1993, 1994 and 1995, fees and expenses aggregating $246,406, $32,352 and $96,306, 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.\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\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 $50,655, $53,757 and $87,907 respectively. The increase in 1995 is due, in part, to certain nonrecurring costs incurred in connection with the relocation of the Partnership's offices.\nOn November 16, 1995, the Partnership borrowed $2,300,000 from W.P. Carey in connection with the retirement of a mortgage loan (see Note 11). The loan which is evidenced by a promissory note and bears interest at the prime rate requires the Partnership to pay the entire principal amount and accrued interest thereon on demand. The Partnership may prepay the note, in whole or in part, at any time without penalty. The retired mortgage loan had a fixed interest rate of 10%. Interest incurred of $25,586 on the loan is included in interest expense for the year ended December 31, 1995. Such amount is also included in accounts payable to affiliates as of December 31,1995. The Partnership repaid $1,500,000 to W.P. Carey since December 31, 1995.\nThe Partnership's ownership interests in certain properties are jointly held with affiliated entities as tenants-in-common with the Partnership's ownership interests in such jointly held properties ranging from 16.76% to 71.5%. 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: ----------------------------------------------------------------------\nThe scheduled minimum future rentals, exclusive of renewals, under a noncancelable operating lease with Hughes Markets, Inc. aggregate approximately $84,000 through April 1996 at which time the lease terminates.\nContingent rentals were approximately $36,000 in both 1993 and 1994 and $39,000 in 1995.\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 noncancelable direct financing leases amount to approximately $4,338,000 in 1996, $4,375,000 in 1997, $4,339,000 in 1998, $4,321,000 in 1999 and $4,360,000 in 2000 and aggregate approximately $72,193,000 through 2013.\nContingent rentals were approximately $1,904,000 in both 1993 and 1994 and $1,142,000 in 1995.\n6. Distributions: --------------\nDistributions are declared and paid to partners quarterly and are summarized as follows:\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nDistributions of $15,599 to the General Partners and $804,540 to the Limited Partners for the quarter ended December 31, 1995 were declared and paid in January 1996.\n7. 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:\n8. Industry Segment Information: -----------------------------\nThe Partnership's operations consist of the investment in and the leasing of industrial and commercial real estate.\nIn 1993, 1994 and 1995, the Partnership earned its total operating revenues (rental income plus interest income from direct financing leases) from the following lease obligors:\n9. Properties Formerly Leased to New Valley Corporation: ----------------------------------------------------- The Partnership and Corporate Property Associates 2 (\"CPA(R):2\"), an affiliate, own approximate 61% and 39% interests, respectively, in three properties located in Reno, Nevada; Bridgeton,\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nMissouri and Moorestown, New Jersey. On April 1, 1993, the lessee, New Valley Corporation (\"New Valley\"), filed a petition of voluntary bankruptcy seeking reorganization under Chapter 11 of the United States Bankruptcy Code. In connection with the bankruptcy filing, the Bankruptcy Court approved New Valley's termination of its lease with the Partnership and CPA(R):2 for the Moorestown, New Jersey property in May 1993. In 1993, the Partnership wrote down the Moorestown property to its estimated net realizable value of $1,800,000 and recognized a charge of $1,302,318 on the writedown. In December 1994, the Bankruptcy Court also approved the termination of New Valley's lease on the Reno property effective December 31, 1994. In connection with the lease termination, the Partnership recognized a charge of $697,325 and wrote down the Reno property in 1994 to its estimated net realizable value of $2,000,000.\nOn April 7, 1995, the Partnership and CPA(R):2, entered into a net lease for the property with Sports & Recreation, Inc. (\"Sports & Recreation\") which is retrofitting the Moorestown Property into a retail store. The lease provided for a feasibility period through September 30, 1995 which was extended through December 31, 1995 and is followed by an initial term of 16 years. Sports & Recreation will commence paying rent at the earlier of completion of construction or 120 days after the end of the feasibility period (May 1, 1996). Sports & Recreation will incur all retrofitting costs; however, the Partnership and CPA(R):2 will reimburse Sports & Recreation for the cost of replacing the HVAC system and installing a new roof and drainage system. The Partnership's share of the cost for replacing the HVAC system and installing a new roof and drainage system is estimated to be approximately $458,000. Annual rentals will initially be $308,750 (of which the Partnership's share is approximately $187,750) during the first five lease years with stated increases every five years thereafter.\nIn connection with the termination of the Moorestown and Reno leases, the Partnership and CPA(R):2 expect to receive a bankruptcy settlement from New Valley. The amount of such settlement cannot be estimated and no amounts that the Partnership may ultimately receive have been recorded in the accompanying financial statements. The Partnership and CPA(R):2 are currently remarketing the Reno property.\n10. Gain on Settlement: -------------------\nDuring 1991, The Leslie Fay Company (\"Leslie Fay\") informed the Partnership that it was exercising an option to purchase its leased property from the Partnership as of April 30, 1992. Under the purchase option in the lease, Leslie Fay's purchase exercise price was to be the greater of $9,400,000, the price the Partnership paid for the property in 1982, or the fair market value of the property as impacted by the lease as of the option exercise date. The process of determining the fair market value of the property was underway when Leslie Fay filed suit to ask the court to intervene in order to determine the contractual interpretation of fair value. The court ruled in favor of the Partnership and the ruling was upheld on appeal by the Pennsylvania Superior and Supreme Courts. Leslie Fay also filed a second lawsuit seeking to transfer the property and other benefits of ownership. In connection with this second suit, the court ordered Leslie Fay to pay $7,200,000 to the Partnership as partial payment for the purchase of the Leslie Fay property, post a surety bond for $15,000,000 and to continue making its monthly payments of $190,516 to the Partnership, for application of such payments to the ultimate purchase price. Effective January 1, 1995, the monthly payment was reduced to $65,000. For financial reporting purposes, the $7,200,000 payment and all subsequent monthly payments were recorded as installment payments at the time such payments were received by the Partnership pending final resolution of the suits. In addition, Leslie Fay was entitled to interest on its monthly installments and the Partnership would be entitled to interest on the difference between the ultimate purchase price and the initial $7,200,000 payment upon resolution of the second suit.\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nOn April 5, 1993, Leslie Fay filed a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code and continued to make monthly payments to the Partnership for the period subsequent to the filing of the petition. In July 1995, Leslie Fay, the Partnership, the surety company and the Official Committee of Unsecured Creditors of Leslie Fay signed and entered into a compromise and settlement agreement which was intended to resolve the dispute between Leslie Fay and the Partnership. The agreement was presented to the bankruptcy court on August 7, 1995 and subsequently approved.\nIn connection with a compromise and settlement agreement, on August 29, 1995, the Partnership received $5,250,000 plus interest of $174,149, from the surety company and, in turn, made a lump sum payment to Leslie Fay of $250,000. Under the agreement the Partnership unconditionally retained ownership of the property as well as the aggregate installment payments received from Leslie Fay of $13,665,601, consisting of the initial payment of $7,200,000 and $6,465,601 of monthly payments which were received through September 30, 1995.\nAs the fair value of the property was no longer impacted by the Leslie Fay lease, the Partnership wrote down the estimated estimated fair value of the property, net of anticipated selling costs, to $2,000,000 and recognized a noncash charge of $7,400,000, which is netted against the gain on settlement.\nIn connection with the settlement, the Partnership has recognized a gain of $11,499,176, which consists of aggregate net cash received from Leslie Fay and the surety company of $18,839,750 and the waiving of the $382,706 interest obligation that had been accrued on the Leslie Fay monthly payments, offset by the writedown of $7,400,000 and aggregate management fees, payable to an affiliate, of $323,280 on the monthly payments received from Leslie Fay. Under the compromise and settlement agreement, Leslie Fay is required to dismiss with prejudice all of its suits filed against the Partnership, and the Partnership's bankruptcy claim against Leslie Fay, as an unsecured creditor, has been reduced to $2,650,000. The Partnership may not realize the full amount of the bankruptcy claim.\nAs a result of the settlement, a special distribution of $120 per Limited Partner Unit ($7,920,000) was declared and paid in October 1995. In 1992, a special distribution of $50 per Limited Partner Unit ($3,300,000) was paid from the receipt of the $7,200,000 installment from Leslie Fay.\nOn January 10, 1996, the Partnership sold the vacant property to a third party, net of transaction costs, for $1,853,816. The Partnership has recognized an additional writedown on the property to an amount equal to the net sales proceeds, resulting in a charge to income in 1995 of $146,184. Accordingly, no gain or loss will be recognized in 1996 in connection with the sale.\n11. Properties Leased to Gibson Greetings, Inc.: --------------------------------------------\nOn January 25, 1982, the Partnership and CPA(R):2 entered into a net lease with Gibson Greetings, Inc. (\"Gibson\"), for three properties in Memphis, Tennessee, Berea, Kentucky and Cincinnati, Ohio. In 1988, the Partnership and CPA(R):2 consented to Gibson's sublease of the Memphis, Tennessee property to a wholly-owned subsidiary, Cleo, Inc. (\"Cleo\"). The lease for the three properties had an initial term of 20 years with two five-year renewal options and provided for minimum annual rentals of $5,865,000 with increases every five years based on a formula indexed to the CPI. The lease also provided Gibson with a purchase option which was exercisable during the tenth year of the lease and at the end of the initial term. Gibson declined to exercise its option during the tenth lease year in 1992.\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nIn connection with Gibson's sale of the Cleo subsidiary to CSS Industries, Inc. (\"CSS\"), the Partnership, CPA(R):2 and Gibson entered into a transaction on November 15, 1995, whereby the Memphis, Tennessee property occupied by Cleo was severed from the Gibson master lease, the Gibson lease was amended and Cleo entered into a separate lease for the Tennessee property with CSS as the guarantor of Cleo's lease obligations. The Partnership and CPA(R):2 received $12,200,000 (of which the Partnership's share was $8,723,000) as a one-time lump sum payment in consideration for severing the Tennessee property from the Gibson master lease. Gibson still retains certain specific obligations for any environmental violations which may be detected and which resulted from any pre-existing conditions and is ensuring that roof repairs or replacement are performed on the Tennessee property. Gibson and Cleo have until May 15, 1996 to complete the roof repair.\nThe Gibson lease, as amended, on the two remaining properties in Kentucky and Ohio provides for an initial term which has been extended through November 30, 2013 and provides for one renewal term of ten years. Annual rent is $3,100,000 (of which the Partnership's share is approximately $2,367,000) with stated increases of 20% every five years through the end of the renewal term. The lease includes new purchase options, exercisable on November 30, 2005 and 2010 and Gibson has the right to exercise the purchase option on one of its leased properties or both. The option is exercisable at fair market value of the properties as encumbered by the lease.\nThe Cleo lease provides for a ten-year term through December 31, 2005 with two five-year renewal terms. Annual rent is $1,500,000 (of which the Partnership's share is approximately $1,145,000) with a rent increase effective January 1, 2001. The rent which will be based on a formula indexed to the CPI, will be at least $1,689,000 but no more than $1,898,000. Cleo has an option to purchase the property at any time during the term of the lease including the renewals terms so long as there is no event of monetary default. Exercise of the purchase option requires between six and twelve months notice. The exercise price is the greater of (i) $15,000,000 or (ii) fair market value capped at a maximum of $16,250,000.\nIn connection with consenting to sever the Tennessee property from the Gibson lease, the Partnership has deferred recognition of a gain on restructuring of $8,150,941, consisting of its $8,723,000 share of the lump sum payment offset by costs of $572,059, including management fees of $429,560, payable to an affiliate, and will amortize such deferral over the remaining initial terms of the Gibson and Cleo direct financing leases. The net proceeds from the agreement as well as other available funds were used to pay off the Partnership's share of the mortgage loan collateralized by the Gibson properties of $13,190,566 in November 1995.\n12. Environmental Matters: ----------------------\nAll of the Partnership's properties are subject to environmental statutes and regulations regarding the discharge of hazardous materials and related remediation obligations. All but one of the Partnership's properties are currently leased to corporate tenants. The Partnership generally structures a lease to require the tenant to comply with all laws. In addition, substantially all of the Partnership's net leases include provisions which require tenants to indemnify the Partnership from all liabilities and losses related to their operations at the leased properties. The costs for remediation, which are being performed and paid for by the affected tenant at three of the properties, are not expected to be material. In the event that the Partnership absorbs a portion of\nContinued\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES to FINANCIAL STATEMENTS, Continued\nsuch costs because of a tenant's failure to fulfill its obligations (or because a property currently has no tenant), the General Partners believe such expenditures will not have a material adverse effect on the Partnership's financial condition, liquidity or results of operations.\nIn 1994, based on the results of Phase I environmental reviews performed in 1993, the Partnership voluntarily conducted Phase II environmental reviews on four of its properties. The Partnership believes, based on the results of Phase I and Phase II reviews, that its properties are in substantial compliance with Federal and state environmental statutes and regulations. Portions of certain properties have been documented as having a limited degree of contamination, principally in connection with surface spills from facility activities. For those conditions which were identified, the Partnership advised the affected tenants of the Phase II findings and of their obligations to perform required remediation.\n13. Disclosures About Fair Value of Financial Instruments: ------------------------------------------------------\nThe carrying amounts of cash, receivables and accounts payable and accrued expenses approximate fair value because of the short maturity of these items.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nSCHEDULE OF REAL ESTATE and ACCUMULATED DEPRECIATION\nas of December 31, 1995\nSee accompanying notes to Schedule.\nCORPORATE PROPERTY ASSOCIATES 3 (a California limited partnership)\nNOTES TO SCHEDULE OF REAL ESTATE and ACCUMULATED DEPRECIATION\n(a) Consists of acquisition costs including legal fees, appraisal fees, title costs and other related professional fees, and the purchase of additional land subsequent to purchase.\n(b) The increase (decrease) in net investment is due to the amortization of unearned income producing a constant periodic rate of return on the net investment which is greater (less) than lease payments received, the writedowns to net realizable value of the Moorestown, New Jersey; Reno, Nevada and Wilkes Barre, Pennsylvania properties and adjustments relating to deferred gains on lease restructurings.\n(c) At December 31, 1995, the aggregate cost of real estate owned for Federal income tax purposes is $50,925,119.\n(d) Reconciliation of Real Estate Accounted --------------------------------------- for Under the Operating Method ------------------------------\nDecember 31, ------------ 1994 1995 ---- ---- Balance at beginning of period $ 3,769,927 $5,769,927\nAdditions during period\nReclassification from direct financing real estate 2,000,000 ---------- ---------\nBalance at close of period $5,769,927 $5,769,927 ========== ==========\nReconciliation of Accumulated Depreciation ------------------------------------------\nDecember 31, ----------- 1994 1995 ---- ----\nBalance at beginning of period $ 818,045 $ 976,612\nDepreciation expense for the period 158,567 198,590 ---------- ----------\nBalance at close of period $ 976,612 $1,175,202 =========== ==========\nPROPERTIES - -------------------------------------------------------------------------------\n(1) Formerly leased to New Valley Corporation.\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. As of December 31, 1995 there were 2,457 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 $120 per 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.\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 Francis J. Carey President Director George E. Stoddard Chairman of the Investment Committee Director Raymond S. Clark Chairman of the Executive Committee Director Madelon DeVoe Talley Vice Chairman of the Board Director Barclay G. Jones III Executive Vice President Director Lawrence R. Klein Chairman of the Economic Policy Committee Director Claude Fernandez Executive Vice President Chief Administrative Officer Howard J. Altmann Senior Vice President H. Augustus Carey Senior Vice President John J. Park Senior Vice President Treasurer Debra E. Bigler First Vice President Ted G. Lagried First Vice President Anthony S. Mohl First Vice President Michael 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 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, 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 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 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.\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 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.\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.","section_15":""}
{"filename":"40211_1995.txt","cik":"40211","year":"1995","section_1":"Item 1. Business\nGATX Corporation is a holding company whose subsidiaries engage in the leasing and management of railroad tank cars and specialized freight cars; own and operate tank storage terminals, pipelines and related facilities; provide equipment and capital asset financing and related services; engage in Great Lakes shipping; and provide distribution and logistics support services and warehousing facilities. Information concerning financial data of business segments and the basis for grouping products or services is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995 on page 31 and pages 36 through 39, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nINDUSTRY SEGMENTS\nRAILCAR LEASING AND MANAGEMENT\nThe Railcar Leasing and Management segment (Transportation), headquartered in Chicago, Illinois, is principally engaged in leasing specialized railcars, primarily tank cars, under full service leases. As of December 31, 1995, its domestic fleet consisted of approximately 64,900 railcars, including 53,900 tank cars and 11,000 specialized freight cars, primarily Airslide covered hopper cars and plastic pellet cars. In addition, Transportation has approximately 1,500 railcars in its Mexican fleet. Transportation has upgraded its fleet over time by adding new larger capacity cars and retiring older smaller capacity cars. Transportation's railcars have a useful life of approximately 30 to 33 years. The average age of the railcars in Transportation's fleet is approximately 15 years.\nThe following table sets forth the approximate tank car fleet capacity of Transportation as of the end of each of the years indicated and the number of cars of all types added to Transportation's fleet during such years:\nTransportation's customers use its railcars to ship over 700 different commodities, primarily chemicals, petroleum, food products and minerals. For 1995, approximately 54% of railcar leasing revenue was attributable to shipments of chemical products, 21% to petroleum products, 18% to food products and 7% to other products. Many of these products require cars with special features; Transportation offers a wide variety of sizes and types of cars to meet these needs. Transportation leases railcars to over 700 customers, including major chemical, oil, food and agricultural companies. No single customer accounts for more than 4% of total railcar leasing revenue.\nTransportation typically leases new railcars to its customers for a term of five years or longer, whereas renewals or leases of used cars are typically for periods ranging from less than a year to seven years with an average lease term of about three years. The utilization rate of Transportation's domestic railcars as of December 31, 1995 was approximately 95%.\nUnder its full service leases, Transportation maintains and services its railcars, pays ad valorem taxes, and provides many ancillary services. Through its Car Status Service System, for example, the company provides customers with timely information about the location and readiness of their leased cars to enhance and maximize the utilization of this equipment. Transportation also maintains a network of major service centers consisting of four domestic and one foreign service center, and 25 mobile trucks in 17 locations. Transportation also utilizes independent third-party repair shops.\nTransportation purchases most of its new railcars from Trinity Industries, Inc. (Trinity), a Dallas-based metal products manufacturer, under a contract entered into in 1984 and extended from time to time thereafter, most recently in 1992. Transportation anticipates that through this contract it will continue to be able to satisfy its customers' new car lease requirements. Transportation's engineering staff provides Trinity with design criteria and equipment specifications, and works with Trinity's engineers to develop new technology where needed in order to upgrade or improve car performance or in response to regulatory requirements.\nThe full-service railcar leasing industry is comprised of Transportation, Union Tank Car Company, General Electric Railcar Services Corporation, Shippers Car Line division of ACF Industries, Incorporated, and many smaller companies. Of the approximately 207,000 tank cars owned and leased in the United States at December 31, 1995, Transportation had approximately 53,900. Principal competitive factors include price, service and availability.\nTERMINALS AND PIPELINES\nGATX Terminals Corporation (Terminals) is engaged in the storage, handling and intermodal transfer of petroleum and chemical commodities at key points in the bulk liquid distribution chain. All of its terminals are located near major distribution and transportation points and most are capable of receiving and shipping bulk liquids by ship, rail, barge and truck. Many of the terminals also are linked with major interstate pipelines. In addition to storing, handling and transferring bulk liquids, Terminals provides blending and testing services at most of its facilities. Terminals, headquartered in Chicago, Illinois, owns and operates 28 terminals in 11 states, and eight terminals in the United Kingdom. Terminals also has joint venture interests in 14 international facilities. Additionally, Terminals owns or holds interests in four refined product pipeline systems.\nAs of December 31, 1995, Terminals had a total storage capacity of 75 million barrels. This includes 55 million barrels of bulk liquid storage capacity in the United States, 7 million barrels in the United Kingdom, and an equity interest in another 13 million barrels of storage capacity in Europe and the Far East. Terminals' smallest bulk liquid facility has a storage capacity of 95,000 barrels while its largest facility, located in Pasadena, Texas, has a capacity of over 12 million barrels. Capacity utilization at Terminals' wholly owned facilities was 85% at the end of 1995; throughput for the year was 655 million barrels.\nFor 1995, 75% of Terminals' revenue was derived from petroleum products, 23% from a variety of chemical products, and 2% from other products. Demand for Terminals' facilities is dependent in part upon demand for petroleum and chemical products and is also affected by refinery output, foreign imports, availability of other storage facilities, and the expansion of its customers into new geographical markets.\nTerminals serves approximately 300 customers, including major oil and chemical companies as well as trading firms and larger independent refiners. No single customer accounts for more than 5% of Terminals' revenue. Customer service contracts are both short term and long term. Terminals along with two Dutch companies, Paktank N.V. and Van Ommeren N.V., are the three major international public terminalling companies. The domestic public terminalling industry consists of Terminals, Paktank Corporation, International-Matex Tank Terminals, and many smaller independent terminalling companies. In addition to public terminalling companies, oil and chemical companies also have significant storage capacity in their own private facilities. Terminals' pipelines compete with rail, trucks and other pipelines for movement of liquid petroleum products. Principal competitive factors include price, location relative to distribution facilities, and service.\nFINANCIAL SERVICES\nGATX Financial Services, through its principal subsidiary, GATX Capital Corporation, provides asset-based financing of transportation and industrial equipment through capital leases, secured equipment loans, and operating leases. GATX Capital also provides related financial services which include the arrangement of lease transactions for investment by other lessors and the management of lease portfolios for third parties. In these underwriting and management activities, GATX Capital seeks fee income and residual participation income. In addition to its San Francisco headquarters, GATX Capital has offices in four U.S. cities and five foreign countries.\nThe financial services industry is both crowded and efficient. GATX Capital is one of the larger non-bank capital services companies. GATX Capital competes with captive leasing companies, leasing subsidiaries of commercial banks, independent leasing companies, lease underwriters and brokers, investment bankers, and also with the manufacturers of equipment. Financing companies compete on the basis of service, effective rates and transaction structuring skills.\nGATX Capital participates in selected areas where it believes the application of its strengths can result in above-market returns in exchange for assuming appropriate levels of risk. GATX Capital has developed a portfolio of assets diversified across industries and equipment classifications, the largest of which include aircraft and rail. At December 31, 1995, GATX Capital had approximately 800 financing contracts with 600 customers, aggregating $1.5 billion of investments before reserves. Of this amount, 39% consisted of investments associated with commercial jet aircraft, 18% railroad equipment, 13% warehouse and production equipment, 10% information technology equipment, 7% marine equipment, 4% golf courses, and 9% other.\nGREAT LAKES SHIPPING\nAmerican Steamship Company (ASC), with the largest carrying capacity of the domestic Great Lakes vessel fleets, provides modern and efficient waterborne transportation of dry bulk materials to the integrated steel, electric utility and construction industries. ASC's fleet is entirely comprised of self-unloading vessels which do not require any shoreside assistance to discharge cargo. ASC's eleven vessels range in size from 635 feet to 1,000 feet, transport cargoes from 17,000 net tons up to 70,000 net tons depending on vessel size, and can unload at speeds from 2,800 net tons per hour up to 10,000 net tons per hour. Because the Great Lakes are fresh water, Great Lakes vessels are not subject to the severe rusting condition typical of salt water vessels. As a result, ASC's vessels have expected lives of 50 to 75 years.\nIn 1995, ASC carried 25.5 million tons of cargo. The primary materials ASC transported were iron ore, coal and limestone aggregates. Other commodities transported include sand, salt, potash, gypsum, grain, marble chips and slag. ASC's revenue source by industry served during 1995 was 49% steel, 23% power generation; 20% construction and 8% other. No single customer accounts for more than 24% of ASC's revenue.\nASC competes with three other U.S. flag Great Lakes commercial fleets, which include U.S.S. Great Lakes Fleet, Inc., Oglebay Norton Company, and Interlake Steamship, and with all steel companies which operate captive fleets. Great Lakes shipping is the only major activity of GATX which consumes substantial quantities of petroleum products; fuel for these operations is presently in adequate supply. Competition is based primarily on service and price. ASC is headquartered in Williamsville, New York, with one regional office.\nLOGISTICS AND WAREHOUSING\nGATX Logistics, Inc. (Logistics) is one of the largest third-party providers of distribution and logistics support services and warehousing facilities in the United States. Logistics, headquartered in Jacksonville, Florida, operates 104 facilities covering approximately 24 million square feet of warehousing space in North America with utilization of 97 percent at the end of 1995. Value-adding services are strategically the most important benefit GATX Logistics provides. Examples of these services are logistics planning, information systems, just-in-time delivery systems, packaging, sub-assembly, and returns management.\nGATX Logistics serves about 650 customers, many of which are Fortune 1000-type companies. Most customers are manufacturers, but the customer base also includes retailers. In the warehousing sector, GATX Logistics competes primarily with in-house or private operations and with other national operators as well as multi-regional and local operators. In providing transportation and logistics services, GATX Logistics competes with the major trucking companies and providers of specialized distribution services.\nGATX Logistics' revenue source by industry served during 1995 was 22% motor vehicle parts and components, 16% grocery, 14% consumer products, 11% major appliances, 8% farm and construction equipment, 7% electronics, 5% chemical, 3% health care, and 14% other. No single customer accounts for more than 9% of Logistics' revenue.\nTrademarks, Patents and Research Activities - ------------------------------------------- Patents, trademarks, licenses, and research and development activities are not material to these businesses taken as a whole.\nSeasonal Nature of Business - --------------------------- Great Lakes shipping is seasonal due to the effects of winter weather conditions. However, seasonality is not considered significant to the operations of GATX and its subsidiaries taken as a whole.\nCustomer Base - ------------- GATX and its subsidiaries are not dependent upon a single customer or a few customers. The loss of any one customer would not have a material adverse effect on any segment or GATX as a whole.\nEmployees - --------- GATX and its subsidiaries have approximately 5,900 active employees, of whom 25% are hourly employees covered by union contracts.\nEnvironmental Matters - --------------------- Certain operations of GATX's subsidiaries (collectively GATX) present potential environmental risks principally through the transportation or storage of various commodities. Recognizing that some risk to the environment is intrinsic to its operations, GATX is committed to protecting the environment, as well as complying with applicable environmental protection laws and regulations. GATX, as well as its competitors, is subject to extensive regulation under federal, state and local environmental laws which have the effect of increasing the costs and liabilities associated with the conduct of its operations. In addition, GATX's foreign operations are subject to environmental regulations in effect in each respective jurisdiction.\nGATX's policy is to monitor and actively address environmental concerns in a responsible manner. GATX has received notices from the U.S. Environmental Protection Agency (EPA) that it is a potentially responsible party (PRP) for study and clean-up costs at 11 sites under the requirements of the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (Superfund). Under Superfund and comparable state laws, GATX may be required to share in the cost to clean-up various contaminated sites identified by the EPA and other agencies. In all but one instance, GATX is one of a number of financially responsible PRPs and has been identified as contributing only a small percentage of the contamination at each of the sites. Due to various factors such as the required level of remediation and participation in clean-up efforts by others, GATX's total clean-up costs at these sites cannot be predicted with certainty; however, GATX's best estimates for remediation and restoration of these sites have been determined and are included in its environmental reserves.\nFuture costs of environmental compliance are indeterminable due to unknowns such as the magnitude of possible contamination, the timing and extent of the corrective actions that may be required, the determination of the company's liability in proportion to other responsible parties, and the extent to which such costs are recoverable from third parties including insurers. Also, GATX may incur additional costs relating to facilities and sites where past operations followed practices and procedures that were considered acceptable at the time but in the future may require investigation and\/or remedial work to ensure adequate protection to the environment under current or future standards. If future laws and regulations contain more stringent requirements than presently anticipated, expenditures may be higher than the estimates, forecasts, and assessments of potential environmental costs provided below. However, these costs are expected to be at least equal to the current level of expenditures. In addition, GATX has provided indemnities for environmental issues to the buyers of three divested companies for which GATX believes it has adequate reserves.\nGATX's environmental reserve at the end of 1995 was $94 million and reflects GATX's best estimate of the cost to remediate its environmental conditions. Additions to the reserve were $14 million in 1995 and $27 million in 1994; 1994 included $13 million recorded in conjunction with terminal acquisitions. Expenditures charged to the reserve amounted to $16 million and $12 million in 1995 and 1994, respectively.\nIn 1995, GATX made capital expenditures of $18 million for environmental and regulatory compliance compared to $15 million in 1994. These projects included marine vapor recovery, discharge prevention compliance, waste water systems, impervious dikes, tank modifications for emissions control, and tank car cleaning systems. Environmental projects authorized or currently under consideration would require capital expenditures of approximately $28 million in 1996. GATX anticipates it will make annual expenditures at a similar level over the next five years.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nInformation regarding the location and general character of certain properties of GATX is included in Item 1, Business, of this document and in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995 on page 68, GATX Location of Operations (page reference is to the Annual Report to Shareholders). The major portion of Terminals' land is owned; the balance is leased. Most of the warehouses operated by GATX Logistics are leased; the others are managed for third parties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nA railcar owned by Transportation was involved in a derailment near Dunsmuir, California, in July 1991 that resulted in a spill of metam sodium into the Sacramento River. Various lawsuits seeking damages in unspecified amounts have been filed against General American Transportation Corporation (GATC), or an affiliated company, most of which have been consolidated in the Superior Court of the State of California for the City and County of San Francisco (Nos. 2617 and 2620). GATC has now been dismissed by the class plaintiffs in those cases, and has resolved the claims of the plaintiffs who opted out of the class. There was one other case seeking recovery for response costs and natural resource damages: State of California, et al, vs. Southern Pacific, et al, filed in the Eastern District of California (CIV-S-92 1117). All other actions were consolidated with these two cases. GATC was also\nnamed as a potentially responsible party by the State of California with respect to the assessment and remediation of possible damages to natural resources which claim was also consolidated in the suit in the Eastern District of California. GATC has now entered into settlement agreements with the United States of America, the State of California, Southern Pacific and certain other defendants settling all material claims arising out of the above incident in an amount not material to GATC.\nOn July 14, 1995, a judgment in the amount of $9.7 million was entered against GATC by the U.S. District Court for the Northern District of Illinois in the matter of General American Transportation Corporation v. Cryo-Trans, Incorporated (Case No. 91 C 1305), a case involving an alleged patent infringement by GATC in the construction and use of its ArcticarTM cryogenically cooled railcar. That judgment has been reduced to approximately $9 million. GATC was also permanently enjoined from any further infringement of the patent as of August 1, 1995, subsequently extended to September 1, 1995. Of GATC's 65,000 railcar fleet, the injunction affected only 180 railcars, 80 of which were on lease and 100 on order. GATC has filed an appeal of the decision with the Federal Circuit Court of Appeals. Even in the event of an adverse decision on appeal, GATX does not believe the costs associated with the disposition of the affected cars will have a material adverse effect on GATX.\nVarious lawsuits have been filed in the Superior Court for the State of California and served upon Terminals, Calnev Pipe Line Company, or another GATX subsidiary seeking an unspecified amount of damages arising out of the May 1989 explosion in San Bernardino, California. Those suits, all of which were filed in the County of San Bernardino unless otherwise indicated, are: Aguilar, et al, v. Calnev Pipe Line Company, et al, filed February 1990 in the County of Los Angeles (No. 0751026); Alba, et al, v. Southern Pacific Railroad Co., et al, filed November 1989 (No. 252842); Terry, et al, v. Southern Pacific, et al, filed December 1989 (No. 253604); Charles, et al, v. Calnev Pipe Line, Inc., et al, filed May 1990 (No. 256269); Abrego, et al, v. Southern Pacific Transportation Corporation, et al, filed May 1990 in the County of Los Angeles (No. BC 000947) and settled November, 1995; Glaspie, et al, v. Southern Pacific Transportation, et al, filed May 1990 in the County of Los Angeles (No. BC002047) and settled November 1995; Burney, et al, v. Southern Pacific, et al, filed May 1990 in the County of Los Angeles (BC000876) and settled May, 95; Ledbetter, et al, v. City of San Bernardino, et al, filed May 1990 (No. 256173) and settled April,1995; Mary Washington v. Southern Pacific, et al, filed May 1990 (No. 256346); Stewart, et al, v. Southern Pacific Railroad Co., et al, filed May 1990 (No. 256464); Pearson v. Calnev Pipe Line Company, et al, filed May 1990 in the County of San Bernardino (No. 256206); Pollack v. Southern Pacific Transportation, et al, filed May 1992 (No. 271247); Davis v. Calnev Pipe Line Company, et al, filed May 1990 (No. 256207); J. Roberts, et al, v. Southern Pacific Transportation, et al, filed November 1992 (No. 275936); Brooks, et al, v. Southern Pacific, et al, filed May 1990 (No. 256176) and settled February 1994; Goldie, et al, v. Southern Pacific, et al, filed May 1990 and dismissed July 1993, appeal pending; Irby, et al, v. Southern Pacific, et al, (No. 255715) filed April 1990; Esparza, et al, v. Southern Pacific, et al, (No. 256433) filed May 1990 and settled February 1994; Reese, et al, v. Southern Pacific, et al (No. 256434) filed May 1990; Nancy Washington, et al, v.Southern Pacific, et al, (No. 256435) filed May 1990. As Terminals' insurance carriers have assumed the defense of these lawsuits without a reservation of rights and have paid all of the settlements entered to date, GATX believes that the likelihood of a material adverse effect on GATX's consolidated financial position or operations is remote.\nIn October 1991, GATX and five of its senior officers were named as defendants in Searls vs. Glasser, et al, filed in the U.S. District Court for the Northern District of Illinois, a class action lawsuit filed on behalf of certain purchasers of GATX's common stock alleging violation of the securities laws, common law fraud and negligent misrepresentation in various public statements made by GATX during 1991 concerning 1992 forecasted earnings. Upon the completion of extensive discovery, the District Court granted a motion for summary judgment in favor of GATX. That judgment was appealed and in August 1995 the U.S. Court of Appeals for the 7th Circuit affirmed the decision of the District Court. The plaintiffs then filed a petition with the Court of Appeals for a Rehearing In Banc which was denied. As the time for filing an appeal from the decision of the Court of Appeals has expired, that decision is now final. Accordingly, as there are no further avenues of appeal available to the plaintiff, this matter is now closed.\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), the following information regarding executive officers is included in Part I in lieu of inclusion in the GATX Proxy Statement:\nOffice Held Name Office Held Since Age - ---------------- ---------------------------------- ------- ----- James J. Glasser Chairman of the Board 1978 61\nRonald H. Zech President and Chief Executive Officer 1996 52\nDavid M. Edwards Vice President, Finance and 1994 44 Chief Financial Officer\nDavid B. Anderson Vice President, Corporate Development, 1995 54 General Counsel and Secretary\nWilliam L. Chambers Vice President, Human Resources 1993 58\nRalph L. O'Hara Controller 1986 51\nBrian A. Kenney Treasurer 1995 36\nOfficers are elected annually by the Board of Directors. Previously, Mr. Zech was President of GATX Financial Services from 1985 to 1994. In 1994 Mr. Zech was elected as President and Chief Operating Officer of GATX. On January 1, 1996, he was elected as Chief Executive Officer. Mr. Edwards was Senior Vice President - Finance and Administration of GATX Financial Services from 1990 to 1994. Mr. Anderson was Vice President, Corporate Development, General Counsel and Secretary of Inland Steel Industries from 1986 until 1995. Concurrently, he served as President of Inland Engineered Materials Corporation. Mr. Chambers was engaged in human resource consulting from 1991 until 1993. Mr. Kenney was Managing Director, Corporate Finance and Banking, for AMR Corporation from 1990-1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nInformation required by this item is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995 on page 63, which is incorporated herein by reference (page reference is to the Annual Report to Shareholders).\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation required by this item is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995, on pages 64 and 65, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nItem 7.","section_7":"Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations\nInformation required by this item is contained in Item 1, Business, section of this document and in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995, the management discussion and analysis of 1995 compared to 1994 on pages 33, 34, 35, 41, 43, 45 and 46, the financial data of business segments on pages 36 through 39, and the management discussion and analysis of 1994 compared to 1993 on pages 66 and 67, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of GATX Corporation, included in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995, which is incorporated herein by reference (page references are to the Annual Report to Shareholders):\nStatements of Consolidated Income and Reinvested Earnings -- Years ended December 31, 1995, 1994 and 1993 on page 40. Consolidated Balance Sheets -- December 31, 1995 and 1994, on page 42. Statements of Consolidated Cash Flows -- Years ended December 31, 1995, 1994 and 1993, on page 44. Notes to Consolidated Financial Statements on pages 47 through 62.\nQuarterly results of operations are contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1995 on page 63, which is incorporated herein by reference (page reference is to the Annual Report to Shareholders).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation required by this item regarding directors is contained in sections entitled \"Nominees For Directors\" and \"Additional Information Concerning Nominees\" in the GATX Proxy Statement dated March 13, 1996, which sections are incorporated herein by reference. Information regarding officers is included at the end of Part I.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation required by this item regarding executive compensation is contained in sections entitled \"Compensation of Directors\" and \"Compensation of Executive Officers\" in the GATX Proxy Statement dated March 13, 1996, which sections are incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation required by this item regarding the Company's Common Stock is contained in sections entitled \"Nominees For Directors,\" \"Security Ownership of Management\" and \"Beneficial Ownership of Common Stock\" in the GATX Proxy Statement dated March 13, 1996, which sections are incorporated herein by reference. The following are the only persons known to the Company who beneficially owned as of March 12, 1996 more than 5% of the Company's $3.875 Cumulative Convertible Preferred Stock (\"CCP Stock\"):\nName and Address of Shares Beneficially Beneficial Owner Owned Percent of Class - ------------------- ------------------- ----------------\nFiduciary Trust 300,700 8.87% Company International (1) Two World Trade Center, New York, New York\nSAFECO Corporation (2) 221,000 6.52% SAFECO Plaza Seattle, Washington 98135\n(1) According to Schedule 13Gs dated February 1, 1996 furnished to the Company, United Nations Joint Staff Pension Fund (\"UN\") and its appointed Investment Advisor, Fiduciary Trust Company (\"Fiduciary\"), share voting and dispositive power with respect to 300,000 shares of the CCP Stock and Fiduciary has sole dispositive and sole voting power over 700 shares of the CCP Stock. The 300,700 shares represent voting over 1.28% of the shares of Company Stock entitled to vote at the Company's Annual Meeting.\n(2) According to a Form 13F filed with the Securities and Exchange Commission on January 26, 1996, SAFECO Corporation has sole voting authority over and shares investment discretion over 221,000 shares of the CCP Stock, 111,000 of which are managed by General Insurance Company of America and 110,000 of which are managed by SAFECO Asset Management Company. The 221,000 shares of CCP Stock represent .94% of the shares of the Company stock entitled to vote at the Company's Annual Meeting.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14.","section_14":"Item 14. Financial Statement Schedules, Reports on Form 8-K and Exhibits.\na) 1. -Financial Statements\nThe following consolidated financial statements of GATX Corporation included in the Annual Report to Shareholders for the year ended December 31, 1995, are filed in response to Item 8:\nStatements of Consolidated Income and Reinvested Earnings -- Years ended December 31, 1995, 1994 and 1993 Consolidated Balance Sheets -- December 31, 1995 and 1994 Statements of Consolidated Cash Flows -- Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n2. -Financial Statement Schedules: Page\nSchedule I Condensed Financial Information of Registrant............. 17\nSchedule II Valuation and Qualifying Accounts....... 21\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.\nb) EXHIBIT INDEX\nExhibit Number Exhibit Description Page\n3A. Restated Certificate of Incorporation of GATX Corporation, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n3B. By-Laws of GATX Corporation, as amended and restated as of July 29, 1994, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, file number 1-2328.\n10A. GATX Corporation 1985 Long Term Incentive Compensation Plan, as amended, and restated as of April 27, 1990, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file No. 1-2328. Amendment to said Plan effective as of April 1, 1991, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10B. GATX Corporation 1995 Long Term Incentive Compensation Plan, incorporated by reference to GATX's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1995, file number 1-2328.\n10C. Management Incentive Plan dated January 1, 1995, file number 1-2328, incorporated by reference to GATX's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1995, file number 1-2328.\n10D. Management Incentive Plan dated January 1, 1996, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n10E. GATX Corporation Deferred Fee Plan for Directors, effective April 1982, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10F. 1984 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated September 1, 1984, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10G. 1985 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated July 1, 1985, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\nExhibit Number Exhibit Description Page\n10H. 1987 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated December 31, 1986, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10I. Amendment to Executive Deferred Income Plan Participation Agreements between GATX and certain participating directors and participating executive officers entered into as of January 1, 1990, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 1-2328.\n10J. Retirement Supplement to Executive Deferred Income Plan Participation Agreements entered into as of January 23, 1990, between GATX and certain participating directors incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 1-2328 and between GATX and certain other participating directors incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file number 1-2328.\n10K. Amendment to Executive Deferred Income Plan Participation Agreements between GATX and participating executive officers entered into as of April 23, 1993, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, file number 1-2328.\n10L. Director Retirement Plan effective January 1, 1992, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, file number 1-2328.\n10M. Agreement for Continued Employment Following Change of Control or Disposition of a Subsidiary between GATX Corporation and certain executive officers dated as of January 1, 1995, incorporated by reference to GATX's Quarterly Report on Form 10-Q for the quarterly period ended March 31,1995, file number 1-2328.\n10N. Agreements for Continued Employment Following Change of Control or Disposition of a Subsidiary between GATX Corporation and an additional executive officer dated as of July 1, 1995 and between GATX and another executive officer dated as of January 1, 1996 file number 1-2328. Submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n10O. Agreement dated July 29, 1994, supplementing the Agreement for Continued Employment Following Change of Control or Disposition of a Subsidiary between GATX Corporation and Ronald H. Zech, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, file number 1-2328.\nExhibit Number Exhibit Description Page\n10P. Letter Agreement dated August 17, 1993 between William Chambers and GATX, incorporated by reference to GATX's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995, file number 1-2328.\n10Q. Letter Agreement dated May 31, 1995 between David B. Anderson and GATX, file number 1-2328. Submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n10R. Arrangements between James J. Glasser and GATX associated with Mr. Glasser's retirement from GATX as described on page 11 in the Section of the GATX Proxy Statement dated March 13, 1996 entitled \"Termination of Employment and Change of Control Arrangements\" are incorporated herein by reference thereto, file number 1-2328.\n11A. Statement regarding computation of per share earnings. 22\n11B. Statement regarding computation of per share earnings (full dilution) 23\n12. Statement regarding computation of ratios of earnings to combined fixed charges and preferred stock dividends. 24\n13. Annual Report to Shareholders for the year ended December 31, 1995, pages 31-70, with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n21. Subsidiaries of the Registrant. 25\n23. Consent of Independent Auditors. 26\n24. Powers of Attorney with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n27. Financial Data Schedule for GATX Corporation for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n99A. Undertakings to the GATX Corporation Salaried Employees Retirement Savings Plan, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1982, file number 1-2328.\n99B. Undertakings to the GATX Corporation 1995 Long Term Incentive Compensation Plan for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors GATX Corporation\nWe have audited the consolidated financial statements and related schedules of GATX Corporation and subsidiaries listed in Item 14 (a)(1) and (2) of the Annual Report on Form 10-K of GATX Corporation for the year ended December 31, 1995. These financial statements and related schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and related schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and related schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GATX 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, the related financial statements schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects, the information set forth therein.\nERNST & YOUNG LLP\nChicago, Illinois January 23, 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.\nGATX CORPORATION (Registrant)\n\/s\/Ronald H. Zech -------------------------- Ronald H. Zech President, Chief Executive Officer and Director 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 date indicated.\nJames J. Glasser Chairman of the Board By \/s\/David B. Anderson and Director ---------------------- (David B. Anderson, \/s\/Ronald H. Zech Attorney-in-Fact) - ----------------------- Date: March 22, 1996 Ronald H. Zech President, March 22, 1996 Chief Executive Officer and Director\n\/s\/David M. Edwards - ----------------------- David M. Edwards Vice President Finance and March 22, 1996 Chief Financial Officer\n\/s\/Ralph L. O'Hara - ----------------------- Ralph L. O'Hara Controller and March 22, 1996 Principal Accounting Officer\nFranklin A. Cole Director By \/s\/David B. Anderson James W. Cozad Director --------------------- James M. Denny Director (David B. Anderson, William C. Foote Director Attorney-in-Fact) Deborah M. Fretz Director Richard A. Giesen Director Miles L. Marsh Director Charles Marshall Director Michael E. Murphy Director Date: March 22, 1996\nEXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of subsidiaries included in GATX's consolidated financial statements (excluding a number of subsidiaries which, considered in the aggregate, would not constitute a significant subsidiary), and the state of incorporation of each:\nGeneral American Transportation Corporation (New York)--includes one domestic subsidiary, three foreign subsidiaries and interests in two foreign affiliates, Business Segment--Railcar Leasing and Management GATX Terminals Corporation (Delaware)--three domestic subsidiaries, one foreign subsidiary, one domestic affiliate, and interests in ten foreign affiliates, Business Segment--Terminals and Pipelines GATX Financial Services, Inc. (Delaware)--54 domestic subsidiaries (which includes GATX Capital Corporation), 12 foreign subsidiaries and eight domestic affiliates, Business Segment--Financial Services GATX Logistics, Inc. (Florida)--29 domestic subsidiaries and two foreign subsidiaries, Business Segment--Logistics and Warehousing American Steamship Company (New York)--12 domestic subsidiaries, Business Segment--Great Lakes Shipping\nEXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the following: (i) Registration Statement No. 2-92404 on Form S-8, filed July 26, 1984; (ii) Registration Statement No. 2-96593 on Form S-8, filed March 22, 1985; (iii) Registration Statement No. 33-38790 on Form S-8 filed February 1, 1991; (iv) Registration Statement No. 33-41007 on Form S-8 filed June 7, 1991; and (v) Registration Statement No. 33-61183 filed on July 20, 1995 of GATX Corporation, of our report dated January 23, 1996 with respect to the consolidated financial statements and schedules of GATX Corporation included and\/or incorporated by reference in the Annual Report on Form 10-K for the year ended December 31, 1995.\nERNST & YOUNG LLP\nChicago, Illinois March 20, 1996\nEXHIBIT FILED WITH DOCUMENT\n10D. Management Incentive Plan dated January 1, 1996, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n10N. Agreements for Continued Employment Following Change of Control or Disposition of a Subsidiary between GATX Corporation and an additional executive officer dated as of July 1, 1995 and between GATX and another executive officer dated as of January 1, 1996 file number 1-2328. Submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n10Q. Letter Agreement dated May 31, 1995 between David B. Anderson and GATX, file number 1-2328. Submitted to the SEC along with the electronic transmission of this Annual Report on Form 10-K.\n11A. Statement regarding computation of per share earnings.\n11B. Statement regarding computation of per share earnings (full dilution)\n12. Statement regarding computation of ratios of earnings to combined fixed charges and preferred stock dividends.\n13. Annual Report to Shareholders for the year ended December 31, 1995, pages 31-70, with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n21. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n24. Powers of Attorney with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n27. Financial Data Schedule for GATX Corporation for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n99B. Undertakings to the GATX Corporation 1995 Long Term Incentive Compensation Plan for the fiscal year ended December 31, 1995, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.","section_15":""}
{"filename":"46445_1995.txt","cik":"46445","year":"1995","section_1":"Item 1. Business. - ------ -------- (a) General Development of Business -------------------------------\nHMI Industries Inc. (the \"Company\" or \"registrant\") was known as Health-Mor Inc. until January, 1995. The Company was reorganized in 1968 as a Delaware corporation, succeeding an Illinois corporation originally formed in 1928. The business of the Company is carried out through two primary divisions. The Consumer Goods Division manufactures and sells floor care and air filtration products, primarily portable bagless vacuum cleaners sold under the trade names \"Filter Queen,\" \"Princess\" and \"Majestic,\" central vacuum cleaning systems sold under the trade names \"Vacu-Queen\" and \"Majestic II\", portable canister vacuums sold under the trade names \"Optima\" and \"ElektraPure\", and an upright vacuum sold under the trade name \"Princess 2000\". This division also sells needleless insulin injectors under the AdvantaJet name, and certain tubular consumer products, both of which are manufactured by subsidiaries in the Manufactured Products Division. The operations of the Consumer Goods Division are carried on through the operations at the Payne and Perkins Avenue facilities in Cleveland, Ohio, and the following wholly-owned subsidiaries: HMI Incorporated (incorporated in Ontario, Canada); Health-Mor Mexicana S.A. de C.V. (incorporated in Mexico); Experimental Distributing Inc. (incorporated in Ohio); Home Impressions Inc. (incorporated in Delaware); HMI Personal Care Corp. (incorporated in Delaware); Health-Mor International, Inc., which meets the qualifications under the Internal Revenue Code as a foreign sales corporation (incorporated in the U.S. Virgin Islands); Health-Mor B.V. (incorporated in the Netherlands); Health-Mor Acceptance Corporation (incorporated in Delaware), HMI Acceptance Corporation (incorporated in Ontario, Canada)and Health-Mor Acceptance PTY Ltd. (incorporated in Sydney, Australia).\nThe Manufactured Products Division engages in the fabrication and sale of commercial and industrial stamped components, metal formed tubular products and machined components, and the manufacture of needleless insulin injectors. The operations of this division are carried out by wholly-owned subsidiaries of the Company; Bliss Manufacturing Company (incorporated in Ohio), Tube Form Inc., (incorporated in Ohio), and Tube-Fab Ltd., (incorporated in Ontario, Canada).\nIn 1995 the Company introduced the Captiva brand of filtration products, including furnace and air conditioning filters, electrostatic cone filters and a portable room air cleaner. The electrostatic cone filter and portable room air cleaner provide a level of filtration that is greater than HEPA standards (High Efficiency Particulate Air), which has been an industry standard for years. The company also introduced the Optima brand canister\nvacuum cleaner through its Home Impressions unit. This canister unit uses a bag filter and will be marketed through retail stores worldwide.\nThrough the new HMI Personal Care Corp., the Company is aggressively marketing the Activa line of diabetic care products. Foremost among these is the needleless insulin injector now called AdvantaJet (formerly called Preci-Jet and Freedom Jet). Injectors for sensitive and tougher skin are also available, as are a variety of lifestyle products that will enhance the normalcy of diabetic patients.\n(b) Financial Information About Industry Segments ---------------------------------------------\nThe net sales and operating income of each industry segment and the identifiable assets attributable to each industry segment for the years ended September 30, 1995, 1994 and 1993 are set forth in Note 11 (Business Segments) of the Notes to the Consolidated Financial Statements found on page 41.\n(c) Narrative Description of Business ---------------------------------\nConsumer Goods - --------------\nThe principal products of the Consumer Goods Division of the Company are floor care and air filtration products, primarily portable vacuum cleaners and central vacuum cleaning systems. Portable bagless vacuum cleaners are sold under the trade names \"Filter Queen,\" \"Princess,\" and \"Majestic\". Portable canister vacuums are sold under the trade names \"Optima\" and \"ElektraPure.\" The product line also includes an upright vacuum cleaner sold under the trade name \"Princess 2000\". The central vacuum cleaning systems are sold under the trade names \"Vacu-Queen\" and \"Majestic II.\" The bagless portable and portable canister vacuums consist of a canister type suction cleaner, motorized vacuum cleaning head with a revolving brush (\"Pow-R-Nozzle\"), hose, wand, brushes and other cleaning tools. The Company also offers accessories for use with its bagless and canister vacuum cleaners, most of which are attached to the exhaust outlet and may be used as room deodorizers, air circulators, and for other blowing operations such as the spraying of liquids. The central vacuum cleaning systems use the motorized vacuum cleaning head with a revolving brush, as well as the hose, wand, brushes and other cleaning tools. The Company also manufactures straight suction attachments, which do not have a motorized vacuum cleaning head.\nThe Filter Queen cleaning system has been registered by Underwriters Laboratories and Canadian Standards Authority as an Air Filtration Device, which support filtration claims and potentially expand the market of customers.\nThe Company manufactures a commercial model of its Princess and Optima vacuum cleaners, which it sells to business and industrial users. The Company also manufacturers vacuum cleaner power nozzle heads for other vacuum cleaner companies on a private label basis.\nThe floor care products of the Consumer Goods Division are marketed throughout the United States, Canada, Mexico and forty-five other countries. With the exception of Mexico, the Company markets the Filter Queen Majestic through independent distributors who sell in the home directly through their own independent representatives and who also sell indirectly through the representatives of smaller independent local distributors. In Mexico, the distribution channel is comprised of Company employees. In certain foreign markets, the Princess and the ElektraPure are also marketed in a similar manner. Optima is marketed through retail stores, while the Princess 2000 is marketed on a direct basis.\nThe Company recently opened a direct distributorship in Toledo, Ohio, under the name Experimental Distributing, Inc. which it will use to test new marketing strategies, lead programs and other direct sales techniques.\nHome Impressions Inc. is dedicated to marketing products related to home convenience and comfort. The product offerings are manufactured by the Company's existing divisions as well as being sourced from other manufacturers. New marketing techniques and distribution channels are utilized on a national and international basis. Catalog distribution, infomercials and telemarketing are some of the venues being tested by the Company as a means to exploit this significant business potential.\nA line of products manufactured by the tubular products group of the Company under the name \"Precise Contours\" is a new direction for this division, producing products for the first time for the consumer marketplace. Initial offerings include telescopic flag poles, door and window security bars and a door jam. Other products also include a luggage cart, water broom and a wood rack.\nThe Home Impressions product line also includes a retail product grouping of floor care products, including the \"Optima\", \"Princess 2000\", \"ElektraPure\" and \"Vacu-Queen\". Except for the \"Princess 2000,\" these products are sold primarily through specialty retail vacuum stores in North America. The \"Princess 2000\" will continue to be sold through a direct sales network which was established in 1993. This network began in the United States with the \"Princess 2000\" upright vacuum cleaner by utilizing direct sales strategies and incorporating new, lower cost, lower investment selling techniques to allow greater flexibility in the hiring and training of independent sales associates. Home Impressions will begin selling the \"Precise Counters\" product line, \"Optima\" and \"Vacu-Queen\" internationally at the retail level.\nCentral vacuum cleaning systems are marketed worldwide under the trade name \"Vacu-Queen\" through retail distributors and under the trade name \"Majestic II\" through direct distributors. The Company also markets the Vacu-Queen to building contractors and developers for installation in newly constructed homes and apartments.\nIn 1994, the Company initiated the direct distribution of a line of environmentally friendly household cleaning products. The line of six products is currently being sold through the Filter Queen network under the brand name `Down to Earth'.\nHousehold Rental Systems (\"HRS\") provides steam cleaners and carpet shampooers for rent to consumers through the Filter Queen direct distribution network under the names \"Easy Off\" in Canada and \"Easy Way\" in the United States. HRS also rents steam cleaners and carpet shampooers to consumers through leading grocery chains, drug stores and hardware stores in Canada. The Company estimates that HRS controls approximately 80% of this market in Canada. Independant direct distributors also rent machines to consumers through in-home delivery and pick up. The Easy-Way and Easy Off product lines are full lines of cleaning solutions for use with HRS products, with other similar products or individually. These products are sold by existing retail and Distributor organizations. HRS products meet strong competition for the steam cleaners and carpet shampooers from seven major competitors, most of which are larger than HRS or are part of larger companies with greater resources than HRS.\nHMI Personal Care Corp. markets the AdvantaJet needle-free insulin injector, the Comfort Care Bed, and other health care products. Customer service is crucial to this product line. Local advertising, telemarketing and seminars are used to reach those consumers who can benefit from the AdvantaJet. HMI Personal Care Corp. works with medical professionals and consumer groups to target the customer base. There are two other devices which compete with the AdvantaJet. The Company owns a number of patents in the United States, Canada, United Kingdom, Japan, and various European countries covering the needleless insulin injectors. Active distributor agreements are in effect to distribute this product in the Japan, Korea, Spain, Italy, France and certain countries in Africa and the Middle East.\nThe Company meets strong competition in the sale of its vacuum cleaners and central vacuum systems. In the case of sales through in-home solicitation, this competition is primarily with vacuum cleaner equipment in use in the home at the time of the sales presentation. In the case of sales through retail vacuum cleaner stores, this competition is with the vacuum cleaner equipment in use in the home at the time of the customer's inquiry and\nwith other brands of vacuum cleaners and central vacuum systems sold by the particular store. There are approximately twenty-one significant vacuum cleaner manufacturers, plus many regional and private label manufacturers, who make over forty brand name vacuum cleaners in the United States. Most of these are sold through department stores, discount houses, appliance shops and by catalog, generally at substantially lower prices than the Filter Queen, and often at lower prices than the Optima and ElektraPure. There are approximately twenty manufacturers in the United States and Canada of central vacuum systems. There are nine companies which compete significantly with the Company in the United States and eight companies which compete significantly with the Company in Canada in distribution of vacuum cleaners by in-home solicitation. Many of its competitors in the sale of vacuum cleaners are substantially larger and have greater resources than the Company. The Company believes that its vacuum cleaners are competitive with other vacuum cleaners because of their performance and warranty. It is the practice of the Company, along with other companies in the vacuum cleaner industry, to maintain significant amounts of inventory to meet the rapid delivery requirements of customers. The Consumer Goods Division of the Company operates without a backlog.\nThe Company's Product Development Department, established to create, engineer and oversee the market launch of new and innovative products, introduced the \"Majestic Triple Crown\" throughout the world in 1994 and the Captiva family of filtration products in 1995. Management believes these products (furnace and air conditioning filters, electrostatic cone filter and a portable room air cleaner) will create unparalleled air filtration in the vacuum cleaner, filtration and other industries. This department also developed the Optima canister vacuum cleaner, introduced in mid-1995.\nThe Company is expanding its parts and service business by utilizing its extensive customer data base to market accessories and new products and services designed as part of the Company's \"Friend for Life\" philosophy. The Direct Support Plus program is designed to maintain contact with customers, encourage add-on sales and generate referrals by utilizing these same data bases and the Distributor network. The parts and service business is expanding overseas.\nThe Company's financing program, through its subsidiaries, Health-Mor Acceptance Corporation and HMI Acceptance Corporation continues to be expanded. Health-Mor Acceptance PTY Ltd. was incorporated in Sydney Australia, to offer consumer financing of the Company's products in that country. Filter Queen distributors cite the program's original objective of increasing dealer retention for its continued value to the distribution network. Risk is limited through agreements between the companies and the distribution network which provide for the disbursement of funds to the distribution network after funds are received by the Company from\nthe customer.\nThe Company holds trademark or trade name registration on the principal trademarks and trade names used by the Consumer Goods Division. These trademarks have been registered in the United States, Canada and other countries in which the Company has distributors which sell a significant number of units. The Company has entered into oral or written distributorship agreements with various companies and individuals throughout the world. The Company owns a number of patents in the United States, Canada and other countries on various features of the Filter Queen, Vacu-Queen and related products. The Company does not believe that its business is materially dependent on any patent or group of patents.\nIn 1995, one customer of the Consumer Goods Division accounted for 12% of the Company's consolidated revenues. American Home, Inc., Tokyo, Japan, is the Company's largest distributor. In the event that this distributor were to go out of business, switch to a competing product or switch to products other than floor care products, and the lost revenues were not replaced by sales to new or existing distributors, the loss could have a material adverse effect on the Company. The relationship with American Home is considered stable. The Company realizes that sales fluctuations can occur in this Distributor's primary market, and such fluctuations, if severe enough, could have a material impact on the Company's revenues.\nManufactured Products - ---------------------\nThe Manufactured Products Division of the Company consists of commercial and industrial stamped components, metal formed tubular products, machined components, tools, dies and specialty products and production of needle-less insulin injection systems.\nCommercial and Industrial Stamped Components - --------------------------------------------\nBliss Manufacturing Company (\"Bliss\"), a wholly-owned subsidiary of the Company, engages in the manufacture of various types of sheet metal stamping and sub-assemblies, and painting and welding in conjunction therewith, for customers in the automotive manufacturing, materials handling equipment, military, and plumbing industries. The products manufactured by Bliss are sold primarily to original equipment manufacturers, mostly in the Midwest.\nIn 1995, as in 1994, Bliss continued to increase its capacity with state-of-the-art technology by adding additional computer controlled presses and a plasma cutting machine. This equipment provides the flexibility to produce low volume and prototype work for customers on a quick turn around basis without the need for costly dies. A new large press line currently being installed in its Newton Falls plant will enhance Bliss' capabilities in this area.\nThe ISO 9002 approval granted to Bliss by Freightliner and Volvo has provided additional opportunities as well for special truck order requests.\nThe customers of Bliss issue releases for parts depending upon their own requirements. Therefore, Bliss operates without a backlog.\nThe business of Bliss is significantly dependent upon several automotive manufacturers. One customer of Bliss, Ford Motor Company, accounted for almost 11% of the registrant's consolidated revenues in 1995. In the event that all Ford Motor Company business were to cease immediately, and the revenues were not replaced with sales to other customers, whether existing or new, the loss could have a material adverse effect on the registrant and its subsidiaries, taken as a whole. However, the registrant believes that its relationship with Ford Motor Company is good and, although it anticipates the loss of business for particular parts from time to time as the products in which those parts are incorporated are discontinued or substantially changed, the registrant believes that it can, at least in part, make up for such losses through existing or new customers.\nMetal Formed Tubular Products - -----------------------------\nTube Form Inc. (\"Tube Form\"), a wholly-owned subsidiary of the Company, engages in the bending and sale of steel, aluminum and copper tubing. Tube Form markets its products principally throughout the United States primarily to industrial consumers in the appliance, vacuum cleaner, machine tool, marine, pneumatic, hydraulic and trucking industries.\nTube Form has begun the manufacture of a new line of products for the consumer marketplace under the name brand name \"Precise Contours.\" Initial product offerings include telescopic flag poles, door and window security bars and a door jam. Other products also include a luggage cart, water broom and a wood rack.\nTube Form experiences strong competition from thousands of competitors, none of whom has any sizable share of the market for such products.\nAggregate sales backlog on September 30, 1995 and 1994 were approximately $3,614,000 and $3,760,000, respectively. It is expected that this operation will fill its entire backlog in the current fiscal year.\nPrecision Tube Formers, a division of Tube Form, operates in similar markets to Tube Form but also supplies tubular assemblies to the aerospace market in the United States.\nTube-Fab Ltd. (\"Tube-Fab\"), a wholly-owned subsidiary of the Company, is engaged in the manufacture of high quality tubular products for the aircraft, military, communications and specialty architectural industries.\nTube-Fab experiences strong competition from numerous competitors, none of whom has any sizable share of the market for such products.\nSales backlog on September 30, 1995 and 1994 was approximately $570,000 and $1,350,000, respectively. It is expected that this backlog will be filled during the current fiscal year.\nTools, Dies and Specialty Machinery - -----------------------------------\nMachined Products Division (\"MPD\"), a division of Tube-Fab, engages in the manufacture and sale of precision machined components for aircraft engines for the aerospace industry. The work performed is primarily subcontract work for engine manufacturers. In addition, MPD continues its work with Spar Aerospace manufacturing components for the Canadarm Joint Motor Modules for the Space Station Freedom. MPD has numerous competitors in the machining field, none of whom has any sizable market share. MPD also manufactures the needless insulin injection system sold by HMI Personal Care Corp.\nSales backlog for MPD as of September 30, 1995 and 1994 was approximately $439,000 and $391,000, respectively. It is expected that this backlog will be filled during the current fiscal year.\nEmployees - ---------\nThe Company and its subsidiaries employed 1,187 persons at September 30, 1995 throughout the world.\nEnvironmental Policies and Controls - -----------------------------------\nTo the best of the Company's knowledge, it is in compliance with all applicable Federal, State and local laws relating to the protection of the environment. It does not anticipate that any laws or regulations relating to the protection of the environment will have any material effect on its earnings, capital expenditures, or competitive position. The Company does not anticipate making any material capital expenditures for environmental control facilities during the current and succeeding fiscal years.\nMethods of Production and Raw Materials - ---------------------------------------\nThe Consumer Goods Division of the Company assembles finished parts purchased from various suppliers. Tube Form and Tube-Fab purchase metal tubing from various suppliers and engage in finishing operations, such as bending, beading and flaring. MPD manufactures needle-less insulin injectors and precision machined parts for the aerospace industry. Bliss purchases steel (both coil and blank) from various suppliers and stamps metal parts for its customers. Bliss also engages in welding and painting of certain parts, including the painting of parts for other companies.\nThe Company and its subsidiaries have good relationships with their suppliers and do not anticipate any problems in obtaining any necessary raw materials or, if necessary, in obtaining alternative sources of supply.\n(d) Financial Information About Foreign and Domestic Operations ----------------------------------------------------------- and Export Sales ----------------\nFinancial information relating to foreign and domestic operations for the years ended September 30, 1995, 1994 and 1993 are set forth in Note 11 (Business Segments) of the Notes to Consolidated Financial Statements found on page 41.\nExecutive Officers of the Registrant - ------------------------------------\nKevin Dow, Vice President-Finance and Administration, is the first cousin of Barry L. Needler, a director.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth by industry segment, the location, character and size (in square feet) of the real estate used in the operations of the Company and its subsidiaries at September 30, 1995:\nTools, Dies & Specialty Machinery - ---------------------------------\n(1) The Company is in the process of moving its production and office facilities to a new location with 210,000 square feet. The old production and office facility of 105,420 square feet will be sold upon the Company vacating the facility.\nThe Company owns a 25,000 square foot building in Lombard, Illinois which was leased during 1994 with an option to purchase at any time under the ten year lease term. Under the terms of the agreement, the lessee is responsible for all operating expenses related to the property and the lease payments equal the debt service for the outstanding indebtedness incurred for the original purchase of the property. All other property owned or leased by registrant is fully utilized by registrant or is leased to third parties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nClaims arising in the ordinary course of business are pending against the Company. Although these are in various stages of the litigation process, management believes that none of these matters will have a material adverse 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\nNot Applicable\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe common stock of the Company was listed and traded on the American Stock Exchange under the symbol HMI through December 19, 1994. On December 20, 1994, the Company ceased to trade on that exchange and moved to the NASDAQ Stock Market under the symbol HMII. As of September 30, 1995, there were approximately 292 stockholders of record.\nA summary of the dividends declared and the quarterly high and low sales price of the Company's common stock on the Nasdaq Stock Exchange or American Stock Exchange for the years ended September 30, 1995 and 1994, are as follows:\nThe declaration and payment of quarterly dividends is at the discretion of the Board of Directors, which may raise, lower or omit the dividend in any quarter. It is expected that dividends will continue to be declared and paid quarterly. Under the terms of the Note Purchase Agreement entered into by the Company in November 1990, dividend payments can not exceed 50% of the cumulative net income of the Company since 1990 over a base amount established in the agreement. The restriction remains in effect until the notes are paid in full in 1997.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(A) The Company adopted a fiscal year ending September 30 during 1991, therefore the Five Year Summary includes data as of and for the years ended September 30, 1995, 1994, 1993 and 1992, and for the nine months ended September 30, 1991. In 1994 the Company acquired the assets of Household Rental Systems. On January 13, 1994 and August 6, 1992 the Company declared 3 for 2 common stock splits in the form of dividends payable February 22, 1994 and September 22, 1992. All share and per share information has been restated to reflect the effects of such splits in the Five Year Summary of Operations.\n(B) Depreciation expense from continuing operations was $2,353,681, $2,043,761, $1,761,731, and $1,707,279 for the years ended September 30, 1995, 1994, 1993 and 1992 respectively, and $1,216,491 for the nine months ended September 30, 1991.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nThe working capital balance at September 30, 1995 was $25,607,000 an increase of 12% from the September 30, 1994 balance of $22,941,000 and an increase of 41% from the September 30, 1993 balance of $18,189,000.\nThe effect of foreign exchange fluctuations is primarily limited to the Canadian and Mexican operations. The Consolidated Statements of Cash Flows incorporates the effects of foreign exchange in each of the categories presented. The impact of the devaluation in Mexico during the year of $1,700,000 has been reflected as a component of equity based on the nature of the Company's investment and intended timing of repayment of the amounts due. The value of the Mexican Peso versus the US dollar continues to fluctuate. In managements' opinion, the amount of additional adjustments, if, any, would not have a material effect on consolidated shareholders' equity.\nThe Company's cash decreased $119,000 during the year ended September 30, 1995. Accounts receivable increased by $2,306,000 and finance contracts receivables increased by $278,000. These increases reflect the sales growth in the Consumer Goods Division, particularly in international markets. Finance Contracts Receivable increases (non-current increased by $980,383) reflect the success of this program in assisting and in supporting the Company's distribution channel in Australia, Canada, Mexico and the United States of America. This amount was reduced as stated above, due to the devaluation of the Mexican Peso during the year. Inventories increased by $1,896,000 on account of the introduction of Optima, Captiva and Empress products in the Consumer Goods Division and planned increases in finished goods to meet Consumer Goods Division demand. Unamortized trademarks of $1,557,000 represent amounts paid at the time of the Household Rental Systems acquisition which will be expended during the remainder of the term of the license agreements. Accounts payable increased by $435,000, due to the increases in amounts payable to the participants in the Consumer Goods Division distribution channel as funds are collected on finance Contracts Receivable in inventories and on account of the increase in inventories.\nAt September 30, 1995, $5,000,000 of the unsecured, 9.86%, seven year private placement term notes were outstanding. This debt, obtained in November 1990 to finance the acquisition of Bliss Manufacturing Company, requires annual principal payments in November of each year of $1,666,667 through 1997.\nCapital expenditures during 1995 were $4,807,000, compared to $4,070,000 in 1994. In 1995, capital expenditures in the Consumer\nGoods operation were $2,712,000 and in the Manufactured Products Division $2,095,000. The largest addition during the year was the acquisition of a 210,000 square foot facility in Cleveland to relocate the production and assembly operations of the Consumer Goods Division and the Company's corporate activities. Amounts expended in this regard totaled $690,000. Capital acquisitions in the Household Rental Systems operations were $515,000 for steam cleaning and shampooing machines to increase the fleet of rental machines and begin the distribution of these machines in the USA market. New product tooling investments were $375,000 and tooling replacement costs totaled $197,000. During the year, the Company invested $228,000 in modifications and improvements to the computer hardware and software acquired in 1994. During the year the new filter cone manufacturing machine was completed at a total cost of $450,000 (of which $60,000 remains to be paid). Additions in the Manufactured Products Division include $622,000 to prepare the Bliss Manufacturing building in Newton Falls, Ohio for a new press line for additional capacity. Among the larger assets added at Bliss' stamping operations were three used 1,000 ton presses ($186,000), a turret punch press ($356,000), a plasma cutter ($113,000), and a brake press ($50,000), all of which add capacity for work received in 1995 and in anticipation of work targeted in upcoming periods. Other additions in this operation include $105,000 of building additions and improvements and $98,000 for various computer upgrading and office additions. Expenditures in the tubular products group were $86,000 for an automatic tube cutting machine, $41,000 for tooling upgrades and $68,000 for building improvements.\nThe Company plans to continue making improvements to its recently acquired facility and plans on spending up to $3,000,000 during the next twelve months on improvements and modifications thereto. The date of relocation from the Company's existing Cleveland production facilities will take place in the second fiscal quarter of 1996. The Company has sold the existing facility which is set to close on January 31, 1996 and provide proceeds of approximately $500,000.\nThe outstanding balance on the Company's line of credit was $9,704,000 at September 30, 1995, which bears interest at a half of a percent less than the prime lending rate. This facility was renegotiated in 1995 for $13,000,000 and is available through May 1997. The 1993 financing of the acquisition of Household Rental Systems was accomplished through the utilization of $5,000,000 of the line of credit. Interest expense for 1995 was primarily related to the Private Placement unsecured term notes and borrowing on the line of credit. Other interest relates to the Industrial Revenue Bonds on the Lombard property, interest on capital leases and interest paid on Distributors deposits.\nManagement believes the Company's long-term liquidity needs will continue to be met by cash flow from operations, its access to the line of credit, and its potential to borrow from existing debt sources.\nRESULTS OF OPERATIONS 1995 COMPARED WITH 1994\nNet revenues for the twelve months in 1995 were $137,595,000 as compared to $134,987,000 in 1994 while operating income decreased from $10,985,000 to $9,479,000 in 1995. The continued erosion of the Mexican economy and its effect on sales and profits from the Mexican business, operating inefficiencies at the Company's Tube Form operations and the labor disruption at the Bliss Manufacturing operation during the last quarter combined to offset the growth experienced in the Consumer Goods Division business throughout Asia, Europe and the USA. The swift devaluation of the peso in Mexico and the subsequent collapse of the Mexican consumer economy caused a rapid sales decline and necessitated the write-off of receivables and consumer financing paper. Management estimates that these events reduced revenues by over $3.0 million and operating income by over $1.5 million. In order to hedge against further currency declines, a plan to produce carpet shampoo (rental) machines in Mexico was implemented in 1995. Although the Mexican situation has stabilized, an immediate turnaround in the economy there is not expected. Additionally, the Company's Tube Form operation experienced a decline in profitability due to the erosion of its efficiency of operations and corresponding cost increases. Management estimates that these developments reduced operating income by $1,050,000 in 1995. Plans to restructure Tube Form, thereby reducing operating and overhead costs, will be finalized and implemented in early 1996.\nThe Company's gross margin on its entire operations were 32% as compared to 31% in 1994. Gross margins in the Consumer Goods Division were 43% (44% in 1994) and 18% in the Manufactured Products Division (unchanged from 1994). The slight decline in the Consumer Goods Division gross margin is due to the decline in the Mexican market which has historically had higher gross margins due to the fact that the Company owns the entire distribution channel, unlike the remainder of the operation. Generally, the effects of inflation on costs have not been a significant factor to the Company. For the most part, cost increases continue to follows the trend of inflation and the Company has been able and continues to be able to pass these increases through in the form of price increases without any significant effect on sales volume. In the minority of cases where there is customer resistance to raising prices due to increased costs, the Company has successfully pursued, in some cases, materials substitution to accomplish comparable gross margins.\nSelling, general and administrative expenses as a percentage of revenues were 26% in 1995 as compared to 23% in 1994. Selling expenses increased over 1994 as a result of the entry into new markets and to support the launch of new programs on a global basis.\nOther income consists of interest earned on cash balances and royalty income.\nCosts associated with non-compete agreements arising from acquisitions were expensed during the year leaving no unamortized costs at September 30, 1995, as compared to $400,000 at September 30, 1994.\nThe effective tax rate for 1995 was 27% as compared to 33% for 1994. The 27% rate includes the benefit of tax loss carry forwards in Mexico due to the Company's implementation of a strategy to produce in Mexico the steam and shampooing machines previously purchased from a third party and used in existing Household Rental Systems business and to be used in the expanding USA market. It is anticipated that for 1996 the effective tax rate for the company will approach a more normalized rate of 37%.\nRESULTS OF OPERATIONS 1994 COMPARED WITH 1993\nNet Sales for the twelve months in 1994 were $134,987,000 as compared to $100,827,000 in 1993. The Manufactured Products Division continues to show solid growth in the Commercial and Industrial stamping operations. Consumer Goods Division revenues continue to grow through increased market penetration in existing markets, continued success in the Mexican operations and expansion abroad.\nDue to the mandate of the Financial Accounting Standards Board of Standard No. 109 - Accounting for Income Taxes, the Company included a one- time gain of $719,016 in Net Income.\nThe Company's gross margin on its entire operations increased to 31% compared to 30% in 1993. Gross Margins in the Consumer Goods Division were 44% (40% in 1993) and 18% in the Manufactured Products Division (19% in 1993). The increase in gross margin in the Consumer Goods Division reflects the change of product mix by the addition of Household Rental Systems and the growth of the Mexican operations.\nCost increases followed the trend of inflation and the Company was able to pass these increases through in the form of price increases without any significant effect on sales volume.\nSelling, general and administrative expenses as a percentage of sales from continuing operations was 23% in 1994 compared to 20% in 1993. The increase in selling costs are attributable to the growth in the Mexican operations and the addition of the Household Rental\nSystems operations, both sales activities contribute the highest gross margins in the Company.\nOther income includes interest earned on cash balances and royalty income.\nThe Company recorded $400,000 of amortization related to non-compete agreements arising from acquisitions. There remained $400,000 of unamortized amounts for these non-compete agreements at September 30, 1994.\nThe effective tax rate for 1994 was 33% as compared to 34% for 1993. The 33% rate includes tax refunds received. The 34% rate includes a 2.6% benefit from the application of all available foreign tax credits taken in 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReference is made to the Index to Financial Statements included on page of this report.\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 Registrant\nSee Item 13.\nItem 11.","section_11":"Item 11. Executive Compensation\nSee Item 13.\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\nInformation provided under the captions \"Principal Holders of Voting Securities,\" \"Election of Directors,\" \"Committees and Compensation of the Board of Directors\", \"Security Ownership of Directors and Management\", \"Executive Compensation\", and \"Related Transactions\" in the Proxy Statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference. See \"Executive Officers of the Registrant\" following Item 1 in this Report for information concerning executive officers.\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 Reference is made to the Index To Financial Statements, included as page 27 of this report.\n2. Financial Statement Schedules Reference is made to the Index To Financial Statements, included as page 27 of this report.\n3. Exhibits Reference is made to the Index To Exhibits, included as page 46 of this report.\n(b) Reports on Form 8-K. No report on Form 8-K was filed during the last quarter of 1995.\n(c) Exhibits Reference is made to the Index To Exhibits, included as page of this report.\n(d) Financial Statement Schedules. 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.\nHMI INDUSTRIES INC. (Registrant)\nJanuary 4, 1996 by \/s\/Kevin Dow --------------------------- KEVIN DOW Vice President - Finance and Administration and Principal Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ Kirk W. Foley - ------------------------ KIRK W. FOLEY Chairman, Chief Executive Officer and Director\n01\/04\/96 - -------- Date\n\/s\/ Robert J. Abrahams \/s\/ Donald L. Baker - ---------------------- -------------------- ROBERT J. ABRAHAMS DONALD L. BAKER Director Director\n01\/04\/96 01\/04\/96 - -------- -------- Date Date\n\/s\/ Moffat Dunlap \/s\/ Grace McCarthy - -------------------- ------------------- MOFFAT DUNLAP GRACE MCCARTHY Director Director\n01\/04\/96 01\/04\/96 - -------- -------- Date Date\n\/s\/John S. Meany Jr. \/s\/ Barry L. Needler - -------------------- ---------------------- JOHN S. MEANY, JR. BARRY L. NEEDLER Director Director\n01\/04\/96 01\/04\/96 - -------- -------- Date Date\n\/s\/Frank Rasmussen \/s\/ Ivan Winfield - -------------------- ------------------ FRANK RASMUSSEN IVAN WINFIELD Director Director\n01\/04\/96 01\/04\/96 - -------- -------- Date Date\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 consolidated financial statements, the notes thereto or in Management's Discussion and Analysis of Financial Condition and Results of Operations.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders, HMI Industries Inc.\nWe have audited the accompanying consolidated balance sheets of HMI Industries Inc. and its subsidiaries 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 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HMI Industries Inc. and its 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.\nAs described in Notes 1 and 8 to the Consolidated Financial Statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in 1994.\n\/s\/ Coopers & Lybrand L.L.P. Cleveland, Ohio December 15, 1995\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nFOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of HMI Industries Inc. (\"the Company\") and the following wholly-owned subsidiaries; Tube Form, Inc. (Tube Form), Tube-Fab Ltd. (Tube-Fab), Bliss Manufacturing Company (Bliss), Health-Mor B.V., Health-Mor International, Inc., HMI Incorporated (HMI Inc.), Health-Mor Acceptance Corporation, HMI Acceptance Corporation, Health-Mor Acceptance Pty. Ltd., Health-Mor Mexicana S.A. de C.V., HMI Personal Care Products, Home Impression Inc. And experimental Distributing Inc. All material intercompany transactions have been eliminated in the consolidated financial statements.\nCASH EQUIVALENTS\nCash equivalents consist of short-term highly liquid negotiable instruments with a maturity within 90 days from the date of purchase.\nCOST IN EXCESS OF NET ASSETS OF ACQUIRED BUSINESSES\nCost in excess of net assets of acquired businesses are being amortized on a straight-line basis over a 40-year period. Cost in excess of net assets acquired of $881,121 which related to the acquisition of Tube Form in 1970 will not be amortized unless there is a decrease in its value.\nThe Company regularly assesses the aggregate carrying value of such excess based upon the profitability and performance of the acquired businesses. If there is a diminution in value, recorded balances will be adjusted.\nINVENTORIES\nInventories are stated at the lower of cost or market and are valued using the last-in, first-out (LIFO) and the first-in, first out (FIFO) cost methods. Inventories on the LIFO method were 54.0% and 55.8% of inventories in 1995 and 1994, respectively. If the FIFO method had been used for all inventories, their value would have been approximately $18,496,000 and $16,758,000 at September 30, 1995 and 1994, respectively.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are recorded at cost. Depreciation is provided on the straight-line and declining balance methods over estimated useful lives of 10 to 40 years for buildings and improvements and 3 to 10 years for machinery and equipment. Improvements which extend the useful life of property, plant and equipment are capitalized, and maintenance and repairs are expensed. When property, plant and equipment is retired or othwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.\nINCOME TAXES\nThe Company accounts for income taxes pursuant to the provisions of Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" SFAS 109 was adopted on October 1, 1993 and applied prospectively from that date. Under SFAS 109, the tax consequences in the future years for differences between the financial and tax basis of assets and liabilities at year end are reflected as deferred income taxes. The impact of adopting SFAS 109 was an increase in net income of $719,016 or $.15 per share in fiscal 1994.\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nCash paid for interest was $1,477,552, $1,417,816, and $1,156,111 for the years ended September 30, 1995, 1994 and 1993, respectively. During 1994, the Company acquired approximately $941,000 of fixed assets which were financed through capitalized lease obligations. During 1995, the Company acquired approximately $470,000 of fixed assets which were not paid for as of September 30, 1995. Additionally, approximately $754,000 of accounts receivable were converted to notes receivable.\nINCOME PER SHARE\nOn January 13, 1994, the Board of Directors declared a 3 for 2 common stock split in the form of dividends payable on February 22, 1994. All share and per share information has been restated to reflect the effect of such split.\nIncome per share of common stock is based upon the weighted-average number of common shares and common share equivalents outstanding. The weighted-average number of common shares and common share equivalents outstanding during 1995, 1994 and 1993 was 4,876,599, 4,888,395 and 4,851,192 respectively.\nRECLASSIFICATION\nCertain prior year amounts have been reclassified to conform to the 1995 presentation.\n2. DISCONTINUED OPERATIONS\nOn January 26, 1989 the Company adopted a formal plan to discontinue the operations of HMI Credit, a wholly-owned subsidiary, and to dispose of all related assets. During the fiscal period ended September 30, 1991, all records were transferred to storage and the building in Lombard, Illinois was closed. During the year ended September 30, 1993, the real estate market in the greater Chicago area required that management review the carrying value of the property. A write down of $450,000 ($297,000 net of tax) was recorded and is reflected as a loss from discontinued operations. During the fiscal year 1994 and continuing throughout 1995, the property was leased to a third party, with an option to purchase at any time during the ten year lease term. The tenant is responsisble for all operating expenses related to the property and the lease payments equal the debt service for the variable rate industrial revenue development bonds originally issued to finance the property. The minimum lease payments under the\nterms of the agreement approximate $144,000 per year for the next five years. The related bonds are payable in equal monthly installments of $12,000, including interest at 5.4% with the final installment due May 1, 2004.\nThe land and building have been reclassified to fixed assets and the debt obligation has been included in its respective long-term categories in the accompanying financial statements.\n3. NOTES RECEIVABLE\nLong-term notes receivable consist of the following:\n4. ACCRUED EXPENSES AND OTHER LIABILITIES\nAccrued expenses and other liabilities consist of the following:\n5. LINE OF CREDIT\nThe Company has a $13,000,000 line of credit with a bank at prime less 1% (7.75% at September 30, 1995) of which $9,704,384 was outstanding at September 30, 1995. The commitment is available through May, 1997, and $7,500,000 of the outstanding amount has been classified as long-term debt as of September 30, 1995. Commitment fees for unused amounts on the line of credit are insignificant.\n6. LONG-TERM DEBT\nLong-term debt consists of the following:\nThe principal amount of long-term debt payable in the five years ending September 30, 1996 through 2000 is $2,026,759, $9,551,571, $2,050,778, $279,942 and $120,172, The weighted average interest rate on short term borrowing at September 30, 1995 and 1994 was 8.41% and 9.13%, respectively. The Company believes the Bank line of credit will be renewed upon its expiration in May, 1997. The seven year promissory notes and the Bank line of credit contain various covenants pertaining to maintenance of certain financial ratios. In addition, dividend payments can not exceed 50% of the cumulative net income since 1990 over a base amount established by the promissory note agreements.\n7. LONG-TERM COMPENSATION PLAN\nThe Company adopted the Helath-Mor Inc. 1992 Omnibus Long-Term Compensation Plan (\"Plan\") in 1992. The Plan provides for the granting of stock options, stock appreciation rights, restricted stock awards, phantom stock and\/or performance shares to key employees of the Company and its Subsidiaries and stock options for the non employee directors of the Company. Options granted under the plan expire up to ten years after the date of grant if not exercised and may be exercisable in whole or in part at the discretion of the Committee established by the Board of Directors. The option price may not be less than the fair market value at the date of the grant. Additional information regarding shares subject to option is as follows:\nAt September 30, 1995, 225,000 shares were reserved for the plan. The Company does not expect to adopt the recognition provisions of the recently issued SFAS No. 123 \"Accounting for Stock-Based Compensation\". Disclosures required by new accounting standard will be included in future financial statements pursuant to the effective date criteria.\n8. INCOME TAXES\nThe provision for income taxes relating to continuing operations consists of the following:\nA reconciliation of the provision for income taxes at the Federal statutory rate to that included in the Consolidated Statements of Income related to earnings from continuing operations is as follows:\nEffective October, 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The new requirements resulted in a \"cumulative adjustment from a change in accounting principle\" of $719,016, representing reversal of amounts previously expensed. The statement was applied prospectively, and prior year financial statements have not been restated.\nThe components of deferred tax assets and liabilities are comprised of the following at September 30,\nThe most significant impact of this pronouncement was the consideration of the need to provide a valuation allowance for the Company's deferred tax asset. The Company has determined that it should fully reserve against this potential tax asset to the extent it represents excess available tax net operating loss carryforwards for certain foreign subsidiaries and divisions. Accordingly, such benefits will be realized only as, and if, they are used to reduce future tax expense. The Mexican NOL was recognized as an asset in 1995 due to revised operating plans contractually guaranteed for that unit. Object to evaluation of the continuing need for such valuation allowance, or until fully realized. Income taxes paid during the years ended September 30, 1995, 1994 and 1993 were $1,622,986, $3,543,281 and $1,923,295, respectively. In October, 1993, the Company agreed to modifications in its federal income tax returns filed for the years 1988 to 1990 resulting from an Internal Revenue Service audit. The proposed adjustments included a foreign tax credit carryforward of approximately $200,000 ($.06 per share) which was utilized for the year ended September 30, 1993.\nForeign net operating loss carryforwards (including Mexico) approximately $2,627,000 for tax are available to offset future taxable income. The carryforwards will expire in 2003 through 2010. Undistributed earnings of foreign subsidiaries are reinvested in their operations and therefore, no provision is made for additional income taxes that might be payable on such earnings.\n9. PROFIT SHARING AND PENSION PLANS\nBliss and Tube Form have defined contribution plans which cover substantially all employees. The Bliss plan contribution is at management's discretion and is allocated based on a percentage of each employee's wages. The Tube Form plan requires an annual contribution of a specified percentage of each employees wage, with a minimum contribution of $660 per employee. The Company and Tube-Fab have qualified profit sharing plans which cover substantially all employees. The overall contribution to the Company's plan and the allocation method is at the discretion of the Board of Directors. The allocation to the participants is based on either a fixed amount per participant, a percentage of eligible wages, or a combination of a fixed amount and a percentage of eligible wages. The required annual contribution to the Tube-Fab plan is based upon a percentage of net income after certain adjustments. The allocation to the participants is based upon a formula established in the plan. Profit sharing and pension plan expense for all plans for the years ended September 30, 1995, 1994 and 1993 was $1,042,741, $1,547,125 and $1,304,650, respectively.\n10. COMMITMENTS AND CONTINGENCIES GUARANTEES AND LEASES\nThe Company has guaranteed certain surety bonds totalling $1,260,000 executed by distributors. The Company is obligated under certain operating leases for facilities which expire on various dates through 1995. The minimum annual lease payments under these agreements including renewal options, if exercised, are $97,284, $82,936, $82,936 and $58,746 for the years ending September 30, 1996, 1997, 1998 and 1999, respectively. Rental expense for all leases and other short-term needs was $756,000, $919,000 and $562,000 for the years ended September 30, 1995, 1994 and 1993, respectively.\nLITIGATION\nVarious claims arising in the ordinary course of business are pending against the Company. In the opinion of management none of these matters will have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company.\nEXECUTIVE COMPENSATION AGREEMENT\nDuring 1994, the Company negotiated a five year Compensation Agreement with the Chief Executive Officer, Kirk W. Foley which was ratified at the 1995 Annual shareholders' Meeting. The Agreement combines salary, incentive compensation, loans, stock options and Phantom Stock to employ Mr. Foley and emphasize the Company's objectives of maintaining a stable, long-term organization, increasing shareholder liquidity, expanding the Company's equity base and focusing efforts on increasing the return on capital employed.\n11. BUSINESS SEGMENTS\nAssets and liabilities are translated at current exchange rates, and income and expenses are translated using weighted average exchange rates. The effects of these translation adjustments, as well as gains and losses from certain intercompany transactions, are reported in a separate component of shareholders' equity. Such adjustments will affect net income only upon sale or liquidation of the underlying foreign investments, which is not contemplated at this time. Exchange gains and losses from transactions in a currency other than the local currency of the entity involved are included in income. Net transaction and translation adjustments are not significant.\nCanadian and Mexican sales are not considered export sales. The Company's major foreign operations are located in Canada and Mexico. Business activities are conducted principally in local currency. Identifiable assets of Canadian and Mexican operations were $14,319,414 and $15,937,169 at September 30, 1995 and 1994, respectively. Identifiable revenues of Canadian and Mexican operations for the years ended September 30, 1995, 1994 and 1993 were $18,687,652, $21,618,946 and $11,746,724, respectively. Sales by the Manufactured Products segment to two customers were approximately 19% and 25% of the Company's total sales in 1995 and 1994, respectively. Sales to one customer in the Consumer Goods segment represent 12% and 8% of the Company's total sales in 1995 and 1994 respectively. At September 30, 1995 and 1994, the Company's receivables from companies in the automotive industry were approximately 9% and 23%, respectively, of the consolidated receivables.\n12. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe first three quarters of 1995 have been restated as shown above. Inventory analysis revealed\nthat costs in the Tubular operations were understated for some items previously sold under contract and erroneous accounting entries relating to inventory errors from the Consumer Goods business unit. These errors occurred during fiscal 1995 and have been resolved.\n13. RELATED PARTY TRANSACTIONS\nOn October 15, 1991, the Company purchased for $139,000 certain computer equipment, computer software, and other assets from JCL Medical Systems Ltd. (JCL) based on independent appraisals. These assets are used in management of the Company's databases for Warranty Registration, Mail Order Programs and Distributor\/Dealer Performance activities. At that time JCL was owned by two directors of the Company. At the same time, the Company entered into a four year agreement with JCL to provide computer program and supervision services, all of which relate to the maintenance and processing of the aforementioned databases for $168,000. These services were previously paid for on a monthly basis as incurred.\nThe Company pays Fairway Inc., a corporation controlled by a director of the Company, an annual consulting fee of $100,000 for assisting in obtaining professional advice on Company matters. In 1989, the Company advanced $203,401 to three companies which were controlled by two directors of the Company. In accordance with the terms of the agreement of these advances, collectibility is assured by these directors or corporations they control. The advance bears interest a Canadian prime plus one and one-half percent (9.5% at September 30, 1995). The balance of $295,587 is reflected in current assets as a note receivable at September 30, 1995.\nIn 1988, the Company loaned Amherst Tanti U.S. Inc., a corporation owned by an officer of\nthe Company, $334,123, which is reflected in other assets as long-term note receivable at September 30, 1995. This note shall be forgiven in the future if the net income of the Company reaches certain specified levels.\n14. MAJOR VENDOR\nIn 1991, the Company entered into an agreement that provided for the potential acquisition of Holland Electro B.V. of Rotterdam, the Netherlands, contingent upon attaining certain earnings targets in the two year period ended September 30, 1992. These earnings targets were not reached and accordingly, no consideration was paid. The Company has the ability, at its sole discretion, to effect the acquisition of Holland Electro B.V., in the future for no consideration. The Company has also entered into various agreements with Holland Electro B.V. to provide for the supply of certain floor care products for the Company's non-direct marketing channel. The agreements include the purchase of machinery and equipment, tooling, intellectual property and patents, licensing and distribution arrangements, warehousing and technical support. Holland Electro B.V. will supply Elektra Pure to the Company for North American distribution, and additional products to other world markets utilizing the tooling and intellectual property purchased by the company. The total consideration paid by the Company for these assets was $503,000. In addition, the licensing and distribution agreements require Holland Electro B.V. to pay the Company one Netherlands Guilder for each unit manufactured and the Company is obligated to pay Holland Electro B.V. $2.50 for each Holland Electro B.V. product sold by the Company. Net royalty revenue accrued by the Company was $22,000 in 1995, $25,000 in 1994 and $36,000 in 1993. The Company has paid in advance for inventory to be acquired from Holland Electro B.V. The advances, royalties and other receivables total $1,607,000 at September 30, 1995. During 1995 and 1994, the Company purchased $348,000 and $78,000 respectively, of product from Holland Electro B.V.\nDuring 1992, the Company completed the purchase of certain electric motor production equipment from Holland Electro B.V. for $406,000. The Company continues to negotiate the sale of these assets to a third party.\nThe Company is contingently liable under a Conditional Purchase Agreement to Holland Electro B.V.'s bank in the amount of $1,200,000. If the contingent liability were called upon by the bank, the Company would take possession of finished goods and work in progress inventories and sell them into existing markets. In addition to the ongoing supply of the aforementioned products, the Holland Electro B.V. Rotterdam facility performs the services of a distribution center for the Company's European market. In addition to warehousing, the center manages the handling and documentation associated with all incoming and outbound shipments. Other activities include assistance with European regulatory approvals and providing office space and communication facilities for the Company's management. For these services, the Company has contracted with Holland Electro B.V. to pay approximately $33,000 monthly.\n15. ACQUISITION\nOn December 1, 1993, the Company purchased all of the assets of the Household Rental System Division of Reckitt & Colman Canada, Inc. for $4,875,000 utilizing internal cash and the Company's line of credit facility. In addition, a contingent Earn Out of $1,650,000 may be paid over a ten year period dependent upon business expansion and revenue generation. Household Rental Systems rents carpet cleaning machines and sells products to homeowners primarily through retail stores in Canada. The Agreement includes a license right for various time periods in Canada and the U.S. to the Easy-Off brand names in carpet care applications, which is owned by Reckitt & Colman (Overseas) Ltd. The amounts assigned to these agreements are being amortized over the life of the agreements. The accumulated amortization for these agreements as of September 30, 1995 and 1994 was $1,932,017 and $963,546, repectively.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"808264_1995.txt","cik":"808264","year":"1995","section_1":"Item 1. Business Mortgage Securities III Trusts A, B, C, D, E and F (the \"Trusts\") were established under the laws of Delaware by a trust agreement. Prior to December 27, 1987, the trust agreement was among Mortgage Securities III Corporation, Weyerhaeuser Real Estate Company and Wilmington Trust Company. On December 27, 1987, Weyerhaeuser Real Estate Company dividended its beneficial interests in Mortgage Securities III Trusts A, B, C, D, E and F to Weyerhaeuser Company. The Trusts were organized to, and are engaged to raise funds through the issuance and sale of Collateralized Mortgage Obligation bonds collateralized by Government National Mortgage Association (GNMA) and Federal National Mortgage Association (FNMA) certificates. The Trusts A, B, C, D, E and F were established on April 8, 1986 and commenced business on June 30, 1986, September 30, 1986, December 30, 1986, February 27, 1987, December 22, 1987 and March 30, 1988, respectively.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties The Trusts A, B, C, D, E and F have no physical properties.\nItem 3.","section_3":"Item 3. Legal Proceedings The Trusts A, B, C, D, E and F are not a party to any material pending proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders Omitted pursuant to General Instruction J(2)(c) of Form 10-K.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Beneficial Interest and Related Security Holder Matters\nAs of March 15, 1996, the Trusts' beneficial interest is owned by Mortgage Securities III Corporation and is not traded on any stock exchange or on the over-the-counter market.\nItem 6.","section_6":"Item 6. Selected Financial Data\nOmitted pursuant to General Instruction J(2)(a) of Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nBusiness activity during 1995, 1994 and 1993 consisted of the collection of principal and interest by the trustee on the GNMA and FNMA certificates and the disbursement of the required payment of interest and principal to the bondholders.\nIn December 1986, the Financial Accounting Standards Board issued Statement No. 91, which established a new method of accounting for nonrefundable fees and costs associated with purchasing a group of loans and the method of recognizing interest income and expense. This statement is applicable to all transactions entered into for fiscal years beginning after December 15, 1987. Retroactive application with restatement of the financial statements for all years presented was optional. Upon evaluation of this accounting statement and the current method of accounting, the Company elected to adopt Statement No. 91 prospectively for Trusts E and F. Under the new standard all discounts and hedging costs will be recognized over the contractual life of the loan as a yield adjustment. The Company elected not to adopt Statement No. 91 retroactively for Trusts A, B, C and D. Since no transactions have been entered into after the effective date of this statement, the Company will continue to use its current method, which approximates the effective interest method, for Trusts A, B, C and D.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements of the Trusts, together with the related Notes to Financial Statements and Report of Independent Public Accountants, for the three years ended December 31, 1995, are included herein.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosures\nThere was no change in accountants, nor any material disagreement with accountants on any matter of accounting principles, practices or financial statement disclosures, during the year ended December 31, 1995.\nPART III Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant Omitted pursuant to General Instruction J(2)(c) of Form 10-K. Item 11.","section_11":"Item 11. Executive Compensation 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 Omitted pursuant to General Instruction J(2)(c) of Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions 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) The following documents are filed as part of this report:\n(1) Financial Statements:\nReport of Independent Public Accountants.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust A.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust B.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust C.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust D.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust E.\nStatements of Operations for the Three Years Ended December 31, 1995 Trust F.\nBalance Sheets as of December 31, 1995 and December 25, 1994 Trust A. Balance Sheets as of December 31, 1995 and December 25, 1994 Trust B. Balance Sheets as of December 31, 1995 and December 25, 1994 Trust C. Balance Sheets as of December 31, 1995 and December 25, 1994 Trust D. Balance Sheets as of December 31, 1995 and December 25, 1994 Trust E. Balance Sheets as of December 31, 1995 and December 25, 1994 Trust F.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust A.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust B.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust C.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust D.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust E.\nStatements of Changes in Owner's Beneficial Interest for the Three Years Ended December 31, 1995 Trust F.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust A.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust B.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust C.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust D.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust E.\nStatements of Cash Flows for the Three Years Ended December 31, 1995 Trust F.\nNotes to Financial Statements for the Three Years Ended December 31, 1995\n(2) Financial Statement Schedules:\nSchedule IV-Indebtedness to Related Parties - Not Current Trust E\nSchedule IV-Indebtedness to Related Parties - Not Current Trust F\nSchedule XIII - Other Security Investments Trust A Schedule XIII - Other Security Investments Trust B Schedule XIII - Other Security Investments Trust C Schedule XIII - Other Security Investments Trust D Schedule XIII - Other Security Investments Trust E Schedule XIII - Other Security Investments Trust F\n(3) Exhibits:\nCertificate of Incorporation of Mortgage Securities III Corporation (incorporated by reference to 3(a) to Registration Statement on Form S-11 dated December 18, 1985).\nBylaws of Mortgage Securities III Corporation (incorporated by reference to Exhibit 3(b) to Registration Statement on Form S-11 dated December 18, 1985).\nForm of Indenture dated June 1, 1986 between the Trust and Texas Commerce Bank National Association, as Trustee, relating to GNMA and FNMA Collateralized Mortgage Obligations (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-11 dated December 18, 1985).\nForm of Supplemental Indenture dated as of June 1, 1986 (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-11 dated July 11, 1986).\n(b) Exhibits are included in Item (a)(3) above.\n(c) Financial Statement Schedules required by Regulation S-X are included in Item (a)(2) above.\nSIGNATURE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 19th day of January 1996.\nMORTGAGE SECURITIES III TRUSTS A, B, C, D, E AND F Trusts acting through Wilmington Trust Company, not in its individual capacity, but solely as Owner Trustee\nBy:\/s\/ John M. Beeson, Jr.\nName: John M. Beeson, Jr.\nTitle: Vice President\nReport of Independent Public Accountants\nTo the Beneficial Owner of Mortgage Securities III Trusts A, B, C, D, E and F\nWe have audited the accompanying balance sheets of Mortgage Securities III Trusts A, B, C, D, E and F (trusts established under the laws of the State of Delaware) as of December 31, 1995 and December 25, 1994, and the related statements of operations, changes in owner's beneficial interest, and cash flows 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 Trust's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mortgage Securities III Trusts A, B, C, D, E and F, as of December 31, 1995 and December 25, 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 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 our audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP\nLos Angeles, California January 19, 1996\nMortgage Securities III Trusts A, B, C, D, E and F Notes to Financial Statements For the Three Years Ended December 31, 1995\n(Dollar amounts in thousands)\nNote 1. Description of business: Mortgage Securities III Trusts A, B, C, D, E and F (the \"Trusts\") were established under the laws of Delaware by a trust agreement. Prior to December 27, 1987, the trust agreement was among Mortgage Securities III Corporation, Weyerhaeuser Real Estate Company and Wilmington Trust Company. On December 27, 1987, Weyerhaeuser Real Estate Company dividended its beneficial interests in Mortgage Securities III Trusts A, B, C, D, E and F to Weyerhaeuser Company which in turn contributed its beneficial interests in the Trusts to Weyerhaeuser Financial Services, Inc., a wholly-owned subsidiary of Weyerhaeuser Company. The Trusts were organized to, and are engaged to raise funds through the issuance and sale of Collateralized Mortgage Obligation bonds collateralized by Government National Mortgage Association (GNMA) and Federal National Mortgage Association (FNMA) certificates. The Trusts A, B, C, D, E and F were established on April 8, 1986 and commenced business on June 30, 1986, September 30, 1986, December 30, 1986, February 27, 1987, December 22, 1987 and March 30, 1988, respectively.\nActivity during 1995, 1994 and 1993, consisted of the collection of principal and interest on the GNMA and FNMA certificates and disbursement of the required payment of principal and interest to the bondholders. Note 2. Accounting policies: 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 reporting period. Actual results could differ from those estimates.\nTrust A, B, C and D's GNMA and FNMA certificates are carried at par value adjusted for any unamortized premiums or discounts. These premiums and discounts are amortized using a method approximating the effective interest method over the estimated life of the underlying mortgage loans. The Bonds are carried at par value less unamortized discounts. These discounts are amortized using a method approx- imately the effective interest method over the estimated life of the Bonds. Due to prepayments on the underlying mortgage loans, revisions are made each quarter to the remaining period to maturity of the certificates and the Bonds. The amortization described above reflects these revisions.\nTrust E's GNMA certificates and Trust F's GNMA and FNMA certificates are carried at par value less unamortized discounts. These discounts are amortized using an interest method which computes a constant effective yield and includes estimates of future prepayments on the certificates in the calculation of the constant effective yield. Hedging costs related to holding GNMA and FNMA certificates have been deferred and are also being amortized using the interest method and includes estimates of future prepayments on the certificates in the calculation of the constant effective yield. The Bonds are carried at par value less unamortized\ndiscounts. These discounts are amortized using the interest method and include estimates of future prepayments on the Bonds in the calculation of the constant effective yield. Semi-annually differences between anticipated future prepayments and actual prepayments are calculated. The effective yield is then recalculated to reflect actual prepayments to date and anticipated future prepayments. The unamortized discounts and accumulated hedging amortization are adjusted (with a corresponding charge or credit to interest income\/expense) to reflect the amount that would have existed had the new effective yield been applied since the purchase of certificates and\/or issuance of Bonds.\nIn December 1986, the Financial Accounting Standards Board issued Statement No. 91, which established a new method of accounting for nonrefundable fees and costs associated with purchasing a group of loans and the method of recognizing interest income and expense. This statement must be applied prospectively to all transactions entered into for fiscal years beginning after December 15, 1987. Retroactive application with restatement of the financial statements for all years presented was optional. Upon evaluation of this accounting statement and the current method of accounting, the Company elected to adopt Statement No. 91 prospectively for Trusts E and F. Under the new standard, all discounts and hedging costs are recognized over the contractual life of the loan as a yield adjustment. The Company elected not to adopt Statement No. 91 retroactively for Trusts A, B, C and D. Since no transactions have been entered into after the effective date of this statement, the Company will continue to use its current method, which approximates the effective interest method, for Trusts A, B, C and D.\nCash and equivalents include cash held in the collection accounts and invested in short term investments with original maturities of less than three months.\nNote 3. Collateralized Mortgage Obligation Bonds:\nThe stated maturity is the date such class will be fully paid, assuming that scheduled interest and principal payments (with no prepayments) on the certificates are timely received.\nAll collections on the certificates pledged as security for the Bonds will be remitted directly to a collection account (the \"Collection Account\") established with the Trustee and together with the reinvestment earnings thereon, will be available for application to the payment of principal and interest on the bonds on the following payment date.\nEach Trust's Bonds are subject to a special redemption, in whole or in part, if , as a result of substantial payments of principal on the underlying mortgage loans and\/or low reinvestment yields, the Trusts determine that the amount of cash anticipated to be on deposit in the Collection Accounts on the next payment date might be insufficient to make required payments on the Bonds. Any such redemption would not exceed the principal amount of Bonds that would otherwise be required to be paid on the next payment date. As a result, a special redemption of Bonds will not result in a payment to bondholders more than two months earlier than the payment date on which such payment would otherwise have been received. The Bonds are not otherwise subject to call at the option of the Trusts except that the Class 1, Class 2 and Class 3 Bonds may, in the case of each such class, be redeemed in whole, but not in part, at the Trusts' option on any payment date if the aggregate outstanding principal amount of the Bonds of the class to be redeemed is less than 10 percent of its aggregate initial principal amount.\nTrust A, B, C, E and F's Class 4 Bonds may be redeemed in whole, but not in part, at the Trusts' option on any payment date on or after July 1, 2001, October 1, 2001, January 1, 2002, January 1, 2003 and April 1, 2003, respectively, if only the Class 4 Bonds are then outstanding (or on any earlier payment date if only the Class 4 Bonds are then outstanding and the current principal amount of Trust A, B, C, E and F's Class 4 Bonds are less than $10,560, $6,100, $10,500, $13,160 and $12,925, respectively).\nTrust D's Class 1 and Class 2 Bonds may be redeemed in whole, but not in part, at the Trust's option on any payment date on or after March 1, 1997 and the Class 3 Bonds may be redeemed in whole, but not in part, at the Trust's option on any payment date on or after March 1, 2002.\nAny such redemptions at the option of the Trusts shall be at a price equal to 100 percent of the unpaid principal amount of such Bonds plus such accrued interest.\nNote 4. Assets pledged:\nNote 5. Related parties: Trusts A, B, C and D purchased from an affiliate, Weyerhaeuser Mortgage Company, GNMA and FNMA certificates which were used to collateralize the Bonds. The purchases were at par value, plus Trust A and D's purchase premiums and less Trust B and C's purchase discounts. The purchases were financed with market-rate short-term debt from this affiliate until proceeds from the bond issuance were obtained.\nTrust E purchased from an affiliate, Weyerhaeuser Mortgage Company, GNMA certificates which were used to collateralize the Bonds. Trust F purchased from an affiliate, Weyerhaeuser Mortgage Company, GNMA and FNMA certificates which were used to collateralize the Bonds. The purchases were at par value, less the purchase discounts. The purchases were financed with the proeeds received from the bond issuances and notes due to Weyerhaeuser Mortgage Company. The notes bear interest at Bank of America's prime rate and interest shall be compounded annually. The principal balances and all accrued interest shall be due on each note on January 1, 2018 (\"Maturity\"). The principal and accrued interest on the notes will be paid by the Trusts with the proceeds of a capital contribution from Weyerhaeuser Financial Services, Inc., to the extent that residual payments from the GNMA and FNMA certificates are insufficient to retire the debt and related interest.\nThe receivable from beneficial owner, Mortgage Securities III Corporation, represents cash received from GNMA and FNMA certificates in excess of bond principal and interest payments required on Class 1 bonds which has been advanced to the beneficial owner. This amount is non- interest bearing and has no fixed repayment terms.\nCertain ongoing administrative and accounting functions are provided by the beneficial owner at no cost to each Trust.\nNote 6. Results of operations:\nAll results of operations will be transferred to the beneficial owner of the Trusts. Mortgage Securities III Corporation will be responsible for all tax liabilities incurred relating to the Trusts' operations.\nNote 7. Investment securities:\nINDEX TO EXHIBITS\nExhibit Number Description of Exhibits Page\n3(a) Certificate of Incorporation of the Mortgage Securities III Corporation (incorporated by reference to Exhibit 3(a) to Registration Statement on Form S-11 dated December 18, 1985). *\n3(b) Bylaws of Mortgage Securities III Corporation (incorporated by reference to Exhibit 3(b) to Registration Statement on Form S-11 dated December 18, 1985). *\n4(a) Form of Indenture dated June 1, 1986 between the Trust and Texas Commerce Bank National Association, as trustee, relating to GNMA and FNMA Collateralized Mortgage Obligations (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-11 dated December 18, 1985). *\n4(a) Form of Supplemental Indenture dated as of June 1, 1986 (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-11 dated July 11, 1986). *\n*Incorporated by reference.","section_15":""}
{"filename":"787977_1995.txt","cik":"787977","year":"1995","section_1":"Item 1. Business.\nGeneral.\nAlex. Brown Incorporated (together with its subsidiaries, the \"Company\"), incorporated in 1986, is a holding company which is the successor to the investment banking and brokerage business founded in 1800 by Alexander Brown. The firm began operating in partnership form in approximately 1805 and continued in that form until 1984 when the firm's investment banking business was transferred to Alex. Brown & Sons Incorporated (\"Alex. Brown\"), the Company's principal operating subsidiary. The Company's investment management business is operated through various entities. In some instances, non-affiliated third parties or the professionals in such businesses hold equity interests in such entities. In certain of those instances, the equity interests of non-affiliated third parties are equal to or greater than the Company's.\nThrough Alex. Brown, the Company provides investment services to individual and institutional investors, and investment banking services to corporate and municipal clients. To support the investment services provided to individual and institutional investors, the Company effects transactions in equity and debt securities as both agent and principal. In addition, the Company's Research Division supplies investment advice to individual and institutional investors regarding corporate securities in selected industry sectors. The Company provides investment banking services to corporate clients primarily in the industry sectors selected for research coverage. The Company also provides investment banking services to municipal clients, including, for example, states, counties, cities, transportation authorities, sewer and water authorities, and housing and health and higher education agencies.\nThe Company's operations are conducted from 24 offices in 14 states and the District of Columbia and from representative offices in London, England, Geneva, Switzerland and Tokyo, Japan. The Company's principal office is in Baltimore, with other offices in major cities including New York, San Francisco, Los Angeles, Boston, Chicago, Dallas, Atlanta, Philadelphia and Washington, D.C.\nAlex. Brown is a member of the New York Stock Exchange, Inc. (\"NYSE\"), the American Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., other regional securities exchanges and the National Association of Securities Dealers, Inc. (the \"NASD\"). Alex. Brown is also a member of the Securities Investor Protection Corporation (\"SIPC\"), and with respect to its representative offices in London, the Securities and Futures Authority.\nInvestment Services. The Company provides investment services to individual and institutional customers.\nThe Company's investment services to individual customers primarily involve transactions in corporate equity and debt and state and local government securities, including securities followed by the Company's research analysts and underwritten on a managed or co-managed basis by the Company. In addition to executing transactions, the Company provides portfolio strategy, investment advice and research services to individual investors. The Company targets its investment services to individuals of high net worth or high annual income.\nThe Company's institutional customers include banks, retirement funds, mutual funds, investment advisers and insurance companies. Services to these customers generally include investment advisory and other services. The majority of the Company's institutional brokerage revenues are generated by the purchase and sale of corporate equity securities, including securities followed by the Company's research analysts and securities underwritten on a managed or co-managed basis by the Company. Institutional investors typically purchase and sell securities in block transactions. Revenues from securities transactions with institutional customers are based on negotiated rates which typically represent a significant discount from the Company's commission schedule.\nResearch. The Company's Research Division develops investment recommendations and market information in the consumer, financial services, health care, industrial growth, media\/communications and technology industries. Within these industries, the Company follows approximately 650 companies.\nResearch reports are made available generally to customers. Research activities include the review and analysis of general market conditions, industries and specific companies; recommendations of specific actions with regard to industries and specific companies; the furnishing of information to retail and institutional customers; and responses to inquiries from customers and investment representatives. Additionally, the Company hosts periodic seminars in a number of industry areas at which Company representatives and industry authorities make presentations with respect to specific companies, the industry and its trends. These seminars are open to the Company's investment services customers and investment banking clients. The Company believes that its research activities have contributed to attracting and retaining its investment services customers and investment banking clients.\nSecurities Commissions. Securities transactions for individual and institutional investors where the Company acts as agent generate securities commission revenues. Commissions are charged on both exchange and over-the-counter agency transactions for individual customers in accordance with a schedule formulated by the Company, which may change from time to time. In certain cases, discounts from the schedule may be granted. The Company's securities commissions result primarily from executing transactions in listed stocks and bonds. The Company also realizes commission revenues when it executes a trade in an over-the-counter security in which it does not make a market. A substantial portion of the commission revenues generated by the Company is attributable to individual and institutional investors who receive the Company's research services.\nPrincipal Transactions. In addition to executing trades as agent, the Company regularly acts as a principal in executing trades in equity and convertible securities, municipal bonds, corporate debt, mortgage and asset-backed securities and United States government and government agency securities. When transactions are executed by the Company on a principal basis, the Company, in lieu of commissions, marks up or marks down securities and records the resulting net gains or losses in revenues from principal transactions. Inventories of various securities are carried to facilitate sales to customers and other dealers. Principal transactions are effected for both individual and institutional customers.\nAs of December 31, 1995, the Company made markets, buying and selling as a principal, in approximately 400 common stocks and other securities traded on the NASD's Automated Quotations System or otherwise in the over-the-counter market and approximately 475 listed securities. The majority of the equity securities in which the Company makes a market are in the industry areas followed by the Company's research analysts.\nThe Company buys and sells as principal a wide range of fixed income securities and variable rate debt obligations, including municipal securities, collateralized mortgage and asset-backed obligations, emerging market debt securities, corporate fixed income securities and U.S. government and agency obligations. Municipal securities include general obligation and revenue bonds and notes issued by states, counties, cities and state and local government agencies and authorities. Corporate fixed income securities include high yield (non-rated and non-investment grade) obligations, convertible debentures and other bonds, notes and preferred stocks. U.S. government and agency obligations include direct U.S. government obligations and U.S. government-guaranteed securities and agency obligations.\nInformation regarding the Company's long and short trading securities positions as of December 31, 1995 and 1994 and principal transactions revenue for the three year period ended December 31, 1995 is set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 4, 5 and 9 of Notes to Consolidated Financial Statements, incorporated herein by reference to pages 28-31, 38-39 and 41, respectively, of the 1995 Annual Report to Stockholders.\nThe level of positions carried in the Company's trading accounts fluctuates significantly. The size of the securities positions on any one date may not be representative of the Company's exposure on any other date because securities positions vary substantially depending upon economic and market conditions, the allocation of capital among types of inventories, underwriting commitments, customer demand and trading volume. The Company may have large positions within its inventories from time to time which increase the Company's exposure to specific credit, event, market or liquidity risks. The aggregate value of inventories that the Company may carry is limited by certain requirements of Rule 15c3-1 (the \"Net Capital Rule\") of the Securities and Exchange Commission (\"SEC\"). See \"Net Capital Requirements.\"\nThe Company's principal transactions expose the Company to risk because securities positions are subject to fluctuations in market value and certain inventory positions are in thinly traded securities. High yield securities can be extremely volatile. Each trading department is subject to internal position limits.\nThe Company also participates as a market maker in the NASD's Small Order Execution System (\"SOES\"), an automated trading system through which participating firms can execute customer orders of limited size against market makers in eligible securities through computer terminal entries. Participating market makers are required to honor such transactions; therefore, SOES participation puts an affirmative obligation on the Company to monitor trading activity in SOES securities in which it makes a market and maintain commensurate control of its positions. SOES participation is mandatory for market makers in all NASDAQ National Market System (\"NMS\") securities, and imposes upon market makers a penalty of 20 business days during which they may not make a market at all in any NMS security in which an unexcused withdrawal has occurred. Withdrawal is excused only in limited circumstances. The NASD is authorized to establish the maximum size of SOES orders at either 200, 500 or 1,000 shares, depending on the trading characteristics of the particular security. It is likely that participation as a SOES market maker will continue to increase the Company's exposure to loss from principal transactions.\nThe SEC and other regulatory organizations are reviewing the structure and operation of the NASDAQ Stock Market. As a major participant in the NASDAQ Stock Market, the Company has received subpoenas and demands for information from the SEC and the United States Department of Justice pertaining to NASDAQ market making and related activities. See also Item 3, Legal Proceedings. Changes in regulations pertaining to the NASDAQ Stock Market may have a material effect on the Company's over-the-counter trading activities.\nInvestment Banking. As an investment banking firm, the Company provides financial advice to, and raises capital for, a broad range of corporate clients primarily in industry areas which have been selected by the Company for research coverage. The Company manages and participates in public offerings and arranges the private placement of equity and debt securities directly with institutional and individual investors.\nThe Company is a major underwriter of corporate and municipal securities. The management of an underwriting syndicate is generally more profitable than participation as a syndicate member because the managing underwriter receives a management fee and a greater amount of securities for distribution.\nCertain risks are involved in the underwriting of securities. Underwriting syndicates agree to purchase securities at a discount from the initial public offering price. If the securities must be sold below the syndicate cost, an underwriter is exposed to losses on the securities that it has committed to purchase. In the last several years, investment banking firms have increasingly underwritten corporate and municipal offerings with fewer syndicate participants or, in some cases, without an underwriting syndicate. In such cases the underwriter assumes a larger part or all of the risk of an underwriting transaction. Under federal securities laws, other laws and court decisions, an underwriter is exposed to substantial potential liability for material misstatements or omissions of fact in the prospectus used to describe the securities being offered. While municipal securities are exempt from the registration requirements of the Securities Act of 1933, as amended (the \"Securities Act\"), underwriters of municipal securities nevertheless are exposed to substantial potential liability in connection with material misstatements or omissions of fact in the offering documents prepared in connection with offerings of such securities.\nIn the past five years, less than 50% (40% in 1995) of the public offerings of equity and corporate debt securities managed or co-managed by the Company have been initial public offerings. Generally, a strong market for new issues occurs when overall market and economic conditions are favorable. New issues are perceived to\nhave a higher degree of risk for investors and investor receptivity to new issues tends to vary as a function of overall market conditions.\nThe Company also provides advice to clients on a wide range of financial matters, including mergers and acquisitions, divestitures, financial planning, financial restructuring and recapitalizations. In connection with mergers and acquisitions, the Company often provides opinion letters and valuations and renders various other services. The Company's traditional clients for such services are companies for which the Company has raised capital or which are followed by the Company's Research Division. The Company also provides these services to companies which are not corporate finance clients or covered by the Company's Research Division but which are, or have subsidiaries or divisions, in industries followed by the Company's Research Division. Historically, the core of the Company's mergers and acquisitions business has been the representation of sellers in negotiated transactions. Fees for these services are negotiated and are generally related to the value of the transaction for which the service is provided.\nThe Company also invests in private equity securities primarily through its partnership interest in ABS Capital Partners, L.P. (\"Capital\"). In most cases, these investments are made either with the management of such companies or to provide expansion financing. Capital may also co-invest with other financial groups in larger transactions where its specific industry expertise may create additional value. Private equity investments have the potential of generating substantial investment returns, but involve a significant degree of risk due to the concentrated investment of capital in securities that generally lack liquidity. As of December 31, 1995, the Company had outstanding $25.4 million of private equity investments and a commitment to invest $10.3 million more in Capital.\nIn addition to its corporate investment banking activities, the Company provides financial advice to, and raises capital for, many types of issuers of tax-exempt securities, including states, counties, cities, transportation authorities, sewer and water authorities and housing and health and higher education agencies. Most of these issuers are located in the eastern U.S. The Company manages public offerings of securities and distributes these securities to individual and institutional investors.\nInvestment Management Services. The Company provides investment advisory, administrative and distribution services to a variety of clients, domestic and international. These services are typically provided for a fee based on the value of the assets for which such services are rendered. Investment advisory services are provided to high net worth individuals, institutional investors, foundations, endowments, mutual funds and private investment funds. As of December\n31, 1995, the Company provided investment advisory, administrative and\/or distribution services with respect to $10.1 billion of assets under management.\nAdvisory, administrative and distribution services are provided to the \"Flag\" family of mutual funds, which are Company sponsored, as well as to mutual funds and investment partnerships sponsored by unaffiliated third parties. Most investment advisory services are provided pursuant to contracts which provide for termination by either party at any time. Advisory fees are generally charged as a percentage of assets managed.\nOther than with respect to advisory services provided to mutual funds, the Company's largest advisory service is Alex. Brown Investment Management (\"ABIM\"), a partnership in which the Company has a 50% interest and its associated investment advisory professionals have the remaining 50% interest. ABIM manages equity and balanced accounts for institutions and individuals.\nIn December, 1995, the Company received approval from the SEC for the formation of Alex. Brown Capital Advisory Incorporated, a registered investment adviser. In January, 1996, the Company transferred certain of its investment management activities to Alex. Brown Capital Advisory Incorporated.\nCorrespondent Services. The Company provides administrative, execution, operational and clearing services to other securities firms on a fully disclosed basis. In addition to commissions and other transaction related fees, the Company receives interest revenue in those instances where it extends margin credit directly to customers of its correspondent brokers. The Company may extend credit directly to its correspondent firms to finance their operations or securities positions which such firms hold for their own accounts. The Company relies on the general credit of its correspondent brokers and may be exposed to risk of loss if any of its correspondents or their customers are unable to meet their financial commitments. The ratio of capital to the level of business of the Company's correspondent brokers may be less than that of the Company. From time to time the Company makes unsecured subordinated loans to correspondent brokers. Such loans are funded through general working capital sources. As of December 31, 1995, the Company provided correspondent services to 44 securities firms.\nMargin Accounts and Interest Income. The Company extends margin financing to its customers and to the customers of correspondent brokers for whom the Company provides clearing and execution services. Margin loans are collateralized by cash and securities in customer accounts, including securities that may be subject to restrictions on sale by the customer. Customers are charged for margin financing\nutilizing a base rate that the Company establishes based upon a variety of factors, including the Company's own cost of funds, with adjustments based upon the size of the loan and other factors. The amount of the Company's interest revenue is affected by the volume of customer borrowing and by prevailing interest rates. The average volume of customer borrowing has increased in each of the last five years.\nMargin lending by the Company is subject to the margin rules of the Board of Governors of the Federal Reserve System, NYSE margin requirements and the Company's internal policies, which in many instances are more stringent than the NYSE requirements. In permitting customers to purchase on margin, the Company assumes the risk that a market decline may reduce the value of the collateral it holds below the customer's indebtedness before the collateral can be sold. The proceeds realizable upon the sale of such collateral can be adversely affected by the liquidity of the market for the security, applicable restrictions on the sale of the security or the size of the collateral position as compared to the trading volume of the security. Under applicable NYSE rules, in the event of a significant decline in the market value of the securities in a margin account, the Company is obligated to require the customer to deposit additional securities or cash in the account or to sell securities to reduce or eliminate the customer's indebtedness to the Company.\nCredit balances and securities in customers' accounts, to the extent not required to be segregated pursuant to rules of the SEC, may be used in the conduct of the Company's business, including the extensions of margin credit. Customer lending activities may influence the basis on which net capital requirements of Alex. Brown are determined under the Net Capital Rule. As these activities expand, the Company's net capital requirements increase. See \"Net Capital Requirements.\"\nAccounting, Administration and Operations. Accounting, administration and operations personnel are responsible for the processing of securities transactions; receipt, identification and delivery of funds and securities; custody of customer securities; internal financial control; accounting functions; office services; personnel services and compliance with regulatory and legal requirements.\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 record heavy trading volume; however, extraordinarily heavy trading volume in the future could result in clearance and processing difficulties. The\nCompany utilizes its own facilities and the services of Automatic Data Processing Inc. for the electronic processing related to recording data pertinent to securities transactions and general accounting.\nThe Company believes that its internal controls and safeguards against securities theft, including use of depositories and periodic securities counts, are adequate. As required by the NYSE and certain other authorities, the Company carries fidelity bonds covering loss or theft of securities as well as 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 posts its books and records daily. Periodic reviews of certain controls are conducted, and administrative and operations personnel meet with management to review operational conditions in the Company to assure compliance with applicable laws, rules and regulations.\nCompetition. The Company encounters intense competition in all aspects of the securities business and competes directly with other securities firms, a significant number of which have substantially greater capital and other resources and many of which offer a wider range of financial services than the Company. Other securities firms, oriented primarily to the market for individual investors, charge commissions that are significantly discounted from those in the range generally charged by the Company to its individual customers. In addition to competition from firms currently in the securities business, there is increasing competition from other sources, such as commercial banks and insurance companies offering financial services, and from other investment alternatives. The Company believes that the principal competitive factors in the securities industry are the quality and ability of professional personnel and relative prices of services and products offered. The Company and its competitors directly solicit potential customers, and many of the Company's competitors engage in advertising programs which the Company does not use to any significant degree. The Company and its competitors also furnish investment research publications in an effort to hold and attract existing and potential clients.\nEmployees. As of December 31, 1995, the Company had approximately 2,350 full-time employees. None of the Company's employees are covered by a collective bargaining arrangement.\nRegulation. The securities industry in the United States is subject to extensive regulation under both federal and state laws. The SEC is the federal agency responsible for the administration of the federal securities laws. Alex. Brown is registered as a broker-dealer with the SEC. Alex. Brown and Alex. Brown Capital Advisory Incorporated as well as other investment advisers in which\nthe Company has an equity interest are registered as investment advisers with the SEC. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the NASD and national securities exchanges such as the NYSE, which has been designated by the SEC as Alex. Brown's primary regulator. These self-regulatory organizations adopt rules (subject to approval by the SEC) that govern the industry and conduct periodic examinations of Alex. Brown's operations. Securities firms are also subject to regulation by state securities administrators in those states in which they conduct business. Alex. Brown is registered as a broker-dealer in all 50 states, the District of Columbia and Puerto Rico.\nBroker-dealers are subject to regulations covering all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers' funds and securities, capital structure of securities firms, record-keeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may directly affect the mode of operation and profitability of broker-dealers. The SEC, self-regulatory organizations and state securities commissions may conduct administrative proceedings which can result in censure, fine, the issuance of cease-and-desist orders or the 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 protection of creditors and stockholders of broker-dealers. From time to time, the Company has been subject to disciplinary actions, none of which, to date, has had a material adverse effect on the operations of the Company.\nAlex. Brown is a member of SIPC, which provides, in the event of the liquidation of a broker-dealer, protection for customers' accounts held by Alex. Brown of up to $500,000 for each customer, subject to a limitation of $100,000 for claims for cash balances. In addition, Alex. Brown has obtained protection in excess of SIPC coverage of $49,500,000 for each account.\nAlex. Brown & Sons Limited and Alex. Brown & Sons Investments Limited, through which the Company operates representative offices in London, England, are subject to the United Kingdom Financial Services Act of 1986, which governs all aspects of United Kingdom investment business and to the rules of the Securities and Futures Authority.\nCertain subsidiaries and employees of the Company are engaged in the insurance business and are subject to regulation and supervision by appropriate authorities in the states in which they conduct their business.\nNet Capital Requirements. As a registered broker-dealer and a member firm of the NYSE, Alex. Brown is subject to the Net Capital Rule, which has also been adopted through incorporation by reference in NYSE Rule 325. The Net Capital Rule, which specifies minimum net capital requirements for registered brokers and dealers, is designed to measure the general financial integrity and liquidity of a broker-dealer and requires that at least a minimum part of its assets be kept in relatively liquid form. Alex. Brown is also subject to the net capital requirements of the Commodities Futures Trading Commission (\"CFTC\") and various commodity exchanges, which generally require that Alex. Brown, as an introducing broker, maintain minimum net capital equal to the alternative net capital requirements discussed below.\nAlex. Brown has elected to compute net capital under the alternative method of calculation permitted by the Net Capital Rule. Under the alternative method, Alex. Brown is required to maintain minimum net capital, as defined in the Net Capital Rule, equal to the greater of $1,500,000 or 2% of the amount of its \"aggregate debit items\" computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (SEC Rule 15c3-3). The \"aggregate debit items\" are assets that have as their source transactions with customers, primarily margin loans. Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC and suspension or expulsion by the NYSE and other regulatory bodies and ultimately may require its liquidation. The Net Capital Rule and NYSE Rule 326 prohibit payments of dividends, redemption of stock, the prepayment of subordinated indebtedness, and making any unsecured advance or loan to a stockholder, employee or affiliate, if net capital thereafter would be less than 5% of aggregate debit items. The Net Capital Rule also provides that the SEC may restrict for up to twenty business days any withdrawal of equity capital, or unsecured loan or advance to a stockholder, employee or affiliate (\"capital withdrawal\") if such capital withdrawal, together with all other net capital withdrawals during a thirty day period, exceeds 30% of excess net capital and the SEC concludes that the capital withdrawal may be detrimental to the financial integrity of the broker-dealer. The Net Capital Rule also provides that the total outstanding principal amount of a broker-dealer's indebtedness under certain subordination agreements, the proceeds of which are included in its net capital, may not exceed 70% of the sum of the outstanding principal amount of all subordinated indebtedness included in net capital, par or stated value of capital stock, paid in capital in excess of par, retained earnings and other capital accounts for a period in excess of 90 days.\nUnder NYSE Rule 326, a member firm is required to reduce its business if its net capital is less than 4% of aggregate debit items. NYSE Rule 326 also prohibits the expansion of business if net capital is less than 5% of aggregate debit items for 15 consecutive days. The\nprovisions of Rule 326 also become operative if capital withdrawals (including scheduled maturities of subordinated indebtedness during the following six months, charges relating to lending on control and restricted securities under NYSE Rule 431 and discretionary liabilities which are included in capital under the Net Capital Rule) would result in a reduction of a firm's net capital to the levels indicated.\nNet capital is essentially defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings and certain discretionary liabilities, and less certain mandatory deductions that result from excluding assets that are not readily convertible into cash and from valuing conservatively certain other assets, such as a firm's positions in securities. Among these deductions are adjustments (called \"haircuts\") to the market value of firm securities to reflect the possibility of a market decline prior to disposition.\nA change in the Net Capital Rule, the imposition of new rules or any unusually large charge against net capital could limit those operations of Alex. Brown that require the intensive use of capital, such as underwriting and trading activities and the financing of customer account balances, and also could restrict the Company's ability to withdraw capital from Alex. Brown which in turn could limit the Company's ability to pay dividends, repay debt and redeem or purchase shares of its outstanding stock.\nAlex. Brown has been in compliance at all times with all aspects of the Net Capital Rule and CFTC net capital requirements applicable to it. As of December 31, 1995, Alex. Brown was required to maintain minimum net capital, in accordance with SEC and CFTC rules, of $26,338,000 and had total net capital (as so computed) of $322,292,000 or $295,954,000 in excess of 2% of aggregate debit items and $256,448,000 in excess of 5% of aggregate debit items.\nItem 1(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 has offices in the following cities:\nAnnapolis, Maryland Naples, Florida Atlanta, Georgia New Orleans, Louisiana Baltimore, Maryland New York, New York Boston, Massachusetts Philadelphia, Pennsylvania Charlotte, North Carolina Richmond, Virginia Chicago, Illinois San Francisco, California Dallas, Texas Timonium, Maryland Fishkill, New York Tokyo, Japan Geneva, Switzerland Towson, Maryland Greenwich, Connecticut Washington, D.C. Houston, Texas West Palm Beach, Florida Jacksonville, Florida Wilmington, Delaware London, England Winston-Salem, North Carolina Los Angeles, California\nThe Company's two most material lease obligations are with respect to its New York and Baltimore facilities. The Company occupies an aggregate of approximately 200,000 square feet of space in downtown Baltimore under leases expiring on various dates from 1996 through 2002. The Company occupies approximately 80,000 square feet of office space in midtown Manhattan under a lease expiring in 2013. In 1995, the Company entered into a lease obligation to occupy approximately 255,000 square feet of office space in downtown Baltimore in order to consolidate the Company's downtown office space and to replace several leases which expire on various dates in 1997. The new Baltimore lease has an effective rent commencement date of January 1, 1997 and an expiration date of December 31, 2011. The Company is a limited partner in a partnership which owns a building in downtown Baltimore where it leases approximately 90,000 square feet.\nThe Company's other offices, including the separate offices of Alex. Brown Investment Management, the Company's operations and data center and offices in 22 U.S. cities, London, Geneva and Tokyo, occupy an aggregate of approximately 456,000 square feet under leases that expire at various dates through 2013. Future minimum rental commitments under existing leases are set forth in Note 11 of Notes to Consolidated Financial Statements incorporated herein by reference to page 41 of the 1995 Annual Report to Stockholders.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nAlex. Brown is a defendant in a number of lawsuits relating to its investment banking and securities brokerage business. Alex. Brown is also a member of a defendant class of underwriters in a number of lawsuits relating to its participation in underwritings and, in addition, may be required to contribute to any adverse final judgments or settlements in actions arising out of its participation in the underwritings of certain issues in which it is not a defendant. The Company cannot state what the eventual outcome of these pending actions will be. A substantial settlement or judgment in any of these cases could have a material adverse effect on the Company. While there can be no assurances of a favorable determination of these actions, the Company believes there are meritorious defenses to all of the cases described herein, and intends to defend each action vigorously. The following are descriptions of certain legal proceedings involving or affecting the Company.\nIn-Store Advertising, Inc. The Company has been named as a defendant in several purported class action lawsuits, as well as one shareholder derivative lawsuit, pertaining to the July 19, 1990 public offering of Common Stock of In-Store Advertising, Inc. (\"In-Store Advertising\"), at $19 per share (the \"Offering\"). The Company co-managed the Offering and directly underwrote 414,000 shares. The lawsuits are pending in the United States District Court for the Southern District of New York, and have been consolidated under the caption In-Store Advertising, Inc. Securities Litigation. Collectively, plaintiffs purport to represent all persons who purchased shares of In-Store Advertising in the Offering, and all persons who purchased shares in the open market during the period from the date of the Offering to August 28, 1990. Plaintiffs allege, among other things, that the prospectus for the Offering contained material misstatements of fact and omitted material facts and that the defendants, including the Company, made untrue statements of material fact and omitted material facts concerning In-Store Advertising's anticipated revenues and earnings. The Plaintiffs allege violations of the federal securities laws and the common law, and seek unspecified actual and punitive damages, rescission, costs, fees and other relief. On July 8, 1993, In-Store Advertising filed for protection under the Bankruptcy Code, and on August 6, 1993, its plan of reorganization was approved. As a result thereof, In-Store Advertising has been discharged from any liability relating to this litigation. Pretrial discovery is proceeding.\nNASDAQ Market-Maker Anti-Trust Litigation and Related Investigations. The Company has been named as a defendant in several purported class action proceedings that allege violations of a Federal anti-trust statute. The Company was joined as defendant in such actions during July, 1994. The actions have been consolidated before\nthe United States District Court for the Southern District of New York under the caption In re NASDAQ Market-Maker Anti-Trust and Securities Litigation. The plaintiffs allege that twenty-four defendants, including the Company, that act as dealers on the NASDAQ computerized quotations system, conspired to raise and fix the spreads between the bid and ask prices of securities traded over NASDAQ. Plaintiffs further allege that as a result of such conspiracy, NASDAQ spreads are larger than spreads for stocks traded on the New York Stock Exchange and the American Stock Exchange. The purported class consists of all persons in the United States who are current customers and who bought or sold securities through NASDAQ within four years prior to the filing of the complaints. Plaintiffs seek treble damages of an unspecified amount. An additional private action has since been filed in the Alabama state court raising the same issues. All defendants, including the Company, have filed a motion requesting that the Alabama case be consolidated into the New York matter. The Company has also received requests from the United States Department of Justice (\"DOJ\") and the SEC to provide information and documents with respect to its NASDAQ market making activities. The DOJ and SEC appear to be conducting investigations of the NASDAQ market generally.\nBanca Cremi, S.A. On April 11, 1995, the Company was named as a defendant in an action pending in the United States District Court in the District of Maryland entitled Banca Cremi, S.A., et al. v. Alex. Brown & Sons Incorporated, et al., Civil Action No. JFM-95-109. The action alleges that the Company and its salespersonnel recommended unsuitable investments to Banca Cremi, a Mexican bank, and thereby violated federal and state laws. The complaint alleges compensatory damages in excess of $26 million.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nExecutive Officers of the Registrant\nThe following information regarding the persons who function as executive officers of the Company is included herein pursuant to Instruction 3 to Item 401(b) of Regulation S-K:\nName Age Position with the Company\nA. B. Krongard................ 59 Chief Executive Officer and Chairman of the Board of Directors Robert F. Price............... 48 Secretary and General Counsel Mayo A. Shattuck III.......... 41 President, Chief Operating Officer and Director Beverly L. Wright............. 47 Treasurer and Chief Financial Officer\nOfficers serve at the discretion of the Board of Directors. There is no family relationship among any of the directors or executive officers of the Company.\nMr. Krongard was first employed by Alex. Brown & Sons (the \"Partnership\") in 1971 and became a general partner in 1980. He has been a Managing Director of Alex. Brown since 1984, was elected Chief Executive Officer of the Company and Alex. Brown in July 1991, and was elected Chairman of the Board of Directors of the Company in 1994.\nMr. Price was first employed by the Partnership in 1976 and became a Managing Director of Alex. Brown in 1987. He served as Secretary and General Counsel from 1984 until 1989 when he resigned from the Company. Upon his return to the Company in 1991, he became Secretary and General Counsel.\nMr. Shattuck was first employed by the Company in 1985. He became a Managing Director of Alex. Brown in 1989, and was elected President and Chief Operating Officer in 1991.\nMs. Wright was first employed by the Partnership in 1978 and became a general partner in 1984. She has been a Managing Director of Alex. Brown since 1984, and was named Treasurer and Chief Financial Officer of the Company and Chief Financial Officer of Alex. Brown in 1986.\nThere is no arrangement or understanding between any of the above-listed officers and any other person pursuant to which any such officer was elected as an officer.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nInformation required by Item 5 is incorporated herein by reference to page 52 of the 1995 Annual Report to Stockholders attached hereto.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nInformation required by Item 6 is incorporated herein by reference to page 48 of the 1995 Annual Report to Stockholders attached hereto.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nInformation required by Item 7 is incorporated herein by reference to pages 28 through 31 of the 1995 Annual Report to Stockholders attached hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial Statements required by Item 8 are listed in the Index to Financial Statements on page 23.\nSupplementary data are incorporated herein by reference to page 49 of the 1995 Annual Report to Stockholders attached hereto.\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 (except as indicated below and that information regarding executive officers called for by Item 10","section_9A":"","section_9B":"","section_10":"Item 10 contained in Part I) is incorporated herein by reference to the definitive proxy statement.\nItem 10. Donald B. Hebb, Jr., who resigned as a director of the Company in November, 1995, filed a Form 5 dated March 7, 1996 in which he reported a gift from his wife of 28,000 shares of Common Stock made on December 15, 1995. The beneficial ownership of these shares had been previously reported in Mr. Hebb's Form 4 dated September 8, 1995.\nPART IV\nItem 14.","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) Exhibits:\nReference is made to the Exhibit Index.\nFinancial Statement Schedules:\nAll 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(b) Reports on Form 8-K.\nNone.\nOther Matters\nFor the purposes of complying with the amendments to the rules governing Form S-3 and Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Forms S-8 Nos. 33-23789, 33-26988, 33-40618, 33-40619, 33-45715, 33-46282, 33-53687, 33-55003, 33-59601 and 33-67050, and on Form S-3 No. 33-60955.\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.\nALEX. BROWN INCORPORATED\nBy: s\/ A. B. Krongard A. B. Krongard Chief Executive Officer Date: 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 in the capacities and on the dates indicated:\nSignature Title Date\ns\/ A. B. Krongard Chief Executive March 25, 1996 A. B. Krongard Officer; Chairman of the Board of Directors (Principal Executive Officer)\ns\/ Mayo A. Shattuck III President; Chief March 25, 1996 Mayo A. Shattuck III Operating Officer; Director\ns\/ Beverly L. Wright Treasurer and Chief March 25, 1996 Beverly L. Wright Financial Officer (Principal Financial and Accounting Officer)\ns\/ Lee A. Ault III Director March 25, 1996 Lee A. Ault III\ns\/ Neil R. Austrian Director March 25, 1996 Neil R. Austrian\ns\/ Thomas C. Barry Director March 25, 1996 Thomas C. Barry\ns\/ Benjamin H. Griswold IV Director March 25, 1996 Benjamin H. Griswold IV\ns\/ Steven Muller, Ph.D. Director March 25, 1996 Steven Muller, Ph.D.\ns\/ David M. Norman Director March 25, 1996 David M. Norman\ns\/ Frank E. Richardson Director March 25, 1996 Frank E. Richardson\nALEX. BROWN INCORPORATED AND SUBSIDIARIES\nPage Financial Statements:\nAlex. Brown Incorporated and Subsidiaries included on pages 33 through 47 of the 1995 Annual Report to Stockholders, incorporated herein by reference and attached hereto:\nConsolidated Statements of Earnings 33 Consolidated Statements of Financial Condition 34 Consolidated Statements of Stockholders' Equity 35 Consolidated Statements of Cash Flows 36 Notes to Consolidated Financial Statements 37-46 Report of Independent Auditors 47\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 Alex. Brown Incorporated\nAlex. Brown Incorporated (the \"Company\") is a holding company whose primary subsidiary is Alex. Brown & Sons Incorporated (\"Alex. Brown\"), a major investment banking and securities brokerage firm. The Company, like other securities firms, is directly affected by general economic and market conditions, including fluctuations in volume and price levels of securities, changes in interest rates and demand for investment banking and securities brokerage services, all of which have an impact on the Company's revenues as well as its liquidity. Substantial fluctuations can occur in the Company's revenues and net earnings due to these and other factors.\nIn periods of reduced market activity, profitability is likely to be adversely affected because certain expenses, consisting primarily of salaries and benefits, communications and occupancy expenses, remain relatively fixed. Accordingly, net earnings for any period should not be considered representative of any other period.\nResults of Operations - ------------------------------------------------------------------------------- 1995 COMPARED TO 1994\nRevenues totalled $809.4 million, a 34% increase from $605.5 million in 1994.\nCommission revenues totalled $173.5 million, a 24% increase from $140.0 million in 1994, primarily as a result of increased private client and institutional listed commissions.\nInvestment banking revenues increased 49% to $293.4 million from $197.5 million in 1994, primarily due to an increase in revenues from underwriting-related activities. Merger and advisory revenues increased 7% to $67.4 million from $63.2 million in 1994.\nPrincipal transaction revenues increased 16% to $139.4 million from $120.1 million in 1994, primarily due to increases in revenues from OTC trading. Partially offsetting this increase were declines in government and mortgage-backed securities trading.\nInterest and dividend revenues increased 54% to $105.5 million from $68.6 million in 1994, due to higher margin loan balances and higher interest rates. Margin loans at year-end totalled $1.4 billion, a 74% increase over the prior year. Average margin balances increased 32%.\nAdvisory and other revenues totalled $97.6 million, a 23% increase from $79.3 million in 1994, which was primarily attributable to increases in advisory and investment revenues. Advisory revenues increased 28% to $55.6 million from $43.3 million in 1994. Revenues from investments increased to $17.0 million as a result of realized gains and increases in the carrying value of investments. In the prior year, the Firm reported investment revenues of $8.1 million and a $7.8 million gain related to the sale of its interests in Alex. Brown Kleinwort Benson Realty Advisory Holding Company. Correspondent services fees increased 26% in 1995.\nTotal operating expenses were $651.2 million, a 34% increase from $487.2 million in 1994.\nCompensation and benefits expense increased 31% to $432.9 million from $329.5 million in 1994, as a result of increased incentive, commission and salary expense.\nCommunications expense increased 21% to $33.9 million from $28.2 million, reflecting expenses required to support increased levels of business activity.\nOccupancy and equipment expense increased 26% to $39.8 million, primarily as a result of expansion in several offices, increased technology expenditures and costs associated with vacating certain office space.\nInterest expense increased 65% to $36.2 million from $21.9 million, primarily due to the cost of financing increased margin loans and interest rate increases.\nFloor brokerage, exchange and clearing fees increased 15% to $18.6 million, due to an increased volume of OTC and listed trades.\nOther expenses increased 50% to $89.8 million from $59.7 million, as a result of increases in expenses associated with the higher level of business activity.\nThe Company's effective tax rate for 1995 decreased to 39.6% from 40.1% in 1994.\nAs a result of the above, net earnings increased to $95.6 million from $70.9 million in 1994. Primary and fully diluted earnings per share were $6.16 and $5.40, respectively, as compared to $4.60 and $4.05 in 1994.\nThe weighted average number of shares outstanding for purposes of calculating earnings per share includes shares related to outstanding dilutive stock options and is affected by the market price of the Company's Common Stock. Additionally, the calculation of fully diluted earnings per share assumes the conversion into Common Stock of the Company's outstanding convertible subordinated debt, if dilutive. These factors can result in lower rates of incre`ase or higher rates of decrease in earnings per share as compared to the rates of increase or decrease in net earnings.\n1994 COMPARED TO 1993 Revenues totalled $605.5 million, a decrease of 4% from $628.2 million in 1993.\nCommission revenues totalled $140.0 million, a 6% increase from $131.7 million in 1993, primarily reflecting increased institutional listed commissions.\nInvestment banking revenues decreased 22% to $197.5 million from $252.8 million in 1993, primarily as a result of decreased underwriting-related revenues. Partially offsetting this decline was a significant increase in merger and advisory fees.\nPrincipal transaction revenues decreased 8% to $120.1 million from $131.0 million in 1993, due to declines in equity, high yield and mortgage-backed trading reflecting unsettled market conditions experienced throughout the year.\nInterest and dividend revenues increased 39% to $68.6 million from $49.3 million in 1993, due to higher interest rates and an increase in margin loans.\nAdvisory and other revenues totalled $79.3 million, a 25% increase from $63.4 million in 1993. The largest contributor to this increase was a gain of $7.8 million relating to the sale of our interests in Alex. Brown Kleinwort Benson Realty Advisory Holding Company. Additionally, revenues from asset management operations increased. Net investment revenue (excluding the gain on sale mentioned above) totalled $8.1 million for the year as compared to $7.9 million in the previous year.\nTotal operating expenses were $487.2 million, a 2% increase from $479.9 million in 1993.\nCompensation and benefits expense decreased 4% to $329.5 million from $344.4 million in 1993, reflecting decreases in commissions and incentive compensation, partially offset by increases in salary expense.\nCommunications expense increased 17% from $24.2 million to $28.2 million, due primarily to increased levels of business activity and increased technology expenditures.\nOccupancy and equipment expense increased 20% to $31.7 million from $26.3 million in 1993, primarily as a result of planned growth, increased technology expenditures and an expense provision related to vacating certain office space prior to expiration of the lease of one of the Company's offices.\nInterest expense increased 47% to $21.9 million from $14.9 million in 1993, primarily as a result of financing increased margin loans and securities positions and increased interest rates.\nFloor brokerage, exchange and clearing fees increased 18% to $16.2 million from $13.8 million, reflecting higher volumes of listed securities transactions, by both Alex. Brown and its correspondents.\nOther operating expenses increased 6% to $59.7 million from $56.3 million in 1993, as a result of costs associated with higher levels of business activity, which were partially offset by a decrease in affiliate expenses.\nThe Company's effective tax rate increased to 40.1% from 39.8% in 1993.\nAs a result of the above, net earnings decreased to $70.9 million from $89.2 million in 1993. Primary and fully diluted earnings per share were $4.60 and $4.05, respectively, as compared to $5.61 and $5.09 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES The Company's consolidated statement of financial condition reflects a liquid financial position. The majority of the securities (both long and short) in Alex. Brown's trading accounts are readily marketable and actively traded. Customer receivables include margin balances and amounts due on uncompleted transactions. Receivables from other brokers and dealers generally represent either current open transactions, which usually settle within a few days, or securities borrowed transactions which normally can be closed out within a few days. Most of the Company's receivables are secured by marketable securities. The Company also has investments in fixed assets and illiquid securities but such investments are not a significant portion of the Company's total assets.\nHigh yield securities, also referred to as \"junk\" bonds, are non-investment grade debt securities which are rated by Standard & Poor's as lower than BBB- and by Moody's Investors Service as lower than Baa3. The market for high yield securities can be extremely volatile and many experienced significant declines in the past several years. At year-end 1995, in its high yield operations, Alex. Brown had $12.9 million and $.6 million of long and short inventory, respectively, as compared to $21.3 million and $1.0 million at year-end 1994.\nAs of year-end 1995, the carrying value of the Company's merchant banking investments was $23.5 million, compared to $13.6 million at year-end 1994. Gains related to merchant banking investments were $6.1 million in 1995 compared to $3.9 million in 1994. At December 31, 1995, the Company had committed to invest an additional $10.3 million in a merchant banking partnership. It is anticipated that merchant banking investments will generally have a holding period of three years or more. It is also anticipated that these activities will be funded with existing sources of working capital. The Company has no outstanding bridge loans.\nFrom time to time the Company makes subordinated loans to correspondents as part of its Correspondent Services business. These loans may be secured or unsecured and are funded through general working capital sources. At year-end 1995, $3.0 million of such loans were outstanding.\nThe Company finances its business through a number of sources, consisting primarily of paid-in capital, funds generated from operations, free credit balances in customers' accounts, deposits received on securities loaned, repurchase agreements and bank loans, as well as through the issuance of debt and equity securities.\nThe Company borrows from banks on a short-term basis both on an unsecured basis and under arrangements pursuant to which the amount of funds available is based on the value of the securities owned by the Company and customers' margin securities pledged as collateral. In addition, the Company borrows on a long-term basis from banks on both an unsecured basis and with fixed assets pledged as collateral (\"term loans\"). The Company has historically been able to obtain necessary bank borrowings and believes that it will continue to be able to do so in the future. The Company has $150 million of unused\ncommitted lines of credit under revolving credit agreements (the \"Credit Facilities\") with various banks. The Credit Facilities expire in August 1996. The Credit Facilities and term loans contain various restrictive covenants, the most significant of which require the maintenance of minimum levels of net worth by both the Company and Alex. Brown and minimum levels of net capital by Alex. Brown. There were no outstanding borrowings under the Credit Facilities at December 31, 1995. At December 31, 1995, the Company and Alex. Brown were in compliance with all restrictive covenants contained in the Credit Facilities and term loans.\nOn July 10, 1995, the Company filed a shelf registration statement with the Securities and Exchange Commission to register the offer and sale of up to $150 million of senior debt and convertible debt securities. On August 16, 1995, the Company issued $110 million of 75\/8% Senior notes due 2005. The Senior notes were issued at a discount to yield 7.705%.\nAlex. Brown is required to comply with the net capital rule of the Securities and Exchange Commission. The Company's ability to withdraw capital from Alex. Brown may be limited by the rule. Alex. Brown has consistently exceeded minimum net capital requirements under the rule. At December 31, 1995, Alex. Brown had aggregate net capital of $322 million, which exceeded the minimum net capital requirements by $296 million.\nDuring 1995, the Company repurchased a total of 29,601 shares of its Common Stock at a cost of $1.2 million. At year-end 1995, the Company had a remaining repurchase authorization of approximately 1.4 million shares. The Company anticipates that, subject to market conditions, it will make additional repurchases.\nManagement of the Company believes that existing capital and credit facilities, when combined with funds generated from operations, will provide the Company with sufficient resources to meet its present and reasonably foreseeable future cash and capital needs.\nRISK MANAGEMENT The Company records securities transactions on a settlement date basis, generally the third business day following the trade execution. The risk of loss on unsettled transactions relates to customers' or brokers' inability or refusal to meet the terms of their contracts. The Company monitors its exposure to market and counterparty risk through a variety of financial, position and credit exposure reporting and control procedures. The Risk Management, Credit and Investment Committees, each of which meets on a regular basis, include members of senior management. Each trading department is subject to internal position limits established by the Risk Management Committee which also reviews positions and results of the trading departments. Alex. Brown's Credit Committee establishes and reviews appropriate credit limits for customers and brokers seeking margin, repurchase and reverse repurchase agreement facilities and securities borrowed and securities loaned arrangements. The Investment Committee approves investment purchases and sales and reviews holdings.\nEFFECTS OF INFLATION Because the Company's assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects the Company's expenses such as employee compensation, office space leasing costs and communication charges, and increases therein may not be readily recoverable in the price of services offered by the Company. To the extent inflation results in rising interest rates and has other adverse effects upon the securities markets and on the value of securities owned by the Company, it may adversely affect the Company's financial position and results of operations.\nCONSOLIDATED STATEMENTS OF EARNINGS Alex. Brown Incorporated\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION Alex. Brown Incorporated\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Alex. Brown Incorporated\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Alex. Brown Incorporated\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alex. Brown Incorporated\n1) Description of Business and Significant Accounting Policies\nThe accompanying consolidated financial statements include the activities of Alex. Brown Incorporated and subsidiaries in which it owns a controlling financial interest (the Company). Its principal subsidiary is Alex. Brown & Sons Incorporated (Alex. Brown), which is wholly owned.\nThe Company is primarily engaged in a single line of business as a securities broker dealer, which includes several types of services, such as principal and agency transactions, underwriting and other investment banking advisory, asset management and correspondent clearing. The Company, like other securities firms, is directly affected by general economic and market conditions, including fluctuations in volume and price levels of securities, changes in interest rates and demand for investment banking and securities brokerage services, all of which have an impact on the Company's revenues as well as its liquidity.\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 may differ from those estimates.\nAll material intercompany transactions and balances have been eliminated. The equity method of accounting is used for investments in entities in which the Company holds a noncontrolling financial interest of 20% to 50%.\nSecurities transactions and the related revenues and expenses are reflected in the financial statements on a settlement date basis, which is generally three business days after trade date. Revenues and expenses on a trade date basis are not materially different from revenues and expenses on a settlement date basis.\nFirm trading and investment securities and securities sold, not yet purchased are carried at market value, and unrealized gains and losses relating thereto are reflected in revenues. Market values are generally based on quoted market prices. If quoted market prices are not available, market values are determined based on other relevant factors, including quoted market prices for similar securities. Investments made in connection with merchant banking transactions are recorded at their initial cost. The carrying values of such investments are adjusted when the market values are supported by listed market prices, adjusted for liquidity and other relevant factors. In addition, the carrying values are reduced when the Company determines that the eventual realizable value is less than the carrying value based on financial and market information relevant to the investment.\nSecurities purchased under agreements to resell and securities sold under repurchase agreements are accounted for as financing transactions. Such securities consist of obligations of the United States government or one of its agencies. The Company's practice is to maintain collateral sufficient to secure amounts receivable pursuant to securities purchased under agreements to resell.\nDepreciation of office equipment is determined using the straight line method over useful lives ranging from 3 to 10 years. Leasehold improvements are amortized on the straight line method over the lesser of the estimated economic useful life of the improvements or the remaining term of the lease.\nDeferred tax assets and liabilities represent the expected future tax consequences of the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The effects of changes in tax rates on deferred tax assets and liabilities are recognized in the period that includes the enactment date.\nThe Company classifies all short-term investments with maturities at dates of purchase of three months or less as cash equivalents except for short-term investments carried in trading accounts.\nCash management facility payable represents the excess of outstanding checks written on certain banks over amounts on deposit at such banks.\nPrimary and fully diluted earnings per share are based on the weighted average number of shares outstanding and assume the exercise of outstanding dilutive options to purchase common stock. Fully diluted earnings per share further assumes the conversion into common stock of convertible subordinated debentures, if dilutive.\nThe Company uses the intrinsic value method to account for stock-based employee compensation plans. Under this method, compensation cost is recognized for awards of shares of common stock to employees under compensatory plans only if the quoted market price of the stock at the grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation.\" Statement No. 123 permits companies to adopt a new fair value based method to account for stock-based employee compensation plans or to continue using the intrinsic value method. If the intrinsic value method is used, information concerning the pro forma effects on net earnings and earnings per share of adopting the fair value based method is required to be presented in the notes to the financial statements. The Company intends to continue using the intrinsic value method and will provide the pro forma disclosures about its stock-based employee compensation plans in its 1996 financial statements, as required by Statement No. 123.\nCertain amounts in 1994 and 1993 have been reclassified to conform to the 1995 presentation.\n2) Receivables from Customers\nReceivables from customers include amounts due on uncompleted transactions and margin balances. Securities owned by customers and held as collateral for these receivables are not reflected in the financial statements.\n3) Receivables from and Payables to Brokers, Dealers and Clearing Organizations\nReceivables from and payables to brokers, dealers and clearing organizations consisted of the following\n(in thousands):\n1995 1994 - --------------------------------------------------------------------------------\nSecurities failed to deliver $ 16,107 $ 23,551 Deposits paid for securities borrowed 357,365 166,976 Other 42,977 46,952 ---------------------------- Total receivables $416,449 $237,479 ============================ Securities failed to receive $ 15,146 $ 11,052 Deposits received for securities loaned 433,808 250,098 Other 31,667 18,487 ---------------------------- Total payables $480,621 $279,637 ============================\nPayables to brokers, dealers and clearing organizations include amounts which are due upon delivery of securities to Alex. Brown. In the event the counterparty does not fulfill its contractual obligation to deliver these securities, Alex. Brown may be required to purchase the securities at prevailing market prices to satisfy its obligations.\n4) Firm Trading Securities\nFirm trading securities consisted of the following (in thousands): 1995 1994 - --------------------------------------------------------------------------------\nUnited States government and agencies thereof $ 9,315 $ 4,946 Mortgage-backed 1 648 States and municipalities 36,607 39,978 Corporate debt 42,945 25,631 Equities and convertible debt 21,696 22,149 ------------------------- $110,564 $93,352 =========================\n5) Principal Transactions Revenue\nThe components of principal transactions revenue were as follows (in thousands):\n1995 1994 1993 - -----------------------------------------------------------------------------\nEquity trading $104,335 $69,915 $ 75,586 Equity derivatives (921) 328 (321) Fixed income trading 36,437 49,110 55,764 Fixed income derivatives (468) 766 1 ------------------------------------------ $139,383 $120,119 $131,030 ==========================================\nThe Company's equity trading operations include trading in over the counter equities, listed equities and convertible securities. The Company's fixed income trading activities include trading in U.S. government and government agency obligations, mortgage-backed securities, state and municipal obligations and investment grade and non-investment grade (high yield) corporate debt. The Company sells short S&P 500 Index futures contracts to hedge its equity inventories and Treasury Bond and Municipal Bond Index futures contracts to hedge its fixed income inventories. The futures contracts involve off-balance-sheet risk since the cost to close out the contracts may exceed the amounts recognized in the Consolidated Statements of Financial Condition. The contracts are listed on regulated exchanges and are marked to market daily with the resulting gain or loss reflected in revenue. The exchanges guarantee performance of counterparties; therefore, credit risk is limited to a default by the exchange. The notional amounts and fair values of these contracts at December 31, 1994 and average fair values during 1995 and 1994 were not material. There were no open futures contracts at December 31, 1995.\n6) Investment Securities\nInvestment securities consisted of the following (in thousands): 1995 1994 - -------------------------------------------------------------------------------\nMerchant banking investments $23,546 $13,555 Investment partnerships 17,703 11,205 Equities 5,036 5,035 Mutual funds 3,359 2,389 U.S. government obligations 650 651 --------------------------- $50,294 $32,835 ===========================\n7) Intangible Asset\nIn December 1993, the Company entered into an agreement to purchase the rights to the name \"Alex. Brown\" for $10.5 million. That agreement was consummated on January 3, 1994. Previously, the name had been used by the Company pursuant to an agreement with certain lineal descendants of Alexander Brown, the founder of the Company. The Company is amortizing the cost of the name over 40 years.\n8) Borrowings\nBANK LOANS\nBank loans were collateralized as follows (in thousands): 1995 1994 - --------------------------------------------------------------------------------\nCustomers' margin securities $100,000 $45,679 Office equipment and leasehold improvements 1,308 5,964 Unsecured 18,700 21,300 --------------------------- $120,008 $72,943 ===========================\nThe Company obtains bank loans which are collateralized by securities owned by the Company and customers' margin securities. Such loans are payable on demand and bear interest based on the federal funds rate (5.3% at December 31, 1995). The weighted average interest rate on these loans was 5.5% at December 31, 1995. The average balances of such loans outstanding were $120,507,000 during 1995 at a weighted average interest rate of 6.4% and $121,263,000 during 1994 at a weighted average interest rate of 4.6%.\nTerm loans of $1,308,000 and $5,964,000 at December 31, 1995 and 1994, respectively, are collateralized by office equipment and leasehold improvements and bear interest at rates ranging from 5.4% to 9.3%. The weighted average interest rates of these term loans were 7.9% during 1995 and 7.8% during 1994. The outstanding term loan at December 31, 1995 matures in 1996.\nA term loan of $5,300,000 and $6,300,000 at December 31, 1995 and 1994, respectively, is unsecured and bears interest at a variable rate based on the London Interbank Offered Rate (5.7% at December 31, 1995). The weighted average interest rates were 6.9% during 1995 and 4.8% during 1994. The loan matures as follows: $1,200,000 in 1996, $2,350,000 in 1997 and $1,750,000 in 1998.\nA term loan of $13,400,000 and $15,000,000 at December 31, 1995 and 1994, respectively, is unsecured and bears interest at a variable rate based on the federal funds rate. The weighted average interest rates were 6.6% during 1995 and 5.6% during 1994. The loan matures as follows: $1,600,000 in 1996, $2,400,000 in each of 1997 and 1998 and $7,000,000 in 1999.\nSENIOR NOTES\nIn August 1995, the Company issued $110,000,000 senior notes due August 2005 which bear interest at 7 5\/8%. The notes were sold at a discount to yield 7.705%.\nCONVERTIBLE SUBORDINATED DEBENTURES\nThe Company issued $25,000,000 convertible subordinated debentures in June 1986. The debentures are due June 2001, bear interest at 53\/4% and are convertible into the Company's common stock at the rate of one share of common stock for each $26.03 of principal amount of debentures. The debentures are redeemable at the option of the Company at prices ranging from 101% (in 1995) to par over the term to maturity. During 1995, $13,040,000 par value of the debentures was converted into 500,952 shares of the Company's common stock.\nCREDIT FACILITIES\nThe Company has $150 million of unused committed lines of credit under revolving credit agreements (the \"Credit Facilities\") with various banks. The Credit Facilities expire in August 1996. The Credit Facilities and term loans contain various restrictive covenants, the most significant of which require the maintenance of minimum levels of net worth by both the Company and Alex. Brown and minimum levels of net capital by Alex. Brown. There were no outstanding borrowings under the Credit Facilities at December 31, 1995. At December 31, 1995, the Company and Alex. Brown were in compliance with all restrictive covenants contained in the Credit Facilities and term loans.\nINTEREST PAYMENTS\nInterest payments, including interest payments on repurchase agreements, securities loaned and convertible subordinated debentures, were $32,210,000, $20,381,000 and $14,122,000 during 1995, 1994 and 1993, respectively.\n9) Securities Sold, Not Yet Purchased\nSecurities sold, not yet purchased consisted of the following (in thousands):\n1995 1994 - -------------------------------------------------------------------------------\nUnited States government and agencies $34,958 $4,750 States and municipalities 67 329 Corporate debt 5,593 3,286 Equities and convertible debt 13,658 17,477 --------------------------- $54,276 $25,842 ===========================\nSecurities sold, not yet purchased represent obligations to purchase securities at prevailing market prices. These transactions result in off-balance-sheet risk since Alex. Brown's ultimate cost to satisfy the obligations is dependent upon future prices of the securities and may exceed the amounts recognized in the Consolidated Statements of Financial Condition.\n10) Net Capital Requirements\nAlex. Brown is required to comply with the net capital rule of the Securities and Exchange Commission. The rule may limit the Company's ability to withdraw capital from Alex. Brown. Alex. Brown has consistently exceeded the minimum net capital requirements under the rule. At December 31, 1995, Alex. Brown's net capital was $322,292,000 which exceeded net capital rule requirements by $295,954,000. Alex. Brown has two London-based subsidiaries which are subject to the capital requirements of the Securities and Futures Authority (SFA). At December 31, 1995, these subsidiaries were in compliance with the SFA capital adequacy requirements.\n11) Commitments and Contingencies\nLEASES\nThe Company's subsidiaries are obligated under operating leases for office facilities and equipment expiring at various dates to 2013. Two leases for office facilities are with partnerships in which certain employees of the Company are partners. Under these leases, the subsidiaries pay all insurance, energy and other occupancy costs. Another lease for office facilities is with a partnership in which the Company has an ownership interest. The approximate annual minimum rentals under the leases payable to such related parties and others as of December 31, 1995 were as follows (in thousands):\nYears Ending December 31 Related Parties Others - ------------------------------------------------------------------ 1996 $2,844 $ 9,187 1997 711 12,178 1998 -- 25,138 1999 -- 13,029 2000 -- 13,076 2001 and thereafter -- 117,174 - ------------------------------------------------------------------\nRent expense, including equipment rentals, was $20,720,000, $16,096,000 and $14,829,000 including $2,450,000, $2,445,000 and $2,939,000 to related parties, for 1995, 1994 and 1993, respectively.\nLETTERS OF CREDIT\nAt December 31, 1995, Alex. Brown was contingently liable for up to $51,000,000 under unsecured letters of credit used to satisfy required margin deposits at five securities clearing corporations.\nINVESTMENT COMMITMENTS\nAt December 31, 1995, the Company had committed to invest up to $11.6 million in certain investment partnerships, including $10.3 million in a merchant banking partnership.\nLITIGATION\nIn the course of its investment banking and securities brokerage business, Alex. Brown has been named a defendant in a number of lawsuits and may be required to contribute to final settlements in actions, in which it has not been named a defendant, arising out of its participation in the underwritings of certain issues. A substantial settlement or judgment in any of these cases could have a material adverse effect on the Company. Although the ultimate outcome of such litigation is not subject to determination at present, in the opinion of management, after consultation with counsel, the resolution of these matters will not have a material adverse effect on the Company's consolidated financial statements.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK\nAlex. Brown executes, settles and finances securities transactions in connection with its customer and correspondent clearing activities (\"customers\"). These activities may expose the Company to off-balance-sheet risk in the event a counterparty is unable to fulfill its contractual obligations.\nIn accordance with industry practice, customers and other brokers are not required to deliver cash or securities to Alex. Brown pursuant to securities transactions until settlement date, which is generally three business days after trade date. The Company is exposed to risk of loss should any counterparty to a securities transaction fail to fulfill its contractual obligations, and Alex. Brown is required to buy or sell securities at prevailing market prices.\nAlex. Brown's customers may sell securities not yet purchased or write option contracts (\"short sales\"). Regulatory and internal margin requirements determine the collateral value that customers who execute short sales must have in their accounts in the form of cash or securities. Customer short sales may expose the Company to risk of loss in the event that collateral held by Alex. Brown is not sufficient to cover losses which customers may incur. In the event a customer fails to fulfill its obligations, Alex. Brown may be required to buy or sell securities at prevailing market prices.\nThe Company seeks to minimize the above risks through a variety of reporting and control procedures. Customers and other brokers are required to maintain collateral in compliance with regulatory and internal requirements. The adequacy of collateral is reviewed daily and customers may be required to deposit additional collateral or reduce short positions when necessary. Alex. Brown sets credit limits for customers executing transactions on margin and monitors compliance with such limits on a daily basis. Alex. Brown establishes credit limits for brokers with which it conducts stock loan, stock borrow and repurchase and reverse repurchase transactions. Alex. Brown monitors compliance with and the appropriateness of such limits.\nFINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK\nAs a securities broker, Alex. Brown engages in various securities trading and brokerage activities with other brokers and institutional and individual customers. In connection with these activities, Alex. Brown enters into reverse repurchase and repurchase agreements which are collateralized by U.S. government and agency securities and securities lending arrangements which may result in credit exposure in the event the counterparty fails to fulfill its contractual obligations. A substantial portion of Alex. Brown's transactions are executed with and on behalf of other brokers and dealers and institutional investors, including commercial banks, insurance companies, pension plans, mutual funds and other financial institutions. The Company's exposure to credit risk can be directly impacted by volatile securities markets which may impair the ability of counterparties to satisfy their contractual obligations.\nThe Company seeks to control its credit risk through the use of a variety of reporting and control procedures described in the preceding discussion of financial instruments with off-balance-sheet risk. Substantially all of Alex. Brown's receivables are collateralized by securities which are generally in physical possession, at depositories or due from other parties.\n12) Fair Value of Financial Instruments\nRECEIVABLES\nReceivables from customers and brokers, dealers and clearing organizations include margin loans which are payable on demand, amounts due on open transactions which usually settle within a few days and cash deposits made in connection with securities borrowed transactions which normally can be closed out within a few days. The carrying amounts of these receivables, which are generally secured by marketable securities, and other receivables approximate fair value.\nFIRM TRADING AND INVESTMENT SECURITIES (LONG AND SHORT)\nFirm trading and investment securities are carried in the consolidated financial statements at market value (see notes 1, 4 , 6 and 9).\nBANK LOANS\nThe principal balance of bank loans which are payable on demand is considered to be the fair value of such loans. The carrying values of the term loans approximated fair values at December 31, 1995 and 1994 based on borrowing rates currently available to the Company for loans with similar terms and remaining maturities.\nPAYABLES\nPayables to customers and brokers, dealers and clearing organizations include free credit balances which are payable on demand, amounts due on open transactions which usually settle within a few days, and cash deposits received in connection with customer short sales and securities loaned transactions which normally can be closed out within a few days. Other payables include expense accruals and amounts due to other brokers resulting from securities underwritings. The carrying amount of payables approximates fair value.\nREPURCHASE AGREEMENTS\nThe carrying amounts of securities sold under repurchase agreements and securities purchased under agreements to resell are considered to be the fair values of such transactions.\nSENIOR NOTES AND CONVERTIBLE SUBORDINATED DEBENTURES\nThe fair values of the Senior notes and Convertible subordinated debentures were as follows (in thousands):\n1995 1994 - --------------------------------------------------------------------- 7 5\/8% Senior notes $117,469 -- 5 3\/4% Convertible subordinated debentures 19,413 $26,595\nThe fair values are based on quoted market prices. At December 31, 1995, the Convertible subordinated debentures were callable at the Company's option at $12,080,000.\n13) Income Taxes\nThe components of income tax expense were as follows (in thousands):\n1995 1994 1993 - ----------------------------------------------------------------------------- Federal $51,153 $ 38,649 $ 47,644 State and local 11,467 8,761 11,465 ------------------------------------------- $62,620 $ 47,410 $59,109 =========================================== Current $72,758 $ 58,106 $62,362 Deferred (10,138) (10,696) (3,253) ------------------------------------------- $62,620 $ 47,410 $59,109 ===========================================\nIncome tax expense is reconciled to amounts computed by applying the federal corporate tax rate to earnings before income taxes as follows (in thousands):\n1995 1994 1993 - -----------------------------------------------------------------------------\nTax at federal statutory rate $55,361 $41,398 $51,917 State and local income taxes, net of federal income tax benefit 7,454 5,695 7,452 Other, net (195) 317 (260) ----------------------------------- $62,620 $47,410 $59,109 ===================================\nThe components of the net deferred income tax asset were as follows (in thousands):\n1995 1994 - ----------------------------------------------------------------------------- Deferred income tax assets: Unrealized loss-- Firm securities $ 3,584 $ 1,851 Equity awards -- 904 Accrued expenses 28,585 18,528 Other investments 106 123 Depreciation 3,892 2,070 Other 1,265 1,613 ---------------------------- Total deferred income tax assets 37,432 25,089 ----------------------------\nDeferred income tax liabilities: Unrealized profit--Firm securities 4,667 1,852 Other investments 1,852 2,221 Depreciation 1,426 1,153 Other 1,674 2,188 ---------------------------- Total deferred income tax liabilities 9,619 7,414 ---------------------------- Net deferred income tax asset $27,813 $17,675 ============================\nThere was no valuation allowance relating to deferred income tax assets at December 31, 1995 and 1994. Income tax payments were $64,903,000, $69,438,000 and $50,428,000 during 1995, 1994 and 1993, respectively.\n14) Employee Benefit Plans\nEMPLOYEE DEBENTURES\nThe Company has sold convertible subordinated debentures to certain employees pursuant to the 1991 Equity Incentive Plan. The debentures are convertible into the Company's common stock three years after the date issued. The debentures may be redeemed at par if the employee terminates employment with the Company. The Company has made loans to the employees, with a six year term, to fund the purchase of the debentures. Information related to debentures outstanding at December 31, 1995 and issued in January 1996 was as follows:\nPrincipal amount Interest Conversion Date issued of debentures rate Due date price\/share - ------------------------------------------------------------------------------\nJanuary 1991 $ 822,000 8.125% June 1997 $8.50 January 1992 1,837,000 6.750% June 1998 25.50 January 1993 2,250,000 6.375% June 1999 23.00 January 1994 3,925,000 5.375% June 2000 28.83 January 1995 5,392,000 8.000% June 2001 33.70 January 1996 7,820,000 5.750% June 2002 46.00\nThe Company has agreed to forgive one-sixth of the loans at the end of each of the first three years if the Company's return on equity exceeds an annual target or one-half of the loans at the end of the third year, to the extent not otherwise forgiven, if the Company's return on equity for the three year period exceeds an average target. The right to receive loan forgiveness is subject to three year cliff vesting. Loan forgiveness targets for the second three year period of the loan term are set at the end of the third year.\nThe Company met the return on equity targets in 1991 through 1995. Compensation expense relating to such loan forgiveness was $2,675,000, $1,804,000 and $1,092,000 for 1995, 1994 and 1993, respectively. Information relating to target returns on equity is set forth below:\nInitial three year period Second three year period Date issued Annual Average Annual Average - --------------------------------------------------------------------------------\nJanuary 1991-January 1992 15% 17% 15% 17% January 1993 15% 17% 15% 15% January 1994-January 1995 15% 17% -- -- January 1996 15% 15% -- --\nEQUITY PARTNERSHIP PLAN\nDuring 1995, 1994 and 1993, the Company sold 58,216, 18,250 and 544,000 shares of common stock, respectively, and convertible subordinated debentures at market to certain key employees pursuant to the 1991 Equity Incentive Plan. The debentures are generally convertible into the Company's common stock in stages beginning four years after the date issued. The debentures may be redeemed at par if the employee terminates employment with the Company. The Company made loans to the employees of $52,379,000 to finance the purchase of the stock and debentures. Under the Plan, the Company may forgive a portion of the principal amount of the loans granted prior to July 1995, not to exceed the difference between market value and book value at the time of purchase. Loan forgiveness resulted in compensation expense of $1,277,000, $1,250,000 and $3,200,000 in 1995, 1994 and 1993, respectively. Information related to debentures outstanding at December 31, 1995 was as follows:\nPrincipal amount Interest Conversion Date issued of debentures rate Due date price\/share - -------------------------------------------------------------------------------\nAugust 1993 $23,434,000 5.32% August 2001 $23.750 May 1994 442,000 6.92% May 2002 26.375 November 1994 532,000 7.45% November 2002 26.625 February 1995 867,000 7.96% February 2003 36.125 May 1995 1,772,000 7.12% May 2003 39.000 July 1995 10,311,000 6.28% July 2005 48.750\nSTOCK OPTIONS\nThe Company has granted nonqualified stock options to certain employees and directors. Payment for the shares may be made in cash, shares of the Company's common stock or a combination thereof. Options were granted to purchase 430,900, 404,000 and 375,000 shares of the Company's common stock in January 1996, 1995 and 1994, respectively. These options and options granted in January 1993 are exercisable in six equal installments beginning one year from the date of grant and expire after ten years. The exercise price for these options is 25% greater than the lesser of the average market value of the Company's common stock 30 days prior to the date of grant or the market value on the date of grant. Options previously granted are generally exercisable in five equal installments beginning one year from the date of grant and expire after five years.\nThe following table sets forth activity relating to the number of shares covered by stock options (options granted include amounts granted through January of the following year):\n1995 1994 1993 - ------------------------------------------------------------------------------- Outstanding at January 1 2,195,109 2,108,156 2,168,568 Granted 439,900 413,000 384,000 Exercised (at $8.50-$31.34) (438,026) (249,105) (356,032) Forfeited (45,484) (76,942) (88,380) ------------------------------------------- Outstanding at December 31 2,151,499 2,195,109 2,108,156 ===========================================\nOptions outstanding at December 31, 1995 and granted in January 1996 have an exercise price range of $8.50-$50.00 per share and a weighted average exercise price of $31.84 per share. Options for 889,603 shares were exercisable at December 31, 1995.\nRESTRICTED STOCK AWARDS\nRestricted stock awards were granted prior to 1991 and vest over five years. Unvested shares are subject to forfeiture if the recipient terminates employment with the Company. The market value of shares granted is being amortized over the periods in which the employees are providing the related services (compensation expense of $52,000 for 1995, $94,000 for 1994, $91,000 for 1993).\nRETIREMENT PLANS\nEffective July 1, 1995, the Company merged its 401(k) deferred compensation and profit sharing plans (the \"Plan\"). Employees are permitted within limitations imposed by tax law to make pretax contributions to the Plan pursuant to salary reduction agreements. The Company may make discretionary matching and profit sharing contributions to the Plan and may make additional contributions to preserve the Plan's tax exempt status. The Company also has retirement plans for certain employees in foreign offices not covered by the Plan. Compensation expense for the Company's contributions to retirement plans was $9,600,000, $5,000,000 and $6,361,000 for 1995, 1994 and 1993, respectively.\nEMPLOYEE STOCK PURCHASE PLAN\nThe Company maintains an employee stock purchase plan pursuant to which employees may purchase shares of the Company's common stock through payroll deductions, subject to certain limitations, at a price equal to 85% of the fair market value of the stock on four quarterly investment dates. The plan provides for the issuance of up to 1,000,000 shares. A total of 657,880 shares have been issued under the plan, including 91,441 shares in 1995.\nEQUITY COMPENSATION PLAN\nDuring 1995, 1994 and 1993, certain key employees had a portion of cash compensation withheld and replaced by restricted common stock of the Company at a 15% discount from market and interests in investment accounts through which the employees can direct investments in selected Company-sponsored investment vehicles. Compensation expense is recorded currently based on the value of the stock and interests in the investment accounts on the award date. The restricted stock cannot be sold and funds cannot be withdrawn from the investment accounts for three years (five years if employment terminates during the initial three year period). These restrictions are removed in the event of death, disability or retirement. Pursuant to the Equity Compensation Plan, $11,102,000, $7,080,000 and $8,729,000 of cash compensation was withheld and replaced by 163,155, 130,058 and 204,242 shares of the Company's common stock and interests in investment accounts for 1995, 1994 and 1993, respectively.\nDEFERRED COMPENSATION PLAN\nThe Company maintains a deferred compensation plan for Private Client investment representatives. Eligible participants can direct the investment of their deferred compensation amounts by selecting among various Company-sponsored investment vehicles and the common stock of the Company at a 15% discount from market. The employees vest in the deferred compensation accounts after four years. The deferred compensation is forfeited if the employee terminates employment with the Company during the vesting period except for termination due to death, disability or retirement. The amount of deferred compensation, including any stock discounts, is being amortized over the periods in which the employees are providing the related services (compensation expense of $1,063,000 for 1999, $1,743,000 for 1998, $2,414,000 for 1995 through 1997, $1,413,000 for 1994 and $769,000 for 1993).\nREPORT OF INDEPENDENT AUDITORS Alex. Brown Incorporated\nBoard of Directors Alex. Brown Incorporated:\nWe have audited the accompanying consolidated statements of financial condition of Alex. Brown Incorporated 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 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alex. Brown Incorporated 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\nBaltimore, Maryland January 24, 1996\nSELECTED CONSOLIDATED FINANCIAL INFORMATION Alex. Brown Incorporated\nQUARTERLY FINANCIAL DATA (UNAUDITED) Alex. Brown Incorporated\nCORPORATE INFORMATION Alex. Brown Incorporated\nPrice Range of Common Stock and Dividends - -------------------------------------------------------------------------------- The common stock of the Company trades on the NYSE under the symbol \"AB.\" As of December 31, 1995, there were approximately 504 holders of record of the Company's common stock. The following tables set forth the high and low sales prices of the common stock and the cash dividends declared on the common stock for the periods indicated.\nPrice Range of Common Stock - -------------------------------------------------------------------------------- 1995 High Low - -------------------------------------------------------------------------------- First Quarter $39 $29 5\/8 Second Quarter $47 5\/8 $38 1\/8 Third Quarter $60 5\/8 $42 1\/8 Fourth Quarter $58 1\/4 $40\n1994 High Low - -------------------------------------------------------------------------------- First Quarter $30 1\/8 $23 3\/4 Second Quarter $28 3\/4 $23 1\/4 Third Quarter $29 5\/8 $24 Fourth Quarter $30 3\/8 $25\nDividend Information - -------------------------------------------------------------------------------- Dividend Per Share Declaration Date Record Date Payment Date - -------------------------------------------------------------------------------- 1995 $.175 April 21, 1995 May 1, 1995 May 10, 1995 $.20 July 25, 1995 August 7, 1995 August 16, 1995 $.20 October 19, 1995 October 30, 1995 November 9, 1995 $.20 January 24, 1996 February 5, 1996 February 15, 1996\n1994 $.15 April 14, 1994 April 26, 1994 May 6, 1994 $.175 July 18, 1994 July 29, 1994 August 10, 1994 $.175 October 18, 1994 October 28, 1994 November 8, 1994 $.175 January 25, 1995 February 6, 1995 February 15, 1995\nForm 10-K - -------------------------------------------------------------------------------- A copy of the Company's Annual Report on Form 10-K for 1995 as filed with the Securities and Exchange Commission is available without charge on request by writing to Beverly L. Wright, Chief Financial Officer, Alex. Brown Incorporated, 135 East Baltimore Street, Baltimore, Maryland 21202.\nAuditors - -------------------------------------------------------------------------------- KPMG Peat Marwick LLP 111 South Calvert Street Baltimore, Maryland 21202 (410) 783-8300\nTransfer Agent and Registrar - -------------------------------------------------------------------------------- Chemical Bank 450 West 33rd Street New York, New York 10001 (800) 851-9677\nCommission File No. 0-14199\nUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nEXHIBITS\nTO\nANNUAL REPORT ON FORM 10-K UNDER THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nAlex. Brown Incorporated\nALEX. BROWN INCORPORATED Annual Report on Form 10-K\nIndex to Exhibits\nExhibit No. Exhibit Page\n3.1 Charter of the Registrant, as amended (4)\n3.2 By-Laws of the Registrant, as amended (2)\n4.1 Indenture dated as of June 12, 1986 between Alex. Brown Incorporated and Bankers Trust Company, Trustee, relating to the Company's 5 3\/4% convertible Subordinated Debentures due 2001 (2)\n4.2 Indenture dated as of July 10, 1995 between Alex. Brown Incorporated and Chemical Bank, Trustee, relating to the Company's 7 5\/8% Senior Notes due 2005 (11)\n4.3 Agreement to furnish Loan Agreements ____\n10.1 Lease dated as of January 1, 1984 by and between Alex. Brown Partners, a Maryland Limited Partnership, and Alex. Brown & Sons Incorporated (1)\n10.1(a) First Amendment to Lease dated July 29, 1993 (9)\n10.2 Lease dated as of January 1, 1985 by and between Brown Realty Company and Alex. Brown & Sons Incorporated (1)\n10.2(a) Amendment to Lease dated July 29, 1993 (9)\n10.3 Lease dated July 2, 1987 by and between Alex. Brown & Sons Incorporated and Calvert-Baltimore Associates Limited Partnership (3)\n10.3(a) First Amendment to Lease dated March 8, 1988 by and between Calvert-Baltimore Associates Limited Partnership and Alex. Brown & Sons Incorporated (5)\n10.3(b) Second Amendment to Lease dated August 10, 1989 by and between Calvert-Baltimore Associates Limited Partnership and Alex. Brown & Sons Incorporated (5)\n10.4 First Amended and Restated Stockholders' Agreement dated June 23, 1989 among the Registrant and certain stockholders of the Registrant, as amended (8)\n10.5* Alex. Brown Incorporated 1991 Equity Incentive Plan (7)\n10.6* Alex. Brown Incorporated 1991 Non-Employee Director Equity Plan (6)\n10.7* Benjamin H. Griswold IV Employment (9) Agreement\n10.8* 1995 Non-Employee Director Stock (10) Purchase Plan\n11 Statement of Computation of per share earnings ____\n12 Statement of Computation of Consolidated Ratio of Earnings to Fixed Charges ____\n13 Pages 28 through 31, 33 through 49 and 52 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1995 (12)\n21 Subsidiaries of the Registrant (2)\n23 Consent of KPMG Peat Marwick LLP ____\n27 Financial Data Schedule ____\n* Connotes a management contract or compensatory plan or other arrangement in which a director or executive officer of the Registrant participates.\n(1) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-2687 on Form S-1 of the Company filed on January 15, 1986.\n(2) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-13289 on Form S-1 of the Company filed on April 9, 1987.\n(3) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n(4) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(5) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(6) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-40618 on Form S-8 of the Company filed on May 16, 1991.\n(7) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-40619 on Form S-8 of the Company filed on May 16, 1991.\n(8) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n(9) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(10) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-59601 on Form S-8 of the Company filed on May 25, 1995.\n(11) Incorporated by reference to the corresponding Exhibit to the Registration Statement No. 33-60955 on Form S-3 of the Company filed on July 10, 1995.\n(12) Incorporated by reference to the corresponding Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995.","section_15":""}
{"filename":"352947_1995.txt","cik":"352947","year":"1995","section_1":"Item 1. Business - ------ -------- Engelhard Corporation and its Subsidiaries (collectively referred to as the Company) are the successors to the businesses previously operated by Engelhard Minerals & Chemicals Corporation (EMC). In 1981, the Company's Common Stock was distributed to the shareholders of EMC, and the Company became a separate, publicly-held corporation. The Company's principal executive offices are located at 101 Wood Avenue, Iselin, NJ, 08830 (telephone number (908) 205-5000).\nThe Company develops, manufactures and markets technology-based specialty chemical products and engineered materials for a wide spectrum of industrial customers, and provides services to precious and base metals customers and markets energy-related services.\nIn 1993 the Company provided for a plan to realign and consolidate businesses, concentrate resources and better position itself to achieve its strategic growth objectives. See Note 2 \"Special Charge\" of the Notes to Consolidated Financial Statements on pages 31-32 of this 10-K. This plan resulted in a special charge of $148.0 million ($91.8 million after tax or $.63 per share) in 1994 consisting of a $118.0 million pre-tax restructure provision for asset writedowns related to product lines or sites being exited together with provisions for facility shutdown, rundown and relocation and for employee reassignment, severance and related benefits and a $30.0 million pretax environmental reserve. See Note 15 \"Environmental Costs\" of the Notes to Consolidated Financial Statements on pages 44-46 of this 10-K and the \"Environmental Matters\" section below on pages 8-10 of this 10-K for a discussion of environmental matters and the amount of the Company's environmental reserve.\nThe Company employed approximately 5,100 people as of January 1, 1996 and operates on a worldwide basis with corporate and operating headquarters and principal manufacturing facilities and mineral reserves in the United States with other operations conducted in the European Community, the Russian Federation and the Asia-Pacific region.\nThe Company's businesses are organized into three segments - Catalysts and Chemicals, Pigments and Additives, and Engineered Materials and Industrial Commodities Management (formerly Precious Metals Management).\nInformation concerning the Company's net sales, operating earnings and identifiable assets by industry segment and by geographic area; inter-area transfers by geographic area; and export sales is included in Note 13 \"Industry Segment and Geographic Area Data\" of the Notes to Consolidated Financial Statements on pages 41-43 of this 10-K.\nCatalysts and Chemicals\nThe Catalysts and Chemicals segment comprises three principal product groups: the Environmental Technologies Group, consisting of Automotive Emission Systems, Heavy Duty Power Systems and Process Emission Systems, serving the automotive, light and heavy duty truck, aircraft, off-road vehicle, power generation and process industries; the Petroleum Catalysts Group, serving the petroleum refining industries; and the Chemical Catalysts Group, serving the chemical, petrochemical, pharmaceutical and food processing industries.\nEnvironmental technology catalysts are used in applications such as the abatement of carbon monoxide, oxides of nitrogen and hydrocarbons from gasoline, diesel and alternate fueled vehicle exhaust gases to meet emission control standards. These catalysts are also used for the removal of odors, fumes and pollutants generated by a variety of process industries including but not limited to the painting of automobiles, appliances and other equipment; printing processes; the manufacture of nitric acid and tires, in the curing of polymers; and power generation sources. In 1994 and 1995, the Company purchased the assets of General Plasma, Advanced Plasma and Jet-Com, suppliers of thermal spray coating technology and services. These acquisitions, when combined with the Company's catalyst technology, provide for a broader offering of emission control systems. In the fourth quarter of 1995, the Company purchased the other half of its Salem Engelhard joint venture formed in 1992 to produce and market products and services to abate, by catalytic and non-catalytic methods, emissions of volatile organic chemicals and other pollutants generated by a variety of process industries.\nThe Company also participates in the manufacture and supply of automobile exhaust emission control catalysts through affiliates serving the Asia-Pacific region: N.E. Chemcat Corporation (Japan) - 38.8 percent owned; and Hankuk- Engelhard (South Korea) - 49 percent owned, both of which also produce other catalysts and products. In the first quarter of 1995, the Company formed a joint venture with W.R. Grace to manufacture and market metallic substrate catalytic converter systems to the automotive industry.\nThe petroleum refining catalyst products consist of a variety of catalysts and processes used in the petroleum refining industry. The principal products are zeolitic fluid cracking catalysts which are widely used to provide economies in petroleum processing. The Company offers commercially a full line of fluid cracking catalyst based on patented technology which can be used to control selectivity and cracking activity virtually independently of one another. This characteristic permits custom catalysts formulation for a large number of users.\nThe Company manufactures reforming, isomerization and hydrotreating catalysts for a variety of petroleum refining processes. Catalysts are marketed in North America and the Caribbean by Acreon Catalysts, a jointly owned partnership formed by the Company and Procatalyse.\nIn March 1994, the Company completed its purchase of the assets of the sorbents and moving bed catalysts businesses of Solvay Catalysts, GmbH, in Nienburg Germany. This acquisition expanded the Company's moving bed catalysts business and provided complementary product lines serving adsorbents applications.\nIn November 1995, the Company and Procatalyse announced plans to expand the production capacity of their joint venture, Acreon Catalysts. To serve market needs more effectively, they plan to add alumina and hydrotreating catalyst manufacturing capacity in North America.\nThe chemical catalysts products consist of catalysts and sorbents used in the production of a variety of products or intermediates, including synthetic fibers, fragrances, antibiotics, vitamins, polymers, plastics, detergents, fuels and lube oils, solvents, oleochemicals and edible products. These catalysts are generally used in both batch and continuous operations requiring special catalysts for each application. Chemical catalysts are based on the Company's proprietary technology and many times are developed in close cooperation with specific customers. Sorbents are used to purify and decolorize naturally occurring fats and oils for manufacture into shortenings, margarines and cooking oils.\nThe products of the Catalysts and Chemicals segment compete in the marketplace on the basis of product performance, technical service and price. No single competitor is dominant in the markets in which the Company operates.\nThe manufacturing operations of the Catalysts and Chemicals segment are carried out in 12 states in the United States. Wholly-owned foreign operations are located in Germany, Italy, The Netherlands, South Africa and the United Kingdom with equity investments located in the U.S., Japan and South Korea. The products are sold principally through the Company's sales organizations or its equity investments, supplemented by independent distributors and representatives.\nThe principal raw materials used by the Catalysts and Chemicals segment include precious metals, procured by the Engineered Materials and Industrial Commodities Management segment; kaolin, supplied by the Pigments and Additives segment; and a variety of minerals and chemicals which are generally readily available. For more information about precious metal supply contracts, see the \"Engineered Materials and Industrial Commodities Management\" section below on pages 6-7 of this 10-K.\nAs of January 1, 1996 the Catalysts and Chemicals segment had approximately 2,350 employees worldwide, many of whom are hourly employees covered by collective bargaining agreements. Employee relations have generally been good.\nPigments and Additives\nThe Pigments and Additives segment comprises two principal product groups: the Paper Pigments and Chemicals Group, serving the paper industry and the Specialty Minerals and Colors Group, serving the plastics, coatings, paint and allied industries.\nPaper pigments and chemicals products consist primarily of coating and extender pigments. The coating pigments provide whiteness, opacity and improved printing properties for high-quality paper and paperboard. Other products are used as extenders and\/or combined with fibers during the manufacture of paper or paperboard. Products for the paper market include Luminex (registered trademark) pigment, a high-brightness material for high-quality paper coating; Ansilex (registered trademark) pigments that provide the desired opacity, brightness, gloss and printability in paper products; Nuclay (registered trademark) specialized coating pigment for lightweight publication papers; Exsilon (registered trademark) structured pigment that improves the printability of lightweight coated paper and carbonless forms; and Spectrafil (registered trademark) pigments for the newsprint and groundwood specialties markets.\nSpecialty minerals and colors kaolin based products are used as pigments and extenders for a variety of purposes in the manufacture of plastic, rubber, ink, ceramic, adhesive products and in paint. Principal products include Satintone (registered trademark) products, ASP (registered trademark) pigments and Translink (registered trademark) surface modified reinforcements. Other specialty minerals and colors products which serve essentially the same end markets as the Company's kaolin-based pigments and extenders comprise a variety of organic and inorganic color pigments. The Group also produces gellants and sorbents for a wide range of applications.\nThe products of the Pigments and Additives segment compete with similar products as well as products made from other materials on the basis of product performance and price. No single competitor is dominant in the markets in which the Company operates.\nPigments and Additives operations are carried out in four states in the United States, and in Finland and Japan. The products are sold principally through the Company's sales organization supplemented by independent distributors and representatives.\nThe principal raw materials used by the Pigments and Additives segment include kaolin and attapulgite from mineral reserves owned or leased by the Company and a variety of minerals and chemicals which are generally readily available.\nAs of January 1, 1996 the Pigments and Additives segment had approximately 1,750 employees worldwide, many of whom are hourly employees covered by collective bargaining agreements. Employee relations have generally been good.\nEngineered Materials and Industrial Commodities Management\nThe Engineered Materials and Industrial Commodities Management segment includes the Engineered Materials Group, serving a broad spectrum of industries and the Industrial Commodities Management Group, which is responsible for precious and base metals sourcing and dealing, for managing the precious and base metals requirements of the Company and its customers, and for power marketing.\nThe products of the Engineered Materials Group consist primarily of metal-based materials such as temperature-sensing devices, precious metals coating and electroplating materials, conductive pastes and powders and brazing alloys. These products are used in the manufacture of automotive components, industrial devices, ceramics, chemicals, instruments, control devices, medical supplies, hardware, furniture and air conditioners. The Group also provides gold refining services to internal and external customers.\nThe products of the Engineered Materials Group compete with similar products as well as products made from other materials on the basis of product performance, technical service and price. No single competitor is dominant in the markets in which the Company operates.\nEngineered Materials manufacturing and refining operations are carried out in four states in the United States and in facilities located in the United Kingdom and France. The products are sold principally through the Company's sales organization, supplemented by independent distributors and representatives.\nThe principal raw materials used by these operations are precious metals including those of the platinum group (platinum, palladium, rhodium, iridium and ruthenium), silver and gold, all of which are generally available.\nIn June 1995 the Company formed a 50\/50 joint venture with CLAL, a Paris-based precious metal fabricator. (See Note 8 \"Investments\" of the Notes to Consolidated Financial Statements on page 37 of this 10-K). The joint venture combined most of the assets of the Engineered Materials business with CLAL. In January 1993 the Company sold its 40 percent interest in M&T Harshaw, an affiliate through which the Company had participated in the base metal plating industry.\nThe Industrial Commodities Management Group is responsible for procuring precious and base metals to meet the requirements of the Company's operations and its customers. Supplies of newly mined platinum group metals are obtained primarily from South Africa and the Russian Federation and to a lesser extent from the United States and Canada, which four regions are the only known significant sources. Most of these platinum group metals are obtained pursuant to a number of contractual arrangements with different durations and terms. The Company has reached an agreement in principle for the replacement of a precious metals supply contract that expires December 31, 1996. The new contract offers smaller quantities and less favorable terms, but management expects the impact to be wholly or partially offset by other precious metals supply contracts and arrangements and by new business programs already underway. Failure to achieve such offsetting income could result in a material adverse impact. Management believes that an adequate supply of these precious metals will be available to meet growing needs. Gold and silver are purchased from various sources. In addition, in the normal course of business, certain customers and suppliers deposit significant quantities of precious metals with the Company under a variety of arrangements. Equivalent quantities of precious metals are returnable as product or in other forms.\nThe Industrial Commodities Management Group also engages in precious and base metals dealing operations with industrial consumers, dealers, central banks, miners and refiners. It also participates in refining of precious metals and marketing of energy-related services. The group does not routinely speculate in the precious and base metals market. For more information regarding precious metals operations, see Note 12 \"Financial Instruments and Precious Metals Operations\" of the Notes to Consolidated Financial Statements on pages 39-41 of this 10-K. Offices are located in the United States, the United Kingdom, Switzerland, Japan and the Russian Federation.\nEngelhard Corporation, through its Industrial Commodities Management Group, has for many years been a successful dealer in platinum, palladium, gold and silver through its offices strategically located throughout the world. As a natural adjunct to this activity and after intensive study, management decided to enter into base metals dealing and brokering during 1995. Accordingly, Engelhard International Ltd. was established in London and staffed by veterans in this field. An associate broker membership on the London Metal Exchange and Securities Futures Authority approval were obtained, and dealing in copper, nickel, and zinc commenced. Engelhard Power Marketing, Inc. (ENGL) was formed in 1995 and received authorization from the Federal Energy Regulatory Commission to take title to electric power for resale at market-based rates. ENGL engages in short, medium and long-term wholesale energy and\/or capacity transactions with utilities located throughout the United States.\nAs of January 1, 1996 the Engineered Materials and Industrial Commodities Management segment had approximately 575 employees throughout the world, some of whom are hourly employees covered by collective bargaining agreements. Employee relations have generally been good.\nOther\nIn early 1994, the Company and ICC Technologies, Inc. formed Engelhard\/ICC, a jointly owned partnership, to develop and commercialize air conditioning and air-treatment systems based on a proprietary new desiccant developed by Engelhard.\nMajor Customer\nApproximately 11 percent of the Company's net sales for the years ended December 31, 1995 and 1994, respectively, was generated from the Ford Motor Company, a customer of both the Catalysts and Chemicals and the Engineered Materials and Industrial Commodities Management segments. Sales to the Ford Motor Company included both fabricated products and precious metal and were therefore significantly influenced by fluctuations in precious metal prices as well as the quantity of metal purchased. In such cases, the market price fluctuations and quantities purchased can result in material variations in sales reported but do not usually have a direct or substantive effect on earnings.\nResearch and Patents\nThe Company currently employs approximately 400 scientists, technicians and auxiliary personnel engaged in research and development in the field of chemistry and metallurgy. These activities are conducted in the United States and abroad. Research and development expense was $53.0 million in 1995, $49.0 million in 1994 and $46.9 million in 1993.\nResearch facilities include fully staffed instrument analysis laboratories, which the Company maintains in order to achieve the high level of precision necessary for its various businesses and to assist customers in understanding the performance of Engelhard products in their specific application.\nThe Company owns or is licensed under numerous patents which have been secured over a period of years. It is the policy of the Company to apply for patents whenever it develops new products or processes considered to be commercially viable and, in appropriate circumstances, to seek licenses when such products or processes are developed by others. While the Company deems its various patents and licenses to be important to certain aspects of its operations, it does not consider any significant portion or its business as a whole to be materially dependent on patent protection.\nEnvironmental Matters\nIn the ordinary course of business, like most other industrial companies, the Company is subject to extensive and changing federal, state, local and foreign environmental laws and regulations, and has made provisions for the estimated financial impact of environmental cleanup related costs.\nThe Company is currently preparing, has under review, or is implementing, with the oversight of cognizant environmental agencies, environmental investigations and cleanup plans at several currently or formerly owned and\/or operated sites, including Plainville, MA, Salt Lake City, UT, Attapulgus, GA, and Newark, NJ. With respect to Plainville, in September 1993 the United States Environmental Protection Agency (EPA) and the Company entered into a consent order under which the Company is investigating contamination and will conduct site stabilization measures. Plainville is also included on the Nuclear Regulatory Commission (NRC) \"Existing Site Decommissioning Management Plan Sites\" list and the Company is currently conducting further investigations of the site pursuant to NRC approved plans. With respect to Salt Lake City, in connection with obtaining an operating permit under the Utah Solid and Hazardous Waste Act, the Company entered into an agreement in December 1993 with the Utah Solid and Hazardous Waste Control Board under which the Company is continuing to investigate the environmental status of the site. With respect to Attapulgus, in January 1994 the Georgia Department of Natural Resources, Environmental Protection Division and the Company entered into a consent order under which the Company was to develop and implement a reclamation program. A reclamation program has been approved and cleanup is underway. With respect to Newark, the Company has substantially completed a cleanup plan in coordination with the New Jersey Department of Environmental Protection.\nIn addition, 18 sites have been identified at which the Company believes liability as a potentially responsible party (PRP) is probable under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or similar state laws (collectively referred to as Superfund) for the cleanup of contamination resulting from the historic disposal of hazardous substances allegedly generated by the Company, among others. Superfund requires cleanup of certain sites from which there has been a release or threatened release of hazardous substances and authorizes EPA or a state to take any necessary action at such sites, including ordering PRPs to cleanup or contribute to the cleanup of a site. Courts have interpreted Superfund to impose strict, joint and several liability under certain circumstances. These claims are in various stages of administrative or judicial proceedings, and include demands for recovery of past costs and future investigative or cleanup action. In many cases, the dollar amount of the claim is unspecified and claims have been asserted against a number of other entities for the same relief sought from the Company. Based on existing information, the Company believes that it is a de minimis contributor of hazardous substances at most of the sites referenced above. Subject to the reopening of existing settlement agreements for extraordinary circumstances or natural resource damages, the Company has settled a number of other cleanup proceedings. The Company has also responded to information requests from EPA and state regulatory authorities in connection with other Superfund sites.\nThe Company's policy is to accrue environmental cleanup related costs of a noncapital nature when those costs are believed to be probable and can be reasonably estimated. The quantification of environmental exposures requires an assessment of many factors, including changing laws and regulations, advancements in environmental technologies, the quality of information available related to specific sites, the assessment stage of each site investigation, preliminary findings, and the length of time involved in remediation or settlement. For Superfund sites, the Company also assesses the financial capability of other PRPs and, where allegations are based on tentative findings, the reasonableness of the Company's apportionment. The Company has not anticipated recoveries from insurance carriers or other potentially responsible third parties in its accruals for environmental liabilities. The liabilities for environmental cleanup related costs recorded in the consolidated balance sheets at December 31, 1995 and 1994 were $54.6 million and $62.2 million, respectively, including $10.0 million and $10.8 million, respectively, for the Superfund sites. These amounts represent those costs which the Company believes are probable and reasonably estimable. Based on currently available information and analysis, the Company's accrual represents approximately 85% of what it believes are reasonably possible environmental cleanup related costs of a noncapital nature. The estimate of reasonably possible costs is less certain than the probable estimate upon which the accrual is based.\nDuring the past three-year period, cash payments for environmental cleanup related matters were $7.6 million, $4.5 million and $.3 million for 1995, 1994 and 1993, respectively. In 1995 and 1994, the amounts accrued in connection with environmental cleanup related matters were not significant. In 1993, $30.0 million was accrued as a result of developments during that year which caused the Company to revise its estimates of environmental cleanup related costs at sites being idled or affected by restructuring, where conditions had recently changed, or where studies and cleanup plans had been approved and the assessment of the likelihood or extent of remediation had changed.\nFor the past three-year period, environmental related capital projects have averaged less than 10% of the Company's total capital expenditure programs and the expense of environmental compliance (environmental testing, permits, consultants and in-house staff) was not significant.\nThere can be no assurances that environmental laws and regulations will not become more stringent in the future or that the Company will not incur significant costs in the future to comply with such laws and regulations. Based on existing information and currently enacted environmental laws and regulations, cash payments for environmental cleanup related matters are projected to approximate $10 million for 1996, all of which has already been accrued. Further, the Company anticipates that the amounts of capitalized environmental projects and the expense of environmental compliance will approximate current levels. While it is not possible to predict with certainty, management believes that environmental cleanup related reserves at December 31, 1995 are reasonable and adequate and that environmental matters are not expected to have a material adverse effect on financial condition. These matters, if resolved in a manner different from the estimates, could have a material adverse effect on the operating results or cash flows when resolved in a future reporting period.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------ ---------- The Company owns approximately 22 acres of land and four buildings with a combined area of approximately 440,000 square feet in Iselin, NJ. These buildings serve as the principal executive and administrative offices of the Company and its operating segments as well as the major research and development facilities for the Company's operations. The Company also owns domestic research facilities in Gordon, GA, Union, NJ and Beachwood, OH. In addition, the Company owns a foreign research facility in DeMeern, The Netherlands.\nThe Catalysts and Chemicals segment owns and operates a complex of plants in Georgia that manufactures petroleum cracking catalysts, and other domestic plants located in Huntsville, AL; Phoenix, AR; East Windsor, CT; Mangonia Park, FL; Wilmington, MA; South Lyon, MI; Jackson, MS; Union, NJ; Elyria, OH; Duncan and Seneca, SC; and Salt Lake City, UT. Foreign manufacturing operations are conducted at owned facilities in Germany, Italy, The Netherlands, South Africa and the United Kingdom. In addition, the segment owns a mine in Mississippi and leases a mine in Arizona.\nThe Pigments and Additives segment owns and operates five kaolin mines and five milling facilities in Middle Georgia which serve an 85 mile network of pipelines to three processing plants. It also owns land containing kaolin clay and leases, on a long-term basis, kaolin mineral rights to additional acreage. The segment also owns and operates an attapulgite processing plant in Attapulgus, GA near the area containing its attapulgite reserves. Management believes that the Company's crude kaolin and attapulgite reserves will be sufficient to meet its needs for the foreseeable future. The segment also owns and operates color pigments manufacturing facilities in Louisville, KY, Sylmar, CA and Elyria, OH. Foreign operations are conducted at owned facilities in Finland. In addition, the segment owns mines in Florida.\nThe Engineered Materials and Industrial Commodities Management segment owns and operates manufacturing facilities in East Newark, NJ; Anaheim, CA; Lincoln Park, MI; and Warwick, RI. Other manufacturing operations are conducted at owned facilities in the United Kingdom and France.\nThe Company is currently restructuring its operations (see Note 2 \"Special Charge\" of the Notes to Consolidated Financial Statements on pages 31-32 of this 10-K). Management believes that the Company's processing and refining facilities, plants and mills are suitable and have sufficient capacity to meet its normal operating requirments for the foreseeable future.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------ ----------------- The Company is a defendant in a number of lawsuits covering a wide range of matters. In some of these pending lawsuits, the remedies sought or damages claimed are substantial. The Company and certain of its officers and directors were named as defendants in purported class action complaints filed in November 1995 in the U.S. District Court for the District of New Jersey on behalf of persons who bought Engelhard Stock between April 1995 and November 1995. The complaints claim that defendants made false statements and omissions and traded on nonpublic information. The complaints are expected to be combined into a Consolidated Amended Complaint. The Company believes the class actions to be without merit and is vigorously defending against them. The Company is also subject to a number of environmental contingencies (see Note 15 \"Environmental Costs\"). While it is not possible to predict with certainty the ultimate outcome of these lawsuits or the resolution of the environmental contingencies, management believes, after consultation with counsel, that resolution of these matters is not expected to have a material adverse effect on financial condition. These matters, if resolved in a manner different from the estimates, could have a material adverse effect on the operating results or cash flows when resolved in a future reporting period.\nIn January 1995, the Company received and is responding to a civil investigative demand to produce documents and answer interrogatories in connection with an investigation by the Antitrust Division of the U.S. Department of Justice into \"price coordination and market allocation by kaolin producers\".\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------- --------------------------------------------------- Not applicable.\nPART II -------\nMarket for Registrant's Common Equity Item 5.","section_5":"Item 5. and Related Stockholder Matters - ------ -------------------------------------\nAs of March 1, 1996, there were 8,840 holders of record of the Company's common stock, which is traded on the New York Stock Exchange (ticker symbol \"EC\"), as well as on the London and Swiss stock exchanges.\nThe range of market prices and cash dividends paid for each quarterly period were as follows: NYSE Cash market price dividends paid High Low per share* ------- ------ -------------- First quarter $19 3\/4 $14 7\/8 $.08 Second quarter 29 1\/4 19 1\/2 .09 Third quarter 32 1\/2 23 1\/8 .09 Fourth quarter 26 3\/8 20 1\/4 .09 First quarter $21 $15 3\/4 $.07 Second quarter 18 7\/8 16 1\/8 .07 Third quarter 19 14 3\/8 .08 Fourth quarter 18 3\/8 13 7\/8 .08\n* Reflects the three-for-two stock split as of June 30, 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------ -----------------------\nSelected Financial Data ($ in millions, except per share amounts)**\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Net sales $2,840.1 $2,385.8 $2,150.9 $2,399.7 $2,436.4 Net earnings (a) 137.5 118.0 .7 10.6 87.9 Net earnings per share(a) .96 .82 - .07 .58 Property, plant and equipment, net $ 609.5 $ 540.4 $ 494.4 $ 514.4 $ 533.3 Total assets 1,645.6 1,440.8 1,279.1 1,287.7 1,279.4 Long-term debt 211.5 111.8 112.2 113.9 114.5 Shareholders' equity 737.7 614.7 531.3 647.2 756.6 Cash dividends paid per share $.35 $ .30 $ .28 $ .25 $ .22 Return on average shareholders' equity(a) 20.3% 20.6% .1% 1.5% 12.0% Current ratio 1.2 1.1 1.1 1.5 1.5 Net cash provided by operating activities $ 138.5 $ 114.8 $ 130.4 $ 169.5 $ 135.4\n** Reflects the three-for-two stock splits as of June 30, 1995, September 30, 1993 and September 30, 1992.\n(a) Results in 1994 include a special credit of $5.0 million after tax ($.03 per share) representing the reversal of excess restructuring reserves; and an after-tax net charge of $5.3 million ($.04 per share) for a change in the Company's estimate of compensation expense relating to stock awards.\nResults in 1993 include a special charge of $91.8 million after tax ($.63 per share) for realignment and consolidation of businesses and environmental matters; an after-tax gain of $6.3 million ($.04 per share) from the sale of the Company's interest in M&T Harshaw, a base-metal plating business; and an after-tax charge for the cumulative effect of an accounting change of $16.0 million ($.11 per share) as a result of adopting the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\".\nResults in 1992 include an after-tax charge for the cumulative effect of accounting changes of $89.5 million ($.59 per share) as a result of adopting the provisions of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", and No. 109, \"Accounting for Income Taxes\".\nManagement's Discussion and Analysis Item 7.","section_7":"Item 7. of Financial Condition and Results of Operations - ------ ------------------------------------------------\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\/Engelhard Corporation\nResults of Operations\nSales: $2.8 billion in 1995, up 19% from $2.4 billion in 1994 which was up 11% from $2.2 billion in 1993.\nNet earnings: $138 million, or $.96 per share in 1995, compared with $118 million, or $.82 per share in 1994 and $.7 million in 1993 .\nNet earnings in 1994 included a special credit (see \"Special Charge\") of $5.0 million ($.03 per share) arising from the reversal of excess restructuring reserves. Net earnings in 1994 also included a net charge of $5.3 million ($.04 per share) for a change in the Company's estimate of compensation expense relating to stock awards (see \"Selling, Administrative and Other Expenses\").\nNet earnings in 1993 included a special charge (see \"Special Charge\") of $91.8 million ($.63 per share) and a gain on the sale of an investment (see \"Gain on Sale of Investment\") of $6.3 million ($.04 per share). Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" was adopted in 1993. Impact: one-time, noncash charge of $16.0 million or $.11 per share.\nCatalysts and Chemicals The Catalysts and Chemicals segment comprises three business groups: Environmental Technologies, Petroleum Catalysts and Chemical Catalysts. These businesses develop, manufacture and market a wide range of catalysts and related products and processes for the automotive, off-road vehicle, aircraft, power generation, petroleum refining, chemical, petrochemical, pharmaceutical and food processing industries, among others. These products are used by customers to improve quality and\/or cost efficiency, achieve desired manufacturing yields and reduce emissions.\n1995 compared with 1994: Sales up 20%; operating earnings up 10%.\nDiscussion: Excellent sales and profit growth for environmental technologies and chemical catalysts offset by lower profit from petroleum catalysts.\nEnvironmental Technologies (formerly Environmental Catalysts)\nThe Environmental Technologies Group provides catalytic and other technologies to reduce emissions from cars, trucks, buses, mining and construction vehicles, wide-body jets, power-generating plants and industrial and other processing facilities.\n1995 performance: Higher sales and operating earnings.\nDiscussion: Auto catalyst volumes were up despite flat worldwide auto production mainly because of the success of new product programs. European market share grew. Engelhard now has the number-one market position worldwide. Technology advances in diesel auto catalysts gained new customers in Europe, while diesel truck catalyst income was lower than in 1994 due to lower prices.\nA new auto catalyst manufacturing facility in South Africa opened in early 1995 and operated at full capacity throughout the year. Capacity was increased in Huntsville, AL.\nIn October, Engelhard purchased the other half of its Salem Engelhard joint venture, which makes catalytic and thermal systems to reduce air pollution from industrial facilities. Higher volumes due to sales to the forest products industry aided performance in 1995.\nSales of systems to abate pollution at power-generation plants were lower, largely because deregulation in the electric power industry is reducing the need for new cogeneration facilities. This market is slow to develop in the United States, where new emission-control regulations are not anticipated before the turn of the century. Markets are developing in Europe and Asia, and the Group is focusing product and market development efforts on these opportunities.\nLooking ahead: The Group completed two acquisitions and an alliance that advance the Company's plan to become the leading supplier of emission systems technology for cars, trucks and buses. Building on the 1994 acquisition of General Plasma thermal spray coatings, the Group purchased the assets and business of two additional advanced-coating technology companies. The new acquisitions expand Engelhard's capabilities in engine coatings, which have demonstrated positive effects on emissions, fuel economy and engine wear.\nMetreon, the joint venture Engelhard formed with W.R. Grace in February 1995, is developing technology to address new automotive emission standards that will be implemented in California and Europe after 1998. Metreon products are being sampled by several automakers.\nFull ownership of Salem Engelhard will enable the Company to use its existing sales, manufacturing and distribution infrastructure to make this a global business. New air pollution standards for stationary source emissions in Europe and Asia Pacific are anticipated in the next two years and are expected to be among the world's strictest.\nIn the short term, worldwide auto sales are expected to remain flat in 1996, but the Environmental Technologies Group expects a continued strong performance due to its advanced technologies, close customer relationships and stricter automotive emission legislation in Europe.\nPetroleum Catalysts\nThe Petroleum Catalysts Group offers fluid catalytic cracking and moving-bed catalysts, additives and hydroprocessing catalysts to produce gasolines, other transportation fuels and heating oils.\n1995 performance: Sales flat, operating earnings down.\nDiscussion: Cost differential between heavy and light crude oils narrowed, making it economical for refiners to use the light crudes and less catalyst. Refinery shutdowns in North America and Europe continued as oil companies sought to enhance profitability. As a result, petroleum catalysts volumes declined, and the product mix of fluid cracking catalysts (Engelhard's major product line) was unfavorable.\nVolumes of moving-bed catalysts, used in older refineries, also declined. The decline was partially offset by improved pricing.\nBy contrast, in the emerging Asia-Pacific market, Engelhard's sales advanced significantly. New catalysts designed especially for this market were principally responsible.\nUnlike competitors, Engelhard has two process technologies that the Company is combining to provide a broader spectrum of products with improved performance. Ultrium catalyst, introduced in 1995, is the first of these combination products and is in trials at several refineries.\nAcreon, Engelhard's hydroprocessing joint venture with Procatalyse, contributed higher equity earnings in 1995 (see \"Equity Earnings\" on page 35). Currently a small supplier in this petroleum catalysts market, Acreon's competitiveness will be aided by an alumina manufacturing plant the two partners are building at Engelhard's existing Savannah, GA facility. This plant will reduce Acreon's raw material costs and boost flexibility.\nA small adsorbent business, located in Germany, was redesigned and delivered significantly higher operating earnings.\nLooking ahead: Market conditions in the U.S. oil refining industry are expected to continue as in 1995 for the next few years. Engelhard is responding with an aggressive program to reduce costs.\nThe Group also is pursuing growth opportunities in the Asia-Pacific region, where plans call for expansion of sales, laboratory and distribution facilities, and with large worldwide customers who are interested in advanced technology and suppliers with global capabilities.\nChemical Catalysts\nThe Chemical Catalysts Group produces catalysts, sorbents and separation products to manufacture plastics, fibers, paints and coatings, pharmaceuticals, edible oils, soaps, margarine, jet fuel and lube oils, among other products.\n1995 performance: Sales and operating earnings up significantly.\nDiscussion: Better economic conditions in the chemical industry and success in growth programs led to growth in sales and profit. Volumes were higher for almost all product lines, but especially for base metal catalysts in North America and precious metal catalysts worldwide. These catalysts are sold to manufacturers of petrochemicals, polymers, nylon, fertilizers and edible oils.\nContributing to the growth was success in \"decaptivating\" or taking over production of catalysts from chemical and consumer product companies that formerly made their own. These companies are narrowing their focus to their core businesses and need suppliers with custom-catalysts capabilities.\nIn mineral sorbents and separation products, sales were about even with 1994. Technology advances in 1995 are expected to lead to improved sales and profits beginning in 1996. Sales of a product that removes lead from drinking water escalated sharply in 1995. Although still a small contributor, continued growth is anticipated for this product line.\nPlants were debottlenecked and capacity was increased by up to 30% to respond to increased demand.\nLooking ahead: The positive economic trend in the chemical industry is expected to continue through 1996. Marketing alliances are offering additional opportunities. An improved method of ammonia production developed by M.W. Kellogg relies on Engelhard catalysts. Two retrofit orders received by Kellogg in 1995 will lead to catalyst sales for Engelhard beginning in 1996.\nA new alliance with Geon, a leading producer and compounder of PVC plastic, will allow Engelhard to sell catalysts directly to plastics producers who use Geon technology.\nPrior Year Comparisons\n1994 compared with 1993: Operating earnings in the Catalysts and Chemicals segment increased 18%, while sales rose 11% over the prior year. Favorable factors included strong volume gains for automotive and diesel truck catalysts and for some petroleum refining catalysts. Lower manufacturing costs in the Chemical Catalysts Group also contributed to the increase.\n1993 compared with 1992: Operating earnings increased 16% in 1993. Sales rose 6%. Significantly higher earnings from the Petroleum and Chemical Catalysts Groups more than offset lower earnings from the Environmental Technologies Group. Strong demand for FCC catalysts produced significantly higher results in the Petroleum Catalysts Group. The Chemical Catalysts Group benefitted from substantial reductions in manufacturing costs. The decline in the Environmental Technologies Group earnings was due to an increase in new product development expenses and lower nonautomotive volumes.\nPigments and Additives\nThe Pigments and Additives segment develops, manufactures and markets coating and extender pigments for the paper industry and color pigments and specialty minerals for a variety of industries. Engelhard's paper pigments are used principally to make coated and uncoated papers. Its color pigments are used primarily in paints and coatings, plastics, rubber and printing inks. Specialty mineral products are sold to the plastics, rubber, wire and cable, coatings, inks and adhesives industries.\nMost of the minerals used by this segment are mined by Engelhard from reserves it owns or has under long-term leases. Engelhard has sufficient mineral reserves for its operations.\n1995 compared with 1994: Sales up 7%; operating earnings up 26%.\nDiscussion: Significant productivity improvements and a higher margin product mix contributed to the earnings growth. A sales decline in the last quarter reflected an inventory correction in the paper industry that is expected to continue through the first quarter of 1996.\nEarly in 1995, the Paper Pigments and Chemicals Group and the Specialty Minerals and Colors Group were combined under one management. This consolidation is generating cost and productivity benefits in purchasing, manufacturing and administration. Separate sales, marketing and technical service functions continue to respond to different customer requirements for these product lines.\nIn February 1995, a major expansion at Engelhard's paper pigments manufacturing facility was completed, enabling the Company to respond to growth in demand for calcined paper pigments. Several new products were introduced to replace more expensive paper additives. The first sales were achieved for one of these products, and another is in trial at several paper mills. A pigment introduced in 1995, called Miragloss, has increased Engelhard's competitiveness in the Asia-Pacific market.\nIn specialty minerals and colors, sales prices were favorable for all product lines. Higher volumes of high-performance, surface-treated mineral products were partially offset by lower volumes of attapulgite and color products.\nEspecially successful were Translink products used as reinforcements for plastics and rubber. Engelhard also increased market share for organic traffic-grade paint pigments. The Company debottlenecked existing manufacturing facilities and also added new capacity at an organic color pigments plant to meet the demand.\nThe planned acquisition of certain assets of the Floridin Company has been delayed pending a federal court decision. This acquisition will enable Engelhard to manufacture its attapulgite products more economically. A resolution is expected shortly.\nLooking ahead: The current paper industry inventory correction is expected to ease up in the early part of 1996, but pricing pressures are anticipated throughout the year. The volume outlook appears positive. Pricing of specialty minerals and colors is expected to remain strong in 1996, as is demand for high-performance, surface-treated products. Additional manufacturing capacity expansions are planned for specialty minerals and colors.\nThe Pigments and Additives business will continue to focus on tight cost control, customer value and technology improvements in order to sustain growth.\nPrior Year Comparisons\n1994 compared with 1993: Operating earnings increased 31% while sales increased 2%. Increased sales of the profitable calcined paper pigments, tighter cost controls, and paper pigments facilities consolidations helped. A favorable product mix of specialty minerals and colors and lower manufacturing costs aided profits.\n1993 compared with 1992: Operating earnings for the Pigments and Additives segment decreased 3%, while sales increased 2%. Lower pricing and higher manufacturing and operating costs for paper pigments, and unfavorable attapulgite volumes and higher manufacturing costs in the minerals business were the main factors.\nEngineered Materials and Industrial Commodities Management\nThe Engineered Materials and Industrial Commodities Management segment develops, manufactures and markets fabricated products and coatings based on precious metals for a broad spectrum of industries. This segment also engages in precious metals management for other Engelhard businesses and for customers who use these metals. In addition, the segment participates in precious metals refining, base metals management and in the marketing of energy-related services.\n1995 compared with 1994: Sales up 22%; operating earnings up 32%. (Segment results exclude sales and earnings from the businesses placed in the Engelhard-CLAL joint venture in June 1995. Earnings related to the venture are reported as equity earnings.)\nDiscussion: In June 1995, Engelhard formed a 50\/50 joint venture with Paris-based CLAL for manufacturing, marketing and refining precious metal containing products. Engelhard's engineered materials operations in Europe and Asia Pacific and in Carteret, NJ and Fremont, CA were placed in the joint venture. Precious metals businesses retained by Engelhard include platinum refining and certain gold refining operations, and plating, coating, electrometallic and metal-joining products. These businesses achieved operating efficiencies and higher sales in the United States. Profits from industrial commodities management services were up sharply.\nPrecious metals are included in the segment's sales figures if the metal has been supplied by Engelhard. In these cases, precious metal market price fluctuations can result in material variations in sales. Often, customers supply the precious metals for the manufactured product. In those cases, precious metals values are not included in sales numbers. The mix of such arrangements and the extent of market price fluctuations can significantly affect the level of reported sales but do not usually have a material effect on earnings. The purchase of metal for customers' products are normally hedged. (See Note 12, \"Financial Instruments and Precious Metals Operations\", of Notes to Consolidated Financial Statements for further information about hedging activities.)\nEngineered Materials\nThe Engineered Materials Group provides fabricated precious metal products used to make a wide range of products in the glass, automotive, electronics, air-conditioning and appliance industries, among others.\n1995 performance: Sales down, operating earnings flat.\nDiscussion: Varying economic trends in customer industries resulted in mixed sales results. The appliance industry, the principal market for Engelhard's metal-joining products, was down compared with 1994, while the electronics industry was up. Automotive sales slowed during the second half of 1995. The electronics and automotive industries are users of Engelhard's conductive powders, pastes and inks and plating chemicals.\nIn the metal-joining business, market share gains and important productivity improvements were achieved. Significant cost reduction was undertaken in both the plating chemicals and precious metal coatings segments in 1995, with new product development efforts expected to generate sales in 1996.\nLooking ahead: Growth is anticipated in the United States and the Asia-Pacific region. A joint venture in flexible conductive inks, formed in early 1996, opens a new area of business for Engelhard and offers a highly innovative technology to the electronics, toy, clothing and other industries.\nIndustrial Commodities Management (formerly Precious Metals Management)\nThe Industrial Commodities Management Group offers strategic metals management services on behalf of Engelhard and customers. It also engages in energy-related services.\n1995 performance: Higher sales and operating earnings.\nDiscussion: Improvement related to a higher level of business activity involving a broader base of customers and services and to favorable market conditions.\nIndustrial Commodities Management works with all of the Company's other business groups and many customers who require commodities expertise.\nBuilding on these strong customer relationships, a small base metals management business was started in 1995 and is expected to be an earnings contributor in 1996. Another new business, power marketing, began operating in response to changing regulations.\nThe Company realized improved efficiency from the transfer of responsibility for platinum group metals refining and salts and solutions to Industrial Commodities Management from another Engelhard business group. These products are now offered as part of a \"full-loop\" metals package to customers.\nLooking ahead: Continued growth is expected by maintaining close customer relationships and offering creative services. Increased business in the Asia-Pacific region should also contribute.\nPrior Year Comparisons\n1994 compared with 1993: Operating earnings were up 19%, while sales increased 13%. Higher earnings from the Engineered Materials Group more than offset slightly lower earnings from Industrial Commodities Management. Higher sales in the U.S. and Asia Pacific, combined with lower manufacturing costs, produced the increased earnings in Engineered Materials. The Industrial Commodities Management Group was adversely affected by weak market conditions worldwide.\n1993 compared with 1992: Operating earnings decreased 26%, and sales declined 19%. Drop in sales was primarily due to lower volumes and pricing for certain platinum group metals. Lower earnings from the Industrial Commodities Management Group more than offset higher earnings from the Engineered Materials Group. Engineered Materials achieved cost savings and sales increases in the U.S.\nSpecial Charge\nA plan was adopted in 1993 to realign and consolidate a number of businesses, concentrate resources and better position Engelhard to achieve strategic growth objectives.\nThe plan resulted in a 1993 special charge of $148 million pretax, or $91.8 million or $.63 per share, after tax. The charge consisted of:\n- $118 million pretax restructuring provision for (1) asset writedowns together with provisions for facilities shutdown, rundown and relocation, and (2) employee reassignment, severance and related benefits, and\n- $30 million pretax environmental provision (see Note 15, \"Environmental Costs\", of Notes to Consolidated Financial Statements for a discussion of environmental matters and the amount of Engelhard's environmental reserve).\nThe restructuring reserve at December 31, 1993 consisted of:\n- The $118 million 1993 special charge, plus\n- $32.4 million of previously established provisions associated with idled sites. Rundown costs continued to be incurred at these sites, while they await the completion of environmental cleanup and\/or the consummation of sales.\nThe following table sets forth the components of the Company's restructuring reserve and related activity for the past two years:\nRestructuring Reserve Employee Asset (in millions) separations writedowns Other Total\nBalance at December 31, 1993 $35.9 $72.2 $42.3 $150.4 Asset writeoffs\/writedowns - (66.6) - (66.6) Cash spending (8.8) - (8.4) (17.2) Cash proceeds - 1.7 - 1.7 Reclassification - 7.5 (7.5) - Reversal - - (8.0) (8.0) ---- ---- ---- ----- Balance at December 31, 1994 27.1 14.8 18.4 60.3 Asset writeoffs\/writedowns - (7.7) - (7.7) Cash spending (9.5) - (8.6) (18.1) Engelhard-CLAL (3.9) 1.0 9.0 6.1 ---- ---- ---- ----- Balance at December 31, 1995 $13.7 $ 8.1 $18.8 $ 40.6\nIn the fourth quarter of 1994, $8 million of restructuring reserve was reversed because an idle Canadian facility was sold earlier and at more favorable terms than originally estimated. Also, a new, less costly approach was adopted for the cleanup and disposal of its idle Newark, NJ site.\nAlso in 1994, the Company:\n- Reconfigured certain production processes of the Middle Georgia facility of the Pigments and Additives Group, which resulted in a writeoff of the associated assets.\n- Kept open two sites originally identified for closure. One of these facilities, a part of the Engineered Materials Group, is continuing to operate because of improved economics and lack of synergy in relocating the manufacturing process. The other facility, a part of the Chemical Catalysts Group, is continuing to operate because the product lines are complementary to the Company's other businesses. The impairment of this facility as opposed to the originally planned shutdown and relocation, resulted in a reclassification of shutdown and relocation costs to asset writedowns.\nIn 1995, the Company completed the formation of Engelhard-CLAL, a Paris-based precious metal fabrication joint venture. This transaction increased the reserve as a result of previously anticipated precious metal and other asset gains, partially offset by a decrease in the reserve for restructuring activities to be performed by the joint venture. In addition, the Company continued to incur costs for severance and related benefits as well as rundown costs at idle sites. Asset writeoffs in 1995 were related to inventory and fixed assets associated with rationalization actions.\nMost of the restructuring actions have been taken. Major actions expected to be completed in 1996 include:\n- Sale of a separation products facility (scheduled for the first half of 1996).\n- Continuing rationalization of the Petroleum Catalysts Group.\n- Continuing rationalization of an environmental technologies facility.\n- Completion of the Floridin acquisition (pending a court decision).\nThe remaining provision for employee separations provides for severance and related benefit payments for former employees and for employees who have generally been notified of severance in connection with pending actions. These amounts will be paid over several years. The remaining provision for asset writedowns primarily relates to pending actions. The remaining provision in \"other\" relates to rundown costs. Net cash outflows for rundown costs will be charged against the reserve until the related sites are sold.\nBy the end of 1996 the Company anticipates annual cost savings of about $20 to $25 million as a result of lower manufacturing and operating expenses, with annual cash savings of about $15 million. To date most of these savings have been realized.\nGain on Sale of Investment\nIn the first quarter of 1993, Engelhard sold its share of M&T Harshaw, a base metal plating business formed in 1990, to its partner, Elf Atochem North America, Inc., for $40 million in cash. The buyer assumed all assets and liabilities. An after-tax gain of $6.3 million or $.04 per share was realized in the transaction.\nAcquisitions and Partnerships (Formerly called \"Investments\" and \"Current Developments\")\nSelling, Administrative and Other Expenses\nSelling, administrative and other expenses in 1995 of $244.7 million were basically flat with 1994 and up from $213.0 million in 1993. In 1994, based on a study of incentive compensation and in response to changing demographics, the Company revised its estimate of current compensation expense relating to stock awards to include the cost of shares where risk of forfeiture by the employee has been removed. Impact: Net charge to 1994 earnings of $8.6 million ($5.3 million after taxes--$.04 per share). See Note 14, \"Stock Option and Bonus Plans,\" of Notes to Consolidated Financial Statements.\nEquity Earnings\nIn 1995, Engelhard's income from equity investments was $0.7 million, compared with $0.6 million in 1994 and $3.4 million in 1993. The decrease in 1994 was primarily due to the start-up losses of a new joint venture (Engelhard\/ICC), and lower volumes at Acreon Catalysts.\nIn June 1995, the Company announced the formation of a 50\/50 joint venture with Paris-based CLAL (Groupe FIMALAC) for manufacturing, marketing and refining precious metal containing products. The new venture, Engelhard-CLAL, combines most of the assets of CLAL and certain assets and liabilities of the Company's Engineered Materials Group in Europe and the Asia-Pacific region, and the engineered materials business currently conducted in Carteret, NJ and Fremont, CA. Engelhard-CLAL is headquartered in Paris and has annual revenues of more than $1.0 billion. In exchange for its 50% interest, the Company contributed approximately $110.0 million of net assets, including approximately $25.0 million in cash. The joint venture is expected to be a positive contributor to equity earnings in 1996, primarily due to the achievement of synergy.\nInterest\nNet interest expense was $31.3 million in 1995, compared with $22.0 million in 1994 and $13.7 million in 1993. Gross interest expense and offsetting contango income--components of net interest expense--reflect the extent of precious metals financed by spot and forward transactions each year. Higher net interest expense in 1995 and 1994 was primarily due to higher interest rates and average debt balances as a result of acquisitions, business investments and common stock purchases.\nLower net interest expense in 1993 was due primarily to expiration of an unfavorable interest rate swap agreement in 1992 and initiation of then favorable interest rate swap agreement in 1993. See Note 12, \"Financial Instruments and Precious Metals Operations\", of Notes to Consolidated Financial Statements for further information about interest rate swap agreements.\nInterest income, included as a component of net sales, was $2.2 million in 1995, $1.1 million in 1994, and $2.0 million in 1993.\nTaxes\nIncome tax provision came to $47.8 million in 1995, $39.3 million in 1994, and a benefit of $21.4 million in 1993 (primarily as a result of the special charge). The effective income tax expense rate, excluding the impact of the special charge, was 25.8% in 1995, 25.0% in 1994, and 24.3% in 1993. Lower rate in 1993 was due primarily to U.S. tax legislation that year that reinstated the research and development credit and increased the income tax rate, creating a favorable impact on Engelhard's net deferred tax asset.\nAt year-end 1995, the net deferred tax asset was $97.3 million, primarily for accrued postretirement and postemployment benefit obligations, the restructuring reserve, the environmental cleanup reserve, and other accruals. Management believes Engelhard will generate sufficient taxable earnings and tax planning opportunities to ensure deferred tax benefits are realized.\nFinancial Condition and Liquidity\nWorking capital was $107 million at 1995 year-end, including $40 million of cash. Year-end market value of Engelhard's precious metals exceeded carrying cost by $36 million. The current ratio (current assets to current liabilities) at year end was 1.2, slightly above last year.\nShort-term bank and commercial paper borrowings increased by $4 million to $183 million at 1995 year-end. The Company issued $100 million of debt instruments in the third quarter of 1995. These noncallable notes bear interest at rates ranging from 6.37% to 6.64% and mature at various dates in 2000. Some of the proceeds were used to reduce short-term borrowings.\nThe ratio of total debt to total capital increased to 35% at year-end 1995 from 32% at year-end 1994, as a result of the higher long-term borrowings. Engelhard currently has $600 million in committed revolving credit facilities available. The Company also has authorization from its Board of Directors to issue up to $350 million in commercial paper ($94 million outstanding at year-end 1995). Engelhard also has uncommitted lines of short-term credit exceeding $650 million. In 1996, management expects to call the $5.5 million 7.91% industrial revenue bonds and the $100 million 10% notes, and to refinance them with comparable long-term debt. Management believes that Engelhard will continue to have adequate access to short-term and long-term credit and capital markets to meet its needs for the foreseeable future.\nOperating activities provided net cash of $138.5 million in 1995, compared with $114.8 million in 1994 and $130.4 million in 1993. For the past three years, cash and internally generated funds were adequate to fund working capital requirements, support capital projects and sustain increased dividend payments. For 1996, management anticipates that cash and cash flows will again be adequate to fund operational and capital requirements.\nCapital Expenditures, Commitments and Contingencies\nCapital projects are designed to maintain capacity, expand operations, improve efficiency or protect the environment. These amounted to $147.7 in 1995, compared with $97.5 million in 1994 and $107.1 million in 1993. Higher capital expenditures in 1995 reflected the Company's purchase, for $57 million, of the land and a building that serve as the principal executive and administrative offices of the Company and its operating businesses. Capital expenditures in 1996 are projected to approximate $100 million. See also Note 15, \"Environmental Costs\", and Note 16, \"Litigation and Contingencies\", of Notes to Consolidated Financial Statements for further information about commitments and contingencies.\nEffect of Foreign Currency Transactions and Translation\nCurrency transactions: Engelhard generally does not speculate in foreign currency, but enters into foreign currency transactions in the normal course of business and has investments in a number of different currencies. The Company is therefore subject to transaction and translation exposure from fluctuations in foreign currency exchange rates. Engelhard uses a variety of strategies, including foreign currency forward contracts and internal hedging to minimize or eliminate foreign currency exchange rate risk associated with substantially all of its foreign currency transactions. In selected circumstances, Engelhard enters into foreign currency forward contracts to hedge the U.S. dollar value of its foreign investments. See Note 12, \"Financial Instruments and Precious Metals Operations\", of Notes to Consolidated Financial Statements for further information about foreign currency hedging activities.\nPrecious metals inventories are generally not impacted by foreign currency rate fluctuations because they are denominated in U.S. dollars.\nDividends and Capital Stock\nDividend increase of 12%: The Board of Directors approved for common stock in the second quarter of 1995, raising the level to $.09 effective at June 30, 1995. The annualized common stock dividend rate at the end of 1995 was $.36 per share.\nThree-for-two split: The Board of Directors authorized this split of common stock effective June 30, 1995. Directors authorized an earlier three-for-two split of common stock effective September 30, 1993.\nStock purchases: In the fourth quarter of 1993, the Board of Directors voted to retire 5.3 million shares of stock previously held in treasury and approved a plan to purchase up to 3.6 million shares of common stock for delivery under its stock incentive and employee benefit plans. At 1994 year-end, 1.6 million shares had been purchased under this plan, which is now closed. In the second quarter of 1992, the Board of Directors approved two separate plans to purchase up to 12.5 million shares of common stock. At December 31, 1995, 11.5 million shares had been purchased under these plans.\nOther Matters\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 Company anticipates no material impact on financial condition or the results of operations from adoption on January 1, 1996. In October 1995, the Financial Accounting Standards Board issued Statement No. 123 \"Accounting for Stock-Based Compensation\". The Company will adopt the disclosure only alternative on January 1, 1996.\nThe Company has reached an agreement in principle for the replacement of a precious metals supply contract that expires December 31, 1996. The new contract offers smaller quantities and less favorable terms, but management expects the impact to be wholly or partially offset by other precious metals supply contracts and arrangements and by new business programs already underway. Failure to achieve such offsetting income could result in a material adverse impact. Management believes that an adequate supply of these precious metals will be available to meet growing needs.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ------ -------------------------------------------\nNotes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of Engelhard Corporation and its wholly-owned subsidiaries (collectively referred to as the Company). All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the current year presentation. All share and per share data have been retroactively restated to give effect to the three-for-two stock split as of June 30, 1995.\nThe preparation of financial statements in conformity with generally accepted account- ing 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.\nCost of Sales and Inventories Inventories are stated at the lower of cost or market. The elements of cost include direct labor and materials, variable overhead and the full absorption of fixed manufacturing overhead. The cost of precious metals inventories is determined using the last-in, first-out (LIFO) method of inventory valuation. The cost of other inventories is principally determined using either the average cost or first-in, first-out (FIFO) method.\nThe Company routinely enters into a variety of arrangements for the sourcing and supply of precious metals. These arrangements are spread among a number of counter-parties, which are generally major industrial companies or highly rated financial institutions. The conduct of this business is closely monitored and appropriate reserves for potential losses are maintained.\nDepreciation, Depletion and Amortization Additions to property, plant and equipment are stated at cost. Depreciation and amortization of plant and equipment are provided primarily on a straight-line basis over the estimated useful lives of the assets. Depletion of mineral deposits and mine development are provided under the unit of production method.\nWhen assets are sold or retired, the cost and related accumulated depreciation or amortization are removed from the accounts and any gain or loss is included in earnings.\nAmortization and Intangible Assets Goodwill and other acquired intangible assets are recorded at cost and amortization is provided on a straight-line basis over the estimated useful lives of the assets, but not in excess of 40 years.\nAccounting Change Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\". This standard requires the accrual method of accounting for certain benefits provided to former or inactive employees after employment but before retirement. As of January 1, 1993, the Company recognized the full actuarially calculated amount of its estimated accumulated\npostemployment benefit obligation. The charge to 1993 earnings was $26.0 million ($16.0 million after tax--$.11 per share). The after-tax amount has been reflected in 1993 as a cumulative effect of an accounting change.\n2. Special Charge\nIn 1993, the Company provided for a plan to realign and consolidate businesses, concentrate resources and better position itself to achieve its strategic growth objectives. That plan resulted in a special charge of $148.0 million ($91.8 million after tax--$.63 per share) in 1993, consisting of a $118.0 million pretax restructure provision for asset writedowns related to product lines or sites being exited together with provisions for facility shutdown, rundown and relocation and for employee reassignment, severance and related benefits and a $30.0 million pretax environmental reserve. See Note 15, \"Environmental Costs\", for a discussion of environmental matters and the amount of the Company's environmental reserve.\nThe Company's restructuring reserve at December 31, 1993, consisted of the $118.0 million 1993 special charge and $32.4 million of previously established provisions associated with idled sites, as rundown costs continue to be incurred at these sites and their disposition is pending completion of environmental cleanup and\/or consummation of sales. During the fourth quarter of 1994, the Company reversed $8.0 million of its restructuring reserve because its idle Canadian facility was sold earlier and at more favorable terms than originally estimated and because of a revised, and less costly, approach to the cleanup\/disposition of its idle Newark, NJ site.\nThe following table sets forth the components of the Company's restructuring reserve and related activity for 1994 and 1995:\nRestructuring Reserve Employee Asset (in millions) separations writedowns Other Total\nBalance at December 31, 1993 $35.9 $72.2 $42.3 $150.4 Asset writeoffs\/writedowns - (66.6) - (66.6) Cash spending (8.8) - (8.4) (17.2) Cash proceeds - 1.7 - 1.7 Reclassification - 7.5 (7.5) - Reversal - - (8.0) (8.0) ---- ---- ---- ----- Balance at December 31, 1994 27.1 14.8 18.4 60.3 Asset writeoffs\/writedowns - (7.7) - (7.7) Cash spending (9.5) - (8.6) (18.1) Engelhard-CLAL (3.9) 1.0 9.0 6.1 ---- ---- ---- ----- Balance at December 31, 1995 $13.7 $ 8.1 $18.8 $ 40.6\nIn 1994, the Company reconfigured certain production processes at the Middle Georgia facility of the Paper Pigments and Chemicals Group, which resulted in the writeoff of the associated assets. Two other Company-owned sites, originally identified for closure, will remain open. One of these facilities, a part of the Engineered Materials Group, will continue to operate because of improved economics and the lack of synergy to be achieved from relocating the manufacturing process. The other facility, a part of the Chemical Catalysts Group, will continue to operate because the product lines are complementary to the Company's other businesses. The impairment of this facility, as opposed to the originally planned shutdown and relocation, resulted in a reclassification of shutdown and relocation costs to asset writedowns.\nIn 1995, the Company completed the formation of Engelhard-CLAL, a Paris-based precious metal fabrication joint venture. This transaction increased the reserve as a result of previously anticipated precious metal and other asset gains, partially offset by a decrease in the reserve for restructuring activities to be performed by the joint venture. In addition, the Company continued to incur costs for severance and related benefits as well as rundown costs at idle sites. Asset writeoffs in 1995 were related to inventory and fixed assets associated with rationalization actions.\nMost of the restructuring actions have been taken. Major actions expected to be completed this year include: the sale of a separation products facility (scheduled for the first half of 1996); the continuing rationalization of the Petroleum Catalysts Group and of a manufacturing facility of the Environmental Technologies Group; and the completion of the Floridin acquisition (pending a court decision).\nThe remaining provision for employee separations provides for severance and related benefit payments for former employees and for employees who have generally been notified of severance in connection with pending actions. These amounts will be paid over several years. The remaining provision for asset writedowns primarily relates to pending actions. The remaining provision in \"other\" relates to rundown costs. Net cash outflows for rundown costs will be charged against the reserve until the related sites are sold.\nBy the end of 1996 the Company anticipates annual cost savings of about $20 to $25 million as a result of lower manufacturing and operating expenses, with annual cash savings of about $15 million. To date, most of these savings have been realized.\n3. Research and Development Costs\nResearch and development costs are charged to expense as incurred and were $53.0 million in 1995, $49.0 million in 1994 and $46.9 million in 1993.\n4. Benefits\nThe Company has domestic and foreign pension plans covering substantially all employees. Plans covering most salaried employees generally provide benefits based on years of service and the employee's final average compensation. Plans covering most hourly, bargaining unit members generally provide benefits of stated amounts for each year of service. The Company makes contributions to the plans to the extent such contributions are currently deductible for tax purposes. Plan assets primarily consist of listed stocks and fixed income securities.\nThe components of the net pension credit for all plans are shown in the following table:\nNet Pension Credit (in millions) 1995 1994 1993 ---- ---- ---- Service cost $ 8.3 $ 9.3 $ 8.1 Interest cost 20.4 19.1 18.8 Actual return on plan assets (40.9) (9.3) (26.9) Net amortization and deferral 8.6 (21.0) (2.2) ------ ------ ------ Net pension credit $ (3.6) $ (1.9) $ (2.2)\nThe weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations for the pension plans are 7.0% to 8.5% and 3.0% to 6.0%, respectively. The expected long-term rate of return on assets is 7.5% to 10.5%.\nThe following table sets forth the plans' funded status:\nFunded Status (in millions) 1995 1994 ---- ---- Actuarial present value of benefit obligations Vested benefit obligation $222.5 $206.9 Accumulated benefit obligation $235.9 $217.8 Projected benefit obligation $267.9 $254.3 Plan assets at fair value $288.8 $283.6 Plan assets in excess of projected benefit obligation $ 20.9 $ 29.3 Unrecognized net loss 37.6 39.8 Unrecognized prior service cost 6.4 6.7 Unrecognized transition asset, net of amortization (8.8) (14.7) Fourth quarter contribution .3 .1 ------ ------ Prepaid pension expense $ 56.4 $ 61.2\nIn June 1995, in connection with the formation of the Engelhard-CLAL joint venture, the Company transferred certain assets and liabilities of the plans to the Engelhard-CLAL joint venture. This transaction reduced the Company's prepaid pension expense by $10.1 million.\nThe Company also sponsors two savings plans covering certain salaried and hourly paid employees. The Company's contributions, which may equal up to 50% of certain employee contributions, were approximately $2 million in 1995, 1994 and 1993.\nThe Company also currently provides postretirement medical and life insurance benefits to certain retirees (and their spouses), certain disabled employees (and their families) and spouses of certain deceased employees. Substantially all U.S. salaried employees and certain hourly paid employees are eligible for these benefits, which are paid through the Company's general health care and life insurance programs, except for certain medicare-eligible salaried and hourly retirees who are provided a defined contribution towards the cost of a partially insured health plan. In addition, the Company provides postemployment benefits to former or inactive employees after employment but before retirement. These benefits are substantially similar to the postretirement benefits but cover a much smaller group of employees.\nThe components of the net expense for these postretirement and postemployment benefits are shown in the following table:\nPostretirement and Postemployment Benefit Expense (in millions) 1995 1994 1993 ---- ---- ---- Service cost $2.3 $ 2.3 $ 2.1 Interest cost 9.0 10.0 13.3 Net amortization (4.9) (4.5) (3.2) ----- ----- ----- Net benefit expense $6.4 $ 7.8 $12.2\nAnnual cash spending for postretirement and postemployment benefits averaged approximately $7.3 million for the past three-year period.\nThe weighted-average discount rate used in determining the actuarial present value of the accumulated postretirement and postemployment benefit obligation is 7.8%. The average assumed health care cost trend rate used for 1995 is 10%, gradually decreasing to 5% by 2004. A 1% increase in the assumed health care cost trend rate would increase aggregate service and interest cost in 1995 by $.6 million and the accumulated postretirement and postemployment benefit obligation as of December 31, 1995 by $5.6 million.\nThe following table sets forth the components of the accrued postretirement and postemployment benefit obligation, all of which are unfunded:\nPostretirement and Postemployment Benefit Obligation (in millions) 1995 1994 ---- ---- Accumulated benefit obligation Retirees $ 74.8 $ 72.3 Fully eligible active participants 15.9 16.0 Other active participants 18.2 33.1 ------ ------ 108.9 121.4 Unrecognized prior service cost 46.5 39.4 Unrecognized net gain (loss) 4.8 7.1 Fourth quarter contribution (2.0) (2.3) ------ ------ Accrued benefit obligation $158.2 $165.6\nIn June 1995, in connection with the formation of the Engelhard-CLAL joint venture, the Company transferred $3.6 million of its accrued benefit obligation to the Engelhard-CLAL joint venture.\n5. Related Party Transactions\nIn the ordinary course of business, the Company has raw material supply arrangements with entities in which Anglo American Corporation of South Africa Limited (Anglo) has material interests and with Engelhard-CLAL and its subsidiaries. Anglo indirectly holds a significant minority interest in the common stock of the Company. Engelhard-CLAL is a 50% owned joint venture. The Company's purchases from such entities amounted to $367.3 million in 1995, $233.1 million in 1994 and $228.7 million in 1993; sales to such entities amounted to $442.4 million in 1995; and metal leases to such entities amounted to $31.7 million in 1995 and $49.7 million in 1994. Management believes these transactions were under terms no less favorable to the Company than those arranged with other parties. At December 31, 1995 and 1994 amounts due to such entities totaled $4.9 million and $14.8 million, respectively.\n6. Income Taxes\nThe components of income tax expense are shown in the following table:\nIncome Tax Expense (Benefit) (in millions) 1995 1994 1993 ---- ---- ---- Current income tax expense Federal $15.9 $13.3 $18.4 State 2.0 1.3 1.6 Foreign 12.0 7.5 7.8 ----- ----- ----- 29.9 22.1 27.8 Deferred income tax expense (benefit) Federal 19.2 13.2 (39.8) Changes in tax rates - 1.3 (1.6) State 2.7 2.7 (2.7) Foreign (2.6) 8.1 (1.2) Loss carryforwards\/tax credits (1.4) (8.1) (3.9) ----- ------ ----- 17.9 17.2 (49.2) ----- ------ ----- Income tax expense (benefit) $47.8 $39.3 $(21.4)\nThe foreign portion of income (loss) before income tax expense (benefit) was income of $40.8 million in 1995, $51.0 million in 1994 and $20.9 million in 1993. Taxes on income of foreign consolidated subsidiaries and affiliates are provided at the tax rates applicable to their respective foreign tax jurisdictions. Tax credits of $8.0 million in 1995, $3.6 million in 1994 and $6.2 million in 1993, in connection with equity transactions, are included in such adjustments for those years and are not reflected in the amounts shown above.\nThe following table sets forth the components of the net deferred income tax asset which results from temporary differences between the amounts of assets and liabilities recognized for financial reporting and tax purposes:\nNet Deferred Income Tax Asset (in millions) 1995 1994 ---- ---- Deferred tax assets Accrued liabilities $71.5 $78.1 Noncurrent liabilities 62.6 66.4 Tax credits and carryforwards 41.0 41.3 Deferred tax liabilities Prepaid pension expense (27.5) (28.5) Property, plant and equipment (8.4) (16.1) Other assets (41.9) (35.8) ------ ------ Net deferred income tax asset $97.3 $105.4\nAs of December 31, 1995, the Company had approximately $16.9 million of non-expiring alternative minimum tax credit carryforwards and approximately $5.0 million of research and development credits with expiration dates through 2010 available to offset future U.S. Federal income taxes. Also, as of December 31, 1995, the Company had approximately $11.0 million of foreign nonexpiring net operating loss carryforwards and approximately $6.0 million of foreign investment tax credits expiring in 2000 available to offset certain future foreign income taxes. Management believes that the Company will generate sufficient taxable earnings and tax planning opportunities to ensure realization of these tax benefits.\nA reconciliation of the difference between the Company's consolidated income tax expense (benefit) and the expense (benefit) computed at the federal statutory rate is shown in the following table:\nConsolidated Income Tax Expense (Benefit) Reconciliation (in millions) 1995 1994 1993 ---- ---- ---- Income tax expense (benefit) at federal statutory rate $64.9 $55.0 $ (1.6) Special charge - - (4.4) Effect of tax law changes - 1.3 (1.6) State income taxes, net of federal effect 3.0 2.6 2.8 Percentage depletion (14.0) (11.6) (11.6) Equity earnings (.9) (.6) - Effect of different tax rates on foreign earnings, net (3.6) 2.3 (4.0) Benefit of tax credits (.7) (7.5) (1.0) Foreign sales corporation (4.1) (3.4) (1.4) Other items, net 3.2 1.2 1.4 ----- ------ ----- Income tax expense (benefit) $47.8 $39.3 $(21.4)\nAt December 31, 1995, the Company's share of the cumulative undistributed earnings of foreign subsidiaries was approximately $256.8 million. No provision has been made for U.S. or additional foreign taxes on the undistributed earnings of foreign subsidiaries because such earnings are expected to be reinvested indefinitely in the subsidiaries' operations. It is not practicable to estimate the amount of additional tax that might be payable on these foreign earnings in the event of distribution or sale; however, under existing law, foreign tax credits would be available to substantially reduce, or in some cases eliminate, U.S. taxes payable.\n7. Inventories\nInventories consist of the following:\nInventories (in millions) 1995 1994 ---- ---- Raw materials $ 68.9 $ 62.9 Work in process 30.1 24.1 Finished goods 117.5 103.0 Precious metals 21.5 53.4 ------ ------ Total inventories $238.0 $243.4\nAll precious metals inventories are stated at LIFO cost. The market value of the precious metals inventories exceeded cost by $35.5 million and $61.0 million at December 31, 1995 and 1994, respectively. The Company also has a long-term investment in precious metals. The combined market value of precious metals in inventories and the investment exceeded cost by $35.8 million and $71.0 million at December 31, 1995 and 1994, respectively.\nIn 1995, the Company contributed certain precious metals inventories to its newly formed joint venture, Engelhard-CLAL.\nIn the normal course of business, certain customers and suppliers deposit significant quantities of precious metals with the Company under a variety of arrangements. Equivalent quantities of precious metals are returnable as product or in other forms.\n8. Investments\nThe Company has investments in affiliates that are accounted for on the equity method. The more significant of these investments are Engelhard-CLAL and N.E. Chemcat Corporation (N.E. Chemcat). Engelhard-CLAL, a 50\/50 joint venture with Paris-based CLAL (Groupe FIMALAC), was established in June 1995 for the purpose of refining, manufacturing and marketing certain precious metal containing products. N.E. Chemcat is a 38.8% owned, publicly-traded Japanese corporation and a leading producer of automotive and chemical catalysts, electronic chemicals and other precious metals based products.\nAt December 31, 1995, the quoted market value of the Company's investment in N.E. Chemcat was in excess of $130 million. The valuation represents a mathematical calculation based on a closing quotation published by the Tokyo over-the-counter market and is not necessarily indicative of the amount that could be realized upon sale.\nIn the first quarter of 1993, the Company sold its investment in M&T Harshaw to its partner for $40 million in cash with the buyer assuming all assets and liabilities. As a result, the Company realized an after-tax gain of $6.3 million ($.04 per share).\nThe summarized unaudited financial information below represents an aggregation of the Company's nonsubsidiary affiliates:\nFinancial Information (unaudited) (in millions) 1995 1994 1993 ---- ---- ---- Earnings data Revenue $1,207.9 $348.1 $327.3 Gross profit 130.8 62.0 55.4 Net earnings 6.2 6.4 10.4 Company's equity in net earnings .7 .6 3.4 Balance sheet data Current assets $ 573.8 $231.2 Noncurrent assets 190.0 123.5 Current liabilities 240.5 103.1 Noncurrent liabilities 90.1 18.8 Net assets 433.2 232.8 Company's equity in net assets 216.1 105.5\nThe Company's share of undistributed earnings of affiliated companies included in consolidated retained earnings was $39.2 million and $41.8 million at December 31, 1995 and 1994, respectively. Dividends from affiliated companies were $3.4 million in 1995, $3.8 million in 1994 and $2.6 million in 1993.\nThe Company has other investments, including an investment in precious metal, that are accounted for at cost.\n9. Property, Plant, and Equipment\nProperty plant and equipment consist of the following:\nProperty, Plant and Equipment (in millions) 1995 1994 ---- ---- Land $ 24.2 $ 14.0 Buildings and building improvements 198.4 155.5 Machinery and equipment 1,001.5 982.5 Construction in progress 71.0 62.9 Mineral deposits and mine development 71.7 70.2 ------- ------- 1,366.8 1,285.1 Accumulated depreciation, depletion and amortization 757.3 744.7 ------- ------- Property, plant and equipment, net $ 609.5 $ 540.4\nIn December 1995, the Company acquired, for $57.0 million, certain properties previously operated under lease agreements. These properties consist of land and a building that serves as the principal executive and administrative offices of the Company and its operating businesses.\n10. Short-term Borrowings and Long-term Debt\nAt December 31, 1995, unsecured committed revolving credit agreements include a $300 million facility with a group of North American money center banks and a $300 million facility with a group of major foreign banks both of which expire in the year 2000. Commitment fees are paid on unused portions of these lines. In connection with its credit facilities, the Company has agreed to certain covenants, none of which is considered restrictive to the operations of the Company.\nAt December 31, 1995 and 1994, short-term bank borrowings were $89.2 million and $52.3 million, respectively, at a weighted-average interest rate of 6.0% and 6.3%, respectively. At December 31, 1995 and 1994, commercial paper borrowings were $94.0 million and $127.3 million, respectively, at weighted-average interest rates of 5.8% and 6.0%, respectively.\nAdditional unused lines of credit available exceeded $650 million at December 31, 1995. The Company's lines of credit with its banks are available in accordance with normal terms for prime commercial borrowers and are not subject to commitment fees or other restrictions.\nThe following table sets forth the components of long-term debt:\nDebt Information (in millions) 1995 1994 ---- ---- Medium-Term Notes with a weighted-average interest rate of 6.53%, due 2000 $100.0 $ - 10% Notes, callable at par in 1996, due 2000 (net of discount) 99.9 99.8 Industrial revenue bonds, 7.91%, currently callable, due 1997 5.5 5.5 Industrial revenue bonds 64.5% to 68% of prime rate, due 1997-1999 5.5 5.5 Foreign bank loans with a weighted-average interest rate of 7.0%, due 1996-2000 .9 1.5 ------ ------ 211.8 112.3 Amounts due within one year .3 .5 ------ ------ Total long-term debt $211.5 $111.8\nAs of December 31, 1995, the aggregate maturities of long-term debt for the succeeding five years are as follows: $.3 million in 1996, $7.1 million in 1997, $4.5 million in 1999, and $199.9 million in 2000. In addition, in 1996 management expects to call the $5.5 million 7.91% industrial revenue bonds and the $100.0 million 10% notes, and refinance them with comparable long-term debt. See Note 12, \"Financial Instruments and Precious Metals Operations,\" for a discussion about an interest rate swap agreement.\n11. Lease Commitments\nThe Company rents real property and equipment under long-term operating leases. Future minimum rental payments required under noncancellable operating leases, having initial or remaining lease terms in excess of one year, are $2.6 million in 1996, $1.6 million in 1997, $2.0 million in 1998, $1.8 million in 1999, $1.3 million in 2000 and $9.2 million thereafter. Rental\/lease expense, including all leases, amounted to $14.2 million in 1995, $14.5 million in 1994 and $13.5 million in 1993.\n12. Financial Instruments and Precious Metals Operations\nThe Company does not generally speculate in or engage in the trading of derivative financial instruments. Derivative financial instruments are used by the Company primarily for hedging purposes to mitigate risk and include foreign currency forward contracts and interest rate swap agreements. The Company's nonderivative financial instruments consist primarily of cash in banks, temporary investments, accounts receivable and debt.\nThe fair value of financial instruments in working capital approximates book value. At December 31, 1995 and 1994, the fair value of long-term debt was about $214.3 million and $114.2 million, respectively, based on current interest rates, compared with a book value of $211.5 million and $111.8 million, respectively.\nThe Company's financial instruments do not represent a concentration of credit risk because the Company deals with a variety of major banks worldwide, and its accounts receivable are spread among a number of major industries, customers and geographic areas. In addition, a centralized credit committee reviews significant credit transactions before consummation and an appropriate level of reserves is maintained. Provisions to these reserves were not significant in 1995, 1994 or 1993. Management believes that should a counterparty fail to perform according to the terms of an agreement, it is unlikely that any of the Company's off-balance sheet financial instruments would result in a significant loss to the Company.\nForeign Currency Forward Contracts In the normal course of business, the Company enters into transactions denominated in foreign currencies. In addition, the Company has subsidiary and nonsubsidiary investments in a number of different currencies. As a result, the Company is subject to transaction and translation exposure from fluctuations in foreign currency exchange rates. The Company uses a variety of strategies, including foreign currency forward contracts and internal hedging, to minimize or eliminate foreign currency exchange rate risk associated with substantially all of its foreign currency transactions. Gains and losses on these hedging transactions are generally recorded in earnings in the same period as they are realized, which is usually in the same period as the underlying or originating transactions. In selected circumstances, the Company enters into foreign currency forward contracts to hedge the U.S. dollar value of its foreign investments. Gains and losses on these hedging contracts are recognized as\ncumulative translation adjustments. In limited and closely monitored situations, for which preapproved exposure levels have been set, the Company may enter into speculative foreign currency transactions. Gains and losses on these transactions are recognized in earnings in the period of the change.\nThere were no speculative positions in foreign currencies as of December 31, 1995 and 1994, and there were no material gains or losses from such positions for any year presented. The following table sets forth, in U.S. dollars, the Company's open foreign currency forward contracts used for hedging:\nForeign Currency Forward Contracts Information (in millions) 1995 1994 ----------------- ------------------ Buy Sell Buy Sell Deutsche Mark $ 1.2 $ 3.8 $ 17.3 $ 29.8 Japanese Yen 40.6 115.6 68.9 99.9 Pound Sterling 7.7 15.5 38.9 15.8 South African Financial Rand - - 1.4 - ------ ------ ------ ------ Total open foreign currency forward contracts $49.5 $134.9 $126.5 $145.5\nNone of these contracts exceeds a year in duration and the net amount of deferred income and expense on foreign currency forward contracts, which will predominately be recognized as cumulative translation adjustments, was $.1 million income in 1995 and $1.0 million expense in 1994.\nInterest Rate Swap Agreement The Company occasionally enters into interest rate swap agreements to modify the characteristics of its outstanding borrowings from fixed to floating rate debt or vice versa. The intent of these transactions is to reduce interest expense. The use and mix of such instruments can vary depending on business and economic conditions and management's interest rate outlook. The Company uses swap instruments only as hedges or as integral parts of borrowings. See Note 10, \"Short-term Borrowings and Long-term Debt\". As such, the differential to be paid or received is accrued and recognized in income as an adjustment to interest expense. During the past three-year period, the Company used one interest rate swap agreement intended to reduce interest expense on certain of its outstanding debt. In connection with the $100 million 10% Notes due in 2000, callable in 1996, the Company entered into a $100 million notional principal amount swap contract running from May 11, 1993, to May 13, 1996, to receive 4.5% and to pay LIBOR. This swap agreement was based on amounts and maturities which coincide with the debt agreement. There has been no speculative trading in this instrument and this agreement is intended to be held to maturity. The impact of this swap contract was to increase interest expense by $1.9 million in 1995, to increase interest expense by $.3 million in 1994 and to decrease interest expense by $.7 million in 1993. The resulting impact on the Company's weighted-average borrowings rate was not material for any year presented.\nPrecious Metals Operations Some of the Company's businesses use precious metals in their manufacturing processes. In addition, sales and purchases of precious metals to\/from industrial and refining customers are transacted through the Company's dealing operations. Secondarily, and usually as a consequence of the above transactions, the Company also engages in precious metals dealing with other counterparties. Generally, all of these precious metals transactions are hedged on a daily basis, using spot, forward, futures or option transactions, to substantially eliminate the exposure to price risk. In limited and closely monitored situations, for which preapproved exposure levels have been set, the Company holds unhedged precious metal positions. Changes in the market value of unhedged (open) precious metal positions are recognized in earnings in the period of the change by marking these positions to their current market value.\nThe following table sets forth the Company's open precious metal positions:\nPrecious Metal Positions Information (in millions) 1995 1994 ----------------- ----------------- Gross Gross Position value Position value -------- ----- -------- ----- Platinum group metals Long $2.9 Long $5.8 Gold Long 3.0 Short (.6) Silver Short (.3) Long .1 ---- ---- Total open precious metal positions $5.6 $5.3\nThe total mark-to-market adjustment related to the above positions was $.2 million expense in 1995 and 1994.\nAs a result of its precious metals transactions, the Company earned contango income of $3.7 million in 1995, $1.1 million in 1994, and $3.6 million in 1993. Contango is a term common to precious metal transactions representing the premium received or paid when settlement of the precious metal transaction is in the future. This premium constitutes an offset to the financing costs associated with carrying the precious metal that underlies the transaction. As such, contango is reflected in the statement of earnings as an adjustment to interest expense because it is an integral component of the Company's financing costs.\n13. Industry Segment and Geographic Area Data\nThe Company operates in three industry segments: Catalysts and Chemicals, Pigments and Additives, and Engineered Materials and Industrial Commodities Management (formerly Precious Metals Management).\nThe Catalysts and Chemicals segment develops, manufactures and markets a wide range of catalysts and related products and processes for the automotive, off-road vehicle, aircraft, power generation, petroleum refining, chemical, petrochemical, pharmaceutical and food processing industries, among others, located principally in the United States, Europe, the Asia-Pacific region and South Africa. The Company's products are used by customers in these industries to reduce emissions, achieve desired manufacturing yields and improve quality and\/or cost-efficiency.\nThe Pigments and Additives segment develops, manufactures and markets coating and extender pigments for the paper industry and color pigments and specialty minerals serving the plastics, coatings, paint and allied industries. The segment's markets are principally located in the United States, Europe and Japan. The Company's paper pigments are used principally to make coated and uncoated papers and paper board. Its color pigments are used primarily in paints and coatings, plastics, rubber and printing inks, while specialty mineral products are sold to the plastics, rubber, wire and cable, coatings, inks and adhesives industries.\nThe Engineered Materials and Industrial Commodities Management segment develops, manufactures and markets fabricated products and coatings based on precious metals for a number of industrial markets, including automotive, electronics, air-conditioning and glass. These markets are principally located in the United States. This segment also engages in precious metals management on behalf of Company businesses and customers that use precious metals. It also participates in refining of platinum group metals, base metal management and marketing of energy-related services.\nThe following table presents certain data by industry segment:\nThe following table presents certain data by geographic area:\nInter-area sales are generally based on market prices. Most of the Company's foreign operations are based in Europe and the Asia-Pacific region. United States export sales to customers throughout the world were $265.8 million in 1995, $237.0 million in 1994 and $231.2 million in 1993.\nThe following table reconciles segment operating earnings with the earnings before income taxes and cumulative effect of an accounting change as shown in the Consolidated Statements of Earnings:\nReconciliation to Consolidated Statements of Earnings\n(in millions) 1995 1994 1993 ---- ---- ---- Operating earnings $245.4 $213.7 $ 19.9 Gain on sale of investment - - 10.1 Equity earnings .7 .6 3.4 Interest and other expenses, net (60.8) (57.0) (38.1) ------ ------ ------ Earnings (loss) before income taxes and cumulative effect of an accounting change $185.3 $157.3 $ (4.7)\nFor the years ended December 31, 1995 and 1994, one customer of both the Catalysts and Chemicals and the Engineered Materials and Industrial Commodities Management segments accounted for 11% of the Company's net sales.\n14. Stock Option and Bonus Plans\nThe Company's Stock Option Plans of 1991 and 1981, as amended (the Key Option Plans) generally provide for the granting to key employees of options to purchase an aggregate of 16,875,000 and 6,834,375 common shares, respectively, at fair market value on the date of grant. No options under the Key Option Plans may be granted after June 30, 2001. In 1993, the Company established the Employee Stock Option Plan of 1993, as amended, which generally provided for the granting to all employees (excluding U.S. bargaining unit employees and key employees eligible under the Key Option Plans) of options to purchase an aggregate of 2,812,500 common shares at fair market value on the date of grant. No additional options may be granted under this plan. Options under all plans become exercisable in installments beginning after one year, and no options may be exercised after 10 years from the date of grant. Outstanding options may be cancelled and reissued under terms specified in the plan documents. The effect of outstanding stock options has been excluded from the calculation of the number of shares outstanding used to compute earnings per share of common stock because it is not significant.\nStock option transactions under all plans are as follows:\nStock Option Information\n15. Environmental Costs\nIn the ordinary course of business, like most other industrial companies, the Company is subject to extensive and changing federal, state, local and foreign environmental laws and regulations, and has made provisions for the estimated financial impact of environmental cleanup related costs.\nThe Company is currently preparing, has under review, or is implementing, with the oversight of cognizant environmental agencies, environmental investigations and cleanup plans at several currently or formerly owned and\/or operated sites, including Plainville, MA, Salt Lake City, UT, Attapulgus, GA, and Newark, NJ. With respect to Plainville, in September 1993 the United States Environmental Protection Agency (EPA) and the Company entered into a consent order under which the Company is investigating contamination and will conduct site stabilization measures. Plainville is also included on the Nuclear Regulatory Commission (NRC) \"Existing Site Decommissioning Management Plan Sites\" list and the Company is currently conducting further investigations of the site pursuant to NRC approved plans. With respect to Salt Lake City, in connection with obtaining an operating permit under the Utah Solid and Hazardous Waste Act, the Company entered into an agreement in December 1993 with the Utah Solid and Hazardous Waste Control Board under which the Company is continuing to investigate the environmental status of the site. With respect to Attapulgus, in January 1994 the Georgia Department of Natural Resources, Environmental Protection Division and the Company entered into a consent order under which the Company was to develop and implement a reclamation program. A reclamation program has been approved and cleanup is underway. With respect to Newark, the Company has substantially completed a cleanup plan in coordination with the New Jersey Department of Environmental Protection.\nIn addition, 18 sites have been identified at which the Company believes liability as a potentially responsible party (PRP) is probable under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or similar state laws (collectively referred to as Superfund) for the cleanup of contamination resulting from the historic disposal of hazardous substances allegedly generated by the Company, among others. Superfund requires cleanup of certain sites from which there has been a release or threatened release of hazardous substances and authorizes EPA or a state to take any necessary action at such sites, including ordering PRPs to cleanup or contribute to the cleanup of a site. Courts have interpreted Superfund to impose strict, joint and several liability under certain circumstances. These claims are in various stages of administrative or judicial proceedings, and include demands for recovery of past costs and future investigative or cleanup action. In many cases, the dollar amount of the claim is unspecified and claims have been asserted against a number of other entities for the same relief sought from the Company. Based on existing information, the Company believes that it is a de minimis contributor of hazardous substances at most of the sites referenced above. Subject to the reopening of existing settlement agreements for extraordinary circumstances or natural resource damages, the Company has settled a number of other cleanup proceedings. The Company has also responded to information requests from EPA and state regulatory authorities in connection with other Superfund sites.\nThe Company's policy is to accrue environmental cleanup related costs of a noncapital nature when those costs are believed to be probable and can be reasonably estimated. The quantification of environmental exposures requires an assessment of many factors, including changing laws and regulations, advancements in environmental technologies, the quality of information available related to specific sites, the assessment stage of each site investigation, preliminary findings, and the length of time involved in remediation or settlement. For Superfund sites, the Company also assesses the financial capability of other PRPs and, where allegations are based on tentative findings, the reasonableness of the Company's apportionment. The Company has not anticipated recoveries from insurance carriers or other potentially responsible third parties in its accruals for environmental liabilities. The liabilities for environmental cleanup related costs recorded in the consolidated balance sheets at December 31, 1995 and 1994 were $54.6 million and $62.2 million, respectively, including $10.0 million and $10.8 million, respectively, for the Superfund sites. These amounts represent those costs which the Company believes are probable and reasonably estimable. Based on currently available information and analysis, the Company's accrual represents approximately 85% of what it believes are reasonably possible environmental cleanup related costs of a noncapital nature. The estimate of reasonably possible costs is less certain than the probable estimate upon which the accrual is based.\nDuring the past three-year period, cash payments for environmental cleanup related matters were $7.6 million, $4.5 million and $.3 million for 1995, 1994 and 1993, respectively. In 1995 and 1994, the amounts accrued in connection with environmental cleanup related matters were not significant. In 1993, $30.0 million was accrued as a result of developments during that year which caused the Company to revise its estimates of environmental cleanup related costs at sites being idled or affected by restructuring, where conditions had recently changed, or where studies and cleanup plans had been approved and the assessment of the likelihood or extent of remediation had changed.\nFor the past three-year period, environmental related capital projects have averaged less than 10% of the Company's total capital expenditure programs and the expense of environmental compliance (environmental testing, permits, consultants and in-house staff) was not significant.\nThere can be no assurances that environmental laws and regulations will not become more stringent in the future or that the Company will not incur significant costs in the future to comply with such laws and regulations. Based on existing information and currently enacted environmental laws and regulations, cash payments for environmental cleanup related matters are projected to approximate $10 million for 1996, all of which has already been accrued. Further, the Company anticipates that the amounts of capitalized environmental projects and the expense of environmental compliance will approximate current levels. While it is not possible to predict with certainty, management believes that environmental cleanup related reserves at December 31, 1995 are reasonable and adequate and that environmental matters are not expected to have a material adverse effect on financial condition. These matters, if resolved in a manner different from the estimates, could have a material adverse effect on the operating results or cash flows when resolved in a future reporting period.\n16. Litigation and Contingencies\nThe Company is a defendant in a number of lawsuits covering a wide range of matters. In some of these pending lawsuits, the remedies sought or damages claimed are substantial. The Company and certain of its officers and directors were named as defendants in purported class action complaints filed in November 1995 in the U.S. District Court for the District of New Jersey on behalf of persons who bought Engelhard Stock between April 1995 and November 1995. The complaints claim that defendants made false statements and omissions and traded on nonpublic information. The complaints are expected to be combined into a Consolidated Amended Complaint. The Company believes the class actions to be without merit and is vigorously defending against them. The Company is also subject to a number of environmental contingencies (see Note 15 \"Environmental Costs\"). While it is not possible to predict with certainty the ultimate outcome of these lawsuits or the resolution of the environmental contingencies, management believes, after consultation with counsel, that resolution of these matters is not expected to have a material adverse effect on financial condition. These matters, if resolved in a manner different from the estimates, could have a material adverse effect on the operating results or cash flows when resolved in a future reporting period.\nIn January 1995, the Company received and is responding to a civil investigative demand to produce documents and answer interrogatories in connection with an investigation by the Antitrust Division of the U.S. Department of Justice into \"price coordination and market allocation by kaolin producers\".\n17. Supplemental Information\nThe following table presents certain supplementary information to the Consolidated Statements of Cash Flows:\nSupplementary Cash Flow Information (in millions) 1995 1994 1993 ---- ---- ---- Cash paid during the year for Interest, net of capitalized amounts and contango $ 29.1 $ 24.2 $ 17.9 Income taxes 21.9 22.1 20.1 Change in assets and liabilities-source (use) Receivables $(31.9) $(27.5) $ 11.7 Inventories (24.3) (20.2) 17.0 Other current assets 8.2 6.0 (5.5) Other noncurrent assets (17.2) (27.2) (60.0) Accounts payable 17.1 28.1 (15.3) Accrued liabilities (6.7) (19.4) (34.9) Noncurrent liabilities (12.4) (7.3) (4.5) ------ ------ ------ Net change in assets and liabilities $(67.2) $(67.5) $(91.5)\nThe following table presents certain supplementary information to the Consolidated Balance Sheets:\nSupplementary Balance Sheet Information (in millions) 1995 1994 ---- ---- Payroll-related accruals $ 34.3 $ 36.4 Environmental reserve 10.0 10.0 Restructuring reserve 32.5 45.5 Other 133.1 141.4 ------ ------ Accrued liabilities $209.9 $233.3\nReport of Independent Accountants _________________________________\nTo the Shareholders and Board of Directors of Engelhard Corporation:\nWe have audited the accompanying consolidated balance sheets of Engelhard 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 Engelhard 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.\nAs discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its method of accounting for postemployment benefits.\nCoopers & Lybrand, L.L.P. New York, New York February 6, 1996\nSelected Quarterly Financial Data (unaudited)\n* Reflects the three-for-two stock split as of June 30, 1995.\nChanges in and Disagreements with Item 9.","section_9":"Item 9. 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 - ------- --------------------------------------------------\n(a) Directors -\nInformation concerning directors of the Company is included under the caption \"Election of Directors\" and \"Information with Respect to Nominees and Directors Whose Terms Continue\" on pages 3 through 6 of the Proxy Statement for the 1996 Annual Meeting of Shareholders and is incorporated herein by reference.\n(b) Executive Officers -\nORIN R. SMITH * Age 60. Chairman and Chief Executive Officer of the Company since January 1995. President and Chief Executive Officer of the Company prior thereto. Mr. Smith is also a director of Ingersoll-Rand Company, The Louisiana Land and Exploration Company, Minorco, Perkin-Elmer Corporation, The Summit Bancorp and Vulcan Materials Company.\nL. DONALD LATORRE * Age 58. President and Chief Operating Officer of the Company since January 1995. Senior Vice President and Chief Operating Officer of the Company prior thereto.\nMARTIN J. CONNOR, JR. Age 63. Controller of the Company from prior to 1991.\nARTHUR A. DORNBUSCH, II Age 52. Vice President, General Counsel and Secretary of the Company from prior to 1991.\nWILLIAM M. DUGLE Age 53. Vice President, Human Resources of the Company from prior to 1991.\n*Also a director of the Company\nWILLIAM E. NETTLES Age 52. Vice President and Chief Financial Officer since May 1995. Group Vice President and General Manager of Chemical Catalysts from July 1992 to January 1995. Group Vice President and General Manager of Specialty Minerals and Colors prior thereto.\nROBERT J. SCHAFFHAUSER Age 57. Vice President, Technology and Corporate Development since January 1995. Vice President, Corporate Development prior thereto.\nMICHAEL A. SPERDUTO Age 38. Treasurer of the Company since January 1993. Vice President of Finance of the Industrial Commodities Management Group prior thereto.\nFRANCIS X. VITALE, JR. Age 51. Vice President, Strategic Development and Corporate Affairs since January 1995. Vice President, Investor Relations and Corporate Communications of the Company prior thereto.\nOfficers of the Company are elected at the meeting of the Board of Directors held in May of each year after the annual meeting of shareholders and serve until their successors shall be elected and qualified and shall serve as such at the pleasure of the Board.\nItem 11.","section_11":"Item 11. Executive Compensation - ------- ---------------------- Information concerning executive compensation is included under the caption \"Executive Compensation and Other Information\" on pages 11 through 21 of the Proxy Statement for the 1996 Annual Meeting of Shareholders and is incorporated herein by reference.\nSecurity Ownership of Certain Item 12.","section_12":"Item 12. Beneficial Owners and Management - ------- -------------------------------- Information concerning security ownership of certain beneficial owners and management is included under the captions \"Information as to Certain Shareholders\" and \"Share Ownership of Directors and Officers\" on pages 2 through 3 and page 7, respectively, of the Proxy Statement for the 1996 Annual Meeting of Shareholders and is incorporated herein by reference.\nCertain Relationships Item 13.","section_13":"Item 13. and Related Transactions - ------- ------------------------ Information concerning certain business relationships of nominees for director and directors and related transactions is included under the captions \"Information as to Certain Shareholders\", \"Information with Respect to Nominees and Directors Whose Terms Continue\", \"Share Ownership of Directors and Officers\" and \"Compensation Committee Interlocks, Insider Participation and Certain Transactions\" on pages 2 through 7 and page 10, respectively, of the Proxy Statement for the 1996 Annual Meeting of Shareholders and is incorporated herein by reference.\nPART IV\nExhibits, Financial Statement Item 14.","section_14":"Item 14. Schedules and Reports on Form 8-K - ------- ---------------------------------\nPage ---- (a) (1) Financial Statements and Schedules\nReport of Independent Accountants 48\nConsolidated Statements of Earnings for each of the 26 three years in the period ended December 31, 1995\nConsolidated Balance Sheets at December 31, 1995 and 1994 27\nConsolidated Statements of Cash Flows for each of the 28 three years in the period ended December 31, 1995\nConsolidated Statements of Shareholders' Equity for each 29 of the three years in the period ended December 31, 1995\nNotes to Consolidated Financial Statements 30-47\n(2) Financial Statement Schedules\nConsolidated financial statement schedules not filed herein have been omitted either because they are not applicable or the required information is shown in the Notes to Consolidated Financial Statement on pages 30-47 on this 10-K.\n(b) Reports on Form 8K: Not applicable\nPage ---- (3) Exhibits\n(3a) Certificate of Incorporation of the Company * (incorporated by reference to Form 10, as amended on Form 8-K filed with the Securities and Exchange Commission on May 19, 1981).\n(3b) By-laws of the Company as amended September 17, 1981 * (incorporated by reference to Form 10-Q for the quarter ended September 30, 1981).\n(3c) Certificate of Amendment to the Restated Certificate * of Incorporation of the Company (incorporated by reference to Form 10-K for the year ended December 31, 1987).\n(3d) Article XVII of the Registrant's By-laws as amended * on May 2, 1988 (incorporated by reference to Form 8-K filed with the Securities and Exchange Commission on May 21, 1988).\n(3e) Certificate of Amendment to the Restated Certificate of * Incorporation of the Company (Incorporated by reference to Form 10-Q for the quarter ended March 31, 1993).\n(10) Material Contracts\n(a) Form of Agreement of Transfer entered into between * Engelhard Minerals & Chemicals Corporation and the Company, dated May 18, 1981 (incorporated by reference to Form 10, as amended on Form 8 filed with the Securities and Exchange Commission on May 19, 1981).\n(b) Engelhard Corporation Stock Option Plan of 1981 59-65 Restated as of December 13, 1989 - conformed copy includes amendments through February 1995.\n(c) Retirement Plan for Directors of Engelhard 66-68 Corporation Effective January 1, 1985 - conformed copy includes amendments through June 1991.\n(d) Deferred Compensation Plan for Key Employees of 69-74 Engelhard Corporation Effective August 1, 1985 - conformed copy includes amendments through December 1993.\n(e) Engelhard Corporation Directors and Executives 75-79 Deferred Compensation Plan (1986-1989) - conformed copy includes amendments through December 1993.\n(f) Employee Agreement with Orin R. Smith, President * and Chief Executive Officer of the Company, dated May 21, 1986 (incorporated by reference to the Engelhard Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1986).\n* Incorporated by reference as indicated.\nPage ----\n(g) Key Employees Stock Bonus Plan of Engelhard 80-84 Corporation Effective July 1, 1986 - conformed copy includes amendments through June 1992.\n(h) Stock Bonus Plan for Non-Employee Directors of 85-89 Engelhard Corporation Effective July 1, 1986 - conformed copy includes amendments through June 1992.\n(i) Deferred Compensation Plan for Directors of 90-95 Engelhard Corporation Restated as of May 7, 1987 - conformed copy includes amendments through December 1993.\n(j) Supplemental Retirement Program of Engelhard 96-104 Corporation as Amended and Restated Effective January 1, 1989 - conformed copy includes amendments through November 1994.\n(k) Engelhard Corporation Directors and Executives 105-110 Deferred Compensation Plan (1990-1993) - conformed copy includes amendments through November 1993.\n(l) Engelhard Corporation Stock Option Plan of 1991 - * conformed copy includes amendments through February 1995 (incorporated by reference to the Engelhard Corporation 1995 definitive Proxy Statement as filed with the Securities and Exchange Commission on March 31, 1995).\n(m) Form of Separation Agreement With Robert L. Guyett, 111-120 Formerly a Director, Senior Vice President and Chief Financial Officer, dated April 28, 1995.\n(n) Engelhard Corporation Directors Stock Option * Plan Effective May 4, 1995 (incorporated by reference to the Engelhard Corporation 1995 definitive Proxy Statement as filed with the Securities and Exchange Commission on March 31, 1995).\n(o) Form of Agreement With Key Employees in the 121-132 Event of an Acquisition of a Control Interest in the Company, dated November 2, 1995.\n(p) Main Supply Agreement between P.G.M. (Brakspruit) ** (Proprietary) Limited and Engelhard Industries International Limited effective as of January 1, 1972 and supplementary letter with respect thereto (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1972).\n* Incorporated by reference as indicated. ** Incorporated by reference as indicated and granted confidential treatment pursuant to an application filed by Engelhard Minerals & Chemicals Corp.\nPage ----\n(q) Supplementary Supply Agreement between Rustenburg ** Platinum Mines Limited and Engelhard Minerals & Chemicals Corporation, effective as of January 1, 1972 (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1972).\n(r) Agreement between Rustenburg Platinum Mines Limited ** and Engelhard Minerals & Chemicals Corporation, dated November 3, 1972 (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1972).\n(s) Amendment to the Supplementary Supply Agreement ** between Rustenburg Platinum Mines Limited and Engelhard Minerals & Chemicals Corporation, effective as of January 1, 1972 dated April 1, 1973 (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1973).\n(t) Addendum to the Supplementary Supply Agreement ** between Rustenburg Platinum Mines Limited and Engelhard Minerals & Chemicals Corporation dated June 18 and July 5, 1974 (incorporated by reference to Form 10-K, as amended on Form 8 filed with the Securities and Exchange Commission on May 19, 1981).\n(u) Amendment dated December 14, 1977 as supplemented ** January 10, 1978 to the Main Supply Agreement and Supplementary Supply Agreement between Rustenburg Platinum Mines Limited and Engelhard Minerals & Chemicals Corporation (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1977).\n(v) Amendment dated April 3, 1979 to the Supplemental ** Supply Agreement between Rustenburg Platinum Mines Limited and Engelhard Minerals & Chemicals Corporation (incorporated by reference to the Engelhard Minerals & Chemicals Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1979).\n** Incorporated by reference as indicated and granted confidential treatment pursuant to an application filed by Engelhard Minerals & Chemicals Corp.\nPage ----\n(w) Letters from Rustenburg Platinum Mines Limited * dated March 13, 1992 advising that the Main Supply and Supplementary Supply Agreements (Exhibits P through V above) will terminate in their present forms on December 31, 1996, the end of the initial period (incorporated by reference to the Engelhard Corporation Annual Report, Form 10-K for the fiscal year ended December 31, 1992).\n(21) Subsidiaries of the Registrant 133-134\n(23) Consent of Independent Accountants 135-136\n(24) Powers of Attorney 137-146\n(99) (a) Annual Report on Form 11-K of the Salary 147-167 Deferral Savings Plan of Engelhard Corporation for each of the three years in the period ended December 31, 1995.\n(b) Annual Report on Form 11-K of the Engelhard 168-183 Corporation Savings Plan for Hourly Paid Employees for each of the three years in the period ended December 31, 1995.\n* Incorporated by reference as indicated.\nSignatures ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Iselin, New Jersey on the 22nd day of March 1996.\nEngelhard Corporation --------------------- Registrant\n\/s\/Orin R. Smith --------------------- Orin 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.\nSignature Title Date --------- ----- ----\n\/s\/Orin R. Smith Chairman and Chief Executive March 22, 1996 - ---------------------- Officer & Director Orin R. Smith (Principal Executive Officer)\n\/s\/William E. Nettles Vice President and March 22, 1996 - ---------------------- Chief Financial Officer William E. Nettles (Principal Financial Officer)\n\/s\/Martin J. Connor, Jr. Controller March 22, 1996 - --------------------------- (Principal Accounting Officer) Martin J. Connor, Jr.\n* Director March 22,1996 - --------------------------- Linda G. Alvarado\n* Director March 22, 1996 - --------------------------- Marion H. Antonini\n* Director March 22, 1996 - --------------------------- L. Donald LaTorre\n* Director March 22, 1996 - -------------------------- Anthony W. Lea\n* Director March 22, 1996 - -------------------------- James V. Napier\n* Director March 22, 1996 - ------------------------- Norma T. Pace\n* Director March 22, 1996 - ------------------------- Reuben F. Richards\n* Director March 22, 1996 - ------------------------- Henry R. Slack\n* Director March 22, 1996 - ------------------------- Douglas G. Watson\n* By this signature below, Arthur A. Dornbusch, II has signed this Form 10-K as attorney-in-fact for each person indicated by an asterisk pursuant to duly executed powers of attorney filed with the Securities and Exchange Commission included herein as Exhibit 25.\n\/s\/Arthur A. Dornbusch, II March 22, 1996 - ------------------------------- Arthur A. Dornbusch, II\nEXHIBIT 10(b):\nENGELHARD CORPORATION STOCK OPTION PLAN OF 1981\n[Conformed Copy -- Includes amendments made in June, 1992 and in February, 1995]\nENGELHARD CORPORATION STOCK OPTION PLAN OF 1981\n(Restated as of December 13, 1989)\n1. Purposes. This Stock Option Plan (the \"Plan\") of Engelhard Corporation (the \"Company\") is established so that the Company may make available to essential executives the opportunity to acquire ownership of Company stock pursuant to options constituting incentive or non-qualified stock options under the Internal Revenue Code. It is anticipated that such stock options will materially assist the Company in providing incentives to essential executives.\n2. Administration. The Plan shall be administered by a committee (the \"Committee\") which shall be appointed from time to time by the Board of Directors of the Company (the \"Board of Directors\"), and shall consist of not less than two directors of the Company who qualify as \"disinterested persons\" under Rule 16b-3(c)(2) issued by the Securities and Exchange Commission. The Committee shall have full power and authority, subject to the terms and conditions of the Plan, to determine the essential executives to whom awards may be made under the Plan, the number of such shares to be awarded to each of such essential executives, the applicable terms and conditions of such awards and all other matters which may arise in the administration of the Plan. The determination of the Committee concerning any matter arising under or with respect to the Plan or any awards granted hereunder shall be final, binding and conclusive on all interested persons. The Committee may as to all questions of accounting rely conclusively upon any determinations made by the independent auditors of the Company.\n3. Stock Available for Options. There shall be available for option under the Plan 3,695,000 shares of the Company's Common Stock (the \"Stock\"), subject to any adjustments which may be made pursuant to Section 5(g) hereof. Subject to any adjustments which may be made pursuant to Section 5(g) hereof, the aggregate of all shares of Stock that may be subject to Type A Options (defined below) shall not at any time exceed 3,525,000 shares and the aggregate of all shares of Stock that may be subject to Type B Options (defined below) shall not at any time exceed 170,000 shares. Shares of Stock used for purposes of the Plan may be either authorized and unissued shares or treasury shares or both. Stock covered by options which have terminated or expired prior to exercise or have been surrendered and cancelled as contemplated by Section 7(b) hereof shall be available for further option hereunder.\n4. Eligibility. Essential managers and other key employees, including officers and directors of the Company, and of any subsidiary corporation, as defined in Section 424(f) of the Internal Revenue Code (\"Subsidiary\") of the Company, shall be eligible to receive options under the Plan, provided that no option may be granted to any director who is not also an employee of the Company or a Subsidiary.\n5. Terms and Conditions of Options. There shall be two classes of options that may be granted under this Plan entitled Type A Options and Type B Options, respectively. Each option granted hereunder shall be in writing, shall specify its class and shall contain such terms and conditions as the Committee may determine, which terms and conditions need not be the same in each case or within each class, subject to the following:\n(a) Option Price. The price at which each share of Stock covered by a Type A Option granted hereunder may be purchased shall not be less than the greater of the par value of the Stock or the fair market value thereof at the time of grant, as determined by the Board of Directors. The price at which each share of Stock covered by a Type B Option granted hereunder may be purchased shall not be less than the greater of the par value of such Stock or twenty-five percent (25%) of the fair market value thereof at the time of grant, as determined by the Board of Directors.\n(b) Option Period. The period for exercise of a Type A Option shall not exceed ten years from the date the option is granted. The period for exercise of a Type B Option shall not exceed five years from the date the option is granted. Options may be made exercisable in installments during the option period. Any shares not purchased on any applicable installment date, if so provided in the related options, may be purchased thereafter at any time prior to the expiration of the option period. Any option exercisable in installments shall become immediately exercisable in full in the event of an \"acquisition of a control interest\" in the Company. For purposes of this Plan, an \"acquisition of a control interest\" shall occur if: (A) twenty-five percent (25%) or more of the Company's outstanding securities entitled to vote in elections of directors (\"voting securities\") shall be beneficially owned, directly or indirectly (including options, conversion rights, warrants, and the like, considered as if exercised), by any person or group of persons, other than the group presently owning the same (including their affiliates and associates); or (B) the majority of the Board of Directors of the Company ceases to consist of the existing membership or successors nominated by the existing membership or their similar successors. Any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of voting securities owned by other holders shall, for the purposes of the foregoing definition of \"acquisition of a control interest,\" be deemed to constitute each party to such agreement, arrangement or understanding as the owner of such securities.\n(c) Exercise of Options. No option shall be exercisable until the expiration of at least one year from the date the option is granted; provided, however, that an option shall become immediately exercisable in full in the event of an \"acquisition of a control interest\" in this Company (as such term is defined in subsection (b) of this Section 5), whether or not such \"acquisition of a control interest\" in the Company occurs prior to the expiration of one year after the date the option is granted. To exercise an option, the holder thereof shall give written notice to the Company specifying the number of shares to be purchased and accompanied by payment in full of the purchase price therefor. An option holder shall have none of the rights of a stockholder until the shares are paid for in full and issued to him. The purchase price may be paid in whole or in part with shares of Stock having a fair market value on the exercise date equal to the cash amount for which such shares are substituted; provided, however, that in no event may any portion of the purchase price be paid with shares of Stock acquired upon exercise of a stock option granted under this Plan unless such shares were acquired more than thirty days before the applicable date of exercise.\n(d) Effect of Termination of Employment or Death. No option may be exercised after the termination of employment of an optionee, except that: (i) if such termination is by reason of disability or retirement, at normal, deferred or early retirement age, under any retirement plan maintained by the Company or any Subsidiary, or for any other reason specifically approved in advance by the Board of\nDirectors, any options held by the optionee which were granted more than one year before such termination shall thereupon become exercisable in full, and may be exercised by the optionee for a period of three months after such termination; (ii) if such termination is by action of the employer other than as provided in (i) above and other than discharge by reason of willful violation of the rules of the Company or instructions of superior(s), any options held by the optionee which are exercisable at the time his employment terminates may be exercised by him for a period of three months after such termination; (iii) in the event of the death of an optionee within three months after the termination of his employment pursuant to (i) or (ii) above, the person or persons to whom the optionee's rights are transferred by will or the laws of descent and distribution shall have a period of three months from the date of termination of the optionee's employment to exercise any options which the optionee could have exercised during such period; and (iv) in the event of the death of an optionee while employed, any options then held by the optionee, which were granted more than one year before his death, shall thereupon become exercisable in full, and the person or persons to whom the optionee's rights are transferred by will or the laws of descent and distribution shall have a period of one year thereafter to exercise such options. In no event, however, shall any option be exercisable more than ten years from the date of grant thereof.\nNothing contained in the Plan or any option granted hereunder shall confer on any employee any right to continue his employment or interfere in any way with the right of his employer to terminate his employment at any time.\nNotwithstanding any provision of this Plan to the contrary, the Committee shall have the authority (which may be exercised at any time) to extend the period during which any option granted under the Plan may be exercised; provided, however, that no option may be exercisable for more than ten years from the date of grant thereof.\n(e) Nontransferability of the Options. During the optionee's lifetime his option shall be exercisable only by him. No option shall be transferable other than by will or the laws of descent and distribution. (f) Limitation on Transferability of Shares Acquired Through the Exercise of Pre-May 2, 1986 Incentive Stock Options. No shares acquired through the exercise of an Incentive Stock Option granted under the Plan prior to May 2, 1986 shall be transferable within six months from the date of acquisition by reason of such exercise except for transfer by will or by the laws of descent and distribution.\n(g) Adjustment for Change in Stock Subject to Plan. In the event of a stock split, stock dividend, combination of shares, recapitalization, reorganization, merger, consolidation, rights offering, or any other change in the corporate structure or shares of the Company, the Board of Directors shall make such adjustments, if any, as it deems appropriate for purposes hereof in the number and kind of shares subject to the Plan, in the number and kind of shares covered by outstanding options, or in the option prices.\n(h) Registration, Listing and Qualification of Shares. Each option shall be subject to the requirement that if at any time the Board of Directors of the Company shall determine that the registration, listing or qualification of the shares covered thereby upon any securities exchange or under any federal or state law, or the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with, the granting of such option or the purchase of shares thereunder, no such option may\nbe exercised unless and until such registration, listing, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Board of Directors. Any person exercising an option shall make such representations and agreements and furnish such information as the Board of Directors may request to assure compliance with the foregoing or any other applicable legal requirements.\n(i) Incentive Stock Options. Unless otherwise designated by the Committee, options granted under the Plan shall be deemed to be options not intended to qualify as \"Incentive Stock Options\" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the \"Code\"). However, the Committee may designate Type A Options granted prior to March 31, 1991 to an employee other than a 10 percent stockholder (as hereinafter defined) as Incentive Stock Options to the extent that such options and all other incentive stock options (as defined in Section 422 of the Code) held by the employee and exercisable for the first time by such employee during any calendar year (under all plans of the Company and its parent and subsidiary corporations (as hereinafter defined)) cover shares of the Company having an aggregate fair market value (determined by the Committee as of the time the option is granted in such manner as will constitute an attempt in good faith to meet the applicable requirements of Section 422(b) of the Code) of not more than $100,000. Options deemed to be Incentive Stock Options hereunder shall comply with the following requirements in addition to the terms and conditions previously set forth in this Plan. Incentive Stock Options and other stock options granted under the Plan shall be clearly identified as such.\nThe additional requirements referred to are the following:\n(A) Notwithstanding the provisions of this Plan for exercise of stock options after the death of Optionee or any other provision of this Plan, an Incentive Stock Option may not in any event be exercised after the expiration of ten years from the date that Incentive Stock Option is granted. Each stock option agreement shall so Stock Options covered by that agreement.\n(B) An Incentive Stock Option granted prior to March 2, 1989 shall not be exercisable while there is outstanding (within the meaning of Section 422A(c)(7) of the Code in effect prior to January 1, 1987) any incentive stock option (as defined hereinabove) which was granted before the granting of such Incentive Stock Option to the employee to whom the Incentive Stock Option was granted to purchase shares of the Company or stock in a corporation which (at the time of the granting of the Incentive Stock Option) is a parent or subsidiary corporation of the Company or in a predecessor corporation of any of such corporation. (The terms \"parent\" and \"subsidiary\" corporation as used in this Section 5(i) shall have the meanings set forth in Section 424(e) and (f) of the Code.)\n(C) No Incentive Stock Option shall be granted to an individual who, at the time the Incentive Stock Option is granted, owns (within the meaning of Section 422(b)(6) of the Code) stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or of its parent or subsidiary corporation, if any (a \"10 percent shareholder\"), unless, at the time the Incentive Stock Option is granted, the option price is at least 110 percent of the fair market value of the shares subject to the Incentive Stock Option and the Incentive Stock Option by its terms is not exercisable after the expiration of five years from the date the Incentive Stock Option is granted.\n(j) Tax Withholding. The Committee may establish such rules and procedures as it considers desirable in order to satisfy any obligation of the Company or any Subsidiary to withhold Federal income taxes or other taxes with respect to the exercise of an option (other than an Incentive Stock Option) under the Plan, including without limitation rules and procedures permitting an optionee to elect that the Company withhold shares of Stock otherwise issuable upon exercise of such option in order to satisfy such withholding obligation.\n6. Duration. Unless sooner terminated by the Board of Directors, the Plan shall terminate on, and no option shall be granted hereunder after June 30, 1991; provided, however, that no Type B Option shall be granted after December 31, 1981.\n7. (a) Amendment. The Board of Directors of the Company may amend the Plan at any time, provided that no amendment, unless approved by the stockholders of the Company, shall materially: (i) increase the maximum number of shares for which options may be granted under the Plan or increase the maximum number of shares which may be subject to a specified class of option; (ii) reduce the minimum option price provided herein; or (iii) extend the period during which options may be granted or exercised, except that, notwithstanding the foregoing, the Board of Directors shall have the right to accept the surrender of and cancel options issued under the Plan and reissue those options and to amend the terms of outstanding options under the following terms and conditions.\n(b) Surrender, Cancellation and Reissue of Options. The Board of Directors, upon invitation by it during the term of this Plan to any holder(s) of options under this Plan to do so, may accept the surrender of outstanding options, cancel such options and issue in exchange therefor new options under this Plan, provided:\n(1) the tender of options for surrender is in accordance with such conditions as the Board of Directors may set forth in its invitation for that surrender;\n(2) the number of shares covered by an option issued in exchange for a surrendered and cancelled option shall not exceed the number of shares covered by the option surrendered and cancelled;\n(3) the price and all other terms of each option issued in exchange shall comply with the requirements of this Plan for the issuance of options; and\n(4) no such invitation for surrender of options shall be made by the Board of Directors unless it first shall have received a recommendation of the Committee that it is in the interest of the Company to provide an opportunity for the surrender and cancellation of outstanding options and the issue of new options in exchange therefor upon more appropriate terms and conditions, including exercise price.\n(c) Amendments of Outstanding Options. In the event that any options issued under this Plan shall remain outstanding after June 30, 1991, and if the Committee shall determine that it is in the interest of the Company to amend the terms and conditions, including exercise price or prices, of such options, the Committee shall have the right, by written notice to the holders thereof, to amend the terms and conditions of such options including exercise price or prices; provided, however, that (i) no such amendment shall be adverse to the\nholders of the options, and (ii) the amended terms of an option, including exercise price or prices, would have been permitted under this Plan had the Plan been outstanding at the time of such amendment.\n8. Effectiveness of the Plan. This Plan will not be made effective unless Approved by the holders of not less than a majority of the outstanding shares of voting stock of the company represented and entitled to vote thereon at a meeting thereof duly called and held for such purpose, and no option granted hereunder shall be exercisable prior to such approval.\n9. Other Actions. This Plan shall not restrict the authority of the Board of Directors of the Company, for proper corporate purposes, to grant or assume stock options, other than under the Plan, to or with respect to any employee or other person.\n10. Name. This Plan shall be known as the Engelhard Corporation Stock Option Plan of 1981.\nEXHIBIT 10(c):\nRETIREMENT PLAN FOR DIRECTORS OF ENGELHARD CORPORATION EFFECTIVE JANUARY 1, 1985\n[Conformed Copy -- Includes amendments made in June 1991]\nRETIREMENT PLAN FOR DIRECTORS OF ENGELHARD CORPORATION\nEffective January 1, 1985\n1. Purpose\nEngelhard Corporation (the \"Corporation\") has adopted this Retirement Plan for Directors of Engelhard Corporation (the \"Plan\") in order to enhance its ability to attract and retain competent and experienced persons to serve as Directors and to recognize the service of Directors to the Corporation by providing such Directors with retirement benefits.\n2. Definitions\nExcept as otherwise specified or as the context may otherwise require, the following terms have the meanings indicated below for all purposes of this Plan:\n(a) Director means any person who is serving on the Effective Date of the Plan, or who in the future serves, as a member of the Board of Directors of the Corporation (the \"Board\") or as a Director Emeritus.\n(b) Service means service as a Director; provided, however, that Service shall not include any period during which the Director was a salaried employee of the Corporation or any subsidiary of the Corporation. A Director shall be required to terminate Service no later than the date of such Director's 70th birthday; provided, however, that the Board may by resolution waive such requirement or increase such mandatory retirement age at any time generally or with respect to any Director.\n(c) Compensation means the annual Board retainer fee (excluding meeting and committee fees) established by the Board as in effect on the date of the Director's termination of Service (disregarding any increase or decrease in such fee that may be approved after such termination of Service).\n(d) Retirement Date means the first day of the calendar month coinciding with or next following the latest of: (i) the date of the Director's 65th birthday or (ii) the date on which the Director's Service terminates.\n(e) Effective Date means January 1, 1985.\n3. Eligibility\nAny Director who has completed six or more years of Service or whose age and Service at termination equals 65 shall be eligible for retirement benefits as provided herein.\n4. Benefits\nThe retirement benefits payable hereunder to a Director who meets the eligibility requirements shall be an annual amount equal to the Director's Compensation. Benefits shall commence on a Director's Retirement Date and shall be payable in equal monthly installments. Payments shall cease upon the earlier of (i) the date of Director's death or (ii) the completion of payments for a period of time equal to the period of the Director's Service; provided, however, that the Service shall be defined as not less than six years for any person who is a Director on the Effective Date.\n5. Provision of Benefits\nAll benefits payable hereunder shall be provided from the general assets of the Corporation. No Director shall acquire any interest in any specific assets of the Corporation by reason of this Plan. A Director shall have the status of an unsecured general creditor of the Corporation with respect to any benefits which become payable pursuant to this Plan.\n6. Amendment and Termination\nThe Corporation reserves the right to terminate this Plan or amend this Plan in any respect at any time; provided, however, that no such termination or amendment may reduce the retirement benefits then being paid to any retired Director or the retirement benefits then accrued by any Director who has completed at least six years of Service.\n7. Administration\nThis Plan shall be administered by the Compensation Committee of the Board. Such Committee's decision, in making any determination or construction under this Plan and in exercising any discretionary power, shall in all instances be final and binding on all persons having or claiming any rights under this Plan.\n8. Miscellaneous\nThe adoption and maintenance of this Plan shall not constitute a contract between the Corporation and any Director. Nothing herein contained shall be deemed to give any Director the right to be retained as a Director, nor shall it interfere with the Director's right to resign as a Director at any time.\nNo benefit payable hereunder shall be subject to alienation or assignment. The retirement benefits herein contained are in addition to all other awards, arrangements, contracts or benefits, if any, that any Director may have by virtue of service for the Corporation, unless and to the extent that any such award, arrangement, contract or benefit otherwise provides.\nMarch 7, 1985\nEXHIBIT 10(d):\nDEFERRED COMPENSATION PLAN FOR KEY EMPLOYEES OF ENGELHARD CORPORATION EFFECTIVE AUGUST 1, 1985\n[Conformed Copy -- Incorporating amendments made in June 1992, November 1993, December 1993 and August 1995]\nDEFERRED COMPENSATION PLAN FOR KEY EMPLOYEES OF ENGELHARD CORPORATION\n(Effective August 1, 1985)\nThe purpose of the Deferred Compensation Plan for Key Employees of Engelhard Corporation (the \"Plan\") is to provide a procedure whereby a key employee of Engelhard Corporation (the \"Company\") may defer the payment of a part of the future compensation payable to such key employee by the Company.\n1. The persons eligible to participate in the Plan are those key employees of the Company employed in the United States who have at least 1,232 Hay points (the \"Eligible Employees\").\n2. Each Eligible Employee shall have the option exercisable by written notice to the Company on or before November 30 of any calendar year to defer payment of (i) any portion of his salary for the next succeeding calendar year and (ii) all or any portion of any regular or special bonus the amount of which has not been determined as of the date of the deferral election and which is to be paid in the next succeeding calendar year; provided, however, that in no event shall the total amount so deferred exceed thirty percent (30%) of the sum of the amounts described in (i) and (ii) above. Notwithstanding the foregoing, (A) with respect to the 1985 calendar year an Eligible Employee shall have the option exercisable by written notice to the Company on or before July 1, 1985 to defer payment of up to fifteen percent (15%) of his salary for the period from August 1, 1985 through December 31, 1985 and (B) in the case of an individual who first becomes an Eligible Employee during a calendar year, such individual shall have the option exercisable by written notice to the Company to defer payment of up to fifteen percent (15%) of his salary for the period during such calendar year beginning on the date specified by the individual in his deferral election (which shall be at least one month after the date on which his deferral election is filed with the Company) and ending on the last day of such calendar year. An election made by an Eligible Employee pursuant to this paragraph 2 with respect to salary and bonuses for a calendar year shall become irrevocable as of the last day for making the election.\n3. In addition to the deferrals described in paragraph 2 above, each Eligible Employee shall have the option, exercisable not less than two months before any stock award vests under the Company's Key Employees Stock Bonus Plan, to defer delivery of said stock award for a period of at least one year. An election made by an Eligible Employee pursuant to this paragraph 3 with respect to a stock award shall become irrevocable as of the last day for making such election.\n4. All salary and bonuses deferred pursuant to paragraph 2 above shall be held in the general funds of the Company and shall be credited to a bookkeeping account maintained by the Company in the name of the Eligible Employee, and shall bear the equivalent of interest from the end of the calendar month in which the compensation would have been paid if it had not been deferred. Interest equivalents shall be credited on December 31 of each year up to and including the year preceding that in which the last installment is paid, it being the intent that interest equivalents shall not cease to accrue upon payment of the first installment, but shall continue to accrue with respect to the balance undistributed at any time. The amount of interest equivalent credited to the Eligible Employee's account shall be\ndetermined by applying the interest equivalent rate established hereunder to the balance in the Eligible Employee's account (which balance shall include, for this purpose, interest equivalent accrued but not credited to the account) at the end of each month. For purposes of the foregoing, the interest equivalent rate shall be set monthly and shall be equal to 120% of the long-term federal rate, compounded monthly (within the meaning of Section 1274(d) of the Internal Revenue Code of 1986, as amended) as in effect for the month for which interest equivalent is being computed. For periods prior to January 1, 1994 the last two sentences of paragraph 4 are as follows: \"The amount of interest equivalents credited to the Eligible Employee's account annually shall be determined by applying the interest equivalent rate established hereunder to the average balance in the Eligible Employee's account during the year. For purposes of the foregoing, the annual interest equivalent rate shall be determined by averaging the rate of interest for 3-year U.S. Treasury notes as reported in the monthly Federal Reserve Bulletin for each calendar quarter of the year for which interest is being computed.*\n* For periods prior to January 1, 1994 the last two sentences of paragraph 4 are as follows: \"The amount of interest equivalentS credited to the Eligible Employee's account annually shall be determined by applying the interest equivalent rate established hereunder to the average balance in the Eligible Employee's account during the year. For purposes of the foregoing, the annual interest equivalent rate shall be determined by averaging the rate of interest for 3-year U.S. Treasury notes as reported in the monthly Federal Reserve Bulletin for each calendar quarter of the year for which interest is being computed.\"\n5. All stock awards deferred by an Eligible Employee shall be transferred for the benefit of the Eligible Employee to a trust (\"Trust\") established by the Company with such terms and conditions as shall be determined by the Committee described in Section 8 below. The assets of the Trust shall be subject to the claims of the general creditors of the Company. Any dividends payable with respect to any deferred stock awards made for the benefit of the Eligible Employee shall be handled in one of the following ways, as irrevocably elected by the Eligible Employee in his deferral election:\n(i) such dividends shall be added to the bookkeeping account described in paragraph 4 above, and shall be credited with interest equivalents pursuant to said paragraph 4;\n(ii) such dividends shall be paid out currently to such Eligible Employee; or\n(iii)such dividends shall be applied by the Company or the trustee of the Trust to provide the maximum number of whole shares of Common Stock of the Company obtainable at then prevailing prices with such shares being added to the deferred stock awards of the Eligible Employee (and any amount which is insufficient to add an additional whole share shall be added to the bookkeeping account described in paragraph 4 above, and shall be credited with interest equivalents pursuant to said paragraph 4).\nThe Eligible Employee's election of one of the above options with respect to the handling of dividends with respect to a stock award shall become irrevocable as of the last date for making the deferral election with respect to such stock award. In the case of an Eligible Employee who is subject to the limitations of Section 16 of the Securities Exchange Act of 1934, as amended, and who elects the option described in (iii) above, such election shall be effective only with respect to dividends that become payable on or after the date six months following the date such election becomes irrevocable. Depending\non the terms and nature of the Trust established hereunder, the references to dividends in this paragraph 5 may instead refer to dividend equivalents equal to the dividends that would have been payable on the applicable deferred stock awards.\nIn addition, if any voting rights are exercisable with respect to any shares of Common Stock of the Company included in a deferred stock award for the benefit of an Eligible Employee under the Trust, the trustee of the Trust in exercising such voting rights shall follow the directions of such Eligible Employee (and shall not exercise such voting rights to the extent that directions are not received from the Eligible Employee); provided, however, that this sentence shall not apply unless and until the Company receives a letter ruling from the Internal Revenue Service or an attorney's opinion letter satisfactory to the Company to the effect that allowing Eligible Employees to exercise voting rights will not result in inclusion of the value of a deferred stock award in the income of the Eligible Employee for federal income tax purposes.\n6. Except as hereinafter provided with respect to an \"Immediate Payment Event\" or an \"Additional Deferral Election\" (each as hereinafter defined), any amounts to which an Eligible Employee is entitled hereunder (including shares of the Company's Common Stock receivable under a deferred stock award) shall be paid or delivered either (i) in a lump sum on or about the date specified in the Eligible Employee's deferral election or (ii) in annual installments over a period of up to ten years payable on or about January 1 of each payment year beginning with the January 1 specified in the Eligible Employee's deferral election. The Eligible Employee's deferral election with respect to the applicable deferred amounts shall designate the time and manner of payment or delivery of such deferred amounts, and such designation shall become irrevocable with respect to such deferred amounts as of the last date for making the deferral election.\nAn Eligible Employee shall have an option exercisable by written notice to the Company to further irrevocably defer payments previously deferred under paragraph 2 hereof or delivery of stock awards previously deferred under paragraph 3 hereof to a date or dates specified in the Eligible Employee's further deferral election (an \"Additional Deferral Election\"). An Additional Deferral Election shall specify such payment or delivery either (x) in the form of a lump sum on or about the date specified in the Additional Deferral Election or (y) in annual installments over a period of up to ten years payable on or about January 1 of each payment year beginning with the January 1 specified in the Additional Deferral Election. However, in order for an Additional Deferral Election to be effective (i) the Additional Deferral Election must be made at least twelve months prior to the date the payment would otherwise be due or the delivery is otherwise scheduled to be made, as the case may be, in accordance with a prior deferral election under this Plan, (ii) the Eligible Employee must agree with the Company to remain employed by the Company (on the same terms and conditions as in effect on the day preceding the additional period of employment, subject to any changes mutually agreed to by the parities and subject to the Company's right to terminate the Eligible Employee's employment at any time) for at least one additional year following the date of the Additional Deferral Election, (iii) the Additional Deferral Election may not specify any payment of amounts hereunder or any delivery of stock awards hereunder on a date prior to the date such payment or delivery was otherwise due under this Plan, and (iv) the further deferral of each payment or delivery specified in the Additional Deferral Election must be for a period of at least one year.\nIf payment or delivery is to be made in installments, the amount of each installment shall be determined by multiplying the \"Accumulated Account\" (as hereinafter defined) as of the December 31 preceding the installment payment date by a fraction, the numerator of which will be \"1\" and the denominator of which will be the number of annual installments elected by the Eligible Employee less the number of installments theretofore paid. If shares of Common Stock of the Company held in the Trust are to be distributed in installments, each installment payment shall consist of the appropriate number of whole shares (disregarding fractional shares).\nIf an \"Immediate Payment Event\" (as hereinafter defined) occurs prior to the date on which all deferred amounts have been paid or delivered, the Eligible Employee's \"Accumulated Account\" shall be paid or delivered to the Eligible Employee (or, in the event of his death, to his estate) as soon as practicable following such \"Immediate Payment Event.\" If such payment or delivery by reason of an \"Immediate Payment Event\" is not made on or about January 1 of a calendar year, the distribution of the Eligible Employee's \"Accumulated Account\" shall include interest equivalents calculated by the Committee in a manner consistent with paragraph 4 hereof for the period from the preceding December 31 to the last day of the month preceding the date of such payment.\nFor purposes of this paragraph 6, the term \"Accumulated Account\" shall mean (i) the amount of the salary and bonuses deferred by the Eligible Employee pursuant to paragraph 2 hereof, and any dividends (or dividend equivalents) added pursuant to paragraph 5 hereof to the bookkeeping account described in paragraph 4, plus the interest equivalents accumulated thereon, less any portion thereof theretofore distributed to him, and (ii) the amount of the Company's Common Stock held for the benefit of the Eligible Employee pursuant to his election of deferral of a stock award. For purposes of this paragraph 6, the term \"Immediate Payment Event\" shall mean:\n(i) the death of the Eligible Employee;\n(ii) a \"Change of Control\" (as defined below);\n(iii)a \"Hardship\" (as defined below) of the Eligible Employee as determined by the Committee; or\n(iv) such additional events as may be specified by the Eligible Employee in his deferral election with the approval of the Committee.\nA \"Change of Control\" for the purpose of (ii) above shall occur if:\n(A) twenty-five percent (25%) or more of the Company's outstanding securities entitled to vote in elections of directors (\"voting securities\") shall be beneficially owned, directly or indirectly (including options, conversion rights, warrants, and the like, considered as if exercised), by any person or group of persons, other than the group presently owning the same (including their affiliates and associates); or\n(B) the majority of the Board of Directors of the Company ceases to consist of the existing membership or successors nominated by the existing membership or their similar successors.\nAny agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of voting securities owned by other holders shall for the purposes of this provision be deemed to constitute each party to such agreement, arrangement or understanding as the owner of such securities.\nFor the purpose of (iii) above a \"Hardship\" shall mean an immediate and heavy financial need of the Eligible Employee which cannot reasonably be expected to be satisfied from other resources available to the Eligible Employee.\n7. The right of an Eligible Employee to the amounts described hereunder (including shares of the Company's Common Stock receivable under a deferred stock award) shall not be subject to assignment or other disposition by him other than by will, or the laws of descent and distribution. In the event that, notwithstanding this provision, an Eligible Employee attempts to make a prohibited disposition, the Company may disregard the same and discharge its obligation hereunder by making payment or delivery thereof as though no such disposition had been attempted.\n8. The Plan shall be administered by a committee (the \"Committee\") which shall be appointed from time to time by the Board of Directors of the Company, and shall consist of not less than two directors of the Company who qualify as \"disinterested persons\" under Rule 16b-3(c)(2) issued by the Securities and Exchange Commission. The decision of the Committee with respect to any questions arising as to the interpretation of this Plan, including the reconciliation of any inconsistent provisions, the supplying of omissions and the severability of any and all of the provisions hereof, shall be final, binding and conclusive on all interested persons. Notwithstanding the foregoing, with respect to any matter involving deferred stock awards, references to the \"Committee\" shall mean the Committee serving under the Company's Key Employees Stock Bonus Plan.\n9. The Board of Directors of the Company may discontinue the Plan at any time and may from time to time amend the Plan; provided, however, that (a) no such discontinuance or amendment shall operate to annul an election already in effect for the current calendar year or any preceding year or adversely affect the right of an Eligible Employee to receive the amounts described herein, and (b) no such amendment affecting deferred stock awards, unless approved by the stockholders of the Company, shall materially: (i) increase the maximum number of shares of the Common Stock of the Company which may be issued under the Plan; (ii) modify the requirements as to eligibility to defer stock awards hereunder; or (iii) increase the benefits accruing to Eligible Employees hereunder.\n10. Except as and to the extent expressly provided in this Plan or in the Trust, neither the Eligible Employee nor any other person shall have any interest in any fund or in any specific asset of the Company by reason of amounts credited to the Accumulated Account of an Eligible Employee, nor the right to receive any distribution under this Plan. Distributions hereunder shall be made from the general funds of the Company or from the Trust, and the rights of the Eligible Employee shall not be superior to those of an unsecured general creditor of the Company.\n11. Nothing contained herein shall be deemed to give any Eligible Employee the right to be retained in the service of his employer or to interfere with the right of such employer to discharge or retire any Eligible Employee at any time.\nEXHIBIT 10(e)\nENGELHARD CORPORATION DIRECTORS AND EXECUTIVES DEFERRED COMPENSATION PLAN (1986 - 1989)\n[Conformed Copy -- Incorporates amendments made in June 1992, November 1993 and December 1993]\nDEFERRED COMPENSATION PLAN FOR DIRECTORS OF ENGELHARD CORPORATION\n(As restated as of May 7, 1987)\nThe purpose of the Deferred Compensation Plan for Directors of Engelhard Corporation (the \"Plan\") is to provide a procedure whereby a member of the Board of Directors of Engelhard Corporation (the \"Company\") may defer the payment of all or a specified part of the future compensation payable to the Director for services as a Director (including compensation payable to a Director for future services as a member of a committee of the Board).\n1. Each Director who is not an employee of the Company or any of its subsidiaries may elect, on or before December 31 of any calendar year by written notice to the Company, to defer payment of all or a designated portion of the compensation payable to him for service as a Director commencing at the beginning of the next calendar year (inclusive of fees paid for attendance at meetings of the Board and committees thereof).\nAny person elected to fill a vacancy on the Board who was not a Director on the preceding December 31 may elect, within 31 days of the date of his election as a Director by written notice to the Company, to defer payment of all or a designated portion of the compensation payable to him for service as a Director from and after the date on which such election is made during the balance of the calendar year in which he was elected to the Board and thereafter.\nDeferrals hereunder shall continue until the Director notifies the Company in writing, prior to the commencement of any calendar year, that he wishes his compensation for such calendar year and all succeeding periods to be paid on a current basis. Elections to defer payment of compensation, or to discontinue such deferrals, shall be irrevocable when made.\nAny election to defer compensation pursuant to this paragraph 1 shall include an election as to whether the deferred compensation shall be credited to the Accumulated Account described in paragraph 4 or to the Stock Account described in paragraph 5; provided, however, that a Director's election to have deferred compensation credited to the Stock Account, or to discontinue having deferred compensation credited to the Stock Account, shall be effective only with respect to compensation that becomes payable on or after the date six months following the date such election is made (and during such period any compensation deferred by such Director shall be credited to the Accumulated Account).\n2. In addition to the deferrals described in paragraph 1 above, each Director who is not an employee of the Company shall have the option, exercisable not less than two months before any stock award vests under the Company's Stock Bonus Plan for Non-Employee Directors, to defer delivery of said stock award for a period of at least one year. An election made by a Director pursuant to this paragraph 2 with respect to a stock award shall become irrevocable as of the last day for making such election.\n3. For purposes of this Plan:\n(a) The calendar year in which a Director ceases to serve as such shall be referred to as the \"Retirement Year.\"\n(b) The deferred compensation and dividend equivalents for any Director which are credited to the account described in paragraph 4, plus the equivalent of accumulated interest thereon, less any portion thereof theretofore distributed or transferred from such account, shall be referred to as the Director's \"Accumulated Account.\"\n(c) The deferred compensation, deferred stock awards and dividend equivalents for any Director which are credited in the form of units to the stock account described in paragraph 5, less any portion thereof theretofore distributed from such account, shall be referred to as the Director's \"Stock Account.\"\n(d) Shares of Common Stock of the Company shall be referred to as \"Shares.\"\n4. Except for amounts credited to the Stock Account described in paragraph 5, all deferred compensation hereunder shall be held in the general funds of the Company and shall be credited to a bookkeeping account (\"Accumulated Account\") maintained by the Company in the name of the Director, and shall bear the equivalent of interest from, the first day following the end of the calendar quarter to which the compensation is applicable. Interest equivalents shall be credited on December 31 of each year up to an including the year preceding that in which the last installment is paid, it being the intent that interest equivalents shall not cease to accrue upon payment of the first installment, but shall continue to accrue with respect to the balance undistributed at any time. The amount of interest equivalent credited to the Director's account shall be determined by applying the interest equivalent rate established hereunder to the balance in the Director's account (which balance shall include, for this purpose, interest equivalent accrued but not credited to the account) at the end of each month. For purposes of the foregoing, the interest equivalent rate shall be set monthly and shall be equal to 120% of the long-term federal rate, compounded monthly (within the meaning of Section 1274(d) of the Internal Revenue Code of 1986, as amended) as in effect for the month for which interest equivalent is being computed. For periods prior to January 1, 1994 the last two sentences of paragraph 4 are as follows: \"The amount of interest equivalent credited to the Director's account annually shall be determined by applying the interest equivalent rate established hereunder to the average balance in the Director's account during the year. For purposes of the foregoing, the annual interest equivalent rate shall be determined by averaging the rate of interest for 3-year U.S. Treasury notes as reported in the monthly Federal Reserve Bulletin for each calendar quarter of the year for which interest is being computed.\"\n5. All deferred compensation which a Director elects pursuant to paragraph 1 to have credited to the Stock Account (including any amounts transferred from the Accumulated Account pursuant to the last sentence of paragraph 1) and all stock awards deferred by a Director pursuant to paragraph 2 shall be credited in the form of units to a bookkeeping account maintained by the Company in the name of the Director. The number of units so credited shall be equal to the sum of (i) the maximum number of whole Shares obtainable at then prevailing prices with the amounts of the Director's deferred compensation credited to the Stock Account pursuant to paragraph 1 as of the date such compensation is so credited (disregarding fractional shares) and (ii) the number of Shares corresponding to the number of the Director's deferred stock awards pursuant to paragraph 2. Each such unit shall represent the right to receive one Share at the time and in the manner determined pursuant to the Director's deferral election and the terms of this Plan.\nIf any dividends are payable on Shares during the deferral period, dividend equivalents equal to the dividend that would have been payable on the units credited to a Director's Stock Account if such units had constituted Shares shall be handled in one of the following ways, as irrevocably elected by the Director in his deferral election:\n(i) such dividend equivalents shall be added to the Accumulated Account described in paragraph 4 above, and shall be credited with interest equivalents pursuant to said paragraph 4;\n(ii) such dividends shall be paid out currently to such Director; or\n(iii)such dividend equivalents shall be credited to the Stock Account and applied to provide additional units corresponding to the maximum number of whole Shares obtainable at then prevailing prices with such dividend equivalents (disregarding fractional shares).\nThe Director's election of one of the above options with respect to the handling of dividend equivalents shall become irrevocable as of the last date for making the deferral election with respect to such stock award; provided, however, that an election by a Director of the option described in (iii) above shall be effective only with respect to dividend equivalents that become payable on or after the date six months following the date such election becomes irrevocable.\nThe Company may in its discretion establish a trust to satisfy its obligations under this Plan with respect to the units credited to the Stock Account and transfer to such trust Shares corresponding to such units or cash to be used by the trustee to purchase such Shares. The assets of such trust shall be subject to the claims of general creditors of the Company. If such a trust is established, any voting rights which are exercisable with respect to a number of Shares held in such trust corresponding to the number of units credited to a Director's Stock Account shall be exercised by the trustee of such trust in accordance with the directions of such Director (and the trustee shall not exercise voting rights with respect to such Shares to the extent that directions are not received from the Director).\n6. The amount to which a Director is entitled hereunder shall be paid to him in any number of annual installments, as initially elected by him, up to ten, payable in January of each payment year beginning with the calendar year designated by the Director in his initial deferral election. A Director may irrevocably elect by written notice to the Company to further defer payments previously deferred under paragraph 1 hereof or delivery of stock awards previously deferred under paragraph 2 hereof to a date or dates specified in the Director's further deferral election (an \"Additional Deferral Election\"). An Additional Deferral Election shall specify the calendar year in which such payments or deliveries will commence and the number of annual installment payments or deliveries (up to ten). Such annual installments shall be payable in January of each payment year beginning with the calendar year specified in the Additional Deferral Election. However, in order for an Additional Deferral Election to be effective (i) the Additional Deferral Election must be made at least twelve months prior to the date the payment would otherwise be due or the delivery is otherwise scheduled to be made, as the case may be, in accordance with a prior deferral election under this Plan, (ii) the Director must agree with the Company that, if nominated and elected, he will continue to serve as a Director of the Company for at least one year following the date of the Additional Deferral Election, (iii) the Additional Deferral Election may not specify any payment of amounts hereunder or any delivery of stock hereunder on a date prior to the date such payment or delivery was otherwise due under this Plan, and (iv) the further deferral of each payment or delivery specified in the Additional Deferral Election must be for a period of at least one year. The amount of each installment shall be determined by multiplying the Accumulated Account amount and the units credited to the Director's Stock Account as of the\nDecember 31 preceding the installment payment date by a fraction, the numerator of which shall be \"1\" and the denominator of which shall be the number of annual installments initially elected by the Director less the number of installment payments theretofore made. If a Director should die before full payment of all amounts owing to him, his Accumulated Account and the units credited to the Director's Stock Account as of December 31 of the year of his death shall be paid to his estate in January of the calendar year following the year of his death, or the Accumulated Account and the units credited to the Director's Stock Account as at such earlier date as the Board of Directors, in its discretion, may determine may be paid in lieu thereof. Any such in lieu payment from the Accumulated Account shall be adjusted for interim interest equivalent additions to such extent, if any, as the Board of Directors shall determine. Each installment payment of units credited to a Director's Stock Account shall be made through payment of a number of whole Shares equal to the number of units which are then payable (disregarding fractional units).\n7. The right of a Director to the amounts described hereunder (including Shares) shall not be subject to assignment or other disposition by him other than by will, descent or distribution. In the event that, notwithstanding this provision, a Director makes a prohibited disposition, the Company may disregard the same and discharge its obligation hereunder by making payment or delivery thereof as though no such disposition had been made.\n8. The Plan shall be administered by a committee appointed by the Board of Directors of the Company consisting entirely of members of such Board not eligible to participate in the Plan (\"Committee\"). The decision of the Committee with respect to any questions arising as to the interpretation of this Plan, including the severability of any and all of the provisions thereof, shall be final, conclusive and binding.\n9. The Board of Directors of the Company may discontinue the Plan at any time and may from time to time amend the Plan; provided, however, that no such discontinuance or amendment shall operate to annul an election already in effect for the current calendar year or any preceding year or adversely affect the right of a Director to receive the amounts described herein, and no such amendment affecting Stock Accounts, unless approved by the stockholders of the Company, shall materially: (i) increase the maximum number of Shares which may be issued under the Plan; (ii) modify the requirements as to eligibility to defer compensation or stock awards hereunder; or (iii) increase the benefits accruing to Directors hereunder.\n10. Except as and to the extent otherwise provided in this Plan or in any trust referred to in paragraph 5, neither the Director nor any other person shall have any interest in any fund or in any specific asset of the Company by reason of amounts credited to the Accumulated Account or Stock Account of a Director hereunder, nor the right to receive any distribution under this Plan. Distributions hereunder shall be made from the general funds of the Company or from the trust referred to in paragraph 5, and the rights of the Director shall be those of an unsecured general creditor of the Company.\n11. Nothing contained herein shall impose any obligation on the Company to continue the tenure of the Director beyond the term for which he may have been elected or retained.\nEXHIBIT 10(g)\nKEY EMPLOYEES STOCK BONUS PLAN OF ENGELHARD CORPORATION EFFECTIVE JULY 1, 1986\n[Conformed Copy -- Includes amendments made in June 1991 and June 1992]\nKEY EMPLOYEES STOCK BONUS PLAN OF ENGELHARD CORPORATION\n(Effective July 1, 1986)\n1. Purpose. The Purpose of this Key Employees Stock Bonus Plan (hereinafter referred to as the \"Plan\") is to provide for awards of shares of Common Stock of Engelhard Corporation (the \"Company\") to key employees for services which contribute in a substantial degree to the success of the Company. Key employees are those employees, including officers of the Company and its subsidiaries in managerial or other important positions selected by the Committee administering the Plan who, by virtue of their ability and qualifications, make important contributions to the Company. The Plan supercedes the prior Key Employee Stock Bonus Plan, and any shares awarded under said prior plan which have not vested as of June 30, 1986 shall be governed by the terms of this Plan.\n2. Duration. The Plan will terminate on June 30, 1996 and no shares of the Company's Common Stock may be awarded to key employees after such date; however, shares awarded on or prior to such date may be subsequently delivered to key employees in accordance with the terms and conditions applicable to their awards.\n3. Administration. The Plan shall be administered by a committee (the \"Committee\") which shall be appointed from time to time by the Board of Directors of the Company, and shall consist of not less than two directors of the Company who qualify as \"disinterested persons\" under Rule 16b-3(c)(2) issued by the Securities and Exchange Commission. The Committee shall have full power and authority, subject to the terms and conditions of the Plan, to determine the key employees to whom awards may be made under the Plan, the number of such shares to be awarded to each of such key employees, the applicable terms and conditions of such awards and all other matters which may arise in the administration of the Plan. The determination of the Committee concerning any matter arising under or with respect to the Plan or any awards granted hereunder shall be final, binding and conclusive on all interested persons. The Committee may as to all questions of accounting rely conclusively upon any determinations made by the independent auditors of the Company.determinations made by the independent auditors of the Company.\n4. Shares Available For Awards. The total number of shares of the Company's Common Stock which may be awarded under the Plan shall not exceed 4,500,000 (Currently 10,125,000 due to stock splits--March, 1995) shares and the total number of shares of the Company's Common Stock which may be awarded pursuant to the Plan to key employees in any calendar year shall not exceed 450,000 (Currently 1,012,500 due to stock splits--March, 1995) shares; provided, however, that any number of shares which might have been awarded in any calendar year during the term of the Plan which were not so awarded may be awarded in any subsequent calendar year during the term of the Plan. The foregoing yearly maximum number of shares shall be subject in each case to Paragraph 7 of the Plan. Shares of the Company's Common Stock used for purposes of the Plan may be either authorized but unissued shares or treasury shares or both. Unvested shares of the Company's Common Stock returned to the Company upon the cancellation and termination of awards granted under the Plan shall be available for further awards under the Plan in any calendar year during the term of the Plan; provided, however, that any such returned shares with respect to which benefits of ownership (such as dividends) had been received by key employees\nshall not be available for further awards under the Plan to key employees subject to the requirements of Section 16 of the Securities Exchange Act of 1934, as amended.\n5. Form of Awards and Related Matters. The Company shall deliver (a) to each key employee to whom an award is made a written instrument signed by the Company setting forth the number of shares of the Company's Common Stock represented by such award and the number of shares which shall vest at the end of each anniversary date of such award, and (b) to the escrow agent a certificate or certificates registered in the name of such key employee representing the total number of shares of the Company's Common Stock represented by such award and a copy of such instrument. Such certificate or certificates shall be legended to indicate that the shares represented thereby are subject to the terms and provisions of the award and the Plan. The shares of the Company's Common Stock represented by the certificates held by the escrow agent shall constitute issued and outstanding shares of the Company's Common Stock for all corporate purposes, and the key employee shall receive all cash dividends thereon and have the right to vote such shares provided that the right to receive such dividends and to vote such shares shall forthwith terminate with respect to unvested shares of any key employee whose award has been cancelled. While such shares are held in escrow and until such shares have vested, the key employees for whose account such shares are held shall not have the right to sell or otherwise dispose of such shares or any interest therein and such shares shall not be subject to attachment or any other legal or equitable process brought by or on behalf of any creditor of such employees. As shares of the Company's Common Stock from time to time vest in the key employees in accordance with their awards, the escrow agent shall deliver to the key employees or their respective beneficiary(ies) certificates representing such vested shares.neficiary(ies) certificates representing such vested shares. As a condition precedent to delivering certificates representing shares covered by awards to the escrow agent, the Company may require a key employee to deliver to the escrow agent a duly executed irrevocable stock power or powers (in blank) covering the shares represented by such certificates. In addition, if the shares represented by an award are not registered under the Securities Act of 1933, as a condition precedent to delivering certificates representing such shares to the escrow agent and\/or certificates representing vested shares to the key employees, the Company may require a key employee to agree in writing that such shares are being acquired for investment and without a view to the distribution thereof and may place an appropriate legend on any certificates representing such shares. Certificates representing unvested shares held by the escrow agent for the account of any key employee whose award has been cancelled and terminated shall be returned (together with the related stock power) by the escrow agent to the Company.\n6. Vesting of the Company Common Stock.\n(a) An award of the Company Common Stock shall vest in the key employee to whom it is made at the rate of 20% of the shares covered by such award on each of the five succeeding annual anniversaries of the date of such award, provided and only to the extent that the key employee remains in the service of the Company on such vesting date.\n(b) Upon termination of the service of the key employee with the Company, any award previously made to such key employee shall be automatically cancelled and terminated as of the date of such termination of service to the extent of any unvested shares subject to such award.\n(c) Notwithstanding subparagraphs (a) and (b) above,\n(i) In the case of termination of the key normal retirement age or permitted early retirement age as defined in the Retirement Plan of the Company of which such employee shall have been a member immediately before his\nretirement or as established by the Committee (and not due to discharge for cause even if occurring after attainment of retirement age) or in the case of such termination of service due to permanent disability, the shares of the Company's Common Stock held for his account by the escrow agent shall vest on the date of his termination of service.\n(ii) In the case of the death of a key employee, including a key employee whose service with the Company has terminated but has not been deemed terminated pursuant to (c)(i) above, the shares held for his account by the escrow agent shall vest on the date of his death and the escrow agent shall deliver a certificate or certificates representing such shares to such person or persons as the employee shall theretofore have designated as beneficiary(ies) in a written instrument filed with the Committee and the escrow agent; provided, however,\n(a) that the Committee may refuse to accept a designation of beneficiary(ies) if the Committee determines that there would be an unreasonable expense or difficulty to effect distribution to such beneficiary(ies), and\n(b) the Committee may require such evidence of payment or provision for taxes, liens and claims and evidence of authority and other documentation as it shall determine to be necessary or appropriate in its sole and uncontrolled discretion.\n(iii) In the case of an \"acquisition of a control interest\" in the Company, the shares of the Company's Common Stock held for the key employee's account by the escrow agent shall vest on the date of such \"acquisition of a control interest.\" For this purpose, an acquisition of a control interest\" shall occur if:an acquisition of a control interest\" shall occur if: (a) twenty-five percent (25%) or more of the Company's outstanding securities entitled to vote in elections of directors (\"voting securities\") shall be beneficially owned, directly or indirectly (including options, conversions rights, warrants, and the like, considered as if exercised), by any person or group of persons, other than the groups presently owning of the same (including their affiliates and associates); or\n(b) the majority of the Board of Directors of the Company ceases to consist of the existing membership or successors nominated by the existing membership or their similar successors.\nAny agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of voting securities owned by other holders shall for the purposes of this provision be deemed to constitute each party to such agreement, or arrangement, or under- standing as the owner of such securities.\n7. Effect of Recapitalization. In case of a stock split, stock dividends or other change in the Common Stock of the Company, the Committee, subject to the approval of the Board of Directors of the Company, shall make such adjustment, if any, as it deems appropriate in the number or kind of shares which remain available under the Plan for further awards. Unvested shares held by the escrow agent for the account of key employees shall participate in any of such events to the same extent as any other issued and outstanding shares of the Company's Common Stock, but appropriate adjustments, if required, shall be made by the Committee, subject to the approval of the Board of Directors of the Company, so that after giving effect to the occurrence of any such events the escrow agent shall continue to hold such unvested shares and\/or any other securities delivered in respect thereof for the account of such key employees to the extent practicable upon the terms and conditions of the Plan and of awards granted hereunder.\n8. Escrow Agent. The escrow agent agent shall be appointed by the Committee for such period and upon such terms and conditions as the Committee deems appropriate. The Committee shall have the power to remove any person from the position of escrow agent and to appoint substitute or successor escrow agents. The fees and expenses of the escrow agent shall be paid by the Company. The escrow agent shall not incur liability for any action taken pursuant to the Plan or any award granted thereunder so long as the escrow agent acts in good faith in accordance with the instructions of the Committee, and the Company, at the request of the escrow agent, may enter into an agreement indemnifying the escrow agent against any such liability and costs and expenses related thereto.\n9. Limitations.\n(a) No employee or other person shall have any claim or right (legal, equitable or other) to be granted an award under the Plan, and no director, officer or employee of the Company or any other person shall be authorized to enter into any agreement with any person for the making of an award or to make any representation or warranty with respect thereto.\n(b) The key employee to whom an award is made shall have a right to receive the shares of Common Stock (or other stock or securities in such award) only in accordance with the terms and conditions of the Plan and such award and the determination of the Committee and not otherwise and such key employee may not assign or transfer such award or any shares or securities not distributed to him or any interest therein.\n(c) Neither the action of the Company in establishing the Plan, nor any action taken under it by the Committee, nor any provision of the Plan or any award granted thereunder shall be construed as giving to any employee a right to be retained in the service of the Company.\n10. Amendments. The Board of Directors of the Company may discontinue the Plan at any time and may from time to time amend the Plan; provided, however, that no such discontinuance or amendment shall materially affect adversely any right or obligation with respect to any award theretofore made, and no such amendment, unless approved by the stockholders of the Company, shall materially; (i) increase the maximum number of shares which may be awarded under the Plan (other than pursuant to Section 7); (ii) modify the requirements as to eligibility to receive awards hereunder; (iii) increase the benefits accruing to key employees hereunder or (iv) increase the cost of the Plan to the Company.\n11. Expenses. All expenses to the Plan, including the fees and expenses of the escrow agent, shall be borne by the Company.\n12. Deferred Compensation Plan. Anything in this Plan to the contrary notwithstanding, if a key employee elects to defer receipt of any stock awards under this Plan pursuant to the terms of the Deferred Compensation Plan for Key Employees of Engelhard Corporation (hereinafter referred to as the \"Deferred Compensation Plan\"), the terms of the Deferred Compensation Plan rather than this Plan will govern the vehicle in which the deferred stock awards will be held and the key employee's rights to such stock awards. The terms of the Deferred Compensation Plan affecting such deferred stock awards are hereby incorporated by this reference into and made a part of this Plan.\nEXHIBIT 10(h):\nSTOCK BONUS PLAN FOR NON-EMPLOYEE DIRECTORS OF ENGELHARD CORPORATION EFFECTIVE JULY 1, 1986\n[Conformed Copy -- Includes amendments made in June, 1991 and June, 1992]\nSTOCK BONUS PLAN FOR NON-EMPLOYEE DIRECTORS OF ENGELHARD CORPORATION\n(Effective July 1, 1986)\n1. Purpose. The purpose of this Stock Bonus Plan for Non-Employee Directors of Engelhard Corporation (the \"Plan\") is to encourage the highest level of performance of non-employee directors of Engelhard Corporation (the \"Company\") by providing such directors with a proprietary interest in the Company's success and progress by awarding them shares of the Company's Common Stock (\"Common Stock\"), subject to the terms and conditions set forth below.\n2. Effective Date and Duration. Subject to Section 13, the effective date of the Plan is July 1, 1986. The Plan will terminate on June 30, 1996 and no shares of the Company's Common Stock may be awarded after such date; however, shares awarded on or prior to such date may be subsequently delivered to the persons entitled thereto in accordance with the terms and conditions applicable to such awards.\n3. Administration. The Plan shall be administered by a committee (the \"Committee\") which shall be appointed from time to time by the Board of Directors of the Company, and shall consist of not less than two directors of the Company who qualify as \"disinterested persons\" under Rule 16b-3(c)(2) issued by the Securities and Exchange Commission. The Committee shall have full power and authority, subject to the terms and conditions of the Plan, to determine the persons entitled to awards under the Plan, the applicable terms and conditions of such awards and all other matters which may arise in the administration of the Plan. The determination of the Committee concerning any matter arising under or with respect to the Plan or any awards granted hereunder shall be final, binding and conclusive on all interested persons. The Committee may as to all questions of accounting rely conclusively upon any determinations made by the independent auditors of the Company.\n4. Shares Available for Awards. The total number of shares of the Company's Common Stock which may be awarded under the Plan shall not exceed 45,000 shares. Shares of the Company's Common Stock used for purposes of the Plan may be either authorized but unissued shares or treasury shares or both. Shares of the Company's Common Stock returned to the Company upon the forfeiture of such shares pursuant to the Plan shall not be available for further awards under the Plan unless the forfeiting Non-Employee Director received no benefits of ownership (such as dividends) with respect to such shares.its of ownership (such as dividends) with respect to such shares.\n5. Eligibility and Awards. To be eligible to participate in the Plan, a person must be a director of the Company who is not an officer or employee of the Company or any of its subsidiaries or affiliates (\"Non-Employee Director\"). Each Non-Employee Director on the effective date of the Plan shall be awarded 1,500 shares of Common Stock, effective as of such effective date. In addition, each person who becomes a Non-Employee Director after the effective date of the Plan shall be awarded 1,500 shares of Common Stock, effective as of such Non-Employee Director's election to the Board of Directors (subject to the limitation set forth in Section 4).\n6. Form of Awards and Related Matters. The Company shall deliver (a) to each Non-Employee Director to whom an award is made a written instrument signed by the Company setting forth the number of shares of the Company's Common Stock represented by such award, and (b) to the escrow agent a certificate or certificates representing the total number of shares of the Company's Common Stock represented by such award and a copy of such instrument. Such certificate or certificates shall be legended to indicate that shares represented thereby are subject to the terms and provisions of the award and the Plan. The shares of the Company's Common Stock represented by the certificates held by the escrow agent shall constitute issued and outstanding shares of the Company's Common Stock for all corporate purposes, and the Non-Employee Director shall receive all cash dividends thereon and have the right to vote such shares provided that the right to receive such dividends and to vote such shares shall forthwith terminate with respect to shares of any Non-Employee Director which are forfeited pursuant to the Plan. While such shares are held in escrow and until such shares have been delivered to the applicable Non-Employee Director pursuant to the Plan, the Non-Employee Director for whose account such shares are held shall not have the right to sell or otherwise dispose of such shares or any interest therein and such shares shall not be subject to attachment or any other legal or equitable process brought by or on behalf of any creditor of such Non-Employee Director. At such time as the Non-Employee Director's service as a non-employee director terminates (or following an \"acquisition of a control interest\" as described in subparagraph (c)(iii) of Section 7), the escrow agent shall deliver to the Non-Employee Director or his beneficiary(ies) certificates representing such shares held by the escrow agent for the Non-Employee Director's account as are not forfeited pursuant to Section 7. As a condition precedent to delivering certificates representing shares covered by awards to the escrow agent, the Company may require a Non-Employee Director to deliver to the escrow agent a duly executed irrevocable stock power or powers (in blank) covering the shares represented by such certificates. In addition, if the shares represented by an award are not registered under the Securities Act of 1933, as a condition precedent to delivering certificates representing such shares to the escrow agent and\/or certificates representing shares to Non-Employee Directors, the Company may require a Non-Employee Director to agree in writing that such shares are being acquired for investment and without a view to the distribution thereof and may place an appropriate legend on any certificates representing such shares. Certificates representing shares held by the escrow agent for the account of any Non-Employee Director which are forfeited pursuant to the Plan shall be returned (together with the related stock power) by the escrow agent to the Company.\n7. Vesting of the Company Common Stock.\n(a) An award of the Company's Common Stock shall tentatively vest in the Non-Employee Director to whom it is made at the rate of 10% of the shares covered by such award for each full year of the Non-Employee Director's service as a non-employee director of the Company (including service prior to the date of the award); provided, however, that in no event shall any shares tentatively vest prior to the expiration of the six-month period immediately following the date of their award.\n(b) Upon termination of the service of the Non-Employee Director as a non-employee director of the Company, any award previously made to such Non-Employee Director shall automatically be forfeited as of the date of such termination of service to the extent of (i) any shares subject to such award which have not tentatively vested pursuant to subparagraph (a) above, and (ii) any shares subject to such award as to which the Committee has not made a determination that receipt of such shares by the Non-Employee Director is warranted in light of the Non-Employee Director's services to the Company and the circumstances of the Non-Employee Director's termination of service.\n(c) Notwithstanding subparagraphs (a) and (b) above,\n(i) In the case of termination of the Non-Employee Director's service as a non-employee director of the Company due to permanent disability after the expiration of the six-month period immediately following the date of the award to the Non-Employee Director hereunder, all of the shares of the Company's Common Stock held for his account by the escrow agent shall become fully vested on the date of such termination of service, and the escrow agent shall (in accordance with Section 6) deliver a certificate or certificates representing such shares to the Non-Employee Director.\n(ii) In the case of the death of a Non-Employee Director after the expiration of the six-month period immediately following the date of the award to the Non-Employee Director hereunder, all of the shares held for his account by the escrow agent shall become fully vested on the date of his death and the escrow agent shall (in accordance with Section 6) deliver a certificate or certificates representing such shares to such person or persons as the Non-Employee Director shall theretofore have designated as beneficiary(ies) in a written instrument filed with the Committee and the escrow agent; provided, however,\n(A) that the Committee may refuse to accept a designation of beneficiary(ies) if the Committee determines that there would be an unreasonable expense or difficulty to effect distribution to such beneficiary(ies), and\n(B) the Committee may require such evidence of payment or provision for taxes, liens and claims and evidence of authority and other documentation as it shall determine to be necessary or appropriate in its sole and uncontrolled discretion.\n(iii) In the event of an \"acquisition of a control interest\" in the Company after the expiration of the six-month period immediately following the date of the award to the Non-Employee Director hereunder, all of the shares of the Company's Common Stock held for the Non-Employee Director's account by the escrow agent shall become fully vested on the date of such \"acquisition of a control interest\", and the escrow agent shall (in accordance with Section 6) deliver a certificate or certificates representing such shares to the Non-Employee Director as soon as practicable following such \"acquisition of a control interest.\" For the purpose of this subparagraph (c)(iii), an \"acquisition of a control interest\" shall occur if:\n(A) twenty-five percent (25%) or more of the Company's outstanding securities entitled to vote in elections of directors (\"voting securities\") shall be beneficially owned, directly or indirectly (including options, conversion rights, warrants, and the like, considered as if exercised), by any person or group of persons, other than the group presently owning the same (including their affiliates and associates); or\n(B) the majority of the Board of Directors of the Company ceases to consist of the existing membership or successors nominated by the existing membership or their similar successors.\nAny agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of voting securities owned by other holders shall for the purposes of this provision be deemed to constitute each party to such agreement, arrangement or understanding as the owner of such securities.\n8. Effect of Recapitalization. In case of a stock split, stock dividends or other change in the Common Stock of the Company, the Committee shall make such adjustment, if any, as it deems appropriate in the number or kind of shares which remain available under the Plan for further awards and which are to be awarded to persons becoming Non-Employee Directors. Shares held by the escrow agent for the account of Non-Employee Directors which have not been forfeited pursuant to the Plan shall participate in any of such events to the same extent as any other issued and outstanding shares of the Company's Common Stock, but appropriate adjustments, if required, shall be made by the Committee, so that after giving effect to the occurrence of any of such events the escrow agent shall continue to hold such shares and\/or any other securities delivered in respect thereof for the account of such Non-Employee Directors to the extent practicable upon the terms and conditions of the Plan and of awards granted hereunder.\n9. Escrow Agent. The escrow agent shall be appointed by the Committee for such period and upon such terms and conditions as the Committee deems appropriate. The Committee shall have the power to remove any person from the position of escrow agent and to appoint substitute or successor escrow agents. The fees and expenses of the escrow agent shall be paid by the Company. The escrow agent shall not incur liability for any action taken pursuant to the Plan or any award granted thereunder so long as the escrow agent acts in good faith in accordance with the instructions of the Committee, and the Company, at the request of the escrow agent, may enter into an agreement indemnifying the escrow agent against any such liability and costs and expenses related hereto.\n10. Limitations.\n(a) Nothing in the Plan shall be deemed to create any obligation on the part of the Company to continue any person as a director.\n(b) The Non-Employee Director to whom an award is made shall have a right to receive the shares of Common Stock (or other stock or securities in such award) only in accordance with the terms and conditions of the Plan and such award and the determination of the Committee and not otherwise and such Non- Employee Director may not assign or transfer such award or any shares or securities not distributed to him or any interest therein.\n11. Termination or Amendment of Plan. The Board of Directors of the Company may discontinue the Plan at any time prior to the date set forth in Section 2 and may from time to time amend the Plan; provided, however, that no such discontinuance or amendment shall materially affect adversely any right or obligation with respect to any award theretofore made, and no such amendment, unless approved by the stockholders of the Company, shall materially:\n(i) increase the maximum number of shares which may be awarded under thePlan (other than pursuant to Section 8);\n(ii) modify the requirements as to eligibility to receive awards hereunder; (iii) increase the benefits accruing to Non-Employee Directors hereunder or (iv) increase the cost of the Plan to the Company.\n12. Expenses. All expenses to the Plan, including the fees and expenses of the escrow agent, shall be borne by the Company.\n13. Effectiveness of the Plan. This Plan shall not be effective unless approved by the holders of not less than a majority of the outstanding shares of voting stock of the Company present, or represented, and entitled to vote thereon at a meeting thereof duly called and held for such purpose, and no shares awarded hereunder shall be delivered to any Non-Employee Director or beneficiary prior to such approval.\nEXHIBIT 10(i):\nDEFERRED COMPENSATION PLAN FOR DIRECTORS OF ENGELHARD CORPORATION RESTATED AS OF MAY 7, 1987\n[Conformed Copy -- Incorporates amendments made in June 1992, November 1993 and December 1993]\nDEFERRED COMPENSATION PLAN FOR DIRECTORS OF ENGELHARD CORPORATION\n(As restated as of May 7, 1987)\nThe purpose of the Deferred Compensation Plan for Directors of Engelhard Corporation (the \"Plan\") is to provide a procedure whereby a member of the Board of Directors of Engelhard Corporation (the \"Company\") may defer the payment of all or a specified part of the future compensation payable to the Director for services as a Director (including compensation payable to a Director for future services as a member of a committee of the Board).\n1. Each Director who is not an employee of the Company or any of its subsidiaries may elect, on or before December 31 of any calendar year by written notice to the Company, to defer payment of all or a designated portion of the compensation payable to him for service as a Director commencing at the beginning of the next calendar year (inclusive of fees paid for attendance at meetings of the Board and committees thereof).\nAny person elected to fill a vacancy on the Board who was not a Director on the preceding December 31 may elect, within 31 days of the date of his election as a Director by written notice to the Company, to defer payment of all or a designated portion of the compensation payable to him for service as a Director from and after the date on which such election is made during the balance of the calendar year in which he was elected to the Board and thereafter.\nDeferrals hereunder shall continue until the Director notifies the Company in writing, prior to the commencement of any calendar year, that he wishes his compensation for such calendar year and all succeeding periods to be paid on a current basis. Elections to defer payment of compensation, or to discontinue such deferrals, shall be irrevocable when made.\nAny election to defer compensation pursuant to this paragraph 1 shall include an election as to whether the deferred compensation shall be credited to the Accumulated Account described in paragraph 4 or to the Stock Account described in paragraph 5; provided, however, that a Director's election to have deferred compensation credited to the Stock Account, or to discontinue having deferred compensation credited to the Stock Account, shall be effective only with respect to compensation that becomes payable on or after the date six months following the date such election is made (and during such period any compensation deferred by such Director shall be credited to the Accumulated Account). by such Director shall be credited to the Accumulated Account).\n2. In addition to the deferrals described in paragraph 1 above, each Director who is not an employee of the Company shall have the option, exercisable not less than two months before any stock award vests under the Company's Stock Bonus Plan for Non-Employee Directors, to defer delivery of said stock award for a period of at least one year. An election made by a Director pursuant to this paragraph 2 with respect to a stock award shall become irrevocable as of the last day for making such election.\n3. For purposes of this Plan:\n(a) The calendar year in which a Director ceases to serve as such shall be referred to as the \"Retirement Year.\"\n(b) The deferred compensation and dividend equivalents for any Director which are credited to the account described in paragraph 4, plus the equivalent of accumulated interest thereon, less any portion thereof theretofore distributed or transferred from such account, shall be referred to as the Director's \"Accumulated Account.\"\n(c) The deferred compensation, deferred stock awards and dividend equivalents for any Director which are credited in the form of units to the stock account described in paragraph 5, less any portion thereof theretofore distributed from such account, shall be referred to as the Director's \"Stock Account.\"\n(d) Shares of Common Stock of the Company shall be referred to as \"Shares.\"\n4. Except for amounts credited to the Stock Account described in paragraph 5, all deferred compensation hereunder shall be held in the general funds of the Company and shall be credited to a bookkeeping account (\"Accumulated Account\") maintained by the Company in the name of the Director, and shall bear the equivalent of interest from, the first day following the end of the calendar quarter to which the compensation is applicable. Interest equivalents shall be credited on December 31 of each year up to an including the year preceding that in which the last installment is paid, it being the intent that interest equivalents shall not cease to accrue upon payment of the first installment, but shall continue to accrue with respect to the balance undistributed at any time. The amount of interest equivalent credited to the Director's account shall be determined by applying the interest equivalent rate established hereunder to the balance in the Director's account (which balance shall include, for this purpose, interest equivalent accrued but not credited to the account) at the end of each month. For purposes of the foregoing, the interest equivalent rate shall be set monthly and shall be equal to 120% of the long-term federal rate, compounded monthly (within the meaning of Section 1274(d) of the Internal Revenue Code of 1986, as amended) as in effect for the month for which interest equivalent is being computed. For periods prior to January 1, 1994 the last two sentences of paragraph 4 are as follows: \"The amount of interest equivalent credited to the Director's account annually shall be determined by applying the interest equivalent rate established hereunder to the average balance in the Director's account during the year. For purposes of the foregoing, the annual interest equivalent rate shall be determined by averaging the rate of interest for 3-year U.S. Treasury notes as reported in the monthly Federal Reserve Bulletin for each calendar quarter of the year for which interest is being computed.*\"\n5. All deferred compensation which a Director elects pursuant to paragraph 1 to have credited to the Stock Account (including any amounts transferred from the Accumulated Account pursuant to the last sentence of paragraph 1) and all stock awards deferred by a Director pursuant to paragraph 2 shall be credited in the form of units to a bookkeeping account maintained by the Company in the name of the Director. The number of units so credited shall be equal to the sum of (i) the maximum number of whole Shares obtainable at then prevailing prices with the amounts of the Director's deferred compensation credited to the Stock Account pursuant to paragraph 1 as of the date such compensation is so credited (disregarding fractional shares) and (ii) the number of Shares corresponding to the number of the Director's deferred stock awards pursuant to paragraph 2. Each such unit shall represent the right to receive one Share at the time and in the manner determined pursuant to the Director's deferral election and the terms of this Plan.\n* For periods prior to January 1, 1994 the last two sentences of paragraph 4 are as follows: \"The amount of interest equivalent credited to the Directors' account annually shall be determined by applying the interest\nequivalent rate established hereunder to the average balance in the Director's account during the year. For purposes of the foregoing, the annual interest equivalent rate shall be determined by averaging the rate of interest for 3-year U.S. Treasury notes as reported in the monthly Federal Reserve Bulletin for each calendar quarter of the year for which interest is being computed.\nIf any dividends are payable on Shares during the deferral period, dividend equivalents equal to the dividend that would have been payable on the units credited to a Director's Stock Account if such units had constituted Shares shall be handled in one of the following ways, as irrevocably elected by the Director in his deferral election:\n(i) such dividend equivalents shall be added to the Accumulated Account described in paragraph 4 above, and shall be credited with interest equivalents pursuant to said paragraph 4;\n(ii) such dividends shall be paid out currently to such Director; or\n(iii) such dividend equivalents shall be credited to the Stock Account and applied to provide additional units corresponding to the maximum number of whole Shares obtainable at then prevailing prices with such dividend equivalents (disregarding fractional shares).\nThe Director's election of one of the above options with respect to the handling of dividend equivalents shall become irrevocable as of the last date for making the deferral election with respect to such stock award; provided, however, that an election by a Director of the option described in (iii) above shall be effective only with respect to dividend equivalents that become payable on or after the date six months following the date such election becomes irrevocable.\nThe Company may in its discretion establish a trust to satisfy its obligations under this Plan with respect to the units credited to the Stock Account and transfer to such trust Shares corresponding to such units or cash to be used by the trustee to purchase such Shares. The assets of such trust shall be subject to the claims of general creditors of the Company. If such a trust is established, any voting rights which are exercisable with respect to a number of Shares held in such trust corresponding to the number of units credited to a Director's Stock Account shall be exercised by the trustee of such trust in accordance with the directions of such Director (and the trustee shall not exercise voting rights with respect to such Shares to the extent that directions are not received from the Director).\n6. The amount to which a Director is entitled hereunder shall be paid to him in any number of annual installments, as initially elected by him, up to ten, payable in January of each payment year beginning with the calendar year designated by the Director in his initial deferral election. A Director may irrevocably elect by written notice to the Company to further defer payments previously deferred under paragraph 1 hereof or delivery of stock awards previously deferred under paragraph 2 hereof to a date or dates specified in the Director's further deferral election (an \"Additional Deferral Election\"). An Additional Deferral Election shall specify the calendar year in which such payments or deliveries will commence and the number of annual installment payments or deliveries (up to ten). Such annual installments shall be payable in January of each payment year beginning with the calendar year specified in the Additional Deferral Election. However, in order for an Additional Deferral Election to be effective (i) the Additional Deferral Election must be made at least twelve months prior to the date the payment would otherwise be due or the\ndelivery is otherwise scheduled to be made, as the case may be, in accordance with a prior deferral election under this Plan, (ii) the Director must agree with the Company that, if nominated and elected, he will continue to serve as a Director of the Company for at least one year following the date of the Additional Deferral Election, (iii) the Additional Deferral Election may not specify any payment of amounts hereunder or any delivery of stock hereunder on a date prior to the date such payment or delivery was otherwise due under this Plan, and (iv) the further deferral of each payment or delivery specified in the Additional Deferral Election must be for a period of at least one year. The amount of each installment shall be determined by multiplying the Accumulated Account amount and the units credited to the Director's Stock Account as of the December 31 preceding the installment payment date by a fraction, the numerator of which shall be \"1\" and the denominator of which shall be the number of annual installments initially elected by the Director less the number of installment payments theretofore made. If a Director should die before full payment of all amounts owing to him, his Accumulated Account and the units credited to the Director's Stock Account as of December 31 of the year of his death shall be paid to his estate in January of the calendar year following the year of his death, or the Accumulated Account and the units credited to the Director's Stock Account as at such earlier date as the Board of Directors, in its discretion, may determine may be paid in lieu thereof. Any such in lieu payment from the Accumulated Account shall be adjusted for interim interest equivalent additions to such extent, if any, as the Board of Directors shall determine. Each installment payment of units credited to a Director's Stock Account shall be made through payment of a number of whole Shares equal to the number of units which are then payable (disregarding fractional units).of units which are then payable (disregarding fractional units).\n7. The right of a Director to the amounts described hereunder (including Shares) shall not be subject to assignment or other disposition by him other than by will, descent or distribution. In the event that, notwithstanding this provision, a Director makes a prohibited disposition, the Company may disregard the same and discharge its obligation hereunder by making payment or delivery thereof as though no such disposition had been made.\n8. The Plan shall be administered by a committee appointed by the Board of Directors of the Company consisting entirely of members of such Board not eligible to participate in the Plan (\"Committee\"). The decision of the Committee with respect to any questions arising as to the interpretation of this Plan, including the severability of any and all of the provisions thereof, shall be final, conclusive and binding.\n9. The Board of Directors of the Company may discontinue the Plan at any time and may from time to time amend the Plan; provided, however, that no such discontinuance or amendment shall operate to annul an election already in effect for the current calendar year or any preceding year or adversely affect the right of a Director to receive the amounts described herein, and no such amendment affecting Stock Accounts, unless approved by the stockholders of the Company, shall materially: (i) increase the maximum number of Shares which may be issued under the Plan; (ii) modify the requirements as to eligibility to defer compensation or stock awards hereunder; or (iii) increase the benefits accruing to Directors hereunder accruing to Directors hereunder.\n10. Except as and to the extent otherwise provided in this Plan or in any trust referred to in paragraph 5, neither the Director nor any other person shall have any interest in any fund or in any specific asset of the Company by reason of amounts credited to the Accumulated Account or Stock Account of a Director hereunder, nor the right to receive any distribution under this Plan. Distributions hereunder shall be made from the general funds of the Company or from the trust referred to in paragraph 5, and the rights of the Director shall be those of an unsecured general creditor of the Company.\n11. Nothing contained herein shall impose any obligation on the Company to continue the tenure of the Director beyond the term for which he may have been elected or retained.\nEXHIBIT 10(j):\nSUPPLEMENTAL RETIREMENT PROGRAM OF ENGELHARD CORPORATION AS AMENDED AND RESTATED EFFECTIVE JANUARY 1, 1989\n[Conformed Copy -- Includes amendments made in June 1992, December 1993, April 1994 and November 1994]\nSUPPLEMENTAL RETIREMENT PROGRAM OF ENGELHARD CORPORATION\n(as amended and restated effective January 1, 1989)\n1. Purpose\nThe Supplemental Retirement Program of Engelhard Corporation consists of two separate plans, the terms of which are set forth herein: (i) the Excess Benefit Plan and (ii) the Supplemental Executive Retirement Plan. The purpose of the Excess Benefit Plan is to provide certain salaried employees with a pension benefit payable from employer funds, notwithstanding the limitations of Section 415 of the Internal Revenue Code of 1986, as amended (the \"Code\") as from time to time in effect, having an actuarial value equivalent to the excess of the amount of benefits which would have been payable to such employees under the Retirement Income Plan for Salaried Employees of Engelhard Corporation (\"Pension Plan\") were it not for Section 415 of the Code over the amount thereof in fact payable under the Pension Plan. The purposes of the Supplemental Executive Retirement Plan are (i) to provide certain other salaried employees with a pension benefit payable from employer funds, notwithstanding the limitations of Section 401(a)(17) and 415 of the Code as from time to time in effect (or of any similar provision of the Code or any other law or regulations that may now or hereafter limit benefits payable under qualified pension or retirement plans (all of which are herein referred to as \"IRC limitations\")), having an actuarial value equivalent to the excess of the amount of benefits which would have been payable to such employees under the Pension Plan were it not for the IRC limitations and any election by the employees to defer salary or bonus under the Company's Deferred Compensation Plan for Key Employees over the amount thereof in fact payable under the Pension Plan and (ii) to provide certain elected officers who complete more than ten years of service with retirement benefits in addition to those provided under the Pension Plan and, if applicable, the Excess Benefit Plan.\n2. Eligibility\n(a) Excess Benefit Plan\nAn employee shall be eligible to receive payment under the Excess Benefit Plan provided that, as of his Severance From Service Date as defined in Section 3.7 of the Pension Plan (the \"Severance From Service Date\"), such employee: (i) is a Participant as defined in Section 2.1(dd) of the Pension Plan;\n(ii) is credited under the Pension Plan with no less than 5 years of Vesting Service, as defined in Section 3.5 of the Pension Plan, except that an employee whose Vesting Service is less than 5 years will be eligible to receive payment hereunder if the sum of (A) his age in whole and fractional years, and (B) his Vesting Service, equals or exceeds 65; and\n(iii) is not affected under Section 2.1(ee) of the Pension Plan by the Internal Revenue Code Section 401(a)(17) annual limitation on Pay that can be taken into account for benefit calculation purposes under the Pension Plan.\n(b) Supplemental Executive Retirement Plan\nAn employee shall be eligible to receive payment under Part A of the Supplemental Executive Retirement Plan provided that, as of his Severance From Service Date, such employee:\n(i) is a Participant as defined in Section 2.1(dd) of the Pension Plan;\n(ii) is credited under the Pension Plan with no less than 5 years of Vesting Service, except that an employee whose Vesting Service is less than 5 years will be eligible to receive payment here- under if the sum of (A) his age in whole and fractional years, and (B) his Vesting Service, equals or exceeds 65; and\n(iii) is affected (or would be affected if the Pension Plan were to take into account Deferred Compensation (as defined below) in determining Pay) under Section 2.1(ee) of the Pension Plan by the Internal Revenue Code Section 401(a)(17) annual limitation on Pay that can be taken into account for benefit calculation purposes under the Pension Plan.\nAn employee shall be eligible to receive payment under Part B of the Supplemental Executive Retirement Plan provided that such employee:\n(i) is a Participant as defined in Section 2.1(dd) of the Pension Plan as of his Severance From Service Date;\n(ii) had completed less than 10 years of Credited Service, as defined in Section 3.6 of the Pension Plan, as of January 5, 1984;\n(iii) is an elected officer of Engelhard Corporation (the \"Company\") and designated by the Board of Directors of the Company to participate in Part B of the Supplemental Executive Retirement Plan, and is listed on Schedule A attached hereto; and\n(iv) had completed more than 10 years of Credited Service, as defined in Section 3.6 of the Pension Plan, as of his Severance From Service Date.\n3. Benefit\n(a) Excess Benefit Plan\nAn eligible employee's annual benefit under the Excess Benefit Plan shall be the difference between (i) and (ii) following:\n(i) the annualized Normal Retirement Benefit, Early Retirement Benefit or Disability Benefit, as determined under Sections 4.1, 4.2 and 6.1, respectively, of the Pension Plan (determined before application of Section 415 of the Code); and\n(ii) the benefit payable to him under the Pension Plan after application of Section 415 of the Code, including any required adjustments for retirement before social security retirement age, and other such actuarial adjustments thereto, in effect as of the date benefit payments commence under the Pension Plan.\nIn no event shall an eligible employee be entitled to receive an aggregate benefit, from the Pension Plan and the Excess Benefit Plan, greater than that which he would have received under the Pension Plan but for Section 415 of the Code.\n(b) Part A of Supplemental Executive Retirement Plan\nAn eligible employee's annual benefit under Part A of the Supplemental Executive Retirement Plan shall be the difference between (i) and (ii) following:\n(i) the annualized Normal Retirement Benefit, Early Retirement Benefit or Disability Benefit, as determined under Section 4.1, 4.2 and 6.1, respectively, of the Pension Plan, determined before application of the IRC limitations, and determined as if the employee's Pay (as defined in Section 2.1(ee) of the Pension Plan), for Plan Years beginning on or after January 1, 1994, for a Plan Year included salary and bonus that he elected to defer under the Deferred Compensation Plan for Key Employees of the Company ('Deferred Compensation') and which would otherwise have been paid in the Plan Year; and\n(ii) the benefit payable to him under the Pension Plan after application of the IRC limitations (and without modifying the definition of Pay in the Pension Plan to include Deferred Compensation), including any required adjustment for retirement before social security retirement age, and other such actuarial adjustments thereto, in effect as of the date benefit payments commence under the Pension Plan.\nIn no event shall an eligible employee be entitled to receive an aggregate benefit, from the Pension Plan, the Excess Benefit Plan and Part A of the Supplemental Executive Retirement Plan, greater than that which he would have received under the Pension Plan but for the IRC limitations and, for periods beginning on or after January 1, 1994, his elective deferral of Deferred Compensation. (c)Part B of Supplemental Executive Retirement Plan.\nAn eligible employee's annual benefit under Part B of the Supplemental Executive Retirement Plan shall be the difference between (i) and (ii) following:\n(i) the annualized Normal Retirement Benefit, Early Retirement Benefit or Disability Benefit, as determined under Section 4.1, 4.2 and 6.1, respectively, of the Pension Plan (determined before application of the IRC limitations) as if the employee's number of years of Credited Service were equal to the sum of (A) the employee's actual number of year of Credited Service as of his Severance From Service Date plus (B) the lesser of 5 years of Credited Service or one-half of the employee's actual number of years of Credited Service in excess of 10 as of his Severance From Service Date and as if the employee's Pay, for Plan Years beginning on or after January 1, 1994, for a Plan Year included Deferred Compensation which, but for the employee's deferral election, would have been paid in the Plan Year; and\n(ii) the annualized Normal Retirement Benefit, Early Retirement Benefit or Disability Benefit, as determined under Section 4.1, 4.2 and 6.1, respectively, of the Pension Plan (determined before application of the IRC limitations and by including Deferred Compensation in Pay for Plan Years beginning on or after January 1, 1994 as provided in Section 3(b)(i) hereof) based on the employee's actual number of years of Credited Service as of his Severance From Service Date.\n4. Administration\nThe Excess Benefit Plan and the Supplemental Executive Retirement Plan shall be administered by the Pension and Employee Benefit Plans Committee (the \"Committee\") which, in so doing, shall be entitled to exercise with respect to each such Plan all the powers and authorities with respect to the Pension Plan vested in the Committee under the Pension Plan.\n5. Payment Form\n(a) Except as provided in Paragraphs (b), (c) and (e) of this Section 5, an eligible employee's benefit under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan shall be subject to the same terms, conditions and adjustments as the benefit such employee receives from the Pension Plan, and an employee's elections under the Pension Plan as to retirement date, form of payment, beneficiary, etc., shall be deemed elections under the Excess Benefit Plan and the Supplemental Executive Retirement Plan as well.\n(b) Notwithstanding Paragraph (a) of this Section 5, (i) an employee may elect pursuant to this Paragraph (b) that the benefit payable under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan with respect to him be paid to such employee or, following the employee's death, to his beneficiary or beneficiaries in accordance with the following provisions of this Paragraph (b) by filing a written application with the Committee not less than 60 days prior to the date benefits payable to the employee and his beneficiaries under the Pension Plan commence to be paid and (ii) an employee who elects a lump sum option under Section 7.5(e) of the Pension Plan shall not receive his benefit under the Excess Benefit Plan or the Supplemental Executive Retirement Plan in a lump sum but shall instead be deemed to have elected to receive such benefit in accordance with the following provisions of this Paragraph (b) unless the employee elects another form of distribution pursuant to Paragraph (c) of this Section 5. Notwithstanding the foregoing, an employee who is subject to the limitations of Section 16 of the Securities Exchange Act of 1934, as amended, shall not be entitled to elect (and shall not be deemed to have elected) to have his benefit under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan paid in accordance with the provisions of this Paragraph (b) until after his Severance From Service Date. In the event such an employee does make (or is deemed to have made) such an election following his Severance From Service Date, the \"Pension Distribution Date\" defined in subparagraph (i) below applicable to such employee shall not occur earlier than the date on which the employee makes (or is deemed to have made) such election.\n(i) If an employee elects, or is deemed to have elected, to receive his benefit under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan pursuant to this Paragraph (b), the Committee shall determine the lump sum value of the employee's benefit as of the date benefits payable to the employee and his beneficiaries under the Pension Plan commence to be paid (the \"Pension Distribution Date\"). Said lump sum value shall be equal to the sum of (A) the present value of the benefits otherwise payable to the employee under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan in the form of a straight life annuity determined in accordance with the factors, methods and assumptions used for determining actuarial equivalence under the Pension Plan as in effect on such Pension Distribution Date plus (B) the present value of the benefit derived by the Company from the deferral of payments to the four succeeding anniversaries of such Pension Distribution\nDate in accordance with subparagraph (iii) below as measured on the basis of the excess (if any) of the prime rate prevailing in New York City (as determined by the Committee) on such Pension Distribution Date over the annual dividend rate on the Company's common stock on such date grossed up to a pre-tax figure, determined by dividing the amount of taxable dividends paid per share of Company common stock during the 12-month period ending on the Pension Distribution Date by an amount equal to the mean between the highest and lowest quoted selling prices of a share of such stock on the New York Stock Exchange - Composite Transactions on the Pension Distribution Date and then dividing the result by the difference between 1.00 and the effective federal income tax rate applicable in determining the Company's net after-tax income for its annual accounting period next preceding (or ending on) such Pension Distribution Date. (ii)g (or ending on) such Pension Distribution Date. (ii)ion Distribution Date. (ii)g (or ending on) such Pension Distribution Date.\n(ii) The Committee shall determine the number of shares of the Company's common stock equivalent in value to the lump sum value determined pursuant to subparagraph (i) above by dividing an amount equal to the mean between the highest and lowest quoted selling prices of a share of such stock on the New York Stock Exchange - Composite Transactions on the Pension Distribution Date into the lump sum value determined pursuant to subparagraph (i) above, and rounding to the nearest whole number of shares.\n(iii)Subject to subparagraphs (iv) and (v) below, the number of shares determined pursuant subparagraph (ii) above shall be paid in installments to the employee or, following his death, to his beneficiary or beneficiaries, as follows: (A) a number of shares of the Company's common stock equal to 20% of the number of such shares determined pursuant to subparagraph (ii) above, rounded to the nearest whole number, shall be paid as soon as practicable following the employee's Pension Distribution Date and on each of the three succeeding anniversaries of such Pension Distribution Date and (B) the balance of the number of such shares determined pursuant to subparagraph (ii) above shall be paid on the fourth anniversary of such Pension Distribution Date.\n(iv) As a condition to receiving benefits pursuant to this Paragraph (b), the employee shall agree that for a period of five years following such Pension Distribution Date, he shall not (on his own behalf, either as an officer, shareholder, partner, employee or otherwise or on behalf of any significant competitor of the Company), in any manner, directly or indirectly without the express prior written consent of the Company, or except on behalf of the Company, engage in any activity, accept employment with, render any service in any capacity to or have any interest in (including investment in the equity securities of) any business or enterprise or other activity (x) which will conflict with the significant interests of the Company or its business or (y) which is a significant competitor of or is in significant competition with the Company; provided, however, that the employee may acquire or hold (beneficially and of record) up to but not more than 1% of the equity securities of any such significant competitor or entity without the consent of the Company if such equity securities are listed on the New York Stock Exchange or the American Stock Exchange or are quoted on NASDAQ. If the employee shall violate such agreement, he shall forfeit his right\nto any remaining installments to which he would otherwise have been entitled pursuant to this Paragraph (b) and shall be entitled to no further benefits under the Excess Benefit Plan or the Supplemental Executive Retirement Plan. (v)ental Executive Retirement Plan.\n(v) The Company may in its sole discretion establish a revocable trust as the Company's agent for payment of the installments described in subparagraph (iii) above and transfer to the trustee thereof all or any part of the stock payable pursuant to said subparagraph (iii). If the Company establishes such a trust, the Company shall retain the right to revoke such trust at any time and for any reason. Such trust may provide that any dividends paid on any shares of the Company's common stock held by the trustee shall be paid out to the person or persons to whom the stock is tentatively distributable as an additional benefit and may also provide that the trustee in exercising voting rights with respect to shares held by it shall follow any directions that the trustee may receive from the person or persons to whom the stock is tentatively distributable; provided, however, that the Company shall have the right at any time to eliminate any such provisions from the trust instrument. Neither the employee nor his spouse, child, beneficiary or any other party (other than the Company) shall have any interest in the assets of such trust until amounts are actually distributed, and the employee and his beneficiaries shall have the status of an unsecured general creditor of the employee's employer with respect to any benefits which become payable hereunder. If the necessary shares of the Company's common stock are not held in a trust described in this subparagraph (v) at the time that the employee or his beneficiary or beneficiaries becomes entitled to receive an installment pursuant to subparagraph (iii) above, such installment shall not be paid in the form of shares of the Company's common stock, but the employee or his beneficiary or beneficiaries shall instead receive a cash payment of an amount equal to the value of the shares that would otherwise have been paid (with the value of each such share being based on the mean between the highest and lowest quoted selling prices on the New York Stock Exchange - Composite Transactions for the Company's common stock on the date on which the installment would otherwise have been paid).\n(vi) For the purposes of this Paragraph (b), an employee's beneficiary or beneficiaries shall be the person or persons so designated by the employee on a form filed with the Committee specifically referring to this Paragraph (b). If no such effective designation is on file with the Committee at the time of the employee's death, the employee's beneficiary shall be his estate.of the employee's death, the employee's beneficiary shall be his estate.\n(c) An employee may elect pursuant to this Paragraph (c) that the benefit payable under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan with respect to him be payable in a form (other than in a lump sum) differing from that in which the benefit with respect to him shall be paid under the Pension Plan if such form of benefit under the Excess Benefit Plan and\/or the Supplemental Executive Retirement Plan is (i) selected by the employee in a written application filed with the Committee not less than 60 days prior to the date benefits payable to the employee and his beneficiaries under the Pension Plan commence to be paid, (ii) permissible under the Pension Plan and (iii) approved by the Committee, and shall be subject to the same terms and conditions as would\napply to such benefit had it been paid under the Pension Plan except for any term or condition limiting pursuant to the IRC limitations the benefits that may be paid to any individual.\n(d) Benefits under the Excess Benefit Plan and the Supplemental Executive Retirement Plan shall be paid from the general assets of the employee's employer and shall not be separately funded. No trust shall be established in connection herewith except for any revocable trust established pursuant to Paragraph (b) of this Section 5; and no assets of any employee's employer shall be set aside, other than tentatively, for the purpose of paying benefits under the Excess Benefit Plan or the Supplemental Executive Retirement Plan.\n(e) Anything in this Supplemental Retirement Program to the contrary notwithstanding, in no event may the benefits hereunder be paid in the form of a lump sum distribution other than as provided in Paragraph (b) of this Section 5.\n6. Committee Determinations\nAny determination of the Committee with respect to (a) any employee's eligibility for a benefit under the Excess Benefit Plan or the Supplemental Executive Retirement Plan, (b) the amount of such benefit, (c) the form, duration, terms and conditions of payment thereof, and (d) any other question or matter arising under the Excess Benefit Plan or the Supplemental Executive Retirement Plan, shall be final and binding on the employers, employees, beneficiaries and all other persons.\n7. Interest of Employees and Others\nNo employee, spouse, child, beneficiary or other party shall have any interest in amounts due and payable under the Excess Benefit Plan or the Supplemental Executive Retirement Plan until such amounts are actually distributed and the employee and his beneficiaries shall have the status of an unsecured general creditor of the employee's employer with respect to any benefits which become payable under the Excess Benefit Plan or the Supplemental Executive Retirement Plan.\n8. Non-Qualified Plan\nThe Excess Benefit Plan and the Supplemental Executive Retirement Plan are not intended to qualify under Section 401 of the Internal Revenue Code. The protections, obligations, rights and duties described in the Internal Revenue Code and applicable to employee pension plans qualifying under said Section 401 of the Code have no application to either the Excess Benefit Plan or the Supplemental Executive Retirement Plan. The provisions of the Employee Retirement Income Security Act of 1974 (\"ERISA\") relating to employee pension benefit plans and\/or employee welfare benefit plans shall have no application to the Excess Benefit Plan. In the case of the Supplemental Executive Retirement Plan, the only provisions of ERISA that are applicable are certain reporting and disclosure provisions of Part 1 of Subtitle B of Title I of ERISA and certain provisions relating to administration and enforcement set forth in Part 5 of Subtitle B of Title I of ERISA.\n9. No Enlargement of Employee Rights\nNothing contained in the Excess Benefit Plan or the Supplemental Executive Retirement Plan shall be deemed to give any employee the right to be retained in the service of his employer or to interfere with the right of such employer to discharge or retire any employee at any time.\n10. Amendment and Termination\nThe Company, by action of its Board of Directors, reserves the right to amend or terminate the Excess Benefit Plan or the Supplemental Executive Retirement Plan, or both, at any time. References to provisions of the Pension Plan contained herein relate to the Pension Plan as amended and restated effective as of January 1, 1994. Any subsequent amendment to the Pension Plan, to the extent it affects any reference thereto contained in the Excess Benefit Plan and the Supplemental Executive Retirement Plan, shall be deemed to concurrently amend and shall be given full force and effect under the Excess Benefit Plan and the Supplemental Executive Retirement Plan, as if such amendment were separately adopted hereunder.\nEXHIBIT 10(k):\nENGELHARD COPORATION DIRECTORS AND EXECUTIVES DEFERRED COMPENSATION PLAN (1990-1993)\n[Conformed Copy -- Includes amendments made in November 1993]\nENGELHARD CORPORATION DIRECTORS AND EXECUTIVES DEFERRED COMPENSATION PLAN\n[1990 - 1993]\n1. Eligibility\nParticipation in this Plan is limited to (a) nonemployee directors of Engelhard Corporation and (b) those key executive employees of Engelhard Corporation or its subsidiary corporations (\"Engelhard\") who have been approved for participation in this Plan by the Compensation Committee of the Board of Directors of Engelhard (\"the Committee\") or, if the Committee so resolves, by the Chief Executive Officer of Engelhard.\nAs a condition of eligibility, each person invited to participate may be required to take a physical examination prescribed by Engelhard. The Committee may exclude from participation anyone whose life, based on such examination, is not medically insurable by an insurer of Engelhard's choice at standard premium rates.\n2. Deferral of Compensation\nDuring such period or periods as may from time to time be selected by the Committee each person eligible to participate in the Plan shall be given the opportunity to elect irrevocably to defer a portion of the compensation that otherwise would be payable to such person by Engelhard for services rendered following the making of such election as a director or employee, as the case may be. The period of deferral shall be four years, all deferrals shall be in multiples of $1,000, the minimum amount deferred shall be $8,000 ($2,000 per year), and the maximum amount deferred shall be 15 percent of an employee's Compensation and 100% of an nonemployee director's Compensation. \"Compensation\" for employees is the sum of (i) annualized base salary approved as of December 13, 1989 and (ii) regular or special bonus which was paid in February 1989. For nonemployee directors, \"Compensation\" means annualized Director's fees, attendance fees and Chairman's fees expected to be paid in or payable for 1990. The amount deferred by an employee participant shall be deferred by means of reductions in the employee's (i) base salary, (ii) bonus or (iii) a combination of both base salary and bonus, as the participant shall elect, in four equal annual amounts. The amount deferred by a nonemployee director shall be deferred by means of reductions in the director's quarterly fees, in equal annual amounts to the maximum extent possible, over the four-year deferral period.\nThe opportunity to make the foregoing deferral election shall be given to those persons initially selected to participate in this Plan during the month of December 1989, with respect of Compensation that would otherwise be payable (i) to each nonemployee director for services rendered after receipt by Engelhard during the above referenced election period of the director's irrevocable election to defer and (ii) to each employee for services rendered and bonus paid during the period February 1, 1990 through December 31, 1993. Thereafter, such opportunity shall be given (a) to a person initially eligible to participate only with respect to Compensation that would otherwise be payable to him during the balance of the four-year period commencing in a calendar year following the year in which the election is made, and (b) to a person later selected to participate in this Plan with respect to Compensation that would otherwise be payable to him for services rendered after the end of the calendar month in which Engelhard receives his irrevocable election to defer.\n3. Supplemental Retirement Benefit\nIf a nonemployee director participant continues to serve upon the Engelhard Board of Directors for a period of four years following the commencement of the deferral referred to in Section 2 hereof, or if an employee participant continues in employment or to serve upon the Engelhard Board of Directors throughout the designated four-year amount elected by him, then the participant shall be entitled to receive from Engelhard 180 equal monthly payments in the amount specified as a Supplemental Retirement Benefit in the Participation Agreement. Unless the participant elects otherwise, such payments shall begin on the first day of the month following the participant's 65th birthday or, if later, the end of the four-year deferral period. If the commencement of payments hereunder is subsequent to the first day of the month following a participant's 65th birthday, the participant shall elect, at the time of his deferral election, to have Supplemental Retirement Benefits paid for (a) 180 months or (b) the number of months between the commencement of Supplemental Retirement Benefits and the month in which occurs the participant's 80th birthday. If the participant's election results in payments of less than 180 months' duration, the amount of each monthly payment shall be increased to provide an actuarially equivalent benefit.\nIf the commencement of payments hereunder is prior to the participant's 65th birthday, but in no case before attaining age 60, the participant shall elect, at the time of his deferral election, to have Supplemental Retirement Benefits paid for (a) 180 months or (b) the number of months between the commencement of Supplemental Retirement Benefits and the month in which occurs the participant's 80th birthday. If the participant's election results in payments of greater than 180 months' duration, the amount of each monthly payment shall be decreased to provide an actuarially equivalent benefit.\nA participant may elect by written notice to Engelhard to irrevocably defer the date on which Supplemental Retirement Benefits will commence to be paid to a date specified in the deferral election (the \"Additional Deferral Election\"). The number of Supplemental Retirement Benefit payments to a participant shall not change as a result of the Additional Deferral Election. However, the amount of the Supplemental Retirement Benefit payments shall be adjusted to provide an actuarially equivalent benefit. In order for an Additional Deferral Election to be effective (i) the Additional Deferral Election must be made at least twelve months prior to the date payments would otherwise commence in accordance with a prior deferral election under this Plan, (ii) a participant who is an employee must agree with Engelhard to remain employed by Engelhard (on the same terms and conditions as in effect on the day preceding the additional period of employment, subject to any changes mutually agreed to by the parties and subject to the Company's right to terminate the participant's employment at any time) for at least one additional year following the date of the Additional Deferral Election, (iii) a participant who is a nonemployee director must agree with Engelhard that, if nominated and elected, he will continue to serve as a director of Engelhard for at least one year following the date of the Additional Deferral Election, (iv) the Additional Deferral Election may not specify any payment of amounts hereunder on a date prior to the date such payment or delivery was otherwise due under this Plan, and (v) the deferral of commencement of payments specified in the Additional Deferral Election must be for a period of at least one year.\nIf a participant does not cause the deferral of the full amount elected by him because the compensation payable to such participant has proved insufficient to accommodate such full deferral, of if such participant retires under the Retirement Income Plan for Salaried Employees of Engelhard Corporation (\"Retirement Plan\") prior to the end of such four-year period, or if such participant ceases to be a participant within such four-year period because his employment terminated or he ceases to be a nonemployee director, the amount\npayable shall be reduced by multiplying such Benefit by a fraction (i) the numerator of which shall be the aggregate amount actually deferred prior to termination and (ii) the denominator of which shall be the full amount elected for deferral. A participant whose employer ceases to be a subsidiary of Engelhard shall be considered to have terminated his or her employment on the ted his or her employment on the date such employer ceases to be a subsidiary. date such employer ceases to be a subsidiary.\nIf a participant should die after payment of such Supplemental Retirement Benefit begins but before receipt of the last of such payments, the amounts unpaid shall be paid on their due dates to the participant's beneficiary designated in the Participation Agreement or, failing such designation, to the participant's legal representatives.\n4. Survivor Benefit\nIf a participant should die prior to commencement of payment of the Supplemental Retirement Benefit provided under Section 3 hereof, no Supplemental Retirement Benefit shall become payable, but in lieu thereof the Survivor Benefit specified in the Participation Agreement shall be paid to the participant's designated legal representatives. Such Survivor Benefit shall be paid in 180 equal monthly installments beginning on the first day of the month following the month in which the participant's death occurs.\n5. Amount of Supplemental Retirement and Survivor Benefits\nThe amount of Supplemental Retirement and Survivor Benefits to be included in the Participation Agreements are set forth in the Schedule attached to this Plan, but may be amended as specified in Section 7. In addition, if a participant makes an effective Additional Deferral Election pursuant to Section 3 hereof, his Supplemental Retirement Benefits shall be adjusted in order to provide an actuarially equivalent benefit.\n6. Financing\nEngelhard proposes to finance its obligations under this Plan by the purchase of one or more policies of life insurance upon the lives of participants, with Engelhard to be the owner of and beneficiary under such policies. No participant shall have any right or interest in any such policy or the proceeds thereof or in any other specific fund or asset of Engelhard or any participating subsidiary as a result of the Plan. The rights of participants to benefit payments hereunder shall be no greater than those of an unsecured creditor. Each participant shall cooperate fully in the application by Engelhard for, and in the maintenance of, any policy or policies of insurance upon such participant's life.\n7. Amendment or Termination\nSubject to Section 9, the Board of Directors of Engelhard or the Committee may terminate or amend this Plan at any time. The rights of any participant under a Participation Agreement shall not be impaired by such termination or amendment except that the Board of Directors may amend the amounts of Supplemental Retirement and Survivor Benefits payable under the Plan to reflect any adjustment to the assumed rate of earnings accrued on deferred amounts which the Board of Directors in its sole judgement may deem necessary for Engelhard to provide the plan benefits and cover its cost of borrowed money, in response to changes in the tax laws or insurance policy dividend levels.\n8. Administration\nThe Plan shall be administered by such person or persons as may be appointed from time to time by the Committee. The Committee shall be responsible for any\ninterpretation of the Plan or the Participation Agreement that may be required. The Committee shall have discretionary authority to determine eligibility to participate and the amount of benefits to which participants may be entitled under the Plan.\n9. Change in Control\nNotwithstanding anything contained in this Plan to the contrary, upon the occurrence of a \"Change In Control\" (as hereinafter defined) neither the Board of Directors of Engelhard, nor the Committee, nor any other party shall be entitled to terminate or amend this Plan, or otherwise to impair the rights of any participant hereunder even if there occurs a change in the tax laws or other events adversely affecting the financing of the benefits payable under the Plan. Engelhard or its successor hereby agrees to reimburse participants for any expense incurred by them (including attorneys fees and costs) to enforce their rights under this Section 9.\nAt the time a participant makes a deferral election pursuant to Section 2 hereof, he shall be required to make an irrevocable election as to whether, upon the occurrence of a Change In Control, he wishes to receive a \"lump sum payment\" (as hereinafter defined) or to remain subject to the deferral election so made hereunder. If a participant elects a \"lump sum payment\" he shall also be required to elect whether to receive such payment (a) immediately (i.e., within 90 days) following a Change In Control regardless of whether or not his employment with Engelhard continues or (b) only upon termination of his employment with Engelhard, prior to the date at which Supplemental Retirement Benefits are to commence hereunder, following such Change In Control. \"Lump sum payment\" shall mean a return of all principal amounts deferred by the participant plus earnings accrued at a per annum rate of 11.0% (compounded annually) to the elected Benefit Commencement Date.\nA \"Change In Control\" for the purpose of the preceding paragraphs shall occur if: (A) twenty-five percent (25%) or more of Engelhard's outstanding securities entitled to vote in election of directors (\"voting securities\") shall be beneficially owned, directly or indirectly (including options, conversion rights, warrants, and the like, considered as if exercised), by any person or group of persons, other than the groups owning of the same on January 1, 1990 (including their affiliates and associates); or\n(B) the majority of the Board of Directors of Engelhard ceases to consist of the membership in existence on January 1, 1990 or successors nominated by said existing membership or their similar successor; or\n(C) any other event or transaction occurs as a result of which any payment made pursuant to this Agreement could be treated as contingent on such event or transaction for the purposes of Section 280G of the Code.\nAny agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of voting securities owned by other holders shall for the purposes of this Section 9 be deemed to constitute each party to such agreement, arrangement or understanding as the owner of such securities.\nNotwithstanding the foregoing subparagraph, an event or transaction shall not be considered an \"acquisition of a control interest\" if such event or transaction is approved by a majority of the membership of the Board of Directors of Engelhard as in existence on January 1, 1990 or successors nominated by said existing membership or their similar successors.\nReferences to sections of the Code set forth in this Section 9 shall be deemed to include references to successor sections of the Code or of any successor code or statute.\n10. Miscellaneous\nThe term \"subsidiary\" as used herein shall include any corporation, partnership or joint venture controlled directly or indirectly by Engelhard and the term \"participating subsidiary\" shall mean any subsidiary that adopts the Plan for its subsidiaries with the consent of the Committee.\nNo amount payable under the Plan or any Participation Agreement shall be subject to assignment, transfer, sale, pledge, encumbrance, alienation or charge by a participant or the beneficiary of a participant except as may be required by law.\n\"Actuarial equivalent\" or \"actuarially equivalent\", as used herein, shall mean the present value of benefits determined at a rate of interest of 11.0% per annum, compounded annually.\n11. Termination For Cause\nNotwithstanding any other provision of the Plan or any Participation Agreement, if an employee-participant is terminated by Engelhard \"For Cause\" (as hereinafter defined), then the Supplemental Retirement Benefit to which such participant is otherwise entitled pursuant to Section 3 hereof shall be paid in an actuarially equivalent lump sum as soon as practicable following his termination of employment; provided, however, that interest equivalents credited to the amounts actually deferred by the participant shall be determined at a rate of 6 percent per annum, compounded annually.\nFor the purpose of the preceding paragraph, a termination of employment shall be \"For Cause\" if (a) the participant has been convicted of a felony by a court of competent jurisdiction and such conviction is no longer subject to direct appeal, or (b) the participant has been adjudicated by a court of competent jurisdiction to be liable for a willful and material breach of the participant's duties resulting in material injury to Engelhard and such adjudication is no longer subject to direct appeal.\nEXHIBIT 10(m):\nSEPARATION AGREEMENT WITH ROBERT L. GUYETT\nApril 28, 1995\nMr. Robert Guyett 20 Parsonage Hill Road Short Hills, New Jersey 07078\nDear Bob:\nThis letter is to confirm the terms under which your employment with Engelhard will change.\nYour last day of active employment with Engelhard will be May 4, 1995. Salary continuation will begin on May 5, 1995 and will end upon the first to occur of the following: (i) December 1, 1996, (ii) Orin Smith (whether or not an employee of Engelhard) reasonably determines that you have acted or are acting contrary to Engelhard's interest or, if Orin Smith is unable to make such a determination because of death or incapacity, William Dugle reasonably determines that you have acted or are acting contrary to Engelhard's interest, (iii) your death, or (iv) you have secured alternate employment in violation of the provisions set forth in Attachment 1. Salary continuation payments will be based on your current salary of $31,190.00 per month. The salary continuation provided for in this paragraph is in lieu of any and all payments under any and all other severance or salary continuation plans and policies of Engelhard.\nOnly a portion of the salary continuation period may be included in determining service under the Retirement Income Plan for Salaried Employees of Engelhard Corporation as amended (the \"RIP\"). Since you will not have sufficient service to vest under the RIP, you will not be entitled to receive a pension under the RIP or under the Supplemental Excess Retirement Program of Engelhard Corporation as amended (the \"SERP\"). Engelhard will however pay to you an amount equivalent to the amount you would have received under the RIP and the SERP if your accrued benefit under these plans was vested (\"Alternate Retirement Plan\"). Such amount will be based on the period from September 23, 1991 to the date on which the salary continuation described above terminates, will take into account the salary continuation payments and cash bonus, if any, received by you during that period, will be paid in the same manner as payments are made under the SERP, will terminate on the same basis that benefits under the SERP terminate, and will (as is the case with the SERP) be a nontransferable general unsecured obligation of Engelhard.\nMedical, life insurance and dental coverage will remain in effect until the end of the period for which salary continuation payments are made or until you secure alternate employment, whichever is earlier. These coverages, including the termination of such coverages, will be in accordance with the terms and provisions of each applicable plan. You may be able to extend certain coverages at the end of the applicable period at your expense if you are not covered under another plan.\nAll other coverages and benefits, such as, but not limited to long term disability, short term disability (if you are receiving salary continuation payments as provided for in this letter, such payments do not terminate because of disability), salary deferral savings (401K plan), and vacation, cease on May 4, 1995.\nAny vacation benefit for 1995 which is unused will be paid as a lump sum following the end of the salary continuation period.\nStock options previously awarded to you under the Engelhard Corporation Stock Option Plan of 1991 as amended (\"Stock Option Plan\") and shares previously awarded to you under the Key Employees Stock Bonus Plan of Engelhard Corporation as amended (\"Stock Bonus Plan\") will be subject to the terms of the respective plans. If the shareholders at the Annual Shareholders Meeting of Engelhard scheduled for May 1995 approve the amendment to the Stock Option Plan to permit the Stock Option\/Stock Bonus Committee (the \"Committee\") to extend the period following termination of employment in which an individual may exercise options previously awarded under the Stock Option Plan, Engelhard will recommend to the Committee that the maximum extension be granted with respect to the options previously awarded to you under the Stock Option Plan. Such recommendation to the Committee will be made at the first regularly scheduled meeting of the Committee following approval of the above described amendment to the Stock Option Plan by the shareholders and receipt by Engelhard of the duplicate of this letter signed by you. The Committee may approve such extension conditioned on you not breaching any of your obligations set forth in this letter or its attachments or exhibits. Shares previously awarded to you under the Stock Bonus Plan and options previously awarded to you under the Stock Option Plan will continue to vest and become exercisable in accordance with their existing vesting schedule so long as you continue receiving salary continuation payments. If the salary continuation period terminates on December 1, 1996 and not earlier by reason of your acting or having acted contrary to Engelhard's interest, or by reason of your death, or by reason of you having secured alternate employment, and if you are entitled to receive or are receiving payment or payments under the Alternate Retirement Plan described above, Engelhard has (i) recommended to the Committee that it consider you as having terminated your employment due solely to retirement under Section 6(c)(i) of the Stock Bonus Plan and that the shares held in your account by the escrow agent under the Stock Bonus Plan should vest on December 1, 1996 and (ii) recommended to the Committee that it accelerate the right to exercise all of your remaining unexercisable options.\nIf an event or a series of events occur which make it certain that under no circumstance will you or your beneficiary vest in all or a portion of the shares previously awarded to you under the Stock Bonus Plan, then and only then will Engelhard pay to you or your beneficiary an amount determined by Engelhard in its judgment to be equal to the value of such shares previously awarded under the Stock Bonus Plan and which will not, under any circumstance, vest.\nCommencing on May 5, 1995 and ending on December 1, 1996 (or earlier as provided for in Exhibit A) Engelhard engages you to perform the services described in Exhibit A on the terms and conditions described in Exhibit A and you agree to perform such services on such terms and conditions. Payments to be made to you under the provisions of Exhibit A will be made to you in the same manner as salary payments are made to Engelhard employees (there will be withholding for federal and state income taxes, FICA, and other similar items and a W-2 Form will be issued). Payments made to you under the provisions of Exhibit A will not be included in determining your benefit, if any, under the Alternate Retirement Plan.\nYou will be recommended for a 1995 cash bonus which will take into consideration your contributions to Engelhard and will be based on the period January 1, 1995 to May 4, 1995. The amount of such cash bonus (pro rated for the applicable time period) will be determined and paid by Engelhard in the same manner as cash bonuses for 1995 are determined and paid for other Engelhard executives. This amount, if any, will be included in determining your benefit, if any, under the Alternate Retirement Plan.\nDuring the period you receive salary continuation you may continue to use the company car currently provided to you. Engelhard will maintain insurance with respect to such vehicle; you will be responsible for all other costs and expenses, including but not limited to routine maintenance. If the salary continuation period terminates on December 1, 1996 and not earlier, you will be offered the opportunity to purchase the car at its fair market value. If you want to accept the offer, you must complete the purchase within ten days of the offer being made by Engelhard.\nIn consideration for the extended salary continuation period, your engagement under the terms and conditions of Exhibit A, the offer of the Alternate Retirement Plan (subject to the terms set forth above) and the offer to recommend that the Committee take certain actions (subject to the terms set forth above), you will sign, have notarized and return the Release and Waiver attached as Exhibit B. This will be done by no later than May 31, 1995. In addition, if requested by Engelhard, you will re-execute and have notarized the Release and Waiver promptly following the final salary continuation payment to you. The additional consideration provided to you is subject to and contingent on you executing and re-executing as described the Release and Waiver.\nYour obligations and Engelhard's rights under the Confidentiality and Patent Agreement which you executed remain in effect.\nIf the foregoing accurately sets forth the terms and conditions of your change of employment with Engelhard, please sign the duplicate of this letter where indicate and return it to me by May 31, 1995.\nVery truly yours,\n\/s\/William Dugle ---------------- William Dugle\nREAD AND AGREED TO\n\/s\/Robert Guyett - ---------------- Robert Guyett\nEXHIBIT A\n1. Engelhard engages you to provide financial management services, advice and direction with respect to joint ventures of Engelhard, and such other services as may be requested from time to time by Engelhard's Chief Executive Officer or President on the terms and conditions set forth below. You agree to perform such services as may be requested by Engelhard to the best of your ability.\n2. During the period commencing on May 5, 1995 and ending on December 31, 1995 inclusive you will, if requested by Engelhard, provide at least 25 days of services. As compensation for such services, Engelhard will pay you $50,000 payable as set forth in Schedule 1. If during such period Engelhard requests and you perform more than 25 days of services, Engelhard will pay you $3000 for each such day of services in excess of 25 days. Payment for such excess days of services will be made by Engelhard within 30 days following written notice by you to Engelhard that you have rendered such excess services during such period.\n3. During the period commencing on January 1, 1996 and ending on December 1, 1996 inclusive you will, if requested by Engelhard, provide at least 25 days of services. As compensation for such services, Engelhard will pay you $75,000 payable as set forth in Schedule 1. If during such period Engelhard requests and you perform more than 25 days of services, Engelhard will pay you $3000 for each such day of services in excess of 25 days. Payment for such excess days of services will be made by Engelhard within 30 days following written notice by you to Engelhard that you have rendered such excess services during such period.\n4. From all payments made to you, Engelhard will withhold amounts for federal and state income taxes, FICA and other similar items which Engelhard is obligated to do so with respect to compensation paid to its employees. If your engagement is terminated as provided for in Paragraph 10 below, payments which are not due on or before the date of such termination will not become due, however,\n(i) if such termination is on or before December 31, 1995 (within the period described in Paragraph 2 of this Exhibit A) and if the product of (a) the number of days of service requested by Engelhard and actually rendered by you during the period from May 5, 1995 to termination and (b) $2,000.00 exceeds the amount paid to you with respect to the period described in Paragraph 2 of this Exhibit, Engelhard will pay you the amount of such excess, and\nii) if such termination is on or after January 1, 1996 and on or before December 1, 1996 (within the period described in Paragraph 3 of this Exhibit A) and if the product of (a) the number of days of service requested by Engelhard and actually rendered by you during the period from January 1, 1996 to termination and (b) $3,000.00 exceeds the amount paid to you with respect to the period described in Paragraph 3 of this Exhibit A, Engelhard will pay you the amount of such excess.\n5. A day of rendering services consists of at least four hours during a calendar day spent by you in performing the services requested by Engelhard. If you perform less than four hours of services in any calendar day, you will be deemed to have rendered a fraction of a day of services based on an four hour day. If you perform more than four hours of services in a calendar day, you will, irrespective of anything to the contrary, be deemed to have performed one day of services.\n6. Engelhard will reimburse you for all reasonable travel, lodging and food expenses, as well as other routine business expenses necessarily incurred by you while carrying out requested services as set forth in Paragraph 1 above. You will submit to Engelhard reports of such expenses, accompanied by such receipts as Engelhard may reasonably request.\n7. You will keep in confidence, and will not use for your own benefit or for the benefit of any third party and will not disclose or impart to others, any proprietary material or information disclosed to you by Engelhard, including information received by Engelhard in confidence from third parties as well as any information developed by you at Engelhard's request, unless a release is obtained in writing from Engelhard. You also agree, upon request, to return all written or printed information or samples received from Engelhard.\n8. If, during the term of your engagement, any inventions, improvements or developments are made by you which result from or are related to the services you perform for Engelhard, you will promptly disclose the same to Engelhard and further agree to assign, and do hereby agree to assign, your full rights therein to Engelhard, and to execute all necessary papers transferring such right, title and interest to Engelhard. At Engelhard's request, and with out charge to Engelhard, you will execute any and all additional documents which may be required in connection with the filing of a patent, copyright, or trademark application in the United States or elsewhere covering such inventions, improvements or developments. Engelhard will pay the expenses connected with the preparation and prosecution of all applications filed.\n9. Your obligations under Paragraphs 7 and 8 above are in addition to and not in lieu of any other obligations you may have to Engelhard and its affiliates and subsidiaries with respect to such matters.\n10. Your engagement by Engelhard will automatically terminate upon the earliest of the following:\n(i) December 1, 1996;\n(ii) immediately upon notice from Engelhard to you that in Engelhard's opinion (a) you have failed to perform in accordance with the terms set forth in this EXHIBIT A or (b) you have acted or are acting contrary to Engelhard's interest as reasonably determined by Orin Smith (whether or not he is an employee of Engelhard or, if Orin Smith is unable to make such a determination because of death or incapacity, as reasonably determined by William Dugle;\n(iii) immediately upon your death, incapacity or disability; or\n(iv) immediately upon you securing alternate employment in violation of the provisions of Attachment 1 to the letter to which this EXHIBIT A is attached.\n11. Notwithstanding any termination or expiration of this Agreement, Engelhard's rights and your obligations under Paragraphs 7 and 8 hereof will survive such termination or expiration and shall continue in full force and effect in accordance with the terms hereof.\n12. Each party's obligations and rights under this EXHIBIT A will be interpreted and construed in accordance with the substantive laws of the State of New Jersey.\nSCHEDULE 1 PAYMENT DUE DATES\nFor services described in Paragraph 2 of EXHIBIT A: On or before June 1, 1995 $7200.00 On or before July 1,1995 $7200.00 On or before August 1, 1995 $7200.00 On or before September 1, 1995 $7200.00 On or before October 1, 1995 $7200.00 On or before November 1, 1995 $7200.00 On or before December 1, 1995 $6800.00 -------- TOTAL $50000.00\nFor services described in Paragraph 3 of EXHIBIT A On or before February 1, 1996 $7500.00 On or before March 1, 1996 $7500.00 On or before April 1, 1996 $7500.00 On or before May 1, 1996 $7500.00 On or before June 1, 1996 $7500.00 On or before July 1, 1996 $7500.00 On or before August 1, 1996 $7500.00 On or before September 1, 1996 $7500.00 On or before October 1, 1996 $7500.00 On or before November 1, 1996 $7500.00 -------- TOTAL $75000.00\nFrom the amounts set forth above deductions will be made for federal and state income tax withholding, FICA, and other similar items.\nEXHIBIT B\nRELEASE AND WAIVER\nThis Release and Waiver is made and entered into by Robert Guyett.\n1. For the consideration described in the letter from Engelhard Corporation dated April 28, 1995 (the \"Letter\") to which this Release and Waiver is attached, I hereby knowingly and voluntarily release Engelhard Corporation, its successors, assigns, affiliates, shareholders, officers, directors, agents and employees from any and all claims, liabilities, causes of action and\/or suits of any nature whatsoever which I have or may have as of the date(s) I sign this Release and Waiver, including but not limited to, any such claim that I have or may have under the Americans With Disabilities Act (prohibiting disability discrimination); Title VII of the Civil Rights Act of 1964 (prohibiting race, sex, religion, color and national origin discrimination); the Civil Rights Act of 1866 (prohibiting race discrimination); the laws of the State of New Jersey and\/or of any other federal or state law or common law or any legal or contractual restrictions on Engelhard Corporation's right to termination my employment. This Release and Waiver also includes any claims, causes of action, and suits for breach of employment contract, severance pay, unemployment income assistance and equal pay.\n2. I also specifically release and waive any claims of age discrimination which I may have as of the date(s) I sign this Release and Waiver against Engelhard Corporation, its successors, assigns, affiliates, shareholders, officers, directors, agents and employees under the Age Discrimination in Employment Act, as amended, or any state statute which prohibits discrimination on the basis of age.\n3. I affirm that the only consideration for my agreement to sign, and my signing of this Release and Waiver, is that described in the Letter, that there are no other promises, representations, or agreements of any kind which have been made to me or with me by any person or entity whatsoever to cause me to sign this Release and Waiver except those fully expressed therein.\n4. I agree to use my best efforts to prevent disclosure of the nature and terms of this Release and Waiver, however, I may disclose this Release and Waiver to my attorneys and\/or financial advisors provided that prior to any such disclosure I obtain the agreement of all such persons to whom disclosure is made agree not to disclose the non-public nature and terms of this Release and Waiver. I agree to avoid direct or indirect references to the nature of this Release and Waiver.\n5. I understand and affirm that this Release and Waiver does not constitute any admission by Engelhard Corporation of a violation of any statute, ordinance, or common law; and that the Release and Waiver shall not be deemed an admission, finding, or indication for any purpose whatsoever that Engelhard Corporation has at any time, including the present, acted contrary to the law or violated any rights.\n6. I understand and agree that this Release and Waiver may not be changed orally. Any term of this Release and Waiver which is invalid or unenforceable shall be ineffective to the extent of such invalidity or unenforceability, without affecting in any way the remaining terms hereof.\n7. I understand that I have been encouraged to seek legal advice and counsel regarding the legal and other consequences of the terms and conditions set forth in this document, that I have been advised I have twenty-one days in which to decide to sign this document, and that I have seven days from the date I sign this document to revoke it.\nI have carefully read the foregoing Release and Waiver and affirm that I know and understand the contents thereof. I execute this Release and Waiver of my own free will.\n\/s\/Robert Guyett - --------------------------- Robert Guyett\nATTACHMENT 1\nPROCEDURE REGARDING ALTERNATE EMPLOYMENT\nBefore being employed by any entity or person you will notify in writing Engelhard's Vice President of Human Resources. Such notice will include (i) the name and address of the entity or individual which will employ you, (ii) a detailed description of the services, responsibilities and functions with respect to such employment, (iii) your title, if any, (iv) the title and name of the individual to whom you will report and\/or from whom you will receive assignments, (v) the compensation offered with respect to such employment, and (vi) such other information as Engelhard may request to enable it to make an informed decision whether or not to object to such employment. Employment includes but is not limited to (i) employment in a traditional employer\/employee relationship, (ii) employment as an independent contractor, (iii) the engagement, hiring, retaining or other arrangement under which you provide services to, or for the benefit of, or at the request of, an entity or individual. Employment includes employment on a full time basis and employment on a less than full time basis. Entity includes but is not limited to corporations, companies, firms, partnerships, associations, unions, schools, colleges, universities, governments, and agencies and departments of governments. Engelhard has thirty days of receipt from you of a notice which complies with the requirements for such notice set forth above to object to such employment. Employment excludes directorships on Boards as of May 4, 1995 and enterprises or investments in which you or your family are majority owners. If Engelhard, in its judgment, has a reasonable basis for objecting to you entering into such employment and if you enter into such employment, such employment is alternate employment in violation of the provisions set forth in this Attachment 1.\nNotification by you in one instance does not relieve you of the obligation to subsequently notify Engelhard in other instances or of the obligation to notify Engelhard of subsequent changes with respect to your employment.\nEXHIBIT 10(o):\nFORM OF AGREEMENT WITH KEY EMPLOYEES IN THE EVENT OF AN ACQUISITION OF A CONTROL INTEREST IN THE COMPANY, DATED NOVEMBER 2, 1995\nCHANGE IN CONTROL AGREEMENT\nAgreement, made this 2nd day of November, 1995, by and between ENGELHARD CORPORATION, a Delaware corporation (the \"Company\"), and (the \"Executive\").\nWHEREAS, the Executive is a key employee of the Company, and\nWHEREAS, the Board of Directors of the Company (the \"Board\") considers the maintenance of a sound management to be essential to protecting and enhancing the best interests of the Company and its stockholders and recognizes that the possibility of a change in control raises uncertainty and questions among key employees and may result in the departure or distraction of such key employees to the detriment of the Company and its stockholders; and\nWHEREAS, the Board wishes to assure that it will have the continued dedication of the Executive and the availability of his advice and counsel notwithstanding the possibility, threat or occurrence of a bid to take over control of the Company, and to induce the Executive to remain in the employ of the Company; and\nWHEREAS, the Executive is willing to continue to serve the Company taking into account the provisions of this Agreement;\nNOW, THEREFORE, in consideration of the foregoing, and the respective covenants and agreements of the parties herein contained, the parties agree as follows: 1. Potential Change in Control; Change in Control. Benefits shall be provided hereunder only in the event there shall have occurred a \"Potential Change in Control\" or \"Change in Control,\" as such terms are defined below, and the Executive's employment by the Company shall thereafter have terminated in accordance with Section 2 below within the period beginning on the date of the \"Potential Change in Control\" or \"Change in Control\" and ending on the third anniversary of the date on which a \"Change in Control\" occurs (the \"Protection Period\"); provided, however, that if the Protection Period begins by reason of a \"Potential Change in Control,\" and the Board determines in good faith that a \"Change in Control\" is unlikely to occur, such Protection Period shall end on the date of adoption of a resolution by the Board to that effect. If any Protection Period terminates without the Executive's employment having terminated, any \"Potential Change in Control\" or \"Change in Control\" subsequent to such termination shall give rise to a new Protection Period. No benefits shall be paid under this Agreement if the Executive's employment terminates outside of a Protection Period.\n(i) For purposes of this Agreement, a \"Potential Change in Control\" shall be deemed to have occurred if:\n(A) the Company enters into an agreement the consummation of which, or the approval by shareholders of which, would constitute a Change in Control;\n(B) proxies for the election of directors are solicited by anyone other than the Company;\n(C) any Person (as defined below) publicly announces an intention to take or to consider taking actions which, if consummated, would constitute a Change in Control; or\n(D) any other event occurs which is deemed to be a Potential Change in Control by the Board and the Board adopts a resolution to the effect that a Potential Change in Control has occurred.\n(ii) For purposes of this Agreement, a \"Change in 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 25% or more of either (1) the then outstanding shares of common stock of the Company (the \"Outstanding Company Common Stock\") or (2) 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 the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company (other than by exercise of a conversion privilege); (ii) any acquisition by the Company or any of its subsidiaries; (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any of its subsidiaries; (iv) any acquisition by any corporation with respect to which, following such acquisition, more than 60% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Company Voting Securities immediately prior to such acquisition in substantially the same proportions as their ownership, immediately prior to such acquisition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be; or (v) any acquisition by a Person owning more than 25% of the Outstanding Company Common Stock on the date hereof;\n(B) During any period of two consecutive years, individuals who, as of the beginning of such period, 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 beginning of such period 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 either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act); or\n(C) approval by the shareholders of the Company of a reorganization, merger or consolidation, in each case, with respect to which 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 reorganization, merger or consolidation, do not, following such reorganization, merger or consolidation, beneficially own, directly or indirectly, more than 60% 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 reorganization, merger or consolidation in substantially the same proportions as their ownership, immediately prior to such reorganization, merger or consolidation of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be; or\n(D) approval by the shareholders of the Company of (1) a complete liquidation or dissolution of the Company or (2) a sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation, with respect to which following such sale or other disposition, more than 60% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by 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 sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be.\n2. Termination Following Change in Control. The Executive shall be entitled to the benefits provided in Section 3 hereof upon any termination of his employment with the Company a Protection Period, except a termination of employment (a) because of his death, (b) because of a \"Disability\", (c) by the Company for \"Cause\", or (d) by the Executive other than for \"Good Reason.\"\n(i) Disability. The Executive's employment shall be deemed to have terminated because of a \"Disability\" if the Executive applies for and is determined to be eligible to receive disability benefits under the Company's Long-Term Disability Plan.\n(ii) Cause. Termination of the Executive's employment by the Company for \"Cause\" shall mean termination by reason of the Executive's willful engagement in conduct which involves dishonesty or moral turpitude in connection with his employment and which is demonstrably and materially injurious to the financial condition or reputation of the Company. An act or omission shall be deemed \"willful\" only if done, or omitted to be done, in bad faith and without reasonable belief that it was in the best interest of the Company. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Executive a written notice of termination from the Compensation Committee (the \"Committee\") after reasonable notice to the Executive and an opportunity for him, together with his counsel, to be heard before the Committee, finding that, in the good faith opinion of such Committee, he was guilty of conduct set forth above in the first sentence of this subsection (ii) and specifying the particulars in detail.\n(iii) Without Cause. The Company may terminate the employment of the Executive without Cause during a Protection Period only by giving the Executive written notice of termination to that effect. In that event, the Executive's employment shall terminate on the last day of the month in which such notice is given (or such later date as may be specified in such notice), and the benefits set forth in Section 3 hereof shall be provided to the Executive.\n(iv) Good Reason. Termination of employment by the Executive for \"Good Reason\" shall mean termination:\n(A) within a Protection Period, if there has occurred a reduction by the Company in the Executive's base salary in effect immediately before the beginning of the Protection Period or as increased from time to time thereafter;\n(B) within a Protection Period, and without the Executive's written consent, if the Company has required the Executive to be relocated anywhere in excess of thirty-five (35) miles from his office location immediately before the beginning of the Protection Period, except for required travel on the business of the Company to an extent substantially consistent with the Executive's business travel obligations immediately before the beginning of the Protection Period;\n(C) within a Protection Period, if there has occurred a failure by the Company to maintain plans providing benefits at least as beneficial as those provided by any benefit or compensation plan (including, without limitation, any incentive compensation plan, bonus plan or program, retirement, pension or savings plan, stock option plan, restricted stock plan, life insurance plan, health and dental plan and disability plan) in which the Executive is participating immediately before the beginning of the Protection Period, or if the Company has taken any action which would adversely affect the Executive's participation in or reduce the Executive's benefits under any of such plans or deprive the Executive of any material fringe benefit enjoyed\nby him immediately before the beginning of the Protection Period, or if the Company has failed to provide the Executive with the number of paid vacation days to which he would be entitled in accordance with the normal vacations policy of the Company as in effect immediately before the beginning of the Protection Period; provided, however, that a reduction in benefits under the Company's tax-qualified retirement, pension or savings plans or its life insurance plan, health and dental plan, disability plans or other insurance plans which reduction applies equally to all participants in the plans and has a de minimis effect on the Executive shall not constitute \"Good Reason\" for termination by the Executive;\n(D) within a Protection Period, if the Company has reduced in any manner which the Executive considers important the Executive's title, job authorities or responsibilities immediately before the beginning of the Protection Period;\n(E) within a Protection Period, if the Company has failed to obtain the assumption of the obligations contained in this Agreement by any successor as contemplated in Section 8(c) hereof; or\n(F) within a Protection Period, if there occurs any purported termination of the Executive's employment by the Company which is not effected pursuant to a written notice of termination as described in subsection (ii) or (iii) above.\nThe Executive shall exercise his right to terminate his employment for Good Reason by giving the Company a written notice of termination specifying in reasonable detail the circumstances constituting such Good Reason. In that event, the Executive's employment shall terminate on the last day of the month in which such notice is given.\nA termination of employment by the Executive within a Protection Period shall be for Good Reason if one of the occurrences specified in this subsection (iv) shall have occurred, notwithstanding that the Executive may have other reasons for terminating employment, including employment by another employer which the Executive desires to accept. For purposes of this subsection (iv), any good faith determination of \"Good Reason\" made by the Executive shall be conclusive.\n3. Benefits Upon Termination Within Protection Period. If, within a Protection Period, the Executive's employment by the Company shall be terminated (a) by the Company other than for Cause or because of a Disability, or (b) by the Executive for Good Reason, the Executive shall be entitled to the benefits provided for below:\n(i) The Company shall pay to the Executive through the date of the Executive's termination of employment salary at the rate then in effect, together with salary in lieu of vacation accrued to the date on which his employment terminates, in accordance with the standard payroll practices of the Company;\n(ii) The Company shall pay to the Executive an amount equal to the product of (A) the total incentive pool under the Company's Incentive Compensation Plan (the \"Incentive Plan\") for the Executive for the calendar year that includes the date of the Change in Control, determined based on the Executive's annual base salary in effect at the time of the Change in Control, the Executive's \"Pool Development Factors\" (i.e., cash bonus factor, equity pool factor and stock options factor) under the Incentive Plan for the year that includes the date of the Change in Control, and the highest \"Performance Multiplier\" attributable solely to Company performance under the Incentive Plan for each Pool Development Factor in respect of any of the 3 calendar years immediately preceding the calendar year that includes the date of the Change in Control (or if less than 3 full calendar years have elapsed since December 31, 1994, the number of full calendar years that have elapsed since that date), multiplied by (B) a fraction, the numerator of which is the number of days elapsed in the calendar year through the date of termination of the Executive's employment, and the denominator of which is 365; and such payment shall be made in a lump sum within 10 business days after the date of such termination of employment;\n(iii) The Company shall pay to the Executive an amount equal to the sum of (A) his highest annual salary in effect during any of the 36 months immediately preceding his date of termination of employment, and (B) the total incentive pool under the Incentive Plan for the Executive for the calendar year that includes the date of the Change in Control, determined based on the Executive's annual base salary in effect at the time of the Change in Control, the Executive's \"Pool Development Factors\" (i.e, cash bonus factor, equity pool factor and stock options factor) under the Incentive Plan for the year that includes the date of the Change in Control, and the highest \"Performance Multiplier\" attributable solely to Company performance under the Incentive Plan for each Pool Development Factor in respect of any of the 3 calendar years immediately preceding the calendar year that includes the date of the Change in Control (or if less than 3 full calendar years have elapsed since December 31, 1994, the number of full calendar years that have elapsed since that date); and such payment shall be made in a lump sum within 10 business days after the date of such termination of employment;\n(iv) The Company shall continue to cover the Executive and his dependents under, or provide the Executive and his dependents with insurance coverage no less favorable than, the Company's life, disability, health, dental or other employee welfare benefit plans or programs (as in effect on the day immediately preceding the Protection Period or, at the option of the Executive, on the date of termination of his employment) for a period equal to the lesser of (x) one year following the date of termination or (y) until the Executive is provided by another employer with benefits substantially comparable to the benefits provided by such plans or programs; and\n(v) Following the Executive's termination of employment, the Company shall treat the Executive as if he had continued participation and benefit accruals under the Company's Supplemental Retirement Program or a successor plan (as in effect on the date immediately preceding the Protection Period) for one year following the date of termination, or the Company shall provide an equivalent benefit outside such plan with the result that an additional year of age and service shall be granted to the Executive.\n4. Non-exclusivity of Rights. Nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any benefit, bonus, incentive or other plans, practices, policies or programs provided by the Company or any of its subsidiaries and for which the Executive may qualify, nor shall anything herein limit or otherwise affect such rights as the Executive may have under any stock option or other agreements with the Company or any of its subsidiaries. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, practice, policy or program of the Company or any of its subsidiaries at or subsequent to the date of termination of the Executive's employment shall be payable in accordance with such plan, practice, policy or program.\n5. Full Settlement; Legal Expenses. 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. The Company agrees to pay, upon written demand therefor by the Executive, all legal fees and expenses which the Executive may reasonably incur as a result of any dispute or contest (regardless of the outcome thereof) by or with the Company or others regarding the validity or enforceability of, or liability under, any provision of this Agreement (including as a result of any contest by the Executive about the amount of any payment hereunder), plus in each case interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Internal Revenue Code of 1986, as amended (the \"Code\"). In any such action brought by the Executive for damages or to enforce any provisions of this Agreement, he shall be entitled to seek both legal and equitable relief and remedies, including, without limitation, specific performance of the Company's obligations hereunder, in his sole discretion.\n6. Certain Additional Payments by the Company.\n(a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution made, or benefit provided (including, without limitation, the acceleration of any payment, distribution or benefit), by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 6) (a \"Payment\") would be subject to the excise tax imposed by Section 4999 of the Code (or any similar excise tax) or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the \"Excise Tax\"), then the Executive shall be entitled to receive an additional payment (a \"Gross-Up Payment\") in an amount such that after payment by the Executive of all taxes (including any Excise Tax) imposed upon the Gross-Up Payment and any interest or penalties imposed with respect to such taxes, the Executive retains from the Gross-Up Payment an amount equal to the Excise Tax imposed upon the Payments.\n(b) Subject to the provisions of Section 6(c), all determinations required to be made under this Section 6, including determination of whether a Gross-Up Payment is required and of the amount of any such Gross-Up Payment, shall be made by Coopers & Lybrand (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 of the Executive's employment, if applicable, or such earlier time as is requested by the Company, provided that any determination that an Excise Tax is payable by the Executive shall be made on the basis of substantial authority. The initial Gross-Up Payment, if any, as determined pursuant to this Section 6(b), shall be paid to the Executive within five business days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that he has substantial authority not to report any Excise Tax on his Federal income tax return. Any determination by the Accounting Firm meeting the requirements of this Section 6(b) shall be binding upon the Company and the Executive; subject only to payments pursuant to the following sentence based on a determination that additional Gross-Up Payments should have been made, consistent with the calculations required to be made hereunder (the amount of such additional payments are referred to herein as the \"Gross-Up Underpayment\").\nIn the event that the Company exhausts its remedies pursuant to Section 6(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Gross-Up Underpayment that has occurred and any such Gross-Up Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. The fees and disbursements of the Accounting Firm shall be paid by the Company.\n(c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of a Gross-Up Payment. Such notification shall be given as soon as practicable but not later than ten business days after the Executive receives written notice of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim and that it will bear the costs and provide the indemnification as required by this sentence, the Executive shall:\n(i) give the Company any information reasonably requested by the Company relating to such claim,\n(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company,\n(iii) cooperate with the Company in good faith in order effectively to contest such claim, and\n(iv) permit the Company to participate in any proceedings relating to such claim;\nprovided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 6(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax, including interest or penalties with respect thereto, imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to the payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.\n(d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 6(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then any obligation of the Executive to repay such advance shall be forgiven and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid.\n7. 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 subsidiaries, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its subsidiaries and which shall not be or become public knowledge (other than by acts of the Executive or his representatives in violation of this Agreement). After the date of termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company,\ncommunicate 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 7 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement.\n8. Successors.\n(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 or successor(s) in interest.\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.\n9. Miscellaneous.\n(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(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: If to the Executive:\n------------------------\n------------------------\n------------------------\nIf to the Company:\nEngelhard Corporation 101 Wood Avenue Iselin, New Jersey 08830-0770\nAttention: Arthur A. Dornbusch, II\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 or local taxes as shall be required to be withheld pursuant to any applicable law or regulation.\n(e) The Executive's failure to insist upon strict compliance with any provision hereof shall not be deemed to be a waiver of such provision or any other provision thereof.\n(f) This Agreement contains the entire understanding of the Company and the Executive with respect to the subject matter hereof but does not supersede or override the provisions of any stock option, employee benefit or other plan, program, policy or practice in which Executive is a participant or under which Executive is a beneficiary.\nIN WITNESS WHEREOF, the Executive has hereunto set his hand and, pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed as of the day and year first above written.\nExecutive:\n\/s\/ Martin J. Connor, Jr. \/s\/ Ian P. McLean ------------------------------ ----------------------------- Name: Martin J. Connor, Jr. Name: Ian P. McLean\n\/s\/ Arthur A. Dornbusch, II \/s\/ William E. Nettles ------------------------------ ----------------------------- Name: Arthur A. Dornbusch, II Name: William E. Nettles\n\/s\/ William M. Dugle \/s\/ Barry W. Perry ------------------------------ ----------------------------- Name: William M. Dugle Name: Barry W. Perry\n\/s\/ Joseph E. Gonnella \/s\/ Robert J. Schaffhauser ------------------------------ ----------------------------- Name: Joseph E. Gonnella Name: Robert J. Schaffhauser\n\/s\/ William R. Gustafson \/s\/ Michael A. Sperduto ------------------------------ ----------------------------- Name: William R. Gustafson Name: Michael A. Sperduto\n\/s\/ L. Donald LaTorre \/s\/ Francis X. Vitale, Jr. ------------------------------ ----------------------------- Name: L. Donald LaTorre Name: Francis X. Vitale, Jr.\n\/s\/ James A. Martin ------------------------------ Name: James A. Martin\nENGELHARD CORPORATION\nBy:\/s\/ Arthur A. Dornbusch, II ----------------------------- Name: Arthur A. Dornbusch, II Title: V.P., General Counsel & Secretary Attest:\n\/s\/ William M. Dugle - ----------------------------- Name: William M. Dugle Title: V.P., Human Resources\nEXHIBIT 21:\nSUBSIDIARIES OF THE REGISTRANT\nSubsidiaries of the Registrant ------------------------------ Jurisdiction Under Which Name of Subsidiary Incorporated Or Organized - ------------------ ------------------------- Engelhard West, Inc. California Engelhard Canada, Ltd. Canada Engelhard Industries International, Ltd. Canada Engelhard Technologies, Ltd. Canada EC Delaware, Inc. Delaware Engelhard Asia Pacific, Inc. Delaware Engelhard C Cubed Corporation Delaware Engelhard DT, Inc. Delaware Engelhard EM Holding Company Delaware Engelhard Energy Corporation Delaware Engelhard MC, Inc. Delaware Engelhard Metal Plating, Inc. Delaware Engelhard Pollution Control, Inc. Delaware Engelhard Power Marketing, Inc. Delaware Engelhard Strategic Investments, Inc. Delaware Engelhard Supply Corporation Delaware Mustang Property Corporation Delaware Porocel Corporation Delaware Engelhard Pigments OY Finland Engelhard Pyrocontrole S.A. France Engelhard S.A. France Engelhard Holdings GmbH Germany Engelhard Process Chemicals GmbH Germany Engelhard Technologies GmbH Germany Engelhard Technologies Verwaltsung GmbH Germany Engelhard Italiana S.P.A. Italy Engelhard S.R.L. Italy Engelhard Metals Japan, Ltd. Japan Engelhard DeMeern, B.V. The Netherlands Engelhard Netherlands, B.V. The Netherlands Engelhard Terneuzen, B.V. The Netherlands Harshaw Chemical Company New Jersey Engelhard South Africa, Ltd. South Africa Engelhard Metals A.G. Switzerland Engelhard International, Ltd. United Kingdom Engelhard Limited United Kingdom Engelhard Metals, Ltd. United Kingdom Engelhard Sales, Ltd. United Kingdom Engelhard Technologies, Ltd. United Kingdom Sheffield Smelting Co., Ltd. United Kingdom Engelhard Export Corporation U.S. Virgin Islands\nName of Affiliate - ----------------- Engelhard-CLAL, Ltd. Partnership Delaware Heraeus Engelhard Electrochemistry Delaware Metreon Delaware Engelhard-CLAL SAS France NE Chemcat Corporation Japan Engelhard\/Colortronics New Jersey Engelhard\/ICC Pennsylvania Hankuk-Engelhard Corporation South Korea Acreon Catalysts Texas\nThe names of other subsidiaries have been omitted since such subsidiaries, if considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary as that term is defined in Rule 12b-2 (17 CFR 240.12b-2) promulgated under the Securities Exchange Act of 1934.\nEXHIBIT 23:\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nConsent of Independent Accountants ----------------------------------\nWe consent to the incorporation by reference in the registration statements of Engelhard Corporation on Form S-8 (File Nos. 2-72830, 2-81559, 2-84477, 2- 89747, 33-28540, 33-37724, 33-40365, 33-40338 and 33-43934) of our report dated February 6, 1996, on our audits of the consolidated financial statements of Engelhard Corporation and Subsidiaries, 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.\nCOOPERS & LYBRAND, L.L.P.\nNew York, New York March 22, 1996\nEXHIBIT 24:\nPOWERS OF ATTORNEY ------------------\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Linda G. Alvarado _____________________________ Linda G. Alvarado\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Marion H. Antonini ________________________________ Marion H. Antonini\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ L. Donald LaTorre ________________________________ L. Donald LaTorre\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Anthony W. Lea ________________________________ Anthony W. Lea\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ James V. Napier ______________________________ James V. Napier\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Norma T. Pace ________________________________ Norma T. Pace\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Reuben F. Richards _________________________________ Reuben F. Richards\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Henry R. Slack _______________________________ Henry R. Slack\nENGELHARD CORPORATION\nForm 10-K\nPower of Attorney\nWHEREAS, ENGELHARD CORPORATION intends to file with the Securities and Exchange Commission under the Securities Act of 1934 an Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\nNOW, THEREFORE, the undersigned in his capacity as a director of ENGELHARD CORPORATION hereby appoints Arthur A. Dornbusch, II and Orin R. Smith, or either of them individually, his true and lawful attorney to execute in his name, place and stead, in his capacity as a director of ENGELHARD CORPORATION, said Form 10-K and any and all amendments to said Form 10-K and all instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Said attorney shall have full power and authority to do and perform in the name and on behalf of the undersigned, in any and all capacities, every act whatsoever necessary or desirable to be done in the premises, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of said attorney.\nIN WITNESS WHEREOF, the undersigned has executed this instrument on March 22, 1996.\n\/s\/ Douglas G. Watson _________________________________ Douglas G. Watson\nEXHIBIT 99(a):\nANNUAL REPORT ON FORM 11-K OF THE SALARY DEFERRAL SAVINGS PLAN OF ENGELHARD CORPORATION FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nFORM 11-K\nX ANNUAL REPORT PURSUANT TO SECTION 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)\nFor the fiscal year ended December 31, 1995\n--- TRANSITION REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)\nFor the transition period from _____ to _____\n_______________\nSALARY DEFERRAL SAVINGS PLAN OF ENGELHARD CORPORATION ----------------------------------------------------- (Full title of the plan)\nENGELHARD CORPORATION (Exact name of issuer as specified in its charter)\n101 WOOD AVENUE, ISELIN, NEW JERSEY 08830 - ----------------------------------- --------- (Address of principal executive offices) (Zip code)\nDELAWARE 22-1586002 - ------------------------------- ---------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number)\nSalary Deferral Savings Plan of Engelhard Corporation\nPage ----\nReport of Independent Accountants 150\nStatements of Financial Condition 151-154 at December 31, 1995 and 1994\nStatements of Income and Changes in Plan Equity 155-160 for each of the three years in the period ended December 31, 1995\nNotes to Financial Statements 161-165\nSupplemental Schedule Schedule of Investments at December 31, 1995 and 1994 166-167\nReport of Independent Accountants\nTo the Pension and Employee Benefit Plans Committee of Engelhard Corporation:\nWe have audited the financial statements and the financial statement schedule of the Salary Deferral Savings Plan of Engelhard Corporation listed in the index on Page 149 of this Form 11-K. These financial statements and the financial statement schedule are the responsibility of the Plan'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 the Salary Deferral Savings Plan of Engelhard Corporation as of December 31, 1995 and 1994, and the results of its operations 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.\nNew York, New York March 22, 1996\nNotes to Financial Statements\nNote 1 - Description of the Plan\nThe Salary Deferral Savings Plan of Engelhard Corporation (the Plan), as amended and restated as of January 1, 1995, is designed to provide eligible employees of Engelhard Corporation (the Company) an opportunity to save part of their income by having the Company reduce their compensation and contribute the amount of the reduction to the Plan on a tax deferred or post-tax basis.\nThe following plan description is provided for general information purposes. Participants of the Plan should refer to the plan document for more detailed and complete information.\nEligibility - ----------- Except as specifically included or excluded by the Board of Directors of the Company (the Board), United States salaried employees of the Company and its wholly-owned (directly or indirectly) domestic subsidiaries and all non- collectively bargained hourly employees who have completed at least one year of service, as defined, are eligible to participate in the Plan as of the first day of the month in which they meet the year of service requirement.\nContributions - ------------- The Plan permits eligible employees participating in the Plan the opportunity to defer up to 15 percent of their compensation, as defined, subject to certain restrictions and limitations, and to have that amount contributed to the Plan and the related taxes deferred. Effective January 1, 1995 employees may contribute, subjected to certain restrictions and limitations, up to 10 percent of compensation to the Plan on a post-tax basis.\nMatching Contributions - ---------------------- The Company will contribute, on a monthly basis, subject to certain limitations and exclusions, either cash or common stock of the Company in an amount equal to 50 percent of the first 6 percent contributed by the Participants.\nInvestments - ----------- All contributions to the Plan are held and invested by Vanguard Fiduciary Trust Company (the Trustee). The Trustee maintains eight separate investment funds within the Plan:\na) The Company Stock Fund, consists of assets invested or held for investment in the common stock of the Company. In the event the assets cannot be immediately invested in Company common stock, the funds are invested in short-term securities pending investment in Company common stock.\nb) The Fixed Income Fund, consists of assets invested in shares of the Vanguard Variable Rate Investment Contract Trust. In the event the assets cannot be immediately invested in such shares or deposited as specified above, the assets are invested in direct obligations of the United States Government or agencies thereof or in obligations guaranteed as to the payment of principal and interest by the United States Government.\nc) The Growth Fund, consists of assets invested in the Vanguard Windsor Fund, which invests primarily in common stocks for the purpose of realizing long-term growth of capital and income.\nd) The Balanced Fund, consists of assets invested in the Vanguard Asset Allocation Fund, which invests in stocks, bonds and cash reserves for the purpose of maximizing long- term total return with less volatility than a portfolio of common stock.\ne) The Equity Index Fund, consists of assets invested in the Vanguard Quantitative Portfolio, which invests primarily in common stocks for the purpose of realizing a total return greater than the Standard & Poor's 500 Index while maintaining fundamental investment characteristics similar to such Index.\nf) The International Growth Fund, consists of assets invested in shares of the Vanguard International Growth Portfolio or such other mutual fund or funds which invest primarily in common stocks of companies based outside the United States that have above-average growth potential for the purpose of realizing long-term capital growth.\ng) The Small Cap Fund, consists of assets invested in shares of the Vanguard Small Capitalization Stock Fund or such other mutual fund or funds which invest primarily in common stocks of small-sized companies for the purpose of providing a comparatively low-cost method of passively capturing the investment returns of small-sized companies and attempting to provide investment results that parallel the performance of the unmanaged Russell 2000 Small Stock Index.\nh) The Short-Term Bond Fund, consists of assets invested in shares of the Short-Term Corporate Portfolio of the Vanguard Fixed Income Securities Fund or such other mutual fund or funds which invest primarily in relatively short maturity investment-grade bonds for the purpose of providing a level of current income consistent with a two to three year average maturity while helping to preserve capital.\nParticipants have the right to elect, subject to restrictions, the investment fund or funds in which their contributions are invested. All matching contributions are initially invested in the Company Stock Fund and participants are restricted from transferring these contributions to other funds for one year. Participants at their discretion may elect to transfer to another fund their unrestricted balance. Their unrestricted balance is determined as the sum of all prior year's unrestricted balances plus 25 percent of the prior year's restricted balance after the addition of the prior year's restricted matching contributions.\nThe number of Participants in each fund was as follows at December 31:\nParticipants 1995 1994 ----- ----- Company Stock Fund 1,954 1,958 Fixed Income Fund 1,267 1,377 Growth Fund 1,074 1,069 Balanced Fund 550 532 Equity Index Fund 560 546 International Growth Fund 227 169 Small Cap Fund 139 93 Short-Term Bond Fund 97 42\nThe total number of Participants in the Plan was less than the sum of the number of Participants shown above because many were participating in more than one fund.\nThe number of units representing Participant interests in each fund and the related net asset value per unit were as follows at December 31:\nVesting - ------- Participants at all times have a fully vested and non-forfeitable interest in their contributions and in the matching contributions allocated to their account.\nLoan Provision - -------------- The Plan allows Participants who have participated in the Plan for at least one year to borrow funds from their accounts, subject to certain terms and conditions, at a reasonable interest rate as determined by the Company in accordance with applicable laws and regulations.\nTermination - ----------- The Company, although it expects and intends to continue the Plan indefinitely, has reserved the right of the Board to terminate or amend the Plan.\nDistributions and Withdrawals - ----------------------------- All distributions and withdrawals from the Plan are made to Participants in a lump sum cash payment except those amounts distributed from the Company Stock Fund which may, at the Participant's election, be paid in full shares of the Company's Common Stock with cash paid in lieu of fractional shares.\nNote 2 - Accounting Policies\nThe accounts of the Plan are maintained on an accrual basis. Purchases and sales of investments are reflected on a trade date basis. Assets of the Plan are valued at fair value. Gains and losses on distributions to participants and sales of investments are based on average cost.\nNote 3 - Income Tax Status\nThe Plan and the Trust created thereunder are intended to qualify under Sections 401(a) and 501(a) of the Internal Revenue Code of 1986, as amended (the Code) and the Plan includes a cash or deferred arrangement intended to meet the requirements of Section 401(k) of the Code. The Internal Revenue Service has issued a favorable determination letter as to the Plan's qualified status under the Code. Amounts contributed to and earned by the Plan are not taxed to the employee until a distribution from the Plan is made. In addition, the unrealized appreciation on any shares of common stock of the Company distributed to an employee is not taxed until the time of disposition of such shares.\nNote 4 - Administrative Expenses\nAll expenses of the Plan are paid for by the Company. Investment advisory fees for portfolio management of the Vanguard funds are paid directly from fund earnings. Advisory fees are included in the fund expense ratio and will not reduce the assets of the Plan. Brokerage commissions paid to purchase Engelhard Corporation common stock are being charged against each participant's fund unit value.\nNote 5 - Concentrations of Credit Risk\nFinancial instruments which potentially subject the Plan to concentrations of credit risk consist principally of investment contracts with insurance and other financial institutions. The Plan places its investment contracts with high-credit quality institutions and, by policy, limits the amount of credit exposure to any one financial institution.\nNote 6 - Investments\nInvestments in the Common Stock of the Company are valued at the readily-available, quoted market price as of the valuation date and investments in Vanguard Funds are valued based on the quoted net asset value (redemption value) of the respective investment company as of the valuation date.\nNote 7 - Engelhard-CLAL Transfer\nIn connection with the formation of a joint venture (Engelhard-CLAL) on June 21, 1995, the Plan transferred assets of $4,540,920 to the Engelhard-CLAL-LP Salary Deferral Savings Plan.\nSchedule I\nSalary Deferral Savings Plan of Engelhard Corporation Schedule of Investments at December 31, 1995\nApproximate Cost Market Value ----------- ------------ Company Stock Fund - ------------------\nCommon Stock of $29,299,124 $46,021,699 Engelhard Corporation (2,115,940 shares)\nCash equivalents 225,176 225,176\nFixed Income Fund - -----------------\nVanguard Variable Rate 26,317,093 26,317,093 Investment Contract Trust\nGrowth Fund - -----------\nVanguard Windsor Fund 16,678,535 17,593,710\nBalanced Fund - -------------\nVanguard Asset Allocation Fund 5,251,614 6,167,856\nEquity Index Fund - -----------------\nVanguard Quantitative Portfolio 5,105,725 6,062,770\nInternational Growth Fund - -------------------------\nVanguard International Growth Portfolio 1,753,923 1,913,421\nSmall Cap Fund - --------------\nVanguard Small Capitalization Stock Fund 886,241 991,499\nShort-term Bond Fund - --------------------\nVanguard Fixed Income Securities Fund 424,632 431,943 ----------- -----------\nTotal $85,942,063 $105,725,167\nSchedule I\nSalary Deferral Savings Plan of Engelhard Corporation Schedule of Investments at December 31, 1994\nApproximate Cost Market Value ----------- ------------ Company Stock Fund - ------------------\nCommon Stock of $25,694,373 $33,805,315 Engelhard Corporation (1,519,340 shares)\nCash equivalents 303,198 303,198\nFixed Income Fund - -----------------\nVanguard Variable Rate 24,825,964 24,825,964 Investment Contract Trust\nGrowth Fund - -----------\nVanguard Windsor Fund 13,527,493 12,805,735\nBalanced Fund - -------------\nVanguard Asset Allocation Fund 3,595,263 3,613,654\nEquity Index Fund - -----------------\nVanguard Quantitative Portfolio 3,991,048 3,917,960\nInternational Growth Fund - -------------------------\nVanguard International Growth Portfolio 1,316,791 1,319,115\nSmall Cap Fund - --------------\nVanguard Small Capitalization Stock Fund 609,353 575,560\nShort-term Bond Fund - --------------------\nVanguard Fixed Income Securities Fund 133,640 129,389 ----------- -----------\nTotal $73,997,123 $81,295,890\nEXHIBIT 99(b):\nANNUAL REPORT ON FORM 11-K OF THE ENGELHARD CORPORATION SAVINGS PLAN FOR HOURLY PAID EMPLOYEES FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nFORM 11-K\nX ANNUAL REPORT PURSUANT TO SECTION 15(d) OF THE - --- SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)\nFor the fiscal year ended December 31, 1995\nTRANSITION REPORT PURSUANT TO SECTION 15(d) OF THE - --- SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)\nFor the transition period from _____ to _____\n------------------\nENGELHARD CORPORATION SAVINGS PLAN FOR HOURLY PAID EMPLOYEES ------------------------------------------------------------ (Full title of the plan)\nENGELHARD CORPORATION --------------------- (Exact name of issuer as specified in its charter)\n101 WOOD AVENUE, ISELIN, NEW JERSEY 08830 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code)\nDELAWARE 22-1586002 - ------------------------------- --------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number)\nEngelhard Corporation Savings Plan for Hourly Paid Employees\nPage ----\nReport of Independent Accountants 171\nStatements of Financial Condition 172-173 at December 31, 1995 and 1994\nStatements of Income and Changes in 174-176 Plan Equity for each of the three years in the period ended December 31, 1995\nNotes to Financial Statements 177-181\nSupplemental Schedule Schedule of Investments at December 31, 1995 and 1994 182-183\nReport of Independent Accountants ---------------------------------\nTo the Pension and Employee Benefit Plans Committee of Engelhard Corporation:\nWe have audited the financial statements and the financial statement schedule of the Engelhard Corporation Savings Plan for Hourly Paid Employees listed in the index on Page 170 of this Form 11-K. These financial statements and the financial statement schedule are the responsibility of the Plan'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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Engelhard Corporation Savings Plan for Hourly Paid Employees as of December 31, 1995 and 1994, and the results of its operations 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.\nNew York, New York March 22, 1996\nNotes to Financial Statements\nNote 1 - Description of the Plan\nThe Engelhard Corporation Savings Plan for Hourly Paid Employees (the Plan), effective as of January 1, 1991, is designed to provide eligible employees of Engelhard Corporation (the Company) an opportunity to save part of their income by having the Company reduce their compensation and contribute the amount of the reduction to the Plan on a tax deferred basis.\nThe following plan description is provided for general information purposes. Participants of the Plan should refer to the Plan document for more detailed and complete information.\nEligibility - ----------- Except as specifically included or excluded by the Board of Directors of the Company (the Board), the hourly paid employees of Engelhard Corporation represented by Locals 223, 237 and 238, Independent Workers of North America, Local 1668 of the United Automobile Workers, Local 170 of the United Steel Workers of America, Local 8-406 of the Oil, Chemical and Atomic Workers International Union, Local 663 of the International Chemicals Workers Union and as of January 1, 1996 Local 73 of the International Chemical Workers Union who have completed at least one year of service, as defined, are eligible to participate in the Plan as of the first day of the month in which they meet the year of service requirement.\nContributions - ------------- The Plan permits eligible employees participating in the Plan (the Participants) to elect to reduce their compensation, as defined, by a whole percentage thereof, subject to limitations, and to have that amount contributed to the Plan and the related taxes deferred.\nMatching Contributions - ---------------------- The Company will contribute, on a monthly basis and subject to limitations and exclusions, either cash or common stock of the Company in an amount, ranging from 10 percent to 25 percent, depending on the union contract, of the amount contributed by the Participants. Effective January 1, 1996 the maximum Company contribution was increased to 50 percent, depending on the union contract, of the amount contributed by the Participants.\nInvestments - ----------- All contributions to the Plan are held and invested by Vanguard Fiduciary Trust Company (the Trustee). The Trustee maintains five separate investment funds within the Plan:\na) The Company Stock Fund consists of assets invested or held for investment in the common stock of the Company. In the event the assets cannot be immediately invested in Company common stock, the funds are invested in short-term securities pending investment in Company common stock.\nb) The Fixed Income Fund consists of assets invested in shares of the Vanguard Variable Rate Investment Contract Trust. In the event the assets cannot be immediately invested in such shares or deposited as specified above, the assets are invested in direct obligations of the United States Government or agencies thereof, or obligations guaranteed as to the payment of principal and interest by the United States Government.\nc) The Explorer Fund consists of assets invested in shares of the Vanguard Explorer Fund, which invests in common stocks of small companies with favorable prospects for above-average growth in market value.\nd) The Balanced Fund consists of assets invested in the Vanguard Asset Allocation Fund, which invests in stocks, bonds and cash reserves for the purpose of maximizing long- term total return with less volatility than a portfolio of common stock.\ne) The Equity Index Fund consists of assets invested in the Vanguard Quantitative Portfolio, which invests primarily in common stocks for the purpose of realizing a total return greater than the Standard & Poor's 500 Index while maintaining fundamental investment characteristics similar to such Index.\nParticipants have the right to elect, subject to restrictions, the investment fund or funds in which their contributions are invested. All matching contributions are initially invested in the Company Stock Fund and participants are restricted from transferring these contributions to other funds for one year. Participants at their discretion may elect to transfer to another fund their unrestricted balance. Their unrestricted balance is calculated as the sum of all prior year's unrestricted balances plus 25 percent of the prior year's restricted balance after the addition of the prior year's restricted matching contribution.\nThe number of Participants in each fund was as follows at December 31:\nParticipants 1995 1994 ---- ---- Company Stock Fund 705 633 Fixed Income Fund 396 413 Explorer Fund 1 - Balanced Fund 192 163 Equity Index Fund 199 172\nThe total number of Participants in the Plan was less than the sum of the number of Participants shown above because many were participating in more than one fund.\nThe number of units representing Participant interests in each fund and the related net asset value per unit were as follows at December 31:\nParticipant interests\nCompany Stock Fixed Income Balanced Equity Index Fund Fund Fund Fund ------------- ------------ -------- ------------ 1995: Units 91,532 1,947,712 32,262 27,593 Value per unit $36.90 $1.00 $17.05 $19.95\n1994: Units 73,373 1,853,050 26,186 24,837 Value per unit $25.25 $1.00 $13.54 $15.56\nVesting - ------- Participants at all times have a fully vested and non-forfeitable interest in their contributions and in the matching contributions allocated to their account.\nTermination - ----------- Although it expects and intends to continue the Plan indefinitely, the Company has reserved the right of the Board to terminate or amend the Plan.\nDistributions and Withdrawals - ----------------------------- All distributions and withdrawals from the Plan are made to Participants in a lump sum cash payment except those amounts distributed from the Company Stock Fund which may, at the Participant's election, be paid in full shares of the Company's Common Stock with cash paid in lieu of fractional shares.\nNote 2 - Accounting Policies\nThe accounts of the Plan are maintained on an accrual basis. Purchases and sales of investments are reflected on a trade date basis. Assets of the Plan are valued at fair value. Gains and losses on distributions to participants and sales of investments are based on average cost.\nNote 3 - Income Tax Status\nThe Plan and the Trust created thereunder are intended to qualify under Sections 401(a) and 501(a) of the Internal Revenue Code of 1986, as amended (the Code) and the Plan includes a cash or deferred arrangement intended to meet the requirements of Section 401(k) of the Code. The Internal Revenue Service has issued a favorable determination letter as to the Plan's qualified status under the Code. Amounts contributed to and earned by the Plan are not taxed to the employee until a distribution from the Plan is made. In addition, any unrealized appreciation on any shares of common stock of the Company distributed to an employee is not taxed until the time of disposition of such shares.\nNote 4 - Administrative Expenses\nAll expenses of the Plan are paid for by the Company. Investment advisory fees for portfolio management of Vanguard funds are paid directly from fund earnings. Advisory fees are included in the fund expense ratio and will not reduce the assets of the Plan. Brokerage commissions paid to purchase Engelhard Corporation common stock are being charged against each participant's fund unit value.\nNote 5 - Concentrations of Credit Risk\nFinancial instruments which potentially subject the Plan to concentrations of credit risk consist principally of investment contracts with insurance and other financial institutions. The Plan places its investment contracts with high-credit quality institutions and, by policy, limits the amount of credit exposure to any one financial institution.\nNote 6 - Investments\nInvestments in the Common Stock of the Company are valued at the readily-available, quoted market price as of the valuation date and investments in the Vanguard Funds are valued based on the quoted net asset value (redemption value) of the respective investment company as of the valuation date.\nThe net realized gain (loss) on disposition of investments was computed as follows:\nCommon Equity Stock Balanced Index Net realized gain (loss) Fund Fund Fund Combined ------- --------- -------- -------- Year ended December 31, 1995 - Amount realized $695,731 $153,120 $176,717 $1,025,568 Cost-average 424,567 133,710 156,162 714,439 Net realized gain 271,164 19,410 20,555 311,129\nYear ended December 31, 1994 - Amount realized $181,313 $ 17,714 $ 28,297 $ 227,324 Cost-average 145,839 18,163 29,061 193,063 Net realized gain (loss) 35,474 (449) (764) 34,261\nYear ended December 31, 1993 - Amount realized $ 45,185 $ 12,115 $ 19,261 $ 76,561 Cost-average 35,924 11,224 17,476 64,624 Net realized gain 9,261 891 1,785 11,937\nThe net unrealized appreciation (depreciation) of investments held was computed as follows:\nCompany Equity Net unrealized appreciation Stock Balanced Index (depreciation) Fund Fund Fund Combined --------- --------- -------- ----------\nYear ended December 31, 1995 - Balance, beginning of year $ (15,981) $(8,473) $(16,738) $ (41,192) Net change 541,991 76,481 91,556 710,028 Balance, end of year 526,010 68,008 74,818 668,836\nYear ended December 31, 1994 - Balance, beginning of year $ 211,304 $ 9,313 $ (1,825) $ 218,792 Net change (227,285) (17,786 (14,913) (259,984) Balance, end of year (15,981) (8,473) (16,738) (41,192)\nYear ended December 31, 1993 - Balance, beginning of year $ 205,405 $ 4,099 $ 3,286 $ 212,790 Net change 5,899 5,214 (5,111) 6,002 Balance, end of year 211,304 9,313 (1,825) 218,792\nNote 7 - Engelhard-CLAL Transfer\nIn connection with the formation of a joint venture (Engelhard-CLAL) on June 21, 1995, the Plan transferred assets of $892,347 to the Engelhard-CLAL-LP Plan for Hourly Paid Employees.\nNote 8 - Subsequent Events\nEffective January 1, 1996 the Plan was amended and restated to allow participants who have participated in the plan for at least one year to borrow funds from their accounts, subject to certain terms and conditions, at a reasonable rate of interest as determined by the Company in accordance with applicable laws and regulations.\nEffective January 1, 1996, the Vanguard Money Market reserves will be available as an investment option.\nSchedule I\nEngelhard Corporation Savings Plan for Hourly Paid Employees Schedule of Investments at December 31, 1995\nApproximate Cost Market Value ---------- ------------\nCompany Stock Fund - ------------------\nCommon Stock of $2,727,052 $3,253,062 Engelhard Corporation (149,566 shares)\nCash equivalents 15,917 15,917\nFixed Income Fund - -----------------\nVanguard Variable Rate 1,896,933 1,896,933 Investment Contract Trust\nBalanced Fund - -------------\nVanguard Asset Allocation 466,463 534,471 Fund\nEquity Index Fund - -----------------\nVanguard Quantitative 459,456 534,274 Portfolio ---------- ----------\nTotal $5,565,821 $6,234,657 ========== ==========\nSchedule I\nEngelhard Corporation Savings Plan for Hourly Paid Employees Schedule of Investments at December 31, 1994\nApproximate Cost Market Value ---------- ------------\nCompany Stock Fund - ------------------\nCommon Stock of $1,776,935 $1,760,954 Engelhard Corporation (79,144 shares)\nCash equivalents 15,813 15,813\nFixed Income Fund - -----------------\nVanguard Variable Rate 1,791,769 1,791,769 Investment Contract Trust\nBalanced Fund - -------------\nVanguard Asset Allocation 348,321 339,848 Fund\nEquity Index Fund - -----------------\nVanguard Quantitative 387,365 370,627 Portfolio ---------- ----------\nTotal $4,320,203 $4,279,011 ========== ==========","section_15":""}
{"filename":"278048_1995.txt","cik":"278048","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAuto-trol Technology Corporation and its wholly-owned subsidiaries (referred to hereafter as \"Auto-trol\" or the \"Company\") develop, integrate, market, sell, and support its products and the products of certain third-party vendors for end user markets involved in: product data management, physical network management, mapping, technical illustration, design, engineering, drafting, and manufacturing processes. Historically, the Company sold proprietary hardware products. However, reduced margins on hardware products have caused the Company to sell less hardware to its customers than in past years. The Company continues to shift the sales and support focus from hardware to internally developed software and systems integration. The Company will continue to sell hardware primarily as part of a total systems solution. Auto-trol believes that by offering customers a broad spectrum of applications and options from analysis through implementation and ongoing support, the Company is able to develop long- term relationships with its customers and expand into new markets. The Company's business is not seasonal in nature nor is the Company dependent on any single individual customer. On June 30, 1995, AT Development Inc., a wholly owned subsidiary of Auto-trol Technology Corporation, acquired a 100% interest in Metaware, Inc. doing business as Centra 2000, Inc. Financial results for the years ended September 30, 1995, and 1994 reflect the combination of the Company's results of operations for the years ended September 30, 1995, and 1994 with Centra 2000, Inc. results of operations from commencement of Centra 2000, Inc.'s operations of October 1, 1994. Both the Company and Centra 2000, Inc. were under common control at the date of acquisition.\nPRODUCTS\nCENTRA 2000(TM)\nThe CENTRA 2000 system is a product data management, document management and workflow system specifically designed to solve the complex problems facing engineering, manufacturing, technical publishing, petrochemical and other operations. The product is intended for scaleable implementation from the work group to the entire enterprise. In addition to traditional Product Data Management (PDM) functions, the CENTRA 2000 product manages pure data environments, audio\/video and large document assemblies. The product is designed to fit a customer's environment with a general focus to automate configuration management and project management, as well as processes integrated with a customer's hardware and business systems, rules and procedures. The core CENTRA 2000 technology was used to develop the NASA Electronic Library System (NELS), which serves as a solution for configuration management of technical documentation and programming source code. CENTRA 2000 technology was also used to map and track the parts list for the space station.\nKONFIG(TM)\nThe KONFIG product is advanced software for physical network, cable\/wire, and asset management of data, voice or video networks. The KONFIG software stores and models the entire network infrastructure in ORACLE(R)'S relational database management system (RDBMS), including both active elements such as workstations, hubs, routers, and switches, along with passive elements such as cables, connectors, distribution frames, and patch panels. The spatial location, topological information, connectivity, and non-graphic attributes of each network object are stored in the ORACLE RDBMS. A detailed graphical representation of the network can be automatically generated from the database and overlayed on a facility drawing. Auto-trol's powerful Series 5000(TM) graphic engine is used to generate graphic views of the network as well as create and modify the facility drawings. The KONFIG Network Manager product provides integration with industry-leading network management tools.\nMOZAIC(TM)\nThe Mozaic suite of applications is a new generation of software providing feature-based applications to easily take a product from conceptual design through the manufacturing and assembly processes. Emphasizing ease of use, interoperability, single data modeling and re-use of legacy databases, the core functionality of the Mozaic product is developed using the latest object- oriented technology. The basic Mozaic product offering includes Mozaic Assembly, Mozaic Modeler and Mozaic Drafter modules, along with other external file converters.\nThe Mozaic Assembly module is a feature-based application that allows the user to perform \"top down\" or \"bottom up\" assembly modeling, using solid and\/or surface models as needed. The Mozaic Modeler module is a feature-based solid modeling application that provides the user with a set of tools needed to perform conceptual and detail design work. The Mozaic Drafter module is a robust drafting application that complements Mozaic Assembly and Modeler\nmodules and provides 2D drafting capabilities. Optional Mozaic modules include Mozaic Surfacing, Mozaic Manufacturing and gateways.\nSERIES 5000(TM)\nThe Series 5000 product is a graphics design platform consisting of graphics tools, macro languages and a relational database query language that allows engineers and designers to create, visualize and document their designs. As Auto-trol's flagship product for more than a dozen years, the Series 5000 product is used primarily in the architectural, engineering and construction fields. The Series 5000 product has a set of accompanying products such as data converters, plotter drivers and application specific tools.\nSERIES 7000(TM)\nThe Series 7000 system is a suite of graphics products used to design and document mechanical parts and assemblies. Manufacturing companies are traditionally the largest users of the Series 7000 system. Applications such as three-dimensional part design, the creation of numerical control machining programs, and the engineering analysis of mechanical parts and assemblies are examples of how Auto-trol customers use the Series 7000 system.\nTECH ILLUSTRATOR(TM)\nAuto-trol's Electronic Publishing Solutions (EPS) product line, comprised of a suite of application and converter products, embodies a standards-based solution set that augments illustration productivity \"off-the-shelf\". The EPS product line enables compliance with important military and commercial standards that affect contemporary publishing operations. Auto-trol's solution provides access to a wide variety of reference material ranging from legacy hard copy and electronic archives to current digital 3D design data, for direct use in creating illustration views. The EPS product line provides the added advantage of being easily and extensively customized to adhere to end user requirements.\nGEOSTATION(R) GIS\nThe Geostation product is an integrated exploration data management and mapping solution that allows for visualization of complex data. This product is used as a subsurface exploration tool in oil and gas exploration and for assessment of mineral rights associated with land. Geostation software is also used in the mapping and cartography industry.\nApproximately 23%, 25% and 18% of total revenue was derived from software sales for the years ended September 30, 1995, 1994 and 1993 respectively.\nHARDWARE\nAuto-trol helps its customers configure hardware to be integrated with Auto-trol proprietary and third-party software. The Company integrates hardware from suppliers including Hewlett Packard Company (HP) and Sun Microsystems, Inc. (Sun). For further information see subheading \"Sources of Supply\" under Item 1. In fiscal year 1994, the Company had limited development of hardware products to ancillary products that complement third-party vendor hardware. Approximately 19%, 21% and 23% of total revenue was derived from hardware sales for the years ended September 30, 1995, 1994 and 1993 respectively.\nCUSTOMER SUPPORT\nCONSULTING SERVICES\nAuto-trol offers consulting services that include software and hardware needs assessments, system configuration and implementation of its products, third party product integration and system customization. Additionally, Auto-trol can develop custom software or modify its existing software products to solve specific customer needs. These services are sold in conjunction with product sales and have standard rates. Occasionally, Auto-trol will develop custom software or modify existing software products. Approximately 8%, 9%, and 5% of total revenue was derived from consulting service revenue for the years ended September 30, 1995, 1994 and 1993, respectively.\nEDUCATIONAL SERVICES\nAuto-trol provides comprehensive product training programs for all of the Company's applications. Additionally, Auto-trol provides certified HP and Sun training and offers a wide range of courses both domestically and\ninternationally. Approximately 7%, 5%, and 3% of total revenue was derived from education service revenue for the years ended September 30, 1995, 1994 and 1993, respectively.\nNATIONAL TECHNICAL SUPPORT\nAuto-trol believes that the quality of customer support is an important factor in helping the customer to attain and maintain productivity levels and its related return on investment in Auto-trol products. Post-sale customer support services are provided on a time and materials basis or under warranties and service contracts. Approximately 20% of Auto-trol's employees are engaged in post-sales support functions. A technical staff offers software support services for most problems. Field and applications engineers provide customer support for repair service and preventative maintenance for hardware, and in some cases, support for software applications. Approximately 43%, 41% and 49% of total revenue was derived from customer support revenue for the years ended September 30, 1995, 1994 and 1993, respectively.\nRESEARCH AND PRODUCT DEVELOPMENT\nApproximately 40% of Auto-trol's employees are engaged in research and product development activities. The Company has and will continue significant investment in product development and enhancement due to rapidly changing technology, competitive pressures, and customer demands. The expenditures from 1993 through 1995 are as follows:\nMARKETING\nAuto-trol's customers are chiefly from the petroleum, pharmaceutical, chemical, manufacturing, engineering, and public utility industries. Governmental customers include federal, state and municipal agencies. The Company markets and sells its products and services directly to end users in the United States from its twelve Domestic sales offices. The Company markets its products in Europe through wholly owned subsidiaries with offices located in Germany, Sweden, and the United Kingdom. Additionally, the Company markets its products in Canada through Auto-trol Technology (Canada) Ltd., a wholly owned subsidiary, and in Australia through a Company sales office. Export sales to South America and the Pacific Rim countries are handled by independent distributors. The Company ships product to its distributors after the sale has been negotiated with the end customer. The Company does not grant rights to the distributor to return products for other merchandise, credit, or refund.\nThe following table states the revenue derived from foreign sales for the last three fiscal years. For additional financial information about foreign or domestic operations and export sales, see Note 8 of \"Notes to the Consolidated Financial Statements.\"\nCustomers may purchase hardware and software systems with related services, or they may purchase software and services independently. The Company maintains standard pricing structures for hardware and software products. Pricing of customer service contracts is determined based on customer needs. As is customary in the industry, the Company licenses its software and sublicenses third-party software to protect the ownership of such software. The Company's Process License Agreement provides for a transfer of the product, but limits disclosure of the software to third parties. Auto-trol offers a 90 day warranty on its software products. Auto-trol will administer and recognize vendor warranties of third-party software products. Payment terms are net 30 upon receipt of invoice.\nDue to the competitive pressures in the software industry, the Company strives to minimize the time that elapses from the approval of purchase orders to the date of shipment of the product. Therefore, the Company routinely ships software products to its customers within twenty-four hours after approval of the order. Shipment of hardware products is dependent on vendor supply as the Company does not maintain a large inventory.\nThe Company's backlog at the end of a quarter only represents a portion of future sales and should not be used solely to predict future results. Orders in backlog may be canceled but are subject to a cancellation fee. The Company's recorded backlog was approximately $1.2 million as of September 30, 1995, compared to $1.6 million as of September 30, 1994.\nCOMPETITION\nWithin the Product Data Management market, the Company's primary competitors are Sherpa Corporation, Xerox\/Documentum, and Structural Dynamic Research Company (SDRC). Intergraph Inc. is a competitor in the process industry and technical illustration market. ISICAD, Inc. and Accugraph Corporation are the primary competitors in the physical electronic network market. In the Manufacturing Computer Aided Design (M-CAD) market, Parametric Technology Corporation, SDRC and Computervision Corporation are among the Company's top competitors. The Company believes that its products in the design, drafting, and product and network management markets, uniquely leverage the Company's core competencies in the engineering graphics and documentation areas to provide a total solution to the customer.\nAuto-trol competes primarily on the basis of quality and technical expertise. The Company believes the functionality of its applications products, technical support, and responsiveness to customer needs enhances its competitive position. The Company believes that, although price is a competitive factor, customers consider product functionality, ease of implementation, and user friendliness to be of greater importance when selecting a vendor's product.\nSOURCES OF SUPPLY\nMany of the parts and components used by the Company are available from several sources, although the Company currently purchases certain key components from single suppliers. The Company has agreements with Sun and HP for their hardware platforms. The Company believes relations with its suppliers are good and does not anticipate difficulty in receiving equipment as scheduled. The Company's operations would be adversely affected if it experienced significant delays in delivery from suppliers. Additionally, if production of one or more vendor's computer products was wholly discontinued, operations would be negatively impacted as this would require software modifications in the Company's graphics systems.\nThe agreement in place with HP is dated July, 1994. This agreement renews each year in July and is currently effective through June, 1996. Pursuant to that agreement, HP provides certain hardware equipment at various discounts. This equipment must be used with systems developed by Auto-trol, in the country where the equipment is purchased. This agreement is international in scope. The Company is also providing refurbishment services to HP for hardware components manufactured by HP.\nThe agreement in place with Sun is dated April 30, 1993. This agreement renews each year in June and is currently effective until June, 1996. Pursuant to that agreement, Sun provides certain hardware equipment to Auto-trol at discounts based upon volume with special discounts for certain equipment. This equipment is to be used with systems developed by Auto-trol, in the country where the equipment is purchased. This agreement is international in scope, and provides for marketing cooperation.\nAuto-trol also buys other components and devices such as magnetic disk and tape drives, keyboards and printers from single sources. Alternate sources for these items are generally available and loss of a particular supplier would not have a material effect on the Company's operations.\nPATENTS AND LICENSES\nThe Company holds five patents, issued in the United States, and one patent in each of Canada, Australia and Taiwan for license management methods. Generally, the Company seeks to protect aspects of its systems through trade secret protection. The Company's standard Process License Agreement prohibits the customer from disclosing any confidential or proprietary information. Included in the Company's purchase of vendor equipment is the right to resell and sublicense systems software licenses under Auto-trol's standard Process License Agreement.\nThe Company is also licensed to use and sublicense a limited number of graphics and applications programs developed by others. The Company does not believe that the manufacture and sales of its products require additional licenses from others. If such licenses were required, the Company believes that it would not have a materially adverse financial impact on operations.\nEMPLOYEES\nThe Company has no collective bargaining agreements and there have been no work stoppages due to labor difficulties. The Company believes that relations with its employees are good. As of September 30, 1995, Auto-trol had 353 employees which includes 142 in research and development, 42 in customer support, 65 in administrative support, 87 in sales and support and 17 in marketing.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's 127,000 square foot corporate headquarters facility is located on a 20-acre site about 15 miles North of downtown Denver, Colorado, in the City of Thornton. Financing for this facility was obtained primarily through the issuance of $6 million of Industrial Development Revenue Bonds, Series 1979, by the City of Thornton, Colorado, which mature through 2004.\nThe Company also leases approximately 35,000 square feet of office space throughout the United States, approximately 25,000 square feet in Canada, and approximately 21,000 square feet in Europe.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any material pending legal proceedings before any court, administrative agency or other tribunal.\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 the fiscal year covered by this report.\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 traded on the NASDAQ SmallCap Market System under the symbol ATTC. The following table sets forth the range of high and low closing sale prices in the NASDAQ National Market System and the National SmallCap Market System for the common stock for the fiscal quarters indicated, as reported by NASDAQ.\nAs of December 12, 1995, there were 728 holders of record of the Company's common stock. The Company has never paid or declared any dividends on its common stock. The indenture to the Industrial Development Revenue Bonds restricts the payment of dividends to the amount of $2,000,000 minus 100% of the accumulated deficit subsequent to December 31, 1978.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\/1\/Restated to reflect the acquisition of a 100% interest in Metaware, Inc. on June 30, 1995. See Note 9 to the Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOVERVIEW\nDuring 1995 the Company continued to shift its sales efforts from hardware sales to internally developed software and system integration services. Sales of products based on the Company's Series 5000 and Series 7000 platforms continued to decline as cheaper alternative products on the personal computer platform continue to erode the Company's installed base of UNIX(R) design and drafting products. Operating losses continued for the seventh consecutive year due primarily to the lack of revenue growth from products in development in the M- CAD, PDM and network configuration markets. These sales did not materialize due in part to product development delays as well as an increased complexity of the sales cycle in these markets. The Company continues to believe that its products in these market areas, when complete, will present a unique complementary combination that will differentiate the Company from its competitors.\nDue to the nature of the software industry, the future operating results of the Company depend largely on its ability to rapidly and continuously develop and deliver new software products that are competitively priced and offer enhanced performance. During fiscal 1995, the Company lowered its prices on its product data management and network configuration products. The Company believes that these products are competitive both functionally and from a pricing perspective. However, the Company is unable to predict the impact of new products or the effect that industry economic conditions will have on future results of operations.\nBUSINESS COMBINATION WITH RELATED PARTY - On June 30, 1995, AT Development Inc., a wholly owned subsidiary of Auto-trol Technology Corporation, acquired a 100% interest in Metaware, Inc. doing business as Centra 2000, Inc. Financial results for the years ended September 30, 1995, and 1994 reflect the combination of the Company's results of operations for the years ended September 30, 1995, and 1994 with Centra 2000, Inc. results of operations from commencement of Centra 2000, Inc.'s operations of October 1, 1994. Both the Company and Centra 2000, Inc. were under common control at the date of acquisition.\nREVENUES - For the year ended September 30, 1995, total sales and service revenue decreased $9.5 million, or 27%, from the year ended September 30, 1994. Total sales revenue for fiscal 1995 decreased $5.6 million, or 34%, from the year ended September 30, 1994. Hardware revenue for fiscal 1995 declined $2.7 million or 36%, as compared to fiscal 1994. The Company continues to shift the sales and support focus from hardware to internally developed software and systems integration. The Company will continue to sell hardware primarily as part of a total systems solution. Total software revenue declined $3.0 million, or 33%, as compared to fiscal 1994. The decline can be attributed to reduced sales of the products based on the Company's Series 5000 and 7000 platforms. In addition, the growth in revenue from the M-CAD and PDM, and network management products were below the Company's expectations. Delays in product development contributed to the reduced growth in software from these newer products. In fiscal 1994, the Company received as consideration, $702,000 from Italcad, a former software joint venture partner, in exchange for allowing Italcad to transfer its rights to certain technology to a newly formed company. The Company booked this settlement as Domestic software sales. Domestic hardware sales revenue decreased $1.5 million, or 57%, while Domestic software sales revenue decreased $2.3 million, or 46% during fiscal 1995, excluding the Italcad settlement. International sales revenue decreased $1.8 million, or 20% from fiscal 1994. This decrease consisted of a favorable exchange rate variance of 4% and a 24% decrease in sales volume. The decrease in revenue was entirely due to a decrease of $1.9 million in hardware revenue, as compared to fiscal 1994. International software revenue increased $82,000, or 3%, as compared to fiscal 1994. Canadian sales revenue for fiscal 1995 decreased $2.0 million, or 43% as compared to fiscal 1994. European sales revenue grew $108,000, or 3% in fiscal 1995 as compared to fiscal 1994. Increased sales of the Company's process software in Germany accounted for the majority of the year-to-year improvement in software sales in Europe.\nFor the year ended September 30, 1994, total sales and service revenue decreased $3.3 million, or 9%, from the year ended September 30, 1993. Total sales revenue increased $499,000, or 3%, from the year ended September 30, 1993. Fiscal 1994 hardware sales decreased $1.4 million, or 16%, as compared to fiscal 1993. Fiscal 1994 software sales revenue increased $1.9 million, or 28%, from the year ended September 30, 1993, reflecting growth in software revenue based on the Series 5000 and Series 7000 platforms. Domestic and Canadian operations both experienced an increase in sales revenue in fiscal 1994, compared to fiscal 1993. Domestic sales revenue in fiscal 1994 increased\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-(CONTINUED)\n$1.0 million, or 16% as compared to fiscal 1993. In fiscal 1994, Domestic hardware revenue decreased $1.5 million or 44%, and Domestic software revenue increased $2.6 million, or 80% as compared to fiscal 1993. On November 16, 1993, an agreement between the Company and Italcad was reached whereby the Company was released of its outstanding debt plus accrued interest in exchange for allowing Italcad to transfer its rights to certain technology to a newly formed company. Sales revenue for the year ended September 30, 1994, included $702,000 relating to this agreement. Fiscal 1994 European sales revenue decreased $1.2 million, or 23%, as compared to fiscal 1993. A 9% increase was the result of exchange rate fluctuations with approximately 14% resulting from reduced sales volume. Fiscal 1994 Canadian sales revenue increased $984,000, or 27%, as compared to fiscal 1993. This increase consisted of an unfavorable exchange rate variance of 6% and a 33% increase in sales volume.\nTotal service revenue for the year ended September 30, 1995, decreased $3.8 million, or 21%, from the year ended September 30, 1994. Service revenue is comprised of hardware and software maintenance, training and billable service revenue. Hardware maintenance revenue was down $1.5 million, or 34%, while software maintenance revenue was down $1.6 million, or 16% for fiscal 1995 as compared to fiscal 1994. The Company experienced a decline in service revenue in all geographic locations. As the Company shifts from being a hardware and software solution provider to a software, systems integration, and service provider, revenue from hardware and hardware maintenance will continue to decline. The Company's management expects this trend to continue into the future. The declines in software maintenance revenue can be attributed to a lack of new software products sales combined with a decline in older products maintenance revenue. Billable services revenue declined $902,000, or 31% from fiscal 1994. This decline is consistent with the decline in sales revenue, as these services are performed after the initial sale. Training revenue increased $117,000, or 7%, as compared to fiscal 1994. This increase can be attributed to an increased demand for Sun and HP training given in the Company's training centers in Denver and Calgary. Domestic service revenue, which comprised 54% of the total worldwide service revenue, declined $3.2 million, or 29%, as compared to fiscal 1994. Canadian service revenue declined $166,000 or 5%, as compared to fiscal 1994. European service revenue declined $473,000, or 13%, as compared to fiscal 1994.\nTotal service revenue for the year ended September 30, 1994, decreased $3.8 million, or 17%, from the year ended September 30, 1993. Hardware maintenance revenue was down $2.3 million, or 34%, as compared to fiscal 1993. Software maintenance revenue was down $2.1 million, or 18%, for fiscal 1994 as compared to fiscal 1993. The Company experienced a decline in service revenue in all geographic locations. Billable services were up approximately $334,000, or 13%, as compared to fiscal 1993. This increase can be attributed to the increase in software sales. Domestic service revenues which comprised 63% of the total service revenue, decreased $3.0 million, or 21%, as compared to fiscal 1993. Canadian service revenue declined $92,000, or 3%, as compared to fiscal 1993. European service revenue declined $821,000, or 19%, as compared to fiscal 1993.\nCOST OF SALES AND SERVICE - The result of operations for the year ended September 30, 1995, continued to reflect shifts in product mix from hardware to software and services. For the year ended September 30, 1995, gross profit margins on total revenue increased to 58% from 54% for the year ended September 30, 1994. Gross profit margins on sales revenue for the year ending September 30, 1995, increased to 63% from 61% for the year ended September 30, 1994. In fiscal 1995 gross profit margins on hardware declined $871,000, yielding a gross margin of 28%, as compared to a gross margin of 30% in fiscal 1994. This decline reflects the continued pressure on hardware pricing throughout the computer industry. In fiscal 1995 gross profit margins on software sales declined $2.4 million, yielding a gross margin of 91%, as compared to a gross margin of 88% in fiscal 1994. This increase in gross profit margin can be attributed in part to the reduction in sales of third party software sold by the Company which has a range in costs from a few percent to 50% of the total revenue sold.\nGross profit margins for total service revenue in fiscal 1995 decreased $726,000, yielding a gross margin of 55%, as compared to a gross margin of 47% in fiscal 1994. This improvement reflects Management's efforts to reduce costs while still providing high quality support and services to customers. Gross margins on billable services in fiscal 1995 improved to 51% from 35% in fiscal 1994. Gross margins on training were flat year-to-year at 48%. Gross profit margins on hardware maintenance declined $1.9 million yielding gross margins of 29% in fiscal 1995 as compared to gross margins of 62% in fiscal 1994. The decline in hardware maintenance revenue was not matched with commensurate cost reductions in reducing hardware maintenance support costs. The Company will continue its efforts at cost reduction measures in the coming fiscal year, to reduce field support costs on hardware. Software maintenance\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-(CONTINUED)\ngross margins improved to 66% from 44% in fiscal 1994, reflecting the Company's efforts to control costs in its delivery of support.\nFor the year ended September 30, 1994, gross profit margins on total revenue decreased $1.7 million, yielding a gross margin of 54%, unchanged from the year ended September 30, 1993. Gross profit margin on sales revenue increased $1.4 million, yielding a gross margin of 61% from 54% in fiscal 1993. This improvement reflects the mix shift from hardware to software products.\nGross profit margin on service revenues decreased $3.1 million, yielding a gross margin of 47% in fiscal 1994, from 53% for fiscal 1993. The decrease can be attributed to a reduction in revenue as most of the expenses were fixed in nature and did not fluctuate with the decreased revenue.\nRESEARCH AND PRODUCT DEVELOPMENT - Research and development expenses were approximately 35% of revenue for the year ended September 30, 1995, and 23% and 22% of revenues for the years ended September 30, 1994 and 1993 respectively. The change in research and development spending as a percentage of revenue in fiscal 1995 is due in part to an increase of $925,000, or 12%, in spending coupled with the overall 27% decrease in total revenue as compared to fiscal 1994. The increase in spending is a result of the Company continuing to invest in new product technology.\nIn the year ended September 30, 1994, expenditures for research and product development decreased $398,000, or 5%, from the year ended September 30, 1993, as the Company focused its efforts on limited products.\nIn addition, the fiscal 1995 and 1994 research and product development expenditures were restated to reflect the acquisition of Centra 2000, Inc., which occurred on June 30, 1995. Research and product development expenses were increased by $689,000 and $1,232,000 for fiscal years 1994 and 1995 respectively.\nMARKETING, GENERAL, AND ADMINISTRATIVE - In the year ended September 30, 1995, marketing, and general and administrative expenses decreased $1.2 million, or 7%, from the year ended September 30, 1994. European marketing, and general and administrative spending declined $1.0 million due to the closure of some European offices in fiscal 1994. In fiscal 1995, Canadian marketing, general and administrative spending declined $216,000, as compared to fiscal 1994. In fiscal 1995, Domestic marketing, and general and administrative expenses, increased approximately $14,000, as compared to fiscal 1994.\nDuring fiscal 1995, the Company implemented cost containment measures to streamline both Domestic and International operations. Implementation of these measures resulted in a workforce reduction of 28 employees. The Company will continue to identify and implement cost containment measures and implement them as appropriate.\nAs software sales revenues increase in the future, The Company's management expects to meet these increases without a commensurate increase in general and administrative expenditures as an ordinary course of business. In fiscal 1996, however, the Company expects to increase its spending in research and development as it brings several enhanced products to the marketplace.\nIn the year ended September 30, 1994, marketing, and general and administrative expenses decreased $4.6 million, or 21%, from the year ended September 30, 1993. Of this change, Domestic marketing, and general and administrative expenses decreased 24%, while European and Canadian related expenses decreased 18% and 14% respectively. During fiscal 1994, there was a reduction of 33 employees. Additionally, legal fees declined $171,000 and outside services relating to software developed for internal business use declined $173,000 in comparison to September 30, 1993.\nINTEREST - In the year ended September 30, 1995, interest expense decreased 3% for the year ended September 30, 1994, as a result of converting $12.4 million of related party debt to common stock in three transactions. Interest income increased 42% from fiscal 1994, due to an increase in cash investments from an average monthly balance of $.6 million in fiscal 1994, to $2.1 million in fiscal 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-(CONTINUED)\nIn the year ended September 30, 1994, interest expense decreased 13% to $863,000 from the year ended September 30, 1993, as a result of converting $4 million of related party debt to common stock in February, 1994. In November, 1993, an agreement between the Company and Italcad, a former joint venture partner, was reached whereby the Company was released of its outstanding debt plus accrued interest in exchange for allowing Italcad to transfer its rights to certain technology to a newly formed company, which resulted in reduced interest expense in the amount of $73,000. Interest income decreased 25%, to $188,000, from fiscal 1993, due to a reduction of cash investments from an average monthly balance of $1.1 million in fiscal 1993, to $.6 million in fiscal 1994.\nINFLATION - The Company is affected by inflation principally through increases in salaries and wages and by increases in prices of services, at rates comparable to those experienced by other businesses. Historically, the impact of inflation has been partially mitigated by general price declines in electronic components resulting from improved technology.\nLIQUIDITY AND CAPITAL RESOURCES\nFINANCIAL CONDITION - At September 30, 1995, the Company had approximately $2.4 million in cash and cash equivalents, which was 6% higher than cash balances at September 30, 1994. The Company's net working capital was approximately $1.8 million at September 30, 1995, as compared to $1.7 million at September 30, 1994. Other than the uncertainty of future profitability, there are no known demands, commitments, events, or uncertainties that will result in the Company's liquidity increasing or decreasing in any material way. However, during October and November 1995, the Company borrowed a total of $2,000,000, with the notes bearing interest at 10% per annum, from an affiliate of Howard B. Hillman, the Company's President, Chairman of the Board and principal shareholder. In December 1994, the Company paid $559,000 of accrued interest on the outstanding related party debt of $5,998,000. As of September 30, 1995, the Company had no material commitments for capital expenditures. On May 2, 1989, the Company announced a program to repurchase the Company's stock in the open market. The maximum cost of the shares to be purchased was limited to $2 million. To date, 261,400 shares have been purchased at a cost of $485,000.\nDuring fiscal 1994, the Company received a permanent waiver of financial covenants of its outstanding Industrial Development Revenue Bonds. The Company received a permanent wavier of financial ratio requirements which placed restrictions on long-term lease agreements, debt agreements, and current ratio requirements.\nThe Company will require additional funds from its majority shareholder to continue to fund future operating losses. The shareholder has committed, in writing, to continue providing financial support at least through December 31, 1996. If the Company does not achieve profitability in the near future, it will continue to be dependent on its majority shareholder for additional funding and to continue as a going concern. The Company's long term viability will be in jeopardy if it is not able to achieve financial independence through improved results, or should support from its majority shareholder not continue after December 31, 1996.\nCURRENCY FLUCTUATIONS\nThe Company has four wholly owned subsidiaries and one branch operation. The four subsidiaries are located in Germany, Sweden, Canada and the United Kingdom; the branch is located in Australia. The Company does business in the local currencies of these countries, in addition to other countries where the subsidiaries may have customers, such as Norway, Finland and Italy. These local currency revenues and expenses are translated into dollars for U.S. reporting purposes. A stronger U.S. dollar will decrease the level of reported U.S. dollar revenues and expenses. Approximately $.7 million of favorable exchange rate variance and a $3.1 million decrease in revenue volume resulted in a $2.4 million decrease in non-U.S. revenue between 1995 and 1994. These effects on the Company's results of operations could become significant if the percentage of revenues and expenses attributed to International operations increases and\/or if the dollar fluctuates significantly against international currencies. The Company's International operations are also subject to certain risks inherent in doing business abroad and may be adversely affected by government policies, restrictions, or other factors.\nThe Company does not use foreign exchange contracts, interest rate swaps, or option contracts. Foreign currency risk for the Company is limited to outstanding debt owed to the Company by the subsidiaries. The Company invoices its\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-(CONTINUED)\nsubsidiaries in their local currencies for products that are sold to the subsidiaries' end customers. Upon receipt of payment from the subsidiaries, a foreign currency gain or loss can occur. As of September 30, 1995, and 1994, the Company had realized a loss of approximately $47,000 and $83,000 respectively, through payments it had received from its subsidiaries.\nNEW ACCOUNTING STANDARDS\nStatement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed Of (SFAS 121) was issued in March, 1995, by the Financial Accounting Standards Board. It 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. SFAS 121 is required to be adopted for fiscal years beginning after December 15, 1995. Adopting this statement by the Company is not expected to have a significant effect on the consolidated financial statements.\nStatement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), was issued by the Financial Accounting Standards Board in October, 1995. SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans as well as transactions in which an entity issues its equity instruments to acquire goods or services from non-employees. This statement defines a fair value based method of accounting for 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. Entities electing to remain with the accounting in Opinion 25 must make proforma disclosures of net income and, if presented, earnings per share, as if the fair value based method of accounting defined by SFAS 123 had been applied. SFAS 123 is applicable to fiscal years beginning after December 15, 1995. The Company currently accounts for its equity instruments using the accounting prescribed by Opinion 25. The Company does not currently expect to adopt the accounting prescribed by SFAS 123; however, the Company will include the disclosures required by SFAS 123 in future consolidated financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Auto-trol Technology Corporation:\nWe have audited the accompanying consolidated balance sheets of Auto-trol Technology Corporation 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 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs discussed in Note 2 to the consolidated financial statements, affiliates of the Company's President, Chairman of the Board, and majority shareholder have provided significant financial support to the Company during 1995 and 1994 and in prior years. The Company will continue to be economically dependent upon financial support from the shareholder until it achieves profitable operations. The shareholder has committed to continue providing such financial support at least through December 31, 1996.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Auto-trol Technology 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.\nKPMG PEAT MARWICK LLP\nDenver, Colorado November 10, 1995\nAUTO-TROL TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nAUTO-TROL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nAUTO-TROL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements.\nAUTO-TROL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nNon cash financing and investing activities: During fiscal 1995, 1994 and 1993, $12,438, $4,000 and $7,000 of related party notes payable were converted to common stock. During fiscal 1995, $427 in computer equipment was acquired through capital leases.\nSee Notes to Consolidated Financial Statements.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995, 1994, AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBasis of Presentation - ---------------------\nThe consolidated financial statements include the accounts of Auto-trol Technology Corporation and its subsidiaries, each of which is wholly owned. All significant intercompany transactions and balances have been eliminated in consolidation. The Company develops, integrates and supports its products and the products of certain third party vendors for end user markets involved in: product data management, physical network management, mapping, technical illustration, design, engineering, drafting and manufacturing processes. These products are designed to facilitate the creation, distribution, analysis and management of technical information. The Company provides systems to solve engineering and documentation problems in the traditional Computer Aided Design and Manufacturing markets (CAD and M-CAD).\nStatement of Cash Flows - -----------------------\nCash and cash equivalents include currency on hand, demand deposits with banks or other financial institutions, and other highly liquid securities purchased with an original maturity of three months or less.\nInventories - -----------\nInventories consist of completed computer hardware units and completed components used for resale. Inventories are stated at the lower of cost (first- in, first-out method) or market. Service parts are recorded at cost and amortized on the straight line method over three years or the estimated useful lives, whichever is shorter.\nProperty, Facilities and Equipment - ----------------------------------\nProperty, facilities, and equipment, including leasehold improvements, are recorded at cost and depreciated or amortized on the straight line method over the estimated useful lives of the respective assets or the lease period, whichever is shorter. Gains and losses from retirement or replacement of property, facilities, and equipment is included in operations. Betterments and renewals are capitalized. Maintenance and repairs are charged to operations.\nThe estimated useful lives of facilities and equipment used in determining depreciation and amortization is as follows:\nBuilding and improvements component lives of 10-35 years Leasehold improvements lease period Machinery and equipment 3-7 years Furniture and fixtures 3-7 years\nForeign Currency Exchange and Translation - -----------------------------------------\nThe functional currency of the Company's foreign subsidiaries is its local currency and such assets and liabilities are translated to U.S. dollars at year end exchange rates. The Company does not use foreign exchange contracts, interest rate swaps, or option contracts. Translation gains and losses are not included in operations but are accumulated in a separate component of shareholders' equity. Foreign currency transaction gains and losses, which were not significant, have been included in the results of operations.\nRevenue Recognition - -------------------\nRevenue is derived from equipment sales, software license fees, related customer support contracts, and other support services. Revenues from the sale of equipment and software licenses are generally recorded at the time of delivery to the customer. Revenues are deferred if significant future obligations are to be fulfilled or if collection is not probable. Post-sales customer support revenues are recognized ratably over the contract period. Included in post- contract support costs are direct costs paid to third-party vendors, which are expensed as incurred. In addition, labor and overhead expenses relating to support personnel are included in cost of service and are expensed as incurred. The Company provides a warranty for its products, generally for ninety days from the date of installation, and establishes an allowance to cover warranty costs during this period. Service contract revenues are recognized as the services are performed.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nResearch and Development - ------------------------\nThe Company accounts for its research and product development costs according to Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (SFAS 86).\nAmortization of Software - ------------------------\nPurchased software acquired for use in the business includes the cost of software acquired through acquisitions and from third-party vendors. Amortization of these costs is included in research and product development or marketing, general, and administrative expenses depending on the application of the software. Such costs are amortized using the straight-line method over the estimated useful lives ranging from three to five years. Software amortization expense was $365,000, $351,000, and $311,000 for the years ended September 30, 1995, 1994, and 1993, respectively.\nSoftware Royalties - ------------------\nThe Company pays royalties for software licensed from third-party vendors for sublicense to the Company's customers. Total royalty expense incurred for third-party software was approximately $112,000, $340,000, and $537,000 for fiscal years ended September 30, 1995, 1994, and 1993, respectively. These costs are included in cost of sales.\nLoss Per Share - --------------\nLoss per share is computed on the basis of the weighted average number of common shares outstanding and is adjusted, if applicable, for common stock equivalent shares. For the years ended September 30, 1995, 1994, and 1993, the weighted average number of shares outstanding includes no weighted common stock equivalent shares because their effect would be antidilutive.\n2. ECONOMIC DEPENDENCY ON MAJORITY SHAREHOLDER:\nDuring fiscal years 1995, 1994 and 1993, affiliates of the Company's President, Chairman of the Board, and majority shareholder loaned the Company $10,350,000, $5,100,000 and $5,950,000 respectively. The Company converted $12,438,000, $4,000,000 and $7,000,000 to equity in 1995, 1994 and 1993 respectively, and repaid $1,000,000 in 1995. The shareholder loan balance at September 30, 1995, was $2,900,000. The notes are unsecured and are due on October 1, 1997, bearing interest at 10% per annum. The Company borrowed a total of $2,000,000 in October and November 1995. The Company will continue to be economically dependent upon such financial support until it achieves profitable operations. The shareholder has committed, in writing, to continue providing the Company such financial support at least through December 31, 1996.\n3. DEBT:\nMaturities of long-term debt for each of the five years subsequent to September 30, 1995, and thereafter are as follows:\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(a) The Industrial Development Revenue Bonds were issued by the City of Thornton, Colorado, to finance the cost of the Company's corporate headquarters. The bonds bear interest at 8%, are payable in annual installments of $240,000 through August, 2004, and are collateralized by a mortgage indenture on the facilities. The indenture has debt covenants which place certain limitations on the Company, including restrictions on the sale of assets, and certain common stock transactions including payment of dividends. During fiscal 1994, the Company received a permanent waiver of financial ratio requirements which placed restrictions on long-term lease agreements, debt agreements, and current ratio requirements.\n4. LEASES:\nThe Company leases certain office facilities and equipment under operating leases expiring at various dates through fiscal 2006. The Company also leases computer equipment under capital leases which expire through fiscal 1997.\nAs of September 30, 1995, the future minimum lease payments under capital and noncancellable operating leases (with initial or remaining lease terms in excess of one year) are as follows:\nThere are no material subleases or contingent rentals related to the leases, and the lease payments include no executory costs. Aggregate rental expense under operating leases was $1,964,000, $2,035,000, and $1,809,000 for the years ended September 30, 1995, 1994, and 1993, respectively.\n5. INCOME TAXES:\nThe Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), which requires the use of the asset and liability method of accounting for income taxes. Under the asset and liability method required by 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 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. 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.\nBased on the uncertainty of future realization, a valuation allowance equal to the deferred tax asset relating to the Company's net operating loss carry forwards for income tax purposes of approximately $40.7 million has been provided.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAs of September 30, 1993, the Company had an accrued tax liability of $232,000 relating to a dispute with the German tax authorities concerning the subsidiary's loss carry forward for its German subsidiary. As a conservative measure the Company had accrued the liability in the event the German tax authorities would not accept the Company's loss carry forward calculation. During the second quarter of 1994, the Company reached an agreement with the German tax authorities whereby the Company's loss carry forward was accepted as correct. As a result, the Company realized a tax benefit of $232,000 during the second quarter of 1994.\nThe components of the current provisions for income taxes are as follows:\nThe following summarizes the amount of the Company's loss, before income taxes, contributed by domestic and foreign operations:\nThe Company's effective tax rate varies from the statutory federal income tax rate as follows:\n6. SHAREHOLDERS' EQUITY:\nSTOCK REPURCHASE PROGRAM - On May 2, 1989, the Company established a program to repurchase its common stock in the marketplace from time to time depending on market prices and other market conditions. The maximum cost of shares to be repurchased under the program is limited to $2,000,000. As of September 30, 1995, 261,400 shares have been repurchased under this program.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSTOCK OPTIONS - The Company has in effect two stock option plans: an Incentive Stock Option Plan and a Special Purpose Plan. As amended by the shareholders in January, 1992, the shares of the two plans were pooled resulting in 1,350,000 shares of common stock that have been authorized for issuance thereunder. Information with respect to activity under the stock option plans is set forth below:\n(1) Options outstanding as of September 30, 1995, have exercise prices ranging from $.375 to $2.00 per share with expiration through the year 2005. The exercise price of the shares at date of grant is established as the market price as of that date.\nEMPLOYEE STOCK PURCHASE PLAN - The Company has an Employee Stock Purchase Plan, under which 229,645 shares are available for purchase by employees as of September 30, 1995. Employees have purchased 15,355 shares of common stock under the Company's Employee Stock Purchase Plan through September 30, 1995.\n7. EMPLOYEE RETIREMENT PLAN:\nThe Retirement Savings Plan (Plan) is a cash or deferred profit-sharing plan designed to comply with the requirements of Section 401(a) and 401(k) of the Internal Revenue Code of 1986. Substantially all employees of the Company with six months of service are eligible to participate in the Plan; however, certain employee groups may be made ineligible at the discretion of the Company. The Plan's funds are invested by an independent broker into various funds as selected by the 401(k) Committee. Plan funds may not be invested in common stock of the Company. Under the Plan, employees may contribute ten dollars, plus from 1% to 15% of their compensation per pay period, to a tax deferral account subject to statutory maximums. The Company will contribute to the account of a participant an amount equal to the employee's contribution up to ten dollars per pay period. The Company recognized expense related to the Plan of approximately $46,000, $53,000, and $70,000 in the years ended September 30, 1995, 1994, and 1993, respectively. The Board of Directors may, at its discretion, terminate the plan at any time in whole or in part. Upon such termination, the Plan provides for the distribution of the assets of the fund for the benefit of its participants.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n8. FOREIGN AND DOMESTIC OPERATIONS:\nRevenues, operating results before unallocated expenses, and identifiable assets for the three years ended September 30, 1995 by geographic area are presented in the table below. There were no significant amounts of sales or transfers between foreign areas.\n(1) Export sales were made to various international distributors and through the Company's sales office in Australia. No one customer accounted for 10% or more of total sales for the years ended September 30, 1995, 1994 and 1993.\n(2) Research and development expenses have been allocated to each geographic area based on the revenues generated by each area from internally-developed software products. Management believes this to be a reasonable method for allocating research and development expenses.\nInterest expense has been allocated to each geographic area based on subsidiary assets and liabilities funded by Domestic operations.\n9. BUSINESS COMBINATION WITH RELATED PARTY:\nOn June 30, 1995, AT Development Inc., a wholly owned subsidiary of Auto-trol Technology Corporation, acquired a 100% interest in Metaware, Inc., doing business as Centra 2000, Inc. The consideration for the purchase was four shares of Auto-trol Technology Corporation common stock for each share of Centra 2000, Inc. common stock outstanding. The 1,212,008 shares of Auto-trol Technology Corporation common stock exchanged were not registered under Federal or State securities laws and are subject to restrictions on resale. Additional consideration for existing Centra 2000, Inc. shareholders consists of a cash bonus and stock in Auto-trol Technology Corporation in each of the next four years, which is contingent upon meeting a development schedule and market acceptance of the Centra 2000 product.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAuto-trol Technology Corporation's President and Chairman of the Board, Howard B. Hillman, controls, through various affiliates, the majority of the outstanding shares of capital stock of both Auto-trol Technology Corporation and Centra 2000, Inc. (Centra).\nThe effect of applying the purchase method of accounting to the acquisition of the common stock of Centra owned by the other shareholders was not significant. Accordingly, the acquisition has been accounted for in a manner similar to a pooling of interests of entities under common control. The accompanying consolidated financial statements have been restated for all periods prior to the merger to include the accounts and operations of Centra with those of the Company from the commencement of Centra's operations of October 1, 1994. For income tax purposes, the merger was a nontaxable transaction. Prior to the merger, Centra's fiscal year end was December 31. In connection with the business combination, Centra's financial statements were restated to conform to the Company's September 30 fiscal year end. The total assets of Centra consisted of cash, office furniture and computer equipment, and intangible assets. The office furniture and computer equipment included in the acquisition will continue to be used at the subsidiary in the development of software products.\nThe table below sets forth the composition of the consolidated net revenues and net losses for the years ended September 30, 1995, and 1994 prior to the merger and as restated for the business combination.\nThe effects of restating the Company's September 30, 1994, consolidated balance sheet for the business combination were not significant. Intercompany transactions between Centra and the Company prior to the date of the combination have been eliminated.\nAUTO-TROL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 contained in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on January 30, 1996, under the caption \"Election of Directors\" and \"Executive Officers\", 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 Proxy Statement for the Annual Meeting of Shareholders to be held on January 30, 1996, under the caption \"Executive Compensation\", 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 Proxy Statement for the Annual Meeting of Shareholders to be held on January 30, 1996, under the caption \"Voting Securities and Principal Shareholders\", 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 Proxy Statement for the Annual Meeting of Shareholders to be held on January 30, 1996, under the caption \"Certain Relationships and Related Transactions\", and is incorporated herein by reference.\nThe Company intends to file definitive copies of the Proxy Statement with the Securities and Exchange Commission within 120 days after September 30, 1995, the close of its last fiscal period, and pursuant to General Instruction G to Form 10-K. Information called for by these items is incorporated herein by reference from such definitive Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nAll other schedules are omitted because they are inapplicable, not required under the instructions, or the information is included in the Consolidated Financial Statements or notes thereto.\n3. EXHIBITS\nExhibit number Description of Exhibit ------ ----------------------- 3.1 Articles of Incorporation* 3.2 Amendment to Articles of Incorporation** 3.3 Bylaws* 3.4 Amendment to Bylaws** 4.1 Specimen Certificate* 4.2 Copies of Industrial Development Revenue Bond documents* 4.3 Specimen Debentures, Warrants, Royalty Agreement, and Royalty Certificate issued to purchase Research and Development Limited Partnership Interests+ 10.1 Copy of Incentive Stock Option Plan, as amended through January 28, 1992++ 10.2 Copy of Special Purpose Stock Option Plan, as amended through January 28, 1992++ 10.3 Agreement with Sun Microsystems, Inc. dated April 30, 1993+++ 10.4 Agreement with HP\/Apollo Computer, Inc. dated July 4, 1994+++ 10.5 Agreement with Howard B. Hillman dated November 1, 1995 21 Subsidiaries of the Registrant 24 Consent of KPMG Peat Marwick LLP\n* Incorporated by reference from Registration Statement No. 2-63253, filed January 24, 1979. ** Incorporated by reference from Registration Statement No. 2-73702, filed August 14, 1981. + Incorporated by reference from Form 10-K for fiscal year ended September 30, 1988, dated December 14, 1988. ++ Incorporated by reference from Form 10-K for fiscal year ended September 30, 1993, dated December 18, 1992. +++ Incorporated by reference from Form 10-K for fiscal year ended September 30, 1994, dated December 14, 1994.\n(B) REPORTS ON FORM 8-K\nA Form 8-K was filed July 14, 1995, for the acquisition of Centra 2000, Inc. on June 30, 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Auto-trol Technology Corporation:\nUnder date of November 10, 1995, we reported on the consolidated balance sheets of Auto-trol Technology Corporation 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 years in the three-year period ended September 30, 1995, as contained 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 have also audited the related 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.\nAs discussed in Note 2 to the consolidated financial statements, affiliates of the Company's President, Chairman of the Board, and majority shareholder have provided significant financial support to the Company during 1995 and 1994 and in prior years. The Company will continue to be economically dependent upon financial support from the shareholder until it achieves profitable operations. The shareholder has committed to continue providing such financial support at least through December 31, 1996.\nIn our opinion, this 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.\nKPMG PEAT MARWICK LLP\nDenver, Colorado November 10, 1995\nAUTO-TROL TECHNOLOGY CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES SEPTEMBER 30, 1995\nSee accompanying independent auditors' report\nCONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors Auto-trol Technology Corporation\nWe consent to the incorporation by reference in the registration statements Nos. 2-66611, 2-73702, 2-80142, 33-637, and 33-15533 on Form S-8 of Auto-trol Technology Corporation of our reports dated November 10, 1995, relating to the consolidated balance sheets of Auto-trol Technology Corporation 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 years in the three-year period ended September 30, 1995, and the related financial statement schedule, which reports appear in the September 30, 1995, annual report on Form 10-K of Auto-trol Technology Corporation.\nKPMG PEAT MARWICK LLP\nDenver, Colorado December 12, 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.\nAUTO-TROL TECHNOLOGY CORPORATION\nDate: DECEMBER 14, 1995 By: \/s\/HOWARD B. HILLMAN --------------------------- Howard B. Hillman, 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:\nEXHIBIT INDEX\n* Incorporated by reference from Registration Statement No. 2-63253, filed January 24, 1979. ** Incorporated by reference from Registration Statement No. 2-73702, filed August 14, 1981. + Incorporated by reference from Form 10-K for fiscal year ended September 30, 1988, dated December 14, 1988. ++ Incorporated by reference from Form 10-K for fiscal year ended September 30, 1993, dated December 18, 1992. +++ Incorporated by reference from Form 10-K For fiscal year ended September 30, 1994, dated December 14, 1994.","section_15":""}
{"filename":"804125_1995.txt","cik":"804125","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nPeebles operates 58 specialty department stores offering merchandise for the entire family and selected decorative home accessories. Founded in 1891, the Company operates primarily in smaller communities in ten southeastern and mid-Atlantic states. Peebles positions itself as the leading fashion retailer in these communities, which typically do not have a traditional mall-based department store, and locates its stores in the primary shopping destinations in its markets. Peebles offers its customers consistent value by providing a broad assortment of moderately priced national brands supplemented with quality private label merchandise. Peebles' attractive stores and visual presentation, advertising and promotional programs further reinforce its image as the market's fashion leader.\nReferences to 1990, 1991, 1992, 1993 and 1994 relate to the fiscal years of the Company ending February 2, 1991, February 1, 1992, January 30, 1993, January 29, 1994 and January 28, 1995, respectively. Each of these fiscal years includes 52 weeks.\nOPERATING STRATEGY\nThe following are key elements to Peebles operating strategy:\nFOCUS ON SMALL MARKETS. Peebles locates its stores in smaller communities that typically do not have a traditional mall-based department store, thereby limiting competition and allowing Peebles to be the leading fashion retailer in these communities. The Company believes its ability to successfully operate in markets with as few as 5,000 households is an important competitive advantage over large department stores, which generally cannot profitably operate in such markets. Peebles has operated in small communities for over 100 years and understands its markets and customers.\nOPERATE SMALL STORES WITH LOWER COST STRUCTURE. Peebles, with its focus on small communities, operates stores that are significantly smaller than the traditional full-line department store. Peebles' stores average 32,000 square feet and vary in size from 8,000 to 65,000 square feet. The Company operates profitably despite its smaller stores and lower sales per square foot compared with other department store companies due to its high gross margins, emphasis on cost control and centralized operations.\nDELIVER FASHION TO SMALL COMMUNITIES. Peebles strives to provide its customers with a shopping experience similar to that found in a traditional mall-based department store, although with fewer merchandise categories. The Company emphasizes a broad selection of moderately-priced national brands and private label merchandise, which generally is not available through other retailers in the market. Peebles' attractive stores and visual presentation, advertising and promotional programs further reinforce its image as the market's fashion leader.\nOFFER VALUE TO CUSTOMERS. Peebles emphasizes value pricing and is less promotional than traditional department stores. It is the Company's strategy to use lower initial mark-ons and promote less, thereby maintaining a high level of credibility with its customers. Peebles' commitment to providing value to its customers is integral to creating repeat customers, a critical ingredient for success in smaller markets.\nCENTRALIZE OPERATIONS, BUT TAILOR MERCHANDISE LOCALLY. Peebles believes that centralized decision-making, controls and support functions are critical to its cost-efficient operations and enable the Company's store personnel to maximize the time devoted to selling. In contrast, Peebles employs a decentralized approach in merchandising its individual stores. The merchandise mix is tailored to individual stores to cater to local tastes and preferences based on customer and sales associate feedback and sales trends. Buyers and store associates work together to optimize the use of Peebles' smaller selling spaces to meet customer demand and maximize sales.\nADAPT TO LOCAL REAL ESTATE OPPORTUNITIES. Smaller stores and a flexible store format give the Company the ability to locate in a variety of new or existing sites. As a result, Peebles' growth is not dependent upon the development of new malls. Peebles attempts to position its stores in the primary shopping destination in its markets, which are typically strip shopping centers co-anchored by leading discount, grocery and drug retailers. The Company also operates successfully in enclosed malls and downtown locations.\nEXPANSION STRATEGY\nThe Company has expanded by opening new stores, acquiring and converting stores and groups of stores, and remodeling or relocating existing stores. The Company anticipates expanding its operations through the following:\nOPENING NEW STORES. The Company intends to open eight new stores in 1995 and nine new stores in 1996. As of April 4, 1995 the Company has signed seven leases for stores scheduled to open in 1995, representing approximately 164,000 in total square footage. The Company's new stores will be located in existing and contiguous markets where it can realize distribution efficiencies and where the Peebles concept and merchandise mix will correspond to local demographics. The Company explores a wider range of real estate options than retailers which rely only on new shopping center development, and actively considers space vacated by other retailers.\nREMODELING AND RELOCATING STORES. In addition to new store growth, the Company has an ongoing remodeling program, both upgrading existing stores and reallocating selling space to provide its customers a pleasant, fashion-oriented shopping environment for the merchandise mix for that market. Since January 30, 1993, the Company has remodeled nine stores and plans to remodel two stores in 1995. The Company also expects to relocate selected stores to the desired shopping destination in that market.\nACQUISITIONS. The Company believes that from time to time opportunities may arise for the acquisition of individual stores or groups of stores. In 1993, the Company acquired one store and in 1988, the Company acquired ten stores in Kentucky and Tennessee, adding to its then existing base of 38 stores. The Company is continually evaluating acquisitions of both individual stores and groups of stores.\nPEEBLES STORES\nPeebles stores are designed and managed to create an appealing shopping experience, foster customer convenience and maximize operating efficiency. The Company's stores range in size from 8,000 to 65,000 square feet and average 32,000 square feet, which is significantly smaller than the traditional full-line department store. The Company does not have a standard store format and instead adapts its stores to existing real estate opportunities. The Company's stores feature a bright, modern and accessible layout with an emphasis on the visual presentation of merchandise. The store layout is designed to draw the customer through the store, creating opportunities for cross-selling.\nThe Company targets communities with between 10,000 and 25,000 households. According to Company estimates, as of January 28, 1995, approximately 60% of the Company's stores are located in towns with fewer than 20,000 households. Peebles can operate profitably in a community with as few as 5,000 households. The Company enters larger markets and suburban areas with 25,000 to 40,000 households where the customer base and competitive factors exhibit characteristics similar to markets where the Company's operating strategy has proven successful. The Company prefers to locate its stores in strip shopping centers and enclosed malls where other anchors such as a leading grocery, discount and drug retailers will create a destination shopping location. Of the 58 stores currently in operation, 35 are located in strip shopping centers, 18 in enclosed malls and five in downtown locations.\nMERCHANDISING\nThe Company's merchandise, approximately 80% of which is apparel, is targeted to middle income customers shopping for their families and homes. The Company has fewer departments than a traditional full-line department store, but strives to carry a wide assortment of merchandise within its targeted categories in order to appeal to a broad range of customers. To position itself as the primary fashion retailer in the community with merchandise not found elsewhere in the market, the Company emphasizes moderately-priced national brands, supplemented by a limited selection of prestige brand names and a selection of quality private label merchandise. Peebles merchandise is fashion responsive rather than fashion forward, limiting the Company's inventory exposure. The Company's stores carry apparel for the entire family, accessories and cosmetics, and decorative home accessories.\nManagement believes that brand name merchandise is a significant attraction to its customers and intends to continue emphasizing such merchandise in its stores. For example, the Company carries nationally branded cosmetics in as many of its stores as possible because Peebles is typically the only retailer in the community where consumers can purchase that merchandise. While the gross margins on cosmetics are typically lower than the Company's average gross margin, the availability of this merchandise generates store traffic which facilitates the sale of higher margin merchandise.\nIn 1994, a majority of the merchandise sold by the Company was nationally branded merchandise. Key brands featured by the Company include:\nLadies . . . . . Liz Claiborne, Etienne Aigner, Alfred Dunner, Jones Apparel, Koret, Monet, Napier, Aris, Playtex, Forecaster, Byer of California, Vanity Fair, Judy Bond, Norton McNaughton, Fritzi of California\nMen's . . . . . . Levi, Jantzen, Haggar, Arrow, Van Heusen, Champion, Swank\nYoung Men's and Juniors . . . . . Bugle Boy, Guess, Esprit, B.U.M. Equipment, Union Bay, Lee, Rampage, Bongo, Zeppelin, Duck Head\nChildren's . . . . Oshkosh B'Gosh, HealthTex, Buster Brown, Baby Togs, William Carter\nShoes . . . . . . Nike, Reebok, Brown Shoe, Keds, Fila, LA Gear, Nunn Bush\nHome . . . . . . . Fieldcrest, Springs, Arch, World Bazaars, Mikasa, Crystal Dean\nCosmetics. . . . . Estee Lauder, Elizabeth Arden, Fashion Fair, Calvin Klein, Parfums International\nAs a complement to its national brand merchandise, the Company offers private label merchandise in selected departments to give its customers a wider range of products. Management believes that its private label merchandise provides value to the Peebles customer by offering a quality merchandise alternative at prices lower than national brands. In addition, private label merchandise often has higher gross margins than brand name merchandise and allows the Company to avoid direct price competition.\nIn order to efficiently utilize its smaller selling space, Peebles tailors the merchandise selection at individual stores. The Company utilizes its knowledge of its markets and customers developed over 104 years along with input from the store managers and sales associates to allocate merchandise to the stores. The Company also maintains an inventory tracking system which provides daily information as to sales and inventory levels by store, department, vendor, class, style, size and color. Based on this information, the Company analyzes market trends, identifies fast or slow moving merchandise and makes reordering and pricing decisions on a daily basis.\nPeebles emphasizes value pricing and is less promotional than the traditional department store. It is the Company's pricing strategy to use lower initial mark-ons and promote less, thereby maintaining a high level of credibility with its customers. Peebles' commitment to providing value to its customers is integral to creating repeat customers, a critical ingredient for success in smaller markets. Peebles utilizes its \"Our Price\" program with approximately 30% of the Company's merchandise. With this program, the Company has even lower initial mark-ons on certain national brand name products which are considered to be less fashion sensitive such as jeans, socks and underwear. Products in this program are marketed through special point of sale displays and are featured in the Company's advertising.\nADVERTISING AND PROMOTION\nThe Company's advertising and promotion strategy is designed to support its marketing goals of providing quality merchandise at value- oriented prices and reinforces the Company's image as the leading fashion retailer in its markets. Peebles utilizes a direct mail program, which in part employs information obtained from its charge card program to target mailings to its charge card holders. The Company emphasizes newspaper advertising and mailers rather than television and radio, due to the size and nature of the markets served. Peebles uses both black and white advertisements and full color mailers to highlight promotional items and events as well as products in its \"Our Price\" program.\nIn addition, the Company's advertising and promotional staff organizes special events at the stores and arranges for all Grand Opening and Grand Reopening events. In 1995, the Company became an associate sponsor of a racing team in the NASCAR Busch Grand National stock car racing series, which the Company believes will increase its exposure in both existing and potential markets.\nThe Company's net advertising expenses in 1992, 1993 and 1994 were 2.5%, 2.7% and 2.5% of net sales, respectively, which the Company believes is lower than traditional department stores due to emphasis on an everyday fair price policy and a less promotional strategy.\nPURCHASING AND DISTRIBUTION\nThe Company employs 22 buyers and seven merchandise managers who are responsible for most merchandising decisions including purchasing, pricing, sales promotions, inventory allocations and markdowns. While these decisions are made centrally, the Company endeavors to refine its merchandise assortment to appeal to the customers in each market. Peebles' buying staff has developed specific knowledge with regard to purchasing, inventory and promotions for the Company's smaller sized stores. The merchandising group participates in an incentive plan based on gross margin dollars generated and inventory turnover.\nThe Company places special emphasis on maintaining all merchandise in stock, particularly advertised and basic merchandise, to build and maintain credibility with its customers. By monitoring unit sale information by store, buyers are able to quickly determine the styles, colors and sizes of merchandise to be reordered and distributed to individual stores.\nThe Company purchases its merchandise from approximately 1,275 suppliers and is not dependent on any single source of supply. The Company is a member of Frederick Atkins, Inc., an international cooperative buying service. This cooperative offers members merchandise purchasing opportunities, which the Company has taken advantage of particularly in connection with its imported private label merchandise. During 1992, 1993, and 1994, Frederick Atkins, Inc. was the Company's largest supplier, accounting for retail purchases totaling approximately 17.4%, 17.0% and 17.7%, respectively. The Company believes it has a good relationship with Frederick Atkins, Inc. and is not aware of a situation in which Frederick Atkins, Inc. would not continue to supply the Company. In the event such a situation arose, the Company believes that it could avoid significant disruptions in its purchasing process or significant changes to its merchandise mix through the use of other resources.\nVirtually all merchandise is shipped directly from vendors to the Company's distribution center where it is inspected, sorted, marked, ticketed, packed and held in bins for each individual store. The Company does not warehouse merchandise and has a goal of processing goods through the distribution center in three days. Merchandise is shipped to each store an average of twice a week on Company-owned trucks.\nThe Company's distribution center is located on 31 acres in South Hill, Virginia, adjacent to the Company's headquarters and close to major interstates. In 1992, the Company renovated and expanded the distribution center from 85,000 square feet to its current 117,000 square feet and further automated its distribution process, including an extensive network of conveyors and recycling equipment. The distribution center currently operates one eight hour shift daily. In 1996, the Company plans to add an additional 30,000 square feet to the distribution center. Management believes the cost of this expansion will be approximately $2.5 million and that, with such expansion, the distribution center can service 110 stores.\nSTORE OPERATIONS\nThe Company has structured its store operations to maintain what management believes are key operating advantages including a thorough knowledge of its customer base, the ability to share information between the stores, and cost efficient operations through centralized decision making.\nPeebles performs as many functions as possible at the corporate level so that store level management and sales associates can spend most of their time with customers. Non-sales store personnel are kept to a minimum due to control functions performed at the corporate offices, including sales associate scheduling, customer credit and marking merchandise. All stores utilize a minimum 85% of their total payroll hours in a selling capacity.\nPeebles encourages the participation of all store level management and sales associates in decision making, and management regularly solicits input and suggestions from its employees who are closest to the customer. In addition to its management information systems, Peebles stays in close contact with store operations through its eight regional managers. Each store manager reports to a regional manager, who also manages a store. Regional managers visit their stores at least once a month to review merchandise presentation, personnel training and performance, enforcement of the Company's security procedures and adherence to Company operating procedures. The regional managers meet quarterly to share information.\nThe Company conducts a management training program, which coordinates instruction at the Company's corporate headquarters facility with on-the- job experience. The Company stresses promotion from within, and substantially all of the current store managers have been selected in this manner. Approximately 45% of the store managers have been with the Company ten or more years.\nMost stores typically employ several assistant managers and approximately 30 sales associates, a number of whom are part-time. All Peebles' store personnel, including assistant store managers and sales associates, participate in incentive plans. The Company uses periodic productivity reports and personal reviews to apprise each employee of his or her performance.\nPEEBLES CHARGE CARD\nIn 1992, 1993 and 1994, 42.9%, 42.0% and 40.4%, respectively, of net sales were made using the Company's proprietary credit card. As of January 28, 1995, the Company had approximately 593,300 credit card accounts, of which 169,400 were billed accounts.\nPeebles' charge card sales represent an important element in its marketing strategy because the Company believes that Peebles charge card holders generally constitute its most loyal and active customers. Information regarding purchases by the Company's credit card customers is recorded at the stores' point-of-sale terminals and transmitted directly to the Company's data processing center. This information is used to bill accounts as well as to provide marketing information regarding purchasing habits and merchandise preferences. The Company uses this data to develop segmented advertising and promotional programs to reach specific groups of customers who have established purchasing patterns for certain brands, departments and store locations.\nPeebles administers all aspects of its credit card program, and decisions with respect to the opening of new accounts, extensions of \"instant credit,\" adjustments to bills and responses to customer inquiries are made by Company-trained associates located at Peebles' headquarters. Management believes this in-house credit program provides the Company with an important customer relations advantage over competing retailers which administer their credit programs from remote processing locations or contract for such services from unrelated third parties.\nThe Company's credit plans provide for the option of paying in full within 28 days of the billed date with no finance charge or with revolving credit terms. Terms of the short-term revolving charge accounts require customers to make minimum monthly payments in accordance with prescribed schedules. Peebles bears the risk of the collecting its credit card receivables. In the last two years, Peebles' credit card program had a positive impact on net income.\nThe following table presents a summary of information relating to the Company s charge card sales and receivables (in thousands):\nMANAGEMENT INFORMATION SYSTEMS\nThe Company's management information systems provide the daily financial and merchandising information to make timely and effective pricing decisions and for inventory control. The Company is able to allocate its inventory effectively as a result of its management information systems and can tailor the merchandise mix to meet the individual customer demands at each store.\nThe Company maintains central management information and data processing systems at its corporate headquarters. Each of its stores is equipped with compatible point-of-sale registers, which are polled every evening by the central system to gather sales, accounts receivable and inventory information.\nThe Company's management information and data processing systems primarily use internally developed software. The Company believes this allows management to more closely control the quality, suitability and expense of management information systems and data processing. The Company continues to make selected improvements in computer hardware technology as well as enhancements to software applications as needed.\nEMPLOYEES\nAt January 28, 1995, the Company had 997 full-time employees and 1,344 part-time employees. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its employee relations to be good.\nCOMPETITION\nThe retail industry is highly competitive, with selection, price, quality, service, location and store environment being the principal competitive factors. The Company competes with national and local retail stores, specialty apparel chains, department stores, discount stores and mail order merchandisers, many of which have substantially greater financial and marketing resources than the Company. Demographic changes may alter the character of the Company's markets, which can result in increased competition from other retailers.\nTRADEMARKS\nThe Peebles name is registered as a trademark and a servicemark of the Company. Additionally, the Company has registered several merchandise labels as trademarks under which it sells quality merchandise such as Cape Classic, Private Expressions, Meherrin River Outfitters, Harmony Grove and Sonoma Bay.\nREGULATION\nThe Company is subject to federal, state and local laws and regulations affecting retail department stores generally. The Company believes that it is in substantial compliance with these laws and regulations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAll but one of the Company's stores are leased, and most of the leases contain renewal options. The stores range in size from 8,000 square feet to 65,000 square feet, and average 32,000 square feet. The following table indicates the location of the Company's stores in operation as of April 4, 1995:\nDELAWARE Rehoboth Beach Seaford KENTUCKY Hopkinsville Madisonville MARYLAND Bowie Chestertown Easton Eldersburg Elkton Lexington Park Prince Frederick Salisbury Waldorf NEW JERSEY Rio Grande NEW YORK Geneva NORTH CAROLINA Aberdeen Charlotte Eden Jacksonville Monroe Roxboro Statesville PENNSYLVANIA Gettysburg SOUTH CAROLINA Conway Florence Georgetown Myrtle Beach TENNESSEE Columbia Cookeville Dyersburg Hermitage Murfreesboro VIRGINIA Ashland Blackstone Christiansburg Colonial Heights Covington Danville Emporia Front Royal Hayes Hampton Hopewell Lawrenceville Leesburg Lexington Luray Manassas Norfolk Onley Richmond Rocky Mount Smithfield South Hill Warrenton Waynesboro Williamsburg Woodbridge\nStore leases provide for a base rent of between $1.00 and $6.00 per square foot per year. Most leases also have formulas requiring the payment of additional rent based on a percentage of net sales above specified levels. In 1992, 1993 and 1994, the Company's aggregate rental payments on operating leases were approximately $5.6 million, $6.0 million and $6.4 million, respectively.\nThe Company's corporate headquarters and distribution center facilities are located in South Hill, Virginia. The Company owns the property subject to deeds of trust and security interests granted in connection with the Company's credit agreement. The Company believes the location provides the Company with adequate undeveloped space to expand the corporate headquarters, distribution center or both to meet future growth requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is from time to time involved in routine litigation. The Company believes that none of the litigation in which it is currently involved is material to its financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNONE\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nMARKET INFORMATION\nThere is no existing market for the Common Stock, nor is the Common Stock listed on any exchange. All currently outstanding shares of common stock were issued pursuant to exemptions from registration under the Securities Act of 1933, as amended (the \"Act\"), and any resales of such shares of Common Stock can only be made pursuant to an effective registration statement or an exemption from the registration requirements of the Act.\nHOLDERS\nAs of April 4, 1995, there were 94 holders of Common Stock.\nDIVIDENDS\nThe Company does not currently pay any dividends on its Common Stock. The Company's credit agreement prohibits the payment of dividends absent the consent of the Bank. Accordingly, the Company does not currently intend to declare any dividends to the holders of the Common Stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected historical financial data for Peebles for the five fiscal years ended January 28, 1995 are derived from the Company's audited financial statements. The Company's recapitalization (the \"Recapitalization\") was effective on January 31, 1992. The data should be read in conjunction with the financial statements, related notes and other financial information included herein.\n_____________________ * Not meaningful. (1) On January 31, 1992, the Company completed the Recapitalization. (2) Revaluation of goodwill is a result of the Recapitalization. (3) Reflects a gain on the exchange of debt related to the Recapitalization. (4) Only reflects data for comparable stores. Comparable stores for the current year are those stores which were open for the entire period in the immediately preceding year. (5) Net sales per selling square feet per store is based on stores open one full year. (6) Includes the long-term portion of the capital lease obligations and the current portion of long-term debt. (7) Stockholders' equity was adjusted as of February 1, 1992 to reflect the Recapitalization, including the elimination of a deficit in retained earnings of $10,477.\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 provides information with respect to the results of operations for the three fiscal years ended January 28, 1995.\n1994 COMPARED TO 1993\nNet sales increased $15.9 million, or 10.5%, to $167.7 million in 1994 from $151.8 million in 1993. $6.2 million of the increase was attributable to comparable store sales growth, which increased 4.6% over the prior year. Management attributes the increase in comparable store sales primarily to the Company's ability to tailor its merchandise mix to individual stores. $5.0 million of the increase was attributable to the inclusion of a full year of operation in 1994 of the five stores opened during 1993. The remaining $4.7 million of this increase is from the opening of five new stores in 1994, partially offset by the closing of one store, increasing the total number of stores from 54 to 58. Sales also increased due to better overall economic conditions in the Company's markets.\nGross margin increased $8.9 million, or 14.8%, in 1994 as compared to 1993, and the gross margin percent improved to 41.5% from 40.0%. $6.4 million of this increase was attributable to the increase in net sales and $2.5 million was due to an improvement in gross margin percent. The gross margin percent increased due to a LIFO benefit of $0.2 million in 1994 as compared to a charge of $1.1 million in 1993. The remaining increase in gross margin percent was due to lower markdowns during the 1994 Christmas season as a result of the timing of promotions.\nSelling, general and administrative expenses increased $4.9 million, or 12.1%, and, as a percentage of net sales, increased to 27.0% in 1994 from 26.6% in 1993. The increase in expenses was primarily due to the increase in net sales. The increase as a percentage of net sales was due to the increased number of new stores that typically have higher occupancy, payroll and advertising expenses as a percentage of net sales as compared to mature stores. This increase was also due to higher compensation expense associated with performance-based management incentive plans.\nDepreciation and amortization expense increased $0.7 million, or 11.6%, and as a percentage of net sales was 4.0% for both periods. The increase in dollars was due to the new stores opened in 1994, a full year's depreciation on new stores opened in 1993 and a full year's depreciation on the 1993 expansion of the distribution center.\nAs a result of each of the above factors, operating income increased $3.4 million, or 23.6%, to $17.7 million in 1994 from $14.3 million in 1993.\nInterest expense increased $0.3 million, or 7.6%, but as a percentage of net sales, decreased to 2.7% in 1994 from 2.8% in 1993. This increase was due to increases in the prime interest rate during the year, which caused the interest rate under the Company's credit agreement (the \"Credit Agreement\") to increase. This increase was partially offset by lower amounts outstanding under the Credit Agreement.\nIncome taxes increased $1.2 million. The Company's effective tax rate decreased to 43.5% in 1994 from 45.0% in 1993. The effective tax rate declined because non-deductible amortization expense in 1994 was proportionately lower relative to income before taxes. The effective tax rate is higher than statutory rates because of the non-deductible amortization expense.\nAs a result of the above factors, net income increased $2.0 million, or 35.3%, to $7.5 million in 1994 from $5.5 million in 1993.\n1993 COMPARED TO 1992\nNet sales increased $10.9 million, or 7.7%, to $151.8 million for 1993 from $140.9 million for 1992. $3.3 million of the increase was attributable to comparable store sales growth, which increased 4.3% over the prior year. Management attributes the increase in comparable store sales primarily to the Company's ability to tailor its merchandise mix to individual stores. $3.3 million of the increase was attributable to the inclusion of a full year of operation in 1993 of the one store opened during 1992. The remaining $4.3 million of this increase is from the opening of five new stores in 1993, increasing the total number of stores from 49 to 54. Comparable store sales in the fourth quarter of 1993 increased 9.0% in comparison with the prior year compared to 2.0% comparable store sales increase for the first three quarters of 1993 compared to the prior year. Sales also increased in 1993 due to better overall economic conditions in the Company's markets.\nGross margin increased $3.7 million, or 6.6%, in 1993 compared to 1992 and the gross margin percent decreased to 40.0% from 40.4%. The increase in dollars was attributable to the increase in net sales, which was partially offset by a decline in gross margin percent. The decrease in gross margin percent was primarily attributable to a higher LIFO charge of $1.1 million in 1993 compared to $0.3 million in 1992. Additionally, the initial markup on merchandise as part of the Company's increased emphasis on its everyday fair price program was lower in comparison to the prior year.\nSelling, general and administrative expenses increased $2.6 million, or 6.9%, and as a percentage of net sales decreased to 26.5% in 1993 from 26.8% in 1992. All of the increase in expenses was due to the increase in net sales. The decrease as a percentage of sales was primarily due to increased operating efficiency.\nDepreciation and amortization expense increased $0.5 million, or 8.5%, and as a percentage of net sales was 3.9% for both periods. The increase in dollars was due to the new stores opened in 1993, and a full year's depreciation on a new store opened in 1992.\nAs a result of the above factors, operating income increased $0.7 million, or 4.8%, to $14.3 million in 1993 from $13.6 million in 1992.\nInterest expense decreased $0.7 million, or 14.7%, and as a percentage of net sales, decreased from 3.6% in 1992 to 2.8% in 1993. The decrease in dollars was due to lower average amounts outstanding under the Company's Credit Agreement during the first half of 1993 and lower interest rates.\nIncome taxes increased $0.6 million. The Company's effective tax rate decreased to 45.0% in 1993 from 46.4% in 1992. The effective tax rate declined because non-deductible amortization expense in 1993 was proportionately lower relative to income before taxes. The effective tax rate is higher than statutory rates because of the non-deductible amortization expense.\nAs a result of the above factors, net income increased $1.0 million, or 21.2% to $5.5 million in 1993 from $4.6 million in 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's primary cash requirements are for capital expenditures in connection with both the Company's new store expansion and remodeling program and for working capital needs. The Company's primary sources of funds are cash flow from continuing operations, borrowings under the Credit Agreement and trade accounts payable. The Company's inventory levels typically build throughout the fall, peaking during the Christmas selling season, while accounts receivable peak during December and decrease during the first quarter. Capital expenditures typically occur evenly throughout the first three quarters of each year.\nNet cash provided by operating activities amounted to $21.3 million, $5.8 million, and $13.1 million in 1992, 1993 and 1994, respectively. These amounts represent primarily net income plus depreciation and amortization, partially offset by increases in working capital, including increases of merchandise inventory of $5.8 million and $2.9 million in 1993 and 1994.\nNet cash used in investing activities was $5.9 million, $7.5 million, and $8.7 million in 1992, 1993 and 1994, respectively. These amounts reflect $1.5 million, $2.6 million and $2.6 million of capital expenditures relating to new store openings and $2.6 million, $1.7 million and $3.4 million relating to store remodelings, respectively. In 1993 and 1994, the Company made capital expenditures of $2.1 million relating to the expansion of the distribution center. Net cash provided by financing activities was $1.7 million in 1993, and net cash used in financing activities was $15.5 million and $4.1 million in 1992 and 1994, respectively. The net cash used in 1992 reflects reduction of the Company's indebtedness as a result of the recapitalization, which closed on January 31, 1992.\nThe Company's capital expenditures in 1995 are expected to total approximately $9.3 million. In 1995, the capital expenditures reflect the opening of eight stores, the relocation of two stores and the remodeling of two stores. As of March 1995, the Company had signed seven new leases all of which are scheduled to open in 1995. In 1996, the Company expects to open nine stores, relocate two stores and remodel two stores. The Company expects to continue to lease its stores, and the average new store is anticipated to average approximately 22,500 square feet but may vary depending on the market and real estate availability. Based on experience in 1993 and 1994, the Company estimates that the cost of opening a new store will include capital expenditures of approximately $425,000 for leasehold improvements and fixtures and approximately $425,000 for initial inventory, approximately one-third of which is normally financed through vendor credit. Accounts receivable for new stores typically build to 15% of net sales or approximately $300,000 within 24 months of the store opening. The Company may also incur capital expenditures to acquire existing stores.\nUnder the Company's Credit Agreement the Company may borrow up to the lesser of (i) $76.0 million less the aggregate amount outstanding under the term portion of the Credit Agreement and the aggregate amount of outstanding letters of credit, or (ii) a borrowing base which is a percentage of eligible accounts receivable and inventory. The borrowing base formula is adjusted to accommodate seasonal working capital requirements. The term facility requires quarterly payments of principal of $0.5 million on April 30, July 31, October 31, and January 31 of each year. The Credit Agreement expires on February 1, 1997.\nAmounts outstanding under the Company's revolving facility were $25.1 million, $30.0 million and $28.6 million at year end 1992, 1993 and 1994, respectively. The maximum amount of borrowings outstanding under the revolving credit facility at any month end during 1992, 1993 and 1994 was $38.1 million, $36.7 million and $35.5 million, respectively.\nSEASONALITY AND QUARTERLY RESULTS\nDuring 1993, and 1994, the Company realized 34.0% and 32.9%, respectively, of its net sales in the fourth quarter, and 56.4% and 54.7%, respectively, of its net income. Set forth below is certain summary information with respect to the Company's operations for the eight most recent quarters:\nIMPACT OF INFLATION\nThe Company does not believe that inflation has had a material effect on its results of operations during the past three fiscal years. Peebles uses the retail inventory method applied on a LIFO basis in accounting for its inventories. Under this method, the cost of products sold reported in the financial statements approximates current costs and thus reduces the likelihood of a material impact from increasing costs. However, there can be no assurance that the Company's business will not be impacted by inflation in the future.\nRECENT DEVELOPMENTS\nOn April 4, 1995, Peebles announced that it has signed an agreement to be acquired by PHC Retail Holding Company (\"PHC Retail\"), an affiliate of Kelso & Company, Inc., an investment firm located in New York City. The transaction provides for the merger of a subsidiary of PHC Retail into Peebles and the receipt of cash by shareholders of Peebles. The closing is subject to a number of conditions, including regulatory and shareholder approval, and is expected to be completed in May.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nInformation with respect to this Item is contained in the financial statements and the financial statement schedule of Peebles indicated in the Indices on Pages and S-1 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. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Company's executive officers and directors, their ages, positions and years with the Company are as follows:\nMichael F. Moorman has been Chairman of the Board and a Director of the Company since September 1989, Chief Executive Officer of the Company since May 1989 and President of the Company since June 1988. Prior thereto, Mr. Moorman served as Chief Financial Officer and Treasurer of the Company from August 1989 to June 1992 and Secretary of the Company from August 1989 to June 1990. Mr. Moorman has been employed by the Company in various positions since 1964. Mr. Moorman has been a director of the Company since 1977.\nRonnie W. Palmore has been Senior Vice President, Merchandising of the Company since September 1989 and Assistant Secretary of the Company since 1988. Mr. Palmore served as Senior Vice President, Stores of the Company from June 1988 to August 1989 and has been employed by the Company in various positions since 1973.\nRussell A. Lundy, Sr. has been Senior Vice President, Stores of the Company since September 1989. Mr. Lundy served as Vice President, Stores of the Company from 1984 to August 1989 and has been employed by the Company in various positions since 1954.\nE. Randolph Lail has been Senior Vice President, Finance of the Company since June 1993, Chief Financial Officer and Treasurer of the Company since June 1992 and Secretary of the Company since June 1990. Mr. Lail served as Vice President, Finance of the Company from June 1990 to June, 1993 and as Controller of the Company from January 1988 to June 1990. Mr. Lail is a Certified Public Accountant and has been employed by the Company since January 1988.\nMarvin H. Thomas, Jr. has been Senior Vice President, Operations of the Company since June 1993. Mr. Thomas served as Vice President, Operations of the Company from June 1990 to June 1993 and Vice President, Merchandise Manager of the Company from May 1988 to June 1990. Mr. Thomas has been employed by the Company in various positions since 1979.\nWilliam C. DeRusha has been a Director of the Company since March 1992. Mr. DeRusha is Chairman of the Board and Chief Executive Officer of Heilig-Meyers Company. Mr. DeRusha is a director of Heilig-Meyers Company, Best Products Co. Inc. and Signet Banking Corporation.\nMalcolm S. McDonald has been a Director of the Company since April 1992. Mr. McDonald is President and Chief Operating Officer of Signet Banking Corporation and President and Chief Executive Officer of Signet Bank\/Virginia. From July 1988 to April 1990, Mr. McDonald was Vice Chairman of Signet Bank\/Maryland and Signet Bank\/Virginia. Prior to July 1988, Mr. McDonald was Vice Chairman of Signet Banking Corporation and Chairman of Signet Bank, N.A. Mr. McDonald is a director of Signet Banking Corporation and American Trading and Production Company.\nWellford L. Sanders, Jr. has been a Director of the Company since February 1992. Mr. Sanders is a partner in the law firm of McGuire, Woods, Battle & Boothe, L.L.P. Mr. Sanders is a director of Catherines Stores Corporation and General Medical Corporation.\nExecutive officers of Peebles are elected annually and serve at the discretion of the Board of Directors.\nDIRECTORS COMPENSATION\nEach director who is not an employee of the Company is paid an annual retainer of $20,000, payable quarterly in arrears, and is reimbursed for expenses incurred in attending meetings of the Board of Directors.\nAGREEMENTS TO INDEMNIFY.\nPeebles has entered into agreements with each of the directors and officers of Peebles pursuant to which Peebles agrees to indemnify such director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such director or officer and arising out of his capacity as a director, officer, employee and\/or agent of the corporation of which he is a director or officer to the maximum extent provided by applicable law. In addition, such director or officer shall be entitled to an advance of expenses to the maximum extent authorized or permitted by law to meet the obligations indemnified against. Such agreements also obligate the Company to purchase and maintain insurance for the benefit and on behalf of its directors and officers insuring against all liabilities that may be incurred by such director or officer, in or arising out of his capacity as a director, officer, employee and\/or agent of the Company.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe following tables set forth a summary of compensation paid by the Company to its five highest paid executive officers (the \"Named Executives\") during 1992, 1993 and 1994.\n_______________________________________\n(1) Salary amounts for 1993 and 1994 include tax-deferred contributions of compensation to the Company's 401(K) Profit Sharing Plan (the \"401-K Plan\"), adopted in October 1993. Salary compensation contributed to the 401-K Plan during 1993 and 1994 for each of the Named Executives is Mr. Moorman $2,207 and $2,185; Mr. Palmore $0 and $2,129; Mr. Lundy $980 and $1,958; Mr. Lail $608 and $1,621, and Mr. Thomas $666 and $1,425. (2) Bonus amounts for each of the Named Executives include the accrued bonus paid under the Company's annual incentive plans in 1992, 1993 and 1994. The 1994 bonus amounts include tax-deferred contributions of compensation to the 401-K Plan for each of the Named Executives as Mr. Moorman, $6,809, Mr. Palmore, $2,639, Mr. Lundy, $1,806, Mr. Lail $1,033, and Mr. Thomas $971. Additionally, bonus amounts include the fair market value of shares granted under the Peebles Inc. 1991 Stock\/Warrant plan (the \"1991 Plan\") in 1992 and 1993. (3) The benefits to be received by each of the Named Executives as a result of grants of discounted warrants under the 1991 Plan were excluded in 1993 because the warrants were exchanged for stock options on June 9, 1993 under the 1993 Stock Option Plan (the \"1993 Plan\"). The amounts shown for 1993 represent tax gross-up payments to cover the executive s tax withholding obligations resulting from the corresponding stock grants under the 1991 Plan. (4) In 1992, each Named Executive received a grant of discounted warrants and a tax gross-up payment to cover the executive's tax withholding obligations resulting from the grant of the discounted warrants and a corresponding grant of shares under the 1991 Plan. The value of the discount on warrants granted and the tax gross-up payments to the Named Executives is Mr. Moorman, $57,600 and $152,235; Mr. Palmore, $21,440 and $47,782; Mr. Lundy, $16,800 and $32,354; Mr. Lail, $10,080 and $23,715; and Mr. Thomas, $10,080 and $23,875. The discounted warrants were later exchanged for options in 1993 pursuant to the 1993 Plan. (5) Option\/warrant grants in 1993 to the Named Executives do not include any grants of warrants under the 1991 Plan. The warrants granted in 1992 were exchanged for stock options under the 1993 Plan. In 1993 and 1994, the stock options were granted to certain members of senior management under the 1993 Plan. (6) The cash incentive payouts under the Company's long-term incentive plan were based upon performance versus established goals for the three year period from 1991 to 1993. (7) The amounts in 1994 shown reflect the current value of the benefit to Mr. Lail and Mr. Thomas, respectively, of the portion of the premium paid by the Company with respect to split dollar insurance arrangements (see \"Employment Agreements\"). The benefit was determined by calculating the time value of money (including the applicable long term federal funds rate) of the premium paid by the Company in 1994 ($11,210 for Mr. Lail and $9,650 for Mr. Thomas) for the period from February 1, 1994 to January 31, 1995.\nOPTION GRANT TABLE. The following table sets forth the options granted by the Company to Named Executives during 1994.\n_________________________________________ (1) All incentive stock option grants to the Named Executives were made pursuant to the 1993 Plan and vest in varying equal proportions over three years. (2) Assumes a total of 218,206 stock options granted. (3) The Potential Realizable Values upon exercise of a stock option are equal to the product of the number of shares underlying the options and the difference between (i) the respective hypothetical stock prices on the date of option exercise and (ii) the exercise price per share of the option. The hypothetical stock prices are equal to the Company's common stock price per share as of the date of the option grant compounded annually at the rates of 0%, 5%, and 10%, respectively, over the ten-year term of the option. The rates of appreciation used are required by the Securities and Exchange Commission and do not represent a projection or estimate by the Company on the potential growth of its common stock. Therefore, there can be no assurance that the rate of stock price appreciation presented in this table can be achieved.\nOPTION EXERCISE TABLE. The following table sets forth information concerning the exercise of stock options during 1994 by each of the Named Executives and the year end value of unexercised options.\nOPTIONS EXERCISED IN 1994\n_______________________________________\n(1) There were no stock options exercised by the Named Executives in 1994. (2) The options vest in equal proportions over specified periods. The first vesting date was February 8, 1994; therefore, the options shown were exercisable as of the year ended January 28, 1995. (3) The value of the unexercised options is based on the Company's common stock price at the end of the 1994 fiscal year. There was no public market for the Company's common stock as of the end of 1994. The Board of Directors with the assistance of an appraisal by an independent investment banking firm determined the value of the common stock was not in excess of the $23.75 exercise price. Therefore, there are no options in the money.\nAs of the fiscal year ended January 28, 1995, there were no projected long-term incentive payouts.\nTHE 1993 STOCK OPTION PLAN. In April 1993, the stockholders approved the 1993 Stock Option Plan to replace an equity incentive plan (the \"Equity Incentive Plan\"). Both the Equity Incentive Plan and the 1993 Stock Option Plan were designed to provide a long-term incentive to certain key management personnel. Under the Equity Incentive Plan, 20,000 shares and 40,000 shares of Common Stock were issued in 1993 and 1992, respectively, and the Company recorded additional compensation expense of $792, and $1,590 in 1992 and 1991, respectively. Under the provisions of the 1993 Stock Option Plan, both incentive stock options and non-qualified stock options are granted and, as such, 450,000 shares of Common Stock are reserved for issuance. The Board of Directors has the authority and complete discretion to, among other things, determine the date of grant, the recipient employee, the exercise price and the expiration date of the options to purchase one share of the Common Stock. The options granted under the 1993 Stock Option Plan have an exercise price equal to the estimated fair value of the Common Stock on the date of grant, vest ratably over a three to five year period and expire ten years from the date of grant.\nPENSION PLAN\nPeebles maintains a non-contributory qualified defined benefit pension plan that covers all employees of Peebles who (i) complete 1,000 hours of service during a one-year period with Peebles and (ii) attain age 21 (a \"Participant\"). Contributions to the plan are determined on an actuarial basis without allocation to individuals or groups.\nRetirement benefits are based on a Participant's years of benefit service and the earnings during the five consecutive calendar years which produce the highest average. Earnings are limited to $150,000 in any one year and years of benefit service are limited to 30. A Participant is fully vested after completing five years of benefit service.\nBenefits are payable to vested Participants at normal retirement (age 65), early retirement (age 55), upon a vested Participant's permanent and total disability, or upon a vested Participant's termination of employment.\nThe following table shows estimated annual retirement benefits payable to Participants under the pension plan upon normal retirement at age 65 under various assumptions as to final average annual earnings, date of retirement and years of continuous service without regard to the current earning limit of $150,000.\nAs of January 28, 1995, the credited years of service for Mr. Moorman, Mr. Palmore, Mr. Lundy, Sr., Mr. Thomas, Jr. and Mr. Lail were 31, 22, 41, 16 and 7, respectively.\nPeebles reserves the right at any time by action of its Board of Directors to terminate the plan, although it currently has no intention to do so. If the plan is terminated and appropriately funded at such time, Peebles will not be required to make any further contributions to the plan and each participant shall become 100% vested in his benefit under the plan. Each Participant's benefit will be paid to him after termination of the plan according to the terms of the plan.\nIn addition, Peebles also maintains a supplemental executive retirement plan (the \"SERP\") for certain designated executives. In 1994, Mr. Moorman, Mr. Palmore, Mr. Lundy were participants in this plan. Retirement benefits payable under the SERP are based on 60% of the participant's earnings (without regard to the current earnings limit of $150,000) during the five consecutive calendar years which produce the highest average, reduced by the sum of the participant's qualified defined benefit pension benefit (computed with regard to the applicable earnings limit) and the participant's social security benefits.\nBenefits under the SERP are fully vested upon the earlier of (1) the completion of five years of service with the Company beginning with the date of participation in the SERP, (2) the participant's permanent disability, or (3) the date on which a change of control occurs.\nRetirement benefits are payable to vested participant's at normal retirement (age 65), early retirement (age 55 with 20 years of service), upon permanent and total disability, or upon a vested participant's termination of employment.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring the year ended January 28, 1995, the Company had no formally established compensation committee. The Board of Directors established compensation for the Company's officers for such year. Michael F. Moorman, the sole officer or employee of the Company who is also a member of the Board of Directors, made recommendations to the Board of Directors concerning executive compensation but did not otherwise participate in or vote upon the executive compensation decisions made by the Board of Directors for such year.\nCERTAIN RELATIONSHIPS\nWellford L. Sanders, Jr., a member of the Board of Directors of the Company, is a partner in the law firm of McGuire, Woods, Battle & Boothe, L.L.P., which rendered legal services to the Company during 1994.\nEMPLOYMENT AGREEMENTS\nOn March 30, 1995, Peebles entered into change of control agreements (the \"Change of Control Agreements\") with nine officers of Peebles (including each of the Named Executives). The Change of Control Agreements provide an officer the following benefits if his employment is terminated by the Company without \"Cause\" (as defined in the Change of Control Agreement) or by such officer for \"Good Reason\" (as defined in the Change of Control Agreements) during the three-year period following a \"Change of Control\" of the Company (as defined below) or in the event such officer voluntarily terminates his employment during the thirteenth month following a Change of Control: (i) a lump sum cash payment equal to the officer's full annual base salary through the date of termination to the extent not theretofore paid; (ii) a lump sum cash payment equal to the sum of (x) a bonus payment in an amount equal to the greatest of (A) the average bonus paid or payable to such officer in respect of the three fiscal years immediately preceding the fiscal year in which the Change of Control occurs, (B) 50% of such officer's target bonus for the fiscal year in which the Change of Control occurs or (C) 50% of such officer's target bonus for the fiscal year in which the termination occurs (the greatest of (A), (B) and (C) is hereafter the \"Bonus Payment\") multiplied by (D) a fraction, the numerator of which is the number of days in the fiscal year in which such officer is terminated through his date of termination, and the denominator of which is 365 or 366, plus (y) any compensation previously deferred by the officer (other than pursuant to a tax-qualified plan) and any accrued vacation pay, to the extent unpaid; (iii) a lump sum cash payment equal to the sum of (x) two times the such officer's highest annual base salary during the twelve-month period preceding the date of termination, plus (y) two times the Bonus Payment; (iv) a lump sum cash payment equal to the actuarial equivalent, determined as of the date of termination, of any unvested accrued benefit under the Company's Pension Plan; (v) a lump sum cash payment equal to the value of any unvested portion of employer contributions made on behalf of such officer to any defined contribution plan of the Company; and (vi) two years of continued coverage under the Company's medical, accident, disability and life insurance plans. The payments set forth in clauses (ii) through (iv) above would be paid in lieu of any other amount of severance relating to salary or bonus compensation to be received by such officer upon termination of employment under any severance plan, policy, employment agreement or arrangement of the Company.\nUnder the Change of Control Agreements, an officer cannot voluntarily terminate employment (without Good Reason) during the period of an attempted Change of Control or the ninety-day period following a Change in Control. In the event that prior to a Change in Control, an officer is terminated without Cause at the request of a third party who has indicated an intention or taken steps reasonably calculated to effectuate a Change of Control (and subsequently effectuates a Change of Control) or Good Reason occurs prior to a Change in Control at the request of such a third party, the officer would receive payments under the Change of Control Agreements as if such events had occurred following a Change of Control.\nA Change in Control is defined in the Change of Control Agreements as generally: (i) the acquisition of 50% or more of the outstanding common stock or voting securities of the Company by any person or group (other than the Company, an employee benefit plan sponsored or maintained by the Company or any corporation controlled by the Company, any corporation pursuant to a reorganization, merger or consolidation involving the Company in which the conditions listed in subclauses (A), (B) and (C) in clause (iii) below apply, or the officer) (ii) a change in the majority of the Board (other than changes approved by a majority of the members of the incumbent Board of Directors as of the date of the Change of Control Agreements); (iii) stockholder approval of a reorganization, merger or consolidation of the Company (unless immediately after such transaction, (A) the Company's stockholders continue to own both more than 50% of the outstanding common stock and more than 50% of the outstanding voting securities of the Company, (B) after the reorganization, merger or consolidation, no person (other than the Company, an employee benefit plan sponsored or maintained by the Company or any corporation controlled by the Company, or any person who beneficially owned 50% or more of the outstanding common stock or voting securities of the Company immediately prior to the reorganization, merger or consolidation) beneficially owns either 50% or more of the outstanding common stock or 50% or more of the outstanding voting securities of the resulting corporation, and (C) a majority of the Board of Directors has not changed); or (iv) stockholder approval of a plan of complete liquidation or dissolution of the Company, or the sale or other disposition of all or substantially all of the assets of the Company (other than pursuant to a transaction with respect to which the conditions listed in subclauses (A), (B), and (C) in clause (iii) above apply).\nOn March 30, 1995, Peebles entered into employment agreements (the \"Employment Agreements\") with fourteen other officers of Peebles. The Employment Agreements, all of which expire March 29, 1997, provide that if the officer is terminated for any reason, other than for good cause, he will be entitled to receive his salary at the rate in effect immediately before such termination for the balance of the term of the Employment Agreement. For purposes of the Employment Agreements, good cause is defined as (a) the commission of a serious crime, or (b) the officer, in carrying out his duties under the Employment Agreements, is guilty of (i) willful gross neglect, or (ii) willful gross misconduct resulting in either case in material harm to the Company or any of its subsidiaries.\nIn connection with the termination of the Company's 1991 Plan and the establishment of the 1993 Plan, all optionees under the 1993 Plan entered into a related agreement whereby the Company became obligated to make certain cash payments to the optionees, in exchange for their options, upon a change of control of the Company prior to an underwritten public offering of shares of the Common Stock or certain other events.\nIn addition, Mr. Lail and Mr. Thomas participate in split dollar insurance arrangements with the Company. The executive owns, and therefore has a vested interest in the cash surrender value of the policy in excess of the Company's premium investment. At retirement, the executive can either use the cash value for retirement income or keep the death benefit or a combination of the two. The Company would recover its cost at retirement. In the event of a change in control, the executive would have a nonforfeitable right to the Company's share of the cash surrender value of the policy.\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 Common Stock, as of April 4, 1995, by (a) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock, (b) each of the Company's directors and Named Executives who owns shares of Common Stock and (c) all directors and Named Executives of the Company as a group. Unless otherwise noted in the footnotes to the table, the persons named in the table have sole voting and investing power with respect to all shares of Common Stock indicated as being beneficially owned by them.\n____________________\n* Less than one percent. (1) Does not include (i) 435,699 options to purchase shares of Common Stock, pursuant to the 1993 Plan of which 159,227, 47,110, 32,929, 26,357 and 22,963 were held by Messrs. Moorman, Palmore, Lundy, Lail and Thomas and 288,586 were held by all Names Executives as a group, respectively; and (ii) 95 shares issuable upon exercise of the outstanding warrants described below. (2) Kemper Financial Services, Inc. and First Investors Corp. manage the funds in which the shares of Common Stock listed are held. (3) The managing general partner of Apollo Investment Fund, L.P. is Apollo Advisors, L.P. which may be deemed to be an affiliate of Lion Advisors, L.P. (4) Lion Advisors, L.P. holds the indicated shares for the benefit of an account under management over which Lion Advisors, L.P. holds exclusive investment, voting and dispositive power. Lion Advisors, L.P. and Apollo Advisors, L.P. may be deemed to be affiliates.\nPREVIOUSLY OUTSTANDING WARRANTS\nUpon completion of the Recapitalization on January 31, 1992, there were 6,486 warrants (the \"Peebles Warrants\") to purchase shares of Common Stock issued and outstanding. These Peebles Warrants are exercisable any time on or after July 15, 1994 (the \"Determination Date\") for one share of Common Stock at the exercise price of zero dollars ($0.00) per share. All Peebles Warrants issued and outstanding existing on July 15, 1999 will be deemed automatically exercised. In the event that certain defined conditions do not occur, the Company is required to repurchase the Peebles Warrants at the fair market value of the Common Stock at the Determination Date. Prior to the issuance of common stock, the Peebles Warrants will be accreted to fair market value and reflected as an adjustment to retained earnings. As of January 28, 1995, there were 95 warrants outstanding.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nSee \"Item 10. Directors and Executive Officers of the Registrant\" and \"Item 11. Executive Compensation\" for a description of certain arrangements with respect to present and former executive officers and directors of Peebles.\n(This space intentionally left blank.)\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial statements.\nInformation with respect to this Item is contained in the financial statements indicated on the Indices on Page of this Annual Report on Form 10-K.\n2. Financial statement schedules.\nInformation with respect to this Item is contained on Page S-1 of this Annual Report on Form 10-K.\n3. Exhibits.\nThe exhibits listed on the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K.\nNONE\n(c) Exhibits.\n2.1 Form of Agreement and Plan of Merger dated April 3, 1995 among PHC Retail Holding Company, Peebles Acquisition Corp. and Peebles Inc., exclusive of exhibits and schedules. The Registrant hereby undertakes to furnish to the Commission supplementally upon request a copy of any omitted exhibit or schedule. 3.1+ Form of Amended and Restated Articles of Incorporation of Peebles Inc. 3.2+ Form of Amended and Restated Bylaws of Peebles Inc. 3.3 Amendment to Amended and Restated Articles of Incorporation dated May 3, 1993 4.2* Form of Warrant Agreement between PBL Acquisition Corp. and the Warrant Agent 4.3* Form of Warrant Certificate (included in the Warrant Agreement filed as Exhibit 4.2 hereto). 10.1+ Second Amended and Restated Credit Agreement dated January 31, 1992 by and between NatWest USA Credit Corp. and Peebles Inc. (the \"Credit Agreement\"). 10.2+ Form of Term Note. 10.3+ Form of Credit Note. 10.4+ Amended and Restated Continuing General Borrower Security Agreement made January 31, 1992 by and between Peebles Inc. and NatWest USA Credit Corp. 10.5+ Trademark Security Agreement made January 31, 1992 between Peebles Inc. and NatWest USA Credit Corp. 10.6* Deed of Trust made January 20, 1989 by and among Peebles Inc., the Trustee party thereto and NatWest USA Credit Corp. 10.7* Peebles Inc. Qualified Defined Benefit Pension Plan. 10.8 Standard Service Agreement, as amended, dated January 17, 1995 between Frederick Atkins, Incorporated and Peebles Inc. 10.9++ Waiver and Amendment No. 1 dated, January 4, 1993, to the Credit Agreement. 10.10++ 1993 Stock Option Plan and form of Incentive Stock Option Agreement. 10.11** Form of Indemnification, Guarantee and Contribution Agreement dated as of March 13, 1991 among PBL Acquisition Corp., Peebles Holdings, Inc., Peebles Inc. and each of the directors and officers of Peebles Inc. 10.12++ Form of Agreement providing for cash payment upon certain changes of control of the Company. 10.13+++ Waiver and Amendment No. 2, dated March 24, 1993 to the Credit Agreement. 10.14 Amendment No. 2, dated September 30, 1994 to the Credit Agreement. 10.15 Form of Change of Control Agreement, dated March 30, 1995 entered into by Peebles and nine senior executives of Peebles. 10.16 Form of Employment Agreement, dated March 30, 1995 entered into by Peebles and fourteen executives of Peebles. 21 Subsidiaries of the Registrant. 27 Financial Data Schedule ____________________________\n* Incorporated by reference from the Registration Statement of PBL and Peebles on Form S-1 (Registration No. 33-27126), which was declared effective by the Commission on July 14, 1989.\n** Incorporated by reference from the Form 10-K of PBL and the Company for the fiscal year ended February 2, 1991.\n+ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 1, 1992.\n++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 30, 1993.\n+++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 29, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPEEBLES INC. (Registrant)\nBy \/s\/ Michael F. Moorman Date: April 28, 1995 Michael F. Moorman, President and Chief Executive Officer (Principal Executive Officer)\nBy \/s\/ E. Randolph Lail Date: April 28, 1995 E. Randolph Lail, Senior Vice President Finance, CFO, (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.\nBy \/s\/ Wellford L. Sanders, Jr. Date: April 28, 1995 Wellford L. Sanders, Jr., Director\nBy \/s\/ William C. DeRusha Date: April 28, 1995 William C. DeRusha, Director\nBy \/s\/ Malcolm S. McDonald Date: April 28, 1995 Malcolm S. McDonald, 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.\nThe Company has furnished to the Commission a copy of its proxy statement and form of proxy sent to its security holders in connection with the Company's May 10, 1995 special meeting of stockholders.\nAUDITED FINANCIAL STATEMENTS\nPEEBLES INC.\nJANUARY 28, 1995\nReport of Independent Auditors..........................F-1\nBalance Sheet.........................................\nStatement of Income...................................\nStatement of Changes in Stockholders' Equity..........\nStatement of Cash Flows...............................\nNotes to Financial Statements..........................\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Peebles Inc.\nWe have audited the accompanying balance sheet of Peebles Inc. as of January 28, 1995 and January 29, 1994, and the related statements of income, changes in stockholders' 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 based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Peebles Inc. at January 28, 1995 and January 29, 1994, and the 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.\n\/s\/ Ernst & Young LLP Richmond, Virginia\nMarch 9, 1995, except for Note J, as to which the date is April 4, 1995\nBALANCE SHEET PEEBLES INC. (dollars in thousands, except per share amounts)\nJANUARY 28, JANUARY 29, 1995 1994 -------------- ------------ ASSETS CURRENT ASSETS Cash $ 408 $ 99 Accounts receivable, net 28,812 28,386 Merchandise inventories 44,703 41,652 Prepaid expenses 306 246 Refundable income taxes 778 294 Other 62 554 -------- --------- TOTAL CURRENT ASSETS 75,069 71,231 PROPERTY AND EQUIPMENT Fixtures and equipment 43,991 40,569 Land and building 5,751 5,751 Leasehold improvements 368 502 -------- --------- 50,110 46,822 Accumulated depreciation and amortization 21,159 21,919 -------- --------- 28,951 24,903\nBuildings under capital leases, net 1,230 1,400\nOTHER ASSETS Excess of cost over net assets acquired, net 37,111 38,800 Deferred financing costs, net 277 582 Beneficial leaseholds, net 3,345 3,723 Sundry 2,971 3,088 -------- --------- 43,704 46,193 -------- --------- $148,954 $143,727 ======== ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 8,722 $ 7,306 Accrued compensation and other expenses 5,587 5,627 Deferred income taxes 4,472 4,957 Current maturities of long-term debt 5,850 8,538 Other 566 455 -------- --------- TOTAL CURRENT LIABILITIES 25,197 26,883 LONG-TERM DEBT 34,240 35,602 LONG-TERM CAPITAL LEASE OBLIGATIONS 1,865 2,067 DEFERRED INCOME TAXES 5,416 4,481 COMMON STOCK WARRANTS Subject to redemption, with an exercise price of $0.00; issued and outstanding 95 and 6,486 warrants, respectively 2 164 STOCKHOLDERS' EQUITY Preferred stock--no par value, authorized 1,000,000 shares, none issued or outstanding -- -- Common stock--par value $.10 per share, authorized 5,000,000 shares, issued and outstanding 2,942,690 and 2,933,562, respectively 294 293 Additional capital 64,390 64,174 Retained earnings: Accumulated from February 1, 1992, subsequent to a deficit elimination of $10,477 on that date 17,550 10,063 -------- --------- 82,234 74,530 -------- --------- $148,954 $143,727 See notes to financial statements ======== =========\nSTATEMENT OF INCOME PEEBLES INC. (dollars in thousands, except per share amounts)\nSee notes to financial statements\nSTATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY PEEBLES INC. (dollars in thousands, except per share amounts)\nSee notes to financial statements\nSTATEMENT OF CASH FLOWS PEEBLES INC. (dollars in thousands)\nSee notes to financial statements\nNOTES TO FINANCIAL STATEMENTS PEEBLES INC. JANUARY 28, 1995\n(dollars in thousands, except per share amounts)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND BASIS OF FINANCIAL STATEMENT PRESENTATION: Peebles Inc. (\"Peebles\" or the \"Company\") is the successor to a group of related companies that has operated a retail department store business since 1891 under the name \"Peebles\". The Company currently operates 58 department stores in small and medium-sized communities in ten Southeastern and Mid-Atlantic States.\nFISCAL YEAR: The Company's fiscal year ends on the Saturday nearest January 31. Fiscal years 1994, 1993, and 1992 ended on January 28, 1995, January 29, 1994, and January 30, 1993, respectively. Results of operations for each of these years consisted of fifty-two weeks. References to years relate to fiscal years rather than calendar years.\nQUASI-REORGANIZATION: As a result of a recapitalization of the Company completed January 31, 1992, a quasi-reorganization was implemented as of February 1, 1992. An accumulated deficit of $10,477 was transferred to additional capital.\nSTATEMENT OF CASH FLOWS: Peebles considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. There were no cash equivalents at January 28, 1995 or January 29, 1994. The issuance of certain common stock and common stock warrants increased shareholders' equity by $162, $477 and $1,052 in 1994, 1993 and 1992, respectively, and accordingly, has been excluded from the Statement of Cash Flows as a non-cash transaction.\nMERCHANDISE INVENTORIES: Merchandise inventories are accounted for by the retail inventory method applied on a last in, first out (\"LIFO\") basis.\nPROPERTY AND EQUIPMENT: Property and equipment is stated on the basis of cost. Depreciation of property and equipment is provided primarily by the straight-line method over their estimated useful lives for financial reporting purposes and by accelerated methods for income tax purposes. The cost of leasehold improvements is amortized over the shorter of their economic lives or the terms of the leases by the straight-line method. Amortization of buildings under capital leases is computed by the straight-line method over the lease term and is included in depreciation and amortization expense.\nSTORE OPENING COSTS: Store opening costs are charged to selling, general and administrative expenses as incurred.\nADVERTISING COSTS: Advertising costs, charged to selling, general and administrative expenses as incurred, aggregated $4,255, $4,089 and $3,460 for 1994, 1993 and 1992, respectively.\nEXCESS OF COST OVER NET ASSETS ACQUIRED: The excess of cost over net assets acquired (\"Goodwill\") is being amortized on a straight- line basis over a twenty-five year period. Accumulated amortization at January 28, 1995 and January 29, 1994 was $5,060 and $3,371, respectively.\nDEFERRED FINANCING COSTS: Deferred financing costs are being amortized by the interest method over a period ending February 1, 1996. Amortization expense of $457, $435, and $445 for deferred financing costs are included in interest expense for 1994, 1993, and 1992 respectively. Accumulated amortization at January 28, 1995 and January 29, 1994 was $2,803 and $2,346, respectively.\nBENEFICIAL LEASEHOLDS: Amortization is provided by the straight- line basis over the estimated composite useful lives of the related leases. Accumulated amortization at January 28, 1995 and January 29, 1994 was $2,117 and $1,739, respectively.\nINCOME TAXES: Deferred income taxes are provided for temporary differences between income and expense for financial reporting purposes and for income tax purposes.\nNET INCOME PER SHARE: Net Income per share is based on the weighted-average number of shares and common stock equivalents outstanding.\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE B--MERCHANDISE INVENTORIES\nIn connection with an acquisition of the Company in January 1989, the recorded value of merchandise inventories was increased to fair value (the \"Fair Value Adjustment\"). Merchandise inventories consisted of the following:\nJanuary 28, January 29, January 30, 1995 1994 1993 ----------- ----------- ----------- Merchandise inventories at lower of cost (FIFO) or market $33,332 $30,463 $24,661 Fair Value Adjustment 14,209 14,209 14,530 Reduction in Fair Value Adjustment -- -- (321) LIFO reserve (2,838) (3,020) (1,876) -------- --------- -------- Merchandise inventories at LIFO cost $44,703 $41,652 $36,994 ======== ========= ========\nReduced inventory levels during 1992 resulted in a liquidation of LIFO inventory quantities carried at costs prevailing in prior years. This LIFO decrement affected the base year and therefore resulted in a reduction of the Fair Value Adjustment of $321, charged to cost of sales in 1992.\nNOTE C--ACCOUNTS RECEIVABLE\nAccounts receivable are shown net of $930 and $950 representing the allowance for uncollectible accounts at January 28, 1995 and January 29, 1994, respectively. The provision for doubtful accounts was $620, $546, and $577 for 1994, 1993 and 1992, respectively. Finance charges on credit sales, included as a reduction of selling, general and administrative expenses, aggregated $4,818, $4,576 and $4,652, for 1994, 1993 and 1992, respectively.\nAs a service to its customers, the Company offers credit through the use of its own charge card, certain major credit cards and a layaway plan. The Peebles' customer usually resides in the local community immediately surrounding the store location. Peebles stores serve these local customers in Virginia, Maryland, North Carolina, South Carolina, Tennessee, Kentucky, Delaware, New Jersey, Pennsylvania and New York. The Company does not require collateral from its customers.\nNOTE D--SUNDRY ASSETS\nSundry consisted of: January 28, 1995 January 29, 1994 ---------------- ---------------- Investment in and advances to buying office $ 1,694 $ 1,586 Pension asset, net 1,032 1,176 Other 245 326 ------- ------- $ 2,971 $ 3,088 ======= =======\nNOTE E--LONG-TERM DEBT\nLong-term debt consisted of the following:\nJanuary 28, 1995 January 19, 1994 ---------------- ---------------- Senior Revolving Facility $28,550 $30,000 Senior Term Facility 11,340 13,840 Other 200 300 ------- ------- 40,090 44,140 Less current maturities 5,850 8,538 ------- ------- $34,240 $35,602 ======= =======\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE E--LONG-TERM DEBT - Continued\nThe Senior Revolving Facility (\"Revolving Facility\") and the Senior Term Facility (\"Term Facility\"), together the Second Amended and Restated Credit Agreement (the \"Credit Agreement\"), provide the Company with working capital and funds for capital expenditures. On September 30, 1994, the Company and its bank signed Amendment No. 2 to the Credit Agreement (the \"Amendment\"). The Amendment (i) extended the maturity date of the Credit Agreement one year to February 1, 1997; (ii) reduced the quarterly principal payments due under the Term Facility from $750 to $500; (iii) reduced the annual interest rate from prime plus 1-1\/2% to either prime plus 3\/4%, provided certain quarterly operating criteria are met, or prime plus 1% if the criteria are not satisfied; (iv) increased allowable annual capital expenditures from $8.75 to $10.0 million; and (v) increased the flexibility of certain restrictive debt covenants. The Credit Agreement remains in full force and effect except where amended. The operations of the Company from September 30, 1994 through January 28, 1995 continuously satisfied the criteria of the Credit Agreement such that interest on outstanding borrowings was charged at prime plus 3\/4%. Restrictive covenant provisions of the Credit Agreement prohibit payment of cash dividends in any fiscal year. The Credit Agreement is secured by a first priority security interest in substantially all the personal property and certain real property of Peebles.\nThe amount available for borrowings under the Revolving Facility is determined by a defined asset based formula with maximum borrowings limited to $76,000 less amounts outstanding under the Term Facility. The Company pays a fee of 1\/4% per annum on any unused portion of the Revolving Facility. The Revolving Facility has no specific paydown provisions. Based on the anticipated operations of the Company in the succeeding year, $24,800 and $24,600 were considered long-term obligations at January 28, 1995 and January 29, 1994, respectively, representing the minimum outstanding balance of the Revolving Facility for an uninterrupted period extending beyond one year from the balance sheet date.\nPeebles has commitments for letters of credit with a bank which totaled $462 and $455 at January 28, 1995 and January 29, 1994, respectively. Approximately $127 expire during 1995, and the remainder expires August 1, 1998.\nDuring 1994, 1993 and 1992, Peebles made cash interest payments of $4,091, $3,548, and $4,917, respectively.\nAggregate principal payments on long-term debt for the next five fiscal years are: 1995--$5,850, 1996--$34,240, 1997, 1998 and 1999--$0.\nNOTE F_LEASES\nThe Company leases substantially all of its store locations under capital and operating leases with initial terms ranging from 1 to 25 years and renewal options of 1 to 5 years expiring at various dates through 2033. The following is a summary of assets under capitalized leases:\nJanuary 28, 1995 January 29, 1994 ---------------- ---------------- Buildings under capital leases $ 3,018 $ 3,018 Less--accumulated amortization (1,788) (1,618) ------- ------- $ 1,230 $ 1,400 ======= =======\nTotal rental expense under operating leases was as follows:\n1994 1993 1992 ---- ---- ---- Minimum $ 5,915 $ 5,479 $ 5,162 Contingent 531 490 412 -------- -------- ------- $ 6,446 $ 5,969 $ 5,574 ======== ======== =======\nContingent rentals are based upon a percentage of annual sales in excess of specified amounts.\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE F--LEASES--Continued Future minimum lease payments under capital leases and noncancellable operating leases at January 28, 1995 were as follows:\nCapital Operating Fiscal Year Leases Leases ----------- -------- --------- 1995 $ 487 $ 6,016 1996 487 5,810 1997 487 5,364 1998 377 5,087 1999 377 5,020 Thereafter 1,160 33,235 -------- -------- Total minimum lease payments 3,375 $ 60,532 Less: amounts representing ======== interest (1,308) -------- Present value of net minimum lease payments, including current maturities of $202, with interest rates ranging from 11.3% to 18.1% $ 2,067 ========\nNOTE G--COMMON STOCK WARRANTS On July 15, 1994 (the \"Determination Date\"), 6,486 warrants to purchase one share of Peebles common stock, $.10 par value (the \"Common Stock\") at the exercise price of zero dollars ($0.00) per share (\"Warrant\") became exercisable. Subsequent to the Determination Date, 6,391 Warrants were redeemed for Common Stock. Prior to the redemption, outstanding Warrants are accreted to fair market value and reflected as an adjustment to retained earnings.\nNOTE H--EMPLOYEE BENEFIT PLANS THE EMPLOYEES RETIREMENT PLAN OF PEEBLES INC.: The Company provides a defined benefit pension plan which covers substantially all employees. Participation is dependent on meeting certain age and service requirements. Benefits are based on total years of benefit service and the employee's compensation during the five consecutive calendar years which produce the highest average. Peebles makes annual contributions to the Plan equal to the contribution required to satisfy minimum funding standards under ERISA.\nNet periodic pension cost included the following components:\n1994 1993 1992 ------ ------ ------ Service cost-benefits earned during the period $ 323 $ 297 $ 263 Interest cost on projected benefit obligation 448 443 413 Actual return on plan assets 177 (463) (198) Net amortization and deferral (804) (129) (402) ----- ----- ----- Net periodic pension cost $ 144 $ 148 $ 76 ===== ===== =====\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE H--EMPLOYEE BENEFIT PLANS--Continued\nThe following table sets forth the Plan's funded status and amounts recognized in Peebles balance sheet:\nJanuary 28, 1995 January 29, 1994 ---------------- ---------------- Actuarial present value of benefit obligations: Accumulated benefit obligations including vested benefits of $4,385 and $4,428, $ (4,737) $ (4,861) respectively ========== ========== Projected benefit obligation $ (5,856) $ (6,313) Plan assets at fair value, primarily listed stocks and U.S. Government Treasury Bonds 6,389 6,876 Plan assets in excess of projected ---------- ---------- benefit obligations 533 563 Prior service costs (84) 76 Unrecognized net loss 658 626 Unrecognized net asset (75) (89) Net pension asset recognized ---------- ---------- in the balance sheet $ 1,032 $ 1,176 ========== ==========\nIn calculating the present value of projected benefit obligations for 1994 and 1993, a 5.0% weighted average rate of compensation was used, and weighted-average discount rates of 8.75% and 7.5%, respectively, reduced the projected benefit obligation by some $696. The expected long-term rate of return on plan assets was 9% for 1994, 1993, and 1992.\nTHE PEEBLES INC. 401 (K) PROFIT SHARING PLAN: In October 1993, the Company adopted a qualified profit sharing and retirement savings plan, which under Section 401 (k) of the Internal Revenue Code, allows tax deferred contributions from eligible employees of up to 12% of their annual compensation. The Company does not currently contribute to the plan.\nTHE 1993 STOCK OPTION PLAN: In April 1993, the stockholders approved the 1993 Stock Option Plan to replace an equity incentive plan (the \"Equity Incentive Plan\"). Both the Equity Incentive Plan and the 1993 Stock Option Plan were designed to provide a long-term incentive to certain key management personnel. Under the Equity Incentive Plan, 20,000 shares and 40,000 shares of Common Stock were issued in 1993 and 1992, respectively, and the Company recorded additional compensation expense of $792, and $1,590 in 1992 and 1991, respectively. Under the provisions of the 1993 Stock Option Plan, both incentive stock options and non-qualified stock options are granted and, as such, 450,000 shares of Common Stock are reserved for issuance. The Board of Directors has the authority and complete discretion to, among other things, determine the date of grant, the recipient employee, the exercise price and the expiration date of the options to purchase one share of the Common Stock. The options granted under the 1993 Stock Option Plan have an exercise price equal to the estimated fair value of the Common Stock on the date of grant, vest ratably over a three to five year period and expire ten years from the date of grant.\nActivity under the 1993 Stock Option Plan is as follows:\nShares Under Exercise Option Price Per Share ------------- ------------ INITIAL GRANT, FEBRUARY 8, 1993 231,794 $23.75\nOUTSTANDING OPTIONS, JANUARY 231,794 23.75 29, 1994 Granted 218,206 23.75 Exercised (2,737) 23.75 Canceled (11,564) 23.75 --------- OUTSTANDING OPTIONS, JANUARY 28, 1995 435,699 23.75 ========= ======= EXERCISABLE AT JANUARY 28, 1995 69,636 $23.75 ========= =======\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE I - INCOME TAXES\nThe provisions for income taxes consisted of the following:\n1994 1993 1992 ------- ------- ------- Current: Federal $ 4,354 $ 3,273 $ 2,844 State 943 687 603\nDeferred: Federal 371 455 422 State 79 98 83 ------- ------- ------- $ 5,747 $ 4,513 $ 3,952 ======= ======= =======\nIncome taxes differ from the amounts computed by applying the applicable federal statutory rates due to the following:\n1994 1993 1992 ------- ------- ------ Taxes at the federal statutory rate $ 4,628 $ 3,514 $ 2,893\nIncreases (decreases): State income taxes, net of federal tax 676 518 453 Amortization of purchase accounting adjustments 574 574 574 Other (131) (93) 32 ------ ------ ------ $ 5,747 $ 4,513 $ 3,952 ====== ====== ======\nSignificant components of deferred tax liabilities and assets are as follows:\nJanuary 28, 1995 January 29, 1994 ---------------- ---------------- Deferred tax liabilities: Inventory valuation $ 4,830 $ 5,134 Depreciation and amortization 5,122 4,169 Pensions 397 452 Other -- 190 ---------- --------- 10,349 9,945 Deferred tax assets: Net operating loss carryover -- (1,200) Doubtful accounts (358) (366) Other (103) (141) ---------- --------- (461) (1,707) Valuation allowance -- 1,200 ---------- --------- (461) (507) ---------- --------- Net deferred tax liabilities $ 9,888 $ 9,438 ========== =========\nPeebles made cash income tax payments of $6,183, $4,175 and $3,509 for 1994, 1993 and 1992, respectively.\nThe Internal Revenue Service has completed its examination of the Company's federal income tax returns for the fiscal years ended February 1, 1992, and February 2, 1991, and the Company has agreed to various adjustments proposed by the government. As a result of this agreement, which does not materially affect the Company's financial position or results of operations, the Company's net operating loss carryover and the associated valuation allowance have been eliminated.\nNOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.\nNOTE J - SUBSEQUENT EVENT\nOn April 4, 1995, the Company announced that it had signed an agreement to be acquired by PHC Retail Holding Company (\"PHC Retail\"), an affiliate of Kelso & Company, Inc., an investment firm located in New York City. The transaction provides for the merger of a subsidiary of PHC Retail into Peebles and the receipt of cash by the shareholders of Peebles. The closing of the transaction is subject to a number of conditions, including regulatory and shareholder approval, and is expected to be completed in May.\nNOTE K - QUARTERLY FINANCIAL DATA (UNAUDITED)\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPEEBLES INC.\nSchedule I. Condensed Financial Information of Registrant . . . . . . . . . . . . . . . . . N\/A Schedule II. Valuation and Qualifying Accounts . . . . . . S-1 Schedule III. Real Estate and Accumulated Depreciation . . N\/A Schedule IV. Mortgage Loans on Real Estate . . . . . . . . N\/A Schedule V. Supplemental Information Concerning Property- Casualty Insurance Operations . . . . . . . . N\/A\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nPEEBLES INC.\n(1) Uncollectible accounts written off, net of recoveries.\nEXHIBIT INDEX Exhibit Page No. Description Number\n2.1 Form of Agreement and Plan of Merger among PHC Retail Holding Company, Peebles Acquisition Corp. and Peebles Inc., exclusive of exhibits and schedules. The Registrant hereby undertakes to furnish to the Commission supplementally upon request a copy of any omitted exhibit or schedule. 3.1+ Form of Amended and Restated Articles of Incorporation of Peebles Inc. 3.2+ Form of Amended and Restated Bylaws of Peebles Inc. 3.3 Amendment to Amended and Restated Articles of Incorporation dated May 3, 1993. 4.2* Form of Warrant Agreement between PBL Acquisition Corp. and the Warrant Agent. 4.3* Form of Warrant Certificate (included in the Warrant Agreement filed as Exhibit 4.2 hereto). 10.1+ Second Amended and Restated Credit Agreement dated January 31, 1992 by and between NatWest USA Credit Corp. and Peebles Inc. (the \"Credit Agreement\"). 10.2+ Form of Term Note. 10.3+ Form of Credit Note. 10.4+ Amended and Restated Continuing General Borrower Security Agreement made January 31, 1992 by and between Peebles Inc. and NatWest USA Credit Corp. 10.5+ Trademark Security Agreement made January 31, 1992 between Peebles Inc. and NatWest USA Credit Corp. 10.6* Deed of Trust made January 20, 1989 by and among Peebles Inc., the Trustee party thereto and NatWest USA Credit Corp. 10.7* Peebles Inc. Qualified Defined Benefit Pension Plan. 10.8 Standard Service Agreement, as amended, dated January 17, 1995 between Frederick Atkins, Incorporated and Peebles Inc. the predecessor to Peebles Inc.). 10.9++ Waiver and Amendment No. 1 dated, January 4, 1993, to the Credit Agreement. 10.10++ 1993 Stock Option Plan and form of Incentive Stock Option Agreement.\nExhibit Page No. Description Number\n10.11** Form of Indemnification, Guarantee and Contribution Agreement dated as of March 13, 1991 among PBL Acquisition Corp., Peebles Holdings, Inc., Peebles Inc. and each of the directors and officers of Peebles Inc. 10.12++ Form of Agreement providing for cash payment upon certain changes of control of the Company. 10.13+++ Waiver and Amendment No. 2, dated March 24, 1993 to the Credit Agreement. 10.14 Amendment No. 2, dated September 30, 1994 to the Credit Agreement. 10.15 Form of Change of Control Agreement, dated March 30, 1995 entered into by Peebles and nine senior executives of Peebles 10.16 Form of Employment Agreement, dated March 30, 1995. entered into by Peebles and fourteen executives of Peebles. 21 Subsidiaries of the Registrant. 27 Financial Data Schedule ___________________ * Incorporated by reference from the Registration Statement of PBL and Peebles on Form S-1 (Registration No. 33-27126), which was declared effective by the Commission on July 14, 1989.\n** Incorporated by reference from the Form 10-K of PBL and the Company for the fiscal year ended February 2, 1991.\n+ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 1, 1992.\n++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 30, 1993.\n+++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 29, 1994.","section_15":""}
{"filename":"102267_1995.txt","cik":"102267","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) The registrant, Uptowner Inns, Inc., is a corporation that was incorporated in the State of West Virginia on July 1, 1961. The registrant owns and operates a motor hotel with a Holiday Inns Franchise that consists of dining, banquet, and lounge facilities, and also operates three apartment buildings, rental properties all located in the City for Huntington, West Virginia.\nThe main physical property of Uptowner Inn of Parkersburg, Inc., had a swimming pool, dining and banquet facilities, and two parcels, owned in fee by such subsidiary, located in downtown Parkersburg, West Virginia at 415 Seventh Street. The Hotel was closed on June 30, 1987. On August 31, 1994, the property was sold for $750,000.\nA wholly owned subsidiary of the registrant, Motel and Restaurant Supply, which was incorporated in the State of West Virginia on July 16, 1966, has had no activity since 1981.\nNeither the registrant nor any of its subsidiaries has experienced bankruptcy, receivership or similar proceedings; has been involved in reclassification, merger or consolidation; has acquired or, except as hereinafter set forth, disposed of any material amount of assets otherwise than in the ordinary course of business; or has undertaken any material change in the mode of conducting its business.\n(b) The registrant is engaged in substantially one line of business, to-wit, the operation of motor hotels and related facilities.\n(c) The registrant is engaged in substantially one line of business, to wit, the operation of motor hotels with dining and banquet facilities, and residential\/commercial rentals. The income of the registrant from rentals represents less than ten percent of the consolidated revenue of the registrant and its subsidiaries, which consolidated revenue did not exceed $50,000,000. during any of the last three fiscal years.\nThe hotel industry is highly competitive with the registrant competing against numerous national hotel franchises in Huntington, West Virginia. As the Companies' operations are generally one business segment, its competition locally includes Radisson hotel, Ramada Inn, Holiday Inn, Comfort Inn, and Red Roof Inn.\nSeasonality directly affects this business as a result of people not traveling or vacationing in large numbers in the late fall and winter because of poor weather at these geographical locations.\nAt June 30, 1995, the registrant and its subsidiaries employ approximately 57 employees.\n(d) The registrant has no foreign operation.\nPART II\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\n(a) The main physical property of the registrant is a 140 unit, four story motor hotel, with swimming pool, dining, banquet, and lounge facilities, located in downtown Huntington, West Virginia, at 1415 Fourth Avenue. This property is owned in fee by the registrant and operated with a Holiday Inn Franchise. The motor hotel is subject to a mortgage in favor of the Twentieth Street Bank, Huntington, West Virginia, in the original amount of $2,000,000., payable in monthly installments of $22,568. per month, including interest at 10% until February 4, 2004, when the amount due must be paid in full. The balance at June 30, 1995 is $1,554,279.\n(b) The registrant owns in fee two lots, used for the over- flow parking, across the street from its main motor hotel at 1432-34 Fourth Avenue, in Huntington, West Virginia.\n(c) The registrant owns in fee an undeveloped lot acquired for future development or parking, across an alley from its main motor hotel at 1400 Fifth Avenue in Huntington, West Virginia.\n(d) The registrant owns in fee a lot improved by a three story brick building used as a fraternity house, across an alley from its main motor hotel, 1434 Fifth Avenue, in Huntington, West Virginia, acquired for rental and for future development.\n(e) The registrant owns in fee two lots immediately west of its motor hotel, 1401 Fourth Avenue, in Huntington, West Virginia, acquired for future development and currently used for parking. This property is subject to a first mortgage in favor of the Twentieth Street Bank in the original amount of $2,000,000. as noted in Item 2 (a).\n(f) The registrant owns in fee and operates a 40 unit, two story apartment building within one city block of the motor hotel, at 1340 Fourth Avenue, in Huntington, West Virginia.\n(g) The registrant owns in fee a lot acquired for future development or parking, across the street from its main motor hotel at 1420 Fourth Avenue, in Huntington, West Virginia.\n(h) The registrant owns in fee an undeveloped lot acquired for future development or for parking, across an alley from its main motor hotel at 1438 Fifth Avenue, in Huntington, West Virginia.\n(i) The registrant owns in fee and operates a two story duplex within one city block of the main motor hotel at 1326 Fourth Avenue, in Huntington, West Virginia.\nPART II\n(j) The registrant owns in fee a lot improved by a three story building originally used as a store and apartment, within one city block of the main motor hotel at 1416-18 Fourth Avenue, in Huntington, West Virginia, acquired for rental and for future development, subject to a mortgage in favor of Betty M. Dove, in the original amount of $76,000., 10% interest, maturing June 2002, the balance of which was $44,546. at June 30, 1995.\n(k) The registrant owns in fee two parcels within one city block of the main motor hotel at 1436-38 Fourth Avenue and 1440-42 Fourth Avenue, in Huntington, West Virginia acquired for future development.\n(l) The registrant owns in fee a parcel of real estate on the west side of Huntington approximately 3 miles from the main motor hotel and at an exit for Interstate 64. This purchase was finalized in October 1988 from an option entered into in 1983. The property is to be operated as a rental property until it is deemed beneficial to build and operate a decent motel in that location.\n(m) The registrant purchased a parcel of real estate with a residential building in January 1990. This property is across an alley from the main motor hotel and was acquired for future development and parking.\n(n) The registrant purchased a parcel of real estate with a building housing residential and commercial tenants in July 1991. This property is across the street from its main motor hotel and adjacent to other rental properties and parking facilities. The property has been renovated and is now fully utilized as rental property. The property is subject to a mortgage in favor of West Virginia Housing Development Fund in the original amount of $500,000., 5.5% rate of interest, maturing November 2018, the balance of which is $484,577.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nA suit in which the Uptowner Inns, Inc. is a defendant has been filed by an individual who was severely injured in an auto accident by a patron of the lounge. Legal counsel believes that good defenses exist in this action, and that the case will ultimately be resolved in Uptowner Inns, Inc.'s favor. The insurance company has denied liability in this case and legal counsel believes the risk of loss will fall to Uptowner Inns, Inc.\nPART II\nITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\n(a) The common stock of the registrant is traded in the over- the-counter market. During the past two years, there has been limited activity of common stock. These shares were traded at $.65 a share.\n(b) As of the 11th day of September 1995, the approximate number of record holders of common stock securities of the registrant was 1,184.\n(c) The registrant has paid no dividends with respect to its common stock during the past two years.\nITEM 6. SELECTED FINANCIAL DATA.\nThe following financial information of Uptowner Inns, Inc. and Subsidiaries is for the years ended June 30, 1995, June 30, 1994, June 30, 1993, June 30, 1992 and June 30, 1991 on a scope similar to that set forth in the report included elsewhere in this report. These Summaries should be read in conjunction with the financial statements and related notes included elsewhere in this report.\n[CAPTION] OTHER INCOME (EXPENSE)\n1995 1994 1993\nGain (Loss) on sales of property, plant and equipment $ - $ - $ 1,950. Gain (Loss) on disposal of subsidiary 306,930. - -\nINCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE FEDERAL INCOME TAXES\n1995 1994 1993\n$ 502,600. $( 81,046.) $( 65,637.)\nINCOME TAXES\n1995 1994 1993\nIncome taxes (benefit) $ - $ - $ - Effective tax rate - - -\nThere is no tax benefit for the fiscal years 1994 and 1993 due to the loss and the lack of any taxable income to apply this against. For the year ended June 30, 1995, the Company utilized operating loss carryforwards in the amount of $485,679. to offset taxable income. The Company has a carryforward loss for taxable income until the year 2008.\nINCOME (LOSS)\n1995 1994 1993\n$ 494,600. $( 81,046.) $( 59,848.)\nThe sale of the Parkersburg property in August 1994, with the gain of $306,930., had an obvious impact on income, but the increase in revenues of $203,611. and the decrease of expenses of $65,105. resulted in a significant change in Income From Operations from a loss of $81,046. in 1994 to an increase of $187,670. in 1995.\n[CAPTION] LIQUIDITY AND CAPITAL RESOURCES\n1995 1994\nResources available at June 30, 1995 and 1994\nCash $ 298,380. $ 119,199. Investments 576,470. -\nBecause of resources available to the Company and its current financial condition and structure, it is management's opinion that, barring a severe decline in the nation's economy, there will be financial improvement in the future reporting periods.\nDue to the property sale and significant improvement of income from operations, the liquidity is the strongest the Company has ever experienced. It is anticipated that the next year will provide opportunity to improve the liquidity further, subject to the final costs that may be incurred to update the motor hotel property to retain the Holiday Inn Franchise. The improvement would be as a result of the operating activities continuing to generate a good cash flow and the costs of major improvements not causing declines.\nUPTOWNER INNS, INC. AND SUBSIDIARIES\nPART III\nItem 10. Directors and Executive Officers of the Registrant\nThe information required by Item 10, Part III, will be set forth in the definitive proxy statement to be filed by the registrant, pursuant to Regulation 14A, under the captions \"Election of Directors\" and \"Executive Officers of the Company\" and is incorporated herein by reference.\nItem 11. Executive Compensation\nThe information required by Item 11, Part III, will be set forth in the definitive proxy statement to be filed by the registrant, pursuant to Regulation 14A, under the caption \"Remuneration of Directors and Executive Officers\", and is incorporated herein by reference.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\n(a) The registrant has issued only one type of security, namely, common capital stock. The following table sets forth certain information as to the persons and groups who are known to the registrant to be the beneficial owners of more than five percent of its voting securities.\nTitle of Name and Address Amount and Nature of Percent Class of Beneficial Owner Beneficial Ownership of Class\nCommon Violet Midkiff 673,652 Direct and 42.5 922 Eleventh Street Indirect Huntington, West Virginia\n(b) The following table sets forth certain information as to each class of equity securities of the registrant beneficially owned by all directors and officers of the registrant as a group.\nTitle of Name and Address Amount and Nature of Percent Class of Beneficial Owner Beneficial Ownership of Class\nCommon Arthur J. Huber 30,049 Indirect 1.9\nCommon James R. Camp 6,212 Direct .4\nCommon Violet Midkiff 673,652 Direct and 42.5 Indirect\nItem 12. Security Ownership of Certain Beneficial Owners and Management (Cont'd)\nTitle of Name and Address Amount and Nature of Percent Class of Beneficial Owner Beneficial Ownership of Class\nCommon Louis Abraham 2,546 Direct .2\nCommon Carl Midkiff 9,020 Direct and .6 Indirect\nCommon Olive Hager 21,870 Direct 1.4\nCommon Six Officers and 743,349 Direct and 27.7 Directors as a Indirect Group\n(c) There is no arrangement, known to the registrant, the operation of which may at a subsequent date result in a change in control of the registrant.\nUPTOWNER INNS, INC. AND SUBSIDIARIES\nITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A)(1) Financial Statements:\nUptowner Inns, Inc. and Subsidiaries Opinion of Independent Certified Public Accountant Consolidated Balance Sheets as of June 30, 1995 Consolidated Statement of Income for the Year Ended June 30, 1995 Consolidated Statement of Stockholders' Equity for the Year Ended June 30, 1995 Consolidated Statement of Cash Flows for the Year Ended June 30, 1995 Notes to Consolidated Financial Statements\nUptowner Inns, Inc. and Subsidiaries Opinion of Independent Certified Public Accountant Consolidated Balance Sheets as of June 30, 1994 and 1993 Consolidated Statement of Income for the Years Ended June 30, 1994, 1993 and 1992 Consolidated Statement of Stockholders' Equity for the Years Ended June 30, 1994, 1993 and 1992 Consolidated Statement of Cash Flows for the Years Ended June 30, 1994, 1993 and 1992 Notes to Consolidated Financial Statements\n(A)(2) Schedules:\nSchedule II -- Accounts Receivable from Related Parties and Underwriters Schedule V -- Property, Plant and Equipment Schedule VI -- Accumulated Depreciation of Property, Plant and Equipment Schedule VIII -- Valuation of Qualifying Accounts Schedule XII -- Mortgage Loans on Real Estate\n\t All other schedules are omitted since 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) Exhibits:\n(22) Subsidiaries of Uptowner Inns, Inc.:\nAll other required exhibits are incorporated in the Registration Statement Number 2-90194 of Uptowner Inns, Inc.\nNo reports on Form 8-K have been filed during the period covered by this report. A Form 8-K was filed September 13, 1995 under Item 4","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":"85704_1995.txt","cik":"85704","year":"1995","section_1":"Item 1. Business\nRuddick Corporation (the \"Registrant\") is a diversified holding company which, through its subsidiaries, is engaged in four primary businesses: Harris Teeter, Inc. (\"Harris Teeter\") operates a chain of supermarkets in five southeastern states; American & Efird, Inc. (\"A&E\") manufactures and distributes industrial and consumer sewing thread and sales yarn; Jordan Graphics, Inc. (\"Jordan Graphics\") produces and distributes business forms; and R.S. Dickson & Co., which does business as Ruddick Investment Company (\"Ruddick Investment\"), operates as an investment management, real estate development and venture capital company.\nAt October 1, 1995, the Registrant and its subsidiaries had total consolidated assets of $721,941,000 and had approximately 20,000 employees. The principal executive offices of the Registrant are located at 2000 Two First Union Center, Charlotte, North Carolina 28282.\nRuddick Corporation, which is incorporated under North Carolina law, was created in 1968 through the consolidation of the predecessor companies of A&E and Ruddick Investment. In 1969 the Registrant acquired Harris Teeter and the predecessor company of Jordan Graphics.\nThe businesses in which the Registrant engages through its subsidiaries, together with certain financial information and competitive aspects of such businesses, are discussed separately below. For certain other information regarding industry segments, see the Note entitled \"Industry Segment Information\" of the Notes to Consolidated Financial Statements of Ruddick Corporation and Subsidiaries in the Registrant's 1995 Annual Report to Shareholders (the \"1995 Annual Report\"), which information is incorporated herein by reference.\nThe only foreign operations conducted by the Registrant are through A&E. None of the businesses engaged in by the Registrant would be characterized as seasonal.\nThe Registrant employs nineteen people, including four executives who form and implement overall corporate objectives and policies. The Registrant's employees perform functions in a number of areas including finance, accounting, audit, insurance, reporting, employee benefits, and public and shareholder relations. The Registrant assists its subsidiaries in developing long-range goals, in strengthening management personnel and skills, and in financing operations. Management of each subsidiary is responsible for implementing operating policies and reports to management of the Registrant.\nA&E\nA&E produces industrial sewing thread from natural and synthetic fibers for use by apparel, automotive, upholstered furniture, home furnishings, and footwear manufacturers. A&E also produces consumer sewing thread for use in home sewing. These products are primarily manufactured in twelve plants, all located in North Carolina, and are sold primarily in the United States. Limited quantities of industrial sewing threads are exported. A&E also distributes sewing supplies manufactured by other companies. Thread and notion products accounted for approximately 98% of A&E's net sales in fiscal 1995. A&E also produces a limited quantity of mercerized cotton yarns for use by knitting and weaving industries, which products accounted for 2% of A&E's net sales in fiscal 1995. This yarn production has decreased in recent years as plant capacity has been converted to the manufacture of sewing thread. Sales operations are conducted through A&E's employed salesmen and commission brokers and jobbers. A&E's sales constituted 14% of the Registrant's consolidated sales in fiscal 1995 (14% in 1994 and 15% in 1993).\nThe order backlog, believed to be firm, as of the end of the 1995 fiscal year was approximately $12,920,000 versus $17,863,000 at the end of the preceding fiscal year. Such backlog normally is expected to be filled within three weeks of fiscal year end. A&E has approximately 7,900 active customer accounts. In fiscal 1994, no single customer accounted for more than 8% of total net sales, and the ten largest customers accounted for an aggregate of less then 26% of total net sales.\nA&E purchases cotton from domestic cotton merchants. There is presently a sufficient supply of cotton worldwide and in the domestic market. Synthetic fibers are bought from the principal American synthetic fiber producers and are currently available in an adequate supply.\nThere are no material patents, licenses, franchises, or concessions held by A&E. Research and Development expenditures were $245,000 and $244,000 in fiscal 1995 and fiscal 1994, respectively, none of which expenditures were sponsored by customers. Two employees are engaged in this activity full-time.\nA&E has expanded into international markets as sewing thread demand has increased outside the United States in the apparel, home furnishings, and industrial markets. A&E's value of assets in its subsidiaries in England, Costa Rica, Canada, Korea, Mexico, Hong Kong and Singapore and in its joint ventures in Dominican Republic and Venezuela totals approximately $51 million. Management expects to continue to expand foreign production and distribution operations, primarily through additional joint ventures.\nThe industrial sewing thread industry is highly competitive. A&E is one of the largest producers in the domestic industrial thread market. Principal competitors include Coats\/American and Dixie\/Threads USA. Principal competitive factors include quality, service and price. In the consumer thread market, A&E competes with a number of large, well-established companies, including Coats\/American.\nA&E employed approximately 2,800 persons as of the end of fiscal 1995. A&E considers its employee relations to be good.\nHARRIS TEETER\nHarris Teeter operates supermarkets in North Carolina (90), South Carolina (24), Virginia (19), Georgia (5), and Tennessee (1) for sales of groceries, produce, meat, delicatessen items, bakery items, and non-food items such as health and beauty care and other products normally offered for sale in supermarkets. Harris Teeter has a program in place whereby each retail store will undergo a major remodel every eight years. Harris Teeter remodeled nine stores during fiscal 1995 and expects to remodel nine stores in fiscal 1996. In addition, eleven new stores were opened and eleven older, less profitable, stores were closed. In fiscal 1993, a reserve was established in anticipation of closing 12 smaller, less competitive stores and replacing them with larger stores offering increased variety and drawing from a larger market area. Seven of the eleven stores closed in fiscal 1995 were covered by this reserve. As of fiscal year end, Harris Teeter had 139 stores in operation. Its principal offices and perishable distribution facilities are located near Charlotte, North Carolina, and its dry grocery and cold storage distribution facilities are located in Greensboro, North Carolina. Harris Teeter produces some dairy products, but buys most of the products it sells, including its private label brands. Harris Teeter's sales constituted 83% of the Registrant's consolidated sales in fiscal 1995 (83% in 1994 and 82% in 1993).\nThe supermarket industry is highly competitive. Harris Teeter competes with local, regional, and national food chains, some of which are larger in terms of assets and sales, as well as with independent merchants. Principal competitive factors include store location, price, service, convenience, cleanliness, product quality and product variety. No one customer or group of customers has a material effect upon the business of Harris Teeter.\nAt fiscal year end, Harris Teeter employed approximately 8,300 persons full-time and 8,700 part-time. Warehouse employees and drivers at Harris Teeter's warehouse near Charlotte, North Carolina are represented by a union, but Harris Teeter is not party to a collective bargaining agreement covering such employees. Harris Teeter considers its employee relations to be good.\nJORDAN GRAPHICS\nJordan Graphics produces a line of business forms and printed products and distributes its products through its own sales representatives. Its product line includes custom and stock continuous forms for computer use, snap-apart forms, pressure sensitive labels, sheeted and roll labels, envelopes, many specialty items and multi-color forms for laser printers. Jordan Graphics' offices and principal plant are located near Charlotte, North Carolina. Jordan Graphics manufactures and distributes its products, primarily through its direct sales force, mainly in the eastern United States.\nAs of December 14, 1995, the Registrant and Jordan Graphics entered into a letter of intent to sell the assets of Jordan Graphics to The Reynolds and Reynolds Company.\nReynolds and Reynolds is an integrated information management systems provider headquartered in Dayton, Ohio. The sale of such assets, which is expected to close in the second fiscal quarter, is subject to the execution of a definitive agreement between the parties, the receipt of all necessary consents, releases and approvals and other conditions typical in transactions of this type. For certain financial information with respect to Jordan Graphics, reference is made to the Note entitled \"Industry Segment Information\" of the Notes to the Registrant's Consolidated Financial Statements contained in the 1995 Annual Report, which is incorporated by reference herein.\nThe principal raw materials used by Jordan Graphics include paper, carbon, cartons, and ink. Management believes that sufficient sources of these raw materials are currently available.\nIn fiscal 1995, the largest single customer of Jordan Graphics accounted for 4.1% of total net sales, and the ten largest customers accounted for an aggregate of 24.4% of total net sales. The loss of any one of its five largest accounts would not, in the opinion of management, materially affect Jordan Graphics' business.\nJordan Graphics operates in a highly competitive industry, and many of its competitors are substantially larger, both in terms of assets and sales. The principal methods of competition in the business forms industry are price, quality, and service.\nAt fiscal year end, Jordan Graphics employed 351 persons, of which 60 were in sales. Jordan Graphic considers its employee relations to be good.\nRUDDICK INVESTMENT\nRuddick Investment makes direct venture investments from its own capital base and from internally generated funds. In an increasingly important role, venture investment activities include the development of shopping centers where Harris Teeter serves as an anchor tenant. Additionally, the company's venture capital portfolio is invested in a limited number of industries and may include securities of start-ups and early stage firms, as well as publicly traded securities. Some of the products and services produced by the current portfolio holdings include proprietary building products, textiles, pharmaceuticals and medical diagnostic instrumentation. Ruddick Investment's principal objective is to achieve long-term gains on each of its investments. It is not an operating company and does not offer a service or product in the normal course of business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of the Registrant are located in approximately 8,086 square feet of leased space in a downtown office tower at 2000 Two First Union Center, Charlotte, North Carolina 28282, in which it is a tenant under a lease which expires in May 1998.\nA&E's principal offices and twelve domestic manufacturing plants are all owned by A&E and are all located in North Carolina. Manufacturing plants have an aggregate of 1,467,409 square feet of floor space and an insured value of $250,000,000. A&E has the\ncapacity to produce annually approximately 35,800,000 pounds of industrial sewing thread and 3,250,000 pounds of sales yarn and has a dyeing capacity of approximately 35,000,000 pounds per year. Capacities are based on 168 hours of operations per week. A&E also leases 17 distribution centers scattered throughout its domestic markets at an approximate annual rent of $1,500,000. Through subsidiaries, A&E also owns seven international manufacturing plants with an aggregate of 336,500 square feet of floor space and an insured value of $49,952,000. These subsidiaries have the capacity to produce annually approximately 7,830,000 pounds of sewing thread and have a dyeing capacity of approximately 9,865,000 pounds per year. Capacities are based on 168 hours of operations per week. In addition to its subsidiaries, A&E has a minority interest in two joint ventures.\nHarris Teeter owns its principal offices, which consist of 95,050 square feet of space located on a 10 acre tract of land near Charlotte, North Carolina. Harris Teeter owns a 104 acre tract east of Charlotte where its cold storage distribution facility is located. This facility contains approximately 176,000 square feet, most of which is equipped to store refrigerated or perishable goods. Harris Teeter also owns a 49 acre tract in Greensboro, North Carolina, where its dry grocery and frozen goods warehouses are located. The dry grocery warehouse contains approximately 547,000 square feet and the frozen goods warehouse contains approximately 130,000 square feet. Harris Teeter owns a 18,050 square foot milk processing plant located on 8.3 acres of land in Charlotte, North Carolina and a 81,900 square foot milk processing and ice cream manufacturing facility located on 4.7 acres of land in High Point, North Carolina. Harris Teeter operates its retail stores exclusively from leased properties. The base annual rentals on leased store and warehouse properties as of October 1, 1995 aggregated approximately $31,862,000 net of sublease rentals of approximately $1,556,000. In addition to the base rentals, the majority of the lease agreements provide for additional annual rentals based on 1% of the amount by which annual store sales exceed a predetermined amount. During the fiscal year ended October 1, 1995, the additional rental amounted to approximately $1,277,000. Harris Teeter's supermarkets range in size from approximately 15,000 square feet to 67,000 square feet, with an average size of approximately 34,000 square feet. The following table sets forth selected statistics with respect to Harris Teeter stores for each of the last three fiscal years:\n* Computed on the basis of aggregate sales of stores open for a full year.\nThe corporate offices and principal manufacturing facility and warehouses for Jordan Graphics are located near Charlotte, North Carolina. Jordan Graphics owns this\nfacility, which contains 188,000 square feet and is located on 26 acres of land. In addition, Jordan Graphics closed a smaller manufacturing plant in Baltimore, Maryland. The Baltimore site, consisting of approximately 42,000 square feet located on six acres of land, will be used as a sales office and warehouse until its disposition, which is anticipated during fiscal 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant has entered into an Administrative Order on Consent with Region IV of the United States Environmental Protection Agency, together with 14 other parties who have been designated potentially responsible parties, to perform a remedial investigation\/feasibility study at the Leonard Chemical Company Superfund site in Rock Hill, South Carolina. The Registrant's potential liability is based on the alleged disposal of waste material at this Superfund site by Pargo, Inc. Pargo, Inc. was a wholly owned subsidiary of the Registrant from 1969 to 1972. The Registrant has agreed to participate in the remedial investigation\/feasibility study on the condition that its share of the costs does not exceed 1.8% of the total plus an additional payment of $4,680 for costs previously incurred by other parties. The Registrant estimates that, based on current information, the total cost of the remedial investigation\/feasibility study should be approximately $500,000. Under the interim allocation of costs agreed to by the parties to the Administrative Order on Consent, the Registrant's share is 1.155% of the total cost. The Registrant does not believe that this proceeding will have a material effect on its business or financial condition.\nThe Registrant and its subsidiaries are involved in various matters from time to time in connection with their operations, including various environmental matters. These matters considered in the aggregate have not had, nor does the Registrant expect them to have, a material effect on the Registrant's business or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following list contains the name, age, positions and offices held, and period served in such positions or offices for each of the executive officers of the Registrant.\nR. Stuart Dickson, age 66, has been Chairman of the Executive Committee since February, 1994. Prior to that time he had been Chairman of the Board of the Registrant since its formation in October, 1968.\nAlan T. Dickson, age 64, has been Chairman of the Board since February, 1994. Prior to that time he had been President of the Registrant since its formation in October, 1968.\nJohn W. Copeland, age 60, has been President of the Registrant since February, 1994. Prior to that time he had been President of A&E since October, 1984.\nRichard N. Brigden, age 56, has been Vice President-Finance of the Registrant since December, 1983.\nThomas W. Dickson, age 40, has been President of A&E since February, 1994. Prior to that time, he served as Executive Vice President from 1991 to 1994 and as Senior Vice President-Marketing and International from 1989 to 1991.\nEdward S. Dunn, age 52, has been President of Harris Teeter since January 1, 1989.\nBrian F. Gallagher, age 48, has been President of Jordan Graphics, Inc. since July, 1993. From April, 1993 to July, 1993, he served as Vice President of Manufacturing. From May, 1985 to April, 1993, he served as Plant Manager at several plants for Moore Business Forms.\nThe executive officers of the Registrant and its subsidiaries are elected annually by their respective Boards of Directors. R. Stuart Dickson and Alan T. Dickson are brothers. Thomas W. Dickson is the son of R. Stuart Dickson and the nephew of Alan T. Dickson. No other executive officer has a family relationship with any other executive officer or director or nominee for director as close as first cousin.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information required for this item is incorporated herein by reference to the following sections of the Registrant's 1995 Annual Report: information regarding the principal market for Common Stock, number of shareholders of record, market price information per share of Common Stock and dividends declared per share of Common Stock and $.56 Convertible Preference Stock for each quarterly period in the 1995 and 1994 fiscal years (the $.56 Preference was called for redemption on May 31, 1994) is incorporated by reference to the Note headed \"Quarterly Information (Unaudited)\" to the Notes to Consolidated Financial Statements; and information regarding restrictions on the ability of the Registrant to pay cash dividends is incorporated by reference to \"Management's Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources and Liquidity\" and the Note headed \"Long-Term Debt\" to the Notes to Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required for this item, for each of the last five fiscal years, is incorporated herein by reference to the section headed \"Eleven-Year Financial and Operating Summary\" in the Registrant's 1995 Annual Report.\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 herein by reference to the section headed \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Registrant's 1995 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of the Registrant, including the Report of Independent Public Accountants thereon, are incorporated herein by reference from the Registrant's 1995 Annual Report.\nThe required supplementary financial information is incorporated herein by reference from the Note headed \"Quarterly Information (Unaudited)\" of the Notes to Consolidated Financial Statements in the Registrant's 1995 Annual Report.\nThe financial statement schedules required to be filed herewith, and the Report of Independent Public Accountants thereon, are listed under Item 14(a) of this Report and filed herewith pursuant to Item 14(d) 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 required by this item with respect to executive officers is set forth above in Part I, Item 4A. The other information required by this item is incorporated herein by reference to the sections entitled \"Election of Directors\" and \"Beneficial Ownership of Company Stock\" in the Registrant's Proxy Statement dated December 20, 1995, filed with the Securities and Exchange Commission with respect to the Registrant's 1996 Annual Meeting of Shareholders (the \"1996 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 \"Election of Directors - Directors' Fees and Attendance\" and \"Executive Compensation\" in the Registrant's 1996 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 sections entitled \"Principal Shareholders\" and \"Election of Directors-Beneficial Ownership of Company Stock\" in the Registrant's 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of report\n(1) Financial Statements: The following report and financial statements are incorporated by reference to the Registrant's 1995 Annual Report:\nConsolidated Balance Sheets, October 1, 1995 and October 2, 1994\nStatements of Consolidated Income and Retained Earnings for the fiscal years ended October 1, 1995, October 2, 1994 and October 3, 1993\nStatements of Consolidated Cash Flows for the fiscal years ended October 1, 1995, October 2, 1994 and October 3, 1993\nNotes to Consolidated Financial Statements\nReport of Independent Public Accountants\n(2) Financial Statement Schedules: The following report and financial statement schedules are filed herewith:\nReport of Independent Public Accountants for each of the fiscal years in the three year period ended October 1, 1995\nSchedule II - Valuation and Qualifying Accounts and Reserves\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes thereto.\n(3) Exhibits: The following exhibits are filed with this report or, as noted, incorporated by reference herein:\nExhibit No. Description - ----------- -----------------------------------------------------------------\n27 Financial Data Schedule (For SEC Use Only)\n__________________________ * Indicates management contract or compensatory plan required to be filed as an Exhibit.\n(b) Reports on Form 8-K.\nThe Registrant did not file any reports on Form 8-K during the three months ended October 1, 1995.\n(c) The following exhibits are filed herewith and follow the signature pages:\n11 Statement Regarding Computation of Per Share Earnings.\n13 Ruddick Corporation 1995 Annual Report to Shareholders (consolidated financial statements on pages 20 to 32 and sections headed \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (pages 16 to 19) and \"Eleven-Year Financial and Operating Summary\" (pages 12 to 13) only).\n21 List of Subsidiaries of the Registrant.\n23 Consent of Independent Public Accountants.\n27 Financial Data Schedule. (For SEC Use Only)\n(d) The financial statement schedules listed in Item 14(a)(2) above begin on Page S-1.\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.\nRUDDICK CORPORATION (Registrant)\nBy: \/s\/ John W. Copeland -------------------------------------- John W. Copeland, President\nDated: December 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:\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nS-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Ruddick Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Ruddick Corporation's annual report to shareholders incorporated 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 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\nCharlotte, North Carolina, October 26, 1995.\nS-2\nRUDDICK CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE FISCAL YEARS ENDED OCTOBER 3, 1993, OCTOBER 2, 1994 AND OCTOBER 1, 1995 SCHEDULE II (in thousands)\n* Represents accounts receivable balances written off as uncollectible, less recoveries.\nS-3 INDEX TO EXHIBITS\nExhibit No. (per Item 601 Sequential of Reg. S-K Description of Exhibit Page No. - ----------- ---------------------- --------\n3.1 Restated Articles of Incorporation of the Registrant, * incorporated herein by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 29, 1992 (Commission File No. 1-6905).\n3.2 Amended and Restated Bylaws of the Registrant, * incorporated herein by reference to Exhibit 3.2 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 27, 1992 (Commission File No. 1- 6905).\n4.1 Revolving Credit Agreements for an aggregate of * $100,000,000, entered into as of February 15, 1995, by and between the Registrant and each of First Union National Bank of North Carolina, NationsBank, National Association (Carolinas) and Wachovia Bank of North Carolina, N.A., incorporated herein by reference to Exhibits 4.1, 4.2 and 4.3 of the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended April 2, 1995, (Commission File No. 1-6905). The Registrant has certain other long-term debt, but has not filed the instruments evidencing such debt as part of Exhibit 4 as none of such instruments authorize the issuance of debt exceeding 10 percent of the total consolidated assets of the Registrant. The Registrant agrees to furnish a copy of each such agreement to the Commission upon request.\n10.1 Description of Incentive Compensation Plans, * incorporated herein by reference to Exhibit 10.1 of the Registrant's Annual Report on Form 10-K for the fiscal year ended October 2, 1994 (Commission File No. 1- 6905). **\n10.2 Supplemental Executive Retirement Plan of Ruddick * Corporation, as amended and restated, incorporated herein by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1990 (Commission File No. 1-6905). **\nExhibit No. (per Item 601 Sequential of Reg. S-K Description of Exhibit Page No. - ----------- ---------------------- --------\n10.3 Resolutions adopted by the Board of Directors of the * Registrant and the Plan's Administrative Committee with respect to benefits payable under the Registrant's Supplemental Executive Retirement Plan to Alan T. Dickson and R. Stuart Dickson, incorporated herein by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 29, 1991 (Commission File No. 1-6905). **\n10.4 Deferred Compensation Plan for Key Employees of * Ruddick Corporation and subsidiaries, as amended and restated, incorporated herein by reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1990 (Commission File No. 1-6905). **\n10.5 1982 Incentive Stock Option Plan, incorporated herein * by reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended October 2, 1994 (Commission File No. 1-6905). **\n10.6 1988 Incentive Stock Option Plan, incorporated herein * by reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10-K for the year ended October 2, 1994 (Commission File No. 1-6905). **\n10.7 1993 Incentive Stock Option and Stock Appreciation * Rights Plan, incorporated herein by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the fiscal year ended October 3, 1993 (Commission File No. 1-6905). **\n10.8 Description of the Registrant's Long Term Key * Management Incentive Program, incorporated herein by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 29, 1991 (Commission File No. 1-6905). ** Exhibit No. (per Item 601 Sequential of Reg. S-K Description of Exhibit Page No. - ----------- ---------------------- --------\n10.9 Ruddick Corporation Irrevocable Trust for the Benefit of * Participants in the Long Term Key Management Incentive Program, incorporated herein by reference to Exhibit 10.9 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1990 (Commission File No. 1-6905).**\n10.10 Rights Agreement dated November 15, 1990 by and between * the Registrant and Wachovia Bank of North Carolina, N.A., incorporated herein by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated November 21, 1990 (Commission File No. 1-6905).\n10.11 Ruddick Corporation Senior Officers Insurance Program Plan * Document and Summary Plan Description, incorporated herein by reference to Exhibit 10.10 of the Registrant's Annual Report on Form 10-K for the fiscal year ended September 27, 1992 (Commission File No. 1-6905).**\n11 Statement Regarding the Computation of Per Share Earnings.\n13 Ruddick Corporation 1995 Annual Report to Shareholders (consolidated financial statements on pages 20 to 32 and sections headed \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (pages 16 to 19) and \"Eleven-Year Financial and Operating Summary\" (pages 12 to 13) only).\n21 List of Subsidiaries of the Registrant.\n23 Consent of Independent Public Accountants.\n27 Financial Data Schedule. (For SEC Use Only)\n- -------------- * Incorporated by reference. ** Indicates management contract or compensatory plan required to be filed as an exhibit.","section_15":""}
{"filename":"811828_1995.txt","cik":"811828","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nAtlantis Plastics, Inc. (\"Atlantis\" or the \"Company\"), is a leading U.S. plastics manufacturer comprised of two operating segments: (i) Atlantis Plastic Films, which produces polyethylene stretch and custom films used in a variety of industrial and consumer applications, and (ii) Atlantis Molded Plastics, which produces molded plastic products for a variety of applications, including products and components for the appliance, automotive, recreational vehicle, and dairy industries.\nAtlantis Plastic Films accounts for approximately two-thirds of the Company's net sales and produces (i) stretch films (multi-layer plastic films that are used principally to wrap pallets of materials for shipping or storage), (ii) custom film products (high-grade laminating films, embossed films and specialty film products targeted primarily to industrial and agricultural markets), and (iii) institutional products such as aprons, gloves, and tablecloths which are converted from polyethylene films.\nAtlantis Molded Plastics accounts for approximately one-third of the Company's net sales and consists of three principal technologies, serving a wide variety of specific market segments, described as follows: (i) injection molded thermoplastic parts that are sold primarily to original equipment manufacturers and used in major household appliances, agricultural and automotive products, (ii) a variety of extruded plastic trim and channel systems (profile extrusion) that are incorporated into a broad range of consumer and commercial products such as recreational vehicles, residential windows and doors, office furniture and retail store fixtures, and (iii) blow molded milk, juice, water and industrial containers in a variety of shapes and sizes.\nThe Company's fourteen plastics manufacturing facilities produce a wide spectrum of products for industrial, commercial and consumer markets. Management believes that the Company's diversification and broad range of capabilities reduce the Company's exposure to economic downturns in specific industries and permit the Company to react efficiently to specific market opportunities.\nThe Company was founded in 1984 and initially grew primarily through acquisitions in the plastics, insurance and furniture manufacturing industries. In recent years the Company has concentrated its resources in the plastics industry, and, as part of this strategic focus, on August 31, 1995 the Company sold Western Pioneer Insurance Company (\"Western Pioneer\"), its property-casualty insurance subsidiary which had been classified as a discontinued operation, for $12.0 million to a Massachusetts-based property casualty insurer. The Company also holds for sale a 9% WinsLoew Furniture, Inc. stock investment.\nIn May, 1994 the Company changed its state of incorporation from Delaware to Florida in order to reduce its state franchise taxes. Profiles of the Company's businesses are outlined within the \"Market Capabilities\" section below. Descriptions of the Company's facilities are set forth within Item 2, \"Properties\". The Company's executive offices are located at 1870 The Exchange, Suite 200, Atlanta, Georgia 30339, and its telephone number is (800) 497-7659.\nDuring early 1995, the Company installed a new senior management group and a new strategic operating plan was developed which, as further described below, outlined the following strategic objectives to be accomplished during 1995 and 1996: (i) simplifying the organizational structure with a corresponding decrease in salaried headcount, (ii) the implementation of a cost reduction program targeting both fixed and variable costs throughout the Company, (iii) the reconfiguration of its stretch film sales organization to better service its customer base at a lower cost, (iv) the identification and disposal of non-strategic businesses, and (v) the implementation of an asset management program directed at reducing inventories, accounts receivable, outstanding indebtedness and interest expense.\n- 3 -\nThe Company's growth and profit improvement strategies seek to capitalize on the Company's existing manufacturing capabilities and reputation for product quality and customer service. The Company's specific strategies include (i) ongoing efforts to reduce cost of sales, control the Company's fixed costs and realize manufacturing efficiencies, (ii) concentrated efforts to continually improve product quality and customer satisfaction by training employees in and applying Total Quality Management and Statistical Process Control systems, and (iii) developing new products to increase sales to new and existing customers, to improve profit margins and to enhance the Company's position as a provider of value-added products and services.\nSTRATEGIC OPERATING PLAN\nThe strategic operating plan developed by the Company during 1995 focuses on achieving the following objectives:\nSimplifying the Organizational Structure and Reducing Salaried Headcount. During the first quarter of 1995, the Company's organizational structure was analyzed and simplified, resulting in the removal of one layer of management. Salaried headcount was reduced by approximately 16% in total during the second, third and fourth quarters of 1995. This reduction resulted in an annualized reduction in salaried personnel costs of approximately $2.2 million by December 31, 1995 compared to salaried personnel costs on an annual basis for the Company prior to the restructuring, excluding one-time severance and other personnel-related costs associated with the restructuring.\nImplementation of Cost Reduction Program Targeting both Fixed and Variable Costs. During the fourth quarter of 1995, in order to reduce fixed overhead and variable costs and increase the custom film unit's profitability, the Company downsized its Tulsa, Oklahoma custom film facility, making it a satellite of the Cartersville, Georgia custom film facility and transferring certain of its production volume to the Mankato, Minnesota and the Cartersville custom film facilities. The Tulsa restructuring reduced headcount, removed older equipment from service at that facility, and allowed Atlantis to more effectively utilize its total custom film capacity.\nAlso during the fourth quarter of 1995, the Company's injection molding unit significantly reduced overtime and salaried headcount, initiated continuous operations at its Henderson, Kentucky facility (this change is scheduled for implementation at the remaining injection molding facilities during the first half of 1996), and initiated the decentralization of its engineering and administrative functions which were formerly conducted only at the Henderson facility. As these changes become fully integrated, they are expected to lower operating costs, improve operating efficiency and control, and increase throughput.\nThe Reconfiguration of the Stretch Film Sales Organization to Better Service its Customer Base at a Lower Cost. During the fourth quarter of 1995, the Company reconfigured its stretch film sales organization, converting from an independent sales representative structure to one consisting primarily of direct sales personnel. This change was made in order to improve customer service, account\/pricing control, market intelligence, and relationships with key customers, and also to reduce the Company's marketing costs. The Company incurred approximately $800,000 in one-time expenses during the third and fourth quarters of 1995 associated with this change, and expects to realize annual savings significantly in excess of this one-time expense beginning in 1996.\nThe Identification and Disposal of Non-Strategic Businesses. On August 31, 1995, the Company sold Western Pioneer to a Massachusetts-based property casualty insurance company for $12.0 million. During September 1995, as the Company's planned first step in exiting its blow molding business, the Company sold its 50% interest in the CKS\/Rigal blow molding joint venture to CKS Packaging, Inc., its joint venture partner, for approximately $870,000. The net cash proceeds after expenses from these sales were applied to the Company's revolving credit facility. During January 1996, the Company announced plans to sell Plastic Containers, Inc., its remaining manufacturer of blow molded plastic containers.\n- 4 -\nImplementation of an Asset Management Program to Reduce Inventories, Accounts Receivable, Outstanding Indebtedness and Interest Expense. During the second quarter of 1995, as film demand began to soften and resin price decreases appeared imminent (see discussion of \"Raw Materials\" below), the Company focused on the reduction of inventories, accounts receivable and outstanding indebtedness. As a result, and also due to the declines in resin prices experienced during 1995, significant declines were posted in each of these areas from the levels maintained during late 1994 and early 1995. Outstanding indebtedness was also reduced by the net proceeds from the 1995 sales of Western Pioneer and the Company's 50% interest in the CKS\/Rigal blow molding joint venture. Total debt was reduced from $129.2 million at year-end 1994 and a 1995 high of $142.8 million (May, 1995) to $116.5 million at year-end 1995.\nBUSINESS GROWTH AND PROFIT IMPROVEMENT STRATEGIES\nThe Company's general business strategy emphasizes the following elements:\nImproved Cost Controls and Manufacturing Efficiencies. The Company continues to focus its efforts on reducing operating costs and improving manufacturing efficiencies with a strong emphasis on reducing scrap rates and overtime, increasing plant and equipment yields, reducing equipment downtime, and improving the purchasing cycle in order to reduce material costs. As part of these efforts, cost control goals are continually set and improvements measured in the areas described above, compared to performance levels previously obtained. Strong emphasis is also placed on managing and reducing the total number of stock keeping units (\"SKU\") maintained within each business unit, while still effectively servicing customer needs. SKU reductions have resulted in longer run times between changeovers and lower required inventory levels.\nEmphasis on Quality and Customer Satisfaction. Quality is an integral part of the products and services provided to customers. As a result, the Company has made extensive efforts to train its employees in Total Quality Management Systems. Many of the Company's employees have also been trained in Statistical Process Control (\"SPC\") methods, and two of the Company's three stretch film manufacturing facilities have been ISO 9002 certified, with the third plant expected to be certified during the first half of 1996. The Company's efforts to improve customer satisfaction also include developing stronger relationships with major customers to enhance communications and develop long-term relationships, assuring the production of products which closely match customer specifications, and maximizing on-time delivery rates.\nDevelopment of New Products. Historically, the Company has enhanced its competitive position and operating profitability by developing and introducing products that permit the penetration of new markets, including new lines of thinner gauge polyethylene films. The Company intends to continue to work with its suppliers and customers to develop new products that complement the Company's current product lines and can be produced using the Company's existing manufacturing capabilities. The Company's Customer Applications and Training Laboratory for product development, evaluation and training in its stretch and custom film operating units permits focused research and development efforts. Management believes that the Company's extensive manufacturing capabilities and the geographic scope of its plant locations provide a competitive advantage with respect to attracting and accommodating customers who desire a full service provider. Management also believes that the Company's diversified customer base reduces the Company's exposure to economic downturns in specific industries.\nMARKET CAPABILITIES\nSTRETCH FILMS. Atlantis manufactures multi-layer stretch film used principally to wrap pallets of material for storage or shipping. Stretch film is manufactured using both blown and cast extrusion processes and must meet rigid customer specifications. To produce this product, Atlantis uses a combination of polyethylene resins and other materials to make a film with various characteristics. The resulting product is a very thin film which stretches up to 300%, clings to itself, and is puncture resistant.\n- 5 -\nAtlantis purchases several types of linear low-density resins and other materials to manufacture its stretch film products. Atlantis has contracts with resin manufacturers which allow it to achieve what it believes to be the best combination of price, resin availability and new product development support. Management believes its relationships with its resin suppliers are very good.\nAs described above, during the fourth quarter of 1995 the Company reconfigured its stretch film sales organization, converting from an independent sales representative structure to one consisting primarily of direct sales personnel. The Company's stretch film products are sold primarily through independent industrial packaging distributors and, to a lesser degree, directly to end users. With the majority of its products sold to distributors, Atlantis places particular emphasis on assisting distributors in sales to end users. The Company intends to increase its direct marketing and sales efforts to national accounts in certain areas.\nCUSTOM FILMS. Polyethylene film accounts for approximately 95% of Atlantis' custom film sales and is used for a wide variety of packaging applications. Atlantis manufactures both low density and linear low density polyethylene, the latter being a tougher and more puncture-proof material.\nAtlantis has an internal sales staff to market its roll stock film, primarily to national accounts. Most of the film customers are in industrial markets and consume the film during their manufacturing and\/or delivery process.\nApproximately 20 different types of resin, delivered in pellet form, and approximately ten types of color additives are used in the manufacturing process. Atlantis has supply contracts that fulfill most of its present requirements and believes that it has adequate sources available to meet remaining raw material needs. Relationships with its suppliers are considered very good.\nAtlantis also converts film into institutional products such as plastic gloves, aprons and tablecloths. Since 1993, sales of these products have increased significantly due to the acquisition and integration of the assets of United Plastic Products. This acquisition not only made Atlantis Plastic Films one of the largest producers of polyethylene products for institutional food handling markets, it also added substantial new state-of-the-art cast embossing capacity to complement its current embossed production.\nINJECTION MOLDING. Atlantis produces custom thermoplastic parts by injection molding. These parts are used in large and small appliances (including refrigerators, air conditioners, dehumidifiers, dishwashers and microwave ovens), agricultural and automotive products and hand-held power tools.\nAtlantis operates molding presses ranging from 30 to 1,000 tons and related secondary equipment in Henderson, Kentucky, Ft. Smith, Arkansas, Warren, Ohio, and Nashville and Jackson, Tennessee. This wide variety of equipment configuration and plant location alternatives enable it to accommodate customers that require multiple components, various press sizes and secondary operations.\nDuring 1995, approximately 46% of this unit's sales (10% of the Company's net sales) were to the refrigeration and air conditioning divisions of Whirlpool Corporation. Although Whirlpool has been a customer for over 40 years, there can be no assurance that a significant reduction in Whirlpool-related volume, or the loss of Whirlpool as a customer, would not have a material adverse effect on the Company's financial condition or results of operations.\nThe injection molding unit provides an in-house sales and engineering staff which assists in the design of products to customer specifications, designs molds to produce those products and oversees the construction of the necessary molds. Its \"program management\" concept promotes early involvement with customers' engineers to assist with product and tooling design and the establishment of acceptable quality standards. Its SPC systems enable it to meet these established quality standards on a cost-efficient basis. Management believes that its ability to offer SPC quality assurance, as well as value-added secondary operations such as hot stamping and assembly, provide a competitive advantage in selling to national accounts.\n- 6 -\nThe majority of the sales are generated by Company personnel. Independent sales agencies' representatives, calling primarily on industrial customers in the Midwest, account for the balance.\nThe Company's injection molding customers generally place orders for goods based on their production requirements for the following three to four months with a non-binding estimate of requirements over six to twelve months. Management believes that the relatively long production cycles for its customers make these estimates generally reliable. See \"Backlog.\"\nA wide variety of materials, such as ABS, polystyrene, polyethylene, polycarbonate and nylon are used in the manufacturing process. The Company has multiple sources of supply for these materials.\nPROFILE EXTRUSION. Atlantis produces a variety of extruded plastic trim and channel systems that are incorporated into a broad range of consumer and commercial products. During the past twelve months, the profile extrusion unit utilized approximately 2,000 diffferent dies in fulfilling customer orders, and currently maintains a stock program for approximately 280 products.\nAtlantis' marketing and sales activities are conducted by in-house sales personnel that also oversee a network of independent sales representatives. These representatives in turn call on a diversified customer base in approximately 30 states. Atlantis supplies many industries, including manufacturers of recreational vehicles, residential windows and doors, office furniture, retail store fixtures, and marine products.\nThe use of only five basic types of compound materials in manufacturing allows the purchasing of materials in bulk. These materials are polyvinyl chloride (\"PVC\") in rigid and flexible forms, polyethylene, polypropylene, and thermoplastic rubber (\"TPR\"). Atlantis purchases all of its rigid material and approximately 30% of its flexible materials. The balance of flexible material is blended on-site, allowing for greater control over the quality of the finished product. Atlantis believes that it has adequate sources available to meet its raw material needs.\nBLOW MOLDING. During September 1995, as the Company's planned first step in exiting its blow molding business, the Company sold its 50% interest in the CKS\/Rigal blow molding joint venture to CKS Packaging, Inc., its joint venture partner, for approximately $870,000. During January 1996, the Company announced plans to sell its Plastic Containers, Inc. subsidiary, its remaining manufacturer of blow molded plastic containers. The Company has engaged an outside broker to assist it in pursuing potential sale opportunities. No arrangement or understanding for a sale exists at the present time.\nAtlantis manufactures plastic containers in various sizes, substantially all of which are used for the packaging of dairy, juice, water and industrial products. Containers are manufactured by an extrusion blow-molding process that produces containers at high speeds. Its highly standardized line of products permits a high level of automation in its manufacturing process. Marketing activities are conducted by certain key officers and managers, as well as selected sales representatives, and customer contact is often on a daily basis.\nHigh density polyethylene resin is the primary material used in the manufacture of its plastic containers. By generally limiting the resin usage to high density polyethylene, Atlantis can make large-volume, lower cost purchases. In addition, use of one resin reduces extruder changeover time and allows for a higher degree of automation. Although it has no supply contracts, management believes that adequate supply is available to satisfy present raw material requirements at competitive costs.\n- 7 -\nRAW MATERIALS\nThe primary raw materials used by the Company in the manufacture of its products are various plastic resins, primarily polyethylene. The Company selects its suppliers primarily on the basis of technical support, service and price. Virtually all of the Company's plastic resin supplies are manufactured within the United States. Although the plastics industry has from time to time experienced shortages of plastic resins, the Company has not to date experienced any such shortages. Management believes that there are adequate sources available to meet its raw material needs.\nThe Company uses approximately 300 million pounds of plastic resins annually. Management believes that the Company's large volume purchases of plastic resin have generally resulted in lower raw material costs and enabled the Company to obtain shipments of raw materials even in periods of short supply.\nThe primary plastic resins used by the Company are produced from petrochemical feedstocks mostly derived from natural gas liquids. Based on the supply and demand cycles in the petrochemical industry, substantial cyclical price fluctuations can occur. Consequently, plastic resin prices may fluctuate as a result. Resin prices fluctuated significantly during 1994 and 1995, as further described within Item 7, \"Management's Discussion and Analysis of Operations\".\nWhile the Company has historically passed through changes in the cost of its raw materials to its customers, it may not always be able to pass through its raw material cost increases in the form of price increases, or such \"pass throughs\" may only occur after a time lag. To the extent that increases in the cost of plastic resin cannot be passed on to its customers, or that the duration of time lags associated with \"pass throughs\" becomes significant, such increases may have a material detrimental impact on the profitability of the Company. Furthermore, during periods when resin prices are falling, gross profits may suffer as the Company is selling product manufactured with resin purchased 1-2 months prior at higher prices.\nCOMPETITION\nThe Company's operating subsidiaries face intense competition from numerous competitors, several of which have greater financial resources than the Company. In addition, the markets for certain of the Company's products are characterized by low costs of entry or competition based primarily on price.\nAtlantis Plastic Films competes with a limited number of producers capable of national distribution and a greater number of smaller manufacturers that target specific regional markets and specialty film segments. Competition is based on quality, service (including the manufacturer's ability to supply customers in a timely manner), product differentiation and price. Management believes that Atlantis Plastic Films' subsidiaries successfully compete primarily on the basis of their established reputations for service and quality, as well as their respective positions as efficient, low-cost producers.\nAtlantis Molded Plastics competes in a highly fragmented segment of the plastics industry, with a large number of regional manufacturers competing on the basis of customer service (including timely delivery and engineering\/design capabilities), quality, product differentiation and price. Management believes that the Atlantis Molded Plastics subsidiaries successfully compete primarily on their ability to offer extensive customer service and a wide variety of products.\nBACKLOG\nThe Company's total backlog at December 31, 1995 was $21.3 million compared to $21.6 million at December 31, 1994. Management does not consider any specific month's backlog to be a significant indicator of sales trends due to the various factors that influence any one month's backlog, such as price changes which lead to customer inventory adjustments. Blow molded products have such short production and delivery cycles that their backlogs are immaterial.\n- 8 -\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 1,450 persons. Within the blow molding unit, approximately 75 employees are covered under a collective bargaining agreement with the Retail, Wholesale & Department Store Union, AFL-CIO. Atlantis' overall employee relations are considered to be generally very good.\nPATENTS AND TRADEMARKS\nThe Company and certain of its subsidiaries have registered various trademarks with the United States Patent and Trademark Office and certain overseas trademark regulatory agencies and have applications pending for the registration of other trademarks. Management believes that the Company's trademark position is adequately protected in all markets in which the Company does business. Atlantis Plastic Films produces certain stretch film products under non-exclusive licenses granted by Mobil Oil Corporation. The duration of the licenses is coterminous with the duration of the underlying patents.\nENVIRONMENTAL REGULATION\nActions by Federal, state and local governments concerning environmental matters could result in laws or regulations that could increase the cost of producing the products manufactured by the Company or otherwise adversely affect the demand for its products. At present, environmental laws and regulations do not have a material adverse effect upon the demand for the Company's products. Certain local governments have adopted ordinances prohibiting or restricting the use or disposal of certain plastics products that are among the types produced by the Company. If such prohibitions or restrictions were widely adopted, such regulatory and environmental measures could have a material adverse effect upon the Company. In addition, a decline in consumer preference for plastic products due to environmental considerations could have a material adverse effect upon the Company.\nIn addition, certain of the Company's operations are subject to Federal, state and local environmental laws and regulations that impose limitations on the discharge of pollutants into the air and water and establish standards for the treatment, storage and disposal of solid and hazardous wastes. Historically, the Company has not had to make significant capital expenditures for environmental compliance.\nWhile the Company cannot predict with any certainty its future capital expenditure requirements for environmental compliance because of continually changing compliance standards and technology, the Company has not currently identified any of its facilities as requiring major expenditures for environmental remediation or to achieve compliance with environmental regulations. Accordingly, the Company has not accrued any amounts relating to achieving compliance with currently promulgated environmental laws and regulations. The Company does not currently have any insurance coverage for environmental liabilities and does not anticipate obtaining such coverage in the future.\n- 9 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDuring the first quarter of 1995, the Company relocated certain of its corporate functions from Miami, Florida to Atlanta, Georgia. The Atlanta headquarters office consist of approximately 9,250 square feet of space, with a present annual lease expense of approximately $106,000, expiring in April, 1997.\nAtlantis' Miami offices consist of approximately 13,100 square feet of space that is shared with several entities controlled by the principal stockholders of the Company (or their affiliates). The present annual lease expense of $329,000, as well as certain other general and administrative expenses, are allocated among the Company and these entities. See Part III Item 13 - \"Certain Relationships and Related Transactions.\" This lease expires in August, 2003.\nThe following table describes the manufacturing facilities owned or leased by the Company, with substantially all of the owned facilities pledged as security for debt. Management believes that the Company's manufacturing facilities are adequate to meet current needs and increases in sales volume for the foreseeable future.\n(1) Represents the former profile extrusion manufacturing facility which was sold for $525,000 (prior to selling expenses) in March, 1996.\n- 10 -\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company believes that it is not presently a party to any litigation the outcome of which would have a material adverse effect on its consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the fiscal quarter ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Class A Common Stock is traded on the American Stock Exchange (the \"AMEX\") and the Pacific Stock Exchange under the symbol \"AGH\". The following table sets forth the high and low sales prices for the Class A Common Stock on the AMEX for each quarter of the years 1994 and 1995.\nAs of January 31, 1996, there were approximately 229 holders of record of the 4,192,823 outstanding shares of Class A Common Stock. The closing sales price for the Class A Common Stock on January 31, 1996 was $5.00.\nThe Company's ability to pay cash dividends is subject to the dividend preference of the Company's presently outstanding Series A Convertible Preferred Stock.\nCovenants relating to the Company's 11% Senior Notes indebtedness restrict the Company from paying dividends or taking certain other actions unless specified interest coverage ratio and other tests are met. The Company's recent decline in operating profitability caused it to fall below the interest coverage ratio requirement for the trailing four quarter periods ended September 30 and December 31, 1995, and, accordingly, the Company cannot pay dividends or take certain other actions until it is again able to meet the interest coverage ratio requirement on a trailing four quarters basis. Payment of dividends is also restricted under the terms of the Company's revolving credit facility.\nPrior to 1994, the Company did not pay cash dividends on any class of its Common Stock. During February 1994 the Company's Board of Directors approved a 2.5 cents per share quarterly dividend program beginning in April 1994, and consecutive quarterly dividends were paid through October 1995, after which the dividend program was discontinued for the reasons described above.\n- 11 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes certain selected consolidated financial data of the Company for each of the years in the five-year period ended December 31, 1995. The selected consolidated financial data as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 have been derived from the Company's financial statements included in Item 8, which have been audited by Coopers & Lybrand L.L.P., independent certified public accountants for the Company. The selected consolidated financial data should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto for the three-year period ended December 31, 1995, included in Item 8, and Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nNOTE: For 1992, fully diluted income per share from continuing operations was $0.62 and fully diluted net income per share was $0.74.\n- 12 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAtlantis is a leading U.S. manufacturer of polyethylene stretch and custom films used in a variety of industrial and consumer applications and molded plastic products for the appliance, agricultural, automotive, recreational vehicle, residential window, and dairy and industrial container industries.\nDiscontinued operations in 1995 and 1994 consisted of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary which was sold on August 31, 1995. Prior to 1994, discontinued operations included both Western Pioneer and the Company's interest in Loewenstein Furniture, Inc. (\"Loewenstein\", now known as WinsLoew Furniture, Inc. \"WinsLoew\"). See Note 18.\nAs more fully described in Item 1. \"Business\", during 1995 the Company's new senior management group developed and implemented a strategic operating plan which focuses on achieving a number of objectives during 1995 and 1996. The primary objectives of the strategic operating plan are: (i) to reduce the Company's fixed and variable costs, (ii) to reconfigure its stretch film sales organization, (iii) to exit non-strategic businesses, and (iv) to better manage its assets and reduce its indebtedness. The implementation of certain aspects of the strategic operating plan caused the Company to incur various nonrecurring costs during 1995, which have been segregated within the \"Impairment of long-lived assets\" and \"Other restructuring charges\" categories of the accompanying 1995 Income Statement.\nSales, gross profit, and operating income (loss) for the years ended December 31, 1995, 1994 and 1993 were as follows:\nCOMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1994\nSALES\nThe Company's sales of $281.1 million were 8% ahead of last year's sales, with the sales growth occurring primarily within Atlantis Plastic Films due to higher average selling prices, partially offset by a decline in volume compared to 1994. Atlantis Plastic Films sales for 1995 totalled $192.8 million, 11% ahead of last year's film sales of $173.9 million.\n- 13 -\nDuring the last nine months of 1994, plastic resin prices increased by over 75%, causing film product demand to rise beyond normal levels as customers increased inventories in order to avoid purchases at anticipated higher selling prices. During the second quarter of 1995, the film market, anticipating resin price declines, experienced a significant weakening in demand as customers postponed purchases in order to reduce abnormally high inventories created during the preceding period and to maximize product purchases at expected future lower prices.\nResin prices started declining in June 1995, and fell approximately 29% from early June through December 1995, and a further 6% from December 1995 through February 1996. A price increase of 10-15% was recently announced by the Company's suppliers of plastic resin. Unless withdrawn, this increase will affect the Company's resin purchases starting in April, 1996.\nAtlantis Molded Plastics sales during 1995 of $88.3 million exceeded last year's $86.9 million by 2%, with a slight decline in sales for the Company's injection molding unit, offset by increased sales within the profile extrusion and blow molding units. The lack of sales growth within the injection molding unit was caused by several factors, including: (i) a decline in sales of refrigeration-related parts compared to last year, and (ii) the effects of a negotiated price reduction with a major customer.\nGROSS PROFITS\nThe Company's 1995 gross profit of $39.9 million, or 14% of sales, declined sharply both in dollar and percentage terms from the 1994 gross profit of $51.6 million, or 20% of sales. The 1995 decline was due primarily to the adverse impact of the film inventory correction described above, the adverse effects of an extremely competitive stretch film market during 1995, and lower injection molding profitability compared with last year.\nAtlantis Plastic Films posted gross profit of $30.3 million, or 16% of sales, compared to last year's gross profit of $36.1 million, or 21% of sales. The second and third quarter customer inventory correction and resulting decline in demand reduced sales volume in pounds, and also reduced selling prices due to competitive market pressures. Weak market demand during this time period caused selling prices to drop more rapidly than plastic resin costs. As a result, during 1995 the differential between film selling prices and plastic resin costs (the major raw material component of the Company's film products) declined compared to 1994.\nFilm gross profits also continued to be affected by inefficiencies at the Tulsa, Oklahoma custom film facility. In order to reduce fixed overhead and increase profitability at the Tulsa custom film facility, during the fourth quarter of 1995 the Tulsa custom film facility was downsized, making it a satellite of the Cartersville, Georgia custom facility and transferring certain of its production volume to the Mankato, Minnesota and the Cartersville custom film facilities.\nFilm market conditions remain extremely competitive and continue to exert downward pressure on film volume and selling prices, causing film volumes and selling price\/resin cost differentials to remain depressed compared to the first quarter of 1995. However, the various cost reduction programs initiated during 1995, including the Company-wide reduction in salaried headcount and the downsizing of the Tulsa custom film facility, are expected to lower overhead costs and variable costs of manufacturing within Atlantis Plastic Films during the coming year when compared to 1995.\nThe Atlantis Molded Plastics 1995 gross profit of $9.6 million, or 11% of sales, decreased substantially compared to last year's gross profit of $15.5 million, or 18% of sales. This decline in profitability resulted primarily from a variety of factors within the injection molding unit, including the decline in sales and price reduction described above, manufacturing inefficiencies within certain phases of the production process, and unusually high overtime due to these manufacturing inefficiencies. The Atlantis Molded Plastics 1995 gross profit was also adversely impacted by lower blow molding profitability, partially offset by stronger profile extrusion gross profits compared to 1994.\n- 14 -\nIn order to address the injection molding issues described above, the Company implemented a number of personnel and process improvement changes during the fourth quarter of 1995. The Company's injection molding unit significantly reduced overtime and salaried headcount, initiated continuous operations at its Henderson, Kentucky facility (this change is scheduled for implementation at the remaining injection molding facilities during the first half of 1996), and initiated the decentralization of its engineering and administrative functions which were formerly conducted only at the Henderson facility. These changes have already begun to yield positive results, and as these changes become fully integrated, they are expected to lower operating costs, improve operating efficiency and control, and increase throughput.\nThe 1995 decline in blow molding profitability resulted from continued competitive pricing pressures within the dairy plastic container markets. However, during the fourth quarter of 1995 blow molding profit margins improved due to increases in sales of industrial containers, combined with reductions in manufacturing costs.\nAs more fully discussed in Item 1, \"Business\", the Company sold its 50% blow molding joint venture interest during 1995 for gross proceeds of $870,000, and recognized an after-tax gain on the sale of approximately $36,000. During January, 1996 the Company also announced its plans to sell Plastic Containers, Inc., its remaining blow molding business.\nThe Company's profile extrusion unit posted record sales and profitability during 1995 compared to 1994, and once again achieved operating margins in excess of 20%.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES (\"SG&A\")\nSG&A equaled $28.4 million, or 10% of sales, compared to last year's SG&A of $29.2 million, or 11% of sales. The dollar and percentage decrease in SG&A for 1995 was primarily caused by lower incentive compensation expense resulting from the 1995 decline in profitability, and a reduction in salaried headcount. SG&A expense during 1995 includes approximately $600,000 recorded during the third quarter representing an increase in the reserve for bad debts related to a potentially uncollectable account receivable within the injection molding unit.\nThe various cost reduction programs initiated by the Company during 1995, including the Company-wide reduction in salaried headcount, the reconfiguration of the stretch film sales organization, and the restructuring of the Tulsa custom film facility and the injection molding unit, are expected to reduce SG&A during the coming year when compared to 1995.\nIMPAIRMENT OF LONG-LIVED ASSETS AND RESTRUCTURING CHARGES\nAs more fully discussed in Notes 1 and 17, during 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 for Long-Lived Assets to be Disposed Of\".\nIn connection with the adoption of this statement, during the fourth quarter of 1995 the Company recorded noncash charges of approximately $10.6 million for the impairment of long-lived assets associated with the Tulsa custom film facility, and for the reduction in carrying value of the Company's blow molding unit in connection with its proposed sale. Of this amount, goodwill writeoffs equaled approximately $8.9 million with no associated tax benefit, and fixed asset writedowns equaled approximately $1.7 million pre-tax, or $1 million after-tax.\nDuring 1995, the Company also incurred restructuring charges of approximately $1.9 million related to (i) the first quarter 1995 reorganization of its senior management group (approximately $750,000), (ii) the third and fourth quarter 1995 reconfiguration of its stretch film sales organization (approximately $800,000), and (iii) the fourth quarter 1995 headcount reduction costs associated with the restructuring of the Tulsa custom facility and the injection molding unit (approximately $350,000).\n- 15 -\nNET INTEREST EXPENSE AND TAXES\nNet interest expense increased from $13.1 million in 1994 to $14.3 million in 1995, primarily due to the higher debt balances maintained during the first half of 1995. The significant reduction in debt achieved during the second half of 1995 has reduced net interest expense, with net interest expense for the fourth quarter of 1995 of $3.3 million, compared to $3.4 million during the fourth quarter of 1994 and $3.8 million during the second quarter of 1995.\nBased upon the reduction in outstanding indebtedness achieved during the second half of 1995, assuming market interest rates remain constant, management anticipates a continued reduction in net interest expense compared to the interest expense levels experienced during the first half of 1995.\nThe Company's effective tax rates during 1995 and 1994 were affected by nondeductible goodwill amortization, with the 1995 tax rate also affected by the tax impact of the September 1995 sale of the Company's 50% interest in the CKS\/Rigal blow molding joint venture.\nDISCONTINUED OPERATIONS AND EXTRAORDINARY GAIN\nWestern Pioneer was sold to a Massachusetts-based property and casualty insurance company on August 31, 1995 for $12.0 million. The after-tax gain recognized on the sale of Western Pioneer was approximately $483,000 (see Note 18).\nWestern Pioneer's loss from operations for the period prior to its sale during 1995 totaled $251,000, compared to its 1994 income from operations of $1.2 million. The 1995 decline in income was due to: (i) a significant increase in new policies during 1995, with new business historically less profitable than continuing business, and (ii) poorer than normal weather conditions during the winter of 1994-1995, which caused an increase in accidents and claims during 1995.\nDuring December 1995, the Company repurchased $4.8 million of its 11% Senior Notes in the open market, and recognized an extraordinary gain of $254,000, net of tax.\nNET INCOME (LOSS)\nAs a result of the factors described above, particularly the impact of the impairment of long-lived assets and other restructuring charges, and the decline in gross profit, the 1995 net loss equaled $13.1 million, or $1.83 per share, compared to last year's net income of $6.4 million, or $0.83 per share. The 1995 loss from continuing operations equaled $13.6 million, or $1.90 per share, compared to income from continuing operations of $5.2 million, or $0.67 per share for the year ended 1994.\nCOMPARISON OF YEARS ENDED DECEMBER 31, 1994 AND 1993\nSALES\nThe Company's 1994 sales of $260.8 million were ahead of 1993 sales by 18%, due to higher selling prices during 1994 resulting from a significant increase in resin prices during the last nine months of 1994, and also due to increases in sales volume in both the film and injection molding operating units. In addition, 1994 sales include incremental sales volume resulting from added capacity created by the Company's 1993 and 1994 capital expansion programs, and the contribution from the May 1994 acquisition of Advanced Plastics, Inc. (\"Advanced\"), an injection molder located in Warren, Ohio. (See Note 2 of Notes to the Company's Consolidated Financial Statements.)\n- 16 -\nGROSS PROFITS\nThe 1994 increase in sales resulted in higher gross profit dollar levels compared to 1993, while gross profit as a percentage of sales remained constant at 20% of sales for the 1994 and 1993 periods. During 1994, gross profit equaled $51.6 million, compared to the prior year's gross profit of $43.4 million.\nFor Atlantis Plastic Films, the 1994 gross profit percentage of 21% improved compared to the 1993 gross profit percentage of 19%, reflecting stronger profitability in the custom film unit resulting from improved plant efficiencies combined with lower scrap rates, which served to offset the margin pressure experienced as a result of the significant increase in resin prices during the period.\nThe 1994 Atlantis Molded Plastics gross profit percentage of 18% decreased from the 1993 gross profit percentage of 20%. This decrease reflects lower injection molding profitability resulting from a variety of factors, including: (i) a higher level of tooling sales during 1994, which produced lower margins in comparison to the normal product line, (ii) additional expenses related to debugging costs of new tools, which were placed in service in late 1994 or during 1995, (iii) higher subcontracted and overtime labor costs due to the shortage of qualified labor resulting from low national unemployment levels during 1994, (iv) unfavorable product mix, and (v) a decline in blow molding profitability due to ongoing competitive pricing pressures in the dairy plastic container markets.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSG&A during 1994 totaled $29.2 million, or 11% of sales, compared to 1993 SG&A of $23.9 million, also 11% of sales. The dollar increase in SG&A for 1994 reflected additional employees to support volume growth, higher costs in the injection molding unit, which included the operating results of Advanced since May 1994, and higher commission costs in the stretch film unit resulting from increased sales volume.\nNET INTEREST EXPENSE AND TAXES\nNet interest expense during 1994 of $13.1 million was higher than the $12.6 million in net interest expense for 1993. However, excluding interest income, interest expense was comparable at $13.2 million and $13.1 million, respectively, during 1994 and 1993. These amounts were comparable despite the increase in indebtedness and interest rates during 1994, primarily due to the Company's lower cost of capital resulting from the refinancing of substantially all of its indebtedness during the first quarter of 1993.\nThe Company's effective tax rates during 1994 and 1993 were affected by nondeductible goodwill amortization.\nDISCONTINUED OPERATIONS\nWestern Pioneer's 1994 income totaled $1.2 million, compared to 1993 income of $881,000. Losses and loss adjustment expenses during 1994 of $14.9 million equaled 68% of premiums earned, compared to 72% during 1993. The decrease was primarily due to improved collections of salvage and subrogation, combined with an increase in the 1994 estimate of salvage and subrogation receivable.\nNET INCOME\nAs a result of the factors described above, net income for 1994 equaled $6.4 million, or $0.83 per share, compared to 1993 net income of $3.9 million, or $0.49 per share. Income from continuing operations during 1994 equaled $5.2 million, or $0.67 per share, compared to $5.2 million, or $0.66 per share in 1993.\n- 17 -\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital at December 31, 1995 totaled approximately $23.2 million, compared to $33.0 million at December 31, 1994. Cash totaled $1.3 million at December 31, 1995, compared to $1.4 million at December 31, 1994.\nAs of December 31, 1995, the Company amended certain revolving credit facility covenants and implemented a revolving credit availability formula which provides for gross availability on the credit facility, prior to any borrowings or reductions for outstanding letters of credit, of between $17.5 million and $30.0 million based upon the Company's ratio of cash flow to total indebtedness, as defined in the amendment. At December 31, 1995 the gross availability on the revolving credit facility equaled $17.5 million, and the unused availability equaled $16.2 million, net of approximately $1.3 million for outstanding letters of credit. There were no revolver borrowings outstanding as of December 31, 1995.\nVarious financial covenants contained within certain of the other senior obligations outstanding as of December 31, 1995 were also amended in a manner consistent with the amendments to the revolving credit facility described above. See Note 7 of the Company's Notes to Consolidated Financial Statements.\nAs further discussed in Note 9, the Company's Series A Convertible Preferred Stock (\"Preferred Stock\") entitles the holder to an annual cumulative dividend, payable in equal semiannual installments of $72,500 on April 15 and October 15 of each year. As discussed below within \"Liquidity\", the Company is prohibited from paying preferred dividends until it is able to meet the interest coverage ratio requirement relating to its 11% Senior Notes on a trailing four quarters basis. In the event that three or more dividend payments are in arrears on the Preferred Stock, the holders of the Preferred Stock have the right to elect one director of the Company.\nCASH FLOWS FROM OPERATING ACTIVITIES\nDuring the second quarter of 1995, as film demand began to soften and resin price decreases appeared imminent, the Company focused on the reduction of inventories, accounts receivable and outstanding indebtedness. This program, along with the effects of the resin price declines experienced during 1995, resulted in significant declines in these areas from the levels maintained during late 1994 and early 1995.\nDuring 1995, net cash provided by operating activities was approximately $14.0 million, compared to $2.0 million during 1994. The 1995 net loss was $13.1 million, offset by the noncash provision for the impairment of long-lived assets of $10.6 million, depreciation and amortization of $10.7 million, and the decrease in accounts receivable and inventories of $12.6 million due to the reduction programs initiated by the Company during the second quarter, as described above, and a lower level of film sales volume and selling prices. Accounts payable and accrued expenses at December 31, 1995 decreased by $3.7 million compared to the 1994 year-end balance primarily due to lower incentive compensation and capital expenditures accruals compared to year-end 1994.\nThe Company's management expects that, given the significant working capital reductions achieved in the last nine months of 1995, future working capital fluctuations will not be as significant and will correspond to the Company's future sales levels.\nCASH FLOWS FROM INVESTING ACTIVITIES\nNet cash used in investing activities during 1995 equaled approximately $750,000, consisting of the proceeds from the August and September, 1995 sales of Western Pioneer (see Note 18) and the Company's 50% interest in the CKS\/Rigal blow molding joint venture, for gross proceeds of $12.0 million and $870,000, respectively, offset by capital expenditures of $13.8 million. Capital expenditures decreased during 1995 compared with 1994 capital expenditures of $16.4 million, and the Company expects 1996 capital expenditures to be lower than 1995.\n- 18 -\nCash used in investing activities during 1994 equaled $28.3 million, comprised primarily of capital expenditures, and funds used to acquire the assets of Advanced of $12.4 million (see Note 2 for information regarding the Company's purchase of Advanced in May 1994).\nCASH FLOWS FROM FINANCING ACTIVITIES\nNet cash used in financing activities during 1995 equaled $13.4 million, compared to cash provided by financing activities of $25.5 million during 1994. From May, 1994 through mid-May, 1995 total debt outstanding steadily increased due to: (i) higher inventory and accounts receivable balances associated with higher sales levels and raw material costs compared to the first half of 1994, (ii) revolver borrowings required to finance the May 1994 acquisition of Advanced, and (iii) borrowings in connection with equipment financing programs established during 1994 and 1995.\nTotal debt was reduced from $129.2 million at year-end 1994 and a high of $142.8 million in mid-May to $116.5 million at year-end 1995, primarily due to the previously described reductions in inventories and accounts receivable, along with the sales of Western Pioneer and the CKS\/Rigal joint venture interest. Outstanding indebtedness was also reduced by the Company's December, 1995 repurchases, at a discount, of $4.8 million of its 11% Senior Notes. Other principal payments on long-term debt of approximately $2.0 million were also made during the year.\nNet borrowings on the Company's revolving credit facility were reduced by approximately $21.6 million during 1995, with the unused availability on the Company's revolving credit line favorably impacted by the events described above, and also by the refinancing of outstanding indebtedness from the revolving credit line to borrowings collateralized by certain equipment acquired during 1994 and 1995, and collateralized by Advanced's property, equipment, inventories and accounts receivable. During 1995, $15.6 million of these borrowings were established.\nDuring the period from January to October 1995, the Company paid dividends on common and preferred stock of approximately $677,000. For the reasons cited below, the Company discontinued its 2.5 cents per share quarterly common stock dividend program after the October 1995 dividend payment. (Also see the discussion above regarding the Company's ability to make future required preferred stock dividend payments.)\nLIQUIDITY\nDuring the last half of 1994 and the first half of 1995, the Company utilized equipment financing programs to finance the majority of its capital expenditures. Covenants relating to the Company's 11% Senior Notes indebtedness restrict the Company from taking certain actions unless specified interest coverage ratio and other tests are met. The Company's recent decline in operating profitability caused it to fall below the interest coverage ratio requirement for the trailing four quarters ended September 30 and December 31, 1995, and, accordingly, the Company cannot pay dividends and its ability to incur new debt or take certain other actions is restricted in certain respects until it is again able to meet the interest coverage ratio requirement on a trailing four quarters basis.\nHowever, notwithstanding the foregoing restrictions, the Company is fully permitted to (i) borrow available funds on its revolving credit facility, and to (ii) incur new debt in connection with the refinancing of existing debt and certain other types of financings.\nThe Company's primary needs for liquidity, on both a short and long-term basis, relate to working capital (principally inventory and accounts receivable), debt service and capital expenditures. The Company presently does not have any material commitments for future capital expenditures, and expects to meet its short and long-term liquidity needs with funds generated from continuing operations, along with funds available under its revolving credit facility.\n- 19 -\nACCOUNTING PRONOUNCEMENTS\nAs previously discussed, during the fourth quarter of 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (see Notes 1 and 17).\nIn October, 1995 SFAS No. 123, \"Accounting for Stock Based Compensation\" was issued. SFAS 123 introduces a preferable 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.\nAlthough expense recognition for employee stock-based compensation is not mandatory, SFAS No. 123 requires companies that choose not to adopt the new fair value accounting rules to make certain proforma disclosures. SFAS No. 123 must be implemented no later than fiscal year 1996. The Company has not yet determined the method or effect on operating results of implementing the statement. However, the adoption of SFAS No. 123 is not expected to have a materially adverse effect on consolidated financial position.\n- 20 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\n- 21 -\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe Company's management is responsible for the preparation of the financial statements in accordance with generally accepted accounting principles and for the integrity of all the financial data included in this Form 10-K. In preparing the financial statements, management makes informed judgments and estimates of the expected effects of events and transactions that are currently being reported.\nManagement maintains a system of internal accounting controls that is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed and recorded in accordance with management's policies for conducting its business. This system includes policies which require adherence to ethical business standards and compliance with all laws to which the Company is subject. The internal controls process is continuously monitored by direct management review.\nThe Board of Directors, through its Audit Committee, is responsible for determining that management fulfills its responsibility with respect to the Company's financial statements and the system of internal accounting controls.\nThe Audit Committee, comprised solely of directors who are not officers or employees of the Company, meets periodically with representatives of management and the Company's independent accountants to review and monitor the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent accountants have full and free access to the Audit Committee.\nANTHONY F. BOVA PAUL RUDOVSKY PRESIDENT AND CHIEF EXECUTIVE VICE PRESIDENT, EXECUTIVE OFFICER FINANCE AND ADMINISTRATION\n- 22 -\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Atlantis Plastics, Inc.\nWe have audited the accompanying consolidated balance sheets of Atlantis Plastics, Inc. and subsidiaries as of December 31, 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 Atlantis Plastics, 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 17 to the consolidated financial statements, Atlantis Plastics, Inc. and subsidiaries 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\" during 1995.\nCoopers & Lybrand L.L.P. Atlanta, Georgia February 14, 1996, except for Note 7, as to which the date is February 26, 1996.\n- 23 -\nATLANTIS PLASTICS, INC. AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\n- 24 - ATLANTIS PLASTICS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\n- 25 - ATLANTIS PLASTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\n- 26 - ATLANTIS PLASTICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\n- 27 -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nNOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAtlantis is a leading U.S. manufacturer of polyethylene stretch and custom films used in a variety of industrial and consumer applications and molded plastic products for the appliance, automotive, recreational vehicle, and dairy industries.\nAtlantis Plastic Films manufactures stretch films which are multilayer plastic films that are used principally to stretch-wrap pallets of materials for shipping or storage and custom film products which include high-grade laminating films, embossed films, and specialty film products targeted primarily to industrial and agricultural markets.\nAtlantis Molded Plastics employs three principal technologies, serving a wide variety of specific market segments: (i) injection molded thermoplastic parts that are sold primarily to original equipment manufacturers and used in major household appliances, agricultural, and automotive products, (ii) a variety of extruded plastic trim and channel systems (profile extrusion) that are incorporated into a broad range of consumer and commercial products such as recreational vehicles, residential doors and windows, office furniture, and retail store fixtures, and (iii) blow molded milk, juice, water and industrial containers in a variety of shapes and sizes.\nDiscontinued operations in 1995 and 1994 consisted of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary which was sold on August 31, 1995. Prior to 1994, discontinued operations included both Western Pioneer and the Company's interest in Loewenstein Furniture Group, Inc., (\"Loewenstein\", now known as WinsLoew Furniture, Inc. \"WinsLoew\"). See Note 18.\nThe consolidated financial statements include the accounts of Atlantis and its subsidiaries, all of which are 100% owned. With regard to the Company's 50% interest in the CKS\/Rigal joint venture (sold during September, 1995), the Company recorded its proportionate share of the joint venture's results of operations, during the periods that the Company owned the investment, using the equity method of accounting. All material intercompany balances and transactions have been eliminated. Certain amounts included in prior period financial statements have been reclassified to conform with the current year presentation.\nThe 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(s) of the financial statements, and reported amounts of revenues and expenses during the reporting period(s). Actual results could differ from those estimates.\nThe following is a summary of the Company's significant accounting policies:\nCASH AND EQUIVALENTS The Company classifies as cash and equivalents all highly liquid investments which present insignificant risk of changes in value and have maturities at the date of purchase of three months or less. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts.\nINVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market.\n- 28 -\nPROPERTY AND EQUIPMENT Property and equipment are carried at cost less accumulated depreciation and amortization. The provisions for depreciation and amortization have been computed, using both straight-line and accelerated methods, over the estimated useful lives of the respective assets. Such useful lives generally fall within the following ranges: buildings and improvements - 15 to 30 years; office furniture and equipment - 5 to 10 years; manufacturing equipment - 5 to 30 years; and vehicles - 3 to 8 years.\nWhen assets are retired or otherwise disposed, the costs and accumulated depreciation are removed from the respective accounts, and any related profit or loss is recognized. Maintenance and repair costs are charged to expense as incurred. Additions and improvements are capitalized.\nGOODWILL Goodwill is being amortized on a straight-line basis over forty years from the date of the respective acquisitions. Accumulated amortization amounted to approximately $12.7 million and $10.8 million at December 31, 1995 and 1994, respectively.\nLONG-LIVED ASSETS During 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 for Long-Lived Assets to be Disposed Of\". SFAS No. 121 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 statement also requires that impairment losses be recorded on long-lived assets to be disposed of when the carrying value of the asset exceeds the fair value (usually based on discounted cash flows) less the estimated selling costs. Under the new method, the Company reviews impairment whenever events or changes in circumstances indicate that the carrying amount of any of its assets is not recoverable (see Note 17).\nAMORTIZATION Loan acquisition costs and related legal fees are amortized over the respective terms of the related debt utilizing either: (i) the effective interest method, or (ii) the straight line method when the results do not materially differ from the effective interest method.\nFEDERAL INCOME TAXES The Company and its subsidiaries file consolidated Federal income tax returns. Effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\" which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nPER SHARE DATA Primary earnings (loss) per share are computed by dividing net income (loss) after deduction of annual preferred dividend requirements, by the weighted average number of shares and dilutive share equivalents outstanding during each year. The Company's convertible preferred stock was determined not to be a common share equivalent in computing primary earnings per share (see Note 9). In computing fully diluted income per share, the assumed conversion of the convertible preferred stock was not material.\nNOTE 2. ACQUISITION\nDuring May 1994, the Company purchased substantially all of the assets (excluding cash) and assumed all of the liabilities (excluding interest bearing indebtedness and other amounts due to the seller) of Advanced Plastics, Inc. (\"Advanced\"), an injection molder located in Warren, Ohio, for approximately $12.4 million. The Company also purchased real estate leased by Advanced and owned by the seller. The acquisition was initially funded with borrowings from the Company's revolving credit facility, and was subsequently refinanced during 1995 with indebtedness secured by Advanced's property, equipment, inventories and accounts receivable. The acquisition was accounted for using the purchase method, and accordingly, the results of operations of Advanced have been included in the consolidated income statements since the date of the acquisition.\n- 29 -\nNOTE 3. INVENTORIES\nInventories at December 31, 1995 and 1994 consisted of the following:\nNOTE 4. PROPERTY AND EQUIPMENT\nProperty and equipment at December 31, 1995 and 1994 consisted of the following:\nAs more fully described in Note 17, during the fourth quarter of 1995 the Company wrote down certain fixed assets at its Tulsa custom facility by approximately $1.7 million.\nNOTE 5. INVESTMENTS IN DEBT AND EQUITY SECURITIES\nThe following table summarizes the cost and fair value of the Company's investments, which were classified as available-for-sale at December 31, 1995 and 1994:\n- 30 -\nIn light of the present federal securities law restrictions associated with the disposal of WinsLoew stock, pursuant to SFAS No. 115 only the portion of the stock that could be reasonably disposed of within one year is considered to have a readily determinable fair value. However, without taking into consideration present federal securities law restrictions, the pre-tax unrealized gain on WinsLoew stock equaled approximately $1.1 million and $1.4 million, respectively, at December 31, 1995 and 1994.\nNOTE 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses consisted of the following at December 31, 1995 and 1994:\nNOTE 7. LONG-TERM DEBT\nLong-term debt consisted of the following at December 31, 1995 and 1994:\nDuring the first quarter of 1993, the Company refinanced substantially all of its existing indebtedness through a $100 million, 11% Senior Note offering due February 15, 2003 (the \"Notes\"), and borrowings under a $30.0 million revolving credit facility which matures in 1998. During 1993, an extraordinary loss of $4.6 million was recorded related to debt extinguishments, representing redemption premiums and the write-off of deferred loan fees and unamortized discounts.\nDuring December 1995, the Company repurchased, at a discount, $4.8 million of its $100 million, 11% Senior Notes in the open market, and recognized an extraordinary gain of $254,000, net of tax.\nThe Notes are senior unsecured obligations of the Company, with the Company's plastics subsidiaries guaranteeing the payment of principal and interest. The Company's investment in WinsLoew is generally not subject to the indenture. The Notes may not be redeemed prior to February 15, 1998. On and after that date and until February 15, 2001, the Company may redeem all or any portion of the Notes at redemption prices ranging from 104.125% to\n- 31 -\n101.375% of the principal amount. After February 15, 2001, the Company may redeem all or any portion of the Notes at 100% of the principal amount. The Company must redeem $20.2 million and $25 million, respectively, of the Notes on February 15, 2001 and 2002.\nCovenants relating to the Notes restrict the Company with regard to making certain payments or taking certain actions as described in the related indenture. Among other restrictions, the Company and its subsidiaries may not make certain restricted payments, including dividend payments, stock redemptions or repurchases, or investments in affiliates during the existence and continuation of an event of default under the Notes, or if immediately after giving effect to such restricted payment, certain net equity or other tests are violated. The Company and its subsidiaries are prohibited from paying dividends, incurring certain new debt or otherwise becoming directly or indirectly obligated with respect to any debt unless certain interest coverage ratio tests are met.\nThe Company's recent decline in operating profitability caused it to fall below the interest coverage ratio requirement for the trailing four quarter periods ended September 30 and December 31, 1995. Accordingly, during November 1995 the Company discontinued its quarterly dividend payable on its Class A and B common shares (also see Note 9 regarding the Company's ability to make future required preferred stock dividend payments) and its ability to incur new debt or otherwise become directly or indirectly obligated with respect to any new debt is restricted in certain respects until it is again able to meet the interest coverage ratio requirement on a trailing four quarters basis.\nHowever, notwithstanding the foregoing restrictions, the Company is fully permitted to (i) borrow available funds on its revolving credit facility, and to (ii) incur new debt in connection with the refinancing of existing debt and certain other types of financings.\nUnder the terms of the revolving credit facility, the Company and its subsidiaries are required to, among other things, maintain certain financial ratios and minimum specified levels of net worth; refrain from paying dividends unless certain requirements are met; refrain from incurring additional indebtedness, or guaranteeing the obligations of others; and limit capital expenditures. As of December 31, 1995, the Company amended certain revolving credit facility covenants and implemented a revolving credit availability formula which provides for gross availability on the credit facility, prior to any borrowings or reductions for outstanding letters of credit, of between $17.5 million and $30.0 million based upon the Company's ratio of cash flow to total indebtedness, as defined in the amendment. At December 31, 1995, the gross availability on the revolving credit facility equaled $17.5 million, and the unused availability equaled $16.2 million.\nBorrowings on the revolving credit facility are subject to a borrowing base formula which is based on eligible collateral (accounts receivable, inventories and fixed assets of the subsidiaries), and interest is computed using either LIBOR-based rates plus 3%, or prime plus 1.5%. At December 31, 1995 the 30-day LIBOR rate and the prime rate were 5.8% and 8.5%, respectively.\nOther senior and subordinated indebtedness of approximately $21.3 million consists of equipment and other collateralized financings entered into during 1995 and 1994, along with industrial revenue bonds and capitalized lease obligations entered into prior to 1994. As of December 31, 1995 various financial covenants contained within certain of these obligations were amended in a manner consistent with the amendments to the revolving credit facility described above. This indebtedness provides for maturity dates from 1998 to 2007. At December 31, 1995 and 1994, the weighted average interest rates on these borrowings were 8.4% and 7.8%, respectively, with 85% of the total at floating interest rates, and the remainder at fixed interest rates as of December 31, 1995.\n- 32 -\nScheduled maturities of indebtedness in each of the next five years are as follows (in thousands):\nBased on the quoted market price of the Notes, and the borrowing rates available to the Company for loans with similar terms and average maturities, the fair value of the Company's indebtedness at December 31, 1995 and 1994 was $106.5 million and $123.3 million, respectively.\nNOTE 8. MINORITY INTERESTS\nIn December, 1992 the Company acquired the outstanding minority interest in Atlantis Plastics Injection Molding, Inc. (formerly known as Cyanede Plastics, Inc. (\"the injection molding unit\") for, among other things, 120,400 shares of treasury stock with a cost and market value of $481,600. In connection with this transaction, the Company granted the former injection molding unit minority shareholders the right to require the Company to repurchase such stock in 1995 at a specified formula price based on the injection molding unit's 1994 earnings, and established a liability of $481,600 to be utilized in the event that the repurchase provision was exercised. The Company determined that the repurchase provision would not be exercised and, accordingly, the Company reclassified the carrying value of the repurchase obligation to additional paid-in capital as of December 31, 1994.\nIn November, 1992 Atlantis acquired the Linear Films, Inc. (\"Linear\") minority interest and $7.0 million of the $20.0 million outstanding principal amount of Linear's subordinated debt for a cash payment of $7.3 million. In conjunction with the Company's 1993 refinancing, Atlantis acquired the remaining $13.0 million outstanding principal amount for a cash payment of $13.2 million. The Company allocated the cash payments between the debt and the minority interest based on the estimated fair values of each instrument. In this connection, extraordinary losses of $640,000 and $394,000, net of income taxes, were recognized in 1993 and 1992, respectively, related to the Linear debt extinguishment; and credits to additional paid-in capital of $1.9 million and $1.0 million were recognized in 1993 and 1992, respectively, related to the redemption of the Linear minority interest.\nNOTE 9. CAPITAL STOCK\nGenerally, the Class A Common Stock has one vote per share and the Class B Common Stock has ten votes per share. Holders of the Class B Common Stock are entitled to elect 75% of the Board of Directors; holders of Class A Common Stock are entitled to elect the remaining directors.\nEach share of Class B Common Stock is convertible, at the option of the holder thereof, into one share of Class A Common Stock. Class A Common Stock is not convertible into shares of any other equity security.\nDuring February 1994, the Company's Board of Directors approved a 2.5 cents per share quarterly dividend program beginning in April 1994, and consecutive quarterly dividends were paid through October 1995, after which the dividend program was discontinued (see Note 7).\nAs part of a share repurchase program initiated by the Company during 1993, 122,184 and 185,878 shares of Class A and B Common Stock were repurchased during 1994 and 1993 at a total cost of approximately $729,000 and $1.1 million, respectively.\n- 33 -\nEach share of Series A Convertible Preferred Stock (\"Preferred Stock\") has a liquidation preference of $100 and entitles the holder to an annual cumulative dividend, payable in equal semiannual installments of $72,500 on April 15 and October 15 of each year. As more fully discussed in Note 7, the Company is prohibited from paying preferred dividends until it is able to meet the interest coverage ratio requirement relating to its 11% Senior Notes on a trailing four quarters basis. In the event that three or more dividend payments are in arrears on the Preferred Stock, the holders of the Preferred Stock have the right to elect one director of the Company.\nThe Preferred Stock is convertible at the option of the holder thereof into an aggregate of 205,074 shares of Class A Common Stock. The Company has the right to compel conversion of the Preferred Stock, if the Class A Common Stock has a market value in excess of 100% of the Series A Convertible Preferred Stock's conversion price. The current conversion price is $9.75.\nNOTE 10. INCOME TAXES\nThe income tax (benefit) provision for the years ended December 31, 1995, 1994 and 1993 consisted of the following:\nThe following table provides a reconciliation between the Federal income tax rate and the Company's effective income tax rate:\n- 34 -\nAt December 31, 1995 and 1994, deferred tax assets and liabilities consisted of the following:\nNOTE 11. STOCK OPTION PLANS\nThe Company's Stock Option Plans (\"Option Plans\") are designed to serve as an incentive for retaining qualified and competent employees, directors and agents. Options may be granted under the Option Plans on such terms and at such prices as determined by the Compensation Committee of the Board of Directors (consisting only of outside directors); provided, however, that the exercise price of certain options will not be less than 90% of the fair market value of the Class A Common Stock on the date of grant. Each option will be exercisable after the period or periods specified in the option agreement, but no option shall be exercisable after the expiration of ten years from the date of grant. Options granted under the Option Plans are not transferable other than by will or by the laws of descent and distribution.\n- 35 -\nThe Option Plans also authorize the Company to make loans to optionees to exercise their options. Information with respect to the Option Plans is as follows:\nNOTE 12. BUSINESS SEGMENTS\nThe Company considers its continuing operations to comprise two segments: Atlantis Plastic Films and Atlantis Molded Plastics. During 1995, 1994 and 1993, an Atlantis Molded Plastics customer accounted for approximately 10%, 13%, and 15%, respectively, of the Company's net sales. Summary data for 1995, 1994 and 1993 is as follows:\n- 36 -\nNOTE 13. PROFIT SHARING AND RETIREMENT PLANS\nAtlantis and certain of its subsidiaries have profit sharing and defined contribution retirement plans. Generally, such plans cover all employees who have attained the age of 21 and have at least one year of service. Contributions to the plans are determined by the individual companies' Boards of Directors on an annual basis. Related expenses applicable to continuing operations were approximately $812,000, $1.1 million, and $855,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 14. RELATED PARTIES\nA management agreement exists between the Company and Trivest, Inc. (\"Trivest\"), an affiliate of a major shareholder. Trivest has certain common shareholders, officers and directors with the Company. Fees charged to expense under this agreement, including the portion related to discontinued operations, amounted to $478,000, $399,000, and $326,000 for the years ended December 31, 1995, 1994 and 1993, respectively. This agreement expires in December 1997. In addition to the above fees, Atlantis paid Trivest an acquisition fee of $405,000 relating to the May 1994 acquisition of Advanced.\nAtlantis shares its Miami, Florida office space with several related entities. Rent expense for this office space, as well as certain other non-direct general and administrative expenses, are allocated among Atlantis and these entities.\nNOTE 15. LITIGATION\nThe Company is, from time to time, involved in routine litigation. None of such litigation, in which the Company is presently involved, is believed to be material to its financial position or results of operations. Set forth below is a description of certain non-routine litigation which Atlantis or its subsidiaries were parties.\nIn December 1989, Atlantis filed a complaint against Charter-Crellin, Inc., and certain related parties alleging fraud and misrepresentation relating to a July 8, 1988 stock purchase agreement between Atlantis and Charter-Crellin, Inc. This lawsuit was settled during January 1993, with Atlantis receiving $2.5 million in cash. All litigation relating to this claim has been dismissed.\nNOTE 16. COMMITMENTS\nAtlantis and its subsidiaries lease various office space, buildings, transportation and production equipment with terms in excess of one year. Total expense under these agreements for the years ended December 31, 1995, 1994 and 1993 was approximately $1.5 million, $2.2 million and $2.6 million, respectively.\nThe total minimum rental commitments under operating leases at December 31, 1995 consisted of the following (in thousands):\n- 37 -\nNOTE 17. IMPAIRMENT OF LONG-LIVED ASSETS AND OTHER RESTRUCTURING CHARGES\nDuring the fourth quarter of 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\". In accordance with the provisions of SFAS No. 121, the Company wrote off certain goodwill and wrote down certain fixed assets, as discussed below.\nAs more fully discussed in \"Management's Discussion and Analysis of Operations\", the Company's Tulsa custom film facility was unprofitable during 1995, had experienced operating losses in prior periods, and was expected to continue to incur operating losses in the future if the fourth quarter 1995 restructuring of the business was not undertaken. As part of that restructuring, the Company estimated the facility's future cash flows from its operations and its eventual disposition, compared those amounts to its carrying value, and determined that an impairment loss should be recognized. Accordingly, during the fourth quarter of 1995 goodwill associated with the facility was written off, and its fixed assets were written down to fair value.\nAlso as previously discussed, during the fourth quarter of 1995 the Company decided to dispose of Plastic Containers, Inc., its remaining blow molding operation, as part of its strategy to focus its resources on the manufacture of film products and selected molded products, and to dispose of product groups that are not part of these operations. The Company determined that the carrying value of this operation exceeded its fair value, and determined the amount of the impairment charge by developing its best estimate of the fair value of the long-lived assets and comparing it to the carrying value of those long-lived assets. As a result, the majority of the goodwill associated with this business was written off during the fourth quarter of 1995. This business operates within the Atlantis Molded Plastics segment, and posted 1995 sales and operating income of approximately $12.9 million and $783,000, respectively, excluding the effects of the goodwill writeoff.\nThe fourth quarter 1995 noncash charges for the impairment of long-lived assets associated with the Tulsa custom film facility and the reduction in carrying value of the Company's blow molding unit in connection with its proposed sale totaled $10.6 million. Of this amount, goodwill writeoffs totalled approximately $8.9 million (with no associated tax benefit), and fixed asset writedowns totalled approximately $1.7 million pre-tax, or $1 million after-tax.\nDuring 1995, the Company also recorded restructuring charges of approximately $1.9 million related to (i) the first quarter 1995 reorganization of its senior management group (approximately $750,000), (ii) the third and fourth quarter 1995 reconfiguration of its stretch film sales organization (approximately $800,000), and (iii) the fourth quarter 1995 headcount reduction costs associated with the restructuring of the Tulsa custom facility and the injection molding unit (approximately $350,000).\nNOTE 18. DISCONTINUED OPERATIONS\nDiscontinued operations in 1995 and 1994 consisted of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary which was sold on August 31, 1995 to a Massachusetts-based property casualty insurer for $12.0 million. In connection with the sale, the Company purchased vacant land from Western Pioneer for approximately $639,000. The Company intends to dispose of this land and established a valuation allowance to reduce the carrying value of the land to approximately $370,000. The after-tax gain recognized on the sale was approximately $483,000, including the effects of the land valuation allowance. The net cash proceeds after the land purchase, taxes, expenses and inter-company amounts were applied to the Company's revolving credit facility.\nThe following table summarizes Western Pioneer's operating results for the eight months ended August 31, 1995 and the years ended December 31, 1994 and 1993:\n* Represents operating results for the period January 1 - August 31, 1995.\n- 38 -\nPrior to 1994, discontinued operations included both Western Pioneer and the Company's interest in Loewenstein, now known as WinsLoew. During 1993, Loewenstein accounted for approximately $561,000 of the Company's income from discontinued operations, and a gain of approximately $1,885,000 was recognized on Loewenstein stock transactions. The Company continues to hold for sale a 9% WinsLoew stock investment.\nNOTE 19. ACCOUNTING PRONOUNCEMENTS\nAs previously discussed, during the fourth quarter of 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (see Notes 1 and 17).\nIn October, 1995 SFAS No. 123, \"Accounting for Stock Based Compensation\" was issued. SFAS 123 introduces a preferable 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.\nAlthough expense recognition for employee stock-based compensation is not mandatory, SFAS No. 123 requires companies that choose not to adopt the new fair value accounting rules to make certain proforma disclosures. SFAS No. 123 must be implemented no later than fiscal year 1996. The Company has not yet determined the method or effect on operating results of implementing the statement; however, the adoption of SFAS No. 123 is not expected to have a materially adverse effect on consolidated financial position.\nNOTE 20. QUARTERLY FINANCIAL DATA (UNAUDITED)\nUnaudited consolidated quarterly financial data for the years ended December 31, 1995 and 1994 is as follows:\n- 39 -\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company has had no changes in or disagreements with its independent certified public accountants on accounting and financial disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information with respect to directors and executive officers of the Company is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\n- 40 -\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(2) Financial statement schedules have been omitted because the required information is contained in the financial statements and notes thereto or because such schedules are not required or applicable.\n(3) Exhibits (An asterisk to the left of an exhibit number denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K.)\n2.1 Agreement and Plan of Merger by and between Atlantis Plastics, Inc., a Florida corporation and Atlantis Group, Inc., a Delaware corporation, dated as of April 22, 1994. (2)(1)\n3.1 Registrant's Articles of Incorporation (3.1)(1)\n3.2 Registrant's Bylaws (February 1988) (3.2)(1)\n4.1 Form of Stock Certificate evidencing ownership of Registrant's Class A Common Stock(10)\n4.2 Trust Indenture between Registrant and American Stock Transfer and Trust Company (4.2)(7)\n4.3 Form of Senior Note, dated February 15, 1993 (4.3)(7)\n10.1 Preferred Stock Subscription and Purchase Agreement, dated October 24, 1986, between Registrant and Southeast Banking Corporation (10.20)(1)\n*10.2 Registrant's Amended and Restated Stock Option Plan, dated as of March 16, 1989 (10.1)(4)\n*10.3 Registrant's 1987 Disinterested Directors Stock Option Plan (10.2)(2)\n*10.4 Registrant's Amended and Restated 1990 Stock Option Plan (10.2)(4)\n*10.5 Fourth Amended and Restated Management Agreement between Registrant and Trivest, Inc. (10.5)(6)\n*10.6 Second Amended and Restated Employment Agreement, dated January 1, 1990 between Registrant and Earl W. Powell (10.6) (3)\n- 41 -\n*10.7 First Amendment To Second Amended and Restated Employment Agreement, dated as of April 1, 1992, between Registrant and Earl W. Powell (10.7) (7)\n*10.8 Employment Agreement, dated January 1, 1990, between Registrant and Phillip T. George, M.D. (10.7) (3)\n*10.9 First Amendment to Employment Agreement, dated as of April 1, 1992, between the Registrant and Phillip T. George, M.D. (10.9) (7)\n10.10 Form of Indemnification Agreement (10.47)(9)\n10.11 Office Lease, dated as of December 31, 1993, between Grand Bay Plaza Joint Venture and the Registrant, and First Addendum thereto (8)\n10.12 Settlement Agreement by and between Mobil Oil Corporation and Linear Films, Inc. of Civil Action No. 87 civ. 874-B in the Northern District of Oklahoma, effective as of February 21, 1992 (10.40)(5)\n10.13 License Agreement by and between Mobil Oil Corporation and Linear Films, Inc. for use of U.S. Patent No. 4,518,654, effective as of February 21, 1992 (10.41)(5)\n10.14 Loan Contract, dated October 30, 1987, between State of Minnesota and National Poly Products, Inc. (10.11)(2)\n10.15 Letter of Consent to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated October 30, 1991 (10.43)(5)\n10.16 Letter of Consent to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated January 13, 1992 (10.44 )(5)\n10.17 Consent and Acknowledgment to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated February 18, 1993 (10.22)(7)\n10.18 Loan Agreement between Arkansas Development Finance Authority and Cyanede, dated March 18, 1992 (10.69)(6)\n10.19 Promissory Note from Cyanede to the Arkansas Development Finance Authority, in the amount of $1,600,000, dated June 1, 1992 (10.70)(6)\n10.20 Office Lease, dated as of April 1, 1992, between Euram 1870 Exchange Associates and National Poly Products, Inc. (10.78)(6)\n10.21 Subordination and Attornment Agreement between State Farm Life Insurance Company and National Poly Products, Inc. dated April 6, 1992 (10.78)(6)\n10.22 Intercreditor Agreement between Heller Financial, Inc., Arkansas Development Finance Authority and Worthen Trust Company, Inc. (10.40)(7)\n10.23 Asset Purchase Agreement, dated May 17, 1994, among the Registrant, Advanced Plastics, Inc. and Frederick R. Warren. (9)\n10.24 Credit Agreement, dated February 22, 1993, between the Registrant and Heller Financial, Inc. (the \"Heller Credit Agreement\") (10.39)(7)\n10.25 First Amendment and Waiver, dated March 28, 1994, to Heller Credit Agreement. (10.29) (10)\n- 42 -\n10.26 Consent Letter, dated May 23, 1994, to Heller Credit Agreement. (10.30) (10)\n10.27 Second Amendment, dated August 15, 1994, to Heller Credit Agreement. (10.31) (10)\n10.28 Consent Letter, dated September 9, 1994, to Heller Credit Agreement. (10.32) (10)\n10.29 Consent Letter, dated February 13, 1995, to Heller Credit Agreement. (10.33) (10)\n10.30 Consent and Waiver Letter, dated February 24, 1995, to Heller Credit Agreement. (10.34) (10)\n10.31 Third Amendment to Heller Credit Agreement and Consent, dated as of March 30, 1995. (10.3) (11)\n10.32 Fourth Amendment to Heller Credit Agreement, dated as of September 30, 1995. (10.2) (13)\n10.33 Fifth Amendment to Heller Credit Agreement, dated as of December 31, 1995. (14)\n10.34 Lease with option to purchase Real Estate between Atlantis Plastic Films, Inc. and the City of Mankato, Minnesota, dated as of March 2, 1995. (10.35) (10)\n*10.35 Employment Agreement, dated February 1, 1995, between the Registrant and Anthony F. Bova. (10.1) (11)\n*10.36 Employment Agreement, dated March 6, 1995, between the Registrant and Paul Rudovsky. (10.2) (11)\n10.37 Master Security Agreement and Promissory Note between Cyanede Plastics, Inc. and General Electric Capital Corporation (\"GECC\") in the amount of $2,673,919, dated as of February 23, 1995. (10.4) (11)\n10.38 Corporate Guaranty of the Registrant of the obligations of Cyanede Plastics, Inc. to GECC, dated as of February 23, 1995. (10.5) (11)\n10.39 Master Security Agreement and Promissory Note between Pierce Plastics, Inc. and GECC in the amount of $221,790, dated as of February 23, 1995. (10.6) (11)\n10.40 Corporate Guaranty of the Registrant of the obligations of Pierce Plastics, Inc. to GECC, dated as of February 23, 1995. (10.7) (11)\n10.41 Master Security Agreement and Promissory Note between Plastic Containers, Inc. and GECC in the amount of $340,000, dated as of February 23, 1995. (10.8) (11)\n10.42 Corporate Guaranty of the Registrant of the obligations of Plastic Containers, Inc. to GECC, dated as of February 23, 1995. (10.9) (11)\n10.43 Master Security Agreement and Promissory Note between Atlantis Plastic Films, Inc. (as successor by merger to Linear Films, Inc.) and GECC in the amount of $900,000, dated as of February 23, 1995. (10.10) (11)\n10.44 Promissory Note from Atlantis Plastic Films, Inc. to GECC in the amount of $650,000, dated as of February 23, 1995. (10.11) (11)\n10.45 Corporate Guaranty of the Registrant of the obligations of Atlantis Plastic Films, Inc. to GECC dated as of February 23, 1995. (10.12) (11)\n- 43 -\n10.46 Loan and Security Agreement by the Among Atlantis Plastic Films, Inc., Cyanede Plastics, Inc., Pierce Plastics, Inc., Plastic Containers, Inc. and The CIT\/Equipment Group Financing, Inc. (\"CIT\"), dated as of 4\/13\/95. (10.13) (11)\n10.47 First Amendment to Loan and Security Agreement by and among Atlantis Plastic Films, Inc., Atlantic Plastics Injection Molding, Inc. (formerly known as Cyanede Plastics, Inc.) Pierce Plastics, Inc., Plastic Containers, Inc. and CIT dated to be effective as of December 31, 1995. (14)\n10.48 Promissory Note from Atlantis Plastic Films, Inc., Cyanede Plastics, Inc., Pierce Plastics, Inc., and Plastic Containers, Inc. to CIT in the amount of $15,000,000, dated as of April 13, 1995. (10.14) (11)\n10.49 Guaranty of the Registrant of the obligations of Atlantis Plastic Films, Inc. to CIT, dated as of April 13, 1995. (10.15) (11)\n10.50 Credit Agreement between Atlantis Plastics Injection Molding, Inc. and the Registrant and National City Bank, Northeast, dated as of May 19, 1995. (10.16) (12)\n10.51 First Amendment to National City Bank, Northeast, Credit Agreement, dated as of September 30, 1995. (10.3) (13)\n10.52 Second Amendment to National City Bank, Northeast, Credit Agreement, dated to be effective as of December 31, 1995. (14)\n10.53 Stock Purchase Agreement for the acquisition of Western Pioneer Insurance Company by and between the Commerce Insurance Company, a Massachusetts Corporation and the Registrant, dated as of May 18, 1995. (10.17) (12)\n10.54 Demand Promissory Note from Atlantis Plastic Films, Inc. to GECC in the amount of $1,280,579.70, dated as of May 8, 1995. (10.18) (12)\n10.55 Purchase Agreement for the acquisition of the Joint Venture Interest of Rigal Plastics, Inc. in CKS\/Rigal Plastics, by and between CKS Plastics, Inc., a Florida corporation and the Registrant, dated as of July 31, 1995. (10.1) (13)\n11.1 Calculation of Earnings Per Share(14)\n21.1 Registrant's Subsidiaries(14)\n23.1 Consent of Coopers & Lybrand L.L.P.(14)\n27.1 Financial Data Schedule (for SEC use only) - ----------------\n(1) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Form 8-B filed June 7, 1994.\n(2) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n(3) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(4) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's registration statement on Form S-8 (No. 33-41012).\n- 44 -\n(5) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n(6) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's registration statement on Form S-2 (33-53152).\n(7) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n(8) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(9) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Report on Form 8-K filed June 3, 1994.\n(10) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n(11) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995.\n(12) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.\n(13) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Quarterly Report on Form 10-Q for the ended September 30, 1995.\n(14) Filed herewith.\n(B) REPORTS ON FORM 8-K\nDuring the fourth quarter of 1995, the Registrant filed a current report on Form 8-K, dated November 27, 1995.\n(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K\nThe index to exhibits that are listed in Item 14(a)(3) of this report and not incorporated by reference follows the \"Signatures\" section hereof and is incorporated herein by reference.\n(D) FINANCIAL STATEMENT SCHEDULES REQUIRED BY REGULATION S-X\nSee Item 14(a)2.\n- 45 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nATLANTIS PLASTICS, INC.\nDate: March 29, 1996 By: \/S\/ PAUL RUDOVSKY --------------------------------- PAUL RUDOVSKY EXECUTIVE VICE PRESIDENT, FINANCE AND ADMINISTRATION (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 in the capacities and on the dates indicated.\n- 46 - INDEX TO EXHIBITS\n- 47 -","section_15":""}
{"filename":"720307_1995.txt","cik":"720307","year":"1995","section_1":"Item 1. Business.\nWellesley Lease Income Limited Partnership II-C (the \"Partnership\") is a limited partnership organized under the provisions of the Massachusetts Uniform Limited Partnership Act on January 20, 1984. As of December 31, 1995, the Partnership consisted of a General Partner and 1,776 Limited Partners owning 25,050 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 298 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 April 4, 1984, 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 Partnership shall terminate on December 31, 2011, unless sooner dissolved or terminated as provided in Section 11 of the Amended Agreement of Limited Partnership.\nThe closing date of the Partnership was October 31, 1984, and aggregate equipment purchased through December 31, 1995, is $25,939,110. At the end of 1995, there are 10 leases in place with 7 lessees. The acquisition of these leases and equipment is described more fully in Item 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 $56,963, subject to 10 existing leases with 7 different lessees. All purchases of computer equipment are subject to a 3% acquisition fee paid to the General Partner.\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 8 to the financial statements herein in Item 8. Financial Statements and Supplementary Data.\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.\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 $90,350 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, 100% of each CMI claim would be paid in full, of which 75% would be cash and 25% would be common stock of the reorganized Continental Information Systems Corporation (\"CISC\"), based on a per share price of $4.29.\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 $54,997 and 4,447 shares of common stock in the CISC. 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. On July 20, 1995, the Partnership received the second and final distribution which consisted of cash proceeds of $12,765 and 823 shares of common stock. Following the Trustee's second distribution and the charge off made during the year, the Partnership's net unsecured pre-petition claim has been settled as of July 20, 1995 and there are no other outstanding receivable balances.\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, 25,050 Units had been sold to the public at a price of $500 per Unit (except for 298 Units which were sold for a net price of $460 per Unit to employees of the Corporate 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 25,050 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 distributed to the Partners. Upon reaching the end of its reinvestment period (the ninth anniversary of the Partnership's closing date), the Partnership will also distribute to the Partners \"Distributable Cash From Sales or Refinancings\", if any. The Partnership distributed $187,873 to the Limited Partners in 1995, $375,752 in 1994 and $501,000 in 1993 and distributed $9,888 to the General Partner in 1995, $19,776 in 1994 and $26,368 in 1993. The cumulative cash distributions to the Limited Partners through December 31, 1995, are $14,320,335 as compared with the contributed Limited Partners' net capital of $11,158,769.\n\"Cash From Operations\" and \"Cash From Sales or Refinancings\" 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). Including the distribution for the fourth quarter of 1995 made February 29, 1996, cumulative distributions to date are $572.92 per Unit. This cumulative distribution per Unit amount represents 47.48% 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.\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 October 31, 1984, the Partnership completed its offering and received from the escrow account $12,513,080 representing 25,050 Units of Limited Partnership Interests. Of this amount, the Partnership received proceeds from the sale of 298 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 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 $71,675, $89,491 and $242,805, for the years ended December 31, 1995, 1994, and 1993, respectively. Rental income decreased $17,495 or 10% and $617,442 or 78% in 1995 and 1994, respectively. The decrease in rental income is primarily due to lower rental rates on equipment lease extensions and remarketing and a reduction in the overall equipment portfolio available for lease. Interest income decreased as result of lower average short-term investment balances. The recovery of net unsecured pre-petition claim of $25,940 and $54,997 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, in the original amount of $90,350 (for further discussion refer to note 8 to the financial statements). The current year recovery relates to the receipt of the second and final Trustee's distribution 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 decrease in net gain on sale of equipment can be attributed to fewer sales of equipment during 1995 in comparison to sales made in 1994.\nTotal costs and expenses decreased $158,938 or 57% and $280,684 or 50% in 1995 and 1994, respectively, compared to prior periods. The decrease in costs and expenses each year is primarily the result of lower depreciation expense, which accounted for a decrease of $151,915 and $233,182 in 1995 and 1994, respectively. Depreciation expense decreased each year due to the reduction in the size of the equipment portfolio and an increased portion of the equipment portfolio becoming fully depreciated. Included in depreciation expense in 1994 and 1993 is a provision for $10,000 and $50,000, respectively, to properly reflect the equipment portfolio's net realizable value for those years. The net loss on sale of marketable securities reflects the fourth quarter sale of stock that had been received from the Trustee. The current year increase in management fees resulted from the successful collection efforts of delinquent rents receivable. Management fees decreased sharply in 1994 from the prior year as a result of the decline in rental income accompanied by the increase of delinquent accounts receivable. General and administrative expenses remained relatively flat over the past three years. The Partnership was able to reverse its provision for doubtful accounts in the amount of $4,396 for the year ended December 31, 1995. In comparison, the Partnership established a reserve for doubtful accounts in 1994 in the amount of $7,787.\nThe Partnership recorded net income (loss) per Limited Partnership Unit of $2.16, ($2.56) and $8.27 for the years ended December 31, 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\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 options would generate the most favorable results.\nRental income 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 and will cause certain leases to terminate upon expiration. Future rental revenues amount to $51,122 and are related to leases that expire over the next three years (for further discussion, refer to note 4 to the financial statements).\nDuring the second quarter of 1995, the General Partner announced its intentions of winding down the operations of the Partnership. It is anticipated that substantially all of the assets will be liquidated and the proceeds will be used to settle all outstanding liabilities and make a final distribution during 1996.\nThe Partnership's investing activities for the year resulted in equipment sales with a depreciated cost basis of $8,120 generating $9,755 in proceeds. During the fourth quarter, the Partnership sold 4,161 shares of CISC stock, having a cost basis of $10,403, generating net sales proceeds in the amount of $8,838. 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 and has announced its intentions of winding down the Partnership.\nCash distributions paid in the first quarter of 1996 are currently at an annual level of 1% per Limited Partnership Unit or $1.25 per Limited Partnership Unit on a quarterly basis. During 1995, the Partnership distributed a total of $7.50 per Limited Partnership Unit, of which $2.16 per Unit represents income and $5.34 per Unit represents a return of capital. For the quarter ended December 31, 1995, the Partnership declared a cash distribution of $32,961, of which $1,648 was distributed to the General Partner and $31,313 was distributed to the Limited Partners. The distribution subsequently occurred on February 29, 1996. The Partnership expects distributions to be more volatile as its operations are winding down. The effects of inflation have not been significant to the Partnership and are not expected to have any 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\nThe Partners of Wellesley Lease Income Limited Partnership II-C:\nWe have audited the accompanying balance sheets of Wellesley Lease Income Limited Partnership II-C (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 II-C 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, the General Partner has begun the process of liquidating the assets of the Partnership, and anticipates that the process will be substantially complete in 1996.\nKPMG Peat Marwick LLP\nBoston, Massachusetts March 15, 1996\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nBalance Sheets December 31, 1995 and 1994\nSee accompanying notes to financial statements.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (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 II-C (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 II-C (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 II-C (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 January 20, 1984. The Amended Agreement of Limited Partnership authorized the issuance of up to 25,000 Limited Partnership Units at a per unit gross price of $500 and up to 50 additional units to affiliates. The Partnership closed on October 31, 1984, with 25,050 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 the 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. Including the fourth quarter of 1995 distribution made February 29, 1996, cumulative distributions to date are $572.92 per Unit. This cumulative distribution per Unit amount represents 47.48% of Payout. It is not anticipated that Payout will occur as of the liquidation of this Partnership.\nDuring the second quarter of 1995, the General Partner announced its intentions of winding down the operations of the Partnership. It is anticipated that substantially all of the assets will be liquidated and the proceeds will be used to settle all outstanding liabilities and make a final distribution during 1996.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (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. 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 and 1993 is a provision for $10,000 and $50,000, respectively, to properly reflect the equipment portfolio's net realizable value for those years. 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 $635 and $56, respectively, and $0 and $21,250 included in accounts receivable - affiliates, respectively.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nNotes to Financial Statements\nMarketable Securities\nThe marketable securities are stated at fair value at the balance sheet date and consist of 1,109 shares of common stock in Continental Information Systems Corporation (\"CISC\") received by the Partnership in the distributions made December 27, 1994 and July 20, 1995 by the Trustee of the Liquidating Estate of CIS Corporation, et al, (\"the Trustee\"), with respect to the outstanding net unsecured pre-petition claim. During the second quarter of 1995, the stock began trading, thereby providing an objective valuation measure for establishing the cost basis. Unrealized gains and losses are recorded directly in partners' equity except those gains and losses that are deemed to be other than temporary, which would be reflected in income or loss (see note 7).\nIncome Taxes\nNo provision for federal income taxes has been made as the liability for such taxes is that of the Partners rather than the Partnership. Taxable income (loss), as reported on Schedule K-1, Form 1065 \"Partner's Share of Income, Credits, Deductions, etc.\", was $15,766, $(126,997) and $292,805 in 1995, 1994 and 1993, respectively (see note 6).\n(3) Investment Property\nAt December 31, 1995, the Partnership owned computer equipment with a depreciated cost basis of $56,963, subject to existing leases. All purchases of computer equipment are subject to a 3% acquisition fee paid to the General Partner.\n(4) Leases\nDescription of leasing arrangements:\nOperations consist primarily of leasing computer equipment. All equipment leases are classified as operating leases and expire over the next three years.\nMinimum lease payments scheduled to be received in the future under existing noncancelable operating leases are as follows:\n1996 $ 44,087 1997 5,676 1998 1,359 --------------\n$ 51,122 ==============\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nNotes to Financial Statements\nThe following schedule provides an analysis of the cost of capital equipment by major classes as of December 31, 1995:\nComputer peripherals $ 306,927 Other 222,258 -------------- $ 529,185 ==============\nFive lessees, Caterpillar Tractor Company, Coast Pump & Supply Company, Incorporated, First Option of Chicago, Incorporated, New York Life Insurance Company and Owens Corning Fiberglass, Incorporated, lease equipment in which the related rental payments exceed 10% of the total rental income. The related rental payments comprise 12.91%, 14.10%, 10.14%, 24.04% and 29.68%, respectively, of the total rental income for the year ended December 31, 1995. Caterpillar Tractor Company, Coast Pump & Supply Company Incorporated, First Option of Chicago, Incorporated, New York Life Insurance Company and Owens Corning Fiberglass, Incorporated, lease equipment comprising 12.25%, 10.47%, 4.85%, 25.86% and 23.58%, respectively, of the total equipment portfolio at December 31, 1995.\n(5) 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.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nNotes to Financial Statements\n(6) Reconciliation of Financial Statement Net Income to Taxable Income (Loss) to Partners\nA reconciliation of financial statement net income to taxable income (loss) 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.\n(7) Fair Values of Financial Instruments\nPursuant to Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires investments in debt and equity securities other than those accounted for under the equity method to be carried at fair value or amortized cost for debt securities expected to be held to maturity, the Partnership has classified its investments in equity securities as available for sale. Accordingly, the net unrealized gains and losses computed in marking these securities to market are reported as a component of partners' equity. At December 31, 1995 the difference between the fair value and the cost basis of these securities is an unrealized loss of $416.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nNotes to Financial Statements\nThe fair value is based on currently quoted market prices. The cost basis and estimated fair value of the Partnership's marketable securities at December 31, 1995 are as follows:\nAs was discussed in note 2, Marketable Securities, the Partnership received stock in CISC as part of the December 27, 1994 and July 20, 1995 distributions from the Trustee, with respect to the outstanding net unsecured pre-petition claim. The receivables comprising the net unsecured pre-petition claim had been fully reserved during prior years; thus, during the second quarter of 1995 when the stock began actively trading, the carrying amount for the stock was established to be $2.50 per share which approximated fair value at June 30, 1995.\n(8) 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.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nNotes to Financial Statements\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 $90,350 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, 100% of each CMI claim would be paid in full, of which 75% would be cash and 25% would be common stock of the reorganized Continental Information Systems Corporation (\"CISC\"), based on a per share price of $4.29.\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 $54,997 and 4,447 shares of common stock in the CISC. 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. On July 20, 1995, the Partnership received the second and final distribution which consisted of cash proceeds of $12,765 and 823 shares of common stock. Following the Trustee's second distribution and the charge off made during the year, the Partnership's net unsecured pre-petition claim has been settled as of July 20, 1995 and there are no other outstanding receivable balances.\n(9) 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.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nSchedule II - Valuation and Qualifying Accounts and Reserves\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nComputer Equipment Portfolio (Unaudited) December 31, 1995\nLessee\nBangor Hydro Electric Power, Incorporated Caterpillar Tractor Company Coast Pump & Supply Company, Incorporated First Options of Chicago, Incorporated New York Life Insurance Company Owens Corning Fiberglass, Incorporated South Pacific Transport Company\nEquipment Description Acquisition Price\nComputer Peripherals $ 306,927 Other 222,258 ------------\n$ 529,185 ============\nExhibit 11 WELLESLEY LEASE INCOME LIMITED PARTNERSHIP II-C (A Massachusetts Limited Partnership)\nComputation of Net Income (Loss) 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 5 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 outstanding no 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 25,050 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), except for acquisition fees, as to which TLP receives 25% and CISMS receives 75%. 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 5 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.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K: None.","section_15":""}
{"filename":"743453_1995.txt","cik":"743453","year":"1995","section_1":"ITEM 1 - BUSINESS\nMay Drilling Partnership 1983-3 (the \"Drilling or General Partnership\") and May Limited Partnership 1983-3 (the \"Limited Partnership\") were organized by May Petroleum Inc. (\"May\") to explore for and develop oil and gas reserves primarily in Texas, Oklahoma and Louisiana. Funds received from the sale and production of oil and gas reserves are used to pay the obligations of the Limited Partnership. Funds not required by the Limited Partnership as working capital are distributed to the participants in the Drilling Partnership and the general partner.\nThe general partner of the Limited Partnership is EDP Operating, Ltd., which is one of the operating partnerships for Hallwood Energy Partners, L. P. (\"HEP\"). The Drilling Partnership is the sole limited partner of the Limited Partnership. The Limited Partnership does not have any subsidiaries, nor does it engage in any other kind of business. The Limited Partnership has no employees and is operated by Hallwood Petroleum, Inc. (\"HPI\"), a subsidiary of HEP. In February 1996, HPI employed 133 full-time employees.\nPursuant to the terms of the general partnership agreement and the limited partnership agreement, HEP is obligated, from time to time, to contribute certain amounts, in property, cash or unreimbursed services, to the Limited Partnership. As of December 31, 1995, all such required contributions had been made.\nPARTICIPATION IN EXPENSES AND REVENUES\nThe principal expenses and revenues of the Limited Partnership are shared by the general partner and the Drilling Partnership as set forth in the following table. The charges and credits to participants in the Drilling Partnership are shared among the participants in proportion to their ownership of units of participation.\nIn 1996, the sharing ratio will be 57.7% to the limited partner and 42.3% to the general partner.\nTo the extent that the characterization of any expense of the Limited Partnership depends on its deductibility for federal income tax purposes, the proper characterization is determined by the general partner (according to its intended characterization on the Limited Partnership's federal income tax return) in good faith at the time the expense is to be charged or credited. Such characterization will control related charges and credits to the partners regardless of any subsequent determination by the Internal Revenue Service or a court of law that the reported expenses should be otherwise characterized for tax purposes.\nCOMPETITION\nOil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy. See also \"Marketing\" for a discussion of the market structure for oil and gas sales.\nREGULATION\nProduction and sale of oil and gas is subject to federal and state governmental regulations in a variety of ways including environmental regulations, labor law, interstate sales, excise taxes and federal, state and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases.\nThe production of oil and gas is subject to regulation by the state regulatory agencies in the states in which the Limited Partnership does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas.\nFEDERAL INCOME TAX CONSIDERATIONS\nThe Limited Partnership and the General Partnership are partnerships for federal income tax purposes. Consequently, they are not taxable entities; rather, all income, gains, losses, deductions and credits are passed through and taken into account by the partners on their individual federal income tax returns. In general, distributions are not subject to tax so long as such distributions do not exceed the partner's adjusted tax basis. Any distributions in excess of the partner's adjusted tax basis are taxed generally as capital gains.\nMARKETING\nThe oil and gas produced from the properties owned by the Limited Partnership has typically been marketed through normal channels for such products. Oil has generally been sold to purchasers at field prices posted by the principal purchasers of crude oil in the areas where the producing properties are located. The majority of the Limited Partnership's gas production is sold on the spot market and is transported in intrastate and interstate pipelines. Both oil and natural gas are purchased by refineries, major oil companies, public utilities and other users and processors of petroleum products.\nFactors which, if they were to occur, might adversely affect the Limited Partnership include decreases in oil and gas prices, the availability of a market for production, rising operational costs of producing oil and gas, compliance with and changes in environmental control statutes and increasing costs and difficulties of transportation.\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nENVIRONMENTAL CONSIDERATIONS\nThe exploration for, and development of, oil and gas involve the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the present general interest in environmental problems, the general partner cannot predict what effect possible future public or private action may have on the business of the Limited Partnership. The general partner is continually taking all action necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations and does not presently anticipate that the compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, earnings or the competitive position of the Limited Partnership in the oil and gas industry.\nINSURANCE COVERAGE\nThe Limited Partnership is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. The Limited Partnership maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to the Limited Partnership's, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon the Limited Partnership's earnings and financial position.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Limited Partnership's oil and gas reserves are concentrated in prospects in south Louisiana. The Limited Partnership's reserves are predominantly natural gas, which accounts for 86% of estimated future gross revenues in the Limited Partnership's reserve report as of December 31, 1995.\nSIGNIFICANT PROSPECTS\nAt December 31, 1995, the following prospects accounted for approximately 97% of the Limited Partnership's proved oil and gas reserves. Reserve quantities were obtained from the December 31, 1995 reserve report prepared by HPI's petroleum engineers.\nBOUDREAUX PROSPECT. The Boudreaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 36,800 bbls of oil and 1,711,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest in this prospect ranges up to 3.5%.\nMEAUX PROSPECT. The Meaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 800 bbls of oil and 77,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest in this prospect is 19.8%.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor a description of legal proceedings affecting the Limited Partnership, please refer to Item 8 - Note 3.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNo matter was submitted to a vote of participants during the fourth quarter of 1995.\nPART II -------\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\na) The registrant's securities consist of partnership interests which are not traded on any exchange and for which no established public trading market exists.\nb) As of December 31, 1995, there were approximately 776 holders of record of partnership interests in the Drilling Partnership.\nc) Distributions paid by the Limited Partnership were as follows (in thousands):\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\nMaterial changes in the Limited Partnership's cash position for the years ended December 31, 1995 and 1994 are summarized as follows:\nCash provided by operating activities in 1995 was used for distributions to the partners and additions to oil and gas properties. The Limited Partnership has net working capital of $316,000. This working capital, together with future net cash flows generated from operations may be used to fund future distributions. Future distributions depend on, among other things, continuation of current or higher oil and gas prices, markets for production and future development costs, and the outcome of the litigation described in Item 8, Note 3.\nThe Limited Partnership's ability to generate funds adequate to meet its future needs will be largely dependent upon its ability to continue to develop further its existing reserves. Proved reserves and discounted future net revenues (discounted at 10% and before general and administrative expenses) from proved reserves were estimated at 39,000 bbls and 1,844,000 mcf valued at $3,206,000 in 1995 and 39,000 bbls and 1,870,000 mcf valued at $2,872,000 in 1994. The increase in discounted future net revenues and the fluctuation in the quantities resulted from an increase in year end oil and gas prices as well as changes in the estimated rates of production on certain wells.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nRESULTS OF OPERATIONS - ---------------------\n1995 COMPARED TO 1994 - ---------------------\nOIL REVENUE\nOil revenue increased $11,000 during 1995 as compared with 1994. The increase is comprised of an increase in the average oil price from $16.03 per barrel in 1994 to $17.68 per barrel in 1995 combined with a 2% increase in production as shown in the table below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and sale of another during the second quarter of 1994.\nGAS REVENUE\nGas revenue decreased $40,000 during 1995 as compared with 1994. The decrease is due to a decrease in the average gas price from $2.15 per mcf during 1994 to $1.84 per mcf during 1995, partially offset by an 8% increase in production as shown below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and the sale of another during the second quarter of 1994.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1995 and 1994.\nLEASE OPERATING\nLease operating expense decreased $23,000 during 1995 as compared with 1994 primarily due to the sale of the Warwick Richard #1 during the second quarter of 1994 and the temporary abandonment of the Duhon #1.\nPRODUCTION TAXES\nProduction taxes increased $16,000 during 1995 as compared with 1994 as a result of the settlement of a lawsuit which resulted in lower production taxes during 1994.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $27,000 during 1995 as compared with 1994 due to a decrease in the allocation of overhead from the general partner.\nDEPLETION\nDepletion expense increased $12,000 during 1995 as compared with 1994 due to a higher depletion rate caused by the 8% increase in oil and gas production during 1995.\nLITIGATION SETTLEMENT\nLitigation settlement expense during 1995 primarily represents amounts paid in connection with the settlement of a royalty dispute on the Duhon #1 well.\n1994 COMPARED TO 1993 - ---------------------\nOIL REVENUES\nOil revenues decreased $61,000 in 1994 as compared to 1993. The average oil price decreased from $17.88 per barrel in 1993 to $16.03 per barrel in 1994. Oil production decreased 36% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines. GAS REVENUES\nGas revenues decreased $461,000 as compared to 1993. The average gas price decreased from $2.26 per mcf in 1993 to $2.15 per mcf in 1994. Gas production decreased 42% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1994 and 1993.\nLEASE OPERATING\nLease operating expense decreased $14,000 as compared to 1993, primarily due to the sale of the Warwick Richard #1 during the second quarter of 1994.\nPRODUCTION TAXES\nProduction taxes decreased $45,000 in 1994 as compared to 1993, primarily due to the decrease in revenues mentioned previously.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $26,000 in 1994 as compared to 1993, due to a decrease in allocation of overhead from the general partner.\nDEPLETION\nDepletion expense decreased $68,000 as compared to 1993, primarily due to a lower depletion rate. LITIGATION SETTLEMENT\nLitigation settlement expense during 1993 represents the costs of a lawsuit settlement which is discussed in Item 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE ----\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report 12\nBalance Sheets at December 31, 1995 and 1994 - May Drilling Partnership 1983-3 13\nBalance Sheets at December 31, 1995 and 1994 - May Limited Partnership 1983-3 14\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 15\nStatements of Changes in Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 16\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 17\nNotes to Financial Statements - May Drilling Partnership 1983-3 and May Limited Partnership 1983-3 18-21\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 22\nINDEPENDENT AUDITORS' REPORT ----------------------------\nDRILLING PARTNERSHIP 1983-3 AND MAY LIMITED PARTNERSHIP 1983-3:\nWe have audited the financial statements of May Drilling Partnership 1983-3 (\"General Partnership\") and May Limited Partnership 1983-3 (\"Limited Partnership\") as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, listed in the accompanying index at Item 8. 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 the General Partnership and the Limited Partnership at December 31, 1995 and 1994, and the results of operations and cash flows of the Limited Partnership for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDenver, Colorado February 27, 1996\nMAY DRILLING PARTNERSHIP 1983-3 BALANCE SHEETS (In thousands)\nNote: The statements of operations and cash flows for May Drilling Partnership 1983-3 are not presented because such information is equal to the Limited Partners' share of such activity as presented in the May Limited Partnership 1983-3 financial statements. The May Drilling Partnership carries its investment in May Limited Partnership 1983-3 on the equity method. The May Limited Partnership 1983-3 financial statements should be read in conjunction with this balance sheet.\nMAY LIMITED PARTNERSHIP 1983-3 BALANCE SHEETS (In thousands)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands, except for Units)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nThe accompanying notes are an integral part of the financial statements.\nMAY DRILLING PARTNERSHIP 1983-3 AND MAY LIMITED PARTNERSHIP 1983-3\nNOTES TO FINANCIAL STATEMENTS\n(1) ACCOUNTING POLICIES AND OTHER MATTERS\nGENERAL PARTNERSHIP\nMay Drilling Partnership 1983-3, a Texas general partnership (the \"General Partnership\"), was organized by May Petroleum Inc. (\"May\") for the purpose of oil and gas exploration through May Limited Partnership 1983-3 (the \"Limited Partnership\"). The General Partnership was formed on November 7, 1983, with investors (\"Participants\") subscribing an aggregate of $11,629,000 in assessable $1,000 units. After the expenditure of the initial contributions of the Participants, additional mandatory assessments from each Participant are provided for under the terms of the general partnership agreement in an amount up to 25% of the initial contribution of the Participant. No additional assessments were made.\nThe general partnership agreement requires that the manager, Hallwood Energy Partners, L. P. (\"HEP\"), offer to repurchase partnership interests from Participants for cash at amounts to be determined by appraisal of the Limited Partnership's net assets no later than December 31, 1988, and during the two succeeding years, if such net assets are positive. The manager has made repurchase offers in all years since 1989 and intends to make a repurchase offer in 1996.\nAs the General Partnership is the sole limited partner of the Limited Partnership, its results of operations, cash flows and changes in partners' capital are equal to the limited partner's share of the Limited Partnership's results of operations, cash flows and changes in partners' capital as set forth herein. Therefore, separate statements of operations, cash flows and changes in partners' capital are not presented for the General Partnership.\nLIMITED PARTNERSHIP\nThe Limited Partnership, a Texas limited partnership, was organized by May and the General Partnership, for the purpose of oil and gas exploration and the production of crude oil, natural gas and petroleum products. The Limited Partnership's oil and gas reserves are located in prospects in south Louisiana. Among other things, the terms of the Limited Partnership agreement (the \"Agreement\") give the general partner the authority to borrow funds. The Agreement also requires that the general partner's total capital contributions to the Limited Partnership as of each year end, including unrecovered general partner acreage and equipment advances, must be compared to total Limited Partnership expenditures from inception to date, and if such contributions are less than 15% of such expenditures, an additional contribution in the amount of the deficiency is required. At December 31, 1995, no additional contributions were necessary to comply with this requirement.\nOn June 30, 1987, May sold to HEP all of its economic interest in the Limited Partnership and account receivable balances due from the Limited Partnership. HEP became the general partner of the Limited Partnership in 1988.\nSHARING OF COSTS AND REVENUES\nCapital costs, as defined by the Agreement, for commercially productive wells and the costs related to the organization of the Limited Partnership are borne by the general partner. Noncapital costs and direct expenses, as defined by the Agreement, are charged 1% to the general partner and 99% to the limited partner. Oil and gas sales, operating expenses and general and administrative overhead are shared so that the general partner's allocation will equal the percentage that the amount of Limited Partnership expenses, as defined, allocated to the general partner bears to the aggregate amount of Limited Partnership expenses allocated to the general partner and the limited partner, plus 15 percentage points, but in no event will the general partner's allocation exceed 50%. The sharing ratio for each of the last three years was as follows:\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nINCOME TAXES\nNo provision for federal income taxes is included in the financial statements of the Limited Partnership or the General Partnership because, as partnerships, they are not subject to federal income tax and the tax effects of their activities accrue to the partners. The partnerships' tax returns, the qualification of the General and Limited Partnerships as partnerships for federal income tax purposes, and the amount of taxable income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes to the partnerships' taxable income or loss, the tax liability of the partners could change accordingly.\nOIL AND GAS PROPERTIES\nThe Limited Partnership follows the full cost method of accounting for oil and gas properties and, accordingly, capitalizes all costs associated with the exploration and development of oil and gas reserves.\nThe capitalized costs of evaluated properties, including the estimated future costs to develop proved reserves, are amortized on the unit of production basis. Full cost amortization per dollar of gross oil and gas revenues was $.21 in 1995, $.18 in 1994 and $.16 in 1993.\nCapitalized costs are limited to an amount not to exceed the present value of estimated future net cash flows. No valuation adjustment was required in 1995, 1994 or 1993. Significant price declines in the future could cause the Limited Partnership to experience valuation adjustments and could reduce the amount of future cash flow available for distributions and operations.\nGenerally no gains or losses are recognized on the sale or disposition of oil and gas properties. Maintenance and repairs are charged against income when incurred.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nGAS BALANCING\nThe Limited Partnership uses the sales method for accounting for gas balancing. Under this method, the Limited Partnership recognizes revenue on all of its sales of production, and any over production or under production is recovered at a future date.\nAs of December 31, 1995, the net imbalance to the Limited Partnership interest is not considered material. Current imbalances can be made up with production from existing wells or from wells which will be drilled as offsets to current producing wells.\nUSE OF ESTIMATES\nThe preparation of the financial statements for the Limited Partnership and General Partnership 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.\nRELATED PARTY TRANSACTIONS\nHallwood Petroleum, Inc. (\"HPI\"), a subsidiary of the general partner, pays all costs and expenses of operations and receives all revenues associated with the Limited Partnership's properties. At month end, HPI distributes revenues in excess of costs to the Limited Partnership.\nThe amounts due from HPI were $39,000 and $11,000 as of December 31, 1995 and 1994, respectively. These balances represent net revenues less operating costs and expenses.\nCASH FLOWS\nAll highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior years' amounts to conform to the classifications used in the current year.\n(2) GENERAL AND ADMINISTRATIVE OVERHEAD\nHPI conducts the day to day operations of the Limited Partnership and other affiliated partnerships of HEP. The costs of operating the entities are allocated to each partnership based upon the time spent on that partnership. General and administrative overhead allocated by HPI to the Limited Partnership totaled $80,000 in 1995, $103,000 in 1994 and $143,000 in 1993.\n(3) LEGAL PROCEEDINGS\nIn June 1993, 14 lawsuits were filed against the Limited Partnership in the 15th Judicial District Court, Lafayette Parish, Louisiana, Docket Nos. 93-2332-F through 93-2345-F, styled Lamson Petroleum Corporation v. Hallwood Petroleum, Inc. et al. The plaintiffs in the lawsuits claim that they have valid leases covering streets and roads in the units of the A. L. Boudreaux #1 well, G. S. Boudreaux #1 well, Mary Guilbeau #1 well and Duhon #1 well, which represents approximately 3% to 4% of the Limited Partnership's interest in these properties, and are entitled to a portion of the production from the wells dating from February 1990. The Limited Partnership has not recognized revenue attributable to the contested leases since January 1993. These revenues, totaling $61,000 at December 31, 1995, have been placed in escrow pending resolution of the lawsuits. At this time, the Limited Partnership believes that the difference between the escrowed amount and the amount of any liability that may result upon resolution of this matter will not be material.\nIn February 1994, the Limited Partnership and the other parties to the lawsuit styled SAS Exploration, Inc. v. Hall Financial Group, Inc. et al. settled the lawsuit. The plaintiffs alleged that certain leases in the A. L. Boudreaux #1 and A. M. Duhon #1 wells expired and terminated at the end of their primary terms as a result of production being from the Bol Mex 4 Sand rather than the A. B. Sand. In the settlement, the Limited Partnership and the plaintiffs cross- conveyed interests in certain leases to one another and the Limited Partnership paid the plaintiffs $306,000. The cash paid by the Limited Partnership was reflected as litigation settlement expense in the December 31, 1993 financial statements. The interest conveyance resulted in a decrease in the Limited Partnership's reserves as of December 31, 1993 totaling 197,000 mcf of gas, 4,100 barrels of oil and $371,000 in future net revenues, discounted at 10%.\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited)\nThe following tables contain certain costs and reserve information related to the Limited Partnership's oil and gas activities. The Limited Partnership has no long-term supply agreements and all reserves are located within the United States.\nCOSTS INCURRED -\nCertain reserve value information is provided directly to partners pursuant to the Agreement. Accordingly, such information is not presented herein.\n(a) See Note 3 to 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 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Drilling Partnership and Limited Partnership are managed by affiliates of HEP and do not have directors or executive officers.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe partnerships pay no salaries or other direct remuneration to officers, directors or key employees of the general partner or HPI. The Limited Partnership reimburses the general partner for general and administrative costs incurred on behalf of the partnerships. See Note 2 to the Financial Statements.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo the knowledge of the general partner, no person owns of record or beneficially more than 5% of the Drilling Partnership's outstanding units, other than HEP, the address of which is 4582 S. Ulster Street Parkway, Denver, Colorado 80237, and which beneficially owns approximately 37.2% of the outstanding units. The general partner of HEP is Hallwood Energy Corporation.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information with respect to the Limited Partnership and its relationships and transactions with the general partner, see Part I, Item 1 and Part II, Item 7.\nPART IV -------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. Financial Statements and Schedules: See Index at Item 8.\nb. Reports on Form 8-K - None.\nc. Exhibits:\n3.1 The General Partnership Agreement and the Limited Partnership Agreement filed as an Exhibit to Registration Statement No. 0-11313, are incorporated herein by reference.\nSIGNATURES - ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Partnerships have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.\nMAY DRILLING PARTNERSHIP 1983-3 MAY LIMITED PARTNERSHIP 1983-3 BY: EDP OPERATING, LTD., GENERAL PARTNER\nBY: HALLWOOD G.P., INC. GENERAL PARTNER\nBy: \/s\/William L. Guzzetti -------------------------- William L. Guzzetti 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.\nSignature Title Date --------- ----- ----\n\/s\/Robert S. Pfeiffer Vice President February 29, 1996 --------------------------- (Principal ----------------- Robert S. Pfeiffer Accounting Officer)","section_15":""}
{"filename":"802781_1995.txt","cik":"802781","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nMagnavision Corporation (the \"Registrant\" or the \"Company\") was incorporated under the name Yardley Ventures Inc. in Delaware on April 3, 1986 for the purpose of acquiring one or more potential businesses. Effective December 30, 1991, the Registrant acquired all of the issued and outstanding capital stock of Magnavision Corporation, a New Jersey corporation (\"Magnavision - - N.J.\"), in a tax-free, stock-for-stock acquisition. The shareholders of Magnavision - N.J. received newly issued shares of common stock in the Registrant for their Magnavision - N.J. shares. The newly issued shares constituted approximately 98% of the Registrant's outstanding common stock. In connection with the acquisition, the Registrant effected a one-for-400 reverse split of its common stock and changed its name to Magnavision Corporation. In addition, the board of directors of Magnavision - N.J. became the board of directors of the Registrant and Magnavision - N.J. became a wholly-owned subsidiary of the Registrant.\nThe Registrant does no business and has no significant assets other than its stock in Magnavision - N.J. Unless otherwise specified herein, the terms \"Magnavision\" and the \"Company\" shall be deemed to refer to the Registrant and\/or Magnavision - N.J.\nDEVELOPMENT OF BUSINESS\nThe Company was initially formed for the purpose of owning and operating a multi-channel, wireless, cable television system in the New York market. In August 1990, the Company entered into an agreement to lease channel capacity (the \"Channel Lease Agreement\") from the Department of Education of the Archdiocese of New York (the \"Department\"). The Channel Lease Agreement (subsequently amended in January 1994) grants the Company a lease through January 2004 (with a right to extend for an additional five years, and a right of first refusal for subsequent renewals), which entitles the Company to use twenty-eight (28) wireless cable licenses (168 MHz of spectrum), located on seven different transmitting towers (24 MHz per tower) in New York State. Eight (8) of these channels (48 MHz of spectrum) are located in New York City.\nSince entering into the Channel Lease Agreement, the Company has conducted various marketing and engineering activities to facilitate the planned operation of a wireless system and, pursuant to the requirements of the Channel Lease Agreement, made an escrow deposit of approximately $900,000 to the Department in September 1995 which is to be utilized for system reconstruction. However, as of the date hereof, the Company has not commenced operation of a wireless system, and will require substantial additional funding in order to do so. Since there is no assurance that such funding will be available, the Company has retained Allen & Company Incorporated to assist in exploring various strategic alternatives relating to the Channel Lease Agreement, including potential strategic alliances, joint ventures or a sale or other disposition of the Company's rights under the Channel Lease Agreement.\n- 1 -\nApart from development of its wireless television system, the Company has been engaged, since 1992, in the business of offering a private cable television service to colleges, universities, nursing homes and hospitals throughout the East Coast. As of May 31, 1996, the Company had long term (generally 5-10 years) agreements with a total of 21 institutions located in New York, New Jersey, Pennsylvania, Massachusetts and North Carolina to offer such services. For the year ended December 31, 1995, the Company generated approximately $666,000 of revenues from this business (which constituted 100% of the Company's total revenues for the year). For the year ended December 31, 1995, revenues from three institutions which utilize the Company's private cable television service, Seton Hall University, Wagner College and Fordham University, constituted approximately 32%, 18% and 12% of the Company's revenues, respectively.\nIn August 1995, the Company obtained a $5,000,000 lending facility from IBJ Schroder Bank & Trust Co., IBJS Capital Corporation and KOCO Capital Company, L.P. Approximately $2,637,000 of that amount was furnished to the Company at the time the lending facility was entered into, and the remainder is to be advanced based on the present value of projected cash flow from new contracts with purchasers of the Company's private cable television service, with the funds advanced to be used for equipment and construction costs incurred in connection with installation of the service at the new locations and for working capital. The proceeds furnished at the time the lending facility was entered into were utilized to fund an escrow deposit of $900,000 for system configuration required under the Channel Lease Agreement (as noted above), to repurchase approximately 18% of the Company's issued and outstanding capital stock and to provide working capital. In connection with obtaining the lending facility the Company issued to the lenders warrants to purchase approximately 27% of the Company's Common Stock on a fully diluted basis at exercise prices of $.38 and $.27 per share. On June 3, 1996, the terms of the lending facility were amended. Pursuant to the amendment, the lenders agreed to waive existing defaults and provide up to the sum of $1,200,000 of the remaining amount available under the existing lending facility toward the Company's working capital requirements without regard to the present value formula referred to above. In exchange therefor, the Company agreed to issue warrants to purchase an additional 12% of the Company's Common Stock on a fully diluted basis at an exercise price of $.27 per share. In connection therewith the Company's rights under the Channel Lease Agreement have been transferred to a subsidiary whose stock has been pledged to the lenders as security for amounts advanced under the lending facility. See \"Item 13 - Certain Relationships and Related Transactions\" for further information regarding the transactions with the lenders.\nWIRELESS CABLE TELEVISION BUSINESS\nWireless Technology\nThe wireless cable industry was made commercially possible in 1983 when the Federal Communications Commission (\"FCC\") reallocated a portion of the electromagnetic radio spectrum located between 2500 and 2700 MHz and permitted this spectrum to be used for commercial purposes. Today, there are a maximum of thirty-three microwave channels used for wireless cable in each market. These include thirteen Multipoint\/Multichannel Distribution Service (\"MMDS\") channels (Channels 1, 2 or 2A, E1-E4,-F4 and H1-H3) and the excess capacity on up to 20 additional (\"ITFS\") channels (Channels A1-A4, B1-B4, C1-C4, D1-D4 and G1-G4). Grandfathered ITFS stations on the eight E and F channels also lease excess capacity to wireless cable operators. In each geographic service\n- 2 -\narea of the 50 largest markets, 33 6 Mhz channels (198 MHz) are available for wireless cable. Except in limited circumstances, the 20 ITFS channels (120 MHz) in each market can generally be licensed only to qualified non-profit education organizations and, in general, each of these channels must be used a minimum of 20 hours per week for instructional programming. The remaining \"excess air time\" on an ITFS Channel may be leased to wireless cable operators for commercial use. In addition, the 13 MMDS channels (78 MHz) are made available by the FCC for full time usage without programming restrictions.\nAccording to industry experts, wireless cable can provide customers with the same or superior video television service as that of traditional hardwire cable. A typical wireless cable system consists of head-end equipment (satellite signal reception equipment, transmitters and other broadcast equipment, and a transmission antenna), and reception equipment at each subscriber location (antenna, frequency conversion device and set-top converter). Like a traditional hardwire cable system, wireless cable receives programming by satellite transmission. Unlike hardwire cable systems, however, the programming is then retransmitted over the air from one or more transmit sites to the subscriber's location. At the subscriber's location, these wireless signals are received by a small antenna and then converted to frequencies that can pass through conventional coaxial cable to a descrambling converter located on top of a television set.\nWireless systems currently transmit analog signals over distances of approximately 25 to 35 miles from their central transmission point. The transmission of wireless frequencies requires clear \"line-of-sight\" between the transmitter and the receiving antenna. Dense foliage, hilly terrain or tall buildings can cause signal interference which can diminish or block signals. Certain line-of-sight constraints can be ameliorated by changing transmission power levels and using engineering techniques, such as cross-polarization, frequency offsets, pre-amplifiers, beambenders and signal repeaters.\nLike traditional franchise cable systems, wireless cable systems are capable of employing \"addressable\" subscriber authorization technology which enables the cable operator to centrally control the programming available to each subscriber without the need for a service call to the subscriber home. By eliminating service calls, addressable systems reduce certain operating costs of a pay television system.\nThe Company believes that wireless cable is the most economical technology currently available for delivery of pay television service. Wireless cable systems do not require an extensive network of cable and amplifiers; therefore, the capital cost per subscriber is substantially lower than traditional franchise cable. Furthermore, engineering and construction of a wireless cable transmission facility typically can be completed in 120 days, whereas construction of a traditional franchise cable system with complete coverage may take as long as three years. In addition, since wireless signals are transmitted over the air rather than through underground or aerial networks, wireless systems are less susceptible to outages and are less expensive to operate and maintain than traditional franchise cable systems. Most service problems experienced by wireless cable subscribers are home-specific rather than system-wide or neighborhood-wide, as is often the case with traditional franchise cable systems. As a consequence of the foregoing, the rates charged to subscribers of wireless cable operators are generally lower than hard wire cable systems.\n- 3 -\nCurrently, wireless cable companies are transmitting programming by utilizing analog technology. Analog technology permits a standard 6 MHz wireless cable television channel to carry one full motion audio\/video programming service (such as ESPN or HBO) at a time. However, it is anticipated that in the near or immediate future wireless operators will be able to implement digital video compression technology, which is expected to increase the capacity of each 6 MHz wireless cable channel by four to ten times. As a consequence of this technology, wireless cable companies are expected to be able to offer more than 100 channels of video programming services. However, since digital compression technology is still being tested on an operational basis, and its use by wireless cable companies is still subject to FCC approval, there is no assurance that wireless cable companies will be able to implement digital compression technology in the marketplace in the near or immediate future. If and when digital compression technology is implemented, wireless cable operators are also expected to be able to transmit data, such as stock quotes, electronic mail and news, and to provide services such as home shopping and home banking, simultaneously without interfering with the video entertainment portion of the transmission signal.\nChannel Lease Agreement\nOn August 20, 1990, the Company entered into the Channel Lease Agreement to lease from the Department the use of three (6 MHz) ITFS channels (a total of 18 MHz) located on seven different tower locations (a total of 126 MHz), with an option to utilize one additional 6 MHz ITFS channel also located on each of the seven tower locations when the Department obtains the necessary FCC approvals for such channels. Under the Channel Lease Agreement, the Company also leases three operationally-fixed microwave service (\"OFS\") channels (to serve as links between the ITFS tower sites), with an option for one additional OFS channel. The Channel Lease Agreement expires in January, 2004, although the Company has an option to extend the lease for five years if the FCC renews the Department's license. Following expiration of the option term (if extended) in 2009, the Company has a right of first refusal covering the leased channels. Extension and\/or renewal of the Channel Lease Agreement is contingent upon (as with all broadcast licenses) FCC renewal of the Department's license for the channels, of which there can be no assurance.\nAs noted above, the Company was required to and did make payment of an escrow deposit to the Department of $900,227 in September 1995. The Company also paid a total of $90,000 in monthly royalties to the Department during 1995 and will be required to pay additional monthly royalties during 1996 and beyond as follows:\n(a) Through July 1996, the greater of $9,000 ($12,000 if the option for the additional channels is exercised) plus four cents ($.04) per subscriber or five (5) percent of the gross receipts per month.\n(b) From August 1996 to the expiration of the Channel Lease Agreement, the greater of $12,000 ($16,000 if the option for the additional channels is exercised) plus five cents ($.05) per subscriber or five (5) percent of the gross receipts per month.\nThe Channel Lease Agreement includes the Company's right to use space leased to the Department at the seven transmission sites, including\n- 4 -\nthe Empire State Building, Staten Island, NY, Yonkers, NY, Loomis, NY, Rhinecliff, NY, Haverstraw, NY and Beacon, NY. Additional space is also available at all other locations owned or leased by the Department and can be made available to the Company by the Department for use in providing the Company's service. The Agreement precludes the Company from transmitting movies rated \"R\", \"NC-17\" or \"X\" over the Department's channels. The agreement further precludes the Company from transmitting movies Rated \"X\" or \"NC-17\" over all channels controlled by the Company or its affiliates. The Company may, however, transmit \"R\" rated movies over non-Department channels that may be either controlled by the Company, or the Company's affiliates.\nRecent Developments Regarding Channel Lease Agreement\nThe Registrant has been advised by the Department that CAI Wireless Systems, Inc. (\"CAI\"), a competitor of the Registrant in the New York Area of Dominant Interest (\"ADI\") market, has recently requested the FCC to delay granting the Department's applications for an extension until December 31, 1996 of a certain construction completion deadline and reinstatement of a certain construction permit relating to certain of its ITFS facilities pending the preparation and filing by CAI of comments regarding such applications. Notwithstanding CAI's request, the Registrant has been advised that on July 5, 1996 the Department's applications were granted by the FCC and that public notice of the grant is expected to appear shortly.\nThe Registrant is unaware of the grounds that CAI might cite as a basis for the FCC to issue a reversal of such grant should CAI petition the FCC to reverse its decision. Based upon historical precedent, the Registrant does not expect that the FCC will reverse its decision. However, there is no assurance as to when any such determination will be made or that the FCC will not reverse its decision.\nAvailable Market\nAccording to latest available data, there are approximately seven million households located in the New York ADI market. The Company estimates that approximately 70% of these households can receive wireless cable transmission. (Approximately 51% of such households subscribe to cable.) The Company believes that approximately 70% of all businesses in the New York metropolitan area are capable of receiving wireless cable. The Company also believes that transmission capacity in the New York area can be expanded significantly by activating the additional transmission sites for which it now has rights in areas north of New York City.\nCompetition\nWireless cable television operators face competition from a number of sources, including other MMDS services operating in their areas, hardwire cable systems and satellite broadcast companies. In addition, several technologies are under development and a new regulatory environment may significantly affect the pay television industry and result in new competitors, such as telephone companies, entering the market. At this time, the Company cannot predict the competitive impact of these new technologies, new regulations and competitors to the wireless cable industry. However, the Company expects that wireless cable operators will be able to expand their programming capacity and introduce new services through the use of digital technology while continuing to maintain a cost advantage over other providers of pay television service.\nIn the New York metropolitan area there is currently one other wireless cable operator, CAI, utilizing MMDS and ITFS frequencies.\nThe traditional franchise cable system operators historically have been the principal providers of pay television services. Traditional franchise cable operators have constructed their networks using coaxial cable to deliver service to customers and typically offer a greater number of channels at higher prices than wireless systems. In the New York metropolitan market, the percentage of television households served by traditional cable is estimated at 51% (based on latest figures available from trade services deemed reliable). In New York, the principal providers of hardwire cable providers include Time Warner Cable, Cablevision Systems Corp. and Cox Cable Communications.\nThe Company believes that several traditional franchise cable companies are experimenting with interactive technology that permits a subscriber to transmit data from the subscriber's television set back to the\n- 5 -\noperator's transmission facility. Wireless cable systems are today technically capable of offering selected interactive services by transmitting data from the subscriber's location back to the head-end facility using \"response channels\" licensed to wireless operators by the FCC. Potential applications for interactive technology include, for example, automated pay-per-view service and home shopping activities. However, the introduction of expanded channel capacity and interactive services by traditional franchise cable systems will require substantial new investment. The demand for more expensive, expanded channel offerings and new services is uncertain, and the Company believes that the customer base of the hard-wire cable systems may not be willing to pay substantially higher prices for these expanded channel offerings and new services.\nWireless cable operators also compete against satellite systems, which include \"backyard dish\" services and direct broadcast satellite (\"DBS\") providers. The satellite systems involve the transmission of an encoded signal direct from a satellite to the customer's home. Because the DBS systems transmit a signal at a higher power level and frequency than most satellite-transmitted signals, its reception can be accomplished with a relatively small (18-inch) dish mounted on a rooftop or in the yard. In the Fall of 1994, DirecTV, Inc. and United States Satellite Broadcasting Company, Inc. began offering nationwide DBS service capable of providing approximately 150 channels of programming. According to trade publications, DirecTV had approximately 1.25 million customers as of December 31, 1995. AT&T has announced that it intends to offer DirecTV service with its long distance service. Prime Star Partners, owned by a group of hard-wire cable companies, provides nationwide medium power DBS service. According to trade publications, Prime Star Partners had approximately 1.0 million customers as of December 31, 1995. Echostar Communications Corporation has successfully launched a high power DBS satellite and has announced plans to commence nationwide high-power DBS service in 1996. MCI Communications, Inc. recently acquired high power DBS spectrum at an FCC auction and intends to offer nationwide DBS service with its partner News Corp. within two years. Alphastar, Inc. has leased transponders on a medium-power DBS satellite and has announced plans to commence nationwide medium power DBS service in 1996. Due to the cost of DBS satellites and receiving equipment and lack of local programming and interactivity, the Company believes that wireless cable systems enjoy a comparative advantage over these satellite systems.\nIt is also anticipated that wireless cable operators will be competing with telephone companies. Under the Communications Act of 1934, as amended (the \"Communications Act\"), local exchange carriers (\"LECs\"), including the Regional Bell Operating Companies, were prohibited from providing video programming directly to customers in their respective telephone service areas. The FCC has ruled, however, that LECs may acquire wireless cable operations without violating the prohibition. The FCC also permitted LECs to provide \"video dialtone\" service, allowing LECs to make available to multiple service providers, on a nondiscriminatory common carrier basis, a basic platform that will permit end users to access video program services provided by others. The Telecommunications Act of 1996, however, repealed the FCC's video dialtone regulations, except that existing systems may continue to operate. Some LECs have indicated that they intend to construct or acquire separate hard-wire cable systems within their telephone service areas if authorized. In addition, Bell Atlantic, NYNEX, and Pacific Telesis have all made acquisitions of and investments in wireless cable television systems. Recently, US West Media Group announced that it had an agreement to acquire Continental Cablevision Inc., one of the largest hardwire cable operators in the U.S.\n- 6 -\nThe FCC has also proposed to redesignate the 28 GHz band to create a new video programming delivery service referred to as Local Multi-Band Distribution Service (\"LMDS\"). This service has a relatively short broadcast range and, therefore, would require multiple cellular transmission sites. In July 1995, the FCC proposed to award licenses for this service in each of 493 geographic areas pursuant to auctions. Sufficient spectrum for up to 49 analog channels has been designated for the LMDS service. The FCC has not determined how many licenses it will award in each area. Final rules for LMDS have not been established and auctions are not expected to begin until the second half of 1996.\nGovernment Regulation\nGeneral. The wireless cable industry is subject to regulation by the FCC pursuant to the Communications Act. The Communications Act empowers the FCC, among other things, to issue, revoke, modify and renew licenses within the spectrum available to wireless cable; to approve the assignment and\/or transfer of control of such licenses; to approve the location of wireless cable systems; to regulate the kind, configuration and operation of equipment used by wireless cable systems; and to impose certain equal employment opportunity and other reporting requirements on wireless cable operators.\nThe FCC has determined that wireless cable systems are not \"cable systems\" for purposes of the Communications Act. Accordingly, a wireless cable system does not require a local franchise and is subject to fewer local regulations than a hardwire cable system. Moreover, all transmission and reception equipment for a wireless cable system can be located on private property; hence, there is no need to make use of utility poles or dedicated easements or other public rights of way. Although wireless cable operators typically have to lease the right to use wireless cable channels from the holders of channel licenses, unlike hardwire cable operators they do not have to pay local franchise fees. Recently, legislation has been introduced in some states to authorize state and local authorities to impose on all video program distributors (including wireless cable distributors) a tax on the distributor's gross receipts comparable to the franchise fees cable operators pay. While the proposals vary among states, the bills all would require, if passed, as much as 5% of gross receipts to be paid by wireless distributors to local authorities.\nWireless cable transmissions are governed by FCC regulations governing interference and reception quality. These regulations specify important signal characteristics such as modulation (i.e., AM\/FM) or encoding formats (analog or digital). Current FCC regulations require wireless cable systems to transmit only analog signals and those regulations will have to be modified, either by rule making or by individual application, to permit the use of digital transmission. The Company believes that the necessary FCC approvals will be obtained to permit use of digital compression when digital compression technology becomes commercially available; however, there can be no assurance that these approvals will be forthcoming or timely or that interim relief will be provided by the FCC. The FCC also regulates transmitter locations and signal strength.\nUnder current FCC regulations, a wireless cable operator generally may broadcast anywhere within the line-of-sight of its transmission facility, provided that its signal does not violate interference standards in the FCC-protected area of another wireless license holder. Existing wireless\n- 7 -\nlicense holders generally are protected from interference within 35 miles of the transmission site; however, if that site is moved, the protection remains only within the original 35 mile zone.\nThe 1992 Cable Act. On October 5, 1992, Congress enacted the 1992 Cable Act, which imposes additional regulation on traditional hardwire cable operators and permits regulation of rates in markets in which there is no \"effective competition\". The 1992 Cable Act, among other things, directs the FCC to adopt comprehensive new federal standards for local regulation of certain rates charged by traditional hardwire cable operators. The legislation also provides for deregulation of traditional hardwire cable in a given market once other multi-channel video providers offer comparable programming to at least 50% of the households in the franchise area and serve, in the aggregate, at least 15% of the households in the cable franchise area. Rates charged by wireless cable operators, typically already lower than traditional hardwire cable rates, are not subject to regulation under the 1992 Cable Act.\nOn May 3, 1993, the FCC issued new regulations implementing the rate regulation provisions in the 1992 Cable Act, which generally required traditional hardwire cable operators with rates above a benchmark average price for basic services to reduce their rates by approximately 10%. On February 22, 1994, the FCC announced that it would require the FCC's rate regulation of traditional hardwire cable operators to implement a further reduction in rates of another 7%. These and other aspects of the FCC's rate regulation of traditional hardwire customer fees, along with several other provisions of the 1992 Cable Act, have been challenged in the courts and at the FCC. Furthermore, as noted elsewhere, proposals to substantially reduce and in some instances repeal rate regulation have been adopted by Congress and incorporated into the 1996 Telecommunications Act.\nWhile current FCC regulations are intended to promote the development of a competitive television subscription industry, the rules and regulations affecting the wireless cable industry may change, and any future changes in FCC rules, regulations, policies and procedures could have a material adverse effect on the Company. In addition, a number of legal challenges to the 1992 Cable Act and the regulations promulgated thereunder have been filed, both in the courts and before the FCC. These challenges, if successful, could result in an increase in the operating costs of wireless companies and otherwise have a material adverse effect on the Company. In particular, those sections of the 1992 Cable Act which prohibit discriminatory or unfair practices in the sale of satellite programming to competing multi-channel video programming distributors have been challenged. The cost to acquire satellite programming may be affected by the outcome of those challenges. Other aspects of the 1992 Cable Act empowered the FCC to adopt regulations for the basic subscription rates charged by traditional hardwire cable operators. As described above, the FCC issued rules requiring such cable operators, under certain circumstances, to reduce the rates charged for basic services up to a total of 17% from prior levels. Should these regulations withstand court and regulatory challenges, the extent to which wireless cable operators may continue to maintain a price advantage over traditional hardwire cable operators could be diminished. On the other hand, continued strict regulation of cable rates would tend to impede the ability of hardwire cable operators to upgrade and gain a competitive advantage over the wireless cable.\n1996 Telecommunications Act. In February 1996, Congress passed and the President signed into law the Telecommunications Act of 1996 (the\n- 8 -\n\"1996 Act\"). Some of the provisions of the 1996 Act that directly affect wireless cable television operators are discussed below. Beyond those specific provisions, the 1996 Act contains provisions intended to increase competition in the telephone, radio, broadcast television, and hardwire and wireless cable television businesses. The long term effect on the 1996 Act cannot be determined at this time, although competition in the video programming delivery industry is likely to increase as a result of the adoption of the 1996 Act.\nThe 1996 Act changes the definition of cable television system so that the definition excludes any systems that serve customers without using any public right of way. This change will allow wireless cable system operators to wire together apartment complexes and other similar properties, as long as the wiring system does not cross a public right-of-way, without the need to apply for a local cable television franchise.\nThe 1996 Act expands the effective competition test for deregulating franchised cable operator basic and cable programming services tier rates to include the provision of comparable video programming services directly to customers in a cable operator's franchise area by a telephone company or its affiliate or any multichannel video programming distributor using the facilities of such carrier or its affiliate. The 1996 Act also deregulates cable programming service rates for small cable operators, or such operator's basic service tier if that was the only tier subject to regulation as of December 31, 1994, and deregulates cable programming service rates for all cable operators as of March 31, 1999. These changes may limit or eliminate the extent to which a particular cable operator is subject to rate regulation.\nThe 1996 Act instructs the FCC to adopt regulations to prohibit restrictions that impair any customer's ability to receive video programming services through reception devices. It is likely that such regulations will prohibit local governments from adopting or enforcing zoning regulations that limit a person's ability to have wireless video receiving dishes and panels on their properties.\nPrior to 1996, hardwire cable operators could not own any MMDS license which covered an area that was located in the operator's hardwire cable franchise. The 1996 Act permits a hardwire cable operator to acquire MMDS licenses inside a franchised cable area if effective competition exists in such areas. The 1996 Act also eliminates the cable\/broadcast cross-ownership and cable\/telephone company cross ownership prohibitions, freeing broadcasters and telephone companies to own cable systems within their service areas. This is likely to increase the competition to which wireless companies are subject.\nOther Regulations. Wireless cable license holders are subject to regulation by the Federal Aviation Administration with respect to the construction of transmission towers and to certain local zoning regulations affecting construction of towers and other facilities. There may also be restrictions imposed by local authorities. There can be no assurance that the Company will not be required to incur additional costs in complying with such regulations and restrictions.\nUnder the retransmission consent provisions of the 1992 Cable Act, wireless and hardwire cable operators seeking to retransmit certain commercial television broadcast signals must first obtain the permission of the broadcast station in order to retransmit the station's signal. However, wireless\n- 9 -\ncable and private cable systems, unlike hardwire cable systems, are not required under the FCC's \"must carry\" rules to retransmit a specified number of local commercial television or qualified low power television signals.\nDue to the regulated nature of the cable industry, the Company's growth and operations may be adversely impacted by the adoption of new, or changes to existing, laws or regulations or the interpretations thereof.\nCopyright. Under the federal copyright laws, permission from the copyright holder generally must be secured before a video program may be retransmitted. Under Section 111 of the Copyright Act, certain \"cable systems\" are entitled to engage in the secondary transmission of programming without the prior permission of the holders of copyrights in the programming. In order to do so, a cable system must secure a compulsory copyright license. Such a license may be obtained upon the filing of certain reports with the payment of certain fees to the U.S. Copyright Office. In 1994, Congress enacted the Satellite Home Viewer Act of 1994 which enables operators of wireless cable television systems to rely on the cable compulsory license under Section 111 of the Copyright Act.\nPRIVATE CABLE BUSINESS\nGeneral\nPrivate cable television service is a multi-channel subscription television service where the programming is received at a facility by satellite receiver and then transmitted via coaxial cable throughout private property, often multiple dwelling units (\"MDUs\"), without crossing public rights of way. Private cable companies operate under agreements with private landowners to service a specific MDU institution or commercial establishment.\nSince 1992, the Company has offered private cable television services to various colleges, universities, hospitals and nursing home facilities, primarily in the northeastern United States. To date, the Company has entered into or been awarded contracts with 21 facilities, of which 16 are currently receiving programming from the Company. The Company believes that it has developed the necessary skills and \"know-how\" over time to deliver a quality product and that it has achieved a favorable reputation with its existing customer base. It also believes that this business can be expanded on a national basis with appropriate funding.\nAgreements with Institutions\nThe Company has long-term agreements to provide service to 21 facilities (16 of which are currently operational) for students and patients, with approximately 8,350 outlets, at the following locations:\nSeton Hall University, South Orange, NJ - on line since 1992\nFairleigh Dickinson University, Teaneck, NJ - on line since\nManhattanville College, Purchase, NY - on line since 1992\n- 10 -\nMaritime College, SUNY, Bronx, NY - on line since 1993\nWagner College, SUNY, Bronx, NY - on line since 1993\nGreenhill Retirement Community, West Orange, NJ - on line since 1992\nSarah Frances Nursing Home, Boonton, NJ - on line since 1994\nImmaculata College, Immaculata, PA - on line since 1994\nGeorgian Court College, Lakewood, NJ - on line since 1994\nMontclair State College, Montclair, NJ - Phase I on line since\nFordham University, Manhattan, NY - on line since 1995\nJesuits of Fordham, Inc., Bronx, NY - on line since 1995\nKean College, Union, NJ - on line since 1995\nCurry College, Milton, MA - on line since 1995\nMount Olive College, Mount Olive, NC - on line since 1995\nV.A. Medical Center, East Orange, NJ - on line since February\nMontclair State University, Montclair, NJ - Phase II projected on line in September 1996\nNorth Carolina A&T State University, Greensboro, NC - projected on line in September 1996\nOhio Valley College, Parkersburg, WV- projected on line in September 1996\nIona College, New Rochelle, NY - projected on line in September 1996\nCollege of Mount St. Vincent, Riverdale, NY - projected on line in September 1996\nFrom the date a contract is signed, it generally takes approximately three months to complete an installation and to make a site operational or place it \"on line\". Except for nursing homes and for Manhattanville College, where the Company bills students directly, the Company receives its fees on a monthly basis (nine (9) months a year) from these institutions, which include such charges in the tuition or other fees to students or residents of the subject facilities. The Company believes that the potential market for this segment of its business is, in the near term, located in the Eastern portion of the United States and is represented by hundreds of thousands of potential viewers. The Company has the ability under its standard form of agreement to create its own\n- 11 -\nform of \"TV Guide\" for distribution to students and patients, as the case may be. None of the Company's revenues to date include fees from advertisers. However, at such time as the Company's subscriber base achieves \"critical mass\", estimated at 15,000 outlets, the Company believes that it will have the ability to obtain revenues from advertisers seeking to reach the Company's subscribers who the Company believes are a favored category of consumer for many product manufacturers and service providers.\nSales and Marketing\nThe Company's sales and marketing efforts in the private cable business have and will continue to focus primarily upon institutions with concentrated populations, such as colleges and universities with dormitories, hotels, hospitals, nursing homes and other MDUs. The Company also believes that it will be able to expand its subscriber base by offering service to commercial businesses such as office buildings. Institutional subscribers are asked to commit to long-term agreements. Some state institutions are prohibited from entering into long term agreements, but the Company believes that once it has wired the subject facility and provided private cable television service the relationship will become one of long term duration.\nCompetition\nThe Company's competition in the residential private cable business consists of numerous private cable operators located throughout the United States, none of which is deemed to be a dominant factor. The Company considers this business to be fragmented and subject to consolidation. Numerous companies, including local cable operators, across the country have begun to pursue institutional business in direct competition with the Company. In addition to this competition, any conventional cable operator as well as any other cable television programming distributor can service these institutions in direct competition with the Company. The Company believes, however, that its experience and \"know-how\" in this field and customer endorsements to potential clients will greatly assist the Company when competing for this business.\nRegulation\nThe 1996 Act changed the rules with respect to the 1992 Cable Act's uniform rate requirement and MDUs. Prior to the adoption of the 1996 Act, franchised cable operators were required to offer uniform rates within franchise areas and with respect to bulk service contracts for MDUs. Now franchised cable operators may establish different rates across franchise areas in which they are subject to effective competition and may offer bulk service contracts to MDUs without any uniform pricing requirement, except that the franchised cable operator may not engage in predatory pricing, which concept is undefined in the 1996 Act. This may result in the Company experiencing more significant price competition in its private cable business in the future.\nTRADEMARKS, COPYRIGHTS, PATENTS\nThe Company holds no copyrights or patents but has received a federal service mark registration for the name Magnavision. The Company does not believe that theses proprietary rights are material to its business.\n- 12 -\nPERSONNEL\nThe Company currently has a staff of 11 full time employees (6 in sales, installation, customer service and marketing, 3 in an administration capacity, and 2 in management) and various part time consultants, advisors and subcontractors, none of whom is a member of a union. The Company does not plan to expand its staff until it begins to generate sufficient revenue or receives funding to support expansion. The Company considers its relationship with its employees to be excellent.\nCACOMM, INC.\nCacomm, Inc., a New Jersey corporation (\"Cacomm\"), is the majority shareholder of the Registrant. As of the date of this Form 10-K, Cacomm owns approximately 80.3% of the Registrant's outstanding common stock. All of the directors of the Registrant are also directors of Cacomm. Nicholas Mastrorilli, Sr., holder of approximately 33% of the capital stock of Cacomm, is Chairman of the Board and President of the Registrant, and certain other officers and directors of Cacomm are also directors and officers of the Registrant.\nCacomm is a 25% partner in a general partnership known as The Grand MMDS Alliance (the \"Alliance\"), a designated selectee of the FCC for four MMDS channels in the New York metropolitan market. The possibility exists that the Alliance could commence business in direct competition with the Registrant. However, the Alliance has not commenced operations as of the date of this report. The Company has initiated discussions with the Alliance (the controlling persons of which are unaffiliated with the Registrant) for the purpose of exploring various alternatives relating to the MMDS channels held by the Alliance. However, such discussions have not proven fruitful in the past, and there is no assurance that such discussions will be productive in the future.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant's principal offices are located at 1725 Highway 35, The Wedgewood Building, Wall, New Jersey, where it occupies approximately 1200 square feet under a lease agreement which expires in March, 1997.\nAs part of the Channel Leasing Agreement with the Department, the Company acquired the right to use a portion of the Department's transmitting space at the Empire State Building, in Yonkers, New York and on Staten Island, New York. The Company pays no additional consideration for this space beyond the fees due to the Department under the Channel Leasing Agreement.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to certain litigation incidental to its business, which management does not believe will have a material adverse effect on its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\n- 13 -\nPART I I\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) The Registrant's Common Stock is traded in the over-the-counter market. There is no established public trading market. The range of high and low bid and ask quotations, as reported by the National Quotation Bureau Incorporated, for the Registrant's common stock through the quarter ended December 31, 1995 is as follows:\n- 14 -\n- -------- * Listed in \"Pink Sheets\" Without Prices\nNote: The information is compiled from sources believed to be accurate but the Registrant cannot guarantee its accuracy. The above quotations represent prices between dealers and do not include retail markup, markdown or commission. They do not represent actual transactions.\n(b) As of June 24, 1996, according to the Registrant's transfer agent, the approximate number of holders of record of the Registrant's common stock was 551.\n(c) The Registrant has never paid any cash dividends on its Common Stock and none are presently anticipated. Under the Company's agreements with its lenders, the Company is prohibited, without the consent of the lenders, from declaring or paying any dividends on its Common Stock until the loans made by the lenders have been repaid in full.\n- 15 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following is a summary of selected financial data. 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 OPERATIONS\nRESULTS OF OPERATIONS\nAll of the Company's current revenues are derived from its private cable operations. The wireless channel capacity operations have not commenced; therefore, no revenue has been derived from the wireless operation.\nThe Registrant and its wholly owned subsidiary began service in February 1992 to various colleges and nursing home facilities in the New York\/New Jersey area utilizing direct satellite technology. This involves the use of antennas which are installed at the facility and then separately wired on a room-by-room basis. As of May 31, 1996, the Company has long-term agreements with 16 facilities under which it is currently providing service to students and patients through approximately 5,050 outlets in rooms and common areas at such institutional facilities. The Company recently entered into contracts with an additional five institutions representing approximately 3,300 outlets and expects additional contracts to be signed in the near future. The Company intends to complete installation at the five new institutions so as to go on line in September of 1996. The majority of the facilities using the Company's private cable service are in New Jersey and New York, but the market area currently reaches from North Carolina to Massachusetts.\nMany colleges and nursing homes in the United States do not have cable television, but the current trend is for these institutions to install cable television. Management feels that this trend, coupled with the fact that the Company can offer cable services normally not provided by the traditional wired cable companies, should permit significant subscriber expansion in the future. Each installation is comprised of a number of billing outlets. A billing outlet represents a hookup for a television. The Company collects revenue from each television on-line. For the most part, the colleges are on a nine month billing cycle starting in September and ending in June of the subsequent year. The nursing homes and hospital are on a 12 month billing cycle.\n1995 vs. 1994\nThe net loss for 1995 was $844,493, compared to $531,863 for 1994. The net loss from the private cable operation was $245,111 in 1995, compared to $111,341 for 1994. The loss from the Company's wireless cable business for 1995 was $599,382, which related to expenses such as professional fees, engineering fees, salaries and channel lease expenses, compared to $420,522 for 1994.\nRevenues in 1995 increased by 29% to $666,366 from $516,053 in 1994. The increase was due to the addition of 1,561 outlets in 1995 and the inclusion of a full year's income for the outlets added in 1994.\nOperating expenses primarily consist of salaries, depreciation and amortization, and general and administrative expenses. General and administrative expenses primarily consist of salary payroll taxes, insurance, professional expenses and channel lease costs. Operating expenses increased 38% to $1,122,167 in 1995 from $810,361 in 1994. The major increases in general and\n- 17 -\nadministrative expenses included an increase in professional fees of $138,637 over 1994 and an increase of channel lease expenses of $107,656 over 1994. Salary increased $64,127 over 1994 to $383,884, primarily due to raises and increase of staff over 1994.\n1994 vs. 1993\nThe Company had a loss from operations of $492,520 in 1994, or 37% less than the loss sustained in 1993 of $777,952.\nRevenues in 1994 increased by 34% to $516,053, compared to revenues of $385,512 in 1993. The increase was substantially due to a 24% increase in private cable outlets to 2,640 at the end of 1994. The Company added 628 outlets in 1994 and 689 in 1993. In addition, 1994 reflects the collection of full year's income from the 1993 installed outlets.\nOperating expenses decreased by 15% in 1994 to $810,361 from $953,512 in 1993. However, after excluding a provision in 1993 of $407,722 for a doubtful shareholder loan, the 1994 operating expense increased by $264,571 from 1993. Officers' salaries increased by $112,414, primarily due to raises given personnel who, in management's opinion, were being paid below market. General and administrative expenses increased by $108,962, which increase was substantially due to professional fees and channel lease expenses.\nLIQUIDITY AND CAPITAL RESOURCES\nFor the year ending December 31, 1995, the total cash decreased by $7,704. The net cash used in the operating activities increased from $374,168 in 1994 to $589,685 in 1995, primarily due to increased losses in operations.\nThe cash used in investing activities increased by $1,102,539 to $1,176,683. The increase relates primarily to the investment in the channel lease of $900,277, coupled with the $281,591 increase in purchases of property and equipment.\nCash flow provided by financing activities increased $1,184,585 to $1,758,664 in 1995. Cash flow from financing activities principally came from the proceeds of senior indebtedness.\nFor the year ending December 31, 1994, the total cash increased by $125,767 and total working capital increased by $176,845. The net cash used in the operating activities increased from $236,095 in 1993 to $374,168 in 1994 primarily due to increased losses in operations after excluding the reserve for a shareholder's loan in 1993.\nThe cash used in investing activities decreased by $97,922 to $74,144 in 1994. In 1993, the Company used $141,891 to increase loans to shareholders. The Company also increased capital expenditures from $30,175 in 1993 to $78,704 in 1994. The increase was used to build out more outlets in the private cable business.\n- 18 -\nCash flow from the financing activities increased by $89,289 to $574,079 in 1994. Cash flows from financing activities principally came from the sale of the Company's stock.\nSince the inception of service in 1992, the Company has experienced operating losses and negative cash flow. In addition, at December 31, 1995 the Company had a working capital deficiency and shareholder deficit.\nThe Company's business is not as capital intensive as traditional cable companies, which should provide it with a competitive advantage. The Company's capital commitments at December 31, 1995 include additional capital to construct facilities at the Department of Education of the Archdiocese of New York and capital to expand the number of institutions the Company is currently servicing in its private cable business.\nThe Company plans to meet short term liquidity requirements with the funds available under the amended lending facility described below. On a long term basis the Company intends to create liquidity and to take advantage of the current marketplace interest in wireless spectrum that it controls by exploring various strategic alternatives relating to the Channel Lease Agreement, including potential strategic alliances, joint ventures or a sale or other disposition of the Company's rights under such agreement. Allen & Company Incorporated has been retained to assist the Company in these endeavors. Also, management believes that the continued expansion of the Company's private cable operations should produce positive cash flows in the future.\nHowever, no assurances can be given that the Company will be able to successfully accomplish the strategic alternatives relating to the Channel Lease Agreement or expand the private cable operations to produce positive cash flows.\nIn August 1995, the Company entered into a $5 million lending facility with a bank and two small business investment companies. The Company borrowed $2,637,000 under the lending facility at closing. The funds were used to pay the $900,277 escrow deposit (recorded as a prepaid lease payment) required to maintain the wireless license of the Company under its agreement with the Department and redeem 4,876,354 shares of Common Stock which were being sold by a bank in partial settlement of a loan to a non-management shareholder which was secured by the shares. (The Company issued 250,000 shares of Common Stock to the non-management shareholder in consideration of his assistance in this transaction and an additional 200,000 shares of Common Stock to other non-management shareholders who assisted in facilitating this transaction.) The balance of the proceeds were used to pay closing costs related to the debt agreement and to provide additional working capital. The remaining amounts available under the lending facility are to be advanced based on the present value of projected cash flow from contracts for new outlets, with the funds advanced to be used for the equipment and construction costs of installation of additional outlets and for working capital.\nThe debt agreement contains a prepayment penalty for two years and places limits on stock sales, payment of dividends and management compensation. The agreement also contains several covenants covering, among other items, financial reporting and target performance levels the Company must meet.\n- 19 -\nAs of December 31, 1995, the Company had not met several covenants under the agreement and as of the end of the first quarter of 1996 the Company had not made the first quarter interest payment required under the agreement. The Company amended the agreement with the lenders on June 3, 1996. As part of the amendment, the defaults were either waived or cured. The Company is to receive $1.2 million of the remaining available amount under the existing lending facility without regard to the present value of projected cash flow of new contracts, with the remaining balance of the $5 million to be advanced based on the present value formula.\nThe original agreement required the Company to issue warrants to the lenders to purchase 9,677,486 shares of Common Stock. The exercise price was $.27 for warrants to purchase 2,438,177 shares and $.38 for warrants to purchase 7,239,309 shares. The warrants expire on August 27,2003. The Company is also required to issue additional warrants to purchase 360,000 shares of its Common Stock at an exercise price of $.38 in satisfaction of certain investment banker and finders fees previously agreed to. Under the amended agreement the Company issued warrants to purchase an additional 7,410,930 shares to the lenders. The exercise price of the new warrants is $.27 and they expire on June 4, 2004. The amendment requires the lenders to surrender to the Company warrants for the purchase of up to 6,884,890 shares if, as and when the Company complies with certain conditions outlined in the agreement. The amendment has a put\/call option in the event that the Company sells a significant asset. See \"Item 13 - Certain Relationships and Related Transactions\" for further information with regard to the transactions described above.\nManagement feels that inflation and changing prices will have a minimal effect on operations. The above should be read in conjunction with the Company's financial statements included elsewhere herein.\n- 20 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nSee pages 35 and through.\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nEffective as of January 1, 1996, at the request of, and pursuant to agreements entered into by the Company with its lenders, the Company appointed new independent accountants, KPMG Peat Marwick, LLP, to audit the Company's financial statements commencing with the fiscal year ending December 31, 1995, replacing Lawson, Rescinio, Schibell & Associates, P.C. The Company's Board of Directors recommended and approved such decision. The Company's former accountants' report on the Company's financial statements for the past two years did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles.\nDuring the Company's two most recent fiscal years there were no disagreements with Lawson, Rescinio, Schibell & Associates, P.C. on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. However, following the appointment of KPMG Peat Marwick, LLP, both accounting firms consulted with each other and agreed that amounts carried on the Company's balance sheet as organization costs should have been written off over a five year period commencing in 1991 and a portion of amounts carried on the Company's balance sheet as capitalized construction costs should have been written off in 1992 and the balance reclassified to property and equipment. Such changes were reflected in the Form 10-K\/A for the year ending December 31, 1995 filed on February 8, 1996 with the Securities and Exchange Commission (the \"SEC\") and the report of Lawson, Rescinio, Schibell & Associates, P.C. is contained therein.\nThe Company has provided its former accountant with a copy of the disclosures contained in this item, and has requested such firm to furnish it with a letter addressed to the SEC stating whether it agrees with the statements made by the Company. Such letter is included as Exhibit 16 to this Form 10-K.\n- 21 -\nPART I I I\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information with respect to the directors and officers of the Registrant. These individuals serve in the same capacities with Magnavision - N.J.\nThe above directors and officers will hold office until the next annual meeting of shareholders or until their successors are duly elected and qualified. Nicholas Mastrorilli, Jr., Patrick Mastrorilli and Brian Mastrorilli are brothers. Their father, Nicholas Mastrorilli, Sr. is a Director, Chairman and President of the Registrant. Arnold Dauer, an advisor to the Registrant (see below) performs services that would otherwise be performed by a senior officer of the Registrant.\nNicholas Mastrorilli, Sr., Chairman of the Board and President of the Registrant from the Company's inception in June 1989 to the present; Chairman and President of Cacomm, Inc., a company in the business of producing television programming and video commercials since April 1991 and Executive Vice President from 1981 to 1991. Mr. Mastrorilli as Executive Vice President of Cacomm, Inc. from 1981 to 1989 directed all of such company's video production and distribution business as well as its research and development activities in wireless communications. As a result, Mr. Mastrorilli has extensive experience in cable network broadcasting and information and communication systems. During his tenure at Cacomm, Inc. Mr. Mastrorilli introduced many original concepts to cable systems including, in 1981, television home shopping, \"The Franchise Show\", a concept created to introduce franchises and business opportunities to the general public transmitted via satellite nationwide on the Financial News Network, \"Racing From Monmouth Park\", a first time thoroughbred racing show, and \"Nightlife\" a show produced\n- 22 -\non location at various casinos in Atlantic City, which won the Cape Award from the Cable Television Network Awards Committee for programming excellence.\nMr. Mastrorilli, while Executive Vice President of Cacomm, Inc., one of the first cable programming production companies, was one of the original creators of advertiser supported programming for the cable industry in New Jersey. Mr. Mastrorilli also established the first regional cable television advertising interconnect in New Jersey in 1981. Infomercials, as they are called today, are believed to be a creation of Mr. Mastrorilli who, in 1981, called them 30 minute sellathons.\nMr. Mastrorilli was also responsible for the successful acquisition of wireless cable channel capacity for the Registrant from the New York Catholic Archdiocese. This cooperative business opportunity established the Registrant as the first company to ever sign an agreement with the New York Catholic Archdiocese for multiple-channel leasing. Mr. Mastrorilli is listed in the Who's Who Registry, Worldwide Platinum Edition.\nNicholas Mastrorilli, Jr., Vice President of administration since April of 1991. Mr. Mastrorilli, Jr. has also served as Vice President of Cacomm, Inc. from April 1991 to the present. He also served as director of administration of Cacomm, Inc. from January 1986 to April of 1991. He is responsible for the administrative functions of the Registrant. Until December 31, 1995 Mr. Mastrorilli, Jr. was the Registrant's Chief Financial Officer. Mr. Mastrorilli, Jr., now oversees all day-to-day functions of an administrative nature and assists the Registrant's new Chief Financial Officer with various financial matters, including accounts receivable, accounts payable, payroll, and working capital accounts. In addition, Mr. Mastrorilli, Jr. is responsible for all project construction financial analysis including spreadsheet projection preparation and profitability recommendations. Mr. Mastrorilli, Jr. prepares all reports covering all the above areas of responsibility. He has installed a computerized accounting system for the Company to more efficiently control the marketing and sales of local and national programming ventures. He has eight years of experience in the wireless cable industry serving as Director of Administration of Cacomm, Inc. Cacomm is also an equal partner in the Grand Alliance, a wireless cable television company. Mr. Mastrorilli, Jr. is currently serving as Vice President of Administration for Magnavision Corporation and has been directly involved with the business since its inception.\nPatrick F. Mastrorilli, Vice President of Marketing since April 1991. He also served as Vice President of Cacomm, Inc. from April 1991 to the present. He also served as Director of Sales and Marketing of Cacomm, Inc. from January 1986 to April of 1991. He is responsible for all sales and marketing functions. He institutes and implements advertising campaigns designed to attract additional subscribers to Magnavision's services, as well as overseeing all right-of-entry negotiations with building owners, management companies, colleges, and nursing homes. Mr. Mastrorilli has eight years of experience in the wireless cable field serving as Director of Sales and Marketing of Cacomm, Inc. Mr. Mastrorilli, currently serving as Magnavision's Vice President of Marketing, has worked for the Company since its inception. He has successfully negotiated and signed agreements totaling over six million dollars on behalf of the Company. Non-profit volunteer work is also of interest to Mr. Patrick Mastrorilli who has organized and promoted fund-raising events for Muscular Dystrophy, the Arthritis Foundation, the Foodbank of New Jersey, and the American Cancer Society, just to name a few.\n- 23 -\nKeith M. Heilos, Vice President, Customer Relations at Magnavision since April 1991. Prior to 1991, Mr. Heilos served as Director of Video Production for Cacomm, Inc. from July of 1987 to April 1991. He has co-produced and co-directed a number of productions for Cacomm, Inc. including \"The Franchise Show\", aired on \"Financial News Network\" nationwide, directed and co-produced \"The United States Shopping Network\", a nationwide home shopping network, and has been directly involved in numerous other video productions. Mr. Heilos is directly responsible for customer relations and is the liaison between Magnavision and its client base. Mr. Heilos has served actively in numerous community affairs. He has been a member of the local volunteer fire company for the past ten years, presently serving as Chief. He devotes additional free time to such fund raisers as the New Jersey Burn Center and drug and alcohol awareness programs.\nBrian J. Mastrorilli, Vice President, Technical Operations since April 1991. Prior to 1991, Mr. Mastrorilli served as Director of Technical Operations for Cacomm, Inc. from May of 1988 to April 1991 and Vice President of Cacomm, Inc. from April 1991 to the present. He previously served as Technical Director for Video and Audio operations for Cacomm, Inc. His accomplishments have included the design and construction of a complete three camera studio facility with editing suites. Mr. Mastrorilli is presently responsible for all the Company's technical projects. He has co-produced and co-directed \"The Franchise Show\" aired on the \"Financial News Network\" nationwide via satellite and the \"United States Shopping Network\" a shop-at-home satellite delivered home shopping network. Mr. Mastrorilli is currently the Company's system designer and construction coordinator. He is responsible for all job site equipment requisitions. Mr. Mastrorilli is also responsible for the design and construction of all the Company's TVRO earth stations and distribution systems. He has designed CATV systems supplying over 16,200 students in New Jersey, New York and Pennsylvania. These include Seton Hall University, Fairleigh Dickinson University, Manhattanville College, State University of New York, Wagner College, Immaculata College, Georgian Court College, Montclair State University, Fordham University, Greenhill Memorial Center for Woman and Sarah Frances Nursing Home. Mr. Mastrorilli is also responsible for all of the company's \"point to point\" 18 GHz microwave paths. This includes all FCC licensing, design, purchase and construction.\nJeffrey Haertlein, age 47, was elected as the Company's Chief Financial Officer effective as of January 1, 1996 with responsibility for all of the Registrant's financial matters. Mr. Haertlein was previously Assistant Vice President of Midlantic Corporation from 1978 to 1995 with responsibility for day-to-day financial functions including internal reporting, special projects and financial planning for such bank holding company and its various subsidiaries. Prior thereto and from 1977 to 1978 Mr. Haertlein was employed by Chase Manhattan Bank in the capacity of Internal Auditor. Mr. Haertlein received a B.A. degree from Monmouth College in accounting\/marketing and is currently attending such institution in pursuit of a Masters in Business Administration.\nADVISORS\nArnold Dauer, age 59, is an advisor to the President of Magnavision regarding all aspects of the Registrant's business and has performed such function from June 1989 to the present, and has provided general business consulting services to Cacomm, Inc. (the major shareholder of Magnavision Corporation) from 1985 to the present. Mr. Dauer was\n- 24 -\ncreator and founder of various businesses including Allaire State Bank, where he also served on the Board of Directors from 1971 until the bank merged into The National Community Bank in December of 1982. Mr. Dauer served as Vice President in charge of operations and was co-founder of \"Cathy Arnold\", a small chain of retail apparel stores, and also served as Vice President of Reid Manufacturing, Inc., a manufacturer of apparel, from 1959 until the businesses were sold in 1980. Mr. Dauer was President and founder of Professional Auto Leasing (\"PAL\"), one of the largest auto and equipment leasing companies operating in the tri-state area from 1976 to 1989. During the recession in the late 1980's, a large number of auto leasing defaults occurred, resulting in various corporate loans being called by the financial institution which financed PAL. Mr. Dauer, having personally guaranteed such loans, was forced to file for relief with the U.S. Federal Bankruptcy Court. Mr. Dauer, active in local community affairs, has served as President for both the Jaycees and Kiwanis.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSet forth below is the aggregate remuneration paid or accrued by the Registrant during the years ended December 31, 1995, 1994 and 1993 to the Company's Chief Executive Officer. No other executive officer of the Company received salary and bonus aggregating in excess of $100,000 in any of those years.\nAt present, none of the current officers have employment agreements with the Registrant.\nSUMMARY COMPENSATION TABLE\n- 25 -\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 contains information as of June 24, 1996 as to the beneficial ownership of shares of Common Stock of the Registrant of each person who, to the knowledge of the Registrant at that date, was the beneficial owner of 5% or more of its outstanding shares.\nName and Address Amount and Nature of Beneficial Owner of Beneficial Ownership % of Class - ------------------- ------------------------ ---------- Cacomm, Inc. 18,417,782 (1) 80.3% 1725 Route 35 Wall, NJ 07719\nKOCO Capital Company 6,835,364 (2) 23.0.% 111 Radio Circle Mt. Kisco, NY 10549\nIBJ Schroder Bank & 10,253,046 (3) 30.9% Trust Company One State Street New York, NY 10004\n(1) Includes 300,000 shares which are subject to purchase by third parties pursuant to options granted by Cacomm, Inc. on such shares.\n(2) Constitutes shares subject to currently exercisable warrants issued to KOCO Capital Company.\n(3) Constitutes the aggregate number of shares subject to currently exercisable warrants issued to IBJ Schroder Bank & Trust Company (6,835,364) and its affiliate, IBJS Capital Corporation (3,417,682).\n(b) Security Ownership of Management:\nSet forth below is certain information, as of June 24, 1996, concerning the number and percentage of shares of Common Stock of the Registrant owned of record and beneficially by each officer and director of the Registrant (including Nicholas Mastrorilli, Sr., the Company's Chairman of the Board and President) and by all officers and directors as a group.\n- 26 -\nName of Amount and Nature of Beneficial Owner Beneficial Ownership % of Class - ---------------- -------------------- ----------- Nicholas Mastrorilli, Sr. 1,055,535 (1) 4.4%\nNicholas Mastrorilli, Jr. 296,344 (2) 1.3%\nPatrick Mastrorilli 331,220 (3) 1.4%\nAll Officers and Directors as a Group (5 persons) 2,320,539 (4) 9.7%\n- ---------- (1) Includes 994,075 shares subject to currently exercisable warrants and options held by Mr. Mastrorilli, Sr., but does not include 18,417,782 shares held by Cacomm, Inc., of which Mr. Mastrorilli, Sr. owns approximately 33% of the outstanding shares (and, with members of his family, has the right to acquire an additional 19% on a fully diluted basis) and is the president and a director. Nicholas Mastrorilli, Jr. and Patrick Mastrorilli are also directors and own an insignificant amount of Cacomm, Inc. stock. Mr. Mastrorilli, Sr. disclaims any beneficial ownership of the shares of the Company owned by Cacomm, Inc.\n(2) Constitutes shares subject to currently exercisable warrants and options held by Mr. Mastrorilli, Jr.\n(3) Includes 327,799 shares subject to currently exercisable warrants and options held by Mr. Mastrorilli.\n(4) Includes 2,182,174 shares subject to currently exercisable warrants and options held by all officers and directors.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs described in Part I of this Form 10-K, in August 1995, the Company obtained a $5,000,000 lending facility from IBJ Schroder Bank & Trust Co., IBJS Capital Corporation and KOCO Capital Company, L.P. (the \"Lenders\"). Approximately $2,637,000 of that amount was furnished to the Company at the time the facility was entered into, and the remainder is to be advanced based on the present value of the projected cash flow from new contracts with purchasers of the Company's private cable television service, with the funds advanced to be used for equipment and construction costs incurred in connection with installation of the new outlets and for working capital. In connection therewith the Company executed 12% interest-only promissory notes, the principal of which is due on February 26, 2001. The proceeds furnished at the time the lending facility was entered into were utilized to fund an escrow deposit for system configuration required under the Channel Lease Agreement, to repurchase approximately 18% of the Company's issued and outstanding capital stock (see discussion below) and to provide working capital. In connection with obtaining the lending facility, the Company issued to the Lenders warrants expiring on August 27, 2003 to purchase approximately 27% of the Company's Common Stock on a fully diluted basis at exercise prices of $.38 and $.27 per share. Under the terms of the\n- 27 -\nlending facility, the Lenders also have the right to designate two of the Company's five directors and the Company has agreed to various covenants. In connection therewith the Company is also required to issue additional warrants to purchase 360,000 shares of its Common Stock at an exercise price of $.38 in satisfaction of certain investment banking and finder fees. The obligations of the Company under the lending facility are secured by the Channel Lease Agreement and the Company's private cable service contracts.\nOn June 3, 1996 the Company and its Lenders amended the terms of the lending facility. Pursuant thereto, the Lenders agreed to waive existing defaults and provide up to $1,200,000 of the remaining amount available under the lending facility toward the Company's working capital requirements (of which approximately $470,000 was advanced to the Company on June 4, 1996) without regard to the present value formula referred to above. In exchange therefor, the Company agreed to issue warrants (\"New Warrants\") to purchase additional shares of Common Stock, representing approximately 12% of the Company's Common Stock on a fully diluted basis, at an exercise price of $.27 per share. The New Warrants expire on June 4, 2004. The amended agreements require the Lenders to surrender to the Company warrants representing the right to purchase 6,884,890 shares if, as and when the Company complies with certain conditions outlined in the amended agreements. In addition, the Lenders each have the right to require the Company to repurchase certain, and the Company has the right to repurchase all, of the warrants held by the Lenders under certain conditions. The Lenders also have the option, under certain circumstances, to designate three out of the five directors of a subsidiary which owns the Company's rights under the Channel Lease Agreement and under such circumstances, will receive a proxy to vote the shares thereof.\nThe description of the terms and conditions of the agreements with the Lenders is qualified in its entirety by reference to the entire agreements, copies of which have been filed as exhibits to this Form 10-K.\nAs indicated above, a portion (i.e., $760,000) of the proceeds advanced by the Lenders to the Company in August 1995 was used to redeem shares of Common Stock registered to George S. Callas, a non-management shareholder, which shares represented approximately 18% of the Company's issued and outstanding Common Stock at the time of the redemption. The redemption of the shares was required pursuant to the Company's agreements with the Lenders. The shares had been pledged by Mr. Callas to a bank to secure a loan made to him, and were being sold by the bank in partial settlement of the loan. The redemption by the Company was made pursuant to a right of first refusal which Mr. Callas had been granted by the bank, and which right had been assigned by Mr. Callas to the Company. The $760,000 paid to redeem the shares matched an offer received by the bank from an unaffiliated third party. The Company issued 250,000 shares of Common Stock to Mr. Callas in consideration of his assistance in this transaction and an additional 200,000 shares of Common Stock to other non-management shareholders who assisted in facilitating this transaction and obtaining the lending facility from the Lenders.\nThe Company had previously loaned $407,722 to Mr. Callas in years prior to 1994. No portion of that loan has been repaid and the Company wrote off the loan receivable as of December 31, 1993 after learning that Mr. Callas had filed for bankruptcy protection in 1994.\n- 28 -\nPART I V\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements. The following financial statements are included in Part II, Item 8:\n(a) (2) Schedules. All schedules are omitted since the required information is either not applicable or not present in amounts sufficient to require submission of the schedule.\n(a) (3) Exhibits Page or Document Item Incorporated No. Description of Document by Reference - ---- ------------------------- -------------- (2) Merger Agreement dated September 13, Form 8-K 1991 between Yardley Ventures, Inc. dated 9\/17\/91 and Magnavision Corporation\n(3) (a) Articles of Incorporation and By Laws Form S-1 dated 12\/29\/86\n(3) (b) Amendment to Certificate of Incorporation Form 8-K dated 9\/17\/91\n(10) (a) License Agreement dated August 20, 1990 Form 10-K between Magnavision Corporation and dated 12\/31\/91 Department of Education, Archdiocese of New York\n- 29 -\n(b) Amended License Agreement dated January Form 10-K 6, 1994 between Magnavision Corporation dated 12\/31\/93 and Department of Education, Archdiocese of New York\n(c) Microcell Systems Corporation Agreement Form 10-K dated December 15, 1993 dated 12\/31\/93\n(d) Securities Purchase Agreement dated as of August 25, 1995 among the Registrant, Magnavision Corporation (N.J.), IBJS Capital Corporation, IBJ Schroder Bank & Trust Company and Koco Capital Company, L.P.\n(e) Form of Senior Subordinated Note of the Registrant and Magnavision Corporation (N.J.) due February 26, 2001\n(f) Form of Warrant to Purchase Shares of Registrant's Common Stock expiring on August 27, 2003\n(g) Security Agreement and Collateral Assignment dated as of August 25, 1995 among Magnavision Corporation (N.J.), University Connection, Inc. and IBJS Capital Corporation as agent\n(h) Registration Rights Agreement dated as of August 25, 1995 among the Registrant and the investors listed therein\n(i) Stockholders' Agreement dated as of August 25, 1995 among the Registrant, the investors and the other parties listed therein\n(j) Non-Competition Agreement dated as of August 25, 1995 between Magnavision Corporation (N.J.) and Nicholas Mastrorilli, Sr.\n(k) Indemnification Agreement dated as of August 25, 1995 between the Registrant, Cacomm, Inc., and the investors listed therein\n(l) Lockbox Service Agreement dated as of August 25, 1995 among Magnavision Corporation (N.J.), University Connection, Inc., IBJS Capital Corporation and IBJ Schroder Bank & Trust Company\n(m) Amendment No. 1 dated as of June 3, 1996 to Securities Purchase Agreement dated as of August\n- 30 -\n25, 1995 among the Registrant, Magnavision Corporation (N.J.), Magnavision Wireless Cable, Inc., IBJS Capital Corporation, IBJ Schroder Bank & Trust Company and Koco Capital Company, L.P.\n(n) Amended and Restated Stockholders' Agreement dated as of June 3, 1996 among the Registrant, Magnavision Corporation (N.J), Magnavision Wireless Cable, Inc. and the investors and other parties listed therein\n(o) Amendment No. 1 dated as of June 3, 1996 to the Registration Rights Agreement dated as of August 25, 1995 among the Registrant and the investors listed therein\n(p) Amendment No. 1 dated as of June 3, 1996 to the Security Agreement and Collateral Assignment dated as of August 25, 1995 among Magnavision Corporation (N.J.) Magnavision Wireless Cable, Inc., Magnavision Private Cable, Inc., University Connection, Inc. and IBJS Capital Corporation, as agent\n(q) Amended and Restated Lockbox Service Agreement dated as of June 3, 1996 among Magnavision Corporation (N.J.), University Connection, Inc., Magnavision Private Cable, Inc., IBJS Capital Corporation and IBJ Schroder Bank & Trust Company\n(r) Pledge Agreement dated as of June 3, 1996 between Magnavision Corporation (N.J.) and IBJS Capital Corporation as agent\n(s) Pledge Agreement dated as of June 3, 1996 between Magnavision Corporation (N.J.) and IBJS Capital Corporation as agent\n(t) General Indenture of Conveyance, Assignment and Transfer dated as of June 3, 1996 from Magnavision Corporation (N.J.) and University Connection, Inc. to Magnavision Private Cable, Inc.\n(u) General Indenture of Conveyance, Assignment and Transfer dated as of June 3, 1996 from Magnavision Corporation (N.J.) to Magnavision Wireless Cable, Inc.\n(v) Indenture of Assumption of Liabilities dated as of June 3, 1996 from Magnavision Private Cable, Inc. to Magnavision Corporation (N.J.) and University Connection, Inc.\n- 31 -\n(w) Indenture of Assumption of Liabilities dated as of June 3, 1996 from Magnavision Wireless Cable, Inc. to Magnavision Corporation (N.J.)\n(x) Irrevocable Proxy dated June 3, 1996 issued by Magnavision Corporation (N.J.) to IBJS Capital Corporation as agent\n(y) Form of Amended and Restated Senior Subordinated Notes dated June 3, 1996\n(z) Form of Warrant to Purchase Shares of Registrant's Common Stock expiring on June 4, 2004\n(aa) Letter Agreement dated July 11, 1995 between the Registrant, Cacomm, Inc. and George S. Callas\n(bb) Letter Agreement dated August 25, 1995 among the Registrant, Midlantic Bank, N.A. and George S. Callas\n(cc) Form of Five Year Warrant to Purchase Shares of Registrant's Common Stock issued to various parties during 1994 and 1995\n(dd) Form of Indemnification Agreement for Executive Officers and Directors\n(16) Letter re: change in certifying accountant\n(21) Subsidiaries of Registrant\n(27) Financial Data Schedule\n(b) Form 8-K\nNone\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 the Company's behalf by the undersigned, thereunto duly authorized.\nMAGNAVISION CORPORATION\nDATE: July 19, 1996 By: \/s\/ Nicholas Mastrorilli, Sr. ----------------------------- NICHOLAS MASTRORILLI, SR. Principal Executive Officer\nBy: \/s\/ Jeffrey Haertlein ----------------------------- JEFFREY HAERTLEIN Principal Financial and Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n- 33 -\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 hereof, the Registrant has never sent any annual report or proxy material to its security holders. If and when such annual report or proxy material is furnished to its stockholders, the Registrant shall furnish to the Commission for its information copies of such material. Such material, when furnished, shall not be deemed to be \"filed\" with the Commission or otherwise subject to liabilities of Section 18 of the Act (except to the extent that the Registrant specifically incorporates such material by reference in its Form 10-K).\n- 34 -\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nPage ---- Independent Auditors' Reports\nConsolidated Balance Sheets\nConsolidated Statements of Operations\nConsolidated Statements of Shareholders' Equity\nConsolidated Statements of Cash Flows\nNotes to Consolidated Financial Statements\n- 35 -\nIndependent Auditors' Report\nTo the Board of Directors and Shareholders of: Magnavision Corporation and Subsidiaries\nWe have audited the accompanying consolidated balance sheet of Magnavision Corporation and Subsidiaries 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 are the responsibility of the Company's management. Our responsibility is to express and opinion on these financial statements based on our audit.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Magnavision Corporation and 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.\nKPMG Peat Marwick LLP\nNew York, New York June 3, 1996\nIndependent Auditors' Report\nTo the Board of Directors and Stockholders of: Magnavision Corporation and Subsidiaries Wall, New Jersey\nWe have audited the accompanying consolidated balance sheet of Magnavision Corporation and Subsidiaries as of December 31, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the two-year period ended December 31, 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Magnavision Corporation and Subsidiaries as of December 31, 1994, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\nLawson, Rescinio, Schibell & Assoc., P.C.\nOakhurst, New Jersey January 30, 1995\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nConsolidated Balance Sheets\nAs of December 31, 1995 and 1994\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nConsolidated Statement of Operations\nFor the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity\nFor the Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nFor the Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(1) Operations and Summary of Significant Accounting Policies\n(a) Consolidated Financial Statements\nThe accompanying financial statements present the consolidated accounts of Magnavision Corporation, a Delaware corporation (formerly Yardley Ventures, Inc.), and its wholly owned subsidiary Magnavision Corporation, a New Jersey corporation, and its wholly owned subsidiaries, University Connection, Inc., a New Jersey corporation, Accu-Trek, Inc., a New Jersey corporation, Magnavision Laboratories, Inc., a Delaware Corporation and Magnavision Private Cable, Inc., a Delaware Corporation (\"the Company\"). The consolidated financial statements include all of the assets, liabilities, income, expenses and cash flows for these companies. All significant intercompany transactions and balances have been eliminated.\n(b) Organization, Operations and Liquidity\nMagnavision Corporation (formerly Yardley Ventures, Inc.) was incorporated in Delaware on April 3, 1986, to seek to acquire one or more potential businesses. Magnavision Corporation and its subsidiaries were established to conduct the business of providing wireless and private cable television, which is now the business purpose of the Company, to segments where cable television is not available and as an alternative to cable television. Magnavision Corporation of New Jersey was formed on June 15, 1989, pursuant to the laws of the State of New Jersey.\nSince the inception of service in 1992, the Company has experienced operating losses and negative cash flow. In addition, at December 31, 1995, the Company has a working capital deficiency and shareholders deficit.\nThe Company plans to meet short-term liquidity requirements with the funds available under the amended lending facility described in notes 9 and 13. On a long-term basis, the Company intends to create liquidity and to take advantage of the current marketplace interest in the wireless spectrum that it controls by exploring various strategic alternatives relating to the Channel Lease Agreement (see note 7), including potential strategic alliances, joint ventures or a sale or other disposition of the Company's rights under such agreement. Allen & Company, Incorporated has been retained to assist the Company in these endeavors. Also, management believes the continued expansion of the Company's private cable operations should produce positive cash flows in the future.\nHowever, no assurances can be given that the Company will be able to successfully accomplish the strategic alternatives relating to the Channel Lease Agreement or expand the private cable operations to produce positive cash flows.\n(c) Cash and Cash Equivalents\nFor purposes of the statement of cash flows, the Company considers cash in banks and certificates of deposit maturing within three months of date of purchase as cash and cash equivalents.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(1), Continued\n(d) Property and Equipment\nProperty and equipment are stated at cost. Depreciation, for financial reporting purposes, is provided for on the straight-line method over the estimated useful lives of the related assets, which are:\nOffice Equipment 5 years Furniture and Fixtures 10 years Transportation Equipment 5 years Machinery and Equipment 5 years Leasehold Improvements 7 years\nThe Company uses accelerated methods and lives, as allowed by the Internal Revenue Code, to calculate depreciation for income tax purposes.\n(e) Deferred Revenues\nThe Company records subscriptions received in advance of the service being provided as a current liability.\n(f) Income Taxes\nDeferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.\nDeferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n(g) Use of Estimates\nManagement of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and revenue and expenses 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 these estimates.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(1), Continued\n(h) Fair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (Statement 107), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In many cases, fair value estimates cannot be substantiated by comparison to independent market information and could not be realized in immediate settlement of the instrument. Statement 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.\nIn managements opinion, cash and cash equivalents, trade accounts and other receivables, shareholder loans receivable, deposits, accounts payable and accrued expenses, due to shareholders, long-term debt and notes payable equal or approximate fair value.\n(i) Prepaid Lease Expense\nPrepaid lease expense represents the Company's deposit relating to the Channel Lease Agreement (see note 7). The amount is being amortized over the term of the lease agreement.\n(j) Deferred Financing Costs\nDeferred financing costs represent expenditures relating to the Senior Debt financing (see note 9). Such costs are being amortized over the term of the Senior Debt borrowings.\n(k) Earnings Per Share of Common Stock\nPrimary earnings per share are computed by dividing net income (loss) by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares include shares issuable upon the assumed exercise of stock options and warrants using the treasury stock method when dilutive.\n(2) Related Party Transactions\nThe following, transactions occurred between the Company and related parties:\na. Shareholder loans receivable of $43,861 and $49,046 at December 31, 1995 and 1994, respectively are payable on demand and are interest free.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(2), Continued\nb. Various operating expenses, such as rent, office expenses and telephone, amounting to $800, $1,500, and $8,578 during 1995, 1994, and 1993, respectively were charged to the Company by Cacomm, Inc., the Company's majority shareholder. At December 31, 1995 and 1994, current liabilities include $144,889 and $ 178,925, respectively, payable to this shareholder in connection with these expenses and expenses from prior years.\nc. Beginning June 24, 1992, a shareholder advanced loans to the Company in the aggregate amount of $45,036, which were to be repaid at the Company's earliest convenience. In August 1995, the shareholder forgave the outstanding loan balance of $20,036 and additional accrued expenses owed to him resulting in income from forgiveness of debt of $77,053.\nd. Cacomm, Inc., the Company's majority shareholder, is a 25% partner in a general partnership known as the Grand MMDS Alliance. The Grand MMDS Alliance holds rights to certain MMDS channels, as a designated selectee of the FCC. These channels cover similar broadcast areas as Magnavision, and the possibility exists that The Grand MMDS Alliance could commence business in direct competition with Magnavision, but has not commenced business operations as of the date of this report. Certain officers and directors of Magnavision are also officers and directors of Cacomm, Inc.\n(3) Property And Equipment\nProperty and equipment at December 31, 1995 and 1994 are summarized by major classification as follows:\n1995 1994 ---- ----\nOffice Furniture and Equipment $ 49,246 47,746 Transportation Equipment 51,559 29,180 Machinery and Equipment 665,974 408,262 -------- -------- 766,779 485,188 Less: Accumulated Depreciation (333,870) (214,566) -------- --------\n$ 432,909 270,622 ========= =======\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(3), Continued\nMachinery and equipment relates principally to assets owned by the Company located at the various college and nursing home sites serviced by the Company.\n(4) Income Taxes\nIncome tax expense attributable to income (loss) from operations consists of:\nCurrent -------\nYear ended December 31, 1995: Federal - State 1,452 ------\n1,452 ------\nYear ended December 31, 1994: Federal - State 7,632 ------ 7,632 ------\nYear ended December 31, 1993: Federal 335 ------\n$ 335 ======\nIncome tax expense attributable to net loss before provision for income taxes was $1,452, $7,632 and $335 for the years ended December 31, 1995, 1994 and 1993 and differed from the amounts computed by applying the U.S. Federal income tax rate of 34 percent to pretax income from operations as a result of the following:\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(4), Continued\nThe temporary differences and carryforwards which give rise to significant portions of the deferred tax assets and liabilities at December 31, 1995 and 1994 are presented below:\nAt December 31, 1995, the Company has net loss carryforwards for federal income tax purposes of $4,000,00 which are available to offset future taxable income. These carryforwards expire in varying amounts through 2010. The net change in the total valuation allowance for 1995, 1994 and 1993 was an increase of $334,062, $204,495 and $314,318, respectively.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(5) Long-Term Debt\nLong-term debt at December 31, 1995 and 1994, consisted of the following:\nAt December 31, 1995 maturities of long-term debt are as follows:\nFor the Year Ending Amount ------------------- ------\n1996 $ 3,910 1997 3,686 1998 4,163 1999 4,703 2000 1,692 ---------- Thereafter $ 18,154 ==========\n(6) Operating Leases\nThe Company leases office space and automobiles for use in its operations for terms of 1 to 3 years. Minimum lease payments over the remaining lease terms are as follows:\nFor the Year Ending Amount ------------------- ---------- 1996 $ 31,303 1997 23,343 1998 10,328 ---------- $ 64,974 ==========\nExpenses under operating leases amounted to $24,468,$32,333 and $30,770 for the years ended December 31, 1995, 1994 and 1993, respectively.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(7) Channel Lease Agreement\nOn August 20, 1990, the Company entered into an agreement with the Department of Education, Archdiocese of New York (\"the Archdiocese\") which would permit the Company to use the Transmission Capacity of the Archdiocese. The agreement, which was amended in January 1994, grants the Company a lease through January 2004 with a right to extend for an additional five years and a right of first refusal for subsequent renewals. Pursuant to the agreement, the Company must also pay to the Archdiocese a royalty fee for the use of the Transmission Capacity, in accordance with the terms and amounts described in the amended agreement. In connection with the amended agreement the Company had a contingent obligation to fund the reconstruction of the Archdiocese's system. In 1995, the Company deposited $900,277 in an escrow account for the purpose of system reconstruction upgrades. The Company recorded the deposit as prepaid lease expense, and is amortizing the amount over the life of the agreement through January 2004.\nAt December 31, 1995, the minimum royalty payments over the remaining license term are as follows:\nFor the Year Ending Amount ------------------- ------ 1996 $ 123,000 1997 144,000 1998 144,000 1999 144,000 2000 144,000 Thereafter 444,000 ---------- $1,143,000 ========== (8) Obligations Under Capital Leases\nThe Company leases certain equipment with lease terms through June, 1996. The obligations under capital leases have been recorded in the accompanying financial statements at the present value of the future minimum lease payments, discounted at interest rates from 24.50% to 27.25%. At December 31, 1995, the assets held under the capital leases are included in property and equipment costs as follows:\n1995 1994 ---- ----\nOffice Equipment $ 24,412 24,412 Machinery and Equipment 132,914 132,914 ---------- -------- Total assets, at cost 157,326 157,326\nLess Accumulated Depreciation (104,025) (75,000) --------- ------- $ 53,301 82,326 ========= ========\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(8) Continued\nFuture minimum lease payments under the capital leases and the net present value of the future minimum lease payments at December 31, 1995 are as follows:\nFuture minimum lease payments $ 25,586 Less: Amount Representing Interest 2,175 -------- Present Value of Future Minimum Lease Payments-Current $ 23,411 ========\n(9) Notes Payable - Senior Debt\nIn August 1995, the Company entered into a Securities Purchase Agreement (the \"Agreement\") with a bank and two small business investment companies. The agreement provides for a lending facility of $5,000,000, with interest at 12% payable quarterly on any outstanding balance. Payment of amounts outstanding under the lending facility is due at the final maturity date, February 2001. The amount outstanding at December 31, 1995 of $2,637,219 was advanced at closing and was used to fund a deposit required by the Channel Lease Agreement (see note 7), repurchase common stock (see note 12), pay closing costs relating to the financing and provide additional working capital to the Company. The unused portion of the lending facility will be advanced to fund the equipment and construction costs attributable to new institutional cable contracts, and will also be used to fund working capital needs of the Company.\nThe Agreement is secured by the Channel Lease Agreement and the Company's institutional cable contracts.\nThe Agreement contains a prepayment penalty for the first two years and places limits on stock sales and payment of dividends, and also contains several financial covenants. As of December 31, 1995, the Company had not met several of the financial covenants under the Agreement. The Company amended its agreement with the lenders on June 3, 1996 (See note 13), and as part of the amendment, the defaults were either waived or cured.\nAs part of the Agreement, the Company sold warrants for $ 1,000 to the note holders to purchase 9,677,486 of its common shares. The exercise price of the warrants is $.27 a share and $.38 a share for 2,438,177 and 7,239,309 shares, respectively. The warrants expire on August 27, 2003 and represented 27% of the Company's common stock on a fully diluted basis.\nRelated to the Agreement, the Company also agreed to issue 200,000 common shares in aggregate to two individuals at par value for services provided in obtaining the above financing. At December 31, 1995, the 200,000 shares were not issued. Due to the restrictions placed on such shares, their value is immaterial to the accompanying consolidated financial statements.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(10) Pending Litigation\nThe Company is a party to certain litigation incidental to its business, which the Company's counsel and its management does not believe will have a material adverse effect on its financial condition or results of operations. No material litigation is threatened to management's knowledge. The Company's current liabilities include accruals for management's estimate of amounts that will be payable under the above litigation.\n(11) Sales To Major Customers\nFor the year ending December 31, 1995 and 1994, revenue from three and two customers, respectively, represented 62% and 54%, respectively, of total revenues.\n(12) Stockholders Equity\nIn August 1995, the Company repurchased 4,626,354 common shares, net, from a bank for $760,000. The shares purchased were net of 250,000 shares granted to the original owner of the shares for his assistance in the transaction.\nDuring 1995, the Company issued 283,000 and 182,500 shares of common stock at a price of $.25 and $1.00 per share, respectively, for total proceeds of $253,250.\nIn December 1995, the Company issued 60,000 shares with a negotiated value of $1.00 per share to a vendor in lieu of a cash payment. In addition, 27,066 warrants were exercised at $.25 per share effective December 18, 1995 by various officers of the Company.\nAt December 31, 1995, the Company has unexercised options outstanding, held by certain former consultants, to purchase 47,000 of its common shares. The options contain exercise prices from $.004 a share to $.10 a share and expire at various dates through July 1997.\nDuring 1995, the Company granted 9,997,486 warrants for shares of its common stock at exercise prices ranging from $.25 to $1.00 per share. At December 31, 1995, the Company has unexercised warrants outstanding to purchase 12,813,486 shares of its common stock, which expire at various dates through May 25, 2005.\nPursuant to the original Securities Purchase Agreement with its Senior Lenders, the Company was required to issue additional warrants to purchase 360,000 shares of its common stock at an exercise price of $.38 in satisfaction of certain investment banker and finders fees previously agreed to. These warrants were issued in 1996.\nDuring 1994, the Company issued 767,500 shares of its common stock at various prices per share, for total proceeds of $655,000.\n(Continued)\nMAGNAVISION CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(13) Subsequent Events\nOn June 3, 1996 the Company and its Senior Lenders amended the terms of the lending facility related to the Securities Purchase Agreement (see note 9). Pursuant thereto, the Lenders agreed to waive existing defaults and provide up to $1,200,000 toward the Company's working capital requirements out of the existing commitment (of which approximately $470,000 was advanced to the Company on June 4, 1996). In exchange therefore, the Company agreed to issue warrants (New Warrants) to purchase additional shares of Common Stock representing 7,410,930 common shares of the Company's Common Stock on a fully diluted basis at an exercise price of $.27 per share. The New Warrants expire on June 4, 2004. The amended agreements require the Lenders to surrender to the Company that number of warrants representing up to 6,884,890 common shares of the Company's Common Stock on a fully diluted basis if, as and when the Company complies with certain conditions outlined in the amended agreements. In addition, the Lenders each have the right to require the Company to repurchase certain, and the Company has the right to repurchase all, of the warrants held by the Lenders under such conditions. In connection with the amended agreements, the Company's rights under the Channel Lease Agreement were transferred to a special purpose subsidiary whose stock has been pledged to the lenders as security for amounts advanced under the lending facility. The lenders also have the option, under certain circumstances, to designate three out of five directors of the special purpose subsidiary and under such circumstances, will receive a proxy to vote shares thereof.\nAdditionally, at March 31, 1996 the Company did not make a required interest payment under the Securities Purchase Agreement lending facility in the amount of $82,710. This default was also cured pursuant to the June 3, 1996 amended lending facility.\nDuring 1996, the Company has entered into contracts with five additional institutions to provide cable television service (SMATV).\nIn June 1996, the Company entered into an agreement to retain Allen & Company, Inc., a financial advisory company, to advise the Company with regards to potential strategic alliances, joint ventures, sales or other opportunities pertaining to the Company's rights under the Channel Lease Agreement. The term of the agreement is initially for a one year period, and may be extended by mutual agreement of the parties. In consideration for services to be rendered, the Company paid Allen & Company, Inc. an initial fee of $100,000. The agreement calls for additional payments, based on the occurrence of certain transactions as defined.\nEXHIBIT LIST\nDocument Item Incorporated No. Description of Document by Reference - ---- ----------------------- ------------ (2) Merger Agreement dated September 13, Form 8-K 1991 between Yardley Ventures, Inc. dated 9\/17\/91 and Magnavision Corporation\n(3) (a) Articles of Incorporation and By Laws Form S-1 dated 12\/29\/86\n(3) (b) Amendment to Certificate of Incorporation Form 8-K dated 9\/17\/91\n(10) (a) License Agreement dated August 20, 1990 Form 10-K between Magnavision Corporation and dated 12\/31\/91 Department of Education, Archdiocese of New York\n(b) Amended License Agreement dated January Form 10-K 6, 1994 between Magnavision Corporation dated 12\/31\/93 and Department of Education, Archdiocese of New York\n(c) Microcell Systems Corporation Agreement Form 10-K dated December 15, 1993 dated 12\/31\/93\n(d) Securities Purchase Agreement dated as of August 25, 1995 among the Registrant, Magnavision Corporation (N.J.), IBJS Capital Corporation, IBJ Schroder Bank & Trust Company and Koco Capital Company, L.P.\n(e) Form of Senior Subordinated Note of the Registrant and Magnavision Corporation (N.J.) due February 26, 2001\n(f) Form of Warrant to Purchase Shares of Registrant's Common Stock expiring on August 27, 2003\n(g) Security Agreement and Collateral Assignment dated as of August 25, 1995 among Magnavision Corporation (N.J.), University Connection, Inc. and IBJS Capital Corporation as agent\n(h) Registration Rights Agreement dated as of August 25, 1995 among the Registrant and the investors listed therein\n(i) Stockholders' Agreement dated as of August 25, 1995 among the Registrant, the investors and the other parties listed therein\n(j) Non-Competition Agreement dated as of August 25, 1995 between Magnavision Corporation (N.J.) and Nicholas Mastrorilli, Sr.\n(k) Indemnification Agreement dated as of August 25, 1995 between the Registrant, Cacomm, Inc., and the investors listed therein\n(l) Lockbox Service Agreement dated as of August 25, 1995 among Magnavision Corporation (N.J.), University Connection, Inc., IBJS Capital Corporation and IBJ Schroder Bank & Trust Company\n(m) Amendment No. 1 dated as of June 3, 1996 to Securities Purchase Agreement dated as of August 25, 1995 among the Registrant, Magnavision Corporation (N.J.), Magnavision Wireless Cable, Inc., IBJS Capital Corporation, IBJ Schroder Bank & Trust Company and Koco Capital Company, L.P.\n(n) Amended and Restated Stockholders' Agreement dated as of June 3, 1996 among the Registrant, Magnavision Corporation (N.J), Magnavision Wireless Cable, Inc. and the investors and other parties listed therein\n(o) Amendment No. 1 dated as of June 3, 1996 to the Registration Rights Agreement dated as of August 25, 1995 among the Registrant and the investors listed therein\n(p) Amendment No. 1 dated as of June 3, 1996 to the Security Agreement and Collateral Assignment dated as of August 25, 1995 among Magnavision Corporation (N.J.) Magnavision Wireless Cable, Inc., Magnavision Private Cable, Inc., University Connection, Inc. and IBJS Capital Corporation, as agent\n(q) Amended and Restated Lockbox Service Agreement dated as of June 3, 1996 among Magnavision Corporation (N.J.), University Connection, Inc.,\nMagnavision Private Cable, Inc., IBJS Capital Corporation and IBJ Schroder Bank & Trust Company\n(r) Pledge Agreement dated as of June 3, 1996 between Magnavision Corporation (N.J.) and IBJS Capital Corporation as agent\n(s) Pledge Agreement dated as of June 3, 1996 between Magnavision Corporation (N.J.) and IBJS Capital Corporation as agent\n(t) General Indenture of Conveyance, Assignment and Transfer dated as of June 3, 1996 from Magnavision Corporation (N.J.) and University Connection, Inc. to Magnavision Private Cable, Inc.\n(u) General Indenture of Conveyance, Assignment and Transfer dated as of June 3, 1996 from Magnavision Corporation (N.J.) to Magnavision Wireless Cable, Inc.\n(v) Indenture of Assumption of Liabilities dated as of June 3, 1996 from Magnavision Private Cable, Inc. to Magnavision Corporation (N.J.) and University Connection, Inc.\n(w) Indenture of Assumption of Liabilities dated as of June 3, 1996 from Magnavision Wireless Cable, Inc. to Magnavision Corporation (N.J.)\n(x) Irrevocable Proxy dated June 3, 1996 issued by Magnavision Corporation (N.J.) to IBJS Capital Corporation as agent\n(y) Form of Amended and Restated Senior Subordinated Notes dated June 3, 1996\n(z) Form of Warrant to Purchase Shares of Registrant's Common Stock expiring on June 4, 2004\n(aa) Letter Agreement dated July 11, 1995 between the Registrant, Cacomm, Inc. and George S. Callas\n(bb) Letter Agreement dated August 25, 1995 among the Registrant, Midlantic Bank, N.A. and George S. Callas\n(cc) Form of Five Year Warrant to Purchase Shares of Registrant's Common Stock issued to various parties during 1994 and 1995\n(dd) Form of Indemnification Agreement for Executive Officers and Directors\n(16) Letter re: change in certifying accountant\n(21) Subsidiaries of Registrant\n(27) Financial Data Schedule","section_15":""}
{"filename":"356050_1995.txt","cik":"356050","year":"1995","section_1":"Item 1. BUSINESS\nGeneral Development of Business\nCU Bancorp, (the \"Company\") was incorporated under the laws of the State of California on September 3, 1981. It is the parent of California United Bank, a National Banking Association (the \"Bank\") which is a wholly owned subsidiary of the Company and the sole subsidiary of the Company.\nDESCRIPTION OF BUSINESS\nCommercial Banking Business\nCU Bancorp is a California corporation incorporated in 1981 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company does not conduct any activities other than in connection with its ownership of the Bank which is CU Bancorp's sole subsidiary. The company functions primarily as the sole stockholder of the Bank and establishes general policies and activities for the Bank. The Bank was founded in April 1982 and provides an extensive range of commercial banking services.\nThe Bank is a commercial bank which delivers a mix of banking products and services to middle market businesses, the entertainment industry and high net worth individuals. The Bank offers lending, deposit, accounts receivable financing, letters of credit, cash management, SBA and international trade services from seven full -service offices. The Bank's primary focus is to engage in middle market lending to businesses, professionals, the entertainment industry, and high net-worth individuals. While the Bank does not actively solicit retail or consumer banking business, it offers these services primarily to owners, officers, and employees of its business customers, and customers of accounting and business management firms with which the Bank regularly does business.\nThe Entertainment Division specializes in meeting the banking needs of Southern California's entertainment industry, including motion picture and television financing, record labels, talent agencies, business managers, commercial houses and a variety of other related business activities. This division offers certain specialty products aimed at the entertainment industry and related individuals.\nThe SBA division offers financing alternatives to businesses in the Bank's market through the use of government guaranteed loans. This division offers both term and shorter term credit products.\nThe International Trade Services Group offers a broad range of services to support the import\/export activities of customers. The division has direct correspondent relationships with major overseas banks, providing business customers with a broad international reach. The division facilitates a wide variety of international banking transactions, including letters of credit, short term trade related financing, domestic and foreign collections, wire transfers, standby commitments and government assisted programs.\nThe Bank attracts customers and deposits by offering a personalized approach and a high degree of service. The key to the Bank's deposit generation is personal contacts and services rather than rate competition. A significant portion of its business is with business customers who conduct substantially all of their banking business with the Bank.\nEither alone or in concert with correspondent banks, the Bank offers a wide variety of credit and deposit services to its customers. Management believes that its current and prospective customers favorably respond to the individualized tailored banking services that the Bank provides. Deposit services,\nwhich the Bank offers, include personal and business checking accounts and savings accounts, insured money market deposit accounts, interest-bearing negotiable orders of withdrawal (\"NOW\") accounts, and time certificates of deposit, along with IRA and Keogh accounts. The Bank offers sophisticated on line banking capabilities to customers through its electronic banking programs. The Bank has not requested and does not have regulatory approval to offer trust services; nor does it have any present intention to seek such approval. The Bank has made arrangements with a number of trust companies to refer prospective customers, in connection with which the Bank may receive a referral fee.\nContinued development of a diversified commercial oriented deposit and lending base is the Bank's highest priority. Loans and time and demand deposits are actively solicited by the directors, officers, and employees of the Bank. The executive and senior officers of the Bank have had substantial experience in soliciting bank deposits and in serving the comprehensive banking needs of small and mid-size businesses.\nDuring 1995, the Bank serviced the commercial banking business from five offices including: its head office at 16030 Ventura Boulevard, in Encino, California 91436, a suburb of Los Angeles; an office in West Los Angeles, located at 10880 Wilshire Boulevard, Los Angeles California 90024, in the Westwood commercial and retail district, with close freeway access; a Ventura County (Camarillo) Regional Office; a South Bay Regional office in Gardena, California; and a San Gabriel Valley Regional Office, located in City of Industry, which serves the San Gabriel Valley and northern Orange County. In January 1996, the Bank added branches in Santa Ana and Anaheim in Orange County as a result of its merger with Corporate Bank.\nIn January 1996, the Company completed the acquisition of Corporate Bank of Santa Ana California which was merged into the Bank. Corporate Bank served both small and mid market business entities, as well as offering certain consumer based products such as home equity lines of credit and auto loans and leases. It is contemplated that upon full integration of the Corporate Bank business that the business of these offices will mirror those of the Bank as a whole.\nOn January 10, 1996, the Bank announced an agreement to merge with Home Interstate Bancorp, parent of Home Bank, based in the South Bay. The merger with Home Bank is expected to be completed in mid - 1996, and will create a Bank with 22 branches and over $800 million in assets.\nHistorical Regulatory Matters\nIn 1992, the Bank and Bancorp both consented to agreements with their primary regulators, a Formal Agreement with the OCC and a Memorandum of Understanding with the Federal Reserve Bank of San Francisco. In June of 1992, a new management team replaced substantially all of prior management. In November of 1993, following the first OCC examination subsequent to new management's implementation of internal controls and other new management techniques, the OCC released The Bank from the Formal Agreement and later that same month the Federal Reserve Bank of San Francisco determined that Bancorp had met all the requirements of the Memorandum of Understanding and terminated that document. The Bank's capital ratios, as of December 31, 1995, are in excess of all minimums imposed by law and regulation and qualify to rate the Bank as a \"well capitalized\" bank. For further information see Note 16 to the Financial Statements.\nThe Formal Agreement required the implementation of certain policies and procedures for the operation of the Bank to improve lending operations and management of the loan portfolio. The Formal Agreement required the Bank to maintain a Tier 1 risk weighted capital ratio of 10.5% and a 6% Tier 1 capital ratio based on adjusted total assets. The Formal Agreement mandated the adoption of a written program to essentially reduce criticized assets, maintain adequate loan loss reserves and improve bank administration, real estate appraisal, asset review management and liquidity policies, and restricted the payment of dividends.\nThe agreement specifically required the Bank to: 1) create a compliance committee; 2) have a competent chief executive officer and senior loan officer, satisfactory to the OCC, at all times; 3) develop a plan for supervision of management; 4) create and implement policies and procedures for loan administration; 5) create a written loan policy; 6) develop and implement an asset review program; 7) develop and implement a written program for the maintenance of an adequate Allowance for Loan and Lease Losses, and review the adequacy of the Allowance; 8) eliminate criticized assets; 9) develop and implement a written real estate appraisal policy; 10) obtain and improve procedures regarding credit and collateral documentation; 11) develop a strategic plan; 12) develop a capital program to maintain adequate capital (this provision also restricts the payment of dividends by the Bank unless :(a) the Bank is in compliance with its capital program; (b) the Bank is in compliance with 12 U.S.C. Sections 55 and 60; and (c) with the prior written approval of the OCC Regional Administrator; 13) develop and implement a written liquidity, asset and liability management policy; 14) document and support the reasonableness of any management and other fees to any director or other party; 15) correct violations of law; and 16) provide reports to the OCC regarding compliance.\nThe Company's Memorandum of Understanding (\"MOU\") with the Federal Reserve required: 1) a plan to improve the financial condition of CU Bancorp and the Bank; 2) development of a formal policy regarding the relationship of CU Bancorp and the Bank, with regard to dividends, intercompany transactions, tax allocation and management or service fees; 3) a plan to assure that CU Bancorp has sufficient cash to pay its expenses; 4) ensure that regulatory reporting is accurate and submitted on a timely basis; 5) prior approval of the Federal Reserve Bank prior to the payment of dividends; 6) prior approval of the Federal Reserve Bank prior to CU Bancorp incurring any debt and 7) quarterly reporting regarding the condition of the Company and steps taken regarding the Memorandum of Understanding.\nThe release of both agreements indicates that the Company has complied with the Formal Agreement and the Memorandum of Understanding, including improvement of asset and management quality, the development and implementation of policies and procedures as well as reporting methodologies and the maintenance of the required capital ratios.\nThe Company\nBancorp is a legal entity separate and distinct from the Bank. There are various legal limitations on the ability of the Bank to finance or otherwise supply funds to Bancorp. In particular, under federal banking law, a national bank, such as the Bank, may not declare a dividend that exceeds undivided profits, and the approval of the OCC is required if the total of all dividends declared in any calendar year exceeds such bank's net profits, as defined, for that year combined with its retained net profits for the preceding two years. In addition, federal law significantly limits the extent to which the Bank may supply funds to Bancorp, whether through direct extensions of credit or through purchases of securities or assets, issuance of guarantees or the like. Generally, any loan made by the Bank to Bancorp must be secured by certain kinds and amounts of collateral and is limited to 10% of the Bank's capital and surplus (as defined), and all loans by the Bank to Bancorp are limited to 20% of the Bank's capital and surplus. The Bank may extend credit to Bancorp without regard to these restrictions to the extent such extensions of credit are secured by specific kinds of collateral such as obligations of or guaranteed by the U.S. Government or its agencies and certain bank deposits.\nMortgage Banking\nUntil November 1993, the Bank operated in two distinct segments, commercial banking and mortgage banking. The Bank sold the origination portion of its mortgage banking division in November 1993 to Republic Bancorp of Ann Arbor Michigan. This division had been established in February of 1988. The purpose of this division was to underwrite residential mortgages and subsequently sell them into the secondary market. Mortgages were originated on both a servicing retained and servicing released basis.\nSubstantially all the loans originated by this division were presold to institutional investors or government agencies and are only originated subject to this forward commitment.\nThe Bank retained the mortgage servicing portfolio after the sale of the division, although it retained the former division to service the loans. At December 31, 1995 substantially all of the mortgage loan servicing portfolio had been sold. See Management's Discussion and Analysis for further amplification on operating contributions of this division and the effect of the sale.\nEntertainment Division\nThe Bank's entertainment division, based in its West Los Angeles Regional Office, is designed specifically to serve the needs of accountants and business managers serving artists and other entertainment industry related companies and individuals, while providing a more diverse source of deposits for the Bank as a whole.\nCustomers and Business Concentration\nThe Bank believes that there is no single customer whose loss would have a material adverse effect on the Bank. At year end 1995, the Bank obtained approximately 7.2% of its deposits from companies associated with the real estate business, primarily title and escrow companies. While this appears to be a significant deposit concentration, because these deposits are attributable to a large number of companies in a diverse market (from small single family homes to larger projects), the Bank does not believe there is a problematical concentration in any one industry. To account for seasonal and economic variations in this industry, the Bank has taken a number of steps to insure liquidity. Regarding business concentrations in both lending and deposit activities, see Management's Discussion and Analysis.\nCompetition\nThe Company does not conduct any business unrelated to the business of the Bank and thus is affected by competition only in the Banking industry.\nThe Bank's primary commercial banking market area consists of the area encompassed in an approximately sixty mile radius from the downtown Los Angeles area, including much of Ventura County, the San Fernando Valley, Beverly Hills, West Los Angeles, the San Gabriel Valley, the South Bay area and metropolitan areas of the City and County of Los Angeles. The Bank also serves Orange County.\nThe banking and financial services business in California generally, and in the Bank's market areas specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. The Bank competes for loans and deposits and customers for financial services with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than the Bank. In order to compete with the other financial services providers, the Bank principally relies upon local promotional activities, personal relationships established by officers, directors and employees with its customers, and specialized services tailored to meet its customers' needs. In those instances where the Bank is unable to accommodate a customer's needs, the Bank will arrange for those services to be provided by its correspondents.\nTo compete with major financial institutions, the Bank relies upon specialized services, responsive handling of customer needs, local promotional activity, and personal contacts by its officers, directors, and staff, as opposed to large multi-branch banks which compete primarily by rate and location of branches.\nFor customers whose loan demands exceed the Bank's lending limit, the Bank seeks to arrange for such loans on a participation basis with correspondent banks.\nIn the past, an independent bank's principal competitors for deposits and loans have been other banks (particularly major banks), savings and loan associations, and credit unions. To a lesser extent, competition was also provided by thrift and loans, mortgage brokerage companies, and insurance companies. In the past several years, the trend has been for other financial intermediaries to offer financial services traditionally offered by banks. Other institutions, such as brokerage houses, credit card companies, and even retail establishments, have offered new investment vehicles such as money-market funds or cash advances on credit card accounts. This led to increased cost of funds for most financial institutions. Even within the Banking industry, the trend has been towards offering more varied services, such as discount brokerage, often through affiliate relationships. The direction of federal legislation seems to favor and foster competition between different types of financial institutions and to encourage new entrants into the financial services market. However, it is not possible to forecast the impact such developments will have on commercial banking in general, or on the Bank in particular.\nEffect of Governmental Policies and Recent Legislation\nBanking is a business that depends on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's portfolio comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and growth of the Company are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.\nThe commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.\nFrom time to time, legislation is enacted which 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, in the California legislature and before various bank regulatory and other professional agencies. The likelihood of any major legislative changes and the impact such changes might have on the Company are impossible to predict. See \"Item 1. Business - Supervision and Regulation.\"\nSupervision and Regulation\nBank holding companies and banks are extensively regulated under both federal and state law. Set forth below is a summary description of certain laws which relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.\nThe Company\nThe Company, as a registered bank holding company, is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). The Company is required to file with the Federal\nReserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may conduct examinations of the Company and its subsidiaries.\nThe Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities.\nUnder the BHCA and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, the Company is required by the Federal Reserve Board to maintain certain levels of capital. See \"Item 1. Business - Supervision and Regulation - Capital Standards.\"\nThe Company is required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company.\nThe Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that 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 furnishing services to its subsidiaries. However, the Company, subject to the prior approval of the Federal Reserve Board, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making any such determination, the Federal Reserve Board is required to consider whether the performance of such activities by the Company or an affiliate can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between activities commenced de novo and activities commenced by acquisition, in whole or in part, of a going concern.\nThe FRB has determined, by regulation, that certain activities are so closely related to banking as to be a proper incident thereto within the meaning of the BHC Act. These activities include, but are not limited to: opening an industrial loan company, industrial bank, Morris Plan Bank, mortgage company, finance company, credit card company, or factoring company; performing certain data processing operations; providing investment and financial advice; operation as a trust company in certain instances; selling traveler's checks, U.S. Savings Bonds, and certain money orders; providing certain courier services; providing real estate appraisals; providing management consulting advice to non affiliated depository institutions in some instances; acting as an insurance agent for certain types of credit related insurance; leasing property or acting as agent, broker, or advisor for leasing property on a \"full payout basis\"; acting as a consumer financial counselor, including tax planning and return preparation; performing futures, options, and advisory services, check guarantee services and discount brokerage activities; operating a collection or credit bureau; or performing personal property appraisals.\nRecent amendments to this list allow bank holding companies to own savings associations, arrange commercial real estate equity financing, engage in certain securities brokerage activities, underwrite and deal in government obligations and money market instruments, conduct foreign exchange advisory and transactional services, act as a futures commission merchant, provide investment advice on financial futures\nand options on futures, provide consumer financial counseling, provide tax planning and preparation, operate a check guarantee service, operate a collection agency, and operate a credit bureau. The Company has no present intention to engage in any of such newly permitted activities.\nThe FRB has determined that certain other activities are not so closely related to banking as to be a proper incident thereto within the meaning of the BHC Act. Such activities include: real estate brokerage and syndication; real estate development; property management; underwriting of life insurance not related to credit transactions; and, with certain exceptions previously noted, securities underwriting and equity funding. The area of securities underwriting is under review and will likely be expanded. In the future, the FRB may add or delete from the list of activities permissible for bank holding companies.\nUnder Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. This doctrine has become known as the \"source of strength\" doctrine. Although the United States Court of Appeals for the Fifth Circuit found the Federal Reserve Board's source of strength doctrine invalid in 1990, stating that the Federal Reserve Board had no authority to assert the doctrine under the BHCA, the decision, which is not binding on federal courts outside the Fifth Circuit, was recently reversed by the United States Supreme Court on procedural grounds. The validity of the source of strength doctrine is likely to continue to be the subject of litigation until definitively resolved by the courts or by Congress.\nThe Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the California State Banking Department.\nFinally, the Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, including but not limited to, filing annual, quarterly and other current reports with the Securities and Exchange Commission.\nThe Bank\nThe Bank, as a national banking association, is subject to primary supervision, examination and regulation by the Comptroller of the Currency (the \"Comptroller\"). If, as a result of an examination of a Bank, the Comptroller should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the Comptroller. Such remedies include the power to enjoin \"unsafe or unsound practices,\" to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, and to remove officers and directors. The FDIC has similar enforcement authority, in addition to its authority to terminate a Bank's deposit insurance in the absence of action by the Comptroller and upon a finding that a Bank is in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that its conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors. The Bank is not currently subject to any such actions by the Comptroller or the FDIC.\nThe deposits of the Bank are insured by the FDIC in the manner and to the extent provided by law. For this protection, the Bank pays a semiannual statutory assessment. See \"Item 1. Business - Supervision and Regulation Premiums for Deposit Insurance.\" The Bank is also subject to certain regulations of the\nFederal Reserve Board and applicable provisions of California law, insofar as they do not conflict with or are not preempted by federal banking law.\nVarious other requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, capital requirements and disclosure obligations to depositors and borrowers. Further, the Bank is required to maintain certain levels of capital. See \"Item 1. Business - Supervision and Regulation - Capital Standards.\"\nRestrictions on Transfers of Funds to the Company by the Bank\nThe Company is a legal entity separate and distinct from the Bank. The Company's ability to pay cash dividends is limited by state law.\nThere are statutory and regulatory limitations on the amount of dividends which may be paid to the Company by the Bank. The prior approval of the Comptroller is required if the total of all 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 (as defined) for the preceding two years, less any transfers to surplus.\nThe Comptroller also has authority to prohibit the Bank from engaging in activities that, in the Comptroller's opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the Comptroller could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the Comptroller and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or the Company may pay. The Superintendent may impose similar limitations on the conduct of California-chartered banks. See \"Item 1. Business - Supervision and Regulation - Prompt Corrective Regulatory Action and Other Enforcement Mechanisms\" and - \"Capital Standards\" for a discussion of these additional restrictions on capital distributions.\nAt present, substantially all of the Company's revenues, including funds available for the payment of dividends and other operating expenses, is, and will continue to be, primarily dividends paid by the Bank and exercise of options and warrants to purchase shares of the Company.\nThe Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company or other affiliates, the purchase of or investments in stock or other securities thereof, the taking of such securities as collateral for loans and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and such other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company or to or in any other affiliate is limited to 10% of the Bank's capital and surplus (as defined by federal regulations) and such secured loans and investments are limited, in the aggregate, to 20% of the Bank's capital and surplus (as defined by federal regulations). Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See \"Item 1. Business - - Supervision and Regulation - Prompt Corrective Action and Other Enforcement Mechanisms.\"\nCapital Standards\nThe Federal Reserve Board, the Comptroller and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and\ntransactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.\nA banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%.\nIn addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.\nIn August 1995, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. The final regulations, however, do not include a measurement framework for assessing the level of a bank's exposure to interest rate risk, which is the subject of a proposed policy statement issued by the federal banking agencies concurrently with the final regulations. The proposal would measure interest rate risk in relation to the effect of a 200 basis point change in market interest rates on the economic value of a bank. Banks with high levels of measured exposure or weak management systems generally will be required to hold additional capital for interest rate risk. The specific amount of capital that may be needed would be determined on a case-by-case basis by the examiner and the appropriate federal banking agency. Because this proposal has only recently been issued, the Bank currently is unable to predict the impact of the proposal on the Bank if the policy statement is adopted as proposed.\nIn January 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank's capital adequacy.\nIn December 1993, the federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (a) assets classified loss; (b) 50 percent of assets classified doubtful; (c) 15 percent of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming 12 months.\nFederally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. See \"Item 1. Business -- Supervision and Regulation -- Accounting Changes.\" The federal banking agencies recently issued final rules, effective April 1, 1995, which limit the amount of deferred tax assets that are allowable in computing an institution's regulatory capital. The standard has been in effect on an interim basis since March 1993. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 Capital and total assets and regulatory capital calculations.\nFuture changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. The banking agencies have issued a final rule which requires them to revise their risk based capital guidelines to ensure that their standards take adequate account of interest rate risk (\"IRR\"). These amendments to risk-based capital guidelines had not been finalized for banks as of December 31, 1995.\nThe following table presents the amounts of regulatory capital and the capital ratios for the Bank, compared to its minimum regulatory capital requirements as of December 31, 1995.\nPrompt Corrective Action and Other Enforcement Mechanisms\nFederal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.\nIn September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of federal law. An insured depository institution generally will be classified in the following categories based on capital measures indicated below:\nAn institution that, based upon its capital levels, is classified as \"well capitalized,\" \"adequately capitalized\" or \"undercapitalized\" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as \"critically undercapitalized\" unless its capital ratio actually warrants such treatment.\nThe law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions.\nAn insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is\nsubject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized.\nFurther restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator.\nIn addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.\nSafety and Soundness Standards\nIn July 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action.\nIn December 1992, the federal banking agencies issued final regulations prescribing uniform guidelines for real estate lending. The regulations, which became effective on March 19, 1993, require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations.\nAppraisals for \"real estate related financial transactions\" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for \"complex\" 1-4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with \"federally related transactions\" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities.\nPremiums for Deposit Insurance\nFederal law has established several mechanisms to increase funds to protect deposits insured by the Bank Insurance Fund (\"BIF\") administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the United States Treasury; up to 90% of the fair market value of assets of institutions acquired by the FDIC as receiver from the Federal Financing Bank; and from depository institutions that are members of the BIF. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. The result of these provisions is that the assessment rate on deposits of BIF members could increase in the future. The FDIC also has authority to impose special assessments against insured deposits.\nThe FDIC implemented a final risk-based assessment system, as required by FDICIA, effective January 1, 1994, under which an institution's premium assessment is based on the probability that the deposit insurance fund will incur a loss with respect to the institution, the likely amount of any such loss, and the revenue needs of the deposit insurance fund. As long as BIF's reserve ratio is less than a specified \"designated reserve ratio,\" 1.25%, the total amount raised from BIF members by the risk-based assessment system may not be less than the amount that would be raised if the assessment rate for all BIF members were .023% of deposits. On August 8, 1995, the FDIC announced that the designated reserve ratio had been achieved and, accordingly, issued final regulations adopting an assessment rate schedule for BIF members of 4 to 31 basis points effective on June 1, 1995. On November 14, 1995, the FDIC further reduced deposit insurance premiums to a range of 0 to 27 basis points effective for the semi-annual period beginning January 1, 1996.\nUnder the risk-based assessment system, a BIF member institution such as the Bank is categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and one of three categories based on supervisory evaluations by its primary federal regulator (in the Bank's case, the Comptroller). The three supervisory categories are: financially sound with only a few minor weaknesses (Group A), demonstrates weaknesses that could result in significant deterioration (Group B), and poses a substantial probability of loss (Group C). The capital ratios used by the Comptroller to define well-capitalized, adequately capitalized and undercapitalized are the same in the Comptroller's prompt corrective action regulations. The BIF assessment rates are summarized below; assessment figures are expressed in terms of cents per $100 in deposits.\nAssessment Rates Effective Through the First Half of 1995\nAssessment Rates Effective through the Second Half of 1995\nAssessment Rates Effective January 1, 1996\n*Subject to a statutory minimum assessment of $1,000 per semi-annual period (which also applies to all other assessment risk classifications).\nAt December 31, 1995, the Bank was well capitalized (Group A).\nA number of proposals have recently been introduced in Congress to address the disparity in bank and thrift deposit insurance premiums. On September 19, 1995, legislation was introduced and referred to the House Banking Committee that would, among other things: (i) impose a requirement on all SAIF member institutions to fully recapitalize the SAIF by paying a one-time special assessment of approximately 85 basis points on all assessable deposits as of March 31, 1995, which assessment would be due as of January 1, 1996; (ii) spread the responsibility for FICO interest payments across all FDIC-insured institutions on a pro-rata basis, subject to certain exceptions; (iii) require that deposit insurance premium assessment rates applicable to SAIF member institutions be no less than deposit insurance premium assessment rates applicable to BIF member institutions; (iv) provide for a merger of the BIF and the SAIF as of January 1, 1998; (v) require savings associations to convert to state or national bank charters by January 1, 1998; (vi) require savings associations to divest any activities not permissible for commercial banks within five years; (vii) eliminate the bad-debt reserve deduction for\nsavings associations, although savings associations would not be required to recapture into income their accumulated bad-debt reserves; (viii) provide for the conversion of savings and loan holding companies into bank holding companies as of January 1, 1998, although unitary savings and loan holding companies authorized to engage in activities as of September 13, 1995 would have such authority grandfathered (subject to certain limitations); and (ix) abolish the OTS and transfer the OTS' regulatory authority to the other federal banking agencies. The legislation would also provide that any savings association that would become undercapitalized under the prompt corrective action regulations as a result of the special deposit premium assessment could be exempted from payment of the assessment, provided that the institution would continue to be subject to the payment of semiannual assessments under the current rate schedule following the recapitalization of the SAIF. The legislation was considered and passed by the House Banking Committee's Subcommittee on Financial Institutions on September 27, 1995, and has not yet been acted on by the full House Banking Committee.\nOn September 20, 1995, similar legislation was introduced in the Senate, although the Senate bill does not include a comprehensive approach for merging the savings association and commercial bank charters. The Senate bill remains pending before the Senate Banking Committee.\nThe future of both these bills is linked with that of pending budget reconciliation legislation since some of the major features of the bills are included in the Seven-Year Balanced Budget Reconciliation Act. The budget bill, which was passed by both the House and Senate on November 17, 1995 and vetoed by the President on December 6, 1995, would: (i) recapitalize the SAIF through a special assessment of between 70 and 80 basis points on deposits held by institutions as of March 31, 1995; (ii) provide an exemption to this rule for weak institutions, and a 20% reduction in the SAIF-assessable deposits of so-called \"Oakar banks;\" (iii) expand the assessment base for FICO payments to include all FDIC-insured institutions; (iv) merge the BIF and SAIF on January 1, 1998, only if no insured depository institution is a savings association on that date; (v) establish a special reserve for the SAIF on January 1, 1998; and (vi) prohibit the FDIC from setting semiannual assessments in excess of the amount needed to maintain the reserve ratio of any fund at the designated reserve ratio. The bill does not include a provision to merge the charters of savings associations and commercial banks.\nIn light of ongoing debate over the content and fate of the budget bill, the different proposals currently under consideration and the uncertainty of the Congressional budget and legislative processes in general, management cannot predict whether any or all of the proposed legislation will be passed, or in what form. Accordingly, the effect of any such legislation on the Bank cannot be determined.\nInterstate Banking and Branching\nIn September 1994, the Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") became law. Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain approval under the BHCA to acquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10% of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which the bank is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five year existence requirement.\nThe Interstate Act also permits, beginning June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may permit such combinations earlier than June 1, 1997, and may adopt legislation to prohibit interstate mergers after that date in that state or in other states by that state's banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirements and conditions as for a merger transaction.\nIn October 1995, California adopted \"opt in\" legislation under the Interstate Act that permits out-of-state banks to acquire California banks that satisfy a five-year minimum age requirement (subject to exceptions for supervisory transactions) by means of merger or purchases of assets, although entry through acquisition of individual branches of California institutions and de novo branching into California are not permitted. The Interstate Act and the California branching statute will likely increase competition from out-of-state banks in the markets in which the Company operates, although it is difficult to assess the impact that such increased competition may have on the Company's operations.\nCommunity Reinvestment Act and Fair Lending Developments\nThe Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (\"CRA\") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. The Bank's compliance with CRA is monitored by the Comptroller, which assigns the Bank a publicly available CRA rating. An assessment of CRA compliance is required by both the Comptroller and the Federal Reserve Board in connection with applications for approval of certain activities such as mergers with or acquisitions of other banks or bank holding companies. In April of 1995, the federal regulatory agencies issued a comprehensive revision to the rules governing CRA compliance. In assigning a CRA rating to a bank, the new regulations place greater emphasis on measurements of performance in the areas of lending (specifically the bank's home mortgage, small business, small farm and community development loans), investment (the bank's community development investments) and service (the bank's community development services and the availability of its retail banking services), although examiners are still given a degree of flexibility in taking into account unique characteristics and needs of the bank's community and its capacity and constraints in meeting such needs. The new regulations also require increased collection and reporting of data regarding certain kinds of loans. Although the new regulations became generally effective on July 1, 1995, various provisions have different effective dates, and the new CRA evaluation criteria will go into effect for examinations beginning on July 1, 1997. Although management cannot predict the impact of the substantial changes in the new rules on the Bank's CRA rating, it will continue to take steps to comply with the requirements in all respects.\nIn addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. The Comptroller has rated the Bank \"satisfactory\" in complying with its CRA obligations.\nIn May 1995, the federal banking agencies issued final regulations which change the manner in which they measure a bank's compliance with its CRA obligations. The final regulations adopt a performance-based evaluation system which bases CRA ratings on an institution's actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. In March 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will\nuse to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact.\nAccounting Changes\nIn February 1992, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 109, \"Accounting for Income Taxes,\" which superseded SFAS No. 96 of the same title. SFAS No. 109, which was adopted by the Company effective January 1, 1993, employs an asset and liability approach in accounting for income taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements and as measured by the provisions of enacted tax laws. Adoption by the Company of SFAS No. 109 did not have a material impact on the Company's results of operations.\nIn May 1993, the FASB issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\". SFAS No. 114 prescribes the recognition criterion for loan impairment and the measurement methods for certain impaired loans and loans whose terms are modified in troubled debt restructurings. SFAS No. 114 states that a loan is impaired when it is probable that a creditor will be unable to collect all principal and interest amounts due according to the contracted terms of the loan agreement. A creditor is required to measure impairment by discounting expected future cash flows at the loan's effective interest rate, or by reference to an observable market price, or by determining that foreclosure is probable. SFAS No. 114 also clarifies the existing accounting for in-substance foreclosures by stating that a collateral-dependent real estate loan would be reported as real estate owned only if the lender had taken possession of collateral.\nSFAS No. 118 amended SFAS No. 114, to allow a creditor to use existing methods for recognizing interest income on an impaired loan. To accomplish that it eliminated the provisions in SFAS No. 114 that described how a creditor should report income on an impaired loan. SFAS No. 118 did not change the provisions in SFAS No. 114 that require a creditor to measure impairment 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 observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. SFAS No. 118 amends the disclosure requirements in SFAS No. 114 to require information about the recorded investments in certain impaired loans and about how a creditor recognizes interest income related to those impaired loans. The Company adopted SFAS No. 114 and No. 118 as of January 1, 1995. The Bank had previously measured the allowance for loan losses using methods similar to that prescribed in SFAS 114. As a result, no additional provision was required by the adoption of this pronouncement.\nIn December 1990, FASB issued SFAS No. 106, \"Employers' Accounting for Post-Retirement Benefits Other Than Pensions\" effective for fiscal years beginning after December 15, 1992. In November 1992, FASB issued Statement of Financial Standards No. 112, \"Employers' Accounting For Post-Employment Benefits,\" effective for fiscal years beginning after December 15, 1993. SFAS No. 106 and SFAS No. 112 focus primarily on post-retirement health care benefits. The Company does not provide post-retirement benefits, and SFAS No. 106 and SFAS No. 112 will have no impact on net income in 1996.\nIn May 1993, the FASB issued SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" addressing the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments would be classified in three categories and accounted for as follows: (i) debt and equity securities that the entity has the positive intent and ability to hold to maturity would be classified as \"held to maturity\" and reported at amortized cost; (ii) debt and equity securities that are held for current resale would be classified as trading securities and reported at fair value, with unrealized gains and losses included in operations; and (iii) debt and equity securities not classified as either securities\nheld to maturity or trading securities would be classified as securities available for sale, and reported at fair value, with unrealized gains and losses excluded from operations and reported as a separate component of shareholders' equity. The Company adopted SFAS No. 115 in 1993. The adoption of SFAS 115 did not have a material impact on the financial position or results of operations of the Bank.\nEMPLOYEES\nAs of December 31, 1995, the Company had three employees, its President ,Chief Executive Officer and Chief Financial Officer. At December 31, 1995, the Bank had 115 full-time employees or equivalents. Of these employees, 11 held titles of senior vice president or above. At December 31, 1995, none of the executive officers of the Bank served pursuant to written employment agreements. None of the Company's or the Bank's employees are represented by a labor union. The Company considers its relationship and the Bank's relationship with each company's respective employees to be excellent.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe principal offices of the Company are located in a multi-story office building located at 16030 Ventura Boulevard, Encino, California 91364 for which it pays a monthly rental of $60,000. The lease contains a ceiling on cost on living adjustments of 5% per year. The lease is renewable. The Bank also has certain month to month or short term leases for offices in West Los Angeles, the South Bay, Ventura and the San Gabriel Valley. Each of these leases is short term in nature and is not material to the Company. Management believes that the existing leases will provide for their space requirements for the foreseeable future, at least until the completion of the proposed merger with Home Interstate Bancorp.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn the normal course of business the Bank occasionally becomes a party to litigation. In the opinion of management, based upon consultation with legal counsel, pending or threatened litigation involving the Bank will have no adverse material effect upon its financial condition, or results of operations. For further information, see Note 15 to the Consolidated Financial Statements of the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were presented for a vote of shareholders during fourth quarter 1995.\nItem 4(A). EXECUTIVE OFFICERS OF THE COMPANY\nSet forth below are brief summaries of the background and business experience of each of the directors and executive officers of the Company and the Bank as of December 31, 1995:\nNone of the directors or officers of CU Bancorp or CU Bank were selected pursuant to any arrangement or understanding other than with the directors and officers of CU Bancorp and CU Bank acting in their capacities as such. There are no family relationships between any two or more of the directors, or officers.\nSet forth below are brief summaries of the background and business experience, including principal occupation, of the directors.\nKENNETH L. BERNSTEIN, was elected to the Board of CU Bancorp and CU Bank in December 1993, and assumed the positions in February 1994. He is the President of BFC Financial Corporation and has served in such capacity since 1965. BFC Financial Corporation performs a variety of service for both the finance industry and clients of that industry.\nSTEPHEN G. CARPENTER, joined CU Bank in 1992 from Security Pacific National Bank where he was Vice Chairman in charge of middle market lending from July 1989 to June 1992. Mr. Carpenter was previously employed at Wells Fargo Bank from July 1980 to July 1989, where he was an Executive Vice President. He assumed the additional role of Chairman of CU Bank in February, 1994 and Chairman of CU Bancorp in 1995.\nRICHARD H. CLOSE has been a principal in the law firm of Shapiro, Rosenfeld & Close, a Professional Corporation, in Los Angeles, California, since 1977.\nPAUL W. GLASS is a certified public accountant and has been a principal in the accountancy firm of Glass & Rosen, in Encino, California, since 1980.\nRONALD S. PARKER has been the Chairman of Parker, Mulcahy & Associates, a regional merchant banking firm, since May 1992. Prior to that he was the Executive Vice President and Group Head of the Corporate Banking Group of Security Pacific National Bank from March of 1991 to May of 1992. He held a similar position at Wells Fargo National Bank from 1984 to 1991. Mr. Parker resigned from the Board in December 1993. He was reappointed in 1994.\nDAVID I. RAINER was appointed Executive Vice President of CU Bank in June 1992 and assumed the position of Chief Operating Officer in late 1992. He assumed the additional title of President of CU Bank in February, 1994 and President and Chief Operating Officer of CU Bancorp in 1995. He was elected to the Board of Directors of CU Bancorp and California United Bank in 1993. From July 1989 to June 1992, Mr. Rainer was employed by Bank of America (Security Pacific National Bank) where he held the position of Senior Vice President. From March 1989 to July 1989, Mr. Rainer was a Senior Vice President at Faucet & Company, where he co-managed a stock and bond portfolio. From July 1982 to March 1989, Mr. Rainer was employed by Wells Fargo Bank, where he held the positions of Vice President and Manager.\nNo director, officer or affiliate of CU Bancorp or of CU Bank, no owner of record or beneficially of more than five percent of any class of voting securities of CU Bancorp or no associate of any such director, officer or affiliate is a party adverse to CU Bancorp or CU Bank in any material pending legal proceed\nThe following are officers of CU Bancorp and the Bank as of December 31, 1995:\nSet forth below are brief summaries of the background and business experience, including principal occupation, of the executive officers of CU Bancorp who have not previously been discussed herein.\nPATRICK HARTMAN has been employed by CU Bank since November, 1992. Prior to assuming his present positions he was Senior Vice President\/Chief Financial Officer for Cenfed Bank for a period during 1992. Mr. Hartman held the post of Senior Vice President\/Chief Financial Officer of Community Bank, Pasadena, California, for thirteen years.\nANNE WILLIAMS joined CU Bank in 1992 as Senior Loan Officer. She was named to the position of Chief Credit Officer in July 1993. Prior to that time she spent five years at Bank of America \/ Security Pacific National Bank, where she was a credit administrator in asset based lending, for middle market in the Los Angeles Area. Ms. Williams was trained at Chase Manhattan Bank in New York, and was a commercial lender at Societe Generale in Los Angeles and Boston Five Cents Savings Bank where she managed the corporate lending group.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nSee Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for information relative to the market for the Company's Common Stock.\nHolders of Company's Common Stock\nAs of the close of business on December 31, 1995 there were 416 record holders of the Company's issued and outstanding Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCU BANCORP AND SUBSIDIARY\nAmounts in thousands of dollars, except per share data and amounts expressed as percentages\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS\nOVERVIEW\nThe Company earned $2.9 million, or $0.60 per share, during in 1995, compared to $2.6 million, or $0.56 per share, in 1994 and $2.1 million, or $.47 per share in 1993. Composition of the earnings has changed substantially in 1995. Prior to that, a substantial portion of the Bank's earnings had been attributable to the Mortgage Banking operation, which was sold in November 1993. The Mortgage origination operation contributed about two thirds of the earnings for 1993, and approximately 56% of the earnings in 1994 were attributable to a gain on the sale of mortgage servicing rights retained when the origination operation was sold. Since then, the earnings of the core commercial bank have grown steadily as the mortgage related income has been eliminated. For the year ended December 31, 1995, income related to sales of mortgage servicing was less than 8% of the Bank's earnings.\nThe Bank's asset quality ratios continue to be exceptionally strong. At December 31, 1995, nonperforming assets were $1 million, compared with $36 thousand in 1994. The Bank did not have any real estate acquired through foreclosure at December 31, 1995 or December 31, 1994. The Bank's allowance for loan losses as a percent of both nonperforming loans and nonperforming assets at December 31, 1995 was 677%, compared to 1994 levels of 20,631%.\nCapital ratios are strong, substantially exceeding levels required for the \"well capitalized\" category established by bank regulators. The Total Risk-Based Capital Ratio was 16.19%, the Tier 1 Risk-Based Capital Ratio was 14.92%, and the Leverage Ratio was 10.52% at December 31, 1995, compared to 15.40%, 14.12%, and 10.44%, respectively, at year-end 1994. Regulatory requirements for Total Risk-Based, Tier 1 Risk-Based, and Leverage capital ratios are a minimum of 8%, 4%, and 3%, respectively, and for classification as well capitalized, 10%, 6%, and 5%, respectively.\nThe Bank's strong capital and asset quality position allows the Bank to continue to grow its core business which provides relationship based services to middle market customers and positions the Bank for its acquisition strategy. During the year ended December 31, 1995, the Bank generated approximately $135 million in new loan commitments, compared with about $121 million and $101 million for the comparable periods of 1994 and 1993.\nThe Bank announced actions taken in 1995 and early 1996 that supplement the Bank's successful internal growth with strategically selected mergers and acquisitions. In March of 1995, the Bank had announced the signing of an agreement to acquire Corporate Bank, a Santa Ana based community bank with approximately $70 million in assets. This purchase was completed in January of 1996. In January 1996, the Bank also announced the signing of an agreement to merge with Home Interstate Bancorp, the parent of Home Bank, based in the South Bay. This merger, targeted to be completed near the end of the second quarter of 1996, would create a combined bank with over $800 million in assets and 22 branches.\nBALANCE SHEET ANALYSIS\nLOAN PORTFOLIO COMPOSITION AND CREDIT RISK\nThe Bank's loan portfolio at December 31, 1995 has maintained the high standards of credit quality that have been established as the commercial loan portfolio has been built over the past three years. Non performing assets have been reduced to insignificant levels and exposures to real estate have been greatly reduced to consist primarily of loans secured by real estate made to the Bank's core middle market customers as a secondary part of their total business relationship.\nTotal loans at December 31, 1995 increased by $16 million during the year. Portfolio growth in the last three quarters of 1995 were partially offset by the decline of $6 million in the first quarter of 1995. Loan paydowns for the first quarter were unusually high, with Entertainment related loans declining $7 million as a number of project related loans paid off, combined with normal payoffs and seasonality in the commercial portfolio.\nThe Bank's focus on middle market lending, in its infancy at year-end 1992, gained momentum in 1993 and further accelerated in 1994. Total loans increased $34 million during 1994. Offsetting this, the remaining Held for Sale mortgages of $10.4 million at December 31, 1993 were sold in the first quarter of 1994. Excluding this planned liquidation, loans increased by $44 million, or 34%, for the year ended December 31, 1994.\nTABLE 1 LOAN PORTFOLIO COMPOSITION\nAmounts in thousands of dollars\nTABLE 1A: LOAN PORTFOLIO MATURITIES AT DECEMBER 31, 1995 (in Thousands)\nTable 1a above summarizes the maturities of the loan portfolio based upon the contractual terms of the loans. The Bank does not automatically rollover any loans at maturity. Maturing loans must go through the Bank's normal credit approval process in order to receive a new maturity date.\nThe Bank lending effort is focused on business lending to middle market customers. Current credit policy permits commercial real estate lending generally only as part of a complete commercial banking relationship with a middle market customer. Commercial real estate loans are secured by first or second liens on office buildings and other structures. The loans are secured by real estate that had appraisals in excess of loan amounts at origination.\nMonitoring and controlling the Bank's allowance for loan losses is a continuous process. All loans are assigned a risk grade, as defined by credit policies, at origination and are monitored to identify changing circumstances that could modify their inherent risks. These classifications are one of the criteria considered in determining the adequacy of the allowance for loan losses.\nThe amount and composition of the allowance for loan losses is as follows:\nTABLE 2 ALLOCATION OF ALLOWANCE FOR LOAN LOSSES\nAmounts in thousands of dollars\nAdequacy of the allowance is determined using management's estimates of the risk of loss for the portfolio and individual loans. Included in the criteria used to evaluate credit risk are, wherever appropriate, the borrower's cash flow, financial condition, management capabilities, and collateral valuations, as well as industry conditions. A portion of the allowance is established to address the risk inherent in general loan categories, historic loss experience, portfolio trends, economic conditions, and other factors. Based on this assessment a provision for loan losses may be charged against earnings to maintain the adequacy of the allowance. The allocation of the allowance based upon the risks by type of loan, as shown in Table 2, implies a degree of precision that is not possible when using judgments. While the systematic approach used does consider a variety of segmentations of the portfolio, management considers the allowance a general reserve available to address risks throughout the entire loan portfolio.\nActivity in the allowance, classified by type of loan, is as follows:\nTABLE 3 ANALYSIS OF THE CHANGES IN THE ALLOWANCE FOR LOAN LOSSES\nAmounts in thousands of dollars\nThe Bank's policy concerning nonperforming loans is more conservative than is generally required. It defines nonperforming assets as all loans ninety days or more delinquent, loans classified nonaccrual, and foreclosed, or in substance foreclosed real estate. Nonaccrual loans are those whose interest accrual has been discontinued because the loan has become ninety days or more past due. In addition, it includes loans where there exists reasonable doubt as to\nthe full and timely collection of principal or interest. When a loan is placed on nonaccrual status, all interest previously accrued but uncollected is reversed against operating results. Subsequent payments on nonaccrual loans are treated as principal reductions. At December 31, 1995, nonperforming loans amounted to $1 million compared with $36 thousand at December 31, 1994.\nPotential problem loans are defined as loans as to which there are serious doubts about the ability of the borrowers to comply with present loan repayment terms. It is the policy of the Bank to place all potential problem loans on nonaccrual status. At December 31, 1995, therefore, the Bank had no potential problem loans other than those disclosed in Table 4 as nonperforming loans.\nTABLE 4: NONPERFORMING ASSETS\nAmounts in thousands of dollars\n(a) Past due with respect to principal and\/or interest and continuing to accrue interest.\nSECURITIES\nThe Securities Held to Maturity portfolio totaled $67 million at December 31, 1995, compared with $74 million at year-end 1994. In the fourth quarter of 1995, the Bank performed a one-time reassessment of the designations of securities as held to maturity or available for sale, in accordance with a special report issued by the Financial Accounting Standards Board on the subject of investments. As a result of this assessment, $5.9 million of collateralized mortgage obligations were transferred out of the held to maturity portfolio into the available for sale portfolio.\nThe Securities Available for Sale portfolio totaled $6.3 million at December 31, 1995, with no investments being included in this category in 1994. Included in the December 31, 1995 balance is an unrealized gain of $143 thousand.\nThere have been no realized gains or losses on securities in 1995 or 1994. Gains of $77 thousand were realized in 1993. At December 31, 1995, there were unrealized gains of $623 thousand and losses of $244 thousand in the securities held to maturity portfolio.\nAdditional information concerning securities is provided in the footnotes to the accompanying financial statements.\nOTHER REAL ESTATE OWNED\nThere was no Other Real Estate Owned on the Bank's balance sheet at December 31, 1995 and 1994. The Bank's policy is to carry properties acquired in foreclosure at fair value less estimated selling costs, which is determined using recent appraisal values adjusted, if necessary, for other market conditions. Loan balances in excess of fair value are charged to the allowance for loan losses when the loan is reclassified to other real estate. Subsequent declines in fair value are charged against a valuation allowance for other real estate owned, created by charging a provision to other operating expenses. The Bank has not had any significant expenses related to Other Real Estate Owned in 1995 or 1994. In 1993, expenses related to Other Real Estate Owned totaled $234 thousand.\nDEPOSIT CONCENTRATION\nPrior to 1992, the Bank's focus on real estate-related activities resulted in a concentration of deposit accounts from title insurance and escrow companies. As the Bank has changed its focus to commercial lending, the amounts of title and escrow related deposits has declined for the past three years. These deposits are generally noninterest bearing transaction accounts that contribute to the Bank's interest margin. Noninterest expense related to these deposits is included in other operating expense. The Bank monitors the profitability of these accounts through an account analysis procedure.\nThe Bank offers products and services allowing customers to operate with increased efficiency. A substantial portion of the services, provided through third party vendors, are automated data processing and accounting for trust balances maintained on deposit at the Bank. These and other banking related services, such as deposit courier services, will be limited or charged back to the customer if the deposit relationship profitability does not meet the Bank's expectations.\nNoninterest bearing deposits represent nearly the entire title and escrow relationship. These balances have been reduced substantially as the Bank focused on middle market business loans. The balance at December 31, 1995, was $20 million compared to $44 million at December 31, 1994. The bank has greatly reduced their reliance on title and escrow deposits, with these relationships representing approximately 7% of deposits in 1995, and 17% at year end 1994.\nTABLE 5 REAL ESTATE ESCROW AND TITLE INSURANCE COMPANY DEPOSITS AMOUNTS IN THOUSANDS OF DOLLARS\nThe Bank had $45 million in certificates of deposit larger than $100 thousand dollars at December 31, 1995. The maturity distribution of these deposits is relatively short term, with $31 million maturing within 3 months and $43 million maturing within 12 months.\nLIQUIDITY AND INTEREST RATE SENSITIVITY\nThe objective of liquidity management is to ensure the Bank's ability to meet cash requirements. The liquidity position is managed giving consideration to both on and off-balance sheet sources and demands for funds.\nSources of liquidity include cash and cash equivalents (net of Federal Reserve requirements to maintain reserves against deposit liabilities), securities eligible for pledging to secure borrowings from dealers pursuant to repurchase agreements, loan repayments, deposits, and borrowings from a $25 million overnight federal funds line available from a correspondent bank. Potential significant liquidity requirements are withdrawals from noninterest bearing demand deposits and funding of commitments to loan customers.\nFrom time to time the Bank may experience liquidity shortfalls ranging from one to several days. In these instances, the Bank will either purchase federal funds, and\/or sell securities under repurchase agreements. These actions are intended to bridge mismatches between funding sources and requirements, and are designed to maintain the minimum required balances. The Bank has had no Fed Funds purchased or borrowings under repurchase agreements during 1994 or 1995.\nDuring 1994 and 1995, loan growth for the Bank outpaced growth of deposits from the Banks commercial customers. The Bank funded this growth, combined with the Bank's reduced concentration in title and escrow deposits, in part with certificates of deposit from customers from outside the Bank's normal service area. These out of area deposits are certificates of deposit of $90,000 or greater, that are priced competitively with similar certificates from other financial institutions throughout the country. At December 31, 1995, the Bank had approximately $83 million of these out of area deposits, up from $55 million at December 31, 1994. The Bank's experience with raising out of area deposits for the past two years indicates that the balances are quite stable when priced to the current market.\nThe Bank's portfolio of large certificates of deposit (those of $100 thousand or more), includes both deposits from its base of commercial customers and out of area deposits. At December 31, 1995 this funding source was 17% of average deposits, compared to 16% at December 31, 1994.\nTABLE 6 INTEREST RATE MATURITIES OF EARNING ASSETS AND FUNDING LIABILITIES AT DECEMBER 31, 1995\nAmounts in thousands of dollars\n(1) Ratios greater than 1.0 indicate a net asset sensitive position. Ratios less than 1.0 indicate a liability sensitive position. A ratio of 1.0 indicates risk neutral position.\nAssets and liabilities shown on Table 5 are categorized based on contractual maturity dates. Maturities for those accounts without contractual maturities are estimated based on the Bank's experience with these customers. Noninterest bearing deposits of title and escrow companies, having no contractual maturity dates, are considered subject to more volatility than similar deposits from commercial customers. The net cumulative gap position shown in the table above indicates that the Bank does not have a significant exposure to interest rate fluctuations during the next twelve months.\nCAPITAL\nTotal shareholders' equity was $33 million at December 31, 1995, compared to $30 million at year-end 1994. This increase was due to earnings, plus the exercise of stock options and warrants. The Bank is guided by statutory capital requirements, which are measured with three ratios, two of which are sensitive to the risk inherent in various assets and which consider off-balance sheet activities in assessing capital adequacy. During 1995 and 1994, the Bank's capital levels substantially exceeded the \"well capitalized\" standards, the highest classification established by bank regulators.\nTABLE 7 CAPITAL RATIOS\nIn February of 1995, the Company declared a dividend of $.02 per share payable March 13, 1995 to shareholders of record February 20, 1995. The Company also declared a dividend of $.02 per share for the quarter ended June 30, 1995, payable September 4, 1995 to shareholders of record August 15, 1995. During the third quarter, the company declared a dividend $.02 per share, payable November 27 to shareholders of record November 13. For the fourth quarter of 1995, the company declared a dividend of $.02 per share, payable February 28 to shareholders of record January 31. The dividend payout ratio was 13% for the year ending December 31, 1995. No dividends were paid in 1994 .\nThe common stock of the Company is listed on the National Association of Securities Dealers Automated Quotation (Nasdaq) National Market Systems where it trades under the symbol CUBN.\nTABLE 8 STOCK PRICES - UNAUDITED\nEARNINGS BY LINE OF BUSINESS\nPrior to the sale of the mortgage origination operation in November, 1993, the Bank operated a commercial bank and a mortgage bank as two distinct business segments. Since 1994, real estate lending is generally only done as part of a commercial banking relationship. After 1993, therefore, the Bank operates as only a single segment, the commercial banking operation. Table 9 shows the pre-tax operating contributions.\nTABLE 9 PRE-TAX OPERATING CONTRIBUTION BY LINE OF BUSINESS (i)\nAmounts in thousands of dollars\n(i) Inter-divisional transactions for 1993 have been eliminated at the division level.\nNET INTEREST INCOME AND INTEREST RATE RISK\nNet interest income is the difference between interest and fees earned on earning assets and interest paid on funding liabilities. Net interest income was $15.5 million for the year ended December 31, 1995 compared to $13.9 million in 1994 and $14.4 million in 1993. The change in 1995 is attributable to changes in volume and deposit mix. The Bank's net interest income has improved with the growth of the commercial loan portfolio from 1994 to 1995. This improvement was offset in part by the change in deposit mix away from non interest bearing title and escrow deposits, and the increase in certificates of deposit. The change in 1994 is primarily attributable to lower levels of average loans and deposits in 1994 being offset by favorable rate variations.\nTABLE 10 ANALYSIS OF CHANGES IN NET INTEREST INCOME (1)\nAmounts in thousands of dollars Increases(Decreases)\n(1) The change in interest income or interest expense that is attributable to both change in average balance and average rate has been allocated to the changes due to (i) average balance and (ii) average rate in proportion to the relationship of the absolute amounts of the changes in each.\nYields on earning assets were approximately 8.9% for the year ended December 31, 1995, compared to 7.8% in 1994 and 7.6% in 1993. The higher average yield on earning assets in 1995 is the result of both an increase in the prime rate from an average of 7.1% in 1994 to an average of 8.8% in 1995, and an increasing percentage of assets being held in loans.\nThe higher average yield on earning assets in 1994 is largely due to the higher yield on loans as the prime rate began to rise in 1994. The average prime rate of 7.1% compares with 6% for 1993. Through October 8, 1993, net interest income continued to benefit from an interest rate swap agreement, discussed below.\nRates on interest bearing liabilities resulted in an average cost of funds of 4.2% in 1995, compared with 3.0% for the comparable period of 1994 and 2.9% for 1993. In addition to the generally higher level of interest rates in 1995, certificates of deposit represent a higher proportion of the funding liabilities, rather than lower cost money market or savings accounts.\nExpressing net interest income as a percent of average earning assets is referred to as margin. Margin was 5.66% for 1995, compared to 5.99% in 1994 and 5.85% for 1993. The Bank's margin is strong because it has funded itself with a\nsignificant amount of noninterest bearing deposits. Margin in 1995 is somewhat lower than 1994 due to the lower level of non interest bearing title and escrow deposits in the current year. Margin in 1994 was higher than 1993 as the benefits of rising interest rates offset the maturing of the interest rate swap agreement discussed below.\nThrough October 8, 1993, the Bank continued to benefit from an interest rate swap agreement entered into October 8, 1991, which had a notional amount of $100 million. Under this arrangement, the Bank received a fixed rate of 8.18% and paid interest at prime rate, which was 6.0% during 1993. The income earned from the interest rate swap agreement was $0 in 1994 and 1995, compared to $1.7 million in 1993.\nTABLE 11 AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME\nAmounts in thousands of dollars\n(1) Non-accrual loans are included in average loan balances, and loan fees earned have been included in interest income on loans. (2) Tax exempt securities do not materially affect reported yields.\nOTHER OPERATING INCOME\nA significant portion of other operating income in 1994 was earned as mortgage servicing rights were sold for a gain of $2.6 million. The Bank reported a gain of $383 thousand on the sale of mortgage servicing in 1995, representing final\nsettlement payments received related to open issues on servicing sales from prior quarters. At year end 1995, the Bank did not own any further servicing rights.\nThe majority of other operating income for 1993 was earned as the Mortgage Banking Operation originated and sold mortgage loans.\nThe Mortgage Banking Operation earned fee income on loans originated and gains as loans were sold to permanent investors. Loans for which servicing was retained were conventional mortgages under approximately $200 thousand which were sold to the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and other institutional investors. Excess servicing rights were capitalized, and related gains recognized, based on the present value of the servicing cash flows discounted over a period of seven years. When loan prepayments occurred within this period, the remaining capitalized cost associated with the loan was written off.\nThe servicing rights were retained by the Bank following sale of the mortgage origination operation. The Bank entered into an agreement with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation to dispose of any remaining portion of this portfolio by the end of 1994 because, with the sale of the mortgage origination operation, the Bank was no longer a qualified seller\/servicer of such loans. During 1994, the bank sold the retained servicing rights realizing gains of $2.6 million in 1994 and $383 thousand in 1995.\nThe trends and composition of other operating income are shown in the following table.\nTABLE 12 OTHER OPERATING INCOME\nAmounts in thousands of dollars\nOPERATING EXPENSE\nTotal operating expenses for the Bank were $12.6 million year ended December 31, 1995 , compared to $14.7 million in 1994 and $36.9 million for 1993. The year ended December 31, 1995 reflected lower expenses, in part because of a reduction in FDIC insurance premiums paid, from $.23 to $.04 per $100 of deposits. The current level of operating expense is deemed to be adequate and will be leveraged further as the core middle market business is expanded.\nThe Bank restructured its branch operations functions in 1994, re-engineering its entire work flow and information handling activities. This resulted in a one time charge of $600 thousand for severance pay and other expenses associated with the changes to the operating policies and procedures. Operating expense for the commercial bank excluding this charge was\n$12.6 million in 1995, compared to $14.1 million in 1994 and $13.9 million in 1993. Operating expenses for the consolidated Bank declined in 1994, primarily due to the sale of the mortgage origination operation at the end of 1993.\nExpenses for the Mortgage Banking Division were $22.5 million in 1993. Premium on sales of mortgage loans included in other operating income is directly related to these expenses and subject to the same factors and conditions. The premium on sales of mortgage loans was $18.0 million in 1993.\nPROVISION FOR LOAN LOSSES\nThe Bank has made no provision for loan losses in 1995 or 1994 , compared with $450 thousand for 1993. No loan loss provision has been deemed necessary for 1995 and 1994, due to the declining levels of nonperforming assets, net recoveries received in 1994, and the strong reserve position. The relationship between the level and trend of the allowance for loan losses and nonperforming assets, combined with the results of the ongoing review of credit quality, determine the level of provisions.\nLEGAL AND REGULATORY\nIn the normal course of business the Bank occasionally becomes a party to litigation. In the opinion of management, based upon consultation with legal counsel, the Bank believes that pending or threatened litigation involving the Bank will have no adverse material effect upon its financial condition, or results of operations.\nSince June 1992, the Bank has developed a very positive and proactive relationship with its primary regulators. Results of regular safety and soundness examinations have documented the progress the Bank has achieved. Management is committed to the continuation of this process and maintaining our high standing with our regulators. The following comments refer to regulatory situations that existed in prior years that are reflected in the prior period financial statements provided herein. All of these situations have been successfully resolved and repaired as management transitioned the Bank to its present condition and performance.\nIn June 1992, the Bank entered into an agreement with the Office of the Comptroller of the Currency (OCC), the Bank's primary federal regulator, which required the implementation of certain policies and procedures for the operation of the bank to improve lending operations and management of the loan portfolio. In November 1993, after completion of its annual examination, the OCC released the Bank from the Formal Agreement. Following this, the Federal Reserve Bank of San Francisco (\"Fed\") notified the Company on November 29, 1993, that the Memorandum of Understanding, which it had signed, was terminated because the requirements of the agreement were satisfied.\nMARKET EXPANSION AND ACQUISITIONS\nThe Bank is committed to expanding the market penetration of the commercial bank, including the creation of new branches and pursuing acquisition opportunities. During 1995, the Bank converted its former loan production offices in Ventura County, the San Gabriel Valley and the South Bay to full service banking offices in improved facilities. This expanded the Bank's branch system to five full service locations serving the greater Los Angeles area.\nIn March, 1995, the Company entered into an agreement to acquire Santa Ana based Corporate Bank. The agreement was subsequently amended in October 1995 and the transaction was completed on January 12, 1996 for stock and cash. This acquisition brings two Orange County branches to the Bank, representing an important geographic expansion.\nTable 13 is an approximation of how the Bank's balance sheet would have appeared had the acquisition of Corporate Bank closed by December 31, 1995:\nOn January 10, 1996, the Bank announced an agreement to merge with Home Interstate Bancorp, parent of Home Bank, based in the South Bay. The merger with Home Bank is expected to be completed in mid - 1996, and will create a Bank with 22 branches and over $800 million in assets.\nTable 13: Pro Forma Balance Sheet\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of CU Bancorp and Subsidiary:\nWe have audited the accompanying consolidated statements of financial conditions of CU Bancorp and Subsidiary (the Company) 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 then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CU Bancorp and Subsidiary as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years then ended in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nLos Angeles, California January 19, 1996\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION CU BANCORP AND SUBSIDIARY\nThe accompanying notes are an integral part of these consolidated statements.\nCONSOLIDATED STATEMENTS OF INCOME CU BANCORP AND SUBSIDIARY\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS CU BANCORP AND SUBSIDIARY\nThe accompanying notes are an integral part of these consolidated statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS CU BANCORP AND SUBSIDIARY DECEMBER 31, 1995 (Amounts in thousands unless otherwise specified)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --\nCU Bancorp, a bank holding company (the Company), is a California corporation. The accounting and reporting policies of the Company and its subsidiary conform with generally accepted accounting principles and general practice within the banking industry. The following comments describe the more significant of those policies.\n(a) Principles of consolidation -- The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, California United Bank N.A. (the Bank). All significant transactions and accounts between the Company and the Bank have been eliminated in the consolidated financial statements.\n(b) Investment portfolio -- The Bank's investment portfolio is separated into two groups, Securities Held to Maturity and Securities Available for Sale. Securities are segregated in accordance with management's intention regarding their retention. Accounting for each group of securities follows the requirements of SFAS 115 \"Accounting for Certain Investments in Debt and Equity Securities\". The adoption of SFAS 115 in 1993 did not have a material impact on the financial position or results of operations of the Bank.\nThe Bank has the intent and ability to hold Securities Held to Maturity until maturity. Securities in this classification are carried at cost, adjusted for amortization of premiums and accretion of discounts on a straight-line basis. This approach approximates the effective interest method. Gains and losses recognized on the sale of investment securities are based upon the adjusted cost and determined using the specific identification method.\nSecurities Available for Sale are those where management has the willingness to sell under certain conditions. This category of securities is carried at current market value with unrealized gains or losses recognized as a tax affected adjustment to shareholders' equity in the statement of financial condition.\n(c) Loans -- Loans are carried at face amount, less payments collected, allowance for loan losses, and unamortized deferred fees. Interest on loans is accrued monthly on a simple interest basis. The general policy of the Bank is to discontinue the accrual of interest and transfer loans to non-accrual (cash basis) status where reasonable doubt exists with respect to the timely collectibility of such interest. Payments on non-accrual loans are accounted for using a cost recovery method. No interest income is recorded on non-accrual loans.\nLoan origination fees and commitment fees, offset by certain direct loan origination costs, are deferred and recognized over the contractual life of the loan as a yield adjustment.\nThe allowance for loan losses is maintained at a level considered adequate to provide for losses that can reasonably be anticipated. Management considers the nature of the portfolio, current economic conditions, historical loan loss experience, and other factors in determining the adequacy of the allowance. The allowance is based on estimates and ultimate losses may differ from current estimates. These estimates are reviewed periodically and as adjustments become necessary, they are charged to earnings in the period in which they become known. The allowance is increased by provisions charged to operating expenses, increased for recoveries of loans previously charged-off, and reduced by charge-offs.\nThe Bank adopted SFAS 114, \"Accounting by Creditors for Impairment of a Loan,\" and SFAS 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,\" as of January 1, 1995. SFAS 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. When the measure of the impaired loan is less than the recorded balance of the loan, the impairment is\nrecorded through a valuation allowance included in the allowance for loan losses. The Bank had previously measured the allowance for loan losses using methods similar to the prescribed in SFAS 114. As a result, no additional provision was required by the adoption of this pronouncement.\nThe Bank considers all loans where reasonable doubt exists as to the payment of interest or principal to be impaired loans. All loans that are ninety days or more past due are automatically included in this category. An impaired loan will be charged off when the Bank determines that repayment of principal has become unlikely or subject to a lengthy collection process. All loans that are six months or more past due and not well secured or in the process of collection are charged off.\n(d) Mortgage Banking Division -- The bank's real estate Mortgage Banking Division became operational in 1988. The mortgage origination operation was sold November 10, 1993. The Bank carried the first trust deed loans generated and held for sale by this Operation at the lower of aggregate cost or market. As of December 31, 1993, cost approximated market value. All loan inventory held for sale by this division had been sold prior to the end of 1994.\nDuring 1993, the Bank capitalized $207 in connection with the right to service real estate mortgage loans originated in that Operation. This excess servicing asset, included in other assets, was initially capitalized at its discounted present value and amortized over a period of five to seven years. Amortization for 1995, 1994, and 1993, was $0, $15, and $983 respectively.\n(e) Premises and equipment -- Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful life of the asset. Amortization is computed on the straight-line method over the useful life of leasehold improvements or the remaining term of the lease, whichever is shorter.\n(f) Other real estate owned -- Other real estate owned, acquired through direct foreclosure or deed in lieu of foreclosure, is recorded at the lower of the loan balance or estimated fair market value. When a property is acquired, any excess of the loan balance over the estimated fair market value is charged to the allowance for loan losses. Subsequently, the assets are recorded at the lower of the new cost basis at foreclosure or fair market value less estimated selling expenses. Subsequent write-downs, if any, are included in other operating expenses in the period in which they become known. Gains or losses on sales are recorded in conformity with standards which apply to accounting for sales of real estate. The Bank had no real estate owned at December 31, 1995, and at December 31, 1994.\n(g) Interest Rate Derivatives -- The Company enters into interest rate hedge agreements which involve the exchange of fixed and floating rate interest payments periodically over the life of the agreement without the exchange of the underlying principal amounts. The differential to be paid or received is accrued as interest rate change and recognized over the life of the agreements as an adjustment to interest expense.\nFees received in connection with loan commitments are deferred in other liabilities until the loan is advanced and are then recognized over the term of the loan as an adjustment of the yield. Fees on commitments that expire unused are recognized in fees and commission revenue at expiration. Fees received for guarantees are recognized as fee revenue over the term of the guarantees.\n(h) Income taxes -- As discussed in Note 8, effective January 1, 1993, the Bank adopted the Statement of Financial Accounting Standards No. 109 (SFAS No. 109), \"Accounting for Income Taxes.\" Under SFAS No. 109, deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.\n(i) Earnings per share (amounts in whole numbers) -- Earnings per share are computed based on the weighted average number of shares and common stock equivalents outstanding during each year of 4,857,221 in 1995, 4,593,103 in 1994, and 4,489,861 in 1993, retroactively restated for stock dividends and stock splits. Common stock equivalents include the number of shares issuable on the exercise of outstanding options and warrants reduced by the number of shares that could have been purchased with the proceeds from the exercise of the options and warrants plus any tax benefits, based on the average price of common stock.\n(j) Statements of cash flows -- The Company presents its cash flows using the indirect method and reports certain cash receipts and payments arising from customer loans and deposits, and deposits placed with other financial institutions on a net basis. For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.\n(k) Post-retirement benefits -- The Company provides no post-retirement benefits. Accordingly, the accounting prescribed by Statement of Financial Accounting Standards No. 106 \"Accounting for Post-Retirement Benefits\" has no effect on the Company's consolidated financial statements.\n(l) Stock-Based Compensation In October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\". SFAS 123 requires all companies to change what they disclose about their employee stock-based compensation plans, recommends that they change how they account for these plans and requires those companies who do not change their accounting to disclose what their earnings and earnings per share would have been if they had changed their method of accounting pursuant to this pronouncement. The Company has elected to continue to account for their Stock-Based Compensation in accordance with Accounting Principles Board Opinion (APBO 25) and to adopt only the disclosure requirements of SFAS 123. As a result, the adoption of SFAS 123 will not have an impact on the financial position or results of operations of the company.\n(m) Reclassifications -- Certain amounts have been reclassified in the prior years to conform to classifications followed in 1995.\n(n) Accounting 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 during the reporting period. Actual results could differ from those estimates.\n2. NATURE OF OPERATIONS --\nThe Bank engages in the commercial banking business serving the greater Southern California metropolitan area, with offices located in the San Fernando Valley, West Los Angeles, the San Gabriel Valley , the South Bay portion of the County of Los Angeles, and Ventura County. The Bank's primary focus is to engage in middle market lending to businesses, professionals, the entertainment industry and high net-worth individuals. Retail or consumer banking business is generally limited to the owners, officers and employees of its commercial customers, and customers of accounting and business management firms with which the Bank regularly does business. Deposit services which the Bank offers include personal and business checking accounts and savings accounts, insured money market deposit accounts, NOW accounts, and time certificates of deposits, along with IRA and Keogh accounts. The Bank also provides other customary banking services incidental to maintaining the commercial customer relationships.\n3. AVERAGE FEDERAL RESERVE BALANCES --\nThe average cash reserve balances required to be maintained at the Federal Reserve Bank, under the Federal Reserve Act and Regulation D, were approximately $2.4 million and $6.0 million for the years ended December 31, 1995 and 1994, respectively.\n4. INVESTMENT PORTFOLIO --\nA summary of Securities Held to Maturity at December 31, 1995 and 1994, is as follows:\nA summary of Securities Available for Sale for December 31, 1995 is as follows:\nInvestments with a book value of $27,900 and $29,200 were pledged as of December 31, 1995 and 1994, respectively, to secure court deposits and for other purposes as required or permitted by law. Included in interest on investments in 1995, 1994, and 1993, is $0, $19, and $33, respectively, of interest from tax-exempt securities.\nActual maturities may 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 and market value of Securities Held to Maturity as of December 31, 1995, by maturity, are shown below.\nAt December 31, 1995, the securities available for sale portfolio consisted of Federal Reserve Bank stock and mortgage backed securities. The Federal Reserve Bank stock, with a 6% yield, has no stated maturity. The actual maturity of the mortgage-backed securities is determined by the rate of repayment of the loan pools collateralizing the securities. Actual cash maturities of the Bank's mortgage-backed securities, with an approximate yield of 7%, are expected to be from one to five years.\nIn December 1995, as permitted by a Special report of the Financial Accounting Standards Board \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\", the Bank made a one time transfer of investment securities into the Available for Sale portfolio. These securities had an amortized cost and market value of $5,769 and $5,912, respectively.\nAt December 31, 1994, there were no Securities Available for Sale.\nProceeds from the sales and maturities of debt securities during 1995, 1994, and 1993 were $17,722, $52,882, and $78,545, respectively. Gains of $0, $0, and $77 were realized on those transactions. There were no realized losses on sales in 1995, 1994, and 1993.\n5. LOANS -- The loan portfolio, net of unamortized deferred fees of $522 at December 31, 1995, and $652 at December 31, 1994, consisted of the following:\nAt December 31, 1995, the Bank had $1,000 in impaired loans, against which a loss allowance of $318 has been provided. The recorded loss allowance for all impaired loans has been calculated based on the present value of expected cash flows discounted at the loan's effective interest rate. All impaired loans are on nonaccrual status, and as such no interest income is recognized. The Bank had an average investment in impaired loans of approximately $352 for the year ended December 31, 1995.\nTotal non-performing loans were $4,000 and $36 at December 31, 1995 and 1994, respectively. The interest income, which would have been recognized had non-accrual loans been current, amounted to $ 82, $6, and $469, in 1995, 1994, and 1993, respectively. No interest income has been reported on non-accrual loans for the years 1995, 1994, or 1993.\nAn analysis of the activity in the allowance for loan losses is as follows:\n6. LOANS TO RELATED PARTIES --\nThere were no loans to directors and their affiliates for the years ended 1995 and 1994.\n7. PREMISES AND EQUIPMENT -- Book value of premises and equipment is as follows:\nThe amounts of depreciation and amortization included in noninterest expense were $553, $459, and $821 for the years ended December 31, 1995, 1994 and 1993, respectively, and are based on estimated lives of 1 to 10 years for furniture, fixtures and equipment, and leasehold improvements.\nThe Bank leases facilities under renewable operating leases. Rental expense for premises included in occupancy expenses were $833 in 1995, $741 in 1994, $1,133 in 1993. As of December 31, 1995, the approximate future lease payable under the lease commitments is as follows:\n8. 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 both imposes contractual obligations and rights to exchange cash, and\/or other financial instruments on the parties to the transaction.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash, Due From Banks and Federal Funds Sold For these short term investments, the carrying amount is a reasonable estimate of fair value.\nSecurities Quoted market prices are available for substantially all of the securities owned by the Bank, both in the Held to Maturity and Available for Sale portfolios. These market quotes have been used to estimate fair value. Loans The fair value of loans was estimated by discounting the future cash flows using current market rates adjusted for approximated credit risk, operating costs and interest rate risk inherent in the portfolios. Future cash flows are aggregated based upon the payment terms and maturities of the loans. The discount rate is calculated as the sum of the risk-free rate, a credit quality factor, an operating expense factor and a prepayment option price. The risk-free rate is based on the U.S. treasury curve for the stated maturity. The credit quality factor is based on a combination of the Bank's loss experience and industry standards for various categories of loans. The operating expense factor is based on an internal analysis of the Bank's costs to deliver and service products.\nDeposit Liabilities Fair value for deposit liabilities without contractual maturities is equal to the carrying value of those liabilities. This includes the bank's demand deposits, NOW, savings and money market accounts. Fair value for certificates of deposit are calculated by discounting the future cash flows using a current market rate. The Bank's certificate of deposit portfolio has a fair value which reasonably approximates carrying value, due to the short duration of the portfolio.\nOff Balance Sheet Items The Bank's loan commitments are generally for variable rate loans representing current market rates of interest. The Bank's letters of credit are generally short term and are at terms consistent with the current market. Current valuation of these off balance sheet instruments is immaterial. See footnote 11 for further description of these commitments.\nEstimations of fair value of financial instruments are subject to significant uncertainty because active and liquid markets do not exist for a majority of them. The estimates include assumptions concerning financial conditions, risk characteristics, expected future losses, and market interest levels, among other factors, and if changed could have a significant impact on them. The resulting presentations of estimated fair value is not necessarily indicative of the value realizable in an actual exchange of financial instruments.\n9. INCOME TAXES -\nThe provisions (benefits) for income taxes for the years ended December 31, 1995, 1994 and 1993 for financial reporting were as follows:\nAs of December 31, 1995 and 1994, the temporary differences which give rise to a significant portion of deferred tax assets and liabilities are as follows:\nThe Bank maintains a valuation reserve against net deferred tax assets to reflect the inherent uncertainty of the ultimate realization of those assets. The value of the Bank's largest deferred tax assets represent expenses, such as the loan loss provision, which will become deductible on a future tax return when an actual loss is incurred. Realization of deferred tax assets are dependent on the availability of taxable income in the future or prior years to offset these deductions. Because the State of California does not currently allow net operating loss carrybacks, realization of deferred tax assets related to California Franchise Taxes is subject to a greater degree of uncertainty.\nThe provisions (benefits) for income taxes varied from the Federal statutory rate of 34% for 1995, 1994, and 1993, for the following reasons:\nThe total net deferred tax of $2,513 in 1995 and $3,711 in 1994 is included in Other Assets in the Consolidated Statements of Financial Condition.\nAt December 31, 1993, the Company had a California Franchise Tax carryforward of $1.9 million, with the entire operating loss carryforward being utilized in 1994. The Bank had no operating loss carryforwards at December 31, 1994 or 1995.\n10. SHAREHOLDERS' EQUITY -\nThe Company has three employee stock option plans. The 1983 plan, which authorized the issuance of 400,075 shares of common stock, and the 1985 plan, which authorized the issuance of 350,000 shares of common stock, expired in 1993 and 1995 respectively. The 1993 plan, authorizing the issuance of 400,000 shares of common stock, expires in 2003. Options are granted at a price not less than the fair market value of the stock at the date of grant. Options under these\nplans expire up to ten years after the date of grant. The options granted under the 1983 and 1985 plans are incentive stock options, as defined in the Internal Revenue Code. Options under the 1993 plan can be either incentive stock options or non- qualified options. No shares remain available for future grants for the 1983 and 1985 plans, although outstanding options remain and are exercisable over the period designated by those plans.\nIn 1987, a special stock option plan was approved that is limited to directors of the Company and provides for the issuance of 120,960 shares of common stock. The plan expires in 1997. Options granted under the plan are non-qualified stock options. Each of the directors of the Company, at the time the special stock option plan was approved, received stock options to purchase 15,120 shares at $5.78 per share, which was in excess of the then prevailing market price. Options expire 10 years after the date of grant. There are no remaining options available for grant under the 1987 special stock plan.\nIn 1994, a non-employee director stock option plan was approved that provides for the issuance of 200,000 shares of common stock. The plan expires in 2004. Options granted under the plan are non-qualified stock options. During 1994, options were granted to purchase 27,500 shares at $6.25 per share , which was equal to the market price at the date of grant. During 1995, 27,500 options were granted at $6.88 per share. Options expire 10 years from the date of grant\nThe following table summarizes information on stock options outstanding for the years ended December 31, 1995 and 1994, as follows:\nDuring 1994, 1,000 non-qualified stock options under the 1985 plan were exercised at $4.75 per share. In 1995, 15,120 non-qualified stock options under the 1987 plan were exercised at $5.78 per share. No other stock options were exercised in 1994 or 1995.\nThe following information is presented concerning the stock option plans as of December 31, 1995:\nIn 1984, certain members of the Board of Directors were granted warrants to purchase up to 360,067 shares of common stock at $4.17 per share, primarily for guaranteeing a capital note issued by the Company. These warrants became exercisable when the capital note was paid off in 1987, and had a maturity date of February 15, 1995. During 1995, all outstanding warrants were exercised. During 1995 and 1994, warrants for 135,024 and 57,012 shares were\nexercised. In 1994, warrants to purchase 7,500 shares of common stock at the fair market value at date of grant of $7.00 per share, with an expiration date of February 1, 1999 , were issued to the former chairman of the board.\nOn June 29, 1995, the Company's shareholders approved adoption of a CU Bancorp 1995 Restricted Stock Plan, providing for the issuance of Common Stock to employees, subject to restrictions on sale or transfer. The restrictions on sale or transfer expire over a period of five years. During 1995, 19,000 restricted shares were issued with a market value of $185. This amount was recorded as unearned compensation and is shown as a separate component of shareholders' equity. Unearned compensation is being amortized to expense over the five year vesting period, with expense of $3 recorded for 1995.\n11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND COMMITMENTS AND CONTINGENCIES --\nThe consolidated statements of financial condition do not reflect various commitments relating to financial instruments which are used in the normal course of business. These instruments include commitments to extend credit, standby and commercial letters of credit, and interest rate floor and swap agreements. Management does not anticipate that the settlement of these financial instruments will have a material adverse effect on the Bank's financial position.\nThese financial instruments carry various degrees of credit and market risk. Credit risk is defined as the possibility that a loss may occur from the failure of another party to perform according to the terms of the contract. Market risk is the possibility that future changes in market prices may make a financial instrument less valuable.\nThe Bank primarily grants commercial and real estate loan commitments with variable rates of interest and maturities of one year or less to customers in the greater Los Angeles area. The contractual amounts of commitments to extend credit and standby and commercial letters of credit represent the amount of credit risk. Since many of the commitments and letters of credit are expected to expire without being drawn, the contractual amounts do not necessarily represent future cash requirements. For interest rate floor and swap agreements, the notional amounts do not represent exposure to credit loss.\nCommitments to extend credit are legally binding loan commitments with set expiration dates. They are intended to be disbursed, subject to certain conditions, upon request of the borrower. The Bank evaluates the creditworthiness of each customer. The amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based upon management's evaluation. Collateral held varies, but may include securities, accounts receivable, inventory, personal property, equipment, and income- producing commercial or residential property.\nStandby letters of credit are provided to customers to guarantee their performance, generally in the production of goods and services or under contractual commitments in the financial markets. Standby letters of credit generally have terms of up to one year.\nCommercial letters of credit are issued to customers to facilitate foreign and domestic trade transactions. They represent a substitution of the Bank's credit for the customer's credit. Such letters of credit are generally short term in nature and are collateralized by the merchandise covered by the transaction. At December 31, 1995 and 1994 there were $1.0 million and $1.5 million outstanding, respectively. These amounts reduce the availability under the applicable customer's loan facility.\nInterest rate swaps and floors may be created to hedge certain assets and liabilities of the Bank. These transactions involve either an exchange of fixed or floating rate payment obligations on an underlying notional amount. In the case of a rate floor, there is a guaranteed payment of a rate differential on a notional amount, should a specific market rate fall below a specific agreed upon level. Credit risk related to interest rate swaps is limited to the interest receivable from the counterparty less the interest owed that party or, in the case of rate floors, to interest receivable on the differential between the specific rate contracted in the floor agreement and actual rates in effect at various settlement dates. Market risk fluctuates with interest rates.\nThe following is a summary of various financial instruments with off-balance sheet risk at December 31,1995 and 1994:\nIn response to continued economic declines and anticipating interest rate declines, the Bank entered into an interest rate swap agreement effective October 8, 1991, for $100 million. Terms of this agreement were that the Bank would receive a fixed rate of 8.18% over two years in exchange for paying the average prime rate. Accrued benefits from this transaction amounted to $1,726 in 1993, and are included in interest income. Amounts due the Bank or counterparty were settled quarterly. This agreement expired on October 8, 1993.\nIn the normal course of business, the Company occasionally becomes a party to litigation. See footnote 15.\n12. OTHER OPERATING EXPENSES --\nOther operating expenses included the following:\n13. CONDENSED FINANCIAL INFORMATION OF CU BANCORP --\nAt December 31, 1995 and 1994, the condensed unconsolidated balance sheets of the Company are as follows:\nFor the years ended December 31, 1995, 1994, and 1993, the condensed unconsolidated statements of income of the Company are as follows:\nFor the years ended December 31, 1995, 1994 and 1993, the condensed unconsolidated statements of cash flows are as follows:\nAmounts in thousands of dollars\nUnder National banking law, the Bank is limited in its ability to declare dividends to the Company to the total of its net income for the year, combined with its retained net income for the preceding two years less any required transfers to surplus. The effect of this law was to preclude the bank from declaring any dividends at December 31, 1994 and 1993. The Bank has received permission from the OCC to pay dividends to the Company in 1995, in anticipation of the cash dividends paid by the Company. No dividends were actually paid by the Bank in 1995,1994 or 1993.\n14. SUBSEQUENT EVENTS\nIn March of 1995, the Bank had announced the signing of an agreement to acquire Corporate Bank, a Santa Ana based community bank with approximately $70 million in assets. This purchase was completed in January 1996, with Corporate Bank being acquired in exchange for the issuance of approximately 649 thousand shares of CU Bancorp common stock and $1.7 million cash. The acquisition of Corporate Bank will be reflected using the purchase method of accounting in the first quarter of 1996. Also in January 1996, the Bank announced the signing of an agreement to merge with Home Interstate Bancorp, the parent of Home Bank, based in the South Bay. Home Bank provides retail and business banking from its principal office in Signal Hill and fourteen additional branch locations. The agreement with Home Bank provides for the combination to be effected through the exchange of common stock, and is expected to be accounting for as a pooling of interests. This merger, which is targeted to be completed near the end of the second quarter of 1996, would create a combined bank with over $800 million in assets and 22 branches.\n15. LEGAL MATTERS\nIn the normal course of business the Bank occasionally becomes a party to litigation. In the opinion of management, based upon consultation with legal counsel, the Bank believes that pending or threatened litigation involving the Bank will have no adverse material effect upon its financial condition, or results of operations.\nUntil third quarter 1995, the Bank was a defendant in multiple lawsuits related to the failure of two real estate investment companies, Property Mortgage Company, Inc., (\"PMC\") and S.L.G.H., Inc. (\"SLGH\"). The lawsuits, consisted of a federal action by investors in PMC and SLGH (the \"Federal Investor Action\"), at least three state court actions by groups of Investors (the \"State Investor Actions\"), and an action filed by the Resolution Agent for the combined and reorganized bankruptcy estate of PMC and SLGH (the \"Neilson\" Action). An additional action was filed by an individual investor and his related pension and profit sharing plans (the \"Individual Investor Action\"). Other defendants in these multiple actions and in related actions include financial institutions, title companies, professionals, business entities and individuals, including the principals of PMC and SLGH. The Bank was a depository bank for PMC, SLGH and related companies and was a lender to certain principals of PMC and SLGH (\"Individual Loans\"). Plaintiffs alleged that PMC\/SLGH was or purported to be engaged in the business of raising money from investors by the sale and issuance of interests in loans evidenced by promissory notes secured by real property. Plaintiffs alleged that false representations were to the Bank's conduct with regard to the depository accounts, the lending relationship with the principals and certain collateral taken , pledged by PMC and SLGH in conjunction with the Individual Loans. The lawsuits alleged inter alia violations of federal and state securities laws, fraud, negligence, breach of fiduciary duty, and conversion as well as conspiracy and aiding and abetting counts with regard to these violations. The Bank denied all allegations of wrongdoing. Damages in excess of $100 million were alleged, and compensatory and punitive damages were sought generally against all defendants, although no specific damages were prayed for with regard to the Bank. A former officer and director of the Bank was also been named as a defendant.\nThe Bank entered into a settlement agreement with the representatives of the various plaintiffs, which has now been consummated, with the dismissal of all of the above referenced cases, with prejudice, against the Bank, its officers and directors, with the exception of the officer\/director previously named pending. Court approval of these settlements has been received. In connection with the settlement, the Bank released its security interest in certain disputed collateral and cash proceeds thereof, which the Bank received from PMC, SLGH, or the principals, in connection with the Individual Loans. This collateral had been a subject of dispute in the Neilson Action, with both the Bank and the representatives of PMC\/SLGH asserting the right to such collateral. All the Individual Loans have been charged off. The Bank also made a cash payment to the Plaintiffs in connection with the settlement. The effect of this settlement on CU Bancorp or the Bank's financial statements was immaterial. In connection with the settlement the Bank assigned its rights, if any, under various insurance policies, to the Plaintiffs. The settlement does not resolve the claims asserted against the officer\/director. The Bank is still providing a defense to its former director\/officer who continues as a defendant and who retains his rights of indemnity, if any, against the Bank arising out of his status as a former employee. At this time the only viable claims which appear to remain against the former director\/employee are claims of negligence in connection with certain depository relationships with PMC\/SLGH. While the Bank's Director and Officer Liability Insurer has not acknowledged coverage of any potential judgment or cost of defense, the Insurer is on notice of the action and has participated in various aspects of the case.\n16. REGULATORY MATTERS\nSince June 1992, the Bank has developed a very positive and proactive relationship with its primary regulators. Results of regular safety and soundness examinations have documented the progress the Bank has achieved. Management is committed to the continuation of this process and maintaining a high standing with the regulators. The following comments refer to regulatory situations that existed in prior years that are reflected in the prior period financial statements provided herein. All of these situations have been successfully resolved and repaired as management transitioned the Bank to its present condition and performance.\nOn November 2, 1993, the Office of the Comptroller of the Currency (\"OCC\"), after completion of their annual examination of the Bank, terminated the Formal Agreement entered into in June, 1992. In December 1993, the Fed terminated the Memo of Understanding entered into in August, 1992.\nThe Formal Agreement had been entered into in June 1992 and required the implementation of certain policies and procedures for the operation of the Bank to improve lending operations and management of the loan portfolio. The Formal Agreement required the Bank to maintain a Tier 1 Risk Weighted Capital ratio of 10.5% and a 6.0% Tier 1 Leverage Ratio. The Formal Agreement mandated the adoption of a written program to essentially reduce criticized assets, maintain adequate loan loss reserves and improve bank administration, real estate appraisal, asset review management and liquidity policies, and restricted the payment of dividends.\nThe agreement specifically required the Bank to: 1) create a compliance committee; 2) have a competent chief executive officer and senior loan officer, satisfactory to the OCC, at all times; 3) develop a plan for supervision of management; 4) create and implement policies and procedures for loan administration; 5) create a written loan policy; 6) develop and implement an asset review program; 7) develop and implement a written program for the maintenance of an adequate Allowance for Loan and Lease Losses, and review the adequacy of the Allowance; 8) eliminate criticized assets; 9) develop and implement a written real estate appraisal policy; 10) obtain and improve procedures regarding credit and collateral documentation; 11) develop a strategic plan; 12) develop a capital program to maintain adequate capital (this provision also restricts the payment of dividends by the Bank unless (a) the Bank is in compliance with its capital program; (b) the Bank is in compliance with 12 U.S.C. Section 55 and 60 and (c) the Bank receives the prior written approval of the OCC District Administrator); 13) develop and implement a written liquidity, asset and liability management policy; 14) document and support the reasonableness of any management and other fees to any director or other party; 15) correct violations of law; and 16) provide reports to the OCC regarding compliance.\nThe Memorandum of Understanding was executed in August 1992 and required 1) a plan to improve the financial condition of CU Bancorp and the Bank; 2) development of a formal policy regarding the relationship of CU Bancorp and the Bank, with regard to dividends, inter-company transactions, tax allocation and management or service fees; 3) a plan to assure that CU Bancorp has sufficient cash to pay its expenses; 4) ensure that regulatory reporting is accurate and submitted on a timely basis; 5) prior approval of the Federal Reserve Bank prior to the payment of dividends; 6) prior approval of the Federal Reserve Bank prior to CU Bancorp incurring any debt and 7) quarterly reporting regarding the condition of the Company and steps taken regarding the Memorandum of Understanding.\nItem 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNONE.\nPart III\nIncorporated by reference from Registrant's definitive proxy statement to be filed within 120 days of fiscal year ended December 31, 1995.\nPart IV. Exhibits, Financial Statement Schedules and Reports on Form 8 K.\n(A)\n(1) and (2) Financial Statements and Financial Statement Schedules - See index 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":"745289_1995.txt","cik":"745289","year":"1995","section_1":"Item 1. Business.\nMRI Business Properties Fund, Ltd. II (\"Registrant\") was organized in 1984 as a California limited partnership under the California Uniform Limited Partnership Act. The managing general partner of Registrant is Montgomery Realty Company-84, a California general partnership of which Fox Realty Investors (\"FRI\"), a California general partnership, is the managing general partner and Montgomery Realty Corporation, a California corporation, and Montgomery Partners-84, a California general partnership, are the co-general partners. The associate general partner of Registrant is MRI Associates, Ltd. II, a California limited partnership, of which Fox Realty Investors is the general partner, and Two Broadway Associates III, an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, is the limited partner.\nRegistrant's Registration Statement, filed pursuant to the Securities Act of 1933 (No. 2-90792), was declared effective by the Securities and Exchange Commission on October 19, 1984. Registrant marketed its securities pursuant to its Prospectus dated October 19, 1984 which was thereafter supplemented (the \"Prospectus\"). This Prospectus was filed with the Securities and Exchange Commission pursuant to Rule 424(b) of the Securities Act of 1933 and such Prospectus as supplemented is incorporated by reference herein.\nDuring fiscal 1995 and the first quarter of fiscal 1996, Registrant's remaining Properties were sold. See \"Sales\" and \"Subsequent Events.\" Registrant's principal business was to acquire (either directly or through joint ventures), hold for investment, and ultimately sell hotels. Registrant is a \"closed\" limited partnership real estate syndicate of the unspecified asset type. For a further description of Registrant's business, see the sections entitled \"Risk Factors\" and \"Investment Objectives and Policies\" in the Prospectus.\nBeginning in November 1984 through June 24, 1985, Registrant offered and sold $91,083,000 in Limited Partnership Assignee Units. The net proceeds of this offering were used to purchase interests in four income-producing real properties. Registrant's property portfolio, when acquired, was geographically diversified with properties acquired in four states. The acquisition activities of Registrant were completed on March 13, 1986, and since that time the principal activity of Registrant was to merge managing its portfolio. As a result of an enhanced market for hotel properties, Registrant sold its Marriott Riverwalk property in the third quarter of 1995 (see \"Sales\" below for information with respect to this sale) and its Marriott Somerset and Radisson South properties in the first fiscal quarter of 1996 (see \"Subsequent Events\" for information with respect to these sales). In addition, the Joint Venture in which Registrant held an interest sold its only asset, the Holiday Inn - Crowne Plaza, in the first quarter of 1996. (See, \"Subsequent Events\"). Item 2, \"Properties\" sets forth a description of Registrant's properties.\nRegistrant anticipates that in fiscal 1996 Registrant will be dissolved and, after establishing sufficient reserves, the net assets of Registrant will be distributed to its partners in accordance with the terms of the Partnership Agreement.\nDuring fiscal 1995, Registrant was involved in only one industry segment, as described above. Registrant does not engage in any foreign operations or derive revenues from foreign sources.\nDuring fiscal 1995, Registrant's Radisson South property required an asbestos abatement cleanup. The cost of this cleanup was approximately $3,000,000. Registrant funded this cleanup through working capital reserve.\nRegistrant maintained property and liability insurance on the properties and believes such coverage to be adequate.\nRegistrant's original investment objective of capital growth was not attained. Accordingly, a portion of invested capital may not be returned to limited partners. Upon termination of Registrant the general partners may be required to contribute up to approximately $1,250,000 to Registrant in accordance with the partnership agreement.\nEmployees\/Management\nRegistrant has no employees. Registrant's properties were managed by unaffiliated third party management companies pursuant to management agreements with such third parties.\nRegistrant's affairs were managed by Metric Management Inc., (\"MMI\") or a predecessor from March 1988 to December 1993. On December 16, 1993, the services agreement with MMI was modified and, as a result thereof, Registrant's general partner assumed responsibility for cash management of Registrant as of December 23, 1993 and assumed responsibility for day-to-day management of Registrant's affairs, including portfolio management, accounting and investor relations services as of April 1, 1994.\nOn December 6, 1993, NPI Equity Investment II, Inc. (\"NPI Equity II\" or the \"Managing General Partner\") became the managing partner of FRI. As a result, NPI Equity II became responsible for the operation and management of the business and affairs of Registrant and the other investment partnerships sponsored by FRI and its affiliates. The individuals who had served previously as partners of FRI 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. In the foregoing capacity, such parties continue to hold indirectly certain economic interests in Registrant and such other investment limited partnerships, but have ceased to be responsible for the operation and management of Registrant and such other partnerships. NPI Equity II is a wholly-owned subsidiary of National Property Investors, Inc. (\"NPI\"), a diversified real estate management company with offices in Jericho, New York and Atlanta, Georgia.\nSales\/Refinancings\nIn December, 1994, Registrant refinanced its existing mortgages encumbering the Marriott Riverwalk property. Registrant obtained a $19,400,000 loan which bears interest at 9.85% per annum. On June 16, 1995, Registrant sold the hotel to an unaffiliated third party for $49,268,000. The sale proceeds were comprised of cash of $30,000,000 and the mortgage note of $19,268,000 which was assumed by the buyer. The sale resulted in a gain of $18,749,000, which is net of selling expenses of $256,000. The net proceeds from this sale were distributed in the fourth quarter of fiscal 1995. See Item 5, \"Market for Registrant's Common Equity and Related Stockholder Matters\" for additional information with respect to the distribution.\nSubsequent Events\nOn October 5, 1995, Registrant's Somerset Marriott Hotel was sold to an unaffiliated third party for $24,950,000. After satisfaction of notes payable of approximately $22,530,000 (including accrued interest and a prepayment premium of $500,000), closing costs, credits and adjustments, the Partnership received approximately $2,580,000. At the date of the sale the net carrying value of the property was approximately $22,625,000. The sale resulted in a gain of approximately $1,550,000 which is net of selling expenses of approximately $275,000 and will be recognized in fiscal 1996. Registrant had previously recorded a $10,948,000 provision for impairment of value in 1992 and 1993.\nOn December 1, 1995 the joint venture (in which Registrant has a controlling interest) sold the Radisson South Hotel to an unaffiliated third party for $31,840,000. After satisfaction of mortgage notes of approximately $14,452,000 (including accrued interest), closing costs and adjustments, the joint venture received approximately $17,000,000. In accordance with the joint venture agreement, Registrant was entitled to all of the net proceeds. In addition, Registrant expects to receive approximately $990,000 of cash from operations and to collect approximately $1,300,000 in outstanding receivables. At the date of the sale, the carrying value of the property was $20,730,000. The sale resulted in a gain of approximately $10,950,000 which includes selling expenses of approximately $300,000 and $140,000 of net liabilities assumed by the purchaser.\nAs of July 7, 1995, MRI Business Properties Combined Fund No. 1, a joint venture with MRI Business Properties Fund, Ltd. III (the \"Combined Fund\"), entered into an agreement with its joint venture partner in the Holiday Inn Crowne Plaza pursuant to which the parties agreed to sell the Holiday Inn Crowne Plaza. The agreement provided that the net proceeds to the Combined Fund from any such sale must be at least $5,000,000. On December 1, 1995, the Combined Fund sold the Holiday Inn Crowne Plaza property to an unaffiliated third party for $44,000,000. After satisfaction of the mortgage note of $34,000,000, closing costs and other expenses, the joint venture received approximately $8,900,000. The Combined Fund received $5,000,000 of net proceeds (of which Registrant's share is $2,500,000) in accordance with the July 7, 1995 agreement. Registrant will recognize a gain on disposition of approximately $3,000,000 during the\nfirst quarter of fiscal 1996. The Combined Fund had previously recorded an approximate $12,000,000 provision for impairment of value in 1991 and 1992. A former joint venture partner may be required to contribute certain funds to Registrant in accordance with the joint venture agreement. The amount of contribution, if any, is not determinable at this time.\nMaterial Events\/Change in Control\nOn October 12, 1994, NPI sold one-third of the stock of NPI to an affiliate (\"Apollo\") of Apollo Real Estate Advisors, L.P. Apollo is entitled to designate three of the seven directors of NPI Equity II. In addition, the approval of certain major actions on behalf of Registrant requires the affirmative vote of at least five directors of NPI Equity II.\nOn October 12, 1994, affiliates of Apollo acquired for aggregate consideration of approximately $14,800,000 (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. (\"DeForest II\") and (ii) an additional equity interest in NPI-AP Management, L.P. (\"NPI-AP\"), an affiliate of NPI (bringing its total equity interest in such entity to one-third). NPI-AP is the sole limited partner of DeForest II and one of the limited partners of DeForest I. DeForest I was formed for the purpose of making tender offers (the \"Tender Offers\") for limited partnership interests in Registrant as well as 11 affiliated limited partnerships. DeForest II was formed for the purpose of making tender offers for limited partnership interest in 7 affiliated limited partnerships.\nPursuant to DeForest I's Form 13-D filed with the Securities and Exchange Commission, DeForest I owns 26,615 limited partnership units or 29.24% of the total limited partnership units of Registrant. (See Item 12, \"Security Ownership of Certain Beneficial Owners and Management.\")\nOn August 17, 1995, the stockholders of NPI, the sole shareholder of NPI Equity II, entered into an agreement to sell to IFGP Corporation, an affiliate of Insignia Financial Group, Inc. (\"Insignia\"), all of the issued and outstanding stock of NPI. The sale of the stock is subject to the satisfaction of certain conditions (including, third party consents and other conditions not within the control of the parties to the agreement) and is scheduled to closed in January 1996. Upon closing, it is expected that the current officers and directors of NPI Equity II will resign and Insignia will elect new officers and directors.\nInsignia together with its subsidiaries and affiliates, is a fully integrated real estate service company specializing in the ownership and operation of securitized real estate assets. Insignia's principal offices are located in Greenville, South Carolina and its stock is publicly traded on the New York Stock Exchange under the symbol IFS. According to Commercial Property News and the National Multi-Housing Council, Insignia is the largest property manager in the United States, has been the largest manager of residential properties since 1992, and is among the largest managers of commercial properties. As a full service real estate management organization, Insignia\nperforms property management, asset management, investor services, partnership administrations, real estate investment banking, mortgage banking, and real estate brokerage services for various types of property owners.\nCompetition\nRegistrant was affected by and subject to the general competitive conditions of the lodging industry. In addition, each of Registrant's properties competed in an area which normally contained numerous other properties which may be considered competitive. However, in 1995 the market for hotel properties improved significantly due to the creation of a number of Hotel REITS and numerous acquisitions by hotel\nfranchisers (i.e., Marriott, Radisson, etc.). As a result, Registrant was able to liquidate its portfolio as contemplated by the Prospectus at competitive prices.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nA description of the hotel properties in which Registrant had an ownership interest in fiscal 1995 is as follows: Portfolio Date of Date of Percentage Name and Location Purchase Sale Rooms (6) - ----------------- -------- ---- ----- ----------\nRadisson South Hotel(1) 11\/84 12\/95 575 23 7800 Normandale Blvd. Minneapolis, Minnesota\nMarriott Riverwalk Hotel(3) 11\/84 06\/95 500 26 711 East Riverwalk San Antonio, Texas\nSomerset Marriott Hotel(4) 09\/85 10\/95 434 26 110 Davidson Avenue Franklin Township, Somerset County, New Jersey\nHoliday Inn Crowne Plaza(2)(5) 03\/86 12\/95 492 25 4355 Ashford-Dunwoody Rd. Atlanta, Georgia\n- ------------- (1) The property was owned by a joint venture in which Registrant has a controlling interest. (2) Registrant and an affiliated partnership, MRI Business Properties Fund, Ltd. III, owned a joint venture which had a 50 percent interest in this property. (3) In March 1989, the joint venture which owned this property was dissolved,\nand Registrant was assigned the joint venture partner's interest in this property. (4) In April 1990, the joint venture which owned this property was dissolved, and Registrant was assigned the joint venture partner's interest in this property. (5) Formerly the Hyatt Regency Ravinia Hotel. The name was changed as a result of a change in ownership of the hotel which occurred in fiscal year 1991. (6) Represents the percentage of original cash invested in the individual property of the total original cash invested in all properties.\nSee Item 8, \"Financial Statements and Supplementary Data\", for information regarding any encumbrances to which the properties of Registrant are subject.\nThe following chart sets forth the average occupancy and daily room rate for each of Registrant's properties for the years ended September 30, 1995, 1994 and 1993.\nMRI BUSINESS PROPERTIES FUND, LTD. II OCCUPANCY AND ROOM RATE SUMMARY For the Fiscal Years Ended September 30, 1995, 1994 and 1993\nAverage Average Occupancy Rate (%) Daily Room Rate ($) 1995 1994 1993 1995 1994 1993 HOTELS: Radisson South Hotel 73 69 70 77.02 72.53 69.30 Marriott Riverwalk Hotel(1) - 83 80 - 114.70 116.64 Somerset Marriott Hotel 74 71 69 87.51 84.68 84.30 Holiday Inn Crowne Plaza(2) 75 74 68 95.98 88.32 82.55\n(1) Property was sold in June 1995. (2) Formerly the Hyatt Regency Ravinia Hotel.\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 first quarter of fiscal 1995, limited partners in certain limited partnerships affiliated with Registrant, commenced actions in 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 partners of Registrant, and (b) a breach of, and an inducement to breach, the provisions of the Partnership Agreement of Registrant. The actions, which had been brought as class actions on behalf of limited partners sought monetary\ndamages in an unspecified amount and, in the Whiteside action, to enjoin the tender offers. The temporary restraining order was\nsought 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 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 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 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 Registrant (including the units purchased in the initial tender) constituting up to 49% of the total number of units of 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 Registrant a credit line of $150,000 per property which would bear interest at the lesser of prime rate plus 1% and the rate permitted under the partnership agreement of 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 Registrant's Common Equity and Related Stockholder Matters.\nThe Limited Partnership Assignee Unit holders are entitled to certain distributions as provided in the Partnership Agreement. No market for Limited Partnership Assignee Units exists, nor is expected to develop.\nNo distributions were made during the years ended September 30, 1994 and 1993. Distributions of approximately $26.00 and $329.00 per limited partnership assignee unit were made from operations and sales proceeds, respectively, in the fourth quarter of fiscal 1995. Distributions of approximately $3.00 and $28.00 per limited partnership assignee unit were made from operations and sales proceeds, respectively, in the first quarter of fiscal 1996. See Item 1, \"Business\" and Item 7, \"Management's Discussion and Analysis of Financial Condition and Result of Operations\" for a discussion of Registrant's expected dissolution and financial ability to make distributions.\nAs of December 1, 1995, the approximate number of holders of Limited Partnership Assignee Units was 5,213.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following represents selected financial data for MRI Business Properties Fund, Ltd. II for the fiscal years ended September 30, 1995, 1994, 1993, 1992 and 1991. The data should be read in conjunction with the consolidated financial statements included elsewhere herein. This data is not covered by the independent auditors' report.\n(1) $1,000 original contribution per unit, based on weighted average units outstanding during the year, after giving effect to net loss allocated to the general partner.\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 Consolidated Financial Statements and other Items contained elsewhere in this Report.\nLiquidity and Capital Resources\nAs described in Item 1, \"Business\" and Item 8, \"Financial Statements and Supplementary Data, Notes 10 and 12\", Registrant sold its remaining properties during the second half of fiscal 1995 and the first quarter of fiscal 1996. The aggregate sales prices for these properties was $150,058,000. After satisfaction of existing mortgages, closing costs and amounts distributed to Registrant's joint venture partners in the Radisson South and Holiday Inn-Crowne Plaza properties, net proceeds received by Registrant were approximately $52,080,000. In addition, with respect to the sale of its Radisson South hotel, Registrant expects to receive approximately $990,000 of cash from operations and approximately $1,300,000 in outstanding receivables. As a result of these sales, Registrant will record a gain of $18,749,000 for fiscal 1995 and a gain of approximately $15,500,000 for fiscal 1996.\nSince these were Registrant's last remaining properties, Registrant expects to be terminated in 1996 after collection of receivables, payment of outstanding liabilities and a final distribution to the partners. Registrant expects to distribute a substantial portion of these proceeds in January 1996, with the remaining amount to be distributed upon termination of Registrant.\nRegistrant uses working capital reserves provided from any undistributed cash flow from operations and sales of properties as its primary source of liquidity. During the year ended September 30, 1995, the Radisson South generated positive cash flow while the Somerset Marriott Hotel generated negative cash flow due to significant property improvements. The Holiday Inn Crowne Plaza, owned by the unconsolidated joint venture, experienced positive cash flow during the year ended September 30, 1995. Working capital reserves are usually invested in United States Treasury obligations, money market accounts and repurchase agreements secured by United States Treasury obligations.\nRegistrant distributed $32,334,000 to the limited partners ($354.99 per limited partnership unit) and $660,000 to the General Partners on July 26, 1995. The distributions were from the sale proceeds from Registrant's Marriott Riverwalk Hotel and working capital reserves.\nThe level of liquidity based upon cash and cash equivalents experienced a $4,533,000 decrease at September 30, 1995, as compared to September 30, 1994. Registrant's $6,086,000 of net cash from operating activities was more than offset by $9,398,000 of net cash used in investing activities and $1,221,000 of net cash used in financing activities. Investing activities consisted of $32,994,000 of distributions to partners and property improvements of $7,868,000 which was partially offset by $30,000,000 of net sale proceeds and a decrease in restricted cash of $1,464,000. The decrease in restricted cash is primarily the result of the lender releasing $823,000 of restricted cash relating to completed renovations at Registrant's Marriott Somerset property. Financing activities\nconsisted of $19,874,000 paid in satisfaction of the mortgages encumbering Registrant's Marriott\nRiverwalk property, $747,000 of notes payable principal payments and proceeds of $19,400,000 from refinancing the mortgages encumbering Registrant's Marriott Riverwalk property. A prepayment premium of approximately $640,000 was paid to the former mortgagee. Mortgage costs of $212,000 (operating activities) paid during the year ended September 30, 1995 and $194,000 paid in the prior year were incurred in connection with the refinancing. All other increases (decreases) in certain assets and liabilities are the result of the timing of receipt and payment of various operating activities.\nAs required by the terms of the settlement of the actions brought against, among others, DeForest Ventures I L.P. (\"DeForest\") relating to the tender offer made by DeForest in October 1994 (the \"First Tender Offer\") for units of limited partnership interest in Registrant and certain affiliated partnerships, DeForest commenced a second tender offer (the \"Second Tender Offer\") on June 2, 1995 for units of limited partnership interest in Registrant. Pursuant to the Second Tender Offer, DeForest acquired an additional 339 units of Registrant which, when added to the units acquired during the First Tender Offer, represents approximately 29% of the total number of outstanding units of Registrant (see Item 3, \"Legal Proceedings\"). The Managing General Partner believes that the tender will not have a significant impact on future operations or liquidity of Registrant. Also in connection with the settlement, an affiliate of the Managing General Partner has made available to Registrant a credit line of up to $150,000 per property owned by Registrant. Registrant has no outstanding amounts due under this line of credit. This line of credit was Registrant's only unused source of liquidity.\nOn August 17, 1995, the stockholders of NPI, Inc., the sole shareholder of NPI Equity II, agreed to sell to Insignia all of the issued and outstanding stock of NPI, Inc. The consummation of this transaction is subject to the satisfaction of certain conditions (including, third party consents and other conditions not within the control of the parties to the agreement) and is scheduled to close in January 1996. Upon closing, it is expected that Insignia will elect new officers and directors of NPI Equity II. The Managing General Partner does not believe these transactions will have a significant effect on Registrant's liquidity or results of operation.\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,\" effective for fiscal years beginning after December 15, 1995. This Statement will not affect the financial position or results of operations of Registrant.\nRegistrant's original investment objective of capital growth was not attained. Accordingly, a portion of invested capital may not be returned to limited partners. Upon termination of Registrant the general partners may be required to contribute up to approximately $1,250,000 to Registrant in accordance with the partnership agreement.\nResults of Operations\nFiscal Year 1995 (\"1995\") Compared to Fiscal Year 1994 (\"1994\")\nOperating results, before minority interest in joint venture's operations, improved by $18,964,000 for the year ended September 30, 1995, as compared to 1994. Revenues increased by $15,819,000 and expenses decreased by $3,145,000. Operating\nresults improved primarily due to the $18,749,000 gain on sale of Registrant's Marriott Riverwalk Hotel.\nWith respect to the remaining properties, revenues improved by $4,035,000 for the year ended September 30, 1995, as compared to September 30, 1994, due to increases in room revenues of $2,837,000, food and beverage revenue of $968,000, and other operating revenue of $230,000. Room revenue increased at Registrant's Radisson South and Somerset Marriott hotels due to increases in average daily room rates and occupancy. Food and beverage revenue increased at both of Registrant's hotels primarily due to increased occupancy. Other operating revenues increased primarily due to increases in telephone income and miscellaneous income at both of Registrant's hotels. In addition, interest income increased by $186,000 primarily due to the investment of Registrant's Marriott Riverwalk sale proceeds.\nWith respect to the remaining properties expenses increased by $2,375,000 due to increases in room expenses of $793,000, food and beverage expenses of $614,000, other operating expenses of $700,000 and depreciation and amortization of $419,000, which were partially offset by decreases in interest expense of $89,000 and equity in joint venture operations of $62,000. Room and food and beverage expenses increased due to increases in occupancy at both of Registrant's hotels. Other operating expenses increased at both of Registrant's hotels. Deprecation and amortization increased due to significant fixed asset improvements. Interest expense decreased due to the amortization of the mortgage principal balances. The loss from Registrant's unconsolidated joint venture (Holiday Inn Crowne Plaza) decreased due to improved operations at the hotel. In addition, general and administrative expenses increased by $13,000.\nFiscal Year 1994 (\"1994\") Compared to Fiscal Year 1993 (\"1993\")\nOperating results, before minority interest in joint venture's operations improved by $2,139,000 for the year ended September 30, 1994, as compared to 1993. Revenues increased by $473,000 and expenses decreased by $1,666,000.\nRevenues improved by $473,000 for the year ended September 30, 1994, as compared to September 30, 1993, due to increases in room revenues of $490,000, other operating revenue of $288,000 and interest income of $105,000, which was substantially offset by a decrease in food and beverage revenue of $410,000. Room revenue increased at Registrant's Radisson South and Marriott Riverwalk hotels and declined at the Somerset Marriott Hotel. The increase in room revenue was attributable to an increase in average daily room rates at Registrant's Radisson South Hotel and an increase in occupancy at Registrant's Marriott\nRiverwalk Hotel. Other operating revenues increased primarily due to increases in telephone income and miscellaneous income at all of Registrant's hotels. Interest income increased due to an increase in average working capital reserves available for investment. Food and beverage revenue decreased at Registrant's Marriott Riverwalk and Somerset Marriott hotels.\nExpenses decreased by $1,666,000 due to decreases in provision for impairment of value of $2,007,000, equity in unconsolidated joint venture operations of $720,000 and food and beverage expenses of $276,000, which were partially offset by increases in room expenses of $260,000, other operating expenses of $667,000, interest expense of $174,000, depreciation and amortization of $195,000 and general and administrative expenses of $41,000. The loss from Registrant's unconsolidated joint venture (Holiday Inn Crowne Plaza) decreased due to improved operations at the hotel. Food and beverage expense decreased primarily due to lower food and beverage revenues.\nRoom expenses increased primarily at Registrant's Marriott Riverwalk and Radisson South hotels, and was attributable to the increased revenue at these hotels. Other operating expenses increased at all of Registrant's properties. Interest expense increased due to a debt modification, relating to the Somerset Marriott which became effective during the fourth quarter of 1993. General and administrative expenses increased primarily due to costs associated with the management transition. Depreciation expense increased due to significant fixed assets improvements.\nUnconsolidated Joint Venture Operations (MRI BPF Combined Fund No. 1)\nDuring fiscal years 1995, 1994 and 1993, Registrant was allocated losses from the unconsolidated joint venture which owns the Holiday Inn Crowne Plaza (formerly the Hyatt Regency Ravinia Hotel). The hotel was sold on December 1, 1995. The Consolidated Financial Statements for the unconsolidated joint venture are presented in Item 8, Financial Statements and Financial Statement Schedules. A discussion of its Results of Operations follows:\nFiscal Year 1995 (\"1995\") Compared to Fiscal Year 1994 (\"1994\")\nOperating results, prior to minority interest, improved by $257,000, for the year ended September 30, 1995, as compared to 1994, as revenues increased by $1,349,000 and expenses increased by $1,092,000. The significant increase in revenue is attributable to an increase in average room rates and a slight increase in occupancy. The increase in operating expenses is partially attributable to the increase in occupancy at the hotel. Interest expense increased due to the increased interest rate on the extension of the mortgage.\nFiscal Year 1994 (\"1994\") Compared to Fiscal Year 1993 (\"1993\")\nOperating results, prior to minority interest, improved by $1,202,000, for the year ended September 30, 1994, as compared to 1993, as revenues increased by $2,045,000 and expenses increased by $843,000. The significant increase in\nrevenue is attributable to both higher occupancy and average room rates. The increase in expenses is attributable to the increase in occupancy at the hotel.\nIn addition, under the terms of the joint venture agreement, the loss from the Holiday Inn Crowne Plaza was allocated in different proportions during the year ended September 30, 1994, as compared to 1993. This combined with improved operations, resulted in a smaller loss being allocated to Registrant.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nMRI BUSINESS PROPERTIES FUND, LTD. II\nCONSOLIDATED FINANCIAL STATEMENTS\nYEAR ENDED SEPTEMBER 30, 1995\nINDEX\nMRI BUSINESS PROPERTIES FUND, LTD. II (A LIMITED PARTNERSHIP) Page\nIndependent Auditors' Reports . . . . . . . . . . . . . . . . . . . . . F - 2 Financial Statements: Balance Sheets at September 30, 1995 and 1994 . . . . . . . . . F - 4 Statements of Operations for the Years Ended September 30, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . . . F - 5 Statements of Partners' Equity for the Years Ended September 30, 1995, 1994 and 1993. . . . . . . . . . . . . . F - 6 Statements of Cash Flows for the Years Ended September 30, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . . . F - 7 Notes to Financial Statements. . . . . . . . . . .. . . . . . . F - 8 Financial Statement Schedules: Schedule III - Real Estate and Accumulated Depreciation at September 30, 1995 . . . . . . . . . . . . . . . . . . . . . F - 20\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 (A GENERAL PARTNERSHIP)\nIndependent Auditors' Reports . . . . . . . . . . . . . . . . . . . . . F - 23 Consolidated Financial Statements: Balance Sheets at September 30, 1995 and 1994 . . . . . . . . . F - 24 Statements of Operations for the Years Ended September 30, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . F - 26 Statements of Partners' Equity (Deficit) for the Years Ended September 30, 1995, 1994 and 1993. . . . . . . . . . . . . . F - 27 Statements of Cash Flows for the Years Ended September 30, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . . . F - 28 Notes to Consolidated Financial Statements. . . . . . . . . . . F - 29 Financial Statement Schedules: Schedule III - Real Estate and Accumulated Depreciation at September 30, 1995 . . . . . . . . . . . . . . . . . . . . . F - 35\nFinancial statements and financial schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in this Report.\nF - 1\nTo the Partners MRI Business Properties Fund, Ltd. II Atlanta, Georgia\nIndependent Auditors' Report\nWe have audited the accompanying consolidated balance sheet of MRI Business Properties Fund, Ltd. II (a limited partnership) (the \"Partnership\"), as of September 30, 1995 and 1994, and the related consolidated statements of operations, partners' equity and cash flows for the years then ended. Our audit also included the additional information supplied pursuant to Item 14(a)(2). 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 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 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 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 MRI Business Properties Fund, Ltd. II 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. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in Notes 1 and 12 to the financial statements, the Partnership's remaining joint venture owned properties were sold on December 1, 1995. The Partnership is expected to be terminated in 1996 after collection of receivables, payment of outstanding liabilities and a final distribution to the partners.\n\/s\/ Imowitz, Koenig & Co., LLP Certified Public Accountants\nNew York, N.Y. December 1, 1995\nINDEPENDENT AUDITORS' REPORT\nMRI Business Properties Fund, Ltd. II\nWe have audited the accompanying consolidated statements of operations, partners' equity and cash flows of MRI Business Properties Fund, Ltd. II (a limited Partnership) (the \"Partnership\") for the year ended September 30, 1993. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our 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 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, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the partnership and its subsidiaries for the year ended September 30, 1993, in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nDecember 17, 1993\nMRI BUSINESS PROPERTIES FUND, LTD. II\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nF - 4\nMRI BUSINESS PROPERTIES FUND, LTD. II\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements.\nF - 5\nMRI BUSINESS PROPERTIES FUND, LTD. II\nCONSOLIDATED STATEMENTS OF PARTNERS' EQUITY\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nF - 6\nMRI BUSINESS PROPERTIES FUND, LTD. II\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nF - 7\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nMRI Business Properties Fund, Ltd. II (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 hotel properties. At September 30, 1995, the Partnership owned a hotel property located in Somerset, N.J. (Somerset Marriott) and a controlling joint venture interest in the Radisson South Hotel (Minneapolis, Minnesota). In addition, the Partnership's unconsolidated joint venture hotel property (the Holiday Inn Crowne Plaza Ravinia) is located in Atlanta, Georgia. The Partnership's Marriott Riverwalk Hotel property was sold in June 1995, Somerset Marriott was sold in October 1995 and the Radisson South and the Holiday Inn Crowne Plaza (owned by the unconsolidated joint venture) were sold in December 1995. The Partnership is expected to be terminated in 1996 after collection of receivables, payment of outstanding liabilities and a final distribution to the partners. The managing general partner of the Partnership is Montgomery Realty Company-84 (\"Montgomery\"), a general partnership, and the associate general partner is MRI Associates, Ltd. II (\"MRI\"), a limited partnership. Fox Realty Investors (\"FRI\") is the managing general partner of Montgomery and a general partner of MRI. The Partnership was organized on April 24, 1984 but did not commence operations until November 1984. The capital contributions of $91,083,000 ($1,000 per unit) were made by the limited partners.\nOn December 6, 1993, NPI Equity Investments II, Inc. (\"MGP\") became\nthe managing partner of FRI and assumed operational control over Fox Capital Management Corporation (\"FCMC\"). As a result, MGP became responsible for the operation and management of the business and affairs of the Partnership and the other investment partnerships sponsored by FRI and\/or FCMC. The individuals who had served previously as partners of FRI and as officers and directors of FCMC 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. In the foregoing capacity, such partners will continue to hold indirectly certain economic interests in the Partnership and such other investment partnerships, but will cease to be responsible for the operation and management of the Partnership and such other partnerships. MGP is a wholly-owned subsidiary of National Property Investors, Inc. (\"NPI, Inc\"), a diversified real estate management company headquartered in Jericho, New York and Atlanta, Georgia.\nOn October 12, 1994, NPI, Inc. sold one-third of the stock of NPI, Inc. to an affiliate of Apollo Real Estate Advisors, L.P. (\"Apollo\"). In addition, in October 1994 and June 1995, DeForest Ventures I L.P. (\"DeForest\"), an entity controlled by Apollo and affiliates of NPI Inc., commenced tender offers for limited partnership assignee units of Registrant and 11 other affiliated limited partnerships. Pursuant to the tender offers DeForest acquired approximately 29% of total limited partnership units of the Partnership.\nOn August 17, 1995, the stockholders of NPI, Inc., entered into an agreement to sell to IFGP Corporation, an affiliate of Insignia Financial Group, Inc. (\"Insignia\"), all of the issued and outstanding stock of NPI, Inc. The sale is subject to the satisfaction of certain conditions and is scheduled to close in January 1996.\nF - 8\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nTermination\nAs discussed in Note 12, the Partnership's remaining joint venture owned properties were sold on December 1, 1995. The Partnership is expected to be terminated in 1996 after collection of receivables, payment of outstanding liabilities and a final distribution to the partners.\nConsolidation\nThe consolidated financial statements include the Partnership and the remaining joint venture in which the Partnership has a controlling interest. All significant intercompany transactions and balances have been eliminated.\nThe investment in an unconsolidated joint venture is accounted for under the equity method of accounting (see Note 5).\nDistributions\nOn July 26, 1995 the Partnership made distributions of $32,334,000 to limited partners ($354.99 per limited partnership assignee unit) and $660,000 to the general partner during the fiscal year ended September 30, 1995. These distributions were primarily made from the proceeds received from the sale of the Partnership's Marriott Riverwalk Hotel property.\nIn October 1995 the partnership made distributions of $2,802,000 ($30.76 per limited partnership assignee unit) and $57,000 to the general partners. These distributions were primarily made from the net proceeds received from sale of the Partnership's Somerset Marriott Hotel Property.\nNew Accounting Pronouncements\nIn December 1991, the Financial Accounting Standards Board (\"FASB\") issued Statement No. 107, \"Disclosures About Fair Value of Financial Instruments.\" This Statement was amended in October 1994 by FASB Statement No. 119, \"Disclosures About Derivative Financial Instruments and Fair Value of Financial Instruments.\" These Statements will not affect the financial position or results of operations of the Partnership but will require additional disclosure on the fair value of certain financial instruments for which it is practicable to estimate fair value. Disclosures under these statements will be required in the financial statements for fiscal years ending after December 15, 1995.\nIn March 1995, the FASB issued Statement No. 121 \"Accounting for the Impairment of Long Lived Assets to Be Disposed Of,\" effective for fiscal years beginning after December 15, 1995. This Statement will not affect the financial position or results of operations of the Partnership.\nF - 9\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nCash and Cash Equivalents\nThe Partnership considers cash investments with a 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 (\"FDIC\"). Balances in excess of $100,000 are usually invested in money market accounts, United States Treasury bills and repurchase agreements, which are collateralized by United States Treasury obligations. At times during the year, cash balances exceeded insured levels. At September 30, 1995, the Partnership had $1,752,000 invested in overnight repurchase agreements, secured by United States Treasury obligations, which are included in cash and cash equivalents.\nInventories and Operating Supplies\nInventories and operating supplies, including linen, china and glassware, are stated generally at the lower of cost or market.\nReal Estate\nReal estate properties and improvements are stated at cost. A provision for impairment of value is recorded when a decline in the value of a property is determined to be other than temporary as a result of one or more of the following: (1) a property is offered for sale at a price below its current carrying value, (2) a property has significant balloon payments due within the foreseeable future for which the Partnership does not have the resources to meet, and anticipates it will be unable to obtain replacement financing or debt modification sufficient to allow a continued hold of the property over a reasonable period of time, (3) a property has been, and is expected to continue, generating significant operating deficits and the Partnership is unable or unwilling to sustain such deficit results of operations, and has been unable to, or anticipates it will be unable to, obtain debt modification, financing or refinancing sufficient to allow a continued hold of the property over a reasonable period of time, or, (4) a property's value has declined based on management's expectations with respect to projected future operational cash flows and prevailing economic conditions. An impairment loss is indicated when the undiscounted sum of estimated future cash flows from an asset, including estimated sales proceeds, and assuming a reasonable period of ownership up to five years, is less than the carrying amount of the asset. The impairment loss is measured as the difference between the estimated fair value and the carrying amount of the asset. In the absence of the above circumstances, properties and improvements are stated at cost. Acquisition fees are capitalized as a cost of properties and improvements. Properties which were contributed to the joint ventures by the minority joint venture partners are stated at amounts\nagreed upon among the partners at the date of acquisition or\nF - 10\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nReal Estate (Continued)\ncontribution which approximated fair market value. The Partnership contributed cash to the joint ventures equal to its proportionate ownership interest in the joint ventures. Certain payments received from the joint venture partners pursuant to performance guarantee agreements in excess of the hotel's operating income are applied as a reduction of the cost of the related hotel. The cost of one property was reduced in connection with the dissolution of a joint venture partnership.\nDepreciation\nDepreciation is computed using the straight-line method based on estimated useful lives ranging from 5 years to 39 years. Properties for which a provision for impairment of value has been recorded and are expected to be disposed of within the next year are not depreciated.\nDeferred Financing Costs\nFinancing costs are deferred and amortized, as interest expense, over the lives of the related loans, originally ten years, or expensed if financing is not obtained. At September 30, 1995 and September 30, 1994, accumulated amortization of deferred financing costs totaled $52,000 and $41,000 respectively. Net deferred costs of $38,000 and $107,000 for the years ended September 30, 1995 and 1994, respectively, are included in accounts receivable and other assets.\nIntangible Asset\nThe intangible asset which was acquired by the Partnership in connection with its Marriott Riverwalk acquisition was stated at fair value and was amortized over the estimated useful life of the respective asset which was 30 years. The asset was written off when the Marriott Riverwalk was sold (see Note 10).\nNet Income (Loss) Per Limited Partnership Assignee Unit\nNet income (loss) per limited partnership assignee unit is computed by dividing net income (loss) allocated to the limited partners by 91,083 assignee units outstanding.\nIncome Taxes\nNo provision for Federal and state income taxes has been made in the financial statements because income taxes are the obligation of the partners.\nF - 11\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nReclassification\nCertain amounts 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., which performed partnership management and other services for the Partnership.\nOn January 1, 1993, Metric Management, Inc., (\"MMI\") a company which is not affiliated with the general partner, 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 partner and affiliates after December 31, 1992. Subsequent to December 31, 1992, reimbursements were made to MMI. On December 16, 1993, the service agreement with MMI was modified and, as a result thereof, MGP assumed responsibility for cash management and other partnership services on various dates commencing December 23, 1993. Related party expenses for the years ended September 30, 1995, 1994 and 1993 are as follows:\nReimbursed expenses are included in general and administrative expenses.\nIn accordance with the Partnership Agreement, the general partner is entitled to receive cash distributions from operations as follows: (1) a Partnership management incentive equal to an allocation of ten percent determined on a cumulative, noncompounded basis, of cash available for distribution (as defined in the Partnership Agreement) which is distributed to partners, and (2) a continuing interest representing two percent of cash available for distribution distributed to partners remaining after the allocation of the Partnership management incentive. Subsequent to December 31, 1986, the Partnership management incentive is subordinated to certain cash distributions to the unit holders.\nF - 12\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n2. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES (Continued)\nThe general partner is also entitled to its continuing interest of two percent of net income and net loss, taxable income and taxable loss and distribution of cash available for distribution provided, however, that 20% of realized gains from the sale or other disposition of properties is allocated to the general partners until such time as the general partners do not have deficit capital accounts. Upon termination of the Partnership the general partners may be required to contribute up to approximately $1,250,000 to the Partnership in accordance with the partnership agreement.\nOn July 26, 1995 the general partner received a distribution of $660,000, representing the general partners two percent interest in cash available for distribution which was primarily from the proceeds received on the sale of the Partnership's Marriott Riverwalk Hotel property. There were no cash distributions to the general partner for the years ended September 30, 1994 and 1993.\nIn October 1995 the general partner received a distribution of $57,000, representing the general partners two percent in cash available for distribution which was primarily received from the\nproceeds received on the sale of the Partnership's Somerset Marriott Hotel property.\n3. RELATED PARTY TRANSACTIONS\nApart from the reimbursements paid to the general partner and affiliates as set forth in Note 2 above, the Partnership has an agreement with an affiliate of a joint venture partner, an otherwise non-affiliated third party, which provides for the management and operation of the joint venture property. Management fees paid to the affiliate of such joint venture partner for the years ended September 30, 1995, 1994, and 1993 were $897,000, $805,000, and $762,000, respectively. In addition, $1,451,000, $1,219,000, and $2,208,000 were paid to an affiliate of the joint venture partner for franchise services and reimbursed expenses during the years ended September 30, 1995, 1994, and 1993, respectively.\n4. RESTRICTED CASH\nRestricted cash represents amounts maintained in accounts in accordance with loan agreements on the Marriott Riverwalk Hotel and Somerset Marriott Hotel in order to fund future capital requirements. The September 30, 1994 balance was composed of $1,098,000 for the Marriott Riverwalk Hotel and $823,000 for the Somerset Marriott Hotel.\nF - 13\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n5. INVESTMENT IN UNCONSOLIDATED JOINT VENTURE\nIn February 1986, the Partnership acquired a 50 percent ownership interest in MRI Business Properties Combined Fund No. 1 (\"Combined Fund\"), a joint venture with MRI Business Properties Fund, Ltd. III, a California limited partnership affiliated with the Partnership's general partner. The Combined Fund acquired a majority interest in a joint venture, MRI Ravinia Associates, which on March 13, 1986, acquired the Hyatt Regency Ravinia Hotel. In fiscal year 1991 the Combined Fund effected a change in the joint venture ownership (see discussion below). The Partnership's interest in the Combined Fund is reported using the equity method of accounting.\nIn fiscal year 1990, the joint venture partner at the Hyatt Regency Ravinia Hotel indicated it would not contribute its 50 percent share to fund deficit operations at the hotel. Consequently, in fiscal year 1991, the Partnership and MRI Business Properties Fund Ltd. III, each funded $1,060,000 to the hotel, of which $530,000 from each was funded\non behalf of the joint venture partner. Accordingly, the joint venture partner was not allocated loss in fiscal year 1991.\nFormal notice of deficiency was sent placing the joint venture partner in default. As a result of such default, in fiscal year 1991, the Combined Fund effected a change in the joint venture ownership by amending their agreement with the joint venture, partner and forming a new joint venture with an affiliate of Holiday Inns, Inc. (\"Holiday\"). The new joint venture entered into a new management agreement with Holiday. As consideration for a 50 percent interest in the new joint venture Holiday has agreed to pay for the costs to terminate the Hyatt Management Agreement, the conversion costs associated with the change to a Holiday Inn Crowne Plaza and the coverage of operational losses up to $5,000,000 for up to the first five years of the new joint venture. As a result of the new joint venture, which included the Combined Fund's surrender of certain priority returns, there was a reduction, through provision for impairment of value, to the book basis of the property of the Combined Fund of approximately $7,700,000 which was recognized in 1991. An additional provision for impairment of value of approximately $4,300,000 was recognized in 1992. In July 1993, the guarantee was exhausted and the Combined Fund and its joint venture partner become jointly responsible for their share of operational losses. In October 1993, the Combined Fund and Holiday each contributed $300,000 to cover operational losses. The $34,000,000 mortgage encumbering the hotel which was due to mature in July 1995 was extended to January 1, 1996 and was satisfied on December 1, 1995 on sale of the hotel (see Note 12).\nF - 14\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n6. REAL ESTATE\nHotel properties and improvements at September 30, 1995 and 1994 are summarized as follows:\n7. NOTES PAYABLE\nIndividual properties and improvements are pledged as collateral for the related notes payable. The notes bear interest at rates from 5.1 percent to 14.5 percent. One of the notes has been discounted to yield imputed interest at 13 percent. Amortization of the discount was $285,000, $260,000 and $238,000 for fiscal years 1995, 1994 and 1993, respectively.\nThe Marriott Riverwalk notes were refinanced by the partnership in December 1994 and were fully satisfied in June of 1995 in connection with the sale of the property (see Note 10).\nNotes payable also includes a renovation loan of $650,000 for the Somerset Marriott Hotel to Marriott Corporation which is currently due. The Somerset Marriott Hotel and Radisson South Hotel notes payable were fully satisfied in October 1995 and December 1995, respectively, in connection with the respective sales of the properties (see Note 12). The Radisson South Hotel notes were due to mature on December 1, 1995 and the Somerset Marriott notes were due to mature on December 31, 1997 and February 1, 1998.\n8. PROVISIONS FOR IMPAIRMENT OF VALUE\nDuring fiscal years 1993 and 1992, the Partnership determined that based upon the continuing deterioration of the economic market in Somerset, New Jersey, and projected future operational cash flows, the decline in value of the Somerset Marriott Hotel was other than temporary and that recovery of its carrying value was not likely. Accordingly, provisions for impairment of value of $2,007,000 and $8,941,000 were recognized in fiscal year 1993 and 1992, respectively. Carrying value includes the cost of the property less accumulated depreciation.\nF - 15\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n9. RENTAL COMMITMENTS AND CONTINGENCY\nThe operating leases were assumed by the buyers on the sale of the respective hotel properties. (see Notes 10 and 12). Rental expense for operating leases was $276,000, 407,000 and $304,000 in 1995, 1994\nand 1993, respectively.\n10. GAIN ON SALE OF PROPERTY\nOn June 16, 1995, the Partnership's Marriott Riverwalk (San Antonio, Texas) property was sold to an unaffiliated third party for $49,268,000. The sale proceeds were comprised of cash of $30,000,000 and the mortgage note of $19,268,000 which was assumed by the buyer. At the date of the sale, the net carrying value of the property was $27,326,000 and net assets of approximately $2,937,000 were taken over by the purchaser. The sale resulted in a gain of $18,749,000, which is net of selling expenses of $256,000.\n11. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING\nThe differences between the method of accounting for income tax reporting and the accrual method of accounting used in the financial statements are as follows:\nF - 16\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n11. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING (continued)\n12. SUBSEQUENT EVENTS - SALE OF PROPERTIES\nOn October 5, 1995, the Partnership's Somerset Marriott Hotel was sold to an unaffiliated third party for $24,950,000. After satisfaction of notes payable of approximately $22,530,000 (including accrued interest and a prepayment premium of $500,000), closing costs, credits and adjustments, the Partnership received approximately $2,580,000. At the date of the sale the net carrying value of the property was approximately $22,625,000. The sale resulted in a gain of approximately $1,550,000 which is net of selling expenses of approximately $275,000 and will be recognized in fiscal 1996. The Partnership had previously recorded a $10,948,000 provision for impairment of value in 1992 and 1993.\nOn December 1, 1995 the joint venture (in which the Partnership has a controlling interest) sold the Radisson South Hotel to an unaffiliated third party for $31,840,000. After satisfaction of mortgage notes of approximately $14,452,000 (including accrued interest), closing costs and adjustments, the joint venture received approximately $17,000,000. In accordance with the joint venture agreement, the Partnership is entitled to all the net proceeds. In addition, the Partnership expects to receive approximately $990,000 of cash from operations and to collect approximately $1,300,000 in outstanding receivables. At the date of the sale the carrying value of the property was $20,730,000. The sale resulted in a gain of approximately $10,950,000 which includes selling expenses of approximately $300,000 and $140,000 of net liabilities assumed by the purchaser.\nF - 17\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n12. SUBSEQUENT EVENT - SALE OF PROPERTIES (continued)\nAs of July 7, 1995, the Combined Fund, entered into an agreement with its joint venture partner in the Holiday Inn Crowne Plaza pursuant to which the parties agreed to sell the Holiday Inn Crowne Plaza. The agreement provides that the net proceeds to the Combined Fund from any such sale must be at least $5,000,000. On December 1, 1995, the Combined Fund sold the Holiday Inn Crowne Plaza property to an unaffiliated third party for $44,000,000. After satisfaction of the mortgage note of $34,000,000, closing costs and other expenses, the joint venture received approximately $8,900,000. The Combined Fund received $5,000,000 of net proceeds (of which the Partnership's share is $2,500,000) in accordance with the July 7, 1995 agreement. The Partnership will recognize a gain on disposition of approximately $3,000,000 during the first quarter of fiscal 1996. The Combined Fund had previously recorded an approximate $12,000,000 provision for impairment of value in 1991 and 1992. A former joint venture partner may be required to contribute certain funds to the Partnership in accordance with the joint venture agreement. The amount of contribution, if any, is not determinable at this time.\n13. PRO FORMA FINANCIAL INFORMATION\nThe following pro forma consolidated balance sheet as of September 30, 1995 gives effect to the sales of the Partnership's Somerset Marriott property, Radisson South consolidated joint venture property and the Partnership's joint venture interest in the Holiday Inn Crowne Plaza (see Notes 10 and 12). The adjustments related to the pro forma consolidated balance sheet assume the transactions were consummated at September 30, 1995.\nThe pro forma adjustments are required to eliminate the assets and liabilities of the Somerset Marriott, Radisson South, and Holiday Inn Crowne Plaza properties and to reflect consideration received for the properties.\nThese pro forma adjustments are not necessarily reflective of the results that actually would have occurred if the sales had been in effect as of the period presented.\nPro forma consolidated statement of operations have not been provided because all of the properties have been sold. The Partnership is expected to be terminated after collection of receivables, payment of outstanding liabilities and a final distribution to partners.\nF - 18\nMRI BUSINESS PROPERTIES FUND, LTD. II\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\n13. Pro Forma Financial Information (Continued)\nPro Forma Consolidated Balance Sheet\nF - 19\nSCHEDULE III\nMRI BUSINESS PROPERTIES FUND, LTD. II\nREAL ESTATE AND ACCUMULATED DEPRECIATION SEPTEMBER 30, 1995\nSee accompanying notes.\nF - 20\nSCHEDULE III\nMRI BUSINESS PROPERTIES FUND, LTD. II\nREAL ESTATE AND ACCUMULATED DEPRECIATION SEPTEMBER 30, 1995\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $99,594,000.\n(2) Balance, October 1, 1992 $ 124,959,000 Improvements capitalized subsequent to acquisition 2,681,000 Disposal of property improvements (300,000) -------------- Balance, September 30, 1993 127,340,000 Improvements capitalized subsequent to acquisition 6,541,000 Settlement proceeds (102,000) Disposal of property improvements (998,000) -------------- Balance, September 30, 1994 132,781,000 Improvements capitalized subsequent to acquisition 7,868,000 Sale of property (48,152,000) -------------- Balance, September 30, 1995 $ 92,497,000 ============== (3) Balance, October 1, 1992 $ 53,542,000 Provision for impairment of value 2,007,000 Additions charged to expense 4,828,000 -------------- Balance, September 30, 1993 60,377,000 Additions charged to expense 5,023,000 Disposal of property improvements (998,000) -------------- Balance, September 30, 1994 64,402,000 Additions charged to expense 5,186,000 Sale of property (20,826,000) -------------- Balance, September 30, 1995 $ 48,762,000 ==============\n(4) Depreciation is computed on lives ranging from five to 39 years.\n(5) Encumbrances shown are net of unamortized discount totaling $50,000 and include capital lease obligations.\n(6) Land acquired during fiscal year 1988.\n(7) The hotel consists of three buildings. Two were constructed in 1970 and one was constructed in 1980.\n(8) Certain revenues received from the original sellers in excess of the properties net operating income for a specified period of time after acquisition, have been applied as a reduction of the cost of the related property.\nF - 21\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1\nCONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED\nSEPTEMBER 30, 1995, 1994, AND 1993\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of MRI Business Properties Combined Fund No. 1\nWe have audited the accompanying consolidated balance sheets of MRI Business Properties Combined Fund No. 1 (a general partnership) and its joint venture as of September 30, 1995 and 1994, and the related consolidated statements of operations, partners' equity (deficiency) and cash flows for the years then ended. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated statements of operations, partners' equity (deficiency) and cash flows for the year ended September 30, 1993 of MRI Business Properties Combined Fund No. 1 were audited by other auditors whose report dated December 17, 1993, expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and the 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 1995 and 1994 consolidated financial statements referred to above present fairly, in all material respects, the financial position of MRI Business Properties Combined Fund No. 1 and its joint venture as of September 30, 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 financial statements taken as a whole. The schedule on page 12 is presented for the purpose 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 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.\nAs discussed in Note 9 to the financial statements, the Partnership has sold substantially all of its assets during the first quarter of fiscal 1996. The Partnership is expected to be terminated in 1996 after receipt of receivables, payment of outstanding liabilities and a final distribution to the partners.\nTauber & Balser, P.C. Atlanta, Georgia November 29, 1995 (except for Notes 9, as to which the date is December 1, 1995)\nINDEPENDENT AUDITORS' REPORT\nMRI Business Properties Combined Fund No. 1.\nWe have audited the accompanying consolidated statements of operations, partners' equity (deficiency) and cash flows for the year ended September 30, 1993 of MRI Business Properties Combined Fund No. 1 (a limited partnership) (the \"Partnership\") and its joint venture. 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 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 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, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Partnership and its joint venture for the year ended September 30, 1993, in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nDecember 17, 1993\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1995 AND 1994\nASSETS 1995 1994 ----------- -------- Cash and cash equivalents $ 887,000 $ 561,000 Restricted cash 958,000 564,000 Accounts receivable, less allowance for uncollectible accounts of $40,000 and $39,000, respectively 1,155,000 1,132,000 Inventory 96,000 74,000 Prepaid expenses and other 31,000 27,000\nProperty and improvements 63,148,000 62,898,000 Accumulated depreciation (17,952,000) (16,335,000) Allowance for impairment of value (11,962,000) (11,962,000) ----------- -----------\nNet property and improvements 33,234,000 34,601,000\nOrganization costs, net of accumulated amortization of $207,000 and $157,000, respectively 39,000 90,000 ----------- -----------\nTOTAL ASSETS $36,400,000 $37,049,000 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIENCY\nAccounts payable $ 350,000 $ 507,000 Accrued interest - 266,000 Accrued property taxes 121,000 151,000 Other liabilities 1,334,000 1,396,000 Management fees payable to affiliate 1,578,000 964,000 Due to affiliates 1,491,000 1,131,000 Note payable 34,000,000 34,000,000 ----------- -----------\nTotal liabilities 38,874,000 38,415,000\nJoint venturer's interest (1,238,000) (689,000)\nPartners' deficiency MRI BPF, Ltd. II (618,000) (338,000) MRI BPF, Ltd. III (618,000) (339,000) ----------- ----------- (1,236,000) (677,000) ----------- ----------- TOTAL LIABILITIES AND PARTNERS' DEFICIENCY $36,400,000 $37,049,000 =========== ===========\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30,\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY (DEFICIENCY) FOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30,\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND NATURE OF THE BUSINESS\nMRI Business Properties Combined Fund No. 1 (\"Partnership\") is a general partnership organized February 18, 1986 under the laws of the State of California to obtain a 50 percent interest in a Joint Venture which acquired the Ravinia Hotel. The general partners of the Partnership are MRI Business Properties Fund, Ltd. II (\"MRI BPF, Ltd. II\") and MRI Business Properties Fund, Ltd. III (\"MRI BPF, Ltd. III\") which are California limited partnerships affiliated through their managing general partners.\nThe Partnership is a 50 percent owner in a Joint Venture with Holiday Inn Ravinia, Inc., a wholly-owned subsidiary of Holiday Inn Worldwide, Inc. This Joint Venture owns a 495-room hotel operated as the Holiday Inn Crowne Plaza Ravinia in Atlanta, Georgia (Note 9). Losses of the Joint Venture are allocated to its owners pursuant to the venture agreement based on ownership.\nCONSOLIDATION\nThe consolidated financial statements include the Partnership and a Joint Venture in which the Partnership has a 50 percent interest. The Joint Venture's fiscal year ends on the Thursday prior to September 30 of each year. The year ended September 29, 1994 contained 53 weeks. All significant intercompany transactions and balances have been eliminated.\nCASH AND CASH EQUIVALENTS\nThe Partnership considers all highly liquid investments with a maturity of three months or less when purchased to be \"cash equivalents\".\nINVENTORIES\nInventories consist of food, beverage, and miscellaneous supplies. Inventories are recorded under the first-in,\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nfirst-out method and are generally stated at the lower of cost or market.\nORGANIZATION COSTS\nOrganization costs are deferred and amortized over five years using the\nstraight-line method.\nPROPERTY AND IMPROVEMENTS AND DEPRECIATION\nProperty and improvements are stated at cost. A provision for impairment of value was recorded for the property since the property's value had declined based on management's expectations with respect to projected future operational cash flows and prevailing economic conditions. In the absence of the above circumstances, property and improvements are stated at cost. Acquisition fees are capitalized as a cost of property and improvements.\nDepreciation is computed by the straight-line method over estimated useful lives of 27-40 years for building and improvements and 5-6 years for furnishings.\nINCOME TAXES\nMRI Business Properties Combined Fund No. 1 is not subject to income taxes because it is a Partnership. Instead, each partner is taxed on its share of the Partnership's taxable income, whether or not distributed, and is entitled to deduct on its own income tax return its share of the Partnership net losses to the extent of its tax basis in the Partnership.\nRECLASSIFICATION OF FINANCIAL STATEMENT PRESENTATION\nCertain reclassifications have been made to the 1993 financial statements to conform with the 1995 and 1994 financial statement presentation. Such reclassifications have had no effect on net loss as previously reported.\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 2 - RESTRICTED CASH\nRestricted cash represents monies maintained in an account in accordance with the management agreement on the Holiday Inn Crowne Plaza Ravinia in order to meet future capital requirements. Pursuant to the management agreement, monthly funding is required by the property in the amount of 5 percent of monthly Adjusted Gross Revenues.\nNOTE 3 - ACCOUNTS RECEIVABLE\nAccounts receivable consists of trade receivables due the hotel from guests, corporations, associations and governments.\nNOTE 4 - PROPERTY AND IMPROVEMENTS\nHotel property and improvements are summarized as follows:\n1995 1994 ---- ---- Land $ 9,108,000 $ 9,108,000 Building and improvements 45,356,000 45,179,000 Furnishings 8,684,000 8,611,000 ----------- ----------- 63,148,000 62,898,000\nAccumulated depreciation (17,952,000) (16,335,000) Allowance for impairment of value (see Note 5) (11,962,000) (11,962,000) ----------- ----------- Net property and improvements $33,234,000 $34,601,000 ============ ===========\nDifferences exist between financial statement and federal income tax bases as a result of accelerated depreciation methods. The depreciable property basis used for tax purposes as of September 30, 1995 and 1994 is $38,298,000 and $37,617,000 along with accumulated depreciation of\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 4 - PROPERTY AND IMPROVEMENTS (CONTINUED)\n$9,910,000 and $7,546,000, respectively. Depreciation expense for tax purposes as of September 30, 1995, 1994, and 1993 amounts to $3,638,000,\n$3,617,000, and $3,317,000, respectively.\nNOTE 5 - PROVISION FOR IMPAIRMENT OF VALUE\nThe impairment of value (Note 4) resulted in the reduction of the book basis of the hotel in the amounts of $4,311,000 and $7,651,000 in 1992 and 1991, respectively. For these years, the Joint Venture determined that based upon the continuing deterioration of the economic market in Atlanta, Georgia and projected operational cash flows, the decline in value of the hotel was other than temporary and that recovery of its carrying value was not likely.\nNOTE 6 - DUE TO AFFILIATES\nOf the $1,491,000 due to affiliates, $370,000 is due to an affiliate of the Partnership while the remainder represents an advance from Holiday Inn Worldwide, Inc. issued in 1993. These advances are unsecured and non-interest bearing.\nNOTE 7 - NOTE PAYABLE\nProperty and improvements are pledged as collateral for the note payable of $34,000,000 which bears interest at 12.29% per annum. The note requires monthly payments of interest only with a balloon payment in January 1, 1996 of all outstanding principal and unpaid interest. The note is to be satisfied upon the sale of the collateralized property (Note 9).\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 8 - RELATED PARTY TRANSACTIONS\nThe Partnership has an agreement with Holiday Inn Worldwide, Inc. to provide for the management and operation of the Joint Venture property. Fees paid or payable pursuant to the agreement is based on percentages of gross revenues or gross operating profits from operations of the property. The percentages used for these fees, per the related agreement, are 4% of Adjusted Gross Revenues and 10% of Gross Operating Profit, as defined in the contract.\n1995 1994 1993 ----------- ----------- -------- Adjusted Gross Revenues $20,508,000 $19,375,000 $17,258,000 Basic Management Fee 820,000 775,000 690,000\nGross Operating Profit $ 5,322,000 $ 4,705,000 $ 3,242,000 Incentive Management Fee 532,000 471,000 324,000\nPursuant to the management agreement, incentive management fees are accrued\nat year-end, if unpaid. Accrued management fees amounted to $1,578,000 and $964,000 for the fiscal years ended 1995 and 1994, respectively.\nIn addition, Holiday Inn Worldwide, Inc. provides certain services to the Partnership. Under the agreement, these services are to be provided at cost. The services provided and the related expenses to the Partnership were, exclusive of management fees, for the years ended September 30:\n1995 1994 1993 ---------- ---------- --------- Administrative services $ 159,000 $ 149,000 $139,000 Advertising services 371,000 360,000 274,000 Reservation services 130,000 121,000 100,000 Insurance (Property, Liability, and Workmen's Compensation) 463,000 498,000 474,000 ---------- ---------- -------- $1,123,000 $1,128,000 $987,000 ========== ========== ========\nMRI BUSINESS PROPERTIES COMBINED FUND NO.1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 AND 1994\nNOTE 8 - RELATED PARTY TRANSACTIONS (CONTINUED)\nIn addition, Holiday Inn Worldwide, Inc. provides payroll and asset acquisition services for the Partnership which are included in the basic management fee. The expense incurred with Holiday Inn Worldwide, Inc. for these services for 1995 and 1994 were $390,000 and $492,000, respectively.\nNOTE 9 - SUBSEQUENT EVENT\nOn December 1, 1995 the Partnership sold all of its assets and the purchaser assumed all operating liabilities in accordance with an agreement entered into on July 7, 1995, except for $353,000 of cash, $22,000 of other assets, and $373,000 of other liabilities. Proceeds from the sale were used to satisfy the outstanding principal and interest on the mortgage and the remainder is to be distributed to the partners.\nMRI BUSINESS PROPERTIES COMBINED FUND NO. 1 REAL ESTATE AND ACCUMULATED DEPRECIATION SEPTEMBER 30, 1995\nSCHEDULE III\nNOTES:\n(1) The aggregate cost for Federal income tax purposes is $63,426,000.\n(2) Balance, October 1, 1992 $69,840,000 Improvements capitalized subsequent to acquisition 2,372,000 ---------- Balance, September 30, 1993 72,212,000 Improvements capitalized subsequent to acquisition 1,437,000 Write off of fully depreciated assets (10,751,000) ---------- Balance, September 30, 1994 $62,898,000 Improvements capitalized subsequent to acquisition 446,000 Write off of fully depreciated assets (196,000) ---------- Balance, September 30, 1995 $63,148,000 ==========\n(3) Balance, October 1, 1992 $35,840,000 Additions charged to expense 1,594,000 ----------\nBalance, September 30, 1993 37,434,000 Additions charged to expense 1,614,000 Write off of fully depreciated assets (10,751,000) ----------\nBalance, September 30, 1994 28,297,000 Additions charged to expense 1,813,000 Write off of fully depreciated assets (196,000) ----------\nBalance, September 30, 1995 $29,914,000 ==========\n(4) Depreciation is computed on lives ranging from five to forty years.\n(5) Formerly Hyatt Regency Ravinia Hotel.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nEffective April 22, 1994, Registrant dismissed its prior Independent Auditors, Deloitte & Touche (\"Deloitte\") and retained as its new Independent Auditors, Imowitz Koenig & Co., LLP. Deloitte's Independent Auditors' Report on Registrant's financial statements for fiscal years ended September 30, 1993 and 1992 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. The decision to change Independent Auditors was approved by the Managing General Partner's Directors. During fiscal years ended 1992, 1993 and through April 22, 1994 there were no disagreements between 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, Registrant engaged Imowitz Koenig & Co., LLP as its Independent Auditors. During the last two fiscal years and through April 22, 1994, Registrant did not consult Imowitz Koenig & 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.\nNeither Registrant, Montgomery Realty Company-84 (\"MRC\"), the general partner of Registrant, nor FRI, the general partner of MRC, has any officers or directors. NPI Equity Investments II, Inc. (\"NPI Equity II\"), the Managing General Partner of FRI, manages and controls substantially all of Registrant's affairs and has general responsibility and ultimate authority in all matters affecting its business. NPI Equity is a wholly owned subsidiary of National Property Investors, Inc. (\"NPI\"). NPI Equity II and its affiliates also control, or act as, the managing general partner of 28 other public limited partnerships. All of these partnerships are engaged in the acquisition, leasing and disposition of real estate. As of December 1, 1995, the names, ages and positions held by executive officers and directors of NPI Equity II are as follows:\nHas served as a Director and\/or Officer of NPI Name and Age Positions Held Equity II since - ------------ -------------- ------------------------- Michael L. Ashner (43) President and Director 12\/93\nMartin Lifton (63) Chairman and Director 12\/93\nArthur N. Queler (49) Secretary\/Treasurer 12\/93 and Director\nSteven Lifton (34) Vice President and 12\/93 Director (Director 10\/94)\nW. Edward Scheetz (30) Director 10\/94\nRicardo Koenigsberger (29) Director 10\/94\nLee Neibart (45) Director 10\/94\nMichael L. Ashner has been President and Chairman and Director of NPI and a Director of NPI Property Management Corporation (\"NPI Management\") since their formation in 1984. As the President and a Director of NPI, Mr. Ashner has been involved with the sponsoring of approximately 35 limited partnerships. Mr. Ashner is also the President and Director of NPI Equity Investments, Inc. (\"NPI Equity\") and NPI Equity II, each a wholly owned subsidiary of NPI. NPI Equity and NPI Equity II control, or are, the managing general partners of 31 public partnerships. In addition, since 1981 Mr. Ashner has been President of Exeter Capital Corporation, a firm which has organized and administered real estate limited partnerships. Prior to forming NPI in 1984, Mr. Ashner served as a general partner of seven real estate limited partnerships that were formed by Exeter Capital Corporation to own and operate income producing real estate, including apartments, commercial office space and retail space. He received his A.B. degree cum laude from Cornell University and received a J.D. degree magna cum laude from the University of Miami School of Law, where he was an editor of\nthe law review.\nMartin Lifton is the Chairman of NPI and a Director of NPI Equity, NPI Equity II and NPI Management. In addition, Mr. Lifton is Chairman and President of The Lifton Company, a real estate investment firm. Since entering the real estate business over 35 years ago, Mr. Lifton has engaged in a wide range of real estate activities, including the purchase of apartment complexes and other properties in the New York City metropolitan area and in the southeastern United States. Mr. Lifton's firm currently owns several apartment buildings in New York City and Mr. Lifton is a partner in four industrial warehouse buildings in California and an office building in Baltimore. In partnership with NPI, Mr. Lifton has purchased interests in five apartment complexes since 1988. Mr. Lifton was also one of the founders of The Bank of Great Neck located in Great Neck, New York, of which he currently is Chairman. Mr. Lifton received his B.S. degree from the New York University.\nArthur N. Queler is a co-founder of NPI of which he has been Executive Vice President, Treasurer, Secretary and Director since 1984. Mr. Queler is also the Vice President, Secretary, Treasurer and Director of NPI Management, NPI Equity and NPI Equity II. In addition, since 1983, Mr. Queler has been President of ANQ Securities, Inc., a NASD registered broker-dealer firm which has been responsible for supervision of licensed brokers and coordination with a nationwide broker-dealer network for the marketing of NPI investment programs. Mr. Queler is a certified public accountant. He received his B.A. and M.B.A. degrees from the City College of New York.\nSteven Lifton is a Vice President of NPI having been appointed to this position in January 1991 and has been a director since 1992. In addition, he is a Senior Vice President of The Lifton Company. with The Lifton Company he has had extensive involvement in the budgeting, refinancing, rehabilitation and overall operation of several thousand apartment units. Mr. Lifton has also supervised the operation of other companies affiliated with The Lifton Company which are engaged in the business of real estate brokerage, second mortgage financing, land development and other real estate related activities. Mr. Lifton received his B.B.A. degree from The George Washington University Business School. He is a Director of The Bank of Great Neck.\nW. Edward Scheetz has been a Director of NPI and NPI Equity since October 1994. Since May 1993, Mr. Scheetz has been a limited partner of Apollo Real Estate Advisors, L.P. (\"Apollo\"), the managing general partner of Apollo Real Estate Investment Fund, L.P., a private investment fund. Mr. Scheetz has also served as a Director of Roland International, Inc., a real estate investment company since January 1994, and as a Director of Capital Apartment Properties, Inc., a multi-family residential real estate investment trust, since January 1994. From 1989 to May 1993, Mr. Scheetz was a principal of Trammel Crow Ventures, a national real estate investment firm. Mr. Scheetz received his A.B. in Economics, Magna Cum Laude, from Princeton University.\nRicardo Koenigsberger has been a Director of NPI and NPI Equity since\nOctober 1994. Since October 1990, Mr. Koenigsberger has been an associate of Apollo and of Lion Advisors, L.P., which acts as financial advisor to and representative for certain institutional investors with respect to securities investments. For more than one year prior thereto, Mr. Koenigsberger was an associate with Drexel Burnham Lambert Incorporated. Mr. Koenigsberger received his B.S. degree from The University of Pennsylvania-Wharton School.\nLee Neibart has been a Director of NPI and NPI Equity since October 1994. Mr. Neibart has also been an associate of Apollo since December 1993. From 1986 to 1993, Mr. Neibart also served as Executive Vice President of the Robert Martin Company, a private real estate development and management firm based in Westchester County, New York, and from 1982 to 1985, Mr. Neibart served as President of the New York Chapter of the National Association of Industrial Office Parks, a professional real estate organization. Mr. Neibart holds a B.A. from the University of Wisconsin and an M.B.A. from New York University.\nThere are no family relationships between any of the directors or the executive officers of NPI Equity II, except that Martin Lifton is the father of Steven Lifton. Each director and officer of NPI Equity II will hold office until the next annual meeting of stockholders and directors of NPI Equity II and until his successor is elected and qualified.\nMessrs. Ashner, Lifton and Queler currently are the beneficial owners of 66 2\/3% of the outstanding stock of NPI.\nRegistrant believes, based on written representations received by it, that for the fiscal year ended September 30, 1995, all filing requirements under Section 16(a) of the Securities Exchange Act of 1934 applicable to beneficial owners of Registrant's Securities, Registrant's general partners and officers and directors of such general partners, were complied with.\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 NPI Equity II. NPI Equity II 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 Registrant in accordance with the terms of the Partnership Agreement.\nThe following table sets forth certain information regarding limited partnership units of Registrant owned by each person who is known by Registrant to own beneficially or exercise voting or dispositive control over more than 5% of Registrant's limited partnership units, by each of NPI Equity II's directors\nand by\nall directors and executive officers of NPI Equity II as a group as of December 1, 1995.\nName and address of Amount and nature of Beneficial Owner Beneficial Owner % of Class - ---------------- ---------------- ---------- DeForest Ventures I L.P.(1) 26,615 (2) 29.24 Michael Ashner (3) 15 (4) * Martin Lifton (3) 15 (4) * Arthur Queler (1) 5 (4) * Steven Lifton (3) (4) * Ricardo Koenigsberger (5) - - Lee Neibart (5) - - W. Edward Scheetz (5) - - All directors and executive officers as a group (eight persons) 50(4) * - ---------------- * less than 1%\n(1) Each of such persons may be reached at 5665 Northside Drive, N.W., Atlanta, Georgia 30328.\n(2) Based upon information supplied to Registrant by DeForest Ventures I L.P. on December 1, 1995.\n(3) Each of such persons may be reached at 100 Jericho Quadrangle, Jericho, New York 11753.\n(4) Represents such persons proportionate interest in units held by QAL Associates II and QALA Associates III, each a general partnership in which, among others, Messrs. Ashner, Martin Lifton, Queler and Steven Lifton are partners.\n(5) Each of such persons may be reached at 1301 Avenue of the Americas, New York, New York 10038.\nThere are no arrangements known to Registrant, the operation of which may, at a subsequent date, result in a change in control of Registrant, other than as follows:\n(a) In connection with the admission of NPI Equity II as the managing partner of FRI, PRA reserved the right to remove NPI Equity II from its position as managing partner of FRI if certain events occur, such as an event of bankruptcy or the failure to maintain an adequate net worth. In such event, PRA may, but is not required to, assume the position of managing partner of FRI.\n(b) In connection with the loan made by PaineWebber Real Estate Securities, Inc., formerly known as Kidder Peabody Mortgage Capital Corporation (\"PaineWebber\"), to DeForest Ventures I L.P. (\"DeForest I\") and DeForest Ventures II L.P., (\"DeForest II\") in connection with the consummation of the tender offers made for units in Registrant and 18 affiliated limited partnerships, NPI pledged, as collateral for the loan, all of the issued and outstanding capital stock of NPI Equity II. Accordingly, if DeForest I or DeForest II were unable to satisfy its obligations under the loan and PaineWebber were to foreclose on its collateral, PaineWebber would become the sole shareholder of NPI Equity II.\n(c) See Item 1, \"Business - Material Events\\Change in Control\" for information relating to the sale by the stockholders of NPI of all of the issued and outstanding shares of stock of NPI to an affiliate of Insignia.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe Partnership Agreement provides that MRC will be reimbursed for actual expenses incurred in providing services required by Registrant. From March 1988 to December 1992 such amounts were assigned pursuant to a services agreement by the MRC and affiliates to Metric Realty Services, L.P., which performed partnership management and other services for Registrant. On January 1, 1993, Metric Management, Inc., a company which is not affiliated with the general partner, commenced providing certain property and portfolio management services to Registrant under a new services agreement. As provided in the new services agreement, effective January 1, 1993, no reimbursements were made to the general partner and affiliates after December 31, 1992. Subsequent to December 31, 1992, reimbursements were made to Metric Management, Inc. On December 16, 1993, the services agreement with Metric Management, Inc. was modified and, as a result thereof, the Managing General Partner assumed responsibility for cash management of Registrant as of December 23, 1993 and for day to day management of Registrant's affairs, including portfolio management, accounting, and investor relations services as of April 1, 1994. Related party expenses for the years ended September 30, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 ---------- ---------- -------\nReimbursement of expenses: Partnership accounting and investor services $102,000 $ 76,000 $ 39,000 Professional services - 11,000 7,000 -------- -------- --------\nTotal $102,000 $ 87,000 $ 46,000 ======== ======== ========\nIn accordance with the Partnership Agreement, the general partner is entitled to receive cash distributions from operations as follows: (1) a\nPartnership management incentive equal to an allocation of ten percent determined on a cumulative, noncompounded basis, of cash available for distribution (as defined in the Partnership Agreement) which is distributed to partners, and (2) a continuing interest representing two percent of cash available for distribution distributed to partners remaining after the allocation of the Partnership management incentive. Subsequent to December 31, 1986, the Partnership management incentive is subordinated to certain cash distributions to the unit holders.\nThe general partner is also entitled to its continuing interest of two percent of net income and net loss, taxable income and taxable loss and distribution of cash available for distribution provided, however, that 20% of realized gains from the sale or other disposition of properties is allocated to the general partners until such time as the general partners do not have deficit capital accounts. Upon termination of the Partnership the general partners may be required to contribute up to approximately $1,250,000 to the Partnership in accordance with the partnership agreement.\nOn July 26, 1995 the general partner received a distribution of $660,000, representing the general partners two percent interest in cash available for distribution which was primarily from the proceeds received on the sale of the Partnership's Marriott Riverwalk Hotel property. There were no cash distributions to the general partner for the years ended September 30, 1994 and 1993.\nIn October 1995 the general partner received a distribution of $57,000, representing the general partners two percent in cash available for distribution which was primarily received from the proceeds received on the sale of the Partnership's Somerset Marriott Hotel property.\nApart from the reimbursements paid to the general partner and affiliates as set forth above, the Partnership has an agreement with an affiliate of a joint venture partner, an otherwise non-affiliated third party, which provides for the management and operation of the joint venture property. Management fees paid to the affiliate of such joint venture partner for the years ended September 30, 1995, 1994 and 1993 were $897,000, $805,000 and $762,000, respectively. In addition, $1,451,000, $1,219,000 and $2,208,000 were paid to an affiliate of the joint venture partner for franchise services and reimbursed expenses during the year ended September 30, 1995, 1994 and 1993, respectively.\nSee Item 1. \"Business-Employees\/Management\" for information relating to the acquisition by NPI Equity II of management and control of Registrant.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements 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 Consolidated Financial Statements of Registrant, Notes thereto, and Financial Statement Schedules. (A table of contents to Consolidated Financial Statements and Financial Statement Schedules is included in Item 8 and incorporated herein by reference.)\n(a) (3) Exhibits:\n2. NPI, Inc. Stock Purchase Agreement dated as of August 17, 1995 incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated August 17, 1995.\n3,4. Partnership Agreement incorporated by reference to Registrant's Prospectus filed pursuant to Rule 424 (b) of the Securities Act of 1933.\n16. Letter dated April 27, 1994 from Registrant's Former Independent Auditors incorporated by reference to Registrant's Current Report on Form 8-K dated April 22, 1994.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed by Registrant during the last quarter of Registrant's fiscal year except a report dated August 17, 1995 relating to the sale of all of the issued and outstanding shares of stock of National Property Investors, Inc. (Item 1, Change in Control).\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 on the 27th day of December, 1995.\nMRI BUSINESS PROPERTIES FUND, LTD. II\nBy: Montgomery Realty Company-84, its Managing General Partner\nBy: Fox Realty Investors, its Managing General Partner\nBy: NPI Equity Investments II, Inc., its Managing Partner\nBy: \/s\/ Michael L. Ashner Michael L. Ashner President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of Registrant in their capacities as directors and\/or officers of NPI Equity Investments II, Inc., on the dates indicated below.\nSignature\/Name Title Date\n\/s\/Michael L. Ashner Michael L. Ashner President and Director (Principal Executive Officer) December 27, 1995\n\/s\/Martin Lifton Martin Lifton Chairman and Director December 27, 1995\n\/s\/Arthur N. Queler Arthur N. Queler Secretary\/ Treasurer and Director (Principal Financial Officer) December 27, 1995\n\/s\/Steven J. Lifton Steven J. Lifton Vice President and Director December 27, 1995\nExhibit Index\nExhibit Page\n2. NPI, Inc. Stock Purchase Agreement dated as of (a) August 17, 1995\n3,4. Partnership Agreement (b)\n16. Letter dated April 27, 1994 from Registrant's (c) Former Independent Auditors\n- -----------------------\n(a) Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated August 17, 1995.\n(b) Incorporated by referenced to Registrant's Prospectus filed pursuant to Rule 424 (b) of the Securities Act of 1933.\n(c) Incorporated by reference to Registrant's Current Report on Form 8-K dated April 22, 1994.","section_15":""}
{"filename":"856164_1995.txt","cik":"856164","year":"1995","section_1":"Item 1. Business\nAerovox's predecessor, Aerovox Corporation, began in 1922 producing crystal wireless radios. In 1973, the Aerovox AC capacitor operations, including a plant in New Bedford, Massachusetts, together with the Aerovox name, were purchased from Aerovox Corporation by a newly-created corporation, Aerovox Industries, which was headed by Clifford H. Tuttle, Aerovox's current President and Chairman. In 1978, RTE Corporation (\"RTE\"), a manufacturer of distribution transformers and other utility electrical products, purchased all of the assets of Aerovox Industries through its newly organized subsidiary, Aerovox Incorporated, a Massachusetts corporation (\"Aerovox Massachusetts\"). In 1988, RTE was acquired by Cooper Industries (\"Cooper\"), and Aerovox Massachusetts became an indirect wholly-owned subsidiary of Cooper, through Aerovox Holding Company (\"AHC\"); a Delaware corporation incorporated on May 3, 1988. On May 26, 1989, Aerovox Incorporated was merged into AHC and AHC's name was changed to Aerovox Incorporated. The sole purpose of this merger was to eliminate the passive holding company structure. On February 26, 1990, 5,095,086 shares of Aerovox Common Stock were distributed to Cooper shareholders of record on May 5, 1989.\nOn March 5, 1993, Aerovox purchased all the stock of Aero M, Inc., an aluminum electrolytic capacitor manufacturer, from Cooper Industries. This company now operates as two divisions: Aero M Group in Juarez, Mexico and the Aerovox Foil Division in Huntsville, Alabama. On March 11, 1993, Aerovox purchased certain assets of British aluminum electrolytic capacitor manufacturer, BH Components Ltd., and formed a new company, BHC Aerovox Ltd. which is headquartered in Weymouth, England.\nThe Company now consists of four divisions: the Aerovox Group, Aero M Group, BHC Aerovox Ltd., and the Aerovox Foil Division which are more fully described below.\nAEROVOX GROUP\nThe Aerovox Group, headquartered in New Bedford, Massachusetts, is a leading manufacturer of film capacitors. The Group manufactures AC capacitors, used primarily in air conditioners (with both the compressor and fan motor), fluorescent lighting, high intensity discharge (HID) lighting, microwave ovens and other industrial applications. The Group also manufactures DC capacitors primarily for the communications industry and for various power supply applications; electromagnetic interference (EMI) filters used primarily in AC power supplies for electronic equipment;\npower factor correction equipment and DC energy discharge capacitors used in medical equipment, photocopiers, fusion power and various government research and development programs.\nProducts and Markets\nCapacitors are basic electrical components that store electrical energy and regulate the frequency, timing and condition of electrical signals. They are used to release predetermined amounts of energy and assist in running an electrical device, to send predetermined amounts of energy to start an electrical device, or to store energy for releases at unscheduled future times. A principal functional element of every capacitor is its dielectric (nonconductive) material, which functions as an insulator separating two electrically charged plates (electrodes). Dielectric systems can be made using a variety of materials, such as air, ceramic, tantalum oxide, aluminum oxide, polypropylene film and paper.\nAll the Aerovox Group's AC capacitors are manufactured with polypropylene film and\/or kraft paper, or polyester film (used in small units) as the dielectric system. DC Film capacitors utilize polyester films and polypropylene (for high frequency applications) as the dielectric system.\nEMI filters protect electronic equipment from electrical interference (\"noise\") coming from the power source and suppress high frequency interference that would otherwise be transmitted out of the equipment along the power cord. EMI filters can also be used to suppress high frequency and unintentional \"noise\" generated in electronic and electromechanical equipment. Applications for EMI filters include computer and computer peripheral equipment, telecommunications and variable speed drives. They are also used in sensitive electronic test and medical equipment.\nThe Aerovox Group also produces low and medium voltage AC power factor correction systems. These systems are installed in manufacturing facilities, large office buildings and apartment buildings and hospitals where use of motor- driven equipment, air conditioning and specialized medical equipment is widespread. Power factor correction capacitors improve a facility's electrical system efficiency thus reducing power costs; they can also reduce the incidence of such system problems as brownouts.\nThe Aerovox Group offers a complete line of high voltage, multipurpose DC energy storage and discharge capacitors for both industrial and government applications. The smaller models in this product line are used as components in photocopiers, laser equipment, defibrillators, power supply systems and welding equipment. The Group's larger DC capacitors are used in government and university fusion power and particle acceleration\nresearch products, government weaponry systems, in equipment for high energy x- rays and in high speed trains.\nCompetition\nAC capacitors are made by several domestic and foreign manufacturers, and competition is intense. Aerovox and the General Electric Company are the primary producers of AC metallized film capacitors in North America, each offering a full line of AC products. The other suppliers of these products are generally smaller and do not offer a full line.\nIn the North American AC capacitor market, Aerovox competes almost entirely with domestic manufacturers. Offshore competition has not been a major factor in this market because normally the weight of a typical AC capacitor in relation to its cost makes it uneconomical for European and Far Eastern suppliers to ship such capacitors to the United States. The principal competitive factors in the industry include product reliability, competitive prices, delivery, customer service, and the ability to meet customer specifications.\nThe Aerovox Group is not a major supplier of general purpose AC capacitors in either Europe or Asia and faces strong competition from locally based manufacturers in those markets. However, it is becoming the market leader in various specialty\/niche products in the European marketplace.\nThere are also a significant number of DC wound film capacitor manufacturers, both domestic and international, that serve the North American market and, accordingly, the Aerovox Group faces stiff competition in this market. The competitive factors are primarily price and delivery.\nA significant number of EMI custom filter manufacturers serve the North American marketplace for this product providing strong competition to the Aerovox Group. The principal competitive factors are technical support, quality, delivery and price.\nManufacturing\nMany of the Aerovox Group manufacturing processes are automated; mechanization is essential to its ability to control costs in order to meet competitive prices and still maintain acceptable profit margins. The control of quality levels is an equally important function throughout all departments of the Group and various tests are conducted to assure continuity of high standards. The Group also utilizes an advanced materials requirement planning system; an on-line closed-loop data based system which manages customer orders from order entry through shipping and invoicing.\nEach AC capacitor consists of one or more functional \"sections\" that are enclosed in a metal or plastic container, or have a wax or pitch coating, or are wrapped in polyester tape. Sections are produced on a five-day basis in two production areas - one that produces metallized polypropylene sections and one that produces other types of dielectric system sections (working two shifts). Container covers are produced in both plastic (on a three shift basis) and metal designs (on a two shift basis) in two production areas and are fed to the assembly lines where the sections are assembled into containers to finalize the packaging process. The assembled product is then filled or impregnated with an oil. Each capacitor is then electrically tested and a visual inspection conducted. Some capacitors are painted, if required, and all are marked prior to packaging and shipping.\nThe Company formed a maquiladora, Aerovox de Mexico, S.A. in Juarez, Mexico, in December 1992, to transfer high labor content AC capacitor products and EMI filters for assembly.\nThe DC wound film capacitor operation consists of three production lines: radial box (various sizes); axial leaded capacitors (both round and flat); and special designs and configurations. The basic difference between these three lines is the method of packaging the wound metallized film section for the required application. The section winding is performed in one department. The sections are then separated in a preparation area for zinc end spraying and then distributed to the proper production area for assembly, packaging and testing.\nThe Group's EMI filter products are designed at the Group's New Bedford, Massachusetts, facility. The filters consist of various components, typically including various capacitors, resistors and a copper wire-wrapped magnetic core, all precisely arranged within a steel or plastic container. The completion processes include filling the remaining space in the container with a petroleum distillate, sealing the container and electrically testing the finished product. Prior to 1993, the actual assembly of filters was performed by two subcontractors at two different locations in Mexico. The Company maquiladora, located in Juarez, Mexico, now performs the assembly operations of the EMI filters.\nA special products department in New Bedford assembles the power factor correction systems and energy storage and discharge capacitor product lines on a one-shift basis.\nAEROVOX FOIL DIVISION\nIn 1995, the Aerovox Foil Division, previously part of the Aero M Group, was established as an autonomous organization. This Division etches and forms (chemical and electrical processes) essentially pure aluminum foil to meet the capacitance and voltage specifications of finished\naluminum electrolytic capacitors. Slitting the processed foil to required widths is also completed at the Huntsville, Alabama facility before the foil is sent to Aero M or BHC for assembly into finished capacitors.\nAERO M GROUP\nThe Aero M Group is a leading manufacturer of AC voltage aluminum electrolytic capacitors for the electrical industry as well as various types of DC voltage aluminum electrolytic large can computer grade capacitors for electronic and electrical power supply applications. All products of this group are assembled by Aerovox de Mexico, S.A., a maquiladora formed by the Company in Juarez, Mexico.\nProducts and Markets\nAero M's AC voltage aluminum electrolytic capacitors, are produced primarily for motor-start applications providing torque for single phase electric motors, or for gear applications used as a short period electric motor run.\nAero M DC voltage aluminum electrolytic capacitors are used in the electronic industry primarily for large can applications such as DC power supplies, uninterruptible power supplies, motor drives and energy discharge applications such as welding, strobes and photoflash. The Group also produces a variety of low profile \"snap-ins\", radial and axial tubular capacitors.\nCompetition\nIn the North American AC motor-start capacitor market, Aero M has only one major competitor - North American Philips. Offshore competition has not been a factor in this market. The principal competitive factors in the industry are delivery, quality, customer service and pricing.\nThe large can computer grade DC capacitor market is dominated by CDE, and North American Philips and other foreign-owned domestic manufacturers. This very competitive marketplace has minimum to no standardization and is considered an application-specific product normally requiring design-in and qualification testing by its customers. The principal competitive factors in this industry are technical capability and support, quality, delivery and pricing.\nManufacturing\nThe key material element of an aluminum electrolytic capacitor is an essentially pure aluminum foil that has been processed, chemically and electrically, to meet the capacitance and voltage specifications of the\nfinished capacitor. This processing, known as etching and forming of the aluminum foil, is done at the Aerovox Foil Division in Huntsville, Alabama. Slitting of the processed foil to required widths is also completed at this plant. The foil is then forwarded to the Aero M Juarez, Mexico facility for assembly into a finished aluminum electrolytic capacitor. On separate assembly lines, the aluminum foil is wound into the required sizes and assembled into containers, filled with the appropriate electrolyte, tested and marked. In-can electrical aging to prevent defects caused by surge currents delivers highly reliable capacitors to the packaging and shipping docks.\nBHC AEROVOX LTD.\nBHC Aerovox Ltd., located in Weymouth, England, is one of Europe's leading manufacturers of aluminum electrolytic capacitors with sales throughout Europe.\nProducts and Markets\nBHC Aerovox is the major supplier of AC motor-start capacitors to the European market, serving the fractional horsepower motor and the compressor markets. Their leading edge technology high voltage DC capacitors are supplied to all the major European motor drives manufacturers. Other applications include uninterruptible power supplies, telecommunication power supplies, traction units for trains, welding equipment and other general industrial electronics applications.\nIn 1995, a new building created 40% more space for expansion of the aluminum production and for introduction of a product line for microwave oven capacitors.\nCompetition\nThere is keen competition from a number of European and Far Eastern suppliers for all of the aluminum products made by BHC Aerovox. In each of the main countries, there is at least one local supplier. BHC Aerovox has increased its market share by offering technical backup to support a range of high quality, technically advanced products.\nThere is only one European competitor for microwave capacitors (in Italy). The main competitors are in Korea and the United States. BHC Aerovox will offer the flexibility of a local supplier.\nManufacturing\nBHC Aerovox purchases etched aluminum foil from several sources, including the Aerovox Foil Division. The etched foil is processed to form a dielectric (aluminum oxide) layer according to the voltage requirements.\nThis processed foil is slit to the required width, wound with specially selected tissue, impregnated with an electrolyte fluid and then assembled into containers. A large part of the production is for custom designs to meet the specific customer applications.\nThe microwave production is based on the proven technology from Aerovox USA, but incorporates state-of-the-art impregnation equipment.\nGENERAL\nSales and Distribution\nAerovox sells its products worldwide to over 1,000 customers, primarily original equipment manufacturers (\"OEMs\"), who purchase capacitors and other products manufactured by the Company for use as components in the products they manufacture. No one customer, in 1995, accounted for 10% or more of the net sales of the Company. In 1995, approximately 38% of the Company's net sales were to its 10 largest customers and 83% were made to its 100 largest customers. The Company expects that sales to these customers will continue to represent a significant portion of its total sales.\nCompany foreign sales, primarily United Kingdom sales, represented approximately 19% of total sales in 1995.\nThe Company markets most of its products to domestic OEMs primarily through 21 sales representative organizations which collectively employ over 200 sales people. Aerovox has enjoyed long-term relationships with many of its sales representatives, some of which have sold Aerovox products in excess of twenty- five years. The Company's low and medium voltage power factor correction capacitors, which are manufactured for installation into industrial, commercial and other type facilities, are marketed through a separate group of industrial sales representatives who specialize in these products. In the United Kingdom and Europe, the Company sells direct and also utilizes 16 sales agents to market Company products. In addition, 12 sales organizations facilitate sales in the Far East, Japan, Australia, Mexico, the Middle East and South America. A smaller portion of the Company's sales are made through distributors and a few long-standing customers are handled as house accounts.\nThe Company's sales are slightly seasonal and are affected by Company production and shipping schedules; the net sales for the first half of the year are based on an aggregate average of 127 shipping days compared to 111 days for the last half of the year. Approximately 75% of the net sales are produced under agreements negotiated on an annual basis, usually during the fourth quarter of the year. The Company sells approximately 95% of its products on a manufactured-to-order basis. If an order is canceled the\nCompany bills the customer for materials and labor expended on the order prior to cancellation.\nA critical element to the Company's strategy is its emphasis on customer service. The Company maintains continual, multilevel contacts with many customers and places a high priority on meeting each customer's requirements in a timely manner.\nBacklog\nAerovox's total backlog represents approximately six weeks of production. The Company's manufacturing lead times vary from four to six weeks depending on the product type, although some filter products and special larger EDC products that must be built specifically to order may require longer lead time. Generally, the Company does not book orders as firm, for purposes of calculating backlog, until 90 days before the scheduled delivery date. The total active backlog was $18.2 million at February 24, 1996, and $23.3 million at February 25, 1995. The Company expects to fill all backlog orders in 1996.\nProduct Development and Quality Control\nProduct development and improvement are important elements of Aerovox's strategy. The Company's efforts to develop new products and to improve existing products are continuous and benefit from long-term technical relationships with a number of key suppliers and customers. Formal and informal consultation and discussion on technical matters of common interest with key suppliers have resulted in a number of significant product improvements, including the development of thinner dielectric materials resulting in a more cost efficient capacitor and development of improved capacitor fluid impregnants that reduce capacitance loss.\nMost recently, technical exchanges between the Company's operating groups has resulted in the development of additional new products and processes, a trend the Company is fostering particularly with the establishment of an electrolytic technical center at the Huntsville plant.\nThe Company places a high degree of emphasis on quality control both in product design (through improved design specifications) and in the production process by means of continuous testing conducted throughout the manufacturing cycle. Statistical Quality Control (SQC), a program aimed at encouraging employee involvement and participation through decision making, is typical of the programs that have helped Aerovox achieve significant quality improvements.\nTo meet worldwide quality standards, the Company has established a goal of achieving company-wide International Standards Organization (ISO) certification for all products. The Aerovox Group earned ISO 9002\ncertification for products manufactured in the U.S., in December 1994, and for those manufactured in Mexico in November 1995. BHC Aerovox Ltd. has been ISO 9001 certified for several years. The Aero M Group capacitor operation in Juarez, Mexico successfully underwent a reassessment in 1995 to verify that the quality systems that were certified in the former Glasgow location have been established in the new location.\nEstablishing \"partnership\" programs with customers is another important aspect of Aerovox's quality endeavors. The Company has established such programs with a number of customers wherein the customer commits to placing a major portion of their business with Aerovox, to forecasting that business, and adhering to a forecasted production schedule. Aerovox, in turn, commits to favorable pricing and to quality levels that allow components to be shipped directly to the customer's manufacturing site without customer inspection.\nRaw Materials\nThe Company purchases raw materials from a number of regional, national and international suppliers. All of these raw materials are available from a variety of suppliers with whom the Company has had long-term relationships. The Company purchases its plain and metallized polypropylene from several sources in Europe and Asia and four sources in the United States. There are four Company approved suppliers for metallized polyester, two in the United States and two in Europe. A number of sources are approved to provide aluminum foil for the Company's electrolytic products - three in the United States, four in Europe, and two in Asia.\nPatents, Licenses and Trademarks\nThe Company's most important intellectual property is its capacitor manufacturing processes which have been developed over a period of many years. Aerovox has approximately 29 active patents or pending patents.\nAerovox licenses some of its product technology and process know-how to Lumisistemas in Mexico. This technology licensing activity does not generate material amounts of revenue for Aerovox.\nThe Aerovox trademark is registered or registration is pending in 23 countries in Europe, North and South America, the Far East, the Middle East and Australia. This trademark has been in force since 1976. In addition, the Company holds or has pending, 18 other United States registered trademarks, some of which are registered in other countries, including the Aero M trademark. The duration of Aerovox's product trademark registrations range from one year to fifty-nine years. The Company believes that its trademark status helps to maintain the proprietary nature of its products.\nEmployees\nAs of February 4, l996, Aerovox had 1,607 employees worldwide. An aggregate of 295 employees hold salaried management, supervisory, sales and clerical positions and 1,311 hourly employees are engaged in production and related activities. Unions represent 2.5% of the employees. None of the Company's production departments are unionized. Approximately 275 employees have been with their respective Aerovox company for 10 years or more.\nAerovox considers its employee relations to be good. There have been no labor stoppages in recent years, and union contracts have been renegotiated without difficulty. A new three year agreement was reached with the International Union of Operating Engineers in April 1995, and a new contract with the International Brotherhood of Electrical Workers will be negotiated by the Aerovox Group in April 1996.\nEnvironmental Compliance\nThe Company has made substantial capital expenditures on environmental controls and compliance at its facilities. See, \"Legal Proceedings - Environmental Compliance\" below.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company has invested in automation and equipment necessary to increase production capability (primarily for the metallized polypropylene product line) in New Bedford. Capital has also been expended on the research and development laboratory at this location and on equipment to manufacture new products at the Aerovox Group maquiladora. In Weymouth, England, a 27,000 square foot building to facilitate expanded aluminum electrolytic capacitor production and commencement of microwave oven capacitor production was completed in 1995. Equipment at the Aero M plant in Juarez continues to be up-graded and new equipment acquired for greater efficiency and capability. A quality control, and research and development labs were installed at the plant in Huntsville, Alabama during 1995. The Company believes that its facilities are adequate for its foreseeable needs.\nItem 3.","section_3":"Item 3. Legal Proceedings:\nThe Company settled a claim made against it concerning the cost of clean up of a hazardous waste facility (\"Resolve\") in Massachusetts, in which the Company will pay an amount currently estimated at $1,500,000, but subject to change. Approximately $715,000 of the amount has been reimbursed to the Company by its primary insurers. The Company initiated appropriate action to collect amounts not covered by the primary insurers from its excess\/umbrella liability insurer. The excess insurer denied that it is required to cover this matter and brought suit against the Company seeking a declaration that the excess liability insurance policies issued by it to the Company do not cover claims made by the Company for environmental response costs with respect to the so-called Resolve site. In April of 1993, the insurer moved for Summary Judgment on its claims, relying on a \"sudden and accidental\" pollution exclusion clause. By order, dated October 8, 1993, the Court denied the insurer's motion but stated that the motion would be allowed unless Aerovox submitted additional evidence concerning property damage caused by an earlier fire at the site. A Motion for Reconsideration was filed by the insurer on December 7, 1993. The Company submitted additional evidence on January 6, 1994, in accordance with the Court's Order. On February 28, 1994, the Court released a Memorandum of Decision and Order Denying Plaintiff's Motion for Reconsideration and Denying the Motion for Summary Judgment, stating that Aerovox had complied with the Court's Order of October 8, 1993, and had submitted evidence tending to show a causal link between a \"sudden and accidental\" occurrence and property damage for which it was held liable. On April 27, 1994, the insurer moved for reconsideration of the February 28, 1994, decision and, on September 26, 1994, the Court granted the Plaintiff's Motion for Summary Judgment. Accordingly, the Company charged approximately $500,000 to earnings in the third quarter of 1994. On December 23, 1994, the Company filed a notice of appeal of this decision of the Court. The Appeal Brief was filed on February 13, 1996. The Company, based on information presently available, does not believe that\nthis matter will have a material adverse effect on the Company's financial condition.\nOn February 9, 1990, the Company entered into a settlement agreement (the \"Settlement Agreement\") with the United States and The Commonwealth of Massachusetts (the \"governments\") resolving litigation commenced by the governments in the U.S. District Court for the District of Massachusetts, on December 10, 1983 under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, commonly known as the \"Superfund\" legislation. The litigation concerned the alleged disposal by various defendants of polychlorinated biphenyls (\"PCB's\") in the Acushnet River and New Bedford Harbor. The Settlement Agreement resolved all of the governments' claims against the Company and Aerovox Industries, Inc. (the Company's predecessor, now known as Belleville Industries, Inc.) arising out of the contamination of the Acushnet River and New Bedford Harbor with PCB's, including cleanup costs, study costs and damages to natural resources, now or hereafter incurred, except that the Settlement Agreement provides that the governments may seek damages from the Company and Aerovox Industries, Inc. for future liability in the event that such future liability arises out of unknown conditions at the site.\nEnvironmental Compliance\nThe Company is currently subject to a water discharge permit that allows discharges from the New Bedford, Massachusetts facility of up to 10 parts per billion (\"ppb\") of PCBs in its stormwater and other discharges. For several years, the Company and the United States Environmental Protection Agency (\"EPA\") have been discussing possible changes to this permit. At one point, EPA tentatively proposed a limit of 1 ppb, a level that would be difficult, if not impossible, to meet at all times. As a result of extensive comments submitted by the Company, the EPA in the most recent draft permit, dated August 26, 1991, has proposed separate limits for each discrete discharge point from a maximum of 2 ppb for non-contact cooling water to 61 ppb for stormwater discharges. The draft permit would also require the Company to conduct studies to determine if further reductions are possible. After a thorough review of the draft permit, the Company submitted comments to the EPA requesting the clarification of several technical issues. The Company tentatively believes the limits in the most recent draft permit are attainable. The draft permit must also be reviewed by several Massachusetts state agencies. The Company has been informed that the Massachusetts Department of Environmental Protection (the \"DEP\") has taken the position that the draft permit would not comply with state water quality standards and the EPA has concurred in this view. This assertion may prevent the issuance of the permit at the levels currently proposed. An outlined scope of work for a Storm Water Study Plan and a Best Management Practices Plan was provided to EPA by the Company in December 1992. A response was received in January 1993 from DEP noting concurrence with the scope of work. The following plans were submitted to\nEPA and DEP in June 1994: Stormwater Study Plan, Quality Assurance Project Plan, and Stormwater Best Management Practices Plan. Aerovox will proceed with implementation of the plans upon receipt of EPA and DEP approvals. The Company cannot predict what further actions the EPA or DEP may take with regard to the permit or what impact any such actions may have on the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable. No matter was submitted to stockholders of the Company during the fourth quarter of fiscal 1995.\nItem 4A. Executive Officers - Set forth below are the names, ages and positions of the executive officers of Aerovox in 1995:\nMr. Tuttle received a Bachelor of Arts degree from Amherst College in 1952. In 1964, he founded and became President of Marketing Assistance Incorporated, a consulting organization working with small companies offering technological products. He joined Aerovox Corporation (now AVX Corporation) in June of 1970 as Vice President of Marketing and Sales. In 1973, Mr Tuttle participated in the purchase of Aerovox Corporation's Electrical Products Division. Mr. Tuttle became President of the resulting company, Aerovox Industries, which is the predecessor of Aerovox Incorporated.\nMr. Capra graduated from St. Louis University with a Bachelor of Science Degree in 1954. Mr. Capra's career in the electrical industry spans twenty-five years. From 1987 to 1990, he was President and Chief Executive Officer of Philips Lighting Co., a manufacturer of lighting equipment. He was a consultant to the electrical industry from 1991 to 1993, when he became President of Crescent Electric Supply Co., a wholesaler of electrical supplies to contractors and industrial markets. Mr. Capra joined Aerovox in November 1994 as Senior Vice President of the Company and President of the Aero M Group, and became a part- time employee consultant to Aero M and BHC, the Company's electrolytic operations, in October 1995.\nMr. Chmura graduated with a Bachelor of Science degree in Engineering Sciences from the United States Naval Academy in 1967. Mr. Chmura joined Aerovox in 1977 as a product manager. Since then he has held the positions of Regional Sales Manager, Marketing Manager, Director of Marketing, Director of Sales, Vice President of Sales, and since 1986, Vice President of Sales and Marketing, and since 1995, Senior Vice President, Sales and Marketing.\nMr. Fox graduated from the University of Rhode Island with a Bachelor of Science degree in Industrial Engineering in 1967 and joined Aerovox in 1976 as Manager of Manufacturing Engineering progressing to General Manager of the Electrical Group in December 1990. In 1993, he was named Vice President, Operations Support and in 1994, was promoted to Senior Vice President, Operations Support. Mr. Fox is Chairman of the Board of BHC Aerovox Ltd.\nDr. Hudis holds a Bachelor of Science degree from the University of California in Los Angeles (1965), a PhD in Nuclear Engineering from the Massachusetts Institute of Technology (1970), and a Master of Business Administration from the University of Chicago (1981). He was Vice President for Engineering and Marketing of LH Research, a manufacturer of power supplies, from 1989 to 1991. Dr. Hudis joined Aerovox as Vice President, Technology in January, 1992 and became a Senior Vice President\nin 1995. He is a senior member of The Institute of Electrical and Electronics Engineers, an international organization of electrical and electronic engineers.\nMr. Hunter studied chemistry at Glasgow University. In 1957, he joined British Drug Houses, in charge of an Organic Analytical Laboratory. He joined Daly Condensers in 1962 as Technical Manager, progressing to Managing Director in 1968, and continued to serve this role for three years after STC acquired Daly condensers in 1979. In 1983, Mr. Hunter founded B.H. Components, a manufacturer of aluminum electrolytic capacitors, which was acquired by Aerovox in 1993. Mr. Hunter remained as Managing Director of the successor company, BHC Aerovox Ltd., and was named a Vice President of Aerovox Incorporated in 1994, and Senior Vice President in 1995.\nMr. Kirschmann graduated from Worcester Polytechnic Institute with a Bachelor of Science in Electrical Engineering in 1965, and received a Master of Business Administration degree from Syracuse University in 1966. Mr. Kirschmann worked for General Electric Co. for twenty-four years, and was appointed Manager - capacitor and power protection operations in 1987. He became President of Lapp Insulator Co., a manufacturer of ceramic and polymer insulators for the electrical utility industry in 1990. In February 1993, Mr. Kirschmann joined Aerovox as Senior Vice President and General Manager of the Electrical Group, and in November 1993 was named Senior Vice President and President of the consolidated Aerovox Group.\nMr. Murphy graduated from Bentley College in Boston, Massachusetts, from the Evening Division in 1959. He started his business career in 1955 after an honorable discharge from the U.S. Air Force. In 1967 he joined the Sippican Corporation, a diversified manufacturing and consulting engineering firm, as Corporate Controller, and was promoted to Vice President of Finance in 1971. In 1976, he joined Aerovox as Senior Vice President and Treasurer.\nMr. Allen studied civil engineering at Roger Williams College. He was Director of Quality for North American operations at the Dresser Valve and Controls Division of Dresser Industries from 1988 to 1992. Following that, he served as Director Quality-Worldwide at Branson Ultrasonics Corporation, a division of Emerson Electric Company. Mr. Allen joined Aerovox early in 1995 as Director, Manufacturing for the Aerovox Group. In September of 1995, he was promoted to Vice President, Manufacturing Operations. He is a senior member of the American Society for Quality Control and a member of the American Society for Testing and Materials.\nDr. Arora holds a Bachelor of Engineering degree in Metallurgy from the Indian Institute of Technology, Bombay, India (1964), and a Ph.D. in Materials Science from McMaster University, Hamilton, Canada (1974). After twelve years with Philips Components, where he was the Manager of Foil Development, he joined Aerovox in 1993 to direct the Foil Operations in\nHuntsville. In 1995, he was named Vice President of the newly created Foil Division. Dr. Arora is a member of the Electrochemical Society and the American Society for Metals.\nMr. Bromley graduated from the Franklin Institute in Boston in 1967 with an Associate's degree in Mechanical Engineering. He worked in the capacitor field at General Electric for twenty years and became a Quality Control Manager in 1983, the position he held until joining Aerovox as Director of Quality Assurance in 1988. In 1990, Mr. Bromley was named to the corporate position of Vice President for Quality Assurance.\nMr. Sherman graduated from Bryant College with a Bachelor of Arts degree in 1972. He served as President of Ludell Manufacturing Co., a manufacturer of heat recovery systems and electronic controls for the petro-chemical industry, for 5 years before joining Aerovox as General Manager of the Electronic Group in 1990. In November 1993, he was named Vice President of Marketing for the consolidated Aerovox Group.\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 on NASDAQ National Market System under the symbol ARVX. The Company's Common Stock was distributed to the beneficiaries of the Aerovox Liquidating Trust on February 26, 1990. See \"Shareholder Information\" in the Annual Report to stockholders for the year ended December 30, 1995, incorporated herein by reference, for the quarterly market price range of the Company's Common Stock. The number of record holders of the Company's Common Stock at February 16, 1996 was 7,887. The Company has not declared dividends previously and currently intends to continue to retain earnings for use in its business and does not expect to pay dividends for the foreseeable future. The Company's common stock dividend policy will be reviewed periodically by the Board of Directors as may be appropriate in light of relevant factors.\nItem 6.","section_6":"Item 6. Selected Consolidated Financial Data\nThe information required by this item appears in the Company's 1995 Annual Report to Stockholders on page 31 and is incorporated herein by reference. Such information should be read in conjunction with the Company's consolidated financial statements and the notes thereto which are included in such Annual Report and are incorporated by reference in Item 8 hereof.\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 1995 Annual Report to Stockholders on pages 14-16 and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following financial statements of Aerovox Incorporated appear in the Company's 1995 Annual Report to Stockholders on the pages indicated below 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\n(a) Directors - Information with respect to all directors may be found in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders on pages 2 and 3 under the caption \"Election of Directors,\" which Statement is to be filed with the Securities and Exchange Commission. Such information is incorporated herein by reference.\n(b) Executive Officers - Information with respect to executive officers appears in Item 4A. of Part I.\nItem 11.","section_11":"Item 11. Executive Compensation\nThis information is contained in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders on pages 10-15 under the caption \"Executive Compensation\" and \"Compensation Committee Report\", which Statement is to be filed with the Securities and Exchange Commission. Such information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is contained in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders on page 16 and 17 under the caption \"Security Ownership of Certain Beneficial Owners and Management,\" which Statement is to be filed with the Securities and Exchange Commission. Such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot applicable.\nPART IV. __________________________________________________________\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K.\n(a) Exhibits:\nA list of Exhibits filed with or incorporated by reference in this Report on Form 10-K appears at pages 23-25 hereof, which list is incorporated herein by reference.\n(b) Financial Statements:\nA list of consolidated financial statements is contained in Item 8 and is incorporated here by reference.\nFinancial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts for the years 20 20 ended December 30, 1995, December 31, 1994, and January 1, 1994.\nReport of Independent Accountants on Financial Statement 21 Schedules.\nAll other financial statement schedules are inapplicable or the required information is contained in the Company's consolidated financial statements or notes thereto, which have been incorporated by reference herein.\n(c) Reports on Form 8-K: None\nAEROVOX INCORPORATED VALUATION AND QUALIFYING ACCOUNTS (Amounts In Thousands)\n(1) Allowance for doubtful accounts receivable acquired in acquisitions of businesses. (2) Write-off of accounts receivable.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Aerovox Incorporated\nOur report on the consolidated financial statements of Aerovox Incorporated has been incorporated by reference in this Form 10-K from page thirty-two of the 1995 Annual Report to Stockholders of Aerovox Incorporated. In connection with our audit of such financial statements, we have also audited the related financial statement schedule listed in Item 14(b) of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements as a whole, presents fairly, in all material respects, the information required to be included therein.\nBY \/S\/ COOPERS & LYBRAND L.L.P. - ------------------------------- COOPERS & LYBRAND L.L.P.\nBoston, Massachusetts February 28, 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.\nAerovox Incorporated (Registrant)\nBY \/S\/ CLIFFORD H. TUTTLE, JR. ------------------------------------- Chairman of the Board of Directors President and Chief Executive Officer\nMarch 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.\nEXHIBIT INDEX Aerovox Incorporated Form 10-K (for fiscal year ended December 30, 1995)\nEXHIBIT INDEX\nAerovox Incorporated Form 10-K (for fiscal year ended December 30, 1995)\nEXHIBIT INDEX\nAerovox Incorporated Form 10-K (for fiscal year ended December 30, 1995)\n* Filed as an Exhibit to Registration Statement on Form 10 filed with the Securities and Exchange Commission on October 4, 1989, and incorporated herein by reference.\n** Filed as an Exhibit to Amendment No. 1 to the Registration Statement to Form 10 filed with the Securities and Exchange Commission on December 1, 1989, and incorporated herein by reference.\n*** Filed as an Exhibit to Amendment on Form 8 to the Registration Statement on Form 10, filed with the Securities and Exchange Commission on February 16, 1990.","section_15":""}
{"filename":"751190_1995.txt","cik":"751190","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nMeasurex Corporation (the \"Company\") is engaged worldwide in the design, manufacture and servicing of computer-integrated measurement, control and information systems. The Company's wide range of products are designed to increase productivity, reduce raw material and energy consumption and improve quality and uniformity. Industries served by the Company include paper, plastics, nonwovens, aluminum, steel and rubber. The Company's customers are served by sales and service subsidiaries located in 50 offices and 34 countries around the world. More than half of Measurex's 2,360 employees are dedicated to the sales, support and servicing of the Company's customers.\nThe Company is a corporation organized under the laws of the State of Delaware as the successor to a California Corporation organized in 1968. The Company's principal executive offices are located at One Results Way, Cupertino, California 95014-5991 (telephone number: 408-255-1500).\nThe term \"the Company\" as used hereinafter means Measurex Corporation or Measurex Corporation and its subsidiaries, as the context requires.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nThe response to this section of Item 1 is incorporated by reference to \"Business Segments\" under Notes to Consolidated Financial Statements in the Company's 1995 Annual Report to Shareholders.\nNARRATIVE DESCRIPTION OF BUSINESS.\nThe Company is a leading worldwide supplier of computer-integrated measurement, control and information systems for continuous manufacturing processes. The Company's systems are primarily used to control the manufacturing processes in those industries in which the manufactured product is made in a flat sheet; e.g. paper, plastics, nonwovens, aluminum, steel and rubber.\nThe Company provides measurement and control systems and services that enhance the productivity and efficiency of its customers' processes and improve the quality of its customers' products. These integrated systems utilize sensors and scanners to measure the quality properties of the product. Software running in computers and workstations use these measurements to provide control of the process, computer graphic operator displays and management information. Actuators are regulated by the software to provide precision adjustments to the process.\nThe Company also provides management information systems which integrate the manufacturing process with such functions as order entry, inventory control, product tracking, production scheduling, shipping and invoicing.\nThe Company's systems use international industry communications and computing standards which allow connectivity between the Company's systems and other standards-based measurement and control products.\nThe following table shows the annual revenues and the percentages of annual revenues during the last three fiscal years attributable to the sale of computer-integrated measurement, control and information systems to the paper and industrial systems industries (plastics, nonwovens, aluminum, steel and rubber) and the services provided to customers in those industries.\nPAPER SYSTEMS BUSINESS\nIn 1995, approximately 56% of the Company's revenues were generated from system sales to the paper industry. The Company's systems are used to control the production of practically all kinds of paper and paperboard products including: fine paper used for stationary and books; xerographic paper for copy machines; glossy stock for magazines; paperboard and linerboard for boxes; sack grades for paper bags; newsprint and tissue.\nIn the paper industry, the Company's MXOpen(R) product line includes:\n. Integrated Control Systems and Sensors . Distributed Control Systems . Cross Direction (CD) Profile Control Systems and Actuators . Web Inspection Systems . Integrated Machine Monitoring Systems . Millwide Production and Information Management Systems\nA key component of the Company's measurement and control systems is its proprietary sensor technology. The Company currently offers a wide variety of on-line sensors to its customers in the paper industry which measure many aspects of product quality including basis weight, moisture, caliper, ash content, coatweight, smoothness, gloss, formation, opacity, strength and color. These on-line sensors, generally non-contacting, probe the product with radiation from various parts of the electromagnetic spectrum including infrared, visible light, beta, x-ray and gamma radiation.\nThe Company's web-inspection systems use Charge Couple Device (CCD) camera technology to detect visual defects in paper and other web-produced material.\nThe Company is a leader in the complex technology of cross-direction (CD) profile control. The Company's Cross Direction Profile Control Systems and Actuators allow precise control of paper characteristics in small segments across the entire width of the sheet resulting in optimum quality levels, reduced material and energy use and lower scrappage rates.\nThe Company's products are sold individually as add-ons or upgrades to existing measurement and control systems (the Company or competitor systems) or as complex integrated systems designed for specific applications or processes. The Company's systems are primarily sold by the Company's worldwide sales organization. In addition, the Company has established certain alliances and OEM relationships to provide customers with turnkey paper automation projects. The systems are generally installed at the customer's site by the Company's worldwide service organization.\nINDUSTRIAL SYSTEMS BUSINESS\nIn 1995, approximately 10% of the Company's revenues were generated from system sales to customers in the plastics, nonwovens, aluminum, rubber and other industries. The Company's systems are used to control the materials used in or the production of many products including:\n. Plastics, films and coated products - candy wrap, magnetic media base, food and liquid packaging, vinyl products, labels and tapes. . Nonwoven products - diaper liners, wipes, surgical drapes, roofing, filters, clothing, floor mats and carpet backing. . Rubber products - tire fabrics, roofing, tank liners and belts. . Aluminum products - beverage and food can stock, foil and siding. . Other - chemical, fiberglass, plastic resin and pharmaceuticals.\nThe Company's MXOpen product offering to Industrial Systems' customers include:\n. Measurement Control Systems (MCS) and Sensors . Distributed Control Systems . Profile Control Systems . Web Inspection Systems\nIn December 1994, the Company acquired the Webart Division of The Ohmart Corporation and its ConceptOne(R) measurement and control products. This acquisition added a low-priced PC based system to the Industrial Systems product line, opening a new market for smaller plastics and sheet applications.\nIn January 1996, the Company acquired Data Measurement Corporation (DMC) a manufacturer of measurement systems for the steel industry. The Company intends to expand DMC's gauging system into a full computer-integrated control and information system. Prior to the acquisition, the Company did not participate in the steel market.\nIndustrial Systems products are distributed through the Company's worldwide sales organization and other distribution channels such as OEMs, distributors and agents.\nSERVICE BUSINESS\nIn 1995, service revenues represented approximately 34% of the Company's total revenue. The Company's worldwide sales and service organization supports customers in both the paper and industrial systems businesses. The Company has over 4,000 systems installed in 54 countries, primarily located in North America, South America, Europe and Asia. The Company's service offering includes both resident service contracts and on-demand service for spare parts, preventive and emergency maintenance. Value added services such as process optimization and software enhancements are growing parts of this business. Also, the Company maintains systems of its direct competitors as well as third party non-competitive products.\nRESEARCH AND PRODUCT DEVELOPMENT\nThe Company's systems are the result of the integration of a number of complex technologies including electronics, physics, mechanical design and software. Central to the Company's strategic goals is a commitment to research and development. The Company strongly believes the continued investment in new product development is key to its long-term success.\nDuring fiscal year 1995, 1994 and 1993, the Company spent approximately $19.4 million, $20.0 million and $21.1 million, respectively, on research and development. Those amounts represented 6%, 8% and 8%, respectively, of total revenues and 9%, 13% and 14%, respectively, of system revenue.\nBACKLOG\nSystem backlog at December 3, 1995, was $143 million, 55% higher than the backlog of $92 million at the end of fiscal 1994. Approximately 90% of the $143 million year-end 1995 backlog is scheduled to be shipped during fiscal 1996.\nPATENTS\nThe Company follows a policy of filing appropriate patent applications on inventions it considers significant. As of December 3, 1995, the Company had 69 United States patents and 132 foreign patents in effect. Although important to the business, the Company believes that the invalidity or expiration of any single such patent would not have a material adverse effect on its operations.\nSUPPLY OF MATERIALS AND PURCHASED COMPONENTS\nThe Company produces most of the application software, sensors, scanners, digital logic circuits and actuators used in its systems. Many components, such as integrated circuits, video monitors, printers, cameras, disks, and microcomputers are purchased from other manufacturers and integrated into the systems.\nThe Company currently purchases certain components from single sources of supply. In each instance, components performing similar functions are available from alternative sources, except for radioactive source material which is available from only two suppliers. Use of these alternative components might require a change in the design of certain portions of the system which could result in production delays, additional expenses and contract cancellations while changing vendors. The Company has contracts with certain vendors which entitle, but do not require, the Company to purchase specific quantities of components.\nCOMPETITION\nThe market for process measurement and control is highly competitive and is subject to technological change in both hardware and software development. The principal competitive factors in this market are product quality and reliability, product features, customer support, corporate reputation and relative price\/performance. The Company's competitive strategy is to provide customers with greater economic results than available from competitors by focusing on quality and the unique performance characteristics of the customers' systems. However, any inability of the Company to match or exceed the price\/performance or other features of the systems offered by its competitors could adversely affect future operating results.\nThe Company's principal competition is from distributed control systems suppliers and packaged system suppliers, as well as factory automation system suppliers, many of which have substantially greater resources than the Company. In the supervisory measurement and process control business area, competition includes Asea Brown Boveri Process Automation Inc. (ABB); Lippke, a wholly owned subsidiary of Honeywell; the Valmet Automation Group, a division of Valmet Oy; and Yokogawa-YEW in Japan. The distributed control system business area competition includes Honeywell, Fisher, Foxboro (a subsidiary of Siebe, Inc.), Siemens, and many other companies. In the web-inspection products area, the Company faces competition from ABB and other smaller companies. Competition for production management and process analysis and quality management is very fragmented.\nEMPLOYEES\nAs of December 3, 1995, the Company had approximately 2,360 full-time employees. With the acquisition of DMC in January, 1996, the Company added approximately 340 full-time employees.\nNUCLEAR REGULATORY LICENSES\nIn the United States, the Company and its customers are subject to licensing and regulation by the United States Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954 (the Act) with respect of those parts of its products and systems which utilize nuclear radiation. The NRC has transferred a portion of its licensing and regulatory functions to several state governments, including California, pursuant to Section 274 of the Act. The Company holds all such licenses necessary for its current operations. Licenses are renewed periodically as required.\nThe Company also holds all necessary foreign licenses regarding nuclear radiation for the applicable countries in which it operates.\nUnited States customers possessing the Company's systems containing radioactive sources hold the radioactive material under a General or Specific License issued by their state or federal regulatory authority. Similarly, foreign customers hold licenses issued by their local authorities for radioactive material in the Company's systems.\nENVIRONMENT\nThe operations of the Company involve the use of substances regulated under various federal, state and international laws governing the environment. It is the Company's policy to apply strict standards for environmental protection to sites inside and outside the U.S., even if not subject to regulations imposed by local governments. Liability for environmental remediation is accrued when it is considered probable and costs can be reasonably estimated. Environmental expenditures are presently not material to the Company's operations or financial position.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Company engages in operations in many foreign countries. A large portion of the Company's foreign business is in Europe, Canada, Latin America and Asia.\nAlthough there are risks attendant to foreign operations, such as potential nationalization of facilities, currency fluctuation and restrictions on movement of funds, the Company has taken action to mitigate such risks.\nFor information regarding geographic operations in 1995, 1994, and 1993, see \"Business Segments\" included in the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report to Shareholders.\nRISK FACTORS\nThe Company's future operations are subject to a number of risks and uncertainties including, but not limited to, the following:\nFluctuations in Quarterly Orders - The Company's quarterly orders have fluctuated in the past and may fluctuate significantly in the future due to a number of factors, including the timing of orders from its customers, changes in pricing by the Company or its competitors, discount levels, new product introductions by the Company or its competitors, foreign currency exchange rates, and changes in the economic and political environments of the countries and industries it serves.\nFluctuations in Financial Results - The Company's quarterly and annual financial results have fluctuated in the past and may fluctuate significantly in the future due to a number of factors, including the scheduling of factory shipments, changes in pricing and discount levels, utilization levels of the Company's manufacturing facilities and personnel, amount and growth in operating expenses, changes in applicable tax rates, changes in product mix of system revenue, amount of spares shipments, changes in interest rates, changes in foreign currency exchange rates and the ability of the Company to mitigate the impact of such changes with foreign currency forward contracts.\nCyclicality of the Paper Industry - A substantial portion of the Company's sales have historically come from the paper industry. While the Company has recently expanded its presence in the industrial systems component of its business through its acquisition of Data Measurement Corporation, the paper industry will continue to account for most of the Company's revenues. This industry has in the past, and will likely in the future, be subject to substantial cyclicality and economic downturns. This cyclicality may in turn materially impact the Company's order rate and results of operations.\nRisks Associated with International Operations - A majority of the Company's revenues are typically generated from sales outside of the United States. The Company's international orders, revenues and profitability are subject to inherent risks including timing in obtaining import licenses and letters of credit, fluctuations in local economies, difficulties in staffing and managing foreign operations, changes in foreign currency exchange rates, changes in regulatory requirements, tariffs and other trade barriers, difficulties in repatriation of earnings, and burdens of complying with a wide variety of foreign laws.\nRisks of Serving other Cyclical Industries - The Company's orders and operating results are impacted by the capital expenditure cycles in the plastics, rubber, non-wovens, aluminum and steel industries, all of which are subject to substantial cyclicality.\nAbility to Integrate Acquisitions - A key element of the Company's strategy for growth is the acquisition of products that can be distributed through its worldwide sales and service organization. The success of this component of the Company's strategy is dependent upon the ability of the Company to identify acquisition candidates that meet its acquisition criteria, acquire the acquisition target at a fair price, integrate the acquired operations into the Company and implement its business plan after acquisition. There can be no assurance that the Company will be successful in achieving these goals in every instance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 3, 1995, the Company owned the major facilities described below:\nAs of December 3, 1995, the Company also leased a facility in Waterford, Ireland totaling approximately 20,000 square feet and two facilities in Kuopio, Finland for manufacturing, engineering and sales support. The Company leases office space for sales and service operations throughout the United States and various countries.\nWith the acquisition of DMC in January 1996, the Company also acquired an additional 45,000 square feet leased facilities used by DMC for offices, research and manufacturing operations.\nDuring 1995, the Company was productively utilizing the space in its facilities, while disposing of space determined to be under-utilized. The Company believes current facilities provide adequate production capacity to meet the Company's planned business activities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company or any of its subsidiaries are a party or of which any of their property is the subject, other than ordinary routine litigation incidental to the business. Management believes that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial position and results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable\nEXECUTIVE OFFICERS OF REGISTRANT\nThe following table and notes thereto identify and set forth information about the Company's eight executive officers as of January 31, 1996 (ages are as of December 3, 1995):\n(1) Mr. Bossen, age 68, has been Chairman and Chief Executive Officer and Director since December 1993; President and Chief Executive Officer and Director from 1968 to December 1993.\n(2) Mr. Gingerich, age 59, has been President and Chief Operating Officer and Director since December 1993; Executive Vice President, Worldwide Sales and Service from 1992 to December 1993; President, Americas and Pacific from 1991 to 1992; Executive Vice President from 1990 to 1991.\n(3) Mr. Robert McAdams, Jr., age 56, has been Executive Vice President and Chief Financial Officer since April 1995; Senior Vice President and Chief Financial Officer from September 1994 to April 1995; Senior Vice President Operations and Information Services from 1992 to September 1994; Senior Vice President-Finance and Administration and Chief Financial Officer from 1985 to 1992.\n(4) Mr. William J. Weyand, age 51, has been Executive Vice President, Worldwide Sales and Service since April 1995; Senior Vice President of Worldwide Sales and Service from December 1994 to April 1995; President, North and South America from February to December 1994; Senior Vice President, U.S. and Canada Sales and Service from 1993 to February 1994; Senior Vice President, U.S. Sales and Service from 1991 to 1993.\n(5) Mr. Wienkoop, age 48, has been Executive Vice President, President Industrial Systems Division since September 1994; Executive Vice President, Engineering and Marketing from 1991 to September 1994; President, Measurex Automation Systems from 1985 to 1991.\n(6) Mr. Lance M. Lissner, age 45, has been Vice President, Corporate Planning and Development since 1991; Vice President, Engineering and Marketing, Industry Groups from 1989 to 1991.\n(7) Mr. John G. Preston, age 52, has been Vice President, General Manager, Integrated Control Systems Business Unit since September 1994; President, Measurex Europe from 1992 to September 1994; President, Devron Division from 1991 to 1992; President, Measurex Canada from 1990 to 1991.\n(8) Mr. Charles Van Orden, age 41, has been Vice President, General Counsel and Secretary since April 1995; General Counsel and Secretary from 1988 to April 1995.\nOfficers are elected annually but may be removed at any time at the discretion of the Board of Directors. There are no family relationships among any of the above officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information under the heading \"Market for the Registrant's Common Stock and Related Security Holder Matters,\" which appears on page 31 of Registrant's 1995 Annual Report to Shareholders, is incorporated by reference in this Annual Report on Form 10-K.\nThe Company paid quarterly dividends of $0.11 per share in 1995 and 1994. While the Company intends to pay regular quarterly dividends, the payment of any future dividends is within the discretion of the Board of Directors of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information under the heading \"Selected Financial Data,\" which appears on page 32 of Registrant's 1995 Annual Report to Shareholders, is incorporated by reference in this Annual Report on Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information under the heading \"Management's Discussion and Analysis\" which appears on pages 18 to 19 of Registrant's 1995 Annual Report to Shareholders, is incorporated by reference in this Annual Report on Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information under the heading \"Financial Statements and Supplemental Financial Data,\" which appears on pages 20 to 31 of Registrant's 1995 Annual Report to Shareholders, is incorporated by reference 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\nNot applicable\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the directors of the Company appears in Registrant's definitive Proxy Statement for the annual meeting of shareholders to be held April 12, 1996, under the caption \"Election of Directors\" and is incorporated herein by reference. Information concerning the executive officers of the Company appears at the end of Part I, page 8 of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference to Registrant's definitive Proxy Statement for its annual meeting of shareholders to be held April 12, 1996.\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 annual meeting of shareholders to be held April 12, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference to Registrant's definitive Proxy Statement for its annual meeting of shareholders to be held April 12, 1996.\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 of Measurex Corporation included herein are set forth in the Index to Financial Statements and Schedules submitted as a separate section of this Report.\n2. The Financial Statement Schedules are contained in the accompanying Index to Financial Statements and Schedules submitted as a separate section of this Report.\n3. Exhibits\nSee Index to Exhibits, page 16.\n(b) Reports on Form 8-K.\nThe Company filed a report on Form 8-K dated September 16, 1995 in which the Company reported that it had entered into an agreement to acquire Data Measurement Corporation (DMC).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMEASUREX CORPORATION (Registrant) Date: February 29, 1996 By \/S\/ DAVID A. BOSSEN --------------------------- David A. Bossen Chairman\nKnow all persons by these presents, that each person whose signature appears below constitutes and appoints David A. Bossen and Robert McAdams, Jr., jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nMEASUREX CORPORATION INDEX TO FINANCIAL STATEMENTS AND SCHEDULES Fiscal Year 1995\n------------------\nWith the exception of the aforementioned information, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this report unless otherwise noted.\nOther schedules have not been filed because the conditions requiring the filing do not exist or the required information is given in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders Measurex Corporation\nOur report on the consolidated financial statements of Measurex Corporation and Subsidiaries as of December 3, 1995 and November 27, 1994 and for each of the three fiscal years in the period ended December 3, 1995, has been incorporated by reference in this Form 10-K from page 30 of Measurex Corporation's 1995 Annual Report to Shareholders. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 13 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/S\/ COOPERS & LYBRAND L.L.P. ----------------------------- COOPERS & LYBRAND L.L.P.\nSan Jose, California December 19, 1995\nSCHEDULE VIII\nMEASUREX CORPORATION VALUATION AND QUALIFYING ACCOUNTS (1) Fiscal years 1995, 1994 and 1993 (Amounts in thousands)\nNOTES:\n(1) See the Notes to Consolidated Financial Statements. (2) Deductions for returns of systems or parts of systems and for write-off of noncollectible amounts. (3) Deductions for write-offs of obsolete and scrapped parts and translation adjustments. (4) Represents the reclass to accrued liabilities of reserves relating to certain leases sold with recourse to a financial institution. (5) Represents the reclassification of reserves from current inventories to service parts. (6) Includes allowance on contracts receivable.\nSCHEDULE X\nMEASUREX CORPORATION SUPPLEMENTARY INCOME STATEMENT INFORMATION Fiscal Years 1995, 1994, and 1993 (Amounts in thousands)\n1995 1994 1993 ------- ------- -------\nCharged to costs and expenses: (1)\nAmortization of intangible assets (2) $ 4,530 $ 5,218 $ 4,380 ======= ======== =======\nNOTES:\n(1) Items omitted are less than 1% of revenues. (2) Intangible assets include goodwill, patents and capitalized software.\nMEASUREX CORPORATION INDEX TO EXHIBITS Fiscal Year 1995\nExhibits - --------\n2.1 Copy of the Amended and Restated Agreement and Plan of Reorganization dated as of September 16, 1995 among Measurex, Data Measurement Corporation and Mx Acquisition Company (incorporated by reference from Exhibit 2.1 on Form 8-K reporting on event occurring on January 10, 1996).\n3.1 Certificate of Incorporation of Registrant (incorporated by reference from Exhibit 3.1 on page 30 of Report on Form 10-K for the fiscal year ended November 29, 1987).\n3.2 Bylaws of Registrant, restated and amended as of April 19, 1994 (incorporated by reference from Exhibit 3.2 on page 21 of Report on Form 10-K for the fiscal year ended November 27, 1994).\n4.1 Copy of Registrant's Rights Agreement dated as of December 14, 1988, as amended by Amendment No. 1 thereto dated May 30, 1990, (incorporated by reference from Exhibit 4.1 on page 47 of Report on Form 10-K for the fiscal year ended December 2, 1990).\n10.1 Copy of Registrant's Employee's Stock Option Plan (1993) (incorporated by reference from Form S-8 Registration Statement No. 33-65762 filed with the SEC on July 8, 1993).\n10.2 Copy of Registrant's Management Incentive Plan.\n10.3 Copy of Registrant's Employee Stock Purchase Plan, amended and restated effective December 14, 1993 (incorporated by reference from Exhibit 10.4 on page 21 of Report on Form 10-K for fiscal year ended November 27, 1994)\n10.4 Copy of Registrant's Affiliation Agreement dated as of May 30, 1990, between Measurex Corporation and Harnischfeger Industries, Inc. (incorporated by reference from Exhibit 4.1 to Form 8-K filed with the SEC on June 12, 1990)\n10.5 Copy of Registrant's Repurchase Agreement dated December 29, 1994 (which contains certain amendments to the Affiliation Agreement referred to in Exhibit 10.4) (incorporated by reference from Exhibit 10.6 on page 21 of Report of Form 10-K for fiscal year ended November 27, 1994).\n10.6 Copy of Registrant's Joint Marketing, Sales and Development Agreement dated May 30, 1990 between Measurex Corporation and Beloit Corporation (incorporated by reference from Exhibit 10.1 to Form 8K filed with the SEC on June 12, 1990).\n10.7 Copy of Registrant's Stock Option Agreement (Special Acceleration Grant) dated as of December 14, 1993 (incorporated by reference from Exhibit 10.10 on page 45 of Report on Form 10-K for the fiscal year ended November 25, 1993)\n10.8 Copy of Stock Repurchase Agreement and Amendment to Joint Marketing Sales and Development Agreement dated June 22, 1995 among Measurex, Harnischfeger, HIHC and Beloit Corporation (incorporated by reference from Exhibit 2.1 on Form 8-K filed with the SEC on July 6, 1995)\n10.9 Copy of Letter Agreement for a special severance benefit program for key executives dated May 15, 1995 (incorporated by reference from Exhibit 10.20 on Form 8-K filed with the SEC on October 10, 1995).\n10.10 Copy of Credit Agreement dated as of February 10, 1995 among Measurex Corporation, Bank of America National Trust and Savings Association, as Agent, and the other financial institutions party hereto (incorporated by reference from Exhibit 10.16 on page 22 of Report on Form 10-K for fiscal year ended November 27, 1994).\n10.11 Copy of First Amendment dated June 21, 1995 to Credit Agreement referred to on Exhibit 10.10 (incorporated by reference from Exhibit 10.18 on Form 10-Q for period ended June 4, 1995).\n10.12 Copy of Second Amendment dated October 31, 1995 to Credit Agreement referred to on Exhibit 10.10.\n11.0 Computation of Net Income per Share of Common Stock of the Registrant.\n13.0 Registrant's Annual Report to Shareholders (In accordance with item 601(B)(13) of Regulation S-K, such Annual Report is not filed as part of this Form 10-K, except to the extent incorporated by reference).\n21.0 Subsidiaries of Registrant.\n23.0 Consent of Independent Accountants.\n24.0 Power of Attorney (included on page 12).\n27.0 Financial Data Schedule\nOther exhibits have not been filed because conditions requiring filing do not exist.","section_15":""}
{"filename":"841129_1995.txt","cik":"841129","year":"1995","section_1":"Item 1. Business\nThe Registrant, Inland Mortgage Investors Fund III, L.P. (the \"Partnership\"), was formed in September 1988 pursuant to the Delaware Revised Uniform Limited Partnership Act. On January 9, 1989, the Partnership commenced an Offering of 40,000 (subject to an increase up to 50,000) Limited Partnership Units (\"Units\") pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on January 9, 1991, with total sales of 5,675.50 Units resulting in gross offering proceeds of $2,837,749, which includes the General Partner's $500 contribution. All of the holders of these Units were admitted to the Partnership. As of December 31, 1995, the Partnership funded seven loans utilizing $2,302,064 of capital proceeds collected. The Limited Partners of the Partnership share in the benefits of ownership 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 mortgage loans collateralized by properties located 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 (2) 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 246 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 III, L.P. (a limited partnership)\nFor the years ended December 31, 1995, 1994, 1993, and 1992 and 1991\n(not covered by Report of Independent Accountants)\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nTotal assets......... $1,294,415 1,875,618 1,894,010 2,460,285 2,410,129 ========== ========== ========== ========== ==========\nTotal income......... $ 155,161 180,342 216,738 199,840 174,009 ========== ========== ========== ========== ==========\nNet income........... $ 104,502 128,545 171,779 152,192 125,705 ========== ========== ========== ========== ========== Net income allocated to the one General Partner Unit. $ 5,299 6,259 1,718 1,522 1,257 ========== ========== ========== ========== ========== Net income allocated per Limited Partner Unit (b)..... $ 17.48 21.55 29.97 26.55 21.96 ========== ========== ========== ========== ========== Distributions declared to Limited Partners (c)......... $ 647,086 152,116 765,348 232,679 230,901 ========== ========== ========== ========== ========== Distributions per Unit to Limited Partners (b)....... $ 114.03 26.81 134.87 41.00 40.75 ========== ========== ========== ========== ==========\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 per Unit and distribution per Unit are based upon the weighted average number of Units outstanding (5,674.50 during 1995, 1994, 1993 and 1992 and 5,666.68 during 1991).\n(c) This amount represents the total distributions to the Limited Partners, a portion of which may have been funded by 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\nOn January 9, 1989, the Partnership commenced an Offering of 40,000 (subject to an increase to 50,000) Limited Partnership Units pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on January 9, 1991 with a total of 5,675.50 Units being sold to the public at $500 per Unit resulting in gross offering proceeds of $2,837,749, which includes the General Partner's $500 contribution. As of December 31, 1994, the Partnership has funded seven loans utilizing $2,302,064 of capital proceeds collected. As of December 31, 1995, cumulative distributions to the Limited Partners totaled $2,179,347, of which $1,147,815 represents principal amortization and repayments and $306,874 represents Supplemental Capital Contributions from the General Partner.\nAs of December 31, 1995, the Partnership had cash and cash equivalents of $68,800. The Partnership intends to use such remaining funds to pay distributions and for working capital requirements.\nThe mortgage receivables of the Partnership are currently generating sufficient cash flow to cover the operating expenses of the Partnership. To the extent that cash flow was insufficient to meet the required minimum 8% annualized return to investors through January 9, 1994, as well as any other financial needs, the Partnership received Supplemental Capital Contributions from the General Partner. The sources of future liquidity and distributions to the Limited and General Partners are expected to be from the collection of interest and repayment of principal of the Partnership's mortgage loan investments. 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 liquidate certain mortgage loans or other assets.\nResults of Operations\nThe decrease in interest income on mortgage loans for the year ended December 31, 1995, as compared to the year ended December 31, 1994, is due to the payoff of the loan collateralized by the property located at 9617-18 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.\nThe decrease in interest on mortgage loans receivable for the year ended December 31, 1994, as compared to the year ended December 31, 1993, is due to the payoff of the Edgebrook loans in June 1993.\nOther income for the year ended December 31, 1993 is due to prepayment penalties received from the prepayment of the Edgebrook loans.\nProfessional services to non-affiliates increased for the year ended December 31, 1994, as compared to the year ended December 31, 1993, due to accounting fees relating to audits of the loans collateralized by the Mayline Avenue and Washington properties, which were required pursuant to disclosure requirements of the Securities and Exchange commission.\nInflation\nTo provide a hedge against the effects of inflation, the Partnership invested a portion of its offering proceeds in first mortgage loans with adjustable interest rates, 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 III, L.P. (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.\n5540 W. 103rd St., Oak Lawn, 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*\n5009 & 5013 Florence Avenue, Downers Grove, 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*\n7432 Washington, Forest Park, 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 III, L.P.\nWe have audited the financial statements of Inland Mortgage Investors Fund III, L.P. 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 III, 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.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 25, 1996\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nBalance Sheets\nDecember 31, 1995 and 1994\nAssets ------\n1995 1994 ---- ----\nCash and cash equivalents (Note 1)................ $ 68,800 99,103 Accrued interest receivable....................... 10,366 14,817 Mortgage loans receivable (Note 4)................ 1,215,249 1,761,698 ----------- ----------- Total assets...................................... $ 1,294,415 1,875,618 ============ ============\nLiabilities and Partners' Capital ---------------------------------\nLiabilities: Accounts payable................................ $ 1,106 665 Distributions payable........................... 20,588 56,357 Due to Affiliates (Note 2)...................... 2,158 150 ----------- ----------- Total liabilities............................. 23,852 57,172 ----------- -----------\nPartners' capital (Notes 1, 2 and 3): General Partner: Capital contribution.......................... 500 500 Supplemental Capital Contributions............ 306,874 306,874 Supplemental distributions to Limited Partners (306,874) (306,874) Cumulative net income......................... 16,623 11,324 Cumulative distributions...................... (11,558) (6,259) ----------- ----------- 5,565 5,565 ----------- ----------- Limited Partners: Units of $500. Authorized 40,000 Units, 5,674.50 Units outstanding at December 31, 1995 and 1994 (net of offering costs of $422,642, of which $115,754 was paid to Affiliates)................................. 2,414,607 2,414,607 Supplemental Capital Contributions from General Partner............................. 306,874 306,874 Cumulative net income......................... 722,864 623,661 Cumulative distributions...................... (2,179,347) (1,532,261) ----------- ----------- 1,264,998 1,812,881 ----------- ----------- Total Partners' capital....................... 1,270,563 1,818,446 ----------- ----------- Total liabilities and Partners' capital........... $ 1,294,415 1,875,618 ============ ============\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nStatements of Operations\nFor the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Income: Interest on mortgage loans receivable (Note 4)............. $152,051 179,416 203,421 Interest on investments........... 3,110 926 2,870 Other income...................... - - 10,447 -------- -------- -------- 155,161 180,342 216,738 -------- -------- -------- Expenses: Professional services to Affiliates...................... 10,816 13,281 10,636 Professional services to non-affiliates.................. 19,514 20,120 15,457 General and administrative to Affiliates................... 15,622 14,530 13,920 General and administrative to non-affiliates............... 4,707 3,866 3,916 Amortization of deferred organization costs.............. - - 1,030 -------- -------- -------- 50,659 51,797 44,959 -------- -------- -------- Net income.......................... $104,502 128,545 171,779 ======== ======== ========\nNet income allocated to (Note 3): General Partner................... $ 5,299 6,259 1,718 Limited Partners.................. 99,203 122,286 170,061 -------- -------- -------- Net income.......................... $104,502 128,545 171,779 ======== ======== ========\nNet income allocated to the one General Partner Unit.............. $ 5,299 6,259 1,718 ======== ======== ========\nNet income allocated to Limited Partners per weighted average Limited Partnership Units of 5,674.50.......................... $ 17.48 21.55 29.97 ======== ======== ========\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nStatements of Partners' Capital\nFor the years ended December 31, 1995, 1994 and 1993\nGeneral Limited Partner Partners Total ------- ---------- ----------\nBalance at January 1, 1993............... $ 3,847 2,396,418 2,400,265\nSupplemental Capital Contributions made by the General Partner on behalf of the Limited Partners......... - 39,222 39,222 Net Income............................... 1,718 170,061 171,779 Distributions to Partners ($134.87 per weighted average Limited Partnership Units of 5,674.50)......... - (765,348) (765,348) ------- ---------- ----------\nBalance at December 31, 1993............. 5,565 1,840,353 1,845,918\nSupplemental Capital Contributions made by the General Partner on behalf of the Limited Partners......... - 2,358 2,358 Net Income............................... 6,259 122,286 128,545 Distributions to Partners ($26.81 per weighted average Limited Partnership Units of 5,674.50)......... (6,259) (152,116) (158,375) ------- ---------- ----------\nBalance at December 31, 1994............. 5,565 1,812,881 1,818,446\nNet Income............................... 5,299 99,203 104,502 Distributions to Partners ($114.03 per weighted average Limited Partnership Units of 5,674.50)......... (5,299) (647,086) (652,385) ------- ---------- ---------- Balance at December 31, 1995............. $ 5,565 1,264,998 1,270,563 ======= ========== ==========\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nStatements of Cash Flows\nFor the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Cash flows from operating activities: Net income........................ $ 104,502 128,545 171,779 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of deferred organization costs............ - - 1,030 Changes in assets and liabilities: Accrued interest receivable... 4,451 208 4,530 Accounts payable.............. 441 (29) 694 Due to Affiliates............. 2,008 (300) (802) --------- --------- --------- Net cash provided by operating activities........................ 111,402 128,424 177,231 --------- --------- ---------\nCash flows from investing activities: Principal payments collected...... 546,449 28,728 500,816 --------- --------- --------- Net cash provided by investing activities........................ 546,449 28,728 500,816 --------- --------- ---------\nCash flows from financing activities: Distributions paid................ (688,154) (148,966) (777,168) Supplemental Capital Contributions - 13,575 32,425 --------- --------- --------- Net cash used in financing activities........................ (688,154) (135,391) (744,743) --------- --------- --------- Net increase (decrease) in cash and cash equivalents.............. (30,303) 21,761 (66,696) Cash and cash equivalents at beginning of year................. 99,103 77,342 144,038 --------- --------- --------- Cash and cash equivalents at end of year........................... $ 68,800 99,103 77,342 ========= ========= =========\nSupplemental schedule of non-cash investing and financing activities:\nSupplemental Capital Contribution receivable from General Partner... $ - - 11,217 ========= ========= =========\nAccrued distributions payable....... $ 20,588 56,357 46,948 ========= ========= =========\nSee accompanying notes to financial statements\nINLAND MORTGAGE INVESTORS FUND III, 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 Mortgage Investors Fund III, L.P. (the \"Partnership\"), was formed in September 1988 pursuant to the Delaware Revised Uniform Limited Partnership Act to make or acquire loans collateralized by mortgages on improved, income producing properties generally located in or near Chicago and other metropolitan areas. On January 9, 1989, the Partnership commenced an Offering of 40,000 (subject to an increase up to 50,000) Limited Partnership Units (\"Units\") pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on January 9, 1991, with total sales of 5,675.50 Units resulting in gross offering proceeds of $2,837,749, which includes the General Partner's $500 contribution. All of the holders of these Units were admitted to the Partnership. The Limited Partners of the Partnership share in the benefits of ownership in proportion to the number of Units held. 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.\nDeferred organization costs were amortized over a 60-month period. Offering costs have been offset against the Limited Partners' capital accounts.\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.\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.\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.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\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................ $ 1,294,415 1,294,415 1,875,618 1,875,618\nPartners' capital: General Partner........... 5,565 3,984 5,565 3,984 Limited Partners.......... 1,264,998 1,266,579 1,812,881 1,814,462\nNet income (loss): General Partner........... 5,299 5,299 6,259 2,321 Limited Partners.......... 99,203 99,203 122,286 126,224\nNet income per weighted average number of Limited Partnership Units......... 17.48 17.48 21.55 22.24\nThe net income per Limited Partnership Unit is based upon the weighted average number of Units outstanding of 5,674.50.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\n(2) 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 $2,158 and $150 remained unpaid at December 31, 1995 and 1994, respectively.\nThe General Partner was required to make Supplemental Capital Contributions, if necessary, from time to time in sufficient amounts to allow the Partnership to make cumulative distributions to the Limited Partners amounting to at least 8% per annum on their invested capital through January 9, 1994. The cumulative amount of such Supplemental Capital Contributions is $306,874, all of which has been paid.\nThe Partnership has arranged for Inland Mortgage Servicing Corporation, a subsidiary of the General Partner, to service the Partnership's mortgage loans receivable. The 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 $3,830 in 1995, $4,515 in 1994 and $5,102 in 1993 have been incurred and paid to the subsidiary and are included in the Partnership's general and administrative expenses to Affiliates.\n(3) Partnership Agreement\nThe Partnership Agreement defines the allocation of distributable cash flows and profits and losses. Limited Partners are to receive 95% of Operating Cash Flow then being distributed until the Limited Partners have received a Cumulative Preferred Return of 8% per annum through January 9, 1994 and a 10% Preferential Return for the period commencing January 10, 1994. Thereafter, Operating Cash Flow is to be distributed to the General Partner to the extent of any Supplemental Capital Contributions and then 90% to the Limited Partners and 10% to the General Partner.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\nDistributions of Repayment Proceeds shall first be distributed to the Limited Partners in proportion to their Participating Percentages as of the record dates for such distributions until the Limited Partners shall have received distributions from Repayment Proceeds equal to their Invested Capital plus the amount of any deficiency in the Cumulative Preferred Return of 8% per annum through January 9, 1994 plus any deficiency in the 10% Preferential Return for the period commencing January 10, 1994.\nThereafter, any Repayment Proceeds available shall be distributed to the General Partner in the amount of any Supplemental Capital Contributions made, and any remaining balance shall then be distributed 90% to the Limited Partners and 10% to the General Partner.\nThe General Partner is to 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 is to 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 are to be allocated 1% to the General Partner and 99% to the Limited Partners.\nINLAND MORTGAGE INVESTORS FUND III, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\n(4) Mortgage Loans Receivable\nMortgage loans receivable are collateralized by first mortgages on improved, income producing properties located in Chicago, Illinois or its surrounding metropolitan area. 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 III, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\n(A) In June 1992, the Partnership purchased two $500,000 interests in first mortgage loans funded by Inland Mortgage Investors Fund, L.P.-II, which is another publicly registered partnership sponsored by the General Partner. The $700,000 first mortgage loans were funded in June 1992 to refinance existing mortgages owed to an Affiliate of the General Partner.\nThe loans have a fixed interest rate and require monthly payments of interest only. The Partnership will receive its percentage share of all such payments.\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 $23,357, its proportionate share of the total paydown.\nIn 1995, the borrower on the loan collateralized by the property located at 7432 Washington made additional partial paydowns on the mortgage. The Partnership received $40,500, its proportionate share of the total paydowns.\nIn 1995, the loan collateralized by the property located at 9716-18 and 9806-12 Mayline was prepaid by the borrower. The Partnership received $501,760, its proportionate share of the total prepayment.\n(6) Subsequent Events\nDuring January 1996, the Partnership paid a distribution of $20,588 to the Partners, of which $954 was distributed to the General Partner and $19,634 was distributed to the Limited Partners, including $1,506 of repayment proceeds and $18,128 of net interest income.\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, and a share of profits or losses as described under the caption \"Cash Distributions\" at pages 34 and 35, \"Allocation of Profits or Losses\" on page 34 of the Prospectus and at pages A-6 through A-8 of the Partnership Agreement, included as an exhibit to the Prospectus, incorporated herein by reference. Reference is also made to Note (3) of the Notes to Financial Statements (Item 8 of this Annual Report) for a description of such distributions and allocations.\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\" on pages 7 through 9, \"Conflicts of Interest\" on pages 9 through 11 of the Prospectus and at pages A-10 through A-19 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 $22,608, of which $2,158 is unpaid at December 31, 1995.\nA subsidiary of the General Partner earned mortgage servicing fees of $3,830 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) 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 as of December 31, 1995:\nAmount and Nature of Beneficial Percentage 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 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 (2) 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 Exhibit A and B to the Prospectus dated January 9, 1989, 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. 33-24994, is incorporated herein by reference thereto.\n28 Prospectus dated January 9, 1989, as supplemented, included in Post- effective Amendment No. 1 to Form S-11 Registration Statement, File No. 33-24994, 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 III, 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: 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":"37743_1995.txt","cik":"37743","year":"1995","section_1":"ITEM 1 - BUSINESS\nFluke Corporation (the Company), was founded in 1948 and was incorporated under the laws of the State of Washington on October 7, 1953. In August, 1993, the Company changed its name from John Fluke Mfg. Co., Inc. to Fluke Corporation. The Company is engaged in the design, manufacture and marketing of compact, professional electronic test tools. The Company's principal products are portable instruments that measure the magnitude of voltage, current, power quality, frequency, temperature, pressure and other key functional parameters of electronic equipment.\nThe Company believes that there are a number of key trends occurring throughout the world that are driving the need for portable electronic test tools: increasing device complexity, growing electronic content in existing and new applications, decentralization of electronic systems and increasing reliance on mission critical electronic systems. In addition, the increasing need for companies to improve quality, document compliance with regulatory or industrial standards, and maintain a safe working environment has further increased the need for electronic test tools. These general trends have greatly increased the need for trained technicians to be able to install, maintain and diagnose electrical systems at widespread locations. These trained technicians are responsible for enhancing the up-time of electrical systems and have a new set of needs in the tools they use to perform their jobs. These tools need to be portable, precise, rugged and easy to use. These technicians use these tools to measure electrical parameters across a wide variety of fields and industries.\nFluke's targeted end-users are service, installation and maintenance professionals who use the Company's tools to identify, diagnose and solve electrical problems. Fluke's portable digital multimeters, ScopeMeter (Registered Trademark) test tools and calibration equipment, which have substantial and leading market shares, are used for field testing and verification of a broad range of electronic equipment. The Company has leveraged its competencies and market presence by offering new products for emerging applications. These include products that address local area networks (LANs), process control, data acquisition (temperature control, counting and other unattended data gathering), power analyzers and automotive electronics. The Company also manufactures and markets traditional bench test and measurement instruments, such as bench oscilloscopes.\nPRODUCTS AND SERVICES\nPRODUCTS\nThe Company is in a single line of business, the manufacturing and selling of electronic test tools. Although the products vary in capability, sophistication, use, size and price, they all fundamentally test and measure electrical parameters such as voltage, current, resistance, etc. As of May 1995, the Company offered over 200 product models with over 1,300 options and accessories. These products are divided into two product classes: handheld service tools and benchtop test instruments. Handheld service tools are typically used in field service applications by technicians to install and troubleshoot electronic and electrical equipment. Most of these tools are sold through indirect distribution channels. Representative products include handheld digital multimeters, ScopeMeter test tools, and LAN testers. Benchtop test instruments are used primarily by engineers and are most often sold through Fluke direct sales channels. Products include bench oscilloscopes, calibrators, data acquisition systems, and generators.\nHandheld service tools were approimately 55 percent of the business in 1995, 49 percent in 1994, 50 percent in 1993 and 48 percent in 1992. Benchtop test instruments were approximately 36 percent of the business in 1995, 42 percent in 1994, 41 percent in 1993 and 43 percent in 1992. The remaining business consisted of service and parts for products that the Company sells.\nNEW PRODUCTS\nFluke Corporation introduced the following major products in fiscal 1995.\nScopeMeter Series II. Four new models were introduced. ScopeMeter (registered trademark) test tools combine the functions of an oscilloscope with that of a digital multimeter in a handheld instrument.\n701\/702 Documenting Process Calibrators. These are the first handheld, multifunction calibrators with full documentation capabilities designed specifically for the calibration, troubleshooting and maintenance of process instrumentation.\n5500A Multi-Product Calibrator. This is a new class of multifunction calibrator designed for today's increasingly broad calibration needs. It is used to calibrate a wide range of dc\/low frequency instrumentation.\n860 Series Graphical(Trademark) Multimeters. These test tools combine digital multimeter capabilities with analog, digital and graphical displays. The 860 Series is a family of three instruments.\nDSP-100 LAN CableMeter(Trademark). This handheld test tool is designed to meet the soon to be announced standards for testing installed Category 5, ISO and IEC local area networks (LAN) cabling to 100 MHz. The DSP-100 uses a patented digital signal processing (DSP) technology.\nNetDAQ(Trademark). These networked data acquisition units are portable, 20- measurement channel front-end data acquisition instruments that connect directly to a PC, or can transmit data via an Ethernet network.\nPM3380A CombiScope(Trademark). This is a full function low-cost two channel oscilloscope designed for the engineer.\nPM3394A CombiScope(Trademark). This is another oscilloscope in the CombiScope family of instruments that combine digital storage and an analog oscilloscope.\nPM 6685R Rubidium Timebase Frequency Counter. This frequency counter has a new atomic reference that makes it the most accurate frequency counter on the market in its price range.\nSALES AND DISTRIBUTION\nThe Company currently markets its products in more than 80 countries through both indirect and direct sales channels. The Company's indirect sales channels, those in which the Company does not invoice the end-user, include industrial distributors, catalog houses, automotive warehouses and electrical wholesalers. The Company's direct sales channels include both the Company's internal sales force, which the Company has in Western Europe, Canada, Japan and Singapore and independent manufacturer's representatives located in the U.S. and many other international markets. Direct and indirect sales channels will typically serve different customers in the same geographic areas.\nThe Company generally uses indirect distribution for its hand-held service tools. The Company has found that the end-users purchasing these tools often do not require ongoing product support or specific instructions on tool applications. This distribution channel more effectively serves the customers purchasing needs for these products.\nThe Company uses its direct sales channels primarily for its benchtop test instruments. These products are generally more technically complex products where the customer may require a greater amount of direct contact to close or support a sale. Direct sales channels are also used effectively in 1) those markets in which a substantial knowledge of the end-user's business is required, such as among potential customers for the LANMeter, and 2) in those geographic areas which do not have fully developed indirect distribution channels or where the customer still expects to purchase hand- held service tools through a direct sales force. In May 1995, the Company shifted all of its direct sales responsibilities in the U.S. from an internal sales force to fifteen manufacturer's representatives.\nThe Company's marketing effort consists principally of advertising in trade publications, appearing at trade shows, and to a lesser extent, utilizing direct mail campaigns.\nSUPPLIERS\nThe Company generally uses standard parts and assemblies available from a number of suppliers. However, some components are only available from a single source. The Company has not experienced significant problems in obtaining sole-source components but typically carries extra inventory of any critical sole-sourced components. Fluke works closely as partners with its suppliers in an effort to assure a continuity of supply even during difficult allocation times. The Company is not aware of any facts which would result in a reduction, interruption or termination in the supply of its sole-sourced components.\nPATENTS AND TRADEMARKS\nThe Company regards elements of its products as proprietary and relies primarily on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures, license agreements and other intellectual property protection methods to protect its proprietary technology. The Company holds or has pending United States and foreign patents to protect product designs, processes and techniques for the duration of their value to the Company. No significant patents have been formally upheld in court and no representation is made as to the validity or the degree of protection afforded by any patent. While the Company considers its existing and pending patents to be important and expects to defend and to continue to apply for patents with respect to any significant developments it regards as patentable, it does not consider its business as dependent to any material extent upon any one or more of such patents, nor would its present business be materially adversely affected if any of the patents were held invalid.The Company also owns trademarks, copyrights and proprietary information, which are considered by the Company to have significant value.\nSEASONAL TRENDS AND WORKING CAPITAL REQUIREMENTS\nWhile the Company is subject to minor seasonality effects associated with conducting business in various regions of the world, the impact of these seasonal trends is immaterial to the Company as a whole. The Company does not have any extraordinary working capital requirements.\nCUSTOMERS\nThe Company's customers are generally involved in the installation, service, repair, or calibration of electronic or electrical equipment. They are also involved in research and development activities.\nNo one customer accounted for more than five percent of the Company's sales in fiscal year 1995.\nBACKLOG\nThe Company's backlog of unfilled orders amounted to $45.1 million as of April 28, 1995, and $37.0 million as of April 29, 1994. The Company expects to satisfy nearly all such unfilled orders in fiscal 1996. The backlog consists of many different customer orders with no one customer being a material component.\nCOMPETITION\nThe market for electronic test tools is widely fragmented, consisting of a large number of companies, generally focused on one or a few products or markets. Fluke maintains a broad product offering targeted to many different applications and markets. The Company believes that its products compete principally on the basis of performance, service and warranty, and to a lesser extent, price. While there are numerous firms engaged in the production of electronic test tools, no single company competes with the Company across a substantial portion of its markets. It does, however, have competitors that are substantially larger than the Company and have greater financial resources.\nRESEARCH AND DEVELOPMENT\nThe Company's research activities are directed toward the development of new products that will complement and expand the present product line, and toward the creation of new manufacturing techniques. Research and development expense was $37.7 million for the year ended April 28, 1995 which was 10.0 percent of the Company's fiscal 1995 revenues. Research and development expense was $34.9 million for the year ended April 29, 1994, $13.7 million for the seven months ended ended April 30, 1993 and $22.5 million for the year ended September 1992 which were 9.8, 10.3 and 8.3 percent of the Company's total revenues, respectively. No research contracts are obtained from customers, nor does the Company conduct any research work under government development contracts.\nENVIRONMENTAL CONTROLS\nThe Company does not anticipate any material effects upon its capital expenditures, earnings or competitive position as a result of compliance with federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment.\nEMPLOYEES\nThe Company had 2,516 full-time employees as of April 28, 1995.\nFOREIGN OPERATIONS AND EXPORT SALES\nInformation related to foreign operations and export sales is incorporated herein by reference to Note 10 of the Consolidated Financial Statements on page 52 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to this report.\nThe Company has significant revenues from outside of the United States which increase the complexity and risk to the Company. These risks include increased exposure to the risk of foreign currency fluctuations and the potential economic and political impacts from doing business in foreign countries including changes in labor and tax laws, import and export controls and changes in governmental policies.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe Executive Officers, who serve at the pleasure of the Board of Directors of the Company, as of June 23, 1995, are as follows:\nWILLIAM G. PARZYBOK, JR.\nMr. Parzybok, age 53, has been Chairman of the Board, Chief Executive Officer and a Director of the Company since 1991. He previously had been employed for 22 years by the Hewlett-Packard Company where his most recent position was Vice President and General Manager of Engineering Applications Group from 1988 to 1991. Mr. Parzybok serves on the Executive Committee of the Board. He is also a Director of PENWEST, Ltd.\nGEORGE M. WINN\nMr. Winn, age 51, has been President, Chief Operating Officer and a Director of the Company since 1982. He previously served as Chief Executive Officer of the Company from 1987 to 1991. Mr. Winn serves on the Executive Committee of the Board. He is also a Director of Heart Technology, Inc.\nRICHARD W. VAN SAUN\nMr. Van Saun, age 57, has been a Senior Vice President of the Company and General Manager of the Service Tools Division since 1994. He previously served as Senior Vice President and Group Manager of the Diagnostic Tools Division from 1992 to 1994 and as Vice President and Group Manager of the Service Equipment Group from 1986 to 1992.\nRONALD R. WAMBOLT\nMr. Wambolt, age 60, has been a Senior Vice President of the Company and Director of Worldwide Sales and Service since 1991. He previously served as Senior Vice President and Director of Worldwide Sales from 1987 to 1991.\nWILLIAM R. HOFFMAN\nMr. Hoffman, age 59, is a Vice President of the Company and Manager of Corporate Services. He is also General Manager of Calibration for the Verification Tools Division. He previously served as Vice President of Marketing Services and the Philips T&M Group from 1991 to 1992, and as Vice President of the Company and Group Manager of the Philips T&M Group from 1987 to 1991.\nDAVID E. KATRI\nMr. Katri, age 45, has been a Vice President of the Company and General Manager of the Verification Tools Division since 1992. He previously served as Vice President of the Company and Group Manager of the Manufacturing\/R&D Group from 1991 to 1992, and as Group Manager of the Manufacturing\/R&D Group from 1988 to 1990.\nDOUGLAS G. MCKNIGHT\nMr. McKnight, age 46, has served as Vice President, General Counsel of the Company since 1986 and as Corporate Secretary since 1983.\nPATRICK J. O'HARA\nMr. O'Hara, age 42, has been Vice President, Human Resources and Facilities Manager of the Company since September, 1994. He previously served as Deputy Director of Human Resources at the Los Alamos National Laboratory from 1993 to 1994, and prior to that, as Site Human Resources Manager of the T.J. Watson Research Center of IBM Corporation from 1990 to 1993.\nBARRY L. ROWAN\nMr. Rowan, age 38, has been Vice President and Chief Financial Officer of the Company since 1992. He previously had been employed by Comlinear Corporation where he served as President from 1989 to 1991.\nJOHN R. SMITH\nMr. Smith, age 54, has been Vice President, Treasurer of the Company since 1987.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company owns approximately 162 acres of real estate near Everett, Washington, the site of its corporate headquarters and U.S. manufacturing, warehousing and distribution facilities. These facilities are housed in six separate facilities consisting of approximately 480,000 square feet, 200,000 square feet and four smaller facilities totaling 77,800 square feet. The Company also owns a 25,000 square foot service facility situated on 1.5 acres in Paramus, New Jersey and a 27,000 square foot service facility situated on 4.8 acres in Palatine, Illinois. All facilities owned by the Company are insured at their estimated replacement cost.\nThe Company leases three facilities in The Netherlands, consisting of a 138,400 square foot engineering and manufacturing facility located at Almelo, a 17,600 square foot European headquarters and a 10,700 square foot service facility both located at Eindhoven. These properties could be duplicated, if necessary, with some disruption to operations. The Company has approximately 189,300 square feet of additional leased facilities throughout the world which are utilized for sales and service. The Company believes that its existing facilities are in good condition and are suitable and adequate for its business.\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 information required by this Item is incorporated herein by reference to Stock Price Information on page 58 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to this Report.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated herein by reference to the Financial Summary on pages 56 and 57 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to this Report.\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 28 through 33 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to this 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 to pages 34 through 53 and the Selected Quarterly Financial Data (unaudited) on page 58 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to 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 OF THE REGISTRANT\nThe information required by this Item relating to Directors is incorporated herein by reference to pages 3 through 7 of the Company's proxy statement dated July 25, 1995, to be filed with the Securities and Exchange Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to pages 7 through 9 of the Company's proxy statement dated July 25, 1995, to be filed with the Securities and Exchange Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934.\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 pages 2 and 3 of the Company's proxy statement dated July 25, 1995, to be filed with the Securities and Exchange Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated herein by reference to page 11 of the Company's proxy statement dated July 25, 1995, to be filed with the Securities and Exchange Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements of the Company\nThe following financial statements of Fluke Corporation and Subsidiaries are incorporated herein by reference to pages 34 through 58 of the Company's 1995 Annual Report to Stockholders, a copy of which is filed as Exhibit 13 to this report.\n1. Consolidated Balance Sheets as of April 28, 1995 and April 29, 1994.\n2. Consolidated Statements of Income for the year ended April 28, 1995, the year ended April 29, 1994, for the seven months ended April 30, 1993 and the year ended September 25, 1992.\n3. Consolidated Statements of Cash Flows for the year ended April 28, 1995, the year ended April 29, 1994, for the seven months ended April 30, 1993 and the year ended September 25, 1992.\n4. Consolidated Statements of Stockholders' Equity for the year ended April 28, 1995, the year ended April 29, 1994, for the seven months ended April 30, 1993 and the year ended September 25, 1992.\n5. Notes to Consolidated Financial Statements.\n(a)(2) Financial Statement Schedules\nThe following additional information should be read in conjunction with the Consolidated Financial Statements of the Company described in Item 14 (a)(1):\nSchedule II Valuation and Qualifying Accounts\nSchedules other than those listed above are omitted because they are not required or are not applicable, or because the information is furnished elsewhere in the financial statements or the notes thereto.\n(a)(3) Index to Exhibits\nExhibit Page No. No. Exhibit Sequential Numbering System\n3. Articles of Incorporation and Bylaws\n3.1 Restated copy of Articles of Incorporation as amended on August 11, 1993 (incorporated by reference to Exhibit 3.1 of the Company's Form 10-K Report for the Fiscal Year ended April 29, 1994).\n3.2 Conformed Copy of Bylaws as amended through January 16, 1995\n4. Instruments Defining the Rights of Security Holders, Including Indentures\n4.1 Stockholders Rights Plan (incorporated by reference to the Company's Form 8A Report dated July 11, 1988), the First Amendment to the Stockholders Rights Plan (incorporated by reference to the Company's Form 8A Report dated May 2, 1989) and the Second Amendment to the Stockholders Rights Plan (incorporated by reference to the Company's Form 8A report dated February 15, 1990).\n10. Material Contracts\n10.1 1990 Stock Incentive Plan of the Company (incorporated by reference to Exhibit 10.11 of the Company's Form 10-K Report for the Fiscal Year ended September 27, 1991).\n10.2 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 10.12 of the Company's Form 10-K Report for the Fiscal Year ended September 27, 1991).\n10.3 Employment Agreement dated September 5, 1991 between the Company and William G. Parzybok, Jr. (incorporated by reference to Exhibit 10.7 of the Company's Form 10K Report for the Fiscal Year ended September 27, 1992).\n10.4 Employment Agreement dated September 5, 1991 between the Company and George M. Winn (incorporated by reference to Exhibit 10.8 of the Company's Form 10K Report for the Fiscal Year ended September 27, 1992).\n10.5 Employment Agreement dated September 5, 1991 between the Company and Ronald R. Wambolt (incorporated by reference to Exhibit 10.9 of the Company's Form 10K Report for the Fiscal Year ended September 27, 1992).\n10.6 Employment Agreement dated September 5, 1991 between the Company and Richard W. Van Saun (incorporated by reference to Exhibit 10.10 of the Company's Form 10K Report for the Fiscal Year ended September 27, 1992).\n10.7 Change of Control Agreement dated September 5, 1991 between the Company and John R. Smith. Other executive officers of the Company have identical change of control agreements with the Company (incorporated by reference to Exhibit 10.12 of the Company's Form 10-K Report for the Fiscal Year ended April 30, 1993).\n10.8 Annual Variable Compensation Policy (incorporated by reference to Exhibit 10.17 of the Company's Form 10-K Report for the Fiscal Year ended April 30, 1993).\n10.9 Purchase Agreement between the Company and Philips Electronics N.V. dated February 26, 1993 (incorporated by reference to Exhibit 10.18 of the Company's Form 10-K Report for the Fiscal Year ended April 30, 1993).\n10.10 Stock Purchase Agreement between the Company and Philips Electronics N.V. dated May 26, 1993 (incorporated by reference to Exhibit 10.19 of the Company's Form 10-K Report for the Fiscal Year ended April 30, 1993).\n10.11 Fluke Corporation 1988 Stock Incentive Plan of the Company as amended on June 10, 1993 by stockholders on September 29, 1993 (incorporated by reference to Exhibit 10.11 of the Company's Form 10-K Report for the Fiscal Year ended April 29, 1994\n10.12 Deferred Compensation Plan for Directors of Fluke Corporation as amended on April 29, 1994 (incorporated by reference to Exhibit 10.12 of the Company's Form 10-K Report for the Fiscal Year ended April 29, 1994).\n10.13 Fluke Corporation Supplemental Retirement Income Plan as amended on June 22, 1994 (incorporated by reference to Exhibit 10.13 of the Company's Form 10-K Report for the Fiscal Year ended April 29, 1994).\n11 Computation of Earnings Per Share\n13 1995 Annual Report to Stockholders\n18 Preferability letter from Ernst and Young, independent auditors, dated July 22, 1993 regarding Change in Accounting Principle (incorporated by reference to Exhibit 18 of the Company's Form 10-K Report for the Fiscal Year ended April 30, 1993).\n21 Subsidiaries\n23.1 Consent of Ernst & Young LLP, independent auditors, dated July 27,\nItem 14 (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 April 28, 1995.\nItem 14 (c)Exhibits: See \"Index to Exhibits\" at Item 14(a)(3) above.\nItem 14 (d)Financial Statement Schedules: Schedules required to be filed in response to this portion of Item 14 are listed above in Item 14 (a)(2).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFLUKE CORPORATION (Registrant)\n\/s\/ George M. Winn President George M. Winn Chief Operating Officer July 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 date indicated.\nSignature Title Date \/s\/ William G. Parzybok, Jr. Chairman of the Board July 25, 1995 William G. Parzybok, Jr. Chief Executive Officer \/s\/ George M. Winn President, Chief Operating July 25, 1995 George M. Winn Officer and Director \/s\/ Barry L. Rowan Vice President July 25, 1995 Barry L. Rowan Chief Financial Officer \/s\/ John R. Smith Vice President, Treasurer July 25, 1995 John R. Smith Chief Accounting Officer \/s\/ J. Peter Bingham Director July 25, 1995 J. Peter Bingham \/s\/ Philip M. Condit Director July 25, 1995 Philip M. Condit \/s\/ John D. Durbin Director July 25, 1995 John D. Durbin \/s\/ David L. Fluke Director July 25, 1995 David L. Fluke \/s\/ John M. Fluke, Jr. Director July 25, 1995 John M. Fluke, Jr. \/s\/ Robert S. Miller, Jr. Director July 25, 1995 Robert S. Miller, Jr. \/s\/ William H. Neukom Director July 25, 1995 William H. Neukom \/s\/ Dr. David S. Potter Director July 25, 1995 Dr. David S. Potter \/s\/ N. Stewart Rogers Director July 25, 1995 N. Stewart Rogers \/s\/ Stephen C. Tumminello Director July 25, 1995 Stephen C. Tumminello \/s\/ James E. Warjone Director July 25, 1995 James E. Warjone","section_15":""}
{"filename":"732718_1995.txt","cik":"732718","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nU S WEST, Inc. (\"U S WEST\" or the \"Company\") is incorporated under the laws of the State of Delaware and has its principal executive offices at 7800 East Orchard Road, Englewood, Colorado 80111, telephone number (303) 793-6500. U S WEST is a diversified global communications company, and conducts its operations through U S WEST Communications Group (\"Communications Group\") and U S WEST Media Group (\"Media Group\"). (Financial information concerning U S WEST's operations is set forth in the Consolidated Financial Statements and Notes thereto, which begin on page B-29.) U S WEST and its subsidiaries had 61,047 employees at December 31, 1995.\nCOMMUNICATIONS GROUP. The major component of the Communications Group is U S WEST Communications, Inc. (\"U S WEST Communications\"), which provides telecommunications services to more than 25 million residential and business customers in the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (collectively, the \"Communications Group Region\"). U S WEST Communications serves approximately 80 percent of the Communications Group Region's population and approximately 40 percent of its geographic area.\nMEDIA GROUP. The Media Group is comprised of: (i) cable and telecommunications network businesses outside of the Communications Group Region and internationally, (ii) domestic and international wireless communications network businesses and (iii) domestic and international directory and information services businesses, including telephone directories.\nRECENT DEVELOPMENTS\nAGREEMENT TO ACQUIRE CONTINENTAL CABLEVISION, INC. On February 27, 1996, U S WEST announced a definitive agreement under which Continental Cablevision, Inc. (\"Continental\") will be merged with and into the Company. Continental, the nation's third-largest cable operator, serves 4.2 million U.S. customers, passes more than seven million U.S. households and owns significant other domestic and international assets. The Company will purchase all of Continental's stock for approximately $5.3 billion, and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration of the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; $2.8 billion to $3.3 billion in shares of Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash. The transaction, which is expected to close in the fourth quarter, is subject to a number of conditions, including regulatory and other approvals such as that of Continental's shareholders. There can be no assurance that these conditions will be satisfied.\nRECAPITALIZATION PLAN. On October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\") voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors to reincorporate from Colorado to Delaware and create two classes of common stock that are intended to reflect separately the performance of the communications and multimedia businesses. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to, among other things, designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\"), and the other class is authorized as U S WEST Media Group Common Stock (\"Media Stock\"). Effective November 1, 1995, each share of common stock of U S WEST Colorado converted into one share of Communications Stock and one share of Media Stock.\nThe Communications Stock and Media Stock are designed to provide shareholders with separate securities that are intended to reflect separately the communications businesses of U S WEST Communications and certain other subsidiaries of the Communications Group, and the multimedia businesses of the Media Group.\nThe Communications Group is comprised of U S WEST Communications, U S WEST Communications Services, Inc., U S WEST Federal Services, Inc., U S WEST Advanced Technologies, Inc. and U S WEST Business Resources, Inc. U S WEST Communications comprised approximately 97 percent of the revenues and 98 percent of the assets of the Communications Group in 1995.\nThe Media Group is comprised of U S WEST Marketing Resources Group, Inc., a publisher of White and Yellow Pages telephone directories and other information services including database marketing and other interactive services, U S WEST NewVector Group, Inc., which provides communications and information products and services over wireless networks, U S WEST Multimedia Communications, Inc., which owns domestic cable television operations and investments, and U S WEST International Holdings, Inc., which primarily owns investments in international cable and telecommunications, wireless communications and directory publishing operations.\nDividends paid to the holders of Communications Stock are currently $0.535 per share per quarter. Dividends on the Communications Stock will be paid at the discretion of the Board of Directors of U S WEST, based primarily upon the financial condition, results of operations and business requirements of the Communications Group and the Company as a whole. With regard to the Media Stock, the Board of Directors of U S WEST currently intends to retain future earnings, if any, for the development of the Media Group's businesses and does not anticipate paying dividends on the Media Stock in the foreseeable future.\nTELECOMMUNICATIONS ACT OF 1996. On February 1, 1996, the House of Representatives and the Senate approved a final bill that is intended to promote competition between local telephone companies, long-distance carriers and cable television operators. This bill was signed into law on February 8, 1996, and replaces the antitrust consent decree that broke up the \"Bell System\" in 1984. Major provisions of the legislation include the pre-emption of state regulations that prohibit competition. The Act allows local telephone companies, long-distance carriers and cable television companies to enter each other's lines of business. To participate in the interLATA long-distance business within their regions, the Regional Bell Operating Companies must first open their local networks to facilities-based competition by satisfying a detailed list of requirements, including interconnection and number portability. The legislation also eliminates within three years most regulation of cable television rates. The Act lifts the ban on cross-ownership between cable television and telephone companies, permitting the Regional Bell Operating Companies to enter into the cable business within their respective service territories, but prohibits them from doing so through the purchase of existing cable companies, except in rural communities. The legislation reaffirms the concept of universal service and directs the Federal Communications Commission and the states to determine universal service funding policy. The Federal Communications Commission and state regulators have been given the responsibility to interpret and oversee the implementation of this legislation.\nCOMMUNICATIONS GROUP\nOPERATIONS. The principal types of telecommunications services offered by the Communications Group are (i) local service, (ii) exchange access service (which connects customers to the facilities of interLATA service providers), and (iii) intraLATA long-distance network service. For the year ended December 31, 1995, local service, exchange access service and intraLATA long distance network service accounted for 46%, 33% and 13%, respectively, of the sales and other revenues of the Communications Group. At December 31, 1995, U S WEST Communications had approximately 14,847,000 telephone network access lines in service, a 3.6% increase over year end 1994. Excluding the effect of the sale of approximately 95,000 rural telephone access lines during 1995, access lines increased 4.2% over year end 1994. In 1995, revenues from a single customer, AT&T, accounted for approximately\n11% of the sales and other revenues of the Communications Group, and 9% of the sales and other revenues of U S WEST. The Communications Group expensed $22 million, $31 million and $42 million for research and development costs in 1995, 1994 and 1993, respectively.\nU S WEST Communications incurred capital expenditures of approximately $2.7 billion in 1995 and expects to incur approximately $2.5 billion in 1996. The 1995 capital expenditures of U S WEST Communications were substantially devoted to the continued modernization of telephone plant, to improve customer services and to accommodate additional line capability in several states.\nDEVELOPMENT OF BROADBAND NETWORK. A market trial for a broadband network capable of providing voice, data and video services to customers commenced in the Omaha area in August, 1995. The Communications Group does not intend to expand this service offering beyond the Omaha area because of service cost and pricing issues. The Communications Group does plan to continue to provide the system that delivers basic, premium and pay-per-view video services in the Omaha area. The Communications Group is evaluating the relative costs of alternative video technologies, as well as the near-term feasibility of interactive services. To satisfy anticipated demand for combined video and telephony services on a cost-effective basis, the Communications Group's strategy may include selective investments in wireless cable technologies.\nTHE RESTRUCTURING PLAN. U S WEST announced in 1993 that U S WEST Communications would implement a plan (the \"Restructuring Plan\") designed to provide faster, more responsive customer service and improved repair capabilities while reducing the cost of providing these services. As part of the Restructuring Plan, the Communications Group is developing new systems and enhanced system functionality that will enable it to monitor networks to reduce the risk of service interuptions, activate telephone service on demand, rapidly design and engineer products and services for customers, and centralize its service centers. The Communications Group has consolidated its 560 customer service centers into 26 centers in ten cities and plans on reducing its work force by approximately 10,000 employees in connection with the Restructuring Plan. Work force reductions under the Restructuring Plan will be partially offset by the effects of higher than anticipated volumes of business and the achievement of customer service objectives. All service centers are operational and supported by new systems and system functionality. The Restructuring Plan is expected to be substantially completed by the end of 1997. Implementation has been affected by growth in the business and related service issues, new business opportunities, revisions to system delivery schedules and productivity issues caused by the major rearrangement of resources due to restructuring. These issues will continue to affect the timing of employee separations. See \"Costs and Expenses\" and \"Restructuring Charge\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. B-9 and p. B-10.\nREGULATION. U S WEST Communications is subject to varying degrees of regulation by state commissions with respect to intrastate rates and service, and access charge tariffs. U S WEST is also subject to the jurisdiction of the FCC with respect to interstate access tariffs (that specify the charges for the origination and termination of interstate communications) and other matters.\nU S WEST's interstate services have been subject to price-cap regulation by the FCC since January 1991. Price caps are an alternative form of regulation designed to limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels. In March, 1995, the FCC issued an interim order on price cap regulation. The price cap index for most services is annually adjusted for inflation, productivity level and exogenous costs, and has resulted in reduced access prices paid by interexchange carriers to local telephone companies. The interim order also provides for three productivity options, including a no-sharing option, and for increased flexibility for adjusting prices downward in response to competition. In 1995, the Communications Group selected the lowest productivity option while, prior to this interim order, the Communications Group used an optional higher productivity factor in determining prices. Consequently, the Communications Group expects the order to have no significant near-term impact.\nU S WEST Communications is currently working with state regulators to gain approval of initiatives, including efforts to rebalance prices, advance competitive parity and implement simplified forms of price and service quality regulation. State and local regulatory authorities may also regulate certain terms and conditions of the offering of wireless services, such as the siting and construction of transmitter towers, antennas and equipment shelters and zoning and building permit approvals. See \"Competitive and Regulatory Environment\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. B-22.\nCOMPETITION. The Communications Group faces competition in the local exchange business, exchange access and intraLATA long-distance markets, primarily from competitive access providers (\"CAPS\") and interexchange carriers. CAPs compete with the Communications Group by providing large business customers with high-capacity network services that connect to interexchange carrier facilities or other business locations within a serving LATA. Interexchange carriers compete with the Communications Group by providing intraLATA long-distance services. Such competition is eroding U S WEST Communications' market share of intraLATA long-distance services, including Wide Area Telephone Service and \"800\" services. Interexchange carriers are competing in this area by offering lower prices and packaging these services on an intraLATA and interLATA basis.\nTechnological advancements and regulatory changes will increase competition in the future. Current competitors, including CAPs and interexchange carriers, are positioning themselves to offer local exchange services. New competitors that are affiliates of cable television companies and power companies also are expected to play a greater role in offering local exchange services. In addition to local exchange services, competitors are expected to offer services that will compete with those U S WEST Communications plans to offer, including video programming and interactive multimedia services. Services offered by cellular and PCS operators also will compete with existing and future services of U S WEST Communications, including future wireless services. AT&T's entrance into the wireless communications business through its acquisition of McCaw Cellular Communications, Inc. may create increased competition in local exchange as well as wireless services. The loss of local exchange customers to competitors would affect multiple revenue streams of U S WEST Communications.\nThe adoption of the Telecommunications Act of 1996 will have an impact on the competition faced by the Communications Group. See \"Recent Developments -- Telecommunications Act of 1996,\" and \"Competitive and Regulatory Environment\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. B-22.\nMEDIA GROUP\nOPERATIONS. The Media Group is comprised of (i) cable and telecommunications network businesses outside of the Communications Group Region and internationally, (ii) domestic and international wireless communications network businesses and (iii) domestic and international directory and information services businesses. For the year ended December 31, 1995, domestic and international directory and information services businesses accounted for 10% of the sales and other revenues of U S WEST. The Media Group expensed $3 million, $6 million and $5 million for research and development costs in 1995, 1994 and 1993, respectively.\nCABLE AND TELECOMMUNICATIONS. The Media Group's domestic cable and telecommunications operations are conducted through U S WEST Multimedia Communications, Inc. (\"U S WEST Multimedia\") and consist of domestic cable properties and investments outside of the Communications Group Region, including U S WEST Multimedia's ownership of cable systems in the Atlanta, Georgia metropolitan area (the \"Atlanta Systems\") and its investment in Time Warner Entertainment Company L.P. (\"TWE\" or \"Time-Warner Entertainment\"), the second largest provider of cable television services in the United States.\nOn February 27, 1996, U S WEST announced a definitive agreement to merge with Continental Cablevision, Inc. for a combination of cash, U S WEST preferred stock (convertible to Media Stock)\nand shares of Media Stock valued at $5.3 billion. The transaction also involves an assumption of debt and other obligations amounting to approximately $5.5 billion. See \"Recent Developments -- Agreement to Acquire Continental Cablevision, Inc.\"\nThe Media Group's international cable and telecommunications operations are conducted through U S WEST International Holdings, Inc. (\"U S WEST International\") and include investments in cable and telecommunications that focus on serving mass market business and residential customers in key geographic markets. To decrease investment risk and gain access to technical skills and capabilities, U S WEST International's strategy has been to make these investments with other major cable television companies, including Time Warner Inc. and Tele-Communications, Inc. In certain circumstances, foreign laws require the participation of local partners in these ventures.\nU S WEST International, through subsidiaries, owns a 26.8 percent interest in TeleWest plc (\"TeleWest\"), the largest provider of combined cable television and residential and business telecommunications services in the United Kingdom. In 1995, TeleWest Communications plc merged its cable television and telephony interests with SBC CableComms (UK) to form TeleWest. An affiliate of Tele- Communications, Inc., (\"TCI International\") also owns a 26.8 percent interest in TeleWest, with the remaining interests held by the public.\nWIRELESS COMMUNICATIONS. U S WEST NewVector Group, Inc. (\"NewVector\") provides cellular services to customers over wireless networks in 26 metropolitan service areas and 28 rural service areas located primarily in the Communications Group Region. NewVector's cellular services provide customers with high-quality and readily available two-way communications services that interconnect with local and long-distance telephone networks. As of December 31, 1995, NewVector had approximately 1,463,000 cellular customers, a 51 percent increase from December 31, 1994.\nIn 1994, the Company entered into a definitive agreement with AirTouch Communications to combine their domestic cellular assets. AirTouch's initial equity ownership of the joint venture will be approximately 70 percent and the Media Group's will be approximately 30 percent. The combination will take place in two phases. During Phase I, which U S WEST entered effective November 1, 1995, the two companies are operating their cellular properties separately. A Wireless Management Company (\"WMC\") has been formed and is providing centralized services to both companies on a contract basis. In Phase II, AirTouch and U S WEST will contribute their domestic cellular assets to the WMC. The recent passage of the Telecommunications Act of 1996 has removed significant regulatory barriers to completion of Phase II of the business combination, and the Company expects that Phase II closing could take place by the end of 1996 or in early 1997.\nU S WEST has entered into a venture with AirTouch Communications, Bell Atlantic and NYNEX Corporation to form a strategic national wireless alliance. U S WEST has entered into a separate venture with the same partners to provide personal communications services (\"PCS\"). This PCS venture, known as PCS PrimeCo, acquired rights to 11 licenses in 1995 in the Federal Communications Commission's auction of PCS radio spectrum. The 11 licenses cover 57 million people in Chicago, Dallas, Honolulu, Houston, Jacksonville, Miami, Milwaukee, New Orleans, Richmond, San Antonio and Tampa.\nU S WEST International owns interests in wireless communications systems or investments in several countries, including the United Kingdom, Malaysia, Russia, Hungary, the Czech Republic, the Slovak Republic and Japan.\nU S WEST International, through subsidiaries, owns 50 percent of Mercury One 2 One, a 50-50 joint venture between subsidiaries of U S WEST International and Cable & Wireless plc. Mercury One 2 One operates a PCS system in the United Kingdom. Mercury One 2 One's PCS is a digital cellular communications service designed to offer consumers higher quality service, increased privacy and more features at lower prices than existing cellular communications systems. To meet growing customer demand, Mercury One 2 One has expanded its coverage to reach 30 percent of the United Kingdom's population.\nDIRECTORY AND INFORMATION SERVICES. The Media Group, through Marketing Resources, provides directory publishing as well as database marketing and interactive services. Marketing Resources publishes, prints and sells advertising in more than 300 White and Yellow Pages directories in the Communications Group Region. Marketing Resources' growth strategy is to increase its advertiser base through expanded marketing efforts, the expansion of core products, such as new targeted directories for specific neighborhoods or industries and development of new directory features, and the development and packaging of new information products, such as local audiotext services. Marketing Resources' yellow pages directory advertising business had revenue growth of approximately 6.4 percent in 1995.\nMarketing Resources also provides database marketing services that enable businesses to segment and target customers and is developing the capability to provide one-to-one marketing over interactive networks. In the future Marketing Resources plans to develop, package, market and distribute integrated, interactive communications, entertainment, information and transaction services over networks operated by the Media Group and others, including the networks of the Communications Group in the Communications Group Region.\nU S WEST International owns 100 percent of Thomson Directories, which it acquired in 1994. Thomson Directories annually publishes 156 directories in the United Kingdom, reaching 46 million people, or 80 percent of all households, in the United Kingdom. U S WEST International owns a 50 percent interest in Listel, Brazil's largest telephone directory publisher, which it acquired in 1994. U S WEST International also owns 100 percent of Polska, which publishes 32 directories in Poland with a combined circulation of approximately 1.7 million.\nIn June 1995, a subsidiary of U S WEST International purchased a 9.01% interest in Flextech plc (\"Flextech\"), one of the United Kingdom's largest providers of cable television and satellite programming. U S WEST International has the right to appoint one representative to Flextech's board of directors.\nREGULATION. The products and services of the Media Group are subject to varying degrees of regulation. Under the Telecommunications Act of 1996, the regulation of cable television rates will be discontinued effective March 31, 1999, or earlier if competition exists. The same Act also (i) eliminates certain cross-ownership restrictions among cable operators, broadcasters and multichannel, multipoint distribution system operators, (ii) removes barriers to competition with local exchange providers, and (iii) eliminates restrictions that previously applied to the Media Group relating to long-distance services.\nCable television systems are also subject to local regulation, typically imposed through the franchising process. Local officials may be involved in the initial franchise selection, system design and construction, safety, rate regulation, customer service standards, billing practices, community-related programming and services, franchise renewal and imposition of franchise fees.\nThe Media Group is subject to various regulations in the foreign countries in which it has operations. In the United Kingdom, the licensing, construction, operation, sale and acquisition of cable and wireline and wireless communications systems are regulated by various governmental entities, including the Department of Trade and Industry and the Department of National Heritage.\nCOMPETITION. U S WEST Multimedia's cable television systems generally compete for viewer attention with programming from a variety of sources, including the direct reception of broadcast television signals by the viewer's own antenna, subscription and low power television stations, multichannel multipoint distribution systems (\"MMDS\" or \"wireless cable\"), satellite master antenna (\"SMATV\") service, direct broadcast satellite (\"DBS\") services, telephone companies, including other RBOC's, and other cable companies within an operating area. The extent of such competition in any franchise area is dependent, in part, upon the quality, variety and price of the programming provided by these technologies. Many of these competitive technologies are generally not subject to the same local government regulation that affects cable television. Cable television\nsystems are also in competition for both viewers and advertising in varying degrees with other communications and entertainment media, and such competition may increase with the development and growth of new technologies. TeleWest's cable television services compete with broadcast television stations, DBS services, SMATV systems and certain narrowband operators in the United Kingdom.\nU S WEST Multimedia will be offering telecommunications services in competition with the dominant local exchange carriers (\"LECs\"), CAPs and other potential providers of telephone services in local domestic markets, including the interexchange carriers such as AT&T, MCI Communications and Sprint Corp. The degree of competition will be dependent upon the state and federal regulations concerning entry, interconnection requirements, and the degree of unbundling of the LECs' networks. Competition will be based upon price, service quality and breadth of services offered. TeleWest's telecommunications services compete with domestic telephone companies in the United Kingdom, such as British Telecommunications plc.\nNew Vector's wireless business is subject to FCC regulation and licensing requirements. To assure competition, the FCC has awarded two competitive cellular licenses in each market. Many competing cellular providers are substantial businesses with experience in broadcasting, telecommunications, cable television and radio common carrier services. In many markets, competing cellular service is provided by businesses owned or controlled by a LEC, AT&T or other major telephone companies. Competition is based upon the price of cellular service, the quality of the service and the size of the geographic area served. The development of PCS services will create multiple new competitors for NewVector's wireless businesses. Competition for the provision of wireless services is also provided by providers of enhanced specialized mobile radio services. In the United Kingdom, Mercury One 2 One's operations compete with two established cellular providers and one PCS provider. In addition, Mercury One 2 One competes in the consumer market with telephone companies such as British Telecommunications plc.\nMarketing Resources' directory publishing businesses continue to face significant competition from local and national publishers of directories, as well as other advertising media such as newspapers, magazines, broadcast media, direct mail and operator assisted services. Directory listings are now offered in electronic data bases through telephone company and third party networks. As such offerings expand and are enhanced through interactivity and other features, the Company will experience heightened competition in its directory publishing businesses. Marketing Resources will continue to expand its core products and develop and package new information products to meet its customers' needs. Marketing Resources' database marketing services also continue to face competition from direct mail list providers, co-op direct mail programs and coupon programs. Marketing Resources will also face emerging competition in the provision of interactive services from cable and entertainment companies, on-line services, advertising agencies specializing in interactive advertising and many small companies who are information providers. Many of these potential competitors may also be joint venture partners, suppliers or distributors.\nThe actions of public policy makers play an important role in determining how increased competition affects the Media Group. The Media Group is working with regulators and legislators to help ensure that public policies are fair and in the best interests of customers.\nSee \"Competitive and Regulatory Environment\" under Management's Discussion and Analysis of Financial Condition and Results of Operation on p. B-22.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe properties of U S WEST do not lend themselves to description by character and location of principal units. At December 31, 1995, the majority of U S WEST property was utilized in providing telecommunications services by U S WEST Communications. Substantially all of U S WEST Communications' central office equipment is located in owned buildings situated on land owned in fee, while many garages and administrative and business offices are in leased quarters.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nU S WEST and its subsidiaries are subject to claims and proceedings arising in the ordinary course of business. While complete assurance cannot be given as to the outcome of any contingent liabilities, in the opinion of U S WEST, any financial impact to which U S WEST and its subsidiaries are subject is not expected to be material in amount to U S WEST's operating results or its financial position.\nOn September 22, 1995, U S WEST filed a lawsuit in Delaware Chancery Court to enjoin the proposed merger of Time Warner and Turner Broadcasting. U S WEST has alleged breaches of contract and fiduciary duties by Time Warner in connection with this proposed merger. Time Warner filed a countersuit against U S WEST on October 11, 1995, alleging misrepresentation, breach of contract and other misconduct on the part of U S WEST. Time Warner's countersuit seeks a reformation of the Time Warner Entertainment partnership agreement, an order that enjoins U S WEST from breaching the partnership agreement and unspecified compensatory damages. U S WEST has denied each of the claims in Time Warner's countersuit. Trial for this action concluded on March 22, 1996. A ruling by the Delaware Chancery Court is expected in June 1996.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF U S WEST\nPursuant to General Instructions G(3), the following information is included as an additional item in Part I:\n- ------------------------------ (1) Mr. Anderson was elected Acting Executive Vice President and Chief Financial Officer effective October 6, 1995; he has been Vice President and Treasurer since 1984.\n(2) Mr. Lillis was elected President and Chief Executive Officer, U S WEST Media Group effective August 22, 1995.\n(3) Mr. McCormick was appointed Chief Executive Officer on January 1, 1991, and was elected Chairman of the Board effective May 1, 1992.\n(4) Mr.Trujillo was elected President and Chief Executive Officer of U S WEST Communications, Inc. effective July 1, 1995, and Executive Vice President, U S WEST, Inc. effective October 6, 1995. Previously, Mr. Trujillo was President and Chief Executive Officer of U S WEST Marketing Resources Group, Inc.\nExecutive Officers are not elected for a fixed term of office, but serve at the discretion of the Board of Directors.\nEach of the above executive officers has held a managerial position with U S WEST or an affiliate of U S WEST since 1991, except for Mr. Russ. Mr. Russ was Vice President, Secretary and General Counsel of NCR Corporation from February, 1984 to June, 1992.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required by this item is included in Note 21, Quarterly Financial Data, on page B-63. The U.S. markets for trading in U S WEST common stock are the New York Stock Exchange and the Pacific Stock Exchange. As of December 31, 1995, U S WEST Communications Group common stock was held by approximately 775,125 shareholders of record and U S WEST Media Group common stock was held by approximately 770,346 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nReference is made to the information set forth on pages B-1 through B-2.\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 on pages B-3 through B-26.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nReference is made to the information set forth on pages B-29 through B-63.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nCoopers & Lybrand L.L.P. has served as the Company's independent auditor, and Arthur Andersen LLP has served as the primary auditing firm for major subsidiaries within U S WEST Media Group, since 1984. In view of the Company's new targeted stock structure, the Company determined, following a recommendation of the Audit Committee, that it will be more efficient and effective for the Company to have a single firm perform the auditing function for the entire business.\nDuring the Company's two most recent fiscal years ended December 31, 1995 and December 31, 1994, the reports of Coopers & Lybrand L.L.P. on the Company's financial statements contained no adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles. In addition, during such fiscal years and the interim periods thereafter: (1) no disagreements with Coopers & Lybrand L.L.P. have occurred 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 Coopers & Lybrand L.L.P., would have caused it to make reference to the subject matter of the disagreement in connection with its report on the Company's financial statements; (2) no reportable events involving Coopers & Lybrand L.L.P. have occurred that must be disclosed under applicable securities laws; and (3) the Company has not consulted with Arthur Andersen LLP on items that concerned the application of accounting principles to a specific transaction, either completed or proposed, or on the type of audit opinion that might be rendered on the Company's financial statements.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required by this item with respect to executive officers is set forth in Part I, page 8, under the caption \"Executive Officers of U S WEST.\"\nThe information required by this item with respect to Directors is included in the U S WEST definitive Proxy Statement dated April 8, 1996 (\"Proxy Statement\") under \"Election of Directors\" on pages 4 through 6 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item is included in the Proxy Statement under \"Executive Compensation\" on pages 8 through 20 and \"Compensation of Directors\" on pages 3 and 4 and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this item is included in the Proxy Statement under \"Securities Owned by Management\" on page 4 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:\nFinancial statement schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n(b) Reports on Form 8-K:\nU S WEST filed the following reports on Form 8-K during the fourth quarter of 1995:\n(i) report dated October 6, 1995, reporting the resignation of Richard B. Cheney from the U S WEST board of directors and filing a Form of Underwriting Agreement and a Form of Note concerning the 6 3\/4% Notes due October 1, 2005, issued by U S WEST Capital Funding, Inc.;\n(ii) report dated October 27, 1995, relating to a release of earnings for the period ended September 30, 1995, reporting a change in U S WEST's certifying accountant, and filing a Form of Note, a Form of Distribution Agreement, a Form of Fixed-Rate Medium-Term Note, and Form of Floating Rate Medium-Term Note concerning the U S WEST Capital Funding, Inc. 6.31% Notes due November 1, 2005, unconditionally guaranteed as to payment of principal and interest by U S WEST, Inc.; and\n(iii) report dated November 2, 1995, filing a Form of Fixed Rate Global Note and a Form of Floating Rate Global Note concerning the $500,000,000 U S WEST Capital Funding, Inc. Medium-Term Notes due nine months or more from the date of issue, unconditionally guaranteed as to payment of principal, premium, if any, and interest, by U S WEST, Inc.\n(c) Exhibits:\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (\"SEC\"), are incorporated herein by reference as exhibits hereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Englewood, State of Colorado, on March 28, 1996.\nU S WEST, Inc.\nBy: \/s\/ JAMES T. ANDERSON\n----------------------------------- James T. Anderson ACTING EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nDated March 28, 1996\nINDEPENDENT ACCOUNTANTS' REPORT\nOur report on the consolidated financial statements of U S WEST, Inc., which includes an explanatory paragraph regarding the discontinuance of accounting for the operations of U S WEST Communications, Inc. in accordance with Statement of Financial Accounting Standard No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1993, is included on page B-45 of this Form 10-K. In connection with our audits of such consolidated financial statements, we have also audited the related consolidated financial statement schedule listed in the index on page S-1 of this Form 10-K for the years ended December 31, 1995, 1994 and 1993.\nIn our opinion, the consolidated financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P. Denver, Colorado February 12, 1996\nU S WEST, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN MILLIONS)\n- ------------------------------\nNote: Certain reclassifications within the schedule have been made to conform to the current year presentation.\n(a) Does not include amounts charged directly to expense. These amounts were $6, $10 and $10 for 1995, 1994 and 1993, respectively.\n(b) Represents credit losses written off during the period, less collection of amounts previously written off.\n(c) Provision for estimated loss on disposal of the capital assets segment of $100 and an additional provision of $20 to reflect the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates.\nS-1\nU S WEST, INC. FINANCIAL HIGHLIGHTS\n- ------------------------------ * Actual\n(1) 1995 income from continuing operations includes a gain of $95 ($0.20 per Media share) from the merger of U S WEST's joint venture interest in TeleWest plc with SBC CableComms (UK), a gain of $85 ($0.18 per Communications share) on the sales of certain rural telephone exchanges and $17 ($0.01 per Communications share and $0.02 per Media share) for expenses associated with the November 1, 1995 recapitalization. 1994 income from continuing operations includes a gain of $105 ($0.23 per share) on the partial sale of U S WEST's joint venture interest in TeleWest plc, a gain of $41 ($0.09 per share) on the sale of the Company's paging operations and a gain of $51 ($0.11 per share) on the sales of certain rural telephone exchanges. 1993 income from continuing operations was reduced by a restructuring charge of $610 ($1.46 per share) and a charge of $54 ($0.13 per share) for the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates. 1991 income from continuing operations was reduced by a restructuring charge of $230 ($0.57 per share).\n(2) 1995 net income was reduced by extraordinary items of $12 ($0.02 per Communications share and $0.01 per Media share) for the early extinguishment of debt. 1993 net income was reduced by extraordinary charges of $3,123 ($7.45 per share) for the discontinuance of Statement of Financial Accounting Standards (\"SFAS\") No. 71 and $77 ($0.18 per share) for the early extinguishment of debt. 1993 net income also includes a charge of $120 ($0.28 per share) for U S WEST's decision to discontinue the operations of its\nB-1\ncapital assets segment. 1992 net income includes a charge of $1,793 ($4.35 per share) for the cumulative effect of change in accounting principles. Discontinued operations provided net income (loss) of $38 ($0.09 per share), $103 ($0.25 per share) and $(287) ($0.71 per share) in 1993, 1992 and 1991, respectively.\n(3) Capital expenditures, debt and the percentage of debt to total capital excludes the capital assets segment, which has been discontinued and is held for sale.\n(4) Effective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of U S WEST Communications Group common stock and U S WEST Media Group common stock. Earnings per common share have been presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1995. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n(5) 1995 return on shareowners' equity is based on income before extraordinary items. 1993 return on shareowners' equity is not presented. Return on shareowners' equity for fourth-quarter 1993 was 19.9 percent based on income from continuing operations. 1992 return on shareowners' equity is based on income before the cumulative effect of change in accounting principles.\nB-2\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nTHE RECAPITALIZATION PLAN\nOn October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\"), voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors to reincorporate in Delaware and create two classes of common stock. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or the \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\") and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\").\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nTHE COMMUNICATIONS GROUP\nThe Communications Group primarily provides regulated communications services to more than 25 million residential and business customers in the Communications Group Region (the \"Region\"). The Region includes the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. Services offered by the Communications Group include local telephone services, exchange access services (which connect customers to the facilities of carriers, including long-distance providers and wireless operators), and long-distance services within Local Access and Transport Areas (\"LATAs\") in the Region. The Communications Group provides other products and services, including custom calling features, voice messaging, caller identification, high-speed data applications, customer premises equipment and certain communications services to business customers and governmental agencies both inside and outside the Region. The Telecommunications Act of 1996, enacted into law on February 8, 1996, will dramatically alter the competitive landscape of the telecommunications industry and will further change the nature of services the Communications Group will offer. These future service offerings include interLATA long-distance service, wireless services, cable television and interconnection services provided to competing providers of local services.\nTHE MEDIA GROUP\nThe Media Group is comprised of: (i) cable and telecommunications network businesses outside of the Communications Group Region and internationally, (ii) domestic and international wireless communications network businesses and (iii) domestic and international directory and information services businesses.\nThe Media Group's cable and telecommunications businesses include U S WEST's investment in Time Warner Entertainment Company L.P. (\"TWE\" or \"Time Warner Entertainment\"), the second largest provider of cable television services in the United States, its cable systems in the Atlanta, Georgia metropolitan area (\"the Atlanta Systems\"), and international cable and telecommunications investments, including TeleWest plc (\"TeleWest\"). In 1995, TeleWest Communications plc merged its cable television and telephony interests with SBC CableComms (UK) to form TeleWest, the largest provider of combined cable and telecommunications services in the United Kingdom. The Media Group also owns interests in cable and\/or telecommunications properties in the Netherlands, Sweden, Norway, Hungary, Czech Republic, Malaysia and Indonesia.\nThe Media Group provides domestic wireless communications services, including cellular services, in 13 western and midwestern states to a rapidly growing customer base. The Media Group also provides\nB-3\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) wireless communications services internationally through its Mercury One 2 One (\"One 2 One\") joint venture, the world's first personal communications service located in the United Kingdom. The Media Group also owns interests in wireless properties in Hungary, the Czech and Slovak Republics, Russia, Malaysia, India and Poland.\nThe Media Group's directory and information services businesses develop and package content and information services, including telephone directories, database marketing and other interactive services in domestic and international markets. The Media Group publishes more than 300 White and Yellow Pages directories in 14 western and midwestern states and nearly 200 directories in the United Kingdom and Poland. The Media Group also has a 50 percent interest in Listel, Brazil's largest telephone directory publisher.\nAIRTOUCH MERGER\nDuring 1994, U S WEST signed a definitive agreement with AirTouch Communications to combine their domestic cellular assets. The initial equity ownership of this cellular joint venture will be approximately 70 percent AirTouch and approximately 30 percent U S WEST. The combination will take place in two phases. During Phase I, which U S WEST entered effective November 1, 1995, the two companies are operating their cellular properties separately. A Wireless Management Company (the \"WMC\") has been formed and is providing centralized services to both companies on a contract basis. In Phase II, AirTouch and U S WEST will contribute their domestic cellular assets to the WMC. In this phase, the Company will reflect its share of the combined operating results of the WMC using the equity method of accounting. The recent passage of the Telecommunications Act of 1996 has removed significant regulatory barriers to completion of Phase II of the business combination. U S WEST expects that Phase II closing could take place by the end of 1996 or early 1997.\nPERSONAL COMMUNICATIONS SERVICES\nU S WEST partnered with AirTouch Communications, Bell Atlantic and NYNEX to form a strategic national wireless alliance and formed a venture to provide personal communications services (\"PCS\"). This venture, PCS PrimeCo, purchased 11 licenses in the Federal Communication Commission's (the \"FCC\") PCS auction, covering 57 million people in Chicago, Dallas, Honolulu, Houston, Jacksonville, Miami, Milwaukee, New Orleans, Richmond, San Antonio and Tampa.\nSUBSEQUENT EVENT\nOn February 27, 1996, the Company announced a definitive agreement to merge with Continental Cablevision, Inc. (\"Continental\"). Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nContinental's 4.2 million domestic customers are highly clustered in five large markets -- New England, California, Chicago, Michigan, Ohio and Florida. Upon closing, U S WEST will own or share management of cable systems in 60 of the top 100 American markets and serve nearly one of every three cable households. In addition, Continental has interests in cable properties in Australia, Argentina and Singapore; a 10 percent interest in PRIMESTAR (a direct broadcast satellite service); telephone access businesses in Florida and Virginia; and interests in programming that include Turner Broadcasting System, E! Entertainment Television, the Golf Channel, and the Food Channel.\nB-4\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS -- 1995 COMPARED WITH 1994\nComparative details of income from continuing operations for 1995 and 1994 follow:\n- ------------------------------ (1) 1995 Communications Group income from continuing operations includes a gain of $85 ($0.18 per Communications share) on the sales of certain rural telephone exchanges and $8 ($0.01 per Communications share) for costs associated with the Recapitalization Plan. 1994 Communications Group income from continuing operations includes a gain of $51 ($0.11 per U S WEST share) on the sales of certain rural telephone exchanges.\n(2) 1995 Media Group income from continuing operations includes a gain of $95 ($0.20 per Media share) from the merger of TeleWest with SBC CableComms (UK) and $9 ($0.02 per Media share) for costs associated with the Recapitalization Plan. 1994 Media Group income from continuing operations includes a gain of $105 ($0.23 per U S WEST share) from the partial sale of the Company's joint venture interest in TeleWest and a gain of $41 ($0.09 per U S WEST share) from the sale of the Company's paging operations.\n(3) Percent ownership represents pro-rata priority capital and residual equity interests.\n(4) Primarily includes interest expense and divisional expenses associated with equity investments.\n(5) Earnings per common share from continuing operations have been presented on a pro forma basis as if the Communications Stock and Media Stock had been outstanding since January 1, 1995. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\nCOMMUNICATIONS GROUP\nThe Communications Group's 1995 income from continuing operations, excluding the effects of one-time items described in Note 1 to the table above, was $1,107, an increase of $8, or 0.7 percent, compared with $1,099 in 1994, also excluding the effects of one-time items. Total revenue growth of 3.4 percent was largely offset by significantly higher costs incurred to improve customer service and meet greater than\nB-5\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) expected business growth. Net income growth will also be limited in 1996 while the Communications Group continues to commit significant resources to meet customer service objectives and broaden its range of product and service offerings.\nExcluding the effects of one-time items described in Note 1 to the table above, pro forma earnings per Communications Group common share from continuing operations were $2.35 in 1995.\nDuring 1995, the Communications Group refinanced $145 of long-term debt. Expenses associated with the refinancings resulted in extraordinary charges of $8, net of tax benefits of $5.\nMEDIA GROUP\nDuring 1995, income from continuing operations declined 55 percent, to $59, excluding the effects of the one-time items described in Note 2 to the table above. The decline is due primarily to higher equity losses related to international growth initiatives and increased amortization and interest expense. Interest expense increases relate to debt issued in connection with the Atlanta Systems acquisition and expansion of international investments. The declines were partially offset by improvement in the domestic cellular and Yellow Pages operations.\nExcluding the effects of one-time items described in Note 2 to the table above, pro forma earnings per Media Group common share from continuing operations were $0.12 in 1995.\nDuring 1995, the Media Group incurred an extraordinary loss of $4, net of a tax benefit of $2, related to the early retirement of debt by TWE.\nSALES AND OTHER REVENUES\nAn analysis of the change in U S WEST's consolidated sales and other revenues follows:\nCOMMUNICATIONS GROUP OPERATING REVENUES\nAn analysis of changes in Communications Group operating revenues follows:\nApproximately 97 percent of the revenues of the Communications Group are attributable to the operations of U S WEST Communications, Inc. (\"U S WEST Communications\"), of which approximately 59 percent are derived from the states of Arizona, Colorado, Minnesota and Washington. Approximately 29 percent of the access lines in service are devoted to providing services to business customers. The access\nB-6\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) line growth rate for business customers, who tend to be heavier users of the network, has consistently exceeded the growth rate of residential customers. During 1995, business access lines grew 5.4 percent while residential access lines increased 2.8 percent.\nThe primary factors that influence changes in revenues are customer demand for products and services, price changes (including those related to regulatory proceedings) and refunds. During 1995, revenues from new product and service offerings were $534, an increase of 58 percent compared with 1994. These revenues primarily consist of caller identification, voice messaging, call waiting and high-speed data network transmission services.\nLocal service revenues include local telephone exchange, local private line and public telephone services. In 1995, local service revenues increased principally as a result of higher demand for new and existing services, and demand for second lines. Local service revenues from new services increased $92, or 78 percent, compared with 1994. Reported total access lines increased 511,000, or 3.6 percent, of which 161,000 were second lines. Second line installations increased 25.5 percent compared with 1994. Access line growth was 4.2 percent adjusted for the sale of approximately 95,000 rural telephone access lines during the last 12 months.\nAccess charges are collected primarily from interexchange carriers for their use of the local exchange network. For interstate access services there is also a fee collected directly from telephone customers. Approximately 33 percent of access revenues and 11 percent of total revenues are derived from providing access services to AT&T.\nHigher revenues from interstate access services were driven by an increase of 9.2 percent in interstate billed access minutes of use. The increased business volume more than offset the effects of price reductions and refunds. The Communications Group reduced prices for interstate access services in both 1995 and 1994 as a result of Federal Communications Commission (\"FCC\") orders and competitive pressures. Intrastate access revenues increased primarily due to the impact of increased business volume and multiple toll carrier plans, partially offset by the impact of rate changes.\nLong-distance revenues are derived from calls made within the LATA boundaries of the Region. During 1995 and 1994, long-distance revenues were impacted by the implementation of multiple toll carrier plans (\"MTCPs\") in Oregon and Washington in May and July 1994, respectively. The MTCPs essentially allow independent telephone companies to act as toll carriers. The 1995 impact of the MTCPs was long-distance revenue losses of $62, partially offset by increases in intrastate access revenues of $12 and decreases in other operating expenses (i.e. access expense) of $42 compared with 1994. These regulatory arrangements have decreased annual net income by approximately $10. Similar changes in other states could occur, though the impact on 1996 net income would not be material.\nExcluding the effects of the MTCPs, long-distance revenues decreased by 5.9 percent in 1995, primarily due to the effects of competition and rate reductions. Long-distance revenues have declined over the last several years as customers have migrated to interexchange carriers that have the ability to offer these services on both an intraLATA and interLATA basis. A portion of revenues lost to competition, however, is recovered through access charges paid by the interexchange carriers. Erosion in long-distance revenue will continue due to the loss of 1+ dialing in Minnesota, effective in February 1996, and in Arizona, effective in April 1996. Annual long-distance revenue losses could approximate $30 as a result of these changes. The Communications Group is partially mitigating competitive losses through competitive pricing of intraLATA long-distance services.\nRevenues from other services primarily consist of billing and collection services provided to interexchange carriers, voice messaging services, high-speed data transmission services, sales of service agreements related to inside wiring and the provision of customer premises equipment.\nB-7\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nDuring 1995, revenues from other services increased $44, primarily as a result of continued market penetration in voice messaging services and sales of high-speed data transmission services. Revenue growth from other services is also attributable to maintenance contracts for inside wire services and a large contract related to a wire installation project. These increases were partially offset by a decrease of $20 in revenues from billing and collection services. The decline in billing and collection revenues is primarily related to lower contract prices and a decrease in the volume of services provided to AT&T.\nMEDIA GROUP SALES AND OTHER REVENUES\nAn analysis of the Media Group's sales and other revenues follows:\n- ------------------------------ (1) The Company's paging business was sold in June 1994. Results reflect operations for the six months ending June 30, 1994.\nMedia Group sales and other revenues increased 15 percent, to $2,374 in 1995, excluding the effects of the 1994 Atlanta Systems acquisition and paging sale. The increase was primarily due to strong growth in cellular service revenue.\nDIRECTORY AND INFORMATION SERVICES Revenues related to Yellow Pages directory advertising increased 6.4 percent to $1,026 in 1995, due to price increases of 4.5 percent, higher revenue per advertiser and an increase in Yellow Pages advertising volume.\nInternational directory publishing revenues increased $44 in 1995, primarily due to U S WEST's May 1994 purchase of Thomson Directories in the United Kingdom. The remaining increase is due to an increase in advertisers and revenue per advertiser.\nWIRELESS COMMUNICATIONS Cellular service revenues increased 34 percent, to $845 in 1995, due to a 51 percent increase in subscribers during the last twelve months (with 20 percent of the additions occurring in December), partially offset by a 13 percent drop in average revenue per subscriber to $60.00 per month. The increase in subscribers relates to continued growth in demand for wireless services. The Media Group anticipates continued growth in its subscriber base, although at slightly decreased rates.\nNew distribution programs are being developed which increase availability of cellular products and simplify the cellular service activation process. These programs have contributed to the shift in the customer base from businesses to consumers. This shift, combined with competitive pressures on pricing, will cause the average revenue per subscriber to continue to decline.\nB-8\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCellular equipment revenues decreased 20 percent, to $96 in 1995, as a result of lower cellular equipment costs. These lower equipment costs are being passed on to retailers and to new customers. The Media Group expects this trend to continue in 1996 as the cost of equipment continues to decline and as penetration into the consumer market increases.\nRevenues related to the paging sales and service operations, which were sold in 1994, approximated $28 in 1994.\nCABLE AND TELECOMMUNICATIONS Domestic cable and telecommunications revenues increased $197 in 1995, due to the December 1994 acquisition of the Atlanta Systems.\nCOSTS AND EXPENSES\nEMPLOYEE-RELATED EXPENSES\nEmployee-related expenses include basic salaries and wages, overtime, benefits (including pension and health care), payroll taxes and contract labor. During 1995, improving customer service was the Communications Group's first priority. Overtime payments and contract labor expense associated with customer service initiatives at the Communications Group increased employee-related costs by approximately $168 compared with 1994. Expenses related to the addition of approximately 1,700 employees in 1995 and 1,000 employees in 1994 at the Communications Group also increased employee-related costs. These expenses were incurred to handle the higher than anticipated volume of business and to meet new business opportunities. Partially offsetting these increases was a $34 reduction in the accrual for postretirement benefits, a $22 decrease in travel expense and reduced expenses related to employee separations under reengineering and streamlining initiatives. The Communications Group will continue to add employees to address customer service issues and growth in the core business. Costs related to these work-force additions will partially offset the benefits of employee separations achieved through restructuring. (See \"Restructuring Charge.\")\nEmployee-related expenses also increased due to the 1994 purchases of the Atlanta Systems and Thomson Directories, and growth initiatives in the directory and information services segment.\nOTHER OPERATING EXPENSES\nOther operating expenses include access charges (incurred for the routing of long-distance traffic through the facilities of independent companies), network software expenses, wireless marketing and operating costs, and marketing and related costs associated with publishing activities. The increase in other operating expenses is primarily attributed to the Media Group's 1994 purchases of the Atlanta Systems and Thomson Directories and expansion of the cellular customer base.\nDuring 1995, other operating expenses decreased at the Communications Group primarily due to the effects of the multiple toll carrier plans and a reduction in expenses related to project funding at Bell Communications Research, Inc. (\"Bellcore\"), of which U S WEST Communications has a one-seventh ownership interest. These decreases in other operating expenses were partially offset by increases in costs associated with increased sales of products and services, including bad debt expense.\nB-9\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nTAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes, which consist primarily of property taxes, were relatively flat compared with 1994. Increased taxes associated with the domestic cellular operations were offset by lower taxes at the Communications Group. Lower taxes at the Communications Group were primarily due to favorable property tax valuations and mill levies as compared with 1994. As a result of these valuations and mill levies, 1995 fourth-quarter accruals at the Communications Group decreased by $20 compared with fourth-quarter 1994.\nDEPRECIATION AND AMORTIZATION\nIncreased depreciation and amortization expense was attributable to the effects of a higher depreciable asset base at the Communications Group, expansion of the Media Group's domestic cellular network and the purchase of the Atlanta Systems. These increases were partially offset by the effects of the sales of certain rural telephone exchanges at U S WEST Communications.\nINTEREST EXPENSE AND OTHER\nInterest expense increased primarily as a result of increased debt financing at the Communications Group, the December 1994 acquisition of the Atlanta Systems, new domestic and international investments and a reclassification of debt from net investment in assets held for sale. The average borrowing cost was 6.7 percent in 1995, compared with 6.6 percent in 1994. (See \"Liquidity and Capital Resources.\")\nEquity losses increased $86 in 1995, primarily due to costs related to the expansion of the network and additional financing costs at TeleWest and additional costs associated with the significant increase in customers at One 2 One. Start-up and other costs associated with new international cable and telecommunications investments primarily located in the Czech Republic and Malaysia contributed to the increase. These increased losses were partially offset by earnings in the European wireless operations. Losses related to domestic investments in TWE and PCS PrimeCo also increased. The Media Group expects the PCS partnership to experience several years of operating losses associated with the start-up phase of the PCS business.\nThe decrease in other income is largely attributable to $17 of costs associated with the Recapitalization Plan in 1995, increased minority interest expense associated with domestic cellular operations and a 1994 gain on sale of nonstrategic operations.\nPROVISION FOR INCOME TAXES\nThe increase in the effective tax rate reflects the impacts of goodwill amortization related to the acquisition of the Atlanta Systems, higher state and foreign income taxes, and expenses associated with the Recapitalization Plan. Additionally, a tax benefit was recorded in 1994, related to the sale of paging assets, which contributed to the increase in the effective tax rate. These impacts were partially offset by lower pretax income and the effects of a research and experimentation credit, and adjustments for prior periods.\nRESTRUCTURING CHARGE\nU S WEST's 1993 results reflected a $1 billion restructuring charge (pretax). The related restructuring plan (the \"Restructuring Plan\") is designed to provide faster, more responsive customer services while reducing the costs of providing these services. As part of the Restructuring Plan, the Company is developing new systems and enhanced system functionality that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, rapidly design and engineer products and\nB-10\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) services for customers, and centralize its service centers. The Company has consolidated its 560 customer service centers at U S WEST Communications into 26 centers in 10 cities and plans on reducing its work force by approximately 10,000 employees. All service centers are operational and supported by new systems and enhanced system functionality.\nThe Restructuring Plan is expected to be substantially complete by the end of 1997. Implementation of the Restructuring Plan has been impacted by growth in the business and related service issues, new business opportunities, revisions to system delivery schedules and productivity issues caused by the major rearrangement of resources due to restructuring. These issues will continue to affect the timing of employee separations.\nThe Company estimates that full implementation of the 1993 Restructuring Plan will reduce employee-related expenses by approximately $400 per year. The savings related to work-force reductions will be offset by the effects of inflation and a variety of other factors. These factors include costs related to the achievement of customer service objectives and increased demand for existing services. (See \"Employee-Related Expenses.\")\nFollowing is a schedule of the costs included in the Restructuring Plan:\n- ------------------------------ (1) Employee separation costs, including the balance of a 1991 restructuring reserve at December 31, 1993, aggregate $316.\nEmployee separation costs include severance payments, health-care coverage and postemployment education benefits. Systems development costs include new systems and the application of enhanced system functionality to existing, single-purpose systems to provide integrated, end-to-end customer service. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the new service centers and retraining employees on the methods and systems required in the new, restructured mode of operation.\nEMPLOYEE SEPARATION Under the Restructuring Plan, the Company anticipates the separation of 10,000 employees. Approximately 1,000 employees that were originally expected to relocate have chosen separation or other job assignments and have been replaced. This increased the number of employee separations to 10,000 from 9,000, and increased the estimated total cost for employee separations to $316 from $286, as compared with the original estimate. The $30 cost associated with these additional employee separations was reclassified from relocation to the reserve for employee separations during 1995.\nB-11\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nAnnual employee separations and employee-separation amounts under the Restructuring Plan follow:\n- ------------------------------ (1) Includes the remaining employees and the separation amounts associated with the balance of a 1991 restructuring reserve at December 31, 1993.\n(2) A significant number of the employee reductions originally scheduled for 1996 will be delayed while the Company focuses on overtime and contract-labor expenses. The Restructuring Plan is expected to be substantially complete by the end of 1997.\nCompared with the original estimates, employee reduction and separation amounts shown above have been reduced by 1,600 employees and $51 in 1996, and increased by 4,495 employees and $129 in 1997.\nSYSTEMS DEVELOPMENT The existing information management systems were largely developed to support a monopoly environment. These systems were inadequate due to the effects of increased competition, new forms of regulation and changing technology that have driven consumer demand for products and services that can be delivered quickly, reliably and economically. The Company believes that improved customer service, delivered at lower cost, can be achieved by a combination of new systems and introducing new functionality to existing systems. This is a change from the initial strategy which placed more emphasis on the development of new systems.\nThe systems development program involves new systems and enhanced system functionality for systems that support the following core processes:\nSERVICE DELIVERY -- to support service on demand for all products and services. These new systems and enhanced system functionality will permit customer calls to be directed to those service representatives who can meet their requirements. This process will provide enhanced information to the service representatives regarding the customer requests and the ability of the Communications Group to fulfill them.\nSERVICE ASSURANCE -- for performance monitoring from one location and remote testing in the new environment, including identification and resolution of faults prior to customer impact.\nCAPACITY PROVISIONING -- for integrated planning of future network capacity, including the installation of software controllable service components.\nB-12\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCertain of the new systems and enhanced system functionality have been implemented in the service centers and have simplified the labor-intensive interfaces between systems processes in existence prior to the Restructuring Plan. Enhanced system functionality introduced under the Restructuring Plan since its inception includes the following:\n- The ability to determine facilities' availability while the customer is placing an order;\n- Automated engineering of central office facilities and automated updating of central office facilities' records;\n- The ability to track the status of complex network design jobs from the customer's perspective; and\n- Systems that accurately diagnose network problems and prepare repair packages to correct the problems identified.\nThe direct, incremental and nonrecurring costs of providing new systems and enhanced system functionality follow:\nSystems expenses charged to current operations consist of costs associated with the information management function, including planning, developing, testing and maintaining databases for general purpose computers, in addition to systems costs related to maintenance of telephone network applications. Other systems expenses are for administrative (i.e. general purpose) systems which include customer service, order entry, billing and collection, accounts payable, payroll, human resources and property records. Ongoing systems costs at U S WEST Communications comprised approximately six percent of total operating expenses in 1995, 1994 and 1993. The Company expects systems costs charged to current operations as a percent of total operating expenses to approximate the current level throughout 1996. Systems costs could increase relative to other operating costs as the business becomes more technology dependent.\nB-13\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nPROGRESS UNDER THE RESTRUCTURING PLAN\nFollowing is a reconciliation of restructuring reserve activity since December 1993:\nB-14\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS -- 1994 COMPARED WITH 1993\nComparative details of income from continuing operations for 1994 and 1993 follow:\n- ------------------------------ (1) 1994 income from continuing operations includes a gain of $51 ($0.11 per share) on the sales of certain rural telephone exchanges. 1993 income from continuing operations was reduced by $534 ($1.28 per share) for a restructuring charge and $54 ($0.13 per share) for the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates.\n(2) 1994 income from continuing operations includes a gain of $105 ($0.23 per share) on the partial sale of U S WEST's joint venture interest in TeleWest, and a gain of $41 ($0.09 per share) for the sale of the Company's paging operations. 1993 income from continuing operations was reduced by $76 ($0.18 per share) for a restructuring charge.\n(3) Percent ownership represents pro-rata priority capital and residual equity interests.\n(4) Primarily includes interest expense and divisional expenses associated with equity investments.\nCOMMUNICATIONS GROUP\nThe Communications Group's 1994 income from continuing operations was $1,099, an increase of $120, or 12.3 percent, over 1993, excluding the one-time effects described in Note 1 to the table above. The increase was primarily attributable to increased demand for telecommunications services.\nIn 1993, U S WEST Communications incurred extraordinary charges for the discontinuance of Statement of Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" and the early extinguishment of debt. An extraordinary, noncash charge of $3.1 billion (after tax) was incurred in conjunction with the decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS No. 71. SFAS No. 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, competition notwithstanding, by charging its customers at prices established by its regulators. This decision to discontinue the application of SFAS No. 71 was based on the belief that competition, market conditions and technological advances, more than prices established by regulators, will determine the future cost recovery by U S WEST Communications. As a result of this change, the remaining asset lives of U S WEST\nB-15\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Communications' telephone plant were shortened to more closely reflect the useful (economic) lives of such plant. U S WEST Communications' accounting and reporting for regulatory purposes were not affected by the change.\nDuring 1993, U S WEST Communications refinanced long-term debt issues aggregating $2.7 billion in principal amount. These refinancings allowed U S WEST Communications to take advantage of favorable interest rates. Extraordinary costs associated with the redemptions reduced 1993 income by $77 (after tax).\nMEDIA GROUP\nDuring 1994, income from continuing operations decreased 19 percent, to $130, excluding the effects of the one-time items described in Note 2 to the table above. The decline in income is primarily a result of increased start-up losses associated with international businesses, partially offset by income growth in domestic wireless operations attributable to rapid growth in customer demand.\nDuring 1993, the Board approved a plan to dispose of the capital assets segment, which includes activities related to financial services, financial guarantee insurance operations and real estate. Until January 1, 1995, the capital assets segment was accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, which provides for the reporting of the operating results of discontinued operations separately from continuing operations. The Company recorded a provision of $100 (after tax) for the estimated loss on disposal of the discontinued operations and an additional provision of $20 to reflect the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates. Income from discontinued operations prior to June 1, 1993, was $38, net of $15 in income taxes. Income from discontinued operations subsequent to June 1, 1993, is being deferred and was included within the provision for loss on disposal of the capital assets segment.\nSALES AND OTHER REVENUES\nAn analysis of the change in U S WEST's consolidated sales and other revenues follows:\nCOMMUNICATIONS GROUP OPERATING REVENUES\nAn analysis of changes in the Communications Group's revenues follows:\nIn 1994, local service revenues increased principally as a result of higher demand for services. Reported access lines increased by 3.6 percent. Excluding the sale of approximately 60,000 rural telephone access lines during 1994, access line growth was 4.0 percent.\nB-16\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nHigher revenues from interstate access services were primarily attributable to an increase of 7.8 percent in interstate billed access minutes of use, which more than offset the effects of price decreases. Intrastate access charges increased primarily as a result of higher demand, including demand for private line services.\nLong-distance revenues decreased principally due to the effects of the MTCPs implemented in Oregon and Washington. The 1994 impact was a loss of $68 in long-distance revenues, partially offset by a decrease of $48 in other operating expenses and an increase of $10 in intrastate access revenue. These regulatory arrangements decreased net income by approximately $6 in 1994.\nDuring 1994, revenues from other services increased due to higher revenue from billing and collection services and increased market penetration of new service offerings. Partially offsetting the increase in other services revenues was the 1993 sale of telephone equipment distribution operations, completion of large telephone network installation contracts and lower revenue from customer premises equipment installations.\nMEDIA GROUP SALES AND OTHER REVENUES\nAn analysis of the Media Group's sales and other revenues follows:\n- ------------------------------ (1) The Company's paging business was sold in June 1994. Results reflect operations for the six months ending June 30, 1994.\nDuring 1994, Media Group sales and other revenues increased 25 percent to $1,862, excluding the effect of the 1994 Atlanta Systems acquisition and paging sale. The increase was primarily due to strong growth in cellular service revenue.\nDIRECTORY AND INFORMATION SERVICES Revenues related to Yellow Pages directory advertising increased approximately $59, or 6.5 percent, due primarily to pricing. Product enhancements and the effect of improved marketing programs on business volume also contributed to the increase in revenues. Non-Yellow Pages revenues increased $11, including $7 related to new products. Partially offsetting these increases was the absence of revenues related to certain publishing, software development and marketing operations that were sold, which reduced revenues by $22.\nThe increase in international directory publishing revenue is attributable to U S WEST's May 1994 purchase of Thomson Directories.\nB-17\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nWIRELESS COMMUNICATIONS Cellular service revenues increased 43 percent, to $633 in 1994, due to a 61 percent increase in subscribers (with 24 percent of the additions occurring in December), partially offset by an 8 percent drop in average revenue per subscriber to $70.00 per month.\nCellular equipment revenues increased 90 percent, to $120 in 1994, primarily due to an 83 percent increase in gross customer additions, with a higher percentage of those customers purchasing equipment than in 1993. This increase was partially offset by a 13 percent decline in the average selling price of wireless phones.\nCABLE AND TELECOMMUNICATIONS Domestic cable and telecommunications revenues reflect the December 1994 acquisition of the Atlanta Systems.\nCOSTS AND EXPENSES\nA reduction in the pension credit of approximately $80 contributed to the increase in employee-related expenses. Actuarial assumptions, which include decreases in the discount rate and the expected long-term rate of return on plan assets, contributed to the pension credit reduction. Approximately $150 for overtime payments, contract labor and basic salaries and wages, all related to the implementation of the Restructuring Plan at U S WEST Communications, also contributed to the increase. Additionally, employee-related expenses at the Company's publishing operations increased in connection with new product initiatives. Partially offsetting these increases were the effects of employees leaving the Company under the Restructuring Plan, lower health-care benefit costs, including a reduction in the accrual for postretirement benefits, and lower incentive compensation payments to employees.\nSelling and other operating costs related to growth in the cellular subscriber base increased other operating expenses by approximately $166 in 1994. Partially offsetting this increase was a $48 decrease in access expense related to the effects of the multiple toll carrier plan arrangements.\nThe increase in depreciation and amortization expense was primarily a result of a higher depreciable asset base and increased rates of depreciation at U S WEST Communications.\nInterest expense in 1994 was essentially unchanged from 1993. Incremental financing costs associated with the September 1993 TWE investment were offset by the effects of refinancing debt at lower rates in 1993 at U S WEST Communications, and a reclassification of capitalized interest in 1994. Since the discontinuance of SFAS No. 71, interest capitalized as a component of telephone plant construction is recorded as an offset against interest expense rather than to other income (expense). U S WEST's average borrowing cost decreased to 6.6 percent in 1994, from 6.7 percent in 1993.\nEquity losses in unconsolidated ventures increased over 1993, primarily due to start-up costs related to the build out of TeleWest's network and costs related to the expansion of the customer base at One 2 One.\nB-18\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nOther income increased over 1993 primarily due to an increase in the management fee associated with the Company's TWE investment and a gain on the sale of certain publishing operations, partially offset by the reclassification of capitalized interest to interest expense.\nPROVISION FOR INCOME TAXES\nThe increase in the effective tax rate resulted primarily from the effects of discontinuing SFAS No. 71, an increase in 1994 income before income taxes and the 1993 restructuring charge, partially offset by the cumulative effect on deferred income taxes of the 1993 federally mandated increase in income tax rates.\nLIQUIDITY AND CAPITAL RESOURCES -- THREE YEARS ENDED DECEMBER 31, 1995\nOPERATING ACTIVITIES\nCash provided by operations increased $173 in 1995. Business growth in the Communications Group and the cellular business, and the acquisition of the Atlanta Systems contributed to the increase in cash provided by operations. This increase was partially offset by increases in Restructuring Plan expenditures and higher income tax and interest payments, including approximately $60 related to the partial sale of the Company's joint venture interest in TeleWest.\nCash from operations in 1994 remained relatively flat compared with 1993. Business growth and a decrease in the cash funding for postretirement benefits was offset by increased Restructuring Plan payments.\nINVESTING ACTIVITIES\nTotal capital expenditures were $3,140 in 1995, $2,820 in 1994 and $2,441 in 1993. The 1995 capital expenditures exceeded the 1994 and 1993 levels due to the Communications Group's efforts to improve customer service (including reductions in held orders) and to accommodate additional line capability in several states, and the enhancement and expansion of the cellular network. In 1996, capital expenditures are expected to approximate $3.1 billion. Included in the 1996 capital expenditures estimate are costs to enter new markets as allowed under the Telecommunications Act of 1996, upgrade the Atlanta Systems and expand the cellular network.\nThe Company received cash proceeds of $214 and $93 in 1995 and 1994, respectively, for the sales of certain rural telephone exchanges. Since implementing its rural telephone exchange sales program, the Company has sold approximately 155,000 access lines. Planned sales of rural exchanges for 1996 and beyond aggregate approximately 180,000 lines.\nInvesting activities of the Company also include equity investments in international ventures. In 1995, the Company invested $681 in international ventures, primarily investments in Malaysia, the Netherlands, the Czech Republic and the United Kingdom. The Company invested approximately $444 in developing international businesses in 1994, including the acquisition of Thomson Directories. The Company anticipates that investments in international ventures will approximate $400 in 1996. This includes investments for recently awarded licenses to provide cellular service using digital technology in India and Poland. At December 31, 1995, U S WEST guaranteed debt in the principal amount of approximately $140 related to international ventures.\nIn March 1995, PCS PrimeCo was awarded PCS licenses in 11 markets. The Company's share of the cost of the licenses was approximately $268, all of which was funded in 1995. Under the PCS PrimeCo partnership\nB-19\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) agreement, U S WEST is required to fund approximately 24 percent of PCS PrimeCo's operating and capital costs, including licensing costs. U S WEST anticipates that its total funding obligations to PCS PrimeCo during the next three years will be approximately $400.\nIn 1994, the Company received cash proceeds of $143 from the sale of its paging operations. In 1993, cash proceeds of $30 were received from the sale of certain nonstrategic lines of business. The Company did not receive cash from the 1994 partial sale of its joint venture interest in TeleWest or from the 1995 merger. All proceeds from the 1994 sale have been used by TeleWest for general business purposes, including financing both construction and operations, and repaying debt.\nOn February 27, 1996, U S West announced a definitive agreement to merge with Continental. Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nFINANCING ACTIVITIES\nDuring 1995, debt increased $917 primarily due to the increase in capital expenditures, new investments in international ventures, cash funding of the PCS licenses and a reclassification of debt from net investment in assets held for sale.\nDuring fourth-quarter 1995, U S WEST issued $130 of exchangeable notes, or Debt Exchangeable for Common Stock (\"DECS\"), due December 15, 1998. Upon maturity, each DECS will be mandatorily exchanged by U S WEST for shares of Enhance Financial Services Group, Inc. (\"Enhance\") or, at U S WEST's option, redeemed at the cash equivalent. The capital assets segment currently holds approximately 31.5 percent of the outstanding Enhance common stock.\nThese increases in debt were partially offset by reductions of debt related to the investment in TWE and a refinancing of commercial paper by issuing Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely Company-guaranteed debentures (\"Preferred Securities\"). U S WEST issued $600 of Preferred Securities in 1995. The payment of interest and redemption amounts to holders of the securities are fully and unconditionally guaranteed by U S WEST.\nDuring 1995, U S WEST refinanced $2.6 billion of commercial paper to take advantage of favorable long-term interest rates. In addition to the commercial paper, U S WEST Communications refinanced $145 of long-term debt. In 1993, U S WEST Communications refinanced $2.7 billion of long-term debt. Expenses associated with the refinancing of long-term debt resulted in extraordinary after-tax charges to income of $8 and $77, net of tax benefits of $5 and $48 in 1995 and 1993, respectively.\nDebt increased $739 in 1994, primarily due to the December 1994 acquisition of the Atlanta Systems, partially offset by reductions in debt related to the investment in TWE. The cash investment related to the acquisition of the Atlanta Systems was $745, obtained through short-term borrowing.\nExcluding debt associated with the capital assets segment, the Company's percentage of debt to total capital at December 31, 1995, was 50.7 percent compared with 51.6 percent at December 31, 1994 and 55.1 percent at December 31, 1993. Including debt associated with the capital assets segment, Preferred Securities and other preferred stock, the Company's percentage of debt to total capital was 56.4 percent at\nB-20\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) December 31, 1995, 55.7 percent at December 31, 1994 and 59.7 percent at December 31, 1993. The decrease in the 1994 percentage of debt to total capital is primarily attributable to higher net income and the effects of an increase in common shares outstanding.\nU S WEST maintains a commercial paper program to finance short-term cash flow requirements as well as to maintain a presence in the short-term debt market. In addition, U S WEST maintains lines of credit aggregating approximately $1.9 billion, all of which was available at December 31, 1995. Under registration statements filed with the SEC, as of December 31, 1995, U S WEST is permitted to issue up to approximately $1.5 billion of new debt securities.\nDebt related to discontinued operations decreased $487 in 1995 and $213 in 1994. Cash to the capital assets segment of $101 in 1994 primarily reflects the payment of debt, net of $154 in proceeds from the sale of 8.1 million shares of Financial Security Assurance Holdings, Ltd. (\"FSA\"), an investment of the capital assets segment. For financial reporting purposes debt of the capital assets segment is netted against the related assets. See Consolidated Financial Statements -- Note 20: Net Investment in Assets Held for Sale.\nIn connection with U S WEST's February 27, 1996 announcement of a planned merger with Continental, U S WEST, Inc.'s credit rating is being reviewed by credit rating agencies, which may result in a downgrading. The credit rating of U S WEST Communications was not placed under review by Moody's, has been reaffirmed by Duff and Phelps, and is under review by Fitch and Standard & Poors.\nSubsequent to the acquisition of the Atlanta Systems (See Note 4 to the Consolidated Financial Statements) the Company announced its intention to purchase U S WEST common shares in the open market up to an amount equal to those issued in conjunction with the acquisition, subject to market conditions. In first-quarter 1995, the Company purchased 1,704,700 shares of U S WEST common stock at an average price per share of $37.02. In December 1994, the Company purchased 550,400 shares of U S WEST common stock at an average price per share of $36.30.\nRISK MANAGEMENT\nThe Company is exposed to market risks arising from changes in interest rates and foreign exchange rates. Derivative financial instruments are used to manage these risks. U S WEST does not use derivative financial instruments for trading purposes.\nINTEREST RATE RISK MANAGEMENT\nThe objective of the interest rate risk management program is to minimize the total cost of debt. Interest rate swaps are used to adjust the ratio of fixed- to variable-rate debt. The market value of the debt portfolio, including the interest rate swaps, is monitored and compared with predetermined benchmarks to evaluate the effectiveness of the risk management program.\nNotional amounts of interest rate swaps outstanding were $1.6 billion at December 31, 1995 and 1994, with various maturities extending to 2004. The estimated effect of interest rate derivative transactions was to adjust the level of fixed-rate debt from 88 percent to 94 percent of the total debt portfolio at December 31, 1995, and from 73 percent to 82 percent of the total debt portfolio at December 31, 1994 (including debt associated with the capital assets segment).\nIn conjunction with the 1993 debt refinancing, the Company executed forward contracts to sell U.S. Treasury bonds to lock in the U. S. Treasury rate component of $1.5 billion of the future debt issue. At December 31, 1995, deferred credits of $8 and deferred charges of $51 on closed forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the new debt.\nB-21\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nFOREIGN EXCHANGE RISK MANAGEMENT\nU S WEST has entered into forward and option contracts to manage the market risks associated with fluctuations in foreign exchange rates after consideration of offsetting foreign exposures among international operations. The use of forward and option contracts allow U S WEST to fix or cap the cost of firm foreign investment commitments in countries with freely convertible currencies. The market values of the foreign exchange positions, including the hedging instruments, are continuously monitored and compared with predetermined levels of acceptable risk.\nNotional amounts of foreign exchange forward and option contracts outstanding were $456 and $170 as of December 31, 1995 and 1994, respectively, with maturities of one year or less. These contracts were primarily for the purchase of Dutch guilders and British pounds in 1995 and British pounds in 1994.\nThe Company had foreign exchange risks associated with a Dutch guilder-denominated payable in the translated principal amount of $216 at December 31, 1995, and British pound-denominated receivables in the translated principal amounts of $139 and $48 at December 31, 1995 and 1994, respectively, of which $63 and $48 of these respective balances are with a wholly owned subsidiary. These positions were hedged in 1995.\nDISPOSITION OF THE CAPITAL ASSETS SEGMENT\nU S WEST announced a plan of disposition of the capital assets segment in June 1993. See the Consolidated Financial Statements -- Note 20: Net Investment in Assets Held for Sale. In December 1993, U S WEST sold $2.0 billion of finance receivables and the business of U S WEST Financial Services, Inc. to NationsBank Corporation. Proceeds from the sale of $2.1 billion were used to repay related debt.\nDuring 1994, U S WEST reduced its ownership interest in FSA, a member of the capital assets segment, to 60.9 percent and its voting interest to 49.8 percent through a series of transactions. In May and June 1994, U S WEST sold 8.1 million shares of FSA common stock and received $154 in net proceeds from the public offering. In December 1995, FSA merged with Capital Guaranty Corporation for shares of FSA and cash of $51. The transaction was valued at approximately $203 and reduced U S WEST's ownership interest in FSA to 50.3 percent and its voting interest to 41.7 percent. U S WEST expects to monetize and ultimately reduce its ownership in FSA through the issuance of Debt Exchangeable for Common Stock (\"DECS\") in 1996. At maturity, each DECS will be mandatorily exchanged by U S WEST for FSA common stock held by U S WEST or, at U S WEST's option, redeemed at the cash equivalent.\nOn September 2, 1994, U S WEST issued to Fund American Enterprises Holdings Inc. (\"FFC\") 50,000 shares of cumulative redeemable preferred stock for a total of $50. The shares are mandatorily redeemable in year ten and, at the option of FFC, the preferred stock also can be redeemed for common shares of FSA.\nU S WEST Real Estate, Inc. has sold various properties totaling $120, $327 and $66 in 1995, 1994 and 1993, respectively. The sales proceeds were in line with estimates. Proceeds from building sales were primarily used to repay related debt. U S WEST has completed construction of existing buildings in the commercial real estate portfolio and expects to substantially complete liquidation of this portfolio by 1998. The remaining balance of assets subject to sale is approximately $490, net of reserves, as of December 31, 1995.\nCOMPETITIVE AND REGULATORY ENVIRONMENT\nTHE TELECOMMUNICATIONS ACT OF 1996\nOn February 1, 1996, the House and Senate approved the Telecommunications Act of 1996 (the \"1996 Act\") which is intended to promote competition between local telephone companies, long-distance carriers and cable television operators. The 1996 Act was signed into law on February 8, 1996, and replaces the antitrust consent decree that broke up the \"Bell System\" in 1984. A major provision of the legislation includes the preemption of state regulations that govern competition by allowing local telephone companies,\nB-22\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) long-distance carriers and cable television companies to enter each other's lines of business. Consequently, the Regional Bell Operating Companies (\"RBOCs\") are immediately permitted to offer wireline interLATA toll services out of their regions. However, to participate in the interLATA long-distance market within their regions, the RBOCs must first open their local networks to facilities-based competition by satisfying a detailed checklist of requirements, including requirements related to interconnection and number portability.\nOther key provisions of the 1996 Act: (1) eliminate most of the regulation of cable television rates within three years and eliminate the ban on cross-ownership between cable television and telephone companies in small communities; (2) permit the RBOCs to develop new, competitive cable systems within their regions and to acquire or build wireless cable systems; (3) provide partial relief from the ban against manufacturing telecommunications equipment by the RBOCs; and (4) permit wireless operators to provide interLATA toll service in and out of region without a separate subsidiary and to jointly market or resell cellular service.\nThe FCC and state regulators have been given latitude in interpreting and overseeing the implementation of this legislation, including developing universal service funding policy. The extent and timing of future competition, including the Communications Group's ability to offer in-region interLATA long-distance services, will depend in part on the implementation guidelines determined by the FCC and state regulators, and how quickly the Communications Group can satisfy requirements of the checklist. The Communications Group estimates that fulfillment of the checklist requirements could occur in the majority of its states within 12 to 18 months.\nTHE COMMUNICATIONS GROUP\nMarkets served by the Communications Group, including markets for local, access and long-distance services, are being impacted by the rapid technological and regulatory changes occurring within the telecommunications industry. Current and potential competitors include local telephone companies, interexchange carriers, competitive access providers (\"CAPs\"), cable television companies and providers of personal communications services (\"PCS\").\nThe Communications Group believes that competitors will initially target high-volume business customers in densely populated urban areas. The resulting loss of local service customers will affect multiple revenue streams and could have a material, adverse effect on the Communications Group's operations. The resulting revenue losses, however, could be at least partially offset by the Communications Group's ability to bundle local, long-distance and wireless services, and provide interconnection services.\nThe Communications Group's strategy is to offer integrated communications, entertainment, information and transaction services over both wired and wireless networks to its customers primarily within its Region. The key initiatives to support this strategy include five key elements:\n- Providing superior customer service\n- Building customer loyalty\n- Enhancing network capability and capacity\n- Expanding the product and service portfolio\n- Ensuring a fair competitive environment\nStrategic initiatives to attract and retain customers include: (1) enhancing existing services with products such as caller identification, call waiting and voice messaging; (2) aggressive expansion of data services; (3) pursuing opportunities to offer paging, wireless and cable television services; and (4) rapid entry into the interLATA long-distance market.\nB-23\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nA market trial for a broadband network capable of providing voice, data and video services to customers commenced in the Omaha area in August 1995. The Communications Group does not intend to expand this service offering beyond the Omaha area because of service cost and pricing issues. The Communications Group does plan to continue to provide the system that delivers basic, premium and pay-per-view video services in the Omaha area. The Communications Group is evaluating the relative costs of alternative video technologies, as well as the near-term feasibility of interactive services. To satisfy anticipated demand for combined video and telephony services on a cost-effective basis, the Communications Group's strategy may include selective investments in wireless cable technologies.\nThe Communications Group is subject to varying degrees of federal and state regulation. The Communications Group's regulatory strategy includes working to:\n- Achieve accelerated capital recovery;\n- Reprice local services to cover costs and ensure these services are subsidy free, while lowering toll and access rates to meet competition; and\n- Ensure that the new rules associated with the Telecommunications Act of 1996 concerning the unbundling of interconnection, resale of services and universal service do not advantage one competitor over another.\nThe Communications Group is currently working with state regulators to gain approval of these initiatives.\nTHE MEDIA GROUP\nThe Media Group's strategy is based on the belief that communication and commerce are migrating from other mediums to electronic networks. Over time, this global phenomenon will result in networks replacing traditional distribution channels. To meet the needs of this growing market, the Media Group provides local connections and then integrates market-based service offerings to meet the needs of end users. The Media Group executes this strategy through three lines of business -- cable and telecommunications, wireless and directory and information services -- in selected high-growth markets worldwide.\nCABLE AND TELECOMMUNICATIONS The 1996 Act will enable the Media Group to provide \"one-stop shopping\" for voice, video and data services, a key objective of the Media Group. The Media Group is currently in the process of negotiating reasonable and nondiscriminatory local interconnection rates, terms and conditions with BellSouth and is planning on entering the local exchange market, through the Atlanta Systems, on a competitive basis by the end of 1996.\nThe Atlanta Systems generally compete for viewer attention with programming from a variety of sources, including the direct reception of broadcast television signals by the viewer's own antenna, satellite master antenna service and direct broadcast satellite services. Cable television systems are also in competition for both viewers and advertising in varying degrees with other communications and entertainment media. Such competition may increase with the development and growth of new technologies.\nThe 1996 Act has amended certain aspects of the Cable Television Consumer Protection and Competition Act of 1992 (\"the 1992 Cable Act\"). Under the 1996 Act, cable rates are deregulated effective March 31, 1999, or earlier if competition exists. In addition, the provisions of the 1996 Act simplify the process of filing rate complaints, relax uniform rate requirements and subscriber notice provisions, expand the definition of effective competition and eliminate certain restrictions on the sale of cable systems. Current program access restrictions applying to cable operators are extended to common carriers by the 1996 Act. The 1996 Act also eliminates certain cross-ownership restrictions between cable operators, broadcasters and multichannel, multipoint distribution system operators.\nB-24\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCable television systems are also subject to local regulation, typically imposed through the franchising process. Local officials may be involved in the initial franchise selection, system design and construction, safety, rate regulation, customer service standards, billing practices, community-related programming and services, franchise renewal and imposition of franchise fees.\nIn 1995, the Georgia legislature removed the legal prohibition on local telephone competition by authorizing competition in local telephone exchange service. The Media Group has received certification from the Georgia Public Service Commission to provide local switched and nonswitched telephone service in Georgia and, with the passage of the 1996 Act, certain long-distance services.\nWIRELESS COMMUNICATIONS There are two competitive cellular licenses in each market. Competition is based on the price of cellular service, the quality of the service and the size of the geographic area served. The development of PCS services will increase the number of competitors and the level of competition. The Media Group is unable to estimate the impact of the availability of PCS services on its cellular operations, though it could be significant.\nThe wireless operations are subject to regulation by federal and some state and local authorities. The construction and transfer of cellular systems in the United States are regulated by the FCC pursuant to the Communications Act of 1934. The FCC regulates construction and operation of cellular systems and licensing and technical standards for the provision of cellular telephone service. Pursuant to Congress' 1993 Omnibus Budget Reconciliation Act, the FCC adopted rules preempting state and local governments from regulating wireless entry and most rates.\nThe passage of the 1996 Act eliminates long-distance restrictions imposed by the Modified Final Judgment (\"MFJ\"). As a result, the Media Group, including its wireless partners, are now able to offer integrated local and long-distance services to its wireless customers. The 1996 Act also permits the Media Group to enter into activities related to the manufacture of telecommunications equipment.\nDIRECTORY AND INFORMATION SERVICES The Media Group may face emerging competition in the provision of interactive services from cable and entertainment companies, on-line services and other information providers. Directory listings are beginning to be offered via electronic databases through telephone company and third party networks. As such offerings expand and are enhanced through interactivity and other features, the Media Group may experience heightened competition in its directory publishing businesses. With the passage of the 1996 Act, the Media Group will be able to provide certain information services across LATA boundaries. The Media Group will continue to expand its core products and develop and package new information products to meet its customers' needs.\nOTHER ISSUES\nThe Communications Group's interstate services have been subject to price cap regulation since January 1991. Price caps are an alternative form of regulation designed to limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels. In March 1995, the FCC issued an interim order on price cap regulation. The price cap index for most services is annually adjusted for inflation, productivity level and exogenous costs, and has resulted in reduced access prices paid by interexchange carriers to local telephone companies. The interim order also provides for three productivity options, including a no-sharing option, and for increased flexibility for adjusting prices downward in response to competition. In 1995, the Communications Group selected the lowest productivity option, while prior to this interim order, the Communications Group used an optional higher productivity factor in determining its prices. Consequently, the Communications Group expects the order to have no significant near-term impact.\nThere are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing two exceptions to the\nB-25\nU S WEST, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. This action is still in the discovery process. If a formal filing -- made in accordance with the remand from the Supreme Court -- alleges that the exceptions apply, the range of possible risk is $0 to $150.\nOn September 22, 1995, U S WEST filed a lawsuit in Delaware Chancery Court to enjoin the proposed merger of Time Warner and Turner Broadcasting. U S WEST has alleged breaches of contract and fiduciary duties by Time Warner in connection with this proposed merger. Time Warner filed a countersuit against U S WEST on October 11, 1995, alleging misrepresentation, breach of contract and other misconduct on the part of U S WEST. Time Warner's countersuit seeks a reformation of the Time Warner Entertainment partnership agreement, an order that enjoins U S WEST from breaching the partnership agreement, and unspecified compensatory damages. U S WEST has denied each of the claims in Time Warner's countersuit. The trial for this action concluded on March 22, 1996. A ruling by the Delaware Chancery Court is expected in June 1996.\nOn October 2, 1995, union members approved a new three-year contract with U S WEST. The contract provides for salary increases of 10.6 percent over three years effective January 1 of each year. The contract also provides employees with a lump sum payment of $1,500 in lieu of wage increases becoming effective in August of each year. This lump sum payment is being recognized over the life of the contract. The agreement covers approximately 30,000 Communications Workers of America (\"CWA\") members who work for the Communications Group.\nOn October 15, 1995, U S WEST Direct and the CWA reached a tentative agreement on their contract, subject to ratification by the CWA membership. This contract would provide for salary increases of 10.5 percent over three years and provides employees with a lump sum payment of $850.\nB-26\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowners of U S WEST, Inc.:\nWe have audited the Consolidated Balance Sheets of U S WEST, Inc. 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. These financial 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 U S WEST, 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.\nAs discussed in Note 8 to the Consolidated Financial Statements, the Company discontinued accounting for the operations of U S WEST Communications, Inc. in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1993.\nCOOPERS & LYBRAND L.L.P.\nDenver, Colorado February 12, 1996, except for Note 4, paragraph 3, as to which the date is February 27, 1996\nB-27\nREPORT OF MANAGEMENT\nThe Consolidated Financial Statements of U S WEST have been prepared in conformity with generally accepted accounting principles applied on a consistent basis. The integrity and objectivity of information in these financial statements, including estimates and judgments, are the responsibility of management, as is all other financial information included in this report.\nU S WEST maintains a system of internal accounting controls designed to provide a reasonable assurance as to the integrity and reliability of financial statements, the safeguarding of assets and the prevention and detection of material errors or fraudulent financial reporting. Monitoring of such systems includes an internal audit program designed to assess objectively the effectiveness of internal controls and recommend improvements therein.\nLimitations exist in any system of internal accounting controls based on the recognition that the cost of the system should not exceed the benefits derived. U S WEST believes that the Company's system provides reasonable assurance that transactions are executed in accordance with management's general or specific authorizations and is adequate to accomplish the stated objectives.\nThe independent certified public accountants, whose report is included herein, are engaged to express an opinion on our Consolidated Financial Statements. Their opinion is based on procedures performed in accordance with generally accepted auditing standards, including examining, on a test basis, evidence supporting the amounts and disclosures in the Consolidated Financial Statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.\nIn an attempt to assure objectivity, the financial information contained in this report is subject to review by the Audit Committee of the board of directors. The Audit Committee is composed of outside directors who meet regularly with management, internal auditors and independent auditors to review financial reporting matters, the scope of audit activities and the resolution of audit findings.\nRichard D. McCormick CHAIRMAN AND CHIEF EXECUTIVE OFFICER\nJames T. Anderson ACTING EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nFebruary 12, 1996\nB-28\nU S WEST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\nB-29\nU S WEST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nB-30\nU S WEST, INC. CONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nB-31\nU S WEST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nB-32\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nNOTE 1: RECAPITALIZATION PLAN On October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\"), voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors of U S WEST, Inc. (the \"Board\") to reincorporate in Delaware and create two classes of common stock that are intended to reflect separately the performance of the communications and multimedia businesses. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\"), and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\"). Effective November 1, 1995, each share of common stock of U S WEST Colorado was converted into one share each of Communications Stock and Media Stock.\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nThe Communications Group is comprised of U S WEST Communications, Inc. (\"U S WEST Communications\"), U S WEST Communications Services, Inc., U S WEST Federal Services, Inc., U S WEST Advanced Technologies, Inc. and U S WEST Business Resources, Inc. The Communications Group primarily provides regulated communications services to more than 25 million residential and business customers within a 14 state region.\nThe Media Group is comprised of U S WEST Marketing Resources Group, Inc., which publishes White and Yellow Pages telephone directories, and provides directory and information services, U S WEST NewVector Group, Inc., which provides communications and information products and services over wireless networks, U S WEST Multimedia Communications, Inc., which owns domestic cable television operations and investments, and U S WEST International Holdings, Inc., which primarily owns investments in international cable and telecommunications, wireless communications and directory publishing operations.\nDividends to be paid on Communications Stock are initially $0.535 per share per quarter. Dividends on the Communications Stock will be paid at the discretion of the Board, based primarily on the financial condition, results of operations and business requirements of the Communications Group and the Company as a whole. With regard to the Media Stock, the Board currently intends to retain future earnings, if any, for the development of the Media Group's businesses and does not anticipate paying dividends on the Media Stock in the foreseeable future.\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION The Consolidated Financial Statements include the accounts of U S WEST and its majority-owned subsidiaries, except for the capital assets segment, which is held for sale. All significant intercompany amounts and transactions have been eliminated. Investments in less than majority-owned ventures are accounted for using the equity method.\nCertain reclassifications within the Consolidated Financial Statements have been made to conform to the current year presentation.\nB-33\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In third-quarter 1993, U S WEST discontinued accounting for its regulated telephone operations, U S WEST Communications, under Statement of Financial Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" (See Note 8 to the Consolidated Financial Statements.)\nINDUSTRY SEGMENTS U S WEST consists of two Groups -- the Communications Group and the Media Group. The Communications Group operates in one industry segment (communications and related services) and the Media Group operates in four industry segments (directory and information services, wireless communications, cable and telecommunications, and the capital assets segment, which is held for sale) as defined in SFAS No. 14, \"Financial Reporting for Segments of a Business Enterprise.\"\nPrior to January 1, 1995, the capital assets segment was accounted for as discontinued operations. Effective January 1, 1995, the capital assets segment has been accounted for as a net investment in assets held for sale, as discussed in Note 20 to the Consolidated 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 the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCASH AND CASH EQUIVALENTS Cash and cash equivalents include highly liquid investments with original maturities of three months or less that are readily convertible into cash and are not subject to significant risk from fluctuations in interest rates.\nINVENTORIES AND SUPPLIES New and reusable materials of U S WEST Communications are carried at average cost, except for significant individual items that are valued based on specific costs. Nonreusable material is carried at its estimated salvage value. Inventories of all other U S WEST subsidiaries are carried at the lower of cost or market on a first-in, first-out basis.\nPROPERTY, PLANT AND EQUIPMENT The investment in property, plant and equipment is carried at cost, less accumulated depreciation. Additions, replacements and substantial betterments are capitalized. Costs for normal repair and maintenance of property, plant and equipment are expensed as incurred.\nU S WEST Communications' provision for depreciation of property, plant and equipment is based on various straight-line group methods using remaining useful (economic) lives based on industry-wide studies. Prior to discontinuing SFAS No. 71, depreciation was based on lives specified by regulators. When the depreciable property, plant and equipment of U S WEST Communications is retired or sold, the original cost less the net salvage value is generally charged to accumulated depreciation.\nThe other subsidiaries of U S WEST provide for depreciation using the straight-line method. When such depreciable property, plant and equipment is retired or sold, the resulting gain or loss is included in income.\nDepreciation expense was $2,215, $2,029 and $1,941 in 1995, 1994 and 1993, respectively.\nInterest related to qualifying construction projects, including construction projects of equity method investees, is capitalized and reflected as a reduction of interest expense. At U S WEST Communications, prior to discontinuing SFAS No. 71, capitalized interest was included as an element of other income. Amounts capitalized by U S WEST were $72, $44 and $20 in 1995, 1994 and 1993, respectively.\nINTANGIBLE ASSETS Intangible assets are recorded when the cost of acquired companies exceeds the fair value of their tangible assets. The costs of identified intangible assets and goodwill are amortized by the\nB-34\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) straight-line method over periods ranging from five to forty years. These assets are evaluated, with other related assets, for impairment using a discounted cash flow methodology. Amortization expense was $76, $23 and $14 in 1995, 1994 and 1993, respectively.\nFOREIGN CURRENCY TRANSLATION Assets and liabilities of international investments are translated at year-end exchange rates, and income statement items are translated at average exchange rates for the year. Resulting translation adjustments are recorded as a separate component of equity. Gains and losses resulting from foreign currency transactions are included in income.\nREVENUE RECOGNITION Local telephone service, cellular access and cable television revenues are generally billed monthly, in advance, and revenues are recognized the following month when services are provided. Revenues derived from other telephone services, including exchange access, long-distance and cellular airtime usage, are billed and recorded monthly as services are provided.\nDirectory advertising revenues and related directory costs of selling, composition, printing and distribution are generally deferred and recognized over the period during which directories are used, normally 12 months. For international operations, directory advertising revenues and related directory costs are deferred and recognized upon publication. The balance of deferred directory costs included in prepaid and other is $247 and $234 at December 31, 1995 and 1994, respectively.\nFINANCIAL INSTRUMENTS Net interest received or paid on interest rate swaps is recognized over the life of the swaps as an adjustment to interest expense. Foreign exchange contracts designated as hedges of firm equity investment commitments are carried at market value, with gains and losses recorded in equity until sale of the investment. Forward contracts designated as hedges of foreign denominated loans are recorded at market value, with gains and losses recorded in income.\nINVESTMENTS IN DEBT SECURITIES Debt securities are classified as available for sale and are carried at fair market value with unrealized gains and losses included in equity.\nCOMPUTER SOFTWARE The cost of computer software, whether purchased or developed internally, is charged to expense with two exceptions. Initial operating systems software is capitalized and amortized over the life of the related hardware, and initial network applications software is capitalized and amortized over three years. Subsequent upgrades to capitalized software are expensed. Capitalized computer software of $190 and $146 at December 31, 1995 and 1994, respectively, is recorded in property, plant and equipment. The Company amortized capitalized computer software costs of $70, $62 and $37 in 1995, 1994 and 1993, respectively.\nINCOME TAXES The provision for income taxes consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods in accordance with SFAS No. 109. U S WEST implemented SFAS No. 109, \"Accounting for Income Taxes,\" in 1993. Adoption of the new standard did not have a material effect on the financial position or results of operations, primarily because of the Company's earlier adoption of SFAS No. 96.\nFor financial statement purposes, investment tax credits of U S WEST Communications are being amortized over the economic lives of the related property, plant and equipment in accordance with the deferred method of accounting for such credits.\nEARNINGS (LOSS) PER COMMON SHARE For 1995, earnings per common share for Communications Stock and Media Stock are presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1995. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST. For 1994 and 1993, earnings (loss) per common share are computed on the basis of the weighted average number of shares of U S WEST common stock outstanding during each year.\nB-35\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NEW ACCOUNTING STANDARDS In 1996, U S WEST will adopt 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 long-lived assets and associated intangibles be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. SFAS No. 121 also requires that a company no longer record depreciation expense on assets held for sale. U S WEST expects that the adoption of SFAS No. 121 will not have a material effect on its financial position or results of operations.\nIn 1996, U S WEST will adopt SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard establishes a fair value method for accounting for stock-based compensation plans either through recognition or disclosure. U S WEST will adopt this standard through compliance with the disclosure requirements set forth in SFAS No. 123. Adoption of the standard will have no impact on the financial position or results of operations of U S WEST.\nNOTE 3: INDUSTRY SEGMENTS Industry segment data is presented for the consolidated operations of U S WEST. The Company's equity method investments and the capital assets segment, which is held for sale, are included in \"Corporate and other.\"\nThe businesses comprising the Communications Group operate in a single industry segment -- communications and related services. The Communications Group primarily provides regulated communications services to more than 25 million residential and business customers in the Communications Group region (the \"Region\"). The Region includes the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. Services offered by the Communications Group include local telephone services, exchange access services (which connect customers to the facilities of carriers, including long-distance providers and wireless operators), and long-distance services within Local Access and Transport Areas (\"LATAs\") in the Region. The Communications Group provides other products and services, including custom calling, voice messaging, caller identification, high-speed data applications, customer premises equipment and certain communications services to business customers and governmental agencies both inside and outside the Region.\nApproximately 97 percent of the revenues of the Communications Group are attributable to the operations of U S WEST Communications, of which approximately 59 percent are derived from the states of Arizona, Colorado, Minnesota and Washington.\nThe Media Group operates in four industry segments, including the capital assets segment, which is held for sale. The directory and information services segment consists of the publishing of White and Yellow Pages telephone directories, database marketing services and interactive services in domestic and international markets. The wireless communications segment provides information products and services over wireless networks in 13 western and midwestern states. The cable and telecommunications segment was created with the December 6, 1994 acquisition of cable television systems in the Atlanta Metropolitan area. (See Note 4 to the Consolidated Financial Statements.)\nB-36\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3: INDUSTRY SEGMENTS (CONTINUED) Industry segment financial information follows:\n- ---------------------------------- (1) Includes revenue from directory publishing activities in Europe of $122, $78 and $7, and identifiable assets of $133, $124 and $4 for 1995, 1994 and 1993, respectively.\n(2) Results of operations have been included since the date of acquisition of the Atlanta Systems.\n(3) Includes U S WEST's equity method investments and the capital assets segment, which has been discontinued and is held for sale.\n(4) Includes pretax restructuring charges of $880, $50 and $70 for the communications and related services, directory and information services and wireless communications segments, respectively.\nOperating income represents sales and other revenues less operating expenses, and excludes interest expense, equity losses in unconsolidated ventures, other income (expense) and income taxes. Identifiable assets are those assets used in each segment's operations. Corporate and other assets consist primarily of cash, debt securities, investments in international ventures, the investment in Time Warner Entertainment, the net investment in assets held for sale and other assets. Corporate and other operating losses include general corporate expenses and administrative costs primarily associated with the Media Group equity investments.\nSIGNIFICANT CONCENTRATIONS The largest volume of the Communications Group's services are provided to AT&T. During 1995, 1994 and 1993, revenues related to those services provided to AT&T were $1,085, $1,130 and $1,159, respectively. Related accounts receivable at December 31, 1995 and 1994, totaled $91 and $98, respectively. As of December 31, 1995, the Communications Group is not aware of any other significant concentration of business transacted with a particular customer, supplier or lender that could, if suddenly eliminated, severely impact operations.\nTo ensure consistency and quality of service, the wireless segment uses Motorola as its primary vendor for infrastructure equipment and cellular mobile telephone equipment and accessories. In addition, Motorola provides ongoing technological support for the infrastructure equipment. The infrastructure of approximately 75 percent of the Media Group's major cellular markets is comprised of Motorola equipment.\nWIRELESS COMMUNICATIONS SEGMENT During 1994, U S WEST signed a definitive agreement with AirTouch Communications to combine their domestic cellular assets. The initial equity ownership of this cellular joint venture will be approximately 70 percent AirTouch and approximately 30 percent U S WEST.\nB-37\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3: INDUSTRY SEGMENTS (CONTINUED) The combination will take place in two phases. During Phase I, which U S WEST entered effective November 1, 1995, the two companies are operating their cellular properties separately. A Wireless Management Company (the \"WMC\") has been formed and is providing centralized services to both companies on a contract basis. In Phase II, AirTouch and U S WEST will contribute their domestic cellular assets to the WMC. In this phase, the Company will reflect its share of the combined operating results of the WMC using the equity method of accounting. The recent passage of the Telecommunications Act of 1996 has removed significant regulatory barriers to completion of Phase II of the business combination. U S WEST expects that Phase II closing could take place by the end of 1996 or early 1997.\nNOTE 4: ACQUISITION OF CABLE SYSTEMS\nATLANTA SYSTEMS On December 6, 1994, U S WEST acquired the stock of Wometco Cable Corp. and subsidiaries, and the assets of Georgia Cable Partners and Atlanta Cable Partners L.P. (the \"Atlanta Systems\"), for cash of $745 and 12,779,206 U S WEST common shares valued at $459, for a total purchase price of approximately $1.2 billion. The Atlanta Systems' results of operations have been included in the consolidated results of operations of the Company since the date of acquisition. Had the acquisition occurred as of January 1, 1994, the Company's revenue, net income and earnings per common share for 1994 would have been $11,143, $1,415 and $3.04, respectively.\nThe acquisition was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired (primarily identified intangibles) based on their estimated fair values. The identified intangibles and goodwill are being amortized on a straight-line basis over 25 years.\nCONTINENTAL CABLEVISION, INC. (SUBSEQUENT EVENT) On February 27, 1996, the Company announced a definitive agreement to merge with Continental Cablevision, Inc. (\"Continental\"). Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nNOTE 5: INVESTMENT IN TIME WARNER ENTERTAINMENT\nOn September 15, 1993, U S WEST acquired 25.51 percent pro-rata priority capital and residual equity interests (\"equity interests\") in Time Warner Entertainment Company L.P. (\"TWE\" or \"Time Warner Entertainment\") for an aggregate purchase price of $2.553 billion. TWE owns and operates substantially all of the entertainment assets previously owned by Time Warner Inc. (\"Time Warner\"), consisting primarily of its filmed entertainment, programming-HBO and cable businesses.\nUpon U S WEST's admission to the partnership, certain wholly owned subsidiaries of Time Warner (\"General Partners\") and subsidiaries of Toshiba Corporation and ITOCHU Corporation held pro-rata priority capital and residual equity interests of 63.27, 5.61 and 5.61 percent, respectively. In 1995, Time Warner acquired the limited partnership interests previously held by subsidiaries of each of ITOCHU Corporation and Toshiba Corporation.\nU S WEST has an option to increase its pro-rata priority capital and residual equity interests in TWE from 25.51 percent up to 31.84 percent depending upon cable operating performance. The option is\nB-38\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) exercisable, in whole or part, between January 1, 1999, and May 31, 2005, for an aggregate cash exercise price ranging from $1.25 billion to $1.8 billion, depending upon the year of exercise. Either TWE or U S WEST may elect that the exercise price for the option be paid with partnership interests rather than cash.\nPursuant to the TWE Partnership Agreement, there are four levels of capital. From the most to least senior, the capital accounts are: senior preferred (held by the General Partners); pro-rata priority capital (A preferred -- held pro rata by the general and limited partners); junior priority capital (B preferred - -- held by the General Partners); and common (residual equity interests held pro rata by the general and limited partners). Of the $2.553 billion contributed by U S WEST, $1.658 billion represents A preferred capital and $895 represents common capital. The TWE Partnership Agreement provides for special allocations of income and distributions of partnership capital. Partnership income, to the extent earned, is allocated as follows: (1) to the partners so that the economic burden of the income tax consequences of partnership operations is borne as though the partnership was taxed as a corporation (\"special tax allocations\"); (2) to the partners' preferred capital accounts in order of priority described above, at various rates of return ranging from 8 percent to 13.25 percent; and (3) to the partners' common capital according to their residual partnership interests. To the extent partnership income is insufficient to satisfy all special allocations in a particular accounting period, the unearned portion is carried over until satisfied out of future partnership income. Partnership losses generally are allocated in reverse order, first to eliminate prior allocations of partnership income, except senior preferred and special tax income, next to reduce initial capital amounts, other than senior preferred, then to reduce the senior preferred account and finally, to eliminate special tax allocations.\nA summary of the contributed capital and priority capital rates of return follows:\n- ---------------------------------- (a) Estimated fair value of net assets contributed excluding partnership income or loss allocated thereto.\n(b) Income allocations related to priority capital rates of return are based on partnership income after any special tax allocations.\n(c) The senior preferred is scheduled to be distributed in three annual installments beginning July 1, 1997.\n(d) 11.00 percent to the extent concurrently distributed.\n(e) Includes $300 for the September 1995 reacquisition of assets previously excluded from the partnership (the Time Warner service partnership assets) for regulatory reasons.\n(f) 11.25 percent to the extent concurrently distributed.\nCash distributions are required to be made to the partners to permit them to pay income taxes at statutory rates based on their allocable taxable income from TWE (\"Tax Distributions\"). The aggregate amount of such Tax Distributions is computed generally by reference to the taxes that TWE would have been required to pay if it were a corporation. Tax Distributions were previously subject to restrictions until July 1995, and are now paid to the partners on a current basis. For distributions other than those related to taxes or the senior preferred, the TWE Partnership Agreement requires certain cash distribution thresholds be met to the limited partners before the General Partners receive their full share of distributions. No cash distributions have been made to U S WEST.\nB-39\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) U S WEST accounts for its investment in TWE under the equity method of accounting. The excess of fair market value over the book value of total partnership net assets implied by U S WEST's initial investment was $5.7 billion. This excess is being amortized on a straight-line basis over 25 years. The Company's recorded share of TWE operating results represents allocated TWE net income or loss adjusted for the amortization of the excess of fair market value over the book value of the partnership net assets. As a result of this amortization and the special income allocations described above, the Company's recorded pretax share of TWE operating results before extraordinary item was $(31), $(18) and $(20) in 1995, 1994 and 1993, respectively. In addition, TWE recorded an extraordinary loss for the early extinguishment of debt in 1995. The Company's share of this extraordinary loss was $4, net of an income tax benefit of $2.\nAs consideration for its expertise and participation in the cable operations of TWE, the Company earns a management fee of $130 over five years, which is payable over a four-year period beginning in 1995. Management fees of $26, $26 and $8 were recorded to other income in 1995, 1994 and 1993, respectively. Included in the U S WEST Consolidated Balance Sheet is a note payable to TWE of $169 and $771 and management fee receivables of $50 and $34 at December 31, 1995 and 1994, respectively.\nSummarized financial information for TWE is presented below:\n- ---------------------------------- (1) Includes depreciation and amortization of $1,039, $943 and $902 in 1995, 1994 and 1993, respectively.\n(2) Includes corporate services of $64, $60 and $60 in 1995, 1994 and 1993, respectively.\n- ---------------------------------- (3) Includes cash of $209 and $1,071 at December 31, 1995 and 1994, respectively.\n(4) Includes a loan receivable from Time Warner of $400 at December 31, 1995 and 1994.\n(5) Net of a note receivable from U S WEST of $169 and $771 at December 31, 1995 and 1994, respectively.\n(6) Contributed capital is based on the estimated fair value of the net assets that each partner contributed to the partnership. The aggregate of such amounts is significantly higher than TWE's partner's capital as reflected in the Summarized Financial Position, which is based on the historical cost of the contributed net assets.\nB-40\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) In early 1995, Time Warner announced its intention to simplify its corporate structure by establishing an enterprise that will be responsible for the overall management and financing of the cable and telecommunications properties. Any change in the structure of TWE would require U S WEST's approval in addition to certain creditors' and regulatory approvals. (See Note 19 to the Consolidated Financial Statements for disclosure related to litigation with Time Warner.)\nNOTE 6: RESTRUCTURING CHARGE The Company's 1993 results reflect a $1 billion restructuring charge (pretax). The related restructuring plan (the \"Restructuring Plan\") is designed to provide faster, more responsive customer services, while reducing the costs of providing these services. As part of the Restructuring Plan, the Company is developing new systems and enhanced system functionality that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, rapidly design and engineer new services for customers and centralize its service centers. The Company has consolidated its 560 customer service centers into 26 centers in 10 cities and reducing its total work force by approximately 10,000 employees. This increased the number of employee separations to 10,000 from 9,000, and increased the estimated total cost for employee separations to $316, compared with $286 in the original estimate. Approximately 1,000 employees that were originally expected to relocate have chosen separation or other job assignments and have been replaced. The $30 cost associated with these additional employee separations was reclassified from relocation to the reserve for employee separations during 1995.\nFollowing is a schedule of the costs included in the 1993 restructuring charge:\n- ---------------------------------- (1)Employee-separation costs, including the balance of a 1991 restructuring reserve at December 31, 1993, aggregate $316.\nEmployee separation costs include severance payments, health-care coverage and postemployment education benefits. System development costs include new systems and the application of enhanced system functionality to existing single-purpose systems to provide integrated end-to-end customer service. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the new service centers and retraining employees on the methods and systems required in the new, restructured mode of operation.\nB-41\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6: RESTRUCTURING CHARGE (CONTINUED) The following table shows amounts charged to the restructuring reserve:\n- ---------------------------------- (1) Includes $56 associated with work-force reductions under a 1991 restructuring plan.\nEmployee separations under the Restructuring Plan in 1995 and 1994 were as follows:\nThe Restructuring Plan is expected to be substantially completed by the end of 1997. Implementation of the Restructuring Plan has been impacted by growth in the business and related service issues, new business opportunities, revisions to system delivery schedules and productivity issues caused by the major rearrangement of resources due to restructuring. These issues will continue to affect the timing of employee separations.\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES The significant investments in international ventures follows:\n- ---------------------------------- (C&T) Cable and Telecommunications\n(W)Wireless\nB-42\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES (CONTINUED) The following table shows summarized combined financial information for the Company's significant equity method investments in international ventures:\nIn November 1994, TeleWest plc (\"TeleWest\") made an initial public offering of its ordinary shares. Following the offering, in which U S WEST sold part of its 50 percent joint venture interest, U S WEST owned approximately 37.8 percent of TeleWest. Net proceeds of approximately $650 were used by TeleWest to finance construction and operating costs, invest in affiliated companies and repay debt. It is U S WEST's policy to recognize as income any gains or losses related to the sale of stock to the public. The Company recognized a gain of $105 in 1994, net of $59 in deferred taxes, for the partial sale of its joint venture interest in TeleWest.\nOn October 2, 1995, TeleWest and SBC CableComms (UK) completed a merger of their UK cable television and telecommunications interests, creating the largest provider of combined cable and telecommunications services in the United Kingdom. Following completion of the merger, U S WEST and Tele-Communications, Inc., the major shareholders, each own 26.8 percent of the combined company. The Company recognized a gain of $95 in 1995, net of $62 in deferred income taxes, in conjunction with the merger.\nTeleWest, which is the only equity method investment for which a quoted market price is available, had a market value of $914 at December 31, 1995, and $1,004 at December 31, 1994.\nFOREIGN CURRENCY TRANSACTIONS U S WEST enters into forward and zero-cost combination option contracts to manage foreign currency risk. Under a forward contract, U S WEST agrees with another party to exchange a foreign currency and U.S. dollars at a specified price at a future date. Under combination\nB-43\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES (CONTINUED) options, U S WEST combines purchased options to cap the foreign exchange rate to be paid at a future date with written options to finance the premium of the purchased options. The commitments, forward contracts and combination options are for periods up to one year.\nForward exchange contracts are carried at market value. Gains or losses on the portion of the contracts designated as hedges of firm equity investment commitments are deferred as a component of equity and are recognized in income upon sale of the investment. Gains or losses on the portion of the contracts designated to offset translation of investee net income are recorded in income.\nForward contracts are also used to hedge foreign denominated loans. These contracts are carried at market value with gains or losses recorded in income.\nForeign exchange contracts outstanding follow:\nCumulative deferred gains on foreign exchange contracts of $9 and deferred losses of $25, including deferred taxes (benefits) of $4 and ($10), respectively, are included in equity at December 31, 1995. Cumulative deferred gains on foreign exchange contracts of $7 and deferred losses of $25, including deferred taxes (benefits) of $3 and ($10), respectively, are included in equity at December 31, 1994.\nThe counterparties to these contracts are major financial institutions. U S WEST is exposed to credit loss in the event of nonperformance by these counterparties. The Company does not have significant exposure to an individual counterparty and does not anticipate nonperformance by any counterparty.\nNOTE 8: PROPERTY, PLANT AND EQUIPMENT The composition of property, plant and equipment follows:\nB-44\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8: PROPERTY, PLANT AND EQUIPMENT (CONTINUED) In 1995, U S WEST Communications sold certain rural telephone exchanges with a cost basis of $258. U S WEST Communications received consideration for the sales of $388, including $214 in cash. In 1994, U S WEST Communications sold certain rural telephone exchanges with a cost basis of $122 and received consideration of $204, including $93 in cash.\nThe Media Group businesses depreciate buildings between 15 to 35 years, cellular and cable distribution systems between 5 to 15 years, and general purpose computers and other between 3 to 20 years. See \"Discontinuance of SFAS No. 71\" for depreciation rates used by the Communications Group.\nDISCONTINUANCE OF SFAS NO. 71\nU S WEST Communications incurred a noncash, extraordinary charge of $3.1 billion, net of an income tax benefit of $2.3 billion, in conjunction with its decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" as of September 30, 1993. SFAS No. 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, notwithstanding competition, by charging its customers at prices established by its regulators. U S WEST Communications' decision to discontinue application of SFAS No. 71 was based on the belief that competition, market conditions and technological advances, more than prices established by regulators, will determine the future cost recovery by U S WEST Communications. As a result of this change, the remaining asset lives of U S WEST Communications' plant were shortened to more closely reflect the useful (economic) lives of such plant.\nFollowing is a list of the major categories of telephone property, plant and equipment and the manner in which depreciable lives were affected by the discontinuance of SFAS No. 71:\nU S WEST Communications employed two methods to determine the amount of the extraordinary charge. The \"economic life\" method assumed that a portion of the plant-related effect is a regulatory asset that was created by the under-depreciation of plant under regulation. This method yielded the plant-related adjustment that was confirmed by the second method, a discounted cash flows analysis.\nFollowing is a schedule of the nature and amounts of the after-tax charge recognized as a result of U S WEST Communications' discontinuance of SFAS No. 71:\nB-45\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9: INTANGIBLE ASSETS\nThe composition of intangible assets follows:\nNOTE 10: DEBT\nSHORT-TERM DEBT\nThe components of short-term debt follow:\nThe weighted average interest rate on commercial paper was 5.79 percent and 5.97 percent at December 31, 1995 and 1994, respectively.\nThe bank loan, in the translated principal amount of $216, is denominated in Dutch guilders. The loan was entered into in connection with U S WEST's investment in a cable television venture in the Netherlands and was repaid in February 1996.\nU S WEST maintains a commercial paper program to finance short-term cash flow requirements, as well as to maintain a presence in the short-term debt market. U S WEST is permitted to borrow up to approximately $1.9 billion under lines of credit, all of which was available at December 31, 1995.\nB-46\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10: DEBT (CONTINUED) LONG-TERM DEBT\nInterest rates and maturities of long-term debt at December 31 follow:\nLong-term debt consists principally of debentures, medium-term notes, debt associated with the Company's Leveraged Employee Stock Ownership Plans (\"LESOP\"), and zero coupon subordinated notes convertible at any time into equal shares of Communications Stock and Media Stock. The zero coupon notes have a yield to maturity of approximately 7.3 percent. The zero coupon notes are recorded at a discounted value of $521 and $498 at December 31, 1995 and 1994, respectively.\nIn 1995, U S WEST issued $130 of Debt Exchangeable for Common Stock (\"DECS\"), due December 15, 1998, in the principal amount of $24.00 per note. The notes bear interest at 7.625 percent, of which 1.775 percent has been included in the assets held for sale reserve. Upon maturity, each DECS will be mandatorily redeemed by U S WEST for shares of Enhance Financial Services Group, Inc. (\"Enhance\") held by U S WEST or the cash equivalent, at U S WEST's option. The number of shares to be delivered at maturity varies based on the per share market price of Enhance. If the market price is $24.00 per share or less, one share of Enhance will be delivered for each note; if the market price is between $24.00 and $28.32 per share, a fractional share equal to $24.00 is delivered; if the market value is greater than $28.32 per share, .8475 shares are delivered. The capital assets segment currently owns approximately 31.5 percent of the outstanding Enhance common stock.\nDuring 1995, U S WEST refinanced $2.6 billion of commercial paper to take advantage of favorable long-term interest rates. In addition to the commercial paper, U S WEST refinanced $145 of long-term debt. Expenses associated with the refinancing of long-term debt resulted in extraordinary charges to income of $8, net of an income tax benefit of $5.\nDuring 1993, U S WEST refinanced long-term debt issues aggregating $2.7 billion in principal amount. Expenses associated with the refinancing resulted in an extraordinary charge to income of $77, net of a tax benefit of $48.\nAt December 31, 1995, U S WEST guaranteed debt in the principal amount of approximately $140, primarily related to international ventures.\nB-47\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10: DEBT (CONTINUED) Interest payments, net of amounts capitalized, were $518, $523 and $670 in 1995, 1994 and 1993, respectively, of which $87, $134 and $272, respectively, relate to the capital assets segment.\nINTEREST RATE RISK MANAGEMENT\nInterest rate swap agreements are primarily used to effectively convert existing commercial paper to fixed-rate debt. This allows U S WEST to achieve interest savings over issuing fixed-rate debt directly.\nUnder an interest rate swap, U S WEST agrees with another party to exchange interest payments at specified intervals over a defined term. Interest payments are calculated by reference to the notional amount based on the fixed- and variable-rate terms of the swap agreements. The net interest received or paid as part of the interest rate swap is accounted for as an adjustment to interest expense.\nDuring 1995 and 1994, U S WEST Communications entered into currency swaps to convert Swiss franc-denominated debt to dollar-denominated debt. This allowed U S WEST Communications to achieve interest savings over issuing fixed-rate, dollar-denominated debt. The currency swap and foreign currency debt are combined and accounted for as if fixed-rate, dollar-denominated debt were issued directly.\nThe following table summarizes terms of swaps. Variable rates are indexed to two- and ten-year constant maturity Treasury and 30-day commercial paper rates.\nIn 1993, U S WEST Communications executed forward contracts to sell U.S. Treasury bonds to lock in the U.S. Treasury rate component of the future debt issue. At December 31, 1995, deferred credits of $8 and deferred charges of $51 on closed forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the debt issuance. At December 31, 1995, there were no open forward contracts.\nThe counterparties to these interest rate contracts are major financial institutions. U S WEST is exposed to credit loss in the event of nonperformance by these counterparties. U S WEST manages this exposure by monitoring the credit standing of the counterparty and establishing dollar and term limitations which correspond to the respective credit rating of each counterparty. U S WEST does not have significant exposure to an individual counterparty and does not anticipate nonperformance by any counterparty.\nNOTE 11: FAIR VALUES OF FINANCIAL INSTRUMENTS Fair values of cash equivalents, other current amounts receivable and payable, and short-term debt approximate carrying values due to their short-term nature.\nThe fair values of mandatorily redeemable preferred stock and long-term receivables, based on discounting future cash flows, approximate the carrying values. The fair value of foreign exchange contracts, based on estimated amounts U S WEST would receive or pay to terminate such agreements, approximate the carrying values. It is not practicable to estimate the fair value of financial guarantees associated with international operations because there are no quoted market prices for similar transactions.\nB-48\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) The fair values of interest rate swaps, including swaps associated with the capital assets segment, are based on estimated amounts U S WEST would receive or pay to terminate such agreements taking into account current interest rates and creditworthiness of the counterparties.\nThe fair values of long-term debt, including debt associated with the capital assets segment, are based on quoted market prices where available or, if not available, are based on discounting future cash flows using current interest rates.\nInvestments in debt securities are classified as available for sale and are carried at market value. These securities have various maturity dates through the year 2001. The market value of these securities is based on quoted market prices where available or, if not available, is based on discounting future cash flows using current interest rates.\nThe amortized cost and estimated market value of debt securities follow:\nThe 1995 net unrealized losses of $3 (net of a deferred tax benefit of $2) are included in equity.\nNOTE 12: LEASING ARRANGEMENTS U S WEST has entered into operating leases for office facilities, equipment and real estate. Rent expense under operating leases was $263, $288 and $275 in 1995, 1994 and 1993, respectively. Minimum future lease payments as of December 31, 1994, under noncancelable operating leases, follow:\nB-49\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13: PREFERRED STOCK U S WEST has 200,000,000 authorized shares of preferred stock, 10,000,000 shares of which are designated as Series A Junior Participating Cumulative Preferred Stock, par value $1.00 per share, 10,000,000 shares of which are designated as Series B Junior Participating Cumulative Preferred Stock, par value $1.00 per share, and 50,000 shares of which are designated as Series C Preferred Stock, par value $1.00 per share.\nPREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION\nOn September 2, 1994, the Company issued to Fund American Enterprises Holdings Inc. (\"FFC\") 50,000 shares of 7 percent Series C Cumulative Redeemable Preferred Stock for a total of $50. (See Note 20 to the Consolidated Financial Statements.) Upon issuance, the preferred stock was recorded at fair market value of $51. U S WEST has the right, commencing five years from September 2, 1994, to redeem the shares for one thousand dollars per share plus unpaid dividends and a redemption premium. The shares are mandatorily redeemable in year ten at face value plus unpaid dividends. At the option of FFC, the preferred stock also can be redeemed for common shares of Financial Security Assurance, an investment held by the capital assets segment. The market value of the option was $20 and $22 (based on the Black-Scholes Model) at December 31, 1995 and 1994, with no carrying value.\nNOTE 14: COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY-GUARANTEED DEBENTURES On September 11, 1995, U S WEST Financing I, a wholly owned subsidiary of U S WEST (\"Financing I\"), issued $600 million of 7.96 percent Trust Originated Preferred Securities (the \"Preferred Securities\") and $19 of common securities. U S WEST holds all of the outstanding common securities of Financing I. Financing I used the proceeds from such issuance to purchase from U S WEST Capital Funding, Inc., a wholly owned subsidiary of U S WEST (\"Capital Funding\"), $619 principal amount of Capital Funding's 7.96 percent Subordinated Deferrable Interest Notes due 2025 (the \"Subordinated Debt Securities\"), the obligations under which are fully and unconditionally guaranteed by U S WEST (the \"Debt Guarantee\"). The sole assets of Financing I are and will be the Subordinated Debt Securities and the Debt Guarantee.\nIn addition, U S WEST has guaranteed the payment of interest and redemption amounts to holders of Preferred Securities when Financing I has funds available for such payments (the \"Payment Guarantee\") as well as Capital Funding's undertaking to pay all of Financing I's costs, expenses and other obligations (the \"Expense Undertaking\"). The Payment Guarantee and the Expense Undertaking, including U S WEST's guarantee with respect thereto, considered together with Capital Funding's obligations under the indenture and Subordinated Debt Securities and U S WEST's obligations under the indenture, declaration and Debt Guarantee, constitute a full and unconditional guarantee by U S WEST of Financing I's obligations under the Preferred Securities. The interest and other payment dates on the Subordinated Debt Securities correspond to the distribution and other payment dates on the Preferred Securities. Under certain circumstances, the Subordinated Debt Securities may be distributed to the holders of Preferred Securities and common securities in liquidation of Financing I. The Subordinated Debt Securities are redeemable in whole or in part by Capital Funding at any time on or after September 11, 2000, at a redemption price of $25.00 per Subordinated Debt Security plus accrued and unpaid interest. If Capital Funding redeems the Subordinated Debt Securities, Financing I is required to redeem the Preferred Securities concurrently at $25.00 per share plus accrued and unpaid distributions. As of December 31, 1995, 24,000,000 Preferred Securities were outstanding.\nB-50\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15: SHAREOWNERS' EQUITY\n- ------------------------------ (1) Under the Recapitalization Plan, Media Stock was not issued to shareowners who elected to receive cash rather than Communications Stock and Media Stock. Dissenting shareowners were paid $47.9375 per U S WEST share on December 15, 1995.\nCOMMON STOCK On December 6, 1994, 12,779,206 shares of U S WEST common stock were issued to, or in the name of, the holders of Wometco Cable Corp. in accordance with a merger agreement. (See Note 4 to the Consolidated Financial Statements.) In connection with the settlement of shareowner litigation (\"Rosenbaum v. U S WEST, Inc. et al.\"), the Company issued approximately 5.5 million shares of U S WEST common stock in March 1994 to class members connected with this litigation. U S WEST issued, to certified class members, nontransferable rights to purchase shares of common stock directly from U S WEST, on a commission-free basis, at a 3 percent discount from the average of the high and low trading prices of such stock on the New York Stock Exchange on February 23, 1994, the pricing date designated in accordance with the settlement. U S WEST received net proceeds of $210 from the offering.\nB-51\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15: SHAREOWNERS' EQUITY (CONTINUED) During fourth-quarter 1993, the Company issued 22 million additional shares of U S WEST common stock for net cash proceeds of $1,020. The Company used the net proceeds to reduce short-term indebtedness, including indebtedness incurred from the TWE investment, and for general corporate purposes.\nLEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN (\"LESOP\") U S WEST maintains a defined contribution savings plan for substantially all management and occupational employees of the Company. The Company matches a certain percentage of eligible employee contributions with shares of Communications Stock and\/ or Media Stock in accordance with participant elections. Participants may also elect to reallocate past Company contributions between Communications Stock and Media Stock. In 1989, U S WEST established two LESOPs to provide Company stock for matching contributions to the savings plan. At December 31, 1995, 10,145,485 shares each of Communications Stock and Media Stock has been allocated from the LESOP, while 2,839,435 shares each of Communications Stock and Media Stock remained unallocated.\nThe borrowings associated with the LESOP, which are unconditionally guaranteed by U S WEST, are included in the accompanying Consolidated Balance Sheets and corresponding amounts have been recorded as reductions to common shareowners' equity. Contributions from the Company as well as dividends on unallocated shares held by the LESOP ($8, $11 and $14 in 1995, 1994 and 1993, respectively) are used for debt service. Beginning with the dividend paid in fourth-quarter 1995, dividends on allocated shares are being paid annually to participants. Previously, dividends on allocated shares were used for debt service with participants receiving additional shares from the LESOP.\nU S WEST recognizes expense based on the cash payments method. Total Company contributions to the plan (excluding dividends) were $86, $80 and $75 in 1995, 1994 and 1993, respectively, of which $15, $19 and $24, respectively, have been classified as interest expense.\nSHAREHOLDER RIGHTS PLAN The Board has adopted a shareholder rights plan which, in the event of a takeover attempt, would entitle existing shareowners to certain preferential rights. The rights expire on April 6, 1999, and are redeemable by the Company at any time prior to the date they would become effective.\nSHARE REPURCHASE Subsequent to the acquisition of the Atlanta Systems (See Note 4 to the Consolidated Financial Statements) the Company announced its intention to purchase U S WEST common shares in the open market up to an amount equal to those issued in conjunction with the acquisition, subject to market conditions. In first-quarter 1995, the Company purchased 1,704,700 shares of U S WEST common stock at an average price per share of $37.02. In December 1994, the Company purchased 550,400 shares of U S WEST common stock at an average price per share of $36.30.\nNOTE 16: STOCK INCENTIVE PLANS U S WEST maintains stock incentive plans for executives and key employees, and nonemployees. The Amended 1994 Stock Plan (the \"Plan\") was approved by shareowners on October 31, 1995 in connection with the Recapitalization Plan. The Plan is a successor plan to the U S WEST, Inc. Stock Incentive Plan and the U S WEST 1991 Stock Incentive Plan (the \"Predecessor Plans\"). No further grants of options or restricted stock may be made under the Predecessor Plans. The Plan is administered by the Human Resources Committee of the board of directors with respect to officers, executive officers and outside directors and by a special committee with respect to all other eligible employees and eligible nonemployees.\nDuring calendar year 1995, up to 2,200,000 shares of Communications Stock and 1,485,000 shares of Media Stock were available for grant. The maximum aggregate number of shares of Communications Stock and Media Stock that may be granted in any other calendar year for all purposes under the Plan is nine- tenths of one percent (0.90 percent) and three-quarters of one percent (0.75 percent), respectively, of the shares of such class outstanding (excluding shares held in the Company's treasury) on the first day of such calendar year. In the event that fewer than the full aggregate number of shares of either class available for\nB-52\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 16: STOCK INCENTIVE PLANS (CONTINUED) issuance in any calendar year are issued in any such year, the shares not issued shall be added to the shares of such class available for issuance in any subsequent year or years. Options may be exercised no later than 10 years after the date on which the option was granted.\nData for outstanding options under the Plan is summarized as follows:\n- ------------------------------\n* Includes options granted in tandem with SARs.\nOptions to purchase 2,672,666 shares of Communications Stock and 3,021,166 shares of Media Stock were exercisable at December 31, 1995. Options to purchase 2,374,394 shares of U S WEST stock were exercisable at December 31, 1994. A total of 2,050,466 shares of Communications Stock and 1,419,795 shares of Media Stock were available for grant under the plans in effect at December 31, 1995. A total of 914,816 shares of U S WEST common stock were available for grant under the plans in effect at December 31, 1994. A total of 11,484,792 shares of Communications Stock and 11,121,186 shares of Media Stock were reserved for issuance under the Plan at December 31, 1995.\nNOTE 17: EMPLOYEE BENEFITS\nPENSION PLAN\nU S WEST sponsers a defined benefit pension plan covering substantially all management and occupational employees of the Company. Management benefits are based on a final pay formula, while occupational benefits are based on a flat benefit formula. U S WEST uses the projected unit credit method for the determination of pension cost for financial reporting purposes and the aggregate cost method for funding purposes. The Company's policy is to fund amounts required under the Employee Retirement Security Act of 1974 (\"ERISA\") and no funding was required in 1995, 1994 or 1993.\nB-53\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17: EMPLOYEE BENEFITS (CONTINUED) The composition of the net pension cost and the actuarial assumptions of the plan follow:\nThe expected long-term rate of return on plan assets used in determining net pension cost was 8.50 percent for 1995, 8.50 percent for 1994 and 9.00 percent for 1993.\nThe funded status of the plan follows:\nThe actuarial assumptions used to calculate the projected benefit obligation follow:\nAnticipated future benefit changes have been reflected in the above calculations.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nU S WEST and most of its subsidiaries provide certain health care and life insurance benefits to retired employees. In conjunction with the Company's 1992 adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" U S WEST elected to immediately recognize the accumulated postretirement benefit obligation for current and future retirees. However, the Federal Communications Commission and certain state jurisdictions permit amortization of the transition obligation over the average remaining service period of active employees for regulatory accounting purposes with most jurisdictions requiring funding as a stipulation for rate recovery.\nB-54\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17: EMPLOYEE BENEFITS (CONTINUED) U S WEST uses the projected unit credit method for the determination of postretirement medical and life costs for financial reporting purposes. The composition of net postretirement benefit costs and actuarial assumptions underlying plan benefits follow:\nThe expected long-term rate of return on plan assets used in determining postretirement benefit costs was 8.50 percent for 1995, 8.50 percent in 1994 and 9.00 percent in 1993.\nThe funded status of the plans follows:\n- ------------------------------ (1) Medical plan assets include Communications Stock of $210 and Media Stock of $112 in 1995, and U S WEST common stock of $164 in 1994.\nThe actuarial assumptions used to calculate the accumulated postretirement benefit obligation follow:\n- ------------------------------ * Medical cost trend rate gradually declines to an ultimate rate of 5 percent in 2011.\nB-55\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17: EMPLOYEE BENEFITS (CONTINUED) A one-percent increase in the assumed health care cost trend rate for each future year would have increased the aggregate of the service and interest cost components of 1995 net postretirement benefit cost by approximately $40 and increased the 1995 accumulated postretirement benefit obligation by approximately $350.\nFor U S WEST, the annual funding amount is based on its cash requirements, with the funding at U S WEST Communications based on regulatory accounting requirements.\nAnticipated future benefit changes have been reflected in these postretirement benefit calculations.\nNOTE 18: INCOME TAXES The components of the provision for income taxes follow:\nThe unamortized balance of investment tax credits at December 31, 1995 and 1994, was $199 and $231, respectively.\nAmounts paid for income taxes were $566, $313 and $391 in 1995, 1994 and 1993, respectively, inclusive of the capital assets segment.\nThe effective tax rate differs from the statutory tax rate as follows:\nB-56\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 18: INCOME TAXES (CONTINUED) The components of the net deferred tax liability follow:\nThe current portion of the deferred tax asset was $282 and $352 at December 31, 1995 and 1994, respectively, resulting primarily from restructuring charges and compensation-related items.\nOn August 10, 1993, federal legislation was enacted which increased the corporate tax rate from 34 percent to 35 percent retroactive to January 1, 1993. The cumulative effect on deferred taxes of the 1993 increase in income tax rates was $74, including $20 for the capital assets segment.\nThe net deferred tax liability includes $686 in 1995 and $678 in 1994 related to the capital assets segment.\nNOTE 19: CONTINGENCIES At U S WEST Communications there are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing two exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. This action is still in the discovery process. If a formal filing - -- made in accordance with the remand from the Supreme Court -- alleges that the exceptions apply, the range of possible risk to U S WEST Communications is $0 to $150.\nOn September 22, 1995, U S WEST filed a lawsuit in Delaware Chancery Court to enjoin the proposed merger of Time Warner and Turner Broadcasting. U S WEST has alleged breaches of contract and fiduciary duties by Time Warner in connection with this proposed merger. Time Warner filed a countersuit against U S WEST on October 11, 1995, alleging misrepresentation, breach of contract and other misconduct on the part of U S WEST. Time Warner's countersuit seeks a reformation of the Time Warner Entertainment partnership agreement, an order that enjoins U S WEST from breaching the partnership agreement, and unspecified compensatory damages. U S WEST has denied each of the claims in Time Warner's countersuit. The trial for this action concluded on March 22, 1996. A ruling by the Delaware Chancery Court is expected in June 1996.\nB-57\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE The Consolidated Financial Statements include the discontinued operations of the capital assets segment. During the second quarter of 1993, the U S WEST Board of Directors approved a plan to dispose of the capital assets segment through the sale of segment assets and businesses. Accordingly, the Company recorded an after-tax charge of $100 for the estimated loss on disposition. An additional provision of $20 is related to the effect of the 1993 increase in federal income tax rates. The capital assets segment includes activities related to financial services and financial guarantee insurance operations. Also included in the segment is U S WEST Real Estate, Inc., for which disposition was announced in 1991 and a $500 valuation allowance was established to cover both carrying costs and losses on disposal of related properties.\nEffective January 1, 1995, the capital assets segment has been accounted for in accordance with Staff Accounting Bulletin No. 93, issued by the Securities Exchange Commission, which requires discontinued operations not disposed of within one year of the measurement date to be accounted for prospectively in continuing operations as a \"net investment in assets held for sale.\" The net realizable value of the assets is reevaluated on an ongoing basis with adjustments to the existing reserve, if any, charged to continuing operations. No such adjustment was required in 1995. Prior to January 1, 1995, the entire capital assets segment was accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30.\nDuring 1994, U S WEST reduced its ownership interest in Financial Security Assurance Holdings, Ltd. (\"FSA\"), a member of the capital assets segment, to 60.9 percent, and its voting interest to 49.8 percent through a series of transactions. In May and June 1994, U S WEST sold 8.1 million shares of FSA, including 2 million shares sold to Fund American Enterprises Holdings Inc. (\"FFC\"), in an initial public offering of FSA common stock. U S WEST received $154 in net proceeds from the offering. The Media Group retained certain risks in asset-backed obligations related to the commercial real estate portfolio. On September 2, 1994, U S WEST issued to FFC 50,000 shares of cumulative redeemable preferred stock for a total of $50. (See Note 13 to the Consolidated Financial Statements.) In December 1995, FSA merged with Capital Guaranty Corporation for shares of FSA and cash of $51. The transaction was valued at approximately $203 and reduced U S WEST's ownership interest in FSA to 50.3 percent and its voting interest to 41.7 percent. U S WEST expects to monetize and ultimately reduce its ownership in FSA through the issuance of Debt Exchangeable for Common Stock (\"DECS\") in 1996. At maturity, each DECS will be mandatorily exchanged by U S WEST for shares of FSA common stock held by U S WEST or, at U S WEST's option, redeemed at the cash equivalent.\nU S WEST entered into a transaction to reduce its investment in Enhance Financial Services Group, Inc. (\"Enhance\") during fourth-quarter 1995. U S WEST issued DECS due December 15, 1998. Upon maturity, each DECS will be mandatorily exchanged by U S WEST for shares of Enhance common stock or, at U S WEST's option, redeemed at the cash equivalent. The capital assets segment currently owns approximately 31.5 percent of the outstanding Enhance common stock. (See Note 10 to the Consolidated Financial Statements.)\nU S WEST Real Estate, Inc. has sold various properties totaling $120, $327 and $66 in each of the three years ended December 31, 1995, respectively. The sales proceeds were in line with estimates. Proceeds from building sales were primarily used to repay related debt. U S WEST has completed construction of existing buildings in the commercial real estate portfolio and expects to substantially complete the liquidation of this portfolio by 1998. The remaining balance of assets subject to sale is approximately $490, net of reserves, as of December 31, 1995.\nIn December 1993, U S WEST sold $2.0 billion of finance receivables and the business of U S WEST Financial Services, Inc. to NationsBank Corporation. Sales proceeds of $2.1 billion were used primarily to repay related debt. The pretax gain on the sale of approximately $100, net of selling expenses, was in line\nB-58\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) with management's estimate and was included in the Company's estimate of provision for loss on disposal. The management team that previously operated the entire capital assets segment transferred to NationsBank.\nBuilding sales and operating revenues of the capital assets segment were $237, $553 and $710 in 1995, 1994 and 1993, respectively. Income from discontinued operations for 1993 (to June 1) totaled $38. Income (loss) from the capital assets segment subsequent to June 1, 1993 is being deferred and is included within the reserve for assets held for sale.\nThe assets and liabilities of the capital assets segment have been separately classified on the Consolidated Balance Sheets as net investment in assets held for sale.\nThe components of net investment in assets held for sale follow:\nFinance receivables primarily consist of contractual obligations under long-term leases that U S WEST intends to run off. These long-term leases consist mostly of leveraged leases related to aircraft and power plants. For leveraged leases, the cost of the assets leased is financed primarily through nonrecourse debt which is netted against the related lease receivable.\nThe components of finance receivables follow:\nInvestments in debt securities are classified as available for sale and are carried at market value. Any resulting unrealized holding gains or losses, net of applicable deferred income taxes, are reflected as a component of equity.\nB-59\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) The amortized cost and estimated market value of investments in debt securities are as follows:\nNote: Also included in equity are unrealized gains and losses on debt securities associated with U S WEST's equity investment in FSA. 1995 includes unrealized gains of $24, net of deferred taxes of $13, and 1994 includes unrealized losses of $49, net of deferred tax benefits of $26.\nThe 1995 net unrealized gains of $39 (net of deferred taxes of $21) and the 1994 net unrealized losses of $64 (net of deferred tax benefits of $34), are included in equity.\nDEBT\nInterest rates and maturities of debt associated with the capital assets segment at December 31 follow:\nDebt of $71 and $119 at December 31, 1995 and 1994, respectively, was collateralized by first deeds of trust on associated real estate and assignment of rents from leases.\nThe following table summarizes terms of swaps associated with the capital assets segment. Variable rates are indexed to three- and six-month LIBOR.\n- ------------------------------ (1) The fixed to variable swaps have the same terms as the variable to fixed swaps and were entered into to terminate the variable to fixed swaps. The net loss on the swaps is deferred and amortized over the remaining life of the swaps and is included in the reserve for assets held for sale.\n(2) Variable rate debt based on Treasuries is swapped to a LIBOR-based interest rate.\nB-60\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET CREDIT RISK -- FINANCIAL GUARANTEES\nThe Company retained certain risks in asset-backed obligations related to the commercial real estate portfolio. The principal amounts insured on the asset-backed obligations follow:\nConcentrations of collateral associated with insured asset-backed obligations follow:\nADDITIONAL FINANCIAL INFORMATION\nInformation for U S WEST Financial Services, Inc., a member of the capital assets segment, follows:\nB-61\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 21: QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------------------------\nEffective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of Communications Stock and Media Stock. Earnings per common share for 1995 have been presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1995. For periods prior to the recapitalization, the average common shares outstanding for the two classes of stock are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n1995 first-quarter net income includes $39 ($0.08 per Communications share) from a gain on the sales of certain rural telephone exchanges. 1995 second-quarter net income includes $10 ($0.02 per Communications share) from a gain on the sales of certain rural telephone exchanges. 1995 third-quarter net income includes $21 ($0.04 per Communications share) from a gain on the sales of certain rural telephone exchanges and $10 ($0.01 per Communications share and $0.01 per Media share) for expenses associated with the Recapitalization Plan. 1995 third-quarter net income also includes charges of $9 ($0.01 per Communications share and $0.01 per Media share) for the early extinguishment of debt. 1995 fourth-quarter net income includes $15 ($0.03 per Communications share) from a gain on the sales of certain rural telephone exchanges and $95 ($0.20 per Media share) from the merger of U S WEST's joint venture interest in TeleWest. 1995 fourth-quarter net income also includes other charges of $10 ($0.01 per Communications share and $0.01 per Media share), including $7 for expenses associated with the Recapitalization Plan and an extraordinary charge of $3 for the early extinguishment of debt.\n1994 first-quarter net income includes $15 ($.03 per share) from a gain on the sales of certain rural telephone exchanges. 1994 second-quarter net income includes gains of $16 ($.04 per share) and $41 ($.09 per share) on the sales of certain rural telephone exchanges and paging operations, respectively. 1994 fourth-quarter net income includes gains of $105 ($.23 per share) for the partial sale of a joint venture interest in TeleWest and $20 ($.04 per share) on the sales of certain rural telephone exchanges.\nB-62\nU S WEST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 21: QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)\nB-63\nU S WEST COMMUNICATIONS GROUP FINANCIAL HIGHLIGHTS\n- ------------------------------ * Actual\n(1) 1995 net income includes a gain of $85 ($0.18 per share) on the sales of certain rural telephone exchanges and other charges of $16 ($0.03 per share), including an extraordinary charge of $8 for the early extinguishment of debt and $8 for costs associated with the November 1, 1995 recapitalization. 1994 net income includes a gain of $51 ($0.11 per share) on the sales of certain rural telephone exchanges. 1993 net income was reduced by a $534 restructuring charge and $54 for the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates. 1993 net income was also reduced by extraordinary charges of $3,123 for the discontinuance of Statement of Financial Accounting Standards (\"SFAS\") No. 71 and $77 for the early extinguishment of debt. 1992 net income was reduced by $1,745 for the cumulative effect of change in accounting principles. 1991 net income was reduced by a $173 restructuring charge.\n(2) Effective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of U S WEST Communications Group common stock and U S WEST Media Group common stock. Earnings per common share have been presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n(3) Earnings before interest, taxes, depreciation, amortization and other (\"EBITDA\"). EBITDA also excludes the gain on sales of rural telephone exchanges and restructuring charges. The Communications Group considers EBITDA an important indicator of the operational strength and performance of its businesses. EBITDA, however, should not be considered as an alternative to operating or net income as an indicator of the performance of the Communications Group's businesses or as an alternative to cash flows from operating activities as a measure of liquidity, in each case determined in accordance with generally accepted accounting principles.\n(4) The increases in the percentage of debt to total capital and return on Communications Group equity, and the decrease in Communications Group equity since 1992, are primarily due to the effects of discontinuing SFAS No. 71 in 1993 and the cumulative effect of change in accounting principles in 1992.\n(5) 1995 return on Communications Group equity is based on income before extraordinary items. For 1994, there are no adjustments to net income for this calculation. 1993 return on Communications Group equity is based on income excluding extraordinary items, a restructuring charge and the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates. 1992 return on Communications Group equity is based on income before cumulative effect of change in accounting principles. 1991 return on Communications Group equity is based on income excluding the effects of a restructuring charge.\nC-1\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) THE RECAPITALIZATION PLAN\nOn October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\"), voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors to reincorporate in Delaware and create two classes of common stock. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or the \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\") and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\").\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nTHE COMMUNICATIONS GROUP\nThe Communications Group primarily provides regulated communications services to more than 25 million residential and business customers in the Communications Group Region (the \"Region\"). The Region includes the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. Services offered by the Communications Group include local telephone services, exchange access services (which connect customers to the facilities of carriers, including long-distance providers and wireless operators), and long-distance services within Local Access and Transport Areas (\"LATAs\") in the Region. The Communications Group provides other products and services, including custom calling features, voice messaging, caller identification, high-speed data applications, customer premises equipment and certain communications services to business customers and governmental agencies both inside and outside the Region. The Telecommunications Act of 1996, enacted into law on February 8, 1996, will dramatically alter the competitive landscape of the telecommunications industry and will further change the nature of services the Communications Group will offer. These future service offerings include interLATA long-distance service, wireless services, cable TV and interconnection services provided to competing providers of local services.\nThe Combined Financial Statements of the Communications Group include: (i) the combined historical balance sheets, results of operations and cash flows of the businesses that comprise the Communications Group; (ii) corporate assets and liabilities and related transactions of U S WEST identified with the Communications Group; and (iii) an allocated portion of the corporate expenses of U S WEST. All significant intra-group financial transactions have been eliminated. Transactions between the Communications Group and the Media Group have not been eliminated. For a more complete discussion of U S WEST's corporate allocation policies, see the U S WEST Communications Group Combined Financial Statements -- Note 2: Summary of Significant Accounting Policies.\nThe following discussion is based on the U S WEST Communications Group Combined Financial Statements prepared in accordance with generally accepted accounting principles (\"GAAP\"). The discussion should be read in conjunction with the U S WEST, Inc. Consolidated Financial Statements.\nC-2\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS -- 1995 COMPARED WITH 1994\nComparative details of income before extraordinary items for 1995 and 1994 follow:\n- ------------------------------ 1 1995 income before extraordinary items includes a gain of $85 ($0.18 per share) on the sales of certain rural telephone exchanges and $8 ($0.01 per share) for costs associated with the Recapitalization Plan.\n2 1994 income before extraordinary items includes a gain of $51 ($0.11 per share) on the sales of certain rural telephone exchanges.\n3 Earnings per common share have been presented on a pro forma basis as if the Communications Stock had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST.\nThe Communications Group's 1995 income before extraordinary items, excluding the effects of one-time items described in Note 1 to the table above, was $1,107, an increase of $8, or 0.7 percent, compared with $1,099 in 1994, also excluding the effects of one-time items. Total revenue growth of 3.4 percent was largely offset by significantly higher costs incurred to improve customer service and meet greater than expected business growth. Net income growth will also be limited in 1996 while the Communications Group continues to commit significant resources to meet customer service objectives and broaden its range of product and service offerings.\nExcluding the effects of one-time items described in Note 1 to the table above, pro forma earnings per common share before extraordinary items (\"earnings per share\") were $2.35 in 1995, a decrease of $0.07, or 2.9 percent, compared with $2.42 in 1994, similarly adjusted. Earnings per share in 1995 reflect approximately 17 million additional average common shares outstanding, of which 12.8 million were issued in December 1994.\nDuring 1995, the Communications Group refinanced $145 of long-term debt. Expenses associated with the refinancings resulted in extraordinary charges of $8, net of tax benefits of $5.\nIncreased demand for services resulted in growth in earnings before interest, taxes, depreciation, amortization and other (\"EBITDA\") of 4.8 percent in 1995. The Communications Group believes EBITDA is an important indicator of the operational strength of its businesses. EBITDA, however, should not be considered as an alternative to operating or net income as an indicator of performance or as an alternative to cash flows from operating activities as a measure of liquidity, in each case determined in accordance with generally accepted accounting principles (\"GAAP\").\nC-3\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nOPERATING REVENUES\nAn analysis of changes in operating revenues follows:\nApproximately 97 percent of the revenues of the Communications Group are attributable to the operations of U S WEST Communications, Inc. (\"U S WEST Communications\"), of which approximately 59 percent are derived from the states of Arizona, Colorado, Minnesota and Washington. Approximately 29 percent of the access lines in service are devoted to providing services to business customers. The access line growth rate for business customers, who tend to be heavier users of the network, has consistently exceeded the growth rate of residential customers. During 1995, business access lines grew 5.4 percent while residential access lines increased 2.8 percent.\nThe primary factors that influence changes in revenues are customer demand for products and services, price changes (including those related to regulatory proceedings) and refunds. During 1995, revenues from new product and service offerings were $534, an increase of 58 percent compared with 1994. These revenues primarily consist of caller identification, voice messaging, call waiting and high-speed data network transmission services.\nLocal service revenues include local telephone exchange, local private line and public telephone services. In 1995, local service revenues increased principally as a result of higher demand for new and existing services, and demand for second lines. Local service revenues from new services increased $92, or 78 percent, compared with 1994. Reported total access lines increased 511,000, or 3.6 percent, of which 161,000 were second lines. Second line installations increased 25.5 percent compared with 1994. Access line growth was 4.2 percent adjusted for the sale of approximately 95,000 rural telephone access lines during the last 12 months.\nAccess charges are collected primarily from interexchange carriers for their use of the local exchange network. For interstate access services there is also a fee collected directly from telephone customers. Approximately 33 percent of access revenues and 11 percent of total revenues are derived from providing access services to AT&T.\nHigher revenues from interstate access services were driven by an increase of 9.2 percent in interstate billed access minutes of use. The increased business volume more than offset the effects of price reductions and refunds. The Communications Group reduced prices for interstate access services in both 1995 and 1994 as a result of Federal Communications Commission (\"FCC\") orders and competitive pressures. Intrastate access revenues increased primarily due to the impact of increased business volume and multiple toll carrier plans, partially offset by the impact of rate changes.\nLong-distance revenues are derived from calls made within the LATA boundaries of the Region. During 1995 and 1994, long-distance revenues were impacted by the implementation of multiple toll carrier plans (\"MTCPs\") in Oregon and Washington in May and July 1994, respectively. The MTCPs essentially allow independent telephone companies to act as toll carriers. The 1995 impact of the MTCPs was long-distance revenue losses of $62, partially offset by increases in intrastate access revenues of $12 and decreases in other\nC-4\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) operating expenses (i.e. access expense) of $42 compared with 1994. These regulatory arrangements have decreased annual net income by approximately $10. Similar changes in other states could occur, though the impact on 1996 net income would not be material.\nExcluding the effects of the MTCPs, long-distance revenues decreased by 5.9 percent in 1995, primarily due to the effects of competition and rate reductions. Long-distance revenues have declined over the last several years as customers have migrated to interexchange carriers that have the ability to offer these services on both an intraLATA and interLATA basis. A portion of revenues lost to competition, however, is recovered through access charges paid by the interexchange carriers. Erosion in long-distance revenue will continue due to the loss of 1+ dialing in Minnesota, effective in February 1996, and in Arizona, effective in April 1996. Annual long-distance revenue losses could approximate $30 as a result of these changes. The Communications Group is partially mitigating competitive losses through competitive pricing of intraLATA long-distance services.\nRevenues from other services primarily consist of billing and collection services provided to interexchange carriers, voice messaging services, high-speed data transmission services, sales of service agreements related to inside wiring and the provision of customer premises equipment. Revenues from other services also include directory listings, customer lists, billing and collection and other services provided to the Media Group. These services are sold at market price. However, the Communications Group's accounting and reporting for regulatory purposes is in accordance with regulatory requirements. Revenues for services provided to Media Group were $20 in 1995 and $29 in 1994.\nDuring 1995, revenues from other services increased $44, primarily as a result of continued market penetration in voice messaging services and sales of high-speed data transmission services. Revenue growth from other services is also attributable to maintenance contracts for inside wire services and a large contract related to a wire installation project. These increases were partially offset by a decrease of $20 in revenues from billing and collection services. The decline in billing and collection revenues is primarily related to lower contract prices and a decrease in the volume of services provided to AT&T.\nCOSTS AND EXPENSES\nEmployee-related expenses include basic salaries and wages, overtime, benefits (including pension and health care), payroll taxes and contract labor. During 1995, improving customer service was the Communications Group's first priority. Overtime payments and contract labor expense associated with customer service initiatives increased employee-related costs by approximately $168 compared with 1994. Expenses related to the addition of approximately 1,700 employees in 1995 and 1,000 employees in 1994 also increased employee-related costs. These expenses were incurred to handle the higher than anticipated volume of business and to meet new business opportunities. Partially offsetting these increases was a $34 reduction in the accrual for postretirement benefits, a $22 decrease in travel expense and reduced expenses related to employee separations under reengineering and streamlining initiatives. The Communications Group will continue to add employees to address customer service issues and growth in the core business. Costs related to these work-force additions will partially offset the benefits of employee separations achieved through restructuring. (See \"Restructuring Charge.\")\nC-5\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nOther operating expenses include access charges (incurred for the routing of long-distance traffic through the facilities of independent companies), network software expenses and other general and administrative costs, including allocated costs from U S WEST. During 1995, other operating expenses decreased primarily due to the effects of the multiple toll carrier plans and a reduction in expenses related to project funding at Bell Communications Research, Inc. (\"Bellcore\"), of which U S WEST Communications has a one-seventh ownership interest. These decreases in other operating expenses were partially offset by increases in costs associated with increased sales, including bad debt expense. Allocated costs from U S WEST were $116 and $110 in 1995 and 1994, respectively.\nTaxes other than income taxes, which consist primarily of property taxes, decreased 2.1 percent in 1995, primarily due to favorable property tax valuations and mill levies as compared with 1994. As a result of these valuations and mill levies, 1995 fourth-quarter accruals decreased by $20 compared with fourth-quarter 1994.\nIncreased depreciation and amortization expense was attributable to the effects of a higher depreciable asset base, partially offset by the effects of the sales of certain rural telephone exchanges.\nInterest expense increased primarily as a result of an increased use of debt financing. The average borrowing cost was 6.9 percent in 1995, compared with 6.8 percent in 1994. (See \"Liquidity and Capital Resources.\") The increase in other expense is largely attributable to $8 of costs associated with the Recapitalization Plan in 1995.\nPROVISION FOR INCOME TAXES\nThe decrease in the effective tax rate resulted primarily from the effects of a research and experimentation credit and adjustments for prior periods.\nRESTRUCTURING CHARGE\nThe Communications Group's 1993 results reflected an $880 restructuring charge (pretax). The related restructuring plan (the \"Restructuring Plan\") is designed to provide faster, more responsive customer services while reducing the costs of providing these services. As part of the Restructuring Plan, the Communications Group is developing new systems and enhanced system functionality that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, rapidly design and engineer products and services for customers, and centralize its service centers. The Communications Group has consolidated its 560 customer service centers into 26 centers in 10 cities and plans on reducing its work force by approximately 10,000 employees. All service centers are operational and supported by new systems and enhanced system functionality.\nThe Restructuring Plan is expected to be substantially complete by the end of 1997. Implementation of the Restructuring Plan has been impacted by growth in the business and related service issues, new business opportunities, revisions to system delivery schedules and productivity issues caused by the major rearrangement of resources due to restructuring. These issues will continue to affect the timing of employee separations.\nThe Communications Group estimates that full implementation of the 1993 Restructuring Plan will reduce employee-related expenses by approximately $400 per year. The savings related to work-force reductions will be offset by the effects of inflation and a variety of other factors. These factors include costs related to the achievement of customer service objectives and increased demand for existing services. (See \"Costs and Expenses.\")\nC-6\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nFollowing is a schedule of the costs included in the Restructuring Plan:\n- ------------------------------ 1 Employee separation costs, including the balance of a 1991 restructuring reserve at December 31, 1993, aggregate $311.\nEmployee separation costs include severance payments, health-care coverage and postemployment education benefits. Systems development costs include new systems and the application of enhanced system functionality to existing, single-purpose systems to provide integrated, end-to-end customer service. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the new service centers and retraining employees on the methods and systems required in the new, restructured mode of operation.\nEMPLOYEE SEPARATION. Under the Restructuring Plan, the Communications Group anticipates the separation of 10,000 employees. Approximately 1,000 employees that were originally expected to relocate have chosen separation or other job assignments and have been replaced. This increased the number of employee separations to 10,000 from 9,000, and increased the estimated total cost for employee separations to $311 from $281, as compared with the original estimate. The $30 cost associated with these additional employee separations was reclassified from relocation to the reserve for employee separations during 1995.\nAnnual employee separations and employee-separation amounts under the Restructuring Plan follow:\n- ------------------------------ (1) Includes the remaining employees and the separation amounts associated with the balance of a 1991 restructuring reserve at December 31, 1993.\n(2) A significant number of the employee reductions originally scheduled for 1996 will be delayed while the Communications Group focuses on overtime and contract-labor expenses. The Restructuring Plan is expected to be substantially complete by the end of 1997.\nC-7\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCompared with the original estimates, employee reductions and separation amounts shown above have been reduced by 1,600 employees and $53, respectively, in 1996, and increased by 4,495 employees and $127, respectively, in 1997.\nSYSTEMS DEVELOPMENT. The existing information management systems were largely developed to support a monopoly environment. These systems were inadequate due to the effects of increased competition, new forms of regulation and changing technology that have driven consumer demand for products and services that can be delivered quickly, reliably and economically. The Communications Group believes that improved customer service, delivered at lower cost, can be achieved by a combination of new systems and introducing new functionality to existing systems. This is a change from the initial strategy which placed more emphasis on the development of new systems.\nThe systems development program involves new systems and enhanced system functionality for systems that support the following core processes:\nSERVICE DELIVERY -- to support service on demand for all products and services. These new systems and enhanced system functionality will permit customer calls to be directed to those service representatives who can meet their requirements. This process will provide enhanced information to the service representatives regarding the customer requests and the ability of the Communications Group to fulfill them.\nSERVICE ASSURANCE -- for performance monitoring from one location and remote testing in the new environment, including identification and resolution of faults prior to customer impact.\nCAPACITY PROVISIONING -- for integrated planning of future network capacity, including the installation of software controllable service components.\nCertain of the new systems and enhanced system functionality have been implemented in the service centers and have simplified the labor-intensive interfaces between systems processes in existence prior to the Restructuring Plan. Enhanced system functionality introduced under the Restructuring Plan since its inception includes the following:\n- The ability to determine facilities' availability while the customer is placing an order;\n- Automated engineering of central office facilities and automated updating of central office facilities' records;\n- The ability to track the status of complex network design jobs from the customer's perspective; and\n- Systems that accurately diagnose network problems and prepare repair packages to correct the problems identified.\nThe direct, incremental and nonrecurring costs of providing new systems and enhanced system functionality follow:\nSystems expenses charged to current operations consist of costs associated with the information management function, including planning, developing, testing and maintaining databases for general purpose\nC-8\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) computers, in addition to systems costs related to maintenance of telephone network applications. Other systems expenses are for administrative (i.e. general purpose) systems which include customer service, order entry, billing and collection, accounts payable, payroll, human resources and property records. Ongoing systems costs comprised approximately six percent of total operating expenses in 1995, 1994 and 1993. The Communications Group expects systems costs charged to current operations as a percent of total operating expenses to approximate the current level throughout 1996. Systems costs could increase relative to other operating costs as the business becomes more technology dependent.\nPROGRESS UNDER THE RESTRUCTURING PLAN\nFollowing is a reconciliation of restructuring reserve activity since December 1993:\nRESULTS OF OPERATIONS -- 1994 COMPARED WITH 1993\nComparative details of income before extraordinary items for 1994 and 1993 follow:\n- ------------------------------ (1) 1994 income before extraordinary items includes a gain of $51 on the sales of certain rural telephone exchanges.\n(2) 1993 income before extraordinary items was reduced by $534 for a restructuring charge and $54 for the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates.\nC-9\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nThe Communications Group's 1994 income before extraordinary items was $1,099, an increase of $120, or 12.3 percent, over 1993, excluding the one-time effects described in Notes 1 and 2 to the table above. The increase was primarily attributable to increased demand for telecommunications services.\nIn 1993, U S WEST Communications incurred extraordinary charges for the discontinuance of Statement of Financial Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" and the early extinguishment of debt. An extraordinary, noncash charge of $3.1 billion (after tax) was incurred in conjunction with the decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS No. 71. SFAS No. 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, competition notwithstanding, by charging its customers at prices established by its regulators. This decision to discontinue the application of SFAS No. 71 was based on the belief that competition, market conditions and technological advances, more than prices established by regulators, will determine the future cost recovery by U S WEST Communications. As a result of this change, the remaining asset lives of U S WEST Communications' telephone plant were shortened to more closely reflect the useful (economic) lives of such plant. U S WEST Communications' accounting and reporting for regulatory purposes were not affected by the change.\nDuring 1993, U S WEST Communications refinanced long-term debt issues aggregating $2.7 billion in principal amount. These refinancings allowed U S WEST Communications to take advantage of favorable interest rates. Extraordinary costs associated with the redemptions reduced 1993 income by $77 (after tax).\nRevenue growth, partially offset by higher operating expenses, provided a 7.6 percent increase in EBITDA.\nOPERATING REVENUES An analysis of changes in operating revenues follows:\nIn 1994, local service revenues increased principally as a result of higher demand for services. Reported access lines increased by 3.6 percent. Excluding the sale of approximately 60,000 rural telephone access lines during 1994, access line growth was 4.0 percent.\nHigher revenues from interstate access services were primarily attributable to an increase of 7.8 percent in interstate billed access minutes of use, which more than offset the effects of price decreases. Intrastate access charges increased primarily as a result of higher demand, including demand for private line services.\nLong-distance revenues decreased principally due to the effects of the MTCPs implemented in Oregon and Washington. The 1994 impact was a loss of $68 in long-distance revenues, partially offset by a decrease of $48 in other operating expenses and an increase of $10 in intrastate access revenue. These regulatory arrangements decreased net income by approximately $6 in 1994.\nDuring 1994, revenues from other services increased due to higher revenue from billing and collection services and increased market penetration of new service offerings. Partially offsetting the increase in other services revenues was the 1993 sale of telephone equipment distribution operations, completion of large telephone network installation contracts and lower revenue from customer premises equipment installations. Revenues for services provided to the Media Group were $29 in 1994 and $26 in 1993.\nC-10\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nCOSTS AND EXPENSES\nIn 1994, overtime payments, contract labor and basic salaries and wages, all related to the implementation of major customer service and streamlining initiatives, increased by $150. A $71 reduction in the amount of pension credit allocated to the Communications Group also contributed to the increase in employee-related expenses. Actuarial assumptions, which include decreases in the discount rate and the expected long-term rate of return on plan assets, contributed to the pension credit reduction. Partially offsetting these increases were the effects of employees leaving under the Restructuring Plan, lower health-care benefit costs, including a reduction in the accrual for postretirement benefits, and lower incentive compensation payments to employees.\nOther operating expenses decreased primarily due to the effect of the MTCPs. Lower customer premises equipment installations and lower expenses at Bellcore also contributed to the decrease. Allocated costs assigned from U S WEST to the Communications Group totaled $110 and $117 in 1994 and 1993, respectively. The increase in depreciation and amortization expense was primarily the result of a higher depreciable asset base and increased rates of depreciation.\nInterest expense decreased due to the effects of refinancing debt at lower rates in 1993 at U S WEST Communications, and a reclassification of capitalized interest in 1994. Since the discontinuance of SFAS No. 71, interest capitalized as a component of telephone plant construction is recorded as an offset against interest expense rather than to other expense. The Communications Group's average borrowing cost was 6.8 percent in 1994 compared with 6.9 percent in 1993.\nPROVISION FOR INCOME TAXES\nThe increase in the effective tax rate resulted primarily from the effects of discontinuing SFAS No. 71, an increase in 1994 income before income taxes and the 1993 restructuring charge, partially offset by the cumulative effect on deferred income taxes of the 1993 federally mandated increase in income tax rates.\nLIQUIDITY AND CAPITAL RESOURCES -- THREE YEARS ENDED DECEMBER 31, 1995\nOPERATING ACTIVITIES\nCash from operations increased $210 in 1995 primarily due to the increase in EBITDA and a decrease in the cash funding for postretirement benefits, partially offset by higher payments for restructuring charges. Cash provided by operating activities decreased by $168 in 1994 compared with 1993, largely due to cash payments for restructuring activities of $279 in 1994, compared with $120 in 1993. Further details of cash provided by operating activities are provided in the Combined Statements of Cash Flows.\nC-11\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nThe future cash needs of the Communications Group may increase as a result of new business opportunities, including wireless services, and requirements related to the recently enacted Telecommunications Act of 1996.\nINVESTING ACTIVITIES\nTotal capital expenditures were $2,739 in 1995, $2,477 in 1994 and $2,226 in 1993. The 1995 capital expenditures exceeded the 1994 and 1993 levels due to the Communications Group's efforts to improve customer service (including reductions in held orders) and to accommodate additional line capability in several states. Capital expenditures related to the Restructuring Plan were approximately $190 in 1995 as compared to $265 in 1994. In 1996, capital expenditures are expected to approximate $2.5 billion. Included in the 1996 capital expenditures estimate are costs to enter new markets as allowed under the Telecommunications Act of 1996.\nThe Communications Group received cash proceeds of $214 and $93 in 1995 and 1994, respectively, for the sales of certain rural telephone exchanges. Since implementing its rural telephone exchange sales program, the Communications Group has sold approximately 155,000 access lines. Planned sales of rural exchanges for 1996 and beyond aggregate approximately 180,000 lines.\nFINANCING ACTIVITIES\nDebt increased by $630 in 1995, primarily due to the increase in capital expenditures. The percentage of debt to total capital at year-end 1995 was 66.0. During 1994, debt increased $451, though the percentage of debt to total capital declined to 65.8 at year-end 1994 from 67.6 at year-end 1993. The decrease in the percentage of debt to total capital in 1994 was primarily attributable to higher net income and issuances of equity.\nDuring 1995, U S WEST Communications refinanced $1.5 billion of commercial paper to take advantage of favorable long-term interest rates. In addition to the commercial paper, U S WEST Communications refinanced $145 of long-term debt. In 1993, U S WEST Communications refinanced $2.7 billion of long-term debt. Expenses associated with the refinancing of long-term debt resulted in extraordinary after-tax charges to income of $8 and $77, net of tax benefits of $5 and $48, in 1995 and 1993, respectively.\nU S WEST and U S WEST Communications maintain commercial paper programs to finance short-term cash flow requirements, as well as to maintain a presence in the short-term debt market. In addition, U S WEST Communications is permitted to borrow up to $600 under short-term lines of credit, all of which was available at December 31, 1995. Additional lines of credit aggregating approximately $1.3 billion are available to both the Media Group and the nonregulated subsidiaries in the Communications Group in accordance with their borrowing needs. Under registration statements filed with the Securities and Exchange Commission (\"SEC\"), as of December 31, 1995, U S WEST Communications is permitted to issue up to $320 of new debt securities. An additional $1.2 billion in securities is permitted to be issued under registration statements filed with the SEC to support the requirements of the Media Group and the nonregulated subsidiaries in the Communications Group.\nIn connection with U S WEST's February 27, 1996 announcement of a planned merger with Continental Cablevision, U S WEST, Inc.'s credit rating is being reviewed by credit rating agencies, which may result in a downgrading. The credit rating of U S WEST Communications was not placed under review by Moody's, has been reaffirmed by Duff and Phelps and is under review by Fitch and Standard & Poors.\nFinancing activities for the nonregulated Communications Group businesses and the Media Group, including the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of preferred securities, are managed by U S WEST on a centralized basis. Notwithstanding such centralized management, financing activities for U S WEST Communications are separately identified and accounted for in U S WEST's records and U S WEST Communications continues to conduct its own\nC-12\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) borrowing activities. Debt incurred and investments made by U S WEST and its subsidiaries on behalf of the nonregulated Communications Group businesses and all debt incurred and investments made by U S WEST Communications are specifically allocated and reflected on the financial statements of the Communications Group. All other debt incurred and investments made by U S WEST and its subsidiaries on behalf of the Media Group are specifically allocated to and reflected on the financial statements of the Media Group. Debt incurred by U S WEST or a subsidiary on behalf of a Group is charged to such Group at the borrowing rate of U S WEST or such subsidiary.\nINTEREST RATE RISK MANAGEMENT\nThe Communications Group is exposed to market risks arising from changes in interest rates. Derivative financial instruments are used to manage this risk. The Communications Group does not use derivative financial instruments for trading purposes.\nThe objective of the interest rate risk management program is to minimize the total cost of debt. Interest rate swaps are used to adjust the ratio of fixed-to variable-rate debt. The market value of the debt portfolio including the interest rate swaps is monitored and compared with predetermined benchmarks to evaluate the effectiveness of the risk management program.\nNotional amounts of interest rate swaps outstanding were $784 and $781 at December 31, 1995 and 1994, respectively, with various maturities extending to 2001. The estimated effect of U S WEST Communications' interest rate derivative transactions was to adjust the level of fixed-rate debt from 88 percent to 97 percent of the total debt portfolio at December 31, 1995, and from 76 percent to 86 percent of the total debt portfolio at December 31, 1994.\nIn conjunction with the 1993 debt refinancing, the Communications Group executed forward contracts to sell U.S. Treasury bonds to lock in the U.S. Treasury rate component of $1.5 billion of the future debt issue. At December 31, 1995, deferred credits of $8 and deferred charges of $51 on closed forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the new debt.\nCOMPETITIVE AND REGULATORY ENVIRONMENT\nMarkets served by the Communications Group, including markets for local, access and long-distance services, are being impacted by the rapid technological and regulatory changes occurring within the telecommunications industry. Current and potential competitors include local telephone companies, interexchange carriers, competitive access providers (\"CAPs\"), cable television companies and providers of personal communications services (\"PCS\").\nOn February 1, 1996, the House and Senate approved the Telecommunications Act of 1996 (the \"1996 Act\") which is intended to promote competition between local telephone companies, long-distance carriers and cable television operators. The 1996 Act was signed into law on February 8, 1996, and replaces the antitrust consent decree that broke up the \"Bell System\" in 1984. A major provision of the legislation includes the preemption of state regulations that govern competition by allowing local telephone companies, long-distance carriers and cable television companies to enter each other's lines of business. Consequently, the Regional Bell Operating Companies (\"RBOCs\") are immediately permitted to offer wireline interLATA toll services out of their regions. However, to participate in the interLATA long-distance market within their regions, the RBOCs must first open their local networks to facilities-based competition by satisfying a detailed checklist of requirements, including requirements related to interconnection and number portability.\nOther key provisions of the 1996 Act: (1) eliminate most of the regulation of cable television rates within three years and eliminate the ban on cross-ownership between cable television and telephone\nC-13\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) companies in small communities; (2) permit the RBOCs to develop new, competitive cable systems within their regions and to acquire or build wireless cable systems; (3) provide partial relief from the ban against manufacturing telecommunications equipment by the RBOCs; and (4) permit wireless operators to provide interLATA toll service in and out of region without a separate subsidiary and to jointly market or resell cellular service.\nThe FCC and state regulators have been given latitude in interpreting and overseeing the implementation of this legislation, including developing universal service funding policy. The extent and timing of future competition, including the Communications Group's ability to offer in-region interLATA long-distance services, will depend in part on the implementation guidelines determined by the FCC and state regulators, and how quickly the Communications Group can satisfy requirements of the checklist. The Communications Group estimates that fulfillment of the checklist requirements could occur in the majority of its states within 12 to 18 months.\nThe Communications Group believes that competitors will initially target high-volume business customers in densely populated urban areas. The resulting loss of local service customers will affect multiple revenue streams and could have a material, adverse effect on the Communications Group's operations. The resulting revenue losses, however, could be at least partially offset by the Communications Group's ability to bundle local, long-distance and wireless services, and provide interconnection services.\nThe Communications Group's strategy is to offer integrated communications, entertainment, information and transaction services over both wired and wireless networks to its customers primarily within its Region. The key initiatives to support this strategy include five key elements:\n- Providing superior customer service\n- Building customer loyalty\n- Enhancing network capability and capacity\n- Expanding the product and service portfolio\n- Ensuring a fair competitive environment\nStrategic initiatives to attract and retain customers include: (1) enhancing existing services with products such as caller identification, call waiting and voice messaging; (2) aggressive expansion of data services; (3) pursuing opportunities to offer paging, wireless and cable television services; and (4) rapid entry into the interLATA long-distance market.\nA market trial for a broadband network capable of providing voice, data and video services to customers commenced in the Omaha area in August 1995. The Communications Group does not intend to expand this service offering beyond the Omaha area because of service cost and pricing issues. The Communications Group does plan to continue to provide the system that delivers basic, premium and pay-per-view video services in the Omaha area. The Communications Group is evaluating the relative costs of alternative video technologies, as well as the near-term feasibility of interactive services. To satisfy anticipated demand for combined video and telephony services on a cost-effective basis, the Communications Group's strategy may include selective investments in wireless cable technologies.\nThe Communications Group is subject to varying degrees of federal and state regulation. The Communications Group's regulatory strategy includes working to:\n- Achieve accelerated capital recovery;\n- Reprice local services to cover costs and ensure these services are subsidy free, while lowering toll and access rates to meet competition; and\nC-14\nU S WEST COMMUNICATIONS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\n- Ensure that the new rules associated with the Telecommunications Act of 1996 concerning the unbundling of interconnection, resale of services and universal service do not advantage one competitor over another.\nThe Communications Group is currently working with state regulators to gain approval of these initiatives.\nOTHER REGULATORY ISSUES\nThe Communications Group's interstate services have been subject to price cap regulation since January 1991. Price caps are an alternative form of regulation designed to limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels. In March 1995, the FCC issued an interim order on price cap regulation. The price cap index for most services is annually adjusted for inflation, productivity level and exogenous costs, and has resulted in reduced access prices paid by interexchange carriers to local telephone companies. The interim order also provides for three productivity options, including a no-sharing option, and for increased flexibility for adjusting prices downward in response to competition. In 1995, the Communications Group selected the lowest productivity option while, prior to this interim order, the Communications Group used an optional higher productivity factor in determining its prices. Consequently, the Communications Group expects the order to have no significant near-term impact.\nThere are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing two exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. This action is still in the discovery process. If a formal filing -- made in accordance with the remand from the Supreme Court -- alleges that the exceptions apply, the range of possible risk is $0 to $150.\nUNION CONTRACT\nOn October 2, 1995, union members approved a new three-year contract with U S WEST. The contract provides for salary increases of 10.6 percent over three years effective January 1 of each year. The contract also provides employees with a lump sum payment of $1,500 in lieu of wage increases becoming effective in August of each year. This lump sum payment is being recognized over the life of the contract. The agreement covers approximately 30,000 Communications Workers of America members who work for the Communications Group.\nC-15\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowners of U S WEST, Inc.:\nWe have audited the Combined Balance Sheets of U S WEST Communications Group (as described in Note 2 to the Combined Financial Statements) as of December 31, 1995 and 1994, and the related Combined Statements of 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 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 U S WEST Communications Group as of 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.\nAs more fully discussed in Note 2, the Combined Financial Statements of U S WEST Communications Group should be read in connection with the audited Consolidated Financial Statements of U S WEST, Inc.\nAs discussed in Note 5 to the Combined Financial Statements, U S WEST Communications Group discontinued accounting for the operations of U S WEST Communications, Inc. in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1993.\nCOOPERS & LYBRAND L.L.P.\nDenver, Colorado February 12, 1996\nC-16\nU S WEST COMMUNICATIONS GROUP COMBINED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the Combined Financial Statements.\nC-17\nU S WEST COMMUNICATIONS GROUP COMBINED BALANCE SHEETS ASSETS\nThe accompanying notes are an integral part of the Combined Financial Statements.\nC-18\nU S WEST COMMUNICATIONS GROUP COMBINED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the Combined Financial Statements.\nC-19\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nNOTE 1: RECAPITALIZATION PLAN On October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\"), voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors of U S WEST, Inc. (the \"Board\") to reincorporate in Delaware and create two classes of common stock that are intended to reflect separately the performance of the communications and multimedia businesses. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\"), and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\"). Effective November 1, 1995, each share of common stock of U S WEST Colorado was converted into one share each of Communications Stock and Media Stock.\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nThe Communications Group is comprised of U S WEST Communications, Inc. (\"U S WEST Communications\"), U S WEST Communications Services, Inc., U S WEST Federal Services, Inc., U S WEST Advanced Technologies, Inc. and U S WEST Business Resources, Inc. The Communications Group primarily provides regulated communications services to more than 25 million residential and business customers within a 14 state region.\nThe Media Group is comprised of U S WEST Marketing Resources Group, Inc., which publishes White and Yellow Pages telephone directories, and provides directory and information services, U S WEST NewVector Group, Inc., which provides communications and information products and services over wireless networks, U S WEST Multimedia Communications, Inc., which owns domestic cable television operations and investments, and U S WEST International Holdings, Inc., which primarily owns investments in international cable and telecommunications, wireless communications and directory publishing operations.\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The Combined Financial Statements of the Groups comprise all of the accounts included in the corresponding Consolidated Financial Statements of U S WEST. Investments in less than majority-owned ventures are generally accounted for using the equity method. The separate Group Combined Financial Statements have been prepared on a basis that management believes to be reasonable and appropriate and include: (i) the combined historical balance sheets, results of operations and cash flows of the businesses that comprise each of the Groups, with all significant intra-group amounts and transactions eliminated; (ii) in the case of the Communications Group Combined Financial Statements, certain corporate assets and liabilities of U S WEST and related transactions identified with the Communications Group; (iii) in the case of the Media Group Combined Financial Statements, all other corporate assets and liabilities and related transactions of U S WEST; and (iv) an allocated portion of the corporate expense of U S WEST. Transactions between the Communications Group and the Media Group have not been eliminated.\nNotwithstanding the allocation of assets and liabilities (including contingent liabilities) and stockholders' equity between the Communications Group and the Media Group for the purpose of preparing the respective financial statements of such Group, holders of Communications Stock and Media Stock are subject to risks associated with an investment in a single company and all of U S WEST's businesses, assets and liabilities. Such allocation of assets and liabilities and change in the equity structure of U S WEST does\nC-20\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) not result in a distribution or spin-off to shareholders of any assets or liabilities of U S WEST or any of its subsidiaries or otherwise affect responsibility for the liabilities of U S WEST or such subsidiaries. As a result, the rights of the holders of U S WEST or any of its subsidiaries' debt are not affected. Financial effects arising from either Group that affect U S WEST's results of operations or financial condition could, if significant, affect the results of operations or financial position of the other Group or the market price of the class of common stock relating to the other Group. Any net losses of the Communications Group or the Media Group, and dividends or distributions on, or repurchases of Communications Stock, Media Stock or preferred stock, will reduce the funds of U S WEST legally available for payment of dividends on both the Communications Stock and Media Stock. Accordingly, the Communications Group Combined Financial Statements should be read in conjunction with U S WEST's Consolidated Financial Statements and the Media Group Combined Financial Statements.\nThe accounting policies described herein applicable to the preparation of the Combined Financial Statements of the Communications Group may be modified or rescinded at the sole discretion of the Board without approval of the stockholders, although there is no present intention to do so. The Board may also adopt additional policies depending on the circumstances. Any determination of the Board to modify or rescind such policies, or to add additional policies, including any decision that would have disparate impacts upon holders of Communications Stock and Media Stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of all U S WEST stockholders, including the holders of Communications Stock and the holders of Media Stock. In making such determination, the Board may also consider regulatory requirements imposed on U S WEST Communications by the public utility commissions of various states and the Federal Communications Commission. In addition, generally accepted accounting principles require that any change in accounting policy be preferable (in accordance with such principles) to the policy previously established.\nCertain reclassifications within the Combined Financial Statements have been made to conform to the current year presentation.\nALLOCATION OF SHARED SERVICES Certain costs relating to U S WEST's general and administrative services (including certain executive management, legal, tax, accounting and auditing, treasury, strategic planning and public policy services) are directly assigned by U S WEST to each Group based on actual utilization or are allocated based on each Group's operating expenses, number of employees, external revenues, average capital and\/or average equity. U S WEST charges each Group for such services at fully distributed cost. These direct and indirect allocations were $116, $110 and $117 in 1995, 1994 and 1993, respectively. In 1995, the direct allocations comprised approximately 37 percent of the total shared corporate services allocated to the Communications Group. It is not practicable to provide a detailed estimate of the expenses which would be recognized if the Communications Group was a separate legal entity. However, U S WEST believes that under the Recapitalization Plan, each Group benefits from synergies with the other, including having lower operating costs than might be incurred if each Group was a separate legal entity.\nALLOCATION OF INCOME TAXES Federal, state and local income taxes, which are determined on a consolidated or combined basis, are allocated to each Group in accordance with tax sharing agreements between U S WEST and the entities within the Groups. The allocations will generally reflect each Group's contribution (positive or negative) to consolidated taxable income and consolidated tax credits. A Group will be compensated only at such time as, and to the extent that, its tax attributes are utilized by U S WEST in a combined or consolidated income tax filing. Federal and state tax refunds and carryforwards or carrybacks of tax attributes will generally be allocated to the group to which such tax attributes relate.\nGROUP FINANCING Financing activities for the nonregulated Communications Group businesses and the Media Group, including the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of preferred securities are managed by U S WEST on a centralized basis. Financing\nC-21\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) activities for U S WEST Communications are separately identified and accounted for in U S WEST's records and U S WEST Communications conducts its own borrowing activities. Debt incurred and investments made by U S WEST and its subsidiaries on behalf of the nonregulated Communications Group businesses and all debt incurred and investments made by U S WEST Communications are specifically allocated to and reflected on the financial statements of the Communications Group. All debt incurred and investments made by U S WEST and its subsidiaries on behalf of the Media Group are specifically allocated to and reflected on the financial statements of the Media Group. Debt incurred by U S WEST or a subsidiary on behalf of a Group is charged to such Group at the borrowing rate of U S WEST or such subsidiary.\nAs of November 1, 1995, the effective date of the Recapitalization Plan, U S WEST does not intend to transfer funds between the Groups, except for certain short-term, ordinary course advances of funds at market rates associated with U S WEST's centralized cash management program for the nonregulated businesses. Such short-term transfers of funds will be accounted for as short-term loans between the Groups bearing interest at the market rate at which management determines the borrowing Group could obtain funds on a short-term basis. If the Board, in its sole discretion, determines that a transfer of funds between the Groups should be accounted for as a long-term loan, the Board would establish the terms on which such loan would be made, including the interest rate, amortization schedule, maturity and redemption terms. Such terms would generally reflect the then prevailing terms upon which management determines such Group could borrow funds on a similar basis. The financial statements of the lending Group will be credited, and the financial statements of the borrowing Group will be charged, with the amount of any such loan, as well as with periodic interest accruing thereon. The Board may determine that a transfer of funds from the Communications Group to the Media Group should be accounted for as an equity contribution, in which case an inter-group interest (determined by the Board based on the then current market value of shares of Media Stock) will either be created or increased, as applicable. Similarly, if an inter-group interest exists, the Board may determine that a transfer of funds from the Media Group to the Communications Group should be accounted for as a reduction in the inter-group interest.\nDIVIDENDS Dividends on the Communications Stock will be paid at the discretion of the Board based primarily upon the financial condition, results of operations and business requirements of the Communications Group and U S WEST as a whole. Dividends will be payable out of the lesser of: 1) the funds of U S WEST legally available for the payment of dividends; and 2) the Communications Group Available Dividend Amount.\nThe Communications Group Available Dividend Amount on any date, shall mean the excess, if any, of: 1) the amount equal to the fair market value of the total assets attributed to the Communications Group less the total amount of the liabilities attributed to the Communications Group (provided that preferred stock shall not be treated as a liability), in each case as of such date and determined on a basis consistent with that applied in determining the Communications Group net earnings (loss) over; 2) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding shares of Communications Stock and each class or series of preferred stock attributed to the Communications Group.\nEARNINGS PER COMMON SHARE Earnings per common share for 1995 and 1994 have been presented on a pro forma basis to reflect the Communications Stock as if it had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST.\nINDUSTRY SEGMENT The businesses comprising the Communications Group operate in a single industry segment as defined in Statement of Financial Accounting Standards (\"SFAS\") No. 14, \"Financial Reporting for Segments of a Business Enterprise.\" The Communications Group primarily provides regulated communications services to more than 25 million residential and business customers in the Communications Group region (the \"Region\"). The Region includes the states of Arizona, Colorado, Idaho, Iowa, Minnesota,\nC-22\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. Services offered by the Communications Group include local telephone services, exchange access services (which connect customers to the facilities of carriers, including long-distance providers and wireless operators), and long-distance services within Local Access and Transport Areas (\"LATAs\") in the Region. The Communications Group provides other products and services, including custom calling, voice messaging, caller identification, high-speed data applications, customer premises equipment and certain communications services to business customers and governmental agencies both inside and outside the Region.\nApproximately 97 percent of the revenues of the Communications Group are attributable to the operations of U S WEST Communications, of which approximately 59 percent are derived from the states of Arizona, Colorado, Minnesota and Washington.\nSIGNIFICANT CONCENTRATIONS The largest volume of the Communications Group's services are provided to AT&T. During 1995, 1994 and 1993, revenues related to those services provided to AT&T were $1,085, $1,130 and $1,159, respectively. Related accounts receivable at December 31, 1995 and 1994, totaled $91 and $98, respectively. As of December 31, 1995, the Communications Group is not aware of any other significant concentration of business transacted with a particular customer, supplier or lender that could, if suddenly eliminated, severely impact operations.\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.\nCASH AND CASH EQUIVALENTS Cash and cash equivalents include highly liquid investments with original maturities of three months or less that are readily convertible into cash and are not subject to significant risk from fluctuations in interest rates.\nINVENTORIES AND SUPPLIES New and reusable materials of U S WEST Communications are carried at average cost, except for significant individual items that are valued based on specific costs. Nonreusable material is carried at its estimated salvage value. Inventories of the Communications Group's nontelephone operations are carried at the lower of cost or market on a first-in, first-out basis.\nPROPERTY, PLANT AND EQUIPMENT The investment in property, plant and equipment is carried at cost, less accumulated depreciation. Additions, replacements and substantial betterments are capitalized. Costs for normal repair and maintenance of property, plant and equipment are expensed as incurred.\nU S WEST Communications' provision for depreciation of property, plant and equipment is based on various straight-line group methods using remaining useful (economic) lives based on industry-wide studies. In third quarter 1993, U S WEST Communications discontinued accounting for its regulated telephone operations under SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" (See Note 5 to the Combined Financial Statements.) Prior to discontinuing SFAS No. 71, depreciation was based on lives specified by regulators.\nWhen the depreciable property, plant and equipment of U S WEST Communications is retired or sold, the original cost less the net salvage value is generally charged to accumulated depreciation. The nontelephone operations of the Communications Group provide for depreciation using the straight-line method. When such depreciable property, plant and equipment is retired or sold, the resulting gain or loss is included in income.\nC-23\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Interest related to qualifying construction projects is capitalized and reflected as a reduction of interest expense. At U S WEST Communications, prior to discontinuing SFAS No. 71, capitalized interest was included as an element of other income. Amounts capitalized by the Communications Group were $39, $36 and $15 in 1995, 1994 and 1993, respectively.\nREVENUE RECOGNITION Local telephone service revenues are generally billed monthly, in advance, and revenues are recognized the following month when services are provided. Revenues derived from exchange access and long-distance services are billed and recorded monthly as services are provided.\nFINANCIAL INSTRUMENTS Net interest received or paid on interest rate swaps is recognized over the life of the swaps as an adjustment to interest expense. Gains and losses on forward contracts are deferred and recognized as an adjustment to interest expense over the life of the underlying debt. Currency swaps entered into to convert foreign debt to dollar-denominated debt are combined with the foreign currency debt and accounted for as if fixed-rate, dollar-denominated debt were issued directly.\nCOMPUTER SOFTWARE The cost of computer software, whether purchased or developed internally, is charged to expense with two exceptions. Initial operating systems software is capitalized and amortized over the life of the related hardware, and initial network applications software is capitalized and amortized over three years. Subsequent upgrades to capitalized software are expensed. Capitalized computer software of $183 and $146 at December 31, 1995 and 1994, respectively, is recorded in property, plant and equipment. Amortization of capitalized computer software costs totaled $69, $61 and $37 in 1995, 1994 and 1993, respectively.\nINCOME TAXES The provision for income taxes consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods in accordance with SFAS No. 109. The Communications Group implemented SFAS No. 109, \"Accounting for Income Taxes,\" in 1993. Adoption of the new standard did not have a material effect on the financial position or results of operations, primarily because of U S WEST's earlier adoption of SFAS No. 96.\nFor financial statement purposes, investment tax credits of U S WEST Communications are being amortized over the economic lives of the related property, plant and equipment in accordance with the deferred method of accounting for such credits.\nNEW ACCOUNTING STANDARDS In 1996, U S WEST will adopt 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 long-lived assets and associated intangibles be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. SFAS No. 121 also requires that a company no longer record depreciation expense on assets held for sale. U S WEST expects that the adoption of SFAS No. 121 will not have a material effect on its financial position or results of operations.\nIn 1996, U S WEST will adopt SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard establishes a fair value method for accounting for stock-based compensation plans either through recognition or disclosure. U S WEST will adopt this standard through compliance with the disclosure requirements set forth in SFAS No. 123. Adoption of the standard will have no impact on the financial position or results of operations of U S WEST.\nC-24\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3: RELATED PARTY TRANSACTIONS\nCUSTOMER LISTS, BILLING AND COLLECTION SERVICES, AND OTHER SERVICES U S WEST Communications sells customer lists, billing and collection services, and other services to the domestic publishing operations of the Media Group. These data and services are sold at market price. However, the accounting and reporting for regulatory purposes is in accordance with regulatory requirements. U S WEST Communications charged $20, $29 and $26 for these services in 1995, 1994 and 1993, respectively.\nTELECOMMUNICATIONS SERVICES U S WEST Communications sells telecommunications network access and usage to the domestic cellular operations of the Media Group. U S WEST Communications charged $40, $30 and $24 in 1995, 1994 and 1993, respectively, for these services.\nBELL COMMUNICATIONS RESEARCH, INC. (\"BELLCORE\") Charges relating to research, development and maintenance of existing technologies performed by Bellcore, of which U S WEST Communications has a one-seventh ownership interest, were $84, $111 and $113 in 1995, 1994 and 1993, respectively.\nNOTE 4: RESTRUCTURING CHARGE The Communications Group's 1993 results reflected an $880 restructuring charge (pretax). The related restructuring plan (the \"Restructuring Plan\") is designed to provide faster, more responsive customer services while reducing the costs of providing these services. As part of the Restructuring Plan, the Communications Group is developing new systems and enhanced system functionality that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, rapidly design and engineer new products and services for customers, and centralize its service centers. The Communications Group has consolidated its 560 customer service centers into 26 centers in 10 cities and plans on reducing its work force by approximately 10,000 employees. Approximately 1,000 employees that were originally expected to relocate have chosen separation or other job assignments and have been replaced. This increased the number of employee separations to 10,000 from 9,000, and increased the estimated total cost for employee separations to $311, compared with $281 in the original estimate. The $30 cost associated with these additional employee separations was reclassified from relocation to the reserve for employee separations during 1995.\nFollowing is a schedule of the costs included in the 1993 restructuring charge:\n- ------------------------------ 1 Employee-separation costs, including the balance of a 1991 restructuring reserve at December 31, 1993, aggregate $311.\nEmployee separation costs include severance payments, health-care coverage and postemployment education benefits. Systems development costs include new systems and the application of enhanced system functionality to existing single purpose systems to provide integrated end-to-end customer service. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the new service centers and retraining employees on the methods and systems required in the new, restructured mode of operation.\nC-25\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4: RESTRUCTURING CHARGE (CONTINUED) The following table shows amounts charged to the restructuring reserve:\n- ------------------------------ (1) Includes $56 associated with work-force reductions under a 1991 restructuring plan.\nEmployee separations under the Restructuring Plan in 1995 and 1994 were as follows:\nThe Restructuring Plan is expected to be substantially completed by the end of 1997. Implementation of the Restructuring Plan has been impacted by growth in the business and related service issues, new business opportunities, revisions to system delivery schedules and productivity issues caused by the major rearrangement of resources due to restructuring. These issues will continue to affect the timing of employee separations.\nNOTE 5: PROPERTY, PLANT AND EQUIPMENT The composition of property, plant and equipment follows:\nC-26\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5: PROPERTY, PLANT AND EQUIPMENT (CONTINUED) In 1995, U S WEST Communications sold certain rural telephone exchanges with a cost basis of $258. U S WEST Communications received consideration for the sales of $388, including $214 in cash. In 1994, U S WEST Communications sold certain rural telephone exchanges with a cost basis of $122 and received consideration of $204, including $93 in cash.\nDISCONTINUANCE OF SFAS NO. 71\nU S WEST Communications incurred a noncash, extraordinary charge of $3.1 billion, net of an income tax benefit of $2.3 billion, in conjunction with its decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" as of September 30, 1993. SFAS No. 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, notwithstanding competition, by charging its customers at prices established by its regulators. U S WEST Communications' decision to discontinue application of SFAS No. 71 was based on the belief that competition, market conditions and technological advances, more than prices established by regulators, will determine the future cost recovery by U S WEST Communications. As a result of this change, the remaining asset lives of U S WEST Communications' plant were shortened to more closely reflect the useful (economic) lives of such plant.\nFollowing is a list of the major categories of telephone property, plant and equipment and the manner in which depreciable lives were affected by the discontinuance of SFAS No. 71:\nU S WEST Communications employed two methods to determine the amount of the extraordinary charge. The \"economic life\" method assumed that a portion of the plant-related effect is a regulatory asset that was created by the under-depreciation of plant under regulation. This method yielded the plant-related adjustment that was confirmed by the second method, a discounted cash flows analysis.\nFollowing is a schedule of the nature and amounts of the after-tax charge recognized as a result of U S WEST Communications' discontinuance of SFAS No. 71:\nC-27\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6: DEBT\nSHORT-TERM DEBT\nThe components of short-term debt follow:\nThe weighted average interest rate on commercial paper was 5.79 percent and 5.92 percent at December 31, 1995 and 1994, respectively.\nU S WEST and U S WEST Communications maintain commercial paper programs to finance short-term cash flow requirements, as well as to maintain a presence in the short-term debt market. In addition, U S WEST Communications, which conducts its own borrowing activities, is permitted to borrow up to $600 under short-term lines of credit, all of which was available at December 31, 1995. Additional lines of credit aggregating approximately $1.3 billion are available to both the Media Group and the nonregulated subsidiaries of the Communications Group in accordance with their borrowing needs.\nLONG-TERM DEBT\nInterest rates and maturities of long-term debt at December 31 follow:\nLong-term debt consists principally of debentures, medium-term notes and zero coupon subordinated notes convertible at any time into equal shares of Communications Stock and Media Stock. The zero coupon notes have a yield to maturity of approximately 7.3 percent. The zero coupon notes are recorded at a discounted value of $276 and $264 at December 31, 1995 and 1994, respectively.\nDuring 1995, U S WEST Communications refinanced $1.5 billion of commercial paper to take advantage of favorable long-term interest rates. In addition to the commercial paper, U S WEST Communications refinanced $145 of long-term debt. Expenses associated with the refinancing of long-term debt resulted in extraordinary charges to income of $8, net of tax benefits of $5.\nDuring 1993, U S WEST Communications refinanced long-term debt issues aggregating $2.7 billion in principal amount. Expenses associated with the refinancing resulted in an extraordinary charge to income of $77, net of a tax benefit of $48.\nC-28\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6: DEBT (CONTINUED) Interest payments by the Communications Group, net of amounts capitalized, were $378, $356 and $398 in 1995, 1994 and 1993, respectively.\nINTEREST RATE RISK MANAGEMENT\nU S WEST Communications enters into interest rate swap agreements to effectively convert existing commercial paper to fixed-rate debt. This allows U S WEST Communications to achieve interest savings over issuing fixed-rate debt directly.\nUnder an interest rate swap, U S WEST Communications agrees with another party to exchange interest payments at specified intervals over a defined term. Interest payments are calculated by reference to the notional amount based on the fixed- and variable-rate terms of the swap agreements. The net interest received or paid as part of the interest rate swap is accounted for as an adjustment to interest expense.\nDuring 1995 and 1994, U S WEST Communications entered into currency swaps to convert Swiss franc-denominated debt to dollar-denominated debt. This allowed U S WEST Communications to achieve interest savings over issuing fixed-rate, dollar-denominated debt. The currency swap and foreign currency debt are combined and accounted for as if fixed-rate, dollar-denominated debt were issued directly.\nThe following table summarizes terms of swaps pertaining to U S WEST Communications as of December 31, 1995 and 1994. Variable rates are indexed to two- and ten-year constant maturity Treasury and 30-day commercial paper rates.\nIn 1993, U S WEST Communications executed forward contracts to sell U.S. Treasury bonds to lock in the U.S. Treasury rate component of the future debt issue. At December 31, 1995, deferred credits of $8 and deferred charges of $51 on closed forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the debt issuance. At December 31, 1995, there were no open forward contracts.\nThe counterparties to these interest rate contracts are major financial institutions. U S WEST Communications is exposed to credit loss in the event of nonperformance by these counterparties. U S WEST manages this exposure by monitoring the credit standing of the counterparty and establishing dollar and term limitations which correspond to the respective credit rating of each counterparty. U S WEST Communications does not have significant exposure to an individual counterparty and does not anticipate nonperformance by any counterparty.\nNOTE 7: FAIR VALUES OF FINANCIAL INSTRUMENTS\nFair values of cash equivalents, other current amounts receivable and payable, and short-term debt approximate carrying values due to their short-term nature.\nThe fair values of interest rate swaps are based on estimated amounts U S WEST Communications would receive or pay to terminate such agreements taking into account current interest rates and creditworthiness of the counterparties.\nC-29\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)\nNOTE 7: FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) The fair values of long-term debt are based on quoted market prices where available or, if not available, are based on discounting future cash flows using current interest rates.\nNOTE 8: LEASING ARRANGEMENTS Certain subsidiaries within the Communications Group have entered into operating leases for office facilities, equipment and real estate. Rent expense under operating leases was $210, $235 and $228 in 1995, 1994 and 1993, respectively. Minimum future lease payments as of December 31, 1995, under noncancelable operating leases, follow:\nNOTE 9: COMMUNICATIONS GROUP EQUITY Following are changes in the Communications Group equity for the periods presented:\nU S WEST has issued 1.7 million shares of Communications Stock since the November 1, 1995 recapitalization and has 473,635,025 shares outstanding at December 31, 1995.\nLEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN (\"LESOP\") The Communications Group and the Media Group participate in the defined contribution savings plan sponsored by U S WEST. Substantially all employees of the Communications Group are covered by the plan. U S WEST matches a percentage of eligible employee contributions with shares of Communications Stock and\/or Media Stock in accordance with participant elections. Participants may also elect to reallocate past Company contributions between Communications Stock and Media Stock. In 1989, U S WEST established two LESOPS to provide Company stock for matching contributions to the savings plan. Shares in the LESOP are released as principal and\nC-30\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9: COMMUNICATIONS GROUP EQUITY (CONTINUED) interest are paid on the debt. At December 31, 1995, 10,145,485 shares each of Communications Stock and Media Stock had been allocated from the LESOP, while 2,839,435 shares each of Communications Stock and Media Stock remained unallocated.\nThe borrowings associated with the LESOP, which are unconditionally guaranteed by U S WEST, are reflected in the Media Group Combined Financial Statements. Contributions from the Communications Group and the Media Group, as well as dividends on unallocated shares held by the LESOP ($8, $11 and $14 in 1995, 1994 and 1993, respectively), are used for debt service. Beginning with the dividend paid in fourth-quarter 1995, dividends on allocated shares are being paid annually to participants. Previously, dividends on allocated shares were used for debt service with participants receiving additional shares from the LESOP. Tax benefits related to dividend payments on eligible shares in the savings plan have been allocated to the Communications Group, which paid the dividends.\nU S WEST recognizes expense based on the cash payments method. Contributions to the plan related to the Communications Group, excluding dividends, were $70, $68 and $68 in 1995, 1994 and 1993, respectively, of which $12, $16 and $20, respectively, have been classified as interest expense.\nNOTE 10: STOCK INCENTIVE PLANS U S WEST maintains stock incentive plans for executives and key employees, and nonemployees. The Amended 1994 Stock Plan (the \"Plan\") was approved by shareowners on October 31, 1995 in connection with the Recapitalization Plan. The Plan is a successor plan to the U S WEST, Inc. Stock Incentive Plan and the U S WEST 1991 Stock Incentive Plan (the \"Predecessor Plans\"). No further grants of options or restricted stock may be made under the Predecessor Plans. The Plan is administered by the Human Resources Committee of the board of directors with respect to officers, executive officers and outside directors and by a special committee with respect to all other eligible employees and eligible nonemployees.\nDuring calendar year 1995, up to 2,200,000 shares of Communications Stock were available for grant. The maximum aggregate number of shares of Communications Stock that may be granted in any other calendar year for all purposes under the Plan is nine-tenths of one percent (0.90 percent) of the shares of such class outstanding (excluding shares held in the Company's treasury) on the first day of such calendar year. In the event that fewer than the full aggregate number of shares of either class available for issuance in any calendar year are issued in any such year, the shares not issued shall be added to the shares of such class available for issuance in any subsequent year or years. Options may be exercised no later than 10 years after the date on which the option was granted.\nC-31\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10: STOCK INCENTIVE PLANS (CONTINUED) Data for outstanding options under the Plan is summarized as follows:\n- ------------------------------ * Includes options granted in tandem with SARs.\nOptions to purchase 2,672,666 shares of Communications Stock were exercisable at December 31, 1995. Options to purchase 2,374,394 shares of U S WEST stock were exercisable at December 31, 1994. A total of 2,050,466 shares of Communications Stock were available for grant under the plans in effect at December 31, 1995. A total of 914,816 shares of U S WEST common stock were available for grant under the plans in effect at December 31, 1994. A total of 11,484,792 shares of Communications Stock were reserved for issuance at December 31, 1995.\nNOTE 11: EMPLOYEE BENEFITS\nPENSION PLAN\nThe Communications Group and the Media Group participate in the defined benefit pension plan sponsored by U S WEST. Substantially all management and occupational employees of the Communications Group are covered by the plan. Since plan assets are not segregated into separate accounts or restricted to providing benefits to employees of the Communications Group, assets of the plan may be used to provide benefits to employees of both the Communications Group and the Media Group. In the event the single employer pension plan sponsored by U S WEST would be separated into two or more plans, guidelines in the Internal Revenue Code dictate how assets of the plan must be allocated to the new plans. U S WEST currently has no intention to split the plan. Because of these factors, U S WEST believes there is no reasonable basis to attribute plan assets to the Communications Group as if they had funded separately their actuarially determined obligation.\nC-32\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: EMPLOYEE BENEFITS (CONTINUED) Management benefits are based on a final pay formula while occupational benefits are based on a flat benefit formula. U S WEST uses the projected unit credit method for the determination of pension cost for financial reporting purposes and the aggregate cost method for funding purposes. U S WEST's policy is to fund amounts required under the Employee Retirement Income Security Act of 1974 (\"ERISA\") and no funding was required in 1995, 1994 or 1993. Should funding be required in the future, funding amounts would be allocated to the Communications Group based upon the ratio of service cost of the Communications Group to total service cost of plan participants.\nThe composition of the net pension cost and the actuarial assumptions of the plan follow:\nThe expected long-term rate of return on plan assets used in determining net pension cost was 8.50 percent for 1995, 8.50 percent for 1994 and 9.00 percent for 1993.\nThe funded status of the U S WEST plan follows:\nThe actuarial assumptions used to calculate the projected benefit obligation follow:\nAnticipated future benefit changes have been reflected in the above calculations.\nALLOCATION OF PENSION COSTS U S WEST's allocation policy is to: 1) offset the Company-wide service cost, interest cost and amortization by the return on plan assets; and 2) allocate the remaining net pension cost to the Communications Group based on the ratio of actuarially determined service cost of the Communications Group to total service cost of plan participants. U S WEST believes allocating net pension cost based on service cost is reasonable since service cost is a primary factor in determining pension cost. Net\nC-33\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: EMPLOYEE BENEFITS (CONTINUED) pension costs allocated to the Communications Group were $(2), $0 and $(71) in 1995, 1994 and 1993, respectively. The service and interest costs for 1995 and the projected benefit obligation at December 31, 1995 attributed to the Communications Group were $149, $529 and $8,021, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Communications Group and the Media Group participate in plans sponsored by U S WEST which provide certain health care and life insurance benefits to retired employees. In conjunction with the Company's 1992 adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" U S WEST elected to immediately recognize the accumulated postretirement benefit obligation for current and future retirees. However, the Federal Communications Commission and certain state jurisdictions permit amortization of the transition obligation over the average remaining service period of active employees for regulatory accounting purposes with most jurisdictions requiring funding as a stipulation for rate recovery.\nU S WEST uses the projected unit credit method for the determination of postretirement medical and life costs for financial reporting purposes. The composition of net postretirement benefit costs and actuarial assumptions underlying plan benefits follow:\nThe expected long-term rate of return on plan assets used in determining postretirement benefit costs was 8.50 percent for 1995, 8.50 percent in 1994 and 9.00 percent in 1993.\nThe funded status of the plans follows:\n- ------------------------------ (1) Medical plan assets include Communications Stock of $210 and Media Stock of $112 in 1995, and U S WEST common stock of $164 in 1994.\nC-34\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: EMPLOYEE BENEFITS (CONTINUED) The actuarial assumptions used to calculate the accumulated postretirement benefit obligation follow:\n- ------------------------------ * Medical cost trend rate gradually declines to an ultimate rate of 5 percent in 2011.\nA one-percent increase in the assumed health care cost trend rate for each future year would have increased the aggregate of the service and interest cost components of 1995 net postretirement benefit cost by approximately $40 and increased the 1995 accumulated postretirement benefit obligation by approximately $350.\nAnticipated future benefit changes have been reflected in these postretirement benefit calculations.\nPLAN ASSETS Assets of the postretirement medical and life plans may be used to provide benefits to employees of both the Communications Group and the Media Group since plan assets are not legally restricted to providing benefits to either Group. In the event that either plan sponsored by U S WEST would be separated into two or more plans, there are no guidelines in the Internal Revenue Code for allocating assets of the plan. U S WEST allocates the assets based on historical contributions for postretirement medical costs, and on the ratio of salaries for life plan participants. U S WEST currently has no intention to split the plans.\nPOSTRETIREMENT MEDICAL COSTS The service and interest components of net postretirement medical benefit costs are calculated for the Communications Group based on the population characteristics of the Group. Since funding of postretirement medical costs is voluntary, return on assets is attributed to the Communications Group based on historical funding. The Communications Group's annual funding amount is based on its cash requirements with the funding at U S WEST Communications based on regulatory accounting requirements.\nNet postretirement medical benefit costs recognized by the Communications Group for 1995, 1994 and 1993 were $189, $207 and $238, respectively. The percentage of postretirement medical assets attributed to the Communications Group at December 31, 1995 and 1994, based on historical voluntary contributions, was 96 and 95 percent, respectively. The accumulated postretirement medical benefit obligation attributed to the Communications Group was $3,057 at December 31, 1995.\nALLOCATION OF POSTRETIREMENT LIFE COSTS Net postretirement life costs, and funding requirements, if any, are allocated to the Communications Group in the same manner as pensions. U S WEST will generally fund the amount allowed for tax purposes and no funding of postretirement life insurance occurred in 1995, 1994 and 1993. U S WEST believes its method of allocating postretirement life costs is reasonable.\nNet postretirement life benefit costs allocated to the Communications Group for 1995, 1994 and 1993 were $0, $19 and $14, respectively. The service and interest costs for 1995 and the accumulated postretirement life benefit obligation at December 31, 1995 attributed to the Communications Group were $5, $29, $425, respectively.\nC-35\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12: INCOME TAXES The components of the provision for income taxes follow:\nThe unamortized balance of investment tax credits at December 31, 1995 and 1994, was $199 and $231, respectively.\nAmounts for income taxes paid by the Communications Group were $511, $491 and $297 in 1995, 1994 and 1993, respectively.\nThe effective tax rate differs from the statutory tax rate as follows:\nC-36\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12: INCOME TAXES (CONTINUED) The components of the net deferred tax liability follow:\nThe current portion of the deferred tax asset was $259 and $300 at December 31, 1995 and 1994, respectively, resulting primarily from restructuring charges and compensation related items.\nOn August 10, 1993, federal legislation was enacted which increased the corporate tax rate from 34 percent to 35 percent retroactive to January 1, 1993. The cumulative effect on deferred taxes of the 1993 increase in income tax rates was $54.\nNOTE 13: CONTINGENCIES At U S WEST Communications there are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing two exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. This action is still in the discovery process. If a formal filing - made in accordance with the remand from the Supreme Court - alleges that the exceptions apply, the range of possible risk to U S WEST Communications is $0 to $150.\nC-37\nU S WEST COMMUNICATIONS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14: QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------------------------\nEffective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of Communications Stock and Media Stock. Earnings per common share have been presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n1995 first-quarter net income includes $39 ($0.08 per share) from a gain on the sales of certain rural telephone exchanges. 1995 second-quarter net income includes $10 ($0.02 per share) from a gain on the sales of certain rural telephone exchanges. 1995 third-quarter net income includes $21 ($0.04 per share) from a gain on the sales of certain rural telephone exchanges and $5 ($0.01 per share) for expenses associated with the Recapitalization Plan. 1995 third-quarter net income also includes a charge of $5 ($0.01 per share) for the early extinguishment of debt. 1995 fourth-quarter net income includes $15 ($0.03 per share) from a gain on the sales of certain rural telephone exchanges and other charges of $6 ($0.01 per share), including an extraordinary charge of $3 for the early extinguishment of debt and $3 for expenses associated with the Recapitalization Plan.\n1994 net income includes gains on the sales of rural telephone exchanges of $15 ($0.03 per share), $16 ($0.04 per share) and $20 ($0.04 per share) for first quarter, second quarter and fourth quarter, respectively.\nC-38\nU S WEST MEDIA GROUP FINANCIAL HIGHLIGHTS\nPROPORTIONATE DATA(6)\n- ------------------------------ (1) Earnings before interest, taxes, depreciation, amortization, and other (\"EBITDA\"). EBITDA also excludes gains on asset sales, equity losses and guaranteed minority interest expense.\n(2) 1995 income from continuing operations before extraordinary item includes a gain of $95 from the merger of U S WEST's joint venture interest in TeleWest plc with SBC CableComms (UK) and costs of $9 associated with the November 1, 1995 recapitalization. 1994 income from continuing operations before extraordinary item includes a gain of $105 on the partial sale of U S WEST's joint venture interest in TeleWest and a gain of $41 on the sale of U S WEST's paging operation. 1993 and 1991 income from continuing operations before extraordinary item was reduced by restructuring charges of $76 and $57, respectively.\n(3) Excludes debt associated with the capital assets segment, which has been discontinued and is held for sale.\n(4) Includes Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely Company-guaranteed debentures of $600 in 1995 and preferred stock subject to mandatory redemption of $51 in 1995 and 1994.\n(5) Effective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of U S WEST Communications Group common stock and U S WEST Media Group common stock. Earnings per common share have been presented on a pro forma basis to reflect the Media stock as if it had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n(6) Selected proportionate data is not required by generally accepted accounting principles or intended to replace the Combined Financial Statements prepared in accordance with GAAP. It is presented supplementally because the Company believes that proportionate data facilitates the understanding and assessment of its Combined Financial Statements. Proportionate accounting reflects the Media Group's relative ownership interests in operating revenues and expenses for both its consolidated and equity method investments. The table does not reflect financial data of the capital assets segment.\nD-1\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN MILLIONS) THE RECAPITALIZATION PLAN\nOn October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\"), voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors to reincorporate in Delaware and create two classes of common stock. Under the Recapitalization Plan, shareholders approved an agreement and plan of merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or the \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\") and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\").\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nTHE MEDIA GROUP\nThe Media Group is comprised of: (i) cable and telecommunications network businesses outside of the Communications Group Region and internationally, (ii) domestic and international wireless communications network businesses and (iii) domestic and international directory and information services businesses.\nOn February 27, 1996, U S WEST announced a definitive agreement to merge with Continental Cablevision, Inc. (\"Continental\"). Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nContinental's 4.2 million domestic customers are highly clustered in five large markets -- New England, California, Chicago, Michigan, Ohio and Florida. Upon closing, U S WEST will own or share management of cable systems in 60 of the top 100 American markets and serve nearly one of every three cable households. In addition, Continental has interests in cable properties in Australia, Argentina and Singapore; a 10 percent interest in PRIMESTAR (a direct broadcast satellite service); telephone access businesses in Florida and Virginia; and interests in programming that include Turner Broadcasting System, E! Entertainment Television, the Golf Channel, and the Food Channel.\nThe Media Group's cable and telecommunications businesses include U S WEST's investment in Time Warner Entertainment Company L.P. (\"TWE\" or \"Time Warner Entertainment\"), the second largest provider of cable television services in the United States, its cable systems in the Atlanta, Georgia metropolitan area (\"the Atlanta Systems\"), and international cable and telecommunications investments, including TeleWest plc (\"TeleWest\"). In 1995, TeleWest Communications plc merged its cable television and telephony interests with SBC CableComms (UK) to form TeleWest, the largest provider of combined cable and telecommunications services in the United Kingdom. The Media Group also owns interests in cable and\/or telecommunications properties in the Netherlands, Sweden, Norway, Hungary, Czech Republic, Malaysia and Indonesia.\nD-2\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nThe Media Group provides domestic wireless communications services, including cellular services, in 13 western and midwestern states to a rapidly growing customer base. During 1994, U S WEST signed a definitive agreement with AirTouch Communications to combine their domestic cellular assets. The initial equity ownership of this cellular joint venture will be approximately 70 percent AirTouch and approximately 30 percent Media Group. The combination will take place in two phases. During Phase I, which U S WEST entered effective November 1, 1995, the two companies are operating their cellular properties separately. A Wireless Management Company (the \"WMC\") has been formed and is providing centralized services to both companies on a contract basis. In Phase II, AirTouch and U S WEST will contribute their domestic cellular assets to the WMC. In this phase, the Media Group will reflect its share of the combined operating results of the WMC using the equity method of accounting. The recent passage of the Telecommunications Act of 1996 has removed significant regulatory barriers to completion of Phase II of the business combination. U S WEST expects that Phase II closing could take place by the end of 1996 or early 1997.\nU S WEST partnered with AirTouch Communications, Bell Atlantic and NYNEX to form a strategic national wireless alliance and formed a venture to provide personal communications services (\"PCS\"). This venture, PCS PrimeCo, purchased 11 licenses in the Federal Communication Commission's (the \"FCC\") PCS auction, covering 57 million people in Chicago, Dallas, Honolulu, Houston, Jacksonville, Miami, Milwaukee, New Orleans, Richmond, San Antonio and Tampa. The Media Group also provides wireless communications services internationally through its Mercury One 2 One (\"One 2 One\") joint venture, the world's first PCS service located in the United Kingdom. The Media Group also owns interests in wireless properties in Hungary, the Czech and Slovak Republics, Russia, Malaysia, India and Poland.\nThe Media Group's directory and information services businesses develop and package content and information services, including telephone directories, database marketing and other interactive services in domestic and international markets. The Media Group publishes more than 300 White and Yellow Pages directories in 14 western and mid-western states and nearly 200 directories in the United Kingdom and Poland. The Media Group also has a 50 percent interest in Listel, Brazil's largest telephone directory publisher.\nThe Combined Financial Statements of the Media Group include the (i) combined historical balance sheets, results of operations and cash flows of the businesses that comprise the Media Group; and (ii) corporate assets and liabilities of U S WEST and related transactions not identified with the Communications Group; and (iii) an allocated portion of the corporate expense of U S WEST. All significant intra-group financial transactions have been eliminated. Transactions between the Media Group and the Communications Group have not been eliminated. For a more complete discussion of U S WEST's corporate allocation policies, see the U S WEST Media Group Combined Financial Statements - -- Note 2: Summary of Significant Accounting Policies.\nThe following discussion is based on the U S WEST Media Group Combined Financial Statements prepared in accordance with GAAP. The discussion should be read in conjunction with the U S WEST, Inc. Consolidated Financial Statements. A discussion of the Media Group's operations on a proportionate basis follows the GAAP presentation in \"Selected Proportionate Financial Data.\"\nD-3\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS -- 1995 COMPARED WITH 1994\nComparative details of income from continuing operations before extraordinary item by industry segment and for significant unconsolidated equity investments follow:\n- ------------------------------ (1) 1995 income from continuing operations before extraordinary item includes a gain of $95 from the merger of TeleWest with SBC CableComms (UK) and $9 for costs associated with the Recapitalization Plan.\n(2) 1994 income from continuing operations before extraordinary item includes a gain of $105 from the partial sale of U S WEST's joint venture interest in TeleWest and a gain of $41 from the sale of U S WEST's paging operations.\n(3) Percent ownership represents pro-rata priority capital and residual equity interests.\n(4) Primarily includes interest expense and divisional expenses associated with equity investments.\n(5) Earnings per common share have been presented on a pro forma basis as if the Media Stock had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\nDuring 1995, income from continuing operations before extraordinary item declined 55 percent, to $59, excluding the effects of the one-time items described in Notes 1 and 2 to the table above. The decline is due primarily to higher equity losses related to international growth initiatives and increased amortization and interest expense. Interest expense increases relate to debt issued in connection with the Atlanta Systems acquisition and expansion of international investments. The declines were partially offset by improvement in the domestic cellular and Yellow Pages operations.\nDuring 1995, the Media Group incurred an extraordinary loss of $4, net of a tax benefit of $2, related to the early retirement of debt by TWE.\nDIRECTORY AND INFORMATION SERVICES Income related to Yellow Pages directory advertising increased 10 percent in 1995, to $307, due to pricing, product enhancements and the effect of improved marketing programs on business volume. Yellow Pages income was partially offset by net operating losses of $60 related to new products and other growth initiatives, including development of interactive services. The Media Group views new service offerings as an important part of its strategy and expects investments in new products and services in 1996 will continue to partially offset expected income related to the Yellow Pages business.\nIncome related to directory and information services in 1995 includes $7 in losses related to expansion of international directory publishing operations. The international publishing operations were not significant to the 1994 results of operations.\nD-4\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nWIRELESS COMMUNICATIONS Income related to wireless communications more than doubled, to $62 in 1995, excluding the 1994 gain on sale of paging assets of $41. The increase in wireless communications income is attributable to continued strong growth in cellular subscribers. The cellular subscriber base reached 1,463,000 at December 31, 1995, a 51 percent increase compared with 1994.\nCABLE AND TELECOMMUNICATIONS The 1995 loss of $7 in cable and telecommunications operations is primarily the result of amortization of intangible assets related to the December 1994 acquisition of the Atlanta Systems. The subscriber base of the Atlanta Systems increased 6.7 percent during the last twelve months, to 527,000 at December 31, 1995.\nOPERATING RESULTS OF UNCONSOLIDATED EQUITY INVESTMENTS The net loss related to the Media Group's interests in TWE increased in 1995, due primarily to higher TWE financing costs and depreciation charges, partially offset by increased income related to cable and programming operations. Cable subscribers served by TWE increased almost 6 percent compared with last year, excluding the impact of recent cable transactions.\nOn September 22, 1995, U S WEST filed a lawsuit in Delaware Chancery Court to enjoin the proposed merger of Time Warner and Turner Broadcasting. U S WEST has alleged breaches of contract and fiduciary duties by Time Warner in connection with this proposed merger. Time Warner filed a countersuit against U S WEST on October 11, 1995, alleging misrepresentation, breach of contract and other misconduct on the part of U S WEST. Time Warner's countersuit seeks a reformation of the Time Warner Entertainment partnership agreement, an order that enjoins U S WEST from breaching the partnership agreement, and unspecified compensatory damages. U S WEST has denied each of the claims in Time Warner's countersuit. The trial for this action concluded on March 22, 1996. A ruling by the Delaware Chancery Court is expected in June 1996.\nInternational businesses are experiencing rapid growth associated with their early development phases. New investments in 1995 include the acquisition of a 50 percent interest in cable television systems in the Netherlands, the acquisition of a 29 percent interest in cable television systems in the Czech Republic and additional capital provided to a 20 percent owned joint venture in Malaysia to provide local wireline and wireless communications. The Czech Republic venture incurred significant start-up losses in 1995, of which the Media Group's share was $13. The structure of this venture is being renegotiated.\nU S WEST ventures have recently been awarded licenses to provide cellular services using digital technology in India and Poland. The Media Group expects losses related to international ventures will be significant in 1996.\nIn October 1995, TeleWest completed its merger with SBC CableComms (UK). The Media Group recognized an after-tax gain related to the merger of $95, and has a 26.8 percent interest in the combined company.\nCable television subscribers of TeleWest and its affiliates, based on TeleWest's equity interest in affiliated operations, increased to 457,000 at December 31, 1995, an increase of 44 percent compared with 1994, and telephone access lines increased 93 percent during the last twelve months, to 527,000. Both growth rates exclude the one-time impact of the merger.\nSubscribers to U S WEST's international wireless joint venture operations in the United Kingdom, Hungary, the Czech and Slovak Republics, Russia and Malaysia grew to 682,000 at December 31, 1995, which is almost twice the customer base at December 31, 1994. One 2 One served 375,000 customers at December 31, 1995, an 83 percent increase compared with 1994.\nEffective January 1, 1995, the capital assets segment is being accounted for in accordance with Staff Accounting Bulletin No. 93, issued by the Securities and Exchange Commission (\"SEC\"), which requires discontinued operations not disposed of within one year of the measurement date to be accounted for\nD-5\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) prospectively in continuing operations as a net investment in assets held for sale. The net realizable value of the assets are reevaluated on an ongoing basis with adjustments to the existing reserve, if any, being charged to continuing operations. No adjustment was required in 1995.\nSALES AND OTHER REVENUES\n- ------------------------------ (1) The paging business was sold in June 1994. Results reflect operations for the six months ending June 30, 1994.\nMedia Group sales and other revenues increased 15 percent, to $2,374 in 1995, excluding the effects of the 1994 Atlanta Systems acquisition and paging sale. The increase was primarily due to strong growth in cellular service revenue.\nDIRECTORY AND INFORMATION SERVICES Revenues related to Yellow Pages directory advertising increased 6.4 percent, to $1,026 in 1995, due to price increases of 4.5 percent, higher revenue per advertiser and an increase in Yellow Pages advertising volume.\nInternational directory publishing revenues increased $44 in 1995, primarily due to U S WEST's May 1994 purchase of Thomson Directories. The remaining increase is due to an increase in advertisers and revenue per advertiser.\nWIRELESS COMMUNICATIONS Cellular service revenues increased 34 percent, to $845 in 1995, due to a 51 percent increase in subscribers during the last twelve months (with 20 percent of the additions occurring in December), partially offset by a 13 percent drop in average revenue per subscriber to $60.00 per month. The increase in subscribers relates to continued growth in demand for wireless services. The Media Group anticipates continued growth in its subscriber base, although at slightly decreased rates.\nNew distribution programs are being developed which increase availability of cellular products and simplify the cellular service activation process. These programs have contributed to the shift in the customer base from businesses to consumers. This shift, combined with competitive pressures on pricing, will cause the average revenue per subscriber to continue to decline.\nCellular equipment revenues decreased 20 percent, to $96 in 1995, as a result of lower cellular equipment costs. These lower equipment costs are being passed on to retailers and to new customers. The Media Group expects this trend to continue in 1996 as the cost of equipment continues to decline and as penetration into the consumer market increases.\nRevenues related to the paging sales and service operations, which were sold in 1994, approximated $28 in 1994.\nD-6\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCABLE AND TELECOMMUNICATIONS Domestic cable and telecommunications revenues increased $197 in 1995, due to the December 1994 acquisition of the Atlanta Systems.\nOPERATING INCOME\n- ------------------------------ (1) The paging business was sold in June 1994. Results reflect operations for six months ending June 30, 1994.\n(2) Primarily includes divisional expenses associated with equity investments.\nDuring 1995, Media Group operating income increased 13 percent, to $467, excluding the effects of the 1994 Atlanta Systems acquisition and paging sale. EBITDA increased approximately 16 percent, to $716, on a comparable basis. The Media Group considers EBITDA an important indicator of the operational strength and performance of its businesses. The increases were primarily due to strong growth in wireless communications operations.\nDIRECTORY AND INFORMATION SERVICES During 1995, operating income related to domestic Yellow Pages directory advertising increased $40. Revenue increases of $61 and general cost savings of $15, including $8 associated with assuming the management of certain data base services from the Communications Group contributed to the increase. The revenue gains and cost savings were partially offset by operating cost increases of $36, primarily due to an 11 percent increase in paper, printing, delivery and distribution costs. New product development activities reduced domestic directory and information services operating income by $38 in 1995. The decrease is a result of higher costs associated with the development of new database marketing and interactive services, including a one-time charge of $8 to exit certain product lines.\nOn October 15, 1995, U S WEST Direct and the Communications Workers of America (\"CWA\") reached a tentative agreement on their contract, subject to ratification by the CWA membership. This contract would provide for salary increases of 10.5 percent over three years and provides employees with a lump sum payment of $850.\nEBITDA related to domestic Yellow Pages directory advertising services increased 9 percent, to $519 in 1995. Expansion of the business combined with cost savings led to an EBITDA margin related to the Yellow Pages operations of 50.6 percent in 1995 compared with 49.4 percent in 1994.\nOperating income for international directory publishing operations was unchanged from 1994. The 1995 revenue gains of $44 were offset by increased operating expenses, primarily associated with the May 1994 acquisition of Thomson Directories and increased costs associated with business volume.\nWIRELESS COMMUNICATIONS Cellular operating income increased 79 percent, to $147 in 1995. The increase in operating income is a result of revenue increases associated with the rapidly expanding subscriber\nD-7\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) base combined with efficiency gains. The 1995 decline in revenue per subscriber of 13 percent has been more than offset by decreases in the cost incurred to acquire a customer (\"acquisition costs\") and the cost to maintain a customer (\"support costs\"). Support costs include charges for access and usage of land-line telecommunications networks, subscriber billing, customer service and general support costs, as well as costs associated with roaming, intralata toll calls and fraud. Support costs per subscriber have declined 20 percent in 1995. The decline is generally a result of the efficiencies gained from an expanding customer base without corresponding increases in headcount and infrastructure. The acquisition cost per subscriber added decreased 6 percent in 1995, as a result of the expanding customer base and shifts in the distribution channel resulting in generally less costly subscriber additions.\nCellular EBITDA increased 49 percent during 1995, to $268. The business is realizing operating scale efficiencies that have resulted in lower costs on a per subscriber basis. The efficiencies have resulted in an increase in 1995 cellular service EBITDA margin to 31.7 percent from 28.4 percent in 1994.\nCABLE AND TELECOMMUNICATIONS Cable and telecommunications operating income reflects the December 1994 acquisition of the Atlanta Systems. The Atlanta Systems contributed operating income of $23 and EBITDA of $100 in 1995.\nOTHER Other operating income decreased primarily due to costs associated with growth in international operations.\nINTEREST EXPENSE AND OTHER\nInterest expense increased $34, or 52 percent, primarily as a result of financing costs associated with the December 1994 acquisition of the Atlanta Systems, new domestic and international investments and a reclassification of debt from net investment in assets held for sale.\nEquity losses increased $86 in 1995, primarily due to costs related to the expansion of the network and additional financing costs at TeleWest and additional costs associated with the significant increase in customers at One 2 One. Start-up and other costs associated with new international cable and telecommunications investments primarily located in the Czech Republic and Malaysia contributed to the increase. These increased losses were partially offset by earnings in the European wireless operations. Losses related to domestic investments in TWE and PCS PrimeCo also increased. The Media Group expects the PCS partnership to experience several years of operating losses associated with the start-up phase of the PCS business.\nOther income decreased $41, or 89 percent, primarily as a result of increased minority interest expense associated with the domestic cellular operations, costs associated with the Recapitalization Plan and a 1994 gain on sale of nonstrategic operations.\nPROVISION FOR INCOME TAXES\nThe increase in the effective tax rate primarily reflects the impact of lower pretax income, the effects of goodwill amortization related to the acquisition of the Atlanta Systems, higher state and foreign income taxes, and expenses associated with the Recapitalization Plan. Additionally, a tax benefit was recorded in 1994 related to the sale of paging assets that contributed to the increase in the effective tax rate.\nD-8\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nRESULTS OF OPERATIONS -- 1994 COMPARED WITH 1993\nIncome from continuing operations by industry segment and for significant unconsolidated equity investments follows:\n- ------------------------------ (1) 1994 income from continuing operations includes a gain of $105 from the partial sale of U S WEST's joint venture interest in TeleWest, and a gain of $41 from the sale of U S WEST's paging operations.\n(2) 1993 income from continuing operations was reduced by $76 for restructuring charges; $31 pertaining to the directory and information services segment and $45 pertaining to the wireless segment.\n(3) Percent ownership represents pro-rata priority capital and residual equity interests.\n(4) Primarily includes interest expense and divisional expenses associated with equity investments.\nDuring 1994, income from continuing operations decreased 19 percent, to $130, excluding the effects of the one-time items described in Notes 1 and 2 to the table above. The decline in income is primarily a result of increased start-up losses associated with international businesses, partially offset by income growth in domestic wireless operations attributable to rapid growth in customer demand.\nDuring 1993, the Board approved a plan to dispose of the capital assets segment, which includes activities related to financial services, financial guarantee insurance operations and real estate. Until January 1, 1995, the capital assets segment was accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, which provides for the reporting of the operating results of discontinued operations separately from continuing operations. The Media Group recorded a provision of $100 (after tax) for the estimated loss on disposal of the discontinued operations and an additional provision of $20 to reflect the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates. Income from discontinued operations prior to June 1, 1993, was $38, net of $15 in income taxes. Income from discontinued operations subsequent to June 1, 1993, is being deferred and was included within the provision for loss on disposal of the capital assets segment.\nDIRECTORY AND INFORMATION SERVICES Excluding the effect of the 1993 restructuring charge of $31, income from directory and information services operations decreased 1.6 percent in 1994, to $247. Costs related to the development and launching of new products in directory and information services offset income growth from the Yellow Pages publishing operations.\nWIRELESS COMMUNICATIONS Excluding the effects of the $41 gain on the sale of paging operations in 1994 and a $45 restructuring charge in 1993, cellular income increased $24 to $26 in 1994. The increase is due to the addition of 367,000 subscribers in 1994, a 61 percent increase compared with 1993.\nD-9\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCABLE AND TELECOMMUNICATIONS On December 6, 1994, the Media Group purchased the Atlanta Systems for $1.2 billion. The results of operations of the Atlanta Systems have been included in the Media Group's results of operations since the date of acquisition which did not have a material impact on 1994 net income.\nOPERATING RESULTS OF UNCONSOLIDATED EQUITY INVESTMENTS TWE partnership losses increased in 1994 primarily due to the full year impact (including financing costs) of the TWE investment compared with three months in 1993. The effects of lower prices for cable services also contributed to the higher loss in 1994.\nIn 1994, losses related to international equity investments increased as a result of expansion of the customer base at One 2 One and build out of the network at TeleWest.\nSALES AND OTHER REVENUES\n- ------------------------------ (1) The paging business was sold in June 1994. Results reflect operations for the six months ending June 30, 1994.\nDuring 1994, Media Group sales and other revenues increased 25 percent to $1,862, excluding the effect of the 1994 Atlanta Systems acquisition and paging sale. The increase was primarily due to strong growth in cellular service revenue.\nDIRECTORY AND INFORMATION SERVICES Revenues related to Yellow Pages directory advertising increased approximately $59, or 6.5 percent, due primarily to pricing. Product enhancements and the effect of improved marketing programs on business volume also contributed to the increase in revenues. Non-Yellow Pages revenues increased $11, including $7 related to new products. Partially offsetting these increases was the absence of revenues related to certain publishing, software development and marketing operations that were sold, which reduced revenues by $22.\nThe increase in international directory publishing revenues is attributable to U S WEST's May 1994 purchase of Thomson Directories.\nWIRELESS COMMUNICATIONS Cellular service revenues increased 43 percent, to $633 in 1994, due to a 61 percent increase in subscribers (with 24 percent of the additions occurring in December), partially offset by an 8 percent drop in average revenue per subscriber to $70.00 per month.\nCellular equipment revenues increased 90 percent, to $120 in 1994, primarily due to an 83 percent increase in gross customer additions, with a higher percentage of those customers purchasing equipment than in 1993. This increase was partially offset by a 13 percent decline in the average selling price of wireless phones.\nD-10\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nCABLE AND TELECOMMUNICATIONS Domestic cable and telecommunications revenues reflect the December 1994 acquisition of the Atlanta Systems.\nOPERATING INCOME\n- ------------------------------ (1) Includes pretax restructuring charges of $50 and $70 for the domestic directory and information services and wireless segments, respectively.\n(2) The paging business was sold in June 1994. Results reflect operations for the six months ending June 30, 1994.\n(3) Primarily includes divisional expenses associated with equity investments.\nMedia Group operating income increased 7 percent, to $383 in 1994, excluding the effects of the one-time items described in Notes 1 and 2 to the table above. Revenue growth, partially offset by higher operating expenses, provided an 10.5 percent increase in 1994 EBITDA, on a comparable basis.\nDIRECTORY AND INFORMATION SERVICES Excluding the effect of the 1993 restructuring charge of $50, operating income from domestic directory and information services operations decreased $12, or 3 percent, in 1994. Operating income related to the domestic Yellow Pages directory business increased $20. The increase was driven by strong revenue growth. Non-Yellow Pages operating income decreased $32, primarily a result of increased costs related to development of new database marketing and interactive services.\nThe increase in international directory publishing operating income is attributable to U S WEST's May 1994 purchase of Thomson Directories.\nWIRELESS COMMUNICATIONS Excluding the effect of the 1993 restructuring charge of $70, cellular operating income doubled in 1994 to $41. This is a result of revenue increases associated with the rapidly expanding subscriber base and decreases in the costs incurred to acquire and maintain a customer. Cellular EBITDA increased $55, or 44 percent in 1994. Cellular service EBITDA margin was 28.4 percent, essentially unchanged compared with 1993.\nOTHER Other operating income decreased primarily due to growth in international operations and the inclusion of administrative costs related to the TWE investment for the full year in 1994, compared with three months in 1993.\nD-11\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nINTEREST EXPENSE AND OTHER\nInterest expense increased $39, primarily as a result of incremental financing costs associated with the September 1993 TWE investment.\nEquity losses in unconsolidated ventures increased $47, primarily due to start-up costs related to the build out of TeleWest's network and costs related to the expansion of the customer base at One 2 One.\nOther income increased $37, primarily due to an $18 increase in the TWE management fee. This increase resulted from owning the investment for a full year in 1994, compared with three months in 1993. Other income also includes a $10 gain on the sale of certain software development and marketing operations in 1994.\nPROVISION FOR INCOME TAXES\nThe effective tax rate is significantly impacted by state and foreign taxes on the Media Group Combined Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES --THREE YEARS ENDED DECEMBER 31, 1995\nOPERATING ACTIVITIES\nCash provided by operating activities increased $89 in 1995, to $640. During 1995, an income tax payment related to the 1994 partial sale of the Media Group's joint venture interest in TeleWest reduced cash provided by operations by $60. Adjusted for this one-time income tax payment, operating cash flow of the Media Group increased $149. Growth in operations from the cellular business and acquisition of the Atlanta Systems contributed to the increase. Growth in operating cash flow from directory and information services operations has been reduced by investments related to its growth initiatives. Operating cash flow from Media Group businesses was partially offset by a significant increase in income taxes paid in 1995, primarily due to lower tax benefits generated from the investment in TWE.\nCash provided by operating activities of the Media Group increased $28 in 1994 compared with 1993 primarily due to expansion of the cellular business.\nThe Media Group expects that cash from operations will not be adequate to fund expected cash requirements. Additional financing will come primarily from new debt.\nINVESTING ACTIVITIES\nTotal capital expenditures of the Media Group were $363, $349 and $193 in 1995, 1994 and 1993, respectively, the majority was devoted to enhancement and expansion of the cellular network. In 1996, capital expenditures are expected to exceed $600, of which approximately 50 percent relates to expansion of the cellular network to increase coverage and capacity, and nearly 40 percent relates to enhancement of the Atlanta Systems. The Media Group is in the process of upgrading its Atlanta Systems to 750 megahertz capacity, which will provide more reliability, better signal quality and additional capacity. The upgrade will enable the provision of enhanced cable, data and telecommunications services to its Atlanta customers.\nInvesting activities of the Media Group also include equity investments in international ventures. In 1995, the Media Group invested $681 in international ventures, primarily investments in Malaysia, the\nD-12\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Netherlands, the Czech Republic and the United Kingdom. The Media Group invested approximately $444 in developing international businesses in 1994, including the acquisition of Thomson Directories. The Media Group anticipates that investments in international ventures will approximate $400 in 1996. This includes investments for recently awarded licenses to provide cellular service using digital technology in India and Poland. At December 31, 1995, U S WEST guaranteed debt in the principal amount of approximately $140 related to international ventures.\nIn March 1995, PCS PrimeCo was awarded PCS licenses in 11 markets. The Media Group's share of the cost of the licenses was approximately $268, all of which was funded in 1995. Under the PCS PrimeCo partnership agreement, U S WEST is required to fund approximately 24 percent of PCS PrimeCo's operating and capital costs, including licensing costs. U S WEST anticipates that its total funding obligations to PCS PrimeCo during the next three years will be approximately $400.\nIn 1994, the Media Group received cash proceeds of $143 from the sale of its paging operations. In 1993, cash proceeds of $30 were received from the sale of certain nonstrategic lines of business. The Media Group did not receive cash from the 1994 partial sale of its joint venture interest in TeleWest or from the 1995 merger. All proceeds from the 1994 sale have been used by TeleWest for general business purposes, including financing both construction and operations, and repaying debt.\nOn February 27, 1996, U S WEST announced a definitive agreement to merge with Continental. Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nFINANCING ACTIVITIES\nDuring 1995, debt increased $287 primarily due to new investments in international ventures, cash funding of the PCS licenses and a reclassification of debt from net investment in assets held for sale. During fourth-quarter 1995, U S WEST issued $130 of exchangeable notes, or Debt Exchangeable for Common Stock (\"DECS\"), due December 15, 1998. Upon maturity, each DECS will be mandatorily exchanged by U S WEST for shares of Enhance Financial Services Group, Inc. (\"Enhance\") or, at U S WEST's option, redeemed at the cash equivalent. The capital assets segment currently holds approximately 31.5 percent of the outstanding Enhance common stock.\nThese increases in debt were partially offset by reductions of debt related to the investment in TWE and a refinancing of commercial paper by issuing Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely Company-guaranteed debentures (\"Preferred Securities\"). U S WEST issued $600 of Preferred Securities in 1995. The payment of interest and redemption amounts to holders of the securities are fully and unconditionally guaranteed by U S WEST.\nExcluding debt associated with the capital assets segment, the Media Group's percentage of debt to total capital at December 31, 1995, was 29.1 percent compared with 29.9 percent at December 31, 1994. Including debt associated with the capital assets segment, Preferred Securities and other preferred stock, the Media Group's percentage of debt to total capital was 44.2 percent at December 31, 1995, and 42.8 percent at December 31, 1994.\nD-13\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nDebt increased $288 in 1994, primarily due to the December 1994 acquisition of the Atlanta Systems, partially offset by reductions in debt related to the investment in TWE. The cash investment related to the acquisition of the Atlanta Systems was $745, obtained through short-term borrowing.\nU S WEST maintains a commercial paper program to finance short-term cash flow requirements, as well as to maintain a presence in the short-term debt market. U S WEST maintains lines of credit aggregating approximately $1.3 billion, which is available to both the Media Group and the nonregulated subsidiaries of the Communications Group in accordance with their borrowing needs. Under registration statements filed with the SEC, as of December 31, 1995, U S WEST is permitted to issue up to approximately $1.2 billion of new debt securities, available to both the Media Group and the nonregulated subsidiaries of the Communications Group.\nDebt related to discontinued operations decreased $487 in 1995 and $213 in 1994. Cash to the capital assets segment of $101 in 1994 primarily reflects the payment of debt, net of $154 in proceeds from the sale of 8.1 million shares of Financial Security Assurance Holdings, Ltd. (\"FSA\"), an investment of the capital assets segment. For financial reporting purposes debt of the capital assets segment is netted against the related assets. See Media Group Combined Financial Statements -- Note 20: Net Investment in Assets Held for Sale.\nThe Media Group reinvests earnings, if any, for future growth and does not expect to pay dividends on the Media Stock in the foreseeable future.\nIn connection with U S WEST's announcement on February 27, 1996 of a planned merger with Continental, U S WEST, Inc.'s credit rating is being reviewed by credit rating agencies, which may result in a downgrading.\nFinancing activities for the nonregulated Communications Group businesses and the Media Group, including the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of Preferred Securities, is managed by U S WEST on a centralized basis. Financing activities for U S WEST Communications is separately identified and accounted for in U S WEST's records and U S WEST Communications continues to conduct its own borrowing activities. Debt incurred and investments made by U S WEST and its subsidiaries is specifically allocated to and reflected on the financial statements of the Media Group except that debt incurred and investments made by U S WEST and its subsidiaries on behalf of the nonregulated Communications Group businesses and all debt incurred and investments made by U S WEST Communications is specifically allocated to and reflected on the financial statements of the Communications Group. Debt incurred by U S WEST or a subsidiary on behalf of a Group is charged to such Group at the borrowing rate of U S WEST or such subsidiary.\nRISK MANAGEMENT\nThe Media Group is exposed to market risks arising from changes in interest rates and foreign exchange rates. Derivative financial instruments are used to manage these risks. U S WEST does not use derivative financial instruments for trading purposes.\nINTEREST RATE RISK MANAGEMENT\nThe objective of the interest rate risk management program is to minimize the total cost of debt. Interest rate swaps are used to adjust the ratio of fixed- to variable-rate debt. The market value of the debt portfolio, including the interest rate swaps, is monitored and compared with predetermined benchmarks to evaluate the effectiveness of the risk management program.\nNotional amounts of interest rate swaps outstanding were $825 and $850 as of December 31, 1995 and 1994, respectively, with various maturities that extend to 2004. The estimated effect of U S WEST's interest\nD-14\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) rate derivative transactions was to adjust the level of fixed-rate debt of the Media Group from 86 percent to 87 percent at December 31, 1995, and from 68 percent to 71 percent of the total debt portfolio at December 31, 1994 (including debt associated with the capital assets segment).\nFOREIGN EXCHANGE RISK MANAGEMENT\nU S WEST has entered into forward and option contracts to manage the market risks associated with fluctuations in foreign exchange rates after consideration of offsetting foreign exposures among international operations. The use of forward and option contracts allow U S WEST to fix or cap the cost of firm foreign investment commitments in countries with freely convertible currencies. The market values of the foreign exchange positions, including the hedging instruments, are continuously monitored and compared with predetermined levels of acceptable risk.\nNotional amounts of foreign exchange forward and option contracts outstanding were $456 and $170 as of December 31, 1995 and 1994, respectively, with maturities of one year or less. These contracts were primarily for the purchase of Dutch guilders and British pounds in 1995 and British pounds in 1994.\nThe Media Group had foreign exchange risks associated with a Dutch guilder-denominated payable in the translated principal amount of $216 at December 31, 1995, and British pound-denominated receivables in the translated principal amounts of $139 and $48 at December 31, 1995 and 1994, respectively, of which $63 and $48 of these respective balances are with a wholly owned subsidiary. These positions were hedged in 1995.\nDISPOSITION OF THE CAPITAL ASSETS SEGMENT\nU S WEST announced a plan of disposition of the capital assets segment in June 1993. See the Media Group Combined Financial Statements -- Note 20: Net Investment in Assets Held for Sale. In December 1993, U S WEST sold $2.0 billion of finance receivables and the business of U S WEST Financial Services, Inc. to NationsBank Corporation. Proceeds from the sale of $2.1 billion were used to repay related debt.\nDuring 1994, U S WEST reduced its ownership interest in FSA, a member of the capital assets segment, to 60.9 percent and its voting interest to 49.8 percent through a series of transactions. In May and June 1994, U S WEST sold 8.1 million shares of FSA common stock and received $154 in net proceeds from the public offering. In December 1995, FSA merged with Capital Guaranty Corporation for shares of FSA and cash of $51. The transaction was valued at approximately $203 and reduced U S WEST's ownership interest in FSA to 50.3 percent and its voting interest to 41.7 percent. U S WEST expects to monetize and ultimately reduce its ownership in FSA through the issuance of Debt Exchangeable for Common Stock (\"DECS\") in 1996. At maturity, each DECS will be mandatorily exchanged by U S WEST for FSA common stock held by U S WEST or, at U S WEST's option, redeemed at the cash equivalent.\nOn September 2, 1994, U S WEST issued to Fund American Enterprises Holdings Inc. (\"FFC\") 50,000 shares of cumulative redeemable preferred stock for a total of $50. The shares are mandatorily redeemable in year ten and, at the option of FFC, the preferred stock also can be redeemed for common shares of FSA.\nU S WEST Real Estate, Inc. has sold various properties totaling $120, $327 and $66 in 1995, 1994 and 1993, respectively. The sales proceeds were in line with estimates. Proceeds from building sales were primarily used to repay related debt. U S WEST has completed construction of existing buildings in the commercial real estate portfolio and expects to substantially complete liquidation of this portfolio by 1998. The remaining balance of assets subject to sale is approximately $490, net of reserves, as of December 31, 1995.\nCOMPETITIVE STRATEGY\nThe Media Group's strategy is based on the belief that communication and commerce are migrating from other mediums to electronic networks. Over time, this global phenomenon will result in networks\nD-15\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) replacing traditional distribution channels. To meet the needs of this growing market, the Media Group provides local connections and then integrates market-based service offerings to meet the needs of end users. The Media Group executes this strategy through three lines of business -- cable and telecommunications, wireless and directory and information services -- in selected high-growth markets worldwide.\nCOMPETITIVE AND REGULATORY ENVIRONMENT\nCABLE AND TELECOMMUNICATIONS The Telecommunications Act of 1996 (the \"1996 Act\") opens competition by permitting local telephone companies, long-distance carriers and cable television companies to enter each other's businesses. This legislation will enable the Media Group to provide \"one-stop shopping\" for voice, video and data services, a key objective of the Media Group. The Media Group is currently in the process of negotiating reasonable and non-discriminatory local interconnection rates, terms and conditions with BellSouth and is planning on entering the local exchange market, through the Atlanta Systems, on a competitive basis by the end of 1996.\nThe Atlanta Systems generally compete for viewer attention with programming from a variety of sources, including the direct reception of broadcast television signals by the viewer's own antenna, satellite master antenna service and direct broadcast satellite services. Cable television systems are also in competition for both viewers and advertising in varying degrees with other communications and entertainment media. Such competition may increase with the development and growth of new technologies.\nThe 1996 Act has amended certain aspects of the Cable Television Consumer Protection and Competition Act of 1992 (\"the 1992 Cable Act\"). Under the 1996 Act, cable rates are deregulated effective March 31, 1999, or earlier if competition exists. In addition, the provisions of the 1996 Act simplify the process of filing rate complaints, relax uniform rate requirements and subscriber notice provisions, expand the definition of effective competition and eliminate certain restrictions on the sale of cable systems. Current program access restrictions applying to cable operators are extended to common carriers by the 1996 Act. The 1996 Act also eliminates certain cross-ownership restrictions between cable operators, broadcasters and multichannel, multipoint distribution system operators.\nCable television systems are also subject to local regulation, typically imposed through the franchising process. Local officials may be involved in the initial franchise selection, system design and construction, safety, rate regulation, customer service standards, billing practices, community-related programming and services, franchise renewal and imposition of franchise fees.\nIn 1995, the Georgia legislature removed the legal prohibition on local telephone competition by authorizing competition in local telephone exchange service. The Media Group has received certification from the Georgia Public Service Commission to provide local switched and nonswitched telephone service in Georgia and, with the passage of the 1996 Act, certain long-distance services.\nD-16\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nWIRELESS COMMUNICATIONS There are two competitive cellular licenses in each market. Competition is based on the price of cellular service, the quality of the service and the size of the geographic area served. The development of PCS services will increase the number of competitors and the level of competition. The Media Group is unable to estimate the impact of the availability of PCS services on its cellular operations, though it could be significant.\nThe wireless operations are subject to regulation by federal and some state and local authorities. The construction and transfer of cellular systems in the United States are regulated by the FCC pursuant to the Communications Act of 1934. The FCC regulates construction and operation of cellular systems and licensing and technical standards for the provision of cellular telephone service. Pursuant to Congress' 1993 Omnibus Budget Reconciliation Act, the FCC adopted rules preempting state and local governments from regulating wireless entry and most rates.\nThe passage of the 1996 Act eliminates long-distance restrictions imposed by the Modified Final Judgment (\"MFJ\"). As a result, the Media Group, including its wireless partners, are now able to offer integrated local and long-distance services. The 1996 Act also permits the Media Group to enter into activities related to the manufacture of telecommunications equipment.\nDIRECTORY AND INFORMATION SERVICES The Media Group may face emerging competition in the provision of interactive services from cable and entertainment companies, on-line services and other information providers. Directory listings are beginning to be offered via electronic databases through telephone company and third party networks. As such offerings expand and are enhanced through interactivity and other features, the Media Group may experience heightened competition in its directory publishing businesses. With the passage of the 1996 Act, the Media Group will be able to provide certain information services across LATA boundaries. The Media Group will continue to expand its core products and develop and package new information products to meet its customers' needs.\nD-17\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nSELECTED PROPORTIONATE FINANCIAL DATA\nThe following table shows the entities included in the Media Group Combined Financial Statements and the percent ownership by industry segment. The proportionate financial and operating data for these entities are summarized in the proportionate data table that follows:\nD-18\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nSELECTED PROPORTIONATE FINANCIAL DATA (CONTINUED) The following table and discussion is not required by GAAP or intended to replace the Combined Financial Statements prepared in accordance with GAAP. It is presented supplementally because the Media Group believes that proportionate financial and operating data facilitate the understanding and assessment of its Combined Financial Statements. Proportionate accounting reflects the Media Group's relative ownership interests in operating revenues and expenses for both its consolidated and equity method investments. The financial information included below departs materially from GAAP because it aggregates the revenues and operating income of entities not controlled by the Media Group with those of the consolidated operations of the Media Group. The following table includes allocations of Media Group corporate activity. The table does not reflect financial data of the capital assets segment, which had net assets of $429, $302 and $554 at December 31, 1995, 1994 and 1993, respectively. Previously reported amounts have been reclassified to conform with current year presentation.\nD-19\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nSELECTED PROPORTIONATE FINANCIAL DATA (CONTINUED)\n- ------------------------------ (1) The proportionate results include the Media Group's 25.51 percent pro-rata priority and residual equity interests in reported TWE results. The reported TWE results are prepared in accordance with GAAP and have not been adjusted to report TWE investments accounted for under the equity method on a proportionate basis.\n(2) Proportionate EBITDA represents the Media Group's equity interest in the entities multiplied by the entities' EBITDA. 1993 EBITDA excludes restructuring charges of $59 and $50 related to the domestic wireless and directory and information services segments, respectively.\n(3) POPs are the estimated market population multiplied by U S WEST's ownership interest in the market.\nPROPORTIONATE RESULTS OF OPERATIONS -- 1995 COMPARED WITH 1994\nIn 1995, proportionate Media Group revenue increased 17 percent, to $5.12 billion, and EBITDA increased 17 percent, to $1.15 billion, excluding the one-time impacts of the 1994 Atlanta Systems acquisition and the sale of paging operations. Strong growth in both domestic cable and telecommunications and wireless communications contributed to the increases.\nCABLE AND TELECOMMUNICATIONS During 1995, proportionate revenue for the Media Group domestic cable and telecommunications operations increased 12 percent, to $2,661, and proportionate EBITDA increased 11 percent, to $589, excluding the one-time impact of the 1994 acquisition of the Atlanta systems. Proportionate revenue and EBITDA growth is primarily due to the TWE cable, programming and filmed entertainment operations. Cable growth is attributed to subscriber growth of nearly six percent, excluding the impact of 1995 TWE cable transactions, as well as increases in advertising and pay per view revenues.\nDuring 1995, international cable and telecommunications proportionate revenue increased $43, to $128, and proportionate EBITDA decreased $13 to ($55). Results for new ventures in the Czech Republic, Netherlands and Malaysia, have been included in the proportionate results beginning with the fourth quarter of 1995. The new ventures contributed revenue of $10 and EBITDA of ($14), which reflect the start-up nature of the operations.\nWIRELESS COMMUNICATIONS During 1995, proportionate revenue for the Media Group domestic wireless operations increased 30 percent, to $824, and proportionate EBITDA increased 52 percent, to $226,\nD-20\nU S WEST MEDIA GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nSELECTED PROPORTIONATE FINANCIAL DATA (CONTINUED) excluding the effect of the paging business, which was sold in 1994. Proportionate cellular service revenue increased 39 percent, to $736 in 1995. This increase is due to a 64 percent increase in proportionate subscribers partially offset by a decrease in average revenue per subscriber.\nDuring 1995, international wireless communications proportionate revenue increased $109, to $295, and proportionate EBITDA increased $28, to ($40). Venture results for Indonesia and Russia have been included in the proportionate results beginning with the fourth quarter of 1995. These ventures contributed revenue of $9 and EBITDA of ($4), which reflect the start-up nature of the operations.\nDIRECTORY AND INFORMATION SERVICES Proportionate revenue for domestic directory and information services increased 6 percent, to $1,065 in 1995, and proportionate EBITDA increased 3 percent, to $426. The proportionate revenue increase is due to price and volume increases. Revenue increases were partially offset by reinvestments in the business, resulting in the 3 percent increase in EBITDA.\nProportionate revenue for international directories businesses increased $63, to $142 in 1995, and proportionate EBITDA increased $1, to $3. Results for Listel, a Brazilian directories operation, have been included in the Media Group proportionate results beginning with the fourth quarter 1995. Listel contributed proportionate revenue of $18 and EBITDA of $2.\nPROPORTIONATE DEBT\nProportionate debt increased $552 in 1995. The increase is primarily related to the Media Group's international investments. Both TeleWest and One 2 One raised cash through the issuance of debt in 1995, primarily to fund the continued expansion of their businesses.\nD-21\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowners of U S WEST, Inc.:\nWe have audited the Combined Balance Sheets of U S WEST Media Group (as described in Note 2 to the Combined Financial Statements) as of December 31, 1995 and 1994, and the related Combined Statements of 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 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 U S WEST Media Group as of 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.\nAs more fully discussed in Note 2, the Combined Financial Statements of U S WEST Media Group should be read in connection with the audited Consolidated Financial Statements of U S WEST, Inc.\nWe have also audited the Supplementary Selected Proportionate Results of Operations for the three years in the period ended December 31, 1995, presented on page D-55. The Supplementary Selected Proportionate Results of Operations have been prepared by management to present relevant financial information that is not provided by the Consolidated Financial Statements and is not intended to be a presentation in accordance with generally accepted accounting principles. In our opinion, the Supplementary Selected Proportionate Results of Operations referred to above presents fairly, in all material respects, the information set forth therein on the basis of accounting described on page D-55.\nCOOPERS & LYBRAND L.L.P.\nDenver, Colorado February 12, 1996, except for note 5, paragraph 3, as to which the date is February 27, 1996\nD-22\nU S WEST MEDIA GROUP COMBINED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the Combined Financial Statements\nD-23\nU S WEST MEDIA GROUP COMBINED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of the Combined Financial Statements\nD-24\nU S WEST MEDIA GROUP COMBINED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the Combined Financial Statements\nD-25\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS)\nNOTE 1: RECAPITALIZATION PLAN On October 31, 1995, the shareholders of U S WEST, Inc., a Colorado corporation (\"U S WEST Colorado\") voted to approve a proposal (the \"Recapitalization Plan\") adopted by the Board of Directors of U S WEST, Inc. (the \"Board\") to reincorporate in Delaware and create two classes of common stock that are intended to reflect separately the performance of the communications and multimedia businesses. Under the Recapitalization Plan, shareholders approved an Agreement and Plan of Merger between U S WEST Colorado and U S WEST, Inc., a Delaware corporation (\"U S WEST\" or \"Company\"), pursuant to which U S WEST continues as the surviving corporation. In connection with the merger, the Certificate of Incorporation of U S WEST has been amended and restated to designate two classes of common stock of U S WEST, one class of which is authorized as U S WEST Communications Group Common Stock (\"Communications Stock\"), and the other class which is authorized as U S WEST Media Group Common Stock (\"Media Stock\"). Effective November 1, 1995, each share of common stock of U S WEST Colorado was converted into one share each of Communications Stock and Media Stock.\nThe Communications Stock and Media Stock provide shareholders with two distinct securities that are intended to reflect separately the communications businesses of U S WEST (the \"Communications Group\") and the multimedia businesses of U S WEST (the \"Media Group\" and, together with the Communications Group, the \"Groups\").\nThe Communications Group is comprised of U S WEST Communications, Inc. (\"U S WEST Communications\"), U S WEST Communications Services, Inc., U S WEST Federal Services, Inc., U S WEST Advanced Technologies, Inc. and U S WEST Business Resources, Inc. The Communications Group primarily provides regulated communications services to more than 25 million residential and business customers within a 14 state region.\nThe Media Group is comprised of U S WEST Marketing Resources Group, Inc., which publishes White and Yellow Pages telephone directories, and provides directory and information services, U S WEST NewVector Group, Inc., which provides communications and information products and services over wireless networks, U S WEST Multimedia Communications, Inc., which owns domestic cable television operations and investments, and U S WEST International Holdings, Inc., which primarily owns investments in international cable and telecommunications, wireless communications and directory publishing operations.\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION The Combined Financial Statements of the Groups comprise all of the accounts included in the corresponding Consolidated Financial Statements of U S WEST. Investments in less than majority-owned ventures are generally accounted for using the equity method. The separate Group Combined Financial Statements have been prepared on a basis that management believes to be reasonable and appropriate and include: (i) the combined historical balance sheets, results of operations and cash flows of the businesses that comprise each of the Groups, with all significant intra-group amounts and transactions eliminated; (ii) in the case of the Communications Group Combined Financial Statements, certain corporate assets and liabilities of U S WEST and related transactions identified with the Communications Group; (iii) in the case of the Media Group Combined Financial Statements, all other corporate assets and liabilities and related transactions of U S WEST; and (iv) an allocated portion of the corporate expense of U S WEST. Transactions between the Communications Group and the Media Group have not been eliminated.\nNotwithstanding the allocation of assets and liabilities (including contingent liabilities) and stockholders' equity between the Communications Group and the Media Group for the purpose of preparing the respective financial statements of such Group, holders of Communications Stock and Media Stock are subject to risks associated with an investment in a single company and all of U S WEST's businesses, assets and liabilities. Such allocation of assets and liabilities and change in the equity structure of U S WEST does\nD-26\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) not result in a distribution or spin-off to shareholders of any assets or liabilities of U S WEST or any of its subsidiaries or otherwise affect responsibility for the liabilities of U S WEST or such subsidiaries. As a result, the rights of the holders of U S WEST's or any of its subsidiaries' debt are not affected. Financial effects arising from either Group that affect U S WEST's results of operations or financial condition could, if significant, affect the results of operations or financial position of the other Group or the market price of the class of common stock relating to the other Group. Any net losses of the Communications Group or the Media Group, and dividends or distributions on, or repurchases of Communications Stock, Media Stock or preferred stock, will reduce the funds of U S WEST legally available for payment of dividends on both the Communications Stock and Media Stock. Accordingly, the Media Group Combined Financial Statements should be read in conjunction with U S WEST's Consolidated Financial Statements and the Communications Group Combined Financial Statements.\nThe accounting policies described herein applicable to the preparation of the Combined Financial Statements of the Media Group may be modified or rescinded at the sole discretion of the Board without approval of the stockholders, although there is no present intention to do so. The Board may also adopt additional policies depending on the circumstances. Any determination of the Board to modify or rescind such policies, or to add additional policies, including any decision that would have disparate impacts upon holders of Communications Stock and Media Stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of all U S WEST stockholders, including the holders of Communications Stock and the holders of Media Stock. In making such determination, the Board may also consider regulatory requirements imposed on U S WEST Communications by the public utility commissions of various states and the Federal Communications Commission. In addition, generally accepted accounting principles require that any change in accounting policy be preferable (in accordance with such principles) to the policy previously established.\nCertain reclassifications within the Combined Financial Statements have been made to conform to the current year presentation.\nALLOCATION OF SHARED SERVICES Certain costs relating to U S WEST's general and administrative services (including certain executive management, legal, accounting and auditing, tax, treasury, strategic planning and public policy services) are directly assigned by U S WEST to each Group, and segment within the Group, based on actual utilization or are allocated based on each Group's operating expenses, number of employees, external revenues, average capital and\/or average equity. Beginning in 1996, certain shared services will no longer be allocated to each segment of the Media Group but will be retained at Media Group headquarters. U S WEST charges each Group for such services at fully distributed cost. These direct and indirect allocations were $55, $38 and $43 in 1995, 1994 and 1993, respectively. In 1995, the direct allocations comprised approximately 40 percent of the total shared corporate services allocated to the Media Group. It is not practicable to provide a detailed estimate of the expenses which would be recognized if the Media Group were a separate legal entity. However, U S WEST believes that under the Recapitalization Plan each Group would benefit from synergy's with the other, including lower operating costs than might be incurred if each Group was a separate legal entity.\nALLOCATION OF INCOME TAXES Federal, state and local income taxes, which are determined on a consolidated or combined basis, are allocated to each Group in accordance with tax sharing agreements between U S WEST and the entities within the Groups. The allocations will generally reflect each Group's contribution (positive or negative) to consolidated taxable income and consolidated tax credits. A Group will be compensated only at such time as, and to the extent that, its tax attributes are utilized by U S WEST in a combined or consolidated income tax filing. Federal and state tax refunds and carryforwards or carrybacks of tax attributes will generally be allocated to the Group to which such tax attributes relate.\nD-27\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Media Group includes members which operate in states where U S WEST does not file consolidated or combined state income tax returns. Separate state income tax returns are filed by these members in accordance with the respective states' laws and regulations. The members record a tax provision on a separate company basis in accordance with the requirements of Statement of Financial Accounting Standard (\"SFAS\") No. 109.\nGROUP FINANCING Financing activities for the Media Group and the nonregulated Communications Group businesses, including the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of preferred securities, are managed by U S WEST on a centralized basis. Financing activities for U S WEST Communications are separately identified and accounted for in U S WEST's records and U S WEST Communications conducts its own borrowing activities. Debt incurred and investments made by U S WEST and its subsidiaries on behalf of the Media Group are specifically allocated to and reflected on the financial statements of the Media Group. Debt incurred and investments made by U S WEST and its subsidiaries on behalf of the nonregulated businesses of the Communications Group and all debt incurred and investments made by U S WEST Communications are specifically allocated to and reflected on the financial statements of the Communications Group. Debt incurred by U S WEST or a subsidiary on behalf of a Group is charged to such Group at the borrowing rate of U S WEST or such subsidiary.\nAs of November 1, 1995, the effective date of the Recapitalization Plan, U S WEST does not intend to transfer funds between the Groups, except for certain short-term, ordinary course advances of funds at market rates associated with U S WEST's centralized cash management. Such short-term transfers of funds will be accounted for as short-term loans between the Groups bearing interest at the market rate at which management determines the borrowing Group could obtain funds on a short-term basis. If the Board, in its sole discretion, determines that a transfer of funds between the Groups should be accounted for as a long- term loan, the Board would establish the terms on which such loan would be made, including the interest rate, amortization schedule, maturity and redemption terms. Such terms would generally reflect the then prevailing terms upon which management determines such Group could borrow funds on a similar basis. The financial statements of the lending Group will be credited, and the financial statements of the borrowing Group will be charged, with the amount of any such loan, as well as with periodic interest accruing thereon. The Board may determine that a transfer of funds from the Communications Group to the Media Group should be accounted for as an equity contribution, in which case an inter-group interest (determined by the Board based on the then current market value of shares of Media Stock) will either be created or increased, as applicable. Similarly, if an inter-group interest exists, the Board may determine that a transfer of funds from the Media Group to the Communications Group should be accounted for as a reduction in the inter-group interest.\nDIVIDENDS Under the Recapitalization Plan, U S WEST intends to retain future earnings of the Media Group, if any, for the development of the Media Group's businesses and does not anticipate paying dividends to the Media Group shareholders in the foreseeable future.\nEARNINGS PER COMMON SHARE Earnings per common share for 1995 and 1994 have been presented on a pro forma basis to reflect the Media Group's Stock as if it had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST.\nINDUSTRY SEGMENTS The businesses comprising the Media Group operate in four industry segments, as defined in SFAS No. 14, \"Financial Reporting for Segments of a Business Enterprise,\" consisting of directory and information services, wireless communications, cable and telecommunications and the capital assets segment, which is held for sale.\nD-28\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Prior to January 1, 1995, the capital assets segment was accounted for as discontinued operations. Effective January 1, 1995, the capital assets segment has been accounted for as a net investment in assets held for sale, as discussed in Note 20 to the Media Group Combined 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 the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCASH AND CASH EQUIVALENTS Cash and cash equivalents include highly liquid investments with original maturities of three months or less that are readily convertible into cash and are not subject to significant risk from fluctuations in interest rates.\nPROPERTY, PLANT AND EQUIPMENT The investment in property, plant and equipment is carried at cost, less accumulated depreciation. Additions, replacements and substantial betterments are capitalized. All other repairs and maintenance costs are expensed as incurred.\nInterest related to qualifying construction projects, including construction projects of equity method investees, is capitalized and reflected as a reduction of interest expense. Amounts capitalized by the Media Group were $33, $8 and $5 in 1995, 1994 and 1993, respectively.\nDepreciation is calculated using the straight-line method. When such depreciable property, plant and equipment is retired or sold, the resulting gain or loss is included in income.\nINTANGIBLE ASSETS Intangible assets are recorded when the cost of acquired companies exceeds the fair value of their tangible assets. The costs of identified intangible assets and goodwill are amortized by the straight-line method over periods ranging from five to forty years. These assets are evaluated, with other related assets, for impairment using a discounted cash flow methodology.\nFOREIGN CURRENCY TRANSLATION Assets and liabilities of international investments are translated at year-end exchange rates, and income statement items are translated at average exchanges rates for the year. Resulting translation adjustments are recorded as a separate component of equity. Gains and losses resulting from foreign currency transactions are included in income.\nFINANCIAL INSTRUMENTS Net interest received or paid on interest rate swaps is recognized over the life of the swaps as an adjustment to interest expense. Foreign exchange contracts designated as hedges of firm equity investment commitments are carried at market value, with gains and losses recorded in equity until sale of the investment. Forward contracts designated as hedges of foreign denominated loans are recorded at market value, with gains and losses recorded in income.\nINVESTMENTS IN DEBT SECURITIES Debt securities are classified as available for sale and are carried at fair market value with unrealized gains and losses included in equity.\nREVENUE RECOGNITION AND DEFERRED DIRECTORY COSTS Cellular access and cable television revenues are generally billed monthly, in advance, and revenues are recognized the following month when services are provided. Revenues derived from wireless airtime usage are billed and recorded monthly as services are provided.\nDirectory advertising revenues and related directory costs of selling, composition, printing and distribution are generally deferred and recognized over the period during which directories are used, normally 12 months. For international operations, directory advertising revenues and related directory costs are deferred and recognized upon publication.\nINCOME TAXES The provision for income taxes consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods in accordance with SFAS No. 109. U S WEST\nD-29\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) implemented SFAS No. 109, \"Accounting for Income Taxes\" in 1993. Adoption of the new standard did not have a material effect on the financial position or results of operations, primarily because of U S WEST's earlier adoption of SFAS No. 96.\nNEW ACCOUNTING STANDARDS In 1996, U S WEST will adopt 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 long-lived assets and associated intangibles be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. SFAS No. 121 also requires that a company no longer record depreciation expense on assets held for sale. U S WEST expects that the adoption of SFAS No. 121 will not have a material effect on its financial position or results of operations.\nIn 1996, U S WEST will adopt SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard establishes a fair value method for accounting for stock-based compensation plans either through recognition or disclosure. U S WEST will adopt this standard through compliance with the disclosure requirements set forth in SFAS No. 123. Adoption of the standard will have no impact on the financial position or results of operations of U S WEST.\nNOTE 3: RELATED PARTY TRANSACTIONS\nCUSTOMER LISTS, BILLING AND COLLECTION, AND OTHER SERVICES The domestic publishing operations purchase customer lists, billing and collection and other services from the Communications Group. The data and services are purchased at market price. The charges for these services were $20, $29 and $26 in 1995, 1994 and 1993, respectively.\nTELECOMMUNICATIONS SERVICES The domestic wireless operations purchase telecommunications network access and usage from the Communications Group. The charges for these services were $40, $30 and $24 in 1995, 1994 and 1993, respectively.\nNOTE 4: INDUSTRY SEGMENTS Industry segment data is presented for the combined operations of the Media Group. U S WEST's equity method investments and the capital assets segment, which is held for sale, are included in \"Corporate and other.\" Supplemental Media Group information on a proportionate basis is presented in Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe directory and information services segment consists of the publishing of White and Yellow Pages telephone directories, database marketing services and interactive services in domestic and international markets. The wireless communications segment provides information products and services over wireless networks in 13 western and midwestern states. The cable and telecommunications segment was created with the December 6, 1994 acquisition of cable television systems in the Atlanta metropolitan area. (See Note 5 to the Media Group Combined Financial Statements.)\nD-30\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4: INDUSTRY SEGMENTS (CONTINUED) Industry segment financial information follows:\n- ------------------------------ (1) Includes revenue from directory publishing activities in Europe of $122, $78 and $7, operating losses of $(1), $(1) and $(3), and identifiable assets of $133, $124 and $4 for 1995, 1994 and 1993, respectively.\n(2) Results of operations have been included since the date of acquisition of the Atlanta Systems\n(3) Includes U S WEST's equity method investments and the capital assets segment, which has been discontinued and is held for sale.\n(4) Includes pretax restructuring charges of $50 and $70 for the directory and information services and wireless communications segments, respectively.\nOperating income represents sales and other revenues less operating expenses, and excludes interest expense, equity losses in unconsolidated ventures, other income and income taxes. Identifiable assets are those assets used in each segment's operations. Corporate and other assets consist primarily of cash, debt securities, investments in international ventures, the investment in Time Warner Entertainment, the net investment in assets held for sale and other assets. Corporate and other operating losses include general corporate expenses and administrative costs primarily associated with the Media Group equity investments.\nTo ensure consistency and quality of service, the wireless segment uses Motorola as its primary vendor for infrastructure equipment and cellular mobile telephone equipment and accessories. In addition, Motorola provides ongoing technological support for the infrastructure equipment. The infrastructure of approximately 75 percent of the Media Group's major cellular markets is comprised of Motorola equipment.\nDuring 1994, U S WEST signed a definitive agreement with AirTouch Communications to combine their domestic cellular assets. The initial equity ownership of this cellular joint venture will be approximately 70 percent AirTouch and approximately 30 percent Media Group. The combination will take place in two phases. During Phase I, which U S WEST entered effective November 1, 1995, the two companies are operating their cellular properties separately. A Wireless Management Company (the \"WMC\") has been formed and is providing centralized services to both companies on a contract basis. In Phase II, AirTouch\nD-31\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4: INDUSTRY SEGMENTS (CONTINUED) and U S WEST will contribute their domestic cellular assets to the WMC. In this phase, the Media Group will reflect its share of the combined operating results of the WMC using the equity method of accounting. The recent passage of the Telecommunications Act of 1996 has removed significant regulatory barriers to completion of Phase II of the business combination. U S WEST expects that Phase II closing could take place by the end of 1996 or early 1997.\nNOTE 5: ACQUISITION OF CABLE SYSTEMS\nATLANTA SYSTEMS On December 6, 1994, U S WEST acquired the stock of Wometco Cable Corp. and subsidiaries, and the assets of Georgia Cable Partners and Atlanta Cable Partners L.P. (the \"Atlanta Systems\"), for cash of $745 and 12,779,206 U S WEST common shares valued at $459, for a total purchase price of approximately $1.2 billion. The Atlanta Systems' results of operations have been included in the combined results of operations of the Media Group since the date of acquisition. Had the acquisition occurred as of January 1, 1994, the Media Group revenue and net income for 1994 would have been $2,098 and $265, respectively.\nThe acquisition was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired (primarily identified intangibles) based on their estimated fair values. The identified intangibles and goodwill are being amortized on a straight-line basis over 25 years.\nCONTINENTAL CABLEVISION, INC. (SUBSEQUENT EVENT) On February 27, 1996, U S WEST announced a definitive agreement to merge with Continental Cablevision, Inc. (\"Continental\"). Continental, the nation's third-largest cable operator, serves 4.2 million domestic customers, passes more than seven million domestic homes and holds significant other domestic and international properties. U S WEST will purchase all of Continental's stock for approximately $5.3 billion and will assume Continental's debt and other obligations, which amount to approximately $5.5 billion. Consideration for the $5.3 billion in equity will consist of approximately $1 billion in U S WEST preferred stock, convertible to Media Stock; and, at U S WEST's option, between $1 billion and $1.5 billion in cash, and $2.8 billion to $3.3 billion in shares of Media Stock. The transaction, which is expected to close in the fourth quarter of 1996, is subject to a number of conditions and approvals, including approvals from Continental shareholders and local franchising and government authorities.\nNOTE 6: INVESTMENT IN TIME WARNER ENTERTAINMENT On September 15, 1993, U S WEST acquired 25.51 percent pro-rata priority capital and residual equity interests (\"equity interests\") in Time Warner Entertainment Company L.P. (\"TWE\" or \"Time Warner Entertainment\") for an aggregate purchase price of $2.553 billion. TWE owns and operates substantially all of the entertainment assets previously owned by Time Warner Inc. (\"Time Warner\"), consisting primarily of its filmed entertainment, programming-HBO and cable businesses.\nUpon U S WEST's admission to the partnership, certain wholly-owned subsidiaries of Time Warner (\"General Partners\") and subsidiaries of Toshiba Corporation and ITOCHU Corporation held pro-rata priority capital and residual equity interests of 63.27, 5.61 and 5.61 percent, respectively. In 1995, Time Warner acquired the limited partnership interests previously held by subsidiaries of each of ITOCHU Corporation and Toshiba Corporation.\nU S WEST has an option to increase its pro-rata priority capital and residual equity interests in TWE from 25.51 percent up to 31.84 percent depending upon cable operating performance. The option is exercisable, in whole or part, between January 1, 1999, and May 31, 2005, for an aggregate cash exercise price ranging from $1.25 billion to $1.8 billion, depending upon the year of exercise. Either TWE or U S WEST may elect that the exercise price for the option be paid with partnership interests rather than cash.\nPursuant to the TWE Partnership Agreement, there are four levels of capital. From the most to least senior, the capital accounts are: senior preferred (held by the General Partners); pro-rata priority capital (A\nD-32\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) preferred - held pro-rata by the general and limited partners); junior priority capital (B preferred - held by the General Partners); and common (residual equity interests held pro-rata by the general and limited partners). Of the $2.553 billion contributed by U S WEST, $1.658 billion represents A preferred capital and $895 represents common capital. The TWE Partnership Agreement provides for special allocations of income and distributions of partnership capital. Partnership income, to the extent earned, is allocated as follows: (1) to the partners so that the economic burden of the income tax consequences of partnership operations is borne as though the partnership was taxed as a corporation (\"special tax allocations\"); (2) to the partners' preferred capital accounts in order of priority described above, at various rates of return ranging from 8 percent to 13.25 percent; and (3) to the partners' common capital according to their residual partnership interests. To the extent partnership income is insufficient to satisfy all special allocations in a particular accounting period, the unearned portion is carried over until satisfied out of future partnership income. Partnership losses generally are allocated in reverse order, first to eliminate prior allocations of partnership income, except senior preferred and special tax income, next to reduce initial capital amounts, other than senior preferred, then to reduce the senior preferred account and finally, to eliminate special tax allocations.\nA summary of the contributed capital and priority capital rates of return follows:\n- ------------------------------ (a) Estimated fair value of net assets contributed excluding partnership income or loss allocated thereto.\n(b) Income allocations related to priority capital rates of return are based on partnership income after any special tax allocations.\n(c) The senior preferred is scheduled to be distributed in three annual installments beginning July 1, 1997.\n(d) 11.00 percent to the extent concurrently distributed.\n(e) Includes $300 for the September 1995 reacquisition of assets previously excluded from the partnership (the Time Warner service partnership assets) for regulatory reasons.\n(f) 11.25 percent to the extent concurrently distributed.\nCash distributions are required to be made to the partners to permit them to pay income taxes at statutory rates based on their allocable taxable income from TWE (\"Tax Distributions\"). The aggregate amount of such Tax Distributions is computed generally by reference to the taxes that TWE would have been required to pay if it were a corporation. Tax Distributions were previously subject to restrictions until July 1995, and are now paid to the partners on a current basis. For distributions other than those related to taxes or the senior preferred, the TWE Partnership Agreement requires certain cash distribution thresholds be met to the limited partners before the General Partners receive their full share of distributions. No cash distributions have been made to U S WEST.\nD-33\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)\nNOTE 6: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) U S WEST accounts for its investment in TWE under the equity method of accounting. The excess of fair market value over the book value of total partnership net assets implied by U S WEST's initial investment was $5.7 billion. This excess is being amortized on a straight-line basis over 25 years. The Media Group's recorded share of TWE operating results represents allocated TWE net income or loss adjusted for the amortization of the excess of fair market value over the book value of the partnership net assets. As a result of this amortization and the special income allocations described above, the Media Group's recorded pretax share of TWE operating results before extraordinary item was $(31), $(18) and $(20) in 1995, 1994 and 1993, respectively. In addition, TWE recorded an extraordinary loss for the early extinguishment of debt in 1995. The Media Group's share of this extraordinary loss was $4, net of an income tax benefit of $2.\nAs consideration for its expertise and participation in the cable operations of TWE, the Media Group earns a management fee of $130 over five years, which is payable over a four-year period beginning in 1995. Management fees of $26, $26 and $8 were recorded to other income in 1995, 1994 and 1993, respectively. The Media Group Combined Balance Sheet includes a note payable to TWE of $169 and $771 and management fee receivables of $50 and $34 at December 31, 1995 and 1994, respectively.\nSummarized financial information for TWE is presented below:\n- ------------------------------ (1) Includes depreciation and amortization of $1,039, $943 and $902 in 1995, 1994 and 1993, respectively.\n(2) Includes corporate services of $64, $60 and $60 in 1995, 1994 and 1993, respectively.\n- ------------------------------ (3) Includes cash of $209 and $1,071 at December 31, 1995 and 1994, respectively.\n(4) Includes a loan receivable from Time Warner of $400 at December 31, 1995 and 1994.\n(5) Net of a note receivable from U S WEST of $169 and $771 at December 31, 1995 and 1994, respectively.\n(6) Contributed capital is based on the estimated fair value of the net assets that each partner contributed to the partnership. The aggregate of such amounts is significantly higher than TWE's partner's capital as reflected in the Summarized Financial Position, which is based on the historical cost of the contributed net assets.\nD-34\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6: INVESTMENT IN TIME WARNER ENTERTAINMENT (CONTINUED) In early 1995, Time Warner announced its intention to simplify its corporate structure by establishing an enterprise that will be responsible for the overall management and financing of the cable and telecommunications properties. Any change in the structure of TWE would require U S WEST's approval in addition to certain creditors' and regulatory approvals.\nCONTINGENCIES\nOn September 22, 1995, U S WEST filed a lawsuit in Delaware Chancery Court to enjoin the proposed merger of Time Warner and Turner Broadcasting. U S WEST has alleged breaches of contract and fiduciary duties by Time Warner in connection with this proposed merger. Time Warner filed a countersuit against U S WEST on October 11, 1995, alleging misrepresentation, breach of contract and other misconduct on the part of U S WEST. Time Warner's countersuit seeks a reformation of the Time Warner Entertainment partnership agreement, an order that enjoins U S WEST from breaching the partnership agreement, and unspecified compensatory damages. U S WEST has denied each of the claims in Time Warner's countersuit. The trial for this action concluded on March 22, 1996. A ruling by the Delaware Chancery Court is expected in June 1996.\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES The significant investments in international ventures follows:\n- ------------------------------ (C&T) Cable and Telecommunications\n(W)Wireless\nThe following table shows summarized combined financial information for the Media Group's significant equity method investments in international ventures:\nD-35\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES (CONTINUED)\nIn November 1994, TeleWest plc (\"TeleWest\") made an initial public offering of its ordinary shares. Following the offering, in which U S WEST sold part of its 50 percent joint venture interest, U S WEST owned approximately 37.8 percent of TeleWest. Net proceeds of approximately $650 were used by TeleWest to finance construction and operating costs, invest in affiliated companies and repay debt. It is U S WEST's policy to recognize as income any gains or losses related to the sale of stock to the public. The Media Group recognized a gain of $105 in 1994, net of $59 in deferred taxes, for the partial sale of its joint venture interest in TeleWest.\nOn October 2, 1995, TeleWest and SBC CableComms (UK) completed a merger of their UK cable television and telecommunications interests, creating the largest provider of combined cable and telecommunications services in the United Kingdom. Following completion of the merger, U S WEST and Tele-Communications, Inc., the major shareholders, each own 26.8 percent of the combined company. The Media Group recognized a gain of $95 in 1995, net of $62 in deferred income taxes, in conjunction with the merger.\nTeleWest, which is the only equity method investment for which a quoted market price is available, had a market value of $914 at December 31, 1995, and $1,004 at December 31, 1994.\nFOREIGN CURRENCY TRANSACTIONS U S WEST enters into forward and zero-cost combination option contracts to manage foreign currency risk. Under a forward contract, U S WEST agrees with another party to exchange a foreign currency and U.S. dollars at a specified price at a future date. Under combination options, U S WEST combines purchased options to cap the foreign exchange rate to be paid at a future date with written options to finance the premium of the purchased options. The commitments, forward contracts and combination options are for periods up to one year.\nForward exchange contracts are carried at market value. Gains or losses on the portion of the contracts designated as hedges of firm equity investment commitments are deferred as a component of Media Group equity and are recognized in income upon sale of the investment. Gains or losses on the portion of the contracts designated to offset translation of investee net income are recorded in income.\nForward contracts are also used to hedge foreign denominated loans. These contracts are carried at market value with gains or losses recorded in income.\nD-36\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7: INVESTMENTS IN INTERNATIONAL VENTURES (CONTINUED) Foreign exchange contracts outstanding follow:\nCumulative deferred gains on foreign exchange contracts of $9 and deferred losses of $25, including deferred taxes (benefits) of $4 and ($10), respectively, are included in Media Group equity at December 31, 1995. Cumulative deferred gains on foreign exchange contracts of $7 and deferred losses of $25, including deferred taxes (benefits) of $3 and ($10), respectively, are included in Media Group equity at December 31, 1994.\nThe counterparties to these contracts are major financial institutions. U S WEST is exposed to credit loss in the event of nonperformance by these counterparties. The Company does not have significant exposure to an individual counterparty and does not anticipate nonperformance by any counterparty.\nNOTE 8: PROPERTY, PLANT AND EQUIPMENT The composition of property, plant and equipment follows:\nThe Media Group depreciates buildings between 15 to 35 years, cellular and cable distribution systems between 5 to 15 years, and general purpose computer and other between 3 to 20 years.\nDepreciation expense was $173, $121, and $113 in 1995, 1994 and 1993, respectively.\nD-37\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9: INTANGIBLE ASSETS The composition of intangible assets follows:\nAmortization expense was $76, $23 and $14 in 1995, 1994 and 1993, respectively.\nNOTE 10: RESTRUCTURING CHARGE The Media Group's 1993 results reflected a $120 restructuring charge (pretax) of which $50 related to the directory and information services segment and $70 related to the wireless segment. The restructuring charge includes only specific, incremental and direct costs which can be estimated with reasonable accuracy and are clearly identifiable with the restructuring plan.\nFollowing is a schedule of the costs included in the 1993 restructuring charge and amounts remaining at December 31, 1995 and 1994:\nDuring 1993, the Media Group's wireless subsidiary replaced substantially all of its cellular network equipment, consisting primarily of cell site electronics and switching equipment, in certain of its major market areas.\nSystem development costs includes the replacement of existing, single-purpose systems used in the publishing businesses with new systems designed to provide integrated, end-to-end customer service. Other costs consist primarily of employee separation costs including severance payments, health care coverage and postemployment education benefits and relocation costs. The Media Group expects the restructuring to be substantially completed by the end of 1996. Management does not anticipate any material revisions in total estimated expenditures. However, should expenditures exceed the remaining reserve, additional amounts would be expensed as incurred.\nD-38\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: DEBT\nSHORT-TERM DEBT\nThe components of short-term debt follow:\nThe weighted average interest rate on commercial paper was 5.79 percent and 6.04 at December 31, 1995 and 1994, respectively.\nThe bank loan, in the translated principal amount of $216, is denominated in Dutch guilders. The loan was entered into in connection with U S WEST's investment in a cable television venture in the Netherlands and was repaid in February 1996.\nU S WEST maintains a commercial paper program to finance short-term cash flow requirements, as well as to maintain a presence in the short-term debt market. Additional lines of credit aggregating approximately $1.3 billion are available to the Media Group as well as the nonregulated subsidiaries of the Communications Group in accordance with their borrowing needs. The Media Group expects that cash from operations will not be adequate to fund expected cash requirements. Additional financing will come primarily from new debt.\nLONG-TERM DEBT\nInterest rates and maturities of long-term debt at December 31 follow:\nLong-term debt consists principally of debentures, medium-term notes, debt associated with U S WEST's Leveraged Employee Stock Ownership Plans (\"LESOP\"), and zero coupon subordinated notes convertible at any time into equal shares of Communications Stock and Media Stock. The zero coupon notes have a yield to maturity of approximately 7.3 percent and are recorded at a discounted value of $245 and $234 at December 31, 1995 and 1994, respectively.\nD-39\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11: DEBT (CONTINUED) In 1995, U S WEST issued $130 of Debt Exchangeable for Common Stock (\"DECS\"), due December 15, 1998 in the principal amount of $24.00 per note. The notes bear interest at 7.625 percent, of which 1.775 percent has been included in the assets held for sale reserve. Upon maturity, each DECS will be mandatorily redeemed by U S WEST for shares of Enhance Financial Services Group, Inc. (\"Enhance\") held by U S WEST or the cash equivalent at U S WEST's option. The number of shares to be delivered at maturity varies based on the per share market price of Enhance. If the market price is $24.00 per share or less, one share of Enhance will be delivered for each note; if the market price is between $24.00 and $28.32 per share, a fractional share equal to $24.00 is delivered; if the market value is greater than $28.32 per share, .8475 shares are delivered. The capital assets segment currently owns approximately 31.5 percent of the outstanding Enhance common stock.\nAt December 31, 1995, U S WEST guaranteed debt in the principal amount of approximately $140, primarily related to international ventures.\nInterest payments, net of amounts capitalized, were $140, $167 and $272 for 1995, 1994 and 1993, respectively, of which $87, $134 and $272, respectively, relate to the capital assets segment.\nINTEREST RATE RISK MANAGEMENT\nInterest rate swap agreements are used to effectively convert existing commercial paper to fixed-rate debt. This allows U S WEST to achieve interest savings over issuing fixed-rate debt directly.\nUnder an interest rate swap, U S WEST agrees with another party to exchange interest payments at specified intervals over a defined term. Interest payments are calculated by reference to the notional amount based on the fixed- and variable-rate terms of the swap agreements. The net interest received or paid as part of the interest rate swap is accounted for as an adjustment to interest expense.\nThe following table summarizes terms of swaps. Variable rates are indexed to the 30-day commercial paper rate.\nThe counterparties to these interest rate contracts are major financial institutions. The Media Group is exposed to credit loss in the event of nonperformance by these counterparties. U S WEST manages this exposure by monitoring the credit standing of the counterparty and establishing dollar and term limitations which correspond to the respective credit rating of each counterparty. U S WEST does not have significant exposure to an individual counterparty and does not anticipate nonperformance by any counterparty.\nNOTE 12: FAIR VALUES OF FINANCIAL INSTRUMENTS Fair values of cash equivalents, other current amounts receivable and payable, and short-term debt approximate carrying values due to their short-term nature.\nThe fair values of mandatorily redeemable preferred stock and long-term receivables, based on discounting future cash flows, approximate the carrying values. The fair value of foreign exchange contracts, based on estimated amounts U S WEST would receive or pay to terminate such agreements, approximate the carrying values. It is not practicable to estimate the fair value of financial guarantees associated with international operations because there are no quoted market prices for similar transactions.\nD-40\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12: FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) The fair values of interest rate swaps, including swaps associated with the capital assets segment, are based on estimated amounts U S WEST would receive or pay to terminate such agreements taking into account current interest rates and creditworthiness of the counterparties.\nThe fair values of long-term debt, including debt associated with the capital assets segment, preferred securities and preferred stock, are based on quoted market prices where available or, if not available, are based on discounting future cash flows using current interest rates.\nInvestments in debt securities are classified as available for sale and are carried at market value. These securities have various maturity dates through the year 2001. The market value of these securities is based on quoted market prices where available or, if not available, is based on discounting future cash flows using current interest rates.\nThe amortized cost and estimated market value of debt securities follow:\nThe 1995 net unrealized losses of $3 (net of a deferred tax benefit of $2) are included in Media Group equity.\nNOTE 13: LEASING ARRANGEMENTS U S WEST has entered into operating leases for office facilities, equipment and real estate. Rent expense under operating leases was $60, $63 and $57 in 1995, 1994 and 1993, respectively. Minimum future lease payments as of December 31, 1995, under noncancelable operating leases, follow:\nD-41\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14: COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY-GUARANTEED DEBENTURES On September 11, 1995, U S WEST Financing I, a wholly owned subsidiary of U S WEST (\"Financing I\"), issued $600 million of 7.96 percent Trust Originated Preferred Securities (the \"Preferred Securities\") and $19 of common securities. U S WEST holds all of the outstanding common securities of Financing I. Financing I used the proceeds from such issuance to purchase from U S WEST Capital Funding, Inc., a wholly owned subsidiary of U S WEST (\"Capital Funding\"), $619 principal amount of Capital Funding's 7.96 percent Subordinated Deferrable Interest Notes due 2025 (the \"Subordinated Debt Securities\"), the obligations under which are fully and unconditionally guaranteed by U S WEST (the \"Debt Guarantee\"). The sole assets of Financing I are and will be the Subordinated Debt Securities and the Debt Guarantee.\nIn addition, U S WEST has guaranteed the payment of interest and redemption amounts to holders of Preferred Securities when Financing I has funds available for such payments (the \"Payment Guarantee\") as well as Capital Funding's undertaking to pay all of Financing I's costs, expenses and other obligations (the \"Expense Undertaking\"). The Payment Guarantee and the Expense Undertaking, including U S WEST's guarantee with respect thereto, considered together with Capital Funding's obligations under the indenture and Subordinated Debt Securities and U S WEST's obligations under the indenture, declaration and Debt Guarantee, constitute a full and unconditional guarantee by U S WEST of Financing I's obligations under the Preferred Securities. The interest and other payment dates on the Subordinated Debt Securities correspond to the distribution and other payment dates on the Preferred Securities. Under certain circumstances, the Subordinated Debt Securities may be distributed to the holders of Preferred Securities and common securities in liquidation of Financing I. The Subordinated Debt Securities are redeemable in whole or in part by Capital Funding at any time on or after September 11, 2000, at a redemption price of $25.00 per Subordinated Debt Security plus accrued and unpaid interest. If Capital Funding redeems the Subordinated Debt Securities, Financing I is required to redeem the Preferred Securities concurrently at $25.00 per share plus accrued and unpaid distributions. As of December 31, 1995, 24,000,000 Preferred Securities were outstanding.\nNOTE 15: PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION On September 2, 1994, the Company issued to Fund American Enterprises Holdings Inc. (\"FFC\") 50,000 shares of a class of 7 percent Series C Cumulative Redeemable Preferred Stock for a total of $50. (See Note 20 to the Combined Financial Statements.) The preferred stock was attributed to the Media Group and was recorded at fair market value of $51 at the issue date. U S WEST has the right, commencing five years from September 2, 1994, to redeem the shares for one thousand dollars per share plus unpaid dividends and a redemption premium. The shares are mandatorily redeemable in year ten at face value plus unpaid dividends. At the option of FFC, the preferred stock also can be redeemed for common shares of Financial Security Assurance, an investment held by the capital assets segment. The market value of the option was $20 and $22 (based on the Black-Scholes Model) at December 31, 1995 and 1994, with no carrying value.\nD-42\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)\nNOTE 16: MEDIA GROUP EQUITY Following are the changes in Media Group equity:\nU S WEST has issued 392,000 shares of Media Stock since the November 1, 1995 recapitalization and has 472,314,000 shares outstanding at December 31, 1995.\nIncluded in Media Group equity is the cumulative foreign currency translation adjustment of $(38), $(29) and $(35) at December 31, 1995, 1994 and 1993, respectively, net of income tax benefits of $24, $18 and $9, respectively.\nLEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN (\"LESOP\")\nThe Media Group and the Communications Group participate in the defined contribution savings plan sponsored by U S WEST. Employees of the Media Group are covered by the plan except for Atlanta Systems and foreign national employees. U S WEST matches a percentage of eligible employee contributions with shares of Media Stock and\/or Communications Stock in accordance with participant elections. Participants may also elect to reallocate past company contributions between Media Stock and Communications Stock. In 1989, U S WEST established two LESOPs to provide Company stock for matching contributions to the savings plan. Shares in the LESOP are released as principal and interest are paid on the debt. At December 31, 1995, 10,145,485 shares each of Media Stock and Communications Stock had been allocated from the LESOP to participants accounts while 2,839,435 shares each of Media Stock and Communications Stock remained unallocated.\nThe borrowings associated with the LESOP, which are unconditionally guaranteed by U S WEST, are included in the accompanying Media Group Combined Financial Statements. Contributions from the Communications Group and the Media Group as well as dividends on unallocated shares held by the LESOP ($8, $11 and $14 in 1995, 1994, and 1993, respectively) are used for debt service. Beginning with the dividend paid in fourth-quarter 1995, dividends on allocated shares are being paid annually to participants. Previously, dividends on allocated shares were used for debt service with participants receiving additional shares from the LESOP. Tax benefits related to dividend payments on eligible shares in the savings plan have been allocated to the Communications Group, which paid the dividends.\nU S WEST recognizes expense based on the cash payments method. Contributions to the plan related to the Media Group were $16, $12, and $7 in 1995, 1994 and 1993, respectively, of which $3, $3 and $4, respectively, have been classified as interest expense.\nNOTE 17: STOCK INCENTIVE PLANS U S WEST maintains stock incentive plans for executives and key employees, and nonemployees. The Amended 1994 Stock Plan (the \"Plan\") was approved by shareowners on October 31, 1995 in connection with the Recapitalization Plan. The Plan is a successor plan to the U S WEST, Inc. Stock Incentive Plan and the U S WEST 1991 Stock Incentive Plan (the \"Predecessor Plans\"). No further grants of options or\nD-43\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17: STOCK INCENTIVE PLANS (CONTINUED) restricted stock may be made under the Predecessor Plans. The Plan is administered by the Human Resources Committee of the board of directors with respect to officers, executive officers and outside directors and by a special committee with respect to all other eligible employees and eligible nonemployees.\nDuring calendar year 1995, up to 1,485,000 shares of Media Stock were available for grant. The maximum aggregate number of shares of Media Stock that may be granted in any other calendar year for all purposes under the Plan is three-quarters of one percent (0.75 percent) of the shares of such class outstanding (excluding shares held in the Company's treasury) on the first day of such calendar year. In the event that fewer than the full aggregate number of shares of either class available for issuance in any calendar year are issued in any such year, the shares not issued shall be added to the shares of such class available for issuance in any subsequent year or years. Options may be exercised no later than 10 years after the date on which the option was granted.\nData for outstanding options under the Plan is summarized as follows:\n- ------------------------------ *Includes options granted in tandem with SARs.\nOptions to purchase 3,021,166 shares of Media Stock were exercisable at December 31, 1995. Options to purchase 2,374,394 shares of U S WEST stock were exercisable at December 31, 1994. A total of 1,419,795 shares of Media Stock were available for grant under the plans in effect at December 31, 1995. A total of 914,816 shares of U S WEST common stock were available for grant under the plans in effect at December 31, 1994. A total of 11,121,186 shares of Media Stock were reserved for issuance under the Plan at December 31, 1995.\nD-44\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 18: EMPLOYEE BENEFITS\nPENSION PLAN\nThe Communications Group and the Media Group participate in the defined benefit pension plan sponsored by U S WEST. The employees of the Media Group are covered by the plan except for Atlanta Systems and foreign national employees. Since plan assets are not segregated into separate accounts or restricted to providing benefits to employees of the Media Group, assets of the plan may be used to provide benefits to employees of both the Communications Group and the Media Group. In the event the single employer pension plan sponsored by U S WEST would be separated into two or more plans, guidelines in the Internal Revenue Code dictate how assets of the plan must be allocated to the new plans. U S WEST currently has no intentions to split the plan. Because of these factors, U S WEST believes there is no reasonable basis to attribute plan assets to the Media Group as if they had funded separately their actuarially determined obligation.\nManagement benefits are based on a final pay formula while occupational benefits are based on a flat benefit formula. U S WEST uses the projected unit credit method for the determination of pension cost for financial reporting purposes and the aggregate cost method for funding purposes. The Company's policy is to fund amounts required under the Employee Retirement Income Security Act of 1974 (\"ERISA\") and no funding was required in 1995, 1994 or 1993. Should funding be required in the future, funding amounts would be allocated to the Media Group based upon the ratio of service cost of the Media Group to total service cost of plan participants.\nThe composition of the net pension cost and the actuarial assumptions of the plan follow:\nThe expected long-term rate of return on plan assets used in determining net pension cost was 8.50 percent for 1995, 8.50 percent for 1994 and 9.00 percent for 1993.\nThe funded status of the U S WEST plan follows:\nD-45\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 18: EMPLOYEE BENEFITS (CONTINUED) The actuarial assumptions used to calculate the projected benefit obligation follow:\nAnticipated future benefit changes have been reflected in the above calculations.\nALLOCATION OF PENSION COSTS U S WEST's allocation policy is to 1) offset the company-wide service cost, interest cost and amortizations by the return on plan assets; and 2) allocate the remaining net pension cost to the Media Group based on the ratio of actuarially determined service cost of the Media Group to total service cost of plan participants. U S WEST believes allocating net pension cost based on service cost is reasonable since service cost is a primary factor in determining pension cost. Net pension costs allocated to the Media Group were $0, $0 and $(9) in 1995, 1994 and 1993, respectively. The service and interest costs for 1995 and the projected benefit obligation at December 31, 1995 attributed to the Media Group were $24, $29 and $429, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Communications Group and the Media Group participate in plans sponsored by U S WEST which provide certain health care and life insurance benefits to retired employees. In conjunction with the Company's 1992 adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" the Company elected to immediately recognize the accumulated postretirement benefit obligation for current and future retirees.\nU S WEST uses the projected unit credit method for the determination of postretirement medical and life costs for financial reporting purposes. The composition of net postretirement benefit costs and actuarial assumptions underlying plan benefits follow:\nThe expected long-term rate of return on plan assets used in determining postretirement benefit costs was 8.50 percent for 1995, 8.50 percent in 1994 and 9.00 percent in 1993.\nD-46\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 18: EMPLOYEE BENEFITS (CONTINUED) The funded status of the plans follow:\n- ------------------------------ (1) Medical plan assets include Communications Stock of $210 and Media Stock of $112 in 1995 and U S WEST common stock of $164 in 1994.\nThe actuarial assumptions used to calculate the accumulated postretirement benefit obligation follow:\n- ------------------------------ * Medical cost trend rate gradually declines to an ultimate rate of 5 percent in 2011.\nA one-percent increase in the assumed health care cost trend rate for each future year would have increased the aggregate of the service and interest cost components of 1995 net postretirement benefit cost by approximately $40 and increased the 1995 accumulated postretirement benefit obligation by approximately $350.\nAnticipated future benefit changes have been reflected in these postretirement benefit calculations.\nPLAN ASSETS Assets of the postretirement medical and life plans may be used to provide benefits to employees of both the Communications Group and the Media Group since plan assets are not legally restricted to providing benefits to either Group. In the event that either plan sponsored by U S WEST would be separated into two or more plans, there are no guidelines in the Internal Revenue Code for allocating assets of the plan. U S WEST allocates the assets based on historical contributions for postretirement medical costs, and on the ratio of salaries for life plan participants. U S WEST currently has no intention to split the plans.\nPOSTRETIREMENT MEDICAL COSTS The service and interest components of net postretirement medical benefit costs are calculated for the Media Group based upon the population characteristics of the Group. Since funding of postretirement medical costs is voluntary, return on assets is attributed to the Media Group based upon historical funding. The Media Group has historically funded the maximum annual tax deductible contribution for management employees and the amount of annual expense for occupational employees. The Media Group periodically reviews its funding strategy and future funding amounts, if any, will be based upon the cash requirements of the Group.\nD-47\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 18: EMPLOYEE BENEFITS (CONTINUED) Net postretirement medical benefit costs recognized by the Media Group for 1995, 1994 and 1993 were $14, $11 and $11, respectively. The percentage of postretirement medical assets attributed to the Media Group at December 31, 1995 and 1994, based upon historical voluntary contributions, was 4 and 5 percent, respectively. The accumulated postretirement medical benefit obligation attributed to the Media Group was $161 at December 31, 1995.\nALLOCATION OF POSTRETIREMENT LIFE COSTS Net postretirement life costs, and funding requirements, if any, are allocated to the Media Group in the same manner as pensions. U S WEST will generally fund the amount allowed for tax purposes and no funding of postretirement life insurance occurred in 1995, 1994 and 1993. U S WEST believes its method of allocating postretirement life costs is reasonable.\nNet postretirement life benefit costs allocated to the Media Group for 1995, 1994 and 1993 were $0, $3, and $3, respectively. The service and interest costs for 1995 and the accumulated postretirement life benefit obligation at December 31, 1995 attributed to the Media Group were $1, $3 and $45, respectively.\nNOTE 19: INCOME TAXES The components of the provision for income taxes follow:\nAmounts U S WEST paid for income taxes were $566, $313 and $391 in 1995, 1994 and 1993, respectively, inclusive of the capital assets segment, of which $55, ($178) and $94 related to the Media Group. The Media Group, including the capital assets segment, had taxes payable of $90 and $88 as of December 31, 1995 and 1994, respectively.\nD-48\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 19: INCOME TAXES (CONTINUED) The effective tax rate differs from the statutory tax rate as follows:\nThe components of the net deferred tax liability follow:\nThe current portion of the deferred tax asset was $24 and $52 at December 31, 1995 and 1994, respectively, resulting primarily from restructuring charges and compensation-related items.\nThe net deferred tax liability includes $686 in 1995 and $678 in 1994 related to the capital assets segment.\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE The Combined Financial Statements of the Media Group include the discontinued operations of the capital assets segment. During the second quarter of 1993, the U S WEST Board of Directors approved a plan to dispose of the capital assets segment through the sale of segment assets and businesses. Accordingly, the Media Group recorded an after-tax charge of $100 for the estimated loss on disposition. An additional provision of $20 is related to the effect of the 1993 increase in federal income tax rates. The capital assets segment includes activities related to financial services and financial guarantee insurance operations. Also included in the segment is U S WEST Real Estate, Inc., for which disposition was announced in 1991 and a $500 valuation allowance was established to cover both carrying costs and losses on disposal of related properties.\nD-49\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) Effective January 1, 1995, the capital assets segment has been accounted for in accordance with Staff Accounting Bulletin No. 93, issued by the Securities Exchange Commission, which requires discontinued operations not disposed of within one year of the measurement date to be accounted for prospectively in continuing operations as a \"net investment in assets held for sale.\" The net realizable value of the assets is reevaluated on an ongoing basis with adjustments to the existing reserve, if any, charged to continuing operations. No such adjustment was required in 1995. Prior to January 1, 1995, the entire capital assets segment was accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30.\nDuring 1994, U S WEST reduced its ownership interest in Financial Security Assurance Holdings, Ltd. (\"FSA\"), a member of the capital assets segment, to 60.9 percent, and its voting interest to 49.8 percent through a series of transactions. In May and June 1994, U S WEST sold 8.1 million shares of FSA, including 2 million shares sold to Fund American Enterprises Holdings Inc. (\"FFC\"), in an initial public offering of FSA common stock. U S WEST received $154 in net proceeds from the offering. The Media Group retained certain risks in asset-backed obligations related to the commercial real estate portfolio. On September 2, 1994, U S WEST issued to FFC 50,000 shares of cumulative redeemable preferred stock for a total of $50. (See Note 15 to the Combined Financial Statements.) In December 1995, FSA merged with Capital Guaranty Corporation for shares of FSA and cash of $51. The transaction was valued at approximately $203 and reduced U S WEST's ownership interest in FSA to 50.3 percent and its voting interest to 41.7 percent. U S WEST expects to monetize and ultimately reduce its ownership in FSA through the issuance of Debt Exchangeable for Common Stock (\"DECS\") in 1996. At maturity, each DECS will be mandatorily exchanged by U S WEST for shares of FSA common stock held by U S WEST or, at U S WEST's option, redeemed at the cash equivalent.\nU S WEST entered into a transaction to reduce its investment in Enhance Financial Services Group, Inc. (\"Enhance\") during fourth-quarter 1995. U S WEST issued DECS due December 15, 1998. Upon maturity, each DECS will be mandatorily exchanged by U S WEST for shares of Enhance Common Stock or, at U S WEST's option, redeemed at the cash equivalent. The capital assets segment currently owns approximately 31.5 percent of the outstanding Enhance common stock. (See Note 11 to the Combined Financial Statements.)\nU S WEST Real Estate, Inc. has sold various properties totaling $120, $327 and $66 in each of the three years ended December 31, 1995, respectively. The sales proceeds were in line with estimates. Proceeds from building sales were primarily used to repay related debt. U S WEST has completed construction of existing buildings in the commercial real estate portfolio and expects to substantially complete the liquidation of this portfolio by 1998. The remaining balance of assets subject to sale is approximately $490, net of reserves, as of December 31, 1995.\nIn December 1993, U S WEST sold $2.0 billion of finance receivables and the business of U S WEST Financial Services, Inc. to NationsBank Corporation. Sales proceeds of $2.1 billion were used primarily to repay related debt. The pretax gain on the sale of approximately $100, net of selling expenses, was in line with management's estimate and was included in the Media Group's estimate of provision for loss on disposal. The management team that previously operated the entire capital assets segment transferred to NationsBank.\nBuilding sales and operating revenues of the capital assets segment were $237, $553 and $710 in 1995, 1994 and 1993, respectively. Income from discontinued operations for 1993 (to June 1) totaled $38. Income (loss) from the capital assets segment subsequent to June 1, 1993 is being deferred and is included within the reserve for assets held for sale.\nThe assets and liabilities of the capital assets segment have been separately classified on the Combined Balance Sheets as net investment in assets held for sale.\nD-50\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) The components of net investment in assets held for sale follow:\nFinance receivables primarily consist of contractual obligations under long-term leases that U S WEST intends to run off. These long-term leases consist mostly of leveraged leases related to aircraft and power plants. For leveraged leases, the cost of the assets leased is financed primarily through nonrecourse debt which is netted against the related lease receivable.\nThe components of finance receivables follow:\nInvestments in debt securities are classified as available for sale and are carried at market value. Any resulting unrealized holding gains or losses, net of applicable deferred income taxes, are reflected as a component of Media Group equity.\nD-51\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) The amortized cost and estimated market value of investments in debt securities are as follows:\nNote: Also included in Media Group equity are unrealized gains and losses on debt securities associated with the Media Group's equity investment in FSA. 1995 includes unrealized gains of $24, net of deferred taxes of $13, and 1994 includes unrealized losses of $49, net of deferred tax benefits of $26.\nThe 1995 net unrealized gains of $39 (net of deferred taxes of $21 ) and the 1994 net unrealized losses of $64 (net of deferred tax benefits of $34), are included in Media Group equity.\nDEBT\nInterest rates and maturities of debt associated with the capital assets segment at December 31 follow:\nDebt of $71 and $119 at December 31, 1995 and 1994, respectively, was collateralized by first deeds of trust on associated real estate and assignment of rents from leases.\nThe following table summarizes terms of swaps associated with the capital assets segment. Variable rates are indexed to three- and six-month LIBOR.\n- ------------------------------ (1) The fixed to variable swaps have the same terms as the variable to fixed swaps and were entered into to terminate the variable to fixed swaps. The net loss on the swaps is deferred and amortized over the remaining life of the swaps and is included in the reserve for assets held for sale.\n(2) Variable rate debt based on Treasuries is swapped to a LIBOR-based interest rate.\nD-52\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20: NET INVESTMENT IN ASSETS HELD FOR SALE (CONTINUED) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET CREDIT RISK -- FINANCIAL GUARANTEES\nThe Media Group retained certain risks in asset-backed obligations related to the commercial real estate portfolio. The principal amounts insured on the asset-backed obligations follow:\nConcentrations of collateral associated with insured asset-backed obligations follow:\nADDITIONAL FINANCIAL INFORMATION\nInformation for U S WEST Financial Services, Inc., a member of the capital assets segment, follows:\nD-53\nU S WEST MEDIA GROUP NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 21: QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------------------------\nEffective November 1, 1995, each share of U S WEST, Inc. common stock was converted into one share each of Communications Stock and Media Stock. Earnings per common share have been presented on a pro forma basis to reflect the two classes of stock as if they had been outstanding since January 1, 1994. For periods prior to the recapitalization, the average common shares outstanding are assumed to be equal to the average common shares outstanding for U S WEST, Inc.\n1995 third-quarter net income includes costs of $5 ($0.01 per share) associated with the Recapitalization Plan and costs of $4 ($.01 per share) for the early extinguishment of debt. 1995 fourth-quarter net income includes a gain of $95 ($0.20 per share) from the merger of U S WEST's joint venture interest in TeleWest. 1995 fourth-quarter net income also includes costs of $4 ($.01 per share) associated with the Recapitalization Plan.\n1994 second-quarter net income includes a gain of $41 ($.09 per share) on the sale of paging operations. 1994 fourth-quarter net income includes a gain of $105 ($.23 per share) from the partial sale of U S WEST's joint venture interest in TeleWest.\nD-54\nU S WEST MEDIA GROUP\nSUPPLEMENTARY SELECTED PROPORTIONATE RESULTS OF OPERATIONS\nThe Media Group believes that proportionate financial data facilitates the understanding and assessment of its Combined Financial Statements. The following proportionate accounting table reflects the relative weight of the Media Group's ownership interest in its domestic and international investments in cable and telecommunications, wireless and directory and information services operations. The financial information included below departs materially from generally accepted accounting principles (\"GAAP\") because it aggregates the revenues and operating income of entities not controlled by the Media Group with those of the consolidated operations of the Media Group. This table is not intended to replace the Combined Financial Statements prepared in accordance with GAAP. Supplemental Media Group information on a proportionate basis is presented in Management's Discussion and Analysis.\n- ------------------------------\nNote: Certain reclassifications within the Selected Proportionate Results of Operations have been made to conform to the current year presentation.\n(1) Earnings before interest, taxes, depreciation and amortization (\"EBITDA\").\nD-55","section_15":""}
{"filename":"92416_1995.txt","cik":"92416","year":"1995","section_1":"ITEM 1. BUSINESS\nThe registrant, Southwest Gas Corporation (the Company), is incorporated under the laws of the State of California effective March 1931. The executive offices of the Company are located at 5241 Spring Mountain Road, P.O. Box 98510, Las Vegas, Nevada, 89193-8510, telephone number (702) 876-7237.\nThe Company is principally engaged in the business of purchasing, transporting, and distributing natural gas in portions of Arizona, Nevada, and California. The Company also engaged in financial services activities, through PriMerit Bank, Federal Savings Bank (PriMerit or the Bank), a wholly owned subsidiary. See Selected Financial Data for financial information related to natural gas operations and discontinued financial services operations.\nIn January 1996, the Company entered into a definitive agreement with Norwest Corporation to sell PriMerit. The sale is expected to be finalized in the third quarter of 1996. The financial services activities are accounted for as discontinued operations for consolidated financial reporting purposes. However, as required, the Company has also included the separate, stand-alone financial results and disclosures for the Bank on a going-concern basis in this Form 10-K. Full disclosure of Bank operating activities and results on a going-concern basis is included herein for purposes of providing information considered useful in analyzing the proposed sale.\nSeparate, stand-alone financial results and disclosures reported for the Bank on a going-concern basis are included in ITEM 1, BUSINESS (pages 7 to 23), ITEM 6, SELECTED FINANCIAL INFORMATION (page 29), ITEM 7, MANAGEMENT'S DISCUSSION AND ANALYSIS (MD&A) (pages 37 to 49), and Note 13 of ITEM 8, FINANCIAL STATEMENTS (pages 68 to 96). The separate stand-alone financial results and disclosures reported for the Bank on a going-concern basis differ from the results and disclosures reported for the Bank as a discontinued operation. See Note 12 of the Notes to Consolidated Financial Statements for reconciliations of Bank stand-alone financial information to the amounts shown as discontinued operations in the consolidated financial statements. In 1996, while the Company will continue, as required, to disclose the ongoing operating results of the Bank through the close of the proposed transaction, those amounts will not be realized or recognized by the Company in its consolidated financial statements, consistent with the terms of the sales agreement.\nIn November 1995, the Company entered into a definitive agreement to acquire Northern Pipeline Construction Co. (NPL), a full-service underground gas pipeline contractor. NPL provides local gas distribution companies with installation, replacement and maintenance services for underground natural gas distribution systems. The acquisition is anticipated to be completed during the first half of 1996. See Note 8 of the Notes to Consolidated Financial Statements for additional information.\nCONTINUING OPERATIONS -- NATURAL GAS OPERATIONS\nGENERAL DESCRIPTION\nThe Company is subject to regulation by the Arizona Corporation Commission (ACC), the Public Service Commission of Nevada (PSCN), and the California Public Utilities Commission (CPUC). These commissions regulate public utility rates, practices, facilities, and service territories in their respective states. The CPUC also regulates the issuance of all securities by the Company, with the exception of short-term borrowings. Certain of the Company's accounting practices, transmission facilities, and rates are subject to regulation by the Federal Energy Regulatory Commission (FERC).\nThe Company purchases, transports, and distributes natural gas to approximately 1,029,000 residential, commercial, and industrial customers in geographically diverse portions of Arizona, Nevada, and California. There were 49,000 customers added to the system during 1995. See Natural Gas Operations Segment -- Capital Resources and Liquidity of MD&A for discussion of capital requirements to meet the Company's expected future growth.\nFor each of the years in the three-year period ended December 31, 1995, the percentage of operating margin (operating revenues less net cost of gas) derived from residential and small commercial customers was\n79 percent, while the percentage related to large commercial, industrial, and other users was 7 percent. The remaining 14 percent was derived from transportation, electric generation, and resale customers.\nThe volume of sales and transportation activity for electric utility generating plants varies greatly according to demand for electricity and the availability of alternative energy sources; however, the corresponding income is not material in relation to the Company's earnings. In addition, the Company is not dependent on any one or a few customers to the extent that the loss of any one or several would have a significant adverse impact on the Company.\nTransportation of customer-secured gas to end-users on the Company's system continues to have a significant impact on the Company's throughput, accounting for 56 percent of total system throughput in 1995. Although the volumes were significant, these customers provide a much smaller proportionate share of the Company's operating margin. In 1995, customers who utilized this service transported over one billion therms.\nThe demand for natural gas is seasonal. Variability in weather from normal temperatures may materially impact results of operations. It is management's opinion that comparisons of earnings for interim periods do not reliably reflect overall trends and changes in the Company's operations. Also, earnings for interim periods can be significantly affected by the timing of general rate relief.\nPROPERTIES\nThe plant investment of the Company consists primarily of transmission and distribution mains, compressor stations, peak shaving\/storage plants, service lines, meters, and regulators which comprise the pipeline systems and facilities located in and around the communities served. The Company also includes other properties such as land, buildings, furnishings, work equipment, and vehicles in plant investment. The Company's northern Nevada and northern California properties are referred to as the northern system; the Arizona, southern Nevada, and southern California properties are referred to as the southern system. Several properties are leased by the Company, including a Liquefied Natural Gas (LNG) storage plant on its northern Nevada system and a portion of the corporate headquarters office complex located in Las Vegas, Nevada. See Note 2 of the Notes to Consolidated Financial Statements for additional discussion regarding these leases. Total gas plant, exclusive of leased property, at December 31, 1995, was $1.6 billion, including construction work in progress. It is the opinion of management that the properties of the Company are suitable and adequate for its purposes.\nSubstantially all of the Company's gas mains and service lines are constructed across property owned by others under right-of-way grants obtained from the record owners thereof, on the streets and grounds of municipalities under authority conferred by franchises or otherwise, or on public highways or public lands under authority of various federal and state statutes. None of the Company's numerous county and municipal franchises are exclusive, and some are of limited duration. These franchises are renewed regularly as they expire, and the Company anticipates no serious difficulties in obtaining future renewals.\nWith respect to the right-of-way grants, the Company has had continuous and uninterrupted possession and use of all such rights-of-way, and the associated gas mains and service lines, commencing with the initial stages of the construction of such facilities. Permits have been obtained from public authorities in certain instances to cross, or to lay facilities along, roads and highways. These permits typically are revocable at the election of the grantor, and the Company occasionally must relocate its facilities when requested to do so by the grantor. Permits have also been obtained from railroad companies to cross over or under railroad lands or rights-of-way, which in some instances require annual or other periodic payments and are revocable at the grantors' elections.\nThe Company operates two major pipeline transmission systems: (i) a system owned by Paiute Pipeline Company (Paiute), a wholly owned subsidiary, extending from the Idaho-Nevada border to the Reno, Sparks, and Carson City areas and communities in the Lake Tahoe area in both California and Nevada and other communities in northern and western Nevada; and (ii) a system extending from the Colorado River at the southern tip of Nevada to the Las Vegas distribution area.\nThe Company also owns a 35,000 acre site in northern Arizona which was acquired for the purpose of constructing an underground natural gas storage facility, known as the Pataya Gas Storage Project (Pataya),\nto serve its southern system. Based upon current studies and the continued restructuring of the utility industry, the Company believes that it will need an underground natural gas storage facility, such as Pataya, in the future to meet the needs of its customers on the southern system. Project costs of $11.1 million have been capitalized through December 1995 and include land acquisition and related development costs.\nThe map below shows the locations of the Company's major facilities and major transmission lines, and principal communities to which the Company supplies gas either as a wholesaler or distributor. The map also shows major supplier transmission lines that are interconnected with the Company's systems.\n[MAP]\n[DESCRIPTION: Map of Arizona, Nevada, and southern California indicating the location of the Company's service areas. Service areas in Arizona include most of the central and southern areas of the state including Phoenix, Tucson, Yuma, and surrounding communities. Service areas in northern Nevada include Carson City, Yerington, Fallon, Lovelock, Winnemucca, and Elko. Service areas in southern Nevada include the Las Vegas valley (including Henderson and Boulder City), and Laughlin. Service areas in southern California include Barstow, Big Bear, Needles, and Victorville. Service areas in northern California include the north shore of Lake Tahoe. Companies providing gas transportation services for the Company are indicated by showing the location of their pipelines. Major transporters include El Paso Natural Gas Company, Kern River Gas Transmission Company, Northwest Pipeline Corporation, and Southern California Gas Company. The location of Paiute Pipeline Company's transmission pipeline (extending from the Idaho\/Nevada border to the Reno\/Tahoe area) and the Company's pipeline (extending from Laughlin\/Bullhead City to the Las Vegas valley) are indicated. The LNG facility is located near Lovelock, Nevada. The liquefied petroleum gas facility is located near Reno, Nevada.]\nRATES AND REGULATION\nRates that the Company is authorized to charge its distribution system customers are determined by the ACC, CPUC, and PSCN in general rate cases and are derived using rate base, cost of service, and cost of capital experienced in a historical test year, as adjusted in Arizona and Nevada, and projected for a future test year in California. The FERC regulates the northern Nevada transmission and LNG storage facilities of Paiute and the rates it charges for transportation of gas directly to certain end-users and to various local distribution companies (LDCs). The LDCs transporting on Paiute's system are: Sierra Pacific Power Company (Reno and Sparks, Nevada), Washington Water Power Company (South Lake Tahoe, California), and Southwest Gas Corporation (North Lake Tahoe, California and various locations throughout northern Nevada).\nRates charged to customers vary according to customer class and are fixed at levels allowing for the recovery of all prudently incurred costs, including a return on rate base sufficient to pay interest on debt, preferred dividends, and a reasonable return on common equity. The Company's rate base consists generally of the original cost of utility plant in service, plus certain other assets such as working capital and inventories, less accumulated depreciation on utility plant in service, net deferred income tax liabilities, and certain other deductions. The Company's rate schedules in all of its service areas contain purchased gas adjustment (PGA) clauses which permit the Company to adjust its rates as the cost of purchased gas changes. Generally, the Company's tariffs provide for annual adjustment dates for changes in purchased gas costs. However, the Company may request to adjust its rates more often than once each year, if conditions warrant. These changes have no significant impact on the Company's profit margin. See additional discussion of recent PGA filings in Natural Gas Operations -- Capital Resources and Liquidity of MD&A.\nThe table below lists the docketed general rate filings initiated and\/or completed within each ratemaking area in 1995 and the first quarter of 1996:\n- --------------- (1) Interim rates reflecting the increased revenues became effective in April 1993. The rates were subject to refund until a final order was issued in January 1995.\nSee Natural Gas Operations -- Rates and Regulatory Proceedings of MD&A for a discussion of the financial impact of recent general rate cases.\nCOMPETITION\nElectric utilities are the Company's principal competitors for the residential and small commercial markets throughout the Company's service areas. Competition for space heating, general household, and small commercial energy needs generally occurs at the initial installation phase when the customer\/builder typically makes the decision as to which type of equipment to install and operate. The customer will generally continue to use the chosen energy source for the life of the equipment. As a result of its success in these markets, the Company has experienced consistent growth among the residential and small commercial customer classes.\nUnlike residential and small commercial customers, certain large commercial, industrial, and electric generation customers have the capability to switch to alternative energy sources. The Company has been successful in retaining these customers by setting rates at levels competitive with alternative energy sources\nsuch as fuel oils and coal. As a result, management does not anticipate any material adverse impact on its operating margin. The Company maintains no backlog on its orders for gas service.\nThe Company continues to compete with interstate transmission pipeline companies, such as El Paso Natural Gas Company (El Paso), Kern River Gas Transmission Company (Kern River), and Tuscarora Gas Transmission Company, to provide service to end-users. End-use customers located in close proximity to these interstate pipelines pose a potential bypass threat and, therefore, require the Company to closely monitor each customer's situation and provide competitive service in order to retain the customer.\nThe Company has maintained an intensive effort to mitigate bypass risks through the use of discounted transportation contract rates, special long-term contracts with electric generation and cogeneration customers, and new tariff programs. One such program currently in use in Arizona and proposed in Nevada is the special gas procurement program. This program provides an opportunity for potential bypass customers to purchase all natural gas-related services as a rebundled package, including the procurement of gas supply. The Company would enter into gas supply contracts for eligible customers, which would not be included in its system supply portfolio, and provide nomination and balancing services on behalf of the customer. The Company's competitive response initiatives, and otherwise competitive rates, have resulted in the Company experiencing no significant financial impact from the threat of bypass.\nDEMAND FOR NATURAL GAS\nDeliveries of natural gas by the Company are made under a priority system established by each regulatory commission having jurisdiction over the Company. The priority system is intended to ensure that the gas requirements of higher-priority customers, primarily residential customers and nonresidential customers who use 500 therms of gas per day or less, are fully satisfied on a daily basis before lower-priority customers, primarily electric utility and large industrial customers able to use alternative fuels, are provided any quantity of gas or capacity.\nDemand for natural gas is greatly affected by temperature. On cold days, use of gas by residential and commercial customers may be as much as eight times greater than on warm days because of increased use of gas for space heating. To fully satisfy this increased high-priority demand, gas is withdrawn from storage, or peaking supplies are purchased from suppliers. If necessary, service to interruptible lower-priority customers may also be curtailed to provide the needed delivery system capacity.\nThe Company has entered the residential cooling market by working with the manufacturers of gas air conditioning units and the builders of new residential units in the Arizona and southern Nevada areas. Gas air conditioning represents an emerging market with the long-term potential for the Company to smooth its currently seasonal earnings.\nNATURAL GAS SUPPLY\nThe Company believes that natural gas supplies and pipeline capacity will remain plentiful and readily available. The Company primarily obtains its gas supplies for its southern system from producing regions in New Mexico (San Juan basin), and Texas (Permian basin). For its northern system, the Company primarily obtains gas from Rocky Mountain producing areas and from Canada. The Company arranges for transportation of gas to its Arizona, Nevada, and California service territories through the pipeline systems of El Paso, Kern River, Northwest Pipeline Corporation, and Southern California Gas Company (SoCal). The Company continually monitors supply and pipeline capacity availability on both short-term and long-term bases to ensure the continued reliability of service to its customers.\nThe Company's primary objective with respect to gas supply is to ensure that adequate, as well as economical, supplies of natural gas are available from reliable sources. The Company acquires its gas from a wide variety of sources, including suppliers on the spot market and those who provide firm supplies over short-term and longer-term durations. Balancing firm supply assurances against the associated costs dictate a continually changing natural gas purchasing mix within the Company's supply portfolio. The Company believes its balanced portfolio provides security as well as the operating flexibility needed to meet changing\nmarket conditions. During 1995, the Company acquired gas supplies from over 70 suppliers. In managing its gas supply portfolio, the Company does not utilize derivative financial instruments.\nThe purchase of natural gas at the wellhead is not regulated as all price ceilings were abolished by January 1993. The last few years have generally demonstrated seasonal volatility in the price of natural gas, with higher prices in the heating season and lower prices during the summer or off-peak consumption period.\nThe Company continues to evaluate natural gas storage as an option to enable the Company to take advantage of seasonal price differentials in obtaining natural gas from a variety of sources to meet the growing demand of its customers.\nENVIRONMENTAL MATTERS\nFederal, state, and local laws and regulations governing the discharge of materials into the environment have had little direct impact upon either the Company or its subsidiaries. Environmental efforts, with respect to matters such as protection of endangered species and archeological finds, have increased the complexity and time required to obtain pipeline rights-of-way and sites for other facilities. However, increased environmental legislation and regulation are also perceived to be beneficial to the natural gas industry. Because natural gas is one of the most environmentally safe fuels currently available, its use will allow energy users to comply with stricter environmental standards. For example, management is of the opinion that legislation, such as the Clean Air Act Amendments of 1990 and the Energy Policy Act of 1992, has a positive effect on natural gas demand, including provisions encouraging the use of natural gas vehicles, cogeneration, and independent power production.\nEMPLOYEES\nAt December 31, 1995, the natural gas operations segment had 2,383 regular full-time equivalent employees. The Company believes it has a good relationship with its employees. No employees are represented by a union.\nReference is hereby made to Item 10 in Part III of this report on Form 10-K for information relative to the executive officers of the Company.\nDISCONTINUED OPERATIONS -- FINANCIAL SERVICES ACTIVITIES\nIn January 1996, the Company reached an agreement to sell PriMerit to Norwest Corporation for approximately $175 million in cash. The sale is expected to be finalized in the third quarter of 1996, following receipt of shareholder and various governmental approvals and satisfaction of other customary closing conditions. Due to the intended sale of PriMerit during 1996, the financial services activities are considered discontinued operations for consolidated financial reporting purposes. The following Bank-related information and disclosures present the Bank as a stand-alone entity, and are presented for purposes of additional analysis. See Note 13 of the Notes to Consolidated Financial Statements for the Bank's stand-alone financial information.\nGENERAL DESCRIPTION\nThe Bank is a federally chartered stock savings bank conducting business through branch offices in Nevada. The Bank was organized in 1955 as Nevada Savings and Loan Association which, in 1988, changed its name to PriMerit Bank and its charter from a state chartered stock savings and loan association to a federally chartered stock savings bank. Deposit accounts are insured to the maximum extent permitted by law by the Federal Deposit Insurance Corporation (FDIC) through the Savings Association Insurance Fund (SAIF). The Bank is regulated by the Office of Thrift Supervision (OTS) and the FDIC, and is a member of the Federal Home Loan Bank (FHLB) system.\nThe Bank's principal business is to attract deposits from the general public and make loans secured by real estate and other collateral to enable borrowers to purchase, refinance, construct, or improve such property. Revenues are derived from interest income on real estate loans; debt securities; commercial, construction, corporate, and consumer loans; and to a lesser extent, fees received in connection with loans and deposits. The Bank's major expense is the interest paid on savings deposits and borrowings.\nSince December 31, 1990, total assets have declined from $2.7 billion to $1.8 billion at December 31, 1995 as management restructured the balance sheet to more effectively operate under the guidelines of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), and as part of a long-term strategy to optimize the Bank's size and earnings potential.\nThe following table sets forth certain ratios for the Bank for each of the periods stated:\nLENDING ACTIVITIES\nThe Bank's loan portfolio totaled $1.1 billion at December 31, 1995, representing 61 percent of total assets at that date. The loan portfolio consists principally of intermediate-term and long-term real estate loans and, to a lesser extent, secured and unsecured commercial, corporate, and construction loans, and consumer loans including: recreational vehicle, marine, mobile home, auto, equity, and home improvement loans. The contractual maturity of loans secured by single-family dwellings has historically been 30 years, although in recent years the Bank has made a number of loans with maturities of 23 years or less.\nThe following table sets forth the composition of the loan portfolio by type of loan at the dates indicated (thousands of dollars):\n- --------------- (1) The Bank's construction and land loans are generally due in one year or less.\nLoan Origination and Credit Risk\nOne of the Bank's primary businesses is to make and acquire loans secured by real estate and other collateral to enable borrowers to purchase, refinance, construct, and improve such property. These activities entail potential credit losses, the size of which depends on a variety of economic factors affecting borrowers and the real estate collateral. While the Bank has adopted underwriting guidelines and credit review procedures to minimize credit losses, some losses will inevitably occur. Therefore, periodic reviews are made of the assets in an attempt to identify and deal appropriately with potential credit losses.\nThe Bank originates both fixed- and adjustable-rate loans in the single-family residential, commercial mortgage, and consumer home equity portfolios. The Bank's adjustable-rate loans in these portfolios are based on various indices, including the one-year constant maturity Treasury yield, the prime rate, the six-month London Interbank Offering Rate (LIBOR), and to a lesser extent, the 11th District cost of funds. Other consumer loans are generally fixed-rate, while construction and non-real estate commercial loans are generally adjustable-rate prime-based loans.\nThe Bank currently originates single-family residential (SFR) adjustable-rate mortgage (ARM) loans which generally have an initial interest rate below the current market rate and adjust to the applicable index plus a defined spread, subject to caps, after the first repricing date, which is generally at six months or one year. The Bank's ARM loans generally provide that the maximum rate that can be charged cannot exceed the initial rate by more than six percentage points. The annual interest rate adjustment on the Bank's ARM loans is generally limited to two percentage points.\nMany of the other adjustable-rate loans contain limitations as to both the amount and the interest rate change at each repricing date (periodic caps) and the maximum rates the loan can be repriced at over the life of the loan (lifetime caps). At December 31, 1995, periodic caps in the adjustable loan portfolio ranged from 25 to 500 basis points. Lifetime caps ranged from 9.75 to 22 percent.\nThe Bank's loan policies and underwriting standards are the primary means used to reduce credit risk exposure. The loan approval process is intended to assess both: (i) the borrower's ability to repay the loan by determining whether the borrower meets the established underwriting criteria; and (ii) the adequacy of the proposed collateral by determining whether the appraised value of (and, if applicable, the cash flow from) the collateral property is sufficient for the proposed loan. Under OTS regulations, management is held responsible for developing, implementing, and maintaining prudent appraisal policies.\nThe Bank reviews adherence to approved lending policies and procedures, including proper approvals, timely completion of quarterly asset reviews, early identification of problem loans, reviewing the quality of underwriting and appraisals, tracking trends in asset quality, and evaluating the adequacy of the allowance for estimated credit losses. To further control its credit risk, the Bank monitors and manages its credit exposure in portfolio concentrations. Portfolio concentrations, including collateral types, industry groups, geographic locations, and loan types are assessed and the exposure is managed through the establishment of limitations of aggregate exposures.\nThe Bank maintains a comprehensive risk-rating system used in determining classified assets and allowances for estimated credit losses. The system involves an ongoing review of all assets containing an element of credit risk including loans, real estate, and investment securities. The review process assigns a risk rating to each asset reviewed based upon various credit criteria. If the review indicates that it is probable that some portion of an asset will result in a loss, the asset is written down to its expected recovery value. An allocated valuation allowance is established for each asset reviewed which has been assigned a risk classification. The allowance is determined, subject to certain minimum percentages, based upon probability of default (in the case of loans), and estimated ranges of recovery. An allowance for estimated credit losses on classified assets not subject to a detailed review is established by multiplying a percentage by the aggregate balances of the assets outstanding in each risk category. The percentages assigned increase based on the degree of risk and reflect management's estimate of potential future losses from assets in a specific risk category. With respect to loans not subject to specific reviews, principally single-family residential and consumer loans, the allowance is established based upon historical loss experience. Additionally, an unallocated allowance is established to reflect economic and other conditions that may negatively affect the portfolio in the aggregate.\nAs part of the regular asset review process, management reviews factors relating to the possibility and magnitude of prospective loan and real estate losses, including historical loss experience, prevailing market conditions, and classified asset levels. The Bank is required to classify assets and establish prudent valuation allowances in accordance with OTS regulations.\nEach loan portfolio contains unique credit risks for which the Bank has developed policies and procedures to manage as follows:\nSingle-Family Residential Lending. SFR mortgage loans comprise 53 percent of the loan portfolio at December 31, 1995, compared to 56 percent at December 31, 1994. This portfolio represents the largest lending component and is the component which contains the least credit risk.\nIt is the general policy of the Bank not to make SFR loans which have a loan-to-value ratio in excess of 80 percent unless insured by private mortgage insurance, Federal Housing Authority (FHA) insurance, or guaranteed by the Veterans Administration (VA). Single-family loans are generally underwritten to underwriting guidelines established by FHA, VA, Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA), or preapproved private investors. On its SFR ARM loans offered with initial rates below the current market rate, the Bank qualifies the applicants using the fully indexed rate.\nDuring 1995, the Bank made $24.7 million of loans using brokers. These loans were underwritten by the Bank using the same guidelines as loans originated internally.\nThe Bank requires title insurance on all loans secured by liens on real property. The Bank also requires fire and other hazard insurance be maintained in amounts at least equal to the replacement cost on all properties securing its loans. Earthquake insurance, however, is not required.\nConsumer Lending. Consumer loans include: installment loans secured by auto, recreational vehicles, boats, and mobile homes; home equity and property improvement loans; and loans secured by deposit accounts. Approximately 96 percent of the consumer loan portfolio is collateralized at December 31, 1995. The credit risk of the consumer loan portfolio is managed through both the origination function and the collection process. All consumer loan origination and collection efforts, except for loans secured by deposits, are performed at a central location in order to provide greater control in the process and a more uniform application of credit standards.\nThe Bank originates a majority of its installment loans through automobile, recreational vehicle, and marine dealers. These loans are subject to credit scoring and underwriting by Bank personnel. Additionally, credit reviews of the dealers are performed on a periodic basis. The Bank pays dealers a fee for these loans, in some cases through a broker, based upon the excess of the contractual interest rate of the loan over the Bank's stated rate schedule. The Bank utilizes a credit scoring model to assist in the analysis of loan applications and credit reports. Additionally, as a follow up to the application process, a review of selected originations is performed to monitor adherence to credit standards.\nPremiums on loans primarily represent premiums paid to dealers for originating consumer installment loans for the Bank. Prepayments of the loans can adversely affect the yield of the installment portfolio should the unearned premium be uncollectible from the dealer due to the contractual terms of the dealer agreement or the creditworthiness of the dealer or broker.\nCommercial and Construction. The commercial and construction loan portfolios consist of amortizing mortgage loans on multi-family residential and nonresidential real estate, construction and development loans secured by real estate, and commercial loans secured by collateral other than real estate. Commercial secured loans include corporate loans secured by inventory, receivables, real estate, and collateral other than real estate. Residential tract construction loans are generally underwritten with a stabilized loan-to-value ratio of less than 85 percent, while commercial\/income property loans are generally underwritten with a ratio less than or equal to 75 percent.\nConstruction loans involve risks different from completed project lending because loan funds are advanced upon the security of the project under construction, and if the loan goes into default, additional funds may have to be advanced to complete the project before it can be sold. Moreover, construction projects are subject to uncertainties inherent in estimating construction costs, potential delays in construction time, market demand, and the accuracy of the estimate of value upon completion.\nThe Bank manages its risk in these portfolios through its credit evaluation, approval, and monitoring processes. In addition to obtaining appraisals on real estate collateral-based loans, a review of actual and forecasted financial statements and cash flow analyses is performed. After such loans are funded, they are monitored by obtaining and analyzing current financial and cash flow information on a periodic basis.\nTo further control its credit risk in this portfolio, the Bank monitors and manages credit exposure on portfolio concentrations. The Bank regularly monitors portfolio concentrations by collateral types, industry groups, loan types, and individual and related borrowers. Such concentrations are assessed and exposures managed through establishment of limitations of aggregate exposures. The Bank no longer originates new construction and commercial loans outside of Nevada. At December 31, 1995, 32 percent, or $18.5 million, of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $9.9 million. These loans are generally secured by real estate and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California, and to a lesser extent, Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries. Construction loans and\ncommercial real estate loans (including multi-family) generally have higher default rates than single-family residential loans.\nOrigination, Purchase, and Sale of Loans\nThe Bank originates the majority of its loans within the state of Nevada; however, under current laws and regulations, the Bank may also originate and purchase loans or purchase participating interests in loans without regard to the location of the secured property. The Bank originated $525 million and $466 million in new loans during 1995 and 1994, respectively, virtually all of which were secured by property located in Nevada. As of December 31, 1995, 86 percent of the loan portfolio was secured by property located in Nevada, 9 percent secured by property located in California, and 5 percent secured by property located in Arizona. The Bank originates real estate and commercial loans principally through its in-house personnel, with some broker-originated SFR loans. In 1994, the Bank purchased $41.9 million of single-family residential whole loans, while no such purchases of loans occurred in 1995.\nSecondary Marketing Activity\nThe Bank has been involved in secondary mortgage market transactions through the sale of whole loans. In accordance with the Bank's Accounting Policy, fixed-rate residential loans with maturities greater than 25 years have been designated as held for sale. At December 31, 1995, $5.9 million of residential loans are designated as held for sale. See Note 13 of the Notes to Consolidated Financial Statements for additional discussion relating to such loans.\nUnder its loan participation and whole loan sale agreements, the Bank may continue to service the loans and collect payments on the loans as they become due. The amount of loans serviced for others was $430 million at December 31, 1995, compared to $415 million at year-end 1994, including $58 million and $68 million, respectively, of loans serviced for mortgage-backed securities (MBS) originated and owned by the Bank. The Bank pays the participating lender, under the terms of the participation agreement, a yield on the participant's portion of the loan, which is usually less than the interest agreed to be paid by the borrower. The difference is retained by the Bank as servicing income.\nIn connection with mortgage loan sales, the Bank makes representations and warranties customary in the industry relating to, among other things, compliance with laws, regulations and program standards, and accuracy of information. In the event of a breach of these representations and warranties, or under certain limited circumstances, regardless of whether there has been such a breach, the Bank may be required to repurchase such mortgage loans. Typically, any documentation defects with respect to these mortgage loans that caused them to be repurchased, are corrected and the mortgage loans are resold. Certain repurchased mortgage loans may remain in the Bank's loan portfolio and, in some cases, repurchased mortgage loans are foreclosed and the acquired real estate sold.\nIn May 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 122, \"Accounting for Mortgage Servicing Rights.\" The statement eliminates the previous distinction between purchased and originated mortgage servicing rights. The statement requires an allocation of the cost basis of a mortgage loan between the mortgage servicing rights and the loan when mortgage loans are sold or securitized and the servicing is retained. The Bank adopted SFAS No. 122 effective April 1, 1995.\nThe servicing rights are being amortized over their estimated lives using a method approximating a level yield method. The book value of capitalized mortgage servicing rights at December 31, 1995 was $350,000. As all servicing rights capitalized during the year have been on new loan originations and no significant change in interest rates or servicing rights values have occurred, fair value is estimated to approximate book value at December 31, 1995.\nLoan Fees\nThe Bank receives loan origination fees for originating loans and commitment fees for making commitments to originate construction, income property, and multi-family residential loans. It also receives loan fees and charges related to existing loans, including prepayment fees, late charges, and assumption fees. The amount of loan origination fees, commitment fees, and discounts received varies with loan volumes, loan types, purchase commitments made, and competitive and economic conditions. Loan origination and commitment fees, offset by certain direct loan origination costs, are being deferred and recognized over the contractual life of such loans as yield adjustments.\nASSET QUALITY\nLoan Impairment. On January 1, 1995, the Bank 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 requires the measurement of loan impairment to be based on the present value of expected future cash flows discounted at the loan's original effective interest rate or the fair value of the underlying collateral on collateral-dependent loans. SFAS No. 118 allows a creditor to use existing methods for recognizing interest income on impaired loans.\nUpon adoption of SFAS No. 114 in the first quarter of 1995, $2.9 million of in-substance foreclosed assets were reclassified on the Bank's consolidated statement of financial condition from real estate acquired through foreclosure (REO-F) to loans receivable. SFAS No. 114 eliminated the in-substance designation. No other financial statement impact resulted from the Bank's adoption of SFAS No. 114.\nIn general, under SFAS No. 114, interest income on impaired loans will continue to be recognized by the Bank on the accrual basis of accounting, unless the loan is greater than 90 days delinquent with respect to principal or interest, or the loan has been partially or fully charged-off. Interest on loans greater than 90 days delinquent is generally recognized on a cash basis. Interest income on loans which have been fully or partially charged-off is generally recognized on a cost-recovery basis; that is, all proceeds from the loan payments are first applied as a reduction to principal before any income is recorded.\nInterest payments received on impaired loans are recorded as interest income unless collection of the remaining recorded investment is in doubt, in which case payments received are recorded as reductions of principal.\nNonperforming Assets. Nonperforming assets are comprised of nonaccrual assets, restructured loans, and REO-F. Nonaccrual assets are those on which management believes the timely collection of interest or principal is doubtful. Assets are transferred to nonaccrual status when payments of interest or principal are 90 days past due or if, in management's opinion, the accrual of interest should be ceased sooner. There are no assets on accrual status which are over 90 days delinquent or past maturity.\nNonaccrual assets are restored to accrual status when, in the opinion of management, the financial condition of the borrower and\/or debt service capacity of the security property has improved to the extent that collectibility of interest and principal appears assured and interest payments sufficient to bring the asset current are received.\nRestructured loans represent loans for which the borrower is complying with the terms of a loan modified as to rate, maturity, or payment amount.\nThe following table summarizes nonperforming assets as of the dates indicated (thousands of dollars):\nThe increase in restructured loans in 1994 is a result of the classification of $13.9 million of single-family residential loan modifications made for borrowers with earthquake-related damage in California. Federal agencies encouraged financial institutions to modify loan terms for certain borrowers who were affected by the earthquake which occurred in January 1994. The terms of these modifications were generally three- to six-month payment extensions with no negative credit reporting regarding the borrower. These loans were on a nonaccrual basis during the extension period. Current OTS regulations allow for removal of these loans from the \"troubled debt restructured\" designation, once the loan performs according to its contractual terms for twelve consecutive months. The reduction of $7.4 million in restructured loans from 1994 to 1995 was primarily due to earthquake-modified loans which met this criteria.\nAt December 31, 1995, all nonaccrual loans and REO-F are classified substandard. Additionally, $3.1 million of restructured loans are classified substandard.\nThe amount of interest income that would have been recorded on the nonaccrual and restructured assets if they had been current under their original terms was $1.3 million for 1995. Actual interest income recognized on these assets was $439,000, resulting in $856,000 of interest income foregone for the year. See further discussion below in Provision and Allowance for Estimated Credit Losses.\nClassified Assets. OTS regulations require the Bank to classify certain assets and establish prudent valuation allowances. Classified assets fall in one of three categories -- \"substandard,\" \"doubtful,\" and \"loss.\" In addition, the Bank can designate an asset as \"special mention.\"\nAssets classified as \"substandard\" are inadequately protected by the current net worth or paying capacity of the obligor or the collateral pledged, if any. Assets which are designated as \"special mention\" possess weaknesses or deficiencies deserving close attention, but do not currently warrant classification as \"substandard.\"\nProvision and Allowance for Estimated Credit Losses. The provision for estimated credit losses is dependent upon management's evaluation as to the amount needed to maintain the allowance for losses at a level considered appropriate to the perceived risk of future losses. A number of factors are weighed by management in determining the adequacy of the allowance, including internal analyses of portfolio quality measures and trends, specific economic and market conditions affecting valuation of the security properties, and certain other factors. In addition, the OTS considers the adequacy of the allowance for credit losses and\nthe net carrying value of real estate owned in connection with periodic examinations of the Bank. The OTS has the ability to require the Bank to recognize additions to the allowance or reductions in the net carrying value of real estate owned based on their judgement at the time of such examinations. In connection with the most recent examination by the OTS in 1995, no additional allowances for losses were required to be recorded by the Bank.\nActivity in the allowances for estimated credit losses on loans, debt securities, and real estate is summarized as follows (thousands of dollars):\n* Ratio = Net charge-offs to average loans and real estate outstanding (includes debt securities for 1995).\nAllocation of Allowance for Estimated Credit Losses. The following is a breakdown of allocated loan loss allowance amounts by major categories. However, in management's opinion, the allowance must be viewed in its entirety.\nREAL ESTATE DEVELOPMENT ACTIVITIES\nThe Bank's investment in real estate held for development, net of allowance for estimated losses, excluding REO-F, decreased from $28.1 million at December 31, 1991 to $247,000 at December 31, 1995.\nThe Bank's pretax loss from real estate operations was $196,000 in 1995, $612,000 in 1994, and $910,000 in 1993.\nThe Bank and its subsidiaries have ceased making investments in new real estate development activities as a result of legislative and regulatory actions which have placed certain restrictions on the Bank's ability to invest in real estate. See Regulation -- General herein for additional discussion. The Bank and its subsidiaries are continuing the sale and wind down of remaining real estate investments.\nINVESTMENT ACTIVITIES\nFederal regulations require thrifts to maintain certain levels of liquidity and to invest in various types of liquid assets. The Bank invests in a variety of securities, including commercial paper, certificates of deposit, U.S. government and U.S. agency obligations, short-term corporate debt, municipal bonds, repurchase agreements, and federal funds. The Bank also invests in longer term investments such as MBS and collateralized mortgage obligations (CMO) to supplement its loan production and to provide liquidity to meet unforeseen cash outlays. Income from cash equivalents and debt securities provides a significant source of revenue for the Bank, constituting 41 percent, 32 percent and 29 percent of total revenues for each of the years ended December 31, 1993, 1994 and 1995, respectively.\nIn order to mitigate the interest rate risk (IRR) and credit risk exposure in the debt security portfolio, the Bank has established guidelines within its Investment Portfolio Policy for maximum duration, credit quality, concentration limits per issuer, and counterparty capital requirements. The Investment Portfolio Policy also sets forth the types of permissible investment securities and unsuitable investment activities.\nAdditionally, the debt security portfolio is subject to the Asset Classification Policy of the Bank based on credit risk as determined by private rating firms, such as Standard and Poor's Corporation and Moody's Investors Services.\nOn December 31, 1993, the Bank adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In conjunction with adoption, the Bank designated the vast majority of its debt security portfolio as available for sale. At December 31, 1995 and 1994, no securities were designated as \"trading securities.\"\nIn November 1995, the FASB issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\" (the Special Report). The Special Report allowed a one-time opportunity, until December 31, 1995, for institutions to reassess the appropriateness of their designations of all securities and transfer debt securities from the held-to-maturity portfolio before calendar year-end 1995, without calling into question their intent to hold other debt securities to maturity in the future. The Bank reassessed its securities designations in light of the Special Report guidance and made no reclassifications.\nThe following tables present the composition of the debt security portfolios as of the dates indicated.\nThe following schedule of the expected maturity of debt securities held to maturity is based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\nThe following schedule reflects the expected maturities of MBS and CMO and the contractual maturity of all other debt securities available for sale. The expected maturities of MBS and CMO are based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\n- ---------------\n(1) The yields are computed based on amortized cost.\nDEPOSIT ACTIVITIES\nDeposit accounts are the Bank's primary source of funds constituting 79 percent of the Bank's total liabilities at December 31, 1995. The Bank solicits both short-term and long-term deposits in the form of transaction-based and certificate of deposit accounts.\nThe Bank's average retail deposit base, as a percent of average interest-bearing liabilities, has remained steady during the past three years. The total average deposit base declined in 1994 versus 1993 as a result of the sale of the Bank's Arizona deposits in 1993. See Note 13 of the Notes to Consolidated Financial Statements for further discussion of the Arizona sale. Average retail deposits, as a percentage of average interest-bearing liabilities, were 79 percent in 1995, compared to 80 percent in 1994 and 79 percent in 1993.\nThe Bank has emphasized retail deposits over wholesale funding sources in an effort to reduce the volatility of its cost of funds. Additionally, the Bank has emphasized growth in transaction-based accounts versus term accounts in order to reduce its overall cost of funds.\nThe Bank's deposits increased $26 million during 1995. This growth was principally in transaction-based accounts which increased by $27 million, offset by a decrease of $1 million in certificates of deposit. During 1995, the Bank offered new and restructured money market demand account (MMDA) products in order to encourage this growth and minimize loss of deposits to competitive products offered by other financial intermediaries.\nAt December 31, 1995, the Bank maintained over $419 million in collateral, at market value, which could be borrowed against or sold to offset any deposit outflows which could occur in a declining or low interest rate environment, or as a result of the pending acquisition of the Bank. While some loss of deposits may be experienced by the Bank, the anticipated volume is not expected to be significant.\nThe average balances in and average rates paid on deposit accounts for the years indicated are summarized as follows (thousands of dollars):\nCertificates of deposit include approximately $171 million, $169 million, and $152 million in time certificates of deposits in amounts of $100,000 or more at December 31, 1995, 1994, and 1993, respectively. The following table represents time certificates of deposits, none of which are brokered, in amounts of $100,000 or more by time remaining until maturity as of December 31, 1995 (thousands of dollars):\nBORROWINGS\nSources of funds other than deposits have included advances from the FHLB, reverse repurchase agreements, and other borrowings.\nFHLB Advances. As a member of the FHLB system, the Bank may obtain advances from the FHLB pursuant to various credit programs offered from time to time. The Bank borrows these funds from the FHLB principally on the security of certain of its mortgage loans. See Regulation -- Federal Home Loan Bank System herein for additional discussion. Such advances are made on a limited basis to supplement the Bank's supply of lendable funds, to meet deposit withdrawal requirements and to lengthen the maturities of its borrowings. See Note 13 of the Notes to Consolidated Financial Statements for additional discussion.\nSecurities Sold Under Repurchase Agreements. The Bank sells securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements involve the Bank's sale of debt securities to a broker\/dealer with a simultaneous agreement to repurchase the same debt securities on a specified date at a specified price. The initial price paid to the Bank under reverse repurchase agreements is less than the fair market value of the debt securities sold, and the Bank may be required to pledge additional collateral if the fair market value of the debt securities sold declines below the price paid to the Bank for these debt securities.\nReverse repurchase agreements are summarized as follows (thousands of dollars):\nEMPLOYEES\nAt December 31, 1995, the Bank had 601 full-time equivalent employees. No employees are represented by any union or collective bargaining group and the Bank considers its relations with its employees to be good.\nCOMPETITION\nThe Bank experiences substantial competition in attracting and retaining deposit accounts and in making mortgage and other loans. The primary factors in competing for deposit accounts are interest rates paid on deposits, the range of financial services offered, the quality of service, convenience of office locations, and the financial strength of an institution. Direct competition for deposit accounts comes from savings and loan associations, commercial banks, money market mutual funds, credit unions, and insurance companies. During 1995, the Bank experienced deposit outflows from certificate of deposit accounts as customers sought higher yielding alternative investments in a low interest rate environment. The Bank has sought to retain relationships with these customers by establishing an agreement with a third party broker to offer uninsured investment alternatives in the Bank's branches and through restructuring its MMDA product offerings.\nThe primary factors in competing for loans are interest rates, loan origination fees, quality of service, and the range of lending services offered. Competition for origination of first mortgage loans normally comes from savings and loan associations, mortgage banking firms, commercial banks, insurance companies, real estate investment trusts, and other lending institutions.\nPROPERTIES\nThe Bank occupies facilities at 25 locations in Nevada, of which 11 are owned. The Bank leases the remaining facilities. The Bank opened a new branch in the Las Vegas area in May of 1995 while consolidating another branch during the year. See Note 13 of the Notes to Consolidated Financial Statements for a schedule of net future minimum rental payments that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1995.\nREGULATION\nGeneral\nIn August 1989, FIRREA was enacted into law. FIRREA had and will continue to have a significant impact on the thrift industry including, among other things, imposing significantly higher capital requirements and providing funding for the liquidation of insolvent thrifts. In December 1991, FDICIA was enacted into law. This legislation included changes in the qualified thrift lender test, deposit insurance assessments, and capital standards.\nRegulatory Infrastructure. The Bank's principal supervisory agency is the OTS, an agency reporting to the U.S. Treasury Department. The OTS is responsible for the examination and regulation of all thrifts and for the organization, incorporation, examination, and regulation of federally chartered thrifts.\nThe FDIC is the Bank's secondary regulator and is the administrator of the SAIF which generally insures the deposits of thrifts.\nDeposit Insurance Premiums. During 1993, the FDIC implemented a risk-based deposit insurance premium assessment. Under the regulation, annual deposit insurance premiums ranging from 23 to 31 basis points are imposed on institutions based upon the institution's level of capital and a supervisory risk assessment. Congressional proposals are currently pending to decrease the deposit insurance premiums after a one-time assessment is imposed to fully capitalize the SAIF.\nCapital Standards. Effective December 1989, the OTS issued the minimum regulatory capital regulations (capital regulations) required by FIRREA.\nThe capital regulations require that all thrifts meet three separate capital standards as follows:\n1. A tangible capital requirement equal to at least 1.5 percent of adjusted total assets (as defined).\n2. A core capital requirement equal to at least three percent of adjusted total assets (as defined).\n3. A risk-based capital requirement equal to at least eight percent of risk-weighted assets (as defined).\nThe OTS may establish, on a case by case basis, individual minimum capital requirements for a thrift institution which may vary from the requirements which would otherwise be applicable under the capital regulations. The OTS has not established such minimum capital requirements for the Bank.\nA thrift institution which fails to meet one or more of the applicable capital requirements is subject to various regulatory limitations and sanctions, including a prohibition on growth and the issuance of a capital directive by the OTS requiring the following: an increase in capital, a reduction of rates paid on savings accounts, cessation of or limitations on deposit taking and lending, limitations on operational expenditures, an increase in liquidity, and such other actions as are deemed necessary or appropriate by the OTS. In addition, a conservator or receiver may be appointed under certain circumstances.\nFDICIA requires federal banking regulators to take prompt corrective action if an institution fails to satisfy minimum capital requirements. Under FDICIA, capital requirements include a leverage limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying management fees which are not in capital requirement compliance or if such payment would cause the institution to fail to satisfy minimum levels for any of its capital requirements.\nInsured institutions are divided into five capital categories -- (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The categories are defined as follows:\n- ---------------\nCritically undercapitalized if tangible equity to total assets ratio < or =2%.\nInstitutions must meet all three capital ratios in order to qualify for a given category. At December 31, 1995, the Bank was classified as \"well capitalized.\" At December 31, 1995, under fully phased-in capital rules applicable to the Bank at July 1, 1996, the Bank would have exceeded the \"adequately capitalized\" total risk-based, tier 1 risk-based, and tier 1 leverage ratios by $53.2 million, $81.6 million, and $52.6 million, respectively.\nIn January 1993, the OTS issued a Thrift Bulletin limiting the amount of deferred tax assets that can be used to meet capital requirements. Under the bulletin, for purposes of calculating regulatory capital, net deferred tax assets are limited to the amount which could be theoretically realized from carryback potential plus the lesser of the tax on one year's projected earnings or ten percent of core capital. Transitional provisions apply to deferred tax assets existing at December 31, 1992, which are not subject to the limitation. At December 31, 1995, the Bank has a net deferred tax liability and, therefore, is not subject to the limitation. Management does not anticipate this regulation will impact the Bank's compliance and capital standards in the foreseeable future.\nIn November 1994, the OTS announced its decision to reverse immediately its 1993 interim policy requiring associations to include unrealized gains and losses, net of income taxes, on available for sale (AFS) debt securities in regulatory capital. Under the revised OTS policy, associations exclude any unrealized gains and losses, net of income taxes, on a prospective basis, on AFS debt securities reported as a separate component of equity capital pursuant to SFAS No. 115.\nThe capital regulations specify that only the following elements may be included in tangible capital: stockholder's equity, noncumulative perpetual preferred stock, retained earnings, and minority interests in the equity accounts of fully consolidated subsidiaries. Further, goodwill and investments in and loans to subsidiaries engaged in activities not permitted by national banks must be deducted from assets and capital. See Regulation -- General -- Separate Capitalization of Nonpermissible Activities herein for additional discussion.\nIn calculating adjusted total assets under the capital regulations, certain adjustments are made to exclude certain assets from tangible capital and to appropriately account for the investments in and assets of both includable and nonincludable activities.\nCore capital under the current regulations may include only tangible capital, plus certain intangible assets up to a limit of 25 percent of core capital, provided such assets are: (i) separable from the thrift's assets, (ii) valued at an established market value through an identifiable stream of cash flows with a high degree of certainty that the asset will hold this market value notwithstanding the prospects of the thrift, and (iii) salable in a market that is liquid. In addition, prior to January 1, 1995, certain qualifying \"supervisory\" goodwill was includable as core capital. Under the regulation, on January 1, 1995, none of the Bank's supervisory goodwill was includable in core capital.\nRegarding the risk-based capital requirement, under the capital regulations, assets are assigned to one of four \"risk-weighted\" categories (zero percent, 20 percent, 50 percent or 100 percent) based upon the degree of perceived risk associated with the asset. The total amount of a thrift's risk-weighted assets is determined by multiplying the amount of each of its assets by the risk weight assigned to it, and totaling the resulting amounts.\nThe capital regulation also establishes the concept of \"total capital\" for the risk-based capital requirement. As defined, total capital consists of core capital and supplementary capital. Supplementary capital includes: (i) permanent capital instruments such as cumulative perpetual preferred stock, perpetual subordinated debt, and mandatory convertible subordinated debt (capital notes); (ii) maturing capital instruments such as subordinated debt, intermediate-term preferred stock, mandatory convertible subordinated debt (commitment notes), and mandatory redeemable preferred stock subject to an amortization schedule; and (iii) general valuation loan and lease loss allowances up to 1.25 percent of risk-weighted assets.\nIn 1994, the OTS issued a regulation which added a component to an institution's risk-based capital calculation for institutions with interest rate risk (IRR) exposure classified as \"above normal.\" In 1995, the regulation was indefinitely delayed and allowed \"well capitalized\" institutions, such as the Bank, to utilize their internal model to measure the IRR capital component. As measured by both the Bank's model and the OTS model, the Bank has a \"normal\" classification of IRR exposure as defined in the delayed regulation. Had the regulation been implemented, no capital deduction would have been required during any period presented.\nSee Note 13 of the Notes to Consolidated Financial Statements for the calculation of the Bank's regulatory capital and related excesses as of December 31, 1995 and 1994.\nSeparate Capitalization of Nonpermissible Activities. For purposes of determining a thrift's capital under all three capital requirements, its entire investment in and loans to any subsidiary engaged in an activity not permissible for a national bank must be deducted from the capital of the thrift. The capital regulations provide for a transition period with respect to this provision. During the transition period, a thrift is permitted to include in its calculation the applicable percentage (as provided below) of the lesser of the thrift's investments in and loans to such subsidiaries on: (i) April 12, 1989 or (ii) the date on which the thrift's capital is being determined, unless the FDIC determines with respect to any particular thrift that a lesser percentage should be applied in the interest of safety and soundness.\nIn July 1992, legislation was enacted which delayed the increased transitional deduction from capital for real estate investments, and allowed thrifts to apply to the OTS for use of a delayed schedule. The Bank applied for and received approval for use of the delayed phase-out schedule. The Bank had $674,000 in investments in and loans to nonpermissible activities at December 31, 1995. These investments, which fall under this section of FIRREA, will be deductible from capital by 60 percent from July 1, 1995 to June 30, 1996 and thereafter, totally deductible. Included in this amount are investments in real estate, land loans, and certain REO-F.\nLending Activities. FIRREA limits the amount of commercial real estate loans that a federally chartered thrift may make to four times its capital (as defined). Based on core capital of $122 million at December 31, 1995, the Bank's commercial real estate lending limit was $488 million. At December 31, 1995, the Bank had $179 million invested in commercial real estate loans and, therefore, this limitation should not unduly restrict the Bank's ability to engage in commercial real estate loans.\nFIRREA conformed thrifts' loans-to-one-borrower limitations to those applicable to national banks. After March 1995, thrifts generally are not permitted to make loans to a single borrower in excess of 15 percent of the thrift's Tier 1 and Tier 2 capital actually included in risk-based capital, plus the allowance for loan and lease losses not included in Tier 2 capital, except that a thrift may make loans-to-one-borrower in excess of such limits under one of the following circumstances: (i) for any purpose, in an amount not to exceed $500,000 and (ii) to develop domestic residential housing units, in an amount not to exceed the lesser of $30 million, or 30 percent, of the thrift's unimpaired capital and unimpaired surplus, provided the thrift meets fully phased-in capital requirements and certain other conditions are satisfied. The Bank was in compliance with the loans-to-one-borrower limitation of $21 million at December 31, 1995. This limitation is not expected to materially affect the operations of the Bank.\nIn December 1992, the OTS issued a regulation (Real Estate Lending Standards) as mandated by FDICIA, which became effective in March 1993. The regulation requires insured depository institutions to adopt and maintain comprehensive written real estate lending policies which include: prudent underwriting standards; loan administration procedures; portfolio diversification standards; and documentation, approval, and reporting requirements. The policies must be reviewed and approved annually to ensure appropriateness for current market conditions. The regulation also provides supervisory loan-to-value limits for various types of real estate based loans. Loans may be originated in excess of these limitations up to a maximum of 100 percent of total regulatory capital. The regulation has not made a material impact on the Bank's lending operations.\nIn August 1993, the OTS issued revised guidance for the classification of assets and a new policy on the classification of collateral-dependent loans (where proceeds from repayment can be expected to come only from the operation and sale of the collateral). With limited exceptions, effective September 1993, for troubled collateral-dependent loans where it is probable that the lender will be unable to collect all amounts due, an institution must classify as \"loss\" any excess of the recorded investment in the loan over its \"value\" and classify the remainder as \"substandard.\" The value of a loan is either the present value of the expected future cash flows, the loan's observable market price, or the fair value of the collateral. The policy did not materially impact the Bank.\nThe federal agencies regulating financial institutions issued a joint policy statement in December 1993 providing quantitative guidance and qualitative factors to consider in determining the appropriate level of valuation allowances that institutions should maintain against various asset portfolios. The policy statement also requires institutions to maintain effective asset review systems and to document the institution's process for evaluating and determining the level of its valuation allowance. Management believes the Bank's current policies and procedures regarding valuation allowances and asset review procedures are consistent with the policy statement.\nFDICIA amended the Qualified Thrift Lender (QTL) test prescribed by FIRREA by reducing the qualified percentage to 65 percent and adding certain investments as qualifying investments. A savings institution must meet the percentage in at least 9 of every 12 months. At December 31, 1995, the Bank's QTL\nratio was approximately 79.5 percent. A thrift that fails to meet the QTL test must either become a commercial bank or be subject to a series of restrictions.\nSafety and Soundness Standards. Pursuant to statutory requirements, the OTS issued a proposed rule in November 1993, that prescribes certain \"safety and soundness standards.\" A final rule providing safety and soundness guidelines was issued in August 1995. The standards are intended to enable the OTS to address problems at savings associations before the problems cause significant deterioration in the financial condition of the association. The regulation provides operational and managerial standards for internal controls and information systems; loan documentation; internal audit systems; credit underwriting; interest rate exposure; asset growth; and compensation, fees, and benefits. The regulation also provides for procedures for the submission of compliance plans and the issuance of orders to correct deficiencies, if necessary. This final rule will have no material adverse impact on the Bank.\nFederal Home Loan Bank System\nThe FHLB system consists of 12 regional FHLB banks, which provide a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of San Francisco, is required to own capital stock in that institution in an amount at least equal to: 1 percent of the aggregate outstanding balance at the beginning of the year of its outstanding residential mortgage loans, home purchase contracts, and similar obligations; 0.3 percent of total assets; or 5 percent of its advances from the FHLB, whichever is greater. The Bank is in compliance with this requirement, with an investment in FHLB stock at December 31, 1995, of $11.1 million.\nLiquidity\nThe Bank is required to maintain an average daily balance of liquid assets equal to at least five percent of its liquidity base (as defined in the Regulation) during the preceding calendar month. The Bank is also required to maintain an average daily balance of short-term liquid assets equal to at least one percent of its liquidity base. The Bank has complied with these regulatory requirements and maintains a ratio substantially higher than the requirement due to its higher level of transaction accounts relative to a traditional thrift. For the month of December 1995, the Bank's liquidity ratios were 11.9 percent and 6.5 percent, respectively.\nInvestments\nA Federal Financial Institutions Examinations Council Supervisory Policy Statement on Securities Activities (Policy Statement): (1) addresses the selection of securities dealers, (2) requires depository institutions to establish prudent policies and strategies for securities transactions, (3) defines securities trading or sales practices that are viewed by the agencies as being unsuitable when conducted in an investment portfolio, (4) indicates characteristics of loans held for sale or trading, and (5) establishes a framework for identifying when certain mortgage derivative products are high-risk mortgage securities which must be held either in a trading or held for sale account. Management believes that items (1) through (4) have not unduly restricted the operating strategies of the Bank. Under item (5), the Bank will have to apply the specified tests to any mortgage derivative product, including CMO, Real Estate Mortgage Investment Conduits (REMIC), CMO and REMIC residuals, and stripped MBS purchases in the future.\nInsurance of Deposits\nThe Bank's deposits are insured by the FDIC through the SAIF up to the maximum amount permitted by law, currently $100,000 per insured depositor. The SAIF required quarterly insurance premium payments beginning in 1995 instead of semi-annual payments as in prior years. Legislation is pending to provide for a one-time special assessment of approximately 75 to 79 basis points on SAIF insured deposits. See Regulation -- General -- Deposit Insurance Premiums herein for additional discussion of insurance premiums to be paid by SAIF members.\nInsurance of deposits may be terminated by the FDIC, after notice and hearing, upon a finding by the FDIC that a thrift has engaged in unsafe or unsound practices, or is in an unsafe or unsound condition to\ncontinue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the OTS and FDIC. Management of the Bank is not aware of any practice, condition, or violation that might lead to termination of its deposit insurance.\nCommunity Reinvestment Act\nThe Community Reinvestment Act of 1977 (CRA) and regulations promulgated under the act encourage savings associations to help meet the credit needs of the communities they do business in, particularly the credit needs of low and moderate income neighborhoods. The OTS periodically evaluates the Bank's performance under CRA. This evaluation is taken into account in determining whether to grant approval for new branches, relocations, mergers, acquisitions, and dispositions. The Bank received an \"outstanding\" evaluation in its most recent examination.\nIn April 1995, the Federal Reserve approved the final version of a new CRA regulation, to be fully implemented in July 1997. Data collection for large institutions, such as the Bank, began in January 1996. The regulation provides for different examination procedures for different sized financial institutions, to facilitate the basic differences in institutions structures and operations. The intent of the regulation is to establish performance-based CRA examinations that are complete and accurate but, to the maximum extent possible, mitigate the compliance burden for institutions.\nExaminers will evaluate the CRA performance based on review of objective information about the institution, its community and its competitors, available demographic and economic data, and any information the institution chooses to provide about lending, service, and investment opportunities in its assessment area. The Bank implemented the new CRA regulation in 1995 and it had no material impact.\nFederal Reserve System\nThe Board of Governors of the Federal Reserve System (the Federal Reserve) has adopted regulations that require depository institutions to maintain noninterest earning reserves against their transaction accounts (primarily negotiable order of withdrawal (NOW), demand deposit accounts, and Super NOW accounts) and nonpersonal money market deposit accounts. These regulations generally require that reserves of three percent be maintained against aggregate transaction accounts in an institution, up to $47.7 million, and an initial reserve of ten percent be maintained against that portion of total transaction accounts in excess of such amount. In addition, an initial reserve of three percent must be maintained on nonpersonal MMDA (which include borrowings with maturities of less than four years). These accounts and percentages are subject to adjustment by the Federal Reserve. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the OTS. At December 31, 1995, the Bank was required to maintain approximately $5.3 million in noninterest earning reserves and was in compliance with this requirement.\nAs a creditor and financial institution, the Bank is subject to various additional regulations promulgated by the Federal Reserve, including, without limitation, Regulation B (Equal Credit Opportunity Act), Regulation E (Electronic Funds Transfer Act), Regulation F (Interbank Liabilities), Regulation Z (Truth-in-Lending Act), Regulation CC (Expedited Funds Availability Act), Regulation O (Insider Lending), and Regulation DD (Truth-in-Savings Act).\nHOLDING COMPANY MATTERS\nThe Bank is a wholly owned subsidiary of the Company. As a unitary savings bank holding company, the Company is subject to certain OTS regulation, examination, supervision, and reporting requirements. The Bank is generally prohibited from engaging in certain transactions with the Company and is subject to certain OTS restrictions on the payment of dividends to the Company.\nIn 1990, the OTS issued a regulation governing limitations of capital distributions, including dividends. Under the regulation, a tiered system keyed to capital is imposed on capital distributions. Insured thrifts fall under one of three tiers.\n1. Tier 1 includes those thrifts with net capital exceeding fully phased-in requirements and with Capital, Assets, Management, Earnings, and Liquidity (CAMEL) ratings of 1 or 2. (The CAMEL system was established by the FDIC and adopted by the OTS to comprehensively and uniformly grade all thrifts with regard to financial condition, compliance with laws and regulations, and overall operating soundness.)\n2. Tier 2 includes those thrifts having net capital above their regulatory capital requirement, but below the fully phased-in requirement.\n3. Tier 3 includes those thrifts with net capital below the current regulatory requirement.\nUnder the regulation, insured thrifts are permitted to make dividend payments as follows:\n1. Tier 1 thrifts are permitted to make (without application but with notification) capital distributions of half their surplus capital (as defined) at the beginning of a calendar year plus 100 percent of their earnings to date for the year.\n2. Tier 2 thrifts can make (without application but with notification) capital distributions ranging from 25 to 75 percent of their net income over the most recent four quarter period, depending upon their level of capital in relation to the fully phased-in requirements.\n3. Tier 3 thrifts are prohibited from making any capital distributions without prior supervisory approval.\nBased upon these regulations, the Bank is classified as a Tier 1 thrift.\nIn December 1994, the OTS proposed an amendment to the capital distributions regulation to conform to the FDICIA prompt corrective action system. Under the proposal, a savings association that is not held by a savings and loan holding company and that has a CAMEL rating of \"1\" or \"2\" need not notify the OTS before making a capital distribution. Other institutions that remain adequately capitalized after making a capital distribution would be required to provide notice to the OTS. Troubled and undercapitalized institutions must file and receive approval from the OTS prior to making capital distributions. This proposed regulation has no material impact on the Bank.\nGenerally transactions between a savings and loan association and its affiliates are required to be on terms as favorable to the association as comparable transactions with nonaffiliates. In addition, certain of these transactions are restricted to a percentage of the association's capital. Affiliates of the Bank include the Company. In addition, a savings and loan association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of such affiliates. It is not permissible for bank holding companies to operate a gas utility. Therefore, loans by the Bank to the Company and purchases of the Company's securities by the Bank are prohibited.\nThe Company, at the time that it acquired the Bank, agreed to assist the Bank in maintaining levels of net worth required by the regulations in effect at the time or as they were thereafter in effect so long as it controlled the Bank. The enforceability of a net worth maintenance agreement of this type is uncertain. However, under current regulations, a holding company that has executed a capital maintenance obligation of this type may not divest control of a thrift if the thrift has a capital deficiency, unless the holding company either provides the OTS with an agreement to infuse sufficient capital into the thrift to remedy the deficiency or the deficiency is satisfied. The OTS lifted this net worth maintenance stipulation in June 1995, at the\nrequest of the Company, since laws and regulations have been enacted which govern prompt corrective action measures when the capitalization of a thrift is deficient.\nThe Company is prohibited from issuing any bond, note, lien, guarantee, or indebtedness of any kind pledging its utility assets or credit for or on behalf of a subsidiary which is not engaged in or does not support the business of the regulated public utility. As a result, there are limitations on the Company's ability to assist the Bank in maintaining levels of capital required by applicable regulations.\nThe Company also stipulated in connection with the acquisition of the Bank that dividends paid by the Bank to the Company would not exceed 50 percent of the Bank's cumulative net income after the date of acquisition, without approval of the regulators. In addition, the Company agreed that the Bank would not at any time declare a dividend that would reduce the Bank's regulatory net worth below minimum regulatory requirements in effect at the time of the acquisition or thereafter.\nIn June 1995, the Bank requested the OTS lift the dividend stipulation, since laws and regulations have been enacted since the Company's acquisition of the Bank, in conjunction with FIRREA and FDICIA, which govern capital distributions and prompt corrective action measures when the capitalization of a thrift is deficient. In July 1995, the OTS terminated these stipulations such that capital distributions by the Bank are now governed by the laws and regulations governing all thrifts. In 1995, the Bank declared and paid $500,000 in cash dividends to the Company.\nUnder terms of the definitive sale agreement with Norwest Corporation, the Bank is limited in the amount of dividends payable to the Company through the closing date of the sale to $375,000 per quarter through June 30, 1996 and up to $3.5 million in the third quarter of 1996, dependant upon the timing of the closing date of the sale.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe information appearing in Part I, Item 1, pages 2 and 18 in this report is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal markets on which the common stock of the Company is traded are the New York Stock Exchange and the Pacific Stock Exchange. At March 15, 1996, there were 25,400 holders of record of common stock. The market price of the common stock was $16 1\/4 as of March 15, 1996. Prices shown are those as quoted by the Wall Street Journal in the consolidated transaction reporting system.\nCOMMON STOCK PRICE AND DIVIDEND INFORMATION\nSee Holding Company Matters and Note 13 of the Notes to Consolidated Financial Statements for a discussion of limitations on the Bank's ability to make capital distributions to the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCONSOLIDATED SELECTED FINANCIAL STATISTICS (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\n- ---------------\n(1) Contribution from Financial Services Segment, including 1995 estimated loss on disposal.\nNATURAL GAS OPERATIONS (THOUSANDS OF DOLLARS)\nDISCONTINUED OPERATIONS -- FINANCIAL SERVICES (THOUSANDS OF DOLLARS)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company is principally engaged in the business of purchasing, transporting, and distributing natural gas to residential, commercial, and industrial customers in geographically diverse portions of Arizona, Nevada, and California. The Company also engaged in financial services activities through PriMerit Bank, a wholly owned subsidiary. In January 1996, the Company signed a definitive agreement to sell PriMerit. The sale is expected to be finalized in the third quarter of 1996, following receipt of shareholder and various governmental approvals and satisfaction of other customary closing conditions. Due to the intended sale of PriMerit during 1996, the financial services activities are considered discontinued operations for consolidated financial reporting purposes. See additional discussion of the sale below.\nIn November 1995, the Company entered into a definitive agreement to acquire Northern Pipeline Construction Co. (NPL), a full-service underground gas pipeline contractor, for $24 million. NPL provides local gas distribution companies with installation, replacement, and maintenance services for underground natural gas distribution systems. The agreement is a stock-for-stock exchange in which 100 percent of the stock of NPL will be acquired in exchange for common stock of the Company. The acquisition is anticipated to be completed during the first half of 1996.\nDuring 1995, the gas segment contributed income of $2.6 million, while discontinued operations-financial services experienced a $17.5 million loss, resulting in a total net loss of $14.9 million.\nCAPITAL RESOURCES AND LIQUIDITY\nThe capital requirements and resources of the Company generally are determined independently for the natural gas operations and financial services segments. Each business activity is generally responsible for securing its own financing sources.\nLiquidity refers to the ability of an enterprise to generate adequate amounts of cash to meet its cash requirements. General factors that could significantly affect capital resources and liquidity in future years include inflation, growth in the economy, changes in income tax laws, the level of natural gas prices, interest rates, and changes in the ratemaking policies of regulatory commissions.\nInflation, as measured by the Consumer Price Index for all urban consumers averaged 2.5 percent in 1995, 2.7 percent in 1994, and 2.7 percent in 1993. See separate discussions for impact of inflation on natural gas operations and discontinued operations -- financial services activities.\nThe Company follows a common stock dividend policy which states that the Company will pay common stock dividends at a prudent level that is within the normal dividend payout range for its respective businesses, and that the dividend will be established at a level considered sustainable in order to minimize business risk and maintain a strong capital structure throughout all economic cycles. The Company's quarterly common stock dividend was 20.5 cents per share throughout 1995. The last change was on September 1, 1994, and resulted in a 1 cent, or five percent, increase from the previous level.\nDuring 1995, the Company received $500,000 in cash dividends from the Bank. The Company is not dependent upon such dividends to meet the gas segment's cash requirements.\nCash inflows from operating activities increased $13.7 million from 1994, primarily due to the change in the unrecovered purchased gas cost account from an amount receivable to an amount payable to customers. Cash outflows from investing activities increased $22.2 million from 1994. This change is attributed to construction expenditures related to the upgrade and expansion of the Company's transmission and distribution facilities. Cash flows from financing activities increased $9.6 million, a result of the issuance of common stock, preferred securities, and long-term debt, offset somewhat by repayment of short-term debt.\nSecurities ratings issued by nationally recognized ratings agencies provide a method for determining the credit worthiness of an issuer. The Company's debt ratings are significant since long-term debt constitutes a significant portion of the Company's capitalization. These debt ratings are a factor considered by lenders when determining the cost of debt for the Company (i.e., the better the rating, the lower the cost to borrow funds). Management has undertaken to improve its credit ratings with the various agencies.\nIn September 1995, Duff & Phelps upgraded the Company's long-term unsecured debt from BB+ to BBB-. Duff & Phelps debt ratings range from AAA (highest credit quality) to DD (defaulted debt obligation). The Duff & Phelps rating of BBB- indicates that the Company's credit quality is considered sufficient for prudent investment.\nIn February 1995, Standard and Poor's (S&P) reaffirmed the Company's unsecured long-term debt rating at BBB-. S&P debt ratings range from AAA (highest rating possible) to D (obligation is in default). According to S&P, the BBB- rating indicates the debt is regarded as having an adequate capacity to pay interest and repay principal.\nIn November 1994, Moody's upgraded the Company's unsecured long-term debt rating from Ba1 to Baa3. Moody's debt ratings range from Aaa (best quality) to C (lowest quality). Moody's applies a Baa3 rating to obligations which are considered medium grade obligations, i.e., they are neither highly protected nor poorly secured.\nA security rating is not a recommendation to buy, sell, or hold a security, and it is subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating.\nSee separate discussions of Capital Resources and Liquidity for the natural gas operations and discontinued operations -- financial services segments.\nRESULTS OF OPERATIONS\n1995 vs. 1994\nLoss per share for the year ended December 31, 1995 was $0.66, a $1.88 decline from earnings per share of $1.22 recorded for the year ended December 31, 1994. The loss was composed of per share earnings of $0.10 from natural gas operations and a per share loss of $0.76 from discontinued operations. Average shares outstanding increased by 2.1 million shares between years primarily resulting from a 2.1 million share public offering in May 1995. See separate discussions for an analysis of these changes. Dividends paid in 1995 were $0.82 per share reflecting the first full year of the dividend increase authorized by the Board in 1994.\n1994 vs. 1993\nEarnings per share for the year ended December 31, 1994, were $1.22, a $0.51 increase from earnings per share of $0.71 recorded for the year ended December 31, 1993. Earnings per share were composed of per share earnings of $1.09 from natural gas operations and $0.13 per share earnings from discontinued operations. Average shares outstanding increased by 349,000 shares between years. Dividends paid increased $0.06 to $0.80 per share, the result of the Board's decision to increase quarterly dividends. See separate discussions for an analysis of these changes.\nRECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS\nRecently issued accounting standards include SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which the Company adopted January 1, 1996, and SFAS No. 123, \"Accounting for Stock-Based Compensation.\" See Note 1 of the Notes to Consolidated Financial Statements for a discussion of the impact of these new standards.\nCONTINUING OPERATIONS NATURAL GAS OPERATIONS\nThe Company is engaged in the business of purchasing, transporting, and distributing natural gas in portions of Arizona, Nevada, and California. Its service areas are geographically as well as economically diverse. The Company is the largest distributor in Arizona, selling and transporting natural gas in most of southern, central, and northwestern Arizona, including the Phoenix and Tucson metropolitan areas. The Company is also the largest distributor and transporter of natural gas in Nevada, and serves the Las Vegas metropolitan area and northern Nevada. In addition, the Company distributes and transports natural gas in portions of California, including the Lake Tahoe area in northern California and high desert and mountain areas in San Bernardino County.\nAs of December 31, 1995, the Company had approximately 1,029,000 residential, commercial, industrial, and other customers, of which 605,000 customers were located in Arizona, 317,000 in Nevada, and 107,000 in California. Residential and commercial customers represented over 99 percent of the Company's customer base. During 1995, the Company added 49,000 customers, a five percent increase, of which 22,000 customers were added in Arizona, 25,000 in Nevada, and 2,000 in California. These additions are largely attributable to continued population growth in the Company's service areas. Customer growth over the past three years averaged five percent annually. Based on current commitments from builders, the Company expects customer growth to approximate five percent in 1996. During 1995, 57 percent of operating margin was earned in Arizona, 32 percent in Nevada, and 11 percent in California. This pattern is consistent with prior years and is expected to continue.\nTotal gas plant increased from $1.2 billion to $1.6 billion, or at an annual rate of eight percent, during the three-year period ended December 31, 1995. The increase is attributed to the investment in new transmission and distribution plant in Arizona, Nevada, and California to meet the demand from the Company's growing customer base.\nCAPITAL RESOURCES AND LIQUIDITY\nThe growth of the Company has required capital resources in excess of the amount of cash flow generated from operating activities (net of dividends paid). During 1995, capital expenditures were $166 million. Cash flow from operating activities (net of dividends) provided $78 million, or approximately 47 percent, of the required capital resources pertaining to these construction expenditures. The remainder was provided from net external financing activities.\nIn October 1995, the Securities and Exchange Commission declared effective a $270 million shelf registration statement filed by the Company. This registration statement replaced a $300 million shelf registration statement which became effective in October 1994. Under the new registration statement, the Company may offer, up to the registered amount, any combination of debt securities, preferred stock, depositary shares, common stock, and preferred securities.\nDuring 1995, the Company obtained external financing from a number of sources. In January 1995, term loan facilities totaling $165 million were refinanced with a new $200 million term loan facility. See Note 6 of Notes to Consolidated Financial Statements for further discussion. In May 1995, the Company completed an offering of 2.1 million primary shares of common stock. The net proceeds from this offering were $28.5 million after deducting underwriting discounts, commissions, and expenses. In October 1995, Southwest Gas Capital I (the Trust), a subsidiary of the Company, completed an offering of 2.4 million 9.125% Trust Originated\nPreferred Securities. The Trust was formed for the sole purpose of issuing preferred securities and investing the proceeds thereof in an equivalent amount of subordinated debt of the Company. The net proceeds from the offering were $57.7 million after deducting underwriting discounts, commissions, and expenses. The proceeds from these various financings were used to repay short-term borrowings and finance utility construction.\nThe Company currently estimates that construction expenditures for its natural gas operations for the three-year period ending December 31, 1998 will be approximately $470 million. It is currently estimated that cash flow from operating activities (net of dividends) will fund approximately one-half of the gas operation's total construction expenditures for the three-year period ending December 31, 1998. A portion of the construction expenditure funding will be provided by $36 million of funds held in trust from the 1993 Clark County, Nevada, Series A issue and 1993 City of Big Bear Lake, California, Series A issue industrial development revenue bonds (IDRB). The remaining cash requirements are expected to be provided by external financing sources. The timing, types, and amounts of these additional external financings will be dependent on a number of factors, including conditions in the capital markets, timing and amounts of rate relief, and growth factors in the Company's service areas. These external financings may include the issuance of both debt and equity securities, bank and other short-term borrowings, and other forms of financing.\nNatural gas, labor, and construction are the categories most significantly impacted by inflation. Changes to the Company's cost of gas are generally recovered through purchased gas adjustment (PGA) mechanisms and do not significantly impact net earnings. Labor is a component of the cost of service, and construction costs are the primary component of rate base. In order to recover increased costs, and earn a fair return on rate base, general rate cases are filed by the Company, when deemed necessary, for review and approval by its regulatory authorities. Regulatory lag, that is, the time between the date increased costs are incurred and the time such increases are recovered through the ratemaking process, can impact earnings. See Rates and Regulatory Proceedings for discussion of recent rate case proceedings.\nThe Company's rate schedules in all of its service areas contain PGA clauses which permit the Company to adjust its rates as the cost of purchased gas changes. The PGA mechanism allows the Company to change the gas cost component of the rates charged to its customers to reflect increases or decreases in the price expected to be paid to its suppliers and companies providing upstream pipeline transportation service. In addition, the Company uses this mechanism to either refund amounts overcollected or charge for amounts undercollected as compared to the price paid by the Company for natural gas during the period since the last PGA rate change went into effect. Generally, the Company's tariffs provide for annual adjustment dates for changes in purchased gas costs. However, the Company may request to adjust its rates more often than once each year, if conditions warrant. These changes have no significant impact on the Company's profit margin.\nWhile the changes relating to PGA have no significant net income impact, the Company's cash flow can be impacted. At December 31, 1994, the Company had a purchased gas cost asset of $15.2 million, reflecting payments to suppliers and pipelines in excess of rates paid by customers during the year. However, gas prices decreased dramatically, leading to an overcollection from customers of $32.8 million at December 31, 1995, or a $48 million change during the twelve-month period. The Company filed for PGA adjustments in five of its rate jurisdictions during the last half of 1995 to lower the gas cost component of rates charged in customer bills. The rates were also designed to refund the PGA overcollected balance within one year, with the exception of northern and southern Nevada, where a two-year period was approved. The aggregate amount of\nthese decreases on an annual basis was $55.9 million. The following table shows the most recent PGA adjustments authorized by rate jurisdiction (thousands of dollars):\nIn February 1996, the Company filed for additional annualized PGA decreases of $9.7 million in southern Nevada and $3.9 million in northern Nevada.\nRESULTS OF NATURAL GAS OPERATIONS\n1995 vs. 1994\nContribution to consolidated net income decreased $20.9 million from 1994. The decrease was primarily attributed to a decrease in operating margin between periods. Increased operating costs and net interest deductions also contributed to the decrease in gas segment contribution.\nOperating margin decreased $13.6 million, or four percent, during 1995 compared to 1994. Record-breaking warm weather throughout the Company's service territories for much of the 1995 heating seasons was the primary factor influencing the change. Temperatures in the Southwest were significantly above normal in January, February, November and December, the Company's prime heating months. As a result, operating margin was approximately $28 million less than would be expected if normal weather had been experienced. However, record customer growth and rate relief in southern Arizona and California partially mitigated the negative impact of warmer weather, contributing an additional $15 million of operating margin between years. During 1995, the Company added 49,000 new customers, an increase of 5 percent, and expects similar growth in 1996 based on commitments for new service.\nOperations and maintenance expenses increased $9.7 million, or five percent, reflecting increases in labor and maintenance costs, including the incremental expenses associated with meeting the needs of the Company's growing customer base.\nDepreciation expense and taxes other than income taxes increased $7 million, or nine percent, primarily due to an increase in average gas plant in service of $130 million, or nine percent. This is attributable to capital expenditures for the upgrade of existing operating facilities and the expansion of the system to accommodate customer growth.\nNet interest deductions increased $3.9 million, or eight percent, in 1995, after deducting interest costs associated with discontinued operations. The change is attributed to an overall increase in average debt outstanding during 1995 of six percent, which consisted of a $70 million net increase in average long-term debt offset by a $27 million decrease in average short-term debt. The increase in long-term debt is attributed to the drawdown of IDRB funds previously held in trust and replacement of the $165 million term facilities with a new $200 million term loan facility. The proceeds from the common stock issuance in May 1995 and the preferred securities issuance in October 1995 are the primary factors for the decrease in average short-term debt. Higher interest rates on variable-rate debt also contributed to the increase in net interest deductions.\n1994 vs. 1993\nContribution to consolidated net income was $23.5 million, an increase of $9.8 million from 1993, the result of increased operating margin, partially offset by increased operations and maintenance expenses, depreciation expense, and general taxes. The recognition of the Arizona pipe replacement program disallowances during 1993 also contributed to the change.\nOperating margin increased $22.8 million, or seven percent, during 1994 compared to 1993. This increase was primarily due to annualized rate relief totaling $9.5 million in the Arizona, southern California, and federal rate jurisdictions. The balance of the increase in margin is attributed to customer growth and weather. Increased demand for natural gas, through the addition of 48,000 customers, directly benefitted margin. Differences in heating demand between periods also positively impacted the change in margin, since weather more closely approximated normal in 1994 compared to 1993's warmer than normal conditions.\nOperations and maintenance expenses increased $8.4 million, or five percent, reflecting a general increase in labor costs, increased costs of materials and contractor services related to maintenance and other operating expenses. These increases are attributable to the incremental costs of providing service to the Company's steadily growing customer base.\nDepreciation expense and taxes other than income taxes increased $3.4 million, or four percent, primarily due to an increase in average gas plant in service of $80 million, or six percent. This is attributable to capital expenditures for the upgrade of existing operating facilities and the expansion of the system to accommodate customer growth.\nOther expenses for 1993 include the Arizona pipe replacement program disallowances. See Arizona Pipe Replacement Program Disallowances herein for additional information.\nNet interest deductions increased $7.6 million, or 18 percent, in 1994. Average debt outstanding during 1994 increased 13 percent compared to 1993, and consisted of a $38 million increase in average long-term debt, net of funds held in trust, and a $41 million increase in average short-term debt. The increase in debt is attributed primarily to borrowings for construction expenditures and operating activities as well as the drawdown of the IDRB funds previously held in trust. Higher interest rates on the variable-rate term loan facilities and short-term debt accounted for $2.7 million of the increase in net interest deductions.\nArizona Pipe Replacement Program Disallowances. In August 1990, the ACC issued its opinion and order on the Company's 1989 general rate increase requests applicable to the Company's Central and Southern Arizona Divisions. Among other things, the order stated that $16.7 million of the total capital expenditures incurred as part to the Company's Central Arizona Division pipe replacement program were disallowed for ratemaking purposes and all costs incurred as part of the Company's Southern Arizona Division Pipe Replacement program were excluded from the rate case and rate consideration was deferred to the Company's next general rate application, which was filed in November 1990.\nThe Company pursued various legal avenues seeking relief from the decision. Ultimately, the Arizona Court of Appeals issued a Mandate ordering the Company to comply with the ACC opinion and order. In December 1993, the Company wrote off $15.9 million in gross plant related to the central and southern Arizona pipe replacement program disallowances. The impact of these disallowances, net of accumulated depreciation, tax benefits, and other related items, was a noncash reduction to 1993 net income of $9.3 million, or $0.44 per share.\nIn addition, as part of the July 1994 settlement related to a southern Arizona general rate case, the Company agreed to write off an additional $3.2 million of gross plant in service related to the pipe replacement program. The settlement also established a disallowance formula to be used in future rate cases for expenditures related to defective materials and\/or installation. The impact of both Arizona disallowances, net of accumulated depreciation, tax benefits, and other related items, was a noncash reduction to net income of $9.6 million, or $0.45 per share, $9.3 million of which was recognized in December 1993. The Company believes this settlement effectively resolves all financial issues associated with currently challenged Arizona pipe replacement programs, that it has adequately provided for future disallowances and does not anticipate further material effects on results of operations as a result of gross plant disallowances related to these pipe replacement programs.\nRATES AND REGULATORY PROCEEDINGS\nCalifornia\nThe Company filed a general rate application in January 1994 to increase annual margin by $1.1 million for its southern and northern California rate jurisdictions effective January 1995. In December 1994, the CPUC approved a settlement agreement effective January 1995 authorizing a $1.1 million increase in margin. The settlement, which is in effect through 1998, suspends the supply adjustment mechanism (SAM) previously utilized in California. SAM was a mechanism by which actual margin was adjusted to the margin authorized in the Company's current tariff. The Company is now able to retain all margin generated from additional volumes sold, but is also at risk for reductions in margin resulting from lower than projected sales volumes. In addition, the settlement suspends required annual attrition filings for southern California, but retains attrition adjustments in northern California for certain safety-related improvements. A safety-related operational attrition was filed in November 1995 related to northern California. The filing was approved effective January 1996, authorizing a $223,000 increase in annual margin.\nNevada\nIn December 1995, the Company filed general rate cases with the PSCN seeking approval to increase revenues by $15.8 million, or 12 percent, annually for its southern Nevada rate jurisdiction and $5 million, or 10 percent, annually for its northern Nevada rate jurisdiction. The Company is seeking recovery of increased operating and maintenance costs, construction-related financing, tax, insurance, and depreciation expenses associated with its expanding customer base. The Company is also proposing changes in its current rate design to reflect ongoing restructuring in the natural gas industry and to remain competitive with third-party providers of service to large customers. Rate relief is expected to become effective in the third quarter of 1996.\nArizona\nIn October 1993, the Company filed a rate application with the ACC seeking approval to increase annual revenues by $10 million, or 9.3 percent, for its southern Arizona jurisdiction. In July 1994, the ACC approved a settlement agreement of the southern Arizona general rate case which specified a $4.3 million, or 3.9 percent, rate increase which became effective July 1994. The Company also agreed not to file another general rate request for its southern Arizona jurisdiction before November 1996.\nThe Company anticipates filing for general rate relief in both southern and central Arizona rate jurisdictions in late 1996. The amount to be requested has yet to be determined. In Arizona, it takes approximately one year from the time of filing to receive a final rate order.\nFERC\nIn October 1992, Paiute filed a general rate case with the FERC requesting approval to increase revenues by $6.8 million annually. Paiute sought recovery of increased costs associated with its capacity expansion project that was placed into service in February 1993. Interim rates reflecting the increased revenues became effective in April 1993, which were subject to refund until a final order was issued. In January 1995, the FERC approved a settlement authorizing a $4.3 million increase in revenue. Refunds of approximately $5 million, including interest, were made to customers in March 1995. These refunds were fully reserved as of December 31, 1994.\nPaiute intends to file a new general rate case in the second quarter of 1996. Under FERC rules, rates would be expected to go into effect, subject to refund, six months from the date of filing.\nDISCONTINUED OPERATIONS -- FINANCIAL SERVICES SEGMENT\nIn January 1996, the Company reached an agreement to sell PriMerit Bank to Norwest Corporation for approximately $175 million in cash. The sale is expected to be finalized in the third quarter of 1996, following receipt of shareholder and various governmental approvals and satisfaction of other customary closing conditions. Due to the intended sale of PriMerit, the financial services segment is considered discontinued operations for consolidated financial reporting purposes. The following Bank-related information and disclosures present the Bank as a stand-alone entity, and are presented for purposes of additional analysis. See Note 13 of the Notes to Consolidated Financial Statements for the Bank's stand-alone financial information.\nThe separate stand-alone financial results and disclosures reported for the Bank on a going-concern basis differ from the results and disclosures reported for the Bank as a discontinued operation. See Note 12 of the Notes to Consolidated Financial Statements for reconciliations of Bank stand-alone financial information to the amounts shown as discontinued operations in the consolidated financial statements. In 1996, while the Company will continue, as required, to disclose the ongoing operating results of the Bank through the close of the proposed transaction, those amounts will not be realized or recognized by the Company in its consolidated financial statements, consistent with the terms of the sales agreement.\nThe Bank recorded a net loss of $3.2 million for the year ended December 31, 1995 compared to net income of $7.7 million and $6.6 million for the years ended December 31, 1994 and 1993, respectively. The 1995 net loss was attributable to recording $11.8 million in goodwill impairment as a result of the pending sale of the Bank to Norwest. Bank income from core banking operations in 1995 was $11.9 million. The Bank's 1994 income from core banking operations was $11.3 million compared to $7.9 million in 1993.\nFINANCIAL AND REGULATORY CAPITAL\nAt December 31, 1995, recorded stockholder's equity was $173.6 million compared to $166.4 million at December 31, 1994. Stockholder's equity increased $7.2 million compared to December 31, 1994, as a result of the increase in unrealized gains, after tax, on debt securities available for sale partially offset by a net loss of $3.2 million and cash dividends of $500,000 paid to the Company during 1995. During 1995, the Bank's regulatory capital levels and ratios decreased under each of the three fully phased-in FDICIA capital standards. The decrease was primarily due to a decrease in the amount of goodwill and real estate investments includable in regulatory capital.\nAs discussed in Note 13 of the Notes to Consolidated Financial Statements, as of December 31, 1995 and 1994, the Bank exceeded all three fully phased-in minimum capital requirements under the regulatory capital regulations and is considered \"well capitalized\" under FDICIA.\nDuring 1993, the Bank achieved \"well capitalized\" status through a combination of increased capital from net income and unrealized gains from debt securities, and the reduction of assets and goodwill through the Arizona sale. It is management's intent to maintain and improve the level of capital through earnings and the stabilization of the asset base. The Bank maintained its \"well capitalized\" status throughout 1994 and 1995.\nUnder SFAS No. 115, unrealized gains and losses, net of tax, on securities available for sale are recorded as an adjustment to stockholder's equity. Under OTS regulations in 1993, this component of equity was included as regulatory capital under all three capital measures. In 1994, the OTS and other federal banking regulators issued regulations excluding this component from regulatory capital. Approximately $8.8 million of\nunrealized gain was includable in capital for 1993, whereas, in 1994 and 1995, no such gain (or loss) was included in regulatory capital.\nDEPOSIT PREMIUMS\nThe deposit accounts of savings associations, including those of PriMerit, are insured to the maximum extent permitted by law by the FDIC through the SAIF. The deposit accounts of commercial banks are separately insured by the FDIC through the bank insurance fund (BIF). Commercial banks and savings associations are separately assessed annual deposit insurance premiums. For savings associations, the deposit premiums range from 23 to 31 cents per $100 of deposits and, under current requirements, will remain at that level until the SAIF is capitalized at 1.25 percent of insured deposits. The SAIF is not expected to reach this level of capitalization for several years. The BIF has reached the 1.25 percent capitalization level. As a result, the FDIC reduced the deposit insurance premiums paid by most commercial banks insured by BIF to a floor of $100. This regulatory change has given commercial banks a competitive advantage over savings associations and has placed additional pressure on the SAIF.\nA number of plans have been proposed in Congress to deal with the undercapitalization of the SAIF. Several proposals provide for a one-time special assessment, estimated to approximate 75 to 79 basis points, on SAIF-insured deposits to fully capitalize the SAIF to 1.25 percent of insured deposits and require federally chartered thrifts, like the Bank, to change to a bank charter. These proposals would subsequently reduce annual premiums to levels similar to those of BIF-insured commercial banks and eventually merge the BIF and SAIF insurance funds. A change to a bank charter, under current law, would require recapture of the Bank's tax bad debt reserve. Proposals to deal with this issue include a \"fresh start\" approach, whereby thrifts would not need to recapture reserves established prior to December 31, 1987. The Bank is unable to predict if these proposals, or other proposals, will ultimately be approved by Congress.\nAssuming a one-time special assessment and change in charter requirement was approved by Congress and became law in 1996, and was immediately charged against results of operations, the one-time assessment and tax bad debt recapture would, most likely, have a material impact on the Bank's 1996 results of operations. However, management believes the Bank would continue to be classified as \"well-capitalized\" under fully phased-in FDICIA capital rules. In addition, the Bank would not face any liquidity issues as a result of a one-time assessment.\nCAPITAL RESOURCES AND LIQUIDITY\nLiquidity is defined as the Bank's ability to have sufficient cash reserves on hand and unencumbered assets, which can be sold or utilized as collateral for borrowings at a reasonable cost, or with minimal losses. The Bank's debt security portfolio provides the Bank with adequate levels of liquidity so that the Bank is able to meet any unforeseeable cash outlays and regulatory liquidity requirements.\nPotential liquidity demands may include funding loan commitments, deposit withdrawals, and other funding needs. In order to achieve sufficient liquidity for the Bank without taking a large liquid or illiquid position and avoiding funding concentrations, the Bank has taken the following actions: 1) maintaining lines of credit with authorized brokers\/dealers; 2) managing the debt security portfolio to ensure that maturities meet liquidity needs; 3) limiting investment or lending activities at certain times; and 4) establishing maximum borrowing limits for meeting liquidity needs.\nThe OTS has issued regulations regarding liquidity requirements which state that the Bank is required to maintain an average daily balance of liquid assets equal to at least five percent of its liquidity base (as defined in the OTS Regulations) during the preceding calendar month. The Bank is also required to maintain an average daily balance of short-term liquid assets equal to at least one percent of its liquidity base as defined in the regulations. Throughout 1995, the Bank exceeded both regulatory liquidity requirements. For the month of December 1995, the Bank's liquidity ratios were 11.9 percent and 6.5 percent, respectively. The Bank's liquidity ratio is substantially higher than the regulatory requirement due to the Bank's increasing level of transaction accounts. The regulatory requirement is aimed at a more traditional savings institution which has a higher level of certificate of deposit accounts versus transaction accounts.\nBorrowings, in the form of reverse repurchase agreements, decreased from $282 million at December 31, 1994 to $141 million at December 31, 1995. During 1995, the Bank repaid $107 million in long-term borrowings, $18.7 million in short-term borrowings, and $15.2 million in flex repurchase agreements.\nThe Bank has adequate levels of liquidity and unencumbered assets to meet its day-to-day operational needs and to meet the regulatory requirements for liquidity. The daily operational liquidity needs of the Bank in 1995 were primarily met through $494 million of repayments on loans and debt securities, $118 million of borrowings from the FHLB, $38 million of loan sales, and $26 million in deposit growth.\nThe Bank's borrowing capacity is a function of the availability of its readily marketable, unencumbered assets and the Bank's financial condition. Secured borrowings may be obtained from the FHLB in the form of advances and from authorized broker\/dealers in the form of reverse repurchase agreements. At December 31, 1995, the Bank maintained in excess of $311 million of unencumbered assets, with a market value of $313 million, which could be borrowed against, or sold, to increase liquidity levels.\nThe primary management objective of the investment portfolio is to invest the excess funds of the Bank. This includes ensuring that the Bank maintains adequate levels of liquidity so it is able to meet any unforeseeable cash outlays. This task is accomplished by active investment in securities that provide the greatest return, for a given price and credit risk, in order to maximize the total return to the Bank.\nThe secondary management objective of the investment portfolio is to serve as the Bank's primary short-term tool to manage the IRR exposure of the institution. The Bank's asset\/liability management objective generally requires a trade-off between achieving the highest profitability in terms of net interest income, while maintaining acceptable levels of IRR. To accomplish these objectives, management has designated the majority of the investment portfolio as available for sale. This enables management the flexibility to change the composition of the investment portfolio to quickly adjust the IRR exposure and to take advantage of interest rate changes in the markets.\nAs of December 31, 1995, the Bank's debt security portfolio was composed of securities with a fair value of $486 million (amortized cost of $485 million) with a yield of 7.16 percent compared to a debt security portfolio with a fair value of $629 million (amortized cost of $646 million) yielding 6.79 percent at December 31, 1994.\nDuring 1995, the debt security portfolio balance declined by $145 million. The decline in the portfolio is primarily the result of sales, maturities, and principal repayments during 1995.\nThe Bank's assets and liabilities consist primarily of monetary assets (cash, cash equivalents, debt securities, and loans receivable) and liabilities (savings deposits and borrowings) which are, or will be converted into a fixed amount of dollars in the ordinary course of business regardless of changes in prices. Monetary assets lose purchasing power due to inflation, but this is offset by gains in the purchasing power of liabilities, as these obligations are repaid with inflated dollars.\nThe level and movement of interest rates is of much greater significance. Inflation is but one factor that can cause interest rate volatility and changes in interest levels. The results of operations of the Bank are dependent upon its ability to manage such movements. See Risk Management -- Interest Rate Risk Management herein for additional discussion.\nRISK MANAGEMENT\nThe financial services industry has certain risks. In order to be successful and profitable, in an increasingly volatile and competitive marketplace, the Bank must accept some forms of risk and manage these risks in a safe and sound manner. Generally, transactions that the Bank enters into require the Bank to accept some measure of credit and interest rate risk, and utilize equity capital. The Bank has established certain guidelines in order to manage the Bank's assets and liabilities. These guidelines will help ensure that the risks taken and consumption of capital are optimized to achieve maximum profitability, while minimizing risks to equity and the federal deposit insurance fund.\nInterest Rate Risk (IRR) Management\nFor a complete discussion and additional disclosure of the Bank's methods and tools for measuring and managing its IRR, see Note 13 of Notes to Consolidated Financial Statements.\nAt December 31, 1995, the Bank had financial assets of $1.7 billion with a weighted average yield of 7.70 percent, and financial liabilities of $1.6 billion with a weighted average rate of 4.64 percent. The Bank's cumulative one-year static gap was a negative $60 million, or 3.5 percent of financial assets. The Bank's financial assets and financial liabilities are presented according to their frequency of repricing, and scheduled and expected maturities in the following table, also known as a static gap analysis (thousands of dollars):\nSTATIC GAP AS OF DECEMBER 31, 1995\nNote: Loans receivable exclude allowance for credit losses, discount reserves, deferred loan fees, loans in process, and accrued interest on loans.\nSTATIC GAP ASSUMPTIONS AS OF DECEMBER 31, 1995\n(1) Based on the contractual maturity or term to next repricing of the instrument(s).\n(2) Maturity sensitivity is based upon characteristics of underlying loans. Portions represented by adjustable-rate securities are included in the \"Within 1 Year\" category, as underlying loans are subject to interest rate adjustment at least semiannually or annually. Portions represented by fixed-rate securities are based on contractual maturity, projected repayments, and projected prepayments of principal of the underlying loans.\n(3) Adjustable rate loans are included in each respective category depending on the term to next repricing and projected repayments and prepayments of principal.\n(4) Maturity sensitivity is based upon contractual maturity, and projected repayments and prepayments of principal.\n(5) FHLB stock has no contractual maturity. The Bank receives quarterly dividends on all shares owned and the balance is therefore included in the \"Within 1 Year\" category. The amount of such dividends is not fixed and varies quarterly.\n(6) Interest-bearing demand deposits, money market deposits, and savings deposits may be subject to daily interest rate adjustment and withdrawal on demand, and are therefore included in the \"Within 1 Year\" category.\n(7) Noninterest-bearing demand deposits have no contractual maturity, and are included in each repricing category based on the Bank's historical attrition of such accounts.\n(8) Floating-rate reverse repurchase agreements are included in the \"Within 1 Year\" category. Principal repayments of flexible reverse repurchase agreements are based on the projected timing of construction or funding of the underlying project.\n(9) Hedging consisted of fixed rate interest rate swaps as of December 31, 1995.\nWhile the static gap analysis is a useful asset\/liability management tool, it does not fully assess IRR. Static gap analysis does not address the effects of customer options (such as early withdrawal of time deposits, withdrawal of deposits with no stated maturity, and mortgagors' options to prepay loans) and Bank strategies (such as delaying increases in interest rates paid on certain interest-bearing demand and money market deposit accounts) on the Bank's net interest income, net income, and market value of the Bank's assets and liabilities. In addition, the static gap analysis assumes no changes in the spread relationships between market rates on interest-sensitive financial instruments (basis risk), or in yield curve relationships. Therefore, a static gap analysis is only one tool with which management analyzes IRR, and must be reviewed in conjunction with other asset\/liability management reports.\nCredit Risk Management\nManagement has also established certain guidelines and criteria in order to manage the credit risk of the Bank's debt security portfolios, including concentration limits, credit rating; and geographic distribution requirements. The following table presents the credit quality of the debt security portfolios:\nLoan Impairment. On January 1, 1995, the Bank 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 requires the measurement of loan impairment to be based on the present value of expected future cash flows discounted at the loan's original effective interest rate or the fair value of the underlying collateral on collateral-dependent loans. SFAS No. 118 allows a creditor to use existing methods for recognizing interest income on impaired loans.\nUpon adoption of SFAS No. 114, in the first quarter of 1995, $2.9 million of in-substance foreclosed assets were reclassified on the Bank's consolidated statement of financial condition from foreclosed real estate to loans receivable as SFAS No. 114 eliminated the in-substance designation. No other financial statement impact resulted from the Bank's adoption of SFAS No. 114.\nIn general, under SFAS No. 114, interest income on impaired loans will continue to be recognized by the Bank on the accrual basis of accounting, unless the loan is greater than 90 days delinquent with respect to principal or interest, or the loan has been partially or fully charged-off. Interest on loans greater than 90 days delinquent is generally recognized on a cash basis. Interest income on loans which have been fully or partially charged-off is generally recognized on a cost-recovery basis; that is, all proceeds from the loan payments are first applied as a reduction to principal before any income is recorded.\nOTS regulations require the Bank to classify certain assets into one of three categories -- \"substandard,\" \"doubtful,\" and \"loss.\" An asset which does not currently warrant classification as substandard but which possesses weaknesses or deficiencies deserving close attention is considered a criticized asset and is designated as \"special mention.\" The Bank designated $35.8 million of its assets as \"special mention\" at December 31, 1995.\nThe following table sets forth the amounts of the Bank's classified assets and ratio of classified assets to total assets, net of specific reserves and charge-offs, as of the dates indicated (thousands of dollars):\nThe Bank's \"substandard\" assets decreased from $60 million at December 31, 1994 to $35 million at December 31, 1995, primarily as a result of the upgrade and paydowns of an investment security from substandard to special mention, payoffs and paydowns of real estate loans, and the disposition of foreclosed real estate. Assets classified as \"substandard\" are inadequately protected by the current net worth or paying capacity of the obligor or the collateral pledged, if any. Foreclosed real estate decreased $4.2 million during 1995, principally as a result of sales. It is the Bank's practice to charge-off all assets which it considers to be \"loss.\" As a result, none of the Bank's assets, net of charge-offs, were classified as \"loss\" at December 31, 1995.\nThe upgrade of the privately issued $20.2 million investment security from \"substandard\" to \"special mention\" during the second quarter of 1995 was the result of the stabilization of delinquencies of the security's underlying loans and the market values of collateral supporting such loans, and management's analysis of the credit enhancement of the security versus loss estimates on the underlying loans. The Bank continues to\nreceive scheduled monthly payments of principal and interest on this security. At December 31, 1995, the balance of this security totaled $16.9 million and is included in special mention assets.\nSpecial mention assets increased from $32.2 million at December 31, 1994 to $35.8 million at December 31, 1995. This increase was caused, primarily by the change in classification of the investment security from substandard to special mention, partially offset by a $3 million reclassification to substandard of a construction loan and paydowns of California residential loans, commercial real estate loans, and commercial loans.\nThe current level of the Bank's classified assets reflects significant improvement from the prior two years. Aggressive management of the resolution of these assets along with some stabilization within the economy contributed to the success in reducing the classified asset portfolio. Although progress has been positive, the Bank is unable to predict at this time what level, if any, of these assets may subsequently be charged-off or may result in actual losses.\nAs a result of the Bank's internal review process, the allowance for estimated credit losses on loans decreased from $17.7 million at December 31, 1994, to $16.4 million at December 31, 1995. During 1995, the Bank established provisions for estimated credit losses totaling $8.3 million, of which $8.1 million related to the Bank's loan, foreclosed real estate, and debt security portfolio and $162,000 was related to its real estate investment portfolio. In 1994, the Bank established provisions for estimated credit losses totaling $7.4 million, of which $163,000 related to the Bank's real estate investment portfolio and $7.2 million related to its loan, foreclosed real estate portfolio, and debt security portfolio.\nThe Bank's loan portfolio is concentrated primarily in Nevada, California, and Arizona. The following table summarizes the geographic concentrations of the Bank's loan portfolios at December 31, 1995 (thousands of dollars):\nLOANS BY REGION\nAt December 31, 1995, 32 percent or $18.5 million of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $9.9 million. These loans are generally secured by real estate, machinery, and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California, and Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries.\nThe following table sets forth by geographic location the amount of classified assets at December 31, 1995 (thousands of dollars):\nCLASSIFIED ASSETS BY GEOGRAPHIC LOCATION\nClassified construction and land loans include committed but undisbursed loan amounts.\nThe following table sets forth by type of collateral, the amount of classified assets at December 31, 1995 (thousands of dollars):\nCLASSIFIED ASSETS BY TYPE OF LOAN\nThe largest substandard loan at December 31, 1995 was an $8.1 million multi-family real estate loan in Nevada. In addition, the Bank had four other substandard loans at December 31, 1995, in excess of $1 million: two hotel loans, one multi-family loan, and a shopping center loan, all located in Nevada.\nThe largest parcel of foreclosed real estate owned by the Bank at December 31, 1995, was a $460,000 single-family residence located in California.\nSubstandard real estate held for investment includes a $780,000 Nevada branch facility whose operations were consolidated with another branch in Nevada. This branch facility was formerly included in premises and equipment.\nThe following table presents the Bank's net charge-off experience for loans receivable, debt securities, and foreclosed real estate by loan type (thousands of dollars):\nThe $186,000 of commercial mortgage charge-offs for the year ended December 31, 1995, were comprised principally of one apartment complex and one hotel\/motel property totaling $161,000, both located\nin Nevada. Construction and land losses in 1995 consisted primarily of four California loans totaling $483,000 offset by sales of $123,000 on a single-family construction property also located in California. Nonmortgage loan charge-offs during 1995 were principally comprised of $2.6 million in charge-offs from the corporate loan portfolio, $2.5 million of losses related to installment loans, $390,000 of signature line charge-offs, and $362,000 in checking account charge-offs. SFR charge-offs for 1994 and 1993 consisted primarily of California-based loans and foreclosed real estate.\nDuring the second quarter of 1995, the Bank transferred $4.4 million of its allowance for estimated credit losses affiliated with loans to separate allowances for credit losses affiliated with foreclosed real estate and debt securities. Of this amount, $1.3 million was transferred to the foreclosed real estate allowance for losses and $3.1 million was transferred to the allowance for losses on debt securities. Prior to the second quarter, the evaluation of the adequacy of the Bank's allowance for estimated credit losses affiliated with loans receivable incorporated estimates for losses in the foreclosed real estate and debt security portfolios, but were not deemed material enough to be segregated as separate allowances. Additionally, prior to the second quarter, no credit losses had been experienced in the debt security portfolio. Losses in the foreclosed real estate portfolio subsequent to foreclosure had been accounted for as loan losses. Based upon management's review and the recent performance of the debt security, the loss allowance was eliminated at December 31, 1995.\nRESULTS OF FINANCIAL SERVICES OPERATIONS\nThe Bank's net income depends in large part on the difference, or interest rate spread, between the yield it earns from its loan and debt security portfolios and the rates it pays for deposits and borrowings.\nThe following table reflects, for the periods indicated, the components of net interest income of the Bank, setting forth average assets, liabilities, and equity; interest income on interest-earning assets and interest expense on interest-bearing liabilities; average yields on interest-earning assets and interest-bearing liabilities; and net interest income (thousands of dollars):\n- --------------- Note: Loans receivable include accrued interest and loans on nonaccrual, and are net of undisbursed funds, allowances for estimated credit losses, discounts, and deferred loan fees.\nThe following table shows, for the periods indicated, the effects of the two primary determinants of the Bank's net interest income: interest rate spread and the relative amounts of interest-sensitive assets and liabilities. The table also shows the extent to which changes in interest rates and changes in the volumes of interest-sensitive assets and liabilities have affected the Bank's interest income and expense for the periods indicated. Changes from period to period are attributed to: (i) changes in rate (change in weighted average interest rate multiplied by prior period average portfolio balance); (ii) changes in volume (change in average portfolio balance multiplied by prior period rate); and (iii) net or combined changes in rate and volume. Any changes attributable to both rate and volume that cannot be segregated have been allocated proportionately between the two factors.\n1995 vs. 1994\nThe Bank recorded a net loss of $3.2 million for the year ended December 31, 1995, compared to net income of $7.7 million for the year ended December 31, 1994. The decrease in net income was principally due to the goodwill impairment of $11.8 million in 1995. Core earnings from Banking operations increased from $11.3 million at December 31, 1994 to $11.9 million at December 31, 1995, primarily due to increased net interest margin.\nThe higher interest-earning asset base is the result of the Bank's strategy of offering loans tied to market rates held in the portfolio. The increase in the average yield on interest-earning assets is the result of increased loan and security yields as a result of a large portion of the asset portfolio's adjustable-rate attributes and new originations at higher rates, which partially offset the increased cost in interest-bearing liabilities.\nThe following summarizes the significant effects of these factors:\n(i) Interest on cash equivalents increased due to the higher yield which was a result of the higher interest rates during the year.\n(ii) The average balance on debt securities held to maturity and the average yield were higher in 1995 due to the purchase of higher yielding securities late in 1994. The income on debt securities available for sale increased due to increased rates on adjustable-rate securities offsetting most of the decrease in balances due to paydowns on securities, maturities and sales.\n(iii) Total loan originations for 1995 were $525 million compared to originations of $466 million for 1994. The increase in loan originations for 1995 was due to the growth in the Las Vegas real estate market. The average yield on loans increased as a result of an increase in market interest rates resulting in higher rates on adjustable-rate mortgage loans.\n(iv) Dividends on FHLB stock decreased as a result of stock sales and the higher interest rate environment in 1995.\n(v) The increase in the cost of savings was due to a slight increase in balances combined with the higher interest rate environment.\n(vi) The decrease in interest on securities sold under agreements to repurchase was due to net repayments of borrowings during the year, largely offset by an increase in the rate paid.\n(vii) The increase in the average balance for FHLB advances was due to the new borrowings during the year. The increase in the cost of these advances was due to higher interest rates on the new borrowings.\nThe Bank's cost of hedging activities increased principally as a result of the increased outstanding balance of interest rate swaps of $98.2 million (notional amount) in 1995 compared to $72.5 million (notional amount) of interest rate swaps in 1994.\nThe net gain on sale of loans increased $843,000 from $247,000 in 1994 to $1.1 million in 1995, due to higher prices received on loans sold and implementation of SFAS No. 122. The loans sold were $46 million in 1994 and $38 million in 1995. Net gains on the sale of debt securities increased from a net gain of $34,000 in 1994 to $970,000 in 1995, primarily due to the sale of CMO residuals to take advantage of favorable market conditions, eliminate an area of possible regulatory concern due to the volatile aspects of the securities, and enhance the credit quality of the investment portfolio. In January 1994, the Bank sold its credit card portfolio and recognized a gain of $1.7 million ($1.1 million, net of charge-offs).\nThe Bank's high effective tax rate of 238 percent in 1995 was primarily the result of impairment of goodwill associated with the anticipated sale to Norwest Corporation, which is not tax deductible.\n1994 vs. 1993\nThe Bank recorded net income of $7.7 million for the year ended December 31, 1994, compared to net income of $6.6 million for the year ended December 31, 1993. The increase in net income was principally due to an improved net interest margin, along with increased operational efficiency.\nThe lower interest-earning asset base is the result of the Bank's strategy of reducing its total asset size. The increase in the average yield on interest-earning assets is the result of the repricing of interest-sensitive loans and debt securities, repayment of lower yielding loans and debt securities, and the replacement of such loans and debt securities with higher yielding originations and purchases.\nThe following summarizes the significant effects of these factors:\n(i) Interest on cash equivalents increased due to the higher yield which was a result of higher interest rates and increased volume during the year.\n(ii) Debt securities, in total, decreased principally as a result of the sale of $334 million to fund the transfer of the Arizona-based deposit liabilities in 1993 (Arizona sale) and paydowns within the portfolio, offset partially by purchases of $296 million. The decrease in average balance of debt securities also resulted in a decrease of the interest on debt securities. As the Arizona sale did not occur until the last half of 1993, the average balance of the debt securities was higher in 1993. The increase in the yield was\ndue to sales of lower coupon securities in 1993 and to the purchase of higher yielding debt securities in 1994.\n(iii) The average loans receivable portfolio increased principally due to a decrease in loan payoffs from 1994 compared to 1993, partially offset by decreased loan originations. Total loan originations for 1994 were $466 million compared to originations of $500 million for 1993. The decline in loan originations for 1994 was due to a rising interest rate environment and a corresponding decline in refinancing activity. The rise in interest rates also slowed down the prepayments within the Bank's mortgage loan portfolio. The average yield on loans declined as a result of lower interest rates on newly funded adjustable-rate mortgage loans.\n(iv) Dividends on FHLB stock increased as a result of a higher declared dividend rate in 1994.\n(v) The average balance for deposits decreased as a result of the Arizona sale of $321 million in 1993. The average balance of deposits was higher in 1993 because the sale occurred in the last half of the year. The decrease in the cost of savings was due to the lower interest rate environment.\n(vi) The decrease in interest on securities sold under agreements to repurchase was due to net repayments of borrowings during the year, partially offset by an increase in the cost.\n(vii) The increase in the average balance for FHLB advances was due to new borrowings during the year, partially offset by repayment of advances. The decrease in the cost of these advances was due to lower interest rates on the new borrowings versus the higher rates on these advances paid off.\n(viii) Interest on notes payable declined primarily as a result of the repayment of $10.4 million in the third quarter of 1993.\n(ix) Interest on unsecured senior notes declined as a result of the pay-off of the $25 million balance in the third quarter of 1993.\nThe Bank's cost of hedging activities increased principally as a result of an increase in the notional amount of interest rate swaps outstanding of $72.5 million in 1994 compared to $7.5 million in 1993.\nProvisions for estimated credit losses increased in 1994 versus 1993 as a result of management's evaluation of the adequacy of the allowances for estimated credit losses. See Risk Management -- Credit Risk Management herein.\nThe net gain on sale of loans decreased $1.5 million from $1.7 million in 1993 to $247,000 in 1994, due to a decrease in the amount of loans sold from $78 million in 1993 to $46 million in 1994. Net gains on the sale of debt securities decreased from a net gain of $8 million in 1993 to $34,000 in 1994, primarily due to the sale in 1993 of $361 million in debt securities, of which $334 million were sold to fund the Arizona sale. In January 1994, the Bank sold its credit card portfolio and recognized a gain of $1.7 million ($1.1 million net of charge-offs). Other income decreased principally due to a legal settlement of $1.2 million received in 1993, while legal fees of $810,000 were incurred in 1994 associated with a Las Vegas apartment complex which the Bank built.\nGeneral and administrative expenses decreased $4.8 million, or 10 percent, in 1994. This decrease was due to the general and administrative expenses associated with the Arizona operations which were incurred in 1993 until the sale in the third quarter of that year, which were not incurred in 1994 along with increases in efficiency and focus on cost reduction.\nThe Bank's effective tax rate was 45.4 percent in 1994 primarily as a result of goodwill amortization.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n- --------------- * At December 31, 1995, 1.5 million common shares were registered and available for issuance under provisions of the Employee Investment Plan and the Company's Dividend Reinvestment and Stock Purchase Plan.\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation. The Company follows generally accepted accounting principles (GAAP) in all of its businesses, which requires the use of estimates made by management for the preparation of financial statements. Accounting for the Company's gas utility operations conforms with GAAP as applied to regulated companies and as prescribed by federal agencies and the commissions of the various states in which the utility operates.\nConsolidation. The accompanying financial statements are presented on a consolidated basis and include the accounts of Southwest Gas Corporation and its wholly owned subsidiaries, excluding PriMerit Bank. All significant intercompany balances and transactions have been eliminated. In January 1996, management reached an agreement to sell PriMerit Bank, which constituted the financial services segment of the business. For consolidated financial reporting purposes, the financial services segment is classified as discontinued operations.\nReclassifications. The financial statements for prior years have been reclassified to conform to the current year presentation of the Bank as discontinued operations. Additional reclassifications have also been made to prior years amounts to conform to the current year presentation.\nNet Utility Plant. Net utility plant includes gas plant at original cost, less the accumulated provision for depreciation and amortization, plus the unamortized balance of acquisition adjustments. Original cost includes contracted services, material, payroll and related costs such as taxes and benefits, general and administrative expenses, and an allowance for funds used during construction less contributions in aid of construction.\nDeferred Purchased Gas Costs. The Company is authorized by the various regulatory authorities having jurisdiction to adjust its billing rates for changes in the cost of gas purchased. The difference between the current cost of gas purchased and the cost of gas recovered in billed rates is deferred. Generally, these deferred amounts are recovered or refunded within one year.\nIncome Taxes. The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.\nInvestment tax credits (ITC) related to gas utility operations are deferred and amortized over the life of related fixed assets.\nGas Operating Revenues. Revenues are recorded when customers are billed. Customer billings are based on monthly meter reads and are calculated in accordance with applicable tariffs. The Company also recognizes accrued utility revenues for the estimated amount of services rendered between the meter-reading dates in a particular month and the end of such month.\nDepreciation and Amortization. Depreciation is computed on the straight-line remaining life method at composite rates considered sufficient to amortize costs over estimated service lives, including components which adjust for salvage value and removal costs, as approved by the appropriate regulatory agency. When plant is retired from service, the original cost of plant, including costs of removal, less salvage, is charged to the accumulated provision for depreciation. Acquisition adjustments are amortized as ordered by regulatory bodies at the date of acquisition, which periods approximate the remaining estimated life of the acquired properties. Costs related to refunding utility debt and debt issuance expenses are deferred and amortized over the weighted average lives of the new issues.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Allowance for Funds Used During Construction (AFUDC). AFUDC represents the cost of both debt and equity funds used to finance utility construction. AFUDC is capitalized as part of the cost of utility plant. The Company capitalized $1.2 million, $805,000, and $470,000 of AFUDC related to natural gas utility operations for each of the years ended December 31, 1995, 1994, and 1993, respectively. The debt portion of AFUDC is reported in the consolidated statements of income as an offset to net interest deductions and the equity portion is reported as other income. Utility plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into operation, and general rate relief is requested and granted.\nEarnings Per Common Share. Earnings per common share are calculated based on the weighted average number of shares outstanding during the period.\nCash Flows. For purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand and financial instruments with a maturity of three months or less, but excludes funds held in trust for industrial development revenue bonds.\nNew Accounting Standards. Effective for fiscal years beginning January 1, 1996, 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,\" requires the 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. The adoption of this standard will not have a material impact on the Company's current financial condition or results of operations.\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This new standard permits the continued use of accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25, \"Accounting for Stock Issued to Employees,\" or use of the fair value based method of accounting as encouraged by the statement. The adoption of this standard will not have a material impact on the Company's current financial condition or results of operations.\nNOTE 2 -- UTILITY PLANT\nNet utility plant as of December 31, 1995 and 1994 was as follows (thousands of dollars):\nDepreciation expense on gas plant was $62 million, $56.5 million, and $54 million during the years ended December 31, 1995, 1994, and 1993, respectively.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 2 -- UTILITY PLANT (CONTINUED)\nLeases and Rentals. The Company leases a portion of its corporate headquarters office complex in Las Vegas and the LNG facilities on its northern Nevada system. The leases provide for initial terms which expire in 1997 and 2003, respectively, with optional renewal terms available at the expiration dates. The rental payments are $3.1 million annually, and $4.6 million in the aggregate over the remaining initial term for the Las Vegas facility, and $6.7 million annually and $50 million in the aggregate for the LNG facilities.\nRentals included in operating expenses with respect to these leases amounted to $9.8 million in each of the three years in the period ended December 31, 1995. Both of these leases are accounted for as operating leases and are treated as such for regulatory purposes. Other operating leases of the Company are immaterial individually and in the aggregate.\nNOTE 3 -- RECEIVABLES AND RELATED ALLOWANCES\nThe Company's business activity with respect to gas utility operations is conducted with customers located within the three-state region of Arizona, Nevada, and California. At December 31, 1995, approximately 59 percent of the gas utility customers were in Arizona, 31 percent in Nevada, and 10 percent in California. While the Company seeks to minimize its credit risk related to utility operations by requiring security deposits for new customers, certain customer accounts are ultimately not collected. Provisions for uncollectible accounts are recorded monthly, as needed, and are included in the ratemaking process as a cost of service. Activity in the allowance for uncollectibles is summarized as follows (thousands of dollars):\nNOTE 4 -- REGULATORY ASSETS AND LIABILITIES\nThe Company's natural gas operations are subject to the regulation of the Arizona Corporation Commission, the Public Service Commission of Nevada, the California Public Utilities Commission, and the Federal Energy Regulatory Commission. The Company's accounting policies conform to generally accepted accounting principles applicable to rate-regulated enterprises 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 with related revenues.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 4 -- REGULATORY ASSETS AND LIABILITIES (CONTINUED)\nThe following table represents existing regulatory assets and liabilities (thousands of dollars):\nNOTE 5 -- PREFERRED STOCK, PREFERENCE STOCK, AND PREFERRED SECURITIES\nIn December 1995, the Company redeemed all remaining outstanding $100 Cumulative Preferred Stock, 9.5% Series. Scheduled annual mandatory redemption requirements were 8,000 shares, or $800,000 per year, through 1999. After the 1995 annual mandatory redemption requirement was satisfied, the Company exercised its option to redeem an additional 8,000 shares at par. The remaining 24,000 shares were redeemed at $102 per share, plus accrued and unpaid dividends. The stock was redeemed because other less costly financing options were available.\nDuring 1994, the Company redeemed, as required, the remaining shares of its Second Preference Stock, Third Series. The dividend rate on Second Preference Stock was cumulative and varied from 3 to 16 percent, based on a formula tied to operating results with respect to the gas distribution system purchased from Arizona Public Service Company. During 1993 and 1994, the dividend rate was 3 percent.\nPreferred Securities of Southwest Gas Capital I. In October 1995, Southwest Gas Capital I (the Trust), a consolidated wholly owned subsidiary of the Company, issued $60 million of 9.125% Trust Originated Preferred Securities (the Preferred Securities). In connection with the Trust's issuance of the Preferred Securities and the related purchase by the Company of all of the Trust's common securities (the Common Securities), the Company issued to the Trust $61.8 million principal amount of its 9.125% Subordinated Deferrable Interest Notes, due 2025 (the Subordinated Notes). The sole assets of the 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 Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to the holders of the Preferred Securities and holders of the Common Securities in liquidation of the Trust. The Subordinated Notes are redeemable at the option of the Company on or after December 31, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. In the event that the Subordinated Notes are repaid, the Preferred Securities and the Common Securities will be redeemed on a pro rata basis at $25 per Preferred Security and Common Security plus accumulated and unpaid distributions. The Company's obligations under the Subordinated Notes, the Declaration of Trust (the agreement under which the Trust was formed), the guarantee of payment of certain distributions, redemption payments and liquidation payments with respect to the Preferred Securities to the extent the Trust has funds available therefor and the indenture governing the Subordinated\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 5 -- PREFERRED STOCK, PREFERENCE STOCK, AND PREFERRED SECURITIES (CONTINUED)\nNotes, including the Company's agreement pursuant to such indenture to pay all fees and expenses of the Trust, other than with respect to the Preferred Securities and Common Securities, taken together, constitute a full and unconditional guarantee on a subordinated basis by the Company of payments due on the Preferred Securities. As of December 31, 1995, 2.4 million Preferred Securities were outstanding.\nThe Company has the right to defer payments of interest on the Subordinated Notes by extending the interest payment period at any time for up to 20 consecutive quarters (each, an Extension Period). If interest payments are so deferred, distributions will also be deferred. During such Extension Period, distributions will continue to accrue with interest thereon (to the extent permitted by applicable law) at an annual rate of 9.125% per annum compounded quarterly. There could be multiple Extension Periods of varying lengths throughout the term of the Subordinated Notes. If the Company exercises the right to extend an interest payment period, the Company shall not during such Extension Period (i) declare or pay dividends on, or make a distribution with respect to, or redeem, purchase or acquire or make a liquidation payment with respect to, any of its capital stock, or (ii) make any payment of interest, principal or premium, if any, on or repay, repurchase, or redeem any debt securities issued by the Company that rank pari passu with or junior to the Subordinated Notes; provided, however, that restriction (i) above does not apply to any stock dividends paid by the Company where the dividend stock is the same as that on which the dividend is being paid. The Company has no present intention of exercising its right to extend the interest payment period.\nNOTE 6 -- LONG-TERM DEBT\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 6 -- LONG-TERM DEBT (CONTINUED)\nIn January 1995, the Company finalized a $200 million term-loan facility with a group of banks. This facility was utilized to refinance existing loans and short-term notes payable which were classified as long-term debt at December 31, 1994. The $200 million facility provides for a revolving period through January 1999 at which time any amounts borrowed under the agreement become payable on demand. Direct borrowing options provide for the payment of interest at either the LIBOR or certificate of deposit rate, plus a margin based on the Company's credit rating, or the prime rate. In addition to direct borrowing options, a letter of credit is available to provide credit support for the issuance of commercial paper. During 1995, the average cost of this facility was 6.86 percent.\nPrior to obtaining the $200 million facility, the Company had two term-loan facilities totaling $165 million. The first facility was a Restated and Amended Credit Agreement dated April 1990 in the amount of $125 million. The average cost of this facility during 1994 was 4.99 percent. The second term loan was a $40 million Bridge Term Loan Facility (Bridge Loan) which was used to refinance a $40 million Amended and Restated Domestic Credit Agreement in August 1994. During 1994, the average interest rate for the Bridge Loan and the Amended and Restated Domestic Credit Agreement was 5.26 percent.\nThe interest rate on the variable rate industrial development revenue bonds is established on a weekly basis and averaged 4.80 percent during 1995 and 3.85 percent during 1994. At the option of the Company, the interest period can be converted from a weekly rate to a daily-term or variable-term rate.\nThe fair value of the term-loan facilities approximates carrying value. Market values for the debentures and fixed-rate IDRB were determined based on dealer quotes using trading records for December 31, 1995 and 1994, as applicable, and other secondary sources which are customarily consulted for data of this kind. The carrying value of the IDRB Series due 2028 was used as the estimate of fair value based upon the variable interest rate of the bonds.\nRequirements to retire long-term debt at December 31, 1995 for the next five years are expected to be $5 million, $5 million, $11 million, $211 million, and $11 million, respectively. Upon completion of the sale of PriMerit Bank, the Company intends to use the proceeds to retire indebtedness of the Company. In the consolidated balance sheet, $120 million of long-term debt is shown as current maturities.\nNOTE 7 -- SHORT-TERM DEBT\nThe Company has an agreement with several banks for committed credit lines which aggregate $150 million at December 31, 1995. The agreement provides for the payment of interest at competitive market rates. The lines of credit also require the payment of a commitment fee based on the long-term debt rating of the Company. The committed credit lines have no compensating balance requirements and expire in July 1996. Short-term borrowings at December 31, 1995 and 1994 were $37 million and $92 million, respectively. The weighted average interest rates on these borrowings were 6.64 percent at December 31, 1995 and 6.36 percent at December 31, 1994.\nNOTE 8 -- COMMITMENTS AND CONTINGENCIES\nPending Acquisition. In November 1995, the Company entered into a definitive agreement to acquire Northern Pipeline Construction Co. (NPL), a full-service underground gas pipeline contractor, for $24 million. NPL provides local gas distribution companies with installation, replacement and maintenance services for underground natural gas distribution systems. The agreement is a stock-for-stock exchange in which 100 percent of the stock of NPL will be acquired in exchange for common stock of the Company. The acquisition is anticipated to be completed during the first half of 1996.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 8 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)\nLegal Proceedings. The Company has been named as defendant in various legal proceedings. The ultimate dispositions of these proceedings are not presently determinable; however, it is the opinion of management that no litigation to which the Company is subject will have a material adverse impact on its financial position or results of operations.\nNOTE 9 -- EMPLOYEE POSTRETIREMENT BENEFITS\nThe Company has a qualified retirement plan covering the employees of its natural gas operations segment. The plan is noncontributory with defined benefits, and covers substantially all employees. It is the Company's policy to fund the plan at not less than the minimum required contribution nor more than the tax deductible limit. Plan assets are held in a master trust whose investments consist of common stock, corporate bonds, government obligations, real estate, a mutual fund investing in foreign stocks, an insurance company contract, and cash or cash equivalents.\nThe plan provides that an employee may earn benefits for a period of up to 30 years and will be vested after 5 years of service. Retirement plan costs were $6.8 million in 1995, $7.8 million in 1994, and $6.6 million in 1993.\nThe following table sets forth the plan's funded status and amounts recognized on the Company's consolidated balance sheets and statements of income.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 9 -- EMPLOYEE POSTRETIREMENT BENEFITS (CONTINUED)\nIn addition to the basic retirement plan, the Company has a separate unfunded supplemental retirement plan which is limited to certain officers. The plan is noncontributory with defined benefits. Senior officers who retire with ten years or more of service with the Company are eligible to receive benefits. Other officers who retire with 20 years or more of service with the Company are eligible to receive benefits. Plan costs were $2 million in 1995, $2 million in 1994, and $1.5 million in 1993. The accumulated benefit obligation of the plan was $14.9 million, including vested benefits of $13.9 million, at December 31, 1995. The Company also has an unfunded retirement plan for directors not covered by the employee retirement plan. The cost and liability for this plan are not significant.\nThe Company has a deferred compensation plan for all officers and members of the Board. The plan provides the opportunity to defer from a minimum of $2,000 up to 50 percent of annual compensation. The Company matches one-half of amounts deferred up to six percent of an officer's annual salary. Payments of compensation deferred, plus interest, commence upon the participant's retirement in equal monthly installments over 10, 15, or 20 years, as determined by the Company. Deferred compensation earns interest at a rate determined each January. The interest rate represents 150 percent of Moody's Seasoned Corporate Bond Index.\nThe Employees' Investment Plan (401k) provides for purchases of the Company's common stock or certain other investments by eligible employees through deductions of up to 16 percent of base compensation, subject to IRS limitations. The Company matches one-half of amounts deferred up to six percent of an employee's annual compensation. The cost of the plan was $2.3 million in 1995, $2.6 million in 1994, and $1.9 million in 1993.\nThe Company provides postretirement benefits other than pensions (PBOP) to its qualified retirees for health care, dental, and life insurance. In December 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The statement requires the Company to account for PBOP on an accrual basis rather than reporting these benefits on a pay-as-you-go basis. The Company adopted SFAS No. 106 in January 1993. The PSCN, CPUC, and FERC have approved the use of SFAS No. 106 for ratemaking purposes, subject to certain conditions, including funding. The Company did not receive approval to recover PBOP costs on an accrual basis in its Arizona rate jurisdictions, but was authorized to continue to recover the pay-as-you-go costs for ratemaking purposes. The Company began funding the non-Arizona portion of the PBOP liability in 1994. Plan assets are combined with the pension plan assets in a master trust.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 9 -- EMPLOYEE POSTRETIREMENT BENEFITS (CONTINUED)\nThe following table sets forth the PBOP funded status and amounts recognized on the Company's consolidated balance sheets and statements of income.\nThe Company makes fixed contributions, based on age and years of service, to retiree spending accounts for the medical and dental costs of employees who retire after 1988. The Company pays up to 100 percent of the medical coverage costs for employees who retired prior to 1989. The medical inflation assumption in the table above applies to the benefit obligations for pre-1989 retirees only. This inflation assumption was estimated at ten percent in 1995 and decreases one percent per year until 1997 and one-half of one percent per year until 2003, at which time the average annual increase is projected to be five percent. A one percent increase in these assumptions would change the accumulated postretirement benefit obligation by approximately $900,000 at December 31, 1995. Future annual benefit costs would increase $130,000.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 10 -- INCOME TAXES\nIncome tax expense (benefit) consists of the following (thousands of dollars):\nDeferred income tax expense (benefit) consists of the following significant components (thousands of dollars):\nThe consolidated effective income tax rate for the period ended December 31, 1995 and the two prior periods differs from the federal statutory income tax rate. The sources of these differences and the effect of each are summarized as follows:\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 10 -- INCOME TAXES (CONTINUED) Deferred tax assets and liabilities consist of the following (thousands of dollars):\nPrior to 1981, federal income tax expense for the gas segment was reduced to reflect additional depreciation and other deductions claimed for income tax purposes (flow-through method). Subsequently, deferred taxes have been provided for all differences between financial book and taxable income (normalization method) in all jurisdictions. The various utility regulatory authorities have consistently allowed the recovery of previously flowed-through income tax benefits on property related items by means of increased federal income tax expense in determining cost of service for ratemaking purposes.\nFor regulatory and financial reporting purposes, the Company has deferred recognition of investment tax credits (ITC) by amortizing the benefit over the depreciable lives of the related properties.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 11 -- QUARTERLY FINANCIAL DATA (UNAUDITED)\nCONSOLIDATED QUARTERLY FINANCIAL DATA\n- --------------- * The sum of quarterly earnings (loss) per average common share may not equal the annual earnings (loss) per share due to the ongoing change in the weighted average number of common shares outstanding.\nThe demand for natural gas is seasonal, and it is management's opinion that comparisons of earnings for the interim periods do not reliably reflect overall trends and changes in the Company's operations. Also, the timing of general rate relief can have a significant impact on earnings for interim periods. See MD&A for additional discussion of the Company's operating results.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 12 -- DISCONTINUED OPERATIONS -- FINANCIAL SERVICES ACTIVITIES\nIn January 1996, the Company entered into a definitive agreement to sell PriMerit Bank (the Bank), a wholly owned subsidiary, to Norwest Corporation (Norwest) for approximately $175 million in cash. The intended use of the proceeds will be to reduce outstanding long-term debt. The sale is expected to be finalized in the third quarter of 1996, following receipt of shareholder and various governmental approvals and satisfaction of other customary closing conditions.\nThe Company estimates that the disposition of the Bank will result in a net loss of approximately $13 million, which includes a pretax book loss of approximately $3.1 million plus income taxes estimated at $9.9 million. The income tax expense results from the Company's tax basis in the Bank being lower than its book basis. The net loss is reported as loss on disposal of discontinued segment in the 1995 consolidated financial statements.\nDue to the pending sale of the Bank, the results of operations and net assets of the financial services activities have been classified as discontinued operations in the consolidated financial statements of the Company as of December 31, 1995. Comparative consolidated financial statements of the Company presented for previous years have been reclassified to reflect the financial services activities as discontinued operations.\nIncome Statement Presentation. The amounts shown as discontinued operations in the Consolidated Statements of Income consist of the income (loss) from the Bank's stand-alone income statements adjusted for corporate carrying costs allocated to the Bank to properly reflect the contribution of the financial services activities to consolidated net income (loss). (See Note 13 of the Notes to Consolidated Financial Statements for the complete stand-alone financial statements of the Bank.) Included in the discontinued operations amount shown in the consolidated income statement for 1995 is an accrual relating to a proposed Savings Association Insurance Fund (SAIF) assessment ($7.2 million after tax) and a reversal of the goodwill impairment recorded by the Bank. The estimated goodwill impairment recorded by the Bank is replaced in the consolidated statements of income with the Company's loss on disposal calculation.\nA reconciliation of the Bank's stand-alone net income to the discontinued operations and contribution to net income (loss) shown in the consolidated statements of income for each of the three years in the period ended December 31, 1995 follows (thousands of dollars):\nBalance Sheet Presentation. The amounts shown as net assets of discontinued operations in the Consolidated Balance Sheets represent the Company's ownership of 100 percent of the common equity of the Bank. For years prior to 1995, the Company's investment equaled the stand-alone equity of the Bank (excluding the unrealized gain (loss) relating to securities covered by SFAS No. 115). For 1995, the net assets of discontinued operations equals the estimated realizable value to the Company of the net assets of the Bank. (See the table below for a reconciliation of Bank's equity to the net assets of discontinued operations as\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 12 -- DISCONTINUED OPERATIONS -- FINANCIAL SERVICES ACTIVITIES (CONTINUED)\nshown on the consolidated balance sheet of the Company.) An accrual for the anticipated loss on disposal, including taxes, is included in other accrued liabilities in the consolidated balance sheet of the Company.\nA reconciliation of the stand-alone equity of the Bank to the net assets of discontinued operations shown in the consolidated balance sheets as of December 31, 1995 and 1994 follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK\nPRIMERIT BANK\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (THOUSANDS OF DOLLARS)\nSee accompanying notes to PriMerit financial statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nPRIMERIT BANK\nCONSOLIDATED STATEMENTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nSee accompanying notes to PriMerit financial statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nPRIMERIT BANK\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nSee accompanying notes to PriMerit financial statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nPRIMERIT BANK\nCONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED) (THOUSANDS OF DOLLARS)\nSee accompanying notes to PriMerit financial statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote A -- Summary of Significant Accounting Policies ----------------------------------------------------\nBusiness\nPriMerit Bank and subsidiaries (the Bank), a wholly owned subsidiary of Southwest Gas Corporation (Southwest or the Company), operates in the thrift industry as a federal savings bank with membership in the Federal Home Loan Bank (FHLB) system. The Bank's deposit accounts are insured by the Savings Association Insurance Fund, a division of the Federal Deposit Insurance Corporation, up to the maximum permitted by law.\nThe Bank is engaged in retail and commercial banking. The Bank's principal business is to attract deposits from the general public and to make loans. The loans may be secured by real estate or other collateral for borrowers to purchase, construct, refinance, or improve such collateral.\nRevenues are derived from interest income on single-family residential loans; debt securities; commercial, construction, and corporate loans; consumer loans, and to a lesser extent, deposit and loan related fees. The Bank occupies facilities at 25 locations in Nevada, of which 17 are located in southern Nevada and 8 are in northern Nevada.\nThe Bank follows generally accepted accounting principles (GAAP) as applied to the banking and thrift industries. The application of GAAP requires the use of management estimates which are periodically reviewed. Actual results may differ from those estimates used.\nSale of Bank\/Impairment of Goodwill\nIn January 1996, Southwest entered into a definitive agreement to sell the Bank to Norwest Corporation for approximately $175 million in cash, subject to regulatory and stockholder approval. The sale is anticipated to close in the third quarter of 1996. The Bank recorded an $11.8 million impairment loss in 1995 on its excess of cost over net assets acquired (goodwill) originating from Southwest's acquisition of the Bank in 1986. The impairment loss is based upon the difference between the purchase price compared to the Bank's projected equity on the closing date and will be adjusted in future periods for changes in the estimated projected closing equity. The Bank will record no goodwill amortization expense in 1996 as a result of the pending acquisition and related impairment loss.\nThe separate stand-alone financial results and disclosures reported for the Bank on a going-concern basis differ from the results and disclosures reported for the Bank as a discontinued operation. See Note 12 of the Notes to Consolidated Financial Statements for reconciliations of Bank stand-alone financial information to the amounts shown as discontinued operations in the consolidated financial statements. In 1996, while Southwest will continue, as required, to disclose the ongoing operating results of the Bank through the close of the proposed transaction, those amounts will not be realized or recognized by Southwest in its consolidated financial statements, consistent with the terms of the sales agreement.\nSale of Arizona Branch Operations\nIn May 1993, the Bank signed a Definitive Agreement with World Savings and Loan Association (World) of Oakland, California, whereby World agreed to acquire the Bank's Arizona branch operations, including all related deposit liabilities of approximately $321 million (Arizona sale). The transaction was approved by the appropriate regulatory authorities and closed in August 1993. During 1993, the Bank recorded a write-off of $5.9 million in goodwill and $367,000 in other net costs related to the Bank's Arizona operations included in Loss on sale -- Arizona branches in the Bank's Statements of Operations.\nExcess of Cost Over Net Assets Acquired\nExcess of cost over net assets acquired (goodwill) arose from Southwest's acquisition of the Bank in 1986 and from the Bank's acquisition of a thrift institution in 1988. The goodwill which arose from the acquisition of a thrift institution in 1988 was written-off in conjunction with the Arizona sale in 1993. Goodwill related to\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nSouthwest's acquisition of the Bank in 1986 was being amortized to expense over a 25 year period using the straight-line method prior to the impairment loss described above.\nPrinciples of Consolidation\nThe accompanying financial statements consolidate the accounts of the Bank and all of its subsidiaries. All material intercompany transactions and accounts have been eliminated.\nPrinciples of Statements of Cash Flows\nFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one business day. In addition, the Bank considers all debt securities with maturities of three months or less to be cash equivalents. The statements of cash flows present gross cash receipts and disbursements from lending and deposit gathering activities.\nDebt Securities\nOn December 31, 1993, the Bank adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement requires classification of investments in debt and equity securities into one of three categories: held to maturity, available for sale, or trading. At the time of purchase, the Bank designates a security into one of these three categories.\nDebt securities classified as held to maturity are those which the Bank has the positive intent and ability to hold to maturity. These securities are carried at cost adjusted for the amortization of the related premiums or accretion of the related discounts into interest income using methods approximating the level-yield method or a method based on principal repayments over the actual lives of the underlying loans. The Bank has the ability and it is its policy to hold the debt securities so designated until maturity. The Bank's current accounting policy states that no security with a remaining maturity greater than 25 years may be designated as held to maturity.\nSecurities classified as available for sale are those which the Bank intends to hold for an indefinite period and may be sold in response to changes in market interest rates, changes in the security's prepayment risk, the Bank's need for liquidity, changes in the availability and yield of alternative investments, and other asset\/liability management needs. Securities classified as available for sale are stated at fair value in the Bank's Statements of Financial Condition. Changes in fair value are reported net of tax as a separate component of stockholder's equity. At December 31, 1995, the Bank recorded a $1.4 million unrealized gain, net of tax, on $422 million of debt securities available for sale. Subsequent gains or losses are recorded into income when these securities are sold.\nTrading securities are those which are bought and held principally for the purpose of selling them in the near term. Trading securities include MBS held for sale in conjunction with mortgage banking activities. Trading securities are measured at fair value with changes in fair value included in earnings. At December 31, 1995 and 1994, no securities were designated as trading securities.\nIn November 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\" (the Special Report). The Special Report allowed a one-time opportunity, until December 31, 1995, for institutions to reassess the appropriateness of their designations of all securities and transfer debt securities from their held-to-maturity portfolio before calendar year-end 1995, without calling into question their intent to hold other debt securities to maturity in the future. The Bank reassessed its securities designations in light of the Special Report guidance and made no reclassifications.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nLoans Receivable\nReal estate loans are recorded at cost, net of the undisbursed loan funds, loan discounts, unearned interest, deferred loan fees and provisions for estimated credit losses. Interest on loans receivable is generally credited to income when earned.\nFees are charged for originating and in some cases, for committing to originate loans. In accordance with SFAS No. 91, \"Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,\" loan origination and commitment fees, offset by certain direct origination costs, are being deferred, and the net amounts amortized as an adjustment of the related loans' yields over the contractual lives thereof. Unamortized fees are recognized as income upon the sale or payoff of the loan.\nUnearned interest, premiums and discounts on consumer installment, and equity and property improvement loans are amortized to income over the contractual lives of the loans using a method which approximates the level-yield method.\nOn January 1, 1995, the Bank 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 requires the measurement of loan impairment to be based on the present value of expected future cash flows discounted at the loan's original effective interest rate or the fair value of the underlying collateral on collateral-dependent loans. SFAS No. 118 amends SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on impaired loans. The Bank's initial adoption of these statements on January 1, 1995 did not have a material impact on its financial position or results of operations.\nMortgage Banking Activities\nThe Bank's accounting policy designates all fixed-rate interest-sensitive assets with maturities greater than or equal to 25 years (which possess normal qualifying characteristics required for sale) as held for sale or available for sale, along with single-family residential loans originated for specific sales commitments. Fixed-rate interestsensitive assets with maturities less than 25 years, and all adjustable-rate interest-sensitive assets continue to be held for investment unless designated as held for sale or available for sale at the time of origination or purchase.\nGains and losses on loan and debt security sales are determined using the specific identification method. Gains and losses are recognized to the extent that sales proceeds exceed or are less than the cost basis of the loans and debt securities. Loans sold with servicing retained have included a normal servicing fee to be earned by the Bank as income over the life of the loan. Loans held for sale may be securitized into mortgage-backed securities and designated as trading securities.\nIn May 1995, the FASB issued SFAS No. 122, \"Accounting for Mortgage Servicing Rights.\" The statement eliminates the previous distinction between purchased and originated mortgage servicing rights. The statement requires an allocation of the cost basis of a mortgage loan between the mortgage servicing rights and the loan when mortgage loans are sold or securitized and the servicing is retained. The Bank adopted SFAS No. 122 effective April 1, 1995. As a result of implementation, pretax earnings increased $344,000 ($224,000, after tax). The amount of mortgage servicing rights capitalized during 1995 was $486,000, including $109,000 in allocated costs for loans subject to definitive sales agreements. Amortization for the year was $33,000.\nThe servicing rights are being amortized over their estimated lives using a method approximating a level yield method. The book value of capitalized mortgage servicing rights at December 31, 1995 was $350,000. As all servicing rights capitalized during the year have been on new loan originations and no significant change in\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\ninterest rates or servicing rights' values have occurred, fair value is estimated to approximate book value at December 31, 1995.\nReal Estate Acquired Through Foreclosure\nReal estate acquired through foreclosure is stated at the lower of cost or fair value less costs to sell. In 1994, real estate acquired through foreclosure included loans foreclosed in-substance, representing loans accounted for as foreclosed property even though actual foreclosure had not occurred. Although the collateral underlying these loans had not been repossessed, the borrower had little or no equity in the collateral at its current estimated fair value. Proceeds for repayment were expected to come only from the operation or sale of the collateral, and it was doubtful the borrower would rebuild equity in the collateral or repay the loan by other means in the foreseeable future. Included in real estate acquired through foreclosure is $2.9 million of loans foreclosed in-substance at December 31, 1994. Upon adoption of SFAS No. 114 in the first quarter of 1995, $2.9 million of in-substance foreclosed assets were reclassified on the Bank's Consolidated Statement of Financial Condition from real estate acquired through foreclosure to loans receivable as SFAS No. 114 eliminated the in-substance designation. No other financial statement impact resulted from the Bank's adoption of SFAS No. 114. Write downs to fair value, disposition gains and losses, and operating income and costs are charged to the allowance for estimated credit losses.\nAllowance for Estimated Credit Losses\nOn a routine basis, management evaluates the adequacy of the allowances for estimated losses on loans, investments, and real estate and establishes additions to the allowances through provisions to expense. The Bank utilizes a comprehensive internal asset review system and valuation allowance methodology. Valuation allowances are established for each of the loan and real estate portfolios for estimated losses. A number of factors are taken into account in determining the adequacy of the level of allowances including management's review of the extent of existing risks in the portfolios and of prevailing and anticipated economic conditions, actual loss experience, delinquencies, regular reviews of the quality of the loan, investment, and real estate portfolios and examinations by regulatory authorities.\nCharge-offs are recorded on specific assets when it is determined that the fair or net realizable value of an asset is below the carrying value. When a loan is foreclosed, the asset is written down to fair value less costs to sell based on a current appraisal of the subject property.\nWhile management uses currently available information to evaluate the adequacy of allowances and to estimate identified losses for charge-off, ultimate losses may vary from current estimates. Adjustments to estimates are charged to earnings in the period in which they become known.\nPremises and Equipment\nDepreciation and amortization of premises and equipment are provided using the straight-line method over the estimated useful lives of the various classes of assets. Maintenance and repairs are charged to expense as incurred. Major expenditures for renewals and betterments are capitalized and depreciated over their estimated useful lives.\nInterest Rate Exchange Agreements\nThe derivative financial instruments approved for the Bank to use to hedge its exposure to interest rate risk (IRR) include: interest rate swaps, interest rate caps, interest rate collars, interest rate futures, and put and call options. These instruments are used only to hedge asset and liability portfolios and are not used for\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nspeculative purposes. Premiums, discounts, and fees associated with interest rate exchange agreements are amortized to expense on a straight-line basis over the contractual lives of the agreements. The net interest received or paid is reflected in interest expense as a cost of hedging. Gains or losses resulting from the early cancellation of agreements hedging assets and liabilities which remain outstanding are deferred and amortized over the remaining contractual lives. Gains or losses are recognized in the current period if the hedged asset or liability is retired.\nIncome Taxes\nThe Bank files a consolidated federal income tax return with Southwest. Income taxes for the Bank are provided for on a separate return basis. On January 1, 1993, the Bank adopted SFAS No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 supersedes Accounting Principles Board Opinion (APB) No. 11 and SFAS No. 96. The statement utilizes the liability method for recognition and measurement of income taxes and allows recognition of deferred tax assets. SFAS No. 109 generally eliminates on a prospective basis, APB No. 23 exceptions, including the tax bad debt reserve of savings and loan institutions. Under SFAS No. 109, no deferred taxes are provided on bad debt reserves arising prior to December 31, 1987, unless it becomes apparent that those differences will reverse in the foreseeable future. Deferred taxes are provided on bad debt reserves arising after December 31, 1987. The Bank adopted SFAS No. 109 on a prospective basis, with the cumulative effect of this accounting change amounting to a reduction of financial statement tax liability of $3 million in 1993.\nPension Plan\nIt is the policy of the Bank to reflect in the projected benefit obligation all benefit improvements to which the Bank is committed as of the current valuation date. The Bank uses the market value of assets to determine pension expense and amortizes the increases in prior service costs over the expected future service of active participants as of the date such costs are first recognized.\nReclassifications\nCertain reclassifications have been made to conform the prior years with the current year presentation.\nNote B -- Fair Value of Financial Instruments ---------------------------------------------\nFair value estimates of financial instruments were made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant portion of the Bank's financial instruments, fair value estimates were based on judgments regarding current economic conditions, risk characteristics of various financial instruments, prepayment assumptions, future expected loss experience, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be considered as precise. Changes in assumptions could significantly affect the estimates.\nThe fair value estimates are disclosed based on existing on- and off-balance sheet financial instruments, without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that were not considered financial instruments. Significant assets and liabilities that were not considered financial assets or liabilities include the Bank's retail branch network; deferred tax assets and liabilities; furniture, fixtures, and equipment; and goodwill.\nThe Bank intends to hold a significant portion of its assets and liabilities to their stated maturities. Therefore, the Bank does not intend to realize any significant differences between carrying value and fair value\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nthrough sale or other disposition. No attempt should be made to adjust stockholder's equity to reflect the following fair value disclosures.\nFair value estimates, methods, and assumptions are set forth below for the Bank's financial instruments as of December 31 (thousands of dollars):\nThe fair value of cash and due from banks, cash equivalents, and FHLB stock was estimated as the carrying value. This was based upon the short-term nature of the instruments and in the case of FHLB stock, the book value represents the price at which the FHLB will redeem the stock. The fair value of debt securities held to maturity, debt securities available for sale, and loans receivable held for sale was estimated using direct broker quotes and quoted market prices, with the exception of privately issued debt securities and collateralized mortgage obligation (CMO) residuals. Privately issued debt securities were valued based on the estimated fair value of the underlying loans. CMO residuals were valued using the discounted estimated future cash flows from these investments. The fair value for securities sold under agreements to repurchase and notes payable was estimated by discounting the future cash flows using market and dealer quoted rates available to the Bank for debt with the same remaining maturities and characteristics. The fair value for advances from FHLB was estimated using the quoted cost to prepay the advances.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nFair values for loans receivable were estimated for portfolios of loans with similar financial characteristics. Loans were segregated by type, such as commercial, commercial real estate, residential mortgage, installment, and other consumer. Each loan category was further segregated into fixed- and adjustable-rate interest terms. Fair value for single-family residential loans was estimated by discounting the estimated future cash flows from these instruments using quoted market rates and dealer prepayment assumptions. Fair value for commercial mortgage, construction, land, and other commercial loans was derived by discounting the estimated future cash flows from these instruments using the rate that loans with similar maturity and underwriting characteristics would be made on December 31, 1995 or 1994, as applicable. Fair value for consumer loans was estimated using dealer quotes for securities backed by similar collateral. The book value for the allowance for estimated credit losses was used as the fair value estimate for credit losses within the entire loan portfolio. Originated servicing rights capitalized during the year have been on new loan originations. These new loan originations have had no significant adverse changes in interest rates or servicing rights values during the year. Fair value of originated servicing rights is estimated to approximate book value at December 31, 1995.\nThe fair value of commitments to originate loans was estimated by calculating a theoretical gain or loss on the sale of funded loans considering the difference between current levels of interest rates and the committed loan rates. Letters of credit were valued based on fees currently charged for similar agreements. The fair value of interest rate swaps was determined by using various dealer quotes. The fair value for loan servicing rights originated prior to 1995 was estimated based upon dealer and market quotes for the incremental price paid for loans sold servicing released, adjusted for the age of the portfolio and the type of loan. Outstanding firm and master commitments to purchase and sell loans and debt securities were valued based on the market and dealer quotes to terminate or fill the commitments.\nThe fair value of demand, savings, and money market deposits was estimated at book value as reported in the financial statements since it represents the amount payable on demand. The fair value of fixed maturity deposits was estimated using the rates currently offered by the Bank for deposits with similar remaining maturities. The fair value of deposits does not include an estimate of the long-term relationship value of the Bank's deposit customers or the benefit that results from the low cost funding provided by deposit liabilities compared to the cost of borrowing funds in the market.\nNote C -- Cash Equivalents --------------------------\nCash equivalents are stated at cost, which approximates fair value, and include the following (thousands of dollars):\nSecurities purchased under resale agreements of $67.8 million at December 31, 1995 and $77.7 million at December 31, 1994 matured within 12 days and 11 days, respectively, and called for delivery of the same securities. The collateral for these agreements consisted of debt securities which at December 31, 1995 and 1994 were held on the Bank's behalf by its safekeeping agents for various investment bankers. The securities purchased under resale agreements represented 39 percent of the Bank's stockholder's equity at December 31, 1995 and 47 percent at December 31, 1994.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe average amount of securities purchased under resale agreements outstanding during the years ended December 31, 1995 and 1994 were $31.5 million and $36.2 million, respectively. The maximum amount of resale agreements outstanding at any month end was $73.2 million during 1995 and $77.7 million during 1994.\nNote D -- Debt Securities Held to Maturity and Debt Securities Available for ------------------------------------------------------------------ Sale ----\nDebt securities held to maturity are stated at amortized cost. The yields are computed based upon amortized cost. The amortized cost, estimated fair values, and yields of debt securities held to maturity are as follows (thousands of dollars):\nThe following schedule of the expected maturity of debt securities held to maturity is based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\nDebt securities available for sale are stated at fair value. The yields are computed based upon amortized cost. The amortized cost, estimated fair values, and yields of debt securities available for sale are as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe following schedule reflects the expected maturity of MBS and CMO and the contractual maturity of all other debt securities available for sale. The expected maturity of MBS and CMO are based upon dealer prepayment expectations and historical prepayment activity, and can change based upon a number of factors, including the level of market interest rates (thousands of dollars).\nProceeds, gains, and losses from the sales of debt securities are summarized as follows (thousands of dollars):\nIn 1991, the Bank purchased $10 million of adjustable-rate MBS issued by the Resolution Trust Corporation. The securities were rated AA by Standard & Poor's (S&P) and Aa2 by Moody's on the dates of issuance and purchase. When the Bank implemented SFAS No. 115 on December 31, 1993, these securities were designated as held to maturity. The securities were still rated AA and Aa2 at that time. The loans underlying the securities were affected by high delinquency and foreclosure rates, and higher than anticipated losses on the ultimate disposition of real estate acquired through foreclosure. This resulted in rating agency downgrades of the securities beginning in July 1994, and substantial deterioration in the amount of the loss absorption capacity provided by credit enhancement features. At December 31, 1994, the securities were performing according to their contractual terms, and all realized losses from the disposition of foreclosed real\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nestate were being absorbed by credit enhancement features of the securities. In April 1995, S&P and Moody's lowered their ratings on the securities to the below investment grade ratings of BB and Ba3, respectively. As a result of this deterioration, the Bank determined that the securities should be considered \"other than temporarily\" impaired under the provisions of SFAS No. 115. A pretax loss of $1.9 million was recorded as a credit-related charge-off through the valuation allowance for debt securities in the second quarter. In June 1995, the Bank sold these securities. No additional loss was recorded at the time of sale.\nAlso during the second quarter of 1995, the Bank sold a $1.5 million security from its available for sale portfolio at a loss of $181,000. The security was a privately issued MBS whose credit rating was downgraded by Moody's to Baa3 in April 1995. As a result of the downgrade, the Bank sold the security and recorded the loss as a credit related charge-off to the general valuation allowance for debt securities.\nIn 1993, the Bank sold $334 million of MBS to effect the sale of Arizona-based deposit liabilities to World and to maintain the Bank's IRR position. The sale of the securities resulted in a gain of $7.4 million ($4.9 million after tax) included in gain on sale of debt securities in the Statements of Operations for 1993.\nNote E -- Loans Receivable and Loans Receivable Held for Sale -------------------------------------------------------------\nLoans receivable held for investment, recorded at amortized cost, are summarized as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nLoans receivable held for sale are stated at the lower of aggregate cost or market and are summarized as follows:\nLoans collateralized by single-family residential real estate (thousands of dollars):\nAdditional loan information (thousands of dollars):\nMany of the Bank's adjustable-rate loans contain limitations as to both the amount the interest rate can change at each repricing date (periodic caps) and the maximum rate the loan can be repriced to over the lifetime of the loan (lifetime caps). At December 31, 1995, periodic caps in the adjustable loan portfolio ranged from 25 basis points to 500 basis points. Lifetime caps ranged from 9.75 to 22 percent.\nOutstanding commitments to originate loans represent agreements to originate real estate secured loans to customers at specified rates of interest. Commitments generally expire in 30 to 60 days and may require payment of a fee. Some of the commitments are expected to expire without being drawn upon, therefore the total commitments do not necessarily represent future cash requirements.\nThe Bank has designated portions of its portfolio of residential real estate loans and SBA loans as held for sale. These loans are carried at the lower of aggregate cost, market, or sales commitment price. In January 1994, the Bank sold its credit card portfolio held for sale and recorded a gain of approximately $1.7 million ($1.1 million net of charge-offs).\nAt December 31, 1995, 32 percent or $18.5 million of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $9.9 million. These loans are generally secured by real estate, machinery, and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California, and Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries.\nThe Bank's loan approval process is intended to assess both: (i) the borrower's ability to repay the loan by determining whether the borrower meets the Bank's established underwriting criteria, and (ii) the adequacy of the proposed security by determining whether the appraised value of the security property is sufficient for the proposed loan.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nIt is the general policy of the Bank not to make single-family residential loans when the loan-to-value ratio exceeds 80 percent unless the loans are insured by private mortgage insurance, FHA insurance or VA guarantee. Residential tract construction loans are generally underwritten with a stabilized loan-to-value ratio of less than 85 percent, while commercial income property loans are generally underwritten with a ratio less than or equal to 75 percent.\nInterest payments received on impaired loans are recorded as interest income unless collection of the remaining recorded investment is in doubt, in which case payments received are recorded as reductions of principal. Interest income recognized on impaired loans during the year ended December 31, 1995 consisted of $2.8 million using an accrual basis of accounting and $21,000 using a cash basis of accounting. The average balance outstanding of impaired loans for the year ended December 31, 1995 was $23.9 million, while at December 31, 1995, the outstanding impaired loan balance was $25.3 million.\nPremiums on loans primarily represent premiums paid to dealers for originating consumer installment loans for the Bank. Prepayments of the loans can adversely affect the yield of the installment portfolio should the unearned premium be uncollectible from the dealer due to the contractual terms of the dealer agreement or the credit worthiness of the dealer.\nNote F -- Allowances for Estimated Credit Losses ------------------------------------------------\nActivity in the allowances for losses on loan, debt securities, and real estate is summarized as follows (thousands of dollars):\n- --------------- * Allowance for estimated loss balances for impaired and other loans at December 31, 1994 have been reclassified to reflect adoption of SFAS No. 114.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nIncluded in the \"other loans\" category are charge-offs, net of recoveries, of $585,000 for single-family residential loans and $3.3 million for consumer loans. These are considered homogeneous pools of loans that are excluded from the definition of impaired loans for evaluation under SFAS No. 114.\nThe Bank establishes allowances for estimated credit losses by portfolio through charges to expense. On a regular basis, management reviews the level of allowances which have been provided against the portfolios. Adjustments are made thereto in light of the level and trends of problem loans, portfolio growth, and current economic conditions.\nWrite-downs to fair value, disposition gains and losses, and operating income and costs affiliated with real estate acquired through foreclosure are charged to the allowance for estimated credit losses.\nNote G -- Premises and Equipment --------------------------------\nPremises and equipment are summarized as follows (thousands of dollars):\nThe Bank leases certain of its facilities under noncancelable operating lease agreements. The more significant of these leases have terms expiring between 1996 and 2029 and provide for renewals subject to certain escalation clauses. The following is a schedule of net future minimum rental payments under various operating lease agreements that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1995 (thousands of dollars):\nNet rental expense was approximately $2.5 million in 1995, $2.7 million in 1994, and $3.1 million in 1993.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote H -- Deposits ------------------\nDeposits are summarized as follows (thousands of dollars):\nThe above balance includes $5.9 million deposited by the State of Nevada that is collateralized by single-family residential loans and debt securities with a fair value of approximately $6.3 million at December 31, 1995. There were no brokered deposits at December 31, 1995 and 1994.\nInterest expense on deposits for the years ended December 31, is summarized as follows (thousands of dollars):\nCertificates of deposit maturity schedule (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote I -- Securities Sold Under Agreements to Repurchase --------------------------------------------------------\nThe Bank sells securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements are treated as borrowings and are reflected as liabilities in the Bank's Statements of Financial Condition. Reverse repurchase agreements are summarized as follows (thousands of dollars):\nAll agreements are collateralized by MBS and U.S. Treasury notes and require the Bank to repurchase identical securities as those which were sold. The securities collateralizing the agreements are reflected as assets with a carrying value of $473,000 less than the borrowing amount and a weighted average maturity of 1.34 years. Agreements were transacted with the following dealers: Morgan Stanley & Co., Inc.; Lehman Brothers; and Bear Stearns. Reverse repurchase agreements are collateralized as follows (thousands of dollars):\nAt December 31, 1995, borrowings of $37.1 million were outstanding in accordance with a long-term agreement executed with one dealer. The agreement, which allows for a maximum borrowing of $300 million with no minimum, matures in July 2000. The interest rate on the borrowings is adjusted monthly based upon a spread over or under the one month London Interbank Offering Rate (LIBOR), dependent upon the underlying collateral.\nThe Bank is also party to a separate flexible reverse repurchase agreement (flex repo) totaling $4.4 million with an average rate of 8.86 percent at December 31, 1995. A flex repo represents a long-term fixed-rate contract to borrow funds through a primary dealer, collateralized by MBS with a flexible repayment schedule. The principal balance of the Bank's flex repo agreement is expected to mature in July 1996.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote J -- Borrowings --------------------\nBorrowings are summarized as follows (thousands of dollars):\nBorrowings coupon interest rates are as follows:\nPrincipal payments on borrowings at December 31, 1995 are due as follows (thousands of dollars):\nBorrowings are collateralized as follows (thousands of dollars):\nIn 1994, the FHLB established a financing availability for the Bank which currently totals 25 percent of the Bank's assets with terms up to 360 months. All borrowings from the FHLB must be collateralized by mortgages or securities.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote K -- Income Taxes ----------------------\nThe Bank utilizes the accrual basis of accounting for tax purposes. Under the Internal Revenue Code, the Bank is allowed a special bad debt deduction (unrelated to the amount of losses charged to earnings) based on a percentage of taxable income (currently eight percent). Under SFAS No. 109, no deferred taxes are provided on tax bad debt reserves arising prior to December 31, 1987, unless it becomes apparent that these differences will reverse in the foreseeable future. At December 31, 1995, the tax bad debt reserves not expected to reverse are $16.9 million, resulting in a retained earnings benefit of $5.9 million.\nIncome tax expense (benefit) consists of the following (thousands of dollars):\nThe components of the net deferred income tax expense resulting from timing differences in the recognition of revenue and expense for financial reporting purposes in different accounting periods than for income tax purposes are as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe income tax benefit (payable) reported on the Bank's Statements of Financial Condition include the following asset (liability) components (thousands of dollars):\nAt December 31, the net deferred tax asset (liability) is comprised of the following items (thousands of dollars):\nNo valuation allowance has been recorded for deferred tax assets as all assets are expected to be realized through the terms of the tax sharing agreement with the Company.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe effective tax rates in 1995, 1994, and 1993 differ from the federal statutory tax rate of 35 percent. The sources of these differences and the effect of each are summarized as follows:\nThe provisions for income taxes related to the gain on sale of loans and debt securities were $721,000 in 1995, $98,000 in 1994, and $3.4 million in 1993.\nNote L -- Regulatory Matters ----------------------------\nRegulatory Capital\nThe Bank is subject to various capital adequacy requirements under a uniform framework administered by the Federal banking agencies. Specific capital guidelines require the Bank to maintain minimum amounts and ratios as set forth below.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required the federal banking agencies to adopt regulations implementing a system of progressive constraints as capital levels decline at banks and savings institutions. The federal banking agencies have enacted uniform \"prompt corrective action\" rules which classify banks and savings institutions into one of five categories based upon capital adequacy, ranging from \"well capitalized\" to \"critically undercapitalized.\" Banks become subject to prompt corrective action when their ratios fall below the \"adequately capitalized\" status. A reconciliation of stockholder's equity, as shown in the Bank's Statements of Financial Condition, to the FDICIA capital standards and the Bank's resulting ratios are set forth in the table below (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED) - ------------------------------------\nAs of December 31, 1995 and 1994, PriMerit Bank exceeded the adequately capitalized ratios and was categorized as \"well capitalized.\"\nThe decline in the Bank's risk-based capital ratios over prior year-end is principally the result of the change in the amount of allowable supervisory goodwill includable in capital and an increase in the risk-weighted asset base caused by a higher level of real estate and commercial loans replacing mortgage-backed securities, partially offset by year-to-date net income, excluding goodwill amortization and impairment, of $12.5 million. At December 31, 1995, under fully phased-in capital rules applicable to the Bank at July 1, 1996, the Bank would have exceeded the \"adequately capitalized\" fully phased-in, total risk-based, tier 1 risk-based, and tier 1 leverage ratios by $53.2 million, $81.6 million, and $52.6 million, respectively.\nThe Office of Thrift Supervision (OTS) regulation requiring institutions with IRR exposure classified as \"above normal\" to reduce their risk-based capital has been indefinitely delayed. As measured by both the Bank's model and the OTS model, the Bank has a \"normal\" classification of interest rate risk as defined in the delayed regulation. Had the regulation been implemented, no capital deduction would have been required during any period presented.\nOther Regulatory and Contractual Matters\nThe Company, at the time that it acquired the Bank, stipulated in an agreement with the Federal Home Loan Bank Board (predecessor to the OTS) that it would assist the Bank in maintaining levels of regulatory capital required by the regulations in effect at the time or as they were amended thereafter and limited dividends from the Bank to specified amounts, so long as it controlled the Bank. In July 1995, upon the request of the Company, the OTS terminated these stipulations, such that capital distributions by the Bank and capitalization of the Bank are now governed by the laws and regulations governing all other thrifts. During 1995, the Bank paid the Company $500,000 in cash dividends.\nUnder the terms of the definitive sale agreement with Norwest, the Bank is limited in the amount of dividends payable to the Company through the closing date of the sale of $375,000 per quarter through June 30, 1996 and up to $3.5 million in the third quarter of 1996, dependant upon the timing of the closing date of the sale.\nThe deposit accounts of savings associations, including those of PriMerit, are insured to the maximum extent permitted by law by the FDIC through the SAIF. The deposit accounts of commercial banks are separately insured by the FDIC through the bank insurance fund (BIF). Commercial banks and savings associations are separately assessed annual deposit insurance premiums. For savings associations, the deposit premiums range from 23 to 31 cents per $100 of deposits and, under current requirements, will remain at that level until the SAIF is capitalized at 1.25 percent of insured deposits. The SAIF is not expected to reach this level of capitalization for several years. Under current assessments, a number of plans have been proposed in Congress to deal with the undercapitalization of the SAIF. Several proposals provide for a one-time special assessment estimated to approximate 75 to 79 basis points, on SAIF-insured deposits to fully capitalize the SAIF to 1.25 percent of insured deposits. These proposals would subsequently reduce annual premiums to levels similar to those of BIF-insured commercial banks and eventually merge the BIF and SAIF insurance funds.\nAssuming a one-time special assessment was approved by Congress and became law in 1996, and was immediately charged against results of operations, the one-time assessment would approximate $10 million, pretax, for the Bank. Management believes the Bank would continue to be classified as \"well-capitalized\" under fully phased-in FDICIA capital rules and would not face any liquidity issues as a result of such a one-time assessment.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote M -- Employee Benefits ---------------------------\nPension Plan\/Employees' 401(k) Plan\nThe Bank maintains a defined benefit pension plan for substantially all of its employees. The Bank's policy is to fund the pension expense accrued for each year but not less than the minimum required contribution nor more than the tax deductible limit. Commencing April 1994, the pension plan was curtailed. Employees hired on or after that date will not be able to participate in the pension plan, while existing employees will not be able to increase benefits under the pension plan through additional service with the Bank. The Bank offers all its eligible employees participation in the Employees' 401(k) plan of PriMerit Bank. The 401(k) plan provides for purchases of certain investment vehicles by eligible employees through annual payroll deductions of up to 15 percent of base compensation. The cost and liability of both plans are not material.\nOther Benefits\nThe Bank has contractual obligations with selected officers of the Bank which require payment to the officers of additional one time compensation should a change of control (as defined) of the Bank occur and additional one time compensation to the officers if their employment is terminated subsequent to the change of control. These contingent obligations total approximately $3 million at December 31, 1995.\nNote N -- Asset\/Liability Management ------------------------------------\nAsset\/Liability Management is a unified process for managing the structure and mix of the Bank's balance sheet and off-balance sheet financial instruments to provide for optimum levels of net interest income while maintaining prudent levels of IRR and liquidity. The Bank's Board of Directors has established written policies governing the management of the Bank's IRR that include defined acceptable levels of IRR and acceptable tools for the management of IRR within these levels. Also included in the Board's written policies are defined acceptable classes and uses of derivative financial instruments as tools in the management of the Bank's IRR.\nIRR in general is one of several inherent risks of the financial services industry. Profitable operation of the Bank depends in part on prudent acceptance and successful management of IRR. There are two general forms of IRR, both of which derive from future changes in interest rates: the risk that future levels of net interest income will be reduced, and the risk that the Bank's net market value will be reduced.\nIRR results from (a) timing differences in the maturity and\/or repricing of the Bank's assets, liabilities, and off-balance sheet contracts; (b) the exercise of options embedded in the Bank's financial instruments and accounts, such as prepayments of loans before scheduled maturity, caps on amounts of interest rate movement permitted for adjustable-rate loans, and the withdrawals of funds on deposit with and without stated terms to maturity; and (c) changes in the spread relationships between lending and funding interest rates, referred to as basis risk.\nTraditional measures of IRR have focused on that portion of the risk resulting from timing differences in the maturity and\/or repricing of assets, liabilities, and off-balance sheet contracts, and are usually expressed in the form of a static gap report. The \"gap\" for a given period is positive when repricing and maturing assets exceed repricing and maturing liabilities within that period. The gap for a given period is negative when repricing and maturing liabilities exceed repricing and maturing assets within that period. A positive or negative cumulative gap may indicate in a general way how the Bank's net interest income should respond to interest rate fluctuations. A positive cumulative gap for a given period would generally mean that rising interest rates would be reflected in financial assets sooner than in financial liabilities, resulting in higher net\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\ninterest income. A negative cumulative gap for a given period might result in higher net interest income over that period if interest rates declined.\nAt December 31, 1995 and 1994, the Bank's one-year cumulative static gap was $(60) million and $(145) million, respectively, or negative 3.5 percent and negative 8.4 percent of total financial assets.\nWhile providing a rough measure of IRR as it relates to expected future levels of net interest income, gap has a number of drawbacks; including that it is a static, point-in-time measurement, it does not capture the effects of basis risk, and it does not capture risk that varies either asymmetrically or nonproportionately with changes in interest rates. Because of these limitations and weaknesses, the Bank uses a dynamic simulation model as its primary method of measuring potential risks to future levels of net interest income. The simulation model captures not only gap repricing and maturity mismatches, but also the effects of basis risk, embedded customer and contractual options, and the effects of prepayments of assets and resulting funds reinvestment risk. Through selective variation of a number of modeling assumptions and possible interest rate changes, management is able to more completely assess the sources and size of potential risk and optimize the Bank's balance sheet size and structure and\/or utilize derivative financial instruments to minimize such risks.\nAs compared to the IRR profile of a typical commercial bank, the Bank's IRR profile is comparatively longer-term in nature. Whereas static gap measures and net interest income simulation usually focus on potential IRR effects over a one-year horizon, indicators of the level of IRR inherent in the Bank's current balance sheet and off-balance sheet contracts over the entire maturity spectrum can be measured through market value analysis. The Bank maintains a market valuation model to facilitate such analysis.\nThe Bank's market valuation model computes the net present value of discounted future cash flows for each category of the Bank's assets, liabilities, and derivative financial instruments. In this type of analysis, net present values of discounted future cash flows are used as a proxy for actual market values, since factors unrelated to current and projected future levels of interest rates can have significant effects on actual market values.\nThe theoretical market value of the Bank's stockholder's equity can be derived from the net market values of the Bank's assets, liabilities, and derivative financial instruments. This theoretical market value of stockholder's equity is known as Net Portfolio Value (NPV) under OTS regulations. By analyzing the behavior of the Bank's NPV under varying assumptions as to changes in the general level of interest rates, management is further able to optimize the Bank's balance sheet mix and devise strategies using derivative financial instruments and on balance sheet strategies to mitigate potential adverse effects of interest rate fluctuations on future net interest income levels.\nThe Bank's Board of Directors' written policy governing management of the Bank's IRR sets forth maximum allowable levels for changes in the Bank's NPV under specific assumed changes in the general level of interest rates. Under the policy, the maximum allowable change in the Bank's NPV for an immediate and sustained interest rate change of 200 basis points (2.00 percent) is a decline of 30.0 percent. The Bank's estimates of its Net Portfolio Values were significantly within this limit for each quarter of 1995 and 1994. The following table sets forth management's estimates of the Bank's NPV as of December 31, 1995 and 1994, and under simulated 200 basis point changes in interest rates (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe financial instruments approved by the Bank's Board of Directors for use in managing the Bank's IRR include the Bank's debt security portfolio, borrowings from the FHLB and other sources, interest rate swaps, interest rate caps, interest rate collars, interest rate futures, and put and call options. These financial instruments provide effective methods of reducing the impact of changes in interest rates on the Bank's net interest income and NPV. The Bank also actively manages its retail and wholesale funding sources to minimize its cost of funds and provide stable funding sources for its loan and investment portfolios. Management's use of particular financial instruments is based on a complete analysis of the Bank's current IRR exposure and the projected effect of a proposed strategy on the Bank's IRR exposure.\nThe Bank is exposed to IRR through the issuance of fixed-rate loan commitments. Fixed-rate loan commitments represent firm commitments to originate loans secured by real estate to specific borrowers at predetermined interest rates. Fixed-rate loan commitments generally expire in 30 to 60 days. The Bank generally receives a fee for these types of commitments. Many of the commitments are expected to expire without fully being drawn upon; therefore, the total commitments do not necessarily represent future cash requirements.\nThe Bank hedges IRR on fixed-rate loan commitments expected to be sold in the secondary market and the inventory of loans held for sale through a combination of commitments from permanent investors, optional delivery commitments, and mandatory forward contracts. Outstanding firm commitments to sell loans represent agreements to sell loans to a third party at a specified price on a specified date. These commitments are used to hedge loans for sale and to hedge outstanding commitments to originate loans. Outstanding master commitments to sell loans represent agreements to sell a stated volume of loans to a third party within a specified period of time without regard to price. Master commitments are entered in order to ensure availability of a buyer for loans meeting specified underwriting criteria and to maximize the sales price at the time a firm commitment is executed. Related hedging gains and losses are recognized at the time gains and losses are recognized on the related loans. See Note B -- Fair Value of Financial Instruments for commitments outstanding and their estimated fair values.\nAt December 31, 1995 and 1994, the Bank had issued and held interest rate swap agreements as a hedge to convert certain fixed-rate permanent loans into variable-rate instruments. The interest rate swap agreements require the Bank to make fixed payments on nonamortizing notional balances, and in turn, the Bank receives variable interest payments based on the six month LIBOR on these same balances. If the balances of the loans on the Bank's balance sheet that are related to the interest rate swap were to decline below the nominal amounts of the interest rate swaps, the excess portions of the interest rate swaps would be marked to market, and the resulting gains or losses included in the Bank's income.\nThe following table presents the notional amounts of interest rate swaps outstanding, unrealized gains and losses of the interest rate swaps, the weighted average interest rates payable and receivable, and the remaining terms (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nThe notional amounts of interest rate swaps do not represent amounts exchanged by the parties and, thus, are not a measure of the Bank's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the interest rates.\nThe Bank is exposed to credit-related losses in the event of nonperformance by counterparties to off-balance sheet financial contracts, but does not expect any counterparties to fail to meet their obligations. The Bank performs credit analyses on all counterparties, and its credit exposure at any given time is limited to the value of off-balance sheet contracts that have become favorable to the Bank and have unrealized gains on that date. The Bank generally uses only highly rated Wall Street investment firms as counterparties to its off-balance sheet financial contacts, but because of the different business emphasis of each of the firms, adverse economic changes or conditions are not likely to produce similar adverse changes to the credit risk of all of the Bank's counterparties to the same extent.\nNo interest rate swaps matured or were terminated during 1995, 1994 or 1993. The interest rate swap agreements at December 31, 1995 are collateralized with MBS with a fair value of $6.5 million. The net expense on interest rate swaps of $624,000, $485,000 and $24,000 in 1995, 1994 and 1993, respectively, are included in interest expense as a cost of hedging activities in the Bank's Statements of Operations.\nNote O -- Legal Proceedings ---------------------------\nThe Bank has been named as defendant in various legal proceedings. The ultimate dispositions of these proceedings are not presently determinable; however, it is the opinion of management, based upon the advice of counsel, it is unlikely that any litigation to which the Bank or any of its subsidiaries is subject will have a material adverse impact on the Bank's financial condition or results of operations.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- PRIMERIT BANK (CONTINUED)\nNote P -- Quarterly Financial Data (Unaudited) ----------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders, Southwest Gas Corporation:\nWe have audited the accompanying consolidated balance sheets of Southwest Gas Corporation (a California corporation, hereinafter referred to as the Company) 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 the 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.\nARTHUR ANDERSEN LLP\nLas Vegas, Nevada February 7, 1996\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Identification of Directors. The names of the members of the Board of Directors, the principal occupation of each member and his or her employer for the last five years or longer, and the principal business of the corporation or other organization, if any, in which such occupation or employment is carried on, follow.\nRALPH C. BATASTINI Former President, Vice Chairman and Chief Financial Officer The Dial Corp (Formerly The Greyhound Corporation)\nDirector Since: 1992 Board Committees: Audit (Chairman), Pension Plan Investment\nMr. Batastini, 66, received his undergraduate degree from Illinois State University and his M.B.A. degree in finance from the University of Chicago. He joined The Greyhound Corporation in 1957 and retired in 1984 as vice chairman and chief financial officer. At the time of his retirement Mr. Batastini headed the Greyhound financial group of companies involved in capital equipment leasing, computer leasing, reinsurance, money orders, mortgage insurance, and real estate. He subsequently served as president of Batastini & Co. from 1985 to 1990. He currently is the president of the Barrow Neurological Foundation and has been a director of PriMerit Bank since 1992.\nMANUEL J. CORTEZ President and Chief Executive Officer Las Vegas Convention and Visitors Authority\nDirector Since: 1991 Board Committees: Nominating and Compensation, Pension Plan Investment\nMr. Cortez, 57, served four terms (1977-1990) on the Clark County Commission and is a former chairman of the Commission. He has been active on various boards, including the Environmental Quality Policy Review Board, the Las Vegas Valley Water District Board of Directors and the University Medical Center Board of Trustees, and served as chairman of the Liquor and Gaming Licensing Board and the Clark County Sanitation District. He has also held leadership roles with numerous civic and charitable organizations such as Boys and Girls Clubs of Clark County, Lied Discovery Children's Museum, and Boys Town. Currently, Mr. Cortez holds professional memberships in the American Society of Association Executives, the Professional Convention Managers Association, the International Association of Convention and Visitors Bureaus, and the American Society of Travel Agents. He has been a director of PriMerit Bank since 1991.\nLLOYD T. DYER Retired President and Chief Executive Officer Harrah's\nDirector Since: 1978 Board Committees: Executive, Nominating and Compensation\nMr. Dyer, 68, obtained a degree in banking and finance from the University of Utah prior to his employment with Harrah's, a hotel\/gaming corporation with its principal facilities in Reno and Lake Tahoe, in 1957. He was elected president and chief operating officer of Harrah's in 1975, and elected president and chief executive officer in 1978. He remained in those positions with Harrah's until his retirement in April 1980.\nMr. Dyer has been a director of PriMerit Bank since 1986. He is also a trustee of the William F. Harrah Trusts.\nKENNY C. GUINN Chairman of the Board Southwest Gas Corporation and PriMerit Bank\nDirector Since: 1981 Board Committees: Executive (Chairman), Nominating and Compensation\nMr. Guinn, 59, was appointed President and Chief Operating Officer of Southwest Gas Corporation in 1987, Chairman and Chief Executive Officer in 1988 and was elected Chairman of the Board of Directors in 1993. Mr. Guinn is actively involved in numerous business, charitable, and civic activities. He is past chairman of the Las Vegas Metropolitan Police Fiscal Affairs Committee and past chairman of the Board of Trustees for the University of Nevada, Las Vegas Foundation. In May 1994 he was appointed Interim President of the University of Nevada, Las Vegas and served in this capacity for approximately one year. He is also a director for Oasis Residential, Inc., Boyd Gaming Corporation, and Del Webb Corporation. Mr. Guinn was elected a director of PriMerit Bank in 1980 and has served as Chairman of the Board of Directors of PriMerit since 1987.\nTHOMAS Y. HARTLEY President and Chief Operating Officer Colbert Golf Design and Development\nDirector Since: 1991 Board Committees: Audit, Nominating and Compensation\nMr. Hartley, 62, obtained his degree in business from Ohio University in 1955, and was employed in various capacities by Deloitte Haskins & Sells from 1959 until his retirement as an area managing partner in 1988. Mr. Hartley is actively involved in numerous business and civic activities. He is chairman of the University of Nevada, Las Vegas Foundation and president of the Las Vegas Founders Club. He has also held executive positions with the Nevada Development Authority, the Las Vegas Founders Golf Foundation, the Las Vegas Chamber of Commerce, and the Boulder Dam Area Council of the Boy Scouts of America. He is a director of Rio Hotel and Casino, Inc., Sierra Health Services, Inc. and has been a director of PriMerit Bank since 1991.\nMICHAEL B. JAGER Private Investor\nDirector Since: 1989 Board Committees: Audit, Pension Plan Investment\nMr. Jager, 64, obtained a degree in petroleum geology from Stanford University in 1955. After a four-year employment with the Richfield Oil Corporation as a petroleum geologist, he joined the Frank H. Ayres & Son Construction Company and was involved in the construction of subdivisions and homes in southern California until 1979. Since that time he has consulted in the single family residential development industry, and owns and manages a number of businesses in Oregon and Nevada. He has been a director of PriMerit Bank since 1989.\nLEONARD R. JUDD Former President, Chief Operating Officer, and Director Phelps Dodge Corporation\nDirector Since: 1988 Board Committees: Audit, Nominating and Compensation (Chairman)\nMr. Judd, 57, former president, chief operating officer, and director of Phelps Dodge Corporation, joined Phelps Dodge in 1963 and worked at that company's operations in Arizona, New Mexico and New York City. He was elected to the Phelps Dodge board of directors in 1987, became president of Phelps Dodge Mining Company in 1988 and became president and chief operating officer of Phelps Dodge in 1989. He remained in those positions until November 1991. Mr. Judd is a member of various professional organizations and is active in numerous civic groups. He serves as a director of the Kasler Holding Company, the Montana College of Mineral Science and Technology Foundation, and has been a director of PriMerit Bank since 1988.\nJAMES R. LINCICOME Retired Executive Vice President and General Manager, Government Electronics Group, Motorola Corporation\nDirector Since: 1987 Board Committees: Audit, Executive, Nominating and Compensation\nMr. Lincicome, 70, was employed by Motorola in its Communications Division in 1950. After progressing through positions in that Division, he transferred to the Government Electronics Group, where from 1979 until his retirement in 1987, he was General Manager responsible for various national defense, space exploration and other government related programs. Mr. Lincicome is a member of various professional organizations and is past Chairman of the Arizona State University Engineering Advisory Council, Junior Achievement of Central Arizona, the Phoenix Urban League, United for Arizona, and the Valley of the Sun United Way. He has held a number of leadership roles in other civic and charitable organizations in Arizona, including the Research Committee of the Arizona Town Hall and Board Member of the Goldwater Institute, and was vice chairman of the Government Division of the Electronic Industries Association in 1986. He has been a director of PriMerit Bank since 1988.\nMICHAEL O. MAFFIE President and Chief Executive Officer Southwest Gas Corporation\nDirector Since: 1988 Board Committees: Executive\nMr. Maffie, 48, joined the company in 1978 as Treasurer after seven years with Arthur Andersen & Co. He was named Vice President\/Finance and Treasurer in 1982, Senior Vice President and Chief Financial Officer in 1984, Executive Vice President in 1987, President and Chief Operating Officer in 1988, and President and Chief Executive Officer in 1993. He has been a director of PriMerit Bank since 1993. He received his undergraduate degree in accounting and his M.B.A. degree in finance from the University of Southern California. A member of various professional organizations, he serves as a board member of the United Way of Nevada, Nevada School of the Arts, Boys and Girls Clubs of Las Vegas, a trustee of the Las Vegas Symphony Orchestra, the University of Nevada, Las Vegas Foundation, and the Nevada Development Authority. He also serves as a Commissioner on the State of Nevada Commission on Substance Abuse Education, Prevention, Enforcement and Treatment, and is a former president of the Allied Arts Council. He is a director of the Pacific Coast Gas Association and a former director of the American Gas Association.\nCAROLYN M. SPARKS Co-Founder International Insurance Services, Ltd.\nDirector Since: 1988 Board Committees: Audit, Pension Plan Investment (Chairperson)\nMrs. Sparks, 54, graduated from the University of California at Berkeley in 1963, and with her husband, co-founded International Insurance Services, Ltd., in 1966 in Las Vegas. She has served on the University and Community College System of Nevada Board of Regents since 1984, and in 1991 was elected to a two-year term as Chairperson of the Board of Regents. Mrs. Sparks is actively involved with numerous charitable and civic organizations, including founding chairperson of the University Medical Center Foundation and the Children's Miracle Network Telethon. She also served on the board for Bishop Gorman High School and is currently chair of the board for the Las Vegas Center for Children. She is a director of Showboat, Inc., a hotel\/gaming corporation and has been a director of PriMerit Bank since 1988.\nROBERT S. SUNDT Retired President Sundt Corp.\nDirector Since: 1987 Board Committees: Executive, Pension Plan Investment\nMr. Sundt, 69, has been associated with Sundt Corp. in a variety of positions since 1948. He was named President of Sundt Corp. in 1983. He is now retired and has no continuing association with Sundt Corp. He has been a director of PriMerit Bank since 1988. He is a member of the American Institute of Constructors, Consulting Constructors Council of America and a life director of the Associated General Contractors of America. He is a member of the American Arbitration Association and serves as an arbitrator on disputes concerning the construction industry. He is past member of the Construction Industry Presidents Forum. Mr. Sundt is affiliated with a number of community organizations and is past chairman of the Tucson Metropolitan Chamber of Commerce.\n(b) Identification of Executive Officers. The name, age, position and period position held during the last five years for each of the Executive Officers of the Company are as follows:\n(c) Identification of Certain Significant Employees.\nNone.\n(d) Family Relationships. None of the Company's Directors or Executive Officers are related to any other either by blood, marriage or adoption.\n(e) Business Experience. Information with respect to Directors is described in (a) above. All Executive Officers have held responsible positions with the Company for at least five years as described in (b) above.\n(f) Involvement in Certain Legal Proceedings.\nNone.\n(g) Item 405 Review. Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (SEC) and the New York Stock Exchange. Officers, directors and beneficial owners of more than ten percent of any class of equity securities are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nThe Company has adopted procedures to assist its directors and executive officers in complying with Section 16(a) of the Securities and Exchange Act of 1934, which includes assisting in the preparation of forms for filing. For 1995, all the required reports were filed timely.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDIRECTORS COMPENSATION\nOutside directors receive an annual retainer of $20,000, plus $900 for each Board or committee meeting attended. Committee chairpersons receive an additional $500 for each committee meeting attended. The outside directors also receive an annual retainer of $16,000 and fees for serving on the Board of Directors of PriMerit Bank. Each director receives a fee of $700 for each Bank Board or committee meeting attended, and the Bank committee chairpersons also receive an additional $250 for each committee meeting attended. The Chairman of the Company's Board, Mr. Guinn, receives an additional $25,000 annually for serving in that capacity. Directors who are full-time employees of the Company or its subsidiaries receive no additional compensation for Board service.\nOutside directors may defer their compensation until retirement or other termination of status as a director. Amounts deferred bear interest at 150 percent of the Moody's Seasoned Corporate Rate.\nThe Company also provides a retirement plan for its outside directors. With a minimum of ten years of service, an outside director can retire and receive a benefit equal to the annual retainer, at retirement, for serving on the Company's Board. Directors who retire before age 65, after satisfying the minimum service obligation will receive retirement benefits upon reaching age 65.\nEXECUTIVE COMPENSATION\nThe following table provides for fiscal years ended December 31, 1993, 1994 and 1995, compensation earned by the Company's Chief Executive Officer and each of the four other most highly compensated executive officers of the Company.\nSUMMARY COMPENSATION TABLE(1)\n- --------------- (1) All compensation reflected in the Summary Compensation Table is reported on an earned basis for each fiscal year.\n(2) Bonuses and performance shares accrued for calendar years 1993, 1994 and 1995 were paid and awarded in 1994, 1995 and 1996, respectively.\n(3) Dividends equal to the dividends paid on the Company's Common Stock will accrue on the performance shares awarded under the long-term component of the Company's management incentive plan during the restriction period.\n(4) Messrs. Maffie, Trimble, Biehl and Stewart were awarded performance shares (restricted stock) under the Company's management incentive plan. Mr. Cheever does not participate in the Company's management incentive plan. The total number of performance shares granted in 1994 and 1995, for calendar years 1993 and 1994, and their value based on the market price of Company Common Stock at December 29, 1995 for each individual are as follows:\n(5) If the impending sale of the Bank is consummated, the long-term performance awards under the performance periods described below, or $94,959, will be paid to Mr. Cheever at least one week prior to closing.\n(6) For Messrs. Maffie, Trimble, Biehl and Stewart, the amounts shown in this column for each year consist of above-market interest on deferred compensation and matching contributions under the Company's executive deferral plan. Under the plan, executive officers may defer up to 50 percent of their annual compensation for payment at retirement or at some other employment terminating event. Interest on such deferrals is set at 150 percent of the Moody's Seasoned Corporate Rate. As part of the plan, the\nCompany provides matching contributions that parallel the contributions made under the Company's 401(k) plan, which is available to all Company employees, equal to one-half of the deferred amount, up to six percent of their annual salary.\n(7) For Mr. Cheever, the amounts shown in this column for each year consist of matching contributions under the Bank's 401(k) plan, and for 1994 include a matching contribution under the Bank's executive deferral plan. Under the Bank's executive deferral plan, Mr. Cheever may defer up to 50 percent of his annual salary and bonus for payment at retirement or at some other employment terminating event. Interest on executive plan deferrals is set at 150 percent of the Moody's Seasoned Corporate Rate. For 1994 and the first two months of 1995, the Bank provided matching contributions equal to the amount deferred under each plan, up to six percent of Mr. Cheever's annual salary and bonus. For the remainder of 1995, such matching contributions were only provided to Mr. Cheever under the provisions of the Bank's executive deferral plan.\n(8) All Other Compensation consists of matching contributions under the Company's or PriMerit Bank's deferral plans and interest on such deferrals in excess of 120 percent of the Applicable Federal Long-term [bond] Rate. The breakdown of such compensation for each named executive officer is as follows:\nLONG-TERM INCENTIVE PLAN AWARDS FOR 1995\nThe following table summarizes the long-term cash incentive awards earned by Dan Cheever under PriMerit Bank's performance based executive compensation plan for the three-year performance periods of January 1, 1994 through December 31, 1996 and January 1, 1995 through December 31, 1997. Of the named executive officers, only Mr. Cheever was eligible to participate in the PriMerit Bank plan. If the impending sale of the Bank is consummated, the long-term performance awards under both performance periods will be paid to Mr. Cheever at least one week prior to closing and the plan will be terminated.\nLONG-TERM INCENTIVE PLAN TABLE\n- --------------- (1) The long-term performance award earned by Mr. Cheever for the first performance period represents 30 percent or the second year's percentage of such award. Mr. Cheever earned 20 percent, or $23,170, during the first year of this performance period. This year's award is not subject to further adjustment during the performance period, and if the pending sale of the Bank is consummated, the awards earned through the end of 1995 will be paid out to Mr. Cheever at least one week prior to closing.\n(2) The long-term performance award earned by Mr. Cheever for the second performance period represents 33 percent or the first year's percentage of such award. This year's award is not subject to further adjustment during the performance period, and if the pending sale of the Bank is consummated, the awards earned through the end of 1995 will be paid out to Mr. Cheever at least one week prior to closing.\nBENEFIT PLANS\nSouthwest Gas Basic Retirement Plan. The named executive officers, except Mr. Cheever, participate in the Company's non-contributory, defined-benefit retirement plan, which is available to all employees of the Company and its subsidiaries (except PriMerit Bank which has a separate plan). Benefits are based upon an employee's years of service, up to a maximum of 30 years, and the employee's highest five consecutive years salary within the final 10 years of service.\nSOUTHWEST GAS PENSION PLAN TABLE(1)(2)\n- --------------- (1) Years of service beyond 30 years will not increase benefits under the basic retirement plan.\n(2) For 1996, the maximum annual compensation that can be considered in determining benefits under the plan is $150,000. For future years the maximum annual compensation will be adjusted to reflect changes in the cost of living as established by the Internal Revenue Service.\nCompensation covered under the basic retirement plan is based on salary depicted in the Summary Compensation Table. As of December 31, 1995, the credited years of service for the named executive officers shown in the Summary Compensation Table are as follows: Mr. Maffie, 17 years; Mr. Biehl, 10 years; Mr. Stewart, 11 years; and Mr. Trimble, 9 years.\nAmounts shown in the pension plan table are straight-life annuity amounts, notwithstanding the availability of joint survivorship benefit provisions. Benefits paid under the basic and supplemental retirement plans are not reduced by any Social Security benefits received.\nSupplemental Retirement Plan. The named executive officers, except Mr. Cheever, also participate in the Company's supplemental retirement plan. Such officers with 10 or more years of service may retire at age 55 or older and will receive benefits under the plan. Such benefits, when added to benefits received under the basic retirement plan, will equal 60 percent of their highest 12 months of compensation with the Company. The total benefit may be reduced if an officer retires prior to age 60, depending upon his age and total years of service with the Company. The cost to the Company for benefits under the supplemental retirement plan for any one of the named executive officers cannot be properly allocated or determined because of the overall plan assumptions and options available.\nPriMerit Bank Retirement Income Plan. Mr. Cheever, who is a named executive officer, participates in the Bank's non-contributory, defined-benefit retirement plan, which was available to all employees of the Bank and its subsidiaries. Through March 1994, benefits were based upon an employee's years of service, up to a maximum of 15 years, and the employee's 60 highest paid consecutive months of employment with the Bank. Commencing April 1, 1994, the plan was curtailed. Employees hired on or after that date will not be able to participate in the plan, while existing employees will not be able to increase benefits under the plan through additional service with the Bank. Salary changes for existing employees, however, will continue to affect plan benefits. If the pending sale of the Bank is consummated, the plan will be merged with the defined-benefit retirement plan of Norwest.\nPRIMERIT BANK PENSION PLAN TABLE(1)(2)\n- --------------- (1) Prior to March 31, 1994, years of service beyond 15 years would not increase benefits under the plan. With the curtailment of the plan, additional years of service will no longer increase benefits under the plan.\n(2) For 1996, the maximum annual compensation that can be considered in determining benefits under the Plan is $150,000. For future years, the maximum annual compensation will be adjusted to reflect changes in the cost of living as established by the Internal Revenue Service.\nCompensation covered under the Bank's retirement plan is based on salary depicted in the Summary Compensation Table. At the time the plan was curtailed, Mr. Cheever had five years of service with the Bank. Only future salary changes will affect Mr. Cheever's benefits under the plan.\nAmounts shown in the pension plan table are straight life annuity amounts notwithstanding the availability of joint survivorship benefit provisions. Benefits paid under the Bank's retirement and supplemental retirement plans are not reduced by any Social Security benefits.\nPriMerit Bank Supplemental Executive Retirement Plan. Mr. Cheever also participates in the Bank's supplemental retirement plan. Participation in the supplemental plan is limited to officers of the Bank selected by the Bank's Board of Directors. Benefits under the plan, when added to benefits received under the defined benefit retirement plan, will equal 60 percent of the participant's average annual salary over the 60 highest paid consecutive months of service. The total benefit will be reduced if a participant retires prior to age 65, and with less than 15 years of service with the Bank. The cost to the Bank for benefits under the supplemental retirement plan for Mr. Cheever cannot be properly determined because of the overall plan assumptions and options available. If the pending sale of the Bank is consummated, the plan will be terminated and Mr. Cheever's accrued benefit, estimated to be $75,000, would be paid prior to closing.\nCHANGE IN CONTROL ARRANGEMENT\nPriMerit Bank, during 1994, entered into an agreement with Mr. Cheever that is designed to support his continued employment with the Bank. Under the terms of the agreement, Mr. Cheever would be entitled to a lump sum benefit payment of $500,000 if he is employed by the Bank at the time of a change in control of the Bank. Such payment would become due and payable only after the occurrence of a change in control. The agreement also provides that Mr. Cheever would be entitled to a lump sum deferred compensation benefit equal to 200 percent of his annual salary if his employment with the Bank is terminated (or his responsibilities are substantially changed without his consent) within 12 calendar months of a change in control for other than cause, death, disability, or retirement. The one-year agreement was extended through May 1996.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Directors who served on the Company's Nominating and Compensation Committee during 1995 were Leonard R. Judd (Chairman), Manuel J. Cortez, Lloyd T. Dyer, Kenny C. Guinn, Thomas Y. Hartley, and James R. Lincicome. Mr. Guinn retired as Chairman and Chief Executive Officer of the Company on May 12, 1993, and retired as a full-time employee of the Company on August 31, 1993. Mr. Guinn became a member of the Committee after his retirement as an officer of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Not applicable.\n(b) The following table discloses all common stock of the Company beneficially owned by the directors and executive officers of the Company as of March 1, 1996.\n- --------------- (1) As of March 1, 1996, the directors and executive officers of the Company beneficially owned 183,566 shares, which represents less than 1 percent of the outstanding shares of the Company's Common Stock. No investor owned more than 5 percent of the outstanding voting stock of the Company as of March 1, 1996.\n(2) The Common Stock holdings listed in this column include performance shares granted to the Company's executive officers under the Company's Management Incentive Plan for 1993, 1994, and 1995.\n(3) Number of shares includes 3,000 shares held in trust for Margaret Jager, over which Mr. Jager has no control.\n(4) Number of shares does not include 6,618 shares held by the Southwest Gas Corporation Foundation, which is a charitable trust. Messrs. Maffie, Trimble, and Biehl are trustees of the Foundation but disclaim beneficial ownership of said shares.\n(c) Not applicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring 1995, some directors and executive officers of the Company were depositors of, and had transactions with, PriMerit Bank. These transactions were on the same terms (including interest rates, repayment terms, and collateral) as those prevailing at the time for comparable transactions with other persons of similar credit-worthiness and, in the opinion of the Board of Directors of the Bank, do not involve more than a normal risk of collectibility or other unfavorable characteristics.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report on Form 10-K:\n(1) The following are included in Part II, Item 8 of this Form:\n(2) All schedules have been omitted because the required information is either inapplicable or included in the Notes to Consolidated Financial Statements.\n(3) See list of exhibits.\n(b) Reports on Form 8-K\nThe Company filed a Form 8-K, dated November 13, 1995, reporting on the proposed acquisition of Northern Pipeline Construction Co.\nThe Company filed a Form 8-K, dated January 8, 1996, reporting on the agreement to sell PriMerit Bank, a wholly owned subsidiary, to Norwest Corporation.\nThe Company filed a Form 8-K, dated February 14, 1996, reporting summary financial information for the year ended December 31, 1995.\nThe Company filed a Form 8-K, dated March 5, 1996, disclosing the adoption of a Rights Agreement.\n(c) See Exhibits.\nLIST OF EXHIBITS\n- --------------- (1) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1982.\n(2) Incorporated herein by reference to the Company's Registration Statement on Form S-2, No. 2-92938.\n(3) Incorporated herein by reference to the Company's Registration Statement on Form S-3, No. 33-7931.\n(4) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1986.\n(5) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended March 31, 1987.\n(6) Incorporated herein by reference to the Company's report on Form 8-K dated August 23, 1988.\n(7) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended June 30, 1992.\n(8) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended September 30, 1992.\n(9) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1992.\n(10) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1993.\n(11) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended June 30, 1994.\n(12) Incorporated herein by reference to the Company's Registration Statement on Form S-3, No. 33-55621.\n(13) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1994.\n(14) Incorporated herein by reference to the Company's Registration Statement on Form S-3, No. 33-62143.\n(15) Incorporated herein by reference to the Company's Amendment No. 1 to Registration Statement on Form S-3, No. 33-62143.\n(16) Incorporated herein by reference to the Company's report on Form 8-K dated October 26, 1995.\n(17) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended September 30, 1995.\n(18) Incorporated herein by reference to the Company's report on Form 8-K dated January 8, 1996.\n(19) Incorporated herein by reference to the Company's report on Form 8-K dated March 5, 1996.\nSIGNATURES\nPursuant to the requirements of Section 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHWEST GAS CORPORATION\nBy MICHAEL O. MAFFIE ------------------------------------ Michael O. Maffie, President (Chief Executive Officer)\nDate: March 26, 1996\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSIGNATURES\nPursuant to the requirements of Section 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nGLOSSARY OF TERMS\nEXHIBIT INDEX","section_15":""}
{"filename":"718449_1995.txt","cik":"718449","year":"1995","section_1":"Item 1. BUSINESS\nTBC Corporation's business began in 1956 under the name Cordovan Associates, Incorporated. The present company was incorporated in Delaware in 1970 under the name THE Tire & Battery Corporation. In 1983, the Company changed its name to TBC Corporation.\nThe Company and its wholly-owned subsidiaries are principally engaged in the business of distributing products in the automotive replacement market. Unless the context indicates otherwise, the term \"Company\" refers to TBC Corporation and its subsidiaries.\nProducts\nThe Company's products are made by leading manufacturers and include tires, batteries, tubes, wheels, ride-control products, filters, brake parts, chassis parts, automotive service equipment and other products. Gross margin percentages on sales of tires and non-tire products do not differ significantly. Substantially all of the Company's products carry the Company's proprietary brand names.\nThe Company's Cordovan, Multi-Mile and Sigma brand lines of tires are three of the most complete lines in the replacement tire market, including tires for passenger, truck, farm, industrial, recreational and other applications. Sales of tires accounted for approximately 89% of the Company's total sales in 1995 and 1994 and 88% in 1993. The Company believes it is the largest independent wholesale distributor of replacement tires in the United States.\nOther brands under which the Company's products are marketed include Grand Prix, Grand Am, Grand Spirit, Wild Spirit, Grand Sport, Aqua-Flow, Power King, Harvest King, and Astro-Lite .\nMarketing and Distribution\nThe Company distributes its products other than those sold through its Battery Associates, Inc. subsidiary (\"TBC products\") through a network of distributors in the United States, Canada and Mexico. Some of these distributors act as wholesalers, some operate retail outlets, and some function as both wholesalers and retailers. The loss of any major distributor of TBC products could have a material adverse effect upon the Company's business pending the Company's establishment of a replacement distributor.\nThrough its distributors and their customers, the Company estimates that TBC products are sold by over 20,000 retail outlets. The retail outlets handling TBC products consist primarily of independent tire dealers.\nBattery Associates, Inc. distributes batteries and related products for automobiles, trucks, motorcycles and other uses through its own nationwide distribution network of wholesale and retail distributors.\nMajor Customers\nThe Company's ten largest distributors accounted for 51% of the Company's gross sales in 1995. Sales to Carroll's, Inc., Hapeville, Georgia, excluding sales to distributors which operate under arrangements with and may pay compensation to Carroll's, represented 15% of the Company's gross sales in 1995. No distributor other than Carroll's individually accounted for more than 10% of the Company's 1995 gross sales. See Item 13 of this Report for additional information concerning major customers.\nSuppliers\nThe Company purchases its products, in finished form, from a number of major rubber companies, battery manufacturers and other suppliers to the automotive replacement market. The Company owns the brand names under which most of its products are sold and, in the case of tires, many of the molds in which they are made. The Company has not heretofore experienced any difficulty in purchasing products in quantities needed by it, but there can be no assurance that such difficulties will not be encountered in the future.\nThe Kelly-Springfield Tire Company, a division of Goodyear Tire and Rubber Company, has been a supplier to the Company since 1963. Kelly- Springfield manufactured more than half of the tires purchased by the Company in 1995, pursuant to a supply agreement entered into in 1977 and a 10-year commitment signed in 1994. The Company also has written contracts with certain other suppliers.\nTrademarks\nSubstantially all of the Company's products carry the Company's own brand names.\nThe ability to offer products under recognized trademarks represents an important marketing advantage in the automotive replacement industry, and the Company regards its trademarks as valuable assets of its business. The Company holds federal registrations for substantially all of its trademarks.\nSeasonality and Inventory\nThe Company normally experiences its highest level of sales in the second and third quarters of each year, with the first quarter exhibiting the lowest level. Since 1991, first quarter sales have represented, on the average, approximately 22% of annual sales; the second and third quarters approximately 26% and 28%, respectively; and the fourth quarter approximately 24%. The Company's inventories generally fluctuate with anticipated seasonal sales volume.\nOrders for the Company's products are usually placed with the Company by computer transmission, facsimile or telephone. Orders for TBC products are filled either out of the Company's inventory or by direct shipment to the customer from the manufacturers' plants at TBC's request. Sales made by Battery Associates to its distributors are made by direct shipments to customers from the manufacturers' plants at Battery Associates' request.\nSince distributors look to the Company to fulfill their needs on short notice, the Company maintains a large inventory of products. The average of beginning and end-of-year inventories was $44,600,000 in 1995. The Company's inventory turn rate (cost of sales, including the cost of direct shipments from manufacturers to distributors, divided by average inventory) was 10.9 for 1995.\nCompetition\nThe industry in which the Company operates is highly competitive, and many of the Company's competitors are significantly larger and have greater financial and other resources than the Company. The Company's direct competitors at its level of distribution are the manufacturers, including its own suppliers, and independent distributors of the products it sells. Indirectly, the Company also competes against tire company stores, chain and department stores, warehouse clubs, oil companies and automotive product retailers, since retailers selling the Company's products must compete against the products offered by other retailers. The Company believes it is able to compete successfully in its industry because of its ability to offer quality products under its proprietary brand names, its efficient distribution systems, and its good relationships with its distributors and suppliers.\nEmployees\nAs of December 31, 1995, the Company employed 271 persons. The Company considers its employee relations to be satisfactory. The Company's employees are not currently represented by a union.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's executive offices and warehouse distribution facilities, which total approximately 1,300,000 square feet under roof, are located in Memphis, Tennessee. The Company owns the office building and one of its warehouses. One warehouse is leased under an agreement expiring in 2005 and two other warehouses are leased under agreements expiring in 2000. Battery Associates, Inc. owns its facilities, which are also located in Memphis. The Company's Northern States Tire, Inc. subsidiary owns facilities in New Hampshire, Vermont and Maine and leases distribution facilities in Massachusetts.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is a defendant in a number of personal injury lawsuits based upon alleged defects in products sold by the Company. Such actions are commonplace in the automotive replacement business, particularly with respect to tires. The Company believes that in substantially all such cases it is covered by its manufacturers' indemnity agreements or their product liability insurance. The Company also maintains its own product liability insurance.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table presents certain information concerning the executive officers of the Company. The term of office of all executive officers of the Company is until the next Annual Meeting of Directors (April 25, 1996) or until their respective successors are elected.\nCapacities in which Individual Serves Name Age the Company\nLouis S. DiPasqua 61 President and Chief Executive Officer\nKenneth P. Dick 49 Senior Vice President Sales\nBob M. Hubbard 61 Senior Vice President Purchasing and Engineering\nRonald E. McCollough 55 Senior Vice President Operations\nLarry D. Coley 38 Vice President and Controller\nCharles B. Quinn, Jr. 47 Vice President and Treasurer\nMr. DiPasqua has been Chief Executive Officer since July 1994, and President since joining the Company in 1991. Mr. DiPasqua has been a director since 1991 and served as the Company's Chief Operating Officer from 1991 until July 1994. From 1989 until 1991, Mr. DiPasqua was Vice President, Replacement Tire Sales and Marketing for the Goodyear Tire & Rubber Company and prior to that was President and Chief Executive Officer of Kelly Springfield Tire Company, a division of Goodyear. From 1984 to 1988, Mr. DiPasqua was Chairman and Managing Director of Goodyear Great Britain.\nMr. Dick has served as Senior Vice President Sales of the Company since 1988. From 1982 until his election as Senior Vice President Sales, Mr. Dick served as Vice President Sales of the Company. Mr. Dick joined the Company in 1971, and from 1980 until 1982, served as Sales Manager of the Company.\nMr. Hubbard was elected Senior Vice President Purchasing and Engineering of the Company in 1982. From 1973 until his election as a Senior Vice President, Mr. Hubbard was Vice President Purchasing and Quality Assurance of the Company.\nMr. McCollough has been Senior Vice President Operations of the Company since 1982 and served as Controller of the Company from 1973 to 1985. From 1978 until his election as a Senior Vice President, Mr. McCollough was also Vice President Operations of the Company.\nMr. Coley has been a Vice President of the Company since 1993 and the Controller of the Company since 1989. Prior to that, Mr. Coley was the Company's Manager of Financial Reporting.\nMr. Quinn has been a Vice President of the Company since 1982 and the Treasurer of the Company since 1980.\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 Nasdaq Stock Market under the symbol TBCC. As of December 31, 1995, the Company had approximately 6,100 stockholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings. The Company did not declare any cash dividends during 1995 or 1994.\nThe following table sets forth for the periods indicated the high and low sale prices for the Company's Common Stock as reported by the Nasdaq National Market.\nPrice Range\nHigh Low Quarter ended\n03\/31\/94............ 13.88 11.25\n06\/30\/94............ 13.50 11.50\n09\/30\/94............ 11.75 9.38\n12\/31\/94............ 10.25 8.50\n03\/31\/95............ 10.50 8.75\n06\/30\/95............ 11.75 10.00\n09\/30\/95............ 11.00 8.88\n12\/31\/95............ 9.75 6.63\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSet forth below is selected financial information of the Company for each year in the five-year period ended December 31, 1995. The selected financial information should be read in conjunction with the consolidated financial statements of the Company and notes thereto which appear elsewhere in this Report. The Company did not declare any cash dividends during the five-year period ended December 31, 1995.\nYear ended December 31,\n1995 1994 1993 1992 1991 INCOME STATEMENT DATA (1):\nNet sales ............. $536,122 $551,920 $568,700 $569,508 $499,469\nNet income ............ 15,249 19,546 21,375 22,474 17,667\nEarnings per share (2). .62 .71 .74 .76 .59\nAverage shares and equivalents outstanding (2).... 24,683 27,683 28,945 29,584 30,106\nBALANCE SHEET\nDATA (1):\nTotal assets .......... $179,952 $169,682 $166,746 $176,859 $135,284\nWorking capital ....... 76,600 91,279 95,114 80,630 71,959\nLong-term debt ........ 555 - - - -\nStockholders' equity .. 104,823 113,983 116,550 102,960 90,370\n(1) In thousands except per share amounts.\n(2) Reflects 3-for-2 stock splits effective November 15, 1991 and December 11, 1992.\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:\nNet sales for 1995 decreased 2.9% from the 1994 level, due principally to a 3.1% decline in tire sales. Sales of tires accounted for approximately 89% of total sales in both 1995 and 1994. Unit tire shipments decreased 6.5% from the year-earlier level, reflecting increased competitive pressures and sluggishness in the replacement tire market during 1995. Partially offsetting the lower unit volume was a 3.7% increase in the average tire sales price, primarily related to the effect of industry price increases since the beginning of 1994.\nCost of sales as a percentage of net sales increased from 90.6% in 1994 to 91.2% in 1995. The fluctuation was due to the combined effects of the above-noted competitive pressures and a shift in the Company's sales toward shipments direct from manufacturers rather than through the Company's distribution facilities. Margins on shipments direct from manufacturers are typically lower than through the Company's own facilities.\nDistribution expenses were relatively unchanged in the current year compared to the year-earlier level.\nSelling and administrative expenses declined slightly in 1995 due to the recognition in 1994 of a charge of $2.5 million for supplemental retirement benefits. Excluding that charge, selling and administrative expenses increased principally due to the addition of facilities in the northeastern United States in 1995, higher pension costs and increased selling expenses.\nNet other income\/expense shifted from net other income of $1.8 million in 1994 to net other expense of $520,000 in 1995. The fluctuation was due primarily to increased interest expenses associated with higher bank borrowing levels and interest rates than in 1994. The increase in average bank borrowings in 1995 was largely related to repurchases of common stock and higher inventory levels during the year.\n1994 Compared to 1993:\nNet sales for 1994 were $551.9 million, a 3.0% decrease from 1993 net sales of $568.7 million. Sales of tires accounted for approximately 89% of total sales in 1994 compared to 88% in 1993. Tire sales declined 1.5%, the result of a 1.7% decrease in unit tire shipments partially offset by a 0.2% increase in the average tire sales price. The reduction in sales of non-tire products was primarily due to lower unit shipments of batteries.\nCost of sales as a percentage of net sales increased from 90.4% in 1993 to 90.6% in 1994, due to higher net product costs from suppliers and an increase in shipments direct from manufacturers rather than through the Company's distribution facilities.\nDistribution expenses decreased 9.2% in 1994 compared to 1993, due principally to decreases in labor and related costs.\nSelling and administrative expenses increased from the 1993 level, due primarily to charges of $2.5 million for supplemental retirement benefits. See Note 6 to the consolidated financial statements.\nNet other income was higher in 1994 than in 1993, due primarily to decreased interest expenses associated with lower bank borrowings.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial position and liquidity are strong. At December 31, 1995, working capital totaled $76.6 million and the current ratio was 2.04. At the end of 1994, working capital was $91.3 million and the Company's current ratio was 2.66.\nThe Company has arrangements for short-term borrowings totaling $73.0 million. At December 31, 1995, borrowings under these arrangements totaled $50.8 million. Capital expenditures totaled $9.2 million in 1995, which included the purchase of certain distribution facilities and equipment in the northeastern United States and expenditures of $4.2 million for tire molds. This was compared to capital expenditures of $3.6 million in 1994, principally for tire molds. The Company expects to fund 1996 day-to-day operating expenses and normally recurring capital expenditures out of operating funds and its present financial resources. The Company had no material commitments for capital expenditures at the end of 1995.\nCash generated by operations, together with the available credit arrangements, enabled the Company to fund stock repurchases totaling $24.6 million in 1995 and $22.3 million in 1994, as well as the above-mentioned capital expenditures. The latest repurchase plans, approved by the Board of Directors in 1995, authorized the repurchase of a total of 2,500,000 shares of common stock in market and other transactions, of which approximately 1,285,000 shares had been repurchased as of the end of 1995.\nIncluded in other assets at December 31, 1995 and 1994 is a promissory note receivable of $4,897,000 from a former distributor. (See Note 4 to the Consolidated Financial Statements for a discussion of the legal proceedings relative to that receivable.) Other assets increased $1.9 million during 1995, due primarily to investments by the Company in a Mexican joint venture and a domestic import\/export joint venture.\nAccounts payable decreased from $20.8 million at December 31, 1994 to $10.1 million at the end of 1995, as the Company took advantage of certain early payment terms from suppliers which were not offered at the end of 1994.\nNotes payable to banks increased from $25.8 million at December 31, 1994 to $50.8 million at December 31, 1995. This increase was due to the above-noted early payment of accounts payable, as well as increased inventories and the aforementioned capital expenditures and stock repurchases during 1995.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary financial information required by this Item 8 are included on the following 12 pages of this Report.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholders TBC Corporation\nWe have audited the accompanying consolidated balance sheets of TBC 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 consolidated financial position of TBC 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.\nMemphis, Tennessee January 26, 1996\nTBC CORPORATION\nCONSOLIDATED BALANCE SHEETS\n(In thousands)\nASSETS\nDecember 31,\n1995 1994\nCURRENT ASSETS\nAccounts and notes receivable, less allowance for doubtful accounts of $8,014 in 1995 and $7,069 in 1994: Related parties $ 17,208 $ 13,557 Other 78,330 88,221\nTotal accounts and notes receivable 95,538 101,778\nInventories 49,538 39,754 Refundable federal and state income taxes 472 383 Deferred federal income taxes 2,389 1,928 Other current assets 2,252 2,482\nTotal current assets 150,189 146,325\nPROPERTY, PLANT AND EQUIPMENT, AT COST\nLand and improvements 2,572 1,560 Buildings 10,985 8,438 Equipment 20,324 16,943 Furniture and fixtures 2,381 2,101 Leasehold improvements 600 600 36,862 29,642 Less accumulated depreciation 17,714 15,020\nTotal property, plant and equipment 19,148 14,622\nOTHER ASSETS 10,615 8,735\nTOTAL ASSETS $179,952 $169,682\nThe accompanying notes are an integral part of the financial statements.\nTBC CORPORATION\nCONSOLIDATED BALANCE SHEETS\n(In thousands)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nDecember 31,\n1995 1994\nCURRENT LIABILITIES\nOutstanding checks, net $ 8,120 $ 4,257\nNotes payable to banks 50,838 25,780\nCurrent portion of long-term debt 81 -\nAccounts payable, trade 10,117 20,763\nOther current liabilities 4,433 4,246\nTotal current liabilities 73,589 55,046\nLONG-TERM DEBT, LESS CURRENT PORTION 555 -\nNONCURRENT LIABILITIES 985 653\nSTOCKHOLDERS' EQUITY\nCommon stock, $.10 par value, shares issued and outstanding - 23,784 in 1995 and 26,282 in 1994 2,378 2,628\nAdditional paid-in capital 9,543 10,391\nRetained earnings 92,902 100,964\nTotal stockholders' equity 104,823 113,983\nTOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $179,952 $169,682\nThe accompanying notes are an integral part of the financial statements.\nTBC CORPORATION\nCONSOLIDATED STATEMENTS OF INCOME\n(In thousands, except per share amounts)\nYears ended December 31,\n1995 1994 1993\nNET SALES* $536,122 $551,920 $568,700\nCOSTS AND EXPENSES\nCost of sales 488,717 500,085 514,174 Distribution 8,040 8,010 8,825 Selling and administrative 14,073 14,158 11,991 Other (income) expense - net 520 (1,764) (915)\nTotal costs and expenses 511,350 520,489 534,075\nINCOME BEFORE INCOME TAXES 24,772 31,431 34,625\nPROVISION FOR INCOME TAXES 9,523 11,885 13,250\nNET INCOME $ 15,249 $ 19,546 $ 21,375\nEarnings per share $ .62 $ .71 $ .74\nWeighted average number of shares and equivalents outstanding 24,683 27,683 28,945\n* Including sales to related parties of $130,215, $135,786 and $140,343 in the years ended December 31, 1995, 1994 and 1993, respectively.\nThe accompanying notes are an integral part of the financial statements.\nTBC CORPORATION\nCONSOLIDATED STATEMENTS OF\nSTOCKHOLDERS' EQUITY\n(In thousands)\nYears ended December 31, 1993, 1994 and 1995\nCommon Stock Additional Number of Paid-In Retained Shares Amount Capital Earnings Total\nBALANCE, JANUARY 1, 1993 29,032 $2,903 $10,593 $89,464 $102,960\nNet income for year 21,375 21,375\nIssuance of common stock under stock option and incentive plans 48 5 713 - 718\nRepurchase and retirement of common stock (703) (70) (272) (8,183) (8,525)\nTax benefit from exercise of stock options - - 22 - 22\nBALANCE, DECEMBER 31, 1993 28,377 2,838 11,056 102,656 116,550\nNet income for year 19,546 19,546\nIssuance of common stock under stock option and incentive plans 20 2 131 - 133\nRepurchase and retirement of common stock (2,115) (212) (837) (21,238) (22,287)\nTax benefit from exercise of stock options - - 41 - 41\nBALANCE, DECEMBER 31, 1994 26,282 2,628 10,391 100,964 113,983\nNet income for year 15,249 15,249\nIssuance of common stock under stock option and incentive plans, net 19 2 132 - 134\nRepurchase and retirement of common stock (2,517) (252) (1,002) (23,311) (24,565)\nTax benefit from exercise of stock options - - 22 - 22\nBALANCE, DECEMBER 31, 1995 23,784 $2,378 $ 9,543 $ 92,902 $104,823\nThe accompanying notes are an integral part of the financial statements.\nTBC CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(In thousands)\nYears ended December 31, 1995 1994 1993 Operating Activities: Net income $ 15,249 $ 19,546 $ 21,375\nAdjustments to reconcile net income to net cash provided by operating activities: Depreciation 4,612 4,012 3,838 Amortization 23 86 105 Deferred federal income taxes (461) 238 839 Changes in operating assets and liabilities: Receivables 6,179 (6,270) 1,981 Inventories (9,784) 3,559 4,768 Other current assets 230 (601) (240) Other assets (280) (375) - Outstanding checks, net 3,863 3,276 981 Accounts payable, trade (10,646) 2,281 (13,674) Federal and state income taxes refundable or payable (67) (426) (771) Other current liabilities 187 (312) (2,694) Noncurrent liabilities 332 653 -\nNet cash provided by operating activities 9,437 25,667 16,508\nInvesting Activities: Purchase of property, plant and equipment (9,151) (3,580) (3,078) Investments in joint ventures (1,562) - - Other 13 378 29\nNet cash used in investing activities (10,700) (3,202) (3,049) Financing Activities: Net bank borrowings (repayments) under short-term borrowing arrangements 25,058 (311) (7,523) Net increase in long-term debt 636 - - Issuance of common stock under stock option and incentive plans, net of repurchase 134 133 718 Repurchase and retirement of common stock (24,565) (22,287) (8,525)\nNet cash provided by (used in) financing activities 1,263 (22,465) (15,330)\nDecrease in cash and cash equivalents - - (1,871)\nCash and cash equivalents: Balance - Beginning of year - - 1,871\nBalance - End of year $ - $ - $ -\nSupplemental Disclosures of Cash Flow Information: Cash paid for - Interest $ 2,956 $ 1,324 $ 1,844 - Income Taxes 10,051 12,073 13,182\nSupplemental Disclosure of Non-Cash Financing Activity: Tax benefit from exercise of stock options $ 22 $ 41 $ 22\nThe accompanying notes are an integral part of the financial statements.\nTBC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation - The accompanying financial statements include the accounts of TBC Corporation and its subsidiaries, all of which are wholly-owned. All significant intercompany 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, liabilities, revenues and expenses, as well as certain financial statement disclosures.\nCash equivalents - Cash equivalents consist of short-term, highly liquid investments which are readily convertible into cash.\nInventories - Inventories, consisting of automotive products held for resale, are valued at the lower of cost (principally last in-first out) or market. Current costs of inventories exceeded the LIFO value by $6,863,000 and $5,746,000 at December 31, 1995 and 1994, respectively.\nRevenue recognition - Sales are recognized upon shipment of products. Estimated costs of returns and allowances are accrued at the time products are shipped.\nInterest on early payments to suppliers for product - Interest income associated with early payments to suppliers for product is recorded as a reduction of product cost. The portion of this interest which was included in the statements of income as a reduction to cost of sales represented 1.59% of net sales in 1995, 1.44% in 1994 and 1.45% in 1993.\nConcentrations of credit risk - The Company sells its products to distributors in the automotive replacement market. The Company performs ongoing credit evaluations of its customers and typically requires some form of security, including collateral, guarantees or other documentation. The Company maintains allowances for potential credit losses. The Company maintains cash balances with financial institutions who maintain high credit ratings. The Company has not experienced any losses with respect to bank balances in excess of government-provided insurance.\nProperty, plant and equipment - Depreciation is computed on the straight-line method over 3-20 years. Amounts expended for maintenance and repairs are charged to operations, and expenditures for major renewals and betterments are capitalized. When property, plant and equipment is retired or otherwise disposed of, the related gain or loss is included in operations.\nIncome taxes - In 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Accordingly, the Company follows the liability approach of accounting for income taxes as prescribed by SFAS No. 109. Prior to 1993, the Company used the deferred method of accounting for income taxes. The cumulative effect of applying SFAS No. 109 was not material.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n1. SIGNIFICANT ACCOUNTING POLICIES (Continued)\nStandard warranty - The costs of anticipated adjustments for defective workmanship and materials that are the responsibility of the Company are estimated and charged to expense currently.\nEarnings per share - Earnings per share have been computed by dividing net income by the weighted average number of shares of common stock and equivalents outstanding. Common stock equivalents included in the computation represent shares issuable upon assumed exercise of stock options, which would have a dilutive effect in the respective years. Fully diluted earnings per share did not significantly differ from primary earnings per share in the years presented.\nRecently-issued pronouncements - Statement of Financial Accounting Standards No. 121, \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of\", was issued in March 1995. Adoption of this statement, which established accounting standards for long-lived assets and certain intangible assets beginning in 1996, is not expected to have a material impact on the Company's consolidated financial statements.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", was issued in October 1995. This statement encourages companies to recognize stock-based compensation using new fair value accounting rules and requires companies not adopting such rules to make certain financial disclosures, beginning in 1996. The company does not expect to change its expense recognition policies as a result of this pronouncement but plans to adopt the required disclosure provisions.\n2. RELATED PARTY TRANSACTIONS\nThe Company's operations, consisting of the distribution of products for the automotive replacement market, are managed through the Board of Directors, members of which owned or are affiliated with companies which owned approximately 9% of the Company's common stock at December 31, 1995. Sales to distributors represented on the Board, including affiliates of such distributors, accounted for approximately 24% of the Company's net sales during 1995 and 25% in 1994 and 1993. One distributor accounted for approximately 15% of net sales in 1995 and 16% in 1994 and 1993. Sales to joint ventures in which the Company has an ownership interest accounted for approximately 1% of the Company's 1995 net sales. Accounts receivable resulting from transactions with related parties are presented separately in the balance sheets.\n3. SHORT-TERM FINANCING AGREEMENTS\nThe Company has lines of credit for short-term borrowings totaling $53,000,000, bearing interest at a negotiated rate not to exceed prime. In addition, the Company may borrow up to $20,000,000 under a bank revolving loan. The unused amount under these arrangements at December 31, 1995 was $22,162,000. The weighted average interest rate on short-term borrowings at December 31, 1995 and 1994 was 6.80% and 7.23%, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n4. OTHER ASSETS\nOther assets consist of the following (in thousands):\nDecember 31,\n1995 1994\nNotes receivable $ 7,961 $7,900 Investments in joint ventures 1,562 - Intangible assets, net of amortization 1,058 835 Other 34 -\n$10,615 $8,735\nThe notes receivable totals include a note for $4,897,000 from a former distributor. The maker of the note was discharged in a proceeding under Chapter 11 of the Bankruptcy Code in 1991. The Company received distributions totaling $308,000 from the bankruptcy proceeding. The Company holds written guarantees of the distributor's account, absolute and continuing in form, signed by the principal former owners and officers of the distributor and their wives, upon which the Company filed suit in 1989. The defendants have pleaded various defenses based on, among other things, an alleged oral cancellation of the guarantees. The defendants have also filed a third party complaint against the Company's former chief executive officer in which they claim the right to recover against him for any liability they may have to the Company. The Company believes, on the basis of applicable Tennessee law, that those defenses are invalid and that there is no merit to the third-party complaint. In October 1994, the Court granted the Company's motion to exclude evidence of any oral cancellation of the guarantees. The Court's order has been appealed and no date for trial has been scheduled. The Company knows of no reason to believe that the defendants will be unable to pay any judgment that may be entered against them in the action.\n5. INCOME TAXES\nIncome taxes provided for the years ended December 31, 1995, 1994 and 1993 were as follows (in thousands):\n1995 1994 1993 Current: Federal $ 8,868 $10,349 $11,095 State 1,116 1,298 1,316 9,984 11,647 12,411 Deferred - Federal (461) 238 839\n$ 9,523 $11,885 $13,250\nThe provision for deferred income taxes is based on the liability method prescribed by Statement of Financial Accounting Standards No. 109 and represents the change in the Company's deferred income tax asset during the year, including the effect of enacted tax rate changes. Deferred income taxes arise from temporary differences between the tax basis of the Company's assets and liabilities and\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n5. INCOME TAXES (Continued)\ntheir reported amounts in the financial statements. The net deferred income tax assets in the financial statements at December 31, 1995, 1994 and 1993 included approximately $2,762,000, $2,474,000 and $2,740,000, respectively, related to the allowance for doubtful accounts and notes.\nThe difference between the Company's effective income tax rate and the statutory U. S. Federal income tax rate is reconciled as follows:\n1995 1994 1993\nStatutory U.S. Federal rate 35.0% 35.0% 35.0% State income taxes 2.9 2.7 2.5 Other .5 .1 .8 Effective tax rate 38.4% 37.8% 38.3%\n6. RETIREMENT PLANS\nThe Company has a defined benefit pension plan covering the majority of its employees. The benefits are based on years of service and the employee's final compensation. The Company's present funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. This amount is computed using a different actuarial cost method and different assumptions from those used for financial reporting purposes.\nThe following table sets forth the defined benefit pension plan's funded status and amounts recognized in the Company's balance sheets (in thousands): December 31,\n1995 1994 Actuarial present value of accumulated benefit obligations, including vested benefits of $2,850 in 1995 and $2,863 in 1994 $(3,325) $(3,202)\nActuarial present value of projected benefit obligations for service rendered to date $(5,053) $(4,553)\nPlan assets at fair value, primarily listed stocks and U.S. bonds 5,695 5,247\nPlan assets over projected benefit obligation 642 694 Unrecognized net loss from experience different from that assumed 1,357 1,485\nUnrecognized net assets at January 1, 1995 and 1994, being recognized over 15.53 years (91) (108)\nUnrecognized prior service cost 133 170\nPrepaid pension cost $ 2,041 $ 2,241\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n6. RETIREMENT PLANS (Continued)\nThe net expense for the defined benefit pension plan for 1995, 1994 and 1993 included the following (in thousands):\n1995 1994 1993\nService cost $ 274 $ 319 $ 289 Interest cost 349 375 356 Return on plan assets (757) (2) (862) Net amortization and deferral 616 (633) 291\n$ 482 $ 59 $ 74\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the 1995 actuarial present value of the projected benefit obligation were 7.25% and 5%, respectively. The expected long-term rate of return on assets was 10%.\nThe Company also has an unfunded supplemental retirement plan for certain of its executive officers, to provide benefits in excess of amounts permitted to be paid by its defined benefit pension plan under current tax law. In addition, supplemental retirement provisions are included in the employment agreement of the Company's President and Chief Executive Officer and were included in the former Chief Executive Officer's employment agreement. During 1994, the Company determined that expenses should be recorded under these arrangements, and that the accumulated benefit obligation, which was previously unaccrued, should be reflected as a liability in the consolidated balance sheets until paid. As a result, expenses for 1994 included supplemental retirement charges of $2,548,000. Expenses in 1995 included supplemental retirement charges of $199,000. At December 31, 1995, the projected benefit obligation was $1,048,000 and the accumulated benefit obligation, which was reflected as a noncurrent liability, totaled $985,000.\nIn 1994, the Company adopted an employee savings plan under Section 401(k) of the Internal Revenue Code, covering the majority of its employees. Contributions made by the Company to the 401(k) plan are based on a specified percentage of employee contributions. Expenses recorded in 1995 and 1994 for the Company's contributions totaled $62,000 and $39,000, respectively.\n7. STOCKHOLDERS' EQUITY\nThe Company is authorized to issue 50,000,000 shares of $.10 par value common stock. In addition, 2,500,000 shares of $.10 par value preferred stock are authorized, none of which were outstanding at December 31, 1995 or 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n7. STOCKHOLDERS' EQUITY (Continued)\nThe Company has a 1983 stock option plan (\"1983 Plan\") and a 1989 stock incentive plan (\"1989 Plan\"). The 1989 Plan effectively replaced the 1983 Plan; however, all options and stock appreciation rights outstanding under the 1983 Plan remain in full force and effect. The 1989 Plan provides for the grant of options to purchase shares of the Company's common stock to officers and other key employees of the Company upon terms and conditions determined by a committee of the Board of Directors. The committee may also grant stock appreciation rights, either singly or in tandem with stock options, which entitle the holder to benefit from market appreciation in the Company's common stock without requiring any payment on the part of the holder.\nThe 1989 Plan also authorizes the committee to grant performance awards and restricted stock awards to officers and other key employees. Additionally, the 1989 Plan provides for the annual grant of restricted stock with a market value of $5,000 to each non-employee director of the Company. Each of these shares of restricted stock is accompanied by four options, which are only exercisable under certain conditions and the exercise of which results in the forfeiture of the associated share of restricted stock. The options expire in one-third increments as the associated restricted stock vests. Such tandem options are not included in the totals shown below for outstanding options.\nAt December 31, 1994, the Company had options for 438,540 shares outstanding, with exercise prices equal to market value on the date of grant, ranging from $1.48 to $12.13 per share. Options for 119,325 shares were granted in 1995, with an exercise price equal to market value of $9.69 per share. Options for 37,918 shares were exercised in 1995 at prices ranging from $1.48 to $8.00 per share, and options for 6,604 shares were forfeited. At December 31, 1995, options for 513,343 shares were outstanding with exercise prices ranging from $1.48 to $12.13 per share. Stock appreciation rights for options on 38,280 and 63,280 shares were outstanding at December 31, 1995 and 1994, respectively. Amounts included in the statements of income relating to stock appreciation rights included a charge of $23,000 in 1995 and credits of $198,000 in 1994 and $162,000 in 1993.\nThe Company has a Stockholder Rights Plan whereby outstanding shares of the Company's common stock are accompanied by preferred stock purchase rights. The rights become exercisable ten days after either a person or group has acquired 20% or more of the Company's common stock or the commencement of a tender offer which would result in the offeror's ownership of 30% or more of TBC's common stock. Under defined circumstances, the rights allow TBC stockholders to purchase stock in either the Company or an acquiring company at a price less than the market price. The rights expire on July 31, 1998 unless redeemed at an earlier date.\nIn 1995 and 1994, shares of the Company's common stock were repurchased and retired under plans approved by the Board of Directors. The latest plans, approved in 1995, authorized the repurchase of 2,500,000 shares in market and other transactions. As of December 31, 1995, approximately 1,285,000 shares had been repurchased under these plans.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n8. LEASES\nRental expense of $2,069,000, $2,160,000 and $2,149,000 was charged to operations in 1995, 1994 and 1993, respectively. Minimum noncancelable real property lease commitments at December 31, 1995, were as follows (in thousands):\nYear Amount\n1996 2,004 1997 2,144 1998 1,179 1999 1,179 2000 1,180 Thereafter through 2005 4,914\n$12,600\nThe commitments relate substantially to distribution facilities in Memphis, Tennessee. In addition to the above rental payments, the Company is obligated in some instances to pay real estate taxes, insurance and certain maintenance.\nSUPPLEMENTARY DATA:\nQUARTERLY FINANCIAL INFORMATION\nUnaudited quarterly results for 1995 and 1994 are summarized as follows:\n(In thousands, except per share amounts)\nFirst Second Third Fourth Quarter Quarter Quarter Quarter\nNet sales $130,343 $132,223 $147,171 $126,385 Cost of sales 118,432 120,270 135,253 114,762 Net income 4,276 4,035 3,870 3,068 Earnings per share $ .17 $ .16 $ .16 $ .13\nNet sales $133,780 $132,925 $157,513 $127,702 Cost of sales 120,963 119,988 143,929 115,205 Net income 5,086 3,603 5,664 5,193 Earnings per share* $ .18 $ .13 $ .21 $ .20\n* The total of earnings per share for each of the quarters of 1994 does not equal earnings per share for the year ended December 31, 1994, due to the decrease in average shares outstanding.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nExcept for information concerning executive officers of the Company which is set forth in Part I of this Report, the information required by this Item 10 is set forth in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held April 25, 1996, and is incorporated herein by this reference.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is set forth in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held April 25, 1996, and, with the exception of the information disclosed in the Proxy Statement pursuant to Item 402(k) or 402(l) of Regulation S-K, is incorporated herein by this 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 in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held April 25, 1996, and is incorporated herein by this reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is set forth in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held April 25, 1996, and is incorporated herein by this reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) FINANCIAL STATEMENTS\nThe following items, including consolidated financial statements of the Company, are set forth at Item 8 of this Report:\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - December 31, 1995, and 1994\nConsolidated Statements of Income - 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(a) (2) FINANCIAL STATEMENT SCHEDULES\nReport of Independent Certified Public Accountants (at p. 30 of this Report)\nSchedule VIII - Valuation and qualifying accounts (at p. 31 of this Report)\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) EXHIBITS\nSee INDEX to EXHIBITS included at p. 32 of this Report\n(b) REPORTS ON FORM 8-K\nThe Company 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, TBC Corporation has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Memphis, Tennessee, on this 2nd day of February, 1996.\nTBC CORPORATION\nBy: \/s\/ LOUIS S. DiPASQUA Louis S. DiPasqua 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 TBC Corporation and in the capacities and on the dates indicated:\nName Title Date\n\/s\/ LOUIS S. DiPASQUA President, Chief February 2, 1996 Louis S. DiPasqua Executive Officer and Director\n\/s\/ RONALD E. McCOLLOUGH Senior Vice President February 2, 1996 Ronald E. McCollough Operations (principal accounting and financial officer)\n* MARVIN E. BRUCE Chairman of the Board February 2, 1996 Marvin E. Bruce of Directors\nDirector February , 1996 Robert E. Carroll, Jr.\nDirector February , 1996 Robert H. Dunlap\n* STANLEY A. FREEDMAN Director February 2, 1996 Stanley A. Freedman\nDirector February , 1996 Dwain W. Higginbotham\n* RICHARD A. McSTAY Director February 2, 1996 Richard A. McStay\n* ROBERT M. O'HARA Director February 2, 1996 Robert M. O'Hara\n* ROBERT R. SCHOEBERL Director February 2, 1996 Robert R. Schoeberl\n* NICHOLAS F. TAUBMAN Director February 2, 1996 Nicholas F. Taubman\n* The undersigned by signing his name hereto does sign and execute this Report on Form 10-K on behalf of each of the above-named directors of TBC Corporation pursuant to a power of attorney executed by each such director and filed with the Securities and Exchange Commission as an exhibit to this Report.\n\/s\/ LOUIS S. DiPASQUA Louis S. DiPasqua Attorney-in-Fact\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholders TBC Corporation\nOur report on the consolidated financial statements of TBC Corporation and Subsidiaries is included on page 13 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 at 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.\nMemphis, Tennessee January 26, 1996\nTBC CORPORATION\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(In thousands)\nAdditions Charged Charged to Costs to Balance and Other Balance January 1, Expenses Accounts Deductions December 31,\nWarranty reserve...... $ 975 $1,591 - $1,564 (1) $1,002\nAllowance for doubtful accounts..... 7,069 1,546 123 724 (2) 8,014\nWarranty reserve...... 861 1,643 - 1,529 (1) 975\nAllowance for doubtful accounts..... 7,828 1,320 - 2,079 (2) 7,069\nWarranty reserve...... 755 1,466 - 1,360 (1) 861\nAllowance for doubtful accounts..... 7,066 1,453 - 691 (2) 7,828\n(1) Amounts paid during current year and payable at year end less amount payable at beginning of year.\n(2) Accounts written off during year.\nINDEX TO EXHIBITS\nLocated at Manually Numbered Page\n(3) ARTICLES OF INCORPORATION AND BY-LAWS:\n3.1 Certificate of Incorporation of TBC Corporation, as amended April 29, 1988, was filed as Exhibit 3.1 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1994 ..... *\n3.2 Amendment to Restated Certificate of Incorporation of TBC Corporation dated April 23, 1992, was filed as Exhibit 3.2 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .. *\n3.3 By-Laws of TBC Corporation as amended January 13, 1988, were filed as Exhibit 3.3 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1993 ............... *\n3.4 Amendment to By-Laws of TBC Corporation dated January 6, 1993 was filed as Exhibit 3.4 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .................. *\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES:\n4.1 Amended and Restated Promissory Note, dated June 30, 1993 from TBC Corporation to First Tennessee Bank National Association, for $15,000,000 line of credit, was filed as Exhibit 4.1 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1993 .. *\n4.2 Modification and Extension Agreement, dated June 30, 1995 between TBC Corporation and First Tennessee Bank National Association, regarding the $15,000,000 line of credit ...................... 38\n4.3 Promissory Note, dated June 30, 1993 from TBC Corporation to First Tennessee Bank National Association, for $44,500,000 line of credit, was filed as Exhibit 4.2 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1993 .................................. *\n4.4 Second Modification and Extension Agreement, dated June 30, 1995 between TBC Corporation and First Tennessee Bank National Association, regarding the $44,500,000 line of credit ......................... 40\n4.5 Promissory Note (revolving loan), dated April 1, 1993 from TBC Corporation to Third National Bank in Nashville, for $20,000,000, was filed as Exhibit 4.3 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1993 .. *\n# Other long-term debt instruments ................... #\n(10) MATERIAL CONTRACTS:\nManagement Contracts and Compensatory Plans or Arrangements\n10.1 Executive Employment Agreement between the Company and Mr. Louis S. DiPasqua, amended and restated as of January 31, 1995, was filed as Exhibit 10.1 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 ..... *\n10.2 Executive Consulting Agreement between the Company and Mr. Marvin E. Bruce dated January 1, 1995, was filed as Exhibit 10.2 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 ............................... *\n10.3 Louis S. DiPasqua Trust Agreement dated as of October 22, 1992 between the Company and First Tennessee Bank National Association was filed as Exhibit 10.6 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .. *\n10.4 TBC Corporation 1983 Stock Option Plan, as amended April 23, 1992 was filed as Exhibit 10.7 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 ................... *\n10.5 TBC Corporation 1989 Stock Incentive Plan, as amended April 23, 1992 was filed as Exhibit 10.8 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 ............... *\n10.6 TBC Corporation Deferred Compensation Plan for Directors was filed as Exhibit 10.10 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1993 ....................... *\n10.7 Executive Employment Agreement dated as of November 1, 1988 between the Company and Mr. Kenneth P. Dick, including Trust Agreement as Exhibit A thereto, as extended as of November 1, 1991 and as amended as of July 1, 1992, was filed as Exhibit 10.10 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .................................. *\n10.8 Agreement to Extend Executive Employment Agreement, between the Company and Mr. Kenneth P. Dick dated October 31, 1994 ................................... *\n10.9 Executive Employment Agreement dated as of November 1, 1988 between the Company and Mr. Bob M. Hubbard, including Trust Agreement as Exhibit A thereto, as extended as of November 1, 1991 and as amended as of July 1, 1992, was filed as Exhibit 10.11 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .................................. *\n10.10 Agreement to Extend Executive Employment Agreement, between the Company and Mr. Bob M. Hubbard dated October 31, 1994 ................................... *\n10.11 Executive Employment Agreement dated as of November 1, 1988 between the Company and Mr. Ronald E. McCollough, including Trust Agreement as Exhibit A thereto, as extended as of November 1, 1991 and as amended as of July 1, 1992, was filed as Exhibit 10.12 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .................................. *\n10.12 Agreement to Extend Executive Employment Agreement, between the Company and Mr. Ronald E. McCollough dated October 31, 1994 ............................. *\n10.13 TBC Corporation 1995 Management Incentive Compensation Plan, effective for the calendar year 1995 and thereafter, was filed as Exhibit 10.1 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 ................ *\n10.14 Amendment dated July 20, 1995 to the TBC Corporation 1995 Management Incentive Compensation Plan .................................. 42\n10.15 TBC Corporation Executive Supplemental Retirement Plan, as amended October 22, 1992, was filed as Exhibit 10.14 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 .. *\nOther Material Contracts\n10.16 1994 Amendment to the TBC Corporation Executive Supplemental Retirement Plan, dated November 30, 1994, was filed as Exhibit 10.16 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1994................ *\n10.17 Lease Agreement, dated February 25, 1980, between TBC Corporation and Vantage-Memphis, Inc. was filed as Exhibit 10.2 to TBC Corporation Registra- tion Statement on Form S-1 (Reg. No. 2-83216) ...... *\n10.18 Modification and Ratification of Lease, dated April 16, 1991, between TBC Corporation and Vantage-Memphis, Inc. was filed as Exhibit 10.11 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1991 ............... *\n10.19 Lease Agreement, dated September 23, 1992, between TBC Corporation and Weston Management Company (for Weston Building #105) was filed as Exhibit 10.18 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 ..... *\n10.20 Lease Agreement, dated September 23, 1992, between TBC Corporation and Weston Management Company (for Weston Building #108) was filed as Exhibit 10.19 to the TBC Corporation Annual Report on Form 10-K for the year ended December 31, 1992 ..... *\n10.21 Form of TBC Corporation's standard Distributor Agreement was filed as Exhibit 10.1 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 ........................ *\n10.22 Agreement, dated October 1, 1977, between TBC Corporation and The Kelly-Springfield Tire Company, including letter dated June 30, 1978, was filed as Exhibit 10.6 to TBC Corporation Registration Statement on Form S-1 (Reg. No. 2-83216) ................................. *\n10.23 Ten-Year Commitment Agreement, dated March 21, 1994, between the Company and The Kelly-Springfield Tire Company, was filed as Exhibit 10.2 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 ....................... *\n10.24 Agreement, effective January 1, 1994, signed April 25, 1994, between the Company and Cooper Tire & Rubber Company, was filed as Exhibit 10.2 to the TBC Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 ................ *\n(21) SUBSIDIARIES OF THE COMPANY:\n21.1 List of the names and jurisdictions of incorporation of the subsidiaries of the Company ... 43\n(23) CONSENTS OF EXPERTS AND COUNSEL:\n23.1 Consent of Coopers & Lybrand L.L.P., Independent Certified Public Accountants, to incorporation by reference of their reports dated January 26, 1996 in Post-Effective Amendment No. 1 to Registration Statement on Form S-8 for the Company's 1983 Stock Option Plan (Reg. No. 2-97888) and Registration Statement on Form S-8 for the Company's 1989 Stock Incentive Plan (Reg. No. 33-43166) ................. 44\n(24) POWER OF ATTORNEY:\n24.1 Power of attorney of each person who signed this Annual Report on Form 10-K on behalf of another pursuant to a power of attorney .................... 45\n(27) FINANCIAL DATA SCHEDULE:\n27.1 Financial Data Schedule ............................ +\n(99) ADDITIONAL EXHIBITS:\n99.1 Rights Agreement, dated as of July 21, 1988, between TBC Corporation and the First National Bank of Boston, as Rights Agent, was filed as an Exhibit to the Company's Registration Statement on Form 8-A dated July 21, 1988. The Rights Agreement includes as Exhibit A the form of Certificate of Designation, Preferences and Rights; as Exhibit B, the form of Rights Certificate; and as Exhibit C, the form of Summary of Rights .................................. *\n\"*\" Indicates that the Exhibit is incorporated by reference into this Annual Report on Form 10-K from a previous filing with the Commission.\n\"#\" The total amount of securities authorized under other long-term debt instruments does not exceed 10% of the total assets of the company and its subsidiaries on a consolidated basis. A copy of each such instrument will be furnished to the commission upon request.\n\"+\" Included only in the Company's electronic filing with the Commission.\nTBC CORPORATION\nEXHIBITS\nTO\nFORM 10-K\nFOR THE YEAR ENDED DECEMBER 31, 1995\nEXHIBIT 4.2\nMODIFICATION AND EXTENSION AGREEMENT\nTHIS AGREEMENT, made and entered into as of the 30th day of June, 1995 by and between FIRST TENNESSEE BANK NATIONAL ASSOCIATION, a national banking association having its principal place of business in Memphis, Tennessee (hereinafter referred to as the \"Bank\"), and TBC CORPORATION, a Delaware corporation (hereinafter referred to as the \"Borrower\").\nWITNESSETH:\nWHEREAS, Bank has extended to the Borrower a committed line of credit in the maximum principal amount not to exceed the sum of Fifteen Million Dollars ($15,000,000.00)(the \"Loan\") advances pursuant to which are evidenced by a promissory note (the \"Note\"), dated June 30, 1993, in the principal amount of Fifteen Million Dollars ($15,000,000.00), executed by the Borrower and payable to the order of the Bank; and\nWHEREAS, the Note provided for principal to be payable on demand, and if no demand made, on June 30, 1994; and\nWHEREAS, the Bank has extended the maturity of the Note to June 30, 1995, pursuant to that certain Modification and Extension Agreement, dated as of the 30th day of June, 1994; and\nWHEREAS, the Borrower and the Bank now desire to enter into this Agreement in order to extend the maturity of the indebtedness evidenced by the Note.\nNOW, THEREFORE, for good and valuable considerations, the receipt and sufficiency of which are hereby acknowledged, it is agreed by the parties as follows:\nAgreements\n1. At the request of the Borrower, the Bank, as the legal holder of the indebtedness evidenced by the Note, does hereby modify the payment of indebtedness, so that said indebtedness, together with interest from date at the variable rate per annum as set forth in the Note, shall be due and payable on demand, and if no demand is made, on June 30, 1996.\n2. It is expressly understood and agreed that the Note shall continue as evidence of the indebtedness until the same is paid. As modified, amended, and extended hereby,\nthe Note evidencing the indebtedness above-mentioned is hereby ratified, approved and confirmed in all respects.\nIN WITNESS WHEREOF, the Borrower has executed this Modification and Extension Agreement and the Bank has caused this Agreement to be executed by its duly authorized officer, on this the day and year first above written.\nFIRST TENNESSEE BANK NATIONAL ASSOCIATION\nBy: \/s\/ James G. Moore, Jr. Title: Vice President\nTBC CORPORATION\nBy: \/s\/ Louis S. DiPasqua Title: President\/CEO\nBy: \/s\/ Charles B. Quinn, Jr. Title: Vice President\/Treasurer\nEXHIBIT 4.4\nSECOND MODIFICATION AND EXTENSION AGREEMENT\nTHIS SECOND MODIFICATION AND EXTENSION AGREEMENT (\"Second Modification\"), made and entered into as of the 30th day of June, 1995 by and between FIRST TENNESSEE BANK NATIONAL ASSOCIATION, a national banking association having its principal place of business in Memphis, Tennessee (hereinafter referred to as the \"Bank\"), and TBC CORPORATION, a Delaware corporation (hereinafter referred to as the \"Borrower\").\nWITNESSETH:\nWHEREAS, Bank has extended to the Borrower an offering line of credit in the maximum principal amount not to exceed the sum of Forty-Four Million Five Hundred Thousand Dollars ($44,500,000.00) (the \"Loan\") advances pursuant to which are evidenced by a promissory note (the \"Note\"), dated June 30, 1993, in the principal amount of Forty-Four Million Five Hundred Thousand Dollars ($44,500,000.00), executed by the Borrower and payable to the order of the Bank; and\nWHEREAS, the Note originally provided for principal to be payable on demand, and, if no demand made, on June 30, 1994; and\nWHEREAS, the provision for making payment of principal by June 30, 1994 if no demand had been made previously was modified to provide that outstanding principal would be payable on June 30, 1995 if no demand had been made previously (the \"First Modification\"); and\nWHEREAS, the Borrower and the Bank now desire to enter into this Second Modification in order to reduce the maximum principal amount of the Loan (a) to Forty-Three Million Dollars ($43,000,000.00) during the period from the date the Bank notifies the Borrower that the Bank has received all of the required documentation for an offering line of credit to TBC de Mexico, S.A. de C.C.V. (the \"TBC de Mexico Notice\") through September 30, 1995, and (b) to Thirty-Eight Million Dollars ($38,000,000.00) as of October 1, 1995; and\nWHEREAS, the Borrower and the Bank further desire to modify the Note to provide that outstanding principal will be payable on June 30, 1996 if no demand has been made previously.\nNOW, THEREFORE, for good and valuable considerations, the receipt and sufficiency of which are hereby acknowledged, it is agreed by the parties as follows:\nAgreements\n1. At the mutual agreement of the Borrower and the Bank, as the legal holder of the indebtedness evidenced by the Note, the maximum principal amount which may be borrowed on the Loan (a) from the date of the TBC de Mexico Notice through September 30, 1995 is Forty-Three Million Dollars ($43,000,000.00) and (b) beginning October 1, 1995, is Thirty-Eight Million dollars ($38,000,000.00).\n2. At the request of the Borrower, the Bank, as the legal holder of the indebtedness evidenced by the Note, does hereby modify the payment of the indebtedness, so that said indebtedness, together with interest from date at the variable rate per annum as set forth in the Note, shall be due and payable on demand, and if no demand is made, on June 30, 1996.\n3. It is expressly understood and agreed that the Note, as modified by the First Modification and this Second Modification, shall continue as evidence of the indebtedness until the same is paid. As modified, amended, and extended by the First Modification and hereby, the Note evidencing the indebtedness above-mentioned is hereby ratified, approved and confirmed in all respects.\nIN WITNESS WHEREOF, the Borrower has executed this Second Modification and Extension Agreement and the Bank has caused this Second Modification and Extension Agreement to be executed by its duly authorized officer, on this the day and year first above written.\nFIRST TENNESSEE BANK NATIONAL ASSOCIATION\nBy: \/s\/ James G. Moore, Jr. Title: Vice President\nTBC CORPORATION\nBy: \/s\/ Louis S. DiPasqua Title: President\/CEO\nBy: \/s\/ Charles B. Quinn, Jr. Title: Vice President\/Treasurer\nEXHIBIT 10.14\nJULY 20, 1995 AMENDMENT TO TBC CORPORATION 1995 MANAGEMENT INCENTIVE COMPENSATION PLAN\nOn July 20, 1995, the Compensation Committee of the Board of Directors of TBC Corporation amended the TBC Corporation Management Incentive Compensation Plan by adding the following language to the end of the first sentence of Section 7(b) of the Plan:\n\"provided further, however, that there shall be no forfeiture if the Participant ceases to be employed by the Company prior to the end of the Restricted Period by reason of normal retirement under a retirement plan of the Company or the Participant otherwise retires with the consent of the Company, or the Participant's employment is terminated by death or disability, or if the Company terminates his or her employment otherwise than by reason of fault on the part of the Participant.\"\nEXHIBIT 21.1\nSUBSIDIARIES OF TBC CORPORATION\nTBC Corporation has four subsidiaries, each of which is wholly-owned by TBC Corporation. The subsidiaries and their states of incorporation are as follows:\nName of Subsidiary State of Incorporation\nBattery Associates, Inc. Delaware\nNorthern States Tire, Inc. Delaware\nTBC International, Inc. Delaware\nTBC Sales, Inc. Delaware\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the amended form S-8 registration statement for TBC Corporation's 1983 Stock Option Plan and the form S-8 registration statement for TBC Corporation's 1989 Stock Incentive Plan of our reports dated January 26, 1996, on our audits of the consolidated financial statements and financial statement schedule of TBC Corporation as of December 31, 1995 and 1994 and for the years ended December 31, 1995, 1994 and 1993, which reports are included in this Annual Report on Form 10-K.\nCOOPERS & LYBRAND L.L.P.\nMemphis, Tennessee January 26, 1996\nEXHIBIT 24.1\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 1st day of February, 1996.\n\/s\/ Marvin E. Bruce Marvin E. Bruce\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 1st day of February, 1996.\n\/s\/ Stanley A. Freedman Stanley A. Freedman\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 2nd day of February, 1996.\n\/s\/ Richard A. McStay Richard A. McStay\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 1st day of February, 1996.\n\/s\/ Robert M. O'Hara Robert M. O'Hara\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 1st day of February, 1996.\n\/s\/ Robert R. Schoeberl Robert R. Schoeberl\nTBC CORPORATION\nLIMITED POWER OF ATTORNEY\nWHEREAS, TBC Corporation (the \"Company\") intends to file with the Securities and Exchange Commission its Annual Report on Form 10-K for the year ended December 31, 1995;\nNOW, THEREFORE, the undersigned, in his capacity as a director of the Company, hereby appoints Louis S. DiPasqua and\/or Ronald E. McCollough, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, to execute in his name, place and stead, the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (including any amendment to such report), and any and all other instruments necessary or incidental in connection therewith, and to file the same with the Securities and Exchange Commission. Either of said attorneys shall have full power and authority to do and perform in the name and on behalf of the undersigned, in the aforesaid capacity, every act whatsoever necessary or desirable to be done, as fully to all intents and purposes as the undersigned might or could do in person. The undersigned hereby ratifies and approves the acts of either of said attorneys.\nIN WITNESS WHEREOF, the undersigned has executed this instrument this 1st day of February, 1996.\n\/s\/ Nicholas F. Taubman Nicholas F. Taubman","section_15":""}
{"filename":"46428_1995.txt","cik":"46428","year":"1995","section_1":"ITEM 1. BUSINESS\nHealth-Chem Corporation is a Delaware corporation and conducts its business primarily through its wholly-owned subsidiaries, Herculite Products, Inc. (\"Herculite\") and Pacific Combining Corp. (\"Pacific\"), through its 90% owned subsidiary Transderm Laboratories Corporation (\"Transderm\") and through its 98.5% owned subsidiary Hercon Environmental Corporation (\"Hercon Environmental\"). Unless the context otherwise requires, the term \"Company\" includes Health-Chem Corporation and all its subsidiaries. The Company's executive offices are located in New York, New York.\nThe Company develops, manufactures and distributes products relying on or derived from laminated or coated films. The products fall into several categories - reinforced synthetic fabrics for industrial and health care use, controlled release dispensers for pharmaceuticals and controlled release dispensers for environmental chemicals.\nThrough Herculite and Pacific, which maintain facilities in Pennsylvania and California, the Company manufactures and markets multilayered synthetic fabrics which are sold domestically and internationally to health-care, industrial, military, maritime and institutional markets. The manufacturing process of these products involves laminating a layer of vinyl or urethane to one or both sides of a synthetic textile. The result is a strong and durable fabric.\nFabrics for industrial use include heavy-duty, and high visibility fabrics, and a variety of custom engineered fabrics. Some of the applications for these fabrics include tension structures, livestock curtains for poultry, cattle and hogs, awnings, banners, tents, inflatable lumbar support bladders for automobile seats, tennis court wind screens, fabrics for use in motor homes, swimming pool and spa covers, gymnasium pads and mats, trampolines and other mass merchandised toys, long-term storage covers for military and commercial equipment and fabrics for use in nuclear power plants.\nHerculite's Staph-Chek(R) products employ molecular migration technology to make them self-deodorizing and anti-bacterial. A wide variety of thicknesses and colors are sold to manufacturers of institutional mattresses, pillows, laundry carts, shower and cubicle curtains and many related products. Herculite's Staph-Chek Synergy(R) and Staph-Chek Comfort(R) products are the latest additions to the Company's new generation of fabrics designed for increased patient comfort and pressure relief in the growing specialty mattress market for hospitals and nursing homes. Another fabric, Lectrolite(R), is also electrically conductive; by dissipating static electricity it helps reduce the hazard of explosion in flammable, gaseous atmospheres. It is sold to manufacturers of pads for various types of hospital equipment and operating room tables, and to manufacturers in the computer industry to reduce static problems. Both Herculite and Pacific are also actively engaged in the development of product improvements and innovations to capture existing and new market opportunities for fabric reinforced composites.\nThe Company's fabric products are sold to more than 1,800 customers by a sales force consisting of several sales and marketing executives, 20 domestic manufacturers representatives, and sales agents in Europe and other parts of the world. The Company also distributes its fabric products through a network of 25 domestic and foreign distributors.\nThe Company also employs molecular migration technology to manufacture very different controlled release products.\nThrough Hercon Environmental, the Company manufactures and distributes controlled release dispensers and pheromone products for insect control and household use. Insecticide or insect pheromone products are contained in insoluble, vinyl dispensers to kill, trap or monitor insects as part of safer, more ecologically sound pest management programs. These products are sold to industry, farmers, the United States Department of Agriculture, and a variety of state agencies. Sales are effected primarily by a four person sales team. In an effort to decrease the seasonality and cyclical nature of Hercon Environmental's business, the Company plans to increase product development and marketing of products for household use. In late 1995, the Company received Environmental Protection Agency (\"EPA\") registrations for three pheromone products which will be marketed in the United States and in selected foreign countries in 1996. Additional new products are being developed through joint programs with governmental and private enterprises.\nThrough Transderm's 98.5% owned subsidiary Hercon Laboratories Corporation (\"Hercon Laboratories\"), the Company is engaged in the development and manufacture of controlled release products for the pharmaceutical industry to deliver a variety of drugs topically or transdermally. Many medications can be administered to or through a patient's skin at precise rates from small, adhesive patches. Among their advantages, controlled release dispensers provide steady dose rates and reduce dosage frequency. They also can be used for oral, buccal and subdermal delivery of medication.\nSince 1986, Hercon Laboratories has manufactured a transdermal nitroglycerin patch which was the first such product introduced in the U.S. for the generic market. This product is used for transdermal relief of vascular and cardiovascular symptoms related to angina pectoris. The Company distributes the transdermal nitroglycerin patch to pharmaceutical companies who distribute it in the United States and in Europe. The Company is currently awaiting FDA approval of its applications to market improved transdermal nitroglycerin products, thinner, smaller, more comfortable transparent patches. Some of these applications are the subject of a lawsuit instituted by Key Pharmaceuticals, Inc. in August 1995 (see Item 3. Legal Proceedings). In addition to its nitroglycerin transdermal products, the Company is also developing transdermal products for treatment of post-menopausal symptoms. The Company is also working on transdermal products for other hormone replacement therapies including a testosterone product and combination products. There can be no assurance that FDA filings for any of these additional products will be effected or that FDA approval for any of these products will be obtained.\nThe Company has additional products in early development and is conducting a number of feasibility studies on drugs to be developed independently or for client companies.\nRESEARCH AND DEVELOPMENT\nThe Company's pharmaceutical research and development laboratory facilities are maintained at its York, Pennsylvania facilities. The Company currently utilizes the skills of approximately 20 full-time employees with varying technical backgrounds, including pharmaceutics and pharmaceutical sciences, to conduct its research and development efforts in this area. Independent laboratories are often engaged for special projects. Research and development for the Company's synthetic fabric operations are conducted at the Company's York and Los Angeles, California facilities. The York facilities also serve the Company's environmental product operations. See the Consolidated Statements of Operations for the amount of research and development costs incurred during 1995, 1994 and 1993.\nSUPPLIERS; RAW MATERIALS\nMost of the products and materials used by the Company are purchased from a variety of suppliers and are readily available on the open market. Several materials used in the manufacture of the Company's products are available only from sole source suppliers. The Company has not experienced difficulty acquiring such materials which generally have been available to the Company and the industries in which the Company operates on commercially reasonable terms.\nCOMPETITION\nEach of the businesses in which the Company is engaged is highly competitive. Many of its competitors are large national and international manufacturers and distributors, with considerably more financial, marketing and other resources than the Company. The Company believes that its principal competitive strength lies in its research, engineering and manufacturing capabilities.\nPATENTS AND PROPRIETARY RIGHTS\nThe Company has obtained various U.S. and foreign patents and trademarks (which expire from time to time) for certain of its products and processes. While it is the Company's view that these patents and trademarks are a valuable asset, the Company does not consider any single patent or trademark to be of material importance to its business as a whole. The Company continues to seek patent and trademark protection for its proprietary technologies and products as it believes is appropriate in the U.S. and abroad.\nENVIRONMENTAL MATTERS\nThe Company does not believe that compliance by it with federal, state or local laws and regulations which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has or will have any material effect upon the capital expenditures, earnings or competitive position of the Company. There can be no assurance, however, (i) that changes in federal, state or local laws or regulations, changes in regulatory policy or the discovery of unknown problems or conditions will not in the future require substantial expenditures, or (ii) as to the extent of the Company's liabilities, if any, for past failures, if any, to comply with laws, regulations and permits applicable to its operations.\nBACKLOG; SEASONALITY\nThe Company's backlog orders usually do not exceed 60 days. Neither the backlog nor the Company's operations are subject to substantial seasonal variations, although its manufacturing operations typically are shut down for a one-week vacation period during the third quarter, which is reflected in results of operations for the period.\nCUSTOMERS; GOVERNMENT CONTRACTS\nSales of transdermal nitroglycerin patches to Mylan Pharmaceuticals, Inc. accounted for approximately 14% of the Company's consolidated net sales during the fiscal year ended December 31, 1995. Other than Mylan, there was no single customer nor, to the Company's knowledge, any group of affiliated customers to which sales during the fiscal year ended December 31, 1995 were in the aggregate equal to 10% or more of the Company's consolidated net sales. Government contracts are not material to the Company's consolidated net sales.\nEMPLOYEES\nThe Company employs approximately 286 employees, of whom 108 are covered by collective bargaining agreements. The Company believes its relationship with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table lists the principal facilities owned or leased by the Company as of December 31, 1995. In the opinion of management, the facilities are adequate for their purposes. Lease Approx. Expiration Location Sq. Ft. Date Use\nNew York, NY 7,000 3\/99 Executive offices\nYork, PA 61,000 (owned) Pharmaceutical production, warehouse, research facility & office\nYork, PA 278,000 (1) (owned) Production, warehouse, & office\nLos Angeles, CA 30,000 2\/99 Production, office and warehouse; synthetic fabrics\nLos Angeles, CA 25,000 6\/98 Warehouse; synthetic fabrics\n(1) Non-affiliated tenants lease approximately 114,000 square feet under a lease expiring in September 1997, with an option to extend the lease term through September 2000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn August 1995, Key Pharmaceuticals, Inc., a subsidiary of Schering-Plough Corporation (\"Key\"), commenced an action against the Company's Hercon Laboratories subsidiary in the United States District Court for the District of Delaware alleging that Hercon Laboratories' submission to the United States Food and Drug Administration (\"FDA\") of three Abbreviated New Drug Applications (\"ANDAs\") relating to some of Hercon Laboratories' improved transdermal nitroglycerin products for which the Company is awaiting FDA approval constitutes infringement of Key's patent for its Nitro-Dur(R) products. Key seeks certain injunctive relief, monetary damages if commercial manufacture, use or sale occurs, and a judgment that the effective date for FDA approval of the above-referenced ANDAs be not earlier than February 16, 2010, the expiration date of Key's patent. By Answer and Counterclaim dated August 28, 1995, Hercon Laboratories denied the material allegations of the complaint, asserting, among other things, that the Key patent is invalid and unenforceable and that Hercon Laboratories has not infringed and does not infringe any claim of the patent. In its counterclaim against Key, Hercon Laboratories seeks a declaratory judgment of patent noninfringement, invalidity and unenforceability. Discovery in this action has commenced. Management believes that Key's claims are without merit and intends to defend the action vigorously.\nIn October 1995, Gershon Yormack, a stockholder of the Company, initiated an action in the Delaware Chancery Court (New Castle County) against the Company, its directors and its Transderm subsidiary seeking injunctive and declaratory relief with respect to certain options to purchase Transderm common stock to be granted to each of Marvin M. Speiser, the Company's Chairman of the Board and President, and Robert D. Speiser, the Company's Executive Vice President, in 1995. Pursuant to Employment Agreements entered into in April 1995, in November 1995 the Company caused Transderm to issue an option to purchase shares of\nTransderm's common stock at an exercise price of $.10 per share to each of Marvin M. Speiser and Robert D. Speiser. The plaintiff alleges that this exercise price, which is the same per share price as the subscription price for Transderm common stock offered by the Company to stockholders under a registered subscription rights offering (via a prospectus dated September 18, 1995), is substantially less than the fair market value of such Transderm common stock. Management believes that the claims are without merit and intends to defend the action vigorously.\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.\nFORM 10-K PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's Common Stock is traded on the American Stock Exchange, Inc. under the symbol HCH.\nThe following information indicates the range of sale prices at which the Company's Common Stock traded on the American Stock Exchange, Inc. during the past two years:\n1995 1994\nQUARTER High Low High Low 1st 3 1\/8 2 3\/4 4 5\/8 3 1\/2 2nd 2 15\/16 2 5\/8 4 2 3\/4 3rd 3 1\/8 2 1\/8 3 7\/16 2 3\/4 4th 2 1\/4 1 5\/16 3 1\/4 2 5\/8\nThere were approximately 1,558 holders of record of the Company's Common Stock as of February 29, 1996.\nThe Company has not paid cash dividends on its Common Stock during the five years ended December 31, 1995. See Note 4 to the Consolidated Financial Statements concerning restrictions on the payment of dividends.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nYear ended December 31, 1995 versus December 31, 1994\nSales decreased $.4 million, or 1% for the twelve months ended December 31, 1995 as compared to the same period for 1994. The decrease is due primarily to decreases in sales of synthetic fabrics and environmental products of $.7 million and $.1 million, respectively, partially offset by a $.4 million increase in sales of the Company's transdermal nitroglycerin patches. The synthetic fabrics sales decrease is due principally to lower governmental and foreign sales and timing of customer demand for certain fabrics. Environmental product sales decreased due primarily to the loss of a customer for the Japanese Beetle Lures. Sales decreases were partially offset by a $.4 million transdermal nitroglycerin patch sales increase which was due primarily to greater demand from both domestic and foreign distributors.\nGross profit decreased $1.8 million or 12% for the twelve months ended December 31, 1995 as compared to the same period in 1994. Gross profit as a percent of sales was 29% for the twelve months ended December 31, 1995 as compared to 32% for the same period in 1994. Gross profit for synthetic fabrics and environmental products decreased $2.2 million and $.1 million, respectively, while transdermal nitroglycerin patch gross profit increased $.5 million as compared to the same period in 1994. The synthetic fabrics gross profit decrease is due primarily to unfavorable manufacturing variances and rising raw material cost of $1.5 million and higher plant overhead of $.7 million. Management believes that synthetic fabrics margins will improve in 1996 as manufacturing deficiencies are rectified in part by implementation of a new computer system. Transdermal nitroglycerin patch gross profit increased due primarily to increased domestic sales volumes of higher margin products. Gross profit as a percent of sales for transdermal nitroglycerin patches was 60% for the twelve months ended December 31, 1995 as compared to 58% for the same period in 1994 reflecting domestic price increases, reduced operating costs and increased domestic sales volumes.\nSelling, general and administrative expenses increased $.5 million for the twelve months ended December 31, 1995 as compared to the corresponding period in 1994. The increase is due primarily to higher 1995 payroll-related expenses of $.5 million, including $.4 million related to pension accruals, and to a 1994 $.2 million non-recurring reduction to expenses from a receipt of life insurance proceeds relating to a former officer. These increases were partially offset by decreased sales commissions and royalty expense.\nResearch and development expense increased $.2 million for the twelve months ended December 31, 1995 as compared to the same period in 1994. The Company anticipates research and development expenses related to pharmaceutical products in 1996 to equal or exceed 1995 levels as new studies for patch applications are developed from initial formulation work through commercial scale up and current studies advance through various phases of completion.\nInterest expense was approximately the same for the twelve months ended December 31, 1995 as compared to the same period in 1994 as lower interest rates were offset by an increase in the level of long-term debt.\nOther income - net decreased $.1 million for the twelve months ended December 31, 1995 as compared to the corresponding period in 1994. The decrease is due primarily to 1994 nonrecurring income producing items.\nIncome from operations before taxes and minority interest decreased $2.6 million for the twelve month period ended December 31, 1995 as compared to the corresponding period in 1994 due primarily to lower synthetic fabrics profit margins related to unfavorable manufacturing variances, rising material costs and higher plant overhead.\nThe Company reported less than a $.1 million tax benefit on a loss from operations for the twelve months ended December 31, 1995 as compared to a $.8 million tax provision on income from operations in 1994. Income tax provision or benefit varies with the amount and nature of the components of income or loss from operations before income taxes. The 1995 federal tax benefit resulting from this loss was partially offset by the provision for state taxes which was generated from income associated with the sale of transdermal nitroglycerin patches. Note 12 to the accompanying consolidated financial statements presents a reconciliation of taxes on income for 1995 and 1994.\nMinority interest represents a 1.5% interest of a former Hercon Laboratories president in the equity of Hercon Environmental.\nYear ended December 31, 1994 versus December 31, 1993\nSales increased $2.1 million, or 5% for the twelve months ended December 31, 1994 as compared to the same period for 1993. The increase was due primarily to a $3.7 million increase in the sales of synthetic fabrics, offset by a $1.4 million decrease in the sales of the Company's transdermal nitroglycerin patches. Synthetic fabrics sales increased $3.7 million due principally to an overall increase in market activity, timing of customer demand for certain fabrics and biannual foreign sales. Pharmaceutical sales were adversely affected in 1994 by actions taken by distributors in 1993 to build their inventories to desired levels after adjusting for market demand. Environmental product sales decreased $.2 million due primarily to a reduction of government contracts for the Gypsy Moth Lure.\nGross profit decreased $.4 million, or 3% for the twelve months ended December 31, 1994 as compared to the same period in 1993. Gross profit as a percent of sales was 32% for the twelve months ended December 31, 1994 as compared to 35% for the same period in 1993. The decrease was due primarily to decreased sales volumes of higher margin transdermal nitroglycerin patches. Lower gross profits also reflect rising raw material costs and higher labor costs which could not be passed on to the customers because of market conditions.\nSelling, general and administrative expenses decreased $.7 million for the twelve months ended December 31, 1994 as compared to the corresponding period in 1993. The decrease was primarily due to reductions in expenses for bonus accruals of $.7 million, life insurance of $.3 million and royalties of $.1 million, partially offset by increases in sales commissions of $.2 million and payroll and fringe costs of $.2 million.\nResearch and development expense was approximately the same for the twelve months ended December 31, 1994 as compared to the same period in 1993. A $.2 million increase for costs related to new product development of synthetic product lines, relating primarily to associated payroll and fringe costs, was offset by research and development costs related to pharmaceutical products.\nInterest expense decreased $.1 million for the twelve months ended December 31, 1994 as compared to the same period in 1993 due primarily to lower average outstanding balances on the Company's long-term line of credit and subordinated debentures.\nOther income - net decreased $.5 million for the twelve months ended December 31, 1994 as compared to the corresponding period in 1993. The decrease was due primarily to a 1993 nonrecurring recovery of expenses representing an insurance recovery and a reduction of reserves from certain litigation contingencies settled in 1993.\nIncome from operations before taxes decreased $.1 million for the twelve month period ended December 31, 1994 as compared to the corresponding period in 1993 primarily due to the change in other income mentioned above. Income tax provision increased $1 million for the twelve months ended December 31, 1994 as compared to the same period in 1993 due to full recognition of benefits of tax loss carryforwards and other tax credits in 1993 and no such items existing in 1994. Note 12 to the accompanying consolidated financial statements presents a reconciliation of taxes on income for 1994 and 1993.\nLiquidity and Capital Resources\nThe following measures of liquidity are drawn from the Company's Consolidated Financial Statements: December 31, 1995 1994\nWorking capital (current assets less current liabilities, in thousands) $9,041 $8,179 Current ratio (current assets\/ current liabilities) 2.3 2.0 Quick ratio (cash and receivables\/ current liabilities) .7 .7\nWorking capital increased $.9 million from December 31, 1994 to December 31, 1995 due to a $1.5 million decrease in current liabilities, partially offset by a $.6 million decrease in current assets. Increases in working capital were primarily the result of decreases in accounts payable and accrued expenses and other current liabilities of $.5 million and $.6 million, respectively, along with an increase in other current assets of $.8 million. These increases to working capital were partially offset by decreases in accounts receivable, net and inventories of $.6 million and $.5 million, respectively. The accounts receivable decrease is due primarily to a decrease in transdermal nitroglycerin patch sales in the fourth quarter of 1995 as compared to the fourth quarter of 1994. Management believes this decrease is temporary. Inventory decreases of $.8 million were achieved in the synthetic fabrics area due principally to the implementation of improvements to the material management system. Efforts were enhanced by the new computer system which was brought on line January 1, 1995 for the Company's Herculite subsidiary. Accrued expenses and other current liabilities have decreased principally due to accruals related to payroll expenses, legal expenses and audit fees.\nCash and cash equivalents decreased $.4 million at December 31, 1995 as compared to the same period in 1994. Cash generated from operations and financing activities for the year ended December 31, 1995 was $.9 million and $2.3 million, respectively. The Company made capital expenditures of $3.7 million in 1995, of which $1.8 million was related to the building of a new production line for its Pacific subsidiary. This new production line will increase capacity for both current products and new products created through research and development. The remaining $1.9 million was for additions consisting of manufacturing tooling and equipment and leasehold improvements.\nThe Company expects to meet $.6 million of debenture interest payments each April and October and other periodic interest payments out of working capital. The required $1.5 million sinking fund payment on the Company's subordinated debentures due on April 15, 1996 is to be satisfied by application of $.8 million of debentures previously repurchased and by the Company's option to call for redemption of an additional $.7 million of debentures.\nThe Company has not paid cash dividends and does not anticipate paying such dividends on its common stock in the foreseeable future.\nAt December 31, 1995, the Company had borrowed $3.9 million on its $6.0 million line of credit from the First National Bank of Maryland (First National). The credit line bears interest, at the Company's option, at either the bank's prime rate or the London Inter-Bank Offer Rate, is secured by the Company's assets with the exception of real estate, and expires in October of 1997. The Company's line of credit balance of $3.9 million was unchanged at February 29, 1996. It is the Company's practice to utilize the line of credit to fund current obligations when required and to pay down the line of credit when funds become available.\nAt December 31, 1995, the Company had purchased, in market transactions throughout 1995, $.7 million principal amount of its 10.375% convertible subordinated debentures for $.7 million. Subsequent to the end of the year, through February 29, 1996, the Company, purchased in market transactions, $.1 million principal amount of its debentures for $.1 million. Additional debentures may be repurchased and retired or if debentures are not available for purchase, the Company has an option to call for redemption the amount required to meet future sinking fund requirements.\nThe Company's debt to equity ratio was 3:1 at December 31, 1995 unchanged from December 31, 1994. The Company's debt to equity ratio decreased at December 31, 1994 down from 4:1 at December 31, 1993. This lower ratio reflects increases in stockholders' equity from net income of $1.4 million for the twelve months ended December 31, 1994 and the common stock transactions of $1.1 million discussed in Note 9 of the accompanying Notes to Consolidated Financial Statements.\nManagement believes anticipated expenditures in 1996 such as capital expenditures, debenture repurchasing, research and development costs and other operating expenses will be funded with cash generated from operations, supplemented by the utilization of the line of credit. The Company anticipates capital expenditures for property, plant and equipment in 1996 to decrease from the $3.7 million expended in 1995 to approximately $1.2 millon. These capital expenditures will primarily consist of manufacturing tooling and equipment and leasehold improvements.\nInflation\nThe Company believes that inflation has not had a material effect upon its results of operations and liquidity and capital resources for any of the periods presented.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nIndex to Consolidated Financial Statements.\nPAGE\nIndependent Auditors' Reports 13-14\nConsolidated Balance Sheets - December 31, 1995 and 1994 15-16\nConsolidated Statements of Operations Years Ended December 31, 1995, 1994 and 1993 17\nConsolidated Cash Flow Statements Years Ended December 31, 1995, 1994 and 1993 18-19\nConsolidated Statements of Stockholders' Equity Years Ended December 31, 1995, 1994 and 1993 20\nNotes to Consolidated Financial Statements 21-34\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders of Health-Chem Corporation:\nWe have audited the accompanying consolidated financial statements and the financial statement schedule of Health-Chem Corporation (Company) as of December 31, 1995 and for the year then ended 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 audit.\nWe conducted our audit 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 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 Health-Chem Corporation 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. 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. One South Market Square Harrisburg, Pennsylvania March 15, 1996 (Except for the last two paragraphs of Note 9 which are dated as of March 26, 1996)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders of Health-Chem Corporation:\nWe have audited the accompanying consolidated financial statements of Health- Chem Corporation and subsidiaries as of December 31, 1994, and for each of the two years in the period ended December 31, 1994 listed in Item 14(a)1. Our audits also included the financial statement schedule for each of the two years in the period ended December 31, 1994 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 the consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Health- Chem Corporation 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, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE, LLP Baltimore, Maryland March 15, 1995\nHEALTH-CHEM CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994, 1993\n1. Accounting Policies\na. Principles of consolidation\nThe consolidated financial statements include the accounts of Health-Chem Corporation (\"Health-Chem\") and all of its subsidiaries (collectively the \"Company\").\nIn April 1995, the Company's Board of Directors approved a plan to realign certain of its business operations in order to separate its transdermal pharmaceutical business from its hospital and industrial laminated fabrics and environmental chemical business. As part of such realignment, Hercon Laboratories Corporation (\"Hercon Laboratories\") effectively transferred its environmental chemical business to a subsidiary of Health-Chem, Hercon Environmental Corporation.\nFollowing the completion of the transfer of the environmental business, the Company and its subsidiaries Transderm Laboratories Corporation (\"Transderm\") and Herculite Products, Inc. (\"Herculite\") entered into a Plan of Reorganization and Asset Exchange Agreement effective August 31, 1995.\nThe Plan of Reorganization and Asset Exchange Agreement required, among other things:\n. The transfer from Herculite to Transderm of the manufacturing facility in which Hercon Laboratories' operations are conducted and the 985 shares of Hercon Laboratories' common stock owned by Herculite in exchange for 1,000,000 shares of Transderm's redeemable preferred stock, $10.00 par value.\n. Hercon Laboratories issuance to the Company of a $7,000,000, 9% Subordinated Promissory Note evidencing the approximate amount of intercompany advances owed to the Company by Hercon Laboratories.\n. Transderm's issuance of 40,000,000 shares of its authorized 60,000,000 shares of common stock, $.001 par value, in exchange for the previously issued 50 shares of its $.01 par value common stock.\n. Transderm's payment to the Company as it uses its net operating loss and tax credit carryforwards to offset future taxable income as a result of entering into a Tax Sharing Agreement.\nTransactions between the Company and its subsidiaries have been eliminated in consolidation.\nb. Cash equivalents\nMoney market funds and investment instruments with original maturities of ninety days or less are considered cash equivalents.\nc. Inventories\nInventories are stated at lower of cost (first-in, first-out basis) or market.\nd. Depreciation and amortization\nProperty, plant and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method by charges to operations over the estimated useful lives of depreciable assets or, where applicable, the terms of the respective leases, whichever is shorter. The cost and related accumulated depreciation of disposed assets are removed from the applicable accounts and any gain or loss is included in income in the period of disposal. Depreciation expense on property, plant and equipment was $1,712,000, $1,565,000 and $1,420,000 for 1995, 1994 and 1993, respectively.\ne. Amortization of excess of cost over fair value of assets acquired\nThe excess of cost over fair value of assets acquired is being amortized over 40 years on a straight-line basis. The accumulated amortization at December 31, 1995 and 1994 was $175,000 and $150,000 respectively. The Company's policy is to record an impairment loss against the net unamortized cost in excess of net assets of businesses acquired in the period when it is determined that the carrying amount of the asset may not be recoverable. An evaluation is made at each balance sheet date (quarterly) and it is based on such factors as the occurrence of a significant change in the environment in which the business operates or if the expected future net cash flows (undiscounted and without interest) would become less than the carrying amount of the asset.\nf. Research and development\nResearch and development costs are charged to operations as incurred.\ng. Income taxes\nDeferred tax assets and liabilities are provided for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts. The deferred tax assets and liabilities are measured using the enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Income tax expense is computed as the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities (See Note 12).\nh. Per share information\nPrimary and fully diluted earnings per share are computed based upon the weighted average number of common shares outstanding during each year after adjustment for any dilutive effect of the Company's 10.375% subordinated debentures and stock options and excluding the weighted average number of redeemable common shares outstanding (See Note 9). Interest on the subordinated debentures, when dilutive, net of applicable taxes, is added to net income for the purpose of computing earnings per share. In 1994 and 1993 accretion of discount of $45,000 and $90,000 respectively on redeemable common stock was deducted from net income and income before extraordinary gain for the purpose of computing earnings per share. Subordinated debentures are anti-dilutive and a portion of the stock options are dilutive for each of the years ended December 31, 1995, 1994 and 1993.\ni. Fair Value of Financial Instruments\nIn 1995, the Company adopted Statement of Financial Accounting Standards #107, \"Disclosures about Fair Value of Financial Instruments,\" which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. The carrying amount reported in the consolidated balance sheets at December 31, 1995 for cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate fair value due to the short-term nature of these instruments. The carrying amount of the Company's notes receivable and long-term debt approximate fair value because the underlying instruments reprice frequently. The fair value of the Company's convertible subordinated debentures is based on quoted market prices and at December 31, 1995 approximated carrying value.\nj. Use 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.\nk. Reclassifications\nCertain amounts included in the Consolidated Financial Statements and Notes thereto relating to prior periods have been reclassified to conform to the current presentation.\n2. Inventories (In thousands) December 31, 1995 1994\nRaw materials $4,326 $5,222 Finished goods and work in process 4,744 4,318 Total $9,070 $9,540\n3. Accrued Expenses and Other Current Liabilities (In thousands)\nDecember 31, 1995 1994\nAllowance for litigation contingencies $ 201 $ 201 Current portion of long-term debt 993 939 Accrued interest on debt 293 319 Accrued research and development 135 218 Accrued legal and audit fees 168 351 Accrued payroll and related liabilities 197 564 Financed insurance premiums 164 140 Other 311 337 Total accrued expenses and other current liabilities $2,462 $3,069\n4. Long-Term Debt\nThe Company's long-term debt balances are as follows (in thousands):\nDecember 31, 1995 1994\n10.375% convertible subordinated debentures, due April 15, 1991 through April 15, 1999 $12,500 $14,000 Less debentures purchased to meet sinking fund requirements 757 561 Total 10.375% convertible subordinated debentures $11,743 $13,439\nLong-term line of credit payable $ 3,923 $ 1,519 Long-term bank debt term loan 1,500 0 Other long-term debt 200 400 Total other long-term debt $ 5,623 $ 1,919\nInterest on the debentures is payable semi-annually. The debentures are subject to redemption through a sinking fund whereby the Company is required to redeem at face value $1,500,000 of the debentures each April 15, from 1991 through 1998. The balance is due on April 15, 1999. The debentures are convertible into shares of the Company's common stock at $19.52 per share and are redeemable in whole or in part at par. During 1995, 1994, and 1993 the Company repurchased debentures with a face amount of $2,224,000 in market transactions and called for redemption $1 million to meet future sinking fund requirements. The Company satisfied the 1995 sinking fund requirement by application of $.5 million of debentures previously repurchased and by calling for redemption the remaining $1 million. The Company has elected to satisfy the 1996 sinking fund requirement by application of $.8 million of debentures previously repurchased and redemption of the remaining $.7 million.\nThe terms of the indenture relating to the debentures restrict the Company's ability to pay cash dividends and\/or repurchase its capital stock pursuant to a formula based upon the consolidated net income of the Company and other factors. Under the formula, at December 31, 1995, no amount was available for the payment of dividends and\/or the repurchase of capital stock.\nThe Company's $6.0 million long-term line of credit from The First National Bank of Maryland (\"First National\") replaced its $4.5 million long-term line of credit from The Bank of Tokyo Trust Company in July 1994. The line of credit's borrowing base is limited to the sum of 80% of eligible accounts receivable and 35% of eligible inventory. Borrowings under the line of credit are collateralized by a pledge of substantially all of the assets of the Company with the exception of real estate. At the Company's option, borrowings under the line of credit bear interest at the lender's prime rate or the London Inter-Bank Offer Rate, as amended. The weighted average interest rate was 7.6% at December 31, 1995. In addition, the Company pays a facility fee of 1\/4 of 1% on the amount of the unused credit facility. The borrowing agreement, which expires on October 15, 1997, contains various covenants which, among other things, require the Company to maintain specified ratios of debt to tangible net worth and fixed charge coverage, and minimum levels of tangible net worth and limits capital additions. At December 31, 1995 the Company was in compliance with the covenants, as amended.\nOn October 11, 1995, Pacific, a subsidiary of the Company, obtained a $1,750,000 term loan from First National. Borrowings under the term loan, as with the Company's $6,000,000 line of credit with First National, are collateralized by a pledge of substantially all of the assets with the exception of real estate of Pacific, the Company, and its other operating subsidiaries. Unless Pacific elects otherwise in accordance with the loan documents, borrowings under the term loan will bear interest at the lender's prime rate plus .375%. The interest rate was 7.74% at December 31, 1995. The term loan, which expires on November 15, 2000, requires quarterly principal payments starting February 1996 through November 2000 and is subject to various financial covenants which are similar to the covenants of the line of credit agreement.\nSubsequent to the end of the year, through February 29, 1996, the Company purchased in market transactions $.1 million principal amount of its 10.375% convertible subordinated debentures for $.1 million.\nOther long-term debt represents the final portion of a settlement to be paid to Circa Pharmaceuticals, Inc. (formerly Bolar Pharmaceutical Co., Inc.). The December 31, 1995 balance is payable in 1997, bearing interest at prime plus 1%.\nAnnual maturities of long-term debt for each of the five years following December 31, 1995 are as follows:\nConvertible Line of Other Subordinated Credit Term Long-Term Year Debentures(1) Payable Loan (2) Debt\n1996 $ 743 $ 0 $ 250 $ 0 1997 1,500 3,923 350 200 1998 1,500 0 383 0 1999 8,000 0 383 0 2000 0 0 384 0 Subtotal 11,743 3,923 1,750 200\nLess: Current portion 743 0 250 0 Total $11,000 $3,923 $1,500 $ 200\nNote: (1) Amounts shown are net of face value of repurchased debentures and assume application of such debentures to meet, in part, sinking fund requirements for 1996.\n(2) The term loan requires quarterly principal payments commencing with $62,500 in February 1996, increasing to $87,500 in 1997 and $95,833 from 1998 through November 2000.\n5. Supplemental Pension Agreements\nIn April 1995, Health-Chem entered into five-year Employment Agreements with each of Marvin M. Speiser and Robert D. Speiser which entitle them to receive upon retirement on or after January 1, 2000, in the case of Marvin M. Speiser, and on or after January 1, 2010, in the case of Robert D. Speiser, an annual supplemental pension benefit equal to 60% of such executive's final base salary, which for this purpose will be the highest nominal annual salary paid to him during his employment. The supplemental pension will be payable for a period of ten (10) years beginning on the retirement date, or if later, the January 1, following termination of employment. In the event of termination of employment prior to the retirement date, the amount of the supplemental pension payable on that date will be prorated based on the period of employment from December 31, 1994 to the date of termination. No proration will be applied, however, if the executive's employment is involuntarily terminated. An actuarially reduced supplemental pension benefit may be paid if the benefit is commenced upon termination of employment prior to the retirement date. For the year ended December 31, 1995 the related pension accrual in the amount of $399,000 has been recorded in other long-term liabilities on the Consolidated Balance Sheets.\nNet pension cost included in the operating results for fiscal year ended December 31, 1995 consisted of the following components:\nService costs $ 50 Interest costs 107 Net amortization 242 Net pension cost $399\nThe supplemental pension agreements currently are not funded. The status of these plans at December 31, 1995 is as follows:\nAccumulated benefit obligations $<1,515> Projected benefit obligation <2,194> Plan assets in excess of projected obligation <2,194> Unrecognized prior service cost 1,795 Accrued pension cost $< 399>\nThe assumed discount rate used in determining the accumulated benefit obligation was 7% for 1995.\n6. Employee Benefit Plan\nAll permanent, full-time non-union employees of the Company are eligible to participate in Health-Chem's 401(k) Plan (the \"Plan\") following six months of employment. The Plan allows eligible employees to defer up to 20% of their income on a pre-tax basis through contributions to the Plan. The Company may contribute for each participant a matching contribution equal to a percentage of the elective contributions made by the participants. The decision to make matching contributions and the amount of such contributions will be made each year by the Company. These Company matching contributions were $59,000, $61,000, and $56,000 in 1995, 1994 and 1993, respectively.\n7. Commitments\nThe Company leases office space in New York City and two production\/warehouse facilities in Los Angeles. Minimum rental commitments required under non- cancelable operating leases having a term of more than one year as of December 31, 1995 were as follows (in thousands):\nYear Amount 1996 448 1997 448 1998 405 1999 80 Total $1,381\nRent expense was $502,000, $424,000 and $419,000 in 1995, 1994 and 1993, respectively.\nAt December 31, 1995, commitments under employment arrangements aggregated $3,084,000 through 2000. Certain employees were provided bonuses based upon defined earnings or the attainment of certain sales levels, which amounted to $416,000 and $1,194,000 in 1994 and 1993, respectively.\n8. Litigation\nIn August 1995, Key Pharmaceuticals, Inc., a subsidiary of Schering-Plough Corporation (\"Key\"), commenced an action against the Company's Hercon Laboratories subsidiary in the United States District Court for the District of Delaware alleging that Hercon Laboratories' submission to the United States Food and Drug Administration (\"FDA\") of three Abbreviated New Drug Applications (\"ANDAs\") relating to some of Hercon Laboratories' improved transdermal nitroglycerin products for which the Company is awaiting FDA approval constitutes infringement of Key's patent for its Nitro-Dur(R) products. Key seeks certain injunctive relief, monetary damages if commercial manufacture, use or sale occurs, and a judgment that the effective date for FDA approval of the above- referenced ANDAs be not earlier than February 16, 2010, the expiration date of Key's patent. By Answer and Counterclaim dated August 28, 1995, Hercon Laboratories denied the material allegations of the complaint, asserting, among other things, that the Key patent is invalid and unenforceable and that Hercon Laboratories has not infringed and does not infringe any claim of the patent. In its counterclaim against Key, Hercon Laboratories seeks a declaratory judgment of patent noninfringement, invalidity and unenforceability. Discovery in this action has commenced. Management believes that Key's claims are without merit and intends to defend the action vigorously.\nIn October 1995, Gershon Yormack, a stockholder of the Company, initiated an action in the Delaware Chancery Court (New Castle County) against the Company, its directors and its Transderm subsidiary, seeking injunctive and declaratory relief with respect to certain options to purchase Transderm common stock to be granted to each of Marvin M. Speiser, the Company's Chairman of the Board and President, and Robert D. Speiser, the Company's Executive Vice President, in 1995. Pursuant to Employment Agreements entered into in April 1995, in November 1995 the Company caused Transderm to issue an option to purchase shares of Transderm's common stock at an exercise price of $.10 per share to each of Marvin M. Speiser and Robert D. Speiser. The plaintiff alleges that this exercise price, which is the same per share price as the subscription price for Transderm common stock offered by the Company to stockholders under a registered subscription rights offering (via a prospectus dated September 18, 1995), is substantially less than the fair market value of such Transderm common stock. Management believes that the claims are without merit and intends to defend the action vigorously.\n9. Redeemable Common Stock and Stockholders' Equity\nOn July 15, 1994, the Company exercised its option to purchase 525,000 shares of the Company's Common Stock, par value $.01 per share, at $2.00 per share, from National Union Fire Insurance Company of Pittsburgh, PA. These shares are included in treasury stock. As of December 31, 1993, these shares had been classified as Redeemable Common Stock.\nIn compliance with certain restrictive covenants under the indenture governing the Company's 10.375% convertible subordinated debentures due April 15, 1999, the Company paid for the 525,000 shares from the proceeds of the substantially concurrent sale of 575,000 shares of the Company's treasury stock (\"1994 Option Shares\") at $2.00 per share, to Marvin M. Speiser. Under a Stock Purchase and Option Agreement, Mr. Speiser has granted the Company an option to purchase these shares at any time until June 30, 1999 at a price equal to his actual cost of $2.00 per share plus interest incurred on borrowings to finance the purchase. In addition, under this agreement, Mr. Speiser has agreed to vote these shares in the same proportion that all other shares of common stock are voted.\nThe effect of the above transactions on the financial position of the Company was a reduction of redeemable common stock of $1,050,000 and an increase in stockholders' equity of $1,112,000 after $38,000 of expenses of issuing the common stock.\nOn March 26, 1996, the Board of Directors of the Company approved the Company's entering into a stock purchase agreement with Marvin M. Speiser (the \"Stock Purchase Agreement\") relating to 1,782,689 shares of Common Stock owned by him subject to the Company's option to repurchase. Pursuant to the Stock Purchase Agreement, the Company will undertake a subscription rights offering of up to 1,320,000 shares of the Common Stock to its stockholders (other than Mr. Speiser). This offering will be registered under the Securities Act of 1933, as amended.\nThe Stock Purchase Agreement provides that Mr. Speiser will sell to the Company such number of shares of Common Stock as are subscribed to in the offering at a per share price equal to the combined weighted average exercise price per share of: (i) 1,207,689 shares of Common Stock which the Company has the right to acquire pursuant to an option agreement, dated as of December 28, 1990 and amended on August 30, 1991, between Mr. Speiser and the Company (the \"1991 Option Shares\"); and (ii) the 1994 Option Shares. Mr. Speiser will not receive any subscription rights in the offering but the total number of shares being offered will reflect his retention of such number of shares as would have been offered to him, pro rata. The excess, if any, of the aggregate subscription price received by the Company over the aggregate purchase price paid to Mr. Speiser will be retained by the Company to be applied against the expenses of the transaction and for other corporate purposes. The Stock Purchase Agreement also provides that upon the conclusion of the offering, the agreements relating to the 1991 Option Shares and the 1994 Option Shares and all further rights of the Company to purchase said Option Shares shall be terminated.\n10. Stockholders' Equity\na. A summary of the changes in shares of common and treasury stock is as follows: [CAPTION] Treasury Stock Common Convertible Common Stock Special Stock Stock [S] [C] [C] [C] Balance at 1\/1\/93 and 12\/31\/93 7,930,424 738,667 6,540,632\nShares repurchased (1) <525,000> 0 525,000 Shares issued (1) 575,000 <575,000>\nBalance at 12\/31\/94 7,980,424 738,667 6,490,632\nStock options exercised 2,000 0 0\nBalance at 12\/31\/95 7,982,424 738,667 6,490,632\n(1) See Note 9 to the accompanying consolidated financial statements\nb. Convertible special stock\nThe convertible special stock has the same rights as common stock except that it is nonvoting. Each share is convertible into 1 1\/3 shares of the Company's common stock. The conversion rate is subject to change under certain circumstances. No shares of convertible special stock are outstanding.\nc. Reserved shares Number of Purpose of Reservation Shares\nConversion of convertible special stock 984,889 Stock option plans 1,231,000 Conversion of 10.375% convertible subordinated debentures 601,588 Total reserved shares 2,817,477\nd. Stock rights plan\nOn February 28, 1989, the Company adopted a stock rights plan which was amended November 7, 1990. Pursuant to such plan, the Board of Directors declared a dividend of one right (\"Right\") for each share of common stock of the Company outstanding on March 21, 1989. In the event that a person or affiliated group, other than any present officer or director, acquires, obtains the right to acquire, or tenders for 30% or more of the Company's outstanding common stock (other than through certain permissibly structured tender offers), then each holder of a Right, other than the 30% stockholder or tender offeror, shall be entitled to receive upon exercise of each Right, common shares of the Company which have a market value equal to two times the exercise price of the Right, or capital stock of the acquiring company which has a market value of two times the exercise price of the Right.\nThe Company may redeem the Rights for a nominal amount at any time prior to 10 days (subject to extension by the Board of Directors) after a person or group acquires or tenders for 30% or more of the Company's common stock. Unless redeemed earlier, all Rights expire on February 27, 1999.\n11. Stock Options\nOptions granted under various stock option plans are exercisable in installments commencing one year from the date of grant and expire five to ten years from the grant date.\nTransactions under the plans were as follows:\nNumber of Range of Option Shares Price Per Share\nBalance, January 1, 1993 570,200 $2.50 - $11.13\nGranted during 1993 152,000 3.75 Exercised during 1993 -0- Cancelled or expired during 1993 <121,500> 2.50 - 10.63\nBalance, December 31, 1993 600,700 2.50 - 11.13\nGranted during 1994 179,000 3.25 Exercised during 1994 -0- Cancelled or expired during 1994 <82,100> 3.25 - 10.25\nBalance, December 31, 1994 697,600 2.50 - 11.13\nGranted during 1995 -0- Exercised during 1995 <2,000> 2.50 Cancelled or expired during 1995 <80,600> 3.25 - 11.13\nBalance, December 31, 1995 615,000 2.50 - 10.25\nExercisable portion at December 31, 1995 343,800\nAvailable for future grant at December 31, 1995 616,000\nIn March 1995, the Company adopted the 1995 Performance Equity Plan (\"1995 Plan\") which was designed to attract and retain employees of the highest caliber, to provide increased incentive for officers and key employees and to continue to promote the well-being of the Company. Pursuant to the 1995 Plan, up to an aggregate of 600,000 shares of the Company's Common Stock are available for the granting of stock or stock related incentive awards.\nPursuant to the five-year Employment Agreements referred to in Note 5, on November 13, 1995, the Company caused its 90% owned subsidiary Transderm Laboratories Corporation (\"Transderm\") to enter into stock option agreements with Robert D. Speiser and Marvin M. Speiser allowing each of them to purchase 5,000,000 shares of Transderm's common stock at $.10 per share, which was the per share subscription exercise price in Transderm's initial public offering effected pursuant to the Plan of Reorganization and Asset Exchange Agreement referred to in Note 1a. The options are exercisable in full commencing November 13, 1996, each such option representing ten percent (10%) of the outstanding common stock of Transderm on a fully-diluted basis.\nDuring October 1995, the FASB issued Statement No. 123, \"Accounting for Stock- Based Compensation\". SFAS 123 encourages employers to adopt its prescribed fair value-based method of accounting to recognize compensation expense for employee stock compensation plans, however, it does allow the Corporation to continue to account for its plans using its current method. The Corporation intends to adopt the provisions of SFAS 123 effective January 1, 1996 under its disclosure-only alternative.\n12. Taxes on Income (In thousands)\nYear Ended December, 31, 1995 1994 1993 Taxes on income include provision for: Federal income taxes $ <105> $ 680 $ <228> State and local income taxes 63 167 78 Total $ <42> $ 847 $ <150>\nTaxes on income are comprised of: Currently payable $ 236 $ 414 $ <173> Deferred payable <278> 433 23 Total $ <42> $ 847 $ <150>\nCharged to: Income before extraordinary gain $ <45> $ 844 $ <150> Extraordinary gain on repurchase of debentures 3 3 0 Total $ <42> $ 847 $ <150>\nA reconciliation of taxes on income to the federal statutory rate is as follows:\nYear Ended December, 31, 1995 1994 1993\nTax provision at statutory rate $ <107> $ 771 $ 844 Increase resulting from: State and local taxes, net of federal tax benefit 13 128 144 Proceeds from officer's life insurance 0 <81> 0 Reversal of previously provided income taxes 0 0 <411> Recognition of tax loss and tax credit carryforwards (not previously recognized) 0 <7> <774> Intangibles and officers' life insurance premiums 20 14 35 Other 32 22 12 Tax provision $ <42> $ 847 $ <150>\nAt December 31, 1995 and 1994, the deferred tax liabilities and assets result from the following temporary differences and carryforwards:\n1995 1994\nLiabilities: Leveraged leases $ 0 $<1,968> Accelerated depreciation <1,097> <1,078> Other <65> <67> Subtotal <1,162> <3,113>\nAssets: Net operating and other tax loss carryforwards 8,730 9,815 Tax credit carryforwards 709 1,039 Provision for litigation contingencies 189 283 Allowances for bad debts 285 341 Inventory reserves 207 302 Capitalization of overhead costs as inventory in accordance with tax laws 187 243 Leveraged leases 0 305 Retirement benefits 187 0 Other 21 128 Subtotal 10,515 12,456 Valuation Allowance <8,730> <9,918> Total $ 623 $ <575>\nAt December 31, 1995, the net deferred tax asset is comprised of a current asset of $631,000 partially offset by a non-current liability of $8,000. The net deferred tax liability at December 31, 1994 is comprised of a non-current liability of $317,000 and a current liability of $334,000 which is offset by a current asset of $76,000. These amounts are included in deferred income taxes, income taxes payable and other current assets in the consolidated balance sheets as of December 31, 1995 and 1994. For the year ended December 31, 1995 the valuation allowance decreased by $1,188,000 primarily as a result of utilization of federal net operating loss carryforwards. In 1995, the leveraged lease term expired thus reversing the remaining deferred tax liabilities and related reserves.\nAt December 31, 1995, the Company had approximately $13 million of net operating loss carryforwards for federal income tax purposes which expire in various years from 2000 through 2007 and tax credit carryforwards that expire in various years from 1996 through 2008. The Company also had net operating loss carryforwards in various states in which the Company and its subsidiaries operate which are available to absorb allocated portions of future taxable income for state tax purposes. The state operating loss carryforwards expire from 1996 through 2009. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes the deferred tax asset net of a valuation allowance is an amount that is more likely than not to be realized. 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.\n13. Interest Expense - Net (In thousands)\nYear ended December 31, 1995 1994 1993 Interest expense $1,646 $1,605 $ 1,652 Interest income <175> <178> <183> Capitalized interest <120> <83> 0\nTotal interest expense - net $1,351 $1,344 $ 1,469\n14. Other Income - Net (In thousands) Year ended December 31, 1995 1994 1993 Recovery of litigation losses $ 0 $ 0 $ 568 (A) Rental income 319 340 473 Other income net of expense 193 289 110 Other income - net $ 512 $ 629 $1,151\n(A) Consists of a payment of $340,000 from the Company's general liability insurance carrier representing a recovery of certain defense costs and adjustments to the allowance for litigation contingencies.\n15. Extraordinary Gain\nThe Company's Board of Directors has authorized the repurchase (subject to certain bank credit facility restrictions) of up to $12 million in principal amount of the Company's 10.375% convertible subordinated debentures to be used to satisfy redemption requirements which began in April 1991. As of December 31, 1995, $7,257,000 principal amount of debentures had been repurchased in market transactions and $1,000,000 were called for redemption. Extraordinary gains on the repurchase of debentures during 1995, 1994 and 1993 have been recognized as follows (in thousands):\n1995 1994 1993\nExtraordinary gain from repurchase of subordinated debentures before taxes $ 10 $ 8 $ 75 Tax provision (See Note 12) <3> <3> 0 Extraordinary gain from repurchase of subordinated debentures $ 7 $ 5 $ 75\n16. Segment Information and Foreign Sales\nThe Company's operations consist of a single dominant segment which manufactures and distributes several products. These products are related mainly by manufacturing processes requiring lamination of materials and usually involve common technological features such as the slow timed release of various substances. Most products are wholesaled through distributors or to other manufacturers.\nForeign sales, consisting primarily of sales to European countries, were $2.0 million or 4% of sales in 1995. In each of 1995, 1994 and 1993, foreign sales were less than 10% of total revenues.\nIn 1995, 1994 and 1993, sales of transdermal nitroglycerin patches to Mylan Pharmaceuticals, Inc. accounted for approximately 14%, 12% and 12% of consolidated net sales, respectively.\n17. Related Party Transactions\nThe consolidated financial statements include the following items applicable to related parties (in thousands): December 31, Balance Sheets: 1995 1994\nReceivable from director and executive officer included in other current assets (1994 balance repaid in February 1995) $254 $ 60\n10.375% convertible subordinated debentures held by directors and executive officers 467 524\nStockholder notes receivable arising from exercise of stock options 148 188\nYear ended December 31, Income Statements: 1995 1994 1993\nManagement fees - charged to selling, general and administrative expense $ 20 $ 60 $ 60\nInterest expense - net 36 54 39\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nAt its board meeting on November 13, 1995, the Board of Directors of the Company approved the recommendation of the Company's Audit Committee to appoint the accounting firm of Coopers & Lybrand L.L.P. as independent accountants for the Company for the year ending December 31, 1995. The audit work of Deloitte & Touche LLP was terminated as of November 13, 1995. During the two most recent fiscal years and subsequent interim period preceding the termination of Deloitte & Touche LLP, there were no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure or any reportable events. Deloitte & Touche LLP's report on the financial statements for the past two years contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles.\nFORM 10-K PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information responsive to this item is incorporated by reference to the Company's Proxy Statement in connection with the registrant's Annual Meeting of Stockholders to be held on May 7, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information responsive to this item is incorporated by reference to the Company's Proxy Statement in connection with the registrant's Annual Meeting of Stockholders to be held on May 7, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information responsive to this item is incorporated by reference to the Company's Proxy Statement in connection with the registrant's Annual Meeting of Stockholders to be held on May 7, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information responsive to this item is incorporated by reference to the Company's Proxy Statement in connection with the registrant's Annual Meeting of Stockholders to be held on May 7, 1996.\nFORM 10-K PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPAGE (a) 1. FINANCIAL STATEMENTS\nIndependent Auditors' Reports 13-14\nConsolidated Balance Sheets-December 31, 1995 and 1994 15-16\nConsolidated Statements of Operations Years Ended December 31, 1995, 1994 and 1993 17\nConsolidated Cash Flow Statements Years Ended December 31, 1995, 1994 and 1993 18-19\nConsolidated Statements of Stockholders' Equity Years Ended December 31, 1995, 1994 and 1993 20\nNotes to Consolidated Financial Statements 21-34\n(a) 2. FINANCIAL STATEMENT SCHEDULES\nSchedule II - Valuation and Qualifying Accounts and Reserves 40\nAll other schedules are omitted because they are not required, are inapplicable, or the information is included in the financial statements or notes thereto.\n(a) 3. EXHIBITS\n2. Plan of Reorganization and Asset Exchange Agreement dated as of June 30, 1995, by and among the Company, Herculite Products, Inc. (\"Herculite\") and Transderm Laboratories Corporation (\"Transderm\"). Incorporated herein by reference to Exhibit 2 to Registration Statement on Form S-1 (Reg. No. 33-95080) for Transderm, as filed with the Commission on July 28, 1995.\n3.1 Restated Certificate of Incorporation and amendments of the Registrant. Incorporated herein by reference to Exhibit No. 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985.\n3.2 Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant dated May 8, 1987. Incorporated herein by reference to Exhibit No. 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n3.3 By-Laws of the Registrant. Incorporated herein by reference to Exhibit 3.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n4.1 Indenture relating to the Company's 10 3\/8% Convertible Subordinated Debentures due 1999. Incorporated herein by reference to Exhibit No. 4.2 to the Company's Registration Statement on Form S-7 (Reg. No. 2- 71341) as filed with the Commission on April 15, 1981.\n4.2 Rights Agreement between the Company and Harris Trust Company of New York as Rights Agent dated February 28, 1989. Incorporated herein by reference to Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.\n4.3 Amendment dated as of November 7, 1990 to the Rights Agreement between the Company and Harris Trust Company of New York as Rights Agent dated February 28, 1989. Incorporated herein by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.1 The 1986 Stock Option Plan as approved by the Company's Stockholders on April 26, 1986 and as amended by the Company's Board of Directors on December 30, 1987. Incorporated herein by reference to Exhibit No. 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.2 The 1980 Stock Option Plan. Incorporated herein by reference to Exhibit 10.1 to Form S-8 as filed with the Commission on March 1, 1983.\n10.3 Amendment to the 1980 Stock Option Plan as approved by the Company's Board of Directors on December 30, 1987. Incorporated herein by reference to Exhibit No. 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.4 Second Amendments to the 1986 Stock Option Plan and the 1980 Stock Option Plan as approved by the Company's Board of Directors on May 6, 1993. Incorporated herein by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.5 The 1995 Performance Equity Plan. Incorporated herein by reference to Exhibit A to the Company's definitive Proxy Statement dated March 1, 1995 in connection with the Company's 1995 Annual Meeting of Stockholders.\n10.6(a) Loan and Security Agreement between the Company, Hercon Laboratories Corporation (\"Hercon Laboratories\"), Herculite, Pacific Combining Corporation (\"Pacific\") and The First National Bank of Maryland (\"First National\") dated July 15, 1994. Incorporated herein by reference to Exhibit 1 to Current Report on Form 8-K filed with the Commission on July 25, 1994.\n10.6(b) Modification Agreement dated August 31, 1995 by and between First National, the Company, Hercon Laboratories, Herculite, Pacific, Hercon Environmental Corporation (\"Hercon Environmental\") and Transderm. Incorporated herein by reference to Exhibit 10.6(b) to Amendment No. 1 filed with the Commission on September 6, 1995 (\"Amendment No. 1\") to Transderm's Registration Statement on Form S-1 No. 33-95080 filed with the Commission on July 28, 1995.\n10.6(c) Second Modification Agreement dated as of October 11, 1995 by and between the Company, Hercon Laboratories, Herculite, Pacific, Hercon Environmental and Transderm. Incorporated herein by reference to Exhibit 10.5 to the Company's Report on Form 10-Q for the quarter ended September 30, 1995. (Commission File No. 1-6787).\n10.7 Stock Purchase and Option Agreement by and between Marvin M. Speiser and the Company dated July 15, 1994. Incorporated herein by reference to Exhibit 3 to Current Report on Form 8-K filed with the Commission on July 25, 1994.\n10.8 Indemnification Agreement between Marvin M. Speiser and Laura G. Speiser and the Company dated July 15, 1994. Incorporated herein by reference to Exhibit 4 to Current Report on Form 8-K filed with the Commission on July 25, 1994.\n10.9 Stipulation and Agreement of Compromise and Settlement dated March 15, 1991 and amended on June 7, 1991 with respect to Delaware Stockholders' Derivative Action. Incorporated herein by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.10 Lease Agreement between Herculite and WORCO dated August 17, 1994. Incorporated herein by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.11 Amended and Restated Option Agreement, dated as of August 30, 1991, by and between Marvin M. Speiser and the Company. Incorporated herein by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.12 Distribution Agreement between Hercon Laboratories and Bolar Pharmaceutical Co., Inc. dated as of January 4, 1993. Incorporated herein by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.13 Employment Agreement between Marvin M. Speiser and the Company dated April 4, 1995. Incorporated herein by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1995.\n10.14 Employment Agreement between Robert D. Speiser and the Company dated April 4, 1995. Incorporated herein by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended March 31, 1995.\n10.15 Stock Option Agreement between Transderm and Marvin M. Speiser dated November 13, 1995. Incorporated herein by reference to Exhibit 10.3 to Tranderm's Annual Report on Form 10-K for the year ended December 31, 1995.\n10.16 Stock Option Agreement between Transderm and Robert D. Speiser dated November 13, 1995. Incorporated herein by reference to Exhibit 10.4 to Transderm's Annual Report on Form 10-K for the year ended December 31, 1995.\n10.17 Asset Acquisition Agreement dated April 28, 1995 between Hercon Environmental and Hercon Laboratories. Incorporated herein by reference to Exhibit 10.7 to Transderm's Registration Statement on Form S-1 Reg. No. 33-95080 as filed with the Commission on July 28, 1995.\n10.18 $7,000,000 principal amount Subordinated Promissory Note of Hercon Laboratories. Incorporated herein by reference to Exhibit 10.8 to Amendment No. 1.\n10.19 Corporate Services Agreement dated as of August 31, 1995 between the Company and Transderm. Incorporated herein by reference to Exhibit 10.9 to Amendment No. 1.\n10.20 Tax Sharing Agreement dated as of August 31, 1995 between the Company and Transderm. Incorporated herein by reference to Exhibit 10.10 to Amendment No. 1.\n10.21 Loan and Security Agreement dated as of October 11, 1995 by and between Pacific, the Company, Hercon Laboratories, Herculite, Hercon Environmental and Transderm and First National. Incorporated herein by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated October 11, 1995.\n22 Subsidiaries of the Registrant. Filed herewith on page 42.\n(b) REPORTS ON FORM 8-K\nDuring the quarter ended December 31, 1995 the Company filed the following two reports on Form 8-K:\n(1) Report dated October 11, 1995 in connection with the Company's Pacific Combining subsidiary obtaining a $1,750,000 term loan from the First National Bank of Maryland;\n(2) Report dated November 13, 1995 in connection with the Company's change in independent accountants.\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.\nHEALTH-CHEM CORPORATION\nDate: March 26, 1996\n\/s\/ Marvin M. Speiser \/s\/ Paul R. Moeller By: Marvin M. Speiser By: Paul R. Moeller Chairman of the Board and Vice President-Finance President (Principal (Principal Financial Officer) Executive Officer) (Principal Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following Directors on behalf of the Registrant on the dates indicated:\n\/s\/ Bruce M. Schloss Martin Benis Bruce M. Schloss March 26, 1996\n\/s\/ Steven Bernstein \/s\/ Gregory P. Speiser Steven Bernstein March 26, 1996 Gregory P. Speiser March 26, 1996\n\/s\/ Matthew Goldstein \/s\/ Marvin M. Speiser Matthew Goldstein March 26, 1996 Marvin M. Speiser March 26, 1996\n\/s\/ Samuel R. Goodson \/s\/ Robert D. Speiser Samuel R. Goodson March 26, 1996 Robert D. Speiser March 26, 1996\n\/s\/ Paul R. Moeller \/s\/ Milton Y. Zussman Paul R. Moeller March 26, 1996 Milton Y. Zussman March 26, 1996\n\/s\/ Eugene Roshwalb Eugene Roshwalb March 26, 1996","section_15":""}
{"filename":"312907_1995.txt","cik":"312907","year":"1995","section_1":"ITEM 1. BUSINESS\nVallen Corporation (together with its subsidiaries, the \"Company\" or \"Vallen\") was incorporated under the laws of Texas in 1960 as the successor to a business founded in 1947. The Company operates a manufacturing subsidiary, Encon Safety Products, Inc. (\"Encon\"), a distribution subsidiary, Vallen Safety Supply Company (\"Vallen Safety\"), and an inactive import subsidiary, Safety World, Inc. Vallen Safety operates a Canadian subsidiary, Vallen Safety Supply Company, Ltd. (\"Vallen Safety Canada\"). Additionally, Vallen Safety, through a 50% owned Mexican company, Proveedora de Seguridad Industrial Del Golfo, S.A. (\"Proveedora\") engages in distribution in Mexico.\nVallen Safety is a distributor of industrial safety and health products designed for the protection of the individual worker and the workplace environment. Its customer base is nationwide; major markets serviced include chemical production, oil and gas extraction, railroad transportation, petroleum refining, utilities, pulp and paper products, primary metals extraction, general manufacturing, various governmental agencies, business services, transportation equipment, electrical machinery and construction. Encon manufactures industrial safety equipment for sale by Vallen Safety and unaffiliated distributors. During the past fiscal year, the distribution and manufacturing segments contributed 68% and 32%, respectively, of the Company's operating income before corporate general and administrative expenses.\nThe table included in Note 12 to the Company's Consolidated Financial Statements provides certain information regarding Vallen's distribution and manufacturing industry segments for the Company's last three fiscal years.\nThe Company's corporate headquarters are in Houston, Texas. Corporate management has responsibility for overall organization, planning, business development and control of Company operations, as well as specific oversight in the areas of compensation and benefits, finance and accounting, data systems, risk management, taxes and employee training and development.\nDISTRIBUTION\nVallen Safety distributes a broad range of personal protective and other safety and health related products and services, including approved respiratory equipment and gas detection instruments to meet specific safety and health needs of industrial customers. Respiratory equipment and atmospheric hazard detection instruments are used where work is performed in limited breathing environments, or where workers are exposed to hazards associated with possible escape of toxic or combustible gases or to carcinogens and other dangerous atmospheric particulates.\nSupplied-air respiratory equipment includes both portable self-contained units and air line respirators worn by industrial, fire fighting and other personnel in environments where ambient conditions require a dependable, alternative source of breathable air. Supplied-air respiratory equipment contributed 7.8%, 9.8% and 10.7% of consolidated net sales for the years ended May 31, 1995, 1994 and 1993, respectively. The organization distributes air purifying equipment including gas masks, chemical cartridge and particulate type respirators for protection against breathing dusts, mists, fumes and fogs associated with certain industrial process environments.\nA wide variety of personal protective equipment and other workplace commodities is distributed, including eye protection devices, head and hearing protection items, gloves, first aid products and emergency shower and eye-wash products, as well as protective clothing and similar items. As an additional service business, a program has been added to provide prescription safety eyewear service at specific customer sites.\nVallen Safety markets a series of portable electronic instruments and colorimetric tubes used to detect and measure the presence and levels of toxic and combustible gases or oxygen deficient atmospheres. Portable devices used in enforcing industrial pollution control programs are also marketed.\nOther product lines include fire safety equipment and fire control agents, ergonometric enhancing products, material handling equipment and netting, safety signs, lights and alarms.\nVallen Safety's distribution activities are controlled centrally from the distribution headquarters in Houston. Across the U.S., Vallen Safety has six regional hubs that use their large distribution centers to ship directly to customers and to supply the 35 satellite branches. Sales representatives receive training from Vallen Safety and certain of its suppliers regarding appropriate applications and relevant regulatory and industry standards for various kinds of safety and health equipment. Vallen Safety also sponsors safety equipment and safety awareness training programs and seminars for customer personnel.\nVallen Safety has steadily expanded its \"in-plant store\" concept: safety stores physically located on the customers' premises. The stores distribute a variety of products directly to customer personnel, and Vallen Safety manages the safety inventory stocks for the customers. The number of in-plant stores now totals 25.\nVallen Safety maintains service centers which inspect, repair and calibrate respiratory equipment and electronic atmospheric hazard detection instruments. Vallen Safety also operates mobile respiratory service vans, staffed by factory certified technicians who perform scheduled in-plant inspection and repair work for customers.\nVallen Safety purchased 50% of the outstanding common stock of Proveedora, a health and safety products distribution company headquartered in Tampico, Mexico, on December 17, 1992. Proveedora, a company organized under the laws of Mexico, represents many of the same industrial safety equipment suppliers that Vallen Safety does. It operates through 16 locations throughout Mexico.\nVallen Safety opened its first Canadian branch operation in May, 1993. Vallen Safety Supply Company, Ltd., a company organized under the laws of Canada, was formed to conduct those operations. The Canadian company generally represents the same supplier group as Vallen Safety's U.S. operations. There are currently 3 Canadian branch operations. Sales at these locations for the year ended May 31, 1995 were approximately $3,000,000.\nThe Company has announced the following acquisitions transactions, which have been completed subsequent to May 31, 1995:\n(1) Vallen Corporation and Vallen Safety announced the closing of the purchase of a 50% interest in Century Sales and Service Limited (Century), a Canadian corporation, that is an Edmonton, Alberta based distributor of mill supply and industrial hardware products as of June 6, 1995. Additional considerations for the 50% purchase will be paid in January, 1996 based upon the audited financial results of Century's November 30, 1995 fiscal year. Vallen has the option to purchase the remaining 50% interest in Century based upon a purchase formula either 5 or 6 years following the initial 50% purchase price closing date. Century operates a major distribution center at its Edmonton corporate headquarters, with a total of 12 distribution sites in Alberta and Saskatchewan provinces. Its operations cover these two Canadian provinces plus the Northwest and Yukon territories and parts of British Colombia. Century's sales are approximately $50 million Canadian annually. It employs approximately 214 people in its operations.\n(2) Effective July 24, 1995, Vallen Corporation and Vallen Safety completed the purchase of the major assets and assumption of certain liabilities, as well as the rights, to the name of Safety Centers Incorporated (SCI), a South Holland (Chicago) Illinois based distributor of safety equipment and protective clothing, as well as novelty merchandise through 22 on-site safety center locations and two distribution hubs. SCI employs approximately 120 persons. SCI's primary markets are in the steel production and automobile and related parts manufacturing sectors. Its markets are throughout the United States, with particular concentration in the midwest. The safety stores will be operated as a division of Vallen Safety. SCI's annual sales are approximately $25 million.\n(3) Effective August 18, 1995, Vallen acquired 100% of the capital stock and the business of All Supplies, Inc., a Baton Rouge, Louisiana based distributor of mill, safety and industrial welding supplies. All Supplies sales are approximately $9 million annually.\nVallen Safety's distribution operations sell to a diverse customer base. No customer accounted for 10% or more of consolidated revenues. Sales to Proveedora and to domestic companies for export purposes were less than 3% of distribution net sales during the year ended May 31, 1995. Vallen Safety is unable to assess its overall market position relative to other competing entities due to the overall fragmented nature of its principal business.\nOf the more than 400 suppliers whose products are regularly distributed by Vallen Safety, the top 10 accounted for approximately 40% in dollar amount of distribution sales during the year ended May 31, 1995. All of the Company's arrangements with suppliers are terminable by either party on short notice. Sales of respiratory equipment purchased from Scott Aviation, a division of Figgie International, Inc., comprised approximately 8.5% in dollar amount of all products sold during the year ended May 31, 1995. Termination of Vallen Safety's distribution of Scott equipment could have a materially adverse effect on the Company's business. Vallen has been a distributor of safety equipment manufactured by Scott continuously since 1953 and considers its relations with this supplier to be satisfactory. No other supplier accounted for as much as 10% in dollar amount of distribution products sold during the year ended May 31, 1995.\nCompetitive factors in distribution of safety and health products include quality and breadth of lines distributed, ability to fill orders promptly from inventory, technically knowledgeable sales personnel, reputation, service and repair capability in certain product lines, and price. The Company maintains adequate inventories in order to avoid any substantial distribution backlog created by unfilled customer orders. The Company engages in active competition with a large number of other safety and health product distributors in each of its product lines and geographical markets. Most such distributors are small enterprises selling to customers in a limited geographic area. Most manufacturers of industrial safety and health products sell through distributors because of the relative direct marketing costs of a narrow product line to customers. One of the major competitors in the industry, however, is an integrated manufacturer and distributor of safety and health products whose sales, earnings and financial resources exceed Vallen's; however, this competitor's principal geographical areas of concentration are not within Vallen's primary market areas.\nMANUFACTURING\nEncon was formed in 1964 to produce specialized safety equipment for which the Company could find no suitable source of supply to meet customer needs. Encon currently manufactures various lines of safety equipment for use in industries where workers are exposed to potentially hazardous conditions. Many components of its manufactured products are fabricated by others, although on- site tooling and fabrication have been implemented where justified by volume, cost and other factors.\nEncon produces fixed and portable eye-wash and face-wash equipment and emergency drench and enclosed showers for use in plant areas where workers risk contact with dangerous chemicals or other similar hazards.\nEncon produces the Encon 160, a chemical splash goggle which is designed to be cosmetically appealing to the worker and incorporates a replaceable cylindrical lens for increased clarity and peripheral vision. Encon also specializes in the manufacturing of other protective eyewear including the first spherical-lens protective goggle. This spherical-lens goggle provides the customer with a less expensive alternative to the Encon 160, while maintaining the optimum in eye protection. Encon also produces a high quality visitor spectacle which meets industry specifications and standards for primary protective eyewear.\nEncon Custom Plastics, a division of Encon acquired in February 1990, is a contract manufacturer of vacuum formed and injection molded thermoplastic parts. Its primary product line includes wall cases for emergency self-contained breathing apparatus and fire extinguishers, Therma Flow covers, AWARENESS(TM) shower signs and various other products manufactured by vacuum forming and molding.\nEncon manufactures cool air delivery systems for individual workers. These systems utilize the vortex tube assembly (a no-moving-parts heat exchanger) to separate delivered compressed air into hot and cold streams and, in conjunction with insulated aluminized reflective garments, permit safe and comfortable working environments for extended periods in conditions of high ambient temperature and radiant heat.\nDuring the year ended May 31, 1995, 31% of manufacturing net sales were made to the Company's distribution operations. The remaining 69% were made primarily to unaffiliated regional distributors and, to a lesser extent, to industrial mail-order catalog firms, overseas sales representatives, certain industrial users and distributors specializing in particular market segments. Encon also sells vortex tube assemblies and certain other components to original equipment manufacturers for incorporation into finished products. Manufactured products are marketed primarily under the \"Encon\" name. Other than as noted above, no single customer accounted for 10% or more of net sales for the manufacturing operations for the year ended May 31, 1995.\nApproximately $1,985,000, or 10%, of manufacturing net sales for the year ended May 31, 1995, were to foreign purchasers in various geographical regions. The Company accepts payment only in United States dollars and makes sales outside the United States only to established customers or against letters of credit drawn on major money center banks.\nEncon competes with numerous other manufacturers, some of which have substantially greater resources. The Company does not believe that its manufactured products account for a significant share of any of its markets. The Company does not consider that its manufacturing operations or its business as a whole are materially dependent upon any one product or any related group of products.\nEffective January 12, 1995, Vallen Corporation invested cash to acquire a 50% equity interest in Nuclear Utility Products, Inc. (NUPRO), a new company formed to manufacture and supply protective clothing and engineered products used in the nuclear power production business. Vallen, through its wholly-owned distribution subsidiary, Vallen Safety, has contracts to supply safety products to the Tennessee Valley Authority (TVA). Vallen's partner in NUPRO has 25 years experience in the manufacture and supply of such protective clothing and related products to the nuclear power industry. The size of NUPRO and the results of operations of this company are not significant to Vallen Corporation or its distribution subsidiary.\nThe Company's manufacturing operations are not dependent on one or a small number of suppliers or fabricators for any raw materials or tooled components.\nREGULATION\nMarketability of the Company's distributed and manufactured products depends, in many instances, upon compliance with manufacturing, quality control, performance, test and other published standards of entities such as the Occupational Safety and Health Administration (\"OSHA\"), the National Institute for Occupational Safety and Health (\"NIOSH\"), the American National Standards Institute (\"ANSI\"), the American Society of Testing Materials (\"ASTM\"), Underwriters' Laboratories (\"UL\"), Factory Mutual (\"FM\"), and the Canadian Standards Association (\"CSA\"). To the extent applicable, the Company's manufactured products currently meet or exceed such published standards or criteria, and compliance of various other products marketed by Vallen Safety is certified by their manufacturers. Such standards could, however, change in the future so as to render one or more of Vallen's products or product lines at least temporarily unmarketable. The Company believes that the manufacturers of its products, including its manufacturing subsidiary, should be able to adapt such products to any reasonably foreseeable new standards which might be adopted in the future.\nThe Company believes that compliance by its customers with federal regulations regarding occupational safety and health has been an important factor in its past growth. The Company cannot predict the level of future regulation.\nINSURANCE\nFailure of a safety product marketed or manufactured by the Company could expose it to large damage claims. The Company is named as an additional insured under the products liability policies maintained by certain of its suppliers and maintains product liability and other insurance in amounts believed by the Company to be in accordance with industry practices. Nevertheless, such insurance coverage may not be adequate to protect the Company against all liability or loss which might arise from a product failure.\nEMPLOYEES\nThe Company employed 732 persons at May 31, 1995 and believes that relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nVallen's corporate and distribution headquarters are located in a 50,000 square foot building in northwest Houston. The building, constructed in 1978, and the five-acre tract on which it is situated, are owned by the Company. The Company constructed a new 65,000 square foot manufacturing facility in Houston and the Houston manufacturing operation moved into the new facility in fiscal 1991. The existing corporate and distribution headquarters' staff absorbed the space vacated by the manufacturing personnel. The Company owns and operates a 10,000 square foot manufacturing facility in Coudersport, Pennsylvania and leases a 15,000 square foot manufacturing facility in Houston, Texas. The Company owns branch-warehouses with an aggregate of 207,000 square feet of space in Mobile, Alabama; Bolingbrook (Chicago), Illinois; Baton Rouge, Louisiana; Philadelphia, Pennsylvania and Beaumont, Brazosport, Corpus Christi, Dallas, Odessa and Pasadena, Texas; and leases an aggregate of 264,000 square feet of warehouse and office space in Birmingham, Alabama; Anchorage, Alaska; Phoenix, Arizona; Sacramento, Pittsburg and Los Angeles, California; Atlanta, Georgia; Peoria, Illinois; Waterloo, Iowa; Lake Charles and New Orleans, Louisiana; Baltimore, Maryland; Midland, Michigan; Albuquerque, New Mexico; Charlotte, North Carolina; Canton, Ohio; Tulsa, Oklahoma; Knoxville, Nashville, Kingsport and Memphis, Tennessee; Austin, Houston, Longview and Texas City, Texas; Richmond, Virginia; Seattle and Longview, Washington; and Kingston, Ottawa, Sarnia and Toronto, Ontario, Canada.\nAs a part of the restructuring process described in the Management's Discussion and Analysis section, the Company closed four locations, aggregating some 24,000 square feet of warehouse and office space in fiscal 1995.\nAggregate rentals of real property during the year ended May 31, 1995 were $1,157,000. Reference is made to Notes 5 and 10 of the Notes to Consolidated Financial Statements for information regarding mortgages on real estate and commitments under long-term operating leases. The Company considers all property owned or leased by it to be well-maintained, adequately insured and suitable for its purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNo claims are currently pending against the Company other than claims in the ordinary course of business which are not material or as to which the Company believes it either has adequate insurance coverage or has made adequate provision.\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 during the fourth quarter of the year ended May 31, 1995.\nPART I I\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock began public trading on October 9, 1979 and is traded over-the-counter on the NASDAQ National Market System under the symbol VALN. At August 4, 1995 there were approximately 1,500 holders of the Company's Common Stock including individual participants in certain security position listings. The Company has not paid any cash dividends on its Common Stock since its organization.\nThe following table sets forth for the periods indicated the high and low sale prices for the Company's common stock as reported by the NASDAQ Stock Market.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nVALLEN CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA\nIN THOUSANDS (EXCEPT PER SHARE DATA)\n* Adjusted for stock split in 1991.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's discussion and analysis of certain aspects of the Company's results of operations and financial conditions should be read in conjunction with the Consolidated Financial Statements and the Selected Financial Data included elsewhere herein.\nRESULTS OF OPERATIONS\nThe table below is presented to assist in analyzing changes in operating results for the fiscal years 1995, 1994 and 1993, indicating changes in various items in the statement of earnings as a percentage of net sales, and the increase (decrease) in such items in 1995, 1994 and 1993 compared to the prior year.\n\/(1)\/ This amount includes categories interest and dividend income, interest expense, earnings from foreign affiliate and other income and expense in the Consolidated Statement of Earnings.\nSales increased in the year ended May 31, 1995. Gross profit for the distribution segment was down slightly, as a percentage of net sales, while operating expenses were flat. The gross profit margin reduction results primarily from increased importance of renewing annual sales contracts with larger national and multi-national customers and strong competition in markets serviced by the Company. Additionally, the Company's manufacturing segment experienced significant materials cost increases in the current fiscal year, not all of which were passed through to customers during the year due to market competition conditions. This combination and the Company's ability to hold down the rate of operating expense increase during the year resulted in increased net earnings. The Company continues to invest in the long-term growth of the Company through the opening of more efficient distribution facilities, upgrading of its manufacturing facilities and by continuing to expand market share. Management believes that technology investment is a key to future success and expansion of the Company's business.\nThe Company purchased a 50% interest in Proveedora, based in Tampico, Mexico, on December 17, 1992. The initial investment and subsequent capital contribution was $2,767,000. Gross sales for Proveedora for the years ended May 31, 1995 and 1994, in U.S. dollar equivalents, were $7,701,000 and $6,927,000, respectively.\nNET SALES\nConsolidated net sales increased $17,533,000 or 9.4% during fiscal 1995 as compared to an increase of $10,146,000 or 5.8% in 1994. Sales increased 9.4% in the distribution segment and 6.7% in the manufacturing segment during fiscal 1995. The increase in consolidated sales for fiscal 1995 and 1994 was primarily due to new distribution branches and in-plant facilities being opened in fiscal 1995 and 1994, as well as the growth in the national accounts programs. The increase in the manufacturing sales level was primarily related to a volume increase in the shower and eye protection lines.\nGROSS PROFIT\nConsolidated gross profit as a percentage of net sales was 26.2%, 26.5% and 27.3% for fiscal years 1995, 1994 and 1993, respectively. The manufacturing subsidiary's gross profit margins increased slightly in fiscal 1995. The distribution subsidiary's sales, which are at a lower gross profit margin, were a greater percentage of the consolidated total sales. Gross profit margins for the distribution operations were slightly lower each of the past three years, due to increased competition for relatively flat markets in the personal protection product lines, and in part a result of the increasing percentage of total net sales attributable to high volume, lower margin national supply contract sales. These factors, in combination with a trend toward lower distribution margin, resulted in a lower consolidated margin in fiscal 1995 and 1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses, as a percentage of net sales, decreased to 20.7% in fiscal 1995, compared to 22.2% in 1994 and 21.7% in 1993. Included in fiscal 1994's expenses are restructuring charges of $460,000, comprised of $350,000 of lease obligations and $110,000 of severance pay for the Company's employee terminations. Selling, general and administrative expenses increased 2.0% to $42,123,000 in fiscal 1995 and 8.6% to $41,314,000 in fiscal 1994. New distribution locations were the primary reasons for the increase in fiscal year 1995. In fiscal year 1994 increased locations, numbers of personnel and related expenses were the primary expense increase factors. In addition, fiscal 1994's expense increase was impacted by additional unabsorbed manufacturing facility expenses.\nNET EARNINGS\nConsolidated net earnings as a percentage of net sales was 3.5%, 2.5% and 3.6% for fiscal year 1995, 1994 and 1993, respectively. The 1995 net earnings of $7,142,000, or $1.00 per share, represented a 56.7% increase compared to fiscal 1994.\nThe increase was primarily the result of reducing the rate of operating expense growth relative to the net sales level growth between years. These factors are attributable in part to the restructuring activities at the corporate location at the beginning of fiscal 1995, and a focus on cost control at the distribution sites in 1995.\nThe net earnings increase for fiscal 1995 compared to fiscal 1994 was also attributable to a reduction in capital expenditures in fiscal 1995 and a corresponding reduction in the depreciation expense addition in the year related to the capital spending program, primarily in the areas of new distribution center additions and computer hardware and software upgrades.\nEARNINGS FROM FOREIGN AFFILIATE, INTEREST AND DIVIDEND INCOME, AND OTHER INCOME (EXPENSE)\nEarnings from foreign affiliate, net, were $387,000 at May 31, 1995 versus $217,000 for the year ended May 31, 1994. The earnings are from the Company's 50% position in Proveedora.\nInterest and dividend income increased in 1995 by $298,000 and decreased in 1994 by $44,000 due to fluctuating interest rates and cash levels available for investment. Interest expense increased in 1995 by $102,000 and in 1994 by $6,000 primarily due to the increased long-term debt due to the Chicago building mortgage and the variable interest rates on the Encon industrial development bonds. In 1995, other expense, net increased $45,000 due primarily to increased amortization of intangibles from previous acquisition activity and due to the loss on an equity accounting basis in 1995 from Vallen's investment in NUPRO since January 13, 1995 of $54,000. Other expense, net, in 1994 increased $57,000 due primarily to increased amortization of intangibles.\nINCOME TAXES\nThe effective tax rates for fiscal years 1995, 1994 and 1993 were 36.5%, 37.2% and 36.5%, respectively.\nIn February 1992, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Statement 109 requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Effective June 1, 1992, the Company adopted Statement 109 and has reported the cumulative effect of the change in the method of accounting for income taxes in the 1993 consolidated statement of earnings. The cumulative effect of the implementation of Statement 109 was immaterial. For a more thorough discussion of FASB Statement 109, see the Notes to Consolidated Financial Statements.\nFINANCIAL CONDITION\nLIQUIDITY\nThe net cash provided by operations for fiscal years 1995, 1994 and 1993 was $5,799,000, $7,239,000, and $6,622,000 respectively. Management is not aware of any potential impairment to the Company's liquidity. Included in accrued expenses payable at May 31, 1994 is $460,000 for restructuring charges also described in the Notes to Consolidated Financial Statements, Note 2. In connection with certain acquisitions made subsequent to May 31, 1995, as noted in Part 1 of this document, the Company paid a total of $6,940,904 in cash and re-issued a total of 120,732 shares of common stock from treasury shares.\nAlso, in connection with these acquisitions made by the Company subsequent to May 31, 1995, Vallen Safety and the Company, as guarantor, entered into a $6 million non-secured term-revolver credit agreement as of July 24, 1995. The duration of the credit facility is four years, and has both prime and LIBOR based borrowing options. As of the date of this document, $5 million has been drawn, in connection with an acquisition made subsequent to May 31, 1995.\nLONG-TERM OBLIGATIONS\nOn March 28, 1990, the Company issued $2,750,000 in industrial development bonds (See Note 5 of Notes to Consolidated Financial Statements). The bonds are secured by a letter of credit agreement and further secured by a lien upon a manufacturing facility in Houston constructed with the proceeds.\nOn December 1, 1994, the Company signed a long-term loan with a bank for $1,720,000. The loan is secured by a mortgage on the regional distribution center and surrounding property in Bolingbrook, Illinois.\nIMPACT OF INFLATION\nManagement of the Company believes that inflation has not significantly impacted either net sales or net earnings during the three years ended May 31, 1995. The Company has generally been able to pass along price increases from its manufacturing suppliers.\nCAPITAL EXPENDITURES\nDuring fiscal 1995 the Company invested $2,590,000 in capital assets for its distribution segment and $262,000 for its manufacturing segment. The distribution expenditures were primarily comprised of $927,000 for rental equipment, $707,000 for land, buildings and building improvements, $544,000 for new computer hardware and software, $392,000 for furniture and operating equipment and $20,000 for delivery vehicles. The manufacturing expenditures were primarily for tools, dies and other equipment used in the manufacturing process.\nThe capital expenditure program is designed to (1) focus the distribution activity of the Company in modern, technologically advanced regional centers, (2) match the Company's management information systems to the demanding, flexible marketplaces in which the Company competes to maintain its position as an industry leader in customer satisfaction, and (3) maintain efficient and cost competitive manufacturing operation facilities.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nVALLEN CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nTHE BOARD OF DIRECTORS VALLEN CORPORATION\nWe have audited the consolidated financial statements of Vallen Corporation and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vallen Corporation and subsidiaries as of May 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 May 31, 1995, in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK LLP\nHouston, Texas July 17, 1995\nVALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Thousands of Dollars)\nSee accompanying Notes to Consolidated Financial Statements.\nVALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (Thousands of Dollars Except for Per Share Amounts)\nSee accompanying Notes to Consolidated Financial Statements.\nVALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Thousands of Dollars, Except for Per Share Amounts)\nSee accompanying Notes to Consolidated Financial Statements.\nVALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars)\nSee accompanying Notes to Consolidated Financial Statements.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation --- The consolidated financial statements include the accounts of Vallen Corporation (the Company) and its wholly-owned subsidiaries, Vallen Safety Supply Company, Encon Safety Products, Inc., Safety World, Inc. and Vallen Safety Supply Company, Ltd. All significant inter- company transactions and amounts have been eliminated in consolidation. Unconsolidated affiliates are included on the equity basis. Certain prior year amounts have been reclassified to conform with current year presentation.\nInvestment Securities --- The Company held only trading securities for investment in 1995, 1994 and 1993. Cost and estimated fair value were identical, therefore no unrealized gains or losses occurred in any year presented. Trading securities consist of obligations of states and political subdivisions and corporate issuers, and totaled $7,255,000 and $7,231,000 at May 31, 1995 and 1994, respectively.\nInventory Valuation --- Inventories are stated at the lower of cost (weighted average) for Vallen Safety and lower of cost (first in, first out) for Encon, or market (replacement).\nProperty, Plant and Equipment --- Depreciation of property, plant and equipment is based on the estimated useful life, less salvage, if any, of the various assets as follows:\nAcquisitions --- Acquisitions have been accounted for by the purchase method and, accordingly, the acquired company's assets are recorded at fair value as of the acquisition date. Results of operations are included from the date of acquisition.\nIntangibles --- Goodwill, which represents cost in excess of fair value of net assets of purchased businesses, is amortized over a 40 year period, and the related accumulated amortization was $60,000 and $49,000 at May 31, 1995 and 1994, respectively. Other intangibles are amortized over their statutory or estimated useful lives. Accumulated amortization of these other intangibles was $1,567,000 and $1,278,000 at May 31, 1995 and 1994, respectively.\nIncome Taxes --- In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Statement 109 requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Effective June 1, 1992, the Company adopted Statement 109 and has reported the cumulative effect of the change in the method of accounting for income taxes in the 1993 consolidated statement of earnings. The cumulative effect of the implementation of Statement 109 was immaterial.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ---(CONTINUED)\nForeign Currency Translation --- The Company's foreign subsidiaries' books and records are maintained in the local currency. 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 statement accounts are translated at the average exchange rate prevailing during the period. Gains and losses from translations and transactions in foreign currencies were immaterial in the year ended May 31, 1994. A translation adjustment of $625,000, was recorded in the equity section of the Company's balance sheet in the third quarter of fiscal 1995, as a result of a devaluation of the Mexican peso relative to the U.S. dollar in December, 1994. As of May 31, 1995, the cumulative adjustment amounted to $417,000, calculated based upon requirements set forth in Statement of Financial Accounting Standards, No. 52, Foreign Currency Translation.\nImpairment of Long Lived Assets -- 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 is effective for fiscal years beginning after December 15, 1995. The Company has not completed the analysis required by SFAS 121 as of May 31, 1995; however, the impact of the adoption of SFAS 121 is not expected to have a material impact on the Company's financial statements.\nEarnings Per Common Share --- Earnings per common share computations are based on the weighted average number of shares of common stock outstanding during the respective periods. Common stock equivalents have not been included from the date of their issuance due to their insignificant effect on the computation.\nStatements of Cash Flows --- 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.\nNOTE 2. RESTRUCTURING CHARGES\nIn May 1994, the Company completed an extensive assessment of future distribution plans and strategy. As a result, four distribution branches were closed in fiscal 1995, due to proximity to regional shipping \"hub\" locations and the need to eliminate redundant stocking and shipping activities. Certain personnel positions associated with those closings were eliminated. Several positions at the Company's corporate headquarters were also eliminated. Accordingly, in the fourth quarter of fiscal 1994, the Company recorded a restructuring charge of $460,000 which included a $350,000 non-cash recognition of long term lease commitments related to the branches to be closed, and $110,000 for severance pay for the eliminated positions.\nNOTE 3. INVENTORIES\nEffective April 1995, Vallen Safety changed its inventory valuation method from first-in, first-out (FIFO) to a weighted-average valuation method. The Company believes that the new accounting method provides a better matching of inventory cost with the related revenues. The cumulative effect on prior years and on the operating results for the current year ended May 31, 1995 are immaterial. The manufacturing subsidiary continues to utilize the First-in, First-out (FIFO) method.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)\nNOTE 4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment costs are summarized as follows:\nMaintenance and repairs are expensed as incurred. Gains and losses from sales and retirements are recognized at the time of disposal.\nNOTE 5. LONG-TERM DEBT\nLong-term debt is summarized as follows:\nDebt maturities for the five years subsequent to May 31, 1995 are $161,000 $165,000, $169,000, $173,000, and $174,000, respectively.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)\nNOTE 6. CAPITAL STOCK\nThe Company has a stock option plan for key employees, (the \"Plan\") and has reserved for issuance 1,125,000 shares of its common stock. The Plan authorizes the Company to grant to its key employees options to purchase shares of common stock at prices per share equal to the fair market value of such stock at the date of grant.\nOptions have been granted and are outstanding as to 278,000 shares as of May 31,1995. These options are exercisable in increments of 33 1\/3% , beginning in years after fiscal 1993, should the Company achieve three specified consolidated earnings per share targets.\nInformation relating to stock options is summarized as follows:\nThe Company's shareholders approved a non-employee director stock option plan (the \"Director Plan\") effective October 12, 1993. The Company has reserved for issuance 30,000 shares of its common stock to be used in the plan. The Director Plan authorizes the Company to grant non-employee directors options to purchase shares of common stock at prices equal to the average last sale price of the Company's stock for the five most recent trading days on which trades occurred including the date of grant. Each of the non-employee directors was granted 3,000 options based upon a formula set forth in the Director Plan. The options are exercisable ratably on the first, second and third anniversary dates of the grant date. None of the options granted were exercised on the first anniversary date.\nThe Company adopted an employee stock purchase plan effective January 1, 1991. The Company has reserved for issuance 675,000 shares of its common stock to be used in the plan. The plan allows eligible employees to purchase shares at 85% of the lower of market value on January 1 or December 31. The difference between the employees' actual purchase price and the price on December 31 is compensation expense to the Company. Employee stock purchase plan expense was $24,000 for both years ended May 31, 1995 and 1994.\nDuring fiscal year 1992, the Company established an Annual Incentive Compensation Plan for its officers and has reserved 300,000 shares of the Company common stock for issuance in connection with the stock portion of the incentive awards. Under the Plan, the annual award pool for each year will be an amount equal to 20% of the portion of net earnings in excess of the net earnings required to achieve a 15% return on average shareholders' equity. One- half of each participant's award will be paid in the form of a single cash payment. The remaining 50% is paid in the form of Company common stock, which vests to the participant over a five year period. No amounts were required to be paid under the Plan for the years ended May 31, 1995 and 1994.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ---(CONTINUED)\nThe reasons for the differences between the amount of tax expense provided and the amount of tax expense computed by applying the federal statutory income tax rate of 34% in 1995, 1994 and 1993, to earnings before income taxes were as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at May 31, 1995 and 1994 are presented below.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)\nThere is no valuation allowance for the fiscal years ended May 31, 1995 or May 31, 1994. It is the opinion of management that future operations will more likely than not generate taxable income to realize the deferred tax assets.\nDeferred tax assets are included in prepaid expenses and other current assets category on the Consolidated Balance Sheets.\nNOTE 8. PROFIT SHARING, DEFERRED COMPENSATION AND BONUS INCENTIVE PLANS\nThe Company has established a profit sharing trust which covers substantially all employees. The Company makes quarterly cash contributions of 10% of net earnings, as defined by the trust agreement. Total profit sharing expense for the years ended May 31, 1995, 1994 and 1993 was $622,000, $520,000 and $613,000, respectively.\nDuring December 1990, the Company amended the profit sharing plan to include a 401(k) deferred compensation plan covering a majority of the Company's employees. Under the terms of the 401(k) plan, the Company makes matching contributions equal to 25% of the participants' contributions subject to certain participant vesting requirements. Total Company 401(k) contribution expense for the years ended May 31, 1995, 1994 and 1993 was $236,000, $218,000 and $173,000, respectively.\nThe Company also has bonus incentive plans for its officers, managers and other key employees. Cash bonuses are awarded based on incentive award schedules which measure achievement of individual and corporate objectives, among other factors. Bonus incentive plan expense was $713,000, $258,000 and $387,000, for the years ended May 31, 1995, 1994 and 1993, respectively.\nNOTE 9. INVESTMENT IN FOREIGN AFFILIATE\nOn December 17, 1992, the Company purchased 50% of the outstanding common stock of Proveedora de Seguridad Industrial Del Golfo, S.A. de C.V., (Proveedora) a company organized under the laws of Mexico, based in Tampico, Mexico. The initial investment and subsequent capital contribution was $2,767,000. The Company accounts for its Proveedora investment using the equity method of accounting.\nThe Company's share of earnings from Proveedora, net of associated amortization of goodwill and foreign currency translation amounts, was $387,000, $217,000 and $122,000 for the years ended May 31, 1995, 1994 and the period December 17, 1992 through May 31, 1993, respectively.\nNOTE 10. COMMITMENTS AND CONTINGENCIES\nThe Company conducts certain operations from leased premises under noncancellable operating leases. Under the terms of some of the leases, the Company pays taxes, maintenance, insurance and certain other operating expenses. Various computer, transportation and other equipment is also leased under short- term operating leases. Management generally intends to renew leases that expire during the normal course of business. Rental expense for the years ended May 31, 1995, 1994 and 1993 amounted to $1,639,000, $2,056,000 and $1,560,000, respectively. Lease commitments for noncancellable operating leases for the five years subsequent to May 31, 1995 are $1,512,000, $1,016,000, $651,000, $302,000 and $147,000, respectively.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)\nCertain claims that result from litigation incurred in the ordinary course of business have been asserted against the Company. Management believes that the ultimate resolution of such matters will not materially affect the financial position or results of operations of the Company.\nNOTE 11. CONCENTRATION OF CREDIT RISK\nThe Company has a broad customer base, representing many diverse industries, doing business in most regions of the United States and in Mexico and Canada. The Company evaluates credit risks on an individual customer basis before extending credit, and believes the allowance for doubtful accounts adequately provides for losses on uncollectible accounts. In each of the years ended May 31, 1995, 1994 and 1993, no single customer accounted for more than 10% of consolidated sales. Letters of credit are required on most foreign sales, except to customers in Mexico and Canada. Consequently, in management's opinion, no significant concentration of credit risk exists for the Company.\nNOTE 12. BUSINESS SEGMENTS\nThe Company operates in two business segments, distribution of industrial safety and health products and manufacturing of industrial safety equipment. The following table summarizes, for the periods indicated, the amounts of consolidated net sales, operating income, identifiable assets, capital expenditures and depreciation and amortization attributable to the Company's distribution and manufacturing operations. Substantially all intersegment sales are based on published price lists, the same as to unaffiliated customers. The Company does not derive 10% or more of its net sales from any single customer, nor does the Company derive 10% or more of its net sales from foreign sources. Sales of supplied-air respiratory equipment contributed 7.8%, 9.9% and 10.7% of consolidated net sales for the year ended May 31, 1995, 1994 and 1993, respectively. The effect of the Company's operation in Mexico and Canada is immaterial on the amounts in the table below.\nVALLEN CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)\nNOTE 13. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe Company's quarterly operating results for 1995 and 1994 are summarized as follows:\nNOTE 14. SUBSEQUENT EVENTS\nEffective June 6, 1995, Vallen Corporation and Vallen Safety announced the closing of the purchase of a 50% interest in Century Sales and Service Limited (Century), a Canadian Corporation. Century is an Edmonton, Alberta based distributor of mill supply and industrial hardware products. Additional consideration for the 50% interest purchase will be paid in January, 1996 based upon audited financial results of Century's November 30, 1995 fiscal year. The purchase was funded with a combination of cash and Vallen common stock. Vallen has the option to purchase the remaining 50% interest in Century based upon a purchase formula either 5 or 6 years following the initial 50% purchase price closing date. Century operates a total of 12 distribution centers in Alberta and Saskatchewan provinces, including a centralized warehouse facility at its Edmonton headquarters site. Its operations also cover the Northwest and Yukon territories and parts of British Columbia. Century's sales are approximately $50 million Canadian annually. It employs approximately 214 people in its operations.\nEffective July 24, 1995, Vallen Corporation and Valley Safety completed the purchase of the major assets and assumption of certain liabilities, as well as the rights, to the name of Safety Centers Incorporated (SCI), a South Holland (Chicago) Illinois based distributor of safety equipment and protective clothing, as well as novelty merchandise through 22 on-site safety center locations and two distribution hubs. SCI employs approximately 120 persons. The asset purchase was funded with a combination of cash and Vallen Common stock. In connection with the assumption of certain debts of SCI, Vallen Safety borrowed $5 million under a credit facility with a major commercial bank. SCI's primary markets are in the steel production and automobile and related parts manufacturing sectors. Its markets are throughout the United States, with particular concentration in the midwest. The safety stores will be operated as a division of Vallen Safety. SCI's annual sales are approximately $25 million.\nEffective August 18, 1995, Vallen acquired 100% of the capital stock and the business of All Supplies, Inc., a Baton Rouge, Louisiana based distributor of mill, safety and industrial welding supplies. The stock purchase was funded with a combination of cash and Vallen Common stock. All Supplies sales are approximately $9 million annually.\nOn July 24, 1995, Vallen Safety, and the Company as guarantor, entered into a non-secured, term-revolver credit facility with a major bank. The credit facility provides for borrowings up to $6 million. Interest rate options provided are at (1) the bank's prime lending rate, or (2) at a spread over the London Interbank offering (LIBOR) rate. The facility expires in four years. A total of $5 million has been drawn under the facility in connection with the financing of acquisitions subsequent to May 31, 1995, as noted above.\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nDIRECTORS OF THE REGISTRANT\nThe following table provides information as of August 1, 1995 regarding each of Vallen's directors:\n---------- Mr. Bruce, who has 46 years of experience in safety equipment distribution, founded the Company in 1947. He has been Chairman of the Board of Directors since 1960.\nMr. Thompson joined the Company in June of 1994 as President and Chief Operating Officer of Vallen Safety Supply Company. He was named President and Chief Executive in January, 1995. He was formerly employed by Westburne Supply Company of Naperville, Illinois as Senior Group Vice President, and prior to that he was with Westinghouse Electric Supply Company for 18 years.\nMr. Code served as President and Chief Executive Officer of the Company from June 1985 until January 1995. He is currently retired.\nDr. Winick has been President of Winick Consultants, or its related management consulting firms, since 1981.\nMr. Attwell has been President of Travis International, Inc., a holding company for industrial distribution operations, since January 1987.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table provides information as of August 1, 1995 regarding each of Vallen's executive officers:\nThe terms of each officer will expire at the next annual meeting of directors or when his successor is elected and qualified.\nMr. Bruce, who has over 48 years of experience in safety equipment distribution, founded the Company in 1947. He has been Chairman of the Board of Directors since 1960.\nMr. Thompson joined the Company in June 1994 as President and Chief Operating Officer of Vallen Safety Supply Company. He was named President and Chief Executive Officer in December 1994. He was formerly with Westburne Supply Company and Westinghouse Electric Supply Company. Mr. Thompson was elected to the Board of Directors in June 1994.\nMr. Wolff joined the Company in February, 1995, as Executive Vice President of Marketing. He was formally elected to this position in August, 1995. He was formerly with Wesco\/Westinghouse Electric Corporation.\nMr. Hutton has been with the Company since 1968. He was elected Vice President - Southwest Region in 1981 and after serving in several sales and managerial positions, including Marketing Manager of North Texas. He was named Executive Vice President of Sales in 1989.\nMr. Stephenson has been employed with the Company since December, 1993. Before joining Vallen, he was with United Artists Entertainment and worked six years with the audit firm of Coopers & Lybrand.\nMr. Edwards has been with the Company since 1974. He has served Vallen in a variety of sales and staff positions including corporate level responsibilities for Administrative Services and Human Resources. He was named Vice President - Human Resources in 1990.\nMr. Zachry has been with the Company since 1983. He has been General Manager of Encon Safety Products, Inc., the Company's manufacturing subsidiary, since 1987. He was previously responsible for marketing at Vallen Safety.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nAlthough not formally elected to the position of Executive Vice President, Marketing until August, 1995, Mr. Wolff has effectively acted in that capacity since February, 1995. No Form 3 for Mr. Wolff was filed at that time.\nA Form 5 with the necessary corrective information will be filed with respect to the 1995 fiscal year.\nPART I I I\nIn accordance with General Instruction G(3) to Form 10-K, items 11, 12 and 13 have been incorporated by reference to the Company's definitive proxy statement complying with Regulation 14A involving the election of directors which will be filed with the Commission not later than 120 days after the close of its fiscal year.\nPART I V\nITEM 14.","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following financial statements are filed as part of this report.\n1. Consolidated Financial Statements, as listed in the Index to Financial Statements provided in response to Item 8 hereof. (see page 11 for Index)\n2. Financial Statement Schedules, as listed in the Index to Financial Statements provided in response to Item 8 hereof. (see page 11 for Index)\n3. The following exhibits are filed as part of this report:\n3i. Restated Articles of Incorporation as amended. Incorporated by reference is Exhibit 3a to the Company's Form 10-K, as filed with the Securities and Exchange Commission on August 17, 1990 (the \"1990 Form 10-K\").\n3ii. Bylaws of the Company as amended through June 23, 1994 - attached.\n10a. Vallen Corporation Stock Incentive Plan, specimen Non-qualified Stock Option Agreement and specimen Stock Appreciation Rights Agreement. Incorporated by reference is Exhibit 5.1 to the Company's Registration Statement No. 2-65349 on Form S-1 as filed with the Securities and Exchange Commission on August 27, 1979 (the \"Registration Statement\").\n10b. Vallen Corporation 1985 Stock Option Plan for Key Employees. Incorporated by reference is Exhibit 10b. to the Company's Form 10-K as filed with the Securities and Exchange Commission on August 27, 1985 (the \"1985 Form 10-K\"). *\n10c. Amendment to Vallen Corporation 1985 Stock Option Plan for Key Employees - attached. (see page 30 for Index). *\n10d. Agreement dated June, 1985 between the Company and J. M. Wayne Code. Incorporated by reference is Exhibit 10c. to the 1985 Form 10-K. *\n10e. Vallen Corporation 1990 Employee Stock Purchase Plan. Incorporated by reference is Exhibit 10d to the 1990 Form 10-K. *\n10f. Vallen Corporation Annual Incentive Compensation Plan. Incorporated by reference is Annex A to the Company's 1991 Proxy Statement. *\n10g. Agreement dated June 6, 1994 between the Company and James W. Thompson. Incorporated by reference is Exhibit 10f to the Company's Form 10-K as filed with the Securities and Exchange Commission on August 17, 1994 (the \"1994 Form 10-K\"). *\n21. Subsidiaries of the Company attached. (see page 30 for Index)\n23. Consent of KPMG Peat Marwick LLP to the incorporation by reference of their report to the Registration Statement (No. 33-16663 and 33- 38126) on Forms S-8 attached. (see page 30 for Index)\n27. Financial Data Schedule.\n4. The Company hereby agrees to furnish to the Commission, on request, a copy of any instrument which defines the rights of holders of any long term debt of the Company in excess of 10% of the total assets of the Company.\n(b) No reports on Form 8-K were required to be filed by this registrant during the last quarter of the fiscal year covered by this report.\n* Management compensation 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.\nVALLEN CORPORATION\nBy \/s\/ JAMES W. THOMPSON _____________________________________ JAMES W. THOMPSON President\nDate: August 21, 1995\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nINDEX TO EXHIBITS\nExhibit numbers are in accordance with exhibit table in Item 601 of Regulation S-K.","section_15":""}
{"filename":"785988_1995.txt","cik":"785988","year":"1995","section_1":"ITEM 1. BUSINESS\nKrupp Cash Plus-II Limited Partnership (the \"Partnership\") was formed on December 18, 1985 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Krupp Corporation and The Krupp Company Limited Partnership-IV are the General Partners of the Partnership. Krupp Depositary Corporation is the Corporate Limited Partner. For details, see Note A to Financial Statements included in Item 8 (Appendix A) of this report.\nOn March 28, 1986 the Partnership commenced the marketing and sale of 7,500,000 units of Depositary Receipts (\"Units\") for a maximum offering of $150,000,000. The Partnership raised $149,845,812 from its public offering. The Partnership invested the net proceeds from the offering in a portfolio of unleveraged real estate (see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Partnership has unleveraged investments in four retail centers having an aggregate of 364,894 square feet of leasable space and one apartment complex having 222 units, all of which are wholly- owned by the Partnership. In addition, the Partnership has an unleveraged joint venture investment (the \"Joint Venture\") in a shopping center with 474,138 square feet of leasable space. Additional detailed information with respect to individual properties is contained in Note D to Financial Statements, Schedule III and the Financial Statements for Brookwood Village Joint Venture included in Item 8 (Appendix A) to this report.\nA summary of the Partnership's real estate investments is presented below.\n(1) The Partnership has a 50% joint venture interest in this property.\nThe Partnership has no present plans for major improvements or developments of its unleveraged real estate. Only improvements necessary to keep the Partnership's properties competitive in their respective markets were done and are expected to continue in the next year.\nThere were no tenants at any of the properties occupying 10% or more of the Partnership's leasable space as of December 31, 1995.\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 property 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 is no public market for the Units and it is not anticipated that any such public market will develop. The transfer of Units is subject to certain limitations contained in the Partnership Agreement.\nThe number of Investor Limited Partners (\"Unitholders\") as of December 31, 1995 was approximately 9,900.\nThe Partnership has made the following distributions to its Partners during the years ended December 31, 1995 and 1994.\nOne of the objectives of the Partnership is to make partially tax sheltered distributions of cash flow generated by the Partnership's properties and MBS. However, there is no assurance that future operations will continue to generate sufficient cash to maintain the current level of distributions and to provide sufficient liquidity for the Partnership. The Partnership pays a $.20 per Unit, per quarter distribution to its investors.\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 Supplementary Data, which are included in Items 7 and 8 to this report, respectively.\n(a) During the years ended December 31, 1995, 1994, 1993, 1992 and 1991 the Limited Partners' average Per Unit return of capital was $.04, $.20, $1.21, $.13 and $.38, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe Partnership's liquidity is derived from the operations of the Partnership's properties (Encino Oaks, Alderwood Towne, Canyon Place, Coral Plaza and Cumberland Glen), distributions from the Partnership's interest in the Joint Venture, earnings and collections on MBS, and interest earned on its short-term investments. The Partnership's liquidity is utilized to pay operating costs and to fund distributions to the partners.\nManagement has found it necessary in recent years to have the Partnership pay a large share of tenant buildouts to attract quality tenants to our retail centers. This policy has proven to be successful in attracting tenants and maintaining high occupancies at properties where it has been undertaken and is expected to continue in 1996. In order to remain competitive in their respective markets, the Partnership's properties are anticipated to spend approximately $620,000 for fixed assets in 1996, most of which are tenant buildouts at retail centers. The Joint Venture is expected to spend approximately $860,000 for capital improvements.\nThe Partnership holds MBS that are guaranteed by Government National Mortgage Association (\"GNMA\"), Federal National Mortgage Association (\"FNMA\"), and Federal Home Mortgage Corporation (\"FHLMC\"). The principal risks in respect to MBS are the credit worthiness of GNMA, FNMA, or FHLMC, and the risk that the current value of any MBS may decline as a result of changes in market interest rates. The General Partners believe the interest rate risk is minimal due to the fact that the Partnership has the ability to hold these securities to maturity. Principal collections on MBS have decreased significantly in 1995 because rising interest rates slowed the pace of refinancings that were experienced in 1994.\nThe Partnership currently enjoys significant liquidity. The General Partners, on an ongoing basis, assess the current and future liquidity needs in determining the levels of working capital the Partnership should maintain. Adjustments to distributions are made when appropriate to reflect such assessments.\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 by Section 17 of the Partnership Agreement for the year ended December 31, 1995 and the period from inception to 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 flow as a measure of liquidity.\n(a) Represents distributions paid in 1995, except the February, 1995 distribution which relates to 1994 cash flows, and includes an estimate of the distribution to be paid in February, 1996. (b) Includes an estimate of the distribution to be paid in February, 1996. (c) Limited Partners' average per Unit return of capital as of February, 1996 is $4.53 [$12.51 - $7.98]. Operations\nPartnership\n1995 compared to 1994 Cash flow increased due to decreased capital improvements, increased rental revenues and distributions received from the Joint Venture. Rental revenues in 1995 have increased when compared to 1994 as a result of changes at Canyon Place and Cumberland Glen. Canyon Place experienced an 8% increase in occupancy in 1995 as compared to 1994. This increase in occupancy is due to the opening of the 4,391 square foot Payless Shoes and the 10,592 square foot Petco Pet Food and Supplies stores in the fourth quarter of 1994 and to the expansion of several tenants within the last year. At Cumberland Glen, the strong economic environment in the Atlanta, Georgia area has allowed management to increase rental rates on certain floor plans. All other properties have experienced relatively stable occupancies with minor rental increases during 1995.\nTotal expenses as a whole remained relatively stable. However, individually, maintenance, operating, general and administrative, and real estate taxes all changed significantly in 1995 as compared to 1994. Operating and general and administrative expenses decreased as a result of management's efforts to reduce reimbursable expenses throughout 1995. Maintenance expense decreased in 1995 as compared to the same period in 1994 due to preventive maintenance at Encino Oaks, roof repairs at Canyon Place, and improvements to the parking lot and building interiors at Cumberland Glen, all performed in 1994. The increase in real estate taxes is due primarily to a refund of approximately $270,000 recorded in the second quarter of 1994 for prior years' real estate taxes at Coral Plaza.\n1994 compared to 1993\nIn comparing 1994 to 1993, distributable cash flow increased $60,000 as increased distributions from the Joint Venture more than offset increases in capital improvements. Rental revenues for 1994 as compared to 1993 remained relatively stable due mainly to consistent occupancy levels at all the Partnership's properties within the period.\nTotal expenses decreased $242,000 in 1994 as compared to 1993. This was primarily due to a reduction in real estate taxes. Coral Plaza received a refund of approximately $270,000 for prior years' real estate taxes in the second quarter of 1994. Depreciation increased by $108,000 in 1994 as compared to 1993 as a result of higher tenant buildouts at Canyon Place and Encino Oaks in order to attract quality tenants to their respective retail centers.\nMBS and Other Income\nMBS interest income decreased $151,000 in 1995 from 1994, and $411,000 in 1994 from 1993 due to large prepayments of principal which occurred from 1993 to the first half of 1995. The asset balance on which income is generated has decreased approximately 13% since\nDecember 31, 1994 and approximately 33% since December 31, 1993. Interest income on short-term investments has increased since 1993 due to higher average cash and cash equivalent balances.\nJoint Venture\nThe Joint Venture's revenues for 1995 as compared to 1994 have remained relatively stable as a result of steady occupancy throughout 1995. Total expenses in 1995 as compared to 1994 have remained relatively flat. Real estate taxes decreased as a result of an abatement in the third quarter of 1995 due to the revaluation of the Joint Venture by the local taxing authority. This reduction is offset by an increase in operating expense attributable to increased leasing efforts by management. Depreciation expense increased due to a large number of tenant buildouts and improvements completed in 1995 and 1994.\nThe Joint Venture's revenues increased in 1994 primarily due to an increase in occupancy of 4% over 1993. Depreciation expense increased due to a large number of tenant buildouts and capital renovations completed in 1994 and 1993.\nGeneral\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate assets.\nThe Partnership's investments in properties and the Joint Venture are carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down investments in properties and the Joint Venture to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are signifantly impaired.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A 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\nThe Partnership has no directors or executive officers. Information as to the directors and executive officers of The Krupp Corporation, which is a General Partner of both the Partnership and The Krupp Company Limited Partnership-IV, the other General Partner of the Partnership, is as follows:\nPosition with Name and Age The Krupp Corporation\nDouglas Krupp (49) Co-Chairman of the Board George Krupp (51) Co-Chairman of the Board Laurence Gerber (39) President Robert A. Barrows (38) Senior Vice President and Corporate Controller\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, healthcare facility ownership and the management of the Company. 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 $4 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 is Chairman of the Board and a Director of Berkshire Realty Company, Inc. (NYSE-BRI). George Krupp is Douglas Krupp's brother.\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 $4 billion under management for institutional and individual clients. Mr. Krupp attended the University of Pennsylvania and Harvard University. Mr. Krupp also serves as Chairman of the Board and Trustee of Krupp Government Income Trust and as Chairman of the Board and Trustee of 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 Director of Berkshire Realty Company, Inc. (NYSE-BRI) and President and Trustee of Krupp Government Income Trust and President and Trustee of Krupp Government Income Trust II.\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 of record owned or was known by the General Partners to own beneficially more than 5% of the Partnership's 7,499,818 outstanding Depositary Receipts. 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\nThe Partnership does not have any directors, executive officers or nominees for election as director. Additionally, as of December 31, 1995, no person of record owned or was known by the General Partners to own beneficially more than 5% of the Partnership's outstanding Units.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements - see Index to Financial Statements and Schedule included under Item 8 (Appendix A) on page of this report.\n2. Financial Statement Schedule - 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.\n3. Financial Statements - as required by Rule 3-09 of Regulation S-X. The financial statements and schedule for Brookwood Village Joint Venture (the \"Joint Venture\") are included under Item 8 (Appendix A) on pages to of this report.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable Exhibits required under Item 601 of Regulation S-K:\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended Agreement of Limited Partnership dated as of March 25, 1986 [Exhibit A to Prospectus included in Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated March 26, 1986 (File No. 33-2312)].*\n(4.2) Subscription Agreement Specimen [Exhibit D to Prospectus included in Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated March 26, 1986 (File No. 33-2312)].*\n(4.3) Eleventh Amendment and Restatement of Certificate of Limited Partnership filed with the Massachusetts Secretary of State as of February 6, 1987. [Exhibit 4.3a to Registrant's Report on Form 10-K dated December 31, 1986 (File No. 33-2312)].*\n(10) Material Contracts:\nEncino Oaks Plaza\n(10.1) Krupp Standard Purchase Agreement dated July 16, 1986 between Krupp Realty and Development, Inc., a Massachusetts corporation and Cal-American Income Property Fund II, a California limited partnership. [Exhibit 1 to Registrant's Report on Form 8-K dated July 31, 1986 (File No. 33-2312)].*\n(10.2) Assignment of Contract between Krupp Realty and Development, Inc., a Massachusetts corporation and Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership dated July 28, 1986. [Exhibit 2 to Registrant's Report on Form 8-K dated July 31, 1986 (File No. 33-2312)].*\n(10.3) Partnership Grant Deed dated July 31, 1986 from Cal-American Income Property Fund II a California limited partnership, to Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership. [Exhibit 3 to Registrant's Report on Form 8-K dated July 31, 1986 (File No. 33-2312)].*\n(10.4) Management Agreement dated July 31, 1986 between Krupp Cash Plus-II Limited Partnership, as Owner and Krupp Asset Management Company, now known as Berkshire\nProperty Management (\"BPM\"), as Agent. [Exhibit 10.4a to Registrant's Report on Form 10-K dated December 31, 1986 (File No. 33- 2312)].*\nAlderwood Towne Center\n(10.5) Krupp Standard Option Agreement dated July 16, 1986 between Krupp Realty and Development, Inc., a Massachusetts corpora- tion and Alderwood Towne Center, a Washington tenancy-in-common. [Exhibit 10.5 included in Registrant's Post Effective Amendment No. 2 to its Form S-11 Registration Statement dated September 3, 1986 (File No. 33-2312)].*\n(10.6) Escrow Agreement dated August 12, 1986 between Krupp Realty and Development, Inc., a Massachusetts corporation and Alderwood Towne Center, a Washington tenancy-in-common. [Exhibit 10.5 included in Registrant's Post Effective Amendment No. 2 to its Form S-11 Registration Statement dated September 3, 1986 (File No. 33-2312)].*\n(10.7) Amendment to Option Agreement dated July 17, 1986 between Krupp Realty and Development, Inc., a Massachusetts corporation and Alderwood Towne Center, a Washington tenancy- in-common. [Exhibit 10.5 included in Registrant's Post Effective Amendment No. 2 to its Form S-11 Registration Statement dated September 3, 1986 (File No. 33-2312)].*\n(10.8) Assignment of Option Agreement between Krupp Realty and Development, Inc. a Massachusetts corporation and Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership dated August 20, 1986. [Exhibit 4 to Registrant's Report on Form 8-K dated September 3, 1986 (File No. 33-2312)].*\n(10.9) Statutory Warranty Deed dated September 3, 1986 between Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership and Alderwood Towne Center Associates. [Exhibit 5 to Registrant's Report on Form 8-K dated September 3, 1986 (File No. 33-2312)].*\n(10.10) Property Management Agreement dated September 3, 1986 between Krupp Cash Plus-II Limited Partnership, as Owner and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 6 to Registrant's Report on Form 8-K\ndated September 3, 1986 (File No. 33-2312)].*\nBrookwood Village Mall and Convenience Center\n(10.11) Purchase and Sale Agreement dated December 5, 1986 between Krupp Realty and Development Inc., a Massachusetts corporation and Everett Shepherd, Jr. et al as assigned to Brookwood Village Joint Venture. [Exhibit 1 to Registrant's Report on Form 8-K dated December 16, 1986 (File No. 33-2312)].*\n(10.12) Statutory Warranty Deed with Vendors' Lien dated December 16, 1986 between Brookwood Village Joint Venture and Everett Shepherd, Jr. et al. [Exhibit 2 to Registrant's Report on Form 8-K dated December 16, 1986 (File No. 33-2312)].*\n(10.13) Business Certificate dated December 11, 1986 establishing Brookwood Village Joint Venture. [Exhibit 3 to Registrant's Report on Form 8-K dated December 16, 1986 (File No. 33-2312)].*\n(10.14) Brookwood Village Joint Venture Agreement dated December 15, 1986 between Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership and Krupp Cash Plus-III Limited Partnership, a Massachusetts limited partnership, now known as Berkshire Realty Company, Inc. [Exhibit 10.14 to Registrant's Report on Form 10-K dated December 31, 1986 (File No. 33-2312)].*\n(10.15) Property Management Agreement dated December 16, 1986 between Brookwood Village Joint Venture, as Owner and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 4 to Registrant's Report on Form 8-K dated December 16, 1986 (File No. 33- 2312)].*\nCanyon Place Shopping Center\n(10.16) Krupp Standard Option Agreement dated October 24, 1986 between Krupp Realty and Development, Inc., a Massachusetts corporation and Canyon Place Associates, a Washington tenancy-in-common. [Exhibit 1 to Registrant's Report on Form 8-K dated December 23, 1986 (File No. 33-2312)].*\n(10.17) Amendment to Option Agreement dated December 9, 1986 between Krupp Realty and Development, Inc., a Massachusetts\ncorporation and Canyon Place Associates, a Washington tenancy-in-common. [Exhibit 2 to Registrant's Report on Form 8-K dated December 23, 1986 (File No. 33-2312)].*\n(10.18) Assignment of Option Agreement dated December 17, 1986 between Krupp Realty and Development, Inc., a Massachusetts corporation and Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership. [Exhibit 3 to Registrant's Report on Form 8-K dated December 23, 1986 (File No. 33-2312)].*\n(10.19) Warranty Deed dated December 23, 1986 between Canyon Place Associates, a Washington tenancy-in-common, as Grantor and Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership, as Grantee. [Exhibit 4 to Registrant's Report on Form 8-K dated December 23, 1986 (File No. 33-2312)].*\n(10.20) Property Management Agreement dated December 23, 1986 between Krupp Cash Plus- II Limited Partnership, as Owner and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 6 to Registrant's Report on Form 8-K dated December 23, 1986 (File No. 33-2312)].*\nCoral Plaza Shopping Center\n(10.21) Purchase and Sale Agreement dated May 8, 1987 between Harris Trust and Savings Bank, as trustee under Trust No. 42703, and Krupp Realty and Development, Inc., a Massachusetts corporation, as assigned to Krupp Cash Plus-II Limited Partnership. [Exhibit 19.1 to Registrant's Report on Form 10-Q dated June 30, 1987 (File No. 33- 2312)].*\n(10.22) Assignment between Coral Plaza Limited Partnership and Harris Trust and Savings Bank, as Trustee under Trust No. 42703, collectively as \"Assignor,\" and Krupp Cash Plus-II Limited Partnership, a Massachusetts limited partnership, as \"Assignee\" dated June 2, 1987. [Exhibit 19.2 to Registrant's Report on Form 10-Q dated June 30, 1987 (File No. 33-2312)].*\n(10.23) Trustee's Deed dated May 28, 1987 from Harris Trust and Savings Bank, as trustee\nunder Trust No. 42703, to Krupp Cash Plus- II Limited Partnership. [Exhibit 19.3 to Registrant's Report on Form 10-Q dated June 30, 1987 (File No. 33-2312)].*\n(10.24) Property Management Agreement, dated June 1, 1987, between Krupp Cash Plus-II Limited Partnership, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 19.4 to Registrant's Report on Form 10-Q dated June 30, 1987 (File No. 33- 2312)].*\nCumberland Glen Apartments\n(10.25) Agreement of Purchase and Sale, dated August 24, 1987 between FNBC Properties, Inc., a Delaware corporation, as \"Seller,\" and Krupp Realty and Development, Inc., a Massachusetts corporation, as \"Purchaser.\" [Exhibit 19.5 to Registrant's Report on Form 10-Q dated September 30, 1987 (File No. 0-15816)].*\n(10.26) Assignment of purchase and sale agreement, dated August 24, 1987 between Krupp Realty and Development, Inc., and Krupp Cash Plus- II Limited Partnership, a Massachusetts limited partnership. [Exhibit 19.6 to Registrant's Report on Form 10-Q dated September 30, 1987 (File No. 0-15816)].*\n(10.27) Quit Claim Deed, dated September 3, 1987, between The First National Bank of Chicago, and Krupp Cash Plus-II Limited Partnership. [Exhibit 19.7 to Registrant's Report on Form 10-Q dated September 30, 1987 (File No. 0-15816)].*\n(10.28) Property Management Agreement, dated September 3, 1987, between Krupp Cash Plus- II Limited Partnership, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 19.8 to Registrant's Report on Form 10-Q dated September 30, 1987 (File No. 0-15816)].*\n* Incorporated by reference.\n(c) Reports on Form 8-K\nDuring the last quarter of the year end 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 21st day of March, 1996.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nBy: The Krupp Corporation, a General Partner\nBy: \/s\/Douglas Krupp Douglas Krupp, Co-Chairman (Principal Executive Officer) and Director of The Krupp Corporation\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the 21st day of March, 1996.\nSignatures Titles\n\/s\/Douglas Krupp Co-Chairman (Principal Executive Officer) Douglas Krupp Director of The Krupp Corporation (a and General Partner of the Registrant)\n\/s\/George Krupp Co-Chairman (Principal Executive Officer) George Krupp and Director of The Krupp Corporation (a) General Partner of the Registrant)\n\/s\/Laurence Gerber President of The Krupp Corporation (a Laurence Gerber General Partner of the Registrant)\n\/s\/Robert A. Barrows Senior Vice President and Corporate Robert A. Barrows Controller of the Krupp Corporation (a General Partner of the Registrant)\nAPPENDIX A\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nITEM 8 of FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1995\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nReport of Independent Accountants\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' 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 III - Real Estate and Accumulated Depreciation -\nFinancial Statements - Brookwood Village Joint Venture -\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 Cash Plus-II Limited Partnership:\nWe have audited the financial statements and financial statement schedule of Krupp Cash Plus-II Limited Partnership (the \"Partnership\") listed in the index on page of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Cash Plus-II 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.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. January 31, 1996\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\nThe accompanying notes are an integral part of the financial statements.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nA. Organization\nKrupp Cash Plus-II Limited Partnership (the \"Partnership\") was formed on December 18, 1985 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Partnership has issued all of the General Partner Interests to The Krupp Corporation and The Krupp Company Limited Partnership-IV in exchange for capital contributions aggregating $3,000. Except under certain limited circumstances upon termination of the Partnership, the General Partners are not required to make any additional capital contributions. The Partnership will continue to exist until December 31, 2025, unless earlier terminated upon occurrence of certain events as set forth in the Partnership Agreement.\nThe Partnership has issued 100 Limited Partner Interests to Krupp Depositary Corporation (the \"Corporate Limited Partner\") in exchange for a capital contribution of $2,000. The Corporate Limited Partner, in turn, has issued Depositary Receipts (\"Units\") to the investors and has assigned all of its rights and interest in the Limited Partner Interests (except for its $2,000 Limited Partner's interest) to the holders of Depositary Receipts. As of January 21, 1987, the Partnership completed its public offering having sold 7,499,818 Units for $149,845,812, net of $150,548 of purchase volume discounts.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (see Note K).\nRisks and Uncertainties\nThe Partnership invests its cash primarily in deposits and money market funds with commercial banks. The Partnership has not experienced any losses to date on its invested cash.\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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCash Equivalents\nThe Partnership includes all short-term investments with\nmaturities of three months or less from the date of acquisition in cash and cash equivalents. The cash equivalents are recorded at cost, which approximates current market values.\nRental Revenues\nLeases require the payment of base rent monthly in advance. Rental revenues are recorded on the accrual basis. Commerical leases generally contain provisions for additional rent based on a percentage of tenant sales and other provisions which are also recorded on the accrual basis, but are billed in arrears. Minimum rental revenue for long term commercial leases is recognized on a straight- line basis over the life of the related lease.\nLeasing Commissions\nLeasing commissions on commercial properties are deferred and amortized over the life of the related lease.\nDepreciation\nDepreciation is provided for by the use of the straight-line method over the estimated useful lives of the related assets as follows:\nBuildings and improvements 2 to 25 years Appliances, carpeting and equipment 3 to 5 years\nImpairment of Long-Lived Assets\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate assets.\nThe Partnership routinely performs market and growth studies along with yearly appraisals of its unleveraged real estate. The investments in properties and Joint Venture are carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down investments in properties and the Joint Venture to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are significantly impaired.\nInvestment in Joint Venture\nThe Partnership has a 50% interest in the Joint Venture. This investment is accounted for using the equity method of accounting as the Partnership Agreement requires a simple majority vote for all major decisions regarding the Joint\nVenture. As such, the Partnership does not have control of the operations of the underlying assets. Under the equity method of accounting, the Partnership's equity investment in the net income of the Joint Venture is included currently in the Partnership's net income. Cash distributions received from the Joint Venture reduce the Partnership's investment.\nMBS\nMBS are held for long-term investment and are carried at amortized cost. Premiums or discounts are amortized over the life of the underlying securities using the effective yield method. The market value of MBS is determined based on quoted market prices.\nIncome Taxes\nThe Partnership is not liable for federal or state income taxes as Partnership income is allocated to the partners for income tax purposes. In the event that the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and the examination results in a change in the Partnership's taxable income, such change will be reported to the partners.\nReclassifications\nCertain prior year balances have been reclassified to conform with current year financial statement presentation.\nC. Cash and Cash Equivalents\nCash and cash equivalents at December 31, 1995 and 1994 consist of the following: December 31, 1995 1994\nCash and money market accounts $ 710,395 $ 546,430 Commercial paper 6,365,784 5,534,478 Bankers' acceptance 989,727 991,219\n$8,065,906 $7,072,127\nAt December 31, 1995, commercial paper and bankers acceptance represent corporate issues complying with Section 6.2(a) of the Partnership Agreement purchased through a corporate issuer maturing in the first quarter of 1996. At December 31, 1995, the carrying value of the Partnership's investment in both commercial paper and bankers' acceptance approximates fair value.\nD. Investment in Joint Venture\nThe Partnership and an affiliate of the Partnership each have a 50% interest in the Joint Venture. The express purpose of entering into the Joint Venture was to acquire and operate\nBrookwood Village Mall and Convenience Center (\"Brookwood Village\"). Brookwood Village is a shopping center containing 474,138 net leasable square feet located in Birmingham, Alabama.\nUnder the purchase and sale agreement entered into by the Partnership, its affiliates and the previous owner, the previous owner retained an interest related to the future development at Brookwood Village. The seller is entitled to receive up to $5,000,000 of proceeds from the sale of Brookwood Village and potentially additional amounts related to expansion and development. The Joint Venture holds title to Brookwood Village free and clear from all other material liens or encumbrances.\nFinancial statements for Brookwood Village Joint Venture are included on pages to of this report.\nE. Mortgage Backed Securities\nAt December 31, 1995, the Partnership's MBS Portfolio has an approximate market value of approximately $9,044,000 with unrealized gains of approximately $542,000 and no unrealized losses. At December 31, 1994, the Partnership's MBS Portfolio had an approximate market value of approximately $9,902,000 with unrealized gains of approximately $217,000 and unrealized losses of approximately $130,000. The Portfolio consists of Federal Home Loan Mortgage Corporation holdings with coupon rates ranging from 8.0% to 10.0% per annum maturing in the years 2009 through 2017, Federal National Mortgage Association holdings with coupon rates ranging from 9.5% to 10.0% per annum maturing in the year 2016 and Government National Mortgage Association holdings with coupon rates of 9.0% per annum maturing in the years 2008 through 2009. The Partnership has the intention and ability to hold the MBS and other investments until maturity.\nF. Accrued Expenses and Other Liabilities\nAccrued expenses and other liabilities consist of the following at December 31, 1995 and 1994: 1995 1994\nAccrued real estate taxes $264,996 $276,181 Tenant security deposits 186,242 188,385 Other accrued expenses 34,636 86,494 Prepaid rent 47,459 42,063 $533,333 $593,123\nG. Partners' Equity\nProfits or losses from Partnership operations and Distributable Cash Flow are allocated 98% to the Unitholders and Corporate Limited Partner (the \"Limited Partners\") (based on Units held) and 2% to the General Partners. Profits arising from a capital transaction will be allocated in the same manner as related cash distributions which is described below. Losses from a capital transaction will be allocated 98% to the Limited Partners and 2% to the General Partners.\nUpon the occurrence of a capital transaction, as defined in the Partnership Agreement, proceeds will be applied to the payment of all debts and liabilities of the Partnership then due and then fund any reserves for contingent liabilities. Remaining net cash proceeds will then 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, to the Limited Partners until they have received any deficiency in the 12% cumulative return on invested capital through fiscal years prior to the date of the capital transaction, fourth, to the General Partners until they have received an amount necessary so that the amounts of net cash proceeds whenever allocated under number three and number four are in the ratio of 85 to 15, and fifth, 85% to the Limited Partners and 15% to the General Partners.\nAs of December 31, 1995, the following cumulative partner contributions and allocations have been made since inception of the Partnership:\nH. Related Party Transactions\nCommencing with the date of acquisition of the Partnership's properties, the Partnership entered into agreements under which property management fees are paid to an affiliate of the General Partners for services as management agent. Such agreements provide for management fees payable monthly at a rate up to 6% of the gross receipts net of leasing commissions from commercial properties under management and up to 5% of the gross receipts from residential properties under management. The Partnership also reimburses affiliates of the General Partners for certain expenses incurred in connection with the operation of the properties including accounting, computer, insurance, travel, legal and payroll, and with the preparation and mailing of reports and other communications to the Unitholders.\nAmounts paid to the General Partners or their affiliates were as follows:\n1995 1994 1993\nManagement Fees $374,554 $348,589 $356,485\nExpense Reimbursements 322,733 537,516 565,807\nCharged to operations $697,287 $886,105 $922,292\nI. Future Base Rents Due Under Commercial Operating Leases\nFuture base rents due under commercial operating leases for the years 1996 through 2000 and thereafter are as follows:\n1996 $3,964,700 1997 3,244,700 1998 2,907,500 1999 2,640,200 2000 2,218,100 Thereafter 5,895,300\nJ. Real Estate Taxes\nDuring the second quarter of 1994, the Partnership successfully petitioned for the reassessment of prior years' real estate taxes on Coral Plaza. The Partnership received a tax refund for the 1987, 1988 and 1989 fiscal real estate tax years of approximately $270,000, which was reflected as a reduction of 1994 real estate tax expense.\nK. Federal Income Taxes\nFor federal income tax purposes, the Partnership is depreciating its property using the accelerated cost recovery system (\"ACRS\") and the modified accelerated cost recovery system (\"MACRS\") depending on which is applicable.\nThe reconciliation of the income for each year reported in the accompanying statement of operations with the income reported in the Partnership's 1995, 1994 and 1993 federal income tax return follows:\nThe allocation of the net income for federal income tax purposes for 1995 is as follows:\nDuring the years ended December 31, 1995, 1994 and 1993 the average per Unit income to the Unitholders for federal income tax purposes was $.57, $.48, and $.47, respectively.\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nSCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\n(a) The Partnership uses the cost basis for property valuation for both income tax and financial statement purposes. The Partnership holds title to its properties free and clear from all mortgage indebtedness or other material liens or encumbrances. The aggregate cost for federal income tax purposes at December 31, 1995 is $60,500,636.\n(b) Canyon Place received a cash settlement of $50,406, net of legal costs, for the granting of a railroad easement in 1994. For financial reporting purposes, the carrying value of land has been reduced accordingly.\nContinued\nKRUPP CASH PLUS-II LIMITED PARTNERSHIP\nSCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued December 31, 1995\nReconciliation of Real Estate and Accumulated Depreciation for each of the three years in the period ended December 31, 1995:\nBROOKWOOD VILLAGE JOINT VENTURE\nFINANCIAL STATEMENTS AND SCHEDULE For the Year Ended December 31, 1995\nBROOKWOOD VILLAGE JOINT VENTURE\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nReport of Independent Accountants\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' 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 III - Real Estate and Accumulated Depreciation -\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 Joint Venture Partners of Brookwood Village Joint Venture:\nWe have audited the financial statements and financial statement schedule of Brookwood Village Joint Venture (the \"Joint Venture\") listed in the index on\\ page of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Joint Venture'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 the Joint 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. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. January 31, 1996\nBROOKWOOD VILLAGE JOINT VENTURE\nBALANCE SHEETS December 31, 1995 and 1994\nThe accompanying notes are an integral part of the financial statements.\nBROOKWOOD VILLAGE JOINT VENTURE\nSTATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nBROOKWOOD VILLAGE JOINT VENTURE\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nBROOKWOOD VILLAGE JOINT VENTURE\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nBROOKWOOD VILLAGE JOINT VENTURE\nNOTES TO FINANCIAL STATEMENTS\nA. Organization\nOn December 16, 1986 Brookwood Village Joint Venture (the \"Joint Venture\") acquired Brookwood Village Mall and Convenience Center (\"Brookwood Village\"), a retail development located in Birmingham, Alabama. Brookwood Village consists of a covered mall, a covered garage and a detached strip shopping center with an aggregate net leasable square footage of 474,138. The Joint Venture is 50% owned by Krupp Cash Plus-II Limited Partnership and Texas Apartments Limited Partnership (\"Joint Venture Partners\"), both with similar investment objectives. The express purpose of entering into the Joint Venture was to purchase, own, manage and operate Brookwood Village. Neither the Joint Venture Partners nor the Joint Venture had any affiliation with the seller. The Joint Venture shall exist until December 16, 2006 unless earlier terminated upon occurrence of certain events as set forth in the Brookwood Village Joint Venture Agreement. The seller has retained an interest related to future development at Brookwood Village entitling the seller to the first $5,000,000 of proceeds from the sale of Brookwood Village.\nB. Significant Accounting Policies\nThe Joint Venture uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (see Note H):\nRisks and Uncertainties\nThe Joint Venture invests its cash primarily in deposits and money market funds with commercial banks. The Joint Venture has not experienced any losses to date on its invested cash.\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 of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCash Equivalents\nThe Joint Venture includes all short-term investments with maturities of three months or less from the date of acquisition in cash and cash equivalents. Cash equivalents are recorded at cost, which approximates current market value.\nRental Revenues\nCommercial leases require the payment of base rent monthly in\nadvance. Rental revenues are recorded on the accrual basis. Commercial leases generally contain provisions for additional rent based on a percentage of tenant sales and other provisions which are recorded as income when received. Minimum rental revenue from long-term commercial leases is recognized on a straight-line basis over the life of the related lease.\nDepreciation\nDepreciation of building and improvements is provided for by the use of the straight-line method over estimated useful lives of 3-25 years. Tenant improvements are depreciated over the life of the lease.\nImpairment of Long-Lived Assets\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate assets.\nThe Joint Venture Partners routinely perform market and growth studies along with yearly appraisals of their unleveraged real estate. The properties are carried at cost less accumulated depreciation unless the Joint Venture Partners believe there is a significant impairment in value, in which case a provision to write down investments in properties to fair value will be charged against income. At this time, the Joint Venture\nPartners do not believe that any assets of the Joint Venture are significantly impaired.\nLeasing Commissions\nLeasing commissions are deferred and amortized over the life of the related lease.\nIncome Taxes\nThe Joint Venture is not liable for federal or state income taxes because Joint Venture income or loss is allocated to the Joint Venture Partners for income tax purposes. In the event the Joint Venture's tax returns are examined by the Internal Revenue Service or state taxing authority and such an examination results in a change in the Joint Venture taxable income or loss, such change will be reported to the Joint Venture Partners.\nC. Cash and Cash Equivalents\nCash and cash equivalents at December 31, 1995 and 1994 consist\nof the following: December 31, 1995 1994\nCash and money market accounts $234,661 $271,662 Commercial paper - 348,464\n$234,661 $620,126\nD. Accrued Expenses and Other Liabilities\nAccrued expenses and other liabilities consist of the following at December 31, 1995 and 1994:\nE. Partner's Equity\nUnder the terms of the Brookwood Village Joint Venture Agreement, profits, losses and distributions are allocated 50% to each Joint Venture Partner.\nAs of December 31, 1995, the following cumulative Joint Venture Partner contributions and allocations had been made since inception of the Joint Venture:\nF. Related Party Transactions\nCommencing with the date of acquisition of Brookwood Village, the Joint Venture entered into agreements under which property management fees are paid to an affiliate of the Joint Venture Partners for services as management agent. Such agreements provide for management fees payable monthly at the rate of up to 6% of the gross receipts net of leasing commissions. The Joint Venture also reimburses affiliates of the Joint\nVenture Partners for certain expenses incurred in connection with the operation of Brookwood Village including accounting, computer, insurance, travel, legal and payroll.\nAmounts paid to affiliates of the Joint Venture Partners were as follows:\n1995 1994 1993\nManagement Fees $376,424 $356,030 $330,055\nExpense Reimbursements 137,455 224,200 223,568\nCharged to operations $513,879 $580,230 $553,623\nG. Future Base Rents Due Under Commercial Operating Leases\nFuture base rents due under commercial operating leases in the five years 1996 through 2000 and thereafter are as follows:\n1996 $ 4,074,300 1997 3,706,900 1998 3,375,200 1999 3,048,200 2000 2,450,400 Thereafter 12,965,116\nH. Federal Income Taxes\nThe reconciliation of the income for each year reported in the accompanying statement of operations with the income reported in the Joint Venture's 1995, 1994 and 1993 federal income tax return follows:\nThe allocation of the 1995 net income for federal income tax purposes is as follows:\nPassive Portfolio Income Income Total\nKrupp Cash Plus-II Limited Partnership $1,194,268 $25,328 $1,219,596\nTexas Apartments Limited Partnership 1,111,225 25,328 1,136,553\n$2,305,493 $50,656 $2,356,149\nPassive income differs due to individual Joint Venture Partner depreciation elections.\nBROOKWOOD VILLAGE JOINT VENTURE\nSCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\n(a) The Partnership uses the cost basis for property valuation for both income tax and financial statement purposes. The Partnership holds title to its properties free and clear from all mortgage indebtedness or other material liens or encumbrances. The aggregate cost for federal income tax purposes at December 31, 1995 is $47,590,141.\nContinued\nBROOKWOOD VILLAGE JOINT VENTURE\nSCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued December 31, 1995\nReconciliation of Real Estate and Accumulated Depreciation for each of the three years in the period ended December 31, 1995:","section_15":""}
{"filename":"350797_1995.txt","cik":"350797","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nThe Company's principal business is creating, marketing and managing mutual funds and providing management and counseling services to institutions and individuals. The Company has been in the investment management business for over seventy years, tracing its history to two Boston-based investment managers: Eaton & Howard formed in 1924 and Vance, Sanders & Company organized in 1934. As of October 31, 1995, the Company managed $16.0 billion in portfolios with investment objectives ranging from high current income to maximum capital gain.\nOn October 31, 1995, the Company and its wholly owned subsidiaries had 361 full-time employees. On October 31, 1994, the comparable figure was 385.\nINVESTMENT MANAGEMENT ACTIVITIES\nThe Company conducts its investment management and counseling business through two wholly owned subsidiaries, Eaton Vance Management (\"EVM\") and Boston Management and Research (\"BMR\"), each of which is a Massachusetts business trust registered with the Securities and Exchange Commission (\"the Commission\") as an investment adviser under the Investment Advisers Act of 1940, as amended (the \"Advisers Act\"). Eaton Vance Distributors, Inc. (\"EVD\"), a wholly owned broker\/dealer registered under the Exchange Act, markets and sells the Eaton Vance Funds.\nAs of October 31, 1995, the Company provided investment advisory and administration services to 154 Funds (\"Funds\") and to over 953 separately managed accounts. At that date the Funds had aggregate net assets of $14.2 billion and the Company's separately managed accounts had aggregate net assets of $1.8 billion. The following table shows net assets in the Funds and the separately managed accounts for the dates indicated:\n================================================================================ Fund and Separate Account Assets (in millions)\nAt October 31, - -------------------------------------------------------------------------------- 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- Funds: - -------------------------------------------------------------------------------- Money Market $ 200 $ 200 $ 200 $ 400 $ 400 - -------------------------------------------------------------------------------- Equities 2,400 2,300 2,200 1,600 1,600 - -------------------------------------------------------------------------------- Bank Loans 1,400 600 800 1,100 1,700 - -------------------------------------------------------------------------------- Taxable Fixed Income 1,300 1,300 1,100 1,500 1,200 - -------------------------------------------------------------------------------- Non-Taxable Fixed Income 8,900 9,000 8,900 4,600 2,500 - -------------------------------------------------------------------------------- Total 14,200 13,400 13,200 9,200 7,400 - -------------------------------------------------------------------------------- Separately Managed Accounts 1,800 1,600 2,200 2,100 2,000 - -------------------------------------------------------------------------------- Total $16,000 $15,000 $15,400 $11,300 $ 9,400 ================================================================================\nITEM 1. BUSINESS (CONTINUED)\nINVESTMENT MANAGEMENT ACTIVITIES (CONTINUED)\nInvestment decisions for all but ten of the 154 Funds are made by portfolio managers employed by the Company and are made in accordance with each Fund's investment objectives and policies. Investment decisions for the Company's ten international equity funds are made by Lloyd George Management, an independent investment management company based in Hong Kong. The Company's portfolio management staff consists of 39 portfolio managers and analysts who have, on average, more than 20 years of experience in the securities industry. The Company's investment advisory agreements with each of the Funds provide for fees ranging from 45 to 95 basis points of average net assets annually for management services provided. The investment advisory agreements must be approved annually by the trustees of the respective Funds, including a majority of the independent trustees, i.e., those unaffiliated with the management company. Amendments to the investment advisory agreements must be approved by Fund shareholders. These agreements are generally terminable upon 30 to 60 days notice without penalty.\nInvestment decisions for the separately managed accounts are made by twenty investment counselors employed by the Company. The investment counselors are assisted by an additional eleven financial analysts and managers with part-time counseling responsibilities. The Company's investment counselors use the same sources of information as Fund portfolio managers but tailor investment decisions to the needs of individual clients. The Company's investment advisory fee agreements for the separately managed accounts provide for fees ranging from 30 to 80 basis points of average net assets on an annual basis. These agreements are generally terminable upon 30 to 60 days notice without penalty.\nThe following table shows investment advisory and administration fees received for the past five years ended October 31, 1995:\n================================================================================ Investment Advisory and Administration Fees* (in thousands)\nYear ended October 31, - -------------------------------------------------------------------------------- 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- Investment Advisory Fees - Funds $69,094 $68,284 $59,322 $50,776 $44,550 - -------------------------------------------------------------------------------- Separately Managed Accounts 8,712 9,807 8,934 8,949 6,957 - -------------------------------------------------------------------------------- Administration Fees - Funds 4,631 4,257 3,295 4,685 5,388 - -------------------------------------------------------------------------------- Total $82,437 $82,348 $71,551 $64,410 $56,895 ================================================================================\n* Excludes gold mining investment management fees and administration fees received from funds other than Eaton Vance Funds.\nThe Company's growth has resulted from its ability to develop and offer successfully new funds and to increase the assets of existing Funds. The Company's strategy is to develop products with clearly understood and clearly presented investment characteristics coupled with distribution arrangements that are attractive to third-party distributors of the Funds.\nITEM 1. BUSINESS (CONTINUED)\nINVESTMENT MANAGEMENT ACTIVITIES (CONTINUED)\nIn 1993, the Company introduced the Hub and Spoke(R) structure. Hub and Spoke(R) is a two-tiered arrangement in which mutual funds (Spokes) with substantially identical investment objectives pool their assets by investing in a common portfolio (Hub). Eaton Vance used Hub and Spoke(R) to introduce three distinct mutual fund families (Traditional, Marathon and Classic), with each family having its own prospectus, sales literature, product design and distribution structure (see Marketing and Distribution of Fund Shares below). The structure is intended to benefit fund shareholders through lower operating costs, while allowing the Company to offer cost-effective distribution alternatives to the broker\/dealer community and its clients. The Company has converted most of its Funds to a Hub and Spoke(R) structure.\nIn 1995, the Company converted Eaton Vance Prime Rate Reserves to the Hub and Spoke(R) structure and offered two sister spoke funds: EV Classic Senior Floating-Rate Fund, also an SEC registered closed-end fund, and EV Medallion Senior Floating-Rate Fund, a Cayman Island domiciled off-shore fund. The Company believes these were the first closed-end funds converted to the Hub and Spoke(R) structure. Sales of these funds represented the highest rate of sales by asset class in fiscal 1995.\nThe Company also used the Hub and Spoke(R) structure for Capital Exchange Fund, Inc., an SEC registered investment company closed to new investors. If similar funds managed by EVM adopt the structure in 1996, the diversification of assets for each fund's shareholders should increase and the expense ratio of each fund should decline.\nIn 1995, the Company increased its ownership interest in Lloyd George Management (BVI) Limited (LGM), an independent investment management company based in Hong Kong. The two firms became affiliated in 1992 with the introduction of the Eaton Vance Greater China Funds, which are advised by Lloyd George Management from its headquarters in Hong Kong. The investment management capabilities of LGM, with offices in Hong Kong, London and Bombay, coupled with the introduction of the EV Medallion family of offshore funds, allows Eaton Vance both to manage and to distribute mutual funds globally.\nThe Company introduced two new groups of open-end funds in fiscal 1995. Eaton Vance High Yield Municipals Fund, introduced in the fourth quarter, invests primarily in below investment grade municipal obligations. The fund complements Eaton Vance's largest fund, Eaton Vance National Municipals Fund. The Eaton Vance Information Age Fund, also offered in the fourth quarter, is jointly managed by EVM and LGM and seeks long-term capital growth by investing in a global and diversified portfolio of securities of information age companies.\nITEM 1. BUSINESS (CONTINUED)\nINVESTMENT ADVISORY AGREEMENTS AND DISTRIBUTION PLANS\nEach Eaton Vance Fund (excluding those managed by LGM) has entered into an investment advisory agreement with either EVM or BMR. Although the specific terms of each such agreement vary, the basic terms of the agreements are similar. Pursuant to the agreements, either EVM or BMR, as applicable, provides overall management services to each of the Funds, subject to the supervision of each Fund's Board of Trustees in accordance with each Fund's fundamental investment objectives and policies. The investment advisory agreements are approved by Fund shareholders and their continuance must be approved annually by the trustees of the respective Funds, including a majority of the Independent Trustees. Amendments to the investment advisory agreements must be approved by Fund shareholders.\nEVM also serves as administrator or manager under an Administration Agreement or Management Contract (each an \"Agreement\") to certain Funds (including those managed by LGM). Under such Agreement(s) EVM is responsible for managing the business affairs of these Funds, subject to the supervision of each Fund's Board of Trustees. EVM's services include recordkeeping, preparing and filing documents required to comply with federal and state securities laws, supervising the activities of the Funds' custodian and transfer agent, providing assistance in connection with the Funds' shareholders meetings and other administrative services, including furnishing office space and office facilities, equipment and personnel which may be necessary for managing and administering the business affairs of the Funds. EVM (or an affiliate) may or may not provide investment management or advisory services to these Funds. For the services provided under the Agreement(s), each Fund is required, in some cases, to pay EVM a monthly fee calculated at an annual rate not to exceed 0.25% of average daily net assets. Each Agreement remains in full force and effect indefinitely, but only to the extent that the continuance of such Agreement is specifically approved at least annually by the Fund's Board of Trustees.\nIn addition, certain of the Funds have adopted distribution plans which, subject to applicable law, provide for the reimbursement to the Company for the payment of applicable sales commissions to the retail distribution firms through the payment of an ongoing distribution fee (i.e., a 12b-1 fee). These distribution plans are implemented through a distribution agreement between EVD and the Fund. Although the specific terms of each such agreement may vary, the basic terms of the agreements are similar. Pursuant to the agreements, EVD acts as underwriter for the Fund and distributes shares of the Fund through unaffiliated dealers. Pursuant to the terms of the distribution plans and agreements and the Investment Company Act, each distribution plan and agreement is initially approved and its subsequent continuance must be approved annually by the trustees of the respective Funds, including a majority of the Independent Trustees.\nEach Fund bears all expenses associated with its operation and the issuance and redemption or repurchase of its securities, except for the compensation of directors and officers of the fund who are employed by the Company. Under some circumstances, particularly in connection with new fund introductions and special promotions, EVM or BMR may waive a portion of its fee and pay for some expenses of the Fund.\nEVM has entered into investment advisory agreements which set forth investment objectives and fee schedules with respect to each separately managed account. Pursuant to the agreements, EVM invests the assets of the accounts in accordance with the stated investment objectives. The Company's investment counselors may assist clients in formulating investment strategy.\nITEM 1. BUSINESS (CONTINUED)\nMARKETING AND DISTRIBUTION OF FUND SHARES\nThe Company markets and distributes the Funds through EVD. EVD sells the Funds through a retail network of national and regional dealers, including those affiliated with banks, insurance companies and financial planners. Although the firms in the Company's retail distribution network have entered into a selling agreement with the Company, such agreements (which generally are terminable by either party) do not legally obligate the firms to sell any specific amount of the Company's investment products. For the 1995 and 1994 calendar years, the five dealer firms responsible for the largest volume of fund sales accounted for approximately 42% and 56%, respectively, of the Company's fund sales volume.\nWhile a substantial majority of sales are made through national and large regional firms, in 1990 the Company embarked on a program to broaden its channels of distribution by establishing the Independent Financial Institutions sales force, a separate wholesaling force focusing on banks and financial planners. EVD currently maintains a sales force of more than 30 wholesalers and 30 sales assistants. Wholesalers and their assistants work closely with the retail distribution network to assist in selling Eaton Vance Funds.\nEVD currently sells the Funds under three separate commission structures: 1) front-end load commission (Traditional); 2) spread-load commission (Marathon); and 3) level-load commission (Classic).\nIn the front-end load commission structure (Traditional), the shareholder pays the broker's commission and EVD receives an underwriting commission of up to 75 basis points of the dollar value of the Fund shares sold. The Fund pays a service fee to authorized firms of up to 25 basis points of average net assets.\nIn the spread-load commission structure (Marathon), EVD pays a commission to the dealer at the time of sale and such payments are capitalized and amortized in the Company's financial statements over a four to six year period. The shareholder pays a contingent sales charge to EVD in the event shares are redeemed within a four, five or six year period from the date of purchase. EVD uses its own funds (which may be borrowed) to pay such commissions. EVD \"recovers\" the dealer commissions paid on behalf of the shareholder through distribution plan payments limited to an annual rate of 75 basis points of the average net assets of the Fund in accordance with a distribution plan adopted by the Fund pursuant to Rule 12b-1 under the Investment Company Act. Like the investment advisory agreement, the distribution plan and related payments must be approved annually by a vote of the trustees, including a majority of the independent trustees. The Commission has taken the position that Rule 12b-1 would not permit a Fund to continue making compensation payments to EVD after termination of the plan and that any continuance of such payments may subject the Fund to legal action. These distribution plans are terminable at any time without notice or penalty. In addition, the Fund pays a service fee to authorized firms of up to 25 basis points of average net assets.\nIn the level-load commission structure (Classic), the shareholder pays no front-end commissions or contingent deferred sales charges after the first year. EVD pays a commission to the dealer at the time of sale. The Fund makes monthly distribution plan payments similar to the spread-load Funds, equal to 75 basis points of average net assets and service fees of up to 25 basis points of average net assets on an annual basis to EVD and authorized firms. The introduction of level-load shares is consistent with the efforts of many broker\/dealers to rely less on transaction fees and more on continuing fees for servicing assets.\nReference is made to Note 13 of the Notes to Consolidated Financial Statements contained in the Eaton Vance Corp. Annual Report to Shareholders for the fiscal year ended October 31, 1995 (which report is furnished as Exhibit 13.1 hereto) for a description of the major customer that provided over 10% of the total revenue of the Company.\nITEM 1. BUSINESS (CONTINUED)\nCOMPETITIVE CONDITIONS\nThe Company is subject to substantial competition in all aspects of its business. The Company's ability to market investment products is highly dependent on access to the retail distribution systems of national and regional securities dealer firms, which generally offer competing internally and externally managed investment products. Although the Company has historically been successful in gaining access to these channels, there can be no assurance that it will continue to do so. The inability to have such access could have a material adverse effect on the Company's business.\nThere are few barriers to entry by new investment management firms. The Company's funds compete against an ever increasing number of investment products sold to the public by investment dealers, banks, insurance companies and others that sell tax-free investments, taxable income funds, equity funds and other investment products. Many institutions competing with the Company have greater resources than the Company. The Company competes with other providers of investment products on the basis of the range of products offered, the investment performance of such products, quality of service, fees charged, the level and type of sales representative compensation, the manner in which such products are marketed and distributed and the services provided to investors.\nREGULATION\nEVM and BMR are each registered with the Commission under the Advisers Act. The Advisers Act imposes numerous obligations on registered investment advisers including fiduciary duties, recordkeeping requirements, operational requirements and disclosure obligations. Each Eaton Vance Fund is registered with the Commission under the Investment Company Act and each nationally offered Fund is qualified for sale (or is exempt) in all states in the United States and District of Columbia; and each single-state Fund is qualified for sale (or is exempt) in the state for which it is named and other designated states. Virtually all aspects of the Company's investment management business are subject to various federal and state laws and regulations. These laws and regulations are primarily intended to benefit shareholders of the Funds and investment counseling clients and generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict the Company from carrying on its investment management business in the event that it fails to comply with such laws and regulations. In such event, the possible sanctions which may be imposed include the suspension of individual employees, limitations on EVM's or BMR's engaging in the investment management business for specified periods of time, the revocation of EVM's or BMR's registration as an investment adviser and other censures or fines.\nEVD is registered as a broker\/dealer under the Securities Exchange Act of 1934 and is subject to regulation by the Commission, the National Association of Securities Dealers (NASD) and other federal and state agencies. EVD is subject to the Commission's net capital rule designed to enforce minimum standards regarding the general financial condition and liquidity of a broker\/dealer. Under certain circumstances, this rule limits the ability of the Company to make withdrawals of capital and receive dividends from EVD. EVD's regulatory net capital has consistently exceeded such minimum net capital requirements. The securities industry is one of the most highly regulated in the United States, and failure to comply with related laws and regulations can result in the revocation of broker\/dealer licenses, the imposition of censures or fines and the suspension or expulsion from the securities business of a firm, its officers or employees.\nThe Company's officers, directors and employees may from time to time own securities which are held by one or more of the Funds. The Company's internal policies with respect to individual investments require prior clearance of certain types of transactions and reporting of all securities transactions, and restrict certain transactions so as to avoid the possibility of conflicts of interest.\nITEM 1. BUSINESS (CONTINUED)\nFIDUCIARY AND RELATED BANKING SERVICES\nEaton & Howard, one of the Company's two predecessors, formed IB&T in 1969. IB&T was the first \"non-bank bank\" in the country to obtain FDIC insurance. While it has a charter with full banking powers from the Commonwealth of Massachusetts, IB&T elected not to make commercial loans. As a result of enactment of the Competitive Equality Banking Act of 1987 (\"CEBA\"), IB&T, as an FDIC-insured depository institution, became a \"bank\" for purposes of the Bank Holding Company Act of 1956 (the \"BHC Act\"). Pursuant to CEBA, the Company was permitted to retain its ownership of IB&T without being treated as a bank holding company for purposes of the BHC Act provided that, among other requirements IB&T limited the increase in its assets to no more than 7% during any 12-month period beginning after August 10, 1988 (this limitation does not apply to assets under custody). The Company is not considered to be a bank holding company under the BHC Act.\nOn November 10, 1995, the Company completed the spin-off of Investors Financial Services Corp. (IFSC), the new parent company of IB&T, in a tax-free distribution to Eaton Vance Corp. shareholders. Each shareholder of the Company received 2.799 shares of Common Stock of IFSC and .538 shares of Class A Common Stock of IFSC for each ten shares of Eaton Vance Corp. stock held at the close of business on October 30, 1995, which was the record date of the distribution. As a result of the spin-off, IB&T was released from the Federal banking law restrictions which imposed constraints on its growth.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n(a) Northeast Properties, Inc., a wholly owned subsidiary of the Company, owns various investment properties including an office building located at 24 Federal Street in Boston in which the Company is the primary tenant. For information with respect to the properties, reference is made to Schedule III and Notes 5 and 7 of the Notes to Consolidated Financial Statements contained in the Eaton Vance Corp. 1995 Annual Report to Shareholders (Exhibit 13.1 hereto), which are incorporated herein by reference.\n(b) The Company presently owns 100% of the capital stock of Energex Energy Corporation, which owns interests in certain oil and gas properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company was informed on January 13, 1995, that a National Association of Securities Dealers (NASD) arbitration panel had awarded a former wholesaler for the firm $0.6 million in damages and an additional $1.2 million in punitive damages in response to his claim for wrongful termination of employment. Through October 31, 1995, the Company has accrued $2.2 million, including interest, for these damages. The Company has appealed the decision to the courts and intends to pursue all legal steps to overturn the decision.\nFrom time to time, the Company is a party to various employment-related claims, including claims of discrimination, before federal, state and local administrative agencies and courts. The Company vigorously defends itself against these claims. In the opinion of management, after consultation with counsel, it is unlikely that any adverse determination in one or more of such claims 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 STOCKHOLDER MATTERS\nThe Company's Voting Common Stock, $0.0625 par value, is not traded and, as of October 31, 1995, was held by five Voting Trustees pursuant to the Voting Trust described in paragraph (a) of Item 12 hereof, which paragraph (a) is incorporated herein by reference.\nThe Company's Non-Voting Common Stock, $0.0625 par value, is traded on the Boston Stock Exchange and in the Over-the-Counter market on the NASDAQ National Market System under the symbol EAVN. The approximate number of holders of record of the Company's Non-Voting Common Stock at October 31, 1995, was 1,056. The additional information required to be disclosed in Item 5 is found on page 4 of the Company's 1995 Annual Report to Shareholders (furnished as Exhibit 13.1 hereto), under the caption \"Eaton Vance Corp.\", and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n================================================================================ Eaton Vance Corp.\nSelected Financial Data (Unaudited) (in thousands, except per share figures)\nYear Ended October 31, - -------------------------------------------------------------------------------- 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- Total revenue $167,922 $171,216 $152,276 $120,711 $92,562 - -------------------------------------------------------------------------------- Net income from continuing operations 26,968 25,810 25,517 18,087 12,108 - -------------------------------------------------------------------------------- Total assets 357,586 455,506 425,547 318,199 273,713 - -------------------------------------------------------------------------------- Long-term obligations 56,102 60,311 73,228 78,358 63,961 - -------------------------------------------------------------------------------- Net income from continuing operations per common share $2.90 $2.72 $2.88 $2.33 $1.66 - -------------------------------------------------------------------------------- Cash dividends declared per common share 0.65 0.60 0.49 0.36 0.29 ================================================================================\nOn November 10, 1995, the Company completed the spin-off of Investors Financial Services Corp. (IFSC), the new parent company of Investors Bank & Trust Company (IB&T), in a tax-free distribution to Eaton Vance Corp. shareholders. The banking business has been treated as a discontinued operation in the Selected Financial Data furnished above for fiscal 1995. Total revenue, net income from continuing operations and net income from continuing operations per common share for fiscal years 1994, 1993, 1992 and 1991 have been restated to reflect this accounting treatment.\nNet income from continuing operations and net income from continuing operations per common share for 1994 include a gain of $1.3 million, or $0.14 per share, resulting from the implemenation of Statement of Financial Accounting Standards (SFAS) No. 109.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company's primary sources of revenue are investment adviser fees and distribution fees received from the Eaton Vance funds and separately managed accounts. Such fees are generally based on the net asset value of the investment portfolios managed by the Company and fluctuate with changes in the total value of the assets under management. The Company's major expenses, other than the amortization of deferred sales commissions, include employee compensation, occupancy costs, service fees and other marketing costs.\nRESULTS OF OPERATIONS\nYEAR ENDED OCTOBER 31, 1995 TO YEAR ENDED OCTOBER 31, 1994\nAssets under management of $16.0 billion on October 31, 1995, were 7 percent higher than the $15.0 billion reported a year earlier. Market appreciation and reinvested dividends contributed to the increase in the Company's assets under management. Mutual fund sales for the year ended October 31, 1995 of $1.6 billion were 53 percent below the $3.4 billion reported in fiscal 1994. Redemptions of $2.1 billion in 1995 were 17 percent above the $1.8 billion in 1994. Net sales (gross sales minus redemptions), however, improved in every quarter in 1995.\nOn November 10, 1995, the Company completed the spin-off of Investors Financial Services Corp. (IFSC), the new parent company of Investors Bank & Trust Company (IB&T), in a tax-free distribution to Eaton Vance Corp. shareholders. Under the plan of distribution, the Company transferred net banking assets totaling approximately $14.0 million, including $10.1 million in cash and cash equivalents, to the newly formed bank holding company. The banking business has been treated as a discontinued operation in the accompanying consolidated statements of income and cash flows, and fiscal years 1994 and 1993 have been restated to reflect this accounting treatment.\nTotal revenue from continuing operations decreased $3.3 million to $167.9 million in 1995. Investment adviser and distribution fees decreased by $2.4 million in 1995 to $163.4 million from $165.8 million a year earlier. The decrease in investment adviser and distribution fees can be attributed primarily to lower average assets under management in comparison with the same period a year ago and to redemptions in excess of new mutual fund sales early in the year. The impact of the decrease in mutual fund sales on distribution fees was partially offset by an increase in contingent deferred sales charges received on early redemptions.\nTotal operating expenses decreased $2.6 million to $120.7 million in fiscal 1995. Compensation expense of $38.9 million was little changed from the prior year's expense of $39.3 million. Other expenses for fiscal 1995 include a one-time charge of $2.2 million relating to the accrual of a National Association of Securities Dealers (NASD) arbitration panel award in the first quarter of 1995. The Company is vigorously pursuing all legal steps to overturn the arbitration panel's decision. Other expenses for the comparable period a year ago included $1.4 million in development costs associated with two fund products that were not launched in 1994. A decrease in the average dollar value of assets in spread commission funds due to redemptions in excess of mutual fund sales in fiscal 1995 resulted in a decrease in the amortization of deferred sales commissions of $2.6 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nYEAR ENDED OCTOBER 31, 1995 TO YEAR ENDED OCTOBER 31, 1994 (CONTINUED)\nThe Company's two gold mining partnerships contributed losses of $1.4 million and $0.3 million during 1995 and 1994, respectively. These losses resulted primarily from fluctuations in the portfolio valuations of the two partnerships. After accounting for management fees, operating expenses and income taxes, the Company's gold mining and energy operations had no impact on total fiscal year 1995 or 1994 earnings. The realization for tax purposes of gold mining losses in fiscal 1995 resulted in a decrease in the Company's effective tax rate on income from continuing operations from 40 percent in 1994 to 38 percent in 1995.\nIncome from discontinued banking operations, net of taxes, increased by 26 percent from $2.7 million, or $0.28 per share, for the year ended October 31, 1994, to $3.4 million, or $0.37 per share, for the year ended October 31, 1995. Assets custodied and administered by IB&T totaled $91.1 billion at October 31, 1995, an increase of $18.7 billion over October 31, 1994.\nNet income from continuing operations of the Company amounted to $27.0 million for the year ended October 31, 1995, compared to $27.1 million for the year ended October 31, 1994. Earnings per share from continuing operations were $2.90 and $2.86 for 1995 and 1994, respectively. Net income and earnings per share from continuing operations for 1994 included a gain of $1.3 million, or $0.14 per share, resulting from the implementation of Statement of Financial Accounting Standards (SFAS) No. 109.\nTotal assets, excluding discontinued banking operations, increased 5 percent to $343.6 million at October 31, 1995 from $327.9 million at October 31, 1994. Cash and cash equivalents and short-term investments increased by $54.4 million to $79.1 million at October 31, 1995. Investments in affiliates increased by $6.1 million, primarily due to an increase in the Company's investment in Lloyd George Management (BVI) Limited, an independent investment management company based in Hong Kong. Deferred sales commissions decreased $46.8 million to $209.5 million at October 31, 1995 primarily due to amortization and redemptions in excess of new sales in spread commission funds in fiscal 1995.\nIn fiscal 1996 the Company will be required to adopt Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation.\" SFAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans and requires certain disclosures about employee stock options based on their fair value at the date of grant. Management does not believe the adoption of SFAS No. 123 will have a material impact on the consolidated financial statements.\nYEAR ENDED OCTOBER 31, 1994 TO YEAR ENDED OCTOBER 31, 1993\nTotal revenue from continuing operations rose $18.9 million to $171.2 million from $152.3 million in 1993. This gain was due primarily to increases in investment adviser fees and distribution income, which increased $10.6 million and $8.4 million, respectively, in 1994. Both investment adviser fees and distribution income are based on the average net asset values of portfolios managed by the Company, which rose to $15.5 billion for the year ended October 31, 1994 from $13.1 billion for the year ended October 31, 1993. Fund assets under management were increased by net sales of mutual funds of $2.0 billion in 1994 and reduced, primarily, by depreciation in the market value of managed assets of $1.8 billion. Separately managed accounts, in contrast, decreased to $1.6 billion in 1994 from $2.2 billion in 1993. Most of the decrease was the result of the withdrawal of one large public retirement fund client.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nYEAR ENDED OCTOBER 31, 1994 TO YEAR ENDED OCTOBER 31, 1993 (CONTINUED)\nGross sales of mutual funds of $3.4 billion for 1994 were down 21 percent from 1993 when the Company achieved record sales of $4.3 billion. Redemptions in 1994 rose 38 percent to $1.8 billion from 1993's redemptions of $1.3 billion.\nThe two major components of total expenses are compensation of officers and employees and amortization of deferred sales commissions. In 1994, total expenses increased $15.2 million to $123.4 million. Compensation expense was little changed from 1993. Larger average dollar value of assets in spread commission funds increased the amortization of deferred sales commissions by $11.9 million. Other expenses rose a total of $3.7 million to $31.3 million in 1994 from $27.6 million in 1993. This increase included $1.4 million in development costs associated with two fund products that were not launched in 1994. Additionally, higher marketing and administrative costs were incurred to increase the distribution of the Company's funds.\nPortfolio valuations of gold mining investment partnerships contributed net partnership losses of $0.3 million in 1994 in comparison with net partnership gains of $3.9 million in 1993.\nIncome from discontinued banking operations, net of taxes, increased by 46 percent from $1.8 million, or $0.21 per share, for the year ended October 31, 1993, to $2.7 million, or $0.28 per share, for the year ended October 31, 1994.\nNet income from continuing operations of the Company amounted to $27.1 million for the year ended October 31, 1994, compared to $25.5 million for the year ended October 31, 1993. Earnings per share from continuing operations were $2.86 and $2.88 for the fiscal years ended October 31, 1994 and 1993, respectively. Net income and earnings per share from continuing operations for 1994 included a gain of $1.3 million, or $0.14 per share, associated with the implementation of Statement of Financial Accounting Standards (SFAS) No. 109.\nDuring 1994 the Company's total assets increased significantly. Deferred sales commissions increased to $256.3 million from $240.0 million in 1993 as a result of sales of shares of the Company's spread commission funds. Payment of sales commissions was funded primarily by cash flows from operating activities. The difference between the book and tax accounting treatment for these commissions caused deferred income taxes to increase by $13.7 million. The increase in deferred income taxes was partially offset by the cumulative effect of the change in accounting for income taxes of $1.3 million resulting from the Company's implementation of SFAS No. 109.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and cash equivalents, excluding discontinued banking operations, increased by $43.0 million to $67.7 million at October 31, 1995. In addition, the Company had short-term investments of $11.5 million at October 31, 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY AND CAPITAL RESOURCES (CONTINUED)\nCash provided by continuing operating activities in 1995 was $72.2 million, compared to $28.7 million in the previous year. The Company's primary sources of cash flows from continuing operating activities were net income from continuing operations of $27.0 million and capitalized sales charges received on early redemptions of spread commission funds of $36.2 million. The primary use of cash was for the payment of $39.8 million of sales commissions associated with the sale of spread commission mutual funds.\nCash used for investing in continuing operations was $19.1 million in fiscal 1995. Major uses were the purchase of $11.0 million in short term investments and an increase in the Company's investment in Lloyd George Management (BVI) Limited, an independent investment management company based in Hong Kong. The Company paid $4.8 million in cash and issued non-voting common stock valued at $2.7 million for the additional interest in Lloyd George Management in fiscal 1995.\nSignificant financing activities during the fiscal year were the repayment of a maturing mortgage note of $6.2 million and the payment of dividends to the Company's shareholders of $5.9 million. On November 17, 1995, a subsidiary of the Company entered into an agreement to retire an existing mortgage with a remaining unpaid balance of $4.0 million at October 31, 1995. Based on the terms of the agreement, the Company expects to realize an extraordinary gain of $1.6 million (net of income taxes of $1.1 million) in fiscal 1996.\nOn November 10, 1995, the Company completed the spin-off of its interest in IFSC in a tax-free distribution to the Company's shareholders. The spin-off resulted in a reduction in shareholders' equity of $14.0 million, which approximated the carrying value of IFSC at the time of the spin-off.\nAt October 31, 1995, the Company had no borrowings under its $75.0 million bank credit facility.\nEFFECTS OF INFLATION\nThe major sources of revenue for the Company, i.e., adviser fees, administrative fees and distribution plan payments, are calculated as percentages of assets under management. If, as a result of inflation, expenses rise and assets under management decline, lower fee income and higher expenses will reduce or eliminate profits. If expenses rise and assets rise, bringing increased fees to offset the increased expenses, profits may not be affected by inflation. There is no predictable relationship between changes in financial assets under management and the rate of inflation. If inflation leads to increases in the price of gold or in the price of real estate, the value of the Company's investments in precious metal properties or real estate may be increased.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's consolidated financial statements and related notes thereto and the independent auditors' report appearing on pages 20 through 42 of the Company's 1995 Annual Report to Shareholders, furnished as Exhibit 13.1 hereto, 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 names of all directors and executive officers of Eaton Vance Corp. as of October 31, 1995, as well as their ages, family relationships between them, and offices with the Company held by each of them, are as follows:\nFamily Name Age Relationship Office\nLandon T. Clay (1)(2) 69 None Chairman of the Board of Directors\nM. Dozier Gardner (1)(2) 62 None President, Chief Executive Officer and Director\nJames B. Hawkes (1)(2) 54 None Executive Vice President and Director\nH. Day Brigham, Jr. (1)(2) 68 None Vice President, Director and Chairman of Management Committee\nBenjamin A. Rowland, Jr. (1)(2) 60 None Vice President and Director\nJohn G. L. Cabot 61 None Director\nRalph Z. Sorenson 62 None Director\nThomas Otis 64 None Vice President and Secretary\nLaurie G. Russell 29 None Vice President and Internal Auditor\nJohn P. Rynne 53 None Vice President and Corporate Controller\nWilliam M. Steul (1) 53 None Vice President and Chief Financial Officer\n(1) Member of Management Committee established by the Company's Board of Directors (2) Voting Trustee. See Item 12(a) hereof.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)\nEaton Vance Corp. was formed as a holding company by its subsidiary, Eaton & Howard, Vance Sanders Inc., in February, 1981. Eaton & Howard, Vance Sanders Inc. (renamed Eaton Vance Management, Inc. in June, 1984 and reorganized as Eaton Vance Management in October, 1990) was formed at the acquisition of Eaton & Howard, Incorporated by Vance, Sanders & Company, Inc. on May 1, 1979. In this paragraph, the absence of a corporate name indicates that, depending on the dates involved, the executive held the indicated titles in a firm in the chain of Vance, Sanders & Company, Inc., Eaton & Howard, Vance Sanders Inc., or Eaton Vance Corp. Mr. Clay was a Vice President from November, 1968 until October, 1971 and Chief Executive Officer from October, 1971 until October 1990; he has been a Directorsince 1970 and Chairman of the Board since 1971.. Mr. Gardner was elected President in October, 1979; he has been a Director since July, 1970 and the Chief Executive Officer since October, 1990.\nMr. Brigham has been a Director since April, 1979; from 1967 through 1973 he was Vice President and General Counsel of Eaton & Howard, Incorporated, and from 1973 until April, 1979, he was President of Eaton & Howard. Mr. Hawkes has been Executive Vice President since January, 1990, a Vice President since June, 1975, and a Director since January, 1982. Mr. Rowland has been a Vice President since April, 1969, and a Director since January, 1973. Mr. Cabot became a Director of Eaton Vance Corp. in March, 1989. Mr. Sorenson became a Director of Eaton Vance Corp. in March, 1989. Mr. Otis has been Secretary since October, 1969, a Vice President since April, 1973, and has been the Company's counsel since 1966. Ms. Russell joined Eaton Vance Corp. as a Vice President in August, 1994. Ms. Russell was most recently a Senior Accountant with Deloitte & Touche LLP. Mr. Rynne has been Corporate Controller of Eaton Vance Corp. since January, 1984. Mr. Steul joined the company in November, 1994, as Vice President and Chief Financial Officer. Mr. Steul most recently was Vice President, Finance and Chief Financial Officer of Digital Equipment Corporation.\nIn general, the foregoing officers hold their positions for a period of one year or until their successors are duly chosen or elected. Mr. Clay is an officer, trustee, director or general partner of a number of investment companies of which Eaton Vance Management or Boston Management and Research acts as investment adviser. He is Vice President and a Director of Fulcrum Management, Inc., and MinVen, Inc., both wholly owned subsidiaries of Eaton Vance Corp. Mr. Clay is also a Director of ADE Corp. (a manufacturer of non-contact measuring devices).\nMr. Gardner is an officer or trustee of a number of investment companies for which Eaton Vance Management or Boston Management and Research acts as investment adviser.\nMr. Brigham is an officer or trustee of a number of investment companies for which Eaton Vance Management or Boston Management and Research acts as investment adviser, and Vice President, Secretary and Trustee of EquiFund-Wright National Fiduciary Equity Funds, The Wright Managed Equity Trust, The Wright Managed Income Trust and The Wright Managed Money Market Trust. He is also a Director of Northeast Properties, Inc.\nMr. Hawkes is an officer, trustee or director of a number of investment companies for which Eaton Vance Management or Boston Management and Research acts as investment adviser.\nMr. Rowland is a Director of Energex Energy Corporation, a wholly owned subsidiary of Eaton Vance Corp., and Northeast Properties, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n(A) SUMMARY COMPENSATION TABLE\n* Bonuses include payments in lieu of option grants to Mr. Clay in 1995 of $35,520, in 1994 of $43,520 and in 1993 of $54,500.\nThe amounts appearing under \"Other Annual Compensation\" represent the 10% discount on the purchase of the Company's stock under the Company's Employee Stock Purchase Plan and Incentive Plan - Stock Alternative.\nITEM 11. EXECUTIVE COMPENSATION (CONTINUED)\n(A) SUMMARY COMPENSATION TABLE (CONTINUED)\nThe amounts appearing under \"All Other Compensation\" represent the Company's contribution to its Profit Sharing and 401(k) Plans. The Company's contribution to the Profit Sharing Plan is 15% of the base compensation of all eligible employees, is allocated based on the employee's salary and years of service, and is vested at the rate of 20% for each year of employment. The Company's contribution to the 401(k) plan, which is presently known as the Savings Plan and Trust, is a 100% matching of the first $20.00 of the participant's weekly contribution. Vesting in the Savings Plan and Trust is 100%. The overall contribution to the employee benefit plans may not exceed the statutory limitation of $30,000 per year.\n(B) OPTION GRANTS IN LAST FISCAL YEAR\n(C) AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nITEM 11. EXECUTIVE COMPENSATION (CONTINUED)\n(D) COMPENSATION OF DIRECTORS\nDirectors not otherwise employed by the Company receive a retainer of $4,000 per quarter and $750 per meeting. During the fiscal year ended October 31, 1995, John G.L. Cabot and Ralph Z. Sorenson each received $22,000; in addition, each was granted options for 900 shares.\n(E) COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nM. Dozier Gardner, President of the Company, is a member of the Compensation Committee of the Board of Directors of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nAll outstanding shares of the Company's Common Stock, $0.0625 par value, (which is the only class of the Company's stock having voting rights) are deposited in a Voting Trust, of which the Voting Trustees were (as of December 19, 1995), Landon T. Clay (Chairman of the Board of Directors of the Company), M. Dozier Gardner (President and a Director of the Company), Benjamin A. Rowland, Jr. (a Vice President and a Director of the Company), H. Day Brigham, Jr. (a Vice President and a Director of the Company) and James B. Hawkes (Executive Vice President and a Director of the Company). The Voting Trust (a copy of which is incorporated by reference as Exhibit 9.1 hereto) expires December 31, 1996. The Voting Trustees have unrestricted voting rights for the election of the Company's directors. At December 19, 1995, the Company had outstanding 19,360 shares of Common Stock. Inasmuch as the five Voting Trustees of said Voting Trust have unrestricted voting rights with respect to said Common Stock (except that the Voting Trust Agreement provides that the Voting Trustees shall not vote such Stock in favor of the sale, mortgage or pledge of all or substantially all of the Company's assets or for any change in the capital structure or powers of the Company or in connection with a merger, consolidation, reorganization or dissolution of the Company without the written consent of the holders of Voting Trust Receipts representing at least a majority of such Stock subject at the time to the Voting Trust Agreement), they may be deemed to be the beneficial owners of all of the Company's outstanding Common Stock by virtue of Rule 13d-3(a)(1) under the Securities Exchange Act of 1934. The Voting Trust Agreement provides that the Voting Trustees shall act by a majority if there be three or more Voting Trustees; otherwise they shall act unanimously except as otherwise provided in the Voting Trust Agreement. The address of said Voting Trustees is 24 Federal Street, Boston, Massachusetts 02110.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONTINUED)\n(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS (CONTINUED)\nThe following table sets forth the beneficial owners at December 19, 1995, of the Voting Trust Receipts issued under said Voting Trust Agreement, which Receipts cover the aggregate of 19,360 shares of the Common Stock then outstanding:\n================================================================================ Title of Class Name Number of Shares of % of Voting Common Stock Class Covered by Receipts - -------------------------------------------------------------------------------- Voting Common Stock Landon T. Clay 4,640 24% - -------------------------------------------------------------------------------- Voting Common Stock M. Dozier Gardner 4,640 24% - -------------------------------------------------------------------------------- Voting Common Stock James B. Hawkes 4,640 24% - -------------------------------------------------------------------------------- Voting Common Stock Benjamin A. Rowland, Jr. 2,920 15% - -------------------------------------------------------------------------------- Voting Common Stock H. Day Brigham, Jr. 2,520 13% ================================================================================\nMessrs. Clay, Gardner, Hawkes, Rowland and Brigham are all officers and Directors of the Company and Voting Trustees of the Voting Trust. No transfer of any kind of the Voting Trust Receipts issued under the Voting Trust may be made at any time unless they have first been offered to the Company at book value. In the event of the death or termination of employment by the Company of a holder of the Voting Trust Receipts, they must be offered to the Company at book value. Similar restrictions exist with respect to the Common Stock, all shares of which are deposited and held of record in the Voting Trust.\n(B) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(1) The Articles of Incorporation of Eaton Vance Corp. (\"EVC\") provide that EVC's Non-Voting Common Stock, $0.0625 par value, shall have no voting rights under any circumstances whatsoever. As of December 19, 1995, the officers and directors of EVC, as a group, beneficially owned 2,971,999 shares of such Non-Voting Common Stock or 30.72% of the 9,675,971 shares then outstanding. (Such figures include 227,838 shares subject to options exercisable within 60 days and is based solely upon information furnished by the officers and directors.)\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONTINUED)\n(B) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONTINUED)\nThe following table sets forth the beneficial ownership (i.e., investment power within the meaning of Rule 13d-3(a)(2) under the Securities Exchange Act of 1934) of EVC's Directors and named executive officers of such Non-Voting Common Stock as at December 19, 1995 (such investment power being sole unless otherwise indicated):\n================================================================================ Title of Class Beneficial Owners Amount of % of Beneficial Class Ownership (a) (b) - -------------------------------------------------------------------------------- Non-Voting Common Stock Landon T. Clay 1,806,877 (c)(d)(g) 19.12 - -------------------------------------------------------------------------------- Non-Voting Common Stock M. Dozier Gardner 346,736 (c)(f) 3.66 - -------------------------------------------------------------------------------- Non-Voting Common Stock James B. Hawkes 304,596 (c)(d)(f) 3.18 - -------------------------------------------------------------------------------- Non-Voting Common Stock Benjamin A. Rowland Jr. 217,904 (c)(e) 2.30 - -------------------------------------------------------------------------------- Non-Voting Common Stock H. Day Brigham, Jr. 137,900 1.46 - -------------------------------------------------------------------------------- Non-Voting Common Stock William M. Steul 8,041 (c) 0.09 - -------------------------------------------------------------------------------- Non-Voting Common Stock Wharton P. Whitaker 70,206 (c) 0.74 - -------------------------------------------------------------------------------- Non-Voting Common Stock John G. L. Cabot 21,774 (c) 0.23 - -------------------------------------------------------------------------------- Non-Voting Common Stock Ralph Z. Sorenson 8,367 (c) 0.09 ================================================================================\n(a) Based solely upon information furnished by the officers and directors.\n(b) Based on 9,448,133 outstanding shares plus options exercisable within 60 days of 27,990 for Mr. Gardner, 123,843 for Mr. Hawkes, 22,352 for Mr. Rowland, 6,041 for Mr. Steul, 27,184 for Mr. Whitaker, 3,358 for Mr. Cabot and 3,358 for Mr. Sorenson.\n(c) Includes shares subject to options exercisable within 60 days granted to, but not exercised by, each officer and director as listed in Note (b) above.\n(d) Includes 4,800 shares held by Mr. Hawkes as custodian for a minor child, 635 shares held by Mr. Hawkes' daughter and 2,500 shares held by Mr. Clay's children.\n(e) Includes 1,200 shares owned by Mr. Rowland's spouse as to which Mr. Rowland disclaims beneficial ownership.\n(f) Includes 37,609 shares owned by Mr. Gardner's spouse, and 10,300 shares owned by Mr. Hawkes' spouse.\n(g) Includes 1,045 shares held in the trust of Profit Sharing Retirement Plan for employees of Flowers Antigua, of which the sole beneficiary is the spouse of Mr. Clay. Also includes 6,355 shares held in trust of Profit Sharing Retirement Plan for employees of LTC Corp., wholly owned by Mr. Clay.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONTINUED)\n(B) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONTINUED)\n(2) As of October 31, 1995, certain directors and officers of EVC held various partnership interests in VenturesTrident, L.P., VenturesTrident II, L.P., Fulcrum Management Partners, L.P. and Fulcrum Management Partners II, L.P. (limited partnerships described in Item 13(a) below), each of which may be deemed to be an \"affiliate\" of MinVen, Inc. (see Item 13","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS\nOn February 28, 1985, the Company became a limited partner in VenturesTrident, L.P. (\"VenturesTrident\"), a Delaware Limited Partnership formed to invest in equity securities of public and private mining ventures, principally in precious metals. As a limited partner, the Company has invested an aggregate of $5,000,000 in cash in VenturesTrident. The investment by the Company was made entirely from internally generated funds.\nThe general partner of VenturesTrident is Fulcrum Management Partners, L.P. (\"Fulcrum Partners\"), a Delaware Limited Partnership of which Landon T. Clay (the Company's Chairman of the Board and principal stockholder) and MinVen Inc. (\"MinVen\") are the general partners. MinVen owns a 79.24% interest in Fulcrum Partners, and Mr. Clay owns a 16.09% interest therein. The Company, by reason of MinVen's 79.24% interest in Fulcrum Partners, indirectly owns an additional 15.85% interest in VenturesTrident.\nMr. Clay and entities controlled by Mr. Clay, other than the Company, have acquired limited partnership interests in VenturesTrident for cash investments aggregating $5,550,000. Mr. Clay and such entities, solely through their ownership of such limited partnership interests, in the aggregate currently own a 13.48% interest in VenturesTrident; Mr. Clay, by reason of his 16.093% interest in Fulcrum Partners, indirectly owns an additional 3.219% interest in VenturesTrident. Mr. Clay's wife, Lavinia D. Clay, acquired a limited partnership interest in VenturesTrident for an investment of $100,000; she currently owns a 0.24% interest in VenturesTrident. Certain institutions and other investors have also acquired limited partnership interests in VenturesTrident.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)\n(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS (CONTINUED)\nTwo other directors of the Company, M. Dozier Gardner and Benjamin A. Rowland, Jr., have acquired limited partnership interests in VenturesTrident; each of such investments amounts to $50,000, and each such director owns a 0.12% interest in VenturesTrident. Mr. Clay and the other directors of the Company, by reason of their positions with and ownership of stock of the Company, have an indirect interest in the aggregate 27.988% interest in VenturesTrident directly and indirectly owned by the Company.\nAll net operating income and losses and all net realized capital gains and losses of VenturesTrident with respect to each of its fiscal years will generally be allocated 80% to the limited partners (which include the Company, Mr. and Mrs. Clay and the other two directors of the Company who own limited partnership interests) of VenturesTrident and 20% to Fulcrum Partners (of which Mr. Clay owns a 16.093% interest and the Company owns through MinVen a 79.24% interest). Mr. Clay is an officer and director of MinVen and Fulcrum Management.\nIn accordance with the VenturesTrident Limited Partnership Agreement, as amended, the Fulcrum Partners terminated the Partnership effective December 31, 1995. The Partnership Agreement makes provision for Fulcrum Partners to act as liquidator to wind up the affairs of the Partnership in an orderly manner. The termination and liquidation of VenturesTrident are discussed in VentureTrident's letter of December 15, 1995 to its limited partners attached hereto as Exhibit 99.1 and incorporated herein by reference. VenturesTrident, after paying or providing for its liabilities and obligations, will allocate and distribute its remaining assets among its partners, to the best extent feasible, in cash in proportion to the capital accounts of its partners (and, if a distribution in kind is necessary, after allocating any gain or loss deemed to have been realized in connection with such a distribution in the manner provided in the Limited Partnership Agreement). The Company as limited partner, Mr. and Mrs. Clay and the other two directors of the Company who own limited partnership interests, and Fulcrum Partners as general partner, will receive their pro rata portion of the remaining assets of VenturesTrident in accordance with the provisions of the Limited Partnership Agreement.\nOn November 4, 1987, the Company became a limited partner in VenturesTrident II, L.P. (\"VenturesTrident II\"), a Delaware Limited Partnership formed to invest in equity securities of public and private mining ventures, principally in precious metals. As a limited partner, the Company has invested $3,000,000 in cash in VenturesTrident II. The investment by the Company was made entirely from internally generated funds. The Company, through its ownership of such limited partnership interest, currently owns a 3.042% interest in VenturesTrident II.\nIn addition to the above, MinVen, a wholly owned subsidiary of the Company, has acquired a general partnership interest in the general partner of VenturesTrident II. This acquisition required MinVen to pay $748,235 to such general partner.\nThe general partner of VenturesTrident II is Fulcrum Management Partners II, L.P. (\"Fulcrum Partners II\"), a Delaware Limited Partnership of which Landon T. Clay (the Company's Chairman of the Board and principal stockholder) and MinVen are the general partners. MinVen owns a 82.13% interest in Fulcrum Partners II, and Mr. Clay owns a 3.87% interest therein. The Company, by reason of MinVen's 82.13% interest in Fulcrum Partners II, indirectly owns an additional 16.43% interest in VenturesTrident II. VenturesTrident II has entered into a service agreement with Fulcrum Management, Inc. (\"Fulcrum Management\"), a wholly-owned subsidiary of the Company, whereby Fulcrum Management will provide management and administration services to VenturesTrident II for a quarterly fee equal to .675% of VenturesTrident II's aggregate committed capital. Fulcrum Management has entered into a separate agreement with Castle Group, Inc., a Colorado corporation, pursuant to which Castle will provide such services to VenturesTrident II.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)\n(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS (CONTINUED)\nMr. Clay and entities controlled by Mr. Clay, other than the Company, acquired limited partnership interests in VenturesTrident II for cash investments aggregating $2,650,000. Mr. Clay and such entities, solely through their ownership of such limited partnership interests, in the aggregate currently own a 2.69% interest in VenturesTrident II; Mr. Clay, by reason of his 3.87% interest in Fulcrum Partners II, indirectly owns an additional .77% interest in VenturesTrident II. Investors Bank & Trust Company, as custodian for the benefit of Thomas M. Clay and Richard T. Clay (both of whom are minor children of Landon T. Clay), acquired limited partnership interests in VenturesTrident II for investments of $100,000 for each such child; each such child currently owns a .10% interest in VenturesTrident II. Certain institutions and other investors have also acquired limited partnership interests in VenturesTrident II.\nTwo other directors of the Company, M. Dozier Gardner and Benjamin A. Rowland, Jr., have acquired limited partnership interests in VenturesTrident II; each of such investments amounts to $50,000, and each such director currently owns a .05% interest in VenturesTrident II. Mr. Clay and the other directors of the Company, by reason of their positions with and ownership of stock of the Company, have an indirect interest in the aggregate 19.47% interest in VenturesTrident II directly and indirectly owned by the Company.\nAll net operating income and losses and all net realized capital gains and losses of VenturesTrident II with respect to each of its fiscal years will generally be allocated 80% to the limited partners (which include the Company, Mr. Clay, Mr. Clay's minor children and the other two directors of the Company who own limited partnership interests) of VenturesTrident II and 20% to Fulcrum Partners II (of which Mr. Clay owns a 3.87% interest and the Company owns through MinVen a 82.13% interest). Mr. Clay is an officer and director of MinVen and Fulcrum Management.\n(B) CERTAIN BUSINESS RELATIONSHIPS\nLandon T. Clay, M. Dozier Gardner, James B. Hawkes and H. Day Brigham, Jr., each of whom is a director and executive officer of the Company, are officers and directors, trustees or general partners of various investment companies for which the Company's wholly owned subsidiary, Eaton Vance Management or Boston Management and Research, serves as investment adviser, for which Eaton Vance Distributors, Inc. (a wholly-owned subsidiary of Eaton Vance Management) acts as principal underwriter, and for which Investors Bank & Trust Company (a 77.3% owned subsidiary spun off by the Company on November 10, 1995) serves as custodian; such investment companies make substantial payments to Eaton Vance Management or Boston Management and Research for advisory and management services, substantial payments to Eaton Vance Distributors, Inc. under their distribution plans, and substantial payments to Investors Bank & Trust Company for custodial services.\n(C) INDEBTEDNESS OF MANAGEMENT\nIn 1995, the Company increased to $10,000,000 the amount of money in the Executive Loan Program which is available for loans to certain key employees for the purpose of financing the exercise of stock options for shares of the Company's Non-Voting Common Stock. Such loans are written for a seven-year period, at varying fixed interest rates, and notes evidencing them require repayment in annual installments commencing with the third year in which the loan is outstanding. Loans outstanding under this program amounted to $3,313,000 at October 31, 1995.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)\n(C) INDEBTEDNESS OF MANAGEMENT (CONTINUED)\nThe following table sets forth the executive officers and Directors of the Company who were indebted to the Company under the foregoing loan programs at any time since November 1, 1994, in an aggregate amount in excess of $60,000:\n================================================================================ Largest Amount of Loans Rate of Interest Loans Outstanding Outstanding Charged on Loans Since 11\/1\/94 as of as of 12\/31\/95 12\/31\/95 - -------------------------------------------------------------------------------- Landon T. Clay $176,940 $154,805 8.06%-8.58% (1) - -------------------------------------------------------------------------------- M. Dozier Gardner 634,682 575,809 6.22%-8.06% (2) - -------------------------------------------------------------------------------- James B. Hawkes 525,149 490,982 5.31%-8.58% (3) - -------------------------------------------------------------------------------- H. Day Brigham, Jr. 364,295 332,300 5.31%-8.06% (4) - -------------------------------------------------------------------------------- Wharton P. Whitaker 127,749 43,749 6.57% (5) - -------------------------------------------------------------------------------- Benjamin A. Rowland, Jr. 92,500 42,500 5.31% (6) - -------------------------------------------------------------------------------- John P. Rynne 83,250 83,250 5.74%-8.28% (7) ================================================================================\n(1) 8.06% interest payable on $87,965 principal amount of loan, and 8.58% interest payable on $66,840 principal amount.\n(2) 6.22% interest payable on $99,000 principal amount of loan, 7.55% interest payable on $138,600 principal amount, 8.06% interest payable on $87,965 principal amount, and 6.36% interest payable on $250,244 principal amount.\n(3) 5.31% interest payable on $156,888 principal amount, 5.74% interest payable on $63,102 principal amount, 6.11% interest payable on $110,000 principal amount, 7.61% interest payable on $38,500 principal amount, 8.06% interest payable on $79,968 principal amount and 8.58% interest payable on $42,525 principal amount.\n(4) 5.31% interest payable on $177,100 principal amount of loan, 6.11% interest payable on $88,000 principal amount, and 8.06% interest payable on $67,200 principal amount.\n(5) 6.57% interest payable on $43,749 principal amount.\n(6) 5.31% interest payable on $42,500 principal amount of loan.\n(7) 5.74% interest payable on $15,000 principal amount of loan, 7.32% interest payable on $42,000 principal amount of loan and 8.28% interest payable on $26,250 principal amount of loan.\n(D) TRANSACTIONS WITH PROMOTERS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES\n(A) (1) The following financial statements of Eaton Vance Corp. and the independent auditors' report relating thereto, are incorporated herein by reference into Item 8 hereto:\nSeparate Document Eaton Vance Corp. 1995 Annual Report to Shareholders Page Number\nIndependent Auditors' Report 42\nConsolidated Balance Sheets as of October 31, 1995 and 1994 20-21\nConsolidated Statements of Income for each of the three years in the period ended October 31, 1995 22\nConsolidated Statements of Cash Flows for each of the three years in the period ended October 31, 1995 23\nConsolidated Statements of Shareholders' Equity for each of the three years in the period ended October 31, 1995 24-25\nNotes to Consolidated Financial Statements 26-41\nThe following auditors' report relating to the consolidated financial statement schedules of Eaton Vance Corp. is filed herewith and included in Item 14(a)(1):\nIndependent Auditors' Report 26\n(A)(2) The following financial statement schedules are included herein:\nSchedule Number Description Page Number\nII Valuation and Qualifying Accounts 27\nIII Real Estate and Accumulated Depreciation 28-30\nIV Mortgage Notes Receivable on Real Estate 31-32\nAll Schedules not listed above are omitted because they are not applicable, or the required information is shown in the financial statements or in the notes thereto, or there have been no changes in the information required to be filed from that last previously reported.\n(b) The list of exhibits required by Item 601 of Regulation S-K is set forth in the Exhibit Index and is incorporated herein by reference.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Eaton Vance Corp.:\nWe have audited the consolidated financial statements of Eaton Vance Corp. and its subsidiaries as of October 31, 1995 and 1994, and for each of the three years in the period ended October 31, 1995, and have issued our report thereon dated November 21, 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 consolidated financial statement schedules of Eaton Vance Corp. and its subsidiaries, listed in Item 14. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nBoston, Massachusetts November 21, 1995\nEATON VANCE CORP. VALUATION AND QUALIFYING ACCOUNTS Schedule II\nYears ended October 31, 1995, 1994 and 1993\nEATON VANCE CORP. REAL ESTATE AND ACCUMULATED DEPRECIATION Schedule III\nOctober 31, 1995\nEATON VANCE CORP. REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) Schedule III\nOctober 31, 1995\n(1) The aggregate cost of real estate for federal income tax purposes is approximately the same as the gross carrying amount recorded for book purposes.\nEATON VANCE CORP. REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) Schedule III\n================================================================================ October 31, -------------------------------------------- 1995 1994 1993 - -------------------------------------------------------------------------------- LAND AND BUILDINGS - -------------------------------------------------------------------------------- Gross carrying amount: - -------------------------------------------------------------------------------- Balance, beginning of year $29,812,704 $29,447,609 $28,949,047 - -------------------------------------------------------------------------------- Additions - improvements, etc. 475,329 365,095 528,562 - -------------------------------------------------------------------------------- Balance, end of year $30,288,033 $29,812,704 $29,477,609 - -------------------------------------------------------------------------------- Accumulated depreciation: - -------------------------------------------------------------------------------- Balance, beginning of year $ 7,510,277 $ 6,594,381 $ 5,691,142 - -------------------------------------------------------------------------------- Additions - depreciation 914,212 915,896 903,239 - -------------------------------------------------------------------------------- Balance, end of year $ 8,424,489 $ 7,510,277 $ 6,594,381 ================================================================================\nEATON VANCE CORP. MORTGAGE NOTES RECEIVABLE ON REAL ESTATE Schedule IV\nOctober 31, 1995\nNOTES:\n(A) Periodic payment terms -\nFHA Notes - Interest and principal payments are made at variable amounts over life to maturity, no prepayment penalty.\nConventional Notes - $225,000 note with interest payable at level amounts over life to maturity. Balloon payment of $224,000 due in 1997, no prepayment penalty.\n$34,600 note with interest and principal payments made at level amounts, no prepayment penalty.\nEATON VANCE CORP. MORTGAGE NOTES RECEIVABLE ON REAL ESTATE (Continued) Schedule IV\nOctober 31, 1995\n(B) Reconciliation of the Carrying Amount of Mortgage Loans -\n================================================================================ 1995 1994 1993 - -------------------------------------------------------------------------------- Balance, beginning of year $301,411 $330,654 $360,906 - -------------------------------------------------------------------------------- Collections of principal (23,481) (29,243) (30,252) - -------------------------------------------------------------------------------- Balance, end of year $277,930 $301,411 $330,654 ================================================================================\n(C) The aggregate cost for federal income tax purposes is equal to the carrying amount of the mortgages.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Eaton Vance Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEATON VANCE CORP.\nBy ____________________________ M. Dozier Gardner President, Director and Principal Executive Officer\nDate __________________________\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Eaton Vance Corp. and in the capacities and on the dates indicated:\nEXHIBIT INDEX\nEach Exhibit is listed in this index according to the number assigned to it in the exhibit table set forth in Item 601 of Regulation S-K. The following Exhibits are filed as a part of this Report or incorporated herein by reference pursuant to Rule 12b-32 under the Securities Exchange Act of 1934:\nExhibit No. Description\n3.1 The Company's Amended Articles of Incorporation are filed as Exhibit 3.1 to the Company's registration statement on Form 8-B dated February 4, 1981, filed pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 (S.E.C. File No. 1-8100) and are incorporated herein by reference.\n3.2 The Company's By-Laws are filed as Exhibit 3.2 to the Company's registration statement of Form 8-B dated February 4, 1981, filed pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 (S.E.C. File No. 1-8100) and are incorporated herein by reference.\n3.3 Copy of the Company's Articles of Amendment effective at the close of business on November 22, 1983, has been filed as Exhibit 3.3 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1983, (S.E.C. File No. 1-8100) and is incorporated herein by reference.\n3.4 Copy of the Company's Articles of Amendment effective at the close of business on February 25, 1986 has been filed as Exhibit 3.4 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1986, (S.E.C. File No. 1-8100) and is incorporated herein by reference.\n4.1 The rights of the holders of the Company's Common Stock, par value $.0625 per share, and Non-Voting Common Stock, par value $.0625 per share, are described in the Company's Amended Articles of Incorporation (particularly Articles Sixth, Seventh and Ninth thereof) and the Company's By-Laws (particularly Article II thereof)--See Exhibits 3.1, 3.2 and 3.3 above as incorporated herein by reference.\nEXHIBIT INDEX (CONTINUED)\nExhibit No. Description\n9.1 Copy of the Voting Trust Agreement made as of December 22, 1993 is filed as Exhibit 9.1 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1993, (SEC File No. 1-8100) and is incorporated herein by reference.\n10.1 Description of Performance Bonus Arrangement for Members of Investment Division of Eaton Vance Management is filed herewith.\n10.2 Description of Incentive Bonus Arrangement for Marketing Personnel of Eaton Vance Distributors, Inc. is filed herewith.\n10.3 Copy of 1984 Executive Loan Program relating to financing or refinancing the exercise of options, the purchase of stock, the tax obligations associated with such exercise or purchase and similar undertakings by key directors, officers, and employees adopted by the Company's Directors on October 19, 1984, has been filed as Exhibit 10.8 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1984, (S.E.C. File No. 1-8100) and is incorporated herein by reference.\n10.4 Copy of 1988 Profit Improvement Bonus Plan of Eaton Vance Management, Inc. has been filed as Exhibit 10.9 of the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1987 (S.E.C. File No 1-8100) and is incorporated herein by reference.\nEXHIBIT INDEX (CONTINUED)\nExhibit No. Description\n10.5 Description of 1990 Performance and Retention of Officers Pool (bonus plan to reward key officers of Eaton Vance Management and Eaton Vance Distributors, Inc.) of Eaton Vance Corp. has been filed herewith.\n10.6 Copy of 1992 Stock Option Plan as adopted by the Eaton Vance Corp. Board of Directors on April 8, 1992 has been filed as Exhibit 10.12 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1992 S.E.C. File No. 1-8100), and is incorporated herein by reference.\n10.7 Copy of 1986 Employee Stock Purchase Plan as amended and restated by the Eaton Vance Corp. Board of Directors on April 8, 1992 has been filed as Exhibit 10.13 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1992 (S.E.C. File No. 1-8100), and is incorporated herein by reference.\n10.8 Copy of 1992 Incentive Plan - Stock Alternative as adopted by the Eaton Vance Corp. Board of Directors on July 17, 1992 has been filed as Exhibit 10.14 to the Annual Report on Form 10-K of the Company for the fiscal year ended October 31, 1992 (S.E.C. File No. 1-8100), and is incorporated herein by reference.\n10.9 Copy of 1995 Stock Option Plan as adopted by the Eaton Vance Corp. Board of Directors on October 12, 1995, is filed herewith.\n10.10 Copy of 1986 Employee Stock Purchase Plan as amended and restated by the Eaton Vance Corp. Board of Directors on October 12, 1995, is filed herewith.\n10.11 Copy of 1995 Executive Loan Program relating to financing or refinancing the exercise of options by key directors, officers, and employees adopted by the Company's Directors on October 12, 1995, is filed herewith.\nEXHIBIT INDEX (CONTINUED)\nExhibit No. Description Page Number\n11.1 Statement of Computation of average number of Shares outstanding (filed herewith).\n13.1 Copy of the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1995 (furnished herewith--such Annual Report, except for those portions thereof which are expressly incorporated by reference in this report on Form 10-K, is furnished solely for the information of the Securities and Exchange Commission and is not to be deemed \"filed\" as a part of this report on Form 10-K).\n21.1 List of the Company's Subsidiaries as of October 31, 1995 (filed herewith).\n23.1 Independent Auditors' Consent (filed herewith)\n27.1 Financial Data Schedule as of October 31, 1995 (filed herewith - electronic filing only).\n99.1 VenturesTrident letter of December 15, 1995 to its limited partners is filed herewith.\n99.2 List of Eaton Vance Corp. Open Registration Statements (filed herewith).","section_15":""}
{"filename":"215310_1995.txt","cik":"215310","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nBMC Industries, Inc. is a Minnesota corporation with its executive offices located at Two Appletree Square, Minneapolis, Minnesota 55425; telephone (612) 851-6000. Unless the context otherwise indicates, the terms \"Company\" or \"BMC\" as used herein mean BMC Industries, Inc. and its consolidated subsidiaries.\nBMC was organized in 1907 under the name Buckbee-Mears Company. Over the course of its early history, the Company developed an expertise in photolithography and in the chemical etching of metals. In the 1950's, BMC collaborated in the development of chemically etched aperture masks for color cathode ray tubes. The Company entered the optical business in 1969 with the acquisition of Vision- Ease Lens, a manufacturer of glass multi-focal ophthalmic lenses, based in St. Cloud, Minnesota.\nIn the early 1980's, the Company sought accelerated growth through acquisitions, acquiring additional optical products operations and operations producing electronic interconnection components and related manufacturing equipment. In 1985, the Company determined that the interest burden from acquisition-related debt and a worsening economy in the electronics industry made it impossible to sustain the growth strategy. Between 1985 and 1987, the Company divested several optical products operations and all of the interconnection component operations. Additionally, a contact lens manufacturing operation and the Company's former European optical products businesses were divested in 1989.\nThe Company presently is composed of two product groups, referred to as Precision Imaged Products and Optical Products. Precision Imaged Products is composed of two units. Mask Operations, the group's principal business, produces aperture masks, an integral component of every color television and computer monitor picture tube. The Company, through its Mask Operations, is the only independent aperture mask manufacturer located outside Asia. Buckbee-Mears St. Paul, the second unit of Precision Imaged Products, is a leading domestic producer of precision photo-etched parts. Precision Imaged Products, through its Mask Operations, also is involved in the sale, design, manufacture and installation of aperture mask manufacturing equipment and the licensing of BMC's related proprietary process technology in developing nations. Optical Products designs, manufactures and distributes polycarbonate, glass and hard-resin plastic multi-focal and single-vision ophthalmic lenses for the personal eyewear market. During the fourth quarter of 1995, the Company, through its Vision-Ease Lens division, acquired the assets of a glass multi-focal lens manufacturer in St. Cloud, Minnesota and acquired a lens distributor in London, England. As of December 31, 1995, the Company had 1,915 employees.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nFinancial information about the Company's business segments for the three most recent fiscal years is contained on pages 37-38 of the 1995 Annual Report, and is incorporated herein by reference.\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\nThe Company's business is divided into two product groups: Precision Imaged Products and Optical Products.\nPRECISION IMAGED PRODUCTS\nPrecision Imaged Products (\"PIP\") is composed of two units, Mask Operations and Buckbee-Mears St. Paul, which design, manufacture and market precision etched metal parts, including aperture masks, specialty printed circuits, precision electroformed components and precision etched and filled glass products. The group's Mask Operations also is involved in the sale, design, manufacture and installation of aperture mask manufacturing equipment and the licensing of the Company's related proprietary process technology in developing nations.\nPRODUCTS AND MARKETING. PIP includes Mask Operations, composed of Buckbee-Mears Cortland (Cortland, New York) and Buckbee-Mears Europe (Mullheim, Germany), and Buckbee-Mears St. Paul (St. Paul, Minnesota). The Cortland and Mullheim facilities primarily manufacture aperture masks. The St. Paul facility manufactures precision etched metal parts, specialty printed circuits, precision electroformed components and precision etched and filled glass products. The St. Paul facility also operates a continuous precision parts etching line at the Company's Mullheim facility. Four customers each accounted for more than 10% of PIP's 1995 total revenues, while two accounted for more than 10% of the Company's 1995 total revenues. Thomson, S.A. of France (including its U.S. based operations) accounted for approximately 28% of the Company's 1995 total revenues. Thomson produces televisions in North America and Europe under various trademarks, including RCA and GE. Philips Components B.V. of the Netherlands accounted for approximately 13% of the Company's 1995 total revenues.\nAperture masks are photochemically etched fine screen grids found in every color television and computer monitor picture tube. An aperture mask allows electron beams to activate selectively the red, green or blue phosphors on the inside face plate of the cathode ray tube, producing a color image. Aperture masks are made from cold rolled steel or invar (a nickel alloy) and range in size from 6 inch to 42 inch diagonal dimensions. The Company's facilities employ an automated continuous photochemical etching process originally developed by the Company. Aperture masks are sold directly by the Company to color picture tube manufacturers in North America, Western and Eastern Europe, India, and Asia. Mask Operations maintains an in-house sales staff to sell aperture masks directly to its customers. Net sales of aperture masks comprised 57%, 54% and 53% of the Company's consolidated total revenues in 1995, 1994 and 1993, respectively.\nDuring the 1980's, the Company expanded its aperture mask production capacity by adding additional aperture mask production lines in 1984 and 1988 at its Cortland, New York facility and in 1986 at its Mullheim, Germany facility. In 1986, the Company also added a specialized production line at Mullheim. The specialized line is designed to manufacture precision etched components other than aperture masks, such as gimbal springs for use in computer disk drives. During the fourth quarter of 1995, Buckbee-Mears St. Paul began production on this line of several demanding precision etched components. At its Cortland operation, the Company also manufactures small quantities of special-purpose, very-high-resolution foil aperture masks for military avionics use.\nThe Company was engaged in research and development efforts in recent prior years aimed at developing the manufacturing and technical expertise necessary to produce aperture masks for high definition television (\"HDTV\") and other large color cathode ray tube applications (\"jumbo masks\"). As a result, the Company has delivered limited quantities of prototype HDTV aperture masks to customers engaged in HDTV research and development. Commercial production deliveries of other jumbo masks, which are manufactured from invar and steel, have increased significantly in the last three years due to a corresponding increase in sales of jumbo televisions, particularly in the United States. In addition, over\nthe past few years, the Company has engaged in research and development efforts aimed at developing the manufacturing and technical expertise necessary to produce aperture masks for high-resolution color computer monitors.\nIn 1993, the Company modified one of the three manufacturing lines at its Cortland, New York facility to permit the production of high-resolution masks for computer monitors. An initial pre-production run of high-resolution masks was completed during the fourth quarter of 1993. During 1994, the Company qualified as a high-resolution computer monitor mask vendor and began its first volume shipments of the product. Due to strong demand for larger size television aperture masks in 1995, the Company converted this line back to television aperture mask production. In February 1994, the Company began steps to upgrade another one of the three manufacturing lines at its Cortland facility. The upgraded line in Cortland will serve the growing demand for large and jumbo masks for high-performance color television tubes. The Company expects to complete the process upgrades by the second quarter of 1996.\nIn February 1994, the Company initiated construction of a new production line at its Mullheim, Germany facility. The start-up of the new production line began in the fourth quarter of 1995. The German facility currently is working to increase yields with a ramp into full volume production anticipated during 1996. The new production line in the German facility will be dedicated exclusively to the production of high-resolution computer monitor masks.\nIn 1995, the Company announced its plans to add two new production lines at the Cortland, NY facility, one for television aperture masks and the other for high- resolution computer monitor masks. The Company began engineering and construction of this expansion in the third quarter of 1995. The Company anticipates that the first of the two new production lines at Cortland will become operational during the first quarter of 1997, with the second line expected to begin production during the second quarter of 1997. These new production lines, along with the new production line in the German facility and the upgraded line in Cortland, will add manufacturing capacity for 13 to 14 million television aperture masks and will increase production capacity for computer monitor masks to 10 million masks annually. The expansion is focused particularly on the growing market for large masks (25-29 inch), medium masks (19-23 inch) and high resolution computer monitor masks.\nProducts manufactured at the St. Paul, Minnesota facility include precision etched metal parts; large size, tight tolerance specialty printed circuits up to four by ten feet in area; precision electroformed components; and, precision etched and filled glass products. These products are sold directly by the Company, both by in-house sales personnel and manufacturers representatives, to manufacturers of automotive components, filtration equipment, microwave antennas, computers and printers, various consumer products, medical electronics and computer aided design\/computer aided manufacturing (\"CAD\/CAM\") equipment and military and avionics electronics.\nIn 1991, the Company (through its Mask Operations) largely completed delivery and installation of aperture mask manufacturing equipment to a Chinese customer; in 1992, acceptance testing of the equipment was completed and the customer commenced commercial production. The Company receives royalty payments on products produced by this customer. In 1993, the Company (through Mask Operations) entered into a $26 million contract to deliver and install aperture mask manufacturing equipment to another Chinese customer. The Company anticipates successful completion of this contract during 1996, at which time the Company will receive royalty payments on products manufactured by this customer.\nINTELLECTUAL PROPERTY. The Company has a number of patents which are important to the success of its PIP operations. These patents range in their expiration dates from 1998 to 2014. The loss of any single patent would not have a material adverse effect on the business of the Company as a whole. The Company believes that improvement of existing products and processes and a reliance on trade secrets and unpatented proprietary know-how are as important as patent protection in establishing and maintaining the Company's competitive position. At the same time, the Company continues to seek patent protection for its products and processes on a selective basis. However, there can be no assurance that any patents obtained will provide substantial protection or be of commercial value. The Company generally requires its consultants and employees to agree in writing to maintain the confidentiality of the Company's information and (within certain limits) to assign to the Company any inventions, and any patent or other intellectual property rights, relating to the Company's business.\nCOMPETITION. Competition with respect to the products described above is intense, with no one competitor dominating the market. The principal methods of competition are pricing, product quality and product availability, and the Company competes on the basis of each of these methods.\nThe Company is one of only five independent aperture mask manufacturers in the world. In addition, several color picture tube manufacturers operate captive aperture mask production facilities. State directed ventures operate in China. The Company believes that it has approximately a 20% share of the total world aperture mask market held by independent manufacturers. The Company is the only independent aperture mask manufacturer with production facilities outside Asia.\nMany producers compete in the market for precision etched metal parts produced by the St. Paul facility; there is no clear market share leader. The Company sells its precision etched metal parts to approximately 250 industrial users. The specialty printed circuit market served by that facility includes producers of a wide variety of end products; its size therefore is difficult to quantify. The Company estimates that there are approximately 20 customers for specialty circuits, primarily military and industrial users.\nSUPPLIES. Each of the PIP operations have available multiple sources of the raw materials needed to manufacture its products. The Cortland operation imports from Japan and Germany all of its steel and invar requirements necessary in the manufacture of its products; the Mullheim operation imports from Japan a portion of its steel and invar requirements. Importation of such steel into the United States is subject to restrictions imposed by U.S. federal trade legislation and regulations, but the Company does not anticipate difficulty in obtaining this or any other raw materials. In 1992, the Company was involved in a successful effort to exclude aperture mask steel from products currently involved in a dumping investigation by the U.S. International Trade Commission.\nBACKLOG. As of December 31, 1995, the backlog of PIP sales orders believed to be firm was $177 million, compared with $126 million as of December 31, 1994. The Company expects that all of the December 31, 1995 backlog orders will be filled within the current fiscal year. Backlog orders are based on the results of annual price\/quantity negotiations with aperture mask customers and purchase orders in hand from other customers. Backlog orders may be changed or cancelled by aperture mask customers without penalty.\nENVIRONMENTAL. Chemically etching metals, which is performed by all PIP operations, requires the Company to utilize chemical substances which must be handled in accordance with applicable laws and regulations. The etching processes also generate wastewater, which is treated using on-site wastewater treatment systems, and wastes, some of which are classified as hazardous under applicable environmental laws and regulations. The Company employs systems for either disposing of such wastes in accordance\nwith applicable laws or regulations or recycling the chemicals it utilizes through the manufacturing process. The wastes and the wastewater treatment systems are monitored by environmental agencies to assure compliance with applicable standards. Generation of waste does entail that the Company maintain responsibility for the waste even after proper disposal. As of March 22, 1996, the Company is involved in a total of eight (8) sites where environmental investigations are occurring and final settlement has not been reached, of which five (5) relate to the PIP division and three (3) relate to the Optical Products division. See \"Optical Products -- Environmental\" for a discussion of the sites relating to the Optical Products division.\nDuring 1995, the Company was identified as a potentially reponsible party (\"PRP\") at a site for which the Environmental Protection Agency (the \"EPA\") previously requested information regarding the Company's potential involvement at the site. It is the Company's belief that its involvement at this site was minimal and, therefore, is seeking de minimis status. Also in 1995, the Company reached a de minimis settlement of its liability with the non-de minimis PRP group at a site in which the Company was a PRP. This activity maintains a total of five (5) sites, involving the Company's PIP division, where the Company has been involved in environmental investigations and where final settlement has not been reached.\nIn addition to the above sites, the Company was named previously as a defendant in connection with real property located in Irvine, California previously occupied by a discontinued operation of the Company's PIP division. In 1995, the Company settled this litigation with the other parties to the lawsuit and all claims have been dismissed with prejudice. Remediation of the site has begun in accordance with a remediation system approved by the applicable state regulatory agency. The settlement amount and the anticipated cost of the remediation system are both within the $3.3 million reserved by the Company for this matter. The Company has also been named as a defendant by parties identified as PRP's for a site in Cortland, New York. The Company strongly believes it has no involvement with this site and is committed to a vigorous defense of this case. It is impossible at this time to predict the likely outcome of this matter or the Company's exposure if this case is decided adversely. However, it is not currently anticipated that this case, or the Company's share of the costs of environmental remediation activities for any of the sites discussed above will have a materially adverse effect on the financial condition of the Company as a whole.\nPIP estimates that in 1995 and 1994 it incurred approximately $5.1 and $3.4 million, respectively, in expenditures (including capital expenditures) related to efforts to comply with applicable laws and regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. In addition, it estimates that it will make approximately $2.0 million and $1.9 million dollars in capital expenditures for environmental control facilities during 1996 and 1997-98, respectively.\nSEASONALITY. The Company's earnings from PIP are generally lower in the first and third quarters due to maintenance shutdowns at the Company's Cortland, N.Y. and Mullheim, Germany facilities. Also, the seasonality of televisions, the end product of aperture masks, affects the Company's annual earnings pattern.\nOPTICAL PRODUCTS\nOptical Products, operating under the Vision-Ease Lens trademark (\"Vision- Ease\"), is a major U.S. manufacturer of ophthalmic lenses, including semi- finished polycarbonate, glass and hard-resin plastic multi-focal and single- vision lenses and finished polycarbonate single-vision lenses, with group headquarters located in Brooklyn Park, Minnesota. Vision-Ease includes manufacturing operations located in Brooklyn Center and St. Cloud, Minnesota and in Ft. Lauderdale, Florida. Vision-Ease also has 13 distribution centers in the U.S. and Canada, a sales subsidiary in Canada and a distribution subsidiary in England.\nPRODUCTS AND MARKETING. Ophthalmic lenses are manufactured from three principal materials: polycarbonate (\"poly\"), glass and hard-resin plastic. Hard-resin plastic includes both standard plastic lenses and high-index plastic lenses. Semi-finished lenses are sold to independent wholesale optical laboratories or retail outlets with on-site laboratories, which then finish the lens by grinding and polishing the back side of the lens according to the prescription provided by the optometrist or ophthalmologist. After processing, the lens is edged and inserted into the frame by either the wholesale laboratory or the retail optical dispenser. The Company also factory finishes and sells to wholesale and retail laboratories a broad range of standard power prescription poly lenses. These finished lenses are ready to be edged and inserted into the frame without laboratory surfacing. Vision-Ease additionally markets limited quantities of lenses produced by third party manufacturers.\nVision-Ease manufactures finished and semi-finished single-vision and semi- finished multi-focal poly lenses, including progressive power multi-focal lenses, at its Brooklyn Center facility. Progressive power multi-focal lenses provide a gradual transition from distance to near viewing without the visual \"jump\" generally associated with a multi-focal lens. Due to the strong market demand, Vision-Ease increased its polycarbonate manufacturing capacity by approximately 40% in 1995, after nearly doubling it in both 1994 and 1993. The Company produces semi-finished glass multi-focal and single-vision lenses at its St. Cloud facility. The Ft. Lauderdale facility manufactures semi-finished hard-resin plastic multi-focal (including high-index) and single-vision lenses, including plastic progressive power multi-focal lenses, and glass progressive power multi-focal lenses.\nIn 1994, the Company entered into a strategic supply agreement with a low-cost, off-shore supplier for mid-range power standard hard-resin plastic lenses. Under the terms of the supply agreement, Vision-Ease is committed to purchase approximately $10.7 million dollars of lens over a four year period. This agreement allows Vision-Ease to focus manufacturing capabilities on higher- margin products within this segment and to be cost-competitive on mid-range, lower-margin products.\nOver the last three years, the Company has made increasing investments in lens development work, particularly in poly lens development and other higher margin products. The result has been the first quarter 1993 introduction of a poly progressive lens product line and other new poly products, and the introduction of several new products in 1994, including VersaLite-Registered Trademark- 1.0 (a thin and light single-vision lens). The Company added several new products during 1995, including VersaLite-Registered Trademark- SunRx-Registered Trademark- (a premium glare reducing sunglass lens). Vision-Ease will continue to make significant investments in poly lens development.\nVision-Ease also markets the Optifacts-TM- computer software system. Optifacts- TM- combines proprietary software and standard major manufacturer computer hardware for use by optical wholesale laboratories. The Optifacts-TM- software assists the laboratory in order entry, inventory tracking and related business functions.\nVision-Ease markets its optical products to more than 600 wholesalers and retailers in the U.S. and to more than 60 in international markets. No single customer of Vision-Ease accounted for more than 10% of its or the Company's total revenues in 1995. Vision-Ease utilizes independent sales representatives to market its lens products, and the Company advertises in industry publications. Vision-Ease also maintains an internal sales and marketing department to coordinate all sales and promotional activities and provide customer service.\nACQUISITIONS. Vision-Ease made two acquisitions during 1995. In November 1995, Vision-Ease purchased the assets of Lantz Lenses, Inc. (\"Lantz\"), a glass multi- focal lens manufacturer in St. Cloud, Minnesota.\nIn December 1995, Vision-Ease acquired Optical Manufacturing Supplies Limited (\"OMS\"), a distributor of lenses in London, England. The Company believes that the acquisition of Lantz will increase its sales of multi-focal glass products and the acquisition of OMS will expand its direct distribution of Vision-Ease products into Europe.\nINTELLECTUAL PROPERTY. The Company has several patents protecting certain of the products and manufacturing processes of its Vision-Ease operations. These patents have expiration dates ranging from 1998 to 2012. The loss of any single patent would not have a material adverse effect on the business of the Company as a whole. The Company believes that improvement of existing products and processes, the development of new lens products and a reliance on trade secrets and unpatented proprietary know-how are as important as patent protection in establishing and maintaining the Company's competitive position. At the same time, the Company continues to seek patent protection for its products and processes on a selective basis. However, there can be no assurance that any patents obtained will provide substantial protection or be of commercial value. The Company generally requires its consultants and employees to agree in writing to maintain the confidentiality of the Company's information and (within certain limits) to assign to the Company any inventions, and any patent or other intellectual property rights, relating to the Company's business.\nCOMPETITION. Competition in the ophthalmic industry with respect to all of the products described above is intense, with no one firm dominating the industry. The principal methods of competition in the industry are product offerings, pricing, product quality and customer service, particularly with respect to turnaround time from order to shipment. The Company competes on each of these methods. Vision-Ease continues to investigate all low-cost manufacturing opportunities to increase its competitiveness.\nSUPPLIES. Vision-Ease has available multiple sources of the raw materials required to manufacture all of its products, with the exception of the monomer required in the production of standard hard-resin plastic lenses, which is available domestically only through Pittsburgh Plate Glass Industries, Inc. and Akzo Chemie America, the monomer required in the production of high-index plastic lenses, available only from Daiso, a Japanese company, and photochromic glass blanks used in producing photochromic glass lenses, which are available domestically only from Corning Glass. Although the Company's principal supplier of standard monomer is Akzo Chemie America, the products of both domestic suppliers are qualified for use in the Company's production process. Alternate offshore supplies of both standard monomer and photochromic glass blanks are available in the event of any disruption of supplies from domestic sources.\nBACKLOG AND INVENTORY. Due to the significance to the ophthalmic industry of rapid turnaround time from order to shipment, the backlog of sales orders is not material. Due to the large number of stock-keeping units required, there is a need to maintain a significant amount of inventory in order to satisfy rapid response time.\nENVIRONMENTAL. As part of its lens manufacturing processes, the Company utilizes hazardous chemical substances, which must be handled in accordance with applicable laws and regulations. The lens manufacturing processes also generate wastewater and wastes, some of which are classified as hazardous under applicable environmental laws and regulations. The Company employs systems for either disposing of such wastes in accordance with applicable laws and regulations, or recycling the chemicals it utilizes through the manufacturing process. The wastes and the wastewater treatment systems are monitored by environmental agencies to assure compliance with applicable standards. The wastes generated by Vision-Ease operations must be managed and disposed of properly and the Company retains responsibility for those wastes even after proper disposal. As of March 22, 1996, the Company is involved in a total of eight\n(8) sites where environmental investigations are occurring and final settlement has not been reached, of which five (5) relate to the PIP division and three (3) relate to the Optical Products division. See \"Precision Imaged Products -- Environmental\" for a discussion of the sites relating to the PIP division.\nIn addition to the above sites, the Company has continued its site investigations at its Fort Lauderdale facility. The Company's consultant has begun testing at the site. Following compilation of all test results, the Company will submit its recommendations regarding the site to the state regulatory agency for concurrence. The Company's consultant has indicated that it is reasonably probable that some type of remediation will be required and has provided the Company an approximate cost range for that remediation. Based on the consultant's estimates, and in accordance with generally accepted accounting principles, the Company has reserved for potential remediation costs. Because the governmental bodies have not yet identified the full extent of any remedial actions, it is still impossible at this time to predict the likely outcome of the Fort Lauderdale matter, as well as the additional eight sites discussed above, or the Company's exposure if any of these cases are decided adversely.\nIt is not currently anticipated that the Company's share of the costs of environmental remediation activities for any of the sites, including the range provided by the Company's consultant for the Fort Lauderdale facility, will have a materially adverse effect on the financial condition of the Company.\nVision-Ease estimates that in 1995 and 1994 it incurred approximately $635,000 and $580,000, respectively, in expenditures (including capital expenditures) related to efforts to comply with applicable laws and regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. In addition, it estimates that it will make approximately $71,000 in capital expenditures for environmental control facilities during 1996.\nSEASONALITY. The Company's earnings from Optical Products are generally lower in the first quarter due to the seasonality of eyeglasses, the end product of the Company's lenses.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.\nFinancial information about the Company's foreign and domestic operations and export sales for the three most recent fiscal years is contained on page 38 of the 1995 Annual Report, and is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe locations of the Company's principal production facilities are as follows:\nThe Company leases approximately 9,500 square feet in Minneapolis, Minnesota for its corporate administrative offices. The Company leases approximately 6,000 square feet in Brooklyn Park, Minnesota for the administrative offices of Vision-Ease. The Company's leases in St. Paul and Brooklyn Center expire in February 1999 and March 1998, respectively, and its lease in Ft. Lauderdale expires in November 1996. The Company is not renewing the Ft. Lauderdale lease. The Company's management is evaluating its options for continuing hard resin plastic lens production currently conducted at the Ft. Lauderdale facility, including moving the operation to a more appropriately sized and lower cost facility.\nThe Company's existing facilities are fully utilized. The Company began construction of two new production lines at its Cortland facility in 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWith regard to certain environmental matters, See Item 1(c) \"Narrative Description of Business\" and Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nOther than as noted above, there are no material pending or threatened legal, governmental, administrative or other proceedings to which the Company is a party or of which any of its property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company, their ages, the year first elected or appointed as an executive officer and the offices held as of March 22, 1996 are as follows:\nThere are no family relationships between or among any of the executive officers of the Company. Executive officers of the Company are elected by the Board of Directors for one-year terms, commencing with their election at the first meeting of the Board of Directors immediately following the annual meeting of stockholders and continuing until the next such meeting of the Board of Directors.\nExcept as indicated below, there has been no change in the principal occupations or employment of the executive officers of the Company during the past five years.\nMr. Burke is also a director of the Company. Mr. Burke joined the Company as Associate General Counsel in June, 1983, and became Vice President, Secretary and General Counsel in August, 1985. In November, 1987, he was appointed Vice President, Fort Lauderdale Operations of the Company's Vision-Ease Lens division and in May, 1989, he was appointed President of Vision-Ease Lens. In May, 1991, Mr. Burke was elected President and Chief Operating Officer of the Company, and in July, 1991, he became President and Chief Executive Officer. Mr. Burke was appointed Chairman of the Board in May, 1995.\nMr. Gburek joined the Company in January, 1993 as Vice President\/General Manager of Buckbee-Mears St. Paul. In August, 1995, he was appointed Vice President of Corporate Development. Prior to joining the Company, Mr. Gburek served as Director, Manufacturing Operations, LTV Aerospace and Defense Co., a subsidiary of LTV Corporation.\nMr. Hawks joined the Company in October, 1983 as Assistant Corporate Controller and became Corporate Controller in August, 1985. In May, 1993, Mr. Hawks became Treasurer and Secretary of the Company and in August, 1995, he became Vice President of Finance and Administration, Chief Financial Officer and Secretary.\nMr. Nygaard joined the Company in July, 1984 as Director of Taxes and became Corporate Controller in May, 1993. Mr. Nygaard was appointed Vice President of Taxes in January, 1996.\nMr. Wright joined the Company in January, 1996. From February, 1993 to January, 1996, he served in several capacities with Employee Benefit Plans, Inc., most recently as Vice President and Treasurer. Prior to February, 1993, Mr. Wright worked in several audit and business advisory positions with Arthur Andersen, L.L.P.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n\"Price Range of Common Stock\" on page 41 of the 1995 Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Historical Financial Summary\" on page 22 of 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\n\"Management's Discussion and Analysis\" on pages 23-26 of the 1995 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 related notes on pages 27- 39 and the Report of its Independent Auditors on page 40 of the 1995 Annual Report are incorporated herein by reference, as is the unaudited information under the caption \"Selected Quarterly Data\" on page 42.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT\n(a) DIRECTORS OF THE REGISTRANT\nThe information under the caption \"Election of Directors\" on pages 2-5 of the 1996 Proxy Statement is incorporated herein by reference.\n(b) EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning Executive Officers of the Company is included in this report under Item 4A, \"Executive Officers of the Registrant\".\n(c) COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nThe information under the caption \"Section 16 Compliance\" on page 16 of the 1996 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained under the caption \"Executive Compensation\" on pages 7-9 and \"Election of Directors - Information About the Board and Its Committees\" on pages 3-4 of the 1996 Proxy Statement 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 and Management\" on pages 5-6 of the 1996 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained under the caption \"Certain Transactions\" on pages 15- 16 of 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. FINANCIAL STATEMENTS:\nThe following items are incorporated herein by reference from the pages indicated in the Registrant's 1995 Annual Report:\nConsolidated Financial Statements: Page: ---------------------------------- -----\nConsolidated Statements of Earnings for the Years Ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . 27\nConsolidated Balance Sheets, December 31, 1995 and 1994. . . . . 28\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . 29\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . 30\nNotes to Consolidated Financial Statements . . . . . . . . . . . 31-39\nReport of Independent Auditors . . . . . . . . . . . . . . . . . 40\n2. FINANCIAL STATEMENT SCHEDULE:\nThe selected quarterly financial data (unaudited) included under the caption \"Selected Quarterly Data\" on page 42 of the 1995 Annual Report is incorporated herein by reference.\nThe following supplemental financial data is included herein and should be read in conjunction with the consolidated financial statements referenced above:\nConsent of Independent Auditors (filed as Exhibit 23.1 to this Form 10-K)\nSupplemental Schedule: Page: ---------------------- ----- II - Valuation and Qualifying Accounts 16\nSchedules other than the one listed above are omitted because of the absence of the conditions under which they are required or because the information required is included in the consolidated financial statements or the notes thereto.\n3. EXHIBITS:\nReference is made to the Exhibit Index hereinafter contained on pages 18-23 of this Form 10-K.\nA copy of any of the exhibits listed or referred to herein will be furnished at a reasonable cost to any person who was a stockholder of the Company as of March 1, 1996, upon receipt from any such person of a written request for any such exhibit. Such request should be sent to Investor Relations Department, BMC Industries, Inc., Two Appletree Square, Minneapolis, Minnesota 55425.\nThe following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c):\na) 1984 Omnibus Stock Program, as amended effective December 19, 1989 (incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-8467)).\nb) 1995 Management Incentive Bonus Plan Summary (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467)).\nc) 1996 Management Incentive Bonus Plan Summary (filed herewith as Exhibit 10.3).\nd) Interest Rate Supplement Program (incorporated by reference to written description thereof on page 10 of the Company's Proxy Statement dated March 22, 1991 (File No. 1-8467)).\ne) Revised Executive Expense Policy (effective as of January 1, 1993) (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-8467)).\nf) BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 (File No. 1-8467)).\ng) First and Second Declaration of Amendment, effective March 15, 1991 and June 3, 1991, respectively, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-8467)).\nh) Third Declaration of Amendment, effective as of January 1, 1992, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-8467)).\ni) Fourth Declaration of Amendment, effective as of June 30, 1992, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-8467)).\nj) BMC Industries, Inc. Profit Sharing Plan 1994 Revision, as amended (incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467)).\nk) BMC Industries, Inc. Savings Plan 1994 Revision, as amended (incorporated by reference to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467)).\nl) Directors' Deferred Compensation Plan (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1984 (File No. 1-8467)).\nm) Form of Change of Control Agreement entered into between the Company and Messrs. Burke, Kerr, Hawks and Nygaard (incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1- 8467)).\nn) Change of Control Agreement Entered into between the Company and Mr. Gburek (filed herewith as Exhibit 10.32).\no) 1994 Stock Incentive Plan (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467)).\np) BMC Stock Option Exercise Loan Program, as revised December 14, 1994 (incorporated herein by reference to Exhibit 10.15 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467)).\nq) BMC Industries, Inc. Benefit Equalization Plan (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467)).\n(b) REPORTS ON FORM 8-K\nThe Company did not file any reports on Form 8-K during the quarter ended December 31, 1995.\n(c) EXHIBITS\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n(d) FINANCIAL STATEMENT SCHEDULES\nThe response to this portion of Item 14 is submitted as a separate section of this report.\nSchedule II Valuation and Qualifying Accounts Years Ended December 31 (in thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on March 29, 1996, on its behalf by the undersigned, thereunto duly authorized.\nBMC INDUSTRIES, INC.\nBy \/s\/ Michael P. Hawks ----------------------- Michael P. Hawks Vice President of Finance and Administration, Chief Financial Officer and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on March 29, 1996, by the following persons on behalf of the Registrant and in the capacities indicated.\nSignature Title\n\/s\/ Paul B. Burke Chairman of the Board, President - ------------------------------------ and Chief Executive Officer Paul B. Burke (Principal Executive Officer)\n\/s\/ Michael P. Hawks Vice President of Finance and - ------------------------------------ Administration, Chief Michael P. Hawks Financial Officer and Secretary (Principal Financial Officer)\n\/s\/ Jeffrey L. Wright Corporate Controller (Principal - ------------------------------------ Accounting Officer) Jeffrey L. Wright\n\/s\/ Lyle D. Altman Director - ------------------------------------ Lyle D. Altman\n\/s\/ John W. Castro Director - ------------------------------------ John W. Castro\n\/s\/ Joe E. Davis Director - ------------------------------------ Joe E. Davis\n\/s\/ Harry A. Hammerly Director - ------------------------------------ Harry A. Hammerly\n\/s\/ S. Walter Richey Director - ------------------------------------ S. Walter Richey\n\/s\/ Richard A. Swalin Director - ------------------------------------ Richard A. Swalin\nBMC Industries, Inc. Exhibit Index to Annual Report on Form 10-K For the Year Ended December 31, 1995\nExhibit No. Exhibit Method of Filing - ----------- ------- ----------------\n3.1 Second Restated Incorporated by reference Articles of to Exhibit 3.1 to the Incorporation of the Company's Annual Report Company, as amended. on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n3.2 Amendment to the Incorporated by reference Second Restated to Exhibit 3.2 to the Articles of Company's Annual Report Incorporation, on Form 10-K for the year dated May 8, 1995. ended December 31, 1994 (File No. 1-8467).\n3.3 Amendment to the Incorporated by reference Second Restated to Exhibit 3.1 to the Articles of Company's quarterly Incorporation, dated report on Form 10-Q for October 30, 1995. the quarter ended September 30, 1995 (File No. 1-8467).\n3.4 Restated Bylaws of Incorporated by reference the Company, as to Exhibit 3.4 to the amended. Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n4.1 Specimen Form of the Incorporated by reference Company's Common to Exhibit 4.3 to the Stock Certificate. Company's Registration Statement on Form S-2 (File No. 2-83809).\n10.1 1984 Omnibus Stock Incorporated by reference Program, as amended to Exhibit 10.1 to the effective December Company's Annual Report 19, 1989. on Form 10-K for the year ended December 31, 1989 (File No. 1-8467).\n10.2 1995 Management Incorporated by reference Incentive Bonus Plan to Exhibit 10.3 to the Summary. Company's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n10.3 1996 Management Filed electronically. Incentive Bonus Plan Summary.\n10.4 Interest Rate Incorporated by reference Supplement Program. to written description thereof on page 10 of the Company's Proxy Statement dated March 22, 1991 (File No. 1-8467).\n10.5 Revised Executive Incorporated by reference Expense Policy to Exhibit 10.7 to the (effective as of Company's Annual Report January 1, 1993). on Form 10-K for the year ended December 31, 1991 (File No. 1-8467).\n10.6 BMC Industries, Inc. Incorporated by reference Supplemental to Exhibit 10.10 to the Executive Retirement Company's Annual Report Plan. on Form 10-K for the year ended December 31, 1988 (File No. 1-8467).\n10.7 First and Second Incorporated by reference Declaration of to Exhibit 10.9 to the Amendment, effective Company's Annual Report March 15, 1991 and on Form 10-K for the year June 3, 1991, ended December 31, 1991 respectively, to BMC (File No. 1-8467). Industries, Inc. Supplemental Executive Retirement Plan.\n10.8 Third Declaration of Incorporated by reference Amendment, effective to Exhibit 10.9 to the as of January 1, Company's Annual Report 1992, to BMC on Form 10-K for the year Industries, Inc. ended December 31, 1992 Supplemental (File No. 1-8467). Executive Retirement Plan.\n10.9 Fourth Declaration Incorporated by reference of Amendment, to Exhibit 10.10 to the effective as of June Company's Annual Report 30, 1992, to BMC on Form 10-K for the year Industries, Inc. ended December 31, 1992 Supplemental (File No. 1-8467). Executive Retirement Plan.\n10.10 BMC Industries, Inc. Incorporated by reference Profit Sharing Plan to Exhibit 10.10 to the 1994 Revision, as Company's Annual Report amended. on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n10.11 BMC Industries, Inc. Incorporated by reference to Savings Plan 1994 Exhibit 10.11 to the Company's Revision, as amended. Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n10.12 Directors' Deferred Incorporated by reference Compensation Plan. to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1984 (File No. 1-8467).\n10.13 1994 Stock Incentive Incorporated by reference to Plan. Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467).\n10.14 BMC Stock Option Incorporated by reference Exercise Loan to Exhibit 10.15 to the Program, as revised Company's Annual Report December 14, 1994. on Form 10-K for the year ended December 31, 1994 (File No. 1-8467).\n10.15 BMC Industries, Inc. Incorporated by reference Benefit Equalization to Exhibit 10.14 to the Plan. Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467).\n10.16 Lease Agreement, Incorporated by reference dated November 20, to Exhibit 10.9 to the 1978, between Company's Registration Control Data Statement on Form S-2 Corporation and the (File No. 2-79667). Company.\n10.17 Amendment to Lease Incorporated by reference Agreement, dated to Exhibit 10.24 to the December 27, 1983, Company's Annual Report between Control Data on Form 10-K for the year Corporation and the ended December 31, 1983 Company. (File No. 1-8467).\n10.18 Amendment to Lease Incorporated by reference Agreement, dated to Exhibit 10.15 to the April 9, 1986, Company's Annual Report between Control Data on Form 10-K for the year Corporation and the ended December 31, 1987 Company. (File No. 1-8467).\n10.19 Amendment to Lease Incorporated by reference Agreement, dated to Exhibit 10.14 to the April 12, 1989, Company's Annual Report between GMT on Form 10-K for the year Corporation as ended December 31, 1989 successor in (File No. 1-8467). interest to Control Data Corporation) and the Company.\n10.20 Amendment to Lease Incorporated by reference Agreement, dated to Exhibit 10.15 to the March 19, 1990, Company's Annual Report between GMT on Form 10-K for the year Corporation and the ended December 31, 1989 Company. (File No. 1-8467).\n10.21 Amendment to Lease Incorporated by reference Agreement, dated May to Exhibit 10.20 to the 17, 1993, between Company's Annual Report GMT Corporation and on Form 10-K for the year the Company. ended December 31, 1993 (File No. 1-8467).\n10.22 Amendment of Lease, Incorporated by reference dated April 6, 1994 to Exhibit 10.23 to the by and between GMT Company's Annual Report Corporation and the on Form 10-K for the year Company. ended December 31, 1994 (File No. 1-8467).\n10.23 Waiver of Condition Incorporated by reference Precedent, dated to Exhibit 10.24 to the July 29, 1994, by Company's Annual Report and between GMT on Form 10-K for the year Corporation and the ended December 31, 1994 Company. (File No. 1-8467).\n10.24 Lease Agreement, Incorporated by reference dated June 25, 1987, to Exhibit 10.17 to the between ATS II Company's Annual Report Associates Limited on Form 10-K for the year Partnership and the ended December 31, 1987 Company. (File No. 1-8467).\n10.25 Amendment to Lease Incorporated by reference Agreement, dated to Exhibit 10.19 to the December 4, 1992, by Company's Annual Report and between ATS II on Form 10-K for the year Associates Limited ended December 31, 1992 Partnership and the (File No. 1-8467). Company.\n10.26 Amendment to Lease, Incorporated by reference dated December 7, to Exhibit 10.27 to the 1994, by and between Company's Annual Report ATS II Associates on Form 10-K for the year Limited Partnership ended December 31, 1994 and the Company. (File No. 1-8467).\n10.27 Amendment to Lease, Incorporated by reference dated February 16, to Exhibit 10.28 to the 1995, by and between Company's Annual Report ATS II Associates on Form 10-K for the year Limited Partnership ended December 31, 1994 and the Company. (File No. 1-8467).\n10.28 Lease Agreement, Incorporated by reference dated December 8, to Exhibit 10.32 to the 1983, between ARI Company's Annual Report Limited Partnership on Form 10-K for the year and the Company. ended December 31, 1983 (File No. 1-8467).\n10.29 Lease, dated January Incorporated by reference 26, 1994, by and to Exhibit 10.24 to the between 7100 Company's Annual Report Northland Circle and on Form 10-K for the year the Company. ended December 31, 1993 (File No. 1-8467).\n10.30 Second Amendment to Incorporated by reference Lease, dated October to Exhibit 10.31 to the 14, 1994, by and Company's Annual Report between Lutheran on Form 10-K for the year Brotherhood and the ended December 31, 1994 Company. (File No. 1-8467).\n10.31 Form of Change of Incorporated by reference Control Agreement to Exhibit 10.31 to the entered into between Company's Annual Report the Company and on Form 10-K for the year Messrs. Burke, Kerr ended December 31, 1991 and Hawks and (File No. 1-8467). Nygaard.\n10.32 Change of Control Filed electronically. Agreement entered into between the Company and Mr. Gburek.\n10.33 Credit Agreement, Incorporated by reference dated September 30, to Exhibit 10.33 to the 1994, by and between Company's Annual Report The First National on Form 10-K for the year Bank of Chicago and ended December 31, 1994 the Company. (File No. 1-8467).\n10.34 Credit Agreement, Incorporated by reference dated September 30, to Exhibit 10.34 to the 1994, by and between Company's Annual Report Norwest Bank on Form 10-K for the year Minnesota, National ended December 31, 1994 Association and the (File No. 1-8467). Company.\n10.35 Credit Agreement, Incorporated by reference dated September 30, to Exhibit 10.35 to the 1994, by and between Company's Annual Report NBD Bank, N.A. and on Form 10-K for the year the Company. ended December 31, 1994 (File No. 1-8467).\n10.36 Product Incorporated by reference Manufacturing and to Exhibit 10.36 to the Sales Agreement, Company's Annual Report dated October 17, on Form 10-K for the year 1994, between ended December 31, 1994 Polycore Optical, (File No. 1-8467). PTE. Ltd. and Vision-Ease, a unit of the Company, without exhibits.\n13.1 Portions of the Filed electronically. Company's 1995 Annual Report to Stockholders incorporated herein by reference in this Annual Report on Form 10-K.\n21.1 Subsidiaries of the Filed electronically. Registrant.\n23.1 Consent of Ernst & Filed electronically. Young LLP, Independent Auditors.\n27.1 Financial Data Filed electronically. Schedule\n99.1 Press Release, dated Filed electronically. November 20, 1995.\n99.2 Press Release, dated Filed electronically. December 8, 1995.\n99.3 Press Release, dated Filed electronically. January 25, 1996.\n99.4 Press Release, dated Filed electronically. February 15, 1996.\n99.5 Press Release, dated Filed electronically. March 8, 1996","section_15":""}
{"filename":"804188_1995.txt","cik":"804188","year":"1995","section_1":"ITEM 1. BUSINESS\nCapital Associates, Inc. (\"CAI\"), was incorporated as a holding company in October 1986. Its principal operating subsidiary, Capital Associates International, Inc. (\"CAII\"), was incorporated in December 1976. Capital Associates, Inc., is principally engaged in (1) buying, selling, leasing and remarketing new and used equipment, (2) managing equipment on and off-lease, (3) sponsoring, co-sponsoring, managing and co-managing publicly-registered income funds and (4) arranging equipment-related financing.\nHISTORICAL BUSINESS AND FISCAL YEAR 1995 SIGNIFICANT ACCOMPLISHMENTS\nPrior to fiscal year 1987, the Company's principal business was (1) brokering tax-advantaged, high-technology equipment lease transactions to, and for the benefit of, third party investors and (2) remarketing high technology equipment. The Tax Reform Act of 1986 effectively eliminated substantially all of the tax benefits associated with that business for individual investors. For the period fiscal year 1987 through the end of fiscal year 1991, the Company shifted its principal business to originating leases for its own account while at the same time continuing to (a) broker tax-advantaged equipment lease transactions to, and for the benefit, of corporate investors and (b) remarketing equipment. The Company financed its equity investment in new lease originations during this period with funds drawn on its short-term recourse debt facility.\nThe Company reported net losses of $6,177,000, $13,630,000 and $16,066,000 during fiscal years 1992, 1991 and 1990, respectively, in part due to the change in its business and the changes in the tax laws described above. Beginning in the first quarter of fiscal year 1991, the Company agreed with its lenders to begin repaying its short-term recourse debt facility. Thereafter, through the end of the second quarter of fiscal year 1995 (the \"Restructuring Period\") , the Company used substantially all of its cash flow after payment of operating expenses to repay its short-term recourse debt facility. As a result of making these payments, the Company did not have the funds during the Restructuring Period to add new leases to its own lease portfolio and the Company's lease portfolio and related revenue declined significantly during this period.\nDuring fiscal years 1995, 1994 and 1993, the Company reported net income of $1,116,000, $710,000, and $1,396,000, respectively, and twelve consecutive profitable quarters. During fiscal year 1995, the Company:\n* refinanced its short-term recourse debt facility with a new recourse debt facility with a new senior bank lending group in December 1994; the new recourse debt facility (the \"Debt Facility\") consists of a $32 million warehousing facility (the \"Warehouse Facility\"), a $5 million working capital facility (the \"Working Capital Facility\") and a $13 million, three-year term loan (the \"Term Loan\")\n* favorably resolved several legal proceedings in which it was involved, including the MBank litigation which had been ongoing since early 1992; the Company received approximately $8.4 million in settlement of its claims in the MBank litigation;\n* raised $24 million through the offering of Class A Limited Partner Units in Capital Preferred Yield Fund III, the Company's sixth public income fund\n* sold one jet aircraft and placed a previously non-earning $5 million aircraft under lease\n2 of 20\nITEM 1. BUSINESS, continued\nHISTORICAL BUSINESS AND FISCAL YEAR 1995 SIGNIFICANT ACCOMPLISHMENTS, continued\nThe ability of the Company to operate profitably in the future will depend largely on the amount of new capital available to the Company and the cost of that capital. The Company continues to explore possible sources of new capital including, for example, obtaining new or additional recourse debt, obtaining new equity capital (which could include a sale of the Company, possibly coupled with an infusions of new funds from the purchaser into the Company), securitizing lease transactions, obtaining equity capital from private investor purchases of equipment leases originated by the Company and\/or entering into strategic alliances\/combinations with other leasing or financial services companies. The Company intends to invest any new capital that it obtains in leases for its own portfolio. If the Company is unsuccessful in obtaining new capital, the ability of the Company to continue to operate profitably will depend on (1) equipment sales margins from new lease originations, (2) originating leases for its own account with a substantial rate spread, (3) remarketing of equipment at a profit and (4) further reducing its operating costs.\nLEASING ACTIVITIES\nAll of the Company's leases are noncancelable \"net\" leases which contain provisions under which the customer must make all lease payments regardless of any defects in the equipment and which require the customer to insure the equipment against casualty loss, and pay all related property, sales and other taxes. The Company originates two basic types of leases, direct financing leases (\"DFLs\") and operating leases (\"OLs\"). Under generally accepted accounting principles (\"GAAP\"), the primary distinguishing factor between these two types of leases is the present value of the rents in relation to the cost of the leased equipment. In the case of a DFL, the Company is contractually entitled to recover at least 90% of its original investment in the equipment from the present value of the initial lease rentals. In the case of an OL, the Company is contractually entitled to recover less than 90% of its original investment in the equipment from the present value of the initial lease rentals. As of May 31, 1995, the Company's net investment in DFLs was approximately $14 million and its net investment in OLs was approximately $20 million. See Note 1 to Notes to Consolidated Financial Statements for a detailed discussion of the Company's lease accounting policies.\nLeases are originated for the Company's own account, its public income funds (the \"PIFs\") and private third party purchasers of equipment. The Company's lease origination marketing strategy is transaction driven. With each lease origination opportunity, the Company evaluates both the prospective lessee and the equipment to be leased. With respect to each potential lessee, the Company evaluates the lessee's credit worthiness. With respect to the equipment, the Company evaluates the remarketing, upgrade potential and the probability that the lessee will renew the lease or return the equipment at the end of the lease, as well as its importance to the lessee's business.\nPrior to fiscal year 1991, more than 50% of the equipment leases originated by the Company consisted of office technology equipment, including data processing and communications equipment. Since then, the Company has de-emphasized computer equipment and diversified its own equipment lease portfolio (as well as, the equipment portfolio it manages for private investors and the PIFs) to include a wide variety of high technology equipment as well as transportation equipment, materials handling equipment, manufacturing equipment, office automation equipment, retail equipment, medical equipment, mining equipment, industrial equipment, construction equipment, furniture, fixtures and equipment and other equipment that meets the Company's underwriting standards.\nThe Company leases equipment to lessees in diverse industries throughout the United States. To minimize credit risk, the Company generally leases equipment to (1) lessees that have a credit rating of not less than Baa as determined by Moody's Investor Services, Inc., or comparable credit ratings as determined by other recognized credit rating services, or (2) companies, which although not rated by a recognized credit rating service or rated below Baa, are believed by the Company to be sufficiently creditworthy to satisfy the financial obligations under the lease. As of May 31, 1995, approximately 79% of the equipment owned by the Company was leased to companies that meet the above criteria.\n3 of 20\nITEM 1. BUSINESS, continued\nLEASING ACTIVITIES, continued\nThe Company finances equipment purchases with the proceeds of borrowings under its Warehouse Facility, pending the sale of the equipment to a private investor or PIF, the permanent non-recourse financing of the equipment or the securitization of the equipment\/lease for its own account. In the case of equipment financed with permanent non-recourse debt or securitized equipment\/leases, it is the Company's policy to recover all but its equity investment in the equipment at the time it closes the financing, and all such borrowings are secured by a first lien on the equipment and the related lease rental payments. The Company recovers its equity investment in equipment for its own account from renewal rents received and\/or sales proceeds realized from the equipment after repayment in full of the related permanent non-recourse debt or securitization funding.\nThe Company's level of lease originations declined significantly during the Restructuring Period. During that period, the Company sold substantially all new lease originations to its PIFs and retained very few lease originations for its own account. Since the closing of the Company's new Debt Facility, the Company has resumed originating more leases for its own account. Lease originations of approximately $96 million for fiscal 1995 were financed through $44 million of sales to the PIFs, $25 million of sales to private investors, discounting $8 million of noncancelable lease rentals to various financial institutions at fixed rates on a nonrecourse basis, and the remainder for the Company's account of approximately $19 million through the use of the Company's Debt Facility.\nNo payments from any single lessee during fiscal year 1995 accounted for more than ten percent (10%) of the Company's consolidated revenues. During fiscal years 1995, 1994 and 1993, revenue from leasing activities was approximately $8 million $13 million and $26 million, respectively.\nUNDERWRITING STANDARDS\nAll initial leases are subject to review under the Company's underwriting standards. Each potential lessee is assigned a credit risk rating of 1 (the highest rating) through 6 (the lowest rating), based on the application of specific criteria during the credit review process. The Company originates leases for its own account that have a credit rating of 1, 2 or 3. The Company originates leases for its PIFs consistent with each PIF's own lease origination standards, which are similar to those of the Company.\nThe Company's Transaction Review Committee (the \"TRC\"), which is composed of members of senior management, (1) reviews and approves all material aspects of lease transactions, the credit ratings assigned to lessees and certain pricing and residual value assumptions, (2) advises on lease documentation requirements and deal structuring guidelines, (3) is responsible for monitoring asset quality on an on-going basis in order to estimate and assess the net realizable value at the end of the lease term for the Company's equipment and for reviewing and approving the quarterly Asset Quality Report and (4) revises and updates the underwriting standards, when and as necessary. Generally, all transactions over $3,000,000 must also be approved by a sub-committee of the Board of Directors.\nREMARKETING ACTIVITIES\nRemarketing activities consist of (1) lease portfolio management (i.e., managing equipment under lease) and (2) asset management (i.e., managing off-lease equipment). Revenue from remarketing activities was approximately $5 million, $9 million and $20 million during fiscal years 1995, 1994 and 1993, respectively. One of the Company's principal goals is to minimize off-lease equipment by proactively managing such equipment while it is under lease (e.g., renewing or extending the lease, or re-leasing, upgrading or adding to the equipment before the end of the initial lease term), and by selling such equipment after termination of the lease if it cannot be profitably re-leased.\n4 of 20\nITEM 1. BUSINESS, continued\nREMARKETING ACTIVITIES, continued\nThe Company attempts to maximize the remarketing proceeds from, and minimize the warehousing costs for, off-lease equipment by (1) employing qualified and experienced remarketing personnel, (2) developing equipment remarketing expertise in order to maximize the profit from sales of off-lease equipment, (3) minimizing the amount of off-lease equipment stored at independently operated equipment warehouses and thereby reducing warehousing costs, (4) leasing and operating its own general equipment warehouse to further reduce warehousing costs, (5) eliminating scrap inventory from the warehouses and (6) conducting on-site equipment inspections. The Company further supports these activities by carefully monitoring the residual values of its equipment portfolio and maintaining adequate reserves on its books, when and as needed, to reflect anticipated future reductions in such values due to obsolescence and other factors.\nPRIVATE INVESTOR PROGRAMS, EQUITY SYNDICATIONS AND PIFS\nThe Company sells ownership interests in leased equipment to third-party investors. The Company sold approximately $25 million, $43 million, and $14 million of equipment to private investors during fiscal years 1995, 1994 and 1993, respectively. The Company receives fees upon sale of its ownership interests in its leased equipment. In addition, the Company may retain participation interests in the residual value of such sold leased equipment.\nThe Company currently sponsors or co-sponsors six PIFs. The Company sells a significant portion of the equipment it acquires for lease to its PIFs. The Company sold approximately $44 million, $70 million and $62 million of equipment to its PIFs during fiscal years 1995, 1994 and 1993, respectively. Various subsidiaries and affiliates of the Company act as the general partners or co-general partners of the PIFs. In addition, CAII contributes cash and\/or equipment to each PIF in exchange for a Class B limited partner interest (\"Class B interest\"). Public investors purchase units of Class A limited partnership interest (\"Class A units\") for cash, which the PIFs use to purchase equipment on-lease to lessees. The Company receives (1) fees for performing various services for the PIFs (subject to certain dollar limits), (2) reimbursement for organizational and offering expenses incurred in selling the Class A Units (subject to certain dollar limits), (3) Class B partner cash distributions from each PIF (subordinated to the cash returns on the Class A Units) and (4) general partner cash distributions.\nCapital Preferred Yield Fund-III is the only PIF currently offering Class A units for sale to the public. In the aggregate, the six PIFs have sold $295 million of Class A units to the public through May 31, 1995. Up to $26 million of Class A units will be offered for sale to the public during fiscal year 1996. CAII's maximum remaining obligation to make Class B partner cash contributions is $0.3 million.\nCOMPETITION\nThe Company competes mainly on the basis of its remarketing capability, terms offered in its leasing transactions, reliability in meeting its commitments and customer service. The Company's continued ability to compete effectively may be materially affected by the availability of financing, the costs of such financing, and the marketplace for public income fund investments. The Company competes with a large number of equipment lessors, many of which have greater financial resources, greater economies of scale and lower costs of capital than the Company.\nEMPLOYEES\nThe Company had 92 employees as of May 31, 1995 versus 114 employees as of May 31, 1994, none of whom were represented by a labor union. The Company believes that its employee relations are good.\n5 of 20\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases office facilities (approximately 20,000 square feet) in Lakewood, Colorado (a suburb of Denver). These facilities house the Company's administrative, financing and marketing operations and were consolidated from approximately 43,000 square feet as of June 1, 1995. The Lakewood, Colorado lease is for a term of 5 years, with 5 years remaining in the term, and with a base rent, as of May 31, 1995, of approximately $27,000 per month, plus a pro-rata share of building costs and expenses. The Lakewood, Colorado facility adequately provides for present and future needs, as currently planned. In addition, the Company leases a warehouse facility and regional marketing offices at an aggregate rental of approximately $110,000 per year.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in the following legal proceedings:\na. THE MBANK LITIGATION. See Footnote 15 to Notes to Consolidated Financial Statements appearing elsewhere herein for a description of the MBank Litigation.\nb. THE PAINEWEBBER CLASS ACTION. A series of class actions have been filed in the United States District Court for the Southern District of New York against PaineWebber Incorporated (\"PaineWebber\") and certain of its affiliates in connection with its sale and sponsorship of limited partnership units in various limited partnerships, one of which is PaineWebber Preferred Yield Fund L.P., one of the Company's PIFs. The Company and its subsidiary, CAI Equipment Leasing II Corporation (\"CAIEL II\"), are not named defendants in these class actions. On July 27, 1995 PaineWebber announced that it (1) was taking a one-time charge of $200 million during its second quarter of 1995 to cover the financial cost of resolving these actions and other related claims and (2) hoped to resolve these actions within ninety (90) days of the date of its announcement. Management believes that the PaineWebber Class Action Lawsuit will not have a material adverse effect on the financial condition or operations of the Company or CAIEL II.\nc. The Company is also involved in routine legal proceedings incidental to the conduct of its business. Management believes that none of these legal proceedings will have a material adverse effect on the financial condition or operations of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to a vote of security holders during the three months ended May 31, 1995.\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Company's common stock trades on the Nasdaq National Market under the symbol: CAII.\nOn June 2, 1995, the Nasdaq Stock Market, Inc. (\"Nasdaq\"), informed the Company that it was not in compliance with the minimum $1.00 bid price requirement (or the alternative $3 million value of public float requirement) for continued listing of its Common Stock on the Nasdaq National Market (both tests are collectively referred to herein as the \"Stock Price Requirement\"). At a hearing in front of Nasdaq on July 13, 1995, the Company requested an extension of time to comply with the Stock Price Requirement. By letter, dated August 2, 1995, Nasdaq (1) agreed to extend the period of time for the Company to comply with the Stock Price Requirement through August 31, 1995, and (2) advised the Company that if the Company is unable to comply with the Stock Price requirement by that date, the Company will no longer be listed on the Nasdaq National Market. The Company intends to seek a further extension of time beyond August 31, 1995 to comply with the Stock Price Requirement if it is not in compliance with such requirements as of August 31, 1995. No assurance can be given that the Company will be able to obtain such further extension of time. If the Company does not satisfy the Stock Price Requirement as of August 31, 1995, and cannot obtain a further extension of time to comply with such requirement, the Company's Common Stock will be delisted from the Nasdaq National Market and will most likely thereafter be traded on the OTC Bulletin Board.\n6 of 20\nPART II\nThe following table sets forth the high and low sales prices of the Company's common stock for the periods indicated, according to published sources. High and low sales prices shown reflect inter-dealer quotations without retail markups, markdowns or commissions and do not necessarily represent actual transactions.\n1996 HIGH LOW\nFirst Quarter (through August 18, 1995) 29\/32 5\/8\n1995 HIGH LOW\nFirst Quarter 15\/16 5\/8 Second Quarter 15\/16 5\/8 Third Quarter 13\/16 15\/32 Fourth Quarter 13\/16 7\/16\n1994 HIGH LOW\nFirst Quarter 1 5\/8 15\/16 Second Quarter 1 1\/2 11\/16 Third Quarter 1 3\/8 27\/32 Fourth Quarter 15\/16 13\/16\nOn August 18, 1995, the date on which trading activity last occurred, the closing sales price of the Company's stock was $.78125. On August 18, 1995, there were approximately 230 shareholders of record and at least 800 beneficial shareholders of the Company's outstanding common stock.\nNo dividends were paid during the periods indicated. The Company does not anticipate that it will pay cash dividends on its common stock in the foreseeable future. See Note 9 to Notes to Consolidated Financial Statements for a discussion of restrictions upon CAII's ability to transfer funds to the Company in the form of cash dividends, loans or advances that limit the Company's ability to pay dividends on its outstanding Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe table on the following page sets forth selected consolidated financial data for the periods indicated derived from the Company's consolidated financial statements. The data should be read in conjunction with Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Company's consolidated financial statements and notes thereto appearing elsewhere herein.\n7 of 20\nIncome Statement Data (in thousands, except per share and number of shares data)\n8 of 20\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULTS OF OPERATIONS\nDuring the preceding five fiscal years, revenue and assets have declined. The reason for this is that, during the Restructuring Period, the Company used substantially all of its cash flow after payment of operating expenses to repay its prior short-term recourse debt facility. As a result of making these payments, and until the Company closed its new Debt Facility in December 1994, the Company did not have the funds necessary to significantly add to its leasing portfolio. Because a leasing portfolio declines in size as it matures, these circumstances resulted in a substantial decline in the Company's own leasing portfolio and related revenue (referred to in this discussion as \"portfolio run-off\").\nThe Company originates leases for its own account and for sale to private investors and its PIFs. Leasing is an alternative to financing equipment with debt. Therefore, the ultimate profitability of the Company's leasing transactions is dependent, in part, on the general level of interest rates. Lease rates tend to rise and fall with interest rates, although lease rate movements generally lag interest rate movements.\nBecause the Company finances its lease transactions with recourse and non-recourse debt, the ultimate profitability of leasing transactions is dependent, in part, on the difference between the interest rate inherent in the lease and the underlying debt rate (\"rate spread\"). Certain of the Company's competitors have access to lower cost funds than the Company. As a result, the Company is at a competitive disadvantage in pricing new leasing transactions because the Company cannot achieve rate spreads as great as some of its competitors, or cannot drop rates to win new lease transactions and remain profitable.\nDuring fiscal years 1994 and 1995, the Company's business plan provided for originating mostly DFLs financed with permanent non-recourse debt for its own account because such leases report constant returns (after interest expense on related non-recourse debt) over the term of the DFLs (as opposed to OLs, which report lower returns during the early term of the leases). The presently low interest rate environment and the expansion by commercial banks of their leasing activities have reduced the availability of high quality DFLs. Accordingly, the Company's 1996 business plan provides for originating mostly OLs for its account.\nPresented below are schedules showing condensed income statement categories and analyses of changes in those condensed categories derived from the Consolidated Statements of Income appearing on page of this report on Form 10-K, prepared solely to facilitate the discussion of results of operations (in thousands).\n9 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULTS OF OPERATIONS, continued\nEQUIPMENT SALES\nEquipment sales revenue (and the related equipment sales margin) consists of the following (in thousands):\n10 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULTS OF OPERATIONS, continued\nEQUIPMENT SALES, continued\nTo partially offset the effect on income of portfolio run-off while the Company is growing its lease portfolio, one of the Company's strategies is to increase sales margins from equipment sold during its initial lease term to offset the decrease in sales margins from transactions subsequent to initial lease termination. In the ordinary course of business, the Company will (1) sell new lease originations to its PIFs (to the extent the PIFs have funds available for such purpose) or private investors and (2) sell seasoned lease transactions (previously originated leases held in the Company's portfolio) to private investors. To the extent sales of seasoned leases exceed new lease originations, growth in the Company's portfolio will be slower.\nEQUIPMENT SALES TO PIFS\nEquipment sales to the PIFs were lower during fiscal year 1995, as compared to fiscal year 1994, primarily because (1) the PIFs were more fully leveraged during fiscal year 1995 and, therefore, had less available borrowing capacity to acquire additional equipment and (2) only one PIF, CPYF-III, was offering Class A units for sale. Continuing to offer Class A units in CPYF-III for sale is a principal operating goal of the Company and to accomplish that goal, the Company almost doubled its PIF marketing staff of wholesalers by the end of fiscal year 1995.\nEquipment sales to PIFs increased during fiscal year 1994 as compared to fiscal year 1993, principally because more leases that satisfied the Company's underwriting standards were identified, in part as a result of the opening of new sales offices.\nEQUIPMENT SALES TO PRIVATE INVESTORS\nEquipment sales to private investors for fiscal year 1994 included sales of approximately $14 million of \"seasoned\" leases (i.e., previously originated leases held in the Company's portfolio) and approximately $29 million of new lease originations. This compares to fiscal year 1995 amounts of approximately $5 million and $20 million for \"seasoned\" leases and new lease originations, respectively. Equipment sales to private investors during fiscal year 1995 were less than in the prior year primarily because lease originations identified for sale to private investors were less than the prior year. The continued development of a customer base of private investors and growth in new lease originations suitable for private equipment sales are principal operating goals of the Company.\nMBANK SALE PROCEEDS\nThe increase in equipment sales margin during fiscal year 1995 as compared to fiscal year 1994 is due to the MBank sale. The parties settled their claims to the cash collateral for the original MBank lease and the Company received approximately $8.4 million from the cash collateral for the original MBank lease (net of amounts the Company has agreed to refund to BankOne, Texas N.A.). The Company recorded $6.1 million in equipment sales margin from the MBank sale (i.e., proceeds of approximately $8.4 million less a carrying value of approximately $2.3 million).\n11 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULTS OF OPERATIONS, continued\nREMARKETING OF THE PORTFOLIO AND RELATED PROVISION FOR LOSSES\nThe remarketing of equipment for an amount greater than its book value is reported as equipment sales margin (if the equipment is sold) or as leasing margin (if the equipment is re-leased). The realization of less than the carrying value of equipment (which is typically not known until remarketing subsequent to the initial lease termination has occurred) is recorded as provision for losses. As shown in the tables above, the realizations from sales exceeded the provision for losses for fiscal years 1995, 1994 and 1993, even without considering realizations from remarketing activities recorded as leasing margin as discussed below. This circumstance of realizing in excess of the aggregate carrying value on the Company's portfolio has occurred in each of the last twelve quarters.\nMargins from remarketing sales (i.e., sales occurring after the initial lease term) are affected by the amount of equipment leases that matures in a particular quarter. In general, as the size of the Company's lease portfolio declines, fewer leases mature and less equipment is available for remarketing each quarter. As a result, remarketing revenue and the related margin declined during both fiscal year 1995 as compared to fiscal year 1994, and fiscal year 1994 as compared to fiscal year 1993. Remarketing revenue and margin are expected to decline further as portfolio runoff continues. The Company's ability to remarket additional amounts of equipment and realize a greater amount of remarketing revenue in future periods is dependent on adding additional leases to its portfolio. However, adding leases to the Company's portfolio will not offset the effect of portfolio runoff because new leases typically are not remarketed until after their initial term (which averages three to four years).\nResidual values are established equal to the estimated value to be received from the equipment following termination of the lease. In estimating such values, the Company considers all relevant facts regarding the equipment and the lessee, including, for example, the likelihood that the lessee will re-lease the equipment. The nature of the Company's leasing activities is that it has credit exposure and residual value exposure and, accordingly, in the ordinary course of business it will incur losses arising from these exposures. The Company performs ongoing quarterly assessments of its assets to identify other than temporary losses in value.\nThe provision for losses of $2.9 million recorded during fiscal year 1995 included $2.3 million recorded during the fourth fiscal quarter 1995. The provision for losses for the fiscal year included the following more significant items:\n* approximately $750,000 to record the Company's loss exposure related to approximately $3 million of net book value of equipment leased to a lessee who filed Chapter 11 bankruptcy during July 1995\n* approximately $550,000 recorded to write-down the carrying value of IBM equipment retained residuals to fair market values based upon current third-party quotes\n* approximately $500,000 for equipment originally expected to remain with the lessee upon lease termination which the Company now believes will be returned\n* approximately $400,000 recorded to write-down the carrying value of one of the Company's aircraft to fair market value because of the deteriorating financial condition of the lessee at May 31, 1995\n* approximately $250,000 to record the Company's loss exposure related to approximately $350,000 of net book value of equipment leased to another lessee that filed Chapter 11 bankruptcy during December 1994.\n12 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULT OF OPERATIONS, continued\nLEASING MARGIN\nLeasing margin consists of the following (in thousands):\nFiscal Years Ended May 31, --------------------------------------- 1995 1994 1993 -------- -------- --------\nLeasing revenue $ 7,672 $ 13,368 $ 26,003 Leasing costs and expenses (3,893) (5,511) (12,148) Net interest expense on related discounted lease rentals (1,162) (3,343) (6,565) -------- -------- --------\nLeasing margin $ 2,617 $ 4,514 $ 7,290 ======== ======== ========\nLeasing margin ratio 34% 34% 28% == == ==\nLeasing margin has declined as a result of portfolio run-off and is expected to decline further until the Company has significantly added to its lease portfolio. See the discussion under \"Business Plan\" below.\nAs discussed under \"Business Plan\" below, the Company intends to continue to grow its lease portfolio in the future, subject to profitability considerations from immediate sale of leases as discussed above. The Company's equipment under lease increased for the first time since fiscal year 1991. The changes in the Company's equipment under lease during the fiscal year ended May 31, 1995 consisted of the following (in thousands):\n13 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULT OF OPERATIONS, continued\nOTHER INCOME\nOther Income consists of the following (in thousands):\nOther than fees and distributions from the company-sponsored PIFs, most of the transactions above are \"one-time\" transactions and, accordingly, the Company does not expect to realize material amounts in the future with respect to the Other Income items listed above.\nOPERATING AND OTHER EXPENSES\nOperating and other expenses decreased approximately $0.7 million (6%) for fiscal year 1995, compared to fiscal year 1994 due to on-going efforts to minimize costs.\nOperating and other expenses decreased approximately $1.8 million (12%) for fiscal year 1994, compared to fiscal year 1993. The decrease was principally due to (1) approximately $0.4 million from reductions in restructuring costs, related to the Company's prior debt facility, (2) approximately $0.8 million from compensation expense reductions and (3) a reduction of approximately $0.6 million in legal fees.\nINTEREST INCOME AND EXPENSE\nInterest income on discounted lease rentals arises when equipment financed with non-recourse debt is sold to investors. The Consolidated Statements of Income include an equal amount of interest expense. The decline in interest income and non-recourse debt interest expense is due to portfolio run-off.\nOver the last three fiscal years, the decrease in recourse debt interest expense reflects the decline in interest rates and the continuing reduction in the outstanding balance of the Company's Debt Facility.\nINCOME TAXES\nIncome tax expense is provided on income at the appropriate statutory rates applicable to such earnings. The appropriate statutory tax rate for fiscal years 1995, 1994 and 1993 was 40%. Adjustments to the valuation allowance are recognized as a separate component of the provision for income tax expense. Consequently, the actual income tax rate for 1995 was less than the effective rate of 40% due to the reduction in the valuation allowance of $230,000.\n14 of 20\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nI. RESULT OF OPERATIONS, continued\nINCOME TAXES, continued\nIncome tax expense does not reflect actual tax payments by the Company because net operating loss (\"NOL\") carryforwards and investment tax credit (\"ITC\") carryforwards were utilized to offset taxable income. At May 31, 1995, the Company had fully utilized all remaining NOL carryforwards. During 1995, the Company paid alternative minimum tax (\"AMT\") of $1.6 million. The deferred tax asset balance at May 31, 1995 primarily reflects the payment of, and anticipated future recovery of, such amount.\nAs shown in the table in Note 11 to Notes to the Consolidated Financial Statements, the Company's significant deferred tax assets consist of an ITC carryforward of $7.4 million (which expire from 1996 through 2001) and alternative minimum tax (\"AMT\") credits of $3.3 million (which are not subject to expiration). These tax assets are available to offset federal income tax liability. However, the amount of ITC carryforward and AMT credits that may be utilized to reduce tax liability is significantly limited in computing AMT liability. As a result of this limitation on the ITC carryforward, the Company has established a valuation allowance for deferred tax assets to reflect the uncertainty that the ITC carryforward will be fully utilized prior to expiration. During 1995, the valuation allowance was reduced by $230,000 to reflect utilization of ITC carryforward for which a valuation allowance had previously been provided.\nII. LIQUIDITY AND CAPITAL RESOURCES\nThe Company's activities are principally funded by its Working Capital Facility and Warehouse Facility (see Note 9 to Notes to Consolidated Financial Statements), rents, proceeds from sales of on-lease equipment (to its PIFs and third party investors), non-recourse debt, fees and distributions from its PIFs, sales or re-leases of equipment after the expiration of the initial lease terms and other cash receipts. Management believes the Company's ability to generate cash from operations is sufficient to fund operations, particularly when operations are viewed as including investing and financing activities.\nTo reverse the effects of portfolio run-off, the Company needs to significantly grow its lease portfolio. To the extent possible, the Company intends to use proceeds from its Debt Facility, the MBank sale proceeds and the possible financing proceeds from its jet aircraft to finance the equity component of leases until such leases mature. While these sources of capital will be sufficient for the Company's short-term needs, the Company will pursue opportunities to obtain other sources of new capital.\nDuring July 1995, the Company and certain of its sponsored PIFs entered into an agreement to debt finance up to $40 million of lease receivables with a lender as part of a lease securitization program. As with nonrecourse debt financings of lease rentals, securitized financings are also collateralized by the leased equipment and related rentals, and the Company has no recourse liability to the lender for repayment of the debt. The Company selected this securitized debt vehicle because of attractive interest rates and anticipates that certain unleveraged leases will be debt financed using this facility.\nCurrently the Company is offering units of CPYF III for sale to the public. During fiscal year 1995, the Company sold a total of $22.7 million of Class A units of CPYF III and sold $21.8 million during fiscal year 1994. During fiscal year 1996, the Company has up to $26 million of Class A units in CPYF III available for sale, which will represent a source of liquidity and acquisition fee income for the Company. Four of the Company's PIFs, including CPYF-III, are in their reinvestment stage and are using a portion of their available cash to purchase additional equipment from the Company. The Company expects to sell approximately $64 million of equipment to these PIFs during fiscal year 1996. Two of the Company's PIFs are in their liquidation stage and are no longer purchasing equipment.\nInflation has not had a significant impact upon the operations of the Company.\n15 of 20\nIII. BUSINESS PLAN\nManagement has identified the following trends in results of operations:\n* although the Company has reported a profit of $.10 per share for fiscal year 1995 (its ninth, tenth, eleventh and twelfth consecutive profitable quarters), the profit resulted largely from \"other income\" items;\n* although the Company had been continually enhancing its lease origination capabilities by adding lease originators, the level of lease originations were substantially below their 1995 expectations;\nThe Company has identified several factors which could adversely impact profitability in the future:\n* because of the flattening of the yield curve for debt securities during calendar year 1994 and into calendar year 1995, lease rates are not rising in line with the Company's cost of funds which makes it difficult to maintain a substantial spread between lease rates and the Company's cost of funds;\n* even if lease originations increase significantly, growth in the Company's profits will be slow because as a portfolio grows, under generally accepted accounting principles, operating leases produce lower leasing margin after interest expense during the early term of such leases;\n* the cost of funds for many of the Company's competitors is lower than the Company's cost of funds; and\n* certain of the Company's competitors also price transactions with tax benefits not available to the Company.\nDuring the Restructuring Period, the Company could not originate a significant amount of leases for its own account because it did not have the financing to fund and hold such originations. The Company believes that it has the necessary funding capability for fiscal year 1996 to (1) continue to increase the size of its own lease portfolio, and (2) originate\/acquire additional leases for sales to PIFs and private equity investors. The Company has recently hired a new complement of field lease originators to originate new leases for the Company's own portfolio and for sale to third parties.\nHowever, while growing the Company's lease origination function and adding new leases to the Company's portfolio will positively affect the Company's results of operations over time, such actions will not positively affect the Company's results of operations in the near term because (a) it will take a period of time before new lease transactions can be closed, (b) new operating lease transactions \"throw off\" lower returns (for financial reporting purposes) during their early term and (c) the Company will incur additional operating expenses in increasing the size of its marketing force. During this period of growth, the Company may realize small operating losses or reduced operating profits as a result of these circumstances. In addition to factors discussed above, operating results are subject to fluctuations resulting from several of other factors, including variations in the relative percentages of the Company's leases entered into during the period which are classified as DFLs, OLs, or sold for fee income.\nThe ability of the Company to operate profitably in the future will depend largely on the amount of new capital available to the Company and the cost of that capital. The Company continues to explore possible sources of new capital including, for example, obtaining new or additional recourse debt, obtaining new equity capital (which could include a sale of the Company, possibly coupled with an infusions of new funds from the purchaser into the Company), securitizing lease transactions, obtaining equity capital from private investor purchases of equipment leases originated by the Company and\/or entering into strategic alliances\/combinations with other leasing or financial services companies. The Company intends to invest any new capital that it obtains in leases for its own portfolio. If the Company is unsuccessful in obtaining new capital, the ability of the Company to continue to operate profitably will depend on (1) equipment sales margins from new lease originations, (2) origination leases for its own portfolio with a substantial rate spread, and (3) remarketing of equipment at a profit and (3) further reducing its operating costs.\n16 of 20\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee the Index to Financial Statements and Schedules appearing at Page of this Report.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers\nThe information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the Company's fiscal year end.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item is incorporated by reference to the Company's definitive proxy statement to be filed within 120 days after the Company's fiscal year end.\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 definitive proxy statement to be filed within 120 days after the Company's fiscal year end.\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 definitive proxy statement to be filed within 120 days after the Company's fiscal year end.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) and (d) Financial Statements and Schedules\nThe financial statements and schedules listed on the accompanying Index of Financial Statements and Schedules (page) are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nOn March 22, 1995, a Form 8-K was filed disclosing developments related to the MBank litigation discussed under Item 3 above.\n(c) Exhibits\nIncluded as exhibits are the items listed in the Exhibit Index. The Company will furnish to its shareholders of record as of the record date for its 1995 Annual Meeting of Stockholders, a copy of any of the exhibits listed below upon payment of $.25 per page to cover the costs to the Company of furnishing the exhibits.\n17 of 20\nITEM NO. EXHIBIT INDEX\n3.1 Certificate of Incorporation of Capital Associates, Inc. (the \"Company\"), incorporated by reference to Exhibit 3.1 of the Company's registration statement on Form S-1 (No. 33-9503).\n3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Annual Report on Form 10-K for the fiscal year ended May 31, 1991 (the \"1991 10-K\").\n10.1 Amended and Restated Stock Option Plan of the Company incorporated by reference to Exhibit 10.1 of the Annual Report on Form 10-K for the fiscal year ended May 31, 1992 (the \"1992 10-K\").\n10.2 Form of Stock Option Agreement between the Company and the directors of the Company (the \"Option Agreement\"), incorporated by reference to Exhibit 19.12 of the Quarterly Report on Form 10-Q for the quarter ended February 28, 1991 (the \"February 1991 10-Q\").\n10.3(a) Amended and Restated Exhibit A to the Option Agreement between the Company and James D. Edwards, incorporated by reference to Exhibit 19.1 of the Quarterly Report on Form 10-Q for the quarter ended August 31, 1991 (the \"August 1991 10-Q\").\n10.3(c) Amended and Restated Exhibit A to the Option Agreement between the Company and William B. Patton, Jr., incorporated by reference to Exhibit 19.1 of the August 1991 10-Q.\n10.3(d) Amended and Restated Exhibit A to the Option Agreement between the Company and Peter F. Schabarum, incorporated by reference to Exhibit 19.1 of the August 1991 10-Q.\n10.4 Defined Contribution Plan and Trust, incorporated by reference to Exhibit 10.2 of the Annual Report on Form 10-K for the fiscal year ended May 31, 1990 (the \"1990 10-K\").\n10.5(a) Stockholder's Agreement dated October 27, 1982 among the Company, Richard Kazan, Jack M. Durliat, and Gary M. Jacobs, as amended, incorporated by reference to exhibit 10.3 to the Company's registration statement on Form S-1 (No. 33-9503).\n10.5(b) Amendment to Stockholder's Agreement dated August 1, 1990, incorporated by reference to Exhibit 10.3(b) of the 1990 10-K.\n10.6 Form of Indemnification Agreement by and between the Company and its directors, incorporated by reference to Exhibit 10.16 of the 1990 10-K.\n10.8(a) Executive Employment Agreement, executed October 25, 1991 and effective as of September 7, 1991, by and between Dennis J. Lacey, the Company and Capital Associates International, Inc. (\"CAII\") (the \"Lacey Employment Agreement\"), incorporated by reference to Exhibit 19.1 of the Quarterly Report on Form 10-Q for the quarter ended November 30, 1991 (the \"November 1991 10-Q\").\n10.8(b) Amendment No. 1 to the Lacey Employment Agreement dated as of September 7, 1992, incorporated by reference to Exhibit 19.1 of the Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1992 (the \"November 1992 10-Q\").\n10.8(c) Amendment No. 2 to the Lacey Employment Agreement dated as of April 9, 1993, incorporated by reference to exhibit 10.8(c) to the Annual Report on Form 10-K for the fiscal year ended May 31, 1993 (the \"1993 10-K\").\n18 of 20\nITEM NO. EXHIBIT INDEX\n10.8(d) Form of Amendment No. 3 to the Lacey Employment Agreement dated as of April 20, 1993, incorporated by reference to exhibit 10.8(d) to the 1993 10-K.\n10.8(e) First Amended and Restated Lacey Employment Agreement dated as of June 15, 1993, incorporated by reference to exhibit 10.8(c) to the 1993 10-K.\n10.10(a) Crisis Recovery Employee Incentive Bonus plan dated as of December 2, 1991, incorporated by reference to Exhibit 19.3 of the November 1992 10-Q.\n10.10(b) Capital Associates, Inc. Incentive Program to Enhance Earnings Growth dated June 27, 1993, incorporated by reference to exhibit 10.10(b) to the 1993 10-K.\n10.40 Purchase Agreement, dated as of December 30, 1991 by and among CAII, the Company and Bank One, Texas, N.A., incorporated by reference to Exhibit 19.11 of the November 1991 10-Q.\n10.41 Form of Consulting Agreement, dated as of April 30, 1993 by and among the Company CAII and William B. Patton, Jr., incorporated by reference to Exhibit 10.41 of the 1993 10-K.\n10.42 Amendment to Stockholders' Agreement, dated as of June 1, 1994, by and between the Company, Durliat, Jacobs and Kazan, incorporated by reference to Exhibit 10.42 of the 1994 10-K.\n10.43 Confidentiality and Standstill Agreement, dated as of June 1, 1994, by and between the Company and Kazan, incorporated by reference to Exhibit 10.43 of the 1994 10-K.\n10.44 Indemnification Agreement, dated as of January 14, 1994, by and between the Company and Jacobs, incorporated by reference to Exhibit 10.44 of the 1994 10-K.\n10.45 Form of Stock Option Agreement between the Company and the directors of the Company (with a grant date of August 27, 1993 for Kazan, Patton, Edwards and Schabarum and a grant date of January 14, 1994 for Jacobs), incorporated by reference to Exhibit 10.45 of the 1994 10-K.\n10.48 Form of Credit and Security Agreement, dated as of November 30, 1994, by and among CAII, Norwest Bank Colorado, National Association (\"Norwest\"), Norwest Equipment Finance, Inc., and First Interstate Bank of Denver, N.A. (\"First Interstate\") (the \"New Lenders\"), incorporated by reference to Exhibit 10.48 of the February 1995 10-Q.\n10.49 Settlement Agreement and Release of Liens and Claims, dated as of December 2, 1994, by and among the Company, CAII, each of the Company's and CAII's wholly-owned subsidiaries, Mellon Bank, N.A., as Agent, and the Lenders, incorporated by reference to Exhibit 10.49 of the February 1995 10-Q.\n11 Statement regarding Computation of Per Share Earnings.\n21 List of Subsidiaries.\n23 Consent of KPMG Peat Marwick.\n27 Financial Data Schedule\n19 of 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 on August 29, 1995.\nCAPITAL ASSOCIATES, INC.\nBy \/s\/John E. Christensen ------------------------------- John E. Christensen 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 in the capacities indicated and on the dates listed.\nSignature Title Date\n\/s\/William B. Patton, Jr. Chairman of the Board August 29, 1995 - ------------------------- and Director William B. Patton, Jr.\n\/s\/William H. Buckland Director August 29, 1995 - ------------------------- William H. Buckland\n\/s\/James D. Edwards Director August 29, 1995 - ------------------------- James D. Edwards\n\/s\/Gary M. Jacobs Director August 29, 1995 - ------------------------- Gary M. Jacobs\n\/s\/Dennis J. Lacey President, Chief Executive August 29, 1995 - ------------------------- Officer and Director Dennis J. Lacey\n\/s\/Peter F. Schabarum Director August 29, 1995 - ------------------------- Peter F. Schabarum\n\/s\/James D. Walker Director August 29, 1995 - ------------------------- James D. Walker\n\/s\/Joseph F. Bukofski Assistant Vice President August 29, 1995 - ------------------------- and Controller Joseph F. Bukofski (Principal Accounting Officer)\n20 of 20\nINDEX OF FINANCIAL STATEMENTS AND SCHEDULES\nFinancial Statements - --------------------\nIndependent Auditors' Report\nConsolidated Balance Sheets as of May 31, 1995 and 1994\nConsolidated Statements of Income for the Years Ended May 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity for the Years Ended May 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended May 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements to\nSchedules - ---------\nIndependent Auditors' Report\nSchedule II - Valuation and Qualifying Accounts and Reserves for the Years Ended May 31, 1995, 1994 and 1993\nF - 1\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Directors Capital Associates, Inc.:\nWe have audited the accompanying consolidated balance sheets of Capital Associates, Inc. and subsidiaries as of May 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 May 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 Capital Associates, Inc. and subsidiaries as of May 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 May 31, 1995, in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK\n\/s\/ KPMG Peat Marwick ---------------------\nDenver, Colorado July 14, 1995, except for Note 15 which is as of August 23, 1995\nF - 2\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except par value)\nASSETS\nMay 31, 1995 1994 -------- --------\nCash $ 923 $ 2,072 Accounts receivable, net of allowance for doubtful accounts of $308 and $343 563 1,625 MBank receivable (Note 15) 10,800 - Equipment held for sale or re-lease 66 5,242 Residual values and other receivables arising from equipment under lease sold to private investors 5,608 5,098 Net investment in direct finance leases 19,319 18,106 Leased equipment, net 19,987 15,615 Investment in affiliated limited partnerships 10,316 12,178 Other 2,970 5,779 Deferred income taxes 1,800 - Notes receivable arising from sale-leaseback transactions 21,037 32,417 Discounted lease rentals assigned to lenders arising from equipment sale transactions 65,283 111,593 --------- ---------\n$ 158,672 $ 209,725 ========= =========\nLIABILITIES AND STOCKHOLDERS' EQUITY\nWorking Capital Facility $ 1,531 $ 49 Warehouse Facility 12,156 - Accounts payable and other liabilities 13,446 8,187 Term Loan 10,833 18,718 Deferred income taxes - 830 Obligations under capital leases arising from sale-leaseback transactions 21,024 32,337 Discounted lease rentals 77,192 128,505 --------- ---------\n136,182 188,626 --------- ---------\nCommitments and contingencies (Notes 10, 12, 15, and 16)\nStockholders' equity: Common stock, $.008 par value, 15,000,000 shares authorized, 10,214,000 and 9,759,000 shares issued 63 60 Additional paid-in capital 16,961 16,689 Retained earnings 5,517 4,401 Treasury stock, at cost (51) (51) --------- --------- Total stockholders' equity 22,490 21,099 --------- ---------\n$ 158,672 $ 209,725 ========= =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nF - 3\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)\nYear Ended May 31, 1995 1994 1993 ---------- ---------- ---------- Revenue: Equipment sales to affiliated limited partnerships $ 43,638 $ 70,085 $ 62,252 Other equipment sales (Note 15) 37,732 52,384 33,981 Leasing 7,672 13,368 26,003 Interest 11,386 15,027 15,526 Other 4,516 4,101 3,638 ---------- ---------- ---------\nTotal revenue 104,944 154,965 141,400 ---------- ---------- ---------\nCosts and expenses: Equipment sales (Note 15) 70,866 114,440 85,423 Leasing 3,893 5,511 12,148 Operating and other expenses 11,603 12,307 14,060 Provision for losses 2,940 1,315 2,070 Interest: Non-recourse debt 12,548 18,370 22,091 Recourse debt 1,618 1,839 3,282 ---------- ---------- ---------\nTotal costs and expenses 103,468 153,782 139,074 ---------- ---------- ---------\nNet income before income taxes 1,476 1,183 2,326\nIncome tax expense 360 473 930 ---------- ---------- ---------\nNet income $ 1,116 $ 710 $ 1,396 ========== ========== =========\nEarnings per common and dilutive common equivalent share:\nPrimary $ .10 $ .07 $ .14 ========== ========== =========\nFully diluted $ .10 $ .07 $ .13 ========== ========== =========\nWeighted average number of common and dilutive common equivalent shares outstanding used in computing earnings per share:\nPrimary 10,649,000 10,901,000 10,306,000 ========== ========== ==========\nFully diluted 10,672,000 10,901,000 10,888,000 ========== ========== ==========\nThe accompanying notes are an integral part of these consolidated financial statements.\nF - 4\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands)\nThe accompanying notes are an integral part of these consolidated financial statements.\nF - 5\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)\nThe accompanying notes are an integral part of these consolidated financial statements.\nF - 6\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL ACCOUNTING PRINCIPLES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Capital Associates, Inc. (\"CAI\") and its subsidiaries (collectively, the \"Company\"). Intercompany accounts and transactions are eliminated in consolidation.\nThe Company has investments in affiliated public income funds (the \"PIFs\", consisting of both general partnership and subordinated limited partnership interests) and other 50%-or-less owned entities. Such investments are primarily accounted for using the equity method. The parent company's assets consist solely of its investments in subsidiaries and it has no liabilities separate from its subsidiaries.\nINCOME TAXES\nThe Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"), Accounting for Income Taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEQUIPMENT HELD FOR SALE OR RE-LEASE\nEquipment held for sale or re-lease, recorded at the lower of cost or market value expected to be realized, consists of equipment previously leased to end users which has been returned to the Company following lease expiration.\nINCOME PER COMMON AND COMMON EQUIVALENT SHARE\nIncome per common and common equivalent share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents (consisting solely of common stock options) outstanding during the period.\nRECLASSIFICATIONS\nCONSOLIDATED STATEMENTS OF CASH FLOW - The principal portion of receipts of direct financing leases and proceeds from sales of equipment have been classified as \"Cash flows from operating activities\". Previously, such amounts were reported as \"Cash flows from investing activities\".\nF - 7\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued\nGENERAL ACCOUNTING PRINCIPLES, continued\nRECLASSIFICATIONS, continued\nThe effect of the reclassification on previously issued financial statements is as follows (in thousands):\nEQUIPMENT LEASING AND SALES\nLease Accounting - Statement of Financial Accounting Standards No. 13 requires that a lessor account for each lease by either the direct financing, sales-type or operating lease method. Direct financing and sales-type leases are defined as those leases which transfer substantially all of the benefits and risks of ownership of the equipment to the lessee. The Company currently utilizes the direct financing or the operating method for substantially all of the Company's lease originations. The Company currently utilizes the sales-type and operating lease methods for substantially all subsequent lease activity for an item of equipment after the expiration of the initial lease term. For all types of leases, the determination of profit considers the estimated value of the equipment at lease termination, referred to as the residual value. After the origination of a lease, the Company may engage in financing of lease receivables on a non-recourse basis and\/or equipment sale transactions to reduce or recover its investment in the equipment.\nThe Company's accounting methods and their financial reporting effects are described below:\nLease Inception ---------------\nDIRECT FINANCING LEASES (\"DFLs\") - The cost of equipment is recorded as net investment in DFLs. Leasing revenue, which is recognized over the term of the lease, consists of the excess of lease payments plus the estimated residual value over the equipment's cost. Earned income is recognized monthly to provide a constant yield and is recorded in leasing revenue in the accompanying statements of income. Initial direct costs (\"IDC\") are capitalized and amortized over the lease term in proportion to the recognition of earned income. Residual values are established at lease inception equal to the estimated value to be received from the equipment following termination of the initial lease (which in certain circumstances includes anticipated re-lease proceeds) as determined by the Company. In estimating such values, the Company considers all relevant information and circumstances regarding the equipment and the lessee.\nF - 8\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued\nGENERAL ACCOUNTING PRINCIPLES, continued\nEQUIPMENT LEASING AND SALES, continued\nOPERATING LEASES (\"OLs\") - Leasing revenue consists principally of monthly rentals. The cost of equipment is recorded as leased equipment and is depreciated on a straight-line basis over the lease term to an amount equal to the estimated residual value at the lease termination date. Residual values are established at lease inception equal to the estimated value to be received from the equipment following termination of the initial lease (which in certain circumstances includes anticipated re-lease proceeds) as determined by the Company. In estimating such values, the Company considers all relevant information and circumstances regarding the equipment and the lessee. IDC are capitalized and amortized over the lease term in proportion to the recognition of rental income. Depreciation expense and amortization of IDC are recorded as leasing costs in the accompanying statements of income. Because revenue, depreciation expense and the resultant profit margin before interest expense are recorded on a straight-line basis, and interest expense on discounted lease rentals is incurred on the interest method, profit is skewed toward lower returns in the early years of the term of an OL and higher returns in later years.\nTransactions Subsequent to Lease Inception ------------------------------------------\nNON-RECOURSE DISCOUNTING OF RENTALS - The Company may assign the rentals from leases to financial institutions at fixed interest rates on a non-recourse basis. In return for such future lease payments, the Company receives the discounted value of the payments in cash. In the event of default by a lessee, the financial institution has a first lien on the underlying leased equipment, with no further recourse against the Company. Cash proceeds from such financings are recorded on the balance sheet as discounted lease rentals. As lessees make payments to financial institutions, leasing revenue and interest expense are recorded.\nSALES TO PRIVATE INVESTORS OF EQUIPMENT UNDER LEASE - The Company sells title to leased equipment that in some cases is subject to existing non-recourse debt in equipment sale transactions with third-party investors. In such transactions, the investors obtain ownership of the equipment as well as rights to equipment rentals and tax benefits. Upon sale, the Company records equipment sales revenue equal to the sales price of the equipment which may include a residual interest retained by the Company (recorded as an asset at present value using an appropriate interest rate) and records equipment sales cost equal to the carrying value of the related assets (including remaining unamortized IDC). Income is recorded on residual interests retained by the Company after cumulative cash collections on such residuals exceed the recorded asset amount. Fees for remarketing equipment associated with such transactions are reflected in operations as realized.\nOther accounts arising from private equity sales include:\nDISCOUNTED LEASE RENTALS, etc. - Pursuant to FASB Technical Bulletin No. 86-2, although private investors and PIFs may acquire the equipment sold to them by the Company subject to the associated non-recourse debt, the debt is not removed from the balance sheet unless such debt has been legally assumed by the third-party investors. If not legally assumed, a corresponding asset (\"discounted lease rentals assigned to lenders arising from equipment sale transactions\") is recorded representing the present value of the end user rentals receivable relating t o such transactions. Interest income is recorded on the discounted lease rentals and an equal amount of interest expense on the related liability is recorded in the accompanying statements of income.\nF - 9\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued\nGENERAL ACCOUNTING PRINCIPLES, continued\nEQUIPMENT LEASING AND SALES, continued\nSALE-LEASEBACK TRANSACTIONS - In sale-leaseback transactions, the Company leases equipment, obtains non-recourse financing on the equipment, sells the equipment to a third party and leases the equipment back from the third party. Income in a sale-leaseback transaction is deferred and principally amortized over the leaseback term in proportion to the reduction in the leased asset. For financial reporting purposes, a note receivable from the third-party, a capital lease obligation equal to the present value of the leaseback payments and a deferred gain are recorded at the time of the transaction. Amortization of the deferred gain is generally recorded as a reduction of leasing costs and expenses in the accompanying statements of income unless the estimated residual value of the underlying equipment has experienced an other than temporary decline in value, in which case amortization ceases. The Company has not entered into a sale\/leaseback transaction since fiscal year 1991.\nINTEREST INCOME - Interest income, as shown in the accompanying statements of income, includes interest on discounted lease rentals and interest on notes receivable arising from sale-leaseback transactions.\nSALES TO PIFS - Upon the sale of equipment to its PIFs, the Company records equipment sales revenue equal to the sales price of the equipment (including any acquisition fees earned) and costs of sales equal to the carrying value of the related assets (including remaining unamortized IDC). Fees for services the Company performs for the PIFs are recognized at the time the services are performed.\nTransactions Subsequent to Initial Lease Termination ----------------------------------------------------\nAfter the initial term of equipment under lease expires, the equipment is either sold or released. When the equipment is sold, the remaining net book value of equipment sold is removed and gain or loss recorded. When the equipment is released, the Company utilizes the sales-type method (described below) or the OL method (described above).\nSales-type Leases -----------------\nThe excess of the present value of future rentals and the present value of the estimated residual value (collectively, \"the net investment\") over the carrying value of the equipment subject to the sales-type lease is reflected in operations at the inception of the lease. Thereafter, the net investment is accounted for as a DFL, as described above.\nALLOWANCE FOR LOSSES\nAn allowance for losses is maintained at levels determined by management to adequately provide for any other than temporary declines in asset values. In determining losses, economic conditions, the activity in used equipment markets, the effect of actions by equipment manufacturers, the financial condition of lessees, the expected courses of action by lessees with regard to leased equipment at termination of the initial lease term, and other factors which management believes are relevant, are considered. Assets are reviewed quarterly to determine the adequacy of the allowance for losses.\nF - 10\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued\nGENERAL ACCOUNTING PRINCIPLES, continued\nALLOWANCE FOR LOSSES, continued\nThe Company evaluates the realizability of the carrying value of its investment in its PIFs based upon all estimated future cash flows from the PIFs. As a result of such analyses, certain distributions have been accounted for as a recovery of cost instead of income.\n2. RESIDUAL VALUES AND OTHER RECEIVABLES ARISING FROM EQUIPMENT UNDER LEASE SOLD TO PRIVATE INVESTORS\nAs of May 31, 1995 and 1994, the equipment types for which the Company recorded the present value of the estimated residual values and other receivables arising from private sales of equipment under lease were (in thousands):\nDescription 1995 1994 ----------- ------ ------\nFurniture and fixtures $1,284 $1,118 Mining, manufacturing and material handling 786 725 Aircraft 396 518 Other miscellaneous equipment 404 812 IBM, primarily peripheral computer equipment - 461 ------ ------\nTotal equipment residuals 2,870 3,634 Notes receivable due directly from investors 2,678* 1,289 End user rentals under existing leases assigned to the Company by investors 60 175 ------ ------\n$5,608 $5,098 ====== ======\n*Balance was collected during June 1995\nResidual values and other receivables arising from equipment under lease sold to private investors were net of an allowance for doubtful accounts of $1,654,000 and $6,934,000 as of May 31, 1995 and 1994, respectively.\n3. NET INVESTMENT IN DFLS\nThe components of the Company's net investment in DFLs as of May 31, 1995 and 1994 were (in thousands):\n1995 1994 ------ ------\nMinimum lease payments receivable $ 21,486 $ 18,214 Estimated residual values 1,161 2,256 IDC 159 136 Less unearned income (3,487) (2,500) -------- --------\n$ 19,319 $ 18,106 ======== ========\nF - 11\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. LEASED EQUIPMENT, net\nThe Company's investment in equipment under OLs, by major classes, as of May 31, 1995 and 1994 were (in thousands):\n1995 1994 -------- --------\nMaterial handling $ 7,151 $ 2,074 Other technology and communication equipment 5,536 4,168 Other 4,274 5,361 Aircraft 4,125 9,040 Mining equipment 3,989 402 IBM processors and peripheral computer equipment 3,329 6,973 Furniture and fixtures 2,460 447 IDC 239 103 -------- -------- 31,103 28,568 Less accumulated depreciation (8,700) (11,212) Less allowance for losses (2,416) (1,741) -------- --------\n$ 19,987 $ 15,615 ======== =========\nDepreciation on leased equipment was $3,771,000, $5,209,000, and $11,425,000 for fiscal years 1995, 1994 and 1993, respectively.\n5. FUTURE MINIMUM LEASE PAYMENTS\nFuture minimum lease payments receivable from noncancelable leases on equipment owned by the Company as of May 31, 1995, were as follows (in thousands):\nYears Ending May 31 DFLs OLs ---- ---\n1996 $ 9,607 $ 7,099 1997 3,802 5,619 1998 2,035 2,847 1999 1,288 1,680 2000 4,754 1,017 Thereafter 0 708 ------- -------\n$21,486 $18,970 ======= =======\n6. NOTES RECEIVABLE AND OBLIGATIONS UNDER CAPITAL LEASES ARISING FROM SALE- LEASEBACK TRANSACTIONS\nIn sale-leaseback transactions, the leaseback payments are generally equal in amount to the principal and interest payments due under the note receivable and, accordingly, the notes receivable and obligations under capital leases arising from sale-leaseback transactions do not represent future net cash inflows or outflows of the Company.\nF - 12\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. NOTES RECEIVABLE AND OBLIGATIONS UNDER CAPITAL LEASES ARISING FROM SALE- LEASEBACK TRANSACTIONS, continued\nAggregate maturities of notes receivable and obligations under capital leases arising from sale-leaseback transactions are as follows (in thousands): Notes Years Ending May 31 Receivable Obligations ---------- -----------\n1996 $ 12,628 $ 12,603 1997 7,666 7,673 1998 743 748 --------- ---------\n$ 21,037 $ 21,024 ======== ========\nNotes receivable and obligations arising from sale-leaseback transactions bear interest at rates ranging from 10% to 12%.\n7. CONCENTRATION OF CREDIT RISK\nThe Company leases various types of equipment to companies in diverse industries throughout the United States. To minimize credit risk, the Company generally leases equipment to (i) companies that have a credit rating of not less than Baa as determined by Moody's Investor Services, Inc., or comparable credit ratings as determined by other recognized credit rating services, or (ii) companies, which although not rated by a recognized credit rating service or rated below Baa, are believed by the Company to be sufficiently creditworthy to satisfy the financial obligations under the lease.\nAt May 31, 1995, equipment under OLs and DFLs owned by the Company was leased to companies with the following credit ratings:\nPercentage of the net book value of Credit Rating equipment under lease ------------- ---------------------\nBaa (or equivalent) or above 79% Below Baa (or equivalent) 18 In bankruptcy 3\n8. DISCOUNTED LEASE RENTALS\nDiscounted lease rentals outstanding at May 31, 1995 bear interest at rates between 6% to 12%. Aggregate maturities of such non-recourse obligations are (in thousands):\nYears Ending May 31:\n1996 $ 37,485 1997 26,147 1998 10,516 1999 2,377 2000 667 --------\n$ 77,192 ========\nF - 13\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. DEBT FACILITIES\nThe Company closed a new recourse debt facility (the \"Debt Facility\") on December 2, 1994. The lender group currently consists of Norwest Bank Colorado, National Association (the \"Agent\"), Norwest Equipment Finance, Inc. (the \"Collateral Agent\"), First Interstate Bank of Denver, N.A., The Daiwa Bank, Ltd. and The First National Bank of Boston (the \"Lenders\"). The Borrower under the Debt Facility is Capital Associates International, Inc., a wholly-owned subsidiary of the Company (\"CAII\").\nThe Debt Facility consists of three components, a term loan facility (the \"Term Loan\"), a revolving working capital facility (the \"Working Capital Facility\") and a revolving warehousing facility (the \"Warehouse Facility\"). The principal terms of the three facilities are as follows (in thousands):\nPrincipal reductions under the Term Loan are scheduled to occur as follows (in thousands):\nFiscal year ending May 31, 1996 $ 4,333 Fiscal year ending May 31, 1997 4,333 Fiscal year 1998 through November 30, 1997 2,167 --------\n$ 10,833 ========\nThe Debt Facility (1) is collateralized by all of CAII's assets and (2) is senior, in order of priority, to all of CAII's indebtedness, subject to certain limited exceptions. The Company and certain of the Company's and CAII's subsidiaries have pledged all of their assets, with limited exceptions, to collateralize their guarantees. The Debt Facility restricts CAII's ability to pay dividends or loan or advance funds to the Company.\nAs of May 31, 1995, there were no defaults existing under the Debt Facility.\nF - 14\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. RELATED PARTIES\nPIFs:\nThe Company sponsors or co-sponsors six PIFs that purchase equipment under lease from the Company. The Company acts as either a general partner or co-general partner of each PIF for which it receives general partner distributions as well as management fees. As of May 31, 1995, approximately $0.4 million was receivable from the PIFs for such fees. In addition, the Company is required to make subordinated limited partnership investments in the PIFs. The Company has a maximum remaining obligation to make further cash contributions of approximately $0.3 million for all of the existing PIFs (which relates solely to CPYF III). Amounts related to the PIFs are as follows (in thousands):\n1995 1994 1993 ------ ------ ------\nEquipment sales margin $ 1,047 $ 1,774 $ 1,773 Fees and distributions 2,908 3,293 2,925 Investment contributions in subordinated limited partnership interests 230 200 130\nOTHER RELATED PARTY TRANSACTIONS:\nA director and principal shareholder of the Company is a shareholder and executive officer of Corporate Express, Inc. (\"CE\"). During fiscal year 1995, the Company sold all of its investment in CE resulting in a gain of $671,000, which is included in \"Other Revenue\" in the accompanying Consolidated Statements of Income.\n11. INCOME TAXES\nThe components of the income tax expense (benefit) charged to continuing operations were (in thousands):\n1995 1994 1993 ------ ------ ------ Current: Federal $ 1,990 $ 1,000 $ 730 State and local 1,000 143 400 ------- ------- ------ 2,990 1,143 1,130 ------- ------- ------ Deferred: Federal (1,800) (400) (150) State and local (830) (270) (50) ------- ------- ------ (2,630) (670) (200) ------- ------- ------ Total tax provision $ 360 $ 473 $ 930 ======= ======= ======\nIncome tax expense differs from the amounts computed by applying the U.S. federal income tax rate of 34% to pre-tax income from continuing operations as a result of the following:\n1995 1994 1993 ------ ------ ------\nComputed \"expected\" tax expense $ 502 $ 402 $ 791 State tax provisions, net of federal benefits 88 71 139 Reduction in valuation allowance for deferred income tax assets (230) - - ------ ------ ------ $ 360 $ 473 $ 930 ====== ====== ======\nF - 15\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. INCOME TAXES, continued\nIncome taxes are provided on income from continuing operations at the appropriate federal and state statutory rates applicable to such earnings. The effective tax rate for the fiscal years ended May 31, 1995 and 1994 was 40%.\nComponents of income tax expense attributable to net income before income taxes is as follows (in thousands):\nSignificant components of the Company's deferred tax liabilities and assets as of May 31, 1995 and 1994, were as follows (in thousands):\nF - 16\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. INCOME TAXES, continued\nAt May 31, 1995, the Company had an investment tax credit carryforward of $7.4 million, which expires from 1996 through 2001, and AMT credits of $3.3 million. Under present United States tax law, AMT credits may be carried forward indefinitely and may be utilized to reduce regular tax liability to an amount equal to AMT liability.\nThe Company has established a valuation allowance for deferred taxes due to the uncertainty that the full amount of the ITC carryforward will be utilized prior to expiration. The reduction in the valuation allowance recorded in fiscal 1995 of $230,000 represents the utilization of an ITC carryforward for which a valuation allowance had previously been provided.\n12. COMMON AND PREFERRED STOCK\nThe Company has authority to issue 2,500,000 shares of preferred stock at $0.008 par value. At May 31, 1995, no shares of preferred stock had been issued.\nTwo principal stockholders, who together own approximately 32% of the outstanding shares of the Company's stock are parties to an agreement with the Company pursuant to which each of them has granted the Company and, secondarily, the other, a right of first refusal under certain circumstances to purchase their shares of common stock at current market value. Upon the death or disability of one of them, the Company is obligated to purchase his shares at an amount equal to the greater of $1 million or the amount of insurance proceeds to be received by the Company in the event of death. The Company is the owner of life insurance policies providing approximately $3 million of coverage with respect to each of the principal stockholders.\n13. STOCK OPTIONS\nThe Company has a qualified incentive stock option plan whereby stock options may be granted to employees to purchase shares of the Company's common stock at prices equal to 100% of the estimated fair value at the date of grant. The Company has a non-qualified plan covering all directors except the CEO.\nCommon stock received through the exercise of qualified incentive stock options which are sold by the optionee within two years of grant or one year of exercise result in a tax deduction for the Company equivalent to the taxable gain recognized by the optionee. For financial reporting purposes, the tax effect of this deduction is accounted for as additional paid-in capital. Such optionee sales resulted in tax benefits to the Company of $58,000 and $19,000 in fiscal years 1995 and 1994, respectively.\nF - 17\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n13. STOCK OPTIONS, continued\nThe following table summarizes the activity in this plan for the periods indicated:\nOptions Exercise Price Options Outstanding Per Share Exercisable ----------- -------------- -----------\nOutstanding at June 1, 1992 2,693,000 0.0625 - 2.7500 1,112,000 ========== Exercised (56,000) 0.3400 - 0.5625 Granted 160,000 0.4065 - 1.1250 Canceled (446,000) 0.3400 - 2.7500 --------- Outstanding at May 31, 1993 2,351,000 0.0625 - 1.1250 1,336,000 ========== Exercised (23,000) 0.3400 - 0.5625 Granted 55,000 0.8125 - 1.2188 Canceled (119,000) 0.3400 - 1.1250 --------- Outstanding at May 31, 1994 2,264,000 0.0625 - 1.2188 1,682,000 ========== Exercised (454,000) 0.0625 - 1.0625 Granted 491,000 0.6250 - 0.6600 Canceled (208,000) 0.3400 - 1.1875 --------- Outstanding at May 31, 1995 2,093,000 0.3400 - 1.2188 1,670,000 ========= ==========\n14. QUARTERLY FINANCIAL DATA (unaudited)\nSummarized quarterly financial data for the years ended May 31, 1995 and 1994 are (in thousands, except per share data):\nTotal Net Income Per Common and Fiscal year 1995: Revenue Income Common Equivalent Share ---------------- ------- ------ -----------------------\nFirst quarter $ 18,769 $ 163 $ .02 Second quarter 24,396 71 .01 Third quarter 29,471 54 .01 Fourth quarter 32,308 828 .08\nTotal Net Income Per Common and Fiscal year 1994: Revenue Income Common Equivalent Share ---------------- ------- ------ -----------------------\nFirst quarter $ 52,342 $ 281 $ .03 Second quarter 39,900 174 .02 Third quarter 22,297 187 .02 Fourth quarter 40,426 68 .01\n15. LEGAL PROCEEDINGS\nMBank Litigation - Capital Associates International, Inc. (\"CAII\") had been a third party defendant in certain litigation involving Bank One Texa s, N.A. (\"Bank One\"), The Prudential Insurance Company (\"Prudential\"), Texas Commerce Bank, N.A. (\"TCB\") and the Federal deposit Insurance Corporation (\"FDIC\") since January 1992 (the \"MBank Litigation\"). The MBank Litigation involved multiple disputes among the parties concerning the ownership of certain equipment (the \"Equipment\") that the Company leased (the \"Lease\") to MBank Dallas, N.A. (\"MBank\"), in 1987 and the rights to certain cash collateral for MBank's obligations under that Lease (the \"Cash Collateral\") following MBank's default under the Lease in 1989.\nF - 18\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n15. LEGAL PROCEEDINGS, continued\nMBANK LITIGATION, continued\nOn March 16, 1995, the United States District Court for the Northern District of Texas, Dallas Division (the \"District Court\") granted the motions for partial summary judgment of CAII, Prudential and TCB and denied the motion for partial summary judgment of the FDIC (the \"District Court's Opinion\").\nOn August 15, 1995, the FDIC (in its corporate capacity and in its capacity as receiver for MBank), Prudential, TCB and CAII agreed to settle their claims on the terms set forth in that Settlement Agreement, dated as of the same date and filed with the District Court a Joint Motion Regarding Settlement of Claims Among FDIC, CAI, TCB and Prudential (the \"Joint Motion\"), seeking to have the District Court (a) ratify and approve the dismissal of the arties claims against each other, (b) accept tender of the bill of sale for the equipment and (c) approve distribution of the remaining Cash Collateral as follows:\na. $7.0 million to the FDIC; and\nb. $2.0 million to TCB and Prudential, jointly, to be divided between TCB and Prudential as they agree; and\nc. the remaining proceeds (in the approximate amount of $10.8 million) to CAII (CAII agreed to pay approximately $2.4 million of the $10.8 million to Bank One, in repayment of the monies received from Bank One in 1992, with interest thereon at the rate of 18% per annum, as required by that certain Purchase Agreement, by and among CAII, the Company and Bank One (the \"Bank One Purchase Agreement\"));\nOn August 16, 1995, the District Court approved the Joint Motion. On August 23, 1995, TCB distributed approximately $10.8 million to CAII.\nBank One is not a party to the Settlement Agreement or the Joint Motion. In August 1995, the District Court approved Bank One's request to file its first amended complaint in the MBank Litigation (\"Bank One's Amended Complaint\"). Bank One's Amended Complaint seeks, with respect to CAII, (1) a declaratory judgment that CAII is obligated to convey title to the Equipment to Bank One and (2) a permanent injunction prohibiting CAII from transferring title to the equipment to the FDIC (\"Bank One's Amended Claims\"). Bank One's Amended Complaint does not assert any money damage claims against CAII. CAII delivered a confirmatory bill of sale for the Equipment to the District Court on August 15, 1995. The Company has filed a motion with the District Court asking it to dismiss Bank One's Amended Claims against CAII. CAII intends to defend vigorously Bank One's Amended Claims. Management believes, based upon the advice of counsel, that the ultimate outcome with respect to Bank One's Amended Claims will not have a material adverse effect on the Company's financial position.\nThe MBank sale proceeds of approximately $8.4 million and the MBank equipment carrying value of approximately $2.3 million were included in \"Other equipment sales\" and \"Cost of equipment sales\", respectively, in the accompanying Consolidated Statements of Income.\n16. COMMITMENTS\nThe Company leases office space under long-term non-cancelable operating leases. The leases contain renewal options and provide for annual escalation for utilities, taxes and service costs. Minimum future rental payments required by such leases are as follows (in thousands):\nF - 19\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n16. COMMITMENTS, continued\nYear Ending May 31, 1996 $ 400 1997 353 1998 353 1999 340 2000 321 -------\n$ 1,767 =======\n17. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following disclosure of the estimated fair value of financial instruments was made in accordance with Statements of Financial Standards No. 107 (\"SFAS No. 107\"), Disclosures about Fair Value of Financial Instruments. SFAS No. 107 specifically excludes certain items from its disclosure requirements such as the Company's investment in leased assets. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the net assets of the Company.\nThe carrying amounts at May 31, 1995 for cash, accounts receivable, residual values and other receivables arising from equipment under lease sold to private investors, the Working Capital Facility, the Warehouse Facility, accounts payable and other liabilities and the Term Loan approximate their fair values due to the short maturity of these instruments, or because the related interest rates approximate current market rates.\nAs of May 31, 1995, discounted lease rentals and discounted lease rentals assigned to lenders arising from equipment sale transactions of $77,192,000 and $65,283,000, respectively, have fair values of $76,551,000 and $64,741,000, respectively. The fair values were estimated utilizing market rates of comparable debt having similar maturities and credit quality as of May 31, 1995.\nF - 20\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Directors Capital Associates, Inc.:\nUnder date of July 14, 1995, except for note 15, which is as of August 23, 1995, we reported on the consolidated balance sheets of Capital Associates, Inc. and subsidiaries as of May 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 May 3, 1995, as contained 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 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, 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\n\/s\/KPMG Peat Marwick ------------------------------\nDenver, Colorado July, 14, 1995\nF - 21\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES for the years ended May 31, 1995, 1994 and 1993 (in thousands)\nF - 22\nExhibit 11\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES COMPUTATION OF PRIMARY EARNINGS PER SHARE\nYear Ended May 31, ----------------------------------- 1995 1994 1993 -------- -------- --------\nShares outstanding at beginning of period 9,727,000 9,654,000 8,948,000\nShares issued during the period (weighted average) 377,000 58,000 642,000\nDilutive shares contingently issuable upon exercise of options (weighted average) 1,905,000 2,251,000 1,708,000\nLess shares assumed to have been purchased for treasury with assumed proceeds from exercise of stock options (weighted average) (1,360,000) 1,062,000) (992,000) ----------- ---------- ----------\nTotal shares, primary 10,649,000 10,901,000 10,306,000 =========== ========== ==========\nNet Income $ 1,116,000 $ 710,000 1,396,000 =========== ========== ==========\nIncome per common and common equivalent share, primary .10 $ .07 $ .14 =========== ========== ==========\nF - 23\nExhibit 11\nCAPITAL ASSOCIATES, INC. AND SUBSIDIARIES COMPUTATION OF FULLY DILUTED EARNINGS PER SHARE\nYear Ended May 31,\n1995 1994 1993 -------- -------- --------\nShares outstanding at beginning of period 9,727,000 9,654,000 8,948,000\nShares issued during the period 377,000 58,000 642,000 (weighted average)\nDilutive shares contingently issuable upon exercise of options 1,905,000 2,251,000 1,708,000 (weighted average)\nLess shares assumed to have been purchased for treasury with assumed proceeds from exercise of stock options (1,337,000) (1,062,000) (410,000) (weighted average) ----------- ---------- ---------\nTotal shares, fully diluted 10,672,000 10,901,000 10,888,000 =========== ========== ==========\nNet Income $ 1,116,000 $ 710,000 $1,396,000 =========== ========== ==========\nIncome per common and common equivalent share, fully diluted $ .10 $ .07 $ .13 =========== ========== ==========\nF - 24","section_15":""}
{"filename":"101909_1995.txt","cik":"101909","year":"1995","section_1":"ITEM 1. BUSINESS.\nUnitog Company, the registrant, together with its subsidiaries is referred to herein as the \"Company\". The Company was first incorporated in Missouri in 1948 and was reincorporated under the laws of Delaware in 1969. The Company's executive offices are located at 101 West 11th Street, Kansas City, Missouri 64105, and its telephone number is (816) 474-7000.\nA. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nInformation incorporated herein by reference from the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995, page 23.\nB. NARRATIVE DESCRIPTION OF BUSINESS.\nGENERAL\nThe Company is a leading provider of high quality uniform rental services to a variety of industries and sells custom-designed uniforms primarily to national companies in connection with their corporate image programs. The Company manufactures substantially all the uniforms it rents or sells. The Company provides national uniform programs for many of the largest companies in the United States on both a rental and direct sale basis. In addition, the Company believes it is one of the largest suppliers of uniforms to employees of the United States Postal Service. Rental operations accounted for 70.6%, 70.3% and 67.9% of the Company's total revenues in fiscal 1995, 1994 and 1993, respectively. Uniform Direct sales accounted for the remaining revenues.\nRENTAL OPERATIONS\nThe Company rents uniforms and other industrial items, such as dust mops, wiping towels and entrance mats, and, to a lesser extent, linen items, such as sheets, pillowcases, tablecloths and napkins, to customers who prefer a rental laundry service instead of purchasing and maintaining such items themselves.\nUniform Rentals. The Company's rental services are designed to address customers' requirements for managing employee uniform programs. The services provided by Unitog include assistance in selecting fabrics, styles and colors appropriate for a customer's needs; maintaining necessary inventory to match the customer's changing employment levels; replacing worn items and providing pick-up, cleaning, maintenance and delivery services on a regularly scheduled basis.\nThe Company provides rental services in 44 markets to customers in 26 states. Rental services are provided through industrial laundry facilities at which the cleaning and processing of garments is performed. In addition, the Company operates sales and service branches which serve as sales offices and warehouse and distribution sites, allowing the Company to provide rental services to customers in geographic areas adjacent to the immediate area of an industrial laundry facility.\nGenerally, the Company's uniform rental service contracts cover a multi-year term and provide compensation to Unitog in the event a customer terminates the contract before the end of the term. In addition, if a rental item is lost, stolen or destroyed, Unitog receives a specified replacement value.\nLinen Rentals. The Company rents linens, such as sheets, pillowcases, tablecloths and napkins, primarily to customers in the hotel and food service industries. Unitog has historically retained linen volume if the linen volume does not adversely impact the operating efficiency of the rental plant. In those instances where operating efficiency was affected, the Company has sold linen volume.\nDIRECT SALES\nThe Company has over 60 years of experience in supplying custom-designed uniforms to national customers in connection with corporate image programs. A majority of the Company's direct sales are to companies in diverse industries, including automotive services, petroleum, brewing, soft drink bottling and transportation industries. The Company believes that it has remained a leader in uniform sales by consistently offering superior program management, prompt order fulfillment and high quality uniforms in a variety of styles, colors and fabrics.\nUnitog provides a total uniform management program to its customers. The Company assists its customers in designing attractive, readily recognizable uniforms to complement the customer's overall corporate identity. The Company's product line consists of shirts, trousers, jackets, coveralls, rainwear, selected women's apparel and related accessories. In many cases, a national customer selects a particular style of uniform and designates approved suppliers to sell the uniforms to the customer's independent distributors, franchisees or employees throughout the customer's distribution system. Unitog specializes in assisting these national customers by promoting the benefits of approved uniform programs through the use of professionally designed brochures, promotional programs and direct sales contacts.\nThe Company has sold uniforms to employees of the United States Postal Service under the Brookfield label for over 25 years. The Postal Service provides an annual allotment ranging from $50 to\n$310 to each postal employee for uniform purchases. The individual employee is then free to select uniforms from any supplier approved by the Postal Service. Payment is made by the Postal Service directly to the Company to the extent of the employee's allotment and any excess is paid directly by the employee.\nSALES AND MARKETING\nThe Company considers its target market to be national and regional customers seeking improved image and employee recognition as well as higher levels of product quality and customer service.\nThe selling efforts of the Rental and Direct sales forces are combined under common regional sales managers, creating a company-wide marketing approach to maximize cross-selling opportunities by identifying customers' needs, whether rental or direct sale. Unitog believes the program has resulted in a more professional sales team, upgraded sales training and improved salesperson productivity.\nUniform programs on the national level are handled by the national account marketing department, whose members call directly on existing and prospective rental and direct sale national accounts. The Company's Rental sales force is comprised of salespersons based at the rental locations who call on customers within the geographic service area of the rental location. In addition to the Rental sales force, the Company's route salespersons have responsibility for increasing sales to customers on their routes. The Company maintains a Direct sales force that covers the continental United States, with each member being assigned a specific sales territory. Sales of Postal Service uniforms are made through direct sales calls on postal employees by commissioned representatives.\nMANUFACTURING AND DISTRIBUTION\nThe Company manufactures garments and emblems for both the Rental and Direct sales operations at four plants located in Missouri, one plant located in Arkansas and one plant located in Honduras. The Company performs manufacturing operations, consisting mainly of cutting, sewing and finishing garments, for substantially all its product line. From time to time Unitog contracts with independent garment manufacturers for a portion of its requirements. Certain uniform accessories sold or rented by the Company, such as shoes, ties and belts, are purchased from other manufacturers.\nThe Company maintains distribution centers in Ontario, California, Atlanta, Georgia and Kansas City and Warrensburg, Missouri where its uniforms are stored pending shipment to customers. The Company believes that its experience and efficiency\nin the manufacturing and distribution processes enable the Company to provide quick delivery of customized products.\nSOURCES OF RAW MATERIALS\nSubstantially all of the fabrics used by Unitog in its manufacturing process are acquired from textile mills located in the United States. Alternative sources of these materials are generally available.\nSEASONALITY\nRental operations are not generally subject to seasonality. Subject to the effects of the introduction of new programs with national accounts, Direct sales have historically been higher in the third and fourth quarters due to the sale of fall and winter garments. As a result, operating income can be higher in such quarters.\nCUSTOMERS\nNo material part of the business of the Company is dependent upon a single customer or a small number of customers.\nCOMPETITION\nThe business in which Unitog is engaged is highly competitive, and the Company competes in both the sale and rental of uniforms with a large number of other firms. The Company believes that the primary competitive factors that affect its operations are design, quality, service and price. The Company believes it maintains prices comparable to those of its major competitors and endeavors to offer prompt and high quality service to its customers and superior products as the principal methods of distinguishing itself from its competition. Unitog's Rental operation competes with a number of national, regional and local companies in the geographic areas it serves. The Company's Direct sales operation also competes on a national basis with other suppliers and uniform manufacturers. Some of these competitors are larger and have greater financial resources than the Company.\nENVIRONMENTAL MATTERS\nThe Company is subject to federal, state and local laws governing the use and disposal of various wastes, including wastewater from its washing processes. The Company has a continuing program to upgrade wastewater treatment processes, where necessary, to avoid improper disposal. Although the Company is subject to administrative and judicial proceedings from time to time involving environmental matters, the Company does not believe that costs incurred in connection with environmental compliance\nwill have a material adverse effect on the consolidated financial statements of the Company.\nThe Company is subject to various federal, state and local laws which require the investigation and, in some cases, remediation of environmental contamination. The Company is currently engaged in soil and groundwater investigations at its Phoenix, Minneapolis and Los Angeles rental plants. The Phoenix and Los Angeles plants are located in federal superfund sites several square miles in size. The Company, along with certain unaffiliated parties, has been designated by the U.S. EPA as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act with respect to the Phoenix site. The Company entered into a consent order with EPA requiring a soil and groundwater investigation at the Phoenix site. The cost of the investigation will be borne by two other parties pursuant to a settlement agreement with the Company. Test results at the Phoenix site indicate that volatile organic compound contamination is present in the soil, necessitating soil remediation. Groundwater tests have not detected on-site contamination, although additional periodic groundwater testing is expected. Test results at the Minneapolis and Los Angeles plants indicate that volatile organic compound contamination is present in the soil and groundwater at those plants. The Company believes that it will be required to remediate the soil at the Minneapolis plant and has begun soil remediation at Los Angeles. Additional testing is being conducted to determine if groundwater remediation will be required at those facilities. The Company's estimate of the expense related to all three of these sites has been accrued and charged to operating expense. Based on information currently available, the Company does not believe that additional costs of investigation and remediation at these sites are individually or in the aggregate material to the consolidated financial statements of the Company.\nEXECUTIVE OFFICERS OF THE COMPANY\nCertain information about the executive officers of the Company is set forth below.\nPRINCIPAL OCCUPATION FOR NAME AGE LAST FIVE YEARS - ---- --- ------------------------ Randolph K. Rolf 53 Mr. Rolf has served as Chairman of the Board since May 1991 and as a Director of the Company since 1986. He has served as its President and Chief Executive Officer since May 1988.\nJohn W. Hall 64 Mr. Hall has served as the Company's Senior Vice President - Human Resources and Industrial Relations since 1984.\nJ. Craig Peterson 42 Mr. Peterson has served as the Company's Senior Vice President - Finance and Administration and Chief Financial Officer since July 1991. Prior to that time he was a partner at KPMG Peat Marwick.\nJ. Keith Schreiman 53 Mr. Schreiman has served as the Company's Senior Vice President - Sales and Marketing since May 1993. From May 1988 to May 1993 he was the Company's Senior Vice President - Direct Sales.\nTerence C. Shoreman 40 Mr. Shoreman has served as the Company's Senior Vice President - Rental Operations since May 1993. From December 1989 to May 1993 he was a Vice President of the Company's rental subsidiary.\nG. Jay Arrowsmith 47 Mr. Arrowsmith has served as the Company's Vice President - Manufacturing since August 1994. From March 1994 to August 1994 he was a Vice President - Manufacturing for Fruit of the Loom. Prior to that time he was Sewing Operations Manager for Jostens Sportswear.\nRobert M. Barnes 37 Mr. Barnes has served as Vice President, General Counsel and Secretary of the Company since May 1994. From January 1990 until May 1994, he was General Counsel and Secretary of the Company.\nPRINCIPAL OCCUPATION FOR NAME AGE LAST FIVE YEARS\nRonald J. Harden 52 Mr. Harden has served as the Company's Controller since 1981.\nEMPLOYEES\nThe Company had approximately 3,225 full-time employees as of January 29, 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's rental processing plants have the necessary equipment to clean and process uniforms and non-uniform items and also contain administrative, sales and service personnel for the market serviced by the plant. The Company owns substantially all of the machinery and equipment used in its operations and owns and leases a fleet of vehicles.\nThe Company believes its facilities are generally of adequate size and productive capacity to meet its current needs. The following chart provides information concerning the Company's principal facilities.\nLocation Type of Facility\nBirmingham, Alabama**.................. Processing Plant Decatur, Alabama*...................... Processing Plant Gadsden, Alabama*...................... Sales and Service Branch Tempe, Arizona**....................... Processing Plant Fort Smith, Arkansas**................. Manufacturing Facility Long Beach, California**............... Processing Plant Long Beach, California**............... Processing Plant Ontario, California.................... Sales and Service Branch and Distribution Center San Diego, California.................. Processing Plant San Fernando, California*.............. Sales and Service Branch Union City, California*................ Processing Plant Whittier, California**................. Processing Plant Denver, Colorado*...................... Sales and Service Branch Greeley, Colorado...................... Processing Plant Atlanta, Georgia*...................... Processing Plant Atlanta, Georgia*...................... Distribution Center Freeport, Illinois*.................... Sales and Service Branch Villa Park, Illinois**................. Processing Plant Ft. Wayne, Indiana..................... Sales and Service Branch Goshen, Indiana*....................... Processing Plant Indianapolis, Indiana*................. Sales and Service Branch Muncie, Indiana........................ Processing Plant Cedar Rapids, Iowa*.................... Sales and Service Branch Charles City, Iowa*.................... Processing Plant\nLocation Type of Facility\nDes Moines, Iowa*...................... Sales and Service Branch Glenwood, Iowa**....................... Processing Plant Duluth, Minnesota**.................... Processing Plant Eagan, Minnesota....................... Processing Plant Minneapolis, Minnesota**............... Processing Plant Concordia, Missouri*................... Manufacturing Facility Kansas City, Missouri*................. Corporate Offices Kansas City, Missouri**................ Processing Plant and Distribution Center St. Charles, Missouri**................ Manufacturing Facility University City, Missouri**............ Processing Plant Warrensburg, Missouri**............... Manufacturing Facility and Distribution Center Warsaw, Missouri**..................... Manufacturing Facility Las Vegas, Nevada*..................... Sales and Service Branch Charlotte, North Carolina*............. Sales and Service Branch Cleveland, Ohio*....................... Sales and Service Branch Lima, Ohio*............................ Sales and Service Branch Toledo, Ohio*(1)....................... Processing Plant Xenia, Ohio*........................... Sales and Service Branch Bloomsburg, Pennsylvania*.............. Processing Plant Bristol, Pennsylvania**................ Processing Plant Nashville, Tennessee**................. Sales and Service Branch Dallas, Texas*......................... Processing Plant Houston, Texas*........................ Processing Plant La Ceiba, Honduras*.................... Manufacturing Facility - --------------- * Leased for various terms expiring from fiscal 1996 to fiscal 2004. The Company expects that it will be able to renew or replace its leases on satisfactory terms. Except as otherwise noted, all other properties are owned. ** Pledged to secure certain long-term indebtedness. (1) Includes an option to purchase in 2000 upon payment of a nominal amount.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a party to litigation incidental to its business, primarily involving claims for personal injury, employment claims and environmental matters as described in Item 1 above. Based on information currently available, the Company does not believe its costs with respect to pending legal matters will 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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation incorporated herein by reference from the information provided under the caption \"Common Stock Information\" and \"Price Range\" in the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995, page 26.\nDividends on the outstanding common stock totaled $.08 and $.07 per share in fiscal 1995 and 1994, respectively, and are paid semi-annually. The Company's principal credit agreements contain certain restrictions on dividends. At January 29, 1995, the Company had $16.5 million in unrestricted stockholders' equity available to pay future dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nInformation incorporated herein by reference from the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995, page 25.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nInformation incorporated herein by reference from the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995, pages 8 - 11.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nInformation incorporated herein by reference from the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995, pages 12 - 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.\nInformation incorporated herein by reference from the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders under the captions \"Nominees for Three-Year Terms\", \"Continuing Directors\" and \"Stock Ownership and Trading Reports\", pages 5 - 7, and from Item 1, \"Executive Officers of the Company\", in Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation incorporated herein by reference from the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders under the captions \"Compensation of Directors\" and \"Executive Compensation and Other Information\", page 6 and pages 8 - 13, except information under the captions \"Board Compensation Committee Report on Executive Compensation\" and \"Total Market Return\" are not incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation incorporated herein by reference from the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders under the caption \"Stock Ownership of Certain Beneficial Owners and Management\", pages 3 and 4.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation incorporated herein by reference from the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders under the caption \"Related Party Transaction\", page 7.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of the report:\n1. Financial Statements (incorporated by reference from pages 12 - 24 of the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1995).\n- - Independent Auditors' Report. - - Consolidated Balance Sheets--January 29, 1995 and January 30, 1994. - - Consolidated Statements of Earnings--Years ended January 29, 1995, January 30, 1994 and January 31, 1993. - - Consolidated Statements of Stockholders' Equity--Years ended January 29, 1995, January 30, 1994 and January 31, 1993. - - Consolidated Statements of Cash Flows--Years ended January 29, 1995, January 30, 1994 and January 31, 1993. - - Notes to Consolidated Financial Statements.\n2. Exhibits.\n3(a) Second Restated Certificate of Incorporation and amendment thereto (incorporated by reference to Exhibit\n3(a) to Amendment No. 2 to Registration Statement on Form S-1 (SEC No. 33-27969)).\n3(b) Third Amended and Restated Bylaws and amendment thereto (incorporated by reference to Exhibit 3(b) to registrant's Annual Report on Form 10-K for the fiscal year ended January 28, 1990).\n4(a) Specimen common stock certificate (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-3 (SEC No. 33- 59628)).\n4(b) Reference is made to the Fourth Article of the Second Restated Certificate of Incorporation (Exhibit 3(a) hereto), and Sections 9, 47, 48, 49 and 50 of the Third Amended and Restated Bylaws, as amended (Exhibit 3(b) hereto).\n4(c) Loan and Letter of Credit Reimbursement Agreement, dated September 10, 1993, among Unitog Company, Unitog Rental Services, Inc., United Missouri Bank, N.A., Harris Trust and Savings Bank and NBD Bank, N.A., including promissory notes issued thereunder (incorporated by reference to Exhibit 4(a) of Quarterly Report on Form 10-Q for the quarterly period ended August 1, 1993).\n4(d) Amendment No. 1 to Loan and Letter of Credit Reimbursement Agreement, dated December 29, 1994, among Unitog Company, Unitog Rental Services, Inc., United Missouri Bank, N.A., Harris Trust and Savings Bank and NBD Bank, N.A.\n4(e) Trust Indenture, dated as of December 7, 1988, between Unitog Company, Unitog Rental Services, Inc., jointly and severally, and Peoples Bank and Trust Company, including specimen copy of note (incorporated by reference to Exhibit 4(h) to Registration Statement on Form S-1 (SEC No. 33-27969)).\n4(f) Amendment No. 1 to Trust Indenture, dated as of September 10, 1993, between Unitog Company, Unitog Rental Services, Inc. and Peoples Bank and Trust Company (incorporated by reference to Exhibit 4(c) of Quarterly Report on Form 10-Q for the quarterly period ended August 1, 1993).\n4(g) Amendment No. 2 to Trust Indenture, dated December 29, 1994, between Unitog Company, Unitog Rental Services, Inc. and Peoples Bank and Trust Company.\n4(h) Note Agreement, dated as of December 1, 1993, among Unitog Company, Unitog Rental Services, Inc. and Metropolitan Life Insurance Company, and the Note issued\nthereunder (incorporated by reference to Exhibit 4(a) to Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1993).\n10(a)* Employment Agreement, dated July 1, 1991, between the registrant and J. Craig Peterson (incorporated by reference to Exhibit 10(c) to registrant's Annual Report on Form 10-K for the fiscal year ended January 26, 1992).\n10(b)* Unitog Company 1992 Stock Option Plan (incorporated by reference to Exhibit 10(d) to registrant's Annual Report on Form 10-K for the fiscal year ended January 26, 1992).\n10(c)* Amendment No. 1 to Unitog Company 1992 Stock Option Plan (incorporated by reference to Exhibit 10(d) to registrant's Annual Report on Form 10-K for fiscal year ended January 30, 1994).\n10(d)* Description of Management Incentive Plan (incorporated by reference to Exhibit 10(e) to registrant's Annual Report on Form 10-K for fiscal year ended January 30, 1994).\n10(e)* Unitog Company Outside Director Fee\/Stock Program (incorporated by reference to Exhibit B to registrant's definitive proxy statement for its 1995 Annual Meeting of Stockholders).\n13 Information incorporated by reference from the Annual Report to Stockholders for the fiscal year ended January 29, 1995.\n21 Subsidiaries of the registrant (incorporated by reference to Exhibit 22 of the registrant's Annual Report on Form 10-K for the fiscal year ended January 28, 1990).\n23 Consent of independent public accountant.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit by Item 601 of Regulation S-K.\n(b) There were no reports on Form 8-K filed during the fourth quarter of fiscal 1995.\nUNITOG COMPANY AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEX\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNITOG COMPANY\nBy: \/s\/ Randolph K. Rolf ------------------------- Randolph K. Rolf Chairman, President and Chief Executive Officer April 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.\nSIGNATURE TITLE DATE - --------- ------------- -----------\n\/s\/ Randolph K. Rolf Chairman, President April 25, 1995 - ------------------------- and Chief Executive Randolph K. Rolf Officer\n\/s\/ J. Craig Peterson Senior Vice President April 25, 1995 - ------------------------- Finance and Adminis- J. Craig Peterson tration and Chief Financial Officer\n\/s\/ Ronald J. Harden Controller April 25, 1995 - ------------------------- Ronald J. Harden\nSIGNATURE TITLE DATE - --------- ---------- ---------\n\/s\/ G. Kenneth Baum Director April 25, 1995 - -------------------------- G. Kenneth Baum\n- -------------------------- Director April , 1995 John W. Caffry\n\/s\/ D. Patrick Curran Director April 25, 1995 - -------------------------- D. Patrick Curran\n\/s\/ Robert F. Hagans Director April 25, 1995 - -------------------------- Robert F. Hagans\n- -------------------------- Director April , 1995 David B. Sharrock\n\/s\/ William D. Thomas Director April 25, 1995 - -------------------------- William D. Thomas\nINDEX TO EXHIBITS\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT PAGE\n3(a) Second Restated Certificate of Incorpora- tion and amendment thereto (incorporated by reference to Exhibit 3(a) to Amendment No. 2 to Registration Statement on Form S-1 (SEC No. 33-27969)).\n3(b) Third Amended and Restated Bylaws and amendment thereto (incorporated by refer- ence to Exhibit 3(b) to registrant's Annual Report on Form 10-K for the fiscal year ended January 28, 1990).\n4(a) Specimen common stock certificate (incorporated by reference to Exhibit 4(a) to Registration Statement on Form S-3 (SEC No. 33-59628)).\n4(b) Reference is made to the Fourth Article of the Second Restated Certificate of Incorp- oration (Exhibit 3(a) hereto), and Sec- tions 9, 47, 48, 49 and 50 of the Third Amended and Restated Bylaws, as amended (Exhibit 3(b) hereto).\n4(c) Loan and Letter of Credit Reimbursement Agree- ment, dated September 10, 1993, among Unitog Company, Unitog Rental Services, Inc., United Missouri Bank, N.A., Harris Trust and Savings Bank and NBD Bank, N.A., including promissory notes issued thereunder (incorporated by refer- ence to Exhibit 4(a) of Quarterly Report on Form 10-Q for the quarterly period ended August 1, 1993).\n4(d) Amendment No. 1 to Loan and Letter of Credit Reimbursement Agreement, dated December 29, 1994, among Unitog Company, Unitog Rental Services, Inc., United Missouri Bank, N.A., Harris Trust and Savings Bank and NBD Bank, N.A.\n4(e) Trust Indenture, dated as of December 7, 1988, between Unitog Company, Unitog Rental Services, Inc., jointly and severally, and Peoples Bank and Trust Company, including\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT PAGE\nspecimen copy of note (incorporated by reference to Exhibit 4(h) to Registration Statement on Form S-1 (SEC No. 33-27969)).\n4(f) Amendment No. 1 to Trust Indenture, dated as of September 10, 1993, between Unitog Company, Unitog Rental Services, Inc. and Peoples Bank and Trust Company (incorporated by reference to Exhibit 4(c) of Quarterly Report on Form 10-Q for the quarterly pe- riod ended August 1, 1993.\n4(g) Amendment No. 2 to Trust Indenture, dated December 29, 1994, between Unitog Company, Unitog Rental Services, Inc. and Peoples Bank and Trust Company.\n4(h) Note Agreement, dated as of December 1, 1993, among Unitog Company, Unitog Rental Services, Inc. and Metropolitan Life Insurance Company, and the Note issued thereunder (incorporated by reference to Exhibit 4(a) to Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1993).\nLong-term debt instruments authorizing debt which does not exceed 10% of the total consolidated assets of the Company are not filed herewith but will be furnished on request of the Commission.\n10(a) Employment Agreement, dated July 1, 1991, between the registrant and J. Craig Peterson (incorporated by reference to Ex- hibit 10(c) to registrant's Annual Report on Form 10-K for the fiscal year ended January 26, 1992).\n10(b) Unitog Company 1992 Stock Option Plan (incorporated by reference to Exhibit 10(d) to registrant's Annual Report on Form 10-K for the fiscal year ended January 26, 1992).\n10(c) Amendment No. 1 to Unitog Company 1992 Stock Option Plan (incorporated by reference to Exhibit 10(d) to registrant's Annual Report on Form 10-K for the fiscal year ended January 30, 1994)\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT PAGE\n10(d) Description of Management Incentive Plan (incor- porated by reference to Exhibit 10(e) to regis- trant's Annual Report on Form 10-K for the fiscal year ended January 30, 1994).\n10(e) Unitog Company Outside Director Fee\/Stock Program (incorporated by reference to Exhibit B to registrant's definitive proxy statement for its 1995 Annual Meeting of Stockholders).\n13 Information incorporated by reference from the Annual Report to Stockholders for the fiscal year ended January 29, 1995.\n21 Subsidiaries of the registrant (incorporated by reference to Exhibit 22 of the regis- trant's Annual Report on Form 10-K for the fiscal year ended January 28, 1990).\n23 Consent of independent public accountant.","section_15":""}
{"filename":"783233_1995.txt","cik":"783233","year":"1995","section_1":"ITEM 1. BUSINESS.\nCERTAIN OF THE INFORMATION CONTAINED IN THIS FORM 10-K, INCLUDING THE DISCUSSION WHICH FOLLOWS IN THIS ITEM 1 OF THE COMPANY'S PLANS AND STRATEGIES FOR ITS BUSINESS AND RELATED FINANCING, AND THE MANAGEMENT'S DISCUSSION AND ANALYSIS FOUND IN ITEM 7 OF THIS REPORT, CONTAIN FORWARD- LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS, PLEASE CAREFULLY REVIEW THE DISCUSSION OF RISK FACTORS CONTAINED IN THIS ITEM 1, AS WELL AS THE OTHER INFORMATION CONTAINED IN THIS REPORT AND IN THE COMPANY'S PERIODIC REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION (THE \"SEC\" OR \"COMMISSION\").\nACC Corp. is a switch-based provider of telecommunications services in the United States, Canada and the United Kingdom. The Company primarily provides long distance telecommunications services to a diversified customer base of businesses, residential customers and educational institutions. As a result of recent regulatory changes, ACC has begun to provide local telephone service as a switch-based local exchange reseller in upstate New York and as a reseller of local exchange services in Ontario, Canada. ACC operates an advanced telecommunications network consisting of seven long distance international and domestic switches located in the U.S., Canada and the U.K., a local exchange switch located in the U.S., leased transmission lines, and network management systems designed to optimize traffic routing.\nThe Company's objective is to grow its long distance telecommunications customer base in its existing markets and to establish itself in deregulating Western European markets that have high density telecommunications traffic, such as France and Germany, when the Company believes that business and regulatory conditions warrant. The key elements of the Company's business strategy are: (1) to broaden ACC's penetration of the U.S., Canadian and U.K. telecommunications markets by expanding its long distance, local and other service offerings and geographic reach; (2) to utilize ACC's operating experience as an early entrant in deregulating markets in the U.S., Canada and the U.K. to penetrate other deregulating telecommunications markets that have high density telecommunications traffic; (3) to achieve economies of scale and scope in the utilization of ACC's network; and (4) to seek acquisitions, investments or strategic alliances involving assets or businesses that are complementary to ACC's current operations.\nThe Company's principal competitive strengths are: (1) ACC's sales and marketing organization and the customized service ACC offers to its customers; (2) ACC's offering of competitive prices which the Company believes generally are lower than prices charged by the major carriers in each of its markets; (3) ACC's position as an early entrant in the U.S., Canadian and U.K. markets as an alternative carrier; (4) ACC's focus on more profitable international telecommunications traffic between the U.S., Canada and the U.K.; and (5) ACC's switched-based networking capabilities. The Company believes that its ownership of switches reduces its reliance on other carriers and enables the Company to efficiently route telecommunications traffic over multiple leased transmission lines and to control costs, call record data and customer information. The availability of existing transmission capacity in its markets makes leasing of transmission lines attractive to the Company and enables it to grow network usage without having to incur the significant capital and operating costs associated with the development and operation of a transmission line infrastructure.\nACC primarily targets business customers with approximately $500 to $15,000 of monthly usage, selected residential customers and colleges and universities. The Company believes that, in addition to being price-driven, these customers tend to be focused on customer service, more likely to rely on a single carrier for their telecommunications needs and less likely to change carriers than larger commercial customers. The diversity of ACC's targeted customer base enhances network utilization by combining business- driven workday traffic with night and weekend off-peak traffic from student and residential customers. The Company strives to be more cost effective, flexible, innovative and responsive to the needs of its customers than the major carriers, which principally focus their direct sales efforts on large commercial accounts and residential customers.\nThe Company was originally incorporated in New York in 1982 under the name A. C. Teleconnect Corp. and was reincorporated in Delaware in 1987 under the name ACC Corp. As used herein, unless the context otherwise requires, the ''Company'' and ''ACC'' refer to ACC Corp. and its subsidiaries, including ACC Long Distance Corp. (''ACC U.S.''), ACC TelEnterprises Ltd., the Company's 70% owned Canadian subsidiary (''ACC Canada''), and ACC Long Distance UK Limited (''ACC U.K.''). The Company's principal executive offices are located at 400 West Avenue, Rochester, New York 14611 and its telephone number at that address is (716) 987-3000.\nIn this Report, references to ''dollar'' and ''$'' are to United States dollars, references to ''Cdn. $'' are to Canadian dollars, references to '''' are to British pounds sterling, the terms ''United States'' and ''U.S.'' mean the United States of America and, unless the context otherwise requires, its states, territories and possessions and all areas subject to its jurisdiction, and the terms ''United Kingdom'' and ''U.K.'' mean England, Scotland and Wales.\nFor certain financial information concerning the Company's foreign and domestic operations, see Note 9 to the Consolidated Financial Statements in Item 8 of this Report.\nINDUSTRY OVERVIEW\nThe global telecommunications industry has dramatically changed during the past several years, beginning in the U.S. with AT&T Corp.'s (\"AT&T\") divestiture of its 22 regional operating companies (\"RBOCs\") in 1984 and culminating with the recently enacted amendments to the U.S. Communications Act of 1934 (the \"U.S. Communications Act\"), and continuing in Canada, the U.K. and other countries with various regulatory changes. Previously, the long distance telecommunications industry in the U.S., Canada and the U.K. consisted of one or a few large facilities-based carriers, such as AT&T, Bell Canada and British Telecommunications PLC (\"British Telecom\"). As a result of the AT&T divestiture and the recent legislative changes in the U.S. and fundamental regulatory changes in Canada and the U.K., coupled with technological and network infrastructure developments which increased significantly the voice and data telecommunications transmission capacity of dominant carriers, the long distance industry has developed into a highly competitive one consisting of numerous alternative long distance carriers in each of these countries. In addition, since the AT&T divestiture in 1984, competition has heightened in the local exchange market in the U.S. and Canada. The Company anticipates that deregulatory and economic influences will promote the development of competitive telecommunications markets in other countries.\nLONG DISTANCE MARKET. The U.S. long distance market has grown to approximately $67 billion in annual revenues during 1994, according to Federal Communications Commission (\"FCC\") estimates. AT&T has remained the largest long distance carrier in the U.S. market, retaining slightly more than 55% of the market, with MCI Telecommunications Corporation (\"MCI\") and Sprint Corp. (\"Sprint\") increasing their respective market shares to approximately 17% and 10% of the market during 1994. AT&T, MCI and Sprint constitute what generally is regarded as the first tier in the U.S. long distance market. Large regional long distance companies, some with national capabilities, such as WorldCom, Inc. (formerly LDDS Metromedia Communications, Inc.) (\"WorldCom\"), Cable & Wireless Communications, Inc., Frontier Corp. and LCI International, constitute the second tier of the industry. The remainder of the U.S. long distance market share is comprised of several hundred smaller companies, including ACC U.S., known as third- tier carriers. In addition, recent U.S. legislation, which removes certain long-standing restrictions on the ability of the RBOCs to provide long distance services, will have a substantial impact on the long distance market.\nSince 1990, competition has existed in the Canadian long distance market. The Canadian long distance market is dominated by a consortium of facilities-based local and long distance telephone companies (E.G., Bell Canada, BC Tel, Maritime Tel) operating as the ''Stentor'' group of companies. A second group of long distance providers, consisting principally of Unitel Communications Inc. (\"Unitel\"), Sprint Canada (a subsidiary of Call-Net Telecommunications Inc.) and fONOROLA Inc., own and operate transmission lines through which they provide long distance voice and data services in the Canadian markets. Other long distance providers, including ACC Canada, generally lease transmission lines through which they resell long distance services in the Canadian market.\nThe international, national and local markets for voice telephone services in the U.K. and Northern Ireland accounted for approximately 1.4 billion, 2.1 billion and 2.2 billion, respectively, in revenues during the 12 months ended March 31, 1995, accordingly to estimates from The Office of Telecommunications (\"Oftel\"), the U.K. telecommunications regulatory authority. In the U.K., British Telecom historically has dominated the telecommunications market. British Telecom was the largest carrier during such 12 month period, with approximately 69%, 83% and 94% of the revenues from international, national and local voice telephone services, respectively. Mercury Communications Ltd. (\"Mercury\"), which owns and operates interexchange transmission facilities, is the second largest carrier of voice telecommunications in the U.K. The remainder of the U.K. long distance market is comprised of an emerging market of licensed public telephone operators, such as Energis Communications Ltd., (''Energis'') and switched-based resellers such as ACC U.K., AT&T, WorldCom, Esprit Telecom of the U.K. Ltd. (''Esprit'') and Sprint.\nLong distance carriers in the U.S., Canada and the U.K. can be categorized by several distinctions. One distinction is between transmission facilities-based companies and non-transmission facilities- based companies, or resellers. Transmission facilities-based carriers, such as AT&T, Bell Canada and British Telecom, own their own long distance interexchange or transmission facilities and originate and terminate calls through local exchange systems. Profitability for transmission facilities- based carriers is dependent not only upon their ability to generate revenues but also upon their ability to manage complex networking and transmission costs. All of the first- and most of the second-tier long distance companies in the U.S. markets are transmission facilities-based carriers and generally offer service nationwide. Most transmission facilities-based carriers in the third tier of the market offer their service only in a limited geographic area. Some transmission facilities- based carriers contract with other transmission facilities-based carriers to provide transmission where they have geographic gaps in their facilities. Switched-based resellers, such as the Company, carry their long distance traffic over transmission lines leased from transmission facilities-based carriers, originate and terminate calls through local exchange systems or \"competitive access providers\" (\"CAPs\") such as Teleport or MFS Communications Co., Inc. (\"MFS\"), and contract with transmission facilities-based carriers to provide transmission of long distance traffic either on a fixed rate lease basis or a call volume basis. Profitability for non-transmission facilities-based carriers is dependent largely on their ability to generate and retain sufficient revenue volume to negotiate attractive pricing with one or more transmission facilities- based carriers.\nA second distinction among long distance companies is that of switch- based versus switchless resellers. Switch-based resellers, such as the Company, have one or more switches, which are computers that direct telecommunications traffic to form a transmission path between a caller and the recipient of a call. All transmission facilities-based carriers are switch-based carriers, as are many non-transmission facilities-based carriers, including ACC. Switchless resellers depend on one or more transmission facilities-based carriers or switch-based resellers for transmission and switching facilities. The Company believes that its ownership of switches reduces its reliance on other carriers and enables the Company to efficiently route telecommunications traffic over multiple leased transmission lines and to control costs, call record data and customer information. The availability of existing transmission capacity in its markets makes leasing of transmission lines attractive to the Company and enables it to grow network usage without having to incur the significant capital and operating costs associated with the development and operation of a transmission line infrastructure.\nLOCAL EXCHANGE MARKET. In the U.S., the existing structure of the telecommunications industry principally resulted from the AT&T divestiture. As part of the divestiture, seven RBOCs were created to offer services in specified geographic areas called Local Access and Transport Areas (\"LATAs\"). The RBOCs were separated from the long distance provider, AT&T, resulting in the creation of distinct local exchange and long distance markets. Since the AT&T divestiture, several factors have served to promote competition in the local exchange market, including (i) the local exchange carriers' monopoly position, which provided little incentive for the local exchange companies to reduce prices, improve service or upgrade their networks, and related regulations which required the local exchange carriers to, among other things, lease transmission facilities to alternative carriers, such as the Company, (ii) customer desire for an alternative to the local exchange carriers, which developed in part as a result of competitive activities in the long distance market and increasing demand for lower cost, high quality, reliable services, and (iii) the advancement of fiber optic and digital electronic technology, which combined the ability to transmit voice, data and video at high speeds with increased capacity and reliability.\nDuring the past several years, regulators in some states and at the federal level have issued rulings which favored competition and promoted the opening of markets to new entrants. These rulings have allowed competitive access providers of telecommunications services to offer a number of new services, including, in certain states, a broad range of local exchange services. The Company believes the trend toward increased competition and deregulation of the telecommunications industry is continuing, and will be accelerated by the recently enacted U.S. legislation.\nIn Canada, similar factors promoting competition in the local exchange market developed in response to regulatory developments in the Canadian long distance telecommunications market and to technological advances in the telecommunications industry. The Canadian Radio-television and Telecommunications Commission (\"CRTC\") has approved, in concept, the reduction of the remaining restrictions on local exchange services in Canada and a proceeding is being conducted to determine the appropriate timetable and terms for implementation of its decision.\nBUSINESS STRATEGY\nThe Company was an early entrant as an alternative carrier in the U.S., Canada and the U.K. The Company's objective is to grow its telecommunications customer base in its existing markets and to establish itself in other deregulating Western European markets with high density telecommunications traffic. The key elements of the Company's business strategy are to increase penetration of existing markets, enter new markets, improve operating efficiency, and pursue acquisitions, investments and strategic alliances.\nINCREASE PENETRATION OF EXISTING MARKETS. ACC's consolidated revenue and customer accounts have grown from $105.9 million and 98,400 to $188.9 million and 310,815, respectively, over the three fiscal years ended December 31, 1995, although the Company expects its growth to decrease over time. The Company plans to increase further its revenue and customer base in the U.S., Canadian and U.K. markets by expanding its service offerings and geographic reach. The expansion of the Company's service offerings is designed to reduce the effects of price per minute decreases for long distance service and to decrease the likelihood that customers will change telecommunications carriers. Through this strategy, the Company will seek to build a broad base of recurring revenues in the U.S., Canada and the U.K. The Company also intends to offer local telephone services in selected additional U.S. and Canadian markets, initially in New York, Massachusetts and Ontario, as well as additional data communications services in the U.S. and Canada. The Company believes that offering local services will enhance its ability to attract and retain long distance customers and reduce the Company's access charges as a percentage of revenues. In addition, the Company is conducting feasibility studies to identify the market potential and regulatory environment for adding or expanding distribution of video conferencing, paging, domestic and international call back, Internet access, smart card, facsimile and frame relay services in certain of its targeted markets, and plans to introduce certain of those services in selected markets during 1996.\nENTER NEW MARKETS. The Company believes that its operating experience in deregulating markets in the U.S., Canada and the U.K. and its experience as an early entrant as an alternative carrier in those markets will assist ACC in identifying opportunities in other deregulating countries with high density telecommunications traffic. In particular, the Company believes that its position in the U.S., Canadian and U.K. telecommunications markets and its experience in providing international telecommunications service will assist it in establishing a presence in France and Germany and other countries when the Company believes that business and regulatory conditions warrant.\nIMPROVE OPERATING EFFICIENCY. The Company strives to achieve economies of scale and scope in the use of its network, which consists of leased transmission facilities, seven international and domestic switches, a local exchange switch and information systems. In order to enhance the efficiency of the fixed cost elements of its network, the Company seeks to increase its traffic volume and balance business-driven workday traffic with night and weekend off-peak traffic from student and residential customers. The Company anticipates that competition among transmission facilities-based providers of telecommunications services in the U.S. and Canadian markets will afford ACC opportunities for reductions in the cost of leased line facilities. The Company seeks to reduce its network cost per billable minute of use by more than any reduction in revenue per billable minute. The Company also intends to acquire additional switches and upgrade its existing switches to enhance its network in anticipation of growth in the Company's customer base and provide additional telecommunications services. The Company believes that its network switches enable the Company to efficiently route telecommunications traffic over multiple transmission facilities to reduce costs, control access to customer information and grow network usage without a corresponding increase in support costs.\nPURSUE ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES. As the Company expands its service offerings and its network, the Company anticipates that it will seek to develop strategic alliances both domestically and internationally and to acquire assets and businesses or make investments in companies that are complementary to the Company's current operations. The Company believes that the pursuit of an active acquisition strategy is an important means toward achieving growth and economies of scale and scope in its targeted markets. Through acquisitions, the Company believes that it can further increase its traffic volume to further improve the usage of the fixed cost elements of its network.\nSERVICES\nCOMMERCIAL LONG DISTANCE SERVICES. The Company offers its commercial customers in the U.S. and Canada an array of customized services and has developed a similar range of service offerings for commercial customers in the U.K.\nIn the U.S., although the Company historically has originated long distance voice services principally in New York and Massachusetts, ACC is currently authorized to originate long distance voice and data services in 44 states. The Company's U.S. services include ''1+'' inter-LATA long distance service, and private line service for which a customer is charged a fixed monthly rate for transmission capacity that is reserved for that customer's traffic. The Company's U.S. business services also include toll- free ''800'' or ''888'' services. In addition, the Company currently provides intra-LATA service in certain areas for customers who make a large number of intra-LATA calls. The Company installs automatic dialing equipment to enable customers to place such calls over the Company's network without having to dial an access code. However, various states, including New York, are moving to implement ''equal access'' for intra-LATA toll calls such that the Company's customers in such jurisdictions will be able to use the Company's network on a ''1 +'' basis to complete intra-LATA toll calls. The Company's ability to compete in the intra-LATA toll market depends upon the margin which exists between the access charges it must pay to the local exchange company for originating and terminating intra-LATA calls, and the retail toll rates established by the local exchange carriers for the local exchange carriers' own intra-LATA toll service. The Company's commercial services generally are priced below the rates charged by the major carriers for similar services and are competitive with those of other carriers. See the Risk Factor discussion of \"Increasing Domestic and International Competition'' in this Item 1 below.\nIn Canada, ACC currently originates long distance voice and data services in the Montreal, Toronto and Vancouver metropolitan areas as well as throughout Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario and Quebec. The Company offers its Canadian commercial customers both voice and data telecommunications services. The Company's long distance voice services are offered to its business customers in a nine-level discount structure marketed under the name ''Edge.'' Discounts are based on calling volume and call destination and typically result in savings ranging from 10% to 20% when compared to Stentor member rates. Calls to the U.S. are priced at a flat rate regardless of the destination and international calls are priced at a percentage discount to the rates charged by the Stentor group. The Company also offers toll-free ''800'' services within Canada, as well as to and from the U.S., and offers an ACC Travel Card providing substantial savings off Stentor member ''Calling Card'' rates. ACC Canada has introduced a frame relay network and Internet access services and now provides these services in all provinces except Saskatchewan and Newfoundland.\nACC originates long distance voice services throughout the U.K. The Company presently offers its U.K. customers voice telecommunications services. These services include indirect access (known as ''ACCess 1601'') through the public switched telephone network (''PSTN'') and the use of direct access lines to the Company's network (known as ''ACCess Direct'') for higher-volume business users. Because ACCess 1601 is a mass market service, the prices offered are built around a standard price list with volume discounts for high-volume users. ACCess Direct is generally cost effective only for customers making at least 5,000 per month in calls.\nThe Company's U.S. and Canadian commercial customers are offered customized services, such as comprehensive billing packages and its ''Travel Service Elite'' domestic calling cards, which allow the customer to place long distance calls at competitive rates from anywhere in the U.S. and Canada. The Company's standard monthly statement includes a management summary report, a call detail report recording every long distance call and facsimile call, and a pricing breakdown by call destination. Optional calling pattern reports, which are available at no extra cost, include call summaries by account code, area or city code, LATA (for U.S. bound calls), international destination and time-of-day. This information is available to customers in the form of hard copy, magnetic tape or disk.\nIn the U.S., the Company is conducting feasibility studies to identify the market potential and regulatory environment for offering additional services, including video conferencing, paging, international call back, Internet access, facsimile and frame relay services, and expects to introduce Internet access, enhanced travel cards and video conferencing in 1996. In Canada, the Company plans to expand frame relay and Internet access services in 1996. In the U.K., the Company is also considering additional service offerings, including teleconferencing, voice mail, calling cards, call-back and smart card services and plans to introduce Internet access and prepaid calling cards in 1996.\nUNIVERSITY PROGRAM. The Company's university program offers a variety of telecommunications services to educational institutions ranging from long distance service for administration and faculty, to integrated on- campus services, including local and long distance service, voice mail, intercom calling and operator services for students, administrators and faculty. The Company's sales, marketing and engineering professionals work directly with college and university administrators to design and implement integrated solutions for providing and managing telecommunications equipment and services to meet the current and prospective communications needs of their institutions. As part of its program, the Company often installs telecommunications equipment which, depending upon the circumstances, may include a switch or private branch exchange, voice mail, cabling and, in the U.K., pay telephones. Pay phone usage in the U.K., particularly at universities, is more prevalent than in the U.S. and Canada. To access this market directly, the Company has established a pay phone division in the U.K., which supplies pay phones that will automatically route calls from universities and other institutions over ACC U.K.'s network.\nAs of December 31, 1995, the Company had entered into a total of approximately 130 contracts with colleges and universities in its three geographic regions, of which approximately 100 were long-term agreements with terms which generally range from three to 10 years in length. The Company provided services to approximately 129,000 student accounts in the U.S., Canada and the U.K., as of December 31, 1995. The Company's long distance rates in the U.S. for students generally are priced at a 10% discount from those charged by the largest long distance carriers. The contracts in the U.S. typically provide the Company with a right of first refusal to provide the institution with any desired additional telecommunications services or enhancements (based on market prices) during the term of the contract. The Company's university contracts in Canada generally provide it with the exclusive right, and in the U.K. the opportunity, to market to the school's students, faculty and administration. Most of the Company's contracts in Canada also provide for exclusive university support for marketing to alumni. These arrangements allow the Company to market its services to these groups through its affinity programs.\nThe Company offers university customers in the U.S., Canada and the U.K. certain customized services. The Company offers academic institutions a comprehensive billing package to assist them in reviewing and controlling their telecommunications costs. For its university student customers in the U.S. and Canada, the Company provides a billing format that indicates during each statement period the savings per call (in terms of the discount from the largest long distance carrier's rates) realized during the billing period, and for all university customers the Company provides a call detail report recording every long distance call. In addition, for university student customers, the Company provides individual bills for each user of the same telephone in a dormitory room or suite so that each student in the dormitory room or suite can be billed for the calls he or she made.\nMany of the Company's university customers in the U.S. are offered operator services, which are available 24 hours per day, seven days per week. The Company also offers its U.S. university customers its ''Travel Service Elite'' domestic calling card. In addition, the Company sells a prepaid calling card in the U.S., which allows customers to prepay for a predetermined number of ''units'' representing long distance minutes. The rate at which the units are used is determined by the destination of the calls made by the customer.\nThe Company's sales group targets university customers in the U.S., Canada and in the U.K. In the U.S. university market, the Company generally targets small to medium size universities and colleges with full time enrollments in the range of 1,000 to 5,000 students. In Canada, the Company has been able to establish relationships with several large universities. The Company believes that, while its marketing approach in Canada is similar to that in the U.S., its nationwide presence in Canada assists it in marketing to larger academic institutions. In the U.K., the Company has been able to establish long-term relationships with several large universities. The Company believes that, while its marketing approach in the U.K. is similar to that in the U.S., it is able to access larger educational institutions because of its nationwide presence and because transmission facilities-based carriers have not focused on this market. The Company believes that competition in the university market is based on price, as well as the marketing of unique programs and customizing of telecommunications services to the needs of the particular institution and that its ability to adapt to customer needs has enhanced its development of relationships with universities.\nRESIDENTIAL LONG DISTANCE SERVICES. The Company offers its residential customers in the U.S. and Canada a variety of long distance service plans and is currently offering and developing similar plans for its residential customers in the U.K. In the U.S., the Company's ''Save Plus'' program provides customers with competitively priced long distance service. In addition, U.S. customers are provided with a ''Phone Home'' long distance service through which, by dialing an 800 number plus an access code, callers can call home at competitive rates. In general, the Company's residential services are priced below AT&T's premium rates for similar services. In Canada, the Company offers three different residential service plans. The basic offering is a discount plan, with call pricing discounted from the Stentor companies' tariffed rates for similar services depending on the time of day and day of the week. The Company also offers its ''Sunset Savings Plan,'' which allows calling across Canada and to the continental U.S. at a flat rate per minute. In the Toronto metropolitan area, the Company offers ''Extended Metro Toronto'' calling, which provides flat rate calling within areas adjacent to Toronto that are long distance from each other. Customized billing services are also offered to the Company's U.S. and Canadian residential customers. In the U.K., all residential customers use the Company's ACCess 1601 service, which provides savings of as much as 28% off the standard rates charged for residential service by British Telecom or Mercury, but requires the customer to dial a four digit access code before dialing the area code and number.\nINTERNATIONAL LONG DISTANCE SERVICES. The Company offers international products and services to both its existing customer base and to potential customers in the U.S., Canada and the U.K. The Company's international simple resale licenses (the ''ISR Licenses'') allow the Company to resell international long distance service on leased international circuits connected to the PSTN at both ends between the U.S. and Canada, the U.S. and the U.K., Canada and the U.K., and certain other countries. The Company believes it can compete effectively for international traffic due to the ISR Licenses it has obtained for traffic between the U.S., Canada and the U.K. which allow it to price its services at cost-based rates that are lower than the international settlement-based rates that would otherwise apply to such traffic. However, numerous other carriers also have international simple resale licenses. The Company has leased fixed cost facilities between these countries and is developing services for customers with high volumes of traffic between and among the U.S., Canada and the U.K.\nLOCAL EXCHANGE SERVICES. Building on its experience in providing local telephone service to various university customers, the Company took advantage of recent regulatory developments in New York State and in 1994 began offering local telephone service to commercial customers in upstate New York. As a result of its August 1995 acquisition of Metrowide Communications, the Company provides local telephone service as a reseller in Ontario, Canada. The Company believes that it can strengthen its relationships with existing commercial, university and college and residential customers in New York State and in Ontario, Canada and can attract new customers by offering them local and long distance services, thereby providing a single source for comprehensive telecommunications services. Providing local telephone service will also enable the Company to serve new local exchange customers even if they are already under contract with a different interexchange carrier for long distance service. Commencing in 1996, the Company plans to expand its local telephone operations to selected other metropolitan areas in New York and Massachusetts.\nThe Company has only limited experience in providing local telephone services, having commenced providing such services in 1994, and to date has experienced an operating cash flow deficit in that business. In order to attract local customers, the Company must offer substantial discounts from the prices charged by local exchange carriers and must compete with other alternative local companies that offer such discounts. Larger, better capitalized alternative local providers, including AT&T and Time Warner Cable, among others, will be better able to sustain losses associated with discount pricing and initial investments and expenses. The local telephone service business requires significant initial investments and expenses in capital equipment, as well as significant initial promotional and selling expenses. There can be no assurance that the Company will be able to lease transmission facilities from local exchange carriers at wholesale rates that will allow the Company to compete effectively with the local exchange carriers or other alternative providers or that the Company will generate positive operating margins or attain profitability in its local telephone service business.\nSALES AND MARKETING\nThe Company markets its services in the U.S., Canada and the U.K. through a variety of channels, including ACC's internal sales forces, independent sales agents, co-marketing arrangements and affinity programs, as described below. The Company has a total of approximately 130 internal sales personnel and approximately 200 independent sales agents serving its U.S., Canadian and U.K. markets. Although it has not experienced significant turnover in recent periods, a loss of a significant number of independent sales agents could have a significant adverse effect on the Company's ability to generate additional revenue. The Company maintains a number of sales offices in the Northeastern U.S., Canada, and in London, Manchester and Cambridge, England. In addition, with respect to its university and student customers in each country, the Company has designated representatives to assist in customer enrollment, dissemination of marketing information, complaint resolution and, in some cases, collection of customer payments, with representatives located on some campuses. The Company actively seeks new opportunities for business alliances in the form of affinity programs and co-marketing arrangements to provide access to alternative distribution channels.\nThe following table indicates the approximate number of commercial, residential and student customer accounts maintained by the Company as of December 31, 1994 and 1995 in the U.S., Canada and the U.K., respectively:\nDuring each of the last three years, no customer accounted for 10% or more of the Company's total revenue.\nUNITED STATES. The Company markets its services in the U.S. through ACC's internal sales personnel and independent sales agents as well as through attendance and representation at significant trade association meetings and industry conferences of target customer groups. The Company's sales and marketing efforts in the U.S. are targeted primarily at business customers with $500 to $15,000 of monthly usage, selected residential customers and universities and colleges. The Company also markets its services to other resellers and rebillers. The Company plans to leverage its market base in New York and Massachusetts into other New England states and Pennsylvania and to eventually extend its marketing focus in other states. ACC has obtained authorization to originate long distance voice services in 44 states. The Company plans to expand its local telephone service operations to selected other New York and Massachusetts metropolitan areas.\nCANADA. The Company markets its long distance services in Canada through internal sales personnel and independent sales agents, co-marketing arrangements and affinity programs. The Company focuses its direct selling efforts on medium-sized and large business customers. The Company also markets its services to other resellers and rebillers. The Company uses independent sales agents to target small to medium-sized business and residential customers throughout Canada. These independent sales agents market the Company's services under contracts that generally provide for the payment of commissions based on the revenue generated from new customers obtained by the representative. The use of an independent agent network allows the Company to expand into additional markets without incurring the significant initial costs associated with a direct sales force.\nIn addition to marketing its residential services in Canada through independent sales agents, the Company has developed several affinity programs designed to attract residential customers within specific target groups, such as clubs, alumni groups and buying groups. The use of affinity programs allows the Company to target groups with a nationwide presence without engaging in costly nationwide advertising campaigns. For example, ACC Canada has established affinity programs with such groups as the Home Service Club of Canada, the University of Toronto and the University of British Columbia. In addition, the Company has developed a co-marketing arrangement with Hudson's Bay Company (a large Canadian retailer) through which the Company's telecommunications services are marketed under the name ''The Bay Long Distance Program.''\nUNITED KINGDOM. In the U.K., the Company markets its services to business and residential customers, as well as other telecommunications resellers, through a multichannel distribution plan including its internal sales force, independent sales agents, co-marketing arrangements and affinity programs.\nThe Company generally utilizes its internal sales force in the U.K. to target medium and large business customers, a number of which have enough volume to warrant a direct access line to the Company's switch, thereby bypassing the PSTN. The Company markets its services to small and medium- sized businesses through independent sales agents. Telemarketers also are used to market services to small business customers and residential customers and to generate leads for the other members of the Company's internal sales force and independent sales agents. ACC U.K. has established an internal marketing group that is focused on selling its service to other telecommunications resellers in the U.K. and certain European countries on a wholesale basis. In October 1995, the Company entered into a co-marketing arrangement with London Electric PLC through which the electric utility offers long distance telephone services to its London customers which are co-branded with ACC.\nNETWORK\nIn the U.S., Canada and the U.K., the Company utilizes a network of lines leased under volume discount contracts with transmission facilities- based carriers, much of which is fiber optic cable. To maximize efficient utilization, the Company's network in each country is configured with two- way transmission capability that combines over the same network the delivery of both incoming and outgoing calls to and from the Company's switches. The selection of any particular circuit for the transmission of a call is controlled by routing software, located in the switches, that is designed to cause the most efficient use of the Company's network. The Company evaluates opportunities to install switches in selected markets where the volume of its customer traffic makes such an investment economically viable. Utilization of the Company's switches allows ACC to route customer calls over multiple networks to reduce costs. As of December 31, 1995, the Company operated switches for its call traffic in eight locations and maintained 19 additional points of presence (''POPs'') in the U.S., Canada and the U.K.\nSome of the Company's contracts with transmission facilities-based carriers contain under-utilization provisions. These provisions require the Company to pay fees to the transmission facilities-based carriers if the Company does not meet minimum periodic usage requirements. The Company has not been assessed with any underutilization charges in the past. However, there can be no assurance that such charges would not be assessed in the future. Other resellers generally contract with the Company on a month-to- month basis, select the Company almost exclusively on the basis of price and are likely to terminate their arrangements with the Company if they can obtain better pricing terms elsewhere. The Company uses projected sales to other resellers in evaluating the trade-offs between volume discounts and minimum utilization rates it negotiates with transmission facilities-based carriers. If sales to other resellers do not meet the Company's projected levels, the Company could incur underutilization charges and be placed at a disadvantage in negotiating future volume discounts.\nACC generally utilizes redundant, highly automated advanced telecommunications equipment in its network and has diverse alternate routes available in cases of component or facility failure. Automatic traffic re-routing enables the Company to provide a high level of reliability for its customers. Computerized automatic network monitoring equipment facilitates fast and accurate analysis and resolution of network problems. The Company provides customer service and support, 24-hour network monitoring, trouble reporting and response, service implementation coordination, billing assistance and problem resolution.\nIn the U.S., the Company maintains two long distance switches, one local exchange switch and nine additional points of presence. These switches and POPs provide an interface with the PSTN to service the Company's customers. Lines leased from transmission facilities-based carriers link the Company's U.S. POPs to its switches. ACC U.S. maintains a leased, direct trans-Atlantic link with ACC U.K. that it established in 1994 following the Company's receipt of its ISR License for U.K.-U.S. calls and international private line resale authority in the U.S.\nIn Canada, the Company maintains switches in Toronto, Montreal and Vancouver, together with seven POPs to provide an interface with the Canadian PSTN. The Company also maintains frame relay nodes for switched data in Toronto, Montreal, Vancouver and Calgary. The Company uses transmission lines leased from transmission facilities-based carriers to link its Canadian POPs to its switches. This network is also linked with the Company's switches in the U.S. and the U.K. ACC Canada also maintains a leased, direct trans-Atlantic link with ACC U.K. that it established in 1993 following the grant to ACC U.K. of its ISR License. This transmission line enables ACC Canada to send traffic to the U.K. at rates below those charged by Teleglobe Canada (''Teleglobe Canada''), the exclusive Canadian transmission facilities-based carrier for international calls, other than those to and from the U.S. and Mexico.\nIn the U.K., the Company maintains switches in London and Manchester, England. ACC U.K. maintains three additional POPs providing interfaces with the PSTN in the U.K., which are linked to its switches through transmission lines leased from the major transmission facilities-based carriers. This network is also linked with the Company's switches in the U.S. and Canada. Customers can access the Company's U.K. network through direct access lines or by dial-up access using auto dialing equipment, indirect access code dialing or least cost routing software integrated in the customer's telephone equipment.\nNetwork costs are the single largest expense incurred by the Company. The Company strives to control its network costs and its dependence on other carriers by leasing transmission lines on an economical basis. The Company also has negotiated leases of private line circuits with carriers that operate fiber optic transmission systems at rates independent of usage, particularly on routes over which ACC carries high volumes of calls such as between the U.S., Canada and the U.K. The Company attempts to maximize the efficient utilization of its network in the U.S., Canada and the U.K. by marketing to commercial and academic institution customers, who tend to use its services most frequently on weekdays during normal business hours, and residential and student customers, who use these services most often during night and weekend off-peak hours.\nINFORMATION SYSTEMS\nThe Company believes that maintaining sophisticated and reliable billing and customer services information systems that integrate billing, accounts receivables and customer support is a core capability necessary to record and process the data generated by a telecommunications service provider. While the Company believes its management information system is currently adequate, it has not grown as quickly as the Company's business and substantial investments are needed. In order to meet this challenge, ACC has made arrangements with a consultant and a vendor to develop new proprietary information systems which ACC has licensed to integrate customer services, management information, billing and financial reporting. The Company has budgeted approximately $6.0 million for these systems, which are expected to be installed during 1996. The systems are designed to (I) enhance the Company's ability to monitor and respond to the evolving needs of its customers by developing new and customized services, (ii) improve least-cost routing of traffic on ACC's international network, (iii) provide sophisticated billing information that can be tailored to meet the requirements of its customer base, (iv) provide high quality customer service, (v) detect and minimize fraud, (vi) verify payables to suppliers of telecommunications transmission facilities and (vii) integrate additions to its customer base. A variety of problems are often encountered in connection with the implementation of new information systems. There can be no assurance that the Company will not suffer adverse consequences or cost overruns in the implementation of the new information systems or that the new systems will be appropriate for the Company. See the Risk Factor discussion of \"Dependence on Effective Information Systems'' in this Item 1 below.\nCOMPETITION\nThe telecommunications industry is highly competitive and is significantly influenced by the marketing and pricing decisions of the larger industry participants. In each of its markets, the Company competes primarily on the basis of price and also on the basis of customer service and its ability to provide a broad array of telecommunications services. The industry has relatively insignificant barriers to entry, numerous entities competing for the same customers and a high average churn rate, as customers frequently change long distance providers in response to the offering of lower rates or promotional incentives by competitors. Although many of the Company's customers are under multi-year contracts, several of the Company's largest customers (primarily other long distance carriers) are on month-to-month contracts and are particularly price sensitive. Revenues from other resellers accounted for approximately 22%, 7% and 9% of the revenues of ACC U.S., ACC Canada and ACC U.K., respectively, in 1995, and are expected to account for a higher percentage in the future. With respect to these customers, the Company competes almost exclusively on price and does not have long term contracts. The industry has experienced and will continue to experience rapid regulatory and technological change. Many competitors in each of the Company's markets are significantly larger than the Company, have substantially greater resources than the Company, control transmission lines and larger networks than the Company and have long-standing relationships with the Company's target customers. There can be no assurance that the Company will remain competitive in this environment. Regulatory trends have had, and may have in the future, significant effects on competition in the industry. As the Company expands its geographic coverage, it will encounter increased competition. Moreover, the Company believes that competition in non-U.S. markets is likely to increase and become more like competition in the U.S. markets over time as such non-U.S. markets continue to experience deregulatory influences. See the Risk Factor discussions of \"Potential Adverse Effects of Regulation\" and \"Increasing Domestic and International Competition'' and the discussion of ''Regulation\" all in this Item 1 below.\nCompetition in the long distance industry is based upon pricing, customer service, network quality, value-added services and customer relationships. The success of a non-transmission facilities-based carrier such as the Company depends largely upon the amount of traffic that it can commit to the transmission facilities-based carrier and the resulting volume discount it can obtain. Subject to contract restrictions and customer brand loyalty, resellers like the Company may competitively bid their traffic among other national long distance carriers to gain improvement in the cost of service. The relationship between resellers and the larger transmission facilities-based carriers is twofold. First, a reseller is a customer of the services provided by the transmission facilities-based carriers, and that customer relationship is predicated primarily upon the pricing strategies of the first tier companies. The reseller and the transmission facilities-based carriers are also competitors. The reseller will attract customers to the extent that its pricing for customers is generally more favorable than the pricing offered the same size customers by larger transmission facilities-based carriers. However, transmission facilities-based carriers have been aggressive in developing discount plans which have had the effect of reducing the rates they charge to customers whose business is sought by the reseller. Thus, the business success of a reseller is significantly tied to the pricing policies established by the larger transmission facilities-based carriers. There can be no assurance that favorable pricing policies will be continued by those larger transmission facilities-based carriers.\nUNITED STATES. In the U.S., the Company is authorized to originate long distance service in 44 states (although it currently derives most of its U.S. revenues principally from calls originated in New York and Massachusetts). The Company competes for customers, transmission facilities and capital resources with numerous long distance telecommunications carriers and\/or resellers, some of which are substantially larger, have substantially greater financial, technical and marketing resources, and own or lease larger transmission systems than the Company. AT&T is the largest supplier of long distance services in the U.S. inter-LATA market. The Company also competes within its U.S. call origination areas with other national long distance telephone carriers, such as MCI, Sprint and regional companies which resell transmission services. In the intra-LATA market, the Company also competes with the local exchange carriers servicing those areas. In its local service areas in New York State, the Company presently competes or in the future will compete with New York Telephone Company (\"New York Telephone\"), Frontier Corp., AT&T, Citizens Telephone Co., MFS, Time Warner Cable and with cellular and other wireless carriers. These local exchange carriers all have long-standing relationships with their customers and have financial, personnel and technical resources substantially greater than those of the Company. Furthermore, the recently announced joint venture between MCI and Microsoft Corporation (\"Microsoft\"), under which Microsoft will promote MCI's services, the recently announced joint venture among Sprint, Deutsche Telekom AG and France Telecom, to be called Global One, and other strategic alliances could increase competitive pressures upon the Company.\nIn addition to these competitive factors, recent and pending deregulation in each of the Company's markets may encourage new entrants. For example, as a result of legislation recently enacted in the U.S., RBOCs will be allowed to enter the long distance market, AT&T, MCI and other long distance carriers and utilities will be allowed to enter the local telephone services market and cable television companies will be allowed to enter the telecommunications market. In addition, the FCC has, on several occasions since 1984, approved or required price reductions by AT&T and, in October 1995, the FCC reclassified AT&T as a ''non-dominant'' carrier, which substantially reduces the regulatory constraints on AT&T. The Company believes that the principal competitive factors affecting its market share in the U.S. are pricing, customer service and variety of services. By offering high quality telecommunications services at competitive prices and by offering a portfolio of value-added services including customized billing packages, call management and call reporting services, together with personalized customer service and support, the Company believes that it competes effectively with other local and long distance telephone carriers and resellers in its service areas. The Company's ability to continue to compete effectively will depend on its continued ability to maintain high quality, market-driven services at prices generally below those charged by its competitors.\nCANADA. In Canada, the Company competes with facilities-based carriers, other resellers and rebillers. The Company's principal transmission facilities-based competitors are the Stentor group of companies, in particular, Bell Canada, the dominant suppliers of long distance services in Canada, Unitel, which provides certain facilities- based and long distance services to business and residential customers, and Sprint Canada and fONOROLA Inc., which provide certain transmission facilities-based services and also acts as reseller of telecommunications services. The Company also competes against CamNet, Inc., a reseller of telecommunications services. The Company believes that, for some of its customers and potential customers, it has a competitive advantage over other Canadian resellers as a result of its operations in the U.S. and the U.K. In particular, the trans-Atlantic link that it established in June 1993 between the U.K. and Canada allows ACC Canada to sell traffic to the U.K. with a significantly lower cost structure than many other resellers.\nUNITED KINGDOM. In the U.K. the Company competes with facilities-based carriers and other resellers. The Company's principal competitors in the U.K. are British Telecom, the dominant supplier of telecommunications services in the U.K., and Mercury. The Company also faces competition from emerging licensed public telephone operators (who are constructing their own facilities-based networks) such as Energis, and from other resellers including IDB WorldCom Services Inc., Esprit and Sprint. The Company believes its services are competitive, in terms of price and quality, with the service offerings of its U.K. competitors primarily because of its advanced network-related hardware and software systems and the network configuration and traffic management expertise employed by it in the U.K.\nREGULATION\nUNITED STATES\nThe services which the Company's U.S. operating subsidiaries provide are subject to varying degrees of federal, state and local regulation. The FCC exercises jurisdiction over all facilities of, and services offered by, telecommunications common carriers to the extent that they involve the provision, origination or termination of jurisdictionally interstate or international communications. The state regulatory commissions retain jurisdiction over the same facilities and services to the extent they involve origination or termination of jurisdictionally intrastate communications. In addition, many regulations may be subject to judicial review, the result of which the Company is unable to predict.\nTELECOMMUNICATIONS ACT OF 1996. In February 1996, the ''Telecommunications Act of 1996'' was enacted. The legislation is intended to introduce increased competition in U.S. telecommunication markets. The legislation opens the local services market by requiring local exchange carriers to permit interconnection to their networks and by establishing local exchange carrier obligations with respect to unbundled access, resale, number portability, dialing parity, access to rights-of-way, mutual compensation and other matters. In addition, the legislation codifies the local exchange carriers' equal access and nondiscrimination obligations and preempts inconsistent state regulation. The legislation also contains special provisions that eliminate the AT&T Divestiture Decree (the \"AT&T Divestiture Decree\") (and similar antitrust restrictions on the GTE Operating Companies) which restricts the RBOCs from providing long distance services. These new provisions permit an RBOC to enter the ''out-of- region'' long distance market immediately and the ''in-region'' long distance market if it satisfies several procedural and substantive requirements, including showing that facilities-based competition is present in its market and that it has entered into interconnection agreements which satisfy a 14-point ''checklist'' of competitive requirements. The Company is likely to face significant additional competition, including from NYNEX Corp., the RBOC in the Company's Northeastern U.S. service area, which may be among the first RBOCs permitted to offer in-region long distance services. The new legislation provides for certain safeguards to protect against anticompetitive abuse by the RBOCs, but whether these safeguards will provide adequate protection to alternative carriers, such as the Company, and the impact of anticompetitive conduct if such conduct occurs, is unknown.\nUnder the legislation, any entity, including long distance carriers such as AT&T, cable television companies and utilities, may enter any telecommunications market, subject to reasonable state consumer protection regulations. The legislation also eliminates the statutory barrier which prevented local telephone companies from providing video programming services in their regions. The FCC may also forbear from regulating, in whole or in part, certain types of carriers upon compliance with certain procedural requirements. Such legislation, and the regulations that implement it will subject the Company to increased competition and may have other, as yet unknown, effects on the Company.\nFEDERAL. The FCC has classified ACC U.S. as a non-dominant interexchange carrier. Generally, the FCC has chosen not to exercise its statutory power to closely regulate the charges or practices of non- dominant carriers. Nevertheless, the FCC acts upon complaints against such carriers for failure to comply with statutory obligations or with the FCC's rules, regulations and policies. The FCC also has the power to impose more stringent regulatory requirements on the Company and to change its regulatory classification. The Company believes that, in the current regulatory environment, the FCC is unlikely to do so.\nUntil October 1995, AT&T was classified as a dominant carrier but AT&T successfully petitioned the FCC for non-dominant status in the domestic interstate and interexchange market. Therefore, certain pricing restrictions that once applied to AT&T have been eliminated, which could result in increased prices for services the Company purchases from AT&T and more competitive retail prices offered by AT&T to customers. However, to date, the Company has not found rate changes attributable to the price cap regulation of AT&T and the local exchange carriers to have substantially adversely affected its business. AT&T is, however, still classified as a dominant carrier for international services. AT&T's application for reclassification as non-dominant in the international market is currently pending.\nBoth domestic and international non-dominant carriers must maintain tariffs on file with the FCC. Prior to a recent court decision which reversed the FCC's ''forbearance policy'' that had excused non-dominant interexchange carriers from filing tariffs with the FCC, domestic non- dominant carriers were permitted by the FCC to file tariffs with a ''reasonable range of rates'' instead of the detailed schedules of individual charges required of dominant carriers. However, the Company must now file tariffs containing detailed actual rate schedules. In reliance on the FCC's past relaxed tariff filing requirements for non-dominant domestic carriers, the Company and most of its competitors did not maintain detailed rate schedules for domestic offerings in their tariffs. AT&T has filed suit against three of its major competitors for failing to file tariffs during the period preceding the court decision. Until the two year statute of limitations expires, the Company could be held liable for damages for its past failure to file tariffs containing actual rate schedules. Recent legislative changes may, however, result in the FCC's adopting a new forbearance policy, and the FCC is expected to institute a rule-making proceeding to consider the merits of reinstating a forbearance policy. There can be no assurance in this regard, however.\nIn contrast to these recent developments affecting domestic long distance service, the Company's U.S. subsidiaries have long been subject to certification and tariff filing requirements for all international resale operations. The Company's U.S. subsidiaries' international rates are not subject to either rate-of-return or price cap regulation. The Company must seek separate certification authority from the FCC to provide private line service or to resell private line services between the U.S. and any foreign country. The Company's ACC Global Corp. subsidiary has received authority from the FCC to resell private lines on a switched service basis between the U.S. and Canada, and was the first entity to file to obtain such authority between the U.S. and the United Kingdom, which it received in September 1994.\nAmong domestic local carriers, only the incumbent local exchange carriers are currently classified as dominant carriers. Thus, the FCC regulates many of the local exchange carriers' rates, charges and services to a greater degree than the Company's, although FCC regulation of the local exchange carriers is expected to decrease over time, particularly in light of recent U.S. legislation.\nTo date, the FCC has exercised its regulatory authority to supervise closely the rates only of dominant carriers. However, the FCC has increasingly relaxed its control in this area. For example, the FCC is in the process of repricing local transport charges (the fee for the use of the local exchange carrier's transmission facility connecting the local exchange carrier's central offices and the interexchange carrier's access point). In addition, the local exchange carriers have been afforded a degree of pricing flexibility in setting access charges where adequate competition exists, and the FCC is considering certain proposals which would relax further local exchange carriers access regulation. Under interim rate structures adopted by the FCC, projected access charges for AT&T, and possibly other large interexchange carriers, would decrease while access charges for smaller interexchange carriers, including the Company, would increase. While the outcome of these proceedings is uncertain, should the FCC adopt permanent access charge rules along the lines of the interim structures it has allowed to take effect, it could place the smaller interexchange carriers, such as the Company, at a cost disadvantage, thereby adversely affecting their ability to compete with AT&T and larger interexchange carriers.\nThe FCC had previously required local exchange carriers to allow ''collocation'' of CAPs in or near the central office switching areas of the local exchange carriers, to enable such CAPs to provide transport service between a local exchange carrier's central office switch and an interexchange carrier's point-of-presence or end user location. However, a 1995 decision of the Federal Court of Appeals struck down the FCC's Order as beyond its statutory authority. The FCC has replaced the requirement of ''collocation'' with a requirement of ''virtual collocation,'' which similarly expands the authority and ability of CAPs to provide competing transport service. The recently enacted Telecommunications Act of 1996 provides the FCC with additional statutory authority to mandate collocation.\nIn addition to its status as an access customer, the Company is now an access provider in connection with its provision of local telephone service in upstate New York. Under the Telecommunications Act of 1996, the Company may become subject to many of the same obligations to which the RBOCs and other telecommunications providers are subject in their provision of local exchange services, such as resale, dialing parity and reciprocal compensation.\nSTATE\nThe Company's intrastate long distance operations are subject to various state laws and regulations including, in most jurisdictions, certification and tariff filing requirements. The Company provides long distance service in all or some portion of 40 states and has received the necessary certificate and tariff approvals to provide intrastate long distance service in 44 states. All states today allow some form of intrastate telecommunications competition. However, some states restrict or condition the offering of intrastate\/intra-LATA long distance services by the Company and other interexchange carriers. In the majority of those states that do permit interexchange carriers to offer intra-LATA services, customers desiring to access those services are generally required to dial special access codes, which puts the Company at a disadvantage relative to the local exchange carrier's intrastate long distance service, which generally requires no such access code dialing. Increasingly, states are reexamining this policy and some states, such as New York, have ordered that this disadvantage be removed. The Telecommunications Act of 1996 requires local exchange companies to adopt ''intra-LATA equal access'' as a pre-condition for the local exchange carriers entering into the inter-LATA long distance business. Accordingly, it is expected that the dialing disparity for intra-LATA toll calls will be removed in the future. The Company expects to have ''equal access'', with respect to intra-LATA calls, for over 90% of its New York State subscribers by the end of 1996. Implementation in other states may take longer. Relevant state public service commissions (\"PSCs\") also regulate access charges and other pricing for telecommunications services within each state. The RBOCs and other local exchange carriers have been seeking reduction of state regulatory requirements, including greater pricing flexibility. This could adversely affect the Company in several ways. The regulated prices for intrastate access charges that the Company must pay could increase both relative to the charges paid by the largest interexchange carriers, such as AT&T, and in absolute terms as well. Additionally, the Company could face increased price competition from the RBOCs and other local exchange carriers for intra-LATA long distance services, which may also be increased by the removal of former restrictions on long distance service offerings by the RBOCs as a result of recently enacted legislation.\nNEW YORK STATE REGULATION OF LONG DISTANCE SERVICE. Beginning in 1992, the New York Public Service Commission (''NYPSC'') commenced several proceedings to investigate the manner in which local exchange carriers should be regulated. In July 1995, the NYPSC ordered the acceptance of a Performance Regulation Plan for New York Telephone. The terms of the plan, as ordered, included: (I) a limitation on increases in basic local rates for the 5-year term of the plan, (ii) implementation of intra-LATA equal access by no later than March 1996, (iii) reductions in the intrastate inter-LATA equal access charges which the Company and other interexchange carriers pay over the next five years totaling 33%, (iv) reductions in the intra-LATA toll rates charged to the end user customer over the next five years totaling 21%, and (v) an intercarrier compensation plan that reduced the rates paid by the competitive local exchange carriers (including the Company's subsidiaries) by one-half. New York Telephone does have some increased ability to restructure rates and to request rate reductions, but all rate changes are still subject to NYPSC approval. New York Telephone is also required to meet various service quality measurements, and will be subject to financial penalties for failure to meet these objectives.\nIn a manner similar to the FCC, the NYPSC has adopted revised rules governing the manner in which intrastate local transport elements of access charges are to be priced. These revisions accompanied its decision ordering local exchange carriers to permit ''collocation'' for intrastate special access and switched access transport services. In general, where CAPs have established interconnections at the switches of individual local exchange carriers, the local exchange carriers will be given expanded authority to enter into individually negotiated contracts with interexchange carriers for transport service. At the same time, the access charges to other interexchange carriers located at the same switching facilities generally will be lowered. If insufficient competition is present at that switching facility, the pre-existing intrastate ''equal price per unit of traffic'' rule will remain in effect. While the presence of switch interconnections may actually lower the price the Company may pay for local transport services, the ability of carriers that handle large traffic volumes, such as AT&T, to negotiate flat rate direct transport charges may result in the Company paying more per unit of traffic than its competitors for local transport service.\nNEW YORK STATE REGULATION OF LOCAL TELEPHONE SERVICE. The NYPSC has determined that it will allow competition in the provision of local telephone service in New York State, including ''alternate access,'' private line services and local switched services. The Company applied to the NYPSC for authority to provide such services, and received certifications in early 1994 to offer these services. The NYPSC has also authorized resale of local exchange services, which may allow significant market entry by large toll carriers such as AT&T and MCI.\nThe Company's ability to offer competing local services profitably will depend on a number of factors. For the Company to compete effectively against New York Telephone, Frontier Corp. and other local exchange carriers in the Company's upstate New York service areas, it must be able to interconnect with the network of local exchange carriers in the markets in which it plans to offer local services, obtain direct telephone number assignments and, in most cases, negotiate with those local exchange carriers for certain services such as leased lines, directory assistance and operator services on commercially acceptable terms. The order issued in the New York Telephone Performance Regulation Plan (described above) established prices for interconnection and required New York Telephone to tariff this service, making it generally available to all competitors, including the Company. The actual monies paid by the Company to New York Telephone for terminating the Company's traffic, and the monies received by the Company from New York Telephone for terminating New York Telephone traffic, are subject to NYPSC regulation and will depend upon the Company's compliance with certain service obligations imposed by the NYPSC, including the obligation to serve residential customers. The rates will also affect the Company's competitive position in the intra-LATA toll market relative to the local exchange carrier and major interexchange carriers such as AT&T and MCI, which may offer intra-LATA toll services. The NYPSC has also issued orders assuring local telephone service competitors access to number resources, listing in the local exchange carrier's directory and the right to reciprocal intercarrier compensation arrangements with the local exchange carriers, and also establishing interim rules under which competitive providers of local telephone service are entitled to comparable access to and inclusion in local telephone routing guides and access to the customer information of other carriers necessary for billing or other services. The Company has obtained number assignments in 12 upstate New York markets and has applications pending in 11 additional cities.\nThe NYPSC has also adopted interim rules that would subject competitive providers of local telephone service to a number of rules, service standards and requirements not previously applicable to ''nondominant'' competitors such as the Company. These rules include requirements involving ''open network architecture,'' provision of reasonable interconnection to competitors, and compliance with the NYPSC's service quality standards and consumer protection requirements. As part of its ''open network architecture'' obligations, the Company could be required to allow collocation with its local toll switch upon receipt of a bona fide request by an interexchange carrier or other carrier. Compliance with these rules in connection with the Company's provision of local telephone service may impose new and significant operating and administrative burdens on the Company. This proceeding will also determine the responsibilities of new local service providers with respect to subsidies inherent in existing local exchange carrier rates.\nUnder the Telecommunications Act of 1996, incumbent local exchange companies such as New York Telephone and Frontier must allow the resale of both bundled local exchange services (known as \"loops\") as well as unbundled local exchange \"elements\" (known as \"links\" and \"ports\"). The NYPSC is currently conducting a proceeding to establish rates for those services under pricing formulas set forth in the new federal legislation. The Company generally intends to provide local service through the resale of unbundled links rather than through the resale of bundled loops. Accordingly, the outcome of the NYPSC proceeding, including decisions regarding the pricing of bundled loops and unbundled links, could affect the Company's competitive standing as a local service provider in relation to larger companies, such as AT&T and MCI, which may initially enter the local service market through resale of bundled loops.\nLOCAL TELEPHONE SERVICE IN MASSACHUSETTS. The Massachusetts Department of Public Utilities (''DPU'') has initiated a docket (currently in its briefing stages) to determine the format for local competition in that state. The format appears to be similar to the structure developing in New York State. Pending the outcome of this proceeding, the DPU is allowing companies to apply for certification as local exchange carriers and to begin operations under interim agreements. The Company is in the process of applying for certification.\nThe Company's ability to construct and operate competitive local service networks for both local private line and switched services will depend upon, among other things, implementation of the structural market reforms discussed above, favorable determinations with respect to obligations by the state and federal regulators, and the satisfactory implementation of interconnection with the local exchange carriers.\nCANADA\nLong distance telecommunications services in Canada generally are subject to regulation by the CRTC. As a result of significant regulatory changes during the past several years, the historical monopolies for long distance service granted to regional telephone companies in Canada have been terminated. This has resulted in a significant increase in competition in the Canadian long distance telecommunications industry. In addition to the proceedings referred to below, the CRTC continues to take steps toward increased competition, including proceedings relating to the convergence between telecommunications and broadcasting.\nCRTC DECISIONS. In March 1990, the CRTC for the first time permitted non-facilities-based carriers, such as ACC Canada, to aggregate the traffic of customers on the same leased interexchange circuits in order to provide discounted long distance voice services in the provinces of Ontario, Quebec and British Columbia. In September 1990, the CRTC also authorized carriers in addition to members of the Stentor consortium to interconnect their transmission facilities with the Message Toll Service (''MTS'') facilities of Teleglobe Canada, for the purpose of allowing resellers, such as ACC Canada, to resell international long distance MTS service. Prior to this decision, Bell Canada and other members of Stentor were the exclusive long distance carriers interconnected to Teleglobe Canada's MTS facilities.\nIn December 1991, the CRTC permitted the resale on a joint-use basis of the international private line services of Teleglobe Canada to provide interconnected voice services. Resellers are subject to charges levied by Teleglobe Canada for the use of its facilities and contribution charges payable to Teleglobe Canada and remitted to the telephone companies. In September 1993, the CRTC allowed Teleglobe Canada to restructure its overseas MTS to allow domestic service providers (including resellers) who commit to a minimum level of usage to interconnect with Teleglobe Canada's international network at its gateways for the purpose of providing outbound direct-dial telephone service. Overseas inbound traffic would be allocated to Stentor and other domestic service providers (including resellers) in proportion to their outbound market shares.\nIn February 1996, the CRTC introduced a regime of price regulation for Teleglobe Canada's services to be in effect from April 1996 to December 1999, barring any exceptional changes to Teleglobe Canada's operating environment. Under this regime, Teleglobe Canada must reduce prices on an annual basis for its telephone and Globeaccess VPN Services, and must adhere to a price ceiling for most of its regulated non-telephone services. These rate reductions will have the effect of reducing the price the Company can charge its customers. The Canadian federal government is currently conducting a review to determine whether to extend Teleglobe Canada's status as the monopoly transmission facilities-based provider of Canada-overseas telecommunications services beyond March 1997.\nIn June 1992, the CRTC effectively removed the monopoly rights of certain Stentor member companies with respect to the provision of transmission facilities-based long distance voice services in the territories in which they operate and opened the provision of these services to substantial competition in all provinces of Canada other than Alberta, Saskatchewan and Manitoba. Competition has subsequently been introduced in Alberta and Manitoba, which are subject to CRTC regulation, and Saskatchewan, which has not yet become subject to CRTC regulation. Among other things, the CRTC also directed the telephone companies that were subject to this decision to provide Unitel with ''equal ease of access,'' I.E., to allow Unitel to directly connect its network to the telephone companies' toll and end office switches to allow Unitel's customers to make long distance calls without dialing extra digits. In July 1993, the CRTC ordered the same telephone companies to provide resellers with equal ease of access upon payment of contribution, network modification and ongoing access charges on the same general basis as for transmission facilities-based carriers.\nAt the same time, the CRTC also required telephone company competitors to assume certain financial obligations, including the payment of ''contribution charges'' designed to ensure that each long distance carrier bears a fair proportion of the subsidy that long distance services have traditionally contributed to the provision of local telephone service. As a result, contribution charges payable by resellers were increased. These charges are levied on resellers as a monthly charge on leased access lines. The charges vary for each telephone company based on that company's estimated loss on local services. Contribution charges were reduced by a discount which was initially 25%, and which declines over time to zero in 1998. Resellers whose access lines were connected only to end offices on a non-equal access basis initially paid contribution charges of 65% of the equal access contribution rates, rising over a five-year period to an 85% rate thereafter. The CRTC also established a mechanism under which contribution rates will be re-examined on a yearly basis. In March 1995, the CRTC decreased the contribution charges required to be paid by alternate long distance service providers to the local telephone companies, and made such decreases retroactive to January 1, 1994. Contribution charges payable to Bell Canada were reduced by 23%, and those payable to BC Tel by 13%.\nTransmission facilities-based competitors and resellers that obtained equal ease of access also assumed approximately 30% of the estimated Cdn. $240 million cost required to modify the telephone companies' networks to accommodate interconnection with competitors as well as a portion of the ongoing costs of the telephone companies to provide such interconnection. Initial modification charges are spread over a period of 10 years. These charges and costs are payable on the basis of a specified charge per minute.\nIn December 1993, the CRTC gave permission to Bell Canada to file proposed tariffs for local rates for business customers--including resellers--which would make rates dependent on the number of outgoing calls made. Outgoing calls exceeding a threshold would be charged on a per- minute basis. The threshold would not apply to the customer's incoming traffic. The threshold would vary by rate group bands to take into account usage differences. Bell Canada has recently filed proposed tariffs which would give business customers the option of choosing local measured service or flat rate service.\nAs contemplated in the CRTC's June 1992 decision, initial implementation of single carrier 800 number portability occurred in Canada in January 1994 and 800 number multi-carrier selection capability has recently been approved on an interim basis.\nIn April 1994, the CRTC initiated a proceeding to consider whether there should be a balloting process to permit customers to select a long distance service provider. In June 1995, the CRTC rejected the proposal for a balloting process. However, in August 1994, it directed the major telephone companies to include a customer bill insert from the CRTC during the fall of 1994 providing a message about equal access and the customers' ability to select an alternate toll service provider.\nIn July 1994, the CRTC modified the rules governing the consideration of new toll services to be offered by telephone companies and of rate reductions for their existing services to require the telephone companies to show that the revenues (or the average revenue per minute) for each service equal or exceed the sum of causal costs and contribution amounts for the service.\nIn November 1994, the CRTC varied certain elements of its Phase III costing procedures. These procedures are used to enable the CRTC to identify the costs and revenues of the dominant telephone companies associated with various categories of their services, in order, among other things, to identify the extent and nature of any cross-subsidies which may exist among those categories. The net effect of these Phase III changes was to lower contribution payments.\nIn September 1994, the CRTC established substantial changes to Canadian telecommunications regulation, including: (I) initiation of a program of rate rebalancing, which would entail three annual increases of Cdn. $2 per month in rates for local service, with corresponding decreases in rates for basic toll service, and an indication from the CRTC that there would be no price changes which would result in an overall price increase for North American basic toll schedules combined; (ii) the telephone companies' monopoly local and access services, including charges for bottleneck services (i.e., essential services which competitors are required to obtain from Stentor members) provided to competitors (the Utility segment), would remain in the regulated rate base, and the CRTC would replace earnings regulation for the Utility segment with price caps effective January 1, 1998; (iii) other services (the Competitive segment) would not be subject to earnings regulation after January 1, 1995, after which a Carrier Access Tariff would become effective, which would include charges for contribution, start-up cost recovery and bottleneck services and would be applicable to the telephone companies' and competitors' traffic based on a per minute calculation, rather than the per trunk basis previously used to calculate contribution charges; (iv) while the CRTC considered it premature to forbear from regulating interexchange services, it considered that the framework set forth in the decision may allow forbearance in the future (such forbearance has subsequently occurred in the case of certain non-dominant transmission facilities-based carriers and certain telephone company services); (v) the CRTC concluded that barriers to entry should be reduced for the local service market, including basic local telephone service and switched network alternatives, and has subsequently initiated proceedings to implement unbundled tariffs, co- location of facilities and local number portability; and (vi) the intention to consider applying contribution charges to other services using switched access, not only to long distance voice services.\nChanges to these matters that were announced in October 1995 were the following: (I) rate rebalancing, with Cdn. $2 per month local rate increases commencing in each of January 1996 and January 1997 and another unspecified increase in 1998 (the contribution component of the Carrier Access Tariff is to be reduced correspondingly, but a corresponding reduction of basic North American long distance rates ordered by the CRTC was reversed by the Federal Cabinet in December 1995); (ii) reductions in contribution charges effective January 1, 1995, with contribution charges payable to Bell Canada reduced from 1994 levels by 16%, and those payable to BC Tel by 27%; (iii) changes to the costing methodology of the telephone companies including (a) the establishment of strict rules governing telephone company investments in competitive services involving broadband technology, (b) the requirement that the Competitive segment pay its fair share of joint costs incurred by both the Utility and Competitive segments, and (c) a directive specifying that revenues for many unbundled items must be allocated to the Utility segment thereby reducing the local shortfall and therefore contribution charges; (iv) directory operations of the telephone companies will continue to remain integral to the Utility segment, meaning that revenues from directory operations will continue to be assigned to the Utility segment to help reduce the local shortfall and therefore contribution payments; and (v) Stentor's request to increase the allowed rate of return of the Utility segment was denied and the CRTC restated its intention to retain the fifty basis point downward adjustment to the total company rate of return used to derive the Utility segment rates of return for the telephone companies.\nIn December 1995, the CRTC announced that the per trunk basis for calculating contribution charges would be replaced by a per minute basis for calculating contribution charges starting June 1, 1996. The off-peak contribution rate will be one-half the peak rate, with the peak rate applicable between 8 a.m. and 5 p.m., Monday through Friday. The Company expects that, based on existing and anticipated regulations and rulings, its Canadian contribution charges will increase by up to approximately Cdn. $2 million in 1997 over 1995 levels, which the Company will seek to offset with increased volume efficiencies.\nThe Company cannot predict the timing or the outcome of any of the pending and ongoing proceedings described above, or the impact they may have on the competitive position of ACC Canada.\nTELECOMMUNICATIONS ACT. In October 1993, the Telecommunications Act replaced the Railway Act (Canada) as the principal telecommunications regulatory statute in Canada. This Act provides that all federally- regulated telecommunications common carriers as defined therein (essentially all transmission facilities-based carriers) are under the regulatory jurisdiction of the CRTC. It also gives the federal government the power to issue directions to the CRTC on broad policy matters. The Act does not subject non-facilities-based carriers, such as ACC Canada, to foreign ownership restrictions, tariff filing requirements or other regulatory provisions applicable to facilities-based carriers. However, to the extent that resellers acquire their own facilities in order to better control the carriage and routing of their traffic, certain provisions of this Act may be applicable to them.\nUNITED KINGDOM\nUntil 1981, British Telecom was the sole provider of public telecommunications services throughout the U.K. This monopoly ended when, in 1981, the British government granted Mercury a license to run its own telecommunications system under the British Telecommunications Act 1981. Both British Telecom and Mercury are licensed under the subsequent Telecommunications Act 1984 to run transmission facilities-based telecommunications systems and provide telecommunications services. See the Risk Factors discussion of \"Dependence on Transmission Facilities-Based Carriers and Suppliers'' in this Item 1 below.\nIn 1991, the British government established a ''multi-operator'' policy to replace the duopoly that had existed between British Telecom and Mercury. Under the multi-operator policy, the U.K. Department of Trade and Industry (the ''DTI'') will recommend the grant of a license to operate a telecommunications network to any applicant that the DTI believes has a reasonable business plan and where there are no other overriding considerations not to grant such license. All public telecommunications operators and international simple resellers operate under individual licenses granted by the Secretary of State for Trade and Industry pursuant to the Telecommunications Act 1984. Any telecommunications system with compatible equipment that is authorized to be run under an individual license granted under this Act is permitted to interconnect to British Telecom's network. Under the terms of British Telecom's license, it is required to allow any such licensed operator to interconnect its system to British Telecom's system, unless it is not reasonably practicable to do so (E.G., due to incompatible equipment).\nOftel has imposed mandatory price reductions on British Telecom which are expected to continue through at least 1997 and this has had, and may have, the effect of reducing the prices the Company can charge its customers in order to remain competitive.\nACC U.K. was granted an ISR License in September 1992 by the DTI and, for a period of approximately 18 months thereafter, was involved in protracted negotiations with British Telecom concerning the terms and conditions under which it could interconnect its leased line network and switching equipment with British Telecom's network. The ISR License allows the Company to offer domestic and international long distance services via connections to the PSTN of certain originating and terminating countries at favorable leased-line rates, rather than per call international settlement rates. Over time, larger carriers will be able to match the Company's rates because they also have, or are expected to obtain, international simple resale licenses. The DTI has, to date, designated the U.K., the U.S., Canada, Australia, Sweden, New Zealand and Finland for international simple resale traffic. The designation of a country by the DTI implies that the DTI has determined that the designated country has an equivalent regulatory framework that would permit the receipt of terminating traffic. In some cases, legislative approval of the extension of the ISR License by the designated country may be required. The Company presently utilizes the license primarily for traffic between the U.K., the U.S. and Canada.\nACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES\nAs the Company expands its service offerings, geographic focus and its network, the Company anticipates that it will seek to acquire assets and businesses of, make investments in or enter into strategic alliances with, companies providing services complementary to ACC's existing business. The Company believes that, as the global telecommunications marketplace becomes increasingly competitive, expands and matures, such transactions will be critical to maintaining a competitive position in the industry.\nThe Company's ability to effect acquisitions and strategic alliances and make investments may be dependent upon its ability to obtain additional financing and, to the extent applicable, consents from the holders of debt and preferred stock of the Company. While the Company may in the future pursue an active strategic alliance, acquisition or investment policy, no specific strategic alliances, acquisitions or investments are currently in negotiation and the Company has no immediate plans to commence such negotiations. If the Company were to proceed with one or more significant strategic alliances, acquisitions or investments in which the consideration consists of cash, a substantial portion of the Company's available cash could be used to consummate the acquisitions or investments. If the Company were to consummate one or more significant strategic alliances, acquisitions or investments in which the consideration consists of stock, shareholders of the Company could suffer a significant dilution of their interests in the Company.\nMany business acquisitions must be accounted for as purchases. Most of the businesses that might become attractive acquisition candidates for the Company are likely to have significant goodwill and intangible assets, and the acquisitions of these businesses, if accounted for as a purchase, would typically result in substantial amortization charges to the Company. In the event the Company consummates additional acquisitions in the future that must be accounted for as purchases, such acquisitions would likely increase the Company's amortization expenses. In connection with acquisitions, investments or strategic alliances, the Company could incur substantial expenses, including the fees of financial advisors, attorneys and accountants, the expenses of integrating the business of the acquired company or the strategic alliance with the Company's business and any expenses associated with registering shares of the Company's capital stock, if such shares are issued. The financial impact of such acquisitions, investments or strategic alliances could have a material adverse effect on the Company's business, financial condition and results of operations and could cause substantial fluctuations in the Company's quarterly and yearly operating results. See the Risk Factor discussion of \"Substantial Indebtedness; Need for Additional Capital'' in this Item 1 below and ''Management's Discussion and Analysis of Financial Condition and Results of Operations'' in Item 7 of this Report.\nEMPLOYEES\nAs of December 31, 1995, the Company had 631 full-time employees worldwide. Of this total, 222 employees were in the U.S., 266 were in Canada and 143 were in the U.K. The Company has never experienced a work stoppage and its employees are not represented by a labor union or covered by a collective bargaining agreement. The Company considers its employee relations to be good.\nRISK FACTORS\nRECENT LOSSES; POTENTIAL FLUCTUATIONS IN OPERATING RESULTS\nAlthough the Company has recently experienced revenue growth on an annual basis, it has incurred net losses and losses from continuing operations during each of its last two fiscal years. The 1995 net loss of $5.4 million resulted primarily from the expansion of operations in the U.K. (approximately $6.8 million), increased net interest expense associated with additional borrowings (approximately $4.9 million), increased depreciation and amortization from the addition of equipment and costs associated with the expansion of local service in New York State (approximately $1.6 million) and management restructuring costs (approximately $1.3 million), offset by positive operating income from the U.S. and Canadian long distance subsidiaries of approximately $9.0 million. The 1994 net loss of $11.3 million resulted primarily from operating losses due to expansion in the U.K. (approximately $5.6 million), the recording of the valuation allowance against deferred tax benefits (approximately $3.0 million), implementation of equal access in Canada (approximately $2.2 million) and operating losses due to expansion in local telephone service in the U.S. (approximately $0.9 million). There can be no assurance that revenue growth will continue or that the Company will achieve profitability in the future. The Company intends to focus in the near term on the expansion of its service offerings, including its local telephone business, and geographic markets, which may adversely affect cash flow and operating performance. As each of the telecommunications markets in which the Company operates continues to mature, growth in the Company's revenues and customer base is likely to decrease over time.\nThe Company's operating results have fluctuated in the past and may fluctuate significantly in the future as a result of a variety of factors, some of which are outside of the Company's control, including general economic conditions, specific economic conditions in the telecommunications industry, the effects of governmental regulation and regulatory changes, user demand, capital expenditures and other costs relating to the expansion of operations, the introduction of new services by the Company or its competitors, the mix of services sold and the mix of channels through which those services are sold, pricing changes and new service introductions by the Company and its competitors and prices charged by suppliers. As a strategic response to a changing competitive environment, the Company may elect from time to time to make certain pricing, service or marketing decisions or enter into strategic alliances, acquisitions or investments that could have a material adverse effect on the Company's business, results of operations and cash flow. The Company's sales to other long distance companies have been increasing. Because these sales are at margins that are lower than those derived from most of the Company's other revenues, this increase may reduce the Company's gross margins as a percentage of revenue. In addition, to the extent that these and other long distance carriers are less creditworthy, such sales may represent a higher credit risk to the Company. See the Risk Factor discussion below of \"Risks Associated With Acquisitions, Investments and Strategic Alliances'' in this Item 1 and ''Management's Discussion and Analysis of Financial Condition and Results of Operations'' in Item 7 of this Report.\nSUBSTANTIAL INDEBTEDNESS; NEED FOR ADDITIONAL CAPITAL\nThe Company will need to continue to enhance and expand its operations in order to maintain its competitive position, expand its service offerings and geographic markets and continue to meet the increasing demands for service quality, availability and competitive pricing. As of the end each of its last five fiscal years, the Company has experienced a working capital deficit. During 1995, the Company's income from operations plus depreciation and amortization (\"EBITDA\") minus capital expenditures and changes in working capital was $(7.0) million. The Company is highly leveraged. The Company's leverage may adversely affect its ability to raise additional capital. In addition, the Company's indebtedness requires significant repayments over the next five years. The Company may need to raise additional capital from public or private equity or debt sources in order to finance its anticipated growth, including local service expansion, which is capital intensive, working capital needs, debt service obligations, contemplated capital expenditures and the optional redemption of the Series A Preferred Stock if it is not converted. In addition, the Company may need to raise additional funds in order to take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of, investments in or strategic alliances with companies that are complementary to the Company's current operations, or to develop new products or otherwise respond to unanticipated competitive pressures. If additional funds are raised through the issuance of equity securities, the percentage ownership of the Company's then current shareholders would be reduced and, if such equity securities take the form of Preferred Stock or Class B Common Stock, the holders of such Preferred Stock or Class B Common Stock may have rights, preferences or privileges senior to those of the holders of Class A Common Stock. There can be no assurance that the Company will be able to raise such capital on satisfactory terms or at all. If the Company decides to raise additional funds through the incurrence of debt, the Company would need to obtain the consent of its lenders under its revolving credit facility with First Union National Bank of North Carolina and Fleet Bank of Connecticut (formerly Shawmut Bank Connecticut, N.A.), as agents (the ''Agents''), which expires on July 1, 2000 (the ''Credit Facility'') and would likely become subject to additional or more restrictive financial covenants. In the event that the Company is unable to obtain such additional capital or is unable to obtain such additional capital on acceptable terms, the Company may be required to reduce the scope of its presently anticipated expansion, which could materially adversely affect its business, results of operations and financial condition and its ability to compete. See ''Management's Discussion and Analysis of Financial Condition and Results of Operation-Liquidity and Capital Resources'' in Item 7 of this Report.\nDEPENDENCE ON TRANSMISSION FACILITIES-BASED CARRIERS AND SUPPLIERS\nThe Company does not own telecommunications transmission lines. Accordingly, telephone calls made by the Company's customers are connected through transmission lines that the Company leases under a variety of arrangements with transmission facilities-based long distance carriers, some of which are or may become competitors of the Company, including AT&T, Bell Canada and British Telecom. Most inter-city transmission lines used by the Company are leased on a monthly or longer-term basis at rates that currently are less than the rates the Company charges its customers for connecting calls through these lines. Accordingly, the Company is vulnerable to changes in its lease arrangements, such as price increases and service cancellations. ACC's ability to maintain and expand its business is dependent upon whether the Company continues to maintain favorable relationships with the transmission facilities-based carriers from which the Company leases transmission lines, particularly in the U.K., where British Telecom and Mercury are the two principal, dominant carriers. The Company's U.K. operations are highly dependent upon the transmission lines leased from British Telecom. The Company generally experiences delays in billings from British Telecom and needs to reconcile billing discrepancies with British Telecom before making payment. Although the Company believes that its relationships with carriers generally are satisfactory, the deterioration in or termination of the Company's relationships with one or more of those carriers could have a material adverse effect upon the Company's business, results of operations and financial condition. Certain of the vendors from whom the Company leases transmission lines, including from the 22 RBOCs and other local exchange carriers, currently are subject to tariff controls and other price constraints which in the future may be changed. Under recently enacted U.S. legislation, constraints on the operations of the RBOCs have been dramatically reduced, which will bring additional competitors to the long distance market. In addition, regulatory proposals are pending that may affect the prices charged by the RBOCs and other local exchange carriers to the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. See the Risk Factor discussion of \"Potential Adverse Effects of Regulation'' below and the discussion of \"Regulation'' above in this Item 1. The Company currently acquires switches used in its North American operations from one vendor. The Company purchases switches from such vendor for its convenience and switches of comparable quality may be obtained from several alternative suppliers. However, a failure by a supplier to deliver quality products on a timely basis, or the inability to develop alternative sources if and as required, could result in delays which could have a material adverse effect on the Company's business, results of operations and financial condition.\nPOTENTIAL ADVERSE EFFECTS OF REGULATION\nLegislation that substantially revises the U.S. Communications Act was signed into law on February 8, 1996. The legislation provides specific guidelines under which the RBOCs can provide long distance services and will permit the RBOCs to compete with the Company in the provision of domestic and international long distance services. The legislation opens all local service markets to competition from any entity (including long distance carriers, such as AT&T, cable television companies and utilities). Because the legislation opens the Company's markets to additional competition, particularly from the RBOCs, the Company's ability to compete is likely to be adversely affected. Moreover, as a result of and to implement the legislation, certain federal and other governmental regulations will be amended or modified, and any such amendment or modification could have a material adverse effect on the Company's business, results of operations and financial condition.\nIn the U.S., the FCC and relevant state PSCs have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities, and the terms and conditions under which the Company's services are provided. Federal and state regulations and regulatory trends have had, and in the future are likely to have, both positive and negative effects on the Company and its ability to compete. The recent trend in both Federal and state regulation of telecommunications service providers has been in the direction of lessened regulation. In general, neither the FCC nor the relevant state PSCs currently regulate the Company's long distance rates or profit levels, but either or both may do so in the future. However, the general recent trend toward lessened regulation has also given AT&T, the largest long distance carrier in the U.S., increased pricing flexibility that has permitted it to compete more effectively with smaller interexchange carriers, such as the Company. There can be no assurance that changes in current or future Federal or state regulations or future judicial changes would not have a material adverse effect on the Company.\nIn order to provide their services, interexchange carriers, including the Company, must generally purchase ''access'' from local exchange carriers to originate calls from and terminate calls in the local exchange telephone networks. Access charges presently represent a significant portion of the Company's network costs in all areas in which it operates. In the U.S., access charges generally are regulated by the FCC and the relevant state PSCs. Under the terms of the AT&T Divestiture Decree, a court order entered in 1982 which, among other things, required AT&T to divest its 22 wholly-owned RBOCs from its long distance division, the RBOCs were required to price the ''local transport'' portion of such access charges on an ''equal price per unit of traffic'' basis. In November 1993, the FCC implemented new interim rules governing local transport access charges while the FCC considers permanent rules regarding new rate structures for transport pricing and switched access competition. These interim rules have essentially maintained the ''equal price per unit of traffic'' rule. However, under alternative access charge rate structures being considered by the FCC, local exchange carriers would be permitted to allow volume discounts in the pricing of access charges. If these rate structures are adopted, access charges for AT&T and other large interexchange carriers would decrease, and access charges for small interexchange carriers would increase. While the outcome of these proceedings is uncertain, should the FCC adopt permanent access charge rules along the lines of the proposed structures it is currently considering, the Company would be at a cost disadvantage with regard to access charges in comparison to AT&T and larger interexchange carrier competitors.\nThe Company currently competes with the RBOCs and other local exchange carriers in the provision of ''short haul'' toll calls completed within a LATA, and will in the future, under provisions of recently enacted federal legislation, compete with such carriers in the long-haul, or inter-LATA, toll business. To complete long-haul and short-haul toll calls, the Company must purchase ''access'' from the local exchange carriers. The Company must generally price its toll services at levels equal to or below the retail rates established by the local exchange carriers for their own short-haul or long-haul toll rates. To the extent that the local exchange carriers are able to reduce the margin between the access costs to the Company and the retail toll prices charged by local exchange carriers, either by increasing access costs or lowering retail toll rates, or both, the Company will encounter adverse pricing and cost pressures in competing against local exchange carriers in both the short-haul and long-haul toll markets.\nIn Canada, services provided by ACC Canada are subject to or affected by certain regulations of the CRTC. The CRTC annually reviews the ''contribution charges'' (the equivalent of access charges in the U.S.) it has assessed against the access lines leased by Canadian long distance resellers, including the Company, from the local telephone companies in Canada. The Company expects that, based on existing regulations and rulings, its Canadian contribution charges will increase by approximately Cdn. $1.5 million in 1997 over 1995 levels. Additional increases in these contribution charges could have a material adverse effect on the Company's business, results of operations and financial condition. The Canadian long distance telecommunications industry is the subject of ongoing regulatory change. These regulations and regulatory decisions have a direct and material effect on the ability of the Company to conduct its business. The recent trend of such regulations has been to open the market to commercial competition, generally to the Company's benefit. There can be no assurance, however, that any future changes in or additions to laws, regulations, government policy or administrative rulings will not have a material adverse effect on the Company's business, results of operation and financial condition.\nThe telecommunications services provided by ACC U.K. are subject to and affected by regulations introduced by Oftel. Since the break up of the U.K. telecommunications duopoly consisting of British Telecom and Mercury in 1991, it has been the stated goal of Oftel to create a competitive marketplace from which detailed regulation could eventually be withdrawn. The regulatory regime currently being introduced by Oftel has a direct and material effect on the ability of the Company to conduct its business. Although the Company is optimistic about its ability to continue to compete effectively in the U.K. market, there can be no assurance that future changes in regulation and government will not have a material adverse effect on the Company's business, results of operations and financial condition. See the discussion \"Business-Regulation'' above in this Item 1.\nINCREASING DOMESTIC AND INTERNATIONAL COMPETITION\nThe long distance telecommunications industry is highly competitive and is significantly influenced by the marketing and pricing decisions of the larger industry participants. The industry has relatively insignificant barriers to entry, numerous entities competing for the same customers and high churn rates (customer turnover), as customers frequently change long distance providers in response to the offering of lower rates or promotional incentives by competitors. In each of its markets, the Company competes primarily on the basis of price and also on the basis of customer service and its ability to provide a variety of telecommunications services. The Company expects competition on the basis of price and service offerings to increase. Although many of the Company's university customers are under multi-year contracts, several of the Company's largest customers (primarily other long distance carriers) are on month-to-month contracts and are particularly price sensitive. Revenues from other resellers accounted for approximately 22%, 7% and 9% of the revenues of ACC U.S., ACC Canada and ACC U.K., respectively, in 1995, and are expected to account for a higher percentage in the future. With respect to these customers, the Company competes almost exclusively on price.\nMany of the Company's existing competitors are significantly larger, have substantially greater financial, technical and marketing resources and larger networks than the Company, control transmission lines and have long- standing relationships with the Company's target customers. These competitors include, among others, AT&T, MCI and Sprint in the U.S.; Bell Canada, BC Telecom, Inc., Unitel and Sprint Canada (a subsidiary of Call- Net Telecommunications Inc.) in Canada; and British Telecom, Mercury, AT&T and WorldCom in the U.K. Other U.S. carriers are also expected to enter the U.K. market. The Company also competes with numerous other long distance providers, some of which focus their efforts on the same business customers targeted by the Company and selected residential customers and colleges and universities, the Company's other target customers. In addition, through its local telephone service business in upstate New York, the Company competes with New York Telephone, Frontier Corp., Citizens Telephone Co., MFS and Time Warner Cable and others, including cellular and other wireless providers. Furthermore, the recently announced joint venture between MCI and Microsoft, under which Microsoft will promote MCI's services, the recently announced joint venture among Sprint, Deutsche Telekom AG and France Telecom, and other strategic alliances, could also increase competitive pressures upon the Company and have a material adverse effect on the Company's business, results of operations and financial condition.\nIn addition to these competitive factors, recent and pending deregulation in each of the Company's markets may encourage new entrants. For example, as a result of legislation recently enacted in the U.S., RBOCs will be allowed to enter the long distance market, AT&T, MCI and other long distance carriers will be allowed to enter the local telephone services market, and any entity (including cable television companies and utilities) will be allowed to enter both the local service and long distance telecommunications markets. In addition, the FCC has, on several occasions since 1984, approved or required price reductions by AT&T and, in October 1995, the FCC reclassified AT&T as a ''non-dominant'' carrier, which substantially reduces the regulatory constraints on AT&T. As the Company expands its geographic coverage, it will encounter increased competition. Moreover, the Company believes that competition in non-U.S. markets is likely to increase and become more similar to competition in the U.S. markets over time as such non-U.S. markets continue to experience deregulatory influences. Prices in the long distance industry have declined from time to time in recent years and, as competition increases in Canada and the U.K., prices are likely to continue to decrease. For example, Bell Canada substantially reduced its rates during the first quarter of 1994. The Company's competitors may reduce rates or offer incentives to existing and potential customers of the Company. To maintain its competitive position, the Company believes that it must be able to reduce its prices in order to meet reductions in rates, if any, by others. See ''Management's Discussion and Analysis of Financial Condition and Results of Operations'' in Item 7 of this Report and the discussion ''Business-Competition'' above in this Item 1.\nThe Company has only limited experience in providing local telephone services, having commenced providing such services in 1994, and, although the Company believes the local business will enhance its ability to compete in the long distance market, to date the Company has experienced an operating cash flow deficit in the operation of that business in the U.S. on a stand-alone basis. The Company's revenues from local telephone services in 1995 were $1.35 million. In order to attract local customers, the Company must offer substantial discounts from the prices charged by local exchange carriers and must compete with other alternative local companies that offer such discounts. The local telephone service business requires significant initial investments in capital equipment as well as significant initial promotional and selling expenses. Larger, better capitalized alternative local providers, including AT&T and Time Warner Cable, among others, will be better able to sustain losses associated with discount pricing and initial investments and expenses. There can be no assurance that the Company will achieve positive cash flow or profitability in its local telephone service business.\nRISKS OF GROWTH AND EXPANSION\nThe Company plans to expand its service offerings and principal geographic markets in the United States, Canada and the United Kingdom. In addition, the Company may establish a presence in deregulating Western European markets that have high density telecommunications traffic, such as France and Germany, when the Company believes that business and regulatory conditions warrant. There can be no assurance that the Company will be able to add service or expand its markets at the rate presently planned by the Company or that the existing regulatory barriers will be reduced or eliminated. The Company's rapid growth has placed, and in the future may continue to place, a significant strain on the Company's administrative, operational and financial resources and increased demands on its systems and controls. As the Company increases its service offerings and expands its targeted markets, there will be additional demands on the Company's customer support, sales and marketing and administrative resources and network infrastructure. There can be no assurance that the Company's operating and financial control systems and infrastructure will be adequate to maintain and effectively monitor future growth. The failure to continue to upgrade the administrative, operating and financial control systems or the emergence of unexpected expansion difficulties could materially adversely affect the Company's business, results of operations and financial condition.\nRISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS\nA key component of the Company's strategy is its planned expansion in international markets. To date, the Company has only limited experience in providing telecommunications service outside the United States and Canada. There can be no assurance that the Company will be able to obtain the capital it requires to finance its expansion in international markets on satisfactory terms or at all. In many international markets, protective regulations and long-standing relationships between potential customers of the Company and their local providers create barriers to entry. Pursuit of international growth opportunities may require significant investments for an extended period before returns, if any, on such investments are realized. In addition, there can be no assurance that the Company will be able to obtain the permits and operating licenses required for it to operate, to hire and train employees or to market, sell and deliver high quality services in these markets. In addition to the uncertainty as to the Company's ability to expand its international presence, there are certain risks inherent in doing business on an international level, such as unexpected changes in regulatory requirements, tariffs, customs, duties and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political risks, fluctuations in currency exchange rates, foreign exchange controls which restrict or prohibit repatriation of funds, technology export and import restrictions or prohibitions, delays from customs brokers or government agencies, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world and potentially adverse tax consequences resulting from operating in multiple jurisdictions with different tax laws, which could materially adversely impact the success of the Company's international operations. In many countries, the Company may need to enter into a joint venture or other strategic relationship with one or more third parties in order to successfully conduct its operations. As its revenues from its Canadian and U.K. operations increase, an increasing portion of the Company's revenues and expenses will be denominated in currencies other than U.S. dollars, and changes in exchange rates may have a greater effect on the Company's results of operations. There can be no assurance that such factors will not have a material adverse effect on the Company's future operations and, consequently, on the Company's business, results of operations and financial condition. In addition, there can be no assurance that laws or administrative practices relating to taxation, foreign exchange or other matters of countries within which the Company operates will not change. Any such change could have a material adverse effect on the Company's business, financial condition and results of operations.\nDEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS\nTo complete its billing, the Company must record and process massive amounts of data quickly and accurately. While the Company believes its management information system is currently adequate, it has not grown as quickly as the Company's business and substantial investments are needed. The Company has made arrangements with a consultant and a vendor for the development of new information systems and has budgeted approximately $6.0 million for this purpose in 1996. The Company believes that the successful implementation and integration of these new information systems is important to its continued growth, its ability to monitor costs, to bill customers and to achieve operating efficiencies, but there can be no assurance that the Company will not encounter delays or cost overruns or suffer adverse consequences in implementing the systems. A vendor of the Company's software, which formerly was an affiliate of the Company, has a unique knowledge of certain of the Company's software and the Company may be dependent on the vendor for any modifications to the software. The Company believes that it currently is the only customer of the vendor and, as a result, the vendor is financially dependent on the Company. In addition, as the Company's suppliers revise and upgrade their hardware, software and equipment technology, there can be no assurance that the Company will not encounter difficulties in integrating the new technology into the Company's business or that the new systems will be appropriate for the Company's business. See the discussion ''Business-Information Systems'' above in this Item 1.\nRISKS ASSOCIATED WITH ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES\nAs part of its business strategy, the Company expects to seek to develop strategic alliances both domestically and internationally and to acquire assets and businesses or make investments in companies that are complementary to its current operations. As of the date of this Report, the Company has no present commitments or agreements with respect to any such strategic alliance, investment or acquisition. Any such future strategic alliances, investments or acquisitions would be accompanied by the risks commonly encountered in strategic alliances with or acquisitions of or investments in companies. Such risks include, among other things, the difficulty of assimilating the operations and personnel of the companies, the potential disruption of the Company's ongoing business, the inability of management to maximize the financial and strategic position of the Company by the successful incorporation of licensed or acquired technology and rights into the Company's service offerings, the maintenance of uniform standards, controls, procedures and policies and the impairment of relationships with employees and customers as a result of changes in management. In addition, the Company has experienced higher attrition rates with respect to customers obtained through acquisitions, and may continue to experience higher attrition rates with respect to any customers resulting from future acquisitions. Moreover, to the extent that any such acquisition, investment or alliance involved a business located outside the United States, the transaction would involve the risks associated with international expansion discussed above under \"Risks Associated with International Expansion.'' There can be no assurance that the Company would be successful in overcoming these risks or any other problems encountered with such strategic alliances, investments or acquisitions.\nIn addition, if the Company were to proceed with one or more significant strategic alliances, acquisitions or investments in which the consideration consists of cash, a substantial portion of the Company's available cash could be used to consummate the strategic alliances, acquisitions or investments. If the Company were to consummate one or more significant strategic alliances, acquisitions or investments in which the consideration consists of stock, shareholders of the Company could suffer a significant dilution of their interests in the Company. Many of the businesses that might become attractive acquisition candidates for the Company may have significant goodwill and intangible assets, and acquisitions of these businesses, if accounted for as a purchase, would typically result in substantial amortization charges to the Company. The financial impact of acquisitions, investments and strategic alliances could have a material adverse effect on the Company's business, financial condition and results of operations and could cause substantial fluctuations in the Company's quarterly and yearly operating results. See the discussion ''Business-Acquisitions, Investments and Strategic Alliances'' above in this Item 1.\nTECHNOLOGICAL CHANGES MAY ADVERSELY AFFECT COMPETITIVENESS AND FINANCIAL RESULTS\nThe telecommunications industry is characterized by rapid and significant technological advancements and introductions of new products and services utilizing new technologies. There can be no assurance that the Company will maintain competitive services or that the Company will obtain appropriate new technologies on a timely basis or on satisfactory terms.\nDEPENDENCE ON KEY PERSONNEL\nThe Company's success depends to a significant degree upon the continued contributions of its management team and technical, marketing and sales personnel. The Company's employees may voluntarily terminate their employment with the Company at any time. Competition for qualified employees and personnel in the telecommunications industry is intense and, from time to time, there are a limited number of persons with knowledge of and experience in particular sectors of the telecommunications industry. The Company's success also will depend on its ability to attract and retain qualified management, marketing, technical and sales executives and personnel. The process of locating such personnel with the combination of skills and attributes required to carry out the Company's strategies is often lengthy. The loss of the services of key personnel, or the inability to attract additional qualified personnel, could have a material adverse effect on the Company's results of operations, development efforts and ability to expand. There can be no assurance that the Company will be successful in attracting and retaining such executives and personnel. Any such event could have a material adverse effect on the Company's business, financial condition and results of operations.\nRISK ASSOCIATED WITH FINANCING ARRANGEMENTS; DIVIDEND RESTRICTIONS\nThe Company's financing arrangements are secured by substantially all of the Company's assets and require the Company to maintain certain financial ratios and restrict the payment of dividends, and the Company anticipates that it will not pay any dividends on Class A Common Stock in the foreseeable future. These financial arrangements will require the repayment of significant amounts and significant reductions in borrowing capacity thereunder during the next five years. The Company's secured lenders would be entitled to foreclose upon those assets in the event of a default under the financing arrangements and to be repaid from the proceeds of the liquidation of those assets before the assets would be available for distribution to the Company's other creditors and shareholders in the event that the Company is liquidated. In addition, the collateral security arrangements under the Company's existing financing arrangements may adversely affect the Company's ability to obtain additional borrowings or other capital. The Company may need to raise additional capital from equity or debt sources to finance its projected growth and capital expenditures contemplated. See the Risk Factor discussion above under ''Substantial Indebtedness; Need for Additional Capital'' and ''Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources'' in Item 7 of this Report.\nHOLDING COMPANY STRUCTURE; RELIANCE ON SUBSIDIARIES FOR DIVIDENDS\nACC Corp. is a holding company, the principal assets of which are its operating subsidiaries in the U.S., Canada and the U.K. ACC Canada, a 70% owned subsidiary of ACC Corp., is a public company listed on the Toronto Stock Exchange and the Montreal Stock Exchange. The ability of ACC Canada to declare and pay dividends is restricted by the terms of the agreement under which the Company's Series A Preferred Stock was issued. In addition, ACC Canada's ability to make other payments to ACC Corp. and its other subsidiaries may be dependent upon the taking of action by ACC Canada's Board of Directors, applicable Canadian and provincial law and stock exchange regulations, in addition to the availability of funds. At the present time, three of ACC Canada's seven directors are representatives of ACC Corp. ACC Corp.'s percentage ownership interest in ACC Canada may decrease over time as a result of stock issuances or sales or, alternatively, may increase over time as a result of stock purchases, investments or other transactions. ACC U.S., ACC Canada, ACC U.K. and other operating subsidiaries of the Company are subject to corporate law restrictions on their ability to pay dividends to ACC Corp. There can be no assurance that ACC Corp. will be able to cause its operating subsidiaries to declare and pay dividends or make other payments to ACC Corp. when requested by ACC Corp. The failure to pay any such dividends or make any such other payments could have a material adverse effect upon the Company's business, financial condition and results of operations.\nPOTENTIAL VOLATILITY OF STOCK PRICE\nThe market price of the Class A Common Stock has been and may continue to be highly volatile. See the discussion under Item 5 of this Report, \"Market for Registrant's Common Equity and Related Shareholder Matters.\" Factors such as variations in the Company's revenue, earnings and cash flow, the difference between the Company's actual results and the results expected by investors and analysts and announcements of new service offerings, marketing plans or price reductions by the Company or its competitors could cause the market price of the Class A Common Stock to fluctuate substantially. In addition, the stock markets recently have experienced significant price and volume fluctuations that particularly have affected telecommunications companies and resulted in changes in the market prices of the stocks of many companies that have not been directly related to the operating performance of those companies. Such market fluctuations may materially adversely affect the market price of the Class A Common Stock.\nRISKS ASSOCIATED WITH DERIVATIVE FINANCIAL INSTRUMENTS\nIn the normal course of business, the Company uses various financial instruments, including derivative financial instruments, to hedge its foreign exchange and interest rate risks. The Company does not use derivative financial instruments for speculative purposes. By their nature, all such instruments involve risk, including the risk of nonperformance by counterparties, and the Company's maximum potential loss may exceed the amount recognized on the Company's balance sheet. Accordingly, losses relating to derivative financial instruments could have a material adverse effect upon the Company's business, financial condition and results of operations. See ''Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7 of this Report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's principal executive offices are located at 400 West Avenue, Rochester, New York in corporate office space leased through June 2004. It also leases office space for its Canadian headquarters in Toronto, Canada, and for its U.K. headquarters in London, England, as well as office space at various other locations. For additional information regarding these leases, see Notes 8 and 10 to the Company's Consolidated Financial Statements contained herein.\nThe Company has eight switching centers worldwide. The Company's switching equipment for the Rochester call origination area is located at its headquarters at 400 West Avenue, Rochester, New York with additional switching equipment located in Syracuse, New York, in Toronto, Ontario, Montreal, Quebec, and Vancouver, British Columbia, and in London and Manchester, England, all of which sites are leased. Branch sales offices are leased by the Company at various locations in the northeastern U.S., Canada and the U.K. The Company also leases equipment and space located at various sites in its service areas.\nThe Company's financing arrangements are secured by substantially all of the Company's assets. The Company's secured lenders would be entitled to foreclose upon those assets and to be repaid from the proceeds of the liquidation of those assets in the event of a default under the financing arrangements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere were no material legal proceedings pending at December 31, 1995 involving 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 SHAREHOLDER MATTERS.\nThe Company's Class A Common Stock is quoted on The Nasdaq Stock Market's National Market System under the symbol ''ACCC.'' The following table sets forth, for the periods indicated, the high and low sale prices of the Class A Common Stock, as reported by The Nasdaq Stock Market, and the cash dividends declared per share of Class A Common Stock:\nCash Dividends COMMON STOCK PRICE Declared HIGH LOW PER SHARE\n1994: First Quarter $ 26 1\/4 $17 $0.03 Second Quarter 24 1\/4 13 0.03 Third Quarter 19 3\/4 12 3\/4 0.03 Fourth Quarter 19 13 3\/4 0.03\n1995: First Quarter $ 19 1\/4 $14 $0.03 Second Quarter 17 13 0.03 Third Quarter 19 1\/4 14 1\/2 --- Fourth Quarter 24 1\/8 15 3\/4 ---\n1996: First Quarter (through March 25, 1996) $ 30 1\/4 $22 1\/4 ---\nOn March 1, 1996, the closing price for the Company's Class A Common Stock in trading on The Nasdaq Stock Market was $28.50 per share, as published in The Wall Street Journal. As of March 1, 1996, the Company had approximately 456 holders of record of its Class A Common Stock.\nThe Company ceased paying quarterly cash dividends on its Class A Common Stock in 1995 to use its cash to invest in the growth of its business. The Company anticipates that future earnings, if any, generated from operations will be retained by the Company to develop and expand its business. Any future determination with respect to the payment of dividends on the Class A Common Stock will be at the discretion of the Board of Directors and will depend upon, among other things, the Company's operating results, financing condition and capital requirements, the terms of then- existing indebtedness and preferred stock, general business conditions, Delaware corporate law limitations and such other factors as the Board of Directors deems relevant. The terms of the Company's Credit Facility prohibit the payment of dividends without the Agents' consent. In addition, the Company is prohibited, under the terms of the Company's Series A Preferred Stock, from paying or declaring any dividend upon the Company's Class A Common Stock unless the prior written consent of the holders of a majority of the outstanding shares of Series A Preferred Stock is obtained. The Company's holding company structure may adversely affect the Company's ability to obtain payments when needed from ACC Corp.'s operating subsidiaries. See the Risk Factor discussions of \"Holding Company Structure; Reliance on Subsidiaries for Dividends\" in Item 1 of this Report and Note 5 of the Notes to the Company's Consolidated Financial Statements contained in Item 8 of this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected historical consolidated financial data for each of the years presented have been derived from the Company's audited consolidated financial statements. The consolidated financial statements of the Company as of December 31, 1994 and 1995 and for each of the three years in the period ended December 31, 1995, together with the notes thereto and related report of Arthur Andersen LLP, independent public accountants, are included elsewhere in this Report. The following data should be read in conjunction with, and are qualified by, the consolidated financial statements and related notes and ''Management's Discussion and Analysis of Financial Condition and Results of Operations,'' which are included in Items 8 and 7 of this Report, respectively.\n(1) Includes the results of operations of Metrowide Communications from August 1, 1995, the date of acquisition.\n(2) Represents $2,160 of charges incurred in 1994 in connection with enhancement of the Company's network to prepare for equal access for its Canadian customers. See ''Management's Discussion and Analysis of Financial Condition and Results of Operations-1995 Compared With 1994'' in Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nTHE FOLLOWING DISCUSSION INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS INCLUDING, BUT NOT LIMITED TO CONTINUED DEVELOPMENT OF THE COMPANY'S MARKETS, ACTIONS OF REGULATORY AUTHORITIES AND COMPETITORS AND DEPENDENCE ON MANAGEMENT INFORMATION SYSTEMS, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, SEE THE DISCUSSION OF ''RISK FACTORS'' IN ITEM 1 OF THIS REPORT AND THE COMPANY'S PERIODIC REPORTS FILED WITH THE SEC.\nGeneral\nThe Company's revenue is comprised of toll revenue and leased lines and other revenue. Toll revenue consists of revenue derived from ACC's long distance and operator-assisted services. Leased lines and other revenue consists of revenue derived from the resale of local exchange services, data line services, direct access lines and monthly subscription fees. Network costs consist of expenses associated with the leasing of transmission lines, access charges and certain variable costs associated with the Company's network. The following table shows the total revenue (net of intercompany revenue) and billable minutes of use attributable to the Company's U.S., Canadian and U.K. operations during each of 1995, 1994 and 1993:\nThe following table presents certain information concerning toll revenue per billable minute and network cost per billable minute attributable to the Company's U.S., Canadian and U.K. operations during each of 1995, 1994 and 1993:\nThe Company believes that its historic revenue growth as well as its historic network costs and results of operations for each of its U.S., Canadian and U.K. operations generally reflect the state of development of the Company's operations, the Company's customer mix and the competitive and deregulatory environment in each of those markets. The Company entered the U.S., Canadian and U.K. telecommunications markets in 1982, 1985 and 1993, respectively.\nDeregulatory influences have affected the telecommunications industry in the U.S. since 1984 and the U.S. market has experienced considerable competition for a number of years. The competitive influences on the pricing of ACC U.S.'s services and network costs have been stabilizing during the past few years. This may change in the future as a result of recent U.S. legislation that further opens the market to competition, particularly from RBOCs. The Company expects competition based on price and service offerings to increase. See the Risk Factor discussions of \"Potential Adverse Effects of Regulation'' and \"Increasing Domestic and International Competition\" in Item 1 of this Report.\nBecause the deregulatory trend in Canada, which commenced in 1989, has increased competition, ACC Canada experienced significant downward pressure on the pricing of its services during 1994. The Company expects such downward pressure to continue, although it is expected that the pricing pressure may abate over time as the market matures. The impact of this pricing pressure on revenues of ACC Canada is being offset, in part, by an increase in the Canadian residential and student billable minutes of usage as a percentage of total Canadian billable minutes of usage. Toll revenue per billable minute attributable to residential and student customers in Canada generally exceeds the toll revenue per billable minute attributable to commercial customers. The Company expects that, based on existing and anticipated regulations and rulings, its Canadian contribution charges will increase by up to approximately Cdn. $2 million in 1997 over 1995 levels, which the Company will seek to offset with increased volume efficiencies. The Company also believes that its network costs per billable minute in Canada may decrease during periods after 1996 if there is an anticipated increase in long distance transmission facilities available for lease from Canadian transmission facilities-based carriers as a result of expected growth in the number and capacity of transmission networks in that market. The foregoing forward-looking statements are based upon expectations of actions that may be taken by third parties, including Canadian regulatory authorities and transmission facilities-based carriers. If such third parties do not act as expected, the Company's actual results may differ materially from the foregoing discussion.\nThe Company believes that, because deregulatory influences have only recently begun to impact the U.K. telecommunications industry, the Company will continue to experience a significant increase in revenue from that market during the next few years. The foregoing belief is based upon expectations of actions that may be taken by U.K. regulatory authorities and the Company's competitors; if such third parties do not act as expected, the Company's revenues in the U.K. might not increase. If ACC U.K. were to experience increased revenues, the Company believes it should be able to enhance its economies of scale and scope in the use of the fixed cost elements of its network. Nevertheless, the deregulatory trend in that market is expected to result in competitive pricing pressure on the Company's U.K. operations which could adversely affect revenues and margins. Since the U.K. market for transmission facilities is dominated by British Telecom and Mercury, the downward pressure on prices for services offered by ACC U.K. may not be accompanied by a corresponding reduction in ACC U.K.'s network costs and, consequently, could adversely affect the Company's business, results of operations and financial condition, particularly in the event revenue derived from the Company's U.K. operations accounts for an increasing percentage of the Company's total revenue. Moreover, the Company's U.K. operations are highly dependent upon the transmission lines leased from British Telecom. See ''Risk Factors-Dependence on Transmission Facilities-Based Carriers and Suppliers'' in Item 1 of this Report. As each of the telecommunications markets in which it operates continues to mature, growth in its revenue and customer base in each such market is likely to decrease over time.\nThe Company believes that competition in non-U.S. markets is likely to increase and become more like competition in the U.S. markets over time as non-U.S. markets continue to experience deregulatory influences. Prices in the long distance industry have declined from time to time in recent years and, as competition in Canada and the U.K. increases, prices are likely to continue to decrease.\nSince the commencement of the Company's operations, the Company has undertaken a program of developing and expanding its service offerings, geographic focus and network. In connection with this development and expansion, the Company has made significant investments in telecommunications circuits, switches, equipment and software. These investments generally are made significantly in advance of anticipated customer growth and resulting revenue. The Company also has increased its sales and marketing, customer support, network operations and field services commitments in anticipation of the expansion of its customer base and targeted geographic markets. The Company expects to continue to expand the breadth and scale of its network and related sales and marketing, customer support and operations activities. These expansion efforts are likely to cause the Company to incur significant increases in expenses from time to time, in anticipation of potential future growth in the Company's customer base and targeted geographic markets.\nThe Company's operating results have fluctuated in the past and they may continue to fluctuate significantly in the future as a result of a variety of factors, some of which are beyond the Company's control. The Company expects to focus in the near term on building and increasing its customer base, service offerings and targeted geographic markets, which will require it to increase significantly its expenses for marketing, and development of its network and new services and may adversely impact operating results from time to time. The Company's sales to other long distance carriers have been increasing. Revenues from other resellers accounted for approximately 22%, 7% and 9% of the revenues of ACC U.S., ACC Canada and ACC U.K., respectively, in 1995, and are expected to account for a higher percentage in the future. With respect to these customers, the Company competes almost exclusively on price, does not have long term contracts and generates lower gross margins as a percentage of revenue. See ''Risk Factors-Recent Losses; Potential Fluctuations in Operating Results\" in Item 1 of this Report.\nRESULTS OF OPERATIONS\nThe following table presents, for the three years ended December 31, 1995, certain statement of operations data expressed as a percentage of total revenue:\n(1) Includes the results of operations of Metrowide Communications from August 1, 1995, the date of acquisition.\n1995 COMPARED WITH 1994\nRevenue. Total revenue for 1995 increased by 49.4% to $188.9 million from $126.4 million in 1994, reflecting growth in both toll revenue and leased lines and other revenue. Toll revenue for 1995 increased by 48.1% to $175.2 million from $118.3 million in 1994. In the United States, toll revenue increased 19.3% as a result of a 9.2% increase in billable minutes of use and a more favorable mix of toll services provided, offset slightly by a decrease in prices per minute. The volume increases are primarily a result of increased revenue attributable to other U.S. carriers (approximately $5.8 million), commercial (approximately $33.8 million), residential (approximately $3.6 million) and student (approximately $10.5 million) customers in the Company's service region. In Canada, toll revenue increased 20.9%, primarily as a result of a 23.8% increase in billable minutes (primarily because of a 47.3% increase in the number of customer accounts from approximately 104,000 to 153,000), offset by a slight decline in prices. The price declines are a result of the price competition, particularly in Canada, in 1994 which decreased rates in the middle of that year. Since the end of 1994, ACC's revenues per minute on a consolidated basis have been increasing slightly as a result of the increasing percentage of U.K. revenues and the Company's successful introduction of higher price per minute products. In the United Kingdom, toll revenue increased 830.7%, due to significant volume increases (including a 310% increase in the number of customer accounts from approximately 11,000 to 45,000), offset by lower prices that resulted from entering the commercial and residential markets and from competitive pricing pressure. Exchange rates did not have a material impact on revenue in either the U.K. or in Canada. At December 31, 1995, the Company had approximately 311,000 customer accounts compared to approximately 203,000 customer accounts at December 31, 1994, an increase of 53%. During 1995, customer accounts increased from 88,589 to 113,717 in the U.S.; from 103,535 to 152,504 in Canada; and from 10,867 to 44,594 in the U.K. See the discussion under \"Business-Sales and Marketing\" in Item 1 above in this Report.\nFor 1995, leased lines and other revenue increased by 67.6% to $13.6 million from $8.1 million in 1994. This increase was due to the Metrowide Communications acquisition as of August 1, 1995 (approximately $2.9 million from the date of acquisition through year end), local service revenue (approximately $1.5 million) generated through the university program in the U.S. and the local exchange operations in upstate New York, which generated nominal revenues in 1994.\nNETWORK COSTS. Network costs increased to $114.8 million for 1995, from $79.4 million in 1994, due to the increase in billable long distance minutes. However, network costs, expressed as a percentage of revenue, decreased to 60.8% for 1995 from 62.8% in 1994 due to reduced contribution charges in Canada and increased volume efficiencies in the U.K. Contribution charges represented 5.2% of revenue in 1995 as compared to 10.1% in 1994. These efficiencies were partially offset by reduced margins in the U.S. due to increased carrier traffic.\nOTHER OPERATING EXPENSES. Depreciation and amortization expense increased to $11.6 million for 1995 from $8.9 million in 1994. Expressed as a percentage of revenue, these costs decreased to 6.1% in 1995 from 7.1% in 1994, reflecting the increases in revenue realized during 1995. The $2.7 million increase in depreciation and amortization expense was primarily attributable to assets placed in service in the fourth quarter of 1994 and during 1995, particularly equipment at U.S. university sites, switching centers in London and Manchester in the U.K., and switch upgrades in Rochester, Syracuse, Vancouver and Toronto. Amortization of approximately $0.4 million associated with the customer base and goodwill recorded in the Metrowide Communications acquisition also contributed to the increase.\nSelling expenses for 1995 increased by 49.1% to $21.6 million compared with $14.5 million in 1994. Expressed as a percentage of revenue, selling expenses were 11.4% for 1995 compared to 11.5% for 1994. The $7.1 million increase in selling expenses was primarily attributable to increased marketing costs and sales commissions associated with the rapid growth of the Company's operations in Canada (approximately $1.7 million) and the U.K. (approximately $5.6 million). General and administrative expenses for 1995 were $39.2 million compared with $29.7 million in 1994. Expressed as a percentage of revenue, general and administrative expenses were 20.8% for 1995, compared to 23.5% in 1994. The increase in general and administrative expenses was primarily attributable to a $9.5 million increase in personnel and customer service costs associated with the growth of the Company's customer bases and geographic expansion in each country. Also included in general and administrative expenses for 1995 was approximately $1.8 million related to the Company's local service market sector in New York State.\nThe Company also incurred in 1995 non-recurring costs of $1.3 million related to management restructuring. These costs consisted of a $0.8 million payment in consideration of a non-compete agreement with the Chairman of the Board which was negotiated and agreed to in connection with his resignation as Chief Executive Officer. The remaining $0.5 million related to severance expenses relating to three other members of executive management, the terms of which were negotiated at the time of the executives' departures based on their existing agreements with the Company. In connection with the departure of one executive, the vesting schedule for options to purchase 16,150 shares of Class A Common Stock (out of the options to purchase a total of 33,600 shares which had been granted to the executive) were accelerated to allow him to exercise the options.\nDuring the third quarter of 1994, the Company initiated the process of enhancing its network to prepare for equal access for its Canadian customers. \"Equal access\" allows customers to place a call over the Company's network simply by dialing \"1\" plus the area code and telephone number. Before equal access was available, the Company needed to install a \"dialer\" on its customers' premises or require the customer to dial an access code before placing a long distance call. Costs associated with this process included maintaining duplicate network facilities during transition, recontacting customers and the administrative expenses associated with accumulating the data necessary to convert the Company's customer base to equal access. This process was completed during the fourth quarter of 1994 at a total cost of $2.2 million, which has been reflected as a charge to income from operations for 1994. This network enhancement, the costs of which are non-recurring, will enable the Company to offer a broader range of services to Canadian customers and increase customer convenience in using the Company's telecommunications services.\nOTHER INCOME (EXPENSE). Net interest expense increased to $4.9 million for 1995 compared to $1.9 million in 1994, due primarily to the Company's increased weighted average borrowings on revolving lines of credit (approximately $3.1 million) related to financing of university projects in the U.S., expansion of the U.K. and the local service businesses during 1995, write-off of deferred financing costs (approximately $0.3 million) related to the Company's lines of credit which were refinanced in July 1995, debt service costs associated with 12% subordinated notes issued in May 1995 (approximately $0.4 million), and contingent interest associated with the Credit Facility (approximately $0.3 million). On September 1, 1995, the subordinated notes were exchanged for Series A Preferred Stock and, consequently, there will be no further interest expense associated with the 12% subordinated notes. The Series A Preferred Stock accrues dividends at the rate of 12% per annum. Upon any conversion of Series A Preferred Stock, the accrued and unpaid dividends thereon will be extinguished and no longer deemed payable.\nForeign exchange gains and losses reflect changes in the value of Canadian and British currencies relative to the U.S. dollar for amounts lent to foreign subsidiaries. Foreign exchange rate changes resulted in a net loss of $0.1 million for 1995, compared to a $0.2 million gain in 1994. The Company continues to hedge all foreign currency transactions in an attempt to minimize the impact of transaction gains and losses on the income statement. The Company does not engage in speculative foreign currency transactions.\nDuring 1994, the Company increased its income tax provision to provide for a valuation allowance equal to 100% of the amount of the Company's foreign tax benefits which had been recorded at December 31, 1993. No income tax benefits have been recorded for the 1995 operating losses in Canada or the U.K. due to the uncertainty of recognizing the income tax benefit of those losses in the future.\nMinority interest in loss of consolidated subsidiary reflects the portion of the Company's Canadian subsidiary's income or loss attributable to the approximately 30% of that subsidiary's common stock that is publicly traded in Canada. For 1995, minority interest in earnings of the consolidated subsidiary was a loss of $0.1 million compared to a gain of $2.4 million in 1994.\nThe Company's net loss for 1995 was $5.4 million, compared to $11.3 million in 1994. The 1995 net loss resulted primarily from the expansion of operations in the U.K. (approximately $6.8 million), increased net interest expense associated with additional borrowings (approximately $4.9 million), increased depreciation and amortization from the addition of equipment and costs associated with the expansion of local service in New York State (approximately $1.6 million) and management restructuring costs (approximately $1.3 million), offset by positive operating income from the U.S. and Canadian long distance subsidiaries of approximately $9.0 million.\n1994 COMPARED WITH 1993\nRevenue. Total revenue for 1994 increased by 19.3% to $126.4 million from $105.9 million in 1993, reflecting growth in toll revenue and leased lines and other revenue. Toll revenue for 1994 increased by 17.6% to $118.3 million from $100.6 million in 1993. This increase was due to the continued expansion of the Company's university program in the U.S., Canada, and the U.K., and growth in both the commercial and residential customer bases in Canada through affinity programs and expansion throughout Western Canada. For a discussion of the Company's affinity programs, see the discussion under \"Business-Sales and Marketing\" in Item 1 of this Report. At December 31, 1994, the Company had approximately 203,000 customer accounts compared to approximately 98,000 customer accounts at December 31, 1993, an increase of more than 100%. During 1994, customer accounts increased from 50,287 to 88,589 in the U.S.; from 45,615 to 103,535 in Canada; and from 2,000 to 10,867 in the U.K.\nFor 1994, leased lines and other revenue increased by 53.1% to $8.1 million from $5.3 million in 1993. This increase was due to growth in data line sales in Canada as well as increased local service revenue generated through the university program in the U.S.\nNETWORK COSTS. Network costs increased to $79.4 million for 1994, from $70.3 million in 1993, due to the increase in billable long distance minutes. Network costs, as a percentage of revenue, decreased to 62.8% for 1994 from 66.3% in 1993 due to the Company's more efficient utilization of its leased facilities in Canada through economies of scale and a more favorable mix of traffic from increased residential and student usage during off peak hours, which combined to decrease network costs by 4.4% of total consolidated revenue.\nOTHER OPERATING EXPENSES. Depreciation and amortization expense increased to $8.9 million for 1994, from $5.8 million in 1993. Expressed as a percentage of revenue, these costs increased to 7.1% in 1994 from 5.5% in 1993, reflecting the cost of investments in additional equipment (approximately $19.3 million) in the U.S., Canada and the U.K. incurred in advance of anticipated billable minute volume growth. The $3.1 million increase in depreciation and amortization expense was primarily attributable to assets placed in service in the fourth quarter of 1993 and the first three quarters of 1994 related to the Company's continued expansion of its network throughout Canada, the installation of additional switches (approximately $5.2 million) and increased on- site equipment at universities in the U.S. (approximately $2.9 million).\nSelling expenses for 1994 increased by 66.1% to $14.5 million from $8.7 million in 1993. Expressed as a percentage of revenue, selling expenses were 11.5% for 1994 compared to 8.2% in 1993. This increase was attributable in part to the aggressive expansion of the Company's marketing territory into Western Canada, including the expansion following the installation of a switch in Vancouver, British Columbia and the opening of sales offices in Calgary, Alberta and Winnipeg, Manitoba (approximately $0.3 million) and the start-up of a nationwide marketing campaign in the U.K. during the second half of 1994 (approximately $0.5 million). During 1994, the Company added over 100,000 customers compared to approximately 46,000 added in 1993. The total costs of the marketing effort related to these customers are reflected in the results for the year while the revenue generated by the majority of these customers (universities and students) did not begin until the end of the third quarter corresponding to the beginning of the fall semester for most colleges and universities. General and administrative expenses for 1994 increased by 48.1% to $29.7 million from $20.1 million in 1993. Expressed as a percentage of revenue, general and administrative expenses were 23.5% for 1994 compared to 19.0% in 1993. The increase was primarily attributable to increased personnel costs (approximately $5.1 million) and customer service costs (approximately $0.6 million) associated with the growth of the Company's customer bases in each country. Also included in general and administrative expenses for 1994 was approximately $3.0 million in start-up costs related to the Company's entry into the local service market sector in New York state which occurred during the fourth quarter of 1994.\nDuring 1993, the Company recorded a non-cash expense of $12.8 million related to the write-down of the carrying value of certain assets of its U.S. and Canadian operations. This charge included approximately $5.1 million relating to certain fixed assets, including equipment used in connection with a microwave network deemed obsolete due to technological changes, $1.2 million related to the goodwill and customer bases from U.S. acquisitions, $2.8 million pertaining to an acquired customer base and accounts receivable relating to acquisitions made by ACC Canada and $3.8 million relating to autodialing equipment of ACC Canada resulting from the anticipated implementation by the CRTC of equal ease of access regulations in July 1994.\nOTHER INCOME (EXPENSE). Net interest expense increased to $1.9 million for 1994 compared to $0.2 million in 1993, due primarily to the Company's increased borrowings on lines of credit throughout 1994. During 1994, the Company incurred terminated merger costs of $0.2 million resulting from a transaction which was not completed. During 1993, the Company recognized gains of $9.3 million from the sale of stock in its Canadian subsidiary and $10.2 million (net of provision for income taxes) from the sale of the Company's cellular assets.\nForeign exchange gains and losses reflect changes in the value of Canadian and British currencies relative to the U.S. dollar for amounts lent to these foreign subsidiaries. Foreign exchange rate changes resulted in a net gain of $0.2 million for 1994, compared to a $1.1 million loss in 1993 due to the Company's program of hedging against foreign currency exposures for intercompany indebtedness which began at the end of 1993.\nDuring 1994, the Company increased its income tax provision to provide for a valuation allowance equal to 100% of the amount of the Company's foreign tax benefits which had been recorded at December 31, 1993. These benefits had been accrued based on the Company's history of profitability in Canada. However, given the magnitude of the Canadian subsidiary's losses in 1994, the Company believed that a valuation allowance was necessary to reflect the uncertainty of realizing the income tax benefits of those losses in the future.\nMinority interest in loss of consolidated subsidiary reflects the portion of the Company's Canadian subsidiary's income or loss attributable to the approximately 30% of that subsidiary's common stock that is publicly traded in Canada. For 1994, minority interest in loss of consolidated subsidiary increased to $2.4 million from $1.7 million in 1993 due to the increase in net losses generated by ACC Canada in 1994 when compared to 1993.\nDuring the third quarter of 1993, the Company recognized a gain of $11.5 million, net of taxes, from the sale of the operating assets and liabilities of its former cellular subsidiary, Danbury Cellular Telephone Co. The operating loss from these discontinued operations was $1.3 million for 1993, resulting in a net gain on the disposition of these operations of $10.2 million.\nThe Company's net loss for 1994 was $11.3 million compared to net income of $11.9 million in 1993. The 1994 net loss resulted primarily from operating losses due to expansion in the U.K. (approximately $5.6 million), the recording of the valuation allowance against deferred tax benefits (approximately $3.0 million), implementation of equal access in Canada (approximately $2.2 million) and operating losses due to expansion in local telephone service in the U.S. (approximately $0.9 million). The 1993 net income was primarily attributable to the gain on the sale of the Company's cellular assets.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company historically has satisfied its working capital requirements through cash flow from operations, through borrowings and financings from financial institutions, vendors and other third parties, and through the issuance of securities. In addition, the Company used the proceeds from the 1993 sale of ACC Canada common stock and the 1993 sale of its cellular operations to fund the expansion of its operations in Canada and the U.K. During 1995, the Company raised $20.0 million, through the issuance of 825,000 shares of Class A Common Stock for $11.1 million (net of issuance expense) and notes which were exchanged for 10,000 shares of Series A Preferred Stock for $8.9 million (net of issuance expenses). The proceeds from the 1995 issuances of Class A Common Stock and notes were used to reduce indebtedness and for working capital and capital expenditures. In July 1995, the Company entered into the five-year $35.0 million Credit Facility.\nNet cash flows generated by operations was $1.1 million and $4.0 million during 1994 and 1995, respectively. The increase of approximately $2.9 million in the cash flow provided by operating activities during 1995 versus 1994 was primarily attributable to the improved financial performance of ACC Canada during 1995 in comparison to 1994 and an increase in accounts receivable resulting from the expansion in the Company's customer base and related revenues which was partially offset by a decline in other receivables. If additional competition were to result in significant price reductions that are not offset by reductions in network costs, net cash flows from operations would be materially adversely affected.\nNet cash flows used in investing activities was $21.0 million and $15.3 million during 1994 and 1995, respectively. The decrease of approximately $5.7 million in net cash flow used in investing activities during 1995 versus 1994 was principally attributable to a decrease in capital expenditures incurred by the Company, which was partially offset by the use of cash flow in connection with the Metrowide Communications acquisition.\nAccounts receivable increased by $18.5 million during 1995 as a result of the expansion of the Company's customer base due to sales and marketing efforts, the Metrowide Communications acquisition and a customer base acquisition. Sales to customers in Canada and the U.K. in 1995 represented approximately 65.1% of total revenues, as opposed to 56.8% in 1994. Account balances from the Company's customers in Canada and the U.K. are typically outstanding longer than those in the U.S. market. In addition, the Company acquired approximately $0.9 million of Canadian accounts receivable in 1995 without a corresponding increase in revenues as a result of the Metrowide Communications acquisition. The Company's sales to other carriers (which typically pay more slowly than other customers of the Company) also increased during 1995. Accounts receivable, expressed as a percentage of total revenue, increased to 20.6% for 1995 from 16.2% in 1994.\nThe acquisition of Metrowide Communications was accounted for as a purchase and resulted in the allocation of approximately $5.0 million to goodwill, which will be amortized over five years from the date of acquisition. Accounts payable decreased by $3.2 million during 1995, principally as a result of the payment of an accrued payable which existed at December 31, 1994 relating to a capital project completed during 1995. Accrued network costs increased by $17.7 million during 1995, principally as a result of the incurrence of costs relating to the leasing and usage of transmission facilities in order to accommodate actual and potential future growth in the Company's customer base, particularly in the U.K. Accrued network costs also increased due to delays in billing by British Telecom in the U.K.\nOther accrued expenses increased by $6.4 million during 1995. This increase was primarily related to an increase in accrued taxes of approximately $2.6 million, an increase in accrued commissions, compensation and benefits of approximately $1.3 million, an increase in accruals relating to customers and service providers of approximately $0.8 million, and an increase in recurring general business accruals of approximately $1.7 million.\nThe Company's principal need for working capital is to meet its selling, general and administrative expenses as its business expands. In addition, the Company's capital resources have been used for the Metrowide Communications acquisition, capital expenditures, various customer base acquisitions and, prior to the termination thereof during the second quarter of 1995, payments of dividends to holders of its Class A Common Stock. The Company has had a working capital deficit at the end of the last several years and, at December 31, 1995, the Company had a working capital deficit of approximately $10.3 million. This related to short term debt associated with the Metrowide Communications acquisition and delays in billings from, or the resolution of billing discussions with, vendors. The Company has experienced delays from time to time in billings from carriers from which it leases transmission lines. In addition, prior to making payment to the carriers, the Company typically needs to resolve discrepancies between the amount billed by the carriers and the Company's records concerning usage of leased lines. The Company accrues an expense for the amount of its estimated obligation to the carriers pending the resolution of such discussions. During 1995, the Company's EBITDA minus capital expenditures and changes in working capital was $(7.0) million.\nThe Company anticipates that, during 1996, its capital expenditures will be approximately $26.0 million for the expansion of its network, the acquisition, upgrading and development of switches and other telecommunications equipment as conditions warrant, the development, licensing and integration of its management information system and other software, the development and expansion of its service offerings and customer programs and other capital expenditures. ACC expects that it will continue to make significant capital expenditures during future periods. The Company's actual capital expenditures and cash requirements will depend on numerous factors, including the nature of future expansion (including the extent of local exchange services, which is particularly capital intensive) and acquisition opportunities, economic conditions, competition, regulatory developments, the availability of capital and the ability to incur debt and make capital expenditures under the terms of the Company's financing arrangements. Prior to 1995, the Company had funded capital expenditures through its credit facilities and other short term debt arrangements, which were refinanced in 1995 with the Credit Facility.\nThe Company is obligated to pay the lenders under the Credit Facility a contingent interest payment based on the appreciation in market value of 140,000 shares of the Company's Class A Common Stock from $14.92 per share, subject to a minimum of $0.75 million and a maximum of $2.1 million. The payment is due upon the earlier of (I) January 21, 1997, (ii) any material amendment to the Credit Facility, (iii) the signing of a letter of intent to sell the Company or any material subsidiary, or (iv) the cessation of active trading of the Company's Class A Common Stock on other than a temporary basis. The Company is accruing this obligation over the 18-month period ending January 21, 1997 ($0.6 million has been accrued through March 1, 1996).\nAny holder of Series A Preferred Stock has the right to cause the Company to redeem such Series A Preferred Stock upon the occurrence of certain events, including the entry of a judgment against the Company or a default by the Company under any obligation or agreement for which the amount involved exceeds $500,000.\nAs of January 31, 1996, the Company had approximately $0.9 million of cash and cash equivalents and maintained the $35.0 million Credit Facility, subject to availability under a borrowing base formula and certain other conditions (including borrowing limits based on the Company's operating cash flow), under which borrowings of approximately $19.0 million were outstanding, approximately $13.0 million was available for borrowing and $3.0 million was reserved for letters of credit. The maximum aggregate principal amount of the Credit Facility is required to be reduced by $2.5 million per quarter commencing on July 1, 1997 and by $2.9 million per quarter commencing on January 1, 1999 until maturity on July 1, 2000. During 1995 the Company entered into swap agreements with respect to $11.5 million of indebtedness under the Credit Facility, as required by the terms of the Credit Facility. The swap agreements expire at various times through December 1998 and require the Company to pay interest at rates ranging from 5.98% to 6.25% per annum and permit the Company to receive interest at variable rates.\nThe Company also is obligated to pay, on demand commencing in August of 1996, the remaining $1.1 million (after the February 1996 payment) pursuant to a note issued in connection with the Metrowide Communications acquisition. In addition, the Company has $2.9 million, $2.6 million and $2.1 million of capital lease obligations which mature during 1996, 1997 and 1998, respectively. The Company's financing arrangements, which are secured by substantially all of the Company's assets and the stock of certain subsidiaries, require the Company to maintain certain financial ratios and prohibit the payment of dividends.\nIn the normal course of business, the Company uses various financial instruments, including derivative financial instruments, for purposes other than trading. These instruments include letters of credit, guarantees of debt, interest rate swap agreements and foreign currency exchange contracts relating to intercompany payables of foreign subsidiaries. The Company does not use derivative financial instruments for speculative purposes. Foreign currency exchange contracts are used to mitigate foreign currency exposure and are intended to protect the U.S. dollar value of certain currency positions and future foreign currency transactions. The aggregate fair value, based on published market exchange rates, of the Company's foreign currency contracts at December 31, 1995 was $24.5 million. Interest rate swap agreements are used to reduce the Company's exposure to risks associated with interest rate fluctuations. The Company was party to interest rate swap agreements at December 31, 1995 which had the effect of converting interest in respect of $11.5 million principal amount of the Credit Facility to a fixed rate. As is customary for these types of instruments, collateral is generally not required to support these financial instruments.\nBy their nature, all such instruments involve risk, including the risk of nonperformance by counterparties, and the Company's maximum potential loss may exceed the amount recognized on the Company's balance sheet. However, at December 31, 1995, in management's opinion there was no significant risk of loss in the event of nonperformance of the counterparties to these financial instruments. The Company controls its exposure to counterparty credit risk through monitoring procedures and by entering into multiple contracts, and management believes that reserves for losses are adequate. Based upon the Company's knowledge of the financial position of the counterparties to its existing derivative instruments, the Company believes that it does not have any significant exposure to any individual counterparty or any major concentration of credit risk related to any such financial instruments.\nThe Company believes that, under its present business plan, the net proceeds from a public offering of up to 2,012,500 shares of its Class A Common Stock for which the Company has filed a Registration Statement on Form S-3 with the SEC, together with borrowings under the Credit Facility, vendor financing and cash from operations will be sufficient to meet anticipated working capital and capital expenditure requirements of its existing operations. The forward-looking information contained in the previous sentence may be affected by a number of factors, including the matters described in this paragraph and under ''Risk Factors'' in Item 1 of this Report. The Company may need to raise additional capital from public or private equity or debt sources in order to finance its operations, capital expenditures and growth for periods after 1996 and for the optional redemption of Series A Preferred Stock if it is not converted. Moreover, the Company believes that continued growth and expansion through acquisitions, investments and strategic alliances is important to maintain a competitive position in the market and, consequently, a principal element of the Company's business strategy is to develop relationships with strategic partners and to acquire assets or make investments in businesses that are complementary to its current operations. The Company may need to raise additional funds in order to take advantage of opportunities for acquisitions, investments and strategic alliances or more rapid international expansion, to develop new products or to respond to competitive pressures. If additional funds are raised through the issuance of equity securities, the percentage ownership of the Company's then current shareholders may be reduced and such equity securities may have rights, preferences or privileges senior to those of holders of Class A Common Stock. There can be no assurance that the Company will be able to raise such capital on acceptable terms or at all. In the event that the Company is unable to obtain additional capital or is unable to obtain additional capital on acceptable terms, the Company may be required to reduce the scope of its presently anticipated expansion opportunities and capital expenditures, which could have a material adverse effect on its business, results of operations and financial condition and could adversely impact its ability to compete.\nThe Company may seek to develop relationships with strategic partners both domestically and internationally and to acquire assets or make investments in businesses that are complementary to its current operations. Such acquisitions, strategic alliances or investments may require that the Company obtain additional financing and, in some cases, the approval of the holders of debt or preferred stock of the Company. The Company's ability to effect acquisitions, strategic alliances or investments may be dependent upon its ability to obtain such financing and, to the extent applicable, consents from its debt or preferred stock holders.\nSFAS NO. 123\nThe Company is required to adopt SFAS No. 123, ''Accounting for Stock-Based Compensation'' in 1996. This Statement encourages entities to adopt a fair value based method of accounting for employee stock option plans (whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the employee service period) rather than the current intrinsic value based method of accounting (whereby compensation cost is measured at the grant date as the difference between market value and the price for the employee to acquire the stock). If the Company elects to continue using the intrinsic value method of accounting, pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting had been applied, will need to be disclosed. Management has not decided if the Company will adopt the fair value based method of accounting for the Company's stock option plans. The Company believes that adopting the fair value basis of accounting could have a material impact on the financial statements and such impact is dependent upon future stock option activity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSUPPLEMENTAL INFORMATION: SELECTED QUARTERLY FINANCIAL DATA\nThe following table sets forth certain unaudited quarterly financial data for the preceding eight quarters through the quarter ended December 31, 1995. In the opinion of management, the unaudited information set forth below has been prepared on the same basis as the audited information set forth elsewhere herein and includes all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the information set forth herein. The operating results for any quarter are not necessarily indicative of results for any future period.\nThe Company's quarterly operating results have fluctuated and will continue to fluctuate from period to period depending upon factors such as the success of the Company's efforts to expand its geographic and customer base, changes in, and the timing of expenses relating to, the expansion of the Company's network, regulatory and competitive factors, the development of new services and sales and marketing and changes in pricing policies by the Company or its competitors. In view of the significant historic growth of the Company's operations, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance and that the Company may experience significant period- to-period fluctuations in operating results in the future. See ''Risk Factors-Recent Losses; Potential Fluctuations in Operating Results\" in Item 1 of this Report.\nHistorically, a significant percentage of the Company's revenue has been derived from university and college administrators and students, which caused its business to be subject to seasonal variation. To the extent that the Company continues to derive a significant percentage of its revenues from university and college customers, the Company's results of operations could remain susceptible to seasonal variation.\nDuring the third quarter of 1994, the Company initiated the process of enhancing its network to prepare for the introduction of equal access for its Canadian customers. The acquisition of Metrowide Communications and the management restructuring charges in 1995, and the Canadian equal access costs in 1994, affect the comparability of the quarterly financial data set forth above. See \"Management's Discussion and Analysis, Results of Operations-1995 Compared With 1994-Other Charges\" above in Item 7 of this Report.\nFINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders of ACC Corp.:\nWe have audited the accompanying consolidated balance sheets of ACC Corp. (a Delaware 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 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 ACC Corp. 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.\nRochester, New York \/s\/ARTHUR ANDERSEN LLP February 6, 1996\n(Except with respect to the matters discussed in Notes 10 and 11.A, as to which the dates are February 20, 1996 and February 8, 1996, respectively)\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE BALANCE SHEETS.\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.\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nACC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (AMOUNTS IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nACC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. PRINCIPLES OF CONSOLIDATION:\nThe consolidated financial statements include all accounts of ACC Corp. (a Delaware corporation) and its direct and indirect subsidiaries (the ''Company'' or ''ACC''). Principal operating subsidiaries include: ACC Long Distance Corp. (U.S.), ACC TelEnterprises Ltd. (Canada), ACC Long Distance UK Ltd., and ACC National Telecom Corp. All operating subsidiaries are wholly- owned, with the exception of ACC TelEnterprises Ltd. (See B. below). All significant intercompany accounts and transactions have been eliminated.\nThe accompanying consolidated financial statements reflect the results of operations of acquired companies since their respective acquisition dates.\nB. SALE OF SUBSIDIARY STOCK:\nOn July 6, 1993, the Company's then wholly-owned Canadian subsidiary, ACC TelEnterprises Ltd., completed an initial public offering of 2 million common shares for Cdn. $11.00 per share. The Company received net proceeds of approximately Cdn. $20.7 million after underwriters' fees and before other direct costs of the offering of Cdn. $1.3 million. As a result of the offering, ACC Corp.'s ownership was reduced to approximately 70 percent.\nThe Company recognized a gain of $9.3 million after related expenses on this transaction due to the increase in the carrying amount of the Company's investment in ACC TelEnterprises Ltd. No deferred taxes have been provided for on this gain as the Company has the ability to defer the recognition of taxable income related to this transaction indefinitely.\nMinority interest represents the approximately 30% non-Company owned shareholder interest in ACC TelEnterprises Ltd.'s equity primarily resulting from the 1993 public offering. Assuming the sale of subsidiary stock occurred on January 1, 1993, then, on a pro forma basis, the minority interest in loss of the consolidated subsidiary would have been approximately $1.6 million for the year ended December 31, 1993. This pro forma information has been prepared for comparative purposes only. During 1994, the Company repurchased 58,300 shares of ACC TelEnterprises Ltd. stock for approximately $3.69 per share.\nC. TOLL REVENUE:\nThe Company records as revenue the amount of communications services rendered, as measured by the related minutes of toll traffic processed or flat-rate services billed, after deducting an estimate of the traffic or services which will neither be billed nor collected.\nD. OTHER RECEIVABLES:\nOther receivables consist of operating receivables primarily related to the financing of university projects (approximating $3,039,000 and 2,920,000 at December 31, 1995 and 1994, respectively). Other components include taxes receivable (approximating $650,000 at December 31, 1995 and approximately $1,791,000 at December 31, 1994) and other nominal, miscellaneous receivables (approximating $276,000 and $722,000 at December 31, 1995 and 1994, respectively).\nE. PROPERTY, PLANT AND EQUIPMENT:\nThe Company's property, plant and equipment consisted of the following at December 31, 1994 and 1995 (dollars in thousands):\n1995 1994 Equipment $69,174 $53,700 Computer software and software licenses 6,869 4,648 Other 7,580 4,270 TOTAL $83,623 $62,618\nDepreciation and amortization of property, plant and equipment is computed using the straight-line method over the following estimated useful lives:\nLeasehold improvements Life of lease Equipment, including assets under capital leases 2 to 15 years Computer software and software licenses 5 to 7 years Office equipment and fixtures 3 to 10 years Vehicles 3 years\nEquipment and computer software include assets financed under capital lease obligations. A summary of these assets at December 31, 1994 and 1995 is as follows (dollars in thousands):\n1995 1994\nCost $13,935 $7,360 Less-accumulated amortization (4,538) (3,482) Total, net $ 9,397 $ 3,878\nBetterments, renewals, and extraordinary repairs that extend the life of the asset are capitalized; other repairs and maintenance are expensed. The cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss on disposition is recognized in income.\nF. DEFERRED INSTALLATION COSTS:\nCosts incurred for the installation of local access lines are amortized on a straight-line basis over a three-year period which represents the average estimated useful life of these lines. Accumulated amortization of deferred installation costs totaled approximately $3.3 million and $4.5 million at December 31, 1994 and 1995, respectively.\nG. GOODWILL AND CUSTOMER BASE:\nAll of the Company's acquisitions have been accounted for as purchases and, accordingly, the purchase prices were allocated to the assets and liabilities of the acquired companies based on their fair values at the acquisition date.\nAs of August 1, 1995, ACC TelEnterprises Ltd. acquired Metrowide Communications (''Metrowide'') in a business combination accounted for as a purchase. Metrowide is based in Toronto, Canada, and provides local and long distance services to Ontario, Canada based customers. The results of operations of Metrowide are included in the accompanying financial statements since the date of acquisition. The total cost of the acquisition was Cdn. $14.7 million (U.S. $10.8 million) including Cdn. $8.7 million (U.S. $6.3 million) of liabilities assumed, of which Cdn. $2.0 million (U.S. $1.5 million) was paid at the date of purchase, with the remaining Cdn. $4.0 million (U.S. $3.0 million) due in installments through August 1, 1996.\nGoodwill associated with the Metrowide purchase of Cdn. $7.0 million (U.S. $5.0 million) is being amortized over 20 years, and customer base of Cdn. $4.2 million (U.S. $3.1 million) is being amortized over five years. Accumulated amortization of goodwill approximated U.S. $108,000 at December 31, 1995.\nThe Company amortizes acquired customer bases on a straight-line basis over five to seven years. Accumulated amortization of customer base totaled $1.7 million and $3.1 million at December 31, 1994 and 1995, respectively.\nDuring 1995, the Company adopted 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 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 and requires that an impairment loss be recognized based on the existence of certain conditions. This Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of their carrying amount or fair value less cost to sell.\nThe effect of adopting SFAS No. 121 was immaterial to the consolidated financial statements. The Company continually evaluates its intangible assets in light of events and circumstances that may indicate that the remaining estimated useful life may warrant revision or that the remaining value may not be recoverable. When factors indicate that intangible assets should be evaluated for possible impairment, the Company uses an estimate of the undiscounted cash flow over the remaining life of the intangible asset in measuring whether that asset is recoverable.\nH. COMMON AND COMMON EQUIVALENT SHARES:\nPrimary earnings per common share are based on the weighted average number of common shares outstanding during the year and the assumed exercise of dilutive stock options and warrants, less the number of treasury shares assumed to be purchased from the proceeds using the average market prices of the Company's Class A Common Stock.\nThe weighted average number of common shares outstanding for the fiscal years ended December 31, 1993, 1994, and 1995 were approximately 7.025 million shares, 7.068 million shares and 7.789 million shares, respectively.\nPrimary earnings per share were computed by adjusting net income (loss) for dividends and accretion applicable to Series A Preferred Stock, as follows (dollars in thousands):\nFully diluted earnings per share are not presented for the year ended December 31, 1995, because the effect of the assumed conversion of the Series A Preferred Stock shares, which were authorized and issued during 1995, would be anti-dilutive.\nAll references to common and common equivalent shares have been retroactively restated to reflect a February 4, 1993 three-for-two stock dividend.\nI. FOREIGN CURRENCY TRANSLATION:\nAssets and liabilities of ACC TelEnterprises Ltd. and ACC Long Distance UK Ltd., operating in Canada and the United Kingdom, respectively, are translated into U.S. dollars 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 exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are included as part of the cumulative translation adjustment component of shareholders' equity, while gains and losses resulting from foreign currency transactions are included in net income. In 1993, the Company recognized a foreign exchange loss of approximately $0.8 million due to the repayment of intercompany debt from its Canadian subsidiary. This debt had previously been considered of a long-term investment nature and gains and losses had been included in cumulative translation adjustment on the Company's balance sheet.\nJ. INCOME TAXES:\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, ''Accounting for Income Taxes'' in 1993. Deferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. The cumulative effect of this change was not material to the financial statements of the Company.\nK. CASH EQUIVALENTS AND RESTRICTED CASH:\nThe Company considers investments with a maturity of less than three months to be cash equivalents.\nIn connection with an agreement described in Note 8, the Company had placed approximately $0.6 million in an escrow account. During 1994 and 1995, approximately $0.2 million and $0.4 million, respectively, was paid to an officer of the Company in accordance with the agreement. The $0.4 million was reflected as ''restricted cash'' on the balance sheet at December 31, 1994.\nL. DERIVATIVE FINANCIAL INSTRUMENTS:\nThe Company uses derivative financial instruments to reduce its exposure from market risks from changes in foreign exchange rates and interest rates. The Company does not hold or issue financial instruments for speculative trading purposes. The derivative instruments used are currency forward contracts and interest rate swap agreements. These derivatives are non-leveraged and involve little complexity.\nThe Company monitors and controls its risk in the derivative transactions referred to above by periodically assessing the cost of replacing, at market rates, those contracts in the event of default by the counterparty. The Company believes such risk to be remote. In addition, before entering into derivative contracts, and periodically during the life of the contracts, the Company reviews the counterparty's financial condition.\nThe Company enters into contracts to buy and sell foreign currencies in the future in order to protect the U.S. dollar value of certain currency positions and future foreign currency transactions. The gains and losses on these contracts are included in income in the period in which the exchange rates change. The discounts and premiums on the forward contracts are amortized over the life of the contracts.\nAt December 31, 1995, the Company had foreign currency contracts outstanding to sell forward the equivalent of Cdn. $37.9 million and 5.3 million pounds sterling and to buy forward the U.S. dollar equivalent of Cdn. $10.0 million and 2.7 million pounds sterling. These contracts mature throughout 1996.\nAt December 31, 1994, the Company had foreign currency contracts outstanding to sell forward the equivalent of Cdn. $19.0 million and 7.9 million pounds sterling and to buy forward the U.S. dollar equivalent of 2.4 million pounds sterling.\nThe aggregate fair value, based on published market exchange rates, of foreign currency contracts at December 31, 1994 and 1995, was $22.7 million and $24.5 million, respectively.\nThe Company uses interest rate swaps to effectively convert variable rate obligations to a fixed rate basis. The differentials to be received or paid under these agreements is recognized as an adjustment to interest expense related to the debt. Gains and losses on terminations of interest rate swaps are recognized when terminated in conjunction with the retirement of the associated debt. The fair value of interest rate swap agreements is estimated based on quotes from the market makers of these instruments and represents the estimated amounts that the Company would expect to receive or pay to terminate these agreements. The Company's exposure related to these interest rate swap agreements is limited to fluctuations in the interest rate. At December 31, 1995, the estimated fair value of these interest rate swaps was not material (see Note 3).\nM. 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 reporting period. Actual results could differ from those estimates.\nN. RECLASSIFICATIONS:\nCertain reclassifications have been made to previously reported balances for 1994 and 1993 to conform to the 1995 presentation.\n2. OPERATING INFORMATION\nACC is a switch-based provider of telecommunications services in the United States, Canada and the United Kingdom. The Company primarily offers long distance telecommunications services to a diversified customer base of businesses, residential customers, and educational institutions. ACC has begun to provide local telephone service as a switch-based local exchange reseller in upstate New York and as a reseller of local exchange services in Ontario, Canada. ACC primarily targets business customers with approximately $500 to $15,000 of monthly long distance usage, selected residential customers and colleges and universities. For the year ended December 31, 1995, long distance revenues account for approximately 93% of total Company revenues, while local exchange revenues and data-line sales are 2% and 3%, respectively, of total Company revenues. Geographic area information is included in Note 9.\nACC operates an advanced telecommunications network consisting of seven long distance international and domestic switches located in the United States, Canada and the United Kingdom; a local exchange switch in the United States; leased transmission lines; and network management systems designed to optimize traffic routing.\nAt December 31, 1995, approximately $14.8 million of the Company's telecommunications equipment was located on 50 university, college, and preparatory school campuses in the Northeastern United States and in the United Kingdom. Each of these institutions has signed agreements, with terms ranging from three to eleven years, for the provision of a variety of services by the Company.\nIn the United States, the Federal Communications Commission (''FCC'') and relevant state Public Service Commissions (''PSCs'') have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities, and the terms and conditions under which the Company's services are provided. In Canada, services provided by ACC TelEnterprises Ltd. are subject to or affected by certain regulations of the Canadian Radio-Television and Telecommunications Commission (the ''CRTC''). The telecommunications services provided by ACC Long Distance U.K. Ltd. are subject to and affected by regulations introduced by The Office of Telecommunications, the U.K. telecommunications regulatory authority (''Oftel'').\nIn addition to regulation, the Company is subject to various risks in connection with the operation of its business. These risks include, among others, dependence on transmission facilities-based carriers and suppliers, price competition and competition from larger industry participants.\nConcentrations with respect to trade receivables are limited, except with respect to resellers, due to the large number of customers comprising the Company's customer base and their dispersion across many different industries and geographic regions. At December 31, 1995, approximately 14% of the Company's billed accounts receivable balance was due from resellers.\nThe Company has contracted with a vendor to purchase license rights to certain software used in its operations. The Company believes that it is currently the only customer of the vendor and, as a result, the vendor is financially dependent on the Company. Any future modifications or enhancements to such software are dependent on the continued viability of the vendor.\nA. DISCONTINUED OPERATIONS:\nIn 1993, the Company recorded a gain of $11.5 million, or $1.64 per share, net of a provision for income taxes of $8.4 million, related to the sale of the operating assets and liabilities of its cellular subsidiary, Danbury Cellular Telephone Co. The proceeds of the sale were approximately $43.0 million, of which $41.0 million was received in October, 1993 with the remaining $2.0 million received in October, 1994. Revenue related to this business segment for the nine months ended September 30, 1993 was $3.9 million. The results of the cellular business segment have been reported separately as discontinued operations in the consolidated statements of operations.\nB. ASSET WRITE-DOWN:\nIn 1993, the Company recorded a non-cash pretax charge of $12.8 million related to write-downs of certain assets of the Company's U.S. and Canadian operations.\nThe U.S. write-down of intangibles amounted to approximately $1.2 million. The intangibles written off resulted from the acquisition of a number of businesses since 1985. Changes in the Company's operations since those companies were acquired, as well as an evaluation of the future undiscounted cash flow from those acquisitions, led the Company to the conclusion that the purchased intangibles no longer had value.\nThe write-down of fixed assets in the U.S. totaled approximately $5.1 million which represented the excess of net book value over estimated recoverable value for certain assets. These assets were written down due to technological changes which made it uneconomical for the Company to continue to use these assets in the production of revenue. Included in this amount was approximately $3.0 million of equipment related to the Company's 180 mile microwave network in New York State.\nThe Canadian write-down included approximately $2.8 million for acquired customer base and accounts receivable and $3.8 million for autodialing equipment. The write-down of the customer base and accounts receivable was due to the future undiscounted cash flow from those acquisitions being significantly less than originally anticipated.\nThe write-down of autodialing equipment reflected the excess of net book value over estimated recoverable value for those assets as a direct effect of the decision of the Canadian Radio-Television and Telecommunications Commission on July 23, 1993, which resulted in the implementation, starting in July, 1994, of equal access in Canada. These assets were fully depreciated at December 31, 1994.\nC. EQUAL ACCESS COSTS:\nDuring 1994, the Company initiated the process of converting its network to equal access for its Canadian customers. Costs associated with this process were approximately $2.2 million and include maintaining duplicate network facilities during transition, recontacting customers, and the administrative expenses associated with accumulating the data necessary to convert the Company's customer base to equal access.\n3. DEBT, LINES OF CREDIT, AND FINANCING ARRANGEMENTS\nA. DEBT:\nThe Company had the following debt outstanding as of December 31, 1995 and 1994 (dollars in thousands):\nBased on borrowing rates currently available to the Company for loans and lease agreements with similar terms and average maturities, the fair value of its debt approximates its recorded value.\nB. SENIOR CREDIT FACILITY AND LINES OF CREDIT:\nOn July 21, 1995, the Company entered into an agreement for a $35.0 million five year senior revolving credit facility with two financial institutions. Borrowings are limited individually to $5.0 million for ACC Long Distance UK Ltd. and $2.0 million for ACC National Telecom Corp., with total borrowings for the Company limited to $35.0 million. Initial borrowings under the agreement were used to pay down and terminate the Company's previously existing lines of credit and to pay fees related to the transaction. Subsequent borrowings have been, and will be, used to finance capital expenditures and to provide working capital. Fees associated with obtaining the financing are being amortized over the term of the agreement.\nIn conjunction with the closing, the Company issued to a financial advisor warrants to purchase 30,000 shares of the Company's Class A Common Stock at an exercise price of $16.00 per share. The warrants expire on January 21, 1999.\nThe agreement limits the amount that may be borrowed against this facility based on the Company's operating cash flow. The agreement also contains certain covenants including restrictions on the payment of dividends, maintenance of a maximum leverage ratio, minimum debt service coverage ratio, maximum fixed charge coverage ratio and minimum net worth, all as defined under the agreement, and subjective covenants. Regarding a certain subjective covenant related to transactions with affiliates (see Note 10), a waiver was obtained covering such transactions through December 31, 1995. At December 31, 1995, the Company had available $8.7 million under this facility. The total available facility will be reduced in quarterly increments of $2.450 million from July 1, 1997 to October 1, 1998, $2.905 million from January 1, 1999 to April 1, 2000 and by $2.870 million on maturity at July 1, 2000. Borrowings under the facility are secured by certain of the Company's assets and will bear interest at either the LIBOR rate or the base rate (base rate being the greater of the prime interest rate or the federal funds rate plus 1\/2 %), with additional percentage points added based on a ratio of debt to operating cash flow, as defined in the facility agreement. The weighted average interest rate for borrowings during 1995 was 8.4%.\nUnder the agreement, the Company is obligated to pay the financial institutions an aggregate contingent interest payment based on the minimum of $750,000 or the appreciation in value of 140,000 shares of the Company's Class A Common Stock over the 18 month period ending January 21, 1997, but not to exceed $2.1 million. The contingent interest is due upon the earlier of the occurrence of a triggering event, as defined, or 18 months after the closing date.\nIn connection with the agreement, the Company must enter into hedging agreements with respect to interest rate exposure. The agreements have certain conditions regarding the interest rates, are subject to minimum aggregate balances of $10.0 million and must have durations of at least two years. The Company entered into three interest rate swap agreements in 1995 to convert the variable interest rate charged on $11.5 million of the outstanding credit facility to a fixed rate. Under these agreements, the Company is required to pay a fixed rate of interest on a notional principal balance. In return, the Company receives a payment of an amount equal to the variable rate calculated as of the beginning of the month. The interest rate swap agreements in effect as of December 31, 1995, are as follows:\nVariable FIXED NOTIONAL BALANCE Rate RATE\n$2,000,000 5.938% 5.98% $7,500,000 5.938% 6.25% $2,000,000 5.938% 6.02%\nThese agreements expire at various times through November, 1998.\nAt December 31, 1995, the Company has issued letters of credit totaling $1.4 million which reduce the available balance of the credit facility. The letters of credit guarantee performance to third parties. Management does not expect any material losses to result from these off-balance sheet instruments because the Company will meet its obligations to the third parties, and therefore, management is of the opinion that the fair value of these instruments is zero.\nAs of December 31, 1994, the Company had available up to $30.0 million under two separate bank-provided line of credit agreements. During 1995, the Company obtained a commitment letter to extend its then existing lines of credit for a period greater than twelve months. In accordance with SFAS No. 6, ''Classification of Short- Term Obligations Expected to be Refinanced,'' the outstanding lines of credit borrowings at December 31, 1994 were classified as long-term debt.\nEach agreement was an unsecured working capital line for up to $15.0 million at the respective bank's prime rate. Outstanding principal under each line of credit was due on demand. At December 31, 1994, the Company had available approximately $3.1 million under one line of credit. The weighted average interest rate for borrowings on this line during 1994 and 1995 was 7.4% and 8.9% respectively. At December 31, 1994, the Company had available $66,000 under the second line of credit. The weighted average interest rate for borrowings on this line during 1994 and 1995 was 7.8% and 8.8%, respectively.\n4. 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 SFAS No. 109, ''Accounting for Income Taxes.'' The cumulative effect of adopting this Statement as of January 1, 1993 was immaterial to net income.\nThe following is a summary of the U.S. and non-U.S. income (loss) from continuing operations before provision for (benefit from) income taxes and minority interest, the components of the provision for (benefit from) income taxes and deferred income taxes, and a reconciliation of the U.S. statutory income tax rate to the effective income tax rate.\nIncome (loss) from continuing operations before provision for (benefit from) income taxes and minority interest (dollars in thousands):\nProvision for (benefit from) income taxes (dollars in thousands):\nProvision for (benefit from) deferred income taxes (dollars in thousands):\nReconciliation of U.S. statutory income tax rate to effective income tax rate:\nDeferred income tax assets and liabilities 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. At December 31, 1995, the Company had unused tax benefits of approximately $9.8 million related to non-U.S. net operating loss carryforwards totaling $25.3 million for income tax purposes, of which $14.4 million have an unlimited life, $2.6 million expire in 2000, $7.7 million expire in 2001, and $0.6 million expire in 2002. In addition, the Company had $1.1 million of deferred tax assets related to non-U.S. temporary differences. The valuation allowance was increased by $3.5 million to approximately $10.9 million to offset the related non- U.S. deferred tax assets due to the uncertainty of realizing the benefit of the non-U.S. loss carryforwards.\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31, (dollars in thousands):\n5. REDEEMABLE PREFERRED STOCK\nOn May 22, 1995, the Company completed a $10.0 million private placement of 12% subordinated convertible debt to a group of investors. The notes were converted into 10,000 shares of cumulative, convertible Series A Preferred Stock on September 1, 1995. The Series A Preferred Stock has a liquidation value of $1,000 per share, and accrues cumulative dividends, compounded on the accumulated and unpaid balance, as defined, at a rate of 12% annually. The dividends shall accrue whether or not the dividends have been declared and whether or not there are profits, surplus or other funds of the Company legally available for the payment of dividends. The dividends are payable upon redemption unless the Series A Preferred Stock is converted into Class A Common Stock at an initial conversion price of $16.00 per share, or 625,000 shares, subject to certain adjustments and conditions. The conversion price can fluctuate if the Company, among other actions, grants or sells options at prices less than the conversion price of the Series A Preferred Stock, or issues or sells convertible securities at a price per share less than the conversion price of the Series A Preferred Stock.\nOn the seventh anniversary of the private placement, all of the outstanding shares of Series A Preferred Stock shall be redeemed in cash or in a combination of cash and Class A Common Stock. Redemption may be made at the price per share equal to the greater of (I) the liquidation value ($1,000 per share) plus all accrued and unpaid dividends; or (ii) the fair market value of the underlying Class A Common Stock into which the Series A Preferred Stock is convertible. Optional redemptions of all or a portion of shares, as defined, of the then outstanding shares are permitted at any time.\nAll of the issued and outstanding Series A Preferred Stock will be automatically converted into Class A Common Stock if, after the second anniversary of the closing: (I) the daily trading volume of the Class A Common Stock exceeds 5% of the number of shares of Class A Common Stock issuable upon conversion of the Series A Preferred Stock for 45 consecutive trading days; (ii) the holders of the Series A Preferred Stock are not subject to any underwriters' lockup agreement restricting transferability of the shares of Class A Common Stock issuable upon conversion of such Series A Preferred Stock; and (iii) the average closing price of the Class A Common Stock for 15 consecutive trading days, through July 2002, equals or exceeds the price, as defined, ranging from $32.00 to $57.33 per share.\nNoncompliance with the terms of the Series A Preferred Stock and the agreement under which the Series A Preferred Stock was issued, can result depending on the cause of the default in an increase of the dividend rate to 15 percent, a one-third reduction in the conversion price which existed prior to the event of default, or immediate redemption at the liquidation value plus accrued and unpaid dividends.\nConcurrent with the private placement, warrants to purchase 100,000 shares of the Company's Class A Common Stock were issued at an initial exercise price of $16.00 per share. These warrants expire in July 2002. In addition, the Company issued warrants to purchase Class A Common Stock that will become exercisable upon one or more optional repayments of the Series A Preferred Stock at an exercise price of $16.00 per share, subject to adjustments, as defined, and will permit each holder to acquire initially the same number of shares of Class A Common Stock into which the Series A Preferred Stock is convertible as of the relevant repayment date. These warrants expire in July 2002.\nThe Series A Preferred Stock is senior to all classes and series of preferred stock and Class A Common Stock as to the payment of dividends and redemptions, and upon liquidation at liquidation value, senior to all other classes of the Company's capital stock. In certain circumstances, the holders of the Series A Preferred Stock will have preemptive rights to purchase, on an as- converted basis, a pro rata portion of certain Class A Common Stock issuances by the Company. The holders of the Series A Preferred Stock are entitled to elect one director to the Company's Board of Directors, so long as at least 33% of the Series A Preferred Stock is outstanding. The holders also have the right to approve certain transactions, as defined, including the payment of dividends and acquisition of shares of treasury stock.\nAt December 31, 1995, the Series A Preferred Stock is reflected on the accompanying balance sheet as redeemable preferred stock, and is shown inclusive of cumulative unpaid dividends, and net of unamortized issuance costs of approximately $1.1 million. The carrying value of the redeemable preferred stock will be accreted to the liquidation value, as defined, over the seven year term.\n6. EQUITY\nDuring 1995, the Company's shareholders approved an amendment to the Company's Certificate of Incorporation that authorized the creation of 2,000,000 shares of Series A Preferred Stock, par value $1.00 per share, authorized the creation of 25,000,000 shares of Class B non-voting Common Stock, par value $.015 per share, and redesignated the 50,000,000 shares of Common Stock, par value $.015 per share, that were previously authorized for issuance as 50,000,000 shares of Class A Common Stock.\nA. PRIVATE PLACEMENT:\nDuring 1995, the Company made an offshore sale of 825,000 shares of its Class A Common Stock at an average price of $14.53 per share. The sale raised net proceeds of $11.1 million, after deduction of fees and expenses of $0.9 million. In conjunction with this transaction, warrants to purchase 82,500 shares of Class A Common Stock at an exercise price of $14.40 per share were issued. These warrants were exercised prior to December 31, 1995.\nB. EMPLOYEE LONG TERM INCENTIVE PLAN:\nIn October 1994, the Company's shareholders approved an amendment to the Employee Long Term Incentive Plan whereby options to purchase an aggregate of 2,000,000 shares of Class A Common Stock may be granted to officers and key employees of the Company. In July 1995, shareholders of the Company approved an additional 500,000 shares of Class A Common Stock to be reserved for issuance under this plan, and authorized the issuance of stock incentive rights (\"SIRs\") thereunder. The exercise price of the stock options must not be less than the market value per share at the date of grant, and no options shall be exercisable after ten years and one day from the date of grant. Options generally become exercisable on a pro-rata basis over a four-year period beginning on the date of grant and 25% on each of the three anniversary dates thereafter. SIRs represent the right to receive shares of the Company's Class A Common Stock without any cash payment to the Company, conditioned only on continued employment with the Company through a specified incentive period of at least three years. At December 31, 1995, no SIRs had been awarded under the plan.\nChanges in the status of the plan during 1995, 1994, and 1993 are summarized as follows:\nThe Company is required to adopt SFAS No. 123, ''Accounting for Stock-Based Compensation'' in 1996. This Statement encourages entities to adopt a fair value based method of accounting for employee stock option plans (whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the employee service period) rather than the current intrinsic value based method of accounting (whereby compensation cost is measured at the grant date as the difference between market value and the price for the employee to acquire the stock). If the Company elects to continue using the intrinsic value method of accounting, pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting had been applied, will need to be disclosed. Management has not decided if the Company will adopt the fair value based method of accounting for their stock option plans. The Company believes that adopting the fair value basis of accounting could have a material impact on the financial statements and such impact is dependent upon future stock option activity.\nC. EMPLOYEE STOCK PURCHASE PLAN:\nIn October 1994, the Company's shareholders approved an employee stock purchase plan which allows eligible employees to purchase shares of the Company's Class A Common Stock at 85% of market value on the date on which the annual offering period begins, or the last business day of each calendar quarter in which shares are purchased during the offering period, whichever is lower. Class A Common Stock reserved for future employee purchases aggregated 463,684 shares at December 31, 1995. There were 12,754 shares issued at an average price of $11.89 per share during the year ended December 31, 1994 and 23,562 shares issued at an average price of $12.56 per share during the year ended December 31, 1995. There have been no charges to income in connection with this plan other than incidental expenses related to the issuance of shares.\n7. TREASURY STOCK\nIn January 1994, an officer of the Company exercised stock options to acquire 99,000 shares of the Company's Class A Common Stock at $3.30 per share by delivering to the Company 16,542 common shares at the then current market price of $19.75 per share.\nThe average cost of all treasury stock currently held by the Company is $2.22 per share.\n8. COMMITMENTS AND CONTINGENCIES\nA. Operating Leases:\nThe Company leases office space and other items under various agreements expiring through 2004. At December 31, 1995, the minimum aggregate payments under non-cancelable operating leases are summarized as follows (dollars in thousands): YEAR Amount\n1996 $ 3,804 1997 3,734 1998 3,314 1999 4,458 2000 1,924 Thereafter 7,134 $24,368\nRent expense for the years ending December 31, 1995, 1994 and 1993 was approximately $1,965,000, $1,640,000, and $1,369,000, respectively.\nB. EMPLOYMENT AND OTHER AGREEMENTS:\nIn October 1995, the Company's former Chief Executive Officer resigned his position, but remains an employee and Chairman of the Company's Board of Directors. A new Chief Executive Officer was hired. In conjunction with the management changes, the Company entered into agreements with both executives. The contract with the Chief Executive Officer has a two year term and provides for continuation of salary and benefits for the term of the agreement, in the event of a change in control of the Company. At December 31, 1995, the Company's maximum potential liability under this agreement was approximately $660,000. The contract with the Chairman of the Board provides for an annual base salary, including an annual bonus and other benefits, and also for a payment of $1.0 million, payable over a three year term, in the event that he resigns or is terminated without cause. Payments under this agreement are accelerated and are due in full within 30 days following a change in control of the Company. In consideration for a non- compete agreement, the Chairman of the Board received a payment of $750,000, which was expensed in 1995.\nThe Company has entered into employee continuation incentive agreements with certain other key management personnel. These agreements provide for continued compensation and continued vesting of options previously granted under the Company's Employee Long Term Incentive Plan for a period of up to one year in the event of termination without cause or in the event of termination after a change in control of the Company. At December 31, 1995, the Company's maximum potential liability under these agreements totaled approximately $2.5 million.\nIn connection with the sale of cellular assets, the Company entered into an agreement with an officer. The agreement called for a fee of approximately $0.6 million to be paid as a result of the closing of the sale of the Company's cellular assets. This amount was placed in an escrow account at the time of the sale. The agreement requires, among other things, that the officer remain an employee of the Company through July 1, 1996. During 1994, the officer had an outstanding loan from the Company in the amount of $0.2 million. Subsequent to December 31, 1994, the agreement was amended to accelerate the vesting provisions and funds from the escrow account were used to repay the loan.\nC. PURCHASE COMMITMENT:\nIn 1993, ACC Long Distance Ltd., a subsidiary of ACC TelEnterprises Ltd., entered into an agreement with one of its vendors to lease long distance facilities totaling a minimum of Cdn. $1.0 million per month for eight years. The Company currently leases more than Cdn. $1.0 million per month of such facilities from this vendor. This commitment allows the Company to receive up to a 60 percent discount on certain monthly charges from this vendor.\nD. DEFINED CONTRIBUTION PLANS:\nThe Company provides a defined contribution 401(k) plan to substantially all U.S. employees. Amounts contributed to this plan by the Company were approximately $137,000, $167,000, and $183,000 in 1993, 1994 and 1995, respectively. The Company's Canadian subsidiary provides a registered retirement savings plan to substantially all Canadian employees. Amounts contributed to this plan by the Company were Cdn. $28,000, Cdn. $62,000 and Cdn. $106,000 in 1993, 1994 and 1995, respectively.\nE. ANNUAL INCENTIVE PLAN:\nDuring 1995, the Company's Board of Directors authorized incentive bonuses based upon the Company's sales, gross margin, operating expenses and operating income. Prior to 1995, incentive bonuses were discretionary as determined by the Company's management and approved by the Board of Directors. The amounts included in operations for these incentive bonuses were approximately $619,000, $633,000 and $1.4 million for the years ended December 31, 1993, 1994 and 1995, respectively.\nF. LEGAL MATTERS:\nThe Company is subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability as of December 31, 1995 will not have a material adverse effect on the Company's financial condition or results of operations.\n9. GEOGRAPHIC AREA INFORMATION (DOLLARS IN THOUSANDS)\nIntercompany revenue is recognized when calls are originated in one country and terminated in another country over the Company's leased network. This revenue is recognized at rates similar to those of unaffiliated companies. Income from continuing operations before income taxes of the Canadian and United Kingdom operations includes corporate charges for general corporate expenses and interest.\nCorporate general and administrative expenses are allocated to subsidiaries based on actual time dedicated to each subsidiary by members of corporate management and staff.\n10. RELATED PARTY TRANSACTIONS\nIn February 1994, the Company's Board of Directors approved a plan to move the Company's headquarters to a new facility in Rochester, New York. The new location is in a building owned by a partnership in which the Company's Chairman of the Board has a fifty percent ownership interest. A Special Committee of the Company's Board of Directors reviewed the lease to ensure that the terms and conditions were commercially reasonable and fair to the Company prior to approval of the plan. Minimum monthly lease payments for this space range from $44,000 to $60,000 over the ten year term of the lease, which began on May 1, 1994. The Company also pays a pro-rata share of maintenance costs. Total rent and maintenance payments under this lease were approximately $0.2 million and $0.6 million during 1994 and 1995, respectively.\nDuring 1994 and early 1995, the Company initiated efforts to obtain new telecommunications software programs from a software development company. The Company's Chairman of the Board and former Chief Executive Officer was a controlling shareholder of the software development company during such period. In May 1995, anticipating material agreements with the software development company, all of the common shares owned by the Company's Chairman of the Board were placed in escrow under the direction of a Special Committee of the Company's Board of Directors. The Special Committee, its outside consultants and the Company's management then proceeded to review and evaluate the software technology and the terms and conditions of the proposed transactions.\nSubsequent to December 31, 1995, the Special Committee approved a software license agreement between the Company and a newly formed company (the purchaser of the software development company's intellectual property and other assets and an affiliate of such company). Immediately prior to entering into the agreement, the shares of the software development company held in escrow were returned to such company and the related party nature of the Company's relationship with the software development company was thereby extinguished. Total amounts accrued at December 31, 1994 and 1995 relating to this vendor were $0 and $44,000, respectively. For an aggregate consideration of $1.8 million, the Company in return will receive a perpetual right to use the newly developed telecommunications software programs. During 1995, the Company paid the software development company $1.2 million, of which $772,000, relating to the purchase of certain hardware and acquisition of certain software licenses, was capitalized and recorded on the balance sheet as a component of property, plant and equipment and $500,000 relating to software development was expensed. During 1994, the Company paid the software development company $132,000, all of which related to software development, which was expensed.\n11. SUBSEQUENT EVENTS\nA. Telecommunications Legislation Revisions:\nLegislation that substantially revises the U.S. Communications Act of 1934 (the ''U.S. Communications Act'') was recently enacted by Congress and was signed into law on February 8, 1996. The legislation provides specific guidelines under which the regional operating companies (''RBOCs'') can provide long distance services, which will permit the RBOCs to compete with the Company in the provision of domestic and international long distance services. Further, the legislation, among other things, opens local service markets to competition from any entity (including long distance carriers, such as AT&T, cable television companies and utilities).\nBecause the legislation opens the Company's U.S. markets to additional competition, particularly from the RBOCs, the Company's ability to compete is likely to be adversely affected. Moreover, as a result of and to implement the legislation, certain federal and other governmental regulations will be amended or modified, and any such amendment or modification could have a material adverse effect on the Company's business, results of operations and financial condition.\nB. NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN:\nOn January 19, 1996, subject to shareholder approval, the Company's Board of Directors adopted a Non-Employee Directors' Stock Option Plan (the Directors' Stock Option Plan). The Directors' Stock Option Plan provides for grants of options to purchase 5,000 shares of Class A Common Stock at an exercise price of 100% of the fair market value of the stock on the date of grant, which options vest at the first anniversary of the date of grant. The maximum number of shares with respect to which options may be granted under the Directors' Stock Option Plan is 250,000 shares, subject to adjustment for stock splits, stock dividends and the like. Vested options to purchase 20,000 shares of Class A Common Stock were granted on January 19, 1996, pursuant to this plan, subject to shareholder approval of the plan at the Company's 1996 Annual Meeting.\nEach option shall be exercisable for ten years and one day after its date of grant. Any vested option is exercisable during the holder's term as a director (in accordance with the option's terms) and remains exercisable for one year following the date of termination as a director (unless the director is removed for cause). Exercise of the options would involve payment in cash, securities, or a combination of cash and securities.\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 following sets forth information concerning the Directors and executive officers of the Company and its principal operating subsidiaries as of March 1, 1996:\nNAME AGE POSITION(S)\nRichard T. Aab 46 Chairman of the Board of Directors David K. Laniak 60 Chief Executive Officer, Director Arunas A. Chesonis 33 President and Chief Operating Officer, Director Michael R. Daley 34 Executive Vice President, Chief Financial Officer and Treasurer Steve M. Dubnik 33 Chairman of the Board of Directors, President and Chief Executive Officer, ACC TelEnterprises Ltd. Michael L. LaFrance 36 President, ACC Long Distance Corp. Christopher Bantoft 48 Managing Director, ACC Long Distance UK Ltd. John J. Zimmer 37 Vice President--Finance George H. Murray 49 Vice President--Human Resources and Corporate Communications Sharon L. Barnes 29 Controller Hugh F. Bennett 39 Director Willard Z. Estey 76 Director Daniel D. Tessoni 48 Director Robert M. Van Degna 51 Director\nRichard T. Aab is a co-founder of the Company who has served as Chairman of the Board of Directors since March 1983 and as a Director since October 1982. Mr. Aab also served as Chief Executive Officer from August 1983 through October 1995, and as Chairman of the Board of Directors of ACC TelEnterprises Ltd. from April 1993 through February 1994.\nDavid K. Laniak was elected the Company's Chief Executive Officer in October 1995. Mr. Laniak has been a Director of the Company since February 1989. Prior to joining the Company, Mr. Laniak was Executive Vice President and Chief Operating Officer of Rochester Gas and Electric Corporation, Rochester, New York, where he worked in a variety of positions for more than 30 years. Mr. Laniak also has served since October 1995 and from May 1993 through July 1994 served as a Director of ACC TelEnterprises Ltd.\nArunas A. Chesonis was elected President and Chief Operating Officer of the Company in April 1994. He previously served as President of the Company and of its North American operations since April 1994, and as President of ACC Long Distance Corp. from January 1989 through April 1994. From August 1990 through March 1991, he also served as President of ACC TelEnterprises Ltd., and from May 1987 through January 1989, Mr. Chesonis served as Senior Vice President of Operations for ACC Long Distance Corp. Mr. Chesonis was elected a Director of the Company in October 1994.\nMichael R. Daley was elected the Company's Executive Vice President and Chief Financial Officer in February 1994, and has served as Treasurer of the Company since March 1991. He previously served as the Company's Vice President-Finance from August 1990 through February 1994, as Treasurer and Controller from August 1990 through March 1991, as Controller from January 1989 through August 1990, and various other positions with the Company from July 1985 through January 1989. Mr. Daley has served as a Director of ACC TelEnterprises Ltd. since October 1994.\nSteve M. Dubnik was elected the Chairman of the Board of Directors, President and Chief Executive Officer of ACC TelEnterprises Ltd. in July 1994. Previously, he served from 1992 through June 1994 as President, Mid-Atlantic Region, of RCI Long Distance. For more than five years prior thereto, he served in progressively senior positions with Rochester Telephone Corporation (now Frontier Corp.) including assignments in engineering, operations, information technology and sales.\nMichael L. LaFrance was elected the President of ACC Long Distance Corp. in April 1994. From May 1992 through May 1994, he served as Executive Vice President and General Manager of Axcess USA Communications Corp., from June 1990 through May 1992, as Director of Regulatory Affairs and Administration of LDDS Communications, Inc. and from February 1987 through June 1990, as Vice President of Comtel- TMC Telecommunications. Since April 1994, Mr. LaFrance has served as the President of ACC National Telecom Corp., the Company's local service subsidiary.\nChristopher Bantoft was elected Managing Director of ACC Long Distance UK Ltd. in February 1994. From 1986 through 1993, he served as Sales and Marketing Director, Deputy Managing Director, and most recently as Managing Director of Alcatel Business Systems Ltd., the U.K. affiliate of Alcatel, N.V.\nJohn J. Zimmer, a certified public accountant, was elected the Company's Vice President-Finance in September 1994. He previously served as the Company's Controller from March 1991 through September 1994. Prior to March 1991, he served as a staff accountant and then as a manager of accounting with Arthur Andersen LLP.\nGeorge H. Murray was elected the Company's Vice President-Human Resources and Corporate Communications in August 1994. For more than five years prior to his joining the Company, he served in various senior management positions with First Federal Savings and Loan of Rochester, New York.\nSharon L. Barnes, a certified public accountant, was elected the Company's Controller in September 1994. Previously, she served as Accounting Manager from April 1993 through September 1994. Prior to joining the Company in 1993, she served for more than four years as a staff and senior accountant with Arthur Andersen LLP.\nHugh F. Bennett has been a Director of the Company since June 1988. Since March 1990, Mr. Bennett has been a Vice President, Director and Secretary-Treasurer of Gagan, Bennett & Co., Inc., an investment banking firm.\nThe Hon. Willard Z. Estey, C.C., Q.C., was elected a Director of the Company at its 1994 Annual Meeting. Mr. Estey is Counsel to the Toronto, Ontario law firm of McCarthy, Tetrault. After serving as Chief Justice of Ontario, Mr. Estey was a Justice of the Supreme Court of Canada from 1977 through 1988. From 1988 through 1990, Mr. Estey was Deputy Chairman of Central Capital Corporation, Toronto, Ontario. Since May 1993, Mr. Estey has also served as a Director of ACC TelEnterprises Ltd.\nDaniel D. Tessoni has been a Director of the Company since May 1987. Mr. Tessoni is an Associate Professor of Accounting at the College of Business of the Rochester Institute of Technology, where he has taught since 1977. He holds a Ph.D. degree, is a certified public accountant and is Treasurer of several privately-held business concerns.\nRobert M. Van Degna has been a Director of the Company since May 1995. Mr. Van Degna is Managing Partner of Fleet Equity Partners, an investment firm affiliated with Fleet Financial Group, Inc. and based in Providence, Rhode Island. Mr Van Degna joined Fleet Financial Group in 1971 and held a variety of lending and management positions until he organized Fleet Equity Partners in 1982 and became its general partner. Mr. Van Degna currently serves on the Board of Directors of Orion Network Systems, Inc. and Preferred Networks, Inc., as well as several privately-held companies. Mr. Van Degna was initially elected to the Company's Board of Directors pursuant to the terms of the investment in the Company by Fleet Venture Resources, Inc. and affiliated entities described under the Principal Shareholders Table in Item 12 below.\nCOMPLIANCE WITH SECTION 16 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 other persons who own more than ten percent of the Company's securities (collectively, \"reporting persons\") to file reports of their ownership of and changes in ownership in their Company shareholdings with both the SEC and The Nasdaq Stock Market and to furnish the Company with copies of all such forms (known as Forms 3, 4 and 5) filed. Based solely on its review of the copies of such forms it received and on written representations received from certain reporting persons that they were not required to file a Form 5 report with respect to 1995, the Company believes that with respect to transactions occurring in 1995, all Form 3, 4 and 5 filing requirements applicable to its reporting persons were complied with.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table sets forth information concerning the compensation and benefits paid by the Company for all services rendered during 1995, 1994 and 1993 to five individuals: David K. Laniak, who is and was, at December 31, 1995, serving as the Company's Chief Executive Officer, and Richard T. Aab, Arunas A. Chesonis, Christopher Bantoft, and Steve M. Dubnik, who were, as of December 31, 1995, the other four most highly compensated executive officers of the Company whose 1995 salary and bonus exceeded $100,000 in amount (individually, a \"Named Executive\" and collectively, the \"Named Executives\"):\nSUMMARY COMPENSATION TABLE\n______________________________\nNA Indicates Not Applicable, because the particular Named Executive was not an executive officer of the Company during the year indicated.\n(1) The Company has a two-year Employment Agreement with Mr. Laniak that runs through October 1997, under the terms of which he will receive a base salary of $300,000 per year, plus a bonus determined under the Company's Annual Incentive Plan, plus other benefits given to the Company's other executives. This agreement also provides for payment of his then current compensation and benefits for the remainder of the term of the agreement and vesting of all outstanding stock options if, as a result of or within one year following a change in control of the Company, Mr. Laniak's employment is terminated without cause by the Company or the acquiror or Mr. Laniak voluntarily terminates his employment as a result of certain events, including a significant change in the nature or scope of his duties, relocation outside of the Rochester, New York area or a reduction in his compensation or benefits. The severance payment to Mr. Laniak is conditioned on his agreement not to compete with the Company during and for one year following termination of his employment and to maintain confidentiality of trade secrets.\n(2) Under applicable SEC rules, the value of any perquisites or other personal benefits provided by the Company to any of the Named Executives need not be separately detailed and described if their aggregate value does not exceed the lesser of $50,000 or 10% of that executive's total salary and bonus for the year shown. For the year indicated, the value of such personal benefits, if any, provided by the Company to this Named Executive did not exceed such thresholds.\n(3) In connection with his becoming the Company's new Chief Executive Officer, on October 5, 1995, Mr. Laniak was granted incentive stock options (\"ISOs\") to purchase 17,391 shares of the Company's Class A Common Stock at an exercise price of $17.25 per share, exercisable over a ten-year term, and non-qualified stock options (\"NQSOs\") to purchase 50,609 shares of Class A Common Stock also at an exercise price of $17.25 per share and exercisable over a term of ten years and one day, all under the Company's Employee Long Term Incentive Plan (\"LTI Plan\"). The NQSOs granted are subject to the additional vesting conditions that 50% of such options would vest at such time as the closing price for the Company's Class A Common Stock closed at or above $21.56 per share for 15 consecutive trading days (a 25% increase over their exercise price), with the additional 50% of such options to vest at such time as the closing price for the Company's Class A Common Stock closed at or above $25.88 per share for 15 consecutive trading days (a 50% increase over their exercise price).\n(4) This amount represents additional group term life insurance premiums paid on Mr. Laniak's behalf during 1995.\n(5) Effective October 6, 1995, Mr. Aab resigned his position as the Company's Chief Executive Officer. He remains its Chairman of the Board and an employee of the Company, however. In connection with this change, the Company entered into both a Non-Competition Agreement and a Salary Continuation and Deferred Compensation Agreement with Mr. Aab. Under the terms of Mr. Aab's Non-Competition Agreement, he will not compete against the Company for three years following any \"event of termination\" (as defined in this Agreement) as an employee of the Company and as its Chairman of the Board, for which he received a lump-sum payment of $750,000 in 1995. Under the terms of his Salary Continuation and Deferred Compensation Agreement, Mr. Aab will receive a salary of $200,000 per year, plus a bonus determined under the Company's Annual Incentive Plan, plus continuation of his current benefits for as long as he remains the Chairman of the Board and an employee of the Company. At such time as he ever resigns or is terminated as a Company employee and from serving as the Chairman of the Board, except in a circumstance involving a \"termination for cause\" as defined in this Agreement, he will receive a payment of $1,000,000, payable over a three year term following the date of such termination or resignation, with the payment of such amount accelerated and paid in full within 30 days following a change in control of the Company. Mr. Aab would also receive such payment if, as a condition precedent to, as a result of or within one year following a change in control of the Company, he were terminated for cause.\n(6) On January 3, 1995, Mr. Aab was granted ISOs to purchase 24,644 shares of the Company's Class A Common Stock at an exercise price of $16.23 per share, exercisable over a five-year term, under the LTI Plan.\n(7) Of this total, $750,000 represents the lump sum payment made to Mr. Aab under his Non- Competition Agreement discussed in note (5) above, $4,413 represents the Company's 1995 contribution to Mr. Aab's account under its 401(k) Deferred Compensation and Retirement Savings Plan (\"401(k) Plan\"), and $5,732 represents taxable group term and single policy life insurance premiums paid by the Company on Mr. Aab's behalf during 1995.\n(8) The amounts shown represent the Company's contributions under its 401(k) in the amount of: $ 4,601 for 1994; and $4,497 for 1993; as well as taxable group term and single policy life insurance premiums paid on Mr. Aab's behalf in the amount of: $2,384 in 1994; and $4,808 in 1993.\n(9) Of this total, $155,000 represents Mr. Aab's bonus paid in 1994 for services rendered in 1993, and $175,000 represents the one-time award he was paid in 1993 in connection with the sale of the Company's cellular operations. In early 1993, the Executive Compensation Committee of the Board of Directors determined that certain Company executives, including this Named Executive, were eligible to receive a special one-time award in 1993 contingent upon the execution of a definitive agreement to sell the cellular assets of the Company's Danbury Cellular Telephone Co. subsidiary. This award was paid in lieu of any bonus for services rendered during 1992.\n(10) The Company has entered into Employment Continuation Incentive Agreements with Mr. Chesonis, certain other executive officers of the Company, and key Company personnel, which agreements provide that if such employee is ever terminated without cause or as the result of a change in control of the Company as defined in the agreement, then the employee shall be entitled to receive his\/her then current salary and benefits and continued vesting of any options previously granted under the Company's Employee Long Term Incentive Plan for up to one year following such termination. In addition, should such employee be terminated without cause while he\/she is disabled, or in the event the employee dies during the term of the agreement, any unexercised stock options that he\/she may hold on the date of either such event shall automatically become fully exercisable for one year following such date, subject to the original term of the relevant option grant(s). These agreements also provide for each employee's agreement not to compete with the Company so long as he\/she is receiving payments thereunder. These agreements are for an indefinite term and subject to termination twelve months following receipt of the Company's notice of its intent to terminate them.\n(11) On January 3, 1995, Mr. Chesonis was granted ISOs to purchase 21,700 shares of the Company's Class A Common Stock at an exercise price of $14.75 per share, exercisable over a ten-year term, under the LTI Plan.\n(12) The amounts shown represent the Company's contributions under its 401(k) Plan in the amount of: $4,410 for 1995; $4,806 for 1994; and $4,132 for 1993; as well as additional group term life insurance premiums paid on Mr. Chesonis's behalf in the amount of: $363 in 1995; $267 in 1994; and $151 in 1993.\n(13) On February 8, 1994, Mr. Chesonis was granted ISOs to purchase 50,000 shares of the Company's Class A Common Stock at an exercise price of $19.25 per share, exercisable over a ten-year term, under the LTI Plan. This award was cancelled and regranted on August 11, 1994 at an option exercise price of $14.25 per share.\n(14) On September 7, 1993, Mr. Chesonis was granted ISOs to purchase 30,000 shares of the Company's Class A Common Stock at an exercise price of $15.00 per share, exercisable over a ten-year term, under the LTI Plan.\n(15) The Company has an Employment Agreement with Mr. Bantoft employing him as Managing Director of ACC Long Distance UK Ltd. under the terms of which he will receive a base salary of at least 85,000 per year, plus a bonus determined under the Company's Annual Incentive Plan, plus other benefits given to the Company's other executives. This agreement also provides for payment of his then current compensation and benefits for a period of one year if, as a result of or within one year following a change in control of the Company, Mr. Bantoft's employment is terminated without cause by the Company or the acquiror or Mr. Bantoft voluntarily terminates his employment as a result of certain events, including a significant change in the nature or scope of his duties or a reduction in his compensation or benefits. The agreement also requires Mr. Bantoft to maintain confidentiality of the Company's trade secrets during its term and indefinitely following termination of his employment.\n(16) On January 3, 1995, Mr. Bantoft was granted ISOs to purchase 10,200 shares of the Company's Class A Common Stock at an exercise price of $14.75 per share, exercisable over a ten-year term, under the LTI Plan.\n(17) This amount represents U.K. pension payments made on Mr. Bantoft's behalf during 1995.\n(18) On January 4, 1994, Mr. Bantoft was granted ISOs to purchase 10,000 shares of the Company's Class A Common Stock at an exercise price of $18.75 per share, on August 11, 1994, he was granted ISOs to purchase 15,000 shares of the Company's Class A Common Stock at an exercise price of $14.25 per share, and on November 15, 1994, he was granted ISOs to purchase 25,000 shares of the Company's Class A Common Stock at an exercise price of $17.25 per share, each tranche exercisable over a ten-year term, under the LTI Plan.\n(19) This amount represents U.K. pension payments made on Mr. Bantoft's behalf during 1994.\n(20) The Company has an Employment Agreement with Mr. Dubnik under the terms of which he will receive a base salary of Cdn.$208,312 per year, plus a bonus determined under the Company's Annual Incentive Plan, plus other benefits given to the Company's other executives. The agreement also provides that if Mr. Dubnik is ever terminated without cause or as the result of a change in control of the Company as defined in the agreement, then he will be entitled to receive his\/her then current salary and benefits for one year following such termination. The agreement also provides that Mr. Dubnik will not solicit Company customers during and for one year following the termination of his employment, that he will not compete with the Company so long as he is receiving payments thereunder, and that he will maintain the confidentiality of the Company's trade secrets during the term of the agreement and indefinitely following termination of his employment.\n(21) On January 3, 1995, Mr. Dubnik was granted ISOs to purchase 11,200 shares of the Company's Class A Common Stock at an exercise price of $14.75 per share, exercisable over a ten-year term, under the LTI Plan.\n(22) Of this total, $447 represents additional group term life insurance premiums paid on Mr. Dubnik's behalf, $3,556 represents the Company's 1995 contribution to his Canadian Registered Retirement Savings Plan account, and $30,000 represents moving expense reimbursements paid to Mr. Dubnik during 1995 in connection with his relocation from the Washington, D.C. metropolitan area to Toronto, Canada.\n(23) On August 11, 1994, Mr. Dubnik was granted ISOs to purchase 50,000 shares of the Company's Class A Common Stock at an exercise price of $14.25 per share, exercisable over a ten-year term, under the LTI Plan.\n(24) This amount represents moving expense reimbursements paid to Mr. Dubnik during 1994 in connection with his relocation from the Washington, D.C. metropolitan area to Toronto, Canada.\nCOMPENSATION PURSUANT TO PLANS\nEMPLOYEE LONG TERM INCENTIVE PLAN. The Company has an Employee Long Term Incentive Plan (formerly known as the Employee Stock Option Plan) (the \"LTI Plan\" or \"Plan\"), which it instituted in February, 1982, to provide long- term incentive benefits to key Company employees as determined by the Executive Compensation Committee of the Board of Directors (the \"Committee\"). This Plan is administered by the Committee, whose duties include selecting the employees who will receive stock option grants and\/or awards of stock incentive rights (\"SIRs\") thereunder, the number of SIRs to be awarded and their vesting schedule, and the numbers and exercise prices of the options granted to optionees. In making its selections and determinations, the Committee has substantial flexibility and makes its judgments based largely on the functions and responsibilities of the particular employee, the employee's past and potential contributions to the Company's profitability and growth, and the value of the employee's service to the Company. Options granted under this Plan are either intended to qualify as \"incentive stock options\" (\"ISOs\") within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or are non- qualified stock options (\"NQSOs\"). Options granted under this Plan represent rights to purchase shares of the Company's Class A Common Stock within a fixed period of time and at a cash price per share (\"exercise price\") specified by the Committee on the date of grant. The exercise price cannot be less than the fair market value of a share of Class A Common Stock on the date of award. Payment of the exercise price may be made in cash or, with the Committee's approval, with shares of the Company's Class A Common Stock already owned by the optionee and valued at their fair market value as of the exercise date. Options are exercisable during the period fixed by the Committee, except that no ISO may be exercised more than ten years from the date of grant, and no NQSO may be exercised more than ten years and one day from the date of the grant.\nBeginning in July 1995, the Committee is also authorized, in its discretion, to award SIRs under the Plan. SIRs are rights to receive shares of the Company's Class A Common Stock without any cash payment to the Company, conditioned only on continued employment with the Company throughout a specified incentive period of at least three years. In general, the recipient must remain employed by the Company for the designated incentive period before receiving the shares subject to the SIR award; earlier termination of employment, except in the event of death, permanent disability or normal retirement, would result in the automatic cancellation of an SIR. Should an SIR holder die, become permanently disabled or retire during an SIR incentive period, he\/she, or his\/her estate, as the case may be, would receive a pro-rated number of the shares underlying the SIR award based upon the ratio that the number of months since the SIR had been granted bore to the designated incentive period, less any shares already issued in the case of an SIR with a staggered vesting schedule.\nDuring the incentive period, should the Company declare any cash dividends on its Class A Common Stock, the holder of an SIR would be entitled to receive from the Company cash \"dividend equivalent\" payments equal to any such cash dividends that the holder would have received had he\/she owned the shares of Class A Common Stock underlying his\/her SIR. However, the holder of an SIR would not have any other rights with respect to the shares underlying an SIR award, E.G., the right to vote or pledge such shares, until such shares were actually issued to the holder.\nAn employee can be awarded both SIRs and stock options in any combinations that the Committee may determine. In such an event, an exercise of an option would not in any way affect or cancel any SIRs an employee may have received, nor would the earnout of shares under an SIR award in any way affect or cancel any options held by an employee.\nThe following table shows information concerning options granted under this Plan during 1995 to the five Named Executives:\nOPTION GRANTS IN LAST FISCAL YEAR\n_________________________________\n(1) These calculations show the potential gain that would be realized if the options shown were not exercised until the end of their full five- or ten-year term, assuming the compound annual rate of appreciation of the exercise prices indicated (0%, 5%, and 10%) over the respective terms of the options shown, net of the exercise prices paid.\n(2) These options were granted on October 5, 1995. Of this total, 17,391 are ISOs and 50,609 are NQSOs. The ISOs are for a term of ten years, one-third of which first exercisable on April 5, 1996, and an additional one-third of which become exercisable on the first and second anniversaries of the grant date. The NQSOs are for a term of ten years and one day, and are subject to the additional vesting conditions that 50% of such options will vest at such time as the closing price for the Company's Class A Common Stock is at or above $21.56 per share for 15 consecutive trading days (a 25% increase over their exercise price), with the additional 50% of such options to vest at such time as the closing price for the Company's Class A Common Stock is at or above $25.88 per share for 15 consecutive trading days (a 50% increase over their exercise price).\n(3) These ISOs were granted on January 3, 1995, for a term of five years, 25% of which first became exercisable on July 4, 1995, and an additional 25% of which become exercisable on the first, second and third anniversaries of the grant date.\n(4) These ISOs were granted on January 3, 1995, for a term of ten years, 25% of which first became exercisable on July 4, 1995, and an additional 25% of which become exercisable on the first, second and third anniversaries of the grant date.\nThe following table reflects information concerning option exercises under this Plan by the Named Executives during 1995, together with information concerning the number and value of all unexercised options held by each of the Named Executives at year end 1995 under this Plan:\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n________________________________\n(1) For each Named Executive, these values are calculated by subtracting the per share option exercise price for each block of options held on December 31, 1995 from the closing price of the Company's Class A Common Stock on that date ($23.06 on December 29, 1995), then multiplying that figure by the number of options in that block, then aggregating the resulting subtotals.\nAs of December 31, 1995, 483,108 shares of the Company's Class A Common Stock were available for grants under this Plan. As of that date, there were 1,070,919 options outstanding, with a weighted average exercise price of $14.04 per share. The expiration dates of these option grants range from May 22, 1999 through October 6, 2005. During 1995, no SIRs were awarded under the Plan.\n401(K) DEFERRED COMPENSATION AND RETIREMENT SAVINGS PLAN. The Company has a 401(k) Deferred Compensation and Retirement Savings Plan in which employees with a minimum of six months continuous service are eligible to participate. Contributions to a participating employee's 401(k) account are made in accordance with the regulations set forth under Section 401 of the Internal Revenue Code of 1986, as amended. Under this Plan, the Company may make matching contributions to the account of a participating employee up to an annual maximum of 50% of the annual salary contributed in that year by that employee, up to a maximum of 3% of that employee's salary. The Company's contributions vest at the rate of 20% per year of credited service as defined in the plan and become fully vested after five years of credited service.\nEMPLOYEE STOCK PURCHASE PLAN. The Company has an Employee Stock Purchase Plan (\"Stock Purchase Plan\"), in which all employees who work 20 or more hours per week are eligible to participate. Under this Plan, employees electing to participate can, through payroll deductions, purchase shares of the Company's Class A Common Stock at 85% of market value on the date on which the annual offering period under this Plan begins or on the last business day of each calendar quarter in which shares are automatically purchased for a participant during an offering period, whichever is lower. Participants cannot defer more than 15% of their base pay into this Plan, nor purchase more than $25,000 per year of the Company's Class A Common Stock through this Plan. As of December 31, 1995, participants had purchased a total of 36,316 shares through this Plan, at an average price during 1995 of $12.56 per share, leaving a total of 463,684 shares available for future purchases under the Plan.\nANNUAL INCENTIVE PLAN. The Company has an annual incentive plan, which it instituted in 1995, pursuant to which the annual cash bonuses paid to the Company's senior management and key personnel are determined. Under this plan, at the beginning of a fiscal year, the Executive Compensation Committee of the Board establishes performance targets based upon the Company's revenues, gross margin, operating expenses and operating income for that fiscal year. At the end of that year, the extent to which these performance targets were met for the year determines the bonuses, if any, to be paid for that year.\nOTHER COMPENSATION PLANS. The Company provides additional group term life and supplemental disability insurance coverage to its officers. The additional group term life insurance provides additional life insurance protection to an officer in the amount of two and one-half times his\/her current salary. The supplemental disability insurance provides additional disability insurance protection to an officer in an amount selected by the executive, not to exceed, when combined with the coverage provided by the Company's basic disability insurance provided to all of its employees, 70% of his\/her current annual salary.\nThe Company also has a legal, medical and financial planning reimbursement plan for its senior executives pursuant to which it will reimburse each of them generally up to $4,000 per year (up to $12,000 per year for Mr. Aab) for legal, accounting, financial planning and uninsured medical expenses incurred by the executive.\nCOMPENSATION OF DIRECTORS\nDirectors who are not also employees of the Company are paid an annual retainer of $6,000, plus a fee of $500 for each Board meeting attended. Additionally, outside Directors who serve on committees of the Board receive $300 per committee meeting attended.\nOn January 19, 1996, subject to obtaining shareholder approval at their 1996 Annual Meeting, the Company's Board of Directors adopted a Non-Employee Directors' Stock Option Plan (the \"Directors Stock Option Plan\"), and Messrs. Bennett, Estey, Tessoni and Van Degna each received vested options to purchase 5,000 shares of Class A Common Stock at an exercise price of $23.00 per share pursuant to this Plan. Subject to obtaining shareholder approval at the 1996 Annual Meeting, this plan provides for annual grants of non-qualified stock options to purchase 5,000 shares of Class A Common Stock at an exercise price equal to 100% of the fair market value of the stock on the date of grant, which options vest at the first anniversary of the date of grant. The maximum number of shares with respect to which options may be granted under this Plan is 250,000, subject to adjustment for stock splits, stock dividends and the like.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSECURITIES OWNED BY COMPANY MANAGEMENT\nThe following table sets forth, as of March 1, 1996, the number and percentage of outstanding shares of Class A Common Stock beneficially owned by each Director of the Company, by each of the four Named Executives (in addition to Mr. Laniak) named in the compensation tables that appear in Item 11 above and by all Directors and executive officers of the Company as a group. The Company believes that each individual in this group has sole investment and voting power with respect to his or her shares subject to community property laws where applicable and except as otherwise noted:\nName of Nominee for Director Shares Beneficially Owned OR EXECUTIVE OFFICER NUMBER PERCENTAGE\nRichard T. Aab 927,554 (1) 11.5\nHugh F. Bennett 3,000 (2) * Arunas A. Chesonis 86,508 (3) 1.1 Willard Z. Estey -0- * David K. Laniak 62,406 (4) * Daniel D. Tessoni 22,500 (5) * Robert M. Van Degna 725,000 (6) 8.3 Christopher Bantoft 20,100 (7) * Steve M. Dubnik 20,100 (8) *\nAll Directors and Executive Officers as a Group (14 persons, including those named above) 1,955,917 (1) (2) 21.7 (3) (4) (5) (6) (7) (8) (9) __________________________________\n* Indicates less than 1% of the Company's issued and outstanding shares.\n(1) This number includes 139,500 shares that are owned by Melrich Associates, L.P., a family partnership of which Mr. Aab is a general partner and therefore shares investment and voting power with respect to such shares, and options to purchase 12,322 that are currently exercisable by Mr. Aab. Does not include 29,722 shares issuable upon the exercise of options that are not deemed to be presently exercisable.\n(2) Mr. Bennett shares investment and voting power with his wife with respect to 1,500 of these shares. Does not include an option to purchase 5,000 shares granted to him, subject to shareholder approval, under the Non-Employee Directors' Stock Option Plan.\n(3) Includes 488 shares owned by Mr. Chesonis's spouse, options to purchase 76,350 shares that are currently exercisable by Mr. Chesonis, and options to purchase 6,950 shares that are currently exercisable by Mr. Chesonis's spouse. Does not include 80,850 shares issuable upon the exercise of options that are not deemed to be presently exercisable by Mr. Chesonis nor 3,050 shares issuable upon the exercise of options that are not deemed to be presently exercisable by Mr. Chesonis's spouse.\n(4) Includes options to purchase 56,406 shares that are currently or will become exercisable by Mr. Laniak within the next 60 days. Does not include 37,694 shares issuable upon the exercise of options that are not deemed to be presently exercisable.\n(5) Mr. Tessoni and his wife share investment and voting power with respect to all shares which he beneficially owns. Does not include an option to purchase 5,000 shares granted to him, subject to shareholder approval, under the Non-Employee Directors' Stock Option Plan.\n(6) Includes (i) 456,750 shares of Class A Common Stock beneficially owned by Fleet Venture Resources, Inc. (''Fleet Venture Resources''), of which 393,750 shares are issuable upon the conversion of Series A Preferred Stock and 63,000 shares are issuable upon the exercise of warrants; (ii) 195,750 shares of Class A Common Stock beneficially owned by Fleet Equity Partners VI, L.P. (''Fleet Equity Partners''), of which 168,750 shares are issuable upon the conversion of Series A Preferred Stock and 27,000 shares are issuable upon the exercise of warrants; and (iii) 72,500 shares of Class A Common Stock beneficially owned by Chisholm Partners II, L.P. (''Chisholm''), of which 62,500 shares are issuable upon the conversion of Series A Preferred Stock and 10,000 shares are issuable upon the exercise of warrants. As of March 1, 1996, the conversion price for the Series A Preferred Stock and the exercise price of such warrants was $16.00 per share. Does not include a total of 625,000 shares of Class A Common Stock issuable to Fleet Venture Resources, Fleet Equity Partners and Chisholm upon the exercise of warrants, which warrants would become exercisable upon an optional redemption of the Series A Preferred Stock by the Company. Mr. Van Degna is the Chairman and Chief Executive Officer of Fleet Venture Resources and the Chairman and Chief Executive Officer or President of each general partner of Fleet Equity Partners and Chisholm. Mr. Van Degna disclaims beneficial ownership of the shares held by these entities, except for his limited partnership interest in Fleet Equity Partners and in the general partner of Chisholm.\n(7) Includes options to purchase 20,100 shares that are currently exercisable by Mr. Bantoft. Does not include 49,900 shares issuable upon the exercise of options that are not deemed to be presently exercisable, nor 10,000 SIRs granted on February 5, 1996.\n(8) Includes options to purchase 18,100 shares that are currently exercisable by Mr. Dubnik. Does not include 53,700 shares issuable upon the exercise of options that are not deemed to be presently exercisable.\n(9) Includes options to purchase a total of 39,400 shares that are or will become exercisable by four executive officers of the Company, in addition to those named above, within the next 60 days. Does not include a total of 162,575 shares issuable upon the exercise of options that are not deemed to be presently exercisable by five executive officers of the Company, in addition to those named above.\nPRINCIPAL HOLDERS OF COMMON STOCK\nThe following table reflects the security ownership of those persons who are known to the Company to have been the beneficial owners of more than 5% (401,970 shares) of the Company's outstanding Class A Common Stock as of March 1, 1996:\nNAME AND ADDRESS AMOUNT AND NATURE OF PERCENT OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS\nRichard T. Aab 927,554 (1) 11.5 400 West Avenue Rochester, New York 14611\nRobert M. Van Degna 725,000 (2) 8.3 c\/o Fleet Venture Resources, Inc. 111 Westminster Street Providence, Rhode Island 02903\nFleet Venture Resources, Inc. 456,750 (3) 5.4 111 Westminster Street Providence, Rhode Island 02903\nMontgomery Asset Management, L.P. 445,760 (4) 5.5 600 Montgomery Street San Francisco, California 94111\n(1) This number includes 139,500 shares that are owned by Melrich Associates, L.P., a family partnership of which Mr. Aab is a general partner and therefore shares investment and voting power with respect to such shares, and options to purchase 12,322 that are currently exercisable by Mr. Aab. Does not include 29,722 shares issuable upon the exercise of options that are not deemed to be presently exercisable.\n(2) Includes (i) 456,750 shares of Class A Common Stock beneficially owned by Fleet Venture Resources, Inc. (\"Fleet Venture Resources\"), of which 393,750 shares are issuable upon the conversion of Series A Preferred Stock and 63,000 shares are issuable upon the exercise of warrants; (ii) 195,750 shares of Class A Common Stock beneficially owned by Fleet Equity Partners VI, L.P. (\"Fleet Equity Partners\"), of which 168,750 shares are issuable upon the conversion of Series A Preferred Stock and 27,000 shares are issuable upon the exercise of warrants; and (iii) 72,500 shares of Class A Common Stock beneficially owned by Chisholm Partners II, L.P. (''Chisholm''), of which 62,500 shares are issuable upon the conversion of Series A Preferred Stock and 10,000 shares are issuable upon the exercise of warrants. As of March 1, 1996, the conversion price for the Series A Preferred Stock and the exercise price of such warrants was $16.00 per share. Does not include a total of 625,000 shares of Class A Common Stock issuable to Fleet Venture Resources, Fleet Equity Partners and Chisholm upon the exercise of warrants, which warrants would become exercisable upon an optional redemption of the Series A Preferred Stock by the Company. Mr. Van Degna is the Chairman and Chief Executive Officer of Fleet Venture Resources and the Chairman and Chief Executive Officer or President of each general partner of Fleet Equity Partners and Chisholm. Mr. Van Degna disclaims beneficial ownership of the shares held by these entities, except for his limited partnership interest in Fleet Equity Partners and in the general partner of Chisholm.\n(3) Does not include shares beneficially owned by Fleet Equity Partners or Chisholm (see note (2) above).\n(4) These shares are held for investment purposes by Montgomery Asset Management, L.P., a registered Investment Advisor, as reported in a Schedule 13G that was filed with the SEC in January 1996, a copy of which was received by the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nTo accommodate its need for increased space, in June 1994, the Company moved its principal executive offices to an industrial complex located at 400 West Avenue, Rochester, New York, which is owned by a real estate partnership in which Richard T. Aab, the Company's Chairman and former Chief Executive Officer, is a general partner. For 1995, the Company paid a total of approximately $600,000 in rent and maintenance fees for this space to this partnership.\nDuring 1994 and early 1995, the Company initiated efforts to obtain new telecommunications software programs from AMBIX Systems Corp. (\"AMBIX\"), a software development company. The Company's Chairman of the Board and then Chief Executive Officer, Richard T. Aab, was a controlling shareholder of AMBIX during such period. In May of 1995, anticipating material agreements with AMBIX and desiring to eliminate a conflict of interest situation, all of the common shares owned by Mr. Aab in AMBIX were placed in escrow under the direction of a Special Committee of the Company's Board of Directors with the option of the Special Committee to authorize the Company to accept the transfer and delivery of the shares in exchange for the release or indemnification of Mr. Aab of his personal guarantee of certain obligations of AMBIX to its lender and the substitution of the Company as the guarantor of such obligations. The Special Committee, its outside consultants and the Company's management then proceeded to review and evaluate the software technology and the terms and conditions of proposed transactions with AMBIX.\nOn February 21, 1996, pursuant to the approval of the Special Committee, a software license agreement was entered into by and between the Company and AMBIX Acquisition Corp., which is the purchaser of AMBIX's intellectual property and other assets and is an affiliate of AMBIX. Immediately prior thereto, the shares of AMBIX held in escrow were returned to AMBIX and the related party nature of the Company's relationship with AMBIX was thereby extinguished. In connection with the return of Mr. Aab's shares to AMBIX, the Company paid approximately $200,000 to AMBIX's lender to release Mr. Aab's personal guarantee of certain obligations of AMBIX to its lender. Such benefit to Mr. Aab was the only consideration he received from the Company for the return of his shares to AMBIX, and, to the Company's knowledge, Mr. Aab did not receive any additional consideration from AMBIX for the return of his shares nor did he receive any cash distributions from AMBIX during his ownership of such shares.\nFor an aggregate consideration of $1.8 million (including the payment by the Company of certain obligations of AMBIX to its lender) paid to or for the benefit of AMBIX or AMBIX Acquisition Corp., the Company in return has received a perpetual right to use the newly developed telecommunications software programs. In making a business judgment as to the amount of such consideration, the Special Committee considered a number of factors including, among other matters, the opinion of its independent software consultants with respect to the estimated cost of developing the major software program covered by the license, the recommendations of management of the Company who were experienced with oversight responsibilities for the development of software programs, and the known benefit to the Company of the software programs as demonstrated by their preliminary testing and use by the Company. The Company does not know the full costs incurred by AMBIX in developing the software programs.\nThe software programs and the Company's license to use them are considered by the Company to be material and integral to its operations. During 1995 the Company paid AMBIX $1.2 million, of which approximately $700,000, relating to the purchase of certain hardware and acquisition of certain software licenses, was capitalized and recorded on the balance sheet as a component of property, plant and equipment, and $500,000 relating to software development was expensed. During 1994 the Company paid AMBIX $132,000, all of which related to software development which was expensed. The Company anticipates that it will attempt to negotiate and enter into an arrangement with AMBIX Acquisition Corp. to provide maintenance and support for the software programs. There can be no assurance that the Company will negotiate or enter into any such arrangements or regarding the terms thereof.\nOn May 22, 1995, Mr. Aab, the Company's Chairman of the Board and then Chief Executive Officer, entered into a Participation Agreement with Fleet Venture Resources, Inc., Fleet Equity Partners VI, L.P. and Chisholm Partners II, L.P. (collectively, the \"Fleet Investors\") in connection with the purchase by the Fleet Investors of $10 million in aggregate principal amount of 12% convertible subordinated notes of the Company, which notes were subsequently converted into 10,000 shares of Series A Preferred Stock. The Participation Agreement requires Mr. Aab to notify the Fleet Investors and the Company of certain proposed transfers of his Class A Common Stock of the Company and, if any of the Fleet Investors elect to participate in the proposed transaction, Mr. Aab is required to obtain the agreement of the purchaser to acquire from any participating Fleet Investor, at the same price and on the same terms offered to Mr. Aab, a pro rata portion of the shares proposed to be purchased from Mr. Aab. The Participation Agreement does not apply to certain transfers of shares by Mr. Aab, including pursuant to a public offering registered under the Securities Act of 1933, as amended (the \"Act\"), pursuant to Rule 144 adopted under the Act, certain charitable transfers and transfers resulting from any foreclosure upon shares which have been pledged, and the transfer restrictions are extinguished if Mr. Aab ceases to be a director or employee of the Company or if the Series A Preferred Stock and certain warrants issued to the Fleet Investors are no longer outstanding.\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. (a) The following Financial Statements of the Company and the accountant's report thereon are included in Part II of this Report above:\nConsolidated Financial Statements:\nConsolidated Balance Sheets, 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\nReport of Independent Public Accountants\n(b) Financial Statements for ACC Corp. Employee Stock Purchase Plan for Plan year ended December 31, 1995:\nReport of Independent Public Accountants\nStatement of Financial Condition\nStatement of Changes in Participants' Equity\nNotes to Financial Statements\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Plan Administrator of the ACC Corp. Employee Stock Purchase Plan:\nWe have audited the accompanying statements of financial condition of the ACC Corp. Employee Stock Purchase Plan (the \"Plan\") as of December 31, 1995 and 1994, and the related statements of changes in participants' equity for the year ended December 31, 1995 and for the period from adoption (February 8, 1994) to December 31, 1994. These financial statements are the responsibility of the Plan's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial condition of the Plan as of December 31, 1995 and 1994, and the results of its changes in participants' equity for the year ended December 31, 1995 and for the period from adoption (February 8, 1994) to December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP Rochester, New York February 23, 1996\nACC Corp. Employee Stock Purchase Plan Statements of Financial Condition December 31, 1995 and 1994\nASSETS: 1995 1994\nReceivable from ACC Corp. $683 $557\nTOTAL ASSETS $683 $557\nLIABILITIES AND PARTICIPANTS' EQUITY: Participants' equity $683 $557\nTOTAL LIABILITIES AND PARTICIPANTS' EQUITY $683 $557\nThe accompanying notes to financial statements are an integral part of these statements.\nACC Corp. Employee Stock Purchase Plan Statements of Changes in Participants' Equity For the Year Ended December 31, 1995 and For the Period from Adoption (February 8, 1994) to December 31, 1994\n1995 1994 ADDITIONS: Employee contributions $331,256 $155,651\nDEDUCTIONS:\nStock purchased 296,023 151,600 Employee withdrawals 35,107 3,494\nTotal deductions 331,130 155,094\nNET INCREASE IN PARTICIPANTS' EQUITY 126 557 PARTICIPANTS' EQUITY, BEGINNING OF PERIOD 557 -\nPARTICIPANTS' EQUITY, END OF PERIOD $683 $557\nThe accompanying notes to financial statements are an integral part of these statements.\nACC Corp. Employee Stock Purchase Plan Notes to Financial Statements\n1. PLAN DESCRIPTION:\nThe ACC Corp. Employee Stock Purchase Plan (the \"Plan\") was adopted by the Board of Directors on February 8, 1994 and was ratified by the shareholders on October 13, 1994. The first offering period began July 1, 1994. Officers did not participate until the ratification by the shareholders occurred. The Plan was established to provide employees with increased employment and performance incentives and to enhance ACC Corp.'s (the \"Company\") efforts to attract and retain employees of outstanding ability. The Plan permits eligible Company employees to make periodic purchases of shares of the Company's Class A Common Stock through payroll deductions at prices below then-prevailing market prices. As of December 31, 1995, 500,000 shares of the Company's Class A Common Stock (which may be treasury shares, authorized and unissued shares, or a combination thereof at the Company's discretion) are reserved for issuance under the Plan. The Plan is administered by the Executive Compensation Committee of the Board of Directors of ACC Corp. (the \"Committee\"). None of the members of the Committee is eligible to participate in the Plan. Reference should be made to the Plan for more complete information.\nAny employee of the Company or any of its subsidiaries who is employed at least 20 hours per week is eligible to participate in the Plan. Participants may enroll in the Plan prior to an offering commencement date. Employees may authorize payroll deductions of up to 15% of their then-current straight-time earnings during the term of an offering, which will be applied to the purchase of shares under the Plan. These payroll deductions will begin on that offering commencement date and will end on the last purchase date applicable to any offering in which he\/she holds any options to purchase shares of the Company's Class A Common Stock, or if sooner, on the effective date of his\/her termination of participation in the Plan. Newly hired employees hired subsequent to an offering commencement date may begin participation in the Plan at the beginning of the next calendar quarter following their date of hire.\nPayroll deductions will be held by the Company as part of its general funds for the credit of the participants and will not accrue interest pending the periodic purchase of shares under the Plan. On the last business day of each calendar quarter during the term of an offering, a participant will automatically be deemed to have exercised his\/her options to purchase, at the applicable purchase price, the maximum number of full shares that can be purchased with the amounts deducted from the participant's pay during that quarter, together with any excess funds from preceding quarters. The purchase price at which shares may be purchased under the Plan is 85% of the closing price of the Company's Class A Common Stock in Nasdaq trading on either a) the offering commencement date (or, in the case of interim participation by newly hired employees, the date on which they are permitted to begin participation in that offering) or b) the date on which shares are purchased through the automatic exercise of an option to purchase shares under the Plan, whichever is lower. The maximum number of shares that a participant will be permitted to purchase in any single offering is subject to certain limitations, as set forth in the plan document.\nA participant may, at any time and for any reason, withdraw from further participation in any offering or from the Plan by giving written notice. In such event, the participant's payroll deductions which have been credited to his\/her plan account and not already expended to purchase shares under the Plan will be refunded without interest. No further payroll deductions will be made from his\/her pay during the term of that offering. No withdrawing participant will be permitted to re-commence his\/her participation in an offering, however, termination of participation in an offering or in the Plan will not have any effect upon subsequent eligibility to participate in the Plan. A participant's retirement, death or other termination of employment will be treated as a permanent withdrawal from participation. In the event of a participant's death, his\/her estate or designated beneficiary shall have the right to elect, no later than 60 days following his\/her date of death, to receive either the accumulated payroll deductions in the deceased participant's plan account or to exercise, on the next subsequent purchase date, the deceased participant's options to purchase the number of full shares of Class A Common Stock that can be purchased with the balance in the decedent's plan account as of his\/her date of death, together with the return of any excess cash, without interest.\nThe Plan will expire on the first to occur of the following: (1) the date as of which participants purchase a number of shares equal to or greater than the number of shares authorized for issuance under the Plan; or (2) the date as of which the Board of Directors of the Company or the Committee terminates the Plan. In either case, all funds accumulated in each participant's plan account but not yet expended to purchase shares will be refunded without interest. If the Plan is terminated by reason of the exercise of rights to purchase a greater number of shares than are authorized for issuance under the Plan, all remaining shares available for issuance will be allocated to participants on a pro-rata basis.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nThe financial statements are prepared using the accrual basis of accounting. The Company pays all of the Plan's administrative expenses.\n3. INCOME TAX STATUS:\nThe Plan is intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code. In order for favorable tax treatment to be available to the participant, the participant cannot dispose of any shares acquired under the Plan within two years following the date the option to purchase was granted, nor within one year following the date the shares were actually purchased.\n4. STOCK PURCHASES:\nStock purchases by offering period are as follows:\nPurchase price Number of Offering Period Valuation Date per share shares purchased\nJuly 1, 1994 - July 1, 1994 $13.625 8,681 December 31, 1994 December 31,1994* $14.750 4,073 January 1, 1995 - December 31, 1994 $14.75 17,935 December 31, 1995 March 31, 1995* $16.75 70 June 30, 1995* $14.75 67 September 30, 1995* $16.50 51\nJuly 1, 1995 - June 30, 1995 $14.75 5,164 December 31, 1995 September30, 1995* $16.50 275\n*For those employees who began participation during the offering period.\nThe valuation date is the date during the offering period, as defined, on which the stock price was the lowest, therefore becoming the base for the calculation of shares to be purchased.\n(2) FINANCIAL STATEMENT SCHEDULES. The following Financial Statement Schedules and the accountant's report thereon are included herewith as follows:\nReport of Independent Public Accountants\nII Consolidated Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993\nAll other schedules are not submitted because they are not applicable, not required or because the required information is included in the consolidated financial statements or notes thereto.\n(3) EXHIBITS. The following constitutes the list of exhibits required to be filed as a part of this Report pursuant to Item 601 of Regulation S-K:\n* Indicates a 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(b) REPORTS ON FORM 8-K. On October 27, 1995, the Company filed a Report on Form 8-K (which was amended on December 8, 1995) to report, under the heading of Item 2, Acquisition or Disposition of Assets, on the August 14, 1995 acquisition by the Company's 70% owned Canadian subsidiary, ACC TelEnterprises Ltd., of four affiliated privately-held Canadian corporations operating under the business name of Metrowide Communications. No financial statements were required to be filed with this Report.\n(c) EXHIBITS. See Exhibit Index.\n(d) FINANCIAL STATEMENT SCHEDULES. Are attached, along with the report of the independent public accountants thereon, as follows:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo ACC Corp.:\nWe have audited in accordance with generally accepted auditing standards the financial statements included in this Form 10-K, and have issued our report thereon dated February 6, 1996 (except with respect to the matters discussed in Notes 10 and 11.A, as to which the dates are February 20, 1996 and February 8, 1996, respectively). Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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 Rochester, New York March 29, 1996\n________________________________ (1) Represents valuation allowance associated with loss carryforwards of Metrowide Communications which was purchased by ACC Canada on August 1, 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.\nACC CORP.\nDated: March 29, 1996 By:\/s\/ David K. Laniak David K. Laniak, 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.\nDated: March 29, 1996 By:\/s\/ David K. Laniak David K. Laniak, Chief Executive Officer and a Director\nDated: March __, 1996 By:____________________________________ Richard T. Aab, Chairman of the Board and a Director\nDated: March 29, 1996 By:\/s\/ Michael R. Daley Michael R. Daley, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDated: March 29, 1996 By: \/s\/ Hugh F. Bennett Hugh F. Bennett, Director\nDated: March 29, 1996 By: \/s\/ Arunas A. Chesonis Arunas A. Chesonis, President and Chief Operating Officer and a Director\nDated: March __, 1996 By:___________________________________ Willard Z. Estey, Director\nDated: March 29, 1996 By: \/s\/ Daniel D. Tessoni Daniel D. Tessoni, Director\nDated: March 29, 1996 By: \/s\/ Robert M. Van Degna Robert M. Van Degna, Director","section_15":""}
{"filename":"3000_1995.txt","cik":"3000","year":"1995","section_1":"ITEM 1. BUSINESS - ------------------- a) General Development of Business -------------------------------- Airborne Freight Corporation (herein referred to as \"Airborne Express\" or the \"Company\", which reference shall include its subsidiaries and their assets and operations, unless the context clearly indicates otherwise) was incorporated in Delaware on May 10, 1968. The Company is an air express company and air freight forwarder that expedites shipments of all sizes to destinations throughout the United States and most foreign countries.\nThe Company holds a certificate of registration issued by the United States Patent and Trademark Office for the service mark AIRBORNE EXPRESS. Most public presentation of the Company carries this name. The purpose of using this trade name is to more clearly communicate to the market place the primary nature of the business of the Company.\nABX Air, Inc., the Company's principal wholly-owned subsidiary (herein referred to as \"ABX\"), was incorporated in Delaware on January 22, 1980. ABX provides domestic express cargo service and cargo service to Canada. The Company is the sole customer of ABX for this service. ABX also offers limited charter service.\nb) Financial Information about Industry Segments ---------------------------------------------- None\nc) Narrative Description of Business ---------------------------------- Airborne Express provides door-to-door express delivery of small packages and documents throughout the United States and to and from most foreign countries. The Company also acts as an international and domestic freight forwarder for shipments of any size. The Company's strategy is to be the low cost provider of express services for high volume corporate customers.\nDomestic Operations - -------------------- The Company's domestic operations, supported by approximately 265 facilities, primarily involve express door-to-door delivery of shipments weighing less than 100 pounds. Shipments consist primarily of business documents and other printed matter, electronic and computer parts, software, machine parts, health care items, films and videotapes, and other items for which speed and reliability of delivery are important.\nThe Company's primary service is its overnight express product. This product, which comprised approximately 58% of the Company's domestic shipments during 1995, generally provides for before noon delivery on the next business day to most metropolitan cities in the United States. The Company also provides Saturday and holiday pickup and delivery service for most cities.\nDuring the last five years, the Company has also offered a deferred service product, Select Delivery Service (\"SDS\"), which provided for next\nafternoon or second day delivery. SDS service shipments weighing five pounds or less were delivered on a next afternoon basis with shipments weighing more than five pounds delivered on a second day basis. SDS shipments, which comprised approximately 42% of total domestic shipments during 1995, are lower priced than the overnight express product reflecting the less time sensitive nature of the shipments.\nIn early 1996, the Company began phasing in two new levels of deferred service to replace its SDS product. The services, Next Afternoon Service and Second Day Service, will expand the Company's deferred service options. Next Afternoon Service will be available for shipments weighing five pounds or less and Second Day Service will be offered for shipments of all weights. Next Afternoon Service rates will be higher than Second Day Service rates.\nWhile the Company's domestic airline system is designed primarily to handle express shipments, any available capacity is also utilized to carry shipments which the Company would normally move on other carriers in its role as an air freight forwarder.\nCommunications System - ---------------------- FOCUS (Freight On-line Control and Update System) is a proprietary communications system which provides real time information for purposes of tracking and providing the status of customer's shipments as well as monitoring the performance of the Company's operational systems. The Company's facilities and international agents are linked to FOCUS and provide inputs to the system, in part through the driver's use of hand-held scanners which read bar-codes on the shipping documents, with information necessary to determine the status and location of customer shipments 24 hours a day. FOCUS also allows for direct customer access to shipment information through the use of their own computer systems.\nFOCUS also provides the Company's personnel with important information for use in coordinating its operational activities. Information regarding Company-operated aircraft arrivals and departures, weather, and documentation requirements for shipments destined to foreign locations are several examples of the information maintained by FOCUS.\nPickup and Delivery - -------------------- The Company accomplishes its door-to-door pickup and delivery service using approximately 12,800 radio-dispatched delivery vans and trucks, of which approximately 4,500 are owned by the Company. Independent contractors under contract with the Company provide the balance of the pickup and delivery services.\nBecause convenience is an important factor in attracting business from less frequent shippers, the Company has an ongoing program to place drop boxes in convenient locations. The Company has approximately 9,800 boxes in service. Sort Facilities - ---------------- The Company's main sort center is located in Wilmington, Ohio. As express delivery volume has increased, the main sort center has been expanded. In 1995, the sort center was expanded and currently has the capacity to handle approximately 980,000 pieces during the primary 2-1\/2 hour nightly sort operation. On average, approximately 835,000 pieces were sorted each weekday night at the sort center during the fourth quarter of 1995. In addition to the sort facilities, the Wilmington location consists of a Company-owned airport which includes maintenance, storage, training and refueling facilities; and operations and administrative offices.\nThe Company also conducts a day sort operation at Wilmington. The day sort serviced SDS shipments weighing in excess of five pounds that are consolidated at certain regional hub facilities and either flown or trucked into or out of Wilmington. Beginning in 1996, the Company plans to have the day sort handle shipments weighing five pounds or less that are designated for Second Day Service.\nThe operation of the Wilmington facility is critical to the Company's business. The inability to use the Wilmington airport, because of bad weather or other factors, would have a serious adverse effect on the Company's service. However, contingency plans, including landing at nearby airports and transporting packages to and from the sort center by truck, can be implemented to address temporary inaccessibility of the Wilmington airport.\nIn addition to the main sort facility at Wilmington, ten regional hub facilities have been established primarily to sort shipments originating and having a destination within approximately a 300 mile radius of a regional hub.\nIn the fourth quarter of 1995, approximately 59% and 16% of total shipment weight was handled through the night sort and day sort operations at Wilmington, respectively, with the remaining 25% being handled exclusively by the regional hubs.\nShipment Routing - ----------------- The logistical means of moving a shipment from its origin to destination are determined by several factors. Shipments are routed differently depending on shipment product type, weight, geographic distances between origin and destination, and locations of Company stations relative to the locations of sort facilities. Shipments generally are moved between stations and sort facilities on either Company aircraft or contracted trucks. A limited number of shipments are transported airport- to-airport on commercial air carriers.\nOvernight express shipments and deferred service shipments weighing five pounds or less are picked up by local stations and generally consolidated with other stations' shipments at Company airport facilities. Shipments that are not serviced through regional hubs are loaded on Company aircraft departing each weekday evening from various points within the United States and Canada. These aircraft may stop at other airports to permit additional locations and feeder aircraft to consolidate their cargo onto the larger aircraft before completing the flight to the Wilmington hub. The aircraft are scheduled to arrive at Wilmington between approximately 11:30 p.m. and 3:00 a.m. at which\ntime the shipments are sorted and reloaded. The aircraft are scheduled to depart before 6:00 a.m. and return to their applicable destinations in time to complete scheduled next business morning or deferred service commitments. The Wilmington hub also receives shipments via truck from selected stations in the vicinity of the Wilmington hub for integration with the nightly sort process.\nFor the day sort operation, generally eight aircraft return to Wilmington from overnight service destinations on Tuesday through Thursday. These aircraft, and trucks from six regional hubs, arrive at Wilmington between 10:00 a.m. and noon, at which time shipments are sorted and reloaded on the aircraft or trucks by 3:00 p.m. for departure and return to their respective destinations.\nThe Company also performs weekend sort operations at Wilmington to accommodate Saturday pickups and Monday deliveries of both overnight express and deferred service shipments. This sort is supported by 13 Company aircraft and by trucks.\nAircraft - --------- The Company currently utilizes used aircraft manufactured in the late 1960s and early 1970s. Upon acquisition, the aircraft are substantially modified by the Company. At the end of 1995, the Company's in-service fleet consisted of a total of 105 aircraft, including 33 McDonnell Douglas DC-8s (consisting of 11 series 61, 6 series 62 and 16 series 63), 61 DC-9s (consisting of 2 series 10, 41 series 30 and 18 series 40), and 11 YS-11 turboprop aircraft. The Company owns the majority of the aircraft it operates, but has completed sale-leaseback transactions with respect to six DC-8 and six DC-9 aircraft. In addition, approximately 70 smaller aircraft are chartered nightly to connect small cities with Company aircraft that then operate to and from Wilmington.\nIn December 1995, the Company announced an agreement to purchase 12 used Boeing 767-200's between the years 1997 and 2000 and its plans to pursue the acquisition of 10 to 15 additional used 767-200's between the years 2000 and 2004. This newer generation of aircraft should increase operating efficiency and allow the Company to meet anticipated demand for additional lift capacity. There are no plans to retire any aircraft as a result of the acquisitions.\nAt year end 1995, the nightly lift capacity of the system was about 3.5 million pounds versus approximately 3.1 million pounds and 2.8 million pounds at the end of 1994 and 1993, respectively. Over the past several years the Company's utilization of available lift capacity has exceeded 80%.\nIn response to increased public awareness regarding the operation of older aircraft, the Federal Aviation Administration (\"FAA\") periodically mandates additional maintenance requirements for certain aircraft, including the type operated by the Company. In 1995, the Company completed a significant inspection and maintenance program pertaining to corrosion as required by an Airworthiness Directive issued by the FAA. The FAA could, in the future, impose additional maintenance requirements for aircraft and engines of the type operated by the Company or interpret existing rules in a manner which could have a material effect on the Company's operations and financial position.\nIn accordance with federal law and FAA regulations, only subsonic turbojet aircraft classified as Stage 2 or 3 by the FAA may be operated in the United States. Generally, Stage 3 aircraft produce less noise than a comparable Stage 2 aircraft.\nIn 1990, Congress passed the Airport Noise and Capacity Act of 1990 (the \"Noise Act\"). Among other things, the Noise Act generally requires turbojet aircraft weighing in excess of 75,000 pounds and operating in the United States (the type of DC-8 and DC-9 aircraft operated by the Company) to comply with Stage 3 noise emission standards on or before December 31, 1999. The Company's YS-11 turboprop aircraft are not subject to these requirements. In accordance with the Noise Act, the FAA has issued regulations establishing interim compliance deadlines. These rules require air carriers to reduce the base level of Stage 2 aircraft they operate 50% by December 31, 1996; and 75% by December 31, 1998. As of December 31, 1995 the Company had reduced the base level of its Stage 2 aircraft by approximately 41% and expects to meet or exceed the compliance percentage at the interim compliance deadline of December 31, 1996. As of December 31, 1995, 49 of the Company's turbojet aircraft (23 DC-8 and 26 DC-9 aircraft) were Stage 3 aircraft, the balance being Stage 2 aircraft. In addition to FAA regulation, certain local airports also regulate noise compliance. See \"Business - Regulation\".\nThe Company, in conjunction with several other companies, has developed noise suppression technology known as hush kits for its DC-9 series aircraft which have been certified to meet FAA Stage 3 requirements. Stage 3 requirements have been met on 26 DC-9 series aircraft. The capital cost for Stage 3 hush kits is approximately $1.2 million for each DC-9 series aircraft. The Company has installed hush kits which satisfy Stage 3 compliance requirements on all of its DC-8-62 and DC-8-63 series aircraft and one of its DC-8-61 series aircraft. The estimated capital cost for these hush kits and related hardware on the DC-8-62 and 63 series aircraft is approximately $1.6 million per aircraft. The capital cost to modify the DC-8-61 aircraft to meet Stage 3 noise standards is approximately $4.0 million per aircraft.\nInternational Operations - ------------------------- The Company provides international express door-to-door delivery and a variety of freight services. These services are provided in most foreign countries on an inbound and outbound basis through a network of Airborne offices and independent agents. Most international deliveries are accomplished within 24 to 96 hours of pickup.\nThe Company's domestic stations are staffed and equipped to handle international shipments to or from almost anywhere in the world. In addition to its extensive domestic network, the Company operates its own offices in the Far East, Australia, New Zealand, and the United Kingdom. The Company's freight and express agents worldwide are connected to FOCUS, Airborne's on-line communication network, through which the Company can provide its customers with immediate access to the status of shipments almost anywhere in the world.\nThe Company's international air express service is intended for the movement of non dutiable and certain dutiable shipments weighing less than 99 pounds. The Company's international air freight service handles heavier\nweight shipments on either an airport-to-airport, door-to-airport or door- to-door basis. The Company also offers ocean service capabilities for customers who want a lower cost shipping option.\nThe Company's strategy is to use a variable-cost approach in delivering and expanding international services to its customers. This strategy uses existing commercial airline lift capacity in connection with the Company's domestic network to move shipments to and from overseas destinations and origins. Additionally, service arrangements with independent freight and express agents have been entered into to accommodate shipments in locations not currently served by Company-owned operations. The Company currently believes there are no significant service advantages which would justify the operation of its own aircraft on international routes, or making significant investment in additional offshore facilities or ground operations. In order to expand its business at a reasonable cost, the Company continues to explore possible joint venture agreements, similar to its arrangement with Mitsui & Co., Ltd. in Japan, which combine the Company's management expertise, domestic express system and information systems with local business knowledge and market reputation of suitable partners.\nCustomers and Marketing - ------------------------ The Company's primary domestic strategy focuses on express services for high volume corporate customers. Most high volume customers have entered into service agreements providing for specified rates or rate schedules for express deliveries. As of December 31, 1995, the Company serviced approximately 430,000 active customer shipping locations.\nThe Company determines prices for any particular domestic express customer based on competitive factors, anticipated costs, shipment volume and weight, and other considerations. The Company believes that it generally offers prices that are competitive with, or lower than, prices quoted by its principal competitors for comparable services.\nInternationally, the Company's marketing strategy is to target the outbound express and freight shipments of U.S. corporate customers, and to sell the inbound service of the Company's distribution capabilities in the United States.\nBoth in the international and domestic markets, the Company believes that its customers are most effectively reached by a direct sales force, and accordingly, does not currently engage in mass media advertising. Domestic sales representatives are responsible for selling both domestic and international express shipments. In addition, the International Division has its own dedicated direct sales organization for selling international freight service.\nThe Company's sales force currently consists of approximately 300 domestic representatives and approximately 70 international specialists. The Company's sales efforts are supported by the Marketing and International Divisions, based at the Company headquarters. Senior management is also active in marketing the Company's services to major accounts.\nValue-added services continue to be important factors in attracting and retaining customers. Accordingly, the Company is automating more of its operations to make the service easier for customers to use and to provide them with valuable management information. The Company believes that it is generally competitive with other express carriers in terms of reliability, value-added services and convenience.\nFor many of its high volume customers, the Company offers a metering device, called LIBRA II, which is installed at the customer's place of business. With minimum data entry, the metering device weighs the package, calculates the shipping charges, generates the shipping labels and provides a daily shipping report. At year end 1995, the system was in use at approximately 8,200 domestic customer locations and 700 international customer locations. Use of LIBRA II not only benefits the customer directly, but also lowers the Company's operating costs, since LIBRA II shipment data is transferred into the Airborne FOCUS shipment tracking system automatically, thus avoiding duplicate data entry.\n\"Customer Linkage\", an electronic data interchange (\"EDI\") program developed for Airborne's highest volume shippers, allows customers, with their computers, to create shipping documentation at the same time they are entering orders for their goods. At the end of each day, shipping activities are transmitted electronically to the Airborne FOCUS system where information is captured for shipment tracking and billing purposes. Customer Linkage benefits the customer by eliminating repetitive data entry and paperwork and also lowers the Company's operating costs by eliminating manual data entry. EDI also includes electronic invoicing and payment remittance processing. The Company also has available a software program known as Quicklink, which significantly reduces programming time required by customers to take advantage of linkage benefits.\nIn 1995, the Company unveiled \"LIGHTSHIP-TRACKER\", a PC-based tracking software, which is the first in a series of planned new software products designed to improve customer productivity and provide convenient access to the Company's various services. LIGHTSHIP-TRACKER allows customers, working from their PCs, to view the status of and receive information regarding their shipments through access to the Airborne FOCUS system.\nThe Company offers a number of special logistics programs to customers through its Advanced Logistics Services Corp. (\"ALS\") subsidiary. This subsidiary operates the Company's Stock Exchange and Hub Warehousing and other logistics programs. These programs provide customers the ability to maintain inventories which can be managed either by Company or customer personnel. Items inventoried at Wilmington can be delivered utilizing either the Company's airline system or, if required, commercial airlines on a next-flight-out basis. ALS' Central Print program allows information to be sent electronically to customer computers located at Wilmington where Company personnel monitor printed output and ship the material according to customer instructions.\nIn addition, the Company's Sky Courier business provides expedited next-plane-out service at premium prices. Sky Courier also offers a Regional Warehousing program where customer inventories are managed at any of over 60 locations around the United States and Canada.\nThe Company has obtained ISO 9000 certification for its Chicago, Philadelphia and London stations and its Seattle Headquarters. ISO 9000 is a program developed by the International Standards Organization (\"ISO\"), based in Geneva, Switzerland. This organization provides a set of international standards on quality management and quality assurance presently recognized in 92 countries. The certification is an asset in doing business worldwide and provides evidence of the Company's commitment to excellence and quality.\nCompetition - ------------ The market for the Company's services has been and is expected to remain highly competitive. The principal competitive factors in both domestic and international markets are price, the ability to provide reliable pickup and delivery, and value-added services.\nFederal Express continues to be the dominant competitor in the domestic express business, followed by United Parcel Service. Airborne Express ranks third in shipment volume behind these two companies in the domestic express business. Other domestic express competitors include the U.S. Postal Service's Express Mail Service and several other transportation companies offering next morning or next-plane-out delivery service. The Company also competes to some extent with companies offering ground transportation services and with facsimile and other forms of electronic transmission.\nThe Company believes it is important to maintain an active capital expansion program to increase capacity, improve service and increase productivity as its volume of shipments increases. However, the Company has significantly less capital resources than its two primary competitors.\nIn the international markets, in addition to Federal Express and United Parcel Service, the Company competes with DHL, TNT and other air freight forwarders or carriers and most commercial airlines.\nEmployees - ---------- As of December 31, 1995, the Company and its subsidiaries had approximately 11,500 full-time employees and 8,000 part-time and casual employees. Approximately 5,400 full-time employees (including the Company's 660 pilots) and 3,400 part-time and casual employees are employed under union contracts, primarily with locals of the International Brotherhood of Teamsters and Warehousemen.\nLabor Agreements - ----------------- Most labor agreements covering the Company's ground personnel were recently renegotiated for four-year terms expiring in 1998. The Company's pilots are covered by a contract which became amendable on July 31, 1995. Negotiations with the pilots are ongoing and the Company believes the contract will be amended without experiencing any work disruption.\nSubsidiaries - ------------- The Company has the following wholly-owned subsidiaries:\n1. ABX Air, Inc., a Delaware corporation, is a certificated air carrier which owns and operates the Company's domestic express cargo service. Its wholly-owned subsidiaries are as follows:\na) Wilmington Air Park, Inc., an Ohio corporation, is the owner of the Wilmington airport property (Airborne Air Park).\nb) Airborne FTZ, Inc., an Ohio corporation, is the holder of a foreign trade zone certificate at the Wilmington airport property and owns and manages the Company's expendable aircraft parts inventory.\nc) Aviation Fuel, Inc., an Ohio corporation, purchases and sells aviation and other fuels.\nd) Advanced Logistics Services Corp., an Ohio corporation, provides customized warehousing, inventory management and shipping services.\ne) Sound Suppression, Inc., an Ohio corporation with nocurrent operating activities.\n2. Awawego Delivery, Inc., a New York corporation, holds trucking rights in New York and Connecticut.\n3. Airborne Forwarding Corporation, a Delaware corporation doing business as Sky Courier, provides expedited courier service.\n4. Airborne Freight Limited, a New Zealand corporation, provides air express and air freight services.\nRegulation - ----------- The Company's operations are regulated by the United States Department of Transportation (\"DOT\"), the FAA, and various other federal, state, local and foreign authorities.\nThe DOT, under federal transportation statutes, grants air carriers the right to engage in domestic and international air transportation. The DOT issues certificates to engage in air transportation and has the authority to modify, suspend or revoke such certificates for cause, including failure to comply with federal law or the DOT regulations. The Company believes it possesses all necessary DOT-issued certificates to conduct its operations.\nThe FAA regulates aircraft safety and flight operations generally, including equipment, ground facilities, maintenance and communications. The FAA issues operating certificates to carriers who possess the technical competence to conduct air carrier operations. In addition, the FAA issues certificates of airworthiness to each aircraft which meets the requirements for aircraft design and maintenance. The Company believes it holds all\nairworthiness and other FAA certificates required for the conduct of its business, although the FAA has the power to suspend or revoke such certificates for cause, including failure to comply with federal law.\nThe federal government generally regulates aircraft engine noise at its source. However, local airport operators may, under certain circumstances, regulate airport operations based on aircraft noise considerations. The Noise Act provides that in the case of Stage 2 aircraft restrictions, the airport operator must notify air carriers of its intention to propose rules and satisfy the requirements of federal statutes before implementation of the rules or in the case of Stage 3 aircraft, the airport operator must obtain the carriers' or the governments' approval of the rule prior to its adoption. The Company believes the operation of its aircraft either complies with or is exempt from compliance with currently applicable local airport rules. However, if more stringent aircraft operating regulations were adopted on a widespread basis, the Company might be required to expend substantial sums, make schedule changes or take other actions.\nThe Company's aircraft currently meet all known requirements for emission levels. However, under the Clean Air Act, individual states or the Federal Environmental Protection Agency (the \"EPA\") may adopt regulations requiring the reduction in emissions for one or more localities based on the measured air quality at such localities. The EPA has proposed regulations for portions of California calling for emission reductions through restricting the use of emission producing ground service equipment or aircraft auxiliary power units. There can be no assurance, that if such regulations are adopted in the future or changes in existing laws or regulations are promulgated, such laws or rules would not have a material adverse effect on the Company.\nUnder currently applicable federal aviation law, the Company's airline subsidiary could cease to be eligible to operate as an all-cargo carrier if more than 25% of the voting stock of the Company were owned or controlled by non-U.S. citizens or the airline were not effectively controlled by U.S. citizens. Moreover, in order to hold an all-cargo air carrier certificate, the president and at least two-thirds of the directors and officers of an air carrier must be U.S. citizens. The Company has entered into a Rights Agreement designed, in part, to discourage a single foreign person from acquiring 20% or more, and foreign persons in the aggregate from acquiring 25% or more, of the Company's outstanding voting stock without the approval of the Board of Directors. To the best of the Company's knowledge, foreign stockholders do not control more than 25% of the outstanding voting stock. Two of the Company's officers are not U.S. citizens.\nThe Company believes that its current operations are substantially in compliance with the numerous regulations to which its business is subject; however, various regulatory authorities have jurisdiction over significant aspects of the Company's business, and it is possible that new laws or regulations or changes in existing laws or regulations or the interpretations thereof could have a material adverse effect on the Company's operations.\nFinancial Information Regarding International and Domestic Operations - ---------------------------------------------------------------------- Financial information relating to foreign and domestic operations for each of the three years in the period ended December 31, 1995 is presented in\nNote K (Segment Information) of the Notes to Consolidated Financial Statements appearing in the 1995 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - --------------------- The Company leases general and administrative office facilities located in Seattle, Washington.\nAt year end the Company maintained approximately 265 domestic and 7 foreign stations, most of which are leased. The majority of the facilities are located at or near airports.\nThe Company owns the airport at the Airborne Air Park, in Wilmington, Ohio. The airport currently consists of two runways, taxi-ways, aprons, buildings serving as aircraft and equipment maintenance facilities, a sort facility, storage facilities, a training center, and operations and administrative offices. In 1995, the Company completed a significant expansion of the airpark which included construction of a second runway, taxiways and several other facilities.\nThe Company believes its existing facilities are adequate to meet current needs.\nInformation regarding collateralization of certain property and lease commitments of the Company is set forth in Notes E and F of the Notes to Consolidated Financial Statements appearing in the 1995 Annual Report to Shareholders and is incorporated herein by reference.\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\nITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT - -----------------------------------------------\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED - ---------------------------------------------------------------- STOCKHOLDERS MATTERS - --------------------- The response to this Item is contained in the 1995 Annual Report to Shareholders and the information contained therein is incorporated by reference.\nOn February 26, 1996 there were 1,496 shareholders of record of the Common Stock of the Company based on information provided by the Company's transfer agent.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ---------------------------------- The response to this Item is contained in the 1995 Annual Report to Shareholders and the information contained therein is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - -------------------------------------------------------------------------- RESULTS OF OPERATIONS - ---------------------- The response to this Item is contained in the 1995 Annual Report to Shareholders and the information contained therein is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------------------------------------------------------ The response to this Item is contained in the 1995 Annual Report to Shareholders and the information contained therein is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - -------------------------------------------------------------------------- FINANCIAL DISCLOSURE - --------------------- None\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------- The response to this Item is contained in part in the Proxy Statement for the 1996 Annual Meeting of Shareholders under the captions \"Election of Directors\" and \"Exchange Act Compliance\" and the information contained therein is incorporated herein by reference.\nThe executive officers of the Company are elected annually at the Board of Directors meeting held in conjunction with the annual meeting of shareholders. There are no family relationships between any directors or executive officers of the Company. Additional information regarding executive officers is set forth in Part I, Item 4a.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------- The response to this Item is contained in the Proxy Statement for the 1996 Annual Meeting of Shareholders under the caption \"Executive Compensation\" and the information contained therein is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------- The response to this Item is contained in the Proxy Statement for the 1996 Annual Meeting of Shareholders under the captions \"Voting at the Meeting\" and \"Stock Ownership of Management\" and the information contained therein is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------- The response to this Item is contained in the Proxy Statement for the 1996 Annual Meeting of Shareholders under the caption \"Executive Compensation\" and the information contained therein is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- (a)1. Financial Statements --------------------- The following consolidated financial statements of Airborne Freight Corporation and its subsidiaries as contained in its 1995 Annual Report to Shareholders are incorporated by reference in Part II, Item 8:\nConsolidated Statements of Net Earnings\nConsolidated Balance Sheets\nConsolidated Statements of Cash Flows\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\nAll other schedules are omitted because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto.\n(a)3. Exhibits - --------------- A) The following exhibits are filed with this report:\nEXHIBIT NO. 3 Articles of Incorporation and By-laws - ----------------------------------------------------- 3(a) The Restated Certificate of Incorporation of the Company, dated as of August 4, 1987 (incorporated herein by reference from Exhibit 3(a) to the Company's Form 10-K for the year ended December 31, 1987).\n3(b) The By-laws of the Company as amended to April 26, 1994 (incorporated herein by reference from Exhibit 3(b) to the Company's Form 8-K dated April 26, 1994).\nEXHIBIT NO. 4 Instruments Defining the Rights of Security Holders - ------------------------------------------------------------------- Including Indentures - --------------------- 4(a) Indenture dated as of September 4, 1986, between the Company and Peoples National Bank of Washington (now U.S. Bank of Washington), as trustee (and succeeded by First Trust Washington), relating to $25 million of the Company's 10% Senior Subordinated Notes due 1996 (incorporated by reference from Exhibit 4(c) to Amendment No. 1 to the Company's\nRegistration Statement on Form S-3, No. 33-6043, filed with the Securities and Exchange Commission on September 3, 1986).\n4(b) Note Purchase Agreement dated September 3, 1986 among the Company and the original purchasers of the Company's 10% Senior Subordinated Notes due 1996 (incorporated by reference from Exhibit 4(d) to Amendment No. 1 to the Company's Registration Statement on Form S-3, No. 33-6043, filed with the Securities and Exchange Commission on September 3, 1986).\n4(c) Indenture dated as of August 15, 1991, between the Company and Bank of America National Trust and Savings Association, as Trustee, with respect to the Company's 6-3\/4% Convertible Subordinated Debentures due August 15, 2001 (incorporated herein by reference from Exhibit 4(i) to Amendment No. 1 to the Company's Registration Statement on Form S-3 No. 33-42044 filed with the Securities and Exchange Commission on August 15, 1991).\n4(d) First Supplemental Trust Indenture dated as of June 30, 1994 between the Company and LaSalle National Bank, as Successor Trustee, with respect to the Company's 6-3\/4% Convertible Subordinated Debentures due August 15, 2001.\n4(e) Indenture dated as of December 3, 1992, between the Company and Bank of New York, as trustee, relating to the Company's 8-7\/8% Notes due 2002 (incorporated by reference from Exhibit 4(a) to Amendment No. 1 to the Company's Registration Statement on Form S-3, No. 33-54560 filed with the Securities and Exchange Commission on December 4, 1992).\n4(f) First Supplemental Indenture dated as of September 15, 1995, between the Company and Bank of New York, as trustee, relating to the Company's 7.35% Notes due 2005 (incorporated by reference from Exhibit 4(b) to Amendment No. 1 to the Company's Registration Statement on Form S-3, No. 33-61329, filed with the Securities and Exchange Commission on September 5, 1995).\n4(g) Rights Agreement, dated as of November 20, 1986 between the Company and First Jersey National Bank (predecessor to First Interstate Bank, Ltd.), as Rights Agent (incorporated by reference from Exhibit 1 to the Company's Registration Statement on Form 8-A, dated November 28, 1986).\n4(h) Certificate of Designation of Series A Participating Cumulative Preferred Stock Setting Forth the Powers, Preferences, Rights, Qualification, Limitations and Restrictions of Such Series of Preferred Stock of the Company (incorporated by reference from Exhibit 2 to the Company's Registration Statement on Form 8-A, dated November 28, 1986).\n4(i) Form of Right Certificate relating to the Rights Agreement (see 4(g) above, incorporated by reference from Exhibit 3 to the Company's Registration Statement on Form 8-A, dated November 28, 1986).\n4(j) Letter dated January 5, 1990, from the Company to First Interstate Bank, Ltd. (\"FIB\"), appointing FIB as successor Rights Agent under the Rights Agreement dated as of November 20, 1986, between the Company and The First Jersey National Bank (incorporated by reference from Exhibit 4(c) to the Company's Form 10-K for the year ended December 31, 1989).\n4(k) Amendment to Rights Agreement entered into as of January 24, 1990, between the Company and First Interstate Bank, Ltd. (incorporated herein by reference from Exhibit 4(d) to the Company's Form 10-K for the year ended December 31, 1989).\n4(l) Third Amendment to Rights Agreement entered into as of November 6, 1991 between the Company and First Interstate Bank, Ltd. (incorporated herein by reference from Exhibit 4(a) to the Company's Form 10-K for the year ended December 31, 1991).\n4(m) 6.9% Cumulative Convertible Preferred Stock Purchase Agreement dated as of December 5, 1989, among the Company, Mitsui & Co., Ltd., Mitsui & Co. (U.S.A.), Inc., and Tonami Transportation Co., Ltd. (incorporated herein by reference from Exhibit 4(b) to the Company's Form 10-K for the year ended December 31, 1989).\n4(n) Amendments to the above Stock Purchase Agreement irrevocably waiving all demand registration rights and relinquishing the right of Mitsui & Co., Ltd. to designate a representative to Airborne's Board of Directors, and resignation of T. Kokai from said Board (incorporated herein by reference from Amendment No. 1 to Schedule 13D of Mitsui & Co., Ltd., Intermodal Terminal, Inc. (assignee of Mitsui & Co. (USA) Inc.) and Tonami Transportation Co., Ltd., filed with the Securities and Exchange Commission on December 21, 1993).\n4(o) Certificate of Designation of Preferences of Preferred Shares of Airborne Freight Corporation, as filed on January 26, 1990, in the Office of the Secretary of the State of Delaware (incorporated herein by reference from Exhibit 4(a) to the Company's Form 10-K for the year ended December 31, 1989).\nEXHIBIT NO. 10 Material Contracts - ---------------------------------- Executive Compensation Plans and Agreements - -------------------------------------------- 10(a) 1979 Airborne Freight Corporation Key Employee Stock Option and Stock Appreciation Rights Plan, as amended through February 2, 1987 (incorporated by reference from Exhibit 10(d) to the Company's Form 10-K for the year ended December 31, 1986).\n10(b) 1983 Airborne Freight Corporation Key Employee Stock Option and Stock Appreciation Rights Plan, as amended through February 2, 1987 (incorporated by reference from Exhibit 10(c) to the Company's Form 10-K for the year ended December 31, 1986).\n10(c) 1989 Airborne Freight Corporation Key Employee Stock Option and Stock Appreciation Rights Plan (incorporated herein by reference from Exhibit 10(d) to the Company's Form 10-K for the year ended December 31, 1989).\n10(d) 1994 Airborne Freight Corporation Key Employee Stock Option and Stock Appreciation Rights Plan (incorporated herein by reference from the Addendum to the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders).\n10(e) Airborne Freight Corporations Directors Stock Option Plan (incorporated herein by reference from the Addendum to the Company's Proxy Statement for the 1991 Annual Meeting of Shareholders).\n10(f) Airborne Express Executive Deferral Plan dated January 1, 1992 (incorporated by reference from Exhibit 10(b) to the Company's Form 10-K for the year ended December 31, 1991).\n10(g) Airborne Express Supplemental Executive Retirement Plan dated January 1, 1992 (incorporated by reference from Exhibit 10(c) to the Company's Form 10-K for the year ended December 31, 1991).\n10(h) Airborne Express 1995-1999 Executive Incentive Compensation Plan (incorporated by reference from Exhibit 10(i) to the Company's Form 10-K for the year ended December 31, 1994).\n10(i) Employment Agreement dated December 15, 1983, as amended November 20, 1986, between the Company and Mr. Robert G. Brazier, President and Chief Operating Officer (incorporated by reference from Exhibit 10(a) to the Company's Form 10-K for the year ended December 31, 1986). Identical agreements exist between the Company and the other six executive officers.\n10(j) Employment Agreement dated November 20, 1986 between the Company and Mr. Lanny H. Michael, then Vice President, Treasurer and Controller (incorporated by reference from Exhibit 10(b) to the Company's Form 10-K for the year ended December 31, 1986). The Company and its principal subsidiary, ABX Air, Inc., have entered into substantially identical agreements with most of their officers.\nOther Material Contracts ------------------------- 10(k) $240,000,000 Revolving Loan Facility dated as of November 19, 1993 among the Company, as borrower, and Wachovia Bank of Georgia, N.A., as agent, and Wachovia Bank of Georgia, N.A., ABN AMRO Bank N.V., United States National Bank of Oregon,\nSeattle-First National Bank, CIBC, Inc., Continental Bank N.A., Bank of America National Trust and Savings Association, The Bank of New York, NBD Bank, N.A., as banks (incorporated herein by reference from Exhibit 10(k) to the Company's Form 10-K for the year ended December 31, 1993).\n10(l) First Amendment to Revolving Loan Facility dated as of March 31, 1995 among the Company, as borrower, and Wachovia Bank of Georgia, N.A., as Agent, and Wachovia Bank of Georgia, N.A., ABN AMRO Bank N.V., United States National Bank of Oregon, Seattle-First National Bank, CIBC, Inc., National City Bank, Columbus, Bank of America National Trust and Savings Association, The Bank of New York, and NBD Bank, N.A., as banks (incorporated by reference from Exhibit 10 to the Company's Form 10-Q for the quarter ended March 31, 1995).\n10(m) Shareholders Agreement entered into as of February 7, 1990, among the Company, Mitsui & Co., Ltd., and Tonami Transportation Co., Ltd., relating to joint ownership of Airborne Express Japan, Inc. (incorporated herein by reference from Exhibit 10(c) to the Company's Form 10-K for the year ended December 31, 1989).\n10(n) Used Aircraft Sales Agreement entered into as of December 22, 1995 between ABX Air, Inc. and KC-One, Inc; KC-Two, Inc.; and KC-Three, Inc. Confidential treatment has been requested for confidential commercial and financial information, pursuant to Rule 24b-2 under the Securities Exchange Act of 1934.\nEXHIBIT NO. 11 Statement Re Computation of Per Share Earnings - -------------------------------------------------------------- 11 Statement re computation of earnings per share\nEXHIBIT NO. 12 Statements Re Computation of Ratios - --------------------------------------------------- 12 Statement re computation of ratio of senior long-term debt and total long-term debt to total capitalization\nEXHIBIT NO. 13 Annual Report to Security Holders - ------------------------------------------------- 13 Portions of the 1995 Annual Report to Shareholders of Airborne Freight Corporation\nEXHIBIT NO. 21 Subsidiaries of the Registrant - ---------------------------------------------- 21 The subsidiaries of the Company are listed in Part I of this report on Form 10-K for the year ended December 31, 1995.\nEXHIBIT NO. 23 Consents of Experts and Counsel - ----------------------------------------------- 23 Independent Auditors' Consent and Report on Schedule\nEXHIBIT NO. 27 Financial Data Schedule - --------------------------------------- 27 Financial Data Schedule\nAll other exhibits are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.\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.\nAIRBORNE FREIGHT CORPORATION\nBy \/s\/ Robert S. Cline -------------------------- Robert S. Cline Chief Executive Officer\nBy \/s\/ Robert G. Brazier -------------------------- Robert G. Brazier Chief Operating Officer\nBy \/s\/ Roy c. Liljebeck -------------------------- Roy C. Liljebeck Chief Financial Officer\nBy \/s\/ Lanny H. Michael -------------------------- Lanny H. Michael Treasurer and Controller\nDate: March 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 date indicated:\n\/s\/ Robert G. Brazier \/s\/ Richard M. Rosenberg - ----------------------------- ----------------------------- Robert G. Brazier (Director) Richard M. Rosenberg (Director)\n\/s\/ Robert S. Cline \/s\/ Andrew V. Smith - ----------------------------- ----------------------------- Robert S. Cline (Director) Andrew V. Smith (Director)\n\/s\/ Harold M. Messmer, Jr. - ----------------------------- Harold M. Messmer, Jr. (Director)\nAIRBORNE FREIGHT CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In thousands)\npgae 22\nEXHIBIT INDEX\nEXHIBIT NO. 3 Articles of Incorporation and By-laws - ----------------------------------------------------\nEXHIBIT NO. 4 Instruments Defining the Rights of Security Holders - ------------------------------------------------------------------ Including Indentures - --------------------\nEXHIBIT NO. 10 Material Contracts - ----------------------------------- Executive Compensation Plans and Agreements - --------------------------------------------\nEXHIBIT NO. 11 Statement Re Computation of Per Share Earnings - ---------------------------------------------------------------\nEXHIBIT NO. 12 Statements Re Computation of Ratios - ----------------------------------------------------\nEXHIBIT NO. 13 Annual Report to Security Holders - --------------------------------------------------\nEXHIBIT NO. 21 Subsidiaries of the Registrant - -----------------------------------------------\nEXHIBIT NO. 23 Consents of Experts and Counsel - ------------------------------------------------\nEXHIBIT NO. 27 Financial Data Schedule - ----------------------------------------\nAll other exhibits are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.","section_15":""}
{"filename":"12978_1995.txt","cik":"12978","year":"1995","section_1":"Item 1. Business\nAs used in this annual report, the term \"Company\" includes Boise Cascade Corporation and its consolidated subsidiaries and predecessors. The terms \"Boise Cascade\" and \"Company\" refer, unless the context otherwise requires, to Boise Cascade Corporation and its consolidated subsidiaries.\nBoise Cascade Corporation is an integrated paper and forest products company headquartered in Boise, Idaho, with operations located primarily in the United States. The Company manufactures and distributes paper and paper products, office products, and building products and owns and manages timberland to support these operations. The Company was incorporated under the laws of Delaware in 1931 under the name Boise Payette Lumber Company of Delaware, as a successor to an Idaho corporation formed in 1913; in 1957, its name was changed to its present form.\nThe Company is a participant with equity affiliates in connection with certain of its businesses. The Company's principal investments in affiliates include a 30% interest in Rumford Cogeneration Company Limited Partnership, a 47% interest in Voyageur Panel, and a 25% interest in Ponderosa Fibres of Washington. (See Note 9 of the Notes to Financial Statements of the Company's 1995 Annual Report. This information is incorporated herein by this reference.)\nFinancial information pertaining to each of the Company's industry segments and to each of its geographic areas for the years 1995, 1994, and 1993 is presented in Note 10, \"Segment Information,\" of the Notes to Financial Statements of the Company's 1995 Annual Report and is incorporated herein by this reference.\nThe Company's sales and income are affected by the industry supply of product relative to the level of demand and by changing economic conditions in the markets it serves. Demand for paper and paper products and for office products correlates closely with real growth in the gross domestic product. Paper and paper products operations are also affected by demand in international markets and by inventory levels of users of these products. The Company's building products businesses are dependent on repair-and-remodel activity, housing starts, and commercial and industrial building, which in turn are influenced by the availability and cost of mortgage funds. Declines in building activity that may occur during winter affect the Company's building products businesses. In addition, energy and some operating costs may increase at facilities affected by cold weather. However, seasonal influences are generally not significant.\nThe management practices followed by the Company with respect to working capital conform to those of the paper and forest products industry and common business practice in the United States.\nThe Company occasionally engages in acquisition discussions with other companies and makes acquisitions from time to time. It is the Company's policy to review its operations periodically and to dispose of assets which fail to meet its criteria for return on investment or which cease to warrant retention for other reasons. (See Notes 1, 6, and 9 of the Notes to Financial Statements of the Company's 1995 Annual Report. This information is incorporated herein by this reference.)\nPaper and Paper Products\nThe products manufactured by the Company, made both from virgin and recycled fibers, include uncoated business, printing, forms, and converting papers; coated white papers for magazines, catalogs, and direct-mail advertising; newsprint; containerboard; and market pulp. These products are available for sale to the related paper markets, and certain of these products are sold through the Company's office products distribution operations. In addition, containerboard is used by the Company in the manufacture of corrugated containers.\nThe Company is a major North American pulp and paper producer with 7 paper mills. The total annual practical capacity of the mills was approximately 3.3 million tons at December 31, 1995. The Company's products are sold to distributors and industrial customers primarily by the Company's own sales personnel.\nThe Company's paper mills are supplied with pulp principally from the Company's own integrated pulp mills. Pulp mills in the Northwest manu- facture chemical pulp primarily from wood waste produced as a byproduct of wood products manufacturing. Pulp mills in the Midwest, Northeast, and South manufacture chemical, thermomechanical, and groundwood pulp mainly from pulpwood logs and, to some extent, from purchased wood waste and pulp from deinked recycled fiber. Wood waste is provided by Company sawmills and plywood mills in the Northwest and, to a lesser extent, in the South, and the remainder is purchased from outside sources.\nIn October 1994, Rainy River Forest Products Inc. (Rainy River), the Company's former Canadian subsidiary, completed an initial public offering of units of its equity and debt securities. As a result of the offering, the Company owned 49% of the outstanding voting common shares and 60% of the total equity of Rainy River. Rainy River was accounted for on the equity method retroactive to January 1, 1994, in the Company's consolidated financial statements and its results of operations were included in \"Equity in net income (loss) of affiliates.\" Rainy River owned and operated the Company's former newsprint mill in Kenora, Ontario, Canada, an uncoated groundwood paper mill in Fort Frances, Ontario, Canada, and a newsprint mill in West Tacoma, Washington.\nIn November 1995, the Company divested its remaining interest in Rainy River through Rainy River's merger with Stone-Consolidated Corporation. At December 31, 1995, the Company holds approximately 6,600,000 shares of Stone-Consolidated Corporation's common stock representing 6.4% of its outstanding common stock and 2,800,000 shares of its redeemable preferred stock. The Company accounts for its holdings in Stone-Consolidated Corporation on the cost method. (See Note 9 of the Notes to Financial Statements of the Company's 1995 Annual Report. This information is incorporated herein by this reference.)\nThe Company currently manufactures corrugated containers at 7 plants, which have annual practical capacity of approximately 3.9 billion square feet. The containers produced at the Company's plants are used to package fresh fruit and vegetables, processed food, beverages, and many other industrial and consumer products. The Company sells its corrugated containers primarily through its own sales personnel. The Company is building a full-line corrugated container plant in Utah, which is scheduled for completion in mid-1996 and will replace an existing plant.\nThe following table sets forth sales volumes of paper and paper products for the years indicated:\n1995 1994 1993 1992 1991 Paper (thousands of short tons)\nUncoated free sheet 1,177 1,271 1,215 1,110 1,050 Containerboard 602 595 559 560 540 Coated papers 428 447 418 397 371 Newsprint(1) 416 415 860 831 838 Market pulp 217 212 205 260 284 Discontinued grades - - 299 319 319 ______ ______ ______ ______ ______ 2,840 2,940 3,556 3,477 3,402\n(millions of square feet)\nCorrugated Containers(2) 3,114 3,237 2,961 4,715 6,478\n(1) Newsprint for 1995 and 1994 excludes production from Rainy River, which was reported on the equity method from January 1, 1994, through\nNovember 1, 1995. On November 1, 1995, Rainy River merged with Stone-Consolidated Corporation.\n(2) In mid-1992, the Company sold 11 of its corrugated container plants.\nOffice Products\nIn April 1995, the Company's wholly owned subsidiary, Boise Cascade Office Products Corporation (BCOP), completed the initial public offering of 5,318,750 shares of common stock at a price of $25 per share. After the offering, the Company owned 82.7% of the outstanding BCOP common stock. At December 31, 1995, the Company owned approximately 81.5% of the outstanding BCOP common stock. (See Note 6 of the Notes to Financial Statements of the Company's 1995 Annual Report. This information is incorporated herein by this reference.)\nBCOP distributes a broad line of items for the office, including office and computer supplies, office and computer furniture, and photocopy paper. All of the products sold by this segment are purchased from other manufacturers or from industry wholesalers, except for copier and similar papers, which are sourced primarily from the Company's paper operations. BCOP sells these office products directly to corporate, government, and other offices nationwide and, beginning in 1996, in Canada, as well as to individuals, home offices, and small and medium-sized business offices in the United States and Great Britain.\nCustomers with multisite locations across the country are often serviced via national contracts that provide for consistent pricing and product offerings and, if desired, summary billings, usage reporting, and other special services. At December 31, 1995, BCOP operated 36 distribution centers. During 1995, BCOP completed or announced acquisitions of 13 office products distribution businesses. These included a national office products distributor in Canada, and office products businesses in Ohio (two businesses), Virginia, Kentucky, Idaho, New York, Missouri, Pennsylvania, Florida, Maine, Vermont, and Great Britain. BCOP's distribution centers provide next-day delivery to substantially all locations. The Company also operates four retail office supply stores in Hawaii. The Canadian acquisition was completed in February 1996 and included approximately 80 retail stores and 6 distribution centers.\nThe following table sets forth sales dollars for BCOP for the years indicated:\n1995 1994 1993 1992 1991\nSales (millions) $1,316 $ 909 $ 683 $ 672(1) $1,039\n(1) Early in 1992, BCOP sold essentially all of its wholesale office products distribution operations, enabling them to focus on the consumer channel on a national basis. In 1991, sales of the 13 distribution centers and 1 minidistribution center that comprised the wholesale operations were approximately $400 million.\nBuilding Products\nThe Company is a major producer of lumber, plywood, and particleboard, together with a variety of specialty wood products. The Company also manufactures engineered wood products consisting of laminated veneer lumber (LVL), which is a high-strength engineered structural lumber product, and wood I-joists that incorporate the LVL technology. Most of its production is sold to independent wholesalers and dealers and through the Company's own wholesale building materials distribution outlets. The Company's wood products are used primarily in housing, industrial construction, and a variety of manufactured products. Wood products manufacturing sales for 1995, 1994, and 1993 were $977 million, $997 million, and $941 million.\nThe following table sets forth annual practical capacities of the Company's wood products facilities as of December 31, 1995:\nNumber of Mills(1) Practical Capacity (millions)\nPlywood 12 1,965 square feet (3\/8\" basis) Lumber 11 725 board feet Particleboard 1 196 square feet (3\/4\" basis) Engineered Wood Products(2)(3) 1 6 cubic feet\n(1) The Company closed a sawmill in Idaho in early 1995. (2) The Company is constructing an LVL plant with 4.4 million cubic feet of annual capacity in Alexandria, Louisiana. The plant will start up in mid-1996. (3) In 1995, the Company formed a joint venture to build an oriented strand board (OSB) plant in Barwick, Ontario, Canada. The Company owns 47% of the joint venture. The plant, with 400 million square feet of annual capacity, will begin production in 1997.\nThe Company operates 11 wholesale building materials distribution facilities. These operations market a wide range of building materials, including lumber, plywood, particleboard, engineered wood products, fiberboard siding, roofing, gypsum board, insulation, ceiling tile, paneling, molding, windows, doors, builders' hardware, and related products. These products are distributed to retail lumber dealers, home centers specializing in the do-it-yourself market, and industrial custom- ers. A portion (approximately 36% in 1995) of the wood products required by the Company's Building Materials Distribution Division is provided by the Company's manufacturing facilities, and the balance are purchased from outside sources. In late 1995, the Company agreed to purchase land and buildings in Albuquerque, New Mexico, to establish a wholesale building materials distribution facility. The facility is expected to be operational in early 1996.\nThe following table sets forth sales volumes of wood products and sales dollars for engineered wood products and the building materials distribution business for the years indicated:\n1995 1994 1993 1992 1991 (millions)\nPlywood (square feet - 3\/8\" basis) 1,865 1,894 1,760 1,788 1,621 Lumber (board feet) 711 754 760 805 815 Particleboard (square feet - 3\/4\" basis) 196 194 182 186 182 Engineered wood products (sales dollars) $ 88 $ 82 $ 71 $ 38 $ 13 Building materials distribution (sales dollars) $598 $657 $590 $447 $328\nTimber Resources\nBoise Cascade owns or controls approximately 3.1 million acres of timberland in North America. The amount of timber harvested each year by the Company from its timber resources, compared with the amount it purchases from outside sources, varies according to the price and supply of timber for sale on the open market and according to what the Company deems to be in the interest of sound management of its timberlands. During 1995, the Company's mills processed approximately 1.1 billion board feet of sawtimber and 2.0 million cords of pulpwood; 36% of the sawtimber and 37% of the pulpwood were harvested from the Company's timber resources, and the balance was acquired from various private and government sources. Approximately 75% of the 1.2 million bone-dry tons of softwood and hardwood chips consumed by the Company's Northwest pulp and paper mills in 1995 were provided from the Company's Northwest wood products manufacturing facilities as residuals from the processing of solid wood products and from a whole-log chipping facility. Of the 726 bone-dry tons of residual chips used in the South, 46% were provided by the Company's Southern wood products manufacturing facilities.\nAt December 31, 1995, the acreages of owned or controlled timber resources by geographic area and the approximate percentages of total fiber requirements available from the Company's respective timber resources in these areas and from the residuals from processed purchased logs are shown in the following table.\nLong-term leases generally provide the Company with timber harvesting rights and carry with them the responsibility for management of the timberlands. The average remaining life of all leases and contracts is in excess of 40 years. In addition, the Company has an option to purchase approximately 203,000 acres of the timberland it currently has under leases and contracts in the South.\nThe Company seeks to maximize the utilization of its timberlands through efficient management so that the timberlands will provide a continuous supply of wood for future needs. Site preparation, planting, fertilizing, thinning, and logging techniques are continually improved through a variety of methods, including genetic research and computerization.\nThe Company assumes substantially all risks of loss from fire and other casualties on all the standing timber it owns, as do most owners of timber tracts in the U.S.\nAdditional information pertaining to the Company's timber resources is presented under the caption \"Timber Supply\" of the Financial Review of the Company's 1995 Annual Report. This information is incorporated herein by this reference.\nCompetition\nThe markets served by the Company are highly competitive, with various substantial companies operating in each. The Company competes in its markets principally through price, service, quality, and value-added products and services.\nEnvironmental Issues\nThe Company's discussion of environmental issues is presented under the caption \"Environmental Issues\" of the Financial Review of the Company's 1995 Annual Report. This information is incorporated herein by this reference.\nEmployees\nAs of December 31, 1995, the Company and its subsidiaries had 17,820 employees, 7,445 of whom were covered under collective bargaining agreements. Major negotiations concluded for 1995, included the Company's pulp and paper mills in Rumford, Maine, and Jackson, Alabama. These facilities ratified new six-year contracts that expire in 2001.\nAmong the negotiations scheduled for 1996 are labor contracts covering the Company's wood products facilities in Oakdale, Louisiana; Florien, Louisiana; and Fisher, Louisiana.\nIdentification of Executive Officers\nThe information with respect to the executive officers of the registrant, which is set forth in Item 10 of this annual report on Form 10-K, is incorporated into this Part I by this reference.\nCapital Investment\nThe Company's capital expenditures in 1995 were $428 million, compared with $272 million in 1994 and $221 million in 1993. Details of 1995 spending by segment and by type are as follows:\nReplacement, Quality\/ Timber and Environmental, Expansion Efficiency(1)Timberlands and Other Total (expressed in millions)\nPaper and paper products $ 84 $ 71 $ - $ 88 $ 243 Office products(2) 81 8 - 14 103 Building products 38 14 - 17 69 Timber and timberlands - - 6 - 6 Other 2 - - 5 7 _____ _____ _____ _____ _____ Total $ 205 $ 93 $ 6 $ 124 $ 428\n(1) Quality and efficiency projects include quality improvements, modernization, energy, and cost-saving projects. (2) Capital expenditures include acquisitions made by BCOP through the issuance of common stock.\nThe level of capital investment in 1996 is expected to be about $400 million, excluding acquisitions and any spending related to the new paper machine at the Jackson, Alabama, facility which is expected to be funded by a joint venture to be formed with the Brazilian pulp and paper company, Suzano de Papel e Celulose. The 1996 capital budget will be allocated to cost-saving, modernization, expansion, replacement, maintenance, environmental, and safety projects.\nEnergy\nThe paper and paper products segment is the primary energy user of the Company. Self-generated energy sources in this segment, such as wood wastes, pulping liquors, and hydroelectric power, provided 52% of total 1995 energy requirements, compared with 59% in 1994 and 55% in 1993. The energy requirements fulfilled by purchased sources in 1995 were as follows: natural gas, 58%; electricity, 30%; residual fuel oil, 11%; and other sources, 1%.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns substantially all of its non-office products operating facilities. Regular maintenance, renewal, and new construction programs have preserved the operating suitability and adequacy of those properties. The majority of the office products facilities are rented under operating leases.\nFollowing is a list of the Company's facilities by segment as of December 31, 1995. Information concerning timber resources is presented in Item 1 of this Form 10-K.\nPaper and Paper Products\n7 pulp and paper mills located in Alabama, Louisiana, Maine, Minnesota, Oregon, and Washington (2). In late 1995, a decision was made to reconfigure the Company's Vancouver, Washington, pulp and paper mill and reduce, over time, its production.\n6 regional service centers located in California, Georgia, Illinois, New Jersey, Oregon, and Texas.\n1 converting facility located in Oregon.\n7 corrugated container plants located in Idaho (2), Nevada, Oregon, Utah, and Washington (2).\nOffice Products\n31 contract stationer distribution centers located in Arizona, California (2), Colorado, Connecticut, Florida (2), Georgia, Hawaii, Idaho, Illinois, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Missouri (2), New Jersey, New York, Ohio (2), Oregon, Pennsylvania (2), South Carolina, Texas (2), Utah, Virginia, and Washington.\n5 direct-mail distribution facilities located in Delaware, Georgia, Illinois, Nevada, and Great Britain.\n4 retail outlets located in Hawaii.\nBuilding Products\n11 sawmills located in Alabama, Idaho (2), Louisiana, Oregon (4), and Washington (3).\n12 plywood and veneer plants located in Idaho, Louisiana (2), Oregon (7), and Washington (2).\n1 particleboard plant located in Oregon.\n1 engineered wood products plant located in Oregon.\n1 wood beam plant located in Idaho.\n11 wholesale building materials units located in Arizona, Colorado (2), Idaho (2), Montana, Utah, and Washington (4).\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company has been notified that it is a \"potentially responsible party\" under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) or similar federal and state laws with respect to a number of sites where hazardous substances or other contaminants are located. In 1993, the Company filed a lawsuit in State District Court in Boise, Idaho, against its current and previous insurance carriers seeking insurance coverage for response costs the Company has incurred or may incur at these sites. The Company has settled with most carriers and a trial has been set to begin June 3, 1996, involving those companies who remain in the case. The Company cannot predict with certainty the total response and remedial costs, the Company's share of the total costs, the extent to which contributions will be available from other parties, the amount of time necessary to complete the cleanups, or the availability of insurance coverage. However, based on the Company's investigations, the Company's experience with respect to cleanup of hazardous substances, the fact that expenditures will, in many cases, be incurred over extended periods of time, and the number of solvent potentially responsible parties, the Company does not presently believe that the known actual and potential response costs will, in the aggregate, have a material adverse effect on its financial condition or the results of operations.\nOn December 7, 1995, the Company entered into a consent decree with the Yakima County, Washington, Clean Air Authority (YCCAA) to resolve air emission issues involving the Yakima Timber and Wood Products facility. The consent decree required the Company to pay the YCCAA approximately $125 thousand and provided for a period of time in which to study methods to reduce certain air emissions from the facility.\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 recovery, if any, or the Company's liability, if any, under any pending litigation or administrative proceeding, including that described in the preceding paragraphs would not materially affect its financial condition or operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock is listed on the New York, the Chicago, and the Pacific Stock Exchanges. The high and low sales prices for the Company's common stock, as well as the frequency and amount of dividends paid on such stock, is included in Note 11, \"Quarterly Results of Operations (unaudited),\" of the Notes to Financial Statements in the Company's 1995 Annual Report. Additional information concerning dividends on common stock is presented under the caption \"Dividends\" of the Financial Review section of the Company's 1995 Annual Report, and information concerning restrictions on the payments of dividends is included in Note 3, \"Debt,\" of the Notes to Financial Statements in the Company's 1995 Annual Report. The approximate number of common shareholders, based upon actual record holders at year-end, is presented under the caption \"Financial Highlights\" of the Company's 1995 Annual Report. The information under these captions is incorporated herein by this reference.\nShareholder Rights Plan\nPursuant to the shareholder rights plan adopted in December 1988 and as amended in September 1990, holders of common stock received a distribution of one right for each common share held. The rights become exercisable ten days after a person or group acquires 15% of the Company's outstanding voting securities or ten business days after a person or group commences or announces an intention to commence a tender or exchange offer that could result in the acquisition of 15% of these securities. If a person acquires 15% or more of the Company's outstanding voting securities, on the tenth day thereafter, unless this time period is extended by the board of directors, each right would, subject to certain adjustments and alternatives, entitle the rightholder to purchase common stock of the Company or the acquiring company having a market value of twice the $175 exercise price of the right (except that the acquiring person or group and other related holders would not be able to purchase common stock of the Company on these terms). The rights are nonvoting, may be redeemed by the Company at a price of 1 cent per right at any time prior to the tenth day after an individual or group acquires 15% of the Company's voting stock, unless extended, and expire in 1998. Additional details are set forth in the Amended and Restated Rights Agreement filed as Exhibit 1 in the Company's Form 8-K with the Securities and Exchange Commission on September 25, 1990.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth selected financial data of the Company for the years indicated and should be read in conjunction with the disclosures in Item 7","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nManagement's discussion and analysis of financial condition and results of operations are presented under the caption \"Financial Review\" of the Company's 1995 Annual Report and are incorporated herein by this reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Company's consolidated financial statements and related notes, together with the report of the independent public accountants, are presented in the Company's 1995 Annual Report and are incorporated herein by this reference. Selected quarterly financial data is presented in Note 11, \"Quarterly Results of Operations (unaudited),\" of the Notes to Financial Statements in the Company's 1995 Annual Report and is incor- porated herein by this reference.\nThe consolidated income statement for the three months ended December 31, 1995, is presented in the Company's Fact Book for the fourth quarter of 1995 and is incorporated herein by this reference.\nThe 10.125% Notes issued in December 1990, the 9.85% Notes issued in June 1990, the 9.9% Notes issued in March 1990, and the 9.45% Debentures issued in October 1989 each contain a provision under which in the event of the occurrence of both a designated event, as defined, and a rating decline, as defined, the holders of these securities may require the Company to redeem the securities.\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 directors and nominees for directors of the Company are presented under the caption \"Election of Directors\" in the Company's definitive proxy statement dated March 6, 1996. All of the nominees are presently directors. This information is incorporated herein by this reference.\nExecutive Officers as of February 29, 1996 Date First Elected as Name Age Position or Office an Officer\nGeorge J. Harad(1) 51 Chairman of the Board and Chief Executive Officer 5\/11\/82\nPeter G. Danis Jr.(2) 64 Executive Vice President 7\/26\/77\nTheodore Crumley 50 Senior Vice President and Chief Financial Officer 5\/10\/90\nA. Ben Groce 54 Senior Vice President 2\/8\/91\nAlice E. Hennessey 59 Senior Vice President 10\/28\/71\nTerry R. Lock 54 Senior Vice President 2\/17\/77\nRichard B. Parrish 57 Senior Vice President 2\/27\/80\nN. David Spence 60 Senior Vice President 12\/8\/87\nA. James Balkins III 43 Vice President, Associate General Counsel, and Corporate Secretary 9\/5\/91\nJ. Ray Barbee 48 Vice President 9\/26\/89\nStanley R. Bell 49 Vice President 9\/25\/90\nJohn C. Bender 55 Vice President 2\/13\/90\nCharles D. Blencke 52 Vice President 12\/11\/92\nTom E. Carlile 44 Vice President and Controller 2\/4\/94\nGary M. Curtis 45 Vice President 9\/28\/95\nJ. Michael Gwartney 55 Vice President 4\/25\/89\nJohn W. Holleran 41 Vice President and General Counsel 7\/30\/91\nH. John Leusner 60 Vice President 12\/11\/92\nIrving Littman 55 Vice President and Treasurer 11\/1\/84\nJeffrey G. Lowe 54 Vice President 12\/11\/92\nChristopher C. Milliken(3) 50 Vice President 2\/3\/95\nCarol B. Moerdyk(4) 45 Vice President 5\/10\/90\nTerry M. Plummer 42 Vice President 9\/28\/95\nD. Ray Ryden 62 Vice President 4\/26\/88\nDonald F. Smith 54 Vice President 12\/8\/87\nJ. Kirk Sullivan 60 Vice President 9\/30\/81\nGary M. Watson 48 Vice President 2\/5\/93\n(1) Chairman of the Board, Boise Cascade Office Products Corporation (2) President and Chief Executive Officer, Boise Cascade Office Products Corporation (3) Senior Vice President, Operations, Boise Cascade Office Products Corporation (4) Senior Vice President and Chief Financial Officer, Boise Cascade Office Products Corporation\nAll of the officers named above except A. Ben Groce and Gary M. Watson have been employees of the registrant or one of its subsidiaries for at least five years. Mr. Groce rejoined the Company in 1991 after resigning in June 1989. Prior to his resignation, he had served as an officer of the Company since December 1987. Mr. Watson joined Boise Cascade in 1992 as director of the Company's Paper Research and Development Center in Portland, Oregon.\nGary M. Curtis was elected a vice president in September 1995. Mr. Curtis received a A.S. degree in pulp and paper technology from the University of Maine in 1971. He also received a B.S. degree from the University of Maine in 1973. In 1988, Mr. Curtis attended the Harvard Program for Management Development at Harvard University. He joined the Company in 1982 and has held various positions in the Company's paper division.\nTerry M. Plummer was elected a vice president in September 1995. Mr. Plummer received a B.A. degree in economics and political science from Willamette University in 1974. In 1981, he received an M.B.A. degree with distinction from Harvard University. Mr. Plummer joined the Company in 1981. Prior to his current position in Marketing and Planning in the Company's paper division, he was the director of research and development.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation concerning compensation of the Company's executive officers for the year ended December 31, 1995, is presented under the caption \"Compensation Tables\" in the Company's definitive proxy statement dated March 6, 1996. This information is incorporated herein by this reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Information concerning the security ownership of certain benefi- cial owners as of December 31, 1995, is set forth under the caption \"Beneficial Ownership\" in the Company's definitive proxy statement dated March 6, 1996, and is incorporated herein by this reference.\n(b) Information concerning security ownership of management as of December 31, 1995, is set forth under the caption \"Security Ownership of Directors and Executive Officers\" in the Company's definitive proxy statement dated March 6, 1996, and is incorpo- rated herein by this reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation concerning certain relationships and related transactions during 1995 is set forth under the caption \"Consulting and Legal Services\" in the Company's definitive proxy statement dated March 6, 1996, and is incorporated herein by this reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as a part of this annual report on Form 10-K for Boise Cascade Corporation and subsidiaries:\n(1) Financial Statements\n(i) The Income Statement for the three months ended December 31, 1995, is incorporated herein by this reference from the Company's Fact Book for the fourth quarter of 1995.\n(ii) The Financial Statements, the Notes to Financial Statements, and the Report of Independent Public Accountants listed below are incorporated herein by this reference from the Company's 1995 Annual Report.\n- Balance Sheets as of December 31, 1995 and 1994. - Statements of Income (Loss) for the years ended December 31, 1995, 1994, and 1993. - Statements of Cash Flows for the years ended December 31, 1995, 1994, and 1993. - Statements of Shareholders' Equity for the years ended December 31, 1995, 1994, and 1993. - Notes to Financial Statements. - Report of Independent Public Accountants.\n(2) Financial Statement Schedules.\nNone required.\n(3) Exhibits.\nA list of the exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated herein by this reference.\n(b) Reports on Form 8-K.\nThe Company filed a Form 8-K with the Securities and Exchange Commission on January 18, 1996, to file a copy of its announcement of fourth quarter income. The Form 8-K also reports the ratio of earnings to fixed charges.\nThe Company filed a Form 8-K with the Securities and Exchange Commission on November 14, 1995, to report unaudited pro forma financial information giving effect to the merger of Rainy River Forest Products Inc. and Stone-Consolidated Corporation. The Form 8-K also included the news release issued by the Company announcing the completion of the merger of Rainy River and Stone-Consolidated Corporation.\n(c) Exhibits.\nSee Index to exhibits.\nFor the purpose of complying with the rules governing Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 33-47892 (filed May 14, 1992), 33-28595 (filed May 8, 1989), 33-21964 (filed June 6, 1988), 33-31642 (filed November 7, 1989), 33-45675 (filed February 12, 1992), and 33-62263 (filed August 31, 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.\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.\nBoise Cascade Corporation\nBy George J. Harad George J. Harad Chairman of the Board and Chief Executive Officer Dated: March 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 and in the capacities indicated on March 15, 1996.\nSignature Capacity\n(i) Principal Executive Officer:\nGeorge J. Harad Chairman of the Board and George J. Harad Chief Executive Officer\n(ii) Principal Financial Officer:\nTheodore Crumley Senior Vice President and Theodore Crumley Chief Financial Officer\n(iii) Principal Accounting Officer\nTom E. Carlile Vice President Tom E. Carlile and Controller\n(iv) Directors:\nGeorge J. Harad A. William Reynolds George J. Harad A. William Reynolds\nAnne L. Armstrong Jane E. Shaw Anne L. Armstrong Jane E. Shaw\nRobert E. Coleman Frank A. Shrontz Robert E. Coleman Frank A. Shrontz\nRobert K. Jaedicke Edson W. Spencer Robert K. Jaedicke Edson W. Spencer\nJames A. McClure Robert H. Waterman, Jr. James A. McClure Robert H. Waterman, Jr.\nPaul J. Phoenix Ward W. Woods, Jr. Paul J. Phoenix Ward W. Woods, Jr.\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report dated January 26, 1996, included or incorporated by reference in this Form 10-K for the year ended December 31, 1995, into Boise Cascade Corporation's previously filed post-effective amendment No. 1 to Form S-8 registration statement (File No. 33-28595); the registration statement on Form S-8 (File No. 33-47892); post-effective amendment No. 1 to Form S-8 registration statement (File No. 33-21964); the registration statement on Form S-8 (File No. 33-31642); the registration statement on Form S-8 (File No. 33-45675); the registration statement on Form S-3 (File No. 33-54533); the registration statement on Form S-3 (File No. 33-55396); and the registration statement on Form S-8 (File No. 33-62263).\nARTHUR ANDERSEN LLP\nBoise, Idaho March 15, 1996\nBOISE CASCADE CORPORATION\nINDEX TO EXHIBITS Filed with the Annual Report on Form 10-K for the Year Ended December 31, 1995\nPage Number Description Number(1)\n2 Inapplicable - 3.1 (2) Restated Certificate of Incorporation, as amended - 3.2 (3) Certificate of Designation of Convertible Preferred Stock, Series D, dated July 10, 1989 - 3.3 (4) Bylaws, as amended, September 29, 1994 - 3.4 (5) Certificate of Designation of Cumulative Preferred Stock, Series F, dated January 29, 1993 - 3.5 (6) Certificate of Designation of Conversion Preferred Stock, Series G, dated September 17, 1993 - 4.1 (7) Trust Indenture between Boise Cascade Corporation and Morgan Guaranty Trust Company of New York, Trustee, dated October 1, 1985, as amended - 4.2 (8) 1994 Revolving Loan Agreement -- $600,000,000, dated April 15, 1994, as amended July 10, 1995 - 4.3 (9) Shareholder Rights Plan, as amended September 25, 1990 - 9 Inapplicable - 10.1 Key Executive Performance Plan for Executive Officers, as amended through December 7, 1995, with the 1995 and 1996 Performance Criteria 10.2 1986 Executive Officer Deferred Compensation Plan, as amended through December 7, 1995 10.3 1983 Board of Directors Deferred Compensation Plan, as amended through December 7, 1995 10.4 1982 Executive Officer Deferred Compensation Plan, as amended through December 7, 1995 10.5 (5) Executive Officer Severance Pay Policy - 10.6 Supplemental Early Retirement Plan for Executive Officers, as amended through December 7, 1995 10.7 (10) Boise Cascade Corporation Supplemental Pension Plan, effective as of January 1, 1994 - 10.8 1987 Board of Directors Deferred Compensation Plan, as amended through December 7, 1995 10.9 1984 Key Executive Stock Option Plan and Forms of Agreement, as amended through February 1, 1996 10.10 (5) Executive Officer Group Life Insurance Plan description - 10.11 Executive Officer 1980 Split-Dollar Life Insurance Plan, as amended through December 7, 1995 10.12 Forms of Agreements with Executive Officers, as amended through December 7, 1995 10.13 (5) Supplemental Health Care Plan for Executive Officers - 10.14 (5) Nonbusiness Use of Corporate Aircraft Policy, as amended - 10.15 (5) Executive Officer Financial Counseling Program description - 10.16 (5) Family Travel Program description - 10.17 (5) Form of Directors' Indemnification Agreement - 10.18 (11) Deferred Compensation and Benefits Trust, as amended by the Form of Third Amendment dated December 7, 1995 10.19 Director Stock Compensation Plan, as amended through December 7, 1995 10.20 Boise Cascade Corporation Director Stock Option Plan, as amended through December 7, 1995 10.21 1995 Executive Officer Deferred Compensation Plan, effective January 1, 1996 10.22 1995 Board of Directors Deferred Compensation Plan, effective January 1, 1996 10.23 Boise Cascade Corporation 1995 Split-Dollar Life Insurance Plan, as amended through December 7, 1995 11 Inapplicable - 12 Ratio of Earnings to Fixed Charges\n13.1 Incorporated sections of the Boise Cascade Corporation 1995 Annual Report 13.2 Incorporated sections of the Boise Cascade Corporation Fact Book for the fourth quarter of 1995 16 Inapplicable - 18 Inapplicable - 21 Significant subsidiaries of the registrant 22 Inapplicable - 23 Consent of Arthur Andersen LLP (See page __) 24 Inapplicable - 27 Financial Data Schedule 28 Inapplicable - 99 Inapplicable -\n(1) This information appears only in the manually signed original of the Annual Report on Form 10-K.\n(2) Exhibit 3.1 was filed under the same exhibit number in the Company's 1987 Annual Report on Form 10-K and is incorporated herein by this reference.\n(3) The Certificate of Designation of Convertible Preferred Stock, Series D, dated July 10, 1989, was filed as Exhibit 4.4 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and is incorporated herein by this reference.\n(4) The Bylaws, as amended September 29, 1994, were filed as Exhibit 3 in the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, and are incorporated herein by this reference.\n(5) Exhibits 3.4, 10.5, 10.10, 10.13, 10.14, 10.15, 10.16, and 10.17 were filed under the same exhibit numbers in the Company's 1993 Annual Report on Form 10-K and are incorporated herein by this reference.\n(6) The Certificate of Designation of Conversion Preferred Stock, Series G, dated September 17, 1993, was filed as Exhibit 3.6 in the Company's 1993 Annual Report on Form 10-K and is incorporated herein by this reference.\n(7) The Trust Indenture between Boise Cascade Corporation and Morgan Guaranty Trust Company of New York, Trustee, dated October 1, 1985, as amended, was filed as Exhibit 4 in the Registration Statement on Form S-3 No. 33-5673, filed May 13, 1986. The First Supplemental Indenture, dated December 20, 1989, to the Trust Indenture between Boise Cascade Corporation and Morgan Guaranty Trust Company of New York, Trustee, dated October 1, 1985, was filed as Exhibit 4.2 in the Pre- Effective Amendment No. 1 to the Registration Statement on Form S-3 No. 33-32584, filed December 20, 1989. The Second Supplemental Indenture, dated August 1, 1990, to the Trust Indenture was filed as Exhibit 4.1 in the Company's Current Report on Form 8-K filed on August 10, 1990. Each of the documents referenced in this footnote is incorporated herein by this reference.\n(8) The 1994 Revolving Loan Agreement was filed as Exhibit 4.2 in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, and is incorporated herein by this reference. The Form of First Amendment to the 1994 Revolving Loan Agreement was filed as Exhibit 4 in the Company's Form 10-Q for the quarter ended June 30, 1995, and is incorporated herein by this reference.\n(9) The Rights Agreement, dated as of December 13, 1988, as amended September 25, 1990, was filed as Exhibit 1 in the Company's Form 8-K filed with the Securities and Exchange Commission on September 25, 1990, and is incorporated herein by this reference.\n(10) Exhibit 10.7 was filed under the same exhibit number in the Company's 1994 Annual Report on Form 10-K and is incorporated herein by this reference.\n(11) The Deferred Compensation and Benefits Trust, as amended and restated December 1, 1988, together with Amendment No. 1 dated December 15, 1988, and Amendment No. 2 dated June 30, 1989, were filed under the same exhibit number in the Company's 1993 Annual Report on Form 10-K and are incorporated herein by this reference.","section_15":""}
{"filename":"67517_1995.txt","cik":"67517","year":"1995","section_1":"Item 1. Business.\nReference is hereby made to pages 4 and 5 of registrant's 1995 annual report to stockholders (filed herewith as Exhibit 13) for a description of registrant's business, including information regarding industry segments. Such information is hereby incorporated herein by reference. In addition, registrant submits the following information:\nThe registrant did not introduce any new products nor begin to do business in a new industry segment during 1995.\nThe registrant owns and operates a quarry located adjacent to the Humboldt, Kansas plant which contains all essential raw materials presently used by the registrant. This quarry contains reserves estimated to be sufficient to maintain operations at the Humboldt plant's present capacity for approximately 40 years.\nThe registrant's products are marketed under registered trademarks using the name \"MONARCH\". The registrant's operations are not materially dependent on any trademarks, franchises, patents or on any licenses relating to the use thereof.\nDue to inclement construction weather in the registrant's market area during January, February and March, normally about 85% of the registrant's sales occur in April through December.\nIt is necessary for the registrant to invest a significant portion of its working capital in inventories. At December 31, 1995 the registrant had inventories as follows:\nThe registrant is heavily dependent upon the construction industry and is directly affected by the level of activity in that industry. However, no customer accounted for 10% or more of the registrant's consolidated net revenue during 1995, 1994 or 1993.\nBacklog of customers' orders is not a material factor in the registrant's business.\nThe registrant has no contracts which are subject to renegotiation of profits or termination thereof at the election of the government.\nThe manufacture and sale of cement and ready-mixed concrete are extremely competitive enterprises. A number of producers, including several nationwide manufacturers, compete for business with the registrant in its market area. The registrant is not a significant factor in the nationwide portland cement or ready-mixed concrete business but does constitute a significant market factor for cement in its market area. Cement generally is produced to meet standard specifications and there is little differentiation between the products sold by the registrant and its competitors. Accordingly, competition exists primarily in the areas of price and customer service.\nThe registrant did not spend a material amount in the last three fiscal years on registrant sponsored research and development. However, the registrant is a member of the Portland Cement Association which conducts research for the cement industry.\nRegistrant has, during the past several years, made substantial capital expenditures for pollution control equipment. The registrant also incurs normal operating and maintenance expenditures in connection with its pollution control equipment.\nAt December 31, 1995, the Company and its subsidiaries employed approximately 440 hourly (production) employees and 115 salaried employees, which included plant supervisory personnel, sales and executive staff.\nAll of the registrant's operations and sales are in one geographic area.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe registrant's corporate offices and cement plant, including equipment and raw materials are located at Humboldt, Kansas, approximately 110 miles southwest of Kansas City, Missouri. The registrant owns approximately 2,000 acres of land on which the Humboldt plant, offices and all essential raw materials are located. Raw material reserves are estimated to be sufficient to maintain operations at this plant's present capacity for approximately 40 years. The registrant believes that this plant and equipment are suitable and adequate for its current level of operations. This plant has a present annual capacity of 650,000 tons of cement.\nThe registrant also owns approximately 690 acres of land in Des Moines, Iowa on which a formerly operated cement plant is located. Due to its age and condition and other economic factors, the registrant discontinued full-line production of cement at this plant in 1986 and began transferring clinker produced in Humboldt, Kansas to the Des Moines site for grinding into finished cement. During 1994, the registrant ceased the grinding operations and converted this facility into a cement terminal. The registrant is currently transferring finished cement produced in Humboldt, Kansas to this terminal for distribution to its Iowa customers. The registrant also owns, but is not currently operating, a rock quarry located near Earlham, Iowa, approximately 30 miles west of Des Moines, Iowa.\nThe registrant owns various companies which sell ready-mixed concrete, concrete products and sundry building materials in metropolitan areas within the Humboldt cement production facility's primary market. In management's opinion, these ready-mix facilities and equipment are suitable and adequate for their current level of operations. Individual locations do not have a material affect on the registrant's overall operations.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe registrant was not a party to any material legal proceedings during 1995.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThe registrant did not submit any matter to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nPursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on page 7 of the registrant's 1995 annual report to stockholders.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nPursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on page 2 of the registrant's 1995 annual report to stockholders.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nPursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on pages 2 through 4 of the registrant's 1995 annual report to stockholders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nPursuant to General Instruction G(2) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on pages 8 through 20 of the registrant's 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.\nPursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on pages 3 through 5 of the registrant's definitive proxy statement prepared in connection with its 1996 annual meeting of stockholders pursuant to Regulation 14A and previously filed with the Commission.\nItem 11.","section_11":"Item 11. Executive Compensation.\nPursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on pages 7 through 10 (except for the information set forth under the heading \"Board of Directors' Report on Executive Compensation\" which is expressly excluded from such incorporation) of the registrant's definitive proxy statement prepared in connection with its 1996 annual meeting of stockholders pursuant to regulation 14A and previously filed with the Commission.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nPursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on pages 6 and 7 of the registrant's definitive proxy statement prepared in connection with its 1996 annual meeting of stockholders pursuant to Regulation 14A and previously filed with the Commission.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nPursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the material responsive to this Item on page 8 of the registrant's definitive proxy statement prepared in connection with its 1996 annual meeting of stockholders pursuant to Regulation 14A and previously filed with the Commission.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\nFinancial Statements The report of Independent Public Accountants; the Consolidated Balance Sheets--December 31, 1995 and 1994; the Consolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993; the Consolidated Statements of Stockholders' Investment for the Years Ended December 31, 1995, 1994 and 1993; the Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993; and the Notes to Consolidated Financial Statements are incorporated by reference in Item 8 to this report from the registrant's 1995 annual report to stockholders at pages 8 through 20.\nSupporting Schedules Schedule II -- Valuation and Qualifying Accounts All other schedules have been omitted because the required information is shown in management's discussion and analysis of the financial statements or notes thereto, because the amounts involved are not significant or because the required subject matter is not present.\nExhibits 3(i) Articles of Incorporation. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 3(i) and incorporated herein by reference.) 3(ii) By-laws. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 3(ii) and incorporated herein by reference.) 10 Severance Pay Plan for Salaried Employees.* (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1985 (File No. 0-2757) as Exhibit 10(f) and incorporated herein by reference.) 13 1995 Annual Report to Stockholders. 21 Subsidiaries of the Registrant. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 21 and incorporated herein by reference.) 27 Financial Data Schedule.\n*Management contracts or compensatory plans or arrangements required to be identified by Item 14(a)(3).\nForm 8-K There were no Form 8-K reports required to be filed during the last quarter of 1995.\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.\nThe Monarch Cement Company (Registrant)\nBy: \/s\/ Jack R. Callahan Jack R. Callahan President\nDate: March 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 and in the capacities and on the dates indicated.\nBy: \/s\/ Jack R. Callahan By: \/s\/ Byron K. Radcliff Jack R. Callahan Byron K. Radcliff President, Principal Executive Director Officer and Director\nDate: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Karl Callaway By: \/s\/ Walter H. Wulf, Jr. Karl Callaway Walter H. Wulf, Jr. Director Director\nDate: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Robert M. Kissick By: \/s\/ Lyndell G. Mosley Robert M. Kissick Lyndell G. Mosley, CPA Director Assistant Secretary-Treasurer (Principal Financial Officer)\nDate: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Richard N. Nixon By: \/s\/ Debra P. Roe Richard N. Nixon Debra P. Roe, CPA Director Principal Accounting Officer\nDate: March 15, 1996 Date: March 15, 1996\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in The Monarch Cement Company's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 16, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The 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. 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.\n\/s\/ Arthur Andersen LLP\nKansas City, Missouri, February 16, 1996\nEXHIBIT INDEX\nExhibit Number Description\n3(i) Articles of Incorporation. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 3(i) and incorporated herein by reference.)\n3(ii) By-laws. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 3(ii) and incorporated herein by reference.)\n10 Severance Pay Plan for Salaried Employees. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1985 (File No. 0-2757) as Exhibit 10(f) and incorporated herein by reference.)\n13 1995 Annual Report to Stockholders.\n21 Subsidiaries of the Registrant. (Filed with the registrant's annual report on Form 10-K for the year ended December 31, 1994 (File No. 0-2757) as Exhibit 21 and incorporated herein by reference.)\n27 Financial Data Schedule.","section_15":""}
{"filename":"731131_1995.txt","cik":"731131","year":"1995","section_1":"Item 1. Business\nNational Housing Partnership Realty Fund I (A Maryland Limited Partnership) (the Partnership) was formed under the Maryland Revised Uniform Limited Partnership Act as of October 21, 1983. On May 25, 1984, the Partnership commenced offering 20,000 limited partnership interests, at a price of $1,000 per interest, through a public offering registered with the Securities and Exchange Commission (the Offering). The Offering was managed by Dean Witter Reynolds, Inc. and was terminated on November 29, 1984, with subscriptions for 11,519 limited partnership interests.\nThe General Partner with a 1% interest in the Partnership is The National Housing Partnership (NHP), a District of Columbia limited partnership, whose sole general partner (0.2%) is National Corporation for Housing Partnerships (NCHP). Following a corporate reorganization in August 1995, which involved an initial public offering of NHP Incorporated's management-related service companies (the \"Reorganization\"), the remaining 99.8% of NHP's limited partnership interest is owned by NHP Partners Two Limited Partnership (Partners Two), a Delaware limited partnership. NCHP is wholly owned by NHP Partners, Inc. (Partners), a Delaware corporation. Notwithstanding the Reorganization, control of NCHP, Partners Two and Partners remains with Demeter Holdings Corporation (a Massachusetts nonprofit corporation, which is wholly-owned\/controlled by the President and Fellows of Harvard College, a Massachusetts educational corporation created by the constitution of Massachusetts), Capricorn Investors, L.P. (a Delaware investment limited partnership, whose general partner is Capricorn Holdings, G.P., a Delaware general partnership), and J. Roderick Heller, III (Chairman, President and Chief Executive Officer of NCHP and Partners).\nThe Original Limited Partner of the Partnership is 1133 Fifteenth Street Associates, a District of Columbia limited partnership, whose general partner is NHP and whose limited partners were key employees of NCHP at the time the Partnership was formed. The Original Limited Partner holds a 1% interest in the Partnership.\nThe remaining 98% limited partnership interests in the Partnership are held by the investors who subscribed to the Offering.\nThe Partnership's business is to hold limited partnership interests in ten limited partnerships (Local Limited Partnerships), each of which owns and operates multi-family rental housing properties (Properties) which receive one or more forms of assistance from the Federal Government.\nThe Partnership acquired interests in the Local Limited Partnerships from sellers who originally developed the Properties. In each instance, NHP is the general partner of the Local Limited Partnership and the Partnership is the principal limited partner. As a limited partner, the Partnership's liability for obligations of the Local Limited Partnerships is limited to its investment, and the Partnership does not exercise control over the activities of the Local Limited Partnerships in accordance with the partnership agreements.\nThe Partnership's investment objectives are to:\n(1) preserve and protect Partnership capital;\n(2) provide current tax benefits to Limited Partners to the extent permitted by law, including, but not limited to, deductions that Limited Partners may use to offset otherwise taxable income from other sources;\n(3) provide capital appreciation through increase in value of the Partnership's investments, subject to considerations of capital preservation and tax planning; and\n(4) provide potential cash distributions from sales or refinancings of the Partnership's investments and, on a limited basis, from operations.\nThe Partnership does not have any employees. Services are performed for the Partnership by the General Partner and agents retained by it.\nThe following is a schedule of the Properties owned by the Local Limited Partnerships in which the Partnership is a limited partner:\nSCHEDULE OF PROPERTIES OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH NATIONAL HOUSING PARTNERSHIP REALTY FUND I HAS AN INVESTMENT\n(A) The mortgage is insured by the Federal Housing Administration under the provisions of Section 236 of the National Housing Act.\n(B) Section 8 of Title II of the Housing and Community Development Act of 1974.\nAlthough each Local Limited Partnership in which the Partnership has invested owns an apartment complex which must compete with other apartment complexes for tenants, government mortgage interest and rent subsidies make it possible to rent units to eligible tenants at below market rates. In general, this insulates the Properties from market competition. Fairmeadows and Lakeview Apartments Section 8 subsidy contracts covering 90 and 60 units, respectively, are scheduled to expire in September 1996. Additionally, Gates Mills I and Hurbell IV have contracts for 107 and 60 units, respectively, scheduled to expire in June, 1996. In January 1996, President Clinton signed into law H.R. 2880. This legislation includes a provision that requires HUD to provide a one-year renewal for Section 8 contracts scheduled to expire during the first nine months of 1996. All other Section 8 contracts are scheduled to expire between 1997 and 2003.\nOn August 1, 1989, an order was entered in the condemnation proceeding before the Superior Court of Muscogee County, Georgia, condemning a portion of Northgate Village Apartments' land for a city right of way to build a road. The city of Columbus, Georgia, has released damage proceeds of approximately $84,500 to the mortgage lender, Federal National Mortgage Association (FNMA), which have been placed in an escrow account which the property can draw upon to cover the cost of repairs and construction related to damages resulting from the condemnation. As of December 31, 1994, $66,999 had been drawn from the escrow to cover the cost of engineering studies for the damage repair work at the site, reconstruction of one of the property's parking areas, relocating dumpster pads, resurfacing the parking lot and stripe painting. During 1995, the remaining $17,501 was released to the property for final repairs to the parking lot.\nOperations at all other Properties were generally satisfactory during the period.\nNCHP was a significant participant in the drafting and passage of the Low Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA). LIHPRHA creates a procedure under which owners of properties assisted under the HUD Section 236 or 221(d)(3) program may be eligible to receive financial incentives in return for agreeing to extend their property's use as low income housing. Virtually all of the Local Limited Partnership Properties may be eligible for these incentives; however, not all may benefit from the particular incentives provided for under LIHPRHA. The appropriation for the Department of Housing and Urban Development (which administers LIHPRHA) for the 1996 fiscal year has not yet been approved, and NHP management expects that funding for the 1996 fiscal year, if approved, will be limited. Management also expects that funding for LIHPRHA is unlikely to be renewed in future fiscal years. Anticipating these developments, Notices of Intent to participate in the LIHPRHA program have been filed for Fairmeadows, Southridge, Gates Mills I, Northgate, San Jose and Talladega. All filings except San Jose are in the early stages of processing, and only San Jose is anticipated to be in a position to receive incentives. Depending on the outcome of this process, the ability of the Partnership to sell or refinance any of the Local Limited Partnership Properties under LIHPRHA could be adversely affected.\nAs discussed in Note 7 to the combined financial statements, all of the Local Limited Partnerships in which the Partnership has invested carry deferred acquisition notes due the original owner of each Property. With the exception of Fairmeadows and Southridge, these notes will reach final maturity between 1997 and 1999. These notes are secured by both the Partnership's and NHP's interests in the Local Limited Partnerships. In the event of a default on the notes, the noteholders would be able to assume NHP's and the Partnership's interests in the Local Limited Partnerships.\nThe Fairmeadows and Southridge notes finally matured on September 24, 1994 and October 18, 1994, respectively. The noteholders have not yet formally declared the notes in default. The General Partner has been negotiating with the noteholders to extend the maturity date of the notes and to discount the notes to protect the Partnership's interest. To date, these negotiations have been unsuccessful. Should no agreement be reached, and the noteholders declare the notes in default, the Partnership may lose its interest in these Local Limited Partnerships. Should the Partnership lose its interest in the Local Limited Partnership, partners in the Partnership may incur adverse tax consequences. The impact of the tax consequences is dependent upon each partner's individual tax situation.\nOn October 2, 1995, Forest Green and Village Green Limited Partnerships entered into a discount buyout agreement for early settlement of their deferred acquisition notes and related accrued interest payable. The agreements\nprovide for a total buyout amount of $175,000 per Partnership, payable in two installments. The first installments of $120,000 each, which were applied against accrued interest on deferred acquisition note payable, were paid upon execution of the agreements. The final installments of $55,000 each are due on or before May 1, 1996. The Local Limited Partnerships have the option of extending the due date of the final installment to June 3, 1996. The first installments were paid with $104,395 and $40,375, respectively, in available surplus cash and $15,605 and $79,625, respectively in proceeds from a General Partner loan (see Note 3 to the Partnership's financial statements).\nThe Forest Green Local Limited Partnership anticipates paying the final installments with surplus cash generated during 1995. Village Green Local Limited Partnership, however, did not generate sufficient surplus cash during 1995 to fully fund the final installment and will require a loan from the Partnership of $23,709 to complete the payment of the final installment. Upon payment of the final installment, the balances of the total deferred acquisition notes payable and related accrued interest ($1,398,910 and $1,409,813, respectively, as of December 31, 1995) will be relieved. The deferred acquisition notes will remain in full force and effect until the final installments are paid. If the final installments are not made before the due date, the buyout agreements are terminated and the deferred acquisition notes will remain in force through their original maturity date of September 6, 1999.\nThe following details the Partnership's ownership percentages of the Local Limited Partnerships and the cost of acquisition of such ownership. All interests are limited partner interests. Also included is the total mortgage encumbrance on each property for each of the Local Limited Partnerships as of December 31, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSee Item 1 for the real estate owned by the Partnership through the ownership of limited partnership interests in Local Limited Partnerships.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not involved in any material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Partnership Interests and Related Partnership Matters\n(a) Interests in the Partnership were sold through a public offering managed by Dean Witter Reynolds, Inc. There is no established market for resale of interests in the Partnership. Accordingly, an investor may be unable to sell or otherwise dispose of his or her interest in the Partnership.\n(b) As of December 31, 1995, there were 1,108 registered holders of limited partnership interests (in addition to 1133 Fifteenth Street Associates - See Item 1).\n(c) No cash dividends or distributions have been declared from the inception of the Partnership to December 31, 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(A) The Partnership holds limited partnership interests in the Local Limited Partnerships, and since its liability for obligations is limited to its original investment, its investment account is not reduced below zero (creating a liability) for the investments in Local Limited Partnerships. As a result, during 1995, 1994, 1993, 1992 and 1991, $1,751,784, $1,604,334, $3,186,365, $1,413,722 and $1,531,646, respectively, of losses from ten Local Limited Partnerships have not been recognized by the Partnership.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Properties in which the Partnership has invested, through its investments in the Local Limited Partnerships, receive one or more forms of assistance from the Federal Government. As a result, the Local Limited Partnerships'\nability to transfer funds either to the Partnership or among themselves in the form of cash distributions, loans or advances is generally restricted by these government assistance programs. These restrictions, however, are not expected to impact the Partnership's ability to meet its cash obligations.\nSome of the Properties in which the Partnership has invested may be eligible to participate in LIHPRHA. LIHPRHA creates a procedure under which properties assisted under the HUD Section 236 or 221(d)(3) program may be eligible to receive financial incentives in return for agreeing to extend their property's use as low income housing.\nAll the Local Limited Partnerships in which the Partnership has invested carry deferred acquisition notes due to the original owners of the Properties. In the event of a default on these notes, the noteholders would re-assume both NHP's and the Partnership's interests in the Local Limited Partnerships. Notes related to the acquisition of Fairmeadows and Southridge had final maturity dates in 1994. All of the other notes have final maturity dates between 1997 and 1999.\nThe Fairmeadows and Southridge notes finally matured on September 24, 1994 and October 18, 1994, respectively. The noteholders have not yet formally declared the notes in default. The General Partner has been negotiating with the noteholders to extend the maturity date of the notes and to discount the notes in order that both the noteholders and the partners can receive a financial benefit from participation in LIHPRHA. To date, these negotiations have been unsuccessful. The General Partner has filed Notice of Intent to have Fairmeadows and Southridge participate in LIHPRHA and has begun processing the properties through the program. Should no agreement be reached, and the noteholders declare the notes in default, these Local Limited Partnerships may not be able to participate in the LIHPRHA program and the Partnership may lose its interest in these Local Limited Partnerships. A loss of interests in these Local Limited Partnerships may cause the partners in the Partnership to incur adverse tax consequences. The impact of the tax consequences is dependent upon each partner's individual tax situation. There can be no assurance that the General Partner will be successful in its efforts to renegotiate the terms of these notes.\nOn October 2, 1995, Forest Green and Village Green Limited Partnerships entered into a discount buyout agreement for early settlement of their deferred acquisition notes and related accrued interest payable. The agreements provide for a total buyout amount of $175,000 per Partnership, payable in two installments. The first installments of $120,000 each, which were applied against accrued interest on deferred acquisition note payable, were paid upon execution of the agreements. The final installments of $55,000 each are due on or before May 1, 1996. The Local Limited Partnerships have the option of extending the due date of the final installment to June 3, 1996. The first installments were paid with $104,395 and $40,375, respectively, in available surplus cash and $15,605 and $79,625, respectively in proceeds from a partner loan (see Note 3 to the Partnership's financial statements).\nThe Forest Green and Village Green Local Limited Partnerships anticipate paying the final installments with surplus cash generated during 1995. If surplus cash is insufficient to pay the final installment, these Local Limited Partnerships anticipate obtaining a partner loan from the General Partner to make the final payment. Upon payment of the final installment, the balances of the total deferred acquisition notes payable and related accrued interest ($1,398,910 and $1,409,813, respectively, as of December 31, 1995) will be relieved. The deferred acquisition notes will remain in full force and effect until the final installments are paid. If the final installment is not made before the due date, the buyout agreements are terminated and the deferred acquisition notes will remain in force through their original maturity date of September 6, 1999.\nDuring 1995, the Partnership advanced $95,230 to two Local Limited Partnerships as discussed in the preceding paragraph. During 1994, the Partnership advanced $2,300 to Local Limited Partnerships by paying expenses on the behalf of the Local Limited Partnerships. During 1995 and 1994, there were no repayments of advances to the Partnership. During 1995, one Local Limited Partnership paid $37,561 of interest on advances to the Partnership. At December 31, 1995, the Partnership's working capital advances to Local Limited Partnerships amounted to $392,730. During 1993, the Partnership re-evaluated the timing of the collectibility of the advances, and determined, based on the Local Limited Partnerships' current operations, that such advances are not likely to be collected currently and, for accounting purposes, treated the advances balance as additional \"Investment in Local Limited Partnerships.\" The advance balance was then reduced to zero, with a corresponding charge to operations (shown as \"Loss on Investment in\nLocal Limited Partnerships\" in the Statement of Operations) to reflect a portion of the cumulative unrecognized losses on investments. Advances to the Local Limited Partnerships remain due and payable to the Partnership.\nDuring 1995 and 1994, NHP advanced $39,049 and $9,553 to six Local Limited Partnerships for expenses incurred relating to potential sales or refinancing under LIHPRHA. During 1995 and 1994, one and two Local Limited Partnerships made payments of principal of $6,927 and $9,803 and interest of $1,749 and $890, respectively. Eight Local Limited Partnerships owe a total of $62,518 to NHP at December 31, 1995 and seven Local Limited Partnerships owed $30,396 to NHP at December 31, 1994. Interest on these advances is charged at a rate equal to the Chase Manhattan Bank prime interest rate plus 2%.\nNet cash provided by operations for the year ended December 31, 1995 was $47,950 compared to cash used in operations of $36,602 in 1994 and $23,412 in 1993. The increase in cash provided by operations from 1994 to 1995 was the result of no payments for administrative and reporting fees to the General Partner being made in 1995 compared to $82,996 paid in 1994. The increase in cash used in operations from 1993 to 1994 was a result of a payment to the General Partner for administrative and reporting fees made during 1994.\nDistributions received in excess of investment in Local Limited Partnerships represent the Partnership's proportionate share of the excess cash available for distribution from the Local Limited Partnerships. As a result of the use of the equity method of accounting for the Partnership's investment in Local Limited Partnerships, investment carrying values for each of the Local Limited Partnerships has decreased to zero. Cash distributions received are recorded in revenues as distributions received in excess of investment in Local Limited Partnerships. Cash distributions were received from two Local Limited Partnerships during the years ended December 31, 1995 and 1994, respectively. Total cash distributions received were $53,142 and $91,746 for those years, respectively. The receipt of these distributions in future years is dependent on the operations of the underlying properties of the Local Limited Partnerships.\nDuring 1995, one Local Limited Partnership distributed $11,957 from surplus cash to the Partnership. At December 31, 1995, the distribution was not received by the Partnership. Thus, a distribution receivable was recorded by the Partnership for $11,957.\nCash and cash equivalents amounted to $356 at December 31, 1995. The ability of the Partnership to meet its on-going cash requirements, in excess of cash on hand at December 31, 1995, is dependent on distributions from recurring operations received from the Local Limited Partnerships, and proceeds from the sales or refinancings of the underlying properties. Total distributions received from Local Limited Partnerships decreased to $53,142 in 1995 from $91,746 in 1994 which was an increase from $20,600 in 1993. Cash on hand at December 31, 1995 coupled with projected distributions from Local Limited Partnerships should provide sufficient capital to fund the Partnership's operations during 1996.\nAs of December 31, 1995, the Partnership owes the General Partner $657,180 for administrative and reporting services performed. During the year ended December 31, 1994, the Partnership paid $82,996 to the General Partner for administrative and reporting services. This payment was made with distributions received from the Local Limited Partnerships. No payments were made during 1995. There is no guarantee that the Local Limited Partnerships will generate future surplus cash sufficient to distribute to the Partnership in amounts adequate to repay administrative and reporting fees owed; rather, the payment of the unpaid administrative and reporting fees and other advances to the General Partner will most likely result from the sale or refinancing of the underlying properties of the Local Limited Partnerships, rather than through recurring operations.\nResults of Operations\nThe Partnership has invested as a limited partner in Local Limited Partnerships which operate ten rental housing properties. Due to the use of the equity method of accounting as discussed in Note 1 to the Partnership's financial statements, to the extent the Partnership still has a carrying basis in a respective Local Limited Partnership, results of operations would be impacted by the Partnership's share of the losses of the Local Limited Partnerships. As of December 31, 1995\nand 1994, the Partnership had no carrying basis in any of the Local Limited Partnerships and reflected no share of losses for Local Limited Partnerships in 1995, 1994, and 1993.\nThe Partnership's net loss increased to $127,226 in 1995 from a net loss of $48,798 in 1994. Net loss per unit of limited partnership interest approximated $11 and $4 for the year ended December 31, 1995 and 1994, respectively. The increase in the net loss was primarily due to the loss on the investment in advances to Local Limited Partnerships. The Partnership did not recognize $1,751,781 of its allocated share of losses from ten Local Limited Partnerships for the year ended December 31, 1995, as the Partnership's net carrying basis in them was reduced to zero in a prior year (see Note 3 to the Partnership's financial statements). The Partnership's share of losses from the Local Limited Partnerships, if not limited to its investment account balance, would have increased $240,380 between years. The increase primarily was the result of an approximately $520,000 increase in interest on acquisition notes partially offset by an approximately $240,000 increase in rental revenues between years.\nThe Partnership's net loss decreased to $48,798 in 1994 from a net loss of $407,754 in 1993. Net loss per unit of limited partnership interest approximated $4 and $35 for the year ended December 31, 1994 and 1993, respectively. The decrease in the net loss was primarily due to increase in distributions received in excess of investment in Local Limited Partnerships and a decrease in the loss on the investment in advances to Local Limited Partnerships. The Partnership did not recognize $1,604,334 of its allocated share of losses from ten Local Limited Partnerships for the year ended December 31, 1994, as the Partnership's net carrying basis in them was reduced to zero in a prior year (see Note 3 to the Partnership's financial statements). The Partnership's share of losses from the Local Limited Partnerships, if not limited to its investment account balance, would have decreased $1,874,934 between years. The decrease was the result of two Local Limited Partnerships, during 1993, recording a loss on reduction of carrying value of their respective rental property which totaled $1,900,000 as the estimated future undiscounted cash flows from operations and ultimate sale is less than the current net book value (discussed more fully in Note 3 to the Partnership's financial statements). No such losses were recorded during 1994.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary schedule of the Partnership are included on pages 10 through 25 of this report.\nIndependent Auditors' Report\nTo The Partners of National Housing Partnership Realty Fund I Washington, D.C.\nWe have audited the accompanying statements of financial position of National Housing Partnership Realty Fund I (the 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, and the supporting schedule listed in the Index at Item 14. 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 Hurbell IV Limited Partnership and Gates Mills I Limited Partnership (investees of the Partnership) for the years ended December 31, 1995, 1994 and 1993. The Partnership's equity in the net assets of these investees has been reduced to zero in accordance with the equity method of accounting. The accompanying statement of operations includes $29,506 of revenue from distributions in excess of investment for these two investees for the year ended December 31, 1995. The financial statements do not include any equity, earnings or losses from these investees for the years ended December 31, 1994 and 1993. The financial statements of these investees were audited by other auditors whose reports thereon have been furnished to us, and our opinion, insofar as it relates to amounts included for these investees, 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 financial statements 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 cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles, and the schedule referred to above presents fairly, in all material respects, when read in conjunction with the related financial statements, the information therein set forth.\nDeloitte & Touche LLP March 11, 1996 Washington, D.C.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nSTATEMENTS OF FINANCIAL POSITION\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nSee notes to financial statements.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIT)\n(A) General Partner\n(B) Original Limited Partner\n(C) Consists of 11,519 investment units of .0085% held by 1,113 investors.\nSee notes to financial statements.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF PARTNERSHIP ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nNational Housing Partnership Realty Fund I (the Partnership) is a limited partnership organized under the laws of the State of Maryland under the Maryland Revised Uniform Limited Partnership Act on October 21, 1983. The Partnership was formed for the purpose of raising capital by offering and selling limited partnership interests and then investing in limited partnerships (Local Limited Partnerships), each of which owns and operates an existing rental housing project which is financed and\/or operated with one or more forms of rental assistance or financial assistance from the U.S. Department of Housing and Urban Development (HUD). On May 25, 1984, inception of operations, the Partnership began raising capital and acquiring interests in Local Limited Partnerships.\nThe General Partner was authorized to raise capital for the Partnership by offering and selling not more than 20,000 limited partnership interests at a price of $1,000 per interest. During 1984, the sale of interests was closed after the sale of 11,519 interests to limited partners.\nDuring 1984, the Partnership acquired limited partnership interests of 99% in nine Local Limited Partnerships and 98% in one Local Limited Partnership. Each Local Limited Partnership was organized to acquire and operate an existing rental housing project.\nSignificant Accounting Policies\nThe financial statements of the Partnership are prepared on the accrual basis of accounting. Direct costs of acquisition, including acquisition fees and reimbursable acquisition expenses paid to the General Partner, have been capitalized as investments in the Local Limited Partnerships. Other fees and expenditures of the Partnership are recognized as expenses in the period the related services are performed.\nInvestments in Local Limited Partnerships are accounted for using the equity method and thus are carried at cost less the Partnership's share of the Local Limited Partnerships' losses and distributions (see Note 3). An investment account is maintained for each of the limited partnership investments and losses are not recognized once an investment account has decreased to zero. Cash distributions are limited by the Regulatory Agreements between the Local Limited Partnerships and HUD to the extent of surplus cash as defined by HUD. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus cash in excess of current requirements. Distributions received from Local Limited Partnerships in which the Partnership's investment account has decreased to zero are recorded as revenue in the year they are received. Advances to Local Limited Partnerships are included with Investments in Local Limited Partnerships to the extent that the advances are not temporary advances of working capital.\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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFor purposes of the Statements of Cash Flows, the Partnership considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(CONTINUED)\n2. CASH AND CASH EQUIVALENTS\nCash and cash equivalents consist of the following:\n3. INVESTMENTS IN AND ADVANCES TO LOCAL LIMITED PARTNERSHIPS\nThe Partnership owns a 98% limited partnership interest in Gates Mills I Limited Partnership and 99% limited partnership interests in nine other Local Limited Partnerships: Fairmeadows Limited Partnership, Forest Green Limited Partnership, Griffith Limited Partnership, Northgate Village Limited Partnership, Southward Limited Partnership, San Jose Limited Partnership, Southridge Apartments Limited Partnership, Hurbell IV Limited Partnership and Village Green Limited Partnership. Since the Partnership, as a limited partner, does not exercise control over the activities of the Local Limited Partnerships in accordance with the partnership agreements, these investments are accounted for using the equity method. Thus, the investments are carried at cost less the Partnership's share of the Local Limited Partnerships' losses and distributions. However, since the Partnership is not legally liable for the obligations of the Local Limited Partnerships, or is not otherwise committed to provide additional support to them, it does not recognize losses once its investment in each of the individual Local Limited Partnerships, reduced for its share of losses and cash distributions, reaches zero. As a result, the Partnership did not recognize $1,751,784, $1,604,334 and $3,186,365 of losses from ten Local Limited Partnerships during 1995, 1994 and 1993, respectively. As of December 31, 1995 and 1994, the Partnership has not recognized $12,930,693 and $11,178,909, respectively, of its allocated share of cumulative losses from the Local Limited Partnerships in which its investment is zero.\nDuring 1995, the Partnership advanced $95,230 to two Local Limited Partnerships to fund the early settlement of their deferred acquisition notes. During 1994, the Partnership advanced $2,300 for working capital purposes. During 1995 and 1994, there were no repayments of advances to the Partnership. At December 31, 1995, the Partnership's working capital advances to Local Limited Partnerships amounted to $392,730. During 1993, the Partnership re-evaluated the timing of the collectibility of certain advances and determined, based on the Local Limited Partnerships' current operations, that such advances are not likely to be collected currently and, for accounting purposes, treated the advances balance as additional Investment in Local Limited Partnerships. The balance was then reduced to zero, with a corresponding charge to operations (shown as \"Loss on Investment in Local Limited Partnerships\" in the Statement of Operations) to reflect a portion of the cumulative unrecognized losses on investments.\nAdvances to the Local Limited Partnerships remain due and payable to the Partnership. Interest is calculated at the Chase Manhattan Bank prime rate plus 2%. Payment of principal and interest is contingent upon the Local Limited Partnerships having available surplus cash, as defined by HUD regulations, from operations or from refinancing or sale of the Local Limited Partnership properties. Any future repayment of advances or interest will be reflected as\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(CONTINUED)\nPartnership income when received. During 1995, the Partnership received a payment of interest of $37,561 from one Local Limited Partnership.\nSummaries of the combined financial position of the aforementioned Local Limited Partnerships as of December 31, 1995 and 1994, and the combined results of operations for each of the three years in the period ended December 31, 1995, are provided on the following page.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nCOMBINED FINANCIAL POSITION OF THE LOCAL LIMITED PARTNERSHIPS\nCOMBINED RESULTS OF OPERATIONS OF THE LOCAL LIMITED PARTNERSHIPS\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nThe combined financial statements of the Local Limited Partnerships are prepared on the accrual basis of accounting. Each Local Limited Partnership was formed during 1984 for the purpose of acquiring and operating a rental housing project originally organized under Section 236 of the National Housing Act. During the year ended December 31, 1995, all of the projects received a substantial amount of rental assistance from HUD.\nDepreciation of the buildings and improvements for nine of the Local Limited Partnerships is computed on a straight-line method, assuming a 50-year life from the date of initial occupancy at the time of construction or after substantial rehabilitation of the building, and depreciation of equipment is calculated using accelerated methods over estimated useful lives of 5 to 27 years. Depreciation for one of the Local Limited Partnerships is computed using the straight-line method, assuming a 30-year life and a 30% salvage value.\nThe mortgage notes payable are insured by the Federal Housing Administration (FHA) and collateralized by first deeds of trust on the rental properties. The notes bear interest at rates ranging from 7% to 8.5% per annum. However, FHA makes subsidy payments directly to the mortgage lender reducing the monthly principal and interest payments of the project owner to an effective interest rate of 1% over the forty-year term of the notes. The liability of the Local Limited Partnerships under the mortgage notes is limited to the underlying value of the real estate collateral plus other amounts deposited with the lenders.\nDeferred acquisition notes of $14,236,437 at both December 31, 1995 and 1994 bear simple interest at rates of 9% or 10% per annum except for two notes which matured in 1994 and now bear interest at the rate of 18% per annum. These notes are collateralized by security interests in all partnership interests of the Local Limited Partnerships. Neither principal nor interest are payable currently; all principal and accrued interest are payable upon the earlier of the sale, transfer, or refinancing of the project or maturity of the notes. Notes for two Local Limited Partnerships have matured and are due and payable. Other notes mature between 1997 and 1999.\nThe notes may be extended for periods ranging from two to five years except for the notes on Fairmeadows and Southridge which were extended previously to September 1994 and October 1994, respectively. As a result of the 1994 note maturities on Fairmeadows and Southridge, there is substantial doubt about the ability of these two Local Limited Partnerships to continue as going concerns. The General Partner has been negotiating with the noteholders to extend the maturity date of the notes and to discount the notes in order that both the noteholders and the partners can receive a financial benefit from participation in LIHPRHA. To date, these negotiations have been unsuccessful. The General Partner has filed Notices of Intent to have Fairmeadows and Southridge participate in LIHPRHA and has begun processing the properties through the program. Should no agreement be reached, and the noteholders declare the notes in default, the Partnership may not be able to participate in the LIHPRHA program and may lose its interest in these Local Limited Partnerships.\nOn October 2, 1995, Forest Green and Village Green Limited Partnerships entered into a discount buyout agreement for the deferred acquisition notes and related accrued interest payable. The agreements provide for a total buyout amount of $175,000 per Partnership, payable in two installments. The first installments of $120,000 each, which were applied against accrued interest on deferred acquisition note payable, were paid upon execution of the agreements. The final installments of $55,000 each are due on or before May 1, 1996. The Local Limited Partnerships have the option of extending the due date of the final installments to June 3, 1996. The first installments were paid with $104,395 and $40,375, respectively, in available surplus cash and $15,605 and $79,625, respectively in proceeds from a partner loan.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nThe Local Limited Partnerships anticipate paying the final installments with surplus cash generated during 1995. If surplus cash is insufficient to pay the final installment, the Partnerships anticipate obtaining a loan from the General Partner to make the final payment. Upon payment of the final installment, the balance of the two deferred acquisition notes payable and related accrued interest ($1,398,910 and $1,409,813, respectively, as of December 31, 1995) will be relieved. The deferred acquisition notes will remain in full force and effect until the final installment is paid. If the final installment is not made before the due date, the buyout agreements are terminated and the deferred acquisition notes will remain in force through their original maturity date of September 6, 1999.\nFor operating real estate property, generally accepted accounting principles (GAAP) require that the Local Limited Partnerships evaluate whether it is probable that the estimated undiscounted future cash flows of each of its properties, plus cash projected to be received upon an assumed sale of the property (Net Realizable Value) is less than the net carrying value of the property. If such a shortfall exists, is material, and is deemed to be other than temporary in nature, then a write-down equal to the shortfall would be warranted. The Local Limited Partnerships perform such evaluations on an ongoing basis.\nDuring 1993, using a methodology consistent with GAAP, two of the Local Limited Partnerships, Griffith Limited Partnership and Southward Limited Partnership, determined that the net book value of their respective rental property exceeded the rental properties' estimated Net Realizable Value. As a result, these two Local Limited Partnerships recorded adjustments aggregating $1,900,000 to reduce the carrying value of the rental properties to their estimated net realizable value.\nAdditionally, regardless of whether a write-down of an individual property has been recorded or not, the carrying value of each of these properties may still exceed their fair market value as of December 31, 1995. Should a Local Limited Partnership be forced to dispose of any of its properties, it could incur a loss.\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\") effective for financial statements for fiscal years beginning after December 15, 1995. Adoption of this Statement during the year ending December 31, 1996 will require an impairment loss to be recognized if the sum of estimated future cash flows (undiscounted and without interest charges) is less than the carrying amount of rental property. The impairment loss would be the amount by which the carrying value exceeds the fair value of the rental property. If the rental property is to be disposed of, fair value is calculated net of costs to sell. The Local Limited Partnerships have not estimated the effect of implementing the Statement. Adoption of the Statement for the year ending December 31, 1996 will not have a significant impact on the results of operations and financial position of the Partnership because its investment in each Local Limited Partnership has been reduced to zero.\n4. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES OF THE GENERAL PARTNER\nThe General Partner of the Partnership is The National Housing Partnership (NHP). National Corporation for Housing Partnerships (NCHP) is the sole general partner of NHP and NHP Partners Two Limited Partnership is the sole limited partner of NHP. The Original Limited Partner of the Partnership is 1133 Fifteenth Street Associates, whose limited partners were key employees of NCHP at the time the Partnership was formed and whose general partner is NHP.\nThe Partnership accrued administrative and reporting fees payable to the General Partner of $86,392 annually during 1995, 1994, and 1993. During 1994, the Partnership paid the General Partner $82,996 for such fees accrued in\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nprior years. No payments for such fees were made in 1995 and 1993. As of December 31, 1995 and 1994, the Partnership owed $657,180 and $570,788, respectively, to the General Partner for accrued administrative and reporting fees.\nAn affiliate of the General Partner, NHP Management Company (NHPMC) is the project management agent for the projects operated by eight of the Local Limited Partnerships. NHPMC and other affiliates of NCHP earned $756,629, $729,364 and $672,982 from the Local Limited Partnerships for management fees and other services provided to the Local Limited Partnerships during 1995, 1994 and 1993, respectively.\nPersonnel working at the project sites, which are managed by NHPMC, were NCHP employees and, therefore, the projects reimbursed NCHP for the actual salaries and related benefits. Beginning January 1, 1996, project employees became employees of NHP Incorporated. At December 31, 1995 and 1994, other liabilities include $60 and $9,151, respectively, due to NCHP. Total reimbursements earned for salaries and benefits for the years ended December 31, 1995, 1994 and 1993, were approximately $795,000, $828,000 and $747,000, respectively.\n5. INCOME TAXES\nThe Partnership is not taxed on its income. The partners are taxed in their individual capacities upon their distributive share of the Partnership's taxable income and are allowed the benefits to be derived from off-setting their distributive share of the tax losses against taxable income from other sources subject to passive loss limitations. The taxable income or loss differs from amounts included in the statements of operations because different methods are used in determining the losses of the Local Limited Partnerships as discussed below. The tax loss is allocated to the partner groups in accordance with Section 704(b) of the Internal Revenue Code and therefore is not necessarily proportionate to the interest percentage owned.\nFor Federal income tax purposes, the ten Local Limited Partnerships compute depreciation of the buildings and improvements using the Accelerated Cost Recovery System (ACRS) and the Modified Accelerated Cost Recovery System (MACRS). Rent received in advance is included as income in determining the taxable income or loss for Federal income tax purposes, while, for financial statement purposes, the amount is considered a liability. In addition, interest expense on the acquisition notes payable by the Local Limited Partnerships is computed for Federal income tax purposes using the economic accrual method; while for financial statement purposes interest is computed using a simple interest rate. The Partnership's allocable share of losses from the Local Limited Partnerships is not recognized for financial statement purposes when its investment account is decreased to zero while, for income tax purposes, losses continue to be recognized. Other differences result from the allocation of tax losses in accordance with Section 704(b) of the Internal Revenue Code.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nA reconciliation follows:\nAs discussed in Note 3, two of the Local Limited Partnerships in which the Partnership has invested may not be able to continue as a going concern. Should a Local Limited Partnership not continue as a going concern, or the Partnership itself not continue as a going concern (see Note 7), there could be adverse tax consequences to the partners in the Partnership. The impact of the tax consequences is dependent upon each partner's individual tax situation.\n6. ALLOCATION OF RESULTS OF OPERATIONS, CASH DISTRIBUTIONS AND GAINS AND LOSSES FROM SALES OR REFINANCING\nCash received by the Partnership from the sale or refinancing of any underlying property of the Local Limited Partnerships, after payment of the applicable mortgage debt and the payment of all expenses related to the transaction is to be distributed in the following manner in accordance with Realty Fund I's Partnership Agreement.\nFirst, to the General Partner for any unrepaid loans to the Partnership and any unpaid fees (other than disposition and refinancing fees);\nSecond, to the Limited Partners until the Limited Partners have received a return of their capital contributions, after deduction for prior cash distributions from sales or refinancing, but without deduction for prior cash distributions from operations;\nThird, to the Limited Partners, until each Limited Partner has received an amount equal to a cumulative noncompounded 6% annual return on its capital contribution, after deduction of (a) an amount equal to 50% of the tax losses allocated to the Limited Partner and (b) prior cash distributions from operations and prior cash distributions from sales or refinancing;\nFourth, to the General Partner until the General Partner has received a return of its capital contribution, after deduction for prior cash distributions from sales or refinancing, but without deduction for prior cash distributions from operations;\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nFifth, to the General Partner for disposition and refinancing fees, including prior disposition and refinancing fees which have been accrued but are unpaid;\nSixth, to the partners with positive capital accounts to bring such accounts to zero; and\nFinally, 85% of the remaining sales proceeds to the Limited Partners and 15% to the General Partner.\nNet income or loss from operations of the Partnership is allocated 98% to the Limited Partners, 1% to the General Partner and 1% to the Original Limited Partner. Cash distributions from operations, after payment of certain obligations including reimbursement on a cumulative basis of direct expenses incurred by the General Partner or its affiliate in managing the properties and payment of annual cumulative administrative and reporting fees, is distributed 98% to the Limited Partners, 1% to the General Partner and 1% to the Original Limited Partner.\nGain for federal income tax purposes realized in the event of dissolution of the Partnership or upon sale of interests in a Local Limited Partnership or underlying property will be allocated in the following manner:\nFirst, to the Limited Partners in an amount up to the negative balances of the capital accounts of Limited Partners in the same proportion as each Limited Partner's negative capital account bears to such aggregate negative capital accounts;\nSecond, to the General Partner in an amount up to the General Partner's negative capital account, if any;\nThird, to the Limited Partners up to the aggregate amount of capital contributions of the Limited Partners, after deduction for prior cash distributions from sales or refinancing, but without deduction for prior cash distributions from operations, in the same proportion that each Limited Partner's capital contribution bears to the aggregate of all Limited Partners' capital contributions;\nFourth, to the Limited Partners, until each Limited Partner has been allocated an amount equal to a cumulative noncompounded 6% annual return on its capital contribution, after deduction of (a) an amount equal to 50% of the tax losses allocated to the Limited Partner and (b) prior cash distributions from operations and prior cash distributions from sales or refinancing;\nFifth, to the General Partner up to the aggregate amount of capital contributions made by the General Partner, after deduction for prior cash distributions from sales or refinancing, but without deduction for prior cash distributions from operations; and\nFinally, 85% of the remaining gain to the Limited Partners and 15% to the General Partner.\nLosses for federal income tax purposes realized in the event of dissolution of the Partnership or upon sale of interests in a Local Limited Partnership or underlying property will be allocated 85% to the Limited Partners and 15% to the General Partner.\n7. FUTURE OPERATIONS AND CASH FLOWS\nIn recent years, the Partnership has incurred operating expenses, exclusive of amounts due to the General Partner, in excess of operating revenues. Should cash and cash equivalents on hand, coupled with future distributions\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(Continued)\nfrom the Local Limited Partnerships not be adequate to fund operating expenses, the Partnership may need other sources of funding such as loans from the General Partner. However, the General Partner is under no obligation to provide such loans.\nThe Partnership's continued existence as a going concern is dependent upon maintaining positive cash flows from operations, obtaining additional capital from partners, or borrowing additional funds. NHP intends to manage the Partnership prudently so as to produce positive cash flows from its operations.\n********************\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I A LIMITED PARTNERSHIP SCHEDULE XI - REAL ESTATE AND ACCUMULATED DEPRECIATION OF LOCAL LIMITED PARTNERSHIPS IN WHICH NHP REALTY FUND I HAS INVESTED DECEMBER 31, 1995\nSee notes to Schedule XI\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO SCHEDULE XI - REAL ESTATE AND\nACCUMULATED DEPRECIATION OF LOCAL LIMITED\nPARTNERSHIPS IN WHICH NHP REALTY FUND I HAS INVESTED\nDECEMBER 31, 1995\n(1) Schedule of Encumbrances\n(a)Currently due and payable - see Note 7 to the partnership financial statements.\n(2) The aggregate cost of land for Federal income tax purposes is $3,559,204 and the aggregate costs of buildings and improvements for Federal income tax purposes is $41,302,508. The total of the above-mentioned items is $44,861,712.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nA LIMITED PARTNERSHIP\nNOTES TO SCHEDULE XI - REAL ESTATE AND\nACCUMULATED DEPRECIATION OF LOCAL LIMITED\nPARTNERSHIPS IN WHICH NHP REALTY FUND I HAS INVESTED\nDECEMBER 31, 1995\n(CONTINUED)\n(3) Reconciliation of real estate\nReconciliation of accumulated depreciation\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on 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), (b) and (c). The Partnership has no directors, executive officers or significant employees of its own.\n(a), (b), (c), (e) and (f). The names, ages, business experience and involvement in legal proceedings of the directors and executive officers of National Corporation for Housing Partnerships (NCHP), the sole general partner of The National Housing Partnership, the sole general partner of the Partnership, and certain of its affiliates, are as follows:\nDirectors of NCHP\nSeven individuals comprise the Board of Directors of NCHP. Three directors were appointed by the President of the United States, by and with the advice and consent of the Senate.\nJ. Roderick Heller, III (age 58) was elected President, Chief Operating Officer and a Director of NCHP in 1985, Chief Executive Officer of NCHP in 1986 and Chairman in 1988. He currently serves as Chairman, President and Chief Executive Officer of NHP Incorporated and NCHP and their affiliate, NHP Real Estate Corporation. Mr. Heller also serves as Chairman and Chief Executive Officer of NHP Management Company, another principal affiliate of NCHP. He had been President and Chief Executive Officer of Bristol Compressors, Inc., Bristol, Virginia, a manufacturer of air conditioning compressors, from 1982 until 1985. Prior to that, he was a partner in the Washington, D.C. law firm of Wilmer, Cutler & Pickering from 1971 until 1982, and while there, represented NCHP on legal matters from its organization in 1970. He serves on the boards of directors of Auto-Trol Technology Corporation and a number of nonprofit organizations, including the National Trust for Historic Preservation. Mr. Heller was re-elected to the Board of Directors in 1992 and continues to serve.\nSusan R. Baron (age 44) is an attorney specializing in conventional and government-assisted real estate development and finance in the residential and commercial markets. From 1978 to 1993 she was with the Washington, D.C. law firm of Dunnells, Duvall & Porter. Ms. Baron serves on the board of directors of Seeds of Peace and is a past president of the National Leased Housing Association. She was appointed to the Board of Directors by the President of the United States in September 1994 to complete a term expiring in October 1994 and continues to serve until the appointment of a successor.\nDanny K. Davis (age 54) has been a Commissioner on the Cook County Board of Commissioners since November 1990. Prior to his service on the Cook County Board, he served as an Alderman on the Chicago City Council for 11 years. Mr. Davis is also a member of numerous civic and professional organizations. He was appointed to the Board of Directors by the President of the United States in September 1994 for a term to expire on October 27, 1996.\nAlan A. Diamonstein (age 64) has been a member of the Virginia House of Delegates since 1967, currently serving as Chairman of the General Laws Committee and a member of the standing committees on Appropriations, Education and Rules. He is chairman of the Virginia Housing Study Commission and is a member of the Peninsula Board of Advisors for Signet Bank, the Jamestown-Yorktown Board of Trustees, as well as a number of educational and civic organizations. Mr. Diamonstein is the senior partner in the law firm of Diamonstein, Becker and Staley. He was appointed to the Board of Directors by the President of the United States in October 1994 and continues to serve until the appointment of a successor.\nMichael R. Eisenson (age 40) is the President and Chief Executive Officer of Harvard Private Capital Group, Inc., the wholly-owned subsidiary of Harvard Management Company, Inc. which manages the direct investment and private equity portfolio of the Harvard University endowment fund. Between 1981 and 1986, Mr. Eisenson was a principal with the Boston Consulting Group. Mr. Eisenson serves on the boards of directors of Harken Energy Corporation, ImmunoGen, Inc. and Somatix Therapy Corporation, as well as a number of private companies. Under a\nShareholders Agreement between NHP Incorporated, Demeter Holdings Corporation and Capricorn Investors, L.P. (see Item 1, above), Demeter is entitled to elect two members of the NCHP Board of Directors. Pursuant to this agreement, Mr. Eisenson was re-elected to the Board of Directors in 1992 and continues to serve.\nTim R. Palmer (age 38) is a Managing Director of Harvard Private Capital Group, the wholly-owned subsidiary of Harvard Management Company, Inc. which manages the direct investment and private equity portfolio of the Harvard University endowment fund. Prior to joining Harvard Private Capital in 1990, Mr. Palmer was a manager of business development at The Field Corporation and an attorney with Sidley & Austin. Mr. Palmer serves on the board of directors of PriCellular Corporation, as well as on the boards of several private companies. Under a Shareholders Agreement between NHP Incorporated, Demeter Holdings Corporation and Capricorn Investors, L.P. (see Item 1, above), Demeter is entitled to elect two members of the NCHP Board of Directors. Pursuant to this agreement, Mr. Palmer was re-elected to the Board of Directors in June 1994, for a term to expire in 1997.\nHerbert S. Winokur, Jr. (age 52) has been the President of Winokur & Associates, Inc. and Winokur Holdings, Inc., and the Managing General Partner of Capricorn Investors, L.P. since 1987. Mr. Winokur is the Chairman of DynCorp and serves on the boards of directors of Enron Corporation, Marine Drilling Companies, Inc. and NacRe Corporation. Under a Shareholders Agreement between NHP Incorporated, Demeter Holdings Corporation and Capricorn Investors, L.P. (see Item 1, above), Capricorn is entitled to elect one member of the NCHP Board of Directors. Pursuant to this agreement, Mr. Winokur was re-elected to the Board of Directors in 1994, for a term to expire in 1997.\nEXECUTIVE OFFICERS\nThe current executive officers of NCHP and a description of their principal occupations in recent years are listed below. Also listed and described are certain of the executive officers of NHP Incorporated, NCHP's parent company, and both NHP Real Estate Corporation (Realco) and NHP Management Company (NHP Management), two principal affiliates of NCHP. References below to \"NHP\" are intended to include NCHP and its principal affiliates, as appropriate.\nJ. Roderick Heller, III (age 58). See \"Directors of NCHP.\"\nAnn Torre Grant (age 38) has served as Executive Vice President, Chief Financial Officer and Treasurer of NHP since February 1995. She was Vice President and Treasurer of USAir, Inc. and USAir Group, Inc. from 1991 through January 1995, and held other finance positions at the airline between 1988 and 1991. From 1983 to 1988, she held various finance positions with American Airlines, Inc. Ms. Grant is a graduate of the University of Notre Dame and has a Masters of Business from Cornell University. Ms. Grant serves as a director of the Mutual Series Funds.\nLinda J. Brower (age 44) has served as Executive Vice President of NHP since March 1994 and served as Senior Vice President of NCHP from February 1992 to March 1994. Ms. Brower is responsible for asset management of the multifamily portfolio. From 1984 to 1991, Ms. Brower was Vice President and Area Director for the Orange County, California and Washington, D.C. offices of Citicorp Real Estate and was responsible for analyzing investment proposals, asset management and restructuring. She is a graduate of UCLA, holds a Masters degree in finance from the University of Texas and is a licensed real estate broker.\nLinda G. Davenport (age 46) has served as Executive Vice President of the Company since March 1994. She is primarily responsible for corporate and portfolio acquisitions. Ms. Davenport served as Executive Vice President and Chief Operating Officer of NCHP from 1990 to January 1994 and as General Counsel and Senior Vice President of the Company from 1986 to 1989. Prior to joining NCHP in 1979 as Assistant General Counsel, Ms. Davenport was employed in the Office of the General Counsel of the Federal Deposit Insurance Corporation. She is a graduate of Michigan State University and holds J.D. degree form California Western School of Law.\nRobert M. Greenfield (age 48) has served as Executive Vice President of NHP since March 1994. He joined NCHP in October 1991 as Senior Vice President. Mr. Greenfield is primarily responsible for corporate and portfolio acquisitions. From 1978 to 1984, and from 1990 to 1991, Mr. Greenfield was a consultant in corporate strategy for the\nBoston Consulting Group, providing analyses and recommendations to clients in the areas of corporate strategy, business development and diverstiture. From 1984 to 1991, he was a principal in Schindler Greenfield, Inc. and OCC, Inc., closely held real estate development firms. In February of 1992, Mr. Greenfield and his wife filed for protection under Chapter 7 of the United States Bankruptcy Code as a result of their inability to meet certain direct and guaranteed obligations on borrowings by or on behalf of Schindler Greenfield, Inc. and its affiliates. Mr. Greenfield graduated with honors from the University of Chicago and holds a Masters of Business Administration with honors from Harvard Business School.\nJ. Robert Hiner (age 44) has served as Executive Vice President of NHP Management Co. since October 1993. He previously served as Senior Vice President of NHP Management Co. from 1991 to 1993. During 1990, Mr. Hiner served as President of Shadwell-Jefferson Property Management, Inc., a retail property management company formed to manage 71 shopping centers in the midwestern and southern United States. From 1986 to 1990, he served as President of Cardinal Apartment Management Group, Inc., which was responsible for the management of 55,000 apartment units. Mr. Hiner is a graduate of the University of Virginia and holds a Masters of Business Administration from Capital University.\nJoel F. Bonder (age 47) has served as Senior Vice President and General Counsel of the Company since April 1994. Mr. Bonder also served as Vice President and Deputy General Counsel from June 1991 to March 1994, as Associate General Counsel from 1986 to 1991, and as Assistant General Counsel of the Company from 1985 to 1986. From 1983 to 1985, he was with the Washington, D.C. law firm of Lane & Edson, P.C. From 1979 to 1983, Mr. Bonder practiced with the Chicago law firm of Ross and Hardies. He is a graduate of the University of Rochester and received a J.D. degree from the Washington University School of Law.\nCharles S. Wilkins, Jr. (age 45) has served as Senior Vice President of NCHP since September 1988 and is currently responsible for legislative and regulatory affairs. He was formerly responsible for asset and property management of the affordable multifamily portfolio. Prior to joining NCHP, Mr. Wilkins was Senior Vice President of Westminster Company, a regional real estate development firm where he was responsible for the property management of a diverse portfolio of properties. Mr. Wilkins is immediate past-president of the National Assisted Housing Management Association and is a director of the National Leased Housing Association, as well as various regulatory committees, including the Executive Committee of the HUD Occupancy Task Force. He graduated with honors from the University of North Carolina at Chapel Hill, is a Certified Property Manager and a licensed real estate broker.\nJeffrey J. Ochs (age 38) has served as Vice President and Chief Accounting Officer of NHP since September 1995. From 1994 until September 1995, Mr. Ochs was Assistant Controller of USAir, Inc. From 1987 to 1994, he held various accounting positions with USAir, Inc. Mr. Ochs is a CPA and has a Masters of Business Administration from Clarion University of Pennsylvania, where he also earned a B.S. in Business Administration.\nEugene H. Goodsell (age 42) serves as Vice President and Controller of NHP Incorporated, NCHP, Realco and NHP Management. He has been with NCHP since 1983. Prior to joining NHP, Mr. Goodsell, a CPA, was an audit manager with the public accounting firm of Arthur Andersen LLP.\n(d) There is no family relationship between any of the foregoing directors and executive officers.\nItem 11.","section_11":"Item 11. Executive Compensation\nNational Housing Partnership Realty Fund I has no officers or directors. However, as outlined in the prospectus, various fees and reimbursements are paid to the General Partner and its affiliates. Following is a summary of such fees paid or accrued during the year ended December 31, 1995:\n(i) Administrative and reporting fees of $86,392 accrued during the year but not yet paid to the General Partner for managing the affairs of the Partnership and for investor services.\n(ii) Annual partnership administration fee of $75,000, payable but not yet paid, to the General Partner for its services as General Partner of the Local Limited Partnerships. Payments of $52,500 were made in 1995.\n(iii) An affiliate of the General Partner, NHP Management Company (NHPMC) is the project management agent for the Properties operated by the Local Limited Partnerships. During 1995, NHPMC and other affiliates of NCHP earned $756,629 for management fees and other services provided to the Local Limited Partnerships.\n(iv) In 1995, personnel working at the project sites which were managed by NHPMC were NCHP employees, and therefore the project reimbursed NCHP for the actual salaries and related benefits. At December 31, 1995, $60 was due to NCHP. Total reimbursements for salaries and benefits earned for the year ended December 31, 1995, was approximately $795,000.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n1133 Fifteenth Street Associates, a Maryland Limited Partnership, whose general partner is NHP and whose limited partners were key employees of NCHP at the time the Partnership was formed, owns a 1% interest in the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Partnership has had no material transactions or business relationships with NHP or its affiliates except as described in Items 8, 10, and 11, 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\nThe financial statements, notes, and reports listed below are included herein:\n2. Financial statement schedules\nFinancial statement schedules for the Registrant:\nSchedule XI is included in the financial statements listed under Item 14(a)(1) above. All other schedules have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nFinancial statements required by Regulation S-X which are excluded from the annual report of shareholders by Rule 14a-3(b): See 3 below.\n3. Exhibits\nThe following combined financial statements of the Local Limited Partnerships in which the Partnership has invested are included as an exhibit to this report and are 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, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNational Housing Partnership Realty Fund I By: The National Housing Partnership, its sole general partner By: National Corporation for Housing Partnerships, its sole general partner\nMarch 28, 1996 \/s\/ J. Roderick Heller, III - -------------- ----------------------------------------------- Date J. Roderick Heller, III, Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nMarch 28, 1996 \/s\/ J. Roderick Heller, III - -------------- ----------------------------------------------- Date J. Roderick Heller, III Chairman, President, Chief Executive Officer and Director\nMarch 28, 1996 \/s\/ Ann Torre Grant - -------------- ----------------------------------------------- Date Ann Torre Grant Executive Vice President, Chief Financial Officer and Treasurer\nMarch 28, 1996 \/s\/ Jeffrey J. Ochs - -------------- ----------------------------------------------- Date Jeffrey J. Ochs Vice President and Chief Accounting Officer\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Susan R. Baron, Director\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Michael R. Eisenson, Director\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Danny K. Davis, Director\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Tim R. Palmer, Director\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Alan A. Diamonstein, Director\nMarch 28, 1996 * - -------------- ----------------------------------------------- Date Herbert S. Winokur, Jr., Director\nThis registrant is a limited partnership whose sole general partner, The National Housing Partnership, is also a limited partnership. The sole general partner of The National Housing Partnership is National Corporation for Housing Partnerships. The persons indicated are Directors of National Corporation for Housing Partnerships. Powers of Attorney are on file in Registration Statement No. 33-1141 and as Exhibit 25 to the Partnership's Form 10-K for the fiscal years ended December 31, 1987, December 31, 1988, December 31, 1990 and December 31, 1991. Other than the Form 10-K report, no annual report or proxy materials have been sent to security holders.\n*By J. Roderick Heller, III pursuant to Power of Attorney.\n\/s\/ J. Roderick Heller, III ---------------------------\nIndependent Auditors' Report\nTo The Partners of National Housing Partnership Realty Fund I Washington, D.C.\nWe have audited the accompanying combined statements of financial position of the Local Limited Partnerships in which National Housing Partnership Realty Fund I (the Partnership) holds a limited partnership interest as of December 31, 1995 and 1994, and the related combined 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 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 Hurbell IV Limited Partnership and Gates Mills I Limited Partnership (two of the ten Local Limited Partnerships) for the years ended December 31, 1995, 1994 and 1993 which statements represent total assets constituting 23% of combined total assets at December 31, 1995 and 1994, respectively, and net losses constituting 15%, 26% and 9% of combined net loss for each of the three years in the period ended December 31, 1995. The financial statements of these two Local Limited Partnerships were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for these Local 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing 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 financial statements present fairly, in all material respects, the combined financial position of the Local Limited Partnerships in which National Housing Partnership Realty Fund I holds a limited partnership interest as of December 31, 1995 and 1994, and the combined 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.\nDeloitte & Touche LLP March 11, 1996 Washington, D.C.\nIndependent Auditor's Report\nPartners Hurbell IV Limited Partnership - Talladega Downs Reston, VA\nWe have audited the accompanying statement of financial position of Hurbell IV Limited Partnership (Talladega Downs), A Limited Partnership, FHA Project No. 062-44054-LD, as of December 31, 1995, and the related statements of profit and loss (on HUD Form No. 92410), changes in partners' equity (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, Government Auditing Standards, issued by the Comptroller General of the United States, and the Consolidated Audit Guide for Audits of HUD Programs, issued by the U.S. Department of Housing and Urban Development, Office of Inspector General, in July 1993. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 Hurbell IV Limited Partnership (Talladega Downs), a 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 was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The additional information, as referred to in the Table of Contents, 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 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.\nRussell, Thompson, Butler & Houston Mobile, Alabama January 20, 1996\nIndependent Auditor's Report\nPartners Hurbell IV Limited Partnership - Talladega Downs Reston, VA\nWe have audited the accompanying statement of financial position of Hurbell IV Limited Partnership (Talladega Downs), A Limited Partnership, FHA Project No. 062-44054-LD, as of December 31, 1994, and the related statements of profit and loss (on HUD Form No. 92410), changes in partners' equity (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, and Government Auditing Standards, issued by the Comptroller General of 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 audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Hurbell IV Limited Partnership (Talladega Downs), a Limited Partnership, at December 31, 1994, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The additional information, as referred to in the Table of Contents, is presented for purposes of additional analysis and is not a required part of the basic financial statements. This additional information is the responsibility of the Partnership's management. Such 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.\nRussell, Thompson, Butler & Houston Mobile, Alabama January 21, 1995\nIndependent Auditor's Report\nPartners Hurbell IV Limited Partnership - Talladega Downs Reston, VA\nWe have audited the accompanying statement of financial position of Hurbell IV Limited Partnership (Talladega Downs), A Limited Partnership, FHA Project No. 062-44054-LD, as of December 31, 1993, and the related statements of profit and loss (on HUD Form No. 92410), changes in partners' equity (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, and Government Auditing Standards, issued by the Comptroller General of 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 audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Hurbell IV Limited Partnership (Talladega Downs), a Limited Partnership, at 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.\nOur audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The additional information, as referred to in the Table of Contents, is presented for purposes of additional analysis and is not a required part of the basic financial statements. This additional information is the responsibility of the Partnership's management. Such 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.\nRussell, Thompson, Butler & Houston Mobile, Alabama January 15, 1994\nIndependent Auditors' Report\nPartners Gates Mills I Limited Partnership Washington, D.C.\nWe have audited the accompanying statement of financial position of Gates Mills I Limited Partnership, An Ohio Limited Partnership, FHA Project No. 042-44062-LDP, as of December 31, 1995, and the related statements of profit and loss (on HUD Form No. 92410), partners' 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 and Government Auditing Standards, issued by the Comptroller General of 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 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 Gates Mills I Limited Partnership 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. The supplemental information, as referred to in the Table of Contents, 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 audit of the basic financial statements and, in our opinion, the supplemental information is fairly stated, in all material respects, in relation to the basic financial statements taken as a whole.\nReznick Fedder & Silverman Bethesda, Maryland January 30, 1996\nIndependent Auditors' Report\nPartners Gates Mills I Limited Partnership Washington, D.C.\nWe have audited the accompanying statement of financial position of Gates Mills I Limited Partnership, An Ohio Limited Partnership, FHA Project No. 042-44062-LDP, as of December 31, 1994, and the related statements of profit and loss (on HUD Form No. 92410), partners' 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 and Government Auditing Standards, issued by the Comptroller General of 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 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 Gates Mills I Limited Partnership as of December 31, 1994, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental information, as referred to in the Table of Contents, 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 audit of the basic financial statements and, in our opinion, the supplemental information is fairly stated, in all material respects, in relation to the basic financial statements taken as a whole.\nReznick Fedder & Silverman Bethesda, Maryland February 1, 1995\nIndependent Auditors' Report\nPartners Gates Mills I Limited Partnership Washington, D.C.\nWe have audited the accompanying statement of financial position of Gates Mills I Limited Partnership, An Ohio Limited Partnership, FHA Project No. 042-44062-LDP, as of December 31, 1993, and the related statements of profit and loss (on HUD Form No. 92410), partners' 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 and Government Auditing Standards, issued by the Comptroller General of 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 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 Gates Mills I Limited Partnership as of December 31, 1993, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental information, as referred to in the Table of Contents, 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 audit of the basic financial statements and, in our opinion, the supplemental information is fairly stated, in all material respects, in relation to the basic financial statements taken as a whole.\nReznick Fedder & Silverman Bethesda, Maryland February 1, 1994\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I LOCAL LIMITED PARTNERSHIPS COMBINED STATEMENTS OF FINANCIAL POSITION\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nCOMBINED STATEMENTS OF OPERATIONS\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nCOMBINED STATEMENTS OF PARTNERS' EQUITY (DEFICIT)\n(A) Holds a 98% limited partnership interest in Gates Mills I Limited Partnership and a 99% limited partnership interest in the nine remaining Local Limited Partnerships.\n(B) Holds a 1% general partnership interest in ten Local Limited Partnerships.\n(C) Holds a 1% limited partnership interest in Gates Mills I Limited Partnership.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I LOCAL LIMITED PARTNERSHIPS COMBINED STATEMENTS OF CASH FLOWS\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nCOMBINED STATEMENTS OF CASH FLOWS\n(CONTINUED)\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n1. SUMMARY OF PARTNERSHIP ORGANIZATION, BASIS OF COMBINATION AND SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nNational Housing Partnership Realty Fund I (the Partnership) is a limited partnership organized on October 21, 1983, under the laws of the State of Maryland under the Maryland Revised Uniform Limited Partnership Act. The Partnership was formed for the purpose of raising capital by offering and selling limited partnership interests and then investing in Local Limited Partnerships, each of which owns and operates an existing rental housing project which is financed and\/or operated with one or more forms of rental assistance or financial assistance from the U.S. Department of Housing and Urban Development (HUD). A substantial portion of each Local Limited Partnership is received from the housing assistance agreement discussed in Note 4 below. On May 25, 1984, inception of operations, the Partnership began raising capital and acquiring interests in Local Limited Partnerships.\nDuring 1984, the Partnership acquired a 98% limited partnership interest in Gates Mills I Limited Partnership and 99% limited partnership interests in nine other Local Limited Partnerships, each of which was organized during 1984 to acquire and operate an existing rental housing project originally organized under Section 236 of the National Housing Act. As a limited partner in these Local Limited Partnerships, the Partnership does not exercise control over the activities of the Local Limited Partnerships in accordance with the partnership agreements.\nBasis of Combination\nThe combined financial statements include the accounts of the following ten Local Limited Partnerships in which the Partnership holds a limited partnership interest.\nFairmeadows Limited Partnership Forest Green Limited Partnership Gates Mills I Limited Partnership Griffith Limited Partnership Hurbell IV Limited Partnership Northgate Village Limited Partnership San Jose Limited Partnership Southridge Apartments Limited Partnership Southward Limited Partnership Village Green Limited Partnership\nSignificant Accounting Policies\nThe financial statements of the Local Limited Partnerships are prepared on the accrual basis of accounting. For nine of the Local Limited Partnerships, depreciation of the buildings and improvements is computed using the straight-line method, assuming a 50-year life from the date of initial occupancy, and depreciation of equipment is calculated using accelerated methods over estimated useful lives of 5 to 27 years. Depreciation of the buildings and improvements is computed using the straight-line method, assuming a 30-year life and a 30% salvage value for one of the Local Limited Partnerships. Cash distributions are limited by the Regulatory Agreement between the Local Limited\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nPartnerships and HUD to the extent of surplus cash as defined by HUD. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus in excess of current requirements.\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.\nFor purposes of the statements of cash flows, the Local Limited Partnerships consider all highly liquid debt instruments purchased with initial maturities of three months or less to be cash equivalents.\n2. CHANGE IN ESTIMATE\nDuring 1993, for nine of the Local Limited Partnerships, depreciation of the building has been computed using the straight-line method, assuming a 50-year life from the date of initial occupancy at the time of construction or after substantial rehabilitation of the building. Depreciation of the building in prior years was computed using the straight-line method, assuming a 30-year life and 30% salvage value. This change in the estimate of the life and salvage value of the building decreased the combined net loss in 1993 by $45,125.\n3. ACCOUNTS RECEIVABLE\nAccounts receivable consist of the following:\n4. HOUSING ASSISTANCE AGREEMENTS\nThe Federal Housing Administration (FHA) has contracted with the ten Local Limited Partnerships under Section 8 of Title II of the Housing and Community Development Act of 1974, to make housing assistance payments to the Local Limited Partnerships on behalf of qualified tenants. The terms of the agreements are five years with either one or two five-year renewal options. The agreements expire at various dates over the next ten years. Each Local Limited\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nPartnership has an agreement in effect during 1996. Four Local Limited Partnerships have assistance agreements which expire during June and September 1996. Fairmeadows and Lakeview Apartments Section 8 subsidy contracts covering 90 and 60 units, respectively, are scheduled to expire in September 1996. Additionally, Gates Mills I and Hurbell IV have contracts for 107 and 60 units, respectively, scheduled to expire in June, 1996. In January 1996, President Clinton signed into law H.R. 2880. This legislation includes a provision that requires HUD to provide a one-year renewal for Section 8 contracts scheduled to expire during the first nine months of 1996. All other Section 8 contracts are scheduled to expire between 1997 and 2003. The Local Limited Partnerships received a total of $3,467,209, $3,291,320 and $2,973,210 in the form of housing assistance payments during 1995, 1994 and 1993, respectively, which is included in \"Rental Income\" on the combined statements of operations.\n5. RENTAL PROPERTY\nRental property consists of the following:\nAs further described in Note 10, during 1993 two of the Local Limited Partnerships recorded adjustments aggregating $1,900,000 to reduce the carrying value of the rental properties to their estimated net realizable value.\n6. MORTGAGE NOTES PAYABLE\nThe mortgage notes payable are insured by FHA and collateralized by first deeds of trust on the rental properties. The notes bear interest at rates ranging from 7% to 8.5% per annum. However, FHA makes subsidy payments directly to the mortgage lender reducing the monthly principal and interest payments of the project owner to an effective interest rate of 1% over the forty-year term of the notes. The liability of the Local Limited Partnerships under the mortgage notes is limited to the underlying value of the real estate collateral, plus other amounts deposited with the lenders.\nUnder agreements with the mortgage lenders and FHA, the Local Limited Partnerships are required to make monthly escrow deposits for taxes, insurance and reserves for the replacement of project assets, and are subject to restrictions as to operating policies, rental charges, operating expenditures and distributions to partners.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nApproximate maturities of mortgage notes payable for the next five years are as follows:\n1996 $516,000 1997 $557,000 1998 $601,000 1999 $649,000 2000 $701,000\n7. DEFERRED ACQUISITION NOTES PAYABLE\nThe deferred acquisition notes bear simple interest at rates of 9% and 10% per annum. These notes are nonrecourse and are collateralized by security interests in all partnership interests of the Local Limited Partnerships. All principal balances and accrued interest are payable upon the earlier of the sale, transfer or refinancing of the projects, or the final maturity date of the notes. The notes may be extended for periods ranging from two to five years. The notes may be prepaid in whole or in part at any time without penalty.\nMaturities of deferred acquisition notes payable as of December 31, 1995, are as follows:\nMatured, due and payable $ 4,015,475 1996 - 1997 1,199,396 1998 1,608,550 1999 and thereafter 7,413,016 ----------\n$14,236,437 ==========\nThe deferred acquisition notes on Fairmeadows and Southridge apartments matured in September and October 1994. From the date of maturity, interest accrues at 18% per annum. The noteholders have not declared the notes to be in default, and the General Partner is negotiating with the noteholders to obtain an amendment of the notes to extend the due date.\nOn October 2, 1995, Forest Green and Village Green Limited Partnerships entered into a discount buyout agreement for early settlement of their deferred acquisition notes and related accrued interest payable. The agreements provide for a total buyout amount of $175,000 per Partnership, payable in two installments. The first installments of $120,000 each, which were applied against accrued interest on deferred acquisition note payable, were paid upon execution of the agreements. The final installments of $55,000 each are due on or before May 1, 1996. The Local Limited Partnerships have the option of extending the due date of the final installments to June 3, 1996. The first installments were paid with $104,395 and $40,375, respectively, in available surplus cash and $15,605 and $79,625, respectively in proceeds from a partner loan.\nThe Partnerships anticipate paying the final installments with surplus cash generated during 1995. If surplus cash is insufficient to pay the final installment, the Local Limited Partnerships anticipate obtaining a loan from the General Partner to make the final payment. Upon payment of the final installment, the balance of the deferred acquisition notes payable and related accrued interest ($1,398,910 and $1,409,813, respectively, as of December 31, 1995) will be relieved. The deferred acquisition notes will remain in full force and effect until the final installments are\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\npaid. If the final installments are not made before the due date, the buyout agreements are terminated and the deferred acquisition notes will remain in force through their original maturity date of September 6, 1999.\nDuring 1993, the deferred acquisition notes on five Local Limited Partnerships were extended to due dates in 1999 or later.\n8. DUE TO PARTNERS\nThe Local Limited Partnerships accrued annual partnership administration fees payable to the General Partner, The National Housing Partnership (NHP), of $75,000 during 1995, 1994 and 1993, respectively. Payments of these fees are made to NHP without interest from surplus cash available for distribution to partners pursuant to HUD regulations. During 1995, 1994 and 1993, the Local Limited Partnerships paid $52,500, $94,494 and $42,878, respectively. The accumulated fees owed to NHP are $387,769, $365,269 and $384,763, at December 31, 1995, 1994 and 1993, respectively.\nDuring 1995 and 1994, NHP advanced $39,049 and $9,553 to six Local Limited Partnerships for expenses incurred relating to potential sales or refinancing under the Low Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA). During 1995 and 1994, one and two Local Limited Partnerships made payments of principal of $6,927 and $9,803 and interest of $1,749 and $890, respectively. Eight Local Limited Partnerships owe a total of $62,518 to NHP at December 31, 1995 and seven Local Limited Partnerships owed $30,396 to NHP at December 31, 1994. Interest on these advances is charged at a rate equal to the Chase Manhattan Bank prime interest rate plus 2%.\nDuring 1995, the Partnership advanced $96,280 and $2,300 to two Local Limited Partnerships. No advances were repaid to the Partnership in 1995 and 1994. During 1995, one Local Limited Partnership made a payment of interest at $37,561. At December 31, 1994 and December 31, 1993, the balance owed the Partnership by six Local Limited Partnerships was $392,730 and $296,450, respectively. Interest is charged at the Chase Manhattan Bank rate of prime plus 2%.\nDuring 1993, the Local Limited Partnerships revised their estimate of interest to be paid due to a trend in government initiatives providing economic incentives to owners of subsidized multifamily housing, which may someday result in refinancing opportunities and increased allowable distributions, which would provide cash to pay interest. Accordingly, accrued interest of $143,396 owed on the above loans was recorded. Of this amount, $102,867 relates to periods prior to 1993 and $40,529 relates to 1993. During 1995 and 1994, interest of $63,943 and $46,278, respectively, were accrued. Accrued interest at December 31, 1995 and 1994 was $213,417 and $188,784, respectively.\nAll advances and accumulated interest will be paid in conformity with HUD and\/or other regulator requirements and applicable partnership agreements.\n9. FEDERAL AND STATE INCOME TAXES\nThe Local Limited Partnerships are not taxed on their income. The partners are taxed in their individual capacities upon their distributive share of the partnerships' taxable income and are allowed the benefits to be derived from offsetting their distributive share of the tax losses against taxable income from other sources subject to passive\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nloss rule limitations. The taxable income or loss differs from amounts included in the statement of operations primarily because of different methods used in determining depreciation expense and interest on acquisition notes for tax purposes.\nFor Federal income tax purposes, the Local Limited Partnerships compute depreciation of the buildings and improvements using the Accelerated Cost Recovery System (ACRS) and the Modified Accelerated Cost Recovery System (MACRS). Rent received in advance is included as income in determining the taxable income or loss for Federal income tax purposes; while for financial statement purposes the amount is considered a liability. In addition, interest expense on the acquisition notes payable by the Local Limited Partnerships is computed for Federal income tax purposes using the economic accrual method; while for financial statement purposes interest is computed using a simple interest rate. Other differences result from the allocation of tax losses in accordance with Section 704(b) of the Internal Revenue Code.\nA reconciliation follows:\n10. LOSS ON REDUCTION OF CARRYING VALUE OF RENTAL PROPERTY\nFor operating real estate property, generally accepted accounting principles (GAAP) require that the Local Limited Partnership evaluate whether it is probable that the estimated undiscounted future cash flows of its property, plus cash projected to be received upon an assumed sale of the property (Net Realizable Value) is less than the net carrying value of the property. If such a shortfall exists, is material, and is deemed to be other than temporary in nature, then a write-down equal to the shortfall would be warranted. The Local Limited Partnership performs such evaluations on an ongoing basis.\nDuring 1993, using a methodology consistent with GAAP, two of the Local Limited Partnerships, Griffith Limited Partnership and Southward Limited Partnership, determined that the net book value of their respective rental property exceeded the rental properties' estimated net realizable value. As required by GAAP, the Local Limited Partnerships recorded adjustments aggregating $1,900,000 to reduce the carrying value of the rental properties to their estimated net realizable value.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nAdditionally, regardless of whether a write-down of an individual property has been recorded or not, the carrying value of each of these properties may still exceed their fair market value as of December 31, 1995. Should a Local Limited Partnership be forced to dispose of any of its properties, it could incur a loss.\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\") effective for financial statements for fiscal years beginning after December 15, 1995. Adoption of this Statement during the year ending December 31, 1996 will require an impairment loss to be recognized if the sum of estimated future cash flows (undiscounted and without interest charges) is less than the carrying amount of rental property. The impairment loss would be the amount by which the carrying value exceeds the fair value of the rental property. If the rental property is to be disposed of, fair value is calculated net of costs to sell. The Local Limited Partnerships have not estimated the effect of implementing the Statement. Adoption of the Statement for the year ending December 31, 1996 could have a significant impact (noncash) on the results of operations and financial position.\n11. RELATED-PARTY TRANSACTIONS\nThe General Partner of the Partnership is NHP. National Corporation for Housing Partnerships (NCHP) is the sole general partner of NHP. NHP is the sole general partner of the Local Limited Partnerships. An affiliate of the General Partner, NHP Management Company (NHPMC) is the project management agent for the projects operated by eight of the Local Limited Partnerships. NHPMC and other affiliates of NCHP earned $756,629, $729,364 and $672,982, for management fees and other services provided to the Local Limited Partnerships during 1995, 1994 and 1993, respectively. As of December 31, 1995 and 1994, amounts due NHPMC and unpaid by the Local Limited Partnerships amounted to $48,092 and $47,793, respectively.\nPersonnel working at the project sites, which are managed by NHPMC, are NCHP employees, and therefore the projects reimburse NCHP for the actual salaries and related benefits. At December 31, 1995 and 1994, trade payables include $60 and $9,151, respectively, due to NCHP. Total reimbursements for salaries and benefits for the years ended December 31, 1995, 1994 and 1993, were approximately $795,000, $828,000 and $747,000, respectively.\nAn affiliate of the Local Partner of one of the Local Limited Partnerships provides management services for the property owned by the Local Limited Partnership. During 1995, they received $69,977 for these services, and in 1994 they received $73,541 for these services. Additionally, in 1995 and 1994, $4,949 and $4,593, respectively, was paid to another affiliate of this Local Partner for painting services.\n12. FUTURE OPERATIONS AND CASH FLOWS\nAs discussed in Note 7, all of the Local Limited Partnerships in which the Partnership has invested carry deferred acquisition notes due the original owner of each property. With the exception of Fairmeadows Limited Partnership and Southridge Limited Partnership, these notes will reach final maturity between 1997 and 1999. Fairmeadows and Southridge notes matured on September 24, 1994 and October 18, 1994, respectively. These notes are secured by both the Partnership's and NHP's interests in the respective Local Limited Partnerships. In the event of a default on the notes, the noteholder would be able to assume NHP's and the Partnership's interests in Fairmeadows and Southridge. Currently, the noteholder has not declared the notes to be in default.\nNATIONAL HOUSING PARTNERSHIP REALTY FUND I\nLOCAL LIMITED PARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(CONTINUED)\nDue to the weakness in the rental market conditions where the Fairmeadows and Southridge properties are located, the General Partner believes the amounts due on the acquisition notes will likely exceed the value to be obtained through the properties' participation in LIHPRHA or other sale or refinancing opportunities. The General Partner is negotiating with the noteholder to obtain an amendment of the note to extend the due date. Should no agreement be reached, the Partnership may lose its interest in these Local Limited Partnerships. Should the Partnership lose its interest in these Local Limited Partnerships, the partners in the Partnership may incur adverse taxable consequences. The impact of the tax consequences is dependent upon each partner's individual tax situation.\nThe total assets, deficit, revenues, and net loss of Fairmeadows and Southridge represent 30%, 27%, 31% and 58%, respectively, of the applicable amounts included in the accompanying combined financial statements as of December 31, 1995 and for the year then ended.\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFASB Statement No. 107, \"Disclosures 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 the FHA and are secured by the rental property. The operations generated by the rental property are subject to various government rules, regulations and restrictions which make it impracticable to obtain the information to estimate the fair value of the mortgage note and the partner loans and related accrued interest. For the deferred acquisition notes and related accrued interest, a reasonable estimate of fair value could not be made without incurring excessive costs. The carrying amount of other assets and liabilities reported on the statement of financial position that require such disclosure approximates fair value.\n14. NON-CASH INVESTING ACTIVITY\nDuring 1995, six of the Local Limited Partnerships incurred costs in the aggregate of $98,696 for buildings and equipment which are included in trade payables as of December 31, 1995. Included in trade payables as of December 31, 1994 is $22,570 of such costs incurred by five Local Limited Partnerships.\n15. CONTINGENCY\nFor Fairmeadows Limited Partnership, the local taxing authority has assessed the value of the rental property much higher than in prior years. As a result, real estate taxes for 1995 have been increased by the taxing authority to approximately $120,000 from approximately $50,000 in the prior year. The Local Limited Partnership has appealed the new assessment and has accrued $74,000 for real estate tax expense in the accompanying financial statements. The remaining balance of $46,000 is in dispute and no provision for this amount has been included in the financial statements.","section_15":""}
{"filename":"15393_1995.txt","cik":"15393","year":"1995","section_1":"Item 1. Business --------- General Development of Business and Narrative Description of Business ------------------------------------------------------------- Business of BNA and Subsidiaries - -------------------------------- The Bureau of National Affairs, Inc. (BNA), is a leading publisher of specialized business, legislative, judicial, and regulatory information services. BNA was founded in 1929, and was incorporated in its present form as an employee owned company in 1946. BNA is independent, for profit, and is the oldest fully employee-owned company in the United States.\nBNA and its publishing subsidiaries, Tax Management Inc. and Pike & Fischer, Inc., are engaged in providing labor, legal, economic, tax, health care and other regulatory information to business, professional, and academic users. They prepare, publish, and market subscription information services in print and compact disc formats, books, pamphlets, and research reports.\nSales are made principally in the United States through field sales personnel who are supported by direct mail, space advertising, and telemarketing. Customers include lawyers, accountants, business executives, human resource professionals, health care administrative professionals, labor unions, trade associations, educational institutions, government agencies, and libraries in the United States and throughout the world.\nOnline products are marketed through database vendors such as LEXIS\/NEXIS, West Publishing Company, Dialog, Legislate, Cambridge Information Group, and others. Beginning in 1996, the Company will offer many of its products for electronic delivery via Lotus Notes and the Internet.\nBNA Software, a division of Tax Management Inc., develops, produces, and markets tax and financial planning software for use on personal computers. Sales are made to accountants, lawyers, tax and financial planners, and others. The products are marketed through direct mail, space advertising, and BNA field sales representatives.\nBNA International Inc. is the Company's agent outside of North America for sale of its domestic services and also engages in independent publishing activity, including adaptation of the Company's domestic products for sales abroad.\nThe McArdle Printing Co., Inc. provides printing services to mid-Atlantic area customers. It utilizes modern equipment and technology in printing information products for publishers, trade associations, professional societies, other non-profit organizations, financial institutions and governmental organizations. Approximately 59 percent of its business is derived from the BNA publishing companies.\nBNA Communications Inc. is engaged in the business of producing, publishing, and marketing multimedia programs for training in the Equal Employment Opportunity and safety and health related fields. The programs promote awareness, facilitate regulatory compliance, and develop skills for managers and employees in industry and government.\nItem 1 General Development of Business and Narrative Description of Business (Continued) ---------------------------------------------------------\nREVIEW OF OPERATIONS\nFundamental changes in publishing technologies, an unsettled legislative and regulatory climate, and new competitive pressures continued to challenge BNA and its subsidiary companies in 1995. Nevertheless, consolidated revenues and net income hit new highs.\nThe changing information industry environment, marked by a growing number of new players and multiplying new forms of media, required some difficult choices and a disciplined allocation of resources to maintain the high quality of existing products while pursuing promising new ways of organizing and delivering information.\nProduct development expenditures were stepped up substantially during the year. BNA and its publishing subsidiaries introduced new CD-ROM products and enhanced with both proprietary and public domain material those introduced successfully over the previous two years. CD-ROMs accounted for about 60 percent of new subscription sales in 1995.\nContracts with principal online vendors were renegotiated during the year to increase BNA's share of revenue while protecting the integrity of its core business. Simultaneously, a new online distribution system for notification services was developed for launch early in 1996.\nNew print services also were introduced during the year, and several older services were extensively revamped to reflect changing conditions. About 75 percent of 1995 publishing revenues came from traditional print services.\nConsolidated revenues rose to $226.5 million, a 5.1 percent increase over 1994. Revenues of parent company and Tax Management services, which accounted for a major share of consolidated revenues, grew 6.2 percent in 1995 as a result of strong new service sales in 1994 and 1995. Aggregate revenue of the other business units was essentially even with 1994.\nTwo 1995 transactions affect the comparability of the year's results to prior years. The McArdle Printing Company's former plant site in Silver Spring, Md., was sold early in the year resulting in a $2.4 million pre- tax gain. Included in non-operating income, this gain was mostly offset by a required new way of accounting for advertising costs, described in Note 2 to the financial statements, which resulted in a one-time $2.1 million pre-tax charge to operating expense.\nThe consolidated operating profit, excluding the change in accounting for advertising expense, was $9.9 million, down nearly 10 percent from 1994. The decline was due mainly to higher product development costs for the parent company, higher selling expenses relating to record sales in the prior year and largely amortized in 1995, and a substantial operating loss by BNA Communications Inc.\nThe decline in comparable operating profit was more than offset, however, by a substantial increase in 1995 investment income. Consolidated net income of $12.1 million was 3.7 percent higher than the previous year.\nNon-operating income, excluding the one-time gain on sale of the Silver Spring property, was $7.3 million compared to $5.1 million in 1994. Investment income, reflecting additions to the corporate portfolios and strong financial markets, rose by 40 percent in 1995. The sale of five publications -- four of the parent company's California-specific services and a BNA International product -- produced additional gains.\nCash and investment balances increased by 34 percent to $114.8 million because of strong operating cash flows, asset sales, net sales of capital stock, and market gains on the investment securities. BNA's financial strength and liquidity, in addition to providing current investment income, ensure that the company has the resources to reinvest in the business as necessary and to meet repurchase obligations inherent in employee ownership.\nA REVIEW OF 1995 OPERATIONS OF THE PARENT COMPANY AND EACH SUBSIDIARY FOLLOWS:\nPARENT COMPANY\nInitial forays into CD-ROM publishing became an integral and profitable part of the parent's subscription services business in 1995, providing some reassuring answers to questions about the viability of this delivery mechanism and our ability to exploit its possibilities. And, while this transition was neither easy nor inexpensive, we accomplished it in the traditional BNA way -- by allocating resources in a manner that allowed us to maintain a high level of quality in our products and services while protecting and growing the solid financial foundation of the company.\nParent company revenues reached $157 million in 1995, a 4.7 percent increase over the previous year. Operating expenses increased at a greater rate, however, primarily driven by a nearly 50 percent increase in product development costs and significantly higher selling expenses related to 1994's record-shattering sales year.\nConsiderable effort in 1995 went into converting our CD-ROM products into a Windows^TM format. The effort provided a good illustration of the progress we have made in this area: each product was delivered on time and on budget. The effort also illustrates a distinguishing characteristic of the electronic product line -- the need for constant improvement. This involves not only expanded coverage and continual attempts to make the products more \"user-friendly,\" but also changes to accommodate the market's adoption of new technologies. And, while product improvements do give rise to new sales opportunities, the driving force is the need to protect the revenue base already established for these products.\nIn addition to enhancing existing products, two new CD-ROM products were launched in 1995. BNA'S INTELLECTUAL PROPERTY LIBRARY ON CD is a new version of BNA's oldest publication, U.S. PATENTS QUARTERLY. This new product will enable intellectual property lawyers, who have been among BNA's most loyal subscribers, to have 50 years of USPQ material on their desktops. The second CD-ROM product, BNA's EMPLOYEE BENEFITS LIBRARY ON CD, does not have a print equivalent. Instead, this product combines BNA and Tax Management information with the full text of relevant public domain material, to provide a one-stop research product for employee benefit professionals. It was launched late in the year.\nMarket response to our CD-ROM products continues to be enthusiastic. Once again, CD-ROM products accounted for more than half of the year's new sales. New subscription sales totaled $32.9 million, making 1995 the second best new sales year in the company's history. The credit goes to high quality editorial products and an experienced and professional sales force which made its numbers despite a belt-tightening market, aggressive competition, and an increasingly complex product line. For the third year in a row, BNA'S ENVIRONMENT LIBRARY ON CD-ROM was the best selling product.\nTwo new print notification services also were introduced during the year. BNA's MANAGED CARE REPORTER, the latest addition to BNA's growing Health Care Services Division, was launched. In its first six months, it has outpaced its first-year projections and continues to exhibit strong growth. BNA's INSURANCE COVERAGE LITIGATION REPORT was launched in September. This is our first attempt to bring BNA's news reporting capabilities to the insurance area. We are convinced that there will be a significant market for print products for the foreseeable future, and plans for 1996 include another notification service and a new portfolio series. Top print sellers in 1995 included some very familiar names: LABOR RELATIONS REPORTER, ENVIRONMENT REPORTER, and the daily reports.\nThe need to leverage the company's unique news reporting capabilities led to a major 1995 initiative that will come to fruition in 1996. Beginning this spring, all of BNA's notification services, including the dailies, will be available for electronic delivery via the Lotus Notes Network and the Internet's World Wide Web. Thus, subscribers will be able to receive their BNA information at their desktops the day it's published, without having to wait for the mail or the delays inherent in a long routing list.\nUltimately, BNA must make its information available to subscribers in any format that meets their needs. To do that economically, the company is in the midst of a multi-year effort to build a new publishing system, PS2000. Last year was a breakthrough year for that effort, as we began to migrate publications to the new system. At the end of 1995, nine BNA publications were being produced on the new system. The migration to the new system will in itself be a multi-year effort, but the fact that a single system is now actually being used to produce reference services such as PAYROLL ADMINISTRATION GUIDE and BNA'S PAYROLL LIBRARY ON CD, as well as notification services such as SECURITIES REGULATION AND LAW REPORT -- in both print and electronic formats -- is a major achievement.\nA distinct characteristic of electronic products is the demand for increased customer support. Subscribers expect our service, like our products, to be the best. As always, many subscribers turn to their BNA sales representatives for help, and our sales force has done an outstanding job of introducing and explaining our new products.\nBut more was needed. BNA PLUS, the Circulation Department, and the Information Systems Department all accepted the challenge of making sure our subscribers got the most out of our products. The PLUS Customer Support Unit expanded its hours of operation so that West Coast subscribers could get the support they needed. The unit also began a training program whereby subscribers can schedule set times for telephone training especially designed for their knowledge level. In the fall, as the new Windows^TM products began hitting the market, the Circulation Department began calling subscribers to determine whether they needed help in installing and using the new products. And finally, the IS Department\nhandled those customer needs that were more technical rather than substantive. This support effort is expensive, but it is an important element in our subscribers' decisions to purchase, use, and renew BNA's electronic products.\nCareful use of resources also requires us to recognize when our efforts are not meeting expectations. In 1995, we ended our effort to build a BNA California business, and sold the four California publications to another publisher. While the publications were of high quality and well respected, the financial return did not warrant the level of investment that would have been required to build that business. BNA also ceased publishing the BNA CIVIL TRIAL MANUAL and transferred its sister publication, the BNA CRIMINAL PRACTICE MANUAL, to Pike & Fischer.\nMuch of 1995 was spent in efforts to solidify the market gains of the new electronic products. We believe we have done that. But the effort has not come cheaply, and this year's operating profit fell as a result. However, we believe we have made great progress in incorporating the electronic products as an important and growing piece of BNA's strong product line, which has been and will continue to be the source of the company's enviable record of growth and success.\nBNA BOOKS\nThe Book Division enjoyed another successful year in 1995, with revenues of $4.6 million equaling 1994's record year. The Division's profit margin of $547,000 was the highest ever, both in terms of dollars and as a percent of revenue. Over 40 titles were published during the year.\nThe Division continued to build on its successful relationship with the American Bar Association Section of Labor and Employment Law by releasing two new treatises: EMPLOYEE DUTY OF LOYALTY and THE RAILWAY LABOR ACT. Also, the Section's employee benefits law treatise was incorporated in BNA'S EMPLOYEE BENEFITS LIBRARY ON CD. Supplements to four other BNA\/ABA titles were published and agreements were signed for three new titles with the Section.\nThe emphasis on producing high-quality, renewable products has worked well for the Division. By the end of 1996 almost 80 percent of the Division's active titles will have renewable lives, which should provide a stable and growing revenue base for years to come.\nTAX MANAGEMENT INC.\nStrong renewal of its firmly established services and the introduction of innovative new products combined to make 1995 a very successful year for Tax Management. The subsidiary's revenues, including BNA Software, climbed to $44.8 million, a 10.4 percent gain over the previous year. Operating profit was up by 11 percent, and net income was 20 percent higher, permitting the subsidiary to pay the parent company a dividend of $3.9 million.\nNew service sales remained strong throughout the year, with a heavy concentration of CD-ROM products. PORTFOLIO PLUS is widely accepted in the marketplace and TAX PRACTICE SERIES is making great inroads into the accounting market.\nMULTISTATE TAX PORTFOLIOS, launched in the fall of 1994, exceeded first- year sales projections and has proven to be a valuable addition to the product line. Several new portfolios were added to the series during the year, and coverage of state tax legislation and regulation was expanded in the MULTISTATE TAX REPORT.\nOngoing editorial work for an expanding line of tax services has been greatly increased by the addition of full text, forms, and research aids to TM's CD-ROM products. In addition, PORTFOLIO PLUS and TAX PRACTICE SERIES were made available in Windows^TM format by year-end, greatly increasing production and customer service efforts.\nThe CD-ROM services were expanded further in early 1996 with a new disc that provides full text of state, as well as federal, tax forms. Additional enhancements are scheduled throughout the year.\nThe national debate on various tax proposals is having no immediate impact on TM's services. Current regulation and litigation is providing substantial need to revise and update our services. Even if a flat tax were enacted, the outlook is for substantial need for authoritative interpretation of the business, estate, and foreign tax consequences.\nBNA SOFTWARE\nBNA Software finished 1995 with $8.8 million in revenues, a new high for the division. Operating profit was healthy and ahead of budget, but lower than 1994.\nSlightly lower new sales in 1995 are attributed to the uncertainty about new tax legislation that existed throughout the year. Renewal sales remained high, however, and circulation levels increased slightly over the prior year.\nEditorial expenses were up about 10 percent over 1994 due to increased expenditures in new and existing product development activities. These activities, along with several new product launches, remain a priority for 1996.\nProduction and distribution expenditures also were higher due to higher internal allocations and a series of successful promotional campaigns to get users to switch to the new BNA INCOME TAX PLANNER FOR WINDOWS^TM. Over half of the eligible users made the switch and new sales for the Windows^TM version remained strong throughout the year.\nIn March 1995, the BNA REAL ESTATE INVESTMENT SPREADSHEET was discontinued. The circulation of this product had been declining for several years due to the Tax Reform Act of 1986, which closed many real estate tax loopholes, and to the extended decline of the real estate market in general. In September, operations were further streamlined with the integration of the BNA CORPORATE FOREIGN TAX CREDIT PLANNER into the BNA CORPORATE TAX PLANNER. This product transition was smooth and well received by customers.\nBNA Software's prospects for 1996 appear bright as the division strengthens its position in existing markets and enters new segments with products that are anticipated to be market \"firsts.\"\nBNA INTERNATIONAL INC.\n1995 was a record year for BNA International as the subsidiary confirmed its ability to generate meaningful profits. A break-even performance had been budgeted to allow for new product initiatives. However, the continuing focus on cost control, revenue growth, and a gain from the sale of DIRECT INVESTMENT IN NORTH AMERICA to another publisher, resulted in a net income of $207,000, well above the previous year.\nRevenues from BNAI products were up by 6.1 percent over 1994 due to the success of its new WORLD SECURITIES LAW REPORT and above budget performance of several services. Foreign sales of parent company and Tax Management products were sustained at previous years' levels despite recession in several key markets. Foreign circulation of parent company and Tax Management products increased by 1.8 percent.\nThe subsidiary continued to seek efficiency gains, and additional savings were made in production and editorial costs. TAX PLANNING INTERNATIONAL and WORLD INTELLECTUAL PROPERTY REPORT generated significant profits, while EASTERN EUROPE REPORTER joined the list of profitable BNAI services for the first time.\nHaving succeeded in putting the company on a profitable path, management's focus turned to developing a strategy for future growth. This will be achieved through a combination of new product introductions and continuous appraisal of acquisition opportunities. The first result of this effort will be the introduction of a new international tax related loose-leaf service in late 1996. BNAI will acquire content for this publication by partnering with an outside organization. If successful, this publishing model will be actively considered in the future. Research continues into other potential subject areas for new international products.\nWith a pattern of profitability established, BNAI will continue to seek innovative ways of growing by exploiting the potential of international markets.\nPIKE & FISCHER, INC.\nPike & Fischer's net income in 1995 topped $1 million for the first time ever, even though the company invested heavily in improving both its print and CD-ROM communications law services.\nNearly 30 years of full-text case law was added to COMMUNICATIONS REGULATION ON CD-ROM and the 46-year-old RADIO REGULATION print service was relaunched under the new title COMMUNICATIONS REGULATION. These investments were necessary to counter new competitive threats to Pike & Fischer's position as the leading publisher of communications law reference materials. Market reaction to the upgrade and relaunch has been highly favorable.\nOffsetting these unusual expenditures were better than expected increases in revenues from the telecommunications and GREEN MARKETS product groups of 7 percent and 5 percent, respectively. Overall, revenues moved up 3.2 percent to a new high. Net income remained at 20 percent of revenues for the second year in a row, and Pike & Fischer once again paid a $650,000 dividend to BNA.\nThe launch of COMMUNICATIONS REGULATION was a large and complicated project. Over three million new pages were printed, bound, and distributed free of charge to RADIO REGULATION subscribers. The printing, binding, boxing, and labeling were all done in-house, with BNA's Distribution Center providing essential logistical support to get the finished product to Pike & Fischer's customers.\nEven without the rebuilding effort on behalf of the COMMUNICATIONS REGULATION products, 1995 would have been an especially busy year for the company. \"Print on demand\" was introduced for making up loose-leaf books, the company's leasehold in Bethesda was expanded, and the BNA CRIMINAL PRACTICE MANUAL was moved to Pike & Fischer from the parent company.\nThe initiatives undertaken in 1995 will enable Pike & Fischer to continue contributing to BNA's long-term financial and strategic objectives well into the future.\nBNA COMMUNICATIONS INC.\nBNAC's 1995 sales were down 7.8 percent from 1994, reflecting a flat year for the training media business as a whole as well as a dearth of new product releases by the subsidiary. However, a number of important steps were taken to reorganize the company for growth and profitability in 1996.\nSignificant turnover at all levels of management and among the sales force adversely affected 1995 operations. The decline in revenue, together with write-downs of underperforming assets and restructuring costs, led to a net loss of $756,000.\nAs the year drew to a close, BNAC took the following steps to restore the company to a firm financial footing:\no Shifted video production to outside producers and subject matter experts, thereby eliminating the internal production unit.\no Contracted with a large technology company to launch a new line of multimedia CD-ROM safety training programs which promise new synergies with the parent company.\no Eliminated the export department due to declining international sales.\no Contracted to install a new computer system to reduce costs and increase productivity.\nThese steps combined with new cost controls and an aggressive schedule of new product releases bode encouragingly for a return to profitable operations in 1996.\nBNA WASHINGTON, INC.\nBNAW's 1995 operating revenue from outside tenants was $1.8 million. Operating costs for all facilities combined were 6 percent lower than in 1994.\nOffice space planning, utilization, and accommodating growth were major activities for the subsidiary during the year. Although actual employee\ngrowth was less than projected, the demand for available space, as well as redesign of existing space, increased in 1995. Numerous space renovation, expansion, and redesign projects were undertaken affecting some 500 employees and involving almost 60,000 square feet of office space. All demands were accommodated within existing facilities and, with continued efficient utilization of available space, the facilities should handle projected needs through 1996.\nThe strategic facility planning committee made considerable progress in 1995. The options under consideration are development of new facilities or relocation to existing space in the District, Maryland, or Virginia. The committee has reviewed relocation and facility development financial models for several sites in the District of Columbia and close-in Maryland and Virginia. In addition, consideration is being given to staying in the West End and continuing to supplement growth requirements with leased space in the immediate area. It is expected that the committee will complete the planning and make recommendations by midyear.\nTHE McARDLE PRINTING CO., INC.\nMcArdle's 1995 results show that progress continues to be made growing the business and improving profitability while enhancing product quality and responsiveness.\nOperating revenues were $24.2 million, a 1.4 percent increase, and operating profit was essentially even with the previous year. Net income was lower because 1994 had included substantial tax refunds. The subsidiary paid the parent company a dividend of $500,000, a 25 percent increase over 1994.\nMcArdle's top priorities continue to be improving quality and increasing revenues. The Total Quality Management (TQM) program, established in 1993, is progressing as planned. In addition to Process Improvement and Task Force Teams, the TQM effort has been expanded to include more employees. The company believes that emphasis on quality will pay dividends in increased sales from existing customers and by attracting new business.\nDuring the year, McArdle installed a computerized labeling system to address the more than 12 million mailings annually to BNA subscribers. This system, which codes, addresses, and prints all required information on generic envelopes, will reduce BNA's mailing expense by more than $125,000 annually and bring work previously subcontracted into the subsidiary.\nIn the last quarter of 1995, McArdle purchased an integrated printing operations system which will apply proven state-of-the-art management information technology to almost every aspect of the company's operations. The system will provide more timely and accurate information to identify, react, respond, and track plant operations. It will become operational during 1996.\nThe McArdle Printing Company is committed to improving quality through TQM and by keeping abreast of the rapidly advancing technological changes in the industry. With these commitments, existing facilities, and personnel, it is and will remain well positioned to meet BNA's present and future printing requirements and to offer competitively priced, superior quality, and on-time printing services to commercial markets.\nPART I -------- Item 1. Business --------- General Development of Business and Narrative Description of Business Cont. - ----------------------------------------------------------------------- The Bureau of National Affairs, Inc. (\"BNA\" or the \"Company\") operates primarily in the business information publishing industry. Operations consist of the production and marketing of information products in print and electronic form, and outside printing services. Activities in other industry segments are less than 10 percent of total revenue.\nAs a response to customer demand, advances in technology, and competition, the Company has increased its electronic product offerings with CD-ROM being the most successful. CD-ROM's allow the economical addition of value-added features such as searching capabilities and additional information content.\nCompetition in the business information industry continues to intensify and some competitors are larger and have greater resources than BNA. The Company has invested in sales aids to help its sales force demonstrate the CD-ROM products to customers. Additionally, the Company has embarked on a plan to redesign its publishing system to more effectively produce information for electronic or print delivery. This process is expected to be developed over several years.\nThe number of employees of BNA and its subsidiaries was 1,863 at December 31, 1995.\nPart I -------- Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------- BNA Washington Inc. owns and manages the buildings presently used by BNA and some of its Washington area subsidiaries. Principal operations are conducted in three adjacent buildings at 1227-1231 25th Street, NW, Washington, D.C. The office building at 1227 25th Street is being used primarily by BNA and also for commercial leasing. BNA also leases office space at 1250 23rd Street, NW, Washington, D.C.\nBNA's Circulation Department and BNA Communications Inc. operate in an owned facility at 9435 Key West Avenue, Rockville, Maryland. Pike & Fischer, Inc. leases office space for its operations at 4600 East-West Highway, Bethesda, Maryland. BNA International Inc. conducts its operations from leased offices at Heron House, 10 Dean Farrar Street, London, England. The McArdle Printing Co., Inc. owns its office and plant facilities at 800 Commerce Drive, Upper Marlboro, Maryland. Property at the former printing site in Silver Spring, Maryland was sold in January, 1995.\nItem 3.","section_3":"Item 3. Legal Proceedings ----------------- The Company is involved in certain 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 statements.\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 I -------\nItem X. EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------\nThe following persons were executive officers of The Bureau of National Affairs, Inc., at December 31, 1995. Executive officers are elected annually by the Board of Directors and serve until their successors are elected.\nName Age Present position and prior experience - ----------------- ---- -------------------------------------- William A. Beltz 66 Chairman of the Board, President and Chief Executive Officer Elected Chairman in 1994, president and editor-in-chief in 1979 and chief executive officer in 1980. Joined BNA in 1956. Served as president until February, 1995.\nJacqueline M. 46 Vice President for Human Resources Blanchard Elected to vice president in 1994. Previously was director of labor and employee relations since 1987. Joined BNA in 1984.\nJohn P. Boylan, Jr. 56 Vice President for Administration Elected to present position in 1986. Joined BNA in 1974 after employment at Fisher-Stevens, Inc. (a former BNA subsidiary) since 1962.\nRobert Brooks 46 Vice President and Director of Sales and Marketing Elected to present position in 1991. Previously General Manager of BNA Software since 1984. Joined BNA in 1974. Resigned January 31, 1996.\nKathleen D. Gill 49 Vice President and Executive Editor Elected to vice president and executive editor in 1993. Previously was associate editor for business and human resources services since 1987. Joined BNA in 1970.\nJohn E. Jenc 53 Treasurer Elected to present position in 1990. Joined BNA as Controller in 1981.\nGeorge J. Korphage 49 Vice President and Chief Financial Officer Elected vice president in 1988 and chief financial officer in 1989. Joined BNA in 1972.\n(Continued)\nItem X. EXECUTIVE OFFICERS OF THE REGISTRANT (Continued) -------------------------------------------------\nName Age Present position and prior experience - ---------------- ---- -------------------------------------- John V. Schappi 66 Vice Chairman of the Board Elected to Vice Chairman in 1993 and served as vice president for human resources from 1987 to 1994. Previously was associate editor for labor services since 1972. Joined BNA in 1955. Retired in December 1994.\nMary Patricia Swords 50 Vice President and Director-Elect of Sales and Marketing Elected to present position on Februrary 1, 1996. Previously was regional manager of Mountain sales region since 1985. Joined BNA in 1977.\nRobert L. Velte 48 Vice President for Strategic Development and President, BNA International, Inc. (BNAI) Elected to vice president in 1995 and president of BNAI in 1994. Previously was president of BNA Communications since 1986. Joined BNA Communications in 1976.\nPaul N. Wojcik 47 President and Chief Operating Officer Elected President 1995, senior vice president in 1994 and general counsel in 1988. Joined BNA in 1972.\nPART II --------- Item 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters --------------------------------------------------------------\nMarket Information, Holders, and Dividends - ------------------------------------------- There is no established public trading market for any of BNA's three classes of stock, but the Stock Purchase and Transfer Plan provides a market in which Class A stock can be bought and sold.\nThe Board of Directors establishes semi-annually the price at which Class A shares can be bought and sold through the Stock Purchase and Transfer Plan and declares cash dividends. In accordance with the corporation's bylaws, the price and dividends on non-voting Class B and Class C stock are the same as on Class A stock. Dividends have been paid continuously for 46 years, and they are expected to continue.\nAs of March 1, 1996, there were 1,514 Class A shareholders, 219 Class B shareholders, and 40 Class C shareholders. The company repurchased 55,829 shares of Class B stock and 9,069 shares of Class C stock from retired employees or their estates in the 12 months ending March 1, 1996.\nEstablished stock price and dividends declared during 1995 and 1994 were as follows:\nStock Price January 1, 1994 - March 26, 1994 $20.50 March 27, 1994 - September 24, 1994 21.50 September 25, 1994 - March 25, 1995 22.00 March 26, 1995 - September 23, 1995 24.00 September 24, 1995 - December 31, 1995 24.75\nDividends Declared March 26, 1994 $ .45 September 24, 1994 .45 March 25, 1995 .47 September 23, 1995 .47\nThe principal market for trading of voting shares of common stock of The Bureau of National Affairs, Inc., is through the Trustee of the Stock Purchase and Transfer Plan.\nPart II --------- Item 6.","section_6":"Item 6. Selected Financial Data ------------------------\nPART II --------- Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ------------------------------------------------------------\n1995 VS. 1994 - CONSOLIDATED - ---------------------------- Consolidated revenues of $226 million were up 5.1 percent from the prior year's $215 million. Operating profit was lower than last year, but net income of $12.1 million was the highest in Company history.\nService revenues (from print and CD-ROM subscriptions and online products) increased 6.2 percent over 1994 due to continued growth in the combined subscription revenue base for print and CD-ROM products. This growth has been fueled by the market acceptance of the CD products, which generated over half of all new subscription sales dollars this year. Service revenues were 86.4 percent of consolidated revenues in 1995 and 85.6 percent in 1994. Non-service revenues (from software, outside printing, training media, books, and other units) declined slightly, as revenues were generally unchanged from the prior year, except for a 7.8 percent decline in training media.\nOperating expenses increased 6.9 percent overall in 1995. For services, the expense increase was mainly due to higher salaries, increased postage and paper rates, higher CD production costs for growing circulations and new products, increased product development costs, higher selling expenses related to record prior-year new sales, and an accounting adjustment for advertising expenses. The operating expense increase was mitigated by lower press runs for some products and the discontinuance of a costly print product in June, 1994. Four new services were launched in 1995, including two in CD format. In addition, Windows^tm versions of the Company's most successful CD products were developed and launched. Product development expenses for new products and improvements on existing products were $6.6 million in 1995 compared to $4.7 million in 1994. Operating expenses in 1995 also include an identifiable $5.5 million for developing improved business and publishing systems and $6.6 million in 1994. Non-service operating expenses were 4.8 percent higher in 1995, primarily related to software product improvement costs.\nAs described in Note 2 to the financial statements, during 1995 the Company adopted SOP 93-7 \"Reporting on Advertising Costs\", which requires that all advertising costs now be expensed as incurred. Previously, advertising costs were deferred and expensed over subscription terms. Implementing this change increased the 1995 operating expenses because current advertising costs were expensed, and in addition, $2.1 million of previously deferred advertising costs were also expensed. Operating profit declined 28.4 percent in 1995. Excluding the previously deferred advertising costs, the operating profit decline was 9.7 percent.\nNon-operating income nearly doubled in 1995 due to higher investment income related to larger portfolios, and $3.2 million of gains on the sale of a former printing plant site and sales of publications.\nThe consolidated federal, state, and local effective income tax rate was 31.2 percent in 1995 compared to 27.4 percent in 1994. In 1994, a 2.4 percent reduction for research and development credit lowered the effective income tax rate.\n(Continued)\nEarnings per share were $1.38 per share compared to $1.36 per share in 1994.\n1994 VS. 1993 - CONSOLIDATED - ---------------------------- Consolidated revenues of $215 million were up 7.3 percent from the prior year's $201 million and operating profit increased 13.5 percent. Net income of $11.7 million increased 3.6 percent.\nRevenues increased in all operating units of the Company in 1994. Service revenues increased 6.7 percent over 1993 due to record-setting new sales and higher prices. Approximately half of the new sales were for CD products. Some of the CD sales replaced print products, but since CD products have more value-added features, they afford an opportunity for higher pricing than their print counterparts. Service revenues were 85.6 percent of consolidated revenues in 1994 and 86.1 percent in 1993. Non- service revenues increased 11.2 percent, primarily due to much higher printing sales to outside customers.\nOperating expenses increased 7 percent overall in 1994. For services, the expense increase was mainly due to higher costs for salaries, commissions, and bonuses on record new sales, royalties on CD products, depreciation on new equipment, and systems development costs. Four new services were launched in 1994, including three in CD format. Product development expenses totalled $4.7 million, 10.4 percent lower than the $5.3 million in 1993 when 11 new products were launched. Operating expenses in 1994 also include an identifiable $6.6 million for developing improved business and publishing systems. Non-service operating expenses were 14.6 percent higher in 1994, primarily related to the higher outside printing revenues.\nNon-operating income declined this year due to lower gains on sales of securities. In 1993, the Company realized gains on securities sales of $2 million, resulting from the decline in interest rates in that year. Realized gains on securities sales were only $.3 million in 1994.\nThe consolidated federal, state, and local effective income tax rate was 27.4 percent in 1994 compared to 28.5 percent in 1993. In 1994, a 2.4 percent reduction for research and development credit lowered the effective income tax rate. In 1993, the effective rate was reduced 2 percent by the effect of the federal income tax rate change on net deferred tax assets.\nEarnings per share were $1.36 per share compared to $1.32 per share in 1993.\nDEFERRED TAX ASSETS\nIn accordance with SFAS 109, the Company has recorded $14.4 million of net deferred tax assets as of year-end 1995. This amount includes $19 million related to the accrued postretirement benefits liability.\nIn assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will 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. The Company has a consistent history of profitability and taxable income, and management believes this trend will continue. Factors supporting this conclusion are\n(Continued)\nconsistent profitable operations, a quality reputation in the markets served by the Company, a high renewal rate for subscription products, a large deferred revenue liability (representing payments and orders for future fulfillment), and the recent successful introduction of products using new CD and electronic delivery methods.\nIn the opinion of management, it is more likely than not that the existing deferred tax assets will be realized in future years, and no valuation allowance is necessary.\nFINANCIAL RESOURCES AND CASH FLOWS\nThe Company maintains its financial reserves in cash and investment securities which, along with its operating cash flows, are sufficient to fund ongoing cash expenditures for operations and to support employee ownership. Cash provided from operating activities amounted to $25.4 million in 1995 reflecting a 4.1 percent increase in collections, and only a 2.8 percent increase in expenditures.\nCash outlays for investing activities netted to $16.5 million, reflecting $15.6 million transferred to the Company's investment portfolio and capital expenditures of $5.2 million, which were partially offset by $4.3 million in proceeds from sales of assets. Capital expenditures for 1996 are budgeted to be over $10 million.\nSales of Class A capital stock to employees provided $6.4 million of equity capital in 1995; the Company paid $1.6 million for repurchases of Class B and Class C capital stock and $8.3 million for dividends.\nWith $114.8 million in cash and investment portfolios, no term debt, and a $10 million line of credit, the financial position and liquidity of the Company remains very strong. Should more funding become necessary in the future, the Company has substantial additional debt capacity based on its operating cash flows and real estate equity. Since subscription monies are collected in advance, cash flows from operations, along with existing financial reserves and proceeds from the sales of capital stock, have been sufficient in past years to meet all operational needs, new product introductions, capital expenditures, debt repayments, and, in addition, provide funds for dividend payments and the repurchase of Class B and Class C stock tendered by shareholders.\nPart II -------- Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data --------------------------------------------\nTHE BUREAU OF NATIONAL AFFAIRS, INC.\nConsolidated Financial Statements\nDecember 31, 1995 and 1994\n(With Independent Auditors' Report Thereon)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders The Bureau of National Affairs, Inc.:\nWe have audited the consolidated financial statements of The Bureau of National Affairs, Inc. as listed in the accompanying index in Part IV, Item 14(a)(1). In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index in Part IV, 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Bureau of National Affairs, Inc. 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in Note 2 of the consolidated financial statements, the Company adopted the provisions of the American Institute of Certified Public Accountants' Statement of Position (SOP) 93-7, \"Reporting on Advertising Costs\" in 1995.\ns\\ KPMG Peat Marwick LLP -------------------------- KPMG Peat Marwick Washington, DC February 20, 1996\nTHE BUREAU OF NATIONAL AFFAIRS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION\nThe accompanying consolidated financial statements include the accounts of The Bureau of National Affairs, Inc. (the \"Parent\"), and its subsid- iaries (consolidated, the \"Company\"). The Company operates primarily in the business information publishing industry. Operations consist pri- marily of the production and marketing of specialized labor, legal, economic, tax, health care and other regulatory information services in print and electronic formats, and outside printing services. Activities in other industry segments provide less than 10 percent of total revenue. Customers are primarily domestic lawyers, accountants, business executives, human resource professionals, health care admin- istrative professionals, labor unions, trade associations, educational institutions, government agencies, and libraries. The Company did not derive 10 percent or more of its revenues from any one customer or government agency or from foreign sales, nor did it have ten percent or more of its assets in foreign locations.\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.\nMaterial intercompany transactions and balances have been eliminated. Certain prior year balances have been reclassified to conform with current year presentation.\n(2) RECOGNITION OF SUBSCRIPTION REVENUES AND SELLING EXPENSES\nSubscription revenues and related field selling expenses are deferred and amortized over the subscription terms, which are primarily one year. Deferred subscription revenue is classified on the balance sheet as a current item; however the fulfillment of the Company's subscription liability will use substantially less current assets than the liability amount shown.\nDuring 1995, the Company adopted the provisions of the American Institute of Certified Public Accountants' Statement of Position (SOP) 93-7, \"Reporting on Advertising Costs\", which requires that advertising costs be expensed as incurred. Prior to 1995, the Company's policy was to defer and amortize these costs in the same manner as field selling costs. The adoption of SOP 93-7 increased 1995 operating expenses because $5,379,000 of currently incurred advertising costs were ex- pensed, and in addition, $2,055,000 of previously deferred advertising costs were also required to be expensed. The effect of expensing 1995 advertising costs as incurred, compared to the prior amortization method, was to decrease 1995 net income by $1,064,000, or $0.12 per share. Advertising expense under the prior amortization method in 1994 and 1993 was $5,870,000 and $6,057,000, respectively. (Continued)\n(3) EMPLOYEE BENEFIT PLANS\nThe Company has noncontributory defined benefit pension plans covering employees of the Parent and certain subsidiaries. Benefits are based on years of service and average annual compensation for the highest paid five years during the last 10 years of service. The plans provide for five-year cliff vesting.\nThe Company's funding practice is to contribute amounts which, at a min- imum, satisfy ERISA requirements. The Company contributed $3,899,000 to the Plan in 1995, $3,217,000 in 1994, and $2,914,000 in 1993.\nPension expense is recorded on an accrual basis in accordance with financial reporting standards. Components of the net pension expense, based on the actuarial study as of January 1 for each year, were as follows (in thousands of dollars): 1995 1994 1993 -------- -------- -------- Service cost - benefits earned during the year $ 3,207 $ 3,448 $ 2,505 Interest cost 4,939 4,526 4,009 Actual return on plan assets during the year - (gain) loss (14,287) 256 (5,904) Net asset gain (loss) deferred for later recognition 10,146 (4,389) 2,255 Amortization of transition assets and unrecognized prior service costs (174) (102) (93) -------- -------- -------- Net pension expense $ 3,831 $ 3,739 $ 2,772 ======== ======== ========\n(Continued)\nThe following table sets forth the funded status of the Plan and the liabilities recognized in the Company's Consolidated Balance Sheets (in thousands of dollars, except percentages): December 31, 1995 1994 -------- -------- Actuarial present value of benefit obligations: Vested benefits $ 44,618 $ 37,121 Nonvested benefits 10,711 6,912 -------- -------- Accumulated benefit obligation 55,329 44,033 Projected future compensation 21,923 15,776 -------- -------- Projected benefit obligation 77,252 59,809 Plan assets at fair value 67,595 53,035 -------- -------- Projected benefit obligation in excess of plan assets 9,657 6,774 Unrecognized net asset 2,628 3,004 Unrecognized net gain (loss) (2,662) 113 Unrecognized prior service cost (1,698) (1,899) -------- -------- Accrued pension liability 7,925 7,992 Less - current portion 3,900 3,899 -------- -------- Long-term portion $ 4,025 $ 4,093 ======== ======== Assumed discount rate 6.75% 8.0% Assumed rate of compensation increase 5.0% 5.0% Expected long-term rate of return on assets 8.0% 8.0%\nPlan assets included equity securities, fixed income securities, and temporary investments. Calculations of benefit obligations as of December 31, 1995, have been estimated by an independent actuary and are subject to revision upon completion of a detailed actuarial study.\nIn addition, some acquired subsidiaries have defined contribution pen- sion plans and union-sponsored multi-employer pension plans. Contribu- tions under some of these plans are at the discretion of the Board of Directors of the respective subsidiaries. Total contributions under these plans were $775,000 in 1995, $775,000 in 1994 and $721,000 in 1993.\nThe Company also has a cash profit sharing plan based on operating in- come before taxes, as defined, covering employees of the Parent and certain subsidiaries. Profit sharing expense was $966,000 in 1995, $1,128,000 in 1994, and $849,000 in 1993.\nIn addition to providing pension benefits, the Company extends certain health care and life insurance benefits (\"other postretirement bene- fits\") to retired employees. Most of the Company's employees are eligible for these benefits\n(Continued)\nif they retire while working for the Company. The Company's policy is to fund these benefits as claims and premiums are paid.\nPostretirement benefits expense is recorded in accordance with financial reporting standards which require that the present value of these bene- fits be accrued during employees' working careers. Components of the postretirement benefit expense, based on the actuarial study as of January 1 for each year, were as follows (in thousands of dollars):\n1995 1994 1993 -------- -------- -------- Service cost-benefits earned during the year $ 1,505 $ 1,824 $ 1,993 Interest cost 2,493 2,543 3,073 Amortization of net gain (844) (331) (39) -------- -------- -------- Postretirement benefits expense $ 3,154 $ 4,036 $ 5,027 ======== ======== ========\nThe following table sets forth the liabilities for these benefits recog- nized in the Company's Consolidated Balance Sheets (in thousands of dollars):\nDecember 31, 1995 1994 ------- ------- Actuarial present value of benefit obligation: Retirees $11,589 $11,324 Fully eligible active plan participants 985 856 Other active plan participants 24,716 17,978 ------- ------- Accumulated benefit obligation 37,290 30,158 Unrecognized net gain 11,549 16,463 Unrecognized prior service cost 622 677 ------- ------- Accrued other postretirement benefits liability 49,461 47,298 Less - current portion 1,068 1,088 ------- ------- Long-term portion 48,393 46,210 ======= ======= Assumed discount rate 6.75% 8.0% Assumed rate of compensation increase 5.0% 5.0%\nThe December 31, 1995 accumulated benefit obligation was determined using an assumed health care cost trend rate of 6 percent in 1996, de- clining to 5 percent per year in the year 2001 and thereafter over the projected payout period of the benefits.\nThe effect of a one percent increase in the health care cost trend rate at December 31, 1995 would have resulted in a $6,901,000 increase in the accumulated benefit obligation and an $823,000 increase in the 1995 postretirement benefit expense.\n(Continued)\n(4) INVESTMENTS AND INVESTMENT INCOME\nCash and investments were as follows (in thousands of dollars):\nDecember 31, 1995 1994 -------- -------- Cash and cash equivalents $ 17,763 $ 12,428 Short-term investments 11,123 6,045 Marketable securities 85,884 67,180 -------- -------- Total $114,770 $ 85,653 ======== ========\nCash equivalents consist of short-term investments, with a maturity of three months or less at the time of purchase. Short-term investments consist of other fixed-income investments, maturing in one year or less. Marketable securities consist of equity securities and fixed-income securities maturing in more than one year.\nInvestment income consisted of the following (in thousands of dollars):\n1995 1994 1993 -------- -------- -------- Interest income $4,906 $3,629 $3,581 Dividend income 969 827 640 Net gain on sales of securities 672 341 1,969 Interest expense (95) (183) (431) -------- -------- -------- Total $6,452 $4,614 $5,759 ======== ======== =======\nProceeds from the sales and maturities of securities were $75,373,000, $65,269,000 and $156,284,000 in 1995, 1994 and 1993, respectively. Gross realized gains and (losses) from these sales were $867,000 and $(195,000) in 1995, $588,000 and $(247,000) in 1994, and $2,179,000 and $(210,000) in 1993.\nThe specific identification method is used in computing realized gains and losses.\n(Continued)\nThe Company's investment securities have been classified as available- for-sale and are reported at their fair values (quoted market price), which were as follows (in thousands of dollars): Gross Gross Amortized Unrealized Unrealized December 31, 1995 Cost Gains Losses Fair Value ---------- ---------- ---------- ---------- Equity securities $ 20,355 $ 267 $ (50) $ 20,572 U.S. Government securities 9,632 101 (23) 9,710 Municipal bonds 64,221 2,450 (46) 66,625 Corporate debt 100 - - 100 ---------- ---------- ---------- ---------- Total $ 94,308 $ 2,818 $ (119) $ 97,007 ========== ========== ========== ==========\nGross Gross Amortized Unrealized Unrealized December 31, 1994 Cost Gains Losses Fair Value ---------- ---------- ---------- ---------- Equity securities $ 14,791 $ 11 $ (976) $ 13,826 U.S. Government securities 7,949 - (225) 7,724 Municipal bonds 52,933 435 (1,893) 51,475 Corporate debt 200 - - 200 ---------- ---------- ---------- ---------- Total $ 75,873 $ 446 $ (3,094) $ 73,225 ========== ========== ========== ==========\nThe differences between amortized cost and fair value result in unreal- ized gains or losses, which are reported, net of tax, as a separate component of Stockholders' Equity.\nFair values of the Company's investment securities are inversely affect- ed by changes in market interest rates. Generally, the longer the maturity of fixed-income securities, the larger the exposure to the risks and rewards resulting from changes in market interest rates. Contractual maturities of the fixed-income securities as of December 31, 1995 were as follows (in thousands of dollars):\nAmortized Cost Fair Value --------- --------- Within one year $ 11,067 $ 11,123 One through five years 20,886 21,458 Five through ten years 23,135 23,931 Over ten years 18,865 19,923 --------- --------- Total $ 73,953 $ 76,435 ========= =========\n(Continued)\n(5) OTHER INCOME\nOther income was comprised of the following (in thousands of dollars):\n1995 1994 1993 -------- -------- -------- Gain on sales of publishing assets $ 981 $ 503 $ 311 Gain on sale of land 2,408 - - (Loss) on disposals of other property and equipment (185) (44) (8) Other 53 - - -------- -------- -------- Total $ 3,257 $ 459 $ 303 ======== ======== ========\n(6) GOODWILL\nGoodwill represents the excess of the cost of purchased publications and the capital stock of subsidiaries over the fair value of net assets at the dates of their respective acquisitions, net of accumulated amort- ization of $3,583,000 in 1995 and $3,270,000 in 1994.\nGoodwill acquired prior to November 1, 1970, in the amount of $634,000, is not being amortized because, in management's opinion, it has con- tinuing value. Other goodwill is amortized on a straight-line basis, using forty years. Amortization expense was $313,000 for 1995, $312,000 for 1994, and $313,000 for 1993.\n(7) INCOME TAXES\nThe total income tax expense (benefit) was allocated as follows (in thousands of dollars): 1995 1994 1993 -------- -------- -------- Income Statement -- Provision for Income Taxes $ 5,487 $ 4,397 $ 4,482 Stockholders' Equity -- Change in: Unrealized gain (loss) on marketable securities 1,873 (1,795) 902 Foreign currency translation adjustment (24) (34) 4 -------- -------- -------- Total $ 7,336 $ 2,568 $ 5,388 ======== ======== ========\n(Continued)\nThe provision for income taxes consisted of the following (in thousands of dollars):\n1995 1994 1993 -------- -------- -------- Taxes currently payable: Federal $ 7,933 $ 2,873 $ 3,398 State and local 1,267 286 383 -------- -------- -------- 9,200 3,159 3,781 -------- -------- -------- Deferred tax provision: Federal (3,007) 995 571 State and local (706) 243 130 -------- -------- -------- (3,713) 1,238 701 -------- -------- -------- Total $ 5,487 $ 4,397 $ 4,482 ======== ======== ========\nThe deferred tax provision for 1993 includes a reduction of $310,000 for changes in tax rates enacted during that year.\nReconciliation of the U.S. statutory rate to the Company's consolidated effective income tax rate was as follows: Percent of Pretax Income ------------------------------- 1995 1994 1993 --------- --------- --------- Federal statutory rate 35.0% 35.0% 35.0% Rate difference due to level of taxable income - (.8) (.9) State and local income taxes, net of Federal income tax benefit 2.1 2.2 2.0 Goodwill amortization and other nondeductible expenses 1.8 1.8 1.2 Tax-exempt interest exclusion (6.7) (6.0) (6.5) Dividends received exclusion (1.3) (1.2) (.9) Adjustment to deferred taxes for enacted changes in tax rates - - (2.0) Research and development credit - (2.4) (.1) Others, net .3 (1.2) .7 --------- --------- --------- Total 31.2% 27.4% 28.5% ========= ========= =========\n(Continued)\nThe tax effects of temporary differences that gave rise to the deferred tax assets and liabilities were as follows (in thousands of dollars):\nDecember 31, 1995 1994 --------- --------- Deferred tax assets: Other postretirement benefits $ 19,748 $ 19,041 Pension expense 3,217 3,253 Annual leave 1,846 1,724 Inventories 1,731 1,610 Others 2,083 3,002 --------- --------- Total deferred tax assets 28,625 28,630 --------- --------- Deferred tax liabilities: Deferred selling expenses (9,985) (13,333) Depreciation (3,156) (2,535) Others (1,075) (97) --------- --------- Total deferred tax liabilities (14,216) (15,965) --------- --------- Net deferred tax assets $ 14,409 $ 12,665 ========= =========\nIn the opinion of management, it is more likely than not that the deferred tax assets will be realized in future years, and no valuation allowance is necessary.\n(8) OTHER BALANCE SHEET INFORMATION\nCertain year-end balances consisted of the following (in thousands of dollars):\n1995 1994 --------- --------- Receivables: Customers $ 39,407 $ 45,167 Others 5,392 5,417 Allowance for doubtful accounts (1,628) (1,446) --------- --------- Total $ 43,171 $ 49,138 ========= =========\n1995 1994 --------- --------- Inventories: Materials and supplies $ 4,055 $ 4,273 Work in process 274 246 Finished goods 1,939 2,314 --------- --------- Total $ 6,268 $ 6,833 ========= =========\nInventories are valued at the lower of cost (principally average cost method) or market.\n(Continued)\n1995 1994 --------- --------- Property and Equipment (at cost): Land $ 4,250 $ 5,176 Buildings and improvements 48,809 48,145 Furniture, fixtures and equipment 59,190 57,315 Accumulated depreciation (58,984) (52,663) --------- --------- Total $ 53,265 $ 57,973 ========= =========\nThe Company uses straight-line and accelerated methods of depreciation based on estimated useful lives ranging from 5 to 45 years for buildings and improvements and 5 to 11 years for furniture, fixtures and equipment. Depreciation expense was $8,761,000 in 1995, $8,604,000 in 1994, and $8,552,000 in 1993. Expenditures for maintenance and repairs are expensed while major replacements and improvements are capitalized.\n1995 1994 -------- -------- Other assets: Amortizable assets - Customer lists $ 749 $ 910 Film production costs 1,245 1,749 Lease commissions 414 468 Software 976 849 -------- -------- 3,384 3,976 Notes and other receivables 543 581 -------- -------- Total $ 3,927 $ 4,557 ======== ========\nFilm production costs are amortized using the revenue forecast method. Other amortizable assets are expensed evenly over their respective estimated lives, ranging from 3 to 10 years. Amortization expense for these assets was $1,142,000 in 1995, $940,000 in 1994, and $1,361,000 in 1993.\nAccumulated amortization for customer lists was $451,000 in 1995 and $290,000 in 1994.\n1995 1994 --------- --------- Payables and accrued liabilities: Accounts payable $ 16,315 $ 16,179 Employee compensation and benefits 11,862 11,945 Postretirement benefits 4,968 4,987 Income taxes 424 8 --------- --------- Total $ 33,569 $ 33,119 ========= =========\n(Continued)\n(9) COMMITMENTS AND CONTINGENCIES\nDuring 1994, the Company arranged a two year, $10,000,000 unsecured re- volving line of credit to be used for letters of credit and corporate borrowing. The Company's borrowing rate options are at the prime rate or the secondary CD rate plus 1\/2%, or the LIBOR rate plus 1\/4%; facilities fees are immaterial. The arrangement contains certain restrictive covenants, with which the Company is in compliance. As of December 31, 1995, there had been no borrowings, but $500,000 of the credit line had been used to secure a letter of credit.\nThe Company has non-cancelable operating leases for office space, data processing equipment, and vehicles. Total rent expense was $3,851,000 in 1995, $3,699,000 in 1994, and $3,673,000 in 1993 (net of sublease income of none, $105,000, and $195,000, respectively).\nAs of December 31, 1995, future minimum lease payments under non- cancelable operating leases were as follows: 1996 - $3,562,000; 1997 - $3,397,000; 1998 - $2,777,000; 1999 - $2,664,000; 2000 - $2,231,000; thereafter - $127,000.\nThe Company has continuing service agreements with software authors and a multi-year editorial service agreement with a law firm. The Company's minimum financial commitment related to these agreements is $1,955,000 for the year 1996. Future minimum amounts will be based on future activities.\nThe Company is involved in certain legal actions arising in the ordinary course of business. In the opinion of management the ultimate disposi- tion of these matters will not have a material adverse effect on the consolidated financial statements.\n(10) STOCKHOLDERS' EQUITY\nOwnership and transferability of Class A, Class B, and Class C stock are substantially restricted to current and former employees by provisions of the Parent's certificate of incorporation and bylaws. Ownership of Class A stock, which is voting, is restricted to active employees. Class B stock and Class C stock are nonvoting. No class of stock has preference over another upon declaration of dividends or liquidation. As of December 31, 1995 and 1994, authorized shares of Class A, Class B, and Class C were 6,700,000, 5,300,000, and 1,000,000, respectively.\nThe Company's commitment to employee ownership is supported by its policy to repurchase all Class B and Class C stock tendered by share- holders. As of December 31, 1995, Class B and Class C stock having a total market value of $2,690,000 are known or expected to be tendered during 1996. The Company, as a matter of policy, is also committed to repurchase any Class A stock tendered by shareholders to the Stock Purchase & Transfer Plan Trustee which the Trustee is unable to purchase with proceeds from the sale of Class A stock to employees.\n(Continued)\nTreasury share transactions were as follows:\nTreasury Stock Shares ------------------------------------- Class A Class B Class C ----------- ----------- ----------- Balance, January 1, 1993 2,980,591 23,786 54,987 Sale of Class A shares to employees (143,536) - - Repurchase of shares 17,502 86,457 7,455 Conversion of Class A shares to Class B shares 110,243 (110,243) - Exchange of Class A shares for newly issued Class B shares 324,645 - - ----------- ----------- ----------- Balance, December 31, 1993 3,289,445 0 62,442 Sale of Class A shares to employees (260,936) - - Repurchase of shares - 148,992 13,006 Conversion of Class A shares to Class B shares 41,441 (41,441) - Exchange of Class A shares for newly issued Class B shares 7,483 - - ----------- ----------- ----------- Balance, December 31, 1994 3,077,433 107,551 75,448 Sale of Class A shares to employees (271,896) - - Repurchase of shares - 56,793 9,245 Conversion of Class A shares to Class B shares 109,573 (109,573) - ----------- ----------- ----------- Balance, December 31, 1995 2,915,110 54,771 84,693 =========== =========== ===========\nEarnings per share have been computed based on the aggregate weighted average number of all outstanding shares of stock, which was 8,759,516 in 1995, 8,599,118 in 1994, and 8,549,522 in 1993.\nAssets and liabilities of the Company's United Kingdom subsidiary are denominated in British pounds and translated into U.S. dollars at year- end exchange rates. Any resulting gain or loss is reflected, net of taxes, directly in Stockholders' Equity in the accompanying Consolidated Balance Sheets.\nPART II -------\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 accountants on accounting and financial disclosures during the two years ended December 31, 1995 or through the date of this Form 10-K.\nPART III -------- Except as set forth in this Form 10-K under Part I, Item X, \"EXECUTIVE OFFICERS OF THE REGISTRANT,\" the information required by Items 10, 11, 12, and 13, is contained in the Company's definitive Proxy Statement (the \"Proxy Statement\") filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, to be filed with the SEC within 120 days of December 31, 1995. Such information is incorporated herein by reference.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant --------------------------------------------------- The information required under this Item 10 is contained in the Proxy Statement under the headings \"I. ELECTION OF DIRECTORS\" and \"BIOGRAPHICAL SKETCHES OF NOMINEES,\" and is incorporated herein by reference. Information related to Executive Officers is omitted from the Proxy Statement in reliance on Instruction 3 to Regulation S-K, Item 401(b), and included as Item X of Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation ---------------------- The information required under this Item 11 is contained in the Proxy Statement under the headings \"IV. EXECUTIVE COMPENSATION\" and \"V. EMPLOYEE BENEFIT PLANS\" and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Beneficial Owners and Management ------------------------------------------------------ The information required under this Item 12 is contained in the Proxy Statement under the heading \"I. ELECTION OF DIRECTORS\" and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information required under this Item 13 is contained in the Proxy Statement under the heading \"IV. EXECUTIVE COMPENSATION\" and is incorporated herein by reference.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Report on Form 8-K ------------------------------------------------------ The following documents are filed as part of this report.\n(a)(1) Financial Statements: Page --------------------- ---- Report of Independent Auditors 22\nConsolidated Balance Sheets as of December 31, 1995 and 1994. 24-25\nConsolidated Statements of Income, Consolidated Statements of Cash Flows, and Consolidated Statements of Changes in Stockholders' Equity for each of the years ended December 31, 1995, 1994, and 1993 23, 26-28\nNotes to Consolidated Financial Statements 29-40\n(2) Financial Statement Schedule: ---------------------------- Report of Independent Auditors as to the financial statement schedule 22\nVIII Valuation and Qualifying Accounts and Reserves 41\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(a)(3) Exhibits: -------- 3.1 Certificate of Incorporation, as amended ****\n3.2 By laws, as amended **\n11 Statement re: Computation of Per Share Earnings is contained in the 1995 Consolidated Financial Statements in the Notes to Consolidated Financial Statements, Note 10, \"Stockholders' Equity,\" at page 40 of this Form 10-K.\n22 Subsidiaries of the Registrant. *\n24.1 Consent of Independent Auditors for 1995, 1994 and 1993 financial statements.\n28.1 Proxy Statement for the Annual Meeting of security holders to be held on April 20, 1996 ***\n28.2 Annual Report on Form 11-K related to the Company's Deferred Stock Purchase Plan for the fiscal year ended December 31, 1995. *\n* Filed herewith.\n** Incorporated by reference to the Company's 1988 Form 10-K, Commission File Number 2-28286, filed on March 30, 1989. The exhibit numbers indicated above correspond to the exhibit numbers in that filing.\n*** Previously filed with the Securities and Exchange Commission.\n**** Incorporated by reference to the Company's 1993 Form 10-K, Commission File Number 2-28286, filed on March 31, 1994. The exhibit numbers indicated above correspond to the exhibit numbers in that filing.\nUpon written or oral request to the Company's General Counsel, a copy of any of the above exhibits will be furnished at cost.\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.\nSIGNATURE --------- 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.\nTHE BUREAU OF NATIONAL AFFAIRS, INC.\nBy: s\\ William A. Beltz ----------------------------------------- William A. Beltz, Chief Executive Officer\nDate: March 8, 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 dates indicated.\nBy: s\\ William A. Beltz By: s\\ George J. Korphage ------------------------------- ------------------------------------ William A. Beltz, George J. Korphage, Chief Executive Officer Vice President and Chief Financial Director Officer (Chief Accounting Officer) Director\nDate: March 8, 1996 Date: March 8, 1996 ---------------------- ---------------------------\nBy: s\\ J. M. Blanchard 3\/8\/96 By: s\\ John V. Schappi 3\/8\/96 ----------------------- ------- ------------------------ ------- Jacqueline M. Blanchard Date John V. Schappi Date\nBy: s\\ John P. Boylan 3\/8\/96 By: s\\ Frederick A. Schenck 3\/8\/96 ----------------------- ------- ----------------------- ------- John P. Boylan Date Frederick A. Schenck Date\nBy: s\\ Sandra C. Degler 3\/7\/96 By: s\\ Mary P. Swords 3\/8\/96 ----------------------- ------- ----------------------- ------- Sandra C. Degler Date Mary P. Swords Date\nBy: s\\ Kathleen D. Gill 3\/7\/96 By: s\\ Daniel W. Toohey 3\/8\/96 ----------------------- ------- ----------------------- -------- Kathleen D. Gill Date Daniel W. Toohey Date\nBy: s\\ John E. Jenc 3\/7\/96 By: s\\ Loene Trubkin 3\/8\/96 ----------------------- ------- ----------------------- -------- John E. Jenc Date Loene Trubkin Date\nBy: s\\ Eileen Z. Joseph 3\/7\/96 By: s\\ Paul N. Wojcik 3\/8\/96 ----------------------- ------- ----------------------- -------- Eileen Z. Joseph Date Paul N. Wojcik Date\nEXHIBIT INDEX -------------\nExhibit Sequential Page Number Description Number - ------- ----------- ---------------\n3.1 Certificate of Incorporation, as amended ***\n3.2 By laws, as amended *\n11 Statement re: Computation of Per Share Earnings is contained in the 1995 Consolidated Financial Statements in the Notes to Consolidated Financial Statements, Note 10, \"Stockholders' Equity,\"\n22 Subsidiaries of the Registrant 47\n24.1 Consent of Independent Auditors for 1995, 1994, and 1993 financial statements. 48\n28.1 Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1996 **\n28.2 Annual Report on Form 11-K related to the Company's Deferred Stock Purchase Plan for the fiscal year ended December 31, 1995 49\n* Incorporated by reference to the Company's 1988 Form 10-K, Commission File Number 2-28286, filed on March 30, 1989. The exhibit numbers indicated above correspond to the exhibit numbers in that filing.\n** Previously filed with the Securities and Exchange Commission.\n*** Incorporated by reference to the Company's 1993 Form 10-K,Commission File Number 2-28286, filed on March 31, 1994. The exhibit numbers indicated above correspond to the exhibit numbers in that filing.\nEXHIBIT 22\nSUBSIDIARIES OF REGISTRANT\nSTATE OF INCORPORATION RELATIONSHIP ------------- ------------\nBNA Communications Inc. Delaware 100% owned by Registrant\nBNA International Inc. Delaware 100% owned by Registrant\nBNA Washington Inc. Delaware 100% owned by Registrant\nThe McArdle Printing Co., Inc. Delaware 100% owned by Registrant\nPike & Fischer, Inc. Delaware 100% owned by Registrant\nTax Management Inc. (a) Delaware 100% owned by Registrant\nBNA Holdings Inc. Delaware 100% owned by Registrant\n(a) Tax Management Inc. owns 100% of TM Holding Company Inc., a Delaware corporation.\nEXHIBIT 24.1\nCONSENT OF INDEPENDENT AUDITORS\nThe Board Of Directors and Stockholders The Bureau of National Affairs, Inc.:\nWe consent to the incorporation by reference in the registration statement (No. 333-01647) on Form S-8 of The Bureau of National Affairs, Inc., filed on March 12, 1996, of our report dated February 20, 1996, relating to the consolidated balance sheets of The Bureau of National Affairs, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in stockholders' equity, and cash flows and related consolidated financial statement schedule 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 The Bureau of National Affairs, Inc. Our report refers to the adoption by the Company fo the American Institute of Certified Public Accountants Statement of Position, \"Reporting on Advertising Costs\" in 1995.\ns\\ KPMG Peat Marwick LLP ----------------------- KPMG Peat Marwick LLP Washington, D.C. March 26, 1996\nSecurities and Exchange Commission\nWashington, D.C. 20549\nFORM 11-K\n(Mark One) ( X ) ANNUAL REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFor the fiscal year ended December 31,1995 ------------------------------------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFor the transition period from __________________ to ___________________ Commission file number 2-28286, as exhibit 28.2 -------------------------------------------------- A. Full title of the plan and the address of the plan, if different from that of the issuer named below: THE BNA DEFERRED STOCK PURCHASE PLAN\nB. Name of issuer of the securities held pursuant to the plan and the address of its principal executive office:\nThe Bureau of National Affairs, Inc. 1231 25th Street, N. W. Washington, D. C. 20037\nIndex to form 11-K: Page ---- Financial Statements - Report of Independent Auditors 52 Statements of Net Assets Available for Benefits December 31, 1995 and 1994 53 Statements of Changes in Net Assets Available for Benefits-Years Ended December 31, 1995, 1994, and 1993 54 Notes to Financial Statements - December 31, 1995, 1994, and 1993 55-57 Financial Statement Schedules 58-59\nSIGNATURE\nPursuant to the requirements of the Securities Exchange Act of 1934, the Deferred Stock Purchase Plan Administrative Committee has duly caused this annual report to be signed by the undersigned thereunto duly authorized.\nTHE BNA DEFERRED STOCK PURCHASE PLAN\nDate March 22, 1996 ------------------------------\nBy s\\ Paul N. Wojcik ------------------------------- Paul N. Wojcik, Chairman of the Administrative Committee of The BNA Deferred Stock Purchase Plan\nTHE BNA DEFERRED STOCK PURCHASE PLAN\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994, TOGETHER WITH INDEPENDENT AUDITORS' REPORT\nIndependent Auditors' Report ----------------------------\nTo the Administrative Committee of The BNA Deferred Stock Purchase Plan:\nWe have audited the accompanying statement of net assets available for benefits of The BNA Deferred Stock Purchase Plan (the Plan) as of December 31, 1995 and 1994, and the related statements of changes in net assets available for benefits for each of the years in the three-year period ended December 31, 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 audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide 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 benefits of the Plan as of December 31, 1995 and 1994, and the changes in net assets available for benefits for each of the years in the three-year period ended December 31, 1995 in accordance with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules of investments at fair value and reportable transactions are presented for the purpose of additional analysis and are not a required part of the basic financial statements but are supplementary information required by the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974. The supplemental schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opioion, are fairly stated in all material respects in relation to the basic financial statements taken as a whole.\ns\\ KPMG Peat Marwick LLP -------------------------- KPMG Peat Marwick LLP Washington, D.C. March 12, 1996\nTHE BNA DEFERRED STOCK PURCHASE PLAN\nSTATEMENTS OF NET ASSETS AVAILABLE FOR BENEFITS\nDECEMBER 31, 1995 AND 1994\n1995 1994 ----------- ----------- Investments, at fair value (Note 2) (Cost of $20,165,114 in 1995 and $16,981,162 in 1994) $30,969,675 $25,270,784\nCash 154,132 124,695 ----------- ----------- Net assets available for benefits $31,123,807 $25,395,479 =========== ===========\nSee accompanying notes to financial statements.\nTHE BNA DEFERRED STOCK PURCHASE PLAN\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n(1) SUMMARY DESCRIPTION OF PLAN\nThe BNA Deferred Stock Purchase Plan (the \"Plan\") is a contributory benefit plan sponsored by The Bureau of National Affairs, Inc. (the \"Company\"), for the benefit of employees of the Company and certain of its subsidiaries. The Plan was established in 1982 with an effective date of January 1, 1983, and is subject to the provisions of the Employee Retirement Income Security Act of 1974 (\"ERISA\"). The Plan is designed to provide benefits to participants or their beneficiaries, and encourages savings through investments in the Company's Common Stock.\nEmployees are eligible to participate in the Plan upon completion of one full year of service. To participate, eligible employees authorize the Company to contribute, on their behalf, a salary reduction amount to a Trust (the \"Trust\") established by the Plan. Such contributions may be between 1% and 15% of the participant's compensation for each Plan year, subject to certain ceiling limitations provided in the Plan, by tax laws, and by ERISA.\nThe Trust maintains separate accounts for each participant in the Plan. These accounts are credited with the participants' salary reduction contributions and dividend income. These cash balances are used to purchase shares of Company Class A Common Stock, which are credited to the accounts of the individual participants. Share and cash balances in the participants' accounts are fully vested. Distributions of participants' equity can be made in the event of retirement, death, qualifying hardships, total and permanent disability, or other severance of service. If upon terminating employment, a participant's account value exceeds $3,500, the participant may opt to delay distribution until reaching age 59 1\/2.\nThe Company's Class A Common Stock may only be purchased by employees. Former employees and, in some cases, their beneficiaries may hold Class A Common Stock for up to three years. The Company's Class B Common Stock is issued to employees in exchange for Class A Common Stock upon their retirement. The Company's Class C Common Stock is issued in exchange for\n(Continued)\nClass A Common Stock to employees of any subsidiary, upon disposition of the subsidiary. The Trust may redeem or exchange Class A Common Stock for cash, Class B, or Class C Common Stock, if necessary to comply with the above ownership restrictions. Proceeds from such exchanges are held for the Plan participants in their accounts. Dividends received from Class B and Class C Common Stock are not reinvested in Company stock, but earn interest in a money market account.\nAn administrative committee appointed by the Company's Board of Directors acts as administrator of the Plan. An officer of the Company serves as the Trustee.\n(2) INVESTMENTS\nAt December 31, 1995, the Trust held 1,185,198 shares of the Company's Class A Common Stock and 66,102 shares of the Company's Class B Common Stock, each valued at $24.75 per share, for 1,133 plan participants. At December 31, 1994, the Trust held 1,078,843 shares of the Company's Class A Common Stock and 69,829 shares of the Company's Class B Common Stock, each valued at $22.00 per share, for 1,049 plan participants.\nThe fair value of the stock is set solely by the Company's Board of Directors semiannually for the Stock Purchase and Transfer Plan (SPTP). The SPTP is the primary market for sale and purchase of the Company's Class A Stock. The Plan values its investments in the Company's stock at the then most current price fixed for the SPTP market.\n(Continued)\nThe following information summarizes the Plan's investment and distribution transactions during 1994 and 1995 involving the Company's Common Stock. Number Fair of Shares Value --------- ------------ Balance, January 1, 1994 1,053,003 $21,586,562\nAcquired 163,159 3,496,349\nDistributed to participants (67,490) (1,427,303)\nAppreciation during the year in the market value of shares of Company stock held at year end - 1,615,176 --------- ------------ Balance, December 31, 1994 1,148,672 25,270,784\nAcquired 180,079 4,278,988\nDistributed to participants (77,451) (1,861,219)\nAppreciation during the year in the market value of shares of Company stock held at year end - 3,281,122 --------- ----------- Balance, December 31, 1995 1,251,300 $30,969,675 ========= ===========\nThe Company's Board of Directors have fixed the fair value of the stock at $26.00 per share, effective March 25, 1996.\n(3) ADMINISTRATIVE COSTS\nThe Company pays most of the administrative costs of the Plan. Such costs are not reflected in the accompanying financial statements.\n(4) INCOME TAXES\nThe Plan received its latest favorable determination letter from the Internal Revenue Service on January 19, 1996 indicating that the Plan, as designed, is qualified under the applicable requirements of the Internal Revenue Code and is therefore exempt from federal income taxes. It is the intent of the Plan's management that the Plan remain qualified and its underlying trust remain tax exempt under the applicable provisions of the Internal Revenue Code.\nSchedule 1 ----------\nTHE BUREAU OF NATIONAL AFFAIRS, INC. THE BNA DEFERRED STOCK PURCHASE PLAN\nINVESTMENTS AT FAIR VALUE DECEMBER 31, 1995\nFair Description Value Cost - ------------------------------------- ------------ ------------ 1,251,300 shares Bureau of National Affairs, Inc. Common Stock $ 30,969,675 $20,165,114\nSchedule 2 ----------\nTHE BUREAU OF NATIONAL AFFAIRS, INC. THE BNA DEFERRED STOCK PURCHASE PLAN\nSCHEDULE OF REPORTABLE TRANSACTIONS FOR THE YEAR ENDED DECEMBER 31, 1995\nNumber of Purchase Number Purchases Price or of Shares Description or Sales Proceeds Gain - --------- ------------------------- --------- ---------- ------- Purchases: 180,079 Bureau of National Affairs, Inc. Common Stock 80 $4,278,988 -\nSales: 77,451 Bureau of National Affairs, Inc. Common Stock 101 1,861,219 $766,182\nNote: The items listed above represent transactions or a series of trans- actions which are in excess of 5% of the market value of Plan assets at January 1, 1995, ($1,263,539) and are reportable under Section 2520.103.6 of Chapter XXV of the Department of Labor Employee Retirement Income Security Act annual reporting requirements.\nEXHIBIT 24.1\nCONSENT OF INDEPENDENT AUDITORS\nThe Administrative Committee of The Bureau of National Affairs, Inc.\nWe consent to the incorporation by reference in the registration statement (No. 333-01647) on Form S-8 of The Bureau of National Affairs, Inc., filed on March 12, 1996, of our report dated March 12, 1996 relating to the statement of net assets available for benefits of the BNA Deferred Stock Purchase Plan as of December 31, 1995 and 1994, and the related statements of changes in net assets available for benefits 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 11-K of the BNA Deferred Stock Purchase Plan.\ns\\ KPMG Peat Marwick LLP ------------------------- KPMG Peat Marwick LLP\nWashington, D.C. March 26, 1996","section_15":""}
{"filename":"41850_1995.txt","cik":"41850","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\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 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 STOCKHOLDER MATTERS\nThe Company's Common Stock, $0.10 par value per share, is listed on the New York Stock Exchange under the symbol \"GLM.\" At January 31, 1996, there were 8,015 stockholders of record of the Common Stock. The high and low sales prices of the Common Stock as reported on the New York Stock Exchange Composite Transactions Tape for each full quarterly period within the past two years appear under \"Consolidated Selected Quarterly Financial Data,\" which follows the notes to the consolidated financial statements.\nThe Company has not declared any dividends on its common stock since 1985. Subject to the preferential dividend rights of holders of the Company's preferred stock, if any, the holders of the Common Stock will be entitled to receive when, as and if declared by the Board of Directors out of funds legally available therefor, all other dividends payable in cash, in property, or in shares of Common Stock. The indenture governing the Company's Senior Secured Notes contains certain restrictions with respect to the payment of dividends on the Common Stock (other than stock dividends). (See Note 6 of Notes to Consolidated Financial Statements.) It is not expected that dividends will be declared or paid on the Common Stock in the foreseeable future.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOperating Results\nSummary\nFor 1995, operating income increased to $60.3 million from $26.1 million for 1994. The improvement in operating results was primarily due to generally higher contract drilling dayrates and utilization, lower depreciation expense due to a change in estimated rig service lives, the commencement of operations in 1995 of three offshore drilling rigs purchased in 1994, and an increase in the number of turnkey wells completed.\nFor 1994, operating income increased to $26.1 million from $3.2 million for 1993. The improvement in operating results was due to (i) higher revenues and lower operating expenses attributable to operating five additional rigs in the lower-cost Gulf of Mexico market during 1994 compared to 1993, when the rigs were operating for a portion of the year in weaker, higher-cost foreign markets, (ii) the full-year effect of three rigs acquired from Transocean Drilling AS in September 1993, (iii) lower mobilization expense attributable to moving fewer rigs during 1994, (iv) increased contract drilling dayrates in the U.S. Gulf of Mexico for 1994 compared to 1993, and (v) an increase in the number of turnkey drilling contracts completed. These improvements were partially offset by lower turnkey profit margins, normal declines in oil and gas production and lower oil and gas sales prices.\nData relating to the Company's operations by business segment follows:\nThe Company reported net income of $51.9 million for 1995 as compared with net income of $1.3 million for 1994 and a net loss of $26.5 million for 1993. Net income for 1995 included a $14.7 million gain on the sale of the offshore drilling rig, Glomar Main Pass III. Net income for 1994 included a $3.5 million charge for the cumulative effect of a required change in accounting for postemployment benefits. Excluding such nonrecurring items, net income for 1995 and 1994 was $37.2 million and $4.8 million, respectively, compared to a net loss of $26.5 million for 1993.\nIn the U.K. sector of the North Sea, increased rig demand and a decrease in the number of rigs available have resulted in higher contract drilling dayrates in 1995 as compared with 1994, particularly for semisubmersible rigs. A current oversupply of natural gas in the North Sea's U.K. sector, however, has created uncertainty regarding future demand for North Sea jackups. An oversupply of jackups in the North Sea, which could result from any reduction in future demand, could put downward pressure on dayrates and utilization rates for the Company's two jackup drilling rigs which operate in the U.K. sector of the North Sea. Demand in other sectors of the North Sea remains strong. Offshore West Africa, industry utilization and dayrates have steadily improved since the end of 1994. In the U.S. Gulf of Mexico, industry demand began weakening in late December 1994 due to seasonal factors, but stabilized during the first quarter of 1995. Since March 1995, demand in the U.S. Gulf of Mexico has increased, and, as of December 31, 1995, 141 Gulf rigs were under contract, up from a low of 109 earlier in the year.\nContract Drilling Operations\nData with respect to the Company's contract drilling operations follows:\nOf the $43.0 million increase in contract drilling revenues for 1995 compared to 1994, $26.4 million was attributable to increases in dayrates, $14.2 million was attributable to increases in rig utilization, and $2.4 million was attributable to an increase in non-dayrate revenue. On a regional basis, revenues from the North Sea increased by $26.5 million due to higher utilization and dayrates. The $23.5 million increase in revenues attributable to offshore West Africa was primarily the result of the full-year effect of two rigs mobilized to West Africa from other areas in 1994 and the commencement of operations of the Glomar Adriatic IX and Glomar Adriatic X in 1995. The $6.2 million decline in revenues in the \"other\" category for 1995 compared to 1994 was due to the mobilization of the two rigs to West Africa in 1994 noted above.\nOf the $12.3 million increase in contract drilling revenues for 1994 compared to 1993, $16.7 million was attributable to increases in rig utilization and $2.0 million was attributable to increases in dayrates. Such increases were partially offset by a decrease of $6.4 million in non-dayrate revenue primarily attributable to the completion of an integrated services contract in the North Sea in December 1993. Regionally, revenues from the Gulf of Mexico increased by $37.3 million due to (i) the 1993 mobilization to the Gulf of two rigs from West Africa and three rigs from the North Sea, (ii) the full-year effect of two of three rigs acquired from Transocean Drilling AS and (iii) higher dayrates for the Company's other rigs in the Gulf of Mexico. Revenues from the North Sea decreased by $28.1 million due to (i) the mobilization of the three rigs from the North Sea to the Gulf of Mexico in 1993, (ii) the sale of the offshore drilling rig, Glomar Moray Firth, to Transocean Drilling AS in September 1993 and the termination of a management contract with respect to that rig in December 1993, and (iii) lower North Sea dayrates and utilization. The $2.9 million increase in revenues in the \"other\" category for 1994 compared to 1993 was due to higher dayrates and utilization with respect to one rig in the Far East, the 1993 mobilization of one rig to Trinidad from the Gulf of Mexico, and the full-year effect of one of the three rigs acquired from Transocean Drilling AS in September 1993, partially offset by the mobilization of one rig from Alaska to West Africa in the fourth quarter of 1994 and the termination of a management contract in Alaska during 1993.\nEffective January 1, 1995, the Company increased to 25 years the estimated useful lives of its jackup drilling rigs and increased to 20 years the estimated useful lives of its semisubmersible drilling rigs and drillship. In addition, salvage values were reduced to $500,000 per rig for jackups and $1,000,000 per rig for both semisubmersibles and the drillship. The effect of the change in estimated service lives and salvage values was to decrease 1995 depreciation expense by approximately $11.2 million. Depreciation expense for contract drilling operations totaled $27.4 million for 1995, $34.9 million for 1994 and $32.0 million for 1993. The number of rigs subject to depreciation averaged 25 rigs in 1995 and 1994 and 24 rigs in 1993. Three rigs, the Glomar Adriatic IX, Glomar Adriatic X, and Glomar Adriatic XI, were not in service nor subject to depreciation for part of 1995. The Glomar Adriatic IX and Glomar Adriatic X were purchased by the Company in February 1994 and began undergoing refurbishment at that time. Refurbishment of the Glomar Adriatic IX was completed in March 1995, and the rig was mobilized to Nigeria where it began drilling in May. Refurbishment of the Glomar Adriatic X was completed in October 1995, and the rig was mobilized to Angola where it began drilling for a customer in November. The Glomar Adriatic XI was purchased by the Company in November 1994 and began operations for a customer in the North Sea in October 1995 after extensive modifications were completed.\nThe Company's operating profit margin for contract drilling operations for 1995 increased to 21 percent from 12 percent in 1994 and 2 percent in 1993. The increase in operating profit margin in 1995 compared to 1994 was due to the decrease in depreciation expense discussed above as well as to higher dayrates earned on the Company's rigs in 1995. Operating expenses other than depreciation increased by $21.5 million in 1995 compared to 1994. The increase in operating expenses in 1995 was due in part to (i) the 1995 commencement of operations of the Glomar Adriatic IX, Glomar Adriatic X and Glomar Adriatic XI, (ii) a higher payout under a net revenue-sharing arrangement with Transocean Drilling AS with respect to two rigs, (iii) the March 1995 commencement of a drilling contract in Nigeria for a rig which was mobilized from Alaska where it had been on standby for a customer in 1994, (iv) the September 1994 commencement of a drilling contract in Angola for a rig which was previously leased to an operator in Saudi Arabia under a bareboat charter agreement, and (v) higher utilization of three North Sea rigs which were idle for a significant part of 1994. The operating profit margin for 1993 was relatively low primarily as a result of the cost of mobilizing a number of rigs from the North Sea and West Africa to the Gulf of Mexico in 1993, as well as to lower dayrates and utilization in 1993.\nFor the offshore drilling industry as a whole, the number of rigs under contract in the Gulf of Mexico increased throughout 1993 due to stronger domestic natural gas prices and a growing number of drilling prospects developed from enhanced seismic technology. As demand in the Gulf increased, drilling contractors during 1993 and 1994 relocated a significant number of offshore rigs from weak overseas markets to the Gulf, resulting in downward pressure on Gulf dayrates. A seasonal decline in demand beginning in December 1994 was exacerbated by low natural gas prices, and the number of rigs under contract industry-wide fell substantially from December 1994 to February 1995. As a result of this weakening in demand, dayrates received for newly contracted jackups in the Gulf of Mexico trended downward between November 1994 and March 1995. Despite stagnant natural gas prices in the first half of 1995, drilling demand in the Gulf increased significantly since March and, as of December 31, 1995, 141 Gulf rigs were under contract. As demand increased, dayrates for jackups in the Gulf began recovering. Aside from the seasonal recovery, the strength in demand in the U.S. Gulf of Mexico beginning in the second quarter of 1995 can be attributed to, among other things, (i) improved seismic and drilling technologies which have lowered the finding costs of oil and gas and lower oil and gas producers' operating costs, making exploration and production economical at lower oil and natural gas prices, and (ii) expectations of higher future natural gas prices. For the full year, average demand in the Gulf increased to 134 rigs under contract (76 percent utilization) for 1995 from 131 rigs (75 percent utilization) for 1994 and 118 rigs (78 percent utilization) for 1993. As of February 15, 1996, all eleven of the Company's rigs in the Gulf of Mexico were under contract. The Company averaged 100 percent utilization for its rigs in the Gulf of Mexico for 1995, 99 percent for 1994 and 95 percent for 1993.\nIn the U.K. sector of the North Sea, (i) promising oil discoveries west of the Shetland Islands, (ii) operators' increased drilling to fulfill commitments to drill previously awarded blocks, (iii) fewer available North Sea rigs, (iv) increasing optimism with respect to the outlook for stable oil prices, and (v) increased levels of operators' cash flow, among other factors, have resulted in higher dayrates and utilization in the U.K. sector of the North Sea in 1995 compared to 1994, particularly for semisubmersible rigs. However, an oversupply of natural gas in the U.K. sector of the North Sea has caused some gas drilling programs to be delayed and has created uncertainty over future demand for North Sea jackups, which in the U.K. drill predominantly for gas. An oversupply of jackups in the North Sea, which could result from any reduction in future demand, could put downward pressure on dayrates and utilization rates for the Company's Glomar Labrador I and Glomar Adriatic XI jackups. Under the Glomar Labrador I's current contract, which is expected to terminate in April 1996, the dayrate is subject to adjustment periodically based on an index of market dayrates. The Glomar Adriatic XI is under contract through approximately October 1996 at dayrates higher than or equal to the dayrate the rig is presently receiving. The Company's two semisubmersible rigs operating in the North Sea, the Glomar Arctic I and Glomar Arctic III, compete in markets driven primarily by oil prices and are not expected to be affected by any weakness caused by low natural gas prices. For the fourth quarter of 1995, average drilling industry demand in the North Sea decreased to 76 rigs under contract (94 percent utilization) from 77 rigs (96 percent utilization) for the third quarter of 1995. For the full year, average demand in the North Sea increased to 71 rigs under contract (90 percent utilization) for 1995 from 64 rigs (76 percent utilization) for 1994. For 1993, North Sea demand averaged 81 rigs (79 percent utilization). As of February 15, 1996, all four of the Company's rigs in the North Sea were under contract. The Company averaged 100 percent utilization for its drilling rigs in the North Sea for 1995, 68 percent for 1994 and 83 percent for 1993.\nDuring 1993, the civil war in Angola, a reduction of the Nigerian national oil company's participation in ongoing projects and volatile oil prices caused a reduction in the demand for drilling rigs offshore West Africa and, accordingly, a reduction in dayrates. Despite the unrest, supply and demand stabilized in 1994. As a result, the Company mobilized two offshore drilling rigs, the Glomar High Island IX and the Glomar Adriatic VIII, from weakening other markets to West Africa during 1994. In 1995, the Company placed into service the recently acquired Glomar Adriatic IX and Glomar Adriatic X, which commenced drilling operations offshore West Africa in May and November, respectively. For the fourth quarter of 1995, average drilling industry demand offshore West Africa increased to 35 rigs under contract (87 percent utilization) from 32 rigs (84 percent utilization) for the third quarter of 1995. For the full year, average demand offshore West Africa increased to 31 rigs under contract (83 percent utilization) for 1995 from 24 rigs (75 percent utilization) for 1994. For 1993, West African demand averaged 26 rigs (70 percent utilization). In February 1996, the Company began mobilizing the Glomar High Island III from the U.S. Gulf of Mexico to Angola where it will begin drilling for a customer in March. The cost of the mobilization is expected to be substantially reimbursed by the client. As of February 15, 1996, all eight of the Company's rigs located offshore West Africa, including the Glomar High Island III, were under contract. The Company's average utilization rate for its rigs located offshore West Africa was 95 percent for 1995, 98 percent for 1994 and 88 percent for 1993.\nAs of December 31, 1995, the worldwide industry utilization rate for competitive offshore rigs was 83 percent, with 91 of the 546 worldwide competitive rigs unemployed. The Company anticipates that contracts on 18 of the Company's 26 rigs under contract as of February 15, 1996, will expire at varying times on or prior to May 31, 1996. No assurance can be made that the Company will obtain drilling contracts for its rigs upon the completion of current contracts; however, short-term contracts have been typical in the industry for the past decade, and the Company considers its upcoming contract expirations typical of prevailing market conditions and consistent with the normal course of business.\nDrilling Management Services\nRevenues for drilling management services increased by $70.0 million to $212.8 million in 1995 from $142.8 million in 1994. Operating income increased by $6.5 million to $17.3 million in 1995 from $10.8 million in 1994. The $70.0 million increase in revenues for the year consisted of (i) a $41.9 million increase attributable to an increase in the number of wells drilled, from 52 in 1994 to 67 in 1995, (ii) a $12.3 million increase attributable to higher average turnkey revenues per well, (iii) $13.9 million from the completion work on a multi-well North Sea turnkey project in 1995, and (iv) a $1.9 million increase in other drilling management revenues. Average turnkey revenues per well were higher because a higher percentage of the wells drilled in 1995 were directional and\/or deep, high-pressured wells as compared with those completed in the prior year.\nFor 1994, drilling management services reported an $82.9 million increase in revenues to $142.8 million from $59.9 million in 1993, and a $3.2 million increase in operating income to $10.8 million from $7.6 million in 1993. The improvement resulted from the completion of 52 wells in 1994 as compared to 18 wells in 1993, partially offset by lower average profit margins on the 1994 wells.\nThe increase in the number of turnkey wells drilled in 1995 and in 1994 was attributable in part to a more competitive pricing policy and oil and gas operators' increased reliance on turnkey contractors to supplement internal drilling staffs.\nOperating income for drilling management services expressed as a percentage of drilling management revenues declined to 8 percent for each of 1995 and 1994 as compared with 13 percent for 1993. Four wells in 1995 incurred losses aggregating $5.7 million, compared to losses on seven wells aggregating $5.4 million in 1994, and no losses on wells in 1993.\nOil and Gas Operations\nData related to the Company's oil and gas production follows:\nDespite higher oil and natural gas production and higher oil prices, revenues from oil and gas were unchanged at $9.8 million for each of 1995 and 1994 due to a decline in the average price received for gas. The increase in oil and gas production was due to production from new properties, partially offset by normal production declines. Operating income of $3.4 million for 1995 was slightly lower than for 1994 due principally to higher depletion expense.\nOil and gas revenues in the amount of $9.8 million for 1994 were lower than the $11.6 million of revenues reported for 1993 due to lower volumes of oil and gas produced and lower oil and gas prices. Oil and gas production decreased as a result of normal production declines, the 1993 sale of an oil producing property, and the temporary suspension of production in order to repair an oil and gas well in 1994, partially offset by production from two new properties. Operating income of $3.7 million for 1994 was lower than the $5.3 million of operating income reported for 1993 due to the lower revenues discussed above and higher costs associated with the development of new prospects, offset in part by a lower depletion rate in 1994 as compared with 1993. Depletion expense decreased to $1.9 million for 1994 from $3.3 million for 1993. The lower depletion rate resulted in part from the property sale in 1993, and from the deferral of net profits earned on certain turnkey drilling contracts, which reduced the depletable base.\nOther Income and Expense\nInterest expense was $30.2 million for each of 1995 and 1994 compared to $32.1 million in 1993. The decrease in interest expense from 1993 to 1994 was due to the reduction in long-term debt resulting from the retirement of the rig mortgage note for the Glomar Baltic I in August 1993.\nInterest capitalized increased by $1.9 million to $5.6 million in 1995 from $3.7 million in 1994. Interest capitalized in 1994 was attributable to the acquisition and refurbishment of two offshore drilling rigs, the Glomar Adriatic IX and Glomar Adriatic X, which were acquired in February 1994. The increase in interest capitalized in 1995 was primarily due to the construction work on the Glomar Adriatic XI, which was acquired in November 1994, and to higher amounts capitalized with respect to the Glomar Adriatic IX and Glomar Adriatic X as a result of continuing capital expenditures. The higher interest capitalization was offset in part by the completion of the refurbishment of the Glomar Adriatic IX in the second quarter of 1995. Work on the Glomar Adriatic X and Glomar Adriatic XI was completed in the fourth quarter of 1995.\nInterest income increased by $0.9 million to $4.7 million in 1995 from $3.8 million in 1994 primarily due to higher short-term investment balances. Interest income increased to $3.8 million for 1994 from $2.7 million for 1993, primarily due to the recognition of $0.8 million in connection with the favorable 1994 settlement of the Company's demobilization obligations with respect to a third-party owned rig aboard the Glomar Beaufort Sea I.\nIn June 1995 the Company completed the sale of its offshore drilling rig, the Glomar Main Pass III, for $22.4 million in cash, net of expenses, and recognized a gain of $14.7 million.\nOther income for 1994 consisted of $1.4 million in dividend income and a $0.6 million gain on the sale of marketable equity securities.\nFor 1995, the provision for income taxes was not significant due to the utilization of net operating loss carryforwards for U.S. federal income tax purposes. Income tax expense for 1995, 1994 and 1993 primarily consisted of income taxes applicable to foreign countries in which the Company had no loss carryforwards.\nAs of December 31, 1995, the Company had approximately $1.1 billion of net operating loss carryforwards (\"NOLs\") expiring in various amounts at various times from the year 2000 to 2009. The NOLs may be used to reduce taxable income in future years prior to their expiration. The Company's ability to utilize the NOLs is dependent on the amount and timing of future earnings. Due to the uncertain nature of their ultimate realization, the Company has not recognized on its balance sheet an asset for the amount of the future tax benefits of the NOLs. Instead, the Company has recorded a valuation allowance against the deferred tax asset in the amount of $381.8 million as of December 31, 1995. The amount of the valuation allowance is subject to periodic review. A reasonable possibility exists that the conditions which existed at December 31, 1995 giving rise to the recognition of the valuation allowance as of that date may change in the near term. If the allowance is reduced in a future period, the adjustment would be recorded as a reduction to income tax expense.\nDuring 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits.\" The cumulative impact of this change was to decrease 1994 net income by $3.5 million.\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which sets forth accounting and disclosure requirements for stock-based compensation arrangements. The new statement encourages, but does not require, companies to measure stock-based compensation cost using a fair-value method, rather than the intrinsic-value method prescribed by Accounting Principles Board (\"APB\") Opinion No. 25. Companies choosing to continue to measure stock-based compensation using the intrinsic-value method must disclose on a pro forma basis net income and net income per share as if the fair-value method were used. The Company intends to adopt the disclosure requirements of SFAS No. 123 in 1996 and to continue to measure stock-based compensation cost using the intrinsic-value approach prescribed by APB Opinion No. 25. Adoption of the new standard is not expected to have a material effect on the Company's earnings.\nLiquidity and Capital Resources\nDuring the three-year period ended December 31, 1995, the Company entered into a number of transactions designed to improve its financial and competitive positions. In 1993 the Company sold 21,150,000 shares of common stock for $74.2 million, of which $26.0 million was used to retire a rig mortgage note and $17.0 million was used to pay part of the purchase price of three offshore drilling rigs. In 1994 the Company sold marketable securities received in connection with a 1992 settlement of natural gas take-or-pay litigation for total cash proceeds of $30.8 million. The Company used the $30.8 million sale proceeds plus available cash, for a total of $39.8 million, to purchase three offshore drilling rigs in 1994. In 1994 and 1995, the Company spent an additional $56 million to refurbish and upgrade the three rigs purchased in 1994. Finally, in 1995 the Company sold a jackup rig for $22.4 million, recognizing a gain of $14.7 million.\nIn 1995, cash flow provided by operating activities amounted to $75.0 million. An additional $23.9 million was provided from sales of properties and equipment, primarily the sale of the Glomar Main Pass III. From the $98.9 million sum of cash flow from operations and proceeds from sales of properties and equipment, plus available cash, $73.5 million was used for capital expenditures, and $28.8 million was used for purchases of marketable securities (net of maturities). In 1994, cash flow provided by operating activities totaled $61.3 million, including $17.9 million in proceeds from the liquidation of a promissory note received in connection with the 1992 settlement of the Company's take-or-pay litigation.\nAs of December 31, 1995, the Company's long-term debt totaled $225.0 million, consisting entirely of 12-3\/4% Senior Secured Notes due 1999 (the \"Senior Secured Notes\"), and shareholders' equity totaled $269.0 million. The annual interest on the Senior Secured Notes is $28.7 million, payable semiannually, each June and December.\nThe Senior Secured Notes do not require any payments of principal prior to their stated maturity in December 1999, but the Company is required to make offers to purchase Senior Secured Notes upon the occurrence of certain events defined in the indenture, such as asset sales, or a change of control, or if the annual cash flow of the Company exceeds certain specified levels. In the first quarter of 1996, the Company will make an offer to purchase, at a price of 100 percent of principal, $39.3 million aggregate principal amount of Senior Secured Notes from the sum of the excess cash flow for 1995 and the proceeds of asset sales that were not applied to the purchase of Replacement Assets as defined in the indenture. As of February 9, 1996, the quoted market price of the Senior Secured Notes was 110 percent of principal, which exceeds the price at which the Company is required to make its purchase offer. The amount of Senior Secured Notes the Company will purchase, if any, is not expected to be material. The portion of the $39.3 million of cash that is not used to purchase Senior Secured Notes will become unrestricted and available to the Company for general purposes upon termination of the Company's purchase offer in the second quarter of 1996.\nThe Senior Secured Notes are not redeemable at the option of the Company prior to December 15, 1997. On or after December 15, 1997, the Senior Secured Notes are redeemable at the option of the Company, in whole at any time or in part from time to time, at a price of 102 percent of principal if redeemed during the twelve months beginning December 15, 1997, or at a price of 100 percent of principal if redeemed on or after December 15, 1998, in each case together with interest accrued to the redemption date. The Company presently expects that, absent unforeseen circumstances, it will seek to retire the Senior Secured Notes from the Company's cash and marketable securities, to the extent available, and\/or the proceeds of debt financings as early as December 1997.\nThe indenture under which the Senior Secured Notes are issued imposes significant operating and financial restrictions on the Company and requires that a first lien in favor of the trustee be maintained, for the benefit of the holders of Senior Secured Notes, on a significant portion of the Company's material assets. Such restrictions affect, and in many respects limit or prohibit, among other things, the ability of the Company to incur additional indebtedness, make capital expenditures, create liens, sell assets, engage in mergers or acquisitions, and make dividends or other payments. The restrictive covenants contained in and liens provided for under the indenture could significantly limit the ability of the Company to respond to changing business or economic conditions or to respond to substantial declines in operating results.\nCapital expenditures for 1996 are estimated to be $35 million, principally for improvements to the Company's drilling fleet.\nAs of December 31, 1995, the Company had $86.6 million in cash, cash equivalents and marketable securities, including $42.1 million which was restricted from use for general corporate purposes. The restricted amount includes (i) $27.7 million in proceeds from asset sales and $11.6 million in excess cash flow for 1995, which will become unrestricted only after and to the extent not used to purchase Senior Secured Notes in the Senior Secured Notes purchase offer in the first quarter of 1996, and (ii) $2.8 million collateralizing outstanding operating letters of credit. As of December 31, 1994, the Company had $57.9 million in cash and marketable securities, net of restricted amounts of $19.3 million.\nAn additional source of liquidity is the cash flow from the Company's oil and gas properties and drilling management service operations, both of which are available to service the Company's debt and to fund its working capital requirements and capital expenditures. Cash flow from the Company's drilling management services may be limited by certain factors, in particular, the ability of the Company to obtain and successfully perform turnkey drilling contracts based on competitive bids, which in turn is largely dependent on the number of such contracts available for bid. Accordingly, results of the Company's drilling management service operations may vary widely from quarter to quarter and from year to year. Furthermore, turnkey operations may be constrained by the availability of rigs as demand for rigs increases. In the U.S. Gulf of Mexico, ADTI relied on third-party rigs for approximately 97 percent of its rig-time in 1995, and had an average of five rigs under short-term contracts during the year. To minimize the risk of not having a rig available for a turnkey job, ADTI considers and may undertake to commit to several rigs under term contracts of from three to twelve months. In the North Sea and West Africa, the market for turnkey drilling is not well established, and growth in these markets may be constrained by rig availability in 1996.\nIn February 1996, the Company entered into an agreement to extend to December 1998 its $25 million revolving credit and letter of credit facility with a major international bank. Under the credit facility, the Company may borrow an amount of up to 80 percent of eligible accounts receivable. Borrowings under the facility would accrue interest at the lowest of three market-based interest rates. The unused portion of the line of credit is subject to an annual commitment fee of .1875 percent. There were no borrowings or letters of credit outstanding under the facility as of December 31, 1995 or 1994. As of December 31, 1995, the Company was eligible to borrow the full $25 million under the revolving credit facility.\nThe Company believes that it will be able to meet all of its current obligations, including capital expenditures and debt service, from its cash flow from operations and its cash, cash equivalents and marketable securities.\nAs part of upgrading and expanding its rig fleet and other assets, the Company considers and pursues the acquisition of suitable additional rigs and other assets on an ongoing basis. If the Company decides to undertake an acquisition, the issuance of additional shares of stock or additional debt could be required. The Company may also consider the disposition of rigs and other assets if and when a disposition can be effected on favorable terms. Disposition proceeds, to the extent available, could also be used as a source of acquisition financing.\nIn April 1995, the Company filed with the Securities and Exchange Commission a Registration Statement on Form S-3 for the proposed offering from time to time of (i) debt securities, which may be subordinated to other indebtedness of the Company, (ii) shares of preferred stock, $0.01 par value per share, and\/or (iii) shares of common stock, $0.10 par value per share, for an aggregate initial public offering price not to exceed $75 million. Any net proceeds from the sale of offered securities would be used for general corporate purposes which may include, but are not limited to, capital expenditures and the financing of acquisitions. The Registration Statement was declared effective by the Commission in June 1995. The Company has not yet offered for sale or sold any securities under the Registration Statement.\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 Global Marine Inc.\nWe have audited the consolidated balance sheet of Global Marine 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 Global Marine 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 1994 the Company adopted the new method of accounting for postemployment benefits, as prescribed by Statement of Financial Accounting Standards No. 112.\n\/s\/ Coopers & Lybrand L.L.P.\nHouston, Texas February 9, 1996\nNote 1 - Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Global Marine Inc. and its majority-owned subsidiaries. Unless the context otherwise requires, the term \"Company\" refers to Global Marine Inc. and its consolidated subsidiaries. Intercompany accounts and transactions have been eliminated.\nCash Equivalents\nCash equivalents consist of all highly liquid debt instruments with remaining maturities of three months or less at the time of purchase.\nProperties and Depreciation\nRigs and Drilling Equipment. Rigs and drilling equipment are carried at an amount equal to the fair market values of the rigs in the fleet as of December 31, 1988, plus the cost of rig acquisitions and other additions and improvements to the existing fleet thereafter. Included in the cost of rigs and drilling equipment is an allocation of the interest cost incurred during the period required to construct or refurbish a rig. Expenditures for maintenance and repairs are charged to expense as incurred. Costs of property sold or retired and the related accumulated depreciation are removed from the accounts; resulting gains or losses are included in income.\nEffective January 1, 1995, the Company increased to 25 years the estimated useful lives of its jackups and increased to 20 years the estimated useful lives of its semisubmersibles and drillship. In addition, salvage values were reduced to $500,000 per rig for jackups and $1,000,000 per rig for semisubmersibles and the drillship. The effect of the change in estimated service lives and salvage values was to decrease 1995 depreciation expense by approximately $11.2 million.\nEffective January 1, 1995, the Company adopted 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 that certain long-lived assets be reviewed for impairment whenever events indicate that the carrying amount of an asset may not be recoverable, and that an impairment loss be recognized under certain circumstances in the amount by which the carrying value exceeds the fair value of the asset. The adoption of SFAS No. 121 had no effect on the Company's results of operations or financial position.\nOil and Gas Properties. The Company capitalizes all costs attributable to the acquisition, exploration and development of oil and gas reserves under the full cost method of accounting. The depreciation, depletion and amortization provision is computed using the units-of-production method. The depletable base consists of capitalized costs, estimated future costs to develop proved reserves and estimated future dismantlement costs, and is reduced by the aggregate net profit earned on the Company's turnkey drilling contracts for wells drilled on properties in which the Company has working interests. In addition, the depletable base is reduced by proceeds from sales of oil and gas properties, unless the sale involves a significant quantity of reserves in relation to total reserves, in which case a gain or loss would be recognized. The costs of unproved properties and major development projects are not subject to depreciation, depletion and amortization until they are fully evaluated. All unproved properties are reviewed at least annually to ascertain if impairment has occurred. Costs of proved oil and gas properties which exceed the present value of estimated future net revenues are charged to expense.\nRevenue Recognition\nContract drilling services are performed generally on a daily-rate basis under individual contracts for either a stated period of time or the time required to drill a well or number of wells. Revenues from contract drilling services and the related expenses are recognized on a per-day basis as the work progresses. Revenues from turnkey drilling contracts, which are classified under drilling management revenues, are derived from the design and execution of a specific offshore drilling program at a fixed price to the oil and gas operator. Revenues from turnkey drilling contracts and the related expenses are recognized upon completion of the turnkey contract.\nForeign Currency Translation\nThe U.S. dollar is the functional currency for all of the Company's operations. Realized and unrealized foreign currency transaction gains and losses are recorded in income.\nThe Company may be exposed to the risk of foreign currency exchange losses in connection with its foreign operations. Such losses are the result of holding net monetary assets (cash and receivables in excess of payables) denominated in foreign currencies during periods of a strengthening U.S. dollar. The Company's foreign exchange gains and losses, which are primarily attributable to the British pound, have not been and are not expected to be material. This is because the Company's revenues are primarily denominated in U.S. dollars, revenues in each foreign currency are approximately equal to the Company's local expenses in that currency, and the Company does not speculate in foreign currencies or maintain significant foreign currency cash balances.\nPostemployment Benefits\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 requires the recognition of expense for postemployment benefits on an accrual basis rather than the cash basis used previously. Postemployment benefits include severance pay, disability-related benefits and certain health care benefits during the period after termination of employment but before retirement. The cumulative effect of the change as of January 1, 1994, was a charge to earnings in the amount of $3.5 million ($0.02 per share). Other than the cumulative effect, the effect of the change on earnings was not material.\nNote 2 - Investments\nAt December 31, 1995 and 1994, all of the Company's investments in cash equivalents and marketable securities consisted of debt securities which were classified as held-to-maturity and were carried at amortized cost. A summary of the estimated fair values of investments as of December 31 follows:\nThe estimated fair values of investments approximated their amortized cost; therefore, there were no unrealized gains or losses as of December 31, 1995 or 1994.\nThe estimated fair values of investments as of December 31 grouped by contractual maturities were as follows:\nAs of December 31, 1995, $42.1 million of the Company's marketable securities was restricted from general use. The restricted amount is comprised of (i) $27.7 million in proceeds from asset sales and $11.6 million in excess cash flow for 1995 which will become unrestricted only after and to the extent not used in the offering to purchase Senior Secured Notes in the first quarter of 1996 (see Note 3) and (ii) $2.8 million collateralizing outstanding operating letters of credit.\nNote 3 - Long-term Debt\nLong-term debt as of December 31, 1995 and 1994, consisted entirely of 12-3\/4% Senior Secured Notes due 1999 (the \"Senior Secured Notes\") in the aggregate principal amount of $225.0 million, due December 15, 1999. Interest on the Senior Secured Notes is payable semiannually each June and December. The Senior Secured Notes do not require any payments of principal prior to their stated maturity on December 15, 1999, but the Company is required to make offers to purchase Senior Secured Notes upon the occurrence of certain events defined in the indenture, such as asset sales, or a change of control, or if the annual cash flow of the Company exceeds certain specified levels. In the first quarter of 1996, the Company will make an offer to purchase, at a price of 100 percent of principal, $39.3 million aggregate principal amount of Senior Secured Notes from the sum of the excess cash flow for 1995 and the proceeds of asset sales that were not applied to the purchase of Replacement Assets as defined in the Senior Secured Note indenture. As of February 9, 1996, the quoted market price of the Senior Secured Notes was 110 percent of principal, which exceeds the price at which the Company is required to make its purchase offer. The amount of Senior Secured Notes the Company will purchase, if any, is not expected to be material. The portion of the $39.3 million of cash that is not used to purchase Senior Secured Notes will become unrestricted and available to the Company for general purposes upon termination of the Company's purchase offer in the second quarter of 1996.\nThe Senior Secured Notes are not redeemable at the option of the Company prior to December 15, 1997. On or after December 15, 1997, the Senior Secured Notes are redeemable at the option of the Company, in whole at any time or in part from time to time, at a price of 102 percent of principal if redeemed during the twelve months beginning December 15, 1997, or at a price of 100 percent of principal if redeemed on or after December 15, 1998, in each case together with interest accrued to the redemption date. The Company presently expects that, absent unforeseen circumstances, it will seek to retire the Senior Secured Notes from the Company's cash and marketable securities, to the extent available, and\/or the proceeds of debt financing as early as December 1997.\nThe Senior Secured Notes are collateralized by 22 rigs and all of the capital stock of the Company's direct or indirect subsidiaries, excluding the stock of Petdrill, Inc., and certain other subsidiaries as defined in the indenture. The indenture under which the Senior Secured Notes are issued imposes significant operating and financial restrictions on the Company. Such restrictions affect, and in many respects limit or prohibit, among other things, the ability of the Company to incur additional indebtedness, make capital expenditures, create liens, sell assets, engage in mergers or acquisitions, and make dividends or other payments.\nIn February 1996, the Company entered into an agreement to extend to December 1998 its $25 million revolving credit and letter of credit facility with a major international bank. Under the credit facility, the Company may borrow an amount of up to 80 percent of eligible accounts receivable. Borrowings under the facility would accrue interest at the lowest of three market-based interest rates. The unused portion of the line of credit is subject to an annual commitment fee of .1875 percent. There were no borrowings or letters of credit outstanding under the facility as of December 31, 1995 or 1994. As of December 31, 1995, the Company was eligible to borrow the full $25 million under the revolving credit facility.\nNote 4 - Commitments and Contingencies\nThe Company has numerous noncancelable operating leases for office facilities and equipment. The leases have remaining terms ranging up to six years, some of which may be renewed at the Company's option. Certain leases are subject to rent revisions based on the Consumer Price Index or increases in building operating costs. Rent expense for 1995, 1994, and 1993 was $4.9 million, $6.9 million, and $6.1 million, respectively.\nFuture minimum rental payments for the Company's lease obligations as of December 31, 1995, were as follows:\nDuring 1995 the Company completed the purchase of a concrete island drilling system (\"CIDS\"), the Glomar Beaufort Sea I, which was previously chartered by the Company under a long-term lease. The Company has agreed to pay a purchase price of up to $9.3 million out of the rig's future cash flow or proceeds from the sale of the rig, if any. The full $9.3 million will be paid only if the Company's share of future cash flow or rig sale proceeds exceeds $48 million. The Company will have no obligation to pay any amount if the rig fails to generate any future cash flow. The Glomar Beaufort Sea I is a special-purpose mobile offshore rig designed for arctic operations and was last under contract in 1990.\nThe Company is involved in various lawsuits resulting from personal injury and, from time to time, performance of services and property damage. The Company maintains insurance coverage against certain general and marine public liability, including liability for personal injury, in the amount of $200 million, subject to a self-insured retention of no more than $250,000 per occurrence. In addition, the Company's rigs and related equipment are separately insured under hull and machinery policies against certain marine and other perils, subject to a self-insured retention generally of no more than $300,000 per occurrence. The Company accrues for its share of the anticipated cost of settlement of claims in the normal course of business; actual costs have generally been within management's expectations. In the opinion of management, resolution of these matters will not have a material adverse effect on its results of operations, financial position or cash flows.\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 - Financial Instruments\nConcentrations of Credit Risk\nThe market for the Company's services and products is the offshore oil and gas industry, and the Company's customers consist primarily of major integrated international oil companies and independent oil and gas producers. The Company performs ongoing credit evaluations of its customers and generally does not require material collateral. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations.\nAt December 31, 1995 and 1994, the Company had cash deposits concentrated primarily in four major banks. In addition, the Company had certificates of deposits, commercial paper and Eurodollar time deposits with a variety of companies and financial institutions with strong credit ratings. As a result of the foregoing, the Company believes that credit risk in such instruments is minimal.\nFair Values of Financial Instruments\nThe estimated fair value of the Company's $225.0 million carrying value of long-term debt approximated $248.0 million and $240.8 million as of December 31, 1995 and 1994, respectively. The estimates of fair values were based on quoted market prices. The fair values of the Company's cash equivalents, marketable securities, trade receivables and trade payables approximated their carrying values due to the short-term maturities of these instruments (see Note 2).\nNote 6 - Capital Stock\nThe Company is authorized to issue 300,000,000 shares of common stock, $0.10 par value per share, and 10,000,000 shares of preferred stock, $0.01 par value per share. As of December 31, 1995, 133,541,917 shares of common stock were unissued, including 13,541,852 shares reserved for issuance under stock option and incentive plans. None of the preferred stock was issued or outstanding as of December 31, 1995.\nThe indenture governing the Senior Secured Notes contains certain restrictions with respect to the payment of dividends on the common stock (other than stock dividends). Specifically, the indenture restricts the payment of dividends based on (i) availability of funds under a formula based on previously unapplied cumulative net income since September 30, 1992 plus certain stock sale proceeds after December 23, 1992 and (ii) satisfaction of the then applicable minimum interest coverage ratio for debt incurrence. Cumulative net income for purposes of the test excludes gains or losses on asset sales and certain other nonrecurring charges or credits specified in the indenture. Although the Company was not prohibited from paying cash dividends under the terms of the indenture as of December 31, 1995, management does not intend to declare any cash dividends in the foreseeable future.\nThe Company has three stock option plans, the Global Marine Inc. 1989 Stock Option and Incentive Plan (the \"Employee Plan\"), the Global Marine Inc. 1994 Non-Employee Stock Option and Incentive Plan (the \"Non-Employee Plan\"), and the 1990 Non-Employee Director Stock Option Plan (the \"Director Plan\"). Under the Employee Plan, incentive and non-qualified options to purchase shares of common stock may be granted to key employees; under the Non-Employee Plan, non-qualified options may be granted to certain non-employees; and under both plans, shares of common stock may be sold at prices below the market price at the time of the sale. Under the Director Plan, non-qualified options to purchase shares of common stock are automatically granted each year to outside directors of the Company. Under the Plans, one-half of each option grant outstanding at December 31, 1995 was exercisable beginning one year after the date of grant with the remainder exercisable after two years. Options expire ten years after the date of grant. Options become exercisable in full if more than 50 percent of the Company's outstanding common stock is acquired by a person or a single group of persons.\nThe following is a summary of stock option transactions:\nDuring 1995 and 1994, up to 262,500 and 200,000 shares of common stock, respectively, were offered for conditional sale under the Employee Plan to certain key employees at a price of $0.10 per share. The exact number of shares to be offered is dependent on the performance of the Company as measured against certain long-term performance goals. To the extent the performance goals are met, shares offered in 1995 and 1994 will be issued in 1998 and 1997, respectively.\nShares of common stock available for future option grants and incentive stock sales under the option plans totaled 3,243,951 and 5,830,637 at December 31, 1995 and 1994, respectively.\nNote 7 - Net Income (Loss) per Common Share\nPrimary and fully diluted net income per common share were computed by dividing net income by the weighted average number of common shares outstanding and, for those periods in which they had a dilutive effect, shares contingently issuable due to outstanding employee stock options and incentive sales. The net loss per common share was computed by dividing the net loss by the weighted average number of common shares outstanding.\nPrimary net income or loss per common share was based on 165,142,881 shares for 1995, 163,828,711 shares for 1994, and 151,984,669 shares for 1993. Primary shares excluded contingently issuable shares because their effect was either immaterial or antidilutive.\nFully diluted net income per common and common equivalent share was based on 172,540,316 and 166,996,378 shares for 1995 and 1994, respectively.\nNote 8 - Income Taxes\nThe provision for income taxes consisted of the following:\nA reconciliation of the differences between income taxes computed at the U.S. federal statutory rate of 35 percent and the Company's reported provision for income taxes follows:\nDeferred tax assets and liabilities are recorded in recognition of the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The significant components of the Company's deferred tax assets and liabilities as of December 31 were as follows:\nThe Company's ability to utilize the net operating loss carryforwards and other deferred tax assets is dependent on the amount and timing of future earnings. Due to the uncertain nature of their ultimate realization, the Company has recorded against the deferred tax assets a valuation allowance in the amount of $381.8 million as of December 31, 1995. The amount of the valuation allowance is subject to periodic review. A reasonable possibility exists that the conditions which existed at December 31, 1995 giving rise to the recognition of the valuation allowance as of that date may change in the near term. If the allowance is reduced in a future period, the adjustment would be recorded as a reduction to income tax expense.\nAs of December 31, 1995, the Company had $1,134.2 million in net operating loss carryforwards (\"NOLs\") and $28.7 million in investment tax credit carryforwards (\"Credits\") expiring as follows:\nThe NOLs and Credits are subject to review and potential disallowance by the Internal Revenue Service (\"IRS\") upon audit of the federal income tax returns of the Company. Section 382 of the Internal Revenue Code of 1986, as amended, may impair the future availability of the NOLs and the Credits if there is a change in ownership of more than 50 percent of the Company's common stock. This limitation, if it applied, would limit the utilization of the NOLs and the Credits in each taxable year to an amount equal to the product of the federal long-term tax-exempt bond rate prescribed monthly by the IRS and the fair market value of all the Company's stock at the time of the ownership change. The interpretation of Section 382 is subject to numerous uncertainties. Accordingly, while the Company believes its loss carryforwards are available to it without limitation, such availability is not certain, nor is it certain that such carryforwards, if presently available without limitation, will continue to be available without limitation.\nNote 9 - Industry Segment Information\nThe Company provides offshore drilling services on a contract daily-rate basis principally in the U.S. Gulf of Mexico, the North Sea, and offshore West Africa and on a turnkey basis primarily in the U.S. Gulf of Mexico. In addition, the Company has oil and gas production interests principally in the U.S. Gulf of Mexico. In the industry segment data which follows, revenues from turnkey drilling services are included in drilling management services. Intersegment revenues are recorded at transfer prices which are intended to approximate the prices charged to unaffiliated customers and have been eliminated from consolidated revenues. Operating income consists of revenues less the related operating costs and expenses, excluding interest and unallocated corporate expenses. Adjustments and eliminations with respect to operating income represent the reduction to drilling management services operating income in the amount of the aggregate net profit earned in connection with service contracts on oil and gas properties in which the Company has economic interests.\nIn 1995 one customer provided $40.9 million of contract drilling revenues and $10.3 million of drilling management revenues. No single customer provided more than ten percent of revenues for 1994. In 1993 one customer provided $29.2 million of contract drilling revenues.\nExport sales by geographic areas were as follows:\nNote 10 - Retirement Plans\nPensions\nThe Company has defined benefit pension plans covering substantially all of its employees. For the most part, benefits are based on the employee's length of service and average earnings for the five highest consecutive calendar years of compensation during the last fifteen years of service. Substantially all benefits are paid from funds previously provided to trustees. The Company is the sole contributor to the plans, and its funding objective is to fund participants' benefits under the plans as they accrue, taking into consideration future salary increases. The components of net pension cost were as follows:\nThe following table sets forth the funded status of the plans by plan type (for federal income tax reporting purposes) and the amounts recognized in the Company's consolidated balance sheet as of December 31:\nPlan assets consist primarily of listed stocks and bonds, fixed-income investments and real estate.\nThe Company has established grantor trusts to provide funding for the benefits payable under certain of the nonqualified plans. The trusts are irrevocable, and assets contributed to the trusts can only be used to pay such benefits with certain exceptions. Assets of the trusts consisted of interest-bearing cash in the amount of $1.6 million and $0.5 million as of December 31, 1995 and 1994, respectively, and were included in other assets on the consolidated balance sheet.\nThe expected long-term rate of return on plan assets used to compute pension cost was 9.0 percent for 1995, 1994, and 1993. The assumed rate of increase in future compensation levels ranged from 5.5 percent to 6.5 percent for each of 1995, 1994, and 1993. The discount rate used to compute the actuarial present value of the projected benefit obligation was 7.25 percent for 1995, 8.25 percent for 1994 and 7.5 percent for 1993.\nThe Company has a defined contribution savings plan in which substantially all of the Company's domestic employees are eligible to participate. Company contributions to the savings plan are based on the amount of employee contributions. Charges to expense with respect to this plan totaled $0.6 million for 1995 and $0.5 million for each of 1994 and 1993.\nOther Postretirement Benefits\nThe Company provides, for a period of two years following retirement, health care benefits to retirees, their covered dependents and beneficiaries. In addition, the Company provides term life insurance to retirees. Generally, employees who have reached the age of 55 and have rendered a minimum of five years of service are eligible for such retirement benefits. For the most part, health care benefits are contributory while life insurance benefits are noncontributory.\nNet postretirement life insurance and health care cost consisted of the following components:\nBenefits under the Company's postretirement life insurance and health care plans are not funded. The status of the plans as of December 31 was as follows:\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8.0 percent for 1996, gradually declining to 6.0 percent by the year 2015 and remaining at that level thereafter. The effect of a one-percentage point increase in the assumed health care cost trend rate for each future year on (i) the portion of the accumulated postretirement benefit obligation applicable to health care benefits as of December 31, 1995 and (ii) the net postretirement health care cost for the year then ended would be immaterial. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.0 percent for 1995 and 1994.\nNote 11 - Supplemental Cash Flow Information\nCash interest payments totaled $28.7 million for 1995 and 1994 and $28.9 million for 1993. Cash payments for income taxes totaled $3.6 million in 1995, $1.1 million in 1994, and $5.4 million in 1993.\nDuring 1994, the Company acquired one offshore drilling rig in an all-cash transaction and two other drilling rigs for $26.0 million in cash plus 750,000 shares of Global Marine Inc. common stock.\nIn September 1993, the Company acquired a 100 percent ownership interest in three offshore drilling rigs in exchange for a 100 percent ownership interest in its offshore drilling rig, the Glomar Moray Firth I, plus $17.0 million in cash.\nSUPPLEMENTAL OIL AND GAS DISCLOSURE (Unaudited)\nThe Company's estimated net proved reserves and proved developed reserves of crude oil, natural gas and natural gas liquids are shown in the table below:\nUsers of this information should be aware that the process of estimating quantities of \"proved\" and \"proved developed\" natural gas and crude oil reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions to existing reserve estimates occur from time to time. Although every reasonable effort is made to ensure that reserve estimates reported represent the most accurate assessments 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 are estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. All of the Company's proved reserves are located in the United States. Proved developed reserves are those proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.\nThe estimates of the Company's proved oil and gas reserves were prepared by Ryder Scott Company Petroleum Engineers and were based on data supplied to them by the Company. Ryder Scott Company Petroleum Engineers has issued reports that include descriptions of the bases used in preparing the reserve estimates. These reports are filed as exhibits to the Company's Annual Report on Form 10-K.\nCapitalized costs of unproved oil and gas properties excluded from the full cost amortization pool as of December 31, 1995 and 1994 totaled $0.7 million and $1.1 million, respectively. Costs incurred related to oil and gas activities consisted of the following:\nThe calculation of estimated future net cash flows in the following table assumed the continuation of existing economic conditions. Future net cash inflows were computed by applying year-end prices (except for future price changes as allowed by contract) of oil and gas to the expected future production of proved reserves, less estimated future expenditures (based on year-end costs) expected to be incurred in developing and producing such reserves.\nThe standardized measure of discounted future net cash flows relating to proved oil and gas reserves as of December 31 follows:\nPrincipal sources of changes in the standardized measure of discounted future net cash flows follow:\nResults of operations from producing activities follow:\nNet income for the second quarter of 1995 included a $14.7 million gain on the sale of an offshore drilling rig.\nDuring the first quarter of 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" The cumulative impact of the change as of January 1, 1994 was an increase in the net loss in the amount of $3.5 million ($0.02 per share). Other than the cumulative effect, the effect of the accounting change was not material.\nThe net loss for the first quarter of 1994 also included $1.1 million in dividend income.\nNet income for the fourth quarter of 1994 included interest income of $0.8 million recognized in connection with the favorable settlement of the Company's demobilization obligations with respect to a third-party owned rig aboard the Glomar Beaufort Sea I.\nThe Company did not declare any dividends on its common stock in either 1995 or 1994.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Global Marine Inc.\nOur report on the consolidated financial statements of Global Marine Inc. and subsidiaries is included on page 28 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 56 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P.\nHouston, Texas February 9, 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\nAs permitted by General Instruction G, the information called for by this item with respect to the Company's directors is incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year. Information with respect to the Company's executive officers is set forth in Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nAs permitted by General Instruction G, the information called for by this item is incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs permitted by General Instruction G, the information called for by this item is incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs permitted by General Instruction G, the information called for by this item is incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nSchedules other than those listed above are omitted for the reason that they are not applicable.\n(3) Exhibits\nThe following instruments are included as exhibits to this Annual Report on Form 10-K and are filed herewith unless otherwise indicated. Exhibits incorporated by reference are so indicated by parenthetical information.\n3(i).1 Restated Certificate of Incorporation of the Company as filed with the Secretary of State of Delaware on March 15, 1989, effective March 16, 1989. (Incorporated herein by this reference to Exhibit 3(i).1 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n3(i).2 Certificate of Amendment of the Restated Certificate of Incorporation of the Company as filed with the Secretary of State of Delaware on May 11, 1990. (Incorporated herein by this reference to Exhibit 3(i).2 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n3(i).3 Certificate of Correction of the Restated Certificate of Incorporation of the Company as filed with the Secretary of State of Delaware on September 25, 1990. (Incorporated herein by this reference to Exhibit 3(i).3 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n3(i).4 Certificate of Amendment of the Restated Certificate of Incorporation of the Company as filed with the Secretary of State of Delaware on May 11, 1992. (Incorporated herein by this reference to Exhibit 3(i).4 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n3 (i).5 Certificate of Amendment of the Restated Certificate of Incorporation of the Company as filed with the Secretary of State of Delaware on May 12, 1994. (Incorporated herein by this reference to Exhibit 4.5 of the Registrant's Registration Statement on Form S-3 (No. 33-53691) filed with the Commission on May 18, 1994.)\n3(ii).1 By-laws of the Company as amended on May 10, 1989. (Incorporated herein by this reference to Exhibit 3(ii).1 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n4.1 Indenture, dated as of December 23, 1992, between the Company and Wilmington Trust Company, as Trustee, with respect to the Senior Secured Notes. (Incorporated herein by this reference to Exhibit 4.5 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.2 First Priority Naval Mortgage, dated April 29, 1993, from Global Marine Drilling Company to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.6 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n4.3 First Preferred Fleet Mortgage, dated December 23, 1992, from Global Marine Drilling Company to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.7 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.4 Release of Vessel from Lien of First Preferred Fleet Mortgage, dated April 30, 1993, by Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.8 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n4.5 First Preferred Fleet Mortgage, dated December 23, 1992, from Global Marine Deepwater Drilling Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.8 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.6 Release of Vessel from Lien of Mortgage, dated January 27, 1993, by Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.6 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n4.7 First Priority Naval Mortgage, dated March 17, 1993, from Global Marine Nautilus Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.10 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n4.8 Release of Vessel from Lien of First Priority Naval Fleet Mortgage, dated September 8, 1993, by Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.8 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n4.9 Supplement No. 1, dated September 8, 1993, to First Priority Naval Fleet Mortgage from Global Marine Nautilus Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.9 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n4.10 Assumption Agreement and Supplement No. 2, dated December 16, 1993, to First Priority Naval Fleet Mortgage among Global Marine Drilling Company and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.10 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n4.11 First Preferred Fleet Mortgage, dated December 23, 1992, from Global Marine West Africa Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.10 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.12 First Preferred Ship Mortgage, dated December 23, 1992, from Global Marine Adriatic Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.11 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.13 Assumption Agreement and Supplement No.1, dated March 4, 1993, to First Preferred Ship Mortgage among Global Marine Adriatic Inc., as Original Mortgagor, Global Marine Drilling Company, as Assuming Mortgagor, and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.13 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n4.14 First Preferred Ship Mortgage, dated December 23, 1992, from Global Marine Australia Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.12 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.15 Release of Vessel from Lien of Mortgage, dated May 19, 1995, by Wilmington Trust Company, as Trustee.\n4.16 First Preferred Ship Mortgage, dated December 23, 1992, from Global Marine Bismarck Sea Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.13 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.17 First Priority Naval Mortgage, dated March 17, 1993, from Global Marine North Sea Inc. to Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.16 of the Registrant's Registration Statement on Form S-3 (No. 33-65272 ) filed with the Commission on June 30, 1993.)\n4.18 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Adriatic Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.15 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.19 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Australia Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.16 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.20 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Bismarck Sea Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.17 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.21 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Deepwater Drilling Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.18 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.22 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Drilling Company Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.19 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.23 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine Nautilus Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.20 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.24 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine North Sea Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.21 of Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.25 Subsidiary Pledge Agreement, dated December 23, 1992, between Global Marine West Africa Inc. and Wilmington Trust Company, as Trustee. (Incorporated herein by this reference to Exhibit 4.22 of Post- Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-3 (No. 33-34013) filed with the Commission on January 22, 1993.)\n4.26 Subsidiary Pledge Agreement, dated December 21, 1995, between Global Marine International Services Corporation and Wilmington Trust Company, as Trustee.\n10.1 Credit Agreement, dated June 24, 1993, among Global Marine Inc., Global Marine Drilling Company, Global Marine Australia Inc., Global Marine Baltic Inc., Global Marine Deepwater Drilling Inc. and Societe Generale, New York Branch. (Incorporated herein by this reference to Exhibit 10.1 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n10.2 Amendment No. 1, dated February 26, 1996, to Credit Agreement among Global Marine Inc., Global Marine Drilling Company, Global Marine Australia Inc., Global Marine Baltic Inc., Global Marine Deepwater Drilling Inc. and Societe Generale, New York Branch.\n10.3 Memorandum of Agreement, dated June 6, 1993, between Global Marine Inc. and Transocean Drilling AS, and Amendment No. 1 thereto dated June 16, 1993. (Incorporated herein by this reference to Exhibit 99.1 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n10.4 Letter of Intent in Order to Form a Joint Venture, dated June 6, 1993, between Global Marine Inc. and Transocean Drilling AS. (Incorporated herein by this reference to Exhibit 99.2 of the Registrant's Registration Statement on Form S-3 (No. 33-65272) filed with the Commission on June 30, 1993.)\n10.5 Purchase and Sale Agreement, dated August 24, 1993, between Global Marine Inc. and Transocean Drilling AS. (Incorporated herein by this reference to Exhibit 10.3 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n10.6 Management Agreement (relating to Glomar Moray Firth I), dated September 10, 1993, between Global Marine Nautilus Inc. and Transocean Drilling AS. (Incorporated herein by this reference to Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n10.7 Management Agreement (relating to Transocean No. 5), dated September 10, 1993, between Global Marine Nautilus Inc. and Transocean Drilling AS. (Incorporated herein by this reference to Exhibit to 10.5 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n* 10.8 Letter Employment Agreement dated February 14, 1995, between the Company and C. Russell Luigs. (Incorporated herein by this reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* 10.9 Consulting Agreement dated February 14, 1986, between Challenger Minerals Inc. and Donald B. Brown. (Incorporated herein by this reference to Exhibit 10.2 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.)\n* 10.10 Form of Letter Severance Agreement dated February 7, 1989, between the Company and six executive officers, respectively. (Incorporated herein by this reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.)\n* 10.11 Letter Severance Agreement dated May 7, 1992,between the Company and one executive officer. (Incorporated herein by this reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.)\n* 10.12 Global Marine Inc. 1989 Stock Option and Incentive Plan. (Incorporated herein by this reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.)\n* 10.13 First Amendment to Global Marine Inc. 1989 Stock Option and Incentive Plan. (Incorporated herein by this reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.)\n* 10.14 Second Amendment to Global Marine Inc. 1989 Stock Option and Incentive Plan. (Incorporated herein by this reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n* 10.15 Third Amendment to Global Marine Inc. 1989 Stock Option and Incentive Plan. (Incorporated herein by this reference to Exhibit 10.19 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n* 10.16 Fourth Amendment to Global Marine Inc. 1989 Stock Option and Incentive Plan. (Incorporated herein by this reference to Exhibit 10.16 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* 10.17 Form of Incentive Stock Sale Agreement dated February 14, 1995, between the Company and nine executive officers, respectively. (Incorporated herein by this reference to Exhibit 10.18 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* 10.18 Form of Incentive Stock Sale Agreement dated February 20, 1996, between the Company and two executive officers, respectively.\n* 10.19 Form of Performance Stock Memorandum dated June 7, 1994, regarding conditional opportunity to acquire Company stock granted to six executive officers, respectively. (Incorporated herein by this reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.)\n* 10.20 Form of Performance Stock Memorandum dated February 14, 1995, regarding conditional opportunity to acquire Company stock granted to six executive officers, respectively. (Incorporated herein by this reference to Exhibit 10.20 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* 10.21 Form of Performance Stock Memorandum dated February 20, 1996, regarding conditional opportunity to acquire Company stock granted to six executive officers, respectively.\n* 10.22 Executive Life Insurance Plan. (Incorporated herein by this reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.)\n* 10.23 Global Marine Inc. Executive Supplemental Retirement Plan of 1990. (Incorporated herein by this reference to Exhibit 10.8 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.)\n* 10.24 Global Marine Executive Deferred Compensation Trust as established effective January 1, 1995.\n* 10.25 Global Marine Benefit Equalization Retirement Plan effective January 1, 1990. (Incorporated herein by this reference to Exhibit 10.8 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.)\n* 10.26 Global Marine Benefit Equalization Retirement Trust as established effective January 1, 1990. (Incorporated herein by this reference to Exhibit 10.9 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.)\n* 10.27 Form of Indemnification Agreement entered into between the Company and each of its directors and officers. (Incorporated herein by this reference to Exhibit 10.12 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.)\n* 10.28 Resolutions dated August 3, 1994 regarding Directors' Compensation.\n* 10.29 Amended and Restated Retirement Plan for Outside Directors. (Incorporated herein by this reference to Exhibit 10.12 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.)\n* 10.30 Global Marine Inc. 1990 Non-Employee Director Stock Option Plan (Incorporated herein by this reference to Exhibit 10.18 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n* 10.31 First Amendment to Global Marine Inc. 1990 Non-Employee Director Stock Option Plan (Incorporated herein by this reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.)\n* 10.32 Global Marine Inc. 1995 Management Incentive Award Plan. (Incorporated herein by this reference to Exhibit 10.29 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* 10.33 Global Marine Inc. 1996 Management Incentive Award Plan.\n11.1 Computation of Earnings Per Common Share.\n21.1 List of Subsidiaries.\n23.1 Consent of Coopers & Lybrand L.L.P., Independent Accountants.\n23.2 Consent of Independent Petroleum Engineers (Ryder Scott Company Petroleum Engineers).\n27.1 Financial Data Schedule. (Exhibit 27.1 is being submitted as an exhibit only in the electronic format of this Annual Report on Form 10-K being submitted to the Securities and Exchange Commission. Exhibit 27.1 shall not be deemed filed for purposes of Section 11 of the Securities Act of 1933, Section 18 of the Securities Exchange Act of 1934 or Section 323 of the Trust Indenture Act, or otherwise be subject to the liabilities of such sections, nor shall it be deemed a part of any registration statement to which it relates.)\n99.1 Report of Independent Petroleum Engineers dated February 8, 1996.\n99.2 Report of Independent Petroleum Engineers dated February 8, 1995. (Incorporated herein by this reference to Exhibit 99.1 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n99.3 Reports of Independent Petroleum Engineers dated February 7, 1994. (Incorporated herein by this reference to Exhibit 99.1 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n- --------------------------- * Management contract or compensatory plan or arrangement.\nThe Company hereby undertakes, pursuant to Regulation S-K, Item 601(b), paragraph (4) (iii), to furnish to the Securities and Exchange Commission on request agreements defining the rights of holders of long-term debt of the Company and its consolidated subsidiaries not filed herewith in accordance with said Item.\n(b) Reports on Form 8-K\nThe Company did not file any Current Reports on Form 8-K during the last quarter of 1995.\nSIGNATURES REQUIRED FOR FORM 10-K\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGLOBAL MARINE INC. (REGISTRANT)\nDate: February 28, 1996 By: J. C. MARTIN --------------------------- (J. C. Martin) 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.\nSignature Title Date - --------- ----- ----\nC. R. LUIGS Chairman of the Board, February 28, 1996 - ------------------- President and Chief (C. R. Luigs) Executive Officer\nJ. C. MARTIN Senior Vice President and February 28, 1996 - ------------------- Chief Financial Officer (J. C. Martin) (Principal Financial Officer) and Director\nTHOMAS R. JOHNSON Vice President and February 28, 1996 - ------------------- Corporate Controller (Thomas R. Johnson) (Principal Accounting Officer)\nDirector - ------------------- (Patrick M. Ahern)\nDONALD B. BROWN Director February 28, 1996 - ------------------- (Donald B. Brown)\nE. J. CAMPBELL Director February 28, 1996 - ------------------- (E. J. Campbell)\nTHOMAS CASON Director February 28, 1996 - ------------------- (Thomas Cason)\nPETER T. FLAWN Director February 28, 1996 - ------------------- (Peter T. Flawn)\nJOHN M. GALVIN Director February 28, 1996 - ------------------- (John M. Galvin)\nL. L. LEIGH Director February 28, 1996 - ------------------- (L. L. Leigh)\nPAUL J. POWERS Director February 28, 1996 - ------------------- (Paul J. Powers)\nSIDNEY A. SHUMAN Director February 28, 1996 - ------------------- (Sidney A. Shuman)\nW. R. THOMAS Director February 28, 1996 - ------------------- (W. R. Thomas)","section_15":""}
{"filename":"894651_1995.txt","cik":"894651","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":"930454_1995.txt","cik":"930454","year":"1995","section_1":"Item 1. Business\nFormation\nUST Private Equity Investors Fund, Inc. (the \"Company\" or the \"Registrant\") is a Maryland corporation organized on September 16, 1994. The Fund is a non-diversified, closed-end management investment company operating as a business development company under the Investment Company Act of 1940 and has registered its shares under the Securities Act of 1933. The Company's investment objective is to achieve long-term capital appreciation by investing in private later-stage venture capital and private middle-market companies and in certain venture capital, buyout and private equity funds that the Managing Investment Adviser (defined herein) believes offer significant long-term capital appreciation.\nUnited States Trust Company of New York (the \"Managing Investment Adviser\" or \"U.S. Trust\") provides investment management services to the Company pursuant to a management agreement dated December 9, 1994, as amended (the \"Management Agreement\"), between the Managing Investment Adviser and the Company. The Managing Investment Adviser is a subsidiary of U.S. Trust Corporation. All officers of the Company are employees and\/or officers of the Managing Investment Adviser. The Managing Investment Adviser is responsible for performing the management and administrative services necessary for the operation of the Company.\nPursuant to a Registration Statement on Form N-2 (File No. 33-84290) which was declared effective on December 16, 1994, the Company publicly offered up to 50,000 shares of common stock (the \"Shares\") at $1,000 per Share. The Company held its initial and final closings on July 31, 1995, and October 31, 1995, respectively. The Company sold a total of 40,463 Shares in the public offering for gross proceeds totaling $40,463,000 (after taking into account the 1 Share purchased for $1,000 on September 16, 1994, by David I. Fann, the Company's President). Shares of the Company were made available through U.S. Trust Company of California, N.A. (the \"Selling Agent\") to clients of U.S. Trust and its affiliates who meet the Company's investor suitability standards.\nIn connection with the public offering of its Shares, the Managing Investment Adviser paid to the Selling Agent a commission totaling $10,000. The Company incurred offering and organizational costs associated with the public offering totaling $374,891. Net proceeds to the Company from the public offering, after offering and organizational costs, totaled $40,117,109.\nThe Company's articles of incorporation provide that the duration of the Company will be ten years from the final closing of the sale of the Shares, subject to the rights of the Managing Investment Adviser and the investors to extend the term of the Company. Additional characteristics of the Company's business are discussed in the \"Company\", \"Risk Factors\" and \"Investment Objective and Policies\" sections of the Prospectus, which sections are incorporated herein by reference.\nPortfolio Investments\nThe Company commenced investment operations on August 1, 1995 and during the year ended October 31, 1995 (\"fiscal 1995\"), the Company was invested only in temporary investments in accordance with the terms and conditions outlined in the Prospectus. At October 31, 1995, the Company's investment portfolio consisted of marketable securities with an aggregate cost of $29,563,366 and a fair value of $29,556,406.\nA description of the Company's investments as of October 31, 1995 is set forth in Item 8.\nCompetition\nThe Company encounters competition from other entities and individuals having similar investment objectives. Primary competition for desirable investments comes from investment partnerships, venture capital affiliates of large industrial and financial companies, investment companies and wealthy individuals. Some of the competing entities and individuals have investment managers or advisers with greater experience, resources and managerial capabilities than the Company and may therefore be in a stronger position than the Company to obtain access to attractive investments. To the extent that the Company can compete for such investments, it may not be able to do so on terms as favorable as those obtained by larger, more established investors.\nEmployees\nAt October 31, 1995, the Company had no full-time employees. All personnel of the Company are employed by and compensated by the Managing Investment Adviser pursuant to the Management Agreement.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company does not own or lease physical properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is not party to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\n(Page> PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe Company has 100,000 Shares authorized, of which 40,463 Shares were issued and outstanding on October 31, 1995. On October 31, 1995, the Company declared a dividend payable to shareholders of record on October 27, 1995 in the amount of $11.84 per share.\nThere is no established public trading market for the Company's Shares.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nAll selected financial data for the year ended October 31, 1995 may be found in the financial statements. See Item 8.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nDuring fiscal 1995, the Company focused on raising capital. The Company began the initial public offering of its Shares on December 16, 1994. At the end of July 1995, the Company held the first closing on its Shares, representing over $28.0 million. An extension of the offering period for the Shares was approved and at the end of October 1995, the Company held its second and final closing for an additional $12.4 million. The Company sold a total of 40,463 Shares at $1,000 per Share in the public offering (after taking into account the 1 Share purchased for $1,000 on September 16, 1994, by David I. Fann, the Company's President). Gross proceeds received by the Company for the sale of its Shares during 1995 totaled $40,463,000 and net proceeds after the payment of offering and organizational expenses totaled $40,117,109. With a total capitalization of $40,463,000, the Company expects to have access to a greater number of investment opportunities.\nAt October 31, 1995, the Company held $10,977,421 in cash and $29,556,406 in investments. Funds needed to cover future operating expenses and portfolio investments will be obtained from the Company's existing cash reserves, from interest income and from proceeds received from the sale of current investments.\nResults of Operations\nThe Company commenced investment operations on August 1, 1995, subsequent to the first closing of its Shares. During the period from August 1, 1995 to October 31, 1995, the Company was invested in temporary investments in accordance with the terms and conditions outlined in its Prospectus.\nDuring fiscal 1995, the managers of the Company worked to develop the Company's presence in the private equity markets with respect to investment opportunities in (1) other venture capital and leveraged buyout funds; (2) later-stage venture capital situations; and (3) middle-market buyouts. The Company reviewed over 167 investment opportunities in fiscal 1995. Of those opportunities evaluated, 10 were selected for serious consideration.\nInvestment Income and Expenses\nFor fiscal 1995, the Company had net investment income of $374,371, attributable to interest on the Company's portfolio of investments, and total operating expenses of $176,351. Operating expenses in the amount of $140,226 were reimbursed by the Managing Investment Adviser, resulting in net operating expenses of $36,125. The net operating expenses of $36,125 represent the management fee pursuant to the Management Agreement.\nNet Assets\nThe Company completed the public offering of its Shares in two separate closings in July and October 1995. The Company sold a total of 40,463 Shares at a cost of $1,000 per Share, resulting in gross proceeds raised in the offering of $40,463,000 (after taking into account the 1 Share purchased for $1,000 on September 16, 1994, by David I. Fann, the Company's President).\nFor fiscal 1995, the Company had a net increase in net assets resulting from operations of $367,411 ($12.69 per Share), comprised of net investment income totaling $374,371 ($12.86 per Share) and net unrealized depreciation of $6,960 ($0.17 per Share). Net assets were reduced by offering costs of $344,891 ($8.53 per Share) and distributions to shareholders of $333,081 ($11.84 per Share).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nUST PRIVATE EQUITY INVESTORS FUND, INC.\nINDEX\nPortfolio of Investments as of October 31, 1995\nStatement of Assets and Liabilities as of October 31, 1995\nStatement of Operations for the period ended October 31, 1995\nStatement of Changes in Net Assets for the period ended October 31, 1995\nFinancial Highlights -- Selected Per Share Data and Ratios\nNotes to Financial Statements\nIndependent Auditors' Report\nNote - All other schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or the notes thereto.\nUST PRIVATE EQUITY INVESTORS FUND, INC. PORTFOLIO OF INVESTMENTS OCTOBER 31, 1995\n* Aggregate cost for Federal tax and book purposes. `D' Floating rate security -- rate disclosed is as of October 31, 1995.\nSee Notes to Financial Statements\nUST PRIVATE EQUITY INVESTORS FUND, INC. STATEMENT OF ASSETS AND LIABILITIES\nSee Notes to Financial Statements\nUST PRIVATE EQUITY INVESTORS FUND, INC. STATEMENT OF OPERATIONS\n* Commencement of operations\nSee Notes to Financial Statements\nUST PRIVATE EQUITY INVESTORS FUND, INC. STATEMENT OF CHANGES IN NET ASSETS\n* Commencement of operations\nSee Notes to Financial Statements\nUST PRIVATE EQUITY INVESTORS FUND, INC. FINANCIAL HIGHLIGHTS -- SELECTED PER SHARE DATA AND RATIOS\n* Commencement of operations ** Annualized `D' Total investment return based on per share net asset value reflects the effects of changes in net asset value based on the performance of the Fund during the period, and assumes dividends and distributions, if any, were reinvested. The Fund's shares were issued in a private placement and are not traded, therefore market value total investment return is not calculated. Total return for periods of less than one year are unannualized.\n`D'`D' Expense ratio before waiver of fees and reimbursement of expenses by adviser.\nSee Notes to Financial Statements\nUST PRIVATE EQUITY INVESTORS FUND, INC NOTES TO FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nUST Private Equity Investors Fund, Inc. ('the Fund') was incorporated under the laws of the State of Maryland on September 16, 1994 and is registered under the Securities Act of 1933, as amended, as a non-diversified, closed-end management investment company which has elected to be treated as a business development company under the Investment Company Act of 1940, as amended.\nThe following is a summary of the Fund's significant accounting policies.\n(A) PORTFOLIO VALUATION:\nThe Fund values portfolio securities quarterly and at other such times as in the Board of Directors' view, as circumstances warrant. Investments in securities that are traded on a recognized stock exchange or on the national securities market are valued at the last sale price for such securities on the valuation date. Short-term debt instruments with remaining maturities of 60 days or less are valued at amortized cost, which approximates market value. Securities and other assets for which market quotations are not readily available are valued, pursuant to guidelines adopted by the Investment Adviser, under the supervision of the Board of Directors.\n(B) SECURITY TRANSACTIONS AND INVESTMENT INCOME:\nSecurity transactions are recorded on a trade date basis. Realized gains and losses on investments sold are recorded on the basis of identified cost. Interest income, adjusted for amortization of premiums and, when appropriate, discounts on investments, is earned from settlement date and is recorded on the accrual basis. Dividend income is recorded on the ex-dividend date.\n(C) REPURCHASE AGREEMENTS:\nThe Fund enters into agreements to purchase securities and to resell them at a future date. It is the Fund's policy to take custody of securities purchased and to ensure that the market value of the collateral including accrued interest is sufficient to protect the Fund from losses incurred in the event the counterparty does not repurchase the securities. If the seller defaults and the value of the collateral declines or if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited.\n(D) FEDERAL INCOME TAXES:\nIt is the policy of the Fund to continue to qualify as a 'regulated investment company' under Subchapter M of the Internal Revenue Code and distribute substantially all of its taxable income to its shareholders. Therefore, no federal income or excise tax provision is required.\nDividends from net investment income are declared and paid at least annually. Any net realized capital gains, unless offset by any available capital loss carryforward, are distributed to shareholders at least annually. Dividends and distributions are determined in accordance with Federal income tax regulations which may differ from generally accepted accounting principles. These 'book\/tax' differences are either considered temporary or permanent. To the extent these differences are permanent, such amounts are reclassified within the capital accounts based on their federal tax basis treatment; temporary differences do not require reclassification.\nThe Fund had permanent book\/tax differences primarily attributable to deferred organizational costs. To reflect reclassifications arising from permanent book\/tax differences as of October 31, 1995, accumulated undistributed net investment income was credited and paid in capital was charged $1,512.\nAt October 31, 1995 the tax basis of the Fund's investments for Federal income tax purposes amounted to $29,563,366. The net unrealized depreciation amounted to $6,960, which is comprised of gross unrealized appreciation of $537 and aggregate gross unrealized depreciation of $7,497.\n2. INVESTMENT ADVISORY FEE, ADMINISTRATION FEE, AND RELATED PARTY TRANSACTIONS\nPursuant to an Investment Management Agreement ('Agreement'), United States Trust Company of New York ('U.S. Trust') serves as the Managing Investment Adviser to the Fund. Under the Agreement, for the services provided U.S. Trust is entitled to receive a fee, at the annual rate of 1.50% of the net assets of the Fund, determined as of the end of each fiscal quarter, that are invested or committed to be invested in Portfolio Companies or Private Funds and equal to an annual rate of 0.50% of the net assets of the Fund, determined as of the end of each fiscal quarter, that are invested in short-term investments and are not committed to Portfolio Companies or Private Funds.\nIn addition to the management fee, the Fund has agreed to pay U.S. Trust an incentive fee in an amount equal to 10% of the cumulative realized capital gains (net of realized capital losses and unrealized net capital depreciation), less the aggregate amount of incentive fee payments in prior years. If the amount of the incentive fee in any year is a negative number, or cumulative net realized gains less net unrealized capital depreciation at the end of any year is less than such amount calculated at the end of the previous year U.S. Trust will be required to repay the Fund all or a portion of the incentive fee previously paid.\nU.S. Trust has voluntarily agreed to waive or reimburse other operating expenses of the Fund, exclusive of management fees, to the extent they exceed 0.42% of the Fund's net assets, and U.S. Trust will waive or reimburse, exclusive of management fees, all such expenses with respect to that portion of the Fund's net assets, determined as of the end of each fiscal quarter, that is invested in short-term investments.\nEach Director of the Fund receives an annual fee of $9,000, plus a meeting fee of $1,500 for each meeting attended, and is reimbursed for expenses incurred for attending meetings. No person who is an officer, director or employee of U.S. Trust, or of any parent or subsidiary thereof, who serves as an officer, director or employee of the Fund receives any compensation from the Fund.\n3. PURCHASES AND SALES OF SECURITIES\nPurchases of securities, excluding short-term investments, for the Fund aggregated $1,280,913. There were no long-term sales.\n4. ORGANIZATION COSTS:\nThe Fund has borne all costs in connection with the initial organization of the Fund. All such costs are being amortized on a straight-line basis over a period of five years from the date on which the Fund commenced operations.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nShareholders and Board of Directors UST Private Equity Investors Fund, Inc.\nWe have audited the accompanying statement of assets and liabilities of UST Private Equity Investors Fund, Inc. including the portfolio of investments, as of October 31, 1995, and the related statements of operations and changes in net assets, and financial highlights for the period from August 1, 1995 (commencement of operations) to October 31, 1995. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights 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 and financial highlights 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 October 31, 1995 by correspondence with the custodian and others. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of UST Private Equity Investors Fund, Inc. at October 31, 1995, the results of its operations, the changes in its net assets, and the financial highlights for the period from August 1, 1995 to October 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP\nNew York, New York November 22, 1995\nItem 9.","section_9":"Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nSet forth below are names, ages, positions and certain other information concerning the current directors and executive officers of the Company as of October 31, 1995.\nServed in Present Name and Age Position Capacity Since - ------------ -------- -----------------\nDavid I. Fann [31] President; Chief September 16, 1994 Executive Officer\nDouglas A. Lindgren [33] Executive July 6, 1995 Vice President\nLisa A. Cummings [32] Treasurer; Treasurer Vice President since September 16, 1994; Vice President since July 6, 1995\nRonald A. Schwartz [47] Secretary September 16, 1994\nEdith A. Cassidy* [42] Director September 16, 1994\nGene M. Bernstein [48] Director December 1, 1994\nStephen V. Murphy [50] Director December 1, 1994\n*Indicates director who is an \"interested person\" of the Company within the meaning of the Investment Company Act of 1940.\nAdditional information concerning the directors and executive officers of the Company is incorporated herein by reference from the section entitled \"Management -- Directors, Officers and Investment Professionals\" in the Prospectus as modified by the Supplement dated August 28, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation.\nAt October 31, 1995, the Company had no full-time employees. Pursuant to the Management Agreement, the Managing Investment Adviser employs and compensates all of the personnel of the Company, and also furnishes all office facilities, equipment, management and other administrative services required for the operation of the Company. In consideration of the services rendered by the Managing Investment Adviser, the Company pays a management fee based upon a percentage of the net assets of the Company invested or committed to be invested in certain types of investments and an incentive fee based in part on a percentage of realized capital gains of the Company, For fiscal 1995, the Managing Investment Adviser reimbursed $140,226 to the Company, representing operating expenses (excluding its management fee of $36,125). Additional information with respect to the management fee payable to the Managing Investment Adviser is set forth in the \"Management\" section of the Prospectus, as modified by the supplement thereto dated October 31, 1995, which section is incorporated herein by reference.\nThe disinterested directors receive compensation of $9,000 on an annual basis and $1,500 for each Board of Directors' meeting attended plus reasonable expenses. For fiscal 1995, and for the period from September 16, 1994 (organization of the Company) to October 31, 1994, the disinterested directors of the Company each received compensation totaling $15,000.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nNot applicable. As of October 31, 1995, no person or group is known by the Company to be the beneficial owner of more than 5% of the aggregate number of Shares held by all shareholders. David I. Fann, Chief Executive Officer of the Company, owns 22 Shares. The directors and officers of the Company as a group own 251 Shares.\nThe Company is not aware of any arrangement 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 Company has engaged in no transactions with the executive officers or directors other than as described above, in the notes to the financial statements, or in the Prospectus.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1. Financial Statements\nPortfolio of Investments as of October 31, 1995\nStatement of Assets and Liabilities as of October 31, 1995\nStatement of Operations for the period ended October 31, 1995\nStatement of Changes in Net Assets for the period ended October 31, 1995\nFinancial Highlights -- Selected Per Share Data and Ratios\nNotes to Financial Statements\nIndependent Auditors' Report\n2. Exhibits\n(3)(a) Articles of Incorporation of the Company (1)\n(3)(b) Amended and Restated By-Laws of the Company (1)\n(10)(a) Management Agreement(1)\n(10)(b) Transfer Agency and Custody Agreement(1)\n(23) Consent of Independent Auditors\n(27) Financial Data Schedule\n(29) Prospectus of the Company dated December 16, 1994, filed with the Securities and Exchange Commission, as supplemented by supplements thereto dated August 28, 1995 and October 31, 1995(1)\n(b) No reports on Form 8-K have been filed during the last quarter of the period for which this report is filed.\n(1) Incorporated by reference to the Company's Form N-2, as amended, filed September 22, 1994.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nBy \/s\/ David I. Fann David I. Fann, President and Chief Executive Officer\nBy \/s\/ Lisa A. Cummings Lisa A. Cummings, Treasurer and Vice President\nBy \/s\/ Edith A. Cassidy Edith A. Cassidy, Director\nBy \/s\/ Gene M. Bernstein Gene M. Bernstein, Director\nBy \/s\/ Stephen V. Murphy Stephen V. Murphy, Director\nDate: January 29, 1996","section_15":""}
{"filename":"799898_1995.txt","cik":"799898","year":"1995","section_1":"ITEM 1. BUSINESS\nHistory and Organization\nThe Company was organized under the laws of the State of Delaware on August 1, 1986 under the name Michigan Ventures, Inc., and changed its name to AmeriMark Corp. in November, 1987 and changed its name to AmeriShop Corp. in July, 1992 after merging with its subsidiary AmeriShop, Inc. The Company was organized for the purpose of creating a corporate vehicle to seek, investigate and, if such investigation warranted, acquire an interest in business opportunities presented to it by persons or firms who or which desired to employ the Company's funds in their business or to seek the perceived advantages of a publicly-held corporation. On October 27, 1987, the Company acquired the businesses previously operated by Network Direct, Inc., a privately held Kansas corporation (\"NDI\") for 14,967,180 shares of the Company's Common Stock and America's Buyers, Inc., a privately held Michigan Corporation (\"ABI\") for 11,225,385 shares of the Company's Common Stock. The acquisitions were effected by the Company creating two new subsidiaries into which the acquired companies were merged. Effective April 1, 1991, the Company sold Network Direct, Inc. in exchange for 8,967,180 shares of the Company. On July 6, 1992, the Company effected a 1 for 10 reverse split of its outstanding capital stock resulting in total issued and outstanding Common Stock on that date of 2,393,827 shares. AmeriShop, Inc. was formed on February 8, 1988 as a subsidiary of the Company to pursue marketing of a mass market, low price, high volume telephone buying service membership. Effective January 1, 1990, AmeriShop, Inc. was merged into ABI and ABI simultaneously changed its name to AmeriShop Inc. (\"AmeriShop\").\nDescription of Business\nCompany Overview\nAmeriShop Corp. is a marketer of computerized merchandising systems providing an on-line data base of over 60,000 current brand name consumer products (with total access to approximately 250,000 products) representing over 550 manufacturers. The database is a proprietary software system designed, maintained and operated exclusively by the Company providing the user\/consumer the ability to price compare and purchase merchandise from the manufacturers or distributors which carry their products on the database. Access to the database is done via a toll-free telephone call to an AmeriShop personal shopping assistant. The uniqueness of the Company's computerized merchandising system gives the Company the ability to market its services to the premium incentive industry, to individual or group users, on an annual membership basis and through direct response catalogs such as airline in-flight catalogs, and credit card merchandise fliers. The principal client base for the Company's merchandising capabilities are virtually any corporation or organization interested in motivating or \"incentifying\" their employees, sales force, or customers to perform better or purchase more. The Company has entered into, and continues to add on a monthly basis, purchase agreements to provide its various merchandising services throughout the continental United States and Latin America. The premium incentive industry sells merchandise and travel services to client companies who in turn use them as awards for outstanding achievement or participation in or use of some other service or product. A typical incentive program has at its base a set of rules which outlines a specific goal, i.e., to increase sales. By properly structuring these rules, a company can motivate its work force to go above and beyond what they might normally do. In the case of salespeople, they will tend to sell more of a specific product, if by selling that product, they are offered an award. For incentive programs with many participants, the awards tend to be shown in a 4-color catalog consisting of approximately 1,000 items.\nAmeriShop is unique in that not only does it have a 4-color catalog with 1,000+ items, but it also offers companies participating in an incentive program the option to choose items from our database of 60,000 items. With the wide diversity of participants, especially in larger programs, Management believes offering them such a large choice gives AmeriShop a competitive edge in attracting new clients. AmeriShop provides a variety of functions in a typical Incentive Program. After the AmeriShop salesperson has \"sold\" the program, a \"kit\" of material is produced by AmeriShop. This kit consists of a 4-color catalog that contains a wide variety of items at various prices, an order form and program rules. The program rules outline what goals need to be met in order for the program participant to receive award points. As the participant receives award points throughout the program, progress statements are sent out indicating the cumulative total of the participants' awards points. Along with this \"statement,\" a company will typically take the opportunity to promote a new product in order to help \"stimulate\" sales. The accumulated award points are turned in at the end of the program for merchandise chosen out of the catalog or, at the participant's option, AmeriShop's database. This is done by the participant filling out the Award Order form provided in the program kit. The form is then sent to AmeriShop for processing. AmeriShop will verify that the participant truly has the stated amount of points needed for the merchandise selected. Internally at AmeriShop, the ordering processing center notifies the appropriate manufacturer of the selected merchandise, making the necessary order. The manufacturer will tell AmeriShop the approximate time to deliver and that information is passed along to the participant by AmeriShop in the form of an Order Verification letter. Once the merchandise has been shipped, AmeriShop invoices the client based on an agreed upon dollar value per award point redeemed. The manufacturer invoices AmeriShop at a previously agreed price which is lower than that charged to the client. The Company has approximately 50 corporate premium incentive clients as of August 31, 1995. The Company also utilizes its product database to market and fulfill consumer shopping club memberships. By subscribing to AmeriShop's services and paying the current fee, a person can call a toll-free number to obtain pricing information and\/or purchase\nmerchandise from the Company at prices not generally available to the public. Such sales are generally at a price slightly above that paid by the Company. The Company's shopping service business has been primarily a fulfillment of third party private label programs. AmeriShop receives varying service fees from the marketing companies depending upon how the shopping service is sold to the consumer. The shopping service is often combined with other services by the marketing company. As of August 31, 1995, the Company services about 14 private label programs in addition to its own programs with a total membership base of approximately 135,000 members. The products on the data base are maintained with a product description, customer price delivered and suggested retail price with corresponding award point equivalents for the premium incentive program. Additionally, the data base maintains a customer file which contains customer\/member I.D. number, purchase history and credit card number, if available. The Company is continually adding new products to its data base. The manufacturers\/vendors must agree to individually drop ship products. In some cases, the Company has a written contract for merchandise fulfillment from the manufacturer. However, in many circumstances, the relationship is an oral agreement based upon the manufacturer's agreed upon price and ability to drop ship. Once a merchandise order has been placed with the vendor, the Company's Customer Service Department sends the customer an order acknowledgement form notifying them that their order has been placed. All products are shipped directly to the member and come with full manufacturers' warranties. However, if there is a problem with goods arriving damaged, the Company's Customer Service Department will act on the consumer's behalf, contacting the manufacturer or shipper to determine responsibility for the damaged goods and rectifying the situation to the customer's satisfaction. The Company utilizes an IBM System 36 computer that can handle approximately five (5) times the number of transactions it is presently handling with additional memory and storage upgrades. Processing systems are continually upgraded internally to improve efficiency. The telephone system can handle over 2010 operators and associated toll-free telephone lines with 55 lines currently in operation.\nNDI\nAs noted above, NDI was sold effective April 1, 1991. NDI was originally incorporated in 1971 as Modern Guide to Buying. NDI markets telephone buying service memberships through a direct sales force selling individual memberships primarily on a one-on-one basis. NDI does not have the ability to service its own buying service memberships. Since July, 1987, NDI has had an exclusive contract with AmeriShop which was renewed on April 1, 1991 for a period of five years. The service contract gives NDI members access to the Company's database for price comparisons and product purchases. NDI is excluded from utilizing other shopping service companies, however, AmeriShop is not excluded from providing its services to other sales organizations. The service agreement was amended July 1, 1995 for three years. NDI paid the Company $175,000 to renegotiate the agreement early. The new agreement calls for a 15% reduction in service fees paid to the Company for the first 4,000 new members added each year and a 50% reduction in fees for new members in excess of 4,000 per year. The majority of permanent memberships were sold on an installment basis, through financing sources utilized by NDI, with an additional annual renewal fee. NDI normally collects a small down payment with the balance of this initial fee paid monthly. NDI was able to pledge these installment receivables and borrow up to 70% of the balances due from its financing sources.\nBacklog and Seasonality The Company typically realizes approximately 90% of its total membership sales during its last three fiscal quarters. As of June 30, 1995, unfilled merchandise orders in its backlog totaled $281,881. The Company also reflects revenue on certain membership agreements over the 12-month life of the membership. At June 30, 1995, the balance of deferred revenue which will be recognized into income during the year ending June 1996 was approximately $559,000 [see note 1 to financial statements included at Item 14].\nEmployees As of August 24, 1995, the Company had 18 full-time employees, of which 4 were engaged in management and administrative functions, 3 in sales, 9 in clerical functions and 2 phone operators. In addition, the Company has 2 part-time clerical workers and 6 part-time phone operators. At any given time, 3 to 6 phone operators are on duty. Competition The premium incentive industry is highly competitive with a few large companies (Maritz, Inc., Carlson Marketing Group, Inc., BI Performance Services, ITA Group) and thousands of medium to small companies. The Company believes that it can effectively compete in this industry because of its ability to charge a lower price than its large competitors and provide greater administration services than its smaller competitors. The marketing and operation of telephone buying services as offered by AmeriShop is highly competitive. No specific figures are available, but the Company estimates that it has approximately four direct competitors in that area. The Company is not aware of any other entity marketing individual permanent telephone buying service memberships as NDI does. In addition to directly competitive operations, however, the Company's competition could be considered to include mail order catalog discount operations, televised shopping services and catalog showrooms. Many of these competitors are larger and better financed than the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company leases approximately 9,200 square feet of office space in Grand Rapids, Michigan for a term expiring August 31, 2001. In addition, the Company leases computer and telephone equipment, subject to purchase options, and owns office equipment with a net combined book value of $25,873 as of June 30, 1995. The Company considers its leased and owned facilities and equipment to be modern and adequate for the conduct of its business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company is not presently involved in any litigation other than ordinary, routine litigation incidental to its 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 STOCK AND RELATED SHAREHOLDER MATTERS\nThe Company commenced its initial public offering on November 12, 1986 and sold 3,725,385 units which included one share of Common stock and warrants. The initial price to the public was $.10 per share. The stock is traded on a limited basis. The following table sets forth, for the periods indicated, the range of bid quotations as reported by National Quotation Bureau, Inc. while the stock was included in the \"pink sheets.\" These quotations may reflect inter-dealer prices without retail mark-up, mark-down or commission allowances and may not represent actual transactions.\nAs of June 30, 1995, the Company's Common Stock was held by approximately 182 holders of record.\nSubsequent to the initial public offering, additional shares were issued in private offerings and a reverse split of 10 to 1 was effected on July 6, 1992 resulting in 2,393,827 shares issued and outstanding.\nDIVIDEND POLICY The Company has no dividend paying history and does not expect to pay any dividends on its Common Stock for the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nStatement of Operations Data For the years ended June 30, 1995, 1994, 1993, 1992, and 1991\nBalance Sheet as of June 30\n* Includes revenues and income from sale of subsidiary of $1,840,081. ** Adjusted to reflect 1 for 10 reverse stock split on July 6, 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis analysis should be read in conjunction with the Consolidated Financial Statements and accompanying Notes thereto, contained herein.\nGeneral The Company was originally incorporated as Michigan Ventures, Inc., a Delaware corporation, on August 1, 1986. On October 27, 1987, the Company acquired the businesses of America's Buyers, Inc. (\"ABI\") and Network Direct, Inc. (\"NDI\"). On November 26, 1987 the name of the Company was officially changed to AmeriMark Corp. by majority vote of the shareholders. In July 1992, the Company changed its name to AmeriShop Corp.\nLiquidity and Capital Resources The Company has a working capital deficit of approximately $2.88 million at June 30, 1995. A major portion of this deficit relates to convertible debentures, short term notes payable and accrued interest totaling $1.97 million due to an investment fund partnership.\nManagement is currently working with the investment group to extend this debt and\/or covert it into equity. If the debt can be deferred or converted, the Company is left with a $900,000 working capital deficit as of June 30, 1995, of which $559,000 represents deferred membership and non-compete revenue. The deferred revenue will be liquidated through amortization into income over the next twelve months and therefore will not require the use of cash resources. The remaining working capital deficit of $341,000 should be covered through $175,000 received on the NDI contract re-negotiation and an additional $200,000 loan from the investment fund partnership of which $125,000 was received in August, 1995. The Company has an arrangement with an investment fund partnership, as noted above, which has provided $2.0 million in long-term debenture financing. These funds were received by the Company in various amounts from July, 1992 through August, 1993. The Company is in default of its loan covenants regarding current ratio and positive cash flow from operations. It is also in default of its monthly interest installments since May 1, 1994. The covenants and the default from nonpayment of interest have been waived through July 1, 1996. The debentures require principal redemption of $20,000 per month commencing on August 1, 1995 until maturity on July 1, 1999. The remaining principal balance plus any unpaid interest or other expenses are due and payable in one lump sum on July 1, 1999. Management anticipates that the Company must either obtain additional financing to meet these principal payment obligations or the debentures must be converted to equity in order to eliminate the obligations. The Company received approximately $300,000 in short-term loans during fiscal 1995. As of June 30, 1995, the balance of these loans totaled $1,428,445 and was due on July 1, 1995. The Company had a deficiency in stockholders equity of $4,835,325 as of June 30, 1995 and its continuation is dependent upon meeting its obligations as they become due and attaining profitable operations. Management believes that it can obtain profitable operations in the future through its merchandise premium incentive programs which it continues to actively market and through budget reductions established for 1996. The\nCompany has continued to increase its level of incentive merchandise sales as well as its overall gross profit on these sales as documented below in the discussion of Results of Operations. The Company has shown a cash shortfall from operations of approximately $570,000 for fiscal year 1995. Management believes that it will substantially improve these results and possibly reach breakeven in fiscal 1996 if anticipated sales are realized. Fiscal 1996 budgeted operating expenses have been reduced by approximately 20% from 1995 primarily through staff and management reductions. Fiscal 1995 premium incentive sales increased from 9% from 1994 to over $2.25 million. Management anticipates similar improvement in fiscal 1996 based upon programs currently in process and new programs that it believes can be obtained during the coming months. For the long term, the Company continues to add new premium incentive business which will improve its results from operations. However, the Company requires additional in-house sales representatives to generate substantial growth in this business. Management believes that adding up to six sales representatives disbursed over several regions within the United States would be sufficient to increase accelerated sales. There is a delay between hiring sales representatives and realizing the sales from their efforts. This is due to a period of time necessary to develop and sell programs (6 to 12 months), then once the program is sold, it takes 6 to 12 months, generally, for the participants to earn the awards before they are redeemed. It is Management's intent initially to hire experienced individuals already in the premium incentive industry in order to accelerate the sales effort. Because of this, it is anticipated that salary, benefits, travel and other expenses for these sales persons could be as high as $100,000 per year each. Since the sales generated by the new sales representatives will not be realized for 12 to 18 months, the Company will require additional equity financing to cover these expenses. Management continues to pursue this financing primarily through private placement funding. The Company currently has three sales persons in-house and about 30 independent agents. Management believes that it must increase its in-house sales force to provide it with more control over its sales efforts since independent agents utilize other suppliers in\naddition to AmeriShop. Also, sales costs, primarily commissions, are substantially lower with in-house agents providing the Company with higher gross profit margins. In its shopping service membership business, the Company has taken steps to create further growth through two recent contractual agreements. On July 1, 1995, the Company re-negotiated a new three year membership fulfillment agreement with Network Direct, Inc. (NDI). This extension solidifies the Company's long-standing relationship with NDI to continue membership fulfillment for their customers. Furthermore, the Company received a $175,000 up front, one-time cash fee from NDI. This fee was consideration for re-negotiating the new agreement 11 months prior to the expiration of the current term of the NDI\/AmeriShop agreement (April 1, 1996) with the new agreement extended to July 1, 1998. The new agreement calls for a 15% reduction in service fees paid to the Company for the first 4,000 new members added each year and a 50% reduction in fees for new members in excess of 4,000 per year. NDI had a strong membership year providing the Company $635,000 in membership fees in fiscal 1995. NDI's goals for fiscal 1996 are to exceed fiscal 1995's memberships which should also aid the Company's cash flow and profits. In addition to the three year NDI extension agreement, the Company also signed a new two year test marketing membership agreement with the Safecard (\"Safecard\") Services, Inc. division of Ideon Group, Inc. (NYSE:IQ) to market the Company's Shopping Service membership program. In aligning itself with Safecard, the Company affords itself the opportunity to be involved in an arrangement with the largest provider of credit card registration protection programs serving over 13 million credit card holders. The Company and Safecard will commence test marketing an annual Shopping Club membership service under a joint venture, profit sharing agreement in fiscal 1996. The Company will provide its 60,000 item consumer merchandise data base to create and fulfill the annual shopping service. Safecard will market the shopping service utilizing its extensive credit card relationships. The joint goal is to begin building a high volume, renewable shopping service membership base over the next 12 to 24 months. If successful, this will establish the foundation to substantially improve the Company's revenue growth and earnings.\nThe Company is at the stage where it needs to restructure its balance sheet, primarily converting into equity its long and short term debt with Renaissance Capital, the Company's investment fund partner. As discussed above, the Renaissance Capital financing is currently carried on the balance sheet as debt that is accruing interest month-to-month. The Company has taken budgetary cuts to attain profitability and positive cash flow in fiscal 1996 that would allow Renaissance Capital to convert its debentures into equity, thereby eliminating the Company's existing debt structure and interest payments. The subsequent improvement in the balance sheet will position the Company to actively pursue a new common stock issuance in either a public or private offering. Management believes it needs to obtain a minimum of $5,000,000 in net proceeds to adequately enhance its shareholder equity position, hire additional sales representatives and cover operating expense shortfalls until sales are sufficient to generate profits. In the short term, Management believes it can attain profitable results in the next 12 to 18 months. Management's goal over the next three years is to continue to shift the merchandise sales mix from the fiscal 1995 mix of 40% member and 60% incentive to 10% member and 90% incentive. Premium incentive sales for the fourth quarter of 1995 exceeded the same period in 1994 by $211,000 resulting in a higher accounts receivable balance at June 30, 1995 compared to June 30, 1994. There were no material write-offs of receivables against bad debts during fiscal 1995 or 1994. To increase sales substantially, the Company must continue to add salaried representatives to its sales force. To accomplish this, it is necessary for the Company to obtain additional equity financing.\nResults of Operations - Year Ended June 30, 1995 For the year ended June 30, 1995, the Company experienced a loss of $698,285 compared to a loss of $993,047 in the prior year; an improvement of $294,762 (30%). Loss from operations (exclusive of other income, interest income and interest expense) was $269,661 and $700,273 for 1995 and 1994, respectively; an improvement of $430,612 (61%). However, of the 1995 operating loss of $269,661, approximately $40,000 is attributable to organizational charges in personnel reductions taken in June 1995. The improved operating\nresults were primarily due to increased gross profit from merchandise, promotional programs and an increase in membership fee revenues. Membership fee revenues increased by 17% over the prior year due to increased volume from third party membership programs. The Company did not actively market any new retail shopping service members in 1995 and its existing base has been slowly declining over the last few years. The Company continues to service Network Direct, Inc. (NDI) members and gross new member and renewal receipts totaled approximately $635,000 in fiscal 1995 compared to $597,000 in fiscal 1994. NDI membership receipts represented 84% and 82% of total membership receipts for 1995 and 1994, respectively. Overall, merchandise sales decreased in total by 13% from the prior year to $3.9 million as a result of a $543,000 decrease in direct response merchandise sales, and a $218,000 decline in merchandise sales to shopping service members. However, merchandise incentives sales increased by 9% to $2.25 million in 1995 versus $2.07 million in 1994. The Company has been focusing its efforts on increasing its merchandise incentive sales which provide higher gross profit margins (20%-30% after commissions) than member merchandise sales (approximately 2%). Merchandise incentives sales represented 58% and 46% of total merchandise sales in 1995 and 1994, respectively. Promotional expense decreased by $54,000 from the prior year as a result of a reduction in catalog costs related to a bank card insert program which was discontinued in fiscal 1994. Selling, general and administrative expenses decreased by $295,000 (or 14%) over the prior year which resulted from budget cuts.\nResults of Operations - Year Ended June 30, 1994 For the year ended June 30, 1994, the Company experienced a loss of $993,047 compared to a loss of $1,069,087 in the prior year. Loss from operations (exclusive of other income, interest income and interest expense) was $700,273 and $915,747 for 1994 and 1993 respectively; an improvement of 24%. The improved operating results were primarily due to increased gross profit from merchandise and travel programs and a decrease in promotional expenses.\nMembership fees decreased by 7% from the prior year. The Company did not actively market any new retail shopping service members in 1994 and its existing base has been slowly declining over the last few years. The Company continues to service Network Direct, Inc. (NDI) members and gross new member and renewal receipts totaled approximately $597,000 in fiscal 1994 compared to $553,000 in fiscal 1993. NDI membership receipts represented 82% and 86% of total membership receipts for 1994 and 1993, respectively. Merchandise sales increased in total by 4% over the prior year to $4.5 million as a result of a $1,065,000 increase in merchandise incentive sales and a $900,000 decline in merchandise sales to shopping service members. The Company has been focusing its efforts on increasing its merchandise incentive sales which provide higher gross profit margins (20%-30% after commencement) than member merchandise sales (approximately 2%). Merchandise incentives sales represented 47% and 25% of total merchandise sales in 1994 and 1993 respectively. Promotional materials expense decreased by $200,000 from the prior year as a result of a reduction in catalog costs related to an airline in-flight catalog program which was discontinued in January, 1994. Selling, general and administrative expenses increased by $68,000 (or 3%) over the prior year which resulted from increased sales volume.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Registrant hereby incorporates the financial information required by this item by reference to Item 14 hereof.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None\nPART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS\nDirectors and Executive Officers The Directors and Executive Officers of the Company are as follows:\nName Age Position ---- --- -------- Joseph B. Preston 48 President, Chairman, Chief Executive Officer and Director\nSteven Salasky 33 Secretary\/Treasurer\nJames W. Kenney 54 Director\nJoseph B. Preston has served as a director of the Company and as its President and Chief Executive Officer since October 27, 1987. He has been Chairman of the Company since March, 1991. He served as President of ABI from May 1, 1986 to October 27, 1987. From December, 1984 to April 30, 1986, Mr. Preston was President of Preston Marketing Group, Inc., a consulting firm specializing in marketing and general management consulting. Prior to owning his own consulting firm, Mr. Preston was Vice President of Sales\/Marketing for Root-Lowell Manufacturing Corporation from October, 1983 to December, 1984. Mr. Preston was also with Amway Corporation from February, 1978 to October, 1983 as Senior Manager of International Marketing handling development of Amway's product lines for all its international markets. Mr. Preston served in the U.S. Navy as a Naval Flight Officer for five (5) years following completion of his M.B.A. in Marketing and B.S. degree in Packaging Engineering both from Michigan State University. Steven Salasky has served as Controller since August, 1994 and as Secretary\/Treasurer since July, 1995. He graduated from Michigan State University with a B.A. in Accounting. He gained his public accounting experience at Egly, Brink & Co.\nwhich is a regional public accounting firm located in Kalamazoo, Michigan, and was certified in 1989. Mr. Salasky joined AmeriShop in September 1989 as the Accounting Manager. James W. Kenney has been a Director since September, 1992. He is currently associated with San Jacinto Securities, Inc. as Executive Vice President and owner. From February, 1992 to June, 1993 he served as Vice President of Investments for Renaissance Capital Group, Inc. From October, 1989 to February, 1992 he served as Senior Vice President, Director of Trading and Syndicates for Capital Institutional Services. From February, 1987 to October, 1989, he served as Senior Vice President for retail sales for Rauscher Pierce Refsnes, Inc. Mr. Kenney received a B.A. degree in economics from the University of Colorado in Boulder, Colorado. Mr. Kenney also currently serves on the Board of Directors of the following companies: Consolidated Health Care Associates, Inc., CCC Coded Communications Corp., Industrial Holdings, Inc., Prism Group, Inc., Scientific Measurement Systems, Appoint Technologies, Tecnal Medical Products, Inc., and Tricom Corporation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table. The following table sets forth the cash compensation paid by the Company to each of its executive officers for services rendered during the fiscal year ended June 30, 1995, whose cash compensation for that period exceeded $100,000.\nIncentive Stock Option Plan. On October 1, 1992, the Company amended its Incentive Stock Option Plan (the \"Plan\") under which options granted are intended to qualify as \"incentive stock options\" under Section 422A of the Internal Revenue Code of 1986, as amended, (the \"Code\"). Pursuant to the Plan, options to purchase up to 600,000 shares of the Company's common stock may be granted to employees of the Company. The Plan is administered by the Board of Directors, which is empowered to determine the terms and conditions of each option, subject to the limitation that the exercise price cannot be less than the market value of the common stock on the date of the grant and no option can have a term in excess of ten (10) years. Options to purchase 492,800 shares are outstanding under this plan as of June 30, 1995. Options totalling 81,500, 29,800, 181,500 and 200,000 shares may be exercised at $.30, $.75, $1.00, and $1.10 per share respectively. No options have been exercised as of the date of this report.\nCompensation Committee Interlocks and Insider Participation. The Company's Board of Directors does not have a compensation committee nor any other committee performing such function. During the year, Mr. Preston participated in all Board of Directors' deliberations concerning executive compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of the date of this Form 10-K, the stock ownership of each person known by the Company to be the beneficial owner of five percent or more of the Company's Common Stock, all Directors individually and all Directors and Officers of the Company as a group. Each person has sole voting and investment power with respect to the shares shown. When calculating percentage ownership for each person, options held by that person are considered exercised but are not considered exercised when calculating percentage ownership for others.\n___________________________\n(1) Totals include shares which may be acquired through exercise of options granted as follows: Mr. Preston, 200,000 shares; Mr. Salasky, 17,000 shares; and Mr. Kenney, 15,000 shares.\n(2) For purposes of calculating the percentage of outstanding shares owned by each person and the indicated group, these shares are deemed to be outstanding.\n(3) Mr. Kenney has a 14-1\/2% interest in the general partner of Renaissance Capital Partners, II, Ltd., a limited partnership. This general partner has a 20% interest in the profits of that limited partnership above a formula return to the limited partners. The assets of the limited partnership include an option to purchase 3,551,830 shares of the Company's Common Stock (see footnote 5, below). This interest is, therefore, not determinable at this point and is not included with Mr. Kenney's beneficial ownership.\n(4) Includes 3,551,830 shares that this entity may acquire upon conversion of amounts loaned by it to Company.\n(5) Does not include 144,749 shares (2.3%) owned by Francis Hamlin, mother of W. Stephen Hamlin, beneficial ownership of which is disclaimed by W. Stephen Hamlin.\n(6) Mr. Preston's beneficial ownership includes 384,260 shares owned by W. Stephen Hamlin which he has full voting rights based upon a settlement and option agreement between the Company and Mr. Hamlin. Mr. Hamlin's beneficial ownership includes 275,000 shares which the Company has an option to purchase.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On April 1, 1991, the Company renewed its ongoing Shopping Service fulfillment agreement with Network Direct, Inc. (NDI). The agreement was renewed for a five year term. Under the agreement the Company received $635,350 from NDI during fiscal year 1995. Messrs. Stearns and Lyons are each a 50% owner, an officer and an employee of NDI. On July 1, 1995, the Company amended its service agreement with NDI through July 1, 1998. In exchange for $175,000 in cash, the Company renegotiated its existing agreement which was scheduled to run until April 1, 1996. Under the terms of the new agreement, the service fee paid by NDI for new memberships serviced by the Company were reduced by 15% for the first 4,000 members per year and by 50% for any new memberships added in excess of 4,000 per year. NDI has not submitted over 4,000 members in any single year in the 8-year relationship with the Company. The Company also extended its agreement not to compete against NDI for certain types of membership programs through July 1, 1998. On December 14, 1994, the Company entered into a settlement, release and option agreement with W. Stephen Hamlin whereby Mr. Hamlin granted options to purchase 275,000 shares of the Company's common stock for $2.00 per share in exchange for the Company's release of any and all rights or claims that it may have had against him arising from his resignation from the Company and subsequent employment in a related field. The options are exercisable in whole or in part for a three year period and, with respect to 137,500 shares, for an additional year. In addition to the options, Mr. Hamlin appointed the Company's President, Joseph B. Preston, with full power of substitution to vote all of the\nstock the Company held by Mr. Hamlin, currently 384,260 shares during the four year term of the option agreement. On July 10, 1992, the Company entered into a convertible debenture loan agreement with Renaissance Capital Partners Limited II (RCP) whereby RCP agreed to provide up to $1,500,000 of convertible debenture financing to the Company. The agreement provided for an initial loan of $750,000 which was closed on July 10, 1992 and three standby loan commitments of $250,000 each which were closed September 30, December 31, 1992 and March 31, 1993, respectively. On July 8, 1993, the convertible debenture loan agreement was modified to provide for up to $2,000,000 of financing. The additional debentures of $250,000 each were issued on July 8, 1993 and August 2, 1993. The terms of the seven year debentures require that the Company make interest only payments for the first three years and principal and interest for the remaining four years with a balloon payment due at maturity. RCP has the right at any time to convert any issued debenture into the Common Stock of the Company at $0.56309 per share. The debenture can be redeemed by the Company at any time after the third year at varying premium rates above par. The debentures are secured by all of the assets of the Company, including its software, data files, trademarks and trade names.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K - INDEX\n(a) The following documents are filed as part of this report:\nAMERISHOP CORP.\nFINANCIAL STATEMENTS FOR THE YEARS ENDED JUNE 30, 1995, 1994, AND 1993 AND INDEPENDENT AUDITORS' REPORT\nAMERISHOP CORP.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders AmeriShop Corp. Grand Rapids, Michigan\nWe have audited the accompanying balance sheets of AmeriShop Corp. as of June 30, 1995 and 1994, and the related statements of operations, changes in shareholders' equity (deficiency in assets) 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 AmeriShop Corp. 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.\nThe accompanying financial statements as of and for each of the three years in the period ended June 30, 1995, have been prepared assuming that the Company will continue as a going concern. As discussed in Note 11 to the financial statements, the Company's recurring losses from operations and shareholders' capital deficiency raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are described in Note 11. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP\nSeptember 6, 1995\nAMERISHOP CORP.\nBALANCE SHEETS JUNE 30, 1995 AND 1994\nSee notes to financial statements.\nAMERISHOP CORP.\nSTATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nSee notes to financial statements.\nAMERISHOP CORP.\nSTATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY IN ASSETS) YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nSee notes to financial statements.\nAMERISHOP CORP.\nSTATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1995, 1994 AND 1993\n(Continued)\nAMERISHOP CORP.\nSTATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nSee notes to financial statements. (Concluded)\nAMERISHOP CORP.\nNOTES TO FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION - Effective July 6, 1992, the Company's subsidiary, AmeriShop, Inc. was merged into AmeriMark Corp. which then changed its name to AmeriShop Corp. The Company operates a computerized merchandising system and services customers through discount shopping memberships, merchandise and travel incentive award programs, and direct response merchandise catalogs. Sales to one major customer for the years ended June 30, 1995, 1994 and 1993 accounted for approximately 25%, 18% and 12%, respectively, of the Company's total revenues.\nREVENUE RECOGNITION - Membership fees allow members to use services provided by the Company. These fees are generally assessed annually although some programs provide for multi-year fees. Fees are recorded as deferred revenue when received and recognized as income on the straight-line basis over the service period.\nMerchandise sales are recorded when the merchandise is shipped to the customer.\nTravel revenue is recognized after the travel event has been completed.\nCASH EQUIVALENTS - Cash and cash equivalents consist of cash and highly-liquid investments purchased with an original maturity of three months or less.\nACCOUNTS RECEIVABLE - Accounts receivable represent current amounts due from customers for merchandise, travel programs, catalogs and other printed materials, program administration fees and membership fees. The majority of receivables are from corporate customers. Bad debts are recognized as incurred. A reserve for uncollectible accounts has not been established since the Company's history of charge-offs has been negligible.\nEQUIPMENT AND DEPRECIATION - Equipment is stated at cost less accumulated depreciation. Improvements and betterments are capitalized; maintenance and repairs are charged to expense as incurred. Depreciation is provided by the use of the straight-line method over the estimated useful life of the related equipment which ranges from 3 to 8 years.\nLOSS PER SHARE - The loss per common share is based upon the weighted average number of shares outstanding of 2,516,327, 2,516,327 and 2,487,464 for the years ended June 30, 1995, 1994 and 1993, respectively. The weighted average number of shares outstanding is based upon the revised number of shares after the 1 for 10 reverse stock split which was effective July 6, 1992.\nTAXES ON INCOME - Taxes on income are provided based upon Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Prior to the year ended June 30, 1994, deferred taxes on income were recognized for the tax effects of items which enter in the determination of income for financial reporting purposes in different periods than for tax purposes.\n2. SALE OF SUBSIDIARY\nOn April 1, 1991, the Company sold a wholly-owned subsidiary, Network Direct, Inc. (NDI) to its two former owners in exchange for 8,967,180 shares of AmeriShop Corp. common stock.\nAt the time of the sale of the subsidiary, the Company owed NDI $550,000. Subsequent to the sale, the Company and NDI entered into an agreement whereby the $550,000 was transferred to a non-refundable membership advance. The membership advance is being amortized into income on a straight-line basis over the five year service agreement period. At June 30, 1995 and 1994, $110,000 and $220,000, respectively, is included in deferred membership revenue on the balance sheets.\nIn a related transaction, the Company entered into a five-year non-compete agreement with NDI which calls for the Company to receive $250,000 and the right to be the sole service fulfillment company for NDI in exchange for not competing in professional shopping network programs which sell memberships for a price in excess of $150. The $250,000 is being amortized into income on a straight-line basis over the five-year period of the agreement. At June 30, 1995 and 1994, $37,483 and $87,487, respectively, is included in deferred non-compete agreement on the balance sheets.\nThe Company also entered into option agreements with the two former owners to repurchase an additional 1,000,000 pre-reverse split shares of AmeriShop Corp. common stock from each individual. The agreements were amended in July 1992 to provide for a price of $.15 per share (pre-reverse split price). Effective July 11, 1995, the options expired unexercised.\nThe Company is related to NDI by common ownership. The Company receives enrollment and membership fees which are amortized into income over the period of service. The following is a summary of these transactions with NDI:\nOn July 1, 1995, the Company amended its service agreement with NDI through July 1, 1998. In exchange for $175,000 in cash, the Company modified its existing agreement which was scheduled to run until April 1, 1996. Under the terms of the revised agreement, the service fees paid by NDI for new memberships serviced by the Company were reduced by 15% for the first 4,000 memberships per year and by 50% for any new memberships in excess of 4,000 per year.\nIn accordance with this amendment, the Company also extended the term of the non-compete agreement with NDI for a three-year period expiring on July 1, 1998.\n3. INCOME TAXES\nFor tax purposes, the Company has net operating loss carryforwards of approximately $4,218,000 at June 30, 1995. The net operating loss carryforwards will expire as follows:\nThe provisions of SFAS 109, effective July 1, 1993, were adopted prospectively and accordingly, earnings for 1993 have not been restated. The cumulative effect of adopting SFAS No. 109 was not material.\nDeferred tax assets resulting from carryforwards are as follows at June 30, 1995:\n4. EQUIPMENT\nEquipment consists of the following:\n5. NOTE PAYABLE\nNote payable represents borrowings from an investment fund partnership. Effective September 30, 1994, the Company consolidated the four separate notes payable to the partnership with an aggregate principal balance of $1,235,000 plus accrued interest on the notes and the convertible debenture (see Note 6) into a single demand note requiring monthly interest payments of 12.5% per annum. The Company has defaulted on its monthly interest installments on the note.\n6. LONG-TERM DEBT\nLong-term debt consists of the following:\nThe convertible debenture loan requires the Company, among other things, to maintain a ratio of current assets to current liabilities of not less than 1.0 to 1.0 and to maintain a positive average monthly cash flow. The Company was in violation of these covenants at June 30, 1995. In addition, since May 1, 1994, the Company has failed to make certain scheduled interest and principal payments as they became due. The covenant violations and the default from nonpayment have been waived through July 1, 1996.\nThe investment fund partnership has the right at any time to convert any issued debenture into the common stock of the Company at $0.56309 per share. The debenture can be redeemed by the Company at any time after July 1995 at varying premium rates above par.\nThe Company is leasing its office space under a lease that requires reduced rentals in the early years of the agreement. The total amount due under the lease is being expensed ratably over the lease term. The resulting accrued rent will be repaid beginning September 1994 (see Note 7).\nThe following is a schedule of estimated maturities of long-term debt:\n7. LEASES\nThe Company leases a vehicle, office equipment, furniture and fixtures and data processing equipment under capital leases. The assets and liabilities under the capital leases are recorded at the lower of the present value of the minimum lease payments at the inception of the lease or the fair value of the assets. The assets are amortized over the shorter of their\nlease terms or their estimated useful lives. Amortization of assets under capital leases of $19,851, $32,499, and $50,435 is included in depreciation expense for 1995, 1994 and 1993, respectively.\nThe following is a summary of equipment held under capital leases:\nMinimum future lease payments under capital leases as of June 30, 1995 are as follows:\nEffective interest rates on capital leases range from 4.9% to 27.3%. The Company also leases office space and equipment under operating leases. Rent expense under these leases for the years ended June 30, 1995, 1994 and 1993 was $175,886, $185,223 and $195,938, respectively. The leases have expiration dates through 2001. Future minimum rental obligations at June 30, 1995 for all noncancellable operating leases are as follows:\n8. PREFERRED STOCK\nThe preferred stock may be issued by the Board of Directors in one or more series. The Board shall determine the distinguishing features of each, including preferences, rights and restrictions, upon the establishment of such series.\n9. STOCK OPTION PLAN\nOn October 1, 1992, the Company amended its Incentive Stock Option Plan (the \"Plan\") under which options granted are intended to qualify as \"incentive stock options\" under Section 422A of the Internal Revenue Code of 1986 as amended. Pursuant to the Plan, options to purchase up to 600,000 shares of the Company's common stock may be granted to employees of the Company. The Plan is administered by the Company's Board of Directors, which is empowered to determine the terms and conditions of each option, subject to the limitation that the exercise price cannot be less than the market value of the common stock on the date of the grant and no option can have a term in excess of 10 years.\nOptions to purchase 492,800 shares have been issued under the Plan as of June 30, 1995. Options totaling 81,500, 29,800, 181,500 and 200,000 shares may be exercised at $.30, $.75, $1.00 and $1.10 per share, respectively. No options have been exercised as of the date of this report.\n10. RELATED PARTY TRANSACTIONS\nOn June 18, 1992, the Board of Directors approved the sale of 1,500,000 pre-split shares of treasury stock to certain officers of the Company at a price of $.02 per share. On August 1, 1992, 97,500 post-split shares were purchased. An additional 25,000 post-split shares were paid as a finders fee related to the debenture financing. The remaining 127,500 post-split shares were cancelled and retired.\n11. MANAGEMENT'S PLANS REGARDING FUTURE OPERATIONS AND GOING CONCERN\nFor the year ended June 30, 1995, the Company experienced a loss of $698,285 compared to a loss of $993,047 in the prior year. Loss from operations (exclusive of other income, interest income and interest expense) was $269,661 and $700,273 for 1995 and 1994, respectively; an improvement of 61%. The improved operating results were primarily due to increased gross profit from merchandise and promotional programs and an increase in membership fee revenues.\nThe Company has a working capital deficit of approximately $2,871,000 at June 30, 1995. Included in this deficit is $559,193 of deferred membership and non-compete revenue. The deferred revenue will be liquidated through amortization into income over the next 12 months and therefore will not require the use of cash resources.\nThe Company has shown a cash shortfall from operations of approximately $572,000 for fiscal year 1995. In response to the continued losses from operations and negative cash flows, management has reduced fiscal year 1996 budgeted operating expenses by approximately 20% from 1995, primarily through staff reductions made in May 1995.\nTo address short-term liquidity needs, the Company modified its existing service agreement with NDI in exchange for $175,000 in cash (see Note 2). In addition, the Company received $125,000 from an investment fund partnership in August 1995 and anticipates the receipt of an additional $75,000 in September 1995 in return for the issuance of term notes payable due March 31, 1996.\nManagement anticipates continuing increases in its premium incentive merchandise sales along with improved gross profits. Management believes that these increases, combined with the expense reductions should provide for substantially improved operating results in the coming fiscal year.\nAt the present time, the Company's office space, telephone system and computer system capabilities are underutilized. Management anticipates that a substantial number of new members and merchandise incentive programs can be added without significant capital expenditures. By adding new memberships and merchandise incentive programs, management believes there will be an improvement in operating results by more fully utilizing the Company's facilities.\n12. RECLASSIFICATIONS\nCertain reclassifications have been made to the 1994 and 1993 financial statements to conform to the classifications used in 1995.\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.\nAMERISHOP CORP.\nBy: \/s\/ Joseph B. Preston -------------------------------------- Joseph B. Preston, Chairman, President and Chief Executive Officer\nBy: \/s\/ Steven Salasky -------------------------------------- Steven Salasky, Secretary, Treasurer and Principal Accounting Officer Dated: September 28, 1995 ---------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature and Title Date ------------------- ----\nBy: Joseph B. Preston September 28, 1995 -------------------------------------------- ------------------ Joseph B. Preston, Director\nBy: James W. Kenney September 28, 1995 -------------------------------------------- ------------------ James W. Kenney, Director\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO 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.","section_15":""}
{"filename":"702301_1995.txt","cik":"702301","year":"1995","section_1":"Item 1. Business.\nGeneral\nCornerstone Properties Inc. (formerly ARICO America Realestate Investment Company) (\"Cornerstone\" or the \"Company\") was incorporated under the laws of the State of Nevada in May, 1981. The Company's principal place of business is located at 126 East 56th Street, New York, New York 10022. The Company was organized initially to invest in and finance development of One Norwest Center, an office complex in downtown Denver, Colorado. See \"Properties - One Norwest Center\". In 1986, the Company invested in two additional office towers, one in Minneapolis, Minnesota and the other in Seattle, Washington. See \"Properties - Norwest Center\" and \"Properties - Washington Mutual Tower\". In 1995, the Company invested in an additional office tower in Boston, Massachusetts. See \"Properties - 125 Summer Street\".\nTax Status\nThe Company has elected to be taxed as a real estate investment trust (\"REIT\") under Sections 856-860 of the United States federal income tax laws, commencing in calendar year 1982. In order to qualify as a REIT, the Company must, among other things (i) distribute at least 95 percent of its annual taxable income, (ii) derive at least 75 percent of its annual gross income from passive real estate or real estate mortgage investments, (iii) derive an additional 20 percent of its income from passive real estate or mortgage investments plus dividends or interest from any source, or gain from the sale or other disposition of stocks and securities, (iv) derive less than 30 percent of gross income from the sale of stock and securities held less than six months, the sale of inventory-type property and the sale of real property held for less than four years, and (v) at least 75 percent of the value of the REIT's total assets must be represented by real estate assets, cash and government securities at the close of each quarter of its taxable year. Of the remaining 25 percent of total assets, not more than 5 percent of the value of the REIT's assets may consist of the securities of any one issue, and not more than 10 percent of the outstanding voting securities of any particular issue may be owned by the REIT. With certain limited exceptions, the Company is not subject to United States federal income taxes at the corporate level on the net income that is currently distributed to its shareholders. Each shareholder, however, is subject to United States federal taxation on that net income to the extent it is distributed to him.\nInvestment Policies of the Company\nThe following information concerning the investment policies of the Company represents the current policies of the Board of Directors of the Company. In general, the Company intends to structure its investments so as to maintain its treatment as a REIT under the United States federal income tax laws.\nInvestment Properties Prior to 1995, the Company's principal investments consisted of interests in three partnerships, each primarily owning a downtown office building. The\nbuildings are located in Denver, Colorado, Minneapolis, Minnesota and Seattle, Washington. See \"Properties.\" During 1995, the Company made an additional direct investment in one downtown office building located in Boston, Massachusetts. See \"Properties.\" Other investments, including debt or equity (or both) investments in other real estate properties may be made in the future if attractive opportunities arise. In such case, the Company would acquire or invest primarily in the ownership, development, and equity and\/or debt financing or refinancing of income-producing real estate properties (directly or through partnerships, joint ventures, or other entities) in the United States and Canada. In considering and selecting real estate investments, the executive officers and directors of the Company will consider such matters as the safety of principal, cash flow expectations, quality of tenancy, long-term appreciation potential, future financing and refinancing prospects, and the current value of the properties. The Company's objectives are to generate current cash flow and to provide capital appreciation.\nInterim Investment Funds that the Company may obtain from time to time, including taxable income earned and held prior to distribution to the shareholders, will be placed in investments, including but not limited to certificates of deposit, interest-bearing accounts, United States government obligations, money market funds and mortgages or investments secured by mortgages on real property.\nSales of Securities The Company may finance or refinance its investments by additional issues and sales of its debt or equity securities. The Company may also issue its securities in exchange for property or property interests. Such issues and sales may not be on the same terms as, or may have rights senior to those of the common stock of the Company. In addition, such issues and sales may have the result of diluting the relative interests of holders of common stock and may result in changes in distributable income per share of common stock.\nMortgage and Trust Deeds The Company may finance or refinance its investments through borrowings collateralized by first or subordinate mortgages or deeds of trust. The extent to which the Company's borrowing capabilities are utilized at any time will be determined by the executive officers and directors of the Company after considering such factors as the availability of suitable investments, the cost of borrowed funds, the tax effects of such borrowing and the Company's projected cash flow.\nSale of Investments Generally, the Company does not currently intend to sell its real estate investments and any such sales will likely be made, if at all, at least four years after acquisition of the investment. Managerial judgment, however, will be applied on a continuing basis, and, accordingly, specific investments may be disposed of, if and when, in the opinion of the Company and its shareholders, it is a prudent time to do so. When the Company sells an equity investment, it may take back from the buyer, as whole or partial payment for the investment, a purchase money obligation under which the buyer may not have personal liability. The Company may sell its debt investments as management deems appropriate. Sales of Company investments will be structured so as to maintain the Company's status as a REIT.\nInvestment in Real Estate Mortgages The Company may, from time to time, invest in real estate mortgages or securities collateralized by such mortgages. Such investments may be short-term or long-term investments collateralized by mortgages on income-producing\nproperties to be developed and will generally not be guaranteed by the United States Federal Housing Administration or the United States Veterans' Administration. The Company may also invest in long-term convertible mortgages that may be converted into equity interests in the mortgaged properties.\nSecurities of or Interests in Persons Primarily Engaged in Real Estate Activities The Company may invest in securities or interests in other persons primarily engaged in real estate activities, but only to the extent the Company is permitted by law to maintain its status as a REIT. Such securities or interests may include partnership or joint venture interests or direct interests in real estate. Generally, the Company will invest in or with the parties whose primary activities are the ownership, development, and\/or financing of income-producing real estate. The criteria by which investments in such securities and interests will be made will be the same as those for the Company's own real property investments.\nProperty Management\nIndependent contractors manage and operate the Company's properties and furnish or render services to the tenants of such properties. Certain adverse United States federal income tax consequences regarding the Company's qualification as a REIT could result if the Company or any joint venture or partnership of which the Company is a member earned fees from or performed services for tenants which are not considered ordinary and customary in the markets in which they are performed.\nHines Interests Limited Partnership (\"HILP\") acts as manager of One Norwest Center pursuant to a management agreement. The term of the management agreement is for ten years, expiring on December 31, 2005.\nHILP also manages Norwest Center pursuant to a management agreement. The initial term of this agreement expires December 31, 2001.\nWright Runstad Associates Limited Partnership (\"WRALP\") manages Washington Mutual Tower pursuant to a management agreement. The initial term of this agreement expires December 31, 1999.\nHILP also manages 125 Summer Street pursuant to a management agreement. The initial term of this agreement expires December 31, 1999.\nCompetition\nThere is significant competition in the Denver, Minneapolis, Seattle, and Boston office markets from a wide variety of institutions and other investors, who may have greater financial resources than the Company and\/or the partnerships that own the properties.\nThe Denver Class \"A\" office market has approximately 16,087,000 square feet of office space, of which approximately 2,300,000 square feet (approximately 14.3%) were vacant at December 31, 1995.\nThe amount of space in Class \"A\" properties in downtown Minneapolis was estimated to be approximately 12,677,000 square feet, of which approximately 574,000 square feet (approximately 4.5%) were vacant at December 31, 1995.\nThe amount of space in Class \"A\" properties in downtown Seattle was estimated to be approximately 13,803,851 square feet, of which approximately 1,091,807 square feet (approximately 7.9%) were vacant at December 31, 1995.\nThe amount of space in Class \"A\" properties in the Boston Financial District was estimated to be approximately 9,837,000 square feet, of which approximately 761,000 square feet (approximately 7.7%) were vacant at December 31, 1995.\nAs a result of the available space, projects under construction and announced projects, market rental rates may decline or tenant concessions may increase. There can be no assurance that these market conditions will not have an adverse affect upon future leasing activities of the Company's properties.\nEmployees\nThe Company currently has 16 employees, its principal executive offices are located at 126 East 56th Street, New York, New York 10022, and its phone number is 212-605-7100.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nONE NORWEST CENTER\nGeneral\nThe Company owns, through its wholly-owned subsidiary, ARICO-Denver, Inc., (\"ARICO-Denver\") a 90% general partnership interest in 1700 Lincoln Limited (\"Lincoln\"), which has a fee interest in One Norwest Center. Hines Colorado Limited (\"HCL\") holds a 9% managing general partnership interest and a 1% limited partnership interest in Lincoln. The Company is entitled to 100% of the cash flow (after payment of $1,620,000 per year to HCL) from Lincoln through 1998 and (after the Company receives a certain preference related to capital investments) 90% of such cash flow thereafter. The Company has the right, at its sole discretion, to elect to become the managing general partner of Lincoln.\nEffective January 1, 1996, Cornerstone, through its wholly-owned qualified REIT subsidiary 1700 Lincoln Inc., purchased HCL's General and Limited partnership interests in Lincoln. In exchange for its interests, HCL received a $12,925,976 convertible promissory note and 349,650 newly-issued shares of common stock of Cornerstone.\nThe Company also owns a $10,000,000 promissory note, which it purchased in 1988 at par. The promissory note is the non-recourse obligation of HCL and is for indebtedness incurred under the original ground lease for the land underlying One Norwest Center. The promissory note bears interest at the rate of 10.5116% per annum and is payable in monthly installments of principal and interest in the amount of $135,000 from February 1, 1989 to January 1, 1999. The outstanding principal amount of the note is approximately $4,153,000\nat December 31, 1995. HCL has pledged its priority distribution and 10 percent partnership interest under the amended partnership agreement from Lincoln to collateralize payment of this promissory note.\nLocation and Description\nOne Norwest Center is located near the center of Denver's central business district - the major business, financial, government and cultural center for the Rocky Mountain region. The central business district contains approximately 100 city blocks and covers just over one square mile. The compact central core area of offices, financial institutions, retail stores, and hotels is bordered by adjacent districts of public buildings. One Norwest Center is located at 17th Street and Lincoln Street on the east boundary of the financial district, which is an eleven block strip concentrated between 17th Street and 19th Street from Market Street to Lincoln Street. Historically, this financial district has been the major hub of Denver's financial institutions.\nCompleted in 1983, One Norwest Center is a 50-story, granite and glass office tower containing approximately 1,188,000 square feet of net rentable area and a 12-level, 1004-vehicle parking facility.\nLeases and Tenants\nNORWEST BANK DENVER NATIONAL ASSOCIATION LEASE. Lincoln entered into a lease agreement dated February 5, 1981, with the United Bank of Denver (the \"United Bank of Denver Lease\"). The United Bank of Denver Lease commenced on July 5, 1983 and expires July, 2013. During 1992, this lease was assumed by Norwest Bank Denver National Association as part of the acquisition of United Bank of Denver by Norwest Corporation. The net rental rate until July, 1998 is $14.89 per square foot. The net rental rate from July, 1998 through 2003 will be $16.00 per square foot. The net rental rate from July, 2003 through 2008 will be the sum of (i) $16.00 per square foot and (ii) 50% of the excess of the market rental rate for a single floor office tenant located between floors 1 and 20 in the building as of July, 2003 over $15.00 per square foot. The net rental rate from July, 2008 through July, 2013 will be the greater of (i) the rental rate in the prior five-year period or (ii) the rental rate for such five-year period plus 50% of the excess of the market net rental rate for a single floor office tenant located between floors 1 and 20 in the building as of July, 2008 over the rate for the prior five-year period minus $1.00 per square foot. Norwest Bank Denver National Association has three five-year renewal options beginning in July, 2013.\nIn addition, Norwest Bank Denver National Association pays variable rent to Lincoln, as lessor, equal to Norwest Bank Denver National Association's proportionate share of operating expenses incurred in connection with the operation of One Norwest Center. Basic and variable rent are payable monthly.\nPrincipal Tenants The following table lists tenants of One Norwest Center who leased approximately 5% or more of its net rentable area as of December 31, 1995:\nHistorical Occupancy Rates\nAs of December 31, for the noted years, the following percentage of the net rentable area in One Norwest Center was leased at the average effective annual rental per square foot:\nLease Expirations\nLong-Term Collateralized Debt\nOn February 17, 1987, Cornerstone, through its wholly-owned, consolidated subsidiary One United Realty Corporation (\"OURC\"), issued notes under a private placement offering and received $107,000,000 in proceeds, as follows:\nThe interest-bearing notes will mature on February 17, 1997, and bear interest from February 17, 1987, at 8.893 percent, payable semi-annually, commencing August 17, 1987.\nOn November 4, 1994, the Company entered into an amending agreement with the holders of the above mentioned notes in order to prepay the outstanding balance of the zero coupon notes. The total payment of approximately $18,529,000 was composed of approximately $17,948,000 of accreted principal on the notes and approximately $581,000 in prepayment penalties. The zero coupon notes had a yield to maturity of 9.141 percent, compounded semi-annually, and such yield was recognized as interest expense and accreted to the balance of the zero coupon notes.\nAll the notes are collateralized by a non-recourse mortgage on One Norwest Center and an assignment of all leases and rents, and certain other property, rights and interests related to One Norwest Center.\nIn order to facilitate the above mentioned prepayment of the zero coupon debt, the Company increased the principal on its term loan with Deutsche Bank New York Branch (\"DBNY\") and Deutsche Bank Cayman Island Branch (\"DBCI\") from $27,000,000 to $33,000,000. On August 8, 1995, the term loan in the amount of $32,500,000 was extended by Deutsche Bank AG London through December 31, 2003, at an interest rate of 5.00 percent. The term loan is collateralized by the Company's pledge of its partnership interest in 1700 Lincoln Limited and all of its stock in ARICO-Denver, Inc. The loan must be prepaid at par upon the sale of either Norwest Center or Washington Mutual Tower. The balance of the term loan at December 31, 1995 was $32,500,000.\nAdditionally, Cornerstone pays to DBNY, for an interest rate swap agreement used to fix the interest rates on the notes, an amount equal to 0.752 percent on a notional amount of $107,000,000 throughout the term of the notes. This amount has been treated as a yield adjustment on the long-term debt and has been included in interest expense. Payments on the swap are due January 30 and July 30 each year until the termination date of July 30, 1998.\nAs protection against market interest rates rising prior to the maturity of the above stated program, on September 29, 1993, the Company entered into an interest rate swap agreement with Deutsche Bank AG with an effective date of February 18, 1997. The interest rate swap agreement is for a fixed rate of 7.14 percent on a notional amount of $98,000,000 for a period of ten years. The swap agreement contains a mutual termination clause by\nwhich either party may terminate the swap on February 18, 1997 at its then current market value.\nReal Estate Taxes\nReal property tax expense for 1995 was approximately $1,846,000. The tenant leases for One Norwest Center generally contain provisions passing through to tenants the cost of real estate taxes, and therefore, such taxes should not have a material effect on net operating income from One Norwest Center (assuming that One Norwest Center is fully leased), although an assessment exceeding that of similar properties could affect occupancy or absorption.\nNORWEST CENTER\nGeneral\nThe Company owns, through its wholly-owned subsidiary, ARICO-Minneapolis, Inc. (\"ARICO-Minneapolis\") a 50% general partnership interest in NWC Limited Partnership (\"NWC\"), which was formed on August 5, 1986 for the purposes of (i) acquiring certain land in downtown Minneapolis, Minnesota and (ii) constructing and operating Norwest Center and related parking facilities and other improvements on such land. Sixth & Marquette Limited Partnership (\"S & M\"), holds a 49% managing general partnership interest and a 1% limited partnership interest in NWC. Effective December 31, 1993, the Company has the right, at its sole discretion, to elect to become the managing general partner of NWC.\nNWC's principal place of business is located at 5400 Norwest Center, 90 S. Seventh Street, Minneapolis, Minnesota 55402-3902. Norwest Center is a 55-story, granite and glass office tower containing approximately 1,118,000 square feet of net rentable area and a 340-vehicle underground parking facility.\nThe Partnership Agreement\nNWC is a Minnesota limited partnership formed for the purpose of acquiring, constructing and operating Norwest Center. The managing general partner has the right to manage and operate NWC's business. During construction and the Preference Period (defined below), the managing general partner and the Company each hold a 50% interest in NWC, and after the Preference Period the Company will hold a 60% interest (subject to increases in the Company's interest that may result from early termination of the Preference Period) and S & M a 40% interest.\nThe managing general partner of NWC is currently S & M, a Minnesota limited partnership formed on August 5, 1986. The limited partners of S & M are Norwest Center, Inc., a Minnesota corporation and affiliate of Norwest Corporation, and Faegre & Benson, a Minnesota partnership, as nominee for a Minnesota partnership comprised of persons who were partners in Faegre & Benson as of August 5, 1986. The general partner of S & M is itself a Minnesota limited partnership in which Gerald D. Hines, individually, and entities\naffiliated with Gerald D. Hines are directly or indirectly the sole general partners. Gerald D. Hines and related or affiliated persons or entities are herein collectively called \"Hines\".\nThe Company received distributions equal to 9.0% per annum of the Company's Capital Base until August 7, 1989, which was the end of the construction period. This 9.0% return paid to the Company during the construction period constituted a project cost.\nDuring the Preference Period (which commenced on August 8, 1989 at the end of the construction period and continues until certain cash flow levels have been achieved for two consecutive years), the Company is entitled to receive an annual Preference Return equal to 7.0% of its Capital Base (which is $92,300,000 as of December 31, 1995.) The Preference Return is cumulative, and if operating revenues (after payment of operating costs, capital expenditures and debt service) are not sufficient to fund the distribution of any Preference Return then due, the amount of such deficiency shall accumulate and shall bear interest at the rate of 7.0% per annum, compounded annually.\nSubject to the preferential distributions to the Company described above, all of NWC's operating revenues remaining after making payments required for the operations of NWC and Norwest Center and the payment of debt service will be distributed 50% to the Company and 50% to S & M during the Preference Period and 60% to the Company and 40% to S & M thereafter (or in such other percentages as may be equivalent to their respective post-Preference Period interests in NWC). Refinancing funds and sales proceeds relating to Norwest Center, if any, remaining after payment of indebtedness of NWC and distribution to the Company of any Cumulative Preference Deficits and the unpaid Preference Return shall be distributed (i) first to the Company in reduction of its Capital Base, (ii) then to the Company 1\/10 of the amount distributed in (i), (iii) then to the Company $1,000,000, (iv) then to S & M until S & M has received an amount (the \"Equalizing Payment\") equal to the sum of all distributions received by the Company in reduction of its Capital Base multiplied by a fraction based in general on the ratio of S & M's and the Company's respective post-Preference Period interest in NWC, and (v) finally to S & M and the Company pro rata in accordance with their then-applicable interests in NWC.\nLeases and Tenants\nNorwest Corporation Lease. NWC has leased to Norwest Corporation approximately 452,000 square feet of office space, which is approximately 40% of the net rentable area in the building. The initial term of the lease is for 30 years beginning in August 1988. Upon the expiration of the initial term, the tenant has seven successive ten-year renewal options, subject to the right of NWC, as landlord, to terminate the lease and demolish the building after forty years from the commencement date. Net rent was payable monthly to NWC at the annual rate of $18.25 per square foot of net rentable area for the first five-year period of the initial term, $20.00 per square foot of net rentable area for the second five-year period of the initial term, $23.00 per square foot of net rentable area for the third five-year period of the initial term, $27.00 per square foot of net rentable area for the fourth five-year period of the initial term, $32.00 per square foot of net rentable area for the fifth five-year period of the initial term, and $38.00 per square foot of net rentable area for the sixth five-year period of the initial term. Basic rent for each of the renewal option periods shall be at the then prevailing market rate. In addition, Norwest Corporation pays variable rent to NWC equal to the sum of Norwest Corporation's proportionate share of operating\nexpenses incurred in connection with the operation of Norwest Center, Norwest Corporation's proportionate share of all real property taxes, assessments and governmental charges, and any other taxes and assessments attributable to Norwest Center.\nFAEGRE & BENSON LEASE. NWC leased to the law firm of Faegre & Benson a total of approximately 197,000 square feet of office space, which is approximately 18% of the net rentable area in the building. The initial term of the lease is for 10 years beginning in September 1988. Upon the expiration of the initial term, the tenant has four successive five year extension options. Base rent which is payable monthly to NWC is $19.00 per square foot of net rentable area for the first five years of the initial term and an annual rate of $20.75 per square foot of net rentable area for the remaining five years of the initial term. Base rent during the extension option periods shall be at either 95%, 92-1\/2%, or 90% of the prevailing market rate, the percentage depending upon the number of full floors being leased by Faegre & Benson at the time of exercising the option. In addition, Faegre & Benson pays variable rent to NWC, as landlord, equal to the sum of Faegre & Benson's proportionate share of operating expenses incurred in connection with the operation of Norwest Center, and Faegre & Benson's proportionate share of all real property taxes, assessments and governmental charges, and any other taxes and assessments attributable to Norwest Center. By the terms of the Faegre & Benson lease, the individual partners of Faegre & Benson bear no personal liability for defaults of the Faegre & Benson partnership under the lease.\nPrincipal Tenants The following table lists those tenants of Norwest Center who leased approximately 5% or more of its net rentable area as of December 31, 1995:\nHistorical Occupancy Rates\nAs of December 31, for the noted years, the following percentage of the net rentable area in Norwest Center was leased at the average effective annual rental per square foot:\nLease Expirations\nLong-Term Collateralized Debt\nNWC has borrowed $110 million (\"NWC Project Loan\") from NWC Funding Corporation, a Delaware close corporation wholly-owned by the Company (\"NWC Funding\"), to pay certain project costs. The NWC Project Loan bears interest at a fixed rate of 8.74% per annum, payable monthly in arrears. The NWC Project Loan shall mature and be due and payable on December 31, 2005. The NWC Project Loan is collateralized by a first lien mortgage and security agreement covering Norwest Center and assignment of leases and certain other contract rights of NWC in Norwest Center.\nOn April 7, 1995, the Third Amended and Restated Promissory Note, dated as of August 5, 1986, made by NWC Limited Partnership payable to the order of NWC Funding Corporation in the original principal amount of $110,000,000 was sold to Norwest Corporation.\nReal Estate Taxes\nReal property tax expense for 1995 was approximately $8,177,000. The tenant leases for Norwest Center generally contain provisions passing through to tenants increases in the cost of real estate taxes, and therefore, increases in such taxes should not have a material effect on net operating income from Norwest Center (assuming that Norwest Center remains fully leased), although an assessment exceeding that of similar properties could affect occupancy or absorption.\nWASHINGTON MUTUAL TOWER\nGeneral\nThe Company owns, through its wholly-owned subsidiary ARICO-Seattle, Inc. (\"ARICO-Seattle\") a 50% general partnership interest in Third and University Limited Partnership (\"Third Partnership\"), which was formed for the purposes of (i) acquiring the\nblock (\"Block 5\") in downtown Seattle, Washington, bounded by Third Avenue, University Street, Second Avenue, and Seneca Street, (ii) constructing and operating Washington Mutual Tower and the related parking facilities and other improvements on Block 5, and (iii) obtaining certain rights and undertaking certain obligations with respect to existing improvements on the east half of the block (\"Galland and Seneca Buildings\" or \"Block 6\") in downtown Seattle, Washington, bounded by Second Avenue, University Street, First Avenue, and Seneca Street.\nWashington Mutual Tower is a 55-story, granite and glass office tower containing approximately 1,066,000 square feet of net rentable area. The building is primarily commercial office space but also provides underground parking for approximately 820 vehicles and has a retail shopping arcade around an outdoor plaza.\nThird Partnership is the successor in interest as lessee under a thirteen year lease, expiring in 2005, of the improvements on Block 6. The Block 6 improvements have been substantially renovated and were 97% leased at December 31, 1995. Third Partnership leases the improvements on Block 6 to protect the views of Puget Sound from Washington Mutual Tower located on Block 5. Block 6's location, immediately to the west of Block 5 between Puget Sound and Washington Mutual Tower, and the relatively low height of the improvements on Block 6 is perceived by the Company as a possible benefit to the marketing of commercial office space in Washington Mutual Tower. Third Partnership had provided $8,000,000 to an affiliate for construction of leasehold improvements in the form of a note receivable bearing interest at 11.5% collateralized by the leasehold improvements and assignments of rents. In 1992, due to the failure of the affiliate to meet scheduled payments, the carrying value of the note and interest receivable was decreased $600,000 to the estimated recoverable amount. On December 30, 1993 Third Partnership accepted a deed and assignment of leases and rents in lieu of foreclosure and assumed ownership of the Galland and Seneca Buildings. The difference between the recorded value of the note at the time of foreclosure and the estimated fair market value of the collateral and net assets assumed was recorded as a loss during 1993 in the amount of approximately $1,502,000. The Company intends to hold the Galland & Seneca Buildings as income-producing property.\nThe Partnership Agreement\nThird Partnership, a Washington limited partnership, was formed as of October 3, 1986 for the purpose of acquiring, developing, leasing and operating Washington Mutual Tower. The Company was admitted to, and the initial limited partner withdrew from, Third Partnership effective October 14, 1986. 1212 Second Avenue Limited Partnership, a Washington limited partnership (\"1212 Partnership\") was originally the only general partner and is now the managing general partner with the obligation to manage and operate Third Partnership's business. Perkins Building Partnership, a Washington general partnership comprised of partners in the Seattle law firm of Perkins Coie, a Washington general partnership, is the sole limited partner of 1212 Partnership. 1201 Third Avenue Limited Partnership, a Washington limited partnership (\"1201\"), is the sole general partner of 1212 Partnership. Wright Runstad Associates Limited Partnership (\"WRALP\") is the sole general partner of 1201, and Wright Runstad is the sole general partner of WRALP. The majority of\nthe limited partners of 1201 and WRALP are employees or other affiliates of Wright Runstad & Co.\nThe Partnership Agreement was amended and restated to reflect the additional $47 million equity contribution made by Cornerstone effective September 27, 1995. The Agreement had been previously amended effective December 31, 1992 to allow the Company the right, at its sole discretion, to elect to become the managing general partner of Third Partnership. The Company currently holds a 50% general partnership interest and 1212 Partnership currently holds a 49% managing general partnership interest and a 1% limited partnership interest.\nDuring the Preliminary Period (from commencement of construction until October 14, 1989), the Company received distributions equal to 9% per annum on the amount of the Company's Capital Base. Amounts distributed to the Company during the Preliminary Period constituted a project cost.\nThe Preference Period commenced on October 15, 1989 and is expected to continue for the foreseeable future. During the Preference Period, the Company is entitled to receive an annual Preference Return equal to 8% of its Capital Base. The Preference Return is cumulative, and if operating revenues (after payment of operating costs, capital expenditures and debt service) plus amounts 1212 Partnership is obligated to contribute in respect of the Preference Return, plus amounts funded by TULP Funding as Special Costs, are insufficient to fund the distribution of any Preference Return then due, the amount of such deficiency shall accumulate and shall bear interest at the rate of 8% per annum, compounded annually. As of December 31, 1995, the Company is due a cumulative preference deficit, including accrued interest, of $7,121,000 which will be reduced as cash flow becomes available. The Preference Period ends when certain performance levels have been achieved for two consecutive years.\nSubject to the preferences in favor of the Company described above, all of Third Partnership's operating revenues remaining, after making payments required for (i) the operations of Third Partnership and Washington Mutual Tower, (ii) net Block 6 costs, and (iii) the payment of debt service, will be distributed 50% to the Company and 50% to 1212 Partnership during the Preference Period and 60% to the Company and 40% to 1212 Partnership thereafter.\nLeases and Tenants\nPERKINS COIE LEASE. 1212 Partnership originally leased to Perkins Coie (\"Perkins Lease\") a total of 176,000 square feet of space, which is approximately 17% of the net rentable area in Washington Mutual Tower. The Perkins Lease was assigned by 1212 Partnership to Third Partnership on October 14, 1986. The Perkins Lease commenced in July 1988 with an initial term of 16 years, followed by five successive five-year renewal options. Perkins Coie has the right to terminate the Perkins Lease after ten years upon payment of a certain termination fee. Gross rent will be payable monthly to Third Partnership, as lessor, at the annual net rate of $26.25 per square foot of net rentable area for the initial term. In addition, Perkins Coie pays its proportionate share of the increases (over a specified base year amount) in real property taxes and the operating expenses incurred in connection with the operation of\nWashington Mutual Tower. By the terms of the Perkins Lease, individual partners of Perkins Coie are released from liability upon their withdrawal, retirement or expulsion from the Perkins Coie partnership.\nWASHINGTON MUTUAL SAVINGS BANK LEASE. Third Partnership originally leased to Washington Mutual Savings Bank (\"Washington Mutual\") approximately 138,000 square feet of space in Washington Mutual Tower, which is approximately 13% of the net rentable area of the building. The lease is for a primary term of 18 years, commencing December 1, 1988. There was no rent payable prior to April 30, 1989. Thereafter, gross rent was payable at the rate of $23.25 per square foot, per year for the first five years, $26.25 per square foot, per year for the second five years, and $28.25 per square foot, per year for the last eight years. On July 11, 1994, the lease was amended, thereby reducing the rent by $95,000 per month for the period August 1, 1994 through April 30, 2007. The lease to Washington Mutual provides for the tenant to pay variable rent for its share of increases in operating expenses above 1989 operating expenses and for its share of increases in property taxes above $1.50 per square foot per year. Washington Mutual has three renewal options of five years each, at a rental rate equal to 90% of the then fair market rate. If Washington Mutual renews, it must renew for at least 50% of its space. Washington Mutual has expansion options for approximately 143,000 square feet of space, to be made available in varying increments between December 1, 1990 and December 1, 2002. Base rent for expansion space is 90% of the then fair market rental rate.\nPrincipal Tenants The following table lists those tenants of Washington Mutual Tower who leased approximately 5% or more of its net rentable area as of December 31, 1995:\nHistorical Occupancy Rates\nAs of December 31, for the noted years, the following percentage of the net rentable area in Washington Mutual Tower was leased at the average effective annual rental per square foot:\nLease Expirations\nLong-Term Collateralized Debt\nOn September 28, 1995, Third Partnership, refinanced the credit facility provided by TULP Funding Corporation, a subsidiary of Cornerstone. The amount outstanding, $126,100,000, was refinanced with a $79,100,000 mortgage note to Teachers Insurance Annuity Association (\"Teachers\") and a $47,000,000 capital contribution from Cornerstone. The loan matures September 30, 2005 and bears interest at the rate of 7.53 percent with the outstanding principal due at maturity. The loan is collateralized by a first mortgage on Washington Mutual Tower and assignment of all leases and rents. The mortgage debt agreement stipulates that all prepayments of rent in excess of one month are to be held in escrow by Third Partnership until due as rental income.\nReal Estate Taxes\nReal property tax expense for 1995 was approximately $1,790,000. The tenant leases for Washington Mutual Tower generally contain provisions passing through to tenants increases in the cost of real estate taxes above their base year amounts, and therefore, increases in such taxes should not have a material effect on net operating income from Washington Mutual Tower (assuming that Washington Mutual Tower is fully leased), although an assessment exceeding that of similar properties could affect occupancy or absorption.\n125 SUMMER STREET\nGeneral\nThe Company acquired, through its wholly-owned subsidiary, CStone-Boston Inc., (\"CStone-Boston\") the fee interest in 125 Summer Street in Boston, Massachusetts on November 1, 1995.\nLocation and Description\n125 Summer Street is located on the edge of the financial district in the Central Business District of Boston, one block from Boston's busiest train station (South Station).\nCompleted in 1989, 125 Summer Street is a 22-story, granite and glass office tower containing approximately 464,000 square feet of net rentable area and a 292-vehicle underground parking facility.\nLeases and Tenants\nDELOITTE & TOUCHE LEASE. CStone-Boston leases office space at 125 Summer Street to Deloitte & Touche, as successor in interest to Touche Ross & Co., under the terms of a lease dated February 5, 1988. The Deloitte & Touche net rent payment is based on a total of approximately 106,000 square feet and is calculated as follows: (i) $37.50 per rentable square foot for tenant's area on the 5th floor; (ii) $32.00 per rentable square foot for tenant's area on the 17th floor; (iii) $55.80 per rentable square foot for tenant's area on floors 19 and 20; and (iv) $62.40 per rentable square foot for tenant's area on floors 21 and 22. Tenant is not obligated to pay the installments of rent applicable to the first two months for each of the remaining lease years with respect to the 93,485 square feet on floors 19 through 22. The Deloitte & Touche lease term expires on October 31, 1999. Deloitte & Touche pays its proportionate share of operating costs and taxes, respectively, in excess of $5.00 per rentable square foot for each item exclusive of the 17th floor. Deloitte pays its proportionate share of these variable costs for the 17th floor in excess of the following: (i) actual tax expense per rentable square foot for the fiscal tax year 1994; and (ii) actual operating expense per rentable square foot for the calendar year 1993. Deloitte and Touche has two (2) options to renew its lease for a period of five (5) years each.\nBOT FINANCIAL CORPORATION LEASE. CStone-Boston currently leases 68,182 square feet at a net rental rate of $37.50 per square foot to BOT Financial Corporation (the \"BOT Lease\"). The net rental rate remains fixed until the expiration of the original term on January 14, 1997. BOT Financial Corporation pays to CStone-Boston, as additional rent, its proportionate share of operating expenses and taxes, respectively, in excess of $5.00 per rentable square foot. BOT Financial Corporation has the option to renew the BOT Lease for a period of three years. Upon the terms of a separate lease agreement dated June 5, 1989, BOT Financial Corporation assumed additional premises comprising a total of 23,099 square feet (expanding its total premises to approximately 91,000 square feet on floors 2 through 5). The rental rate for the added area is $26.50 per square foot for the entire lease term. The additional area lease term is coterminous with the BOT Lease. As additional rent for the added area, BOT Financial Corporation pays its proportionate share of operating costs and taxes in excess of the building's actual operating expense and taxes per square foot.\nBURNS & LEVINSON LEASE. CStone-Boston leases 85,169 square feet of office space at 125 Summer Street to Burns & Levinson (\"B & L\") under the terms of a lease dated December 16, 1987. The net rental rate for the lease term, which expires on April 3, 2000, is $34.00 per rentable square foot. B & L is liable for its proportionate share of operating costs and\ntaxes in excess of the total sum of $10.00 per rentable square foot. Additionally, through calendar year 1997, B & L pays to CStone-Boston 33% of the amount by which its income from operations exceeds its adjusted base income (i.e. B & L's income from 1992 as adjusted to reflect any change in the number of partners), up to an aggregate of $2.5 million over the five years.\nPrincipal Tenants The following table lists those tenants of 125 Summer Street who leased approximately 5% or more of its net rentable area as of December 31, 1995:\nHistorical Occupancy Rates\nAs of December 31, for the noted years, the following percentage of the net rentable area in 125 Summer Street was leased at the average effective annual rental per square foot:\nLease Expirations\nLong-Term Collateralized Debt\nOn December 20, 1995, the Company, through its wholly-owned subsidiary CStone-Boston, executed a promissory note with Northwestern Mutual Life Insurance Company and received proceeds of $50,000,000. The loan is collateralized by 125 Summer Street and matures on January 1, 2003. The loan pays interest only at the rate of 7.20 percent until February 1, 2001 at which time interest and principal (calculated on a 25 year level amortization period) is payable.\nReal Estate Taxes\nReal property tax for 1995 was approximately $2,600,000 of which $483,000 was expensed by CStone-Boston. The tenant leases for 125 Summer Street generally contain provisions passing through to tenants increases in the cost of real estate taxes, and therefore, increases in such taxes should not have a material effect on net operating income from 125 Summer Street (assuming that 125 Summer Street is fully leased), although an assessment exceeding that of similar properties could affect occupancy or absorption.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nThere are no material legal proceedings involving 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 shares of common stock of the Company are traded on the Luxembourg, Frankfurt and Duesseldorf Stock Exchanges. Quotations of the common stock in Luxembourg are made in United States Dollars. Quotations in Duesseldorf and Frankfurt are made in Deutsche Marks. The high and low sales prices (in United States Dollars) on the Luxembourg Stock Exchange for each quarter of 1994 and 1995 were as follows:\nThe high and low sales prices (in Deutsche Marks) on the Frankfurt Stock Exchange for each quarter of 1994 and 1995 were as follows:\nThe high and low sales prices (in Deutsche Marks) on the Duesseldorf Stock Exchange for each quarter of 1994 and 1995 were as follows:\nThe closing quotation of the Company's common stock on March 18, 1996 was U.S. $14.00 on the Luxembourg Stock Exchange, DM20.80 on the Frankfurt Stock Exchange and DM 20.50 on the Duesseldorf Stock Exchange.\nTrading in the common stock of the Company has been conducted only outside the United States under laws that prevent disclosure of the number of beneficial owners of the common stock, most of whom hold their shares through banks or other fiduciaries. The company estimates, however, that the number of beneficial owners of its common stock as of March 18, 1996 exceeds 13,000.\nReturn of capital distributions of U.S. $0.57 per share was paid on August 31, 1993 and $0.58 per share was paid on January 31, 1994 for the year 1993; $0.58 per share was paid on August 31, 1994, $0.29 per share was paid on October 17, 1994 and $0.29 per share was paid on January 31, 1995 for the year 1994; $0.68 per share was paid on August 31, 1995 and $0.48 per share was paid on December 27, 1995 for the year 1995.\nThe Company intends to continue to declare semi-annual distributions on its shares. However, no assurance can be made as to the amounts of future distributions since such distributions are subject to the Company's funds from operations, earnings, financial condition, and such other factors as the Board of Directors deem relevant.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\nThe selected financial data has been derived from, and should be read in conjunction with, the related audited consolidated financial statements.\n(1) Effective December 31, 1993, the financial statements of NWC have been consolidated with the financial statements of the Company (See Note 1 of the Notes to Consolidated Financial Statements).\n(2) Effective December 31, 1992, the financial statements of Lincoln and Third Partnership have been consolidated with the financial statements of the Company (See Note 1 of the Notes to Consolidated Financial Statements).\nSee Item 7","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nCONSOLIDATION. Cornerstone's principal source of income is rental revenues received through its investment in three real estate partnerships and one fee simple investment held by four wholly-owned subsidiaries: 1700 Lincoln Limited owned by ARICO-Denver, Inc., NWC Limited Partnership owned by ARICO-Minneapolis, Inc., Third and University Limited Partnership owned by ARICO-Seattle, Inc. and 125 Summer Street owned by CStone-Boston, Inc., respectively. As of December 31, 1993, NWC Limited Partnership has been consolidated since Cornerstone has a majority interest in the economic benefits and has the right to become managing general partner at its sole discretion; the results of operations of NWC Limited Partnership are consolidated for 1994 and reflected on the equity method of accounting prior to January 1, 1994. Effective December 31, 1992, investments in 1700\nLincoln Limited and Third and University Limited Partnership have been accounted for using the consolidation method of accounting.\nNET EARNINGS AND LOSSES. On a consolidated basis, Cornerstone's share in net earnings and losses of its real estate investments increased to $12,400,000 in 1995 from $7,883,000 in 1994. Cornerstone's share in net earnings and losses decreased to $7,883,000 in 1994 from $9,806,000 in 1993. The increase in 1995 is primarily attributable to the debt refinancing at Third and University Limited Partnership resulting in lower debt service costs, the completion of garage repairs at One Norwest Center in 1994 and the earnings from 125 Summer Street acquired November 1, 1995. The decrease in 1994 was primarily attributable to the sale of the Atrium and garage repairs at One Norwest Center and the participation of our partner in the income of NWC Limited Partnership.\nPROPERTY RESULTS. For the year ended December 31, 1995, the increase in office and parking rentals from 1994 of $4,991,000 is due to the purchase of 125 Summer Street, higher expense recoveries due to higher real estate taxes, and increasing occupancy and rental rates. The $1,371,000 increase in real estate taxes is due to the purchase of 125 Summer Street and an approximately 12 percent increase in taxes at Norwest Center in Minneapolis. For the year ended December 31, 1994, the increases in office and parking rentals of $35,464,000, building operating expenses of $6,023,000, and real estate taxes of $7,185,000 were due to the consolidation of NWC Limited Partnership. Included in building operating expenses for 1993 is a loss of approximately $1,502,000 which was recorded when Third and University Limited Partnership accepted a deed and assignment of leases and rents in lieu of foreclosure resulting from an affiliate's failure to repay a loan to Third and University Limited Partnership, and assumed ownership in commercial property (the Galland and Seneca Buildings) that is adjacent to Washington Mutual Tower. The loss represents the difference between the recorded value of the loan at the time of foreclosure and the estimated fair market value of the collateral and net assets assumed.\nINTEREST AND OTHER INCOME. Interest and other income was $3,839,000 in 1995, $2,017,000 in 1994 and $11,548,000 in 1993. These amounts primarily consist of interest earned from short-term investments, notes receivable from partners, interest income on the mortgage note to NWC Limited Partnership in 1993 and income from the advisory contracts in 1995. Also included in interest and other income is interest earned on notes receivable from Hines Colorado Limited (HCL) in the amount of $501,000, $612,000 and $713,000 for 1995, 1994 and 1993, respectively. The 1995 increase in interest and other income of $1,822,000 from 1994 is due to the stock placement proceeds being held in short term investments from the date of placement (August 4) until the date of investment (November 1) when the Company purchased 125 Summer Street. The decrease in interest and other income for 1994 was due to the consolidation of NWC Limited Partnership.\nINTEREST EXPENSE. Interest expense incurred by Cornerstone relating to its financing activities was $29,467,000, $30,792,000, and $31,652,000 for 1995, 1994 and 1993, respectively. The decrease in 1995 is primarily due to the refinancing and partial prepayment of the Washington Mutual Tower debt and the interest rate reduction on the $32,500,000 term loan from approximately 9.66% to 5.00%. The decrease in 1994 primarily resulted from the prepayment of the zero coupon debt. The restructuring of certain debt agreements during the year resulted in a decrease in interest expense of NWC Funding Corporation and TULP Funding Corporation which amounted to $17,491,000 in 1994 and\n$18,172,000 in 1993. In addition to the interest expense for the two funding corporations, interest on the One United Realty Corporation (OURC) notes, including accrued interest on the zero coupon portion, amounted to $9,520,000, $11,411,000 and $10,942,000 in 1995, 1994 and 1993, respectively. The remaining amount of interest expense represents interest on Cornerstone's borrowings under its lines of credit.\nDEPRECIATION AND AMORTIZATION. Depreciation and amortization expense increased to $23,877,000 in 1995 from $23,432,000 in 1994 due to the purchase and depreciation of 125 Summer Street. The increase to $23,432,000 in 1994 from $17,454,000 in 1993 was due to the consolidation of NWC Limited Partnership.\nADMINISTRATIVE EXPENSES. The aggregate amount of Cornerstone administrative expenses has increased to $5,553,000 in 1995 from $3,869,000 in 1994 and $3,728,000 in 1993. The increase in 1995 of $1,684,000 was due to the change to self-administration on July 1; however, when considered with the advisory income from third party contracts of $813,000 and the savings of transaction fees relating to property acquisitions of approximately $1,360,000 which would have been due under the prior advisory contract, the net overall savings from the change to self-administration was approximately $489,000. The increase from 1993 to 1994 was primarily as a result of increased non-recurring legal and professional fees. The largest component of administrative expenses prior to 1995 was advisory fee expense which amounted to $2,100,000 in 1994 and $2,133,000 in 1993.\nUNREALIZED LOSS ON INTEREST RATE SWAP. The Company does not trade in derivative instruments, but uses interest rate swap agreements to hedge the interest rate risk on its financings with the intention of obtaining the lowest effective interest cost on its indebtedness. The unrealized loss of $7,672,000 represents the estimated amount, at December 31, 1995, that the Company would pay to terminate the $98,000,000 notional amount forward interest rate swap with a maturity date of February 17, 2007. The Company has not terminated this swap agreement and intends to structure its future financings in accordance with the policy stated above. The future unrealized mark to market adjustment on this swap agreement will fluctuate with market interest rates.\nLiquidity and Capital Resources\nCAPITAL STOCK TRANSACTIONS. On June 19, 1995, the Company increased the number of authorized shares from 40,000,000 shares of common stock, without par value, to 115,000,000 shares of capital stock, without par value, of which 15,000,000 shares are preferred stock and 100,000,000 shares are common stock.\nOn August 4, 1995, the Company received $90,447,500 gross proceeds from the placement of 6,325,000 new shares of common stock at a price of $14.30 per share with retail investors in Germany through underwriters led by Deutsche Bank. The net proceeds were used for the purchase of 125 Summer Street and the Tower 56 mortgage note.\nAlso on August 4, 1995, 3,030,303 preferred shares were issued to Deutsche Bank for gross proceeds of $50,000,000. The preferred shares are 7.0 percent cumulative and convertible into common stock at $16.50 per share any time after August 4, 2000. At December 31, 1995 there was approximately $1,449,000 or $0.48 per share in dividends in arrears on these preferred shares. The net proceeds from the preferred share issuance were used to retire existing indebtedness.\nOn December 27, 1995, through a dividend reinvestment plan available to all shareholders, Cornerstone received proceeds of approximately $2,840,000 and issued an additional 207,302 shares of common stock to shareholders.\nFUNDS FROM OPERATIONS. The Company calculates Funds from Operations (FFO) based upon guidance from the National Association of Real Estate Investment Trusts. FFO is defined as net income, excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated joint ventures. The Company has adjusted FFO by the unrealized loss on interest rate swap previously discussed due to the unrealized, non-cash nature of this charge. Due to the unique nature of Cornerstone's leases, a further adjustment to the standard definition of FFO is made to reduce FFO by the amount of free and deferred rental revenue which has been recognized in the financial statements. In the opinion of management, these amounts relate to benefits which will not be realized, in the form of increased cash flow, until future periods and would distort the FFO calculation.\nIndustry analysts generally consider FFO to be an appropriate measure of performance of an equity Real Estate Investment Trust (REIT) such as Cornerstone. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and, therefore, should not be considered a substitute for net income as a measure of performance or for cash flow from operations as a measure of liquidity calculated in accordance with generally accepted accounting principles.\nThe table below illustrates the adjustments which were made to the net loss of Cornerstone for the last three years in the calculation of FFO (in thousands):\nThe increase in FFO from 1994 to 1995 was primarily due to the completion in 1994 of the garage repair and increased rents from One Norwest Center, the purchase of 125 Summer Street, the repayment of the zero coupon debt in 1994, increased advisory income,\nand the reduction of the outstanding debt and the end of the priority distribution at Washington Mutual Tower.\nThe FFO for 1994 and 1993 represents an exceptional low and high, respectively. This was anticipated by management and arose from certain non-recurring events. The non-recurring events were the following: (i) the receipt of certain non-recurring income in 1993, (ii) the elimination of the Atrium rental payments in 1994 and (iii) the one-time expense for the repair of the Denver parking structure in 1994. The non-recurring income received in 1993 related to (i) the final guarantee period contribution in 1993 by Cornerstone's partner in Third and University Limited Partnership which was triggered upon successfully attaining 98 percent leasing levels at Washington Mutual Tower, and (ii) the reallocation of partnership income triggered at NWC Limited Partnership due to the achievement of increased property cash flow. The sale of the Atrium in September 1993 was consummated in order to reduce leverage. The elimination of income from the Atrium resulted in an offsetting elimination of interest expense as the zero coupon notes collateralized by One Norwest Center in Denver were retired. The one-time costs related to the repair of the Denver parking structure are consistent with first-class portfolio management. These one-time events had no impact on the underlying operations or tenancy of the Company's properties. After adjusting for these one-time events, FFO for 1994 is substantially consistent with the 1993 amount.\nMORTGAGE NOTE RECEIVABLE. On December 19, 1995, the Company purchased two mortgage notes collateralized by Tower 56 in New York City with a face value of $54,000,000 and accrued interest of approximately $11,000,000 for a purchase price of $30,150,000. The carrying amount of the mortgage note receivable at December 31, 1995 includes the purchase price, closing adjustments and related acquisition costs. The existing owner, Tower 56 Partners, has agreed to a \"pre-packaged\" bankruptcy plan through which it will transfer title of Tower 56 to Cornerstone during the second quarter of 1996. At the time of the transfer, Cornerstone will make a payment of $2,125,000 to two of the partners of Tower 56 Partners. Additionally, HRO International, an affiliate of Tower 56 Partners, will manage the building under a five year management agreement for a fee of 3 percent of gross revenues and will receive one-third of the cash flow above that which provides Cornerstone a 9 percent return on its Capital Base. HRO International will also receive one-third of the property sale proceeds above that which provides Cornerstone with a 12 percent cumulative internal rate of return.\nMORTGAGE INDEBTEDNESS. The Company, through OURC, had $98,000,000 in long-term debt outstanding at December 31, 1995. Interest only is due on these notes, which mature on February 17, 1997, at a rate of 8.893 percent. The notes are collateralized by a non-recourse mortgage on One Norwest Center and an assignment of all leases and rents, and certain other property, rights and interests related to One Norwest Center. The Company is currently in negotiations with prospective lenders regarding a refinancing of this indebtedness.\nAs protection against market interest rates rising prior to the maturity of the above stated notes, on September 29, 1993, Cornerstone entered into an interest rate swap with Deutsche Bank AG with an effective date of February 18, 1997. The interest rate swap is at a fixed rate of 7.14 percent per annum on a notional amount of $98,000,000 for a period of ten years. The swap contains a mutual termination clause by which either party may terminate the swap on February 18, 1997 at its then current market value.\nOn April 7, 1995, the Third Amended and Restated Promissory Note, dated as of August 5, 1986, made by NWC Limited Partnership payable to the order of NWC Funding Corporation in the original principal amount of $110,000,000 was sold to Norwest Corporation. The loan matures December 31, 2005 and bears interest at the rate of 8.74 percent. The loan is collateralized by a first mortgage on Norwest Center and assignment of all leases and rents.\nOn September 28, 1995, Third and University Limited Partnership, through Teachers Insurance and Annuity Association, refinanced $79,100,000 of outstanding debt collateralized by Washington Mutual Tower. The loan matures September 30, 2005 and bears interest at the rate of 7.53 percent with the principal due at maturity. The loan is collateralized by a first mortgage on Washington Mutual Tower and assignment of all leases and rents.\nOn December 20, 1995, the Company, through its wholly-owned subsidiary CStone-Boston, Inc., executed a promissory note with Northwestern Mutual Life Insurance Company and received proceeds of $50,000,000. The loan is collateralized by 125 Summer Street and matures on January 1, 2003. The loan pays interest only at the rate of 7.20 percent until February 1, 2001 at which time interest and principal (calculated on a 25 year level amortization period) is payable.\nOTHER INDEBTEDNESS. On August 8, 1995, the existing $32,500,000 term loan was extended through December 31, 2003 and assigned to Deutsche Bank AG London at an interest rate of 5.00 percent. The loan must be repaid at par upon the sale of either Norwest Center or Washington Mutual Tower. The term loan had a $32,500,000 balance at December 31, 1995.\nAt December 31, 1995, Cornerstone had a $12,000,000 revolving line of credit with DBNY. The line is available for general corporate purposes at a rate equivalent to LIBOR plus 0.625 percent or, at Cornerstone's option, the then prime interest rate. The line is also available for standby letters of credit at a rate of 0.375 percent and expires in June, 1996. At December 31, 1995, none of the credit line had been drawn upon.\nOTHER MATTERS. The Company is not aware of any environmental issues at any of its properties. The Company does not believe inflation will have a significant effect on its results. The Company believes it has sufficient insurance coverage at each of its properties.\nSHAREHOLDERS' DISTRIBUTIONS. Cornerstone intends to distribute at least 95 percent of its taxable income to maintain its qualification as a REIT. Currently, Cornerstone has no taxable income and anticipates that FFO will exceed taxable income for the foreseeable future. Cornerstone's distribution policy is to pay distributions based upon FFO, less prudent reserves. For 1995, Cornerstone paid distributions from its contributed capital to its shareholders of $0.68 per share on August 31, 1995 (to shareholders of record on July 31, 1995), and $0.48 per share on December 27, 1995 (to shareholders of record as of November 29, 1995).\nLIQUIDITY. At December 31, 1995, the Company had $7,740,000 in cash and cash equivalents and $4,393,000 in restricted cash. Restricted cash is being held by the trustee for\nthe OURC notes, representing credit support payments to be used for interest payments on the long-term debt. In addition, Cornerstone anticipates it will receive distributions from real estate partnerships and rents under tenant leases on a monthly basis which will be used to cover normal operating expenses and pay distributions to its shareholders. Based upon its cash reserves and other sources of funds, Cornerstone has sufficient liquidity to meet its cash requirements for the foreseeable future.\nIMPACT OF NEW ACCOUNTING STANDARDS. During 1995, the Financial Accounting Standards Board issued SFAS #121, \"Accounting for Impairment of Long Lived Assets and Long Lived Assets to be Disposed of\" and SFAS #123, \"Accounting for Stock Based Compensation.\" During 1995, Cornerstone adopted SFAS #121 and is currently assessing the impact of SFAS #123 which will be effective for fiscal years beginning on or after December 15, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nSee the Financial Statements included as a part hereof.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nThe information required to be included in Form 10-K in response to the following items is to be included in the Company's Proxy Statement for its Annual Meeting to be held on June 20, 1996, to be filed pursuant to Regulation 14A, and pursuant to applicable rules 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- ----------------------- * Filed herewith.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCORNERSTONE PROPERTIES INC. (Registrant)\n\/s\/ John S. Moody -------------------- John S. Moody, President & CEO DATED: 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\/ John S. Moody - ------------------------------------------------------------------ John S. Moody, President and Director (Principal Executive Officer)\n\/s\/ Thomas P. Loftus - ------------------------------------------------------------------ Thomas P. Loftus, Vice President and Controller (Principal Financial and Accounting Officer)\n*\/s\/ Dr. Rolf-E. Breuer - ------------------------------------------------------------------ Dr. Rolf-E. Breuer, Director and Chairman\n*\/s\/ Blake Eagle - ------------------------------------------------------------------ Blake Eagle, Director\n*\/s\/ Dr. Karl-Ludwig Hermann - ------------------------------------------------------------------ Dr. Karl-Ludwig Hermann, Director\n*\/s\/ Hans C. Mautner - ------------------------------------------------------------------ Hans C. Mautner, Director\n*\/s\/ Berthold T. Wetteskind - ------------------------------------------------------------------ Berthold T. Wetteskind, Director\n*By \/s\/John S. Moody - ------------------------------------------------------------------ John S. Moody, as Attorney-in-Fact for the persons indicated\nDATED: March 27, 1996\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994 AND FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Cornerstone Properties Inc.\nWe have audited the consolidated financial statements and financial statement schedules of Cornerstone Properties Inc. and Subsidiaries (the \"Company\") as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, listed in item 14(a)(i) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs disclosed in Note 1, prior to December 31, 1993, the Company used the equity method of accounting for its investment in NWC Limited Partnership. As of December 31, 1993, the Company began using the consolidation method of accounting since the Company has a majority interest in the economic benefits and acquired the right to become the managing general partner at its sole discretion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cornerstone Properties 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. 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, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, NY March 5, 1996\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (Dollar amounts in thousands) (Note 1)\nThe accompanying notes are an integral part of these consolidated financial statements\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Dollar amounts in thousands, except per share amounts) (Note 1)\nThe accompanying notes are an integral part of these consolidated financial statements\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Dollar amounts in thousands) (Notes 1 and 10)\nThe accompanying notes are an integral part of these consolidated financial statements\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Dollar amounts in thousands) (Notes 1 and 17)\nThe accompanying notes are an integral part of these consolidated financial statements\nCORNERSTONE PROPERTIES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993\n1. NATURE OF THE COMPANY'S BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF THE COMPANY'S BUSINESS Cornerstone Properties Inc. (formerly known as ARICO America Realestate Investment Company, prior to September 18, 1995), a Nevada corporation (Cornerstone or the Company), was formed on May 5, 1981, to invest in major commercial real estate projects in North America. At December 31, 1995, Cornerstone has, through its wholly-owned subsidiary ARICO-Denver, Inc. (ARICO-Denver), a 90 percent general partnership interest in 1700 Lincoln Limited (Lincoln) (Note 2), which operates One Norwest Center in Denver, Colorado and owned (until September 29, 1993 when it was sold) an approximately 48 percent undivided interest in the Atrium adjacent to One Norwest Center (the Atrium); through its wholly-owned subsidiary ARICO-Minneapolis, Inc. (ARICO-Minneapolis), a 50 percent general partnership interest in NWC Limited Partnership (NWC) (Note 3), which operates Norwest Center in Minneapolis, Minnesota; through its wholly-owned subsidiary ARICO-Seattle, Inc. (ARICO-Seattle), a 50 percent general partnership interest in Third and University Limited Partnership (Third Partnership) (Note 4), which operates Washington Mutual Tower in Seattle, Washington; through its wholly-owned subsidiary CStone-Boston, Inc. (CStone-Boston), 100 percent ownership of 125 Summer Street in Boston, Massachusetts (Note 5); and through its wholly-owned subsidiary CStone-New York, Inc., the first mortgage on Tower 56 in New York (Note 6). Certain wholly-owned subsidiaries, One United Realty Corporation (OURC), NWC Funding Corporation (NWC Funding) and TULP Funding Corporation (TULP Funding) were organized to provide financing for Cornerstone's investments in Lincoln, NWC and Third Partnership.\nPRINCIPLES OF CONSOLIDATION The accompanying financial statements include the accounts of Cornerstone, its wholly-owned qualified REIT subsidiaries and controlled partnerships. As of December 31, 1993, NWC has been consolidated since Cornerstone has a majority interest in the economic benefits and has the right to become managing general partner at its sole discretion; the results of operations of NWC are consolidated for 1994 and reflected on the equity method of accounting prior to January 1, 1994. Lincoln and Third Partnership balance sheet accounts were consolidated as of December 31, 1992; the results of operations of such partnerships have been consolidated since 1993. All significant intercompany balances and transactions have been eliminated in consolidation.\nINVESTMENT PROPERTY The costs of the buildings, garages and improvements are being depreciated on the straight-line method over their estimated useful lives, ranging from 20 years for electrical and mechanical installations to 40 years for structural components. Tenant improvements are being amortized over the terms of the related leases.\nThe balances of accumulated depreciation and amortization of $175,167,000 and $154,228,000 at December 31, 1995 and 1994, respectively, are the result of consolidating the following:\nLincoln's investment in Lincoln Atrium Limited (Note 2), which was sold on September 29, 1993, had been accounted for using the equity method of accounting.\nCornerstone and the real estate partnerships hold the real estate projects for long-term investment and such investments are carried at cost less accumulated depreciation. Management continuously monitors and considers the effect of local and regional economic conditions on the operations and realizable values of such projects. In the event management were to make a determination that the carrying value of the real estate projects had been impaired, the decline in value would be reported as a charge to earnings when such determination is made.\nDEFERRED LEASE COSTS As an inducement to execute a lease, incentives are sometimes offered which may include cash and\/or other allowances. These incentives and other lease costs, such as commissions, which are directly related to specific leases, are deferred and amortized over the terms of the related leases. Other marketing costs (which include sales facility costs, model office costs, building models, etc.) and other lease costs not related to specific leases, which were incurred during the buildings' development stage, were deferred and are being amortized over their expected benefit period of 10 years.\nOTHER DEFERRED COSTS Costs incurred in the underwriting and issuance of long-term debt, in arranging financing for Cornerstone's real estate partnerships and in investigating investments in real estate partnerships have been deferred. The costs incurred in connection with the long-term debt are being amortized over the term of the debt. The costs incurred in connection with the financing for the real estate partnership investments are being amortized over the respective financing periods. Deferred organization and start-up costs related to investments in real estate partnerships are being amortized over a period of 60 months, beginning with the formation of the partnerships.\nTENANT RECEIVABLES Rental revenue is recognized ratably as earned over the terms of the leases. Deferred tenant receivables result from rental revenues which have been earned but will be received in future periods as a result of rent concessions provided to tenants and scheduled future rent increases. These account balances are the result of consolidating the following balance sheet accounts:\nAn allowance for doubtful accounts of approximately $65,000 and $35,000, respectively, has been recorded at December 31, 1995 and 1994, relating to tenant and other receivables. Included in building operating expenses for the year ended December 31, 1993 is a provision for bad debts totaling approximately $604,000. Included in the provision is approximately $486,000 relating to deferred rent receivable from a tenant at Norwest Center. Bad debt write-offs totaled approximately $30,000 and $564,000 during 1995 and 1994, respectively.\nINTEREST RATE SWAP AGREEMENTS Cornerstone and\/or its subsidiaries are parties to several interest rate swap agreements used to hedge its interest rate exposure on floating rate debt (Notes 13 and 16). The differential to be paid or received is recognized in the period incurred and included net in interest expense. Cornerstone and\/or its subsidiaries may be exposed to loss in the event of non-performance by the other party to the interest rate swap agreements. However, Cornerstone does not anticipate non-performance by the counterparty.\nFEDERAL INCOME TAXES No provision for United States Federal income taxes has been made in the accompanying financial statements. Cornerstone has elected to be taxed as a real estate investment trust under Sections 856-860 of the United States Internal Revenue Code. Under these sections of the Internal Revenue Code, Cornerstone is permitted to deduct dividends paid to shareholders in computing its taxable income.\nAll taxable earnings and profits of Cornerstone since inception have been distributed to the shareholders. For each of the three years ended December 31, 1995, there were no earnings and profits.\nRECLASSIFICATIONS Certain 1994 amounts have been reclassified to conform to the 1995 financial statement presentation.\nLOSS PER SHARE Loss per share is computed based on the weighted average number of common shares outstanding of 15,909,805 for 1995 and 13,240,500 for 1994 and 1993. For 1995, the dividends in arrears applicable to the preferred stock have been deducted from the net loss in computing loss per share. (Note 10)\nCASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include investments with original maturities of three months or less from the date of purchase. At December 31, 1995 and 1994, Cornerstone had on deposit with Deutsche Bank AG New York Branch (DBNY) substantially all of its cash and cash equivalents. In addition, Lincoln, NWC, Third Partnership and CStone-Boston had on deposit with major financial institutions substantially all of their cash and cash equivalents. Cornerstone believes it mitigates its risk by investing in or through major financial institutions. Recoverability of investments is dependent upon the performance of the issuer.\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. The most significant estimates and assumptions are related to the unrealized loss on an interest rate swap agreement, recoverability and depreciable lives of investment property, the recoverability of deferred tenant receivables and contingencies. Actual results could differ from those estimates.\n2. 1700 LINCOLN LIMITED\nPARTNERSHIP MATTERS AND OPERATIONS: Cornerstone, through ARICO-Denver, holds a 90 percent general partnership interest in Lincoln while Hines Colorado Limited (HCL) holds a 9 percent managing general partnership interest and a 1 percent limited partnership interest. Lincoln was formed on February 5, 1981, and is the owner of the fee interest in the land located in Denver, Colorado, upon which it constructed One Norwest Center, a 50-story office tower with related improvements. One Norwest Center was designated as operational for financial reporting purposes as of January 1, 1984.\nFor the period commencing December 29, 1988 to September 29, 1993, Lincoln was the owner of a 48 percent undivided interest in a steel and glass structure and related lands commonly known as the Atrium, which is adjacent to One Norwest Center. This 48 percent undivided interest was effected through the ownership of a 99 percent interest in a partnership known as Lincoln Atrium Limited (LAL), which owned in total, a 48.4848 percent undivided interest in the Atrium. On September 29, 1993, LAL sold its undivided interest for approximately $14,394,000 which resulted in a loss of approximately $472,000. Lincoln received its 99 percent share of the proceeds or $14,250,000.\nAt December 31, 1995, approximately 1,168,000 square feet representing approximately 99 percent of the project's net rentable space (including garage retail) was committed under operating leases to tenants. Tenant leases expire in various years to 2003, except for leases for 47 percent of the building's net rentable space with Norwest Bank Denver National Association which expire during 2003 and 2013. The tenant leases provide for annual rentals, which generally include the tenants' proportionate shares of certain building operating expenses. Included in revenues for the year ended December 31, 1995 is approximately $2,844,000 and $11,155,000 from two major tenants who lease approximately 14 percent and 47 percent of the building, respectively.\nFixed minimum future rental receipts and square feet expiring in various years are as follows:\nNorwest Bank Denver National Association had leased LAL's entire interest in the Atrium under an operating lease for the period which began on January 1, 1989 and ended September 29, 1993. All operating expenses, including taxes, have been the responsibility of Norwest Bank Denver National Association.\nFINANCING: In 1987, Cornerstone, through OURC, placed a non-recourse mortgage on One Norwest Center to collateralize the refinancing of its equity interest in Lincoln through a loan with a face amount of $120,000,178. This loan consisted of current coupon notes in the amount of $98,000,000 and zero coupon notes with a face amount of $22,000,178. On November 4, 1994, Cornerstone, based upon an agreement with its lenders, prepaid the zero coupon notes and the mortgage lien related to such zero coupon notes was released (Note 8).\nRESTRUCTURING OF PARTNERSHIP: On December 30, 1988, Lincoln was restructured whereby Cornerstone purchased an additional partnership interest of 29 percent from HCL for $2,500,000 and acquired the tract of land upon which One Norwest Center was developed for $2,900,000 and an effective 48 percent interest in the Atrium for $17,100,000, both of which were simultaneously contributed to Lincoln. In conjunction with the partnership restructuring, Cornerstone is obligated to fund all capital investment costs (as defined), which include the cost of leasehold improvements, brokers fees, tenant inducements and other tenant leasing costs incurred by Lincoln until December 31, 1998. During 1995, 1994, and 1993, Cornerstone contributed approximately $176,000, $601,000, and $813,000, respectively, in leasing costs under this agreement.\nFor the period beginning with January 1, 1989, through December 31, 1998, Cornerstone receives 100 percent of all earnings and cash flow, after a preference payment of $1,620,000 per annum to HCL. Subsequent to December 31, 1998, such earnings and cash flow will be allocated 90 percent to Cornerstone and 10 percent to HCL. For the years ended December 31, 1995, 1994 and 1993, Cornerstone received distributions from Lincoln of approximately $12,715,000, $10,171,000 and $27,040,000, respectively. The 1993 distribution includes approximately $13,601,000 from the sale of the Atrium.\nRELATED PARTY TRANSACTIONS: Hines Interests Limited Partnership (HILP), an affiliate of HCL, manages the operations and maintenance of One Norwest Center pursuant to a management agreement entered into between HILP and Lincoln. As compensation for its services, HILP receives a monthly management fee equal to 3 percent of the gross rents billed to tenants during the month, plus 1.5 percent of the gross rents collected from the garage operations. Lincoln paid a management fee of approximately $609,000 in 1995, $578,000 in 1994, and $594,000 in 1993. The initial term of this management agreement expires December 31, 1998. In addition, HILP charged Lincoln for other services rendered in the amounts of approximately $1,152,000 for 1995, $1,070,000 for 1994 and $1,158,000 for 1993.\nCondensed income statements for Lincoln for the years ended December 31, 1995, 1994 and 1993, respectively, were as follows (in thousands):\nIncluded in revenues are tenants' proportionate shares of certain building operating expenses of approximately $6,644,000, $6,331,000 and $6,333,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n3. NWC LIMITED PARTNERSHIP\nPARTNERSHIP MATTERS AND OPERATIONS: NWC was formed effective August 5, 1986. Cornerstone, through ARICO-Minneapolis, holds a 50 percent general partnership interest and Sixth & Marquette Limited Partnership (S & M) holds a 49 percent managing general partnership interest and a 1 percent limited partnership interest. NWC is the owner of the fee interest in a tract of land and a 55-story office tower, garage and improvements located in Minneapolis, Minnesota, known as Norwest Center. Norwest Center was designated as operational for financial reporting purposes as of April 1, 1989.\nAt December 31, 1995, approximately 1,118,000 square feet representing approximately 100 percent of the project's net rentable space was committed under operating leases to tenants. Tenant leases expire in various years to 2009, except for a lease for 41 percent of the project's net rentable space with Norwest Corporation expiring in 2018.\nThe tenant leases provide for annual rentals, which generally include the tenants' proportionate share of certain building operating expenses. Included in operating revenue for the year ended December 31, 1995 is approximately $5,832,000 and $17,604,000 from two affiliates of S & M, who lease approximately 18 percent and 41 percent of the building, respectively.\nFixed minimum future rental receipts and square feet expiring in various years are as follows:\nPREFERENCE RETURN TO CORNERSTONE: Cornerstone is currently entitled to an annual preference return equal to 7 percent of its capital base ($92,300,000 at December 31, 1995), plus 50 percent of any remaining cash flow. The preference period ends when certain performance levels have been achieved for two consecutive years. At the end of the preference period, Cornerstone will become a 60 percent general partner and will be entitled to 60 percent of the cash flow of NWC after debt service. If operating revenues (as defined) of NWC are insufficient in any calendar month to distribute to Cornerstone an amount equal to the preference return accrued to Cornerstone on a year-to-date basis, the amount of the deficiency is accumulated and bears interest at the rate of 7 percent beginning on the first day of the next succeeding calendar month, such interest compounds each December 31. For the years ended December 31, 1995, 1994 and 1993, Cornerstone received distributions from NWC of approximately $8,811,000, $8,584,000 and $8,719,000, respectively. As of December 31, 1995, Cornerstone is not due any cumulative preference deficit.\nRELATED PARTY TRANSACTIONS: HILP, an affiliate of S & M, acts as manager of Norwest Center pursuant to a management agreement entered into between HILP and NWC, the form, terms and provisions of which shall be subject to the reasonable approval of Cornerstone. As compensation for its services, HILP receives a management fee equal to 3 percent of the Management Fee Base (as defined), except for the Management Fee Base derived from the Faegre & Benson lease and the Norwest Corporation lease for which it receives 2.5 percent. The total management fee paid to HILP under this agreement was approximately $905,000, $881,000 and $869,000 in 1995, 1994 and 1993, respectively. The initial term of this agreement expires December 31, 2001.\nIn addition, HILP charged NWC approximately $1,055,000 in 1995, $990,000 in 1994 and $1,027,000 in 1993, for other services rendered. Included in accounts payable, accrued expenses and other liabilities at December 31, 1995 and 1994, is approximately $5,000 and $500, respectively, related to these other services rendered.\nNWC incurred legal fees of approximately $19,000 in 1995, $20,000 in 1994 and $45,000 in 1993, to Faegre & Benson, an affiliate of S & M. NWC paid approximately $54,000 in 1995 and $14,000 in 1993 to HILP for tenant inducement costs for the building management office.\nIncluded in deferred tenant receivables and tenant and other receivables are amounts due from two affiliates of S & M of approximately $416,000 and $25,143,000 at December 31, 1995 and $601,000 and $22,324,000 at December 31, 1994, respectively.\nCondensed income statements of NWC for the years ended December 31, 1995, 1994 and 1993, respectively, were as follows (in thousands):\nIncluded in revenues are tenants' proportionate shares of certain building operating expenses of approximately $13,235,000, $12,821,000 and $13,664,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n4. THIRD AND UNIVERSITY LIMITED PARTNERSHIP\nPARTNERSHIP MATTERS AND OPERATIONS: Cornerstone, through ARICO-Seattle, holds a 50 percent general partnership interest in Third Partnership with 1212 Second Avenue Limited Partnership (1212 Partnership), the limited partner and the managing general partner. Third Partnership was formed in October 1986, and owns, leases and operates a 55-story office building and related improvements known as Washington Mutual Tower located in Seattle, Washington. Washington Mutual Tower was designated as operational for financial reporting purposes as of April 1, 1989.\nEffective December 30, 1993, Third Partnership accepted a deed and assignment of leases and rents in lieu of foreclosure resulting from an affiliate's failure to repay a loan to Third Partnership and assumed ownership in commercial property (the Galland and Seneca Buildings) that is adjacent to Washington Mutual Tower. Third Partnership also assumed the tenant lease arrangements for the Galland and Seneca Buildings. The Galland and Seneca Buildings have approximately 98,000 square feet of net rentable space, of which approximately 98 percent was committed under operating leases to tenants at December 31, 1995. The difference between the recorded value of the note at the time of foreclosure and the estimated fair market value of the collateral and net assets assumed has been recorded as a loss of approximately $1,502,000 which was included in the property's operating expenses for 1993. The estimated fair value of the buildings was based on projected cash flows using a discount rate of 12 percent.\nAt December 31, 1995, Washington Mutual Tower has approximately 1,066,000 square feet of rentable space, of which approximately 97 percent was committed under operating leases to tenants. The tenant leases provide for annual rentals, which generally include the tenants' proportionate share of certain building operating expenses. Base lease terms, excluding options to renew leases, range from 1 to 17 years.\nFixed minimum future rental receipts and square feet expiring for Washington Mutual Tower and the Galland and Seneca Buildings in various years are as follows:\nThird Partnership leases office space to two affiliates of 1212 Partnership. The total rental income received from the affiliates was $5,788,000, $6,085,000 and $5,888,000 in 1995, 1994 and 1993, respectively. Future rental receipts include approximately $38,307,000 from these two affiliates which aggregate approximately 18 percent of the net rentable space of the project. This balance is net of a prepayment by one of these affiliates of $2,500,000 for six months of rent.\nThird Partnership also leases office space to a tenant which occupies approximately 14 percent of the project's net rentable space. The total rental income received from this tenant was $2,806,000, $3,563,000 and $3,472,000 in 1995, 1994 and 1993, respectively. Future rental receipts include approximately $32,778,000 from this tenant. This balance is net of a prepayment by this tenant of $7,505,000 for approximately 13 years of rent for one of its leased spaces in Washington Mutual Tower.\nRESTRUCTURING OF THIRD PARTNERSHIP: On January 30, 1990, by agreement of its partners, Third Partnership was restructured, primarily as a result of cost overruns on Washington Mutual Tower project costs. In conjunction with the restructuring, Cornerstone (1) converted its 50 percent limited partnership interest to a general partnership interest, (2) agreed to increase the funding obligation of TULP Funding by up to $10,000,000 to fund certain costs, (3) obtained certain collateral from the managing general partner to collateralize its cost overrun contributions, and (4) increased the limit of commercial paper to be issued by TULP Funding to $130,000,000. The partners agreed that certain finance related cost overruns (special costs) would be shared partnership costs and funded through the increased TULP Funding financing arrangement.\nThe total project costs for Washington Mutual Tower were approximately $236,900,000, including cost overruns of $16,900,000. The cost overruns are being funded from the TULP Funding financing arrangement and from contributions by 1212 Partnership. As of December 31, 1995, 1212 Partnership had funded $10,800,000 of such overruns and $6,100,000 has been funded under the TULP Funding financing arrangement.\nPREFERENCE RETURN TO CORNERSTONE: During the construction period of the Washington Mutual Tower, which ended on October 14, 1989, Cornerstone was entitled to an annual preference return equal to 9 percent of its capital base. After completion, the annual preference return equals 8 percent of the capital base of $100,000,000, plus 50 percent of any remaining cash flow. The preference return is payable on a current basis until the earlier of (i) 5 years (April 27, 1995) after 1212 Partnership has made its first capital contribution or (ii) net rental offsets (as defined) is sufficient to meet debt service and current preference for 12 consecutive months. After either of these tests are met, until the end of the preference period, preference returns will accumulate and accrue interest at 8 percent to the extent not funded by cash flow after debt service. As of\nDecember 31, 1995, Cornerstone is due a cumulative preference deficit, including accrued interest, of approximately $7,121,000 which will be reduced as cash flow becomes available. The preference period ends when certain performance levels have been achieved for two consecutive years. At the end of the preference period, Cornerstone will become a 60 percent general partner and will be entitled to 60 percent of the cash flow of the partnership after debt service. For the years ended December 31, 1995, 1994 and 1993, Cornerstone received distributions from Third Partnership of approximately $8,606,000, $5,331,000, and $5,367,000, respectively.\nIn 1995, Cornerstone contributed an additional $47,000,000 to the Partnership as part of the debt refinancing (Note 8). According to the Third Amended and Restated Articles of Limited Partnership, Cornerstone, through ARICO-Seattle, receives a preferred return equal to 9.53 percent on the additional equity contribution through December 31, 2003. Thereafter the preference return will equal a rate to be determined. To the extent to which ARICO-Seattle does not receive a preferred return equal to the preferred return rate, the amount of the deficiency will accumulate and earn interest at 8.74 percent. As of December 31, 1995, there is no preferred return deficit on the additional equity contribution.\n1212 Partnership receives priority distributions which are payable only from the rentals received from a specified tenant and, accordingly, 1212 Partnership receives a special allocation of the related rental income. In August 1994, this tenant renegotiated its lease and prepaid rent through April 2007 in the amount of $7,505,000, which was distributed to 1212 as a priority distribution, as noted above. Also, 1212 Partnership is obligated to fund cash flow deficits of Third Partnership in an amount sufficient to ensure that Cornerstone receives its preferred return. To the extent 1212 Partnership funds such deficits, it receives a special allocation of interest expense.\nRELATED PARTY TRANSACTIONS: Third Partnership has entered into a management agreement with Wright Runstad Associates Limited Partnership (WRALP), an affiliated entity, to provide building leasing and management services. Third Partnership paid $1,901,000, $1,831,000 and $1,614,000 under this agreement during the years ended December 31, 1995, 1994 and 1993, respectively.\nThird Partnership has also entered into an agreement with WRALP to perform services related to the design, construction, development and leasing of the project. The development agreement provided for a fixed fee of $3,600,000, plus reimbursement of certain salaries and out-of-pocket expenses. The final payment of $600,000 was paid during 1993 upon achievement of certain project milestones as defined in the agreement.\nIncluded in tenant and other receivables are amounts due from two affiliates of 1212 Partnership totaling approximately $39,000 and $215,000 at December 31, 1995 and 1994, respectively. Included in accounts payable, accrued expenses and unearned revenue at December 31, 1995 and 1994 is approximately $2,761,000 and $3,511,000, respectively, of which $2,500,000 and $3,279,000 represents prepaid rentals received from an affiliate of 1212 Partnership for 1995 and 1994, respectively.\nCondensed statements of operations of Third Partnership for the years ended December 31, 1995, 1994 and 1993, respectively, were as follows (in thousands):\nIncluded in revenues are tenants' proportionate shares of certain building operating expenses of approximately $1,288,000 and $1,322,000 for the years ended December 31, 1995 and 1994, respectively.\n5. 125 SUMMER STREET\nOn November 1, 1995, Cornerstone, through CStone-Boston, purchased 125 Summer Street in Boston, Massachusetts for a purchase price of approximately $105 million of which $50 million was permanently financed through Northwestern Mutual Life Insurance Company (Note 8). 125 Summer Street is a twenty-two story, 93 percent leased Class A office building located in the Central Business District of Boston, containing approximately 450,000 square feet of office space, 13,000 square feet of first floor retail space, and five levels of underground parking for approximately 290 vehicles.\nFixed minimum future rental receipts and square feet expiring for 125 Summer Street in various years are as follows:\nPro forma Financial Information (Unaudited) The pro forma financial information shown below is based on the consolidated historical statements of Cornerstone after giving effect to the acquisition of 125 Summer Street as if such acquisition took place on January 1, 1994. The pro forma financial information is presented for informational purposes only and may not be indicative of results that would have actually occurred if the acquisition had been in effect at January 1, 1994. Also, they may not be indicative of the results that may be achieved in the future.\n6. MORTGAGE NOTE RECEIVABLE\nOn December 19, 1995, the Company purchased two mortgage notes collateralized by Tower 56 in New York City with a face value of $54,000,000 and accrued interest of approximately $11,000,000 for a purchase price of $30,150,000. The carrying amount of the mortgage note receivable at December 31, 1995 includes the purchase price, closing adjustments and related acquisition costs. The existing owner, Tower 56 Partners, has agreed to a \"pre-packaged\" bankruptcy plan through which it will transfer title of Tower 56 to Cornerstone during the second quarter of 1996. At the time of the transfer, Cornerstone will make a payment of $2,125,000 to two of the partners of Tower 56 Partners. Additionally, HRO International, an affiliate of Tower 56\nPartners, will manage the building under a five year management agreement for a fee of 3 percent of gross revenues and will receive one-third of the cash flow above that which provides Cornerstone a 9 percent return on its Capital Base. HRO International will also receive one-third of the property sale proceeds above that which provides Cornerstone with a 12 percent cumulative internal rate of return.\n7. NOTES RECEIVABLE\nDuring the December 30, 1988 restructuring of Lincoln, Cornerstone purchased $10,000,000 of ground rent notes from Lincoln Building Corporation, the prior ground lessor. These notes receivable, which bear interest at approximately 10.5 percent, are payable in 120 equal monthly installments of $135,000 through December 1998 by HCL. HCL has pledged its priority distribution and 10 percent partnership interest under the amended partnership agreement of Lincoln to collateralize payment of these promissory notes. The balances of the notes receivable at December 31, 1995 and 1994 were approximately $4,153,000 and $5,272,000, respectively.\nOn December 31, 1992, Cornerstone completed a loan agreement committing to loan WRALP $1,000,000 for a term of 10 years. The loan bears interest at 8 percent and is collateralized by first priority pledges of the interests of WRALP in 1201 Third Avenue Limited Partnership (a Washington limited partnership and the sole general partner of 1212 Partnership) and any other interests WRALP held which directly or indirectly related to Third Partnership. During 1993 and 1994 interest accreted on the funding at 8 percent, compounded monthly. During 1995, interest accreted on the funding until the principal balance became equal to $1,000,000, at which time, interest became payable monthly. During December, 1995, the loan was repaid in full by WRALP and associated liens were released. The balance of the loan receivable at December 31, 1994 was approximately $757,000.\n8. LONG-TERM DEBT\nINTEREST BEARING NOTES: On February 17, 1987, Cornerstone, through its wholly-owned subsidiary OURC, issued notes under a private placement offering and received $107,000,000 in proceeds, as follows:\nThe interest-bearing notes mature on February 17, 1997, and bear interest from February 17, 1987, at 8.893 percent, payable semi-annually.\nOn November 4, 1994, Cornerstone entered into an amending agreement with the holders of the above mentioned notes in order to prepay the outstanding balance of the zero coupon notes. The total payment of approximately $18,529,000 was composed of approximately $17,948,000 of accreted principal on the notes and approximately $581,000 in prepayment penalties, which was recorded as an extraordinary loss in the fourth quarter of 1994. The zero coupon notes had a yield to maturity of 9.141 percent, compounded semi-annually, and such yield was recognized as interest expense and accreted to the balance of the zero coupon notes.\nAll the notes are collateralized by a non-recourse mortgage on One Norwest Center and an assignment of all leases and rents, and certain other property, rights and interests related to One Norwest Center (Note 2). In addition, as of December 31, 1995, Cornerstone had $4,393,000, recorded as restricted cash, on deposit with the trustee to meet interest payments on the notes. As of December 31, 1994, Cornerstone had a $2,905,000 letter of credit and $1,453,000, which is included in restricted cash, on deposit with the trustee to meet interest payments on the notes.\nAdditionally, Cornerstone will pay to DBNY, for an interest rate swap agreement used to fix the interest rates on the notes, an amount equal to 0.752 percent on a notional amount of $107,000,000 throughout the term of the notes. This amount has been treated as a yield adjustment on the long-term debt and has been included in interest expense. Payments on the swap are due January 30 and July 30 each year until the termination date of July 30, 1998.\nAs protection against market interest rates rising prior to the maturity of the above stated notes, on September 29, 1993, Cornerstone entered into an interest rate swap agreement with Deutsche Bank AG with an effective starting date of February 18, 1997. The interest rate swap agreement is for a fixed rate of 7.14 percent on a notional amount of $98,000,000 for a period of ten years. The swap agreement contains a mutual termination clause by which either party may terminate the swap on February 18, 1997 at its then current market value.\nTERM LOAN: On August 8, 1995, the $32,500,000 term loan was assigned to Deutsche Bank AG London and extended through December 31, 2003, at an interest rate of 5.00 percent. Prior to August 8, 1995 the term loan was with DBNY and Deutsche Bank Cayman Islands Branch bearing interest at a rate of LIBOR plus 1.50 percent, a portion of which had been fixed at a rate of 9.66 percent through an interest rate swap agreement with DBNY. The term loan is collateralized by the Company's pledge of its partnership interest in Lincoln and all of its stock in ARICO-Denver. The loan must be prepaid at par upon the sale of either Norwest Center or Washington Mutual Tower. The balance of the term loan at December 31, 1995 and December 31, 1994 was $32,500,000.\nMORTGAGE LOANS: On April 7, 1995, the Third Amended and Restated Promissory Note, dated as of August 5, 1986, made by NWC Limited Partnership payable to the order of NWC Funding Corporation in the original principal amount of $110,000,000 was sold to Norwest Bank (Note 2). The proceeds from the sale were used to prepay the outstanding credit facility NWC Funding Corporation had with Deutsche Bank AG (Note 9). The loan matures December 31, 2005 and bears interest at the rate of 8.74 percent. The loan is collateralized by a first mortgage on Norwest Center and assignment of all leases and rents.\nOn September 28, 1995, Third Partnership, through Teacher's Insurance and Annuity Association, refinanced $79,100,000 of outstanding debt collateralized by Washington Mutual Tower. These proceeds, in addition to the preferred stock proceeds (Note 10), were used to prepay the outstanding credit facility TULP Funding Corporation had with Deutsche Bank AG (Note 9). The loan matures September 30, 2005 and bears interest at the rate of 7.53 percent with the outstanding principal due at maturity. The loan is collateralized by a first mortgage on Washington Mutual Tower and assignment of all leases and rents.\nThe acquisition of 125 Summer Street (Note 5) was permanently financed with a $50,000,000 mortgage loan from Northwestern Mutual Life Insurance Company. The loan bears interest at the rate of 7.20 percent and matures on January 1, 2003. Payment terms on the loan call for interest only payments for the first 5 years and a 25 year principal amortization thereafter. The loan is collateralized by a first mortgage on 125 Summer Street and assignment of all leases and rents.\n9. LINES OF CREDIT\nCORNERSTONE DBNY has provided Cornerstone with a $12,000,000 revolving credit line which is available for general corporate purposes at a rate equivalent to LIBOR, plus 0.625 percent, or, at Cornerstone's option, the then prime interest rate, as well as for the issuance of standby letters of credit at a rate of 0.375 percent. At December 31, 1995, none of the credit line had been drawn. The revolving credit line was renewed for a one year term on June 30, 1995.\nNWC FUNDING On April 7, 1995 NWC Funding's letter of credit agreement with Deutsche Bank AG was terminated and the lien on Norwest Center was released. The outstanding balance was paid in full from the sale of NWC's Promissory Note payable to the order of NWC Funding (Note 8). The unamortized deferred costs related to the formation of the letter of credit agreement were written-off and the associated interest rate swap agreement was terminated and included in the net $184,000 extraordinary loss. The interest rates charged on the loans were current commercial paper rates plus 0.125 percent, but through an interest rate swap agreement had been effectively set at 8.095 percent for 1995, 1994 and from July 9, 1993 to December 31, 1993. The effective rate for the period January 1, 1993 through July 8, 1993 was 8.11 percent. At December 31, 1994, loans in the amount of $109,956,000 were outstanding under the letter of credit agreement.\nTULP FUNDING On September 28, 1995 TULP Funding's letter of credit agreement with Deutsche Bank AG was terminated and the lien on Washington Mutual Tower was released. The outstanding balance was paid in full from the Third Partnership refinancing (Note 8) and preferred stock proceeds (Note 10). An extraordinary loss of approximately $4,261,000 was recorded on the transaction resulting from the write-off of the unamortized deferred costs related to the formation of the letter of credit agreement and the termination of the associated interest rate swap agreement. The interest rates charged on the loans were current commercial paper rates plus 0.125 percent, but through an interest rate swap agreement had been effectively set at 7.19 percent for 1995, 1994 and from August 19, 1993 to December 31, 1993. The effective interest rate for the period January 1, 1993 through August 18, 1993 was 7.05 percent. At December 31, 1994, loans in the amount of $126,511,000 were outstanding under the letter of credit agreement.\n10. CAPITAL STOCK\nOn June 19, 1995, the Company increased the number of authorized shares from 40,000,000 shares of common stock, without par value, to 115,000,000 shares of capital stock, without par value, of which 15,000,000 shares are preferred stock and 100,000,000 shares are common stock.\nOn August 4, 1995, the Company received $90,447,500 gross proceeds from the placement of 6,325,000 new shares of common stock at a price of $14.30 per share with retail investors in Germany through underwriters led by Deutsche Bank. The net proceeds were used for the purchase of 125 Summer Street and the Tower 56 mortgage note.\nOn August 4, 1995, 3,030,303 preferred shares were issued to Deutsche Bank for gross proceeds of $50,000,000. The preferred shares are 7.0 percent cumulative and convertible into common stock at $16.50 per share any time after August 4, 2000. At December 31, 1995 there was approximately $1,449,000 or $0.48 per share in dividends in arrears on these preferred shares. The net proceeds from the preferred share issuance were used to retire existing indebtedness.\nOn December 27, 1995, through a dividend reinvestment plan available to all shareholders, Cornerstone received proceeds of approximately $2,840,000 and issued an additional 207,302 shares of common stock to shareholders.\n11. ADVISORY AGREEMENT\nEffective July 1, 1995, Cornerstone became self managed and terminated its advisory agreement dated June 30, 1991 with Deutsche Bank Realty Advisors, Inc. (DBRA) under which DBRA acted as Cornerstone's investment advisor and provided assistance in various administrative functions. The original term of the agreement was for one year but was automatically renewed for additional one year terms. In return for its services, DBRA was entitled to a quarterly fee of up to 0.0875 percent of Cornerstone's total asset value (with real estate assets based on the most recent appraised values) as of the end of the respective quarter. DBRA was also entitled to an incentive fee based on annual distributions to shareholders greater than $1.15 per share. DBRA was entitled to a transaction fee equal to 1 percent of the total value of any investments, refinancings or sales. In addition, DBRA was entitled to receive reimbursement for out-of-pocket expenses in connection with providing these services. During 1995, 1994 and 1993, DBRA earned $1,050,000, $2,334,000 and $2,307,000, respectively, relating to this agreement. As of December 31, 1994, accounts payable, accrued expenses and other liabilities included approximately $609,000 relating to this agreement.\n12. LONG-TERM INCENTIVE COMPENSATION\nDuring 1995, the Board of Directors approved the issuance of stock options to certain officers, covering 1,000,000 shares of common stock. The purchase price of shares subject to each option granted equal their fair market value at the date of grant. The options have a ten-year term and are exercisable after one year from the date of grant, at the rate of 20% per year. At December 31, 1995, 137,500 shares were available for granting further options and options for 862,500 shares were outstanding at $14.30 per share, of which none were exercisable.\nDuring 1995, 186,713 restricted stock grants were awarded to officers. The grants vest over a five year period, 13.333% on June 30 of 1996, 1997, 1998, and 1999; with the balance of 46.668% vesting on June 30, 2000. Deferred compensation of $2,670,000, or $14.30 per grant share, is being amortized according to the respective amortization schedule for each vesting period noted above, with the unamortized balance shown as a deduction from shareholders' equity.\n13. UNREALIZED LOSS ON INTEREST RATE SWAP\nThe Company does not trade in derivative instruments but rather uses interest rate swap agreements to hedge the interest rate risk on its financings with the intention of obtaining the lowest effective interest cost on its indebtedness. The unrealized loss of $7,672,000 represents the estimated amount, at December 31, 1995, that the Company would pay to terminate the $98,000,000 notional amount forward interest rate swap with a maturity date of February 17, 2007. The Company has not terminated this swap agreement and intends to structure its future financings in accordance with the policy stated above. The future unrealized mark to market adjustment on this swap agreement will fluctuate with market interest rates.\n14. RELATED PARTY TRANSACTIONS\nInterest earned by Deutsche Bank as creditor to Cornerstone for the years ended December 31, 1995, 1994 and 1993 was approximately $11,816,000, $22,077,000 and $22,937,000, respectively. Deutsche Bank also earned approximately $4,522,000 in underwriting fees for the year ended December 31, 1995.\nFor the year ended December 31, 1995, an affiliate of Deutsche Bank earned $175,000 in marketing fees and approximately $452,000 in underwriting fees.\n15. RETIREMENT PLANS\nThe eligible employees of the Company participate in a noncontributory age-weighted profit sharing plan. The Company's contribution to such plan was approximately $76,000 for the year ending December 31, 1995.\nThe eligible employees of the Company also participate in a contributory savings plan (401K). Under the plan, the Company matches contributions made by eligible employees based on a percentage of the employee's salary. The Company will match 100 percent of contributions up to 5 percent of such employee's salary with an annual maximum matching contribution of $4,000 per employee. The Company's matching contribution was approximately $13,000 for the year ending December 31, 1995.\n16. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Financial Accounting Standards Board has issued Statement of Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments (SFAS 107) which became effective in 1992. Under SFAS 107, Cornerstone is required to disclose the fair value of financial instruments for which it is practicable to estimate that value.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments at December 31, 1995:\nMORTGAGE NOTE RECEIVABLE The carrying amount of the mortgage note receivable at December 31, 1995 approximates its fair market value at December 31, 1995.\nNOTES RECEIVABLE The fair value of the note receivable at December 31, 1995 from HCL is approximately $4,394,000 based on the present value of expected future note payments using a market discount rate of 6.67 percent (Note 7). The fair value of the note receivable at December 31, 1994 from HCL was approximately $5,402,000 based on the present value of expected future note payments using a market discount rate of 9.22 percent (Note 7).\nLONG-TERM DEBT (NOTE 8) The fair value of Cornerstone's long-term debt at December 31, 1994 was not significantly different than the carrying amount at December 31, 1994 since the interest rates on the existing debt represented rates that management believed were currently offered for long-term financing. The fair value of the $32,500,000 term loan at December 31, 1994 approximated its carrying value at December 31, 1994 as the interest rate on the loan adjusted with changes in the market. The fair values of the following debt instruments for December 31, 1995 were calculated based on the present value of expected future cash payments and market discount rates:\nBORROWINGS UNDER LINES OF CREDIT The carrying amount of the borrowings under lines of credit at December 31, 1994 approximated market at December 31, 1994 as the interest rate on the lines adjusted with changes in the market.\nUNRECOGNIZED FINANCIAL INSTRUMENTS The fair value of interest rate swaps, used for hedging purposes, is the estimated amount that the Company would (pay) or receive to terminate the swap agreements at December 31, 1995 and 1994 taking into account current interest rates and the creditworthiness of the counterparty. The following fair values have been obtained from the swap dealer as of December 31, 1995 and 1994 (Note 1):\nAll of the above swaps are considered to be operating hedges for federal income tax purposes.\n17. SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid for interest was approximately $32,609,000, $32,075,000 and $30,363,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNON-CASH INVESTING AND FINANCING ACTIVITIES: Effective December 30, 1993, Third Partnership accepted a deed and assignment of leases and rents in lieu of foreclosure on a loan due from an affiliate, and assumed ownership in commercial property adjacent to Washington Mutual Tower. The estimated fair market value of the collateral and net assets assumed was deemed to be approximately $5,800,000.\n18. SUBSEQUENT EVENTS\nEffective January 1, 1996, Cornerstone, through its wholly-owned qualified REIT subsidiary 1700 Lincoln Inc., purchased HCL's General and Limited partnership interests in Lincoln. In exchange for its interests, HCL received a $12,925,976 convertible promissory note and 349,650 newly-issued shares of common stock of the Company. Additionally, the management agreement between Lincoln and HILP was extended through December 31, 2005.\n19. IMPACT OF NEW ACCOUNTING STANDARDS\nDuring 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\" (\"SFAS #121\"). Cornerstone's policy is to assess any impairment in value by making a comparison of the current and projected cash flows of the property over its remaining useful life, on an undiscounted basis, to the carrying amount of the property. Such carrying amounts would be adjusted, if necessary, to reflect the fair value of the assets in accordance with the provisions of SFAS #121.\nDuring 1995, the Financial Accounting Standards Board issued SFAS #123, \"Accounting for Stock-Based Compensation.\" Cornerstone is currently assessing the impact of this statement which will be effective for fiscal years beginning on or after December 15, 1995.\nCORNERSTONE PROPERTIES INC. REAL ESTATE AND ACCUMULATED DEPRECIATION SCHEDULE III December 31, 1995\nCORNERSTONE PROPERTIES INC. REAL ESTATE AND ACCUMULATED DEPRECIATION SCHEDULE III December 31, 1995 (continued)\nReconciliation of \"Real Estate and Accumulated Depreciation\"\n(1) Deed in lieu of foreclosure on a loan receivable from an affiliate of Third and University Limited Partnership.\nCORNERSTONE PROPERTIES INC. MORTGAGE LOANS ON REAL ESTATE SCHEDULE IV December 31, 1995\nEXHIBIT INDEX\n- ----------------------- * Filed herewith.","section_15":""}
{"filename":"837893_1995.txt","cik":"837893","year":"1995","section_1":"ITEM 1. Business\nParker & Parsley Producing Properties 88-A, L.P. (the \"Registrant\") is a limited partnership organized in 1988 under the laws of the State of Delaware. The managing general partner is Parker & Parsley Development L.P. (\"PPDLP\"). PPDLP's general partner is Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"). The managing general partner during the year ended December 31, 1994 was Parker & Parsley Development Company (\"PPDC\"). PPDC was merged into PPDLP on January 1, 1995. See Item 12 (c).\nA Registration Statement, as amended, filed pursuant to the Securities Act of 1933, registering limited partnership interests aggregating $60,000,000 in a series of Delaware limited partnerships formed under the Parker & Parsley Producing Properties Program-II, was declared effective by the Securities and Exchange Commission on February 11, 1988. On August 31, 1988, the offering of limited partnership interests in the Registrant, the first partnership formed under such statement, was closed, with interests aggregating $5,611,000 being sold to 525 subscribers.\nThe Registrant's primary business plan and objectives are to purchase producing oil and gas properties and distribute the cash flow from operations to its partners. The Registrant is not involved in any industry segment other than oil and gas. See \"Item 6. Selected Financial Data\" and \"Item 8. Financial Statements and Supplementary Data\" of this report for a summary of the Registrant's revenue, income and identifiable assets.\nThe principal markets during 1995 for the oil produced by the Registrant were refineries and oil transmission companies that have facilities near the Registrant's oil producing properties. The principal markets for the Registrant's gas were companies that have pipelines located near the Registrant's gas producing properties. Of the Registrant's revenues for 1995, approximately 63%, 14% and 10% were attributable to sales made to Phibro Energy, Inc., GPM Gas Corporation and Western Gas Resources, Inc., respectively.\nBecause of the demand for oil and gas, the Registrant does not believe that the termination of the sales of its products to any one customer would have a material adverse impact on its operations. The loss of a particular customer for gas may have an effect if that particular customer has the only gas pipeline located in the areas of the Registrant's gas producing properties. The Registrant believes, however, that the effect would be temporary, until alternative arrangements could be made.\nFederal and state regulation of oil and gas operations generally includes the fixing of maximum prices for regulated categories of natural gas, the imposition of maximum allowable production rates, the taxation of income and other items, and the protection of the environment. Although the Registrant believes that its business operations do not impair environmental quality and that its costs of complying with any applicable environmental regulations are not currently significant, the Registrant cannot predict what, if any, effect these environmental regulations may have on its current or future operations.\nThe Registrant does not have any employees of its own. PPUSA employs 623 persons, many of whom dedicated a part of their time to the conduct of the Registrant's business during the period for which this report is filed. The Registrant's managing general partner, PPDLP through PPUSA, supplies all management functions.\nNo material part of the Registrant's business is seasonal and the Registrant conducts no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Registrant's properties consist primarily of working interests in properties on which oil and gas wells are located. Such property interests are often subject to landowner royalties, overriding royalties and other oil and gas leasehold interests.\nThe Registrant completed one purchase of producing properties. This acquisition involved the purchase of working interests in 21 properties, all of which are operated by the managing general partner. One uneconomical well was plugged and abandoned in 1992. The Registrant also participated in the drilling of three oil and gas wells of which two were completed as producers in 1989 and one in 1990.\nFor information relating to the Registrant's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993, and changes in such quantities for the years then ended, see Note 7 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below. Such reserves have been estimated by the engineering staff of PPUSA with a review by an independent petroleum consultant.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Registrant is not aware of any material legal proceedings (other than routine litigation in the ordinary course of the Registrant's business) to which it is a party or to which its property is 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 during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters\nAt March 8, 1996, the Registrant had 11,222 outstanding limited partnership interests held of record by 542 subscribers. There is no established public trading market for the limited partner ship interests. Under the limited partnership agreement, PPDLP has made certain commitments to purchase partnership interests at a computed value.\nRevenues which, in the sole judgement of the managing general partner, are not required to meet the Registrant's obligations are distributed to the partners at least quarterly in accordance with the limited partnership agreement. During the years ended December 31, 1995 and 1994, $444,788 and $419,477, respectively, of such revenue-related distributions were made to the limited partners.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe following table sets forth selected financial data for the years ended December 31: 1995 1994 1993 1992 1991 ---------- ---------- ---------- ---------- ---------- Operating results: Oil and gas sales $ 754,343 $ 787,939 $ 911,709 $1,070,139 $1,360,832 ========= ========= ========= ========= ========= Impairment of oil and gas properties $ 369,426 $ - $ - $ - $ - ========= ========= ========= ========= ========= Net income (loss) $ (225,390) $ 37,254 $ 130,022 $ 373,866 $ 400,866 ========= ========= ========= ========= ========= Allocation of net income (loss): Managing general partner $ (2,253) $ 373 $ 1,525 $ 4,076 $ 4,345 ========= ========= ========= ========= ========= Limited partners $ (223,137) $ 36,881 $ 128,497 $ 369,790 $ 396,521 ========= ========= ========= ========= ========= Limited partners' net income (loss) per limited part- nership interest $ (19.88) $ 3.29 $ 11.45 $ 32.95 $ 35.33 ========= ========= ========= ========= ========= Limited partners' cash distributions per limited part- nership interest $ 39.64 $ 37.38 $ 55.92 $ 64.21 $ 88.74 ========= ========= ========= ========= ========= At year end: Total assets $2,578,655 $3,253,374 $3,639,742 $4,143,372 $4,497,180 ========= ========= ========= ========= =========\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\nThe Registrant's 1995 oil and gas revenues decreased to $754,343 from $787,939 in 1994, a decrease of 4%. The decline in revenues resulted from a 9% decrease in barrels of oil produced and sold, a 5% decrease in mcf of gas produced and sold and declining average prices received per mcf of gas, offset by an increase in the average price received per barrel of oil. In 1995, 32,260 barrels of oil were sold compared to 35,518 in 1994, a decrease of 3,258 barrels. In 1994, 119,167 mcf of gas were sold compared to 125,142 in 1994, a decrease of 5,975 mcf. Because of the decline characteristics of the Registrant's oil and gas properties, management expects a certain amount of decline in production to continue in the future until the Registrant's economically recoverable reserves are fully depleted.(1)\nThe average price received per barrel of oil increased $1.31, or 8%, from $15.88 for 1994 to $17.19 in 1995. The average price received per mcf of gas decreased from $1.79 for 1994 to $1.68 in 1995. The market price for oil and gas has been extremely volatile in the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.(1) The Registrant may therefore sell its future oil and gas production at average prices lower or higher than that received in 1995.(1)\nTotal costs and expenses increased in 1995 to $1,005,236 as compared to $768,011 in 1994, an increase of $237,225, or 31%. This increase was the result of the 1995 impairment of oil and gas properties, offset by declines in production costs, general and administrative expenses (\"G&A\") and depletion.\nProduction costs were $353,452 in 1995 and $358,514 in 1994, resulting in a $5,062 decrease. The decrease was due to less well repair and maintenance costs and lower production taxes attributable to declining oil and gas revenues.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 4% from $23,638 in 1994 to $22,630 in 1995. The Registrant paid the managing general partner $18,109 in 1995 and $17,663 in 1994 for G&A incurred on behalf of the Registrant. G&A is allocated, in part, to the Registrant by the managing general partner. The Partnership agreement limits allocated G&A to 3% of the gross oil and gas revenues. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Registrant relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.(1)\nDepletion was $259,728 in 1995 compared to $385,859 in 1994. This represented a decrease of $126,131, or 33%. Depletion was computed property-by-property\nutilizing the unit-of-production method based upon the dominant mineral produced, generally oil. Oil production decreased 3,258 barrels in 1995 from 1994, while oil reserves of barrels were revised upward by 20,541 barrels, or 5%.\nEffective for the fourth quarter of 1995 the Registrant 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\") which requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, 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 of recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment is recognized based on the asset's fair value as determined for oil and gas properties by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of the natural gas price environment and the Registrant's expectation of future cash flows from its oil and gas properties at the time of review, the Registrant recognized a non-cash charge of $369,426 associated with the adoption of SFAS 121.\n1994 compared to 1993\nThe Registrant's 1994 oil and gas revenues decreased to $787,939 from $911,709 in 1993, a decrease of 14%. The decline in revenues resulted from a 4% decrease in barrels of oil produced and sold, a 5% decrease in mcf of gas produced and sold and declines in the average price received per barrel of oil and mcf of gas. In 1994, 35,518 barrels of oil were sold compared to 37,009 in 1993, a decrease of 1,491 barrels. In 1994, 125,142 mcf of gas were sold compared to 131,875 in 1993, a decrease of 6,733 mcf. The decreases in production volumes were primarily due to the decline characteristics of the Registrant's oil and gas properties.\nThe average price received per barrel of oil decreased $1.38 from $17.26 for 1993 to $15.88 in 1994. The average price received per mcf of gas decreased from $2.07 for 1993 to $1.79 in 1994.\nTotal costs and expenses decreased in 1994 to $768,011 as compared to $796,800 in 1993, a decrease of $28,789, or 4%. This decrease was the result of declines in production costs, G&A and amortization of organization costs, offset by an increase in depletion.\nProduction costs were $358,514 in 1994 and $378,871 in 1993, resulting in a $20,357 decrease, or 5%. The decrease was attributable to less well repair and maintenance costs.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 14% from $27,350 in 1993 to $23,638 in 1994. The Registrant paid the managing general partner $17,663 in 1994 and $21,919 in 1993 for G&A incurred on behalf of the Registrant.\nDepletion was $385,859 in 1994 compared to $368,135 in 1993. This represented an increase of $17,724, or 5%. Oil production decreased 1,491 barrels in 1994 from 1993, while oil reserves of barrels were revised downward by 671 barrels.\nImpact of inflation and changing prices on sales and net income\nInflation impacts the fixed overhead rate charges of the lease operating expenses for the Registrant. During 1993, the annual change in the index of average weekly earnings of crude petroleum and gas production workers issued by the U.S. Department of Labor, Bureau of Labor Statistics, decreased by 1.1%. The 1994 annual change in average weekly earnings increased by 4.8%. The 1995 index (effective April 1, 1995) increased 4.4%. The impact of inflation for other lease operating expenses is small due to the current economic condition of the oil industry.\nThe oil and gas industry experienced volatility during the past decade because of the fluctuation of the supply of most fossil fuels relative to the demand for such products and other uncertainties in the world energy markets causing significant fluctuations in oil and gas prices. Since December 31, 1994, prices for oil production similar to the Registrant's ranged from approximately $16.00 to $19.00 per barrel of oil. For February 1996, the average price for the Registrant's oil was approximately $18.00.\nPrices for natural gas are subject to ordinary seasonal fluctuations, and this volatility of natural gas prices may result in production being curtailed and, in some cases, wells being completely shut-in.(1)\nLiquidity and capital resources\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities increased to $439,800 during the year ended December 31, 1995, a $45,737 increase from the year ended December 31, 1994. The increase resulted from a decrease in production costs, primarily due to less well repair and maintenance costs in 1995 compared to 1994.\nNet Cash Used in Investing Activities\nThe Registrant's principal investing activities during 1995 was for repair and maintenance activity on various oil and gas properties.\nNet Cash Used in Financing Activities\nCash was sufficient in 1995 for distributions to the partners of $449,329 of which $444,788 was distributed to the limited partners and $4,541 to the managing general partner. In 1994, cash was sufficient for distributions to the partners of $423,622 of which $419,477 was distributed to the limited partners and $4,145 to the managing general partner.\nIt is expected that future net cash provided by operations will be sufficient for any capital expenditures and any distributions.(1) As the production from the properties declines, distributions are also expected to decrease.(1)\n- ---------------\n(1) This statement is a forward looking statement that involves risks and uncertainties. Accordingly, no assurances can be given that the actual events and results will not be materially different than the anticipated results described in the forward looking statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Registrant's audited financial statements are included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nThe Registrant does not have any officers or directors. Under the limited partnership agreement, the Registrant's managing general partner, PPDLP, is granted the exclusive right and full authority to manage, control and administer the Registrant's business. PPUSA, the sole general partner of PPDLP, is a wholly-owned subsidiary of Parker & Parsley Petroleum Company (the \"Company\"), a publicly-traded corporation on the New York Stock Exchange.\nSet forth below are the names, ages and positions of the directors and executive officers of PPUSA. Directors of PPUSA are elected to serve until the next annual meeting of stockholders or until their successors are elected and qualified.\nAge at December 31, Name 1995 Position\nScott D. Sheffield 43 Chairman of the Board and Director\nJames D. Moring (a) 59 President, Chief Executive Officer and Director\nTimothy A. Leach 36 Executive Vice President and Director\nSteven L. Beal 36 Senior Vice President, Treasurer and Chief Financial Officer\nMark L. Withrow 48 Senior Vice President and Secretary\n- --------------- (a) Mr. Moring retired from the Company and subsidiaries effective January 1, 1996. Mr. Sheffield assumed the positions of President and Chief Executive Officer of PPUSA effective January 1, 1996.\nScott D. Sheffield. Mr. Sheffield, a graduate of The University of Texas with a Bachelor of Science degree in Petroleum Engineering, has been the President and a Director of the Company since May 1990 and has been the Chairman of the Board and Chief Executive Officer since October 1990. Mr. Sheffield joined PPDC, the principal operating subsidiary of the Company, as a petroleum engineer in 1979. Mr. Sheffield served as Vice President - Engineering of PPDC from September 1981 until April 1985 when he was elected President and a Director of PPDC. In March 1989, Mr. Sheffield was elected Chairman of the Board and Chief Executive Officer of PPDC. On January 1, 1995, Mr. Sheffield resigned as President and Chief Executive Officer of PPUSA, but remained Chairman of the Board and a Director of PPUSA. On January 1, 1996, Mr. Sheffield reassumed the positions of President and Chief Executive Officer of PPUSA. Before joining PPDC, Mr. Sheffield was principally occupied for more than three years as a production and reservoir engineer for Amoco Production Company.\nJames D. Moring. Mr. Moring, a graduate of Texas Tech University with a Bachelor of Science degree in Petroleum Engineering has been a Director of the Company since October 1990 and was Senior Vice President - Operations of the Company from October 1990 until May 1993, when he was appointed Executive Vice President - Operations. Mr. Moring has been principally occupied since July 1982 as the supervisor of the drilling, completion, and production operations of PPDC and its affiliates and has served as an officer of PPDC since January 1983. Mr. Moring has been Senior Vice President - Operations and a Director of PPDC since June 1989 and in May 1993, Mr. Moring was appointed Executive Vice President - Operations. Mr. Moring was elected President and Director and appointed Chief Executive Officer of PPUSA on January 1, 1995. Effective January 1, 1996, Mr. Moring retired from the Company and subsidiaries. In the five years before joining PPDC, Mr. Moring was employed as a Division Operations Manager with Moran Exploration, Inc. and its predecessor.\nTimothy A. Leach. Mr. Leach, a graduate of Texas A&M University with a Bachelor of Science degree in Petroleum Engineering and the University of Texas of the Permian Basin with a Master of Business Administration degree, was elected Executive Vice President - Engineering of the Company on March 21, 1995. Mr. Leach had been serving as Senior Vice President Engineering since March 1993 and served as Vice President - Engineering of the Company from October 1990 to March 1993. Mr. Leach was elected Executive Vice President of PPUSA on December 1, 1995. He had joined PPDC as Vice President - Engineering in September 1989. Prior to joining PPDC, Mr. Leach was employed as Senior Vice President and Director of First City Texas - Midland, N.A.\nSteven L. Beal. Mr. Beal, a graduate of the University of Texas with a Bachelor of Business Administration degree in Accounting and a certified public accountant, was elected Senior Vice President - Finance of the Company in January 1995 and Chief Financial Officer of the Company on March 21, 1995. On January 1, 1995, Mr. Beal was elected Senior Vice President, Treasurer and Chief Financial Officer of PPUSA. Mr. Beal has been the Company's Chief Accounting Officer since November 1992 and been the Company's Treasurer since October 1990. Mr. Beal joined PPDC as Treasurer in March 1988 and was elected Vice President - Finance in October 1991. Prior to joining PPDC, Mr. Beal was employed as an audit manager of Price Waterhouse.\nMark L. Withrow. Mr. Withrow, a graduate of Abilene Christian University with Bachelor of Science degree in Accounting and Texas Tech University with a Juris Doctorate degree, was Vice President - General Counsel of the Company from February 1991 to January 1995, when he was appointed Senior Vice President - General Counsel, and has been the Company's Secretary since August 1992. On January 1, 1995, Mr. Withrow was elected Senior Vice President and Secretary of PPUSA. Mr. Withrow joined PPDC in January 1991. Prior to joining PPDC , Mr. Withrow was the managing partner of the law firm of Turpin, Smith, Dyer, Saxe & MacDonald, Midland, Texas.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Registrant does not have any directors or officers. Management of the Registrant is vested in PPDLP, the managing general partner. The Registrant\nparticipates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. Under the limited partnership agreement, PPDLP pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating, general and administrative expenses. In return, PPDLP is allocated 1% of the Registrant's revenues. See Notes 6 and 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below for information regarding fees and reimbursements paid to the managing general partner or its affiliates by the Registrant.\nThe Registrant does not directly pay any salaries of the executive officers of PPUSA, but does pay a portion of PPUSA's general and administrative expenses of which these salaries are a part. See Note 6 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Beneficial owners of more than five percent\nThe Registrant is not aware of any person who beneficially owns 5% or more of the outstanding limited partnership interests of the Registrant. PPDLP owned 78 limited partner interests at January 1, 1996.\n(b) Security ownership of management\nThe Registrant does not have any officers or directors. The managing general partner of the Registrant, PPDLP, has the exclusive right and full authority to manage, control and administer the Registrant's business. Under the limited partnership agreement, limited partners holding a majority of the outstanding limited partnership interests have the right to take certain actions, including the removal of the managing general partner or any other general partner. The Registrant is not aware of any current arrangement or activity which may lead to such removal. The Registrant is not aware of any officer or director of PPUSA who beneficially owns limited partnership interests in the Registrant.\n(c) Changes in control\nOn January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of Parker & Parsley Producing Properties 88-A, L.P., as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, which previously served as the managing general partner of the Registrant. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Registrant.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nTransactions with the managing general partner or its affiliates\nPursuant to the limited partnership agreement, the Registrant had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- ---------\nPayment of lease operating and supervision charges in accordance with standard industry operating agreements $ 125,028 $ 123,658 $ 128,788\nReimbursement of general and administrative expenses $ 18,109 $ 17,663 $ 21,919\nPurchase of oil and gas properties and related equipment, at predecessor cost $ - $ 2,451 $ 1,146\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ 116 $ - $ -\nUnder the limited partnership agreement, the managing general partner pays 1% of the Registrant's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Registrant's revenues. Also, see Notes 6 and 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below, regarding the Registrant's participation with the managing general partner in oil and gas activities of the Program.\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 are filed as part of this annual report:\nIndependent Auditors' Report\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\n2. Financial statement schedules\nAll financial statement schedules have been omitted since the required information is in the financial statements or notes thereto, or is not applicable nor required.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits listed on the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.\nS I G N A T U R E S\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.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P.\nDated: March 29, 1996 By: Parker & Parsley Development L.P., Managing General Partner\nBy: Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), General Partner\nBy: \/s\/ Scott D. Sheffield ------------------------------ Scott D. Sheffield, 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.\n\/s\/ Scott D. Sheffield President, Chairman of the Board, March 29, 1996 - ------------------------- Chief Executive Officer and Scott D. Sheffield Director of PPUSA\n\/s\/ Timothy A. Leach Executive Vice President March 29, 1996 - ------------------------- and Director of PPUSA Timothy A. Leach\n\/s\/ Steven L. Beal Senior Vice President, March 29, 1996 - ------------------------- Treasurer and Chief Steven L. Beal Financial Officer of PPUSA\n\/s\/ Mark L. Withrow Senior Vice President and March 29, 1996 - ------------------------- Secretary of PPUSA Mark L. Withrow\nINDEPENDENT AUDITORS' REPORT\nThe Partners Parker & Parsley Producing Properties 88-A, L.P. (A Delaware Limited Partnership):\nWe have audited the financial statements of Parker & Parsley Producing Properties 88-A, L.P. as listed in the accompanying index under Item 14(a). 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 Parker & Parsley Producing Properties 88-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.\nAs discussed in Notes 2 and 3 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets and for long-lived assets to be disposed of in 1995 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\"\nKPMG Peat Marwick LLP\nMidland, Texas March 8, 1996\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P. (A Delaware Limited Partnership)\nBALANCE SHEETS December 31\n1995 1994 ----------- ----------- ASSETS\nCurrent assets: Cash and cash equivalents, all interest bearing deposits $ 444,066 $ 454,847 Accounts receivable - affiliate 74,105 110,141 ---------- ---------- Total current assets 518,171 564,988\nOil and gas properties - at cost, based on the successful efforts accounting method 4,834,585 4,833,333 Accumulated depletion (2,774,101) (2,144,947) ---------- ----------\nNet oil and gas properties 2,060,484 2,688,386 --------- ----------\n$ 2,578,655 $ 3,253,374 ========== ========== PARTNERS' CAPITAL\nPartners' capital: Limited partners (11,222 interests) $ 2,553,220 $ 3,221,145 Managing general partner 25,435 32,229 ---------- ----------\n$ 2,578,655 $ 3,253,374 ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P. (A Delaware Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31\n1995 1994 1993 ---------- ---------- ----------\nRevenues: Oil and gas sales $ 754,343 $ 787,939 $ 911,709 Interest income 25,503 17,326 15,113 --------- --------- ---------\nTotal revenues 779,846 805,265 926,822\nCosts and expenses: Production costs 353,452 358,514 378,871 General and administrative expenses 22,630 23,638 27,350 Depletion 259,728 385,859 368,135 Impairment of oil and gas properties 369,426 - - Amortization of organization costs - - 22,444 --------- --------- ---------\nTotal costs and expenses 1,005,236 768,011 796,800 --------- --------- ---------\nNet income (loss) $ (225,390) $ 37,254 $ 130,022 ========= ========= =========\nAllocation of net income (loss): Managing general partner $ (2,253) $ 373 $ 1,525 ========= ========= =========\nLimited partners $ (223,137) $ 36,881 $ 128,497 ========= ========= =========\nNet income (loss) per limited partnership interest $ (19.88) $ 3.29 $ 11.45 ========= ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P. (A Delaware Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nManaging general Limited partner partners Total --------- ---------- ----------\nPartners' capital at January 1, 1993 $ 40,577 $4,102,795 $4,143,372\nDistributions (6,101) (627,551) (633,652)\nNet income 1,525 128,497 130,022 -------- --------- ---------\nPartners' capital at December 31, 1993 36,001 3,603,741 3,639,742\nDistributions (4,145) (419,477) (423,622)\nNet income 373 36,881 37,254 -------- --------- ---------\nPartners' capital at December 31, 1994 32,229 3,221,145 3,253,374\nDistributions (4,541) (444,788) (449,329)\nNet loss (2,253) (223,137) (225,390) -------- --------- ---------\nPartners' capital at December 31, 1995 $ 25,435 $2,553,220 $2,578,655 ======== ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P. (A Delaware Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31\n1995 1994 1993 --------- --------- ---------\nCash flows from operating activities:\nNet income (loss) $(225,390) $ 37,254 $ 130,022 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depletion and amortization 259,728 385,859 390,579 Impairment of oil and gas properties 369,426 - - Changes in assets: (Increase) decrease in accounts receivable 36,036 (29,050) 43,485 -------- -------- --------\nNet cash provided by operating activities 439,800 394,063 564,086\nCash flows from investing activities:\nAdditions to oil and gas equipment (1,252) (7,216) (35,721)\nCash flows from financing activities:\nCash distributions to partners (449,329) (423,622) (633,652) -------- -------- --------\nNet decrease in cash and cash equivalents (10,781) (36,775) (105,287) Cash and cash equivalents at beginning of year 454,847 491,622 596,909 -------- -------- --------\nCash and cash equivalents at end of year $ 444,066 $ 454,847 $ 491,622 ======== ======== ========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P. (A Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNote 1. Organization and nature of operations\nParker & Parsley Producing Properties 88-A, L.P. (the \"Partnership\") is a limited partnership organized in 1988 under the laws of the State of Delaware.\nThe Partnership engages primarily in oil and gas production in Texas and is not involved in any industry segment other than oil and gas.\nNote 2. Summary of significant accounting policies\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\nImpairment of long-lived assets - Effective for the fourth quarter of 1995 the Partnership 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\"). Consequently, the Partnership reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows is less than the carrying amount of the assets. In this circumstance, the Partnership recognizes an impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset.\nThe Partnership accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less costs to sell once management has committed to a plan to dispose of the assets.\nOil and gas properties - The Partnership utilizes the successful efforts method of accounting for its oil and gas properties and equipment. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized while nonproductive exploration costs are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method on a property-by-property basis based on proved oil (dominant mineral) reserves as determined by the engineering staff of Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), the sole general partner of Parker & Parsley Development L.P. (\"PPDLP\"), the Partnership's managing general partner, and reviewed by independent petroleum consultants. The carrying amounts of properties sold or otherwise disposed of and the related allowances for depletion are eliminated from the accounts and any gain or loss is included in operations.\nPrior to the adoption of SFAS 121 in the fourth quarter, the Partnership's aggregate oil and gas properties were stated at cost not in excess of total\nestimated future net revenues and the estimated fair value of oil and gas assets not being depleted.\nUse of estimates in the preparation of financial statements - Preparation of the accompanying 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 reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nOrganization costs - Organization costs are capitalized and amortized on the straight-line method over 60 months.\nNet income (loss) per limited partnership interest - The net income (loss) per limited partnership interest is calculated by using the number of outstanding limited partnership interests.\nIncome taxes - A Federal income tax provision has not been included in the financial statements as the income (loss) of the Partnership is included in the individual Federal income tax returns of the respective partners.\nStatements of cash flows - For purposes of reporting cash flows, cash and cash equivalents include depository accounts held by banks.\nGeneral and administrative expenses - General and administrative expenses are allocated in part to the Partnership by the managing general partner or its affiliates. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Partnership relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.\nEnvironmental - The Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nNote 3. Impairment of long-lived assets\nThe Partnership adopted SFAS 121 effective for the fourth quarter of 1995. SFAS 121 requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be\nrecoverable. Long-lived assets to be disposed of are to be accounted for at the lower of carrying amount or fair value less cost to sell when management has committed to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 for fiscal years beginning after December 15, 1995.\nIn order to determine whether an impairment had occurred, the Partnership estimated the expected future cash flows of its oil and gas properties and compared such future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Partnership adjusted the carrying amount of those oil and gas properties to their fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result, the Partnership recognized a non-cash charge of $369,426 related to its oil and gas properties during the fourth quarter of 1995.\nAs of December 31, 1995, management had not committed to sell any Partnership assets.\nNote 4. Income taxes\nThe financial statement basis of the Partnership's net assets and liabilities was $628,213 less than the tax basis at December 31, 1995.\nThe following is a reconciliation of net income (loss) per statements of operations with the net income per Federal income tax returns for the years ended December 31: 1995 1994 1993 --------- --------- ---------\nNet income (loss) per statements of operations $(225,390) $ 37,254 $ 130,022 Intangible development costs capitalized for financial reporting purposes and expensed for tax reporting purposes - - (10,163) Depletion and depreciation provisions for tax reporting purposes under amounts for financial reporting purposes 34,318 130,378 79,914 Impairment of oil and gas properties for financial reporting purposes 369,426 - - Salvage income 441 - 1,262 -------- -------- -------- Net income per Federal income tax returns $ 178,795 $ 167,632 $ 201,035 ======== ======== ========\nNote 5. Oil and gas producing activities\nThe following is a summary of the costs incurred, whether capitalized or expensed, related to the Partnership's oil and gas producing activities for the years ended December 31: 1995 1994 1993 ---------- ---------- --------- Property acquisition costs $ 1,252 $ 7,246 $ 20,480 ========= ========= ========\nCapitalized oil and gas properties consist of the following:\n1995 1994 1993 ----------- ----------- ----------- Proved properties: Property acquisition costs $ 4,088,545 $ 4,087,293 $ 4,080,047 Completed wells and equipment 746,040 746,040 746,040 ---------- ---------- ---------- 4,834,585 4,833,333 4,826,087 Accumulated depletion (2,774,101) (2,144,947) (1,759,088) ---------- ---------- ---------- Net capitalized costs $ 2,060,484 $ 2,688,386 $ 3,066,999 ========== ========== ==========\nDuring 1995, the Partnership recognized a non-cash charge against oil and gas properties of $369,426 associated with the adoption of SFAS 121. See Note 3.\nNote 6. Related party transactions\nPursuant to the limited partnership agreement, the Partnership had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 125,028 $ 123,658 $ 128,788 Reimbursement of general and administrative expenses $ 18,109 $ 17,663 $ 21,919 Purchase of oil and gas properties and related equipment, at predecessor cost $ - $ 2,451 $ 1,146 Receipt of proceeds for the salvage value of retired oil and gas equipment $ 116 $ - $ -\nThe Partnership participates in oil and gas activities through an income tax partnership (the \"Program\") pursuant to the Program agreement. PPDLP, P&P Employees Producing Properties 88- A (\"EMPL\") and the Partnership are parties to the Program agreement. EMPL is a general partnership organized for the benefit of certain employees of PPUSA.\nThe costs and revenues of the Program are allocated to PPDLP, EMPL and the Partnership as follows: PPDLP (1) and EMPL Partnership ---------- ----------- Revenues: Revenues from oil and gas production, proceeds from sales of producing properties and all other revenues: Before payout 4.040405% 95.959595% After payout 19.191920% 80.808080% Costs and expenses: Property acquisition costs, operating costs, general and administrative expenses and other costs: Before payout 4.040405% 95.959595% After payout 19.191920% 80.808080%\n(1) Excludes PPDLP's 1% general partner ownership which is allocated at the Partnership level and 78 limited partner interests owned by PPDLP.\nNote 7. Oil and gas information (unaudited)\nThe following table presents information relating to the Partnership's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities during the years then ended. All of the Partnership's reserves are proved and located within the United States. The Partnership's reserves are based on an evaluation prepared by the engineering staff of PPUSA and reviewed by an independent petroleum consultant, using criteria established by the Securities and Exchange Commission. Reserve value information is available to limited partners pursuant to the Partnership agreement and, therefore, is not presented. Oil (bbls) Gas (mcf) ---------- ---------- Net proved reserves at January 1, 1993 505,518 1,825,271 Revisions of estimates of January 1, 1993 (565) 182,355 Production (37,009) (131,875) ---------- ---------- Net proved reserves at December 31, 1993 467,944 1,875,751 Revisions of estimates of December 31, 1993 (671) 182,006 Production (35,518) (125,142) ---------- ---------- Net proved reserves at December 31, 1994 431,755 1,932,615 Revisions of estimates of December 31, 1994 20,541 (3,131) Production (32,260) (119,167) ---------- ---------- Net proved reserves at December 31, 1995 420,036 1,810,317 ========== ==========\nThe estimated present value of future net revenues of proved reserves, calculated using December 31, 1995 prices of $19.38 per barrel of oil and $1.90 per mcf of gas, discounted at 10% was approximately $2,623,000 and undiscounted was $5,108,000 at December 31, 1995.\nThe Partnership emphasizes that reserve estimates are inherently imprecise and, accordingly, the estimates are expected to change as future information becomes available.\nNote 8. Major customers\nThe following table reflects the major customers of the Partnership's oil and gas sales during the years ended December 31:\n1995 1994 1993 ---- ---- ----\nPhibro Energy, Inc. 63% 62% 61% GPM Gas Corporation 14% 21% 23% Western Gas Resources, Inc. 10% - -\nPPDLP is party to a long-term agreement pursuant to which PPDLP and affiliates are to sell to Phibro Energy, Inc. (\"Phibro\") substantially all crude oil (including condensate) which any of such entities has the right to market from time to time. On December 29, 1995, PPDLP and Phibro entered into a Memorandum of Agreement (\"Phibro MOA\") that cancels the prior crude oil purchase agreement between the parties and provides for adjusted terms effective December 1, 1995. The price to be paid for oil purchased under the Phibro MOA is to be competitive with prices paid by other substantial purchasers in the same area who are significant competitors of Phibro. The price to be paid for oil purchased under the Phibro MOA also includes a market-related bonus that may vary from month to month based upon spot oil prices at various commodity trade points. The term of the Phibro MOA is through June 30, 1998, and it may continue thereafter subject to termination rights afforded each party. Although Phibro was required to post a $16 million letter of credit in connection with purchases under the prior agreement, it is anticipated that this security requirement will be replaced by a $25 million payment guarantee by Phibro's parent company, Salomon Inc.\nNote 9. Organization and operations\nThe Partnership was organized August 31, 1988 as a limited partnership under the Delaware Act for the purpose of acquiring and developing oil and gas properties. The following is a brief summary of the more significant provisions of the limited partnership agreement:\nManaging general partner - On January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of the Partnership as a result of the merger into it of Parker & Parsley Development Company (\"PPDC\"), a Delaware corporation, and an affiliate of PPDLP and the Company, and which previously served as the managing general partner of the Partnership. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Partnership, including the development drilling program in which the Partnership participates. PPDLP has the power and authority to manage, control and administer all Partnership affairs. Under the limited\npartnership agreement, the managing general partner pays 1% of the Partnership's acquisition, drilling and completion costs and 1% of its operating and general and administrative expenses. In return, it is allocated 1% of the Partnership's revenues.\nLimited partner liability - The maximum amount of liability of any limited partner is the total contributions of such partner plus his share of any undistributed profits.\nInitial capital contributions - The limited partners entered into subscription agreements for aggregate capital contributions of $5,611,000. PPDLP is required to contribute amounts equal to 1% of initial Partnership capital less commission and offering expenses allocated to the limited partners and to contribute amounts necessary to pay costs and expenses allocated to it under the Partnership agreement to the extent its share of revenues does not cover such costs.\nPARKER & PARSLEY PRODUCING PROPERTIES 88-A, L.P.\nINDEX TO EXHIBITS\nThe following documents are incorporated by reference in response to Item 14(c):\nExhibit No. Description Page\n3(a) Agreement of Limited Partnership - of Parker & Parsley Producing Properties 88-A, L.P.\n4(a) Agreement of Limited Partnership - of Parker & Parsley Producing Properties 88-A, L.P.\n4(b) Form of Subscription Agreement - and Power of Attorney\n4(c) Specimen Certificate of Limited - Partnership Interest\n10(a) Operating Agreement -\n10(b) Exploration and Development Program - Agreement","section_15":""}
{"filename":"352789_1995.txt","cik":"352789","year":"1995","section_1":"ITEM 1. BUSINESS:\nIomega Corporation (\"Iomega\" or the \"Company\") designs, manufacturers and markets innovative data storage solutions, based on removable-media technology, that help personal computer users \"manage their stuff.\" The Company's data storage solutions include disk drives marketed under the tradenames Zip and Jaz, and a family of tape drives marketed under the tradename Ditto. The Company's Zip and Jaz disk drives are designed to provide users with the benefits of high capacity and rapid access generally associated with hard disk drives and the benefits of media removability generally associated with floppy disk drives, including expandable storage capacity and data transportability, management and security. The Company's Ditto tape drives primarily address the market for backup data storage. The Company began shipping Zip drives in March 1995 and Jaz drives in limited quantities in December 1995.\nIomega Solutions\nThe Company believes its recently introduced Zip and Jaz disk drives address key information storage and management needs of today's personal computer users by providing affordable, easy-to-use storage solutions that combine the high capacity and rapid access of hard disk drives with the benefits of media removability generally associated with floppy disk drives. Specifically, the Company's products offer the following benefits to personal computer users.\nExpandable Storage Capacity\nAs personal computer users are increasingly forced to expand their primary storage capacity (generally provided by the hard disk drive incorporated in the computer), Zip and Jaz provide an easy and efficient way to do so. Both the Zip and the Jaz drive can be easily connected or installed and offer unlimited additional storage capacity, in increments of 100 MBs (in the case of Zip) and 1 GB (in the case of Jaz).\nMedia Removability\nBoth Zip and Jaz store data on high-capacity removable disks, thus enabling computer users to:\n- take programs and files from an office computer and work with them on a home or laptop computer;\n- share programs and files with other personal computer users;\n- organize data by storing different files on different disks;\n- create a \"separate personal computer\" for each person using the computer (such as different family members) -- each user can store all of his or her software and data on a single disk that can be removed from the computer and privately stored when that person is not using the computer; and\n- remove particularly sensitive or valuable information from the computer for storage in a different location, thus protecting it against viewing or modification by another user of the computer and against damage to the computer.\nData Backup\nThe Company's family of Ditto tape drives, as well as the Zip and Jaz drive, offer a convenient and effective way for personal computer users to create backup copies of their programs and files.\nAttractive Price, Performance and Features\nThe Company believes that its Zip and Jaz drives provide a combination of price, performance and features that makes them attractive data storage solutions for their target markets. Zip offers data access times and transfer rates and storage capacity that greatly exceeds that offered by conventional floppy disk drives, along with the benefits of removable media, at a price that is attractive to mass-market customers. Jaz offers many performance features comparable to those of most other data storage devices (including conventional hard disk drives), at a lower price than other currently available comparably performing removable-media storage devices.\nProducts\nThe Company offers products targeted at both the mass market and the high-performance market. The Zip drive and the Ditto 420 and Ditto Easy 800 tape drives were designed to achieve price levels which the Company determined are critical to mass-market consumers. The Jaz drive and Ditto 3200 tape drive, on the other hand, are principally targeted to more technically demanding, high-end customers, who the Company believes are less price sensitive than typical mass-market consumers.\nThe following table lists the principal data storage devices currently being offered by the Company:\n* Drives are available in internal and external versions. The indicated capacities for Ditto drives represent the maximum capacity using data compression. ** Indicates the typical price at which the external version of the drive and the highest capacity media for that drive is sold at retail. Prices for the internal version of a drive and for smaller capacity media are generally lower. The price for the Ditto 420 is the internal version price. Disk prices represent per unit purchase price in multi-packs. Media prices for tape are not presented because revenues from tape minicartridge sales are not material to the Company.\nZip\nThe Company began shipping external Zip drives and 100-MB Zip disks in March 1995. Designed as an affordable mass-market product, the Zip drive addresses multiple needs of personal computer users; hard drive expansion, data transportability, management and security and data backup. The drive uses interchangeable 100-MB Zip disks to provide users of IBM-compatible and Apple Macintosh personal computers with 70 times the capacity of, and superior performance to, traditional floppy disks. Zip drives were designed with 100-MB disks based on the results of the Company's market research, which showed that 85% of the files stored on personal computers are 100 Mbs or less.\nZip drives use durable, high-capacity flexible media and Winchester-style nanoslide heads with a special airbearing surface combined with a linear voice coil motor. The Zip drive provides high capacity and rapid access and can be used for a number of data storage purposes. The SCSI version of the Zip drive, which offers faster performance than the parallel port version of the drive, features 29 millisecond average seek time and an average sustained data transfer rate of 1.00 MB per second. Software included with the Zip drive provides a total data storage solution by helping users organize and copy their data and offers software read\/write protect, which further enables users to secure and protect their data.\nThe external, portable version of the Zip drive weighs approximately one pound and is offered in a parallel port version for use with IBM PC-compatible computers and a SCSI version for use with Apply Macintosh computers or IBM PC-compatible computers which have a SCSI adapter board. The parallel port version features printer pass through to allow normal operation of a printer in the same port. The SCSI version has two connectors allowing it to be connected with other SCSI devices. The external Zip drive has a unique compact design, including a royal blue color, a window allowing visibility of the label on the cartridge being used, rubber feet for positioning the drive flat or on its side, operation lights and a finger slot for easy cartridge insertion and removal.\nIn September 1995, Power Computing, the first Macintosh clone manufacturer, began offering internal 5.25-inch Zip SCSI drives as a $159 option on its computers. The Company has also designed an internal version of the Zip drive which incorporates a conventional 3.5-inch floppy disk drive. In addition, the Company has developed an internal 3.5-inch IDE version of the Zip drive, which it expects will be available in the first quarter of 1996.\nDuring 1995, Zip received numerous awards from industry publications in select categories including: PC\/Computing's Most Valuable Product; Publish magazine's 1995 Publish Impact Award; Cadence magazine's Editor's Choice Award; the International Digital Imaging Association's \"Best New Hardware\" award; and, listing in Computer Life magazine's \"Best of Everything\" list.\nThe Zip drive carries a one-year warranty and Zip disks are sold with a limited lifetime warranty.\nJaz\nThe Company began shipping Jaz drives and 1-GB Jaz disks in limited quantities in December 1995. Jaz addresses the high-performance needs of personal computer users in three areas: multimedia applications (audio, video and graphics), personal data management, and hard drive upgrade. The Jaz drive offers data transfer rates comparable to those of most current hard disk drives, with an average sustained transfer rate of 5.4 MBs per second, 12 millisecond average seek time and 17.5 millisecond average access time. Jaz disks are currently available in a capacity of 1 GB, which the Company's market research indicated was a capacity that many high-performance computer users demand, and 540-MB Jaz disks are expected to be available in the first half of 1996. Using 1-GB disks, Jaz is capable of storing and playing up to two hours of MPEG1 compressed DSS satellite quality video, up to eight hours of CD-quality audio, more than 20,000 scanned documents for document imaging or up to four minutes of full-screen, full-motion broadcast-quality video. The Jaz drive will be available in an external SCSI version, which is expected to be sold by retailers for approximately $599 and is available in an internal SCSI version, which is expected to be sold by retailers for approximately $499. Each 1-GB and 540-MB Jaz cartridge is expected to sell for approximately $99 and $69, respectively, in five-packs. The Company expects an internal IDE version of the Jaz drive to be available beginning in the second half of 1996.\nThe Jaz drive incorporates many innovative technological features including tri-pad, thin-film recording heads, dynamic head loading and drag and drop motorized cartridge ejection. Jaz disks feature a dual rigid platter cartridge and a proprietary disk capture system which secures the dual disk platters when not installed in a drive, eliminating rattle and reducing the possibility of losing valuable information. The drive operates with leading operating systems for personal computers and workstations, including Windows 95, Windows NT, Windows 3.x, Macintosh and OS\/2.\nThe external version of the drive, which weighs approximately two pounds, features design enhancements similar to those introduced with the external Zip drive, including a unique jade colored casing, a window to allow visibility of the label on the cartridge being used, operating lights and a finger slot for easy cartridge insertion and removal. Additional features include an auto-switching powersupply to allow operation in different countries, auto-sensing SCSI termination and anti-gyro disk locking to increase durability.\nThe Jaz drive carries a one-year warranty and Jaz disks are sold with a limited lifetime warranty.\nDitto\nThe Company's Ditto family of tape drives addresses the need of personal computer users for an easy-to-use, dependable backup solution. In response to the information learned from consumers regarding the characteristics demanded from backup storage devices, beginning in 1994 the Company redesigned its family of tape drives, which had first been introduced in 1992. The Company offers internal and external models based on leading industry standards ranging in capacity from 420 MBs to 3.2 GBs (using data compression). The tape drives are primarily designed to backup and protect against loss of data stored on hard disk drives in IBM PC-compatible computers. Iomega's tape drives have a patented beltless design which the Company believes enhances reliability. The storage media used by Iomega's tape products is the industry-standard QIC-compatible minicartridge. In addition, the Ditto Easy 800 and Ditto Easy 3200 support new high-capacity Travan cartridge technology.\nThe Ditto family of tape drives has achieved several industry first. In April 1992, the Iomega Tape 250 (later renamed the Ditto 250) became the industry's first commercially available QIC-standard, one-inch high tape drive and in March 1995 because the industry's first internal 250-MB tape drive to sell for under $100. In June 1995, the Ditto 420 became the industry's first internal 420-MB tape drive to sell for under $100. In October 1995, the Company introduced the Ditto Easy 800, which the Company believes was the industry's first external parallel port 800-MB tape drive to sell for under $150. The Ditto Easy 800 features an enhanced design similar to, and is stackable with, the Zip and Jaz drives.\nThe Company's tape products are generally available in either internal or external models. The internal versions attach to the standard floppy drive interface in IBM PC-compatible computers, while the external versions attach to the parallel port on IBM PC-compatible computers and offer pass-through capability for a printer. The drives are shipped with backup software for both DOS and Windows.\nIn connection with the introduction of the Ditto Easy 800 in October 1995, the Company also introduced new 1-Step software designed to permit the backup of an entire hard disk in a single step while the user continues working.\nThe Ditto Easy 800 and the Ditto Easy 3200 carry a two-year warranty and the Ditto 420 carries a five-year warranty. Ditto media is sold with a two-year warranty.\nBernoulli\nThese 5.25-inch half-height drives are removable-media storage devices based on the Company's proprietary Bernoulli technology. The Company's Bernoulli drives and the associated disks are sold both in the form of a complete storage subsystem for leading personal computers and workstations and in the form ofcomponents for integration into larger systems by OEMs or value-added resellers (\"VARs\"). The Bernoulli MultiDisk 150 drive began shipping in October 1992 and was Iomega's first drive to use multiple capacity disks - 35, 65, 105 and 150 Mbs. The Company began shipping the Bernoulli 230 drive in September 1994. The Bernoulli drives are sold in internal and transportable versions.\nThe Company is now focusing its development and marketing efforts on its Zip, Jaz and Ditto products, and does not expect Bernoulli products to represent a significant portion of the Company's revenues in the future.\nMarketing and Sales\nThe Company believes that broadening the distribution of its products through strategic marketing alliances with a variety of key companies within the computer industry is a critical element in the Company's strategic goal of establishing its products as industry standards. The Company's initial marketing strategy for the introduction of its new products during 1995 was to generate consumer awareness of and demand for such products by focusing on aftermarket sales to existing users of personal computers through leading computer retail channels. As the next step in its strategy of promoting its products as new industry standards, the Company is increasingly focusing its efforts on establishing OEM relationships with leading personal computer manufacturers who will include the Company's products on a factory-installed basis to purchasers of new personal computers.\nRetail Distribution\nRetail outlets for the Company's products include mail order catalogs, computer superstores, office supply superstores, consumer electronics superstores and specialty computer stores. The Company sells its products to retail channels directly, as well as indirectly through distributors. The Company's products are sold at a retail level by most of the leading retailers of computer products in the United States. The following is a partial listing of the retail chains carrying the Company's products.\nBest Buy Electronics Boutique CDW Computer Center Elek-Tek Circuit City Fry's Electronics CompUSA MicroCenter Computer City NeoStar Creative Computer Office Max Egghead Software PC Warehouse\nStrategic Marketing Alliances\nIn addition to sales through these retail channels, the Company has entered into a number of strategic marketing alliances with a variety of companies within the computer industry. These alliances include OEM arrangements providing for certain of the Company's products to be incorporated in new computer systems at the time of purchase. For example, Power Computing, the first Macintosh clone manufacturer, is offering Zip drives as an option in certain of its new computers, and Micron Electronics, a mail-order manufacturer of IBM PC-compatible personal computers, has announced plans to offer Zip, Ditto and Jaz drives as a factory-installable option in certain of its new computers. In addition, Hewlett-Packard recently announced that it will provide the Zip drive as a feature in its recently announced HP Pavilion 7110Z Multimedia PC. The Company's strategic alliances also include private- branding and co-branding arrangements with major vendors of computer products covering the resale of the Company's products by such companies. For example, the Company has entered into co-branding arrangements with Seiko Epson, Maxell and Fuji, which offer Zip drives in Japan in packages which feature Iomega's name in addition to the partner's name, and has entered into a private-branding arrangement with Reveal Computer Products, which sells Zip drives and disks under Reveal's tradename.\nInternational\nThe Company sells its products outside of North America primarily through international distributors. The Company has increased its sales efforts in the European market in the past several years. Sales are accomplished primarily through offices located in Germany, Austria, Belgium, France, Ireland, Italy, Norway, Spain and the United Kingdom. The Company plans to open a Singapore office in 1996. The Company has been invoicing predominantly in foreign currencies since January 1992. In total, sales outside of the United States represented 32%, 37%, and 28% for the years ended December 31, 1995, 1994 and 1993, respectively.\nMarketing\nThe Company's marketing group is responsible for positioning and promoting the Company's products. The Company participates in various industry tradeshows, including MacWorld and COMDEX, and seeks to generate coverage of its products in a wide variety of trade publications. Although the Company did not engage in significant direct consumer marketing in 1995 in light of the large number of favorable articles about the Company's products which appeared in newspapers and computer magazines and constraints on the Company's ability to further increase production levels, the Company expects marketing and advertising expenses to increase significantly as the Company seeks to expand market awareness of its products.\nAs is common practice in the industry, the Company's arrangements with its customers generally allow customers, in the event of a price decrease, credit equal to the difference between the price originally paid and the new decreased price on units in the customers' inventories on the date of the price decrease. When a price decrease is anticipated, the Company establishes reserves for amounts estimated to be reimbursed to qualifying customers. In addition, customers generally have the right to return excess inventory within specified time periods. There can be no assurance that these reserves will be sufficient or that any future returns or price protection charges will not have a material adverse effect on the Company's results of operations.\nThe Company markets its products primarily through computer product distributors and retailers. Accordingly, since the Company grants credit to its customers, a substantial portion of outstanding accounts receivable are due from computer product distributors and certain large retailers. At December 31, 1995, the customers with the ten highest outstanding accounts receivable balances totaled $47.1 million or 43% of gross accounts receivable, with one customer accounting for $15.2 million, or 14% of gross accounts receivable. If any one or a group of these customers' receivable balances should be deemed uncollectible, it would have a material adverse effect on the Company's results of operations and financial condition.\nDuring the year ended December 31, 1994, sales to Ingram Micro D, Inc., a distributor, accounted for 11% of sales. No other single customer accounted for more than 10% of the Company's sales in 1994 or 1995.\nManufacturing\nThe Company's products are manufactured both by the Company at its facilities in Roy, Utah and by independent parties manufacturing products for the Company on a contract basis. Manufacturing activity generally consists of assembling various components, subcomponents and prefabricated parts manufactured by the Company or outside vendors. The Company currently has third-party manufacturing relationships with Seiko Epson (Zip drives), MegaMedia Computer (Zip disks), Sequel (Jaz drives) and First Engineering Plastics (Ditto drives). Although the Company substantially increased its manufacturing capacity (through both internal expansion and arrangements with third-party manufacturers) during 1995, the Company was not able to produce enough Zip drives and Zip disks in 1995 to fill all orders for such products due to component supply constraints and normal manufacturing start-up issues. To minimize its manufacturing costs, to take maximum advantage of its available personnel and facilities and to benefit from the expertise of experienced high-volume manufacturing companies, the Company plans to use third-party manufacturers to produce a majority of its products in the future. There can be no assurance that the Company will be successful in establishing and managing such third-party manufacturing relationships, or that third-party manufactures will be able to meet the Company's quantity or quality requirements for manufactured products. Moreover, the Company may grant certain of its third-party manufacturers, among others, the right to sell significant quantities of the Zip and Jaz drives they produce for their own account, thereby reducing the supply of such drives to the Company and increasing competition.\nMany components incorporated in, or used in the manufacture of, the Company's products are currently only available from sole source suppliers. Moreover, the Company has experienced difficulty in the past, is currently experiencing difficulty, and expects to continue to experience difficulty in the future, in obtaining a sufficient supply of many key components. For example, many of the integrated circuits used in the Company's Zip and Jaz drives are currently available only from sole source suppliers. The Company has been unable to obtain a sufficient supply of certain of these integrated circuits due to industry-wide shortages. In addition, the Company has been advised by certain sole source suppliers, including the manufacturers of critical integrated circuits for Zip and Jaz, that they do not anticipate being able to fully satisfy the Company's demand for components during 1996. These component shortages have limited the Company's ability to produce sufficient Zip drives to meet market demand and have limited the Company's ability to implement certain cost reduction and productivity improvement plans, and the Company expects that the shortage of components may limit production of Zip and Jaz products for the foreseeable future. The Company also experienced difficulty during 1995 in obtaining a sufficient supply of the servowriting equipment used in the manufacture of Zip disks. Such equipment shortages in 1995 limited the Company's production of Zip disks, and there can be no assurance that similar equipment shortages will not occur in the future.\nThe Company purchases all of its sole and limited source components and equipment pursuant to purchase orders placed from time to time and has no guaranteed supply arrangements. The inability to obtain sufficient components and equipment, or to obtain or develop alternative sources of supply at competitive prices and quality or to avoid manufacturing delays, could prevent the Company from producing sufficient quantities of its products to satisfy market demand, result in delays in product shipments, increase the Company's material or manufacturing costs or cause an imbalance in the inventory level of certain components. Moreover, difficulties in obtaining sufficient components may cause the Company to modify the design of its products to use a more readily available component, and such design modifications may result in product performance problems. Any or all of these problems could in turn result in the loss of customers, provide an opportunity for competing products to achieve market acceptance and otherwise adversely affect the Company's business and financial results.\nThe Company had a backlog as of January 28, 1996 of approximately $157 million, compared to a backlog at the end of January 1995 of approximately $5 million. Substantially all of the January 28, 1996 backlog was related to the Company's Zip and Jaz products, for which the Company has experienced component shortages. Based in part on the Company's current estimates regarding the expected availability of components (which estimates are based on information provided to the Company by its suppliers, the Company's current inventory of components, sales recorded since January 19, 1996 and the Company's experience in its business) and the Company's manufacturing capabilities, the Company believes that it will be able to fill all orders in the January 28, 1996 backlog during the first half of the current fiscal year, unless such orders are scheduled for delivery outside the first half of 1996 or first canceled or rescheduled. However, there can be no assurance that the Company's current estimates regarding the expected availability of components will in fact turn out to be correct. In addition, the purchase agreements or purchase orders pursuant to which orders are made generally allow the customer to cancel orders without penalty, and the Company has experienced some cancellations or rescheduling of orders in backlog. Moreover, it is common in the industry during periods of product shortages for customers to engage in practices such as double ordering in order to increase a customer's allowance of available product. Accordingly, the Company's backlog as of any particular date should not be relied upon as an indication of the Company's actual sales for any future period.\nProduct Development\nAn important element of the Company's business strategy is the ongoing enhancement of existing products and the development of new products. During 1994 and 1995, the Company's product development efforts were primarily devoted to the development of its Zip and Jaz products, which began commercial shipment in March 1995 and December 1995, respectively. During 1996 the Company expects that its development efforts will be primarily focused on enhancing the features, developing higher capacity versions and reducing the production costs of its existing Zip, Jaz and Ditto products. In particular, there are projects underway to develop higher capacity removable-media disk drives and tape products, to develop different system interfaces for the Company's removable-media disk drive products, such as IDE interface versions of Zip and Jaz, and to develop smaller subsystem versions of the Company's products, including a version of Zip which could be installed in laptop computers.\nDuring 1995, 1994 and 1993, the Company's research and development expenses were $19,576,000, $15,438,000 and $18,972,000, respectively (or 6.0%, 10.9% and 12.9%, respectively, of sales). The decline in research and development spending from 1993 to 1994 was the result of the Company's decision to discontinue certain research and development projects relating to floptical technology, digital audiotape technology, and thin-film head development. Research and development spending in 1995 was primarily related to efforts focused on the Company's Zip, Jaz and Ditto product lines.\nThe Company operates in an industry that is subject to both rapid technological change and rapid change in consumer demands. For example, over the last 10 years the typical hard disk drive included in a new personal computer has increased in capacity from approximately 40 Mbs to over 1 GB while the price of a hard disk drive has remained constant or even decreased. The Company's future success will depend in significant part on its ability to continually develop and introduce, in a timely manner, new removable disk drives and tape products with improved features, and to develop and manufacture those new products within a cost structure that enables the Company to sell such products at lower prices than those of comparable products today. There can be no assurance that the Company will be successful in developing, manufacturing and marketing new and enhanced products that meet both the performance and price demands of the data storage market.\nCompetition\nThe Company believes that its Zip and Jaz products compete most directly with other removable-media data storage devices, such as magnetic cartridge disk drives, optical disk drives and \"floptical\" disk drives. Current suppliers of removable-media data storage devices include Syquest Technology (which offers magnetic disk drives with removable cartridges based on hard drive technology), Panasonic (which offers the Power Drive, a removable optical drive) and Sony (which offers the MD-DATA drive, a disk drive based on removable magneto-optical technology). Although the Company believes the Zip and Jaz products offer price, performance or usability advantages over the other removable-media storage devices available today, the Company believes that the price, performance and usability of existing removable-media products will improve and that other companies will introduce new removable-media storage devices. Accordingly, the Company believes that its Zip and Jaz products will face increasingly intense competition. In particular, a consortium comprised of Compaq Computer, 3M and MKE has announced the Floptical 120, a high-capacity floptical drive that is compatible with conventional floppy disks. In addition, both Mitsumi and Swan Instruments are expected to introduce high-capacity, removable-media disk drives in 1996 that would also directly compete with Zip and Jaz. As new and competing removable-media storage solutions are introduced, it is possible that any such solution that achieves a significant market presence or establishes a number of significant OEM relationships will emerge as an industry standard and achieve a dominant market position. If such is the case, there can be no assurance that the Company's products would achieve significant market acceptance, particularly given the Company's size and market position vis-a-vis other competitors.\nTo the extent that Zip and Jaz drives are used for incremental primary storage capacity, they also compete with conventional hard disk drives, which are offered by companies such as Seagate Technology, Western Digital Corporation, Quantum Corporation, Conner Peripherals (which was recently acquiried by Seagate Technology), Micropolis Corporation and Maxtor Corporation, as well as integrated computer manufacturers such as Hewlett- Packard, IBM, Fujitsu, Hitachi and Toshiba. In addition, the leading suppliers of conventional hard disk drives could at any time determine to enter the removable-media storage market.\nThe Company believes that it is currently the only source of supply for the disks used in its disk drives. However, this situation may change either as a result of another party succeeding in producing disks that are compatible with Zip and Jaz drives without infringing the Company's proprietary rights, or as a result of licenses granted by the Company to other parties.\nThe Company's tape drives compete in the market for backup data storage with other QIC and DC2000-type products (which includes QIC and Irwin), including parallel port interface products. DC2000-type products currently offer capacities up to 4 Gbs with compression. The Company's two major competitors in the tape drive market are Conner Peripherals and Colorado Memory Systems, a division of Hewlett-Packard. Tape drives may in the future encounter increased competition from other forms of removable-media storage devices. The tapes used in the Company's tape drives are available from a number of sources and the Company is not the primary source of supply for these tapes.\nIn the OEM market for both its disk drives and tape drives, the Company competes with the vendors mentioned above, as well as with the manufacturers of personal computers, who may elect to manufacture data storage devices themselves.\nThe Company intends to license its products or technology to other computer manufactures on a royalty-bearing basis in order to increase market use and acceptance of its products and help promote them as industry standards. Accordingly, the Company expects to compete in the future with licensees of the Company's products.\nThe Company believes that most consumers distinguish among competitive data storage products on the basis of some or all of the following criteria: price (cost per unit and cost per megabyte of storage capacity), performance (speed and capacity), functionality (reliability, product size and removability), ease of installation and use, and security of data. Price is a particularly important factor with respect to the Company's mass-market products (the Zip drive and the Ditto 420 and Ditto Easy 800 tape drives). An additional competitive consideration, particularly in the OEM market, is the size (form factor) of the drive. Winchester drives are available in 5.25-inch, 3.5-inch, 2.5-inch and 1.8-inch form factors. The most common form factor for Winchester and floppy drives is 3.5-inches. The Company currently offers 3.5- inch Zip, Jaz and Ditto drives, and 5.25-inch Bernoulli disk drives.\nThe data storage industry is highly competitive, and the Company expects that competition will substantially increase in the future. In addition, the data storage industry is characterized by rapid technological development. The Company competes with a number of companies that have greater financial, manufacturing and marketing resources than the Company. The introduction by a competitor or products with superior performance or substantially lower prices would adversely affect the Company's business.\nProprietary Rights\nThe Company relies on a combination of patent, copyright and trade secret laws to protect its technology. The Company has filed approximately 40 U.S. and foreign patent applications relating to its Zip and Jaz drives and disks, although there can be no assurance that such patents will issue. The Company holds over 50 U.S. and foreign patents, three of which relate to its Ditto products and the remainder of which relate to its Bernoulli products. Although the Company believes that a combination of patent rights (pursuant to a number of pending patent applications) and copyright protection should prevent another party from manufacturing and selling disks that work effectively with the Company's Zip and Jaz drives (except pursuant to a license from the Company), there can be no assurance that the steps taken by the Company to protect such technology will be successful. If another party were to succeed in producing and selling Zip- or Jaz-compatible disks, the Company's sales would be materially adversely affected. Moreover, because the Company's Zip and Jaz disks have significantly higher gross margins than the Zip and Jaz drives, the Company's net income would be disproportionately affected by any such sales shortfall. Due to the rapid technological change that characterizes the Company's industry, the Company believes that the success of its disk drives will also depend on the technical competence and creative skill of its personnel than on the legal protections afforded its existing drive technology.\nAs is typical in the data storage industry, from time to time the Company has been, and may in the future be, notified that it may be infringing certain patents and other intellectual property rights of others. The Company, however, is not currently aware of any threatened or pending legal challenge to the technology which is incorporated in its products which it expects to have a material adverse effect on its business or financial results. The Company has in the past been engaged in several patent infringement lawsuits, both as plaintiff and defendant. There can be no assurance that future claims will not result in litigation. If infringement were established, the Company could be required to pay damages or be enjoined from selling the infringing product. In addition, there can be no assurances that the Company will be able to obtain any necessary licenses on satisfactory terms.\nCertain technology used in the Company's products is licenses on a royalty- bearing basis from third parties, including the backup software included with the Company's Ditto products and certain patent rights relating to Zip. The Company is in the process of negotiating a definitive license agreement for the Ditto backup software and, although it has entered into a letter agreement regarding the Zip patent rights, is in the process of negotiating a more detailed license agreement for the Zip patent rights. The failure to execute definitive agreements or the termination of any such license arrangements could have a material adverse effect on the Company's business and financial results.\nEmployees\nAs of December 31, 1995, the Company employed 1,667 persons (1,645 full- time and 22 part-time), including 143 in research and development, 1,209 in manufacturing, 139 in sales, marketing and service, 103 in general management and administration, and 73 in its European operations.\nThe Company's business growth during 1995 has resulted in additional personnel needs and an increased level of responsibility for management personnel and the Company anticipates hiring a substantial number of new employees in the near future. There can be no assurance that the Company will be successful in hiring, integrating or retaining such personnel.\nGovernment Contracts\nNo material portion of the Company's business is subject to renegotiation of profits or termination of contracts at the election of the United States government.\nEnvironmental Matters\nCompliance with federal, state and local environmental protection laws had no material effect on the Company in 1995 and is not expected to have a material effect in 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThe Company currently leases an aggregate of approximately 210,000 square feet of space in seven buildings located in Roy, Utah, where its executive offices, manufacturing and distribution facilities, and primary research and development facilities are located. The leases for these buildings expire at various dates from 1998 to 2000 and provide for an aggregate base rent of approximately $1,100,000 for 1996.\nThe Company expects to lease an additional 70,000 square feet of space in the Roy area, which it estimates will cost an additional $765,000 in annual rent. The Company expects that such additional space will be ready for occupancy by the end of 1996. Pending the availability of that space, the Company may rent additional space in the Roy area in 1996 on a temporary basis.\nThe Company leases an 11,000 square foot facility in San Diego, California and a 10,000 square foot facility in San Jose, California, each for certain research and development activities. The Company may seek to increase its leased space in San Jose to approximately 50,000 square feet during 1996. The Company has also rented a 20,000 square foot facility in Freiburg, Germany for use as its European headquarters. In addition, the Company leases small sales offices, typically on a short-term basis, at 11 locations in the United States and in Canada, Austria, Belgium, France, Ireland, Italy, Spain and the United Kingdom.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nThere are no legal proceedings, other than ordinary routine litigation incidental to its business, to which the Company or its subsidiaries is a party or of which any of their property is the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:\nNo matters were submitted to a vote of the Company's security holders during the quarter ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are as follows:\nName Age Position - -------------- ---- --------------------- Kim B. Edwards 48 President, Chief Executive Officer and Director\nLeonard C. Purkis 47 Senior Vice President, Finance and Chief Financial Officer\nSrini Nageshwar 53 Senior Vice President, Europe\nAnton J. Radman, Jr. 43 Senior Vice President, Strategic Business Development\nLeon J. Staciokas 67 Senior Vice President and Chief Internal Operating Officer\nM. Wayne Stewart 50 Senior Vice President, Operations\nEdward D. Briscoe 33 Vice President, Sales\nReed M. Brown 42 Vice President, Manufacturing\nTimothy L. Hill 37 Vice President, Marketing\nWillard C. Kennedy 49 Vice President, Worldwide Logistics and Materials\nDonald R. Sterling 59 Vice President, Corporate Counsel and Secretary\nJohn G. Thompson 55 Vice President, Outsourcing\nKim B. Edwards joined the Company as President and Chief Executive Officer on January 1, 1994. Mr. Edwards served as President and Chief Executive Officer of Gates Energy Products, Inc., a manufacturer of rechargeable batteries and the successor of General Electric Battery Division, from March 1993 to December 1993. From January 1987 until March 1993, Mr. Edwards served in various other executive positions for Gates Energy Products, Inc., including Vice President and General Manager of its Consumer Business Unit and Vice President of Marketing and Sales. Prior to that, Mr. Edwards was employed for 18 years at General Electric Company in various marketing and sales positions.\nLeonard C. Purkis joined the Company as Senior Vice President, Finance and Chief Financial Officer in March 1995. Mr. Purkis also served as Treasurer of the Company from March 1995 until January 1996. Mr. Purkis joined Iomega following 12 years at General Electric Company, where his most recent assignment was as Senior Vice President of Finance at GE Capital Fleet Services. He also held positions in the Financial Services, Lighting and Plastics businesses, with assignments in Europe and the U.S.\nSrini Nageshwar was promoted to Senior Vice President, Europe in April 1991. Mr. Nageshwar joined the Company in January 1991 as Vice President, Europe. Prior to joining the Company, Mr. Nageshwar was Executive Vice President for Marketing, Sales and Operations of OAZ Communications, a network fax server company, from February 1990 to December 1990. Prior to that, he was President and Chief Operating Officer of Cumulus Corp., a memory peripherals manufacturing company, from January 1989 to February 1990. Prior to that, Mr. Nageshwar spent 24 years in marketing and general management positions with Hewlett-Packard, a computer company, most recently as Value- Added Business Manager.\nAnton J. Radman, Jr., has been Senior Vice President, Strategic Business Development since April 1995. Mr. Radman joined the Company in April 1980 and his previous positions with the Company have included Senior Vice President, Sales and Marketing, Senior Vice President, Corporate Development, President of the Bernoulli Optical Systems Co. (BOSCO) subsidiary of the Company, Vice President, Research and Development, Vice President, OEM Products and Sales Manager, and Senior Vice President, Micro Bernoulli Division.\nLeon J. Staciokas has been Senior Vice President and Chief Internal Operating Officer since April 1993. Mr. Staciokas joined the Company in August 1987 as Senior Vice President - Operations. He served as acting Chief Executive Officer of the Company from October 1993 until January 1994. Mr. Staciokas plans to retire during 1996, although he may continue with the Company for some period of time in a consulting role.\nM. Wayne Stewart joined the Company as Senior Vice President, Operations in January 1996. Prior to that, Mr. Stewart was Vice President of Global Manufacturing Concepts and Engineering Services at Whirlpool Corporation, a consumer appliance company, from January 1995 to December 1995. From September 1970 to December 1994, Mr. Steward was Manufacturing Manager for Hewlett- Packard.\nEdward D. Briscoe joined the Company as Vice President, Sales in January 1995. From May 1993 to January 1995, Mr. Briscoe was Director of Sales and Marketing for Apple Computer's Personal Interactive Electronics Division. Prior to that, Mr. Briscoe was Executive Assistant to the President of Apple USA. From July 1987 to April 1992, he held various sales management positions with Apple Computer, Inc. Previously, Mr. Briscoe was an Account Marketing Representative for IBM, Inc. From June 1984 to July 1987.\nReed M. Brown joined the Company as Vice President, Manufacturing in February 1996. Prior to that, Mr. Brown was Director of Manufacturing at Quantum Corporation, a manufacturer of hard disk drives, from March 1994 to January 1996. From January 1979 to February 1994, Mr. Brown was Production Manager for Hewlett-Packard Company.\nTimothy L. Hill joined the Company as Vice President, Marketing in July 1994. Mr. Hill was Vice President, Marketing of Falcon Microsystems, a federal reseller and systems integrator, from August 1993 to July 1994. Prior to that, Mr. Hill was Director of Marketing and Sales for the Consumer Business Division of Gates Energy Products from January 1988 to August 1993. Prior to January 1988, Mr. Hill was Marketing Manager for the Consumer Camera Products Division of Polaroid Corporation, a producer of photography equipment and supplies.\nWillard C. Kennedy joined the Company as Vice President, Worldwide Logistics and Materials in November 1995. From January 1994 to November 1995, he was Senior Vice President and General Manager of the Digital Videocommunications Systems for Philips Consumer Electronics. He also held positions at Philips Consumer Electronics as Vice President of Logistics from October 1992 to January 1994 and Vice President of Purchasing from September 1990 to October 1992. Before joining Philips, Mr. Kennedy held a variety of management positions in manufacturing, purchasing and engineering over a period of 20 years with General Electric Company.\nDonald R. Sterling was promoted to Vice President, Corporate Counsel and Secretary in April 1994. Prior to that, he was Vice President for Legal Affairs and Secretary from August 1993 to March 1994. Mr. Sterling joined the Company in September 1988.\nJohn G. Thompson has been Vice President, Outsourcing since January 1996. He was Vice President, Corporate Manufacturing from January 1993 to January 1996. Prior to that, Mr. Thompson was Vice President, Materials, Procurement and Engineering Services from March 1988 until January 1992. Mr. Thompson was Vice President\/Controller of the Company from January 1988 until March 1988.\nExecutive Officers are elected on an annual basis and serve at the discretion of the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS:\nThe information required by this item is found in the section entitled \"Securities\" of the Company's 1995 Annual Report, which section is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nThe information required by this item is found in the tables entitled \"Trends in Operations\" and \"Financial Conditions and Trends\" of the Company's 1995 Annual Report, which tables are incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nThe information required by this item is found in the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of the Company's 1995 Annual Report, which section is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nThe information required by this item is contained in the section entitled \"Financial and Operating Highlights\" of the Company's 1995 Annual Report, which section is incorporated herein by reference, and in the financial statements and schedules referred to in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a part of this Annual Report on Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:\nThe information required by this item appears in the section entitled \"ELECTION OF DIRECTORS - Nominees\" of the Company's Proxy Statement for its 1996 annual meeting of stockholders and the section of such Proxy Statement entitled \"ELECTION OF DIRECTORS - Board and Committee Meetings\", which sections are incorporated herein by reference. Information regarding the executive officers of the Company is furnished in Part I of this Annual Report on Form 10-K under the heading \"Executive Officers of the Company.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nThe information required by this item appears in the sections entitled \"ELECTION OF DIRECTORS -- Director's Compensation\", \"ELECTION OF DIRECTORS -- Executive Compensation\", \"ELECTION OF DIRECTORS -- Employment and Severance Agreements\" and \"ELECTION OF DIRECTORS -- Certain Business Relationships\" of the Company's Proxy Statement for its 1996 annual meeting of stockholders, which sections are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\nThe information required by this item is contained in the section entitled \"Beneficial Ownership of Common Stock\" of the Company's Proxy Statement for its 1996 annual meeting of stockholders, which section is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe information required by this item is contained in the sections entitled \"ELECTION OF DIRECTORS -- Employment and Severance Agreements\" and \"ELECTION OF DIRECTORS -- Certain Business Relationships\" of the Company's Proxy Statement for its 1996 annual meeting of stockholders, which sections are incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K:\n(a) The following documents are filed as part of or are included in this Annual Report on Form 10-K:\n1. The financial statements listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a part of this Annual Report on Form 10-K.\n2. The financial statement schedule listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a part of this Annual Report on Form 10-K.\n3. The exhibits listed in the Exhibit Index filed as a part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed by the Company during the last quarter of the year ended December 31, 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.\nIOMEGA CORPORATION\nBy: \/s\/ Kim B. Edwards Kim B. Edwards 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 the registrant and in the capacities and on the dates indicated.\nName Title Date ) \/s\/Kim B. Edwards Chief Executive Officer and ) Kim B. Edwards Director (Principal executive ) officer) ) ) \/s\/Leonard C. Purkis Senior Vice President-Finance and ) Leonard C. Purkis Chief Financial Officer (Principal) financial and accounting officer) ) ) \/s\/ David J. Dunn Chairman of the Board of Directors) David J. Dunn ) ) \/s\/ Willem H.J. Andersen Director ) Willem H.J. Andersen ) ) Director ) Robert P. Berkowitz ) ) Director ) Anthony L. Craig ) ) \/s\/ Michael J. Kucha Director ) Michael J. Kucha ) ) \/s\/ John R. Myers Director ) John R. Myers ) ) \/s\/ John E. Nolan, Jr. Director ) John E. Nolan, Jr. ) ) \/s\/ Johne E. Sheehan Director ) The Honorable ) John E. Sheehan )\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements appear in the Company's 1995 Annual Report to Stockholders and are incorporated herein by reference:\nDescription\nReport of Independent Public 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 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\nThe following schedule is included in this Annual Report on Form 10-K:\nDescription Page Reference\nReport of Independent Public Accountants on Consolidated Financial Statement Schedules . . . . . . . . . . . 21\nII - Valuation and Qualifying Accounts. . . . . . . . . 22\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULE\nTo Iomega Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Iomega Corporation's annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 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 on page 20 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/Arthur Andersen LLP ARTHUR ANDERSEN LLP\nSalt Lake City, Utah January 26, 1996\nIOMEGA CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n* Represents write-offs of Accounts Receivable\n** Credits granted against Accounts Receivable\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8, File Nos. 2-87671, 33-13083, 33-20432, 33-23822, 33-41083, 33-54438, 33-59027 and 33-62029.\n\/s\/ Arthur Andersen LLP ARTHUR ANDERSEN LLP\nSalt Lake City, Utah March 29, 1996\nEXHIBIT INDEX\nThe following exhibits are filed as part of this Annual Report on Form 10-K:\nExhibit Number Description - --------- ------------------------------- 3.1 (17) Restated Certificate of Incorporation of the Company, as amended\n3.2 (1) By-Laws of the Company, as amended\n4.1 (18) Indenture, dated March 13, 1996, between the Company and State Street Bank and Trust Company\n4.2 (7) Rights Agreement dated as of July 28, 1989 between the Company and The First National Bank of Boston, as Rights Agent\n4.2(a) (8) Amendment No. 1 dated September 24, 1990 to Rights Agreement dated as of July 28, 1989 between the Company and The First National Bank of Boston\n10.1 (11) Lease dated January 6, 1993 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 1\n10.1(a) Amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 1\n10.2 Lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 2\n10.3 (3) Lease dated November 9, 1992 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 3\n10.3(a) Amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 3\n10.4 (3) Lease dated November 9, 1992 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 4\n10.4(a) Amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 4\n10.5 (4) Lease Agreement dated October 29, 1984 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership (formerly with Western Mortgage Loan Corporation) (including an Amendment thereto dated January 30, 1986) relating to Iomega Park Building (Parking Lot) No. 5\n10.6 (11) Lease dated January 6, 1993 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 6\n10.6(a) Amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 6\n10.7 (2) Lease dated June 21, 1991 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 7\n10.7(a)(13) Amendment to Lease dated May 20, 1994 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 7\n10.7(b) Second amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 7\n10.8 (3) Lease dated November 9, 1992 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 8\n10.8(a) Amendment to lease dated August 14, 1995 between the Company and Damson\/Birtcher Realty Income Fund-II, Limited Partnership relating to Iomega Park Building No. 8\n10.9 Lease Agreement dated January 25, 1996 between the Company and Boyer Iomega LLC, by the Boyer Company, L.C., its Manager\n**10.10 (2) 1981 Stock Option Plan of the Company, as amended\n**10.11 (2) 1987 Stock Option Plan of the Company, as amended\n**10.12 (2) 1987 Director Option Plan of the Company, as amended\n**10.13 (18) 1995 Director Stock Option Plan of the Company, as amended\n**10.14 (2) Employment Letter dated January 11, 1991 between the Company and Srini Nageshwar\n**10.15 (13) Employment Letter dated November 29, 1993 between the Company and Kim Edwards\n**10.16 (3) Expatriate Agreement dated January 1, 1992 between the Company and Srini Nageshwar\n10.17 (3) Form of Indemnification Agreement between the Company and each of its directors\n10.18 (7) Rights Agreement dated as of July 28, 1989 between the Company and The First National Bank of Boston, as Rights Agent\n10.18(a)(8) Amendment No. 1 dated September 24, 1990 to Rights Agreement dated as of July 28, 1989 between the Company and The First National Bank of Boston\n10.19 (13) Indemnity Agreement, dated April 21, 1994 between the Company and Srini Nageshwar\n**10.20 (11) Secured Installment Promissory Note, dated September 17, 1993, between the Company and Fred Wenninger\n**10.21 (11) Letter Agreement, dated April 13, 1993, between the Company and Anton J. Radman, Jr.\n**10.22 (14) 1995 Iomega Incentive Plan\n**10.22(a)(15) 1995 Iomega Incentive Plan Awards for Named Executive Officers\n10.23 (14) Consulting Agreement with John Myers\n10.24 (16) Iomega Incentive Plan for Kim B. Edwards\n10.26 (16) Loan Agreement, dated July 5, 1995, between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.26(a)(16) Security Agreement, dated July 5, 1995, between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.26(b)16) Wells Fargo Continuing Commercial Letter of Credit Agreement, dated July 5, 1995\n10.26(c) First Amendment to Loan Agreement, dated August 24, 1995, between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.26(d) Second Amendment to Loan Agreement, dated October 16, 1995, between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.26(e) Third Amendment to Loan Agreement, dated November 30, 1995, between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.26(f) Fourth Amendment to Loan Agreement, dated January 12, 1996 between the Company and Wells Fargo Bank, N.A., Commercial Finance Division\n10.27 Master Lease Agreement, dated August 29, 1995, between the Company and USL Capital Corporation\n10.28 Loan Commitment Agreement, dated October 23, 1995, between the Company and Heller Financial, Inc., Commercial Equipment Finance Division\n10.29 Factoring Agreement, dated November 10, 1995, between Iomega Europe GmbH and Heller Bank, AG\n10.30 Revolving Loan Agreement, dated January 12, 1996, between the Company and First Security Bank of Utah, N.A.\n10.31 (17) Indenture, dated March 13, 1996, between the Company and State Street Bank and Trust Company\n13.1 Portions of the Company's 1995 Annual Report (which is not deemed to be \"filed\" except to the extent that portions thereof are expressly incorporated by reference in this Annual Report of Form 10-K)\n21.1 Subsidiaries of the Company\n23.1 Consent of Independent Public Accountants (appears on page 24 of this Annual Report on Form 10-K)\n- ------------ ** Management contract or compensation plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n(1) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended July 4, 1993.\n(2) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n(3) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(4) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n(5) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n(6) Incorporated herein by reference to the exhibits to the Company's Registration Statement on Form S-1 (File No. 2-96209).\n(7) Incorporated herein by reference to the exhibits to the Company's Current Report on Form 8-K filed on August 12, 1989.\n(8) Incorporated herein by reference to the exhibits to the Company's Amendment No. 1 to Current Report on Form 8-K filed on September 25, 1990.\n(9) Incorporated herein by reference to the exhibits to the Company's Amendment No. 1 to Annual Report on Form 10-K for the year ended December 31, 1992.\n(10) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended October 3, 1993.\n(11) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n(12) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended October 2, 1994.\n(13) Incorporated herein by reference to the exhibits to the Company's Annual Report on Form 10-K for the period ended December 31, 1994.\n(14) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended April 2, 1995.\n(15) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended July 2, 1995.\n(16) Incorporated herein by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the period ended October 1, 1995.\n(17) Incorporated herein by reference to the exhibits to the Company's Registration Statement on Form S-3. (File No. 33-64995)\n(18) Incorporated by reference to Appendix to the Company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders.","section_15":""}
{"filename":"725684_1995.txt","cik":"725684","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Cable TV Fund 11-B, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed pursuant to the public offering of limited partnership interests in the Cable TV Fund 11 Limited Partnership Program (the \"Program\"), which was sponsored by Jones Intercable, Inc. (the \"General Partner\"). Cable TV Fund 11-A, Ltd. (\"Fund 11-A\"), Cable TV Fund 11-C, Ltd. (\"Fund 11-C\") and Cable TV Fund 11-D, Ltd. (\"Fund 11-D\") are the other partnerships that were formed pursuant to the Program. The Partnership, Fund 11-A, Fund 11-C and Fund 11-D formed a general partnership known as Cable TV Joint Fund 11 (the \"Venture\") in which the Partnership owns an 8 percent interest, Fund 11-A owns an 18 percent interest, Fund 11-C owns a 27 percent interest and Fund 11-D owns a 47 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership directly owns cable television systems serving the communities of Lancaster, Lockport and Orchard Park, New York (the \"New York System\"), and the Venture operates a cable television system in Manitowoc, Wisconsin (the \"Manitowoc System\"). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe cable television systems owned by the Partnership and the Venture 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 New York System's cable plant passed approximately 57,700 homes, representing an approximate 68% penetration rate, and the Manitowoc System's cable plant passed approximately 16,000 homes, representing an approximate 71% 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.\nCABLE TV FUND 11-B, LTD. - ------------------------\nCABLE TV JOINT FUND 11 - ----------------------\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn January and February 1996, a special vote of the limited partners of the Partnership was conducted through the mails on behalf of the Partnership by the General Partner for the purpose of obtaining limited partner approval of the sale to Global Acquisition Partners, L.P. of the New York System for $84,000,000 in cash, subject to normal working capital closing adjustments. Limited partners of record at the close of business on December 31, 1995 were entitled to notice of, and to participate in, this vote of limited partners. Of the 38,026\nlimited partnership interests entitled to vote, 26,333 interests, or 69.25 percent, voted to approve the transaction, 76 interests, or .20 percent, voted against the transaction, 210 interests, or .55 percent, abstained from voting and 11,407 interests, or 30 percent, did not vote on the proposal. It is anticipated that the sale of the New York System will occur on or about April 1, 1996. See Item 1, Business.\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 3,164.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(a) Net income resulted primarily from the sale of the Grand Island System by Cable TV Fund 11-B, Ltd.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCABLE TV FUND 11-B, LTD.\nRESULTS OF OPERATIONS\n1995 compared to 1994\nRevenues of Cable TV Fund 11-B, Ltd. (the \"Partnership\") totaled $14,366,359 in 1995 as compared to $12,791,832 in 1994, an increase of $1,574,527, or approximately 12 percent. Basic rate increases accounted for approximately 64 percent of the increase in revenues. An increase in the subscriber base accounted for approximately 33 percent of the increase in revenues. The number of basic subscribers increased 2,116, or approximately 6 percent, to 39,735 at December 31, 1995 from 37,619 at December 31, 1994. No other factors individually were significant to the increase in revenues.\nOperating expenses consist primarily of costs associated with the administration of the Partnership's cable television 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 totaled $8,123,450 in 1995 compared to $7,459,002 in 1994, an increase of $664,448, or approximately 9 percent. Operating expenses represented approximately 57 percent of revenues in 1995 compared to approximately 58 percent of revenues in 1994. The increase in operating expenses was due to increases in programming fees and system maintenance costs, due, in part, to the increase in the subscriber base. These increases were offset, in part, by decreases in personnel related expense. No other factors individually were significant to the increase in the Partnership's operating expenses.\nManagement fees and allocated overhead from the General Partner totaled $1,755,599 in 1995 compared to $1,629,178 in 1994, an increase of $126,421, or approximately 8 percent, due to the increase in revenues, upon which such fees and allocations are based.\nDepreciation and amortization expense totaled $2,957,444 in 1995 compared to $2,379,471 in 1994, an increase of $577,973, or approximately 24 percent, due to capital additions in 1995 and 1994.\nOperating income totaled $1,529,866 in 1995 compared to $1,324,181 in 1994, an increase of $205,685, or approximately 16 percent, due to the increase in revenues exceeding the increases in operating expenses, management fees and allocated overhead from the General Partner and depreciation and amortization expense.\nThe cable television industry generally measures the 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 totaled $4,487,310 in 1995 compared to $3,703,652 in 1994, an increase of $783,658, or approximately 21 percent, due to the increase in revenues exceeding the increases in operating expenses and management fees and overhead from the General Partner.\nInterest expense totaled $1,773,876 in 1995 compared to $1,126,399 in 1994, an increase of $647,477, or approximately 57 percent, due to higher outstanding balances on interest bearing obligations and higher effective interest rates during 1995.\nThe Partnership recognized net loss before equity in net income of cable television joint venture of $194,179 in 1995 compared to income before equity in net income of cable television joint venture of $107,920 in 1994, a decrease of $302,099, due primarily to the increase in interest expense.\n1994 compared to 1993\nRevenues of the Partnership totaled $12,791,832 in 1994 compared to $11,922,307 in 1993, an increase of $869,525, or approximately 7 percent. An increase in basic subscribers primarily accounted for the increase in revenues. The number of basic subscribers increased 1,742, or approximately 5 percent, to 37,619 at December 31, 1994 from 35,877 at December 31, 1993. The increase in revenues would have been greater but for the reduction in basic rates due to basic rate regulations issued by the FCC in April 1993 with which the Partnership complied effective September 1, 1993. No other factors individually were significant to the increase in revenues.\nOperating expenses totaled $7,459,002 in 1994 compared to $7,476,761 in 1993, a decrease of $17,759, or less than 1 percent. Operating expenses represented approximately 58 percent of revenues in 1994 compared to approximately 63 percent in 1993. The decrease in operating expenses was due primarily to decreases in personnel related and marketing related expenses. These decreases were partially offset by increases in programming fees and plant maintenance costs. No other factors individually were significant to the decrease in operating expenses.\nManagement fees and allocated overhead from the General Partner totaled $1,629,178 in 1994 compared to $1,421,026 in 1993, an increase of $208,152, or approximately 15 percent, due to the increase in revenues, upon which such fees and allocations are based, and to an increase in expenses allocated from the General Partner. The General Partner experienced increases in expenses in 1994.\nDepreciation and amortization expense totaled $2,379,471 in 1994 compared to $1,899,145 in 1993, an increase of $480,326, or approximately 25 percent, due to capital additions in 1994 and 1993.\nOperating income totaled $1,324,181 in 1994 compared to $1,125,375 in 1993, an increase of $198,806, or approximately 18 percent, due to the increase in revenues exceeding the increases in operating expenses, management fees and allocated overhead from the General Partner and depreciation and amortization expense.\nInterest expense totaled $1,126,399 in 1994 compared to $636,263 in 1993, an increase of $490,136, or approximately 77 percent, due to higher outstanding balances on interest bearing obligations and higher effective interest rates.\nIncome before equity in net income of cable television joint venture totaled $107,920 in 1994 compared to $461,481 in 1993, a decrease of $353,561, or approximately 77 percent, due to the increase in interest expense exceeding the increase in operating income.\nIn addition to the New York System owned by it, the Partnership also owns an 8 percent interest in Cable TV Joint Fund 11 (\"Joint Fund 11\"). Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for Joint Fund 11 for details pertaining to its operation.\nFINANCIAL CONDITION\nOn October 6, 1995, the Partnership entered into an asset purchase agreement pursuant to which it agreed to sell the New York System to an unaffiliated cable television system operator for a sales price of $84,000,000. This transaction was approved by a majority of the Partnership's limited partnership interests in a vote conducted during the first quarter of 1996. The closing of the sale of the New York System is subject to the successful transfer of the New York System's franchises. Closing of this sale is expected to occur on or about April 1, 1996.\nUpon consummation of the proposed sale of the New York System, the Partnership will pay all of its indebtedness, which totaled approximately $23,808,000 at December 31, 1995, its sales tax liability of approximately $1,750,000 and a brokerage fee of $2,100,000 to The Jones Group, Ltd., a subsidiary of the General Partner, and then the Partnership will distribute the approximate $56,047,500 net proceeds to its partners of record as of February 29, 1996. Because limited partners have already received distributions in an amount equal to 100 percent of the capital initially contributed to the Partnership by the limited partners, the net proceeds from the New York System's sale will be distributed 75 percent to the limited partners and 25 percent to the General Partner. Based upon the pro forma financial information as of December 31, 1995, as a result of the New York System's sale, the limited partners of the Partnership, as a group, will receive approximately $42,035,600 and the General Partner will receive approximately $14,011,900. Limited partners will receive $1,105 for each $500 limited partnership interest, or $2,211 for each $1,000 invested in the\nPartnership, from the net proceeds of the New York System's sale. Once the distribution of the net proceeds from the sale of the New York System has been made, limited partners will have received a total of $1,605 for each $500 limited partnership interest, or $3,211 for each $1,000 invested in the Partnership, taking into account distributions to limited partners made in July 1990 and July 1992. The Partnership will continue to own its 8 percent interest in the Venture until the Manitowoc System also is sold. Upon the closing of the sale of the Partnership's New York System and the Venture's Manitowoc System, the Partnership will be liquidated and dissolved.\nOn September 5, 1995, Joint Fund 11 entered into an asset purchase agreement pursuant to which it agreed to sell the Manitowoc System to the General Partner for a sales price of $15,735,667, subject to normal working capital closing adjustments. The closing of the sale of the Manitowoc System is subject to a number of conditions, including the approval of the holders of a majority of the limited partnership interests in each of the four partnerships that comprise Joint Fund 11 in votes to be conducted in 1996 and the successful renewal and transfer of the Manitowoc System's franchise.\nIf the proposed sale of the Manitowoc System is closed, Joint Fund 11 will pay all of its indebtedness, which totaled $55,175 at December 1995, including $45,258 owed to the General Partner, and then the net sales proceeds plus cash on hand will be distributed to Joint Fund 11's partners in proportion to their ownership interests in Joint Fund 11. The Partnership accordingly will receive 8 percent of such proceeds, estimated to total approximately $1,432,700. Because limited partners will have already received distributions in an amount in excess of the capital initially contributed to the Partnership by the limited partners, the Partnership's portion of the net proceeds from the Manitowoc System's sale will be distributed 75 percent to the limited partners and 25 percent to the General Partner. Based upon pro forma financial information as of December 31, 1995, as a result of the Manitowoc System's sale, the limited partners of the Partnership, as a group, will receive approximately $1,074,500 and the General Partner will receive approximately $358,200. As a result, it is anticipated that the limited partners will receive approximately $28 for each $500 limited partnership interest, or approximately $57 for each $1,000 invested in the Partnership, from the Partnership's portion of the net proceeds of the Manitowoc System's sale. After the Partnership distributes its portion of the proceeds from the sale of the Manitowoc System to its partners, the Partnership will be dissolved and liquidated.\nThe Partnership expended approximately $4,143,000 on capital improvements during 1995. Of this total, approximately 34 percent related to the completion of the franchise required rebuild and upgrade of the New York System. Plant extensions and service drops to subscriber homes accounted for approximately 24 percent of the capital expenditures. Converters accounted for approximately 10 percent of the capital expenditures. The remainder of the expenditures were for various other enhancements in the New York System. Funding for these expenditures was provided primarily by cash generated from operations and borrowings under the Partnership's credit facility. Capital additions for 1996 will consist of expenditures necessary to maintain the value of the plant until the New York System is sold. Funding for these expenditures is expected to be provided by cash generated from operations and available borrowings from the Partnership's existing credit facility.\nOn February 28, 1995, the Partnership entered into a $25,000,000 revolving credit and term loan agreement. The revolving credit period expires January 1, 1997, at which time the outstanding balance converts to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1997. As of December 31, 1995, $23,600,000 was outstanding under this agreement, leaving $1,400,000 available for future needs of the Partnership. Interest payable on outstanding amounts is at the Partnership's option of the Base Rate plus 1\/2 percent or the London InterBank Offered Rate plus 1-3\/8 percent. This loan is expected to be paid in full upon closing of the sale of the New York System.\nThe Partnership has sufficient sources of capital available to meet its presently anticipated needs from its ability to generate cash from operations and from borrowings available under its credit facility.\nIn addition to the New York System owned by it, the Partnership owns an 8 percent interest in Joint Fund 11. This investment is accounted for under the equity method. When compared to the December 31, 1994 balance, this investment has increased by $35,314 from $550,483 at December 31, 1994 to $585,797 at December 31, 1995. This increase represents the Partnership's proportionate share of income generated by Joint Fund 11. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for Joint Fund 11 for details pertaining to its financial condition.\nREGULATION AND LEGISLATION\nThe Partnership has filed cost-of-service showings in response to rulemakings concerning the 1992 Cable Act for the New York System and thus anticipates no further reductions in rates in this system. The cost-of-service showings have\nnot yet received final approvals from regulatory authorities, however, and there can be no assurance that the Partnership's cost-of-service showings will prevent further rate reductions in this system 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 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.\nCABLE TV JOINT FUND 11\nRESULTS OF OPERATIONS\n1995 compared to 1994\nRevenues in Joint Fund 11's Manitowoc System totaled $3,632,675 in 1995 compared to $3,296,103 in 1994, an increase of $336,572, or approximately 10 percent. An increase in the subscriber base accounted for approximately 55 percent of the increase in revenues in 1995. The number of basic subscribers increased by 602 subscribers, or approximately 6 percent, to 11,436 at December 31, 1995 from 10,834 at December 31, 1994. The number of premium subscribers increased by 635 subscriptions, or approximately 9 percent, to 7,726 at December 31, 1995 from 7,091 at December 31, 1994. Basic service rate increases accounted for approximately 14 percent of the increase in revenues. An increase in advertising sales activity accounted for approximately 22 percent of the increase in revenues. No other individual factor contributed significantly to the increase in revenues.\nOperating expenses consist primarily of costs associated with the administration of the Manitowoc 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 in the Manitowoc System totaled $2,327,354 in 1995 compared to $2,026,763 in 1994, an increase of $300,591, or approximately 15 percent. Operating expenses represented approximately 64 percent of revenues in 1995 compared to approximately 61 percent of revenues in 1994. The increase in expenses was primarily due to an increase in programming fees, property tax expense and advertising sales related expenses. The increase in advertising sales related expenses was due, in part, to an increase in advertising sales activity. No other individual factor significantly affected the increase in operating expenses.\nManagement fees and allocated overhead from the General Partner totaled $463,691 for 1995 compared to $437,558 in 1994, an increase of $26,133, or approximately 6 percent. The increase was due to the increase in revenues, upon which such fees and allocations are based, and increases in allocated expenses from the General Partner.\nDepreciation and amortization expense totaled $545,237 in 1995 compared to $522,593 in 1994, an increase of $22,644, or approximately 4 percent, due to capital additions in 1995 and 1994.\nOperating income totaled $296,393 in 1995 compared to $309,189 in 1994, a decrease of $12,796, or approximately 4 percent. The decrease was due to the increases in operating expenses, management fees and allocated overhead from the General Partner and depreciation and amortization expense exceeding the increase in revenues.\nThe cable television industry generally measures the 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 totaled $841,630 for 1995 compared to $831,782 in 1994, an increase of $9,848, or approximately 1 percent. The increase was due to the increase in revenues exceeding the increases in operating expenses and management fees and allocated overhead from the General Partner.\nInterest income totaled $166,280 in 1995 compared to $87,134 in 1994, an increase of $79,146, or approximately 91 percent. This increase was due to higher cash balances and higher interest rates on interest-bearing accounts in 1995.\nInterest expense totaled $10,003 in 1995 compared to $15,716 in 1994, a decrease of $5,713, or approximately 36 percent. The decrease was due to lower outstanding balances on interest bearing obligations in 1995.\nNet income of Joint Fund 11 totaled $453,912 in 1995 compared to $373,181 in 1994, an increase of $80,731, or approximately 22 percent. The increase was due primarily to the increase in interest income.\n1994 compared to 1993\nRevenues in the Manitowoc System totaled $3,296,103 in 1994 compared to $3,292,675 in 1993, an increase of $3,428, or less than 1 percent. An increase in the subscriber base primarily accounted for the increase in revenues. Basic service subscribers increased 1,066, or approximately 11 percent, to 10,834 at December 31, 1994 from 9,768 at December 31, 1993. Premium service subscriptions increased 1,795, or approximately 34 percent, to 7,091 at December 31, 1994 from 5,296 at December 31, 1993. The increase in revenues would have been greater but for reductions in basic service rates due to basic service rate regulations issued by the FCC in May 1993 and February 1994. No other individual factor was significant to the increase in revenues.\nOperating expenses in the Manitowoc System totaled $2,026,763 in 1994 compared to $1,947,068 in 1993, an increase of $79,695, or approximately 4 percent. The increase in operating expenses was due primarily to increases in programming fees and marketing related costs due to increases in basic service subscribers and premium service subscriptions. These increases were partially offset by a decrease in copyright fees. No other individual factor contributed significantly to the increase in operating expenses. Operating expenses represented approximately 61 percent of revenues in 1994 compared to approximately 59 percent of revenues in 1993.\nManagement fees and allocated overhead from the General Partner totaled $437,558 in 1994 compared to $411,577 in 1993, an increase of $25,981, or approximately 6 percent. The increase was due to an increase in allocated expenses from the General Partner. The General Partner experienced increases in expenses in 1994.\nDepreciation and amortization expense totaled $522,593 in 1994 compared to $517,441 in 1993, an increase of $5,152, or approximately 1 percent, due to capital additions in 1994 and 1993.\nOperating income in the Manitowoc System totaled $309,189 in 1994 compared to $416,589 in 1993, a decrease of $107,400, or approximately 26 percent. The decrease was due to the increases in operating expenses, allocated overhead from the General Partner and depreciation and amortization expense exceeding the increase in revenues.\nInterest expense for Joint Fund 11 totaled $15,716 in 1994 compared to $22,912 in 1993, a decrease of $7,196, or approximately 31 percent, due to a lower outstanding balance on interest bearing obligations. Other expense totaled $7,426 in 1994 compared to $248,912 in 1993, primarily as a result of Joint Fund 11 incurring costs associated with the litigation with the City of Manitowoc during 1993. No such costs were incurred in 1994.\nNet income for Joint Fund 11 totaled $373,181 in 1994 compared to $246,536 in 1993, an increase of $126,645, or approximately 51 percent, due primarily to the decrease in litigation costs discussed above.\nFINANCIAL CONDITION\nOn September 5, 1995, Joint Fund 11 entered into an asset purchase agreement pursuant to which it agreed to sell the Manitowoc System to the General Partner for a sales price of $15,735,667, subject to normal working capital closing adjustments. This sales price is the average of three separate independent appraisals of the fair market value of the Manitowoc System and the General Partner's offer was the only bid tendered in a public bidding process for the Manitowoc System. The General Partner assigned its rights and obligations under the asset purchase agreement to Jones Cable Holdings, Inc. (\"JCH\"), a wholly owned subsidiary of the General Partner. The closing of the sale will occur on a date upon which Joint Fund 11 and JCH mutually agree by September 30, 1996. The sale of the Manitowoc System is subject to a number of conditions, including approval of the transaction by the holders of a majority of the Partnership's limited partnership interests and approvals from governmental authorities and other third parties necessary to the transfer of the Manitowoc System. If all conditions precedent to JCH's obligation to close are not eventually satisfied or waived, JCH's obligation to purchase the Manitowoc System will terminate on September 30, 1996.\nIn order to sell the Manitowoc System, Joint Fund 11 must obtain the consent of the City of Manitowoc and third parties with whom Joint Fund 11 has contracts related to the Manitowoc System, such as pole attachment agreements or other service agreements, to the transfer thereof. Joint Fund 11 was unsuccessful in its efforts to sell the Manitowoc System in June 1990, at the time of Joint Fund 11's sale of its remaining Wisconsin cable television systems, due to the refusal of the City of Manitowoc to consent to the transfer of the system's franchise. Negotiations with the City of Manitowoc with respect to the renewal and transfer of the Manitowoc System's franchise are continuing, and the Manitowoc System currently is being operated pursuant to a temporary extension of the franchise's term until March 29, 1996. The General Partner hopes that the City ultimately will agree to the renewal and transfer of the franchise and that the City will not take any action that will prevent the closing of the sale of the Manitowoc System, but given the current status of negotiations with the City there can be no assurance that the sale will occur as planned.\nIf the proposed sale of the Manitowoc System is closed, Joint Fund 11 intends to distribute the sale proceeds, after the repayment of debt, to Cable TV Fund 11-A, Ltd., Cable TV Fund 11-B, Ltd., Cable TV Fund 11-C, Ltd. and Cable TV Fund 11-D, Ltd. Net sales proceeds plus Joint Fund 11's cash on hand, which are expected to total approximately $18,420,800, will be distributed as follows: Cable TV Fund 11-A, Ltd. will receive approximately $3,356,700; Cable TV Fund 11-B, Ltd. will receive approximately $1,432,700; Cable TV Fund 11-C, Ltd. will receive approximately $4,994,100 and Cable TV Fund 11-D, Ltd. will receive approximately $8,637,300. After Joint Fund 11 distributes the proceeds from the sale of the Manitowoc System to its partners, Joint Fund 11 will be liquidated and dissolved.\nJoint Fund 11 had no bank debt outstanding at December 31, 1995.\nDuring 1995, Joint Fund 11 expended approximately $311,000 for capital expenditures in the Manitowoc System. These expenditures were used for various projects to maintain the value of the system. These expenditures were funded from cash generated from operations.\nCapital expenditures in 1996 for the Manitowoc System will consist of expenditures necessary to maintain the value of the Manitowoc System until it is sold. It is expected that these capital expenditures will be funded from cash on hand and cash generated from operations. Joint Fund 11 has sufficient liquidity and capital resources, including cash on hand and its ability to generate cash from operations, to meet its anticipated needs.\nREGULATION AND LEGISLATION\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 Joint Fund 11 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 Joint Fund 11 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 Joint Fund 11. See Item 1.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nCABLE TV FUND 11-B, LTD. AND CABLE TV JOINT FUND 11\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1995 AND 1994\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Fund 11-B, Ltd.:\nWe have audited the accompanying balance sheets of CABLE TV FUND 11-B, LTD. (a Colorado 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 General Partner's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cable TV Fund 11-B, 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.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1996.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B, LTD. (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Fund 11-B, Ltd. (the \"Partnership\"), a Colorado limited partnership, was formed on June 17, 1983, under a public program sponsored by Jones Intercable, Inc. The Partnership was formed to acquire, construct, develop and operate cable television systems. Jones Intercable, Inc. (\"Intercable\"), a publicly held Colorado corporation, is the \"General Partner\" and manager of the Partnership. Intercable and its subsidiaries also own and operate cable television systems. In addition, Intercable manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nThe Partnership owns and operates the cable television system serving the municipalities of Lancaster, Lockport and Orchard Park, New York (the \"New York System\"). In addition to the New York System, the Partnership owns an 8 percent interest in Cable TV Joint Fund 11 (\"Joint Fund 11\") through capital contributions made during 1984 of $3,500,000. Joint Fund 11 owns and operates the cable television system serving the city of Manitowoc, Wisconsin (the \"Manitowoc System\").\nProposed Sales of Cable Television Systems\nOn October 6, 1995, the Partnership entered into an asset purchase agreement pursuant to which it agreed to sell the New York System to an unaffiliated cable television system operator for a sales price of $84,000,000. This transaction was approved by a majority of the Partnership's limited partnership interests in a vote conducted during the first quarter of 1996. The closing of the sale of the New York System is subject to the successful transfer of the New York System's franchises. Closing of this sale is expected to occur on or about April 1, 1996.\nUpon consummation of the proposed sale of the New York System, the Partnership will pay all of its indebtedness, which totaled approximately $23,808,000 at December 31, 1995, its sales tax liability of approximately $1,750,000 and a brokerage fee of $2,100,000 to The Jones Group, Ltd., a subsidiary of the General Partner, and then the Partnership will distribute the approximate $56,047,500 net proceeds to its partners of record as of February 29, 1996. Because limited partners have already received distributions in an amount equal to 100 percent of the capital initially contributed to the Partnership by the limited partners, the net proceeds from the New York System's sale will be distributed 75 percent to the limited partners and 25 percent to the General Partner. Based upon the pro forma financial information as of December 31, 1995, as a result of the New York System's sale, the limited partners of the Partnership, as a group, will receive approximately $42,035,600 and the General Partner will receive approximately $14,011,900. Limited partners will receive $1,105 for each $500 limited partnership interest, or $2,211 for each $1,000 invested in the Partnership, from the net proceeds of the New York System's sale. Once the distribution of the net proceeds from the sale of the New York System has been made, limited partners will have received a total of $1,605 for each $500 limited partnership interest, or $3,211 for each $1,000 invested in the Partnership, taking into account distributions to limited partners made in July 1990 and July 1992. The Partnership will continue to own its 8 percent interest in the Venture until the Manitowoc System also is sold. Upon the closing of the sale of the Partnership's New York System and the Venture's Manitowoc System, the Partnership will be liquidated and dissolved.\nOn September 5, 1995, Joint Fund 11 entered into an asset purchase agreement pursuant to which it agreed to sell the Manitowoc System to the General Partner for a sales price of $15,735,667, subject to normal working capital closing adjustments. The closing of the sale of the Manitowoc System is subject to a number of conditions, including the approval of the holders of a majority of the limited partnership interests in each of the four partnerships that comprise Joint Fund 11 in votes to be conducted in 1996 and the successful renewal and transfer of the Manitowoc System's franchise.\nIf the proposed sale of the Manitowoc System is closed, Joint Fund 11 will pay all of its indebtedness, which totaled $55,175 at December 1995, including $45,258 owed to the General Partner, and then the net sales proceeds plus cash on hand will be distributed to Joint Fund 11's partners in proportion to their ownership interests in Joint Fund 11. The Partnership\naccordingly will receive 8 percent of such proceeds, estimated to total approximately $1,432,700. Because limited partners will have already received distributions in an amount in excess of the capital initially contributed to the Partnership by the limited partners, the Partnership's portion of the net proceeds from the Manitowoc System's sale will be distributed 75 percent to the limited partners and 25 percent to the General Partner. Based upon pro forma financial information as of December 31, 1995, as a result of the Manitowoc System's sale, the limited partners of the Partnership, as a group, will receive approximately $1,074,500 and the General Partner will receive approximately $358,200. As a result, it is anticipated that the limited partners will receive approximately $28 for each $500 limited partnership interest, or approximately $57 for each $1,000 invested in the Partnership, from the Partnership's portion of the net proceeds of the Manitowoc System's sale. After the Partnership distributes its portion of the proceeds from the sale of the Manitowoc System to its partners, the Partnership will be dissolved and liquidated.\nContributed Capital\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital. No limited partner is obligated to make any additional contribution to partnership capital.\nIntercable purchased its interest in the Partnership by contributing $1,000 to partnership capital.\nAll profits and losses of the Partnership are allocated 99 percent to the limited partners and 1 percent to Intercable, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the partnership agreement and interest income earned prior to the first acquisition by the Partnership of a cable television system, which was allocated 100 percent to the limited partners.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Partnership's tax returns are also prepared on the accrual basis.\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 Partnership's investment in Joint Fund 11 is accounted for under the equity method due to the Partnership's influence on Joint Fund 11 as a general partner. When compared to the December 31, 1994 balance, this investment has increased by $35,314. This increase represents the Partnership's proportionate share of income generated by Joint Fund 11 during 1995. The operations of Joint Fund 11 are significant to the Partnership and should be reviewed in conjunction with these financial statements. Reference is made to the accompanying financial statements of Joint Fund 11 on pages 35 to 43.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nAllocation of Cost of Purchased Cable Television Systems\nThe Partnership allocated the total contract purchase price of cable television systems acquired as follows: first, to the fair value of net tangible assets acquired; second, to the value of subscriber lists; and third, to franchise costs. Brokerage fees paid to an affiliate of Intercable and other system acquisition costs were capitalized and charged to distribution systems.\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\nReclassification\nCertain prior year amounts have been reclassified to conform to the 1995 presentation.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees, Distribution Ratios and Reimbursement\nIntercable manages the Partnership and receives a fee for its services equal to 5 percent of the gross revenues of the Partnership, excluding revenues from the sale of cable television systems or franchises. For the years ended December 31, 1995, 1994 and 1993 management fees paid to Intercable, excluding the Partnership's 8 percent interest in Joint Fund 11, were $718,318, $639,592, and $596,115, respectively.\nAny partnership distributions made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses) are allocated 99 percent to the limited partners and 1 percent to Intercable. Any distributions other than interest income on limited partner subscriptions earned prior to the acquisition of the Partnership's first cable television system or from cash flow, such as from the sale or refinancing of the system or upon dissolution of the Partnership, will be made as follows: first, to the limited partners in an amount which, together with all prior distributions, will equal the amount initially contributed to the Partnership capital by the limited partners; the balance, 75 percent to the limited partners and 25 percent to Intercable. In July 1990, $9,153,740 of the limited partners' initial capital contributions was distributed to the limited partners from funds received from Joint Fund 11. In July 1992, the remaining amount of limited partners' initial capital ($9,859,381) was distributed to the limited partners from funds received from the sale of the Grand Island System. Any future distributions will be made 75 percent to the limited partners and 25 percent to Intercable.\nThe Partnership reimburses Intercable for certain allocated overhead and administrative expenses. These expenses represent the salaries and related benefits paid to corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Partnership. These reimbursements are limited to 25 percent of the gross revenues of the Partnership. Allocations of personnel costs are primarily based upon actual time spent by employees of Intercable with respect to each partnership managed. Remaining 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 Intercable and all other systems owned by partnerships for which Intercable is the general partner are also allocated a proportionate share of these expenses. The General Partner believes that the methodology used in allocating overhead and administrative expenses is reasonable. Reimbursements by the Partnership to the General Partner for allocated overhead and administrative expenses, excluding the Partnership's 8 percent interest in Joint Fund 11, were $1,037,281, $989,586 and $824,911 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Partnership was charged interest during 1995 at an average interest rate of 10.51 percent on amounts due Intercable, which approximated Intercable's weighted average cost of borrowings. Total interest charged by the General Partner to the Partnership was $13,980, $14,287 and $13,350 in 1995, 1994 and 1993, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Partnership 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 approximately $21,712, $21,977 and $21,590 in 1995, 1994 and 1993, respectively. Payments to Mind Extension University totaled approximately $23,227, $19,914 and $12,565 in 1995, 1994 and 1993, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $46,392 and $-0- in 1995 and 1994, respectively.\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 $38,629 and $186 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:\nOn February 28, 1995, the Partnership entered into a $25,000,000 revolving credit and term loan agreement. The revolving credit period expires January 1, 1997, at which time the outstanding balance converts to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1997. Proceeds from this credit facility were used to repay amounts outstanding under the Partnership's previous credit facility, repay amounts due the General Partner and fund capital expenditures. As of December 31, 1995, $23,600,000 was outstanding under this agreement, leaving $1,400,000 available for future needs of the Partnership. Interest payable on outstanding amounts is at the Partnership's option of the Base Rate plus 1\/2 percent or the London InterBank Offered Rate plus 1-3\/8 percent. The effective interest rates on outstanding obligations as of December 31, 1995 and 1994 were 7.03 percent and 6.77 percent, respectively. This loan is expected to be paid in full upon closing of the sale of the New York System.\nInstallments due on debt principal for each of the five years in the period ending December 31, 2000 and thereafter, $62,355, $2,894,355, $3,602,355, $3,796,784, $4,248,000 and $9,204,000. Substantially all of the Partnership's property, plant and equipment are pledged as security for the above indebtedness.\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(6) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners. The Federal and state income tax returns of the Partnership are prepared and filed by Intercable.\nThe Partnership's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to the Partnership's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable income reported to the partners is different from that reported in the statements of operations due to the difference in depreciation allowed under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income or losses and the net income or losses reported in the statements of operations.\n(7) COMMITMENTS AND CONTINGENCIES\nThe Partnership has filed cost-of-service showings in response to rulemakings concerning the 1992 Cable Act for the New York System and thus anticipates no further reductions in rates in this system. The cost-of-service showings have not yet received final approvals from regulatory authorities, however, and there can be no assurance that the Partnership's cost-of-service showings will prevent further rate reductions in this system until such final approvals are received.\nThe Partnership rents office and other facilities under various long-term lease arrangements. Rent expense paid under such lease arrangements totaled $9,145, $16,093 and $31,480, 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 is presented below:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Joint Fund 11:\nWe have audited the accompanying balance sheets of CABLE TV JOINT FUND 11 (a Colorado general partnership) as of December 31, 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 General Partners' management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cable TV Joint Fund 11 as of December 31, 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\nDenver, Colorado, March 8, 1996.\nCABLE TV JOINT FUND 11 (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV JOINT FUND 11 (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Joint Fund 11 (\"Joint Fund 11\"), a Colorado general partnership, was formed on February 1, 1984, through a joint venture agreement made by and among Cable TV Fund 11-A, Ltd. (\"Fund 11-A\"), Cable TV Fund 11-B, Ltd. (\"Fund 11-B\"), Cable TV Fund 11-C, Ltd. (\"Fund 11-C\") and Cable TV Fund 11-D, Ltd (\"Fund 11-D\"), all Colorado limited partnerships (the \"Joint Venture Partners\"). Joint Fund 11 was formed to acquire, construct, develop and operate cable television systems. Joint Fund 11 owns and operates the cable television system serving the areas in and around the city of Manitowoc, Wisconsin (the \"Manitowoc System\"). Jones Intercable, Inc. (\"Intercable\"), who is the \"General Partner\" of each of the Joint Venture Partners, manages Joint Fund 11. Intercable and its subsidiaries also own and operate other 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.\nProposed Sale of Cable Television System\nOn September 5, 1995, Joint Fund 11 entered into an asset purchase agreement pursuant to which it agreed to sell the Manitowoc System to the General Partner for a sales price of $15,735,667, subject to normal working capital closing adjustments. This sales price is the average of three separate independent appraisals of the fair market value of the Manitowoc System and the General Partner's offer was the only bid tendered in a public bidding process for the Manitowoc System. The General Partner assigned its rights and obligations under the asset purchase agreement to Jones Cable Holdings, Inc. (\"JCH\"), a wholly owned subsidiary of the General Partner. The closing of the sale will occur on a date upon which Joint Fund 11 and JCH mutually agree by September 30, 1996. The sale of the Manitowoc System is subject to a number of conditions, including approval of the transaction by the holders of a majority of the Partnership's limited partnership interests and approvals from governmental authorities and other third parties necessary to the transfer of the Manitowoc System. If all conditions precedent to JCH's obligation to close are not eventually satisfied or waived, JCH's obligation to purchase the Manitowoc System will terminate on September 30, 1996.\nIn order to sell the Manitowoc System, Joint Fund 11 must obtain the consent of the City of Manitowoc and third parties with whom Joint Fund 11 has contracts related to the Manitowoc System, such as pole attachment agreements or other service agreements, to the transfer thereof. Joint Fund 11 was unsuccessful in its efforts to sell the Manitowoc System in June 1990, at the time of Joint Fund 11's sale of its remaining Wisconsin cable television systems, due to the refusal of the City of Manitowoc to consent to the transfer of the system's franchise. Negotiations with the City of Manitowoc with respect to the renewal and transfer of the Manitowoc System's franchise are continuing, and the Manitowoc System currently is being operated pursuant to a temporary extension of the franchise's term until March 29, 1996. The General Partner hopes that the City ultimately will agree to the renewal and transfer of the franchise and that the City will not take any action that will prevent the closing of the sale of the Manitowoc System, but given the current status of negotiations with the City there can be no assurance that the sale will occur as planned.\nIf the proposed sale of the Manitowoc System is closed, Joint Fund 11 will pay all of its indebtedness, which totaled $55,175 at December 1995, including $45,258 owed to the General Partner, and then the net sales proceeds plus cash on hand will be distributed to the Joint Venture Partners in proportion to their ownership interests in Joint Fund 11. The net sales proceeds will be distributed as follows: Fund 11-A will receive approximately $3,356,700; Fund 11-B will receive approximately $1,432,700; Fund 11-C will receive approximately $4,994,100 and Fund 11-D will receive approximately $8,637,300.\nContributed Capital, Sharing Ratios and Distribution\nThe capitalization of Joint Fund 11 is set forth in the accompanying statements of partners' capital. Profits and losses of Joint Fund 11 are allocated to the partners in proportion to their respective partnership interests.\nAll partnership distributions, including those made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses), from the sale or refinancing of partnership property and on dissolution of Joint Fund 11, are made to the partners also in proportion to their approximate respective interests in Joint Fund 11 as follows:\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. Joint Fund 11's tax returns are also prepared on the accrual basis.\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 determined using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises and subscriber lists were amortized using the straight-line method over their estimated useful lives.\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\n(3) TRANSACTIONS WITH JONES INTERCABLE, INC. AND AFFILIATES\nManagement Fees and Reimbursements\nIntercable manages Joint Fund 11 and receives a fee for its services equal to 5 percent of the gross revenues, excluding revenues from the sale of the cable television systems or franchises. Management fees paid to Intercable during 1995, 1994 and 1993 were $181,634, $164,805 and $164,634, respectively.\nIntercable is reimbursed for certain allocated overhead and administrative expenses. These expenses represent the salaries and related benefits paid to corporate personnel, rent, data processing services and other corporate facilities costs.\nSuch personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to Joint Fund 11. Allocations of personnel costs are primarily based upon actual time spent by employees of Intercable with respect to each partnership managed. Remaining 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 is the general partner are also allocated a proportionate share of these expenses. Intercable believes that the methodology used in allocating overhead and administrative expenses is reasonable. The amount of allocated overhead and administrative expenses charged to Joint Fund 11 during 1995, 1994 and 1993 was $282,057, $272,753 and $246,943, respectively.\nJoint Fund 11 was charged interest during 1995 at an average interest rate of 10.5 percent on the amounts due Intercable, which approximated Intercable's weighted average cost of borrowings. Total interest charged during 1995, 1994 and 1993 was $6,848, $13,306 and $21,071, respectively.\nPayments to\/from Affiliates for Programming Services\nJoint Fund 11 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 $6,318, $6,105 and $6,040 in 1995, 1994 and 1993, respectively. Payments to Mind Extension University totaled $6,759, $5,532 and $3,515 in 1995, 1994 and 1993, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $12,760 and $3,316 in 1995 and 1994, respectively.\nJoint Fund 11 receives a commission from Product Information Network based on a percentage of advertising revenue and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to Joint Fund 11 totaling $4,559 and $510 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 capital lease obligations with maturities of 1 to 4 years. Installments due on debt principal for the five years in the period ending December 31, 2000, respectively, are: $2,776, $2,776, $2,776, $1,589, and $-0-.\n(6) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue to the partners of Funds 11-A, 11-B, 11-C and 11-D, which are general partners in Joint Fund 11.\nJoint Fund 11's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable partnership income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes with respect to the Joint\nFund 11's qualification as such, or in changes with respect to Joint Fund 11's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable income reported to the partners is different from that reported in the statements of operations due to the difference in depreciation allowed under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income and the net income reported in the statements of operations.\n(7) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information is presented below:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nGlenn R. Jones 66 Chairman of the Board and Chief Executive Officer Derek H. Burney 56 Vice Chairman of the Board James B. O'Brien 46 President and Director Ruth E. Warren 46 Group Vice President\/Operations Kevin P. Coyle 44 Group Vice President\/Finance Christopher J. Bowick 40 Group Vice President\/Technology George H. Newton 61 Group Vice President\/Telecommunications Timothy J. Burke 45 Group Vice President\/Taxation\/Administration Raymond L. Vigil 49 Group Vice President\/Human Resources and Director Cynthia A. Winning 44 Group Vice President\/Marketing Elizabeth M. Steele 44 Vice President\/General Counsel\/Secretary Larry W. Kaschinske 36 Controller Robert E. Cole 63 Director William E. Frenzel 67 Director Donald L. Jacobs 57 Director James J. Krejci 54 Director John A. MacDonald 42 Director William E. Frenzel 67 Director Raphael M. Solot 62 Director Daniel E. Somers 48 Director Howard O. Thrall 48 Director Robert B. Zoellick 42 Director\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\nIndividual 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. 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 Derek H. Burney, John A. MacDonald and Daniel E. Somers are directors 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 Partnership and the Venture. Such personnel are employed by the General Partner and, the cost of such employment is charged by the General Partner to the Partnership or 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 Partnership and the Venture. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Partnership or the Venture from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Partnership or the Venture from unaffiliated parties.\nThe General Partner charges a management fee, and the General Partner is reimbursed 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 Partnership and 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 receive stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party, educational video programming from Mind Extension University, Inc., an affiliate of the General Partner, and computer video programming from Jones Computer Network, Ltd., an affiliate of the General Partner, for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Systems. In consideration, the revenues generated from the third parties are shared between PIN and the Partnership and the Venture. During the year ended December 31, 1995, the Partnership received revenues from PIN of $38,629, and the Venture received revenues from PIN of $4,559.\nThe charges to the Partnership and the Venture for related party transactions are as follows for the periods indicated:\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. See index to financial statements for the list of financial statements and exhibits thereto filed as part of this report.\n3. The following exhibits are filed herewith.\n2.1 Asset Purchase Agreement dated September 5, 1995 between Cable TV Joint Fund 11 and Jones Intercable, Inc. relating to the Manitowoc System. (1)\n2.2 Purchase and Sale Agreement dated October 6, 1995 among Cable TV Fund 11-B, Ltd., Jones Intercable, Inc. and Global Acquisition Partners, L.P.\n4.1 Limited Partnership Agreement of Cable TV Fund 11-B, Ltd. (2)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Manitowoc, Wisconsin. (Joint Fund 11) (2)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Barker, New York. (Fund 11-B) (3)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Clarence, New York. (Fund 11-B)\n10.1.4 Copy of order renewing franchise adopted 12\/11\/91. (Fund 11-B) (4)\n10.1.5 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Cheektowaga, New York. (Fund 11-B) (5)\n10.1.6 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Elma, New York. (Fund 11-B) (2)\n10.1.7 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Lancaster, New York. (Fund 11-B)\n10.1.8 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (4)\n10.1.9 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Lancaster, New York. (Fund 11-B) (2)\n10.1.10 Copy of renewal order adopted 5\/4\/88. (Fund 11-B) (4)\n10.1.11 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Lockport, New York. (Fund 11-B) (4)\n10.1.12 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Newfane, New York. (Fund 11-B) (2)\n10.1.13 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (4)\n10.1.14 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town and Village of Orchard Park, New York. (Fund 11-B)\n10.1.15 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Somerset, New York. (Fund 11-B) (3)\n10.2.1 Copy of Credit Agreement dated as of February 28, 1995 among the Registrant, various financial institutions as lenders and Shawmut Bank Connecticut, N.A., as agent for the lenders\n27 Financial Data Schedule\n(1) Incorporated by reference from Registrant's Report on Form 8-K dated September 8, 1995.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1985.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.\n(b) Reports on Form 8-K. 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.\nCABLE TV FUND 11-B, LTD. a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones ------------------------------- Glenn R. Jones Chairman of the Board and Chief Dated: March 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\nEXHIBIT INDEX\nExhibit Number Exhibit Description Page - ------- ------------------- ----\n2.1 Asset Purchase Agreement dated September 5, 1995 between Cable TV Joint Fund 11 and Jones Intercable, Inc. relating to the Manitowoc System. (1)\n2.2 Purchase and Sale Agreement dated October 6, 1995 among Cable TV Fund 11-B, Ltd., Jones Intercable, Inc. and Global Acquisition Partners, L.P.\n4.1 Limited Partnership Agreement of Cable TV Fund 11-B, Ltd. (2)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Manitowoc, Wisconsin. (Joint Fund 11) (2)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Barker, New York. (Fund 11-B) (3)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Clarence, New York. (Fund 11-B)\n10.1.4 Copy of order renewing franchise adopted 12\/11\/91. (Fund 11-B) (4)\n10.1.5 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Cheektowaga, New York. (Fund 11-B) (5)\n10.1.6 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Elma, New York. (Fund 11-B) (2)\n10.1.7 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Lancaster, New York. (Fund 11-B)\n10.1.8 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (4)\n10.1.9 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Lancaster, New York. (Fund 11-B) (2)\n10.1.10 Copy of renewal order adopted 5\/4\/88. (Fund 11-B) (4)\n10.1.11 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Lockport, New York. (Fund 11-B) (4)\n10.1.12 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Newfane, New York. (Fund 11-B) (2)\n10.1.13 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (4) EXHIBIT INDEX\nExhibit Number Exhibit Description Page - ------- ------------------- ----\n10.1.14 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town and Village of Orchard Park, New York. (Fund 11-B)\n10.1.15 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Somerset, New York. (Fund 11-B) (3)\n10.2.1 Copy of Credit Agreement dated as of February 28, 1995 among the Registrant, various financial institutions as lenders and Shawmut Bank Connecticut, N.A., as agent for the lenders\n27 Financial Data Schedule\n(1) Incorporated by reference from Registrant's Report on Form 8-K dated September 8, 1995.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1985.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.","section_15":""}
{"filename":"92284_1995.txt","cik":"92284","year":"1995","section_1":"Item 1. Business\n(a) General\nDue to the Company's development and finance division's acquiring and selling properties, the number of properties owned, operated, leased and the number of wrap around mortgages held fluctuates constantly. The table below show the various different business holdings for the last five years.\nNote 1. On August 15, 1990, the Company acquired Downtowner passport International Motel Corporation, the owner of Downtowner and Passport registered marks. This acquisition of corporate stock was in the nature of a conveyance in satisfaction of debt. In late 1991 the Company deemed the 1990 acquisition to be flawed and in February of 1992, the Company acquired the assets of Passport International Motel Corporation for assumption of debt and simultaneously conveyed same to Hospitality International, Inc. the Company's franchising subsidiary, for the same consideration.\nNote 2. One property leased from a third party is being operated as a restaurant by Company's sub-lessee.\n(b) Segment Information - Note 3\nThe Company identifies its significant industry segments as set forth in the table below. All revenue items represent sales to unaffiliated customers, as sales or transfers between industry segments are negligible.\n* Included in Financing & Property Development Information.\n(c) Description of Business\n(I) Products and Services\nThe Company's franchise division offers advertising, reservation, group sales, quality assurance and consulting services to motel owner\/operators.\nThe Company's Financing division provides owner financing to persons acquiring motel properties previously operated and\/or owned by the Company. For amounts of revenue of similar products and services in excess of 15% total, see Item 1 (b) above.\n(II) Status of Products and Segments\nEach of the Company's industry segments is fully developed with an operational history of several years under Company's direction.\n(III) Raw Materials\nIn a sense, independent motel operations seeking national affiliation for their properties constitute raw materials for the Company's franchising division, and sites suitable for development and existing properties which may be acquired constitute raw materials for both the Company's lodging division and its financial division.\nTo date, the Company has experienced little difficulty in obtaining information on locations to be reviewed by either its franchise committee or its evaluation committee.\n(IV) Patents, Trademarks, Licenses, Franchises, and Concessions\nThe Company has no patents. The Company does own the trade names \"Master Hosts Inns,\" \"Red Carpet Inns,\" \"Scottish Inns,\" \"Downtowner Inns,\" \"Passport Inns\" and related trademarks, etc. used in operating lodging facilities under these names.\n(V) Seasonability\nThe Company's financing business by its nature is not subject to seasonal fluctuations. The revenues from the Company's franchising division tends to be concentrated in the Spring and Summer months during peak travel periods.\n(VI) Working Capital\nThe Company's financing receipts are comprised primarily of interest which does not become reflected on its balance sheet until after it is earned, whereas its payments on underlying debts are comprised primarily of principal reduction and the portion which will be returned over the next twelve months is reflected on the balance sheet as a current liability. Because of this, the Company believes a current ratio of less than one to one is appropriate for its business. However, the Company continues to, among other things, (1) reduce and contain overhead costs, (2) seek to dispose of underproductive assets, and (3) seek the most advantageous financing terms available.\n(VII) Customers\nThe Company's business of franchising motels is contingent upon its being able to locate qualified property owner-operators who are seeking national affiliation. Through use of its franchise sales force, the Company has not experienced insurmountable difficulty in locating independent motel owner-operators nor does it anticipate any such difficulty in the future. However, more franchisors are offering multi-level brands, resulting in more down-scaling conversions into the economy lodging sector and, therefore, providing more competition. Likewise, the Company's financing division requires that it locate qualified owner-operators or investors for its properties. Because of its franchise affiliations the financing division has not experienced, nor does it anticipate experiencing too much difficulty in locating qualified investors to purchase its developed properties. However, due to the Company's desire to limit the loans it holds to a manageable number and because third party or institutional financing\nfor used motel properties are difficult to arrange, once a property is sold the Company carries the entire financing package and accordingly, each individual loan represents a larger portion of portfolio than it does with traditional lending institutions. Therefore, the continued performance of each existing loan may be material to the operation of the financing division.\n(IX) Government Contracts\nThe Company is not involved in, nor does it anticipate becoming involved in, any government contracts.\n(X) Competition\nThe Company's franchising, leased lodging and leased food service division each compete with other similar businesses, many of which are larger and have more national recognition than does the Company. Each of these divisions compete on the basis of service and price\/value relationship.\nThe Company's financing division competes with other, more traditional sources of long-term financing, most of which have greater financial resources than does the Company.\nCompetition in developing and financing lodging properties has been significantly affected by over-development in some areas as well as the area's and the country's general economic condition, and by the market force of the Resolution Trust Corporation, the latter of which decreased in the current reporting period.\n(XI) Research and Development\nNo significant research activities were conducted by the Company during the Fiscal year and the Company does not expect to expend sums on research activities during the next Fiscal Year.\n(XII) Environmental Protection\nThe Company is not directly affected by environmental protection measures of federal, state or local authorities to any extent which would reasonably be expected to cause material capital expenditures for compliance, so far as in known. However, it is possible that an approximately five and three-tenths (5.3) acre tract of land held as an investment and acquired as a possible motel site, located on I-10 in Ocean Springs, Mississippi, may under the new guidelines, be determined to be in part \"wetlands.\" If so, its use and value would be adversely affected. On January 27, 1995, 3.2 acres of said tract were sold at a consideration undiminished by the wetlands issue; the value of the remaining 5.3 acres, therefore, may not be diminished.\n(XIII) Employees\nNote 3: These are not employees of the Company at date of this writing, since operations are leased out but are given for comparative purposes.\n(d) Foreign Operations\nThe Company, as of June 30, 1995, was not then currently involved in any business operations outside of the United States of America, except through its franchising division which does do limited business in Canada and has one franchisee in the Bahamas. As of April 30, 1995, the franchising division has two franchisees in Costa Rica and two in Jamaica.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties\nThe following table sets forth certain information, as of this writing, concerning properties on which the Company holds notes secured by mortgages and other types of financing instruments held by the Company:\n* While the indenture in favor of a bank in connection with this receivable is not a mortgage, an original sum of $475,000.00 of the receivable was assigned and pledged in 1990 to a bank and might be considered as being in the nature of an underlying mortgage. Said $475,000 is reduced to $290,563.31.\nThe following table sets forth certain information, as of this writing, concerning motel properties owned by the Company and under management contract or leased to Operators.\nNote 5 These properties, on April 1, 1990, were leased to First Hospitality Management Corporation, a corporation owned by Robert H. Douglas, a Director of the Company and a former employee of the Company.\nNote 6 Title to this property was reacquired by foreclosure December 7, 1990. It re-opened for business April, 1990, under an agreement with Alahunt, Inc., a corporation wholly owned by Richard A. Johnson, a Director of Registrant. During the current reporting period, the Company leased this property to Thelma Pullin, a sister of the Registrant's then president.\nNote 7 The Marietta property in 1992 was operated by the Company. Since 1993, it has been leased to Timothy J. DeSandro, a former employee of the Company.\nAlso, until August 2, 1991, the Company operated one \"Omelet House\" restaurant located in New Iberia, Louisiana, which it leases from an individual. On August 1, 1991, the Company entered into a rental agreement with Alfred W. Schoeffler, who operated same from August 3, 1991, through September 24, 1992; the property was vacant until March of 1993 since which time the property has been leased to First Hospitality Management Company.\nThe following table sets forth certain information, as of this writing, concerning other properties owned or recently owned by the company.\nNote On 6\/9\/94 our interest in Purvis, MS land was sold subject to then debt for consideration of $250,000 to John M. Hill, a partner of Nelson & Hill, owner of the other undivided 1\/2 interest in said land.\nItem 3","section_3":"Item 3 Legal Proceedings\nWaymon Barron, Plaintiff, v. Southern Scottish Inns, of Mississippi, Inc., et al, Defendants\nOn or about September 4, 1986, a Complaint for damages for negligence and breach of implied warranty was filed in the circuit Court of Warren County, Mississippi, styled Waymon Barron v. Motel Recovery & Development, Ltd., d\/b\/a Scottish Inn of Vicksburg, a Partnership, Lewis Slaughter and Southern Scottish Inns, Inc., General Partner, and Sam Patel, bearing Cause No. 14,307 on the docket of said Court. Service of Process was not had on Registrant.\nOn or about August 10, 1987, an Amended Complaint for damages in the same matter was filed in the same Court, styled Waymon Barron v. Motel Recovery & Development, a Limited Partnership, Lewis Slaughter and Reba Slaughter, General Partners, Scott Yeoman and James Johnstone, Limited Partners; Southern Scottish Inns of Mississippi, Inc., N. V. Patel and Sam Patel, bearing Cause No. 14,307 C on the docket of said Court. Later, Registrant and Hospitality International, Inc., a partially owned subsidiary of the Company, were made additional party Defendants. The Company and its defendant subsidiaries have obtained separate counsel, answered the complaints and are preparing defenses.\nThe Amended Complaint demands judgement of $1,500,000 plus interest and costs of Court, and trial by jury.\nThe Amended Complaint alleges that Plaintiff on October 26, 1985, while a guest in Room 101 of the Scottish Inn in Vicksburg stepped onto a rotten place in the floor, that his leg went through and he fell injuring his back, which injury required surgery and resulted in loss of wage earning ability and loss of his ability to enjoy life.\nOn October 25, 1985, the date Mr. Barron checked into said room and on October 26, 1985, the date of his injury, the record title of the Scottish Inn in Vicksburg was in Defendant Southern Scottish Inns of Miss., Inc. The motel was not being operated by said subsidiary of the Company or the Registrant on either of said dates.\nOn January 26, 1984, this motel was the subject of a Contract For Deed with Defendants Lewis Slaughter and Reba K. Slaughter, his wife. Subsequently, and prior to August of 1984, said Defendants transferred their rights, duties and interest under and in the Contract For Deed to Defendant Motel Recovery and Development, a limited partnership, of which the named individual persons were the general or limited partners. In August of 1984, Motel Recovery and Development, leased the subject motel to Defendant N. V. Patel. On October 2, 1984, Registrant and its defendant subsidiary recognized the transfer from Mr. and Mrs. Slaughter to Motel Recovery and Development and the lease from Motel Recovery and development to N. V. Patel. In May of 1986, Registrant and its defendant subsidiary, through surrender of possession and of operation of Mr. Patel and Motel Recovery and Development regained possession and leased same.\nFor some time, the Plaintiff did not diligently pursue this claim, except for the taking of depositions of the Plaintiff's doctor and of an expert building tradesman. Motions for Summary Judgement were filed by the Co- Defendants, Southern Scottish Inns, Inc. and Southern Scottish Inns of Miss., Inc. Also, Hospitality International, Inc. filed a motion for Summary Judgement. Circa October 31, 1993, the Court file reflects that during the last eight (8) months, the insurer for our Franchisee settled, on behalf of Hospitality, with the plaintiff and Hospitality International, Inc. was dismissed. During the current reporting period, the Registrant was dismissed on Summary Judgement and Southern Scottish Inns, of Mississippi, Inc. was dismissed on Summary Judgements. Plaintiff has appealed both dismissals and the appeals are pending.\nPART II\nItem 5","section_4":"","section_5":"Item 5 Market for Registrant's Common Equity Securities and Related Matters\n(a) The common stock, no par value, of the Registrant is traded on the Over-the-Counter market. The following table sets forth the range of per share bid and asked price quotations during the periods indicated. The following represents quotations between dealers, and do not include retail mark-ups, mark-downs, or other fees or commissions, and do not represent actual transactions.\n(b) As of this writing, there are approximately 910 shareholders of the Registrant's common stock.\n(c) No cash dividends have been paid on the Company's common stock during the two most recent Fiscal Years and none are anticipated to be paid in the foreseeable future.\nItem 6","section_6":"Item 6 Selected Financial Data\nThe following table summarizes selected financial data of the Company for the past five Fiscal Years. It should be read in conjunction with the more detailed consolidated financial statements of the Company appearing elsewhere in this Annual report.\nItem 7","section_7":"Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations\nCapital Resources\n(I) No material commitments for capital expenditures are planned other than any possible purchases or development of properties through the financing division.\nHospitality International, Inc. was able to acquire a suitable office facility and moved into same on November 1, 1992. The property consists of 2.76 acres of land and 26,888 square feet of office space, of which 15,592 square feet is in use , of which Hospitality uses 11,296 square feet. The property costs $425,000, of which $409,000 was financed. The loan was guaranteed by Registrant and by Bob Guimbellot, personally. During the first week of February of 1994, the Company moved its offices into this facility. At this time, and for the foreseeable future, Southern Scottish Inns, Inc., Red Carpet Inns International, Inc. and Hospitality International, Inc. are all sharing the same office building.\n(II) The trend in capital resources has resulted in a loosening of credit with regard to new motel construction but has not changed perceptively with regard to older properties. This has forced more sellers of older properties into the seller financed arena creating more competition for the Company in its Finance and Development Division. This fact, coupled with tighter credit on the purchase side, has meant less profitable opportunities for the Company.\nItem 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplemental Data\nThe financial statements and financial statement schedules filed as part of the Annual report are listed in Item 14 below.\nItem 9","section_9":"Item 9 Disagreements of Accounting and Financial Disclosures\nNot applicable.\nPart III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors and Executive Officers of the Registrant\nThe Following persons are the directors and the executive officers of the Registrant.\nThe Board of Directors of the Company held one regularly scheduled meeting in 1994.\nThe term of office for all directors expires at the close of the next annual meeting of shareholders. Officers serve at the please of the Board of Directors.\nBobby E. Guimbellot served as President of the Registrant from January of 1976 through 1994. Mr. Guimbellot remains as Chief Executive Officer of Registrant. Mr. Guimbellot is also the principal shareholder and Chairman of the Board of Western Wireline Services, Inc. (\"Western Wireline\"), an oil well service company headquartered in Belle Chasse, Louisiana. Mr. Guimbellot has been Chairman of Red Carpet Inns, International, Inc. a subsidiary of the registrant, since 1982, and has been President of Red Carpet since January 1, 1992.\nMichael M. Bush is President and Chief Executive Officer of the Mississippi River Bank, Belle Chasse, Louisiana, a position which he has held for more than six years.\nDonald Deaton is President of Hospitality International, Inc., a motel franchising company and subsidiary of the Registrant.\nRobert H. Douglas was Director of Motel Operations for the Company until April 1, 1990, and prior to assuming that position has been in the independent plant nursery business. He previously served as Secretary and Treasurer of the Registrant from September 1983, until April 1986. Prior to that, Mr. Douglas was Director of Operations for the Company for 8 years. On April 1, 1990, Mr. Douglas, formed the corporation to whom several of the Company's motels are leased.\nJack M. Dubard is currently the Registrant's President, after having served as the Vice President for several years, and was previously an independent consultant to the Registrant and its affiliates. Prior to that, he held an administrative position with Red Carpet Inns International, Inc. Since early 1994, Mr. Dubard has served as CEO of Hospitality International, Inc., the Company's franchising subsidiary.\nC. Guy Lowe, Jr. is a self-employed real estate developer and also provides office building management services. He has been so engaged for more than 8 years.\nHarry C. McIntire is a retired senior captain (pilot) with Delta Air Lines, Inc. and has been a captain for more than 25 years prior to his retirement. He has served as Vice Chairman of registrant's Board of Directors and as a Vice President. Upon Dr. Hotho's resignation, Captain McIntire was elected as Chairman of the Registrant's Board.\nGretchen W. Nini was a Director, Corporate Secretary, and treasurer of Western Wireline Services, Inc., an oil well service company headquartered in Bell Chasse, Louisiana, a position she held for more than 5 years (See Bobby E. Guimbellot, supra).\nGeorge O. Swindell formerly owned Diamond Realty Construction, Gretna Louisiana; he has been a real estate broker since 1970 and has been a general contractor of over 18 years.\nRichard A. Johnson has had prior experience in construction, manufacturing, health care, agriculture, recreational facilities, apartments and real estate. Since June of 1992, Mr. Johnson served as Franchise Development Coordinator for Hospitality International, Inc., a subsidiary of the Registrant. He resigned in July 1995 from his employment by Hospitality International, Inc.\nMelanie Campbell is the current Corporate Secretary and Treasurer of Western Wireline Services, Inc. She has been with this company for more than six years and during that time has held the position of Office Administrator for Western. (See Bobby E. Guimbellot, supra).\nMelinda P. Hotho - Dr. Vincent W. Hotho, after being a Director of the Registrant for over twenty-two (22) years, the last eighteen (18) of which he served with distinction as Chairman, due to some imprudent personal investments and a potentially ruinous malpractice suit went through a Chapter 7 Bankruptcy proceeding. He felt it to be in the best interest of the Registrant and of the Company that he resign as Director and Chairman. The Board of Directors, pending action of the Stockholders, selected Melinda P. Hotho, his daughter, to serve on an interim basis.\nJohn L. Snyder, Jr. is recently retired from his position as manager of engineering at Mid-America Transportation Company. Mr. Snyder had more than thirty years experience in marine operations. He previously held administrative or managerial positions with Wisconsin Barge Line, Walker Boat Yard and Mid-South Towing Company.\nTimothy J. Desandro has been selected to serve as Director on an interim basis. He is currently the Lessee of the Scottish Inn located in Marietta, Georgia, which property he has managed for the past six (6) years. Previously he functioned in the capacity of oil well service operator, a position that Mr. DeSandro held for 20 years.\nDirectors who have resigned:\nRichard H. Rogers was employed as marketing consultant for the Knoxville's World's Fair from January 1982 to May 1982. From 1978 to January 1982, Mr. Roger served as Vice President and Director of Operations of Cindy's Inc., a hotel company. He became President of Hospitality International, Inc. as subsidiary of the Registrant, in May 1982. On October 1993, Mr. Rogers resigned his presidency of Hospitality International, Inc. He resigned for personal reasons and to pursue other interests. Mr. Rogers resigned as Director of the Registrant in 1994.\nDr. Vincent W. Hotho, M.D., after being a Director of the Registrant for over twenty-two (22) years, the last eighteen (18) of which he served with distinction as Chairman, due to some imprudent personal investments and a potentially ruinous malpractice suit went through a Chapter 7 Bankruptcy proceeding. He felt it to be in the best interest of the Registrant and of the company that ye resign as Director and Chairman. The Board of Directors, pending action of the Stockholders, selected Melinda P. Hotho, his daughter, to serve on an interim basis. The Directors elected Harry C. McIntire as Chairman upon Dr. Hotho's resignation.\nHarry C. Geller, an able and loyal Director for the past fourteen (14) years, in an effort to shed some activities with a view toward his imminent retirement, resigned in 1994 as a Director of the Registrant. Mr. Geller, the sole stockholder and president of Securities Transfer Company, the Registrant's Transfer Agent, has given Registrant notice that he is closing Securities Transfer Company at Calendar year end.\nCommittees of the Board of Directors\nThe Board of Directors of the Registrant does not maintain any standing committees.\nItem 11","section_11":"Item 11 Executive Compensation\nFor services rendered in all capacities to the Company and its subsidiaries during the Fiscal Year ended December 31, 1995, the Company paid aggregate cash compensation in the amount of $98,000.00 to Mr. Guimbellot, the Registrant's then President and present Chief Executive Officer. His salary was partially deferred and he is owed $169,687.27, most of which is from prior periods. His annual salary is $88,200. In 1995, the Company paid aggregate cash compensation in the amount of $62,969.99 to Mr. Dubard, who for most of said period was vice president of Registrant and CEO of its franchising subsidiary, and who for the latter part of said period was Registrant's president and CEO of Hospitality Inc.The Company provides Messrs. Guimbellot and Dubard with automobiles and does not require them to account for the personal use, if any, of the automobiles. The cost is not included in the compensation reported above. However, the Company estimates that the amount, which cannot be specifically or precisely ascertained, does not exceed 10% of the aggregate compensation, paid and unpaid, reported above.\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management\nPrincipal Holders\nThe following table sets forth, as of this writing, information with respect to each person who, to the knowledge of the Registrant, might be deemed to own beneficially 5% or more of the outstanding Southern Scottish Inns, Inc. common stock, which is the only class of voting securities of the Registrant. Except, as otherwise indicated, the named beneficial owners possess sole voting power and sole investment power with respect to the shares set forth opposite their respective names.\nNote 8 Based on 2,322,466 shares outstanding.\nNote 9 Includes 470,750 shares owned by Bobby Guimbellot d\/b\/a Coastal Companies, and 35,238 owned by Industrial Funds, an entity of Western Wireline Services, Inc. Mr. Guimbellot's shares also include 17,713 and 1,664 shares owned by Lift Boats, Inc. and Tri Delta Dredge, Inc., respectively and 361,405 shares owned by Shelly Plantation. Ms. Campbell shares voting rights as to Industrial Funds shares with Mr. Guimbellot.\nNote 10 Voting and investment power on 113,331 shares are shared with his wife.\nManagement Ownership\nThe following table sets forth, as of this writing, information concerning the ownership of Southern Scottish Inns, Inc. common stock by all directors and by all directors and officers as a group. Southern Scottish Inns, Inc. common stock is the only class of equity securities of the registrant. Except as otherwise indicated, the named beneficial owners possess sole voting power and sole investment power with respect to the shares set forth opposite their respective names.\nNote 11 Based on 2,322,466 shares outstanding.\nNote 12 Includes 250 shares in the name of his minor son.\nNote 13 Includes 470,750 shares owned by Bobby Guimbellot d\/b\/a Coastal Companies, and 35,238 owned by Industrial Funds, an entity of Western Wireline Services, Inc. Mr. Guimbellot's shares also include 17,713 and 1,664 shares owned by Lift Boats, Inc. and Tri Delta Dredge, Inc., respectively and 361,405 shares owned by Shelly Plantation. Melanie Campbell, the Secretary of Western Wireline Services, Inc., shares voting and investment powers with respect to the 35,238 shares owned by Industrial Funds.\nNote 14 Includes 413 shares in the name of his wife.\nNote 15 Voting and investment powers on 113,331 shares are shared with his wife.\nNote 16 Includes 639 shares in the name of her minor child.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions\nJ. Puckett and Company\/Buena Vista Venture\nThis entity is an ordinary particular Louisiana partnership. The Registrant owns twenty-five (25) of the one hundred (100) partnership units. Bobby E. (Bob) Guimbellot, individually, Registrant's Chief Executive Officer, owns eleven (11) of said partnership units. Additionally, Mr. Guimbellot, d\/b\/a Coastal Companies, owns twenty (20) of said units. Emilee B. Guimbellot, Bob Guimbellot's mother, owns one (1) said units. Shelly Plantation Ventures, a partnership in which Mr. Guimbellot is a principal unit owner and in which his mother is a small unit owner, while not a partner, is a three (3) per cent equity owner in J. Puckett. The Registrant, in June of 1992, borrowed $50,000.00 from J. Puckett. This debt was represented by a demand note bearing interest at twelve (12) % per year and was paid off March 1995. On November 17, 1995 this partnership sold the motel it owned on the Southside of Highway 90 in Biloxi, Mississippi. Funds from the sale were placed on deposit in a Trust Account with the intention of the partnership finding a like kind exchange. After the 45 day period, it was clear that a like kind property had not been found. The Registrant's portion of the sale was received in January, 1996. At the time of the property sale, a note held by J. Puckett on a prior property credit sale on the Northside of Highway 90 in Biloxi, Mississippi was paid and the Registrant received $258,000 in November, 1995 from that payment.\nPan American Hospitality\nFrom time to time, and on an as needed basis, the Registrant has made advances to Pan American Hospitality, a partnership comprised of Red Carpet Inns International, Inc. (a subsidiary of the Registrant), Bobby E. Guimbellot, Emilee Guimbellot (Mr. Guimbellot's mother), Western Wireline Services, Inc., Mildred Puckett, Mary R. Dubard (wife of Jack M. Dubard), and two unrelated individuals. As of December 31, 1995, these advances total $145,676.\nC. Guy Lowe, Jr.\nOn April 4, 1986, the Company acquired from C. Guy Lowe, Jr., (a director of the Registrant) all of the outstanding stock of O.S. of South Louisiana, Inc. in exchange for the Registrant's promissory note in the face amount of $132,448. On May 5, 1986, Mr. Lowe assigned this note to Merchants Trust and Savings Bank. No scheduled payments were made on this note. On July 31, 1990, Red Carpet Inns International, Inc., a consolidated subsidiary of the Company, borrowed $100,000 from Merchants Trust and Savings Bank and loaned it to the Company. The Company, in turn, paid the $100,000 back to Merchants Trust and savings Bank as assignee, in full, compromise settlement of the original note of $132,448 to Mr. Lowe. The Company will lower its basis in its O.S. of South Louisiana, Inc. stock. The new note from Merchants Trust and Savings Bank to Red Carpet Inns International, Inc. was guaranteed by two affiliated entities belonging to the Company President, Bobby E. Guimbellot. The Company is now indebted to Red Carpet Inns International, Inc. in the amount of $70,000 at an interest rate of one and one-half (1\/2%) percent over Chase Manhattan Bank prime rate.\nPART IV\nItem 14","section_14":"Item 14 Exhibits, Financial schedules and Reports on Form 8-K\n(a) Listed below are the following documents which are filed as a part of this Annual Report.\n1. Financial statements Auditor's Report. Note 17 Consolidated balance sheets of the Company as of December 31, 1995 and 1994. Consolidated statements of changes in cash flow of the Company for the Fiscal Years ended December 31, 1995, 1994 and 1993. Notes to consolidated financial statements.\n2. Financial statement schedules.\n3. Exhibits. The exhibits filed as part of the Annual report are listed on the exhibit index which immediately precedes and is bound with such exhibits.\n(b) No reports on Form 8-K have been filed by the Registrant during the last quarter of the period covered by this Annual Report.\nNote 17 For the company's fiscal years of 1985 through 1990, our Auditor was Robert M. Mosher, C.P.A. of Biloxi, Mississippi. For the Company's fiscal years of 1991 through 1992, our Auditor was the firm of Fountain, Seymour, Mosher & Associates of D'Iberville, Mississippi. In February of 1994 (See Item 7, Capital Resources (I)), Registrant and Company moved to the Atlanta area. About such time and in connection with future audits, the decision was made to change auditors and to employ Robert J. Clark, P.C. of Roswell, Georgia. Mr. Clark had done the Company's Audits for 1983 and 1984. Mr. Clark had done the Audits of 1992 and 1993 for Red Carpet Inns International, Inc., an affiliate of Registrant. Mr. Clark has done the Audits for Hospitality International, Inc., a partially owned subsidiary of Registrant, continuously since 1982. For the year 1994 and for the foreseeable future, Mr. Clark will do the audits for Southern Scottish Inns, Inc., Red Carpet Inns International, Inc. and Hospitality International, Inc. Mr. Mosher cooperated with Mr. Clark in the transition. In accordance with the SEC PRACTICE SECTION of the A.I.C.P.A., a partner other than the partner in charge must perform a concurring review of the audit report. When the firm is a sole proprietorship, an outside qualified professional must be utilized and one was so utilized.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHERN SCOTTISH INNS, INC. ---------------------------- (Registrant)\nBy: Bobby E. Guimbelott 9\/5\/95 By: Jack M. Dubard 9\/5\/95 --------------------------- ------------------------ Bobby E. Guimbellot Date Jack M. Dubard Date Chief Executive Officer President & CFO\nSIGNATURES (Cont.)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nFOR THE BOARD OF DIRECTORS:\nMichael M. Bush Melinda P. Hotho - ------------------------ ------ ------------------------ ------ Michael M. Bush Date Melinda P. Hotho Date Director Director\nMelanie Campbell Richard A. Johnson - ------------------------ ------ ------------------------ ------ Melanie Campbell Date Richard A. Johnson Date Director Director\nDonald Deaton C. Guy Lowe, Jr. - ------------------------ ------ ------------------------ ------ Donald Deaton Date C. Guy Lowe, Jr. Date Director Director\nTimothy D. DeSandro Harry C. McIntire - ------------------------ ------ ------------------------ ------ Timothy D. DeSandro Date Harry C. McIntire Date Director Director\nRobert H. Douglas Gretchen W. Nini - ------------------------ ------ ------------------------ ------ Robert H. Douglas Date Gretchen W. Nini Date Director Director\nJack M Dubard John Snyder - ------------------------ ------ ------------------------ ------ Jack M. Dubard Date John Snyder Date Director Director\nBobby E. Guimbellot George O. Swindell - ------------------------ ------ ------------------------ ------ Bobby E. Guimbellot Date George O. Swindell Date Director Director\nSOUTHERN SCOTTISH INNS, INC.\nCONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nBoard of Directors Southern Scottish Inns, Inc.\nINDEPENDENT AUDITOR'S REPORT\nWe have audited the accompanying consolidated balance sheets of Southern Scottish Inns, Inc. and subsidiaries as of December 31, 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 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 Southern Scottish Inns, 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.\nROBERT J. CLARK, PC Roswell, Georgia June 7, 1996\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED BALANCE SHEETS - CONTINUED DECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENTS OF CASH FLOW YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENTS OF CASH FLOW - CONTINUED FOR THE YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\nHISTORY\nThe Company was incorporated on November 8, 1971 under the laws of the State of Louisiana.\nThe Company has consolidated the operations of two corporations: Red Carpet Inns International, Inc. and Hospitality International, Inc. The Company owns a 50% interest in Hospitality International, Inc. and Red Carpet Inns International, Inc. owns the other 50%; therefore, all of its operations are included in these financial statements and it is noted as the franchising division. The Company owns 70.8% of Red Carpet Inns International, Inc.\nThe Company's financing and investing division provides owner financing to persons acquiring motel properties previously operated and\/or owned by the Company. They look to acquire properties for development and\/or future sale. The Company also invests in companies whose business operations include property development. These activities primarily occur in the Southeast.\nThe Company's franchise division offers advertising, reservation, group sales, quality assurance and consulting services to motel owner\/operators. It is the exclusive franchisor for Red Carpet Inns and Master Host Inns as well as Scottish Inns and owns the Downtowner\/Passport trademarks. Its market has historically been the contiguous United States; however, in 1994 the Company began to explore international markets. The Company also provides a nationwide central reservation service for its franchisees.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and all subsidiaries except where control is temporary or does not rest with the Company. The Company's investments in companies in which it has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method. Accordingly, the Company's share of the net earnings of these Company's is included in consolidated net income. The Company's investments in other companies are carried at cost or fair value, as appropriate. All significant inter-company accounts and transactions are eliminated.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nESTIMATES 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 amounts reported in the financial statements and accompanying notes. Although these estimates are based on management's knowledge of current events and actions it may undertake in the future, they may ultimately differ from actual results.\nREVENUE AND EXPENSE RECOGNITION\nI. Accrual Basis\nThe accrual basis of accounting is used for both book and tax records. Revenue is recognized when it is earned. Expenses are recognized when incurred.\nII. Franchise Fees\nRevenue from franchise sales are recognized when all material conditions of the sale have been substantially performed. Substantial performance by the franchisor occurs when, 1) the franchisor is not obligated in any way to excuse payment of any unpaid notes or to refund any cash already received, 2) initial services required by the franchisor by contract or otherwise have been substantially performed, and 3) all other conditions have been met which affect the consummation of the sale.\nACCOUNTING POLICY - STATEMENT OF CASH FLOWS\nFor purposes of the cash flow statement, the Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents.\nIn 1995 the Company purchased an investment for $512,192 and recorded a payable for the same amount. The cash was paid in January 1996.\nDuring 1994, the Company had the following non-cash transactions: 1. The Company exchanged land for an installment note receivable of $13,000. 2. The Company purchased a building and land by financing $250,000 of the purchase price with a mortgage note.\nIn 1995, the company paid $95,149 in income taxes and approximately $261,113 in interest.\nIn 1994, the Company paid $985 in income taxes and approximately $236,940 in interest.\nIn 1993, the Company paid approximately $361,361 in interest.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nINVENTORY\nInventory is valued at the lower of cost or market and consists of hotel and motel furniture. The method used in determining the cost is the average cost paid for the items. The furniture sold in 1993 had a zero basis; and therefore, no cost of sales was recorded. Inventory was sold at a loss in 1994. In 1995, $175 of inventory was sold at a cost of $120.\nREAL ESTATE SALES\nGains on real estate transactions on which substantial down payments are not received are deferred and recognized as income only when the principle amount of the obligation is received. This deferred income is shown on the balance sheet as a deferred credit.\nDEFERRED DEBT ISSUE COSTS\nDeferred debt costs (primarily commitment fees) are being amortized over the original term of the long-term debt to which they relate.\nNET INCOME PER SHARE\nNet income per common share is computed by dividing net income by the weighted average number of shares outstanding during the period. The weighted average number of shares outstanding for the years ending December 31, 1995 and 1994 was 2,322,466 and 2,319,694 in 1993.\nACCOUNTS, MORTGAGES AND NOTES RECEIVABLE\nFor accounts receivable - trade, an allowance account is provided based on a percentage of the outstanding accounts. During the year, all bad debt write-offs were made to the allowance account. Accounts receivables for 1995 and 1994 are presented net of allowance for doubtful accounts of $71,082, and $92,318 respectively.\nThe Company extends credit to individuals and companies in the normal course of its operations. These loans relate to motel properties located throughout the southeast and the Company requires these advances to be secured by mortgages on the related property. The Company's exposure to loss on these notes is dependent on the financial performance of the property and the fair value of the property.\nNo reserve for uncollectible mortgages and notes receivable is maintained. Questionable unsecured notes receivable are written down to net realizable value; secured mortgages and notes receivable are written down to the adjusted basis of the secured property.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nACCOUNTS, MORTGAGES AND NOTES RECEIVABLE - (CONTINUED)\nIncluded in the mortgages and notes receivable - short term are notes the Company has with franchisees for initial franchise fees, royalty fees, sign rental and room reservation income. The notes are either non-interest bearing or convey an interest rate of up to 12%. The management elected to write off some of the accrued interest for this year. These notes amount to $32,469 in 1995 and $46,762 in 1994. All are due within one year. Certain notes have been extended and have been outstanding for over one year. Those notes due over one year are interest bearing.\nMortgages and notes receivable are stated net of associated discounts. In 1995, these totaled $135,897.\nThe weighted average interest rate of the mortgage notes held by the Company is 11.4%, and they range from 10% to 12.5%.\nMaturities over the next five (5) years are as follows:\nLOAN EMPLOYEES\nLoan Employees represents travel advances and\/or loans to employees.\nINVESTMENTS IN UNCONSOLIDATED AFFILIATES\nThe Company has investments in unconsolidated affiliates that are accounted for under the equity method. Under the equity method, original investments are recorded at cost and adjusted by the Company's share of earnings, losses and distributions of these companies. Investments in unconsolidated affiliates consist of the following:\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nINVESTMENTS IN UNCONSOLIDATED AFFILIATES - (CONTINUED)\nThose negative investments reflect losses in excess of investment, and the Company is at risk up to at least the amount noted.\nAll the Company's investments in unconsolidated affiliates operate with fiscal years ending on December 31. Summarized balance sheet information of the unconsolidated affiliates as of December 31, 1995 and 1994 are as follows:\nINTANGIBLE ASSETS - TRADEMARKS\nTrademarks are stated on the basis of cost and are amortized, on a straight-line basis, over the estimated future periods to be benefited (not exceeding 40 years). They are periodically reviewed for impairment based on an assessment of future operations to ensure that they are appropriately valued. Accumulated amortization was $246,158 and $212,329 on December 31, 1995 and 1994, respectively.\nThe trade name \"Red Carpet Inns\" is also owned by the Company. A historical cost basis in excess of $600,000 was carried on the books of the old Red Carpet Inns company prior to its acquisition by the Company. This amount apparently was written off prior to the acquisition. Management believes the current value far exceeds the historical cost to the old company and thus the company has in its possession an asset of substantial worth that has no recorded cost in the financial statements.\nIn 1993 the franchising division accepted the marks of Downtowner\/Passport International Hotel Corporation from Southern Scottish Inns, Inc. in satisfaction of Southern Scottish Inns, Inc. payable to the franchising division. In this transaction, the Company also assumed some debt of Downtowner\/Passport International Hotel Corporation to outside parties. The amount booked as Downtowner\/Passport International Hotel Corporation's trademark comprises three amounts: (1) the receivable from Southern Scottish Inns, Inc., (2) the debts of Downtowner\/Passport International Hotel Corporation assumed and (3) an outstanding receivable due to the company from Downtowner\/Passport International Hotel Corporation.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nINCOME TAX\nThe components of the provision for income taxes are as follows:\nThe reconciliation of the difference between the federal statutory tax rate and the Company's effective tax rate is as follows:\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nINCOME TAX - (CONTINUED)\nThe income tax effects of temporary differences between financial and income tax reporting that gave rise to deferred income tax assets and liabilities are as follows:\nOn December 31, 1992, the Company had an unused net operating loss of $628,319 to be applied toward future taxable income. Listed below are the years, amounts, and tax benefit of the net loss carryforward. The remaining loss carryforward was totally used against taxable income in 1995. Such amounts reduce the current portion of tax that is actually payable.\nThe Company and its subsidiaries file unconsolidated tax returns. The entities are not subject to Internal Revenue Code Section 1563. The taxes have been calculated accordingly.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nDEBT OBLIGATIONS\nThe Company has incurred debt obligations primarily through public and private offerings and bank loans. Debt obligations consist of the following:\nMaturities of long-term debt for the five years succeeding December 31, 1995, are as follows (in thousands):\nThe above notes include various restrictions, none of which are presently significant to the Company.\nOPERATING LEASES\nThe Company leases out as office space a portion of the building it owns. The allocated cost of the portion leased is $161,856 and its allocated accumulated depreciation is $16,700 at the end of 1995. The company also leases properties it owns in various states. These properties are recorded in Property & Equipment and total $2,859,661 with accumulated depreciation of $448,926. The terms of lease agreements vary by tenant and circumstance; however, all current lease agreements are for one year or less. Contingent lease income for one property is based on ninety percent of property profits and amounts to $471,700 in 1995.\nSchedule of Minimum Future Rental on Noncancelable Operating Leases\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nINDUSTRY SEGMENTS\nThe information about the Company's operations in different industries are as follows:\nIncluded in the Financing & Investing Segment the Company has included net income from unconsolidated equity investments totaling $375,316 in 1995, $305,398 in 1994 and $164,747 in 1993.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nPROPERTY AND EQUIPMENT\nMajor classifications of property and equipment and their respective depreciable lives are summarized below:\nProperty and equipment are recorded at cost. Depreciation is provided on straight-line over the estimated useful lives of the respective assets. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized. When items of property or equipment are sold or retired, the related cost and accumulated deprecation are removed from the accounts and any gain or loss is included in the statement of income.\nDepreciation and amortization expense was $270,081 in 1995, $216,313 in 1994 and $188,378 in 1993.\nRELATED PARTY TRANSACTIONS\nThe Company paid expenses on behalf of four of its unconsolidated subsidiaries. The balance due from the subsidiaries was $116,016 at December 31, 1995 and $80,057 at December 31, 1994.\nThe Company purchased a mortgage note of a related unconsolidated partnership from a third party in 1995. The mortgage is on the motel which the partnership operates and derives its revenues. The mortgage was purchased for $350,000 cash when it had a carrying value of $481,943; therefore, the Company booked an original issue discount of $131,943.\nThe following is a schedule of loans to related parties:\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nRELATED PARTY TRANSACTIONS - (CONTINUED)\nThe following is a schedule of loans from related parties:\nMaturities of Long-Term:\nCONDEMNED BUILDING WRITE OFF\nIn 1993 an existing building was condemned and written off. The loss shown on the books was $148,904.00. The fixed asset and accumulated depreciation for this property was removed from the corporate books, except for an allowance of $50,000 for salvage of scrap metal. This amount was written off in 1994.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nPENDING LITIGATION\nAt present time the company has a pending litigation against them in the amount of $1,500,000. The lawsuit has been dismissed, however the plaintiff still has time to appeal. The Company is also the defendant in other various legal actions. In the opinion of management and counsel such actions will not materially affect the financial position or results of operations of the Company.\nCHANGE IN METHODOLOGY FOR CALCULATING MINORITY INTEREST IN SUBSIDIARIES\nA change in the calculation for determining minority interest was made in 1993. Minority interest was increased based on requirements stated in Statements of Financial Accounting Standards No. 94.\nSTOCK ISSUANCE TO OFFICERS\nDuring 1993 common stock was issued to corporate officers. These shares were exchanged for Red Carpet Inns International, Inc. common stock based on like kind market rules and totaled 3,334 shares.\nLITIGATION SETTLEMENTS\nIn 1994 and 1995 the franchising division aggressively pursued its legal rights to its trademarks. It has been successful in stopping motel operations from illegally using its trademarks, as well as enforcing compliance to its franchise agreements. Settlements were reached on a number of lawsuits in 1995 and 1994 that significantly increased the revenues of the Company. Attorneys collected one-third of settlements as fees; therefore, legal expenses also increased significantly in 1995 and 1994.\nADVERTISING COSTS\nThe franchising division collects advertising income to fund advertising services that are provided to benefit franchisees. Advertising costs are expensed as incurred with the exception of its semi-annual directories which are amortized on a monthly basis. The Company is carrying a prepaid advertising balance for the years ending 1995 and 1994 in the amount of $85,678 and $49,967 respectively.\nA summary of advertising income and advertising costs for the years ended December 31,\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nSIGNS - RED CARPET INNS\nThe Company held Red Carpet Inns signs for future sale. In 1994, a change in personnel and a lack of sufficient documentation made the existence and thus valuation of the signs unknown and accordingly management decided to write-off these assets at their historical cost.\nCONTINGENCIES\nThe amount of accounts receivable in litigation or collections at the end of 1995 was $59,365 and $35,571 in 1994. It was management's and counsel's opinion that the chances for collection were good.\nThe Company's franchising division pays commissions to its sales representatives on franchises sold. The Company policy is to pay the sales person based on receipts of royalties from the franchisee. The commissions are recognized as earned when the franchisee pays the royalty fees. Estimated contingent commissions for future years are approximately $102,000. The turnover of franchises makes the likelihood of payment only reasonably possible; therefore, this amount has not been accrued.\nIn 1995, the Company purchased an equity interest in a corporation and guaranteed some of its loans. The guarantees totaled $235,760. The Company also perfected an interest in the corporation's property.\nPRIOR PERIOD ADJUSTMENT\nThe Company made an adjustment to the retained earnings for 1993 to correctly amortize its trademarks and to properly account for tax benefits of the net operating loss carryforward on the books of a consolidated subsidiary. The amortization of the trademarks does not have any income tax effect, and it reduced net income in years prior to 1993 by $165,750. The tax benefit of the carryforward loss increased net income in years prior to 1993 by $196,559. This carryforward benefit was completely used in 1995.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED) December 31, 1995\nFINANCIAL INSTRUMENTS\nI. MARKET AND OFF BALANCE SHEET RISK\nThe Company holds financial instruments that relate to real estate located throughout the Southeast. If these properties decline significantly in market value, the valuation of the associated receivable could become impaired. No such decline is foreseen at the present time.\nThe Company is carrying a 13% investment in a partnership which operates a motel and restaurant. This Partnership has had operating losses in previous years and the Company has loaned the Partnership monies to fund its daily operations. These loans total $263,954 and carry an interest rate ranging from 9% to 12%. The loans are due on demand; however, the Company does not intend to call them in the near future. If the property and all of its assets were sold at their estimated fair market values, the monies received might not yield enough to repay these unsecured loans to the Company. However, the Company does own the mortgage note on the property of the Partnership. (See related party notes.) Since the note was purchased at a discount and the estimated fair value of the property exceeds the carrying value of the note, the Company reasonably expects to recover the purchase price of the mortgage.\nThe Company has three secured mortgage notes classified as non- performing. They total $2,806,221 with accrued interest of $186,589 at December 31, 1995. However, the fair market values of the properties secured by these mortgages exceed the balance of principal and accrued interest.\nII. FAIR VALUE OF FINANCIAL INSTRUMENTS\nINVESTMENTS - It is not practicable to estimate the fair value of Investments because there are no quoted market prices for its untraded common stock investments, and a reasonable estimate of fair value could not be made without incurring excessive costs. (See Investments.)\nMORTGAGES AND NOTES RECEIVABLE - The fair value of the mortgage and notes receivable was determined by management estimates of the property values which secure the mortgage notes. The fair value of these instruments is $7,175,293 at December 31, 1995 and $6,053,833 at December 31, 1994.\nLONG-TERM DEBT - The fair value of the long-term debt is based on the borrowing rates currently available to the Company for bank loans with similar security arrangements, terms and average maturities. The fair value for these instruments is $2,833,924 at December 31, 1995 and $2,679,462 at December 31, 1994.\nConsolidated statements of share-holders equity","section_15":""}
{"filename":"775158_1995.txt","cik":"775158","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nThe company engineers, manufactures and markets a broad range of specialized trucks, trailers, and proprietary parts under the \"Oshkosh\" trademark. As a specialized vehicle producer, the company holds a unique position in the industry, having acquired the engineering and manufacturing expertise and flexibility to profitably build specialty vehicles in competition with companies much larger than itself. Mass producers design a vehicle to serve many markets. In contrast, the company's vehicles, manufactured in low to medium production volumes, are engineered for market niches where a unique, innovative design will meet a purchaser's requirements for use in specific, usually adverse operating conditions. Many of the company's products are found operating in snow, deserts and soft or rough terrain where there is a need for high performance or high mobility. Because of the quality of its specialized vehicles, the company believes its products perform at lower life cycle costs than those that are mass-produced.\nMarkets served by the company domestically and internationally are categorized as defense and commercial. Since 1980, specialized vehicle sales to the defense market have significantly increased and in fiscal 1995 represented 60% of the company's sales volume, after reaching a peak of 83% in fiscal 1987.\nThe company primarily depends upon components made by suppliers for its products, but manufactures certain important proprietary components. The company has successfully managed its supply network, which consists of approximately 1700 active vendors. Through its reliance on this supply network for the purchase of certain components, the company is able to avoid many of the preproduction and fixed costs associated with the manufacture of those components. However, while the company purchases many of the high dollar components for assembly, such as engines, transmissions and axles, it does have significant machining and fabricating capability. This capability is used for the manufacture of certain axles, transfer cases, cabs and many smaller parts which add uniqueness and value to the company's products. Some of these proprietary components are marketed to other manufacturers.\nProducts and Markets\nThe company currently manufactures eight different series of commercial trucks, and during fiscal 1995, had two active contracts with the U.S. Government related to production of the Palletized Load System (PLS) and Heavy Expanded Mobility Tactical Truck (HEMTT) vehicles. Within each series there is a varying number of models. Models are usually distinguished by differences in engine, transmission, and axle combinations. Vehicles produced generally range in price from $60,000 to $1 million; in horsepower from 210 to 1,025; and in gross vehicle weight from 33,000 to 150,000 pounds. The company has designed vehicles to operate in the environmental extremes of arctic cold or desert heat. Most vehicles are designed with the capability to operate in both highway and off-road conditions. Oshkosh manufactures a broad range of trailers including vans, flatbed, container chassis, fruit haulers, and a variety of military trailers. The company aggressively supports its products with an aftermarket parts and service organization.\nDefense\nThe company manufactures a broad range of wheeled vehicles for the U.S. Department of Defense and export markets and is the free world's largest producer of heavy-duty wheeled vehicles. The company has performed major defense work for the past 50 years. Contracts with the Department of Defense generally are multi-year contracts. Each contract provides that the government will purchase a base quantity of vehicles with options for additional purchases. All obligations of the government under the contracts are subject to receipt of government funding, and it is customary to expect purchases when Congress has annually funded the purchase through budget appropriations and after the government has committed the funds to the contractor. The following are defense contracts that were active in fiscal 1995:\nPalletized Load System (PLS). In July 1990 the company was selected as the producer of the Army's new generation heavy-duty transport truck. This ten wheel drive truck self-loads and unloads flatracks carrying palletized cargo. The five year contract for 2,626 units and associated trailers and flatracks was awarded in September 1990. The PLS contract contains a 100% option clause, which expires at the end of January 1996. Production began in fiscal 1992, and the company received first article test approval on January 3, 1994. Production will conclude approximately September 1996. If options are exercised, the production period will be extended. The company has produced 2,243 units as of September 30, 1995. The contract is currently funded at $822 million for 2,683 trucks under all five program years, and there is $246 million available under unexercised options. Backlog at September 30, 1995 was $112 million, which will be produced ratably through September 1996.\nHeavy Expanded Mobility Tactical Truck (HEMTT). In August 1994 the company was awarded a $39 million contract for the production of 190 HEMTTs, with an option for an additional 150 units. The Company also received add-on quantities of 285 vehicles. The eight-wheel drive HEMTT family of vehicles is made up of five different models. 1) The M977 performs ammunition resupply to field artillery, infantry and cavalry units; 2) The M985 is the prime ammunition resupplier of rocket pods for the Multiple Launch Rocket System (MLRS); 3) The M978 is a fuel servicing transporter for wheeled vehicles, tracked vehicles, and helicopters; 4) The M984 is a multi-purpose wrecker capable of recovery, lift and tow, retrieval, and maintenance operations for the Army's fleet of tactical wheeled and some tracked vehicles. Base production deliveries began in March 1995 and will be substantially complete by July 1996. The contract is funded at $120 million for the base units, exercised options, and add- on units. As of September 30, 1995, the company has delivered 291 units and will deliver 334 units in fiscal 96.\nCommercial\nThe company manufactures a wide variety of heavy-duty specialized trucks for the vocational and airport markets. Products are uniquely engineered for specific severe-duty requirements where innovative design provides superior performance.\nThe construction business focuses on forward and rear discharge concrete carriers. The forward placement S-series design allows the driver to oversee faster, more accurate placement of concrete, with fewer support personnel. This leads to greater efficiency and superior customer service. A traditional rear discharge F-series is also offered as an integrated package allowing for one stop service and sales. The F-series is also sold in the utility and heavy haul transport markets. In addition, the company produces the J-series for desert oil field and extreme heavy hauling applications.\nThe company serves airport markets with products that include Aircraft Rescue and Firefighting (ARFF) and snow removal vehicles. ARFF vehicles are offered from 1000 to 3000 gallon capacities. Oshkosh also offers the innovative Snozzle\/R\/, an extendable turret with an integrated video camera and automated remote controls that can pierce into an aircraft interior and position the agent flow precisely at the location of the fire. Suppressant Application is faster and uses up to 50% less agent than with conventional mass application techniques. The all-wheel drive Oshkosh H-series snowblower keeps runways open by casting 4,000 tons of snow per hour. The H-series snowblower provides multi-purpose use with an interchangeable blower, blade plows and brooms. The all-wheel drive P- series with its heavy-duty frame has an unsurpassed reputation for durability.\nThe refuse business consists of two low entry, dual drive models, the NK and NL. The NL recently passed an extensive six month durability test in one of the toughest urban environments with a 97% availability status. The NK and NL feature eighteen inch step-in heights. Municipalities as well as commercial contractors look to the improved visibility and safety features a low entry low cab forward vehicle provides.\nBacklog\nThe company has a funded backlog as of September 30, 1995, of $350 million. The backlog as of September 30, 1994, was $498 million. The majority of the current backlog relates to funded base and option quantities under the company's existing defense contracts. Approximately 7% of the current backlog relates to firm orders for commercial trucks, trailers, or non-military parts sales. In addition, option quantities under the PLS contract could amount to another $258 million, if exercised.\nGovernment Contracts\nA significant portion of the company's sales are made to the United States Government under long-term contracts and programs in which there are significant risks, including the uncertainty of economic conditions and defense policy. The company's defense business is substantially dependent upon periodic awards of new contracts and the purchase of base vehicle quantities and the exercise of options under existing contracts. The company's existing contracts with the U.S. Government may be terminated at any time for the convenience of the government. Upon such termination, the company would be entitled to reimbursement of its incurred costs and, in general, to payment of a reasonable profit for work actually performed.\nThere can be no assurance that the U.S. Government will continue to purchase the company's products at comparable levels. The termination of any of the company's significant contracts, failure of the government to purchase quantities under existing contracts or failure of the company to receive awards of new contracts could have a material adverse effect on the business operations of the company.\nUnder firm fixed-price contracts with the government, the price paid the company is not subject to adjustment to reflect the company's actual costs, except costs incurred as a result of contract changes ordered by the government or for economic price adjustment clauses contained in certain contracts. The company generally attempts to negotiate with the government the amount of increased compensation to which the company is entitled for government-ordered changes which result in higher costs. In the event that the company is unable to negotiate a satisfactory agreement to provide such increased compensation, the company may file an appeal with the Armed Services Board of Contract Appeals or the U.S. Claims Court. The company has no such appeals pending.\nMarketing and Distribution\nAll domestic defense products are sold direct and the company maintains a liaison office in Washington, D.C. The company also sells defense products to foreign governments direct, through representatives, or under the United States Foreign Military Sales program. The company's commercial vehicles, trailer products and aftermarket parts are sold either direct to customers, or through dealers or distributors, depending upon geographic area and product line. Supplemental information relative to export shipments is incorporated by reference to Note 9 of the financial statements included in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995.\nAlliance\nOn June 2, 1995, the company entered into a far reaching strategic alliance with Freightliner Corporation. The company is optimistic that the alliance between Oshkosh and Freightliner, a wholly-owned subsidiary of Daimler-Benz (NYSE-DAI), will give a further boost to the company's commercial and defense businesses. The alliance agreement calls for Oshkosh to market certain of its vocational products through Freightliner's strong distribution system and for Oshkosh to build several series of Freightliner's severe-duty trucks. As part of the agreement, Freightliner will transfer its non-commercial military business to Oshkosh, broadening Oshkosh's defense product line and strengthening its worldwide presence.\nCompetition\nIn all the company's markets, the competitors include smaller, specialized manufacturers as well as the larger, mass producers. The company believes it has greater technical strength and production capability than other specialized manufacturers. The company also believes it has greater flexibility than larger competitors and has the engineering and manufacturing expertise in the low to middle production volumes that allows it to compete effectively in its markets against mass producers.\nThe principal method of competition for the company in the defense and municipal markets, where there is intense competition, is generally on the basis of lowest qualified bid. In the non-governmental markets, the company competes mainly on the basis of price, innovation, quality and product performance capabilities.\nEngineering, Test and Development\nFor fiscal years 1995, 1994, and 1993 the company incurred engineering, research and development expenditures of $5.4 million, $6.6 million, and $9.0 million, respectively, portions of which were recoverable from customers, principally the government. The company does not believe that patents are a significant factor in its business success.\nEmployees\nAs of September 30, 1995, the company had approximately 1,600 employees. Production workers at the company's principal facilities in Oshkosh, Wisconsin are represented by the United Auto Workers union. The company's five-year contract with the United Auto Workers expires September 30, 1996.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nThe company's principal offices and manufacturing facilities are located in Oshkosh, Wisconsin. Space occupied encompasses 688,000 square feet, 52,000 of which is leased. One-half of the space owned by the company has been constructed since 1970. The company owns approximately 50 acres of vacant land adjacent to its existing facilities. The company additionally owns a 28,000 square foot manufacturing facility located in Weyauwega, Wisconsin, and owns a 287,000 sq. ft. trailer manufacturing facility located in Bradenton, Florida.\nThe company's equipment and buildings are modern, well maintained and adequate for its present and anticipated needs.\nIn addition, the company has leased parts and service facilities in Hartford, CT, Greensboro, NC, Chicago, IL and Salt Lake City, UT, and owns similar facilities in Lakeland, FL and Oshkosh, WI.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nVarious actions or claims have been brought or asserted or may be contemplated by government authorities against the company. Among these is a potential action by government authorities against the company in connection with a grand jury investigation which commenced on April 28, 1989. No charges have been filed against the company or its employees. The company and its employees have cooperated fully with the government investigation.\nBased on internal reviews and after consultation with counsel, the company does not have sufficient information to reasonably estimate what potential future costs, if any, the company may incur as a result of the government claims or actions. As a result, no provision related to these issues has been recorded in the accompanying financial statements. Costs incurred in responding to these actions and claims have been expensed as 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 during the fourth quarter of the fiscal year ended September 30, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the company are as follows:\nName Age* Title\nR. Eugene Goodson 60 Chairman & Chief Executive Officer, Member of Executive Committee and Director Robert G. Bohn 42 President & Chief Operating Officer Timothy M. Dempsey 55 Vice President, General Counsel and Secretary Paul C. Hollowell 54 Executive Vice President & President-Oshkosh International Matthew J. Zolnowski 42 Vice President-Administration\n*As of November 15, 1995\nAll of the company's officers serve terms of one year and until their successors are elected and qualified.\nR. EUGENE GOODSON - Mr. Goodson joined the company in 1990 in his present position. Prior thereto, Mr. Goodson served as Group Vice President and General Manager of the Automotive Systems Group of Johnson Controls, Inc., a supplier of automated building controls, automotive seating, batteries and plastic packaging, which position he held since 1985. Mr. Goodson is also a director of Donnelly Corporation.\nROBERT G. BOHN - Mr. Bohn joined the company in 1992 as Vice President-Operations. He was appointed President and Chief Operating Officer in 1994. Prior to joining the company Mr. Bohn was Director- European Operations for Johnson Controls, Inc. from 1984 until 1992. He was elected a director of the company by the Board of Directors in June 1995.\nTIMOTHY M. DEMPSEY - Mr. Dempsey joined the company in October 1995 as Vice President, General Counsel and Secretary. Mr. Dempsey has been and continues to be a partner in the law firm of Dempsey, Magnusen, Williamson and Lampe in Oshkosh, Wisconsin.\nPAUL C. HOLLOWELL - Mr. Hollowell joined the company in 1989 as Vice President-Defense Products and assumed his present position in 1994. Mr. Hollowell was previously employed by General Motors Corporation where he served for three years as manager of their Washington, DC office for military tactical vehicle programs. He previously served 22 years in the U.S. Army from which he retired with the rank of Lieutenant Colonel.\nMATTHEW J. ZOLNOWSKI - Mr. Zolnowski joined the company as Vice President-Human Resources in 1992 and assumed his present position in 1994. Before joining the company Mr. Zolnowski was Director, Human Resources and Administration at Rexene Products Company from 1990 through 1992 and Director, Headquarters Employee Relations at PepsiCo, Inc. from 1982 through 1990.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe information under the captions \"Shareholder Information\", Note 8 to the Consolidated Financial Statements, and \"Financial Statistics\" contained in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is hereby incorporated by reference in answer to this item.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nThe information under the caption \"Financial Highlights\" contained in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is hereby incorporated by reference in answer to this item.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" contained in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is hereby incorporated by reference in answer to this item.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements set forth in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is hereby incorporated by reference in answer to this item. Data regarding quarterly results of operations included under the caption \"Financial Statistics\" in the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is hereby incorporated by reference.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information under the captions \"Election of Directors\" and \"Other Matters\" of the company's definitive proxy statement for the annual meeting of shareholders on January 22, 1996, as filed with the Securities and Exchange Commission, is hereby incorporated by reference in answer to this Item. Reference is also made to the information under the heading \"Executive Officers of the Registrant\" included under Part I of this report.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nThe information under the captions \"Executive Compensation\" contained in the company's definitive proxy statement for the annual meeting of shareholders on January 22, 1996, as filed with the Securities and Exchange Commission is hereby incorporated by reference in answer to this Item.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information under the caption \"Shareholdings of Nominees and Principal Shareholders\" contained in the company's definitive proxy statement for the annual meeting of shareholders on January 22, 1996, as filed with the Securities and Exchange Commission, is hereby incorporated by reference in answer to this Item.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information contained under the captions \"Election of Directors\" and \"Certain Transactions\" contained in the company's definitive proxy statement for the annual meeting of shareholders on January 22, 1996, as filed with the Securities and Exchange Commission, is hereby incorporated by reference in answer to this Item.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements: The following consolidated financial statements of the company and the report of independent auditors appearing at the indicated pages of the Annual Report to Shareholders for the fiscal year ended September 30, 1995, are incorporated by reference in Item 8:\nConsolidated Balance Sheets at September 30, 1995, and 1994 Consolidated Statements of Income for the years ended September 30, 1995, 1994, and September 25, 1993 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1995, 1994, and September 25, 1993. Consolidated Statements of Cash Flows for the years ended September 30, 1995, 1994, and September 25, 1993 Notes to Consolidated Financial Statements Report of Ernst & Young, LLP Independent Auditors\n2. Financial Statement Schedules:\nSchedule II - Valuation & Qualifying Accounts\nAll other schedules are omitted because they are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.\n3. Exhibits:\n3.1 Restated Articles of Incorporation * 3.2 Bylaws of the company, as amended ***** 4.1 Credit Agreement dated February 20, 1995.####### 4.2 Series A Warrant to purchase shares of Class B Common Stock of Oshkosh Truck Corporation delivered to Freightliner Corporation by Oshkosh. ###### 10.1 Lease with Cadence Company (formerly Mosling Realty Company) and related documents * 10.2 1990 Incentive Stock Plan for Key Employees, as amended (through January 25, 1995) #### @ 10.3 Form of Key Employee Employment and Severance Agreement with R. E. Goodson, Chairman & CEO ** @ 10.4 Employment Agreement with R. E. Goodson, Chairman & CEO as of April 16, 1990 **** @ 10.5 Restricted stock grant to R. E. Goodson, Chairman & CEO**** @ 10.6 Incentive Stock Option Agreement to R. E. Goodson, Chairman & CEO **** @ 10.7 Employment Agreement with R. E. Goodson, Chairman & CEO as of April 16, 1992 ## @ 10.8 1994 Long-Term Incentive Compensation Plan dated March 29, 1994 #### @ 10.9 Form of Key Employees Employment and Severance Agreement with Messrs. R.G. Bohn, T.M. Dempsey, P.C. Hollowell, and M.J. Zolnowski #### @ 10.10 Employment Agreement with P.C. Hollowell, Executive Vice President and President, Oshkosh International @ 10.11 Form of Oshkosh Truck Corporation 1990 Incentive Stock Plan, as amended, Nonqualified Stock Option Agreement.##### @ 10.12 Form of Oshkosh Truck Corporation 1990 Incentive Stock Plan, as amended, Nonqualified Director Stock Option Agreement. ##### @ 10.13 Alliance Agreement, dated as of June 2, 1995, between Freightliner and Oshkosh. ###### 10.14 Letter Agreement among J. Peter Mosling, Jr., Stephen P. Mosling, Freightliner, Oshkosh and R. Eugene Goodson. ###### 10.15 Lease extension with Cadence Company (as referenced under 10.1) 10.16 Form of 1994 Long-Term Incentive Compensation Plan Award Agreement @ 11. Computation of per share earnings (contained in Note 1 of \"Notes to Consolidated Financial Statements\" of the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995) 13. 1995 Annual Report to Shareholders, to the extent incorporated herein by reference 23. Consent of Ernst & Young LLP (contained in Consent of Independent Auditors which accompanies financial statement schedules) 27. Financial Data Schedule\n*Previously filed and incorporated by reference to the company's Form S-1 registration statement filed August 22, 1985, and amended September 27, 1985, and October 2, 1985 (Reg. No. 2-99817). **Previously filed and incorporated by reference to the company's Form 10- K for the year ended September 30, 1987. ****Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1990. *****Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1991. ## Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1992. #### Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1994. @Denotes a management contract or compensatory plan or arrangement. ##### Previously filed and incorporated by reference to the company's Form S-8 filing dated September 22, 1995. (Reg. No. 33-62687) ###### Previously filed and incorporated by reference to the company's Form 8-K filing dated June 2, 1995. ####### Previously filed and incorporated by reference to the company's Form 10-Q for the quarter ended April 1, 1995.\n(b) No report on Form 8-K was required to be filed by the registrant\nduring 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.\nOSHKOSH TRUCK CORPORATION\nDecember 22, 1995 By \/S\/ R. Eugene Goodson R. Eugene Goodson Chairman & 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 registrant and in the capacities on the dates indicated.\nDecember 22, 1995 \/S\/ R. E. Goodson R. E. Goodson Chairman & CEO, Member of Executive Committee and Director (Principal Executive and Financial Officer)\nDecember 22, 1995 \/S\/ P. F. Mueller P. F. Mueller Corporate Controller (Principal Accounting Officer)\nDecember 22, 1995 \/S\/ J. W. Andersen J. W. Andersen Director\nDecember 22, 1995 \/S\/ D. T. Carroll D. T. Carroll Director\nDecember 22, 1995 \/S\/ T. M. Dempsey T. M. Dempsey Director\nDecember 22, 1995 \/S\/ M. W. Grebe M. W. Grebe Director\nDecember 22, 1995 \/S\/ J. L. Hebe J. L. Hebe Director\nDecember 22, 1995 \/S\/ S. P. Mosling S. P. Mosling Director and Member of Executive Committee\nDecember 22, 1995 \/S\/ J. P. Mosling, Jr. J. P. Mosling, Jr. Director and Member of Executive Committee\nSCHEDULE II\nOSHKOSH TRUCK CORPORATION VALUATION AND QUALIFYING ACCOUNTS\nYears Ended September 30, 1995, 1994, and September 25, 1993 (In Thousands)\nBalance at Additions Beginning Charged to Balance at Classification of Year Expense Reductions* End of Year\nReceivables - Allowance for doubtful accounts:\n1993...... $517 $ 83 $(183) $417\n1994...... $417 $288 $(274) $431\n1995...... $431 $143 $( 97) $477\n*Represents amounts written off to the reserve, net of recoveries.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report on Form 10-K of Oshkosh Truck Corporation of our report dated November 7, 1995, included in the 1995 Annual Report to Shareholders of Oshkosh Truck Corporation.\nOur audits also included the financial statement schedule of Oshkosh Truck Corporation listed in Item 14(a). This schedule is the responsibility of the company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nWe also consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-38822 and No. 33-62687) pertaining to the Oshkosh Truck Corporation 1990 Incentive Stock Plan and in the related prospectus of our report dated November 7, 1995, with respect to the consolidated financial statements and schedule of Oshkosh Truck Corporation included or incorporated by reference in the Annual Report (Form 10-K) for the year ended September 30, 1995.\nErnst & Young LLP\nMilwaukee, Wisconsin December 22, 1995\nEXHIBIT INDEX\nExhibits\n3. Exhibits:\n3.1 Restated Articles of Incorporation * 3.2 Bylaws of the company, as amended ***** 4.1 Credit Agreement dated February 20, 1995.####### 4.2 Series A Warrant to purchase shares of Class B Common Stock of Oshkosh Truck Corporation delivered to Freightliner Corporation by Oshkosh. ###### 10.1 Lease with Cadence Company (formerly Mosling Realty Company) and related documents * 10.2 1990 Incentive Stock Plan for Key Employees, as amended (through January 25, 1995) #### @ 10.3 Form of Key Employee Employment and Severance Agreement with R. E. Goodson, Chairman & CEO ** @ 10.4 Employment Agreement with R. E. Goodson, Chairman & CEO as of April 16, 1990 **** @ 10.5 Restricted stock grant to R. E. Goodson, Chairman & CEO**** @ 10.6 Incentive Stock Option Agreement to R. E. Goodson, Chairman & CEO **** @ 10.7 Employment Agreement with R. E. Goodson, Chairman & CEO as of April 16, 1992 ## @ 10.8 1994 Long-Term Incentive Compensation Plan dated March 29, 1994 #### @ 10.9 Form of Key Employees Employment and Severance Agreement with Messrs. R.G. Bohn, T.M. Dempsey, P.C. Hollowell, and M.J. Zolnowski #### @ 10.10 Employment Agreement with P.C. Hollowell, Executive Vice President and President, Oshkosh International @ 10.11 Form of Oshkosh Truck Corporation 1990 Incentive Stock Plan, as amended, Nonqualified Stock Option Agreement.##### @ 10.12 Form of Oshkosh Truck Corporation 1990 Incentive Stock Plan, as amended, Nonqualified Director Stock Option Agreement. ##### @ 10.13 Alliance Agreement, dated as of June 2, 1995, between Freightliner and Oshkosh. ###### 10.14 Letter Agreement among J. Peter Mosling, Jr., Stephen P. Mosling, Freightliner, Oshkosh and R. Eugene Goodson. ###### 10.15 Lease extension with Cadence Company (as referenced under 10.1) 10.16 Form of 1994 Long-Term Incentive Compensation Plan Award Agreement @ 11. Computation of per share earnings (contained in Note 1 of \"Notes to Consolidated Financial Statements\" of the company's Annual Report to Shareholders for the fiscal year ended September 30, 1995) 13. 1995 Annual Report to Shareholders, to the extent incorporated herein by reference 23. Consent of Ernst & Young LLP (contained in Consent of Independent Auditors which accompanies financial statement schedules) 27. Financial Data Schedule\n*Previously filed and incorporated by reference to the company's Form S-1 registration statement filed August 22, 1985, and amended September 27, 1985, and October 2, 1985 (Reg. No. 2-99817). **Previously filed and incorporated by reference to the company's Form 10- K for the year ended September 30, 1987. ****Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1990. *****Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1991. ## Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1992. #### Previously filed and incorporated by reference to the company's Form 10-K for the year ended September 30, 1994. @Denotes a MANAGEMENT contract or compensatory plan or arrangement. ##### Previously filed and incorporated by reference to the company's Form S-8 filing dated September 22, 1995. (Reg. No. 33-62687) ###### Previously filed and incorporated by reference to the company's Form 8-K filing dated June 2, 1995. ####### Previously filed and incorporated by reference to the company's Form 10-Q for the quarter ended April 1, 1995.\n(b) No report on Form 8-K was required to be filed by the registrant\nduring the last quarter of the period covered by this report.","section_15":""}
{"filename":"67472_1995.txt","cik":"67472","year":"1995","section_1":"ITEM 1 - BUSINESS\nGENERAL DEVELOPMENT OF THE BUSINESS\nMolex Incorporated originated from an enterprise established in 1938. It was incorporated in 1972 in the state of Delaware. As used herein the term \"Molex\" or \"Company\" includes Molex Incorporated and its United States and international subsidiaries.\nDuring fiscal 1995, Molex purchased the remaining shares of Molex Fiber Optics Inc. and Molex Eastern Europe, S.A., and increased its holdings in Molex (India) Ltd. and DeCoupage Moulage De Savoie S.A. In addition, $9.3 million in cash, along with 1.2 million shares of Class A Common Stock, was used to purchase Mod-Tap W. Corp. During fiscal 1994, Molex purchased the remaining shares outstanding of Molex Nanco Ltd. and acquired an additional 20 percent interest of Dongguan Molex South-China Connector Co. Ltd.\nGENERAL DESCRIPTION OF THE BUSINESS\nMolex is a leading manufacturer of electronic, electrical and fiber optic interconnection products and systems; switches; and application tooling. Molex operates 44 plants in 21 countries and employs 9,500 people worldwide. Molex serves original equipment manufacturers in industries that include computer, computer peripheral, business equipment, home entertainment and home appliance, automotive, telecommunications, local area network and residential construction. Molex offers more than 50,000 products to customers primarily through a network of direct sales representatives and authorized distributors. Products manufactured and sold outside the U.S. generated more than 70% of Molex sales in fiscal 1995. The worldwide market for electronic connectors, cable assemblies and backplanes was estimated at $22.4 billion* in sales for fiscal year 1995. With 5.3% of that market, Molex is the second-largest connector manufacturer in the world.\n* Source: Fleck International\nMolex conducts business in one industry segment: the manufacture and sale of electrical components. The Company designs, manufactures, and distributes electrical and electronic devices such as terminals, connectors, planer cables, cable assemblies, interconnection systems, fiber optic interconnection systems, backplanes and mechanical and electronic switches. Crimping machines and terminal inserting equipment (known as \"application tooling\") are offered on a lease or purchase basis to\nthe Company's customers for the purpose of applying the Company's components to the customers' products. Net revenue from application tooling constitutes approximately 2% of the Company's net revenues. Molex products are designed for use in a broad range of electrical and electronic applications as set forth below:\nThe Company sells its products primarily to original equipment manufacturers and their subcontractors and suppliers. The Company's customers include various multinational companies, including Apple, AT&T, Canon, Compaq, Ford, General Motors, Hewlett Packard, IBM, JVC, Matsushita, Motorola, Philips, Sony, Thomson and Xerox, many of which Molex serves on a global basis. Net revenues contributed by different industry groups fluctuate due to various factors including model changes, new technology, introduction of new products and composition of customers. No customer accounted for 10% or more of net revenues in fiscal years 1995, 1994 or 1993. While its customers generally make purchasing decisions on a decentralized basis, Molex\nbelieves that, due to its financial strength and product development capabilities, it has and will continue to benefit from the trend of many of its customers towards the use of fewer vendors.\nIn the United States and Canada, the Company sells its products primarily through direct sales engineers and industrial distributors. Internationally, Molex sells primarily through its own sales organizations in Japan, Hong Kong, Singapore, Taiwan, South Korea, Malaysia, Thailand, China, Australia, England, Italy, Ireland, France, Spain, Germany, the Netherlands, Switzerland, Poland, Sweden, Norway, Denmark, South Africa, India, Canada, Mexico and Brazil.\nOutside of the United States and Canada, Molex also sells its products through manufacturers' representative organizations, some of which act as distributors, purchasing from the Company for resale. The manufacturers' representative organizations are granted exclusive territories and are compensated on a commission basis. These relationships are terminable by either party on short notice. All sales orders received are subject to approval by the Company.\nThe Company promotes its products through leading trade magazines, direct mailings, catalogs and other promotional literature. Molex is a frequent participant in trade shows and also conducts educational seminars for its customers and its manufacturers' representative organizations.\nThere was no significant change in the Company's suppliers, products, markets or methods of distribution during the last fiscal year.\nMolex generally seeks to locate manufacturing facilities to serve local customers and currently has 44 manufacturing facilities in 21 countries on six continents. This year, the Molex factory in Little Rock, Arkansas became the first U.S. plant to receive the ISO 9000 credential, joining all of the Molex facilities in the Far East North and Far East South Regions and all but one plant in the European Region.\nThe principal raw materials and component parts Molex purchases for the manufacture of its products include brass, copper, aluminum, steel, tin, nickel, gold, silver, nylon and other molding materials, and nuts, bolts, screws and rivets. Virtually all materials and components used in the Company's products are available from several sources. Although the availability of such materials has generally been adequate, no assurance can be given that additional cost increases or material shortages or allocations imposed by its suppliers in the future will not have a materially adverse effect on the operations of the Company.\nCOMPETITION\nThe business in which the Company is engaged is highly competitive. Most of the Company's competitors offer products in some but not all of the industries served by the Company. Molex believes that the ability to meet customer delivery requirements and maintenance of product quality and reliability are competitive factors that are as important as product pricing. Some of the Company's competitors have been established longer and have substantially larger manufacturing, sales, research and financial resources.\nPATENTS\/TRADEMARKS\nAs of June 30, 1995, the Company owned 533 United States patents and had 133 patent applications on file with the United States Patent Office. The Company also has 675 corresponding patents issued and 2,143 applied for in other countries as of June 30, 1995. No assurance can be given that any patents will be issued on pending or future applications. As the Company develops products for new markets and uses, it normally seeks available patent protection. The Company believes that its patents are of importance but does not consider itself materially dependent upon any single patent or group of related patents.\nBACKLOG\nThe backlog of unfilled orders at June 30, 1995 was approximately $245.7 million; this compares to $175.8 million at June 30, 1994. Substantially all of these orders are scheduled for delivery within twelve months. The Company's experience is that orders are normally delivered within ninety days from acceptance.\nRESEARCH AND DEVELOPMENT\nMolex incurred total research and development costs of $78.1 million in 1995, $64.8 million in 1994, and $56.2 million in 1993. The Company incurred costs relating to obtaining patents of $4.9 million in 1995, $3.3 million in 1994, and $2.8 million in 1993 which are included in total research and development costs. The Company's policy is to charge these costs to operations as incurred.\nThe Company had approximately 630 full-time employees in 1995 (606 in 1994 and 558 in 1993), engaged in research, development and engineering functions.\nThe Company introduced many new products during the year; however, in the aggregate, these products did not require a material investment of assets.\nCOMPLIANCE\nThe Company believes it is in full compliance with federal, state and local regulations pertaining to environmental protection. The Company does not anticipate that the costs of compliance with such regulations will have a material effect on its capital expenditures, earnings or competitive position.\nEMPLOYEES\nAs of June 30, 1995, the Company employed 9,500 persons worldwide. The Company believes its relations with its employees are favorable.\nINTERNATIONAL OPERATIONS\nThe Company is engaged in material operations in foreign countries. Net revenue derived from international operations for the fiscal year ended June 30, 1995 was approximately 70% of consolidated net revenue.\nThe Company believes the international net revenue and earnings will continue to be significant. The analysis of the Company's operations by geographical area appears in footnote 10 on page 42 of the 1995 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nMolex owns and leases manufacturing, warehousing and office space in over 99 locations around the world. The total square footage of these facilities is presented below:\nThe leases are of varying terms with expirations ranging from fiscal 1996 through fiscal 2017. The leases in aggregate are not considered material to the financial position of the Company.\nThe Company's buildings, machinery and equipment have been well maintained and are adequate for its current needs.\nA listing of principal manufacturing facilities is presented below:\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nNone deemed material to the Company's financial position or consolidated 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 following information relates to the executive officers of the Registrant who serve at the discretion of the Board of Directors and are customarily elected for one-year terms at the Regular Meeting of the Board of Directors held immediately following the Annual Stockholders' Meeting. All of the executive officers named hold positions as officers and\/or directors of one or more subsidiaries of the Registrant. For purposes of this disclosure, only the principal positions are set forth.\n(a) John H. Krehbiel, Jr. and Frederick A. Krehbiel (the \"Krehbiel Family\") are brothers. The members of the Krehbiel Family may be considered to be \"control persons\" of the Registrant. The other officers listed above have no relationship, family or otherwise, to the Krehbiel family, Registrant or each other.\n(b) Includes period employed by Registrant's predecessor.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Molex is traded on the National Market System of the NASDAQ in the United States and on the London Stock Exchange. & The information set forth under the captions\n(b) \"Financial Highlights\" and \"Fiscal 1995, 1994, and 1993 by Quarter (Unaudited)\" on page 2 and page 43, respectively, of the 1995 Annual Report to Shareholders is incorporated herein by reference.\n(c) The following table presents quarterly dividends per common share for the last two fiscal years. The fiscal 1995 and fiscal 1994 dividends per share have been restated for the August, 1995 25% stock dividend and November, 1994 25% stock dividend.\nCash dividends on Common Shares have been paid every year since 1977.\nA description of the Company's Common Stock appears in footnote 2 on pages 37 and 38 of the 1995 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe information set forth under the caption \"Ten Year Financial Highlight Summary\" (only the five years ended June 30, 1995) on page 26 of the 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 set forth under the caption \"Management's Discussion of Financial Condition and Results of Operations\" on pages 27 through 31 of the 1995 Annual Report to Shareholders 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 set forth on pages 32 through 42 of the 1995 Annual Report to Shareholders and the independent auditors' report set forth on page 25 of the 1995 Annual Report to Shareholders are incorporated herein by reference:\nIndependent Auditors' Report\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 Shareholders' 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\nThe supplementary data regarding quarterly results of operations, set forth under the caption \"Fiscal 1995, 1994, and 1993 by Quarter (Unaudited)\" on page 43 of the 1995 Annual Report to Shareholders, is incorporated herein by reference.\nThe statement of changes in shares outstanding appears on Page 17 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 information under the caption \"Election of Directors\" in the Company's Proxy Statement for the annual meeting of Stockholders to be held on October 20, 1995 (The \"Company's 1995 Proxy Statement\") is incorporated herein by reference. The information called for by Item 401 of Regulation S-K relating to the Executive Officers is furnished in a separate item captioned \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information under the caption \"Executive Compensation\" in the Company's 1995 Proxy Statement is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under the caption \"Security Ownership of Management and of Certain Beneficial Owners\" in the Company's 1995 Proxy Statement is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under the captions \"Election of Directors\", \"Indebtedness of Management\" and \"Security Ownership of Management and of Certain Beneficial Owners\" in the Company's 1995 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. Financial Statements\nThe following consolidated financial statements contained in the Company's 1995 Annual Report to Shareholders have been incorporated by reference in Item 8.\n(a) 2. Financial Statement Schedules\nAll other schedules are omitted because they are inapplicable, not required under the instructions, or the information is included in the consolidated financial statements or notes thereto.\nSeparate financial statements for the Company's unconsolidated affiliated companies, accounted for by the equity method, have been omitted because they do not constitute significant subsidiaries.\n(a) 3. Exhibits\nThe exhibits listed on the accompanying Index to Exhibits are filed or incorporated herein as part of this Report.\n(b) Reports on Form 8-K\nMolex filed no reports on Form 8-K with the Securities and Exchange Commission during the last quarter of the fiscal year ended June 30, 1995.\nMolex Incorporated Statements of Changes in Shares Outstanding For the Year Ended June 30, 1995, 1994, and 1993\nMolex Incorporated Schedule II - Valuation and Qualifying Accounts For the Year Ended June 30, 1995, 1994, and 1993\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Molex Incorporated Lisle, Illinois\nWe have audited the consolidated financial statements of Molex Incorporated and its subsidiaries 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 August 3, 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 statements of changes in shares outstanding and the financial statement schedule of Molex Incorporated and its subsidiaries, listed in Item 14(a)2. These statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such statements of changes in shares outstanding and 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.\n\/s\/ DELOITTE & TOUCHE LLP Chicago, Illinois August 3, 1995\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 Company has duly caused this Annual Report to be signed on its behalf by the undersigned, there unto duly authorized.\nMOLEX INCORPORATED ----------------------------------- (Company)\n\/s\/ JOHN C. PSALTIS ----------------------------------- September 22, 1995 By: John C. Psaltis Corporate 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.\nSeptember 22, 1995 \/s\/ F. A. KREHBIEL ----------------------------------- F. A. Krehbiel Chairman of the Board and Chief Executive Officer\nSeptember 22, 1995 \/s\/ J. H. KREHBIEL, JR. ----------------------------------- J. H. Krehbiel, Jr. President and Director\nSeptember 22, 1995 \/s\/ JOHN C. PSALTIS ----------------------------------- John C. Psaltis Corporate Vice President, Treasurer and Chief Financial Officer\nSeptember 22, 1995 \/s\/ F. L. KREHBIEL ----------------------------------- F. L. Krehbiel Director\nSeptember 22, 1995 \/s\/ DR. ROBERT J. POTTER ----------------------------------- Dr. Robert J. Potter Director\nSeptember 22, 1995 \/s\/ E. D. JANNOTTA ----------------------------------- E. D. Jannotta Director\nMOLEX INCORPORATED EXHIBIT INDEX\n(All other exhibits are either inapplicable or not required)","section_15":""}
{"filename":"819215_1995.txt","cik":"819215","year":"1995","section_1":"ITEM 1. BUSINESS\nA. GENERAL DEVELOPMENT OF BUSINESS\nWhiteford Partners, L.P. (the \"Partnership\") (formerly Granada Foods, L.P.) was formed on June 30, 1987, as a Delaware limited partnership. The Partnership consists of a General Partner which was formerly Granada Management Corp. and now Gannon Group, Inc., and Limited Partners. The offering period of the Partnership terminated on November 10, 1989, with $13,557,550 of Limited Partner gross subscriptions received in the form of Class A Units. Pursuant to the terms of the Prospectus, offering proceeds in the amount of $140,365 were returned to certain Ohio residents when the Partnership's business acquisition program was not substantially completed by December, 1989. The Partnership was organized principally to form, acquire, own and operate businesses engaged in the development, production, processing, marketing, distribution and sale of food and related products (the \"Food Businesses\").\nIn the first quarter of 1990, the Partnership entered into a limited partnership, Whiteford Foods Venture, L.P. (\"Whiteford's\") which was formerly named Granada\/Whiteford Foods Venture, L.P., with a wholly-owned subsidiary of the former General Partner, G\/W Foods, Inc., for the purpose of acquiring the assets, certain liabilities and the operations of Whiteford's Inc., a further processor and distributor of beef products to major fast food restaurants and regional chains, which was located in Versailles, Ohio. The acquisition, which was made with Partnership funds, was closed March 26, 1990, with the Partnership's resultant equity interest in Whiteford's being in excess of 99%. On April 23, 1990, all outstanding and contingent items were resolved and completed, and the acquisition of the assets was funded on April 24, 1990.\nEffective July 1, 1990, the Partnership, acting through Whiteford's and North American Agrisystems, Inc. (\"NAAS\"), an affiliate of the former General Partner of the Partnership, (\"Granada\") entered into a Texas Joint venture named CMF. The principal activity of CMF was the operation of a beef and chicken further processing facility specializing in cooked products, which was owned by NAAS and located in Cincinnati, Ohio. Whiteford's contributed cash to permit CMF to place cash on deposit for facilities usage and provide working capital and capital expenditure funding for CMF. Whiteford's sharing ratio throughout the venture's operation was 50%. In September of 1991, Granada Management Corporation determined that the continued operation of CMF would no longer be in the best interest of the Partnership due to insufficient sales to cover operating costs. A wind down of the operation of CMF began in October 1991 and was completed in April 1992. Operations subsequent to September 30, 1991, were allocated to Whiteford's under the plan of CMF dissolution. Subsequent to September 30, 1991, Granada Management Corporation advised the Partnership that NAAS and its affiliates would be unable to contribute cash to fully satisfy NAAS's negative capital account in the CMF joint venture and other receivables. Effective October 1, 1991, NAAS assigned its economic interest in the CMF plant and equipment, subject to an existing first mortgage encumbrance of approximately $150,000, to the Partnership. On December 30, 1992, the partnership sold the CMF Plant and remaining equipment for $162,975. All net proceeds realizable from these sales were assigned to Whiteford's and the Partnership.\nOn May 4, 1992, the outstanding shares of G\/W Foods, Inc. were assigned by the former General Partner to Gannon Group, Inc., a corporation owned by Kevin T. Gannon, a Director and Vice President of G\/W Foods, Inc. At that time, Mr. Gannon was also a former Vice President of Granada Corporation and certain of its affiliates. Also on May 4, 1992, Granada Management Corporation assigned its sole general partnership interest in the Partnership to Gannon Group, Inc. The effect of these assignments is for Gannon Group, Inc. to have general partnership authority and responsibility with respect to the Partnership and, through G\/W Foods, Inc., of Whiteford's.\nSubject to the availability of capital resources and\/or financing, the Partnership Agreement permits the acquisition of additional Food Businesses that produce, process or distribute specialty food products including businesses that possess technology or special processes which could increase the productivity or processing capability\nof the Partnership's current Food Business or which enhance the marketability or resale value of the Partnership's Food Business products. At the present time, no acquisitions are contemplated.\nB. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Partnership operates principally in the food processing and distribution business.\nC. DESCRIPTION OF BUSINESS\nThe Partnership was organized to form, acquire, own and operate businesses engaged in the development, production, processing, marketing, distribution and sale of food and related products. The Partnership presently operates further processing and meat production operations at one location--Versailles, Ohio. Operations at a Cincinnati, Ohio facility were terminated in April 1992, and the plant was sold in December 1992.\nVERSAILLES, OHIO PLANT OPERATION\nThe Partnership is a further processor and distributor of meat products to major fast food restaurants and regional chains. It serves major metropolitan areas such as Chicago, Cincinnati, Cleveland, Columbus, Detroit, Indianapolis, Louisville and St. Louis. The Partnership's principal products are fresh frozen hamburger patties; precooked and uncooked ground beef, taco meat and roast beef; marinated beef entrees; and other items processed to customers' specifications. Major fast food chains served include Burger King, Rally's and Rax.\nThe Partnership purchases products principally from major domestic packers and regional distributors. However, it also utilizes imported beef. The General Partner believes its sources of supply are adequate for the foreseeable future.\nFor the years ended December 31, 1995, 1994 and 1993, Whiteford's processed and sold 59.8 million pounds of products ($57.6 million), 58.9 million pounds of products ($64.1 million) and 51.4 million pounds of products ($63.1 million) respectively, through its further processing and distribution operations.\nCINCINNATI, OHIO PLANT OPERATION\nThe Partnership's operations in Cincinnati, conducted through a joint venture in CMF from July 1, 1990, to April 30, 1992, conducted beef and chicken further processing operations in a 50,000-square foot facility under the name of Cincinnati Multifoods. In September 1991, the decision was made to wind down the CMF venture and sell this facility due to continuing significant operating losses caused by insufficient sales volumes to cover operating costs. The venture's operating activities were terminated in April 1992, with substantially all of the processing equipment relocated, to the Versailles, Ohio plant for utilization and the CMF land, building and unutilized equipment were placed on the market for sale. The CMF property was sold on December 30, 1992.\nMARKETING AND SALES\nWhiteford's customers consist primarily of major national and regional fast food retail chains in addition to HRI (Hotel, Restaurant, Institutional) customers and food products distributors. Sales operations are conducted locally by sales representatives from the Versailles location and through unaffiliated food products distributors and food brokers.\nThe following customers contributed more than 10% of Whiteford's revenues for the fiscal year ended December 31, 1995: Gordon Food Service, 20.09%; Prosource Distribution Service, 16.95%; I Supply, 12.70%; Sygma Network of Ohio, Inc., 12.50%; and Maines Paper and Food Service, 10.09%.\nHistorically, a significant portion of Whiteford's business has been lodged with relatively few major national and regional accounts. Whiteford's believes that its relationships with its current significant customers are satisfactory. In the past, Whiteford's has been able to obtain additional orders for products from existing accounts or obtain orders for products from new accounts when a significant account diminishes or terminates its purchases with Whiteford's.\nAll of Whiteford's sales are to customers in the United States and Canada.\nREGULATORY MATTERS\nAll of Whiteford's meat production operations are subject to ongoing inspection and regulation by the United States Department of Agriculture (\"USDA\"). Whiteford's plant and facilities are subject to periodic or continuous inspection, without advance notice, by USDA employees to ensure compliance with USDA standards of sanitation, product composition, packaging and labeling. All producers of meat and other food products must comply with substantially similar standards. Compliance with these standards is not expected to have a significant effect on Whiteford's competitive position.\nWhiteford's is subject to federal, state and local laws and regulations governing environmental protection, compliance with which has required capital and operating expenditures. The General Partner believes Whiteford's is in substantial compliance with such laws and regulations and does not anticipate making additional capital expenditures for such compliance in 1996. The General Partner is not aware of any violations of, or pending changes in such laws and regulations that are likely to result in material penalties or material increases in compliance costs. Changes in the requirements or mode of enforcement of certain of these laws and regulations, however, could impose additional costs upon Whiteford's which could materially and adversely affect its cost of doing business.\nWhiteford's is subject to various other federal, state and local regulations, none of which imposes material restrictions on its operations.\nEMPLOYEES\nThe Partnership's operations have been managed by its general partner, Gannon Group, Inc. since May 4, 1992, and Granada Management Corporation from inception to May 4, 1992. Directly, the Partnership has no employees. The Partnership has utilized the services of employees of the General Partner and the former General Partner as needed for certain administrative services. Through May 4, 1992, Granada and affiliates had substantially reduced the scope of their respective operations as a result of cash flow limitations which necessitated the sale of assets to retire secured and unsecured debt. Accordingly, the availability of Granada personnel to provide administrative services for the Partnership had been curtailed at December 31, 1991, and eliminated as of May 4, 1992.\nThe Whiteford's operation at Versailles, Ohio employed 269 personnel at December 31, 1995. The General Partner believes there will be sufficient personnel available to adequately manage the Partnership's business affairs.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPROPERTIES UTILIZED BY THE PARTNERSHIP\nThe Partnership's executive offices are those of the General Partner, located at 770 North Center Street, Versailles, Ohio 45380.\nThe following table sets forth Whiteford's operational facilities and approximate capacities as of December 31, 1995.\nAll Whiteford's facilities are subject to a mortgage with two banks and subordinated mortgage with Greenaway Consultant, Inc.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending or threatened legal proceedings involving the Partnership, known to either the Partnership or the General Partner.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of the Limited Partners of the Partnership during 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 Partnership's Limited Partnership Units.\nThe following table sets forth the amounts and dates of distributions to holders of Limited Partnership Units in each of the two most recently completed years:\nCertain of the Partnership's loans with its lender contain restrictive covenants. One of the covenants restricts the Partnership from declaring or paying any distributions to its partners without the prior written consent of the bank, except for amounts already classified as reinvested distributions in the balance sheet.\nThe following table sets forth the approximate number of holders of record of the equity securities of the Partnership as of December 31, 1995:\nTitle of Class Number of Record Holders -------------- ------------------------ Limited Partnership Units 1,567\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data set forth below should be read in conjunction with the consolidated financial statements, the notes thereto and other financial information included elsewhere herein, including \"Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The table following reflects the results of operations of acquired businesses for periods subsequent to their respective acquisition dates.\nBALANCE SHEET DATA (DECEMBER 31):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nManagement's discussion and analysis set forth below should be read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere herein.\nThe Partnership was organized as a Limited Partnership with a maximum operating life of twenty years ending 2007. The source of its capital has been from the sale of Class A, $10 Limited Partnership units in a public offering that terminated on November 10, 1989.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995, COMPARED TO YEAR ENDED DECEMBER 31, 1994\nRevenues for the year ended December 31, 1995 were $57,826,711 versus $64,345,321 for the year ended December 31, 1994, a decrease of 10.1%. During the 1995 period, 59,776,527 pounds of meat products were sold versus 58,941,688 pounds during the 1994 period, an increase of 834,839 pounds or 1.4%. The increase in pounds of meat products sold is primarily attributable to the increased sales effort and production capabilities at the Versailles plant. Sales revenues did not increase commensurately due to declining commodity prices during 1995. The average sales price per pound for 1995 was $.965 versus the average sales price per pound for 1994 of $1.088.\nCosts of meat products sold for the year ended December 31, 1995 were $53,757,014 versus $60,428,954 for the year ended December 31, 1994, a decrease of 11.0% During the 1995 period, 59,776,527 pounds of meat products were sold versus 58,941,688 pounds during the 1994 period, an increase of 1.4%. The average cost of meat products sold for 1995 was $.899 versus $1.025 in the 1994 period, a decrease of 12.2%. The decline in the cost per pound is primarily attributable to general commodity price declines. The General Partner expects general commodity prices to decline slightly during 1996.\nGross margins on meat sales were 6.8% for the year ended December 31, 1995 and 5.7% for the 1994 period. This increase is gross margins is primarily attributable to: i) decline in revenues and raw material costs associated with the general decline in meat prices during the 1995 period versus the 1994 period; ii) the semi-variable nature of certain costs in the costs of meat products sold such as labor, packaging, and utilities and iii) the increased efficiencies associated with the recently renovated Versailles plant whereby lower labor and utilities costs are realized in the manufacture and warehousing of products.\nSelling and administrative expenses increased to $2,197,506 during the year ended December 31, 1995 versus $1,963,623 for the same period in 1994. Such increase is primarily attributable to inefficiencies associated with the freezer completion and the installation of new equipment during the first six months of 1995.\nDepreciation and amortization expense for the year ended December 31, 1995 was $1,052,213 versus $831,116 for the same period in 1994, an increase of 26.6%. Such increase is primarily due to the expansion of the freezer space at the Versailles plant. Such construction project was completed during 1995 and the property was put into service in March 1995.\nInterest expense for the year ended December 31, 1995 was $799,494 versus interest expense of $290,116 for the same period in 1994. This increase of $509,378 primarily relates to the increase in the average debt outstanding during 1995 due primarily to the $3.8 million expansion of the Versailles plant.\nThe Partnership reported net income of $20,544 for the year ended December 31, 1995 versus $831,512 for the 1994 period. This decline in operating profit is primarily attributable to two factors. First, the Partnership completed a renovation of the fixed plant including the construction of freezer space and the installation of new equipment during 1995. The construction and installation disrupted the normal operations of the plant resulting in an inefficient production process during the first six months of 1995. Management estimates the loss due to their inefficiency amounted to $400,000. Second, the overall price of meat products underwent a general decline during the 1995 period versus the 1994 period. Such general declines in meat prices tend to lower net income from operation due to lower inventory valuations and lower margins.\nYEAR ENDED DECEMBER 31, 1994, COMPARED TO YEAR ENDED DECEMBER 31, 1993\nRevenues for the year ended December 31, 1994 were $64,345,321 versus $63,338,797 for 1993, an increase of $1,006,524 or 1.6% over the revenues for the prior period. This increase was primarily attributable to the increased sales efforts and production capability at the Versailles, Ohio plant.\nGross profit from the sale of meat products increased to $3,679,437 in 1994 from $3,063,500 in 1993, reflecting increased sales activity. Gross margins for 1994 were 5.7% versus 4.9% in 1993.\nSelling and administrative expenses increased to $1,963,623 in 1994 from $1,622,827 in 1993, a total increase of $340,796 or 21.0% over 1993 amounts. This increase was primarily attributable to increased poundage. Selling and administrative expenses represented 3.1% of sales in 1994 versus 2.6% of revenue during 1993.\nDepreciation and amortization increased to $831,116 in 1994 from $723,498 in 1993, a total increase of $107,618, due primarily to the expansion of the Versailles, Ohio facility and equipment used therein.\nInterest expense decreased to $290,116 in 1994 from $349,319 in 1993. The decrease was primarily attributable to capitalizing construction in 1994.\nThe Partnership reported a net income of $831,512 for 1994 versus a net income of $523,868 for 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Partnership had a negative working capital position of $525,037, versus a working capital of $154,050 at December 31, 1994. The decline in the working capital position is primarily attributable to the expansion of the Versailles facility as described below.\nCash provided by operating activities was $849,003 for the year ended December 31, 1995 reflecting net income of $20,544, depreciation and amortization of $1,052,213, offset by net decreases in other net operating assets of $223,754. Cash provided by operating activities for the year ended December 31, 1994 was $2,473,105, with a net income of $831,512, depreciation of $831,116, offset by net increases in other net operating assets of $810,477.\nCash used in investing activities was $3,155,430 for 1995 versus $3,932,535 for 1994. The decrease in cash used in investing activities is primarily attributable to investment in new equipment and the expansion of the freezer facility at the Versailles plant during 1995 as described below.\nThe Limited Partnership Agreement provides for the General Partner to receive an annual administrative fee. The fee is equal to 2% (adjusted for changes in the Consumer Price Index after 1989) of net business investment (defined as $8.50 multiplied by Partnership units outstanding). However, such amounts payable to the General Partner are limited to 10% of aggregate distributions to all Partners from \"Cash Available for Distributions.\" As defined in the Limited Partnership Agreement, that portion of the management fee in excess of such 10% limitation is suspended, and future payment is contingent.\nThe Administrative Management Fees paid to the General Partner and recorded by the Partnership were $10,455 in 1995, $13,069 in 1994, $2,614 in 1993, and $0.00 in 1992. Suspended fees during 1995, 1994, 1993 and 1992 respectively, are $290,000, $222,000, $229,000, and $228,000.\nCash provided by financing activities for 1995 consisted of net increases in bank debt of $2,470,814 offset by distributions to limited and general partners of $105,597.\nWhiteford's working capital and equipment requirements are primarily met by (a) a revolving credit agreement with Whiteford's principal lender in the maximum amount of $2,600,000 (with $2,312,289 outstanding at December 31, 1995), (the \"Principal Revolver\"); (b) a five year term credit facility of $2,200,000 (the \"Principal Term Loan\"); (c) a five year credit facility of $4,165,000 (the \"Principal Mortgage Loan\"); (d) a two year credit facility of $700,000, (the \"Second Term Loan\"); (e) a five year credit facility of $500,000, (the \"Third Term Loan\") and (f) a credit facility with Greenaway Consultant, Inc. for $420,000, with $262,500 outstanding as of December 31, 1995 (the \"GCI Loan\"),(collectively, the \"Loans\").\nThe Principal Revolver bears interest at prime plus 1\/2%. The Principal Term Loan bears an interest rate of 8.717%. The Principal Mortgage Loan bears an interest rate of 9.89%. The Second Term Loan bears an interest rate of prime plus 1.25%. The Third Term Loan bears an interest rate of 9.42%. The Loans require the Partnership to meet certain financial covenants and restrict the ability of the Partnership to make distributions to Limited Partners without the consent of the principal lender. The Principal Revolver and the Principal Term Loan (together with the Principal Mortgage Loan provided by the principal lender) are secured by real property, fixed assets, equipment, inventory, receivables and intangibles of Whiteford's.\nThe GCI Loan bears interest at a rate equal to 1-1\/2% above the prime rate established from time to time by the Company's financial institution lender having the highest outstanding credit balance. The GCI Loan is secured by real property, fixed assets, equipment, inventory and intangibles and is subordinated to the Principal Revolver, the Principal Term Loan, and the Principal Mortgage Loan.\nThe Partnership's 1996 capital budget calls for the expenditure of approximately $900,000 for building, plant, and equipment modifications and additions. The General Partner believes Whiteford's is in compliance with environmental protection laws and regulations, and does not anticipate making additional capital expenditures for such compliance in 1996. Such amounts are expected to be funded by internally generated cash flow. A lease agreement has been secured to provide funding for two mechanical freeze tunnel systems that will replace four liquid nitrogen freeze tunnels. The installation of these units was completed in the third quarter of 1995 and require monthly lease payments of $31,119. The General Partner believes that the above credit facilities along with cash flow from operations will be sufficient to meet the Partnerships' working capital and credit requirements for 1996.\nThe nature of the Partnership's business activities (primarily meat processing) are such that should annual inflation rates increase materially in the foreseeable future, the Partnership would experience increased costs for personnel and raw materials; however, it is believed that increased costs could substantially be passed on in the sales prices of its products.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data of the Partnership are included in this report after the 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 PARTNERSHIP\nMANAGEMENT\nThe Partnership has no officers or directors. The affairs of the Partnership are managed by the Gannon Group, Inc., the General Partner. The directors, executive officers and key employees of the General Partner as of December 31, 1995, are as follows:\nKEVIN T. GANNON, age 39, sole director, President and sole stockholder of Gannon Group, Inc.\nMr. Gannon is a Managing Director of Robert A. Stanger & Co., Inc., a New Jersey based investment banking, investment research and consulting firm. Mr. Gannon was formerly a Vice President - Corporate Development of Granada Corporation and Director and Vice President of Granada BioSciences, Inc. and Granada Foods Corporation, former affiliate of the Partnership. From August 1983 to April 1988, Mr. Gannon was employed by Robert A. Stanger & Co. Ltd. Mr. Gannon is a Certified Public Accountant.\nNo director or officer of the General Partner was, during the last five (5) years, the subject (directly, or indirectly as a general partner of a partnership or as an executive officer of a corporation) of a bankruptcy or insolvency petition, of any criminal proceeding (excluding traffic violations and other minor offenses), or restrictive orders, judgments or decrees enjoining him from or otherwise limiting him from acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity, engaging in any business activity, or engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of Federal or State securities laws or Federal commodities laws, or was the subject of any existing order of a federal or state authority barring or suspending for more than sixty (60) days the right of such person to be engaged in such activity.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCURRENT YEAR REMUNERATION\nThe Partnership has no officers or directors. Accordingly, no direct remuneration was paid to officers and directors of the Partnership for the year ended December 31, 1995. Remuneration to the General Partner is pursuant to Articles VI of the LIMITED PARTNERSHIP AGREEMENT (filed as Exhibit A to the Prospectus included in the Partnership's Registration Statement on Form S-1 [File No. 2-98273]) and incorporated herein by reference.\nPursuant to Section 6.4(c) of the Limited Partnership Agreement, the General Partner is entitled to receive a management fee of approximately $300,000 for the calendar year 1995. However, Section 6.4(c)(v) limits all amounts payable to the General Partner pursuant to Section 6.4(c) to an amount which does not exceed 10% of aggregate distributions to Partners from \"Cash Available for Distributions\". Under the Limited Partnership Agreement, Cash Available for Distributions is comprised of cash funds from operations (after all expenses, debt repayments, capital improvements and replacements, but before depreciation) less amounts set aside for restoration or reserves. That portion of the management fee in excess of such 10% limitation is suspended, and future payment is delayed until such payment may be made without exceeding such limit.\nOn dissolution of the Partnership, Section 15.3(a)(ii) of the Limited Partnership Agreement generally provides for the payment of creditors, and then pro rata payment to record holders for loans or other amounts owed to them by the Partnership, including without limitation any amounts owed to the General Partner pursuant to Section 6.4. Any amounts payable to the General Partner under Section 15.3(a)(ii) will be dependent upon the funds available for distribution on the dissolution of the Partnership.\nSection 6.4(e) of the Limited Partnership Agreement also provides the General Partner a subordinated special allocation equal to 15% of any gain on the sale of partnership assets or food businesses. Among other things, this special allocation is subordinated to payments to the limited partners for certain distributions. Any payment pursuant to Section 6.4(e) will be dependent upon the ultimate sale price of such partnership assets or food businesses.\nDuring calendar year 1995 and 1994, the Partnership made aggregate distributions to Partners from Cash Available for Distribution in the amounts of $104,551 and $130,689. As a result in 1995, the Partnership paid the General Partner 10% of such amount or $10,455, and suspended payment of approximately $290,000 of such management fee. The cumulative amount of annual management fees that have been suspended is $969,000. Suspended fees during 1995, 1994, 1993, and 1992, respectively, are $290,000, $222,000, $229,000, and $228,000. In addition, the General Partner received a pro rata distribution of partnership Cash Available for Distribution in the amount of $1,046.\nOTHER COMPENSATION ARRANGEMENTS\nThere is no plan provided for or contributed to by the Partnership or the General Partner which provides annuity, pension or retirement benefits for the General Partner or the officers and directors of the General Partner. There is no existing plan provided for or contributed to by the General Partner which provides annuity, pension or benefits for its officers or directors. There are no arrangements for remuneration covering services as a director between the Partnership and any director of the General Partner. No options to purchase any securities of the General Partner were granted or exercised during its fiscal year ended December 31, 1995. No options were held to purchase securities of the Partnership as of December 31, 1995, and as of the date hereof.\nAfter the Partnership acquired the assets of Whiteford's, Inc., Whiteford's entered into a Services Agreement with Greenaway Consultant, Inc. (\"GCI\") under which GCI managed Whiteford's. GCI is owned by one of Whiteford's, Inc.'s former principal shareholders.\nSubsequent to the Services Agreement, Whiteford's determined that it was desirable to lessen the cash flow burden resulting from the Installment Loan and the tax payment obligation. Whiteford's determined it was in a position to refinance $250,000 of the Installment Loan on a more favorable amortization basis and at a more favorable interest rate. As a result, Whiteford's consulted with GCI about GCI's willingness to accept a partial payment of the Installment Loan, extend the payments under the Installment Loan and to accept a right to receive payments in the future in lieu of being awarded part of the limited partnership units. As a result, Whiteford's and GCI entered into a \"1993 Services Agreement\" which (i) rescinds the original Services Agreement and the Letter Agreement, (ii) reaffirms the covenant not to compete for GCI and its shareholder, (iii) provides for the remaining principal balance of the Installment Loan ($420,000) to be payable over a four year period with quarterly principal payments of $26,250 plus interest, (the first quarterly payment beginning March 31, 1994), restricts GCI's equity interest in the limited partnership units to 1.00% (all of which has been delivered to GCI effective January 1, 1994), (v) provides for Whiteford's payment to GCI of approximately $250,000 per year for its management services, and $500,000 upon a change of control or the sale of substantially all Whiteford's assets.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPRINCIPAL SECURITY HOLDERS\nThe General Partner owns the entire general partnership interest, which interest controls the Partnership. The General Partner does not beneficially own, either directly or indirectly, any equity security in the Partnership, other than the general partner interest.\nCONTRACTUAL ARRANGEMENTS AFFECTING CONTROL\nOn May 4, 1992, the outstanding shares of G\/W Foods, Inc. were assigned by Granada Management Corporation to Gannon Group, Inc., a corporation owned by Kevin T. Gannon, a Director and Vice President of G\/W Foods, Inc. and also a former Vice President of Granada Corporation and certain of its affiliates. Also on May 4, 1992, Granada Management Corporation assigned its sole general partnership interest in the Partnership to Gannon Group, Inc. The effect of these assignments is for Gannon Group, Inc. to have general partnership authority and responsibility with respect to the Partnership and, through G\/W Foods, Inc., of Whiteford's.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWhiteford Partners L.P. ----------------------------------- (Registrant) By Gannon Group, Inc. Its General Partner\nDate: March 29, 1996 \/s\/ Kevin T. Gannon ----------------------------- ----------------------------------- 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 Registrant and in the capacities and on the dates indicated:\nSIGNATURES TITLE DATE - -------------------------- ------------------------------- ----------------\n\/s\/ Kevin T. Gannon Chief Executive Officer, March 29, 1996 - -------------------------- President, Chairman of the Board Kevin T. Gannon and Sole Director (Principal Executive Officer), Chief Financial Officer, and Chief Accounting Officer\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) AND (2), (c) AND (d)\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCERTAIN EXHIBITS\nYEAR ENDED DECEMBER 31, 1995\nWHITEFORD PARTNERS, L.P.\nFORM 10-K -- ITEM 8, ITEM 14 (a) (1) AND (2), (c) AND (d)\nThe following financial statements and financial statement schedules of the Partnership are included as part of this report at Item 8:\n(a) 1. Financial Statements\nCONSOLIDATED BALANCE SHEETS - December 31, 1995, and 1994.\nCONSOLIDATED STATEMENTS OF OPERATIONS - for the years ended December 31, 1995, 1994, and 1993.\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL - 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\n(a) 2. See Index to Exhibits immediately following the financial statement schedules.\nWHITEFORD PARTNERS, L.P. CONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nWHITEFORD PARTNERS, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements.\nWHITEFORD PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL\n$.10 and .10 weighted average outstanding units of Limited Capital in 1995 and 1994 respectively.\nSee notes to consolidated financial statements.\nWHITEFORD PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nWHITEFORD PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\nNOTE A - ORGANIZATION, BUSINESS AND ACQUISITIONS\nWhiteford Partners, L.P., (the Partnership), formerly Granada Foods, L.P., was formed on June 30, 1987, as a Delaware limited partnership. Prior to May 4, 1992, the Partnership consisted of a General Partner, Granada Management Corporation, (Granada), and the Limited Partners. On May 4, 1992, Granada assigned its sole general partner interest in the Partnership to Gannon Group, Inc. and the Partnership was renamed Whiteford Partners, L.P.\nThe operational objectives of the Partnership are to own and operate businesses engaged in the development, production, processing, marketing, distribution and sale of food and related products (Food Businesses) for the purpose of providing quarterly cash distributions to the partners while providing capital appreciation through the potential appreciation of the Partnership's Food Businesses. The Partnership expects to operate for twenty years from inception, or for such shorter period as the General Partner may determine is in the best interest of the Partnership, or for such shorter period as determined by the majority of the Limited Partners.\nThe Partnership Agreement provides that a maximum of 7,500,000 Class A, $10 partnership units can be issued to Limited Partners. Generally, Class A units have a preference as to cumulative quarterly cash distributions of $.25 per unit. The sharing of income and loss from the Partnership operations is 99% to the Class A and 1% to the General Partner. Amounts and frequency of distributions are determinable by the General Partner.\nOn March 26, 1990, the Partnership, through Whiteford Foods Venture, (Whiteford's) L.P. (formerly Granada\/Whiteford Foods Venture, L.P.), a joint venture with an affiliate of the then General Partner, acquired the business assets of Whiteford's Inc., a meat processing and distribution company. The Partnership's interest in the operations and equity of Whiteford's is greater than 99.9%. The cash purchase price of the assets was $8,275,000 with liabilities of $3,776,806 assumed. The excess of the purchase price over the estimated fair value of the net tangible assets acquired of approximately $3,825,000 was recorded as goodwill. The acquisition was accounted for using the purchase method of accounting and, accordingly, the financial statements include the operations of Whiteford's from the date of acquisition.\nIn 1993, the Partnership entered into a settlement agreement with certain participants in the Partnership's Distribution Reinvestment and Unit Acquisition Plan under which the Partnership repurchased 33,165 class A Units for a total purchase price of $218,194 payable over a five year period. The first installment in the amount of $62,049 was paid in 1993 with four subsequent annual installments of $39,036.25.\nAt December 31, 1995 and at December 31, 1994, the Partnership had 1,306,890 Class A limited partnership units issued and outstanding.\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the Partnership and Whiteford's, from the date of acquisition (March 26, 1990). Significant intercompany account balances and transactions have been eliminated in consolidation.\nINVENTORIES. Inventories of meat, meat products and packaging supplies are stated at the lower of first-in, first-out (FIFO) cost or market. The major components of inventories are as follows at December 31:\nPROPERTY AND EQUIPMENT. Property and equipment is stated at cost. Depreciation, computed using the straight-line method on the basis of the estimated useful lives of the depreciable assets, was $924,719, $703,623 and $596,004 in years 1995, 1994 and 1993, respectively. The costs of ordinary repairs and maintenance are charged to expense, while betterment and major replacements are capitalized.\nOTHER ASSETS. Goodwill associated with the acquisition of Whiteford's Inc. is being amortized on a straight-line basis over a thirty-year period. Accumulated amortization at December 31, 1995, 1994, and 1993, was $718,476, $597,606 and $476,737, respectively.\nDISTRIBUTIONS. The Partnership records distributions of income and\/or return of capital to the General Partner and Limited Partners when paid. Special transfers of equity, as determined by the General Partner, from the General Partner to the Limited Partners are recorded in the period of determination. Distributions of $104,551 and $130,869 to Limited Partners were recorded in 1995 and 1994 respectively.\nINCOME TAXES. The Partnership files an information tax return. The items of income and expense are allocated to the partners pursuant to the terms of the Partnership Agreement. Income taxes applicable to the Partnership's results of operations are the responsibility of the individual partners and have not been provided for in the accounts of the Partnership. At December 31, 1995, the book basis of assets exceeds the tax basis of such assets by approximately $2,692,000 primarily due to the use of accelerated depreciation methods utilized for tax reporting purposes.\nCASH, CASH EQUIVALENTS AND CASH FLOWS. For the purpose 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. Total interest paid was $747,959, $394,766 and $325,725 for 1995, 1994 and 1993, respectively.\nNET INCOME PER UNIT OF LIMITED PARTNERS CAPITAL. The net income per unit of limited partners capital is calculated by dividing the net income allocated to limited partners by the weighted average units outstanding.\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 results.\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 operation 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 C - RELATED PARTY TRANSACTIONS\nThe Limited Partnership Agreement provides for the General Partner to receive an annual administrative fee. The fee is equal to 2% (adjusted for changes in the consumer price index after 1989) of net business investment (defined as $8.50 multiplied by Partnership units outstanding). However, such amounts payable to the General Partner are limited to 10% of aggregate distributions to all Partners from \"Cash Available for Distributions\". As defined in the Limited Partnership Agreement, that portion of the management fee in excess of such 10% limitation is suspended, and future payment is contingent.\nThe Administrative Management Fees paid to the General Partner and recorded by the Partnership were $10,455 in 1995, $13,069 in 1994 and $2,614 in 1993. Suspended fees during 1995, 1994 and 1993 respectively are $290,000, $222,000 and $229,000. The Partnership also has a service agreement with Greenaway Consultant, Inc. (GCI), which provides for the former principal owner of Whiteford's to provide consulting services to the Partnership. The agreement is for approximately five years expiring December 31, 1997, and provides minimum consulting fees of approximately $250,000 per annum. During 1995, 1994 and 1993 the minimum was paid. In addition, GCI will receive limited partnership units ultimately representing 1.0%, (all of which was received as of December 31, 1994) of all outstanding limited partnership units of Whiteford's. GCI will receive payment of $500,000 upon a change of control or sale of substantially all of the assets of the Partnership.\nNOTE D - LONG TERM DEBT\nThe following schedule summarizes long-term debt at December 31:\nThe Note payable to Greenaway Consultant, Inc. represents amounts due to a consulting company owned by a former owner of Whiteford's Inc., (see Note C). This debt is subordinated to the bank notes.\nThe notes payable and the revolving credit agreement with the bank contain restrictive covenants. The covenants restrict the Partnership from declaring or paying any distributions to its partners without the prior written consent of the bank, except for amounts already classified as reinvested distributions in the balance sheet; limit the level of capital expenditures the Partnership may make in any fiscal year and require the Partnership to maintain certain financial ratios. In addition, the Partnership must maintain a monthly average of $100,000 on deposit with the bank as a compensating balance.\nThe revolving credit agreement permits borrowing of up to $2,600,000 of which $287,711 was available at December 31, 1995. Long-term debt and borrowing under the revolving credit agreement are collateralized by substantially all of the Partnership's property and equipment, inventory and accounts receivable.\nThe aggregate annual maturities on the long-term debt for the Partnership for the three years subsequent to 1996 are: $932,069, $583,351, $296,115.\nDuring 1995, 1994 and 1993, the weighted average interest rate on short- term borrowing was 9.4%, 8.3% and 7.6% respectively, while the weighted average month end amount outstanding was $2,812,838, $1,541,883 and $1,236,036 respectively. The largest outstanding month end balance was $3,245,938 in 1995, $2,294,073 during 1994 and $1,861,943 during 1993.\nNOTE E - LEASES\nLEASE COMMITMENTS. The Partnership's leases, buildings and equipment, are under various noncancelable operating lease agreements. Lease rental expense for 1995, 1994 and 1993 was $375,963, $215,574 and $206,095, respectively. The future minimum lease payments under the leases are as follows:\nNOTE F - EMPLOYEE BENEFIT PLAN\nThe Partnership has a 401K Plan which covers substantially all employees who have completed one year of service. The Partnership matches 10% of the participant's contributions up to 6% of employee eligible compensation. Contributions to the Plan were $10,900 in 1995, $8,200 in 1994, and $4,600 in 1993.\nNOTE G - MAJOR CUSTOMERS\nWhiteford's facility, located in Versailles, Ohio, operates as a further processor and distributor of beef products to major fast food restaurants and regional chains. Whiteford's principal products are fresh frozen hamburger patties; precooked and uncooked ground beef taco meat and roast beef, marinated beef entrees; and other items processed to the customers' specifications. Major fast food chains served include Burger King, Rally's and Rax.\nSales of meat products to major customers are summarized as follows for the fiscal years ended December 31, 1995, and 1994.\nThe total amounts receivable from these customers on December 31, 1995, and 1994, were $2,008,659 and $1,809,526, respectively.\nINDEPENDENT AUDITOR'S REPORT\nLimited and General Partners Whiteford Partners, L.P.\nWe have audited the accompanying consolidated balance sheets of Whiteford Partners, L.P. (a Delaware limited partnership) and subsidiary as of December 31, 1995 and 1994, and the related consolidated 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 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 Whiteford Partners, L.P. and subsidiary 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\nFebruary 19, 1996\nINDEX TO ATTACHED EXHIBITS\nINDEX TO ATTACHED EXHIBITS (CONT.)\nINDEX TO ATTACHED EXHIBITS (CONT.)","section_15":""}
{"filename":"841281_1995.txt","cik":"841281","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nResorts International Hotel, Inc. (\"RIH\") owns and operates Merv Griffin's Resorts Casino Hotel (the \"Resorts Casino Hotel\") in Atlantic City, New Jersey. RIH was incorporated in New Jersey in 1903. RIH is a wholly owned subsidiary of GGRI, Inc. (\"GGRI\"), which is a wholly owned subsidiary of Griffin Gaming & Entertainment, Inc. (\"GGE\"). GGE was known as Resorts International, Inc. until its name change, which was effective June 30, 1995. \"GGE\" is used herein to refer to RIH s ultimate parent corporation both before and after its name change. GGRI has no assets or operations other than those represented by its investment in RIH.\nThe Resorts Casino Hotel is located on the Atlantic City Boardwalk and has approximately 660 guest rooms, a 70,000 square foot casino, an 8,000 square foot simulcast parimutuel betting and poker area and related facilities.\nCasino operations in Atlantic City are conducted under a casino license which is subject to periodic review and renewal by action of the New Jersey Casino Control Commission (the \"Casino Control Commission\"). RIH's current license was renewed in January 1996 through January 31, 2000 subject to a financial stability review after two years. See \"Regulation and Gaming Taxes and Fees\" under \"(c) Narrative Description of Business\" below.\n1994 Restructuring\nIn April 1994 the joint plan of reorganization (the \"Plan\") proposed by GGE, GGRI, RIH and certain other of GGE s subsidiaries was confirmed by the Bankruptcy Court for the District of Delaware and on May 3, 1994 (the Effective Date ) the Plan became effective.\nPursuant to the Plan, certain of GGE s previously outstanding public debt was exchanged for, among other things, $125,000,000 principal amount of 11% Mortgage Notes (the \"Mortgage Notes\") due September 15, 2003 and $35,000,000 principal amount of 11.375% Junior Mortgage Notes (the \"Junior Mortgage Notes\") due December 15, 2004. The Mortgage Notes and the Junior Mortgage Notes were issued by Resorts International Hotel Financing, Inc. (\"RIHF\"), a subsidiary of GGE, and are guaranteed by RIH. The Mortgage Notes are secured by a $125,000,000 promissory note made by RIH (the \"RIH Promissory Note\"), the terms of which mirror the terms of the Mortgage Notes. The Junior Mortgage Notes are secured by a $35,000,000 promissory note made by RIH (the \"RIH Junior Promissory Note\"), the terms of which mirror the terms of the Junior Mortgage Notes. The RIH Promissory Note, the RIH Junior Promissory Note and RIH's guarantees of the Mortgage Notes and the Junior Mortgage Notes are secured by liens on the Resorts Casino Hotel.\n- 3 -\nFor further description of the securities issued pursuant to the Plan and the related affiliated notes, guarantees and mortgages issued by RIH see Note 7 of Notes to Consolidated Financial Statements. For a description of a senior note purchase agreement (the \"Senior Facility\") entered into by RIH pursuant to the Plan and other effects of the Plan on RIH see Notes 9 and 2, respectively, of Notes to Consolidated Financial Statements.\n(b) Financial Information about Industry Segments\nRIH operates in one business segment. See \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\n(c) Narrative Description of Business\nGaming Facilities\nThrough May 1995, the Resorts Casino Hotel in Atlantic City, New Jersey, had a 60,000 square foot casino and a simulcast parimutuel betting and poker area of approximately 8,000 square feet. In late May 1995, the casino was expanded by approximately 10,000 square feet which enabled RIH to increase the number of slot machines by approximately 315 machines. At December 31, 1995, these gaming areas contained 43 blackjack tables, 18 poker tables, 11 roulette tables, 10 dice tables, eight Caribbean stud poker tables, two baccarat tables, two let it ride poker tables, one mini-baccarat table, one pai gow poker table, one big six wheel, one sic bo table, 2,338 slot machines, and five betting windows and four customer-operated terminals for simulcast parimutuel betting. Also included in the simulcast area is a keno lounge which has two keno cashier windows. There are also two keno windows in the bus waiting area and one on the casino floor.\nDuring 1995, RIH had total gaming revenues of $267,757,000. This compares to total gaming revenues of $250,482,000 for 1994 and $244,116,000 for 1993. In the last several years, approximately a dozen new table games have been introduced in order to provide more variety than the basic five table games of blackjack, roulette, craps, baccarat and big six, which were the only games available for the initial 15 years of the gaming industry in Atlantic City. RIH has offered simulcast betting and poker since June 1993, keno since June 1994 and Caribbean stud poker since November 1994.\nCasino gaming in Atlantic City is highly competitive and is strictly regulated under the New Jersey Casino Control Act and regulations promulgated thereunder (the \"Casino Control Act\"), which affect virtually all aspects of RIH's casino operations. See \"Competition\" and \"Regulation and Gaming Taxes and Fees\" below.\nResort and Hotel Facilities\nThe Resorts Casino Hotel commenced operations in May 1978 and was the first casino\/hotel opened in Atlantic City. This was accomplished by the conversion of the former Haddon Hall Hotel, a classic hotel structure originally built in the early 1900's, into a casino\/hotel. It is situated on approximately seven acres of land with approximately\n- 4 -\nfeet of Boardwalk frontage overlooking the Atlantic Ocean. The Resorts Casino Hotel consists of two hotel towers, the 15-story East Tower and the nine-story North Tower. In addition to the casino f a c ilities described above, the casino\/hotel complex includes approximately 660 guest rooms and suites, the 1,400-seat Superstar Theater, seven restaurants, one cocktail lounge, a VIP slot and table player lounge, an indoor swimming pool and health club, and retail stores. The complex also has approximately 50,000 square feet of convention facilities, including eight large meeting rooms and a 16,000 square foot ballroom.\nRIH owns a garage that is connected to the Resorts Casino Hotel by a covered walkway. This garage is used for patrons' self parking and accommodates approximately 700 vehicles. RIH also leases a lot f r o m an unaffiliated party which provides valet parking for approximately 180 cars. In June 1995 GGE acquired approximately 4.4 acres adjoining the Resorts Casino Hotel (the \"Chalfonte Site\"). RIH leases this acreage from GGE for additional uncovered self parking for approximately 140 cars and valet parking for approximately 420 cars. Prior to GGE s acquisition of the Chalfonte Site, RIH had leased this property from an unaffiliated party. The Chalfonte Site includes approximately 265 feet of Boardwalk frontage. RIH intends to expand the Resorts Casino Hotel by constructing hotel rooms, casino space and a parking garage on this acreage commencing in late 1996. The expanded facilities will be connected to the existing hotel structure by a covered walkway already in place.\nConsistent with industry practice, RIH reserves a portion of its hotel rooms and suites as complimentary accommodations for high-level casino wagerers. For 1995, 1994 and 1993 the average occupancy rates, including complimentary rooms, which were primarily provided to casino patrons, were 94%, 91% and 92%, respectively. The average occupancy rate and weighted average daily room rental, excluding complimentary rooms, were 51% and $59, respectively, for 1995. This compares with 47% and $64, respectively, for 1994, and 47% and $62, respectively, for 1993.\nCapital Improvements\nRIH has pursued a major capital improvements program since 1989 in order to compete more effectively in the Atlantic City market. During these seven years capital additions at Resorts Casino Hotel exceeded $122,000,000. In 1995 RIH expanded its casino by approximately 10,000 square feet and added approximately 315 slot machines. Also in 1995, a new restaurant, California Pizza Kitchen, was constructed and opened, five suites were renovated, and the exterior of the building was painted. In 1994 RIH purchased 221 slot machines, most of which replaced older models, and completed various capital maintenance projects. In prior years, RIH converted certain back-of-the-house space into an 8,000 square foot simulcast facility, opened the VIP slot and table player lounge, \"Club Griffin,\" and converted the parking garage from valet to self-parking. RIH has a continual capital maintenance program whereby it renovates its guest rooms, replaces its slot machines with newer models, renovates its p u blic areas, including restaurants, as well as improves its infrastructure such as elevators and air conditioning.\n- 5 -\nAs stated above, RIH intends to expand the Resorts Casino Hotel by constructing hotel rooms, additional casino space and a parking garage on the Chalfonte Site which GGE now owns. RIH s expansion plans are preliminary at this time, so the number of rooms and parking spaces and the size of the additional casino space to be constructed, as well as the estimated cost, are not yet determined. Excluding any expenditures on the proposed expansion, capital expenditures in 1996 on the Resorts Casino Hotel will be limited to those of a capital maintenance nature and are estimated to approximate $10,000,000.\nMarketing\nRIH continues to take advantage of the celebrity status of Merv Griffin, who is actively engaged in the marketing of the Resorts Casino Hotel. Mr. Griffin, who is Chairman of the Board of GGE, is featured in television commercials and in print advertisements. Mr. Griffin also appears live at the Resorts Casino Hotel in numerous e n t ertainment events including the nationally televised \"Merv Griffin's New Year's Eve Special 1995\" which featured Harry Belafonte, Tony Bennett and Trisha Yearwood. Merv Griffin's New Year's Eve Special has been produced live at the Resorts Casino Hotel each year since 1991. Mr. Griffin is to continue to participate in the operations and marketing of the Resorts Casino Hotel through the term of a License and Services Agreement described in Note 10 of Notes to Consolidated Financial Statements.\nRIH's marketing strategy is designed to enhance the appeal of the Resorts Casino Hotel to the mid and premium-level slot and table game players, although slot players have been, in recent years, the primary focus of RIH's marketing efforts. In 1993 RIH introduced the \"cash-back\" program, which rewards slot players with cash refunds or complimentaries based on their volume of play, and expanded and upgraded \"Hollywood Hills,\" its high-limit slot area. This area was further expanded in late May 1995. In the fall of 1994, RIH increased its charter flight program to recapture lost market share in table win. The charter program was further expanded in 1995 to attract mid- level slot players. In the fall of 1994, RIH introduced the \"Griffin Games,\" created by Merv Griffin, whereby slot players are chosen at random to participate in daily slot tournaments; daily tournament winners qualify to participate in a $100,000 \"winners tournament.\" In January 1995 the \"Griffin Games\" were expanded to include patrons playing blackjack and in January 1996 they were further expanded to include roulette players. RIH also has a VIP slot and table player lounge, \"Club Griffin,\" which serves complimentary food and beverages. As in prior years, RIH continues to emphasize entertainment as an integral part of its marketing program. The production show Wahoo Baby, created by Merv Griffin, opened in September 1995 to excellent reviews. The entertainment schedule is supplemented on a monthly basis with headliners who included, among others, Regis & Kathie Lee, Rosie O Donnell and Tony Danza in 1995; for 1996 all of the preceding headliners are scheduled, as well as Wayne Newton, Tom Jones and the Beach Boys. In addition to the above, RIH continues to rely heavily on its bus program to supply a critical mass of low to mid-level slot players.\n- 6 -\nNew Convention Center and Casino\/Hotel Expansion\nIn January 1992, the State of New Jersey enacted legislation that authorized a financing plan for the construction of a new convention center to be located on a 30-acre site next to the Atlantic City train station at the base of the Atlantic City Expressway. Management of RIH understands that the new convention center will have 500,000 square feet of exhibit space and an additional 109,000 square feet of meeting rooms. Construction of the new convention center began in early 1993 and it is scheduled to be completed in early 1997.\nThe convention center is part of a broader plan that includes an additional expansion of the Atlantic City International Airport, the transformation of the main entryway into Atlantic City into a new corridor, and the construction of a new 500 room convention hotel. Officials have commented upon the need for improved commercial air service into Atlantic City as a factor in the success of the proposed convention center. See further discussion under \"Transportation Facilities\" below. The corridor will link the new convention center and hotel with the Boardwalk. In all, six blocks are to be transformed into an expansive park with extensive landscaping, night- time lighting, a large fountain and pool with a 60-foot lighthouse.\nIt is believed that additional hotel rooms are necessary to support the convention center as well as to allow Atlantic City to become a competitive destination resort. Thus, in addition to the 500 room convention hotel, to further spur construction of new hotel rooms and renovation of substandard hotel rooms into deluxe accommodations, up to a total of $100,000,000 has been set aside by the Casino Reinvestment Development Authority (the \"CRDA\"), a public authority created under the Casino Control Act, to aid in financing such projects. To date, the CRDA has approved the expansion projects submitted by eight casino\/hotels which are to receive CRDA financing totaling the $100,000,000 set aside, and could result in the construction of approximately 4,000 hotel rooms. The New Jersey legislature is currently discussing the possibility of increasing the fund by an additional $50,000,000 to provide further incentive for additional hotel rooms. Also, Mirage Resorts, Inc., a Las Vegas, Nevada casino\/hotel company, has been selected to be the developer of an approximately 180 acre tract in the Marina area of Atlantic City. Mirage Resorts, Inc., proposes to build a $500,000,000, 2,000 room casino\/hotel on that tract. Management of RIH understands that feasibility studies for development of the tract and its associated infrastructure are in the preliminary stages.\nAlthough these developments are viewed as positive and favorable to the future prospects of the Atlantic City gaming industry, management of RIH, at this point, can make no representations as to whether, or to what extent, its results may be affected by the completion of the new convention center, the proposed airport expansion projects and the proposed increase in number of hotel rooms in the area.\n- 7 -\nTransportation Facilities\nThe lack of an adequate transportation infrastructure in the Atlantic City area continues to negatively affect the industry's ability to attract patrons from outside a core geographic area. In 1989, Amtrak express rail service to Atlantic City commenced from Philadelphia, New York, Washington and other major cities in the northeast. This service was expected to improve access to Atlantic City and expand the geographic size of the Atlantic City casino industry's marketing base. However, Amtrak discontinued its express rail service to Atlantic City in 1995.\nAlso, in 1989 the terminal at the Atlantic City International Airport (located approximately 12 miles from Atlantic City) was expanded to handle additional air carriers and large passenger jets, but scheduled service to that airport from major cities by national air carriers remains extremely limited. In order to attract increased air service, expansion of the existing terminal is currently in progress. This construction, which will double the size of the terminal, is expected to be completed in the spring of 1996. This project includes a new second level for the terminal, additional departure gates, an improved baggage handling system and sheltered walkways connecting the terminal and planes.\nSince the inception of gaming in Atlantic City there has been no significant change in the industry's marketing base or in the principal means of transportation to Atlantic City, which continues to be automobile and bus. The resulting geographic limitations and traffic congestion have restricted Atlantic City's growth as a major destination resort.\nRIH continues to utilize day-trip bus programs. A non-exclusive easement enables the Resorts Casino Hotel to utilize a bus tunnel under the adjacent Trump Taj Mahal Casino-Resort (the \"Taj Mahal\"), which connects Pennsylvania and Virginia Avenues, and a service road exit from the bus tunnel. This reduces congestion around the Pennsylvania Avenue bus entrance to the Resorts Casino Hotel. To accommodate its bus patrons, Resorts Casino Hotel has a waiting facility which is located indoors, adjacent to the casino, and offers various amenities.\nCompetition\nCompetition in the Atlantic City casino\/hotel industry is intense. Casino\/hotels compete primarily on the basis of promotional allowances, entertainment, advertising, services provided to patrons, caliber of personnel, attractiveness of the hotel and casino areas and related amenities, and parking facilities. The Resorts Casino Hotel competes directly with 11 casino\/hotels in Atlantic City which, in the aggregate, contain approximately 880,000 square feet of gaming area, including simulcast betting and poker rooms, and 8,700 hotel rooms. Significant additional expansion is expected in the near future due to the previously discussed projects to be financed by the CRDA as well as the expected re-opening in April 1996 of the Trump Regency Hotel, which contains 500 hotel rooms and approximately 50,000 square feet of casino floor space.\n- 8 -\nThe Resorts Casino Hotel is located at the eastern end of the Boardwalk adjacent to the Taj Mahal, which is next to the Showboat Casino Hotel (the \"Showboat\"). These three properties have a total of more than 2,700 hotel rooms and approximately 308,000 square feet of gaming space in close proximity to each other. In 1995, the three casino\/hotels combined generated approximately 30% of the gross gaming revenue of Atlantic City. A 28-foot wide enclosed pedestrian bridge between the Resorts Casino Hotel and the Taj Mahal allows patrons of both hotels and guests for events being held at the Resorts Casino Hotel and at the Taj Mahal to move between the facilities without exposure to the weather. A similar enclosed pedestrian bridge connects the Showboat to the Taj Mahal, allowing patrons to walk under cover among all three casino\/hotels. The remaining nine Atlantic City casino\/hotels are located approximately one-half mile to one and one-half miles to the west on the Boardwalk or in the Marina area of Atlantic City.\nIn recent years, competition for the gaming patron outside of Atlantic City has become extremely intense. In 1988, only Nevada and New Jersey had legalized casino operations. Currently, twenty four states have legalized casinos on land, water or Indian reservations. Also, The Bahamas and other destination resorts in the Caribbean and Canada have increased the competition for gaming revenue. Thus, the competition for the destination resort patron has intensified. Directly competing with Atlantic City for the day-trip patron is a casino\/hotel on an Indian reservation in Connecticut which currently operates more than 3,880 slot machines and whose slot revenue for the year 1995 exceeded $575,000,000, which is twice the slot revenue of the largest casino\/hotel in Atlantic City. A second casino\/hotel on another Indian reservation located in the same area in Connecticut is expected to open in the fall of 1996. In July 1993 the Oneida Indians opened a casino near Syracuse, New York. Other Indian reservation projects have been announced in the states of New York and Rhode Island which would increase the competition for day-trip patrons.\nThis rapid expansion of casino gaming, particularly that which has been or may be introduced into jurisdictions in close proximity to Atlantic City, adversely affects RIH's operations as well as the Atlantic City gaming industry.\nGaming Credit Policy\nCredit is extended to selected gaming customers primarily in order to compete with other casino\/hotels in Atlantic City which also extend credit to customers. Credit play represented 19% of table game volume at the Resorts Casino Hotel in 1995, 21% in 1994 and 24% in 1993. The credit play percentage of table game volume for the Atlantic City industry excluding RIH was 22% in 1995, 23% in 1994 and 23 % in 1993. RIH's gaming receivables, net of allowance for uncollectible amounts, were $3,813,000, $4,216,000 and $3,618,000 as of December 31, 1995, 1994 and 1993, respectively. The collectibility of gaming receivables has an effect on results of operations, and management believes that overall collections have been satisfactory. Atlantic City gaming debts are enforceable under the laws of New Jersey and certain other states, although it is not clear whether other states will honor this policy or\n- 9 -\nenforce judgments rendered by the courts of New Jersey with respect to such debts.\nSecurity Controls\nGaming at the Resorts Casino Hotel is conducted by personnel trained and supervised by RIH. Prior to employment, all casino personnel must be licensed under the Casino Control Act. Security checks are made to determine, among other matters, that job applicants for key positions have had no criminal ties or associations. RIH employs extensive security and internal controls at its casino. Security in the Resorts Casino Hotel utilizes closed circuit video cameras to monitor the casino floor and money counting areas. The count of monies from gaming is observed daily by government representatives.\nSeasonal Factors\nRIH's business activities are strongly affected by seasonal factors that influence the New Jersey beach tourist trade. Higher revenues and earnings are typically realized during the middle third of the year.\nEmployees\nRIH had a maximum of approximately 3,800 employees during 1995 and RIH believes that its employee relations are satisfactory. Approximately 1,500 of RIH's employees are represented by unions. Of these employees, approximately 1,200 are represented by the Hotel Employees and Restaurant Employees International Union Local 54, whose contract expires in September 1999. There are several union contracts covering other union employees.\nAll of RIH's casino employees and casino hotel employees must be licensed under the Casino Control Act. Casino hotel employees are those employees whose work requires access to the casino, the casino simulcasting facility or restricted casino areas. Each casino and casino hotel employee must meet applicable standards pertaining to such matters as financial responsibility, good character, ability, casino training and experience, and New Jersey residency. Hotel employees are no longer required to be registered with the Casino Control Commission.\nRegulation and Gaming Taxes and Fees\nGeneral\nRIH's operations in Atlantic City are subject to regulation under the Casino Control Act, which authorizes the establishment of casinos in Atlantic City, provides for licensing, regulation and taxation of casinos and created the Casino Control Commission and the Division of Gaming Enforcement to administer the Casino Control Act. In general, the provisions of the Casino Control Act concern: the ability, character and financial stability and integrity of casino operators, their officers, directors and employees and others financially interested in a casino; the nature and suitability of hotel and casino facilities, operating methods and conditions; and financial and accounting practices. Gaming operations are subject to a number of restrictions\n- 10 -\nrelating to the rules of games, type of games, credit play, size of hotel and casino operations, hours of operation, persons who may be e m p loyed, companies which may do business with casinos, the maintenance of accounting and cash control procedures, security and other aspects of the business.\nThere were significant regulatory changes from 1993 through early 1995. The Casino Control Commission approved poker and keno, which were implemented by casinos in the summers of 1993 and 1994, respectively. Also, the Casino Control Act was amended to allow casinos to expand their casino floors before building the requisite number of hotel rooms, subject to approval of the Casino Control Commission. This amendment was designed to encourage hotel room construction by giving casino licensees an incentive and an added ability to generate money to finance hotel construction. Previous law only allowed for casino expansion if a casino built new hotel rooms first. In addition, the minimum casino square footage has been increased from 50,000 square feet to 60,000 square feet for the first 500 qualifying rooms and allows for an additional 10,000 square feet for each additional 100 qualifying rooms over 500, up to a maximum of 200,000 square feet. Future costs of regulation have been reduced as new legislation (i) no longer requires hotel employees to be registered, (ii) extends the term for casino and casino key employee license renewals from two years to four years and (iii) allows greater efficiency by either reducing or eliminating the time permitted the Casino Control Commission to approve internal controls, patron complimentary programs and the movement of gaming equipment.\nCasino License\nA casino license is initially issued for a term of one year and must be renewed annually by action of the Casino Control Commission for the first two renewal periods succeeding the initial issuance of a casino license. Until recently, the Casino Control Commission was given the authority to renew a casino license for a period of two years. This period has been extended to four years, although the Casino Control Commission may reopen licensing hearings at any time. A license is not transferable and may be conditioned, revoked or suspended at any time upon proper action by the Casino Control Commission. The Casino Control Act also requires an operations certificate which, in effect, has a term coextensive with that of a casino license.\nOn February 26, 1979, the Casino Control Commission granted a casino license to RIH for the operation of Resorts Casino Hotel. In January 1996, RIH's license was renewed until January 31, 2000. RIH's renewed license is subject to a financial stability review midway through the license period.\nRestrictions on Ownership of Equity and Debt Securities\nThe Casino Control Act imposes certain restrictions upon the ownership of securities issued by a corporation which holds a casino license or is a holding, intermediary or subsidiary company of a corporate licensee (collectively, \"holding company\"). Among other restrictions, the sale, assignment, transfer, pledge or other\n- 11 -\ndisposition of any security issued by a corporation which holds a casino license is conditional and shall be ineffective if disapproved by the Casino Control Commission. If the Casino Control Commission finds that an individual owner or holder of any securities of a corporate licensee or its holding company must be qualified and is not qualified under the Casino Control Act, the Casino Control Commission has the right to propose any necessary remedial action. In the case of corporate holding companies and affiliates whose securities are publicly traded, the Casino Control Commission may require divestiture of the security held by any disqualified holder who is required to be qualified under the Casino Control Act.\nIn the event that entities or persons required to be qualified refuse or fail to qualify and fail to divest themselves of such security interest, the Casino Control Commission has the right to take any necessary action, including the revocation or suspension of the casino license. If any security holder of the licensee or its holding company or affiliate who is required to be qualified is found disqualified, it will be unlawful for the security holder to (i) receive any dividends or interest upon any such securities, (ii) exercise, directly or through any trustee or nominee, any right conferred by such securities or (iii) receive any remuneration in any form from the corporate licensee for services rendered or otherwise. The Amended and Restated Certificate of Incorporation of GGE provides that all securities of GGE are held subject to the condition that if the holder thereof is found to be disqualified by the Casino Control Commission pursuant to provisions of the Casino Control Act, then that holder must dispose of his or her interest in the securities. The Mortgage Notes and Junior Mortgage Notes are also subject to the qualification, divestiture and redemption provisions under the Casino Control Act described herein.\nRemedies\nIn the event that it is determined that a licensee has violated the Casino Control Act, or if a security holder of the licensee required to be qualified is found disqualified but does not dispose of his securities in the licensee or holding company, under certain circumstances the licensee could be subject to fines or have its license suspended or revoked.\nThe Casino Control Act provides for the mandatory appointment of a conservator to operate the casino and hotel facility if a license is revoked or not renewed and permits the appointment of a conservator if a license is suspended for a period in excess of 120 days. If a conservator is appointed, the suspended or former licensee is entitled to a \"fair rate of return out of net earnings, if any, during the period of the conservatorship, taking into consideration that which amounts to a fair rate of return in the casino or hotel industry.\"\nUnder certain circumstances, upon the revocation of a license or failure to renew, the conservator, after approval by the Casino Control Commission and consultation with the former licensee, may sell, assign, convey or otherwise dispose of all of the property of the casino\/hotel. In such cases, the former licensee is entitled to a summary review of such proposed sale by the Casino Control Commission and creditors of the\n- 12 -\nformer licensee and other parties in interest are entitled to prior written notice of sale.\nLicense Fees, Taxes and Investment Obligations\nThe Casino Control Act provides for casino license renewal fees and other fees based upon the cost of maintaining control and regulatory activities, and various license fees for the various classes of employees. In addition, a casino licensee is subject annually to a tax of 8% of \"gross revenue\" (defined under the Casino Control Act as casino win, less provision for uncollectible accounts up to 4% of casino win) and license fees of $500 on each slot machine. Also, the Casino Control Act has been amended to create a new Atlantic City fund (the \"AC Fund\") for economic development projects other than the construction and renovation of casino\/hotels. Beginning in fiscal year 1995\/1996 and for the following three fiscal years, if the amount of money expended by the Casino Control Commission and the Division of Gaming Enforcement is less than $57,300,000, the prior year s budget for these agencies, the amount of the difference is to be contributed to the AC Fund. Thereafter, beginning with fiscal year 1999\/2000 and for the following three fiscal years, an amount equal to the average paid into the AC Fund for the previous four fiscal years shall be contributed to the AC Fund. Each licensee s share of the amount to be contributed to the AC Fund is based upon its percentage of the total industry gross revenue for the relevant fiscal year. After eight years, the casino licensee s requirement to contribute to this fund ceases.\nThe following table summarizes, for the periods shown, the fees and taxes assessed upon RIH by the Casino Control Commission.\nFor the Year 1995 1994 1993\nGaming tax $21,402,000 $19,996,000 $19,545,000 License, investigation, inspection and other fees 3,917,000 4,218,000 3,985,000 Contribution to AC Fund 224,000\n$25,543,000 $24,214,000 $23,530,000\nThe Casino Control Act, as originally adopted, required a licensee to make investments equal to 2% of the licensee's gross r e venue (the \"investment obligation\") for each calendar year, commencing in 1979, in which such gross revenue exceeded its \"cumulative investments\" (as defined in the Casino Control Act). A licensee had five years from the end of each calendar year to satisfy this investment obligation or become liable for an \"alternative tax\" in the same amount. In 1984 the New Jersey legislature amended the Casino Control Act so that these provisions now apply only to investment obligations for the years 1979 through 1983. As discussed in Note 14 of Notes to Consolidated Financial Statements certain issues have been raised concerning the satisfaction of RIH's investment obligations for the years 1979 through 1983.\n- 13 -\nEffective for 1984 and subsequent years, the amended Casino Control Act requires a licensee to satisfy its investment obligation by purchasing bonds to be issued by the CRDA or by making other investments authorized by the CRDA, in an amount equal to 1.25% of a licensee's gross revenue. If the investment obligation is not satisfied, then the licensee will be subject to an investment alternative tax of 2.5% of gross revenue. Licensees are required to make quarterly deposits with the CRDA against their current year investment obligations. RIH s investment obligations for the years 1 9 9 5, 1994 and 1993 amounted to $3,348,000, $3,124,000, and $3,054,000, respectively, and, with the exception of a $127,000 credit received in 1995 for making a donation, have been satisfied by deposits made with the CRDA. At December 31, 1995, RIH held $5,567,000 face amount of bonds issued by the CRDA and had $18,197,000 on deposit with the CRDA. The CRDA bonds issued through 1995 have interest rates ranging from 3.9% to 7% and have repayment terms of between 20 and 50 years.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\nVirtually all of RIH's operations are conducted in Atlantic City, New Jersey. See \"(c) Narrative Description of Business\" above.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRIH's casino, resort hotel and related properties in Atlantic City are owned in fee, except for approximately 1.2 acres of the Resorts Casino Hotel site which are leased pursuant to ground leases expiring from 2056 through 2067.\nRIH's fee and leasehold interests in the Resorts Casino Hotel, the contiguous parking garage and property, and related personal property of RIH compose the collateral securing the Mortgage Notes and the Junior Mortgage Notes.\nRIH has leased the approximately 4.4 acre Chalfonte Site from GGE since GGE acquired the property in June 1995. Prior thereto, RIH leased this property from an unaffiliated party. RIH currently uses the Chalfonte Site for parking; however, as noted above, RIH intends to expand the Resorts Casino Hotel by constructing hotel rooms, casino space and a parking garage on this property commencing in late 1996.\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 disclosure required by Item 4 has been omitted pursuant to General Instruction J of Form 10-K.\n- 14 -\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThere is no trading market for RIH's common stock, all of which is owned by GGRI.\nOn May 3, 1994, as part of the Plan the following distributions were made to RIH's parent companies:\n(i) RIH issued the RIH Promissory Note and the RIH Junior Promissory Note with a combined estimated fair value of $135,300,000 to GGE in repayment of RIH's intercompany balance of $43,236,000 to GGE, with the balance of $92,064,000 a distribution to GGE;\n(ii) RIH distributed to GGRI a $50,000,000 note receivable by RIH along with $3,375,000 accrued interest thereon and\n(iii) RIH distributed all of its cash and equivalents in excess of $15,000,000 as of the Effective Date, or $12,262,000, to GGRI which, in turn, distributed such cash to GGE for its ultimate distribution to certain of GGE s noteholders pursuant to the Plan.\nThe indentures pursuant to which the Mortgage Notes and the Junior Mortgage Notes were issued prohibit RIH and its subsidiaries from paying dividends, from making other distributions in respect of their capital stock and from purchasing or redeeming their capital stock, with certain exceptions, unless certain interest coverage r a tios are attained. As of December 31, 1995 dividends of approximately $10,000,000 were permitted under these indentures.\n- 15 -\nAt December 31, Balance Sheet Information (Note A) 1995 1994 1993 1992 1991\nTotal assets $224,397 $212,734 $ 264,164 $ 250,636 $ 235,235\nCurrent maturities of notes payable to affiliate and other long-term debt (Note F) $ 589 $ 325,000 $ 643 $ 958\nNotes payable to affiliate and other long-term debt, excluding current maturities (Note F) $127,680 $125,309 $ 325,904 $ 326,539\nShareholder's equity (deficit) $ 45,676 $ 35,136 $(147,995) $(164,358) $(180,772)\n\/TABLE\nNotes to Selected Financial Data\nNote A: See Note 2 of Notes to Consolidated Financial Statements for a description of the transactions that occurred in connection with the Plan, which was effective May 3, 1994.\nNote B: Recapitalization costs in 1992 through 1994 represent RIH's allocated portion of GGE's consolidated recapitalization costs.\nNote C: Includes interest income, interest expense and amortization of debt discounts.\nNote D: See Notes 1 and 12 of Notes to Consolidated Financial Statements for discussion of income taxes for 1995, 1994 and 1993.\nIn 1992 and 1991 RIH had an agreement with GGE to provide for federal and state income taxes at a combined rate of 40%.\nNote E: In November 1994, RIH purchased $12,899,000 principal amount of Junior Mortgage Notes through the purchase of 12,899 Units (each $1,000 principal amount of Junior Mortgage Notes is traded as a \"Unit\" along with one share of GGE's Class B redeemable common stock) at a price of $6,740,000. The resulting gain of $4,008,000 was recorded as an extraordinary item.\nNote F: These items are presented net of unamortized discounts.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nLiquidity\nAt December 31, 1995 RIH had working capital of $22,144,000 including $38,027,000 of unrestricted cash and equivalents. The day- to-day operations of RIH require approximately $10,000,000 of currency and coin on hand which amount varies by days of the week, holidays and seasons. Additional cash balances are necessary to meet current working capital needs.\nAs described in Note 2 of Notes to Consolidated Financial Statements, in 1994 GGE restructured certain of its previously outstanding public debt pursuant to a prepackaged bankruptcy plan. The Plan was confirmed by the Bankruptcy Court on April 22, 1994 and became effective on May 3, 1994. Pursuant to the Plan, through its affiliated notes payable to RIHF, RIH is the principal source of funds for servicing the Mortgage Notes and the Junior Mortgage Notes, as well as any notes issued under the Senior Facility or similar working capital facility, to the extent issued. Annual interest expense on the Mortgage Notes and the Junior Mortgage Notes, after the reduction for interest on the $12,899,000 principal amount of Junior Mortgage Notes purchased by RIH in November 1994, will total approximately $16,500,000. Based on projected operating results, management believes that RIH's liquidity\n- 17 -\nwill continue to be satisfactory; however, management can give no assurances as to RIH's future liquidity due to the possibility of unanticipated events and circumstances inherent in any projections.\nCapital Expenditures and Other Uses of Funds\nIn recent years, capital expenditures have consistently been a significant use of financial resources by RIH. Capital additions in 1 9 93 amounted to $21,618,000, as RIH converted certain back-of-the-house space into an 8,000 square foot simulcast facility which also houses poker tables, various other table games, a keno lounge and a full service bar. Also 280 slot machines were purchased, most of which replaced older models, and the VIP slot and table player lounge, \"Club Griffin,\" opened. Capital expenditures in 1994 at Resorts Casino Hotel totaled $7,744,000 and included the purchase of 221 slot machines, most of which replaced older models, the purchase of equipment and minor renovations to accommodate keno and Caribbean stud poker and various other capital maintenance projects. Capital expenditures in 1995 at Resorts Casino Hotel totaled $13,272,000. These included approximately $4,000,000 for the conversion of certain existing facilities into an additional 10,000 square feet of casino gaming area as RIH modified a portion of its bus waiting area to house approximately 155 slot machines and converted Mr. G s lounge to accommodate approximately 160 more slot machines. The cost noted above includes the cost of slot machines and related equipment. RIH also converted the space formerly occupied by the Celebrity Deli into a California Pizza Kitchen and the new Oceanside cocktail lounge at a cost of approximately $2,900,000. The balance of capital expenditures for 1995 included approximately $900,000 for suite renovations, as well as various other capital maintenance projects.\nAs discussed in Resort and Hotel Facilities under ITEM 1. BUSINESS - (c) Narrative Description of Business, RIH intends to expand its operations by constructing hotel rooms, additional casino space and a parking garage on GGE s newly acquired Chalfonte Site, though its plans are preliminary at this time. RIH is proceeding with the development of cost estimates for such expansion and has not yet determined the extent to which additional financing, if any, will be required.\nPursuant to the Plan, RIH distributed all of its cash and cash equivalents in excess of $15,000,000 as of the Effective Date, which amounted to $12,262,000, to GGRI. GGRI, in turn, distributed such cash to GGE for its ultimate distribution to certain of GGE s noteholders pursuant to the Plan.\nIn November 1994 RIH purchased $12,899,000 principal amount of Junior Mortgage Notes through the purchase of 12,899 Units at a price of $6,740,000.\nAnother significant use of funds in the last several years has been deposits with the CRDA as required by the Casino Control Act.\n- 18 -\nCapital Resources and Other Sources of Funds\nSince 1993, operations have been the most significant source of funds to RIH.\nIn 1995, in connection with the casino expansion at Resorts Casino Hotel, RIH financed the purchase of slot machines and related equipment with a $1,815,000 bank loan.\nThe $19,738,000 Senior Facility (which is further described in Note 9 of Notes to Consolidated Financial Statements) is available for the period ending May 2, 1996 should RIH or GGE have additional cash needs. Management believes that the Senior Facility will also serve as a source of funds for expansion, development and\/or an investment opportunity as well as a safeguard if an emergency arises from current operations. However, market interest rates and other economic conditions, among other factors, will determine if it is appropriate to draw on the Senior Facility or obtain a substitute facility.\nRESULTS OF OPERATION\nRIH operates in one business segment. Following is a discussion of the results of operations for 1995 compared to 1994 and 1994 compared to 1993. The discussion should be read in conjunction with the consolidated financial statements included herein.\nRevenues\nCasino revenues from RIH's casino\/hotel increased by $17,275,000 in 1995 and by $6,366,000 in 1994. RIH s slot and table game win increased by $18,585,000 in 1995 and by $3,516,000 in 1994. RIH s slot and table game win increases, which amounted to 8.1% in 1995 and 1.4% in 1994, compare to increases for the Atlantic City gaming industry of 9.7% and 2.8% for those periods, respectively. This market growth favorably reflects the expansion of existing Atlantic City casinos and hotels; however, such expansion by RIH s competitors adversely affects RIH's operations in that it significantly increases its cost of obtaining additional revenue. In that regard, several competing properties have announced expansion projects. See New Convention Center and Casino\/Hotel Expansion under ITEM 1. BUSINESS - (c) Narrative Description of Business for related discussion.\nIn 1995 RIH s slot win increased by $16,310,000, due to increased amounts wagered, and its table game win increased by $2,275,000, primarily due to an increase in hold percentage (ratio of casino win to total amount of chips purchased). The increased amounts wagered by slot patrons reflect RIH s 10,000 square-foot casino expansion during 1995, which enabled RIH to increase its number of slot machines by more than 15%, as well as increased emphasis on bus and junket air programs. Further affecting the comparison of RIH s casino revenues during the years presented was poor weather conditions during the first quarter of 1994, which adversely affected operations in that period as the principal means of transportation to Atlantic City is by automobile or bus. RIH s revenue from poker, simulcasting and keno combined decreased by $1,310,000 in 1995.\n- 19 -\nIn the fall of 1994 RIH increased its program of charter flights in an effort to recapture some of its lost market share of table game win. During 1995 RIH also targeted table players through certain other efforts, including match play promotions, the expansion of the Griffin Games to include table players and renovation of some of Resorts Casino Hotel s suites. More suite renovations are planned for 1996. However, in light of the increased promotions offered by competing properties, RIH s expanded efforts in this area enabled RIH to maintain, but not increase, its market share of table game win in 1995.\nIn 1994 RIH's slot win increased by $10,084,000 due to increased amounts wagered, and table game win was down $6,568,000 primarily due to decreased amounts wagered. RIH s percentage increase in slot win in 1994 exceeded that of the Atlantic City industry. However, in 1994 the industry experienced a slight increase in table game win while RIH s table game win decreased by 8.4%. These results reflect the fact that slot players had been the prime focus of RIH's marketing efforts until the fall of 1994 as discussed above. RIH's revenue from poker, simulcasting and keno combined increased by $2,850,000 in 1994, the first full year these games were offered.\nThe decrease in RIH s food and beverage revenues in 1995 was due primarily to the closing of the Celebrity Deli in early April and, to a lesser extent, Mr. G s lounge in mid March for the renovations discussed under FINANCIAL CONDITION - Capital Expenditures and Other Uses of Funds above. Also, there was a decline in the number of patrons served at the \"all-you-can-eat Beverly Hills Buffet. This decline was attributable to price increases effected during the second quarter of 1994 as management determined that this promotion was no longer cost effective at the prior price levels.\nRIH's food and beverage revenues were down in 1994 primarily due to reduced patronage at the Beverly Hills Buffet due to price increases noted above. Also in 1994, there was a general decline in the number of patrons served at all of RIH's food and beverage facilities.\nAs discussed above, because the principal means of transportation to Atlantic City is by automobile or bus, the industry s results may be affected by periods of inclement weather. In January and February of 1996 the northeastern United States experienced the Blizzard of 1996\" and other storms. These storms, as well as the threat of other severe weather, adversely affected RIH s gaming revenues and may have adversely affected its operating results in early 1996.\nEarnings from Operations\nC a sino, hotel and related operating results increased by $5,555,000 for 1995 as the increased revenues described above were partially offset by a net increase in operating costs. The most significant variances in operating expenses were increases in casino promotional costs ($7,300,000), casino win tax ($1,500,000), payroll and related costs ($1,000,000) and the accrual for performance and incentive bonuses ($1,000,000). Casino promotional costs increased due to the expanded junket air program as well as increases in the amount of cash giveaway to bus patrons. Casino win tax increased relative to the increase in\n- 20 -\ncasino revenues. Payroll and related costs increased due to increased salary and wage rates, as the average number of employees was down slightly for the year.\nCasino, hotel and related operating results increased by $8,723,000 for 1994 due to the combination of the increased revenues described above and a net decrease in operating expenses. The most significant decreases in operating expenses in 1994 were in payroll and related costs ($2,500,000), food and beverage costs ($1,400,000) and advertising expense ($900,000). Payroll and related costs were down primarily due to decreased staffing levels. The decrease in food and beverage costs resulted primarily from reduced patronage at the Beverly Hills Buffet and, to a lesser extent, other food and beverage facilities as described above. Advertising costs were down largely because 1993 included advertising costs associated with the introduction of the \"cash-back\" program (a promotion which rewards slot players by giving cash back to patrons based on their level of play) and the 15th anniversary celebration of Resorts Casino Hotel. Favorable variances in these and other costs were partially offset by increases in other expenses. The most significant increase was in casino promotional costs ($2,500,000) due primarily to the \"cash-back\" program noted above, which commenced in late April 1993, and increased cash giveaways to bus patrons. Another significant cost increase was in the accrual for performance and incentive bonuses ($700,000).\nFor a discussion of competition in the Atlantic City casino\/hotel industry see \"Competition\" under \"ITEM 1. BUSINESS - (c) Narrative Description of Business.\"\nOther Income (Deductions)\nThrough the Effective Date, RIH's interest income had been largely attributable to a $50,000,000 note receivable from a former Bahamian affiliate. This note was canceled as part of the Plan.\nRIH's interest expense before the Effective Date was limited to minor amounts incurred on capitalized lease obligations. Since the Effective Date, RIH has borne, indirectly, the interest on the Mortgage Notes and the Junior Mortgage Notes through notes payable to RIHF, the terms of which mirror the terms of such notes. RIH will also bear, indirectly, interest on any notes issued under the Senior Facility or a similar working capital facility. See Notes 7 and 9 of Notes to Consolidated Financial Statements for the terms of the Mortgage Notes, the Junior Mortgage Notes and the Senior Facility.\n- 21 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nRIH's consolidated financial statements and supplementary data are presented on the following pages:\nPage Financial Statements Reference\nReport of Independent Auditors 23\nConsolidated Balance Sheets at December 31, 1995 and 1994 24\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 26\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 27\nConsolidated Statements of Changes in Shareholder's Equity for the years ended December 31, 1995, 1994 and 1993 28\nNotes to Consolidated Financial Statements 29\nFinancial Statement Schedule:\nSchedule II: Valuation Accounts for the years ended December 31, 1995, 1994 and 1993 44\nSupplementary Data\nSelected Quarterly Financial Data (Unaudited) 45\n- 22 -\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholder Resorts International Hotel, Inc.\nWe have audited the accompanying consolidated balance sheets of Resorts International Hotel, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in shareholder's equity, and cash flows for each of the three years in the period ended December 31, 1995. Resorts International Hotel, Inc. i s an indirect wholly owned subsidiary of Griffin Gaming & Entertainment, Inc. 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 Resorts International Hotel, 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.\n\/s\/ Ernst & Young LLP\nPhiladelphia, Pennsylvania February 19, 1996\n- 23 -\nRESORTS INTERNATIONAL HOTEL, INC. CONSOLIDATED BALANCE SHEETS (In Thousands of Dollars)\nDecember 31, Assets 1995 1994\nCurrent assets: Cash (including cash equivalents of $22,334 and $12,695) $ 38,027 $ 26,876 Restricted cash equivalents 750 Receivables, net 6,933 6,232 Inventories 2,447 1,793 Prepaid expenses 6,078 8,566 Total current assets 54,235 43,467\nProperty and equipment: Land and land rights 53,060 53,060 Land improvements 158 158 Hotels and other buildings 115,960 108,051 Furniture, machinery and equipment 50,036 45,097 Construction in progress 200 41 219,414 206,407 Less accumulated depreciation (62,074) (48,906) Net property and equipment 157,340 157,501\nDeferred charges and other assets 12,822 11,766\n$224,397 $212,734\nSee Notes to Consolidated Financial Statements.\n- 24 -\nRESORTS INTERNATIONAL HOTEL, INC. CONSOLIDATED BALANCE SHEETS (In Thousand of Dollars, except par value)\nLiabilities and Shareholder's December 31, Equity 1995 1994\nCurrent liabilities: Current maturities of long-term debt $ 589 Accounts payable and accrued liabilities 26,044 $ 24,365 Interest payable to affiliate 4,244 4,113 Due to GGE 1,214 4,411 Total current liabilities 32,091 32,889\nNotes payable to affiliate, net of unamortized discounts 126,761 125,309\nOther long-term debt 919\nDeferred income taxes 18,950 19,400\nCommitments and contingencies (Note 14)\nShareholder's equity: Common stock - $1 par value - 1,000,000 shares outstanding 1,000 1,000 Capital in excess of par 21,366 21,366 Retained earnings 23,310 12,770 Total shareholder's equity 45,676 35,136\n$224,397 $212,734\nSee Notes to Consolidated Financial Statements.\n- 25 -\nRESORTS INTERNATIONAL HOTEL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands of Dollars)\nFor the Year Ended December 31, 1995 1994 1993\nRevenues: Casino $267,757 $250,482 $244,116 Rooms 6,978 7,134 6,974 Food and beverage 12,704 14,609 15,926 Other casino\/hotel revenues 5,787 4,508 4,463 293,226 276,733 271,479\nExpenses: Casino 156,091 143,748 141,608 Rooms 3,698 3,243 3,402 Food and beverage 14,235 15,823 17,710 Other casino\/hotel operating expenses 34,155 34,759 34,764 Selling, general and administrative 35,635 36,101 39,352 GGE parent services fee 9,651 9,082 8,911 Depreciation 13,415 13,186 13,664 266,880 255,942 259,411\nEarnings from operations 26,346 20,791 12,068\nOther income (deductions): Interest income 2,386 3,623 7,615 Interest expense (16,740) (10,858) (193) Amortization of debt discounts (1,452) (757) Recapitalization costs (975) (2,727)\nEarnings before income taxes and extraordinary item 10,540 11,824 16,763 Income tax expense (400)\nEarnings before extraordinary item 10,540 11,824 16,363 Extraordinary item 4,008\nNet earnings $ 10,540 $ 15,832 $ 16,363\nSee Notes to Consolidated Financial Statements.\n- 26 -\nRESORTS INTERNATIONAL HOTEL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands of Dollars)\nFor the Year Ended December 31, 1995 1994 1993\nCash flows from operating activities: Cash received from customers $ 291,573 $ 274,467 $ 272,150 Cash paid to suppliers and employees (247,048) (242,154) (250,281) Cash flow from operations before interest and income taxes 44,525 32,313 21,869 Interest received 2,308 1,296 10,973 Interest paid (16,609) (6,745) (193) Income taxes paid to GGE (450) Net cash provided by operating activities 29,774 26,864 32,649\nCash flows from investing activities: Payments for property and equipment (13,019) (7,744) (21,013) Purchase of 12,899 Units (6,740) CRDA deposits and bond purchases (3,152) (3,044) (3,025) Proceeds from sale of property and equipment 116 Net cash used in investing activities (16,171) (17,412) (24,038)\nCash flows from financing activities: Proceeds from borrowing 1,815 Distribution to GGRI (12,262) Advances from (repayments to) GGE (3,197) 4,788 (515) Recapitalization costs paid to GGE (975) (2,727) Repayments of non-affiliated debt (320) (74) (2,065) Net cash used in financing activities (1,702) (8,523) (5,307) Net increase in cash and cash equivalents 11,901 929 3,304 Cash and cash equivalents at beginning of period 26,876 25,947 22,643 Cash and cash equivalents at end of period $ 38,777 $ 26,876 $ 25,947\nSee Notes to Consolidated Financial Statements.\n- 27 -\nRESORTS INTERNATIONAL HOTEL, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY (In Thousands of Dollars)\nCapital in excess of par (excess of liabilities RIH over assets at common August 31, 1990 Retained stock reorganization) earnings\nBalance at December 31, 1992 $ -0- $(198,829) $ 34,471\nNet earnings for year 1993 16,363\nBalance at December 31, 1993 -0- (198,829) 50,834\nDistribution of RIH Promissory Note and RIH Junior Promissory Note to GGE (38,168) (53,896)\nShares issued to GGRI in exchange for the RIH-GGRI Note 1,000 324,000\nDistribution of RIB Note and accrued interest thereon to GGRI (53,375)\nDistribution to GGRI (12,262)\nNet earnings for year 1994 15,832\nBalance at December 31, 1994 1,000 21,366 12,770\nNet earnings for year 1995 10,540\nBalance at December 31, 1995 $1,000 $ 21,366 $ 23,310\nSee Notes to Consolidated Financial Statements.\n- 28 -\nRESORTS INTERNATIONAL, HOTEL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nResorts International Hotel, Inc. (\"RIH\") owns and operates Merv Griffin's Resorts Casino Hotel (the \"Resorts Casino Hotel\"), a casino\/hotel complex located in Atlantic City, New Jersey. RIH is a wholly owned subsidiary of GGRI, Inc. (\"GGRI\"), which is a wholly owned subsidiary of Griffin Gaming & Entertainment, Inc. (\"GGE\"). GGE was known as Resorts International, Inc. until its name change, which was effective June 30, 1995. \"GGE\" is used herein to refer to RIH s ultimate parent corporation both before and after its name change.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of RIH and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nAccounting Estimates\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. Actual results could differ from those estimates.\nRevenue Recognition\nRIH records as revenue the win from gaming activities which represents the difference between amounts wagered and amounts won by patrons. Revenues from hotel and related services and from theater ticket sales are recognized at the time the related service is performed.\nComplimentary Services\nThe Consolidated Statements of Operations reflect each category of operating revenues excluding the retail value of complimentary services provided to casino patrons without charge. The retail value of such complimentary services excluded from revenues amounted to $28,494,000, $26,074,000 and $25,560,000 for the years 1995, 1994 and 1993, respectively. The rooms, food and beverage, and other casino\/hotel operations departments allocate a percentage of their total operating expenses to the casino department for complimentary services provided to casino patrons. These allocations do not n e c essarily represent the incremental cost of providing such complimentary services to casino patrons. Amounts allocated to the casino department from the other operating departments were as follows:\n- 29 -\n(In Thousands of Dollars) 1995 1994 1993\nRooms $ 4,813 $ 4,016 $ 3,728 Food and beverage 16,846 14,547 16,250 Other casino\/hotel operations 6,403 7,404 7,216\nTotal allocated to casino $28,062 $25,967 $27,194\nCash Equivalents\nRIH considers all of its short-term money market securities purchased with maturities of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value due to the short maturity of these instruments.\nInventories\nInventories of provisions, supplies and spare parts are carried at the lower of cost (first-in, first-out) or market.\nProperty and Equipment\nProperty and equipment are depreciated over their estimated useful lives reported below using the straight-line method for financial reporting purposes.\nLand improvements 10 - 25 years\nHotels and other buildings 22 - 28 years\nFurniture, machinery and equipment 4 - 5 years\nCasino Reinvestment Development Authority (\"CRDA\") Obligations\nUnder the New Jersey Casino Control Act (\"Casino Control Act\"), RIH is obligated to purchase CRDA bonds, which will bear a below- market interest rate, or make an alternative qualifying investment. RIH charges to expense an estimated discount related to CRDA investment obligations as of the date the obligation arises based on fair market interest rates of similar quality bonds in existence as of that date. On the date RIH actually purchases the CRDA bond, the estimated discount previously recorded is adjusted to reflect the actual terms of the bonds issued and the then existing fair market interest rate for similar quality bonds.\nThe discount on CRDA bonds purchased is amortized to interest income over the life of the bonds using the effective interest rate method.\n- 30 -\nIncome Taxes\nRIH and GGE's other domestic subsidiaries file consolidated federal income tax returns with GGE.\nRIH accounts for income taxes under the liability method prescribed by Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" Under this method, the deferred tax liability is determined based on the difference between the financial reporting and tax bases of assets and liabilities and enacted tax rates which will be in effect for the years in which the differences are expected to reverse. Deferred tax liabilities are recognized for differences that will result in taxable amounts in future years. Deferred tax assets are recognized for differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized based on estimates of the likelihood that some portion or all of the deferred tax asset will not be realized. Although RIH is a member of a consolidated group for federal income tax purposes, RIH applies SFAS 109 on a separate return basis for financial reporting purposes.\nCertain indentures described in Note 7 provide for a tax sharing agreement between RIH and GGE which limits RIH s tax payments to GGE to reimbursements of cash payments made by GGE for income or alternative minimum taxes arising from the earnings or operations of RIH.\nImpact of Newly Issued Accounting Standards\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 (\"SFAS 121\"), which requires impairment losses to be recorded on long-lived assets used in o p erations 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. RIH will adopt SFAS 121 in 1996 and, based on current circumstances, believes the effect, if any, of adoption will be insignificant.\nNOTE 2 - 1994 RESTRUCTURING\nIn April 1994 the joint plan of reorganization (the \"Plan\") proposed by GGE, GGRI, RIH and certain other of GGE s subsidiaries was confirmed by the Bankruptcy Court for the District of Delaware and on May 3, 1994 (the \"Effective Date\") the Plan became effective.\nPursuant to the Plan, certain of GGE s previously outstanding public debt was exchanged for, among other things, $125,000,000 principal amount of 11% Mortgage Notes (the \"Mortgage Notes\") due September 15, 2003 and $35,000,000 principal amount of 11.375% Junior Mortgage Notes (the \"Junior Mortgage Notes\") due December 15, 2004. The Mortgage Notes and the Junior Mortgage Notes were issued by Resorts International Hotel Financing, Inc. (\"RIHF\"), a subsidiary of GGE, and are guaranteed by RIH. The Mortgage Notes are secured by a $125,000,000 promissory note made by RIH (the \"RIH Promissory Note\"), the terms of\n- 31 -\nwhich mirror the terms of the Mortgage Notes. The Junior Mortgage Notes are secured by a $35,000,000 promissory note made by RIH (the \"RIH Junior Promissory Note\"), the terms of which mirror the terms of the Junior Mortgage Notes. The RIH Promissory Note, the RIH Junior Promissory Note, RIH's guarantees of the Mortgage Notes and the Junior Mortgage Notes and related collateral are described further in Note 7.\nAlso pursuant to the Plan, RIHF, RIH and GGE entered into the senior note purchase agreement (the \"Senior Facility\") described in Note 9.\nThe Plan also prescribed the following transactions between RIH and its affiliates:\n- RIH issued the RIH Promissory Note and the RIH Junior Promissory Note in repayment of RIH's balance due to GGE on the Effective Date with the remainder a distribution to GGE. RIH's retained earnings of $53,896,000 at April 30, 1994 was included in that distribution.\n- RIH exchanged a $325,000,000 non-interest bearing note payable to GGRI (the \"RIH-GGRI Note\") for 999,900 shares of common stock of RIH. In order to accomplish this, RIH authorized an additional 4,997,500 shares of its common stock.\n- GGE contributed to GGRI the 100 shares of common stock of RIH which GGE owned. This resulted in RIH's becoming a wholly owned subsidiary of GGRI and an indirect subsidiary of GGE. RIH now has a total of 5,000,000 shares of common stock authorized, of which 1,000,000 shares are issued and outstanding.\n- RIH distributed to GGRI, as a return of surplus, a $50,000,000 note receivable from a former Bahamian affiliate (the \"RIB Note\") and accrued interest thereon. The RIB Note bore interest at 13 1\/2% per annum, with interest payments due each May 1 and November 1.\n- RIH distributed all of its cash and cash equivalents in excess of $15,000,000 as of the Effective Date to GGRI. GGRI distributed such cash to GGE so that GGE, in turn, could distribute cash to holders of its previously outstanding debt.\nNOTE 3 - CASH EQUIVALENTS\nRIH's cash equivalents at December 31, 1995 included U.S. Treasury Bills and reverse repurchase agreements (federal government securities purchased under agreements to resell those securities) under which RIH had not taken delivery of the underlying securities.\nRestricted cash equivalents at December 31, 1995 represent a certificate of deposit which is pledged as collateral for a letter of credit.\n- 32 -\nNOTE 4 - RECEIVABLES\nComponents of receivables at December 31 were as follows:\n(In Thousands of Dollars) 1995 1994\nGaming $ 7,332 $ 8,035 Less allowance for doubtful accounts (3,519) (3,819) 3,813 4,216 Non-gaming: Hotel and related 1,163 799 Other 2,008 1,299 3,171 2,098 Less allowance for doubtful accounts (51) (82) 3,120 2,016\n$ 6,933 $ 6,232\nNOTE 5 - CRDA OBLIGATORY INVESTMENTS\nThe Casino Control Act, as originally adopted, required a licensee to make investments equal to 2% of the licensee's gross revenue (as defined in the Casino Control Act) (the \"investment obligation\") for each calendar year, commencing in 1979, in which such gross revenue exceeded its \"cumulative investments\" (as defined in the Casino Control Act). A licensee had five years from the end of each calendar year to satisfy this investment obligation or become liable for an \"alternative tax\" in the same amount. In 1984 the New Jersey legislature amended the Casino Control Act so that these provisions now apply only to investment obligations for the years 1979 through 1983.\nEffective for 1984 and subsequent years, the amended Casino Control Act requires a licensee to satisfy its investment obligation by purchasing bonds to be issued by the CRDA, or by making other investments authorized by the CRDA, in an amount equal to 1.25% of a licensee's gross revenue. If the investment obligation is not satisfied, then the licensee will be subject to an investment alternative tax of 2.5% of gross revenue. Since 1985, a licensee has been required to make quarterly deposits with the CRDA against its current year investment obligation.\nFrom time to time RIH has donated certain funds it has had on deposit with the CRDA in return for either relief from its obligation to purchase CRDA bonds or credits against future CRDA deposits.\nAt December 31, 1995, RIH had $5,567,000 face value of bonds issued by the CRDA and had $18,197,000 on deposit with the CRDA. The CRDA bonds have interest rates ranging from 3.9% to 7% and have repayment terms of between 20 and 50 years. These bonds and deposits, net of an estimated discount charged to expense to reflect the below-market interest rate payable on the bonds, are included in other assets in RIH's Consolidated Balance Sheet.\n- 33 -\nRIH records charges to expense to reflect the below-market interest rate payable on the bonds it may have to purchase to fulfill its investment obligation at the date the obligation arises. The charges in 1995, 1994 and 1993 for discounts on obligations arising in those years were $1,567,000, $1,461,000 and $1,541,000, respectively.\nNOTE 6 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nComponents of accounts payable and accrued liabilities at December 31 were as follows:\n(In Thousands of Dollars) 1995 1994\nAccrued payroll and related taxes and benefits $ 9,763 $ 9,417 Accrued gaming taxes, fees and related assessments 7,211 7,064 Customer deposits and unearned revenues 2,081 2,152 Trade payables 2,148 1,410 Other accrued liabilities 4,841 4,322\n$26,044 $24,365\nNOTE 7 - NOTES PAYABLE TO AFFILIATES\nAs described in Note 2, RIHF issued the Mortgage Notes and the Junior Mortgage Notes and RIH issued the RIH Promissory Note and the RIH Junior Promissory Note (the \"RIH Notes\") in connection with the Plan. RIH issued the RIH Notes to GGE. GGE then transferred the RIH Notes to RIHF in exchange for the Mortgage Notes and the Junior Mortgage Notes, which were distributed pursuant to the Plan, and RIH amended and restated the RIH Notes making them payable to RIHF.\nThe Mortgage Notes are secured by the $125,000,000 RIH Promissory Note, the terms of which mirror the terms of the Mortgage Notes. The RIH Promissory Note and RIH s guaranty of the Mortgage Notes are secured by liens on the Resorts Casino Hotel, consisting of RIH s fee and leasehold interests in the Resorts Casino Hotel, the contiguous parking garage and property, and related personal property. The liens securing the Mortgage Notes will be subordinated to the lien securing the Senior Facility Notes (described in Note 9) or notes issued under a similar working capital facility, if such notes are issued.\nThe Junior Mortgage Notes are secured by the $35,000,000 RIH Junior Promissory Note, the terms of which mirror the terms of the Junior Mortgage Notes. The RIH Junior Promissory Note and RIH s guaranty of the Junior Mortgage Notes are also secured by liens on the Resorts Casino Hotel property as described above. The liens securing the Junior Mortgage Notes will be subordinated to the lien securing the Senior Facility Notes or notes issued under a similar working capital facility, if such notes are issued, and are subordinated to the liens securing the Mortgage Notes.\n- 34 -\nThe indentures pursuant to which the Mortgage Notes and the Junior Mortgage Notes were issued (collectively, the \"Indentures\") prohibit RIH and its subsidiaries from paying dividends, from making other distributions in respect of their capital stock, and from purchasing or redeeming their capital stock, with certain exceptions, unless certain interest coverage ratios are attained. As of December 31, 1995 dividends of approximately $10,000,000 were permitted under these Indentures.\nThe Indentures also contain certain other restrictive covenants on the part of RIH and its subsidiaries, including (i) limitations on incurring additional indebtedness, with certain exceptions; (ii) restrictions on making loans to an affiliate or other person other than (x) intercompany advances to GGE not in excess of $1,000,000 in the aggregate at any time outstanding and (y) loans to GGE from the proceeds of the Senior Facility (or a similar working capital facility), provided, however, that RIH can make certain loans or engage in certain credit transactions in the operation of Resorts Casino Hotel, if such loans or credit transactions are in the ordinary course of business of operating a casino\/hotel and (iii) restrictions from entering into certain transactions with affiliates on terms less favorable to RIH or its subsidiaries than an arm s length transaction. In this regard, the Indentures specifically permit affiliated transactions in connection with the Senior Facility, the Griffin Services Agreement described in Note 10, the parent services agreement with GGE which provides for the payment of the three percent services fee described in Note 10, and a tax sharing agreement with GGE which limits RIH s tax payments to GGE to reimbursements of cash payments made by GGE for income or alternative minimum taxes arising from the earnings or operations of RIH.\nIn November 1994 RIH purchased $12,899,000 principal amount of Junior Mortgage Notes through the purchase of 12,899 Units (each $1,000 principal amount of Junior Mortgage Notes is traded as a \"Unit\" along with one share of GGE's Class B redeemable common stock) at a price of $6,740,000. The resulting gain of $4,008,000 was reported as an extraordinary item.\n- 35 -\nThe carrying value and fair value by component of notes payable to affiliate at December 31, 1995 and 1994 were as follows:\n1995 1994 Carrying Fair Carrying Fair (In Thousands of Dollars) Value Value Value Value\nRIH Promissory Note $125,000 $115,313 $125,000 $83,750 Less unamortized discount (16,872) (18,123) 108,128 106,877\nRIH Junior Promissory Note 35,000 35,000 Less principal amount of Junior Mortgage Notes held by RIH (12,899) (12,899) 22,101 20,333 22,101 13,040 Less unamortized discount (3,468) (3,669) 18,633 18,432\n$126,761 $135,646 $125,309 $96,790\nThe fair values presented above are based on December 31 closing market prices for RIHF's publicly traded debt because RIHF's debt is (i) dependent on the RIH Notes for debt service and (ii) collateralized and guaranteed by RIH.\nNo principal payments are due on the RIH Notes during the next five years.\nThe accrual of interest and amortization of discounts on the RIH Notes commenced on May 3, 1994. Interest on the RIH Promissory Note is payable semi-annually on March 15 and September 15 in each year. Interest on the RIH Junior Promissory Note is payable semi-annually on June 15 and December 15 in each year. In certain circumstances, interest payable on the Junior Mortgage Notes may be satisfied by the issuance of additional Junior Mortgage Notes, in which case the balance of the RIH Junior Promissory Note would increase accordingly.\nThe effective interest rates on the RIH Promissory Note and the RIH Junior Promissory Note are 14.1% and 14.8%, respectively.\nNOTE 8 - OTHER LONG-TERM DEBT\nIn May 1995, RIH obtained a bank loan in the amount of $1,815,000 in order to finance the purchase of new slot machines and related equipment. The loan bears interest at 9.2% per year. Principal payments on the loan are due as follows: 1996 - $589,000, 1997 - $636,000 and 1998 - $283,000.\n- 36 -\nNOTE 9 - SENIOR FACILITY\nPursuant to the Plan, RIHF, GGE and RIH entered into the Senior Facility with certain funds and accounts advised or managed by Fidelity Management & Research Company. The Senior Facility, as amended, is available for a single borrowing of up to $19,738,000 during the period ending May 2, 1996, through the issuance of notes (the \"Senior Facility Notes\"). If issued, the Senior Facility Notes will bear interest at 11.75% and will be due in 2002. The Senior Facility Notes will be senior obligations of RIHF secured by a promissory note from RIH in an aggregate principal amount of up to $19,738,000 payable in amounts and at times necessary to pay the principal of and interest on the Senior Facility Notes. The Senior Facility Notes will be guaranteed by RIH and secured by a lien on the Resorts Casino Hotel property as described in Note 7. Market interest rates and other economic conditions, among other factors, will determine if it is appropriate to draw on the Senior Facility.\nNOTE 10 - RELATED PARTY TRANSACTIONS\nRIH recorded the following income and expenses from GGE and its other subsidiaries:\n(In Thousands of Dollars) 1995 1994 1993\nInterest income from a former Bahamian affiliate $ 2,250 $6,750\nExpenses: Interest and amortization of discounts on notes payable to RIHF $18,071 $11,604 Parent services fee to GGE 9,651 9,082 $8,911 Property rentals to GGE 810 325 325 Billboard rental to affiliate 50\n$28,582 $21,011 $9,236\nGGE charges RIH the parent services fee of three percent of gross revenues for administrative and other services.\nIn addition to the above, charges for insurance costs are allocated to RIH based on relative amounts of operating revenue, payroll, property value, or other appropriate measures. Also, recapitalization costs reflected on the Consolidated Statements of Operations represent RIH's allocated portion of GGE's consolidated recapitalization costs. See also Note 12 for a discussion of alternative minimum taxes allocated to RIH by GGE.\nLicense and Services Agreement\nIn April 1993, GGE, RIH and The Griffin Group, Inc. (the \"Griffin Group\"), a corporation controlled by Merv Griffin, Chairman of the Board\n- 37 -\nof GGE, entered into a license and services agreement (the \"Griffin Services Agreement\") effective as of September 17, 1992. Pursuant to the Griffin Services Agreement, Griffin Group granted GGE and RIH a non-exclusive license to use the name and likeness of Merv Griffin to advertise and promote facilities and operations of GGE and its subsidiaries. Also pursuant to the Griffin Services Agreement, Mr. Griffin is to provide certain services to GGE and RIH, including serving as Chairman of the Board of GGE and as a host, producer and featured performer in various shows to be presented in Resorts Casino Hotel, and furnishing marketing and consulting services.\nThe Griffin Services Agreement is to continue until September 17, 1997 and provides for earlier termination under certain circumstances including, among others, a change of control (as defined) of GGE and RIH and Mr. Griffin ceasing to serve as Chairman of the Board of GGE.\nThe Griffin Services Agreement provides for compensation to Griffin Group in the amount of $2,000,000 for the year ended September 16, 1993, and in specified amounts for each of the following years, which increase at approximately 5% per year. In accordance with the Griffin Services Agreement, upon signing, RIH paid Griffin Group $4,100,000, representing compensation for the first two years. Thereafter, the Griffin Services Agreement called for annual payments on September 17, each representing a prepayment for the year ending two years hence. In the event of an early termination of the Griffin Services Agreement, and depending on the circumstances of such early termination, all or a portion of the compensation paid to Griffin Group in respect of the period subsequent to the date of termination may be required to be repaid to GGE and RIH.\nIn the Griffin Services Agreement GGE and RIH agreed to indemnify, defend and hold harmless Griffin Group and Mr. Griffin against certain claims, losses and costs, and to maintain certain insurance coverage with Mr. Griffin and Griffin Group as named insureds.\nAs part of the 1994 restructuring, the payment due Griffin Group on September 17, 1994 was settled by applying $2,310,000 as a reduction of the balance of a note payable to GGE by Griffin Group. On August 1, 1994, following review and approval by the independent members of GGE's Board of Directors, GGE agreed to issue 388,000 shares of common stock of GGE to an affiliate of Griffin Group in satisfaction of the final payment obligation of RIH and GGE under the Griffin Services Agreement. This payment of $2,425,000 would have been due on September 17, 1995. The closing price of GGE's common stock on the date of the agreement was $5.3125 per share. (The number of shares and closing price stated herein were adjusted to reflect a one-for-five reverse stock split of GGE s common stock which occurred on June 30, 1995.) The shares are not registered under the Securities Act of 1933 and are restricted securities.\nOther\nRIH reimbursed Griffin Group $183,000, $207,000 and $130,000 for charter air services related to RIH business rendered in 1995, 1994 and 1993, respectively.\n- 38 -\nIn 1995 and 1994 RIH incurred charges from unaffiliated parties of $450,000 and $394,000, respectively, in producing the nationwide television broadcast of \"Merv Griffin's New Year's Eve Special\" from Resorts Casino Hotel. For the 1993 production of \"Merv Griffin's New Year's Eve Special,\" which was also broadcast nationwide, RIH paid $100,000 and provided certain facilities, labor and accommodations to subsidiaries of January Enterprises, Inc., of which Merv Griffin formerly was Chairman.\nAlso from time to time RIH has reimbursed Griffin Group, at cost, for certain costs incurred by Griffin Group on behalf of RIH. RIH has also paid standard room rates for hotel rooms occupied by RIH personnel or patrons of RIH at certain hotels owned or controlled by Griffin Group.\nNOTE 11 - RETIREMENT PLANS\nRIH has a defined contribution plan in which substantially all non-union employees are eligible to participate. Employees of certain other affiliated companies are also eligible to participate in this plan. RIH and other subsidiaries of GGE make contributions to the plan based on a percentage of eligible employee contributions. RIH's pension expense for this plan was $641,000, $637,000 and $681,000 for the years 1995, 1994 and 1993, respectively.\nUnion employees are covered by various multi-employer pension plans to which contributions are made by RIH and other unrelated employers. RIH's pension expense for these plans was $881,000, $842,000 and $844,000 for the years 1995, 1994 and 1993, respectively.\nNOTE 12 - INCOME TAXES\nIn 1995 RIH was allocated $450,000 of GGE s consolidated federal alternative minimum tax (\"AMT\") in accordance with the tax sharing agreement provided for in the Indentures. These charges reduced RIH s deferred tax liability as the resulting AMT credits carry forward indefinitely.\nIn 1995, 1994 and 1993 RIH had current federal provisions of $1,100,000, $1,100,000 and $2,600,000, respectively. These were offset by deferred federal tax benefits of the same amounts resulting from the recognition of the carryback of future deductible amounts.\nIn August 1993 tax law changes were enacted which resulted in an increase in RIH's federal income tax rate. The increase resulted in a $400,000 increase in RIH's deferred income tax liability and a deferred income tax provision of the same amount.\nNo state tax provision was recorded in 1995, 1994 or 1993 due to the utilization of state net operating loss (\"NOL\") carryforwards.\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\n- 39 -\npurposes. Significant components of RIH's deferred tax liabilities and assets as of December 31 were as follows:\n(In Thousands of Dollars) 1995 1994\nDeferred tax liabilities - basis differences on property and equipment $(21,400) $(21,000)\nDeferred tax assets: NOL carryforwards 65,400 65,800 Book reserves not yet deductible for tax 11,100 10,000 Tax credit carryforwards 800 2,100 Other 2,100 2,400 Total deferred tax assets 79,400 80,300\nValuation allowance for deferred tax assets (76,950) (78,700) Deferred tax assets, net of valuation allowance 2,450 1,600\nNet deferred tax liabilities $(18,950) $(19,400)\nThe effective income tax rate on earnings before income taxes and extraordinary items varies from the statutory federal income tax rate as a result of the following factors:\n1995 1994 1993\nStatutory federal income tax rate 35.0% 35.0% 35.0%\nDeferred income tax benefit of temporary differences (10.4%) (15.0%) (19.5%)\nNOL carryforwards utilized (28.5%) (23.1%) (16.3%)\nOther, including impact of increase in tax rate in 1993 3.9% 3.1% 3.2%\nEffective tax rate 0.0% 0.0% 2.4%\nF o r federal tax purposes RIH had NOL carryforwards of approximately $187,000,000 at December 31, 1995 which expire as follows: $40,000,000 in 2003, $50,000,000 in 2004, $96,000,000 in 2005 and $1,000,000 in 2009. The NOL carryforward expiring in 2009 represents charitable contributions in excess of amounts currently d e ductible, which GGE elected to convert to NOLs. The NOL carryforwards scheduled to expire in 2003 through 2005 were produced in periods prior to a change in ownership of the consolidated group of which RIH is a part; therefore, these loss carryforwards are limited in their availability to offset future taxable income. For federal tax purposes, this limitation is considered to be owned by a common parent and would not be available to\n- 40 -\nRIH unless the parent made an affirmative election to allocate some of the limitation to RIH. Such election would not be made until such time as RIH ceases to be a member of the group.\nFor financial reporting purposes, the tax provision has been computed as if RIH were entitled to a full allocation of the group's limitation. This has the effect of reducing RIH's current tax provision; any remaining current tax provision of RIH is fully offset by a deferred tax benefit based on the reversal of temporary differences.\nFor tax purposes, because RIH files a consolidated tax return with GGE and GGE s other subsidiaries, it is able to utilize the current period losses and NOL carryforwards of the entire group; thus, its usage of its own NOLs is substantially less than the taxable income it generates.\nAt December 31, 1995, RIH had approximately $125,000,000 of NOL carryforwards in New Jersey which expire as follows: $13,000,000 in 1996, $111,000,000 in 1997 and $1,000,000 in 2001.\nAlso at December 31, 1995, RIH had federal income tax credit carryforwards of approximately $400,000, which expire $100,000 per y e ar between 2006 and 2009, and federal AMT tax credits of approximately $400,000 which carry forward indefinitely.\n- 41 -\nNOTE 13 - STATEMENTS OF CASH FLOWS\nSupplemental disclosures required by Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows,\" are presented below.\n(In Thousands of Dollars) 1995 1994 1993\nReconciliation of net earnings to net cash provided by operating activities: Net earnings $10,540 $15,832 $16,363 Adjustments to reconcile net earnings to net cash provided by operating activities: Extraordinary gain on purchase of 12,899 Units (4,008) Depreciation 13,415 13,186 13,664 Provision for discount on CRDA obligations, net of amortization 1,561 1,456 1,538 Amortization of debt discounts 1,452 757 Provision for doubtful receivables 925 297 901 Deferred tax provision (benefit) (450) 400 Recapitalization costs 975 2,727 Net loss on dispositions of property and equipment 18 8 323 Net increase in receivables (1,879) (1,415) (609) Net (increase) decrease in interest receivable from affiliate (2,250) 3,375 Net (increase) decrease in inventories and prepaid expenses 1,834 (2,963) (3,992) Net (increase) decrease in deferred charges and other assets 530 1,164 (754) Net increase in interest payable to affiliate 131 4,113 Net increase (decrease) in accounts payable and accrued liabilities 1,697 (288) (1,287)\nNet cash provided by operating activities $29,774 $26,864 $32,649\n- 42 -\n(In Thousands of Dollars) 1995 1994 1993\nNon-cash investing and financing transactions:\nDistribution of RIH Promissory Note and RIH Junior Promissory Note as: Repayment of advances from GGE $ 43,236 Distribution to GGE 92,064\nExchange RIH-GGRI Note for shares of RIH common stock 325,000\nDistribution of RIB Note and accrued interest thereon to GGRI 53,375\nIncrease in liabilities for additions to property and equipment and other assets 80 $632\nNOTE 14 - COMMITMENTS AND CONTINGENCIES\nCRDA\nCertain issues have been raised by the CRDA and the State of New Jersey Department of the Treasury (the \"Treasury\") concerning the satisfaction of RIH s investment obligations for the years 1979 through 1983 (see Note 5). These matters were dormant for some time until late 1995, when RIH was contacted by the CRDA. In a recent meeting with CRDA representatives RIH was informed that it would be hearing from the Treasury in the near future regarding a resolution of these matters. If these issues are determined adversely, RIH could be required to pay the relevant amount in cash to the CRDA. However, management believes a negotiated settlement with an insignificant monetary cost to RIH is probable.\nLitigation\nRIH is a defendant in certain litigation. In the opinion of management, based upon advice of counsel, the aggregate liability, if any, arising from such litigation will not have a material adverse effect on the accompanying consolidated financial statements.\n- 43 -\nSCHEDULE II\nRESORTS INTERNATIONAL HOTEL, INC. AND SUBSIDIARIES VALUATION ACCOUNTS (In Thousands of Dollars)\nBalance at Additions Balance at beginning charged to end of of period expenses Deductions (A) period\nFor the year ended December 31, 1995:\nAllowance for doubtful receivables: Gaming $3,819 $902 $(1,202) $3,519 Other 82 23 (54) 51 $3,901 $925 $(1,256) $3,570\nFor the year ended December 31, 1994:\nAllowance for doubtful receivables: Gaming $4,498 $237 $ (916) $3,819 Other 40 60 (18) 82 $4,538 $297 $ (934) $3,901\nFor the year ended December 31, 1993:\nAllowance for doubtful receivables: Gaming $4,200 $901 $ (603) $4,498 Other 48 (8) 40 $4,248 $901 $ (611) $4,538\n(A) Write-off of uncollectible accounts, net of recoveries. \/TABLE\nSELECTED QUARTERLY FINANCIAL DATA (Unaudited) (In Thousands of Dollars)\nThe table below reflects selected quarterly financial data for the years 1995 and 1994.\n1995 1994 For the Quarter First Second Third Fourth First Second Third Fourth\nOperating revenues $67,680 $74,560 $83,456 $67,530 $58,873 $72,220 $77,679 $67,961\nEarnings (loss) from operations $ 2,819 $ 7,440 $12,947 $ 3,140 $(1,691) $ 6,988 $11,445 $ 4,049\nRecapitalization costs (604) (371)\nOther income (deductions), net (A) (3,998) (3,927) (3,948) (3,933) 1,920 (2,240) (4,319) (3,353)\nEarnings (loss) before extraordinary item (1,179) 3,513 8,999 (793) (375) 4,377 7,126 696\nExtraordinary item 4,008\nNet earnings (loss) $(1,179) $ 3,513 $ 8,999 $ (793) $ (375) $ 4,377 $ 7,126 $ 4,704\n(A) Includes interest income, interest expense and amortization of debt discounts. \/TABLE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe following Items have been omitted pursuant to General Instruction J of Form 10-K: 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) Documents Filed as Part of This Report\n1. The financial statement index required herein is incorporated by reference to \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\n2. The index of financial statement schedules required herein is incorporated by reference to \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\" Financial statement schedules not included have been omitted because they are either not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n3. The following exhibits are filed herewith or incorporated by reference:\nExhibit Numbers Exhibit\n(2) Plan of Reorganization. (Incorporated by reference to Appendix A of the Information Statement\/Prospectus included in registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(3)(a)(1) R e s tated Certificate of Incorporation of RIH. (Incorporated by reference to Exhibit 3.03 to registrant's Form S-1 Registration Statement in File No. 33-23063.)\n(3)(a)(2) Certificate of Amendment to the Certificate of Incorporation of RIH. (Incorporated by reference to Exhibit 3.05 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n- 46 -\n(3)(a)(3) Form of Certificate of Amendment of Certificate of Incorporation of RIH. (Incorporated by reference to Exhibit 3.05(a) to registrant's Form S-1 Registration Statement in File No. 33-53371.)\n(3)(b) By-Laws of RIH. (Incorporated by reference to Exhibit 3.06 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(a) See Exhibits (3)(a) and (3)(b) as to the rights of holders of registrant's common stock.\n(4)(b)(1) F o rm of Indenture among RIHF, as issuer, RIH, as guarantor, and State Street Bank and Trust Company of Connecticut, National Association, as trustee, with respect to RIHF 11% Mortgage Notes due 2003. (Incorporated by reference to Exhibit 4.04 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(2) Form of Mortgage between RIH and State Street Bank and Trust Company of Connecticut, National Association, securing Guaranty of RIHF Mortgage Notes. (Incorporated by reference to Exhibit 4.22 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(3) Form of Mortgage between RIH and RIHF, securing RIH Promissory Note. (Incorporated by reference to Exhibit 4.23 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(4) Form of Assignment of Agreements made by RIHF, as Assignor, to State Street Bank and Trust Company of Connecticut, National Association, as Assignee, regarding RIH Promissory Note. (Incorporated by reference to Exhibit 4.24 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(5) Form of Assignment of Leases and Rents made by RIH, as Assignor, to RIHF, as Assignee, regarding RIH Promissory Note. (Incorporated by reference to Exhibit 4.25 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(6) Form of Assignment of Leases and Rents made by RIH, as Assignor, to State Street Bank and Trust Company of Connecticut, National Association, as Assignee, regarding Guaranty of RIHF Mortgage Notes. (Incorporated by reference to Exhibit 4.26 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n- 47 -\n(4)(b)(7) Form of Assignment of Operating Assets made by RIH, as Assignor, to State Street Bank and Trust Company of Connecticut, National Association, as Assignee, regarding Guaranty of RIHF Mortgage Notes. (Incorporated by reference to Exhibit 4.28 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(8) Form of Assignment of Operating Assets made by RIH, as Assignor, to RIHF, as Assignee, regarding RIH Promissory Note. (Incorporated by reference to Exhibit 4.34 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(b)(9) Form of Amended and Restated $125,000,000 RIH Promissory Note. (Incorporated by reference to Exhibit A to Exhibit (4)(b)(1) hereto.)\n(4)(c)(1) Form of Indenture between RIHF, as issuer, RIH, as guarantor, and U.S. Trust Company of California, N.A., as trustee, with respect to RIHF 11.375% Junior Mortgage Notes due 2004. (Incorporated by reference to Exhibit 4.05 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(2) Form of Mortgage between RIH and U.S. Trust Company of California, N.A., securing Guaranty of RIHF Junior Mortgage Notes. (Incorporated by reference to Exhibit 4.29 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(3) Form of Mortgage between RIH and RIHF, securing RIH Junior Promissory Note. (Incorporated by reference to Exhibit 4.30 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(4) Form of Assignment of Agreements made by RIHF, as Assignor, to U.S. Trust Company of California, N.A., as Assignee, regarding RIH Junior Promissory Note. (Incorporated by reference to Exhibit 4.31 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(5) Form of Assignment of Leases and Rents made by RIH, as Assignor, to RIHF, as Assignee, regarding RIH Junior Promissory Note. (Incorporated by reference to Exhibit 4.32 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(6) Form of Assignment of Leases and Rents made by RIH, as Assignor, to U.S. Trust Company of California, N.A., as Assignee, regarding Guaranty of RIHF Junior Mortgage Notes. (Incorporated by reference to Exhibit 4.33 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n- 48 -\n(4)(c)(7) Form of Assignment of Operating Assets made by RIH, as Assignor, to U.S. Trust Company of California, N.A., as Assignee, regarding the Guaranty of the RIHF Junior Mortgage Notes. (Incorporated by reference to Exhibit 4.35 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(8) Form of Assignment of Operating Assets made by RIH, as Assignor, to RIHF, as Assignee, regarding RIH Junior Promissory Note. (Incorporated by reference to Exhibit 4.27 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(4)(c)(9) Form of Amended and Restated $35,000,000 RIH Junior Promissory Note. (Incorporated by reference to Exhibit A to Exhibit (4)(c)(1) hereto.)\n(10)(a)(1)* Resorts Retirement Savings Plan. (Incorporated by reference to Exhibit (10)(c)(2) to GGE's Form 10-K Annual Report for the fiscal year ended December 31, 1991, in File No. 1-4748.)\n(10)(a)(2)* Resorts International, Inc. Senior Management Stock Option Plan. (Incorporated by reference to Exhibit 8.5 to Exhibit 35 to GGE's Form 8 Amendment No. 1 to its Form 8-K Current Report dated August 30, 1990, in File No. 1-4748.)\n(10)(a)(3)* Resorts International, Inc. 1994 Stock Option Plan (as amended on June 27, 1995). (Incorporated by reference to Exhibit (4)(b) to GGE s Form 10-Q Quarterly Report for the quarter ended June 30, 1995, in File No. 1-4748.)\n(10)(b)(1)* License and Services Agreement, dated as of September 17, 1992, among Griffin Group, GGE and RIH. (Incorporated by reference to Exhibit 10.34(a) to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(10)(b)(2)* Form of Amendment to License and Services Agreement, dated as of September 17, 1992, among Griffin Group, GGE and RIH. (Incorporated by reference to Exhibit 10.34(b) to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(10)(c) Form of Intercreditor Agreement by and among RIHF, RIH, GGE, GGRI, State Street Bank and Trust Company of Connecticut, National Association, U.S. Trust Company of California, N.A. and any lenders which provide additional facilities. (Incorporated by reference to Exhibit 10.64 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n- 49 -\n(10)(d)(1) Form of Note Purchase Agreement dated May 3, 1994, among RIHF, GGE and RIH, and certain funds advised or managed by Fidelity Management & Research Company with respect to issuance of Senior Facility Notes. (Incorporated by reference to Exhibit 10.65 to Form S-1 Registration Statement in File No. 33-53371.)\n(10)(d)(2) Revised term sheet for 11.0% Senior Secured Loan due 2002 with RIHF as issuer. (Incorporated by reference to Exhibit 10.54 to registrant's Form S-4 Registration Statement in File No. 33-50733.)\n(10)(d)(3) Letter agreement dated February 27, 1995 amending Exhibit (10)(d)(1) hereto. (Incorporated by reference to Exhibit (10)(n)(3) to GGE's Form 10-K Annual Report for the fiscal year ended December 31, 1994, in File No. 1-4748.)\n(10)(e) Form of Registration Rights Agreement dated as of April 29, 1994, among GGE, RIHF, RIH, Fidelity Management & Research Company and The TCW Group, Inc. (Incorporated by reference to Exhibit 10.66 to Form S-1 Registration Statement in File No. 33-53371.)\n(10)(f) Form of Nominee Agreement between RIHF and RIH. (Incorporated by reference to Exhibit 10.57 to Form S-1 Registration Statement in File No. 33-53371.)\n(27) Financial data schedule. _________________\n* Management contract or compensatory plan.\nRegistrant agrees to file with the Securities and Exchange Commission, upon request, copies of any instrument defining the rights of the holders of its consolidated long-term debt.\n(b) Reports on Form 8-K\nNo current report on Form 8-K was filed by RIH covering an event during the fourth quarter of 1995. No amendments to previously filed Forms 8-K were filed during the fourth quarter of 1995.\n(c) Exhibits Required by Item 601 of Regulation S-K\nThe exhibits listed in Item 14(a)3. of this report, and not incorporated by reference to a separate file, follow \"SIGNATURES.\"\n(d) Financial Statement Schedules Required by Regulation S-K\nThe financial statement schedule required by Regulation S-K is incorporated by reference to \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\n- 50 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nRESORTS INTERNATIONAL HOTEL, INC. (Registrant)\nDate: March 8, 1996 By \/s\/ Matthew B. Kearney Matthew B. Kearney Director and Executive Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nBy \/s\/ Matthew B. Kearney March 8, 1996 Matthew B. Kearney Director and Executive Vice President (Principal Executive, Financial and Accounting Officer)\nBy \/s\/ Lawrence Cohen March 8, 1996 Lawrence Cohen Director\nSUPPLEMENTAL INFORMATION\nBecause it is an indirect wholly owned subsidiary of GGE, a reporting company under the Securities Exchange Act of 1934, the registrant does not prepare an annual report to security holders or any proxy soliciting material.\n- 51 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(2) Plan of Reorganization. Incorporated by reference to Appendix A of the Information Statement\/Prospectus included in registrant's Form S-4 Registration Statement in File No. 33- 50733.\n(3)(a)(1) Restated Certificate of Incorporated by reference Incorporation of RIH. to Exhibit 3.03 to registrant's Form S-1 Registration Statement in File No. 33-23063.\n(3)(a)(2) Certificate of Amendment Incorporated by reference to the Certificate of to Exhibit 3.05 to Incorporation of RIH. registrant's Form S-4 Registration Statement in File No. 33-50733.\n(3)(a)(3) Form of Certificate of Incorporated by reference Amendment of Certificate to Exhibit 3.05(a) to of Incorporation of RIH. registrant's Form S-1 Registration Statement in File No. 33-53371.\n(3)(b) By-Laws of RIH. Incorporated by reference to Exhibit 3.06 to registrant's Form S-4 Registration Statement in File No. 33-50733.\n(4)(a) See Exhibits (3)(a) and (3)(b) as to the rights of holders of registrant's common stock.\n- 52 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(4)(b)(1) Form of Indenture among Incorporated by reference RIHF, as issuer, RIH, as to Exhibit 4.04 to guarantor, and State registrant's Form S-4 Street Bank and Trust Registration Statement in Company of Connecticut, File No. 33-50733. National Association, as trustee, with respect to RIHF 11% Mortgage Notes due 2003.\n(4)(b)(2) Form of Mortgage between Incorporated by reference RIH and State Street Bank to Exhibit 4.22 to and Trust Company of registrant's Form S-4 Connecticut, National Registration Statement in Association, securing File No. 33-50733. Guaranty of RIHF Mortgage Notes.\n(4)(b)(3) Form of Mortgage between Incorporated by reference RIH and RIHF, securing to Exhibit 4.23 to RIH Promissory Note. registrant's Form S-4 Registration Statement in File No. 33-50733.\n(4)(b)(4) Form of Assignment of Incorporated by reference Agreements made by RIHF, to Exhibit 4.24 to as Assignor, to State registrant's Form S-4 Street Bank and Trust Registration Statement in Company of Connecticut, File No. 33-50733. National Association, as Assignee, regarding RIH Promissory Note.\n(4)(b)(5) Form of Assignment of Incorporated by reference Leases and Rents made by to Exhibit 4.25 to RIH, as Assignor, to registrant's Form S-4 RIHF, as Assignee, Registration Statement in regarding RIH Promissory File No. 33-50733. Note.\n- 53 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(4)(b)(6) Form of Assignment of Incorporated by reference Leases and Rents made by to Exhibit 4.26 to RIH, as Assignor, to registrant's Form S-4 State Street Bank and Registration Statement in Trust Company of File No. 33-50733. Connecticut, National Association, as Assignee, regarding Guaranty of RIHF Mortgage Notes.\n(4)(b)(7) Form of Assignment of Incorporated by reference Operating Assets made by to Exhibit 4.28 to RIH, as Assignor, to registrant's Form S-4 State Street Bank and Registration Statement in Trust Company of File No. 33-50733. Connecticut, National Association, as Assignee, regarding Guaranty of RIHF Mortgage Notes.\n(4)(b)(8) Form of Assignment of Incorporated by reference Operating Assets made by to Exhibit 4.34 to RIH, as Assignor, to registrant's Form S-4 RIHF, as Assignee, Registration Statement in regarding RIH Promissory File No. 33-50733. Note.\n(4)(b)(9) Form of Amended and Incorporated by reference Restated $125,000,000 RIH to Exhibit A to Exhibit Promissory Note. (4)(b)(1) hereto.\n(4)(c)(1) Form of Indenture between Incorporated by reference RIHF, as issuer, RIH, as to Exhibit 4.05 to guarantor, and U.S. Trust registrant's Form S-4 Company of California, Registration Statement in N.A., as trustee, with File No. 33-50733. respect to RIHF 11.375% Junior Mortgage Notes due 2004.\n- 54 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(4)(c)(2) Form of Mortgage between Incorporated by reference RIH and U.S. Trust to Exhibit 4.29 to Company of California, registrant's Form S-4 N.A., securing Guaranty Registration Statement in of RIHF Junior Mortgage File No. 33-50733. Notes.\n(4)(c)(3) Form of Mortgage between Incorporated by reference RIH and RIHF, securing to Exhibit 4.30 to RIH Junior Promissory registrant's Form S-4 Note. Registration Statement in File No. 33-50733.\n(4)(c)(4) Form of Assignment of Incorporated by reference Agreements made by RIHF, to Exhibit 4.31 to as Assignor, to U.S. registrant's Form S-4 Trust Company of Registration Statement in California, N.A., as File No. 33-50733. Assignee, regarding RIH Junior Promissory Note.\n(4)(c)(5) Form of Assignment of Incorporated by reference Leases and Rents made by to Exhibit 4.32 to RIH, as Assignor, to registrant's Form S-4 RIHF, as Assignee, Registration Statement in regarding RIH Junior File No. 33-50733. Promissory Note.\n(4)(c)(6) Form of Assignment of Incorporated by reference Leases and Rents made by to Exhibit 4.33 to RIH, as Assignor, to U.S. registrant's Form S-4 Trust Company of Registration Statement in California, N.A., as File No. 33-50733. Assignee, regarding Guaranty of RIHF Junior Mortgage Notes.\n- 55 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(4)(c)(7) Form of Assignment of Incorporated by reference Operating Assets made by to Exhibit 4.35 to RIH, as Assignor, to U.S. registrant's Form S-4 Trust Company of Registration Statement in California, N.A., as File No. 33-50733. Assignee, regarding the Guaranty of the RIHF Junior Mortgage Notes.\n(4)(c)(8) Form of Assignment of Incorporated by reference Operating Assets made by to Exhibit 4.27 to RIH, as Assignor, to registrant's Form S-4 RIHF, as Assignee, Registration Statement in regarding RIH Junior File No. 33-50733. Promissory Note.\n(4)(c)(9) Form of Amended and Incorporated by reference Restated $35,000,000 RIH to Exhibit A to Exhibit Junior Promissory Note. (4)(c)(1) hereto.\n(10)(a)(1) Resorts Retirement Incorporated by reference Savings Plan. to Exhibit (10)(c)(2) to GGE's Form 10-K Annual Report for the fiscal year ended December 31, 1991, in File No. 1-4748.\n(10)(a)(2) Resorts International, Incorporated by reference Inc. Senior Management to Exhibit 8.5 to Exhibit Stock Option Plan. 35 to GGE's Form 8 Amendment No. 1 to its Form 8-K Current Report dated August 30, 1990, in File No. 1-4748.\n- 56 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(10)(a)(3) Resorts International, Incorporated by reference Inc. 1994 Stock Option to Exhibit (4)(b) to Plan (as amended on June GGE s Form 27, 1995). 10-Q Quarterly Report for the quarter ended June 30, 1995, in File No. 1- 4748.\n10)(b)(1) License and Services Incorporated by reference Agreement, dated as of to Exhibit 10.34(a) to September 17, 1992, among registrant's Form S-4 Griffin Group, GGE and Registration Statement in RIH. File No. 33-50733.\n(10)(b)(2) Form of Amendment to Incorporated by reference License and Services to Exhibit 10.34(b) to Agreement, dated as of registrant's Form S-4 September 17, 1992, among Registration Statement in Griffin Group, GGE and File No. 33-50733. RIH.\n(10)(c) Form of Intercreditor Incorporated by reference Agreement by and among to Exhibit 10.64 to RIHF, RIH, GGE, GGRI, registrant's Form S-4 State Street Bank and Registration Statement in Trust Company of File No. 33-50733. Connecticut, National Association, U.S. Trust Company of California, N.A. and any lenders which provide additional facilities.\n(10)(d)(1) Form of Note Purchase Incorporated by reference Agreement dated May 3, to Exhibit 10.65 to Form 1994, among RIHF, GGE and S-1 Registration RIH, and certain funds Statement in File No. 33- advised or managed by 53371. Fidelity Management & Research Company with respect to issuance of Senior Facility Notes.\n- 57 -\nRESORTS INTERNATIONAL HOTEL, INC.\nForm 10-K for the fiscal year ended December 31, 1995\nEXHIBIT INDEX\nReference to previous Exhibit filing or page number Number Exhibit in Form 10-K\n(10)(d)(2) Revised term sheet for Incorporated by reference 11.0% Senior Secured Loan to Exhibit 10.54 to due 2002 with RIHF as registrant's Form S-4 issuer. Registration Statement in File No. 33-50733.\n(10)(d)(3) Letter agreement dated Incorporated by reference February 27, 1995 to Exhibit (10)(n)(3) to amending Exhibit GGE's Form 10-K Annual (10)(d)(1) hereto. Report for the fiscal year ended December 31, 1994, in File No. 1-4748.\n(10)(e) Form of Registration Incorporated by reference Rights Agreement dated as to Exhibit 10.66 to Form of April 29, 1994, among S-1 Registration GGE, RIHF, RIH, Fidelity Statement in File No. 33- Management & Research 53371. Company and The TCW Group, Inc.\n(10)(f) Form of Nominee Agreement Incorporated by reference between RIHF and RIH. to Exhibit 10.57 to Form S-1 Registration Statement in File No. 33- 53371.\n(27) Financial data schedule. Page 59.\n- 58 -","section_15":""}
{"filename":"318154_1995.txt","cik":"318154","year":"1995","section_1":"Item 1. BUSINESS\nOverview\nAmgen Inc. (\"Amgen\" or the \"Company\") is a global biotechnology company that develops, manufactures and markets human therapeutics based on advanced cellular and molecular biology.\nThe Company manufactures and markets two human therapeutic products, NEUPOGEN(R) (Filgrastim) and EPOGEN(R) (Epoetin alfa). NEUPOGEN(R) selectively stimulates the production of neutrophils, one type of white blood cell. The Company markets NEUPOGEN(R) in the United States, countries of the European Union (\"EU\"), Canada and Australia for use in decreasing the incidence of infection in patients undergoing myelosuppressive chemotherapy. In addition, NEUPOGEN(R) is marketed in most of these countries for use in reducing the duration of neutropenia for patients undergoing myeloablative therapy followed by bone marrow transplantation, for treating patients with severe chronic neutropenia, and to support peripheral blood progenitor cell (\"PBPC\") transplantations. EPOGEN(R) stimulates the production of red blood cells and is marketed by Amgen in the United States for the treatment of anemia associated with chronic renal failure in patients on dialysis.\nThe Company focuses its research on biological cell\/tissue events and its development efforts on human therapeutics in the areas of hematopoiesis, neurobiology, inflammation, endocrinology, and soft tissue repair and regeneration. The Company has research facilities in the United States and Canada and has clinical development staff in the United States, the EU, Canada, Australia, Japan and Hong Kong. To augment internal research and development efforts the Company has established external research collaborations and has acquired certain product and technology rights.\nAmgen operates commercial manufacturing facilities located in the United States and Puerto Rico. A sales and marketing force is maintained in the United States, the EU, Canada, and Australia. In addition, Amgen has entered into licensing and co-promotion agreements to market NEUPOGEN(R) and EPOGEN(R) in certain geographic areas.\nThe Company was incorporated in California in 1980 and was merged into a Delaware corporation in 1987. Amgen's principal executive offices are located at 1840 Dehavilland Drive, Thousand Oaks, California 91320-1789.\nProducts\nRecombinant human granulocyte colony-stimulating factor\nNEUPOGEN(R) (proper name - Filgrastim) is Amgen's trademark for its recombinant human granulocyte colony-stimulating factor (\"G- CSF\"), a protein that selectively stimulates production of certain white blood cells known as neutrophils. Neutrophils are the body's first defense against infection. Treatments for various diseases and diseases themselves can result in extremely low numbers of neutrophils, or neutropenia. Myelosuppressive chemotherapy, one treatment option for individuals with cancer, targets cell types which grow rapidly, such as tumor cells, neutrophils and other blood cells. Providing NEUPOGEN(R) as an adjunct to myelosuppressive chemotherapy can reduce the duration of neutropenia and thereby reduce the potential for infection.\nCongenital neutropenia is an example of disease-related neutropenia. In congenital neutropenia, the body fails to manufacture sufficient neutrophils. Chronic administration of NEUPOGEN(R) has been shown to reduce the incidence and duration of neutropenia-related consequences such as fever and infections in patients with congenital neutropenia.\nPatients undergoing bone marrow transplantation are treated with NEUPOGEN(R) to accelerate recovery of neutrophils following chemotherapy and bone marrow infusion. NEUPOGEN(R) also has been shown to induce immature blood cells (progenitor cells) to migrate (mobilize) from the bone marrow into the blood circulatory system. When these progenitor cells are collected from the blood, stored and re-infused after chemotherapy (transplanted), recovery of platelets, red blood cells and neutrophils is accelerated. PBPC transplantation is becoming an alternative to autologous bone marrow transplantation in some patients.\nThe Company began selling NEUPOGEN(R) in the United States in February 1991 (see \"Joint Venture and Business Relationships - Kirin Brewery Company, Limited\"). NEUPOGEN(R) was initially indicated to decrease the incidence of infection as manifested by febrile neutropenia for patients with non-myeloid malignancies undergoing myelosuppressive chemotherapy. The U.S. Food and Drug Administration (\"FDA\") subsequently cleared supplements to the Filgrastim product license which include claims to reduce the duration of neutropenia for patients with non-myeloid malignancies undergoing myeloablative therapy followed by bone marrow transplantation and to reduce the incidence and duration of neutropenia-related consequences in symptomatic patients with congenital neutropenia, cyclic neutropenia or idiopathic neutropenia. In December 1995, NEUPOGEN(R) received FDA clearance for use in mobilization of PBPC for stem cell transplantation.\nIn the EU, Canada and Australia, NEUPOGEN(R) is marketed as an adjunct to chemotherapy and a treatment for patients with severe chronic neutropenia. In the EU and Australia, NEUPOGEN(R) is also marketed for use in reducing the duration of neutropenia for patients undergoing myeloablative therapy followed by bone marrow transplantation and to support PBPC transplantations. In March 1996, NEUPOGEN(R) was approved for use in the United Kingdom as a supportive therapy to treat neutropenia in people with advanced HIV infection.\nIn Japan, Taiwan and Korea, Kirin Brewery Company, Limited (\"Kirin\"), was granted rights to market G-CSF under licensing agreements with Kirin-Amgen, Inc. (\"Kirin-Amgen\"). Kirin-Amgen is a joint venture between the Company and Kirin (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). Kirin markets its G-CSF product in these countries under the trademark GRAN(R).\nThe Company is conducting numerous clinical trials with NEUPOGEN(R). Later stage trials are examining NEUPOGEN(R) as an adjunct to dose-intensified chemotherapy in patients with various tumor types and for the treatment of neutropenia in HIV-infected patients. In 1995, the Company completed a Phase 3 clinical trial in patients with severe community-acquired pneumonia. Although the primary endpoint was not met, NEUPOGEN(R) was found to have statistically significant clinical benefits relating to two serious complications of pneumonia: reducing the incidence of end organ failures and reducing the incidence of adult respiratory distress syndrome. The Company is continuing the clinical development of NEUPOGEN(R) for severe pneumonia. The Company also completed clinical trials examining NEUPOGEN(R) as an adjunct to chemotherapy in patients with acute myelogenous leukemia. A licensing application for approval of this supplemental indication will be submitted to the U.S., European, Canadian and Australian regulatory authorities.\nFor the years ended December 31, 1995, 1994 and 1993, sales of NEUPOGEN(R) accounted for approximately 48%, 50% and 52%, respectively, of total revenues.\nRecombinant human erythropoietin\nEPOGEN(R) (proper name - Epoetin alfa) is Amgen's trademark for its recombinant human erythropoietin product, a protein that stimulates red blood cell production. EPOGEN(R) is effective in the treatment of anemia associated with chronic renal failure for patients on dialysis and is indicated to elevate or maintain the red blood cell level (as manifested by hematocrit or hemoglobin determinations) and to decrease the need for blood transfusions in these patients.\nIn the United States, Amgen was granted rights to market recombinant human erythropoietin under a licensing agreement with Kirin-Amgen (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). The Company began selling EPOGEN(R) in 1989 when the FDA gave clearance for its use in the treatment of anemia associated with chronic renal failure. The FDA designated EPOGEN(R) as an orphan drug, and such designation will expire in 1996. In July 1994, the FDA cleared a supplement to the Epoetin alfa product license which included an expanded target hematocrit range for patients with chronic renal failure. The target hematocrit, or percentage of red blood cells, was expanded to a range of 30 to 36 percent from the previously indicated range of 30 to 33 percent. Ongoing clinical trials are investigating whether there are additional benefits for dialysis patients in maintaining a higher, even more normal, hematocrit range. The Company markets EPOGEN(R) in the United States for dialysis patients, a market to which Amgen has maintained exclusive rights.\nAmgen has granted Ortho Pharmaceutical Corporation, a subsidiary of Johnson & Johnson, hereafter referred to as \"Johnson & Johnson\", a license to pursue commercialization of recombinant human erythropoietin as a human therapeutic in the United States in all markets other than dialysis and diagnostics. See Note 1 to the Consolidated Financial Statements - \"Product sales\" and Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitrations\".\nIn August 1995, the U.S. Patent and Trademark Office issued to the Company a patent on the process for the manufacture of recombinant human erythropoietin. The patent provides protection against the making, importation, use or sale of recombinant human erythropoietin in the United States.\nIn Japan, Kirin was granted rights to market recombinant human erythropoietin under a licensing agreement with Kirin-Amgen (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). Kirin markets its recombinant human erythropoietin product under the trademark ESPO(R).\nIn countries other than the United States, the People's Republic of China and Japan, Johnson & Johnson was granted rights to pursue the commercialization of erythropoietin as a human therapeutic under a licensing agreement with Kirin-Amgen. Affiliates of Johnson & Johnson market erythropoietin for treatment of anemia associated with chronic renal failure under the trademark EPREX(R) in several countries.\nFor the years ended December 31, 1995, 1994 and 1993, sales of EPOGEN(R) accounted for approximately 45%, 44% and 42%, respectively, of total revenues.\nProduct Candidates\nConsensus interferon\nInterferons are a class of naturally occurring proteins with anti-viral and anti-tumor activity that also modulate the immune system. INFERGEN(R), Amgen's consensus interferon, is a non- naturally occurring protein that combines structural features of many interferon sub-types. A Phase 3 clinical trial for treatment of chronic hepatitis C with INFERGEN(R), completed in 1995, indicated that INFERGEN(R) is safe and effective in treating this disease. Hepatitis C viral infection is a potentially deadly disease that, if not treated, may lead to cirrhosis and liver cancer. The Company is preparing a biologics license application for submission to the FDA. Amgen is exploring out-licensing opportunities for INFERGEN(R) with several companies as a potential alternative to marketing this product candidate through the Company's sales force. A decision will be made in 1996.\nHematopoietic growth factors\nHematopoietic growth factors are proteins which influence growth, migration, and maturation of certain types of blood cells. Stem cell factor (\"SCF\"), one of the Company's hematopoietic growth factors in development, may influence the production, mobilization, and maturation of progenitor cells. Human clinical trials are underway to investigate the utility of SCF in combination with NEUPOGEN(R) for improved mobilization of progenitor cells prior to PBPC transplantation. A Phase 3 study of SCF in this indication is underway.\nThe Company's novel platelet growth factor, MGDF, another hematopoietic growth factor, has been shown in pre-clinical and early clinical research to be a promising agent for ameliorating the thrombocytopenia caused by intensive chemotherapy or irradiation. Thrombocytopenia, or severely depressed platelet numbers, can result in severe internal bleeding. The Company is collaborating in the development of MGDF with Kirin (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"), and human clinical testing is underway. In 1995, Amgen, Kirin, and Kirin-Amgen signed agreements with Novo Nordisk A\/S and certain of its subsidiaries (including ZymoGenetics, Inc.) for rights to thrombopoietin, a protein hormone that stimulates the production of platelets in the blood. The acquisition of these rights complements the development of MGDF.\nCell therapy\nCell selection technology complements the Company's research and development efforts in hematopoiesis. Amgen's hematopoietic growth factors, together with selected hematopoietic cells, enable the Company to pursue the investigation of new and potentially more effective cancer therapy protocols. In 1994, Amgen acquired an equity interest in AmCell Inc. (\"AmCell\"), a U.S. company which will develop and manufacture cell selection and characterization devices based on the technology of Miltenyi Biotec GmbH. Amgen and AmCell entered into an agreement whereby AmCell will manufacture certain cell selection devices for Amgen, and Amgen will clinically develop and commercialize these devices (see \"Joint Ventures and Business Relationships - AmCell Inc.\"). Amgen has initiated clinical trials in cell selection.\nNeurobiology\nThe Company has extensive discovery programs in neurological and neuroendocrine disorders. Neurotrophic factors are proteins which play a role in nerve cell protection and regeneration and which may therefore be useful in treating a variety of neurological disorders, including neurodegenerative diseases of the central and peripheral nervous systems, and also nerve injury or trauma. Human clinical testing of two neurotrophic factors, brain-derived neurotrophic factor (\"BDNF\") and neurotrophin-3 (\"NT-3\"), is currently being conducted in collaboration with Regeneron Pharmaceuticals, Inc. (\"Regeneron\") (see \"Joint Ventures and Business Relationships - Regeneron Pharmaceuticals, Inc.\"). BDNF is being investigated to treat amyotrophic lateral sclerosis (\"ALS\" or Lou Gehrig's disease), a fatal disorder which causes rapid degeneration of motor neurons that innervate skeletal muscles. In 1995, Phase 1\/2 trials with BDNF were completed showing that BDNF appears to be safe and well tolerated in treating people with ALS, and a Phase 3 trial was initiated to confirm the therapeutic benefits and safety of BDNF in slowing the progression of ALS. NT-3 is being investigated in treating peripheral neuropathies. Glial cell line derived neurotrophic factor (\"GDNF\") was added to the Company's neurobiology research program through the acquisition of Synergen, Inc. (\"Synergen\") (see Note 2 to the Consolidated Financial Statements). GDNF is in preclinical studies for possible use in the treatment of Parkinson's disease and other motor neuron diseases.\nInflammation\nThe inflammatory response is essential for defense against harmful micro-organisms and for the repair of damaged tissues. The failure of the body's control mechanisms regulating inflammatory response occurs in conditions such as rheumatoid arthritis, acute respiratory distress syndrome and asthma. Tumor necrosis factor binding protein (\"TNFbp\") and interleukin-1 receptor antagonist (\"IL- 1ra\") are two product candidates added to the Company's inflammation research program through the acquisition of Synergen. TNFbp is currently in preclinical studies for possible use in the treatment of rheumatoid arthritis, inflammatory bowel disease, pancreatitis and multiple sclerosis. IL-1ra is in clinical studies for rheumatoid arthritis. The Company is also conducting research to discover and develop other molecules for the treatment of inflammatory diseases.\nEndocrinology\nLeptin is the protein produced by the obesity gene which is made in fat cells and is believed to help regulate the amount of fat stored by the body. This protein has been shown in some early pre- clinical animal models to produce a reduction in body weight and body fat. In 1995, The Rockefeller University granted to the Company an exclusive license which allows the Company to develop products based on the obesity gene (see \"Joint Venture and Business Relationships - Other business relationships\"). The Company anticipates beginning human clinical trials of Leptin in 1996.\nPrimary hyperparathyroidism (\"HPT\") is a disorder that causes excessive secretion of parathyroid hormone from the parathyroid gland, leading to elevated serum calcium, called hypercalcemia. Symptoms may include bone loss, gastrointestinal distress, muscle weakness, depression and forgetfulness. This disorder currently lacks effective treatment other than surgery. Secondary HPT is commonly seen as a result of kidney failure, affecting as many as 80 percent of dialysis patients. The Company has entered into an agreement with NPS Pharmaceuticals, Inc. (\"NPS\") for Amgen to develop and commercialize NPS's NORCALCIN(TM) and other compounds based on NPS's proprietary calcium receptor technology for the treatment of HPT and certain other indications (see \"Joint Venture and Business Relationships - Other business relationships\"). NORCALCIN(TM) is being investigated as a treatment for primary and secondary HPT.\nSoft tissue repair and regeneration\nSoft tissue growth factors are believed to play a role in accelerating or improving tissue regeneration and wound healing. In some cases, these agents may also protect tissues from injuries such as irradiation, chemotherapy, and hyperoxia. These growth factors likely regulate a broad range of cellular activities. Amgen currently is conducting research on certain tissue growth factors including keratinocyte growth factor (\"KGF\"). Human clinical trials have been initiated for KGF.\nJoint Ventures and Business Relationships\nThe Company intends to self-market its products where possible. From time to time it may supplement this effort by using joint ventures and other business relationships to provide additional marketing and product development capabilities. The Company also supplements its internal research and development efforts with acquisitions of product and technology rights and external research collaborations. Amgen has established the relationships described below and may establish others in the future.\nF. Hoffmann-La Roche Ltd.\nAmgen and F. Hoffmann - La Roche Ltd. (\"Roche\") entered into a co-promotion agreement in September 1988 for the sale of NEUPOGEN(R) (Filgrastim) in the EU. Under this agreement, Amgen and Roche share the clinical development, regulatory and commercialization responsibilities for the product. Amgen manufactures NEUPOGEN(R), and the two companies share in the profits from sales of NEUPOGEN(R) in the EU. This agreement allows Amgen the option to regain complete control for marketing the product in the future.\nIn 1989, Amgen and Roche entered into another agreement to commercialize NEUPOGEN(R) in certain European countries not located within the EU. Under this agreement, Roche markets NEUPOGEN(R) in these countries and pays a royalty to Amgen on these sales.\nJohnson & Johnson\nAmgen granted Johnson & Johnson a license to pursue commercialization of recombinant human erythropoietin as a human therapeutic in the United States in all markets other than dialysis and diagnostics. The Company is engaged in arbitration proceedings regarding this agreement. For a complete discussion of this matter, see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitrations\".\nKirin Brewery Company, Limited\nThe Company has a 50-50 joint venture (Kirin-Amgen) with Kirin. Kirin-Amgen was formed in 1984 to develop and commercialize certain of the Company's technologies. Amgen and Kirin have been exclusively licensed by Kirin-Amgen to manufacture and market recombinant human erythropoietin in the United States and Japan, respectively. Kirin- Amgen has also granted Amgen an exclusive license to manufacture and market G-CSF in the United States, Europe, Canada, Australia and New Zealand. Kirin has been licensed by Kirin-Amgen with similar rights for G-CSF in Japan, Taiwan and Korea. Kirin markets recombinant human erythropoietin in the Peoples Republic of China under a separate agreement. In 1994, Kirin-Amgen licensed to Amgen and Kirin the rights to develop and market MGDF.\nPursuant to the terms of agreements entered into with Kirin- Amgen, the Company conducts certain research and development activities on behalf of Kirin-Amgen and is paid for such services at a negotiated rate. Included in revenues from corporate partners in the Company's Consolidated Financial Statements for the years ended December 31, 1995, 1994 and 1993, are $72.6 million, $58.6 million and $41.2 million, respectively, related to these agreements.\nIn connection with its various agreements with Kirin-Amgen, the Company has been granted sole and exclusive licenses for the manufacture and sale of certain products in specified geographic areas of the world. In return for such licenses, the Company paid Kirin-Amgen stated amounts upon the receipt of the licenses and\/or pays Kirin-Amgen royalties based on sales. During the years ended December 31, 1995, 1994 and 1993, Kirin-Amgen earned royalties from Amgen of $74.2 million, $67.5 million and $53.1 million, respectively, under such agreements.\nRegeneron Pharmaceuticals, Inc.\nIn 1990, the Company entered into a collaboration agreement with Regeneron to co-develop and commercialize BDNF and NT-3 in the United States. In addition, Regeneron licensed these potential products to Amgen for development in certain other countries. To facilitate this collaboration, the Company and Regeneron formed Amgen-Regeneron Partners, a 50-50 partnership. Amgen-Regeneron Partners commenced operations with respect to BDNF in June 1993. Operations with respect to NT-3 began in January 1994.\nAmCell Inc.\nDuring 1994, Amgen acquired an equity interest in AmCell Inc., a company which will manufacture cell selection and characterization devices based on the technology of Miltenyi Biotec GmbH (\"Miltenyi\"). Amgen has an exclusive license to clinically develop and commercialize selected products of AmCell incorporating Miltenyi technology in exchange for development funding and milestone payments.\nSynergen Clinical Partners\nSynergen Clinical Partners, L.P. (\"SCP\"), a limited partnership, was formed to fund development and commercialization of IL-1ra in certain geographic areas. The general partner of SCP was a wholly- owned subsidiary of Synergen and is now a wholly-owned subsidiary of the Company. This wholly-owned subsidiary would be obligated to pay SCP royalties on sales of such products and a milestone payment upon receiving the first FDA marketing approval of an IL-1ra product. In connection with the formation of SCP, Synergen was granted options to purchase all of the limited partners' interests in SCP upon the occurrence of certain future events for a specified amount of consideration.\nOther business relationships\nIn 1995, the Company obtained an exclusive license from The Rockefeller University which allows the Company to develop products based on the obesity gene. Amgen made a $20 million payment upon signing the agreement and will make payments for milestones and royalties on sales of any resulting products. The Company also entered into an agreement with NPS Pharmaceuticals, Inc. for Amgen to develop and commercialize NORCALCIN(TM) and other compounds based on NPS's proprietary technology. Under this agreement, Amgen made a $10 million signing payment and will make milestone payments and royalty payments on sales of any resulting products. In addition to these agreements, the Company has an extensive number of other corporate and academic research collaborations.\nMarketing\nIn the United States, the Company's sales force markets its products to physicians and pharmacists primarily in hospitals and clinics. The Company has chosen to use major wholesale distributors of pharmaceutical products as the principal means of distributing EPOGEN(R) (Epoetin alfa) and NEUPOGEN(R) (Filgrastim) to clinics, hospitals and pharmacies. Sales to Bergen Brunswig Corporation and Cardinal Distribution, two major distributors of these products, accounted for 21% and 15%, and 22% and 16%, respectively, of total revenues for the years ended December 31, 1995 and 1994, respectively. Sales to Bergen Brunswig Corporation and McKesson Drug Company accounted for 23% and 10% of total revenues for the year ended December 31, 1993.\nNEUPOGEN(R) is reimbursed by both public and private payors, and changes in coverage and reimbursement policies of these payors could have a material effect on sales of NEUPOGEN(R). EPOGEN(R) is primarily reimbursed by the Federal Government through the End Stage Renal Disease Program (\"ESRD\") of Medicare. The ESRD Program reimburses approved providers for 80% of allowed dialysis costs; the remainder is paid by other sources, including Medicaid, state kidney patient programs and private insurance. The reimbursement rate is established by Congress and is monitored by the Health Care Financing Administration. The reimbursement rate for EPOGEN(R) is subject to yearly review. Changes in coverage and reimbursement policies could have a material effect on the sales of EPOGEN(R). Except for purchases by Veterans Administration hospitals, the Company does not receive any payments directly from the Federal Government, nor does it have any significant supply contracts with the Federal Government. However, the use of NEUPOGEN(R) and EPOGEN(R) by hospitals, clinics, and physicians may be impacted by the amount and methods of reimbursement that they receive from the Federal Government.\nIn the EU, Amgen and Roche share clinical development, regulatory and commercialization responsibilities for NEUPOGEN(R) under a co-promotion agreement. In addition, Amgen manufactures NEUPOGEN(R) for sale in the EU, and the two companies share in the profits from sales of the product. NEUPOGEN(R) is distributed to wholesalers and\/or hospitals in all EU countries depending upon the distribution practice of hospital products in each country. Patients receiving NEUPOGEN(R) for approved indications are covered by government health care programs. The consumption of NEUPOGEN(R) is affected by budgetary constraints imposed by certain EU countries.\nNEUPOGEN(R) sales volumes in both the United States and Europe are influenced by a number of factors including underlying demand, government financial constraints, private sector financial constraints, seasonal changes in cancer chemotherapy administration, and wholesaler management practices.\nIn Canada and Australia, NEUPOGEN(R) is marketed by the Company directly to hospitals, pharmacies and medical practitioners. Distribution is handled by third party contractors.\nCompetition\nCompetition is intense among companies that develop and market products based on advanced cellular and molecular biology. Amgen has a number of competitors, including Chiron Corp., Chugai Pharmaceutical Co., Ltd., Genetics Institute and Immunex Corp. (subsidiaries of American Home Products Corp.), Genentech, Inc., Rhone-Poulenc Rorer Inc., Sandoz Ltd. and Schering-Plough Corp. For products which the Company manufactures and markets, it faces significant competition from these and other biotechnology and pharmaceutical firms in the United States, Europe and elsewhere, some of whom have greater resources than the Company. Certain specialized biotechnology firms have also entered into cooperative arrangements with major companies for development and commercialization of products, creating an additional source of competition.\nAny products or technologies that successfully address anemias could negatively impact the market for recombinant human erythropoietin. Similarly, any products or technologies that successfully address the causes or incidence of low levels of neutrophils could negatively impact the market for G-CSF. These include products that could receive approval for indications similar to those for which NEUPOGEN(R) (Filgrastim) has been approved, development of chemotherapy treatments that are less myelosuppressive than existing treatments and the development of anti-cancer modalities that reduce the need for myelosuppressive chemotherapy. NEUPOGEN(R) currently faces market competition from a competing CSF product, granulocyte macrophage colony-stimulating factor (\"GM- CSF\") and from the chemoprotectant, amifostine (WR-2721). Potential future sources of competition include other GM-CSF products, PIXY 321, PGG-glucan, FLT-3 ligand and IL-11, among others.\nChugai Pharmaceuticals Co., Ltd. (\"Chugai\") markets a G-CSF product in Japan as an adjunct to chemotherapy and as a treatment for bone marrow transplant patients. In June 1993, Chugai and Rhone- Poulenc Rorer Inc. received a favorable opinion from the Committee for Proprietary Medicinal Products for this G-CSF product as an adjunct to chemotherapy and as a treatment in bone marrow transplant settings and began market launches in certain EU countries in early 1994. Chugai, through its licensee, AMRAD, markets this G-CSF product in Australia as an adjunct to chemotherapy and as a treatment for patients receiving bone marrow transplants. Under an agreement with Amgen, Chugai is precluded from selling its G-CSF product in the United States, Canada and Mexico.\nImmunex Corp. markets GM-CSF in the United States for bone marrow transplant and PBPC transplant patients and as an adjunct to chemotherapy treatments for acute non-lymphocytic leukemia (\"ANLL\"). Immunex Corp. is also pursuing other indications for its GM-CSF product including use in treating HIV-infected patients, other infectious diseases and as an adjunct to chemotherapy outside the limited setting of ANLL. Behringwerke AG markets this GM-CSF product in Europe in similar settings. Sandoz Ltd. markets another GM-CSF product for use in bone marrow transplant patients, as an adjunct to chemotherapy and as an adjunct to gancyclovir treatment of HIV- infected patients in the EU and certain other countries. This GM-CSF product is currently being developed for similar indications in the United States and Canada.\nIn 1995, amifostine received clearance from the FDA as a cytoprotective agent for the combination regimen cyclophosphamide and cisplatinum in patients with advanced ovarian carcinoma. It is used to limit renal toxicity associated with this treatment. Amifostine is also being pursued as a treatment to reduce fever, infection and neutropenia during chemotherapy. U.S. Bioscience, in collaboration with Alza Corp., markets amifostine in the United States. Schering Plough markets amifostine in the EU.\nImmunex Corp. is developing PIXY 321 in the United States as an adjunct to chemotherapy and for treating patients receiving bone marrow transplants. PIXY 321 is being developed for use outside North America by American Home Products Corp. Alpha Beta Technologies is developing PGG-glucan for the treatment of certain infectious diseases, as an adjunct to chemotherapy and for use in PBPC transplantation. Other products which address potential markets for G-CSF may be identified and developed by competitors in the future. Such products could also present competition in potential markets for SCF. Research and development of other hematopoietic growth factors, including those that may compete with MGDF, is being conducted by several companies including Genentech, Inc., Immunex Corp., Sandoz Ltd. and Genetics Institute, Inc.\nINFERGEN(R) would face competition from interferons and other related products, several of which are in development or on the market. Schering-Plough Corp. and Roche are major suppliers of interferons.\nSeveral companies are developing neurotrophic factors including Cephalon Inc., Genentech, Inc. and Regeneron. Many companies are believed to be conducting research in the area of inflammation including Celltech, Ltd., ICOS Corporation, Rhone-Poulenc Rorer Inc. and AutoImmune.\nMany companies have obesity research programs and are believed to be developing obesity treatments including Millennium Pharmaceuticals, Inc. (in collaboration with Roche), Progenitor Inc. (a subsidiary of Interneuron Pharmaceuticals Inc.), Neurogen Inc. (in collaboration with Pfizer), Bristol Myers Squibb, CIBA Geigy, Eli Lilly and Merck. NORCALCIN(TM) would face competition from a product currently marketed by Abbott Laboratories which treats secondary HPT. In addition, other products to treat primary and secondary HPT are currently being developed by Abbott Laboratories, Lunar and Chugai.\nThe Company faces competition from several companies in the development and utilization of cell selection and characterization devices. Companies involved in the development of these devices and ex-vivo cell expansion with growth factors are Baxter, Cellpro, Rhone Poulenc Rorer Inc. in collaboration with Applied Immune Sciences and Systemix in collaboration with Sandoz Ltd.\nCompanies believed to be developing certain tissue growth factors include Creative Biomolecules, Inc., Chiron Corp. (in collaboration with Johnson & Johnson), Genentech, Inc., Immunex Corp., Scios Nova Inc. and ZymoGenetics, Inc.\nResearch and Development\nThe Company's two primary sources of new product candidates are internal research and development and acquisition and licensing from third parties. Research and development expense, which includes technology license fees paid to third parties, for the years ended December 31, 1995, 1994 and 1993 were $451.7 million, $323.6 million and $255.3 million, respectively. The amount for the year ended December 31, 1994 excludes a $116.4 million write-off of in-process technology purchased in connection with the acquisition of Synergen (see Note 2 to the Consolidated Financial Statements). Government Regulation\nRegulation by governmental authorities in the United States and other countries is a significant factor in the production and marketing of the Company's products and its ongoing research and development activities. In order to clinically test, manufacture and market products for therapeutic use, Amgen must satisfy mandatory procedures and safety standards established by various regulatory bodies.\nIn the United States, the Company's products and product candidates are regulated primarily on a product by product basis under federal law and are subject to rigorous FDA approval procedures. After purification, laboratory analysis and testing in animals, an investigational new drug application is filed with the FDA to begin human testing. A three-phase human clinical testing program must then be undertaken. In Phase 1, studies are conducted to determine the safety and optimal dosage for administration of the product. In Phase 2, studies are conducted to gain preliminary evidence of the efficacy of the product. In Phase 3, studies are conducted to provide sufficient data for the statistical proof of safety and efficacy. The time and expense required to perform this clinical testing can far exceed the time and expense of the research and development initially required to create the product. No action can be taken to market any therapeutic product in the United States until an appropriate license application has been cleared by the FDA. Even after initial FDA clearance has been obtained, further studies are required to provide additional data on safety and would be required to gain clearance for the use of a product as a treatment for clinical indications other than those initially approved. In addition, use of products during testing and after initial marketing could reveal side effects that could delay, impede or prevent marketing approval, limit uses or expose the Company to product liability claims.\nIn addition to human clinical testing, the FDA inspects equipment and facilities prior to providing clearance to market a product. If, after receiving clearance from the FDA, a material change is made in manufacturing equipment, location or process, additional regulatory review may be needed.\nIn the EU countries, Canada and Australia, regulatory requirements and approval processes are similar in principle to those in the United States.\nAmgen's research and manufacturing activities are conducted in voluntary compliance with the National Institutes of Health Guidelines for Recombinant DNA Research. The Company's present and future business has been and will continue to be subject to various other laws and regulations, including environmental laws and regulations.\nPatents and Trademarks\nPatents are very important to the Company in establishing proprietary rights to the products it has developed. The Company has filed applications for a number of patents and it has been granted patents relating to recombinant human erythropoietin, G-CSF, consensus interferon and various potential products. The Company has obtained licenses from and pays royalties to third parties. Other companies have filed patent applications or have been granted patents in areas of interest to the Company. There can be no assurance any licenses required under such patents would be available for license on reasonable terms or at all. The Company is engaged in arbitration proceedings with Johnson & Johnson and various patent litigation. For a discussion of these matters see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitrations\" and Item 3, \"Legal Proceedings\".\nThe Company has obtained U.S. registration of its EPOGEN(R), NEUPOGEN(R) and INFERGEN(R) trademarks. In addition, these trademarks have been registered in several other countries.\nHuman Resources\nAs of December 31, 1995, the Company had 4,046 employees of which 1,965 were engaged in research and development, 629 were engaged in manufacturing and associated support, 824 were engaged in sales and marketing and 628 were engaged in finance and general administration. There can be no assurance that the Company will be able to continue attracting and retaining qualified personnel in sufficient numbers to meet its needs. None of the Company's employees are covered by a collective bargaining agreement, and the Company has experienced no work stoppages. The Company considers its employee relations to be excellent.\nGeographic Area Financial Information\nFor financial information concerning the geographic areas in which the Company operates see Note 12 to the Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAmgen's principal executive offices and a majority of its administrative, manufacturing and research and development facilities are located in 34 buildings in Thousand Oaks, California. Twenty- nine of the buildings are owned and five are leased. Adjacent to these facilities are four buildings that are under construction and other property acquired in anticipation of future expansion. The Thousand Oaks, California facilities include manufacturing plants licensed by various regulatory bodies that produce commercial quantities of Epoetin alfa and NEUPOGEN(R) (Filgrastim).\nElsewhere in North America, Amgen owns nine buildings in Boulder, Colorado housing research facilities and a pilot plant. The Company has purchased land in Longmont, Colorado on which it plans to build a new EPOGEN(R) manufacturing plant, and it owns a distribution center in Louisville, Kentucky. The Company leases a research facility and administrative offices in Toronto, Canada, an administrative office in Washington, D.C. and five regional sales offices. Outside North America, the Company has a formulation, fill and finish facility in Juncos, Puerto Rico which has been licensed by various regulatory bodies. The Company leases facilities in thirteen European countries, Australia, Japan, Hong Kong and the People's Republic of China for administration, marketing and research and development. In addition, the Company has started construction of a European distribution center in the Netherlands.\nAmgen believes that its current facilities plus anticipated additions are sufficient to meet its needs for the next several years.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is engaged in arbitration proceedings with one of its licensees. For a complete discussion of this matter see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitrations\". Other legal proceedings are discussed below. While it is impossible to predict accurately or to determine the eventual outcome of these matters, the Company believes that the outcome of these proceedings will not have a material adverse effect on the financial statements of the Company.\nSynergen ANTRIL (TM) litigation\nLawsuits have been filed against Synergen (now Amgen Boulder Inc.) alleging misrepresentations in connection with its research and development of ANTRIL(TM) for the treatment of sepsis.\nIn Johnson v. Amgen Boulder Inc., et al., suits filed on February 14, 1995 in the Superior Court for the State of Washington, King County and in the United States District Court for the Western District of Washington, plaintiff seeks rescission of certain payments made to one of the defendants (or unspecified compensatory damages not less than $50.0 million) and treble damages. The Superior Court action has been removed to federal court and consolidated with the suit filed in the United States District Court for the Western District of Washington. Plaintiff, a limited partner of defendant Synergen Clinical Partners, L.P., represents a class of other limited partners. The complaints allege violations of federal and state securities laws, violations of other federal and state statutes, fraud, misrepresentation and breach of fiduciary duty. The defendants include Synergen, Synergen Clinical Partners, L.P., Synergen Development Corporation and former officers and directors of Synergen. The Company has answered the complaint, denying plaintiffs' claims and asserting various affirmative defenses.\nSusquehanna Investment Group, et al. v. Amgen Boulder, Inc., et al., was filed in the United States District Court in Denver, Colorado against Synergen and certain of its former officers and directors. The suit, filed on May 19, 1995, is brought by broker- dealers who acted as market makers in Synergen options. The plaintiffs claim in excess of $3.2 million in trading losses on option positions as the result of alleged misrepresentations. Elanex Pharmaceuticals litigation\nIn October 1993, the Company filed a complaint for patent infringement against defendants Elanex Pharmaceuticals, Inc. (\"Elanex\"), Laboratorios Elanex De Costa Rica, S. A., Bio Sidus S.A., Merckle GmbH, Biosintetica S. A. and other unknown defendants. The complaint, filed in the United States District Court for the Western District of Washington in Seattle, seeks injunctive relief and damages for Elanex's infringement of the Company's patent for DNA sequences and host cells useful in producing recombinant erythropoietin. The complaint also alleges that the foreign defendants entered into agreements with Elanex relating to the production or sale of recombinant erythropoietin and thereby have induced Elanex's infringement.\nIn December 1993, Elanex responded to the complaint denying the material allegations thereof, and filed a counterclaim seeking a declaratory judgment that the Company's patent is invalid and that Elanex's recombinant erythropoietin technology does not infringe any valid claims of the Company's patent. The counterclaim also seeks an award of reasonable attorneys' fees and other costs of defense but does not seek damages against the Company. The case is currently in discovery.\nGenetics Institute litigation\nOn June 21, 1994, Genetics Institute filed suit in the United States District Court for the District of Delaware in Wilmington, against Johnson & Johnson, a licensee and distributor of the Company, seeking damages for the alleged infringement of a recently issued U.S. Patent 5,322,837 relating to Johnson & Johnson's manufacture, use, and sale of erythropoietin.\nOn September 12, 1994, the Company filed suit in the United States District Court for the District of Massachusetts in Boston, against Genetics Institute, seeking declaratory judgment of patent non-infringement, invalidity and unenforceability against Genetics Institute in respect to U.S. Patent 5,322,837 issued to Genetics Institute, which relates to homogeneous erythropoietin. Genetics Institute answered the complaint and filed a counterclaim against the Company alleging infringement of the same patent. On February 14, 1995, the United States District Court for the District of Massachusetts granted Amgen's motion for a summary judgment enforcing a prior judgment against Genetics Institute and barring Genetics Institute from asserting its U.S. Patent 5,322,837 against Amgen's recombinant erythropoietin. On March 13, 1995, Genetics Institute filed notice of appeal with the United States Court of Appeals for the Federal Circuit. On December 6, 1995, the Federal Circuit Court heard oral argument on the appeal and reserved decision.\nBiogen litigation\nOn June 15, 1994, Biogen, Inc. (\"Biogen\") filed suit in the Tokyo District Court in Japan, against Amgen K.K., a subsidiary of the Company, seeking injunctive relief for the alleged infringement of two Japanese patents relating to alpha-interferon.\nOn March 10, 1995, Biogen filed suit in the United States District Court for the District of Massachusetts alleging infringement by the Company of certain claims of U.S. Patent 4,874,702 relating to vectors for expressing cloned genes. Biogen alleges that Amgen has infringed its patent by manufacturing and selling NEUPOGEN(R). On March 28, 1995, Biogen filed an amended complaint further alleging that the Company is also infringing the claims of two additional patents allegedly assigned to Biogen, U.S. Patent 5,401,642 and U.S. Patent No. 5,401,658, relating to vectors, methods for making vectors and expressing closed genes. The amended complaint seeks injunctive relief, unspecified compensatory damages and treble damages. On April 24, 1995, the Company answered Biogen's amended complaint, denying its material allegations and pleading counterclaims for declaratory judgment of non-infringement, patent invalidity and unenforceability.\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. PART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock\nThe Company's common stock trades on The Nasdaq Stock Market under the symbol AMGN. As of March 5, 1996, there were approximately 13,000 holders of record of the Company's common stock. No cash dividends have been paid on the common stock to date, and the Company currently intends to retain any earnings for development of the Company's business and for repurchases of its common stock.\nThe following table sets forth, for the fiscal periods indicated, the range of high and low closing sales prices of the common stock as quoted on The Nasdaq Stock Market for the years 1995 and 1994 (as adjusted retroactively for the August 1995 stock split effected in the form of a dividend of one share of common stock for each share of outstanding common stock):\nHigh Low 1995 ------- ------- 4th Quarter................... $59-3\/8 $43-1\/2 3rd Quarter................... 52 39-1\/4 2nd Quarter................... 40-7\/32 33-1\/16 1st Quarter................... 35-3\/8 28-1\/4\n4th Quarter................... $29-11\/16 $25-7\/16 3rd Quarter................... 28-7\/16 21-5\/8 2nd Quarter................... 23-19\/32 17-11\/16 1st Quarter................... 25-7\/8 18-7\/8\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA (in millions)\nYears Ended December 31, 1991 1992 1993 1994 1995 ---- ---- ---- ---- ---- Consolidated Statement of Operations Data: Revenues: Product sales............... $645.3 $1,050.7 $1,306.3 $1,549.6 $1,818.6 Other revenues.............. 36.7 42.3 67.5 98.3 121.3 Total revenues............... 682.0 1,093.0 1,373.8 1,647.9 1,939.9 Research and development expenses................... 120.9 182.3 255.3 323.6 451.7 Write-off of in-process technology purchased....... - - - 116.4 - Marketing and selling expenses................... 122.2 184.5 214.1 236.9 272.9 General and administrative expenses................... 80.4 107.7 114.3 122.9 145.5 Legal assessment (award)..... 129.1 (77.1) (13.9) - - Net income(1)................ 97.9 357.6 383.3 319.7 537.7 Primary earnings per share(1)................... .34 1.21 1.33 1.14 1.92 Cash dividends declared per share...................... - - - - -\nAt December 31, 1991 1992 1993 1994 1995 ---- ---- ---- ---- ---- Consolidated Balance Sheet Data: Total assets................. $865.5 $1,374.3 $1,765.5 $1,994.1 $2,432.8 Long-term debt............... 39.7 129.9 181.2 183.4 177.2 Stockholders' equity......... 531.1 933.7 1,172.0 1,274.3 1,671.8\n(1) Includes an increase to net income of $8.7 million, or $.03 per share, to reflect the cumulative effect of a change in accounting principle to adopt Statement of Financial Accounting Standard No. 109 in 1993 (see Note 1 to Consolidated Financial Statements). Also includes the write-off of in-process technology purchased of $116.4 million, or $.42 per share, associated with the acquisition of Synergen in 1994 (see Note 2 to Consolidated Financial Statements). Item 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nCash provided by operating activities has been and is expected to continue to be the Company's primary source of funds. In 1995, operations provided $773.2 million of cash compared with $531.9 million in 1994. The Company had cash, cash equivalents, and marketable securities of $1,050.3 million at December 31, 1995, compared with $696.7 million at December 31, 1994.\nCapital expenditures totaled $162.7 million in 1995 compared with $130.8 million in 1994. Over the next few years, the Company expects to spend approximately $250 million to $350 million per year on capital projects and equipment to expand the Company's global operations.\nThe Company receives cash from the exercise of employee stock options. In 1995, stock options and their related tax benefits provided $145.4 million of cash compared with $67.5 million in 1994. Proceeds from the exercise of stock options and their related tax benefits will vary from period to period based upon, among other factors, fluctuations in the market value of the Company's stock relative to the exercise price of such options. In 1994, the exercise of warrants associated with Amgen Clinical Partners, L.P. provided $15.3 million of cash. The right to exercise these warrants expired on June 30, 1994.\nThe Company has a stock repurchase program (see Note 7 to the Consolidated Financial Statements) to offset the dilutive effect of its employee benefit stock option and stock purchase plans. During the year ended December 31, 1995, the Company purchased 7.3 million shares of common stock at a cost of $285.7 million compared with 12.9 million shares purchased at a cost of $300.5 million in 1994. The Company expects to repurchase $350 million to $450 million under the program in 1996.\nTo provide for financial flexibility and increased liquidity, the Company has established several sources of debt financing. The Company has a shelf registration under which it can issue up to $200 million of Medium Term Notes. At December 31, 1995, $109.0 million of Medium Term Notes were outstanding which mature in approximately two to eight years. The Company also has a commercial paper program which provides for short-term borrowings up to an aggregate face amount of $200 million. At December 31, 1995, $69.7 million of commercial paper was outstanding, with maturities of less than three months. The Company also has a $150 million revolving line of credit, which primarily supports the Company's commercial paper program. No borrowings on this line of credit were outstanding at December 31, 1995.\nThe Company invests its cash in accordance with a policy that seeks to maximize returns while ensuring both liquidity and minimal risk of principal loss. The policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings, and places restrictions on maturities and concentration by type and issuer. The majority of the Company's portfolio is composed of fixed income investments which are subject to the risk of market interest rate fluctuations, and all of the Company's investments are subject to risks associated with the ability of the issuers to perform their obligations under the instruments.\nThe Company has a program to manage certain portions of its exposure to fluctuations in foreign currency exchange rates. These exposures primarily result from European sales. The Company generally hedges the related receivables with foreign currency forward contracts, which typically mature within six months. The Company uses foreign currency option and forward contracts which generally expire within 12 months to hedge certain anticipated future sales. At December 31, 1995, outstanding foreign currency option and forward contracts totaled $13.2 million and $70.1 million, respectively.\nThe Company believes that existing funds, cash generated from operations, and existing sources of debt financing are adequate to satisfy its working capital and capital expenditure requirements and to support its stock repurchase program for the foreseeable future. However, the Company may raise additional capital from time to time to take advantage of favorable conditions in the markets or in connection with the Company's corporate development activities.\nResults of Operations\nProduct sales\nIn 1995 product sales increased $269.0 million or 17% over the prior year. In 1994, product sales increased $243.3 million or 19% over the prior year.\nNEUPOGEN(R) (Filgrastim)\nThe Company's worldwide NEUPOGEN(R) sales were $936.0 million in 1995, an increase of $107.0 million or 13% over the prior year. In 1994, sales were $829.0 million, an increase of $109.6 million or 15% over the prior year.\nDomestic sales of NEUPOGEN(R) were $661.8 million in 1995, an increase of $44.6 million or 7% over the prior year due primarily to increased usage of NEUPOGEN(R) and price increases. In 1994, domestic sales were $617.2 million, an increase of $71.7 million or 13% over the prior year due primarily to the increased usage of NEUPOGEN(R). These results reflect the ongoing and intensifying cost containment pressures in the health care marketplace, including use of guidelines in patient care. This pressure has contributed to the slowing of growth in domestic NEUPOGEN(R) usage over the past several years and is expected to continue to influence such growth for the foreseeable future. During 1995, NEUPOGEN(R) was approved in the United States to support peripheral blood progenitor cell transplants, the product's fourth indication. International sales of NEUPOGEN(R), primarily in Europe, were $274.2 million in 1995, an increase of $62.4 million or 29% over the prior year. Three factors, each contributing approximately one third, account for this increase: (1) strong unit demand growth, (2) the inclusion of sales from three additional countries as the result of Austria, Sweden, and Finland joining the European Union (\"EU\") on January 1, 1995 and (3) the favorable effects of strengthened foreign currencies. Prior to the entry of the three additional countries into the EU, F. Hoffmann La Roche paid the Company royalties on sales in these countries under a license agreement. In 1994, international sales were $211.8 million, an increase of $37.9 million or 22% over the prior year. This increase was primarily due to increased demand. The Company's overall share of the colony stimulating factor market in the EU has decreased since the introduction in 1994 of competing colony stimulating factor products.\nQuarterly NEUPOGEN(R) sales volume in the United States is influenced by a number of factors including underlying demand, seasonal changes in cancer chemotherapy administration, and wholesaler inventory management practices. Wholesaler inventory reductions tend to reduce domestic NEUPOGEN(R) sales in the first quarter each year. In prior years, NEUPOGEN(R) sales in the EU have experienced a seasonal decline to varying degrees in the third quarter.\nEPOGEN(R) (Epoetin alfa)\nEPOGEN(R) sales were $882.6 million in 1995, an increase of $162.0 million or 22% over the prior year. In 1994, EPOGEN(R) sales were $720.6 million, an increase of $133.7 million or 23% over the prior year. These increases were primarily due to an increase in the U.S. dialysis patient population, the administration of higher doses, and to a lesser extent, increased penetration of the dialysis market.\nCost of sales\nCost of sales as a percentage of product sales was 15.0%, 15.4% and 16.8% for the years ended December 31, 1995, 1994 and 1993, respectively. In 1996, cost of sales as a percentage of product sales is expected to range from 14% to 15%.\nResearch and development\nIn 1995 and 1994, research and development expenses increased $128.1 million or 40% and $68.3 million or 27%, respectively, compared with the prior years primarily due to expansion of the Company's internal research and development staff and increases in external research collaborations. The current year amount includes a charge for a $20 million signing payment to The Rockefeller University and a $10 million charge related to a license fee to NPS Pharmaceuticals for exclusive licenses to certain technologies. Annual research and development expenses are expected to increase at a rate exceeding the anticipated annual product sales growth rate due to planned increases in internal efforts on new product discovery and development and increases in external research collaboration costs, including acquisitions of product and technology rights.\nWrite-off of in-process technology purchased\nIn December 1994, the Company acquired Synergen, a biotechnology company engaged in the discovery and development of protein-based pharmaceuticals. Synergen was acquired for $254.5 million in cash, including related acquisition costs. The purchase price was assigned to the acquired tangible and intangible assets based on their estimated fair values at the date of acquisition. The value assigned to in-process technology of $116.4 million was expensed during the quarter ended December 31, 1994.\nMarketing and selling\nIn 1995 and 1994, marketing and selling expenses increased $36.0 million or 15% and $22.8 million or 11%, respectively, compared with the prior years. These increases primarily reflect marketing efforts to increase the number of patients receiving NEUPOGEN(R) and to bring more patients receiving EPOGEN(R) within the target hematocrit range. In 1996, marketing and selling expenses combined with general and administrative expenses are expected to have an aggregate annual growth rate lower than the anticipated 1996 annual growth in product sales.\nGeneral and administrative\nIn 1995 and 1994, general and administrative expenses increased $22.6 million or 18% and $8.6 million or 8%, respectively, compared with the prior years. These increases are primarily due to staff- related expenses. In 1996, general and administrative expenses combined with marketing and selling expenses are expected to have an aggregate annual growth rate lower than the anticipated 1996 annual growth in product sales.\nInterest and other income\nInterest and other income increased $44.6 million or 207% in 1995 compared with the prior year. This increase is primarily due to: (1) capital gains realized in the Company's investment portfolio during 1995 while capital losses were incurred in 1994, (2) higher interest rates earned by the Company's investment portfolio during 1995 and (3) higher current year cash balances. Interest and other income decreased $5.7 million or 21% in 1994 compared with the prior year. Due to significant increases in interest rates during 1994, the Company elected to reposition its fixed income investment portfolio which resulted in capital losses of $16.1 million for the year. In 1993, there were no significant capital gains or losses in the investment portfolio. Interest and other income is expected to fluctuate from period to period primarily due to changes in interest rates and cash balances. Income taxes\nIn 1995, the Company's effective tax rate was 32.3%. This tax rate reflects tax benefits from the sale of products manufactured in the Puerto Rico fill-and-finish facility which began in the first quarter of 1995. In 1994, the Company's effective tax rate was 45.7%, which is higher than the Company's statutory rate. This is primarily due to the write-off of in-process technology purchased in connection with the Synergen acquisition, which is not deductible for income tax purposes. In 1993, the Company's effective tax rate was 36.8%. The Company expects to maintain tax benefits from its Puerto Rico operations in 1996.\nFinancial Outlook\nWorldwide NEUPOGEN(R) sales for 1996 are expected to grow at a rate lower than the 1995 growth rate. Future NEUPOGEN(R) sales increases are dependent primarily upon further penetration of existing markets, the timing and nature of additional indications for which the product may be approved and the effects of competitive products. NEUPOGEN(R) usage is expected to continue to be affected by cost containment pressures on health care providers worldwide. In addition, international NEUPOGEN(R) sales will continue to be subject to changes in foreign currency exchange rates and increased competition.\nEPOGEN(R) sales for 1996 are expected to grow at a rate lower than the 1995 growth rate. The Company anticipates that increases in both the U.S. dialysis patient population and dosing will continue to drive EPOGEN(R) sales. The Company believes that as more dialysis patients' hematocrits reach target levels, the contribution of dosing to sales increases will diminish. Patients receiving treatment for end stage renal disease are covered primarily under medical programs provided by the federal government. Therefore, EPOGEN(R) sales may also be affected by future changes in reimbursement rates or the basis for reimbursement by the federal government.\nThe Company anticipates that total product sales and earnings will grow at double digit rates in 1996, but these growth rates are expected to be lower than 1995 growth rates. Estimates of future product sales and earnings, however, are necessarily speculative in nature and are difficult to predict with accuracy.\nExcept for the historical information contained herein, the matters discussed in this Annual Report on Form 10-K are by their nature forward-looking. For the reasons stated in this Annual Report or in the Company's other Securities and Exchange Commission filings, or for various unanticipated reasons, actual results may differ materially.\nLegal Matters\nThe Company is engaged in arbitration proceedings with one of its licensees and various legal proceedings relating to Synergen. For a complete discussion of these matters see Note 5 to the Consolidated Financial Statements. Item 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is incorporated herein by reference to the financial statements listed in Item 14(a) of Part IV of this Form 10-K Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the directors of the Company is incorporated by reference to the section entitled \"Election of Directors\" in the Company's definitive Proxy Statement with respect to the Company's 1996 Annual Meeting to be filed with the Securities and Exchange Commission within 120 days of December 31, 1995 (the \"Proxy Statement\").\nThe executive officers of the Company, their ages as of February 29, 1996 and positions are as follows:\nMr. Gordon M. Binder, age 60, has served as a director of the Company since October 1988. He joined the Company in 1982 as Vice President-Finance and was named Senior Vice President-Finance in February 1986. In October 1988, Mr. Binder was elected Chief Executive Officer. In July 1990, Mr. Binder became Chairman of the Board.\nDr. N. Kirby Alton, age 45, became Senior Vice President, Development, in August 1993, having served as Senior Vice President, Therapeutic Product Development, since August 1992. Dr. Alton previously served as Vice President, Therapeutic Product Development, Responsible Head, from October 1988 to August 1992, and as Director, Therapeutic Product Development, from February 1986 to October 1988.\nMr. Robert S. Attiyeh, age 61, has served as Senior Vice President, Finance and Corporate Development, since joining the Company in July 1994. Prior to joining the Company, Mr. Attiyeh served as a director of McKinsey & Company, a consulting firm, in its Los Angeles, Japan and Scandinavian offices from 1967 to 1994.\nMr. Stanley M. Benson. age 44, has served as Senior Vice President, Sales and Marketing, since joining the Company in June 1995. Prior to joining the Company, Mr. Benson held a number of executive management positions at Pfizer Inc., a pharmaceutical company, from 1987 to 1995.\nDr. Dennis M. Fenton, age 44, became Senior Vice President, Operations, in January 1995, having served as Senior Vice President, Sales and Marketing, since August 1992, and having served as Vice President, Process Development, Facilities and Manufacturing Services, from July 1991 to August 1992. Dr. Fenton previously had served as Vice President, Pilot Plant Operations and Clinical Manufacturing, from October 1988 to July 1991, and as Director, Pilot Plant Operations, from 1985 to October 1988.\nMr. Daryl D. Hill, age 50, became Senior Vice President, Asia Pacific, in January 1994, having served as Vice President, Quality Assurance, from October 1988 to January 1994, and as Director of Quality Assurance from January 1984 to October 1988.\nMr. Larry A. May, age 46, became Vice President, Corporate Controller and Chief Accounting Officer in October 1991, having served as Corporate Controller and Chief Accounting Officer from October 1988 to October 1991, and as Controller from January 1983 to October 1988.\nMr. Kevin W. Sharer, age 47, has served as a director of the Company since November 1992. He has served as President and Chief Operating Officer since October 1992. Prior to joining the Company, Mr. Sharer served as President of the Business Markets Division of MCI Communications Corporation, a telecommunications company, from April 1989 to October 1992, and served in numerous executive capacities at General Electric Company from February 1984 to March 1989. Mr. Sharer also serves as a director of Geotek Communications, Inc.\nMr. George A. Vandeman, age 56, has served as Senior Vice President, General Counsel and Secretary since joining the Company in July 1995. Prior to joining the Company, Mr. Vandeman was a partner of Latham & Watkins, an international law firm, from June 1966 to July 1995.\nDr. Daniel Vapnek, age 57, became Senior Vice President, Research, in October 1988, having served as Vice President, Research, since January 1986.\nDr. Linda R. Wudl, age 50, became Vice President, Quality Assurance, in January 1994, having served as Director of Quality Control from April 1991 to January 1994, and as Manager of Quality Control from April 1987 to April 1991.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe section labeled \"Executive Compensation\" appearing in the Company's Proxy Statement is incorporated herein by reference, except for such information as need not be incorporated by reference under rules promulgated by the Securities Exchange Commission.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section labeled \"Security Ownership of Directors and Executive Officers and Certain Beneficial Owners\" appearing in the Company's Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section labeled \"Certain Transactions\" appearing in the Company's Proxy Statement is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Index to Financial Statements\nThe following Financial Statements are included herein:\nPage Number\nReport of Ernst & Young LLP, Independent Auditors .................F-1 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1995...............F-2 - Consolidated Balance Sheets at December 31, 1995 and 1994 .........F-4 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1995.....F-5 - Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995...............F-7 - Notes to Consolidated Financial Statements .................F-9 -\n(a) 2. Index to Financial Statement Schedules\nThe following Schedules are filed as part of this Form 10-K Annual Report:\nPage Number\nII Valuation Accounts ......................................F-26\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated statements or notes thereto.\n(a) 3. Exhibits\nExhibit No. Description\n3.1 Restated Certificate of Incorporation. (6) 3.2 Certificate of Amendment to Restated Certificate of Incorporation, effective as of July 24, 1991. (11) 3.3 Bylaws, as amended to date. (16) 4.1 Indenture dated January 1, 1992 between the Company and Citibank N.A., as trustee. (12) 4.2 Forms of Commercial Paper Master Note Certificates. (15) 10.1* Company's Amended and Restated 1991 Equity Incentive Plan. (22) 10.2* Company's Amended and Restated 1984 Stock Option Plan. (22) 10.3 Shareholder's Agreement of Kirin-Amgen, Inc., dated May 11, 1984, between the Company and Kirin Brewery Company, Limited (with certain confidential information deleted therefrom). (1) 10.4 Amendment Nos. 1, 2, and 3, dated March 19, 1985, July 29, 1985 and December 19, 1985, respectively, to the Shareholder's Agreement of Kirin-Amgen, Inc., dated May 11, 1984 (with certain confidential information deleted therefrom). (3) 10.5 Product License Agreement, dated September 30, 1985, and Technology License Agreement, dated, September 30, 1985 between the Company and Ortho Pharmaceutical Corporation (with certain confidential information deleted therefrom). (2) 10.6 Product License Agreement, dated September 30, 1985, and Technology License Agreement, dated September 30, 1985 between Kirin-Amgen, Inc. and Ortho Pharmaceutical Corporation (with certain confidential information deleted therefrom). (3) 10.7* Company's Amended and Restated Employee Stock Purchase Plan. 10.8 Research, Development Technology Disclosure and License Agreement PPO, dated January 20, 1986, by and between the Company and Kirin Brewery Co., Ltd. (4) 10.9 Amendment Nos. 4 and 5, dated October 16, 1986 (effective July 1, 1986) and December 6, 1986 (effective July 1, 1986), respectively, to the Shareholders Agreement of Kirin-Amgen, Inc. dated May 11, 1984 (with certain confidential information deleted therefrom). (5) 10.10 Assignment and License Agreement, dated October 16, 1986, between the Company and Kirin-Amgen, Inc. (with certain confidential information deleted therefrom). (5) 10.11 G-CSF European License Agreement, dated December 30, 1986, between Kirin-Amgen, Inc. and the Company (with certain confidential information deleted therefrom). (5) 10.12 Research and Development Technology Disclosure and License Agreement: GM-CSF, dated March 31, 1987, between Kirin Brewery Company, Limited and the Company (with certain confidential information deleted therefrom). (5) 10.13* Company's Amended and Restated 1987 Directors' Stock Option Plan. (22) 10.14* Company's Amended and Restated 1988 Stock Option Plan. (22) 10.15* Company's Retirement and Savings Plan, amended and restated as of January 1, 1993. (13) 10.16 Amendment, dated June 30, 1988, to Research, Development, Technology Disclosure and License Agreement: GM-CSF dated March 31, 1987, between Kirin Brewery Company, Limited and the Company. (6) 10.17 Agreement on G-CSF in the EU, dated September 26, 1988, between Amgen Inc. and F. Hoffmann-La Roche & Co. Limited Company (with certain confidential information deleted therefrom). (8) 10.18 Supplementary Agreement to Agreement dated January 4, 1989 to Agreement on G-CSF in the EU, dated September 26, 1988, between the Company and F. Hoffmann-La Roche & Co. Limited Company, (with certain confidential information deleted therefrom). (8) 10.19 Agreement on G-CSF in Certain European Countries, dated January 1, 1989, between Amgen Inc. and F. Hoffmann-La Roche & Co. Limited Company (with certain confidential information deleted therefrom). (8) 10.20 Rights Agreement, dated January 24, 1989, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (7) 10.21 First Amendment to Rights Agreement, dated January 22, 1991, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (9) 10.22 Second Amendment to Rights Agreement, dated April 2, 1991, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (10) 10.23 Agency Agreement, dated November 21, 1991, between Amgen Manufacturing, Inc. and Citicorp Financial Services Corporation. (13) 10.24 Agency Agreement, dated May 21, 1992, between Amgen Manufacturing, Inc. and Citicorp Financial Services Corporation. (13) 10.25 Guaranty, dated July 29, 1992, by the Company in favor of Merck Sharp & Dohme Quimica de Puerto Rico, Inc. (14) 10.26 936 Promissory Note No. 01, dated December 11, 1991, issued by Amgen Manufacturing, Inc. (13) 10.27 936 Promissory Note No. 02, dated December 11, 1991, issued by Amgen Manufacturing, Inc. (13) 10.28 936 Promissory Note No. 001, dated July 29, 1992, issued by Amgen Manufacturing, Inc. (13) 10.29 936 Promissory Note No. 002, dated July 29, 1992, issued by Amgen Manufacturing, Inc. (13) 10.30 Guaranty, dated November 21, 1991, by the Company in favor of Citicorp Financial Services Corporation. (13) 10.31 Partnership Purchase Agreement, dated March 12, 1993, between the Company, Amgen Clinical Partners, L.P., Amgen Development Corporation, the Class A limited partners and the Class B limited partner. (14) 10.32* Amgen Supplemental Retirement Plan dated June 1, 1993. (17) 10.33 Promissory Note of Mr. Kevin W. Sharer, dated June 4, 1993. (17) 10.34 Promissory Note of Mr. Larry A. May, dated February 24, 1993. (18) 10.35* First Amendment dated October 26, 1993 to the Company's Retirement and Savings Plan. (18) 10.36* Amgen Performance Based Management Incentive Plan. (18) 10.37 Agreement and Plan of Merger, dated as of November 17, 1994, among Amgen Inc., Amgen Acquisition Subsidiary, Inc. and Synergen, Inc. (19) 10.38 Third Amendment to Rights Agreement, dated as of February 21, 1995, between Amgen Inc. and American Stock Transfer Trust and Trust Company (20) 10.39 Credit Agreement, dated as of June 23, 1995, among Amgen Inc., the Borrowing Subsidiaries named therein, the Banks named therein, Swiss Bank Corporation and ABN AMRO Bank N.V., as Issuing Banks, and Swiss Bank Corporation, as Administrative Agent.(21) 10.40* Conforming Amendments to the Amgen Retirement and Savings Plan. 10.41* Second Amendment to the Amgen Retirement and Savings Plan. 10.42* Third Amendment to the Amgen Retirement and Savings Plan. 10.43* Fourth Amendment to the Amgen Retirement and Savings Plan. 10.44 Promissory Note of Mr. George A. Vandeman, dated December 15, 1995. 10.45 Promissory Note of Mr. George A. Vandeman, dated December 15, 1995. 10.46 Promissory Note of Mr. Stan Benson, dated March 19, 1996. 11 Computation of per share earnings. 21 Subsidiaries of the Company. 23 Consent of Ernst & Young LLP, independent auditors. The consent set forth on page 35 is incorporated herein by reference. 24 Power of Attorney. The Power of Attorney set forth on page 34 is incorporated herein by reference. 27 Financial Data Schedule. - ---------------- * Management contract or compensatory plan or arrangement.\n(1) Filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 1984 on June 26, 1984 and incorporated herein by reference. (2) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 1985 on November 14, 1985 and incorporated herein by reference. (3) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended December 31, 1985 on February 3, 1986 and incorporated herein by reference. (4) Filed as an exhibit to Amendment No. 1 to Form S-1 Registration Statement (Registration No. 33-3069) on March 11, 1986 and incorporated herein by reference. (5) Filed as an exhibit to the Form 10-K Annual Report for the year ended March 31, 1987 on May 18, 1987 and incorporated herein by reference. (6) Filed as an exhibit to Form 8 amending the Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 on August 25, 1988 and incorporated herein by reference. (7) Filed as an exhibit to the Form 8-K Current Report dated January 24, 1989 and incorporated herein by reference. (8) Filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 1989 on June 28, 1989 and incorporated herein by reference. (9) Filed as an exhibit to the Form 8-K Current Report dated January 22, 1991 and incorporated herein by reference. (10) Filed as an exhibit to the Form 8-K Current Report dated April 12, 1991 and incorporated herein by reference. (11) Filed as an exhibit to the Form 8-K Current Report dated July 24, 1991 and incorporated herein by reference. (12) Filed as an exhibit to Form S-3 Registration Statement dated December 19, 1991 and incorporated herein by reference. (13) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1992 on March 30, 1993 and incorporated herein by reference. (14) Filed as an exhibit to the Form 8-A dated March 31, 1993 and incorporated herein by reference. (15) Filed as an exhibit to the Form 10-Q for the quarter ended March 31, 1993 on May 17, 1993 and incorporated herein by reference. (16) Filed as an exhibit to the Form 10-Q for the quarter ended June 30, 1993 on August 16, 1993 and incorporated herein by reference. (17) Filed as an exhibit to the Form 10-Q for the quarter ended September 30, 1993 on November 12, 1993 and incorporated herein by reference. (18) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1993 on March 25, 1994 and incorporated herein by reference. (19) Filed as an exhibit to the Form 8-K Current Report dated November 18, 1994 on December 2, 1994 and incorporated herein by reference. (20) Filed as an exhibit to the Form 8-K Current Report dated February 21, 1995 on March 7, 1995 and incorporated herein by reference. (21) Filed as an exhibit to the Form 10-Q for the quarter ended June 30, 1995 on August 11, 1995 and incorporated herein by reference. (22) Filed as an exhibit to the Form 10-Q for the quarter ended September 30, 1995 on November 13, 1995 and incorporated herein by reference.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the three months ended December 31, 1995.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAmgen Inc.\n(Registrant)\nDate: 3\/27\/96 By: \/s\/ ROBERT S. ATTIYEH ------------------------ Robert S. Attiyeh Senior Vice President, Finance and Corporate Development, and Chief Financial Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert S. Attiyeh and Larry A. May, or either of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\n\/s\/GORDON M. BINDER 3\/27\/96 \/s\/WILLIAM K. BOWES, JR. 3\/27\/96 Gordon M. Binder William K. Bowes, Jr. Chairman of the Board Director Chief Executive Officer and Director (Principal Executive \/s\/FRANKLIN P. JOHNSON, 3\/27\/96 Officer) JR. Franklin P. Johnson, Jr. Director \/s\/KEVIN W. SHARER 3\/27\/96 Kevin W. Sharer President, Chief Operating \/s\/STEVEN LAZARUS 3\/27\/96 Officer and Director Steven Lazarus Director\n\/s\/ROBERT S. ATTIYEH 3\/27\/96 Robert S. Attiyeh \/s\/EDWARD J. LEDDER 3\/27\/96 Senior Vice President, Edward J. Ledder Finance and Corporate Director Development, and Chief Financial Officer \/s\/GILBERT S. OMENN 3\/27\/96 Gilbert S. Omenn \/s\/LARRY A. MAY 3\/27\/96 Director Larry A. May Vice President, Corporate Controller and \/s\/JUDITH C. PELHAM 3\/27\/96 Chief Accounting Officer Judith C. Pelham Director\n\/s\/RAYMOND F. BADDOUR 3\/27\/96 Raymond F. Baddour \/s\/BERNARD H. SEMLER 3\/27\/96 Director Bernard H. Semler Director\nEXHIBIT 23\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-5111) pertaining to the 1984 Stock Option Plan, 1981 Incentive Stock Option Plan and Nonqualified Stock Option Plan of Amgen Inc., in the Registration Statement (Form S-8 No. 33- 24013) pertaining to the Amended and Restated 1988 Stock Option Plan of Amgen Inc., in the Registration Statement (Form S-8 No. 33-39183) pertaining to the Amended and Restated Employee Stock Purchase Plan, in the Registration Statement (Form S-8 No. 33-39104) pertaining to the Amgen Retirement and Savings Plan, in the Registration Statement (Form S-8 No. 33-42501) pertaining to the Amended and Restated 1987 Directors' Stock Option Plan, in the Registration Statement (Form S-8 No. 33-42072) pertaining to the Amgen Inc. Amended and Restated 1991 Equity Incentive Plan, in the Registration Statement (Form S-8 No. 33-47605) pertaining to the Retirement and Savings Plan for Amgen Puerto Rico, Inc. and in the Registration Statements (Form S-3 No. 33-22544 and Form S-3 No. 33-44454) of Amgen Inc. and in the related Prospectuses of our report dated January 29, 1996 with respect to the consolidated financial statements and financial statement schedule of Amgen Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1995.\n\/s\/ ERNST & YOUNG LLP Los Angeles, California March 22, 1996\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders of Amgen Inc.\nWe have audited the accompanying consolidated balance sheets of Amgen Inc. as of December 31, 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 Amgen 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.\n\/s\/ ERNST & YOUNG LLP Los Angeles, California January 29, 1996\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993 (In millions, except per share data)\n1995 1994 1993 -------- -------- -------- Revenues: Product sales.................... $1,818.6 $1,549.6 $1,306.3 Corporate partner revenues....... 85.2 70.4 48.6 Royalty income................... 36.1 27.9 18.9 -------- -------- -------- Total revenues................ 1,939.9 1,647.9 1,373.8 -------- -------- -------- Operating expenses: Cost of sales.................... 272.9 238.1 220.0 Research and development......... 451.7 323.6 255.3 Write-off of in-process technology purchased.......... - 116.4 - Marketing and selling............ 272.9 236.9 214.1 General and administrative....... 145.5 122.9 114.3 Loss of affiliates, net.......... 53.3 31.2 12.6 Legal award...................... - - (13.9) -------- -------- -------- Total operating expenses...... 1,196.3 1,069.1 802.4 -------- -------- --------\nOperating income.................. 743.6 578.8 571.4\nOther income (expense): Interest and other income........ 66.1 21.5 27.2 Interest expense, net............ (15.3) (12.0) (6.2) -------- -------- -------- Total other income (expense).. 50.8 9.5 21.0 -------- -------- -------- Income before income taxes and cumulative effect of a change in accounting principle.......... 794.4 588.3 592.4 Provision for income taxes........ 256.7 268.6 217.8 -------- -------- -------- Income before cumulative effect of a change in accounting principle........................ 537.7 319.7 374.6\nCumulative effect of a change in accounting principle.......... - - 8.7 -------- -------- -------- Net income........................ $ 537.7 $ 319.7 $ 383.3 ======== ======== ========\nSee accompanying notes. (Continued on next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS (Continued)\nYears ended December 31, 1995, 1994 and 1993 (In millions, except per share data)\n1995 1994 1993 ----- ----- ----- Earnings per share: Primary: Income before cumulative effect of a change in accounting principle........ $1.92 $1.14 $1.30 Cumulative effect of a change in accounting principle................... - - .03 ----- ----- ----- Net income.................... $1.92 $1.14 $1.33 ===== ===== =====\nFully diluted: Income before cumulative effect of a change in accounting principle........ $1.88 $1.13 $1.30 Cumulative effect of a change in accounting principle................... - - .03 ----- ----- ----- Net income.................... $1.88 $1.13 $1.33 ===== ===== =====\nShares used in calculation of: Primary earnings per share....... 280.7 279.6 287.2 Fully diluted earnings per share......................... 285.3 282.2 288.6\nSee accompanying notes.\nAMGEN INC.\nCONSOLIDATED BALANCE SHEETS\nDecember 31, 1995 and 1994 (In millions, except per share data)\n1995 1994 -------- -------- ASSETS Current assets: Cash and cash equivalents............ $ 66.7 $ 211.3 Marketable securities................ 983.6 485.4 Trade receivables, net of allowance for doubtful accounts of $13.8 in 1995 and $13.3 in 1994............................... 199.3 194.7 Inventories.......................... 88.8 98.0 Deferred tax assets, net............. 51.7 70.2 Other current assets................. 64.0 56.0 -------- -------- Total current assets 1,454.1 1,115.6\nProperty, plant and equipment at cost, net.................................. 743.8 665.3 Investments in affiliated companies..... 95.7 82.3 Other assets............................ 139.2 130.9 -------- -------- $2,432.8 $1,994.1 ======== ========\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable..................... $ 54.4 $ 30.5 Commercial paper..................... 69.7 99.7 Accrued liabilities.................. 459.7 406.2 -------- -------- Total current liabilities.......... 583.8 536.4\nLong-term debt.......................... 177.2 183.4 Contingencies Stockholders' equity: Common stock and additional paid-in capital; $.0001 par value; 750.0 shares authorized; outstanding - 265.7 shares in 1995 and 264.7 shares in 1994..... 864.8 719.3 Retained earnings................... 807.0 555.0 -------- -------- Total stockholders' equity........ 1,671.8 1,274.3 -------- -------- $2,432.8 $1,994.1 ======== ========\nSee accompanying notes.\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYears ended December 31, 1995, 1994 and 1993 (In millions)\nCommon stock and Number additional of paid-in Retained shares capital earnings ------ --------- -------- Balance at December 31, 1992........ 272.6 $573.8 $359.9 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan..................... 4.6 21.7 - Issuance of common stock upon the exercise of warrants.............. 1.3 5.9 - Tax benefits related to stock options........................... - 34.8 - Repurchases of common stock......... (10.1) - (207.4) Net income.......................... - - 383.3 ------ ------ ------\nBalance at December 31, 1993........ 268.4 636.2 535.8 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan..................... 5.7 44.8 - Issuance of common stock upon the exercise of warrants.............. 3.5 15.3 - Tax benefits related to stock options........................... - 23.0 - Repurchases of common stock......... (12.9) - (300.5) Net income.......................... - - 319.7 ------ ------ ------ Balance at December 31, 1994........ 264.7 $719.3 $555.0\nSee accompanying notes. (Continued next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Continued)\nYears ended December 31, 1995, 1994 and 1993 (In millions)\nCommon stock and Number additional of paid-in Retained shares capital earnings ------ --------- -------- Balance at December 31, 1994........ 264.7 $719.3 $555.0 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan..................... 8.3 102.7 - Tax benefits related to stock options........................... - 42.8 - Repurchases of common stock......... (7.3) - (285.7) Net income.......................... - - 537.7 ----- ------ ------\nBalance at December 31, 1995........ 265.7 $864.8 $807.0 ===== ====== ======\nSee accompanying notes.\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993 (In millions)\n1995 1994 1993 -------- -------- --------\nCash flows from operating activities: Net income........................ $ 537.7 $ 319.7 $ 383.3 Write-off of in-process technology purchased ........... - 116.4 - Depreciation and amortization..... 84.2 74.5 50.7 Other non-cash expenses........... 0.1 2.8 7.9 Deferred income taxes............. 23.9 2.4 17.4 Loss of affiliates, net........... 53.3 31.2 12.6 Cash provided by (used in): Trade receivables, net.......... (4.6) (30.4) (8.3) Inventories..................... 9.2 (23.3) (17.9) Other current assets............ (8.0) 1.8 (4.8) Accounts payable................ 23.9 4.6 (14.9) Accrued liabilities............. 53.5 32.2 7.0 ------- ------- ------- Net cash provided by operating activities....... 773.2 531.9 433.0 ------- ------- -------\nCash flows from investing activities: Purchases of property, plant and equipment....................... (162.7) (130.8) (209.9) Increase in marketable securities. - - (131.3) Proceeds from maturities of marketable securities........... 129.6 87.7 - Proceeds from sales of marketable securities...................... 1,018.8 1,505.8 - Purchases of marketable securities...................... (1,646.6) (1,395.1) - Cost to acquire company, net of cash acquired................... - (240.8) - Increase in investments in affiliated companies............ (19.5) (21.8) (21.7) (Increase) decrease in other assets.......................... (13.7) 4.0 (27.0) -------- -------- -------- Net cash used in investing activities................. $ (694.1) $ (191.0) $ (389.9) -------- -------- --------\nSee accompanying notes. (Continued on next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nYears ended December 31, 1995, 1994 and 1993 (In millions)\n1995 1994 1993 -------- -------- --------\nCash flows from financing activities: (Decrease) increase in commercial paper........................... $(30.0) $(10.1) $109.8 Repayment of long-term debt....... (6.2) (12.0) (2.0) Proceeds from issuance of long- term debt....................... - 12.5 53.0 Net proceeds from issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan............. 102.6 44.5 21.5 Tax benefit related to stock options......................... 42.8 23.0 34.8 Net proceeds from issuance of common stock upon the exercise of warrants..................... - 15.3 5.9 Repurchases of common stock....... (285.7) (300.5) (207.4) Other............................. (47.2) (30.8) (22.2) -------- -------- -------- Net cash used in financing activities................. (223.7) (258.1) (6.6) -------- -------- --------\n(Decrease) increase in cash and cash equivalents....................... (144.6) 82.8 36.5\nCash and cash equivalents at beginning of period............... 211.3 128.5 92.0 -------- -------- --------\nCash and cash equivalents at end of period............................ $ 66.7 $211.3 $128.5 ======== ======== ========\nSee accompanying notes.\nAMGEN INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1995\n1. Summary of significant accounting policies\nBusiness\nAmgen Inc. (\"Amgen\" or the \"Company\") is a global biotechnology company that develops, manufactures and markets human therapeutics based on advanced cellular and molecular biology.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries as well as affiliated companies for which the Company has a controlling financial interest and exercises control over their operations (\"majority controlled affiliates\"). All material intercompany transactions and balances have been eliminated in consolidation. Investments in affiliated companies which are 50% or less owned and where the Company exercises significant influence over operations are accounted for using the equity method. All other equity investments are accounted for under the cost method. The caption \"Loss of affiliates, net\" includes Amgen's equity in the operating results of affiliated companies and the minority interest others hold in the operating results of Amgen's majority controlled affiliates.\nCash equivalents and marketable securities\nThe Company considers cash equivalents to be only those investments which are highly liquid, readily convertible to cash and which mature within three months from date of purchase.\nThe Company considers its investment portfolio available-for- sale as defined in Statement of Financial Accounting Standards (\"SFAS\") No. 115. There were no material unrealized gains or losses nor any material differences between the estimated fair values and costs of securities in the investment portfolio at December 31, 1995 and 1994. For the year ended December 31, 1995, realized gains and losses totaled $8.0 million and $3.1 million, respectively. For the year ended December 31, 1994, realized gains and losses totaled $5.0 million and $21.1 million, respectively. The cost of securities sold is based on the specific identification method. The cost of the investment portfolio by type of security, contractual maturity and its classification in the balance sheet is as follows (in millions):\nDecember 31, 1995 1994 -------- -------- Type of security:\nCorporate debt securities.................. $ 486.8 $365.0 U.S. Treasury securities and obligations of U.S. government agencies................ 459.3 170.9 Other interest bearing securities.......... 81.3 151.6 -------- ------ $1,027.4 $687.5 ======== ======\nContractual maturity:\nMaturing in one year or less............... $ 219.4 $411.0 Maturing after one year through three years 569.4 132.8 Maturing after three years................. 238.6 143.7 -------- ------ $1,027.4 $687.5 ======== ======\nClassification in balance sheet:\nCash and cash equivalents.................. $ 66.7 $211.3 Marketable securities...................... 983.6 485.4 -------- ------ 1,050.3 696.7 Less cash.................................. (22.9) (9.2) -------- ------ $1,027.4 $687.5 ======== ======\nThe Company invests its cash in accordance with a policy that seeks to maximize returns while ensuring both liquidity and minimal risk of principal loss. The policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings, and places restrictions on maturities and concentration by type and issuer. The majority of the Company's portfolio is composed of fixed income investments which are subject to the risk of market interest rate fluctuations, and all the Company's investments are subject to risks associated with the ability of the issuers to perform their obligations under the instruments.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined in a manner which approximates the first-in, first-out (FIFO) method. Inventories are shown net of applicable reserves and allowances. Inventories consist of the following (in millions):\nDecember 31, 1995 1994 ----- ----- Raw materials...................... $11.8 $11.0 Work in process.................... 45.9 54.0 Finished goods..................... 31.1 33.0 ----- ----- $88.8 $98.0 ===== =====\nDepreciation and amortization\nDepreciation of buildings and equipment is provided over their estimated useful lives on a straight-line basis. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or lease terms, including periods covered by options which are expected to be exercised.\nProduct sales\nProduct sales consist of two products, EPOGEN(R) (Epoetin alfa) and NEUPOGEN(R) (Filgrastim).\nQuarterly NEUPOGEN(R) sales volume in the United States is influenced by a number of factors including underlying demand, seasonal changes in cancer chemotherapy administration, and wholesaler inventory management practices. Wholesaler inventory reductions tend to reduce domestic NEUPOGEN(R) sales in the first quarter each year. In prior years, NEUPOGEN(R) sales in the European Union (\"EU\") have experienced a seasonal decline to varying degrees in the third quarter.\nThe Company has the exclusive right to sell Epoetin alfa for dialysis, diagnostics and all non-human uses in the United States. The Company sells Epoetin alfa under the brand name EPOGEN(R). Amgen has granted to Ortho Pharmaceutical Corporation, a subsidiary of Johnson & Johnson (\"Johnson & Johnson\"), a license relating to Epoetin alfa for sales in the United States for all human uses except dialysis and diagnostics. Pursuant to this license, Amgen does not recognize product sales it makes into the exclusive market of Johnson & Johnson and does recognize the product sales made by Johnson & Johnson into Amgen's exclusive market. These sales amounts, and adjustments thereto, are derived from third-party data on shipments to end users and their usage (see Note 5, \"Contingencies - Johnson & Johnson arbitrations\").\nResearch and development costs\nResearch and development costs are expensed as incurred. Payments related to the acquisition of technology rights, for which\ndevelopment work is in-process, are expensed and considered a component of research and development costs (Note 2).\nForeign currency transactions\nThe Company has a program to manage foreign currency risk. As part of this program, it has purchased foreign currency option and forward contracts to hedge against possible reductions in values of anticipated foreign currency cash flows over the next 12 months, primarily resulting from its sales in Europe. At December 31, 1995, the Company had net option and forward contracts to exchange foreign currencies for U.S. dollars of $13.2 million and $16.2 million, respectively, all having maturities of one year or less. The option contracts are designated and effective as hedges of anticipated foreign currency transactions for financial reporting purposes, and accordingly, the net gains on such contracts are deferred and will be recognized in the same period as the hedged transactions. The forward contracts do not qualify as hedges for financial reporting purposes, and accordingly, are marked-to-market with changes in market values reflected directly in income.\nThe Company has additional foreign currency forward contracts to hedge certain exposures to foreign currency fluctuations of certain receivables and payables denominated in foreign currencies. At December 31, 1995, the Company had forward contracts to exchange foreign currencies, primarily Swiss francs, for U.S. dollars of $53.9 million, all having maturities of six months or less. These contracts are designated and effective as hedges, and accordingly, gains and losses on these forward contracts are recognized in the same period the offsetting gains and losses of hedged assets and liabilities are realized and recognized.\nInterest rate swaps\nThe Company has two interest rate swap agreements that change the nature of the fixed rate interest paid on $50.0 million of its medium term debt securities (\"Medium Term Notes\") outstanding (Note 4). Under the first agreement, the Company pays a variable rate (LIBOR) of interest in exchange for the receipt of fixed rate interest payments of approximately 6.1%. Under the second agreement, the Company makes fixed rate interest payments of approximately 4.7% and receives variable rate (LIBOR) interest payments at the same time payments are exchanged under the first agreement. These agreements both have notional amounts of $50.0 million, terminate in 1997, and involve the same counterparty. The differential in the fixed rate interest payments is recognized as a reduction of interest expense related to the debt. The related amounts payable to and receivable from the counterparty are recorded in accrued liabilities. The fair values of the swap agreements are not recognized in the financial statements.\nInterest\nInterest costs are expensed as incurred except to the extent such interest is related to construction in progress, in which case interest is capitalized. Interest costs capitalized for the years ended December 31, 1995, 1994 and 1993, were $4.7 million, $3.7 million and $4.0 million, respectively.\nIncome taxes\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which supersedes SFAS No. 96. As permitted under this new accounting standard, prior years' financial statements have not been restated. Net income for the year ended December 31, 1993, was increased by $8.7 million, or $.03 per share on a primary and fully diluted basis, to reflect the cumulative effect of a change in accounting principle to adopt SFAS No. 109 (Note 6).\nStock option and purchase plans\nThe Company's stock options and purchase plans are accounted for under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (Note 8).\nEarnings per share\nEarnings per share are computed in accordance with the treasury stock method. Primary and fully diluted earnings per share are based upon the weighted average number of common shares and dilutive common stock equivalents during the period in which they were outstanding. Common stock equivalents include outstanding options under the Company's stock option plans and outstanding warrants to purchase shares of the Company's common stock.\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 may differ from those estimates.\nReclassification\nCertain prior year amounts have been reclassified to conform to the current year presentation.\n2. Business combination\nIn December 1994, the Company acquired the outstanding stock of Synergen, Inc. (\"Synergen\"), a publicly held biotechnology company engaged in the discovery and development of protein-based pharmaceuticals. Synergen was acquired for $254.5 million, including related acquisition costs. The assignment of the purchase price among identifiable tangible and intangible assets was based on an analysis of the fair values of those assets. Specifically, purchased in-process technology was evaluated through analysis of data concerning each of Synergen's product candidates. The fair values of the identifiable tangible and intangible assets acquired, net of liabilities assumed, exceeded the purchase price, and accordingly, the values of the noncurrent assets (including in-process technology)\nwere reduced pro rata. The value assigned to in-process technology of $116.4 million was expensed on the acquisition date.\nThis business combination has been accounted for using the purchase method. Therefore, the operating results of Synergen are included in the accompanying consolidated financial statements beginning in December 1994.\n3. Related party transactions\nThe Company owns a 50% interest in Kirin-Amgen, Inc. (\"Kirin- Amgen\"), a corporation formed in 1984 for the development and commercialization of certain products based on advanced biotechnology. Pursuant to the terms of agreements entered into with Kirin-Amgen, the Company conducts certain research and development activities on behalf of Kirin-Amgen and is paid for such services at negotiated rates. Included in revenues from corporate partners for the years ended December 31, 1995, 1994 and 1993, are $72.6 million, $58.6 million and $41.2 million, respectively, related to these agreements.\nIn connection with its various agreements with Kirin-Amgen, the Company has been granted sole and exclusive licenses for the manufacture and sale of certain products in specified geographic areas of the world. In return for such licenses, the Company paid Kirin-Amgen stated amounts upon the receipt of the licenses and\/or pays Kirin-Amgen royalties based on sales. During the years ended December 31, 1995, 1994 and 1993, Kirin-Amgen earned royalties from Amgen of $74.2 million, $67.5 million and $53.1 million, respectively, under such agreements, which are included in cost of sales in the accompanying consolidated statements of operations.\nAt December 31, 1995, Amgen's share of Kirin-Amgen's undistributed retained earnings was approximately $50.4 million.\n4. Debt\nThe Company has a commercial paper program which provides for unsecured short-term borrowings up to an aggregate of $200 million. Commercial paper issued under this program is supported by the Company's credit facility (discussed below). At December 31, 1995, $69.7 million of commercial paper was outstanding at effective interest rates averaging 5.8% and maturities of less than three months. At December 31, 1994, $99.7 million of commercial paper was outstanding at effective interest rates averaging 6.0% and maturities of less than four months.\nLong-term debt consisted of the following (in millions):\nDecember 31, 1995 1994 ------- ------- Medium Term Notes.................. $109.0 $113.0 Promissory notes................... 68.2 68.2 Other long-term obligations........ - 2.2 ------ ------ $177.2 $183.4 ====== ======\nThe Company has registered $200 million of unsecured Medium Term Notes of which $109.0 million were outstanding at December 31, 1995. These Medium Term Notes mature in approximately two to eight years and bear interest at fixed rates averaging 5.8%. The Company may offer and issue these securities from time to time with terms determined by market conditions. Under the terms of these securities, the Company is required to meet certain debt to tangible net worth ratios. In addition, these securities place limitations on liens and sale\/leaseback transactions.\nThe Company's promissory notes, which mature in 1997, were issued to assist in financing the acquisition and related construction of a manufacturing facility in Puerto Rico. These notes bear interest, which is payable quarterly, at a floating rate equal to 81% of a Eurodollar base rate, not to exceed 12%. At December 31, 1995, the effective interest rate on these notes was approximately 4.7%.\nIn June 1995, the Company replaced its existing unsecured credit facility with a new unsecured credit facility (the ``credit facility''). The credit facility includes a commitment expiring on June 23, 2000 for up to $150 million of borrowings under a revolving line of credit (the \"revolving line commitment\") and a commitment expiring on December 5, 1997 for up to an additional $73 million of letters of credit. As of December 31, 1995, $150 million was available under the revolving line commitment for borrowing and to support the Company's commercial paper program. Also, as of December 31, 1995, letters of credit totaling $72.4 million were issued and outstanding to secure the Company's promissory notes and accrued interest thereon. Borrowings under the revolving line commitment bear interest at various rates which are a function of, at the Company's option, either the prime rate of a major bank, the federal funds rate or a Eurodollar base rate. Under the terms of the credit facility, the Company is required to meet a minimum interest coverage ratio and maintain a minimum level of tangible net worth. In addition, the credit facility contains limitations on investments, liens and sale\/leaseback transactions.\nThe aggregate stated maturities of all long-term obligations due subsequent to December 31, 1995, are as follows: none - 1996; $118.2 million - 1997; $30.0 million - 1998; $6.0 million - 1999; none - 2000 and $23.0 million thereafter.\n5. Contingencies\nJohnson & Johnson arbitrations\nIn September 1985, the Company granted Johnson & Johnson a license relating to certain patented technology and know-how of the Company to sell a genetically engineered form of recombinant human erythropoietin, called Epoetin alfa, throughout the United States for all human uses except dialysis and diagnostics. Johnson & Johnson sells Epoetin alfa under the brand name PROCRIT(R).\nA number of disputes have arisen between Amgen and Johnson &\nJohnson as to their respective rights and obligations under the various agreements between them, including the agreement granting the license (the \"License Agreement\"). These disputes have been the subject of arbitration proceedings before Judicial Arbitration and Mediation Services, Inc. in Chicago, Illinois commencing in January 1989. A dispute that has not yet been resolved and is the subject of the current arbitration proceeding relates to the audit methodology currently employed by the Company for Epoetin alfa sales. The Company and Johnson & Johnson are required to compensate each other for Epoetin alfa sales which either party makes into the other party's exclusive market. The Company has established and is employing an audit methodology to assign the proceeds of sales of EPOGEN(R) and PROCRIT(R) in Amgen's and Johnson & Johnson's respective exclusive markets. Based upon this audit methodology, the Company is seeking payment of approximately $10 million from Johnson & Johnson for the period 1989 through 1994. Johnson & Johnson has disputed this methodology and is proposing an alternative methodology for adoption by the arbitrator pursuant to which it is seeking payment of approximately $419 million for the period 1989 through 1994. If, as a result of the arbitration proceeding, a methodology different from that currently employed by the Company is instituted to assign the proceeds of sales between the parties, it may yield results that are different from the results of the audit methodology currently employed by the Company. As a result of the arbitration, it is possible that the Company would recognize a different level of EPOGEN(R) sales than are currently being recognized. As a result of the arbitration, the Company may be required to pay additional compensation to Johnson & Johnson for sales during prior periods, or Johnson & Johnson may be required to pay compensation to the Company for such prior period sales. While it is impossible to predict accurately or determine the outcome of these proceedings, based primarily upon the merits of its claims and based upon certain liabilities established due to the inherent uncertainty of any arbitrated result, the Company believes that the outcome of these proceedings will not have a material adverse effect on its financial statements.\nThe trial is scheduled to commence in March 1996 regarding the audit methodologies and compensation for sales by Johnson & Johnson into Amgen's exclusive market and sales by Amgen into Johnson & Johnson's exclusive market. Discovery as to these issues is in progress.\nThe Company has filed a demand in the arbitration to terminate Johnson & Johnson's rights under the License Agreement and to recover damages for breach of the License Agreement. A hearing on this demand will be scheduled following the adjudication of the audit methodologies for Epoetin alfa sales. On October 27, 1995, the Company filed a complaint in the Circuit Court of Cook County, Illinois, which is now pending in the United States District Court for the Northern District of Illinois, seeking an order compelling Johnson & Johnson to arbitrate the Company's claim for termination before the arbitrator. The Company is unable to predict at this time the outcome of the demand for termination or when it will be resolved.\nOn October 2, 1995, Johnson & Johnson filed a demand for a separate arbitration proceeding against the Company before the\nAmerican Arbitration Association (\"AAA\") in Chicago, Illinois. Johnson & Johnson alleges in this demand that the Company has breached the License Agreement. The demand also includes allegations of various antitrust violations. In this demand, Johnson & Johnson seeks an injunction, declaratory relief, unspecified compensatory damages, punitive damages and costs. The Company has filed a motion to stay the arbitration pending the outcome of the existing arbitration proceedings before Judicial Arbitration and Mediation Services, Inc. discussed above. The Company has also filed an answer and counterclaim denying that AAA has jurisdiction to hear or decide the claims stated in the demand, denying the allegations in the demand and counterclaiming for certain unpaid invoices.\nSynergen ANTRIL(TM) litigation\nSeveral lawsuits have been filed against the Company's wholly owned subsidiary, Amgen Boulder Inc. (formerly Synergen, Inc.), alleging misrepresentations in connection with Synergen's research and development of ANTRIL(TM) for the treatment of sepsis. One suit brought by three Synergen stockholders alleges violations of state securities laws, fraud and misrepresentation and seeks an unspecified amount of compensatory damages and punitive damages. Another suit, proposed as a class action, filed by a limited partner of a partnership with which Synergen is affiliated, seeks rescission of certain payments made to one of the defendants (or unspecified damages not less than $50 million) and treble damages based on a variety of allegations. Broker-dealers who acted as market makers in Synergen options have also filed a suit claiming in excess of $3.2 million in trading losses.\nWhile it is not possible to predict accurately or determine the eventual outcome of the Johnson & Johnson arbitration proceedings, the Synergen litigation or various other legal proceedings (including patent disputes) involving Amgen, the Company believes that the outcome of these proceedings will not have a material adverse effect on its financial statements.\n6. Income taxes\nThe provision for income taxes includes the following (in millions):\nYears ended December 31, 1995 1994 1993 -------- -------- -------- Current provision: Federal (including U.S. possessions).............. $211.5 $231.3 $165.8 State....................... 21.3 34.9 25.9 ------ ------ ------ Total current provision... 232.8 266.2 191.7 ------ ------ ------ Deferred provision (benefit): Federal (including U.S. possessions).............. 25.1 0.5 19.7 State....................... (1.2) 1.9 6.4 ------ ------ ------ Total deferred provision.. 23.9 2.4 26.1 ------ ------ ------ $256.7 $268.6 $217.8 ====== ====== ======\nDeferred income taxes reflect the net tax effects of net operating loss carryforwards and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows (in millions):\nDecember 31,\n1995 1994 -------- -------- Deferred tax assets: Net operating loss carryforwards..... $ 81.1 $ 89.5 Expense accruals..................... 61.0 78.5 Fixed assets......................... 23.2 17.0 Research collaboration expenses...... 17.4 8.0 Royalty obligation buyouts........... 11.2 11.8 Other................................ 12.4 16.7 ------ ------ Total deferred tax assets......... 206.3 221.5\nValuation allowance.................... (86.2) (79.5) ------ ------ Net deferred tax assets........... 120.1 142.0 ------ ------ Deferred tax liabilities: Purchase of technology rights........ (29.7) (25.7) Other................................ (3.7) (5.7) ------ ------ Total deferred tax liabilities.... (33.4) (31.4) ------ ------ $86.7 $110.6 ====== ======\nThe net change in the valuation allowance for deferred tax assets during the year ended December 31, 1995 was $6.7 million.\nAt December 31, 1995, the Company had operating loss carryforwards available to reduce future federal taxable income which expire as follows (in millions):\n1997 - 2002.......... $ 0.9 2003 - 2006.......... 19.9 2007................. 26.7 2008................. 81.2 2009................. 81.9 ------ $210.6 ======\nThese operating loss carryforwards relate to the acquisition of Synergen (Note 2). Utilization of these operating loss carryforwards is limited to approximately $16.0 million per year.\nThe provision for income taxes varies from income taxes provided based on the federal statutory rate of 35% as follows (in millions):\nYears ended December 31, 1995 1994 1993 -------- -------- -------- Statutory rate applied to income before income taxes.............. $278.0 $205.9 $207.3 State income taxes, net of federal income tax benefit............... 13.1 23.9 21.0 Benefit of Puerto Rico operations, net of Puerto Rico income taxes.. (27.8) - - Write-off of purchased in-process technology not deductible........ - 40.7 - Retroactive effects of enacted tax law changes...................... - - (9.6) Other, net......................... (6.6) (1.9) (.9) ------ ------ ------ $256.7 $268.6 $217.8 ====== ====== ======\nThe tax provision for the year ended December 31, 1993 was reduced by $9.6 million due to changes in federal tax laws enacted in August 1993. This amount principally relates to the retroactive reinstatement of research and experimentation and orphan drug tax credits to July 1, 1992.\nIncome taxes paid during the years ended December 31, 1995, 1994 and 1993, totaled $100.8 million, $234.2 million and $146.3 million, respectively.\n7. Stockholders' equity\nOn January 24, 1989, the Company's Board of Directors declared a dividend of one common share purchase right (\"Right\") for each outstanding share of common stock. The Rights will become exercisable 10 days after a person acquires 10% or more of the common stock, or 10 days after a person announces a tender offer which would result in such person acquiring 10% or more of the common stock. Subject to certain conditions, the Rights may be redeemed by the Board of Directors. The current redemption price is $.0008 per Right, subject to adjustment. The Rights will expire on January 24, 1999.\nUnder certain circumstances, if an acquirer purchases 10% or more of the Company's outstanding common stock, each Rightholder (other than the acquirer) is entitled for a specified period to buy shares of common stock of the Company at 50% of the then current market price. The number of shares which a holder may purchase upon exercise will be determined by a formula which includes a current exercise price of $80 per share, subject to adjustment. If an acquirer purchases at least 10% of the Company's common stock, but has not achieved a 50% stake, the Board may exchange the Rights (other than the acquirer's Rights) for one share of common stock per Right. In addition, under certain circumstances, if the Company is involved in a merger or other business combination where it is not the surviving corporation, a Rightholder may buy shares of common stock of the acquiring company at 50% of the then current market value.\nIn connection with the sale of limited partnership interests in Amgen Clinical Partners, L.P. (the \"Limited Partnership\"), Amgen issued warrants to the limited partners to purchase 36.3 million shares of its common stock in exchange for the options to purchase the limited partners' interests in the Limited Partnership. Substantially all warrants were exercised prior to their expiration on June 30, 1994.\nIn addition to common stock, the Company's authorized capital also includes 5.0 million shares of preferred stock, $.0001 par value. At December 31, 1995, no shares of preferred stock were issued or outstanding.\nAt December 31, 1995, the Company had reserved 394.4 million shares of its common stock which may be issued through its stock option and stock purchase plans and in connection with the stockholder Rights agreement.\nThe Company has a stock repurchase program to offset the dilutive effect of its employee benefit stock option and stock purchase plans. Stock repurchased under the program is retired. As of December 31, 1995, the Company was authorized to repurchase up to $450 million of its stock during 1996.\nIn July 1995, the Board of Directors approved a two-for-one split of the Company's common stock effected in the form of a 100 percent stock dividend. The dividend was distributed on August 15, 1995, to stockholders of record on August 1, 1995. Accordingly, all share information in the accompanying consolidated\nfinancial statements and notes thereto have been retroactively adjusted to give recognition to this stock split.\n8. Stock option and purchase plans\nThe Company's stock option plans provide for option grants designated as either nonqualified or incentive stock options. The options generally vest over a three to five year period and generally expire seven years from the date of grant. In general, stock option grants are set at the closing price of the Company's common stock on the date of grant. As of December 31, 1995, the Company had 26.3 million shares of common stock available for future grant under its stock option plans.\nMost U.S. employees and certain employees outside the U.S. are eligible to receive a grant of stock options periodically with the number of shares generally determined by the employee's salary grade, performance level and the stock price. In addition, certain management and professional level employees normally receive a stock option grant upon hire. Non-employee directors of the Company receive a grant of stock options annually.\nStock option information with respect to all of the Company's stock option plans follows (in millions, except price information):\nExercise Price ------------------------ Weighted Shares Low High Average ------ --- ---- -------- Balance December 31, 1992, unexercised............... 30.2 $ 1.76 $38.88 $11.09 Granted................ 8.0 $16.06 $35.31 $18.93 Exercised.............. (4.5) $ 1.76 $30.50 $ 4.62 Cancelled.............. (0.6) $ 2.25 $38.38 $15.21 ---- Balance December 31, 1993, unexercised............... 33.1 $ 1.76 $38.88 $13.72 Granted................ 8.5 $17.68 $29.50 $22.07 Exercised.............. (5.6) $ 1.93 $28.00 $ 6.95 Cancelled.............. (1.0) $ 3.69 $37.38 $21.92 ---- Balance December 31, 1994, unexercised............... 35.0 $ 1.76 $38.88 $16.58 Granted................ 7.1 $28.94 $58.88 $39.62 Exercised.............. (8.1) $ 1.93 $38.88 $12.87 Cancelled.............. (1.0) $ 2.25 $39.88 $19.86 ---- Balance December 31, 1995, unexercised............... 33.0 $ 1.76 $58.88 $22.35 ====\nAt December 31, 1995, stock options to purchase 15.7 million shares were exercisable.\nThe Company has an employee stock purchase plan whereby, in accordance with Section 423 of the Internal Revenue Code, eligible employees may authorize payroll deductions of up to 10% of their salary to purchase shares of the Company's common stock at the lower of 85% of the fair market value of common stock on the first or last day of the offering period. During each of the years ended December 31, 1995, 1994 and 1993, approximately 0.2 million shares were purchased by employees at prices of approximately $24.76, $20.88 and $21.04 per share, respectively. At December 31, 1995, the Company had 5.1 million shares available for future issuance under this plan.\n9. Balance sheet accounts\nProperty, plant and equipment consist of the following (in millions):\nDecember 31, 1995 1994 -------- -------- Land................................. $ 59.1 $ 58.4 Buildings............................ 404.5 330.2 Manufacturing equipment.............. 59.2 53.2 Laboratory equipment................. 148.9 123.6 Furniture and office equipment....... 200.4 137.6 Leasehold improvements............... 55.7 53.7 Construction in progress............. 105.6 116.7 -------- ------ 1,033.4 873.4 Less accumulated depreciation and amortization...................... (289.6) (208.1) -------- ------ $ 743.8 $665.3 ======== ======\nOther accrued liabilities consist of the following (in millions):\nDecember 31,\n1995 1994 -------- -------- Income taxes......................... $124.4 $ 35.0 Employee compensation and benefits... 70.8 63.4 Sales incentives, royalties and allowances......................... 65.5 60.0 Due to affiliated companies and corporate partners................ 54.9 51.8 Legal costs.......................... 33.4 60.7 Clinical costs....................... 18.3 29.9 Other................................ 92.4 105.4 ------ ------ $459.7 $406.2 ====== ======\n10. Fair values of financial instruments\nThe following is information concerning the fair values of each class of financial instruments at December 31, 1995:\nCash, cash equivalents and marketable securities\nThe carrying amounts of cash, cash equivalents and marketable securities approximate their fair values. Fair values of cash equivalents and marketable securities are based on quoted market prices.\nDebt\nThe carrying value of commercial paper approximates its fair value due to the short maturity of these liabilities. The fair value of Medium Term Notes was approximately $110 million. This amount was estimated based on quoted market rates for instruments with similar terms and remaining maturities. The carrying value of the promissory notes approximates its fair value since the interest rate on the notes is reset quarterly.\nInterest rate swap agreements\nThe fair values of interest rate swap agreements were not significant based on estimated amounts that the counterparty would receive or pay to terminate the swap agreements taking into account current interest rates.\nForeign currency contracts\nThe fair values of the foreign currency forward contracts and purchased foreign currency option contracts were not significant based on quoted market rates.\n11. Major customers\nAmgen has chosen to use major wholesale distributors of pharmaceutical products as the principal means of distributing the Company's products to clinics, hospitals and pharmacies. The Company performs periodic credit evaluations of its large customers' financial condition and generally requires no collateral. For the years ended December 31, 1995, 1994 and 1993, sales to two large wholesale distributors as a percentage of total revenues were 21% and 15%, 22% and 16%, and 23% and 10%, respectively.\n12. Geographic information\nInformation about the Company's operations in the United States and its possessions, Europe, and other international markets, which include Canada, Australia and Japan is as follows (in millions):\nYears ended December 31, 1995 1994 1993 ---------- ---------- ---------- Sales to unaffiliated customers: United States and possessions... $1,546.1 $1,333.8 $1,130.0 Europe.......................... 254.7 193.0 165.7 Other........................... 17.8 22.8 10.6\nTransfers between geographic areas: United States and possessions... 12.6 15.7 5.4 Other revenue................... 121.3 98.3 67.5 Adjustments and eliminations.... (12.6) (15.7) (5.4) -------- -------- -------- $1,939.9 $1,647.9 $1,373.8 ======== ======== ========\nYears ended December 31, 1995 1994 1993 -------- -------- -------- Operating profit (loss): United States and possessions... $801.7 $624.0 $592.9 Europe.......................... 75.7 50.3 35.8 Other........................... (33.1) (25.6) (14.9) Adjustments and eliminations...... (1.7) (2.8) 1.0 ------ ------ ------ Total operating profit............ 842.6 645.9 614.8 Interest and other income......... 50.8 9.5 21.0 Loss of affiliates, net........... (53.3) (31.2) (12.6) General corporate expenses........ (45.7) (35.9) (30.8) ------ ------ ------ Income before income taxes and cumulative effect of a change in accounting principle......... $794.4 $588.3 $592.4 ====== ====== ======\nOperating profit (loss) represents revenue less operating expenses directly related to each geographic area. Operating profit (loss) excludes interest and other income, loss of affiliates, net and other expenses attributable to general corporate operations.\nIncluded in the operating profit for the United States and its possessions is a write-off of in-process technology purchased of $116.4 million for the year ended December 31, 1994 and a legal award of $13.9 million for the year ended December 31, 1993. Loss of affiliates, net includes the minority interest in earnings of majority controlled European affiliates of $50.7 million, $30.9 million and $22.2 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nInformation about the Company's identifiable assets in each geographic area is as follows (in millions):\nDecember 31, 1995 1994 ---------- ---------- Identifiable assets: United States and possessions...... $ 964.0 $ 906.4 Europe............................. 70.5 50.7 Other.............................. 16.3 22.3 Adjustments and eliminations.......... 1.7 (2.8) -------- -------- Total identifiable assets............. 1,052.5 976.6 Corporate assets including equity method investments................. 1,380.3 1,017.5 -------- -------- Total assets.......................... $2,432.8 $1,994.1 ======== ========\nIdentifiable assets are those assets of the Company that are identified with the operations in each geographic area. Europe's identifiable assets include accounts receivable of approximately $54.7 million and $34.4 million as of December 31, 1995 and 1994, respectively, denominated in foreign currencies. Corporate assets, which are excluded from identifiable assets, are principally comprised of cash, cash equivalents and marketable securities. At December 31, 1995 and 1994, total international assets approximated $124.6 million and $93.8 million, respectively, and total international liabilities approximated $22.2 million and $16.6 million, respectively.\n13. Quarterly financial data (unaudited, in millions, except per share data):\n1995 Quarter Ended Dec. 31 Sept. 30 June 30 Mar. 31 - ------------------ ------- ------- ------- ------- Product sales...... $484.2 $460.6 $462.6 $411.2 Gross margin from product sales.... 418.4 396.5 386.2 344.6 Net income......... 145.6 145.8 137.7 108.6 Earnings per share: Primary.......... .52 .52 .49 .39 Fully diluted.... .51 .51 .49 .39\n1994 Quarter Ended Dec. 31 Sept. 30 June 30 Mar. 31 - ------------------ ------- ------- ------- ------- Product sales...... $413.6 $401.7 $388.6 $345.7 Gross margin from product sales.... 352.3 342.6 324.2 292.4 Net income......... 4.8 (1) 114.0 107.4 93.5 Earnings per share: Primary.......... .02 .41 .38 .33 Fully diluted.... .02 .41 .38 .33\n(1) During the fourth quarter of 1994, net income was reduced by $116.4 million due to the write-off of in-process technology purchased in connection with the acquisition of Synergen (Note 2).\nSCHEDULE II AMGEN INC.\nVALUATION ACCOUNTS\nYears ended December 31, 1995, 1994 and 1993 (In millions)\nAdditions Balance Charged Balance at to Costs at End Beginning and of of Period Expenses Deductions Period -------- -------- ---------- -------\nAllowance for doubtful accounts.................... $13.3 $5.4 $4.9 $13.8\nAllowance for doubtful accounts.................... $12.2 $1.5 $0.4 $13.3\nAllowance for doubtful accounts.................... $11.8 $0.9 $0.5 $12.2","section_15":""}
{"filename":"716054_1995.txt","cik":"716054","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION AND OVERVIEW\nIMRE Corporation (\"IMRE\" or the \"Company\") was incorporated in 1981 to research, develop, manufacture and market medical devices for the treatment and diagnosis of select immune-mediated diseases, transplantations, and cancers. The Company's first product, the PROSORBA-Registered Trademark- column, is a medical device that treats a patient's defective immune system so that it can more effectively respond to certain diseases. The Company received marketing approval from the U.S. Food and Drug Administration (\"FDA\") in December 1987 to distribute the PROSORBA-Registered Trademark- column for treatment of idiopathic thrombocytopenic purpura (\"ITP\"), an immune-mediated bleeding disorder. Since 1987, the Company has had sales of the PROSORBA-Registered Trademark- column of approximately $23 million.\nThe PROSORBA-Registered Trademark- column treats a defective immune system by modulating the immune system to respond more effectively. The modulation can result in the clearance of antigens or control of an autoimmune disease. The Company believes that the PROSORBA-Registered Trademark- column treats a dysfunctional immune system response rather than treating the disease itself.\nThe Company's PROSORBA-Registered Trademark- column is a therapeutic, extracorporeal immunoadsorption device which removes circulating immune complexes (CIC) and immunoglobulin G (IgG) from a patient's plasma in a procedure that takes place in an extracorporeal loop (outside the body) and returns all the other necessary plasma components back to the same patient. CIC are composed of an IgG antibody bound to an antigen. The PROSORBA-Registered Trademark- column is a plastic cylinder measuring three inches in diameter and three and one half inches in height. The cylinder contains a solid binding matrix composed of protein A bound to dry silica (sand) granules. Protein A, a molecule produced by the fermentation of a bacterium, specifically binds to both CIC and IgG, with a preference for CIC. During PROSORBA-Registered Trademark- column therapy, blood is drawn from one arm of the patient, plasma and red blood cells are separated, the plasma is filtered through the PROSORBA-Registered Trademark- column to remove unwanted CIC and IgG, then combined with the red blood cells and returned to the same patient's other arm.\nThe FDA considers the PROSORBA-Registered Trademark- column to be a medical device. The Company produces the PROSORBA-Registered Trademark- column at its own manufacturing facility which meets FDA good manufacturing practice (\"GMP\") regulations for the manufacture of the product in commercial quantities.\nThe Company believes that a key factor in the Company's commercial performance will be its ability to improve PROSORBA-Registered Trademark- column sales for its currently approved indication, obtain FDA marketing approval for additional disease indications for the PROSORBA-Registered Trademark- column, and obtain and develop complementary therapeutic and diagnostic technologies. The Company is seeking opportunities to generate licensing fees and product development revenue by establishing agreements with corporate sponsors interested in accessing the Company's technology and products\nin development. The Company's current clinical efforts are focused primarily on rheumatoid arthritis.\nRHEUMATOID ARTHRITIS\nRheumatoid arthritis is a potentially crippling autoimmune disease that is estimated to affect over 5,000,000 people in North America and Europe. In rheumatoid arthritis, the body's immune system inappropriately makes antibodies, called rheumatoid factors, that collect in the joints and surrounding soft tissue causing inflammation and tissue damage. Joints, typically those in the hand, become painful and swollen, lose movement, and become deformed. These individuals not only suffer a significantly reduced quality of life, but also a shortened life expectancy.\nIn September 1995, the Company announced the results of its 15 patient pilot clinical trial that used the PROSORBA-Registered Trademark- column for therapy in rheumatoid arthritis. The results showed a statistically significant 76% reduction in painful joints and a 70% reduction in swollen joints in 11 patients three months after completing treatment with the PROSORBA-Registered Trademark- column. The Company believes that these findings confirm the potential utility of the PROSORBA-Registered Trademark- column in treating rheumatoid arthritis reported by an earlier independent study published in the JOURNAL OF RHEUMATOLOGY in May 1994.\nAlso in September 1995, the Company submitted the final results of the pilot study as well as a proposed pivotal trial protocol to the FDA. The protocol submitted to the FDA described a prospective, randomized, multi-center, double-blind, controlled trial involving 268 patients. The 268 patients are to be randomly entered into two treatment groups. Approximately 134 patients will be treated with the PROSORBA-Registered Trademark- column and 134 patients with a placebo treatment. In November 1995, the Company announced that the FDA had conditionally approved its application to begin a pivotal trial at 12 centers using the PROSORBA-Registered Trademark- column in the treatment of patients with rheumatoid arthritis. A conditional approval grants the Company permission to begin a trial following approval by the treating institution's institutional review board provided that the Company agrees to submit information and revise the protocol as requested by the FDA. The Company currently expects the commencement of this clinical study to be delayed until 1997. It will be preceded in 1996, instead, by a smaller controlled study in rheumatoid arthritis patients to verify the previously observed effects. The Company believes that favorable results from such a trial will be critical in obtaining the corporate support required to finance a larger pivotal clinical trial.\nOTHER INDICATIONS\nWhile there are multiple additional indications in which the PROSORBA- Registered Trademark- column has demonstrated some clinical effects, the Company has most recently dedicated most of its internal resources, apart from rheumatoid arthritis, toward the indication of kidney transplantation. About 25% of patients awaiting kidney transplantation are ineligible for a transplant because they have developed antibodies, called alloantibodies, to a variety of donor tissues. These alloantibodies would immediately recognize a transplanted kidney as \"foreign\" and mount an immune attack against it. Prevention of this acute rejection involves the use of immunosuppressive drugs to reduce the body's tendency to reject foreign tissue, but drug therapy does not remove the sensitized\nantibodies. Patients waiting for a transplant are typically on dialysis which is an expensive medical maintenance procedure which provides no permanent therapeutic benefit.\nIn August 1995, the Company began a pilot clinical trial to evaluate the PROSORBA-Registered Trademark- column as a means to increase the number of patients eligible for kidney transplantation. The study was designed to determine if the PROSORBA-Registered Trademark- column treatments will reduce the level of sensitizing antibodies which cause acute organ rejection and which prevent a significant portion of the patient population from receiving donor kidneys. The Company has suspended enrollment of patients in this study and is in the process of evaluating the merits of continuing the study in light of the other opportunities available to it.\nAdditionally, the Company intends over-time to pursue applications for the use of the PROSORBA-Registered Trademark- column in the treatment of certain other autoimmune diseases, organ transplantations and cancers. The Company's Investigational Device Exemptions (\"IDEs\") which allow the Company to perform human clinical trials include the following diseases: rheumatoid arthritis, cancer, myasthenia gravis, systemic lupus erythematosus, multiple sclerosis, thrombotic thrombocytopenic purpura, and kidney transplantation. Such trials would be initiated if sufficient financing is obtained and the business potential of each therapeutic opportunity is consistent with the Company's goals. The Company is presently unable to predict when, or if, FDA approval for any such indications will be obtained.\nOTHER TECHNOLOGY\nIn November 1994, the Company's diagnostic division entered into a licensing agreement under which it has licensed the right to use proprietary nucleic acid probe technology (a genetic screening test) to predict which rheumatoid arthritis patients will develop severe disease and hence may benefit from early aggressive therapy. The test is currently a manually performed reference laboratory test. In January 1995, the Company obtained the rights to hybridization and chemical signal generation technology as well as automated clinical instrumentation which combined could provide the Company with the opportunity to create an automated laboratory test using the nucleic acid probe technology.\nThe diagnostics division was originally formed in 1992 as a majority owned subsidiary called CELx Corporation (\"CELx\"). During the quarter ended June 30, 1995, the Company and CELx agreed to the merger of CELx into the Company and the exchange of shares of CELx held by persons other than the Company into an aggregate of 312,500 shares of the Company's Common Stock. The dissolution of CELx resulted in a $625,000 \"purchased in process research and development\" expense. The expense was based on the fair market value of the Company's Common Stocks as of the date of the merger. The diagnostics division was originally created to employ proprietary immunoassay technology to develop specific assays that provide greater sensitivity and specificity than presently available in the market. The diagnostics program is currently under evaluation within the Company and an active effort to find appropriate partners for the program is underway.\nIn 1995, 1994 and 1993, the Company spent approximately $3.22 million, $2.11 million and $2.06 million, respectively, on research and development.\nSCIENCE PROGRAM PROGRESS\nBeginning in 1995, the Company created a program to enhance its standing in the scientific and medical community regarding IMRE's technology, with particular attention to be focused on its application for rheumatoid arthritis. The program includes using the services of a scientific advisory board and a group of consultants. The scientific advisory board's primary function is to evaluate IMRE's clinical development program.\nThe scientific advisory board is composed of internationally recognized rheumatologists including Gerald T. Nepom, Ph.D., M.D., Scientific Director of the Virginia Mason Research Center in Seattle, Washington, and Harold E. Paulus, M.D., Professor of Medicine, Division of Rheumatology, UCLA School of Medicine. In addition, K. Frank Austen, M.D., Director, Inflammation & Allergic Diseases Research Section, Division of Rheumatology & Immunology, Harvard Medical School, serves as a consultant to the scientific advisory board.\nMARKETING AND CUSTOMERS\nDISTRIBUTION AGREEMENT WITH BAXTER\nHistorically, the PROSORBA-Registered Trademark- column was sold by the Company's internal sales force to physicians in the fields of immunology, hematology and oncology. The Company's domestic sales force consisted of 15 sales representatives, all of whom had technical backgrounds and prior sales experience in the medical products area. The Company's marketing program included direct mail, telemarketing, journal advertising, trade show participation, and physician seminars.\nIn February 1994, the Company entered into a 10-year exclusive distribution agreement, with certain \"take or pay\" and purchase commitments, with Baxter Healthcare Corporation (\"Baxter\") granting distribution rights of its PROSORBA- Registered Trademark- column in the United States and Canada for the treatment of thrombocytopenia and the first right to negotiate for new PROSORBA-Registered Trademark- column indications. Baxter assumed its sales and distribution responsibilities in April 1994. Baxter, at its own expense, was to provide sales and marketing support for the sale of the product during the term of the agreement. The Company was to provide significant marketing and promotional support to Baxter for the first three years of the agreement. The Company no longer maintains a domestic internal sales force.\nThe \"take or pay\" commitments and purchase minimums were primarily subject to the Company having FDA marketing approval for immune thrombocytopenic purpura and the lack of any new significant competitive technology being introduced before October 1995 to the thrombocytopenia therapy marketplace. The Company received a response from the FDA in January 1995 to a PMA supplement filed in March 1993 requesting the name of the Company's approved indication be changed from idiopathic thrombocytopenic purpura to immune\nthrombocytopenic purpura. The request was made by the Company as it believes the two names are used interchangeably by the medical community. The FDA's response denied the Company's request for such a change.\nAs a result of the FDA action, Baxter exercised its right to re-negotiate minimums in February 1995. In March 1995, the two companies amended the agreement whereby Baxter: (a) made a take-or-pay payment for the first sales year of $3.0 million on March 31, 1995 compared to the original $3.5 million due, (b) agreed to purchase $1.0 million of product during the second quarter of 1995, (c) released the Company from its obligation to provide marketing and promotional support for the second and third years of the agreement, (d) gave the Company the right to co-market with Baxter, (e) relinquished its first right to negotiate for new PROSORBA-Registered Trademark- column indications, and (f) agreed under certain circumstances to provide advance payments to the Company for Baxter's 1996 purchases. The Company has agreed to eliminate purchase minimums and the take-or-pay concept included in the original agreement and has freed Baxter to pursue competing thrombocytopenia therapies. The term of the agreement remains ten years, and consistent with the original agreement, both companies have agreed to review the terms at the end of the third year. Both companies have the right to terminate the agreement as of September 30, 1997, if the parties are unable to agree on terms for the remainder of the agreement or based on performance through September 30, 1997.\nOTHER\nIn the international arena, the Company has entered into exclusive agreements for distribution of the PROSORBA-Registered Trademark- column in Spain, Korea, Mexico, Brazil, Argentina, and Hong Kong. However, sales to international customers represent less than 10% of the Company's product sales.\nGenerally, in the United States the cost of treatment for ITP using the PROSORBA-Registered Trademark- column has been reimbursed by third-party payers.\nNo customer represented more than 10% of the Company's annual sales during the year ended December 31, 1993. For the years ended December 31, 1994 and 1995, sales to Baxter represented approximately 70% and 91% respectively, of the Company's sales.\nPATENTS AND PROPRIETARY TECHNOLOGY\nThe Company believes that its success depends primarily on the experience, capabilities, and skills of its personnel. Notwithstanding this fact, however, the Company seeks to protect its intellectual property rights by a variety of means, including patents, maintaining trade secrets and proprietary know-how, and technological innovation to develop and maintain its competitive position. There can be no assurance that the Company will be able to obtain additional patents either in the United States or in foreign jurisdictions or that, if issued, such patents will provide sufficient protection or be of commercial benefit to the Company. Insofar as the Company relies on trade secrets and unpatented proprietary know-how, there can be no assurance that others will\nnot independently develop similar technology or that secrecy will not be breached. Finally, there can be no assurance that the Company will be able to develop further technological innovations.\nThe Company presently owns nine issued U.S. patents and four foreign patents which expire during 2004 to 2009. The process used in manufacturing the PROSORBA-Registered Trademark- column is covered by one of these patents. The Company has an exclusive license for a U.S. patent for a genetic screening test to predict which rheumatoid arthritis patients will develop severe disease. In addition, the Company has an exclusive license for a U.S. patent for treating cellular Fc receptor-mediated hypersensitivity immune disorders.\nThere can be no assurance that the Company's patents will afford commercially significant protection of its proprietary technology or have commercial application. There has been no judicial determination of the validity or scope of its proprietary rights. Moreover, the patent laws in foreign countries may differ from those of the United States, and the degree of protection afforded by foreign patents may be different.\nOthers have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights relating to products or processes competitive with those of the Company. The scope and validity of such patents is presently unknown. If existing or future patents are upheld as valid by courts, the Company may be required to obtain licenses to use technology covered by such patents.\nIn November 1995, a complaint was filed with the United States District Court, Northern District of California, claiming that the Company's PROSORBA- Registered Trademark- column allegedly infringes a patent issued to David S. Terman, M.D. which was assigned in July 1993 to DTER-ENT, Inc., a California corporation. The Company first received notice of a claim of infringement from DTER-ENT, Inc. in July 1993. The Company has disclosed this claim in its public filings for the past two years. The Company has reviewed this matter with patent counsel and has been advised that the claims of the patent allegedly infringed are invalid or unenforceable or that the PROSORBA-Registered Trademark- column does not infringe the claims. Although the Company intends to vigorously contest the claim, there can be no assurances that the Company will be successful.\nOpinions of patent counsel are based upon certain facts and information available at the time such opinions are rendered. The prosecution and defense of validity and infringement issues before the forums in which such issues may be raised are complicated, and it is not possible to predict the outcome with certainty. Opinions of patent counsel are not binding on such forums.\nVarious scientific personnel of the Company in the past have been associated with non-profit research or educational institutions that typically require researchers to execute agreements giving such institutions broad rights to inventions created or developed during the period that the scientist is associated with such institution. The Company's Chairman of the Board and Chief Scientific Officer Dr. Frank R. Jones have been parties to such agreements in the past. While no such institution has to date asserted rights to the Company's technology, such assertions may be made in the future. If such assertions are made, the Company may be forced to litigate to protect its rights to such technology.\nPROSORBA-Registered Trademark- column is a registered trademark of the Company.\nFDA REGULATIONS AFFECTING THE COMPANY\nThe PROSORBA-Registered Trademark- column is regulated by the FDA as a Class III device. The regulatory approval of a Class III device in the United States intended for therapeutic use in humans involves many steps including preclinical and clinical testing. Preclinical evaluation of a Class III device includes testing to demonstrate that in clinical studies with human subjects the product would not present an unreasonable hazard. Preclinical evaluation of the PROSORBA-Registered Trademark- column was conducted as part of the approval process for treatment of patients with ITP.\nFor each additional disease that the Company wants to treat with the PROSORBA-Registered Trademark- column, clinical testing must be conducted. Before such clinical testing can begin, an investigational device exemption (\"IDE\") application must be prepared and filed with the FDA. This application consists of (i) information on the composition of the product, (ii) manufacturing data, (iii) results of all preclinical safety and effectiveness studies, and (iv) a design of the study and protocol. If the application has not been denied or if additional information has not been requested by the FDA within 30 days of submission, the applicant may then begin clinical trials.\nThe clinical testing of a device may consist of a preliminary feasibility study leading to a larger study of safety and effectiveness, or it may consist of only the larger safety and effectiveness study. Upon completion of the study and compilation of the data, a pre-market approval (\"PMA\") application can be filed. The FDA is required to respond to the PMA submission within 180 days, although the FDA may not and often does not adhere to this schedule and further review may take additional time. After the FDA completes its review of the PMA application, the clinical study data is reviewed by an advisory panel of medical experts who are not part of the FDA. The applicant is required to answer questions posed by this panel. Based on its review of the data, the advisory panel may make a recommendation of approval or nonapproval to the FDA. The FDA usually follows the recommendation of the panel but is not required to. Assuming the advisory panel recommends approval of the PMA, the FDA may approve the application and the product may then be commercially distributed.\nThe manufacture and distribution of medical devices are subject to continuing FDA regulation. In addition to the requirement that the device be marketed only for its approved uses, applicable law requires compliance with the FDA's good manufacturing practices (\"GMP\") regulations. Failure to comply with the GMP regulations or with other applicable legal requirements can lead to federal seizure of volatile products, injunctive actions brought by the federal government, and potential criminal liability on the part of the Company and of the officers and employees of the Company who are responsible for the activities that lead to the violations.\nEven though the Company has received marketing approval from the FDA for the treatment of ITP with the PROSORBA-Registered Trademark- column, there can be no assurance that any marketing clearances for other diseases or products will be granted on a timely basis, or at all, or that it will be economically feasible to commercialize the PROSORBA-Registered Trademark- column for these other diseases. The FDA may also require post-marketing testing and surveillance programs to monitor the\neffectiveness and safety of the Company's products. Product marketing approvals may be withdrawn for noncompliance with regulatory standards or the occurrence of unforeseen problems following initial marketing.\nThe PROSORBA-Registered Trademark- column is commercially distributed under a PMA that was approved by the FDA in 1987. Changes to the product and its manufacturing process, and certain types of labeling changes must be approved by the FDA prior to implementation. The Company currently has one supplement to the PMA pending with the FDA for a labeling change, such change dealing with the use of ancillary equipment during the use of the PROSORBA-Registered Trademark- column. The FDA has indicated to the Company that the PMA supplement would be approvable if certain additional information is provided. There can be no assurance that any future supplements will be approved by the FDA.\nCOMPETITION\nThe PROSORBA-Registered Trademark- column, as well as other products which may be developed by the Company in the future, are intended to compete with conventional methods of treatment which generally consist of surgery, drug, or radiation therapy and which have been accepted by the medical community as classical treatment methods. In addition, the Company intends to compete with methods of treatment focusing on the artificial stimulation and\/or modification of the human immune system by material or synthetic drugs or genetically engineered compounds which are being pursued by numerous biotechnology and medical companies and research institutions. Many of the Company's potential competitors have significantly greater resources than the Company. The PROSORBA-Registered Trademark- column as well as the other products currently under consideration for development by the Company represent a different approach to the treatment of immune-related diseases inasmuch as they focus on the removal of CIC that are suppressive to the body's immune system. The Company is aware of a select number of other companies which are known to be pursuing approaches to disease treatment similar to the Company's methodology. In addition, it is always possible that established companies and research institutions with greater resources may develop other treatment methods for various diseases.\nThe Company believes that its success will depend primarily on, among other things, the market acceptance of its therapeutic approach, its scientific expertise, the PROSORBA-Registered Trademark- column's performance measured against competing products, adequate funding, and on its ability to develop, protect, and market products in the future.\nThe Company's competitive success will also depend on its continued ability to attract and retain skilled and experienced personnel, to develop and secure the rights to advanced proprietary technology and to commercially exploit its technology prior to the development of competitive products by others.\nRAW MATERIALS SUPPLY\nThe Company believes that raw materials and other components are available in sufficient quantities to meet production requirements for the PROSORBA- Registered Trademark- column. Sale of the PROSORBA-Registered Trademark- column is not subject to seasonal fluctuation.\nHUMAN RESOURCES\nIn early January 1996, the Company notified approximately twenty employees, which was slightly greater than half of its work force, that their positions were being terminated immediately as part of a restructuring. Such positions were from all departments of the Company. As of January 31, 1996, the Company employed approximately 20 full-time employees, including seven who have doctorate degrees and three who are registered nurses.\nNone of the Company's employees is covered by a collective bargaining agreement, and the Company considers its employee relations to be excellent.\nMANAGEMENT CHANGES\nIn December 1995, Martin D. Cleary resigned as Chief Executive Officer and a member of the Board of Directors of the Company, and Harvey J. Hoyt resigned as Executive Vice President and a member of the Board of Directors. Jay D. Kranzler, M.D., Ph.D. was appointed as Chief Executive Officer and Vice Chairman of the Board of Directors and Debby Jo Blank, M.D. was appointed as President, Chief Operating Officer and a member of the Board of Directors. Frank R. Jones, Ph.D. serves as the Company's Chief Scientific Officer and Chairman of the Board of Directors.\nRESTRUCTURING PLAN\nThe Company is in the process of implementing a substantial restructuring plan. The restructuring plan includes a streamlining of operations and a pending relocation of all operations of the Company, except manufacturing operations, to San Diego, California by the end of 1996. Such a restructuring and relocation is expected to result in the loss of a majority of the employees of the Company. In parallel, the Company's new management is reviewing the Company's current activities and long term strategy, which also may be subject to revision.\nRISK FACTORS\nExcept for the historical information contained herein, the following discussion contains forward-looking statements within the meaning of Section 21E of the Exchange Act that involves risks and uncertainties. The Company's actual results could differ materially from those discussed below and elsewhere in this Report. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this Report. In analyzing the Company and its business, investors should carefully consider, among other things, the following risk factors:\nNEED FOR ADDITIONAL CAPITAL.\nThe Company is actively seeking opportunities to raise additional capital through the private equity market or corporate partners. Such capital would be used primarily to support research and development activities, including funding clinical trials for rheumatoid arthritis and certain platelet disorders. The amount of required capital is primarily dependent upon the following: results of clinical trials, results of current research and development efforts, the FDA regulatory process, potential competitive and technological advances, and levels of product sales. Because the Company is unable to predict the outcome of the previously noted factors, some of which are\nbeyond the Company's control, the Company is unable to estimate, with certainty, its mid- to long-term total capital needs. If the Company is unable to obtain additional financing, however, it may be required to delay, scale back or eliminate some or all of its activities, to license to third parties technologies that the Company would otherwise seek to develop itself, to seek financing through the debt market and\/or to seek additional methods of financing.\nHISTORY OF OPERATING LOSSES.\nThe Company has operated at a loss since its formation in October, 1981. In the years ended December 31, 1994 and 1995, the Company had revenues of $4,918,126 and $4,104,224 and net losses of $6,151,312 and $6,826,252, respectively. As of December 31, 1995, the Company had an accumulated deficit of $44,041,634. The ability of the Company to achieve profitability is dependent upon successful completion of anticipated clinical trials and obtaining FDA marketing approval of the PROSORBA-Registered Trademark- column for the treatment of additional diseases in a timely manner, among other factors. The Company would have to significantly scale back its plans, curtail clinical trials, and limit its present operations in order to become profitable or operate on a break-even basis if it does not receive marketing approval from the FDA for the PROSORBA-Registered Trademark- column for the treatment of diseases in addition to idiopathic thrombocytopenic purpura (\"ITP\"). There can be no assurance that the Company will meet applicable regulatory standards or successfully market its products to generate sufficient revenues to render the Company profitable.\nMANAGEMENT CHANGES; RESTRUCTURING PLAN; DEPENDENCE UPON KEY PERSONNEL.\nThe Company has recently undergone changes in senior management and new management is in the process of developing and implementing a substantial restructuring plan. The restructuring plan has not been completed and there can be no assurance that it will be completed. Even if such a restructuring plan is completed, there can be no assurance that the restructuring will be successfully implemented. The Company's success is dependent upon certain key management and technical personnel, including the new senior management members. The loss of the services of any of these key employees could have a material adverse effect on the Company. See \"Management Changes\" and \"Restructuring Plan.\"\nFDA APPROVAL AND REGULATIONS.\nThe Company is currently planning to conduct a controlled clinical trial of the PROSORBA-Registered Trademark- column for treatment of rheumatoid arthritis. Although the FDA has approved the commercial sale of the PROSORBA-Registered Trademark- column for the treatment of ITP, there can be no assurance that current or future clinical trials will produce data satisfactory to the FDA to establish the effectiveness of the PROSORBA-Registered Trademark- column for treatment of diseases other than ITP, such as rheumatoid arthritis, transplantations and certain cancers, or that the FDA will approve the PROSORBA- Registered Trademark- column for treatment of such diseases in a timely manner, if at all.\nThe PROSORBA-Registered Trademark- column is commercially distributed under a pre-market approval (\"PMA\") application that was approved by the FDA in 1987. Changes to the product and its manufacturing process, and certain types of labeling changes must be approved by the FDA prior to\nimplementation. The Company currently has one supplement to the PMA pending with the FDA for a labeling change dealing with the use of ancillary equipment during the use of the PROSORBA-Registered Trademark- column. The FDA has indicated to the Company that the PMA supplement would be approvable if certain additional information is provided. There can be no assurance that the Company will receive approval of its pending PMA supplement or any future PMA supplements will be approved by the FDA.\nEven if FDA approval is granted to market a product for treatment of a particular disease, subsequent discovery of previously unknown problems may result in restrictions on the product's future use or withdrawal of the product from the market. In addition, any other products developed in the future will require clinical testing and FDA marketing approval before they can be commercially exploited in the United States. Such approval process is typically very lengthy and there is no assurance that approvals will be obtained.\nThe manufacture and distribution of medical devices are subject to continuing FDA regulation. In addition to the requirement that the device be marketed only for its approved use, applicable law requires compliance with the FDA's good manufacturing practices (\"GMP\") regulations. Failure to comply with the GMP regulations or with other applicable legal requirements can lead to federal seizure of non-complying products, injunctive actions brought by the federal government, and potential criminal liability on the part of the Company and of the officers and employees of the Company who are responsible for the activities that lead to the violations.\nCOMPETITIVE ENVIRONMENT; TECHNOLOGICAL CHANGE; EFFECTIVENESS OF PRODUCTS.\nThe field of medical devices in general and the particular areas in which the Company will market its products are extremely competitive. In developing and marketing medical devices to treat immune-mediated diseases and cancers, the Company competes with other products, therapeutic techniques and treatments which are offered by national and international healthcare and pharmaceutical companies, many of which have greater marketing, human and financial resources than the Company.\nThe immunological therapies market is characterized by rapid technological change and potential introductions of new products or therapies. To respond to these changes, the Company may be required to develop or purchase new products to protect its technology from obsolescence. There can be no assurance that the Company will be able to develop or obtain such products, or, if developed or obtained, that such products will be commercially viable. In addition, there can be no\nassurance that the Company's products will prove effective in the treatment of diseases other than ITP.\nDEPENDENCE OF THIRD PARTY ARRANGEMENTS.\nThe Company's commercial sale of its proposed products and its future product development may be dependent upon entering into arrangements with corporate partners and other third parties for the development, marketing, distribution and\/or manufacturing of products utilizing the Company's proprietary technology. While the Company is currently seeking collaborative research and development arrangements and joint venture opportunities with corporate sponsors and other partners, there can be no assurance that the Company will be successful in entering into such arrangements or joint ventures or that any such arrangements will prove to be successful.\nEXCLUSIVE AGREEMENT WITH BAXTER.\nIn February 1994, the Company entered into a 10-year exclusive distribution agreement, with Baxter Healthcare Corporation (\"Baxter\") granting to Baxter distribution rights of its PROSORBA-Registered Trademark- column in the United States and Canada for the treatment of thrombocytopenia and the first right to negotiate for new PROSORBA-Registered Trademark- column indications. The distribution agreement also contained certain \"take or pay\" and minimum purchase committments. Baxter, at its own expense, was to provide sales and marketing support for the sale of the product during the term of the agreement. Baxter assumed the Company's sales and distribution responsibilities in April 1994. The Company was to provide significant marketing and promotional support to Baxter for the first three years of the agreement. The Company no longer maintains a domestic sales force.\nThe \"take or pay\" commitments and purchase minimums were primarily subject to the Company having FDA marketing approval for immune thrombocytopenic purpura and the lack of any new significant competitive technology being introduced before October 1995 to the thrombocytopenia therapy marketplace. The Company received a response from the FDA in January 1995 to a PMA supplement filed in March 1993 requesting the name of the Company's approved indication be changed from idiopathic thrombocytopenic purpura to immune thrombocytopenic purpura. The request was made by the Company as it believes the two names are used interchangeably by the medical community. The FDA's response denied the Company's request for such a change.\nAs a result of the FDA action, in February 1995 Baxter exercised its right to re-negotiate the minimum purchase commitments. In March 1995, the two companies amended the agreement whereby Baxter: (a) made a take-or-pay payment for the first sales year of $3.0 million on March 31, 1995 compared to the original $3.5 million due, (b) agreed to purchase $1.0 million of product during the second quarter of 1995, (c) released the Company from its obligation to provide marketing and promotional support for the second and third years of the agreement, (d) gave the Company the right to co-market with Baxter, (e) relinquished its first right to negotiate for new PROSORBA-Registered Trademark- column indications, and (f) agreed under certain circumstances to provide advance payments to the Company for Baxter's 1996 purchases. The Company has agreed to eliminate purchase minimums and the take-or-pay concept included in the original agreement and freed Baxter to pursue competing thrombocytopenia therapies. The term of the agreement remains ten years, and consistent with the\noriginal agreement, both companies have agreed to review the terms at the end of the third year. Both companies have the right to terminate the agreement as of September 30, 1997, if the parties are unable to agree on terms for the remainder of the agreement or based on performance through September 30, 1997.\nNo assurance can be given that Baxter will maximize the Company's potential sales in North America, or that Baxter will be successful in marketing the Company's PROSORBA-Registered Trademark- column.\nUNCERTAINTY OF PATENT PROTECTION AND CLAIMS TO TECHNOLOGY.\nThe Company currently holds nine United States and four foreign patents relating to its technology, and has also filed other patent applications. In addition, the Company has an exclusive license for a U.S. patent for a genetic screening test to predict which rheumatoid arthritis patients will develop the severe form of the disease. Neither the protection afforded by these patents nor their enforceability can be assured. Furthermore, there can be no assurance that additional patents will be obtained either in the United States or in foreign jurisdictions or that, if issued, such additional patents will provide sufficient protection to the Company's technology or be of commercial benefit to the Company. Insofar as the Company relies on trade secrets and unpatented proprietary know-how, there can be no assurance that others will not independently develop similar technology or that secrecy will not be breached. There can also be no assurance that the Company will be able to develop further technological innovations.\nOthers have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights relating to products or processes competitive with those of the Company. The scope and validity of such patents is presently unknown. If existing or future patents are challenged in litigation or interference proceedings, the Company may become subject to significant liabilities to third parties or be required to seek licenses from third parties. There can be no assurance that such licenses would be available or, if available, obtainable on acceptable terms.\nIn November 1995, a complaint was filed with the United States District Court, Northern District of California, claiming that the Company's PROSORBA- Registered Trademark- column allegedly infringes a patent issued to David S. Terman, M.D., which patent subsequently was assigned in July 1993 to DTER-ENT, Inc., a California corporation. The Company first received a notice of a claim of infringement from DTER-ENT, Inc. in July 1993. Althought the Company intends to vigorously contest the claim, there can be no assurances that the Company will be successful.\nIn addition, various scientific personnel of the Company were previously associated with non-profit research or education institutions that typically require researchers to execute agreements giving such institutions broad rights to inventions created or developed during the period that the scientist is associated with such institution. Dr. Frank R. Jones, Chairman of the Board and Chief Scientific Officer of the Company, has been a party to such agreements in the past. While no such institution has to date asserted rights to the Company's technology, such assertions may be made in the future, and if made, there can be no assurances that the Company will be successful in any such litigation.\nCONCENTRATION OF OWNERSHIP.\nAllen & Company Incorporated beneficially owns approximately 18.1% of the outstanding Common Stock of the Company and is the largest stockholder of the Company.\nSALES AND MARKETING.\nIn addition to marketing through Baxter, the Company also conducts limited marketing of the PROSORBA-Registered Trademark- column outside the United States through foreign distributors. Sales to foreign distributors have not been material to the Company's results from operations. There can be no assurance, however, that such domestic sales efforts or foreign sales arrangements will become material to the Company's results of operations.\nINSURANCE REIMBURSEMENT.\nSuccessful commercialization of a new medical product, such as the PROSORBA-Registered Trademark- column depends, in part, on reimbursement by public and private health insurers to health care providers for use of such product. The availability of such reimbursement is subject to a variety of factors, many of which could affect the Company as it commercializes use of the PROSORBA-Registered Trademark- column. Although, the Company has been generally successful in assisting health care providers in arranging reimbursement for the use of the PROSORBA-Registered Trademark- column in the treatment of ITP, there can no assurance that public and private insurers will continue to reimburse for the use of the PROSORBA-Registered Trademark- column.\nUNCERTAINTY OF HEALTH CARE REFORM.\nThere are widespread efforts to control health care costs in the U.S. and worldwide. Various federal and state legislative initiatives regarding health care reform and similar issues continue to be at the forefront of social and political discussion. These trends may lead third-party payors to decline or limit reimbursement for the Company's product, which could negatively impact the pricing and profitability of, or demand for, the Company's product. The Company believes that government and private efforts to contain or reduce health care costs are likely to continue. There can be no assurance concerning the likelihood that any such legislative or regulatory initiative will be enacted, or market reform initiated, or that, if enacted such reform or initiative will not result in a material adverse impact on the business, financial condition or results of operations of the Company.\nPRODUCT LIABILITY.\nThe use of the PROSORBA-Registered Trademark- column involves the possibility of adverse effects occurring to end-users that could expose the Company to product liability claims. Although the Company currently maintains product liability insurance coverage, there can be no assurance that such coverage or any increased amount of coverage will be adequate to protect the Company and there can be no assurance that the Company will have sufficient resources to pay any liability resulting from such a claim.\nPOSSIBLE VOLATILITY OF STOCK PRICE; ABSENCE OF DIVIDENDS.\nThere has been a history of significant volatility in the market prices of securities of biotechnology companies, including the Company's Common Stock. Factors such as announcements by the Company or others of technological innovations, results of clinical trials, new commercial products, regulatory approvals or proprietary rights developments, coverage decisions by third-party payers for therapies and public concerns regarding the safety and other implications of biotechnology all may have a significant impact on the Company's business and market price of the Company's Common Stock. No dividends have been paid on the Common Stock to date, and the Company does not anticipate paying cash dividends on the Common Stock in the foreseeable future.\nHAZARDOUS MATERIAL.\nThe Company's research and development programs involve the controlled use of biohazard materials, such as viruses including the HIV virus that causes AIDS. Although the Company believes that its safety procedures for handling such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result, and any such liability could exceed the resources of the Company.\nLIMITATION OF NET OPERATING LOSS CARRY FORWARDS.\nThe Company's sale of Common Stock in November 1990, September 1991, April 1993, and January 1996 when taken together with prior issuances, caused the limitation of Section 382 of the Internal Revenue Code of 1986, as amended (the \"Internal Revenue Code\"), to be applicable. This limitation will allow the Company to use only a portion of the net operating losses which it has accumulated in any future year to offset future taxable income, if any, for federal income tax purposes. Based on the limitations of Section 382 and before consideration of the effect of the sale of securities offered hereby, the Company may be allowed to use no more than approximately $3,700,000 of such losses each year to reduce taxable income, if any. To the extent not utilized by the Company, unused losses will carry forward subject to the limitations to offset future taxable income, if any, until such unused losses expire. All unused net operating losses will expire 15 years after any year in which they were generated. The years in which such expiration will take place range from 1998-2010.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn October 1991, the Company entered into an eight-year lease for 14,400 square feet of production, laboratory and administrative facilities in Seattle, Washington. The Company assembles the PROSORBA-Registered Trademark- column at these facilities.\nThe Company leases 8,000 square feet for its raw materials manufacturing facility in Redmond, Washington. The facility is used to produce commercial quantities of both protein A\nand the chemically coated silica matrix used in the manufacture of the PROSORBA- Registered Trademark- column. The Company's lease expires in 2004.\nBoth of the Company's manufacturing facilities comply with the FDA's GMP regulations.\nIn 1996, the Company intends to combine the manufacturing operations in its Redmond facility and seek a tenant to assume its lease for the facility in Seattle. The Company believes that the combined facility will be adequate to meet the foreseeable manufacturing requirements of the Company. The Company intends to occupy office space in San Diego, California for its administrative, research and medical personnel.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn February 15, 1994, the Company issued a press release announcing the restatement of its results of operations for the third quarter ended September 30, 1993. The Company filed a Current Report on Form 8-K, dated June 23, 1994, with the Securities and Exchange Commission with respect to changing the Company's certifying accountant. On August 16, 1994, the Company received a letter from the Commission notifying the Company that the Commission was conducting a preliminary inquiry into the restatement of the Company's results of operations and the change in the Company's certifying accountant and requesting certain information. The Company has cooperated with the Commission. In January 1996, Commission staff notified the Company that it intended to propose that the Commission initiate proceedings to seek injunctive relief against the Company enjoining it from future violations of the federal securities laws. The Commission staff further advised the Company that it intended to seek similar injunctive relief and civil penalties against Alex P. de Soto, the Chief Financial Officer of the Company. The Commission invited both the Company and Mr. de Soto to prepare and file with the Commission a Wells Submission to provide the Commission with any additional relevant information prior to formal action by the Commission. The Company is fully cooperating with the Commission staff in order to resolve the matters as expeditiously as possible.\nIn November 1995, a complaint was filed with the United States District Court, Northern District of California, claiming that the Company's PROSORBA- Registered Trademark- column allegedly infringes a patent issued to David S. Terman, M.D. which was assigned in July 1993 to DTER-ENT, Inc., a California corporation (\"DTER-ENT\"). The Company first received notice of a claim of infringement from DTER-ENT in July 1993. The Company has disclosed this claim in its public filings for the past two years. The Company has reviewed this matter with patent counsel and has been advised that the claims of the patent allegedly infringed are invalid or unenforceable or that the PROSORBA-Registered Trademark- column does not infringe the patent rights of DTER-ENT.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nAs of December 15, 1995, the Company had received written consents from the holders of 10,154,722 shares of Common Stock, representing 54.66 percent of the 18,579,148 shares of Common Stock outstanding on November 6, 1995, the record date for the consent solicitation,\nauthorizing an amendment to the Certificate of Incorporation of the Company to authorize a new class of \"blank check\" preferred stock and give the Board of Directors the authority to fix by resolution or resolutions any of the designations and the powers, preferences and rights and the qualifications, limitations or restrictions thereof, of series of preferred stock of the Company.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\na) The Company's Common Stock is traded on the Nasdaq Small Cap Market. The principal market for the Company's Common Stock is the over-the- counter market. Set forth below are the high and low closing bid prices for the Company's Common Stock for each quarter of 1995 and 1994 as reported by the Nasdaq Stock Market, Inc.\nThe above quotations are interdealer prices, without retail mark-up, mark- down, or commission and may not necessarily represent actual transactions.\nb) At January 31, 1996, there were approximately 1,100 holders of record of the Company's Common Stock.\nc) The Company has never paid cash dividends on its 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 RESULT OF OPERATIONS\nExcept for the historical information contained herein, the following discussion contains forward looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as in Item 1 and Item 2 contained herein.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital as of December 31, 1995, 1994 and 1993 was a deficit of $0.69 million, and a positive balance of $4.36 million and $3.79 million, respectively. The $5.05 million decrease in working capital in 1995 is principally attributable to the $6.83 million loss from operations for the year ended December 31, 1995 and $0.71 million of capital expenditures which were partially offset by $2.50 million of expenses which did not impact working capital. The $0.57 million increase in working capital in 1994 is principally attributable to $4.25 million of proceeds from the April 1994 issuance of 7% Convertible Debentures due March 31, 2001, (the \"7% Convertible Debentures\") and $2.63 million of proceeds from a private placement of common stock in December 1994, offset by the $6.15 million loss from operations for the year ended December 31, 1994.\nThe Company expects to incur further operating losses until the Company can obtain marketing approval from the FDA for additional disease indications for the PROSORBA-Registered Trademark- column or until sales to the Company's North American distributor, Baxter Healthcare Corporation, for the PROSORBA-Registered Trademark- column for its existing indication of idiopathic thrombocytopenic purpura increase significantly. A controlled clinical trial is planned in 1996 for using the PROSORBA-Registered Trademark- column for rheumatoid arthritis therapy as a follow on to a successful pilot clinical trial completed in 1995. The Company believes that a successful clinical trial would be necessary to attract corporate partners to fund a subsequent pivotal clinical trial. A successful pivotal clinical trial is necessary to apply for marketing approval from the FDA.\nIn September 1995, the Company completed an exchange offering to holders of its 7% Convertible Debentures. The Company offered to exchange the 7% Convertible Debentures for common stock at a price of $2.25 per share. Of the original $4,245,000 outstanding principal amount of the 7% Convertible Debentures, $2,200,000 was converted pursuant to the exchange offering. Subsequent to September 1995, an additional $700,000 of 7% Convertible Debentures has been converted into Common Stock under their original $2.875 per share conversion price. As of December 31, 1995, there was outstanding principal of $1,345,000 of the 7% Convertible Debentures.\nIn January 1996, the Company completed a private placement of approximately 8.5 million shares of its Common Stock resulting in net proceeds to the Company of approximately $12.0 million (the \"Private Placement\").\nIn January 1996, the Company also began implementing a restructuring plan which includes consolidating its manufacturing facilities to one location in the state of Washington and moving all other operations of the Company to San Diego, California. As part of the restructuring plan, the Company, in January 1996, notified approximately twenty employees, which was slightly greater than half of its work force, that their positions were being terminated immediately. The annual salary savings from this reduction in the work force is expected to be in excess of $1.0 million. The Company estimates it will incur approximately $1.0 million of capital expenditures to consolidate its two Washington manufacturing facilities. The Company believes that the funds resulting from the Private Placement coupled with the Company's restructuring will provide the resources necessary to fund operations, including clinical trials, through the latter half of 1997.\nThe Company will require additional financing in order to fund the completion of a pivotal clinical trial in rheumatoid arthritis, initiate pivotal clinical trials using the PROSORBA-Registered Trademark- column in other diseases and apply the Company's technology to applications beyond the PROSORBA- Registered Trademark- column. The Company is seeking corporate partners to fund additional clinical trials.\nThe principal changes in the components of working capital since December 31, 1994 were a $2.66 million decrease in cash resulting from the excess of cash expenditures for 1995 over the $1.0 million of proceeds received from debt financing, a $0.39 million decrease in trade accounts receivable resulting from the lower amount of sales during the end of 1995 compared to 1994, a decrease of $0.35 million in inventory to reflect the lower sales demands of Baxter, and a combined increase of $0.54 million in accounts payable, accrued compensation and accrued liabilities due primarily to increasing payment cycles to suppliers to preserve the Company's cash position as of December 31, 1995.\nRESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994\nEffective April 2, 1994, the Company entered into a 10-year exclusive distribution agreement with Baxter Healthcare Corporation granting distribution rights for the treatment of thrombocytopenia and the first right to negotiate for new PROSORBA-Registered Trademark- column indications. The agreement provided for an annual \"take or pay\" commitment from Baxter to the Company for the first two sales years. These minimums were subject to the Company having FDA product approval for immune thrombocytopenic purpura.\nThe Company received a response from the FDA in January 1995 to a pre- market application (PMA) supplement filed in March 1993 requesting the name of the Company's approved indication be changed from idiopathic thrombocytopenic purpura to immune thrombocytopenic purpura. The request was made by the Company as it believed the two names are used interchangeably by the medical community. The FDA's response denied the Company's request for such a change.\nAs a result of the FDA action, Baxter exercised its right to re-negotiate minimums in February 1995. In March 1995, the two companies amended the agreement whereby Baxter: 1) made a take-or-pay payment for the first sales year of $3.0 million compared to the original $3.5 million due March 31, 1995, 2) purchased $1.0 million of product during the second quarter of 1995, 3) released the Company from its obligation to provide marketing and promotional support for the second and third years of the agreement, 4) gave the Company the right to co-market with Baxter, 5) relinquished its first right to negotiate for new PROSORBA-Registered Trademark- column indications, and 6) under certain circumstances, agreed to provide advance payments to the Company for Baxter's 1996 purchases. The Company agreed to eliminate purchase minimums and the take- or-pay concept included in the original agreement and freed Baxter to pursue competing thrombocytopenia therapies. The term of the agreement remains ten years and consistent with the original agreement, both companies agreed to review the terms at the end of the third year. Both companies have the right to terminate the agreement as of September 30, 1997 if the parties are unable to agree on terms for the remainder of the agreement or based on performance through September 30, 1997.\nThe impact of the revised Baxter agreement referred to above had a variety of effects on the operations of the Company during the year ended December 31, 1995. The Company's revenue included the $3.0 million take or pay payment made by Baxter in March 1995 and sales and marketing costs relative to sales decreased based on Baxter agreeing to assume all marketing and promotional costs.\nNet sales decreased 77.5% from $4.92 million in 1994 to $1.10 million in 1995. Approximately 91% of the 1995 sales were to Baxter, with the remaining 9% primarily to international customers of the Company. The decrease in net sales was due primarily to Baxter selling approximately 50% less product to customers than when the Company sold directly to health care providers. In addition, there is a lower sales price charged to Baxter than the Company previously charged to its customers. A substantial amount of the columns shipped by the Company to Baxter remained in Baxter's ending inventory as of December 31, 1995 because of continued delays by Baxter in fully implementing a sales and marketing program for the PROSORBA-Registered Trademark- column. The Company is unable to predict if shipments in 1996 will exceed those of 1995.\nTotal operating expenses, excluding $2.08 million of non-recurring charges, decreased 19.5% from $11.14 million in 1994 to $8.97 million in 1995. Production costs decreased 20.6% from $2.57 million in 1994 to $2.04 million in 1995. The decrease is primarily a result of the decrease in the number of units shipped in 1995 compared to 1994. The majority of production costs in 1995 represent labor and overhead charges as no significant production occurred during the last six months of 1995. As a result of the previously discussed restructuring, the Company is working to reduce its manufacturing overhead, including a reduction of personnel.\nSales and marketing expenses decreased 76.9% from $3.55 million in 1994 to $0.82 million in 1995. Such expenses decreased primarily because beginning April 1, 1995, under the revised distribution agreement, Baxter provided complete sales and marketing support for the sale of the product. The Company no longer maintains a sales force and terminated three sales employees in 1995 as part of the amended Baxter agreement.\nResearch and development expenses increased 52.7% to $3.22 million in 1995 from $2.11 million in 1994. The increase was primarily a result of the Company conducting its rheumatoid arthritis clinical trial for 15 patients in 1995 and the commencement of a pilot clinical trial in kidney transplantation during the last six months of 1995. In 1994, the Company began its rheumatoid arthritis clinical trial during the last six months of the year and conducted no other clinical trials. In January 1996, the Company suspended enrollment of patients in its kidney transplantation study while it evaluates the merits of continuing the study in light of other clinical opportunities.\nGeneral and administrative expenses decreased 2.5% to $2.63 million in 1995 from $2.69 million in 1994. The decrease is principally a result of a reduction in investor relations and legal expenses partially offset by an increase in salary expenses. This increase resulted from $0.40 million of salary expenses associated with the severance agreement for the Company's former Chief Executive Officer who resigned in December 1995 and $100,000 of signing bonuses paid to the Company's new Chief Executive Officer and its new President. General and administrative salary expenses are expected to increase in 1996 as the Chief Executive Officer and President positions were held by one person in 1995.\nIn 1995, the Company and CELx Corporation (\"CELx\"), the Company's former majority owned subsidiary, agreed to the merger of CELx into the Company and the exchange of shares of CELx by persons other than the Company into an aggregate of 312,500 shares of the Company's common stock. The dissolution of CELx resulted in a charge of $625,000 recorded as purchased in process research and development. The charge was based on the fair market value of the Company's common stock.\nThe Company recorded a non-cash expense of $0.81 million in 1995 as a debt conversion expense for the conversion of the 7% Convertible Debentures discussed above. The expense represents the fair market value of the increased number of shares issued under the terms of the exchange offering compared to the original terms of the 7% Convertible Debentures.\nIn December 1995, the Company recorded a restructuring charge aggregating $645,000 relating to the Company's restructuring plan. The restructuring charge includes approximately $350,000 related to write-downs of equipment and leasehold improvements for the manufacturing facility expected to be vacated in 1996, $200,000 related to abandonment of leases, with the remainder related to a severance agreement with its former Executive Vice President. Costs related to the termination of employees in January 1996 as part of the Company's restructuring plan were $150,000 and will be recorded as a restructuring expense and charged to operations in the quarter ending March 31, 1996. The annual salary savings from these terminations is in excess of $1.0 million. The Company estimates it will incur approximately $0.30 million in costs associated with moving the administration, research and medical departments to San Diego, with most costs being attributable to relocation costs of the few members of management moving to San Diego. Such costs will be expensed as incurred in 1996.\nThe increase in net loss from $6.15 million in 1994 to $6.83 million in 1995 was primarily a result of the decrease in revenues.\nFISCAL 1994 COMPARED TO FISCAL 1993\nThe impact of the original Baxter agreement referred to above had a variety of effects on the operations of the Company during the year ended December 31, 1994. The per unit sales price under the Baxter agreement is lower than formerly charged to end users. The Company began expanding its manufacturing capacity, however, in the short-term, this resulted in a lower utilization of manufacturing overhead costs. Thus the gross margin on sales to Baxter was currently less than the Company received when it sold directly to end users.\nNet sales decreased 9.1% from $5.41 million to $4.92 million. Approximately 70% of the 1994 sales were to Baxter, with the remaining 30% primarily to domestic customers of IMRE. There were no material sales to international customers. The decrease in net sales was due primarily to the lower sales price charged to Baxter than the Company previously charged to its customers. This lower sales price did not offset the increased number of PROSORBA-Registered Trademark- columns shipped by IMRE in 1994 as compared to 1993. However, a substantial amount of the columns shipped by IMRE to Baxter remained in their ending inventory as of December 31, 1994 because of delays by Baxter in fully implementing a sales and marketing program for the PROSORBA- Registered Trademark- column in 1994.\nTotal operating expenses increased 6.0% from $10.51 million in 1993 to $11.14 million in 1994. Production costs increased 62.7% from $1.58 million in 1993 to $2.57 million in 1994. The increase was primarily a result of an increase in the number of units shipped in 1994 compared to 1993. Production costs as a percentage of sales increased to approximately 52.3% in 1994 compared to 29.3% in 1993 principally because the sales price charged to Baxter for the nine months ended December 31, 1994 was less than the sales price the Company formerly charged to end users. In addition, the Company began increasing its manufacturing overhead in 1994 to meet the original shipment demands of Baxter.\nSales and marketing expenses decreased 25.4% from $4.76 million in 1993 to $3.55 million in 1994. Such expenses decreased primarily because Baxter provided partial sales and marketing support for the sale of the product during 1994. Eight sales employees of the Company became employees of Baxter and five other Company sales employees were terminated as a result of the Baxter agreement thus resulting in lower salary, commission and travel costs.\nResearch and development expenses increased 2.4% from $2.06 million in 1993 to $2.11 million in 1994. The increase was less than expected primarily as a result of the Company not beginning its rheumatoid arthritis clinical trial as soon as expected. In addition, the Company did not conduct a clinical trial for the treatment of the classical form of thrombotic thrombocytopenic purpura in 1994 as planned because of difficulties in agreeing upon an acceptable treatment protocol with the FDA. The conditions mandated by the FDA would make the clinical trial too costly to perform in relation to potential investment return from product sales. The increase is\nprimarily a result of increased payroll costs for senior management hired in 1994 offset by a reduction in treatment data costs.\nGeneral and administrative expenses increased 27.5% from $2.11 million in 1993 to $2.69 million in 1994. The increase is principally a result of costs associated with the development of the Company's diagnostic business plan, including expenses associated with seeking funding for the development of the diagnostics technology. Such funding has not been obtained. The increase is also a result of costs associated with hiring the Company's new Chief Executive Officer and the annualized payroll cost effect of increasing the number of management and support personnel in 1993.\nInterest expense increased from $8,000 in 1993 to $220,000 in 1994 because of the issuance in April 1994 of $4.25 million of 7% convertible debentures due March 31, 2001.\nThe increase in total operating expenses and the decrease in revenues resulted in increasing the net loss from $4.92 million in 1993 to $6.15 million in 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage\nReport of Ernst & Young LLP, Independent Auditors . . . . . . . . . . 31\nConsolidated Balance Sheets, December 31, 1995 and 1994 . . . . . . . 32\nConsolidated Statements of Operations for the Years Ended\nDecember 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . 33\nConsolidated Statements of Cash Flows for the Years Ended\nDecember 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . 34\nConsolidated Statements of Stockholders' Equity for the Years\nEnded December 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . 35\nNotes to Consolidated Financial Statements. . . . . . . . . . . . . . 36\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS IMRE CORPORATION\nWe have audited the consolidated balance sheets of IMRE Corporation 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 that our audits provide a reasonable basis for our opinion.\nIn our opinion, the 1995 and 1994 consolidated financial statements referred to above present fairly, in all material respects, the financial position of IMRE Corporation as of December 31, 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.\n\/s\/ Ernst & Young LLP Seattle, Washington January 23, 1996\nIMRE CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nThe accompanying notes are an integral part of the consolidated financial statements.\nIMRE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the consolidated financial statements.\nIMRE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\n-------------------------------------\nThe accompanying notes are an integral part of the consolidated financial statements.\nIMRE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n-----------------------------------------------------\nThe accompanying notes are an integral part of the consolidated financial statements.\nIMRE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n_____________________________\n1. FORMATION AND BUSINESS OF THE COMPANY.\nIMRE Corporation (the \"Company\") is engaged in the business of developing, manufacturing and bringing to market devices and products applicable to the treatment and diagnosis of certain types of immune-mediated diseases, transplantations and cancer. The Company commenced business activities in January 1982.\nThe U.S. Food and Drug Administration (\"FDA\") approved the Company's product, the PROSORBA-Registered Trademark- column, for commercial sale on December 23, 1987, for the treatment of patients with idiopathic thrombocytopenic purpura (\"ITP\"), an immune-related bleeding disorder. The product is approved for the removal of immunoglobulin G (\"IgG\") and circulating immune complexes containing IgG from plasma of patients with ITP with platelet counts below 100,000\/mm3.\nThe Company continues to devote most of its efforts to obtaining FDA marketing approval for additional autoimmune diseases, transplantations and certain cancers. The Company is currently planning in 1996 to conduct a controlled clinical trial using the PROSORBA-Registered Trademark- column for therapy for rheumatoid arthritis as a follow on to a pilot clinical trial completed in September 1995 and clinical trials for certain platelet disorders.\n2. 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 inter-company accounts and transactions have been eliminated.\nIn 1995, the Company and CELx Corporation (\"CELx\"), the Company's former majority owned subsidiary, agreed to the merger of CELx into the Company and the exchange of shares of CELx by persons other than the Company into an aggregate of 312,500 shares of the Company's common stock. The dissolution of CELx resulted in a charge of $625,000 recorded as purchased in process research and development. The charge was based on the fair market value of the Company's common stock.\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.\nCONCENTRATION OF CREDIT RISK\nThe Company invests its excess cash in money market funds with major financial institutions. The securities in such money market funds typically mature within 90 to 180 days and, therefore, bear minimal risk. The Company has not experienced any losses on these investments.\nThe PROSORBA-Registered Trademark- column is sold to its exclusive distributor in North America, Baxter Healthcare Corporation (see Note 4), and a diverse group of international health-care institutions. The Company has not experienced any material losses from the collection of its accounts receivable. Approximately 91% of the Company's sales for the year ended December 31, 1995, were for shipments to Baxter.\nCASH EQUIVALENTS\nThe Company considers all investments with an original maturity of three months or less to be cash equivalents. Cash equivalents primarily represent funds invested in a money market fund whose costs approximate market value.\nINVENTORIES\nInventories are stated at average weighted cost, determined on the first- in, first-out method, but not in excess of net realizable value. The Company maintains access to adequate sources of supply of raw materials.\nPROPERTY AND EQUIPMENT\nProperty and equipment are recorded at cost. Depreciation is provided by the straight-line method over useful lives of three to five years, and leasehold improvements are amortized over the term of the related lease.\nCONVERTIBLE DEBENTURE ISSUANCE COSTS\nConvertible debenture issuance costs are comprised primarily of the value assigned to stock warrants issued for placement agent services (see Note 10), other placement agent fees and legal expenses. Such costs are being amortized over the life of the related debentures.\nSTOCK AND STOCK WARRANTS ISSUED FOR SERVICES\nCommon stock and common stock warrants issued for services rendered to the Company are generally recorded at the fair market value of the stock or stock warrant issued or the value of the services rendered, whichever is more clearly determinable.\nSTOCK COMPENSATION\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. Generally stock compensation, if any, is measured as the difference between the exercise price of a stock option and the fair market value of the Company's stock at the date of grant, which is then amortized over the related service period.\nREVENUE RECOGNITION\nThe Company records sales of its product as earned revenue when the product is shipped.\nRevenue resulting from the settlement of the annual take or pay provisions of the Company's distribution agreement, discussed in Note 4, was recognized at the end of the sales year period ended March 31, 1995.\nADVERTISING COSTS\nAdvertising costs are expensed as incurred.\nNET LOSS PER SHARE\nThe computation of net loss per share is based on the weighted average number of shares of common stock outstanding for each period. Options, warrants and Convertible Debentures have not been considered in the calculation inasmuch as they would have the effect of decreasing net loss per share.\n3. RESTRUCTURING EXPENSE\nIn December 1995, the Company recorded a restructuring charge aggregating $645,000 relating to the Company's plan to consolidate its manufacturing facilities to one location in the state of Washington and to move all other operations to San Diego, California. This charge includes approximately $350,000 related to write-downs of equipment and leasehold improvements for the manufacturing facility expected to be vacated in 1996, $200,000 related to abandonment of leases in Seattle and Princeton with the remainder related to a severance commitment with its former Executive Vice President who resigned on December 28, 1995.\nThe Company estimates it will incur approximately $300,000 in costs associated with moving the administration, research and medical departments to San Diego, with most costs being attributable to relocation costs of the few members of management moving to San Diego. Such costs will be recorded as general and administrative expenses as incurred in 1996. The Company estimates it will incur approximately $1,000,000 of capital expenditures to consolidate its two Washington manufacturing facilities.\nIn January 1996, the Company notified approximately twenty employees, which was slightly greater than half of its work force, that their positions were being terminated immediately as part of the restructuring. Such positions were from all departments of the Company. Costs related to these terminations are approximately $150,000 and will be recorded as a charge to operations as a restructuring expense in the quarter ending March 31, 1996.\n4. DISTRIBUTION AGREEMENT.\nOn February 15, 1994, the Company entered into a 10-year exclusive distribution agreement with Baxter granting distribution rights of its PROSORBA- Registered Trademark- column in the United States and Canada for the treatment of thrombocytopenia and the first right to negotiate for new PROSORBA-Registered Trademark- column indications. Baxter assumed its sales and distribution responsibilities on April 2, 1994. The agreement provided for an annual \"take or pay\"and purchase commitment from Baxter to the Company for the first two sales years.\nBaxter, at its own expense, provides sales and marketing support for the sale of the product during the term of the Agreement, however, the Company was to provide significant marketing and promotional support to Baxter for the first three years of the agreement. During 1994, eight sales and marketing employees of the Company became employees of Baxter and five other sales and marketing employees of the Company were terminated. There was no material impact on net loss associated with these terminations. The Company no longer maintains a domestic sales force.\nThe purchase minimums were primarily subject to the Company having FDA product approval for immune thrombocytopenic purpura and the lack of any new significant competitive technology being introduced before October 1995 to the thrombocytopenic therapy marketplace. The Company received a response from the FDA in January 1995 to a Pre-market Application (PMA) supplement filed in March 1993 requesting the name of the Company's approved indication be changed from idiopathic thrombocytopenic purpura to immune thrombocytopenic purpura. The request was made by the Company as it believes the two names are used interchangeably by the medical community. The FDA's response denied the Company's request for such a change.\nAs a result of the FDA action, Baxter exercised its right to re-negotiate minimums in February 1995. In March 1995, the two companies amended the agreement whereby Baxter: 1) made a take-or-pay payment for the first sales year of $3.0 million compared to the original $3.5 million due March 31, 1995, 2) purchased $1.0 million of product during the second quarter of 1995, 3) released the Company from its obligation to provide marketing and promotional support for the second and third years of the agreement, 4) gave IMRE the right to co-market with Baxter, 5) relinquished its first right to negotiate for new PROSORBA-Registered Trademark- column indications, and 6) under certain circumstances, would provide advance payments to the Company for Baxter's 1996 purchases. IMRE has agreed to eliminate purchase minimums and the take-or-pay concept included in the original agreement and has freed Baxter to pursue competing thrombocytopenia\ntherapies. The term of the agreement remains ten years and consistent with the original agreement, both companies have agreed to review the terms at the end of the third year. Both companies have the right to terminate the agreement as of September 30, 1997 if the parties are unable to agree on terms for the remainder of the agreement or based on performance through September 30, 1997.\n5. INVENTORIES. Inventories are comprised of the following as of December 31:\n6. PROPERTY AND EQUIPMENT. Property and equipment are comprised of the following as of December 31:\n7. ACCRUED LIABILITIES.\nAccrued liabilities are comprised of the following as of December 31:\n8. COMMITMENTS AND CONTINGENCIES.\nOPERATING LEASES\nIn October 1991, the Company entered into an eight-year lease for 14,400 square feet of production, laboratory and administrative facilities in Seattle, Washington. The lease requires the Company to pay the costs associated with building operations including property taxes, insurance, maintenance and other operating costs, and provides for scheduled rent increases during the term of the lease. In connection with the restructuring plan described in Note 3, the Company is in the process of seeking a tenant to sub-lease this facility. The Company leases approximately 8,000 square feet of material preparation facilities in Redmond, Washington. This lease expires in 2004.\nThe table below indicates future minimum lease payments due over the remaining life of the leases, under the agreements in place as of December 31, 1995:\n1996 $397,000 1997 397,000 1998 397,000 1999 397,000 2000 96,000 Thereafter through 2004 384,000 ----------- $2,068,000 ----------- -----------\nTotal rental expense was approximately $521,000, $417,000 and $463,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nDEFINED CONTRIBUTION PENSION PLAN\nThe Company sponsors a defined contribution pension plan pursuant to Section 401(k) of the Internal Revenue Code of 1986. This plan covers substantially all employees who provide more than 1,000 hours of service during the year.\nThe Plan provides for matching contributions whereby the Company contributes common stock to the Plan on behalf of participants in an amount equal to 100% of the participants' contributions during the six-month periods ending on the last day of June and December. The Company's contributions will vest six months after the amount of the contribution is determined if the employee is still employed by the Company at the end of the vesting period, except for employees who have been with the Company more than five years for whom contributions will vest immediately. The expense recognized for shares contributed on behalf of employees was approximately $161,000, $161,000 and $175,000 for the years ended December 31, 1995, 1994 and 1993, respectively, based on the market value of the Company's common stock on the date of the contribution.\nPATENT CONTINGENCY\nIn November 1995, a complaint was filed claiming the PROSORBA-Registered Trademark- column infringes an issued patent. The Company first received a notice of a claim of infringement in July 1993. The Company has reviewed this matter with two independent outside patent counsel and, in both instances, has been advised that the claims of patent infringement are invalid or unenforceable, or not infringed. The Company intends to vigorously contest the claim. The Company does not expect the resolution of this issue to have a material impact on its financial position or results of operations.\nSEVERANCE AGREEMENT\nThe Company entered into a severance agreement as of December 28, 1995 with its former Chief Executive Officer. The terms of the severance agreement were based primarily on the termination clause of the employment agreement entered into between the former officer and the Company in September 1994. Such terms include the payment of $225,000 in 1996 and $168,750 by December 31, 1997. As of December 31, 1995, the officer had vested in options, under the Company's Non-Qualified Stock Option Plan, to purchase 500,000 shares of common stock at $2.1875. Such options will expire on March 30, 1996. The total cost of this severance agreement of $393,750 has been included in general and administrative expenses in the 1995 statement of operations.\nEMPLOYMENT AGREEMENTS\nThe Company entered into employment agreements as of December 28, 1995 through December 31, 2000 with a new Chief Executive Officer and a new President, Chief Operating Officer. The Agreements provide for specified compensation which include salary, signing bonuses, annual performance bonuses and a lump sum payment in the event of a termination of employment, without cause, as defined. Signing bonuses of approximately $100,000 have been included in general and administrative expenses in the accompanying statement of operations. An additional $270,000 of bonuses are due upon certain events which may occur in 1996.\nThe Agreements provide for the granting of options to purchase 8% and 3%, respectively, of the fully diluted shares then outstanding, including these options, at the fair market value of the Company's stock upon the date of grant. The options were granted in January 1996 upon the closing of the private placement discussed in Note 15. Options to purchase 25% of the total amount granted will vest on the date of grant with the remainder to vest daily over a four year period. Such options will vest immediately upon a merger of the Company or in the event of a termination of employment without cause, as defined. The options granted under the agreements are subject to shareholder approval.\nThe Company entered into an employment agreement as of December 28, 1995 with its Chief Scientific Officer. The Agreement provides for specified compensation for 1996 and a lump sum payment equal to one year's salary in the event of termination of employment in 1996.\n9. INCOME TAXES.\nSignificant components of the Company's deferred income tax assets as of December 31, are as follows:\nAs of December 31, 1995 and 1994, the Company has accumulated net operating loss carry-forwards of approximately $39,100,000 and $35,400,000, respectively, which expire beginning 1998 through 2010. Additionally, the Company has research and development tax credit carry-forwards of approximately $400,000 as of December 31, 1995.\nAs a result of the Company's sales of common stock in November 1990, September 1991, April 1993, and January 1996 the utilization of net operating loss carry-forwards which had accumulated as of those dates will be limited to a prescribed amount in each successive year. Based on these limitations the Company may be allowed to use no more than approximately $3,700,000 of such losses each year to reduce taxable income, if any. Approximately $12,200,000 of net operating loss carry-forwards are expected to expire prior to utilization due to the annual Internal Revenue Code Section 382 limitation, accordingly, the tax on this portion of the net operating loss carry-forwards has been excluded from the above table.\n10. 7% CONVERTIBLE DEBENTURES.\nOn April 22, 1994, the Company completed a private placement of $4,245,000 principal amount of 7% convertible debentures due March 31, 2001 (\"7% Convertible Debentures\"). Interest is payable on the 7% Convertible Debentures in cash or shares of Common Stock at the option of the Company. The conversion price for the principal amount is $2.875 per share of registered Common Stock, the fair market value on the date of closing. The conversion price for the interest is the lower of $4.00 per share of Common Stock or the average closing price for the 10 days prior to the annual April 30 interest payment date. The debentures are redeemable by the Company after April 1, 1998 at a redemption price of 106% of the principal amount reduced to 104% and 102% the following two years. Allen & Company Incorporated (\"Allen & Company\"), a shareholder of the Company, acted as placement agent with respect to a majority of this private placement and received a five-year warrant valued at $483,000 to purchase 300,000 shares of Common Stock at $2.875 for its services as placement agent. The cost of issuing the 7% Convertible Debentures, including the cost of the warrants, is deferred and is reported on the accompanying balance sheet net of amortization expense being recorded over the term of the 7% Convertible Debentures. Of the total $4,245,000 principal amount of 7% Convertible Debentures, $1,000,000 was purchased by Allen & Company.\nIn September 1995, the Company completed an exchange offering to holders of the 7% Convertible Debentures. The Company offered to exchange the 7% Convertible Debentures for restricted common stock at $2.25 per share. Of the original $4,245,000 outstanding principal amount, $2,200,000 of the 7% Convertible Debentures were converted. The Company recorded a non-cash expense of $810,000 which represents the fair market value of the increased number of shares issued under the terms of the offering compared to the original conversion terms. Subsequent to September 1995, an additional $700,000 of 7% Convertible Debentures were converted into common stock at the original conversion price. For substantially all 7% Convertible Debentures that were converted, the interest accrued up to the date of conversion was paid through the issuance of common stock at either $2.25 per share or $2.875 per share. The Company also charged $314,000 to additional paid-in capital for the year ended December 31, 1995 for the unamortized deferred debt issuance costs related to the converted debentures.\n11. SENIOR CONVERTIBLE DEBENTURES.\nOn December 29, 1995, the Company completed a private placement of $1,500,000 principal amount of senior convertible debentures due July 1, 1996 (\"Senior Convertible Debentures\") to a group of investors including $500,000 issued to Allen & Company Incorporated, a shareholder of the Company. The Company received $1,000,000 of cash on December 29, 1995. The remaining $500,000 was received during the first week of January 1996 and is recorded in Other Receivables on the accompanying balance sheet. The cost of issuing the Senior Convertible Debentures was approximately $140,000, including placement agent fees of $90,000, and is deferred and reported on the accompanying balance sheet as convertible debenture issuance costs.\nIn January 1996, the Senior Convertible Debentures, under their original terms, were automatically converted at $1.50 per share into 1,000,000 shares of the Company's common stock. The conversion was made simultaneously with the closing of a private placement of common stock (See Note 15).\n12. STOCKHOLDERS' EQUITY.\nAUTHORIZED SHARES\nIn December 1995, the shareholders of the Company authorized 15,000,000 shares of \"blank check\" preferred stock. Terms and rights of such preferred stock shall be determined by the Board of Directors when such preferred stock, if any, is issued. As of December 31, 1995, the Company has not amended its Articles of Incorporation with the State of Delaware for this authorization.\nSTOCK OPTIONS\nINCENTIVE STOCK OPTIONS. In June 1985, the Company adopted an Incentive Stock Option and Appreciation Plan. The plan authorizes options to purchase, and appreciation rights with respect to, the Company's common stock, which may be granted to such officers and key employees as may be selected by the Board of Directors or a committee appointed by the Board\nto administer the plan. The plan was amended in June 1992 to increase the number of shares reserved for issuance to 750,000. The plan expired in 1995, however options granted under the plan remain effective according to their respective terms and conditions.\nNON-QUALIFIED STOCK OPTIONS. The Company has reserved 2,750,000 shares of common stock for issuance under its 1988 Non-qualified Stock Option Plan, as amended in 1992 and 1995 (the \"1988\" Plan). Under the 1988 Plan, directors, officers, employees and consultants, may be granted non-qualified stock options at exercise prices determined by the Board of Directors. Stock options granted under the 1988 Plan will become exercisable for terms up to 10 years in one or more installments in the manner and at the times specified by the Board.\nSTOCK OPTIONS-OTHER. The Company has, at various times, granted to employees and others options to purchase common stock, other than from under a formal option plan.\nWARRANTS\nThe Company has issued warrants to purchase common stock as compensation for services rendered in connection with raising capital. Warrants were also issued in connection with private placements and the 1991 public offering of common stock.\nIn 1991, the Company granted warrants to purchase 749,900 shares of common stock to certain officers, directors and employees, which are now exercisable at $1.875 per share. The warrants will expire on June 10, 2001. In September 1991, the Company granted warrants to purchase 1,850,000 shares of common stock at an exercise price of $2.50 per share in connection with its public offering of units. The warrants will expire on August 29, 1996, and are now redeemable by the Company at $0.75 each. The Company issued Allen & Company a five-year warrant to purchase 300,000 shares of Common stock at $2.875 for its services as a placement agent for the April 22, 1994 7% Convertible Debenture private placement (see Note 10).\nThe following table summarizes the activity of the Company's stock options and warrants:\n13. SUPPLEMENTARY INFORMATION\nThe Company incurred advertising expenses of approximately $77,000, $658,000, and $775,000 for the years ended December 31, 1995, 1994 and 1993, respectively all of which were substantially for advertising agency costs.\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts reported in the balance sheet for cash and cash equivalents, receivables and accounts payable approximate their fair value.\nAs of December 31, 1995 there was $1,345,000 outstanding principal of the 7% Convertible Debentures with a conversion rate of $2.875. The estimated fair value of these securities is estimated to approximate their carrying value based on the fair market value of the Company's common stock as of December 31, 1995, which was $2.8125 per share.\nAs the conversion price of the Senior Convertible Debentures was based on the expected offering price of the Company's January 1996 private placement (See Note 15), the estimated fair value of these securities approximates their carrying value.\n15. SUBSEQUENT EVENT\nIn January 1996, the Company sold approximately 8,500,000 shares of common stock for $1.50 per share in a private placement. The shares are to be registered in February 1996 for re-sale, under the Securities Act of 1933, as amended. The net proceeds to the Company were approximately $12,000,000, or $1.41 per share, after placement costs of approximately $800,000. As a result of this private placement, the Senior Convertible Debentures referred to in Note 11 automatically converted to 1,000,000 shares of common stock. In addition, upon closing of the private placement, the Company issued stock options to the new Chief Executive Officer and President aggregating 4,159,824 shares at an exercise price of $1.50 per share.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information required by Item 304 of Regulation S-K was previously reported on Form 8-K dated June 23, 1994, filed with the Securities and Exchange Commission, and is incorporated by reference herein.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nSubsequent to the year ended December 31, 1995, Frank R. Jones, a Director and Chief Scientific Officer of the Company, filed a Form 5 which delinquently reported the disposition of certain shares in the Company held by his childrens' trusts, for which Dr. Jones disclaims beneficial ownership. In 1995, Dr. Jones was late in filing one Form 4 and in reporting four transactions on Form 4. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company are as follows:\nName Age Position ---- --- --------\nJay D. Kranzler, M.D., Ph.D.(1) 38 Chief Executive Officer and Vice Chairman of the Board of Directors\nDebby Jo Blank, M.D.(1) 44 President, Chief Operating Officer and Director\nFrank R. Jones, Ph.D. 51 Chairman of the Board of Directors and Chief Scientific Officer\nAlex P. de Soto(1) 33 Vice President, Chief Financial Officer and Secretary\nRichard M. Crooks, Jr.(2)(3)(4) 56 Director\nPhilip J. O'Reilly(2)(3)(4) 57 Director\nJack H. Vaughn(2)(4) 75 Director\n(1)Member of the 401(k) Plan Committee (2)Member of Audit Committee (3)Member of Stock Option Committee (4)Member of Compensation Committee\nJay D. Kranzler, M.D., Ph.D. was appointed Chief Executive Officer and Vice Chairman of the Board of Directors of the Company in December 1995. From January 1989 until August 1995, Dr. Kranzler served as President, Chief Executive Officer and a Director of Cytel Corporation, a publicly held biotechnology company. Before joining Cytel, Dr. Kranzler was employed by\nMcKinsey & Company, a management consulting firm, as a consultant specializing in the pharmaceutical industry from 1985 to January 1989. In addition, Dr. Kranzler has been an adjunct member of the Research Institute of Scripps Clinic since January 1989.\nDebby Jo Blank, M.D., was appointed President, Chief Operating Officer and Director of the Company in December 1995. Prior to joining IMRE, from 1994 to December 1995, Dr. Blank was Senior Vice President, Marketing, for Advanced Technology Laboratories, a publicly-held manufacturer and distributor of ultrasound equipment. From 1993 to 1994, she was Vice President, U.S. Marketing for Syntex. From 1989 to 1993, she held various positions at the DuPont Company and the DuPont Merck Pharmaceutical Company (\"Dupont\"), including Vice President Worldwide Marketing, Vice President, New Product Planning & Licensing, and Vice President, Strategy and Business Development. Before joining DuPont, she was employed by the management consulting firm, Arthur D. Little, from 1986 to 1989 as a consultant in its pharmaceutical practice.\nFrank R. Jones, Ph.D., a founder of the Company, is the Company's Chairman of the Board of Directors and Chief Scientific Officer. He has served as Chairman of the Board of Directors since 1981, Chief Executive Officer of the Company from 1981 to September 1994, and President of the Company from 1986 to November 1989. From 1983 to 1986, Dr. Jones was the director of the Immune System Response Program of the Pacific Northwest Research Foundation. Dr. Jones was a Researcher in the Department of Complement and Effector Biology at Memorial Sloan-Kettering Cancer Center (MSKCC) in New York City from 1980 to 1981 and was a Research Associate in the Laboratory of Veterinary Oncology at MSKCC from 1981 until 1983. Dr. Jones holds degrees from California State University (M.A., Bacteriology\/Immunology) and the University of Washington (Ph.D., Biological Structure\/ Cellular Immunology).\nAlex P. de Soto joined the Company in September 1993 as Vice President, Chief Financial Officer and Chief Accounting Officer and also was appointed Secretary of the Company in February 1995. From 1986 through 1993, Mr. de Soto worked as a certified public accountant in the audit practice of Coopers & Lybrand in Seattle and London and was an audit manager in its high technology practice. Mr. de Soto graduated from the University of Southern California.\nRichard M. Crooks, Jr. was appointed a Director of the Company in April 1994. Since June 1990, Mr. Crooks has served as President of RMC Consultants, a financial advisory services firm. Mr. Crooks is also a Director of and consultant to Allen & Company Incorporated, a privately held investment banking firm, which is the Company's principal stockholder. Mr. Crooks served as a Managing Director of Allen & Company Incorporated for more than five years prior to June 1990. Mr. Crooks is also a Director of Excalibur Technologies Corporation.\nPhilip J. O'Reilly a partner in the law firm of O'Reilly, Marsh, Kearney & Corteselli, P.C., in Mineola, New York, became a Director of the Company in April 1994. Mr. O'Reilly has been in private practice for the past five years. Mr. O'Reilly is also a Director of Excalibur Technologies Corporation.\nJack H. Vaughn was appointed a Director of the Company in 1991. Currently, Mr. Vaughn is Chairman of ECOTRUST, a Portland, Oregon-based foundation promoting environmentally friendly development in the Pacific Northwest. From 1988 to 1992, he was the U.S. Government's\nSenior Environmental Advisor for Central America. Prior to 1988, Mr. Vaughn was the founding Chairman of Conversation International, a private foundation encouraging biological diversity. Mr. Vaughn has been a director of Allegheny & Western Energy Corporation since 1981 and is a member of its Compensation Committee.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth information concerning compensation for the fiscal years 1995, 1994 and 1993 for services in all capacities to the Company by each person who served as Chief Executive Officer of the Company during fiscal year 1995 as well as those executive officers whose salary and bonus for fiscal year 1995 exceeded $100,000 (collectively, the \"Named Executive Officers\").\nSUMMARY COMPENSATION TABLE\n(1) The Company's Incentive Stock Option and Appreciation Plan (the \"ISO Plan\"), the Plan and other non-formal option plans are intended to further the interests of the Company by\nproviding certain incentives to key employees of the Company. The plans provide for the granting of options to purchase shares of the Company's Common Stock at not less than fair market value and the ISO Plan permits the grant of stock appreciation rights. There were no SARs granted in 1995. (2) Dr. Kranzler was appointed Chief Executive Officer on December 28, 1995 and received approximately $20,000 as a consultant during 1995. (3) Mr. Cleary resigned as Chief Executive Officer, President and Chief Operating Officer, Director on December 28, 1995. (4) All Other Compensation includes Company 401(k) contributions in the form of Company Common Stock. (5) Includes $393,750 of compensation to be paid in 1996 and 1997 as part of a severance agreement dated December 28, 1995. (6) Dr. Jones was Chief Executive Officer until September 30, 1994, at which time he became Chief Scientific Officer. (7) Dr. Hoyt resigned as Executive Vice President, Director on December 28, 1995. (8) Includes $87,500 of compensation to be paid in 1996 as part of a severance\/consulting agreement dated December 28, 1995. (9) Dr. Blank was appointed President and Chief Operating Officer on December 28, 1995, and received $20,000 as a consultant during 1995.\nThe following table sets forth certain information regarding options granted during the fiscal year ended December 31, 1995, to the Named Executive Officers.\nOPTION GRANTS IN LAST FISCAL YEAR\n(1) Dr. Hoyt resigned as Executive Vice President, Director on December 28, 1995. (2) The potential realizable value is based on the assumption that the price of the Common Stock appreciates at the annual rate shown (compounded annually) from the date of grant until the end option term. Actual realizable value, if any, on stock option exercises is dependent on the future performance of the Common Stock and overall market conditions, as well as the option holder's continued employment through the vesting period.\nThe following table sets forth certain information as of December 31, 1995, regarding options held by the Named Executive Officers. None of such individuals exercised any options during the fiscal year ended December 31, 1995. There were no stock appreciation rights outstanding at December 31, 1995.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n(1) Calculation based on $2.8125, the closing price of the Common Stock on the Nasdaq Small Cap Market on December 31, 1995, less the exercise price.\nEMPLOYMENT AND CHANGE OF CONTROL AGREEMENTS\nThe Company has entered into a five-year term employment agreement with Dr. Jay D. Kranzler, the Company's Chief Executive Officer. Dr. Kranzler's annual compensation consists of base salary of $240,000, performance based bonuses of up to an additional twenty-five percent (25%) of annual base salary. In addition, Dr. Kranzler's employment agreement provides for a sign-on bonus of $185,000, payable in installments upon the occurrence of certain milestone events achieved by the Company and Dr. Kranzler. As of the date hereof, approximately $100,000 of the total sign-on bonus has been paid to Dr. Kranzler.\nIn addition to his base salary and bonus, Dr. Kranzler was granted an option to purchase eight percent (8%) of the Company's Common Stock on a fully diluted basis at an exercise price equal to $1.50 per share. The options vest twenty-five percent (25%) immediately upon grant and thereafter notably and daily over a four (4) year period. Dr. Kranzler's options shall fully vest upon the occurrence of any merger, consolidation, corporate reorganization or transfer of all or substantially all of the assets of the Company and upon the termination without cause of Dr. Kranzler's employment with the Company. Such options are subject to stockholder approval.\nThe Company has entered into a five-year term employment agreement with Dr. Debby Jo Blank, the Company's President and Chief Operating Officer. Dr. Blank's annual compensation consists of base salary of $210,000 and performance based bonuses of up to an additional twenty-five percent (25%) of annual base salary. In addition, Dr. Blank's employment\nagreement provides for a sign-on bonus of $185,000, payable in installments upon the occurrence of certain milestone events achieved by the Company and Dr. Blank. As of the date hereof, approximately $100,000 of the sign-on bonus has been paid to Dr. Blank.\nIn addition to her base salary and bonus, Dr. Blank was granted an option to purchase three percent (3%) of the Company's Common Stock on a fully diluted basis at an exercise price equal to $1.50 per share. The options vest twenty- five percent (25%) immediately upon grant and thereafter notably and daily over a four (4) year period. Dr. Blank's options shall fully vest upon the occurrence of any merger, consolidation, corporate reorganization or transfer of all or substantially all of the assets of the Company and upon the termination without cause of Dr. Blank's employment with the Company. Such options are subject to stockholder approval.\nThe Company entered into a one-year employment agreement effective as of December 28, 1995 with Frank R. Jones, Ph.D., the Company's Chief Scientific Officer. The employment agreement provides for an annual base salary of $220,000 and a lump sum severance payment equal to one year's base salary in the event of termination of employment with or without cause within one year of the date of the agreement. The employment agreement also provides that in the event of termination of employment with or without cause prior to December 28, 1996, previously granted options will be extended or re-issued by the Company so as to remain exercisable until the applicable expiration of such options.\nThe Company entered into a six-month employment agreement on January 8, 1996 with Alex P. de Soto, the Company's Chief Financial Officer and Secretary, which agreement expires by its terms on June 30, 1996, unless otherwise extended by mutual agreement of the parties. The employment agreement provides that the Company shall pay Mr. de Soto a base salary of $10,000 per month for the period January 1, 1996 through March 31, 1996 and $8,000 per month for the period April 1, 1996 through June 30, 1996. In addition to the base salary, Mr. de Soto will be paid a bonus on April 1, 1996 in the amount of $15,000 in the event he has not terminated his employment with the Company as of such date. Mr. de Soto is also entitled to an additional payment equal to $25,000 in the event he continues his employment with the Company after June 1, 1996. Under the employment agreement, Mr. de Soto was granted an option to purchase 60,000 shares of the Company's Common Stock (the \"Option\") at an exercise price of $1.50 per share, which option shall vest and become exercisable as to 50% of the shares subject to the option on the date of grant and the remaining 50% of the shares on June 1, 1996, subject to continued employment on such date. The Option was issued in exchange for all outstanding options to purchase shares of the Company's Common Stock previously granted to Mr. de Soto.\nCOMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Company believes that a competitive, goal-oriented compensation policy is critically important to the creation of value for stockholders. To that end, the Company has created an incentive compensation program intended to reward outstanding individual performance.\nCOMPENSATION PHILOSOPHY\nThe Company's compensation program is intended to implement the following principles:\n- Compensation should be related to the value created for stockholders. - Compensation programs should support the short-term and long-term strategic goals and objectives of the Company. - Compensation programs should reflect and promote the Company's values and reward individuals for outstanding contributions to the Company's success. - Short-term and long-term compensation programs play a critical role in attracting and retaining well-qualified executives. - While compensation opportunities should be based in part upon individual contribution, the actual amounts earned by executives in variable compensation programs should also be based on how the Company performs.\nCOMPENSATION MIX AND MEASUREMENT\nThe Company's executive compensation for the Chief Executive Officer and all other executives is based upon three components, each of which is intended to serve the Company's compensation principles:\nBASE SALARY\nBase salary is targeted at the competitive median for similar companies in the biotechnology industry. For the purpose of establishing these levels, the Compensation Committee compares the Company's compensation structure from time to time to the companies covered in a compensation survey of the biotechnology industry entitled, BIOTECHNOLOGY COMPENSATION AND BENEFITS SURVEY which is prepared by Radford Associates and sponsored by the Biotechnology Industry Organization. Many of the Companies covered in that survey are also included in the published industry line-of-business index included in the Company's Stock Price Performance Graph included elsewhere in this Report.\nThe Committee reviews the salaries of the Chief Executive Officer and other executive officers each year and such salaries may be increased based upon (i) the individual's performance and contribution to the Company and (ii) increases in median competitive pay levels.\nANNUAL INCENTIVES\nThe Company has a cash bonus program whereby bonus amounts are determined based upon the achievement of corporate goals and individual performance. Each executive officer has a target bonus amount calculated as a percentage of his or her annual base salary. The bonus percentage is based in part on Company performance and in part on individual performance. Corporate goals seek advancements in the areas of business development efforts as well as research and development activities as they relate to the overall success of the Company. The Committee believes the target bonus amounts are based upon levels similar to other companies in the biotechnology industry. Bonuses awarded during 1995 were less than targeted amounts because of the Company's minimal cash position as of the end of 1995.\nLONG-TERM INCENTIVES\nLong-term incentive compensation is provided through grants of options to purchase shares of the Company's Common Stock to the Named Executive Officers and others. The stock options are intended to retain and motivate all employees to improve long-term performance of the Company. It is common in the biotechnology industry to grant stock options to all employees. As of the beginning of 1995, stock options had been granted to all employees of the Company. The Committee believes the amount and value of such grants are based upon levels similar to other companies in the biotechnology industry.\nStock options are granted with an exercise price equal to prevailing market value. Generally, the stock options vest in increments over a period of years, and an employee must be employed by the Company at the time of vesting in order to exercise his or her options.\nCOMPENSATION OF THE CHIEF EXECUTIVE OFFICER\nThe Company appointed Jay D. Kranzler, M.D., Ph.D. as its new Chief Executive Officer on December 28, 1995. Accordingly, his compensation was determined based on biotechnology industry prevailing compensation packages to attract an individual of Dr. Kranzler's caliber. His compensation includes an annualized base salary of $240,000, performance cash bonus opportunities and a signing bonus potential of $185,000. In addition, Dr. Kranzler's employment agreement provides that the Company issue to him options to purchase that number of shares of Common Stock of the Company equal to eight percent (8%) of the equity of the Company on a fully diluted basis. In January 1996, Dr. Kranzler was granted options to purchase 3,025,327 shares of the Company's Common Stock at an exercise price of $1.50 per share, subject to stockholder approval.\nUnder the Omnibus Budget Reconciliation Act of 1993, beginning in 1994, the federal income tax deduction for certain types of compensation paid to the Chief Executive Officer and four other most highly compensated officers of publicly held companies is limited to $1,000,000 per officer per fiscal year unless such compensation meets certain requirements. The Committee\nis aware of this limitation and believes that the deductibility of compensation payable in 1995 will not be affected by this limitation.\nSTOCK OPTION COMMITTEE COMPENSATION COMMITTEE\nRichard M. Crooks, Jr. Richard M. Crooks, Jr. Philip O'Reilly Philip O'Reilly Jack H. Vaughn\nSTOCK PRICE PERFORMANCE GRAPH\nCOMPARISON OF 5-YEAR CUMULATIVE RETURN\nThe following Stock Price Performance Graph compares the Company's cumulative total stockholder return on the Company's Common Stock for the periods indicated with the cumulative total return of the NASDAQ OTC Index and a published industry line-of-business index. The Board of Directors approved the use of the NASDAQ Pharmaceuticals Stock Index. Although the Company previously used the Coopers & Lybrand Index as its published line-of-business index, it changed to the NASDAQ Pharmaceuticals Stock Index because of the greater number of peer companies represented and because the Company believes it is a more complete representation of the biotechnology industry. The Company has not declared any dividends since its inception.\nThe Board of Directors and its Compensation Committee recognize that the market price of stock is influenced by many factors, only one of which is Company performance. The historical stock price performance shown on the Stock Price Performance Graph is not necessarily indicative of future stock price performance.\nCOMPARISON OF FIVE YEAR CUMULATIVE RETURN\nAMONG IMRE CORPORATION, NASDAQ OTC, NASDAQ PHARMACUETICAL INDEX AND COOPERS & LYBRAND INDUSTRY INDEX\nThe above comparison assumes $100 invested in the Company's Common Stock and each index on December 31, 1990.\nCOMPENSATION OF DIRECTORS\nMessrs. O'Reilly and Vaughn each received $12,000 in cash compensation for service as a director during fiscal year 1995. Each of Messrs. Crooks, O'Reilly and Vaughn received options to purchase 10,000 shares of Common Stock for service as a director during fiscal year 1995. Directors who are employees of the Company do not receive any fee for their services as directors. None of the Company's directors receive any compensation for their service on the Board of Directors or any of its Committees. All of the Company's directors are reimbursed for their out-of-pocket travel and accommodation expenses incurred in connection with their service as directors of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information as of January 31, 1996 known by the Company with respect to (i) each stockholder known to the Company to be the beneficial owner of more than five percent of its outstanding Common Stock, (ii) each director and nominee, (iii) each of the Named Executive Officers described in the Summary Compensation Table and (iv) all directors and executive officers of the Company as a group. Except as set forth below, each of\nthe named persons and members of the group has sole voting and investment power with respect to the shares shown.\nAmount and Nature of Name and Address Beneficial Ownership Percent of Class ---------------- -------------------- ---------------- Allen & Company Incorporated 5,322,462(1) 18.1% 711 Fifth Avenue New York, New York 10022 Aries Financial Services 1,790,832(2) 6.3% 375 Park Avenue, Suite 1501 New York, New York 10152 Richard M. Crooks, Jr. 1,171,565(3) 4.1% Frank R. Jones 1,105,411(4) 3.8% Martin D. Cleary 503,982(5) 1.7% Jay D. Kranzler 218,881(6) * Debby Jo Blank 218,881(6) * Jack Vaughn 56,000(7) * Philip J. O'Reilly 64,625(8) * Harvey J. Hoyt 51,683(9) * All Directors and Named Executive Officers as a Group (8 persons) 3,149,206(10) 10.6%\n________________________ *less than one percent\n(1) Includes warrants to purchase 1,060,590 shares of Common Stock. Does not include 2,303,890 shares of Common Stock and warrants to purchase 31,600 shares of Common Stock owned by certain individuals who may be considered affiliates of Allen & Company Incorporated. Allen & Company Incorporated disclaims beneficial ownership of these shares of Common Stock. This information is derived from a Schedule 13D dated January 22, 1996, filed by Allen & Company Incorporated. (2) This information is dervived from a Schedule 13D dated January 22, 1996, filed by Aries Financial Services. (3) Includes presently exercisable warrants and options to purchase 30,000 shares of Common Stock. Includes 712,498 shares of Common Stock and presently exercisable warrants to purchase 26,666 shares of Common Stock held by Allen & Company for which the director has beneficial interest in profits upon sale. (4) Includes presently exercisable warrants and options to purchase 705,000 shares of Common Stock. (5) Includes presently exercisable options to purchase 500,000 shares of Common Stock. (6) Includes 218,881 shares of Common Stock held by the Company's 401(k) plan for which the officer as co-trustee of the plan has voting rights to such shares. (7) Includes presently exercisable options to purchase 55,000 shares of Common Stock. (8) Includes presently exercisable warrants and options to purchase 48,825 shares of Common Stock. (9) Includes presently exercisable options to purchase 22,500 shares of Common Stock. (10) Includes warrants and options that are presently exercisable to purchase 1,367,992 shares of Common Stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOn December 29, 1995, Allen & Company purchased, through a private placement, $500,000 principal amount of Senior Convertible Debentures due July 1, 1996 (the \"Debentures\"). The Debentures were convertible at $1.50 per share of Common Stock. Allen & Company acted as placement agent for this private placement and received 20,000 shares of Common Stock as a placement agent fee. The Debentures were converted into 333,333 shares of the Company's Common Stock on January 22, 1996, in conjunction with the closing of a private placement of 8.5 million shares of Common Stock at a purchase price of $1.50 per share.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements Page ---- Report of Ernst & Young LLP, Independent Auditors. . . 31\nConsolidated Balance Sheets, December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . 32\nConsolidated Statements of Operations 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\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 . . . . . 35\nNotes to Consolidated Financial Statements . . . . . . 36\n(2) Financial Statement Schedules\nAll schedules are omitted because of the absence of the conditions under which they are required to be reported or because the required information is included in the Financial Statements and their Notes.\n(3) Exhibits\nExhibit No. Description of Exhibit Incorporated by Reference to ----------- ---------------------- ----------------------------- 3.1 Certificate of Exhibit 3.1 to this Form 10-K Incorporation, as for the year ended December amended 31, 1995 (\"1995 Form 10-K\")\n3.2 By-laws, as amended Exhibit 3.2 to 1995 Form 10-K\n4.1 Form of Stock Exhibit 3.1 to Form S-1 Certificate Registration Statement No. 33-41225 (\"Form S-1\")\n4.2 Form of Common Stock Exhibit 3.1 to Form S-1 Purchase Warrant\nExhibit No. Description of Exhibit Incorporated by Reference to ----------- ---------------------- ----------------------------\n4.3 Incentive Stock Option Exhibit 28.2 to Form S-8 Registration Statement No. 33-20188 (\"Form S-8\")\n4.4 Form of Nonqualified Exhibit 28.2 to Form S-8 Stock Option\n4.5 Form of Stock Option - Exhibit 4.5 to Form 10-K for Other the year ended December 31, 1993 (\"1993 Form 10-K\")\n4.6 Form of Employee Stock Exhibit 10.13 of Form S-1 Warrant\n4.7 Form of 7% Convertible Exhibit 10.1 to Form 10-Q for Debentures the quarter ended March 31,\n4.8 Warrant Agreement Exhibit 10.3 to Form 10-Q for dated as of April 22, the quarter ended March 31, 1994 between IMRE 1994 Corporation and Allen & Company Incorporated\n4.9 Form of 7% Convertible Exhibit 10.4 to Form 10-Q for Debenture Purchase the quarter ended March 31, Agreement 1994\n4.10 Form of Senior Exhibit 4.10 to 1995 Form 10-K Convertible Debenture\n4.11 Form of Senior Exhibit 4.11 to 1995 Form 10-K Convertible Debenture Purchase Agreement\n4.12 Form of a Stock Exhibit 4.12 to 1995 Form 10-K Purchase Agreement for January 1996 Private Placement\n10.1 Stock Option and Stock Exhibit 28.1 to Form S-8 Appreciation Plan\n10.2 1988 Nonqualified Exhibit 28.3 to Form S-8 Stock Option Plan\nExhibit No. Description of Exhibit Incorporated by Reference to ----------- ---------------------- ----------------------------\n10.3 Sub-lease Agreement Exhibit 10.3 to 1993 Form dated October 11, 1991 10-K\n10.4 Lease Agreement dated Exhibit 10.4 to Form 10-K for April 26, 1994 the year ended December 31, 1994 (\"1994 Form 10-K\")\n10.5 Warrant Agreement Exhibit 99.1 to Form S-3 dated as of August 29, Registration Statement No. 1991 between IMRE 33-71278 Corporation and Manufacturers Hanover Trust Company of California (now known as Chemical Trust Company of California)\n10.6 Severance Agreement Exhibit 10.6 to 1995 Form with Martin D. Cleary 10-K\n10.7 Consulting Agreement Exhibit 10.7 to 1995 Form with Harvey J. Hoyt 10-K\n10.8 Employment Agreement Exhibit 10.8 to 1995 Form with Jay D. Kranzler 10-K\n10.9 Employment Agreement Exhibit 10.9 to 1995 Form with DebbyJo Blank 10-K\n10.10 Employment Arrangement Exhibit 10.10 to 1995 with Frank R. Jones Form 10-K\n10.11 Employment Agreement Exhibit 10.11 to 1995 with Alex P. de Soto Form 10-K\n10.12 Baxter Distribution Exhibit 10.1 to Form Agreement 8-K filed March 18,\n10.13 Amendment No. 1 Exhibit 10.1 to Form dated March 28, 8-K dated March 25, 1995 1995 to Baxter Distribution Agreement\nExhibit No. Description of Exhibit Incorporated by Reference to ----------- ---------------------- ----------------------------\n11.1 Statement regarding Item 8 of 1995 Form 10-K computation of per share loss\n16.1 Letter regarding Exhibit 16.1 to 1994 Form 10-K change in certifying accountant\n23.1 Consent of Ernst Exhibit 23.1 to 1995 Form 10-K & Young LLP, 1994 and 1995 auditors\n23.2 Report of Coopers Exhibit 23.2 to 1995 Form 10-K & Lybrand LLP, 1993 auditors\n23.3 Consent of Coopers Exhibit 23.3 to 1995 Form 10-K & Lybrand, LLP, 1993 auditors\n24.1 Powers of Attorney Exhibit 24.1 to 1995 Form 10-K\n27.1 Financial Data Schedule Exhibit 27.1 to 1995 Form 10-K\n(b) Reports on Form 8-K\nOn November 27, 1995, the Company filed a Current Report on Form 8-K which disclosed certain information reported under Item 3.\nOn January 26, 1996 the Company filed a Current Report on Form 8-K which disclosed certain information under Item 5.\n(c) Exhibits\nThe Company hereby files as part of this Form 10-K the exhibits listed in Item 14(a)(3) set forth 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, on February 19, 1996.\nIMRE Corporation\nBy: \/s\/ Jay D. Kranzler ------------------------------------ Jay D. Kranzler, M.D., Ph. D. Chief Executive Officer, Vice Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Jay D. Kranzler _____________________________ February 19, 1996 Jay D. Kranzler, M.D., Ph. D. Vice Chairman of the Board Chief Executive Officer\n\/s\/ Debby Jo Blank _____________________________ February 19, 1996 Debby Jo Blank, M.D. Director, President and Chief Operating Officer\n\/s\/ Frank R. Jones _____________________________ February 19, 1996 Frank R. Jones, Ph.D. Chairman of the Board and Chief Scientific Officer\n\/s\/ Alex P. de Soto _____________________________ February 19, 1996 Alex P. de Soto Vice President, Chief Financial Officer and Chief Accounting Officer\n\/s\/ Richard M. Crooks _____________________________ Director* February 19, 1996 Richard M. Crooks, Jr.\n\/s\/ Philip J. O'Reilly _____________________________ Director* February 19, 1996 Philip J. O'Reilly\n\/s\/ Jack H. Vaughn _____________________________ Director* February 19, 1996 Jack H. Vaughn\n*By Alex P. de Soto as attorney-in-fact.\nEXHIBIT INDEX\nSequential Exhibit No. Description of Exhibit Page No. - ----------- ---------------------- -------- 3.1 Certificate of Incorporation, as amended\n3.2 By-laws, as amended\n4.10 Form of Senior Convertible Debentures\n4.11 Form of Senior Convertible Debenture Purchase Agreement\n4.12 Form of Stock Purchase Agreement for January 1996 Private Placement\n10.6 Severance Agreement with Martin D. Cleary\n10.7 Consulting Agreement with Harvey J. Hoyt\n10.8 Employment Agreement with Jay D. Kranzler\n10.9 Employment Agreement with Debby Jo Blank\n10.10 Employment Arrangement with Frank R. Jones\n10.11 Employment Agreement with Alex P. de Soto\n23.1 Consent of Ernst & Young LLP, 1995 and 1994 auditors\n23.2 Report of Coopers & Lybrand LLP, 1993 auditors\n23.3 Consent of Coopers & Lybrand LLP, 1993 auditors\n24.1 Powers of Attorney\n27.1 Financial Data Schedule","section_15":""}
{"filename":"719625_1995.txt","cik":"719625","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nILC Technology, Inc. (\"ILC\" or the \"Company\") designs, develops, and manufactures high intensity lamps and lighting products for medical, industrial, communication, aerospace, scientific, entertainment, and military industries. ILC Technology, Inc. was incorporated under the laws of the State of California on September 15, 1967. Its principal manufacturing and executive facilities are located at 399 Java Drive, Sunnyvale, California 94089. The Company's telephone number is (408) 745-7900.\nBUSINESS STRATEGY\nThe Company uses a market focused business strategy. ILC targets selected high growth markets which most closely match the Company's technological expertise and manufacturing strengths. With a strong emphasis on research and development, ILC achieves and maintains a leadership position in these market segments through advanced technology, engineering design capability and attentive customer support.\nPRODUCTS - FLASHLAMPS\nThe flashlamp line of products was ILC's founding product line. The Company makes pulsed and direct current arc lamps that are designed to satisfy a wide variety of laser and industrial applications requiring rigorous, high-performance standards. The primary source of sales, of which approximately 80% are for the replacement market, derives from industrial uses such as materials aging (solar simulation), and laser cutting, drilling, scribing and marking. Ancillary sales are generated by the medical field where lasers are utilized in cataract surgery and other exacting procedures. Production is highly labor-intensive and requires a lengthy training period to achieve a quality product. The laser market, while somewhat predictable and a steady source of revenue for the Company, is not expected to grow dramatically. ILC anticipates that the market for flashlamps in low-energy laser pumping applications will erode as alternative technologies such as laser diode pumps become increasingly cost-effective. However, in high-powered laser applications, flashlamps remain more efficient at less than 50% of the total life cycle cost of laser diodes. Therefore, ILC continues to investigate high growth arc lamp markets outside of the laser industry. Some of these include UV sterilization and curing, machine vision and spectrofluoroscopy.\nIn August 1991, ILC purchased Q-Arc Ltd., an arc lamp manufacturing company based in Cambridge, England. In the third quarter of fiscal 1994, ILC invested $2.7 million to expand Q-Arc's manufacturing capacity and using the new facility as a base, ILC has begun to broaden its sales effort for all product lines in key sales locations throughout Europe.\nPRODUCTS - CERMAX(R) AND EQUIPMENT\nThe Company provides short arc xenon lamps that are optically pre-aligned, encased in a very safe ceramic body bonded to a metallized sapphire window, and are capable of transmitting the full spectrum from infrared to ultra-violet wavelengths. In addition, the Company also manufactures fully- encased and open frame power supplies, lamp holders and other accessories to support the Cermax(R) product line. Products also include complete fiber-optic lightsources that are private labelled for manufacturers of medical equipment. Currently, the primary market is in fiber optic illumination for medical procedures such as endoscopy.\nPRODUCTS - CERMAX(R) AND EQUIPMENT (CONTINUED)\nThe market for Cermax(R) lightsources and related equipment used in endoscopy is composed of two segments - a high-intensity or critical segment and a low-intensity or non-critical segment. Critical endoscopy applications require high-intensity Cermax(R) lightsources with specialized power supplies due to the small size of the fiberoptic lightguide. Furthermore, as these applications often use video displays, high-intensity lightsources are required for good color rendition. The low-intensity market is dominated by manufacturers of halogen lightsources. Ancillary industrial uses for Cermax(R) lightsources include illuminating areas that are difficult to inspect such as nuclear reactors or jet engines. Emerging uses include lamps for analytical instruments and video projection. The Company has also targeted new non-medical lightsource markets which include spot UV curing lightsources and Flash-Cermax(R) machine vision systems.\nFor several years, ILC has conducted research and development activities focused on utilizing Cermax(R), with its brightness characteristics, as a light source for the projection of computer and television video images. Using the Cermax(R) light source and a new display technology which is based on Texas Instruments' Digital Micromirror Device (\"DMD\"), Rank Brimar Limited, a division of The Rank Organization Plc, demonstrated a bright, large screen, digital video projector which promises exceptional image quality.\nThe video projection market, for both computer and television applications, is expected to expand as new digital projection technology enables bright, large-screen display of video in a fully lit setting with exceptional image quality. Companies such as Texas Instruments and Rank Brimar have developed this technology for applications in leisure, entertainment and business. Digital projectors are expected to gain acceptance in entertainment venues, corporate environments, conference centers, concerts, advertising and promotional events, training and education and data display.\nThe factors that may adversely affect the Company's Cermax(R) business include the expected entry of competitors into the market. The Company's primary patent on the Cermax(R) lightsource expired in 1991 and the Company expects competition from established and emerging companies. Increased competition could result in price reductions, which in turn could generate lower net sales on stable unit volume. Increased competition could also result in fewer customer orders, reduced gross margins and loss of market share.\nPRODUCTS - SHORT ARC LAMPS MERCURY XENON SHORT ARC LAMPS (\"STEPPER LAMPS\")\nIn fiscal 1995, the Company began commercial shipment of a new product, the mercury xenon short arc lamp (\"stepper lamp\"), which is used to expose patterns during the fabrication of semiconductor wafers. ILC is currently shipping a complete line of 1,000 watt stepper lamps, expects to begin shipping a 2,000 watt stepper lamp by the end of the first quarter of fiscal 1996 and plans to complete the full family of stepper lamps with power ratings from 1,000 to 2,500 watts. Each lamp, fully utilized, lasts for approximately 1-2 months. Accordingly, the Company expects that the product will generate a high repeat business.\nThe market for stepper lamps is currently dominated by a Japanese competitor of the Company. ILC has invested heavily in ensuring the quality of its stepper lamps since end users perceive substantial risk in switching suppliers. In addition, ILC's stepper lamp does not require the end user to modify any of its maintenance procedures. The Company has worked over the last three years with major U.S. end users of stepper equipment, including IBM, Intel, Texas Instruments, Motorola and Hewlett-Packard to ensure that ILC's stepper lamps become qualified at each of its customers' plants. ILC's 1,000 watt stepper lamp has also recently been qualified by Sony and Hitachi in Japan.\nPRODUCTS - SHORT ARC LAMPS (CONTINUED) MERCURY XENON SHORT ARC LAMPS (\"STEPPER LAMPS\")\nThe Company's stepper lamps are engineered to be of equivalent quality and performance and completely interchangeable with lamps provided by other qualified suppliers. ILC has established relationships with sales representatives in Japan, Taiwan and Korea and plans to sell stepper lamps through distributors to reach a broader manufacturing market in Asia. To accommodate an increased volume of stepper lamps, ILC purchased a 20,000 square foot office and manufacturing facility in nearby Santa Clara, California in October 1994. The failure of the Company's stepper lamp to achieve market acceptance would have a material adverse effect on the Company's results of operations.\nMERCURY CAPILLARY LAMPS\nMercury capillary lamps are manufactured using technology and processes that are similar to those developed for stepper lamps. The applications for capillary lamps range from the photolithography of grid patterns on color TV screens to printed circuit boards for computers. The total market for capillary lamps is about $20 million with about 15% annual growth rate.\nPRODUCTS - ADVANCED LIGHTING\nThe Company develops metal halide technologies for a broad range of commercial and military applications. Advanced Lighting products include:\no DTI-The Company began new product development activities in fiscal 1994 to commercialize its aerospace and military metal halide technology. The Company has developed DTI, a series of integral low-power metal halide lamps (less than 500 watts) for commercial projection, stage and medical applications.\no DAYMAX(R) LAMPS-Daymax(R) lamps simulate stable daylight conditions. Originally developed for use in the space program, these products are now widely used throughout the entertainment business. Applications include: indoor and outdoor lighting for motion picture and television productions, high speed and special effects lighting, concert, disco and stadium lighting, theatrical lighting and lighting for projection systems. Daymax(R) lamps are also used for solar simulation in certain manufacturing processes.\no AEROSPACE PRODUCTS-ILC offers standard, modified, and customer systems covering the visible, infrared, and ultraviolet spectrum to meet each space lighting requirement. The Company's lighting systems are key elements of NASA's Space Transportation System. These systems are installed in the Space Shuttle interior and exterior, on the Manned Maneuvering Unit, on Spacelab and in several experiments carried aboard the shuttle orbiters. Other ILC systems are being designed for use on International Space Station Alpha, in future shuttle experiments and payload packages and space robotic vehicles. ILC is the only domestic manufacturer of space lighting qualified to serve NASA and other government agencies in Japan and Europe.\nILC aerospace lighting systems feature efficiency, reliability, ruggedness, light weight and full space qualification. New systems aimed to meet unique requirements can often be developed from ILC's large selection of space-qualified designs and components, substantially reducing development costs and lead times.\no MILITARY PRODUCTS-These products include infrared lamps used by the military on tanks and aircraft to deflect offensive heat seeking missiles.\nPRODUCTS - CONVERTER POWER\nILC acquired Converter Power, Inc. (CPI) in January 1993. CPI is a leading producer of high efficiency, small form factor lamp power sources built to fit compactly into a variety of systems. The Company designs and manufactures a full family of UL and TUV-approved power supplies which can be incorporated into original equipment manufacturer (OEM) equipment. In addition, CPI maintains a business relationship with a particular OEM to design custom power supplies for equipment which services the ion implant sector of the semiconductor manufacturing industry as well as several medical markets.\nCPI also provides power supplies which have been specifically engineered for ILC's Cermax(R) and metal halide lamps. This effort has enabled CPI to design power sources which will eventually be sold into the video projection market.\nPRODUCTS - PRECISION LAMP\nPrecision Lamp, Inc. (PLI), purchased in June 1992, distributes over 1,500 types of miniature to microminiature industrial incandescent lamps, and manufactures the world's only surface-mount lamp small enough to be automatically inserted onto a printed circuit board. These lamps can be used in pagers, watches, camera lenses and many other customized miniature lighting circumstances. Production of the surface-mount lamp and backlight panel are semi-automated.\nThe Company has invested in a liquid crystal display (LCD) backlight panel incorporating the technology of the surface-mount lamp. It is an innovative product in that it distributes light uniformly across a panel whereas direct backlighting or light emitting diodes can result in burn spots or uneven scattering of light. Furthermore, management believes the newly introduced backlight panel is an easier and less expensive component to use than electro-luminescent panels which require drive circuitry. This panel is the first backlight available for small displays. The LCD backlight panel is used in pagers, phones, two-way radios, games, toys, calculators and cameras. ILC received its first order at the end of fiscal 1993 for the backlight panel from an OEM making TV remote controls. Due to the wide range of consumer-driven applications, this product should enable ILC to broaden its customer base. Currently, Precision Lamp is working with major LCD fabricators in Japan, Korea, Taiwan, Singapore and Europe, all of whom are extremely interested in utilizing this component in their products. The failure of the backlight panel to achieve market acceptance would have a material adverse effect on the Company's results of operations.\nMARKETING AND SALES\nILC sells its products through a direct sales force to OEMs and sells to end users through sales representatives and distributors. In situations where the Company is entering an existing market, such as the stepper lamp market, ILC works directly with end users in qualifying the lamps utilizing indirect distribution channels. In addition, ILC maintains a team of ten people to provide sales and customer service support to its customer base and network of foreign and domestic distributors.\nA European sales office located at the facilities of Q-Arc in Cambridge, England, sells and markets the complete line of lamp and equipment products and provides local support for European customers. With the formation of a joint venture in Japan, ILC has broadened its sales reach to Asia and established a local presence for its Asian customers. Sales activities of the Company' subsidiaries, Q-Arc, CPI and PLI, operate independently with overall coordination handled by ILC corporate in Sunnyvale.\nMARKETING AND SALES (CONTINUED)\nFor fiscal 1995, approximately 34.8% of the Company's net sales represented international sales, primarily in the Pacific Rim and Europe. Information regarding the Company's export sales and major customers is incorporated herein by reference to Note 3 of Notes to Consolidated Financial Statements.\nBACKLOG\nAs of September 30, 1995, ILC's backlog of unfilled orders was approximately $33,767,000 as compared to approximately $27,730,000 at October 1, 1994. The Company includes in its backlog only orders which have been released by the customer for shipment within the next 12 months. Due to the possibility of customer changes in delivery schedules or cancellations of orders, backlog as of any particular date may not be representative of actual sales for any succeeding period.\nMANUFACTURING\nILC's lamp groups have built substantial expertise in the fields of sealing technology (ceramic-to- metal, quartz-to-metal, vacuum sealing), materials research, plasma physics, electrical engineering, optoelectronics, and electrode technology. With PLI, ILC obtained unique semi-automated manufacturing capabilities required for high-volume, low-cost manufacturing. With CPI, ILC obtained the essential power supply expertise necessary for providing OEMs with integrated solutions. The manufacturing of most of the Company's lamp and power supply products is labor and capital intensive, and accordingly, the labor force is highly skilled and experienced with specialty equipment. The combination of ILC's technical and manufacturing expertise enables ILC to dominate its selected market niches for specialty lighting.\nILC designs, develops, and manufactures a majority of its products in two facilities totalling 97,000 square feet. These adjoining buildings include lamp development laboratories, separate manufacturing facilities for xenon and krypton arc lamps, Cermax(R) lamps, Daymax(R) metal halide lamps, mercury short arc (\"stepper\") lamps, mercury capillary lamps, Cermax(R) equipment and Aerospace products. The Company also purchased, in October 1994, a facility in Santa Clara, California totalling approximately 20,000 square feet to accommodate stepper lamp manufacturing.\nThe need for more production capacity for the subsidiaries of ILC prompted expansion of existing manufacturing facilities. Q-Arc Ltd purchased a new facility of approximately 36,000 square feet in June 1994 and occupied the new facility in early fiscal 1995. Q-Arc currently occupies approximately 25,000 of the 36,000 square feet and is seeking a tenant to occupy the balance of the space. The 10,000 square foot facility which Q-Arc previously occupied was sublet to a third party. Converter Power, in late fiscal 1995, signed a lease for a 32,000 square foot facility to satisfy the growing production requirements of laser power supplies. CPI had previously occupied a 15,000 square foot facility and is currently seeking a tenant to sublet the property which has one year left on the lease. Precision Lamp occupies a 24,000 square foot facility in Cotati, California for the automated manufacture of surface mounted miniature incandescent lamps and LCD backlight panels. Precision Lamp moved into this facility in fiscal 1993.\nPLI received ISO9001 certification in fiscal 1994 and Q-Arc received ISO9002 certification in fiscal 1995. ILC Sunnyvale has been recommended for ISO9001 certification and management excepts CPI to be certified by late 1996. ISO9001 certification ensures customers that ILC has a quality system that will result in continuous product quality improvement. It is a recognition of a commitment to quality throughout all sections of the organization.\nPATENTS AND TRADEMARKS\nThe Company holds approximately 42 patents related to the key features of several of its products and several applications are pending. While these patents tend to enhance the Company's competitive position, management believes that the Company's success depends primarily upon its proprietary technological, engineering, production and marketing skills and the high quality of its products. The names of two of the Company's products, Cermax(R) and Daymax(R) are registered as trademarks in the United States Patent and Trademark Office and in many other countries in which the Company's products are sold.\nThe Company's patents expire at various dates between 1996 and 2012. There can be no assurance that any patents held by the Company will not be challenged and invalidated, that patents will issue from any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in all countries where the Company's products can be sold to provide meaningful protection or any commercial advantage to the Company. Competitors of the Company also may be able to design around the Company's patents.\nCOMPETITION\nILC competes on the basis of product performance, applications engineering, customer service, reputation and price. The Company competes in many markets in which technology develops and improves rapidly, stimulating ILC to enhance the capability of its products and technologies. Competitors consist of both large and small companies located in the United States, Japan and Europe. They include EG&G Inc., Osram, Philips, Ushio, ORC Japan, Koto, Wolfram and GE. In many market sequents, the competition has established the bench mark for product acceptance at a very high level, causing ILC to continuously improve all phases of its processes for customer satisfaction. The Company believes that by exploiting segmented market areas in which ILC has technological, manufacturing and marketing strengths, ILC can compete effectively. At the same time, by focusing its product development and acquisition activities in these areas, the Company can defend its strengths and maintain its leadership in selected markets.\nENGINEERING AND RESEARCH\nILC's engineering, research, and development efforts consist of three main activities. The first area of activity is extensive application engineering in response to customer requirements. These activities result in customer specific products and modifications to existing products to satisfy the needs of the customers. The second area is that of joint engineering and development work made in connection with customer production contracts. The third area includes those projects funded by the Company to develop new products and technologies. In 1995, the Company spent $4,497,000 for Company funded research and development efforts. This is compared to $3,998,000 and $2,767,000 spent in fiscal years 1994 and 1993, respectively. The Company's engineering and research personnel are engineers and scientists, all of whom have technical degrees.\nIn fiscal 1995, a Corporate Technology Business Unit was formed to provide ILC Sunnyvale with a focused research capability. This core competency will be directed and managed to service generic challenges. This newly formed group will also act as a focus of business opportunities that do not naturally fall within the strategic plans of an existing product line. Initially, this group will direct its efforts toward answering some basic questions regarding electrodes, envelopes and material related processes.\nEMPLOYEES\nAs of September 30, 1995, the Company had 584 full-time employees, comprised of 53 in research and engineering, 21 in marketing and sales, 466 in manufacturing and 44 in general and administrative positions. ILC believes that its future success depends upon its continued ability to recruit and maintain highly skilled employees in all disciplines. Although competition for qualified personnel is strong, ILC has been successful in attracting and retaining skilled employees. None of the Company's employees is represented by a labor union. The Company believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns and leases an aggregate of approximately 153,000 and 56,000 square feet, respectively, of office and manufacturing space in six separate buildings in Sunnyvale, Santa Clara and Cotati, California; Beverly, Massachusetts; and Cambridge, England. In Sunnyvale, the Company owns 97,000 square feet in two adjacent buildings. These buildings were constructed by the Company in 1977 and 1979, sold in 1982 and leased back from the new owners, and re-purchased from the landlord in August 1993. The Company leases to one tenant approximately 5,000 square feet of its space in Sunnyvale under a lease which expires in March 1996. In early October 1994, the Company purchased 20,000 square feet of office and manufacturing space in Santa Clara, California. In June 1994, the Company purchased 36,000 square feet of office and manufacturing space in Cambridge, England. Q-Arc currently occupies approximately 25,000 square feet and is currently seeking a tenant to lease the balance of the space. Q-Arc previously leased a 10,000 square foot facility, which has been sublet to a third party. Precision Lamp moved into a new facility in July 1993. The lease for the 24,000 square feet of office and manufacturing space, located in Cotati, California, expires in 2003. Finally, Converter Power, in late fiscal 1995, entered into a lease to occupy approximately 32,000 square feet of office and manufacturing space in Beverly, Massachusetts. This lease expires in September 2000. Converter Power will begin to move into the new facility in the first quarter of fiscal 1996. CPI previously occupied a 15,000 square foot facility in Ipswich, Massachusetts, under a lease that expires in December 1996. The Company is currently seeking a tenant to sublet the property. For a discussion of the Company's lease commitments, see Note 8 of the Notes to Consolidated Financial Statements appearing elsewhere 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\nThere were no matters submitted to a vote of the 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\nILC's common stock is traded in the Nasdaq National Market (symbol ILCT). The high and low closing sales prices for the common stock on the Nasdaq National Market, are set forth below for the quarters as indicated:\nFISCAL 1995 HIGH LOW\n1st Quarter 10 3\/8 7 1\/2 2nd Quarter 10 3\/4 8 3rd Quarter 11 1\/8 8 3\/4 4th Quarter 11 1\/4 9\nFISCAL 1994 HIGH LOW\n1st Quarter 11 3\/4 10 2nd Quarter 11 1\/2 8 1\/2 3rd Quarter 9 6 5\/8 4th Quarter 9 5\/8 7 1\/4\nThere were approximately 2,000 institutional and individual stockholders as of December 18, 1995. The closing sales price of the common stock on December 18, 1995 as reported by Nasdaq was $9.38. The Company intends to retain earnings for use in its business and does not expect to pay cash dividends in the foreseeable future. The Company's credit agreement with Union Bank provides that the Company shall not declare or pay any dividend or other distribution on its Common Stock (other than a stock dividend) or purchase or redeem any Common Stock, without the bank's prior written consent.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial data of the Company should be read in conjunction with the Consolidated Financial Statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nDuring fiscal 1995, 1994 and 1993, the Company derived approximately 34%, 44% and 45%, respectively, of its net sales from the medical market. During fiscal 1995, 1994 and 1993, the Company's sales in the industrial market accounted for 40%, 44% and 38%, respectively, of net sales. In each of the fiscal years 1995, 1994 and 1993, the Company's sales in the aerospace market accounted for 7% of net sales. Products sold in the medical market are incorporated into products sold into the health-care and health-care related industries. These industries have recently been subject to significant fluctuations in demand which in turn have affected the demand for components used in these products. The Company expects sales to the medical market to continue to decrease as a percentage of net sales for the foreseeable future. Aerospace sales have remained relatively constant over the last two fiscal years. Due to the continuing slowdown in military and defense spending, the Company does not expect aerospace sales to grow significantly from fiscal 1995 and 1994 levels. To compensate for this slowdown, the Company began new product development activities in fiscal 1995 and 1994 for commercial applications for metal halide lamps used for projection and information display.\nFISCAL 1995 COMPARED TO FISCAL 1994\nNet sales for fiscal 1995 were $58,429,000, an increase of 12.3% over fiscal 1994 net sales of $52,022,000. The $6,407,000 increase was primarily attributable to a $4 million sales increase at Converter Power and a $1 million\nFISCAL 1995 COMPARED TO FISCAL 1994 (CONTINUED)\nsales increase at both Precision Lamp and Q-Arc. Although total net sales at ILC Technology remained unchanged between the two fiscal years, Cermax and related equipment sales decreased approximately $2.4 million, due to a softness in the medical market as discussed above. Flash and Quartz lamp sales increased $1 million and Advanced Lighting sales increased $1.4 million. In the second quarter of fiscal 1994, Precision Lamp experienced a significant shortfall in orders from a major customer. Due to this slowdown, sales to this customer are expected to be significantly lower than previously anticipated. (See Note 11 of Notes to Consolidated Financial Statements). During fiscal 1995, sales to this major customer were slightly above the fiscal 1994 sales level. The $1 million Precision Lamp revenue increase discussed above was primarily the result of new product sales.\nCost of sales as a percentage of net sales was 67.1% for fiscal 1995 compared to 67.8% for fiscal 1994. The fiscal 1994 percentage was negatively impacted due to the write off of approximately $500,000 of excess Precision Lamp inventory relating to the slowdown in the release of shippable product from a major customer as discussed above. The ratio of the inventory reserve to year end inventory in fiscal years 1995, 1994 and 1993 was 18.0%, 20.9% and 17.5%, respectively. The fiscal year 1994 ratio excludes the above mentioned $500,000 reserve addition.\nResearch and development expenses, 7.7% of net sales in both fiscal 1995 and 1994, increased $499,000 between the two fiscal years. The majority of the increase was concentrated in the Quartz stepper lamp product.\nMarketing expenses, 5.1% of net sales in fiscal 1995 compared to 4.4% of net sales in fiscal 1994, increased $705,000. The increase between the two fiscal years was primarily due to the addition of personnel, more travel and trade show attendance and additional commission expense on an increased sales volume.\nAs a percentage of sales, general and administrative expenses were 8.7% in fiscal 1995 and 10.0% in fiscal 1994. The $139,000 decrease was due to the accrual in the second quarter of fiscal 1994 for early exit incentives for various long time ILC employees ($500,000) and the write off of a note receivable, doubtful of collection ($250,000). This decrease was partially offset by expenses incurred by Q-Arc in its move to a larger manufacturing facility and by personnel additions and other expenses at Converter Power, totalling approximately $600,000, in fiscal 1995.\nAmortization of intangibles of $290,000 in fiscal 1995 represents the amortization of covenants-not-to-compete arising from the acquisitions of Precision Lamp in 1992 and Q-Arc in 1991. The amortization of intangibles of $3,765,000 in fiscal 1994 includes a $3,400,000 write down of intangibles generated from the acquisition of Precision Lamp. As discussed below, Precision Lamp experienced a significant shortfall in orders from a major customer in the second quarter of fiscal 1994. In assessing the recoverability of the unamortized goodwill and covenant-not-to-compete generated from the acquisition, management determined that an impairment occurred and recorded a $3.4 million charge.\nInterest income was $313,000 in fiscal 1995, which amount included approximately $235,000 of interest income from an income tax refund in the third quarter of fiscal 1995. Interest income in fiscal 1994 was $200,000. Interest expense, $696,000 in fiscal 1995 as compared to $339,000 in fiscal 1994, increased $357,000 between the two fiscal years. The increase was due to additional borrowings on the Company's line of credit and equipment purchases.\nFISCAL 1995 COMPARED TO FISCAL 1994 (CONTINUED)\nThe Company reported income from operations before provision for income taxes of $5,978,000 in fiscal 1995 compared to $1,343,000 in fiscal 1994. The fiscal 1995 provision for income taxes, exclusive of an income tax refund of $238,000 in the third quarter of fiscal 1995, was 28% of pretax income before provision for income taxes. This compares with a fiscal 1994 provision for income taxes of approximately 31% of pretax income before provision for income taxes, which provision is exclusive of the effect related to the non-deductible portion of the write down of intangibles discussed above.\nThe Company believes that inflation and changing prices had no significant impact on sales or costs during fiscal 1995 and 1994.\nFISCAL 1994 COMPARED TO FISCAL 1993\nNet sales remained relatively constant at $52,022,000 and $51,997,000 in fiscal 1994 and 1993, respectively. Although the total net sales were unchanged, Cermax(R) and related equipment sales decreased approximately $2 million, Flash and Quartz lamp sales increased approximately $1 million and Converter Power sales increased approximately $3 million between the two fiscal years. Additionally, in the second quarter of fiscal 1994, Precision Lamp experienced a significant shortfall in orders from a major customer. This slowdown resulted in lower sales of approximately $2 million in fiscal 1994 as compared to fiscal 1993. Sales to this customer are now expected to be significantly lower than previously anticipated. (See Note 11 of Notes to Consolidated Financial Statements.)\nCost of sales as a percentage of net sales was 67.8% for fiscal 1994 compared to 67.0% for fiscal 1993. The percentage increase was primarily due to the write off of approximately $500,000 related to excess Precision Lamp inventory caused by a slowdown in the release of shippable product from a major customer discussed above. The ratio of the inventory reserve to year end inventory in fiscal 1994, 1993 and 1992 was 20.9%, 17.5% and 22.8%, respectively. The fiscal 1994 ratio excludes the above mentioned $500,000 reserve addition.\nSpending in the area of research and development, 7.7% of net sales in fiscal 1994, compared to 5.3% of net sales in fiscal 1993, increased $1,231,000 between the two fiscal years. The increase occurred in Cermax(R) for the development of lamps for video projection, in Quartz lamps for the development of the stepper lamp and in Advanced Lighting for the design and development of lamps used for entertainment applications. Also contributing to the increase was spending at Precision Lamp for the development of panels to light the entire rear of a liquid crystal display and spending at Converter Power for the design of new power supplies.\nMarketing expenses were $2,271,000, or 4.4% of net sales in fiscal 1994 compared to $2,642,000, or 5.1% of net sales in fiscal 1993. The $371,000 decrease between the two fiscal years was due primarily to less travel and trade show attendance coupled with less commission expense associated with lower sales at Precision Lamp caused by the slowdown in the release of shippable product from a major Precision Lamp customer.\nGeneral and administrative expenses, as a percentage of net sales, were 10.0% in fiscal 1994 compared to 7.6% in fiscal 1993. The $1,282,000 increase between the two periods was due to a combination of the accrual for early exit incentives for various long-time ILC employees, the write off of a note receivable, doubtful of collection, which arose from the United Detector Technology divestiture in 1990 and increases to general and administrative expenses at Converter Power and Q- Arc. This increase was partially offset by the suspension of contributions to the ILC profit sharing plan for the first six months of fiscal 1994.\nFISCAL 1994 COMPARED TO FISCAL 1993 (CONTINUED)\nAmortization of intangibles of $3,765,000 in fiscal 1994 includes a $3,400,000 write down of intangibles generated from the acquisition of Precision Lamp in June 1992. As discussed above, Precision Lamp experienced a significant shortfall in orders from a major customer in the second quarter of fiscal 1994. In assessing the recoverability of the unamortized goodwill and covenant-not-to- compete generated from the acquisition, management determined that an impairment occurred in that quarter. Total sales and earnings of Precision Lamp for the period March 1994 to March 2002 as projected at the time of the intangible impairment calculation were approximately 50% and 70% lower than sales and earnings estimates, respectively, at the time of the Precision Lamp acquisition. These projections represent management's best estimate for future results for that subsidiary. Precision Lamp is actively seeking to solicit other customers and alter its products to meet their specifications for the surface mounted miniature incandescent lamp. However, because of the major customer's dominance of its market, and because other manufacturers are numerous and small volume, the Company believes that Precision Lamp will be unable to secure new customers to make up for the significant shortfall in orders. Accordingly, a $3.4 million charge was recorded to write down the intangibles to net realizable value. The writedown was determined based on the currently projected un-discounted cash flows of Precision Lamp from March 1994 to March 2002, which projected aggregate cash flows of approximately $900,000 over that period which was based on projected net income which averaged 9% higher than the net income projection for fiscal 1994 (with no loss years included in the projection), compared with the carrying value of the Company's investment in Precision Lamp, including goodwill, at the date of the writedown. At October 1, 1994, there were net assets associated with the Precision Lamp acquisition of approximately $2,270,000, or approximately 5% of total assets, for which recoverability is primarily dependent upon sales to the major customer discussed above. The amortization of intangibles of $757,000 in fiscal 1993 represents the amortization of covenants-not-to- compete plus the amortization of goodwill both arising from the acquisitions of Precision Lamp in 1992 and Q-Arc in 1991.\nAlthough interest income remained constant between fiscal 1994 and fiscal 1993, interest expense increased by approximately $261,000 during the same period due to the term loan obtained to purchase the Company's two operating facilities in Sunnyvale, California in August 1993 and the manufacturing facility in Cambridge, England in June 1994.\nThe Company reported income before provision for income taxes of $1,343,000 in fiscal 1994 compared to $7,111,000 in fiscal 1993. The provision for income taxes, exclusive of the effect related to the non-deductible portion of the write down of intangibles discussed above, was approximately 31.0% of pretax income before provision for income taxes in fiscal 1994 compared to 33.1% in fiscal 1993.\nThe Company believes that inflation and changing prices had no significant impact on sales or costs during fiscal 1994 and 1993.\nLIQUIDITY AND FINANCIAL POSITION\nCash and cash equivalents decreased to $1,509,000 in fiscal 1995 from $2,462,000 in fiscal 1994. Cash provided from operations amounted to $3,449,000 in fiscal 1995, a decrease of $3,226,000 from $6,675,000 in fiscal 1994. This decrease occurred primarily due to an increase in accounts receivable of $2,767,000 and an increase in inventories of $2,304,000. During fiscal 1995, the Company used cash of $1,745,000 to purchase land and a new manufacturing facility in Santa Clara, California and made capital equipment acquisitions of $3,419,000. In fiscal 1995, the Company increased its net borrowings under its line of credit by $2,000,000, increased its net borrowings under\nLIQUIDITY AND FINANCIAL POSITION (CONTINUED)\nan equipment line by $670,000 and paid down a term loan by $1,578,000. In fiscal 1994, the Company used cash of $2,701,000 to purchase a new office and manufacturing facility in Cambridge, England, deposited $1,300,000 for the purchase of land and a manufacturing facility in Santa Clara, California and paid $312,000 for land in Cotati, California. Capital equipment acquisitions in fiscal 1994 amounted to $2,634,000. In fiscal 1994, the Company increased its net borrowings under a term loan for real estate acquisitions by $800,000 and increased the net borrowings under an equipment line by $591,000. In addition, in fiscal 1994, the Company also repurchased, on the open market, 204,000 shares of its common stock for $1,556,000. In fiscal 1993, the Company used cash of $7,600,000 to purchase its manufacturing facilities and corporate offices in Sunnyvale, California. Also in fiscal 1993, the Company used cash of $1,467,000 for capital equipment acquisitions and borrowed $5,000,000 under a term loan to finance the purchase of the above mentioned facilities in Sunnyvale, California.\nThe Company has working capital of $11,066,000 and a current ratio of 1.94 to 1.0 at September 30, 1995. This compares with working capital of $9,428,000 and a current ratio of 1.79 to 1.0 at October 1, 1994. As of September 30, 1995, the Company has $2,000,000 unused on a $4,000,000 bank line of credit with interest at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995). The Company also has available approximately $690,000 remaining on a $1,500,000 equipment credit facility at the above interest rate. This credit facility can be increased to accomodate the capital equipment needs of the Company. In fiscal 1996, ILC anticipates making capital expenditures of approximately $3 million. These financial resources, together with anticipated additional resources to be provided from operations, are expected to be adequate to meet the Company's working capital needs, capital equipment requirements and debt service obligations at least through fiscal 1996.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation.\" The Company is not required to adopt the provisions of this statement until its fiscal year 1996. The provisions of this statement must be made on a prospective basis. The Company plans to adopt the disclosure provisions of this statement in 1996, and theefore the effect on its financial position and results of operations, upon adoption, will not be significant.\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 Company will adopt the provision of this statement in fiscal 1996 and believes the effect on its financial position and result of operations, upon adoption, will not be significant.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nTABLE OF CONTENTS PAGE\nConsolidated Balance Sheets - September 30, 1995 and October 1, 1994 15 - 16\nConsolidated Statements of Operations for the Three Fiscal Years Ended September 30, 1995 17\nConsolidated Statements of Stockholders' Equity for the Three Fiscal Years Ended September 30, 1995 18\nConsolidated Statements of Cash Flows for the Three Fiscal Years Ended September 30, 1995 19 - 20\nNotes to Consolidated Financial Statements 21 - 30\nForm 10-K Schedule 31\nReport of Independent Public Accountants 32\nILC TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995\n1. THE COMPANY\nILC Technology, Inc. (the \"Company\") was incorporated on September 15, 1967. The Company designs, develops and manufactures high intensity lamps and lighting products for medical, industrial, communication, aerospace, scientific, entertainment and military industries. The Company develops and manufactures the majority of its products at its headquarter facilities in California and the remainder at its subsidiary facilities in Massachusetts, the United Kingdom and another location in California.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe financial statements include the accounts of ILC Technology, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.\nThe Company's fiscal year end is the Saturday closest to September 30.\nUSE OF ESTIMATES IN 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.\nCASH AND CASH EQUIVALENTS\nFor the purpose of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less at the time of issue to be cash equivalents.\nMARKETABLE SECURITIES\nEffective October 3, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting For Certain Investments in Debt and Equity Securities\". The adoption of this statement did not materially impact the Company's results from operations or financial position. Marketable securities at October 1, 1994 were being accounted for as trading securities and were therefore valued at fair market value in the accompanying balance sheet. The change in the net unrealized holding loss, which was included in fiscal 1994 income, was approximately $80,000 during fiscal 1994. During fiscal 1995, all marketable securities were liquidated.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out) or market, and include material, labor and manufacturing overhead. Inventories at September 30, 1995 and October 1, 1994, net of inventory reserves of $2,042,813 and $2,533,233, respectively, consisted of:\n1995 1994 ---- ----\nRaw materials .................... $4,846,508 $ 3,393,249 Work-in-process................... 2,609,006 2,556,006 Finished goods ................... 1,833,693 1,242,942 ---------- ----------- Total inventories................. $9,289,207 $ 7,192,197 ========== ===========\nDEVELOPMENTAL AND MANUFACTURING CONTRACTS\nThe Company contracts with the U.S. Government and other customers for the development and manufacturing of various products under both cost-plus-fixed-fee and fixed-price contracts. Revenues are recognized under these contracts using the percentage of completion method, whereby revenues are reported in the proportion that costs incurred bear to the total estimated costs for each contract. Periodic reviews of estimated total costs during the performance of such contracts may result in revisions of contract estimates in subsequent periods. Any loss contracts are reserved at the time such losses are determined. Revenues from these contracts were less than 10% of net revenues during 1995, 1994 and 1993.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization on property and equipment are provided on a straight-line basis over estimated useful lives of 3 to 31.5 years, except for leasehold improvements which are amortized over the terms of the leases.\nNET INCOME PER SHARE\nNet income per share is computed based on the weighted average number of common shares and common equivalent shares (using the treasury stock method and when such equivalents have a dilutive effect) outstanding during the period. Fully diluted net income per share is not significantly different from net income per share as reported.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation.\" The Company is not required to adopt the provisions of this statement until its fiscal year 1996. The provisions of this statement must be made on a prospective basis. The Company plans to adopt the disclosure provisions of this statement in 1996, and theefore the effect on its financial position and results of operations, upon adoption, will not be significant.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nINTANGIBLE ASSETS\nThe Company has certain intangible assets as a result of its acquisition of two subsidiaries (see Note 10). Subsequent to these acquisitions, the Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful lives of these intangibles may warrant revision or that the remaining balances of intangibles may not be recoverable. When factors indicate that intangibles should be evaluated for possible impairment, the Company uses an estimate of the related subsidiary's undiscounted cash flow over the remaining life of the intangibles in measuring whether the intangibles are recoverable.\nCovenants-not-to-compete are amortized over the period of the covenant.\nINVESTMENT IN JOINT VENTURE\nIn February 1995, the Company invested $450,000 in a lamp manufacturer located in Japan. The Company's investment represents a 49% ownership interest in the equity of the investee, consequently the Company accounts for its investment using the equity method of accounting. The Company's investment is included in Other Assets in the accompanying consolidated balance sheets and its proportionate interest in the income of the investee of $89,000 in fiscal 1995 is included in the accompanying consolidated statements of operations.\nFORWARD EXCHANGE CONTRACTS\nThe Company enters into forward exchange contracts to reduce its exposure to currency exchange risk for purchases from one Japanese vendor. The effect of this practice is to minimize the impact of foreign exchange rate movements on the Company's operating results. The Company's hedging activities do not subject the Company to exchange rate risk, as gains and losses on these contracts offset losses and gains on the liabilities being hedged.\nAt September 30, 1995, the Company had forward exchange contracts maturing from October 1995 to December 1995 to purchase 22,200,000 Japanese yen ($224,000).\n3. REVENUES\nThe Company recognizes revenue on all product sales upon shipment of the product. The Company accrues for estimated warranty obligations at the time of the sale of the related product based upon its past history of claims experience and costs to discharge its obligations.\nThe Company operates in a single industry segment, the designing, developing, manufacturing and marketing of high performance light source products. Revenues are geographically summarized as follows (in thousands):\n1995 1994 1993 ----------- ------------ ------------\nUnited States ................... $ 38,080 $ 31,627 $ 29,994 Europe .......................... 6,062 4,435 5,188 Asia ............................ 14,239 15,794 16,447 Other international ............. 48 166 368 ----------- ------------ ------------ Total revenues ...... $ 58,429 $ 52,022 $ 51,997 =========== ============ ============\n3. REVENUES (CONTINUED)\nCustomers comprising more than 10% of net sales are as follows:\n1995 1994 1993 ----------- ------------ ------------\nCustomer A ............... 10.3% 17.6% 19% Customer B ............... 12.1% 12.8% 17% Customer C ............... 10.3% * *\n*less than 10% of net sales\nThe Company provides credit in the form of trade accounts receivable to its customers. The Company does not generally require collateral to support customer receivables. The Company performs ongoing credit evaluations of its customers and maintains allowances which management believes are adequate for potential credit losses.\nApproximately 34% of the Company's sales in fiscal 1995 were to customers in the health-care industry. This industry has experienced significant fluctuations in demand and the Company expects sales to the medical market to decrease as a percentage of net sales in the forseeable future. Customer C, referred to above, is in the semi-conducto industry. This industry also can be subject to significant fluctuations in demand.\n4. PROPERTY AND EQUIPMENT\nProperty and equipment at September 30, 1995 and October 1, 1994 consisted of:\nProperty and equipment, at cost: Machinery and equipment ................ $15,706,092 $11,856,023 Land and buildings ..................... 14,810,768 11,229,341 Furniture and fixtures ................. 670,145 463,910 Equipment under capital lease .......... 174,268 174,268 Leasehold improvements ................. 244,166 209,830 Construction-in-progress ............... 684,693 1,939,963 ----------- ----------- 32,290,132 25,873,335 Less accumulated depreciation and amortization ........................... (9,848,377) (8,185,058) ----------- -----------\nProperty and equipment, net ............... $22,441,755 $17,688,277 =========== ===========\n5. BANK BORROWINGS\nThe Company has a $4 million line of credit available with a bank which expires in January 1997. Borrowings under this line are at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995) and are limited to 75% of eligible accounts receivable. Under the covenants of the loan agreement, unless written approval from the bank is obtained, the Company is restricted from entering into certain transactions and is required to maintain certain specified financial covenants and profitability. As of September 30, 1995, the Company was in compliance with all bank requirements.\nThe average balance outstanding (based on month-end balances) under the line of credit in 1995 was $1,550,000. The maximum borrowings were $2,450,000 at an average interest rate of 7.8% for 1995. There were no borrowings under the line of credit in fiscal 1994, nor were there any amounts outstanding as of October 1, 1994. As of September 30, 1995, $2 million was available for future borrowings under this line of credit.\n5. BANK BORROWINGS (CONTINUED)\nIn addition, in connection with the purchase of its Sunnyvale manufacturing facilities, the Company entered into a term note with a bank for $5,000,000 in 1993, which was subsequently increased to $6,333,333 in 1994. The note matures in August, 1998. The term loan requires monthly principal payments equal to one-forty-eighth of the principal amount plus interest at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995). The term loan is a reducing revolving credit facility which allows for principal pre-payments and the flexibility for re-borrowing up to the maximum amount that would be outstanding under the term loan given normal amortization to the date of re-borrowing.\nThe Company also has available a $1.5 million equipment line of credit for 100% of the purchase cost of new equipment, which expires in January 1996. Borrowings under this line bear interest at 2% above the LIBOR rate (7.8% at September 30, 1995), with principal balances amortized over a 2 year period. At September 30, 1995, the Company had approximately $690,000 available for future borrowings under this line of credit.\nAs of September 30, 1995 and October 1, 1994, borrowings outstanding under its credit facilities consisted of:\n1995 1994 ----------- -----------\nTerm note ............................. $ 4,222,000 $ 5,800,000 Line of credit ........................ 2,000,000 - Equipment line of credit .............. 2,011,000 1,340,869 Other capital lease ................... 120,540 152,119 ----------- ----------- 8,353,540 7,292,988\nLess: current portion ................. (2,455,500) (2,196,494) ----------- -----------\nLong-term debt ........................ $ 5,898,040 $ 5,096,494 =========== ===========\nAggregate maturities for long-term debt during the next five years are approximately: 1996 - $2,455,500, 1997 - $2,455,500, 1998 - $1,450,000, 1999 none and 2000 - none.\nAll of the above credit facilities are secured by all of the property of the Company.\n6. INCOME TAXES\nEffective October 3, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes\", on a prospective basis. SFAS No. 109 requires an asset and liability approach to accounting for income taxes. The adoption of SFAS No. 109 did not have a material effect on the Company's consolidated financial statements.\nIncome before provision for income taxes consists of the following for fiscal 1995, 1994 and 1993:\n1995 1994 1993 ---- ---- ----\nU.S. $5,456,897 $ 971,283 $6,906,493 Foreign 521,037 371,330 204,178 ---------- ---------- ---------- $5,977,934 $1,342,613 $7,110,671 ========== ========== ==========\n6. INCOME TAXES (CONTINUED)\nThe components of the provision for income taxes are as follows:\n1995 1994 1993 ----------- ------------ ------------ Federal - Current $833,000 $2,373,000 $1,575,000 Deferred 554,000 (1,361,000) - -------- ---------- ----------\n1,387,000 1,012,000 1,575,000 State - Current 199,000 493,000 777,000 Deferred 92,000 (353,000) - --------- --------- ---------\n291,000 140,000 777,000 Federal refund received (238,000) - - --------- --------- --------- Total provision for income taxes $1,440,000 $1,152,000 $2,352,000 ========== ========== ==========\nThe major components of the deferred tax accounts as computed under SFAS No. 109, are as follows:\n1995 1994 ---- ----\nInventory reserve $838,000 $754,000 Bad debt reserve 271,000 258,000 Warranty reserve 105,000 228,000 Accruals not currently deductible for tax purposes 448,000 1,078,000 Amortization of covenant-not-to-compete 278,000 538,000 Excess of tax over book depreciation (801,000) (710,000) Other 315,000 259,000 -------- ---------- $1,454,000 $2,405,000 ========== ==========\nThe provisions for income taxes differ from the amounts which would result by applying the applicable statutory Federal income tax rate to income before taxes as follows: 1995 1994 1993 ---- ---- ---- Computed expected provision $2,092,000 $470,000 $2,418,000 State tax 359,000 81,000 436,000 Amortization and writedown of goodwill - 812,000 90,000 FSC commission (211,000) (259,000) (254,000) General business credits (200,000) (72,000) (33,000) Refund received (238,000) - - Other (362,000) 120,000 (305,000)\n-------- ------- ------- $1,440,000 $1,152,000 $2,352,000 ========== ========== ==========\n7. EMPLOYEE RETIREMENT PLAN\nOn January 1, 1984, the Company adopted a thrift incentive savings plan (the \"Plan\"). The Plan is qualified under section 401(k) of the Internal Revenue Code and is available to all full-time employees with one or more years of employment with the Company. Under the terms of the Plan, participating employees must contribute at least 2% of their salary to the Plan, and the Company contributes (as a matching contribution) 100% of this amount. Employees may also contribute an additional amount up to 13% of their salary to the Plan, with no further contributions by the Company. The Company's contributions vest at a rate of 20% per year, commencing on the first anniversary of employment. Total employer matching contributions under the Plan were $212,000, $163,000, and $145,000 for the fiscal years 1995, 1994 and 1993, respectively.\n8. COMMITMENTS AND CONTINGENCIES\nIn October 1994, Q-Arc Ltd. purchased a new office and manufacturing facility in Cambridge, England. Prior to this, Q-Arc had leased its manufacturing facility under an operating lease agreement, which lease agreement has been assumed by another company.\nIn August 1993, the Company purchased two buildings, which were its two principal operating facilities in Sunnyvale, California, from the landlord for $7,600,000. The Company has leased a small portion of the Sunnyvale facility under a lease which expires in 1996.\nAt September 30, 1995, the future minimum rental payments under all building leases for fiscal 1996 through 2000 are approximately $380,000, $423,000, $424,000, $444,000 and $444,000, respectively, and $660,000 thereafter. The amounts total $2,775,000.\nFor fiscal years 1995, 1994 and 1993, rental expense was approximately $277,000, $318,000 and $934,000 respectively.\n9. STOCK OPTION AND PURCHASE PLANS\nIn 1993, the Company adopted the 1992 Stock Option Plan and reserved 200,000 shares for issuance. The 1992 Option Plan replaced the 1983 Option Plan which expired in June 1993. Although options granted under the 1983 Stock Option Plan before such expiration will remain outstanding in accordance with their terms, no further options will be granted under the 1983 Stock Option Plan after June 1993. The exercise price per share for stock options cannot be less than the fair market value on the date of grant. Options granted are for a ten-year term and generally vest ratably over a period of four years commencing one year after the date of grant. In November 1993, the Company's 1992 Stock Option Plan was amended to provide for the automatic grant of a nonstatutory stock option to purchase shares of Common Stock to each outside Director. Subsequent grants will occur annually during the Company's third fiscal quarter. During fiscal 1995, each outside Director was granted an automatic option to purchase a total of 5,000 shares of the Company's Common Stock. A summary of the option transactions is as follows:\n9. STOCK OPTION AND PURCHASE PLANS (CONTINUED)\nOptions Outstanding -------------------\nOptions Number Available of Price per for Grant Shares Share --------- ------ ---------\nBalance at October 3, 1992 11,624 698,500 $2.13-11.50\n1992 Option Plan new shares approved 200,000 - - Options assumed in Converter Power Acquisition - 26,027 $1.09 Granted (57,500) 57,500 $9.00-11.50 Canceled 5,500 (5,500) $8.75-11.50 Exercised - (30,500) $ 2.13 -3.75 ------- ------- ------------\nBalance at October 2, 1993 159,624 746,027 $1.09-11.50\nGranted (74,000) 74,000 $7.38-11.00 Canceled 18,000 (18,000) $3.75-11.50 Exercised - (82,000) $ 1.09 -8.75 ------- ------ ------------\nBalance at October 1, 1994 103,624 720,027 $1.09-11.50\nGranted (28,000) 28,000 $9.50 Canceled 34,000 (34,000) $8.75-11.50 Exercised - (132,250) $ 2.13 -8.75 ------ ------- ------------\nBalance at September 30, 1995 109,624 581,777 $1.09 -11.50 ======= ======= ============ Options exercisable at September 30, 1995 439,715 $1.09 -11.50 ======= ============\nIn February 1985, the Company adopted an employee stock purchase plan. Under the plan, the Company has reserved 200,000 shares of common stock for issuance to participating employees who have met certain eligibility requirements. In 1994, the Board of Directors and shareholders approved an amendment to the employee stock purchase plan to increase the number of shares reserved for issuance from 200,000 to 300,000 shares. The number of shares available for purchase by each participant is based upon annual base earnings and at a purchase price equal to 85% of the fair market value at the beginning or the end of the quarter of purchase, whichever is lower. During fiscal 1995, 1994 and 1993, a total of 37,973, 25,475 and 14,281 shares of common stock respectively, were purchased by the Company employees under the plan. As of September 30, 1995, 95,797 shares were available for future purchase.\nIf all options outstanding at September 30, 1995 were exercised, the total proceeds to the Company wuld be approximately $4 million (unaudited).\n10. OTHER INCOME\/EXPENSE\nOther (income) expense consists of the following:\n1995 1994 1993 ---- ---- ----\nInterest income ................. $(313,351) $(199,578) $(191,941) Interest expense ................ 695,541 338,751 78,343 Rental and sublease income ...... - - (60,995) Net rental expense on sublet property ....................... - - 138,577 --------- --------- ------- $ 382,190 $ 139,173 $(36,016) ========= ========= =========\n11. ACQUISITIONS\nIn August 1991, the Company acquired all the outstanding stock of Q-Arc Ltd. of Cambridge, England for $1,400,000 in cash and the assumption of certain liabilities. Q-Arc is a manufacturer of specialty lamps for laser and non- laser applications. This transaction was accounted for as a purchase and accordingly, all assets were revalued to their respective fair values. The acquisition price was equal to the fair value of net assets acquired. Net assets included a covenant-not-to-compete of approximately $951,000. The covenant is being amortized over an eight year period. At September 30, 1995, the unamortized balance of the Q-Arc covenant-not-to-compete is approximately $476,000.\nOn June 30, 1992, the Company acquired all of the outstanding stock of Precision Lamp, Inc. located in Cotati, California. Precision Lamp designs, manufactures and distributes miniature incandescent lamps for various applications. The Company paid approximately $2,000,000 in cash for all of the outstanding shares, agreed to pay off approximately $1,100,000 of bank debt and assumed all liabilities ($1,321,000) of Precision Lamp. The Company also agreed to pay at least $2,600,000 to the primary selling shareholder as consideration for a covenant-not-to-compete among the primary selling shareholder, Precision Lamp and ILC. These payments will be made in equal installments through 1997. This transaction was accounted for as a purchase and accordingly, all assets were revalued to their respective fair values. This purchase price allocation resulted in goodwill of approximately $2,650,000 which is being amortized over a ten year period. The $2,600,000 covenant- not-to-compete is being amortized over a seven year period.\nIn the second quarter of fiscal 1994, management determined that an impairment occurred in the recoverability of the unamortized goodwill and covenant-not-to-compete due to a significant shortfall in orders from a major Precision Lamp customer. Accordingly, a $3.4 million charge was recorded to write off the intangibles to net realizable value. The writedown was determined based on the currently projected undiscounted cash flows of Precision Lamp from March 1994 to March 2004, which projected aggregate cash flows of approximately $900,000 (unaudited) over that period and was based on projected net income which averaged 9% higher than the net income projection for fiscal 1994 (with no loss years included in the projection), compared with the carrying value of the Company's investment in Precision Lamp, including goodwill, at the date of the writedown. These projections represented management's best estimate for future results for that subsidiary. At September 30, 1995, the unamortized balance of the Precision Lamp covenant-not-to-compete is approximately $641,000.\n12. RIGHTS AGREEMENT\nOn September 19, 1989, the Company's Board of Directors declared a dividend of one common share purchase right for each outstanding share of common stock, no par value, of the Company. The dividend was payable on October 2, 1989 to the shareholders of record on that date. Each Right entitles the registered holder to purchase from the Company one share of common stock of the Company at a price of $30.00 per common share. The rights will not be exercisable until a party either acquires beneficial ownership of 20% of the Company's common stock or makes a tender offer for at least 30% of its common stock. In the event the rights become exercisable and thereafter a person or group acquires 30% or more of the Company's stock, a 20% shareholder (\"Acquiring Person\") engages in any specified self-dealing transaction, or, as a result of a recapitalization or reorganization, an Acquiring Person's shareholdings are increased by more than 3%, each right will entitle the holder to purchase from the Company, for the exercise price, common stock having a market value of twice the exercise price of the right. In the event the rights become exercisable and thereafter the Company is acquired in a merger or other business combination, each right will enable the holder to purchase from the surviving corporation, for the exercise price, common stock having a market value of twice the exercise price of the right. At the Company's option, the rights are redeemable in their entirety, prior to becoming exercisable, at $.01 per right. The rights are subject to adjustment to prevent dilution and expire September 29, 1999.\n13. REPURCHASE OF COMMON STOCK\nIn March 1994, the Board of Directors authorized the purchase of up to 1,000,000 shares of the Company's common shares outstanding through March 1995. During 1995 and 1994, the Company repurchased 10,000 and 204,000 shares of common stock for an aggregate amount of $76,750 and $1,555,500, respectively. Purchases were made on the open market.\nSCHEDULE VIII\nILC TECHNOLOGY, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR FISCAL YEARS 1995, 1994 AND 1993\nBalance Charged at (Credited) Addition Deductions Balance Beginning to Cost and from and at end of Of Period Expenses Acquisition Write Off Period --------- ----------- ----------- ---------- --------\nALLOWANCE FOR DOUBTFUL ACCOUNTS:\nYear ended October 2, 1993 $341,355 $(98,769) $ 7,258 $ 30,716 $219,128\nYear ended $219,128 $383,902 $ - $270,227 $332,803 October 1, 1994\nYear ended September 30, 1995 $332,803 $103,251 $ - $ 26,104 $409,950\nRESERVE FOR INVENTORY OBSOLESCENCE:\nYear ended October 2, 1993 $1,990,256 $ (22,125) $ - $414,672 $1,553,459\nYear ended October 1, 1994 $1,553,459 $1,772,346 $ - $792,572 $2,533,233\nYear ended September 30, 1995 $2,533,233 $ 206,859 $ - $697,279 $2,042,813\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo ILC Technology, Inc.\nWe have audited the accompanying consolidated balance sheets of ILC Technology, Inc. (a California Corporation) 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 and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ILC Technology, Inc. and subsidiaries as of September 30, 1995 and October 1, 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.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule presented on page 31 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\nSan Jose, California November 3, 1995\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nCertain information required by Part III is omitted from this Report in that registrant will file a definitive proxy statement pursuant to Regulation 14A (the \"Proxy Statement\") for its Annual Meeting of Shareholders to be held February 14, 1996, not later than 120 days after the end of the fiscal year covered by this Report, and the information included therein is incorporated herein by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information regarding directors required by this item appearing in the Company's 1995 Proxy Statement under the caption \"Election of Directors-Nominees\" is incorporated herein by reference.\nThe information regarding executive officers of the Company required by this item appearing in the Company's 1995 Proxy Statement under the caption \"Election of Directors- Other Officers\" is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item appearing in the Company's 1995 Proxy Statement under the captions \"Election of Directors-Director Compensation\" and \"Executive Compensation\" is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item appearing in the Company's 1995 Proxy Statement under the caption \"Election of Directors-Nominees\" is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item appearing in the Company's 1995 Proxy Statement under the captions \"Election of Directors-Director Compensation\" and \"Executive Compensation\" 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, notes thereto, and Report of Independent Public Accountants thereon are included in Part II, Item 8 of this report.\nPage in 2. FINANCIAL STATEMENT SCHEDULE Form 10-K\nSchedule VIII Valuation and Qualifying Accounts and Reserves 31\nAll other schedules have been omitted since 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 or notes thereto.\n3. EXHIBITS\nThe exhibits listed in the Index to Exhibits following the signature page are filed as part of this Report.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the last 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.\nILC TECHNOLOGY, INC.\nBy: \/S\/ HENRY C. BAUMGARTNER Henry C. Baumgartner President and Chief Executive Officer\nDated: December 22, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSIGNATURES TITLE DATE\nChairman of the Board December , 1995 - ------------------------------- (Wirt D. Walker, III) (Director)\n\/S\/ HENRY C. BAUMGARTNER President and Chief December 22, 1995 - ------------------------------- (Henry C. Baumgartner) Executive Officer (Principal Executive Officer and Director)\n\/S\/ RONALD E. FREDIANELLI Chief Financial Officer December 22, 1995 - ------------------------------- Ronald E. Fredianelli) and Secretary (Principal Financial and Accounting Officer)\n(Richard D. Capra) Director December , 1995\n\/S\/ HARRISON H. AUGUR Director December 22, 1995 - ------------------------------- (Harrison H. Augur)\n\/S\/ ARTHUR L. SCHAWLOW Director December 22, 1995 - ------------------------------- (Arthur L. Schawlow)\nINDEX TO EXHIBITS\nExhibit NUMBER DESCRIPTION\n3.1 (A) Restated Articles of Incorporation of ILC Technology, Inc. as filed in the Office of the California Secretary of State on March 8, 1991.\n3.2 (A) Amended and restated Bylaws as of February 8, 1989.\n4.1 (C) Certificate evidencing shares of Common Stock without par value, ILC Technology, Inc.\n10.1 (F) ILC Technology, Inc. 1983 Employee Incentive and Nonstatutory Stock Option Plan, as amended, together with related form of Stock Option Agreement.\n10.2 (B) Rights Agreement between ILC Technology, Inc. and Security Pacific National Bank dated as of September 29, 1989.\n10.3 (D) Employment Agreement between ILC Technology, Inc. and Richard E. DuNah dated July 1, 1992.*\n10.4 (F) ILC Technology, Inc. 1992 Stock Option Plan, as amended, and related form of Option Agreement.*\n10.5 (D) Form of Officer and Director Indemnification Agreement*\n10.6 Credit Agreement dated March 2, 1995, by and between Union Bank and ILC Technology, Inc.\n10.7 (F) Purchase and Sale Agreement dated August 19, 1993, by and between Cambridge Investors I Limited Partnership and ILC Technology, Inc.\n10.8 (F) Standard Industrial\/Commercial Single-Tenant Lease between ILC Technology, Inc. (720 Portal Street, Cotati, California) and John Gary Taylor, dated December 29, 1992.\n10.9 (E) Agreement and Plan of Reorganization among ILC Technology, Inc., ILC Acquisitions, Inc., Converter Power, Inc. and the shareholders of Converter Power, Inc., dated January 29, 1993.\n10.10 (E) Employment Agreement between ILC Technology, Inc. and William F. O'Brien dated January 29, 1993.*\n10.11 (E) Employment Agreement between ILC Technology, Inc. and Dean A. Mac Farland dated January 29, 1993.*\n10.12 (G) Purchase and Sale Agreement dated June 24, 1994, by and between UCB Bank PLC and Q-Arc, Limited relating to property on the south side of Saxon Way, Bar Hill, Cambridge, England.\n10.13 (G) Asset Purchase Agreement dated September 16, 1994, by and between ILC Technology, Inc. and UVP, Inc.\nINDEX TO EXHIBITS (CONTINUED)\n10.14 Lease Agreement between Converter Power, Inc. (150 Sohier Road, Beverly, Massachusetts) and Communications & Power Industries, Inc., dated September 15,\n21.1 (G) Subsidiaries of Registrant\n23.1 Consent of Arthur Andersen LLP\n27.1 Financial Data Schedule\n99.1 Proxy Statement for the Company's 1995 Annual Meeting of Shareholders (to be deemed filed only to the extent required by General Instructions H to Form 10-K)\n- -------------------------------------------------------------------------------\n(A) Incorporated by reference from the Exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended September 28, 1991.\n(B) Incorporated by reference from the Exhibits to Registrant's Current Report on Form 8-K dated September 19, 1989.\n(C) Incorporated by reference from the Exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988.\n(D) Incorporated by reference from the Exhibits to Registrants' Annual Report on Form 10-K for the fiscal year ended October 3, 1992.\n(E) Incorporated by reference from the Exhibits to Registrants' Registration Statement on Form S-3, as amended (File No. 33-59904), effective May 19, 1993.\n(F) Incorporated by reference from the Exhibits to Registrants Annual Report on Form 10-K for the fiscal year ended October 2, 1993.\n(G) Incorporated by reference from the Exhibits to Registrants' Registration Statement on Form 10-K for the year ended October 1, 1994.\n* Management Contract or Compenstory Plan or arrangement.","section_15":""}
{"filename":"771498_1995.txt","cik":"771498","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings required to be reported in response to this item.\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.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nListed below are the names and ages as of March 1, 1996, of each of the present executive officers of the Company together with principal occupations held by each during the past five years. Executive officers are appointed annually to serve for the ensuing year or until their successors have been appointed. No officer is related to any other by blood, marriage or adoption. No arrangement or understanding exists between any officer and any other person under which any officer was elected. Mr. Elers has been employed with the Company since April 1988 and has served in his current capacity since April 1990. Mr. Werneburg has been employed with the Company since November 1989 and has served in his current capacity since April 1990. Messrs. Mazur, Quinn and Reisbick have been employed with the Company since July 1985. Mr. Reisbick previously served as General Manager, North America Exploration until November 1992. Mr. O'Connell was Vice President of the Company from May 1992 until July 1992 when he was named Vice President - Finance and Chief Financial Officer. Prior to joining the Company, Mr. O'Connell served as Assistant Controller, Worldwide Exploration and Production for Marathon Oil Company since January 1991.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE OF COMMON STOCK\nThe Company's common stock, par value $0.10 per share (the \"Common Stock\"), is traded on the New York Stock Exchange (the \"NYSE\"), the Toronto Stock Exchange, the Australian Stock Exchange Limited, the Swiss Stock Exchanges and the Frankfurt Stock Exchange. The ticker symbol for the Common Stock on the exchanges is \"BMG.\"\nThe following table sets forth for the periods indicated the high and low sales prices for the Common Stock as reported on the NYSE Composite Tape.\nAs of March 5, 1996, the Company had 19,237 record holders of Common Stock.\nCash dividends of $0.025 per share were paid in each half of fiscal 1995 and 1994. A determination to pay future dividends and the amount thereof will be made by the Company's Board of Directors and will depend on the Company's future earnings, capital requirements, financial condition and other relevant factors. The Company's ability to pay dividends is subject to certain restrictions contained in the Company's revolving credit facility. These restrictions are not expected to affect the payment of dividends. For a further discussion of the credit facility and of restrictions on Inti Raymi's ability to pay dividends to BMG, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" and Note 5 of Notes to Consolidated Financial Statements under Item 8 herein. The Company intends to retain most of its earnings to support current operations, to fund exploration and development projects and to provide funds for acquiring gold properties.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain consolidated financial data for the respective periods presented and 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\nThe following table presents significant financial data related to the Company's results of operations for the years ending December 31:\n* Includes mining, milling and other plant costs directly related to a mine site and stripping cost adjustments but excludes third party smelting costs, transportation costs, royalties, depreciation, depletion and amortization and taxes.\nRevenues - Gross revenue increased in 1995 compared with 1994 primarily because of increased sales volumes. Sales volumes increased at all of the Company's mines in 1995 compared with 1994 with the largest increases coming from the Kori Kollo mine, the Battle Mountain Complex mines and the Red Dome mine. Production volumes increased at the Kori Kollo mine in 1995 because of increased mill throughput. Production volumes at the Red Dome mine and the Battle Mountain Complex increased in 1995 because 1995 was the first full year of production from the new mine areas at these sites.\nGross revenue increased in 1994 compared with 1993 because of increased sales volumes, primarily from the Kori Kollo and San Cristobal mines, and an increase in the average realized price of gold. Volumes from the Kori Kollo mine increased in 1994 compared with 1993 because 1994 was the first full year of operation of that mine's new milling facilities and because of increased recoveries. Upgrading of the crushing facilities at the San Cristobal mine was the main factor contributing to the increase in that mine's sales volume in 1994. The increases at Kori Kollo and San Cristobal in 1994 compared with 1993 were partially offset by a significant decrease in sales volumes at the Red Dome mine, which was caused primarily by the majority of the mining efforts at that mine being directed at a push back of the existing mine pit. Additionally, a pit wall slippage delayed startup of production from the push back of the mine pit and also delayed access to higher grade ore. The Battle Mountain Complex experienced a decrease in production volumes in 1994 compared with 1993 primarily because the Basin Leach facility which was the complex's main operation during 1993 was nearing the end of its production cycle. This decrease in production at the complex was partially offset by production from the start-up of the Reona Leach facility in October 1994.\nSelling and Operating Costs - Freight, allowances and royalties increased in total and decreased slightly on a cost per equivalent ounce of gold sold basis in 1995 compared with 1994. These costs increased in total because of increased sales volumes and decreased on a cost per equivalent ounce basis because of reduced shipping costs for concentrate shipped from the Red Dome mine. Freight, allowances and royalties decreased in total and on a cost per equivalent ounce of gold sold basis in 1994 compared with 1993 due to fewer concentrate sales from the Red Dome mine in 1994. Shipments from the Red Dome mine carry relatively high shipping costs.\nCash production costs increased in total in 1995 compared with 1994 but remained approximately the same on the basis of cost per equivalent ounce produced. The increase in total cash production costs is directly related to the increase in production from all of the Company's mines as previously discussed.\nCash production costs decreased in total and on a per equivalent ounce of gold produced in 1994 compared with 1993. These costs decreased on a per equivalent ounce of gold produced basis because of an increased percentage (from approximately 41 percent in 1993 to approximately 52 percent in 1994) of volumes being produced at the Kori Kollo mine which has lower cash production costs per equivalent ounce than the rest of the mines. Cash operating costs per equivalent ounce of gold sold at the Kori Kollo mine were lower in 1994 compared with 1993 because of increased recoveries. The San Cristobal mine costs decreased on an equivalent ounce of gold sold basis because of the addition of more efficient crushing equipment. Lower per equivalent ounce cash production costs at the Battle Mountain Complex, the San Luis mine and the Pajingo mine also contributed to the decrease in cash production costs on a per ounce and total basis for 1994.\nDepreciation, depletion and amortization increased 38 percent in total and 11 percent on a per equivalent ounce of gold produced basis for 1995 compared with 1994. These costs have increased on an equivalent ounce basis primarily because of the high capital costs incurred to develop new areas at the Pajingo Complex and the Red Dome mine relative to the amount of production expected from these new areas. Depreciation, depletion and amortization increased 24 percent in total and remained approximately the same on a per equivalent ounce of gold produced basis for 1994 compared with 1993. The increase in total was caused primarily by increased sales volumes.\nExploration Costs - Exploration and evaluation expenses increased 24 percent in 1995 compared with 1994 and 53 percent in 1994 compared with 1993. In 1995 and 1994, the Company expanded its exploration activities in Australia, Indonesia and Bolivia, and also in the vicinity of currently operating mines. (See \"-- Liquidity and Capital Resources -- Investing Activities\").\nWrite-off of Property, Plant and Equipment - In June 1995, management decided that the Company would dismantle portions of the milling facility used for the milling of ore from the depleted Fortitude mine in Nevada rather than renovate it for use in the Phoenix project or other possibilities. Consequently, the net carrying value of this mill and related facilities was written off during June 1995 and resulted in a charge to operations of approximately $2.2 million. Spare parts related to\nthis milling facility were rendered obsolete due to this decision and, therefore, $.9 million was charged to milling and other plant costs to expense these now obsolete parts. No further write-downs are currently anticipated, and none were recorded in 1994 or 1993.\nGeneral and Administrative Costs - The Company's general and administrative costs are presented on a consolidated basis without reduction for minority interest and include the following (in thousands):\nAs a result of evaluations of peer group operational and reporting practices, in 1995 management instituted alternative reporting of certain costs to allocate to mine operations certain costs which previously were recorded as general and administrative costs. The amounts for 1994 and 1993 have been reclassified for comparability to the 1995 treatment of these costs. These reclassifications resulted in a reduction in general and administrative costs in the amount of $4.7 million in 1994 and $4.6 million in 1993.\nOther - Interest income decreased in 1995 compared with 1994 because of lower interest rates and lower average balances of invested cash. Interest income increased in 1994 compared to 1993 primarily due to an increase in invested cash balances and higher interest rates.\nGross interest expense, including amounts capitalized, increased in 1995 compared with 1994 and in 1994 compared with 1993. Gross interest expense increased in 1995 because of increased borrowings. Niugini Mining borrowed $30 million under a bridge financing in order to purchase an additional interest in the Lihir project. This borrowing was repaid in December 1995. All of the interest expense related to this borrowing was capitalized as part of the Lihir investment. Gross interest expense also increased because of borrowings under the Company's new revolving credit facility during the fourth quarter of 1995. All interest related to the latter borrowings was capitalized as part of the Crown Jewel project.\nGross interest expense, including amounts capitalized, increased in 1994 because of generally higher interest rates on Inti Raymi's variable rate debt which was somewhat offset by recoveries from interest rate cap contracts. The increase in gross interest expense due to increases in interest rates was partially offset by a decrease in outstanding debt.\nInterest with respect to borrowings attributable to any given project in the pre-commercial production stage is capitalized. The interest associated with the 6 percent convertible subordinated debentures has been and continues to be capitalized as part of the Lihir investment. Interest expense would be expected to increase when any acquisitions or mine development investments reach the operational stage.\nOther income (expense), net in 1995 included approximately $5.5 million in gains from the sale of various exploration prospects, primarily a $4.2 million gain on the sale of the Plutonic Bore exploration project in Australia. It also includes $1.3 million in royalties received from the owner of the Triple P ore deposit which was sold by the Company in 1993.\nOther income (expense), net in 1994 included approximately $.8 million in royalties from the owner of the Triple P ore deposit and a gain of $.7 million from the sale of a prospect in Chile. This income was offset by foreign currency losses of approximately $1.2 million attributable to Papua New Guinea kina cash deposits. The 1993 income resulted primarily from gains of $3.7 million from the sale of the Triple P ore deposit and $2 million from the sale of certain other long-term investments held by Niugini Mining.\nThe Company's effective income tax benefit rate was 23 percent in 1995 compared with an income tax expense rate of 21 percent in 1994 and an income tax benefit rate of 48 percent in 1993. The effective income tax rate for 1995 was affected by the recognition of deferred tax assets related to foreign tax credits. The Company previously treated foreign taxes paid as deductions for U.S. income tax purposes; however, the Company has determined that it is more likely than not that it will be able to utilize foreign tax credits because of Inti Raymi's projected net income and its ability to remit earnings in the form of dividends to BMG.\nThe effective income tax rate for 1994 was influenced by a reduction in the Company's deferred tax valuation allowance. In 1994, the Company determined that it was more likely than not that additional deferred tax benefits would be realized as a result of the Company's profitability in 1995.\nIncome tax expense in 1994 resulted primarily from the accrual of withholding taxes on income from the Company's majority owned subsidiary Inti Raymi. The income tax benefit in 1993 resulted from the net operating loss generated in 1993.\nNet income attributable to minority interests increased in 1995 compared with 1994 and decreased in 1994 compared with 1993. Net income attributable to minority interest increased in 1995 because of increased profits generated by the Company's majority owned subsidiaries Inti Raymi and Niugini Mining. Minority interest in net income decreased in 1994 because of net losses incurred by Niugini Mining, as calculated under BMG's accounting policies which are in accordance with U.S. GAAP, compared with net income from Niugini Mining in 1993.\nNet income - Net income increased in 1995 compared with 1994 in spite of reduced operating income because of the gains generated on the sale of exploration prospects and the income tax benefit derived from the recognition of foreign tax credits as described above. Operating income decreased in 1995 principally because of the write-off of assets at the Battle Mountain Complex as described above and increased exploration expenditures.\nThe Company generated net income in 1994 primarily because of the increased profitability of its Kori Kollo mine in Bolivia and higher realized gold, silver and copper prices. Production\nincreases and decreased operating costs per equivalent ounce of gold were the main factors contributing to Kori Kollo's profitability.\nDuring 1993, the Company completed the transition of its primary production stream from the Fortitude mine in Nevada to the Kori Kollo mine in Bolivia. As expected, there was little change in the Company's total gold production during this transition period. However, increased costs related to the transition to a lower grade ore body at the Battle Mountain Complex and lower than anticipated production levels from the heap leach operations at the Battle Mountain Complex and the San Cristobal mine resulted in an increase in total operating costs per equivalent ounce of gold sold for 1993. These factors all contributed to the net loss incurred by the Company in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nSummary - At December 31, 1995, the Company had cash and cash equivalents of $46.1 million, of which $6.1 million was held by BMG, $29.4 million was held by Niugini Mining, and $10.6 million was held by Inti Raymi.\nOperating Activities - The Company generated cash flow of $90.6 million, $83.1 million and $30.1 million from operating activities for the years ended December 31, 1995, 1994 and 1993, respectively. The increase in cash flow from operating activities in 1995 compared with 1994 and 1994 compared with 1993 resulted primarily from the increased production and sales. In 1994, the recovery of approximately $8.1 million of refundable value added taxes from the Bolivian government paid in years prior to 1994 related to the construction of the Kori Kollo sulfide mining facilities contributed to the increase for that year. These increases were partially offset by increased outlays for materials and supplies in 1994 which increased inventories of materials and supplies by $4.6 million. Inventories of materials and supplies increased at the expanding Kori Kollo mine operations in Bolivia due to an increase in the quantities of the materials which must be retained at that mine site due to its remote location.\nInvesting Activities - Cash used for investing activities increased to $132.7 million in 1995 from $100.8 million in 1994 and $60.3 million in 1993. Capital and exploration expenditures were the most significant components contributing to the increase in cash flows used for investing activities. The Company has spent approximately $67 million on the Lihir project during 1995. Expenditures in 1995 include the acquisition by Niugini Mining of an additional interest in the Lihir joint venture (see \"Investing Activities - Lihir Project\" below). In 1995, the Company spent a total of approximately $25 million at the Kori Kollo mine on capital expenditures which included approximately $6.3 million for the recovery enhancement system and $1.4 million for the tailings treatment facility. The remaining amount of approximately $17 million was spent at the Kori Kollo mine primarily on various dewatering system projects and on the purchase of haul trucks and other mining equipment. The Company has spent a total of approximately $15.1 million on the recovery enhancement system and approximately $5.9 million on the tailings treatment facility. The new recovery enhancement system at Kori Kollo began operating in start-up mode in January 1996. Based on the varied results to date from partial system operation, a metallurgical review is under way in order to optimize the operating mode. Other throughput efforts to date have increased the recovery rate for sulfide ore by 6 percent compared to feasibility study levels and the objective of\ncurrent plan review is to determine how much additional recovery is possible from the gravity concentrator.\nThe Company has included $47 million for capital expenditures in its 1996 business plan. The plan includes $10.5 million for development of the Phoenix project and $8.4 million for development of the Crown Jewel project. Of the total 1996 projected expenditures, 39 percent is expected to be spent in North America, 24 percent in Latin America, 8 percent in Australia and 29 percent in various countries by Niugini Mining.\nPhoenix Project - BMG has announced its decision to develop the Phoenix project, subject to permitting. The project, which is expected to be in operation in the first half of 1998, includes the construction of a milling facility and is located in the Copper Canyon area of the Battle Mountain Complex. The cost of developing the project is estimated to be approximately $142 million excluding capitalized interest and escalation, of which $7.2 million has been spent through December 31, 1995. The cost of the project has increased substantially primarily because the scope of the project has increased. The new project envisages a milling operation of 14,000 tons per day compared with the original plan of 10,000 tons per day. The project contains reserves of approximately 34.7 million tons of millable ore at an average ore grade of .05 ounces of gold per ton, and 11.9 million tons of heap leach ore with an average grade of .03 ounces of gold per ton, for a total of approximately 1.9 million contained ounces of gold. The project also includes approximately 10.1 million contained ounces of silver. The reserves were determined using cutoff grades ranging from .01 to .024 ounces of gold per ton and an assumed gold price of $385 per ounce. The estimated recovery factor was approximately 86 percent for the mill ore and 65 percent for the leach ore.\nCrown Jewel Project - BMG expects to construct a 3,000 ton per day milling facility with start-up possible in the spring of 1998, depending on the time it will take to complete the permitting process. A Draft Environmental Impact Statement was issued at the end of June 1995. The issuance of the Final Environmental Impact Statement is currently expected by the end of 1996.\nTo earn a 54 percent ownership interest in the Crown Jewel project, BMG has agreed to fund all expenditures for exploration, evaluation and development of the project through commencement of commercial production. The minority partner will not reimburse BMG for any portion of funding provided through the commencement of commercial production. These expenditures, plus acquisition costs, are currently estimated to be approximately $108 million excluding capitalized interest and escalation, of which, as of December 31, 1995, $54 million ($45.2 million of which has been capitalized) has been incurred. Management expects that BMG should be able to recover more than its total investment in the project from its 54 percent interest in the project's operating cash flows based on current market conditions and current expectations of the timing to obtain permitting.\nLihir Project - BMG holds an indirect interest in the Lihir project through its 50.5 percent ownership of Niugini Mining, which in turn now owns 17.15 percent of Lihir Gold Limited (\"LGL\"). With a wholly-owned subsidiary of RTZ Corporation, plc (\"RTZ\") as operator, LGL is now developing and constructing the Lihir Project in Papua New Guinea (\"PNG\"). Financing for\nthe project involved bank debt facilities and an initial public offering of common stock of LGL. The initial public offering was completed on October 6, 1995. The following paragraphs describe the series of now completed transactions related to the financing of the Lihir Project and the restructuring of its ownership.\nIn March 1995, the Special Mining Lease (\"SML\") for the Lihir project was executed by the PNG government and final landowner agreements were executed in April 1995. The SML provided Niugini Mining, and subsidiaries of RTZ and the PNG government, as joint venture partners, the right to develop and operate the Lihir gold project. In connection with the execution of the SML, an entity of the PNG government acquired an intermediate 30 percent joint venture interest, pro rata from RTZ's 80 percent position and Niugini Mining's 20 percent position. In June 1995, Niugini Mining acquired an additional 16 percent of the Lihir joint venture from a subsidiary of RTZ for $54.1 million, which included payment of Niugini Mining's share of joint venture costs and interest dating back to January 1, 1994. Niugini Mining then temporarily owned, pending the planned initial public offering described below, a 30 percent interest in the Lihir joint venture.\nNiugini Mining, and subsidiaries of RTZ and the PNG government (the \"Sponsoring Parties\") formed LGL for the sole purpose of ownership of the Lihir project. Initially, upon transfer of the joint venture interests of the respective owners, LGL was owned 30 percent by Niugini Mining, 40 percent by a subsidiary of RTZ and 30 percent by an entity of the PNG government. On October 6, 1995, LGL completed a planned initial public offering of common stock raising approximately $450 million to be used for the construction, development and initial operation of the Lihir project. Prior to consummation of the offering, the joint venture assets related to the Lihir project were contributed by the Sponsoring Parties to LGL. Additional funding required for the project is to be provided in the form of debt financing by LGL. In connection with the LGL debt financing, Niugini Mining has guaranteed, until project completion, 30 percent of LGL's obligations under the facility (which obligations include up to $300 million of senior facility debt, up to $10 million of subordinated debt incurred to fund the purchase of instruments required in connection with hedging activities and up to $50 million of potential liabilities under hedging arrangements). Neither BMG nor its non- Niugini Mining subsidiaries have any obligation or liability under this guarantee. In addition, Niugini Mining has pledged its LGL shares as security under the facility until project completion.\nThe initial public offering was the final transaction in the series of transactions which restructured and reduced BMG's participation in the Lihir project. As a result of the initial public offering, Niugini Mining now owns a 17.15 percent interest in LGL and BMG's attributable interest is 8.7 percent. In the fourth quarter of 1995, the Company recorded the effects of this series of transactions. An increase in Niugini Mining's shareholders' equity of approximately $57 million related to the issuance of the common stock by LGL at a value in excess of Niugini Mining's carrying value per share in LGL was recorded. This increase was recorded as a credit to additional paid-in capital consistent with the Company's accounting policy with regard to transactions of this nature. An offsetting increase in the carrying value of Niugini Mining's investment in LGL was recorded. The Company attributed $28 million of this increase to minority interest in its consolidated financial statements; the remainder was credited to additional paid in capital. Also, as a result of these transactions, the Company amortized approximately $35 million of its investment\nin Niugini Mining, which has been attributed to the investment in LGL. This amortization was recorded as a charge to the Company's additional paid in capital. The net result of these transactions in the Company's Consolidated Financial Statements was an increase in the carrying value of the LGL investment of approximately $22 million, an increase in minority interest of approximately $28 million and a net decrease in additional paid in capital of approximately $6 million. As of December 31, 1995, the carrying value of the Company's investment in the Lihir project was approximately $225 million. Niugini Mining's interest in LGL is being accounted for using the equity method of accounting.\nThe capital costs for the Lihir project were estimated by the manager of the project at $673 million. The manager's estimate of total cash operating costs, which exclude royalties and sales costs, is $234 per ounce over the expected life of the project. The estimate of minable sulfide reserves is 114.6 million tons, or 14.6 million contained gold ounces, with an average grade of .13 ounces of gold per ton.\nExploration - The Company currently estimates that it will spend approximately $18.3 million on its 1996 exploration programs in search of potential additional mineral deposits. Of this amount, 10 percent is budgeted to be spent in North America, 30 percent in Latin America, 31 percent in Australia and the South Pacific and 23 percent in various countries by Niugini Mining. The remaining six percent of the budgeted amount is earmarked for evaluation of exploration and acquisition opportunities worldwide. During 1995, the Company spent approximately $18.8 million on exploration and evaluation activities and related capital expenditures.\nFinancing Activities - On November 6, 1995, the Company completed a new committed non-reducing revolving credit agreement with a syndicate of six banks, led by Citibank N.A. as agent. In connection with the new revolving credit agreement the Company terminated its previously existing committed revolving credit agreement. The new facility provides for unsecured borrowings of up to $75 million, of which $17 million was outstanding as of December 31, 1995. Interest rates under the facility are based on the facility agent's base rate, LIBOR, applicable certificate of deposit rates or gold funding rates plus an applicable margin which is subject to adjustment in case of certain changes in BMG's credit rating and certain financial ratios. Additionally, interest charges increase when outstanding borrowings under this facility exceed $25 million and, again, when such borrowings exceed $50 million. The revolving credit agreement imposes certain financial covenants upon the Company which include covenants relating to leverage, net worth, contained production, mineral reserves and working capital, as well as certain restrictions on liens, investments, additional debt, lease obligations, and the acquisition or disposition of assets. These restrictions are not expected to affect planned operations.\nBMG may borrow an additional $15 million through a separate uncommitted revolving credit facility. As of December 31, 1995, no borrowings were outstanding under this facility; however, letters of credit amounting to approximately $2.2 million had been issued.\nBMG's majority-owned Bolivian subsidiary, Inti Raymi, borrowed funds from three international agencies, the Overseas Private Investment Corporation (\"OPIC\") ($40 million), the\nInternational Finance Corporation (\"IFC\") ($40 million) and the Corporacion Andina de Fomento (\"CAF\") ($15 million) under three separate but coordinated financing facilities. These facilities provided most of the funding necessary for the development of the Kori Kollo mine. Each of these facilities imposes restrictions on dividend payments and loan repayments by Inti Raymi to its shareholders, and limits additional fixed asset purchases or dispositions, debt and liens. As of February 22, 1996, Inti Raymi owed an aggregate of $65.6 million under these facilities. This amount includes $2.6 million previously owed by Inti Raymi to OPIC. The IFC facility includes a $5 million convertible loan payable on March 1, 2002, which may be converted at any time, at IFC's option, into a 3.98 percent ownership interest in Inti Raymi. Other than the convertible portion, loans under the facilities are to be repaid in semi-annual installments which commenced in December 1994 and will continue through June 2000. Certain prepayments would be required in the event of substantial Kori Kollo reserve losses or significantly improved gold prices.\nIn 1994, Inti Raymi successfully obtained lender acceptance of project completion status under the Kori Kollo project financing agreements. Accordingly, BMG is no longer required to provide financial support to Inti Raymi under the terms of these agreements. Subject to other restrictions in the financing agreements and general operating needs, Inti Raymi may generally pay dividends up to the amount of Inti Raymi's net income for the preceding fiscal year, which ends September 30. In 1995, Inti Raymi paid dividends of $20 million to its shareholders ($17.6 million to BMG). In both 1994 and 1995, dividends paid by Inti Raymi to its shareholders were less than amounts permitted under the financing agreements because available cash was required to fund Kori Kollo plant modifications. Permitted but unpaid amounts of dividends in one year are available for dividend declarations in future years and it is expected that future Inti Raymi dividends will be declared and paid based, in part, on such availability.\nThe OPIC and IFC loan agreements require that the current mining plan indicate that production from the Kori Kollo mine extends at least three years beyond the final scheduled principal payment (\"Reserve Life Provision\"). Failure to meet this Reserve Life Provision results in the suspension of all debt repayments from Inti Raymi to its shareholders and all Inti Raymi dividend payments until such time as compliance with the Reserve Life Provision is achieved by either a pre-payment of a sufficient portion of the debt or an increase in the Kori Kollo mine ore reserves. The IFC and CAF loan agreements contain provisions which entitle their respective agencies to receive principal pre-payments proportionate to those received by OPIC. In the third quarter of 1994, the Company completed a rescheduling of the life of mine production and observed that the new schedule was not in compliance with the Reserve Life Provision due to more accelerated mining and production than originally planned. The then-current plan indicated that production would extend approximately 2.8 years beyond the date of the final scheduled principal payment. To allow continuing payments of dividends and the repayment of intercompany debts, Inti Raymi obtained temporary waivers permitting noncompliance with the Reserve Life Provision until June 30, 1996. Inti Raymi has recently announced reserve additions which the lenders have approved as sufficient to satisfy the Reserve Life Provision.\nIn December 1995, Niugini Mining completed a bonus issue of options under which its shareholders had received one option for each four shares of Niugini Mining stock held as of June\n26, 1995. All the options issued were exercised on December 8, 1995 and each option allowed the holder to purchase one share of Niugini Mining stock for A$2.00. Niugini Mining sold approximately 23.5 million shares of Niugini Mining stock for aggregate proceeds of approximately A$47 million upon exercise of the options. Niugini Mining had agreed to a bridge financing facility of US$30 million which was drawn down in June 1995 to enable consummation of the purchase of the additional interest in the Lihir joint venture (see \"Investing Activities\" above). The bridge financing was secured by the proceeds of the exercise of the options and therefore a majority of the proceeds from the stock issuance were used to repay the bridge financing.\nThe Company does not expect Niugini Mining to pay dividends currently because of Niugini Mining's other business commitments and plans for its working capital.\nBMG has effective a registration statement under the Securities Act of 1933 for what is commonly referred to as a \"universal shelf\" filing covering up to $200 million of its debt securities, preferred stock, depositary shares, common shares and warrants, which BMG may elect to offer from time to time and in any combination. BMG has no current plans to issue securities under this registration statement.\nConclusion - The Company expects the cash currently held along with cash flows from operations and financing facilities currently in place, to be adequate to meet its cash needs at least through the end of 1996.\nGovernment Regulation - All of the Company's mining and processing operations are subject to reclamation and closure requirements. The Company monitors such requirements and periodically revises its cost estimates to meet the legal and regulatory requirements of the various jurisdictions in which it conducts its business. Where possible, plans for ongoing operations and future mine development are implemented in a manner that contributes to the fulfillment of reclamation and closure obligations in a cost effective manner through the conduct of ongoing operating activities. Costs estimated to be incurred in future periods which cannot be addressed in this manner are charged to operations through provisions based on the units of production method such that the estimated cost of ultimate reclamation is fully provided for by the time mineral reserves are depleted. The timing of actual cash expenditures for reclamation may be accelerated or deferred depending on cost and other determinations which may make such decisions prudent in the circumstances. The Company believes that these policies and practices adequately address its reclamation obligations and provide a systematic and rational method of charging such costs to operations consistent with industry practice. Accruals amounting to an aggregate of $8.0 million at December 31, 1995, are included as long-term liabilities in the Company's consolidated balance sheet. At the Battle Mountain Complex, aggregate reclamation expenditures estimated to be spent in future periods are expected to amount to approximately $7.8 million. Actual expenditures made to date have equaled the total amount accrued to date, therefore there is no net accrued liability at December 31, 1995, for this location. Estimated ultimate reclamation obligations and related accrued liability balances at December 31, 1995, respectively, for each of the Company's other operating mines is as follows: San Luis $3.3 million and $1.7 million, Pajingo $2.6 million and\n$1.5 million, Kori Kollo $10.0 million and $1.9 million and Red Dome $3.7 million and $2.9 million. Reclamation expenditures for the San Cristobal mine are not expected to be material.\nLegislative amendment of the General Mining Law, under which the Company holds claims on public lands in the U.S., could take place in 1996. Among other things, such legislation could impose a royalty on production from public lands. Approximately 40 percent of the Reona reserves, 23 percent of Phoenix project reserves and 80 percent of the Crown Jewel ore body are on public lands. However, a First Half - Mineral Entry Final Certificate has been issued with respect to the unpatented portion of the Crown Jewel ore body and mineral surveys have been completed for the claims constituting the unpatented portion of the Crown Jewel, Reona and Phoenix project reserves. The Company cannot yet predict whether existing law will be amended, the extent of such amendment or the impact of any such change on its U.S. activities. However, the passage of legislation that can be reasonably anticipated is not expected to render uneconomic any of the Company's existing operating mines or development projects, assuming current gold prices.\nThe Company has investigated the discharge to groundwater of chloride (salt) from the tailings facility at the Battle Mountain Complex. This facility was unlined at the time it was constructed in keeping with then-accepted practice. The Company is currently evaluating mitigation alternatives to achieve applicable water quality standards. The Company currently expects to achieve the applicable standards by utilizing the high chloride water in connection with its proposed Phoenix operation. Additionally, recent groundwater samples were taken from a highly mineralized area near historic copper leach activities. The results indicate that groundwater in this vicinity is acidic and high in metals. Pursuant to the State-issued Water Pollution Control Permit covering the site, the Company has prepared and submitted a work plan for further investigation of groundwater in this area. Due to the preliminary nature of this investigation, it is not possible to estimate what, if any, remediation might be required.\nIn Bolivia, new environmental regulations to implement federal legislation passed in 1992 became effective in December 1995. The official version of the new regulations is not yet available. Based on the Company's preliminary review of the available unofficial version of such regulations, the new regulations generally will require the preparation of environmental impact studies, set air and water quality discharge standards, provide protocols for dealing with and remediating the effects on the environment of hazardous substances, set site environmental management standards and provide procedures and schedules for existing operations to come into compliance. Such regulations contain new environmental standards and requirements applicable to the Company's Kori Kollo project which, depending on the final form of the regulations and how the regulations are implemented and interpreted, could require expenditures and changes in operations, and it is possible that such expenditures and changes could have a material adverse effect on the Company's financial condition or results of operations. However, based on the Company's initial review of the available version of the regulations and assuming reasonable interpretation and implementation, the Company does not anticipate that compliance will have a material adverse effect on the Company's financial condition or results of operations.\nForward Sales and Hedging - The Company has 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.\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, Inti Raymi was party to three interest rate cap agreements which were effective June 1, 1994, each with a term of three years. The agreements entitle Inti Raymi to receive from counterparties on a quarterly basis the amounts, if any, by which Inti Raymi's interest payments on a portion of its LIBOR based floating-rate Kori Kollo project financing exceed various fixed rates over the term of the caps. The fixed rates in the cap agreements gradually escalate from 5.4 percent in 1995 to 7.2 percent in 1997. Inti Raymi has hedged 50 percent of its net interest rate exposure currently related to the Kori Kollo LIBOR based project financing. The hedge increases to 100 percent of its exposure by June 1996. Inti Raymi has not hedged any of its exposure subsequent to December 1997. The net unamortized cost of the premiums paid for these caps amounting to $.5 million at December 31, 1995, has been included in other assets. Since the interest rate caps were put in place, the Company has amortized approximately $.2 million of such premiums and has received approximately $.2 million in settlement of expiring caps.\nThe Company uses fixed forward sales contracts, spot deferred sales contracts and put options to hedge anticipated sales of gold, silver and copper. The following table summarizes the Company's forward sales contracts at December 31, 1995:\nDeferred costs associated with Inti Raymi's forward sales contracts amounted to $1.3 million and $1.5 million at December 31, 1995 and 1994, respectively. Deferred costs associated\nwith put options amounted to $.2 million at December 31, 1995. There were no put options at December 31, 1994.\nThe Company is exposed to credit-related losses in the event of nonperformance by the counterparties to its interest rate caps and forward sales contracts, but does not expect any counterparties to fail to meet their obligations. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of counterparties.\nIn future periods, the Company may continue to employ selective hedging strategies, where appropriate, to protect cash flow for specific needs.\nForeign Operations - The Company continues to expand and geographically diversify its resource base through the exploration, acquisition, development and exploitation of foreign gold reserves. The Company's identifiable assets attributable to foreign operations as of December 31, 1995, were approximately $570 million and foreign operations represented approximately 81 percent of the total gross revenues of the Company for the year ended December 31, 1995. As a result, the Company is exposed to risks normally associated with foreign operations, including political, economic, social and labor instabilities, as well as foreign exchange controls, currency fluctuations and taxation changes.\nIn Bolivia, presidential and congressional elections are scheduled for mid-1997. Under the Bolivian constitution, a sitting president cannot serve consecutive terms. Therefore, a change in administration will occur in 1997. The current administration has initiated far reaching programs to decentralize central government's authority, to decentralize the distributions of the tax revenues, to reform the education and tax system and to promote private ownership of previously state-owned companies. While the Company believes these reforms are beneficial to the Bolivian people and Bolivian economy, it is difficult to predict the ultimate impacts of these, and associated reforms and a change in administration, on the Company's Bolivian operations.\nForeign operations and investments may also be subject to laws and policies of the United States affecting foreign trade, investment and taxation which could affect the conduct or profitability of those operations.\nInflation and Changing Prices - Gold production costs and corporate expenses are subject to normal inflationary pressures, which, to date, have not had a significant impact on the Company. The Company's results of operations and cash flows are affected by fluctuations in the market prices of gold, silver and copper, and to a lesser extent by changes in foreign currency exchange rates.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Consolidated Financial Statements\nReport of Independent Accountants\nFebruary 23, 1996\nTo the Board of Directors and Shareholders of Battle Mountain Gold Company\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Battle Mountain Gold Company and its subsidiaries at December 31, 1995, and the results of their operations and their cash flows for the year 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 audit. We conducted our audit 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 audit provides a reasonable basis for the opinion expressed above. The consolidated financial statements of Battle Mountain Gold Company and its subsidiaries for the years ended December 31, 1994 and 1993 were audited by other independent accounts whose report dated February 17, 1995 expressed an unqualified opinion on these statements based on their audit and the report of other auditors.\nOur audit of the consolidated financial statements also included an audit of the Financial Statement Schedules as of and for the year ended December 31, 1995 as listed on 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 Houston, Texas\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Battle Mountain Gold Company:\nWe have audited the accompanying consolidated balance sheet of Battle Mountain Gold Company (a Nevada corporation) 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 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 financial statements and schedule based on our audits. We did not audit the financial statements of Niugini Mining Limited and subsidiaries, which statements reflect assets and net sales of 18 percent and 23 percent in 1994 and 17 percent and 29 percent in 1993, respectively, of the consolidated totals. 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 those entities, 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 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 financial position of Battle Mountain Gold Company and subsidiaries as of 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.\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 is not a required part of the basic financial statements. This financial statement schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, based on our audits and the reports of other auditors, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nHouston, Texas February 17, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Battle Mountain Gold Company and the Board of Niugini Mining Limited:\nWe have audited the consolidated balance sheet of Niugini Mining Limited (a company incorporated in Papua New Guinea) 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 and the consolidated financial statement schedules which are not presented separately in the Battle Mountain Gold Company December 31, 1995 Form 10-K. Battle Mountain Gold Company is the Company's majority shareholder. Those financial statements and the financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on those financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Niugini Mining Limited and subsidiaries as of December 31, 1994, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND\nSydney, Australia January 31, 1995\nBATTLE MOUNTAIN GOLD COMPANY CONSOLIDATED STATEMENT OF INCOME\nThe accompanying notes are an integral part of these financial statements.\nBATTLE MOUNTAIN GOLD COMPANY CONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of these financial statements.\nBATTLE MOUNTAIN GOLD COMPANY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nBATTLE MOUNTAIN GOLD COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nBATTLE MOUNTAIN GOLD COMPANY Notes to Consolidated Financial Statements\nNote 1. Summary of Significant Accounting Policies\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of the Battle Mountain Gold Company (\"BMG\") and its wholly-owned and majority-owned subsidiaries (the \"Company\"). The accounts of Niugini Mining Limited, a Papua New Guinea precious metals exploration, development and production company (\"Niugini Mining\"), have been consolidated with the Company's from January 1, 1989 (See Note 10). The accounts of Empresa Minera Inti Raymi S.A., a Bolivian gold mining company (\"Inti Raymi\"), have been consolidated with the Company's from April 1, 1990 (See Note 10). All significant intercompany transactions have been eliminated in consolidation. Certain prior- period items have been reclassified in the consolidated financial statements in order to conform with current year presentation.\nInventories - Inventories, consisting of gold, silver and copper, are reported at the lower of cost or market, using the first-in, first-out method.\nProperty, Plant and Equipment - Property, plant and equipment are stated at cost. Expenditures for development of new mines and major development expenditures at existing mines, which are expected to benefit future periods, are capitalized and amortized, generally, on the units of production method. Exploration and development costs expended to maintain production at operating mines are charged to expense as incurred. In certain cases, mining costs associated with waste rock removal are deferred as development costs and charged to operations on the basis of the average stripping ratio over the life of the mine.\nOther property, plant and equipment includes capitalized lease costs and mine development costs for projects in progress. Capitalized exploration costs are evaluated on an annual basis and costs attributable to unproductive projects are charged directly to abandonment expense.\nGenerally, depreciation, depletion and amortization of mining properties and related assets are determined using the units of production method based upon estimated recoverable ore reserve tonnages or reserve ounces at the beginning of each quarter. However, assets having an estimated life of less than the estimated life of the mineral deposits are depreciated on the straight-line method based on the expected life of the asset. Write-downs and write-offs of depreciable properties are included in accumulated depreciation, depletion and amortization. Effective December 31, 1995, the Company adopted SFAS 121, \"Impairment of Long-lived Assets\". There was no effect on the carrying value of the Company's assets as a result of this adoption.\nExploration and Evaluation Expenditures- With the exception of lease acquisition costs incurred to acquire mineral rights, the Company charges all exploration and predevelopment evaluation\nexpenditures to expense as incurred prior to delineation of economic mineralization. Exploration costs incurred subsequent to delineation of economic mineralization are capitalized.\nCapitalization of Operating Results During Mine Development - During the start-up period for each developing mine, operating costs may exceed revenues earned from the sale of precious metals produced. In these instances, all costs incurred during this pre-commercial production period, net of revenues earned, are capitalized as property costs.\nCapitalization of Interest - Interest expense incurred attributable to pre-commercial production stage projects is capitalized until those projects commence commercial production.\nReclamation and Closure Costs - Reserves for estimated future reclamation and closure costs of the Company's operating sites are accrued on a units of production basis over the estimated lives of the respective mines. These costs are charged to milling and other plant costs as accrued (See Note 14).\nRevenue Recognition - Revenue is recognized when the dore (a combination of gold and silver) or concentrates are delivered against sales agreements or contracts and risk of loss passes to the buyer.\nCurrency Translation - Foreign currency financial statements are translated into U.S. dollars using current exchange rates and translation gains and losses are accumulated in the balance sheet caption \"Cumulative foreign currency translation adjustment,\" a separate component of shareholders' equity.\nEffective January 1, 1994, Niugini Mining changed its functional currency from the Papua New Guinea kina to U.S. dollars for financial reporting purposes.\nIncome (Loss) Per Share - Income (loss) per share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares outstanding for the year, adjusted for common stock equivalents, if dilutive. The effects of common stock equivalents are not included in the computation of income per share for 1993 because of their antidilutive effect. Fully diluted earnings per share are not presented for any year because the effect of other dilutive securities would be antidilutive.\nStatement of Cash Flows - At December 31, 1995, cash and cash equivalents included $29.4 million and $10.6 million attributable to Niugini Mining and Inti Raymi, respectively. Cash and cash equivalents at December 31, 1994, included $39.9 million and $15.4 million held by Niugini Mining and Inti Raymi, respectively. At December 31, 1995 and December 31, 1994, other assets included $5.8 million and $ .9 million, respectively, of restricted cash held by Niugini Mining.\nFor purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.\nDuring the year ended December 31, 1995, the Company paid foreign withholding taxes of $2.2 million. During the year ended December 31, 1994, the Company received a U.S. income tax refund of $4.3 million and paid foreign withholding taxes of .9 million. During the year ended December 31, 1993, the Company paid $.7 million in U.S. income taxes. The Company paid $10.1 million, $6.4 million and $6.8 million in interest, net of amounts capitalized, during 1995, 1994 and 1993, respectively.\nDuring 1995, the Company's investing activities included the exchange of Niugini Mining's interest in the Lihir Joint Venture for the common stock of Lihir Gold Limited (\"LGL\"). During 1994, the Company's investing activities included the issuance of 435,897 shares of BMG's common stock (market value of $4.25 million) and payment of $4.25 million cash for the purchase of an additional 3 percent interest in the Crown Jewel Project. During 1993, the Company's investing activities did not include any significant non-cash transactions.\nIssuance of Stock by Subsidiaries - The issuance of stock by subsidiaries is accounted for as a capital transaction in the Consolidated Financial Statements.\nForward Sales Contracts, Options and Interest Rate Caps - The Company may enter into fixed forward and spot deferred sales contracts for the sale of its metals as a hedge against changes in prices. Gains, losses or expenses related to these transactions are netted against revenue when the hedged production is sold. The Company may also purchase put options for the sale of its produced metals. The premiums paid for the acquisition of put options are netted against revenue in the period of expiry.\nSpot deferred sales contracts allow the Company to defer the delivery of gold under the contract to a later date at the original contract price plus the prevailing premium at the time of the deferral, as long as certain conditions are satisfied. Although spot deferred sales contracts could limit amounts realizable during a period of rising prices, the Company may \"roll forward\" its spot deferred contracts to future periods in order to realize current market price increases, while maintaining future downside protection.\nPremiums paid for purchased interest rate caps are amortized as interest expense over the terms of the interest rate cap agreement. Unamortized premiums are included in other assets in the Consolidated Balance Sheet. Amounts earned under cap agreements are accrued as a reduction of interest expense.\nEstimates, risks and uncertainties - 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 certain assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the related reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Management believes that the estimates are reasonable.\nRealization of the Company's assets is subject to various risks including permitting of the Company's new mines, reserves estimation, gold prices and environmental factors.\nNote 2. Investments\nThe Company's long-term investments as of December 31 include the following:\nLihir Gold Limited (\"LGL\"), which is a company created specifically for the development, financing, operating and ownership of the Lihir project in Papua New Guinea, completed an initial public offering of common stock on October 6, 1995. LGL was formed and initially owned by the prior participants in the Lihir Joint Venture which included a 30 percent ownership by Niugini Mining, a 40 percent ownership by a subsidiary of RTZ Corporation, plc and a 30 percent ownership by an entity of the PNG government. As a result of the initial public offering, Niugini Mining now owns a 17.15 percent interest in LGL and BMG's attributable interest is 8.7 percent. Niugini Mining's interest in LGL is accounted for using the equity method of accounting, effective from October 1995, while the Company's investment in the Lihir Joint Venture was previously recorded in property, plant and equipment.\nThe initial public offering by LGL was the final transaction in a series of planned transactions which restructured and reduced BMG's participation in the Lihir project. The Company recorded the effects of this series of transactions in the fourth quarter of 1995. An increase in Niugini Mining's shareholders' equity of approximately $57 million related to the issuance of the common stock by LGL at a value in excess of Niugini Mining's carrying value per share in LGL was recorded. This increase was recorded as a credit to additional paid-in capital consistent with the Company's accounting policy with regard to transactions of this nature. An offsetting increase in the carrying value of Niugini Mining's investment in LGL was recorded. The Company attributed $28 million of this increase to minority interest in its consolidated financial statements; the remainder was credited to additional paid-in capital. As a result of these transactions, the Company also amortized approximately $35 million of its investment in Niugini Mining attributable to the investment in LGL. This amortization was recorded as a charge to additional paid-in capital. The net result of these transactions in the Company's consolidated financial statements was an increase in the carrying value of the LGL investment of approximately $22 million, an increase in minority interest of approximately $28 million and a net decrease in additional paid-in capital of approximately $6 million.\nInterest costs amounting to $7.8 million in 1995 and $6 million per year in 1994 and 1993 each were capitalized in connection with the Company's investment in the Lihir project.\nNote 3. Property, plant and equipment\nProperty, plant and equipment as of December 31 consists of the following:\nNote 4. Asset Write-downs\nIn June 1995, the Company decommissioned and dismantled the milling facility formerly used at the depleted Fortitude mine in Nevada. Accordingly the remaining net carrying value of this mill and related facilities of approximately $2.2 million was charged to operations. In addition, $.9 million was charged to milling and other plant costs, representing the carrying value of spare parts rendered obsolete by the decommissioning of the milling facility. The Company did not recognize any charges for asset write-downs during 1994 or 1993.\nNote 5. Debt\nThe Company had the following long-term debt outstanding as of December 31:\nThe convertible subordinated debentures are convertible into shares of the Company's common stock at a conversion price of $20 5\/8 per share, subject to anti-dilution adjustment in certain circumstances. There are 4.8 million shares of the Company's common stock reserved for\nissuance upon conversion of the debentures. The debentures are now redeemable at the Company's option at any time at par value plus accrued interest. There are no sinking fund requirements. Interest is payable annually. Proceeds from the issuance were added to working capital and used for general corporate purposes, including mineral acquisitions and development of properties.\nOn November 6, 1995, the Company entered into a new committed non-reducing revolving credit agreement with a syndicate of six banks, led by Citibank N.A. as agent. In connection with the new revolving credit agreement the Company terminated its previous existing committed revolving credit agreement. The new facility, which has a termination date of November 6, 2000, provides for unsecured borrowings of up to $75 million. Interest rates under the facility are based on the facility agent's base rate, LIBOR, applicable certificate of deposit rates or gold funding rates plus an applicable margin which is subject to adjustment in case of certain changes in BMG's credit rating and certain financial ratios. Additionally, interest charges increase when outstanding borrowings under this facility exceed $25 million and, again, when such borrowings exceed $50 million. Other costs associated with the new facility include commitment fees of one-eighth percent per annum on the unused portion of the facility and facility fees of one- eighth percent per annum on the average daily commitment, in each case subject to adjustment in case of certain changes in credit rating or ratios. The revolving credit agreement imposes certain financial covenants upon the Company which include covenants relating to leverage, net worth, contained production, mineral reserves and working capital, as well as certain restrictions on liens, investments, additional debt, lease obligations, and the acquisition or disposition of assets. In addition, the agreement sets forth restrictions limiting the amount of dividends that BMG may pay based on $20 million plus 50% of consolidated net income since December 31, 1994, plus 50% of proceeds received from the sale of BMG's capital stock on a cumulative basis from the date of the agreement. The weighted average interest rate for borrowings under this facility for the year ended December 31, 1995, was 6.7 percent. No borrowings were outstanding under the previous facility in 1994. Interest charges applicable to the previous facility for the year ended December 31, 1993, were based on a weighted average interest rate ranging from 3.9 percent to 6.0 percent.\nDuring 1992, Inti Raymi, established separate but coordinated term credit facilities with the Overseas Private Investment Corporation (\"OPIC\"), International Finance Corporation (\"IFC\") and Corporacion Andina de Fomento (\"CAF\") for the development of its Kori Kollo expansion project in Bolivia. Each loan is secured by a lien on the project and is to be repaid in semi-annual installments which commenced in December 1993 and will continue through June 2000, with certain provisions for accelerated repayment in the event of substantial Kori Kollo reserve losses or significantly improved gold market conditions. Through certain ratio tests, each loan may restrict payments of intercompany debt and dividends by Inti Raymi to the owners of shares of its capital stock. Additional covenants exist which limit fixed asset purchases, additional debt and liens, and require compliance with applicable environmental laws. During 1993, the project met the prerequisite physical and financial completion tests as set forth in the facility agreements and in April 1994 achieved project completion status.\nThe OPIC and IFC loan agreements require that the current mining plan indicate that production from the Kori Kollo mine extends at least three years beyond the final scheduled principal payment (\"Reserve Life Provision\"). Failure to meet this Reserve Life Provision results in the suspension of all debt repayments from Inti Raymi to its shareholders and all Inti Raymi dividend payments until such time as compliance with the Reserve Life Provision is achieved by either a prepayment of a sufficient portion of the debt or an increase in the Kori Kollo mine ore reserves. The IFC and CAF loan agreements contain provisions which entitle their respective agencies to receive principal prepayments proportionate to those received by OPIC. In the third quarter of 1994, the Company completed a rescheduling of the life of mine production and observed that the new schedule was not in compliance with the Reserve Life Provision due to more rapid mining and production than originally planned. The then-current plan indicated that production would extend approximately 2.8 years beyond the date of the final scheduled principal payment. To allow continuing payments of dividends and the repayment of intercompany debts, Inti Raymi obtained a temporary waiver, permitting noncompliance with the Reserve Life Provision until June 30, 1996. Inti Raymi has recently announced reserve additions which the lenders have approved as sufficient to satisfy the Reserve Life Provision well in advance of the scheduled expiration of the temporary waiver.\nThe OPIC facility provided for borrowings of $40 million. Interest rates under the variable rate facility are based on LIBOR plus 2 percent. Additionally, $4.1 million of previously existing OPIC loans to Inti Raymi were restructured as loan obligations under the terms of the agreement, with the exception that they are subject to their originally agreed interest rates. Weighted average interest rates for borrowings under this facility for the years ended December 31, 1995, 1994 and 1993, were 8.5 percent, 6.7 percent and 5.6 percent, respectively.\nUnder the IFC commitment, borrowings of $40 million were made. The interest rate for the non-convertible portion of the loan is based on LIBOR plus 2.375 percent, but Inti Raymi has the right to request an interest rate cap or collar, or may elect at any time to pay a fixed rate of interest. Of the total IFC borrowings, $5 million represents a convertible loan due on March 1, 2002, carrying a fixed annual interest rate of 11 percent with an additional interest rate provision which varies with the price of gold. Weighted average interest rates for borrowings under this facility for the years ended December 31, 1995, 1994 and 1993 were 8.6 percent, 6.9 percent and 6.0 percent, respectively, for the non-convertible portion of the loan and 12.8 percent, 13.7 percent and 12 percent, respectively, for the convertible portion of the loan. The loan may be converted, at IFC's option, into an equity interest of up to a 3.98 percent in Inti Raymi. Upon the conversion of the convertible loan into equity, the Company and Inti Raymi's minority owner would have their interests in the capital stock of Inti Raymi diluted proportionately. Each share of Inti Raymi common stock issued by Inti Raymi as a result of such conversion will have an associated put option which, if exercised by IFC, would require BMG and Inti Raymi's minority shareholder to purchase such share at its fair market value as determined at the time the put is exercised.\nThe CAF facility provided for borrowings of $15 million. Interest rates under the facility are based on LIBOR. These funds were obtained from several sources. CAF charged a supervision and oversight fee and a commitment fee in addition to fees charged by the\nparticipants in the funding. Weighted average interest rates for borrowings under this facility for the years ended December 31, 1995, 1994 and 1993, were 7.3 percent, 5.5 percent and 4.7 percent, respectively.\nThe Company has a $15 million uncommitted revolving credit facility with the Union Bank of Switzerland. Interest rates under the facility are variable, based on either the bank's base rate or a negotiated rate. There are no additional costs or financial restrictions under this facility. No loans were outstanding under this revolving credit facility as of December 31, 1995 and 1994; however, letters of credit amounting to $2.2 million and $4.8 million had been issued against this facility as of December 31, 1995 and 1994, respectively. The weighted average interest rate for borrowings under this facility for the year ended December 31, 1995, was 6.7 percent. There were no interest charges for the year ended December 31, 1994, since the Company did not borrow against this facility in 1994. Interest charges for the year ended December 31, 1993, were based on weighted average interest rates of 3.5 to 4.3 percent.\nScheduled maturities of the Company's long-term debt for each of the next five years are $13.4 million for 1996 through 1999 and $6.9 million in 2000. In addition, all borrowings then outstanding under the new revolving credit facility are due and payable on November 6, 2000.\nBMG has effective a registration statement under the Securities Act of 1933, as amended, for what is commonly referred to as a \"universal shelf\" filing covering up to $200 million of its debt securities, preferred stock, depositary shares, common shares and warrants which may be offered from time to time.\nNote 6. Shareholders' Equity\nReference is made to Note 5 for information regarding the number of shares of common stock reserved for issuance for the conversion of the Company's outstanding convertible subordinated debentures.\nThe Company's Board of Directors is authorized to divide the preferred stock into series. With respect to each series the Board may determine the dividend rights, dividend rates, conversion rights and voting rights (which may be greater or less than the voting rights of the common stock). The Board may also determine the redemption rights and terms, liquidation preferences, sinking fund rights and terms, the number of shares constituting the series and the designation of each series.\nPursuant to their authority to divide the preferred stock into series, the Board of Directors in 1988 designated 2,000,000 shares of preferred stock as \"Series A Junior Participating Preferred Stock\" for possible issuance upon the exercise of stock rights as described below.\nStock Rights - Since November 21, 1988, when the Company's Board of Directors declared a dividend of one right for each outstanding share of the Company's common stock, each share of the Company's outstanding common stock carries with it such right. Each right entitles the holder to purchase from the Company one one-hundredth of a share of Series A Junior\nParticipating Preferred Stock, par value $1.00 per share, for an exercise price of $60, subject to adjustment. The rights expire on November 10, 1998. They will not be exercisable nor transferable apart from the common stock until such time as a person or group acquires 20 percent of the Company's common stock or initiates a tender offer that will result in ownership of 30 percent of the Company's common stock. In the event that the Company is merged, and its common stock is exchanged or converted, the rights will entitle the holders to buy shares of the acquirer's common stock at a 50 percent discount. Under certain other circumstances, the rights can become rights to purchase the Company's common stock at a 50 percent discount. The rights may be redeemed by the Company for one cent per right at any time until 10 days following the first public announcement of a 20 percent acquisition of beneficial ownership of the Company's common stock.\nConvertible Preferred Stock - On May 20, 1993, the Company received $111 million in net proceeds from the issuance of 2.3 million shares of its convertible preferred stock with a liquidation preference of $50 per share plus any accrued and unpaid dividends. Each share of preferred stock will pay an annual cumulative dividend of $3.25 and is convertible at any time at the option of the holder into 4.762 shares of the Company's common stock. The preferred stock is redeemable at the option of the Company solely for shares of the Company's common stock beginning May 15, 1996. There are approximately 11 million shares of the Company's common stock reserved for issuance upon conversion of the preferred stock.\nNote 7. Federal and Foreign Income Tax\nFederal and foreign income tax (benefit) expense consisted of the following at December 31:\nConsolidated income before income taxes includes income from foreign operations of $36.1 million, $32.7 million and $13.8 million in 1995, 1994 and 1993, respectively.\nThe Company's net deferred tax position at December 31, is comprised of the following:\nTemporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities at December 31 are as follows:\nA reconciliation of income tax at the U.S. statutory rate to income tax (benefit) expense as of December 31 follows:\nThe Omnibus Budget Reconciliation Act of 1993, enacted on August 10, 1993, retroactively increased the federal statutory income tax from 34 percent to 35 percent for periods beginning on or after January 1, 1994. The effect of the rate change was not significant to the Company's net deferred income tax position.\nU.S. taxes have been provided on the undistributed earnings of subsidiaries and joint ventures with the exception of Niugini Mining which is in a cumulative loss position.\nThe Company and its domestic subsidiaries file a consolidated U.S. federal income tax return. Such returns have been closed through the year 1991.\nAt December 31, 1995, the Company had approximately $71.8 million of regular net operating losses and $9.3 million of alternative minimum tax net operating loss carryforwards expiring beginning in 2007, available to offset future U.S. federal income tax and approximately $4.6 million of alternative minimum tax credits available on an indefinite carryforward basis. Changes in the ownership of a company can result in an annual limitation under IRC section 382 on the amount of the tax net operating loss carryforwards which can be utilized in any one year. The annual limitation is based on the value of the company as of the ownership change date multiplied by the federal long-term tax exempt rate. It is not anticipated that the section 382 limitation will significantly restrict the future utilization of BMG's net operating loss carryforwards.\nNote 8. Major Customers and Export Gross Revenues\nAll sales of the Company's products are made to precious metals smelters, refiners or traders. Accordingly, the precious metals industry has substantial influence over the market for the Company's products.\nDuring 1995, gross revenues from five separate buyers accounted for $83.2 million, $72.9 million, $35.6 million, $25.2 million and $22.5 million of total gross revenues, respectively, representing 80.0 percent of total gross revenues. International gross revenues for 1995 were $299.3 million, of which $58.1 million were from export of U.S. product. In 1994, gross revenues from four separate buyers of $69.0 million, $64.8 million, $36.8 million and $17.1 million, respectively, accounted for 77.3 percent of total gross revenues. Of the Company's $243.0 million international gross revenues in 1994, $46.6 million were from export of U.S. product. For 1993, 80.1 percent of the Company's total gross revenues were distributed among six separate buyers who accounted for $55.3 million, $36.2 million, $25.3 million, $17.4 million, $17.0 million and $14.8 million in gross revenues, respectively. International gross revenues of $207.2 million in 1993 included $47.9 million from export of U.S. product. Alternate buyers are available to replace the loss of any of the Company's principal customers.\nNote 9. Other Income (Expense), Net\nIncluded in other income (expense), net, are certain non-operating revenues, net of related expenses, consisting of:\nNote 10. Acquisitions\nNiugini Mining - In the aggregate, since January 1, 1989, the Company has paid $204.1 million for 59.3 million shares of the common stock of Niugini Mining representing a 50.5 percent ownership interest as of December 31, 1995. In December 1993, Niugini Mining issued 5.8 million of its common shares at A$5.00 per share in a public offering which provided net proceeds of approximately $19.1 million U.S. equivalent. As a result of this stock offering, BMG's ownership interest in Niugini Mining decreased from 56.5 percent to 52.6 percent. In December 1993, the Company recorded a $2.1 million adjustment to reduce the carrying value of its investment in Niugini Mining to reflect the reduction in ownership interest. In 1995 and 1994, BMG's ownership interest was diluted to 50.6 percent and 51.4 percent, respectively, due to employee stock options that were exercised during the year. In May 1995 and June 1994 the Company recorded adjustments of $2.2 million and $1.2 million, respectively, to reduce the carrying value of its investment in Niugini Mining to reflect these reductions in ownership interest. In December 1995, the Company paid approximately $17 million to purchase 11.9 million additional shares of Niugini Mining through exercise of its share of options issued to Niugini Mining's shareholders in May 1995.\nAt December 31, 1995, the carrying value attributed to the Company's proportionate share of Niugini Mining's investment in LGL exceeded its proportionate share of Niugini Mining's historical cost basis in LGL by $102 million. Such excess will be amortized against the Company's share of the earnings of LGL based on the estimated recoverable reserves attributable to the Lihir project upon commencement of production (See Note 2).\nInti Raymi - On March 8, 1994, the Company purchased an additional 3 percent of Inti Raymi's outstanding stock for $5.2 million from Zeland Mines, S.A. to increase the Company's ownership interest to 88 percent. As of December 31, 1995, the Company had invested an aggregate of $41.1 million in cash and 9 million of its common shares (valued at approximately $76.3 million) to acquire its 88 percent equity interest in Inti Raymi.\nAt December 31, 1995, the carrying value, net of accumulated amortization, attributed to the Company's share of the Kori Kollo and Llallagua gold deposits exceeded its proportionate\nshare of Inti Raymi's historical cost basis in the deposits by $82.8 million. This excess has been capitalized to property and is being amortized by the units of production method based on the deposits' estimated recoverable reserves. Amortization of the excess cost amounted to $10.8 million, $11.1 million and $8.6 million in 1995, 1994 and 1993, respectively.\nInterest costs amounting to $.7 in 1995, $.4 million in 1994 and $.6 million in 1993 were capitalized in connection with the Kori Kollo project.\nNote 11. Common Stock and Stock Options\nStock Options - Under the Company's 1994 Long-term Incentive Plan and a predecessor stock option plan, 5,980,000 shares of the Company's Common Stock were reserved for issuance as of December 31, 1995. Of this number 3,240,582 shares and 3,641,173 shares, respectively, were available for future grants of stock options, restricted stock, performance shares or other stock awards at December 31, 1995 and 1994, respectively.\nNon-employee directors of the Company are granted non-qualified stock options under a separate stock option plan for outside directors. Under this plan, a total of 250,000 shares of the Company's common stock are reserved for issuance, of which 150,000 shares and 160,500 shares are available for future grants at December 31, 1995 and 1994, respectively.\nOptions granted under the above plans are exercisable under the terms of the respective option agreements at the market price of the common stock at the date of grant, subject to anti-dilution adjustments in certain circumstances. Payment of the exercise price may be made in cash or in shares of common stock previously owned by the optionee, valued at current market value.\nUnder a deferred income stock option plan for officers and directors, each participant may elect to receive a non-qualified stock option in lieu of a portion of his compensation. A maximum of 2,000,000 shares of common stock is issuable under the plan, of which 1,729,328 shares and 1,751,391 shares are available for future grants at December 31, 1995 and 1994, respectively. Options granted pursuant to the plan become exercisable at the beginning of the calendar year immediately following the year in which the option was granted. They expire no later than 10 years after the date of grant. The amount of deferred compensation is accrued as compensation expense during the period earned.\nAdditional information for 1995 related to the Company's stock option plans follows:\nAt December 31, 1995, expiration dates for the outstanding options ranged from July 1, 1996, to August 24, 2005. The weighted average exercise price per share was $9.51.\nNote 12. Benefits Plans\nPension Plans - Substantially all U.S. employees of the Company are covered by non-contributory pension plans. The U.S. plans provide benefits based on participants' years of service and compensation or defined amounts for each year of service. The Company makes annual contributions to the U.S. plans that comply with the minimum funding provisions of the Employee Retirement Income Security Act (\"ERISA\").\nDuring 1993, the plans for BMG's Australian employees were changed from non-contributory defined benefit plans to defined contribution plans.\nPension costs are generally accrued and charged to expense currently. Net periodic pension cost included the following components:\nAt December 31, 1995, 1994 and 1993, the projected long-term rate of return on plan assets was 9 percent.\nActual return on the plans' assets was $6.4 million for the year ended December 31, 1995, $1.4 million for the year ended December 31, 1994, and $.3 million for the year ended December 31, 1993.\nThe following sets forth the plans' funded status and related amounts as of December 31:\nPlan assets include equity securities, common trust funds and various debt securities. Weighted average rate assumptions used in determining estimated benefit obligations were as follows:\nContribution Plans - The Company has defined contribution plans available for all full-time U.S. salaried employees and all full-time U.S. hourly employees. The plans provide for savings contributions by employees from 1 to 16 percent of their compensation, subject to ERISA limitations. The Company matches 50 to 100 percent of employee contributions with BMG's common stock, subject to a limit of 6 percent of an employee's compensation during each plan year.\nThe Company has defined contribution plans available for all BMG's Australian salaried and hourly employees. The Company's contributions to the salaried plan are determined in accordance with the trust deed. The Company's contributions to the hourly plan are determined in accordance with the union award.\nAll Company contributions to the plans are expensed and funded currently. The cost of such Company contributions to the U.S. plans was $ .4 million, $.3 million and $.5 million in 1995, 1994 and 1993, respectively. The cost attributable to the Australian plans was $.8 million, $.7 million and $.6 million in 1995, 1994 and 1993, respectively.\nPostretirement Health Care and Life Insurance Benefits - Substantially all of the Company's U.S. employees may become eligible for certain unfunded health care and life insurance benefits when they reach retirement age while working for the Company.\nNet periodic postretirement benefit cost included the following components:\nThe following table presents the plans' status at December 31:\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7.5 percent for 1995 and 8.5 percent for 1994. For 1995 and 1994, the assumed annual rate of increase in the per capita cost of covered health care benefits was 9 and 12 percent, respectively. For 1995 calculations, a gradual decrease in the rate is assumed through the year 2000 when the rate is estimated to reach 6 percent and remain at that level thereafter. For 1994 calculations, a gradual decrease in the rate is assumed through the year 1999 when the rate is estimated to reach 6 percent and remain at that level thereafter. A one percent increase in the assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of December 31, 1995, by approximately $1.1 million, and would increase the total of the service and interest cost components of net periodic postretirement health care cost for 1995 by approximately $.1 million.\nPostemployment Benefits - Effective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\". This standard requires that the expected cost of these benefits must be charged to expense during the periods that employees vest in these benefits. The Company had previously recognized these costs as an expense when paid. Adoption of the standard did not have a material effect on the Company's financial position or on its results of operations. Postemployment benefit costs recognized under this standard do not differ significantly from those that would have been reported under the previous method.\nNote 13. Geographic Segment Information\nThe following table sets forth certain financial information relating to international and domestic operations:\nNote 14. Commitments and Contingencies\nTotal operating lease rental expenses (exclusive of mineral leases) were $3.4 million, $2.2 million and $1.4 million for 1995, 1994 and 1993, respectively.\nAggregate minimum rentals (exclusive of mineral leases) subsequent to December 31, 1995, under non-cancelable leases for the years ending December 31, 1996 to 2000, are estimated to be $3.1 million, $2.4 million, $1.8 million, $1.0 million and $.6 million, respectively. Lease commitments beyond the year 2000 total $1.8 million.\nPursuant to pricing provisions as set out in dore customer contracts, as of December 31, 1995, the Company had committed to sell 14,300 ounces of gold contained in dore valued at approximately $5.6 million at prices determined during various pricing periods in 1995, none of which exceeds 45 days. The average price of gold sold under this commitment is approximately $389 per ounce.\nAll of the Company's mining and processing operations are subject to reclamation and closure requirements. The Company monitors such requirements and periodically revises its cost estimates to meet the legal and regulatory requirements of the various jurisdictions in which it conducts its business. Where possible, plans for ongoing operations and future mine development are implemented in a manner that contributes to the fulfillment of reclamation and closure obligations in a cost effective manner through the conduct of ongoing operating activities. Costs estimated to be incurred in future periods which cannot be addressed in this manner are charged to operations through provisions based on the units of production method such that the estimated cost of ultimate reclamation is fully provided for by the time mineral reserves are depleted. The timing of actual cash expenditures for reclamation may be accelerated or deferred depending on cost and other determinations which may make such decisions prudent in the circumstances. The Company believes that these policies and practices adequately address its reclamation obligations and provide a systematic and rational method of charging such costs to operations consistent with industry practice. Accruals amounting to an aggregate of $8.0 million at December 31, 1995, are included as long-term liabilities in the Company's Consolidated Balance Sheet. At the Battle Mountain Complex, aggregate reclamation expenditures estimated to be spent in future periods are expected to amount to approximately $7.8 million. Actual expenditures made to date have equaled the total amount accrued to date, therefore there is no net accrued liability at December 31, 1995 for this location. Estimated ultimate reclamation obligations and related accrued liability balances at December 31, 1995, respectively, for each of the Company's other operating mines is as follows: San Luis $3.3 million and $1.7 million, Pajingo $2.6 million and $1.5 million, Kori Kollo $10.0 million and $1.9 million and Red Dome $3.7 million and $2.9 million. Reclamation expenditures for the San Cristobal mine are not expected to be material.\nNote 15. Forward Sales and Hedging\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Derivative instruments are used to manage well-defined interest rate, foreign currency exchange rate and commodity price 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, Inti Raymi was party to three interest rate cap agreements which were effective June 1, 1994, each with a term of three years. The agreements entitle Inti Raymi to receive from counterparties on a quarterly basis the amounts, if any, by which Inti Raymi's interest payments on a portion of its LIBOR based floating-rate Kori Kollo project financing exceed various fixed rates over the term of the caps. The fixed rates in the cap agreements gradually escalate from 5.4 percent in 1995 to 7.2 percent in 1997. Inti Raymi has hedged 50 percent of its net interest rate exposure currently related to the Kori Kollo LIBOR based project financing. The hedge increases to 100 percent of its exposure by June 1996. Inti Raymi has not hedged any of its exposure subsequent to December 1997. The net unamortized cost of the premiums paid for these caps amounting to $.5 million at December 31, 1995, has been included in other assets. Since the interest rate caps were put in place, the Company has amortized approximately $.2 million of such premiums and has received approximately $.2 million in settlement of expiring caps.\nThe Company uses fixed forward sales contracts, spot deferred sales contracts and put options to hedge anticipated sales of gold, silver and copper. The following table summarizes the Company's forward sales contracts at December 31, 1995:\nDeferred costs associated with Inti Raymi's forward sales contracts amounted to $1.3 million and $1.5 million at December 31, 1995 and 1994, respectively. Deferred costs associated with put options amounted to $.2 million at December 31, 1995. The Company did not own any put options at December 31, 1994.\nAt December 31, 1995, the aggregate amount by which the net market value of the Company's open forward sales contracts is greater than the spot price of $387 per ounce of gold, $5.19 per ounce of silver, and $2,815 per tonne of copper, before consideration of the deferred costs referred to above, is $2.6 million, of which $.4 million is attributable to minority interests. Australian dollar contracts were converted to U.S. dollars at the December 1995 month end exchange rate of US$.74 to A$1.\nThe Company is exposed to credit-related losses in the event of nonperformance by the counterparties to its interest rate caps and forward sales contracts, but does not expect any counterparties to fail to meet their obligations. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of counterparties.\nNote 16. Fair Value of Financial Instruments\nSFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a\ncurrent transaction between willing parties. The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at December 31:\nThe carrying amounts of the interest rate caps and debt shown in the table are included in the Consolidated Balance Sheet under Other Assets and Long-Term Debt, respectively.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash, cash equivalents, trade receivables, and trade payables - The carrying amounts approximate fair value because of the short maturity of those instruments.\nOther assets - The amounts reported relate to the interest rate cap agreements described in Note 15 . The carrying amount comprises the unamortized premiums paid for the contracts. The fair value is estimated using option pricing models.\nDebt - The fair value of the Company's convertible subordinated debentures is based on the quoted market price of the debentures at the reporting date. Due to the generally variable interest rate features of the OPIC, IFC and CAF loans, the Company believes the carrying amounts approximate the fair value of this debt at the reporting date.\nThe Company has issued corporate guarantees totaling $4.5 million to ensure that the reclamation of the Battle Mountain Complex mines will be performed as specified in the operating permits issued by the State of Nevada. In addition, the Company has a letter of credit outstanding for $2.2 million as collateral for surety bonds provided as security for various reclamation obligations. The Company believes the carrying value of these financial instruments approximates their fair market value.\nSUPPLEMENTAL FINANCIAL INFORMATION (UNAUDITED)\nQUARTERLY RESULTS\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 the captions \"Nominees\" and \"Directors with Terms Expiring in 1997 and 1998\" set forth under \"Election of Three Directors and Director Compensation\" in the Company's definitive Proxy Statement for its 1996 annual meeting of shareholders, as filed within 120 days of December 31, 1995, pursuant to Regulation 14A under the Security Exchange Act of 1934, as amended (the \"Company's 1996 Proxy Statement\"), is incorporated herein by reference. See also \"Executive Officers of the Registrant\" appearing in Part I of this Annual Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under the captions \"Board Organization and Committees\" set forth under \"Election of Three Directors and Director Compensation\" and \"Executive Compensation\" (other than the Compensation and Stock Option Committee Report on Executive Compensation) in the Company'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 under the caption \"Security Ownership\" set forth under \"Election of Three Directors and Director Compensation\" in the Company's 1996 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements and Supplementary Data. Consolidated financial statements of the Company and its subsidiaries are incorporated under Item 8 of this Form 10-K.\n(a)(2) Financial Statement Schedules.\nSchedule I.Condensed Financial Information of Registrant S-1\nOther schedules of Battle Mountain Gold Company and subsidiaries 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: See attached exhibit index, page E-1, which also includes the management contracts or compensatory plans or arrangements required to be filed as exhibits to this Annual Report by Item 601 (10)(iii) of Regulation S-K.\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.\nBATTLE MOUNTAIN GOLD COMPANY\nBy \/s\/ Karl E. Elers -------------------------------- Karl E. Elers Chairman of the Board and Chief Executive Officer\nDate: March 8, 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.\n*By \/s\/ Karl E. Elers ------------------------------ (Karl E. Elers, Attorney in fact)\nBATTLE MOUNTAIN GOLD COMPANY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET\n* Eliminated in consolidation\nThis condensed statement should be read in conjunction with the Consolidated Financial Statements and Notes thereto which are included in Item 8 herein.\nS-1\nBATTLE MOUNTAIN GOLD COMPANY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF INCOME\n* Eliminated in consolidation\nThis condensed statement should be read in conjunction with the Consolidated Financial Statements and Notes thereto which are included in Item 8 herein.\nS-2\nBATTLE MOUNTAIN GOLD COMPANY SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF CASH FLOWS\nThis condensed statement should be read in conjunction with the Consolidated Financial Statements and Notes thereto which are included in Item 8 herein.\nS-3\nINDEX OF EXHIBITS\nE-1\nE-2\nE-3\nE-4\nE-5\nE-6\n* Incorporated by reference as indicated.\n+ Represent management contracts or compensatory plans or arrangements required to be filed as exhibits to this Annual Report by Item 601(10)(iii) of Regulation S-K.\n_ Pursuant to Instruction 2 accompanying paragraph (a) and the Instruction accompanying paragraph (b)(10)(iii)(B)(6) of Item 601 of Regulation S-K, the registrant has not filed each executive officer's individual Executive Supplemental Retirement Income Agreement with the Company as an exhibit hereto; the registrant has agreements substantially identical to Exhibit 10(q)(3) above with each of Karl E. Elers, Kenneth R. Werneburg, Joseph L. Mazur, R. Dennis O'Connell, Robert J. Quinn and Fred B. Reisbick. In addition, the registrant has not filed each executive officer's individual Severance Agreement with the Company as an exhibit hereto; the registrant has agreements substantially identical to Exhibit 10(g)(1) above with each of Messrs. Elers, Werneburg, Mazur, Quinn and Reisbick.\nE-7","section_15":""}
{"filename":"26324_1995.txt","cik":"26324","year":"1995","section_1":"Item 1. Business. Curtiss-Wright Corporation was incorporated in 1929 under the laws of the State of Delaware. Curtiss-Wright operates in two industry segments; Aerospace & Marine, and Industrial. The Corporation revised its industry segment presentation in 1995 to better align its current components of revenue producing products and services to the markets served. In June 1995 the Corporation sold its Buffalo extrusion facility. Its operations were not material to the Corporation's sales or profits in 1995.\nAerospace & Marine Segment\nControl and actuation systems are designed, developed and manufactured by the Corporation for the aerospace industry by Curtiss-Wright Flight Systems, Inc. and Curtiss-Wright Flight Systems\/Shelby, Inc. (collectively \"Flight Systems\"), wholly-owned subsidiaries of the Registrant. Generally speaking, such components and systems are designed to position aircraft control surfaces, or to operate canopies, landing gear or weapon bay doors or other devices through the use of actuators. Products offered consist of electro-mechanical and hydro-mechanical actuation components and systems. They include actuators for the Lockheed Martin, and McDonnell Douglas F\/A-18 fighter planes, the Boeing 737, 747, 757, 767 and 777 jet transports, and the Sikorsky Black Hawk and Seahawk helicopters. In 1995 Flight Systems entered into agreements with the Boeing Commercial Airplane Group to supply trailing edge flap transmissions for Boeing 757 aircraft, trailing edge flap rotary actuators for Boeing 767 aircraft and trailing edge flap transmissions for the redesigned Boeing 737 aircraft. These production contracts run through the year 2002. Flight Systems also provides the airlines and other aircraft users with overhauls of transmissions and actuators previously manufactured by it for Boeing 737 and 747 aircraft and other components for the Lockheed Martin L-1011 aircraft and the GrummanA fighter plane. Overhaul services are also provided for other Boeing aircraft components originally manufactured by other Boeing suppliers. These services, as well as spare parts and components, are offered by Flight Systems and by Curtiss-Wright Flight Systems Europe A\/S (an 80% owned subsidiary). Flight Systems provides the Leading Edge Flap Rotary Actuators (LEFRA) for the aircraft. There are ongoing commitments for new aircraft from the Lockheed Martin\/Fort Worth Company for foreign military customers. In recent years, work on the has been the largest production program at Flight Systems. Future government orders for this aircraft are uncertain and the potential for the is largely dependent on Lockheed Martin's foreign sales. Flight Systems is a major supplier for the Lockheed Martin Advanced Tactical Fighter plane which has been described as the Air Force's future air superiority fighter. While Flight Systems does not expect to begin substantial production on this program for several years, the program is proceeding with the qualification testing and initial hardware phase of this engineering and manufacturing development program. Efforts by Flight Systems to expand its product base include continued work on a control system for the new Bell\/Boeing tilt rotor V-22 aircraft which is also in the qualification testing and initial hardware phase of this engineering and manufacturing development program.\nEngineering, manufacturing and development work is proceeding for the FA-18E\/F Lex Vent Drive System under a contract awarded in 1993 with actual production several years away. Flight Systems' products are sold in keen competition with a number of other systems suppliers, some of which have financial resources greater than those of the Corporation and significant technological and human resources. Flight Systems and these suppliers compete to have their systems selected to perform control and actuation functions on new aircraft. This operation competes primarily on the basis of engineering capability, quality and price. Competition has intensified because relatively few new aircraft models have been produced in recent years. Products are marketed directly to Flight Systems' customers by employees. Metal Improvement Company, Inc. (\"MIC\"), a wholly-owned subsidiary of the Registrant, performs shot-peening and peen-forming operations for aerospace manufacturers and their suppliers. Shot peening is a physical process used primarily to increase fatigue life in metal parts. MIC provides shot-peening services to jet engine manufacturers, landing gear suppliers and many other aerospace manufacturers. Peen forming is a process used to form curvatures in panel shape metal parts to very close tolerances. These panels are used as the \"wing skins\" after assembly on many commercial, military and executive aircraft in service today. Currently, MIC is peen-forming wing skins for jet transports manufactured by McDonnell Douglas. It also participates in the \"Airbus\" commercial jet transport program as a supplier to British Aerospace. MIC's marketing is accomplished through direct sales. While MIC competes with a great many firms and often deals with customers which have the resources to perform for themselves the same services as are provided by MIC, MIC considers that its greater technical expertise and superior quality provide it with a competitive advantage. Target Rock Corporation (\"Target Rock\"), a wholly-owned subsidiary of the Registrant, manufactures and refurbishes highly engineered valves of various types and sizes, such as hydraulically operated, motor operated and solenoid operated globe, gate, control and safety relief valves, which are used to control the flow of liquids and gases, and provide safe relief in the event of system overpressure for use in United States Navy nuclear propulsion systems. It also supplies actuators and controllers for Target Rock manufactured valves as well as for valves manufactured by others. Sales are made by responding directly to requests for proposals from customers and through use of marketing representatives. The production of valves for the United States Navy is characterized by long lead times from order placement to delivery. Target Rock's customers are sophisticated and demanding. Strong competition in valves is encountered primarily from a small number of domestic firms in the military market. Despite a declining market, Target Rock has been able to increase its market share and to maintain its sales volume. Performance, quality, technology, production methods, delivery and price are the principal areas of competition. The business of the Aerospace & Marine Segment would be materially affected by the loss of any one of several important customers. A substantial portion of segment sales are made to Lockheed Martin Corporation for engineering and design work and to the Boeing Company for commercial transport aircraft. A substantial amount of the sales of Target Rock are made to the Westinghouse Electric Corporation for United States Navy end use. The loss of any of these important customers would have a material adverse effect on this segment. Furthermore, the likelihood of future reductions in military programs due to reduced spending continues to exist. U.S. Government direct and end use sales of this segment in 1995, 1994 and 1993 were $38.0, $44.0 and $52.4 million, respectively.\nThe backlog of the Aerospace & Marine Segment as of January 31, 1996 was $119.4 million as compared with $107.3 million as of January 31, 1995. Of the January 31, 1996 amount, approximately 46% is expected to be shipped during 1996. None of the business of this segment is seasonal. Raw materials are generally available in adequate quantities from a number of suppliers.\nIndustrial Segment\nThe MIC subsidiary of the Corporation is engaged in the business of per- forming shot peening and heat treating for a broad spectrum of industrial customers, principally in the automotive, agricultural equipment, construction equipment and oil and gas industries. Heat treating is a metallurgical process used primarily to harden metals in order to provide increased durability and service life. MIC marketing and sales activity are done on a direct sales basis. Operations are conducted in facilities in the United States, Canada, England, France and Germany. Although numerous companies compete in the shot- peening field, and many customers for shot-peening services have the resources to perform such services themselves, MIC believes that its greater technical know-how provides it with a competitive advantage. MIC experiences substantial competition from other companies in heat-treating metal components. Substantial numbers of industrial firms elect to perform shot peening and heat treating for themselves. MIC also competes on the basis of quality, service, price and delivery. MIC is also engaged in the business of precision stamping and finishing of high strength steel reed valves used by various manufacturers of products such as refrigerators, air compressors, and small engines. Flight Systems has designed and developed a commercial rescue tool using its power hinge aerospace technology which is being marketed under the name Power Hawk(TM). The primary use for this tool is the extrication of automobile accident victims. A distribution network for the United States market has been completed and commercial sales commenced in 1995. The Target Rock subsidiary of the Corporation manufactures and refurbishes highly engineered valves of various types and sizes, such as hydraulically operated, motor operated and solenoid operated globe, gate, control and safety relief valves, which are used to control the flow of liquids and gases, and provide safe relief in the event of system overpressure, which are used in new and existing commercial nuclear and fossil fuel power plants and in facilities for process steam regeneration in the petroleum, paper and chemical industries. It also supplies actuators and controllers for Target Rock manufactured valves as well as for valves manufactured by others. Target Rock's packless electronic control valve is offered as a replacement item for competitors' commercial valves containing packing. The success of this valve is dependent upon the future application of stringent new Federal standards limiting air pollution from \"fugitive\" emissions from valves now widely in use. Target Rock's products are sold to domestic and foreign end users. Foreign sales have been for use in nuclear power plant construction projects principally for the Asian market. Strong competition in valves is encountered primarily from a larger number of domestic and foreign sources in the commercial market. Sales to commercial users are accomplished through independent marketing representatives and by direct sales. These valve products are sold to customers who are sophisticated and demanding. Performance, quality, technology, delivery and price are the principal areas of competition. The business of the Industrial segment is not materially dependent upon any single source of supply. The backlog of this segment (which has historically been low relative to sales of the segment) as of January 31, 1996 was $4.4 million as compared with $11.7 million as of January 31, 1995. Virtually all of the January 31, 1996 backlog is expected to be shipped in 1996. None of the business of this segment is seasonal. Raw materials, though not particularly significant to these operations, are available in adequate quantities.\nOther Information Government Sales In 1995, 1994 and 1993, direct sales to the United States Government and sales for United States Government end use aggregated 39%, 31% and 34%, respectively, of total sales for all segments. United States Government sales, both direct and subcontract, are generally made under one of the standard types of government contracts, including fixed price and fixed price-redeterminable. In accordance with normal practice in the case of United States Government business, contracts and orders are subject to partial or complete termination at any time, at the option of the customer. In the event of a termination for convenience by the Government, there generally are provisions for recovery by the Corporation of its allowable incurred costs and a proportionate share of the profit or fee on the work done, consistent with regulations of the United States Government. Subcontracts for Navy nuclear valves usually provide that Target Rock must absorb most of any overrun of \"target\" costs. In the event that there is a cost underrun, however, the customer is to recoup the larger portion of the underrun. It is the policy of the Corporation to seek customary progress payments on certain of its contracts. Where such payments are obtained by the Corporation under United States government prime contracts or subcontracts, they are secured by a lien in favor of the government on the materials and work in process allocable or chargeable to the respective contracts. (See Notes 1.C, 3 and 4 to the Consolidated Financial Statements, on pages 22 and 24 of the 1995 Annual Report to Stockholders, which is attached hereto as Exhibit 13 and hereinafter referred to as the \"Registrant's Annual Report\"). In the case of most valve products for United States Government end use, the subcontracts typically provide for the retention by the customer of stipulated percentages of the contract price, pending completion of contract closeout conditions.\nResearch and Development Research and development expenditures sponsored by the Corporation amounted to approximately $1,180,000 in 1995 as compared to about $1,196,000 in 1994 and $1,420,000 in 1993. During 1995, Curtiss-Wright spent an additional $17.4 million for customer-sponsored development work. The Corporation owns and is licensed under a number of United States and foreign patents and patent applications which have been obtained or filed over a period of years. The Corporation does not consider that the successful conduct of its business is materially dependent upon the protection of any one or more of these patents, patent applications or patent license agreements under which it now operates.\nEnvironmental Protection The effect of compliance upon the Corporation with present legal require- ments concerning protection of the environment is described in the material in Note 12 to the Consolidated Financial Statements which appears on page 28 of the Registrant's Annual Report and is incorporated by reference in this Form 10-K Annual Report.\nEmployees At the end of 1995, the Corporation had approximately 1,500 employees. Most production employees are represented by labor unions and are covered by collective bargaining agreements.\nCertain Financial Information The Industry Segment information is described in the material in Note 19 to the Consolidated Financial Statements, which appears on Pages 30 and 31 of the Registrant's Annual Report and is incorporated by reference in this Form 10-K Annual Report. It should be noted that in recent years a significant percentage of the pre-tax earnings from operations of the Corporation has been derived from European operations of MIC. The Corporation does not regard the risks attendant to these foreign operations to be materially greater than those applicable to its business in the U.S.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. The principal physical properties of the Corporation and its subsidiaries are described below:\nOwned\/ Location Description(1) Leased Principal Use - - -------------- ------------------- -------------- ----------------------------- Wood-Ridge, 2,322,000 Owned(2) Multi-tenant industrial New Jersey sq. ft. on rental facility. 144 acres\nFairfield, 450,000 Owned(3) Manufacture of actuation New Jersey sq. ft. on and control systems 26.7 acres (Aerospace & Marine segment).\nBrampton, 87,000 Owned Shot-peening and peen-forming Ontario, sq. ft. on operations (Aerospace & Canada 8 acres Marine segment).\nEast 195,000 Owned(4) Manufacture of valves Farmingdale, sq. ft. on (Aerospace & Marine New York 11 acres and Industrial segment.)\nShelby, 56,000 Owned(5) Manufacture and overhaul of North Carolina sq. ft on actuation and control systems 29 acres. (Aerospace & Marine segment).\nColumbus, 75,000 Owned Heat-treating (Industrial Ohio sq. ft. on segment). 9 acres\nDeeside, 81,000 Owned Shot-peening and peen-forming Wales sq. ft. on (Aerospace & Marine segment). United Kingdom 2.2 acres\n(1) Sizes are approximate. Unless otherwise indicated, all properties are owned in fee, are not subject to any major encumbrance and are occupied primarily by factory and\/or warehouse buildings.\n(2) Approximately 2,302,000 square feet are leased to others and approximately another 20,000 square feet are vacant and available for lease.\n(3) Approximately 247,000 square feet are leased to other parties.\n(4) Title to approximately six acres of land and the building located thereon is held by the Suffolk County Industrial Development Agency in connection with the issuance of an industrial revenue bond.\n(5) The Corporation's facility in Shelby, North Carolina is being expanded in 1996 because of new contract awards and increases in commercial overhaul activities.\nIn addition to the properties listed above, MIC (Aerospace & Marine and Industrial segments) leases an aggregate of approximately 365,000 square feet of space at nineteen different locations in the United States and England and owns buildings encompassing about 286,000 square feet in thirteen different locations in the United States, France, Germany, and England. Curtiss-Wright Flight Systems\/Shelby, Inc. leases a 25,000 square foot building in Lattimore, North Carolina for warehouse purposes. Curtiss-Wright Flight Systems Europe A\/S, an 80% owned subsidiary, leases 28,000 square feet of space in Karup, Denmark. The Corporation leases approximately 14,000 square feet of office space in Lyndhurst, New Jersey, for its corporate office. It is the Corporation's opinion that the buildings on the properties referred to in this Item generally are well maintained, in good condition, and are suitable and adequate for the uses presently being made of them by the Corporation. No examination of titles to properties owned by the Corporation has been made for the purposes of this Form 10-K Report. The following undeveloped tracts, owned by the Registrant, are not attrib- utable to a particular industry segment and are being held for sale: Hardwick Township, New Jersey, 678 acres; Fairfield, New Jersey, 12.3 acres subdivided from the Fairfield facility's property; Perico Island, Florida, 158 acres, the bulk of which is below water; and Nantucket, Massachusetts, 33 acres. In 1995 4.8 acres in South Hackensack, New Jersey were sold to the property's Lessee and a 44,000 square foot building in Ontario, Canada formerly used by Curtiss-Wright of Canada, Inc. and a 32,000 square foot building in Wyandanch, New York, formerly used by MIC were also sold. In addition, 33 acres of vacant land in Washington Township, New Jersey were sold in January 1996. The Registrant owns approximately 7.4 acres of land in Lyndhurst, New Jersey which is leased, on a long-term basis, to the owner of the commercial building located on the land.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn October 1989 a joint and several liability claim in an unspecified amount was brought by the State of New Jersey Department of Environmental Protection (\"DEP\") against the Registrant and a dozen or more other corpor- ations under the Comprehensive Environmental Response, Compensation and Liability Act for reimbursement of costs incurred by the State in response to the release of hazardous substances at Sharkey Landfill site in Parsippany, New Jersey, for a future declaratory judgment in favor of the State with respect to all future such costs and for penalties and costs of enforcement, including attorney fees. The case was subsequently consolidated for all purposes with U.S. v. CMDG Realty Co., et al., a parallel action by the U.S. Environmental Protection Agency (\"EPA\") in which the Registrant was not a defendant. Both cases are pending in the U.S. District Court for the District of New Jersey. Site remediation is proceeding pursuant to the terms of a consent decree with the DEP and EPA which was filed with the court in December 1994. A third-party complaint in both cases which had been filed against approximately thirty industrial concerns, forty governmental instrumentalities and forty trans- porters, alleging that each of them is liable in some measure for the costs related to the site, is in the discovery phase.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Registrant.\nThe following table sets forth the names, ages, and principal occupations and employment of all executive officers of Registrant. The period of service is for at least the past five years and such occupations and employment are with Curtiss-Wright Corporation, except as otherwise indicated:\nName Principal Occupation and Employment Age - - ------------------ ------------------------------------------------------ ---- David Lasky Chairman (since May 1995) and President (since May 63 1993); previously Senior Vice President, General Counsel and Secretary\nRobert E. Mutch Executive Vice President; President (since July 51 1991), Vice President and General Manager (since 1987) of Curtiss-Wright Flight Systems, Inc., a wholly-owned subsidiary.\nGerald Nachman Executive Vice President; President of Metal 66 Improvement Company, Inc., a wholly-owned subsidiary.\nGeorge J. Yohrling Vice President; Senior Vice President (since July 55 1991); Vice President and General Manager of Curtiss- Wright Flight Systems\/Shelby, Inc., a wholly-owned subsidiary, (since 1985).\nRobert A. Bosi Vice President-Finance (since January 1993); 40 Treasurer, 1989-1993.\nDana M. Taylor, Jr. Secretary, General Counsel (since May 1993); 63 Assistant General Counsel (July 1992 to May 1993); Senior Attorney (February 1979 - July 1992).\nGary J. Benschip Treasurer (since January 1993); Assistant Treasurer, 48 1991 to January 1993; 1989-1991 Financial Consultant.\nKenneth P. Slezak Controller (since July, 1990); Corporate Director, 44 Operational Analysis, March - July, 1990.\nThe executive officers of the Registrant are elected annually by the Board of Directors at its organization meeting in April and hold office until the organization meeting in the next subsequent year and until their respective successors are chosen and qualified. There are no family relationships among these officers, or between any of them and any director of Curtiss-Wright Corporation, nor any arrangements or understandings between any officer and any other person pursuant to which the officer was elected.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.\nSee the information contained in the Registrant's Annual Report on page 33 under the captions \"Common Stock Price Range,\" \"Dividends,\" and \"Stock Exchange Listing\" which information is incorporated herein by reference. The approx- imate number of record holders of the Common Stock, $1.00 par value, of Registrant was 6,000 as of March 14, 1996.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSee the information contained in the Registrant's Annual Report on page 32 under the caption \"Consolidated Selected Financial Data,\" which information is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of\nFinancial Condition and Results of Operations. See the information contained in the Registrant's Annual Report at pages 13 through 16, under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe following Consolidated Financial Statements of the Registrant and its subsidiaries, and supplementary financial information, are included in the Registrant's Annual Report, which information is incorporated herein by reference.\nConsolidated Statements of Earnings for the years ended December 31, 1995, 1994 and 1993, page 18.\nConsolidated Balance Sheets at December 31, 1995 and 1994, page 19.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993, page 20.\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993, page 21.\nNotes to Consolidated Financial Statements, pages 22 through 31, inclusive, and Quarterly Results of Operations on page 32.\nReport of Independent Accountants for the three years ended December 31, 1995, 1994 and 1993, page 17.\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. Information required in connection with directors and executive officers is set forth under the title \"Executive Officers of the Registrant,\" in Part I hereof, at pages 12 and 13, and under the caption \"Election of Directors,\" in the Registrant's Proxy Statement, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation. Information required by this Item is included under the captions \"Executive Compensation\" and in the \"Summary Compensation Table\" in the Registrant's Proxy Statement, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. See the following portions of the Registrant's Proxy Statement, all of which information is incorporated herein by reference: (i) the material under the caption \"Security Ownership and Transactions with Certain Beneficial Owners\" and (ii) material included under the caption \"Election of Directors.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. Information required by this Item is included under the captions \"Executive Compensation\" and \"Security Ownership and Transactions with Certain Beneficial Owners\" in the Registrant's 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) Financial Statements: The following Consolidated Financial Statements of the Registrant and supplementary financial information, included in Registrant's Annual Report, are incorporated herein by reference in Item 8:\n(i) Consolidated Statements of Earnings for the years ended December 31, 1995, 1994 and 1993.\n(ii) Consolidated Balance Sheets at December 31, 1995 and 1994.\n(iii) Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\n(iv) Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\n(v) Notes to Consolidated Financial Statements.\n(vi) Report of Independent Accountants for the years ended December 31, 1995, 1994 and 1993.\n(a)(2) Financial Statement Schedules: The items listed below are presented herein on pages 20 through 21.\nThe Report of Independent Accountants on Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts\nSchedules other than those listed above have been omitted since they are not required, are not applicable, or because the required information is included in the financial statements or notes thereto.\n(a)(3) Exhibits:\n(3)(i) Restated Certificate of Incorporation, as amended May 8, 1987 (incorporated by reference to Exhibit 3(a) to Registrant's Form 10-Q Report for the quarter ended June 30, 1987).\n(3)(ii) By-Laws as amended May 9, 1989 (incorporated by reference to Exhibit 3(b) to Amendment No. 1 to Registrant's Form 10-Q Report for the quarter ended March 31, 1989) and Amendment dated May 11, 1993 (incorporated by reference to Exhibit 3(ii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993).\n(4)(i) Agreement to furnish to the Commission upon request, a copy of any long term debt instrument where the amount of the securities authorized thereunder does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis (incorporated by reference to Exhibit 4 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1985).\n(4)(ii) Revolving Credit Agreement dated October 29, 1991 between Registrant, the Lenders parties thereto from time to time, the Issuing Banks referred to therein and Mellon Bank, N.A. Article I Definitions, Section 1.01 Certain Definitions; Article VII Negative Covenants, Section 7.07, Limitation on Dividends and Stock Acquisitions (incorporated by reference to Exhibit 10(b), to Registrant's Form 10-Q Report for the quarter ended September 30, 1991). Amendment No. 1 dated January 7, 1992 and Amendment No. 2 dated October 1, 1992 to said Agreement (incorporated by reference to Exhibit 4(ii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993). Third Amendment to Credit Agreement dated as of October 29, 1994 (incorporated by reference to Exhibit (4)(ii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994).\n(4)(iii) Short-Term Credit Agreement dated as of October 29, 1994 among Curtiss-Wright Corporation, as Borrower, the Lenders Parties and Mellon Bank, N.A., as Agent (incorporated by reference to Exhibit (4)(iii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994).\n(10) Material Contracts: (i) Modified Incentive Compensation Plan, as amended November 9, 1989 (incorporated by reference to Exhibit 10(a) to Registrant's Form 10-Q Report for the quarter ended September 30, 1989).\n(ii) Curtiss-Wright Corporation 1995 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.1 to Registrant's Form S-8 Registration Statement No. 95602114 filed December 15, 1995).\n(iii) Standard Severance Agreement with Officers of Curtiss-Wright (incorporated by reference to Exhibit 10(iv) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991).\n(iv) Retirement Benefits Restoration Plan as amended May 9, 1989 (incorporated by reference to Exhibit 10(b) to Registrant's Form 10-Q Report for the quarter ended September 30, 1989).\n(v) Curtiss-Wright Corporation Retirement Plan dated September 1, 1994 (incorporated by reference to Exhibit (10)(vi) to Registrant's Annual Report on Form10-K for the year ended December 31, 1994).\n(vi) Curtiss-Wright Corporation Savings and Investment Plan dated March 1, 1995 (incorporated by reference to Exhibit (10)(vii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994).\n(13) Annual Report to Stockholders for the year ended December 31, 1995.\n(21) Subsidiaries of the Registrant.\n(23) Consents of Experts & Counsel -see Consent of Independent Acountants.\n(27) Financial Data Schedule.\n(b) Reports on Form 8-K\nNo report on Form 8-K was 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.\nCURTISS-WRIGHT CORPORATION (Registrant)\nBy: \/s\/ David Lasky David Lasky Chairman and President Date: March 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 dates indicated.\nDate: March 18, 1996 By: \/s\/ Robert A. Bosi Robert A. Bosi Vice President - Finance\nDate: March 18, 1996 By: \/s\/ Kenneth P. Slezak Kenneth P. Slezak Controller\nDate: March 12, 1996 By: \/s\/ Thomas R. Berner Thomas R. Berner Director\nDate: March 11, 1996 By: \/s\/ John S. Bull John S. Bull Director\nDate: March 12, 1996 By: \/s\/ James B. Busey IV James B. Busey IV Director\nDate: March 21, 1996 By: \/s\/ David Lasky David Lasky Director\nDate: March 12, 1996 By: \/s\/ John R. Myers John R. Myers Director\nDate: March 12, 1996 By: \/s\/ William W. Sihler William W. Sihler Director\nDate: March 11, 1996 By: \/s\/ J. McLain Stewart J. McLain Stewart Director\nREPORT OF INDEPENDENT ACCOUNTS ON FINANCIAL STATEMENT SCHEDULE\nOur audits of the consolidated financial statements referred to in our report dated January 31, 1996 appearing on page 17 of the Curtiss-Wright Corporation 1995 Annual Report (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, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ Price Waterhouse LLP PRICE WATERHOUSE LLP Morristown, New Jersey January 31, 1996\nCURTISS-WRIGHT CORPORATION and SUBSIDIARIES SCHEDULE II - VALUATION and QUALIFYING ACCOUNTS for the years ended December 31, 1995, 1994 and 1993 (In thousands)\n---- Additions ---- Charged Charged Balance at to to Other Bal at Beginning Costs & Accts - Deduct'ns End of Description of Period Expenses Describe Describe Period - - ---------------------------- ------- ------- ---------- ------------ ------- Deducted from assets to which they apply: Reserves for doubtful accts & notes:\nYear-ended December 31, 1995 $ 694 $ 93 $ 27 $ 760 Year-ended December 31, 1994 $ 893 $ 32 $ 231(C) $ 694 Year-ended December 31, 1993 $1,031 $ 16 $ 154(C) $ 893\nDeferred tax asset valuation allowance: Year-ended December 31, 1995 $5,460 $ 52 $(3,058)(B) $ 1,360(D) $1,094 Year-ended December 31, 1994 $5,861 $ 193 $ 594(D) $5,460 Year-ended December 31, 1993 $ - $5,861(A) $ - $5,861\nNotes: (A) Includes a deferred tax benefit of an additional capital-loss carry- forward identified in the fourth quarter of 1993. (B) Expiration of available capital-loss carryforwards. (C) Write off of bad debts. (D) Utilization of tax benefits under capital-loss carryforward.\nEXHIBIT INDEX\nThe following is an index of the exhibits included in this report or incorporated herein by reference.\nExhibit No. Name Page\n(3)(i) Restated Certificate of Incorporation, as amended May 8, 1987 * (incorporated by reference to Exhibit 3(a) to Registrant's Form 10-Q Report for the quarter ended June 30, 1987).\n(3)(ii) By-Laws as amended May 9, 1989 (incorporated by reference to * Exhibit 3(b) to Amendment No. 1 to Registrant's Form 10-Q Report for the quarter ended March 31, 1989) and Amendment dated May 11, 1993 (incorporated by reference to Exhibit 3(ii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993).\n(4)(i) Agreement to furnish to the Commission upon request, a copy of * any long term debt instrument where the amount of the securities authorized thereunder does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis (incorporated by reference to Exhibit 4 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1985).\n(4)(ii) Revolving Credit Agreement dated October 29, 1991 between * Registrant, the Lenders parties thereto from time to time, the Issuing Banks referred to therein and Mellon Bank, N.A. Article I Definitions, Section 1.01 Certain Definitions; Article VII Negative Covenants, Section 7.07, Limitation on Dividends and Stock Acquisitions (incorporated by reference to Exhibit 10(b), to Registrant's Form 10-Q Report for the quarter ended September 30, 1991). Amendment No. 1 dated January 7, 1992 and Amendment No. 2 dated October 1, 1992 to said Agreement (incorporated by reference to Exhibit 4(ii) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993).\nThird Amendment to Credit Agreement dated as of October 29, * 1994 (incorporated by reference to Exhibit (4)(ii) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n(4)(iii) Short-Term Credit Agreement dated as of October 29, 1994 * among Curtiss-Wright Corporation, as Borrower, the Lenders parties and Mellon Bank, N.A. (incorporated by reference to Exhibit (4)(iii) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n(10)(i)** Modified Incentive Compensation Plan, as amended November 9, * 1989 (incorporated by reference to Exhibit 10(a) to Registrant's Form 10-Q Report for the quarter ended September 30, 1989).\n(10)(ii)** Curtiss-Wright Corporation 1995 Long-Term Incentive Plan * (incorporated by reference to Exhibit 4.1 to Registrant's Form S-8 Registration Statement No. 95602114 filed December 15, 1995).\n(10)(iii)** Standard Severance Agreement with Officers of Curtiss-Wright * (incorporated by reference to Exhibit 10(iv) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991).\n(10)(iv)** Retirement Benefits Restoration Plan as amended May 9, 1989, * (incorporated by reference to Exhibit 10(b) to Registrant's Form 10-Q Report for the quarter ended September 30, 1989).\n(10)(v)** Curtiss-Wright Corporation Retirement Plan dated September * 1, 1994 (incorporated by reference to Exhibit (10)(vi) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n(10)(vi)** Amended Curtiss-Wright Corporation Savings and Investment * Plan dated March 1, 1995 (incorporated by reference to Exhibit (10)(vii) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n(13) Annual Report to Stockholders for the year ended December 31, 1995\n(21) Subsidiaries of the Registrant\n(23) Consents of Experts and Counsel - see Consent of Independent Accountants\n(27) Financial Data Schedule ________________________\n* Incorporated by reference as noted. ** Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"59229_1995.txt","cik":"59229","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL The Registrant, The Liberty Corporation (\"Liberty\" or \"the Company\") is a holding company engaged through its subsidiaries primarily in the life insurance and television broadcasting businesses.\nThe Company's primary insurance subsidiaries are Liberty Life Insurance Company (\"Liberty Life\") and Pierce National Life Insurance Company (\"Pierce National\"). During 1995, the insurance operations owned by North American National Corporation (\"North American\") an insurance holding company acquired by Liberty in 1994, were merged into Pierce National. The insurance subsidiaries of North American consisted of Pan Western Life Insurance Company (\"Pan Western\"), Brookings International Life Insurance Company (\"Brookings\"), and Howard Life Insurance Company (\"Howard\"). In November 1995, American Funeral Assurance Company (\"American Funeral\"), acquired in 1994, was merged into Pierce National. Together, the insurance subsidiaries offer a diverse portfolio of individual life and health insurance products. In addition to Liberty Life and Pierce National, Liberty Insurance Services Corporation (\"Liberty Insurance Services\") provides home office support services for unaffiliated life and health insurance companies, as well as for some of the Company's insurance operations. Other subsidiaries of the Company provide investment advisory services to the Company's insurance subsidiaries and unaffiliated insurance companies, and property development and management services to the Company.\nThe Company's television broadcasting subsidiary, Cosmos Broadcasting Corporation (\"Cosmos\"), currently owns and operates eight network affiliated television stations, with the most recent acquisition, WLOX-TV in Biloxi, Mississippi, being acquired in February 1995.\nSTRATEGY; RECENT DEVELOPMENTS\nThe Company's principal strategy is to grow internally and through selective acquisitions, while maintaining its emphasis on cost controls. The Company's operations are generally focused in niche markets where Liberty believes it has the products and expertise to serve the market better than its competitors.\nLiberty will continue to seek opportunities to acquire insurance companies and blocks of business that complement or fit with the Company's existing marketing divisions and product lines. The Company's acquisition strategy has focused on both home service and pre-need businesses. Home service business represents the Company's primary core business, whereas the pre-need business is a relatively new line of business for the Company. The Company largely entered the pre-need business with the acquisition of Pierce National in July 1992. The 1994 pre-need acquisitions significantly strengthened the Company's market position in the pre-need market, which provides life insurance products to pre-fund funeral services. The Company believes that the pre-need business has favorable demographics which can provide attractive future premium and earnings growth. During 1995, the Company completed the consolidation of all of the recently acquired pre-need companies into Pierce National. In conjunction with the consolidation, the Company introduced what it believes to be the most comprehensive pre-need product portfolio in the industry. The product portfolio is marketed under the brand name FamilySide.\nManagement's philosophy regarding broadcasting acquisitions is to make selective acquisitions in local markets where it can be among the dominant television stations.\nThe following page summarizes the Company's acquisitions since 1992.\n(1) Represents amount of annualized premiums acquired at the time of acquisition. (2) Represents amount of annual premiums reported by the selling company in its 1992 annual financial statements filed under applicable statutory requirements. (3) Represents amount of annual premiums reported by the selling company in its 1993 annual financial statements filed under applicable statutory requirements.\nBROADCASTING ACQUISITION\nOn February 28, 1995, the Company completed the acquisition of WLOX-TV in Biloxi, Mississippi, bringing to eight the total number of television stations in Cosmos. The purchase price of $40.1 million was funded with a combination of redeemable preferred stock, cash and a note payable. WLOX is an ABC affiliate that carries strong local news and is the top station in its market.\nINSURANCE OPERATIONS\nLIBERTY LIFE. Liberty Life is a stock life insurance company engaged in the business of writing a broad range of individual life insurance policies and accident and health insurance policies. Liberty Life is ranked 131st, based on ordinary life insurance in force among approximately 1,200 United States life insurance companies, according to data provided by A.M. Best Company. While Liberty Life is licensed in forty-nine states, and the District of Columbia, its focus has been the Southeast. For 1995, the largest percentages of its premium income were from South Carolina (28%), North Carolina (21%), Louisiana (7%) and Georgia (4%). The Company believes that Liberty Life is the largest provider of home service business in the Carolinas.\nLife insurance and annuity premiums contributed 84% of Liberty Life's total premiums in 1995, 83% in 1994 and 79% in 1993. Accident and health insurance premiums contributed the remainder.\nIn 1994, the Company decided to cease sales of its products through its general agency distribution system due to the absence of critical volume. Premiums and policy charges from the general agency division represented approximately 2% of the Company's total premiums and policy charges when the decision to cease sales in this division was made.\nLiberty Life continues to market its insurance products through its Home Service and Mortgage Protection divisions. At December 31, 1995, Liberty Life had approximately 500 employees in its home office in Greenville.\nHOME SERVICE DIVISION. The Home Service Division is Liberty Life's largest division, contributing 69% of Liberty Life's premiums in 1995. Home Service agents of Liberty Life sell primarily individual life, including universal life and interest-sensitive whole life products, as well as health insurance. As of December 1995, the Company had approximately 1,300 agents, managers and support staff in this division operating out of 50 district offices. These agents periodically visit the insureds' homes and businesses to collect premiums. Although the Company has broadened this division's area of concentration beyond the Carolinas, principally through strategic acquisitions, the Company has maintained a regional focus for its home service business on the Southeast.\nMORTGAGE PROTECTION DIVISION. The Mortgage Protection Division contributed 26% of Liberty Life's premiums in 1995. The Mortgage Protection Division sells decreasing term life insurance designed to extinguish the unpaid portion of a residential mortgage upon the death of the insured. This division also sells accidental death, disability income and credit life insurance. A staff of full-time representatives and independent brokers offer these products through more than 1,000 financial institutions located throughout the United States. The Company supports the marketing of these products through direct mail and phone solicitations.\nPIERCE NATIONAL. Pierce National provides life insurance products which pre-fund funeral services, referred to as pre-need policies. Pierce National, a stock life insurance company acquired in July 1992, is domiciled in California, but its principal executive and administrative offices are in Greenville, South Carolina. Pre-need policies consist primarily of ordinary life insurance policies for which the premiums are paid in a single payment at the outset or primarily over a three, five or ten-year period. In April 1993, Pierce National acquired through coinsurance all of the ordinary life insurance, representing pre-need life insurance, of Estate Assurance Company, effective as of January 1, 1993. In 1994, Liberty acquired North American National Corporation, an insurance holding company, and American Funeral. As previously mentioned, the insurance subsidiaries of North American and American Funeral were merged into Pierce National during 1995.\nPierce National is currently licensed in forty-one states, the District of Columbia, and ten Canadian provinces. The current plan is to seek licensure in the majority of the remaining states and the province of Quebec. The largest percentages of premium income for 1995 came from Canada (14%), Mississippi (10%) and California (8%).\nAt December 31, 1995, the Pierce National employed approximately 30 people in its home office in Greenville who perform marketing, administrative and clerical duties. Policy administration for Pierce National is carried out by Liberty Insurance Services who employs approximately 85 people in this area.\nPREMIUM BREAKDOWN. The following table sets forth the insurance premiums and policy charges for Liberty Life's marketing and distribution divisions and Pierce National for the years ended December 31.\nUNDERWRITING PRACTICES. Liberty Life's underwriting practices for ordinary life insurance require medical examinations for applicants over age 60 or for policies in excess of certain prescribed face amounts. In accordance with the general practice in the life insurance industry, Liberty Life writes life insurance on substandard risks at increased premium rates. Generally, home service life insurance for non-universal life products is written for amounts under $5,000 and typically no medical examination is required. Mortgage protection life insurance is usually written without medical examination. Substantially all pre-need policies are written for amounts under $5,000, and no medical examination is required unless the applicant requests a preferred rate.\nREINSURANCE. The Company's insurance subsidiaries use reinsurance in two distinct ways: first, as a risk management tool in the normal course of business and second, in isolated strategic transactions to effectively buy or sell blocks of in force business. The Company has ceded $4.6 billion (21%) of its $21.4 billion insurance in force to other companies; however, the Company's insurance subsidiaries remain liable with respect to reinsurance ceded should any reinsurer be unable to meet the obligations it has or will assume.\nFor the years ended December 31, 1995, 1994 and 1993, Liberty had ceded life insurance premiums of $27.8 million, $26.4 million, and $26.1 million, respectively. Accident and health premiums ceded made up the remainder of ceded premiums which were $6.9 million, $3.7 million, and $3.5 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nRISK MANAGEMENT REINSURANCE TRANSACTIONS. Liberty Life reinsures with other insurance companies portions of the life insurance it writes in order to limit its exposure on large or substandard risks. The maximum amount of life insurance that Liberty Life will retain on any life is $300,000, plus an additional $50,000 in the event of accidental death. This maximum is reduced for higher ages and for special classes of risks. The maximum amount of life insurance Pierce National will retain on any life is $50,000. Insurance in excess of the retention limit is either automatically ceded under reinsurance agreements or is reinsured on an individually agreed basis with other insurance companies. Liberty Life has ceded a significant portion of its risks on accidental death and disability coverage to other insurance companies. Liberty Life and Pierce National also have coverage for catastrophic accidents. At December 31, 1995, Liberty Life and Pierce National had ceded, in the normal course of business, portions of their risks to a number of other insurance companies.\nSTRATEGIC REINSURANCE TRANSACTIONS. In 1991, 80% or $3.2 billion face amount of Liberty Life's General Agency Marketing Division net insurance in force was coinsured with Life Reassurance Corporation (\"Life Re\"). The original agreement with Life Re provided for the coinsurance of 50% of this division's insurance in force issued after 1991. Effective July 1, 1995, the amount coinsured on policies written after December 31, 1991, was increased to 80%. The\ntotal face value of amounts ceded to Life Re at December 31, 1995 was $2.9 billion. Under terms of the agreement, assets supporting the business ceded are required to be held in escrow.\nIn order to facilitate the 1991 acquisition through reinsurance of a block of business from Kentucky Central Life Insurance Company, Liberty Life coinsured 50% of its home service traditional life insurance business with Lincoln National Life Reinsurance Company. The Lincoln National reinsurance has been accounted for under generally accepted accounting principles as financial reinsurance. The reinsurance contract contains an escrow agreement that requires assets equal to the reserves reinsured, as determined under statutory accounting principles, be held in escrow for the benefit of this block of business.\nThe Company uses assumption reinsurance to effectively acquire blocks of in force business by acting as the \"reinsurer\" for other insurance companies. For instance, the Company acquired the Kentucky Central and Estate Assurance blocks in this manner.\nOPERATIONS. The administrative functions of underwriting and issuing new policies, and the ongoing servicing and claims settlement of in force policies, are centralized at the home office in Greenville, South Carolina. In acquiring additional blocks of insurance business, the Company's strategy is to integrate the administrative functions into its existing operations, either directly or through Liberty Insurance Services, as soon as practical after the effective date of the acquisition. The Company believes that this centralization permits economies of scale and promotes greater cost efficiencies.\nThe Company's insurance operation services approximately 3.0 million policies representing $21.4 billion of life insurance in force, of which $4.6 billion of insurance in force has been ceded to other companies. Approximately 200,000 policies representing $3.0 billion of life insurance in force were issued during 1995. The Company intends to continue its focus on reducing the unit costs of administrative services by increasing the volume of business through acquisitions of blocks of business similar in nature to its existing business, by internal growth in those businesses, and by investing in up-to-date technology to further improve efficiency in its operations.\nLIBERTY INSURANCE SERVICES. Liberty Insurance Services provides a wide range of home office support services to unaffiliated life and health insurance companies on a fee basis, as well as to the Company's insurance subsidiaries. These services include underwriting, preparation of policies, accounting, customer service and claims processing and adjudication and can be tailored to support the special features of insurance products offered by other companies that desire these services. The Company's strategy is to target (i) insurance companies that have closed blocks of business that are expensive to administer, (ii) insurance companies that have start-up or new product lines requiring new support levels, (iii) small to midsize insurance companies that cannot justify large investments in home office technology, and (iv) insurance companies acquired by financial investors lacking experience in providing home office support. Liberty Insurance Services believes that its economies of scale will permit its customers to reduce their home office support costs and focus resources on marketing their insurance products.\nBeginning in 1996, the operations of Liberty Insurance Services are expected to be combined in a joint venture with Continuum Administrative Services Company, the third party administrative arm of The Continuum Company. The joint venture, operating under the name of ALLIANCE-ONE Services, LP, will be the largest third party administrator of life insurance business in the United States. Liberty will have a 40% ownership interest in the joint venture.\nINSURANCE COMPETITION AND RATINGS The Company's insurance subsidiaries compete with numerous United States and Canadian insurance companies, some of which have greater financial resources, broader product lines and larger staffs. In addition, banks and savings and loan associations in some jurisdictions compete with the Company's insurance subsidiaries for sales of life insurance products, and the insurance subsidiaries compete with banks, investment advisors, mutual funds and other financial entities to attract investment funds generally.\nCompetition in the home service business is largely regional or local, highly dependent on the quality of the local management, and is less price competitive than other insurance markets. The home service business involves frequent contacts by agents with their customers. Liberty emphasizes to its agents the importance of taking advantage of these contacts to establish personal relationships which the Company believes add stability to its home service business.\nThe Company believes that competition in the pre-need market is national and, therefore, has expanded the market of its pre-need business. The Company intends to capitalize on its affinity marketing expertise gained in the mortgage protection insurance business by targeting national chains of funeral homes and by supplementing this effort with direct marketing and telemarketing campaigns.\nThe Company currently believes that it ranks third nationally in mortgage protection insurance with an estimated 13% market share. Slightly over 85% of the mortgage protection market share is believed to be held by four companies and 40% of the market is held by the market leader.\nVarious independent companies issue ratings assessing the ability of insurance companies to meet their policyholder and other contractual obligations, as well as assessing the overall financial performance and strength of companies. The most widely used ratings are those prepared and published by A.M. Best Company, Inc. Ratings by A.M. Best range from \"A++\" (Superior) to \"F\" (In Liquidation). In the Best's Rating Monitor published March, 11, 1996, Liberty Life was rated \"A\" (Excellent) and Pierce National was rated \"B++\" (Very Good). Liberty Life also has a current claims-paying rating of \"AA\" (Very High) by Duff & Phelps Credit Rating Co. The rating agencies base their ratings on information provided by the insurer and their own analysis, studies and assumptions. The ratings apply only to the specific company rated and do not extend to The Liberty Corporation as a whole, nor are the ratings a recommendation to buy, sell or hold securities. The agencies can change or withdraw their published ratings at any time the agency deems circumstances warrant a change. Should Liberty Life's or Pierce National's rating be downgraded, sales of their products and persistency of the existing in-force business could be adversely affected. Insurance company ratings are generally considered to be more important in the annuity and general agency markets, neither of which are major markets for Liberty Life or Pierce National.\nINSURANCE REGULATION. Like other insurance companies, the Company's insurance subsidiaries are subject to regulation and supervision by the state or other insurance department of each jurisdiction in which they are licensed to do business. These supervisory agencies have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of agents, the approval of policy forms, reserve requirements and the form and content of required statutory basis financial statements. As to its investments, each of the Company's insurance subsidiaries must meet the standards and tests established by the National Association of Insurance Commissioners (the \"NAIC\") and, in particular, the investment laws and regulations of the states in which each subsidiary is domiciled. All states and jurisdictions (including the Canadian provinces where Pierce National is also licensed) have their own statutes and regulations, which vary in certain respects. However, the NAIC Model Act and regulations have tended to make the various states' regulation more uniform. The insurance companies are also subject to laws in most states that require solvent life insurance companies to pay guaranty fund assessments to protect the interests of policyholders of insolvent life insurance companies.\nThe NAIC and state regulatory authorities require the Asset Valuation Reserve or \"AVR\" and the Interest Maintenance Reserve or \"IMR\" to be established as a liability on a life insurer's statutory financial statements, but do not affect financial statements of the Company prepared in accordance with generally accepted accounting principles. AVR establishes a statutory reserve for mortgage loans, equity real estate and joint ventures, as well as for fixed maturities and common and preferred stock. AVR generally captures all realized and unrealized gains and losses on such assets, other than those resulting from changes in interest rates. IMR captures the net gains or losses that are realized upon the sale of fixed income securities (bonds, preferred stocks, mortgage-backed securities and mortgage loans) and that result from changes in the overall level of interest rates, and amortizes these net realized gains or losses into income over the remaining life of each investment sold, thus limiting the ability of an insurer to enhance statutory surplus by taking gains on fixed income securities. The IMR and AVR requirements have not had a material impact on the Company's insurance subsidiaries' surplus nor Liberty Life's ability to pay dividends to the parent company.\nIn recent years the NAIC has approved and recommended to the states for adoption and implementation several regulatory initiatives designed to decrease the risk of insolvency of insurance companies in general. These initiatives include the implementation of a risk-based capital formula for determining adequate levels of capital and surplus and further restrictions on an insurance company's payment of dividends to its shareholders. To date, South Carolina has not adopted the NAIC risk-based capital model act; however, it does require prior notice to the South Carolina Commissioner of Insurance of dividend distributions to shareholders, and permits the Commissioner to disapprove or limit the dividend within 30 days of notice if the dividend or distribution is deemed an unreasonable strain on surplus.\nThe NAIC risk-based capital model act or similar initiatives may be adopted by South Carolina or the various states in which Liberty Life and the Company's other insurance subsidiaries are licensed, but the ultimate content and timing of any statutes and regulations adopted by the states cannot be determined at this time.\nUnder the NAIC's risk-based capital requirements (\"RBC\"), insurance companies must calculate and report information under a risk-based capital formula in their annual statutory financial statement. This information is intended to permit insurance regulators to identify and require remedial action for inadequately capitalized insurance companies, but is not designed to rank adequately capitalized companies. The NAIC requirements provide for four levels of potential involvement by state regulators for inadequately capitalized insurance companies, ranging from a requirement for the insurance company to submit a plan to improve its capital, to regulatory control of the insurance company. The RBC ratios for the Company's insurance subsidiaries significantly exceed the minimum capital requirements at December 31, 1995.\nAnother NAIC Model Act limits dividends that may be paid in any calendar year without regulatory approval to the lesser of (i) 10% of the insurer's statutory surplus at the prior year-end, or (ii) the statutory net gain from operations of the insurer (excluding realized capital gains and losses) for the prior calendar year. The current South Carolina statutes applicable to Liberty Life do not conform to the NAIC Model Act (South Carolina limits dividends to the greater of 10% of statutory surplus or gain from operations). Under current South Carolina law, without prior approval from the South Carolina Commissioner of Insurance, dividend payments from Liberty Life to the Company are limited to the greater of the prior year's statutory gain from operations or 10% of the prior year's statutory surplus. The maximum allowable dividend that can be paid in 1996 without approval from the South Carolina Insurance Commissioner is $24.8 million. Actual dividends and distributions paid by Liberty Life were $20.0 million in 1995, $20.3 million in 1994, and $22.0 million in 1993. Under regulations effective July 1, 1995, the South Carolina Insurance Department must be notified of all dividends and distributions to shareholders within five days following the declaration, and at least ten days prior to the payment of the dividend or distribution, and will have the authority to limit the amount of any dividends or distributions. Extraordinary dividends, defined as distributions that, together with all other distributions within a 12 month period, exceed the greater of the net gain from operations or 10% of statutory surplus, cannot be made without the approval of the South Carolina Insurance Department, unless the department has not disapproved the payment within 30 days following the notice of the declaration. The current California statutes applicable to Pierce National limit dividend payments to the Company to the greater of 10% of statutory surplus or the prior year's net gain from operations (excluding realized capital gains and losses). The maximum allowable dividend that Pierce National can pay during 1996 will be $5.1 million; however, the Company does not currently plan to seek dividends from Pierce National during 1996. During 1995, Pierce National paid $2.6 million in dividends to Liberty.\nIn accordance with the rules and practices of the NAIC and in accordance with state law, every insurance company is generally examined once every three years by examiners from its state of domicile and from several of the other states where it is licensed to do business. Examinations of Liberty Life and Pierce National for the periods ended December 31, 1994 have been completed and the reports issued did not indicate any significant areas of concern.\nThe Office of the Superintendent of Financial Institutions -- Canada, and the Canadian provinces regulate and supervise the Canadian operations of Pierce National in the same manner as the NAIC and the states. Separate financial statements are required to meet the Canadian regulatory requirements and a separate examination is conducted by the Canadian regulatory agencies.\nThe Company's insurance subsidiaries are also subject to regulation as an insurance holding company system under statutes which have been enacted in their states of domicile and other states in which they are licensed to do business. Pursuant to these statutes, Liberty Life and Pierce National are required to file an annual registration statement with the Office of the Commissioner of Insurance and to report all material changes or transactions. In addition, these statutes restrict the ability of any person to acquire control (generally presumed at 10% or more) of the outstanding voting securities of the Company without prior regulatory approval.\nBROADCASTING OPERATIONS\nCosmos currently owns and operates the following television stations, seven of which were ranked No. 1 in their market by the November 1995 Nielsen ratings.\nCosmos has approximately 800 full-time employees and 110 part-time employees, including its cable sales operations in Columbia, SC, Florence, SC, Sumter, SC and Frankfort, KY.\nNETWORK AFFILIATES. Each Cosmos station is affiliated with one of the major networks - NBC, ABC, CBS. The affiliation contracts provide that the network will offer to the affiliated station a variety of network programs, both sponsored and unsponsored, for which the station has the right of first refusal against any other television station located in its community. The station has the right to reject or accept the programs offered by the network and also has the right to broadcast programs either produced by the station or acquired from other sources. The major networks provide their affiliated stations with programming and sell the programs, or commercial time during the programs, to national advertisers. Each affiliate is compensated by its network for carrying the network's programs. That compensation is based on the local market rating strength of the affiliate and the audience it helps bring to the network programs. The major networks typically provide programming for approximately 90 hours of the approximately 135 hours per week broadcast by their affiliated stations.\nThe NBC affiliation contracts with each of Cosmos' NBC affiliated stations have been continuously in effect for over thirty-nine years. Cosmos' CBS and ABC affiliation contracts have each been continuously in effect for approximately thirty years.\nSOURCES OF COSMOS' TELEVISION OPERATING REVENUES. The following table shows the approximate percentage of Cosmos' gross television operating revenues by source excluding other income for the three years ended December 31, 1995:\nLocal and regional advertising is sold by each station's own sales representatives to local and other non-national advertisers or agencies. Generally these contracts are short-term, although occasionally longer-term packages will be sold. National spot advertising (generally a series of spot announcements between programs or within the station's own programs) is sold by the station or its sales representatives directly to agencies representing national advertisers. Most of these national sales contracts are also short-term, often covering spot campaigns running for thirteen weeks or less. Network compensation is paid by the network to its affiliated stations for broadcasting network programs that include advertising sold by the network to agencies representing national advertisers. Political advertising is generated by national and local elections, which is by definition very cyclical.\nA television station's rates are primarily determined by the estimated number of television homes it can provide for an advertiser's message. The estimates of the total number of television homes in the market and of the station's share of those homes is based on the AC Nielsen industry-wide television rating service. The demographic make-up of the viewing audience is equally important to advertisers. A station's rate card for national and local advertisers takes into account, in addition to audience delivered, such variables as the length of the commercial announcements and the quantity purchased. The payments by a network to an affiliated station are largely determined by the total homes delivered, the relative preference of the station among the viewers in the market area and other factors related to management and ownership.\nTELEVISION BROADCASTING COMPETITION. The television broadcasting industry competes with other leisure time activities for the time of viewers and with all other advertising media for advertising dollars. Within its coverage area a television station competes with other stations and with other advertising media serving the same area. The outcome of the competition among stations for advertising dollars in a market depends principally on share of audience, advertising rates and the effectiveness of the sales effort.\nCosmos believes that each of its stations has a strong competitive position in its local market, enabling it to deliver a high percentage of the local television audience to local advertisers. Cosmos' commitment to local news programming, combined with syndicated programming, are important elements in maintaining Cosmos' current market positions.\nAnother source of competition is cable television, which brings additional television programming, including pay cable (HBO, Showtime, Movie Channel, etc.), into subscribers' homes in a television station's service area. Cable television competes for the station's viewing audience and, on a more modest scale, its advertising.\nFederal law now requires that cable operators negotiate with television operators for the right to carry a station's signal (programs) on cable systems. Cosmos recently used this \"retransmission consent\" negotiation to forge long-term partnerships with cable operators with the purpose of developing secondary revenue streams from programs and services specifically produced for cable. In 1994 Cosmos formed CableVantage Inc., a marketing company designed to assist local cable operators in the sale of commercial time available in cable network programs.\nSubscription Television, an over-the-air pay television service, and Multipoint Distribution Service, a microwave-distributed pay television service, also compete for television audiences. In addition, licenses are now being granted for Multichannel Multipoint Distribution Service. None of these services has yet significantly fractionalized the audiences of commercial television stations.\nTwo other television broadcast services are providing consumers with additional technical delivery\/programming opportunities. Low power television, sometimes referred to as \"neighborhood TV,\" is authorized to operate in a limited coverage area. Authorizations are being granted by the Federal Communication Commission (\"FCC\") on a lottery basis. Direct Broadcast Satellite, which transmits television signals from satellite transponders to parabolic home antennae, is now being actively marketed.\nFEDERAL REGULATION OF BROADCASTING. Cosmos' broadcasting operations are subject to the jurisdiction of the FCC under the Communications Act. The Communications Act empowers the FCC, among other things, to issue, revoke or modify broadcasting licenses; to assign frequency bands; to determine the location of stations; to regulate the apparatus used by stations; to establish areas to be served; to adopt such regulations as may be necessary to carry out the provisions of the Communications Act and to impose certain penalties for violation of such regulations. The Communications Act prohibits the transfer of a license or the transfer of control or other change in control of a licensee without prior approval of the FCC. The Hipp family is considered by the FCC to have de facto control over Cosmos, and any action that would change such control would require prior approval of the FCC.\nThe Telecommunications Act signed into law in 1996 (the \"1996 Act\") changed many existing regulations concerning, among other things, the ownership of television stations. Under previous regulations governing multiple ownership, a license to operate a television station generally would not be granted to any person (or persons under common control) if such person directly or indirectly held a significant interest in more than 12 television stations or less than 12 television stations if their audience coverage exceeded 25% of total United States households. The 1996 Act allows for unlimited ownership of stations as long as the audience coverage does not exceed 35% of total households.\nPrevious FCC regulations also limited ownership of television stations by those having interests in cable television systems and daily newspapers serving the same service area as the television stations. The 1996 Act dropped the station\/cable same market ownership prohibition. The 1996 Act also lengthened the term for which television broadcasting licenses may be granted from a maximum term of five years to a maximum term of eight years. In the absence of adverse findings by the FCC as to the licensee's qualification, licenses are usually renewed without hearing by the FCC for additional eight year terms. Cosmos' renewal applications have always been granted without hearing for the full term. The loosening of the ownership provisions, as well as the other provisions included in the 1996 Act, are not expected to have any immediate impact on the operations of Cosmos.\nThere are additional FCC Regulations and Policies, and regulations and policies of other federal agencies, principally the Federal Trade Commission, regulating network\/affiliate relations, political broadcasts, children's programming, advertising practices, equal employment opportunity, carriage of television signals by CATV systems, application and reporting procedures and other areas affecting the business and operations of television stations.\nEXECUTIVE OFFICERS\nThe following is a list of the Executive Officers of the Registrant indicating their age and certain biographical data.\nW. HAYNE HIPP, Age 56 Chairman of the Board of Liberty since May, 1995 President and Chief Executive Officer of Liberty since September, 1981 Chairman of the Board of Liberty Life from January, 1979 -- February, 1988; September, 1989 -- present Chairman of the Board of Cosmos -- May , 1989 -- February, 1992\nMARTHA G. WILLIAMS, Age 53 Vice President, General Counsel & Secretary of Liberty since January, 1982 Vice President, General Counsel & Secretary of Liberty Life since January, 1982 Secretary and Counsel of Cosmos since February, 1982\nH. RAY EANES, Age 55 Senior Vice President of Finance and Treasurer of Liberty since May, 1994 Prior to joining Liberty was Vice Chairman -- Finance and Administration of Ernst & Young LLP\nW. KENNETH HUNT, III, Age 42 President of Liberty Life Insurance Company since December, 1994 President of Pierce National Life Insurance Company from September, 1993 to December, 1994 President of Liberty Insurance Services Corporation from August, 1991 to September, 1993 Chief Financial Officer of Liberty Life Insurance Company from February, 1987 to August, 1991\nJENNIE M. JOHNSON, Age 48 President of Pierce National Life Insurance Company since August, 1995 Vice President, Administration of Liberty from February, 1994 to August, 1995 Vice President, Planning of Liberty from February, 1986 to December, 1994\nJAMES M. KEELOR, Age 53 President of Cosmos since February, 1992 Vice President, Operations, of Cosmos from December, 1989 to February, 1992\nM. PORTER B. ROSE, Age 54 President, Liberty Insurance Services, Inc. since June, 1995 President, Liberty Investment Group, Inc. since March, 1992 Chairman, Liberty Capital Advisors, Inc. since January, 1987 Chairman, Liberty Properties Group, Inc. since January, 1987\nJOHN P. SMITH, Age 43 Controller of Liberty since September, 1994 Previously Vice President\/Finance of Liberty Life Insurance Company\nOTHER BUSINESS\nIn addition to the operating subsidiaries, the Company has other minor organizations. These include the Company's administrative staff, an investment advisory company, a property development & management company and transportation operations.\nRESEARCH ACTIVITIES\nThe Company and its subsidiaries do not have a formal program of research on new or improved products. As a part of its operation, each company continues to seek improved methods and products. No material amounts were spent in this area during 1995.\nINDUSTRY SEGMENT DATA\nInformation concerning the Company's industry segments is contained in Selected Financial Data on page 40 of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on page 30 of this report and is incorporated in this Item 1 by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMAIN OFFICES. The main office of the Company, Liberty Life, Pierce National, Liberty Insurance Services, and Cosmos is located on a 30-acre tract in Greenville, SC, and consists of three buildings totaling approximately 360,000 square feet plus parking. The main office facilities are owned by the Company and Liberty Life. Liberty Life leases branch office space in various cities. Leases are normally made for terms of one to ten years.\nCosmos owns its television broadcast studios, office buildings and transmitter sites in Columbia, SC; Montgomery, AL; Toledo, OH; Louisville, KY; Evansville, IN; Jonesboro, AR; Lake Charles, LA; and Biloxi, Mississippi.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn January 1996, a lawsuit was filed against the Company alleging breach of contract in connection with an agreement to develop a state-of-art software system to administer the Company's insurance operations. The suit was filed by the software developer. Management of the Company, after consultation with legal counsel, believes that the lawsuit filed against the Company is without merit and intends to contest the suit vigorously. The Company believes the suit filed against it was in response to a suit filed by the Company in connection with failure of the software developer to deliver the system. The suit against the software developer seeks to recover amounts paid to the software developer, and other costs incurred by the Company, in an attempt to develop the system. The Company believes it will be successful in its lawsuit against the software developer; however, no reasonable estimate of the amount of the recovery is known at this time.\nIn December 1995, a lawsuit was filed against the Company alleging breach of contract. The lawsuit relates to a transaction in which the Company was unsuccessful in acquiring certain entities partially owned by the plaintiff. Management, after consultation with legal counsel, believes the lawsuit is without merit and intends to contest the suit vigorously.\nOther than the suits mentioned above, the Company is not currently engaged in legal proceedings of material consequence other than ordinary routine litigation incidental to its business. Any proceedings reported in prior filings have been settled or otherwise satisfied.\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 STOCK AND RELATED SECURITY STOCKHOLDER MATTERS\nInformation concerning the market for the Company's Common Stock and related stockholder matters is contained on the inside back cover of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on page 29 of this report and is incorporated in this Item 5 by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data for the Company is contained on page 40 of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on page 30 of this report and is incorporated in this Item 6 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 contained on pages 9-13, 16-18 and 21 of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on pages 31 - 38 of this report and is incorporated in this Item 7 by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION\nThe Company's Consolidated Financial Statements and Report of Independent Auditors are contained on pages 8, 14, 15, 19, 20, and 22 - 39 of The Liberty Corporation Annual Report to Shareholders and is filed as Exhibit 13 on pages 39 - 61 of this report and are incorporated in this Item 8 by reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning Directors of the Company is contained in The Liberty Corporation Proxy Statement for the May 7, 1996 Annual Meeting of Shareholders and is incorporated in this Item 10 by reference.\nInformation concerning Executive Officers of the Company is submitted in a separate section of this report in Part I, Item 1 on page 12 and is incorporated in this Item 10 by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning Executive Compensation and transactions is contained in The Liberty Corporation Proxy Statement for the May 7, 1996 Annual Meeting of Shareholders and is incorporated in this Item 11 by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning Security Ownership of Certain Beneficial Owners and Management is contained in The Liberty Corporation Proxy Statement for the May 7, 1996 Annual Meeting of Shareholders and is incorporated in this Item 12 by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning Certain Relationships and Related Transactions is contained in The Liberty Corporation Proxy Statement for the May 7, 1996 Annual Meeting of Shareholders and is incorporated in this Item 13 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 FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of The Liberty Corporation and Subsidiaries are included in the Company's Annual Report to Shareholders for the year ended December 31, 1995, filed as Exhibit 13 to this report and incorporated in Item 8 by reference:\nConsolidated Balance Sheets -- December 31, 1995 and 1994 Consolidated Statements of Income -- For Each of the Three Years Ended December 31, 1995 Consolidated Statements of Cash Flows -- For Each of the Three Years Ended December 31, 1995 Consolidated Statements of Shareholders' Equity -- For Each of the Three Years Ended December 31, 1995 Notes to Consolidated Financial Statements -- December 31, 1995 Report of Independent Auditors\nThe following consolidated financial statement schedules of The Liberty Corporation and Subsidiaries are included in Item 14(d):\nI- Summary of Investments II- Condensed Financial Statements of The Liberty Corporation (Parent Company) III- Supplementary Insurance Information IV - Reinsurance V - Valuation and Qualifying Accounts and Reserves\nAll schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission, but which are excluded from this report, are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(A)(3).LIST OF EXHIBITS\n3.1 Restated Articles of Incorporation, as amended through March 15, 1995.\n3.2 Bylaws, as amended (filed as Exhibit 3.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference).\n4.1 See Articles 4, 5, 7 and 9 of the Company's Restated Articles of Incorporation (filed as Exhibit 3.1) and Articles I, II and VI of the Company's Bylaws (filed as Exhibit 3.2).\n4.2 See the Form of Rights Agreement dated as of August 7, 1990 between The Liberty Corporation and The Bank of New York, as Rights Agent, which includes as Exhibit B thereto the form of Right Certificate (filed as Exhibits 1 and 2 to the Registrant's Form 8-A, dated August 10, 1990, and incorporated herein by reference) with respect to the Rights to purchase Series A Participating Cumulative Preferred Stock.\n4.3 See Credit Agreement dated March 21, 1995 (filed as Exhibit 10 to the Registrant's Quarterly Report on Form 10Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n10. See Credit Agreement dated March 21, 1995 (filed as Exhibit 4.3).\n11. The Liberty Corporation and Subsidiaries Consolidated Earnings Per Share Computation\n13. Portions of The Liberty Corporation Annual Report to Shareholders for the year ended December 31, 1995: Market for the Registrant's Common Stock and Related Security Stockholder Matters Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Statements and Supplementary Information: Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Income - For the three years ended December 31, 1995 Consolidated Statements of Cash Flows - For the three years ended December 31, 1995 Consolidated Statements of Shareholders' Equity - For the three years ended December 31, 1995 Notes to Consolidated Financial Statements - December 31, 1995 Report of Independent Auditors\n21. The Liberty Corporation and Subsidiaries, List of Subsidiaries\n23. Consent of Independent Auditors\n24. A. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1983\nB. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1985\nC. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1986\nD. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1989\nE. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1994\nF. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1995\n27. Financial Data Schedule\n99. Additional Exhibits\nA. Annual Statement on Form 11-K for The Liberty Corporation and Related Adopting Employers' 401(k) Thrift Plan for the year ended December 31, 1995\n(b). REPORTS ON FORM 8-K FILED IN 1995\nNone\n(c). EXHIBITS FILED WITH THIS REPORT\n3.1 Amendment to Articles of Incorporation, as amended through March 15, 1995.\n11. The Liberty Corporation and Subsidiaries Consolidated Earnings Per Share Computation\n13. Portions of The Liberty Corporation Annual Report to Shareholders for the year ended December 31, 1995: Market for the Registrant's Common Stock and Related Security Stockholder Matters Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Statements and Supplementary Information: Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Income - For the three years ended December 31, 1995 Consolidated Statements of Cash Flows - For the three years ended December 31, 1995 Consolidated Statements of Shareholders' Equity - For the three years ended December 31, 1995 Notes to Consolidated Financial Statements - December 31, 1995 Report of Independent Auditors\n21. The Liberty Corporation and Subsidiaries, List of Subsidiaries\n23. Consent of Independent Auditors\n24. Powers of Attorney applicable for certain signatures of members of the Board of Directors in Registrant's 10-K filed for the year ended December 31, 1995.\n27. Financial Data Schedule\n99. Additional Exhibits\nA. Annual Statement on Form 11-K for The Liberty Corporation and Related Adopting Employers' 401(k) Thrift Plan for the year ended December 31, 1995\n(d). CONSOLIDATED FINANCIAL STATEMENT SCHEDULES FILED WITH THIS REPORT\nI- Summary of Investments - December 31, 1995 II- Condensed Financial Statements of The Liberty Corporation (Parent Company) December 31, 1995 and 1994 III-Supplementary Insurance Information - For the Three Years Ended December 31, 1995 IV- Reinsurance - For the Three Years Ended December 31, 1995 V- Valuation and Qualifying Accounts and Reserves - For the Three Years Ended December 31, 1995\nSchedule I THE LIBERTY CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS DECEMBER 31, 1995 (In 000's)\nSchedule II\nTHE LIBERTY CORPORATION (PARENT COMPANY) CONDENSED BALANCE SHEETS DECEMBER 31, 1995 and 1994 (In $000's, except share data)\n* Eliminated in consolidation. See notes to condensed financial statements.\nSchedule II\nTHE LIBERTY CORPORATION (PARENT COMPANY) CONDENSED STATEMENTS OF INCOME FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In $000's)\n* Eliminated in consolidation. ** Differs from consolidated net income by $103 and $1,612 in 1994 and 1993, respectively, due to gains recognized on a consolidated basis previously recognized by subsidiaries on intercompany transactions. Gains were deferred on a consolidated basis until completion of the earnings process. *** Differs from consolidated net income by $1,184 due to gains deferred on a consolidated basis until completion of the earnings process.\nSee notes to condensed financial statements.\nSchedule II\nTHE LIBERTY CORPORATION (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In $000's)\nSchedule II\nTHE LIBERTY CORPORATION (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. NOTES, MORTGAGES AND OTHER DEBT\nThe general debt obligations at December 31, 1995, are as follows:\nOn March 21, 1995, the Parent Company completed the restructuring of its $325,000,000 revolving credit facility into a new $375,000,000, multi-tranche credit facility which will mature on various dates beginning in March 1998. This facility will be used to refinance indebtedness under the $325,000,000 facility, as well as to provide funds to meet working capital requirements and finance acquisitions. Note 5 of The Liberty Corporation and Subsidiaries Consolidated Financial Statements provides additional information as to this agreement. The maturities of the general debt obligations at December 31, 1995 are as follows:\n2. COMMITMENTS AND CONTINGENT LIABILITIES\nThe Parent Company has guaranteed a $7.0 million letter of credit for an unaffiliated marketing company. As of December 31, 1995, $4.0 million was outstanding under the letter of credit.\n3. RETAINED EARNINGS\nAs of December 31, 1995 and 1994, retained earnings of $347,783,000 and $304,060,000 respectively, in The Liberty Corporation (Parent Company) financial statements differs from The Liberty Corporation and Subsidiaries consolidated financial statements. The difference of $2,692,000 and $1,508,000 at December 31, 1995 and 1994, respectively, relates to the capitalization of interest on a consolidated basis and the elimination of gains on intercompany transactions.\nSchedule III\nTHE LIBERTY CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In $000's)\nSchedule IV\nTHE LIBERTY CORPORATION AND SUBSIDIARIES REINSURANCE FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In $000's)\nSchedule V\nTHE LIBERTY CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In 000's)\nNotes: (a) Uncollectible accounts written off, net of recoveries. (b) Reversal of reserves no longer 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 hereunto duly authorized, as of the 27th day of March, 1996\nTHE LIBERTY CORPORATION By: \/s\/ Hayne Hipp - ----------------------- ------------------------ Registrant Hayne Hipp President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, as of the 27th day of March, 1996.\nBy: \/s\/ John P. Smith *By: \/s\/ William S. Lee ----------------- ------------------ John P. Smith William S. Lee Corporate Controller Director\nBy: \/s\/ H. Ray Eanes *By: \/s\/ William O. McCoy ------------------- -------------------- H. Ray Eanes William O. McCoy Sr. Vice President Finance & Treasurer Director\n*By: \/s\/ Rufus C. Barkley, Jr. *By: \/s\/ Buck Mickel -------------------------- --------------- Rufus C. Barkley, Jr. Buck Mickel Director Director\n*By: \/s\/ Edward E. Crutchfield *By: \/s\/ John H. Mullin III ------------------------- ---------------------- Edward E. Crutchfield John H. Mullin III Director Director\n*By: \/s\/ John R. Farmer *By: \/s\/ Benjamin F. Payton ------------------ ---------------------- John R. Farmer Benjamin F. Payton Director Director\n*By: \/s\/ Lawrence M. Gressette, Jr. *By: \/s\/ J. Thurston Roach ------------------------------ --------------------- Lawrence M. Gressette, Jr J. Thurston Roach Director Director\nBy: \/s\/ Hayne Hipp *By: \/s\/ Martha G. Williams -------------- ---------------------- Hayne Hipp *Martha G. Williams, as Director Special Attorney in Fact\n*By: \/s\/ W. W. Johnson ----------------- W. W. Johnson Director\nAnnual Report on Form 10-K\nThe Liberty Corporation\nDecember 31, 1995\nIndex to Exhibits\nEXHIBIT 11\nTHE LIBERTY CORPORATION AND SUBSIDIARIES CONSOLIDATED EARNINGS PER SHARE COMPUTATION FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (In $000's, except per share data)\nEXHIBIT 13\nSTOCK DATA\nThe Liberty Corporation's Common Stock is listed on the New York Stock Exchange. Its symbol is LC. As of December 31, 1995, 1,395 shareholders of record in 44 states, the District of Columbia, Canada, Australia and New Zealand held the 20,060,629 Common Stock shares outstanding. Quarterly high and low stock prices and dividends per share as reported by the Wall Street Journal were:\nThe Company 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. Also, the payment of dividends is subject to the restrictions described in Notes 5 and 8 of the Consolidated Financial Statements.\nCO-REGISTRAR AND CO-TRANSFER AGENTS - --------------------------------------------------------------------------------\nWachovia Bank of North Carolina, N.A. The Bank of New York P. O. Box 3001 101 Barclay Street Winston-Salem, NC 27102 New York, NY 10286\nFor a Copy of the 10-K or other information, contact: The Liberty Corporation Shareholder Relations Box 789 Greenville, SC 29602 Telephone (864) 609-8256\nStock Exchange Listing: New York Stock Exchange Symbol: LC\nAnnual Meeting The Liberty Corporation will hold its annual meeting on Tuesday, May 7, 1996, at 10:30 a.m. in The Liberty Corporation Headquarters, Greenville, South Carolina. All Shareholders are invited to attend.\nEXHIBIT 13\nSELECTED FINANCIAL DATA The Liberty Corporation and Subsidiaries December 31, 1995\nEXHIBIT 13\nMANAGEMENT'S DISCUSSION AND ANALYSIS The Liberty Corporation and Subsidiaries December 31, 1995\nSUMMARY OF CONSOLIDATED RESULTS OF OPERATIONS\nConsolidated income before income taxes and the cumulative effect of accounting changes for 1995 was $88.8 million, up $49.9 million from the $38.9 million reported for 1994. The amounts reported for 1994 included non-recurring charges of $31.2 million.\nAdjusting for realized investment losses of $2.9 million in 1995, income before income taxes and the cumulative effect of accounting changes was $91.7 million, compared with $82.2 million for 1994, after adjusting the 1994 results for the non-recurring charges and realized investment losses. The increase for 1995 was the result of improvements in both the insurance (up $11.3 million) and broadcasting operations (up $5.4 million) offset by higher interest costs at the Corporate level.\nConsolidated income before income taxes and the cumulative effect of accounting changes for 1994 was $38.9 million ($70.1 million prior to the non-recurring charges) and compares with $77.3 million earned in 1993. Excluding realized investment gains and losses from both periods and the non-recurring charges from 1994, earnings before income taxes were $82.2 million and $62.6 million for 1994 and 1993, respectively. The increase in 1994 was primarily the result of contributions from insurance acquisitions closed in 1994 ($10.3 million) and improvement in broadcasting results ($5.5 million).\nThe non-recurring charges in 1994 related to 1) the write-off of previously deferred costs associated with the development of a software system for administration of Liberty's insurance business and 2) a decision to cease marketing products through the general agency distribution system. The deferred systems charges were in connection with an agreement with a software developer to develop a state-of-the-art software system to handle the administration of Liberty's insurance operations. The non-cash charge of $20.9 million (pre-tax) had no impact on Liberty's cash flow. In 1994 Liberty decided to cease sales of its products through its general agency distribution system due to the absence of critical volume. This decision resulted in a pre-tax charge to earnings of $10.3 million, primarily to reduce deferred acquisition costs no longer considered recoverable. Premiums and policy charges from the general agency division represented approximately 2% of Liberty's total premiums and policy charges at the time the decision was made to cease sales though this marketing channel.\nThe cumulative effect of accounting changes reported in 1993 represented a one-time, non-cash charge of $11.9 million relating to the implementation of Statement of Financial Accounting Standard (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nConsolidated 1995 revenues of $605.7 million were up $64.5 million (12%) over last year's $541.2 million. The 1995 revenue growth consisted primarily of a $47.5 million increase in revenues from the insurance operations and a $21.3 million increase in broadcasting revenues. The increase in revenues from insurance operations was a combination of the 1994 insurance acquisitions contributing a full year of revenues and a $14.0 million increase from realized investment gains.\nConsolidated 1994 revenues of $541.2 million were up $68.3 million (14%) over the $472.9 million reported in 1993. This revenue growth consisted primarily of a $55.3 million increase in revenues from insurance operations and a $10.3 million increase in broadcasting revenues. The increase in revenue from insurance operations was a combination of the 1994 insurance acquisitions contributing revenues of $84.3 million offset by a decline of $29.0 million from existing insurance operations. The decline from existing insurance operations was due to a $26.2 million decline in realized investment gains coupled with the 1993 sale of Liberty's medicare supplement business that generated $12.5 million in revenues in 1993.\nEXHIBIT 13\nBUSINESS SEGMENTS\nLiberty reports the results of its business operations in two segments: Insurance and Broadcasting. The insurance segment consists of Liberty's insurance operations, which specializes in providing home service, pre-need and mortgage protection life and health insurance. The broadcasting segment consists of Cosmos Broadcasting, which owns and operates eight network-affiliated television stations. Activities of Corporate and other include financing and real estate operations. In order to make more meaningful comparisons, the segment data excludes the effect of realized investment gains and losses, non-recurring special charges, and accounting changes. A reconciliation of the segment operations to net income is as follows:\nINSURANCE RESULTS OF OPERATIONS Operating earnings from insurance operations were $54.8 million in 1995, an increase of $8.4 million (18%) from the $46.4 million reported in 1994. Liberty Life's operating earnings were $5.3 million higher in 1995 as net investment income, policy benefits and general insurance expenses all improved. Net investment income for Liberty Life was positively impacted by stronger real estate development income in 1995. After a very high first quarter of 1995, Liberty Life's policy benefits improved each quarter and ended the year 60.8% of premium, down over 2% as a percent of premium from the prior year. The decision to stop accepting new business in the general agency division reduced expenses, resulting in a break-even performance in this division, compared to a pre-tax loss of $2.1 million in 1994. The FamilySide pre-need group also reported an increase in operating earnings of $2.3 million (20%) over 1994. FamilySide benefited from having two significant 1994 acquisitions included for a full year in 1995 compared to 10 months in 1994. And, for the first time ever, Liberty Insurance Services reported a profit on its unaffiliated client base.\nThe increase in 1995 operating earnings followed a 13% increase in 1994 over 1993. Substantially all of the increase in 1994 was due to acquisitions (see Insurance Acquisitions section below). Operating earnings of Liberty Life were flat during the period from 1993 to 1994 as lower investment yields and higher mortality offset the benefit of lower general insurance expenses.\nEXHIBIT 13\nRevenues from insurance operations in 1995 were $484.9 million, increasing 7% over last year's $451.3 million. Insurance premiums and policy charges were $331.4 million, an increase of 5% from 1994, and net investment income increased 11% to $144.5 million. FamilySide contributed the majority of the increase in revenues on the strength of both higher premiums and policy charges and higher investment income. Liberty Life reported a 4% increase in insurance premiums and policy charges in 1995 and also reported higher investment income for the year.\nFor 1994 revenues from insurance operations were $451.3 million, an increase of 22% over the $369.8 million reported in 1993. Premiums and policy charges were $315.8 million in 1994, an increase of $64.9 million (26%). The increase in premiums from 1993 was substantially due to the acquisitions closed in 1994. Investment income increased 22% to $129.9 million in 1994. The acquisitions fueled this increase as well. Without the acquisitions, investment income would have been level with the prior year.\nPolicy benefits as a percent of premium were 71% in 1995, compared with 72% in 1994 and 64% in 1993. The increase in the benefit-to-premium ratio from 1993 to 1994 was principally attributable to the product characteristics of the pre-need products. The pre-need products are primarily limited-pay or single-premium products that have a higher benefit ratio than products historically sold by Liberty. As pre-need became a larger percentage of total company premiums in 1994, the overall benefit-to-premium ratio increased. In 1995 Liberty Life experienced higher than expected mortality in the first quarter. Mortality studies were performed and changes were implemented as a result of the studies. The consolidated benefit-to-premium ratio improved in the second half of 1995 as the ratio declined from 74% reported for the first half of 1995 to the annual rate of 71%. Management believes that some of the improvement in the second half of 1995 was attributable to actions taken as a result of the mortality studies; however, claims are inherently variable and will fluctuate, particularly when measured over a short period of time.\nThe commissions-to-premium ratio was 16% in 1995 and 1994. The comparable ratio in 1993 was 18%. The drop in the ratio from 1993 to 1994 occurred as the pre-need products increased as a percent of total premium. The limited-pay characteristics of the pre-need products results in a lower commission structure than traditional life insurance.\nEXHIBIT 13\nGeneral insurance expenses increased $5.6 million (9%) over 1994 levels with $3.6 million of the increase coming from expanding operations at Liberty Insurance Services. Excluding Liberty Insurance Services, the expense-to-premium ratio was 16% for 1995 and 1994, down from 21% in 1993. The 1994 decrease in the expense-to-premium ratio was after adding general expenses of $9.4 million from the 1994 acquisitions and was the result of continued emphasis on expense control.\nAmortization of deferred acquisition costs and cost of business acquired increased 5% over last year. The amortization-to-premium ratio remained constant at 13% of premiums for 1995 and 1994. The primary variable in the amortization expense from year to year is policy persistency, or lapses. For 1995 lapses were at a comparable level to 1994; however, the 1994 level was down significantly from 1993. The amortization expense in 1993 reflected high lapses in both home service and mortgage protection lines. Management believes that the high lapse experience in 1993 in the home service line was related to Liberty's consolidation of branch offices and, for mortgage protection, the high level of home mortgage refinancing in 1993 due to low interest rates. As expected, the persistency in both lines improved substantially in 1994, resulting in reduced amortization expense. As noted earlier, the 1995 persistency levels were comparable to 1994 levels. In the latter half of 1995 and continuing into 1996, mortgage loan interest rates returned to levels comparable to those of 1993; however, there has not been any indication of a marked increase in the level of mortgage protection lapses.\nINSURANCE OPERATIONS ACQUISITIONS AND EXPANSIONS Beginning in 1992 and continuing through the first half of 1994, Liberty established itself as a key player in the fast-growing pre-need market. The purchase of Pierce National Life in July 1992 provided Liberty with a substantial presence in the pre-need market and the opportunity to expand its presence on an international level. Pierce National markets its products through funeral directors and independent agents in the U.S. and Canada. In April 1993, Liberty further expanded its presence in the pre-need market with the acquisition of the assets of Estate Assurance Company, a pre-need insurance subsidiary of Stewart Enterprises, Inc. Additional expansion of Liberty's pre-need operations occurred in February 1994 with the acquisitions of North American National Corporation, headquartered in Columbus, Ohio, and American Funeral Assurance Company, headquartered in Amory, Mississippi. North American was a holding company whose principal subsidiaries, Pan-Western Life Insurance Company, Howard Life Insurance Company, and Brookings International Life Insurance Company, were providers of pre-need life insurance. This acquisition added strategic Midwest markets to Liberty's pre-need territory. American Funeral was one of the largest providers of pre-need life insurance, with extensive affiliations in the funeral industry.\nDuring 1995, Liberty focused on consolidating its pre-need operations. By the end of 1995 all of the pre-need operations had been relocated to Greenville and the companies merged into Pierce National. To cap off the consolidation of the pre-need acquisitions, Liberty introduced what it believes to be the industry's most comprehensive pre-need product portfolio during November 1995. The product portfolio is marketed under the brand name FamilySide. The actions taken in 1995 to consolidate the operations will provide for improved product profitability, focused marketing capability, and consistency and efficiency in administrative support.\nIn addition to the pre-need acquisitions, Liberty grew its home service division through acquisitions. In October 1992, Liberty expanded its home service business with the acquisition of Magnolia Life Insurance Company headquartered in Lake Charles, Louisiana. On April 1, 1994, Liberty acquired State National Capital Corporation, headquartered in Baton Rouge, Louisiana.. These acquisitions gave Liberty a significant presence in the Louisiana home service market. Both Magnolia Life and State National Life were integrated into Liberty Life during 1994.\nIn the fourth quarter of 1995, Liberty announced that the operations of Liberty Insurance Services will be combined in a joint venture with Continuum Administrative Services Company, the third-party administrative arm of The Continuum Company. The joint venture, operating under the name of ALLIANCE-ONE Services, LP, will be the largest third party administrator of life insurance business in the United States. Liberty believes there is substantial long-term potential for the joint venture; however, it is not expected to add substantially to Liberty's results in 1996.\nEXHIBIT 13\nBROADCASTING RESULTS OF OPERATIONS\nGross broadcasting revenues for 1995 were $119.5 million, an increase of $21.2 million (22%) over last year's $98.3 million. Excluding the $12.3 million in revenues added from the February 1995 acquisition of WLOX-TV, gross revenues were up 9%. Strong time sales (both national and local), coupled with increased network compensation, overcame the decline in political revenues as 1995 was an off-year for major political races. The increased network compensation came about as a result of the networks' competing for affiliations with local stations. Cosmos, due to the strength of its stations in the local market, was able to capitalize by re-negotiating network compensation contracts and reported a $4.0 million increase in network compensation revenue in 1995. Broadcasting expenses, excluding the impact of the WLOX-TV acquisition, rose only 2% in 1995. As a result of the increased revenues and expense control, Cosmos reported a $3.7 million increase in income from operations in 1995. Substantially all of the increase in earnings was generated from the existing station group as the WLOX-TV acquisition was not expected to, and did not, contribute significantly to operating earnings in 1995.\nGross broadcasting revenues for 1994 were $98.3 million, an increase of $10.3 million (12%) from 1993 levels. Strong national revenues and the highest political revenues ever drove the revenue increase in 1994. Income from operations in 1994 was up $3.2 million (33%) over 1993, largely due to revenue trends.\nAn additional measure of broadcasting performance is operating cash flow, defined as operating earnings before depreciation and amortization, interest, taxes and corporate expenses. Operating cash flow, and the related efficiency ratio (operating cash flow divided by revenues net of agency commissions) are measurements of broadcasting operating margins. For the year broadcasting cash flow was $44.9 million compared to $33.0 million in 1994 and $27.8 million in 1993. The acquisition of WLOX-TV added $6.2 million to 1995 operating cash flows. The efficiency ratio was at an all time high of 43% in 1995, compared to 40% in 1994 and 38% in 1993.\nThe Company closed the acquisition of WLOX-TV on February 28, 1995. The purchase price of $40.1 million was funded with a combination of 599,985 shares of 1995-A Series convertible preferred stock with a stated value of $35 per share; cash of $5.6 million; and a note payable for $13.5 million.\nCORPORATE AND OTHER Corporate and other includes general corporate activities such as the overall management, legal and finance operations, debt service on debt not allocated to segments, intercompany eliminations and the operations of Liberty Investment Group. The increase in the loss in 1995 in this area was primarily due to higher interest costs as both the outstanding debt and interest rates were at higher levels than 1994.\nEXHIBIT 13\nBALANCE SHEET\nINVESTMENTS\nAs of December 31, 1995, Liberty's consolidated investment portfolio was carried at $2.0 billion compared with $1.7 billion at the end of 1994. Of the $290 million increase in the carrying value of the portfolio, approximately $150 million was from the increase in the market value of the portfolio, with the remainder of the increase coming from investment of cash generated from operating and financing activities. Approximately 72% of consolidated invested assets were in fixed maturity securities (bonds and redeemable preferred stocks), 11% were in mortgage loans, 7% in real estate, with the balance consisting of policy loans (5%), equity securities (4%) and other long-term investments (1%).\nThe overall average credit rating of fixed maturity securities as of December 31, 1995 was AA. Less than investment grade securities comprised 3.3% of the fixed maturity portfolio at December 31, 1995, compared with 5.3% at December 31, 1994.\nStatement of Financial Accounting Standard (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" requires that all debt and equity securities be classified into one of three categories -- held to maturity, available for sale, or trading. As of December 31, 1995, all securities have been classified as available for sale and are carried at fair value. During 1995, the Company transferred the portion of fixed maturity securities previously classified as held to maturity to the available for sale classification. As a result of the transfer, shareholders' equity was increased $14.6 million (net of deferred income taxes and adjustment to deferred acquisition costs) to reflect the unrealized gain on securities previously carried at cost. See Note 1 to the Consolidated Financial Statements for additional discussion of the transfer.\nSFAS 115 requires that available for sale securities be carried at fair value, with unrealized gains and losses, net of adjustment for deferred income taxes and deferred acquisition costs, be reported directly in shareholders' equity. The fair value of Liberty's fixed maturity portfolio, and the related adjustment to shareholders' equity, is significantly affected by changes in the overall interest rate environment. For example, as interest rates fell throughout 1995, shareholders' equity increased $111.1 million, reflecting the change in the fair value of the portfolio. In contrast, primarily as a result of the rising interest rate environment during 1994, the Company reported a net unrealized loss of $69.6 million for the year ended December 31, 1994. While the volatility experienced in 1995 and 1994 is not expected to be repeated on an annual basis, it is likely that there will continue to be significant fluctuations in shareholders' equity as a result of carrying fixed maturity securities at market value.\nAlthough Liberty's entire fixed maturity and equity securities portfolios have been classified as available for sale, Liberty follows a value-oriented, as opposed to a trading-oriented, investment philosophy concerning its securities portfolios. Accordingly, turnover in the portfolios has historically been low, although portfolio turnover in 1995 and particularly in 1994 was higher than historical levels as 1) investment portfolios from the companies acquired in 1994 were restructured to meet Liberty guidelines as to quality, yield and duration, and 2) Liberty took advantage of its tax position at the end of 1994 to sell securities with lower yields and reinvest in higher yielding securities of equal or better credit quality. Gains trading, which Liberty believes is short-sighted, is not consistent with its investment philosophy of longer term value-oriented investing. Going into 1996, yields remain at historically low levels and the yield curve is relatively flat. If this environment continues, in order to generate incremental returns above market yields without sacrificing credit quality, it may be necessary to more actively trade securities.\nApproximately 56% of Liberty's $1.5 billion fixed maturity portfolio at December 31, 1995, was comprised of mortgage-backed securities. This compares to approximately 54% at year-end 1994. Certain mortgage-backed securities are subject to significant prepayment risk or extension risk due to changes in interest rates. In periods of declining interest rates mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments which cannot be reinvested at interest rates comparable to the rates on the prepaid mortgages. In a rising interest rate environment refinancings are significantly curtailed and the payments to the holders of the securities decline, limiting the ability of the holder to reinvest at the higher interest rates. Mortgage-backed pass-through securities and sequential collateralized mortgage obligations (\"CMO's\"), which comprised 20% of the book value of Liberty's mortgage-backed securities at December 31, 1995, and 17% at year-end 1994, are sensitive to prepayment or extension risk. The remaining 80% of Liberty's mortgage-backed investment portfolio at December 31, 1995, consisted of planned amortization class (\"PAC\") instruments. This compares to 83% at December 31, 1994. These investments are designed to amortize in a more predictable manner by shifting the primary prepayment and extension risk of the underlying collateral to investors in other tranches of the CMO. PAC's are tranches of CMO's specifically designed to protect against prepayment or extension risk. In periods of declining interest rates, prepayments are first applied to the non-PAC tranches of the CMO, creating improved call protection for the PAC tranches. Only after all non-PAC tranches have been paid off are prepayments applied to the PAC tranche. In periods of increasing interest rates, prepayments are first applied to the PAC tranche, thus reducing extension risk for PACs. As a result, PACs have a more stable cash flow than most other mortgage securities because they have better call protection and less extension risk.\nMortgage loans of $213.2 million comprised 11% of the consolidated investment portfolio at December 31, 1995. This compares to mortgage loans of $203.4 million, or 12%, of the consolidated investment portfolio at December 31, 1994. Substantially all of these mortgage loans are commercial mortgages with a loan-to-value ratio not exceeding 75% when made. Approximately 50% of these loans at December 31, 1995, are concentrated in North and South Carolina; and 91% are in the states of North Carolina, South Carolina, Virginia, Florida, Georgia,\nEXHIBIT 13\nTennessee and Louisiana. Mortgage loan delinquencies, defined as payments 60 or more days past due, have historically been low and were 1.3% at the end of 1995 compared to the latest available industry rate of 2.4%.\nAs of December 31, 1995 and 1994, investment real estate totaled $135.3 million and $135.5 million, representing 7% and 8%, respectively, of the consolidated investment portfolio. Three property types make up the bulk of the portfolio. Residential land development and industrial land development projects accounted for 64% of the portfolio as of the end of 1995, with business property rentals making up another 26%. In 1995, Liberty decided to sell its existing shopping centers and not allocate future investments to this property type. At the end of 1994 shopping center investments were 15% of the real estate portfolio; however, substantially all of the shopping center properties were sold by the end of 1995. Of Liberty's investment real estate, 96% is located in South Carolina, Florida, Georgia, and North Carolina.\nLiberty has experienced pre-tax impairments on investment assets of $9.5 million, $2.7 million, and $6.2 million for the years ended December 31, 1995, 1994, and 1993, respectively. The high level of impairments in 1995 was due primarily to write-downs taken on an oil and gas investment. While the level of impairments is not predictable, management does not expect impairments to have a significant impact on Liberty's results of operations or liquidity.\nBeginning in 1996 a new accounting standard will potentially change the amounts of impairments recognized and the timing of the recognition. Statement of Financial Accounting Standard No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" prescribes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill that are used in the business, as well as establishing accounting standards for long-lived assets and certain identifiable intangibles to be disposed of. Under the provisions of the statement certain of the Company's investment real estate assets will be required to be valued at fair value, rather than net realizable value; however, the adoption of the statement is not expected to have a material impact on the net income or financial position of the Company.\nLIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY\nIn March 1995, Liberty refinanced its $325 million revolving credit facility into a new $375 million multi-tranche credit facility. The new facility consists of a $225 million three-year revolving credit facility; a $100 million seven year term loan facility; and a $50 million facility substantially identical to the revolving facility, which is convertible into terms substantially identical to the term facility anytime prior to March 1997. The credit facility contains various restrictive covenants typical of a credit facility agreement of this size and nature. These restrictions primarily pertain to levels of indebtedness, limitations on payment of dividends, limitations on the quality and types of investments, and capital expenditures. Additionally, Liberty must also comply with several financial covenant restrictions under the revolving credit agreement including defined ratios of consolidated debt to cash flow, consolidated debt to consolidated total capital, and fixed charges coverage.\nLiberty has entered into various interest rate swaps, caps and corridors in an attempt to minimize the impact of a potential significant rise in short-term interest rates on Liberty's outstanding variable-rate debt. See Note 5 to the Consolidated Financial Statements for additional discussion of these contracts.\nIn 1994, Liberty issued 668,207 shares of Series 1994-A Voting Cumulative Preferred Stock having a total redemption value of $23.4 million, or $35.00 per share, in connection with the acquisition of State National Capital Corporation and 598,656 shares of Series 1994-B Voting Cumulative Preferred Stock having a total redemption value of $22.4 million, or $37.50 per share, in connection with the acquisition of American Funeral Assurance Company. The shares have preference in liquidation and each share is entitled to one vote on any matters submitted to a vote of the shareholders of the Company. Both the Company and the holders of the preferred stock have the right to redeem any or all of the shares from time to time beginning five years and one month after the date of issue in exchange for cash or shares of the Company's common stock. There is no sinking fund for the redemption of either series of preferred stock. Both the 1994-A and 1994-B series of preferred stock are considered redeemable preferred stock and are classified outside of permanent equity.\nOn February 28, 1995, the Company issued 599,985 shares of Series 1995-A Voting Cumulative Convertible Preferred Stock, having a total redemption value of $21.0 million, or $35.00 per share, in connection with the acquisition of WLOX-TV. The Company has the right to redeem any or all of the shares from time to time at any time beginning five years and one month after the date of issue in exchange for cash, common stock, or a combination of both. Generally, the amount of consideration on the 1995-A Series will be equivalent to $35.00 per share plus the amount of any accumulated and unpaid dividends. There is no sinking fund for the redemption of the preferred stock. These shares are considered common stock equivalents for financial reporting purposes.\nDuring December 1992 and January 1993, Liberty completed its public stock offering of 2,725,100 shares of its common stock at a per share price of $28.25, which generated $73 million in net proceeds that were used to pay down outstanding bank debt. Of the total shares issued, 2,400,000 were issued during December 1992. The remaining 325,100 shares were issued in January 1993 as a result of the underwriters exercising the over-allotment provision of the stock offering\nEXHIBIT 13\nThe National Association of Insurance Commissioners (the \"NAIC\") has 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 states as an early warning tool to identify companies that potentially are inadequately capitalized for the purpose of initiating regulatory action. 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. The RBC ratios for the insurance subsidiaries significantly exceed the minimum capital requirements at December 31, 1995.\nCASH FLOWS\nThe parent company's short-term cash needs consist primarily of: (1) working capital requirements, (2) interest on corporate debt, (3) dividends to shareholders and (4) funds for real estate investments. The parent company's primary long-term cash need is the repayment of corporate debt. The parent company depends primarily on dividends, debt service payments and consolidated tax return benefits paid to it by its subsidiaries to meet its short-term and long-term cash needs. Historically, Liberty's primary businesses - insurance and broadcasting - have provided sufficient liquidity to fund their operations and the operations of the parent company. Liberty receives funds from its insurance subsidiaries primarily in the form of dividends. Dividends from each insurance subsidiary are restricted under applicable state law. Annual dividends in excess of maximum amounts prescribed by state statutes (\"extraordinary dividends\") may not be paid without the approval of the insurance commissioner of each state in which an insurance subsidiary is domiciled. In 1994 the National Association of Insurance Commissioners (\"NAIC\") proposed, and certain states 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 parent. See Note 8 to the Consolidated Financial Statements.\nOn a consolidated basis, Liberty's net cash flow from operating activities was $87.4 million for 1995 compared with $87.1 million for the preceding year. Liberty's net cash used in investing activities was $133.6 million for 1995 compared to $176.3 million in 1994. The net cash used in investing activities in 1995 was primarily to fund the purchase of investment securities. Cash used in investing activities in 1994, in addition to funding investment security purchases, was used to fund insurance acquisitions ($54.1 million) and a bulk purchase of real estate assets ($43.0 million). Cash flow from financing activities fluctuates primarily based on the level of borrowings or debt repayment. In 1995 cash flow provided by financing activities was $38.5 million compared with cash provided of $111.2 million for 1994. Proceeds from borrowings exceeded debt repayments by $11.4 million in 1995 compared with $76.9 million in 1994. The excess of borrowings over repayments of debt in 1994 was used to fund insurance and real estate acquisitions. As a result of its activities, Liberty had a net decrease in cash of $7.7 million in 1995 compared with a $21.9 million increase in cash in 1994.\nLiberty believes that its current level of cash and future cash flows from operations is sufficient to meet the needs of its business and to satisfy its debt service. If suitable opportunities arise for additional acquisitions, Liberty plans to draw on its revolving credit facility or use Common Stock or Preferred Stock as payment of all or part of the consideration for such acquisitions; or Liberty may seek additional funds in the equity or debt markets. Under the restructured credit facility, there exists no restriction on acquisition funding; however, consolidated debt is limited to a maximum of $385 million. Outstanding debt at December 31, 1995 totaled $258 million.\nManagement believes liquidity risk of the insurance operations is minimized by investment strategies that stress high quality assets and an integrated asset\/liability matching process. Investments are primarily in intermediate to long-term maturities in order to match the long-term nature of insurance liabilities. Liberty has a relatively small block of universal life products that are interest-sensitive. Liberty actively manages the rates credited on these policies to maintain an acceptable spread between the earned and credited rate. In addition, Liberty has an integrated asset\/liability matching process to minimize the liquidity risk that is associated with interest-sensitive products. Accordingly, most long-term investments are held to maturity and interim market fluctuations present no significant liquidity problems. Liberty's only use of derivative financial instruments is to minimize the exposure on its variable rate debt.\nMost states have laws requiring solvent life insurance companies to pay guaranty fund assessments to protect the interests of policyholders of insolvent life insurance companies. Due to the recent increase in the number of companies that are under regulatory supervision, there is expected to be an increase in assessments by state guaranty funds. Under present law, most assessments can be recovered through a credit against future premium taxes. Liberty has reviewed its exposure to potential assessments, and the effect on its financial position and results of operations is not expected to be material.\nOther Company commitments are shown in Note 7 to the Consolidated Financial Statements. Further discussion of investments and valuation is contained in Notes 1, 2 and 15 to the Consolidated Financial Statements.\nEXHIBIT 13\nCONSOLIDATED BALANCE SHEETS THE LIBERTY CORPORATION AND SUBSIDIARIES (In 000's)\nEXHIBIT 13\nSee notes to consolidated financial statements.\nEXHIBIT 13\nCONSOLIDATED STATEMENTS OF INCOME THE LIBERTY CORPORATION AND SUBSIDIARIES (In $000's, except per share data)\nSee notes to consolidated financial statements.\nEXHIBIT 13\nCONSOLIDATED STATEMENTS OF CASH FLOWS THE LIBERTY CORPORATION AND SUBSIDIARIES (In 000's)\nSee notes to consolidated financial statements.\nEXHIBIT 13\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY THE LIBERTY CORPORATION AND SUBSIDIARIES (Amounts in 000's except per share data)\nSee notes to consolidated financial statements.\nEXHIBIT 13\nTHE LIBERTY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements of The Liberty Corporation and Subsidiaries (the Company) include the accounts of the Company after elimination of all significant intercompany balances and transactions. The primary subsidiaries of the Company are Liberty Life Insurance Company, Pierce National Life Insurance Company (doing business as FamilySide) and Liberty Insurance Services Corporation (collectively referred to as the insurance operations) and Cosmos Broadcasting Corporation.\nORGANIZATION - The Company's operations include the sale and service of life insurance products in the United States and Canada and television broadcasting operations in the United States. The insurance operations are licensed to do business in 49 states and nine Canadian provinces. While the majority of the Company's assets and revenues are generated from its insurance operations, the Company also is a major television group broadcaster, owning and operating eight network affiliated television stations throughout the southeastern and midwestern states. Information on the Company's operations by segment is included on page 40 of this report (see Note 16).\nUSE OF ESTIMATES AND ASSUMPTIONS - Financial statements prepared in accordance with generally accepted accounting principles require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes to the consolidated financial statements. Actual results could differ from those estimates and assumptions.\nINSURANCE PREMIUMS AND POLICY CHARGES - Revenues for traditional life insurance and accident and health insurance are recognized over the premium paying period as they become due. For limited payment whole life products, the excess of the premiums received over the portion of the premiums required to establish reserves is deferred and recognized in income over the anticipated life of the policy. For universal life products, revenues consist of policy charges for the cost of insurance, administration of the policies and surrender charges during the period. Policy issue fees are deferred and recognized in income over the life of the policies in relation to the incidence of expected gross profits.\nBENEFITS TO POLICYHOLDERS AND BENEFICIARIES - Benefits for traditional life insurance and accident and health insurance products include claims paid during the period, accrual for claims reported but not yet paid, and accrual for claims incurred but not reported based on historical claims experience modified for expected future trends. Benefits for universal life products are the amount of claims paid in excess of the policy value accrued to the benefit of the policyholder plus interest credited on account values.\nINSURANCE RESERVES AND POLICY MAINTENANCE EXPENSES - Insurance reserves and policy maintenance expenses for traditional life insurance and accident and health insurance are associated with earned premiums so as to recognize profits over the premium paying period. This association is accomplished by recognizing the liabilities for insurance reserves on a net level premium method based on assumptions deemed appropriate at the date of issue as to future investment yield, mortality, morbidity, withdrawals and maintenance expenses and including margins for adverse deviations. Interest assumptions are based on Company experience. Mortality, morbidity, and withdrawal assumptions are based on recognized actuarial tables or Company experience, as appropriate. Accident and health reserves consist principally of unearned premiums and claims reserves, including provisions for incurred but unreported claims.\nInsurance reserves for universal life products are determined following the retrospective deposit method and consist of policy values that accrue to the benefit of the policyholder, unreduced by surrender charges.\nDEFERRED ACQUISITION COSTS - Acquisition costs incurred by the Company in the process of acquiring new business are deferred and amortized to income as discussed below. Costs deferred consist primarily of commissions and certain policy underwriting, issue and agency expenses that vary with and are primarily related to production of new business.\nCOST OF BUSINESS ACQUIRED is the value assigned the insurance inforce of acquired insurance companies at the date of acquisition.\nFor traditional insurance products, the amortization of deferred acquisition costs and the cost of business acquired is recognized in proportion to the ratio of annual premium revenue to the total anticipated premium revenue, which gives effect to actual terminations. Deferred acquisition costs and the cost of business acquired are amortized over the premium paying period (not to exceed 30 years) of the related policies. Anticipated premium revenue is determined using assumptions consistent with those utilized in the determination of liabilities for insurance reserves.\nEXHIBIT 13\nFor universal life products, the deferred acquisition costs are amortized in relation to the incidence of expected gross profits over the life of the policies (not to exceed 30 years). Gross profits are equal to revenues, as defined previously, plus investment income (including applicable realized investments gains and losses) less expenses. Expenses include interest credited to policy account balances, policy administration expenses, and expected benefit payments in excess of policy account balances.\nINVESTMENTS - Statement of Financial Accounting Standard (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" requires that all debt and equity securities be classified into one of three categories - -- held to maturity, available for sale, or trading. The Company has no securities classified as trading. On November 15, 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\". In accordance with the provisions in that Special Report, on December 31, 1995, the Company chose to reclassify all securities previously classified as held to maturity to available for sale. The market value and amortized cost of the securities transferred were $307,100,000 and $281,691,000, respectively, at December 31, 1995. As a result of the transfer, shareholders' equity was increased $14,645,000 (net of deferred income taxes and adjustment to deferred acquisition costs) to reflect the unrealized gain on securities previously carried at cost. There were no sales of securities previously included in the held to maturity category during 1995 or 1994. Prior to December 31, 1995, the Company classified fixed maturity securities (bonds and redeemable preferred stock) as either held to maturity or available for sale. Management determined the appropriate classification of fixed maturities at the time of purchase. Fixed maturities were classified as held to maturity when the Company had the positive intent and ability to hold the securities to maturity.\nInvestments are reported on the following basis:\n- - Fixed maturities classified as available-for-sale are stated at fair value with unrealized gains and losses, after adjustment for deferred income taxes and deferred acquisition costs, reported directly in shareholders' equity. Fixed maturities classified as held to maturity are stated at amortized cost, including impairments for other than temporary declines in value. Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments. - - Equity securities (common stocks and nonredeemable preferred stocks) are all considered available for sale and are carried at fair value. The fair values for equity securities are based on quoted market prices. - - Mortgage loans on real estate are carried at amortized cost, less an allowance for credit losses and provisions for impaired value, where appropriate. - - Investment real estate is carried at cost less accumulated depreciation and provisions for impaired value where appropriate. Depreciation over the estimated useful lives of the properties is determined principally using the straight-line method. - - Policy loans are carried at cost. - - Other long-term investments are carried at cost which includes provisions for impaired value where appropriate. Included in other long-term investments are investments in venture capital funds and oil and gas properties. - - Short-term investments are carried at cost which approximates fair value.\nUNREALIZED INVESTMENT GAINS AND LOSSES on investments carried at fair value, net of deferred taxes and adjustment for deferred acquisition costs related to universal life products, are recorded directly in shareholders' equity.\nREALIZED INVESTMENT GAINS AND LOSSES are recognized using the specific identification method to determine the cost of investments sold. Gains or losses on the sale of real estate held for investment are included in realized investment gains (losses). Gains and losses on the sale of real estate acquired for development and resale are included in net investment income. Realized gains and losses include write-downs for impaired values of investment assets. The Company establishes impairments on individual, specific assets at the time the Company judges the assets to have been impaired and this impairment can be estimated (see Note 2).\nBUILDINGS AND EQUIPMENT are recorded at cost. Depreciation over the estimated useful lives of the properties is determined principally using the straight-line method.\nINTANGIBLE ASSETS arose in the acquisition of certain television stations. Amounts not being amortized ($4,071,000) represent the excess of the total cost over the underlying value of the tangible and amortizable intangible assets acquired prior to 1970. Amounts being amortized are expensed principally over forty years.\nGOODWILL arose in the acquisition of insurance companies and is being amortized over lives ranging from twenty to forty years.\nFOREIGN CURRENCY TRANSLATION has been accounted for in accordance with SFAS No. 52, \"Foreign Currency Translation.\" The assets and liabilities of the Canadian operations of FamilySide are translated into U.S. dollars at the rate of exchange in effect at the respective balance sheet date. Net exchange gains and losses resulting from translation are included as a separate component of shareholders' equity. Revenues and expenses are translated at average exchange rates for the year. Gains and losses from foreign currency transactions are included in net income.\nEXHIBIT 13\nINTEREST RATE CAPS AND SWAPS are used to limit the impact of changing interest rates on the Company's debt, which is substantially all floating rate (see Note 5). An interest rate swap is used to fix the interest rate on $100,000,000 of debt. The net interest effect of the swap transaction is reported as an adjustment to interest expense as incurred. Interest rate caps are used to protect a portion of the remaining debt against significant increases in interest rates. Premiums paid for the interest rate caps are being amortized to interest expense over the terms of the caps.\nINCOME TAXES are computed using the liability method required by Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes\". Under SFAS 109, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and law that will be in effect when the differences are expected to reverse.\nEARNINGS PER COMMON SHARE is based on net income after redeemable preferred stock dividend requirements and the weighted average number of shares outstanding during the year, including the average number of dilutive shares under stock options.\nNON-PENSION POSTEMPLOYMENT BENEFITS - The Company provides certain health and life insurance benefits to eligible retirees and their dependents. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standard No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" whereby the cost of providing the benefits is accrued during the employees' working years. The Company elected to immediately recognize this obligation, resulting in a $15,254,000 charge ($10,068,000 after-tax) to 1993 operations. The Company also provides certain other postemployment benefits to qualified former and inactive employees. To account for these benefits the Company adopted Statement of Financial Accounting Standard No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective January 1, 1993. SFAS 112 requires the accrual of benefits provided to former or inactive employees after employment but before retirement, be accrued when it is probable a benefit will be provided. The adoption of this standard resulted in a $2,837,000 charge ($1,872,000 after-tax) which was expensed during 1993. With the exception of the one-time transition obligations, the adoption of these accounting standards did not have a material impact on the Company's annual earnings.\nSTATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 114, \"Accounting by Creditors for Impairments of a Loan\" and Statement of Financial Accounting Standard No. 118, \"Accounting by Creditors for Impairments of a Loan--Income Recognition and Disclosures\" were adopted by the Company effective January 1, 1995. Under the standards, the Company provides for estimated credit losses related to the mortgage loans where it is probable that all amounts due according to the contractual terms of the mortgage agreement will not be collected. This provision for credit losses is based on discounting the expected cash flows from the loan using the loan's initial effective interest rate, or the fair value of the collateral for certain collateral dependent loans. The initial adoption of the standards resulted in recording an allowance for credit losses of $507,000 ($330,000 after-tax), which has been included in realized investment gains (losses) in the consolidated statement of income.\nSTATEMENT OF FINANCIAL ACCOUNTING STANDARD 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. This statement prescribes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill that are used in the business, as well as establishing accounting standards for long-lived assets and certain identifiable intangibles to be disposed of. The Company expects to adopt this standard as of January 1, 1996. Under the provisions of the statement certain of the Company's investment real estate assets will be required to be valued at fair value, rather than net realizable value as previously required; however, the adoption of the statement is not expected to have a material impact on the net income or financial position of the Company.\nSTATEMENT OF FINANCIAL ACCOUNTING STANDARD NO. 123, \"Accounting for Stock-Based Compensation\" was issued by the Financial Accounting Standards Board in October 1995. This statement requires companies to measure the fair value of employee stock options at the date granted and expense the estimated fair value of grants or, alternatively, disclose the pro forma impact on net income and earnings per share of the grants in the notes to the financial statement. The Company will adopt this statement as of January 1, 1996 and make the pro forma disclosures required by SFAS 123 in its 1996 financial statements.\nRECLASSIFICATIONS have been made in the 1994 and 1993 Consolidated Financial Statements to conform to the 1995 presentation.\nExhibit 13\n2. INVESTMENTS\nAmortized cost and estimated fair values of investments in available for sale and held to maturity securities at December 31, 1995 and 1994 are as follows:\nAs of December 31, 1995, the Company reclassified all securities previously classified as held to maturity to available for sale (See Note 1).\nEXHIBIT 13\nRealized gains (losses) and the change in unrealized gains (losses) on the Company's fixed maturities and equity securities are summarized as follows:\nThe schedule below details consolidated investment income and related investment expenses for the years ended December 31.\nProceeds from sales of fixed maturities and the related gross realized gains and losses for the three years ended December 31 are shown below. The amounts shown below do not include those related to unscheduled redemptions or prepayments, nor do they reflect any impairments taken during the years presented. No held to maturity securities were sold during 1995 or 1994.\nEXHIBIT 13\nThe following investment assets were non-income producing for the twelve months ended December 31, 1995:\nFor the year ended December 31, 1995, the Company incurred realized losses of $9,462,000 due to impairment of assets included in the year-end investment portfolio. Cumulative provisions for impairments on the total investment portfolio by asset category at December 31, 1995, are as follows:\nThe amortized cost and estimated 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.\n3. REINSURANCE AGREEMENTS\nThe Company uses reinsurance as a risk management tool in the normal course of business and in isolated, strategic assumption transactions to effectively buy or sell blocks of in force business. The reinsurance contracts do not relieve the Company from its contract with its policyholders, and it remains liable should any reinsurer be unable to meet its obligations. At December 31, 1995, $4.6 billion (21%) of the Insurance Group's total $21.4 billion gross insurance in force was ceded to other companies. In the accompanying financial statements, insurance premiums and policy charges, policyholder benefits and deferred acquisition costs are reported net of reinsurance ceded with policy liabilities being reported gross of reinsurance ceded.\nAmounts paid or deemed to be paid for reinsurance contracts are recorded as reinsurance receivables. The cost of reinsurance related to long-term duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.\nIn 1991 Liberty Life entered into an agreement with Life Reassurance Corporation (Life Re) to coinsure the Company's General Agency Division's universal life policies in force. The initial agreement provided for 80% coinsurance on policies in force at December 31, 1991, and 50% coinsurance on policies issued subsequent to such date. Effective July 1, 1995, the amount coinsured on policies written after December 31, 1991, was increased to 80%. Under the terms of the agreement, assets supporting the business ceded are required to be held in escrow. At December 31, 1995, Liberty Life's interest in the assets held in escrow consisted of investments with an amortized cost of $56.3 million and a fair value of $59.7 million. Comparable book and fair value at December 31, 1994 was $62.7 million and $59.3\nEXHIBIT 13\nmillion, respectively. These investments had an average rating of AA+. The total face value of insurance ceded to Life Re at December 31, 1995, was $2.9 billion and the Company has recorded a receivable related to this transaction from Life Re of $257.7 million as of December 31, 1995. Currently, Life Re has an A.M. Best rating of A+. During 1995 and 1994, Liberty Life had ceded premiums and policy charges of $19.3 and $18.0 million, respectively, under the agreement.\nEffective September 30, 1991, Liberty Life entered into an agreement to coinsure 50% of its Home Service line of business. Under generally accepted accounting principles this agreement has been treated as financial reinsurance, and no reserve reduction had been taken for the business ceded. The reinsurance contract contains an escrow agreement that requires assets equal to the reserves reinsured, as determined under statutory accounting principles, be held in escrow for the benefit of this block of business. At December 31, 1995, the amortized cost of the invested assets held in escrow was approximately $228.9 million.\nThe insurance subsidiaries also reinsures with other insurance companies portions of the life insurance they write in order to limit exposure on large or substandard risks. Due to this broad allocation of reinsurance with several insurance companies, there exists no significant concentration of credit risk. The maximum amount of life insurance that Liberty Life will retain on any life is $300,000, plus an additional $50,000 in the event of accidental death. This maximum is reduced for higher ages and for special classes of risks. The maximum amount of life insurance that the other insurance subsidiaries will retain on any life is $50,000. Insurance in excess of the retention limits is either automatically ceded under reinsurance agreements or is reinsured on an individually agreed basis with other insurance companies.\nThe effect of reinsurance on premiums and policy charges and benefits was as follows for the years ending December 31:\n4. DEFERRED ACQUISITION COSTS, COST OF BUSINESS ACQUIRED AND FUTURE POLICY BENEFITS\nA summary of the changes in deferred acquisition costs is as follows:\nEXHIBIT 13\nA summary of the changes in costs of business acquired through acquisitions is as follows:\nThe Company accounts for these costs in a manner consistent with deferred acquisition costs. The Company's interest rate used to amortize these costs is 7.75% for a majority of the asset. Periodically, the Company performs tests to determine that the cost of business acquired remains recoverable from future premiums on the acquired business. The Company incurred no write-offs due to impairments as a result of these tests during the three years ended December 31, 1995. Under current assumptions amortization of these costs, prior to consideration of accrued interest implicit in the calculation of the amortization, for the next five years is expected to be as follows:\nThe liabilities for traditional life insurance and accident and health insurance policy benefits and expenses are computed using a net level premium method, including assumptions based on the Company's experience, modified as necessary to reflect anticipated trends and to include provisions for possible unfavorable deviations. Reserve interest assumptions are graded and range from 3.5% to 9.5%. Such liabilities are, for some plans, graded to equal statutory values or cash values at or prior to maturity. The weighted average assumed investment yield for all traditional life and accident and health policy reserves was 6.6%, 6.8%, and 6.8% in 1995, 1994, and 1993, respectively. 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.\nBenefit reserves for universal life insurance and investment 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 incurred in the period in excess of related policy account balances. Interest crediting rates for universal life and investment products range from 5.5% to 6.8% in 1995, 5.5% to 7.0% in 1994, and 5.8% to 8.0% in 1993.\nParticipating business accounts for approximately 1% of the Company's life insurance in force and premium income. The dividend to be paid is determined annually by the Board of Directors.\n5. DEBT\nThe debt obligations at December 31 are as follows:\nThe mortgage loans are secured by property with a net carrying value of $19.6 million at December 31, 1995.\nEXHIBIT 13\nMaturities of the debt obligations at December 31, 1995, are as follows:\nOn March 21, 1995, the Company refinanced its then-existing $325,000,000 revolving credit facility into a new $375,000,000, multi-tranche credit facility. The current facility consists of a $225,000,000 three-year revolving credit facility; a $100,000,000 seven-year term loan facility; and a $50,000,000 facility substantially identical to the revolving facility, which is convertible into terms substantially identical to the term facility within two years of the closing date of this loan. The revolving portion of the facility will mature in March 1998, while the term portion shall be repaid in twenty quarterly installments of $5,000,000 commencing June 1997, and ending in March 2002.\nThe Company's borrowings against the revolving credit facility were $126,000,000 and against the term facility were $100,000,000 at December 31, 1995. During 1995, the maximum amount outstanding on the revolving facility amounted to approximately $162,000,000, with an average balance outstanding of approximately $129,250,000 and an average weighted interest rate of 6.26%. In addition to the revolving facility, the Company also uses several lines of credit totaling $35,500,000 as of December 31, 1995, to manage day-to-day cash flow. The amount borrowed against the lines of credit at December 31, 1995 was $10,500,000. The average balance outstanding on the lines of credit was approximately $16,400,000 during 1995, with a maximum borrowing of $50,500,000 and an average weighted interest rate of 6.46%.\nThe Company has the option to solicit money market interest quotes from the bank group for borrowings under the revolving credit facility. The revolving credit agreement also provides for borrowing at interest rates based on a formula that incorporates the use of the London Interbank Offered Rate (\"LIBOR\") plus an interest rate margin. The interest rate for the term loan is based upon LIBOR, plus an interest rate margin. A facility fee is charged on the facility based on $275,000,000 of the total commitment. The facility fee and the interest rate margin for the revolving credit facility and the term loan are all based upon the ratio of consolidated debt to cash flow, as defined in the credit agreement.\nThe credit agreement contains various restrictive covenants typical of a credit facility of this size and nature. These restrictions primarily pertain to levels of indebtedness, limitations on payment of dividends, limitations on the quality and types of investments, and capital expenditures. Additionally, the Company must also comply with several financial covenant restrictions under the revolving credit agreement, including defined ratios of consolidated debt to cash flow, consolidated debt to consolidated total capital, and fixed charges coverage. As of December 31, 1995, the Company was in compliance with all covenants under its debt agreement.\nThe Company has entered into interest rate swap and cap agreements as a means of managing its interest rate exposure on its floating rate debt. The interest rate swap effectively fixes the interest rate on the $100,000,000 seven-year term loan facility at 5.965% plus the interest rate margin and will expire in March, 2002. The agreement is a contract to exchange fixed and floating interest rate payments periodically over the life of the agreement without the exchange of the underlying notional amounts. The Company will pay the counterparty interest at 5.965%, and the counterparty will pay the Company interest at a variable rate based on the 3-month LIBOR rate. The notional principal amount under the agreement will amortize proportionately to the paydown of the $100,000,000 term loan as described above. The interest differential to be paid or received on interest rate swaps is accrued and included in interest expense for financial reporting purposes. The agreement is with a major financial institution and the Company's credit exposure is limited to the value of the interest-rate swap that has, or may become favorable to the Company.\nThe Company has entered into interest rate caps and corridors in an attempt to minimize the impact of a potential significant rise in short-term interest rates on the Company's outstanding floating rate debt. As of December 31, 1995, the Company had the following interest rate protection instruments: (1) a $50,000,000 notional amount, interest rate corridor from 8%-10%, which is based on the 3-month LIBOR rate and caps the Company's rate at 8% if the index rate exceeds 8% but is less than 10%, and at LIBOR minus 2% if the rate exceeds 10%, and expiring in December 1996; and (2) a $50,000,000 notional amount cap with a strike rate of 9%, which will be permanently eliminated if rates exceed 11%, based on the 3-month LIBOR rate and expiring in December 1997. The combination of the above instruments protects a portion ($100,000,000 for one year, and $50,000,000 for two years) of the Company's variable rate debt from a potential significant rise in short-term interest rates. The Company was required to pay up-front fees related to these instruments at inception of each contract, which are being amortized straight-line over the term of each contract.\nInterest paid, net of amounts capitalized, amounted to approximately $14,021,000, $12,957,000, and $12,580,000 in 1995, 1994, and 1993, respectively. Interest capitalized amounted to $2,303,000, $2,030,000, and $1,161,000, in 1995, 1994, and 1993, respectively.\nEXHIBIT 13\n6. REDEEMABLE PREFERRED STOCK\nOn February 24, 1994, the Company issued 598,656 shares of Series 1994-B Voting Cumulative Preferred Stock having a total redemption value of $22,449,000, or $37.50 per share, in connection with the acquisition of American Funeral Assurance Company. Additionally, on April 1, 1994, the Company issued 668,207 shares of Series 1994-A Voting Cumulative Preferred Stock having a total redemption value of $23,387,000, or $35.00 per share, in connection with the acquisition of State National Capital Corporation. The shares have preference in liquidation, and each share is entitled to one vote on any matters submitted to a vote of the shareholders of the Company. In accordance with the financial reporting requirements of the Securities and Exchange Commission, the preferred stock has been classified outside of permanent equity as Redeemable Preferred Stock.\nBoth the Company and the holders of the preferred stock have the right to redeem any or all of the shares from time to time beginning five years and one month after the date of issue in exchange for cash or shares of the Company's common stock. The Company will determine the form of all redemptions, which will consist of cash, common stock, or a combination of both. Generally, the amount of consideration on the 1994-A Series will be equivalent to $35.00 per share plus the amount of any accumulated and unpaid dividends; and for the 1994-B Series will be equivalent to $37.50 per share plus the amount of any accumulated and unpaid dividends. In addition, each share of the 1994-A Series and 1994-B Series is convertible, at the option of the shareholder, at any time into one share of the Company's common stock (plus a corresponding attached right to acquire a share of the Company's Series A Participating Cumulative Preferred Stock). There is no sinking fund for the redemption of either series of preferred stock.\nDividends shall be paid on the 1994-A Series at the rate of 6% per annum and on the 1994-B Series at the rate of 5.6% per annum. Dividends accrue daily, are cumulative, and are payable quarterly. Both the 1994-A Series and the 1994-B Series are on a parity in rank with all other series of preferred stock of the Company whether or not such series exist now or are created in the future, with respect to payment of all dividends and distributions, unless a series of preferred stock expressly provides that it is junior or senior to the 1994-A and 1994-B Series. No dividends or distributions on the Company's common stock shall be declared or paid until all accumulated and unpaid dividends on the 1994-A Series and 1994-B Series have been declared and set aside for payment.\n7. COMMITMENTS AND CONTINGENCIES\nIn January 1996, a lawsuit was filed against the Company alleging breach of contract in connection with an agreement to develop a state-of-art software system to administer the Company's insurance operations. The suit was filed by the software developer. Management of the Company, after consultation with legal counsel, believes that the lawsuit filed against the Company is without merit and intends to contest the suit vigorously. The Company believes the suit filed against it was in response to a suit filed by the Company in connection with failure of the software developer to deliver the system. The suit against the software developer seeks to recover amounts paid to the software developer, and other costs incurred by the Company, in the attempt to develop the system (see Note 12 to the Consolidated Financial Statements concerning the 1994 charge taken to write-off deferred system costs). The Company believes it will be successful in its lawsuit against the software developer; however, no estimated recovery is included in the accompanying financial statements.\nIn December 1995, a lawsuit was filed against the Company alleging breach of contract. The lawsuit relates to a transaction in which the Company was unsuccessful in acquiring certain entities partially owned by the plaintiff. Management, after consultation with legal counsel, believes the lawsuit is without merit and intends to contest the suit vigorously.\nThe Company and its subsidiaries are also defendants in various lawsuits arising primarily from claims made under insurance policies. Where applicable, these lawsuits are considered in establishing the Company's policy liabilities. It is the opinion of management and legal counsel that the settlement of these actions will not have a material effect on the financial position or results of operations of the Company.\nThe Company has lease agreements, primarily for branch offices, data processing and telephone equipment, which expire on various dates through 2004, none of which are material capital leases. Most of these agreements have optional renewal provisions covering additional periods of one to ten years. All leases were made in the ordinary course of business and contain no significant restrictions or obligations. Future commitments under operating leases are not material. Annual rental expense amounted to approximately $5,825,000, $5,497,000, and $6,225,000 in 1995, 1994, and 1993, respectively.\nMost states have laws requiring solvent life insurance companies to pay guaranty fund assessments to protect the interests of policyholders of insolvent life insurance companies. Due to the recent increase in the number of companies that are under regulatory supervision, there is expected to be an increase in assessments by state guaranty funds. Under present law, most assessments can be recovered through a credit against future premium taxes. The Company has reviewed its exposure to potential assessments, and the effect on its financial position and results of operations is not expected to be material.\nAt December 31, 1995, the Company had commitments for additional investments and other items totaling $44,341,000.\nEXHIBIT 13\n8. SHAREHOLDERS' EQUITY\nOn February 28, 1995, the Company issued 599,985 shares of Series 1995-A Voting Cumulative Convertible Preferred Stock having a total redemption value of $20,999,475 or $35.00 per share in connection with the acquisition of WLOX-TV. The shares have preference in liquidation, and each share is entitled to one vote on any matters submitted to a vote of the shareholders of the Company. Each share of preferred stock is convertible at the option of the holder into one share of common stock. The Company has the right to redeem any or all of the shares from time to time at any time beginning five years and one month after the date of issue in exchange for cash, common stock, or a combination of both. Generally, the amount of consideration on the 1995-A Series will be equivalent to $35.00 per share plus the amount of any accumulated and unpaid dividends. There is no sinking fund for the redemption of the preferred stock.\nDividends shall be paid on the preferred stock at the rate of 5% per annum. Dividends accrue daily, are cumulative, and are payable quarterly. The 1995-A Series preferred stock is on a parity in rank with all other series of preferred stock of the Company whether or not such series exist now or are created in the future, with respect to payment of all dividends and distributions, unless a series of preferred stock expressly provides that it is junior or senior to the 1995-A Series. No dividends or distributions on the Company's common stock shall be declared or paid until all accumulated and unpaid dividends on the 1995-A Series have been declared and set aside for payment.\nThe Company has adopted a Shareholder Rights Plan and declared a dividend of one preferred stock purchase right for each outstanding share of common stock. Upon becoming exercisable, each right entitles the holder to purchase for a price of $150.00 one one-hundredth of a share of Series A Participating Cumulative Preferred Stock. All of the rights may be redeemed by the Company at a price of $.01 per right until ten business days (or such later date as the Board of Directors determines) after the public announcement that a person or group has acquired beneficial ownership of 20 percent or more of the outstanding common shares (\"Acquiring Person\"). Upon existence of an Acquiring Person, the Company may redeem the rights only with the concurrence of a majority of the directors not affiliated with the Acquiring Person. The rights, which do not have voting power and are not entitled to dividends, expire on August 7, 2000. The rights are not exercisable until ten business days after the public announcement that a person either (i) has become an Acquiring Person, or (ii) has commenced, or announced an intention, to make a tender offer or exchange offer if, upon consummation, such person or group would become an Acquiring Person. If, after the rights become exercisable, the Company becomes involved in a merger or certain other major corporate transactions, each right will entitle its holder, other than the Acquiring Person, to receive common shares with a deemed market value of twice such exercise price.\nThere are 10,000,000 shares of preferred stock, no par value per share authorized for issuance. At December 31, 1995, there were 1,862,318 shares of preferred stock outstanding (See Note 6 for discussion of Redeemable Preferred Stock), and 140,000 shares of preferred stock were reserved for issuance in connection with the Shareholder Rights Plan.\nShareholders' equity as determined under generally accepted accounting principles of the Company's insurance operations was $672,694,000 and $525,478,000 at December 31, 1995 and 1994, respectively. The comparable amounts as determined under statutory accounting practices were $166,469,000 and $161,023,000 at December 31, 1995 and 1994, respectively. The amount that retained earnings exceed statutory unassigned surplus ($448,826,000) is restricted and, therefore, not available for dividends. Without regulatory approval, dividends are generally limited to prior year statutory gain from operations.\nThe components of the balance sheet caption unrealized appreciation (depreciation) on fixed maturity securities available for sale and equity securities in shareholders' equity as of December 31 are as follows:\n9. STOCK OWNERSHIP AND STOCK OPTION PLANS\nThe Company has a Performance Incentive Compensation Program (the \"Program\") which provides that the Compensation Committee of the Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company's common stock; or (e) all or any combination of the foregoing to officers and key employees. Only common stock, not to exceed 2,800,000 shares, may be delivered under the Program; and shares so delivered will be made available from the authorized but unissued shares or from shares reacquired by the\nEXHIBIT 13\nCompany, including shares purchased in the open market. The aggregate number of shares that may be acquired by any participant in the Program shall not exceed 20% of the shares subject to the Program. As of December 31, 1995, fifty-nine officers and employees were participants in the Program.\nRestricted shares awarded to participants under the Program vest in equal annual installments, generally over the five-year period commencing on the date the shares are awarded. Non-vested shares may not be assigned, transferred, pledged or otherwise encumbered or disposed of. During the applicable restriction period, the Company retains possession of the certificates for the restricted shares with executed stock powers attached. Participants are entitled to dividends and voting rights with respect to the restricted shares.\nStock options under the Program are issued at 100% of the market price on the date of grant, are vested over such period of time, which may not be less than one year, as may be established by the Compensation Committee, and expire ten years after the grant. Of the incentive stock options outstanding, 51,165 were exercisable at December 31, 1995; 81,465 were exercisable at December 31, 1994; and 116,240 were exercisable at December 31, 1993. Of the non-qualified options outstanding, 290,480 were exercisable at December 31, 1995; 268,500 were exercisable at December 31, 1994; and 191,800 were exercisable at December 31, 1993. The options expire on various dates beginning February 12, 1996, and ending August 15, 2005.\nThe following schedule summarizes activity in the Program during the three years ending December 31, 1995.\nAt December 31, 1995, there were 414,380 shares of the Company's stock reserved for future grants under the Program.\n10. EMPLOYEE BENEFITS\nThe Company has several postretirement plans that provide medical and life insurance benefits for qualified retired employees. The postretirement medical plans are generally contributory with retiree contributions adjusted annually to limit employer contributions to predetermined amounts. The postretirement life plans provide free insurance coverage up to a maximum of $5,000 for retirees prior to January 1, 1993, of the Company with the exception of Cosmos, whose retirees are insured with an outside company.\nEXHIBIT 13\nNet periodic postretirement benefit cost was $1,506,000, $1,516,000, and $1,477,000 for the years ended December 31, 1995, 1994, and 1993, respectively, and included the following components:\nThe following schedule reconciles the status of the Company's plans with the unfunded postretirement benefit obligation included in its balance sheets at December 31:\nAt December 31, 1995, the weighted-average annual assumed rate of increase in the per capita cost of covered medical benefits is 9.5% for 1996, and is assumed to decrease by 0.5% per year to 8% in 1999, then decrease 1% per year to 5.5% in 2002 and thereafter. At December 31, 1994, the health care cost trend rate assumption was 10% and the rate graded down by 0.5% per year to 8% in 1999, then decreased 1% per year to 6% in 2001 and thereafter. A 1% increase in the per capita cost of health care benefits results in a $679,000 increase in the accrued postretirement benefit obligation and a $55,000 increase in postretirement benefit expense. The assumed weighted average discount rate used in determining the accrued postretirement medical and life benefit obligation was 7.5% and 8% at December 31, 1995 and 1994, respectively.\nThe Company has profit sharing plans for substantially all of its employees. Contributions to these plans are made at the discretion of the Board of Directors and are paid into a trust that is administered by a separate trustee. Contributions for these plans were $5,067,000, $4,840,000, and $4,234,000, in 1995, 1994 and 1993, respectively.\nThe Company has a voluntary thrift and investment plan, qualified under Section 401(k) of the Internal Revenue Code, for substantially all of its employees. The Company makes a matching contribution to the plan of up to 3% of the employee's compensation. The Company's matching contribution percentage may be changed at the discretion of each participating subsidiary's Board of Directors. The Company's contributions for this plan were $2,102,000, $2,148,000, and $2,020,000 in 1995, 1994, and 1993, respectively.\n11. PROVISION FOR INCOME TAXES\nThe provision for income taxes consists of the following:\nEXHIBIT 13\nDeferred income taxes reflect 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. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994, are as follows:\nAt December 31, 1995, the Company had unrealized gains from securities classified as available for sale and equity securities of $97,586,000, for which a deferred tax liability has been established. At December 31, 1994, the Company had unrealized losses from securities classified as available for sale and equity securities of $64,401,000. For financial reporting purposes, a valuation allowance of $11,021,000 was established to offset a portion of the deferred tax asset related to these unrealized losses. The Company also established a valuation allowance of $842,000 in connection with certain capital loss carryforwards in 1994. No valuation allowances were recognized at December 31, 1995, because the December 31, 1994 unrealized losses and capital loss carryforwards were offset against 1995 unrealized and realized gains.\nThe reconciliation of income tax computed at the U.S. federal statutory tax rates to income tax expense is:\nThe Company has net operating loss carryforwards of $5,481,000 and $11,110,000 at December 31, 1995 and 1994, which will expire between the years 2006 and 2008. The utilization of these carryforwards are subject to special rules which provide that these loss carryforwards can only be utilized through earnings from the non-life insurance companies.\nIncome taxes paid were approximately $21,199,000, $21,911,000, and $18,437,000 in 1995, 1994, and 1993, respectively.\nUnder prior tax law, a portion of the life insurance subsidiaries' earnings was not taxed when earned. Such accumulated income (\"policyholders' surplus\") amounts to approximately $65,293,000 at December 31, 1983 and, under the Tax Reform Act of 1984, was frozen at that amount. That amount is not taxable unless it is distributed to the Company or unless it exceeds certain limitations under the Internal Revenue Code. The Company does not intend to take actions nor does it expect any events to occur that would cause tax to be","section_15":""}
{"filename":"815097_1995.txt","cik":"815097","year":"1995","section_1":"Item 1. Business\nA. General\nCarnival Corporation was incorporated under the laws of the Republic of Panama in November 1974. Carnival Corporation and subsidiaries (the \"Company\") is the world's largest multiple-night cruise company based on the number of passengers carried and revenues generated. The Company offers a broad range of cruise products, offering contemporary cruises through Carnival Cruise Lines (\"Carnival\" - a division of Carnival Corporation), premium cruises through Holland America Line and luxury cruises through Windstar Cruises and the Company's joint venture, Seabourn Cruise Line. As of January 1996, the ten Carnival ships have an aggregate capacity of 16,796* passengers with itineraries in the Caribbean and Mexican Riviera. As of January 1996, the seven Holland America Line ships have an aggregate capacity of 8,795 passengers with itineraries in the Caribbean and Alaska and through the Panama Canal, as well as other worldwide itineraries. The three Windstar ships, as of January 1996, have an aggregate capacity of 444 passengers with itineraries in the Caribbean, the South Pacific, and the Mediterranean. During 1995, Seabourn Cruise Line operated two 204 passenger cruise ships with itineraries in the Caribbean, the Baltic, the Mediterranean and the Far East. In January 1996, Seabourn entered into an agreement to acquire a third 204 passenger ship which will begin operation during 1996. In April 1995, the Company sold its 49% equity interest in Epirotiki Line, a Greek cruise operator, for $25 million.\nThe Company has signed agreements with a Finnish shipyard providing for the construction of three additional 2,040-berth SuperLiners for Carnival with delivery now expected in February 1996, March 1998 and November 1998. Two additional 2,640-berth cruise vessels are under contract for construction for Carnival from an Italian shipyard now scheduled for delivery in September 1996 and December 1998. The Company also has agreements with the same Italian shipyard for one 1,266-berth cruise ship and one 1,320-berth cruise ship for Holland America Line with delivery expected in April 1996 and September 1997, respectively. In December 1995, the Company entered into an agreement to charter the 1,146 passenger Carnival cruise ship, Festivale, to Dolphin Cruise Line effective April 28,1996.\nThe Company also operates a tour business: Holland America Westours. Holland America Westours markets sight-seeing tours both separately and as part of Holland America Line cruise\/tour packages. Holland America Westours operates 16 hotels in Alaska and the Canadian Yukon, three luxury day-boats offering tours to the glaciers of Alaska and the Yukon River, over 290 motor coaches used for sight-seeing and charters in the states of Washington and Alaska and in the Canadian Rockies and ten private domed rail cars which are run on the Alaskan railroad between Anchorage and Fairbanks.\nThe Company and Airtours Plc, a United Kingdom public company in the tour business, have been in discussions with regard to future cooperation which could lead to the Company acquiring a stake of less than 30 percent of the equity of Airtours Plc through a purchase of newly issued shares and a partial offer to all existing shareholders. No assurance can be given that any agreement will be reached.\n* In accordance with industry practice all capacities indicated within this document are calculated based on two passengers per cabin even though some cabins can accommodate three or four passengers.\nB. Cruise Ship Segment\nIndustry\nThe passenger cruise industry as it exists today began in approximately 1970. Over time, the industry has evolved from a trans-ocean carrier service into a vacation alternative to land-based resorts and sight-seeing destinations. According to Cruise Lines International Association (\"CLIA\"), an industry trade group, approximately 500,000 North American passengers took cruises in 1970 for three consecutive nights or more. CLIA estimates that this number reached 4.5 million passengers in 1993, an average compound annual growth rate of 10% since 1970. Also, according to CLIA, by the end of 1993 the number of ships in service totaled 139 with an aggregate capacity of approximately 104,000 berths.\nCLIA estimates that the number of passengers carried in North America declined from 4.5 million in 1993 to 4.3 million in 1995. The Company nevertheless has been able to increase the number of passengers it carried by approximately 200,000 in each of the past two years. The number of berths in the industry remained effectively flat totaling 105,000 berths on 126 ships at the end of 1995. CLIA estimates that the number of cruise passengers will grow to 4.7 million in 1996. CLIA also projects that by the end of 1996, North America will be served by 133 vessels having an aggregate capacity of approximately 116,000 berths.\nThe following table sets forth the industry and Company growth over the past five years based on passengers carried for at least three consecutive nights:\n- ------------------------------ *Source: CLIA. - ------------------------------\nFrom 1991 through 1995, the Company's average compound annual growth rate in number of passengers carried was 8.8% versus the industry average of 2.0%.\nThe Company's passenger capacity has grown from 17,973 at November 30, 1991 to 26,035 at November 30, 1995. The delivery of the Statendam, Sensation and Maasdam in 1993 increased capacity an additional 4,572 berths, more than offsetting a decrease of 906 berths related to the sale of the Mardi Gras. During 1994, net capacity increased by 2,369 berths due to the delivery of the Fascination and Ryndam, net of the sale of the 937 berth FiestaMarina. In 1995, with the delivery of the Imagination, capacity increased 2,040 berths.\nIn spite of the cruise industry's growth since 1970, the Company believes cruises represent only approximately 2% of the applicable North American vacation market, defined as persons who travel for leisure purposes on trips of three nights or longer involving at least one night's stay in a hotel. Only an estimated 7% of the North American population has ever cruised.\nCruise Ships and Itineraries\nUnder the Carnival Cruise Lines name, the Company operates ten ships (collectively, the \"Carnival Ships\") which offer contemporary cruises. Nine of the Carnival Ships were designed by and built for Carnival, including eight SuperLiners which are among the largest in the cruise industry. The tenth vessel, the Festivale, which was not built for Carnival, will be chartered to Dolphin Cruise Line effective April 28, 1996. During 1995, eight of the Carnival Ships operated in the Caribbean and two Carnival Ships called on ports in the Mexican Riviera. During 1996 one of the Carnival Ships, the Tropicale, will begin operating in Alaska during the summer season and Carnival will also offer cruises through the Panama Canal and to the Hawaiian Islands.\nThrough its subsidiary, HAL Antillen N.V. (\"HAL\"), the Company operates ten cruise ships offering premium or luxury cruises. Seven of these ships, the Rotterdam, the Nieuw Amsterdam, the Noordam, the Westerdam, the Statendam, the Maasdam and the Ryndam are operated under the Holland America Line name (the \"HAL Ships\"). The remaining three ships, the Wind Star, the Wind Song and the Wind Spirit, are operated under the Windstar Cruises name (the \"Windstar Ships\"). Six of the HAL Ships were designed by and built for HAL. The three Windstar Ships were built for Windstar Sail Cruises, Ltd. ( \"WSCL\") between 1986 and 1988.\nThe HAL Ships offer premium cruises of various lengths, primarily in the Caribbean, Alaska, Panama Canal, Europe, the Mediterranean, Hawaii, Mexico, South Pacific, South America and the Orient. Cruise lengths vary from 3 to 98 days, with a large proportion being seven or ten days in length. Periodically, the HAL Ships make longer grand cruises or operate on short-term special itineraries. For example, in 1995, the Rotterdam made an 85-day world cruise, and a 34-day Grand South Pacific voyage. HAL will continue to offer these special and longer itineraries in order to increase travel opportunities for its customers and strengthen its cruise offerings in view of the fleet expansion. The majority of the HAL Ships operate in the Caribbean during fall to late spring and in Alaska during late spring to early fall. The three Windstar Ships currently operate in the Caribbean, the Mediterranean and the South Pacific.\nThe following table presents summary information concerning the Company's ships. Areas of operation are based on 1995 itineraries and are subject to change.\n________________________________________\n* In accordance with industry practice passenger capacity is calculated based on two passengers per cabin even though some cabins can accommodate three or four passengers.\nCruise Ship Constructions\nThe Company is currently constructing five cruise ships to be operated under the Carnival name and two cruise ships to be operated under the Holland America Line name. The following table presents summary information concerning ships under construction:\n(1) Contracts denominated in a foreign currency and have been fixed into U.S. Dollars through the use of forward currency contracts.\nOther Cruise Activities\nThe Company has a 50% equity interest in a joint venture company (\"Seabourn\") which in April 1992 acquired the cruise operations of K\/S Seabourn Cruise Line. The Company also has a subordinated secured ten-year loan of $15 million to Seabourn. During 1995, Seabourn operated two ultra-luxury ships, which have an aggregate capacity of 408 passengers and have itineraries in the Caribbean, the Baltic, the Mediterranean and the Far East. In January 1996, Seabourn entered into an agreement to acquire a third ship with a capacity of 204 which will begin operation during 1996.\nCruise Tariffs\nUnless otherwise noted herein, brochure prices include round trip airfare from over 175 cities in the United States and Canada. If a passenger chooses not to have the Company provide air transportation, the ticket price is reduced. Brochure prices vary depending on size and location of cabin, the time of year that the voyage takes place, and when the booking is made. The cruise brochure price includes a wide variety of activities and facilities, such as a fully equipped casino, nightclubs, theatrical shows, movies, parties, a discotheque, a health club and swimming pools on each ship. The brochure price also includes numerous dining opportunities daily.\nBrochure pricing information below is per person based on double occupancy:\n- ----------------------------------------------------- (1) Prices represent cruise only - -----------------------------------------------------\nBrochure prices are regularly discounted through the Company's early booking discount program and other promotions.\nOn-Board and Other Revenues\nThe Company derives revenues from certain on-board activities and services including casino gaming, liquor sales, gift shop sales, shore tours, photography and promotional advertising by merchants located in ports of call.\nThe casinos, which contain slot machines and gaming tables including blackjack, craps, roulette and stud poker are generally open only when the ships are at sea in international waters. The Company also earns revenue from the sale of alcoholic and other beverages. Certain onboard activities are managed by independent concessionaires from which the Company collects a percentage of revenues, while certain others are managed by the Company.\nThe Company receives additional revenue from the sale to its passengers of shore excursions at each ship's ports of call. On the Carnival Ships, such shore excursions are operated by independent tour operators and include bus and taxi sight-seeing excursions, local boat and beach parties, and nightclub and casino visits. On the HAL Ships, shore excursions are operated by Holland America Westours and independent parties.\nIn conjunction with its cruise vacations on the Carnival Ships, the Company sells pre- and post-cruise land packages. Such packages generally include one, two or three-night vacations at locations such as Walt Disney World in Orlando, Florida or resorts in the South Florida and the San Juan Puerto Rico areas.\nIn conjunction with its cruise vacations on the HAL Ships, HAL sells pre-cruise and post-cruise land packages which are more fully described below. (See \"Item 1. Business - Tour Segment\")\nPassengers\nThe following table sets forth the aggregate number of passengers carried and percentage occupancy for the Company's ships for the periods indicated:\n- ----------------------------------------- *In accordance with industry practice, total capacity is calculated based on two passengers per cabin even though some cabins can accommodate three or four passengers. Occupancy percentages in excess of 100% indicate that more than two passengers occupied some cabins. - ----------------------------------------- The following table sets forth the actual occupancy percentage for all cruises on the Company's ships during each quarter for the fiscal years ended November 30, 1994 and November 30, 1995:\nSales and Marketing\nThe Company markets the Carnival Ships as the \"Fun Ships \" and uses the themes \"Carnival's Got the Fun \" and \"The Most Popular Cruise Line in the World \", among others.\nCarnival advertises nationally directly to consumers on network television and through extensive print media featuring its spokesperson, Kathie Lee Gifford. Carnival believes its advertising generates interest in cruise vacations generally and results in a higher degree of consumer awareness of the \"Fun Ships \" concept and the \"Carnival \" name. Substantially all of Carnival's cruise bookings are made through travel agents, which arrangement is encouraged as a matter of policy. In fiscal 1995, Carnival took reservations from about 29,000 of approximately 45,000 travel agencies in the United States and Canada. Travel agents receive a standard commission of 10% (15% in the State of Florida), plus the potential of an additional commission based on sales volume. Moreover, because cruise vacations are substantially all-inclusive, sales of Carnival cruise vacations yield a significantly higher commission to travel agents than selling air tickets and hotel rooms. During fiscal 1995, no one travel agency accounted for more than 2% of Carnival's revenues.\nCarnival engages in substantial promotional efforts designed to motivate and educate retail travel agents about its \"Fun Ships \" cruise vacations. Carnival employs approximately 90 field sales representatives and 30 in-house service representatives to motivate independent travel agents and promote its cruises. Carnival believes it has the largest sales force in the industry.\nTo facilitate access and to simplify the reservation process, Carnival employs approximately 360 reservation agents to take bookings from independent travel agents. Carnival's fully-automated reservation system allows its reservation agents to respond quickly to book cabins on its ships. Carnival has a policy of pricing comparable cabins (based on size, location and length of voyage) on its various ships at the same rate (\"common rating\"). Such common rate includes round-trip airfare, which means that any passenger can fly from any one of over 140 cities in the United States and Canada to ports of embarkation for the same price. Through common rating, Carnival is able to offer customers a wider variety of voyages for the same price, which the Company believes improves occupancy on all its cruises. However, discounts from brochure prices may vary depending upon the ship, itinerary, time of year and demand for each cruise.\nCarnival's cruises generally are substantially booked several months in advance of the sailing date. This lead time allows Carnival to adjust its prices, if necessary, in relation to demand for available cabins, as indicated by the level of advance bookings. Carnival's SuperSaver fares, introduced several years ago, are designed to encourage potential passengers to book cruise reservations earlier, which helps the Company to more effectively manage yields (pricing and occupancy). Carnival's payment terms require that a passenger pay approximately 15% of the cruise price within 7 days of the reservation date and the balance not later than 45 days before the sailing date for 3- and 4-day cruises and 60 days before the sailing date for 7-day cruises.\nCarnival believes that its success is due in large part to its unique product positioning within the industry. Carnival markets the Carnival Ship cruises as vacation alternatives to land-based resorts and sight-seeing destinations. Carnival seeks to attract passengers from the broad vacation market, including those who have never been on a cruise ship before and who might not otherwise consider a cruise as a vacation alternative. Carnival's strategy has been to emphasize the cruise experience itself rather than particular destinations, as well as the advantages of a prepaid, all-inclusive vacation package. Carnival markets the Carnival Ship cruises as the \"Fun Ships \" experience, which includes a wide variety of shipboard activities and entertainment, such as full-scale casinos and nightclubs, an atmosphere of pampered service and unlimited food.\nThe Company's products are positioned to offer contemporary, premium and luxury cruises. Luxury cruises typically will have per diems of $300 or higher. Premium cruises typically last 7 to 14 days or more at per diems of $250 or higher. Contemporary cruises typically are 7 days or shorter in length, are priced at per diems of $200 or less, and feature a casual ambiance. The Company believes that the success and growth of the Carnival cruises is attributable to its longstanding efforts to promote contemporary cruise products.\nThe HAL and Windstar Ships offer premium and luxury cruises, respectively. The Company believes that the hallmarks of the HAL experience are beautiful ships and gracious attentive service. HAL communicates this difference as \"A Tradition of Excellence \", a reference to its long standing reputation as a first class and grand cruise line.\nSubstantially all of HAL's bookings are made through travel agents, which arrangement HAL encourages as a matter of policy. In fiscal 1995, HAL took reservations from about 20,000 of approximately 45,000 travel agencies in the U.S. and Canada. Travel agents receive a standard commission of between 10% and 15%, depending on the specific cruise product sold, with the potential for override commissions based upon sales volume. During 1995, no one travel agency accounted for more than 1% of HAL's total revenue.\nHAL has focused much of its sales effort at creating an excellent relationship with the travel agency community. This is related to the HAL marketing philosophy that travel agents have a large impact on the consumer cruise selection process and will recommend HAL more often because of its excellent reputation for service to both consumers and independent travel agents. HAL solicits continuous feedback from consumers and the independent travel agents making bookings with HAL to insure they are receiving excellent service.\nHAL's marketing communication strategy is primarily composed of newspaper and magazine advertising, large scale brochure distribution and direct mail solicitations to past passengers (referred to as \"alumni\") and television. HAL engages in substantial promotional efforts designed to motivate and educate retail travel agents about its products. HAL employs approximately 50 field sales representatives, 15 teleaccount sales representatives and 15 sales and service representatives to support the field sales force. Carnival's approximately 90 field sales representatives also promote HAL products. To facilitate access to HAL and to simplify the reservation process for the HAL ships, HAL employs approximately 260 reservation agents to take bookings from travel agents. HAL's cruises generally are booked several months in advance of the sailing date. The Company also solicits current and former passengers of the Carnival Ships to take future cruises on the HAL and Windstar Ships.\nWindstar Cruises has its own marketing and reservations staff. Field sales representatives for both HAL and Carnival act as field sales representatives for Windstar. Marketing efforts are primarily devoted to a) travel agent support and awareness, b) direct mail solicitation of past passengers, and c) distribution of brochures.\nWindstar's marketing efforts feature the distinctive nature of its graceful, modern sail ships and the distinctive \"casually elegant\" experience on \"intimate itineraries\" (apart from the normal cruise experience). Windstar's philosophy is embodied in the phrase \"180 degrees from ordinary\".\nSeasonality\nThe Company's revenue from the sale of passenger tickets for the Carnival Ships is moderately seasonal. Historically, demand for Carnival cruises has been greater during the periods from late December through April and late June through August. Demand traditionally is lower during the period from September through mid-December and during May. To allow for full availability during peak periods, drydocking maintenance is usually performed in September, October and early December. HAL cruise revenues are more seasonal than Carnival's cruise revenues. Demand for HAL cruises is strongest during the summer months when HAL ships operate in Alaska and Europe and HAL obtains higher prices for these summer products. Demand for HAL cruises is lower during the winter months when HAL ships sail in more competitive markets.\nCompetition\nCruise lines compete for consumer disposable leisure time dollars with other vacation alternatives such as land-based resort hotels and sight-seeing destinations, and public demand for such activities is influenced by general economic conditions.\nCruise ships operated by six other cruise lines offer year round itineraries year round which are similar to those offered by the Carnival Ships sailing from ports in Florida, California and Puerto Rico. Cruise ships operated by an additional ten other cruise lines offer similar itineraries from these ports on a seasonal basis. The HAL Ships are among those which seasonally offer similar itineraries from these ports. Ships operated by Royal Caribbean Cruise Line and Norwegian Cruise Line sail regularly from Miami on itineraries quite similar to those of the Carnival Ships. Ships operated by Royal Caribbean Cruise Line and Princess Cruises embark from Los Angeles to the west coast of Mexico. Cruise lines such as Norwegian Cruise Line, Royal Caribbean Cruise Line, Costa Cruise Lines, Cunard and Princess Cruises offer voyages from San Juan to the Caribbean.\nIn Alaska, cruise ships operated by ten other cruise lines offer itineraries similar to those offered by HAL. The largest of these cruise lines in Princess Cruises.\nIn the Caribbean, cruise ships operated by 16 different cruise lines offer itineraries similar to those offered by HAL. After Carnival, the largest of these cruise lines are Princess Cruises, Royal Caribbean Cruise Line, and Norwegian Cruise Line.\nGovernmental Regulation\nThe Ecstasy, Fantasy, Celebration and Tropicale are Liberian flagged ships, the Festivale is a Bahamian flagged ship, and the balance of the Carnival Ships are registered in Panama. The Ryndam, Maasdam, Statendam and Westerdam are registered in the Bahamas, while the balance of the HAL Ships are flagged in the Netherlands Antilles. The Windstar Ships are registered in the Bahamas. The ships are subject to inspection by the United States Coast Guard for compliance with the Convention for the Safety of Life at Sea and by the United States Public Health Service for sanitary standards. The Company is also regulated by the Federal Maritime Commission, which, among other things, certifies ships on the basis of the ability of the Company to meet obligations to passengers for refunds in case of non-performance. The Company believes it is in compliance with all material regulations applicable to its ships and has all licenses necessary to the conduct of its business. In connection with a significant portion of its Alaska cruise operations, HAL relies on a concession permit from the National Park Service to operate its cruise ships in Glacier Bay National Park, which is periodically renewed. There can be no assurance that the permits will continue to be renewed or that regulations relating to the renewal of such permits, including preference rights, will remain unchanged in the future.\nThe International Maritime Organization has adopted safety standards as part of the \"Safety of Life at Sea\" (\"SOLAS\") Convention, applicable generally to all passenger ships carrying 36 or more passengers. Generally, SOLAS imposes enhanced vessel structural requirements designed to improve passenger safety. The SOLAS requirements are phased in through the year 2010. However, certain stringent SOLAS fire safety requirements must be implemented by 1997. Only two of the Company's vessels, Carnival's Festivale, and HAL's Rotterdam are expected to be significantly affected by the SOLAS 1997 requirements. The decision regarding the additional SOLAS related investments for these two ships is expected to be made during 1996.\nPublic Law 89-777 administered by the Federal Maritime Commission (\"FMC\")requires most cruise line operators to establish financial responsibility for nonperformance of transportation. The FMC's regulations require that a cruise line demonstrate its financial responsibility through a guaranty, escrow arrangement, surety bond, insurance or self-insurance. Currently, the amount required must equal 110% of the cruise line's highest amount of customer deposits over a two-year period up to a maximum coverage level of $15 million, subject to a sliding scale. The FMC has proposed elimination of the $15 million ceiling and revising the existing sliding scale to require coverage for 110% of customer deposits up to $25 million and additional coverage of either (i) 90% of amounts exceeding $25 million or (ii) 75% of customer deposits in excess of $25 million and less than $50 million and 50% coverage of amounts in excess of $50 million. The FMC is also considering elimination of the self-insurance provisions. The proposed new regulations are viewed favorably by the Company and are not expected to have a material effect on the Company. The FMC has received public comments regarding the proposed regulations and may take final action at any time.\nFrom time to time, various other regulatory and legislative changes have been or may in the future be proposed that could have an effect on the cruise industry in general.\nFinancial Information\nFor financial information about the Company's cruise ship segment with respect to the three fiscal years ended November 30, 1995, see Note 10 \"Segment Information\" to the Company's Consolidated Financial Statements as of November 30, 1995 in Exhibit 13 incorporated by reference into this document.\nC. Tour Segment\nIn addition to its cruise business, HAL markets sight-seeing tours separately and as a part of cruise\/tour packages under the Holland America Westours name. Tour operations are based in Alaska, Washington State and western Canada. Since a substantial portion of Holland America Westours' business is derived from the sale of tour packages in Alaska during the summer tour season, tour operations are highly seasonal.\nHolland America Westours\nHolland America Line-Westours Inc. (\"Holland America Westours\") is a wholly-owned subsidiary of HAL. The group of subsidiaries which together comprise the tour operations perform three independent yet interrelated functions. During 1995, as part of an integrated travel program to destinations in Alaska and the Canadian Rockies, the tour service group offered 51 different tour programs varying in length from 7 to 19 days. The transportation group and hotel group support the tour service group by supplying facilities needed to conduct tours. Facilities include dayboats, motor coaches, rail cars and hotels.\nThree luxury dayboats perform an important role in the integrated Alaska travel program offering tours to the glaciers and fjords of Alaska and the Yukon River. The Fairweather cruises the Lynn Canal in Southeast Alaska, the Yukon Queen cruises the Yukon River between Dawson City, Yukon Territory and Eagle, Alaska and the Ptarmigan operates on Portage Lake in Alaska. The three dayboats have a combined capacity of 489 passengers.\nA fleet of over 290 motor coaches using the trade name Gray Line operate in Alaska, Washington and western Canada. These motor coaches are used for extended trips, city sight-seeing tours and charter hire. HAL conducts its tours both as part of a cruise\/tour package and as individual sight-seeing products sold under the Gray Line name. In addition, HAL operates express Gray Line motor coach service between downtown Seattle and the Seattle-Tacoma International Airport.\nTen private domed rail cars, which are called \"McKinley Explorers\", run on the Alaska railroad between Anchorage and Fairbanks, stopping at Denali National Park.\nIn connection with its tour operations, HAL owns or leases motor coach maintenance shops in Seattle, and at Juneau, Fairbanks, Anchorage, Skagway and Ketchikan in Alaska. HAL also owns or leases service offices at Anchorage, Fairbanks, Juneau, Ketchikan and Skagway in Alaska, at Whitehorse in the Yukon Territory, in Seattle and at Vancouver in British Columbia. Certain real property facilities on federal land are used in HAL's tour operations pursuant to permits from the applicable federal agencies.\nWestmark Hotels\nHAL owns and\/or operates 16 hotels in Alaska and the Canadian Yukon under the name Westmark Hotels. Four of the hotels are located in Canada's Yukon Territory and offer a combined total of 585 rooms. The remaining 12 hotels, all located throughout Alaska, provide a total of 1,649 rooms, bringing the total number of hotel rooms to 2,234.\nThe hotels play an important role in HAL's tour program during the summer months when they provide accommodations to the tour passengers. The hotels located in the larger metropolitan areas remain open during the entire year, acting during the winter season as centers for local community activities while continuing to accommodate the traveling public. HAL hotels include dining, lounge and conference or meeting room facilities. Certain hotels have gift shops and other tourist services on the premises.\nThe hotels are summarized in the following table:\nThirteen of the hotels are owned by a HAL subsidiary. The remaining three hotels, Westmark Anchorage, Westmark Cape Fox and Westmark Shee Atika are operated under arrangements involving third parties such as management agreements and leases.\nFor the hotels that operate year-round, the occupancy percentage for 1995 was 58.9%, and for the hotels that operate only during the summer months, the occupancy percentage for 1995 was 76.7%.\nSeasonality\nThe Company's tour revenues are extremely seasonal with a large majority generated during the late spring and summer months in connection with the Alaska cruise season. Holland America Westours' tours are conducted in Washington, Alaska and the Canadian Rockies. The Alaska and Canadian Rockies tours coincide to a great extent with the Alaska cruise season, May through September. Washington tours are conducted year-round although demand is greatest during the summer months. During periods in which tour demand is low, HAL seeks to maximize its motor coach charter activity such as operating charter tours to ski resorts in Washington and Canada.\nSales and Marketing\nHAL tours are marketed both separately and as part of cruise-tour packages. Although most HAL cruise-tours include a HAL cruise as the cruise segment, other cruise lines also market HAL tours as a part of their cruise tour packages and sight-seeing excursions. Tours sold separately are marketed through independent travel agents and also directly by HAL, utilizing sales desks in major hotels. General marketing for the hotels is done through various media in Alaska, Canada and the continental United States. Travel agents, particularly in Alaska, are solicited, and displays are used in airports in Seattle, Washington, Portland, Oregon and various Alaskan cities. Rates at Westmark Hotels are on the upper end of the scale for hotels in Alaska and the Canadian Yukon.\nConcessions\nCertain tours in Alaska are conducted on federal property requiring concession permits from the applicable federal agencies such as the National Park Service or the United States Forest Service.\nCompetition\nHolland America Westours competes with independent tour operators and motor coach charter operators in Washington, Alaska and the Canadian Rockies. The primary competitors in Alaska are Princess Tours (which owns approximately 130 motor coaches and three hotels) and Alaska Sightseeing\/Trav-Alaska (which owns approximately 43 motor coaches). The primary competitor in Washington is Gazelle (with approximately 18 motor coaches). The primary competitors in the Canadian Rockies are Tauck Tours, Princess Tours and Brewster Transportation.\nWestmark Hotels compete with various hotels throughout Alaska, including the Super 8 national motel chain, many of which charge prices below those charged by HAL. Dining facilities in the hotels also compete with the many restaurants in the same geographic areas.\nGovernment Regulation\nHAL's motor coach operations are subject to regulation both at the federal and state levels, including primarily the U.S. Department of Transportation, the Washington Utilities and Transportation Commission, the British Columbia Motor Carrier Commission and the Alaska Transportation Commission. Certain of HAL's tours involve federal properties and are subject to regulation by various federal agencies such as the National Park Service, the Federal Maritime Administration and the U.S. Forest Service.\nIn connection with the operation of its beverage facilities in the Westmark Hotels, HAL is required to comply with state, county and\/or city ordinances regulating the sale and consumption of alcoholic beverages. Violations of these ordinances could result in fines, suspensions or revocation of such licenses and preclude the sale of any alcoholic beverages by the hotel involved.\nIn the operation of its hotels, HAL is required to comply with applicable building and fire codes. Changes in these codes have in the past and may in the future, require substantial capital expenditures to insure continuing compliance such as the installation of sprinkler systems.\nFinancial Information\nFor financial information about the Company's tour segment with respect to the three fiscal years ended November 30, 1995, see Note 10 \"Segment Information\" to the Company's Consolidated Financial Statements as of November 30, 1995 in Exhibit 13 incorporated by reference into this document.\nD. Employees\nThe Company's Carnival operations have approximately 1,300 full-time and 250 part-time employees engaged in shoreside operations. Carnival also employs approximately 360 officers and approximately 7,200 crew and staff on the Carnival Ships.\nThe Company's HAL operations have approximately 2,900 employees engaged in shoreside, tour and hotel operations, of which approximately 1,500 employees hold part-time\/seasonal positions. HAL also employs approximately 220 officers and approximately 3,300 crew and staff on the HAL Ships and Windstar Ships. Due to the seasonality of its Alaska and Canadian operations, HAL tends to increase its work force during the summer months, employing significant additional full-time and part-time personnel. HAL has entered into agreements with unions covering employees in certain of its hotels and certain of its tour and ship employees.\nThe Company considers its employee relations generally to be good.\nE. Suppliers\nThe Company's largest purchases are for airfare, advertising, fuel, food and related items, hotel supplies and products related to passenger accommodation. Although the Company chooses to use a limited number of suppliers for most of its food and fuel purchases, most of the necessary supplies are available from numerous sources at competitive prices. The use of a limited number of suppliers enables the Company to obtain volume discounts.\nF. Insurance\nThe Company maintains insurance covering legal liabilities related to crew, passengers and other third parties on the Carnival Ships and the HAL Ships in operation through The Standard Steamship Owners Protection & Indemnity Association (Bermuda) Limited (the \"SSOPIA\") and the Steamship Mutual Underwriting Association Ltd. (the \"SMUAL\"). The amount and terms of these insurances are governed by the rules of the foregoing associations.\nThe Company currently maintains insurance on the hull and machinery of each vessel in amounts equal to the approximate market value of each vessel. The Company maintains war risk insurance on each vessel which includes legal liability to crew and passengers including terrorist risks for which coverage would be excluded from SSOPIA or SMUAL. The coverage for hull and machinery and war risks is effected with international markets, including underwriters at Lloyds. The Company, as required by the FMC, maintains at all times two $15 million performance bonds for the Carnival Ships, and the HAL and Windstar Ships, respectively, to cover passenger ticket liabilities in the event of a canceled or interrupted cruise. See \"CRUISE SHIP SEGMENT - Government Regulation\" for a discussion of changes to the performance bond requirements proposed by the FMC.\nThe Company maintains certain levels of self insurance for liabilities and hull and machinery through the use of substantial deductibles. Such deductibles may be increased in the future. The Company does not carry coverage related to loss of earnings or revenues for its cruise operations.\nThe Company also maintains various insurance policies to protect the assets, earnings and liabilities arising from the operation of HAL Westours.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's cruise ships are described in Section B of Item 1 under the heading \"Cruise Ship Segment\". The properties associated with HAL's tour operations are described in Section C of Item 1 under the heading \"Tour Segment\".\nCarnival's shoreside operations and corporate headquarters are located at 3655 N.W. 87th Avenue, Miami, Florida, and consists of approximately 231,000 square feet of office space which the Company purchased in December 1994. In order to provide space for the future growth of Carnival and to consolidate existing personnel, approximately 225,000 square feet of office space is being constructed next to the existing facility with an estimated completion date of July 1996. Carnival is also leasing approximately 60,000 square feet of office space at 5225 N.W. 87th Avenue, Miami, Florida until the new facility is completed.\nHAL headquarters are at 300 Elliott Avenue West in Seattle, Washington in leased space in an office building. The lease is for approximately 120,000 square feet.\nItem 3.","section_3":"Item 3. Legal Proceedings\nA purported class action suit was filed against the Company on September 19, 1995 and was subsequently dismissed by the court on jurisdictional grounds on December 15,1995. The suit alleged that the Company had violated the Florida Deceptive and Unfair Trade Practices Act by overcharging passengers for port charges. The plaintiffs refiled their suit in the same court on December 27, 1995 and modified the complaint to add various federal law claims and a state fraud claim. The suit seeks declaratory relief to enjoin the Company from further alleged overcharges and seeks compensatory and punitive damages in an unspecified amount. The action is presently in its early stages and it is not possible at this time to determine the outcome of the litigation. Management of the Company intends to vigorously defend the lawsuit.\nThe United States Attorney for the District of Alaska has commenced an investigation to determine if a Holland America Line vessel discharged bilge water, alleged to have contained oil or oily mixtures, at various locations allegedly within United States territorial waters at various times during the summer and early fall of 1994. It is unknown whether any proceedings will be initiated and, if so, what violations will be alleged. To date, no penalties have been sought or imposed. Management does not believe that the amount of potential penalties will have a material impact on the Company.\nDuring 1995, the Company received $40 million in cash and other compensation from the settlement of litigation with Metra Oy, the former parent company of Wartsila Marine Industries (\"Wartsila\"), related to losses suffered in connection with the construction of three of the Company's cruise ships. Of the $40 million, $6.2 million was used to pay related legal fees, $14.4 million was recorded as other income and $19.4 million was used to reduce the Company's cost basis of certain ships. The Company is continuing to pursue claims in the bankruptcy proceedings in Finland to recover damages suffered in connection with the construction of the three ships.\nThe Company is routinely involved in liability and other claims typical of the cruise ship, hotel and tour businesses. After the application of deductibles, a substantial portion of these claims are fully covered by insurance. The Company is also involved from time to time in commercial, regulatory and employment related disputes and claims. In the opinion of management, such claims, if decided adversely, individually or in the aggregate, would not have a material adverse effect upon the Company's financial condition or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote or Security Holders\nNone.\nExecutive Officers of the Registrant\nPursuant to General Instruction G(3), the information regarding executive officers of the Company called for by Item 401(b) of Regulation S-K is hereby included in Part 1 of this report.\nThe following table sets forth the name, age and title of each executive officer. Titles listed relate to positions within Carnival Corporation unless otherwise noted.\nBusiness Experience of Officers\nMicky Arison, age 46, has been Chief Executive Officer since 1979 and Chairman of the Board since 1990. He was President from 1979 to May 1993 and has also been a director since June 1987. Prior to 1979, he served Carnival for successive two-year periods as sales agent, reservations manager and as Vice President in charge of passenger traffic. He is the son of Ted Arison, Carnival Corporation's founder. He served on the Board of Directors of Ensign Bank, FSB until August 30, 1990. On that date, the Office of Thrift Supervision appointed the Resolution Trust Corporation receiver of Ensign Bank.\nGerald R. Cahill, age 44, is a Certified Public Accountant and has been Vice President-Finance since September 1994. Mr. Cahill was the chief financial officer from 1988 to 1992 and the chief operating officer from 1992 to 1994 of Safecard Services, Inc. From 1979 to 1988 he held financial positions at Resorts International Inc. and, prior to that, spent six years with Price Waterhouse LLP.\nRobert H. Dickinson, age 53, has been President and Chief Operating Officer of Carnival since May 1993. From 1979 to May 1993, he was Senior Vice President--Sales and Marketing of Carnival. He has also been a director since June 1987.\nHoward S. Frank, age 54, has been Vice-Chairman of the Board since October 1993 and has been Chief Financial Officer and Chief Accounting Officer since July 1, 1989 and a Director since 1992. From July 1989 to October 1993 he was Senior Vice President-Finance. From July 1975 through June 1989, he was a partner with Price Waterhouse LLP.\nA. Kirk Lanterman, age 64, is a Certified Public Accountant and has been President and Chief Executive Officer of Holland America Line-Westours Inc. since January 1989 and a Director since 1992. From 1983 to January 1989, he was President and Chief Operating Officer of Holland America Line-Westours Inc. From 1979 to 1983, he was President of Westours which merged in 1983 with Holland America Line.\nLowell Zemnick, age 52, is a Certified Public Accountant and has been Vice President since 1980 and Treasurer since September 1990. Mr. Zemnick was the chief financial officer of Carnival from 1980 to September 1990 and was the Chief Financial Officer of Carnival Corporation from May 1987 through June 1989.\nMeshulam Zonis, age 62, has been Senior Vice President--Operations of Carnival since 1979. He has also been a director since June 1987. From 1974 through 1979, Mr. Zonis was Vice President--Operations of Carnival.\nPART II\nItem 5.","section_5":"Item 5.Market for the Registrant's Common Equity and Related Stockholders Matters\nA. Market Information\nThe information required by Item 201(a) of Regulation S-K, market information, is shown in Exhibit 13 and is incorporated by reference into this Annual Report on Form 10-K.\nB. Holders\nThe information required by Item 201(b) of Regulation S-K, holders of common stock, is shown in Exhibit 13 and is incorporated by reference into this Annual Report on Form 10-K.\nC. Dividends\nAny dividend declared by the Board of Directors on the Company's Common Stock will be paid concurrently at the same rate on the Class A Common Stock and the Class B Common Stock. For its Class A Common Stock and Class B Common Stock (collectively, the \"Common Stock\"), the Company declared cash dividends of $.07 per share in each of the first three quarters of fiscal 1994, $.075 in the fourth quarter of fiscal 1994 and in the first three quarters of fiscal 1995, and $.09 in the fourth quarter of fiscal 1995 and first quarter of fiscal 1996. Payment of future quarterly dividends on the Common Stock will depend, among other factors, upon the Company's earnings, financial condition and capital requirements and certain tax considerations of certain members of the Arison family and trusts for the benefit of Mr. Ted Arison's children (the \"Principal Shareholders\"), some of whom are required to include a portion of the Company's earnings in their taxable income, whether or not the earnings are distributed (see \"D. Taxation of the Company\"). The Company may also declare special dividends to all stockholders in the event that the Principal Shareholders are required to pay additional income taxes by reason of their ownership of the Common Stock, either because of an income tax audit of the Company or the Principal Shareholders or because of certain actions by the Company (such as a failure by the Company to maintain its investment in shipping assets at a certain level) that would trigger adverse tax consequences to the Principal Shareholders under the special tax rules applicable to them.\nWhile no tax treaty currently exists between the Republic of Panama and the United States, under current law the Company believes that distributions to its shareholders are not subject to taxation under the laws of the Republic of Panama. Dividends paid by the Company will be taxable as ordinary income for United States Federal income tax purposes to the extent of the Company's current or accumulated earnings and profits, but generally will not qualify for any dividends-received deduction.\nCertain loan documents entered into by certain of HAL's subsidiaries restrict the level of dividend payments by HAL's subsidiaries to HAL.\nThe payment and amount of any dividend is within the discretion of the Board of Directors, and it is possible that the amount of any dividend may vary from the levels discussed above. If the law regarding the taxation of the Company's income to the Principal Shareholders were to change so that the amount of tax payable by the Principal Shareholders were increased or reduced, the amount of dividends paid by the Company might be more or less than is currently contemplated.\nD. Taxation of the Company\nThe following discussion summarizes the expected United States Federal income taxation of the Company's current operations. State and local taxes are not discussed. The discussion is based upon currently existing provisions of the Internal Revenue Code of 1986, as amended (the \"Code\"), existing and proposed regulations thereunder and current administrative rulings and court decisions. All of the foregoing are subject to change and any such change could affect the continuing validity of this discussion. In connection with the foregoing, investors should be aware that the Tax Reform Act of 1986 (hereinafter, the \"1986 Tax Act\") changed significantly the United States Federal income tax rules applicable to the Company and certain holders of its stock (including the Principal U.S. Shareholders). Although the relevant provisions of the 1986 Tax Act are discussed herein, they have not yet been the subject of extensive administrative or judicial interpretation.\nUnited States Carnival Corporation is a Panamanian corporation, and its material subsidiaries (other than subsidiaries engaged in the bus, hotel and tour business of Holland America Line) are Panamanian, Liberian, Netherlands Antilles, British Virgin Islands, and Bahamian corporations. Accordingly, the Company's income from sources outside of the United States (\"foreign source income\") generally is not subject to United States tax. Moreover, the Company anticipates that, under current law, all or virtually all of its income from sources within the United States (\"United States Source Income\") that constitutes Shipping Income (as defined below) will be exempt from United States corporate income taxation for as long as Carnival Corporation and its subsidiaries meet the requirements of Section 883 of the Code. Section 883 of the Code provides that income of a foreign corporation derived from the international operation, or from the rental on a full or bareboat basis, of ships (\"Shipping Income\") is exempt from United States taxation if (1) the foreign country in which the foreign corporation is organized grants an equivalent exemption to citizens of the United States and to corporations organized in the United States (an \"equivalent exemption jurisdiction\") and (2) the foreign corporation is a controlled foreign corporation (\"CFC\") as defined in Section 957(a) of the Code (the \"CFC Test\"). The Company believes that substantially all of its United States Source Income other than Holland America Line's income from its bus, hotel and tour operations, currently qualifies as Shipping Income, and that Panama, the Netherlands Antilles, the British Virgin Islands, the Bahamas, and Liberia are equivalent exemption jurisdictions. (Holland America Line's income from its hotel and tour operations, is not Shipping Income, and, accordingly, is subject to United States corporate income tax). If, however, Panamanian, Netherlands Antilles, British Virgin Islands, Bahamian or Liberian law were to change adversely, the Company would consider taking appropriate steps (including reincorporating in another jurisdiction) so as to remain eligible for the exemption from United States Federal income tax provided by Section 883 of the Code.\nA foreign corporation is a CFC when stock representing more than 50% of such corporation's voting power or equity value is owned (or considered as owned) on any day of its fiscal year by United States persons who each own (or are considered as owning) stock representing 10% or more of the corporation's voting power (\"Ten Percent Shareholders\"). Stock of the Company representing more than 50% of the total combined voting power of all classes of stock is owned by the Micky Arison 1994 \"B\" Trust (the \"B Trust\"),which is a \"United States Person\", and thus the Company meets the definition of a CFC. The B Trust is a U.S. trust whose primary beneficiary is Micky Arison, the Company's Chairman of the Board. Accordingly, at the corporate level, the Company expects that virtually all of its income (with the exception of its United States source income from the operation of transportation, hotel and tour business of HAL) will remain exempt from United States Income taxes. The B Trust has entered into an agreement with the Company that is designed to ensure, except under certain limited circumstances, that stock possessing more than 50% of the Company's voting power will be held by Ten Percent Shareholders until at least July 1, 1997. Because the Company is a CFC, a pro rata share of the shipping earnings of the Company, as well as certain other amounts, is includable in the taxable income of any \"Ten Percent Shareholder\", as defined above.\nA substantial portion of the Company's income will, as discussed below, be treated as United States Source Income. If the Company were to fail to meet the requirements of Section 883 of the Code with respect to any of its United States Source Income (or if Section 883 of the Code were repealed), some or all of the Company's Shipping Income that is United States Source Income would become subject to a significant United States tax burden. Any such United States Source Income that is considered to be \"effectively connected\" with the conduct of a United States trade or business would be subject not only to general United States Federal corporate income tax, but also to a 30% \"branch level\" tax on effectively connected earnings and profits (generally, adjusted taxable income reduced by taxes and adjusted for the amount of the Company's earnings treated as reinvested in the Company's United States business). Any such United States Source Income that is not considered to be effectively connected with a United States trade or business will instead be subject to a 4% tax on United States source gross transportation income (or, possibly, to a 30% tax if any such income were considered to be 100% United States Source Income under the rules described below, which, as discussed below, the Company does not believe to be the case with respect to any significant portion of its Shipping Income). The Company believes that at least a significant portion of its United States Source Income would probably be considered to be effectively connected with a United States trade or business for this purpose.\nUnder amendments to the Code enacted as part of the 1986 Tax Act, the Company's United States Source Income will include 50% of all transportation income (including income derived from, or in connection with, the use or hiring, or leasing for use of a cruise ship, or the performance of services directly related to such use) attributable to transportation that begins or ends in the United States, and 100% of such transportation income with respect to transportation which begins and ends in the United States. The legislative history of these rules suggests that a cruise which begins and ends in United States ports, but which calls on one or more foreign ports (including ports in possessions of the United States), will be treated as transportation that begins or ends in the United States, rather than as transportation that begins and ends in the United States, thus resulting in no more (and, with respect to a cruise that calls on more than one foreign port, possibly less) than 50% United States Source Income. There are, however, no regulations or other authoritative interpretations of these new rules, and, accordingly, the matter is not entirely free from doubt.\nUnder a provision of the Technical and Miscellaneous Revenue Act of 1988, Section 883 of the Code applies only to income derived from the international operation of ships. The legislative history of that provision indicates that Section 883 of the Code does not apply to Shipping Income that is treated as 100% United States Source Income under the source of income rules discussed in the preceding paragraph since it does not constitute income from the international operation of a ship because it results from transportation that is considered to begin and end in the United States; accordingly, any such income may well be subject to United States corporate tax unless another exception was applicable. As discussed in the preceding paragraph, although the matter is not entirely free from doubt, the Company does not believe that any significant portion of its Shipping Income from its current operations is 100% United States Source Income under the applicable provisions of the Code. Accordingly, the Company does not believe that the 1988 legislation significantly increases its United States corporate tax with respect to its current operations.\nOther Jurisdictions\nThe Company anticipates that its income will not be subject to significant taxation under the laws of the Republic of Panama, Liberia, the Netherlands Antilles, the British Virgin Islands or the Bahamas.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required by Item 6, selected financial data for the five years ended November 30, 1995, is shown in Exhibit 13 and is incorporated by reference into 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 information required by Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation, is shown in Exhibit 13 and is incorporated by reference into this Annual Report on Form 10-K.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements, together with the report thereon of Price Waterhouse LLP dated January 18, 1996, is shown in Exhibit 13 and is hereby incorporated by reference into this Annual Report on Form 10-K.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNone.\nPART III\nItems 10, 11, 12 and 13. Directors and Executive Officers of the Registrant, Executive Compensation, Security Ownership of Certain Beneficial Owners and Management, and Certain Relationships and Related Transactions\nThe information required by Items 10, 11, 12 and 13 is incorporated by reference to the Registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the close of the fiscal year except that the information concerning the Registrant's executive officers called for by Item 401(b) of Regulation S-K has been included in Part I of this report.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) (1)-(2) Financial Statements and Schedules:\nThe financial statements shown in Exhibit 13 are hereby incorporated herein by reference.\n(3) Exhibits:\nThe exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is hereby incorporated herein by reference.\n(b) No reports on Form 8-K were filed during the three months ended November 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 Miami, and the State of Florida on this 22nd day of January 1996.\nCARNIVAL CORPORATION\nBy \/s\/ Micky Arison Micky Arison 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* Portions of documents omitted pursuant to an order for confidential treatment pursuant to Rule 24b-2 under the Securities Act of 1934, as amended.","section_15":""}
{"filename":"922255_1995.txt","cik":"922255","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAlco Capital Resource, Inc. (\"Alco Capital\" or the \"Company\") was formed in 1987 to provide lease financing to customers of Alco Office Products (\"AOP\"), the office products segment of Alco Standard Corporation (\"Alco\"). The Company's offices are located at 1738 Bass Road, Macon, Georgia, 31210 (telephone number 912-471-2300). The Company is a wholly-owned indirect subsidiary of Alco.\nAlco is a public company headquartered in Valley Forge, Pennsylvania with two business segments--AOP and Unisource. AOP is the largest independent copier distribution network in North America and the United Kingdom, with locations in 48 states, six Canadian provinces and in Europe. AOP also provides equipment services and supplies and specialized document copying services. Unisource is North America's largest marketer and distributor of paper and imaging products and supply systems, which includes disposable paper and plastic products, packaging systems and maintenance supplies. Unisource has facilities in every major metropolitan market in the United States, every province of Canada and in Mexico. Alco's fiscal 1995 revenues were $9.9 billion, of which $2.9 billion were generated by AOP.\nThe Company is engaged in the business of arranging lease financing exclusively for office equipment marketed by AOP's wholly-owned office equipment dealers (\"AOP dealers\"), which sell and service copier equipment and facsimile machines. The ability to offer lease financing on this equipment through Alco Capital is considered a competitive marketing advantage which more closely ties AOP to its customer base. During the 1995 fiscal year, 56% of new equipment sold by AOP dealers was financed through the Company. The Company and AOP will seek to increase this percentage in the future, as leasing enhances the overall profit margin on equipment and is considered an important customer retention strategy.\nThe equipment financed by the Company consists of copiers, facsimile machines, and related accessories and peripheral equipment, the majority of which are produced by major office equipment manufacturers including Canon, Oce, Ricoh, and Sharp. Currently 79% of the equipment financed by the Company represents copiers, 15% fax machines, and 6% other equipment. Although equipment models vary, AOP is increasingly focusing its marketing efforts on the sale of higher segment equipment, such as copiers which produce 50 or more impressions per minute.\nThe Company provides AOP dealers with standard lease rates for use in customer quotes. However, AOP dealers may charge the customer more or less than Alco Capital's standard rates, and the AOP dealer would absorb any difference resulting from any such variances from Alco Capital's standard rates.\nThe Company's customer base (which consists of the end users of the equipment) is widely dispersed, with the ten largest customers representing less than 2% of the Company's total lease portfolio. The typical new lease financed by the Company averages $13,900 in amount and 43 months in duration. Although 96% of the leases are scheduled for regular monthly payments, customers are also offered quarterly, semi-annual, and other customized payment terms. In connection with its leasing activities, the Company performs billing, collection, property and sales tax filings, and provides quotes on equipment upgrades and lease-end notification. The Company also provides certain financial reporting services to the AOP dealers, such as a monthly report of dealer increases in leasing activity and related statistics.\nAlco and the Company entered into a support agreement on June 1, 1994 (the \"1994 Support Agreement\") pursuant to which Alco will make payments to the Company, if necessary, to enable the Company to maintain (i) a ratio of income before interest expense and taxes to interest expense of 1.25 times and (ii) a minimum consolidated tangible net worth of $1.00 at all times. In addition, the Company and Alco are currently parties to a maintenance agreement dated August 15, 1991, (the \"1991 Maintenance Agreement\") and an operating agreement dated August 15, 1991, (the \"1991 Operating Agreement\") (collectively, the \"1991 Maintenance and Operating Agreements\") which require Alco to make payments to\nthe Company, if necessary, to meet a specified minimum fixed charge coverage ratio and a maximum debt-to-equity ratio. In addition, the 1991 Operating Agreement requires the AOP dealers to repurchase all defaulted lease contracts. Although the AOP dealers are not subject to such repurchase obligation under the terms of the 1994 Support Agreement, Alco and the Company presently intend to continue such repurchase obligation. (See \"Relationship with Alco Standard Corporation\" below).\nTYPES OF LEASES\nThe lease portfolio of the Company includes direct financing leases and funded leases. Direct financing leases are contractual obligations between the Company and the AOP customer and represent the majority of the Company's lease portfolio. Funded leases are contractual obligations between the AOP dealer and the AOP customer which have been financed by the Company.\nFunded leases represented approximately 21% of the Company's leases as of September 30, 1995. The AOP dealers have assigned to the Company, with full recourse, their rights under the funded leases including the right to receive lease and rental payments as well as a security interest in the related equipment.\nDirect financing leases and funded leases are structured as either tax leases (from the Company's perspective) or conditional sales contracts, depending on the customer's (or, for funded leases, the AOP dealer's) needs. The customer (or the AOP dealer for funded leases) decides which of the two structures is desired. Under either structure, the total cost of the equipment to the customer (or to the AOP dealer) is substantially the same (assuming the exercise of the purchase option).\nTax Leases\nTax leases represented 94% of the Company's total lease portfolio as of September 30, 1995. The Company or the AOP dealer is considered to be the owner of the equipment for tax purposes during the life of these leases and receives the tax benefit associated with equipment depreciation. Tax leases are structured with a fair market value purchase option. Generally, the customer may return the equipment, continue to rent the equipment or purchase the equipment for its fair market value at the end of the lease.\nEach tax lease has a stated equipment residual value generally ranging from 0% to 10%. As of September 30, 1995, the average equipment residual value for all leases in the Company's portfolio was 4.6%. Upon early termination of the lease or at the normal end of the lease term, the Company charges the AOP dealer for the stated residual position, if any, and the equipment is returned to the AOP dealer. Any gain or loss on the equipment's residual value is realized by the AOP dealer.\nConditional Sales Contracts\nConditional sales contracts account for the remaining 6% of the total leases in the Company's portfolio. Under these arrangements, the customer is considered to be the owner of the equipment for tax purposes and would receive any tax benefit associated with equipment depreciation. Each conditional sales contract has a stated residual value of 0%. Conditional sales contracts are customarily structured with higher monthly lease payments than the tax leases and have a $1 purchase option for the equipment at lease-end. Thus, because of the higher monthly payments, the cost of the equipment to the customer (or, for funded leases, to the AOP dealer) under a conditional sales contract is substantially the same as under a tax lease (assuming the exercise of the purchase option). Although the customer has the option of returning or continuing to rent the equipment at lease-end, the customer almost always exercises the $1 purchase option at the end of the lease term.\nLeased Equipment\nThe Company also offers from time to time financing of the cost of office equipment that the AOP dealers maintain in inventory for short-term rental to customers. This category of leased equipment also includes\nequipment currently rented to customers where the rental agreements are considered to be cancelable by the customer, based on the terms and conditions of the rental contracts in effect. Under operating guidelines in effect, any equipment not physically on rental to customers for a period exceeding 120 continuous days must be repurchased by the AOP dealers at its current book value.\nRELATIONSHIP WITH ALCO STANDARD CORPORATION\nThe Company, as the captive finance subsidiary of Alco, derives its customer base from the business sourced by its affiliates within Alco (the AOP dealers). There are several agreements and programs between the Company and Alco, which are described below.\nSupport Agreements\nThe Company and Alco are parties to an agreement (the \"1994 Support Agreement\"), dated as of June 1, 1994. The Company's agreements with noteholders and other lenders entered into after June 1, 1994 generally include covenants that it will not amend the 1994 Support Agreement except under certain circumstances. (See \"1994 Support Agreement\", below).\nThe Company and Alco are also parties to a Maintenance Agreement dated August 15, 1991 and an Operating Agreement dated August 15, 1991 (the \"1991 Maintenance and Operating Agreements\"), which are further described below. The Company has generally agreed with its lenders pursuant to loan agreements entered into before June 1, 1994 that it will not amend the 1991 Maintenance and Operating Agreements without each such lender's consent. Such loan agreements will mature over the next several years, with the latest maturity occurring in August 1998, at which time the Company and Alco intend to terminate the 1991 Maintenance and Operating Agreements.\n1. THE 1994 SUPPORT AGREEMENT\nThe 1994 Support Agreement between the Company and Alco, which was effective as of June 1, 1994, provides that Alco will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed to comply with two requirements: i) that the Company will maintain a pre-tax interest coverage ratio (income before interest expense and taxes divided by interest expense) so that the Company's pre-tax income plus interest expense will not be less than 1.25 times interest expense, and ii) that the Company will maintain a minimum tangible net worth of $1.00. The 1994 Support Agreement further provides that Alco may not assign the 1994 Support Agreement unless: (a) all the outstanding debt of the Company is repaid or (b) both Moody's Investors Service and Standard & Poor's Ratings Group confirm in writing prior to the effectiveness of any such assignment that the Company's debt rating would not be downgraded as a result of such assignment.\nUnlike the 1991 Operating Agreement, which is further described on page 6, the 1994 Support Agreement does not contain a requirement that the AOP dealers repurchase all defaulted lease contracts. The 1994 Support Agreement does not include the repurchase requirement because the Company and Alco wish to preserve the flexibility, on a prospective basis, to allow the credit risk for defaulted contracts to remain with the Company. In such event, the credit decision and reserves for defaulted contracts would become the responsibility of the Company. If the Company were responsible for the credit risk and costs associated with defaulted contracts, the Company would reduce the lease bonus to AOP dealers or increase its current lease rates in order to offset these increased costs. Consequently, the Company believes that the impact of any future shift of the credit risk from the AOP dealers to the Company would not be material to the Company's future results of operations. The Company's (and Alco's) present intention, however, is to continue the repurchase arrangement with the AOP dealers as currently in effect.\nThe Company has generally provided in loan and note agreements entered into after June 1, 1994 (and will provide in the loan and note agreements governing future debt) that the 1994 Support Agreement cannot be amended or terminated without the consent of noteholders or other lenders unless either i) all the outstanding debt of the Company is repaid, or ii) both Moody's Investor Services and Standard & Poor's Ratings Group confirm in writing prior to the effectiveness of any such amendment or termination that the Company's debt rating would not be downgraded as a result of such amendment or termination.\n2. THE 1991 MAINTENANCE AND OPERATING AGREEMENTS\nThe 1991 Maintenance Agreement provides that Alco will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed in amounts sufficient to meet a specified minimum fixed charge coverage ratio and a maximum debt-to-equity ratio. Earnings before fixed charges (primarily interest) must be at least 1.3 times fixed charges. The Company has satisfied this requirement independently without requiring payment or an investment from Alco. The Company's debt-to-equity ratio is limited to 6 to 1 according to the terms of the Maintenance Agreement. The Company must also maintain minimum tangible net worth of not less than $1.00.\nPursuant to the terms of the 1991 Maintenance Agreement, the Company received capital contributions from Alco of $29 million in 1995, $8.3 million in 1994 and $2.6 million in 1993.\nThe 1991 Operating Agreement requires the AOP dealers to repurchase all defaulted lease contracts. A default is defined in the 1991 Operating Agreement as any receivable which is past due for 120 days or is otherwise reasonably declared uncollectible by the Company. The repurchase amount is identified as the net book value of a lease on the default date.\nThe 1991 Maintenance and Operating Agreements provide for modification or amendment with both parties' consent and provide for cancellation by either party upon 90 days written notice. The Company has generally agreed with its lenders in loan agreements entered into prior to June 1, 1994, however, that it will not amend the 1991 Maintenance and Operating Agreements without each such lender's consent. Such loan agreements are scheduled to expire over the next several years, with the latest maturity occurring in August 1998, at which time the Company and Alco intend to terminate the 1991 Maintenance and Operating Agreements.\nCash Management Program\nThe Company participates in Alco's domestic Cash Management program. Under this program, the Company has an account with Alco through which cash in excess of current operating requirements is temporarily placed on deposit. Similarly, amounts are periodically borrowed from Alco. Interest is paid (or charged) by Alco on these amounts. The Company was in a net deposit condition with Alco during 1995 and earned interest income of approximately $1.5 million. The Company was a net borrower in 1994 and 1993 incurring net interest costs of $496,000 and $579,000, respectively under this program.\nManagement Fee\nThe Company is charged a management fee by Alco to cover certain corporate overhead expenses. These charges are included as general and administrative expenses in the Company's financial statements and amounted to $552,000 in 1995, $396,000 in 1994 and $360,000 in 1993.\nFederal Income Tax Allocation Agreement\nAlco and the Company participate in a Federal Income Tax Allocation Agreement dated June 30, 1989, in which the Company consents to the filing of consolidated federal income tax returns with Alco. Alco agrees to collect from or pay to the Company its allocated share of any consolidated federal income tax liability or refund applicable to any period for which the Company is included in Alco's consolidated federal income tax return.\nInterest on Income Tax Deferrals\nThe Company provides substantial tax benefits to Alco through the use of the installment sales method on equipment financed through the Company. Taxes deferred by Alco due to this tax treatment totalled a cumulative amount of approximately $145 million at the end of fiscal 1995. Alco pays the Company interest on the portion of these tax deferrals (approximately $112 million at the end of fiscal 1995) which arise from tax deferrals on intercompany sales. In fiscal 1995 interest was earned by the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. Under this method, the Company\nearned interest at an average rate of 6.7% in 1995 totaling $5.9 million. In fiscal 1994 and 1993, interest was earned by the Company at a rate of 6% and totalled $3.8 million and $2.9 million, respectively.\nLease Bonus Program\nThe Company sponsors a lease bonus subsidy program which provides incentives to AOP dealers when AOP customers lease equipment from the Company. Payments under this program can be reduced or eliminated at any time by joint agreement of the Company and Alco. During fiscal 1995, 1994 and 1993 bonus payments were calculated on the basis of the AOP dealer's increase in the percentage of equipment sales leased through the Company, and totalled $7.3 million, $8.8 million and $5.9 million, respectively.\nCredit Policies and Loss Experience\nEach AOP dealer is responsible for developing and maintaining a formal credit policy that governs credit practices and procedures. In addition, the credit practices of the individual AOP dealers must be consistent with Alco's overall policies for leasing and credit approval.\nThe Company presently has full recourse to the AOP dealer for any lease which becomes past due by 120 days or more. Excluding the effect of recoveries, the gross value of leases charged back to AOP dealers was $20.9 million in fiscal 1995, $14.4 million in fiscal 1994 and $13.3 million in fiscal 1993. For fiscal 1995, 1994 and 1993, the gross chargebacks represented 2.4%, 2.7% and 3.2%, respectively, of the average portfolio balances during the year.\nReserves for credit losses are maintained by the AOP dealers and AOP. On a monthly basis, the Company reports the respective net investment value of the lease portfolio to each AOP dealer so the AOP dealer can properly accrue the credit loss reserve balance. In accordance with AOP policy, each AOP dealer must maintain aggregate reserves of at least 3% of the AOP dealer's total portfolio (including $125 million of net leases sold under an asset securitization agreement being serviced by the Company). Reserves maintained for fiscal 1995 and 1994, as a percentage of the leasing portfolio at fiscal year end, were 4.3% and 5.0%, respectively.\nDelinquencies remained at a consistent level for fiscal 1995 and 1994. During this two-year period, accounts classified as current (less than 30 days past due) ranged from 86% to 91% of the total portfolio balance on a monthly basis. The aging of the Company's lease portfolio receivables at September 30, 1995 (excluding $125 million of net lease receivables sold under an asset securitization agreement being serviced by the Company) was as follows:\nFUNDING\nPrior to July 1994, the majority of the Company's debt funding was through privately placed term notes with banks and an insurance company. The Company follows a policy of matching the maturities of borrowed funds to the average life of the leases being financed in order to minimize the impact of interest rate changes on its operations. All notes carry terms of one to three years and are either at fixed interest rates or have had the interest rate risk eliminated through interest rate swap contracts. (See Note 5 to the Company's Financial Statements on page hereof). Covenants in the note agreements entered into before July 1994 include a minimum fixed charge coverage requirement of 1.3 times fixed charges and a maximum debt-to-equity ratio of 6 to 1. Also, there is a covenant in each such note agreement which requires each lender's consent to any amendment to the 1991 Maintenance and Operating Agreements (see page 5 hereof for a description of the 1991 Maintenance and Operating Agreements). As of September 30, 1995, the amounts outstanding under these note agreements totalled $173 million.\nPrior to July 1994, the only other funding sources for the Company were capital contributions and advances received from Alco. As of September 30, 1995, the Company's total shareholder's equity was $129.9 million, of which $82.4 million consisted of contributed capital.\nEffective July 1, 1994, the Company commenced a medium term note program of $500 million which was fully subscribed as of July 1995. On June 30, 1995, the Company increased the amount available to be offered under this medium term notes program by $1 billion or the equivalent thereof in foreign currency. The program allows the Company to offer to the public from time to time medium term notes having an aggregate initial offering price not exceeding the total program amount. These notes are offered at varying maturities of nine months or more from their dates of issue and may be subject to redemption at the option of the Company or repayment at the option of the holder, in whole or in part, prior to the maturity date in conjunction with meeting specified provisions. Interest rates are determined based on market conditions at the time of issuance. As of September 30, 1995, $602 million of medium term notes were outstanding with a weighted average interest rate of 7.0%.\nIn September 1994, the Company entered into an agreement to sell, under an asset securitization program, an undivided ownership interest in $125 million of eligible direct financing lease receivables. The agreement, which expires in September 1996, contains limited recourse provisions which require the Company to assign an additional undivided interest in leases to cover any potential losses to the purchaser due to uncollectible leases. As collections reduce previously sold interests, new leases can be sold up to $125 million. The weighted average interest rate on the agreement, which is partially fixed by three interest rate swap agreements totaling a principal\/notional amount of $90 million is 7.0% at September 30, 1995. In fiscal year 1995, the Company sold $67 million in leases, replacing leases liquidated during the year and recognized a pretax gain of $1.2 million. Under the terms of the sales agreement, the Company will continue to service the lease portfolio sold.\nEMPLOYEES\nAt September 30, 1995, the Company had approximately 150 employees. Employee relations are considered to be excellent.\nCOMPETITION AND GOVERNMENT REGULATION\nThe finance business in which the Company is engaged is highly competitive. Competitors include leasing companies, commercial finance companies, commercial banks and other financial institutions.\nThe Company competes primarily on the basis of financing rates, customer convenience and quality customer service. AOP dealers offer financing by the Company at the time equipment is leased or sold to the customer, reducing the likelihood that the customer will contact outside funding sources. There is a\ncommunications network between the Company and the AOP dealers to allow prompt transmittal of customer and product information. Contract documentation is straightforward and clearly written, so that financings are completed quickly and to the customer's satisfaction. Finally, both the Company and the AOP dealers are firmly committed to providing excellent customer service over the duration of the contract.\nCertain states have enacted retail installment sales or installment loan statutes relating to consumer credit, the terms of which vary from state to state. The Company does not generally extend consumer credit as defined in those statutes.\nThe financing activities of the Company are dependent upon sales or leases of office equipment by the AOP dealers, who are subject to substantial competition by both independent office equipment dealers and the direct sales forces of office equipment manufacturers. AOP is the largest network of independent copier and office equipment dealers in North America and in the United Kingdom, and represents the only independent distribution network with national scope. AOP dealers compete on the basis of price, quality of service and product performance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's operations are located in Macon, Georgia and occupy approximately 37,000 square feet. The Company uses this facility for normal operating activities such as lease processing, customer service, billing and collections. Certain specialized services (such as legal, accounting, treasury, tax and audit services) are also performed for the Company at Alco's corporate headquarters located in Valley Forge, Pennsylvania. The Company's facilities are deemed adequate by management to conduct the Company's business.\nAny additional information called for by this item has been omitted pursuant to General Instruction J(2)(d).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company is a party (or to which any of its property is subject). To the Company's knowledge, no material legal proceedings are contemplated by governmental authorities against the Company or its properties.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo response to this item is required.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll outstanding shares of the Company's common stock are currently owned by Alco Office Systems, Inc., a subsidiary of MDR Corporation, which is a subsidiary of Alco. Therefore, there is no market for the Company's common stock. No dividends were paid in fiscal 1995, however, the Company paid a dividend of $7 million to its parent in the fourth quarter of fiscal 1994. The Company and Alco will, from time to time, determine the appropriate capitalization for the Company, which will, in part, affect any future payment of dividends to Alco or capital contributions to the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information called for by this item has been omitted pursuant to General Instruction J(2)(a).\nITEM 7.","section_7":"ITEM 7. FINANCIAL INFORMATION\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPursuant to General Instruction J(2)(a) of Form 10-K, the following analysis of the results of operations is presented in lieu of Management's Discussion and Analysis of Financial Condition and Results of Operations.\nFISCAL 1995 COMPARED WITH FISCAL 1994\nComparative summarized results of operations for the fiscal years ended September 30, 1995 and 1994 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage change.\nRevenues\nTotal revenues increased $26 million or 38.2% in fiscal 1995 from fiscal 1994. Approximately 58.6% or $15.2 million of this increase in revenues was a result of increased lease finance income due to growth in the portfolio of direct financing and funded leases. During the twelve-month period from October 1, 1994 to September 30, 1995, the portfolio grew at a 62.7% rate, net of lease receivables that were sold in asset securitization transactions.\nEffective October 1, 1994, the Company began offering a new operating lease program to the AOP dealer network, whereby office equipment placed on rental with a customer, with cancellable terms, could be funded through the Company and rented back to the AOP dealer. In prior years, this equipment was funded by the respective AOP dealer instead of the Company. At September 30, 1995, equipment with a net book value of $25.2 million was leased under this program. This new funding program contributed $7 million in rental income during fiscal 1995.\nEffective October 1, 1995, management decided to revert back to the strategy for funding this equipment utilized in prior fiscal years where the majority of equipment, with the exception of large transactions generally exceeding $250,000 in amount, would once again be funded by the respective Alco dealer, instead of through the Company. Accordingly, management expects operating leases funded through the Company to be at a reduced level during fiscal 1996.\nDuring fiscal 1995, Alco changed the interest rate on deferred taxes, so that the Company earns interest at a rate consistent with the Company's weighted average outside borrowing rate of interest. This change resulted in an average interest rate of 6.7% for fiscal 1995 compared to 6% for fiscal 1994. In addition, the deferred tax base upon which interest payments are calculated increased 46.9% to $111.9 million at September 30, 1995 from $76.2 million at September 30, 1994. Due to the combined effect of the increased rate of interest and the increased deferred tax balances, interest income on deferred taxes rose $2.2 million or 58.1% when comparing fiscal 1995 to fiscal 1994.\nOther income consists primarily of late payment charges and various billing fees. The structure of these fees has remained basically unchanged in fiscal 1995 from fiscal 1994. The growth in other income from fees is primarily due to the increased size of the lease portfolio upon which these fees are based. Overall, fee income from these sources grew by $1.6 million or 50.9%, when comparing fiscal 1995 to fiscal 1994.\nExpenses\nAverage borrowings to finance the lease portfolio in the form of loans from major banks and the issuance of medium term notes in the public markets grew by 30.4%, to average borrowings of $596 million during fiscal 1995, from average borrowings of $457 million during fiscal 1994. Due to the combined effect of increased borrowing to fund the portfolio and an increase in the Company's overall weighted average interest rate on all borrowings, interest expense grew by $10.8 million or 42.4%, when comparing fiscal 1995 to fiscal 1994. For comparative purposes, the Company's combined weighted average interest rate on all borrowings for fiscal 1995 was 6.7% as compared to 5.8% for fiscal 1994. At September 30, 1995, the Company's debt to equity ratio, including intercompany amounts due from Alco, was 5.8 to 1.\nDuring June 1995, the Company completed the filing of a new medium term note registration in the amount of $1 billion, designed to meet the Company's anticipated portfolio funding needs over the next eighteen to twenty-four months. This new note program was structured similar to the original $500 million medium term note program that was filed in June 1994, which was used to meet the Company's portfolio funding needs during the period from July 1994 to June 1995. The new program allows for the issuance of medium term notes in the public market with maturities of at least nine months, through four nationally recognized investment firms. At September 30, 1995, $602 million of medium term notes were outstanding under these two programs with a weighted average interest rate of 7.0%.\nLoans through major banks declined by $157 million to $173 million outstanding at September 30, 1995, from $330 million outstanding at September 30, 1994, at a weighted average rate of 5.6%.\nTotal general and administrative expenses grew by $5.7 million or 27.5%, when comparing fiscal 1995 to fiscal 1994. However, the general and administrative expense category for fiscal 1995 includes depreciation expense on leased equipment totalling $5.9 million. There is no comparable depreciation expense included in general and administrative expenses for fiscal 1994. In addition, lease bonus subsidy payments to AOP dealers were approximately $1.5 million less in fiscal 1995 than in fiscal 1994, due to a reduction in the bonus subsidy percentage.\nExcluding the effects of the addition of approximately $5.9 million of depreciation expense on operating leases in fiscal 1995 and the reduction of approximately $1.5 million in lease bonus payments in fiscal 1995, remaining general and administrative expenses grew approximately $1.3 million, when comparing fiscal 1995\nto fiscal 1994. There have been no significant changes in the portfolio servicing costs of the Company in fiscal 1995 from fiscal 1994; therefore, the increase in general and administrative expenses between these two fiscal years is a direct result of the growth of the lease service portfolio.\nGain on Sale of Lease Receivables\nUnder an asset securitization program entered into in September, 1994 the Company sold an undivided ownership interest in $125 million of eligible direct financing lease receivables. This agreement, which expires in September 1996, was structured as a revolving securitization so that as collections reduce previously sold interests, new leases can be sold up to $125 million. During fiscal 1995, collections reduced previously sold interests by approximately $66.7 million. The Company sold an additional $66.7 million in net eligible direct financing leases and recognized gains of $1.2 million.\nIncome Before Taxes\nIncome before taxes grew by $6.9 million or 27.2%, when comparing pretax earnings for fiscal 1995 to fiscal 1994. This increase in income before taxes was essentially the effect of higher earnings on a larger portfolio base, that was supplemented by strong growth in interest income on deferred taxes and in other income. In addition, income before taxes was positively effected by a slower growth rate in general and administrative expenses during fiscal 1995 than was experienced in fiscal 1994.\nAt the end of fiscal 1994, the Company entered into its existing $125 million asset securitization program and recognized a pretax gain on sale of approximately $3.7 million during fiscal 1994. As mentioned above, securitization gains in fiscal 1995 were approximately $1.2 million on a pretax basis. Excluding the effect of the securitization gains from pretax income for both fiscal years 1995 and 1994, pretax income grew by 43.4% in fiscal 1995 from fiscal 1994.\nTaxes on Income\nApproximately $3.6 million of the increase in income taxes in fiscal 1995 from fiscal 1994 is directly attributable to the higher net income before taxes in fiscal 1995 as compared to fiscal 1994, while $1.1 million relates to a valuation allowance recorded in fiscal 1995 for certain state deferred tax items. During fiscal 1995, the Company's effective federal and state income tax rate was 44.8%, as compared to 38.5% (excluding the cumulative effect adjustment) in fiscal 1994. Excluding the valuation allowance adjustment, the fiscal 1995 effective tax rate was 42.8%.\nFISCAL 1994 COMPARED WITH FISCAL 1993\nComparative summarized results of operation for the fiscal years ended September 30, 1994 and 1993 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage change.\nRevenues\nTotal revenues increased $15.9 million or 30.5% in fiscal 1994 from fiscal 1993. This increase was primarily due to the improvement in lease finance income, reflecting the continued growth in the average lease portfolio of 32.8% in fiscal 1994 from fiscal 1993. This increase in the lease portfolio is a result of a 47% increase in lease fundings of which 43.9% was originated through existing AOP dealers while 3.1% was originated through AOP dealers recently acquired by Alco.\nThe Company charged Alco interest at a 6% rate on the benefit Alco received for income tax deferrals associated with the Company's leasing transactions. Interest income on deferred taxes rose $827,000 or 28.3%, when comparing fiscal 1994 to fiscal 1993. This increase was due to an increased deferred income tax base upon which the interest payment is calculated.\nOther income, which consists primarily of late payment and billing fees, increased by $684,000 or 28.8%, due to the increased size of the lease portfolio upon which these fees are earned.\nExpenses\nAverage borrowings to finance the lease portfolio grew by 32%, to $457 million during fiscal 1994 from $347 million during fiscal 1993. As a result, interest expense grew by $2.9 million or 12.6%.\nReductions in the Company's incremental interest rate largely offset the increase in average borrowings, and allowed interest expense to grow at a slower pace than the average borrowings. For comparative\npurposes, the weighted average interest rate on borrowings for fiscal 1994 was 5.8% as compared to 6.9% for fiscal 1993.\nThe general and administrative expense category includes dealer lease bonus payments based on new lease volume generated by AOP dealers. These payments were $8.8 million for fiscal 1994 and $5.9 million for fiscal 1993. This increase in lease bonus expense was due to increased AOP dealer lease volume in fiscal 1994.\nExcluding the effect of the lease bonus program, the remaining general and administrative expenses rose $4 million or 50% in fiscal 1994 from fiscal 1993. This expense growth continues to be indicative of the overall growth of the lease portfolio and its effects on the operations of the Company. Also reflected in general and administrative expenses are costs related to several initiatives, including facility expansion, a reengineering of the leasing computer software and the development of several new products such as cost per copy leasing, credit scoring, and automation of the lease input process. Such costs amounted to approximately $1.2 million for fiscal 1994 as compared to $200,000 for fiscal 1993.\nUnlike the 1991 Operating Agreement, the 1994 Support Agreement does not contain a requirement that the AOP dealers repurchase all defaulted lease contracts. The Support Agreement does not include the repurchase requirement because the Company and Alco wish to preserve the flexibility, on a prospective basis, to allow the credit risk for defaulted contracts to remain with the Company. In such event, the credit decision and reserves for defaulted contracts would become the responsibility of the Company. If the Company were responsible for the credit risk and costs associated with defaulted contracts, the Company would reduce the lease bonus to AOP dealers or increase its current lease rates in order to offset these increased costs. Consequently, the Company believes that the impact of any future shift of the credit risk from the AOP dealers to the Company would not be material to the Company's future results of operations. The Company's (and Alco's) present intention, however, is to continue the repurchase arrangement with the AOP dealers as currently in effect.\nGain on Sale of Lease Receivables\nUnder an asset securitization program entered into in September 1994 the Company sold $125 million of eligible direct financing lease receivables and recognized a pretax gain of $3.7 million ($2.3 million, net of taxes) in the fourth quarter of fiscal 1994.\nIncome Before Income Taxes\nIncome before income taxes increased $9.9 million or 63.5%, when comparing fiscal 1994 to fiscal 1993. This increase includes the net effect of higher revenues on a larger portfolio and the $3.7 million pre-tax gain on the sale of $125 million of lease receivables offset by higher borrowing costs and general and administrative expenses.\nIncome Taxes\/Accounting Change\nThe increase of $3.6 million in income taxes for fiscal 1994 was directly attributable to increased income before income taxes for fiscal 1994, as compared to fiscal 1993.\nIn the first quarter of fiscal 1994, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes\", which resulted in an increase in net income of $140,000 for fiscal 1994. This amount represented the cumulative effect of this accounting change and was recorded in the first quarter of fiscal 1994.\nAny additional information required by this item has been omitted pursuant to General Instruction J(2)(a) of Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements of Alco Capital Resource, Inc. are submitted herewith on Pages through of this report.\nQUARTERLY DATA\nThe following table shows comparative summarized quarterly results for fiscal 1995 and 1994.\n- -------- (1) Amounts have been reclassified to conform with current presentation. (2) Includes $3.7 million gain on sale of lease receivables ($2.3 million, net of tax).\nAny additional information required by this item has been omitted pursuant to General Instruction J(2)(a) of Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe directors and executive officers of the Company are as follows:\nRICHARD P. MAIER, age 44, has been President of the Company since 1989. He joined Alco (the Company's parent) in 1981 as Controller of the Alco Automotive Group and was promoted to Division Controller of Alco Office Products (which includes all of the AOP dealers) in 1983. He served as Vice President of Acme Business Products (an AOP dealer) from 1984 to 1988 and became Vice President of Alco Capital in 1988.\nROBERT M. KEARNS II, age 42, has been Vice President of the Company since 1993. He was also appointed Vice President--Finance of Alco Office Products in 1993. From 1983 through 1993, Mr. Kearns was Vice President--Finance of Copyrite, an AOP dealer located in Indianapolis, Indiana which was acquired by Alco in 1988.\nKURT E. DINKELACKER, age 42, was appointed the sole director of the Company and President of Alco Office Products in 1995. He has also served as an Executive Vice President of Alco since 1993. From 1993 to 1995, he was Chief Financial Officer of Alco, and was Executive Vice President--Finance of Alco Office Products from 1991 to 1993.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by this item has been 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\nThe information called for by this item has been omitted pursuant to General Instruction J(2)(c) of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Item 1 hereof for information concerning the relationship between the Company, Alco and the AOP dealers.\nAny additional information required by this item has been 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) Financial Statements\nFinancial Statements and Schedules other than those listed above are omitted because the required information is included in the financial statements or the notes thereto or because they are inapplicable.\n(b) Exhibits\n(c) Reports on Form 8-K.\nNone\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors Alco Standard Corporation\nWe have audited the accompanying balance sheets of Alco Capital Resource, Inc. (a wholly-owned subsidiary of Alco Standard Corporation) as of September 30, 1995 and 1994, and the related statements of income, changes in shareholder's 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 Alco Capital Resource, Inc. at 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\/ Ernst & Young LLP _____________________________________ Ernst & Young LLP\nPhiladelphia, Pennsylvania October 17, 1995\nALCO CAPITAL RESOURCE, INC.\nBALANCE SHEETS (IN THOUSANDS)\nSee accompanying notes.\nALCO CAPITAL RESOURCE, INC.\nSTATEMENTS OF INCOME (IN THOUSANDS)\nSee accompanying notes.\nALCO CAPITAL RESOURCE, INC.\nSTATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY (IN THOUSANDS)\n- -------- * Amount is less than one thousand dollars.\nSee accompanying notes.\nALCO CAPITAL RESOURCE, INC.\nSTATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSee accompanying notes.\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS\n1. BUSINESS\nAlco Capital Resource, Inc. (\"ACR\" or the \"Company\"), an indirect wholly- owned subsidiary of Alco Standard Corporation (\"Alco\"), is engaged in the business of arranging lease financing exclusively for office equipment marketed by Alco Office Products (\"AOP\") dealers, which sell and service copier equipment and facsimile machines.\n2. SIGNIFICANT ACCOUNTING POLICIES\nRevenue Recognition\nUnearned lease finance income is amortized into revenue using the effective interest method over the term of the lease agreements or non-cancellable rental contracts.\nProperty and Equipment\nProperty and equipment, including leased equipment, is carried on the basis of cost. Depreciation is principally computed using the straight-line method over the estimated useful lives of the assets.\nIncome Taxes\nThe Company's deferred tax expense and the related liability are primarily the result of the difference between the financial statement and income tax treatment of direct financing leases.\nFair Value Disclosures\nSFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the Company has computed and disclosed the fair value of its notes payable and interest rate swaps (Note 5).\nReclassifications\nCertain prior year amounts have been reclassified to conform with the current year presentation.\n3. AGREEMENTS BETWEEN ACR AND ALCO\nCash Management Program\nThe Company participates in Alco's domestic cash management program. Under this program, the Company has an account with Alco wherein cash temporarily in excess of current operating requirements earns interest at rates established by Alco. Similarly, amounts are periodically borrowed from Alco, with interest charged at market rates on borrowed funds. The Company was in a net deposit position with Alco during 1995 and earned interest income of $1,545,000 (included in interest expense). The Company was a net borrower during fiscal years 1994 and 1993 and incurred net interest costs of $496,000 and $579,000, respectively, under this program. The Company considers its account with Alco to represent its cash balance. Accordingly, the accompanying Statements of Cash Flows present the changes in the caption \"Due from (to) Alco\".\nManagement Fee\nIncluded in general and administrative expenses are corporate overhead expenses charged by Alco of $552,000, $396,000 and $360,000 in fiscal years 1995, 1994 and 1993, respectively. These corporate charges represent management's estimate of costs incurred by Alco on behalf of ACR.\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nInterest on Alco Income Tax Deferrals\nThe Company charges Alco interest on Alco's income tax deferrals associated with the Company's leasing transactions. Such charges were calculated at 6.7% in 1995 and 6% in 1994 and 1993.\nThe 1991 Maintenance and Operating Agreements\nThe Maintenance Agreement between the Company and Alco provides that Alco will pay fees and make capital contributions to the Company in amounts sufficient to meet the restrictive financial covenants included in the Company's loan agreements (Note 5).\nIn the event of default of any lease on equipment purchased by the Company from AOP dealers, the Operating Agreement requires the AOP dealer to repurchase the equipment at the net investment value of the lease on the default date. Default is defined by the Operating Agreement as any receivable becoming 120 days past due or otherwise being reasonably declared uncollectible by the Company. At September 30, 1995, 1994 and 1993, all of the Company's accounts receivable and direct financing leases, including residual values, were subject to such repurchase terms. In view of the foregoing terms of the Operating Agreement, the Company has made no provision in the accompanying financial statements for uncollectible receivables.\nThe 1994 Support Agreement\nThe 1994 Support Agreement between the Company and Alco, which is effective as of June 1, 1994, provides that Alco will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed to comply with certain requirements. This agreement does not contain a requirement that the AOP dealers repurchase all defaulted lease contracts. In such event, the credit decision and reserves for defaulted contracts would become the responsibility of the Company. The present intent of the Company and Alco, however, is to continue the repurchase arrangement with the AOP dealers as currently in effect.\n4. INVESTMENTS IN LEASES\nThe Company's funded leases include certain internal lease portfolios and non-cancellable rental contracts for AOP dealers, which have been financed by the Company. Under the terms of these financing arrangements, the AOP dealer maintains the contractual relationship with the third-party customer. The AOP dealers have assigned to the Company, with full recourse, their rights under the funded leases, including the right to receive lease and rental payments and a security interest in the related equipment.\nAt September 30, 1995, aggregate future minimum payments to be received, including guaranteed residual values, for each of the succeeding fiscal years under direct financing and funded leases are as follows (in thousands):\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nIn September 1994, the Company entered into an agreement to sell, under an asset securitization program, an undivided ownership interest in $125,000,000 of eligible direct financing lease receivables. The agreement, which expires in September 1996, contains limited recourse provisions which require the Company to assign an additional undivided interest in leases to cover any potential losses to the purchaser due to uncollectible leases. As collections reduce previously sold interests, new leases can be sold up to $125,000,000. The weighted average interest rate on the agreement, which is partially fixed by three interest rate swap agreements totaling a principal\/notional amount of $90,000,000 is 7.0% at September 30, 1995. In fiscal year 1995, the Company sold $67,000,000 in leases, replacing leases liquidated during the year and recognized a pretax gain of $1,194,000. A pretax gain of $3,702,000 was recognized in the fourth quarter of fiscal 1994 relating to the original sales transaction. Under the terms of the sales agreement, the Company will continue to service the lease portfolio.\n5. NOTES PAYABLE TO BANKS AND MEDIUM TERM NOTES\nNotes payable at September 30, 1995 bear interest at rates ranging from 4.69% to 6.56% (4.01% to 7.06% at September 30, 1994) and mature on various dates through August 21, 1998. The weighted average interest rate for the notes outstanding at September 30, 1995 was 5.59% (5.76% at September 30, 1994).\nOn June 30, 1995, the Company increased the amount available to be offered under its medium term notes program by $1,000,000,000 or the equivalent thereof in foreign currency. The medium term note program effective July 1, 1994 of $500,000,000 was fully subscribed as of July 1995. The program allows the Company to offer to the public from time to time medium term notes having an aggregate initial offering price not exceeding the total program amount. These notes are offered at varying maturities of nine months or more from their dates of issue and may be subject to redemption at the option of the Company or repayment at the option of the holder, in whole or in part, prior to the maturity date in conjunction with meeting specified provisions. Interest rates are determined based on market conditions at the time of issuance. As of September 30, 1995, $602,000,000 of medium term notes are outstanding with a weighted average interest rate of 7.0%.\nThe Company follows a policy of matching the maturities of borrowed funds to the average life of the leases being financed in order to minimize the impact of interest rate changes on its operations. The Company has therefore entered into interest rate swap agreements to eliminate the impact of interest rate changes on its variable rate notes payable. The interest rate swap agreements effectively convert the variable rate notes into fixed rate obligations. During fiscal 1995, there were two variable rate notes outstanding and two related interest rate swap agreements on a principal\/notional amount of $57,000,000. The weighted average interest rate on these variable rate notes and related interest rate swap agreements was 6.58% and 4.76%, respectively, during fiscal 1995. The Company's interest expense would have been higher in 1995 and lower in 1994 and 1993 if the Company had chosen not to fix the interest rates through the swap agreements. The underlying floating rate expense was higher than the fixed rate by $1,037,000 in fiscal 1995 and lower than the fixed rate by $1,575,000 in fiscal 1994 and $1,844,000 in 1993. The interest rate swap agreements mature at the time the related notes mature. The Company is exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swap agreements. However, the Company does not anticipate nonperformance by the counterparties.\nThe Company must comply with certain restrictive covenants under the terms of its loan agreements. For loan agreements entered into before July 1, 1994, the Company agrees to maintain earnings before fixed charges (primarily interest) of not less than 1.3 times fixed charges, a ratio of debt to tangible net worth not exceeding 6 to 1 and tangible net worth not less than $1. For loan agreements (and medium-term notes)\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) entered into after July 1, 1994, the Company agrees to maintain earnings before fixed charges of not less than 1.25 times fixed charges and a tangible net worth of not less than $1.\nInterest paid amounted to $29,193,000, $25,554,000 and $22,122,000 for the fiscal years ended September 30, 1995, 1994 and 1993, respectively.\nAt September 30, 1995 and 1994, the fair value of the Company's notes payable to banks and medium term notes is estimated to be $782,029,000 and $425,792,000, respectively, using a discounted cash flow analysis. Fair values for the Company's interest rate swaps (off-balance sheet instruments) are estimated to be ($1,747,000) and $1,426,000 in fiscal 1995 and 1994, respectively, based on termination of the agreements.\nFuture maturities of all notes payable and medium term notes outstanding at September 30, 1995 are as follows (in thousands):\n6. LEASE COMMITMENTS\nTotal rent expense under all operating leases aggregated $955,000 in 1995, $342,000 in 1994, and $319,000 in 1993. At September 30, 1995, future minimum payments under noncancellable operating leases with initial or remaining terms of more than one year were: 1996-$437,000; 1997-$437,000.\n7. INCOME TAXES\nTaxable income of the Company is included in the consolidated federal income tax return of Alco and all estimated tax payments and refunds, if any, are made through Alco. The provision for income taxes was determined as if the Company was a separate taxpayer. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\" effective October 1, 1993. The cummulative effect of adopting SFAS No. 109 was to increase net income by $140,000 in fiscal 1994. As permitted under SFAS No. 109, prior years' financial statements have not been restated.\nProvision for income taxes:\nFISCAL YEAR ENDED SEPTEMBER 30 (IN THOUSANDS)\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) The components of deferred income tax assets and liabilities were as follows:\nSEPTEMBER 30 (IN THOUSANDS)\nDeferred taxes resulting from temporary differences between financial and tax accounting, which have not been restated for SFAS No. 109 as of September 30, 1993 were as follows (in thousands):\nThe components of the effective income tax rate were as follows:\nFISCAL YEAR ENDED SEPTEMBER 30\nThe Company made net income tax payments of $1,862,000, $3,432,000 and $4,214,000 in fiscal years 1995, 1994 and 1993, respectively.\n8. PENSION AND STOCK PURCHASE PLAN\nThe Company participates in Alco's defined benefit pension plan covering the majority of its employees. The Company's policy is to fund pension costs as accrued. Pension expense recorded in 1995, 1994 and 1993 was $43,000, $33,600 and $12,000, respectively.\nThe majority of the Company's employees were eligible to participate in Alco's Stock Participation Plan under which they were permitted to invest 2% to 6% of regular compensation before taxes. The Company contributed an amount equal to two-thirds of the employees' investments and all amounts were invested in Alco's common shares. Effective October 2, 1995, the Stock Participation Plan was replaced by a Retirement\nALCO CAPITAL RESOURCE, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nSavings Plan (RSP). The RSP will allow employees to invest 1% to 16% of regular compensation before taxes in six different investment funds. The Company will contribute an amount equal to two-thirds of the employees' investments, up to 6% of regular compensation, for a maximum company match of 4%. All Company contributions are invested in Alco's common shares. Employees vest in a percentage of the Company's contribution after two years of service, with full vesting at the completion of five years of service. In fiscal 1995, Alco charged the Company for costs related to a similar plan for eligible management employees. In prior years, this cost was paid by Alco. The Company's cost of the stock participation plans amounted to $195,000, $98,100 and $63,200 in 1995, 1994 and 1993, respectively.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1995 TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nAlco Capital Resource, Inc.\nDate: December 18, 1995\nBy \/s\/ Robert M. Kearns ------------------------------------ (ROBERT M. KEARNS) VICE PRESIDENT--FINANCE\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS FORM 10-K HAS BEEN SIGNED BELOW ON DECEMBER 18, 1995 BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.\nSIGNATURES TITLE ---------- -----\n*Richard P. Maier President (Principal Executive - ------------------------------------ Officer) (RICHARD P. MAIER)\n\/s\/ Robert M. Kearns Vice President--Finance (Principal - ------------------------------------ Financial Officer and Principal (ROBERT M. KEARNS) Accounting Officer)\n*Kurt E. Dinkelacker Director - ------------------------------------ (KURT E. DINKELACKER)\n*By his signature set forth below, Robert M. Kearns, pursuant to duly executed Powers of Attorney duly filed with the Securities and Exchange Commission, has signed this Form 10-K on behalf of the persons whose signatures are printed above, in the capacities set forth opposite their respective names.\n\/s\/ Robert M. Kearns December 18, 1995 - ------------------------------------ (ROBERT M. KEARNS)\nALCO CAPITAL RESOURCE, INC.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"778923_1995.txt","cik":"778923","year":"1995","section_1":"Item 1. Business.\nGeneral\nLorimar Film Partners L.P. (the \"Partnership\") is a Delaware limited partnership organized on October 1, 1985 to engage in the production, co-production, acquisition and exploitation of feature-length theatrical motion pictures. In 1986, the Partnership received net offering proceeds (gross offering proceeds minus certain expenses) of $28,970,000 from the Partnership's sale of 33,854 depositary units of limited partnership interests (\"Units\") pursuant to a registered public offering. These net proceeds were matched by contemporaneous capital contributions to the Partnership by the Partnership's Managing General Partner, Lorimar Motion Picture Management, Inc. The net offering proceeds and the foregoing capital contributions of the Managing General Partner were used by the Partnership, pursuant to the Partnership Agreement, to acquire rights from an affiliate of the Managing General Partner in and to four films entitled American Anthem, The Boy Who Could Fly, The Morning After and Power (collectively, the \"Partnership Films\"). In 1986, the Managing General Partner contributed an additional $2,675,000 to the capital of the Partnership, which capital contribution was applied by the Partnership to finance its acquisition of rights in and to The Morning After.\nThe Partnership's only current business activity is the continued exploitation of the four Partnership Films pursuant to existing distribution agreements. The Partnership Films have been released in the theatrical, home video, pay television, free television and non-theatrical markets both within and outside of the United States. The Morning After has been shown on network television in the United States. Due to the lack of interest by United States television networks, the Managing General Partner does not anticipate that the remaining Partnership Films will be broadcast on network television in the United States. The Managing General Partner believes that the only remaining market for distribution of the Partnership Films which will result in any material revenues to the Partnership is continued domestic television syndication. Domestic syndication rights to the Partnership Films were licensed to an affiliate of the Managing General Partner which has entered into sublicense agreements under which American Anthem and The Morning After commenced exploitation in the domestic syndication market in 1990, The Boy Who Could Fly commenced exploitation in the domestic syndication market in 1991 and Power commenced exploitation in the domestic syndication market in 1992.\nThe Partnership Films have not performed well in the marketplace and the Partnership has recorded writedowns in previous periods to reflect each film's estimated net realizable value. The Unitholders have been returned only 39% of their capital contributions to date and due to the poor performance of the Partnership Films there is no expectation of any additional distributions in the future to the Unitholders.\nIn 1995, the Partnership continued to be relatively inactive except for the various accounting and reporting functions necessary in maintaining a continuing publicly held business and as required pursuant to its Partnership Agreement. The Partnership is expected to remain inactive as it does not have, and will not have, sufficient funds to make any additional film investments. The Partnership has no employees of its own, and its business was administered by the staff of the General Partners but, because of the resignation of the Co-General Partner, it will now be administered only by the staff of the Managing General Partner (see Note 5. Subsequent Events to Financial Statements).\nAs of December 31, 1995, the Partnership had two General Partners, the Managing General Partner and the Co-General Partner; however, the Co-General Partner, Prudential-Bache Properties, Inc., a wholly-owned subsidiary of Prudential Securities Group Inc., has since withdrawn as a General Partner. On December 18, 1995, the Co-General Partner gave notice to the Managing General Partner that, pursuant to the Partnership Agreement, it was resigning and withdrawing as Co-General Partner effective March 22, 1996. Under the Partnership Agreement, upon the effectiveness of such withdrawal, the Co-General Partner became a Special Limited Partner, and as such, now has all the rights of a Limited Partner; provided that it will continue to have the same interest in Net Income, Net Loss, credits and Distributions as it had in its capacity as Co-General Partner, and its rights to indemnification under the Partnership Agreement are to continue; it is to have no responsibilities under the Partnership Agreement although it will continue to be obligated to appoint an appraiser in the event of the exercise by the Managing General Partner of the MGP (See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.) Option and will continue to have the right to exercise the CGP Option; and it will no longer receive any portion of the Management Fee. Upon such withdrawal, the Management Fee was automatically reduced under the Partnership Agreement from 3% of the aggregate Partnership Share of Gross Receipts to 2% thereof.\nSince June 16, 1992, Lorimar Motion Picture Management, Inc., the Managing General Partner, has been a wholly-owned subsidiary of Warner Communications Inc. (\"WCI\") as a result of the merger of Lorimar Telepictures Corporation (\"Lorimar\") into WCI. On June 30, 1992, WCI contributed certain of Lorimar's former assets (excluding the stock of the Managing General Partner) to Time Warner\nEntertainment Company, L.P., a limited partnership (\"TWE\"), of which WCI is a general partner. All references to Lorimar for all periods prior to June 26, 1992 are intended to refer to Lorimar, for the period from June 26, 1992 through June 30, 1992 are intended to refer to WCI, and for all periods after June 30, 1992 are intended to refer to TWE. WCI is a wholly-owned subsidiary of Time Warner Inc. (\"Time Warner\").\nFilm Distribution\/Distribution Financing\nMarkets Pre-Sold\n. Foreign Territory\nForeign distribution rights to the Partnership Films in all media were licensed, pursuant to a distribution agreement (the \"LDI Foreign Distribution Agreement\"), by the Partnership to Lorimar Distribution International, Inc. (\"LDI\"), then a wholly-owned subsidiary of Lorimar, for a term that was to expire on January 30, 1996 (see Note 5. Subsequent Events to Financial Statements) provided that subdistribution arrangements in certain foreign territories are in effect until January 30, 2011. As a result of various transactions, LDI's rights under the Foreign Distribution Agreement are now held by TWE.\nUnder the Foreign Distribution Agreement, the Partnership is entitled to 100% of all Gross Receipts (as defined in the Foreign Distribution Agreement) derived with respect to each Partnership Film pursuant to this agreement after deducting therefrom Distribution Fees (as defined in the Foreign Distribution Agreement) and Distribution Costs (as defined in the Foreign Distribution Agreement) with respect to that Partnership Film and any minimum guaranteed payments thereunder (discussed below) with respect to any Partnership Film. Distribution Fees vary according to the media and level of Gross Receipts derived by the distributor pursuant to this agreement and range from 10% to 20% of such receipts.\nThe Foreign Distribution Agreement also provides that the Partnership is entitled to minimum guaranteed payments equal to 30% of the Partnership's contribution to the Budget (as defined in said agreement) or the Cost of Production (as defined in said agreement) of each Partnership Film, whichever is less. The final minimum guaranteed payment with respect to the foreign territory was paid to the Partnership in 1990. Minimum guaranteed payments with respect to the foreign territory have aggregated approximately $17,789,000. These minimum guaranteed payments are recoupable by the distributor from the Partnership's share of Gross Receipts from the distribution of all Partnership Films under the Foreign Distribution Agreement.\nDue to the poor performance of the Partnership Films in the foreign market, as of September 30, 1995, the minimum guaranteed payments paid to the Partnership pursuant to the Foreign Distribution Agreement exceeded the Partnership's share of Gross Receipts under that agreement by approximately $4,888,000. As a result of the fact that future Gross Receipts with respect to the foreign territory for periods ending on or prior to January 30, 1996 (and thereafter in the case of certain sublicensing arrangements entered into before January 30, 1996) are to be applied to the payment of Distribution Costs and Distribution Fees and retained by the distributor to recoup the approximately $4,888,000 shortfall before any further payments would be made to the Partnership, it is not anticipated that any further payments will be made to the Partnership under the Foreign Distribution Agreement for periods ending on or prior to January 30, 1996 (and thereafter in the case of certain sublicensing arrangements entered into before January 30, 1996). With respect to foreign distribution subsequent to January 30, 1996, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" and Note 5. Subsequent Events to Financial Statements.\n. Domestic Home Video\nDistribution rights to the Partnership Films in the domestic home video market were licensed, pursuant to a license agreement (the \"Home Video Agreement\"), by the Partnership to a then Lorimar subsidiary, Karl Lorimar Home Video, Inc. (\"LHV\"), for a term that was to expire on January 30, 1996, subject to a sell-off period which was to expire on July 30, 1996 (see Note 5. Subsequent Events to Financial Statements). As a result of various transactions, LHV's rights under the Home Video Agreement are now held by TWE.\nUnder the Home Video Agreement, the Partnership is entitled to a Licensor's Royalty (as defined in the Home Video Agreement) with respect to all videocassettes of the Partnership Films sold or rented by the distributor pursuant to this agreement after deducting therefrom any minimum guaranteed payments thereunder (discussed below) with respect to videocassettes of any Partnership Film. The amount of the Licensor's Royalty ranges between 20% and 25% of the wholesale price of videocassettes of the Partnership Films sold by the distributor, depending on the retail price of the videocassettes.\nThe Home Video Agreement also provides that the Partnership is entitled to minimum guaranteed payments equal to 20% of the Partnership's contribution to the Budget (as defined in said agreement) or the Cost of Production (as defined in said agreement) of each Partnership Film, whichever is less. The final minimum guaranteed payment with respect to this market was paid to the Partnership in 1990. Minimum guaranteed payments with respect to the domestic home video market aggregated approximately\n$11,859,000. These minimum guaranteed payments are recoupable by the distributor from the Licensor's Royalties otherwise payable to the Partnership from the distribution of all Partnership Films under the Home Video Agreement. With respect to domestic video distribution subsequent to January 30, 1996, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nDue to the poor performance of the Partnership Films in the domestic home video market, as of December 31, 1995, the minimum guaranteed payments paid to the Partnership pursuant to the Home Video Agreement exceeded the Licensor's Royalties under that agreement by approximately $6,749,000. As a result of the fact that future Licensor's Royalties otherwise payable to the Partnership under the Home Video Agreement for periods ending on or prior to January 30, 1996 (and thereafter in certain cases) are to be retained by the distributor to recoup the approximate $6,749,000 shortfall before any further payments would be made to the Partnership, it is not anticipated that any further payments will be made to the Partnership under the Home Video Agreement for periods ending on or prior to January 30, 1996 (and thereafter in certain cases). With respect to domestic home video distribution subsequent to January 30, 1996, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" and Note 5. Subsequent Events to Financial Statements.\nMarkets Not Pre-Sold\nDomestic distribution rights to the Partnership Films in most media, other than theatrical and home video, were licensed, pursuant to a distribution agreement (as amended, the \"LDI Domestic Distribution Agreement\"), by the Partnership to LDI for a term that was to expire on January 30, 1996, provided that subdistribution and other license agreements regarding such domestic distribution rights are in effect until June 26, 2001 (see Note 5. Subsequent Events to Financial Statements). As a result of various transactions, LDI's rights under the LDI Domestic Distribution Agreement are now held by TWE. As compensation for its distribution activities under the LDI Domestic Distribution Agreement, the distributor is entitled to receive a distribution fee equal to 17-1\/2% of all gross receipts derived by it pursuant to the LDI Domestic Distribution Agreement and to recoup its distribution expenses thereunder from the first dollar of such gross receipts.\nThe Partnership Films, other than American Anthem, were distributed theatrically and, with certain exceptions, non-theatrically, domestically by Twentieth Century Fox Film Corporation (\"Fox\"). American Anthem was distributed theatrically and in certain other media domestically by Columbia Pictures (\"Columbia\"). Pursuant to its distribution agreements with Fox and\nColumbia, the Partnership paid all of the print and advertising costs and certain other distribution expenses in connection with the distribution of the Partnership Films by Fox and Columbia. As contemplated by the Partnership Agreement, the funds to pay for these costs were derived originally from bank financing and from advances by LDI (the outstanding amount of such bank financing and advances now being owed to TWE.) (See \"Distribution Financing.\") With respect to domestic distribution subsequent to January 30, 1996, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" and Note 5. Subsequent Events to Financial Statements.\nDistribution Financing\nUnder a Credit, Guaranty and Security Agreement dated as of June 6, 1986 (the \"Credit Agreement\"), the Partnership obtained a revolving credit facility in the amount of up to $30,000,000 from a group of banks to finance print and advertising costs for the Partnership Films. The terms of the Credit Agreement provide for the payment of interest quarterly at a rate equal to 1 1\/2% (2 1\/2% in the case of default) over Chemical Bank's prime rate plus commitment fees and agency fees. Lorimar made a payment to the banks on July 31, 1987 of approximately $11,753,000, which was the then outstanding balance of the principal and interest plus fees under the Credit Agreement, and, pursuant to an agreement dated November 1, 1988, in consideration of such payment and certain indemnities by Lorimar, the banks assigned to Lorimar all of their interest in the Credit Agreement, the Partnership's notes made thereunder (collectively, the \"P&A Note\"), the related agreements and, with certain exceptions, the Collateral (as defined in the Credit Agreement). Lorimar has not charged the Partnership any commitment fees or agency fees and charges interest to the Partnership on the P&A Note at Chemical Bank's prime rate.\nThe P&A Note and related accrued but unpaid interest became due and payable on December 31, 1990. As of December 31, 1995, the principal balance owed with respect to the P&A Note was approximately $4,985,000, and the related accrued but unpaid interest was approximately $926,000. As of December 31, 1995, Lorimar had not made demand for payment in full for amounts due with respect to the P&A Note; however, Lorimar had the right to make such a demand at any time. As of December 31, 1995, the Partnership did not have sufficient liquid assets to pay the principal of the P&A Note and interest thereon in full. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 5. Subsequent Events to Financial Statements).\nIn addition to the P&A Note, the Partnership is obligated to reimburse Lorimar for print and advertising costs and other distribution expenses advanced pursuant to the Partnership Agreement on behalf of the Partnership by LDI (the \"P&A Advances\").\nAs of December 31, 1995, the outstanding balance of the P&A Advances owed to Lorimar was approximately $7,328,000 and related accrued but unpaid interest, computed at Chemical Bank's prime rate, was approximately $3,634,000. Lorimar has the right to declare the P&A Advances, and related interest, to be immediately due and payable. As of December 31, 1995, Lorimar had not made demand for payment of such amounts; however, Lorimar had the right to make such a demand at any time. The Partnership does not have sufficient liquid assets to pay the principal of the P&A Advances and interest thereon in full. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 5. Subsequent Events to Financial Statements).\nThere is neither currently nor is it anticipated that at any time during the remaining term of the Partnership, the Partnership will have sufficient assets to pay all of its obligations with respect to both the P&A Note and the P&A Advances. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 5. Subsequent Events to Financial Statements).\nPower Guarantee\nWith respect to Power, pursuant to the LDI Domestic Distribution Agreement, an affiliate of the Managing General Partner had agreed to pay to the Partnership, on or before January 30, 1996, an amount generally equal to the amount by which as of January 30, 1996 (i) the sum of the Partnership's Acquisition Cost (as defined in said agreement) and the Partnership's share of the Distribution Expenses (as defined in said agreement) incurred in connection with the film exceeds (ii) the Partnership's Gross Receipts (as defined in said agreement) from the film (the \"Power Guarantee\"). For this purpose, Gross Receipts consists of all sums actually received with respect to Power by the Partnership pursuant to all applicable distribution agreements. Any payments received by the Partnership with respect to the Power Guarantee were to be Partnership revenues to be used for Partnership purposes in accordance with the Partnership Agreement. Accordingly, all amounts received under the Power Guarantee were to be used to satisfy obligations of the Partnership including those due to affiliates of the Managing General Partner. (See Note 5. Subsequent Events to Financial Statements).\nCompetition\nMotion picture production and distribution is highly competitive. Not only are there numerous producers and distributors of motion pictures in the United States and throughout the world, but there is competition with other media such as television and home video. As previously discussed, the Partnership Films are being distributed in the domestic syndication market through January 30, 1996 (see Note 5. Subsequent Events to\nFinancial Statements) by Warner Bros., a division of TWE, on behalf of Lorimar. Although the distribution arrangements entered into with affiliates of the Managing General Partner terminate subsequent to January 30, 1996, such agreements do not prohibit the Partnership Films from being re-released in the syndication markets in competition with other films and television programs produced or acquired by affiliates of the Managing General Partner and others; in fact, this may occur.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Partnership does not own or lease any property. The Partnership's principal place of business and administrative office is at 4000 Warner Boulevard, Bldg. 2, Room 109, Burbank, California 91522.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nA purported class action lawsuit on behalf of a class of all persons who are or have been holders of limited partnership interests was filed on May 22, 1991 in the Superior Court of California for Los Angeles County. Named as defendants were Lorimar Motion Picture Management, Inc.; Lorimar Telepictures Corporation; Prudential Securities Incorporated; and Prudential-Bache Properties, Inc. (Tillman, et al. v. Lorimar Motion Picture Management, Inc., et al., Case No. BC 028964, L.A. Co. Sup. Ct.). The original complaint charged defendants with fraud, negligence, and breach of fiduciary duty in connection with the offering of the Units and breach of fiduciary duty in connection with the operation of the Partnership. The plaintiffs sought compensatory and punitive damages in an unspecified amount and an accounting. The General Partners had advised the Partnership that they intended to defend the case vigorously. Certain of the charges made in the complaint were similar to charges made in litigation entitled Galloway v. Lorimar Motion Picture Management, Inc., et al., filed in the courts of the State of Ohio. Certain of those charges were dismissed on the merits and the dismissal was affirmed on appeal.\nA demurrer seeking dismissal of the complaint was filed by the defendants in 1991 and, on May 3, 1994, the Tillman court sustained this demurrer. The court ruled that the complaint was insufficient as a matter of law with respect to all claims arising from the public offering of the Units in 1985 and 1986. The court did not permit amendment of those claims. The court also sustained the demurrer challenging the sufficiency of plaintiffs' claims that the General Partners breached certain fiduciary duties under the Partnership Agreement in connection with their operation of the Partnership, but granted plaintiffs' counsel an opportunity to amend those claims to attempt to state a cause of action. An amended complaint for breach of fiduciary duty was filed on June 2, 1994, naming only the General Partners as defendants. The General Partners filed a demurrer to the amended complaint, together with\na motion for summary adjudication that the specific conduct challenged in the amended complaint was undertaken by the General Partners in conformance with the terms and requirements of the Partnership Agreement. A hearing on these matters was held on August 3, 1994, and on November 1, 1994, the court sustained the General Partners' demurrer on the basis that the amended complaint failed to state a claim upon which relief may be granted. The court gave plaintiffs leave to file an amended complaint for breach of fiduciary duty and, for this reason, defendants' motion for summary judgment was denied without prejudice. On January 18, 1995, plaintiffs served their second amended complaint on the defendants. The second amended complaint asserts claims for alleged breaches of the Partnership Agreement and breaches of fiduciary duty by defendants. Plaintiffs seek damages in an unspecified amount but in excess of $500,000. On March 24, 1995, defendants filed an answer to the second amended complaint, denying the allegations therein and asserting several affirmative defenses. Defendants filed a summary judgment motion on April 18, 1995, and a hearing took place on May 24, 1995. On June 12, 1995, the court granted defendants' motion for summary judgment insofar as it sought dismissal of all claims made as a class action on behalf of Unitholders individually. However, the court permitted the action to proceed as a derivative action by plaintiffs on behalf of the Partnership. Pursuant to the court's order, plaintiffs again amended their complaint to seek on behalf of the Partnership recovery from the General Partners of allegedly improperly high fees and interest paid to certain banks which provided P&A Financing to the Partnership. Plaintiffs allege that defendants breached their fiduciary duties by permitting payment of such excess fees and interest and, in the complaint, estimate the allegedly excess fees and interest to exceed $500,000. Defendants continue to assert that their actions were entirely proper under the law and the terms of the Limited Partnership Agreement and that the Partnership did not pay any excess or improper fees or interest to the banks. The Partnership has been advised that the General Partners intend to defend the action vigorously. In December 1995, Prudential-Bache Properties, Inc. was dismissed voluntarily by plaintiffs. Nevertheless, preliminary discussions have been conducted between plaintiff and the Managing General Partner regarding the possibility of presenting to the court for its approval a settlement which would reflect the size of the claim, the relative positions of the parties, and the costs of continued litigation. The terms which have been agreed upon in principle would involve a reduction of certain of the debt owed by the Partnership to the Managing General Partner and affiliates and payment, in part, of attorneys' fees to plaintiffs' counsel by the Managing General Partner. That agreement is subject to documentation and court approval.\nPrudential Securities Incorporated (\"PSI\"), certain of its present and former employees, the Managing General Partner and the former Co-General Partner, among others, have been named defendants\nin a putative class action filed in U.S. District Court for the Southern District of New York, entitled In re Prudential Securities Incorporated Limited Partnerships Litigation (MDL 1005). Two former officers and the parent company of the Managing General Partner were also named as defendants, and the Managing General Partner has undertaken their defense. (Hereinafter, these additional defendants and the Managing General Partner are sometimes referred to collectively as \"the Lorimar Organization Defendants.\") The consolidated complaint, which was filed on June 8, 1994, consolidates complaints previously filed in actions in several federal district courts around the country that were transferred to the Southern District of New York by order of the Judicial Panel on Multidistrict Litigation in April 1994. None of the Lorimar Organization Defendants were named as defendants in any of the transferred actions. The consolidated complaint alleges violations of the federal Racketeer Influenced and Corrupt Organizations Act (\"RICO Act\"), fraud, negligent misrepresentation, breach of fiduciary duties, breach of third-party beneficiary contracts, breach of implied covenants and violations of New Jersey statutes in connection with the marketing and sales of limited partnership interests. Plaintiffs request relief in the nature of: rescission of the purchase of securities, and recovery of all consideration and expenses in connection therewith, as well as compensation for lost use of money invested, less cash distributions; compensatory damages; consequential damages; treble damages for defendants' alleged RICO violations (both federal and New Jersey); general damages for all alleged injuries resulting from negligence, fraud, breaches of contract, and breaches of duty in an amount to be determined at trial; disgorgement and restitution of all earnings, profits, benefits and compensation received by defendants as a result of their allegedly unlawful acts; costs and disbursements of the action; reasonable attorneys' fees; and such other and further relief as the court deems just and proper. The Partnership is listed in the consolidated complaint as being among the limited partnerships at issue in the case. On September 29, 1994, plaintiffs filed a motion to deem each of the constituent complaints (in which the Lorimar Organization Defendants were not named) amended to conform to the consolidated complaint. The Managing General Partner opposed the motion. A hearing was held on November 21, 1994 and on November 28, 1994, the court granted plaintiffs' motion. As a result, the Lorimar Organization Defendants are deemed to be defendants in each of the constituent actions, as well as in the consolidated action. On October 31, 1994, the Managing General Partner filed a motion to dismiss the consolidated complaint (and each of the constituent actions) with respect to the Lorimar Organization Defendants. The hearing on the motion, originally expected in January 1995, was postponed indefinitely by the court, and the parties are awaiting a new hearing date. On December 20, 1994, PSI, along with various other defendants, moved to dismiss the entire consolidated complaint.\nBy order dated August 29, 1995, the court granted plaintiffs' motion for temporary class certification, preliminarily approved a settlement entered into between plaintiffs, the former Co-General Partner and PSI, scheduled a fairness hearing for November 17, 1995, approved the form and content of the notice to class members and directed that it be provided to class members. The settlement was approved by the court at the fairness hearing. The full amount due under the settlement agreement has been paid by PSI.\nSubsequent to the announcement of the Prudential settlement, the Lorimar defendants held settlement negotiations with counsel for the class. Counsel for the class and the Lorimar defendants have agreed in principle to the settlement of all class claims against the Lorimar defendants in exchange for payment by the Lorimar defendants of $400,000, the allocation of which will be provided in the settlement documents. That agreement in principle is subject to agreement on appropriate documentation and to court approval. Upon submission of the agreed upon documentation to the Court, it is expected that the Court would schedule a hearing for approval and direct notice to be given to the class regarding the terms of the settlement and their procedural rights. In connection with, and as a condition to, the proposed settlement between the plaintiffs and the Lorimar defendants, the Managing General Partner will require an agreement between it and the former Co-General Partner regarding certain outstanding matters, including mutual releases, involving them and their affiliates.\nThe Partnership is not aware of any legal proceedings that name the Partnership as a defendant. Neither the Tillman nor the MDL litigation described above name the Partnership as a defendant. The Partnership Agreement provides for indemnification of the General Partners and their affiliates under certain circumstances. The indemnification excludes damages assessed against a General Partner for violation of securities laws, the RICO Act or fraud.\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 established public trading market for the Units or for the limited partnership interests into which the Units are convertible.\nHolders of Units have the right to convert their Units into limited partnership interests. As of December 31, 1995, no Units had been so converted.\nAs of March 1, 1996, there were 6,898 holders of Units, holding an aggregate of 33,854 Units.\nThe Partnership has made cash distributions to Unitholders from minimum guarantee receipts less management fees and general and administrative expenses as follows:\nNo distributions have been made since June 13, 1990. All mandatory distributions relating to minimum guarantees have been made and there will be no further mandatory distributions. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operation.\")\nUnder certain circumstances, provisions of the Revised Uniform Limited Partnership Act of the State of Delaware prohibit Delaware limited partnerships, such as the Partnership, from making distributions to its partners.\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 Partnership's ability to continue to operate at the present time is due exclusively to Lorimar's forbearance with respect to the Partnership's obligations which are currently due and owing to Lorimar and its affiliates principally, as of the date hereof, under the P&A Advances. (See Item 1. \"Business-Distribution Financing\".) The Partnership has no assurance that Lorimar will not make demand at any time with respect to the P&A Advances. The Partnership has neither sufficient liquid assets nor total assets to pay its current liabilities. As of December 31, 1995, the Partnership's current assets were $1,188,809 and its total assets were $11,685,625, while the Partnership's liabilities (all of which were current) were $17,692,933, of which $17,374,018 constituted the amounts owed with respect to the P&A Note and the P&A Advances and other sums to Lorimar and its affiliates. However, on January 30, 1996, in full satisfaction of the Power Guarantee, the Power Guarantee was offset against the full amount of principal and interest owed with respect to the P&A Note plus the interest and a portion of the principal due with respect to the P&A Advances, resulting in a remaining principal balance of the P&A Advances, as of that date, of $7,151,604 (see Note 5. Subsequent Events to Financial Statements). In the event Lorimar demands payment of the balance of the P&A Advances and the Partnership does not satisfy payment thereof in full, Lorimar will have all of its rights under applicable agreements and law, including the right ultimately to proceed against the Partnership's assets (see Note 5. Subsequent Events to Financial Statements). In recognition of the Partnership's financial condition, the independent auditors report issued in connection with the Partnership's financial statements for the year ended December 31, 1995 contains an explanatory paragraph regarding the substantial doubt of the ability of the Partnership to continue as a going concern.\nEven if Lorimar continues to forebear on the principal of the P&A Advances and merely requires current satisfaction of interest, the Managing General Partner believes that the Partnership will continue to incur net operating losses on an annual basis through 1996. These losses are anticipated to result from the fact that the only significant source of Partnership revenue which is anticipated during this period is domestic syndication revenue under existing distribution agreements (which is estimated to aggregate approximately $60,000 through June 26, 1996 (see description of MGP Option below), before deducting fees and expenses), and it is anticipated that this revenue will be less than the Partnership's aggregate annual interest expense (net of interest income) with respect to the P&A Advances during this\nperiod. Further, the general and administrative expenses of the Partnership will continue to increase net losses in the future.\nIn January 1996, the Partnership's distribution agreements which are currently in effect expired. Therefore, subject to the subdistribution, other license and sell-off rights under those agreements (see Item 1. \"Business-Film Distribution\/ Distribution Financing\"), upon the expiration of those distribution agreements, the Partnership would have no agreements in effect in order to exploit the Partnership Films (see Note 5. Subsequent Events to Financial Statements). Accordingly, receipt of any future distribution or licensing revenue will depend upon the ability of the Managing General Partner, on behalf of the Partnership, to enter into new distribution or licensing agreements with respect to the Partnership Films. Moreover, any revenue received under the existing foreign and home video distribution agreements would be subject to recoupment of the minimum guarantees under the Foreign Distribution Agreement and the Home Video Agreement. The Managing General Partner believes that the Partnership will be unable to enter into distribution or license agreements with respect to the Partnership Films in any media other than worldwide television syndication, to the extent not already licensed. Based on the above analysis by the Managing General Partner, the Managing General Partner does not believe that any such distribution arrangements, after recoupment of fees and expenses, would provide income to the Partnership sufficient to satisfy all of the Partnership's obligations.\nThe Managing General Partner believes that the fair market value of the Partnership's assets will be less than the amount of the Partnership's current liabilities throughout the remaining term of the Partnership. Accordingly, the Managing General Partner believes that the Partnership will be unable to fully satisfy the P&A Advances and that the Partnership will be unable to make any further distributions to the Unitholders.\nAs a result of the minimum guarantees, approximately 39% of Unitholders' original capital contributions have been returned through Partnership distributions. All mandatory distributions relating to minimum guarantees have been made and there will be no further distributions to the Unitholders.\nPursuant to the Partnership Agreement, at any time after June 26, 1996, the Managing General Partner has the right (the \"MGP Option\") to purchase the Partnership Films and the Rights (as defined in the Partnership Agreement) at their Appraised Fair Market Value (as defined in and determined pursuant to the Partnership Agreement). Based on the Managing General Partner's judgments as to the inability of the Partnership to derive further exploitation revenue from the Partnership Films, the Managing General Partner believes that the purchase price under the MGP\nOption would be insufficient to satisfy all of the Partnership's liabilities.\nIn lieu of purchasing the Partnership Films and the Rights, as part of the MGP Option, the Managing General Partner also has the option from and after June 26, 1996 to purchase the Depositary Units and Limited Partnership Interests for an amount equal to the amount that the Unitholders and Limited Partners would be entitled to receive if the Managing General Partner had exercised the MGP Option and thereupon the Partnership was liquidated and dissolved.\nBased on the above analysis of estimated future Partnership revenue, in the event of the exercise of the MGP Option and upon the subsequent liquidation and dissolution of the Partnership, there would be no amounts payable to the Unitholders or the Limited Partners and no amounts payable to them as the purchase price for their Units or Limited Partnership Interests if the Managing General Partner elects to purchase the same pursuant to the MGP Option. The Managing General Partner has indicated to the Co-General Partner that it is its current intention to exercise the MGP Option, but it has no obligation to do so.\nResults of Operations\nThe results of operations are not necessarily comparable from year to year since the Partnership's income is determined by exploitation of its four films in the various media of the exploitation cycle (i.e. theatrical, home video, pay television, non-theatrical, network television, and domestic syndication).\nThe domestic theatrical release dates for Power, American Anthem, The Boy Who Could Fly and The Morning After were January 1986, June 1986, September 1986, and December 1986, respectively. The Partnership has recorded the majority of the revenue which it expects to recognize over the life of its films. During the years ended December 31, 1995, 1994 and 1993 revenues (net of distribution fees and costs) were recorded from the following media (in thousands):\nOf the revenues (net of distribution fees and costs) recorded during the year ended December 31, 1995 the entire amount was used to reduce the amount due to Lorimar related to the P&A Note and the P&A Advances and to an affiliate of the Managing General Partner for residual costs.\nPursuant to the LDI Domestic Distribution Agreement, the distributor for the domestic syndication market, which is an affiliate of the Managing General Partner, has entered into sublicense agreements pursuant to which American Anthem and The Morning After commenced exploitation in this market in 1990, The Boy Who Could Fly did so in 1991 and Power did so in 1992. Any Partnership revenues from the domestic syndication market has been and will continue to be applied first to reduce the amounts contractually due Lorimar for the P&A Note and the P&A Advances (see Note 5. Subsequent Events to Financial Statements).\nInterest expense accruing at any time is based on the then outstanding balance of the P&A Note and the P&A Advances. Although there have been no new borrowings since March 1988, accrued but unpaid interest has been added to the outstanding balance (see Note 5. Subsequent Events to Financial Statements).\nExpenses related to maintaining the Partnership will continue until termination of the Partnership. If the Partnership cash were applied in full to the obligations due to Lorimar and its affiliates, there would be insufficient cash to fund ongoing Partnership expenses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nLORIMAR FILM PARTNERS L.P.\nPAGE NO.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS 20 BALANCE SHEETS - DECEMBER 31, 1995 AND DECEMBER 31, 1994 21\nSTATEMENTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 22\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT) - YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 23\nSTATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 24\nNOTES TO FINANCIAL STATEMENTS 25 - 35\nSchedules are omitted as such are not required.\nReport of Independent Auditors\nThe Partners Lorimar Film Partners L.P.\nWe have audited the accompanying balance sheets of Lorimar Film Partners L.P., a Delaware 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 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 Lorimar Film 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.\nAs discussed in Note 3 to the financial statements, the Partnership's assets are insufficient to satisfy payment of its liabilities, raising substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nErnst & Young LLP Ernst & Young LLP\nLos Angeles, California March 4, 1996\nLORIMAR FILM PARTNERS L.P. BALANCE SHEETS DECEMBER 31, 1995 AND DECEMBER 31, 1994\nSee accompanying notes to Financial Statements.\nLORIMAR FILM PARTNERS L.P. STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to Financial Statements.\nLORIMAR FILM PARTNERS L.P. STATEMENTS OF PARTNERS' CAPITAL (DEFICIT) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to Financial Statements.\nLORIMAR FILM PARTNERS L.P. STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to Financial Statements.\nLORIMAR FILM PARTNERS L.P. NOTES TO FINANCIAL STATEMENTS Note 1. Organization:\nLorimar Film Partners L.P., a Delaware limited partnership (\"the Partnership\"), was organized in October 1985. The Partnership is engaged in the exploitation of four full-length theatrical motion pictures. Since June 16, 1992, Lorimar Motion Picture Management, Inc., the Managing General Partner, has been a wholly-owned subsidiary of Warner Communications Inc. (\"WCI\") as a result of the merger of Lorimar Telepictures Corporation (\"Lorimar\") into WCI. On June 30, 1992 WCI contributed certain of Lorimar's former assets (excluding the stock of the Managing General Partner) to Time Warner Entertainment Company, L.P., a limited partnership (\"TWE\"), of which WCI is a general partner. All references in these notes to Lorimar for all periods prior to June 26, 1992 are intended to refer to Lorimar, for the period from June 26, 1992 through June 30, 1992 are intended to refer to WCI, and for all periods after June 30, 1992 are intended to refer to TWE. WCI is a wholly-owned subsidiary of Time Warner Inc. Prudential-Bache Properties, Inc., a wholly-owned subsidiary of Prudential Securities Group Inc., is the Co-General Partner. Prudential Securities Group Inc. has given notice of its withdrawal as Co-General Partner and, effective as of March 22, 1996, it will cease to be a General Partner and will become a Special Limited Partner (see Note 5. Subsequent Events). Any references made to Limited Partners within the financial statements means the same as Unitholders.\nNote 2. Summary of Significant Accounting Policies:\nRevenues and Film Costs:\nThe Partnership acquired four motion pictures in 1986 for initial exhibition in domestic theaters followed by distribution in the domestic home video, pay cable, basic cable, broadcast network and syndicated television markets, as well as applicable foreign markets. Generally, distribution to the theatrical, home video and pay cable markets was completed within eighteen months of initial release. Substantially all of the revenues recorded during the three year period ended December 31, 1995 resulted from syndicated television license agreements, which are recognized as royalty statements are received from the distributor.\nFilm costs, which included costs to acquire the films and deferred prints and advertising costs, are stated at estimated net realizable value determined on an individual film forecast basis. The cost of each individual film is amortized based on the\nroportion that current revenues from the film bear to an estimate of total revenues anticipated from all markets. These estimates are revised periodically and losses, if any, are provided in full.\nCosts of the released films were allocated between current and non-current assets based on the estimated future revenue from their primary and secondary markets. The primary markets for feature films are the theatrical, video and pay cable television markets; the secondary markets are the network television, basic cable and domestic and foreign syndication markets.\nAs of December 31, 1995, based upon the Partnership's estimate of remaining ultimate revenue, including proceeds under the Power guarantee (see Note 3), the remaining unamortized balance of film costs will be amortized over the remaining terms of the distribution agreements. As of December 31, 1995, the net carrying value of Power was $9,840,486, which is to be recouped by the end of January 1996 principally from the receipt of the Power guarantee (see Note 3).\nCash Equivalents:\nThe Partnership considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.\nIncome Taxes:\nNo provision has been made for federal income taxes in the accompanying financial statements since all income and losses will be allocated to the partners for inclusion in their respective tax returns.\nThe Partnership has reported for the years ended December 31, 1995, 1994 and 1993, net losses for federal income tax purposes (tax basis) of $1,632,448, $1,235,500 and $1,045,479 respectively. Differences between financial statement net losses and tax basis net losses are generally due to the timing of revenues and distribution costs recognition and the resulting differential in the related amortization of motion picture costs and the recognition of management fees.\nUnitholders' Capital:\nAt December 31, 1995 , the Unitholders had a deficit capital account balance of $5,739,702. Under the Partnership Agreement and the Delaware Revised Uniform Limited Partnership Act, the fact that the Limited Partners have a deficit capital account balance does not impose any liability upon the Unitholders.\nNet loss per Depositary Unit of Limited Partnership Interest (\"Unit\"):\nNet loss per Unit was computed by dividing the Limited Partners' share of net loss by the weighted average number of Units outstanding during the period. The weighted average number of Units was 33,854 for the years ended December 31, 1995, 1994 and 1993.\nNote 3. Transactions with General Partners and Affiliates:\nThe Partnership purchased the rights to four motion picture films by paying the budgeted production costs of each film. All Partnership films have been completed. The Partnership has reimbursed the Managing General Partner and its affiliates for the budgeted production costs of these films. Partnership funds were insufficient to pay the full budgeted cost of acquiring The Morning After; therefore, the Limited Partners' interest in that film was reduced in proportion to their contribution with the balance provided by an additional capital contribution by the Managing General Partner to the Partnership of approximately $2,675,000. The Limited and Managing General Partners' investment shares in The Morning After are 42.66% and 57.34%, respectively. The Partnership's capital contributions have been fully invested; reinvestment of operating cash flows in additional films will not occur.\nThe Partnership Agreement provides for allocations of net income and distributions of 49.5% to the Limited Partners and 50.5% to the General Partners, except with respect to The Morning After. Generally, net loss is allocated 50% to the Limited Partners and 50% to the Managing General Partner. In addition, the Partnership is obligated to the General Partners for the following:\na. A management fee equal to 3% of the Partnership's share of gross receipts (see Note 5).\nb. Mandatory distributions that are payable to the partners to the extent minimum guarantees are received in excess of estimated general and administrative expenses and management fees.\nc. Reimbursement of other costs and expenses.\nWith respect to Power, pursuant to the LDI Domestic Distribution Agreement, an affiliate of the Managing General Partner has agreed to pay to the Partnership, on or before January 30, 1996, an amount generally equal to the amount by which as of January 30, 1996 (i) the sum of the Partnership's Acquisition Cost (as defined in said agreement) and the Partnership's share of the Distribution Expenses (as defined in said agreement) incurred in connection with the film exceeds (ii) the Partnership's Gross Receipts (as defined in said agreement) from the film (the \"Power\nGuarantee\"). For this purpose, Gross Receipts consists of all sums actually received with respect to Power by the Partnership pursuant to all applicable distribution agreements. Any payments received by the Partnership with respect to the Power Guarantee will be Partnership revenues to be used for Partnership purposes in accordance with the Partnership Agreement. Accordingly, all amounts received under the Power Guarantee will be used to satisfy obligations of the Partnership including those due to affiliates of the Managing General Partner (see Note 5. Subsequent Events).\nForeign distribution in all media and domestic home video distribution of Partnership Films was originally licensed to Lorimar Distribution International, Inc. and Karl Lorimar Home Video, Inc., respectively, both affiliates of the Managing General Partner. The licenses were for minimum guaranteed payments equal to 30% and 20%, respectively, of the Partnership's contribution to each film's budget or cost of production, whichever is less. The foreign distribution and domestic home video distribution arrangements were assigned to other affiliates of the Managing General Partner in January 1989 and June 1988, respectively. As a result of various transactions, the foreign distribution and domestic home video distribution rights are now held by TWE. All minimum guarantees related to foreign distribution and domestic home video distribution have been recorded and received by the Partnership. Under the Partnership Agreement, these minimum guarantees were required to be distributed to the partners as mandatory distributions after deduction for management fees and general and administrative expenses. All mandatory distributions relating to minimum guarantees have been made and there will be no further mandatory distributions attributable to minimum guarantees in the future.\nThe Managing General Partner, the Co-General Partner and their affiliates have charged to the Partnership the following Partnership expenses (excluding management fees) incurred by them:\nAmounts due to the Managing General Partner and affiliates and to the Co-General Partner are comprised of the following:\nInterest paid to the Managing General Partner and affiliates is:\nUnder a Credit, Guaranty and Security Agreement dated as of June 6, 1986 (the \"Credit Agreement\"), the Partnership obtained a revolving credit facility in the amount of up to $30,000,000 from a group of banks to finance print and advertising costs for the Partnership Films. The terms of the Credit Agreement provided for the payment of interest quarterly at a rate equal to 1 1\/2% (2 1\/2% in the case of default) over Chemical Bank's prime rate plus commitment fees and agency fees. Lorimar made a payment to the banks on July 31, 1987 of approximately $11,753,000, which was the then outstanding balance of the principal and interest plus fees under the Credit Agreement, and, pursuant to an agreement dated November 1, 1988, in consideration of such payment and certain indemnities by Lorimar, the banks assigned to Lorimar all of their interest in the Credit Agreement, the Partnership's notes made thereunder (collectively, the \"P&A Note\"), the related agreements and, with certain exceptions, the Collateral (as defined in the Credit Agreement). Lorimar has not charged the Partnership any commitment fees or agency fees and charges interest to the Partnership on the P&A Note at Chemical Bank's prime rate.\nThe P & A Note and related accrued but unpaid interest became due and payable on December 31, 1990. As of December 31, 1995, the principal balance owed with respect to the P&A Note was approximately $4,985,000, and the related accrued but unpaid interest was approximately $926,000. As of December 31, 1995, Lorimar had not made demand for payment in full for amounts due with respect to the P&A Note; however, Lorimar had the right to make such a demand at any time. As of December 31, 1995, the Partnership did not have sufficient liquid assets to pay the principal of the P&A Note and interest thereon in full (see Note 5. Subsequent Events).\nIn addition to the P&A Note, the Partnership is obligated to reimburse Lorimar for print and advertising costs and other distribution expenses advanced pursuant to the Partnership Agreement on behalf of the Partnership by LDI (the \"P&A Advances\"). As of December 31, 1995, the outstanding balance of the P&A Advances owed to Lorimar was approximately $7,328,000 and related accrued but unpaid interest, computed at Chemical Bank's prime rate, was approximately $3,634,000. Lorimar has the right to declare the P&A Advances, and related interest, to be immediately due and payable. As of December 31, 1995, Lorimar had not made demand for payment of such amounts; however, Lorimar had the right\nto make such a demand at any time. The Partnership does not have sufficient liquid assets to pay the principal of the P&A Advances and interest thereon in full (see Note 5. Subsequent Events).\nAll amounts due to the Managing General Partner and its affiliates have been classified as current liabilities.\nNeither currently nor at any time over the remaining term of the Partnership is it anticipated that the Partnership will have sufficient liquid assets to pay the principal plus interest on both the P&A Note and the P&A Advances.\nThe Partnership maintains a checking account and an interest-earning mutual fund account. The interest-earning account is managed by an affiliate of the Co-General Partner. The interest rate earned on funds fluctuates daily and approximated 5.5% during the year ended December 31, 1995. Interest earned on this account was $70,275, $55,560 and $47,786 for the years ended December 31, 1995, 1994 and 1993, respectively.\nAs of December 31, 1995, Prudential Securities Incorporated, an affiliate of the Co-General Partner, owned 113 Units.\nNote 4. Litigation:\nA purported class action lawsuit on behalf of a class of all persons who are or have been holders of limited partnership interests was filed on May 22, 1991 in the Superior Court of California for Los Angeles County. Named as defendants are Lorimar Motion Picture Management, Inc.; Lorimar Telepictures Corporation; Prudential Securities Incorporated; and Prudential-Bache Properties, Inc. (Tillman, et al. v. Lorimar Motion Picture Management, Inc., et al., Case No. BC 028964, L.A. Co. Sup. Ct.). The original complaint charged defendants with fraud, negligence, and breach of fiduciary duty in connection with the offering of the Units and breach of fiduciary duty in connection with the operation of the Partnership. The plaintiffs sought compensatory and punitive damages in an unspecified amount and an accounting. The General Partners had advised the Partnership that they intended to defend the case vigorously. Certain of the charges made in the complaint were similar to charges made in litigation entitled Galloway v. Lorimar Motion Picture Management, Inc., et al., filed in the courts of the State of Ohio. Certain of those charges were dismissed on the merits and the dismissal was affirmed on appeal.\nA demurrer seeking dismissal of the complaint was filed by the defendants in 1991 and, on May 3, 1994, the Tillman court sustained this demurrer. The court ruled that the complaint was insufficient as a matter of law with respect to all claims arising from the public offering of the Units in 1985 and 1986. The court did not permit amendment of those claims. The court also sustained the demurrer challenging the sufficiency of plaintiffs' claims that the General Partners breached certain fiduciary duties under the\nPartnership Agreement in connection with their operation of the Partnership, but granted plaintiffs' counsel an opportunity to amend those claims to attempt to state a cause of action. An amended complaint for breach of fiduciary duty was filed on June 2, 1994, naming only the General Partners as defendants. The General Partners filed a demurrer to the amended complaint, together with a motion for summary adjudication that the specific conduct challenged in the amended complaint was undertaken by the General Partners in conformance with the terms and requirements of the Partnership Agreement. A hearing on these matters was held on August 3, 1994, and on November 1, 1994, the court sustained the General Partners' demurrer on the basis that the amended complaint failed to state a claim upon which relief may be granted. The court gave plaintiffs leave to file an amended complaint for breach of fiduciary duty and, for this reason, defendants' motion for summary judgment was denied without prejudice. On January 18, 1995, plaintiffs served their second amended complaint on the defendants. The second amended complaint asserts claims for alleged breaches of the Partnership Agreement and breaches of fiduciary duty by defendants. Plaintiffs seek damages in an unspecified amount but in excess of $500,000. On March 24, 1995, defendants filed an answer to the second amended complaint, denying the allegations therein and asserting several affirmative defenses. Defendants filed a summary judgment motion on April 18, 1995, and a hearing took place on May 24, 1995. On June 12, 1995, the court granted defendants' motion for summary judgment insofar as it sought dismissal of all claims made as a class action on behalf of Unitholders individually. However, the court permitted the action to proceed as a derivative action by plaintiffs on behalf of the Partnership. Pursuant to the court's order, plaintiffs again amended their complaint to seek on behalf of the Partnership recovery from the General Partners of allegedly improperly high fees and interest paid to certain banks which provided P&A Financing to the Partnership. Plaintiffs allege that defendants breached their fiduciary duties by permitting payment of such excess fees and interest and, in the complaint, estimate the allegedly excess fees and interest to exceed $500,000. Defendants continue to assert that their actions were entirely proper under the law and the terms of the Limited Partnership Agreement and that the Partnership did not pay any excess or improper fees or interest to the banks. The Partnership has been advised that the General Partners intend to defend the action vigorously. In December 1995, Prudential-Bache Properties, Inc. was dismissed voluntarily by plaintiffs. Nevertheless, preliminary discussions have been conducted between plaintiff and the Managing General Partner regarding the possibility of presenting to the court for its approval a settlement which would reflect the size of the claim, the relative positions of the parties, and the costs of continued litigation. The terms which have been agreed upon in principle would involve a reduction of certain of the debt owed by the Partnership to the Managing General Partner and affiliates and payment, in part, of attorneys' fees to plaintiffs' counsel by the Managing General Partner. That agreement is subject to\ndocumentation and court approval.\nPrudential Securities Incorporated (\"PSI\"), certain of its present and former employees, the Managing General Partner and the Co-General Partner, among others, have been named defendants in a putative class action filed in U.S. District Court for the Southern District of New York, entitled In re Prudential Securities Incorporated Limited Partnerships Litigation (MDL 1005). Two former officers and the parent company of the Managing General Partner were also named as defendants, and the Managing General Partner has undertaken their defense. (Hereinafter, these additional defendants and the Managing General Partner are sometimes referred to collectively as \"the Lorimar Organization Defendants.\") The consolidated complaint, which was filed on June 8, 1994, consolidates complaints previously filed in actions in several federal district courts around the country that were transferred to the Southern District of New York by order of the Judicial Panel on Multidistrict Litigation in April 1994. None of the Lorimar Organization Defendants were named as defendants in any of the transferred actions. The consolidated complaint alleges violations of the federal Racketeer Influenced and Corrupt Organizations Act (\"RICO Act\"), fraud, negligent misrepresentation, breach of fiduciary duties, breach of third-party beneficiary contracts, breach of implied covenants and violations of New Jersey statutes in connection with the marketing and sales of limited partnership interests. Plaintiffs request relief in the nature of: rescission of the purchase of securities, and recovery of all consideration and expenses in connection therewith, as well as compensation for lost use of money invested, less cash distributions; compensatory damages; consequential damages; treble damages for defendants' alleged RICO violations (both federal and New Jersey); general damages for all alleged injuries resulting from negligence, fraud, breaches of contract, and breaches of duty in an amount to be determined at trial; disgorgement and restitution of all earnings, profits, benefits and compensation received by defendants as a result of their allegedly unlawful acts; costs and disbursements of the action; reasonable attorneys' fees; and such other and further relief as the court deems just and proper. The Partnership is listed in the consolidated complaint as being among the limited partnerships at issue in the case. On September 29, 1994, plaintiffs filed a motion to deem each of the constituent complaints (in which the Lorimar Organization Defendants were not named) amended to conform to the consolidated complaint. The Managing General Partner opposed the motion. A hearing was held on November 21, 1994 and on November 28, 1994, the court granted plaintiffs' motion. As a result, the Lorimar Organization Defendants are deemed to be defendants in each of the constituent actions, as well as in the consolidated action. On October 31, 1994, the Managing General Partner filed a motion to dismiss the consolidated complaint (and each of the constituent actions) with respect to the Lorimar Organization Defendants. The hearing on the motion, originally expected in January 1995, was postponed indefinitely by the court, and the parties are awaiting\na new hearing date. On December 20, 1994, PSI, along with various other defendants, moved to dismiss the entire consolidated complaint.\nBy order dated August 29, 1995, the court granted plaintiffs' motion for temporary class certification, preliminarily approved a settlement entered into between plaintiffs, the Co-General Partner and PSI, scheduled a fairness hearing for November 17, 1995, approved the form and content of the notice to class members and directed that it be provided to class members. The settlement was approved by the court at the fairness hearing. The full amount due under the settlement agreement has been paid by PSI.\nSubsequent to the announcement of the Prudential settlement, the Lorimar defendants held settlement negotiations with counsel for the class. Counsel for the class and the Lorimar defendants have agreed in principle to the settlement of all class claims against the Lorimar defendants in exchange for payment by the Lorimar defendants of $400,000, the allocation of which will be provided in the settlement documents. That agreement in principle is subject to agreement on appropriate documentation and to court approval. Upon submission of the agreed upon documentation to the Court, it is expected that the Court would schedule a hearing for approval and direct notice to be given to the class regarding the terms of the settlement and their procedural rights. In connection with, and as a condition to, the proposed settlement between the plaintiffs and the Lorimar defendants, the Managing General Partner will require an agreement between it and the Co-General Partner regarding certain outstanding matters, including mutual releases, involving them and their affiliates.\nThe Partnership is not aware of any legal proceedings that name the Partnership as a defendant. Neither the Tillman nor the MDL litigation described above name the Partnership as a defendant. The Partnership Agreement provides for indemnification of the General Partners and their affiliates under certain circumstances. The indemnification excludes damages assessed against a General Partner for violation of securities laws, the RICO Act or fraud.\nNote 5. Subsequent Events:\nPursuant to three separate Amendments to Distribution Agreements dated as of January 26, 1996, between the Partnership and Warner Bros., a division of TWE, on behalf of Lorimar, (collectively, the \"Amendments\"), the Partnership extended the term of its domestic distribution agreement, its foreign distribution agreement, and its license agreement regarding domestic home video. In each case, subject to earlier termination as summarized below, the term was extended from January 30, 1996 to July 31, 1996, subject in the event of the exercise during the extended Term of the MGP Option to further extension automatically to the completion of the purchases upon such exercise. Either party to\nany of the distribution agreements or the license agreement may terminate any of those agreements on 60 days notice given to the other. The Amendments limit the right of the distributor or licensee, as the case may be, to use certain revenues derived after January 30, 1996 to recoup various distribution expenses and advances incurred prior to January 30, 1996.\nPayment in full of the Power Guarantee in the amount of $9,840,486 was due on January 30, 1996. In full satisfaction of the Power Guarantee, on that date the following were offset against it: the full amount of the then outstanding principal of the P&A Note plus accrued but unpaid interest thereon aggregating $5,952,350, plus $176,500 of the outstanding principal of the P&A Advances and $3,711,636 of accrued but unpaid interest on the P&A Advances. As a result, as of January 30, 1996 the Power Guarantee and the P&A Note were each satisfied in full and the remaining principal balance of the P&A Advances was $7,151,604.\nThe Co-General Partner gave notice of its withdrawal as Co-General Partner and, effective March 22, 1996, it withdrew as a General Partner and became a Special Limited Partner.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThere are no directors or executive officers of the Partnership. The affairs of the Partnership are managed by the Managing General Partner and the Co-General Partner both through March 22, 1996, and, thereafter, solely by the Managing General Partner.\nThe directors and executive officers of the Managing General Partner are as follows:\nName Position\nPeter R. Haje President\nRichard J. Bressler Director and Senior Vice President, Finance\nStephen Ross Vice President\nPaul B. Stager, Jr. Vice President, Assistant Secretary\nBarry M. Meyer Director and Vice President\nSpencer B. Hays Director and Vice President, Secretary\nEdward A. Romano Vice President, Treasurer\nWarren A. Christie Vice President - Taxes\nRobert A. Fisher Vice President\nThe following paragraphs provide additional information, including business experience during the past five years, for the persons serving as directors and executive officers of the Managing General Partner. All of such persons were first elected or appointed to positions with the Managing General Partner in 1989, except for Mr. Stager, who was first appointed in 1985 and Messrs. Haje and Bressler, who were appointed in January 1995. All of such persons hold their principal employment with affiliates of the Managing General Partner, including Lorimar, WCI, the Warner Bros. division (\"Warner Bros.\") of TWE and Time Warner. For the period prior to June 1992, all references to Warner Bros. are to Warner Bros. Inc., the predecessor-in-interest to Warner Bros.\nPeter R. Haje, age 61, has served as Executive Vice President and General Counsel of Time Warner since October 1990. Prior to that time, he was a member of the law firm of Paul, Weiss, Rifkind, Wharton & Garrison.\nRichard J. Bressler, age 38, has served as Senior Vice President and Chief Financial Officer of Time Warner since March 16, 1995. Prior to that, he served as Senior Vice President, Finance from January 1, 1995; and as a Vice President prior to that.\nStephen Ross, age 47, has served as Executive Vice President - Special Projects of Warner Bros. since January 1996; prior to that time, he served a Senior Vice President-Special Projects of Warner Bros. from January 1989. Mr. Ross also served as Senior Vice President and General Counsel of Lorimar from February 1986 to June 1992.\nPaul B. Stager, Jr., age 66, has served as Senior Vice President and Studio General Counsel for the Warner Bros. Television Production division of TWE since June 1992. Prior to that time, Mr. Stager served as Vice President and Legal Counsel for Lorimar, Inc. He first joined Lorimar in 1982.\nBarry M. Meyer, age 52 has served as Executive Vice President\/Chief Operating Officer of Warner Bros., a division of Time Warner Entertainment Company, L. P. since April 1994; prior to that time, he served as Executive Vice President of Warner Bros. from June 1984. He first joined Warner Bros. in 1971.\nSpencer B. Hays, age 51, has served as Vice President and General Counsel of WCI since September 1992 and Vice President and Deputy General Counsel of Time Warner since January 1993. He served as Senior Vice President and General Counsel of WCI from January 1990 until September 1992 and from February 1986 until January 1990 he served as Vice President and Deputy General Counsel of WCI.\nEdward A. Romano, age 53, has served as Executive Vice President and Chief Financial Officer of Warner Bros. since March 1994; prior to that time, he served as Senior Vice President, Finance and Controller from January 1990 and, until that time, served as Vice President and Corporate Controller from 1974.\nWarren A. Christie, age 50, has served as Vice President of Time Warner since January 1990. Mr. Christie also has served as Vice President - Taxes of WCI since 1983.\nRobert A. Fisher, age 47, has served as Senior Vice President - Financial Investments of Warner Bros. since August 1994; prior to that time, he served as Vice President - Financial Investments from February 1986.\nBased on a review of Forms 3 and 4 and amendments thereto furnished to the Registrant pursuant to Rule 16a-3(e) during its most recent fiscal year and Form 5 and amendments thereto furnished to the Registrant with respect to its most recent fiscal year and written representations pursuant to Item 405(b)(2)(i) of Regulation\nS-K, neither the Managing General Partner, nor its directors, officers, or beneficial owners of more than 10% of the Units, failed to file on a timely basis reports required by Section 16(a) of the Securities Exchange Act of 1934 during the most recent fiscal or prior fiscal years.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe Partnership does not pay or accrue any fees, salaries or any other form of compensation to directors or executive officers of the General Partners for their services. However, as discussed in the financial statements included herein, the Partnership does compensate the General Partners for services provided on behalf of the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of March 22, 1996, there were no beneficial owners of more than five percent (5%) of the Units.\nAs of March 22, 1996, no director or officer of the Managing General Partner owned directly or beneficially any Units.\nNo director or executive officer of the Managing General Partner own directly or beneficially any interest in the voting securities of the Managing General Partner.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nReference is made to Item 8 - Note 3 of the Notes to Financial Statements, which discusses the services provided by the Managing General Partner and the former Co-General Partner and their affiliates to the Partnership and the amounts paid or payable for these services.\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 - See Item 8 of this report.\n2. Financial Statement Schedules - Schedules are omitted as such are not required.\n3. Exhibits\n(a) Exhibits 3 Amended and Restated Certificate of Limited Partnership of the Partnership dated as of January 30, 1986[1] 4.1 Amended and Restated Agreement of Limited Partnership of the Partnership dated as of January 30, 1986[1] 4.2 Amendment to Agreement of Limited Partnership of the Partnership dated as of March 31, 1986[1] 4.3 Depositary Agreement between the Partnership, the Managing General Partner, the Co-General Partner, the Assignor Limited Partner and the Principal Selling Agent[1] 4.4 Depository Receipt[1] 10.1 Distribution Agreement between LPI and Fox[1] 10.2 Distribution Agreement between LPI and Columbia[1] 10.3 Distribution Agreement between LPI and PSO with respect to \"Power\"[1] 10.4 Distribution Agreement between LPI and PSO with respect to \"The Boy Who Could Fly\"[1] 10.5 Distribution Agreement between the Partnership and LDI with respect to domestic distribution[1] 10.6 Distribution Agreement between the Partnership and LDI with respect to foreign distribution[1] 10.7 Distribution Agreement between the Partnership and Karl-Lorimar Home Video, Inc.[1] 10.8 Form of Assignment by LPI to the Partnership[1] 10.9 Form of Promissory Note of the Managing General Partner, payable to the Partnership[1] 10.10 Form of Guarantee of Lorimar to the Partnership[1] 10.11 Form of Escrow Agreement between the Partnership, the Managing General Partner, the Co-General Partner and The Bank of New York[1] 10.12 Form of Production Services Agreement between the Partnership and production service company[1] 10.13 Credit Agreement between the Partnership and a group of banks[2] 10.14 Assignment of Credit Agreement from banks to Lorimar[3]\n10.15 Amendment to Distribution Agreement between the Partnership and LDI with respect to domestic distribution 10.16 Amendment to Distribution Agreement between the Partnership and LDI with respect to foreign distribution. 10.17 Amendment to Distribution Agreement between the Partnership and Karl-Lorimar Home Video, Inc.\n[1]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1986, on file with the Securities and Exchange Commission.\n[2]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1987, on file with the Securities and Exchange Commission.\n[3]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1989, on file with the Securities and Exchange Commission.\n(b) Reports on Form 8-K No reports on Form 8-K were filed by the Partnership during the last quarter of the period covered by this report.\nSignatures\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLORIMAR FILM PARTNERS L.P.\nBy: Lorimar Motion Picture Management, Inc. (Managing General Partner) By: \/s\/ Barry Meyer Date: March 29, 1996 Barry Meyer Director and Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities (with respect to the General Partner) and on the dates indicated.\nLorimar Motion Picture Management, Inc. (Managing General Partner) By: \/s\/ Peter R. Haje Date: March 29, 1996 Peter R. Haje President (principal executive officer)\nBy: \/s\/ Richard J. Bressler Date: March 29, 1996 Richard J. Bressler Director and Senior Vice President, Finance (principal financial officer)\nBy: \/s\/ Paul Stager Date: March 29, 1996 Paul Stager Vice President, Assistant Secretary\nBy: \/s\/ Barry Meyer Date: March 29, 1996 Barry Meyer Director and Vice President\nBy: \/s\/ Spencer B. Hays Date: March 29, 1996 Spencer B. Hays Director and Vice President, Secretary\nBy: \/s\/ Edward A. Romano Date: March 29, 1996 Edward Romano Vice President, Treasurer (principal accounting officer)\nEXHIBIT INDEX Sequential Exhibit Page Number Description Number\n3 Amended and Restated Certificate of Limited Partnership of the Partnership dated as of January 30, 1986[1] 4.1 Amended and Restated Agreement of Limited Partnership of the Partnership dated as of January 30, 1986[1] 4.2 Amendment to Agreement of Limited Partnership of the Partnership dated as of March 31, 1986[1] 4.3 Depositary Agreement between the Partnership, the Managing General Partner, the Co-General Partner, the Assignor Limited Partner and the Principal Selling Agent[1] 4.4 Depository Receipt[1] 10.1 Distribution Agreement between LPI and Fox[1] 10.2 Distribution Agreement between LPI and Columbia[1] 10.3 Distribution Agreement between LPI and PSO with respect to \"Power\"[1] 10.4 Distribution Agreement between LPI and PSO with respect to \"The Boy Who Could Fly\"[1] 10.5 Distribution Agreement between the Partnership and LDI with respect to domestic distribution[1] 10.6 Distribution Agreement between the Partnership and LDI with respect to foreign distribution[1] 10.7 Distribution Agreement between the Partnership and Karl- Lorimar Home Video, Inc.[1] 10.8 Form of Assignment by LPI to the Partnership[1] 10.9 Form of Promissory Note of the Managing General Partner, payable to the Partnership[1] 10.10 Form of Guarantee of Lorimar to the Partnership[1] 10.11 Form of Escrow Agreement between the Partnership, the Managing General Partner, the Co-General Partner and The Bank of New York[1] 10.12 Form of Production Services Agreement between the Partnership and production service company[1] 10.13 Credit Agreement between the Partnership and a group of banks[2] 10.14 Assignment of Credit Agreement from banks to Lorimar[3] 10.15 Amendment to Distribution Agreement between the Partnership and LDI with respect to domestic distribution 10.16 Amendment to Distribution Agreement between the Partnership and LDI with respect to foreign distribution. 10.17 Amendment to Distribution Agreement between the Partnership and Karl-Lorimar Home Video, Inc.\n[1]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1986, on file with the Securities and Exchange Commission.\n[2]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1987, on file with the Securities and\nExchange Commission.\n[3]Incorporated by reference to the Partnership's 10-K Report for the year ended March 31, 1988, on file with the Securities and Exchange Commission.\nSignatures\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLORIMAR FILM PARTNERS L.P.\nBy: Lorimar Motion Picture Management, Inc. (Managing General Partner)\nBy: Date: Barry Meyer Director and Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities (with respect to the General Partner) and on the dates indicated.\nLorimar Motion Picture Management, Inc. (Managing General Partner)\nBy: Date: Peter R. Haje President (chief executive officer)\nBy: Date: Richard J. Bressler Director and Senior Vice President, Finance (chief financial officer\nBy: Date: Paul Stager Vice President, Assistant Secretary\nBy: Date: Barry Meyer Director and Vice President\nBy: Date: Spencer B. Hays Director and Vice President, Secretary By: Date: Edward A. Romano Vice President, Treasurer (principal accounting officer)","section_15":""}
{"filename":"748103_1995.txt","cik":"748103","year":"1995","section_1":"ITEM 1. BUSINESS ----------------- CORE COMPETENCE\nABC (\"the Company\") is a technology firm. Our core competence is our ability to use existing technology and to create new technology to develop dispensing systems and mechanisms. Our interpretation of dispensing systems and the related technology is unrestricted. The Company is not limited to dispensing liquids; the Company will dispense virtually any substance. The Company is not limited to pneumatic or electronic technology, the Company will utilize any technology including mechanical, electro-mechanical, hydraulic, and sonic.\nPure research is time consuming and expensive. The Company concentrates on developing solutions for specific known applications. The Company has a unique approach to creating new, innovative solutions by combining first principles of physics with state-of-the-art electronics. The Company designs its own computer controlled systems--both hardware and software.\nThe Company has a talented, creative, experienced, and motivated staff. The Company is a technology firm, not a manufacturer. However, two operational advantages the Company has over technically oriented firms are: (1) the ability to produce the systems we design and (2) our ability to offer field technical support (training, installation, and emergency service). Design advantages include speed, ease of use, reduced maintenance and reduced environmental impact. The Company has developed products which have gained commerical acceptance in both the paint and beverage industries.\nDISPENSING MARKET\nDispensing pervades nearly every industry.\nDispensing plays a key role in some of the world's largest industries: for example, transportation, medical\/pharmaceutical, and food service, to name a few. In addition to a growing, global demand for dispensing systems for fuel, drugs, and beverages, there is a need for dispensing systems in the construction industry for concrete additives, the graphics industry for printing ink, and the paint industry for tints and bases. Everyday each of us uses water in our homes, without thinking of it as a dispensing system--but it is. The industrial use of water for cooling, heating, and cleaning also requires a dispensing system. Dispensing systems are an ubiquitous part of most individual's and business' daily routines. Dispensing occurs at the manufacturing, wholesale, retail levels, and residential. The current trend in corporate downsizing could create additional opportunities for outsourced research and development.\nDispensing systems are designed to accurately and efficiently control and measure product movement; i.e., the Company does not narrowly define dispensing as only moving a product from point A to point B. Further, the Company sees opportunity to use our unique technology to incorporate production functions with the dispensing process (e.g., customize at the point-of-sale), thereby providing our customers additional cost savings and other market advantages.\nThe Company also sees opportunities for dispensing systems to contribute to global environmental improvements. Some of our beverage systems employ computer controlled mixing techniques which reduce product waste in calibration procedures. Also, our tint dispensing systems have eliminated the need for daily product purges. Further, the Company believes dispensing technology could help reduce packaging and packaging waste.\nMISSION STATEMENT & STRATEGY\nThe Company is dedicated to the development and commercialization of dispensing technology for a wide range of industries.\nOur strategy is to develop dispensing systems and components in partnership with industry leaders who have significant market shares and effective marketing organizations. These new dispensing systems are to be marketed by our business partners. Our joint efforts will maximize our technological strengths and capitalize on the marketing strengths of our industry leading partners.\nDispensing technology can be transferred among industries. This means that the Company does not have to start with a clean slate for the development of every new product. Every new system and component that is developed makes the next one less expensive and more readily obtainable.\nThe Company markets both self contained, complete dispensing systems and individual dispensing components (valves, nozzles, controls, etc.). Components can be designed for a specific objective or developed as part of a complete system and then sold to meet other dispensing needs. The number of components will automatically grow with the growth in the number of complete systems being developed. In addition to the development and commercialization of the dispensing products, the Company offers a complete array of supporting services, including quality assurance, training, installation, and field support. These are more than ancillary services to the development process; they help us to better understand the marketplace, and are an integral part of the Company's long-term growth plan.\nBUSINESS RISKS\nAs a research and development company, the Company faces certain inherent risks: (1) new product ideas may not advance beyond the development stage; (2) new products could be technically successful but fail commercially; (3) successful new products could develop unplanned warranty expenses or face recall; and, (4) new products could be replaced by more advanced competitive products. The Company has taken steps to monitor and mitigate these potential risks, including the utilization of advanced Quality and Project Management Systems.\nPRODUCTS\nBeverage -------- The Company is currently selling four beverage dispensing products:\nThe Company's unique Juice Dispenser attracted a $7 million initial order on July 17, 1995. The customer name cannot be divulged at this time pursuant to their request for secrecy for competitive reasons. This new product substantially reduces waste, spoilage, and dispensing time. This new product also marks a substantial reduction in turnaround time between the start of development and the receipt of the initial major order. This microprocessor-driven system mixes and dispenses juice from concentrates, ensuring a controlled mixture and an accurate, standard portion. The technology could have broad commercialization prospects. Juices are typically only available in cans, cartons or bottles at most restaurants and other food outlets. This technology is adaptable for fountain juice dispensing to serve today's health conscious consumers.\nThe Company is currently field testing its new Cold Coffee Dispenser in several Starbucks Coffee Company (\"Starbucks\") locations, in conjunction with The North American Coffee Partnership (a Starbucks and Pepsi-Cola Company [\"Pepsi\"] joint venture). The partnership's first product is a new fountain cold coffee beverage, called MAZAGRAN. The Company has developed a custom dispensing system for this refreshing, lightly carbonated beverage made with Starbucks coffee. The microprocessor-driven system mixes and dispenses more ingredients than conventional dispensers that only mix soda and a syrup. The Company has applied for a patent on the coffee dispensing technology for the system; this dispenser also employs some of the Company's previously patented technology. The North American Coffee Partnership will determine the length of the test and future rollout of the system.\nThe Company markets a line of Classic(TM) computerized soft drink dispensers. The Classic line evolved from the original Omnitron(TM) system. The advantages of the Classic line are competitive speed and ability to control the following: brix (ratio), stratification, foam, carbonation, and portion control. The Classic line is priced above the competitors' dispensing equipment. Marketing efforts are directed primarily towards theater chains. The Company demonstrates the advantages of the dispenser and the improved customer satisfaction by conducting \"no charge\" tests in operating retail locations. To date, approval of the Classic line has not been granted by Pepsi or Coca-Cola Company (\"Coke\"). The soft drink dispensing equipment market is highly competitive. There are several well-established competitors that have the approval and support of Pepsi and\/or Coke. Sales of soft drink dispensers and components were approximately $375,000, or 11 percent of total Company sales in fiscal 1995.\nThe Company also markets a line of liquor dispensing systems. The UltraBar(TM) system is able to quickly pour complex mixed drinks via a customized touch-sensitive drink selector. Advantages are electronic cash and inventory accountability, and reduction of the following: theft, breakage, spillage, overpours, and giveaways. Marketing efforts are limited and are directed primarily towards nightclubs and bowling centers. Sales of liquor dispensing systems were approximately $450,000, or 13 percent of total Company sales in fiscal 1995.\nPaint ----- The Company is currently selling two paint dispensing products:\nThe automated paint tint dispensing system, Tint-A-Color(TM), was the Company's first entrant into industrial dispensing. This product was developed exclusively for The Sherwin-Williams Company (\"Sherwin-Williams\") and is marketed exclusively by them. This exclusivity agreement applies to North America only through May 1996. The first order for Tint-A-Color Systems was received in February 1993; production commenced in April 1993. This system accurately dispenses tints to match precise color formulas stored in an interfaced computer. Features include higher reliability due to the utilization of pneumatic pumps (versus conventional gear-driven pumps) and increased yield through the elimination of tint purging. The Tint-A-Color is approximately the size of a standard office copier, and is geared for high volume retail and paint contractor outlets. Another order (the fourth), worth $1.9 million, was received from Sherwin-Williams in April 1995.\nThe Company developed a second tint dispenser for Sherwin-Williams, called the \"TAC-CB\" This unit is smaller and less expensive than the Tint-A-Color. In February 1995, the Company received its first production order, worth $1 million, for the new smaller computerized paint tint dispensing system. Sherwin-Williams has exclusive rights to this new dispenser in North America through May 1997. Commercialization of the small scale system represents an important benchmark in the Company's paint dispensing business, because it addresses the needs of the largest segment of the worldwide retail paint market. The Company's growth strategy is sharply focused on developing and bringing to market computerized dispensing products which can gain substantial market share in the paint industry. This new system had been in development for about two years under a joint design program between the Company and Sherwin-Williams. Since the unit was designed expressly for paint retailers and \"do-it-yourself\" chains, the technological advantages of this user-friendly system should lead to higher customer satisfaction at the retail level. The new unit can be electronically interfaced with bar code scanners and color matching equipment and has size, cost and maintenance advantages. The user-friendly, computer controlled system dispenses tints into pint, quart, gallon and five gallon cans and has the same \"no purge\" feature as the larger Tint-A-Color system.\nThe Company has begun marketing its paint products to potential customers in Europe, Latin America, and the Far East and expects to introduce its paint product line into other international markets. Automatic tint dispensing systems have been available for many years. The Company's products must compete on price and performance levels with these existing conventional systems.\nSales of paint dispensing systems were approximately $1,700,000, or 51 percent of total Company sales in fiscal 1995.\nEmerging Products ----------------- The Company has several new products in development and plans to introduce them in 1996. The Company is developing these emerging products for specific industry leaders who have significant market shares and effective marketing organizations. The Company must limit the availability of information on these emerging products to protect the Company and the above-referenced marketing partners from their respective competition.\nServices -------- The Company has more than 20 years of field service experience. In addition to servicing the Company's dispensing systems, the Field Service Division is qualified and prepared to install and service all types of pneumatic, electro-mechanical, and microprocessor controlled products. Through the Company's marketing efforts, it has been determined that many manufacturers lack the resources, technical skills, or the desire to install and service their own equipment. In many situations, these manufacturers have customers in remote locations with no economical way to service them. The Company is able to offer economical installation and service arrangements to these manufacturers by utilizing the Company's existing field service structure. As a result, these manufacturers achieve an economical solution to their installation and service problems, thereby potentially increasing their ability to sell and open up new markets, thus potentially increasing the demand for the Company's field service force.\nAdditionally, a technological benefit is gained by offering field service support. The Company is learning and working with different technologies that it may otherwise not have been exposed to. This information will assist the Company's research and development teams in their product conceptualization and design functions.\nThe Company is planning to expand its field service force to take advantage of these opportunities.\nSALES BACKLOG\nAs of April 29, 1995, sales order backlog (unshipped product orders) was $3.1 million. As of April 30, 1994, order backlog was $1.8 million. The $7 million Juice Dispenser order was received on July 17, 1995, boosting the backlog to $9.4 million at that date.\nINTERNATIONAL SALES\nVirtually all international sales for fiscal 1995 were shipments of liquor dispensing systems to Canada. International sales for fiscal years 1995, 1994, and 1993 were 3, 2, and 15 percent of total sales, respectively.\nHUMAN RESOURCES\nAs of July 17, 1995, the Company had 49 full-time employees compared to 43 last year. The Company has cash and stock option incentive plan programs for substantially all full-time employees. The employees are not represented by a union. Temporary workers are utilized in the production process. A highly qualified labor pool exists in the immediate geographic area should the Company need to expand our workforce.\nPATENTS AND TRADEMARKS\nThe Company has consistently sought patent protection for our proprietary technology and products. To date, 26 patents are outstanding and an additional 11 are pending. Patent coverage of our dispensing technology is broad. Research and development expenditures for the fiscal years 1995, 1994, and 1993 were $606,000, $386,000, and $391,000, respectively.\nTrademarks have been issued for the following:\nFlavorGuard Classic 1000 Classic 2000 UltraBar Classic 100 \"Innovative Solutions Through Applied Science\" ABC Dispensing Technologies\nENTITIES & FISCAL YEAR\n\"ABC\" is comprised of three legal entities: the parent (public entity)--American Business Computers Corporation (a Florida corporation) (NASDAQ:ABCC), the operating subsidiary--ABC Dispensing Technologies, Inc. (an Ohio corporation), and a second subsidiary that holds the patents--ABC Tech Corp. (an Ohio corporation).\n\"Fiscal Year 1995\" ended April 29, 1995. The Company has adopted a fiscal year ending on the Saturday closest to April 30. Each quarter consists of 13 weeks:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ------------------ The Company owns a single floor building of approximately 18,400 square feet of office, laboratory and production space located in Akron, Ohio. The facility and adjacent land were purchased in June, 1994 by the Company from Joseph W. Shannon, former Chairman of the Company, for $490,000. Prior to the purchase, the facility and land were appraised for $535,000. The Company had previously leased the facility from Mr. Shannon. This acquisition was partially financed by a bank note; the balance on this note was $288,000 as of April 29, 1995.\nThe Company leases additional laboratory and warehouse space from independent third parties on an as needed basis.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -------------------------- A. SECURITIES LITIGATION\nOn March 2, 1995 the Company reported it had reached a settlement with the plaintiffs in a class action lawsuit, filed originally in 1991. The Federal Court approved the settlement on June 16, 1995. The plaintiffs are current and former shareholders who purchased shares during the period January 24, 1990 through August 1, 1991. The settlement provides for the payment to the plaintiff class of a minimum aggregate of $6,500,000 in cash and shares of the Company's common stock. The cash portion of the settlement will consist of $1,850,000, of which approximately $1,400,000 has been funded by certain of the named individual defendants who are current or former officers or directors, with the Company funding the remaining $450,000 on June 8, 1995. The stock portion of the settlement will consist of 1,550,000 shares of the Company's common stock, subject to adjustment if the per-share price falls below $3.00 or rises above $4.50. The Company will fund 150,000 shares, with the Pepsi-Cola Company funding 1,000,000 shares and Hussmann Corporation funding 400,000 shares. Pepsi-Cola and Hussmann were co-defendants in the litigation. The Company will grant common stock purchase warrants having a term of five years to Pepsi for 500,000 shares and to Hussmann for 200,000 shares, at an exercise price of $3.50 per share. The warrants are callable after three years if the price of the Company's common stock is in excess of $10.00 per share.\nRefer to Form 10-K for the fiscal year ended April 30, 1994 for more information on this litigation.\nB. CONTRACT LITIGATION\nOn December 22, 1994, the Company reported it had reached a definitive settlement agreement with the Pepsi-Cola Company relating to litigation that had been pending since 1993 in the United States District Court for the Northern District of Ohio in Akron. The Company sought to recover damages for substantial breaches of contract by Pepsi with respect to the development, manufacture, and sales of the Omnitron, Minitron, Midtron, and Advanced Omnitron soft drink dispensing systems. Pepsi has agreed for a period of five years to offer its customers using the Company's beverage dispensing equipment its standard marketing, merchandising or equipment allowances, which will help the Company build its beverage dispensing sales. Pepsi has agreed to give any application for approval of the Company's fountain equipment and soft drink dispensing equipment fair consideration in accordance with its supplier approval procedures, with Pepsi retaining the right to approve within its sole discretion. Pepsi is also under no obligation to recommend, encourage, or promote the sale or use of the Company's products.\nRefer to Form 10-K for the fiscal year ended April 30, 1994 for more information on this litigation.\nAs of June 30, 1995, Pepsi owned 2,000,000 common shares of the Company, or 12.5% of the total outstanding stock. Subsequent to Pepsi's funding of 1,000,000 shares to the Securities Litigation settlement, Pepsi's ownership will be reduced to approximately 6.2%.\nC. LEGAL FEE AND SETTLEMENT COST ACCRUAL\nThe estimated legal fees and settlement costs have been accrued for both of the above actions. The accrual as of April 29, 1995 was $1,498,000. The accrual (legal fees, only) as of April 30, 1994 was $946,000.\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 fiscal 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER ------------------------------------------------------------------------- MATTERS ------- A. PRICE RANGE OF COMMON STOCK --------------------------- Bid and ask prices for the Company's common stock (symbol `ABCC') have been quoted on the NASDAQ system since March 28, 1985. The table below shows the range of bid prices of the common stock for the last two years as reported by NASDAQ.\nB. APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS ---------------------------------------------\nC. DIVIDENDS --------- The Company has never paid a dividend and has no current plans to do so. Future dividend policy will be determined by the Board of Directors based on the Company's earnings, financial condition, capital requirements, and other existing conditions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA --------------------------------\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nEffective May 1, 1994, the Company changed the fiscal year end to the Saturday closest to April 30. All references to fiscal years 1995, 1994, and 1993 are to the twelve months ended April 29, 1995, April 30, 1994, and April 30, 1993, respectively. \"FY95,\" for example, refers to the fiscal year ending April 29, 1995.\nSIGNIFICANT SUBSEQUENT EVENT\nOn July 17, 1995, the Company received a $7 million initial order for its new Juice Dispenser. This is the largest single order the Company has ever received and brings the Company's backlog to a record $9.4 million as of July 17, 1995. The microprocessor-driven system mixes and dispenses juice from concentrates, ensuring a controlled mixture and an accurate, standard portion. The Company filed for a patent on the controlling electronics and software. Shipments of this new product are expected to begin in the December 1995-January 1996 time period. The shipments are expected to spread over a period of 18 months.\nLITIGATION\nOn December 22, 1994, the Company reported it had reached a definitive settlement with the Pepsi-Cola Company relating to the breach of contract litigation.\nOn March 2, 1995 the Company reported it had reached a settlement with the plaintiffs in a class action lawsuit, filed originally in 1991. The Federal Court approved the settlement on June 16, 1995. The plaintiffs are current and former shareholders who purchased shares during the period January 24, 1990 through August 1, 1991. The settlement provides for the payment to the plaintiff class of a minimum aggregate of $6,500,000 in cash and shares of the Company's common stock. The cash portion of the settlement will consist of $1,850,000, of which approximately $1,400,000 has been funded by certain of the named individual defendants who are current or former officers or directors, with the Company funding the remaining $450,000 on June 8, 1995. The stock portion of the settlement will consist of 1,550,000 shares of the Company's common stock, subject to adjustment if the per-share price falls below $3.00 or rises above $4.50. The Company will fund 150,000 shares, with the Pepsi-Cola Company funding 1,000,000 shares and Hussmann Corporation funding 400,000 shares. Pepsi-Cola and Hussmann were co-defendants in the litigation. The Company will grant common stock purchase warrants having a term of five years to Pepsi for 500,000 shares and to Hussmann for 200,000 shares, at an exercise price of $3.50 per share. The warrants are callable after three years if the price of the Company's common stock is in excess of $10.00 per share.\nThe Company accrued an additional $1 million in fiscal year 1995 (\"FY95\") to account for the settlement expenses and remaining legal fees. The Company is liable for additional settlement expenses (additional shares at fair market value) should the Company's common stock market price per share fall below $3.00 during a future defined settlement period (Fall 1995). For example, a common stock price of $2.75 would require the Company to contribute to the settlement fund an additional 141,000 shares and incur an additional $275,000 settlement expense.\nFISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994\nThe net loss was $2,681,000 for FY95 compared to $1,378,000 for fiscal year 1994 (\"FY94\"). Decreased revenues and the $1 million accrual for legal settlement expenses and fees were responsible for the increased loss.\nFY95 total revenues were $3,359,000 compared to FY94 total revenues of $5,010,000. The decline in revenues was due primarily to reduction in shipments of Tint-A-Color paint dispensers in FY95. The following is a comparison of equipment sales (which includes royalty and product development fees):\nThe history of Tint-A-Color orders and shipments is as follows:\nThe Company did receive a $1,866,000 order for additional Tint-A-Color units in April 1995 and will begin shipping them in July 1995. The order and ship dates were delayed due to significant changes made to this most recent version of the Tint-A-Color.\nOn February 13, 1995, the Company also received a $990,000 initial order of \"TAC-CB\" units, the down-sized, lower-cost tint dispenser designed expressly for paint retailers and chains. The TAC-CB was in joint development for two years with Sherwin-Williams. The Company began shipping this new unit in May 1995 (the beginning of fiscal year 1996).\nThe Company's gross profit on overall equipment sales decreased from 25.3% in FY94 to 21.8% in FY95 due to the $150,000 inventory obsolescence reserve writeoff taken in the third quarter for slow-moving beverage products. Without this additional reserve, the gross margin on overall equipment sales for FY95 is 27.7%.\nThe Company offers technical field support for its products. Revenues from this field support group was $686,000 for FY95 compared to $590,000 for FY94. As previewed on Page 4 of this Form 10-K, the Company expects to significantly expand this technical group in FY96.\nAn activity-based costing system was implemented at the beginning of FY95. Operating costs and expenses are now recorded based on the activity that drives them (i.e. Products & Services, G&A, Selling and Marketing, Research and Development). Certain reclassifications have been made to the FY94 (and FY93) figures to conform with FY95 classifications.\nGeneral and administrative expenses increased 5% from FY94 primarily as a result of increased public entity related costs, such as public relation expenses.\nSelling and marketing expenses increased 8% from FY94 due to the following additions: (1) In November 1994, Randolph D. Letsch was recruited as V.P. Paint Sales of ABC Dispensing Technologies, Inc., the Company's operating subsidiary. Mr. Letsch joined the Company from Sherwin-Williams where he was Director of Sales, OEM and National Accounts, a position he held since 1986. The Company's intent was to acquire marketing expertise needed to expand the commercialization of paint dispensing both domestically and internationally; (2) In February 1995, the Company promoted David B. Hudson to V.P. Sales - Domestic Beverage Equipment of ABC Dispensing Technologies, Inc. to enhance the beverage marketing efforts; (3) In March 1995, the Company recruited Keith P. Jordan from Pepsi-Cola Company, Houston, to enhance both beverage and new product marketing efforts.\nResearch and development expenses increased 57% from FY94 as a result of increased new product development activity. (1) Numerous dispensing applications were under development during FY95 and these development projects have continued into FY96. The Juice Dispenser and TAC-CB were two such projects. (2) The activity-based costing system provides for any employee incurring time on new product development to be accounted for as an \"R&D expense\" regardless of their basic functional responsibilities. Therefore, administrative personnel, if assigned a task on a new product development team, can and have added to R&D expenses.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash balance decreased $712,000 during FY95, from $2,021,000 to $1,309,000.\nOperating activities required $1,510,000. This requirement was partially funded by the net proceeds ($979,000) from a private placement of 1 million common shares in August-September 1994. Officers, directors, and employees purchased 271,000 shares. The Company financed the officer and employee purchases with 5-year notes. For each share of common stock, subscribers were also granted a warrant to buy one additional share of common stock for $2.00. These warrants expire 5 years from their issue date. The common shares and warrants were registered with the Security and Exchange Commission in May 1995 and can be traded at this time.\nIn August 1994, the Company acquired the Akron, Ohio headquarters facility and adjacent land for $490,000 from Joseph W. Shannon, former Chairman of the Company. The facility and land were appraised for $535,000. The Company financed 60 percent of this acquisition with a bank note (see Note 4 to Consolidated Financial Statements). The 40 percent balance was originally financed by a margin account on a short-term investment; this margin account was paid in full subsequent to FY95.\nThe Company ended FY95 with a cash balance of $1,309,000. Subsequent to FY95 year end, the Company (1) paid approximately $700,000 in legal settlement expenses and fees, and (2) acquired inventory for the current TAC-CB and Tint-A-Color production runs. The resulting cash balance as of July 17, 1995 was $215,000.\nThrough July 17, the Company has issued $400,000 in 10% senior subordinated notes due June 1, 1998. Each unit ($25,000) of this note was granted 12,500 three-year warrants at an exercise price of $2.00. Interest payments are due semi-annually on June 1 and December 1. The Company also agreed to use 40% of the net proceeds of the issuance of common stock (other than via employee\/director stock options) to prepay the notes within 60 days of the receipt of such proceeds. These notes are, therefore, being utilized as a \"bridge\" until some or all of the warrants from the August-September 1994 Placement are exercised.\nFY96 is a growth year for the Company. The current backlog of orders (as of July 17, 1995) is $9.4 million, nearly 3 times the total revenues of the Company for FY95. The Company must complete the development of certain new products, acquire inventory, build and ship finished products, and collect its receivables to complete each business cycle. The Company also anticipates the need for capital expenditures, mostly R&D related, in the range of $300,000 to $600,000 for FY96.\nDuring this growth period, the Company will seek additional alternative sources of cash through:\na. Trade credit (suppliers extending terms) b. Accounts receivable and inventory credit lines c. Private placements d. Warrant exercises e. Employee\/director stock option exercises\nAvailable for placement are 600,000 shares of shelf (uncommitted) common stock which were included in the Form S-2 Registration Statement approved by the Securities and Exchange Commission in May 1995.\nOf the 20 million authorized shares of common stock, 16 million are issued and outstanding, 2.2 million are committed for warrants, 400,000 are committed for employee\/director stock options, and 150,000 are committed to the class action settlement fund. Approximately 1.2 million shares remain uncommitted. The Company will seek approval in its upcoming Proxy Statement from the shareholders for authorization to issue additional shares of common stock.\nRESULTS OF OPERATIONS\nFISCAL YEAR 1994 COMPARED TO THE FISCAL YEAR 1993\nOur strategy provided positive results in FY94. Total revenues were up 115% and the net loss was reduced 144%, to $1,378,000 compared to the prior year net loss of $3,359,000.\nThe gross profit margin on all equipment\/royalty\/product development sales was 25.3% compared to the prior year margin of 18.9%.\nService and support revenues were $590,000 for the year versus $698,000 for the prior year. The decline is attributable to the decrease in computerbar and soft drink dispenser sales; fewer installations were performed during the year.\nPAINT DISPENSING LINE\nAs of April 30, 1994, the backlog of tint dispenser orders totaled $1,676,000; the majority of this backlog is scheduled to ship in the first quarter of fiscal 1995. The paint market is seasonal; future tint dispenser revenues may fluctuate from highs in the summer months to lows in the winter months.\nSOFT DRINK DISPENSING LINE\nSoft drink dispensers are being sold directly to end-users. We do not have the approval of Pepsi or Cola nor do we anticipate this approval. It will be difficult for us to gain extensive market penetration. The ongoing litigation with Pepsi has adversely affected our soft drink revenues. Because of this situation, we reviewed our alternatives, such as designing and selling components in lieu of complete systems.\nCOMPUTERBAR DISPENSING LINE\nThe computerbar equipment market in the U.S. has declined and price-based competition has increased. We continue to sell the product direct to end-users as well as through dealers in the U.S. and Canada. Alternatives are being reviewed for this product line.\nRESEARCH, DEVELOPMENT AND DESIGN\nResearch, Development and Design expenditures were $583,000 of which 49% ($286,000) was invested in specific new product development.\nResearch, Development and Design costs will increase as we explore and develop new applications for our dispensing technology. We have and will continue to expand our technical staff and resources to meet the increased demand. Development work is progressing on two new dispensing products. Each development agreement is contingent upon creating a product acceptable to our business partner(s). We cannot predict the likelihood of this event, nor can we predict commercial success of these products.\nSELLING AND MARKETING\nThe Company increased its selling and marketing efforts. A new brochure was created; ads were placed in specific industry publications. Expenses in this category decreased temporarily during the Company's transition from a provider of soft drink and liquor systems to a broad based supplier of dispensing technology and services. Sales and marketing expenses will be increasing.\nITEM 8.","section_7":"","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ----------------------------------------------------\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\nThe Board of Directors and Stockholders\nAmerican Business Computers Corporation\nWe have audited the accompanying consolidated balance sheets of American Business Computers Corporation as of April 29, 1995 and April 30, 1994, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the periods ended April 29, 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 American Business Computers Corporation at April 29, 1995 and April 30, 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 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.\nERNST & YOUNG LLP\nAkron, Ohio July 11, 1995\nAMERICAN BUSINESS COMPUTERS CORPORATION CONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nAMERICAN BUSINESS COMPUTERS CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS\nSee accompanying notes.\nAMERICAN BUSINESS COMPUTERS CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\nAMERICAN BUSINESS COMPUTERS CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Years ended April 29, 1995, April 30, 1994, and April 30, 1993\nSee accompanying notes.\nAMERICAN BUSINESS COMPUTERS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. BUSINESS DESCRIPTION ----------------------------\nThe Company is a technology firm. The Company's core competence is the ability to use existing technology and create new technology to develop dispensing systems and mechanisms.\n2. SIGNIFICANT ACCOUNTING POLICIES ---------------------------------------\nYear End - Effective May 1, 1994, the Company changed the fiscal year end to the Saturday closest to April 30, which results in a fifty-two or fifty-three week year. Fiscal 1995 consisted of fifty-two weeks. Fiscal 1994 and 1993 were calendar years.\nConsolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, ABC Dispensing Technologies, Inc. and ABC TechCorp. Significant intercompany transactions and balances have been eliminated in consolidation.\nCash equivalents - The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nConcentration of credit - In the normal course of business, the Company enters into transactions to meet the financing needs of customers. The Company performs ongoing credit evaluations of customers' financial condition and generally requires collateral from customers who finance purchases beyond thirty days. The Company's exposure to credit risk associated with nonperformance on these transactions is limited to amounts reflected in the Company's consolidated financial statements, less the value, if any, of the secured equipment.\nInventories - Inventories are valued at the lower of cost or market, using the first-in, first-out (FIFO) method.\nProperty, Plant, and Equipment - These assets are recorded at cost. Depreciation is provided primarily by use of the straight-line method over the estimated useful lives of the assets.\nPatents - Patents are recorded at cost. Amortization is provided under the straight-line method over a period of five years or less. Patents pending are recorded as a prepaid expense.\nRevenue Recognition - Revenue on equipment sales is recognized when the product is shipped and title transfers, including equipment that requires subsequent installation. Revenue for development services and for service and support is recognized when the service is performed unless there is a service contract. Revenue from service contracts is recognized ratably over the contract term, generally one year. Royalty income is recognized in accordance with the terms of the royalty agreement, which generally provides that royalties are based on units shipped.\nMajor Customer - Revenues from The Sherwin-Williams Company were 59 and 70 percent of the Company's total revenues, for the years ended April 29, 1995 and April 30, 1994, respectively.\nProvision for Warranty Claims - Estimated warranty costs are provided at the time of sale of the warranted products.\nReclassifications - An activity-based cost system was implemented at the beginning of fiscal year 1995. Operating costs and expenses are now recorded based on the activity that drives them (i.e., Products & Services, General & Administrative, Selling and Marketing, and Research and Development). Certain reclassifications have been made to the prior year amounts to conform with current year classifications.\nNet loss per share - Net loss per share is computed on the basis of weighted average number of shares outstanding for the period. Common stock equivalents are not material, and therefore, are not included in the computation of primary earnings per share.\n3. INVENTORIES -------------------\nThe above amounts are net of obsolescence reserves of $943,000 in 1995 and $816,000 in 1994.\nAMERICAN BUSINESS COMPUTERS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n4. FINANCING ARRANGEMENTS ------------------------------\nLong-term debt consists of the following at April 29, 1995:\nThe note payable to bank was entered into during fiscal 1995 to partially finance the purchase of the headquarters facility which was previously leased from the former chairman (see Note 7). The note payable has an adjustable interest rate ( 9.25% at April 29, 1995) which may not increase or decrease by more than 2% once every three years. The maximum increase or decrease is 6% over the life of the loan. Principal and interest payments of $3,026 are payable monthly with the balance of $143,000 due October 1, 2005. The note payable is secured by the headquarters facility. The facility has a net book value of $485,000.\nMaturities of long-term debt for the five years subsequent to April 29, 1995 are as follows: 1996-$10,000; 1997-$11,000; 1998-$12,000; 1999-$13,000 and 2000-$15,000.\nThe Company also has a note payable on a cash equivalent margin account of $190,000 at April 29, 1995 which bears interest at a variable interest rate (7.5% weighted average rate in 1995). The note was repaid in full by the Company in June 1995.\nDuring 1995, the Company incurred interest expense of $28,000, which approximates interest paid.\n5. INCOME TAXES -------------------- Effective May 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method in accordance with the provisions of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes.\" The change had no impact on the accompanying financial statements. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of Company assets and liabilities.\nThe components of the Company's deferred income tax assets are as follows:\nAt April 29, 1995 and April 30, 1994, the Company had Federal net operating loss carryforwards for tax reporting purposes of approximately $12,208,000 and $10,172,000, respectively which expire in the years 1996 to 2010. It is uncertain if benefits relating to these deferred tax assets are realizable and accordingly, a valuation allowance equal to the amount of such deferred tax assets has been recorded.\n6. COMMON STOCK --------------------\nStock Option Plans\nOn February 16, 1990, the Board of Directors adopted the American Business Computers Corporation 1990 Non-qualified Stock Option Plan (the \"1990 Plan\") for directors, officers and employees of the Company, its subsidiaries and affiliates. The 1990 Plan was approved by the affirmative vote of the Company's stockholders at the Annual Meeting on August 24, 1990 authorizing 500,000 shares. All granted options expire five years after grant date; all options were granted at the fair market value at the date of the grant.\nWarrants\nOn May 27, 1994, the Company granted Herbert M. Pearlman, director, warrants to purchase 250,000 restricted shares of common stock. 150,000 warrants are exercisable at $1.25 per share and 100,000 warrants are exercisable at $3.25 per share; the warrants expire on May 27, 1999.\nIn August 1994, the Company completed a private offering of 1 million shares of common stock at a price of $1.25 per share in a transaction exempt from registration under the Securities Act of 1933. Officers, directors and employees purchased 271,000 shares of this private placement. For each share of common stock purchased in this private placement, subscribers were also granted a warrant to buy one additional share of common stock for $2.00; 705,000 warrants expire on August 17, 1999 and 295,000 warrants expire on September 13, 1999. The warrants are callable by the Company, with certain restrictions. The call price is $.10 per warrant. The shares and warrants have been registered in accordance with the provisions of the Securities Act of 1933.\nOn November 28, 1994, the Company granted Randolph D. Letsch, V.P. - Paint Sales of ABC Dispensing Technologies, Inc., warrants to purchase 25,000 restricted shares of common stock at $3.38 per share; the warrants expire on November 28, 1999.\nOn May 2, 1995, the Company granted David B. Hudson, V.P. - Domestic Beverage Sales, and Keith P. Jordan, National Account Manager (both of ABC Dispensing Technologies, Inc.), warrants to purchase 20,000 and 10,000 restricted shares of common stock, respectively, at $3.38 per share; the warrants expire May 2, 2000.\n7. RELATED PARTY TRANSACTIONS ----------------------------------\nThe Company purchased the headquarters facility from Mr. Joseph W. Shannon, former Chairman of the Company, on June 24, 1994 for $490,000. Prior to the purchase, the facility was appraised for $535,000. The Company had previously leased the facility from Mr. Shannon; lease payments were $5,367 per month through November 1993 and $6,440 per month through the purchase date.\n8. OPERATING LEASES ------------------------\nFor the fiscal years 1995, 1994, and 1993, aggregate rental expense for all operating leases, except those with terms of a month or less, was $13,000, $82,000, and $76,000, respectively.\n9. RETIREMENT BENEFITS ---------------------------\nThe Company sponsors a 401(k) plan which covers substantially all full-time employees. Eligible employees may contribute up to 15% of their compensation to this plan. The Company has agreed to match participants' contributions at the rate of 25 cents on the dollar up to a maximum of 3% of the participants' compensation. The cost of the Company's matching contribution for the fiscal years 1995, 1994, and 1993 amounted to $9,000, $9,000, and $8,000, respectively. The Company has the discretion to make a profit-sharing contribution, but no such contribution has been made by the Company.\n10. CONTINGENCIES ---------------------\nA. SECURITIES LITIGATION\nOn March 2, 1995 the Company reported it had reached a settlement with the plaintiffs in a class action lawsuit, filed originally in 1991. The Federal Court approved the settlement on June 16, 1995. The plaintiffs are current and former shareholders who purchased shares during the period January 24, 1990 through August 1, 1991. The settlement provides for the payment to the plaintiff class of a minimum aggregate of $6,500,000 in cash and shares of the Company's common stock. The cash portion of the settlement will consist of $1,850,000, of which approximately $1,400,000 has been funded by certain of the named individual defendants who are current or former officers or directors, with the Company funding the remaining $450,000 on June 8, 1995. The stock portion of the settlement will consist of 1,550,000 shares of the Company's common stock, subject to adjustment if the per-share price falls below $3.00 or rises above $4.50. The Company will fund 150,000 shares, with the Pepsi-Cola Company funding 1,000,000 shares and Hussmann Corporation funding 400,000 shares. Pepsi-Cola and Hussmann were co-defendants in the litigation. The Company will grant common stock purchase warrants having a term of five years to Pepsi for 500,000 shares and to Hussmann for 200,000 shares, at an exercise price of $3.50 per share. The warrants are callable after three years if the price of the Company's common stock is in excess of $10.00 per share.\nRefer to Form 10-K for the fiscal year ended April 30, 1994 for more information on this litigation.\nB. CONTRACT LITIGATION\nOn December 22, 1994, the Company reported it had reached a definitive settlement agreement with the Pepsi-Cola Company relating to litigation that had been pending since 1993 in the United States District Court for the Northern District of Ohio in Akron. The Company sought to recover damages for substantial breaches of contract by Pepsi with respect to the development, manufacture, and sales of the Omnitron, Minitron, Midtron, and Advanced Omnitron soft drink dispensing systems. Pepsi has agreed for a period of five years to offer its customers using the Company's beverage dispensing equipment its standard marketing, merchandising or equipment allowances, which will help the Company build its beverage dispensing sales. Pepsi has agreed to give any application for approval of the Company's fountain equipment and soft drink dispensing equipment fair consideration in accordance with its supplier approval procedures, with Pepsi retaining the right to approve within its sole discretion. Pepsi is also under no obligation to recommend, encourage, or promote the sale or use of the Company's products.\nRefer to Form 10-K for the fiscal year ended April 30, 1994 for more information on this litigation.\nAs of June 30, 1995, Pepsi owned 2,000,000 common shares of the Company, or 12.5% of the total outstanding stock. Subsequent to Pepsi's funding of 1,000,000 shares to the Securities Litigation settlement, Pepsi's ownership will be reduced to approximately 6.2%.\nC. LEGAL FEE AND SETTLEMENT COST ACCRUAL\nThe estimated legal fees and settlement costs have been accrued for both of the above actions. The accrual as of April 29, 1995 was $1,498,000. The accrual (legal fees, only) as of April 30, 1994 was $946,000.\n11. SUBSEQUENT EVENT ------------------------ On June 13, 1995, the Company initiated a private offering to sell 20 units of $25,000 10% Senior Subordinate Notes due June 1, 1998 and three year redeemable warrants to purchase 12,500 shares of the Company's common stock at $2 per share. The transaction was exempt from registration under the Securities Act of 1933. The offering will extend to the earlier of July 31, 1995 or until all 20 units are sold. At the Company's option, 5 additional units can be offered and the offering period can be extended to September 30, 1995. As of July 11, 1995, 16 units have been issued under the offering, providing the Company with $360,000 in proceeds, net of the original issue discount.\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements on Form S-8 No. 33-39875; Amendment No. 2 to Form S-2 No. 33-89596 and Amendment No. 2 to Form S-3 No. 33-89398 of American Business Computers Corporation and in the related Prospectuses of our report dated July 11, 1995, with respect to the consolidated financial statements and schedule of American Business Computers Corporation included in this annual report (Form 10-K) for the year ended April 29, 1995.\nERNST & YOUNG LLP\nAkron, Ohio August 9, 1995\nAMERICAN BUSINESS COMPUTERS CORPORATION (CONSOLIDATED)\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 the Company is incorporated herein by reference from the Company's definitive Proxy Statement of the Annual Meeting of Stockholders to be held October 1995. Certain information concerning the Executive Officers is also included below:\nMr. Herbert M. Pearlman has been Chairman of the Board of Directors of the Company since September 1994, replacing Mr. Joseph W. Shannon, who was Chairman from February 1986 to September 1994.\nMr. Robert A. Cutting has been President of the Company since April 1990 and has been President of the Company's wholly-owned subsidiary, ABC Dispensing Technologies, Inc., since September 1986.\nMr. Gary T. Salhany, CPA, MBA, has been Treasurer of the Company since August 1986.\nMr. William Lerner has been Secretary of the Company since September 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION --------------------------------\nIncorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held October 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -----------------------------------------------------------------------\nIncorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held October 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------------\nIncorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held October 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ------------------------------------------------------------------------\n(a) The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report.\n(b) The following exhibits are incorporated by reference herein or annexed to this Annual Report:\n4.1 Form of Senior Subordinate Promissory Note due June 1, 1998 issued in connection with a private placement of the Registrants Securities (the \"1995 Private Placement\").\n4.2 Form of Common Stock Purchase Warrant issued in connection with the 1995 Private Placement.\n10.1 Development and Manufacture Agreement dated July 27, 1992 between the Company and The Sherwin-Williams Company relating to the Tint-A-Color System.*\n10.2 L.C.R.U. Tint System Development and Manufacture Agreement dated September 14, 1993 between the Company and The Sherwin-Williams Company relating to a lower priced, less automated version of the Tint-A-Color System.*\n10.3 Form of Warrant Agreement to be delivered by the Company to each of PepsiCo, Inc., and Hussmann Corporation in connection with the settlement of the Securities Litigation.\n11.1 Statement regarding computation of per share earnings (see Item 8 of this Annual Report in Form 10-K).\n21.1 Subsidiaries of the Registrant.\n23.1 Consent of Ernst & Young LLP.\n24. Power of Attorney (see signature page).\n27. Financial Data Schedule (for S.E.C. electronic filing only)\n99.1 Stipulation of Settlement entered as of March 13, 1995 in connection with the Securities Litigation.\n* A portion of this exhibit has been omitted pursuant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 promulgated under the Securities Exchange Act of 1934, as amended.\n(c) Current reports on Form 8-K during the quarter ended April 29, 1995.\nNone.\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.\nAMERICAN BUSINESS COMPUTERS CORPORATION\nBy: _______________________________ By: ________________________________ Robert A. Cutting Gary T. Salhany President Treasurer Principal Executive 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.\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.\nAMERICAN BUSINESS COMPUTERS CORPORATION\nBy: \/s\/ ROBERT A. CUTTING By: \/s\/ GARY T. SALHANY -------------------------- ----------------------------- Robert A. Cutting Gary T. Salhany President Treasurer Principal Executive 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.\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.\nAMERICAN BUSINESS COMPUTERS CORPORATION\nBy: _______________________________ By: ________________________________ Robert A. Cutting Gary T. Salhany 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.\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.\nAMERICAN BUSINESS COMPUTERS CORPORATION\nBy: _______________________________ By: ________________________________ Robert A. Cutting Gary T. Salhany 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.\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.\nAMERICAN BUSINESS COMPUTERS CORPORATION\nBy: _______________________________ By: ________________________________ Robert A. Cutting Gary T. Salhany 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.","section_15":""}
{"filename":"740830_1995.txt","cik":"740830","year":"1995","section_1":"Item 1. Business\nBackground\nSouthern Jersey Bancorp of Delaware, Inc. (Registrant), a bank holding company, was organized under the laws of the State of Delaware on June 9, 1989. On July 17, 1989, Registrant acquired all the outstanding common shares of Southern Jersey Bancorp, a bank holding company organized under the laws of the State of New Jersey (predecessor Registrant). As of this same date, Southern Jersey Bancorp was merged into Registrant.\nRegistrant's wholly-owned subsidiary, Farmers and Merchants National Bank of Bridgeton (the Bank), is a commercial bank which was first organized under the laws of the State of New Jersey and the United States Government in 1909, and all outstanding shares of the Bank were acquired by the predecessor Registrant on May 22,1984.\nThe Bank's wholly-owned subsidiary, F&M Investment Company (Investment Company), was organized under the laws of the State of Delaware in 1984 for the purpose of holding and managing investment securities.\nDescription of Business\nRegistrant is engaged in the business of managing or controlling its wholly-owned subsidiary bank and other such businesses related to banking as may be authorized under federal and state banking laws.\nThe Bank provides traditional services that are standard to the commercial banking industry and maintains a Trust Department that provides traditional fiduciary and agency services standard to the banking industry.\nThe Bank operates in the Counties of Cumberland, Gloucester and Salem in Southern New Jersey through branch offices with the main office situated in Bridgeton,New Jersey. Within the market area in which the Bank operates, there are numerouscommercial banks, savings and loan associations, credit unions, etc. The number of competitors cannot be reasonably estimated. The Bank is one of the largest independently owned financial institution in the market area and is one of the most profitable financial institutions in the State of New Jersey. During 1995, the Bank opened two new branch offices in New Jersey. The principal methods of competition are those that are standard to the banking industry, such as interest rates and customer services.\nEnvironmental and Safety Regulations\nIn the opinion of Registrant, compliance with current laws and regulations pertaining to the environment, health and safety has not materially affected its business or financial condition, and Registrant believes that such matters will not have a material effect on its business or financial condition in the foreseeable future. After giving effect to pending programs for environmental compliance, Registrant expects to be in material compliance with currently applicable environmental, health and safety laws and regulations.\nGeneral\nEmployees - Registrant employs approximately 211 people who are not covered by collective bargaining agreements with any unions. In general, relationships with employees have been satisfactory.\nCustomers - Registrant 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 Registrant.\nOther - Registrant does not have research and development expenditures, backlog of orders and inventory, patents or trademarks, any seasonality of business, business under government contracts subject to renegotiation of profits or contract termination or reportable industry segments as described in SFAS 14, and does not use raw materials.\nThe banking business of Registrant and the Bank is subject tocomprehensive and detailed regulation by federal supervisory agencies; in particular, the Office of the Comptroller of Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve Board, as well as the Securities and Exchange Commission. These agencies have broad administrative authority which includes, but is not limited to, dividends, expansion of locations, acquisitions and mergers, interest rates, reserves against deposits, terms, amounts and charges to borrowers, investments, ownership of certain companies by bank holding companies. The banking business of Registrant and the Bank is also subject to the banking laws of the States of New Jersey and Delaware.\nThe federal banking regulatory authorities (The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation) may take action against the Registrant and the Bank for failure to maintain minimum levels of capital and minimum leverage ratios and failure to comply with regulations promulgated under the FDIC Improvement Act of 1991 (FDICIA) and the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). The Bank's Tier 1 and risk weighted capital ratios at December 31, 1995 are 13.9% and 14.8%, respectively. This is well in excess of the minimum required of 4% and 8%.\nFDICIA generally prohibits a 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 growth limitations, prohibitions on the payment of interest rates in excess of 75 basis points above the average market yields for comparable deposits, and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition,for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5% of the depository institution's total assets at the time it became undercapitalized and (ii) the amount which is necessary or would have been necessary to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution that is required to submit a capital restoration plan 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, or desist accepting deposits from correspondent banks, and restrictions on senior executive compensation and on interaffiliate transactions. Critical undercapitalization institutions are subject to a number of additional restrictions including the appointment of a receiver or conservator.\nRegulations promulgated under FDICIA also require that an institution monitor its capital levels closely and notify its appropriate federal banking regulators within 15 days of any material events that affect the capital position of the institution.\nFDICIA directs that each federal banking agency prescribe the standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares, and other such standards as the agency deems appropriate. FDICIA also contains a variety of other provisions that could affect the operations of the Company including new reporting requirements, regulatory standards for real estate lending, \"truth-in-savings\" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch, certain restrictions on investments and activities of state chartered insured banks and their subsidiaries, limitations on credit exposure between banks, restrictions on loans to a bank's insiders, guidelines governing regulatory examinations, and a prohibition on the acceptance or renewal of brokerage deposits by depository institutions that arenot well capitalized or are adequately capitalized and have not received a waiver from the FDIC. Based on the regulations existing in perspective,none of the aforementioned requirements are expected to impose a material cost on the Company or to result in significant changes to the Company's operations.\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 after August 9, 1989, in connection with (i) the default of commonly controlled FDIC insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC insured depository institution in danger of default. \"Default\" is defined generally as the appointment of a conservator or receiver, and \"in danger of default\" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. FIRREA and the Crime Control Act of 1990 expand the enforcement powers available to federal banking regulators including providing greater flexibility to impose enforcement action, expanding the category of persons dealing with a bank or subject to enforcement action, increasing the potential civil and criminal penalties. In addition, in the event of a holding company insolvency, the Crime Control Act of 1990 affords a priority in respect of capital commitments made by a holding company on behalf of subsidiary banks.\n\t\t\tAs more fully discussed in Item 7, Management's Discussion and Analysis, and the Notes to the Consolidated Financial Statements, the Registrant and the Bank are deemed \"well capitalized\" as it significantly exceeds the minimum level required by regulation for each relevant capital measure.\n\t\t\tRegistrant has only domestic operations which are primarily concentrated in Cumberland and Salem Counties of New Jersey.\nItem 1a.","section_1A":"Item 1a. Executive Officers of Registrant\n\t\t\tSet forth below are the names, ages, and titles of persons with Registrant and present and past positions of the persons serving as executive officers of Registrant and its subsidiaries. Unless otherwise stated, each officer has served in his present position since April, 1993.\nNAME AND AGE OFFICE AND EXPERIENCE\nClarence D. McCormick, Sr. 66 President and Chief Executive Officer of Southern Jersey Bancorp of Delaware, Inc., President of F&M Investment Company,Chief Executive Officer of Farmers and Merchants National Bank of Bridgeton, NJ\nClarence D. McCormick, Jr. 35 Vice President of F&M Investment Company and President of Farmers and Merchants National Bank of Bridgeton, NJ since April 20, 1995\nRalph A. Cocove, Sr. 57 Executive Vice President and Cashier of Farmers and Merchants National Bank of Bridgeton, NJ\nRobert C. Wolf 52 Executive Vice President of Administration of Farmers and Merchants National Bank of Bridgeton, NJ since May 13, 1993. Prior to 1993, Mr. Wolf was an officer of United Jersey Bank\/South for 20 years.\nPaul J. Ritter 35 Senior Vice President and Comptroller of Farmers and Merchants National Bank of Bridgeton, NJ since April 20, 1995\nHarry W. Bullock 69 Secretary and Treasurer of Southern Jersey Bancorp of Delaware, Inc., Senior Vice President and Assistant Comptroller of Farmers and Merchants National Bank of Bridgeton, NJ since April 20, 1995\nRussell Chappius, Sr. 54 Senior Vice President and Operations Officer of Farmers and Merchants National Bank of Bridgeton, NJ\nCharles S. Kessler 57 Senior Vice President and Data Processing Manager of Farmers and Merchants National Bank of Bridgeton, NJ\nSimon Aman 59 Senior Vice President and Senior Trust Officer of Farmers and Merchants National Bank of Bridgeton, NJ, and Investment Officer of F&M Investment Company since May 16, 1994. Prior to 1994, Mr. Aman was a Trust Officer with Central National Bank in Canajohaire, New York for 3 1\/2 years and Union National Bank in Albany, New York for 15 years.\nSTATISTICAL DISCLOSURES UNDER GUIDE 3\nSchedule I\nItem I(A) Average Balance Sheets\nDecember 31 1995 1994 1993 ASSETS Cash and due from banks $15,561 $16,348 $15,876 Interest-bearing deposits 2,342 1,540 1,970 Federal funds sold 16,113 21,221 32,341 Investment securities -Taxable 88,496 103,456 99,453 Investment securities -Tax Exempt 38,264 42,266 36,232 Loans net of unearned income 210,327 169,025 145,232 Less: Allowance for loan losses 2,349 2,283 2,076 Net loans 207,978 166,742 143,156 Bank premises and equipment - net 5,819 5,109 5,038 Other assets 8,525 7,839 7,999 ------- ------- ------- TOTAL ASSETS $383,098 $364,521 $342,065\nLIABILITIES AND SHAREHOLDERS' EQUITY\nDeposits Interest-bearing demand deposits $67,548 $58,201 $69,612 Savings accounts 146,401 152,539 140,599 CD's - Over $100,000 37,258 24,498 26,853 Non-interest bearing deposits 92,076 95,719 74,168 ------- ------- ------- Total Deposits 343,283 330,957 311,232 Other liabilities 2,813 2,627 2,555 ------- ------- ------- Total Liabilities 346,096 333,584 313,787\nShareholders' Equity Preferred stock 0 0 0 Common stock 2,129 2,129 2,129 Additional paid-in capital 2,241 2,252 2,210 Retained earnings 35,175 29,729 26,920 Allowance for unrealized (losses)\/gains 750 125 0 ------- ------- ------- 40,295 34,235 31,259 Less:Treasury stock 3,293 3,298 2,981 Total Shareholders' Equity 37,002 30,937 28,278 TOTAL LIAB. & ------- ------- ------- SHAREHOLDERS' EQUITY $383,098 $364,521 $342,065\nGUIDE 3\nSchedule II\nItem I(B) Analysis of Interest Earnings\nFor The Years Ended December 31 (In Thousands) 1995 1994 1993 Interest % Interest % Interest % INTEREST EARNING ASSETS: Interest bearing deposits $164 7.00% $77 5.00% $72 3.65% Federal funds sold 943 5.85% 876 4.13% 968 2.99% Investment securities Taxable 5,720 6.46% 6,435 6.22% 6,477 6.51% Tax-exempt 1,989 5.20% 2,218 5.25% 1,965 5.42% Loans 19,396 9.33% 15,010 9.00% 13,754 9.61% ------- ----- ------- ----- ------- ----- Average Yield $28,212 7.99% $24,616 7.34% $23,236 7.42% INTEREST BEARING LIABILITIES: Interest on deposits: Demand & time deposits $2,837 4.20% $2,358 4.05% $3,168 4.55% Savings 8,311 5.68% 7,018 4.60% 5,707 4.06% CD's - $100,000 or more 1,966 5.28% 1,355 5.53% 1,481 5.52% ------ ----- ------ ----- ------ ----- Average Effective Rate Paid $13,114 5.22% $10,731 4.56% $10,356 4.37% NET YIELD ON INTEREST-EARNING ASSETS $15,098 4.22% $13,885 4.09% $12,880 4.06%\nNOTES:\n(1) Non-accrual loans are not included in the \"Loans net of unearned income\" amount used in the yield computation. (2) No out-of-period items included in the calculation of the changes in interest income and interest expense. (3) Loan fees are immaterial. (4) Tax exempt income is not calculated on a tax equivalent basis.\nGUIDE 3\nSchedule III\nItem I(C)(1) Schedules of Interest Income & Expense Variance\nFor The Years Ended December 31 (In Thousands) 1995 1994 INTEREST VARIANCE INTEREST VARIANCE INTEREST INCOME: Interest-bearing deposits $164 $87 $77 $5 Federal funds sold 943 67 876 (92) Investment securities Taxable 5,720 (715) 6,435 (42) Tax-exempt 1,989 (229) 2,218 253 Loans 19,396 4,386 15,010 1,256 ------- ------ ------- ------ TOTAL INTEREST INCOME $28,212 $3,596 $24,616 $1,380\nItem I(C)(2) INTEREST EXPENSE:\nInterest on deposits: Demand & time deposits $2,837 $479 $2,358 $(810) Savings 8,311 1,293 7,018 1,311 CD's - $100,000 or more 1,966 611 1,355 (126) ------- ------ ------- ------ TOTAL INTEREST EXPENSE $13,114 $2,383 $10,731 $ 375\nSchedule IV\nItem I(C)(2)(a) and (b) Schedules of Volume Variance and Rate Variance\nFor The Years Ended December 31 (In Thousands) 1995 1994 VARIANCE VOLUME RATE VOLUME RATE (a) (b) (a) (b) INTEREST INCOME: Interest-bearing deposits $40 $31 $(16) $27 Federal funds sold (211) 366 (333) 367 Investment securities Taxable (931) 103 261 (291) Tax-exempt (210) 0 327 (64) Loans 3,718 548 2,286 880 ------ ------ ------ ------ TOTAL INTEREST INCOME $2,406 $1,048 $2,525 $(841)\nINTEREST EXPENSE: Interest on deposits: Demand & time deposits $379 $86 $(519) $(348) Savings (282) 1,641 485 762 CD's - $100,000 or more 706 (62) (130) 4 ---- ------ ------- ---- TOTAL INTEREST EXPENSE $803 $1,665 $ (164) $418\nGUIDE 3\nSchedule V\nItem I(C)(2)(c) Schedules of Changes in Rate\/Volume\nDecember 31, 1995 (In Thousands) TOTAL VOLUME RATE RATES\/VOL VARIANCE VARIANCE VARIANCE VARIANCE -------- -------- -------- -------- INTEREST INCOME: Interest-bearing deposits $87 $40 $31 $16 Federal funds sold 67 (211) 366 (88) Investment securities Taxable (715) (931) 103 113 Tax-exempt (229) (210) 0 (19) Loans 4,386 3,718 548 120 ------ ------ ------ ---- TOTAL INTEREST INCOME $3,596 $2,406 $1,048 $142 INTEREST EXPENSE: Interest on deposits: Demand & time deposits $479 $379 $86 $14 Savings 1,293 (282) 1,641 (66) CD's - $100,000 or more 611 706 (62) (33) ------ ---- ------ ----- TOTAL INTEREST EXPENSE $2,383 $803 $1,665 $(85)\nDecember 31, 1994 (In Thousands) TOTAL VOLUME RATE RATES\/VOL VARIANCE VARIANCE VARIANCE VARIANCE -------- -------- -------- -------- INTEREST INCOME: Interest-bearing deposits $5 $(16) $27 $(6) Federal funds sold (92) (333) 367 (126) Investment securities Taxable (42) 261 (291) (12) Tax-exempt 253 327 (64) (10) Loans 1,256 2,282 (880) (146) ------ ---- ------ ----- TOTAL INTEREST INCOME $1,380 $2,521 $(841) $(300) INTEREST EXPENSE: Interest on deposits: Demand & time deposits $(810) $(519) $(348) $57 Savings 1,311 485 762 64 CD's - $100,000 or more (126) (130) 4 0 ------ ---- ------ ----- TOTAL INTEREST EXPENSE $ 375 $(164) $418 $121\nGUIDE 3\nSchedule VI\nItem II(A) and (B) Investment Portfolio\nDecember 31, (In Thousands) 1995 1994 1993 Book Average Book Book Value Yield Value Value U.S. Treasury Securities: Maturing within 1 year $0 $18,117 $13,729 Maturing between 1-5 years 24,527 6.7158% 27,560 32,982 Maturing between 6-10 years 0 1,991 9,879 TOTAL $24,527 47,668 56,590\nU.S. Government Agencies: Maturing within 1 year 4,013 6.1120% 0 2,000 Maturing between 1-5 years 8,995 5.8487% 14,529 11,074 Maturing between 6-10 years 18,946 7.0253% 6,484 4,512 TOTAL 31,954 21,013 17,586 State and Political Subdivisions: Maturing within 1 year 4,785 6.2427% 10,727 10,948 Maturing between 1-5 yrs 16,420 5.5512% 14,460 13,209 Maturing between 6-10 yrs 12,021 6.0727% 16,154 17,349 Maturing over 10 years 73 6.8011% 72 72 TOTAL 33,299 41,413 41,578 Federal Reserve Stock 128 5.8600% 128 128 Other Securities: Maturing within 1 year 6,013 7.0736% 1,999 8,248 Maturing between 1-5 years 15,917 6.2955% 19,266 18,907 Maturing between 6-10 years 1,075 6.0727% 6,572 7,616 TOTAL 23,005 27,837 34,771 Equity Securities Maturing within 1 year Maturing between 1-5 years Maturing between 6-10 years TOTAL 0 0 0 Total Before Allowance For Unrealized Gains 112,913 138,059 150,653 Less: Allowance for Unrealized Gains 1,407 85 0 TOTAL SECURITIES $114,320 $138,144 $150,653\nItem II(C) Securities With One Issuer Exceeding Ten Percent of Stockholders' Equity - NONE\nGUIDE 3\nSchedule VII Analysis of Loans\nItem III(A) - Types of Loans: December 31 (In Thousands) 1995 1994 1993 1992 1991 Real estate loans: 1-4 Family Residential $52,673 $48,443 $46,175 $48,231 $47,220 Farmers 2,337 1,832 1,370 1,054 905 Other 28,695 31,161 49,310 33,538 31,126 Loans to farmers 1,148 1,601 3,069 1,032 1,250 Commercial and industrial loans 83,672 74,165 26,179 41,630 45,558 Loans to individuals: Credit cards 1,661 1,562 1,281 814 579 Other 53,121 35,645 27,406 21,013 23,469 Lease financing receivables 10,059 219 507 564 454 Total Loans 233,366 194,628 155,297 147,876 150,561 Less: Unearned income 1,253 2,110 3,955 6,282 8,039 Allowance for loan losses 2,413 2,146 2,135 1,888 1,288 Net Loans $229,700 $190,372 $149,207 $139,706 $141,234\nItem III(B) - Maturities and Sensitivities of Loans to Changes in Interest Rates at December 31, 1995: (In Thousands) Domestic: Total Loans Interest Rates Predetermined Floating Commercial, Financial and Agricultural Due in 1 year or less $23,005 $13,592 $9,413 Due after 1 year through 5 years 42,333 39,191 3,142 Due after 5 years 19,482 17,508 1,974 $84,820 $70,291 $14,529 Item III(C) - Risk Elements 1. Non-accrual, Past Due and Restructured Loans December 31 1995 1994 1993 1992 1991 (1)(a) Total non-accrual loans $3,133,000 $2,298,000 $1,842,000 $2,080,000 $2,805,000 (1)(b) Accruing loans past due 90 or more days $2,043,000 $1,116,000 786,000 $0 $0 (1)(c) Troubled debt restructuring $1,226,000 $1,147,000 $643,000 424,000 $0 (2)(I) Interest income that would have been recorded on non-accrual loans $144,000 $104,000 $166,000 $139,000 $276,000 (2)(ii) Interest recorded on non-accrual loans included in net income for the period $0 $15,000 $12,000 $4,000 $24,000\n(3) Registrant's policy for placing loans on non-accrual status - See Summary of Significant Accounting Policies under heading \"Loans\" on Registrant's Consolidated Financial Statements for the year ended December 31, 1995, included in Item 8 of Form 10-K. 2. Potential Problem Loans - None Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed under Item III of Industry Guide 3 do not represent or result from trends oruncertainties which Management reasonably expects will materially impact future operating results, liquidity, or capital resources or represent material credits about which Management is aware of any information which causes Management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.\n3. Foreign Outstanding Loans - None\n4. Loan Concentrations - See Item III (A)\nGUIDE 3 Schedule VIII(a) Item III (C)(1)\nTHE FARMERS AND MERCHANTS NATIONAL BANK OF BRIDGETON, NJ\nCHARTER 9498 ANALYSIS OF REPRICING OPPORTUNITIES DECEMBER 31, 1995\nREPRICING OPPORTUNITIES FOR: 1 Day 3 Mo. 3-6 Mo. 6 Mo-One Yr. 1-5YRS Total Loans and Leases $7,947 $13,592 $11,796 $8,257 $127,571 Debt Securities 0 3,024 1,464 10,353 65,183 Trading Account Assets 0 0 0 0 0 Other Interest-Bearing Assets 27,800 0 0 0 0 Total Interest- ------- ------ ------ ------ ------- Bearing Assets 35,747 16,616 13,260 18,610 192,754 Loan and Lease Loss Reserve 0 0 0 0 0 Non-Accrual Loans 0 0 0 0 0 All Other Assets Including Cash 18,981 0 0 0 0 ------- ------- ------- ------- -------- Total Assets $54,728 $16,616 $13,260 $18,610 $192,754\nDeposits in Foreign Offices 0 0 0 0 0 CDs over $100,000 0 $12,376 $8,729 $9,829 $10,008 Other Time Deposits 0 35,516 16,770 22,560 25,257 MMDA Savings & Unregulated NOW 13,554 8,987 17,830 40,370 Other Savings, ATS & Reg. NOW** 0 5,520 5,520 5,520 27,599 Treasury Notes 0 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Interest- Bearing Liabilities $0 $66,966 $40,006 $55,739 $103,234\nDemand Deposits 0 $28,416 0 0 $44,804 All Other Liabilities ------ ------ ------ ------ ------- Total Liabilities $0 $95,382 $40,006 $55,739 $148,038 Total Equity (Excluding Limited Life Pref.Stock) Total Liabilities & Capital $0 $95,382 $40,006 $55,739 $148,038 Net Positions-Total Assets $54,728 $-78,766 $-26,746 $-37,129 $44,716 Less: Liabilities and Capital Cumulative Position Ratios 0.75 0.62 0.54 0.87 Total Assets 54,728 71,344 84,604 103,214 295,968 Total Liabilities & Capital 0 95,382 135,388 191,127 339,165 ------ ------ ------ ------ ------- Total Assets Less Liabilities & Capital $54,728 $-24,038 $-50,784 $-87,913 $-43,197\nREPRICING OPPORTUNITIES All Total FOR: 5 Yrs+ Other Assets %\nTotal Loans and Leases $61,070 0 $230,233 56.95 Debt Securities 34,168 128 114,320 28.28 Trading Account Assets 0 0 0 0 Other Interest-Bearing Assets 0 0 27,800 6.88 Total Interest- ------- ------ ------ ------ Bearing Assets 95,238 128 372,353 92.11 Loan and Lease Loss Reserve 0 -2,413 -2,413 -0.60 Non-Accrual Loans 0 3,133 3,133 .78 All Other Assets Including Cash 0 12,186 31,167 7.71 ------- ------- ------- ------ Total Assets $95,238 $13,034 $404,240 100.00\nDeposits in Foreign Offices 0 0 0 0 CDs over $100,000 0 0 $40,942 10.13 Other Time Deposits 0 0 100,103 24.76 MMDA Savings & Unregulated NOW 9,132 0 89,873 22.23 Other Savings, ATS & Reg. NOW** 11,040 0 55,199 13.66 Treasury Notes 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 ------ ------ ------ ------ Total Interest- Bearing Liabilities $20,172 $0 $286,117 70.78\nDemand Deposits $4,096 0 $77,316 19.13 All Other Liabilities 0 4,164 4,164 1.03 ------ ------ ------ ------ Total Liabilities $24,268 $4,164 $367,597 90.94 Total Equity (Excluding Limited Life Pref.Stock) 0 $36,643 $36,643 9.06\n------- -------- -------- ---- Total Liabilities & Capital $24,268 $40,807 $404,240 100.00\nNet Positions-Total Assets $70,970 $-27,773 Less: Liabilities and Capital Cumulative Position Ratios 1.08 Total Assets 391,206 404,240 Total Liabilities & Capital 363,433 404,240 ------ ------ ------ ------ Total Assets Less Liabilities & Capital $27,773 0\nG A A P TABLE FOOTNOTES**\n1.) These items are generally considered to be non-interest sensitive due to their infrequent repricing characteristics.\n2.) In addition to the rate sensitivity characteristics of assets and supporting funds, sensitivity balances include assumptions for the potential balance volatility of certain deposit categories.\nRegular savings balances are generally considered to be non-interest sensitive due to their infrequent repricing characteristics. However, in order to account for possible internal transfers to other deposit categories or the possibility of deposit disintermediation, a measure of variation has been determined for certain non-interest sensitive deposits. Consequently, an amount representing this measure of variation for savings accounts has been treated as interest rate sensitive within three months, six months and one year and the remainder has been considered non-interest sensitive.\nGUIDE 3 Schedule VIII(a) Item III (C)(1)\nTHE FARMERS AND MERCHANTS NATIONAL BANK OF BRIDGETON, NJ\nCHARTER 9498 ANALYSIS OF REPRICING OPPORTUNITIES DECEMBER 31, 1994\nREPRICING OPPORTUNITIES FOR: 1 Day 3 Mo. 3-6 Mo. 6 Mo-One Yr. 1-5YRS Total Loans and Leases $7,155 $12,925 $5,191 $10,264 $98,292 Debt Securities 0 5,842 8,040 18,958 73,163 Trading Account Assets 0 0 0 0 0 Other Interest-Bearing Assets 11,250 0 0 0 0 Total Interest- ------- ------ ------ ------ ------- Bearing Assets 18,405 18,767 13,231 289,222 171,455 Loan and Lease Loss Reserve 0 0 0 0 0 Non-Accrual Loans All Other Assets Including Cash 20,982 0 0 0 0 ------- ------- ------- ------- -------- Total Assets $39,387 $18,767 $13,231 $29,222 $171,455\nDeposits in Foreign Offices $0 0 0 0 0 CDs over $100,000 0 6,633 5,707 4,655 5,148 Other Time Deposits 0 34,419 14,459 13,375 24,371 MMDA Savings & Unregulated NOW 0 44,458 17,611 17,611 0 Other Savings, ATS & Reg. NOW** 0 5,049 5,049 5,049 0 Treasury Notes 0 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities ------ ------ ------ ------ ------- Total Interest- Bearing Liabilities $0 $90,559 $42,826 $40,690 $29,519 Demand Deposits 0 0 0 0 0 All Other Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities $0 $90,559 $42,826 $40,690 $29,519 Total Equity (Excluding Limited Life Pref.Stock) 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities & Capital $0 $90,559 $42,826 $40,690 $29,519\nNet Positions-Total Assets $38,634 $-71,792 $-29,595 $-11,468 $141,936 Less: Liabilities and Capital 0 0 0 0 0 Cumulative Position Ratios 0.63 0.53 0.57 1.33 Total Assets 38,634 57,401 70,632 99,854 217,309 Total Liabilities & Capital 0 90,559 133,385 174,075 203,594 ------ ------ ------ ------ ------- Total Assets Less Liabilities & Capital $38,634 $-33,158 $-62,753 $-74,221 $67,715\nREPRICING OPPORTUNITIES All Total FOR: 5 Yrs+ Other Assets %\nTotal Loans and Leases $58,503 0 $191,330 51.58 Debt Securities 31,853 288 138,144 37.05 Trading Account Assets 0 0 0 0 Other Interest-Bearing Assets 0 0 12,250 3.02 Total Interest- ------ ------ ------ ------ Bearing Assets 90,356 288 341,724 91.64 Loan and Lease Loss Reserve 0 -2,146 -2,146 -0.58 Non-Accrual Loans 0 2,298 2,298 0.62 All Other Assets Including Cash 0 10,038 31,020 8.32 ------- ------- ------- ------ Total Assets $90,356 $10,478 $372,896 100.00\nDeposits in Foreign Offices 0 0 0 0 CDs over $100,000 0 0 22,153 5.94 Other Time Deposits 0 0 86,624 23.23 MMDA Savings & Unregulated NOW 0 0 79,680 21.37 Other Savings, ATS & Reg. NOW** 0 45,446 60,593 16.25 Treasury Notes 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 ------ ------ ------ ------ Total Interest- Bearing Liabilities $0 $45,446 $249,040 66.79\nDemand Deposits $0 $88,133 $88,183 23.65 All Other Liabilities 0 3,118 3,138 0.84 ------ ------ ------ ------ Total Liabilities $0 $136,747 $340,341 91.27 Total Equity (Excluding Limited Life Pref.Stock) 0 $32,555 $32,555 8.73\n------- -------- -------- ---- Total Liabilities & Capital $0 $169,302 $372,896 100.00\nNet Positions-Total Assets $90,356 -158,071 Less: Liabilities and Capital Cumulative Position Ratios 1.78 Total Assets 361,655 372,499 Total Liabilities & Capital 203,594 372,499 ------ ------ ------ ------ Total Assets Less Liabilities & Capital $158,071 0\nG A A P TABLE FOOTNOTES**\n1.) These items are generally considered to be non-interest sensitive due to their infrequent repricing characteristics.\n2.) In addition to the rate sensitivity characteristics of assets and supporting funds, sensitivity balances include assumptions for the potential balance volatility of certain deposit categories.\nRegular savings balances are generally considered to be non-interest sensitive due to their infrequent repricing characteristics. However, in order to account for possible internal transfers to other deposit categories or the possibility of deposit disintermediation, a measure of variation has been determined for certain non-interest sensitive deposits. Consequently, an amount representing this measure of variation for savings accounts has been treated as interest rate sensitive within three months, six months and one year and the remainder has been considered non-interest sensitive.\nGUIDE 3 Schedule VIII(a) Item III (C)(1)\nTHE FARMERS AND MERCHANTS NATIONAL BANK OF BRIDGETON, NJ\nCHARTER 9498 ANALYSIS OF REPRICING OPPORTUNITIES DECEMBER 31, 1993\nREPRICING OPPORTUNITIES FOR: 1 Day 3 Mo. 3-6 Mo. 6 Mo-One Yr. 1-5YRS Total Loans and Leases $8,676 $7,928 $5,046 $7,181 $72,159 Debt Securities 0 4,379 11,797 18,749 76,172 Trading Account Assets 0 0 0 0 0 Other Interest-Bearing Assets 29,800 0 0 0 0 Total Interest- ------ ------ ------ ------ ------- Bearing Assets 38,476 12,307 16,843 25,930 148,331 Loan and Lease Loss Reserve 0 0 0 0 0 Non-Accrual Loans 0 0 0 0 0 All Other Assets Including Cash 17,353 0 0 0 0 ------- ------- ------- ------- -------- Total Assets $55,829 $12,307 $16,843 $25,930 $148,331\nDeposits in Foreign Offices $0 0 0 0 0 CDs over $100,000 0 5,588 3,525 5,258 12,057 Other Time Deposits 0 33,908 14,616 12,293 25,268 MMDA Savings & Unregulated NOW 0 83,152 0 0 0 Other Savings, ATS & Reg. NOW** 0 4,883 4,883 4,883 0 Treasury Notes 0 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Interest- Bearing Liabilities $0 127,531 $23,024 $22,434 $37,325 Demand Deposits 0 0 0 0 0 All Other Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities $0 127,531 $23,024 $22,434 $37,325 Total Equity (Excluding Limited Life Pref.Stock) 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities & Capital $0 127,531 $23,024 $22,434 $37,325\nNet Positions-Total Assets $55,829 -115,224 $-6,181 $3,496 $111,006 Less: Liabilities and Capital 0 0 0 0 0 Cumulative Position Ratios 0.53 0.56 0.64 1.23 Total Assets 55,829 68,136 54,979 110,909 259,240 Total Liabilities & Capital 0 127,531 150,555 172,989 210,314 ------ ------ ------ ------ ------- Total Assets Less Liabilities & Capital $55,829 $-59,395 $-65,576 $-62,080 $48,926\nREPRICING OPPORTUNITIES All Total FOR: 5 Yrs+ Other Assets %\nTotal Loans and Leases $52,465 0 $153,455 42.79 Debt Securities 39,428 128 150,653 42.01 Trading Account Assets 0 0 0 0 Other Interest-Bearing Assets 0 0 29,800 8.30 Total Interest- ------ ------ ------ ------ Bearing Assets 91,893 128 333,908 93.10 Loan and Lease Loss Reserve 0 -2,135 -2,135 -0.51 Non-Accrual Loans 0 2,298 2,298 0.62 All Other Assets Including Cash 0 7,684 25,037 6.99 ------- ------- ------- ------ Total Assets $91,893 $7,519 $358,652 100.00\nDeposits in Foreign Offices 0 0 0 0 CDs over $100,000 0 0 26,428 7.34 Other Time Deposits 0 0 86,085 24.00 MMDA Savings & Unregulated NOW 0 0 83,152 23.19 Other Savings, ATS & Reg. NOW** 0 43,953 58,602 16.34 Treasury Notes 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 ----- ------ ------ ------ Total Interest- Bearing Liabilities $0 $43,953 $254,267 70.90\nDemand Deposits $0 $72,994 $72,994 20.35 All Other Liabilities 0 2,365 2,365 0.66 ------ ------ ------ ------ Total Liabilities $0 $119,312 $329,626 91.91 Total Equity (Excluding Limited Life Pref.Stock) 0 $29,026 $29,026 8.09\n------- -------- -------- ---- Total Liabilities & Capital $0 $148,338 358,652 100.00\nNet Positions-Total Assets $91,893 -140,819 Less: Liabilities and Capital Cumulative Position Ratios 1.67 Total Assets 351,133 358,652 Total Liabilities & Capital 210,314 358,652 ------ ------ ------ ------ Total Assets Less Liabilities & Capital $140,819 0\nG A A P TABLE FOOTNOTES**\n1.) These items are generally considered to be non-interest sensitive due to their infrequent repricing characteristics.\n2.) In addition to the rate sensitivity characteristics of assets and supporting funds, sensitivity balances include assumptions for the potential balance volatility of certain deposit categories.\nRegular savings balances are generally considered to be non-interest sensitive due to their infrequent repricing characteristics. However, in order to account for possible internal transfers to other deposit categories or the possibility of deposit disintermediation, a measure of variation has been determined for certain non-interest sensitive deposits. Consequently, an amount representing this measure of variation for savings accounts has been treated as interest rate sensitive within three months, six months and one year and the remainder has been considered non-interest sensitive.\nGUIDE 3 Schedule VIII(a) Item III (C)(1)\nTHE FARMERS AND MERCHANTS NATIONAL BANK OF BRIDGETON, NJ\nCHARTER 9498 ANALYSIS OF REPRICING OPPORTUNITIES DECEMBER 31, 1992\nREPRICING OPPORTUNITIES FOR: 1 Day 3 Mo. 3-6 Mo. 6 Mo-One Yr. 1-5YRS Total Loans and Leases $13,427 $7,397 $6,629 $6,629 $73,880 Debt Securities 5,159 6,875 11,373 10,210 63,827 Trading Account Assets 0 0 0 0 0 Other Interest-Bearing Assets 37,100 0 0 0 0 Total Interest- ------ ------ ------ ------ ------- Bearing Assets 55,686 14,269 15,420 16,839 137,707 Loan and Lease Loss Reserve 0 0 0 0 0 Non-Accrual Loans All Other Assets Including Cash 19,235 0 0 0 0 ------- ------- ------ ------- -------- Total Assets $74,921 $14,269 $15,420 $16,839 $137,707\nDeposits in Foreign Offices $0 0 0 0 0 CDs over $100,000 0 17,563 4,581 2,050 15,640 Other Time Deposits 0 37,557 16,555 10,514 20,354 MMDA Savings & Unregulated NOW 0 64,550 0 0 0 Other Savings, ATS & Reg. NOW** 0 0 0 0 0 Treasury Notes 0 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities ------ ------ ------ ------ ------- Total Interest- Bearing Liabilities $0 119,670 $21,136 $12,564 $35,994 Demand Deposits 0 0 0 0 0 All Other Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities $0 119,670 $21,136 $12,564 $35,994 Total Equity (Excluding Limited Life Pref.Stock) 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities & Capital $0 119,670 $21,136 $12,564 $35,994\nNet Positions-Total Assets $74,921 -105,401 $-5,716 $4,275 $101,713 Less: Liabilities and Capital 0 0 0 0 0 Cumulative Position Ratios 0.75 0.74 0.79 1.37 Total Assets 74,921 89,190 104,610 121,449 259,156 Total Liabilities & Capital 0 119,670 140,806 153,370 189,364 ------ ------ ------ ------ ------- Total Assets Less Liabilities & Capital $74,921 $-30,480 $-36,196 $-31,921 $69,792\nREPRICING OPPORTUNITIES All Total FOR: 5 Yrs+ Other Assets %\nTotal Loans and Leases $40,329 0 $145,709 44.32 Debt Securities 23,827 128 121,396 39.92 Trading Account Assets 0 0 0 0 Other Interest-Bearing Assets 0 0 37,100 11.28 Total Interest- ------ ------ ------ ------ Bearing Assets 64,156 128 304,205 92.53 Loan and Lease Loss Reserve 0 -1,888 -1,888 -0.57 Non-Accrual Loans 0 2,080 2,080 0.63 All Other Assets Including Cash 0 5,137 24,732 7.41 ------ ------ ------- ------ Total Assets $64,156 $5,457 $328,769 100.00\nDeposits in Foreign Offices 0 0 0 0 CDs over $100,000 0 0 39,834 12.12 Other Time Deposits 0 0 84,980 25.85 MMDA Savings & Unregulated NOW 0 0 64,550 19.63 Other Savings, ATS & Reg. NOW** 0 44,870 44,870 13.65 Treasury Notes 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 ------ ------ ------ ------ Total Interest- Bearing Liabilities $0 $44,870 $234,234 71.25\nDemand Deposits $0 $66,909 $66,909 20.35 All Other Liabilities 0 1,637 1,637 0.50 ------ ------ ------ ------ Total Liabilities $0 $113,416 $302,780 92.10 Total Equity (Excluding Limited Life Pref.Stock) 0 $25,989 $25,989 7.90\n------- -------- -------- ---- Total Liabilities & Capital $0 $139,405 328,769 100.00\nNet Positions-Total Assets $64,156 -133,948 Less: Liabilities and Capital Cumulative Position Ratios 1.71 Total Assets 323,312 328,769 Total Liabilities & Capital 189,364 328,769 ------ ------ ------ ------ Total Assets Less Liabilities & Capital $133,948 0\nG A A P TABLE FOOTNOTES**\n1.) These items are generally considered to be non-interest sensitive due to their infrequent repricing characteristics.\n2.) In addition to the rate sensitivity characteristics of assets and supporting funds, sensitivity balances include assumptions for the potential balance volatility of certain deposit categories.\nRegular savings balances are generally considered to be non-interest sensitive due to their infrequent repricing characteristics. However, in order to account for possible internal transfers to other deposit categories or the possibility of deposit disintermediation, a measure of variation has been determined for certain non-interest sensitive deposits. Consequently, an amount representing this measure of variation for savings accounts has been treated as interest rate sensitive within three months, six months and one year and the remainder has been considered non-interest sensitive.\nGUIDE 3 Schedule VIII(a) Item III (C)(1)\nTHE FARMERS AND MERCHANTS NATIONAL BANK OF BRIDGETON, NJ\nCHARTER 9498 ANALYSIS OF REPRICING OPPORTUNITIES DECEMBER 31, 1991\nREPRICING OPPORTUNITIES FOR: 1 Day 3 Mo. 3-6 Mo. 6 Mo-One Yr. 1-5YRS Total Loans and Leases $15,634 $14,439 $9,490 $17,477 $77,884 Debt Securities 15,041 1,060 5,425 3,488 46,200 Trading Account Assets 0 0 0 0 0 Other Interest-Bearing Assets 17,700 0 0 0 0 Total Interest- ------ ------ ------ ------ ------- Bearing Assets 48,375 15,499 14,915 20,965 124,084 Loan and Lease Loss Reserve 0 0 0 0 0 Non-Accrual Loans All Other Assets 17,764 0 0 0 0 ------- ------- ------ ------- -------- Total Assets $66,139 $15,499 $14,915 $20,965 $124,084\nDeposits in Foreign Offices $0 0 0 0 0 CDs over $100,000 0 14,412 10,047 9,535 6,411 Other Time Deposits 0 35,956 17,850 12,269 12,663 MMDA Savings & Unregulated NOW 0 65,204 0 0 0 Other Savings, ATS & Reg. NOW** 0 0 0 0 0 Treasury Notes 0 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities ------ ------ ------ ------ ------- Total Interest- Bearing Liabilities $0 115,572 $27,897 $21,804 $19,074\nDemand Deposits 0 0 0 0 0 All Other Liabilities 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities $0 115,572 $27,897 $21,804 $19,074 Total Equity (Excluding Limited Life Pref.Stock) 0 0 0 0 0 ------ ------ ------ ------ ------- Total Liabilities & Capital $0 115,572 $27,895 $21,804 $19,074\nNet Positions-Total Assets 66,139 -100,073 $-12,982 $-839 $105,010 Less: Liabilities and Capital 0 0 0 0 0 Cumulative Position Ratios 0 0 0 0 0 Total Assets 66,139 81,638 96,553 117,518 241,602 Total Liabilities & Capital 0 115,572 143,469 165,273 184,347 ------ ------ ------ ------ ------- Total Assets Less Liabilities & Capital $66,139 $-33,934 $-46,916 $-47,755 $57,255\nREPRICING OPPORTUNITIES All Total FOR: 5 Yrs+ Other Assets %\nTotal Loans and Leases $12,666 0 $147,590 51.31 Debt Securities 30,132 128 101,474 35.28 Trading Account Assets 0 0 0 0 Other Interest-Bearing Assets 0 0 17,700 6.15 Total Interest- ------ ------ ------ ------ Bearing Assets 42,798 128 266,764 92.75 Loan and Lease Loss Reserve 0 -1,288 -1,288 -0.45 Non-Accrual Loans 0 2,805 2,805 0.98 All Other Assets Including Cash 0 1,585 19,349 6.73 ------ ------ ------- ------ Total Assets $42,798 $3,230 $287,630 100.00\nDeposits in Foreign Offices 0 0 0 0 CDs over $100,000 0 0 40,405 14.05 Other Time Deposits 0 0 78,738 27.37 MMDA Savings & Unregulated NOW 0 0 65,204 22.67 Other Savings, ATS & Reg. NOW** 0 23,543 23,543 8.19 Treasury Notes 0 0 0 0 Mortgages & Capitalized Leases 0 0 0 0 Other Nondeposit Interest -Bearing Liabilities 0 0 0 0 ------ ------ ------ ------ Total Interest- Bearing Liabilities $0 $23,543 $207,890 72.28\nDemand Deposits $0 $54,463 $54,463 18.94 All Other Liabilities 0 1,724 1,724 0.60 ------ ------ ------ ------ Total Liabilities $0 $79,730 $264,077 91.81 Total Equity (Excluding Limited Life Pref.Stock) 0 $23,553 $23,553 8.19\n------- -------- -------- ---- Total Liabilities & Capital $0 $103,283 $287,630 100.00\nNet Positions-Total Assets $42,798 -100,053 Less: Liabilities and Capital Cumulative Position Ratios 0 Total Assets 284,400 287,630 Total Liabilities & Capital 184,347 287,630 ------ ------ ------ ------ Total Assets Less Liabilities & Capital $100,053 0\nG A A P TABLE FOOTNOTES**\n1.) These items are generally considered to be non-interest sensitive due to their infrequent repricing characteristics.\n2.) In addition to the rate sensitivity characteristics of assets and supporting funds, sensitivity balances include assumptions for the potential balance volatility of certain deposit categories.\nRegular savings balances are generally considered to be non-interest sensitive due to their infrequent repricing characteristics. However, in order to account for possible internal transfers to other deposit categories or the possibility of deposit disintermediation, a measure of variation has been determined for certain non-interest sensitive deposits. Consequently, an amount representing this measure of variation for savings accounts has been treated as interest rate sensitive within three months, six months and one year and the remainder has been considered non-interest sensitive.\nGUIDE 3 Schedule IX Item IV (A)(1)\nSUMMARY OF LOAN LOSS EXPERIENCE\n(In Thousands) For The Years Ended December 31, 1995 1994 1993 1992 1991 Balances at beginning of year $2,146 $2,135 $1,888 $1,288 $1,120 Loan charge-offs: Mortgage loans 17 151 288 14 50 Installment loans 414 265 116 231 3 Commercial loans 638 383 296 413 525 Total charge-offs 1,069 799 700 658 728 Recoveries of loans previously charged off: Mortgage loans 2 2 33 0 0 Installment loans 51 49 62 52 54 Commercial loans 17 34 52 215 17 Total recoveries 70 85 147 267 71 NET CHARGE-OFFS 999 714 553 391 657 Allowance charged to operations ,266 725 800 991 825 Balances at end of year $2,413 $2,146 $2,135 $1,888 $1,288 Average loans outstanding during year $211,398 $171,887 $149,842 $164,172 $172,110 Ratio of net charge-offs to average loans outstanding during the year 0.473% 0.415% 0.369% 0.238% 0.382%\nItem IV(B) Allocation of Allowance for Loan Losses\nThe allowance for loan losses is maintained at a level considered by Management to be adequate to provide for losses which may be incurred on loans currently held based on a detailed evaluation of the loan portfolio, historical experience, current economic trends and other factors relevant to the collectibility of the loans in the portfolio. Credit risk, the risk that a borrower will fail to perform to the loan agreement, is managed by limiting the total amount of loans outstanding and by applying normal credit policies to all lending activities. Collateral is obtained based on Management's credit assessment of the customer. Loans are further subject to interest rate risk and risk from geographic concentration of lending activities. Interest rate risk is managed through various asset\/liability management techniques. Loan policies and administration are designed to provide assurance that loans will only be granted to creditworthy borrowers, although credit losses are expected to occur because of subjective factors and factors beyond the control of the Bank. The Bank is mandated by the Community Reinvestment Act and other regulations to conduct most of its lending activities within the geographic area where it is located. As a result, the Bank and its borrowers may be vulnerable to the consequences of changes in the local economy. Anticipated amounts of loan charge-offs for the fiscal year are estimated to be an amount equal to the current fiscal year.\nGUIDE 3\nSchedule X\nItem V(A) - Average Deposits\nDecember 31 (In Thousands) 1995 1994 1993 AVG. AMT. % AVG. AMT. % AVG. AMT. % Non-interest bearing demand deposits $92,076 0.0 $95,719 0.0 $74,168 0.0 Interest bearing demand deposits 67,548 4.2 58,201 4.1 69,612 4.6 Savings accounts 146,401 5.7 152,539 4.6 140,599 4.1 CD's - Over $100,000 37,258 5.3 24,498 5.5 26,853 5.5 Total Average Deposits $343,283 5.2 $330,957 4.6 $311,232 4.4\nItem V(D) - Deposits Summary (In Thousands) 1995 ---- Demand deposits Non-interest bearing $77,316 Interest bearing 89,873 (Money Market and N.O.W. Accounts) Savings deposits 55,199 Time deposits 141,045 Total Deposits $363,433\nThe remaining maturity on certificates of deposit of $100,000 or more is presented below:\n(In Thousands) 1995 Maturity ----\n3 months or less $12,376 3 months to 6 months 8,729 6 to 12 months 9,829 Over 12 months to 5 years 10,008 Over 5 years 0 ------- Total $40,942\nGUIDE 3\nSchedule XI\nItem VI - Return on Equity and Assets\nDecember 31 1995 1994 1993 (1) Return on assets 1.27% 1.23% 1.19% (2) Return on equity 13.11% 14.47% 14.38% (3) Dividend payout ratio 22.57% 23.47% 24.46% (4) Equity to assets ratio 9.66% 8.49% 8.27%\nItem 2.","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth the location and principal offices of Registrant and its subsidiary.\nLocation Use\nBridgeton, New Jersey Executive Offices and Main Bank Office Bridgeton, New Jersey Branch Office (West Broad Street) Bridgeton, New Jersey Operations Center and Computer Facilities *Upper Deerfield, New Jersey Branch Office (Carll's Corner) Upper Deerfield, New Jersey Branch Office (Seabrook) Fairton, New Jersey Branch Office Penns Grove, New Jersey Branch Office Pennsville, New Jersey Branch Office Rosenhayn, New Jersey Branch Office *Vineland, New Jersey Branch Office (Cumberland Mall) *Millville, New Jersey Branch Office Millville (Airport), New Jersey Branch Office Wilmington, Delaware Administrative Office for F&M Investment Company *Salem City, New Jersey Branch Office Washington Township, New Jersey Branch Office Cedarville, New Jersey Branch Office\n*Leased Property\nRegistrant owns substantially all properties used in its business Branch office leases are less than $100,000 annually, and Management does not foresee any material changes in terms or amounts of leased property or the ability to renew applicable leases.\nNone of the owned principal properties are subject to any major encumbrance material to the operations of Registrant.\nAll facilities are in good condition and are adequate and suitable for Registrant's business. Management believes that the capacity of the offices is such that no additional office space will be needed in the foreseeable future for administration purposes. In 1996, the Company will open a recently renovated building at the Upper Deerfield (Carll's Corner) location replacing the existing branch. Additional branch offices may be opened in the future when Management deems it necessary for meeting customer needs, expansion and growth.\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 of Registrant during the fourth quarter of fiscal year 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nMarket Information for Common Stock.\nRegistrant's common stock is inactively traded on a local basis, and the range of sales prices known to Management based on quotes from the National Quotation Bureau and transactions noted in the transfer and issuance of Registrant's common stock certificates, for each quarter during the two most recent years are as follows:\n1995 1994 High Low High Low First Quarter $31.50 $31.25 $27.50 $25.50 Second Quarter $31.50 $31.25 30.00 27.00 Third Quarter $33.50 $31.50 31.75 30.00 Fourth Quarter $37.00 $33.00 31.75 31.00\nHolders\nAt March 14, 1996, there were 526 holders of record of Registrant's common stock.\nDividends\nRegistrant declared cash dividends of $0.50 per share payable to its common shareholders on June 30, 1995 and December 31, 1995, for a total of $1.00 per share or approximately $1,093,000.\nRegistrant declared cash dividends of $.48 per share payable to its common shareholders on June 30, 1994 and December 31, 1994, respectively, for a total of $.96 per share or approximately $1,054,000.\nFor restriction on dividends, see Note 7 to the consolidated financial statements.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table presents selected financial data of the Registrant. The historical data should be read in conjunction with the consolidated financial statements and the related notes thereon in Item 8 and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7.","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. SOUTHERN JERSEY BANCORP OF DELAWARE, INC.\nIndex to Consolidated Financial Statements\nPage\nIndependent Auditor's Report 34\nConsolidated Balance Sheets 35\nConsolidated Statements of Operations 36\nConsolidated Statements of Shareholders' Equity 37\nConsolidated Statements of Cash Flow 38\nNotes to Consolidated Financial Statements 39-52\nIndependent Auditor's Report - F&M Investment Company 53\nINDEPENDENT AUDITOR'S REPORT\nTo The Stockholders and Board of Directors Southern Jersey Bancorp of Delaware, Inc. Bridgeton, New Jersey 08302\nWe have audited the consolidated balance sheets of Southern Jersey Bancorp of Delaware, Inc., and its 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 financial statements are the responsibility of the Company's manage- ment. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of F&M Investment Company, a consolidated subsidiary whose statements reflect total assets of 28% and 35% as of December 31, 1995 and 1994, respectively, and total interest income revenues of 25%, 31% and 37% for each of the years in the three year period ended December 31, 1995, of the related consoli- dated totals. 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 the F&M Investment Company, 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 per- form the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based upon our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly in all material respects the consolidated financial position of Southern Jersey Bancorp of Delaware, Inc., and subsi- diaries at December 31, 1995 and 1994, and the consolidated 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.\ns\/ WILLIAM THOS. ATHEY & COMPANY ----------------------------- January 19, 1996 Bridgeton, New Jersey\nSouthern Jersey Bancorp of Delaware, Inc. And Subsidiaries CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share and Per Share Data)\nDecember 31 1995 1994 ASSETS Cash and due from banks (Note 2) $18,981 $17,982 Federal funds sold 27,800 11,250 Cash and Cash Equivalents 46,781 29,232 Interest-bearing deposits in other banks 0 3,000 Investment securities Available for sale (Note 3) 33,754 20,416 Held to maturity (Market value: 1995-$81,486 1994-$113,754) (Note 3) 80,566 117,728 Loans (Notes 1, 4 and 5) 233,366 194,628 Less: Allowance for loan losses 2,413 2,146 Unearned income 1,253 2,110 Net Loans 229,700 190,372 Bank premises and equipment - net (Notes 1 and 6) 5,916 5,308 Other assets 7,523 6,840 TOTAL ASSETS $404,240 $372,896 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Interest bearing deposits $286,117 $249,040 Non-interest bearing deposits 77,316 88,183 Total Deposits 363,433 337,223 Other liabilities 4,164 3,118 Total Liabilities 367,597 340,341 Shareholders' Equity (Note 7) Preferred stock, no par value; shares authorized - 500,000; no shares issued Common stock, par value $1.67 per share; shares authorized - 5,000,000; shares issued - 1,275,000 2,129 2,129 Additional paid-in-capital 2,223 2,258 Retained earnings 35,103 31,344 Unrealized gains on securities (Note 1) 929 56 40,384 35,787 Less: Treasury stock at cost - 190,193 shares in 1995 and 175,767 shares in 1994 3,741 3,232 Total Shareholders' Equity 36,643 32,555 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $404,240 $372,896\nSouthern Jersey Bancorp of Delaware, Inc. And Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data)\nYear Ended December 31 1995 1994 1993 INTEREST INCOME: Investment securities: Taxable $5,720 $6,435 $6,477 Tax-Exempt 1,989 2,218 1,965 Loans and leases (Note 1) 19,396 15,010 13,754 Interest-bearing deposits With depository institutions 164 77 72 Federal funds sold 943 876 968 TOTAL INTEREST INCOME 28,212 24,616 23,236 INTEREST EXPENSE: Deposits 13,114 10,731 10,356 NET INTEREST INCOME 15,098 13,885 12,880 PROVISION FOR LOAN LOSSES (NOTES 1 AND 5) 1,266 725 800 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 13,832 13,160 12,080 OTHER INCOME: Service fees 1,428 1,258 1,240 Trust department income 652 620 591 Other 303 430 355 Net investment security gains(Notes 1 and 3) 360 0 70 TOTAL OTHER INCOME 2,743 2,308 2,256 OTHER EXPENSES: Salaries and wages 4,388 4,164 3,781 Employee benefits (Notes 1, 8 and 9) 1,321 1,070 934 Occupancy and equipment expenses 1,704 1,593 1,465 OCC Exam and FDIC assessments 473 806 745 Postage, stationary and supplies 422 332 389 Professional fees 478 337 350 Other operating expenses 1,237 1,278 1,194 TOTAL OTHER EXPENSES 10,023 9,580 8,858 INCOME BEFORE INCOME TAXES 6,552 5,888 5,478 PROVISION FOR INCOME TAXES (NOTE 10) 1,700 1,411 1,411 NET INCOME $4,852 $4,477 $4,067 EARNINGS PER COMMON SHARE (NOTE 1) $4.43 $4.09 $3.68\nSouthern Jersey Bancorp of Delaware, Inc. And Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For The Three Years Ended December 31, 1995 (In Thousands, Except Share and Per Share Data)\nAdditional Common Paid-in Retained Treasury Urelized Stock Capital Earning Stock Gain\/Loss Total\nBalances at January 1, 1993 $2,129 $2,214 $24,851 $(2,640) $0 $26,554 Year Ended December 31, 1993 Net Income 4,067 4,067 Cash Dividends ($.90 per share) (997) (997) Addition of 29,720 shares to The Treasury (713) (713) Issuance of 6,009 sharesfrom The Treasury 46 69 115 Balances at ----- ----- ------ ------- - ------ December 31, 1993 2,129 2,260 27,921 (3,284) 0 29,026 Year Ended December 31, 1994 Net Income 4,477 4,477 Increase in Unrealized Gains on Securities 56 56 Cash Dividends ($.96 per share) (1,054) (1,054) Addition of 5,970 shares to The Treasury (2) (154) (156) Issuance of 9,304 shares from The Treasury 206 206 Balances at ----- ----- ------ ------- -- ------ December 31, 1994 2,129 2,258 31,344 (3,232) 56 32,555 Year Ended December 31, 1995 Net Income 4,852 4,852 Increase in Unrealized Gains on Securities 873 873 Cash Dividends ($1.00 per share) (1,093) (1,093) Addition of 23,806 shares to The Treasury (35) (765) (800) Issuance of 9,380 shares from The Treasury 256 256 BALANCES AT ------ ------ ------- -------- --- ------- DECEMBER 31, 1995 $2,129 $2,223 $35,103 $(3,741) 929 $36,643\nSouthern Jersey Bancorp of Delaware, Inc. And Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) Year Ended December 31 1995 1994 1993 Cash flows from operating activities Net income $4,852 $4,477 $4,067 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of organization expenses 0 16 32 Depreciation of premises and equipment 401 380 374 Provision for loan losses 1,266 725 800 Premium amortization net of discount accretion 264 68 37 Gains on sales of securities (360) 0 (70) Gain on sale of bank premises and equipment 0 0 (68) Increase in other assets (683) (214) (452) Increase in other liabilities 1,046 753 138 Net cash provided by operating activities 6,786 6,205 4,858 Cash flows from investing activities (Increase)\/Decrease in interest bearing deposits in other banks 3,000 (1,000) 2,000 Purchase of investment securities (29,561) (25,149) (82,620) Proceeds from sales of investment securities 19,426 502 5,243 Proceeds from maturities of investment securities 34,642 36,281 48,171 Net increase in loans (40,594) 41,890) (10,301) Purchase bank premises and equipment (1,035) (689) (483) Proceeds from sale of bank premises and equipment 0 0 173 Proceeds from sale of other real estate 312 861 698 Net cash used for investing activities (13,810) (31,084) (37,119) Cash flows from financing activities Net increase in deposits 26,210 9,962 26,118 Cash dividends (1,093) (1,054) (997) Purchase of Treasury stock (800) (156) (713) Sale of Treasury stock 256 206 115 Net cash provided by financing activities 24,573 8,958 24,523 Net increase\/(decrease) in cash and cash equivalents 17,549 (15,921) (7,738) Cash and cash equivalents at beginning of year 29,232 45,153 52,891 Cash and cash equivalents at end of year $46,781 $29,232 $45,153\nSupplemental disclosures of cash flow information: Cash paid during the period for: Interest $12,493 $10,612 $10,453 Income Taxes 1,172 1,478 1,326 Other non-cash activities: Transfer of loans, net of charge-offs to other real estate owned 164 233 1,208 Unrealized gain on investment securities available for sale 873 56 0\nSouthern Jersey Bancorp of Delaware, Inc. And Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe significant accounting policies followed by Southern Jersey Bancorp of Delaware, Inc. and subsidiaries, and the methods of applying those policies conform to generally accepted accounting principles and to general practice within the banking industry. A summary of these policies is as follows:\nPrinciples of Consolidation:\nThe consolidated financial statements include the accounts of Southern Jersey Bancorp of Delaware, Inc. (Company), and its wholly- owned subsidiary bank, The Farmers and Merchants National Bank of Bridgeton (Bank), and the Bank's wholly-owned subsidiary, F&M Investment Company. All significant intercompany balances and transactions have been eliminated.\nCash and Cash Equivalents:\nCash and cash equivalents include cash on hand, amounts due from banks, and Federal Funds sold. Generally, Federal Funds are purchased or sold for one-day periods.\nInvestment Securities:\nEffective January 1, 1994, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (FAS 115) for investments held as of or acquired after that date. The effect of this accounting change is not material.\nInvestment securities are classified as held to maturity when the Company has the intent and ability to hold those debt securities to maturity. Debt securities held to maturity are stated at cost and adjusted for accretion of discounts and amortization of premiums.\nThose securities that might be sold in response to changes in market interest rates, prepayment risk, the Company's income tax position, the need to increase regulatory capital, or similar other factors are classified as available for sale. Available for sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported as a component of stockholders' equity. Realized gains and losses are determined on the specific certificate method and are included in non-interest income.\nManagement has not classified any investment securities as trading securities, as the Company has not historically nor anticipates buying investment securities and holding them principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price.\nLoans:\nLoans are reported at the principal amount outstanding, net of unearned income and the allowance for loan losses. The interest method is used to amortize unearned income on installment loans. Interest on all other loans is recognized based on the principal amount outstanding. Recognition of interest on\nthe accrual method is generally discontinued when interest or principal payments are ninety days or more in arrears or when other factors indicate the collection of such payments is doubtful. Once placed on non-accrual status, the loan is not returned to accrual status until interest is received on a current basis and the other factors indicating doubtful collection cease to exist.\nAllowance for Loan Losses:\nThe allowance for loan losses is maintained at a level considered by Management to be adequate to provide for losses which may be incurred on loans currently held based on a detailed evaluation of the loan portfolio, historical experience, industry experience, current economic trends and other factors relevant to the collectibility of the loans currently in the portfolio. The allowance is increased by provisions charged to operating expense and reduced by charge-offs.\nOther Real Estate:\nOther real estate comprises properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of the loan balance or fair market value based on appraisals. Write-downs arising from foreclosure transactions, if any, are charged against the allowance for loan losses. The balances of $946,000 and $1,094,000 at December 31, 1995 and 1994, respectively, are included in other assets in the consolidated balance sheets.\nExpenses related to holding the property are charged against earnings in the current period.\nBank Premises and Equipment:\nLand, bank premises, equipment and leasehold improvements are recorded at cost. Depreciation is based on the estimated useful lives of the assets or the term of the lease whichever is less, using the straight-line and declining-balance methods.\nMajor improvements are charged to asset accounts. Maintenance and repairs which do not extend the life of assets are charged to current operating expenses.\nLeased property under capital lease is recorded at the present value of the minimum lease payments and is being amortized using the straight-line method over the term of the lease.\nEmployee Benefit Plans:\nThe Bank has two retirement plans. One is a non-contributory defined benefit pension plan which covers substantially all salaried employees. Benefits under this plan are based on the employees' highest consecutive five years' compensation in the last ten years prior to retirement. The Bank's general funding policy is to contribute amounts when deductible for federal income tax purposes. The other retirement plan, effective January 1, 1995, is a profit sharing retirement plan under which eligible employees may defer a portion of their annual compensation, pursuant to Section 401(K) of the Internal Revenue Code. (See Note 8)\nUnder Farmers and Merchants National Bank of Bridgeton, New Jersey Flexible Benefits\/Health Plan, employees are provided comprehensive health care coverage. Contributions to the Plan are made by participant salary reduction agreements.\nThe Plan includes coverage by both the Bank and the Plan's underwriter. Premiums due the underwriter are accrued and paid monthly. Bank's self-funded liability is also accrued monthly based on amounts provided by the Plan's administrator. (See Note 12)\nIncome Taxes:\nThe Company and its subsidiaries file a consolidated federal income tax return. State income taxes are filed on a separate basis. Certain income and expense items are accounted for in different years for financial reporting purposes than for income tax purposes. Deferred taxes are provided to recognize these temporary differences. (See Note 10)\nEarnings Per Common Share:\nEarnings per common share is computed based upon the weighted average number of common and dilutive common equivalent shares outstanding during the period. Fully diluted and primary earnings per common share are the same amounts for each of the periods presented. Common equivalent shares consist of stock options (calculated using the treasury stock method). Common equivalent shares are excluded as the effect would not be dilutive. Shares used in computing net income per share are 1,094,802 in 1995, 1,095,796 in 1994, and 1,105,608 in 1993.\nNOTE 2 - CASH AND DUE FROM BANKS\nThe Company maintains various deposits in other banks. The withdrawal or usage restrictions on these balances do not have a significant impact on the consolidated operations of the Company. Aggregate reserves of $9,418,000 and $10,374,000 were maintained at the Federal Reserve Bank of Philadelphia as of December 31, 1995 and 1994, respectively, to satisfy federal regulatory requirements.\nNOTE 3 - INVESTMENT SECURITIES\nA summary of the amortized cost and market value of investment securities available for sale and securities held to maturity (in thousands) at December 31, 1995 and 1994 follows:\nAC=AMORTIZED COST GUG=GROSS UNREALIZED GAIN GUL=GROSS UREALIZED LOST MV=MARKET VALUE December 31, 1995 1994 AC GUG GUL MV AC GUG GUL MV U.S. Treasury securities $10,916 $1,060 $0 $11,976 $14,875 $206 $(82) $14,999 U.S. governmental agencies 21,431 347 0 21,778 5,455 0 (38) 5,417 Securities Avail. for Sale $32,347 $1,407 $0 $33,754 $20,330 $206 $(120) $20,416 U.S. Treasury securities $13,610 $26 (10) $13,626 $32,792 $21 $(1,197) $ 31,616 U.S. governmental agencies 10,523 22 (94) 10,451 15,558 33 (801) 14,790 Obligations of states and poli- tical sub- divisions 33,299 760 (46) 34,013 41,413 370 (1,046) 40,737 Other securities 23,134 300 (38) 23,396 27,965 57 (1,411) 26,611 Securities held to maturity $ 80,566 $1,108 (188) $81,486 $117,728 $481 $(4,455) $113,754\nThe amortized cost and estimated market value of investment securities (in thousands) at December 31, 1995, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because obligors have the right to repay obligations without prepayment penalties.\nAvailable for Sale Held to Maturity Amortized Market Amortized Market Cost Value Cost Value\nDue in one year or less $1,000 $1,030 $13,811 $13,936 Due after one year through five years 14,411 15,503 49,681 50,331 Due after five years through ten years 16,936 17,221 16,873 17,006 Due after ten years 0 0 201 213 ------- ------- ------- ------- $32,347 $33,754 $80,566 $81,486\nProceeds from sales and maturities of debt securities classified as available for sale during 1995 were $37,084,000. Gross gains of $271,000 and gross losses of $28,000 were realized on the sales in 1995. There were no sales of securities classified as available for sale during 1994 and 1993. Proceeds from sales and maturities of securities classified as held to maturity during 1995 were $16,984,000. Gross gains of $117,000 and no gross losses were realized on the sales in 1995. No gross gains or losses were realized on the sales in 1994. Gross gains of $70,000 and no gross losses were realized on the sales in 1993.\nInvestment securities with a market value of $18,899,000 and $19,432,000 and a carrying value of $18,250,000 and $19,550,000 were pledged at December 31, 1995 and 1994, respectively, to secure public funds, customer deposits, and for other purposes required by law.\nNOTE 4 - LOANS\nThe loan portfolio is as follows: (In Thousands) December 31 1995 1994\nCommercial and agriculture $84,820 $91,414 Real estate mortgages 83,705 61,241 Installment and consumer credit 54,782 41,622 Lease financing 10,059 351 Total $233,366 $194,628\nLoans have been made to directors, principal officers, principal shareholders, and their related interests in the ordinary course of business. All loans and commitments to loans in such transactions were made on substantially the same terms, including collateral and interest rates as those prevailing at the time for comparable transactions with unrelated persons. In the opinion of Management, these transactions do not involve more than normal risk of collectibility nor present other unfavorable features. It is anticipated that such further extension of credit will be made in the future.\nAs of December 31, 1995 and 1994, such loans aggregated $4,663,000 and $4,062,000, respectively. Activity with said parties during 1995 included principal repayments of $1,184,000 and new loans of $1,785,000.\nLoans that are guaranteed by said parties for which they are contingently liable as of December 31, 1995 and 1994 was $119,000 and $1,233,000, respectively.\nNOTE 5 - ALLOWANCE FOR LOAN LOSSES\nThe changes in the allowance for loan losses are as follows:\n(In Thousands) December 31 1995 1994 1993\nBalances at beginning of year $2,146 $2,135 $1,888 Provision charged to operations 1,266 725 800 Recoveries of loans previously charged off: Mortgage loans 2 2 33 Installment loans 51 49 62 Commercial loans 17 34 52 Total recoveries 70 85 147 Loan charge offs: Mortgage loans (17) (151) (288) Installment loans (414) (265) (116) Commercial loans (638) (383) (296) Total charge offs (1,069) (799) (700) BALANCES AT END OF YEAR $2,413 $2,146 $2,135\nNOTE 6 - BANK PREMISES AND EQUIPMENT\nA summary of bank premises and equipment as of December 31, 1995 and 1994, is as follows:\n(In Thousands) Estimated December 31 Years 995 1994 Land $565 $472 Buildings and improvements 10-80 years 4,378 3,893 Leasehold improvements 5-31 years 1,025 1,016 Furniture, fixtures and equipment 5-10 years 4,674 4,237 Leased equipment under capital lease 7 years 324 324 ------ ----- 10,966 9,942 Less: Accumulated depreciation and amortization 5,050 4,634 Net Bank Premises and Equipment $5,916 $5,308\nDepreciation charged to operating expenses amounted to $401,000 in 1995, $380,000 in 1994 and $374,000 in 1993.\nNOTE 7 - SHAREHOLDERS' EQUITY\nCommon Stock:\nThe Company has 5,000,000 shares of $1.67 par value common stock authorized with 1,275,000 shares issued and 1,084,807 shares outstanding at December 31, 1995, and 1,275,000 shares issued and 1,099,233 shares outstanding at December 31, 1994. Treasury stock totaled 190,193 shares and 175,767 shares at December 31, 1995 and 1994, respectively, and is accounted for under the cost method.\nPreferred Stock:\nThe Company has 500,000 shares of no par value preferred stock authorized, of which none are issued or outstanding.\nStock Rights:\nPursuant to a shareholder rights plan adopted by the Company on November 30, 1989, the Company distributed common stock purchase rights to the shareholders of record on November 30, 1989. Each Right entitles the registered holder thereof to purchase from the Company following the Distribution Date, one one-hundredth of a share of Series A Preferred Stock, no par value, at a Purchase Price of $70.00 per one one-hundredth share, subject to adjustment, or, upon the occurrence of certain events, Common Stock of the Company or common stock of an entity that acquires the Company.\nA Distribution Date will occur upon the earlier of 10 days following a public announcement that a Person or group of affiliated or associated Persons has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of Common Stock; or 10 days following the commencement of a tender offer or exchange offer that would result in a Person or group beneficially owning 30% or more of such outstanding shares of Common Stock.\nThe Rights are not exercisable until the Distribution Date and will expire at the close of business on November 30, 1999, unless redeemed earlier by the Company.\nIn the event that, at any time following the Distribution Date, the Company is the surviving corporation in a merger with an Acquiring Person and the Company's Common Stock is not changed or exchanged; a Person becomes the beneficial owner of more than 30% of the then outstanding shares of Common Stock (except pursuant to an offer for all outstanding shares of Common Stock that the Continuing Directors determine to be fair to and otherwise in the best interests of the Company and its stockholders); an Acquiring Person engages in one or more \"self-dealing\" transactions; or during such time as there is an Acquiring Person, an event occurs that results in such Acquiring Person's ownership interest being increased by more than one percentage point, each holder of a Right will thereafter have the right to receive, upon exercise thereof and in lieu of Preferred Stock, Common Stock (or, in certain circumstances, cash, property, or other securities of the Company) having a value equal to twice the Purchase Price of the Right.\nIn the event that, at any time following the Stock Acquisition Date, the Company is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation; or 50% or more of the Company's assets or earning power is sold or transferred to any Person other than a subsidiary of the Company, each holder of a Right shall thereafter have the right to receive, upon exercise thereof and in lieu of Preferred Stock, common stock of the acquiring Person having a value equal to twice the Purchase Price of the Right.\nAt any time prior to the earlier of November 30, 1999, or 10 days following the Stock Acquisition Date, the Company may redeem the Rights in whole, but not in part, at a price of $0.01 per Right (payable in cash, Common Stock, or other consideration deemed appropriate by the Board of Directors).\nUntil a Right is exercised, the holder will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends.\nStock Option and Stock Appreciation Rights Plan:\nOn August 7, 1988, the Company initiated a stock option and stock appreciation rights plan (Plan #1) for sale or award to key employees as incentive stock options, non-qualified stock options or stock appreciation rights, and may not be exercised later than ten years from the date of the grant. The options exercise price is $18.00 per share.\nOn March 25, 1993, the Company initiated a second stock option and stock appreciation rights plan (Plan #2) with the same terms and conditions as the first plan with the options exercise price at $20.00 per share.\nOn December 8, 1994, the Company initiated a third stock option and stock appreciation rights plan (Plan #3) with the same terms and conditions as the previous two plans with the options exercise price at $31.00 per share.\nThe following table summarizes the options activity. Shares Range ofOption Prices Options outstanding at January 1, 1993 28,410 Options granted (Plan #2) 14,000 $20.00 Options exercised (Plan #1) (4,567) $18.00 Options exercised (Plan #2) (275) $20.00 Options outstanding at December 31, 1993 37,568\nOptions granted (Plan #3) 69,500 $31.00 Options exercised (Plan #1) (4,179) $18.00 Options exercised (Plan #2) (1,825) $20.00 Options outstanding at December 31, 1994 101,064\nOptions granted (Plan #3) 0 $31.00 Options exercised (Plan #1) (3,061) $18.00 Options exercised (Plan #2) (770) $20.00 Options cancelled (Plan #1) (1,000) $18.00 Options outstanding at December 31, 1995 96,233\nOptions exercisable at December 31, 1995 96,233\nAt December 31, 1995, the Company had reserved 96,233 shares of common stock to cover grants under the plans.\nDividend Restriction and Regulatory Matters:\nPermission from the Comptroller of the Currency is required if the total of dividends declared, by the Bank, in a calendar year exceeds the total of its net profits, as defined by the Comptroller, for that year, combined with its retained net profits of the two preceding years. The retained net profits of the Company available for dividends are approximately $11,522,000 at December 31, 1995.\nThe Bank is required to maintain minimum amounts of capital to total \"risk weighted\" assets, as defined by the bank regulatory authorities. At December 31, 1995, the Bank is required to have Tier 1 and Total Capital Ratios of no less than 4.0% and 8.0%, respectively. At December 31, 1995, the Bank's Tier 1 and Total Capital Ratios were 13.9% and 14.8%, respectively, as compared to 14.3% and 15.2% at December 31, 1994. The Bank's leverage ratios at December 31, 1995 and 1994 were 9.1% and 8.8%, respectively.\nNOTE 8 - RETIREMENT PLANS\n401(K) Profit Sharing Plan:\nEffective January 1, 1995, the Company started a profit sharing retirement plan under which eligible employees may defer a portion of their annual compensation, pursuant to Section 401(K) of the Internal Revenue Code. The Company matches employee contributions at a designated rate times elective contribution. All employees with at least one year of service and who have attained the age of 21 are eligible to participate. The Company's contributions to the 401(K) plan were $75,000 for the year ended December 31, 1995.\nDefined Benefit Pension Plan:\nPension expense of $138,000, $106,000, and $71,000 was recognized in 1995, 1994 and 1993, respectively. The following table sets forth the plan's funded status and amounts recognized in the consolidated financial statements:\nDecember 31 (In Thousands) 1995 1994 Actuarial present values of benefit obligations: Vested benefit obligation $2,428 $2,833 Accumulated benefit obligation $2,485 $2,878 Projected benefit obligation $(3,526) $(3,732) Plan assets at fair value 3,892 3,853 Plan assets in excess of projected benefit obligation 366 121 Unrecognized net assets at January 1, 1990, being recognized over 11 years (210) ( 253) Unrecognized net loss 69 146 Prepaid pension cost recognized in the accompanying balance sheets $225 $14\nDecember 31 (In Thousands) 1995 1994 1993 Net pension expense includesthe following: Normal service cost $219 $171 $146 Interest cost on projected benefit obligation 205 275 256 Actual return on plan assets (803) (188) (193) Net amortization and deferral 517 (152) (138) Net pension expense $138 $106 $71\nThe significant majority of plan assets is invested in common stocks, treasury securities and corporate obligations, with the balance in cash and short-term investments. Investment in the Company's stock as of December 31, 1995 and 1994, was 20,544 shares valued at $669,000 and $588,000, respectively.\nThe weighted average discount rate and expected long-term rate of return on assets used were 7.50% and 8.25% as of December 31, 1995 and December 31, 1994. The increase in salary levels was 5%.\nNOTE 9 - DEFERRED COMPENSATION\nThe Bank has a deferred compensation plan for the benefit of key employees. Under the plan, upon retirement after age 65, the employee shall receive a minimum of fifty percent of his then monthly salary for one hundred twenty months. This amount will be reduced by one-half of one percent for each month that retirement is prior to age 65 with the minimum age for retirement at age 60. If a covered employee dies while employed by the Bank, a death benefit of fifty percent of the employee's then annual salary is payable to the employee's beneficiary over ten years. The expense charged to operations for future obligations was $137,000, $101,000, and $95,000 in 1995, 1994 and 1993, respectively.\nNOTE 10 - INCOME TAXES\nThe provision for income taxes is comprised of the following components:\nYear Ended December 31 (In Thousands) 1995 1994 1993 Current income tax expense: Federal $1,026 $1,491 $1,515 State 0 0 0 1,026 1,491 1,515 Deferred income tax (benefit)\/expense 674 (80) (104) Provision for income tax $1,700 $1,411 $1,411\nA reconciliation of the statutory federal income tax rate and the effective rate is as follows: Year Ended December 31 (In Thousands) 1995 1994 1993 Amount % Amount % Amount % Income taxes at the statutory rate $2,228 34 $2,002 34 $1,863 34 Increase\/(decrease) in federal tax expense resulting from: Tax exempt income (636) (10) (637) (11) (545) (10) Prior year underaccrual\/ (overaccrual) (33) 0 18 0 45 1 Other 141 2 28 1 48 1 Provision for income tax $1,700 26 $1,411 24 $1,411 26\nThe significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994 are as follows (in thousands):\nDecember 31 1995 1994 Deferred Tax Assets: Loan loss reserve $ 513 $ 553 Deferred compensation 308 274 Interest income 8 4 Total deferred tax assets 829 831 Deferred Tax Liabilities: Depreciation 248 245 Pension costs 77 5 Lease receivables 597 0 Fair value adjustment, available for sale securities 478 17 ---- --- 1,400 267\nNet Deferred Assets\/ (Liabilities) $(571) $564\nNOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following fair value estimates, methods and assumptions were used to measure the fair value of each class of financial instruments for which it is practical to estimate that value:\nInvestment securities:\nThe fair value of investment securities, except certain state and municipal securities, is estimated based on published bid prices or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.\nLoans:\nFair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, residential mortgage, and other consumer loans.\nThe fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.\nDeposit Liabilities:\nThe fair value of deposits with no stated maturity, such as non- interest bearing demand deposits, savings, and money market and checking accounts, is equal to the amount payable on demand as of December 31, 1995. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.\nThe estimated fair values of the Company's financial instruments are as follows:\n(In Thousands) 1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value Financial Assets: Cash and Short-Term Investments $46,781 $46,781 $32,232 $32,232 Investment Securities 114,320 115,240 138,144 134,170 Loans 232,113 231,657 192,518 188,494 Less: Allowance for Loan Losses 2,413) 2,146) $390,801 $393,678 $360,748 $354,896 Financial Liabilities: Deposits $363,433 $352,178 $337,223 $335,678\nThe fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, and as the fair value for these financial instruments were not material, these disclosures are not included above.\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 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. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nFair value estimates are based on existing on-and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include the deferred tax assets and bank premises and equipment. In addition, the 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 many of the estimates.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES\nFinancial Instruments with Off-Balance Sheet Risk:\nIn the normal course of business, the Company enters into a variety of financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit both of which involve to varying degrees, elements of risk in excess of the amounts recognized in the financial statements. Credit risk, the risk that a counterparty of a particular financial instrument will fail to perform, is the contract amount of commitments to extend credit and standby letters of credit. The credit risk associated with these financial instruments is essentially the same as that involved in extending loans to customers. Credit risk is managed by limiting the total amount of arrangements outstanding and by applying normal credit policies to all activities with credit risk. Collateral is obtained based on Management's credit assessment of the customer. At December 31, 1995 and 1994, the Company had commitments to make loans and outstanding letters of credit totaling $13,930,000\nand $12,526,000, respectively (of this amount, outstanding letters of credit totaled $3,061,000 and $2,841,000, respectively). Many 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.\nConcentration of Credit Risk:\nThe Bank's operations are affected by various risk factors including interest rate risk, credit risk and risk from geographic concentration of lending activities. Management attempts to manage interest rate risk through various asset\/liability management techniques designed to match maturities of assets and liabilities. Loan policies and administration are designed to provide assurance that loans will only be granted to creditworthy borrowers, although credit losses are expected to occur because of subjective factors and factors beyond the control of the Bank. The Bank is mandated by the Community Reinvestment Act and other regulations to conduct most of its lending activities within the geographic area where it is located. As a result, the Bank and its borrowers may be vulnerable to the consequences of changes in the local economy.\nSelf-Funded Health Plan:\nThe Bank provides self-funded comprehensive health care coverage to substantially all of its employees. The plan is covered by an umbrella insurance policy for catastrophic illnesses. The Bank's maximum liability is $25,000 per participant with an overall maximum liability of $325,000 annually.\nOther:\nIn addition, the Bank, from time to time, may be subject to claims and lawsuits relating to the conduct of its normal banking business. The Company, based on advice of legal counsel, has informed us that there are no pending or threatening litigations or unasserted claims against them at the present time.\nNOTE 13 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY\nSOUTHERN JERSEY BANCORP OF DELAWARE, INC. (Parent Company Only) CONDENSED BALANCE SHEET\n(In Thousands Except Share and Per Share Data) December 31 1995 1994 ASSETS Cash and due from banks $667 $628 Investment in bank subsidiary 36,277 32,010 Other assets 250 450 TOTAL ASSETS $37,194 $33,088\nLIABILITIES AND SHAREHOLDERS' EQUITY\nLIABILITIES Dividends Payable $542 $528 Other Liabilities 9 5 Total Liabilities 551 533 SHAREHOLDERS' EQUITY Preferred stock, no par value; shares authorized - 500,000; no shares issued Common stock, par value $1.67 per share; shares authorized - 5,000,000; shares issued - 1,275,000 2,129 2,129 Additional paid-in-capital 2,223 2,258 Retained earnings 35,103 31,344 Unrealized gains on securities 929 56 ------ ------ 40,384 35,787 Less: Treasury stock at cost - 190,193 shares in 1995 and 175,767 shares in 1994 3,741 3,232 Total Shareholders' Equity 36,643 32,555 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $37,194 $33,088\nSOUTHERN JERSEY BANCORP OF DELAWARE, INC. (Parent Company Only) CONDENSED STATEMENT OF INCOME\n(In Thousands) Year Ended December 31 1995 1994 1993 Income: Cash dividends from subsidiary $1,593 $1,554 $1,656 Expenses: Operating Expenses 135 116 101 Income before income taxes 1,458 1,438 1,555 Equity in undistributed earnings of subsidiaries 3,394 3,039 2,512 NET INCOME $4,852 $4,477 $4,067\nCONDENSED STATEMENT OF CASH FLOWS\n(In Thousands) Year Ended December 31 1995 1994 1993 Cash flows from operating activities: Net income $4,852 $4,477 $4,067 Adjustments to reconcile income from continuing operations to net cash provided by operating activities: Equity in net earnings of subsidiary (3,394) (3,039) (2,511) Amortization of organization costs 0 16 32 (Increase)\/decrease in other assets 200 (450) 0 Increase in liabilities 18 12 67 Net cash provided by operating activities 1,676 1,016 1,655 Cash flows from investing activities: Net cash used for investing activities 0 0 0 Cash flows from financing activities: Cash dividends (1,093) 1,054) (997) Purchase of Treasury stock (800) (156) (713) Sale of Treasury stock 256 206 115 Net cash used for financing activities (1,637) (1,004) (1,595)\nNet increase in cash and cash equivalents 39 12 60\nCash and cash equivalents at beginning of year 628 616 556 Cash and cash equivalents at end of year $667 $628 $616\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors of F & M Investment Company\nWe have audited the balance sheets of F & M Investment Company, (a wholly-owned subsidiary of Farmers & Merchants National Bank) as of December 31, 1995 and 1994 and the related statements of stockholders' equity, income 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 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 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 F & M Investment Company, as of December 31, 1995 and 1994 and the results of its operations and cash flows for the years then ended, in conformity with generally accepted accounting principles.\ns\/ Belfint, Lyons & Shuman, P.A. _______________________________________\nJanuary 23, 1996 Wilmington, Delaware\nItem 9.","section_9":"Item 9. Changes in and Disagreements with 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\nInformation regarding Directors of Registrant will be set forth in the Southern Jersey Bancorp of Delaware, Inc. Proxy Statement for the annual meeting of shareholders to be held April 11, 1996, and is incorporated herein by reference. Information regarding executive officers of Registrant is set forth under the caption \"Executive Officers\" in Item 1(a) hereof.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation regarding executive compensation will be set forth in the Southern Jersey Bancorp of Delaware, Inc. Proxy Statement for the annual meeting of shareholders to be held April 11, 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 Southern Jersey Bancorp of Delaware, Inc. Proxy Statement for the annual meeting of shareholders to be held April 11, 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 Southern Jersey Bancorp of Delaware, Inc. Proxy Statement for the annual meeting of shareholders to be held April 11, 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(1) Financial Statements\nThe financial statements filed as a part of this report are listed on the Index to Consolidated Financial Statements on Page 33.\n(2) Financial Statement Schedules\nAll other schedules have been omitted because the required information is shown in the Consolidated Financial Statements or notes thereto, the statistical information in Item 1, pursuant to Industry Guide 3, or they are not applicable.\n(3) (a) Exhibits (numbered in accordance with Item 601 of Regulation S-K)\nExhibit Number Description\n3A Form of Certificate of Incorporation of the Registrant - Incorporation by reference to Definitive Proxy Statement filed and dated June 16, 1989\n3B Form of Bylaws of the Registrant - Incorporation by reference to Definitive Proxy Statement filed and dated June 16, 1989\n4A Form of Common Stock Certificate - Incorporation by reference to Definitive Proxy Statement filed and dated June 16, 1989\n4B Instruments Defining the Rights of Security Holders - Incorporation by reference to Form 8-A filed November 30, 1989\n10A Stock Option and Stock Appreciation Rights Plan - Incorporated by reference to the Registrant's Definitive Proxy Statement filed February 27, 1987, and the Registrant's Annual Report on Form 10-K for the fiscal year ENded December 31, 1987, filed March 31, 1988.\n21 Subsidiaries of the Registrant - Included under Item 1, Page 2 of this filing.\n23 Consent of William Thos. Athey & Company, Certified Public Accountants, Professional Association Independent Public Accountants - Included under Item 8, Page 34 of this filing.\n(3) (b) Reports on Form 8-K\nNo reports on Form 8-K have been filed by the Registrant during the quarter ended December 31, 1995.\n(3) (c) Form of Deferred Compensation Agreement for named executive officers, Clarence D. McCormick, Sr., Harry W. Bullock, and Ralph Cocove is incorporated by reference to Form 10-K filed March 31, 1989.\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.\nSOUTHERN JERSEY BANCORP OF DELAWARE, INC.\nDated:March 28, 1996 By:s\/ Clarence D. McCormick ---------------------- Clarence D. McCormick 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 s\/ Henry L. Backenson Vice Chairman March 28, 1996 - ----------------------------- Henry L. Backenson s\/ Alfred F. Caggiano Vice Chairman March 28, 1996 - ----------------------------- Alfred F. Caggiano s\/ Ephraim M. Carll Director March 28, 1996 - ----------------------------- Ephraim M. Carll s\/ Keron D. Chance Director March 28, 1996 - ----------------------------- Keron D. Chance, Esq. s\/ Harry W. Bullock Director March 28, 1996 - ----------------------------- Harry W. Bullock s\/ Frank LoBiondo Director March 28, 1996 - ----------------------------- Frank LoBiondo s\/ Clarence D. McCormick, Jr. Director March 28, 1996 - ----------------------------- Clarence D. McCormick, Jr. s\/ Louis Pizzo Director March 28, 1996 - ----------------------------- Louis Pizzo s\/ Donald Strang Director March 28, 1996 - ---------------------- Donald Strang\nPART II - OTHER INFORMATION\nEXHIBITS AND REPORTS ON FORM 8-K A. Exhibits Exhibit 27. Financial Data Schedule B. Reports on Form 8-K No reports have been filed on form 8-K during this quarter.","section_15":""}
{"filename":"840251_1995.txt","cik":"840251","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nEAST LINE CIVIL LITIGATION AND FERC PROCEEDING In August 1992, two East Line refiners, Navajo Refining Company (\"Navajo\") and El Paso Refinery, L.P. (\"El Paso\"), filed separate, though similar, civil lawsuits (the \"East Line Civil Litigation\") against the Partnership arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson, Arizona from El Paso, Texas. The Navajo action also sought an injunction to prohibit the Partnership from reversing the direction of flow (from westbound to eastbound) of its six-inch diameter pipeline between Phoenix and Tucson. In addition, El Paso filed a protest\/complaint with the FERC in September 1992 seeking to block the reversal of the six-inch pipeline and challenging the Partnership's proration policy as well as the Partnership's existing East Line rates (the \"FERC Proceeding\").\nEAST LINE CIVIL LITIGATION - -------------------------- The civil actions brought by Navajo and El Paso (El Paso Refining, Inc., and El Paso Refinery, L.P. v. Santa Fe Pacific Pipelines, Inc. and Santa Fe Pacific Pipeline Partners, L.P., No. 92-9144, County Court No. 5, El Paso County, filed August 1992) were filed in New Mexico and Texas, respectively, seeking actual, punitive and consequential damages arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson from El Paso. Generally, the lawsuits allege that the refiners proceeded with significant refinery expansions under the belief that the Partnership would provide additional pipeline capacity to transport their product into Arizona, and that they were damaged by their inability to ship additional volumes into that highly competitive market. This belief of Navajo and El Paso was purportedly based on alleged oral representations made by General Partner personnel and from language contained in a January 1989 settlement agreement with Navajo, relating to a 1985 FERC rate case.\nOn July 28, 1993, the Partnership reached a settlement with Navajo whereby Navajo agreed to dismiss its pending civil litigation in New Mexico and to withdraw any challenge to the direction of flow of the six-inch pipeline, including any such challenge in the FERC proceeding. The Partnership agreed to\nmake certain cash payments to Navajo over three years and to undertake and complete an additional pipeline capacity expansion between El Paso and Phoenix if certain events related to volume levels and proration of pipeline capacity should occur within five years of the date of the agreement.\nEl Paso's August 1992 civil action, as amended, claims unspecified actual damages, which appear to include the $190 million cost of its refinery expansion, plus punitive and consequential damages. In addition, on October 4, 1995, El Paso's general partner, El Paso Refining, Inc. (\"EPRI\"), filed a Second Amended Petition seeking unspecified damages arising from alleged unfulfilled representations of Partnership management with respect to future East Line capacity, alleging that such representations had been relied upon in negotiating the terms by which EPRI exchanged its refinery assets for ownership interests in El Paso in 1989.\nIn October 1992, El Paso filed a petition for reorganization under Chapter 11 of the federal bankruptcy laws and halted refinery operations. In November 1993, the El Paso bankruptcy was converted from a Chapter 11 to a Chapter 7 proceeding. During 1994, the bankruptcy trustee for El Paso retained legal counsel for purposes of pursuing this litigation. Initial rounds of written discovery and witness depositions were conducted by both parties in late-1994 and in 1995, and discovery will continue in 1996.\nTo date, there have been no hearings before the court and there is no pre-trial schedule. Management anticipates that this matter will not come to trial prior to mid-1997. The Partnership believes that the allegations of El Paso and EPRI are without merit and intends to vigorously defend itself in this action.\nFERC PROCEEDING - --------------- At various points following El Paso's September 1992 filing, other customers of the Partnership, including Chevron U.S.A. Products Company (\"Chevron\"), Navajo, ARCO Products Company (\"ARCO\"), Texaco Refining and Marketing Inc. (\"Texaco\"), Refinery Holding Company, L.P. (a partnership formed by El Paso's long-term secured creditors that purchased El Paso's refinery in May 1993), Mobil Oil Corporation and Tosco Corporation, have filed separate complaints challenging, and\/or motions to intervene in proceedings initiated by others challenging, the Partnership's rates on its East and West Lines and, in certain cases, also claiming that a gathering enhancement charge at the Partnership's Watson, California pump station is in violation of the Interstate Commerce Act. In subsequent procedural rulings, the FERC has consolidated these challenges and ruled that they must proceed as a complaint proceeding, with the burden of proof being placed on the complaining parties, who must show that the Partnership's rates and practices at issue violate the requirements of the Interstate Commerce Act.\nIn December 1995, Texaco filed a new complaint concerning charges associated with the use of the Partnership's Watson, California gathering enhancement facilities and of certain lines upstream of its Watson station origin point, and ARCO filed a similar complaint on January 16, 1996. Texaco and ARCO have asked that these complaints not be consolidated with the other proceedings described above. The Partnership has denied the allegations in these complaints.\nIn June 1994, the complainants filed their cases-in-chief with the FERC, seeking reparations for shipments between 1990 and 1993 aggregating in the range of $15 million to $20 million, as well as tariff rate reductions of between 40% and 50% for future shipments. In August 1994, the FERC Staff submitted its case-in-chief in the FERC proceeding, employing rate-making methodologies similar in several respects to those presented by the complainants. In subsequent filings, the complainants revised their requested relief to seek reparations for shipments between 1990 and 1994 aggregating\napproximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter.\nBoth the FERC Staff and several of the complainants argued, among other things, against the Partnership's entitlement to an income tax allowance in its cost of service. They also utilized the Partnership's capital structure at the time of its formation in December 1988, or a hypothetical capital structure, for the purpose of establishing the Partnership's 1985 starting rate base under FERC Opinion 154-B. In addition, the FERC Staff and the complainants would generally exclude most or all of the Partnership's civil and regulatory litigation expense from its cost of service calculations. Each of these positions is adverse to the Partnership's position regarding its existing rate structure.\nOn June 15, 1995, the FERC issued a decision in an unrelated rate proceeding involving Lakehead Pipe Line Company, Limited Partnership (\"Lakehead\"), ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income that is attributable to limited partnership interests held by individuals. In July 1995, Lakehead requested rehearing of the decision by the FERC, and that request is currently pending. Should this ruling be upheld and applied in the Partnership's rate proceeding, the Partnership believes it would currently allow the Partnership to include a substantial portion of the Partnership's income tax allowance in its cost of service, rather than the full entitlement that was reflected in the Partnership's case-in-chief and subsequent testimony in its FERC proceeding. Management intends to vigorously defend its entitlement to a full income tax allowance in its cost of service.\nSuccessive rounds of testimony have been filed by the respective parties, including the Partnership, regarding the above summarized issues and other matters relevant to the appropriateness of the Partnership's tariffs and rates. Among other things, certain of the parties submitted revised cases based on the Partnership's 1994 costs and revenues. The Partnership's surrebuttal presentation responded to those cases, defending the Partnership's current rates based on 1994 data, with certain normalizing adjustments including a significant adjustment to reflect an extensive pipe reconditioning program that was begun in 1994. The present procedural schedule calls for hearings before the FERC Administrative Law Judge to commence in April 1996, with an initial decision not expected before late 1996 or early 1997.\nThe Energy Policy Act of 1992 (\"EPACT\") established as \"just and reasonable\" existing oil pipeline rates that were in effect without challenge for 365 days prior to the bill's enactment in October 1992, with an exception being allowed for parties, such as Navajo, that were prohibited from filing challenges during that period due to the terms of settlement agreements. In October 1993, with respect to Chevron's complaint, the FERC ruled that the Partnership's West Line rates are deemed \"just and reasonable\" under EPACT (i.e., are \"grandfathered\") and may only be challenged upon a showing of a substantial change in the economic circumstances which were a basis for the rate (\"changed circumstances\"). In December 1994, ARCO, Texaco and Chevron filed testimony in which they sought to demonstrate the required \"changed circumstances\" in order to challenge the Partnership's West Line rates, citing such factors as increased West Line volumes. On April 20, 1995, the United States Court of Appeals for the District of Columbia Circuit dismissed petitions for review of the FERC's grandfathering rulings that had been filed by ARCO and Texaco, on the ground that those rulings are not yet final orders and, therefore, are not yet subject to judicial review.\nThe Partnership believes that its rates and practices are lawful under FERC precedent and will continue its vigorous defense of that position. However, because of the complexity of the issues involved and the\nnature of FERC rate-making methodology, which is subject to interpretation and leaves certain issues for determination on a case-by-case basis, it is possible that the rates at issue in the FERC proceeding will not ultimately be upheld. If the FERC were to reach adverse decisions on the issues in the proceeding which result in significant reparations being paid and a significant reduction in the Partnership's current tariffs, such adverse outcome could have a material adverse effect on the Partnership's results of operations, financial condition and ability to maintain its quarterly cash distribution at the current level.\nENVIRONMENTAL MATTERS\nThe Partnership is subject to environmental cleanup and enforcement actions from time to time. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site. Since August 1991, the Partnership, along with several other respondents, has been involved in one cleanup ordered by the United States Environmental Protection Agency (\"EPA\") related to ground water contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven ground water hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies.\nWith respect to the Sparks remediation, the EPA approved the respondents' remediation plan in September 1992. In January 1995, remediation system design, engineering and permitting activities began, and the remediation system began operations in September 1995. During 1995, a Joint Defense, Mediation and Arbitration Agreement Among Defendants was entered into by eight participants, which establishes remediation cost allocation percentages among the participants.\nThe investigation and remediation at and adjacent to the Partnership's storage facilities and truck loading terminal in Sparks, Nevada was also the subject of a lawsuit brought in January 1991 entitled Nevada Division of Environmental Protection v. Santa Fe Pacific Pipelines, Inc., Southern Pacific Transportation Company, Shell Oil Company, Time Oil Company, Berry-Hinckley Terminal, Inc., Chevron U.S.A., Inc., Texaco Refining and Marketing, Inc., Air BP, a division of BP Oil, Unocal Corporation, and Golden Gate Petroleum Company, Case No. CV91- 546, in the Second Judicial District Court of the State of Nevada in and for the County of Washoe (the \"Court\"). This lawsuit was subsequently joined by the County of Washoe Health District (the \"County\") and the City of Sparks, Nevada (the \"City\"). These various parties sought remediation of the contamination at and adjacent to the Sparks terminal as well as unspecified, but potentially significant, damages and statutory penalties. In addition, the Partnership was named as one of the defendants in a number of other lawsuits brought by property owners seeking unspecified, but potentially substantial, damages for, among other things, alleged property value diminishment attributable to soil or groundwater contamination arising from the defendants' operations. In October 1994, a ruling by the Court consolidated all of the outstanding cases against the respondent group for trial purposes. In February 1995, the Court established a procedural schedule which called for the trial to commence in January 1996.\nOn July 27, 1995, the Partnership and seven other defendants (the \"defendant group\") entered into a Stipulation and Consent Decree with the State of Nevada, Division of Environmental Protection (the \"State\"), which was subsequently approved by the Court, settling all claims made by the State in the above- referenced lawsuit, and under which the defendant group agreed to pay the State a total principal amount of $10 million in eleven equal payments over ten years. The defendant group has also entered\ninto a settlement agreement with the County whereby the defendant group will pay the County the sum of $150,000 in settlement of all of the claims brought by the County in its lawsuit.\nOn September 22, 1995, the defendant group reached a settlement agreement with the City, subsequently approved by the Sparks City Council, whereby, among other things, the defendant group paid the City the sum of $5.6 million, including attorney fees, in December 1995 and agreed to purchase an annuity that will fund four annual payments to the City of $1.625 million (aggregating $6.5 million) in the years 2002 through 2005 in settlement of all of the City's claims related to the Sparks environmental site. In addition, the defendant group agreed to use its best efforts to install an enhanced remediation system to accelerate the cleanup of the environmental site and agreed to donate certain water rights to the City if and as needed. In addition, during the months of September through December 1995, the defendant group reached agreements in principle and, in some cases, final agreements, to settle the claims of the seven property owners who had filed lawsuits seeking damages alleged to be attributable to the environmental contamination. These settlement agreements involve various terms, including cash payments, environmental and property value diminishment indemnifications, loan guarantees and the purchase of certain properties.\nThe Partnership's share of the settlements with the City and the property owners will be determined in an arbitration proceeding expected to be held during 1996. The Partnership's estimated share of the costs of all of the settlement agreements associated with the Sparks litigation was included in its 1995 provisions for environmental costs aggregating $24 million.\nDuring the quarter ended December 31, 1995, the Partnership entered into a stipulation with the California Department of Fish and Game, the County of San Diego and the United States Department of Fish and Wildlife to settle all of the agencies' claims arising from a December 1994 product release at the Partnership's facilities in Mission Valley, California. In accordance with this stipulation, in January 1996, the Partnership paid $30,000 in fines and approximately $160,000 in area restorations, and reimbursed approximately $70,000 in oversight costs of the three governmental agencies.\nAs of December 31, 1995, the Partnership is in the process of negotiating with the California Department of Fish and Game to settle the Department's claims arising from three separate product releases from Partnership facilities. Management does not believe that the total cost of any fines or other amounts payable associated with these product releases, either individually or in the aggregate, will be material to the Partnership's results of operations or financial condition, but such amounts may be in excess of $100,000 per occurrence.\nThe Partnership and the General Partner have initiated two legal actions against a total of 34 past and present insurance carriers (SFPP, L.P., Santa Fe Pacific Pipeline Partners, L.P. and Santa Fe Pacific Pipelines, Inc. vs. Agricultural Insurance Company, et al. and SFPP, L.P., Santa Fe Pacific Pipeline Partners, ------ L.P. and Santa Fe Pacific Pipelines, Inc. vs. Associated International Insurance Company, et al., Superior Court of the State of California for the County of San ------ Mateo, Docket Nos. 395109 and 395121, respectively, filed January 1996). These actions seek a judicial determination that the insurance policies issued by the defendant insurers provide coverage to the Partnership and General Partner for certain costs, liabilities and settlements relating to approximately 25 environmental sites, including Sparks, Nevada. To date, the costs at issue in these actions have been borne by the Partnership and General Partner. Although there is no assurance that the Partnership will be successful in these actions, management intends to vigorously pursue these claims. The defendant insurers are still in the process of filing initial responsive pleadings and affirmative defenses, and discovery has not yet begun.\nOTHER The Partnership and Southern Pacific Transportation Company (\"SPTC\") are engaged in a judicial proceeding to determine the extent, if any, to which the rent payable by the Partnership for the use of pipeline easements on rights-of-way held by SPTC should be adjusted pursuant to existing contractual arrangements (Southern Pacific Transportation Company vs. Santa Fe Pacific Corporation, SFP Properties, Inc., Santa Fe Pacific Pipelines, Inc., SFPP, L.P., et al., Superior -- --- Court of the State of California for the County of San Francisco, filed August 31, 1994). Under an agreement entered into among the parties in 1994, the amount of annual rent for such easements for the first year of the ten-year period that began January 1, 1994 is to be based on the fair market value of the easements, with the rent for subsequent years to be subject to annual inflation adjustments. SPTC has asserted in this proceeding that the amount of the easement rent should be increased from the current level of approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership does not believe that the evidence provided by SPTC to date supports an annual rent in excess of the amounts accrued; however, it is not presently possible to predict with certainty the outcome of this matter.\nThe Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these other matters cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, either individually or in the aggregate, when finally resolved, will have a material adverse effect on the annual results of operations, financial condition or liquidity of the Partnership.\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 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Information as to the principal markets on which the Registrant's common units are traded, the high and low sales prices of such units and distributions declared on such units for the two years ended December 31, 1995, and the approximate number of record holders of such units is set forth in Note 8 to the Partnership's consolidated financial statements on page of this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth selected consolidated financial data for the Partnership:\n(a) Effective January 1, 1992, the Partnership adopted new accounting standards for postretirement and postemployment benefits (Statements of Financial Accounting Standards Nos. 106 and 112).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\n1995 COMPARED WITH 1994 - ----------------------- The Partnership reported 1995 net income of $40.4 million, or $2.04 per unit, compared to net income of $76.9 million, or $3.93 per unit, in 1994, with the variance being primarily attributable to special items recorded in both years. Results of operations included provisions for environmental and litigation costs aggregating $34.0 million in 1995 and a $3.1 million credit resulting from changes in eligibility requirements for postretirement medical benefits in 1994. Excluding the 1995 provisions and the 1994 credit, adjusted net income was $73.3 million, or $3.70 per unit, in 1995, compared to $73.9 million, or $3.78 per unit, in 1994.\nTotal 1995 revenues of $233.7 million were 2.5% above 1994 levels. Trunk revenues of $183.3 million were $3.9 million higher than in 1994 primarily due to growth in total volumes transported. Commercial volumes were about 1.5% higher, and military volumes 5% lower, than in 1994, and the average length of haul was slightly higher. Deliveries to most of the markets served by the Partnership increased during 1995, although Southern California deliveries were lower as a result of competition from short-haul trucking to Los Angeles area terminals. The reduction in military volumes is largely attributable to the closure of Castle Air Force Base, in Central California. Storage and terminaling revenues were 1% higher than in 1994. Other revenues increased $1.3 million primarily due to new detergent additive services.\nTotal operating expenses of $157.7 million were $40.7 million higher in 1995 than in 1994, due largely to the 1995 provisions for environmental and litigation costs aggregating $34.0 million. Excluding the 1995 provisions, operating expenses would have been $6.7 million, or 6%, higher than in 1994, with higher general and administrative expenses ($4.7 million), power costs ($1.0 million), depreciation and amortization ($0.7 million) and field operating expenses ($0.5 million), partially offset by lower facilities costs ($0.3 million), accounting for that increase. General and administrative expenses were higher due to outside legal and consulting costs, primarily related to the FERC proceeding and litigation associated with the Sparks, Nevada environmental site, partially offset by lower employee health care and postretirement benefit costs. Power costs increased as the result of increased volumes and greater use of drag reducing agent to increase pipeline capacity on selected routes. The increase in depreciation and amortization resulted from the Partnership's expanding capital asset base, particularly short-lived software costs. The increase in field operating expenses is largely attributable to higher repairs and maintenance, including pipeline reconditioning. The decrease in facilities costs is largely attributable to lower property tax assessments and insurance premiums, partially offset by higher right-of-way rental costs. Excluding the 1995 provisions, environmental remediation and East Line litigation costs recorded as operating expense aggregated $7.0 million in 1995 and $3.8 million in 1994.\nOther income, net decreased $2.1 million compared to 1994, primarily due to the $3.1 million postretirement benefit credit recorded in 1994, partially offset by higher interest income, which resulted from higher interest rates and cash balances.\n1994 COMPARED WITH 1993 - ----------------------- The Partnership reported 1994 net income of $76.9 million, or $3.93 per unit, compared to net income of $41.6 million, or $2.13 per unit, in 1993. Results of operations included the previously mentioned $3.1 million credit in 1994 resulting from changes in eligibility requirements for postretirement medical benefits and, in 1993, provisions for environmental and litigation costs aggregating $27.0 million.\nExcluding the 1994 credit and the 1993 provisions, adjusted net income of $73.9 million, or $3.78 per unit, in 1994 was 8.5% higher than adjusted net income of $68.1 million, or $3.48 per unit, in 1993.\nTotal 1994 revenues of $228.1 million were 4% above 1993 levels. Trunk revenues of $179.3 million were $7.5 million higher than in 1993 primarily due to a 5% growth in total volumes transported. Commercial and military volumes were 5% and 9% higher, respectively, than in 1993, and the average length of haul was even. Despite the higher pipeline volumes, storage and terminaling revenues were even with 1993. Other revenues increased $1.1 million due to higher tank rentals and new terminal services.\nTotal operating expenses of $117.0 million were $24.1 million lower than in 1993, due largely to the previously mentioned 1993 provisions for environmental and litigation costs aggregating $27.0 million. Excluding the 1993 provisions, operating expenses would have been $2.9 million, or 2.5%, higher than in 1993, with higher power costs ($1.8 million), facilities costs ($1.7 million), depreciation and amortization ($0.8 million) and general and administrative expenses ($0.4 million), partially offset by lower field operating expenses ($1.8 million), accounting for that increase. The increase in power costs resulted from higher volumes, increased power rates and greater use of drag reducing agent to increase pipeline capacity on selected routes. Facilities costs increased as a result of higher right-of-way rentals and property taxes. General and administrative expense increased less than 2% as the net result of higher legal expense and reduced overhead recoveries on recollectible projects for customers or governmental agencies, largely offset by lower East Line litigation, employee incentive compensation and information services costs. The decrease in field operating expenses is largely attributable to 1993 pipeline inspection costs associated with the potential conversion of one of the Partnership's pipelines to crude oil service and generally lower major maintenance expense. Excluding the 1993 provisions, environmental remediation and East Line litigation costs recorded as operating expense aggregated $3.8 million and $6.2 million in 1994 and 1993, respectively.\nOther income, net increased significantly in 1994 as the result of a $3.1 million gain resulting from changes in eligibility requirements for postretirement medical benefits and higher interest income.\nFINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 1995, cash flow from operations totaled $83.7 million, compared to $90.0 million in 1994. Working capital cash requirements increased $2.8 million in 1995 due to timing differences in collections of trade and nontrade accounts receivable and payment of accrued obligations. Significant uses of cash in 1995 included cash distributions of $60.0 million and capital expenditures of $31.4 million, resulting in a net decrease in cash and cash equivalents of $7.7 million for the year. Total cash and cash equivalents of $41.2 million at December 31, 1995 included $15.4 million for the fourth quarter 1995 cash distribution, which was paid in February 1996.\nSince the useful lives of the pipeline system and terminal properties are generally long and technological change is limited, replacement of facilities is relatively infrequent. The principal need for capital, therefore, has been in connection with capacity expansions, service enhancements, compliance with increasingly stringent environmental and safety regulations and installation of Supervisory Control and Data Acquisition (\"SCADA\") equipment and related operations systems software.\nFor the year ended December 31, 1995, Partnership capital expenditures aggregated $31.4 million. Capital expenditures for income enhancement projects, including capacity expansions, service enhancements and system upgrades, aggregated approximately $12 million in 1995. Capital\nexpenditures for environmental and safety projects included additions and modifications to storage tanks and vapor recovery systems to comply with more stringent regulations, oily water handling facilities and fire protection improvements. Such expenditures aggregated approximately $7 million in 1995 and are expected to increase over time in response to increasingly rigorous environmental and safety standards.\nIn January 1996, the Partnership completed the purchase, from Kinley Pipelines of California, of a 35-mile, 6-inch diameter pipeline that serves Lemoore Naval Air Station from the Partnership's Fresno, California terminal, for approximately $6 million. In addition to that acquisition, the planned 1996 capital program aggregates approximately $22 million, the majority of which will be invested in sustaining projects. The Partnership presently anticipates that ongoing capital expenditures will average approximately $30 million per year over the next five years. This amount could increase or decrease as the result of changing regulatory requirements or business opportunities associated with pipeline and facility expansions and acquisitions.\nDuring 1995, the Partnership continued to investigate the feasibility of providing pipeline service from the San Francisco Bay area to Colton, in Southern California, by expanding the existing capacity on its North Line and building a new pipeline between Fresno and Colton. The level of shipper throughput commitments obtained to date is not sufficient to proceed and places the viability of this project in doubt. Management anticipates that a decision on the future of this project will be made during 1996.\nThe Partnership expects that it will generally finance its ongoing capital program with internally generated funds; however, the Partnership may use borrowed funds or proceeds from additional equity offerings to finance a portion of significant capital expenditures. Future capital expenditures will continue to depend on numerous factors, some of which are beyond the Partnership's control, including demand for refined petroleum products in the pipeline system's market areas, changes in product supply patterns, governmental regulations and the availability of sufficient funds from operations to fund such expenditures.\nDue to the capital-intensive nature of the Partnership's business, inflation generally causes an understatement of operating expenses because depreciation is based on the historical costs of assets rather than their replacement costs.\nLong-term debt aggregated $355 million at December 31, 1995 and consisted of $327 million of First Mortgage Notes (the \"Notes\") and a $28 million borrowing under the Partnership's bank term credit facility. The Partnership intends to refinance some or all of the Notes as the various series become payable. To facilitate such refinancing and provide for additional financial flexibility, the Partnership presently has available the multi-year term credit facility, with a $60 million aggregate limit, and a $20 million working capital facility with three banks. The term facility may continue to be used for refinancing a portion of the Notes and for capital projects, while the working capital facility is available for general short-term borrowing purposes.\nOTHER MATTERS\nRATE REGULATION The Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission (\"FERC\"). Intrastate common carrier operations in California are subject to regulation by the California Public Utilities Commission (\"CPUC\"). In 1995, rates subject to FERC and CPUC regulation accounted for approximately 55% and 45% of total transportation revenues, respectively.\nIn 1985, the FERC adopted a cost-based methodology for establishing allowable rates for liquid petroleum pipelines; however, this methodology continues to be subject to clarification in individual cases and leaves many issues for determination on a case-by-case basis. Effective January 1995, the FERC established a new rate-making methodology that allows oil pipelines to adjust their transportation rates as long as those rates do not exceed prescribed ceiling levels determined by applying an index equal to annual changes in the Producer Price Index for Finished Goods, minus one percent. Under this methodology, pipelines may apply for cost of service-based rates in those cases where the carrier can demonstrate that a \"substantial divergence\" exists between the rates that would be allowed under cost-based rate-making and the rates produced by indexation. In addition, carriers may establish market-based rates for those markets in which it can be demonstrated that they do not have significant market power. The access to cost-based and market-based rates is significant because the Partnership believes the index selected by the FERC does not adequately reflect historical cost of service increases and, accordingly, the Partnership may need to pursue cost-based or selective market-based rate adjustments in future rate filings. Interstate rate indexing had a minimal impact on Partnership revenues in 1995 and management does not expect that indexing will have a significant impact on trunk revenues in 1996.\nEAST LINE CIVIL LITIGATION AND FERC PROCEEDING Certain of the Partnership's shippers have filed civil suits and initiated Federal Energy Regulatory Commission (\"FERC\") complaint proceedings alleging, among other things, that the shippers were damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's rates and charges on its East and West Lines are excessive. To date, the complainants have filed testimony in the FERC proceeding seeking reparations for shipments between 1990 and 1994 aggregating approximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter. Hearings before a FERC Administrative Law Judge are scheduled to commence in April 1996.\nIn July 1993, the Partnership reached a settlement with one of these shippers, Navajo Refining Company (\"Navajo\"), whereby, among other things, Navajo agreed to dismiss its pending civil litigation in New Mexico and the Partnership agreed to make certain cash payments to Navajo over three years. The remaining civil action, brought by El Paso Refinery, L.P. (\"El Paso\") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.\nIn June 1995, the FERC issued a decision in an unrelated oil pipeline rate proceeding involving Lakehead Pipe Line Company, Limited Partnership (\"Lakehead\") ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income attributable to limited partnership interests held by individuals. If this decision is upheld and applied in the Partnership's FERC proceeding, it would reduce the Partnership's allowable cost of service and, possibly, its revenues.\nIn 1993, the Partnership recorded a $12 million provision for litigation costs, reflecting the terms of the Navajo settlement and management's estimate of other costs related to the resolution of the FERC proceeding and El Paso's civil action, and, during the quarter ended December 31, 1995, recorded a $10 million provision to increase its existing reserves relating to the FERC proceeding, the El Paso action and certain other matters. In the interim, lesser amounts of litigation costs have, from time to time, been recorded as current period expense.\nWhile the Partnership believes it has meritorious defenses in these matters, the complainants and plaintiffs are seeking amounts that, in the aggregate, substantially exceed the Partnership's reserves and, because of the uncertainties associated with litigation and FERC rate-making methodology, management cannot predict with certainty the ultimate outcome of these matters. As additional information becomes available, it may be necessary for the Partnership to record additional charges to earnings to maintain its reserves at a level deemed adequate at that time, and the costs associated with the ultimate resolution of these matters could have a material adverse effect on the Partnership's results of operations, financial condition, or ability to maintain its quarterly cash distribution at the current level.\nENVIRONMENTAL The Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site.\nAlong with several other respondents, the Partnership is presently involved in one cleanup ordered by the United States Environmental Protection Agency related to soil and groundwater contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven groundwater hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies and, from time to time, may be involved in groundwater investigations or remediations at the direction of other governmental agencies. The Partnership is also involved in soil and groundwater remediation projects, at and adjacent to various other terminal and pipeline locations, that have not been mandated by government agencies but are conducted in the ordinary course of business. In a number of remediation projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.\nThe Partnership accrues for environmental costs that relate to existing conditions caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at certain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.\nThe Partnership's environmental reserves are monitored on a regular basis by management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership conducted a comprehensive re-evaluation of its potential liabilities associated with remediation activities at a number of sites and recorded a $15 million provision to increase its reserve for environmental costs. During 1995, the Partnership, as a member of a defendant group, reached agreements in principle settling all of the claims for penalties and damages that had been asserted by several governmental agencies and property owners in lawsuits associated with the soil and groundwater contamination present in the vicinity of the Sparks, Nevada environmental site. The Partnership recorded provisions for environmental costs aggregating $24 million during 1995 largely to reflect its share of these settlement costs.\nThe Partnership's balance sheet at December 31, 1995 and 1994 includes reserves for environmental costs aggregating $37.1 million and $22.7 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, and the cost of performing preliminary environmental investigations at several locations, as well as estimable environmental damage claims, primarily associated with the Sparks environmental site. With respect to the costs accrued at December 31, 1995, the Partnership estimates that between $12.5 million and $15.0 million will be paid in 1996, approximately $2 million to $4 million will be paid per year over the following four years, and approximately $1 million or less will be paid per year over the subsequent five years.\nBased on the information presently available, it is the opinion of management that the Partnership's environmental costs, to the extent they exceed recorded liabilities, will not have a material adverse effect on the Partnership's financial condition; nevertheless, it is possible that the Partnership's results of operations in particular quarterly or annual periods could be materially affected as additional information becomes available.\nDEMAND FOR REFINED PETROLEUM PRODUCTS Demand for transportation and terminaling services is principally a function of product consumption and competition in markets served by the pipeline system. Commercial volumes are generally dependent upon such factors as prevailing economic conditions, demographic changes, transportation and terminaling alternatives and, to a lesser degree, product prices paid by end-users. Military volumes are dependent upon the level of activity at military bases served by the Partnership.\nDuring 1995, the pipeline systems, on average, operated at approximately 75% of capacity. While capacity utilization on individual system segments generally ranged from 70% to 90% of capacity, the lines from the Los Angeles area to San Diego and Colton, California and from the San Francisco Bay area to Reno, Nevada operated at or near full capacity for a portion of the year. Overall, volumes have been moderately seasonal, with somewhat lower than average volumes being transported during the first and fourth quarters of each year, although deliveries to specific locations also experience seasonal variations.\nOTHER The Partnership leases certain rights-of-way under an agreement that became subject to renegotiation effective January 1, 1994; however, to date, the Partnership and the lessor have been unable to reach an agreement on the base annual rental payments for the next ten-year period. In a judicial reference proceeding in this matter, the lessor has asserted that the amount of the easement rent should be increased from approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership has accrued for an increase in the annual rental effective January 1, 1994\nand does not believe that the evidence provided by the lessor to date supports an annual rental in excess of the amounts accrued; however, it is not presently possible to predict with certainty the annual right-of-way rentals that will ultimately be payable.\nDuring 1994, the Partnership began a long-term pipeline reconditioning program on its East Line and the Phoenix-to-Tucson segment of the West Line. In 1994 and 1995, the Partnership's field operating expenses included approximately $320,000 and $1,220,000, respectively, related to this program, which involves replacing the pipeline's original coating and performing repairs determined to be necessary. In 1996 and future years, the Partnership expects that an average of 30 miles of pipeline will be recoated annually, at an expected cost of approximately $3,000,000 per year.\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\" (\"FAS 121\"), which prescribes accounting standards for the recognition and measurement of impairment in long-lived assets, such as properties, plant and equipment. Management does not expect that adoption of FAS 121, which is required no later than the first quarter of 1996, will have a significant effect on the Partnership's financial condition or results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Partnership's consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated January 26, 1996, are set forth on pages through of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The Registrant has no officers, directors or employees. Set forth below is certain information concerning the directors and executive officers of the General Partner.\nEdward F. Swift, age 72, is a director of the General Partner, Chairman of the Audit Committee and a member of the Compensation and Benefits Committee and Committee on Directors. He has been a consultant to Lehman Brothers (investment bankers) since 1990 and previously had been an advisory director of Shearson Lehman Hutton, Inc. (investment banker and broker-dealer) since 1988.\nOrval M. Adam, age 65, is a director of the General Partner, Chairman of the Compensation and Benefits Committee and a member of the Audit Committee and Committee on Directors. He retired in January 1991 from his position as Senior Vice President and Chief Financial Officer of Santa Fe, which he held since April 1988. Mr. Adam is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nWilford D. Godbold, Jr., age 57, is a director of the General Partner and a member of the Audit Committee and Committee on Directors. Mr. Godbold has served as President and Chief Executive Officer of ZERO Corporation (container manufacturer) since 1984. Mr. Godbold is also a director of ZERO Corporation, Pacific Enterprises and Southern California Gas Company.\nMichael A. Morphy, age 63, is a director of the General Partner and a member of the Audit Committee and Compensation and Benefits Committee. Mr. Morphy retired in 1985 from his position as Chairman and Chief Executive Officer of California Portland Cement Company (cement manufacturer). Mr. Morphy is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner, Santa Fe Energy Resources, Inc., First Interstate Bank of California and Cyprus Amax Minerals Company.\nRobert D. Krebs, age 53, is a director of the General Partner, Chairman of the Committee on Directors and a member of the Compensation and Benefits Committee. Mr. Krebs has served as President and Chief Executive Officer of Burlington Northern Santa Fe Corporation (\"BNSF\") since September 1995, and, previously served as Chairman, President and Chief Executive Officer of Santa Fe since 1988. Mr. Krebs is also a director of BNSF, Burlington Northern Inc., Burlington Northern Railroad Company, Santa Fe Energy Resources, Inc., Santa Fe Pacific Gold Corporation, Phelps Dodge Corporation and Northern Trust Corporation.\nDenis E. Springer, age 50, is a director of the General Partner and a member of the Compensation and Benefits Committee and Committee on Directors. Mr. Springer has been Senior Vice President and Chief Financial Officer of BNSF since September 1995 and, previously, served in those same positions at Santa Fe since October 1993. Mr. Springer previously served Santa Fe as Senior Vice President, Treasurer and Chief Financial Officer since January 1992, and as Vice President, Treasurer and Chief Financial Officer since January 1991. Mr. Springer is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner, Burlington Northern Inc. and Burlington Northern Railroad Company.\nIrvin Toole, Jr., age 54, is President, Chief Executive Officer and Chairman of the Board of Directors of the General Partner. From November 1988 until election to his present position in September 1991, Mr. Toole served as Senior Vice President, Treasurer and Chief Financial Officer, and previously as Vice\nPresident-Administration from February 1986 to November 1988. Mr. Toole is also Chairman of the Board of Directors of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nRobert L. Edwards, age 40, is a director of the General Partner and has been Senior Vice President-Business Development and Planning of the General Partner since January 1995. Previously, Mr. Edwards was Senior Vice President, Treasurer and Chief Financial Officer from December 1991 through January 1995. Mr. Edwards served Santa Fe from July 1990 through November 1991 as Vice President- Administration. Prior to that, Mr. Edwards held various executive positions with Santa Fe and the General Partner since May 1985. Mr. Edwards is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nBarry R. Pearl, age 46, has been Senior Vice President, Treasurer and Chief Financial Officer of the General Partner since January 1995. Mr. Pearl previously served as Senior Vice President-Business Development and Planning between January 1992 and January 1995, as Vice President-Business Development and Planning between November 1988 and January 1992 and as Vice President- Operations between May 1986 and November 1988.\nJohn M. Abboud, age 53, has been Senior Vice President-Operations and Engineering of the General Partner since 1985. In his current capacity, Mr. Abboud is responsible for operations, engineering and environmental affairs.\nLyle B. Boarts, age 52, has been Vice President-Human Resources of the General Partner since November 1988. Previously, Mr. Boarts was Director of Human Resources since June 1986.\nR. Gregory Cunningham, age 50, has been Vice President-General Counsel since January 1994. Previously, he served as General Counsel of the General Partner since January 1991 and, prior to such date, as General Attorney since November 1985.\nBurnell H. DeVos III, age 42, has served as Controller and Secretary of the General Partner since January 1993. Mr. DeVos was Assistant Controller of the General Partner from May 1989 through December 1992.\nPatrick L. Avery, age 43, has served as Vice President-Environmental and Safety of the General Partner since October 1993. Mr. Avery was Corporate Environmental Manager at Amerada Hess Corporation from October 1992 to October 1993. Previously, he held various positions at ARCO Products Company since 1982, including Director-California Government Relations and Environmental Health and Safety Manager at ARCO's Los Angeles refinery.\nWilliam M. White, age 50, has served as Vice President-Engineering of the General Partner, with responsibility for engineering and construction, since January 1993. Mr. White previously was Manager-Northern District from May 1986 through December 1992.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe directors, officers and employees of the General Partner receive no direct compensation from the Partnership for their services to the Partnership. The Partnership reimburses the General Partner for all direct costs incurred in managing the Partnership and all indirect costs (principally salaries and other general and administrative costs) allocable to the Partnership.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Security Ownership of Certain Beneficial Owners\nTo the best of the General Partner's knowledge, the following persons are the only persons who are beneficial owners of more than five percent of the Registrant's equity securities:\n(1) As discussed in Items 1 and 2 of this Report, Santa Fe Pacific Pipelines, Inc. is also the general partner of the Partnership, referred to herein as the \"General Partner,\" and is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation (\"Santa Fe\"). On September 22, 1995, Santa Fe and Burlington Northern Inc. consummated a business combination pursuant to which each became direct or indirect wholly owned subsidiaries of a new publicly-held company, Burlington Northern Santa Fe Corporation. Management believes that this merger will have no significant impact on the operations or financial condition of the Partnership or the General Partner.\n(2) This information is based on a Securities and Exchange Commission Schedule 13-G report by J. P. Morgan & Co., Incorporated, dated January 31, 1996, and filed on February 9, 1996.\n(3) This information is based on a Securities and Exchange Commission Schedule 13-G report by Pioneering Management Corporation, dated January 9, 1996, and filed on January 10, 1996.\n(b) Security Ownership of Management\nAs of March 1, 1996, common units beneficially held by all directors and officers as a group represented less than 1% of the Partnership's outstanding units.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Registrant and the Operating Partnership are managed by the General Partner pursuant to the Amended and Restated Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\"), and the Amended and Restated Agreement of Limited Partnership of the Operating Partnership (the \"Operating Partnership Agreement\"). Under the Partnership Agreement and Operating Partnership Agreement, the General Partner and certain related parties are entitled to reimbursement of all direct and indirect costs and expenses related to the business activities of the Partnership and the Operating Partnership. These costs and expenses include compensation and benefits payable to officers and employees of the General Partner, payroll taxes, corporate office building rentals, general and administrative costs, and legal and other professional services fees. These costs to the Partnership totaled $49.3 million, $44.2 million and $43.0 million in 1995, 1994 and 1993, respectively.\nThe Partnership Agreement provides for incentive distribution payments to the General Partner out of the Partnership's \"Available Cash\" (as defined in the Partnership Agreement) which increase as quarterly distributions to unitholders exceed certain specified targets. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all distributions of Available Cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $2,351,000 in 1995 and $1,202,000 in the years 1994 and 1993.\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(2) Financial Statement Schedules: None.\n(3) Exhibits: The following exhibits are filed as a part of this Report. With the exception of Exhibits 21, 24 and 27, all exhibits listed herein are incorporated by reference, with the location of the exhibit in the Registrant's previous filing being indicated parenthetically.\nExhibit Number Description - ------- -----------------------------------------------------------------------\n3.1 Amended and Restated Agreement of Limited Partnership of the Registrant, dated as of December 19, 1988. (1988 Form 10-K - Exhibit 3.1) 3.2 Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of December 19, 1988. (1988 Form 10-K - Exhibit 3.2) 3.3 Certificate of Limited Partnership of the Registrant, dated as of August 23, 1988. (1988 Form 10-K - Exhibit 3.3) 3.4 Certificate of Limited Partnership of the Operating Partnership, dated as of August 23, 1988. (1988 Form 10-K - Exhibit 3.5) 3.5 Assumption Agreement between the Registrant and Santa Fe Pacific Pipelines, Inc., dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.4) 3.6 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of the Registrant, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.2) 3.7 Certificate of Amendment to Certificate of Limited Partnership of the Registrant, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.3) 3.8 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.5) 3.9 Certificate of Amendment to Certificate of Limited Partnership of the Operating Partnership, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.6) 3.10 Amendment No. 2 to Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of January 24, 1990. (1989 Form 10-K - Exhibit 3.8)\nExhibit Number Description - -------- -------------------------------------------------------------------- 3.11 Certificate of Amendment No. 2 to Certificate of Limited Partnership of the Operating Partnership, dated as of January 30, 1990. (1989 Form 10-K - Exhibit 3.9) 4.1 Form of Deposit Agreement between the Registrant, American Stock Transfer & Trust Company and the General Partner, as attorney-in-fact for holders of units and depositary receipts. (Form S-1 Registration Statement No. 33-24395 - Exhibit 4.1) 4.2 First Mortgage Note Agreement, dated December 8, 1988 (a conformed composite of 54 separate agreements, identical except for signatures). (1988 Form 10-K - Exhibit 4.2) 4.3 Deed of Trust, Security Agreement and Fixture Filing, dated December 8, 1988, between the Operating Partnership, the General Partner, Chicago Title Insurance Company and Security Pacific National Bank. (1988 Form 10-K - Exhibit 4.3) 4.4 Trust Agreement, dated December 19, 1988, between the Operating Partnership, the General Partner and Security Pacific National Bank. (1988 Form 10-K - Exhibit 4.4) 4.5 The Operating Partnership has established a $60 million term credit facility with three banks, dated as of October 14, 1993. As the maximum allowable borrowings under this facility do not exceed 10% of the Registrant's total assets, this instrument is not filed as an exhibit to this Report, however, the Registrant hereby agrees to furnish a copy of such instrument to the Securities and Exchange Commission upon request. 21 Subsidiaries of the Registrant* 24 Powers of attorney* 27 Financial Data Schedule as of and for the year ended December 31, 1995*\n* Filed herewith.\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1995: None\nSIGNATURES\nSanta Fe Pacific Pipeline Partners, L.P., pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. (Registrant) By: Santa Fe Pacific Pipelines, Inc., as General Partner\nDated: March 20, 1996 By: \/s\/ IRVIN TOOLE, JR. -------------------------------------- Irvin Toole, Jr. Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities with Santa Fe Pacific Pipelines, Inc., as General Partner, and on the date indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS OF SANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1) on page 25 present fairly, in all material respects, the financial position of Santa Fe Pacific Pipeline Partners, L.P. and its majority-owned operating partnership at December 31, 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 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\nLos Angeles, California January 26, 1996\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. CONSOLIDATED BALANCE SHEET\n(IN THOUSANDS)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. CONSOLIDATED STATEMENT OF INCOME\n(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nCONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------\nORGANIZATION AND BASIS OF ACCOUNTING - The accompanying consolidated financial statements include the accounts of Santa Fe Pacific Pipeline Partners, L.P. (the \"Trading Partnership\") and SFPP, L.P., (the \"Operating Partnership\"), collectively referred to as the \"Partnership\", on a consolidated basis. The Trading Partnership is a publicly traded limited partnership organized under the laws of the state of Delaware in 1988 which owns a 99% limited partnership interest in the Operating Partnership, through which the Partnership conducts all its operations. The Operating Partnership was acquired by the Trading Partnership in December 1988 and is engaged in the transportation of refined petroleum products and related services.\nThe Operating Partnership is managed by its general partner, Santa Fe Pacific Pipelines, Inc. (the \"General Partner\"), which, by virtue of its 1% general partner interest, represents the minority interest in the Partnership's consolidated financial statements. The General Partner, which is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation (\"Santa Fe\"), also holds the 1% general partner interest in the Trading Partnership and, therefore, in total, holds a 2% general partner interest in the Partnership on a consolidated basis. In addition, the General Partner owns 8,148,148 Partnership common units, representing an approximate 42% limited partner interest in the Trading Partnership. In September 1995, Santa Fe and Burlington Northern Inc. consummated a business combination pursuant to which Santa Fe became a subsidiary of a new publicly-held company, Burlington Northern Santa Fe Corporation (\"BNSF\"). The remaining approximate 56% limited partner ownership in the Trading Partnership is represented by 11,000,000 publicly traded common units.\nThe preparation of financial statements in accordance 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 periods presented. Actual results could differ from those estimates.\nREVENUE RECOGNITION - Substantially all revenues are derived from pipeline transportation and storage and terminaling charges and are recognized in income upon delivery. Other revenues, primarily incidental service charges and tank and land rentals, are recognized as earned.\nOperating revenues received from ARCO Products Company and Chevron U.S.A. Products Company accounted for 16.3% and 13.3%, respectively, of total 1995 revenues. These two customers accounted for 16.1% and 12.4%, respectively, of total 1994 revenues, and for 16.9% and 12.9%, respectively, of total 1993 revenues. In addition, Texaco Refining and Marketing Inc. accounted for 10.2% of total 1993 revenues.\nThe Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission (\"FERC\") under a rate-making methodology that is subject to clarification and reconsideration in individual cases and leaves many issues for determination on a case-by-case basis. The Partnership's California intrastate common carrier pipeline operations are subject to rate regulation by the California Public Utilities Commission.\nPROPERTIES, PLANT AND EQUIPMENT - Properties are stated at cost and include capitalized interest on borrowed funds. Additions and replacements are capitalized. Expenditures for maintenance and repairs are charged to income. Upon sale or retirement of depreciable properties, cost less salvage is charged to accumulated depreciation.\nProperties are depreciated on a straight-line basis over the estimated service lives of the related assets. Rates for the Partnership's interstate pipeline properties are prescribed by the FERC. The Partnership's intrastate pipeline properties and its terminal properties are depreciated using similar rates. The following annual rates were used in computing depreciation:\nDepreciation expense aggregated $17,680,000 in 1995, $17,445,000 in 1994 and $16,920,000 in 1993.\nENVIRONMENTAL COSTS - Environmental expenditures that relate to current or future revenues are expensed or capitalized, as appropriate. Expenditures that relate to an existing condition caused by past operations, and do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or clean-ups are probable and the costs can be reasonably estimated.\nINCOME PER UNIT - Income per unit is computed based upon net income of the Partnership less an allocation of income to the general partner of the Trading Partnership in accordance with the partnership agreement, and is based upon 19,148,148 common units. The quarterly allocation of net income to the general partner of the Trading Partnership (which is always equivalent to the minority interest in net income) is based on its percentage of cash distributions from Available Cash at the end of each quarter (see Note 7). The general partner of the Trading Partnership was allocated 3.23%, 2.07% and 2.07% of net income before minority interest for the years 1995, 1994 and 1993, respectively.\nINCOME TAX - For federal and state income tax purposes, the Partnership is not a taxable entity. Accordingly, the taxable income or loss resulting from the operations of the Partnership is ultimately includable in the federal and state income tax returns of the general and limited partners, and may vary substantially from the income or loss reported for financial reporting purposes.\nCASH EQUIVALENTS AND SHORT-TERM INVESTMENTS - The Partnership considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nRECLASSIFICATIONS - Certain comparative prior year amounts have been reclassified to conform with the current year presentation.\nNOTE 2 - DETAIL OF SELECTED BALANCE SHEET ACCOUNTS - --------------------------------------------------\nNOTE 3 - LONG-TERM DEBT - -----------------------\nLong-term debt consists of the following:\nThe Partnership intends to refinance the Series C Notes on a long-term basis upon their maturity and, therefore, has included them in long-term debt at December 31, 1995. The Series F Notes become payable in annual installments, including $31.5 million in 1999 and $32.5 million in 2000. The Notes may also be prepaid beginning in 1999 in full or in part at a price equal to par plus, in certain circumstances, a premium.\nThe First Mortgage Notes (the \"Notes\") are secured by mortgages on substantially all of the properties of the Partnership (the \"Mortgaged Property\"). The Notes contain covenants specifying certain limitations on the Partnership's operations including the amount of additional debt or equity that may be issued, cash distributions, investments and property dispositions. Management does not believe such limitations will adversely affect the Partnership's ability to fund its operations or planned capital expenditures.\nThe Partnership has arranged a $60 million multi-year term credit facility and a $20 million working capital facility with three banks. The term facility is available for refinancing a portion of the Partnership's long-term debt and capital projects, and may be utilized on a revolving basis through October 1998, with any outstanding balance at that time converted to a three-year amortizing term loan. Borrowings under the term facility are also secured by the Mortgaged Property and are generally subject to the same terms and conditions as the Notes. In December 1994, the Partnership refinanced the Series A Notes by borrowing $11 million under this facility and, in December 1995, refinanced the Series B Notes by borrowing an additional $17 million under this facility. The Partnership has selected an interest rate on this loan that is presently determined by reference to a short-term Eurodollar rate, and was 6-5\/16% at December 31, 1995.\nAdvances under the $20 million working capital credit facility can be used for general Partnership purposes and would be secured by certain of the Partnership's accounts receivable. This facility may not be utilized for a 45- day period, the designation of such period to be at the Partnership's discretion, during each year. This facility also provides for certain interest rate options, and is subject to annual renewal and other reasonable and customary terms and conditions. To date, the working capital facility has not been utilized.\nInterest on the Notes is payable semiannually in June and December. Interest on the bank term loan is generally payable quarterly. Total interest paid was $36,985,000 during 1995 and $37,326,000 during both 1994 and 1993. Interest capitalized during the years 1995, 1994 and 1993 aggregated $405,000, $205,000 and $600,000, respectively.\nThe fair value of the Partnership's long-term debt was approximately $430 million at December 31, 1995. Such estimate represents the present value of interest and principal payments on the Notes discounted at present market yields, and assumes the Series F Notes will be prepaid in full in 1999 at par plus a premium. The fair market value of the term loan is considered to be equal to its principal amount.\nNOTE 4 - COMMITMENTS AND CONTINGENCIES - --------------------------------------\nEast Line Civil Litigation and FERC Proceeding\nCertain of the Partnership's shippers have filed civil suits and initiated Federal Energy Regulatory Commission (\"FERC\") complaint proceedings alleging, among other things, that the shippers were damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's rates and charges on its East and West Lines are excessive. To date, the complainants have filed testimony in the FERC proceeding seeking reparations for shipments between 1990 and 1994 aggregating approximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter. Hearings before a FERC Administrative Law Judge are scheduled to commence in April 1996.\nIn July 1993, the Partnership reached a settlement with one of these shippers, Navajo Refining Company (\"Navajo\"), whereby, among other things, Navajo agreed to dismiss its pending civil litigation in New Mexico and the Partnership agreed to make certain cash payments to Navajo over three years. The remaining civil action, brought by El Paso Refinery, L.P. (\"El Paso\") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.\nIn June 1995, the FERC issued a decision in an unrelated oil pipeline rate proceeding involving Lakehead Pipe Line Company, Limited Partnership (\"Lakehead\") ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income attributable to limited partnership interests held by individuals. If this decision is upheld and applied in the Partnership's FERC proceeding, it would reduce the Partnership's allowable cost of service and, possibly, its revenues.\nIn 1993, the Partnership recorded a $12 million provision for litigation costs, reflecting the terms of the Navajo settlement and management's estimate of other costs related to the resolution of the FERC proceeding and El Paso's civil action, and, during the quarter ended December 31, 1995, recorded a $10 million provision to increase its existing reserves relating to the FERC proceeding, the El Paso action and certain other matters. In the interim, lesser amounts of litigation costs have, from time to time, been recorded as current period expense.\nWhile the Partnership believes it has meritorious defenses in these matters, the complainants and plaintiffs are seeking amounts that, in the aggregate, substantially exceed the Partnership's reserves and, because of the uncertainties associated with litigation and FERC rate-making methodology, management cannot predict with certainty the ultimate outcome of these matters. As additional information becomes available, it may be necessary for the Partnership to record additional charges to earnings to maintain its reserves at a level deemed adequate at that time, and the costs associated with the ultimate resolution of these matters could have a material adverse effect on the Partnership's results of operations, financial condition, or ability to maintain its quarterly cash distribution at the current level.\nEnvironmental\nThe Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site.\nAlong with several other respondents, the Partnership is presently involved in one cleanup ordered by the United States Environmental Protection Agency related to soil and groundwater contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven groundwater hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies and, from time to time, may be involved in groundwater investigations or remediations at the direction of other governmental agencies. The Partnership is also involved in soil and groundwater remediation projects, at and adjacent to various other terminal and pipeline locations, that have not been mandated by government agencies but are conducted in the ordinary course of business. In a number of remediation projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.\nThe Partnership accrues for environmental costs that relate to existing conditions caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at certain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.\nThe Partnership's environmental reserves are monitored on a regular basis by management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership conducted a comprehensive re-evaluation of its potential liabilities associated with remediation activities at a number of sites and recorded a $15 million provision to increase its reserve for environmental costs. During 1995, the Partnership, as a member of a defendant group, reached agreements in principle settling all of the claims for penalties and damages that had been asserted by several governmental agencies and property owners in lawsuits associated with the soil and\ngroundwater contamination present in the vicinity of the Sparks, Nevada environmental site. The Partnership recorded provisions for environmental costs aggregating $24 million during 1995 largely to reflect its share of these settlement costs.\nThe Partnership's balance sheet at December 31, 1995 and 1994 includes reserves for environmental costs aggregating $37.1 million and $22.7 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, and the cost of performing preliminary environmental investigations at several locations, as well as estimable environmental damage claims, primarily associated with the Sparks environmental site. With respect to the costs accrued at December 31, 1995, the Partnership estimates that between $12.5 million and $15.0 million will be paid in 1996, approximately $2 million to $4 million will be paid per year over the following four years, and approximately $1 million or less will be paid per year over the subsequent five years.\nBased on the information presently available, it is the opinion of management that the Partnership's environmental costs, to the extent they exceed recorded liabilities, will not have a material adverse effect on the Partnership's financial condition; nevertheless, it is possible that the Partnership's results of operations in particular quarterly or annual periods could be materially affected as additional information becomes available.\nOther Claims and Litigation\nThe Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these other matters cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, either individually or in the aggregate, when finally resolved, will have a material adverse effect on the annual results of operations, financial condition or liquidity of the Partnership.\nLease Commitments\nThe Partnership and the General Partner lease space in office buildings and certain computer equipment. Total lease commitments not subject to cancellation at December 31, 1995 are as follows: $1,680,000 in 1996, $1,125,000 in 1997, $1,090,000 in 1998, $1,215,000 in 1999, $1,225,000 in 2000, and $17,600,000 thereafter.\nThe Partnership also leases certain rights-of-way and land under agreements that can be canceled at any time should they not be required for operations. The annual payments associated with these leases aggregated approximately $5 million in 1993, however a substantial portion of this amount became subject to renegotiation effective January 1, 1994 and, to date, the Partnership and the lessor have been unable to reach an agreement on the base annual rental payments for the next ten-year period. In a judicial reference proceeding in this matter, the lessor has asserted that the amount of the easement rent should be increased from approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership has accrued for an increase in the annual rental effective January 1, 1994 and does not believe that the evidence provided by the lessor to date supports an annual rental in excess of the amounts accrued; however, it is not presently possible to predict with certainty the annual right-of-way rentals that will ultimately be payable. Rental expense recorded for all operating leases was $8,850,000 in 1995, $8,335,000 in 1994 and $7,130,000 in 1993.\nNOTE 5 - RELATED PARTY TRANSACTIONS - -----------------------------------\nThe Partnership has no employees and is managed by the General Partner. Under certain partnership and management agreements, the General Partner and Santa Fe or its subsidiaries are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These expenses, which are included in field operating and general and administrative expenses in the Partnership's statement of income, totaled $49.3 million, $44.2 million and $43.0 million for the years 1995, 1994 and 1993, respectively, and include compensation and benefits payable to officers and employees of the General Partner, payroll taxes, corporate office building rentals, general and administrative costs, tax information and reporting costs and legal and other professional services fees.\nNOTE 6 - PENSION AND POSTRETIREMENT PLANS - -----------------------------------------\nThe General Partner is included with certain other affiliates in the trusteed non-contributory Santa Fe Pacific Retirement Plan (the \"Plan\") which fully complies with ERISA requirements. The Plan covers substantially all officers and employees of Santa Fe and its subsidiaries not covered by collective bargaining agreements. Benefits payable under the Plan are based on years of service and compensation during the sixty highest paid consecutive months of service during the ten years immediately preceding retirement. Santa Fe's funding policy is to contribute annually at a rate not less than the ERISA minimum, and not more than the maximum amount deductible for income tax purposes. Since the General Partner is included with certain other affiliates, detailed Plan information for the General Partner is not available in all cases; however, as of September 30, 1995, the fair value of Plan assets allocated to employees associated with the Partnership's operations was $51.7 million, and the actuarial present value of projected Plan obligations, discounted at 7.5%, was $42.0 million. The expected return on the market value of Plan assets was 9.75% and compensation levels were assumed to increase at 4.0% per year. Primarily as a result of the excess of Plan assets over liabilities, pension income of $470,000, $200,000 and $435,000 was recognized in 1995, 1994 and 1993, respectively.\nAs of June 1994, salaried employees who have rendered ten years of service after attaining age 45 are eligible for both medical benefits and life insurance coverage during retirement. Prior to June 1994, salaried employees who had attained age 55 and who had rendered ten years of service were eligible. This change in eligibility requirements resulted in a $3.1 million curtailment gain in 1994 relating to employees who are no longer currently eligible for postretirement benefits, and a negative plan amendment due to a reduction in the accumulated postretirement benefit obligation related to remaining eligible active employees. This curtailment gain is included in other income in the Partnership's statement of income. The retiree medical plan is contributory and provides benefits to retirees, their covered dependents and beneficiaries. Retiree contributions are adjusted annually. The plan also contains fixed deductibles, coinsurance and out-of-pocket limitations. The life insurance plan is non-contributory and covers retirees only.\nNet periodic postretirement benefit cost was $770,000, $1,500,000 and $1,557,000 in 1995, 1994 and 1993, respectively, and included the following components:\nThe Partnership's policy is to fund benefits payable under the medical and life insurance plans as they come due. The following table shows the reconciliation of the plans' obligations, using a September 30 measurement date, to amounts accrued at December 31, 1995 and 1994:\nThe unrecognized prior service credit will be amortized straight-line over the average future service to full eligibility of the active population. For 1996, the assumed health care cost trend rate for managed care medical costs is 11% and is assumed to decrease gradually to 5% by 2006 and remain constant thereafter. For medical costs not in managed care, the assumed health care cost trend is 13% in 1996 and is assumed to decrease gradually to 5% by 2006 and remain constant thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation for the medical plan by $1.3 million and the combined service and interest components of net periodic postretirement benefit cost recognized in 1995 by $200,000. The weighted-average discount rate assumed in determining the accumulated postretirement benefit obligation was 7.5% in 1995 and 8.5% in 1994. The assumed weighted-average salary increase was 4% in both 1995 and 1994.\nNOTE 7 - PARTNERS' CAPITAL AND CASH DISTRIBUTIONS - -------------------------------------------------\nChanges in partners' capital were as follows:\nThe Partnership makes quarterly cash distributions of substantially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated capital expenditures and contingencies as the General Partner deems appropriate or as are required by the terms of the Notes. Distributions are made 98% to the common unitholders and 2% to the General Partner, subject to the payment of incentive distributions to the General Partner which increase as quarterly distributions to unitholders exceed certain specified target levels. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all quarterly distributions of available cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $2,351,000 in 1995 and $1,202,000 in 1994 and 1993.\nCash distributions declared aggregated $3.00 per unit in 1995, reflecting an increase from $0.70 to $0.75 per unit in the first quarter, and $2.80 per unit in 1994 and 1993. In January 1996, the Partnership announced a fourth quarter 1995 distribution of $0.75 per unit, payable in February 1996.\nNote 8 - SUMMARIZED QUARTERLY OPERATING RESULTS - ----------------------------------------------- AND COMMON UNIT INFORMATION (UNAUDITED) -------------------------------------- Quarterly results of operations are summarized below:\nNote: 1995 operating results included provisions for environmental and litigation costs of $9.0 million in the second quarter and $25.0 million in the fourth quarter.\nSanta Fe Pacific Pipeline Partners, L.P. common units are traded on the New York Stock Exchange, under the symbol SFL. The quarterly price range per unit and cash distributions declared per unit for 1995 and 1994 are summarized below:\nAs of January 31, 1996, there were approximately 18,000 unitholders.","section_15":""}
{"filename":"805298_1995.txt","cik":"805298","year":"1995","section_1":"Item 1. Business\nT. Rowe Price Realty Income Fund III, America's Sales- Commission-Free Real Estate Limited Partnership (the \"Partnership\"), was formed on October 20, 1986, under the Delaware Revised Uniform Limited Partnership Act for the purpose of acquiring, operating and disposing of existing income-producing commercial and industrial real estate properties. On January 5, 1987, the Partnership commenced an offering of $100,000,000 of Limited Partnership Units ($250 per Unit) pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 33-9899) (the \"Registration Statement\"). The Prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933 (the \"Prospectus\") sets forth a complete description of the business of the Partnership in the sections entitled \"Investment Objectives\" and \"Fund Policies\" on pages 18 - 25 of the Prospectus, which pages are incorporated by reference herein. The Gross Proceeds from the offering totaled $63,385,000, and an additional $25,000 was contributed by the initial limited partner, T. Rowe Price Real Estate Group, Inc. The offering terminated on June 30, 1987, and no additional Units will be sold. Forty-two Units have been redeemed by the Partnership on a \"hardship\" basis; there were 253,599 Units outstanding, and 10,364 Limited Partners, as of March 16, 1996.\nIn December of 1991, LaSalle Advisors Limited Partnership (\"LaSalle\") entered into a contract with the general partner of the Partnership, T. Rowe Price Realty Income Fund III Management, Inc. (\"the General Partner\") and the Partnership 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 1995, two of the Partnership's properties produced 15% or more of the Partnership's revenues from operations: Westbrook Commons (21%), and Winnetka Industrial Park (19%). In 1994, three of the Partnership's properties produced 15% of more of the Partnership's revenues from operations: Westbrook Commons (20%), Winnetka Industrial Park (19%), and Brinderson Plaza (16%). In 1993, two of the Partnership's properties produced 15% or more of the Partnership's revenue: Winnetka Industrial Park (17%) and Westbrook Commons (15%). In none of these periods did any single tenant produce more than 10% of the Partnership's revenue.\nThe Partnership owns directly or through joint venture partnerships the properties or interests set forth in Schedule III to this Report, \"Real Estate and Accumulated Depreciation,\" which is set forth in Exhibit 99(b)to this Report, and which is incorporated by reference herein and contains information as to acquisition date and total costs of each of the properties. Additional information regarding these properties and\/or interests, including percentage leased as of December 31, 1995 is set forth in the table, \"Real Estate Holdings,\" appearing on page 6 of the Partnership's 1995 Annual Report to Limited Partners which is hereby incorporated by reference herein. A brief narrative description of each property or investment therein which the Partnership has acquired is as follows.\nScripps Terrace\nThe Partnership owns a 100% interest in this property which consists of two one-story research and development\/office\/service buildings containing 57,000 square feet of space. The property is located in the center of the Scripps Ranch planned community in the I-15 Corridor in suburban San Diego, California.\nActivity at the property during the year consisted of one new 6,300 square foot lease and the loss of one 5,400 square foot tenant after its lease expired. Thus, the property was 82% leased at year-end 1996 versus 81% twelve months earlier. Leases representing 35% of the property's leasable area expire in 1996 and the Partnership is currently negotiating with the three tenants involved.\nNet absorption for the year in the Scripps Ranch\/Scripps Mesa market totaled approximately 81,000 square feet, about the same as the previous year. The year-end vacancy rate for the submarket decreased by four percentage points from one year ago to approximately 8%. However, there continues\nto be limited demand for space in multi-tenant properties such as Scripps Terrace. Total inventory (leased and available) at year-end 1995 remained at approximately 1.7 million square feet. Average net effective rents remained at roughly the same level as the previous year - around an average of $6.00 per square foot per year net of taxes, insurance and utilities (\"NNN\") for competitive properties. There appears to be no new construction planned for industrial\/R&D buildings in the Scripps Ranch area.\nDuring 1994, the Partnership recorded a provision for value impairment of $917,000 in connection with Scripps Terrace. 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 project through future operations or sale. This determination was based upon then-current market conditions and future performance expectations for this investment. No additional provision was deemed warranted in 1995.\nWinnetka\nThe Partnership owns a 100% interest in Winnetka Industrial Park which is located in Crystal, Minnesota, a suburb of Minneapolis. The property consists of two multi-tenant industrial buildings containing 188,000 square feet of space.\nEven though the Partnership lost one 12,900 square foot tenant upon the expiration of its lease, it was able to expand a renewing tenant into that space fairly quickly and also lease the remaining 11,200 square foot vacancy to a new tenant, to bring this suburban Minneapolis industrial project to 100% leased by year-end 1995 versus 94% at year-end 1994. Leases covering 19% of the project expire in 1996.\nThe recent National Association of Industrial and Office Parks (\"NAIOP\") survey of the Twin Cities' West\/Northwest office\/warehouse submarket cited an approximate vacancy rate of 5% versus 6% in 1994. The west and northwest suburban submarket contains approximately 7.5 million square feet, with approximately 390,000 square feet of space available. Net absorption of approximately 106,000 square feet was recorded during the most recent four quarters. Average asking rates for comparable space increased approximately 9% to approximately $7.20 NNN per square foot per year for the office portion of industrial buildings while asking rates rose approximately 4% to $3.59 NNN for the warehouse portion. Virtually no free rent is being offered as a concession to negotiate a transaction, except when space is taken \"as-is.\" With the reduction in vacancy rates,\nspeculative construction is underway. At present, a 130,000 square foot multi-tenant office\/warehouse building is being built in the market. So long as present market conditions continue, the outlook for high occupancy and favorable rents for Winnetka Industrial Park is good.\nSouth Point Plaza\nThe Partnership owns a 50% interest in South Point Partners, a joint venture with its affiliate, T. Rowe Price Realty Income Fund II, America's Sales-Commission-Free Real Estate Limited Partnership (\"RIF II\"). South Point Partners owns a 100% interest in South Point Plaza Shopping Center (\"South Point\"), in Tempe, Arizona. The property consists of two multi-tenant buildings in a neighborhood shopping center, which is also occupied by a supermarket. The total square footage of the multi-tenant buildings is 42,000 square feet. The Partnership also owns pads for two 3,000 square feet single-tenant buildings, one of which is built-out as a restaurant.\nA total of two new leases totaling 2,800 square feet and five renewal and\/or expansion leases totaling 6,200 square feet were signed during the year. This positive activity was partially offset by the loss of one 1,200 square foot tenant who vacated upon its lease expiration. Thus, at year-end, the property improved its leased status to 69% versus 61% the previous year. The Partnership has negotiated extensively with a prospective tenant which would lease over 30% of the center if it signs, filling a space which has been vacant for several years. To improve its negotiating position, the Partnership has obtained some zoning variances which would be required if this prospect leased the space. However, the Partnership is still working with the prospective tenant to reach a mutually satisfactory agreement. In the event a lease is executed, the tenant would not begin paying rent until late 1996, while the Partnership would be required to immediately spend a significant amount on tenant improvements. Scheduled expirations in 1996 represent 19% of the property's leasable area.\nThe metropolitan area Phoenix retail market remains somewhat strong. In the Tempe submarket, approximately 43,000 net square feet were absorbed during the first three quarters of the year. Although there were additions to the inventory of retail space in the Tempe submarket, vacancy still declined by three percentage points to 7%. This level is better than the Metropolitan Phoenix vacancy rate of 9%. Rates per square foot for space in Tempe increased approximately 12% to $9.67 from $8.65 per square foot net of taxes, insurance, and utilities the previous year.\nDuring 1993, the General Partner approved a plan of disposition that, had it been successful, would have resulted in the disposition of South Point Plaza. Based upon the estimated net realizable value for the property, the Partnership recorded a valuation allowance of $1,758,000. This determination was based upon current market conditions and future performance expectations for this investment over the anticipated remaining holding period. The valuation allowance was reduced by $109,000 in 1995 and $73,000 in 1994 to reflect improved market conditions and additional depreciation taken on the property. The Partnership is not currently marketing the property, and a decision on when to commence actively marketing it for sale will be made once a tenant for the large vacant space is obtained. Because the Partnership was not actively marketing Business Plaza at December 31, 1995 the property's carrying value was reassessed and, accordingly, net valuation allowances totaling $1,576,000 were reclassified as a permanent impairment of the property s carrying value.\nTierrasanta\nThe Partnership owns a 30% interest in Tierrasanta 234, a joint venture with its affiliates, RIF II and T. Rowe Price Realty Income Fund IV, America's Sales-Commission-Free Real Estate Limited Partnership (\"RIF IV\"). Tierrasanta 234 owns a 100% interest in Tierrasanta Research Park in San Diego, California. The project contains four office buildings utilized for research and development purposes, for a total of 104,000 square feet of space. It is located in the Kearny Mesa market area, north of San Diego, which is part of the larger \"Interstate 15\" commercial corridor.\nAlthough the property lost one 11,100 square foot tenant due to credit concerns during the year, it was able to re-lease its space in addition to the existing vacancy to bring the leased status to 100% by year-end. In total, three new leases totaling 31,200 square feet, and one 15,800 square foot renewal\/expansion were signed at this San Diego research and development property. During 1996, only one lease expires with a 40,000 square foot tenant. Negotiations have commenced, but it is premature to make a statement about the potential outcome of the negotiations.\nTierrasanta Research Park is part of the Kearny Mesa research and development (\"R&D\")\/office market. The Park competes against both R&D and office buildings. While net absorption in the fourth quarter of 1995 showed a loss of approximately 300,000 square feet, this deterioration was due primarily to the loss of two large tenants totaling 220,000 square feet during that quarter. Overall activity\nin the submarket has been good, with approximately 789,000 of gross absorption for the year, and slightly higher rents than year-end 1994, as discussed below. Vacancy rates at year-end 1995 were approximately 13% and 19% for R&D space and office space, respectively, versus approximately 13% and 21%, respectively, for the previous year.\nRates in this submarket at year-end for Class A R&D space and office space improved with average R&D rates rising from approximately $6.30 per square foot per year net of taxes, insurance and utilities to approximately $7.50 per square foot.\nAverage Class A office rates rose from $13.50 full service per square foot per year to $14.40. Rates for Class B R&D space rose from $4.68 per square foot net of taxes, insurance and utilities to $5.70 per square foot. Class B office rates climbed from $9.30 per square foot full service to $11.40 per square foot. Tierrasanta competes with both Class A and B buildings, but it most frequently competes with the latter. The average net effective rental rate rose from around $3.60 - $4.20 per square foot to $5.40 to $7.80 per square foot, with free rent still virtually nonexistent.\nDuring 1994, the Partnership recorded a provision for value impairment of $550,000 in connection with Tierrasanta. 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 project through future operations or sale. This determination was based upon then-current market conditions and future performance expectations for this investment. No additional provisions were deemed warranted in 1995.\nWood Dale\nThe Partnership owns a 100% interest in two multi-tenant industrial warehouse\/manufacturing\/distribution buildings in Wood Dale, Illinois, a suburb of Chicago located immediately west of O'Hare Airport. (A 22,000 square foot building was sold in 1994.) The buildings are located within a few blocks of each other and contain a total of 90,000 square feet.\nAlthough two tenants totaling 16,900 square feet renewed their leases for three or more years and one 10,400 square-foot tenant extended its lease into 1996, one 9,500 square-foot tenant vacated upon its lease expiration near the end of the year. Thus, this suburban Chicago industrial project experienced a decline in occupancy from 100% to 89% by year end. Leases in place representing 30% of the total leasable area are scheduled to expire in 1996. Rental rates on new\nleases are anticipated to be equal to or higher than on the leases which are expiring in 1996. So long as present market conditions continue the outlook for high occupancy and favorable rents for Wood Dale is good.\nThe western O'Hare suburban Chicago industrial market in which the project is located consists of approximately 157.3 million square feet of space in all types of industrial projects. This submarket is a part of the larger west and northwest Chicago suburban industrial market which experienced positive absorption of approximately 774,000 square feet during the year. At the current pace of absorption, there is only approximately eight months of available space in the market. Thus, speculative construction has commenced, but primarily in outlying areas due to the limited supply of available land. The range of average net rental rates for comparable space has increased from approximately $3.00 to $4.50 net per square foot per year last year to $3.50 to $4.75 per square foot by year end 1995.\nClark Avenue\nThe Partnership owns a 100% interest in this 40,000 square foot office\/industrial building in King of Prussia, Pennsylvania, a northwestern suburb of Philadelphia.\nThe only activity which occurred at this King of Prussia, Pennsylvania, office project during the year was the loss of a tenant which represented 28% of the property one month before its lease expiration due to financial problems. Thus, the property ended the year at 72% leased versus 100% at year end 1994. Although the Partnership has had interest from a few prospective tenants, the Partnership does not believe that a signed lease is imminent. No leases expire in 1996.\nWith an inventory of approximately 10.8 million square feet, the King of Prussia office submarket has a vacancy rate of approximately 12% as of the end of the third quarter of 1995; this represents a decrease from the 15% level at year-end 1994. Net absorption recorded through the third quarter of 1995 was approximately 265,000 square feet. While occupancy by existing tenants in the submarket has declined due to relocation to other areas and consolidations of space within the submarket, an influx of new tenants has resulted in the increase of occupancy. The impact on office requirements of a series of mergers involving the largest tenant in the market, Lockheed Martin, is still unknown. It is not yet known whether Lockheed Martin will close or downsize the division's operations in the submarket; if it does so, there will be a negative impact on vacancy rates\nand rents. At present, rental rates for comparable Class B space have remained at a range of $8.00 to $12.00 per square foot per year net of insurance, taxes, and operating expenses. Fewer concessions are being offered. There was no new construction activity in the King of Prussia\/Valley Forge market and none is planned.\nRiverview\nThe Partnership owns a 100% interest in the Riverview property which is located in the Riverview Industrial Park directly across the Mississippi River from the St. Paul, Minnesota Central Business District. The project consists of three multi-tenant industrial warehouse\/distribution\/light manufacturing buildings containing a total of 114,000 square feet of space.\nThree tenants representing 20,600 square foot or 18% of the space renewed and\/or expanded their leases during 1995. Additionally, one new 10,100 square foot tenant was signed. This positive activity more than offset the loss of two tenants totaling 10,000 square feet who vacated upon their lease expirations. Thus, the property increased its leased status by five percentage points over last year to end the year at 96% leased. Leases representing 22% of the property's leasable area expire in 1996. As discussed below, conditions in the market are improving, and the Partnership believes there is a good possibility that a substantial amount of this space can be leased to new or existing tenants in 1996 at rates which are higher than or equal to those of the expiring leases, although there is no assurance this will occur.\nThe most recent NAIOP survey of the St. Paul, Midway, and Suburban submarket showed that the vacancy rate declined approximately three percentage points to 3% on a total inventory of approximately 5.6 million square feet. Net absorption totaled approximately 428,000 square feet for the four quarters ending June 30, 1995. Average asking rates for office\/warehouse space increased almost 9% for the office portion with an average $7.00 NNN per square foot per year while average asking rates for the warehouse portion remained at $3.00 NNN. Concessions are disappearing, and tenants are beginning to pay for improvements over the initial lease term. Over 500,000 square feet of space is planned or under construction in the submarket.\nWestbrook Commons\nThe Partnership owns a 50% interest in Penasquitos 34, a joint venture with RIF IV. Penasquitos 34 owns a 100% interest in Westbrook Commons Shopping Center (\"Westbrook Commons\"), a neighborhood shopping center in the Village of Westchester, Illinois, a Chicago suburb. The property contains approximately 122,000 rentable square feet of space.\nOne new 3,600 square foot tenant and six renewal leases totaling 8,900 square feet were signed during the year at this suburban Chicago retail center at generally higher rates than previously paid. However, because one 1,300 square foot tenant did not renew, and two tenants occupying a total of 3,700 square feet were lost due to credit issues, the property's occupancy declined slightly - from 97% to 96% by year end 1995. During the year, we initiated a strategy to ensure that the \"dated\" appearance of the center did not hinder further leasing efforts. Thus, we implemented and completed a \"face lift\" which substantially improved the \"curb appeal\" of the property. Leases representing 6% of the property's total leasable area expire in 1996. Activity from prospective tenants, as well as current tenants interested in expanding, has been good.\nThe Westchester market in which the project is located continues to remain a stable and relatively healthy environment for retailers. As a general observation, grocery anchored centers such as Westbrook Commons have proven to be the most successful anchor for the service\/convenience based retailers. Somewhat insulated from an over abundance of competition, little fluctuation has occurred in the overall vacancy and rental rates throughout the submarket. Industry figures place the vacancy rate for the competitive centers within a three mile radius of Westbrook Commons at approximately 4% versus 2% the previous year on a total inventory of 1.1 million square feet. The average rental rates in the submarket are currently $14.00-16.00 NNN per square foot per year for Class A space.\nFairchild Corporate Center (formerly known as Brinderson Plaza)\nThe Partnership owns a 56% interest in Fairchild 234, a joint venture with RIF II and RIF IV. On February 1, 1994, a wholly-owned subsidiary of Fairchild 234 acquired Fairchild Corporate Center, an office development in Irvine, California consisting of two three-story buildings containing 105,000 square feet of space. The Partnership's interest in the development was previously held under a\nparticipating loan. The Partnership previously recorded a loan loss of $4,890,000 in 1991, and valuation allowances totalling $1,638,000 in 1992 and 1993. In conjunction with the first quarter 1994 purchase of Fairchild Corporate Center, the valuation allowance was reduced to $1,629,000 and then reclassified as a reduction in the carrying value of the investment in real estate. In 1995, the Partnership began foreclosure for tax purposes. The process is anticipated to be completed during the second quarter of 1996.\nThe leased status declined at this office property primarily due to the loss on the last day of the year of a tenant representing 9,800 square feet or 9% of the leasable space in the buildings. Additionally, the Partnership lost two tenants totaling 6,100 square feet due to credit concerns and four other tenants totaling 17,200 square feet upon their lease expirations. On the positive side, the first phase of the renovations of the two buildings was completed, the property was renamed, and leasing activity improved significantly. Leases with three new tenants were signed for a total of 17,100 square feet, and renewals and\/or expansions were executed with six existing tenants for another 7,900 square feet. The net result was a decline in the leased status from year-end 1994 of twelve percentage points to 73%. Leases representing 31% of the leasable space expire in 1996.\nThe John Wayne\/Orange County Airport submarket in which the project is located had 454,000 square feet of net absorption during the first three quarters of the year. As a result, vacancy improved to 14% from approximately 16% the previous year on an inventory of approximately 29.2 million square feet. In order to make the property more competitive in its market, the Partnership will continue to renovate some of the common areas in 1996 to update their appearance and bring them into compliance with the Americans with Disabilities Act. The renovation of all common areas should be completed in 1997.\nRental rates have increased from $12.60 to $15.60 per square foot last year to $15.00 to $17.40 per square foot this year for Class B office space such as Fairchild Corporate Center. Only two competitive speculative buildings totaling 140,000 square feet are anticipated to be under construction in 1996.\nRiver Run\nThe Partnership owns a 100% interest in River Run Shopping Center in Miramar, Florida containing 93,000 square feet of space. On October 10, 1995, the Partnership acquired the\nproperty through foreclosure proceedings. The investment was previously held as a participating loan secured by the property. During the fourth quarter of 1993, the loan was restructured to permit the borrower to defer mortgage interest payments to a limited extent. Because the ability of the borrower to repay the loan was in question, the Partnership established a $1.4 million loan loss provision during 1992 and provided allowances for doubtful interest receivables totalling $692,000 at December 31, 1993.\nIn July 1995, the Partnership began consensual foreclosure on the participating mortgage loan secured by the River Run Shopping Center and ceased the accrual of interest income. At September 30, 1995, the carrying value of the loan was reduced from $7,840,000 to $7,700,000, the estimated fair value of the underlying property, and additional loan losses of $118,000 were recognized. On October 10, 1995, the Partnership purchased the property at the foreclosure sale and, in connection therewith, reclassified the participating mortgage loan as an investment in real estate.\nThis South Florida retail center signed two new leases totaling 1,500 square feet and one 1,000 square foot renewal lease. However, three tenants totaling 4,275 square feet did not renew their leases and three tenants occupying 6,300 square feet defaulted on their leases and were forced to vacate. Thus, occupancy declined from 100% at year-end 1994 to 90% at year-end 1995. As the owner, the Partnership now has the ability to operate and lease the property according to its objectives, as opposed to those of the former borrower, and is beginning to reposition the property. As a result, occupancy may further decline in the near term as the Partnership focuses on improving both tenant credit worthiness and tenant mix. Leases covering 1% of the project are scheduled to expire in 1996.\nThe southwest Broward County non-regional mall submarket contains approximately 4.5 million square feet of retail space in 25 projects. The directly competitive market consists of four centers totaling 650,000 square feet. Vacancy rates within this smaller market are less than 1%.\nLeasing activity in the area currently consists of local community and first-time business operators. However, new housing construction in the area may positively impact the center within the foreseeable future. Rental rates for new leases have remained at an average of $10.00 to $15.00 NNN per square foot per year.\nEmployees\nThe Partnership has no employees and, accordingly, the General Partner, the Partnership's investment adviser, LaSalle, and their affiliates and independent contractors perform services on behalf of the Partnership in connection with administering the affairs of the Partnership and operating properties for the Partnership. 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 referred to under Item 1. above, to which reference is made for the name, location and description of each property. 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\nOn March 16, 1996, there were 10,364 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\"), an affiliate of the General Partner, 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 is not obligated to redeem or repurchase Units, but it may do so in certain defined hardship situations.\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.\nDistributions 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\nMarch 31, 1994 $3.54 June 30, 1994 $3.26 September 30, 1994 $7.47 December 31, 1994 $3.18 March 31, 1995 $1.58 June 30, 1995 $1.58 September 30, 1995 $1.58 December 31, 1995 $6.37\nAll of the foregoing distributions were paid from net cash flows from current period operating activities, with the exception of the distribution for the quarter ended December 31, 1995, which included $3.25 per Unit from retained cash balances generated by operations in prior years and a return of capital of $.75 per Unit from proceeds of the initial public offering of Units, which had been retained as cash balances, and the distribution for the quarter ended September 30, 1994, which included $3.92 per Unit from the proceeds of the sale of the Benoris Building, one of the buildings in the Wood Dale property.\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 1995, the Partnership conducted its annual formal unit valuation. The valuation of the Partnership's properties was performed by the General Partner, and then reviewed by an independent professional appraiser to assess the analysis and assumptions utilized. The estimated investment value of limited partnership Units resulting from this process is $158 per Unit. After distributions in February, 1996 of $4.00 per Unit which included a return of capital of $.75 per Unit and $3.25 per Unit from retained cash balances generated by the prior years' operations, the estimated valuation is $154. Units cannot currently 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 sets forth a summary of the selected financial data for the Partnership:\nYEARS ENDED DECEMBER 31, (Dollars in thousands except per-unit amounts)\n1995 1994 1993 1992 1991\nTotal assets $41,733 $41,885 $45,780 48,843 $52,769 Total revenues $6,094 $6,357 $6,211 $6,078 $5,853 Net income (loss) $1,783 $579 $(109) $(1,268) $(2,864) Net income (loss) per Unit $6.96 $2.26 $(0.43) $(4.95) $(11.18) Cash distributions paid to: Limited Partners $2,009 $4,400 $2,932 $2,970 $3,459 General Partner $20 $34 $30 $31 $35\nNotes: 1. 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 Net income (loss) include a loan loss provision of $118 and a valuation recovery of $109 in 1995, provisions for value impairment of $1,467, valuation recoveries of $82, and gain from the sale of the Benoris Building of $80 in 1994, valuation allowances of $1,968 in 1993, a valuation allowance of $1,428 and a provision for loan loss of $1,426 in 1992, and a $4,890 provision for loan loss in 1991.\n3. The figures above for Net income (loss) per Unit include a loan loss provision of $.46 per Unit and a valuation recovery of $.43 per Unit in 1995, provisions for value impairment of $5.73 per Unit, a valuation recovery of $.32 per Unit, and gain from sale of Benoris Building of $.31 per Unit in 1994, valuation allowances of $7.68 per Unit in 1993, and $5.57 per Unit in 1992, a provision for loan loss of $19.09 per Unit in 1991, and a provision for loan loss of $5.57 per Unit in 1992.\nDistributions declared per unit of limited partnership interest for fiscal years 1991 through 1995 were as follows:\nAmount of Distribution Year Ended per Unit\nDecember 31, 1991 $12.65 December 31, 1992 $11.53 December 31, 1993 $11.74 December 31, 1994 $17.45 December 31, 1995 $11.11\nThe foregoing distributions include a return of capital from proceeds of the initial public offering of Units, which had been retained as cash balances, in the amount per Unit of $.75 in 1995, $.49 in 1992, and $.47 in 1991, and a total of $2.92 in 1988-1990. The distribution for 1994 also includes $3.92 per Unit from the proceeds of the sale of the Benoris Building. The remainder of these distributions were paid from cash from operating activities.\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 253,641 Units for a total of $63,410,000, including the contribution of $25,000 from the original Limited Partner. The offering was terminated on June 30, 1987 and no additional units will be sold. After deduction of organizational and offering costs of $3,805,000, the Partnership had $59,605,000 available for investment and cash reserves. Through December 31, 1995 the Partnership had declared distributions constituting return of capital from the proceeds of this offering of approximately $1.2 million.\nThe Partnership owns ten properties or interests therein acquired on an all-cash basis (including two originally recorded as loans). The Partnership has sold a portion of one property, the Wood Dale property, and on February 1,\n1994 and October 10, 1995, respectively, acquired an ownership interest in Fairchild Corporate Center, and a 100% interest in River Run Shopping Center, each of which originated as a participating mortgage loan. The acquisition cost of the Partnership's current real estate investments and subsequent improvements thereto (including its interests in Fairchild Corporate Center and River Run Shopping Center) was $57,508,000. The Partnership has also recorded provisions for loan loss and value impairments totaling $11,106,000, and has sold one building (the Benoris Building) with a gross cost of $1,082,000. Therefore, the net investment in real estate before deduction for depreciation for financial reporting purposes is $45,320,000 as of December 31, 1995. These provisions and allowances are based on the General Partner's concern that the Partnership may be unable to recover the net carrying value of certain properties through future operations and sale. They resulted in part from lower market rents, higher vacancy rates, and\/or lower sale prices for comparable properties in markets where the properties are located.\nThe balance of the proceeds of the initial offering, approximately $1.7 million, is invested in short-term money market interest-bearing investments. The Partnership expects to incur capital expenditures for tenant improvements, lease commissions, and other major repairs and improvements during 1996 totaling approximately $1.6 million. Of this amount approximately $300,000 is budgeted for tenant improvement work and lease commissions in connection with the proposed lease of the large vacant space at South Point Plaza, as discussed in Item 1 above, and the balance is for renovations, leasing commissions and tenant improvements; the majority of these latter expenditures is also dependent on the execution of leases with new and renewing tenants.\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. At year-end 1995 the General Partner determined that 1995 year-end cash balances and cash anticipated to be generated from operating activities during 1996 would be more than adequate to fund the Partnership's current investing and operating needs. The distribution paid in February 1996 for the fourth quarter of 1995 thus included a return of capital of $190,000 ($.75 per Unit) from the Partnership's cash balances. Based on current expectations, cash distributions to partners from operating income may be higher than in 1995, in part because the Partnership is now assured of receiving all cash flow generated by the River Run property.\nAs of December 31, 1995, the Partnership maintained cash and cash equivalents aggregating $3,436,000, down $227,000 from the prior year end. This decrease resulted from slightly lower cash from operations and increased cash used in investing activities, particularly for the improvements at Westbrook Commons and Fairchild Corporate Center. Net cash provided by operating activities in 1995 decreased by $281,000. Net cash used in investing activities in 1995 increased by $1,505,000, due to the sale of the Benoris Building in 1994 and higher property improvement expenditures in 1995. Net cash used in financing activities decreased by $2,405,000 due primarily to lower distributions of cash from operations, and distributions of the proceeds of the sale of the Benoris Building in 1994.\nOperations\nOn January 1, 1996, the Partnership adopted 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 changes the Partnership's current method of accounting for its real estate property investments when circumstances indicate that the carrying amount of a property may not be recoverable. Measurement of an impairment loss on an operating property will now be based on the estimated fair value of the property rather than the sum of expected future cash flows. Properties held for sale will continue to be reflected at the lower of historical cost or estimated fair value less anticipated selling costs. In addition, properties held for sale will no longer be depreciated. No adjustment of the carrying values of the Partnership's real estate property investments was required at January 1, 1996 as a result of adopting SFAS No. 121.\n1995 v. 1994\nWhile the Partnership's statements of operations appear to show that the Fund's performance improved significantly over 1994, income was actually down $210,000 when the effect of value impairments, primarily at Scripps Terrace and Tierrasanta, are backed out of 1994's numbers. The change in River Run's status from a loan to an owned property had the most notable impact on the year-over-year comparison.\nIn the fourth quarter of 1995, the Partnership took over ownership of River Run and began accounting for it as a property rather than as a loan. This meant that its rental income and property level operating expenses, rather than interest, were included in the Partnership's results. Inclusion of its fourth quarter rental income caused that revenue category to be up for the full year over 1994. The\nbenefit, however, was more than offset by the decrease in interest income from the River Run loan and the increase in expenses related to the property, particularly the loan loss provisions and uncollectible interest. The Partnership believes that, over the long term, the Partnership's ownership of River Run will prove to be more beneficial than these early results indicate. This assumes no major deterioration in the local economy and that the Partnership is successful in its leasing efforts.\nTurning to the other properties in the portfolio, the lower average leased status at Fairchild Corporate Center and Clark Avenue drove the overall decline in rental income. The absence of Benoris, which was sold in 1994, also had a negative effect on the revenue comparison. The Partnership has initiated a renovation program at Fairchild and is seeing more interest in the building. Uncertainty over the plans of a major employer in Clark Avenue's market clouds the outlook for this property, but none of its leases is scheduled to expire in 1996.\nThe most noteworthy expense item which had a positive effect on the net income comparison with 1994, other than higher valuation impairments in 1994, was depreciation. Higher tenant improvement charge-offs in 1994 at Wood Dale, Tierrasanta, Scripps Terrace, Winnetka, Clark Avenue, and Riverview led to the decrease in depreciation versus 1994.\nLeases representing 21% of the portfolio's leasable square footage are scheduled to expire in 1996. These leases represent approximately 28% of the portfolio's rental income for 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 90% as of the end of 1995. Management anticipates that occupancy levels will increase in 1996. In most markets, new leases are generally expected to reflect level to higher market rental rates in comparison to the rates of expiring leases.\nThere are no single-tenant properties in the Partnership's portfolio, and no single tenant accounted for more than 10% of the Partnership's revenue in 1995. The Partnership therefore does not expect any material adverse effect on revenue on account of the failure of any single tenant in 1996. The Scripps Terrace property has 35% of its leases scheduled to expire in 1996, but the property accounted for less than 10% of 1995 revenue. At Tierrasanta, 38% of the leases expire in 1996, but the property accounted for less than 10% of 1995 revenues. At Fairchild Corporate Center, 31% of the leases expire in 1996, but the revenues from these leases represent less than 5% of the Partnership's\n1995 revenue from operations. Thus, the Partnership does not expect any material adverse effect as a result of the expiration of leases at these properties in 1996, unless there is an unanticipated economic downturn in the Southern California area, where these properties are located.\n1994 v. 1993\nRevenues in 1994 were up $146,000 over the prior year, while expenses declined $462,000. Net income was up $688,000 including an $80,000 gain on a property disposition.\nIn 1993, almost $2 million in loss provisions were made on two properties, resulting in a net loss of $109,000. In 1994, the Partnership recorded a $550,000 permanent value impairment for Tierrasanta and a $917,000 value impairment for Scripps Terrace. This expense was partially offset by positive adjustments in the valuation allowance for South Point Plaza of $73,000, made in order to maintain its carrying value at its estimated net realizable value, resulting in a net decrease in this expense category of $583,000 compared to the prior year.\nDepreciation increased by $434,000 over 1993, as the Partnership elected to accelerate the depreciation of the cost of tenant improvements to more closely reflect the useful life of the improvements, including cases where a tenant vacates its premises prior to the expiration of its lease term and the premises need to be remodeled prior to occupancy by a new tenant.\nThe increase in rental income related to several of the Partnership's properties. The most significant contributors were Westbrook Commons and Riverview. Higher rental rates at both locations, and a higher overall occupancy level at Riverview drove the improvement. The tenant reimbursement component of rental revenues was also up a Westbrook Commons, although the overall effect on net income was offset by corresponding expenses at the property.\nThe substantial increase in depreciation expense was offset to a great extent by a decrease in bad debt expense, primarily at River Run. The Partnership recorded sizeable loan loss provisions in 1993 to reflect significant concerns about the quality of this loan. In addition, improved quality of tenant accounts at Brinderson Plaza, Riverview, Winnetka, South Point Plaza, and Scripps Terrace also resulted in a decrease in bad debt expense. The only other expense category which increased in 1994 was the management fee to the General Partner, as a result of higher cash available for distribution.\nReconciliation of Financial and Tax Results\nFor 1995, The Partnership's book net income was $1,783,000, and its taxable income was $85,000. The provision for loan loss in connection with River Run was the primary difference. For 1994, the Partnership's book net income was $579,000, and its taxable income was $2,917,000. The valuation allowances in connection with Tierrasanta and Scripps Terrace and the continuation of the accrual of interest on the Brinderson loan for tax purposes were the primary differences. For 1993, the Partnership's book net loss was $109,000, and its taxable income was $2,670,000. The valuation allowance in connection with South Point Plaza and the continuation of the accrual of interest on the Brinderson loan for tax purposes were the primary differences. For a complete reconciliation see Note 9 to the Partnership's consolidated financial statements, which note is hereby incorporated by reference herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements appearing on pages 7 through 14 of the Partnership s 1995 Annual Report to Limited Partners are incorporated by reference in this Form 10-K Annual Report. The report on such financial statements of KPMG Peat Marwick LLP dated January 22, 1996 is filed as Exhibit 99(c) to this form 10-K Annual Report and is hereby incorporated by reference herein. Financial Statement Schedule III, Consolidated Real Estate and Accumulated Depreciation, is filed as Exhibit 99(b) 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 Partnership\nThe General Partner of the Partnership is T. Rowe Price Realty Income Fund III Management, Inc. (\"Fund III Management\"), 100 East Pratt Street, Baltimore, Maryland 21202. The General Partner has the primary responsibility for overseeing the evaluation, structuring, negotiation, management, and liquidation of the Partnership's investments\nas 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 III 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 I Management, Inc. (\"Fund I Management\"), T. Rowe Price Realty Income Fund II Management, Inc. (\"Fund II 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 is also investment manager for T. Rowe Price Renaissance Fund, Ltd., A Sales- Commission-Free Real Estate Investment (\"Renaissance Fund\"), a real estate investment trust sponsored by Associates. Associates was founded in 1937 and as of December 31, 1995 managed over $75 billion of assets.\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 III Management are as follows:\nPosition with T. Rowe Price Name Realty Income Fund III 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 Kenneth J. Rutherford Vice President\nJoseph P. Croteau Controller, also Principal Financial Officer for the Partnership\nMr. Riepe was elected President in 1991. Mr. Vieth was first elected as an officer and as a director in 1993. Ms. Robins was first elected to her current offices in 1987, Mr. Ruhe was first elected in 1988, and Mr. Croteau was first elected as Controller in 1988, and was designated as Principal Financial Officer for the Partnership in 1992. Mr. Rutherford was first elected as a Vice President in 1994. Mr. Hopkins was first elected a director in 1987. In all other cases these individuals have served in these capacities since the inception of Fund III Management in 1986. 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 Managing Director and Director, T. Rowe Price Associates, Inc. (\"Associates\") and Director of its Investment Services Division; President and Chairman of Real Estate Group, and each of the general partners of T. Rowe Price Realty Income Fund I, A No-Load Limited Partnership, T. Rowe Price Realty Income Fund II, America's Sales-Commission- Free Real Estate Limited Partnership, T. Rowe Price Realty Income Fund III, America's Sales-Commission-Free Real Estate Limited Partnership, and T. Rowe Price Realty Income Fund IV, America's Sales-Commission-Free Real Estate Limited Partnership (the \"Realty Income Funds\"); Chairman of four of the 41 mutual funds sponsored by Associates on which he serves as a director or trustee; Chairman of New Age Media Fund; Director, Rh ne-Poulenc Rorer, Inc., a pharmaceuticals company. Mr. Riepe joined Associates in 1982.\nCharles E. Vieth (Born 1956) is a Managing Director of Associates, and President of T. Rowe Price Retirement Plan Services, Inc., Director, Vice President and Manager of Real Estate Group, and Director and Vice President of each of the general partners of the Realty Income Funds. Mr. Vieth joined Associates in 1982.\nDouglas O. Hickman (Born 1949) is President of T. Rowe Price Threshold Fund Associates, Inc. and a Vice President of Associates. He is also a Vice President and Director of each of the general partners of the Realty Income Funds and 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 each of the general partners of the Realty Income Funds. He is also a Vice President 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 T. Rowe Price Services, Inc., and Vice President each of the general partners of the Realty Income Funds. Mr. Rayford joined Associates in 1982.\nLucy B. Robins (Born 1952) is Vice President and Associate Legal Counsel of Associates and Vice President of Real Estate Group and each of the general partners of the Realty Income Funds. Ms. Robins joined Associates in 1986.\nMark B. Ruhe (Born 1954) is an Asset Manager for the Investment Manager, and Vice President of Real Estate Group and each of the general partners of the Realty Income Funds. Mr. Ruhe joined Associates in 1987.\nAlvin M. Younger, Jr. (Born 1949) is Treasurer and Director of each of the general partners of the Realty Income Funds and a Managing Director, Secretary and Treasurer of Associates, and Secretary and Treasurer of Real Estate Group. Mr. Younger joined Associates in 1973.\nKenneth J. Rutherford (Born 1963) is Assistant to the Director of Associates' Investment Services Division, and Assistant Vice President of each of the general partners of the Realty Income Funds. Mr. Rutherford joined Associates in 1992. From 1990 to 1992 he was a student at the Stanford Graduate School of Business.\nJoseph P. Croteau (Born 1954) is a Vice President and Controller of Associates, and Controller of each of the general partners of the Realty Income Funds. Mr. Croteau joined Associates in 1987.\nNo Forms 3, Forms 4, Forms 5, or amendments to any of them, were furnished to the registrant during its most recent fiscal year. Based on a review of and 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, if any, 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 executive officers of the General Partner receive no current or proposed remuneration from the Partnership.\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 \"Income and Losses and Cash Distributions\" of the Prospectus on pages 7-8, and 32-35, respectively, which pages are incorporated herein by reference.\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 the advisory contract. 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 compensation may be based, in part, on the performance of the Partnership. Any 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 issues 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 February 1, 1996, the directors and officers of the General Partner, as a group, beneficially owned 5.76% of the common stock of Associates, including options to purchase 282,870 shares exercisable within 60 days of February 1, 1996, and shares as to which voting power is shared with others. Of this amount, Mr. Riepe owned 2.36% of such stock (550,939 shares, including 42,400 shares which may be acquired by Mr. Riepe upon the exercise of stock options, 70,000 shares held in trusts for members of Mr. Riepe's family and 20,000 shares held by a member of 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 shared voting and disposition power). Mr. Hopkins owned 1.10% (317,484 shares, including 54,000 shares which may be acquired by Mr. Hopkins upon the exercise of stock options). 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 7-12, which pages are hereby incorporated by reference herein.\nAs compensation for services rendered in managing the affairs of the Partnership, the General Partner earned a partnership management fee of $282,000 in 1995, and received 1% of the cash distributions, totaling $28,000 in 1995. In addition, certain operating expenses incurred on behalf of the Partnership are reimbursable to the General Partner. In 1995 the General Partner was reimbursed for expenses incurred by it in the administration of the Partnership and the operation of the Partnership's investments, which amounted to $77,000. An affiliate of the General Partner has earned a fee of $12,000 from the money market mutual funds in which the Partnership made its interim cash investments 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:\n(1) Financial Statements:\nIncorporated by reference from the indicated pages of the Partnership's 1995 Annual Report to Limited Partners:\nPage\nConsolidated Balance Sheets at 7 December 31, 1995 and 1994 Consolidated Statements of Operations 8 for each of the three years in the period ended December 31, 1995 Consolidated Statements of Partners' Capital 9 for each of the three years in the period ended December 31, 1995 Consolidated Statements of Cash Flows for 10 each of the three years in the period ended December 31, 1995 Notes to Consolidated Financial Statements 11-14\nIndependent Auditors' Report - Incorporated by reference from Exhibit 99(c) hereof.\n(2) Financial Statement Schedules:\nIII - Consolidated Real Estate and Accumulated Depreciation, incorporated by reference to Exhibit 99(b) 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) Exhibits\n3, 4. (a) Agreement of Limited Partnership of the Partnership dated October 20, 1986, as amended and restated as of January 5, 1987, included as Exhibit A to the Prospectus of the Partnership, dated January 5, 1987, File Number 33-9899, as filed with the Commission pursuant to Rule 424(b) (\"the Prospectus\"), incorporated by reference herein.\n(b) Certificate of Limited Partnership, incorporated by reference to Exhibit 3,4 to the Partnership's Registration Statement, File No. 33-9899, as filed on January 5, 1987.\n(c) Amendment to the Partnership Agreement dated April l, 1987, incorporated by reference to Exhibit 3,4(b) to Registrant's Report on Form 10-K for the year ended December 31, 1987 (\"the 1987 10-K\").\n(d) Amendment to the Partnership Agreement dated May l, 1987, incorporated by reference to Exhibit 3,4(c) to the 1987 10-K.\n(e) Amendment to the Partnership Agreement dated June l, 1987, incorporated by reference to Exhibit 3,4(d) to the 1987 10-K.\n(f) Amendment to the Partnership Agreement dated July l, 1987, incorporated by reference to Exhibit 3,4(e) to the 1987 10-K.\n(g) Amendment to the Partnership Agreement dated August l, 1987, incorporated by reference to Exhibit 3,4(f) to the 1987 10-K.\n(h) Amendment to the Partnership Agreement dated September l, 1987, incorporated by reference to Exhibit 3,4(g) to the 1987 10-K.\n(i) Amendment to the Partnership Agreement dated March 28, 1988, incorporated by reference to Exhibit 3,4(h) to the 1987 10-K.\n10. (a) Joint Venture Agreement of Fairchild 234, dated as of May 25, 1988, incorporated by reference to Exhibit 10(f) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988 (\"the 1988 10-K\").\n(b) First Amendment to Joint Venture Agreement of Fairchild 234, dated as of July 13, 1988, incorporated by reference to Exhibit 10(g) to the 1988 10-K.\n(c) Forbearance and Loan Modification Agreement relating to River Run Dated November 17, 1993, between Stiles Hunt Properties as Borrower and the Partnership as Lender, incorporated by reference to Exhibit 10(j) to Registrant's Report on Form 10-K for the year ended December 31, 1994.\n13. Annual Report for the year ended December 31, 1995, distributed to limited partners on or about March 6, 1996.\n27. Financial Data Schedule\n99. (a) Pages 7-12, 18-25 and 32-35 of the Prospectus of the Partnership dated January 5, 1987, incorporated by reference to Exhibit 99(a) of the registrant's report on Form 10-K for the year ended December 31, 1994, File Number 0-16542.\n(b) Financial Statement Schedule III - Consolidated Real Estate and Accumulated Depreciation.\n(c) Report of KPMG Peat Marwick LLP dated January 22, 1996 regarding the financial statements of the Partnership.\n(b) Reports on Form 8-K\nThe following reports on Form 8-K were filed for the last quarter of the period covered by this report - None.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:\nDated: March 28, 1996 T. ROWE PRICE REALTY INCOME FUND III, AMERICA'S SALES-COMMISSION-FREE REAL ESTATE LIMITED PARTNERSHIP\nBy: T. Rowe Price Realty Income Fund III Management, Inc., General Partner\nBy:\/s\/James S. Riepe 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: March 28, 1996 James S. Riepe, Director and Chairman of the Board, President T. Rowe Price Realty Income Fund III Management, Inc., Principal Executive Officer for the Partnership\n\/s\/Henry H. Hopkins Date: March 28, 1996 Henry H. Hopkins, Director and Vice President, T. Rowe Price Realty Income Fund III Management, Inc.\n\/s\/Douglas O. Hickman Date: March 20, 1996 Douglas O. Hickman, Director and Vice President, T. Rowe Price Realty Income Fund III Management, Inc.\n\/s\/Alvin M. Younger, Jr. Date: March 28, 1996 Alvin M. Younger, Jr., Director and Treasurer, T Rowe Price Realty Income Fund III Management, Inc.\n\/s\/Charles E. Vieth Date: March 20, 1996 Charles E. Vieth, Vice President and Director, T. Rowe Price Realty Income Fund III Management, Inc.\n\/s\/Joseph P. Croteau Date: March 28, 1995 Joseph P. Croteau, Controller, Principal Financial Officer for the Partnership\nThe Annual Report to Limited Partners for the Year ended December 31, 1995 should be inserted her.\nANNUAL REPORT FOR THE PERIOD ENDED DECEMBER 31, 1995\nFELLOW PARTNERS:\nWhile it appears from the statements of operations on page 8 that the Fund's performance improved significantly over 1994, income was actually down $210,000 when the effect of value impairments, primarily at Scripps Terrace and Tierrasanta, are backed out of last year's numbers. Before discussing operations at the properties owned by the Fund for the full 12 months of 1994 and 1995, we want to point out that the change in River Run's portfolio status had the most notable impact on the year-over-year comparison.\nIn the fourth quarter of 1995, we took over ownership of River Run and began accounting for it as a property rather than as a loan. This meant that its rental income and property level operating expenses, rather than interest, were included in the Fund's results. Inclusion of its fourth quarter rental income caused that revenue category to be up for the full year over 1994. The benefit, however, was more than offset by the decrease in interest income from the River Run loan and the increase in expenses related to the property, particularly the loan loss provision and uncollectible interest, related to River Run. We believe that, over the long term, the Fund's ownership of River Run will prove to be more beneficial than these early results indicate. This assumes, of course, no major deterioration in the local economy and that we are successful in our leasing efforts.\nTurning to the other properties in the portfolio, the lower average leased status at Fairchild and Clark Avenue drove the overall decline in rental income. The absence of Beinoris, which was sold last year, also had a negative effect on the revenue comparison. We have initiated a renovation program at Fairchild and are seeing more interest in the building, which we hope will translate into signed leases. Uncertainty over the plans of a major employer in Clark Avenue's market clouds the outlook for this property, but we find some comfort in the fact that none of its leases is scheduled to expire this year.\nThe most noteworthy expense item which had a positive effect on the net income comparison with last year, other than higher valuation impairments in 1994, was depreciation. Higher tenant improvement charge-offs in 1994 at Wood Dale, Tierrasanta, Scripps Terrace, Winnetka, Clark Avenue, and Riverview led to the decrease in depreciation versus 1994.\nSlightly lower cash from operations and increased cash used in investing activities (particularly for the improvements at Westbrook Commons and Fairchild Corporate Center) led to the decrease in the Fund's cash position during 1995.\nDistributions\nYour distribution for the fourth quarter of 1995 was $6.37 per unit, bringing the total for the year to $11.11. Of the fourth quarter amount, $2.37 was from 1995 operations and $4.00 was distributed from prior-year operations. The initial uncertainty surrounding the ability of the River Run owner to continue the loan payments and the potential costs of foreclosure caused us to maintain a relatively high cash position. Now that we own the property, we no longer need to retain as much cash.\nUnit Valuation\nAs we do at each year-end, we employed a third-party appraiser to review and assess the analysis and assumptions used in determining an estimated current unit value. These interim valuations are not necessarily representative of the value of your units when the Fund ultimately liquidates its holdings, nor could you sell your units today at a price equal to the current estimated value.\nThe estimated unit value at year-end 1995 was $158.00, unchanged from the 1994 amount. The $158.00 included the $4.00 just distributed from prior years' operations, so, as of February 14, the estimated value per unit was reduced by that amount and is now $154.00.\nThe first quarter 1996 distribution has been set at $2.00 per unit. Assuming no unexpected developments or property dispositions, we expect to pay the same amount for the second and third quarters as well. In the fourth quarter, we will adjust the distribution based on the Fund's operations and cash needs.\nOutlook\nAs the Advisor's Report indicates, we hope that a number of initiatives taken in 1995 will bear fruit in 1996. The modernization at Westbrook Commons and renovations at Fairchild were undertaken to enhance the attractiveness of these properties to existing as well as prospective tenants. Barring local market deterioration, we expect these efforts will begin to be rewarded in 1996.\nSincerely,\nJames S. Riepe Chairman\nFebruary 15, 1996\nINVESTMENT ADVISOR'S REPORT\nAs discussed in recent reports, the real estate market is slowly improving, with some segments such as industrial recovering more rapidly than others such as office properties. The absence of meaningful new construction combined with continued net positive absorption in all segments has begun to attract not only opportunistic capital but also some institutional capital into the real estate sector, which is a favorable development.\nThe results of Russell-NCREIF Index, which measures income returns and changes in values for real estate investments, reflect the general state of the market. From 1991 through 1993 property values experienced average annual declines of approximately 10%. This rate slowed as values decreased by 4% and 1% for the 12 months ended September 30, 1994 and 1995, respectively. Income returns of 9% during each of those two years more than offset the value declines, resulting in positive total returns for the index for the first time since September 1990.\nThe index also identifies returns by product type and by geographical region. As anticipated, because of the weak operating environment, office buildings have not performed as well as other product types, with value declines of approximately 3% for the 12 months ended September 30, 1995. This is an improvement, however, over the average 14% per year drop over the last four years. Industrial properties, on the other hand, appreciated in value by 3% for the 12 months ended September 30, 1995. In that same period, other real estate product types, such as retail and multi-family, performed better than they had in prior years.\nProperty values in geographic regions depend significantly on the local economy. The South, where values in general depreciated less than 1% for the 12 months ended September 30, 1995, continues to outperform other regions, but even its recovery has been prolonged due to the depressed energy business. Value declines in the East and Midwest have moderated, and the Western region has experienced a dramatic improvement recently. In 1994, property values in the West were down significantly but, for the 12 months ended September 30, 1995, declined only around 1%. In analyzing this information, it is clear that the multi-family and industrial segments are heavily influencing the results, since the office segment in the West declined approximately 5%. We continue to see increased leasing activity and improved economics for owners.\nWe are encouraged by the positive annual returns of the Russell-NCREIF Index for the past two years. We are even more heartened, however, by the performance of Realty Income Fund III's portfolio, whose value remained stable as opposed to a decrease in the Russell-NCREIF Index.\nProperty Highlights\nActivity during 1995 for new, renewal, and expansion leases totaled 21% of the Fund's square footage. However, the gains were offset, primarily by the loss of three fairly sizable tenants at two properties, so occupancy was unchanged from the prior-year level. In general, occupancy and rental rates in the markets where your properties operate are stable to rising.\nReal Estate Investments __________________________________________\nGross % Leased Leasable ___________________ Area Prior Current 1996 Lease Property (Sq. Ft.) Year-End Year-End Expirations _________________ ________ _______ ________ __________ Scripps Terrace 56,800 81% 82% 35% Winnetka 188,300 94 100 19 South Point 48,400 61 69 19 Tierrasanta 104,200 77 100 38 Wood Dale 89,700 100 89 30 Clark Avenue 40,000 100 72 0 Riverview 113,700 91 96 22 Westbrook Commons 121,600 97 96 6 Fairchild Corporate Center 104,800 85 73 31 River Run 92,800 100 90 1 _________ _____ _____ _____ Fund Total 960,300 90% 90% 21%\nScripps Terrace: One new 6,300 square-foot lease more than offset the loss of a tenant when its lease expired at this San Diego, California, office project. We are actively negotiating with the three tenants whose leases covering 35% of the total space expire this year.\nWinnetka: Even though one sizable tenant vacated upon its lease expiration, a renewal was quickly negotiated with an existing tenant who expanded into the space. We also leased the remaining unoccupied space, bringing this suburban Minneapolis industrial project to 100% leased by year-end.\nSouth Point: One short-term expansion, two new, and four renewal leases for 19% of this Tempe, Arizona, shopping center more than offset the loss of one tenant who did not renew. We continue to be optimistic about our negotiations with a prospective tenant who would represent over 30% of the center. To improve our negotiating position, we have received some zoning variances but are still working with the city and potential tenant to reach a mutually satisfactory agreement. If we are successful, the lease could be signed during the next two to three months. The tenant, however, would not begin paying rent until around the last quarter of 1996. Moreover, significant tenant improvement costs would be incurred.\nTierrasanta: Although we lost one financially troubled tenant during the year, we were able to re-lease its space, bringing the leased status to 100% by year-end. In total, three new leases for 31,000 square feet and one renewal\/expansion were signed at this San Diego property. One lease with a tenant who occupies 38% of the space expires in 1996, and we are actively working with this tenant on renewal terms. It is too early to predict an outcome of the negotiations.\nWood Dale: Two tenants renewed their leases for three or more years and one extended its lease into 1996 for a total of 27,400 square feet. One tenant, however, who occupied 9,500 square feet, vacated upon its lease expiration near the end of the year. Thus, this suburban Chicago industrial property experienced a decline in occupancy during the fourth quarter and from the December 1994 level.\nClark Avenue: The only activity which occurred at this King of Prussia, Pennsylvania, office property during the year was the loss of a financially troubled tenant who occupied 28% of the property one month before its lease expired. Although we have had interest from a couple of prospective tenants, we do not believe that a signed lease is imminent. Market occupancy improved slightly, but the future of local Lockheed Martin operations, which dominate the office market, is still uncertain, and rental rates remain flat despite the lower vacancies.\nRiverview: This St. Paul, Minnesota, industrial project had an eventful year. Three tenants representing 18% of the space renewed and\/or expanded their leases, and one new tenant was signed. This activity more than offset the loss of two tenants who vacated when their leases expired, and the property's leased status increased by five percentage points over last year.\nWestbrook Commons: One new and six renewal leases were signed during the year, generally at higher rates than on the prior leases, at this suburban Chicago retail center. However, one tenant did not renew, and two tenants left because of credit issues, causing occupancy to decline slightly. During the year, we initiated a strategy to update the appearance of the center in order to make it more attractive to prospective tenants. The property's face lift has made a substantial difference.\nFairchild Corporate Center: The leased status declined at this Orange County, California, office property primarily due to the loss on the last day of the year of a tenant representing 9% of the space. Additionally, over the course of the year, two tenants who leased a total of 6% of the property left for financial reasons and three other tenants vacated upon their lease expirations. On the positive side, we completed the first phase of renovating the two buildings, renamed the property, and overall activity has picked up. Three new tenants were signed for 16% of the site, and six existing tenants renewed and\/or expanded for another 8% of the property.\nRiver Run: At this South Florida retail center, the signing of new and renewal leases representing 3% of the total space was not enough to offset the effect of three tenants who did not renew their leases and three others who defaulted and were forced to vacate. As you may recall, the Fund foreclosed on its loan for this property and officially took ownership on October 10. As the new owner, we are in the process of repositioning the property to meet the needs of the surrounding communities. As a result, occupancy may decline further in the near term as we focus on improving both tenant creditworthiness and mix.\nOutlook\nWe believe 1995 was a turning point for Realty Income Fund III. We gained control of River Run, all of the markets except King of Prussia showed signs of improvement, and renovations were commenced at one property and completed at another. We hope 1996 will continue in a favorable vein and that operating results will improve during the year ahead.\nLaSalle Advisors February 15, 1996\nREAL ESTATE HOLDINGS December 31, 1995 (In thousands)\nAccumu- Current Type and Date Total lated De- Carrying Property Name Location Acquired Cost* preciation Amount _____________ ____________ __________ _______ ___________ ________\nScripps Business Park 2\/88 $ 4,354 $ (1,030) $ 3,324 Terrace San Diego, California\nWinnetka Industrial 3\/88 5,794 (1,643) 4,151 Crystal, Minnesota\nSouth Point Retail 4\/88 2,213 (841) 1,372 Tempe, Arizona\nTierrasanta Business Park 4\/88 3,454 (859) 2,595 San Diego, California\nFairchild Office Corporate Irvine, 5\/88 4,063 (465) 3,598 Center California\nWood Dale Industrial 9\/88 3,657 (658) 2,999 Wood Dale, Illinois\nClark Avenue R&D\/Office 10\/88 4,242 (733) 3,509 King of Prussia, Pennsylvania\nRiverview Industrial 12\/88 4,184 (870) 3,314 St. Paul, Minnesota\nRiver Run Retail 6\/89 7,700 (42) 7,658 Miramar, Florida\nWestbrook Retail 12\/90 5,659 (690) 4,969 Commons Westchester, Illinois\n_______ _______ _______ $45,320 $ (7,831) $37,489 _______ _______ _______ _______ _______ _______\n*Includes original purchase price, subsequent improvements, and, in the case of South Point, Tierrasanta, Scripps Terrace, and Fairchild Corporate Center, reductions for permanent impairments.\nCONSOLIDATED BALANCE SHEETS (In thousands)\nDecember 31, December 31, 1995 1994 __________ __________\nAssets Real Estate Property Investments Land. . . . . . . . . . . . . . . . . . . $ 12,181 $ 10,332 Buildings and Improvements. . . . . . . . 33,139 26,475 ________ ________ 45,320 36,807 Less: Accumulated Depreciation and Amortization. . . . . . . . . . . . . (7,831) (7,037) ________ ________ 37,489 29,770 Participating Mortgage Loan and Deferred Interest (less allowance of $1,736 in 1994) . . . . . - 7,840 Cash and Cash Equivalents. . . . . . . . . . 3,436 3,663 Accounts Receivable (less allowances of $230 and $238). . . . . . . . . . . . . . 529 434 Other Assets . . . . . . . . . . . . . . . . 279 178 ________ ________ $ 41,733 $ 41,885 ________ ________ ________ ________\nLiabilities and Partners' Capital Security Deposits and Prepaid Rents. . . . . $ 391 $ 385 Accrued Real Estate Taxes. . . . . . . . . . 433 441 Accounts Payable and Other Accrued Expenses . . . . . . . . . . . 335 238 ________ ________ Total Liabilities. . . . . . . . . . . . . . 1,159 1,064 Partners' Capital. . . . . . . . . . . . . . 40,574 40,821 ________ ________ $ 41,733 $ 41,885 ________ ________ ________ ________\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per-unit amounts)\nYears Ended December 31, 1995 1994 1993 _______ _______ _______\nRevenues Rental Income. . . . . . . . . . . . . . . $5,502 $5,369 $5,220 Interest Income from Participating Mortgage Loan. . . . . . . . . . . . . . . 429 858 897 Other Interest Income. . . . . . . . . . . 163 130 94 _______ _______ _______ 6,094 6,357 6,211 _______ _______ _______\nExpenses Property Operating Expenses. . . . . . . . 1,284 1,249 1,511 Real Estate Taxes. . . . . . . . . . . . . 1,002 936 1,000 Depreciation and Amortization. . . . . . . 1,266 1,572 1,138 Decline (Recovery) of Property Values. . . . . . . . . . . . . . (109) 1,385 1,968 Provision for Loan Loss and Uncollectible Interest . . . . . . . . . . 202 - - Management Fee to General Partner. . . . . 282 342 297 Partnership Management Expenses. . . . . . 384 374 406 _______ _______ _______ 4,311 5,858 6,320 _______ _______ _______\nNet Income (Loss) from Operations before Real Estate Sold. . . . . . . . . . . . 1,783 499 (109) Gain on Real Estate Sold . . . . . . . . . - 80 - _______ _______ _______ Net Income (Loss). . . . . . . . . . . . . $1,783 $ 579 $ (109) _______ _______ _______ _______ _______ _______\nActivity per Limited Partnership Unit Net Income (Loss). . . . . . . . . . . . . $ 6.96 $ 2.26 $(0.43) _______ _______ _______ _______ _______ _______\nCash Distributions Declared from Operations. . . . . . . . . . . . . $11.11 $13.53 $11.74 from Sale Proceeds . . . . . . . . . . . - 3.92 - _______ _______ _______ Total Distributions Declared . . . . . . . $11.11 $17.45 $11.74 _______ _______ _______ _______ _______ _______ Units Outstanding. . . . . . . . . . . . . 253,599 253,605 253,613 _______ _______ _______ _______ _______ _______\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (In thousands)\nGeneral Limited Partner Partners Total ________ ________ ________\nBalance, December 31, 1992 . . . . . $ (127) $ 47,875 $ 47,748 Net Loss . . . . . . . . . . . . . . (1) (108) (109) Cash Distributions . . . . . . . . . (30) (2,932) (2,962) _______ _______ _______ Balance, December 31, 1993 . . . . . (158) 44,835 44,677 Net Income . . . . . . . . . . . . . 6 573 579 Redemption of Units. . . . . . . . . - (1) (1) Cash Distributions . . . . . . . . . (34) (4,400) (4,434) _______ _______ _______ Balance, December 31, 1994 . . . . . (186) 41,007 40,821 Net Income . . . . . . . . . . . . . 18 1,765 1,783 Redemption of Units. . . . . . . . . - (1) (1) Cash Distributions . . . . . . . . . (20) (2,009) (2,029) _______ _______ _______ Balance, December 31, 1995 . . . . . $ (188) $ 40,762 $ 40,574 _______ _______ _______ _______ _______ _______\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nYears Ended December 31, 1995 1994 1993 _______ _______ _______\nCash Flows from Operating Activities Net Income (Loss). . . . . . . . . . . . . $1,783 $ 579 $ (109) Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by Operating Activities Depreciation and Amortization . . . . . 1,266 1,572 1,138 Decline (Recovery) of Property Values . . . . . . . . . . . . (109) 1,385 1,968 Change in Loan Loss Provision . . . . . 202 - - Other Changes in Assets and Liabilities . . . . . . . . . . . . (163) (276) 88 _______ _______ _______ Net Cash Provided by Operating Activities . . . . . . . . . . . 2,979 3,260 3,085 _______ _______ _______\nCash Flows from Investing Activities Proceeds from Property Disposition . . . . - 994 - Investments in Real Estate . . . . . . . . (1,176) (665) (691) _______ _______ _______ Net Cash Provided by (Used in) Investing Activities . . . . . . . . . . . (1,176) 329 (691) _______ _______ _______\nCash Flows from Financing Activities Cash Distributions . . . . . . . . . . . . (2,029) (4,434) (2,962) Redemption of Units. . . . . . . . . . . . (1) (1) - _______ _______ _______ Net Cash Used in Financing Activities . . . . . . . . . . . (2,030) (4,435) (2,962) _______ _______ _______\nCash and Cash Equivalents Net Decrease during Year . . . . . . . . . (227) (846) (568) At Beginning of Year . . . . . . . . . . . 3,663 4,509 5,077 _______ _______ _______ At End of Year . . . . . . . . . . . . . . $3,436 $3,663 $4,509 _______ _______ _______ _______ _______ _______\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION\nT. Rowe Price Realty Income Fund III, America's Sales-Commission-Free Real Estate Limited Partnership (the \"Partnership\"), was formed on October 20, 1986, under the Delaware Revised Uniform Limited Partnership Act for the purpose of acquiring, operating, and disposing of existing income-producing commercial and industrial real estate properties. T. Rowe Price Realty Income Fund III Management, Inc., is the sole General Partner. The initial offering resulted in the sale of 253,641 limited partnership units at $250 per unit.\nIn accordance with provisions of the partnership agreement, income from operations is allocated and related cash distributions are generally paid to the General and Limited Partners at the rates of 1% and 99%, respectively. Sale or refinancing proceeds are generally allocated first to the Limited Partners in an amount equal to their capital contributions, next to the Limited Partners to provide specified returns on their adjusted capital contributions, next 3% to the General Partner, with any remaining proceeds allocated 85% to the Limited Partners and 15% to the General Partner. Gain on property sold is generally allocated first between the General Partner and Limited Partners in an amount equal to the depreciation previously allocated from the property and then in the same ratio as the distribution of sale proceeds. Cash distributions, if any, are made quarterly based upon cash available for distribution, as defined in the partnership agreement. Cash available for distribution will fluctuate as changes in cash flows and adequacy of cash balances warrant.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Partnership's financial statements are prepared in accordance with generally accepted accounting principles which requires the use of estimates and assumptions by the General Partner. Certain 1993 and 1994 amounts have been reclassified to conform with the 1995 presentation.\nThe accompanying consolidated financial statements include the accounts of the Partnership and its pro-rata share of the accounts of South Point Partners, Tierrasanta 234, Fairchild 234, and Penasquitos 34 (Westbrook Commons), all of which are California general partnerships, in which the Partnership has 50%, 30%, 56%, and 50% interests, respectively. The other partners in these ventures are affiliates of the Partnership. All intercompany accounts and transactions have been eliminated in consolidation.\nDepreciation is calculated primarily on the straight-line method over the estimated useful lives of buildings and improvements, which range from five to 40 years. Lease commissions and tenant improvements are capitalized and amortized over the life of the lease using the straight-line method.\nCash equivalents consist of money market mutual funds, the cost of which approximates fair value.\nThe Partnership uses the allowance method of accounting for doubtful accounts. Provisions for uncollectible tenant receivables in the amounts of $192,000, $89,000, and $469,000 were recorded in 1995, 1994, and 1993, respectively. Bad debt expense is included in Property Operating Expenses.\nThe Partnership will review its real estate property investments for impairment whenever events or changes in circumstances indicate that the property carrying amounts may not be recoverable. Such a review results in the Partnership recording a provision for impairment of the carrying value of its real estate investments whenever the estimated future cash flows from a property's operations and projected sale are less than the property's net carrying value. The General Partner believes that the estimates and assumptions used in evaluating the carrying value of the Partnership's properties are appropriate; however, changes in market conditions and circumstances could occur in the near term which would cause these estimates to change.\nRental income is recognized by the Partnership on a straight-line basis over the term of each lease. Rental income accrued, but not yet billed, is included in Other Assets and aggregates $205,000 and $132,000 at December 31, 1995 and 1994, respectively.\nUnder provisions of the Internal Revenue Code and applicable state taxation codes, partnerships are generally not subject to income taxes; therefore, no provision has been made for such taxes in the accompanying consolidated financial statements.\nNOTE 3 - TRANSACTIONS WITH RELATED PARTIES AND OTHER ENTITIES\nAs compensation for services rendered in managing the affairs of the Partnership, the General Partner earns a partnership management fee equal to 9% of net operating proceeds. The General Partner earned partnership management fees of $282,000, $342,000, and $297,000 in 1995, 1994, and 1993, respectively. In addition, the General Partner's share of cash available for distribution from operations, as discussed in Note 1, totaled $28,000, $34,000, and $30,000 in 1995, 1994, and 1993, respectively.\nIn accordance with the partnership agreement, certain operating expenses are reimbursable to the General Partner. The General Partner's reimbursement of such expenses totaled $77,000, $74,000, and $82,000 for communications and administrative services performed on behalf of the Partnership during 1995, 1994, and 1993, respectively.\nAn affiliate of the General Partner earned a normal and customary fee of $12,000, $15,000, and $16,000 from the money market mutual funds in which the Partnership made its interim cash investments during 1995, 1994, and 1993, respectively.\nLaSalle Advisors Limited Partnership (\"LaSalle\") is the Partnership's advisor and is compensated for its advisory services directly by the General Partner. LaSalle is reimbursed by the Partnership for certain operating expenses pursuant to its contract with the Partnership to provide real estate advisory, accounting, and other related services to the Partnership. LaSalle's reimbursement for such expenses during each of the last three years totaled $120,000.\nAn affiliate of LaSalle earned $54,000, $37,000, and $7,000 in 1995, 1994, and 1993, respectively, as property manager for several of the Partnership's properties.\nNOTE 4 - PROPERTY DISPOSITION\nIn September 1994, the Partnership sold the smallest of the three Wood Dale industrial buildings, the Benoiris Building, and received net proceeds of $994,000. The net book value of this property at the time of disposition was $914,000, after accumulated depreciation expense. Results of operations at this building were immaterial to the Funds' results of operations in 1994 and 1993.\nNOTE 5 - FAIRCHILD CORPORATE CENTER\nFairchild Corporate Center, formerly known as Brinderson Plaza, was acquired outright on February 1, 1994 by a corporation, the stockholders of which are the Partnership and certain other affiliated partnerships. The previously established valuation allowance for this property was reduced $9,000 and the remaining allowance of $1,629,000 (including $210,000 arising in 1993) was reclassified as a reduction in the carrying value of the property. Prior to February 1, 1994, the Partnership's underlying investment in Fairchild, in the form of a mortgage loan and minority equity interest, was accounted for as an in-substance foreclosed property in the Partnership's financial statements.\nNOTE 6 - PARTICIPATING MORTGAGE LOAN\nIn July 1995, the Partnership began consensual foreclosure on the participating mortgage loan secured by the River Run Shopping Center and ceased the accrual of interest income. At September 30, 1995, the carrying value of the loan was reduced to $7,700,000, the estimated fair value of the underlying property, and additional loan losses of $118,000 were recognized. On October 10, 1995, the Partnership purchased the property and, in connection therewith, reclassified the participating mortgage loan as an investment in real estate.\nNOTE 7 - PROPERTY VALUATIONS\nBased upon a review of current market conditions, estimated holding period, and future performance expectations of each property, the General Partner has determined that the net carrying value of other operating properties may not be fully recoverable from future operations and disposition. Charges recognized for impairments of the carrying values of Scripps Terrace and Tierrasanta aggregated $1,467,000 in 1994.\nBecause the South Point property was not being actively marketed for sale, its carrying value was assessed and, accordingly, the property's net valuation allowance of $1,576,000 at December 31, 1995 was reclassified as a permanent impairment of the its carrying value. Valuation allowances (recoveries) for this property were ($109,000) in 1995, ($73,000) in 1994 and $1,758,000 in 1993. Because this property continued to operate at the time the valuation allowance was established, the Partnership continued to recognize depreciation expense which, in large part, contributed to the valuation recoveries in 1995 and 1994.\nOn January 1, 1996, the Partnership adopted 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 changes the Partnership's current method of accounting for its real estate property investments when circumstances indicate that the carrying amount of a property may not be recoverable. Measurement of an impairment loss on an operating property will now be based on the estimated fair value of the property rather than the sum of expected future cash flows. Properties held for sale will continue to be reflected at the lower of historical cost or estimated fair value less anticipated selling costs. In addition, properties held for sale will no longer be depreciated. No adjustment of the carrying values of the Partnership's real estate property investments was required at January 1, 1996 as a result of adopting SFAS No. 121.\nNOTE 8 - LEASES\nFuture minimum rentals to be received by the Partnership under noncancelable operating leases in effect as of December 31, 1995, are:\nFiscal Year (in thousands) __________ 1996 $ 3,985 1997 3,166 1998 2,597 1999 1,947 2000 1,478 Thereafter 9,175 _______ Total $ 22,348 _______ _______\nNOTE 9 - RECONCILIATION OF FINANCIAL STATEMENT TO TAXABLE INCOME\nAs described in Note 2, the Partnership has not provided for an income tax liability; however, certain timing differences exist between amounts reported for financial reporting and federal income tax purposes. These differences are summarized below for years ended December 31:\n1995 1994 1993 ________ ________ ________ (in thousands)\nBook net income (loss) . . . . $ 1,783 $ 579 $ (109) Allowances for: Uncollectible accounts receivable . . . . . . . . . (4) 71 117 Property valuations. . . . . (109) 1,385 1,968 Normalized and prepaid rents. . . . . . . . . (23) (103) 56 Interest income. . . . . . . . 661 633 691 Depreciation . . . . . . . . . (283) 353 (62) Accrued expenses . . . . . . . 16 (1) 9 Provision for loan loss. . . . (1,956) - - ________ ________ ________ Taxable income . . . . . . . . $ 85 $ 2,917 $ 2,670 ________ ________ ________ ________ ________ ________\nNOTE 10 - SUBSEQUENT EVENT\nThe Partnership declared a quarterly cash distribution of $6.37 per unit to Limited Partners of the Partnership as of the close of business on December 31, 1995. The distribution totals $1,632,000 and represents cash available for distribution from operations for the period October 1, 1995 through December 31, 1995. The Limited Partners will receive $1,616,000, and the General Partner will receive $16,000.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners T. Rowe Price Realty Income Fund III, America's Sales-Commission-Free Real Estate Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of T. Rowe Price Realty Income Fund III, America's Sales-Commission-Free Real Estate Limited Partnership and its consolidated ventures as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' capital 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 from 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 T. Rowe Price Realty Income Fund III, America's Sales-Commission-Free Real Estate Limited Partnership and its consolidated ventures 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\nChicago, Illinois January 22, 1996","section_15":""}
{"filename":"845779_1995.txt","cik":"845779","year":"1995","section_1":"ITEM 1. BUSINESS\n(a)\tDEVELOPMENT OF BUSINESS\nAbatix Environmental Corp. (\"Abatix\" or the \"Company\") markets and distributes personal protection and safety equipment, and durable and nondurable supplies to the asbestos and lead abatement, industrial safety and hazardous materials industries. In addition to these products, the Company also distributes tools and tool supplies to the construction industry. During 1995, the Company sold over 9,000 products consisting of equipment and supplies to over 4,000 customers from its eight distribution centers in Texas, California, Arizona, Colorado, Washington and Nevada. Currently, approximately 63 percent of the Company's sales are to the asbestos and lead abatement industries, and approximately 13 percent, 12 percent and 12 percent of its sales are to the industrial safety, construction and hazardous materials industries, respectively. The Company believes a majority of its sales for the forseeable future will continue to be made to asbestos and lead abatement contractors, project organizers and managers. At present, the Company estimates its share of the asbestos abatement supply market to be approximately 15 to 20 percent in the geographic markets served by the Company.\nThe Company began operations in May 1983 as an industrial safety supply company located in Dallas, Texas, and was originally incorporated in Texas as T&T Supply Company, Inc. (\"T&T\") in March 1984. T&T expanded its operations to become a supplier to the asbestos abatement industry in January 1986. Abatix was incorporated in Delaware on December 5, 1988 to effect and complete an Agreement and Plan of Merger with T&T on December 9, 1988. Unless the context provides otherwise, all references to the Company include T&T and the Company's wholly owned subsidiary, International Enviroguard Systems, Inc. (\"IESI\").\nThe Company opened its Nederland, Texas sales office in May 1988 and its Hayward, California distribution location in December 1988. During 1989, the Company expanded its customer base to supply the hazardous materials remediation industry.\nIn March 1989, the Company completed its initial public offering of its securities with the sale of 300,000 units, each consisting of two shares of common stock and one redeemable common stock purchase warrant, at a price of $5.00 per unit. Net proceeds of $1,135,251 were realized from the offering. Pursuant to provisions of the initial public offering, the Company issued, on March 2, 1990, a notice of redemption to the warrantholders in respect of all of its outstanding redeemable common stock purchase warrants which were exercisable at $3.00 per share. An aggregate of 231,983 of such warrants was exercised pursuant to the notice. In total, 290,983 warrants were exercised, 8,917 were redeemed and 100 were not presented, resulting in net proceeds of $805,616. Proceeds from the exercise of the warrants enabled the Company to\nincrease its capital base and expand its operations.\nIn February 1990, the Company expanded its Hayward location and opened its Houston, Texas office\/warehouse location. In August 1991, the Company opened its Santa Fe Springs, California office\/warehouse location and, in April 1992, the Nederland, Texas location was converted to a warehouse location. In August 1992, sales and administrative staff were added to the Santa Fe Springs facility to initiate distribution services to the construction tools supply industry.\nOn October 5, 1992, the Company entered into and consummated an Asset Purchase Agreement with International Enviroguard Systems, Inc. (\"IES\"), a Texas corporation, pursuant to which the Company assumed the operation of this company and issued 250,000 shares of the Company's $.001 par value common stock. IES, based in Corpus Christi, Texas, was a manufacturer of sorbents, primarily for the hazardous materials industry. The Company transferred the assets purchased and liabilities assumed to IESI, a Delaware corporation wholly owned by the Company.\nIn response to improved competitive conditions, the Company began asbestos abatement supply distribution operations in Phoenix and Denver in January and February of 1993, respectively, and Seattle in January 1994. The Company opened a distribution center in Corpus Christi, Texas in June 1994 as an attempt to more fully utilize the IESI facilities.\nDuring 1994, because of increased purchasing power, the Company, through IESI, began to import certain products sold through not only the Company's distribution channels, but other distribution companies not in direct competition with Abatix. The Company will continue to review the direct importation of products to obtain lower costs.\nIn December 1994, because of the significant use of cash, the negative impact on earnings and the limited potential for progress towards profitability, the Company announced plans to discontinue the sorbent manufacturing business of IESI. This process was completed during the second quarter of 1995. IESI continues to import products utilizing the Dallas facility.\nThe Corpus Christi location was closed as of September 30, 1995 primarily because the projected costs to operate the facility exceeded the market potential. As was done prior to opening the Corpus Christi location, Abatix's Houston facility will serve the central and south Texas area.\nIn October 1995, the Company expanded its Phoenix location to initiate distribution services to the construction tools supply industry. In December 1995, the newest facility opened in Las Vegas. Although the Las Vegas operation will handle the entire product line, its primary focus is the construction tool industry.\nThe Company, based on local market conditions, intends to expand and diversify the revenue base by developing its full product line in all locations. Acquisitions and the hiring of experienced personnel are two alternatives that will continue to be explored to accomplish this goal.\n(b)\tFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Company is considered to be in one industry segment for financial reporting purposes; therefore, no financial information is presented regarding industry segments.\n(c)\tNARRATIVE DESCRIPTION OF BUSINESS\nASBESTOS ABATEMENT INDUSTRY BACKGROUND\nBetween 1900 and the early 1970's, asbestos was extensively used for insulation and fireproofing in industrial, commercial and governmental facilities as well as private residences in the United States and in other industrialized countries. It is estimated that in the United States, approximately 20 percent of all buildings, excluding residences and schools, contain friable asbestos-containing materials that are brittle, readily crumble and are susceptible to the release of asbestos dust. Various diseases such as asbestosis, lung cancer and mesothelioma, linked to the exposure to airborne asbestos, and the presence of asbestos in insulation, service applications and finishing materials have given rise to the concern about exposure to asbestos. Public awareness of the health hazards posed by asbestos has increased as the results of continuing medical studies have become widely known. Business and other publications and studies have listed asbestos abatement as one of America's critical problems, and legislation previously introduced to the U.S. Congress refers to asbestos as \"one of the most dangerous substances known to science.\" A study performed a few years ago, predicted that as many as 225,000 Americans will die of asbestos related ailments before the year 2000 and that there are currently 65,000 known cases of asbestosis. Litigation involving claimants exposed to asbestos has forced several firms to seek the protection of the bankruptcy courts, and the volume of pending claims has inundated state and Federal courts throughout the country thus prompting many commentators to propose legislative solutions.\nThe United States Environmental Protection Agency (\"EPA\") estimates, in a survey conducted in 1984, that asbestos is present in 30 percent of the nation's 110,000 schools and in 20 percent of the nation's 3.6 million government and commercial buildings. Maintenance, repair, renovation or other activities can disturb asbestos-containing material and, if disturbed or damaged, asbestos fibers become airborne and pose a hazard to building occupants and the environment.\nPrompted by such concerns, Congress, in 1984, authorized the EPA to spend $800 million for asbestos abatement in schools under the Asbestos School Hazard Abatement Act. In October 1986, Congress passed the Asbestos Hazard Emergency Response Act (\"AHERA\") which mandates inspections for asbestos, the adoption of asbestos abatement plans and the removal of asbestos from schools and facilities scheduled for demolition. In addition, state and local governments have also adopted asbestos-related regulations.\nNotwithstanding such legislative impetus and continued awareness of health related hazards associated with asbestos, the budgetary constraints and the lack of improvement in the industrial sectors continue to limit the number and scope of asbestos abatement projects. However, as the U.S. economy improves and commercial real estate demand increases, the Company believes the overall industry will also improve on a limited basis.\nLEAD ABATEMENT INDUSTRY BACKGROUND\nThe hazards of lead-based paint have been known for many years, however, the federal and state regulations requiring identification, disclosure and cleanup have been minimal. In early 1996, the EPA and the Department of Housing and Urban Development unveiled new rules regarding lead-based paint in the residential markets. The new rules give home buyers the right to test for lead-based paint before any contracts are signed. In addition, although a landlord or home seller is not required to test for lead-based paint, the rules do require disclosure of a know lead hazard.\nMany asbestos abatement contractors added lead abatement to their portfolios\nin an attempt to enter a market considered to be in its infancy. The asbestos abatement contractors bring experience, working in a regulatory environment. Although the Company does not anticipate these new rules to result in an onslaught of lead abatement projects, management is encouraged by these new rules and their opportunities, as such rules could create a long-term positive impact on the Company.\nSAFETY AND HAZARDOUS MATERIALS INDUSTRIES BACKGROUND\nThe EPA and the Occupational Safety and Health Administration (\"OSHA\"), together over time, have established numerous rules and regulations governing environmental protection and worker safety and health. The demand for supplies and equipment by U.S. businesses and governments to meet these rules and regulations has resulted in the creation of a multi-billion dollar industry.\nAs research identifies the degree of environmental or health risk associated with various substances and working conditions, new rules and regulations can be expected. These actions inevitably will require more expenditures for supplies and equipment for handling, remediation and disposal of hazardous substances and the creation of safe living and working conditions.\nCONSTRUCTION TOOLS SUPPLY INDUSTRY BACKGROUND\nBesides the normal hand and power tools, and associated consumable parts, supplied to the construction industry, the EPA and OSHA have also established certain rules and regulations governing the protection of the environment and the protection of workers in this industry.\nCurrently, the Company supplies to the construction tools industry in its Santa Fe Springs, Phoenix and Las Vegas facilities. This industry is directly tied to the local economies and more specifically, the real estate conditions within the markets served by Abatix. The real estate market in the Las Vegas and Phoenix areas are strong with vacancy rates for commercial properties low and rental rates high. The condition of the real estate industry in the Los Angeles area has stabilized from a decline over the past several years.\nGEOGRAPHIC DISTRIBUTION OF BUSINESS\nThe Company distributes over 9,000 personal protection, safety, hazardous waste remediation and construction tool products to over 4,000 customers primarily located in the Southwest, Midwest and Pacific Coast. Approximately 63 percent of its products are sold to asbestos and lead abatement firms, 21 percent of its products are sold to manufacturing, chemical and petrochemical firms while the remaining 16 percent of its products are sold to hazardous materials and general construction contractors. The Company estimates that at present, approximately 85 percent of asbestos abatement related sales are made directly to abatement project organizers and managers. During 1995 and 1994, the Company did not have a customer that aggregated 10 percent or more of its sales. The Company considers its relationship with its customers to be excellent and does not believe the loss of any one particular customer would have a material adverse effect on the business.\nThe Company maintains 24-hours-a-day\/7-days-a-week telephone service for its customers and typically delivers supplies and equipment within two or three days of receipt of an order. A substantial amount of asbestos abatement is performed after working hours, on weekends and on holidays. The Company is prepared to provide products on an expedited basis in response to requests from abatement contractors who require immediate deliveries because their\nwork is often performed during non-business hours, involves substantial costs because of the specialized labor crews involved or may arise on short notice as a result of exigent conditions.\nThe Company maintains sales, distribution and warehouse centers in Santa Fe Springs and Hayward, California, Dallas and Houston, Texas, Phoenix, Arizona, Las Vegas, Nevada, Denver, Colorado, and Kent, Washington. The Company expanded its distribution operations in 1995 by opening the Las Vegas facility, as well as, hiring additional salespeople at some of our existing locations.\nEQUIPMENT AND SUPPLIES\nThe Company buys products from manufacturers based on orders received from its customers as well as anticipated needs based on prior buying patterns, customer inquiries and industry experiences. The Company maintains an inventory of disposable products and commodities as well as lower cost equipment items. Approximately 85 percent of the Company's sales for 1995 and 1994 are of disposable items and commodity products which are sold to customers at prices ranging from under $1.00 to $50.00. The balance of sales is attributable to items consisting of lower priced equipment beginning at $20.00 to major product assemblies such as decontamination trailers which retail for approximately $15,000. The Company does not manufacture or lease any products and does not perform any repairs thereon. The Company distributes on a limited basis, disposable items and equipment under its own private label.\nExcept with regard to certain specialty equipment associated with asbestos abatement activities such as filtration, vacuum and pressure differential systems, many of the Company's products can be used interchangeably within many of the industries it supplies. Equipment distributed by the Company includes manufacturers' product descriptions and instructions pertaining to use.\nMARKETING\nThe Company's marketing program is conducted by its sales representatives, as well as by senior management and the general managers at each of its operating facilities. These sales representatives are compensated by a combination of salary and\/or commission which is based upon negotiated sales standards. The Company's personnel participate in training programs at various universities and training schools which enhance the Company's reputation and recognition of its name, personnel and services.\nBACKLOG\nSubstantially all the Company's products are shipped to customers within 48 hours following receipt of the order, therefore backlog is not material to the Company's operations.\nINFLATION\nAs the inflation of the U.S. economy has averaged approximately 3 percent annually, the Company believes inflation has not been a substantial concern nor will inflation have a material impact to the Company's operations or profitability in the near term if inflation remains constant. The Company anticipates it would be able to pass along increases in product costs to its customers in the form of higher selling prices, thereby having no effect on product margins.\nENVIRONMENTAL IMPACT\nThe Company distributes a variety of products in the asbestos abatement industry all of which require the Company to maintain on file Material Safety Data Sheets (\"MSDS\") that inform all purchasers and users of any potential hazards which could occur if the products spilled or leaked. Although the Company provides no assurance, the Company reviews all products that could have a potential for environmental hazards and tries to ensure the products are safe for on site storage and distribution. The Company currently distributes no products it believes would create an environmental hazard if leaked or spilled.\nSEASONALITY\nHistorically, the asbestos abatement services and supply business has been seasonal as a result of the substantial number of abatement contracts that were performed in educational facilities during the summer months or during other vacation periods. The Company believes the non-educational or private sector, which includes the industrial, commercial and residential markets, is an area of potential growth, and that seasonality is not a major characteristic of these markets. In addition to the private sector asbestos business, the Company's expansion of the hazardous material remediation, industrial safety and construction tools supply markets have mitigated any seasonal impacts of government asbestos projects.\nGOVERNMENT REGULATION\nAs a supplier of products manufactured by others to the asbestos and lead abatement, industrial safety and hazardous materials industry, the Company is not subject to federal laws and regulations including those promulgated by the EPA and OSHA. However, most of the contractors and other purchasers of the Company's equipment and supplies are subject to various government regulations, and developments in legislation and regulations affecting manufacturers and purchasers of the Company's products could have a substantial effect on the Company.\nCOMPETITION\nThe asbestos and lead abatement, industrial safety, hazardous materials and construction tools supply businesses are highly competitive. These markets are served by a limited number of large national firms as well as many local firms, none of who can be characterized as controlling the market. The Company competes on the basis of price, delivery, credit arrangements and product variety and quality. The Company's business is not characterized by substantial regulatory or economic barriers to entry. Additional companies could enter the asbestos and lead abatement, industrial safety, hazardous materials and construction tools supply industries and may have greater financial, marketing and technical resources than the Company.\nEMPLOYEES\nAs of February 29, 1996, the Company employed a total of 73 full time employees including 3 executive officers, 8 managers, 36 administrative and marketing personnel and 26 clerical and plant personnel. The Company believes relations with its employees are excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTIES\nThe Company's headquarters are located in Dallas, Texas and occupy\napproximately 3,200 square feet of leased general office space in conjunction with the Dallas branch. This lease expires in July 1999. The eight distribution facilities lease a total of 119,840 square feet of general office and warehouse space. These facilities range in size from 6,875 square feet to 18,680 with leases expiring between August 1996 and November 2000.\nPursuant to the acquisition of certain operating assets of IESI in October 1992, the Company entered into seven-year leases for both its manufacturing plant and office\/warehouse facilities in Corpus Christi, Texas. In December 1994, the Company negotiated the termination of the manufacturing plant lease effective February 15, 1995, for a cash payment equivalent to one year's rent. The Company continues to pay lease obligations for the office\/warehouse facility, however, no operations are performed and no assets are located at that facility. This lease expires in September 1999 and includes a purchase option. The Company is currently negotiating for a sale or lease of this facility which, if completed, would relieve the Company from its lease obligation.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company was named as a defendant in a product liability lawsuit filed in the Superior Court of the State of California for the County of Los Angeles - Central District (Placido Alvarez vs. Abatix Environmental Corp., et al, Case No. BC133537). The Company has requested and received (1) indemnification under the manufacturer's product liability insurance and (2) legal representation at the cost of the manufacturer. As of February 29, 1996, no depositions have been taken, therefore management is not able to assess the merit of the plaintiff's case. However, the Company does not anticipate any material impact on its financial statements as a result of this litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn September 1995, the Company mailed to each of its registered shareholders a copy of an information statement informing them that the Company was applying to the State of Delaware for a reduction in its authorized capital. Effective October 6, 1995, the Company's Certificate of Incorporation with the State of Delaware was changed to reduce the Company's authorized preferred stock from 2,000,000 shares to 500,000 shares and to reduce the Company's authorized common stock from 20,000,000 shares to 5,000,000 shares. Since the Company had a written consent from stockholders owning 51.6 percent of the then outstanding common stock, this action did not require a vote by all of the Company's stockholders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n(a)\tThe Company's common stock is traded on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market under the symbol \"ABIX\". The following table sets forth the high and low bid quotations for the common stock for the periods indicated. These quotations reflect prices between dealers, do not include retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.\nOn February 29, 1996, the closing bid price for the common stock was $ 3 7\/8.\nThe Company's common stock is also listed on the Boston Stock Exchange under the symbol \"ABIX.B\". No sales were reported by the Boston Stock Exchange for 1994 or 1995.\n(b)\tAs of February 29, 1996, the approximate number of holders of record of the Company's common stock was 700.\n(c)\tThe Company has never paid cash dividends on its common stock. The Company presently intends to retain future earnings, if any, to finance the expansion of its business or repay borrowings on its lines of credit and does not anticipate that any cash dividends will be paid in the foreseeable future. Future dividend policy will depend on the Company's earnings, capital requirements, expansion plans, financial conditions and other relevant factors. Although the Company's notes payable to bank do not restrict the payment of dividends, they do require the Company maintain a minimum net worth, which increases each year through 1997. The notes payable to bank also require the Company maintain minimum net income levels through 1997.\n(d)\tSince November 1994, the Board of Directors has authorized management to purchase up to 326,500 shares of the Company's common stock. As of December 31, 1995, the Company has purchased 207,100 shares. Of the 180,600 shares purchased during 1995, 90,000 shares were purchased from a former officer and director of the Company in a privately negotiated transaction in February 1995.\n(e)\tDuring 1994, warrants and options were exercised totaling 43,830 shares, resulting in an increase to stockholders' equity of $122,000. In 1995, options totaling 46,566 shares were exercised, resulting in an increase to stockholders' equity of $86,000.\n(f)\tIn October 1995, the Company amended its Certificate of Incorporation to reduce its authorized capital from 5,000,000 shares to 500,000 shares of preferred stock, and from 20,000,000 shares to 5,000,000 shares of common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe tables below set forth, in summary form, selected financial data of the Company. This data, which is not covered by the independent auditors' report, should be read in conjunction with the consolidated financial statements and notes thereto which are included elsewhere herein (amounts in thousands except per share amounts).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nRESULTS OF CONTINUING OPERATIONS\nNet sales from continuing operations for the year ended December 31, 1995 increased 6 percent to $27,632,000 from $25,982,000 in 1994. The increase in sales is due to efforts to further expand and diversify revenues without\nsacrificing product margins. The increase is a result of recovery in the general economic conditions in the southwest and the expansion of business along the pacific coast region. In addition, the Company expanded its Phoenix and Las Vegas facilities in October and December, 1995, respectively. The improved economic conditions, if maintained, and the expansion should provide the ability for the Company to grow its revenues and maintain its margins, thereby promoting continued profitability in 1996. In addition, these efforts should provide the groundwork for broadening the Company's revenues among its different markets, thereby decreasing its dependence on any one of its markets.\nIndustry-wide sales of asbestos abatement products are expected to remain relatively flat in 1996. However, the Company's sales and share of the asbestos abatement market are expected to continue to increase primarily because of the marketplace's recognition of the Company as a reliable and stable supplier. Several of the Company's competitors have ceased operations or significantly reduced their presence over recent years in the Company's geographic locations.\nSpending on asbestos abatement has dropped in the U.S. over the past several years due largely to the lack of full recovery in the commercial real estate industry. Concerns raised about the comparative health risks of removing asbestos and the costs related to such removal, as opposed to leaving it in place, also have resulted in the delay or cancellation of some projects. The Company also believes that as the U.S. economy continues its economic rebound, it will have a positive impact on its operations. Notwithstanding the above, the asbestos abatement industry will likely diminish over time as asbestos containing materials, last used in construction during 1977-1980, ultimately are removed from schools, office buildings, homes and factories. A 1992 estimate by an industry analyst predicted that as much as $80 billion may be spent nationwide over the next 20 years for asbestos removal, of which the Company estimates $8 billion relates to abatement supplies. Approximately $2 billion in abatement supplies will be spent during this 20 year period in the geographic areas served by the Company's eight distribution centers. At this potential rate of expenditure, and at a presently estimated 15 to 20 percent market share of the asbestos abatement markets served by the Company, the current and intermediate term effects of the diminishing market are not expected to have a material adverse impact on the Company based on its historical ability to increase its share of this market.\nSales to the hazardous materials remediation, industrial safety and construction tools supply markets are increasing both in absolute amounts and as a percentage of revenues to the Company. The Company plans to expand its customer base in these areas through additional salespeople and expects these revenues to increase at a faster rate than the asbestos abatement revenues. In addition, using the Company's financial strength to expand geographically, it has diversified its geographical risk allowing the Company to better serve its regional and national customers.\nGross profit in 1995 of $7,977,000 increased 11 percent from gross profit in 1994 of $7,164,000 due to increased revenues and increased margins. Gross profit margins, expressed as a percentage of sales, increased to 29 percent for 1995 compared to 28 percent for 1994. As expected, margins varied somewhat from location to location due to sales mixes and local market conditions. Gross margins on sales of construction tools and industrial safety products typically were higher than the Company's average margins, while gross margins on sales of asbestos abatement and hazardous material remediation products varied from one market to the next and generally were lower than those of the Company's other products. Overall margins are expected to remain at their current levels in 1996 as continued efforts to\nincrease sales of construction tools and the focus of management on profit margins of all product lines should offset any competitive pressures.\nSelling, general and administrative expenses for 1995 of $6,342,000 increased 7 percent over 1994 expenses of $5,933,000. The increase was attributable primarily to the higher employment costs as a result of additional personnel. Selling, general and administrative expenses were 23 percent of sales for both 1995 and 1994. These expenses are expected to remain in their current range for 1996.\nIn the third quarter of 1995, the Company incurred a special charge of $80,000 to accrue for future lease commitments resulting from the closure of its distribution center in Corpus Christi, Texas. The noncancelable lease expires September 1999. The Company's lease agreement on the building that was occupied by both the operations of IESI and the Corpus Christi branch includes an option enabling the Company to purchase the building. The Company is currently negotiating a sale of this facility which, if completed, would relieve the Company from its lease obligation.\nOther expense, net, of $248,000 in 1995 decreased 4 percent over 1994 expense of $258,000. This decrease is primarily due to decreased interest expense resulting from lower borrowings on the Company's lines of credit. Since the Company's lines of credit are tied to the prime rate, any increases in the prime rate would negatively affect the Company's earnings.\nSee note 5 to the consolidated financial statements for a description of income taxes.\nThe Company's credit policies remain stringent, and charge-offs are significantly below industry experience. Days of sales in net accounts receivable improved 5 days from 1994 to 1995. In August 1995, the Company added another employee to the credit department to improve the collection cycle. The Company believes the reserve for doubtful accounts is adequate.\nRESULTS OF DISCONTINUED OPERATIONS\nThe Company experienced no impact from discontinued operations to its 1995 financial statements because an estimate of $139,000, net of taxes, was recorded in 1994 to accrue for the losses from the discontinuance of the sorbent manufacturing business. This amount included an estimate of a loss from operations from the date of discontinuance through the expected date of disposal. The Company ceased the sorbent manufacturing business in the summer of 1995. The remainder of the reserve relates to the obligation under a noncancelable operating lease which expires September 1999. The lease on this facility, which was shared with the Corpus Christi branch, included a purchase option. The Company is currently negotiating a sale of this facility which, if completed, would relieve the Company from its lease obligation.\nNET RESULTS\nNet earnings in 1995 of $813,000 or $.36 per share increased $596,000 from net earnings of $217,000 or $.09 per share in 1994. The 275 percent increase in net earnings is due to the growth in revenues and product margins, and the losses recorded in 1994 related to the discontinuance of the sorbent manufacturing business, partially offset by the charge in 1995 to close the Corpus Christi branch office.\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board recently 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 must be adopted in the first quarter of 1996. Implementation of this statement is not expected to have a material effect on the Company's financial position or results of operations.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nRESULTS OF CONTINUING OPERATIONS\nNet sales from continuing operations for the year ended December 31, 1994 increased 36 percent to $25,982,000 from $19,085,000 in 1993. The increase in sales is due to efforts to further expand and diversify revenues without sacrificing product margins. The increase is a result of (i) the opening of the Seattle location in January 1994, (ii) the continued development in Santa Fe Springs of the asbestos abatement and construction tools supply businesses, (iii) the development of the Phoenix and Denver distribution locations, and (iv) the impact for the entire year of additional key sales and marketing personnel in the Houston and Santa Fe Springs distribution locations.\nGross profit in 1994 of $7,164,000 increased 34 percent from gross profit in 1993 of $5,354,000 due to increased revenues. Gross profit margins, expressed as a percentage of sales, remained relatively flat at 28 percent for 1994 when compared to 1993. As expected, margins varied somewhat from location to location due to sales mixes and local market conditions. Gross margins on sales of construction tools and industrial safety products typically were higher than the Company's average margins. As in prior years, gross margins on sales of asbestos abatement and hazardous material remediation products varied from one market to the next and generally were lower than those of the Company's other products.\nSelling, general and administrative expenses for 1994 of $5,933,000 increased 24 percent over 1993 expenses of $4,774,000. The increase was attributable primarily to the inclusion of the Seattle branch operation, established early in 1994 and the carryover of acquisition, installation and training for the new computer and telecommunication systems. Selling, general and administrative expenses for 1994 were 23 percent of sales compared to 25 percent of sales for 1993.\nOther expense, net of $258,000 in 1994 increased 85 percent over 1993 expense of $139,000. This increase is primarily due to increased interest expense resulting from higher borrowings on the Company's lines of credit to finance its growth and higher interest rates.\nSee note 5 to the consolidated financial statements for a description of income taxes.\nRESULTS OF DISCONTINUED OPERATIONS\nSales at IESI were $426,000 for the year ended December 31, 1994 compared to sales of $412,000 for 1993. The 1994 loss from discontinued operations of IESI, net of taxes, of $224,000 was higher than the loss in 1993 of $144,000, net of taxes. The higher loss in 1994 is primarily due to the writedown of fixed assets to net realizable value.\nThe results from discontinued operations include an estimate of $139,000, net of taxes, to accrue for the losses from the discontinuance of the sorbent manufacturing business and includes an estimate of a loss from operations from the date of discontinuance through the expected date of disposal.\nNET RESULTS\nNet earnings in 1994 of $217,000 or $.09 per share increased $58,000 from net earnings of $159,000 or $.07 per share in 1993. The 36 percent increase in net earnings is due to the growth in revenues and lower selling, general and administrative expenses relative to the revenue increase, partially offset by higher interest expense and the losses related to the sorbent manufacturing business.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital requirements historically result from the growth of its accounts receivable and inventories, offset by increased accounts payable and accrued expenses, associated with increases in sales volume and the addition of new locations. Net cash provided by operations during 1995 of $1,188,000 resulted principally from increases in the net earnings of the Company and the increases in accounts payable and accrued expenses, partially offset by the increase in inventory.\nCash requirements for non-operating activities during 1995 resulted primarily from the purchases of property and equipment amounting to $233,000 and the repurchases of the Company's common stock totaling $482,000. The equipment purchases in 1995 were primarily computer and telecommunications equipment and delivery vehicles. The Company repurchased its common stock because of the Board of Directors' belief that it was undervalued in the marketplace. The Board of Directors has committed to continue supporting the stock price in the marketplace as long as it remains undervalued. The purchases of property and equipment, repurchase of common stock and the repayment of borrowings from the bank were funded by cash from operations.\nAlthough cash flow from operations at any given point in 1996 may be negative, the entire year is expected to be positive. Several factors contribute to this expectation. The rate of revenue growth in 1996 is expected to be higher than 1995, but at a level that can be funded by cash flow from operations. Also, the Company will not have to fund the operating losses at the Corpus Christi branch in 1996, and the capital expenditures for 1996 are expected to be similar to 1995, as the Company will continue to replace delivery vehicles as needed. The Company currently has no plans to expand geographically in 1996, however, the Company will continue to search for geographic locations that would complement the existing infrastructure. If another location were to be opened in 1996, the Company would fund the startup expenses through its lines of credit. Anticipated cash requirements in 1996 will be satisfied from operations and borrowings on the lines of credit, as required.\nIn addition, the Company is committed to investing in technology to improve the productivity of employees and to enhance the level of customer service. This commitment will require an investment in additional computer hardware and software and additional telecommunications equipment, which will be funded by the Company's capital equipment line of credit. The current excess capacity in the equipment line of credit should be sufficient to fund this investment.\nThe Company maintains a $4,100,000 working capital line of credit at a commercial lending institution that allows the Company to borrow up to 80 percent of the book value of eligible trade receivables plus the lessor of 25 percent of eligible inventory or $500,000. As of February 29, 1996, there are advances outstanding under this credit facility of $2,721,000. Based on the borrowing formula, the Company had the capacity to borrow an additional $1,150,000 as of February 29, 1996. The Company also maintains a $350,000\ncapital equipment credit facility providing for borrowings at 80 percent of cost on purchases. The advances outstanding under this credit facility as of February 29, 1996 were $215,000. Both credit facilities are payable on demand and bear a variable interest rate of interest computed at the prime rate plus one-half of one percent.\nManagement believes, that based on its equity position, the Company's current credit facilities can be expanded during the next twelve months, if necessary, and that these facilities, together with cash provided by operations, will be sufficient for its capital and liquidity requirements for the next twelve months.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data are included under Item 14(a)(l) and (2) 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\nThis Item 10 is incorporated herein by reference from the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than one hundred twenty (120) days after December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis Item 11 is incorporated herein by reference from the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than one hundred twenty (120) days after December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis Item 12 is incorporated herein by reference from the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than one hundred twenty (120) days after December 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis Item 13 is incorporated herein by reference from the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than one hundred twenty (120) days after December 31, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1 and 2. CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe consolidated financial statements and financial statement schedules listed on the index to consolidated financial statements on page F-l are filed as part of this Form l0-K.\n(b) REPORTS ON FORM 8-K\nNone\n(c) EXHIBITS\n(1)(a) \tForm of Underwriting Agreement (filed as Exhibit (1)(a) to the Registration Statement on Form S-18, filed February 9, 1989).\n(1)(b) \tForm of Selected Dealer Agreement (filed as Exhibit (1)(b) to the Registration Statement on Form S-18, filed January 11, 1989).\n(1)(c) \tWarrant Solicitation Agent and Exercise Fee Agreement (filed as Exhibit (l)(c) to the Report on Form 10-K for the year ended December 31, 1989).\n(2)(a) \tAgreement of Merger (filed as Exhibit (2) to the Registration Statement on Form S-18, filed January 11, 1989).\n(2)(b) \tAsset Purchase Agreement (filed as Exhibit (2)(b) to the Report on Form 8-K, filed October 19, 1992).\n(3)(a)(1) \tCertificate of Incorporation (filed as Exhibit (3)(a)(1) to the Registration Statement on Form S-18, filed January 11, 1989; filed electronically as Exhibit 3(i)(a) to the Form 10-Q for the quarter ended September 30, 1995, filed on November 9, 1995).\n(3)(a)(2) \tCertificate of Amendment of Certificate of Incorporation (filed as Exhibit (3)(a)(2) to the Registration Statement on Form S-18, filed January 11, 1989; filed electronically as Exhibit 3(i)(b) to the Form 10-Q for the quarter ended September 30, 1995, filed on November 9, 1995).\n(3)(a)(3) \tCertificate of Amendment of Certificate of Incorporation (filed as Exhibit (3)(i)(c) to the Form 10-Q for the quarter ended September 30, 1995, filed November 9, 1995; filed electronically as Exhibit 3(i)(c) to the Form 10-Q for the quarter ended September 30, 1995, filed on November 9, 1995).\n(3)(b) \tBylaws (filed as Exhibit (3)(b) to the Registration Statement on Form S-18, filed January 11, 1989; filed electronically as Exhibit 3(ii) to the Form 10-Q for the quarter ended September 30, 1995, filed November 9, 1995).\n(4)(a) \tSpecimen Certificate of Common Stock (filed as Exhibit (4)(a) to the Registration Statement on Form S-18, filed January 8, 1989).\n(4)(b) \tSpecimen of Redeemable Common Stock Purchase Warrant (filed as Exhibit (4)(b) to the Registration Statement on Form S-18, filed February 9, 1989).\n(4)(c) \t Form of Warrant to be sold to Culverwell & Co., Inc. (filed as Exhibit (4)(c) to the Registration Statement on Form S-18, filed February 9, 1989).\n(4)(d) \t Warrant Agency Agreement between the Registrant and North American Transfer Company (filed as Exhibit (4)(d) to the Registration Statement on Form S-18, filed February 9, 1989).\n(9)(a)(ii) \tForm of Escrow Agreement with State Street Bank and Trust\nCompany (filed as Exhibit (9)(a)(ii) to the Registration Statement on Form S-18, filed January 11, 1989).\n(10)(a) \tEmployment Agreement with Terry W. Shaver (filed as Exhibit (10)(a) to the Registration Statement on Form S-18, filed January 11, 1989).\n(10)(a)(i) \tEmployment Agreement with Terry W. Shaver effective January 2, 1991 (filed as Exhibit (10)(a)(i) to the Report on Form 10-K for the year ended December 31, 1990).\n(10)(a)(ii) \tEmployment Agreement with Terry W. Shaver effective January 4, 1993 (filed as Exhibit (10)(a)(ii) to the Report on Form 10-K for the year ended December 31, 1992).\n(10)(a)(iii)\tEmployment Agreement with Terry W. Shaver effective January 1, 1995 (filed as Exhibit (10)(a)(iii) to the Report on Form 10-K for the year ended December 31, 1994).\n(10)(b)\t Employment Agreement with Gary L. Cox (filed as Exhibit (10)(b) to the Registration Statement on Form S-18, filed January 11, 1989).\n(10)(b)(i)\t Employment Agreement with Gary L. Cox effective January 2, 1991 (filed as Exhibit (10)(b)(i) to the Report on Form 10-K for the year ended December 31, 1990).\n(10)(b)(ii) \tEmployment Agreement with Gary L. Cox effective January 4, 1993 (filed as Exhibit (10)(b)(ii) to the Report on Form 10-K for the year ended December 31, 1992).\n(10)(b)(iii)\tEmployment Agreement with Gary L. Cox effective January 1, 1995 (filed as Exhibit (10)(b)(iii) to the Report on Form 10-K for the year ended December 31, 1994).\n(10)(c)\t Revolving Credit Agreement with Texas American Bank\/Duncanville, N.A. (filed as Exhibit (10)(c) to the Registration Statement on Form S-18, filed January 11, 1989).\n(10)(d)\t Demand Credit Facility with Comerica Bank-Texas dated February 15, 1989 (filed as Exhibit (10)(d) to the Report on Form 10-Q for the Quarter ended March 31, 1989, filed May 15,1989).\n(10)(e)\t Demand Credit Facility with Comerica Bank-Texas dated June 15, 1989 (filed as Exhibit (10)(e) to the Report on Form 10-Q for the Quarter ended June 30, 1989, filed August 11, 1989).\n(10)(e)(i)\t Demand Credit Facility with Comerica Bank-Texas dated March 1, 1993 (filed as Exhibit (10)(e)(i) to the Report on Form 10-K for the year ended December 31, 1992).\n(10)(e)(ii) \tDemand Credit Facility with Comerica Bank-Texas extension, renewal and increase dated June 1, 1993 (filed as Exhibit (10)(e)(ii) to the Report on Form 10-K for the year ended December 31, 1993).\n(10)(e)(iii)\tDemand Credit Facility with Comerica Bank-Texas extension, renewal and increase dated September 22, 1994 (filed as Exhibit (10)(e)(iii) to the Report on Form 10-K for the year ended December 31, 1994).\n(10)(f)\t Employment Agreement with S. Stanley French effective October 1, 1992 (filed as Exhibit (10)(f) to the Report on Form 8-K, filed October 19, 1992).\n(11)\t Statement Re Computation of Per Share Earnings (Loss).*\n(22) Information Statement dated September 1, 1995.*\n(23)\t Consent of Independent Auditors.*\n(27)\t Financial Data Schedule for the twelve months ended December 31, 1995.*\n*\tFiled herewith as part of the Company's electronic filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 13th day of March, 1996.\n\t\t\t\t\t\tABATIX ENVIRONMENTAL CORP.\n\tBy: \/S\/ TERRY W. SHAVER\t ----------------------- \tTerry W. Shaver \t\tPresident, Chief Executive Officer \t\tand 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 date indicated.\nSIGNATURES\t \tTITLE DATE - ------------------- --------------------------------------- -------------\n\/S\/ TERRY W. SHAVER \tPresident, Chief Executive Officer and \tMarch 13, 1996 - ------------------- Director (Principal Executive Officer) Terry W. Shaver\n\/S\/ GARY L. COX\t Executive Vice President, Chief March 13, 1996 - ------------------- Operating Officer and Director Gary L. Cox\n\/S\/ LAMONT C. LAUE\t Director\t\t \t\t\tMarch 13, 1996 - ------------------- Lamont C. Laue\n\/S\/ FRANK J. CINATL \tVice President and Chief Financial \t\tMarch 13, 1996 - ------------------- Officer (Principal Accounting Officer) Frank J. Cinatl, IV\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nIndex to Consolidated Financial Statements\n\tPAGE ------ Independent Auditors' Report\t\nFinancial Statements: Consolidated 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\nFinancial Statement Schedule: II - Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993\nAll other schedules have been omitted as the required information is inapplicable or the information required is presented in the consolidated financial statements or the notes thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Abatix Environmental Corp.:\nWe have audited the consolidated financial statements of Abatix Environmental Corp. and subsidiary as listed in the accompanying index. In connection with our audits of the consolidated financial statements we also have audited the consolidated financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above\npresent fairly, in all material respects, the financial position of Abatix Environmental Corp. 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. 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 income taxes in 1993.\n\/s\/KPMG Peat Marwick LLP\nDallas, Texas February 23, 1996\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nConsolidated Balance Sheets December 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nConsolidated Statements of Operations Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nConsolidated Statements of Stockholders' Equity Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nConsolidated Statements of Cash Flows Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nNotes to Consolidated Financial Statements\n(1)\tSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) GENERAL\nAbatix Environmental Corp. (\"Abatix\") and subsidiary (collectively, the \"Company\") market and distribute personal protection and safety equipment and durable and nondurable supplies predominantly, based on revenues, to the asbestos abatement industry. The Company also supplies these products to the industrial safety and hazardous materials industries, and, combined with tools and tool supplies, to the construction industry. At December 31, 1995, the Company operated eight distribution centers in six states. The Company\ndiscontinued the sorbent manufacturing business of its wholly owned subsidiary, International Enviroguard Systems, Inc. (\"IESI\"), a Delaware corporation, in December 1994 (see note 2). However, IESI continues to import disposable products sold primarily through the Company's distribution channels.\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 consolidated financial statements include the accounts of Abatix and IESI. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain amounts have been reclassified for consistency in presentation.\n(b) INVENTORIES\nInventories consist of materials and equipment for resale and are stated at the lower of cost, determined by the first-in, first-out method, or market.\n(c) PROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation for financial statement purposes is provided by the straight-line method over the estimated useful lives of the depreciable properties. Accelerated depreciation methods are used for tax purposes.\n(d) REVENUE RECOGNITION\nRevenue is recognized when the goods are shipped.\n(e) EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE\nEarnings (loss) per share is calculated using the weighted average number of common and, when dilutive, common equivalent shares outstanding during each year. Common equivalent shares are comprised of dilutive stock options and warrants. Fully diluted earnings per share are not presented as the effect is immaterial.\n(f) STATEMENTS OF CASH FLOWS\nFor purposes 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. The Company held no cash equivalents at December 31, 1995 or 1994.\nThe Company paid interest of $263,707, $263,850 and $137,513 in 1995, 1994 and 1993, respectively, and income taxes of $544,200, $155,472, and $3,145 in 1995, 1994 and 1993, respectively.\nSignificant noncash transactions include the transfer of accrued compensation totaling $14,729 and $207,678 to additional paid-in capital upon exercise of stock options during 1995 and 1993, respectively.\n(g) INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement 109\"), which requires enterprises to change from the deferred method to the asset and liability method of accounting for income taxes. The asset and liability method establishes deferred income taxes for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax laws or rates.\nThe Company adopted Statement 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $19,697 is determined as of January 1, 1993 and is reported separately in the consolidated statement of operations for the year ended December 31, 1993.\n(2)\tRESTRUCTURING\nOn December 15, 1994, the Company announced a formal plan to discontinue the sorbent manufacturing business of IESI. The Company recorded an estimated loss on disposal of IESI at December 31, 1994 of $139,487, net of taxes. This estimated loss on disposal primarily included costs related to the leased facility, the writedown of fixed assets and inventory to net realizable value and the estimated loss from operations up to the expected disposal date. As of December 31, 1995, the only remaining asset is the fully reserved accounts receivable and the only remaining liability is the reserve related to the discontinuance. The balance of this reserve exists primarily to cover the remaining costs associated with the facility lease, which expires September 1999. Actual costs through December 31, 1995 approximated management's December 1994 estimates. Sales for the discontinued operations of IESI were $142,000, $426,000 and $412,000 in 1995, 1994 and 1993, respectively.\nIn the third quarter of 1995, the Company incurred a special charge of $80,000 to accrue for future lease commitments resulting from the closure of its distribution center in Corpus Christi, Texas. The noncancelable lease expires September 1999. Sales for the Corpus Christi branch were $294,000 and $140,000 in 1995 and 1994, respectively. The Corpus Christi branch also had operating losses of $55,000 and $17,000 in 1995 and 1994, respectively.\nThe Company's lease agreement on the building that was occupied by both the operations of IESI and the Corpus Christi branch includes an option enabling the Company to purchase the building. The Company is currently negotiating a sale of this facility which, if completed, would relieve the Company from its lease obligation.\n(3)\tPROPERTY AND EQUIPMENT\nA summary of property and equipment at December 31, 1995 and 1994 follows:\n(4)\tNOTES PAYABLE TO BANK\nAt December 31, 1995, the Company had two lines of credit with a bank that are due on demand. A working capital facility allows the Company to borrow up to 80 percent of the book value of eligible trade receivables plus the lesser of 25 percent of eligible inventory or $500,000, up to a maximum of $4,100,000. Under this formula, the Company had the capability to borrow $3,777,000 at December 31, 1995, of which $2,425,000 was used. A capital equipment facility provides for individual borrowings, aggregating up to $350,000, at 80 percent of the purchased equipment's cost. At December 31, 1995, the Company had borrowed $206,000 on this facility. Each borrowing under the capital equipment line is due on the earlier of demand or in terms ranging from thirty-six to sixty monthly installments of principal and interest. During 1995, the Company negotiated a one-half of one percent reduction in its rate, thereby reducing the rate of interest on its agreements to prime plus one-half of one percent. As of December 31, 1995 and 1994, the Company's rate of interest on these agreements was 9 percent and 9.5 percent, respectively. These credit facilities are secured by accounts receivable, inventory and equipment\nThe Company's notes payable to bank contain certain financial covenants. These notes require the Company maintain a minimum net worth, which increases each year through 1997, and maintain minimum net income levels through 1997.\n(5)\tINCOME TAXES\nIncome tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993 consists of:\nA reconciliation of the normally expected federal income tax expense relating to continuing operations based on the U.S. corporate income tax rate of 34 percent to actual expense for the years ended December 31, 1995, 1994 and 1994 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 follow:\nManagement has determined, based on the Company's history of prior operating earnings and its expectations for the future, that operating earnings will more likely than not be sufficient to realize the benefit of the deferred tax assets. Accordingly, the Company has not provided a valuation allowance for deferred tax assets.\n(6) STOCKHOLDERS' EQUITY\nOptions to purchase the Company's common stock have been granted to officers\nand employees under various stock option plans. Compensation expense of $21,050 was recognized ratably over the three year vesting period for the options granted in 1992. Options granted subsequent to December 31, 1993 were for exercise prices equal to or greater than the fair market value of the Company's common stock on the date of grant. The options outstanding at December 31, 1995 expire at various dates between March 2, 1996 and December 31, 1997.\nThe Company has granted to various consultants warrants to purchase shares of common stock as part of an agreement to secure their services. These warrants were granted with exercise prices equal to or greater than the fair market value of the Company's common stock on the date of grant and were exercisable immediately. The warrants remaining at December 31, 1995 expired unexercised on January 11, 1996. The activity of the warrants granted to various consultants is summarized in the following table:\nThe Board of Directors has approved the repurchase of 326,500 shares of the Company's common stock in the open market. During 1995, the Company purchased a total of 180,600 shares of stock, including 90,000 shares purchased from a former officer and director of the Company in February 1995. The Company has purchased 207,100 shares since November 1994.\nIn October 1995, the Company amended its Certificate of Incorporation to reduce its authorized capital from 5,000,000 shares to 500,000 shares of preferred stock, and from 20,000,000 shares to 5,000,000 shares of common stock.\n(7)\tBENEFIT PLANS\nThe Company had a noncontributory Simplified Employee Pension - Individual Retirement Account Contribution Plan covering employees 21 years of age or older who had been employed by the Company at least three of the immediately preceding five years. Plan contributions were discretionary and aggregated $20,269 in 1993. During 1993, the Company replaced this plan with a 401(k) profit sharing plan. Under the 401(k) plan, eligible employees may request the Company to deduct and contribute a portion of their salary to the plan. Contributions by the Company to the 401(k) plan aggregated $51,358, $25,657 and $5,018 during 1995, 1994 and 1993, respectively.\n(8)\tMAJOR CUSTOMERS AND CREDIT RISK\nThe Company's sales, substantially all of which are on an unsecured credit basis, are to various customers from its distribution centers in Texas, California, Arizona, Colorado, Washington and Nevada. The Company evaluates credit risks on an individual basis before extending credit to its customers and it believes the allowance for doubtful accounts adequately provides for loss on uncollectible accounts.\nDuring 1993, 1994 and 1995, no single customer accounted for more than 10 percent of sales.\n(9)\tFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe reported amounts of financial instruments such as cash, accounts receivable, accounts payable and accrued expenses approximate fair value because of their short maturity. The carrying value of notes payable to bank approximates fair value because these instruments bear interest at current market rates.\n(10)\tCOMMITMENTS AND CONTINGENCIES\nThe Company leases warehouse and office facilities under long-term noncancelable operating leases. The following is a schedule of future minimum lease payments under these leases as of December 31, 1995:\nRental expense for continuing operations under operating leases for the years ended December 31, 1995, 1994 and 1993 was $341,949, $320,867, and $237,741, respectively. Rental expense for discontinued operations under operating leases for the years ended December 31, 1995, 1994 and 1993 was $16,479, $35,600, and $27,900, respectively.\nThe Company has employment agreements with four key employees. The agreements provide for minimum aggregate cash compensation in each of the next four years as follows:\nThe Company was named as a defendant in a product liability lawsuit. The Company has requested and received (1) indemnification under the manufacturer's product liability insurance and (2) legal representation at the cost of the manufacturer. As of February 29, 1996, no depositions have been taken, therefore management is not able to assess the merit of the defendant's case. However, the Company does not anticipate any material impact on its financial statements as a result of this litigation.\nSCHEDULE II ABATIX ENVIRONMENTAL CORP. AND SUBSIDIARY\nValuation and Qualifying Accounts Years ended December 31, 1995, 1994 and 1993\nA Represents the write-off of uncollectible accounts. B\t Amounts include the allowance for doubtful accounts related to the Company's discontinued operations, which had balances of $7,264, $6,543 and $3,456 at December 31, 1995, 1994 and 1993, respectively. C\t Represents the losses from operations, the loss on sale of fixed assets and the payment of lease obligations. D\t The balance is included in the net liabilities of discontinued operations on the consolidated balance sheet. E\t Represents the reserve established in December 1994 related to the discontinued operations. See note 2 to the consolidated financial statements. F\t Cash settlement in exchange for release from the lease on one of the properties related to the discontinued operations. See note 2 to the consolidated financial statements. G\t The balance is included in the net assets of discontinued operations on the consolidated balance sheet. H\t Amount is primarily the payment of lease obligations.","section_15":""}
{"filename":"6201_1995.txt","cik":"6201","year":"1995","section_1":"ITEM 1. BUSINESS\nAMR Corporation (AMR or the Company) was incorporated in October 1982. AMR's principal subsidiary, American Airlines, Inc. (American), was founded in 1934. For financial reporting purposes, AMR's operations fall within three major lines of business: the Airline Group, The SABRE Group and the Management Services Group.\nAIRLINE GROUP\nThe Airline Group consists primarily of American's Passenger and Cargo divisions, as well as AMR Eagle, Inc. and AMR Leasing Corporation, which are subsidiaries of AMR.\nAMERICAN'S PASSENGER DIVISION is one of the largest scheduled passenger airlines in the world. At the end of 1995, American provided scheduled jet service to more than 160 destinations, primarily throughout North America, the Caribbean, Latin America, Europe and the Pacific.\nAMERICAN'S CARGO DIVISION is one of the largest scheduled air freight carriers in the world. The Cargo Division provides a full range of freight and mail services to shippers throughout the airline's system. In addition, through cooperative agreements with other carriers, it has the ability to transport shipments to virtually any country in the world.\nAMR EAGLE, INC. owns the four regional airlines which operate as \"American Eagle\" -- Flagship Airlines, Inc., Simmons Airlines, Inc., Executive Airlines, Inc. and Wings West Airlines, Inc. The American Eagle carriers provide connecting turboprop service from seven of American's high-traffic cities to smaller markets throughout the United States, Canada, the Bahamas and the Caribbean.\nAMR LEASING CORPORATION is a financing subsidiary which leases regional aircraft to subsidiaries of AMR Eagle.\nTHE SABRE GROUP\nAMR formed The SABRE Group in 1993 to capitalize on the synergies of combining its information technology businesses under common management. The SABRE Group consists primarily of four business units -- SABRE Travel Information Network (STIN), SABRE Computer Services (SCS), SABRE Decision Technologies (SDT) and SABRE Interactive.\nSTIN markets SABRE -- one of the largest privately owned, real-time computer systems in the world -- which provides travel distribution and information services to nearly 30,000 travel agencies in 74 countries on six continents.\nSCS manages and maintains AMR's technology infrastructure. This includes the planning, installation and operation of AMR's data centers, as well as technology and architectural planning for AMR units and for external customers. SCS also provides voice and data communication services to AMR, but is currently in negotiations with a third party to outsource this function.\nSDT provides decision support systems, application software packages, systems development and consulting services to other AMR units and to external companies in the transportation, travel and other industries worldwide.\nSABRE INTERACTIVE is a distribution strategy division formed by The SABRE Group in 1995 to develop opportunities for consumer-direct travel distribution via personal computer, CD-ROM, interactive television, cable television and other media.\nMANAGEMENT SERVICES GROUP\nThe Management Services Group consists of four AMR subsidiaries -- AMR Services Corporation, Americas Ground Services, Inc. (AGS), AMR Investment Services, Inc. and Airline Management Services, Inc. (AMS).\nAMR SERVICES CORPORATION has six operating divisions: Airline Services, AMR Combs, AMR Distribution Systems, TeleService Resources (TSR), Data Management Services (DMS) and AMR Training Group. The Airline Services division's main lines of business include airline passenger, ramp and cargo handling, cabin service and an array of other air transportation-related services for carriers around the world. AMR Combs is a premier corporate aviation services network of 13 facilities in major business centers in the United States and Mexico. It also is involved in a number of other related businesses, including parts and aircraft sales and operation of one of the world's largest executive charter services. AMR Distribution Systems serves the logistics marketplace and specializes in contract warehousing, trucking and multi-modal freight forwarding services. TSR provides comprehensive telemarketing and reservation services for a wide range of clients. DMS provides data capture and document management services to American and to companies in the insurance, financial services and transportation industries. AMR Training Group provides a wide variety of training services and operates the American Airlines Training & Conference Center, which hosts a multitude of AMR training activities, and markets its capabilities to other companies.\nAGS provides airline ground and cabin service handling at 11 locations in eight countries in the Caribbean and Central and South America.\nAMR INVESTMENT SERVICES, INC. serves as an investment advisor to AMR and other institutional investors. It also manages the American AAdvantage Funds, which have both institutional shareholders, including pension funds and bank and trust companies, and individual shareholders. As of December 31, 1995, AMR Investment Services was responsible for management of approximately $13.7 billion in assets, including direct management of approximately $4.5 billion in short-term investments.\nAMS was formed in 1994 to manage the Company's service contracts with other airlines such as the agreement to provide a variety of management, technical and administrative services to Canadian Airlines International, Ltd. which the Company signed in 1994.\nAdditional information regarding business segments is included in Management's Discussion and Analysis on pages 15 through 27 and in Note 14 to the consolidated financial statements.\nROUTES AND COMPETITION\nAIR TRANSPORTATION Most major air carriers have developed hub-and-spoke systems and schedule patterns in an effort to maximize the revenue potential of their service. American operates four hubs: Dallas\/Fort Worth, Chicago O'Hare, Miami, and San Juan, Puerto Rico. In 1995, American implemented schedule reductions which ended the airline's hub operations at Raleigh\/Durham and Nashville. Delta Air Lines and United Airlines have hub operations at American's Dallas\/Fort Worth and Chicago O'Hare hubs, respectively.\nThe American Eagle carriers increase the number of markets the Airline Group serves by providing connections to American at its hubs and certain other major airports. The American Eagle carriers -- Simmons Airlines, Inc., Flagship Airlines, Inc., Wings West Airlines, Inc. and Executive Airlines, Inc. - - -- serve smaller markets through Dallas\/Fort Worth, Chicago, Miami, Nashville, San Juan, Los Angeles and New York John F. Kennedy International Airport. American's competitors also own or have marketing agreements with regional carriers which provide service at their major hubs.\nIn addition to its extensive domestic service, American provides service to and from cities in various other countries, across the Atlantic and Pacific, and between the U.S. and the Caribbean, and Central and South America. American's operating revenues from foreign operations were approximately $4.7 billion in 1995, $4.3 billion in 1994 and $3.9 billion in 1993. Additional information about the Company's foreign operations is included in Note 13 to the consolidated financial statements.\nService over almost all of the Airline Group's routes is highly competitive. Currently, any carrier deemed fit by the U.S. Department of Transportation (DOT) is free to operate scheduled passenger service between any two points within the U.S. and its possessions. On most of its non-stop routes, the Airline Group competes with at least one, and usually more than one, major domestic airline including: America West Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines, Southwest Airlines, Trans World Airlines, United Airlines, and USAir. Competition is even greater between cities that require a connection, for example, Portland, Oregon to Tampa, Florida, where eight airlines compete via the respective hubs of each carrier. The Airline Group also competes with national, regional, all-cargo, and charter carriers and, particularly on shorter segments, ground transportation.\nOn all of its routes, pricing decisions are affected by competition from other airlines, some of which have cost structures significantly lower than American's and can therefore operate profitably at lower fare levels. Approximately 40 percent of American's bookings are impacted by competition from lower-cost carriers. American and its principal competitors use inventory management systems that permit them to vary the number of discount seats offered on each flight in an effort to maximize revenues, yet still be price competitive with lower-cost carriers.\nCompetition in many international markets is subject to extensive government regulation. In these markets, American competes with foreign-investor owned carriers, state-owned airlines and U.S. carriers that have been granted authority to provide scheduled passenger and cargo service between the U.S. and various overseas locations. American's operating authority in these markets is subject to aviation agreements between the U.S. and the respective countries, and in some cases, fares and schedules require the approval of the DOT and the relevant foreign governments. Because international air transportation is governed by bilateral or other agreements between the U.S. and the foreign country or countries involved, changes in U.S. or foreign government aviation policy could result in the alteration or termination of such agreements, diminish the value of such route authorities, or otherwise affect American's international operations. Bilateral agreements between the U.S. and various foreign countries served by American are subject to frequent renegotiation.\nThe major domestic carriers have some advantage over foreign competitors in their ability to generate traffic from their extensive domestic route systems. In many cases, however, U.S. carriers are limited in their rights to carry passengers beyond designated gateway cities in foreign countries. Some of American's foreign competitors are owned and subsidized by foreign governments. To improve their access to each others' markets, various U.S. and foreign carriers - - including American -- have made substantial equity investments in, or established marketing relationships with, other carriers. American has well-developed code sharing programs with Canadian Airlines International, Qantas Airways, Singapore Airlines, South African Airways, Gulf Air, and British Midland. In the coming years, the Company expects to develop these programs further and to evaluate new alliances with other international carriers.\nThe Airline Group believes that it has several advantages relative to its competition. Its fleet is young, efficient and quiet. It has a comprehensive domestic and international route structure, anchored by efficient hubs, which permit it to take full advantage of whatever traffic growth occurs. The Company believes American's AAdvantage frequent flyer program, which is the largest program in the industry, and its superior service also give it a competitive advantage.\nCOMPUTER RESERVATION SYSTEMS The complexity of the various schedules and fares offered by air carriers has fostered the development of electronic distribution systems. Travel agents and other subscribers access travel information and book airline, hotel and car rental reservations and issue airline tickets using these systems. American developed the SABRE computer reservation system (CRS), which is one of the largest CRSs in the world. Competition among the CRS vendors is strong. Services similar to those offered through SABRE are offered by several air carriers and other companies in the United States and abroad.\nThe SABRE CRS has several advantages relative to its competition. SABRE ranks first in market share among travel agents in the U.S. The SABRE CRS is furthering its expansion into international markets and continues to be in the forefront of technological innovation in the CRS industry.\nREGULATION\nGENERAL The Airline Deregulation Act of 1978 (Act) and various other statutes amending the Act eliminated most domestic economic regulation of passenger and freight transportation. However, the DOT and the Federal Aviation Administration (FAA) still exercise certain regulatory authority over air carriers under the Federal Aviation Act of 1958, as amended. The DOT maintains jurisdiction over international route authorities and certain consumer protection matters, such as advertising, denied boarding compensation, baggage liability, and computer reservations systems. The DOT issued certain rules governing the CRS industry which became effective on December 7, 1992, and expire on December 31, 1997.\nThe FAA regulates flying operations generally, including establishing personnel, aircraft and security standards. In addition, the FAA has implemented a number of requirements that the Airline Group is incorporating into its maintenance program. These matters relate to, among other things, inspection and maintenance of aging aircraft, corrosion control, collision avoidance and windshear detection. Based on its current implementation schedule, the Airline Group expects to be in compliance with the applicable requirements within the required time periods.\nThe U.S. Department of Justice has jurisdiction over airline antitrust matters. The U.S. Postal Service has jurisdiction over certain aspects of the transportation of mail and related services. Labor relations in the air transportation industry are regulated under the Railway Labor Act, which vests in the National Mediation Board certain regulatory powers with respect to disputes between airlines and labor unions arising under collective bargaining agreements.\nFARES Airlines are permitted to establish their own domestic fares without governmental regulation, and the industry is characterized by substantial price competition. The DOT maintains authority over international fares, rates and charges. International fares and rates are also subject to the jurisdiction of the governments of the foreign countries which American serves. While air carriers are required to file and adhere to international fare and rate tariffs, many international markets are characterized by substantial commissions, overrides, and discounts to travel agents, brokers and wholesalers.\nFare discounting by competitors has historically had a negative effect on the Airline Group's financial results because the Airline Group is generally required to match competitors' fares to maintain passenger traffic. During recent years, a number of new low-cost airlines have entered the domestic market and several major airlines have begun to implement efforts to lower their cost structures. Further fare reductions, domestic and international, may occur in the future. If fare reductions are not offset by increases in passenger traffic or changes in the mix of traffic that improves yields, the Airline Group's operating results will be negatively impacted.\nAIRPORT ACCESS In 1968, the FAA issued a rule designating New York John F. Kennedy, New York LaGuardia, Washington National, Chicago O'Hare and Newark airports as high density traffic airports. Newark was subsequently removed from the high density airport classification. The rule adopted hourly take-off and landing slot allocations for each of these airports. Currently, the FAA permits the purchasing, selling, leasing and trading of these slots by airlines and others, subject to certain restrictions. Certain foreign airports, including London Heathrow, a major European destination for American, also have slot allocations.\nThe Airline Group currently has sufficient slot authorizations to operate its existing flights and has generally been able to obtain slots to expand its operations and change its schedules. There is no assurance, however, that the Airline Group will be able to obtain slots for these purposes in the future, because, among other factors, slot allocations are subject to changes in government policies.\nENVIRONMENTAL MATTERS The Company is subject to various laws and government regulations concerning environmental matters and employee safety and health in the U.S. and other countries. U.S. federal laws that have a particular impact on the Company include the Airport Noise and Capacity Act of 1990 (ANCA), the Clean Air Act, the Resource Conservation and Recovery Act, the Clean Water Act, the Safe Drinking Water Act, and the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or the Superfund Act). The Company is also subject to the oversight of the Occupational Safety and Health Administration (OSHA) concerning employee safety and health matters. The U.S. Environmental Protection Agency (EPA), OSHA, and other federal agencies have been authorized to promulgate regulations that have an impact on the Company's operations. In addition to these federal activities, various states have been delegated certain authorities under the aforementioned federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations, some of which are similar to federal requirements. As a part of its continuing safety, health and environmental program, the Company has maintained compliance with such requirements without any material adverse effect on its business.\nFor purposes of noise standards, jet aircraft are rated by categories or \"stages.\" The ANCA requires the phase- out by December 31, 1999, of Stage II aircraft operations, subject to certain exceptions. Under final regulations issued by the FAA in 1991, air carriers are required to reduce, by modification or retirement, the number of Stage II aircraft in their fleets 25 percent by December 31, 1994; 50 percent by December 31, 1996; 75 percent by December 31, 1998, and 100 percent by December 31, 1999. Alternatively, a carrier may satisfy the regulations by operating a fleet that is at least 55 percent, 65 percent, 75 percent, and 100 percent Stage III by the dates set forth in the preceding sentence, respectively. At December 31, 1995, approximately 89 percent of American's active fleet was Stage III, the quietest and most fuel efficient rating category.\nThe ANCA recognizes the rights of airport operators with noise problems to implement local noise abatement programs so long as they do not interfere unreasonably with interstate or foreign commerce or the national air transportation system. Authorities in several cities have promulgated aircraft noise reduction programs, including the imposition of night-time curfews. The ANCA generally requires FAA approval of local noise restrictions on Stage III aircraft first effective after October 1990, and establishes a regulatory notice and review process for local restrictions on Stage II aircraft first proposed after October 1990. While American has had sufficient scheduling flexibility to accommodate local noise restrictions imposed to date, American's operations could be adversely affected if locally-imposed regulations become more restrictive or widespread.\nAmerican has been identified by the EPA as a potentially responsible party (PRP) with respect to the following Superfund Sites: Operating Industries, Inc., California; Cannons, New Hampshire; Byron Barrel and Drum, New York; Palmer PSC, Massachusetts; Frontier Chemical, New York and Duffy Brothers, Massachusetts. American has settled the Cannons, Byron Barrel and Drum, Palmer PSC and Frontier Chemical matters, and all that remains to complete these matters are administrative tasks. American has signed a partial consent decree with respect to Operating Industries, Inc. With respect to the Operating Industries, Inc., Palmer PSC, Frontier Chemical and Duffy Brothers sites, American is one of several PRPs named at each site. American's alleged waste disposal volumes are minor compared to the other PRPs.\nAmerican, along with most other tenants at Boston Logan International Airport, has been notified under the Massachusetts State Superfund statute of a claim for contribution by the Massachusetts Port Authority\n(Massport). Massport has claimed that American is responsible for past and future remediation costs at the airport. American is vigorously defending against Massport's claim.\nAmerican, along with most other tenants at the San Francisco International Airport, has been ordered by the California Regional Water Quality Control Board to engage in various studies of potential environmental contamination at the airport and to undertake remedial measures, if necessary.\nThe Miami International Airport Authority is currently remediating various environmental conditions at the Miami International Airport (Airport) and funding the remediation costs through landing fee revenues. Some of the costs of the remediation effort may be borne by carriers currently operating at the Airport, including American, through increased landing fees since certain of the potentially responsible parties are no longer in business. The future increase in landing fees may be material but cannot be reasonably estimated due to various factors, including the unknown extent of the remedial actions that may be required, the proportion of the cost that will ultimately be recovered from the responsible parties, and uncertainties regarding the environmental agencies that will ultimately supervise the remedial activities and the nature of that supervision.\nAMR Combs Memphis, an AMR Services subsidiary, has been named a PRP at an EPA Superfund Site in West Memphis, Arkansas. AMR Combs Memphis' alleged involvement in the site is minor relative to the other PRPs.\nFlagship Airlines, Inc., an AMR Eagle subsidiary, has been notified of its potential liability under New York law at an inactive hazardous waste site in Poughkeepsie, New York.\nAMR does not expect these matters, individually or collectively, to have a significant impact on its financial position or liquidity.\nLABOR\nThe airline business is labor intensive. Approximately 81 percent of AMR's employees work in the Airline Group. Wages, salaries and benefits represented approximately 36 percent of AMR's consolidated operating expenses for the year ended December 31, 1995. To improve its competitive position, American has undertaken various steps to reduce its unit labor costs, including workforce reductions.\nThe majority of American's employees are represented by labor unions and covered by collective bargaining agreements. American's relations with such labor organizations are governed by the Railway Labor Act. Under this act, the collective bargaining agreements among American and these organizations do not expire but instead become amendable as of a stated date. If either party wishes to modify the terms of any such agreement, it must notify the other party before the contract becomes amendable. After receipt of such notice, the parties must meet for direct negotiations, and if no agreement is reached, either party may request the National Mediation Board (NMB) to appoint a federal mediator. If no agreement is reached in mediation, the NMB may determine, at any time, that an impasse exists, and if an impasse is declared, the NMB proffers binding arbitration to the parties. Either party may decline to submit to arbitration. If arbitration is rejected, a 30-day \"cooling-off\" period commences, following which the labor organization may strike and the airline may resort to \"self-help,\" including the imposition of its proposed amendments and the hiring of replacement workers.\nIn October 1995, a panel of arbitrators issued a binding arbitration award that resolved the remaining open issues in the labor contract between American and the Association of Professional Flight Attendants (APFA). The arbitration award included a one-time early retirement program, for which AMR recorded a charge in the fourth quarter. American's collective bargaining agreement with the APFA becomes amendable on November 1, 1998.\nIn 1995, American reached agreements with the members of the Transport Workers Union (TWU) on their labor contracts. The new contracts include a one-time early retirement program, for which AMR recorded a charge in the fourth quarter. American's collective bargaining agreement with the TWU becomes amendable on March 1, 2001.\nAmerican's collective bargaining agreement with the Allied Pilots Association (APA) became amendable on August 31, 1994. In January 1996, the APA filed a petition with the NMB to appoint a federal mediator. A\nmediator has been appointed, and initial meetings have been held between the APA and the NMB mediator and between American and the NMB mediator. Joint meetings began in March 1996.\nA majority of the workforces at the four AMR Eagle carriers is represented by labor unions and covered by a number of different collective bargaining agreements. Certain of these agreements are currently in negotiation. A 1995 decision by the NMB provides that the four AMR Eagle carriers are to be treated as a single carrier for the limited purpose of labor relations, which will result in all employees within each specific job class or craft being represented by a single union for collective bargaining purposes. This decision does not affect the current collective bargaining agreements or the corporate status of the four carriers -- each continues to be a separate company with its own government operating certificates.\nFUEL\nThe Airline Group's operations are significantly affected by the availability and price of jet fuel. American's fuel costs and consumption for the years 1991 through 1995 were:\nBased upon American's 1995 fuel consumption, a one-cent rise in the average annual price-per-gallon of jet fuel would increase American's monthly fuel costs by approximately $2.3 million, not considering the offsetting effect of American's fuel cost hedging program.\nThe impact of fuel price changes on the Company's competitors is dependent upon various factors, including their hedging strategies. However, lower fuel prices may be offset by increased price competition and lower revenues for all air carriers. Conversely, there can be no assurance that American will be able to pass fuel cost increases on to its customers by increasing fares in the future.\nMost of American's fuel is purchased pursuant to contracts which, by their terms, may be terminated upon short notice. While American does not anticipate a significant reduction in fuel availability, dependency on foreign imports of crude oil and the possibility of changes in government policy on jet fuel production, transportation and marketing make it impossible to predict the future availability of jet fuel. If there were major reductions in the availability of jet fuel, American's business would be adversely affected.\nFREQUENT FLYER PROGRAM\nAmerican established the AAdvantage frequent flyer program (AAdvantage) to develop passenger loyalty by offering awards to travelers for their continued patronage. AAdvantage members earn mileage credits for flights on American, American Eagle and certain other participating airlines, or by utilizing services of other program participants, including hotels, car rental companies and bank credit card issuers. American sells mileage credits to the other companies participating in the program. American reserves the right to change the AAdvantage program rules, regulations, travel awards and special offers at any time without notice. American may initiate changes impacting, for example, participant affiliations, rules for earning mileage credit, mileage levels and awards, blackout dates and limited seating for travel awards, and the features of special offers. American reserves the right to end the AAdvantage program with six months notice.\nMileage credits can be redeemed for free, discounted or upgraded travel on American, American Eagle or participating airlines, or for other travel industry awards. Once a member accrues sufficient mileage for an award, the member may request an award certificate from American. Award certificates may be redeemed up to one\nyear after issuance. Most travel awards are subject to blackout dates and capacity controlled seating. All miles earned after July 1989 must be redeemed within three years or they expire.\nAmerican accounts for its frequent flyer obligation on an accrual basis using the incremental cost method. American's frequent flyer liability is accrued each time a member accumulates sufficient mileage in his or her account to claim the lowest level of free travel award (25,000 miles) and such award is expected to be used for free travel. American includes fuel, food, and reservations\/ticketing costs, but not a contribution to overhead or profit, in the calculation of incremental cost. The cost for fuel is estimated based on total fuel consumption tracked by various categories of markets, with an amount allocated to each passenger. Food costs are tracked by market category, with an amount allocated to each passenger. Reservation\/ticketing costs are based on the total number of passengers, including those traveling on free awards, divided into American's total expense for these costs. American defers a portion of revenues from the sale of mileage credits to companies participating in the AAdvantage program and recognizes such revenues over a period approximating the period during which the mileage credits are used.\nAt December 31, 1995 and 1994, American estimated that approximately 4.7 million and 4.5 million free travel awards, respectively, were eligible for redemption. At December 31, 1995 and 1994, American estimated that approximately 4.0 million and 3.6 million free travel awards, respectively, were expected to be redeemed for free travel. In making this estimate, American has excluded mileage in inactive accounts, mileage related to accounts that have not yet reached the lowest level of free travel award, and mileage in active accounts that have reached the lowest level of free travel award but which is not expected to ever be redeemed for free travel. The liability for the program mileage that has reached the lowest level of free travel award and is expected to be redeemed for free travel and deferred revenues for mileage sold to others participating in the program was $370 million and $329 million, representing 7.9 percent and 6.9 percent of AMR's total current liabilities, at December 31, 1995 and 1994, respectively.\nThe number of free travel awards used for travel on American during the years ended December 31, 1995, 1994 and 1993, was approximately 2,204,000, 2,198,000, and 2,163,000, respectively, representing 8.4 percent, 8.5 percent and 9.5 percent of total revenue passenger miles for each period, respectively. American believes displacement of revenue passengers is insignificant given American's load factors, its ability to manage frequent flyer seat inventory, and the relatively low ratio of free award usage to revenue passenger miles.\nOTHER MATTERS\nSEASONALITY AND OTHER FACTORS The Airline Group's results of operations for any interim period are not necessarily indicative of those for the entire year, since the air transportation business is subject to seasonal fluctuations. Higher demand for air travel has traditionally resulted in more favorable operating results for the second and third quarters of the year than for the first and fourth quarters.\nThe results of operations in the air transportation business have also significantly fluctuated in the past in response to general economic conditions. In addition, fare initiatives, fluctuations in fuel prices, labor actions and other factors could impact this seasonal pattern. Unaudited quarterly financial data for the two-year period ended December 31, 1995, is included in Note 16 to the consolidated financial statements.\nNo material part of the business of AMR and its subsidiaries is dependent upon a single customer or very few customers. Consequently, the loss of the Company's largest few customers would not have a materially adverse effect upon AMR.\nINSURANCE American carries insurance for public liability, passenger liability, property damage and all-risk coverage for damage to its aircraft, in amounts which, in the opinion of management, are adequate.\nOTHER GOVERNMENT MATTERS In time of war or during an unlimited national emergency or civil defense emergency, American and other major air carriers may be required to provide airlift services to the Military Airlift Command under the Civil Reserve Air Fleet program.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFLIGHT EQUIPMENT\nOwned and leased aircraft operated by AMR's subsidiaries at December 31, 1995, included:\nFor information concerning the estimated useful lives and residual values for owned aircraft, lease terms and amortization relating to aircraft under capital leases, and acquisitions of aircraft, see Notes 1, 3 and 4 to the consolidated financial statements. See Management's Discussion and Analysis for discussion of the retirement of certain aircraft from the fleet.\nIn April 1995, American announced an agreement to sell 12 of its McDonnell Douglas MD-11 aircraft to Federal Express Corporation (FedEx), with delivery of the aircraft between 1996 and 1999. In addition, American has the option to sell its remaining seven MD-11 aircraft to FedEx with deliveries between 2000 and 2002.\nLease expirations for leased aircraft operated by AMR's subsidiaries and included in the preceding table as of December 31, 1995, were:\nThe table excludes leases for 15 Boeing 767-300 Extended Range aircraft which can be canceled with 30 days' notice during the initial 10-year lease term. At the end of that term in 1998, the leases can be renewed for periods ranging from 10 to 12 years. The table also excludes leases for 10 Saab 340A aircraft, 10 Saab 340B aircraft, seven Saab 340B Plus aircraft, eight ATR 42 aircraft, and three Super ATR aircraft which can be canceled with six months or less notice within certain restrictions.\nSubstantially all of the Airline Group's aircraft leases include an option to purchase the aircraft or to extend the lease term, or both, with the purchase price or renewal rental to be based essentially on the market value of the aircraft at the end of the term of the lease or at a predetermined fixed rate.\nGROUND PROPERTIES\nAmerican leases, or has built as leasehold improvements on leased property, most of its airport and terminal facilities; certain corporate office, maintenance and training facilities in Fort Worth, Texas; its principal overhaul and maintenance base and computer facility at Tulsa International Airport, Tulsa, Oklahoma; its regional reservation offices; and local ticket and administration offices throughout the system. American has entered into agreements with the Tulsa Municipal Airport Trust; the Alliance Airport Authority, Fort Worth, Texas; and the Dallas\/Fort Worth, Chicago O'Hare, Raleigh\/Durham, Nashville, San Juan, New York, and Los Angeles airport authorities to provide funds for constructing, improving and modifying facilities and acquiring equipment which are or will be leased to American. American also utilizes public airports for its flight operations under lease or use arrangements with the municipalities or governmental agencies owning or controlling them and leases certain other ground equipment for use at its facilities.\nFor information concerning the estimated lives and residual values for owned ground properties, lease terms and amortization relating to ground properties under capital leases, and acquisitions of ground properties, see Notes 1, 3 and 4 to the consolidated financial statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn January, 1985, American announced a new fare category, the \"Ultimate SuperSaver,\" a discount, advance purchase fare that carried a 25 percent penalty upon cancellation. On December 30, 1985, a class action lawsuit was filed in Circuit Court, Cook County, Illinois entitled Johnson vs. American Airlines, Inc. The Johnson plaintiffs allege that the 10 percent federal excise transportation tax should be excluded from the \"fare\" upon which the 25 percent penalty is assessed. The case has not been certified as a class action. Summary judgment has been granted for American and the matter is currently on appeal. American believes the matter is without merit and is vigorously defending the lawsuit.\nAmerican has been sued in two class action cases that have been consolidated in the Circuit Court of Cook County, Illinois, in connection with certain changes made to American's AAdvantage frequent flyer program in May, 1988. (Wolens, et al v. American Airlines, Inc., No. 88 CH 7554, and Tucker v. American Airlines, Inc., No. 89 CH 199.) In both cases, the plaintiffs seek to represent all persons who joined the AAdvantage program before May 1988. Currently, the plaintiffs allege that, on that date, American implemented changes that limited the number of seats available to participants traveling on certain awards and established blackout dates during which no AAdvantage seats would be available for certain awards and that these changes breached American's contracts with AAdvantage members. Plaintiffs seek money damages for such alleged breach and attorneys' fees. Previously the plaintiffs also alleged violation of the Illinois Consumer Fraud and Deceptive Business Practice Act (Consumer Fraud Act) and sought punitive damages, attorneys' fees and injunctive relief preventing American from making changes to the AAdvantage program. American originally moved to dismiss all of the claims asserting that they were preempted by the Federal Aviation Act and barred by the Commerce Clause of the U.S. Constitution.\nInitially, the trial court denied American's preemption motions, but certified its decision for interlocutory appeal. In December 1990, the Illinois Appellate Court held that plaintiffs' claims for an injunction are preempted by the Federal Aviation Act, but that plaintiffs' claims for money damages could proceed. On March 12, 1992, the Illinois Supreme Court affirmed the decision of the Appellate Court. American sought a writ of certiorari from the U.S. Supreme Court; and on October 5, 1992, the Court vacated the decision of the Illinois Supreme Court and remanded the cases for reconsideration in light of the U.S. Supreme Court's decision in Morales v. TWA, et al, which interpreted the preemption provisions of the Federal Aviation Act very broadly. On December 16, 1993, the Illinois Supreme Court rendered its decision on remand, holding that plaintiffs' claims seeking an injunction are preempted, but that identical claims for compensatory and punitive damages are not preempted. On February 8, 1994, American filed a petition for a writ of certiorari in the U.S. Supreme Court. The Illinois Supreme Court granted American's motion to stay the state court proceeding pending disposition of American's petition in the U.S. Supreme Court. The matter was argued before the U.S. Supreme Court on November 1, 1994, and on January 18, 1995, the U.S. Supreme Court issued its opinion ending a portion of the suit against American. The U.S. Supreme Court held that a) plaintiffs' claim for violation of the Illinois Consumer Fraud Act is preempted by federal law -- entirely ending that part of the case and eliminating plaintiffs' claim for punitive damages; and b) certain breach of contract claims are not preempted by federal law.\nThe Court did not determine, however, whether the contract claims asserted by the plaintiffs are preempted, and therefore, remanded the case to the state court for further proceedings. Subsequently, plaintiffs filed an amended complaint seeking damages solely for a breach of contract claim. In the event that the plaintiffs' breach of contract claim is eventually permitted to proceed in the state court, American intends to vigorously defend the case.\nIn December, 1993, American announced that the number of miles required to claim a certain travel award under American's AAdvantage frequent flyer program would be increased effective February 1, 1995. On February 1, 1995 a class action lawsuit entitled Gutterman vs. American Airlines, Inc. was filed in the Circuit Court of Cook County, Illinois. The Gutterman plaintiffs claim that this increase in mileage level violated the terms and conditions of the agreement between American and AAdvantage members. On February 9, 1995, a virtually identical class action lawsuit entitled Benway vs. American Airlines, Inc. was filed in District Court, Dallas County, Texas. After limited discovery and prior to class certification, a summary judgment dismissing the Benway case was entered by the Dallas County Court in July 1995. On March 11, 1996, American's motion to dismiss the Gutterman lawsuit was denied, although American's motion for summary judgment is still pending.\nNo class has been certified in the Gutterman lawsuit and to date no discovery has been undertaken. American believes the Gutterman complaint is without merit and is vigorously defending the lawsuit.\nOn February 10, 1995, American capped travel agency commissions for one-way and round trip domestic tickets at $25 and $50, respectively. Immediately thereafter, numerous travel agencies, and two travel agency trade association groups, filed class action lawsuits against American and other major air carriers (Continental, Delta, Northwest, United, USAir and TWA) that had independently imposed similar limits on travel agency commissions. The suits were transferred to the United States District Court for the District of Minnesota, and consolidated as a multi-district litigation captioned In Re: Airline Travel Agency Commission Antitrust Litigation. The plaintiffs assert that the airline defendants conspired to reduce travel agency commissions and to monopolize air travel in violation of sections 1 and 2 of the Sherman Act. The case has been certified as a class action on behalf of approximately 40,000 domestic travel agencies and two travel agency trade associations. In June 1995 after extensive, expedited discovery, the travel agents moved for a preliminary injunction to enjoin the commission caps, and the defendants simultaneously moved for summary judgment. On August 31, 1995, the District Court denied both motions. Pre-trial activities against the defendants, including American, are continuing. American is vigorously defending the lawsuit.\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 REGISTRANT\nThe executive officers of AMR as of December 31, 1995, were:\nRobert L. Crandall Mr. Crandall was elected Chairman and Chief Executive Officer of AMR and American in March 1985. He has been President of AMR since its formation in 1982 and served as President of American from 1980 to March 1995. Age 60.\nDonald J. Carty Mr. Carty was elected President of American in March 1995 and Executive Vice President of AMR in October 1989. Except for two years service as President of Canadian Pacific Air between March 1985 and March 1987, he has been with the Company in various finance and planning positions since 1978. Age 49.\nGerard J. Arpey Mr. Arpey was elected Chief Financial Officer in March 1995 and Senior Vice President in April 1992. Prior to that, he served as Vice President of American since October 1989. Age 37.\nAnne H. McNamara Mrs. McNamara was elected Senior Vice President and General Counsel in June 1988. She had served as Vice President - Personnel Resources of American from January 1988 through May 1988. She was elected Corporate Secretary of AMR in 1982 and American in 1979 and held those positions through 1987. Age 48.\nCharles D. MarLett Mr. MarLett was elected Corporate Secretary in January 1988. He joined American as an attorney in June 1984. Age 41.\nThere are no family relationships among the executive officers of the Company named above.\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.\nPART II\n- - -------------------------------------------------------------------------------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is traded on the New York Stock Exchange (symbol AMR). The approximate number of record holders of the Company's common stock at March 18, 1996, was 15,935.\nThe range of closing market prices for AMR's common stock on the New York Stock Exchange was:\nNo cash dividends on common stock were declared for any period during 1995 or 1994. Payment of dividends is subject to the restrictions described in Note 5 to the consolidated financial statements.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\n(in millions, except per share amounts) - - --------------------------------------------------------------------------------\n(1) Operating income (loss) for 1995 and 1994 includes restructuring costs of $533 million and $278 million, respectively.\n(2) Information on the adjustment to the earnings per share computation for the twelve months ended December 31, 1994, for the effect of the preferred stock exchange is included in Note 5 to the consolidated financial statements.\nNo dividends were declared on common shares during any of the periods above.\nEffective January 1, 1992, AMR adopted Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and No. 109, \"Accounting for Income Taxes.\"\nInformation on the comparability of results is included in Management's Discussion and Analysis and the notes to the consolidated financial statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAMR was incorporated in October 1982. AMR's principal subsidiary, American Airlines, Inc., was founded in 1934. For financial reporting purposes, AMR's operations fall within three major lines of business: the Airline Group, The SABRE Group and the Management Services Group.\nAIRLINE GROUP\nThe Airline Group consists primarily of American's Passenger and Cargo divisions, as well as AMR Eagle, Inc. and AMR Leasing Corporation, which are subsidiaries of AMR.\nAMERICAN'S PASSENGER DIVISION is one of the largest scheduled passenger airlines in the world. At the end of 1995, American provided scheduled jet service to more than 160 destinations, primarily throughout North America, the Caribbean, Latin America, Europe and the Pacific.\nAMERICAN'S CARGO DIVISION is one of the largest scheduled air freight carriers in the world. The Cargo Division provides a full range of freight and mail services to shippers throughout the airline's system. In addition, through cooperative agreements with other carriers, it has the ability to transport shipments to virtually any country in the world.\nAMR EAGLE, INC. owns the four regional airlines which operate as \"American Eagle\" -- Flagship Airlines, Inc., Simmons Airlines, Inc., Executive Airlines, Inc. and Wings West Airlines, Inc. The American Eagle carriers provide connecting turboprop service from seven of American's high-traffic cities to smaller markets throughout the United States, Canada, the Bahamas and the Caribbean.\nAMR LEASING CORPORATION is a financing subsidiary which leases regional aircraft to subsidiaries of AMR Eagle.\nTHE SABRE GROUP\nAMR formed The SABRE Group in 1993 to capitalize on the synergies of combining its information technology businesses under common management. The SABRE Group consists primarily of four business units -- SABRE Travel Information Network (STIN), SABRE Computer Services (SCS), SABRE Decision Technologies (SDT) and SABRE Interactive.\nSTIN markets SABRE -- one of the largest privately owned, real-time computer systems in the world -- which provides travel distribution and information services to nearly 30,000 travel agencies in 74 countries on six continents.\nSCS manages and maintains AMR's technology infrastructure. This includes the planning, installation and operation of AMR's data centers, as well as technology and architectural planning for AMR units and for external customers. SCS also provides voice and data communication services to AMR, but is currently in negotiations with a third party to outsource this function.\nSDT provides decision support systems, application software packages, systems development and consulting services to other AMR units and to external companies in the transportation, travel and other industries worldwide.\nSABRE INTERACTIVE is a distribution strategy division formed by The SABRE Group in 1995 to develop opportunities for consumer-direct travel distribution via personal computer, CD-ROM, interactive television, cable television and other media.\nMANAGEMENT SERVICES GROUP\nThe Management Services Group consists of four AMR subsidiaries -- AMR Services Corporation, Americas Ground Services, Inc. (AGS), AMR Investment Services, Inc. and Airline Management Services, Inc. (AMS).\nAMR SERVICES CORPORATION has six operating divisions: Airline Services, AMR Combs, AMR Distribution Systems, TeleService Resources (TSR), Data Management Services (DMS) and AMR Training Group. The Airline Services division's main lines of business include airline passenger, ramp and cargo handling, cabin service and an array of other air transportation-related services for carriers around the world. AMR Combs is a premier corporate aviation services network of 13 facilities in major business centers in the United States and Mexico. It also is involved in a number of other related businesses, including parts and aircraft sales and operation of one of the world's largest executive charter services. AMR Distribution Systems serves the logistics marketplace and specializes in contract warehousing, trucking and multi-modal freight forwarding services. TSR provides comprehensive telemarketing and reservation services for a wide range of clients. DMS provides data capture and document management services to American and to companies in the insurance, financial services and transportation industries. AMR Training Group provides a wide variety of training services and operates the American Airlines Training & Conference Center, which hosts a multitude of AMR training activities, and markets its capabilities to other companies.\nAGS provides airline ground and cabin service handling at 11 locations in eight countries in the Caribbean and Central and South America.\nAMR INVESTMENT SERVICES, INC. serves as an investment advisor to AMR and other institutional investors. It also manages the American AAdvantage Funds, which have both institutional shareholders, including pension funds and bank and trust companies, and individual shareholders. As of December 31, 1995, AMR Investment Services was responsible for management of approximately $13.7 billion in assets, including direct management of approximately $4.5 billion in short-term investments.\nAMS was formed in 1994 to manage the Company's service contracts with other airlines such as the agreement to provide a variety of management, technical and administrative services to Canadian Airlines International, Ltd. which the Company signed in 1994.\nRESULTS OF OPERATIONS\nSUMMARY AMR's net income in 1995 was $167 million ($2.11 per common share, primary and fully diluted, after preferred dividends). During the fourth quarter of 1995, AMR recorded a charge of $533 million ($334 million after tax) related to the cost of future pension and other postretirement benefits for voluntary early retirement programs offered in conjunction with recently renegotiated labor contracts covering members of the Transport Workers Union (TWU) and the Association of Professional Flight Attendants (APFA), as well as provisions for the writedown of certain McDonnell Douglas DC-10 aircraft and the planned retirement of certain turboprop aircraft, and other restructuring activities. Before the special charge, net earnings were $501 million. In addition to the restructuring charge, the Company's 1995 earnings include a charge of $41 million ($26 million after tax) related to the loss of an aircraft operated by American. The expiration of the airline industry's fuel tax exemption increased the Company's costs by approximately $22 million before tax. The Company's results were adversely affected by the disruption of American Eagle operations at the Chicago and Raleigh\/Durham hubs in the first half of 1995 in response to the FAA's temporary restrictions on the operation of ATR aircraft in known or forecast icing conditions. In addition, in April 1995, a hailstorm at American's Dallas\/Fort Worth hub temporarily disabled approximately 10 percent of American's fleet and approximately nine percent of AMR Eagle's fleet, forcing the carriers to temporarily reduce scheduled service. The combined impact of the Eagle fleet disruption and the hailstorm on 1995 net income was approximately $40 million after tax.\nAMR's net income in 1994 was $228 million ($2.26 per common share, primary and fully diluted, after preferred dividends but before an adjustment to additional paid-in capital for an exchange of debentures for preferred stock). During the fourth quarter of 1994, AMR recorded a charge of $278 million ($174 million after tax) related to the cost of future pension and other postretirement benefits for agent and management\/support staff voluntary early retirement programs, severance and other restructuring activities. Before the special charge, net earnings were $402 million. In addition to the restructuring charge, the Company's 1994 earnings include a charge of $25 million ($16 million after tax) related to the loss of two regional aircraft operated by subsidiaries of AMR Eagle. The Company's results were also adversely affected by the disruption of American Eagle operations at the Chicago and Raleigh\/Durham hubs referenced above.\nIn response to the increasing competitive emphasis on lower costs and lower fares, in 1993 the Company began implementing a new strategic framework, known as the Transition Plan. The Plan has three parts, each intended to improve the Company's results. First, make the core airline business bigger and stronger where economically justified. Second, and conversely, shrink the airline where it cannot compete profitably. Third, encourage and support the growth of the profitable information and management services businesses.\nThe Company's improved results reflect progress on each of these three tenets, as well as strong economies in most of the markets it serves, relatively low jet fuel prices, and a healthier pricing environment which is attributable in part to more modest industry capacity growth.\nAmerican continued its effort to find the most productive use for each of its aircraft. During 1995, the Company made major changes to both its jet and turboprop schedules. American reallocated resources to longer flights and reduced its short-haul flying, thus improving plane miles per jet aircraft by more than four percent. To improve the mix of traffic, American increased frequency in major markets while simultaneously ending hub operations at Raleigh\/Durham and Nashville and reducing or eliminating jet service in 72 city pairs. On the international front, American increased the scope of its service to Latin America and the United Kingdom, and took advantage of the new U.S. - Canadian bilateral agreement to open service on several new Canadian routes and expand its code-sharing program with Canadian Airlines International (CAI).\nTo reduce interest expense, the Company repurchased and retired prior to maturity $378 million in face value of long-term debt, net of sinking fund balances. In addition, $616 million in outstanding principal of certain debt and lease obligations was refinanced during 1995. These transactions resulted in an extraordinary loss of $45 million ($29 million after tax) in 1995.\nThe Company's non-airline businesses continued their strong performances. The SABRE Group posted pre-tax earnings of $371 million, a 15.6 percent increase from 1994. As a result of its increased domestic booking share and the steady pace of international growth, The SABRE Group's revenues were up 11.0 percent from 1994, and its operating margin was approximately 23.5 percent.\nThe Management Services Group's pre-tax earnings were $68 million, a 30.8 percent increase from 1994, due primarily to increased revenues for Airline Management Services, which was formed in 1994 to manage the Company's service contracts with other airlines, including CAI.\nBUSINESS SEGMENTS The following sections provide a discussion of AMR's results by reporting segment. Additional segment information is included in Note 14 to the consolidated financial statements.\nAIRLINE GROUP FINANCIAL HIGHLIGHTS (dollars in millions) - - --------------------------------------------------------------------------------\nREVENUES\n1995 COMPARED TO 1994 Airline Group revenues of $15.5 billion in 1995 were up $606 million, 4.1 percent, versus 1994. American's passenger revenues increased 4.0 percent, $509 million. The increase in passenger revenues resulted primarily from a 4.1 percent increase in passenger traffic, partially offset by a 0.1 percent decrease in passenger yield (the average amount one passenger pays to fly one mile) from 12.97 to 12.96 cents. American's average stage length increased approximately 8.2 percent from 1994 to 1995, which contributed to the decrease in passenger yield since per mile fares for longer trips tend to be lower than for shorter trips. For the year, domestic yield decreased 0.9 percent and Latin American yields decreased 4.2 percent; yield increased 8.1 percent in Europe and 8.2 percent in the Pacific. In 1995, American derived 69.4 percent of its passenger revenues from domestic operations and 30.6 percent from international operations.\nAmerican's domestic traffic increased 1.7 percent, to 71.2 billion revenue passenger miles (RPMs), while domestic capacity, as measured by available seat miles (ASMs), decreased 1.3 percent. International traffic grew 9.8 percent, to 31.7 billion RPMs on capacity growth of 9.6 percent. The increase in international traffic was led by a 13.4 percent increase in Latin America on capacity growth of 12.4 percent, and a 7.4 percent increase in Europe on capacity growth of 7.9 percent.\nThe AMR Eagle carriers' passenger revenues decreased by 1.9 percent or $15 million. Traffic on the AMR Eagle carriers increased 0.2 percent, to 2.5 billion RPMs, while capacity grew 2.5 percent. Passenger yield decreased 2.1 percent, in part due to the carriers' increased stage length as they entered longer-haul markets. In the first quarter of 1995, AMR Eagle redeployed its fleet of ATR aircraft in response to the FAA's temporary restrictions on the operation of ATR aircraft in known or forecast icing conditions. The fleet disruption adversely impacted AMR Eagle's results in the first and second quarters of 1995. As of June 30, 1995, the Eagle aircraft had returned to their original locations.\nOther revenues, consisting of contract maintenance and ground handling services, fees for passenger services such as certain ticketing charges, and miscellaneous other revenues, increased 16.5 percent, $101 million, primarily as a result of an increase in contract maintenance and airport ground services performed by American for other airlines. The remaining portion of the increase is attributable to the growth in passenger traffic.\n1994 COMPARED TO 1993 Airline Group revenues of $14.9 billion in 1994 were up $110 million, 0.7 percent, versus 1993. American's passenger revenues decreased 0.6 percent, $74 million. The decline in passenger revenues resulted primarily from a 2.3 percent decrease in passenger yield from 13.28 to 12.97 cents, partially offset by a 1.8 percent increase in passenger traffic. Yields were driven lower by competitive fare discounting and the greater presence of low-fare competitors in certain domestic markets. In addition, from 1993 to 1994, American's average stage length increased approximately 6.4 percent, contributing to the decline in passenger yields. For the year, domestic yield decreased 4.0 percent, while yield increased 2.6 percent in Latin America and 4.5 percent in Europe. In 1994, American derived 71.5 percent of its passenger revenues from domestic operations and 28.5 percent from international operations.\nAmerican's domestic traffic increased 0.4 percent, to 70.0 billion RPMs, while domestic capacity decreased 6.0 percent. International traffic grew 5.2 percent, to 28.9 billion RPMs, on a capacity reduction of 2.7 percent. The increase in international traffic was led by a 9.7 percent increase in Latin America on capacity growth of 1.1 percent, and a 1.6 percent increase in Europe on a capacity reduction of 6.9 percent. Traffic suffered in 1993 from American's inability to carry passengers during the flight attendants' strike in November 1993 and the adverse effect of the strike on passenger demand in the following month. Traffic in 1994 reflects the negative impact of the FAA's ban on flying ATR aircraft in known or forecast icing conditions which was in effect from December 9, 1994 through January 11, 1995. The restrictions resulted in the temporary suspension of American Eagle ATR service at Chicago and the Company's decision to end American Eagle service at Raleigh\/Durham.\nDespite the effect of the ATR restrictions, the AMR Eagle carriers' passenger revenues increased 11.1 percent, $79 million. Traffic on the AMR Eagle carriers increased 17.0 percent, to 2.5 billion RPMs, while capacity grew 14.6 percent. Passenger yield decreased 5.0 percent, in part due to the carriers' increased stage length as they entered longer-haul markets.\nOther revenues, consisting of fees for excess baggage and other passenger services, tour marketing, contract maintenance and miscellaneous other revenues, increased 15.4 percent, $82 million, primarily as a result of increased passenger traffic, additional contract maintenance work and leasing of excess aircraft.\nEXPENSES\n1995 COMPARED TO 1994 Airline Group operating expenses in 1995 included restructuring charges of $533 million, related to the cost of future pension and other postretirement benefits for voluntary early retirement programs offered in conjunction with recently renegotiated labor contracts covering members of the TWU and the APFA, as well as provisions for the writedown of certain DC-10 aircraft and the planned retirement of certain turboprop aircraft, and other restructuring activities. Airline Group operating expenses in 1994 included restructuring charges of $272 million, primarily resulting from the cost of future pension and other postretirement benefits related to agent and management voluntary early retirement programs. Excluding the restructuring costs, the Airline Group's operating expenses increased 2.8 percent, $395 million. American's capacity increased 1.7 percent, to 155.3 billion ASMs. American's Passenger Division cost per ASM, excluding restructuring costs, increased 1.1 percent to 8.43 cents.\nDespite a 1.0 percent decrease in the average number of equivalent employees, wages, salaries and benefits expense rose 3.2 percent, $159 million. The increase was due primarily to contractual wage rate and seniority increases that are built into the Company's labor contracts and an increase in the provision for profit sharing.\nFuel expense increased 0.6 percent, $9 million, due to the October 1995 expiration of the fuel tax exemption for the airline industry. The expiration of the exemption resulted in additional fuel expense of $22 million for 1995. Absent the fuel tax, fuel expense would have decreased $13 million due primarily to lower jet fuel prices.\nCommissions to agents decreased 3.1 percent, $42 million, due principally to a reduction in average rates paid to agents attributable primarily to the change in commission structure implemented in February 1995, partially offset by commissions on increased passenger revenues.\nOther operating expenses, consisting of aircraft rentals, other rentals and landing fees, food service costs, maintenance expenses and miscellaneous operating expenses, increased 5.0 percent, $256 million. Maintenance materials and repairs expense increased 11.7 percent, $66 million, primarily due to reduced expense in 1994 as a result of warranty recoveries as well as certain engine and airframe service checks that became due for the first time in 1995. Miscellaneous operating expenses (including data processing services, booking fees, crew travel expenses, credit card fees, advertising and communications costs) increased by 7.4 percent or $176 million, primarily due to costs associated with increased contract maintenance work that American performed for other airlines. In addition, the Airline Group recognized approximately $19 million in foreign currency exchange losses attributable to unfavorable exchange rates, primarily in Latin America.\n1994 COMPARED TO 1993 Airline Group operating expenses in 1994 included restructuring charges of $272 million, primarily resulting from the cost of future pension and other postretirement benefits related to agent and management voluntary early retirement programs. Excluding the restructuring costs, the Airline Group's operating expenses decreased 2.8 percent, $402 million. American's capacity decreased 5.1 percent, due primarily to the retirement of 41 older aircraft, partially offset by the addition of 22 new aircraft. Because capacity decreased more rapidly than expenses, American's Passenger Division cost per ASM, excluding restructuring costs, increased 1.1 percent, to 8.34 cents.\nDespite a 4.1 percent decrease in the average number of equivalent employees, wages, salaries and benefits expense rose 1.8 percent, $86 million. The increase was due primarily to contractual and other wage and salary adjustments for existing employees, variable compensation under the Company's various profit sharing plans, and rising pension and other postretirement benefits costs.\nAircraft fuel expense decreased 13.9 percent, $261 million, due to an 8.4 percent decrease in American's average price per gallon and a 6.8 percent decrease in gallons consumed by American. American's average price per gallon decreased from $0.62 per gallon in 1993 to $0.57 per gallon in 1994. American consumed an\naverage of 228 million gallons of jet fuel each month. A one-cent increase in fuel prices costs approximately $2.3 million per month, not considering the offsetting effect of the Company's fuel price hedging program.\nCommissions to agents decreased 7.8 percent, $113 million, due to a lower percentage of passenger revenues subject to commissions and a change in classification of certain international commissions.\nOther operating expenses, consisting of aircraft rentals, other rentals and landing fees, food service costs, maintenance expenses and miscellaneous operating expenses, decreased 2.1 percent, $109 million. Aircraft rentals decreased 6.5 percent, $48 million, primarily due to the expiration of operating leases during 1994 on 19 Boeing 727, 19 Jetstream 32 and five Shorts 360 aircraft. Other rentals and landing fees decreased 1.5 percent, $12 million, due primarily to reduced landing fees expense resulting from American's capacity reductions, partially offset by higher fee rates charged by airports. Food service costs decreased 4.2 percent, $29 million, due to a 1.8 percent decline in passengers boarded and aggressive cost reduction strategies, including changes in meal scheduling policies, renegotiation of contracts and increased use of vendor-prepared products. Maintenance materials and repairs expense decreased 13.7 percent, $90 million. American's maintenance costs were lower as a result of retiring older aircraft from the fleet, increased warranty recoveries, and operational efficiencies gained by reducing the number of maintenance locations and other initiatives. Offsetting the decrease for American, growth of the American Eagle operations generated an increase in its maintenance materials and repairs costs. Miscellaneous operating expenses (including data processing services, booking fees, crew travel expenses, credit card fees, advertising and communications costs) increased 3.0 percent, $70 million, primarily due to increased booking fees.\nOTHER INCOME (EXPENSE) Other Income (Expense) consists of interest income and expense, interest capitalized and miscellaneous - net.\n1995 COMPARED TO 1994 Interest expense, net of amounts capitalized, increased 11.9 percent, $72 million, due primarily to the issuance of $1.02 billion of convertible debentures in exchange for 2.04 million preferred shares in late 1994, and the effect of rising short-term interest rates on floating rate debt and interest rate swap agreements, partially offset by reductions due to the repurchase and retirement of debt. Interest income increased $22 million due primarily to higher average rates and also higher investment balances.\nMiscellaneous - net for 1995 includes a $41 million charge related to the loss of an aircraft operated by American. Miscellaneous - net for 1994 includes a $25 million charge related to the loss of two regional aircraft operated by subsidiaries of AMR Eagle.\n1994 COMPARED TO 1993 Interest expense, net of interest income, increased 1.6 percent, $9 million. Interest expense was higher due to the effect of rising interest rates on floating rate obligations, partially offset by the repurchases and retirement of long-term debt, and savings generated by interest rate swap transactions. Interest capitalized decreased 56.0 percent, $28 million, primarily as a result of the decrease in the average balance during the year of purchase deposits for flight equipment.\nMiscellaneous - net for 1994 includes a $25 million charge related to the loss of two regional aircraft operated by subsidiaries of AMR Eagle. Miscellaneous - net for 1993 includes a $125 million charge related to the retirement of certain DC-10 aircraft.\nTHE SABRE GROUP FINANCIAL HIGHLIGHTS (dollars in millions) - - --------------------------------------------------------------------------------\nREVENUES\n1995 COMPARED TO 1994 Revenues for The SABRE Group increased 11.0 percent, $161 million, primarily due to increased booking volumes as a result of international expansion in Europe, Latin America and Asia, booking fee price increases and revenue generated from AMR's services agreement with Canadian Airlines International (CAI).\n1994 COMPARED TO 1993 Revenues for The SABRE Group increased 12.4 percent, $161 million. Booking fee revenues increased due to growth in booking volumes, increased average fees per booking collected from participating vendors and the introduction of premium-priced products. Revenues of the AMR Training & Consulting Group, which began operations in the first quarter of 1993, increased $29 million. Other revenues rose as a result of increased license fee revenues and systems development sales.\nEXPENSES 1995 COMPARED TO 1994 Wages, salaries and benefits increased 13.6 percent, $54 million, due primarily to a 4.2 percent increase in the average number of equivalent employees, annual salary increases and an increase in the provisions for incentive compensation. Other operating expenses increased 17.0 percent, $82 million, due to increases in various employee-related costs of $29 million, primarily contract programmers, and increases in communications costs, subscriber incentives and other services purchased.\n1994 COMPARED TO 1993 Wages, salaries and benefits increased 5.6 percent, $21 million, due primarily to a 7.5 percent increase in the average number of equivalent employees and increased provisions for incentive compensation. Rentals increased 14.3 percent, $7 million, due to additional leased data processing equipment and facilities costs. Other operating expenses increased 5.9 percent, $27 million, primarily due to expansion in international markets including Europe and Mexico. The SABRE Group's 1994 operating expenses also include $6 million in costs associated with restructuring activities.\nOTHER INCOME (EXPENSE) Other Income (Expense) for 1993 includes a provision of $71 million for losses associated with a reservation system project and resolution of related litigation.\nMANAGEMENT SERVICES GROUP FINANCIAL HIGHLIGHTS (dollars in millions) - - --------------------------------------------------------------------------------\nREVENUES\n1995 COMPARED TO 1994 Revenues for the Management Services Group increased 3.1 percent, $16 million. Revenues for Airline Management Services, which was formed in 1994 to manage the Company's service contracts with other airlines including CAI, increased $25 million. This increase was partially offset by a decrease in AMR Services' revenues of 2.1 percent, $10 million, primarily due to the impact of the sale of AMR Combs' Learjet Service Centers in the first quarter of 1995, more than offsetting substantial revenue growth within AMR Services' other lines of business.\n1994 COMPARED TO 1993 Revenues for the Management Services Group increased 23.0 percent, $97 million. AMR Services' revenues increased 15.1 percent, $62 million, primarily as a result of strong domestic fuel and deicing service sales, the acquisition of an additional domestic fixed-base operator in November 1993 and the expansion of international operations. Revenues of Americas Ground Services, which began operations in the second quarter of 1993, increased $17 million.\nEXPENSES\n1995 COMPARED TO 1994 Wages, salaries and benefits increased 6.9 percent, $16 million, due primarily to a 6.5 percent increase in the average number of equivalent employees. Other operating expenses decreased 10.7 percent, $24 million, due primarily to the effect of the sale of AMR Combs' Learjet Service Centers, offset by increased expenses due to the business growth of AMR Services' other lines of business.\n1994 COMPARED TO 1993 Wages, salaries and benefits increased 36.7 percent, $62 million, due primarily to an increase in the average number of equivalent employees and wage and salary adjustments for existing employees. Other operating expenses increased 13.6 percent, $27 million, due primarily to the expansion of AMR Services and Americas Ground Services.\nINFLATION\nAdjustment of historical cost data to reflect the impact of general inflation and specific price changes would worsen AMR's operating results, principally because of the increased depreciation and amortization resulting from the replacement, at current cost, of equipment and property with assets that have the same service potential. However, because AMR's monetary liabilities exceed monetary assets, the worsened operating results would be partially offset by a decrease in the real value of the net amounts owed.\nLIQUIDITY AND CAPITAL RESOURCES\nOperating activities provided net cash of $2.2 billion in 1995, $1.6 billion in 1994 and $1.4 billion in 1993. The $576 million increase from 1994 to 1995 resulted from an increase in net income before non-cash restructuring charges and provisions for losses of approximately $210 million combined with the timing of cash payments near year-end. Capital expenditures in 1995 totaled $928 million, compared to $1.1 billion in 1994 and $2.1 billion in 1993, and included the acquisition of six Boeing 757-200s and four Boeing 767-300 Extended Range aircraft by American and the acquisition of five Super ATR turboprop aircraft by AMR Leasing. In addition to the purchase of new aircraft by American, sixteen Boeing 727 aircraft, eight formerly recorded as capital leased assets, and eight formerly under operating leases, were purchased upon the expiration of their lease terms. These capital expenditures, as well as the expansion of certain airport facilities, were funded primarily with internally generated cash.\nCAPITAL COMMITMENTS\nFIRM DELIVERIES At December 31, 1995, AMR had firm orders and payments remaining of approximately $100 million for four Boeing 757-200 aircraft, all of which are to be delivered in 1996.\nOTHER The Company also has authorized capital expenditures in 1996 of approximately $350 million for aircraft modifications, computer equipment, renovations of, and additions to, airport and office facilities and various other equipment and assets.\nAMR intends to finance its capital asset acquisitions through the use of internally generated funds. At March 1, 1996, no borrowings were outstanding under American's credit facility and approximately $1.0 billion was available under the facility.\nAMR continually reviews its need for additional aircraft and ground properties and makes investments based on return-on-investment analyses and both short-term and long-term profitability forecasts.\nAIRCRAFT OPTIONS In addition to aircraft on firm order at December 31, 1995, American has 80 jet aircraft available on option - five McDonnell Douglas MD-11s and 75 Fokker 100s. The Company also has 62 turboprop aircraft available on option - 42 Super ATRs, 10 Saab 2000s and 10 ATR 42s.\nOTHER INFORMATION\nWORKING CAPITAL AMR (principally American Airlines) historically operates with a working capital deficit as do most other airline companies. The existence of such a deficit has not in the past impaired the Company's ability to meet its obligations as they become due and is not expected to do so in the future.\nDEFERRED TAX ASSETS As of December 31, 1995, the Company had deferred tax assets aggregating approximately $2.7 billion, including approximately $443 million of alternative minimum tax credit carryforwards. The Company believes substantially all the deferred tax assets will be realized through reversal of existing taxable temporary differences.\nENVIRONMENTAL MATTERS Subsidiaries of AMR have been notified of potential liability with regard to several environmental cleanup sites. At sites where remedial litigation has commenced, potential liability is joint and several. AMR's alleged volumetric contributions at the sites are minimal. AMR does not expect these matters, individually or collectively, to have a significant impact on its financial position or liquidity. Additional information is included in Note 3 to the consolidated financial statements.\nDISCOUNT RATE Due to the decrease in interest rates during 1995, the discount rate used to determine the Company's pension obligations as of December 31, 1995 and the related expense for 1996 has been decreased. The Company expects the increase in 1996 pension expense as a result of the change in the discount rate to be more than offset by the impact of appreciation in the market value of pension plan assets experienced during 1995.\nOUTLOOK FOR 1996\nAMR's improved financial performance in 1995 reflects the positive effects of the Transition Plan the Company began implementing in the early 1990s. The core tenets of the plan are to strengthen the airline wherever possible, to withdraw from markets in which the airline cannot compete effectively, and to grow AMR's profitable non-airline businesses.\nAIRLINE GROUP For the Airline Group, improved performance was driven in part by the strong economy, low jet fuel prices and a more stable pricing environment attributable to the modest level of industry capacity growth.\nAMR continued its effort to find the most productive use for each of its aircraft. During 1995, the Company made major changes to both its jet and turboprop schedules. Resources were reallocated to longer flights and short-haul flying was reduced. The result was an increase in plane miles per jet aircraft of more than four percent.\nAnother 1995 initiative was to increase the number of flights between major business centers such as New York, Chicago, Los Angeles and Dallas\/Fort Worth. In many business markets, American now offers a dozen or more flights per day. Conversely, the airline reduced its operations in Raleigh\/Durham and Nashville, where, despite its best efforts, American had been unable to earn a satisfactory return. Jet service was also eliminated from 29 other city pairs. In many cases, jet service was replaced with turboprop service from American Eagle, American's regional airline affiliate.\nOn the international front, American increased the scope of its service to Latin America and the United Kingdom, and took advantage of the new U.S. - Canadian bilateral agreement to open service on several new Canadian routes.\nAlliances with foreign carriers have become an increasingly prominent part of American's international endeavors. The new aviation accord with Canada cleared the way for a wide-ranging code-sharing agreement with Canadian Airlines. Implemented in phases, this arrangement is one of the industry's largest, and has already generated a great deal of revenue for both airlines.\nSustaining American's strong revenue performance is critically important to AMR because the airline's costs remain uncompetitively high. Fortunately, American did make some progress on the cost front in 1995. The airline substantially reduced distribution expenses by capping travel agency commissions at $50 per round-trip for domestic travel, developed new ways to lower food costs, and cut costs in many other areas as it sought to trim expenses without sacrificing quality.\nCost initiatives in 1995 also included initial work on a ticketless travel product which, when combined with devices to speed aircraft boarding, will streamline and facilitate customers' airport experience. The Company expects this program, which American will begin implementing in mid-1996, to allow airport employees to spend less time making computer entries and more time serving customers.\nDespite these efforts, American will not have the fully-competitive cost structure it needs until it solves its labor cost problem. In this area, as well, the airline made some progress in 1995. First, the Company negotiated a new six-year agreement with the Transport Workers Union, which is expected to save approximately $65 million in 1996, with additional savings in the years beyond.\nSecond, further progress was made on the restructuring of American's airport staffing which began in 1994. American has now outsourced all passenger handling functions at nearly 30 of its smaller stations and many of its\nless specialized customer service functions at most other cities. These efforts are expected to ultimately save approximately $80 million annually when steady state is achieved.\nThird, the Company completed its \"Reinventing Headquarters\" program. This effort is expected to reduce annual headquarters costs by $75 million in total, about $40 million of which was realized in 1995.\nFinally, the long-running arbitration with American's flight attendant union -- the Association of Professional Flight Attendants -- reached its conclusion in October. Although the arbitrators' decision provided pay increases for flight attendants, it also gave the Company the right to implement the most significant productivity improvements it was seeking.\nThese labor developments saved the airline some money in 1995, and will help more in 1996 and in the years beyond. However, until it makes further progress, particularly with the union that represents American's pilots -- the Allied Pilots Association (APA) -- the airline will be unable to reduce its costs to a fully competitive level. Despite American's deteriorating cost position versus many of its major competitors, the airline has been unable to make substantive progress to date with the APA on this issue.\nAs long as the airline's cost structure prevents it from earning a satisfactory return on new aircraft investments, it will not make sense for American to purchase additional aircraft.\nWith no immediate plans to grow its fleet, American has developed an alternative plan to cover the capacity of the 12 McDonnell Douglas MD-11s it agreed to sell to Federal Express in 1995. Delivery of the MD-11s began in early 1996 and will continue through 1999. As the MD-11s are delivered to Federal Express, American will replace them by reconfiguring some of the Airbus A300s now flying in the Caribbean for use on its shorter trans-Atlantic routes.\nThe A300s, in turn, will be replaced by Boeing 727s the airline had previously planned to retire in 1995. This approach will allow American to simultaneously complete the Federal Express transaction and sustain both its European and Caribbean route structures without acquiring new aircraft.\nOverall, the 1996 outlook for the Airline Group is favorable. On the revenue side, many of 1995's favorable trends are expected to continue. Overall industry capacity is expected to grow only modestly and, assuming the U.S. economy remains reasonably healthy, demand should keep pace.\nHowever, the pressure to reduce costs will continue. The Airline Group should see some progress in 1996, due in part to the fact that both the American and American Eagle schedules should be much more stable in 1996 than they were in 1995. Also, American's introduction of its version of electronic ticketing, coupled with an aggressive program of airport automation will, in the latter part of 1996 and in the years beyond, enable the airline to further increase the productivity of its agent workforce while simultaneously saving money in its internal operations.\nThe Airline Group will also have the benefit in 1996 of the full-year effect of the numerous changes made in 1995, which will favorably affect food and beverage costs, distribution expenses and a host of individually smaller items.\nTaken together, the 1995 initiatives and those identified for 1996 are expected to generate non-labor expense savings, and by improving the productivity of most work groups, will impact, to some degree, labor costs as well.\nGiven the inherent volatility of fuel prices, anticipating the impact of fuel expense in 1996 is very difficult. Compounding this is the 4.3 cents per gallon fuel tax on commercial aviation jet fuel for use in domestic operations, which the airline was exempt from until October 1, 1995. On this date, the exemption expired and the resulting tax is scheduled to continue, although fuel tax exemption legislation is pending. American estimates the resulting annual increase in fuel taxes will be approximately $80 million.\nFinally, during 1996, management will continue its efforts to persuade the leadership of the APA that change is a prerequisite to a successful future for American Airlines.\nTHE SABRE GROUP The third objective of the Transition Plan is to grow the Company's profitable non-airline businesses, and AMR was able to do so in 1995. The SABRE Group, the largest of AMR's non-airline enterprises, continued to compete successfully in the travel distribution and information technology industries and recorded both improved earnings and strong margins in 1995.\nOne of the primary goals of The SABRE Group is to ensure that SABRE remains the premier global provider of travel distribution information services. Throughout the year, SABRE made important progress in a number of international markets, continuing its expansion in Canada, Europe, Mexico, Latin America and India and forming joint ventures with Japan Airlines' AXESS Information Network as well as the Civil Aviation Administration of China.\nWhile SABRE's international growth is impressive, the travel distribution industry is changing at an accelerating rate -- and The SABRE Group is changing with it. During 1995, the group came under increasing competitive pressure, as new distribution channels and innovative technology began to divert attention and resources away from more traditional travel distribution channels. The SABRE Group is moving quickly to preserve its industry-leading position.\nDuring 1995, the group announced a number of product enhancements and new products designed to sustain its position as a leading distributor of travel and travel-related products. Additionally, SABRE Interactive, a new business unit within The SABRE Group, was formed to help meet the challenges and opportunities posed by the rapid development of, and growing public interest in, consumer-direct travel distribution.\nSustaining The SABRE Group's leadership position in the years to come will require, in the short term, a significant amount of investment spending, which will be reflected in the group's 1996 results. Nonetheless, The SABRE Group's record of profitable growth should continue.\nAMR plans to more fully develop and market its distinct information technology expertise through The SABRE Group and continues to investigate opportunities for further enhancing the value of its information technology businesses. In furtherance of these opportunities, AMR is taking preliminary steps, such as obtaining certain consents, that will allow it to proceed expeditiously should it decide that a reorganization of The SABRE Group into one or more subsidiaries of AMR is desirable. This reorganization, if concluded, may involve the transfer to AMR, by means of a dividend, of American's STIN, SCS, SDS and SABRE Interactive divisions. A final decision to proceed with a reorganization has not been made, however, and AMR could determine that conducting the business activities of The SABRE Group within the current corporate structure continues to be in the best interests of AMR's shareholders.\nMANAGEMENT SERVICES GROUP The Management Services Group, whose activities are various and diverse, is expected to have continued success in 1996. Similar to the Airline Group, the Management Services Group is expected to benefit from a year of relative stability.\nBALANCE SHEET OUTLOOK In addition to making progress in each of its business segments, AMR also made some significant strides towards a stronger balance sheet in 1995. Since airline earnings, while improved, remain insufficient to justify the purchase of new aircraft, AMR has opted to use much of its cash flow to reduce the Company's outstanding debt. Scheduled and early debt retirement reduced AMR's debt and capital lease obligations by more than $1 billion in 1995, creating a healthier balance sheet and reducing future interest expense.\nAmerican has no immediate plans to acquire either growth or replacement aircraft, and thus AMR's capital spending in 1996 is expected to total only about $900 million. The Company expects to generate surplus cash again in 1996. The Company continues to evaluate uses for its surplus cash, which will likely include the retirement or refinancing of debt and other fixed obligations, as well as the repurchase, in the open market or otherwise, of a significant amount of debt in excess of scheduled 1996 repayments. The total amount and type of debt retired, refinanced and repurchased will depend on market conditions, American's cash position and other considerations during the year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders AMR Corporation\nWe have audited the accompanying consolidated balance sheets of AMR 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 audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AMR 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 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 11 to the consolidated financial statements, effective January 1, 1995, the Company changed its method of accounting for the impairment of long-lived assets to conform with Statement of Financial Accounting Standards No. 121.\nERNST & YOUNG LLP\n2121 San Jacinto Dallas, Texas 75201 January 15, 1996\nAMR CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (in millions, except per share amounts) - - --------------------------------------------------------------------------------\n- - -------------------------------------------------------------------------------- Continued on next page.\nAMR CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (CONTINUED) (in millions, except per share amounts) - - --------------------------------------------------------------------------------\n- - ----------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nAMR CORPORATION CONSOLIDATED BALANCE SHEET (in millions) - - --------------------------------------------------------------------------------\n- - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nAMR CORPORATION CONSOLIDATED BALANCE SHEET (in millions, except shares and par value) - - --------------------------------------------------------------------------------\n- - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nAMR CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (in millions) - - --------------------------------------------------------------------------------\n- - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nAMR CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in millions, except shares and per share amounts) - - --------------------------------------------------------------------------------\n- - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------------\n1. SUMMARY OF ACCOUNTING POLICIES\nBASIS OF CONSOLIDATION The consolidated financial statements include the accounts of AMR Corporation (AMR or the Company), its principal subsidiary, American Airlines, Inc. (American), and its other wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. Certain amounts from prior years have been reclassified to conform with 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 amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.\nINVENTORIES Spare parts, materials and supplies relating to flight equipment are carried at average cost and are expensed when used in operations. Allowances for obsolescence are provided, over the estimated useful life of the related aircraft and engines, for spare parts expected to be on hand at the date aircraft are retired from service. These allowances are based on management estimates, which are subject to change.\nEQUIPMENT AND PROPERTY The provision for depreciation of operating equipment and property is computed on the straight-line method applied to each unit of property, except that spare assemblies are depreciated on a group basis. The depreciable lives and residual values used for the principal depreciable asset classifications are:\n(1) In 1991, American changed the estimated useful lives of its Boeing 727-200 aircraft and engines from a common retirement date of December 31, 1994, to projected retirement dates by aircraft, which results in an average depreciable life of approximately 21 years. (2) Approximate common retirement date.\nEquipment and property under capital leases are amortized over the term of the leases and such amortization is included in depreciation and amortization. Lease terms vary but are generally 10 to 25 years for aircraft and 7 to 40 years for other leased equipment and property.\nMAINTENANCE AND REPAIR COSTS Maintenance and repair costs for owned and leased flight equipment are charged to operating expense as incurred, except engine overhaul costs incurred by AMR's regional carriers, which are accrued on the basis of hours flown.\n1. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)\nINTANGIBLE ASSETS The Company continually evaluates intangible assets to determine whether current events and circumstances warrant adjustment of the carrying values or amortization periods.\nRoute acquisition costs and airport operating and gate lease rights represent the purchase price attributable to route authorities, airport take-off and landing slots and airport gate leasehold rights acquired, and are being amortized on a straight-line basis over 10 to 40 years.\nPASSENGER REVENUES Passenger ticket sales are initially recorded as a component of air traffic liability. Revenue derived from ticket sales is recognized at the time transportation is provided. However, due to various factors, including the complex pricing structure and interline agreements throughout the industry, certain amounts are recognized in revenue using estimates regarding both the timing of the revenue recognition and the amount of revenue to be recognized. Actual results could differ from those estimates.\nADVERTISING COSTS The Company expenses the costs of advertising as incurred. Advertising expense was $192 million, $201 million and $202 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nFREQUENT FLYER PROGRAM The estimated incremental cost of providing free travel awards is accrued when such award levels are reached. American sells mileage credits to companies participating in its frequent flyer program. A portion of the revenue from the sale of mileage credits is deferred and recognized over a period approximating the period during which the mileage credits are used.\nINCOME TAXES AMR and its eligible subsidiaries file a consolidated federal income tax return. Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the income tax amounts.\nDEFERRED GAINS Gains on the sale and leaseback of equipment and property are deferred and amortized over the terms of the related leases as a reduction of rent expense.\nSTATEMENT OF CASH FLOWS Short-term investments, without regard to remaining maturity at acquisition, are not considered as cash equivalents for purposes of the statement of cash flows.\nEARNINGS (LOSS) PER COMMON SHARE Earnings (loss) per share computations are based upon the earnings (loss) applicable to common shares and the average number of shares of common stock outstanding and dilutive common stock equivalents (stock options, warrants and deferred stock) outstanding. The convertible subordinated debentures and the convertible preferred stock are not common stock equivalents. The number of shares used in the computations of primary and fully diluted earnings (loss) per common share for the years ended December 31, 1995, 1994 and 1993, was 76.8 million, 76.2 million and 76.0 million, respectively.\nInformation on the adjustment to the earnings per share computation for the year ended December 31, 1994, for the effect of the preferred stock exchange is included in Note 5.\nSTOCK OPTIONS The Company accounts for officer and key employee stock option grants in accordance with Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (APB 25) and related Interpretations. Under APB 25, no compensation expense is recognized for stock option grants if the exercise price of the Company's stock option grants is at or above the fair market value of the underlying stock on the date of grant.\n2. INVESTMENTS\nShort-term investments consisted of (in millions):\nShort-term investments at December 31, 1995, by contractual maturity included (in millions):\nIn addition, the Company has an investment in the cumulative mandatorily redeemable convertible preferred stock of Canadian Airlines International. This investment is recorded at its estimated fair value of $55 million and $137 million at December 31, 1995 and 1994, respectively. The unrealized loss on this investment was $137 million and $53 million at December 31, 1995 and 1994, respectively.\nAll investments were classified as available-for-sale and stated at fair value. Net unrealized gains and losses, net of deferred taxes, are reflected as an adjustment to stockholders' equity.\n3. COMMITMENTS AND CONTINGENCIES\nThe Company has on order four Boeing 757-200 jet aircraft scheduled for delivery in 1996. Remaining payments for these aircraft and related equipment will be approximately $100 million in 1996. In addition to these commitments for aircraft, the Company has authorized expenditures of approximately $850 million for aircraft modifications, renovations of, and additions to, airport and office facilities and various other equipment and assets. AMR expects to spend approximately $350 million of this amount in 1996.\nIn April 1995, American announced an agreement to sell 12 of its McDonnell Douglas MD-11 aircraft to Federal Express Corporation (FedEx), with delivery of the aircraft between 1996 and 1999. In addition, American has the option to sell its remaining seven MD-11 aircraft to FedEx with deliveries between 2000 and 2002. The carrying value of the 12 aircraft American has committed to sell was approximately $837 million as of December 31, 1995. Included in depreciation expense are charges related to these aircraft which totaled approximately $23 million for the year ended December 31, 1995.\nAMR and American have included an event risk covenant in approximately $330 million of debentures and approximately $2.9 billion of lease agreements. The covenant permits the holders of such instruments to receive a higher rate of return (between 50 and 700 basis points above the stated rate) if a designated event, as defined, should occur and the credit rating of the debentures or the debt obligations underlying the lease agreements is downgraded below certain levels.\n3. COMMITMENTS AND CONTINGENCIES (CONTINUED)\nSpecial facility revenue bonds have been issued by certain municipalities, primarily to purchase equipment and improve airport facilities which are leased by American. In certain cases, the bond issue proceeds were loaned to American and are included in long-term debt. Certain bonds have rates that are periodically reset and are remarketed by various agents. In certain circumstances, American may be required to purchase up to $437 million of the special facility revenue bonds prior to maturity, in which case American has the right to resell the bonds or to use the bonds to offset its lease or debt obligations. American may borrow the purchase price of these bonds under standby letter-of- credit agreements. At American's option, these letters of credit are secured by funds held by bond trustees and by approximately $429 million of short-term investments.\nThe Miami International Airport Authority is currently remediating various environmental conditions at the Miami International Airport (Airport) and funding the remediation costs through landing fee revenues. Some of the costs of the remdiation effort may be borne by carriers currently operating at the Airport, including American, through increased landing fees since certain of the potentially responsible parties are no longer in business. The future increase in landing fees may be material but cannot be reasonably estimated due to various factors, including the unknown extent of the remedial actions that may be required, the proportion of the cost that will ultimately be recovered from the responsible parties, and uncertainties regarding the environmental agencies that will ultimately supervise the remedial activities and the nature of that supervision. The ultimate resolution is not, however, expected to have a significant impact on the financial position or the liquidity of AMR.\nAmerican's collective bargaining agreement with the Allied Pilots Association (APA) became amendable on August 31, 1994. In January 1996, the APA filed a petition with the National Mediation Board (NMB) to appoint a federal mediator. A mediator has been appointed, and initial meetings have been held between the APA and the NMB mediator and between American and the NMB mediator. Joint meetings began in March 1996. The outcome of these negotiations and the impact on the Company cannot be determined at this time.\n4. LEASES\nAMR's subsidiaries lease various types of equipment and property, including aircraft, passenger terminals, equipment and various other facilities. The future minimum lease payments required under capital leases, together with the present value of net minimum lease payments, and future minimum lease payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 1995, were (in millions):\n(1) Future minimum payments required under capital leases include $205 million and $203 million guaranteed by AMR and American, respectively, relating to special facility revenue bonds issued by municipalities. (2) Future minimum payments required under operating leases include $6.2 billion guaranteed by AMR relating to special facility revenue bonds issued by municipalities.\nAt December 31, 1995, the Company had 198 jet aircraft and 109 turboprop aircraft under operating leases, and 74 jet aircraft and 63 turboprop aircraft under capital leases.\n4. LEASES (CONTINUED)\nThe aircraft leases can generally be renewed at rates based on fair market value at the end of the lease term for one to five years. Most aircraft leases have purchase options at or near the end of the lease term at fair market value, but generally not to exceed a stated percentage of the defined lessor's cost of the aircraft. Of the aircraft American has under operating leases, 15 Boeing 767-300 Extended Range aircraft are cancelable upon 30 days' notice during the initial 10-year lease term. At the end of that term in 1998, the leases can be renewed for periods ranging from 10 to 12 years.\nRent expense, excluding landing fees, was $1.3 billion for 1995, 1994 and 1993.\n5. INDEBTEDNESS\nLong-term debt (excluding amounts maturing within one year) consisted of (in millions):\nMaturities of long-term debt (including sinking fund requirements) for the next five years are: 1996 - $228 million; 1997 - $388 million; 1998 - $432 million; 1999 - $63 million; 2000 - $57 million.\nCertain debt is secured by aircraft, engines, equipment and other assets having a net book value of approximately $1.3 billion.\nIn November 1994, AMR issued $1.02 billion in par value of convertible subordinated debentures in exchange for 2.04 million shares of its outstanding convertible preferred stock with a carrying value of $1.0 billion. Each $1,000 debenture is convertible into common stock of AMR at a conversion price of $79 per share, equivalent to 12.658 shares per $1,000 debenture. As a result of the exchange, the Company recorded a $171 million non-cash increase in additional paid-in capital, representing the difference in the fair value of the new debentures and the carrying value of the preferred shares exchanged. While this amount did not impact net earnings for the year ended December 31, 1994, it is included in the computation of earnings per share.\nDuring 1995, AMR repurchased and retired prior to maturity $378 million in face value of long-term debt, net of sinking fund balances. Cash from operations provided the funding for the repurchases and retirements. In addition, $616 million in outstanding principal of certain debt and lease obligations was refinanced during 1995. These transactions resulted in an extraordinary loss of $45 million ($29 million after tax) for the year ended December 31, 1995.\nDuring 1993, AMR repurchased and retired prior to maturity its zero coupon subordinated convertible notes due 2006 and certain other long-term debt with a total carrying value of $802 million. The repurchases and retirements resulted in an extraordinary loss of $21 million ($14 million after tax) for the year ended December 31, 1993. Additional borrowings and cash from operations provided the funding for the repurchases and retirements.\n5. INDEBTEDNESS (CONTINUED)\nAmerican has a $1.0 billion credit facility agreement which expires in 1999. Interest on the agreement is calculated at floating rates based upon the London Interbank Offered Rate (LIBOR). At January 15, 1996, no borrowings were outstanding and $1.0 billion was available under this facility.\nCertain of AMR's debt agreements contain restrictive covenants, including a limitation on the declaration of dividends on shares of capital stock. At December 31, 1995, under the terms of such agreements, all of AMR's retained earnings were available for payment of dividends. Certain of American's debt and credit facility agreements also contain certain restrictive covenants, including a cash flow coverage test, a minimum net worth requirement and limitations on indebtedness and limitations on the declaration of dividends. Certain of these restrictions could affect AMR's ability to pay dividends. At December 31, 1995, under the most restrictive provisions of those agreements, approximately $857 million of American's retained earnings were available for payment of dividends to AMR.\n6. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT\nAs part of the Company's risk management program, AMR uses a variety of financial instruments, including interest rate swaps, fuel swaps and currency exchange agreements. The Company does not hold or issue derivative financial instruments for trading purposes.\nNOTIONAL AMOUNTS AND CREDIT EXPOSURES OF DERIVATIVES\nThe notional amounts of derivative financial instruments summarized in the tables which follow do not represent amounts exchanged between the parties and, therefore, are not a measure of the Company's exposure resulting from its use of derivatives. The amounts exchanged are calculated based on the notional amounts and other terms of the instruments, which relate to interest rates, exchange rates or other indices.\nThe Company is exposed to credit losses in the event of non-performance by counterparties to these financial instruments, but it does not expect any of the counterparties to fail to meet its obligations. The credit exposure related to these financial instruments is represented by the fair value of contracts with a positive fair value at the reporting date, reduced by the effects of master netting agreements. To manage credit risks, the Company selects counterparties based on credit ratings, limits its exposure to a single counterparty under defined guidelines, and monitors the market position of the program and its relative market position with each counterparty. The Company also maintains industry-standard security agreements with the majority of its counterparties which may require the Company or the counterparty to post collateral if the value of these instruments falls below certain mark-to-market thresholds. As of December 31, 1995, no collateral was required under these agreements, and the Company does not expect to post collateral in the near future.\nINTEREST RATE RISK MANAGEMENT\nAmerican enters into interest rate swap contracts to effectively convert a portion of its fixed-rate obligations to floating-rate obligations. These agreements involve the exchange of amounts based on a floating interest rate for amounts based on fixed interest rates over the life of the agreement without an exchange of the notional amount upon which the payments are based. The differential to be paid or received as interest rates change is accrued and recognized as an adjustment of interest expense related to the obligation. The related amount payable to or receivable from counterparties is included in current liabilities or assets. The fair values of the swap agreements are not recognized in the financial statements. Gains and losses on terminations of interest rate swap agreements are deferred as an adjustment to the carrying amount of the outstanding obligation and amortized as an adjustment to interest expense related to the obligation over the remaining term of the original contract life of the terminated swap agreement. In the event of the early extinguishment of a designated obligation, any realized or unrealized gain or loss from the swap would be recognized in income coincident with the extinguishment. Because American's operating results tend to be better in economic cycles with relatively high interest rates and its capital investments tend to be financed with long- term fixed-rate instruments, interest rate swaps in which American pays the floating rate and receives the fixed rate are used to reduce the impact of economic cycles on American's net income.\n6. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (CONTINUED)\nThe following table indicates the notional amounts and fair values of the Company's interest rate swap agreements (in millions):\nThe fair values represent the amount the Company would receive or pay to terminate the agreements at December 31, 1995 and 1994, respectively.\nAt December 31, 1995, the weighted average remaining life of the interest rate swap agreements in effect was 3.1 years. The weighted average floating rates and fixed rates on the contracts outstanding were:\nFloating rates are based primarily on LIBOR and may change significantly, affecting future cash flows. The net impact of the interest rate swap program on interest expense was an increase of $18 million in 1995 and a decrease of $14 million in 1994. The impact on the Company's weighted-average borrowing rate for the periods presented is immaterial.\nFUEL PRICE RISK MANAGEMENT\nAmerican enters into fuel swap contracts to protect against increases in jet fuel prices. Under the agreements, American receives or makes payments based on the difference between a fixed price and a variable price for certain fuel commodities. Gains and losses on fuel swap agreements are recognized as a component of fuel expense when the underlying fuel being hedged is used. At December 31, 1995, American had agreements with broker-dealers to exchange payments on approximately 295 million gallons of fuel products, which represents approximately 11 percent of its expected 1996 fuel needs. The Company does not expect the fuel price hedging program to have a material effect on liquidity. The fair value of the Company's fuel swap agreements at December 31, 1995, representing the amount the Company would receive to terminate the agreements, was immaterial.\n6. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (CONTINUED)\nFOREIGN EXCHANGE RISK MANAGEMENT\nTo hedge against the risk of future currency exchange rate fluctuations on certain debt and lease obligations and related interest payable in foreign currencies, the Company has entered into various foreign currency exchange agreements. Changes in the value of the agreements due to exchange rate fluctuations are offset by changes in the value of the foreign currency denominated debt and lease obligations translated at the current exchange rate. Discounts or premiums are accreted or amortized as an adjustment to interest expense over the lives of the underlying debt or lease obligations. The related amounts due to or from counterparties are included in other liabilities or other assets. The net fair values of the Company's currency exchange agreements, representing the amount AMR would receive to terminate the agreements, were:\nThe Swiss Franc agreement carries an exchange rate of 1.63 Francs per U.S. dollar. The exchange rates on the Japanese Yen agreements range from 66.50 to 137.26 Yen per U.S. dollar.\nTo hedge against the risk of future exchange rate fluctuations on a portion of American's foreign cash flows, the Company entered into various currency put option agreements during 1995 on a number of foreign currencies. The option contracts are denominated in the same foreign currency in which the projected foreign cash flows are expected to be denominated. These contracts are designated and effective as hedges of probable quarterly foreign cash flows for various periods through September 30, 1998, which otherwise would expose the Company to foreign currency risk. Realized gains on the currency put option agreements are recognized as a component of passenger revenue. At December 31, 1995, the notional amount related to these options totaled approximately $743 million and the fair value, representing the amount AMR would receive to terminate the agreements, totaled approximately $16.5 million.\nFAIR VALUES OF FINANCIAL INSTRUMENTS\nThe fair values of the Company's long-term debt were estimated using quoted market prices, where available. For long-term debt not actively traded, fair values were estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. The carrying amounts and fair values of the Company's long-term debt, including current maturities, were (in millions):\n7. INCOME TAXES\nThe significant components of the income tax provision (benefit) were (in millions):\nThe income tax provision (benefit) includes a federal income tax provision of $133 million and $108 million for the years ended December 31, 1995 and 1994, respectively, and a federal income tax benefit of $30 million for the year ended December 31, 1993.\nThe income tax provision (benefit) differed from amounts computed at the statutory federal income tax rate as follows (in millions):\n7. INCOME TAXES (CONTINUED)\nThe components of AMR's deferred tax assets and liabilities were (in millions):\nAt December 31, 1995, AMR had available for federal income tax purposes approximately $443 million of alternative minimum tax credit carryforwards available for an indefinite period, and approximately $2.1 billion of net operating loss carryforwards for regular tax purposes which expire as follows: 2007 - $851 million; 2008 - $838 million; and 2009 - $363 million.\n8. PREFERRED STOCK\nIn 1993, AMR issued 2.2 million shares of 6% Series A cumulative convertible preferred stock, resulting in net proceeds of approximately $1.1 billion. At the holder's option, each preferred share is convertible into 6.3492 shares of common stock at any time. At the Company's option after February 1, 1996, the preferred shares are redeemable at specified redemption prices. In 1994, AMR exchanged $1.02 billion in face value of newly issued 6.125% convertible subordinated debentures due 2024 for 2.04 million of the preferred shares. See Note 5 for a more detailed description of the debentures.\n9. STOCK AWARDS AND OPTIONS\nUnder the 1988 Long Term Incentive Plan (1988 Plan), as amended in 1994, officers and key employees of AMR and its subsidiaries may be granted stock options, stock appreciation rights, restricted stock, deferred stock, stock purchase rights and\/or other stock-based awards. The total number of common shares authorized for distribution under the 1988 Plan is 7,200,000 shares. In the event that additional shares of the Company's common stock are issued, 7.65 percent of such newly issued shares will be allocated to the 1988 Plan, provided that the maximum number of shares which may be allocated to the 1988 Plan may not exceed the total number of authorized shares as of December 31, 1987. The 1988 Plan will terminate no later than May 18, 1998. Options granted are exercisable at the market value of the stock upon grant, generally becoming exercisable in equal annual installments over one to five years following the date of grant and expiring 10 years from the date of grant. Stock appreciation rights may be granted in tandem with options awarded. As of January 1, 1996, all outstanding stock appreciation rights were canceled, while the underlying stock options remain in effect.\nStock option activity was:\n(1) At prices ranging from $39.6875 to $66.75 in 1995; $39.6875 to $64.1875 in 1994; and $39.6875 to $65.75 in 1993. (2) Includes 20,500 and 21,000 options canceled upon exercise of stock appreciation rights for 1995 and 1993, respectively.\nThe aggregate purchase price of outstanding options, number of exercisable options outstanding and stock awards available for grant were:\n9. STOCK AWARDS AND OPTIONS (CONTINUED)\nShares of deferred stock are awarded at no cost to officers and key employees under the 1988 Plan's Career Equity Program and will be issued upon the individual's retirement from AMR or, in certain circumstances, will vest on a pro rata basis. Deferred stock activity was:\nAMR has a restricted stock incentive plan, under which officers and key employees were awarded shares of its common stock at no cost. At December 31, 1993, all 250,000 shares authorized for issuance in connection with the plan had been granted. Vesting of the shares occurs generally over a five-year period.\nA performance share plan was implemented in 1993 under the terms of which shares of deferred stock are awarded at no cost to officers and key employees under the 1988 Plan. The shares vest over a three-year performance period based upon AMR's ratio of operating cash flow to adjusted total assets. Performance share activity was:\nThere were 21.0 million shares of AMR's common stock at December 31, 1995 reserved for the issuance of stock upon the conversion of convertible preferred stock and convertible subordinated debentures, the exercise of options and the issuance of restricted stock and deferred stock.\n10. RETIREMENT BENEFITS\nSubstantially all employees of American and employees of certain other subsidiaries are eligible to participate in pension plans. The defined benefit plans provide benefits for participating employees based on years of service and average compensation for a specified period of time before retirement. Airline pilots and flight engineers also participate in defined contribution plans for which Company contributions are determined as a percentage of participant compensation.\nTotal costs for all pension plans were (in millions):\n(1) In late 1995 and 1994, AMR offered early retirement programs to select groups of employees as part of its restructuring efforts. 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\", AMR recognized additional pension expense of $220 million and $154 million associated with these programs in 1995 and 1994, respectively. Of these amounts, $118 million and $120 million were for special termination benefits and $102 million and $34 million were for the actuarial losses resulting from the early retirements for 1995 and 1994, respectively.\n10. RETIREMENT BENEFITS (CONTINUED)\nThe funded status and actuarial present value of benefit obligations of the defined benefit plans were (in millions):\n(1) AMR's funding policy is to make contributions equal to, or in excess of, the minimum funding requirements of the Employee Retirement Income Security Act of 1974.\nPlan assets consist primarily of domestic and foreign government and corporate debt securities, marketable equity securities, and money market and mutual fund shares, of which approximately $119 million and $141 million of plan assets at December 31, 1995 and 1994, respectively, were invested in shares of mutual funds managed by a subsidiary of AMR.\nThe projected benefit obligation was calculated using weighted average discount rates of 7.25% and 8.75% at December 31, 1995 and 1994, respectively; rates of increase for compensation of 4.20% and 4.40% at December 31, 1995 and 1994, respectively; and the 1983 Group Annuity Mortality Table. The weighted average expected long-term rate of return on assets was 9.50% in 1995 and 1994, and 10.50% in 1993. The vested benefit obligation and plan assets at fair value at December 31, 1995, for plans whose benefits are guaranteed by the Pension Benefit Guaranty Corporation were $4.1 billion and $4.5 billion, respectively.\n10. RETIREMENT BENEFITS (CONTINUED)\nIn addition to pension benefits, other postretirement benefits, including certain health care and life insurance benefits, are also provided to retired employees. The amount of health care benefits is limited to lifetime maximums as outlined in the plan. Substantially all employees of American and employees of certain other subsidiaries may become eligible for these benefits if they satisfy eligibility requirements during their working lives.\nCertain employee groups make contributions toward funding a portion of their retiree health care benefits during their working lives. AMR funds benefits as incurred and began, effective January 1993, to match employee prefunding.\nNet other postretirement benefit cost was (in millions):\nIn addition to net other postretirement benefit cost, in late 1995 and 1994, AMR offered early retirement programs to select groups of employees as part of its restructuring efforts. In accordance with Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" AMR recognized additional other postretirement benefit expense of $93 million and $71 million associated with these programs in 1995 and 1994, respectively. Of these amounts, $26 million and $43 million were for special termination benefits and $67 million and $28 million were for the net actuarial losses resulting from the early retirements for 1995 and 1994, respectively.\nThe funded status of the plan, reconciled to the accrued other postretirement benefit cost recognized in AMR's balance sheet, was (in millions):\n10. RETIREMENT BENEFITS (CONTINUED)\nPlan assets consist primarily of shares of a mutual fund managed by a subsidiary of AMR.\nFor 1995 and 1994, future benefit costs were estimated assuming per capita cost of covered medical benefits would increase at an eight and nine percent annual rate, respectively, decreasing gradually to a four percent annual growth rate in 2000 and thereafter. A one percent increase in this annual trend rate would have increased the accumulated other postretirement benefit obligation at December 31, 1995, by approximately $128 million and 1995 other postretirement benefit cost by approximately $18 million. The weighted average discount rate used in estimating the accumulated other postretirement benefit obligation was 7.25% and 8.75% at December 31, 1995 and 1994, respectively.\n11. RESTRUCTURING COSTS\nIn 1995 and 1994, the Company recorded $533 million and $278 million, respectively, for restructuring costs which included (in millions):\nIn 1995, approximately 2,100 mechanics and fleet service clerks and 300 flight attendants elected early retirement under programs offered in conjunction with renegotiated union labor contracts, and the majority of these employees will leave the Company's workforce during 1996. The Company recorded restructuring costs of $332 million in 1995 related to these early retirement programs. A large portion of the funding for the programs was done in 1995. The remaining cash payments associated with these programs will be expended as required for funding the appropriate pension and other postretirement benefit plans in future years.\n11. RESTRUCTURING COSTS (CONTINUED)\nThe aircraft portion of the 1995 restructuring costs includes a $145 million provision related to the writedown of certain McDonnell Douglas DC-10 aircraft. Effective January 1, 1995, AMR 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,\" 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. In 1995, the Company evaluated its fleet operating plan with respect to the DC-10-10 fleet and, as a result, believes that the estimated future cash flows expected to be generated by these aircraft will not be sufficient to recover their net book value. Management estimated the undiscounted future cash flows utilizing models used by the Company in making fleet and scheduling decisions. As a result of this analysis, the Company determined that a writedown of the DC-10-10 aircraft to the net present value of their estimated discounted future cash flows was warranted, which resulted in a $112 million charge. In addition, the Company recorded a $33 million charge to reflect a diminution in the estimated market value of certain DC-10 aircraft previously grounded by the Company. No cash costs have been incurred or are expected as a result of these DC-10 writedowns. The writedowns are expected to reduce 1996 depreciation expense by approximately $19 million.\nAlso included in the aircraft restructuring costs is a $48 million charge related to the planned early retirement in 1996 of certain turboprop aircraft operated by AMR's regional carriers. The charge relates primarily to future lease commitments on these aircraft past the dates they will be removed from service and writedown of related inventory to its estimated fair value. Cash payments on the leases will occur over the remaining lease terms.\nIn 1994, approximately 1,700 agents and 600 management employees elected early retirement under programs offered to select groups of employees and left the Company's workforce during 1995. The Company recorded restructuring costs of $225 million in 1994 related to these early retirement programs. A large portion of the funding for these programs was done in 1994. The remaining cash payments associated with these programs will be expended as required for funding the appropriate pension and other postretirement benefit plans in future years.\nThe $28 million severance provision recorded in 1994 was for additional workforce reductions affecting approximately 2,300 agent and management personnel as a result of scheduled service reductions and improved administrative efficiencies. Cash outlays for severance payments in 1995 totaled approximately $22 million, with the remaining $6 million expected to occur during 1996.\nThe remaining $25 million included in the 1994 restructuring costs represents provisions for excess leased facilities and other restructuring activities. Cash outlays are estimated to be approximately $18 million, of which approximately $3 million occurred in 1995.\n12. REVENUE AND OTHER EXPENSE ITEMS\nDuring 1994, the Company changed its estimate of the usage patterns of miles awarded by participating companies in American's AAdvantage frequent flyer program. The positive impact of the change in estimate on passenger revenues for 1994 was $59 million. Passenger revenues for 1993 include a $115 million positive adjustment resulting from a change in estimate relating to certain earned passenger revenues.\nMiscellaneous - net in 1995 includes a $41 million charge related to the loss of an aircraft operated by American. Miscellaneous - net in 1994 includes a $25 million charge related to the loss of two regional aircraft operated by subsidiaries of AMR Eagle, Inc. Miscellaneous - net in 1993 includes a provision of $71 million for losses associated with a reservation system project and resolution of related litigation. Also included in 1993 is a $125 million charge related to the retirement of certain McDonnell Douglas DC-10 aircraft.\n13. FOREIGN OPERATIONS\nAmerican conducts operations in various foreign countries. American's operating revenues from foreign operations were (in millions):\n14. SEGMENT INFORMATION\nAMR's operations fall within three industry segments: the Airline Group, The SABRE Group, and the Management Services Group. For a description of each of these groups, refer to Management's Discussion and Analysis on pages 15 and 16.\nThe following table presents selected financial data by industry segment (in millions):\nIdentifiable assets are gross assets used by a business segment, including an allocated portion of assets used jointly by more than one business segment. General corporate and other assets not allocated to business segments were $357 million, $372 million and $436 million at December 31, 1995, 1994 and 1993, respectively, and consist primarily of income tax assets.\n15. SUPPLEMENTAL CASH FLOW INFORMATION\nSupplemental disclosures of cash flow information and non-cash activities (in millions):\n16. QUARTERLY FINANCIAL DATA (UNAUDITED)\nUnaudited summarized financial data by quarter for 1995 and 1994 (in millions, except per share amounts):\n(1) Information on the adjustment to the earnings per share computation for the three months ended December 31, 1994, for the effect of the preferred stock exchange is included in Note 5.\n16. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)\nResults for the fourth quarter of 1995 include $533 million in restructuring costs, primarily representing the cost of early retirement programs for Airline Group employees and provisions for the writedown of certain DC-10 aircraft and the planned retirement of certain turboprop aircraft. Results for the fourth quarter of 1995 also include a $41 million charge related to the loss of an aircraft operated by American.\nResults for the fourth quarter of 1994 include $278 million in restructuring costs, primarily representing the cost of early retirement programs and severance for Airline Group employees. Results for the fourth quarter of 1994 also include a $25 million charge related to the loss of two regional aircraft operated by subsidiaries of AMR Eagle, Inc. During the second quarter of 1994, the Company changed its estimate of the usage patterns of miles awarded by participating companies in American's AAdvantage frequent flyer program. The positive impact of the change in estimate on revenues for the second, third and fourth quarters of 1994 was $35 million, $14 million, and $10 million, respectively, as compared to the same quarters in 1993.\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\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders on May 15, 1996. Information concerning the executive officers is included in Part I of this report on page 12.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders on May 15, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders on May 15, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders on May 15, 1996.\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 accompanying index to financial statements and schedules are filed as part of this report.\n(2) The schedules listed in the accompanying index to financial statements and schedules are filed as part of this report.\n(3) Exhibits required to be filed by Item 601 of Regulation S-K. (Where the amount of securities authorized to be issued under any of AMR's long-term debt agreements does not exceed 10 percent of AMR's assets, pursuant to paragraph (b)(4) of Item 601 of Regulation S-K, in lieu of filing such as an exhibit, AMR hereby agrees to furnish to the Commission upon request a copy of any agreement with respect to such long-term debt.)\nEXHIBIT\n3(a) Composite of the Certificate of Incorporation of AMR, incorporated by reference to Exhibit 3(a) to AMR's report on Form 10-K for the year ended December 31, 1982, file number 1-8400.\n3(b) Amended Bylaws of AMR, incorporated by reference to Exhibit 3(b) to AMR's report on Form 10-K for the year ended December 31, 1990, file number 1-8400.\n10(a) Purchase Agreement, dated as of February 12, 1979, between American and the Boeing Company, relating to the purchase of Boeing Model 767-323 aircraft, incorporated by reference to Exhibit 10(b)(3) to American's Registration Statement No. 2-76709.\n10(b) Description of American's Split Dollar Insurance Program, dated December 28, 1977, incorporated by reference to Exhibit 10(c)(1) to American's Registration Statement No. 2-76709.\n10(c) American's 1992 Incentive Compensation Plan incorporated by reference to Exhibit 10(c) to AMR's report on Form 10-K for the year ended December 31, 1991, file marker 1-8400.\n10(d) 1979 American Airlines (AMR) Stock Option Plan, as amended, incorporated by reference to Exhibit 10(d) to American's report on Form 10-K for the year ended December 31, 1982, file number 1-8400.\n10(e) 1979 American Airlines (AMR) Stock Option Plan, as amended, incorporated by reference to Exhibit 10(e) to American's report on Form 10-K for the year ended December 31, 1982, file number 1-8400.\n10(f) Form of Stock Option Agreement for Corporate Officers under the 1979 American Airlines (AMR) Stock Option Plan, incorporated by reference to Exhibit 10(c)(5) to American's Registration Statement No. 2-76709.\n10(g) Form of Stock Option Agreement under the 1974 and 1979 American Airlines (AMR) Stock Option Plans, incorporated by reference to Exhibit 10(c)(6) to American's Registration Statement No. 2-76709.\n10(h) Deferred Compensation Agreement, dated April 14, 1973, as amended March 1, 1975, between American and Robert L. Crandall, incorporated by reference to Exhibit 10(c)(7) to American's Registration Statement No. 2-76709.\n10(i) Deferred Compensation Agreement, dated October 18, 1972, as amended March 1, 1975, between American and Gene E. Overbeck, incorporated by reference to Exhibit 10(c)(9) to American's Registration Statement No. 2-76709.\n10(j) Deferred Compensation Agreement, dated June 3, 1970, between American and Francis H. Burr, incorporated by reference to Exhibit 11(d) to American's Registration Statement No. 2-39380.\n10(k) Description of informal arrangement relating to deferral of payment of directors' fees, incorporated by reference to Exhibit 10(c)(11) to American's Registration Statement No. 2- 76709.\n10(l) Purchase Agreement, dated as of February 29, 1984, between American and the McDonnell Douglas Corporation, relative to the purchase of McDonnell Douglas Super 80 aircraft, incorporated by reference to Exhibit 10(l) to AMR's report on Form 10-K for the year ended December 31, 1983, file number 1-8400.\n10(m) Purchase Agreement, dated as of June 27, 1983, between American and the McDonnell Douglas Corporation, relative to the purchase of McDonnell Douglas Super 80 aircraft, incorporated by reference to Exhibit 4(a)(8) to American's Registration Statement No. 2-84905.\n10(n) AMR Corporation Restricted Stock Incentive Plan, adopted May 15, 1985, incorporated by reference to Exhibit 10(n) to AMR's report on Form 10-K for the year ended December 31, 1985, file number 1-8400.\n10(o) AMR Corporation Preferred Stock Purchase Rights Agreement, adopted February 13, 1986, incorporated by reference to Exhibit 10(o) to AMR's report on Form 10-K for the year ended December 31, 1985, file number 1-8400.\n10(p) Form of Executive's Termination Benefits Agreement incorporated by reference to Exhibit 10(p) to AMR's report on Form 10-K for the year ended December 31, 1985, file number 1-8400.\n10(q) Amendment, dated June 4, 1986, to Purchase Agreement in Exhibit 10(l) above, incorporated by reference to Exhibit 10(q) to AMR's report on Form 10-K for the year ended December 31, 1986, file number 1-8400.\n10(r) Acquisition Agreement, dated as of March 1, 1987, between American and Airbus Industrie relative to the lease of Airbus A300-600R aircraft, incorporated by reference to Exhibit 10(r) to AMR's report on Form 10-K for the year ended December 31, 1986, file number 1-8400.\n10(s) Acquisition Agreement, dated as of March 1, 1987, between American and the Boeing Company relative to the lease of Boeing 767-323ER aircraft, incorporated by reference to Exhibit 10(s) to AMR's report on Form 10-K for the year ended December 31, 1986, file number 1-8400.\n10(t) AMR Corporation 1988 Long-Term Incentive Plan, incorporated by reference to Exhibit 10(t) to AMR's report on Form 10-K for the year ended December 31, 1988, file number 1-8400.\n10(u) Acquisition Agreement, dated as of July 21, 1988, between American and the Boeing Company relative to the purchase of Boeing Model 757-223 aircraft, incorporated by reference to Exhibit 10(u) to AMR's report on Form 10-K for the year ended December 31, 1988, file number 1-8400.\n10(v) Acquisition Agreement, dated as of February 4, 1989, among American and Delta Airlines, Inc. and others relative to operation of a computerized reservations system incorporated by reference to Exhibit 10(v) to AMR's report on Form 10-K for the year ended December 31, 1988, file number 1-8400.\n10(w) Purchase Agreement, dated as of May 5, 1989, between American and the Boeing Company relative to the purchase of Boeing 757-223 aircraft, incorporated by reference to Exhibit 10(w) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(x) Purchase Agreement, dated as of June 9, 1989, between American and Fokker Aircraft U. S. A., Inc. relative to the purchase of Fokker 100 aircraft, incorporated by reference to Exhibit 10(x) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(y) Agreement for Sale and Purchase, dated as of June 12, 1989, between AMR Leasing Corporation and SAAB Aircraft of America, Inc. relative to the purchase of Saab 340B aircraft, incorporated by reference to Exhibit 10(y) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(z) Purchase Agreement, dated as of June 23, 1989, between American and the Boeing Company relative to the purchase of Boeing 767-323ER aircraft, incorporated by reference to Exhibit 10(z) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(aa) Lease Agreement, dated as of June 29, 1989, between AMR Leasing Corporation and British Aerospace, Inc. relative to the lease of Jetstream Model 3201 aircraft, incorporated by reference to Exhibit 10(aa) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(bb) Purchase Agreement, dated as of August 3, 1989, between American and the McDonnell Douglas Corporation relative to the purchase of MD-11 aircraft, incorporated by reference to Exhibit 10(bb) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(cc) Amendment, dated as of August 3, 1989, to the Purchase Agreement in Exhibit 10(l) above, incorporated by reference to Exhibit 10(cc) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(dd) Amendment, dated as of August 11, 1989, to AMR's Preferred Stock Purchase Rights Agreement in Exhibit 10(o) above, incorporated by reference to Exhibit 10(dd) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(ee) Purchase Agreement, dated as of October 25, 1989, between American and AVSA, S. A. R. L. relative to the purchase of Airbus A300-600R aircraft, incorporated by reference to Exhibit 10(ee) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(ff) Amendment, dated as of November 16, 1989, to Employment Agreement among AMR, American Airlines and Robert L. Crandall, incorporated by reference to Exhibit 10(ff) to AMR's report on Form 10- K for the year ended December 31, 1989, file number 1-8400.\n10(gg) Directors Stock Equivalent Purchase Plan, incorporated by reference to Exhibit 10(gg) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(hh) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and Edward A. Brennan, incorporated by reference to Exhibit 10(hh) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(ii) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and Thomas S. Carroll, incorporated by reference to Exhibit 10(ii) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(jj) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and Antonio Luis Ferre, incorporated by reference to Exhibit 10(jj) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(kk) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and John D. Leitch, incorporated by reference to Exhibit 10(kk) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(ll) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and Charles H. Pistor, Jr., incorporated by reference to Exhibit 10(ll) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(mm) Deferred Compensation Agreement, dated as of January 31, 1990, between AMR and Edward O. Vetter, incorporated by reference to Exhibit 10(mm) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(nn) Amendment, dated as of February 1, 1990, to the Deferred Compensation Agreement, dated December 19, 1984, between AMR and Charles H. Pistor, Jr., incorporated by reference to Exhibit 10(nn) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(oo) Management Severance Allowance, dated as of February 23, 1990, for levels 1-4 employees of American Airlines, Inc., incorporated by reference to Exhibit 10(oo) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(pp) Management Severance Allowance, dated as of February 23, 1990, for level 5 and above employees of American Airlines, Inc., incorporated by reference to Exhibit 10(pp) to AMR's report on Form 10-K for the year ended December 31, 1989, file number 1-8400.\n10(qq) Purchase Agreement, dated as of October 25, 1990, between AMR Leasing Corporation and Avions de Transport Regional relative to the purchase of ATR 42 and Super ATR aircraft, incorporated by reference to Exhibit 10(qq) to AMR's report on Form 10-K for the year ended December 31, 1990, file number 1-8400.\n10(rr) Form of Stock Option Agreement for Corporate Officers under the AMR 1988 Long-Term Incentive Plan, incorporated by reference to Exhibit 10(rr) to AMR's report on Form 10-K for the year ended December 31, 1990, file number 1-8400.\n10(ss) Form of Career Equity Program Deferred Stock Award Agreement under the AMR 1988 Long-Term Incentive Plan, incorporated by reference to Exhibit 10(ss) to AMR's report on Form 10-K for the year ended December 31, 1990, file number 1-8400.\n10(tt) Amendment, dated as of December 3, 1990, to Employment Agreement among AMR, American Airlines and Robert L. Crandall incorporated by reference to Exhibit 10(tt) to AMR's report on Form 10-K for the year ended December 31, 1990, file number 1-8400.\n10(uu) Amendment, dated as of May 1, 1992, to Employment Agreement among AMR, American Airlines and Robert L. Crandall incorporated by reference to Exhibit 10(uu) to AMR's report on Form 10-Q for the period ended June 30, 1992, file number 1-8400.\n10(vv) Irrevocable Executive Trust Agreement, dated as of May 1, 1992, between AMR and Wachovia Bank of North Carolina N.A.\n10(ww) Deferred Compensation Agreement, dated as of December 23, 1992, between AMR and Howard P. Allen.\n10(xx) Deferred Compensation Agreement, dated as of February 5, 1993, between AMR and Charles T. Fisher, III.\n10(yy) Deferred Compensation Agreement, dated as of February 10, 1993, between AMR and Edward O. Vetter.\n10(zz) Deferred Compensation Agreement, dated as of March 8, 1993, between AMR and John D. Leitch.\n10(aaa) Amendment No. 2 to the Rights Agreement, dated as of February 13, 1986, between AMR Corporation and First Chicago Trust Company of New York.\n10(bbb) Form of Guaranty to Career Equity Program under the AMR 1988 Long-Term Incentive Plan.\n10(ccc) Amendment, dated as of July 26, 1993, to Career Equity Program Deferred Stock Award Agreements.\n10(ddd) Second Amendment, dated as of July 26, 1993, to Career Equity Program Deferred Stock Award Agreements.\n10(eee) Deferred Compensation Agreement, dated as of February 10, 1994, between AMR and Charles T. Fisher, III.\n10(fff) Deferred Compensation Agreement, dated as of February 11, 1994, between AMR and Howard P. Allen.\n10(ggg) American Airlines, Inc. 1995 Incentive Compensation Plan for Officers and Key Employees.\n10(hhh) American Airlines , Inc. 1995 Employee Profit Sharing Plan.\n10(iii) Amendment to AMR's 1988 Long-term Incentive Plan dated May 18, 1994, incorporated by reference to Exhibit A to AMR's definitive proxy statement with respect to the annual meeting of stockholders held on May 18, 1994.\n10(jjj) Directors Stock Incentive Plan dated May 18, 1994, incorporated by reference to Exhibit B to AMR's definitive proxy statement with respect to the annual meeting of stockholders held on May 18, 1994.\n10(kkk) Performance Share Program for the years 1993 to 1995 under the 1988 Long-term Incentive Program.\n10(lll) Performance Share Program for the years 1994 to 1996 under the 1988 Long-term Incentive Program.\n10(mmm) American Airlines, Inc. Supplemental Executive Retirement Program dated November 16, 1994.\n10(nnn) Current form of Career Equity Program Agreement.\n10(ooo) Performance Share Program for the years 1995 to 1997 under the 1988 Long-term Incentive Program.\n10(ppp) SABRE Group Performance Share Program for the years 1995 to 1997 under the 1988 Long-term Incentive Program.\n10(qqq) American Airlines, Inc. 1996 Incentive Compensation Plan for Officers and Key Employees.\n10(rrr) Aircraft Sales Agreement by and between American Airlines, Inc. and Federal Express Corporation, dated April 7, 1995.\n10(sss) Deferred Compensation Agreement, dated as of December 27, 1995, between AMR and Howard P. Allen.\n10(ttt) Deferred Compensation Agreement, dated as of February 7, 1996, between AMR and Armando M. Codina.\n10(uuu) Deferred Compensation Agreement, dated as of February 9, 1996, between AMR and Charles T. Fisher, III.\n10(vvv) Deferred Compensation Agreement, dated as of February 23, 1996, between AMR and Charles H. Pistor, Jr.\n11(a) Computation of primary loss per share for the years ended December 31, 1995, 1994 and 1993.\n11(b) Computation of loss per share assuming full dilution for the years ended December 31, 1995, 1994 and 1993.\n19 The 1974 and 1979 American Airlines (AMR) Stock Option plans as amended March 16, 1983, incorporated by reference to Exhibit 19 to AMR's report on Form 10-K for the year ended December 31, 1983, file number 1-8400. Refer to Exhibits 10(d) and 10(e).\n22 Significant subsidiaries of the registrant.\n23 Consent of Independent Auditors appears on page 64 hereof.\n(b) Reports on Form 8-K:\nNone.\nAMR CORPORATION INDEX TO FINANCIAL STATEMENTS AND SCHEDULES COVERED BY REPORT OF INDEPENDENT AUDITORS [ITEM 14(A)]\nAll other schedules are omitted since the required information is included in the financial statements or notes thereto, or since the required information is either not present or not present in sufficient amounts.\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in Registration Statements (Form S-8 No. 2-68366), (Form S-8 No. 33-60725), (Form S-8 No. 33-60727), (Form S-3 No. 33-42027), (Form S-3 No. 33-46325), (Form S-3 No. 33-52121), and (Form S-4 No. 33-55191) of AMR Corporation, and in the related Prospectuses, of our report dated January 15, 1996, with respect to the consolidated financial statements and schedules of AMR Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 1995.\nERNST & YOUNG LLP\nDallas, Texas March 20, 1996\nAMR CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DEDUCTED FROM ASSET TO WHICH APPLICABLE) YEAR ENDED DECEMBER 31, 1995 (IN MILLIONS)\nAMR CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DEDUCTED FROM ASSET TO WHICH APPLICABLE) YEAR ENDED DECEMBER 31, 1994 (IN MILLIONS)\nAMR CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DEDUCTED FROM ASSET TO WHICH APPLICABLE) YEAR ENDED DECEMBER 31, 1993 (IN MILLIONS)\n(a) Transfer to Allowance for obsolescence of inventories.\nPART I - EXHIBIT 11 (A) AMR CORPORATION COMPUTATION OF PRIMARY EARNINGS (LOSS) PER SHARE (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nPART I - EXHIBIT 11 (B) AMR CORPORATION COMPUTATION OF EARNINGS (LOSS) PER SHARE ASSUMING FULL DILUTION (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMR CORPORATION\n\/s\/ Robert L. Crandall - - -------------------------------------------------- Robert L. Crandall Chairman, President and Chief Executive Officer (Principal Executive Officer)\n\/s\/ Gerard J. Arpey - - -------------------------------------------------- Gerard J. Arpey Senior Vice President and Chief Financial Officer (Principal Financial and Accounting 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 noted:\nDate: March 20, 1996\nINDEX TO EXHIBIT\nEXHIBIT NUMBER DESCRIPTION - - ------- -----------\n10(ooo) Performance Share Program for the years 1995 to 1997 under the 1988 Long-term Incentive Program.\n10(ppp) SABRE Group Performance Share Program for the years 1995 to 1997 under the 1988 Long-term Incentive Program.\n10(qqq) American Airlines, Inc. 1996 Incentive Compensation Plan for Officers and Key Employees.\n10(rrr) Aircraft Sales Agreement by and between American Airlines, Inc. and Federal Express Corporation, dated April 7, 1995.\n10(sss) Deferred Compensation Agreement, dated as of December 27, 1995, between AMR and Howard P. Allen.\n10(ttt) Deferred Compensation Agreement, dated as of February 7, 1996, between AMR and Armando M. Codina.\n10(uuu) Deferred Compensation Agreement, dated as of February 9, 1996, between AMR and Charles T. Fisher, III.\n10(vvv) Deferred Compensation Agreement, dated as of February 23, 1996, between AMR and Charles H. Pistor, Jr.\n23 Consent of Independent Auditors appears on Page 64 hereof.","section_15":""}
{"filename":"1049442_1995.txt","cik":"1049442","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nHuntsman Packaging Corporation (\"Huntsman Packaging\" or the \"Company\") was founded in 1992, as a wholly-owned subsidiary of Huntsman Corporation, a privately-owned petrochemical company headquartered in Salt Lake City, Utah. Originally formed to acquire the Wingfoot Films division of Goodyear Tire & Rubber Company, since 1992, we have successfully acquired and integrated 11 additional film businesses. We are now one of the largest manufacturers of film and flexible packaging products in North America.\nIn September 1997, the Company was \"spun off\" from Huntsman Corporation. We continue to be privately owned, however, and all of the owners of the common stock are affiliates or employees of the Company.\nSignificant events in 1998 included our acquisition of Blessings Corporation, a leading manufacturer of personal care and agricultural films, and the closure of some of our less efficient manufacturing facilities. These activities are discussed in more detail in Notes 3, 4 and 12 to the Consolidated Financial Statements included in this report.\nINDUSTRY OVERVIEW\nFlexible packaging and film products are thin, pliable films, bags, pouches and labels for food, consumer and industrial uses. Our products are generally made from blends or co-extrusions of polyethylene, polyvinyl chloride (\"PVC\") or other resins and are used for food packaging, medical and pharmaceutical applications, household goods and retail merchandising. In consumer applications, our flexible packaging replaces rigid containers (paperboard, glass, metals and rigid plastic) with lower-cost and lighter-weight packaging. In industrial applications, stretch and shrink films are used to unitize cans, boxes and loads for transport and are replacing traditional forms of packaging, such as steel strapping, corrugated paper boxes and taping. Our films are also used extensively in personal care products, such as disposable diapers and feminine care products.\nDESCRIPTION OF BUSINESS\nWe offer one of the industry's most diverse product lines. We have plants in the United States, Canada, Mexico, Germany and Australia. For the year ended December 31, 1998, we had net sales of $651.9 million.\nWe focus on technology and product development, strategic acquisitions, and manufacturing improvements to take advantage of current and projected market trends. We have brought new technology and new products to the marketplace, such as Winwrap and the patented G-Bond manufacturing process. We have also sought to continuously improve our operating efficiency, and we have a successful track record of improving capacity utilization, reducing overhead costs and increasing the profits of our acquired businesses.\nWe divide our products into three operating segments for financial and business reporting purposes: design products, industrial films and specialty films. Each of our operating segments is described below. Additional information about our foreign and domestic operations and operations in different business segments appears in Note 13 to the Consolidated Financial Statements included in this report.\nDesign Products\nDesign products accounted for 20.9%, 20.8% and 25.8% of our net sales in 1998, 1997 and 1996, respectively. Our design products include printed polyethylene roll stock, bags and sheets used to package food and consumer goods. Printed roll stock is sold to fresh and frozen food processors, who use their own packaging equipment to fabricate pouches and bags for their products. Printed bags are sold to bakeries, fresh and frozen food processors, textile manufacturers and other dry goods processors. Bread and bakery bags represent a significant portion of our design products business. Our design products group produces approximately one billion bread and bakery bags each year. Approximately 28% of our design products business consists of sales outside the United States.\nIndustrial Films\nIndustrial films accounted for 22.2%, 39.2% and 57.3% of our net sales in 1998, 1997 and 1996, respectively. Our industrial film products include polyethylene stretch films and PVC films. Our stretch films are used primarily to bundle products and wrap pallets. Currently, approximately one-half of all loads shipped in North America are unitized with stretch film.\nPVC films are used by supermarkets, institutions and homes to wrap meat, cheese and produce. Approximately 33% of our industrial films business consists of sales outside the United States.\nSpecialty Films\nSpecialty films accounted for 56.9%, 40.0% and 16.9% of our net sales in 1998, 1997 and 1996, respectively. Our specialty films include converter films and barrier films.\nConverter Films. Converter films are single-layer and multi-layer polyethylene films that are sold to converters and laminators for final processing into consumer products such as bags, pouches and printed products. Converter films may also be laminated to another film or to paper or foil to give each layer a specific performance characteristic, such as moisture, oxygen or odor barriers or light protection. Because converter films are sold for their sealability or barrier characteristics, they must meet stringent performance specifications including gauge control, layer thickness, sealability and web width accuracy. We are a leader in introducing new converter film product offerings to respond to industry trends and to meet customer needs.\nBarrier Films. Barrier films are polyethylene films that are sold to food processors and other end users. These films are puncture resistant and provide specific types of barrier protection against such things as moisture, oxygen and light. Our barrier films include cookie, cracker and cereal films, personal care and medical films, and agricultural and horticultural films.\nCookie, Cracker and Cereal Films. We make coextruded barrier films that are manufactured into box liners for packaging cookies, crackers, cereals and other dry goods. As a leading supplier of these films, we continue to develop advanced coextrusion technology to gain market share and introduce new products.\nPersonal Care and Medical Films. We are also an industry leader in personal care films used in disposable diapers, feminine hygiene products and adult incontinence products. A significant portion of our specialty films business consists of the sale of personal care films to Kimberly-Clark Corporation and its affiliates. Kimberly-Clark accounts for approximately 25% of our specialty films sales and 14% of our consolidated net sales. Our medical films include medical supply packaging and surgical drapes and gowns.\nAgricultural and Horticultural Films. Our agricultural and horticultural films include mulch films, used to protect crops and enhance growth, and greenhouse films that cover greenhouses and protect young plants.\nSEASONALITY\nOur business is generally not subject to large seasonal fluctuations. Historically, however, we have experienced slight increases in sales volumes during the second and third quarters of each year.\nRESEARCH AND DEVELOPMENT\nResearch and development are critical elements of our business. We spent $3.7 million, $2.5 million and $2.1 million on research and development in 1998, 1997 and 1996, respectively. Research and development spending represented approximately 0.6% of our net sales for 1998. Our research and development facilities are located in Akron, Ohio and Newport News, Virginia.\nINTELLECTUAL PROPERTY RIGHTS\nWe believe patents, trademarks and licenses are significant to our business. We have trademarks associated with a number of our products. We own 21 unexpired U.S. patents and routinely apply for patents on significant product developments. Our patents have remaining terms ranging from 2 months to 16 years. We also have exclusive and nonexclusive licenses under patents owned by third parties.\nWe also rely on unpatented proprietary know-how, continuing technological innovation and other trade secrets to develop and maintain our competitive position. We routinely enter into confidentiality agreements designed to protect our trade secrets and proprietary know-how.\nAlthough we constantly seek to protect our patents, trademarks and other intellectual property, there can be no assurance that our precautions will provide meaningful protection against competitors.\nRAW MATERIALS\nOur primary raw materials are low-density and linear low-density polyethylene resins and polyvinyl chloride resin. The costs of our raw materials are a function of, among other things, manufacturing capacity, demand, and the price of crude oil and natural gas feedstocks. Although we contract with large suppliers for raw materials, these materials are generally available from numerous sources. Resin shortages or significant increases in the price of resin, however, could have a significant adverse effect on our business.\nEMPLOYEES\nAs of December 31, 1998, we had approximately 3,000 employees. Management believes its relationships with employees are good. There have been no strikes or work stoppages in our operating history.\nENVIRONMENTAL MATTERS\nOur operations are subject to environmental laws in the United States and abroad, including those described below (\"Environmental Laws\"). Our operating budgets include costs and expenses associated with complying with these laws, including the acquisition, maintenance and repair of pollution control equipment. Additional costs and expenses may also be incurred to meet new requirements under Environmental Laws, as well as in connection with the investigation and remediation of threatened or actual pollution.\nUnder the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and similar state statutes, an owner or operator of real property may be liable for the costs of removing or remediating hazardous substances on or under the property, regardless of whether the owner or operator owned or operated the real property at the time of the release of the hazardous substances and regardless of whether the release or disposal was in compliance with law at the time it occurred. To date, we are not aware of any claims under CERCLA or similar state statutes against us.\nUnder the Resource Conservation and Recovery Act of 1976, as amended (\"RCRA\"), and similar state statutes, companies that hold permits to treat or store hazardous waste can be required to remediate contamination from solid waste management units at a facility, regardless of when the contamination occurred. Our plants generate either small, incidental volumes of hazardous waste or larger volumes which we store for less than 90 days. As a result, we are not required to hold RCRA permits at our individual facilities. Such waste, when generated, is disposed of at fully-permitted, off-site facilities or is recycled in fully-permitted recovery facilities.\nOur operations are also subject to regulation under the Clean Air Act and the Clean Water Act, as well as similar state statutes. Our Rochester, New York and Seattle, Washington plants have the potential to emit air pollutants in quantities that require them to obtain a Title V permit under the Clean Air Act Amendments of 1990 and the implementing state regulations. Both facilities have timely filed Title V applications under their respective state programs. Some capital costs for additional air pollution controls or monitors may be required at both sites. However, such expenditures would not be materially adverse to our business. Several facilities may also be required to obtain stormwater permits under the Clean Water Act and implementing regulations. The cost of this kind of permitting is not material.\nWe are also subject to environmental laws and regulations in those foreign countries in which we operate.\nOur operating expenses for environmental matters totaled less than $0.2 million in each of 1998, 1997 and 1996 and are expected to remain at approximately this level in 1999. We believe this will be sufficient to cover, among other things, our routine measures to prevent, contain and clean up spills of materials that occur in the ordinary course of our business. Our estimated capital expenditures for environmental matters were approximately $0.6 million in 1998, $0.5 million in 1997 and $0.3 million in 1996, and are expected to be approximately $0.7 million in 1999 and approximately $1 million in 2000. Capital expenditures and, to a lesser extent, costs and operating expenses relating to environmental matters will be subject to evolving regulatory requirements and will depend on the timing and promulgation of specific standards which impose requirements on our operations.\nINTERNATIONAL OPERATIONS\nWe operate facilities and sell products in several countries outside the United States, particularly in Mexico. As a result, we are subject to risks associated with selling and operating in foreign countries. These risks include devaluations and fluctuations in currency exchange rates, limitations on conversion of foreign currencies into U.S. dollars and remittance of dividends and other payments by foreign subsidiaries. The imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries, hyperinflation in certain foreign countries, and imposition or increase of investment and other restrictions by foreign governments could also have a negative effect on our business.\nCOMPETITION\nThe markets in which we operate are highly competitive. We believe we compete on the basis of service, product quality, product innovation and price. In addition to competition from many smaller competitors, we face strong competition from a number of large flexible packaging companies. Some of our competitors are substantially larger, are more diversified and have greater financial resources than we do, and, therefore, may have certain competitive advantages.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOur principal executive offices are located at 500 Huntsman Way, Salt Lake City, Utah 84108, and are leased from Huntsman Headquarters Corporation, an indirect, wholly-owned subsidiary of Huntsman Corporation. We own most of the improved real property and other assets used in our operations. We lease a few of the sites at which we have manufacturing operations and we also lease warehouse and office space at various locations. We consider the condition of our plants, warehouses and other properties and the other assets owned or leased by us to be generally good.\nOur principal manufacturing plants are listed below. Unless otherwise indicated, each property is owned.\nDESIGN PRODUCTS Langley, British Columbia* Mexico City, Mexico (two facilities) Rochester, New York Seattle, Washington\nINDUSTRIAL FILMS Calhoun, Georgia Danville, Kentucky Lewisburg, Tennessee Merced, California Phillipsburg, Germany Melbourne, Australia* Toronto, Canada\nSPECIALTY FILMS Birmingham, Alabama Bloomington, Indiana* Chippewa Falls, Wisconsin Dalton, Georgia Danville, Kentucky Deerfield, Massachusetts Harrington, Delaware McAlester, Oklahoma Newport News, Virginia Odon, Indiana* Washington, Georgia\n- ----------\n* Leased properties\nWe have an annual manufacturing capacity of approximately 850 million pounds of polyethylene and PVC films. We believe that the capacities of our plants are adequate to meet our immediate needs. Our plants have historically operated at 75% to 100% of capacity.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nHuntsman Packaging is involved in litigation from time to time in the ordinary course of our business. In management's opinion, none of such litigation is material to our financial condition or operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nWe did not submit any matters to a vote of security holders during the fourth quarter of 1998.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nAt March 26, 1999, the Company had 1,000,001 shares of Class A Common Stock outstanding, 6,999 shares of Class B Common Stock outstanding and 49,511 shares of Class C Common Stock outstanding (the Class A Common Stock, the Class B Common Stock and the Class C Common Stock are herein collectively referred to as the \"Common Stock\"). At March 26, 1999, there were three holders of record of the Class A Common Stock, two holders of record of the Class B Common Stock and four holders of record of the Class C Common Stock. There is no established trading market for any class of the Company's Common Stock.\nThe Company has not declared or paid any cash dividends on its capital stock during the last two years and does not anticipate paying any cash dividends in the foreseeable future. The indenture governing the Company's outstanding debt securities and the Company's bank credit facility contain certain restrictions on the payment of cash dividends with respect to the Company's Common Stock.\nDuring 1998, the Company sold 12,200 shares of Class C Common Stock to certain members of senior management. The shares of Class C Common Stock were sold for $100 per share, the estimated fair market value of the shares on the date of purchase. The Company believes that the issuance of the Class C Common Stock to members of its senior management, which did not involve a public offering or sale of securities, was exempt from the registration requirements of the Securities Act of 1933, as amended (the \"Securities Act\"), pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act. No underwriters, brokers or finders were involved in these transactions. In September 1998, 500 shares of Class C Common Stock were redeemed from one member of senior management who is no longer employed by the Company. In March 1999, 600 shares of Class C Common Stock were redeemed from another member of senior management.\nIn 1999, the Company also sold 12,188 shares of Class C Common Stock to certain members of senior management for $100 per share, the estimated fair market value of the shares on the date of purchase. Also on February 22, 1999, the Company canceled outstanding options to purchase 26,223 shares of Class C Common Stock and sold an additional 26,223 shares of Class C Common Stock to certain members of senior management for $100 per share, the estimated fair market value of the shares on the date of purchase. The Company believes that the foregoing issuances of Class C Common Stock to members of its senior management were exempt from the registration requirements of the Securities Act pursuant to Rule 701 thereunder. Alternatively, the Company believes that the foregoing issuances of Class C Common Stock, which did not involve a public offering or sale of securities, were exempt from the registration requirements of the Securities Act pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act. No underwriters, brokers or finders were involved in these transactions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data have been summarized from our consolidated financial statements and are qualified in their entirety by reference to, and should be read in conjunction with, such consolidated financial statements and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" under Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe purpose of this section is to discuss and analyze our consolidated financial condition, liquidity and capital resources and results of operations. This analysis should be read in conjunction with the consolidated financial statements and notes which appear elsewhere in this report. This section contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our plans, objectives, goals, strategies and financial performance. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth under \"Cautionary Statement for Forward-Looking Information\" below and elsewhere in this report.\nGENERAL\nHuntsman Packaging derives its revenues, earnings and cash flows from the sale of film and flexible packaging products throughout the world. Huntsman Packaging manufactures these products at its facilities located in North America, Europe and Australia. Huntsman Packaging's sales have grown primarily as a result of strategic acquisitions made over the past several years, increased levels of production at acquired facilities and the overall growth in the market for film and flexible packaging products. Our most recent acquisitions include the 1996 acquisitions of Deerfield Plastics Co. Inc. (the \"Deerfield Acquisition\") and United Films Corporation (the \"United Films Acquisition\"), the 1997 acquisition of Huntsman Polymers Corporation's CT Film division (the \"CT Film Acquisition\"), and our 1998 acquisitions of Ellehammer Industries, Ltd. and Ellehammer Packaging Inc. (collectively, the \"Ellehammer Acquisition\") and Blessings Corporation (the \"Blessings Acquisition\").\nIn order to further benefit from these recent acquisitions, we ceased operations at certain less efficient manufacturing facilities and relocated equipment to more efficient facilities. In addition, we sold certain assets and restructured and consolidated our operations and administrative functions. As a result of these activities, we increased manufacturing efficiencies and product quality, reduced costs, and increased operating profitability. As part of this process, in 1998, we undertook the following significant divestitures and closures of manufacturing facilities. (See Notes 3 and 4 to the Consolidated Financial Statements included in this report.)\nDuring the second quarter of 1998, we announced our plan to cease operations at our Clearfield, Utah facility, acquired as part of the CT Film Acquisition. As of December 31, 1998, operations at the facility had ceased and nearly all of the facility's assets had been relocated.\nOn June 1, 1998, Huntsman Container Corporation International, our wholly-owned subsidiary, sold its entire interest in the capital stock of Huntsman Container Company Limited (\"HCCL\") and Huntsman Container Company France SA (\"HCCFSA\") to Polarcup Limited and Huhtamaki Holdings France Sarl, subsidiaries of Huhtamaki Oyj. Together, HCCL and HCCFSA comprised our foam products business segment, which was operated exclusively in Europe. Net proceeds from the sale were approximately $28.3 million.\nIn December 1997, we announced our plan to cease operations at our Carrollton, Ohio facility and relocate certain assets from the Carrollton facility to other facilities. We recognized plant closing costs of approximately $9.3 million in our consolidated income statement for the year ended December 31, 1997 relating to this closure. On\nAugust 11, 1998, we sold the land, building and certain surplus manufacturing equipment associated with the Carrollton facility to North American Plastics Chemicals Incorporated. Net proceeds from the sale were approximately $1.6 million.\nOn August 14, 1998, we sold our entire interest in the capital stock of Huntsman Packaging UK Limited (\"HPUK\") to Skymark Packaging International Limited. HPUK owned our Scunthorpe, UK facility, which manufactured and sold polyethylene film exclusively in Europe. Net proceeds from this sale were approximately $5.6 million.\nIn connection with the Blessings Acquisition, we announced our plan to cease manufacturing operations at our Newport News, Virginia production facility. On November 20, 1998, we sold the land, building and certain surplus manufacturing equipment associated with our Newport News, Virginia production facility. Net proceeds from the sale were approximately $1.3 million.\nRESULTS OF OPERATIONS\nThe following table indicates net sales and expenses, and such amounts as a percentage of net sales, for the years ended December 31, 1998, 1997 and 1996.\n1998 VERSUS 1997\nNet Sales\nNet sales increased by $204.2 million, or 45.6%, in 1998 to $651.9 million from $447.7 million in 1997. The increase was primarily due to the Blessings Acquisition in May 1998 and a full year's results from the September 1997 CT Film Acquisition. The CT Film Acquisition and the Blessings Acquisition collectively accounted for increased net sales of approximately $256 million in 1998. Excluding the sales increases resulting from these acquisitions, we realized increased sales volumes of approximately 1.7% in 1998 compared to 1997. These sales volume related increases were offset by a 4.6% reduction in the average selling prices for our products, excluding the effects of the acquisitions. The average selling price reductions were primarily due to declines in the price of resins, our primary raw material. In the markets we serve, the average selling price of our products generally increases or decreases as resin prices increase or decrease.\nGross Profit\nGross profit increased by $61.4 million, or 105.7%, in 1998 to $119.5 million from $58.1 million in 1997. The increase was due to increased sales volume from the recent acquisitions and internal growth, integration and rationalization of acquired and existing facilities, realization of purchasing and operational synergies associated with the recent acquisitions, and improved manufacturing performance within our operations. Due to our rationalization and integration of operations and facilities, a precise measure of the additional gross profit added in 1998 from the recent acquisitions is not practicable. However, the gross profit for the facilities associated with the CT Film Acquisition and the Blessings Acquisition was approximately $49.2 million, including the effects of the above activities.\nTotal Operating Expenses\nTotal operating expenses (including research and development expenses) increased by $25.1 million, or 55.8%, in 1998 to $70.1 million from $45.0 million in 1997. The increase was due primarily to additional operating expenses resulting from the CT Film Acquisition and the Blessings Acquisition. In addition, we incurred nonrecurring operating expenses totaling approximately $8.0 million in 1998. The nonrecurring expenses included the following components (in millions):\nThe plant closing costs charge relates to the closure of our Clearfield, Utah facility. During 1998, we ceased operations at the Clearfield facility and most of the production equipment was relocated to other of our facilities. The nonrecurring $4.9 million charge includes a $0.6 million charge for the write-off of assets not relocated, a $0.4 million provision for the write-off of impaired goodwill, a $0.5 million charge for reduction of work force costs associated with the elimination of approximately 52 full-time equivalent employees, and an accrual of $3.4 million for estimated future net lease and other costs incurred to close the facility. See Note 4 to the Consolidated Financial Statements included in this report.\nThe indirect plant closing costs include one-time costs to tear down and relocate equipment from closed plants to other of our facilities. The Blessings Acquisition transition costs consist primarily of labor costs relating to former Blessings Corporation employees retained on a temporary basis to assist through the early stages of our ownership of the operation.\nOngoing operating expenses (excluding the nonrecurring charges discussed above) as a percentage of net sales were approximately 9.5% in 1998 compared to 10.5% in 1997, computed subsequent to the September 1997 CT Film Acquisition. We believe the 1998 ongoing operating expense percentage to be indicative of future operating expenses.\nOperating Income\nOperating income increased by $36.3 million, or 277.1%, in 1998 to $49.4 million from $13.1 million in 1997 as a result of the factors discussed above.\n1997 VERSUS 1996\nNet Sales\nNet sales increased by $152.0 million, or 51.4%, in 1997 to $447.7 million from $295.7 million in 1996. The increase was primarily due to the CT Film Acquisition in September 1997 and a full year's results from the 1996 Deerfield and United Films Acquisitions. These acquisitions increased sales by approximately $158.0 million\nin 1997. Excluding the effect of these acquisitions, sales decreased approximately $6.0 million in 1997, primarily due to lower sales volumes of approximately 5% in the North America PVC product line and unfavorable Australian and European currency translation rates.\nAs discussed above, our average sales prices generally follow increases and decreases in resin prices. Average resin prices were relatively stable in 1997, as compared to 1998 and 1996. As a result, 1997 average sales prices were relatively stable as well.\nGross Profit\nGross profit increased by $15.9 million, or 37.7%, in 1997 to $58.1 million from $42.2 million in 1996. The CT Film, Deerfield and United Films Acquisitions discussed above increased gross profit by approximately $22.0 million in 1997. These increases were offset by a decrease in gross profit of approximately $6.0 million in the industrial films segment, due primarily to decreased margins. In stretch film markets of our industrial films segment, gross profit decreased by approximately $3.0 million in 1997, due to general price reductions as a result of excess supply of stretch film. The remaining gross profit decrease was due primarily to reduced North American PVC product line sales volume and unfavorable Australian and European currency translation rates.\nTotal Operating Expenses\nTotal operating expenses for 1997 (including research and development expenses) increased by $6.9 million, or 18.1%, to $45.0 million from $38.1 million in 1996. Additional operating expenses of approximately $8.6 million associated with the Deerfield, United Films and CT Film Acquisitions were incurred in 1997. This increase was partially offset by $1.6 million in reduced plant closing costs, compared to 1996.\nIn 1997, we recognized a nonrecurring plant closing charge of $9.3 million. The CT Film Acquisition in 1997 provided us with relatively new, efficient manufacturing equipment with significant available capacity. Thereafter, we decided to cease operations at the Carrollton, Ohio facility and to relocate most of the equipment to other facilities. The nonrecurring $9.3 million charge includes $4.2 million for the write-off of assets not relocated, $3.3 million for the write-off of goodwill associated with the original acquisition of the Carrollton facility and $1.8 million for work force reduction costs associated with the elimination of approximately 83 full-time equivalent employees and other costs. See Note 4 to the Consolidated Financial Statements included in this report.\nOperating Income\nOperating income increased by $9.0 million, or 219.5%, to $13.1 million from $4.1 million due to the factors discussed above.\nOPERATING SEGMENT REVIEW\nGeneral\nWe have adopted SFAS No. 131, \"Disclosures About Segments of an Enterprise and Related Information.\" Operating segments are components of our company for which separate financial information is available that is evaluated regularly by our chief operating decision maker in deciding how to allocate resources and in assessing performance. For more information on our operating segments, see Note 13 to the Consolidated Financial Statements included in this report.\nOur acquisitions during 1998, 1997 and 1996 led to fundamental changes in our organizational structure, operations and mix of business. These acquisitions allowed us to significantly expand our business, exit non-core businesses, close less efficient plants and organize our company into our current operating segments. These changes were not completed until the end of 1998. Because our business segments, profitability and total assets have\nchanged so dramatically during the past two years, we believe a discussion of the segment changes from 1996 to 1997 is not necessary to gain an understanding of our current business. Accordingly, the following operating segment review focuses on changes from 1997 to 1998.\nDesign Products\nNet Sales\nThe design products segment net sales increased by $42.7 million, or 45.7%, in 1998 to $136.1 million from $93.4 million in 1997. This increase was primarily due to our recent acquisitions and to sales volume increases resulting from production capacity expansions. The Blessings Acquisition added approximately $30.2 million to net sales in 1998. These additional sales relate to our Mexican operation acquired from Blessings Corporation. Excluding the effect of this acquisition, net sales dollars increased by 13.3% and sales volume increased by 16.1%. The sales dollar and volume increases were due to additional production capacity added over the last two years in our Rochester, New York and Seattle, Washington facilities. These increases were off-set by a 2.1% reduction in 1998 average selling prices, excluding the effects of the Blessings Acquisition. As previously discussed, the decreased average selling prices resulted from a reduction in resin prices during 1998.\nSegment Profit\nThe design products segment profit increased by $1.1 million, or 9.7%, in 1998 to $12.4 million from $11.3 million in 1997. The increase was primarily due to our recent acquisitions and increased sales volume resulting from production capacity expansions. In 1997, operating expenses associated with this segment were not allocated to the operating segment. Accordingly, the acquisition and sales volume related segment profit increases were partially off-set by increased operating expenses in 1998 as compared to 1997. The increase in operating expenses was due to the Blessings Acquisition and the establishment of a separate segment management team.\nSegment Total Assets\nThe design products segment total assets increased by $98.8 million, or 180.9%, in 1998 to $153.4 million from $54.6 million in 1997 due primarily to our recent acquisitions and capital expenditures to expand capacity. The 1998 acquisitions added total assets of approximately $84.6 million and 1998 capital expenditures added approximately $18.4 million. These additions were off-set by 1998 depreciation and reductions in working capital.\nCapital expenditures were for significant capacity expansion at our Rochester, New York and Seattle, Washington facilities and normal maintenance expenditures. The capacity expansion expenditures included state-of-the-art, 8-color printing presses that allow us to pursue higher margin printing applications.\nIndustrial Films\nNet Sales\nThe net sales of our industrial films segment decreased by $30.7 million, or 17.5%, in 1998 to $144.7 million from $175.4 million in 1997. The decrease in sales was primarily due to a combination of the closure of our Carrollton, Ohio facility and reductions in our average selling prices. During 1998, we completed the closure of the Carrollton facility. We relocated the more efficient Carrollton manufacturing equipment to facilities in other of our operating segments and the equipment that was not relocated was sold (see Note 4 to the Consolidated Financial Statements included in this report). These asset transfers and dispositions caused net sales to decrease by approximately $17 million in 1998. Excluding the effects of the Carrolton closure, we experienced a decline in our average selling prices of approximately 9.0% as a result of general industry selling price declines resulting from declines in resin prices. The volume of our PVC film business was virtually unchanged in 1998, while our stretch film volume increased approximately 1.8% in 1998, excluding the effects of the Carrollton closure.\nSegment Profit\nThe industrial films segment profit increased by $1.5 million, or 15.8%, in 1998 to $11.0 million from $9.5 million in 1997. The increase in segment profit was primarily due to a combination of dramatically increased stretch film gross profits over 1997 and the closure of the Carrollton plant. The stretch film business realized a return to profitability in 1998 after sustaining significant losses in 1997. During 1997, our stretch film business suffered through historically low gross profits due to excess supply in stretch film markets and lower than expected production efficiencies in our facilities. Although excess supply continued to be a factor in 1998, we realized significantly increased production efficiencies and lower production costs. The closure of the Carrollton plant added approximately $1.0 million to our segment profit, as compared to 1997. The increase in profitability was partially off-set by increased operating expenses in 1998, due to the establishment of a separate segment management team. In 1997, operating expenses associated with this segment were not allocated to the operating segment. Excluding the effects of the increase in segment operating expenses, the PVC business profitability was slightly increased over 1997.\nSegment profit excludes nonrecurring plant closing costs. The Carrollton plant closing, discussed above, resulted in a 1997 plant closing cost charge of $9.3 million. This charge relates entirely to the industrial film operating segment. See Note 4 to the Consolidated Financial Statements included in this report.\nSegment Total Assets\nThe industrial films segment total assets decreased by $13.8 million, or 14.3%, in 1998 to $82.7 million from $96.5 million in 1997. The decrease was due primarily to the closure of the Carrollton plant, 1998 depreciation and reductions in working capital. These reductions were off-set by 1998 capital expenditures of approximately $5.7 million. The capital expenditures were for ongoing maintenance and improvements, as well as a major upgrade to one of our stretch film production lines.\nSpecialty Films\nNet sales\nThe net sales of our specialty films segment increased by $192.3 million, or 107.5%, in 1998 to $371.2 million from $178.9 million in 1997. The increase was due primarily to the 1998 Blessings Acquisition and the inclusion of a full year's results from the 1997 CT Film Acquisition. The addition of these operations resulted in 1998 increased sales of approximately $182.9 million. Excluding the acquisition related increases, our specialty film 1998 volume increased by approximately 12.6%. The volume increase was due primarily to the completion of significant capacity expansions in our barrier film operations and the relocation of equipment from our closed facilities to specialty films' facilities. These increases were slightly off-set by a 5.0% reduction in our average selling prices, excluding the effects of the recent acquisitions. As previously discussed, the reduction in selling prices resulted from declines in 1998 resin prices.\nSegment Profit\nThe specialty films segment profit increased by $26.7 million, or 136.2%, in 1998 to $46.3 million from $19.6 million in 1997. The increase was due primarily to the recent acquisitions and the increase in sales volume resulting from production capacity expansions. In 1997, operating expenses associated with this segment were not allocated to the operating segment. Accordingly, the segment profit increase due to acquisitions and volume increases was partially off-set by increased operating expenses in 1998. The increase in operating expenses was due to the CT Film and Blessings Acquisitions and the establishment of a separate segment management team.\nSegment profit excludes nonrecurring plant closing costs. The Clearfield, Utah plant closing, discussed above, resulted in a 1998 plant closing cost charge of $4.9 million. This charge relates entirely to the specialty films operating segment. See Note 4 to the Consolidated Financial Statements included in this report.\nSegment Total Assets\nThe specialty films segment total assets increased by $247.0 million, or 131.3%, in 1998 to $435.1 million from $188.1 million in 1997. The increase was primarily due to the recent acquisitions and capital expenditures. The 1998 acquisitions increased segment total assets by approximately $244.4 million and 1998 capital expenditures were $26.2 million. 1998 capital expenditures included the purchase of a new barrier film production line at our Bloomington, Indiana facility and ongoing maintenance and enhancements. These increases were off-set by reductions in assets resulting from the closure of the Clearfield, Utah facility, the sale of the Scunthorpe, UK, facility, by 1998 depreciation and by reductions in working capital.\nLIQUIDITY AND CAPITAL RESOURCES\nHuntsman Packaging was separated from Huntsman Corporation on September 30, 1997 (the \"Split-Off\"). Prior to the Split-Off, we financed our operations with borrowings from Huntsman Corporation or its affiliates. In connection with the Split-Off, we issued $125 million of 9.125% unsecured senior subordinated notes due October 1, 2007 (the \"Notes\") and entered into a $225 million credit facility with The Chase Manhattan Bank (\"Chase\") and certain financial institutions party thereto (the \"Credit Agreement\"). Proceeds from the issuance of the Notes and the Credit Agreement were used to repay indebtedness to Huntsman Corporation and to fund the CT Film Acquisition. Since the Split-Off, we have financed our operations through cash provided by operations and by borrowings under the Credit Agreement, as amended. See Note 6 to the Consolidated Financial Statements included in this report.\nHuntsman Packaging's Amended Credit Facilities\nOn May 14, 1998, the Credit Agreement was amended and restated as a $510 million facility (the \"Amended Credit Agreement\"). The Amended Credit Agreement provides for the continuation of a previous term loan (the \"Original Term Loan\") in the principal amount of $75 million, maturing on September 30, 2005; a Tranche A Term Loan (the \"Tranche A Term Loan\") in the principal amount of $140 million, maturing on September 30, 2005; a Tranche B Term Loan (the \"Tranche B Term Loan\") in the principal amount of $100 million, maturing on June 30, 2006; and a term loan (the \"Mexico Term Loan\") to ASPEN Industrial, S.A., our wholly-owned Mexican subsidiary, in the principal amount of $45 million, maturing on September 30, 2005. The Amended Credit Agreement also provides for a $150 million revolving loan facility (the \"Revolver\") maturing on September 30, 2004. The Original Term Loan, the Tranche A Term Loan and the Mexico Term Loan amortize at an increasing rate on a quarterly basis. The Tranche A Term Loan and the Mexico Term Loan began amortizing on December 31, 1998 and the Original Term Loan begins amortizing on December 31, 2001. The Tranche B Term Loan amortizes at the rate of $1 million per year, beginning September 30, 1998, with an aggregate of $93 million due in the last four quarterly installments. The term loans described above are required to be prepaid with the proceeds of certain asset sales, with 50% of the proceeds of the sale of certain Huntsman Packaging equity securities, and with the proceeds of certain debt offerings.\nLoans under the Amended Credit Agreement bear interest, at the election of the Company, at either (i) zero to 0.75%, depending on certain of our financial ratios, plus the higher of (a) Chase's prime rate, (b) the federal funds rate plus 1\/2% or (c) Chase's base CD rate plus 1%, or (ii) the London Interbank Offered Rate plus 1.00% to 2.00%, also depending on certain of our financial ratios.\nOur obligations under the Amended Credit Agreement are guaranteed by substantially all of our domestic subsidiaries and secured by substantially all of our domestic assets. The Amended Credit Agreement is also secured by a pledge of 65% of the capital stock of each of our foreign subsidiaries. See Note 16 to the Consolidated Financial Statements included in this report.\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities was $45.5 million in 1998, an increase of $16.9 million, or 59.1%, from $28.6 million in 1997. The increase resulted primarily from increased net income in 1998 of $8.0 million and a reduction in inventories and prepaid expenses. Net cash provided by operating activities increased\n$8.5 million, or 42.3%, in 1997 to $28.6 million from $20.1 million in 1996. The 1997 increase resulted primarily from increased net income in 1997 of $4.9 million and a reduction in inventories.\nNet Cash Used in Investing Activities\nNet cash used in investing activities was $314.8 million, $87.2 million and $88.9 million for 1998, 1997 and 1996, respectively. The majority of cash was used in the Blessings, Deerfield, United Films and CT Film Acquisitions. During 1998, we made net cash payments of approximately $285.7 million for the purchase of Blessings Corporation and $10.9 million for other acquisitions. During 1997, we made net cash payments of approximately $69.4 million for the purchase of CT Film. During 1996, we made net cash payments of approximately $12.3 million and $63.9 million for the purchase of United Films and Deerfield Plastics, respectively. See Note 12 to the Consolidated Financial Statements included in this report.\nCapital Expenditures\nTotal capital expenditures were $52.1 million, $17.9 million and $12.8 million for 1998, 1997 and 1996, respectively. The 1998 capital expenditures included expenditures to upgrade and relocate equipment, to add capacity in our design products facilities, to add new information systems and upgrades to existing information systems, and to add several new production lines in our specialty films facilities. The 1997 capital expenditures included film production capacity expansions in our newly acquired Deerfield and United Film facilities, as well as printing capacity expansion in our design products facilities. The Company estimates that total maintenance capital expenditures of $12 million per year will be required in the near future.\nNet Cash Provided by Financing Activities\nNet cash provided by financing activities was $275.6 million, $63.2 million and $68.6 million for 1998, 1997 and 1996, respectively. Net cash provided by financing activities consists primarily of net borrowings under our current and prior credit arrangements. See Note 6 to the Consolidated Financial Statements included in this report. Net cash provided by financing activities was used primarily to fund the Blessings, CT Film, Deerfield and United Films Acquisitions, as well as our capital expenditures.\nLiquidity\nAs of December 31, 1998, we had $93.4 million of working capital. As of December 31, 1998, we had approximately $110 million available under the Revolver of our Amended Credit Agreement, $4.2 million of which was issued as letters of credit. The debt under our Amended Credit Agreement bears interest at LIBOR plus 2%, and may adjust downward based upon our leverage ratio (as defined in the Amended Credit Agreement) to a minimum of LIBOR plus 1%.\nAs of December 31, 1998, we had $11.3 million in cash and cash equivalents held by our foreign subsidiaries. The effective tax rate of repatriating this money and future foreign earnings to the United States varies from approximately 40% to 65% depending on various U.S. and foreign tax factors, including each foreign subsidiary's country of incorporation. High effective repatriation tax rates may limit our ability to access cash and cash equivalents generated by our foreign operations for use in our United States operations, including to pay principal, premium, if any, and interest on the Notes and the Amended Credit Agreement. In 1998, 1997 and 1996, our foreign operations generated income from continuing operations of $0.5 million, $1.7 million and $5.0 million, respectively.\nWe expect that cash flows from operating activities and available borrowings under our credit arrangements will provide sufficient working capital to operate our business, to make expected capital expenditures and to meet foreseeable liquidity requirements. If we were to engage in a significant acquisition transaction, however, it may be necessary for us to restructure our existing credit arrangements.\nOTHER MATTERS\nAccounting Standards\nIn June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 133, \"Accounting for Derivative Instruments and Hedging Activities.\" SFAS No. 133 establishes accounting and reporting standards that require derivative instruments to be recorded on the balance sheet as either an asset or liability, measured at fair market value, and that changes in the derivative's fair value be recognized currently in earnings, unless specific hedging accounting criteria are met. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. We expect that the adoption of this statement will not have a material effect on our consolidated financial statements.\nEnvironmental Matters\nOur manufacturing operations are subject to certain federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, the protection of the environment and the generation, storage, handling, transportation, treatment, disposal and remediation of hazardous substances and waste materials (\"Environmental Laws\"). In the ordinary course of business, we are subject to periodic environmental inspections and monitoring by governmental enforcement authorities. We could incur substantial costs, including fines and civil or criminal sanctions as a result of actual or alleged violations of Environmental Laws. In addition, our production facilities require environmental permits that are subject to revocation, modification and renewal (\"Environmental Permits\"). Violations of Environmental Permits can also result in substantial fines and civil or criminal sanctions. We are in substantial compliance with applicable Environmental Laws and Environmental Permits. The ultimate costs under Environmental Laws and the timing of such costs, however, are difficult to predict and potentially significant expenditures could be required in order to comply with Environmental Laws that may be adopted or imposed in the future.\nThe Year 2000 Issue\nWe have performed an analysis of both our computer systems and our production and distribution activities and have implemented procedures to address year 2000 issues. We are currently modifying our computer systems and application programs for year 2000 compliance, and we anticipate that we will complete this task by September 1, 1999. As of December 31, 1998, we had spent approximately $2.5 million on computer systems and application programs upgrades necessary to become year 2000 compliant. We believe the total cost to complete the implementation procedures to address year 2000 issues will be less than $5.0 million. In addition to addressing year 2000 issues, these computer systems and application programs upgrades will significantly enhance our information systems. We will fund these upgrades through operating cash flows. Any costs for new systems will be expensed or capitalized and amortized over the system's useful life, as appropriate. We have a year 2000 third-party compliance policy in place to identify and resolve potential third-party year 2000 problems. Although we are working cooperatively with third parties upon whom we rely for raw materials, utilities, transportation and other products and services, we cannot give any assurances that the systems of other parties will be year 2000 compliant on a timely basis. In the most reasonably likely worst-case scenario involving the failure of our systems and applications or those operated by others, our business, financial condition and results of operations would be materially adversely affected. However, an estimate of the dollar amount of such an adverse effect cannot be practically determined at this time.\nCAUTIONARY STATEMENT FOR FORWARD-LOOKING INFORMATION\nCertain information set forth in this report contains \"forward-looking statements\" within the meaning of federal securities laws. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions and other information that is not historical information. When used in this report, the words \"estimates,\" \"expects,\" \"anticipates,\" \"forecasts,\" \"plans,\" \"intends,\" \"believes\" and variations of such words or similar expressions are intended to identify forward-looking statements. We may also make additional forward-\nlooking statements from time to time. All such subsequent forward-looking statements, whether written or oral, by or on behalf of Huntsman Packaging, are also expressly qualified by these cautionary statements.\nAll forward-looking statements, including without limitation, management's examination of historical operating trends, are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. But, there can be no assurance that management's expectations, beliefs and projections will result or be achieved. All forward-looking statements apply only as of the date made. We undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.\nThere are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in or contemplated by this report. The following factors are among the factors that could cause actual results to differ materially from the forward-looking statements. There may be other factors, including those discussed elsewhere in this report, that may cause our actual results to differ materially from the forward-looking statements. Any forward-looking statements should be considered in light of these factors.\nSubstantial Leverage\nWe are highly leveraged, particularly in comparison to some of our competitors that are publicly owned. Our relatively high degree of leverage may limit our ability to obtain additional financing. In addition, a substantial portion of our cash flow from operations must be dedicated to the payment of principal and interest on our indebtedness, thereby reducing the funds available for other purposes. Certain of our borrowings are at variable rates of interest, exposing us to the risk of increased interest rates. Our leveraged position may also limit our flexibility in adjusting to changing market conditions and our ability to withstand competitive pressures.\nAbility to Service Indebtedness\nOur ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance. Our financial and operating performance is subject to prevailing economic and competitive conditions and to financial, business and other factors beyond our control. These include fluctuations in interest rates, unscheduled plant shutdowns, increased operating costs, raw material and product prices, regulatory developments and our ability to repatriate cash generated outside of the United States without incurring substantial tax liabilities. Any default under our debt facilities could have a significant adverse effect on our business and operations.\nRestrictions under Credit Facilities\nWe are subject to certain restrictive covenants under the indenture relating to our outstanding debt securities and our bank credit facility, including financial and operating covenants. Failure to comply with any of these covenants would permit our bank lenders to cease making further loans and our bank lenders and holders of our debt securities to accelerate the maturity of our debt and institute foreclosure proceedings against us. Such actions would adversely affect our ability to service our indebtedness.\nExposure to Fluctuations in Resin Prices and Dependence on Resin Supplies\nWe use large quantities of resins in manufacturing our products. Significant increases in the price of resins could adversely affect our operating margins, results of operations and ability to service our indebtedness. In addition, should any of our resin suppliers fail to deliver resin or should any significant resin supply contract be canceled, we would be forced to purchase resin in the open market. No assurances can be given that we would be able to make such purchases at prices that would allow us to remain competitive.\nCompetition\nThe markets in which we operate are highly competitive on the basis of service, product quality, product innovation and price. In addition to competition from many smaller competitors, we face strong competition from a number of large flexible packaging companies. Some of these companies are substantially larger, more diversified and have greater financial resources than we have.\nCustomer Relationships\nWe are dependent upon a limited number of large customers with substantial purchasing power for a majority of our sales. In particular, we are currently the sole outside supplier to Kimberly Clark of its breathable personal care films and other film components. Kimberly Clark accounted for approximately 14% of our revenue in 1998. The loss of Kimberly Clark or one or more other customers, or a material reduction in the sales to Kimberly Clark or these other customers, would have a material adverse effect on our operations and on our ability to service our indebtedness.\nRisks Associated with Acquisitions\nWe have completed a number of recent acquisitions. In order to further benefit from these acquisitions, we have ceased operations at less efficient manufacturing facilities and relocated equipment to more efficient facilities. In addition, we have sold assets and restructured and consolidated our operations and administrative functions in an effort to increase manufacturing efficiencies and product quality, reduce costs and increase operating profitability. There can be no assurance, however, that our efforts to integrate the acquired businesses will result in increased sales or profits. Difficulties encountered in the ongoing transition and integration process could have a material adverse effect on our financial condition, results of operations or cash flows.\nRisks Associated with International Operations\nWe operate facilities and sell products in several countries outside the United States, particularly in Mexico. As a result, we are subject to risks associated with selling and operating in foreign countries. These risks include devaluations and fluctuations in currency exchange rates, imposition of limitations on conversion of foreign currencies into U.S. dollars or remittance of dividends and other payments by foreign subsidiaries. The imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries, hyperinflation in certain foreign countries, and imposition or increase of investment and other restrictions by foreign governments could also have a negative effect on our business.\nOther Factors\nIn addition to the factors described above, we face a number of uncertainties, including: (i) changes in demand for our products; (ii) potential legislation and regulatory changes; (iii) our ability and those with which we conduct business to timely resolve Year 2000 issues; (iv) new technologies; (v) changes in distribution channels or competitive conditions in the markets or countries where we operate; (vi) increases in the cost of compliance with laws and regulations, including environmental laws and regulations; and (viii) environmental liabilities in excess of the amounts reserved.\nITEM 7A.","section_7A":"ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK\nWe are exposed to various interest rate and resins price risks that arise in the normal course of business. We finance our operations with borrowings comprised primarily of variable rate indebtedness. Our raw material costs are comprised primarily of resins. Significant increases in interest rates or the price of resins could adversely affect our operating margins, results of operations and ability to service our indebtedness.\nWe enter into interest rate collar and swap agreements to manage interest rate market risks and commodity collar agreements to manage resin market risks. As of December 31, 1998, we had one interest rate collar agreement and one commodity collar agreement in place. The estimated fair market value of the interest rate collar was negative $214,000 and the estimated fair market value of the commodity collar was $80,000. We have performed a sensitivity analysis assuming a hypothetical 10% adverse movement in interest rates and commodity prices applied to the agreements described above. The analysis indicated that such market movements would not have a material effect on our consolidated financial position, results of operations or cash flows. Factors that could impact the effectiveness of our hedging programs include the volatility of interest rates and commodity markets and the availability of hedging instruments in the future.\nITEM 8.","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and supplementary data required by this Item 8 are set forth at the pages indicated in Item 14(a) below.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nOn April 16, 1998, the Company notified Deloitte & Touche LLP (\"Deloitte & Touche\") that effective as of that date, the Company had determined to change its independent accountants. The Company then engaged the accounting firm of Arthur Andersen LLP to serve as its independent accountants.\nNeither Deloitte & Touche's reports on the Company's financial statements for the years ended December 31, 1996 or December 31, 1997 contained an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles.\nThe decision to change accountants was approved by the Company's Board of Directors. The Company does not have an audit or similar committee.\nDuring the years ended December 31, 1996 and December 31, 1997 and the subsequent interim period preceding the Company's replacement of Deloitte & Touche, there were no disagreements with Deloitte & Touche 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, would have caused Deloitte & Touche 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 REGISTRANT\nThe names, ages, positions and offices held, and a brief account of the educational and business experience of each current director and each executive officer is set forth below.\nBOARD OF DIRECTORS AND EXECUTIVE OFFICERS\n* Jon M. Huntsman is Christena H. Durham's father and Richard P. Durham's father-in-law. Karen H. Huntsman is Jon M. Huntsman's wife, Christena H. Durham's mother and Richard P. Durham's mother-in-law. Richard P. Durham and Christena H. Durham are married. Scott K. Sorensen is Richard P. Durham's brother-in-law.\nJON M. HUNTSMAN is a Director and the Chairman of the Board of Directors of Huntsman Packaging and has served as Chairman of the Board, Chief Executive Officer and a Director of Huntsman Corporation, its predecessors, and other Huntsman companies for over 25 years. He is also the Chairman and founder of the Huntsman Cancer Foundation. In addition, Mr. Huntsman serves on numerous charitable, civic and industry boards. In 1994, Mr. Huntsman received the prestigious Kavaler Award as the chemical industry's outstanding Chief Executive Officer. Mr. Huntsman formerly served as Special Assistant to the President of the United States and as Vice Chairman of the U.S. Chamber of Commerce. Mr. Huntsman served as the Company's Chief Executive Officer until March 1997.\nKAREN H. HUNTSMAN was appointed Vice Chairman of Huntsman Packaging Corporation on November 24, 1997, and serves as an officer and director of other Huntsman companies. The Vice Chairman, an advisory position to the Board of Directors, does not vote on matters brought to the Board. Mrs. Huntsman has served as a Vice President and Director of Huntsman Corporation since 1995 and as a Vice President and director of Huntsman Chemical Corporation since 1982 and 1986, respectively. By appointment of the Governor of the State of Utah, Mrs. Huntsman serves as a member of the Utah State Board of Regents. Mrs. Huntsman also serves on the board of directors of various corporate and non-profit entities, including First Security Corporation and Intermountain Health Care Inc.\nRICHARD P. DURHAM became President and Chief Executive Officer of Huntsman Packaging in March 1997. Mr. Durham is a Director of Huntsman Packaging and also is a Director of Huntsman Corporation. Mr. Durham has been with the Huntsman organization in various positions since 1985. Most recently, Mr. Durham served as Co-President and Chief Financial Officer of Huntsman Corporation, where, in addition to being responsible for accounting, treasury, finance, tax, legal, human resources, public affairs, purchasing, research and development, and information systems, he also was responsible for Huntsman Packaging. Mr. Durham attended Columbia College and graduated from the Wharton School of Business at the University of Pennsylvania.\nCHRISTENA H. DURHAM was appointed a Director of Huntsman Packaging Corporation on October 1, 1997, and became a Vice President on November 24, 1997. Prior to joining the Company, Mrs. Durham held no other officer positions or directorships with any other for-profit organizations. Mrs. Durham also serves on the Board of Directors of various non-profit organizations, including the YWCA of Salt Lake City and as a trustee of the Huntsman Excellence in Education Foundation.\nJACK E. KNOTT became Executive Vice President and Chief Operating Officer of Huntsman Packaging on September 1, 1997. Prior to joining the Company, Mr. Knott was a member of the Board of Directors of Rexene Corporation (from April 1996 until August 1997) and held the position of Executive Vice President of Rexene Corporation and President of Rexene Products (from March 1995 to August 1997). Mr. Knott was Executive Vice President-Sales and Market Development of Rexene Corporation (from March 1992 to March 1995), Executive Vice President of Rexene Corporation (from January 1991 to March 1992) and President of CT Film, a division of Rexene Corporation (from February 1989 to January 1991). Prior to joining Rexene Corporation, Mr. Knott worked for American National Can. Mr. Knott received a B.S. degree in Chemical Engineering and an M.B.A. degree from the University of Wisconsin and holds nine patents.\nSCOTT K. SORENSEN joined Huntsman Packaging as Executive Vice President and Chief Financial Officer on February 1, 1998. Prior to joining the Company, Mr. Sorensen was an executive with Westinghouse Electric Corporation, serving as Chief Financial Officer for both the Communication and Information Systems Division and the Power Generation Division. Prior to joining Westinghouse in 1996, Mr. Sorensen spent two years as Director of Business Development and Planning at Phelps Dodge Industries, a subsidiary of Phelps Dodge Corporation, and over four years as a management consultant with McKinsey & Company. Mr. Sorensen received a B.S. degree in Accounting from the University of Utah and an M.B.A. degree from Harvard Business School.\nRONALD G. MOFFITT joined Huntsman Packaging in 1997, after serving as Vice President and General Counsel of Huntsman Chemical Corporation. Prior to joining Huntsman in 1994, Mr. Moffitt was a partner and a member of the board of directors of the Salt Lake City law firm of Van Cott, Bagley, Cornwall & McCarthy, with which he had been associated since 1981. Mr. Moffitt holds a B.A. degree in Accounting, a Master of Professional Accountancy degree, and a J.D. degree from the University of Utah.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following Summary Compensation Table sets forth information about compensation earned in the fiscal years ended December 31, 1998 and 1997 by the Chief Executive Officer and the three other executive officers (as of the end of the last fiscal year) (collectively, the \"Named Executive Officers\").\nSUMMARY COMPENSATION TABLE\n- -------------- (1) Perquisites and other personnel benefits, securities or property, in the aggregate, are less than either $50,000 or 10% of the total annual salary and bonus reported for the named executive officer.\n(2) Prior to September 30, 1997, the compensation of Richard P. Durham and Ronald G. Moffitt, other than Mr. Durham's directors fees for 1997 (which are described in \"Compensation of Directors,\" and listed in the \"All Other Compensation\" column), was paid entirely by Huntsman Corporation. Huntsman Packaging reimbursed Huntsman Corporation for such compensation for the period beginning October 1, 1997 and ending December 31, 1997. Salary figures for Mr. Durham and Mr. Moffitt represent a prorated portion of Huntsman Corporation compensation attributable to the percentage of executive services that were dedicated to Huntsman Packaging.\n(3) Consists of a $25,000 director's fee from Huntsman Packaging, which is also described in \"Compensation of Directors\" and employer's 401(k) contributions of $9,101.\n(4) Mr. Knott joined the Company on September 1, 1997. His 1997 compensation is reported only for the period he was employed by Huntsman Packaging.\n(5) Consists of employer's 401(k) contributions of $8,840.\n(6) Mr. Sorensen joined the Company on February 1, 1998. His 1998 compensation is reported only for the period he was employed by Huntsman Packaging.\n(7) Consists of employer's 401(k) contributions of $6,832 and moving expenses of $77,235.\n(8) Consists of employer's 401(k) contributions of $5,745.\nSTOCK OPTIONS AND RESTRICTED STOCK\nDuring 1998, the Board of Directors of the Company adopted the 1998 Huntsman Packaging Corporation Stock Option Plan (the \"1998 Plan\"). The 1998 Plan authorizes grants of nonqualified stock options covering up to 41,956 shares of the Company's nonvoting Class C Common Stock. During 1998, options covering a total of 41,956 shares were granted under the 1998 Plan. Options covering 5,244 shares were subsequently canceled. In addition, as described below, outstanding options covering 26,223 shares under the 1998 Plan were canceled on February 22, 1999 in connection with the sale of 26,223 shares to certain members of senior management. Options covering a total of 10,489 shares remain outstanding under the 1998 Plan.\nThe following table provides information related to options to purchase shares of the Company's nonvoting Class C Common Stock granted to the Named Executive Officers during the last fiscal year pursuant to the 1998 Plan. The Company has never granted any freestanding stock appreciation rights.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\n- ----------\n(1) Fair market value on date of grant.\n(2) Subject to earlier termination under certain circumstances.\n(3) Potential realizable value is calculated based on an assumption that the price of the Company's Common Stock appreciates at the annual rates shown (5% and 10%), compounded annually, from the date of grant of the option until the end of the option term. The value is net of the exercise price but is not adjusted for the taxes that would be due upon exercise. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future stock values. Actual gains, if any, upon future exercise of any of these options will depend upon the actual value of the Company's Common Stock.\n(4) All of the options granted to the Named Executive Officers during 1998 are subject to vesting requirements. One-half of the options granted to each Named Executive Officer are time vested options, which vest in equal increments over a five-year period beginning December 31, 1998. The remaining one-half of the options granted to each named Executive Officer are performance vested options, which vest in equal increments over a five-year period beginning December 31, 1998, provided that the Company has achieved a specified market value of equity applicable to such increment. For purposes of the performance vested options, the Company's market value of equity is determined pursuant to a formula based upon the Company's adjusted earnings. The terms of the options provide for partial vesting of the performance vested options if at least 80% of the applicable market value of equity is achieved. The terms of the options also provide for accelerated vesting in the event of a change of control.\nIn addition to the options described above, the Company granted short-term options to facilitate the purchase of nonvoting Class C Common Stock by certain Named Executive Officers during 1998. All of these options expired during 1998. The sale of Class C Common Stock pursuant to these options is further described in Item 5. \"Market for the Registrant's Common Stock and Related Stockholder Matters.\"\nThe following table provides information as to the value of options held by each of the Named Executive Officers at the end of 1998 measured in terms of the fair market value of the Company's nonvoting Class C Common Stock on December 31, 1998 ($100 per share, as determined by the Company). None of the named Executive Officers exercised any options under the 1998 Plan during the last fiscal year.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES\nOn February 22, 1999, 26,223 outstanding options under the 1998 Plan were canceled in connection with the sale of 26,223 shares of Class C Common Stock to certain members of senior management. See Item 5. \"Market For the Registrant's Common Stock and Related Stockholder Matters.\" The 26,223 shares were purchased by certain Named Executive Officers for $100 per share, the estimated fair market value of the shares on the date of purchase, pursuant to the terms of an Option Cancellation and Restricted Stock Purchase Agreement between the Company and certain Named Executive Officers. Mr. Durham purchased 15,734 shares, Mr. Sorensen purchased 7,867 shares and Mr. Moffitt purchased 2,622 shares. All of such shares are subject to vesting requirements similar to the canceled options. Accordingly, one-half of the shares purchased by each Named Executive Officer are time vested shares, which vest in equal increments over a five-year period commencing January 1, 1998, and the remaining one-half of the shares purchased by each Named Executive Officer are performance vested options, which vest in equal increments over a five-year period commencing January 1, 1998, provided that the Company has achieved a specified market value of equity applicable to such increment. For purposes of the performance vested shares, the Company's market value of equity is determined pursuant to a formula based upon the Company's adjusted earnings. The terms of the restricted stock purchase agreements provide for partial vesting of the performance vested shares if more than 80% of the applicable market value of equity is achieved. The restricted stock purchase agreements also provide for accelerated vesting in the event of a change of control.\nPENSION PLANS\nThe following table shows the estimated annual benefits payable under Huntsman Packaging's tax-qualified defined benefit pension plan (the \"Pension Plan\") in specified final average earnings and years of service classifications.\nHUNTSMAN PACKAGING PENSION PLAN TABLE\nThe current Pension Plan benefit is based on the following formula: 1.6% of final average compensation multiplied by years of credited service, minus 1.5% of estimated Social Security benefits multiplied by years of credited service (with a maximum of 50% of Social Security benefits). Final Average Compensation is based on the highest average of three consecutive years of compensation. Covered compensation for purposes of the Pension Plan includes compensation earned with affiliates of the Company. The named executive officers were participants in the Pension Plan in 1998. The Final Average Compensation for purposes of the Pension Plan in 1998 for each of the named executive officers is $160,000, which is the maximum that can be considered for the 1998 plan year under federal regulations. Federal regulations also provide that the maximum annual benefit paid from a qualified defined benefit plan cannot exceed $130,000 as of January 1, 1998. Benefits are calculated on a straight life annuity basis. The benefit amounts under the Pension Plan are offset for Social Security as described above.\nThe number of completed years of credit service as of December 31, 1998 under the Pension Plan for the named executive officers participating in the plan were as follows:\n- -------------- (1) The years of credited service under the Pension Plan includes 12 years of service credited with affiliates of the Company for Mr. Durham, 12 years of service credited with affiliates of the Company for Mr. Knott, and 3 years of service credited with affiliates of the Company for Mr. Moffitt. The benefit calculation upon retirement under the Pension Plan is made using all credited service but the benefit is then multiplied by a fraction representing that part of total credited service represented by service for the Company.\nEMPLOYMENT AGREEMENTS\nThe Company has entered into an employment agreement with Jack E. Knott, effective September 1, 1997. The employment agreement provides that Mr. Knott shall be employed as the Executive Vice President and Chief Operating Officer of the Company for an initial term of two years. Thereafter, Mr. Knott will be employed under the employment agreement for 12-month renewal terms unless either party provides notice of non-renewal. The employment agreement establishes Mr. Knott's base salary and sets forth his right to receive a performance bonus and certain other benefits. The employment agreement also contains certain restrictions on Mr. Knott, including restrictions with respect to confidential information, non-competition and non-solicitation of employees.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Board of Directors of the Company has designated the Executive Committee, which is comprised of Jon M. Huntsman and Richard P. Durham, to perform the duties of a compensation committee for the Company. Richard P. Durham is the President and Chief Executive Officer of the Company and Jon M. Huntsman is the Chairman of the Board of Directors of the Company.\nRichard P. Durham serves as a director of Huntsman Corporation, but is not one of the people who performs the duties of a compensation committee of the Board of Directors of Huntsman Corporation.\nOn August 7, 1998, Huntsman Packaging made an offer to the Board of Directors of Applied Extrusion Technologies, Inc. (\"AET\"), a publicly traded company, to purchase all of the outstanding shares of common stock of AET at $10.50 per share in a merger transaction. AET's Board rejected the offer. On September 10, 1998, the Company made another offer to the Board of Directors of AET to purchase all of the outstanding shares of common stock of AET at $12.50 per share in a merger transaction. On September 14, 1998, HPC Investment, Inc., a wholly-owned subsidiary of Huntsman Packaging, purchased shares of the common stock of AET from Richard P. Durham, President and Chief Executive Officer of Huntsman Packaging, for an aggregate purchase price of $3.3 million, in an arms-length transaction approved by the Board of Directors of HPC Investment, Inc. AET's Board of Directors subsequently rejected Huntsman Packaging's second offer.\nCOMPENSATION OF DIRECTORS\nEach director receives an annual fee of $25,000.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSet forth below is certain information as of March 26, 1999 with respect to the beneficial ownership of shares of Common Stock by (i) each director of the Company, (ii) each of the Named Executive Officers and (iii) all directors and executive officers as a group.\n- --------\n* Less than 1%.\n(1) Unless otherwise indicated in these footnotes, the mailing address of each beneficial owner listed is 500 Huntsman Way, Salt Lake City, Utah 84108.\n(2) Except as otherwise indicated in these footnotes, each of the beneficial owners listed has, to the knowledge of the Company, sole voting and investment power with respect to the indicated shares of Common Stock.\n(3) The Company has three classes of Common Stock outstanding: Class A, Class B and Class C. The percentages in the table marked \"total\" have been calculated based upon the total outstanding shares of Common Stock as if all of the outstanding shares were part of a single class. The Class A Common Stock, the Class B Common Stock and the Class C Common Stock have identical rights, except with respect to voting. The Class A shareholders are entitled to elect one of the Company's three directors and the Class B shareholders are entitled to elect the remaining two of the Company's three directors. The Class C shareholders do not have voting rights, except as required by the Utah Revised Business Corporation Act.\n(4) Includes 15,734 shares of Class C Common Stock subject to time and performance vesting requirements.\n(5) 345,001 shares of Class A Common Stock and 4,999 shares of Class B Common Stock are held by The Christena Karen H. Durham Trust for the benefit of Christena H. Durham. Richard P. Durham and Ronald G. Moffitt, as trustees of The Christena Karen H. Durham Trust, share voting power with respect to such shares.\n(6) Includes 1,049 shares of Class C Common Stock subject to options that are exercisable or become exercisable within 60 days of March 26, 1999.\n(7) Includes 7,867 shares of Class C Common Stock subject to time and performance vesting requirements.\n(8) Includes 2,622 shares of Class C Common Stock subject to time and performance vesting requirements.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe principal executive offices of Huntsman Packaging are leased from Huntsman Headquarters Corporation, an indirect wholly-owned subsidiary of Huntsman Corporation. Huntsman Packaging is obligated to pay rent calculated as a pro-rata portion (based on its percentage occupancy) of the mortgage principal and interest payments on the headquarters facility.\nHuntsman Packaging is a party to agreements with certain affiliates of Huntsman Corporation, including but not limited to, Huntsman Polymers Corporation, for the purchase of various resins. All such agreements provide for the purchase of materials or services at prevailing market prices.\nHuntsman Packaging obtains some of its insurance coverage under policies of Huntsman Corporation. Huntsman Packaging is party to an agreement with Huntsman Corporation that provides for reimbursement of insurance premiums paid by Huntsman Corporation on behalf of Huntsman Packaging. The reimbursement payments are based on premium allocations which are determined in cooperation with Huntsman Corporation's independent insurance broker.\nHuntsman Packaging is a party to a services agreement dated as of January 1, 1999 with Huntsman Corporation covering the provision of certain administrative services. These services are provided to Huntsman Packaging at prices that would be payable to an unaffiliated third party.\nDuring 1998, the Company paid a management fee in the amount of $133,333 to Huntsman Financial Corporation, a subsidiary of Huntsman Corporation, for consulting services provided to the Company by Jon M. Huntsman.\nIn connection with the Split-Off, Huntsman Packaging issued 7,000 shares of its common stock to Richard P. Durham, President and Chief Executive Officer and a director of Huntsman Packaging, in exchange for a $700,000 note receivable. Such note bears interest at 7% per annum and is payable over approximately 51 months. As of December 31, 1998, the outstanding balance on this note receivable was $434,000.\nOn August 7, 1998, Huntsman Packaging made an offer to the Board of Directors of Applied Extrusion Technologies, Inc. (\"AET\"), a publicly traded company, to purchase all of the outstanding shares of common stock of AET at $10.50 per share in a merger transaction. AET's Board rejected the offer. On September 10, 1998, the Company made another offer to the Board of Directors of AET to purchase all of the outstanding shares of common stock of AET at $12.50 per share in a merger transaction. On September 14, 1998, HPC Investment, Inc., a wholly-owned subsidiary of Huntsman Packaging, purchased shares of the common stock of AET from Richard P. Durham, President and Chief Executive Officer of Huntsman Packaging, for an aggregate purchase price of $3.3 million, in an arms-length transaction approved by the Board of Directors of HPC Investment, Inc. AET's Board of Directors subsequently rejected Huntsman Packaging's second offer.\nOn February 22, 1999, the Company sold 26,223 shares of Class C Common Stock to certain members of senior management. 15,734 shares were issued to Richard P. Durham, President and Chief Executive Officer and a director of Huntsman Packaging, in exchange for a $1,573,400 note receivable; 7,867 shares were issued to Scott K. Sorensen, Executive Vice President, Chief Financial Officer and Treasurer of Huntsman Packaging, in exchange for a $786,700 note receivable; and 2,622 shares were issued to Ronald G. Moffitt, Senior Vice President, General Counsel and Secretary of Huntsman Packaging, in exchange for a $262,200 note receivable. All of such notes bear interest at 7% per annum and are payable in three annual installments beginning in February 2002.\nDuring 1998, the Company made a $500,000 charitable contribution to the Huntsman Cancer Institute, a public charity. Jon M. Huntsman, Chairman of the Board of Directors of the Company, and Richard P. Durham, President and Chief Executive Officer of the Company, serve on the Board of Trustees of the Huntsman Cancer Institute.\nSee Note 15 to the Consolidated Financial Statements included in this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(3) The following exhibits are filed herewith or incorporated by reference:\nExhibit Number Exhibit\n3.1 Second Amended and Restated Articles of Incorporation of Huntsman Packaging (incorporated by reference to Exhibit 3.1 to Huntsman Packaging's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).\n3.2 Amended and Restated Bylaws of Huntsman Packaging (incorporated by reference to Exhibit 3.2 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n4.1 Indenture, dated as of September 30, 1997, between Huntsman Packaging, the Guarantors and The Bank of New York (incorporated by reference to Exhibit 4.1 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n4.2 Supplemental Indenture No. 1 to Indenture dated as of September 30, 1997, between Huntsman Packaging, the Guarantors and the Bank of New York (incorporated by reference to Exhibit 4.1 to Huntsman Packaging's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).\n4.3 Supplemental Indenture No. 2 to Indenture dated as of September 30, 1997, between Huntsman Packaging, the Guarantors and the Bank of New York (incorporated by reference to Exhibit 4.2 to Huntsman Packaging's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).\n4.4 Form of Exchange Notes (incorporated by reference to Exhibit A-2 to Exhibit 4.1)).\n4.5 Registration Rights Agreement, dated as of September 19, 1997, by and among Huntsman Packaging, BT Alex. Brown Incorporated and Chase Securities Inc. (incorporated by reference to Exhibit 4.3 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.1 Exchange Agreement, dated as of September 26, 1997 by and among Huntsman Corporation and Jon M. Huntsman, Richard P. Durham and Elizabeth Whitsett, as Trustees of the Christena Karen H. Durham Trust (incorporated by reference to Exhibit 10.1 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.2 First Amended Asset Purchase Agreement, dated as of September 26, 1997, between Huntsman Packaging and Huntsman Polymers Corporation (incorporated by reference to Exhibit 10.2 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.3 Amended and Restated Credit Agreement, dated as of May 14, 1998, among Huntsman Packaging, the various lenders party thereto (the \"Lenders\") and The Chase Manhattan Bank, as Administrative Agent for the Lenders (incorporated by reference to Exhibit 10.1 to Huntsman Packaging's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).\n10.4 Guarantee Agreement, dated September 30, 1997, among the subsidiaries of Huntsman Packaging and The Chase Manhattan Bank, as Administrative Agent for the Lenders (incorporated by reference to Exhibit 10.4 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.5 Security Agreement, dated as of September 30, 1997, among Huntsman Packaging, each subsidiary of Huntsman Packaging party thereto and The Chase Manhattan Bank, as Collateral Agent for the Secured Parties (incorporated by reference to Exhibit 10.5 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.6 Pledge Agreement, dated September 30, 1997, among Huntsman Packaging, each subsidiary of Huntsman Packaging party thereto and The Chase Manhattan Bank, as Collateral Agent for the Secured Parties (incorporated by reference to Exhibit 10.6 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.7 Indemnity, Subrogation and Contribution Agreement, dated September 30, 1997, among Huntsman Packaging, each subsidiary of Huntsman Packaging party thereto and The Chase Manhattan Bank, as Collateral Agent for the Secured Parties (incorporated by reference to Exhibit 10.7 to Huntsman Packaging's registration statement on Form S-4 (File No. 333-40067)).\n10.8 Form of Option Cancellation and Restricted Stock Purchase Agreement *(1)\n10.9 Employment Agreement between Huntsman Packaging and Jack E. Knott *(1)\n10.10 1998 Huntsman Packaging Corporation Stock Option Plan.*(1)\n21 Subsidiaries of Huntsman Packaging.*\n27 Financial Data Schedule.*\n* Filed with this report.\n(1) Management contract or compensatory plan or arrangement required to be filed as an exhibit hereto.\n(b) Reports on Form 8-K\nNot Applicable.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 26, 1999.\nHUNTSMAN PACKAGING CORPORATION\nBy \/s\/ Richard P. Durham ---------------------------------------------------- Richard P. Durham, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 26, 1999 by the following persons on behalf of the Registrant and in the capacities indicated.\nBy \/s\/ Jon M. Huntsman ---------------------------------------------------- Jon M. Huntsman, Director and Chairman of the Board of Directors\nBy \/s\/ Richard P. Durham ---------------------------------------------------- Richard P. Durham, Director, President and Chief Executive Officer (Principal Executive Officer)\nBy \/s\/ Christena H. Durham ---------------------------------------------------- Christena H. Durham, Director\nBy \/s\/ Scott K. Sorensen ---------------------------------------------------- Scott K. Sorensen, Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE II\nREPORT OF MANAGEMENT\nHuntsman Packaging's management has prepared the accompanying financial statements and related notes in conformity with generally accepted accounting principles. In so doing, management makes informed judgments and estimates of the expected effects of events and transactions. Financial data appearing elsewhere in this report are consistent with these financial statements.\nHuntsman Packaging maintains a system of internal controls to provide reasonable, but not absolute, assurance of the reliability of the financial records and the protection of assets. The internal control system is supported by policies and procedures, careful selection and training of qualified personnel, and, beginning in 1999, a formal internal audit program.\nThe accompanying financial statements have been audited by Arthur Andersen LLP and Deloitte & Touche LLP, independent public accountants, for the specified periods as indicated in their reports. Their audits were made in accordance with generally accepted auditing standards. They considered Huntsman Packaging's internal control structure only to the extent necessary to determine the scope of their audit procedures for the purpose of rendering an opinion on the financial statements.\nMembers of the Board of Directors meet with management, the internal auditors and the independent public accountants to review accounting, auditing and financial reporting matters. Subject to stockholder approval, the independent public accountants are appointed by the Board of Directors.\nRichard P. Durham Scott K. Sorensen President and Chief Executive Officer Executive Vice President and Chief Financial Officer\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Huntsman Packaging Corporation:\nWe have audited the accompanying consolidated balance sheet of Huntsman Packaging Corporation and subsidiaries as of December 31, 1998, and the related consolidated statements of income, 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 consolidated financial position of Huntsman Packaging Corporation and subsidiaries as of December 31, 1998, 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 presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. Schedule II for the year ended December 31, 1998 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 February 12, 1999, except with respect to the matters discussed in the second and last paragraphs of Note 10 as to which the date is March 26, 1999\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Huntsman Packaging Corporation and Subsidiaries:\nWe have audited the accompanying consolidated balance sheet of Huntsman Packaging Corporation and subsidiaries as of December 31, 1997, and the consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1997. These financial 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 Huntsman Packaging Corporation and subsidiaries at December 31, 1997, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.\nOur audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. Supplemental Schedule II - Valuation and Qualifying Accounts is presented for the purpose of additional analysis and is not a required part of the basic financial statements. This supplemental schedule is the responsibility of the Company's management. Such 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.\nDELOITTE & TOUCHE LLP\nSalt Lake City, Utah February 11, 1998\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 (DOLLARS IN THOUSANDS) - --------------------------------------------------------------------------------\n(Continued)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 (DOLLARS IN THOUSANDS) - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS) - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS) - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS) - --------------------------------------------------------------------------------\n(Continued)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS) - --------------------------------------------------------------------------------\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:\nOn August 1, 1996, we purchased all of the outstanding capital stock of United Films Corporation for approximately $12,276. As part of the acquisition, liabilities assumed were as follows:\n(Continued)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS) - --------------------------------------------------------------------------------\nOn October 21, 1996, we purchased all of the outstanding capital stock of Deerfield Plastics, Inc. for approximately $68,207. As part of the acquisition, liabilities assumed were as follows:\nOn September 30, 1997, we purchased all of the assets of CT Film (a division of Huntsman Polymers Corporation, formerly Rexene Corporation) and Rexene Corporation Limited (a wholly-owned subsidiary of Huntsman Polymers Corporation) for cash of approximately $70,000. As part of the acquisition, liabilities assumed were as follows:\nOn March 12, 1998, we acquired certain assets and assumed certain liabilities of Ellehammer Industries, Ltd. and Ellehammer Packaging, Inc. for cash of approximately $7,900. As part of the acquisition, liabilities assumed were as follows:\nOn May 19, 1998, we purchased all of the outstanding capital stock of Blessings Corporation for cash of approximately $213,000. As part of the acquisition, liabilities assumed were as follows:\nSee notes to consolidated financial statements.\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nHuntsman Packaging Corporation and its subsidiaries (collectively \"Huntsman Packaging\") produce plastic films and printed plastic films and bags. Our manufacturing facilities are located in North America, Germany and Australia.\nRECAPITALIZATION - Prior to September 30, 1997, Huntsman Packaging was a wholly-owned subsidiary of Huntsman Corporation (\"HC\"). On September 30, 1997, Huntsman Packaging was recapitalized by authorizing two new classes of common stock, Class A Common and Class B Common. The 1,000 shares of previously issued and outstanding common stock were canceled.\nOn September 30, 1997, Huntsman Packaging was separated from HC in a tax free transaction under Section 355 of the Internal Revenue Code (the \"Split-Off\") when Jon M. Huntsman and The Christena Karen H. Durham Trust exchanged shares of HC common stock for shares of Huntsman Packaging's newly authorized common stock. Additionally, Richard P. Durham purchased shares of Huntsman Packaging's newly authorized common stock in exchange for a note receivable.\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Huntsman Packaging and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nUSE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS - The preparation of financial statements in conformity with generally accepted accounting principles requires us 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 - Sales revenue is recognized upon shipment of product in fulfillment of a customer order.\nCARRYING VALUE OF LONG-LIVED ASSETS - We evaluate the carrying value of long-lived assets, including intangible assets, based upon current and expected undiscounted cash flows, and recognize an impairment when the estimated cash flows are less than the carrying value of the asset. Measurement of the amount of impairment, if any, is based upon the difference between the asset's carrying value and fair value.\nINVENTORIES - Inventories consist principally of finished film products and the raw materials necessary to produce them. Inventories are carried at the lower of cost (on a first-in, first-out basis) or market value.\nPLANT AND EQUIPMENT - Plant and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated economic useful lives of the assets as follows:\nINTANGIBLE ASSETS - Intangible assets are stated at cost. Amortization is computed using the straight-line method over the estimated economic useful lives of the assets as follows:\nOTHER ASSETS - Other assets consist primarily of deferred debt issuance costs, deposits, spare parts, and the cash surrender values of life insurance policies.\nCASH AND CASH EQUIVALENTS - For the purpose of the consolidated statements of cash flows, we consider cash in checking accounts and in short-term highly liquid investments with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalents generated outside of the United States are generally subject to taxation if repatriated.\nINCOME TAXES - We use the asset and liability method of accounting for income taxes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Subsequent to the Split-Off, we file our own consolidated income tax returns. Prior to the Split-Off, our operations were included in the consolidated U.S. income tax returns of HC. The intercompany tax allocation policy provided for each subsidiary to calculate its own provision on a \"separate return basis.\"\nDERIVATIVE FINANCIAL INSTRUMENTS - We enter into interest rate collar and swap agreements to manage interest rate risk on long-term debt. These agreements are classified as hedges for matched transactions. The differential to be paid or received as interest rates change is accrued and recognized as an adjustment to interest expense. The related amount payable to or receivable from the counterparties is included in other liabilities or assets. Gains and losses on terminations of interest-rate swap agreements are deferred and amortized as an adjustment to interest expense over the lesser of the remaining term of the original contract or the life of the debt. We also enter into commodity collar agreements to manage the market risk of our raw material prices. These agreements are classified as hedges. The differential to be paid or received as commodity prices change is accrued and recognized as an adjustment to inventory. The related amount payable to or receivable from the counterparties is included in other liabilities or assets.\nFOREIGN CURRENCY TRANSLATION - The accounts of our foreign subsidiaries are translated into U.S. Dollars using the exchange rate at each balance sheet date for assets and liabilities and a weighted average exchange rate for each period for revenues, expenses, gains and losses. Transactions are translated using the exchange rate at each transaction date. Where the local currency is the functional currency, translation adjustments are recorded as a separate component of stockholders' equity. Where the U.S. Dollar is the functional currency, translation adjustments are recorded in other income within current operations.\nRECENT ACCOUNTING PRONOUNCEMENT - In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, \"Accounting for Derivative Instruments and Hedging Activities.\" SFAS No. 133\nestablishes accounting and reporting standards that require derivative instruments to be recorded on the balance sheet as either an asset or liability, measured at fair market value, and that changes in the derivative's fair value be recognized currently in earnings, unless specific hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. We expect that the adoption of this statement will not have a material effect on our consolidated financial statements.\n2. INVENTORIES\nInventory Balances - Inventories consist of the following at December 31, 1998 and 1997 (in thousands):\nCOMMODITY COLLAR TERMS - In 1998, we entered into a commodity collar agreement to manage the market risk of one of our major raw materials. The collar agreement entitles us to receive from the counterparty (a major risk management company) the amounts, if any, by which the published market price, as defined in the agreement, of low density polyethylene (\"LDPE\") exceeds $0.35 per pound. The collar agreement requires us to pay the counterparty the amounts, if any, by which the published market price of LDPE is below $0.295 per pound. As of December 31, 1998, the defined published market price for LDPE was $0.30 per pound.\nThere was no premium paid for the collar agreement.\nWe are exposed to credit losses in the event of nonperformance by the counterparty to the agreement. We anticipate, however, that the counterparty will be able to fully satisfy its obligations under the contract. Market risk arises from changes in commodity prices.\nAs of December 31, 1998, the terms of the outstanding LDPE commodity collar agreement are as follows:\n3 SALE OF ASSETS\nOn June 1, 1998, Huntsman Container Corporation International (\"HCCI\"), a wholly-owned subsidiary of Huntsman Packaging, sold its entire interest in the capital stock of Huntsman Container Company Limited (\"HCCL\") and Huntsman Container Company France SA (\"HCCFSA\") to Polarcup Limited and Huhtamake Holdings France Sarl, subsidiaries of Huhtamaki Oyj. Together, HCCL and HCCFSA comprised our foam products operations, which were operated exclusively in Europe. Net proceeds from the sale were approximately $28.3 million and resulted in a gain of approximately $5.2 million, net of applicable income taxes. The financial position and results of operations of this separate business segment are reflected as discontinued operations in the accompanying consolidated financial statements for all years presented. Revenues from the foam products operations for the years ended December 31, 1998, 1997 and 1996 amounted to $15.6 million, $43.4 million and $43.5 million, respectively.\nAs part of our acquisition of the CT Film Division of Huntsman Polymers (see Note 12), we acquired Huntsman Packaging UK Limited (\"HPUK\"). HPUK owned CT Film's Scunthorpe, UK facility, which manufactured and sold polyethylene film exclusively in Europe. At the time of the CT Film acquisition, we announced our intention to close or sell the Scunthorpe, UK facility. During 1998, we adjusted our preliminary estimate of the fair value of the Scunthorpe, UK facility assets acquired, resulting in an increase of $2.9 million to the associated goodwill recorded. On August 14, 1998, we sold our interest in the capital stock of HPUK to Skymark Packaging International Limited. Net proceeds from the sale were approximately $5.6 million, including a note receivable from the buyer. The note receivable balance was approximately $1.3 million at December 31, 1998.\n4. PLANT CLOSING COSTS\nAs part of our recent acquisitions (see Note 12), we developed a plan to close some of our less efficient production facilities and use available capacity at more efficient facilities. During 1998, we announced our plan to cease operations at our Clearfield, Utah facility. Included in 1998 operating expenses is a $4.9 million charge, comprised of a $0.4 million provision for the write-off of impaired goodwill, a $0.6 million provision for the write-down of impaired plant equipment associated with the facility, a $0.5 million charge for reduction of work force costs associated with the elimination of approximately 52 full-time equivalent employees, and an accrual of $3.4 million for estimated future net lease and other costs incurred to close the facility.\nDuring 1997, we announced the cessation of operations at our Carrollton, Ohio facility and our intention to relocate certain assets from that facility to other of our facilities. Included in 1997 operating expenses is a $9.3 million charge, comprised of a $3.3 million provision for the write-off of impaired goodwill, a $4.2 million provision for the write-down of impaired plant equipment associated with the facility, a $1.6 million charge for reduction in work force costs associated with the elimination of approximately 83 full-time equivalent employees, and an accrual of $0.2 million of other costs related to the closure of the facility.\nDuring 1996, we decided to cease operations at our Dallas, Texas and Bowling Green, Kentucky facilities. Included in 1996 operating expenses is a $10.9 million charge, comprised of a $3.3 million charge for the write-off of impaired goodwill, a $5.3 million provision for the write-down of impaired plant equipment associated with the two operations, a $1.1 million charge for reduction in work force costs associated with the elimination of approximately 81 full-time equivalent employees, and an accrual of $1.2 million of other costs related to the closure of the facilities.\nAs of December 31, 1998, all previously announced plant closings were complete and no additional plant closing costs are anticipated for these closed facilities. As of December 31, 1998, the plant closing accrual balance included in accrued liabilities is $2.6 million and relates entirely to the Clearfield, Utah facility closure.\n5. INTANGIBLE ASSETS\nThe cost of intangible assets and accumulated amortization at December 31, 1998 and 1997 is as follows (in thousands):\nAmortization expense for intangible assets was approximately $6.1 million, $3.1 million and $1.6 million for the years ended December 31, 1998, 1997 and 1996, respectively.\n6. LONG-TERM DEBT\nLong-term debt as of December 31, 1998 and 1997 consists of the following (in thousands):\nOn September 30, 1997, we entered into a $225 million credit facility (the \"Credit Agreement\") with various banks. On May 14, 1998, the Credit Agreement was amended and restated as a $510 million facility (the \"Amended Credit Agreement\"). The Amended Credit Agreement provides for the continuation of a previous term loan (the \"Original Term Loan\") in the principal amount of $75 million, maturing on September 30, 2005; a Tranche A Term Loan (the \"Tranche A Term Loan\") in the principal amount of $140 million, maturing on September 30, 2005; a Tranche B Term Loan (the \"Tranche B Term Loan\") in the principal amount of $100 million, maturing on June 30, 2006; and a term loan (the \"Mexico\nTerm Loan\") to ASPEN Industrial, S.A., our wholly-owned Mexican subsidiary, in the principal amount of $45 million, maturing on September 30, 2005. The Amended Credit Agreement also provides for a $150 million revolving loan facility (the \"Revolver\") maturing on September 30, 2004. The Original Term Loan, the Tranche A Term Loan and the Mexico Term Loan amortize at an increasing rate on a quarterly basis. The Tranche A Term Loan and the Mexico Term Loan began amortizing on December 31, 1998 and the Original Term Loan begins amortizing December 31, 2001. The Tranche B Term Loan amortizes at the rate of $1 million per year, beginning September 30, 1998, with an aggregate of $93 million due in the last four quarterly installments. The term loans described above are required to be prepaid with the proceeds of certain asset sales, with 50% of the proceeds of the sale of certain Huntsman Packaging equity securities, and with the proceeds of certain debt offerings.\nLoans under the Amended Credit Agreement bear interest at our election, at either (1) zero to 0.75%, depending on certain of our financial ratios, plus the higher of (a) the agent bank's prime rate, (b) the federal funds rate plus 0.50% or (c) the agent bank's base CD rate plus 1%; or (2) the London Interbank Offered Rate plus 1% to 2%, also depending on certain of our financial ratios.\nWe pay a quarterly commitment fee on the unused amount of the Revolver at an annual rate commencing at 0.50%. The interest rate margins and the commitment fee are subject to reduction if we achieve certain ratios. As of December 31, 1998, we had outstanding letters of credit of approximately $4.2 million.\nObligations under the Amended Credit Agreement are guaranteed by the assets of all of our domestic subsidiaries. The Amended Credit Agreement does not permit cash dividends and contains covenants customary for transactions of this type, including restrictions on indebtedness, liens, asset sales, capital expenditures, acquisitions, investments, transactions with affiliates, and other restricted payments. The Amended Credit Agreement also contains financial covenants, including a ratio of maximum total debt to EBITDA, a minimum interest coverage ratio, and minimum net worth.\nAlso on September 30, 1997, we issued $125 million of 9.125% unsecured senior subordinated notes which mature on October 1, 2007 (the \"Notes\"). Interest on the Notes is payable semi-annually on each April 1 and October 1, commencing April 1, 1998. The Notes are guaranteed by our domestic subsidiaries (see Note 16). The Notes are redeemable, at our option, in whole at any time or in part from time to time, on or after October 1, 2002, at redemption prices decreasing from 104.563% to 100% of the outstanding principal balance after October 2005. Additionally, up to 35% of the Notes may be redeemed prior to October 1, 2000, with the proceeds of one or more equity offerings at a price equal to 109.125% of the principal amount. The Notes are subject to certain covenants customary to this type of transaction, including restrictions on the incurrence of additional indebtedness, certain restricted payments, asset sales, dividend and other payment restrictions affecting subsidiaries, liens, mergers, and transactions with affiliates.\nAs of December 31, 1998, we were in compliance with the covenants of the Amended Credit Agreement and the Notes.\nThe proceeds of the Credit Agreement and the Notes were used to repay indebtedness to HC at the time of the Split-Off and to purchase CT Film. The proceeds of the Amended Credit Agreement were used to purchase the stock of Blessings Corporation (see Notes 1 and 12).\nOn January 29, 1996, we wrote-off approximately $2.1 million of previously deferred loan costs, which were recorded, net of the applicable income tax benefit of approximately $0.8 million, as an extraordinary item in the accompanying 1996 consolidated income statement.\nThe scheduled maturities of long-term debt by year as of December 31, 1998 are as follows (in thousands):\nIn 1997, we purchased an interest rate collar agreement to reduce the impact of changes in interest rates on our floating-rate long-term debt. The collar agreement entitles us to receive amounts from the counterparty (a major bank) if the three-month LIBOR interest rate, as defined in the agreement, exceeds 6.25%. The collar agreement requires us to pay amounts to the counterparty if the three-month LIBOR interest rate is less than 5.25%. As of December 31, 1998, the defined three-month LIBOR interest rate was 5.06%.\nThe net premium paid for the collar agreement purchased is included in other assets in the consolidated balance sheets and is amortized to interest expense over the term of the agreement. Amounts receivable or payable under the agreement are recognized as yield adjustments over the life of the related debt.\nWe are exposed to credit losses in the event of nonperformance by the counterparty to the financial instrument. We anticipate, however, that the counterparty will be able to fully satisfy its obligations under the contract. Market risk arises from changes in interest rates.\nAs of December 31, 1998, we had one outstanding interest rate collar agreement. The terms of the agreement are as follows:\nIn 1997, we also entered into a series of interest rate swap agreements to hedge the interest rate exposure in anticipation of issuing the Notes. The agreements were accounted for as hedges and were subsequently terminated. Termination costs of approximately $1.2 million are being amortized to interest expense over the life of the Notes.\n7. LEASES\nCAPITAL LEASES - We have acquired certain land, building, machinery and equipment under capital lease arrangements that expire at various dates through 2007. At December 31, 1998 and 1997, the gross amounts of plant and equipment and related accumulated amortization recorded under capital leases were as follows (in thousands):\nOPERATING LEASES - We also have several noncancelable operating leases, primarily for vehicles, equipment, warehouse, and office space that expire through 2006, as well as month-to-month leases. The total expense recorded under all operating lease agreements in the accompanying consolidated income statements is approximately $5.8 million, $2.9 million and $2.3 million for the years ended December 31, 1998, 1997 and 1996, respectively.\nFuture minimum lease payments under operating leases and the present value of future minimum capital lease payments as of December 31, 1998 are as follows (in thousands):\n8. INCOME TAXES\nThe following is a summary of domestic and foreign provisions for current and deferred income taxes and a reconciliation of the U.S. statutory income tax rate to the effective income tax rate.\nThe provision (benefit) for income taxes for the years ended December 31, 1998, 1997 and 1996 is as follows (in thousands):\nThe effective income tax rate reconciliations for the years ended December 31, 1998, 1997 and 1996 are as follows (in thousands):\nComponents of net deferred income tax assets and liabilities as of December 31, 1998 and 1997 are as follows (in thousands):\n9. EMPLOYEE BENEFIT PLANS\nDEFINED CONTRIBUTION PLAN - We sponsor a salary deferral plan covering substantially all of our non-union domestic employees. Plan participants may elect to make voluntary contributions to this plan up to 15% of their compensation. We contribute 1% of the participants' compensation and also match employee contributions up to 2% of the participants' compensation. We expensed approximately $5.0 million, $3.1 million and $0.9 million as our contribution to this plan for the years ended December 31, 1998, 1997 and 1996, respectively.\nDEFINED BENEFIT PLANS - We sponsor five noncontributory defined benefit pension plans (the \"United States Plans\") covering domestic employees with 1,000 or more hours of service. We fund the actuarially computed retirement cost. Contributions are intended to not only provide for benefits attributed to service to date but also for those expected to be earned in the future. We also sponsor a defined benefit plan in Germany (the \"Germany Plan\"). The consolidated accrued net pension expense for the years ended December 31, 1998, 1997 and 1996 includes the following components (in thousands):\nThe following table sets forth the funded status of the United States Plans and the Germany Plan as of December 31, 1998 and 1997 and the amounts recognized in the consolidated balance sheets at those dates (in thousands):\nFor the above calculations, increases in future compensation ranging from 4.0% through 5.0% were used for the non-union plans. There was no increase in future compensation used for the three union plans. For the calculations, discount rates ranging from 6.75% through 7.00% and expected rates of return on plan assets ranging from 9.0% through 10.0% were used for all plans.\nIncreases in future compensation ranging from 2.5% through 3.5% and discount rates ranging from 6.5% through 7.0% were used in determining the actuarially computed present value of the projected benefit obligation of the Germany Plan. The cash surrender value of life insurance policies for Germany Plan participants included in other assets is approximately $0.7 million and $0.5 million as of December 31, 1998 and 1997, respectively.\nFOREIGN PLANS OTHER THAN GERMANY - Employees in other foreign countries are covered by various post employment arrangements consistent with local practices and regulations. Such obligations are not significant and are included in the consolidated financial statements in other liabilities.\nOTHER PLANS - As part of the acquisition of Blessings Corporation (see Note 12), we assumed two supplemental retirement plans covering certain former employees of Blessings Corporation. The liability for these plans included in other liabilities at December 31, 1998 was approximately $2.1 million.\n10. STOCK PURCHASE AGREEMENTS AND STOCK OPTION PLAN\nSTOCK PURCHASE AGREEMENTS - During 1998, our shareholders approved stock purchase agreements for the purchase of 12,200 shares of Class C nonvoting common stock by certain officers and a director. The fair market value purchase price was determined by the Board of Directors to be $100 per share. A shareholders agreement governing the shares contains various restrictions, including a right of first refusal and provisions for Huntsman Packaging to purchase any owned shares from an employee within 180 days after termination of employment. The purchasers have the right, following three years from the purchase date, to put any or all shares to Huntsman Packaging for repurchase. The redemption value is based on the following: (1) when there is a public market for the shares, the average of the high and low reported sale prices per share for the 20 trading days prior to the date the put option or our purchase option is exercised; or (2) when there is no public market for the shares, a share price based on a market value of equity, as defined, determined on the last day of the month in which the redemption occurs. During 1998, we redeemed 500 shares of Class C common stock for $100 per share from one officer who terminated his employment with us.\nSubsequent to December 31, 1998, we sold an additional 12,188 shares of Class C common stock to certain officers for $100 per share, the estimated fair market value of the shares on the date of purchase. We redeemed an additional 600 shares of Class C common stock for $100 per share from another officer. The additional 12,188 shares of Class C common stock are subject to the same terms and restrictions as the original 12,200 shares of Class C common stock.\n1998 STOCK OPTION PLAN - During 1998, our shareholders approved the adoption of the Huntsman Packaging Corporation 1998 Stock Option Plan, which provides for the granting of options to purchase up to 41,956 shares of Class C nonvoting common stock to certain officers and directors. The exercise price of the options is $100 per share, which was determined by the Board of Directors to be the fair market value of the related stock on the date of grant. Of these options, 20,978 vest in five equal annual installments beginning December 31, 1998. The remaining 20,978 vest over the same period, subject to the achievement of certain financial performance criteria. All of the options issued under this plan expire on December 31, 2007.\nA summary of stock options outstanding at December 31, 1998 and changes during the year then ended is presented below:\nAt December 31, 1998, 19,667 of the outstanding options are performance-based options and none are exercisable. Of the remaining 19,667 options, 3,933 are exercisable. All outstanding options have a weighted average remaining contractual life of approximately 9 years.\nACCOUNTING FOR STOCK-BASED COMPENSATION PLANS - We apply Accounting Principles Board Opinion No. 25 and related interpretations in accounting for stock-based compensation plans as they relate to employees and directors. No compensation expense has been recognized during 1998 for the stock option grants or shares purchased because the awards were at the estimated fair market value of Huntsman Packaging's Class C nonvoting common stock at the date of grant. Had compensation cost been determined in accordance with SFAS No. 123, \"Accounting for Stock-Based Compensation,\" our income from continuing operations for the year ended December 31, 1998 would have decreased to the pro forma amount presented below:\nThe Black-Scholes option-pricing model was used to calculate the weighted average fair market value of options using the following assumptions for grants: dividend yield of 0%, average risk free interest rate of 6.75% and expected life of 10 years. The weighted average fair market value of options granted under our 1998 Stock Option Plan during 1998 was estimated to be approximately $49. The estimated fair market value of the options granted is subject to the assumptions made and if the assumptions were to change, the estimated fair market value amounts could be significantly different.\nSUBSEQUENT CANCELLATION OF STOCK OPTIONS - On February 22, 1999, we entered into Option Cancellation and Restricted Stock Purchase Agreements with the holders of 26,223 options to purchase Class C common stock. Under the agreements, options to purchase 26,223 shares of Class C common stock were cancelled and 26,223 shares of Class C common stock were sold to the former option holders for $100 per share, the estimated fair market value of the shares on the date of purchase. The purchase price for the shares was payable by delivery of promissory notes to Huntsman Packaging. The 26,223 shares purchased are subject to repurchase rights of Huntsman Packaging that will lapse under conditions substantially the same as the vesting conditions of the options. The repurchase rights for 13,117 shares lapse on a straight-line basis over a five-year period commencing January 1, 1998. The repurchase rights for the remaining 13,116 lapse over the same five years, subject to achievement of certain Huntsman Packaging performance criteria, or if the performance criteria are not met, on December 31, 2007. The shares of Class C common stock are subject to essentially the same restrictions and put options as the other Class C common shares described above.\nAdditionally, options to purchase 2,622 shares of Class C common stock have been cancelled subsequent to December 31, 1998.\n11. COMMITMENTS AND CONTINGENCIES\nINDEMNITY AGREEMENT - Our operations are subject to extensive environmental laws and regulations concerning emissions to the air, discharges to surface and subsurface waters, and the generation, handling, storage, transportation, treatment, and disposal of waste materials, as adopted by various governmental authorities in the jurisdictions in which we operate. We make every reasonable effort to remain in full compliance with existing governmental laws and regulations concerning the environment. As part of a sale of a plant site in 1992, we agreed to indemnify environmental losses of up to $5 million which may have been created at the plant site between January 1, 1988 and May 18, 1992. This indemnity expires on May 8, 2002 and reduces ten percent each year beginning May 12, 1997. We believe that the ultimate liability, if any, resulting from this indemnification will not be material to our consolidated financial statements.\nROYALTY AGREEMENTS - We have entered into royalty agreements (the \"Agreements\") for the right to use certain patents in the production of our Winwrap stretch film. We paid a fee of $450,000 to the patent holder for the first 2,250,000 pounds of film produced in North America. The Agreements require us to pay the patent holder a fee of $.10 for each pound of Winwrap produced in excess of 2,250,000 pounds but less than 37,500,000 pounds and $.05 per pound for each pound of Winwrap produced in excess of 37,500,000 pounds in North America. The Agreements require us to pay certain fees to obtain the rights to sell Winwrap outside of North America. The Agreements also require us to pay $.075 per pound of Winwrap sold outside of North America. We have the option to maintain these rights in subsequent years for certain agreed-upon fees. The Agreements terminate upon the expiration of the related patents in 2009.\nLITIGATION - We are subject to litigation and claims arising in the ordinary course of business. We believe, after consulting with legal counsel, that any liabilities arising from such litigation and claims will not have a material adverse effect on our consolidated financial statements.\n12. ACQUISITIONS\nUNITED FILMS CORPORATION - On July 31, 1996, we acquired all of the issued and outstanding common stock of United Films Corporation for cash of approximately $12.3 million. The acquisition was accounted for using the purchase method of accounting. Accordingly, results of operations are included in the accompanying consolidated financial statements from the date of acquisition. We recorded goodwill of approximately $12.1 million in this acquisition, which is being amortized on a straight-line basis over 40 years.\nDEERFIELD PLASTICS COMPANY, INC. - On October 21, 1996, we acquired all of the issued and outstanding common stock of Deerfield Plastics Company, Inc. for cash of approximately $68.2 million, a $1.4 million payment based on Deerfield's working capital at the acquisition date, and deferred payments totaling approximately $5.2 million. The acquisition was accounted for using the purchase method of accounting. Accordingly, results of operations are included in the accompanying consolidated financial statements from the date of acquisition. We recorded goodwill of approximately $18.4 million in this acquisition, which is being amortized on a straight-line basis over 40 years.\nCT FILM - On September 30, 1997, we acquired all of the assets of CT Film (a division of Huntsman Polymers Corporation, formerly Rexene Corporation) and Rexene Corporation Limited (a wholly-owned subsidiary of Huntsman Polymers Corporation) for approximately $70 million cash. The acquisition was accounted for using the purchase method of accounting. Accordingly, results of operations have been included in the accompanying consolidated financial statements from the date of acquisition. In connection with the acquisition, we planned to exit certain of the activities acquired with the purchase of CT Film, including the film operations at Scunthorpe, UK. During 1998, we sold the Scunthorpe, UK facility acquired from CT Film and adjusted the fair value assigned to the Scunthorpe, UK facility accordingly (see Note 3). We recorded goodwill of approximately $7.8 million in this acquisition, which is being amortized on a straight-line basis over 40 years.\nELLEHAMMER INDUSTRIES LTD. AND ELLEHAMMER PACKAGING, INC. - On March 12, 1998, we acquired certain assets and assumed certain liabilities of Ellehammer Industries Ltd. and Ellehammer Packaging Inc. (collectively, \"Ellehammer\") for cash of approximately $7.9 million. The acquisition was accounted for using the purchase method of accounting. Accordingly, results of operations are included in the accompanying consolidated financial statements from the date of acquisition. We did not record any goodwill in this acquisition.\nBLESSINGS CORPORATION - On May 19, 1998, in accordance with an Agreement and Plan of Merger dated April 1, 1998, we acquired Blessings Corporation (\"Blessings\") by merging our wholly-owned subsidiary, VA Acquisition Corp., with and into Blessings. Blessings then became our wholly-owned subsidiary and Blessings changed its name to Huntsman Edison Films Corporation. The aggregate purchase price for Blessings was approximately $270 million (including the assumption of approximately $57 million of Blessings' existing indebtedness). In connection with the Blessing Acquisition, we incurred transaction costs of approximately $17 million. The financing for the Blessings Acquisition was provided under a $510 million Amended and Restated Credit Agreement (see Note 6). The acquisition was accounted for using the purchase method of accounting. Accordingly, results of operations are included in the accompanying consolidated financial statements from the date of acquisition. We recorded goodwill and intangible assets of approximately $168.7 million in this acquisition, which are being amortized on a straight-line basis over 10 to 30 years.\nOur pro forma results of operations for the years ended December 31, 1998, 1997 and 1996 (assuming the acquisitions of United Films Corporation, Deerfield Plastics Company, Inc., CT Film, Ellehammer and Blessings had occurred as of January 1, 1996) are as follows (in thousands):\nHUNTSMAN CONTAINER CORPORATION INTERNATIONAL (HCCI) - On August 31, 1996, Huntsman Corporation contributed all of the outstanding capital stock of HCCI to Huntsman Packaging in the form of a capital contribution. The transaction was accounted for at historical cost in a manner similar to a pooling of interests. On June 1, 1998 the operations of HCCI, consisting of our European foam business, were sold (see Note 3). The results of operations of HCCI have been reflected as discontinued operations in the accompanying consolidated financial statements from January 1, 1996 through the date of the sale.\n13. OPERATING SEGMENTS\nWe have adopted SFAS No. 131, \"Disclosures About Segments of an Enterprise and Related Information.\" Operating segments are components of our company for which separate financial information is available that is evaluated regularly by our chief operating decision maker in deciding how to allocate resources and in assessing performance. This information is reported on the basis that it is used internally for evaluating segment performance.\nWe have three reportable operating segments: design products, industrial films and specialty films. The design products segment produces printed rollstock, bags and sheets used to package products in the food and other industries. The industrial films segment produces stretch films, used for industrial unitizing and containerization, and PVC films, used to wrap meat, cheese and produce. The specialty films segment produces converter films that are sold to other flexible packaging manufacturers for additional fabrication, barrier films that contain and protect food and other products, and other films used in the personal care, medical, agriculture and horticulture industries.\nThe accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Sales and transfers between our segments are eliminated in consolidation. We evaluate performance of the operating segments based on profit or loss before income taxes, not including plant closing costs and other nonrecurring gains or losses. Our reportable segments are managed separately with separate management teams, because each segment has differing products, customer requirements, technology and marketing strategies.\nSegment profit or loss and segment assets as of and for the years ended December 31, 1998, 1997 and 1996 are presented in the following table (in thousands).\nA reconciliation of the totals reported for the operating segments to our totals reported in the consolidated financial statements is as follows (in thousands):\nThe following table presents financial information by country based on the location of production of the product.\nOur sales to Kimberly Clark Corporation and its affiliates represented approximately 14 percent of consolidated net sales in 1998 and less than 10% of consolidated net sales in 1997 and 1996. Substantially all of the sales to Kimberly Clark are from the specialty films and design products operating segments.\n14. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. In the case of cash and cash equivalents, the carrying amount is considered a reasonable estimate of fair value. The carrying amount of floating rate debt approximates fair value because of the floating interest rates associated with such debt. The fair value of fixed rate debt is estimated by discounting estimated future cash flows through the projected maturity using market discount rates that reflect the approximate credit risk, operating cost, and interest rate risk potentially inherent in fixed rate debt. The estimated fair value of off-balance sheet instruments is obtained from market quotes representing the estimated amount we would receive or pay to terminate the contract, taking into account current interest rates.\nFair value estimates are made at a specific point in time. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, interest rate levels, and other factors. These estimates are subjective in nature and involve uncertainties and matters of judgment and therefore cannot be determined or relied on with any degree of certainty. Changes in assumptions could significantly affect the estimates.\nBelow is a summary of our financial instruments' carrying amounts and estimated fair values as of December 31, 1998 and 1997 (in thousands):\n15. RELATED-PARTY TRANSACTIONS\nThe accompanying consolidated financial statements include the following balances and transactions with affiliated companies not disclosed elsewhere (in thousands). All transactions with affiliated companies have been recorded at estimated fair market values for the related products and services.\nTRANSACTIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996:\nROYALTY TRANSACTION WITH HUNTSMAN GROUP INTELLECTUAL PROPERTIES HOLDING CO. (\"HUNTSMAN INTELLECTUAL\") During 1996, Huntsman Packaging and other affiliates entered into a royalty agreement (the \"Royalty Agreement\") with Huntsman Intellectual whereby we paid Huntsman Intellectual a royalty for the use of certain trademarks, etc. Huntsman Intellectual was owned by Huntsman Packaging and certain subsidiaries of Huntsman Corporation (\"HC\"). During 1997 and 1996, we paid royalties of approximately $1.9 million and $1.7 million, respectively, to Huntsman Intellectual. Huntsman Intellectual recorded a patronage dividend to us of $1.2 million and $1.1 million during 1997 and 1996, respectively. The royalty expense is included in administration and other expense. The dividend is included in other income. Immediately prior to the Split-Off, the patronage dividend receivable from Huntsman Intellectual at the date of the Split-Off was settled in full. Huntsman Packaging's ownership\nof Huntsman Intellectual and its participation in the Royalty Agreement were terminated. We no longer use the trademarks or other intellectual property covered under the Royalty Agreement.\nCT FILM EMPLOYEES - Subsequent to the purchase of CT Film from Huntsman Polymers Corporation (a subsidiary of HC) (\"Huntsman Polymers\") (see Note 12), employees associated with the CT Film operations remained employed by Huntsman Polymers through December 31, 1997. The total payroll and benefits costs incurred by Huntsman Polymers from September 30, 1997 to December 31, 1997 for these employees of approximately $6.2 million was allocated to us and is included in cost of sales and operating expenses in the 1997 consolidated income statement. The entire amount was paid to Huntsman Polymers in 1998.\nINSURANCE COVERAGE - We obtain most of our insurance coverage under policies of HC. Reimbursement payments to HC are based on premium allocations, which are determined in cooperation with an independent insurance broker.\nADMINISTRATIVE EXPENSES - Included in administrative and other expense in the consolidated income statements are HC administrative expenses allocated to us. Prior to the Split-off, these costs represent the estimated portion of costs incurred by HC to provide services to us. Subsequent to the Split-off, these costs are for certain administrative services provided to us by HC under a cancelable services agreement.\nOFFICE SPACE - We are obligated to pay rent calculated as a pro rata portion (based on our percentage occupancy) of the mortgage principal and interest payments related to the HC headquarters facility. Payments under this obligation are included in administrative expenses.\nINVESTMENT - On August 7, 1998, Huntsman Packaging made an offer to the Board of Directors of Applied Extrusion Technologies, Inc. (\"AET\"), a publicly-traded company, to purchase all of the outstanding shares of common stock of AET at $10.50 per share in a merger transaction. AET's Board rejected the offer. On September 10, 1998, Huntsman Packaging made another offer to the Board of Directors of AET to purchase all of the outstanding shares of common stock of AET at $12.50 per share in a merger transaction. On September 14, 1998, HPC Investment, Inc., a wholly-owned subsidiary of Huntsman Packaging, purchased shares of the common stock of AET from Richard P. Durham, President and Chief Executive Officer of Huntsman Packaging, for an aggregate purchase price of $3.3 million, in an arms-length transaction approved by the Board of Directors of HPC Investment, Inc. AET's Board of Directors subsequently rejected Huntsman Packaging's second offer.\n16. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS\nThe following condensed consolidating financial statements present, in separate columns, financial information for (i) Huntsman Packaging Corporation (on a parent only basis), with its investment in its subsidiaries recorded under the equity method, (ii) guarantor subsidiaries (as specified in the Indenture dated September 30, 1997 (the \"Indenture\") relating to Huntsman Packaging Corporation's $125 million senior subordinated notes (the \"Notes\")) on a combined basis, with any investments in non-guarantor subsidiaries specified in the Indenture recorded under the equity method, (iii) direct and indirect non-guarantor subsidiaries on a combined basis, (iv) the eliminations necessary to arrive at the information for Huntsman Packaging Corporation and its subsidiaries on a consolidated basis, and (v) Huntsman Packaging Corporation on a consolidated basis, in each case as of December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and 1996. The Notes are fully and unconditionally guaranteed on a joint and several basis by each guarantor subsidiary and each guarantor subsidiary is wholly-owned, directly or indirectly, by Huntsman Packaging Corporation. There are no contractual restrictions limiting transfers of cash from guarantor and non-guarantor subsidiaries to Huntsman Packaging Corporation. The condensed consolidating financial statements are presented herein, rather than separate financial statements for each of the guarantor subsidiaries, because management believes that separate financial statements relating to the guarantor subsidiaries are not material to investors.\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 1998 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 1998 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1998 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 1997 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 1997 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1997 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS)\nHUNTSMAN PACKAGING CORPORATION AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS)\n(1) Represents the net of accounts written off against the allowance and recoveries of previous write-offs.\n(2) Relates to write-down of goodwill.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Blessings Corporation Newport News, Virginia:\nWe have audited the accompanying consolidated balance sheets of Blessings Corporation and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial 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 Blessings Corporation and Subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nRichmond, Virginia February 20, 1998\nBLESSINGS CORPORATION\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 - --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nBLESSINGS CORPORATION\nCONSOLIDATED STATEMENTS OF EARNINGS FOR THE YEARS ENDED DECEMBER 31, 1996, AND 1997\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nBLESSINGS CORPORATION\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, 1996 AND 1997\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nBLESSINGS CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997\nSee notes to consolidated financial statements\nBLESSINGS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE FISCAL YEARS ENDED DECEMBER 31, 1997; DECEMBER 31, 1996 AND DECEMBER 30, - --------------------------------------------------------------------------------\n1. ACCOUNTING POLICIES\nA. PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned with the exception of NEPSA (see notes 2 and 14). All material intercompany profits, transactions and balances have been eliminated in consolidation. The Company is approximately 54% owned by the Williamson-Dickie Manufacturing Company. The Company has no material transactions with the Williamson-Dickie Manufacturing Company.\nB. CASH AND CASH EQUIVALENTS - The Company considers all highly-liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents.\nC. INVENTORIES - Inventories are stated at the lower of cost or market. The cost of inventories is determined by the first-in, first-out method (FIFO) and an average cost method.\nD. PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment, carried at cost, is depreciated over the estimated useful life of the assets. Depreciation expense is computed on a straight-line basis for book purposes. Accelerated methods are used for income tax purposes. Major improvements are capitalized and ordinary repairs and maintenance are expensed in the year incurred.\nE. ACCOUNTING PERIOD - Effective with the beginning of 1996, the Company changed its accounting periods from four weeks to one month each with the fiscal year coinciding with the calendar year. Accordingly, under the new calendar year, the Company's quarters are each comprised of three calendar months of thirteen weeks each ending March 31, June 30, September 30, and December 31. Formerly, the Company's first quarter was comprised of sixteen weeks, and the remaining three quarters were each comprised of twelve weeks. Therefore, the year ending December 30, 1995 was comprised of fifty-two weeks, while the following two years ending December 31, 1997 and 1996 were comprised of twelve months each. Due to the relative similarity of the year ending December 30, 1995 with the two following years, 1995 results were not recast.\nF. INTANGIBLES RESULTING FROM BUSINESS ACQUISITIONS - Intangible assets resulting from business acquisitions principally consist of the excess of the acquisition cost over the fair value of the net assets of the businesses acquired (goodwill). Goodwill is amortized over twenty-five years. Other intangible assets are amortized on a straight-line basis over their estimated useful lives. The carrying value of goodwill and other intangibles is evaluated if circumstances indicate a possible impairment in value. If undiscounted cash flows over the remaining amortization period indicate that goodwill and other intangibles may not be recoverable, the carrying value of goodwill and other intangibles will be reduced by the estimated shortfall of cash flows on a discounted basis.\nG. TAXES ON INCOME - The company provides deferred taxes to reflect future consequences of differences between the tax basis of assets and liabilities and their reported amounts for financial reporting purposes, in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. The significant components of deferred tax assets and liabilities are principally related to depreciation,\nallowance for doubtful accounts, retirement plans, inventory and accrued expenses not currently deductible.\nH. TRANSLATION OF FOREIGN CURRENCIES - In 1997 the functional currency of the Company's Mexican subsidiary changed from the peso to the dollar. As a result of this change, translation gains and losses previously recorded in shareholders' equity are recorded in income. Prior to 1997, the Company translated foreign currency financial statements by translating balance sheet accounts at the current exchange rate and income statement accounts at the average exchange rate for the year. Translation gains and losses were recorded in shareholders' equity, and transaction gains and losses were reflected in income.\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 reported amounts reflected on those statements. Actual results could differ from those estimates.\nJ. FINANCIAL INSTRUMENTS - The carrying amounts of assets and liabilities as reported on the balance sheet at December 31, 1997, which qualify as financial instruments, approximate fair value. The fair value of interest rate swap agreements held by the Company at year end which were not recorded on the financial statements, was $395,000 and $470,400 which represents the cash requirement to settle these agreements at December 31, 1997 and 1996, respectively.\nK. INTEREST AND DIVIDENDS - NET -\nCash payments for interest were $3,215,600, $2,775,100 and $2,978,600 for the 1997, 1996, and 1995 fiscal years respectively.\nL. OTHER - The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. The adoption of this statement did not have a material impact on the earnings per share calculations for the 1997, 1996 and 1995 fiscal years. During 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The effect of adopting the new standard is not expected to be significant as the Company does not currently have material items of other comprehensive income disclosed outside the statement of operations. Also during 1997, the FASB issued SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. The statement requires enterprises to report financial and descriptive information about its operating segments, products and services, countries and major customers, as well as reconciliations of segment financial information to corresponding amounts in the general-purpose financial statements. SFAS Nos. 130 and 131 will be adopted for the Company's 1998 fiscal year.\n2. NEPSA ACQUISITION\nThe Company acquired 60% of the outstanding common stock of Nacional de Envases Plasticos, S.A. de C.V., and its associated companies, collectively known as NEPSA, on July 5, 1994. The acquisition of NEPSA was accounted for using the purchase method of accounting. The allocation of the purchase price of approximately $46,000,000 resulted in an excess of $26,505,300 in goodwill which will be amortized on a straight-line basis over its estimated life of twenty-five years. Amortization of goodwill was $1,060,200 for 1997, 1996 and 1995.\nThe Company had non-cash investing and financing activities associated with the NEPSA transaction by issuing 400,000 shares of additional Blessings Corporation common stock valued at $5,400,000.\nOn February 9, 1998 the Company purchased the remaining 40% of NEPSA (See note 14).\n3. INVENTORIES\n4. PROPERTY, PLANT AND EQUIPMENT\n5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\n6. LONG-TERM DEBT\nDuring 1996, the Company entered into a $20,000,000 Note Purchase Agreement with a major insurance company. Under the terms of the Note Purchase Agreement, the Company issued $10,000,000 of 7.22% senior unsecured notes due January 30, 2008 and $10,000,000 of 6.55% senior unsecured notes due January 30, 2002. Interest is payable semi-annually on January 30 and July 30 of each year. The Company is not obligated to make principal payments until January 30, 2000. The proceeds were used to repay two secured mortgages and advances under the revolving credit and to finance major capital projects.\nThe Company has available a $25,000,000 two year, unsecured revolving credit agreement with major lending institutions. Borrowings under the revolving credit agreement bear interest at rates based on the London Interbank Offered Rates (LIBOR) or the prime interest lending rate. The Company had no borrowings outstanding under this agreement at December 31, 1997.\nOn February 20, 1998, the Company entered into an $18,500,000 unsecured Term Loan Agreement with a major lending institution. The term loan bears interest at rates based upon either the LIBOR Rates or the Prime Rate and will be payable quarterly. Principal payments will commence on September 15, 1998 and will be payable quarterly thereafter with the final payment on June 15, 2006. The proceeds from the term loan were used to purchase the remaining 40% ownership of NEPSA (see note 14).\nThe Company has short-term lines of credit of $12,000,000 available through its principal lenders. On December 31, 1997, the Company had standby letters of credit of $997,000 outstanding under the lines of credit.\nIn December of 1994 and during the first half of 1995, the Company entered into five interest rate swap agreements to limit its exposure to changes in interest rates on the NEPSA Credit Agreement.\nThe agreements obligate the Company to make fixed payments to a counter party which, in turn, is obligated to make variable payments to the Company. The amount to be paid or received under the terms of the swaps is measured by applying contractually agreed upon variable and fixed rates to the notional amounts of principal. The counterparty to the agreements is a major financial institution which is expected to fully perform under the terms of the agreement. The notional amounts, which decrease over the term of the agreements, are used to measure the contractual amounts to be received or paid and do not represent the amount of exposure to credit loss. The agreements terminate in 2002 and effectively convert approximately $13,900,000 of three month LIBOR-based floating rate debt to 8.21% fixed rate debt. Interest paid on these swaps was recorded as an adjustment to interest expense.\nThe long-term debt agreements contain various restrictive covenants limiting the Company's ability to incur additional indebtedness or to undertake mergers and acquisitions. The agreements also include quarterly tests relating to the maintenance of net worth, cash flow and interest coverage ratios.\nThe maturities on long-term debt are as follows:\n7. COMMITMENTS\nAt December 31, 1997, aggregate rental commitments on long-term real estate operating leases were as follows:\nRent expense for the fiscal years ended December 31, 1997; December 31, 1996; and December 30, 1995, amounted to $1,362,100, $1,449,800 and $2,024,500 respectively. The Company has commitments to purchase raw materials over the next two years of approximately $3,800,000 per year.\n8. PENSION TRUST PLAN\nThe Company sponsors a defined benefit pension plan that covers substantially all employees. The cost of the plan is borne by the Company. The plan calls for benefits to be paid to eligible employees at retirement, based primarily upon years of service with the Company and compensation rates near retirement. Contributions are intended to provide not only for benefits attributable to service to date but also for those expected to be earned in the future. Plan assets consist primarily of bonds, mortgages and common stock.\nPension expense was $806,200, $587,800 and $459,500 in the 1997, 1996 and 1995 fiscal years respectively. Net pension cost for the Company's qualified and nonqualified defined benefit plans for 1997, 1996 and 1995 included the following components:\nThe following table sets for the plan's funded status and amounts recognized in the Company's statement of cash flows at year-end.\nActuarial present value of benefit obligations;\nThe weighted-average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.5% and 5.0%, respectively, for 1997 and 1996. The expected long-term rate of return on assets was 10% of 1997 and 1996.\nDuring 1994 the Company adopted a Supplemental Restoration plan designed to restore pension benefits which have been limited as a result of changes in the Internal Revenue Service code of 1993 (OBRA '93).\nIn December, 1990, and November, 1992, FASB issued SFAS No. 106, Employers' Accounting for Post Retirement Benefits Other Than Pensions and SFAS No. 112, Employers' Accounting for Post Employment Benefits respectively. These pronouncements do not have an effect on the Company's\nfinancial statements as the cost to the Company of providing the benefits covered in these pronouncements is not significant.\n9. PENSION SAVINGS PLAN (401K)\nThe Company initiated a pension savings plan in 1988 designed to comply with Section 401(k) of the Internal Revenue Service code. Under the terms of the plan, the Company matches 50% of the employees' contribution up to a maximum of 3% of salary. The Company's matching contribution to the plan was $436,000, $378,200 and $337,900 for the 1997, 1996 and 1995 fiscal years respectively.\n10. STOCK OPTION PLAN\nUnder the Company's stock option plans, officers, directors and key employees may be granted options to purchase the Company's common stock at no less than 100% of the market price on the date the option is granted. The plans provide options to become exercisable either immediately upon grant or one year from date of grant and can be issued with or without stock appreciation rights with terms of 5 to 10 years. The Company has authorized 443,000 shares for issuance under the plans. At December 31, 1997, there were 130,750 shares available under the plans. As permitted by SFAS No. 123, Accounting for Stock Based Compensation, the Company has elected to follow APB Opinion No. 25 Accounting for Stock issued to Employees, for the measurement and recognition of employee stock-based compensation. Accordingly, no compensation cost has been recognized for the company's plans. The pro forma effect of applying SFAS 123 fair value method of measuring compensation costs to the Company's stock-based awards was not significant to reported net income and earnings per share. A summary of stock option transactions in fiscal 1997, 1996 and 1995 follows:\nThe following table summarizes information about stock options outstanding at December 31, 1997:\nUsing the Black-Scholes model, the weighted average fair value of options granted and significant weighted-average assumptions used were as follows:\n11. TAXES ON INCOME\nThe components of income before taxes are as follows:\nIncome tax expense from continuing operations consisted of the following components in the fiscal year ended on:\nTemporary differences which give rise to deferred tax assets and liabilities at December 31, 1997, December 31, 1996, and December 30, 1995, are as follows:\nA reconciliation of the differences between income taxes computed at the U.S. income tax rate and the consolidated tax provision is as follows:\nCash payments for taxes were $2,994,800, $3,128,200 and $6,442,000 for the 1997, 1996 and 1995 fiscal years respectively\n12. NET EARNINGS PER SHARE\nNet earnings per share for all periods presented have been computed based upon the weighted average number of shares outstanding during the year. The following schedule represents a reconciliation of the numerator and the denominator used to calculate basic and diluted earnings per share for 1997, 1996 and 1995:\n13. QUARTERLY FINANCIAL DATA, MARKET AND DIVIDEND INFORMATION (UNAUDITED)\n14. SUBSEQUENT EVENT\nOn February 9, 1998, the Company purchased the remaining 40% of its 60% owned subsidiary in Mexico, NEPSA for $18,500,000. Pro forma results assuming consolidation of 100% of NEPSA's earnings would have been net earnings of $10,455,300 or $1.03 per share for 1997, $7,885,600 or $.78 per share for 1996 and $6,671,900 or $.66 per share for 1995.\n15. MAJOR CUSTOMER\nA customer of the Company accounted for 44.9%, 44.6% and 46.6% of total sales in the 1997, 1996, and 1995 fiscal years respectively.\n16. SEGMENT AND GEOGRAPHIC INFORMATION\nThe Company operates in one principal industry segment: the design, manufacture and sale of specialty plastics for use in a variety of disposable healthcare products, as well as in numerous industrial, agricultural and packaging end uses. The Company operates in two primary geographic areas: the United States and Mexico.\nGeographic financial information is as follows:\nINDEX TO EXHIBITS\n* Filed with this report.\n(1) Management contract or compensatory plan or arrangement required to be filed as an exhibit hereto.","section_15":""}
{"filename":"63917_1995.txt","cik":"63917","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company was incorporated in Maryland in 1939 under the name McDonnell Aircraft Corporation. On April 19, 1967, the shareholders approved the merger with Douglas Aircraft Company and the name of the corporation was changed to McDonnell Douglas Corporation (the Company or McDonnell Douglas).\nThe Company, its divisions and its subsidiaries operate principally in four industry segments: military aircraft; missiles, space, and electronic systems; commercial aircraft; and financial services and other. Operations in the first two industry segments are conducted primarily by McDonnell Douglas Aerospace and by Military Transport Aircraft, unincorporated operating divisions of the Company, which are engaged in design, development, production, and support of the following major products: military transport aircraft; combat aircraft and training systems; commercial and military helicopters and ordnance; missiles; space launch vehicles and space station systems; and defense and commercial electronics, lasers, sensors, and command, control, communications, and intelligence systems. Operations in the commercial aircraft segment are conducted by Douglas Aircraft Company (DAC), an unincorporated operating division of the Company, which designs, develops, produces, and sells commercial transport aircraft and related spare parts. Through its McDonnell Douglas Financial Services\nCorporation (MDFS) subsidiary, the Company is engaged in aircraft financing and commercial equipment leasing. The Company's subsidiary, McDonnell Douglas Realty Company, was established in 1972 to develop the Company's surplus real estate. While continuing to serve that role, McDonnell Douglas Realty Company has become a full- service developer and property manager in the commercial real estate market as well as for the Company's aerospace business.\nSince 1988, the Company's information systems business has been divested. In 1991, McDonnell Douglas sold substantially all of the assets of McDonnell Douglas Systems Integration Company and certain related assets of McDonnell Douglas Information Systems International (MDISI). In 1992, the Company sold all the outstanding stock of TeleCheck Services, Inc. and in 1993, sold its remaining MDISI business.\nThe business segments in which the Company is engaged and discussion of certain of their respective products appear under the caption: \"Military Aircraft, Missiles, Space, and Electronic Systems\" and \"Commercial Aircraft\" on the Pullout Section appearing after page 20, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 22 through 29 and \"Selected Financial Data by Industry Segment\" on page 30 of the Company's 1995 Annual Report to Shareholders, the text portions of which are incorporated herein by this reference.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nFinancial information regarding the Company's industry segments is provided under the caption \"Selected Financial Data by Industry Segment\" on page 30 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\n10-K Page 3 MARKETING AND MAJOR CUSTOMER - MCDONNELL DOUGLAS AEROSPACE\nDiscussion regarding the Company's most significant customer in the military aircraft and missiles, space, and electronic systems segments is included under the captions \"Business and Market Considerations - Military Aerospace Business\" and \"Government Business Audits, Reviews, and Investigations\" on pages 27 through 29 in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Shareholders, which are incorporated herein by this reference.\nCOMPETITION\nPrograms and products comprising most of the Company's business volume are of a highly technical nature, comparatively few in number, high in unit cost, and have traditionally enjoyed relatively long production lives. There is significant price and product competition in the aerospace industry, both in military and commercial programs.\nThe Company's military segments compete in an industry composed of a few major competitors and a limited number of customers. The number of competitors in these segments has decreased over the past few years due to consolidation brought about by reduced defense spending. However, competition for military programs remains significant.\nThe Company's commercial aircraft sales are subject to intense competition from aircraft manufactured by other companies, both foreign and domestic, including companies which are nationally owned or subsidized and have a larger family of commercial aircraft to meet varied and changing airline requirements. The Company's principal competitors in commercial aircraft are The Boeing Company and Airbus Industrie. To meet competition, the Company maintains a continuous program directed toward enhancing the performance and capability of its products. Additionally, product improvement programs which increase airplane operational capability, improve reliability, enhance maintainability, and increase commonality within current airplane families and across the entire product line will continue. The Company's strategy includes analyzing potential derivatives of the current product line, and developing those derivatives that are economically appropriate.\nMDFS is subject to competition from other financial institutions, including commercial banks, finance companies, and leasing companies. Some full-service leasing companies are larger than MDFS and have greater financial resources, greater leverage ability, and lower effective borrowing costs.\nSUBCONTRACTING, PROCUREMENT AND RAW MATERIALS\nThe most important raw materials required for the Company's aerospace products, from the standpoint of aggregate cost, are aluminum (sheet, plate, forgings, and extrusions), titanium (sheet, plate, forgings, and extrusions) and composites (including carbon and boron). All of these materials are purchased from outside sources and generally are available at competitive prices. Additional sources and capacity exist for these raw materials, but it would take a year or more before they could become qualified alternate sources of supply.\nThe Company purchases many components, such as engines and accessories, electrical power systems, radars, landing gears, fuel systems, refrigeration systems, navigational equipment, and flight and engine instruments for use in aircraft, and propulsion systems, guidance systems, telemetry and gyroscopic devices in support of its space systems and missile programs. In addition, fabricated subassemblies such as engine pods and pylons, fuselage sections, wings and empennage surfaces, doors\n10-K Page 4\nand flaps, are sometimes subcontracted to outside suppliers. The U.S. Government and commercial customers also furnish certain components for incorporation into aircraft and other products they purchase from the Company.\nThe Company is dependent upon the ability of its large number of suppliers and subcontractors to meet performance specifications, quality standards, and delivery schedules at anticipated costs, and their failure to do so would adversely affect production schedules and contract profitability, while jeopardizing the ability of the Company to fulfill commitments to its customers. The Company has encountered some difficulty from time to time in assuring long-lead time supplies of essential parts, subassemblies, and materials. The Company's success in forestalling shortages of critical commodities over the long term is difficult to predict because many factors affecting such shortages are outside its control.\nEMPLOYEES\nAt December 31, 1995, the total employment of the Company, including subsidiaries, was 63,612.\nPATENTS AND LICENSES\nThe Company holds many patents and has licenses under patents held by others. The Company does not believe that the expiration of any patent or group of patents, nor the termination of any patent license agreement, would materially affect its business. The Company does not believe that any of its patents or trademarks are materially important to the conduct of its business.\nENVIRONMENTAL REGULATIONS\nSee \"Environmental Expenditures\" on page 29 in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nRESEARCH AND DEVELOPMENT\nA significant portion of the Company's business with the U.S. Government consists of research, development, test, and evaluation work, which are reflected as sales and costs in the Company's financial statements. Customer-sponsored research and development work amounted to approximately $1.227 billion in 1995, $1.393 billion in 1994, and $1.126 billion in 1993. Company-sponsored research and development and bid and proposal work, related to both commercial business and business with the U.S. Government, amounted to $311 million in 1995, $297 million in 1994, and $341 million in 1993.\nU.S. GOVERNMENT AND EXPORT SALES\nAlthough there are additional risks to the Company attendant to its non-U.S. operations and transactions, such as currency fluctuations and devaluations, the risk of war, changes in foreign governments and their policies, differences in foreign laws, uncertainties as to enforcement of contract rights, and difficulties in negotiating and litigating with foreign sovereigns, the Company's operations and financial position have not been materially adversely affected by these additional risks in its non-U.S. operations and transactions.\n10-K Page 5\nSince most of the Company's foreign export sales involve technologically advanced products, services and expertise, U.S. export control regulations limit the types of products and services that may be offered and the countries and governments to which sales may be made. The Department of State issues and maintains the International Traffic in Arms Regulations pursuant to the Arms Export Control Act. The Department of Commerce issues and maintains the Export Administration Regulations pursuant to the Export Administration Act and the Department of Treasury implements and maintains transaction controls, sanctions, and trade embargoes pursuant to the Trading With the Enemy Act and the International Emergency Economic Powers Act. Pursuant to these regulations, certain products and services cannot be exported without obtaining a license. Most of the military products that the Company sells abroad cannot be sold without such a license. Consequently, the Company's international sales may be adversely affected by changes in the United States Government's export policy, the implementation of trade sanctions or embargoes, or the suspension or revocation of the Company's foreign export control licenses.\nAdditional information required by this item is included in Note 18, \"U.S. Government and Export Sales\" on page 49 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nBACKLOG\nThe Company's backlog of orders at December 31 follows:\n1995 1994 Backlog % Backlog % -------- ----- ------- ----- (Dollars in millions) Firm backlog: Military aircraft $10,121 51.5 $ 8,340 47.6 Commercial aircraft 7,175 36.5 7,544 43.1 Missiles, space, and electronic systems 2,344 12.0 1,619 9.3 -------- ----- -------- ----- Total Firm Backlog $19,640 100.0 $17,503 100.0 ======== ===== ======== =====\nContingent backlog: Military aircraft $ 6,298 72.3 $ 8,597 73.3 Commercial aircraft 1,669 19.1 2,234 19.0 Missiles, space, and electronic systems 746 8.6 898 7.7 -------- ----- -------- ----- Total Contingent Backlog $ 8,713 100.0 $11,729 100.0 ======== ===== ======== =====\nBacklog reported is that of the aerospace segments. Customer options and products produced for short-term lease are excluded from backlog. For a discussion of risks associated with backlog for commercial customers, see \"Backlog\" on page 29 in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nContingent backlog includes: (a) U.S. and other government orders not yet funded; (b) U.S. and other government orders being negotiated as continuations of authorized programs; and (c) unearned price escalation on firm commercial aircraft orders.\n10-K Page 6\nThe backlog amounts include units scheduled for delivery over extended future periods. Since substantially all work for the U.S. and other governments is accounted for on the percentage of completion method of accounting whereby sales are recorded as work is performed, such amounts included in backlog cannot be segregated on the basis of scheduled deliveries. However, with respect to commercial jetliners and related products included in the commercial segment (which are accounted for on a delivery method), the firm backlog related to deliveries scheduled after one year was $5.2 billion at December 31, 1995, and $4.8 billion at December 31, 1994.\nThe Government may terminate its contracts for default, or for its convenience whenever it believes that such termination would be in the best interest of the Government. For a further discussion of termination for default, termination for convenience, and other government contracting risks, see \"Business and Market Considerations - - Military Aerospace Business\" on page 27 in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company at March 6, 1996, were as follows:\nEXECUTIVE AGE POSITIONS AND OFFICES HELD - ---------- --- --------------------------- William M. Austin 49 McDonnell Douglas Aerospace (MDA) Vice President\/General Manager - Business Management since July 1993. MDC Vice President - Treasurer 1991-1993.\nEdward C. Bavaria 63 DAC Deputy President since May 1995. Self-employed consultant 1993-1995 (subsequent to retirement from General Electric Company). Vice President and General Manager - General Electric Company 1983-1993.\nDonald V. Black 54 DAC Senior Vice President - Marketing and Airline Financing since February 1996. DAC Vice President\/General Manager - Airline Financing Group 1994-1995. MDFC Executive Vice President 1989-1994.\nDean C. Borgman 54 McDonnell Douglas Helicopter Systems Senior Vice President - General Manager since September 1993 and McDonnell Douglas Helicopter Company (MDHC) President since March 1992. MDHC Vice President - Commercial Programs 1992. MDHC General Manager MDX Program 1990-1992.\nRobert L. Brand 58 MDC Vice President and Controller since September 1992. McDonnell Douglas Missile Systems Company (MDMSC) Vice President-Business Management and Chief Financial Officer 1992. MDC Controller 1987-1992.\nLaurie A. Broedling 50 MDC Senior Vice President - Human Resources and Quality since May 1995. MDC Vice President - Human Resources 1995. Associate Administrator for Continual Improvement of National Aeronautics and Space Administration 1992-1995. Deputy Under Secretary of Defense -Total Quality Management 1990-1992.\n10-K Page 7\nJohn P. Capellupo* 61 MDA President since December 1994. MDC Executive Vice President 1992-1994. McDonnell Aircraft Company (MCAIR) President 1991-1992. DAC Deputy President 1990-1991.\nMichael J. Cave 35 DAC Vice President\/General Manager - Business Operations and Chief Financial Officer since November 1995. MDA Vice President\/General Manager - Business Management - C-17 Program 1995. MDA Vice President - Business Management 1994-1995. MDA General Manager - Business Program 1993-1994. MDA General Manager - Contracts and Pricing 1991-1993.\nStanley Ebner 62 MDC Senior Vice President - Washington Operations since December 1994. Self- employed attorney, consultant, and writer 1990-1994.\n* Retiring, effective March 31, 1996.\nGeorge G. Field 57 DAC Senior Vice President - Product Support since January 1996. MDA Vice President\/General Manager - Integrated Product Definition and C-17 Deputy Program Manager 1994-1996. MDA Vice President\/General Manager - C-17 Engineering and Test 1993-1994. MDA Vice President\/General Manager - Government Programs - Product Development and Technology 1993-1994. DAC Vice President MD-12 Design and Technology 1992-1993. DAC Vice President - MD-11 1990-1992.\nPatrick J. Finneran Jr. 50 MDA Vice President\/General Manager - Production Aircraft Programs since January 1995. MDA Vice President\/ General Manager AV-8B 1992-1994. MCAIR General Manager AV-8B 1992. MCAIR Deputy General Manager AV-8B 1990-1992.\nSteven N. Frank 47 MDC Vice President, Associate General Counsel and Secretary since April 1994. MDC Vice President, Associate General Counsel and Assistant Secretary 1992- 1994. Partner of Peper, Martin, Jensen, Maichel & Hetlage 1988-1992.\nThomas M. Gunn 52 MDC Senior Vice President - Business Development since May 1995. MDC Vice President\/General Manager, Strategic Business and International Development 1994. MDC Vice President, Strategic Business Development 1993. MDC Vice President, Special Projects 1992. MDHC President 1990-1992.\nFrederick W. Hill 46 MDC Senior Vice President - Communications and Community Relations since May 1995. Vice President - Public Affairs, Westinghouse Electric Corporation 1993 - 1995. Executive Director - Government Affairs, Westinghouse Electric Corporation 1990-1993.\nRobert H. Hood Jr. 63 DAC President since January 1989.\nLeonard F. Impellizzeri 57 MDA Vice President\/General Manager - Production Operations and General Services since August 1995. MDA Vice President\/General Manager - F\/A-18 A\/B\/C\/D 1992 - 1995. DAC Vice President, Deputy General Manager - C-17 Program 1990-1992.\n10-K Page 8\nDonald R. Kozlowski 58 Military Transport Aircraft Senior Vice President - C-17 Program Manager since December 1993. MDC Vice President\/General Manager-High Speed Civil Transport 1992-1993. MCAIR Vice President\/General Manager - F\/A-18 1991- 1992. MCAIR Vice President\/ General Manager 1988-1991.\nRoger A. Krone 39 MDC Vice President - Treasurer since September 1995. MDA Division Director - Information Systems 1994-1995. MDC Director - Financial Planning 1992 - 1994. Program Manager - Israeli Programs, General Dynamics Corporation 1991-1992.\nF. Mark Kuhlmann 47 MDC Senior Vice President and General Counsel since March 1996. MDC Senior Vice President - Administration and General Counsel 1994-1996. MDC Senior Vice President - Administration, General Counsel and Secretary 1992- 1994. MDC Vice President, General Counsel and Secretary 1991-1992. McDonnell Douglas Systems Integration President 1989-1991.\nHerbert J. Lanese 50 MDA President since March 1996. MDA Deputy President 1995-1996. MDC Executive Vice President and Chief Financial Officer 1992-1995. MDC Senior Vice President - Finance 1989-1992.\nJohn F. McDonnell 57 MDC Chairman of the Board since September 1994. MDC Chairman and Chief Executive Officer 1988-1994.\nThomas J. Motherway 53 McDonnell Douglas Finance Corporation and McDonnell Douglas Realty Company President since January 1995. McDonnell Douglas Realty Company President 1991-1994. McDonnell Douglas Realty Company Assistant to President 1991.\nWillard P. Olson 56 MDA Senior Vice President - Space and Defense Systems since January 1995. MDA Vice President\/General Manager - Space and Defense Systems 1994-1995. MDA Vice President\/General Manager - Huntsville 1990-1994.\nWalter J. Orlowski 52 DAC Senior Vice President - MD-11, MD-80 and MD-90 Programs since January 1996. DAC Vice President\/General Manager - Marketing and Business Development 1993-1996. DAC Vice President\/General Manager - Development Programs 1992-1993. DAC Vice President\/General Manager - MD-12 Program 1991-1992.\nJames F. Palmer 46 MDC Senior Vice President and Chief Financial Officer since July 1995. MDC Vice President - Treasurer 1993-1995. MDA Vice President\/General Manager - Business Management 1992-1993. MCAIR Chief Financial Officer 1991-1992. Partner of Ernst & Young LLP 1985-1991.\n10-K Page 9\nJames B. Peterson 51 MDA Vice President\/General Manager - Integrated Product Definition since September 1995. MDA Vice President\/General Manager - Missiles and Aerospace Support 1995. MDA Vice President\/General Manager - Cruise Missiles 1994-1995. MDA Vice President\/ General Manager - Tomahawk Program 1993-1994. MDA Vice President and Deputy - New Aircraft & Missile Products 1992-1993. MDMSC Vice President - Advanced Programs & Technology 1992. MDMSC Vice President - Technology Division 1991-1992. MDMSC Director - Tomahawk All-Up-Round (Block III) 1986-1991.\nJames C. Restelli 54 MDA Vice President\/General Manager - Missile Systems and Aerospace Support since September 1995. MDA Senior Vice President - Operations 1995. MDA Senior Vice President - Tactical Aircraft and Missile Systems 1992 - 1995. MDA Executive Vice President 1991-1992. MDA Vice President - Business Operations 1990 - 1991.\nMichael M. Sears 48 MDA Vice President\/General Manager - F\/A-18 since January 1994. MDA Vice President\/General Manager - F\/A-18E\/F 1991-1994. MCAIR Vice President\/ General Manager - New Aircraft Products Division 1990-1991.\nJames M. Sinnett 56 MDA Senior Vice President - New Aircraft and Missile Products since December 1993. MDA Vice President\/ General Manager - New Aircraft Products Division 1991-1993. MCAIR Vice President\/General Manager - ATF 1990-1991.\nHarry C. Stonecipher 59 MDC President and Chief Executive Officer since September 1994. Chairman of the Board, President and Chief Executive Officer of Sundstrand Corporation 1991-1994. President and Chief Executive Officer of Sundstrand Corporation 1989-1991.\nWilliam L. Stowers 48 MDA Vice President\/General Manager - Supplier Management and Procurement since October 1992. MDA Vice President - Procurement 1990-1992.\nRobert H. Trice Jr. 49 MDA Vice President\/General Manager - Business Development since October 1992. MCAIR Vice President - Business Development 1991-1992. MCAIR Vice President - Program Development 1990-1991.\nJohn J. Van Gels 52 DAC Senior Vice President - Operations since February 1996. DAC Executive Vice President - Operations and Production Programs 1994-1996. DAC Vice President\/General Manager - Production Programs 1993-1994. DAC Vice President\/General Manager- MD-11 1992-1993. DAC Vice President\/General Manager - Production Center Operations 1990-1992.\nJohn D. Wolf 51 DAC Senior Vice President - MD-95 since February 1996. DAC Executive Vice President - Development 1994-1996. DAC Executive Vice President 1991-1994. DAC Vice President\/General Manager - MD-90\/MD-80\/DC-9 Programs 1989-1991.\n10-K Page 10\nAll of the executive officers have been employees of the Company at least five years except Edward C. Bavaria, Laurie A. Broedling, Stanley Ebner, Steven N. Frank, Frederick W. Hill, Roger A. Krone, James F. Palmer and Harry C. Stonecipher. There are no arrangements or understandings between any of the executive officers and any other person pursuant to which he was selected as an officer, except for Harry C. Stonecipher, who is party to an employment agreement incorporated by reference herein as Exhibit 10(i).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAt December 31, 1995 the Company's manufacturing, laboratory, office, and warehouse areas totaled 35.8 million square feet, of which 6.1 million square feet were leased. The Company plants are well maintained and in good operating condition. The Company has long-term arrangements with airport authorities enabling it to share the use of runways, taxiways, and other airport facilities at various locations, including St. Louis, Missouri; Long Beach, California; and Mesa, Arizona. Reduced defense spending and reduced commercial aircraft orders over the past several years has resulted in downsizing of personnel and facility needs. As a result of the Company's downsizing, certain of the Company's facilities are held for sale and certain other facilities are currently underutilized.\nThe Company's principal locations are in five states and Canada. Those in St. Louis, Missouri are chiefly devoted to military aircraft, training systems, and missiles. Those in Mesa, Arizona are primarily used for development, manufacture, and assembly of helicopters. In the Los Angeles, California area, principal properties are located in Huntington Beach and Long Beach. Huntington Beach, California properties are utilized for research and manufacture of spacecraft, launch vehicles, and electronics. Long Beach, California properties are devoted to the development, manufacture, and assembly of commercial and military transport aircraft, and to the financial services and other segment. Subassembly work for the commercial and military aircraft business segments is performed at Macon, Georgia; Salt Lake City, Utah; and Toronto, Canada for shipment to operations at Long Beach.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1991, McDonnell Douglas Corporation and General Dynamics (GD) filed a legal action to contest the Navy's termination for default on the A-12 contract. Additional information relative to this matter and claims filed with the Navy on the T45 contract is included in Note 5, \"Contracts in Process and Inventories\" on page 39 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference. See also Note 16, \"Commitments and Contingencies\" on page 48 of the Company's 1995 Annual Report to Shareholders and \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Government Business Audits, Reviews, and Investigations,\" page 28, which are incorporated herein by this reference.\nMcDonnell Douglas is a party to a number of proceedings brought under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly known as Superfund, or similar state statutes. For additional information, see \"Environmental Expenditures\" on page 29 in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\n10-K Page 11\nA number of legal proceedings and claims are pending or have been asserted against the Company including legal proceedings and claims relating to alleged injuries to persons associated with the disposal of hazardous waste. A substantial portion of such legal proceedings and claims is covered by insurance. The Company believes that the final outcome of such proceedings and claims will not have a material adverse effect on the Company's earnings, cash flow, or financial position.\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 1995.\n10-K Page 12\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation required by this item is included on pages 44, 45, 52, and 56 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data for the five years ended December 31, 1995, consisting of the data under the captions \"Summary of Operations\" and \"Balance Sheet Information\" are included at page 52 of the Company's 1995 Annual Report to Shareholders, which is incorporated herein by this 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 contained on pages 22 through 29 of the 1995 Annual Report to Shareholders, which is incorporated herein by this reference.\nIn March 1996, Standard & Poor's raised its ratings of McDonnell Douglas and McDonnell Douglas Finance Corporation senior debt to A-minus from BBB. The rating agency also upgraded its rating on the MDFC subordinated debt to BBB-plus from BBB-minus.\nIn March 1996, Duff & Phelps Credit Rating Co. raised its ratings of McDonnell Douglas and MDFC senior debt to A-minus from BBB-plus. The rating agency also upgraded its rating on the MDFC subordinated debt to BBB-plus from BBB-minus.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by this item is included on pages 30 through 49, 51, and 56 of the 1995 Annual Report to Shareholders, which are incorporated herein by this reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThis item is not applicable.\nPART III\nITEMS 10, 11, 12 and 13\nThe information called for by Part III, Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"Item 11 \"Executive Compensation,\" Item 12","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)1. LIST OF FINANCIAL STATEMENTS\nThe following consolidated financial statements of McDonnell Douglas Corporation and Subsidiaries included in the 1995 Annual Report to Shareholders at the pages indicated, are incorporated herein by this reference:\nReport of Ernst & Young LLP, Independent Auditors, page 51.\nConsolidated Statement of Operations, years ended December 31, 1995, 1994, and 1993, page 31.\nBalance Sheet, December 31, 1995 and 1994, page 32.\nConsolidated Statement of Shareholders' Equity, years ended December 31, 1995, 1994, and 1993, page 34.\nConsolidated Statement of Cash Flows, years ended December 31, 1995, 1994, and 1993, page 35.\nNotes to Consolidated Financial Statements, pages 36 through 49.\nSelected Financial Data by Industry Segment, page 30.\nQuarterly Results of Operations, page 56.\n(a)2. LIST OF FINANCIAL STATEMENT SCHEDULES\nSee Index to Financial Statement Schedules on page 19.\nAll other schedules for which provision is made in the applicable regulation of the Securities and Exchange Commission are omitted either because they are not applicable or because the required information is included in the financial statements or notes thereto.\n(a)3. EXHIBITS\nSee Index to Exhibits on pages 15 through 18.\n(b) REPORTS ON FORM 8-K FILED DURING THE FOURTH QUARTER OF 1995:\nForm 8-K\/A filed on October 11, 1995, in response to Item 5.\n10-K Page 14\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMCDONNELL DOUGLAS CORPORATION (Registrant)\nDate: March 25, 1996 By: \/s\/ Robert L. Brand --------------- ------------------------------ Robert L. Brand Vice President and Controller and Registrant's Authorized Officer (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 date indicated below.\nSignature Title Date --------- ----- ---- \/s\/ Harry C. Stonecipher March 25, 1996 - ------------------------ Harry C. Stonecipher Director, President & Chief Executive Officer (Principal Executive Officer)\n\/s\/ James F. Palmer March 25, 1996 - ------------------------- James F. Palmer Senior Vice President and Chief Financial Officer (Principal Financial Officer)\n\/s\/ Robert L. Brand March 25, 1996 - ------------------------- Robert L. Brand Vice President and Controller (Principal Accounting Officer)\n\/s\/ John F. McDonnell \/s\/ Kenneth M. Duberstein - --------------------------- ------------------------------- John F. McDonnell, Director Kenneth M. Duberstein, Director\n\/s\/ John H. Biggs \/s\/ William S. Kanaga - --------------------------- ------------------------------- John H. Biggs, Director William S. Kanaga, Director\n\/s\/ B.A. Bridgewater, Jr. \/s\/ James S. McDonnell III - -------------------------- ------------------------------ B.A. Bridgewater, Jr., Director James S. McDonnell III, Director\n\/s\/ Beverly B. Byron \/s\/ George A. Schaefer - -------------------------- --------------------------------- Beverly B. Byron, Director George A. Schaefer, Director\n\/s\/ William E. Cornelius \/s\/ Ronald L. Thompson - --------------------------- --------------------------------- William E. Cornelius, Director Ronald L. Thompson, Director\n\/s\/ William H. Danforth \/s\/ P. Roy Vagelos - -------------------------- --------------------------------- William H. Danforth, Director P. Roy Vagelos, Director\nDate: March 25, 1996\n10-K Page 15\nMCDONNELL DOUGLAS CORPORATION AND SUBSIDIARIES\nINDEX TO EXHIBITS\nEXHIBIT\n3(a) Articles of Restatement of the Company's Charter, as filed June 13, 1994. - Incorporated by reference to Exhibit 4(b) to the Company's Registration Statement on Form S-8, Commission File No. 33-56129, filed with the Commission on October 21, 1994.\n3(b) Bylaws of the Company, as amended March 6, 1996.\n4(a) Indenture dated as of September 1, 1985 between the Company and The Bank of New York as Successor Trustee to Citibank, N.A. - Incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form S-3, Commission File No. 33-36180, filed with the Commission on August 1, 1990.\n4(b) First Supplemental Indenture dated as of July 1, 1986 between the Company and The Bank of New York as Successor Trustee to Citibank, N.A. - Incorporated by reference to Exhibit 4(b) to the Company's Registration Statement on Form S-3, Commission File No. 33-36180, filed with the Commission on August 1, 1990.\n4(c) Second Supplemental Indenture dated as of April 2, 1992 between the Company and The Bank of New York as Successor Trustee to Citibank, N.A. - Incorporated by reference to Exhibit 4(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4(d) Agreement of Resignation, Appointment and Acceptance dated as of May 17, 1993 by and among the Company, Citibank, N.A., as Resigning Trustee, and The Bank of New York, as Successor Trustee. - Incorporated by reference to Exhibit 4(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n4(e) Form of 8-5\/8% Notes due April 1, 1997. - Incorporated by reference to Exhibit 4(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4(f) Form of 9-1\/4% Notes due April 1, 2002. - Incorporated by reference to Exhibit 4(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4(g) Form of 9-3\/4% Debentures due April 1, 2012. - Incorporated by reference to Exhibit 4(h) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4(h) Form of 8-1\/4% Notes due July 1, 2000. - Incorporated by reference to Exhibit 4(h) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n4(i) Rights Agreement dated as of August 2, 1990 between the Company and First Chicago Trust Company of New York, which includes as Exhibit B thereto the form of Rights Certificate. - Incorporated by reference to Exhibits 1 and 2 to the Company's Report on Form 8-K filed with the Commission on August 6, 1990.\n4(j) Amendment Number One to Rights Agreement, dated as of January 3, 1995. - Incorporated by reference to Exhibit 4(j) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10(a)* McDonnell Douglas Corporation Incentive Award Plan, as amended and restated as of July 20, 1990. - Incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10(b)* Incentive Compensation Program, as amended and restated as of March 2, 1992 under the McDonnell Douglas Corporation Incentive Award Plan. - Incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n10(c)* Long-Term Incentive Program, as amended and restated as of February 8, 1995 under the McDonnell Douglas Corporation Incentive Award Plan. - Incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10(d)* McDonnell Douglas Corporation Senior Executive Performance Sharing Plan\n10(e)* McDonnell Douglas Corporation Performance Sharing Plan, as amended and restated as of 5 March 1996.\n10(f)* McDonnell Douglas Corporation Deferred Compensation Plan for Nonemployee Directors. - Incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10-K Page 17\n10(g)* McDonnell Douglas Corporation 1995 Compensation Plan for Nonemployee Directors.\n10(h)* McDonnell Douglas Corporation 1994 Performance and Equity Incentive Plan. - Incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form S-8, Commission File No. 33-56129, filed with the Commission on October 21, 1994.\n10(i)* Employment Agreement between Harry C. Stonecipher and McDonnell Douglas Corporation, dated as of September 24, 1994, as amended as of March 25, 1995.\n10(j)* Stock Option Agreement between Harry C. Stonecipher and McDonnell Douglas Corporation, dated as of September 24, 1994.\n10(k)* Form of Termination Benefits Agreement between the Company and eight Executive Officers of the Company, dated as of March 15, 1996.\n10(l)* Settlement Agreement and General and Special Release between the Company and John P. Capellupo, dated as of March 7, 1996.\n10(m)* Form of Performance Accelerated Restricted Stock Award Agreement (Service-Based Vesting) - Incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10(n)* Form of Performance Accelerated Restricted Stock Award Agreement (Performance-Based Vesting) - Incorporated by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n11 Computation of earnings per share.\n12 Computation of Ratio of Earnings to Fixed Charges.\n10-K Page 18\n13 Sections of 1995 McDonnell Douglas Corporation Annual Report to Shareholders appearing under the caption: \"Military Aircraft, Missiles, Space, and Electronic Systems,\" \"Commercial Aircraft,\" \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" \"Selected Financial Data by Industry Segment,\" \"Consolidated Statement of Operations,\" \"Balance Sheet,\" \"Consolidated Statement of Shareholders' Equity,\" \"Consolidated Statement of Cash Flows,\" \"Notes to Consolidated Financial Statements,\" \"Report of Ernst & Young LLP, Independent Auditors,\" \"Five-Year Consolidated Financial Summary,\" and \"Supplemental Information.\"\n21 Subsidiaries.\n23 Consents of Independent Auditors regarding incorporation of their report included in the 1995 Annual Report to Shareholders of McDonnell Douglas Corporation into Form 10-K and incorporation of Form 10-K into Registration Statements on Form S-3 and Form S-8.\n27 Financial Data Schedule.\n* Represents management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n10-K Page 19\nMCDONNELL DOUGLAS CORPORATION AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedules of McDonnell Douglas Corporation and Subsidiaries for the year ended December 31, 1995, are included herein:\nReport of Independent Auditors\nSchedule II Valuation and Qualifying Accounts\n10-K Page 20\nREPORT OF INDEPENDENT AUDITORS\nWe have audited the consolidated financial statements of McDonnell Douglas Corporation and subsidiaries (MDC) 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 17, 1996 (incorporated by reference elsewhere in this Annual Report on Form 10-K). Our audits also included the financial statement schedule listed in item 14(a) of this Annual Report on 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.\n\/s\/ Ernst & Young LLP\nSt. Louis, Missouri January 17, 1996\n10-K Page 21\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS McDonnell Douglas Corporation Years Ended December 31, 1995, 1994, and 1993 (Millions of Dollars)\nBALANCE CHARGED BALANCE AT TO CHARGED AT BEGINNING COSTS AND TO END OF EXPENSES OTHER DEDUCTIONS OF PERIOD ACCOUNTS PERIOD -------- ---------- -------- ---------- -------\nYear Ended December 31, 1995: Allowance for commercial aircraft financing $10 $ 3 $ $ 1 $12 Allowance for uncollectible accounts 50 13 13 50 --- --- --- --- --- $60 $16 $ $14 $62 === === === === ===\nYear Ended December 31, 1994: Allowance for commercial aircraft financing $20 $ $ $10 $10 Allowance for uncollectible accounts 50 13 13 50 --- --- --- --- --- $70 $13 $ $23 $60 === === === === ===\nYear Ended December 31, 1993: Allowance for commercial aircraft financing $ 6 $14 $ $ $20 Allowance for uncollectible accounts 48 15 2 15 50 --- --- --- --- --- $54 $29 $ 2 $15 $70 === === === === ===\nNOTE: Amounts charged to other accounts are principally reclassifications. Deductions are principally the write off of uncollectible accounts.","section_15":""}
{"filename":"726712_1995.txt","cik":"726712","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSulcus Computer Corporation was incorporated in the Commonwealth of Pennsylvania on November 5, 1979, under the name of \"Ragtronics, Inc.,\" and adopted its present name in December 1982. As used herein, the terms \"Sulcus\" or \"Company\" are used to refer to Sulcus Computer Corporation and its subsidiaries. Sulcus develops, manufactures, markets and installs microcomputer systems designed to automate the creation, handling, storage and retrieval of information and documents. The Company designs its systems primarily for the hospitality and real estate industries and to a lesser extent, the legal profession. The Company's sales practices are currently systems oriented (rather than individual sales of hardware or software) toward the vertical marketing of its integrated products. Systems include a network of hardware, software and cabling as well as stand alone systems for which the hardware and software are not separately sold. The Company's systems are offered together with full services training, maintenance, and support. The Company has installed systems throughout North and South America, Europe, Africa, Asia and Australia. Customers include property management companies, condominiums, hotels, motels, restaurants, resorts, country clubs, cruise lines, real estate loan and closing offices, title insurance companies, abstract companies, escrow offices and law offices.\nHISTORICAL DEVELOPMENT\nThe Company provides its systems to customers on a turnkey basis, meaning that Sulcus provides all of a customer's needs to automate the portion of a customer's business where it competes, including hardware, software, training, maintenance and support. Sulcus believes that this approach is critical in business applications because while some businesses can automate a specific task, most are unable to effectively automate a broad range of a customer's business. The Company's sales practices and trends are currently oriented to sales of systems (rather than individual sales of hardware or software) and to the vertical marketing of its integrated products.\nIn 1988, the Company began to develop a strategic plan to achieve a leadership position in turnkey computer systems with specific software for the real-estate related, hospitality and legal industry groups. The strategic plan envisions internal growth by way of expanded research and development, as well as growth through acquisitions, mergers, joint ventures and similar alliances. As part of its growth strategy, Sulcus has explored acquisition opportunities which create additional market opportunities for existing products, have products that complement or expand existing product lines, and create additional product distribution channels. Sulcus has made numerous acquisitions to date described below:\nIn July 1989, a subsidiary of Sulcus acquired a non-exclusive license from CompuSolv for established property management software systems for the hospitality industry. These systems are used by the hotel, motel, condominium, restaurant and travel industries to automate front office, back office, point of sale and call accounting systems.\nRADIX\nIn August 1990, Sulcus established Radix Systems, Inc., a wholly-owned subsidiary with its primary offices in Conshohocken, Pennsylvania. Radix provided field engineering and support services including site analysis, cabling, and Novell(R) training. Since that time, Radix has added LANmark support and Squirrel system sales and support.\nLODGISTIX\nIn February 1991, Sulcus acquired Lodgistix, Inc., an integrator of property management systems in the hospitality industry. Lodgistix was a developer of automated hotel systems including front office, back office, sales and catering and interfaces to other hotel-related systems. The Lodgistix stockholders received one unit (the \"Unit\") of Sulcus for each 13.479 shares of their Lodgistix Common Stock, each Unit consisting of two shares of Sulcus Common Stock and two Class A Warrants. An aggregate of 484,375 Units were issued to all Lodgistix stockholders with a value of $3,100,000.\nSULCUS (AUSTRALIA) PTY. LTD.\nEffective November 1, 1991, the Company established a direct sales office in Australia by acquiring certain assets, trade names, leasehold improvements and equipment for approximately $200,000 from Belvoir Lodgistix Group Pty. Ltd. and its shareholders. Belvoir Lodgistix was the distributor of Lodgistix, Inc.'s systems in Australia and Eastern Asia. The Company's name was changed to Sulcus (Australia) Pty. Ltd. Sulcus (Australia) Pty. Ltd. sells and supports the full range of the Company's property management and point-of-sale systems.\nSQUIRREL\nIn March 1992, the Company acquired Squirrel Companies, Inc. Squirrel develops and markets touch-screen software systems to the hospitality industry. Squirrel's software systems consist principally of point-of-sale software coupled with food and beverage software and hardware. Sulcus purchased Squirrel in exchange for $500,000, 401,260 shares of Sulcus Common Stock valued at $2,307,245 and options to purchase up to 400,000 shares of Sulcus Common Stock at an exercise price of $4.25 per share. The options for 175,000 shares were vested immediately and the balance were to vest in each of the three years ended December 31, 1992, 1993 and 1994 if Squirrel met its earn-out objective. In addition, the shareholders of Squirrel were entitled to receive up to 451,665 additional shares of the Company's Common Stock if Squirrel attained its earn-out objective for those three years. For the years ended December 31, 1992 and 1994, Squirrel achieved sufficient earnings to entitle the former shareholders to earn-out payments. The Company issued an aggregate of 124,048 shares for 1992 and 1994 respectively, having an aggregate value of $880,288. The amounts of the earn-out payments and other matters relating to the agreement were disputed by the former shareholders of Squirrel. This dispute was settled and all claims and counterclaims were dismissed. (See \"Item 3. Legal Proceedings\")\nNRG\nIn March 1992, the Company acquired NRG Management Systems, Inc. (NRG) in exchange for 61,968 shares of the Company's Common Stock for an aggregate value of $473,207. NRG develops and markets energy and room management software to the hotel and motel industry. The applications include HVAC energy management, in-room safes, mini-bar, maid status, and room occupancy and security. In 1996, the Company began marketing an improved version of the product under the name CIRIS I. The shareholders of NRG were entitled to receive up to 324,324 additional shares of the Company's Common Stock if NRG attained certain projected after tax earnings for the years 1992 through 1994. At December 31, 1992, NRG achieved such earnings for 1992, and the Company issued 16,019 shares of Sulcus Common Stock for an aggregate value of $148,173 ($9.25 per share). For the years ended December 31, 1993 and 1994, NRG did not achieve their projections, therefore, pursuant to the Stock Purchase Agreement, no buy out shares were issued.\nJBA\nIn July and September 1992, respectively, the Company acquired JBA (HK) Ltd. of Hong Kong and JBA Singapore PTE. LTD. The names of the companies were subsequently changed to Sulcus Hospitality Limited and Sulcus Singapore Pte. Ltd., respectively. Sulcus Hospitality Limited and Sulcus Singapore Pte. Ltd. market the full range of the Company's property management and point-of-sale systems. The purchase price of both companies consisted of a total of $1,450,000 in cash. In addition, the former shareholders were entitled to receive shares of Sulcus up to an aggregate value of $8,855,000 contingent upon achieving certain earnings over a three-year period. At December 31, 1992, these entities achieved such earnings for 1992 and the Company issued 297,652 shares of Sulcus Common Stock for an aggregate value of $2,827,691 ($9.50 per share). As a result of the 1992 restatement of earnings, the Company revised the contingent earn-out calculation based on the restatement adjustments that affected it. The Company cancelled the number of shares of stock issued as a result of the original calculation, all of which are restricted. As a result, at December 31, 1994, the Company reduced goodwill by approximately $2,168,000, reduced equity by approximately $912,000, the estimated current value of the shares to be cancelled, and expensed the difference of $1,256,000 in 1994. For the years ended December 31, 1993 and 1994, these companies did not achieve their projection, and therefore, no earn-out shares were issued.\nTECHOTEL\nEffective January 1, 1993, the Company acquired Techotel, AG of Zug, Switzerland, a hotel software development, marketing, and service organization. The name of the company was subsequently changed to Sulcus Hospitality Group EMEA, A.G. The purchase agreement (as amended) provided for the issuance of $1,000,000 of Sulcus Common Stock. In addition, the shareholders of Techotel were entitled to receive additional shares of the Company's Common Stock if Techotel attained certain projected after-tax earnings in the years 1993 through 1995. The company achieved such earnings for 1993 and 1995. As a result, Sulcus will issue to the former shareholders of Techotel 90,517 and 83,676 shares of Sulcus Common Stock for an aggregate value of $698,110 ($7.7125 per share) and $168,399 ($2.0125 per share) for 1993 and 1995, respectively. Sulcus Hospitality Group EMEA, A.G. did not achieve the required earnings for 1994. Sulcus Hospitality Group EMEA, A.G., through Lodgistix (International) AG, a wholly owned subsidiary, sells and supports the full range of the Company's property management and point-of-sale systems in 30 markets in Europe, the Middle East, and Africa, primarily through distributors.\nLODGISTIX SCANDINAVIA\nIn November of 1993, the Company acquired Lodgistix Scandinavia A.S., distributor of Lodgistix systems in Norway, Sweden and Denmark. The name of this company was subsequently changed to Sulcus Scandinavia, A.S. This company sells a full range of Sulcus products including hotel management systems, restaurant point-of-sale systems, and CIRIS I in-room management systems. The purchase price consisted of 120,000 shares of Sulcus Common Stock with a value of $300,000. In addition, the former stockholders of Lodgistix Scandinavia were entitled to receive additional shares of the Company's Common Stock up to a value of $675,000 contingent upon attaining certain earnings over a three year period. Sulcus Scandinavia achieved required earnings for 1993 and 1995, as a result, Sulcus will issue to the former stockholders of Lodgistix Scandinavia 5,808 and 111,801 shares of Sulcus Common Stock for an aggregate value of $44,864 ($7.725 per share) and $225,000 ($2.0125 per share) for 1993 and 1995, respectively. Lodgistix Scandinavia did not achieve the required earnings for 1994.\nINTERNATIONAL OPERATIONS\nThe Company established international operations for the marketing, support, manufacturing and\/or distribution of its products by virtue of certain of the aforementioned acquisitions. The Company's international operations presently consist of the following subsidiaries: Sulcus (Australia) Pty. Ltd., established as a direct sales office in Australia in November 1991; Squirrel Systems of Canada, Ltd., a Canadian subsidiary of Squirrel located in Vancouver, British Columbia which manufactures and sells Squirrel products; Sulcus Hospitality Limited located in Hong Kong, and Sulcus Singapore, Pte. Ltd., located in Singapore, each a direct sales office; Sulcus Hospitality Group EMEA A.G. located in Switzerland; Sulcus Scandinavia A.S., located in Norway; Sulcus (Malaysia) Sdn Bhd; Squirrel (U.K.) Ltd., Sulcus Hospitality (U.K.) Ltd., and NRG Management Systems (U.K.), Ltd. located in the United Kingdom, all direct sales and support offices, and Sulcus Hospitality Group located in Belgium, which operates as a customer support office.\nSulcus localizes its products for use in other countries so that all monetary references, user messages, and documentation reflect the monetary units, language and other conventions of a particular country. The Company's international operations are subject to certain risks common to foreign operations in general, such as governmental regulations and import restrictions.\nPRODUCTS\nHARDWARE\nSulcus markets computer systems consisting of hardware, software, training and ongoing support. The hardware platform utilized by the Company's property management and legal systems can be obtained from Sulcus or from elsewhere--either from a manufacturer with whom Sulcus has a value-added remarketing agreement (whereby Sulcus purchases such hardware at a discount) or from a completely independent supplier. The hardware platform utilized by the Company's point-of-sale systems is manufactured by the Company from commercially available computer components.\nIn the event of a turnkey purchase in which Sulcus supplies hardware, software and training, Sulcus offers a Hardware Service Agreement for the maintenance of the equipment. In certain circumstances the hardware supplier provides the equipment maintenance with no revenue accruing to Sulcus. Sulcus performs certain remanufacturing and assembly operations at its own Greensburg, Pennsylvania, Wichita, Kansas and Vancouver, Canada facilities. Sulcus is not dependent on a specific manufacturer for its components or systems.\nThe base systems are supported by printers and other peripherals (as requested by the customer) purchased by Sulcus from manufacturers. Sulcus is not dependent upon any individual supplier for these peripherals and support devices.\nSOFTWARE\nThrough its in-house staff of applications programmers, systems programmers, and software engineers, Sulcus develops and enhances its own proprietary software. Sulcus attempts to have its software operate with single-input (or file-integration) methods so that the user enters data once and the computer will use that data in the various applications desired. The following is a brief description of the Company's principal products:\nProperty Management Software (PMS)\nCOMPUSOLV is a UNIX-based software system which automates hotel front office operations and back office accounting functions. Rights to this software were obtained under a non-exclusive license.\nLANMARK is the Company's proprietary software which uses local area network technology and is designed for managing hotels ranging in size from 150 to more than 2,000 rooms. Customers can purchase different modules of this system to meet their specific needs including front office operations, back office accounting functions, credit card authorization, group room sales, and meeting\/function space and event planning.\nLANLITE is a proprietary system designed to meet the needs of properties which do not require all of the features of LANmark. As with the LANmark system, customers can purchase different modules to meet their specific needs.\nLANEXEC is a proprietary management information system allowing customized reports drawn from the LANmark database.\nINNMAXX is a proprietary Windows based software system written for small lodging properties including lodges, bed and breakfast inns or small resort properties.\nCIRIS I is the Company's proprietary centralized in-room information system which consists of energy and room management software with applications for HVAC management, in-room safes, mini-bar, maid status and room occupancy and security.\nHOTELTRIEVE is a licensed computer output to laser disc information archival and retrieval system tailored to hospitality industry requirements. This system allows the accurate capture and faithful\nreproduction of all archivable information. This system provides storage for up to one million pages on a single disc and gives the benefits of reduced storage and retrieval costs, shortened access time, distribution of information to multiple locations and integration with existing customer electronic systems.\nPoint-of-Sale Software (POS)\nSQUIRREL RESTAURANT MANAGEMENT SYSTEM offers complete automation of full-service restaurant operations. This proprietary system automates order-entry, credit card processing, labor cost management, time and attendance, food and beverage management and data transfer. In addition to stationary terminals, this system also offers remote operations through hand-held terminals.\nSQUIRRELITE is proprietary software for restaurant operations similar to the Squirrel Restaurant Management System but intended for smaller installations.\nOther Software\nTHE ABSTRACTOR is proprietary software which operates together with portable computers and cellular communication to automate the collection and organization of real estate title searches.\nTHE CLOSER 2000 is proprietary software which automates real estate transfers including closing and settlement statements, truth-in-lending disclosures, escrow and trust accounting, forms creation and information indexing.\nPRODUCT SUPPORT SERVICES\nManagement believes that support is fundamental to the continued business relationship with Sulcus' customers.\nUnder software support agreements, Sulcus offices provide response with their own personnel and, if no solution can be found at that level, Sulcus maintains second-level support through its Wichita, Kansas or Vancouver, British Columbia centers which are staffed by specially trained personnel. This multilevel support is intended to ensure the customer's prompt response and service. These services are provided on a 24-hour, seven-day-per-week basis. Software is serviced for a fee under a Support, Maintenance and Enhancement Agreement.\nSulcus provides hardware support for a fee under a Hardware Service Agreement which enables the user to call for a diagnosis and repair or replacement based upon the circumstances. Certain repairs and replacements come with fees in addition to the support agreement, depending on the circumstances. Additionally, depending upon the level of service purchased by the customer, this service may be provided at a customer's site or at centralized facilities. The Company obtains certain hardware support from manufacturers or other service providers for a fee.\nPRODUCT RESEARCH AND DEVELOPMENT AND IMPROVEMENT\nThe Company has a number of ongoing research and development projects consisting of developing new hardware and software products as well as improving existing products.\nMost of the Company's software products are developed internally although the Company has purchased technology and has licenses for certain intellectual property rights. Product documentation is also created internally. Internal development enables Sulcus to maintain closer technical control over the products and gives the Company the latitude to designate which modifications and enhancements are more beneficial and when they should be implemented. The Company has created and acquired a substantial body of development tools and methodology for creating and enhancing its products. These tools and methodology are intended to simplify a product's integration with different operating systems or computers.\nBy making end-user follow-up contacts and by considering and evaluating end-user requests for additional features to products, Sulcus maintains an information base to evaluate market feasibility of new products. Developing new software and updating existing offerings is a continual process performed by research and development groups in the effort to keep their products competitive. Also, since the functions of several products are affected by changes in tax laws and regulations, Sulcus rewrites such affected software to meet these changes for its customers.\nUpdates are made available without charge to those customers who have purchased support or service agreements. Additionally, formally organized user groups exist to provide input and suggestions on new features and modules for products. These groups have periodic meetings and provides significant user information for new product development. Neither the Company nor any of its principal business units is dependent upon a single group of customers or a few customers, the loss of any one or more of which would have a material adverse effect on the Company or any of its principal business units.\nMARKETS\nSulcus offers turnkey systems consisting of hardware, software, supplies, training, maintenance and support to the hospitality and real estate industries as well as the legal profession. These systems are installed throughout North and South America, Europe, Africa, Australia and Asia. Customers include property management companies, condominiums, hotels, motels, restaurants, resorts, country clubs, cruise lines, real estate, loan and closing offices, title insurance companies, abstract companies, escrow offices and law offices.\nThe Company markets its systems through more than 80 locations in over 20 countries. These include locations maintained by the Company as sales offices as well as locations of distributors. Customer assistance and support services are generally offered 24 hours-a-day. The Company has generally had good experience in utilizing its internal resources as well as distributors to market and sell its products and services. Utilizing distributors allows the Company to take advantage of established operations, eliminate office start-up costs, and control costs associated with sales and marketing. Management intends to continue to build the Company's customer and product bases through current channels and to pursue strategic growth through acquisitions, mergers, joint ventures or other alliances.\nTRAINING\nTraining of users is performed by employees of Sulcus who are themselves required to go through a company training program and occasionally by distributors familiar with the business function of the user. Sulcus also trains its personnel in applying the use of teaching techniques to user requirements. Under the turnkey concept the user is taught to customize the output for his specific needs. Sulcus conducts training at its offices and at customers' sites.\nMARKETING AND ADVERTISING\nSulcus utilizes Company owned locations and distributors for the sales of its systems. The Company owned locations account for the majority of Sulcus' sales and are located throughout the United States and in Australia, Hong Kong, Singapore, Switzerland, United Kingdom, Norway, Malaysia and Canada. Sales personnel are employees of the Company and sell Sulcus products directly to end-users and do not represent any other companies. The Company's compensation arrangements with its sales employees generally provide for a commission based on sales performance. Managers engaged in sales activities are compensated by a combination of salary and commission. Distributors are compensated by means of a discount on the purchase price which varies with products offered and to a lesser extent, the territory assigned. The Company sets minimum sales quota requirements for its sales employees and during the past three fiscal years the Company has terminated sales employees and distributors for failing to meet such requirements. The Company is not dependent upon one or a few sales employees or distributors.\nThe Company does not provide customers or distributors with rights to return products, extended payment terms or similar working capital items. The Company does not offer any warranty on its products and encourages its customers to enter into a service agreement.\nSulcus has a national advertising program primarily geared to trade journals and a local and regional cooperative advertising program which encourages the distributors to advertise in their respective areas and attend local trade exhibits and conventions. Representatives of Sulcus attend and demonstrate its products at national conventions of the various industries in which its customers participate. Some of the conventions and trade shows attended include the International Association of Hospitality Accountants, Hotel Industry Technology Exposition and Conference, National Restaurant Association Convention, and the American Land Title Association Convention. Sulcus also conducts a year-round direct-mail program.\nThrough its product strategies, management believes Sulcus can address the automation requirement of each market segment. By doing so, Sulcus provides a full-service product integration and upgrade path as a customer outgrows its present computerized needs. This approach benefits customers by protecting their investment in hardware and software, and allows greater flexibility for future planning.\nCOMPETITION\nCompetition in the computer software market is generally intense and competitors often attempt to emulate successful programs. Of the major competitors, there does not appear to be a clear dominant vendor, due in part to the increased number of competitors entering the marketplace over the past several years. Increased competition has resulted in greater discounting of prices with no lessening of the cost of providing systems and services. Competitive advantages are afforded to those companies which are better capitalized\nand have programming staffs which are able to meet the changing demands of hotel and resort property owners or managers. There can be no assurance that competitors will not develop competitive products or that Sulcus will be able to successfully compete against such competitors or products. The competitive position of Sulcus is not readily available because many companies in this market are privately held and do not publish financial information. Furthermore, there is no organization that routinely collects and evaluates competitive information from which a competitive position can reliably be ascertained.\nThe Company believes there are approximately five to six competitive Property Management Systems vendors that have about the same or more installations than Sulcus. The major competitors in the hotel\/property management market domestically (U.S.) include Hotel Information Systems, Inc. (HIS), Computerized Lodging Systems, Inc. (a subsidiary of MAI Systems), Encore Systems, Inc., and Fidelio Software Corporation (a subsidiary of Micros Systems, Inc.) In Europe, the Middle East and Africa, the major competitors are Fidelio Software Corporation and Hotel Information Systems, Inc. (HIS). In Asia, Hotel Information Systems, Inc., and Fidelio Software Corporation are the Company's major competitors. In the Full Service Restaurant Management System domestic market, competitors are Micros Systems, Inc., NCR Corporation, Restaurant Data Concepts, Inc., MenuSoft Systems, Inc. and Panasonic Communications and Systems Co's. In Europe, the Middle East and Africa, the major competitors are Remanco International, Inc. and Micros Systems, Inc. In Asia, Remanco International, Inc., Micros Systems, Inc. and NCR Corporation are the Company's major competition. The Company has not relied upon any report, study, or other support in connection with this belief. Sulcus Hospitality has been an active participant in the hospitality industry for over twelve years.\nManagement believes that compared to competitive products, Sulcus products are not only superior in feature and function, but in connectivity and integration to other products. Sulcus differentiates itself in the hospitality marketplace in two ways. First, Sulcus utilizes a state-of-the-art development platform for all of its software products which allows the Company to implement its systems on both UNIX computers and DOS computers. The software development platform is extremely flexible and easy to modify, allowing customization of application programs to meet the specific needs of customers and provide less expensive enhancements to the system over time. The Company's internal labor costs are also reduced because of the efficient manner in which its programs can be created and modified. Second, Sulcus offers a complete family of products to the hospitality industry. These products include central reservation systems, property management systems, restaurant POS systems, and computer-aided training. Management believes that support is fundamental to the continued business relationship with Sulcus' customers and that its software support is among the industry's leaders. See \"Business--Product Support Services.\"\nThe Company has generally had favorable experience in utilizing its own employees as well as distributors for marketing and selling the Company's products and services. Use of distributors and dealers allow the Company to take advantage of established operations having required experience with the Company's products. Office start-up costs are eliminated which help in the control of the Company's costs associated with marketing and sales. The disadvantage to using this method of distribution is the lack of direct control and a risk inherent with changes in business and conditions of the distributor which could result in less sales effort and less than expected revenues.\nPRODUCT PROTECTION\nSulcus regards its software and application systems as proprietary and generally relies on a combination of trade secret laws, copyrights, contracts and internal and external nondisclosure safeguards to protect its products. Each of the contracts under which customers use Sulcus' products contain restrictions on using, copying and transferring the products, and prohibit their disclosure to other parties. Despite these restrictions, it may be possible for users or competitors to copy aspects of the products or to obtain information that Sulcus considers as trade secrets. Sulcus believes that any copies so obtained have limited value without access to the product source code which is kept highly confidential. Additionally, many of Sulcus' products contain software and hardware security devices to prevent unauthorized use or copying. Because of the uncertain enforcement of Sulcus' proprietary rights in foreign countries, most products distributed internationally use internal copy protection methods. Only certain aspects of computer software can be patented, and existing copyright laws afford limited practical protection. Sulcus has not patented any of its products although it may seek patent protection for future products. To maintain competitive advantages, Sulcus believes that rapid technological changes in the computer industry places greater emphasis on the knowledge and experience of its personnel and their ability to develop, enhance and market new products, than on patent or copyright protection of technology. Because of this, all employees are required to sign nondisclosure agreements at the time of their employment.\nSulcus has registered in the United States and uses the following trademarks and service marks on its products and services, and considers each to be proprietary: SULCUS(R), LODGEMATE(R), LANmark(R), SQUIRREL(R), LODGISTIX(R), PROWARE(R) and LAWTOMATION(R).\nSulcus has the exclusive license and assignment of the following trademarks: COMPUSOLV(R), EVIDENCE MASTER(R) and COLLECTION LEDGER(R). Sulcus has applied for, or intends to apply for Federal trademark or service mark registration for HAT...ms(TM), INNMAXX(TM), LANEXEC(TM), HOTELTRIEVE(TM), CIRIS I(TM), SQUIRRELITE(TM), NRG(TM), ONE WORLD ONE SYSTEM(SM), NRG SAVER(SM) and SULCLINK(SM). Additionally, Sulcus has registered or applications are pending for various product names in numerous foreign countries.\nPERSONNEL\nAs of April 10, 1996, Sulcus employed 408 persons, including 31 executives engaged in management, 63 persons in administration and finance, 104 technical personnel, 51 persons engaged in sales marketing and 159 persons in training and product support. None of Sulcus' employees are subject to collective bargaining agreements. Sulcus believes its relations with its employees to be excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSulcus' principal executive, and administrative operations are located at Sulcus Centre, 41 N. Main Street, Greensburg, Pennsylvania 15601, in a facility containing approximately 10,000 square feet. Sulcus leases this building under several leases, with a trust established by Sulcus' principal stockholder and Chairman, Jeffrey S. Ratner, expiring on various dates through September 30, 2001. The annual rental commitment under these leases are $229,111 in 1996, $138,105 in 1997, $85,860 in 1998 and $90,144 in 1999, $91,947 in 2000, and $91,947 thereafter. The leases renew automatically for additional two-year terms at a minimum rental of 2% over the prior year's amount, unless canceled by either party.\nLodgistix leases approximately 22,500 square feet of office space in Wichita, Kansas. The approximate monthly costs are $22,900, pursuant to a lease terminating January 31, 1998. Sulcus Hospitality Group, Inc., leases approximately 4,200 square feet of office space in Phoenix, Arizona. The approximate monthly costs are $6,700 under a lease terminating July 31, 1996. Squirrel Systems of Canada, Inc., leases 21,000 square feet in Vancouver, British Columbia, Canada at an approximate monthly cost of $9,400 under a lease terminating on October 31, 2005. Sulcus also leases regional and branch office space under lease arrangements that vary from one year to month-to-month. The total rent expense for these offices was $165,084; $185,251; and $161,700 for the years ending December 31, 1995, 1994, and 1993, respectively.\nIn December 1992, the Company purchased an office building located at 420 West Boynton Beach Boulevard, Boynton Beach, Florida. The purchase price was $338,000. The building has approximately 6,200 square feet, of which 742 square feet is under lease which expires at December 1996. The Company utilizes this facility for executive, sales and administrative offices and, upon expiration of the existing lease, will also utilize this 742 square feet for such purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCLASS ACTION LITIGATION\nIn April 1994, various individual Sulcus shareholders filed 12 lawsuits in the U.S. District Court for the Western District of Pennsylvania asserting federal securities fraud claims against Sulcus and certain of its officers and directors, and others. On October 11, 1994, these lawsuits were consolidated under the caption \"IN RE: SULCUS COMPUTER CORPORATION SECURITIES LITIGATION, II.\" Among the principal allegations contained in one or more of the lawsuits were the following: the Defendants made materially false and misleading positive public representations, which were included in the Company's quarterly reports, press releases and other documents regarding Sulcus and its operations, management, finances, assets, earnings and future business prospects; Sulcus' financial condition; and that financial statements were false and misleading. The aforesaid adversely affected the integrity of the market for Sulcus common stock and artificially inflated or maintained the price of Sulcus common stock. The complaints sought unspecified damages for the decline in the value of the Company's stock together with Plaintiff's costs and expenses.\nOn December 27, 1995, the parties entered into a settlement agreement which established a settlement fund of $800,000 in cash and 1,400,000 Sulcus Common Shares with a value of $2,800,000 as of the date of settlement. The cash portion of the settlement will be paid by insurance ($666,000) and the Company ($134,000). At December 31, 1995, the Company recorded a provision of $2,861,118 which, together with amounts previously accrued ($250,000) represents costs which the Company expects to incur in connection with this settlement agreement.\nSEC INVESTIGATION\nIn April 1996, the Company entered into an agreement in principle with the Staff of the Securities and Exchange Commission (\"Commission\") resolving the previously disclosed investigation of the Company by the Commission. This agreement is subject to approval by the full Commission. Without admitting or denying any wrongdoing, the Company agreed that it would not in the future violate Sections 17(a)(2) and (a)(3) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 promulgated thereunder. With respect to certain press releases issued during 1991 and 1992, the proposed Order Instituting Proceedings makes findings against Sulcus under Section 10(b) and Rule 10b-5. The proposed Order Instituting Proceedings does not make findings against Sulcus under Section 10(b) or Rule 10b-5 with regard to accounting practices. In addition, John Picardi, a Sulcus employee and former Chief Financial Officer of Sulcus' Hospitality Group, and Jeffrey Ratner, Sulcus' Chairman, without admitting or denying any wrongdoing, agreed that they would not in the future violate Sections 17(a)(2) and (a)(3) of the Securities Act, Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 and 13b2-1 promulgated thereunder. There were no fines or other penalties imposed upon the Company or Mr. Ratner. Mr. Picardi agreed not to practice before the Commission as an accountant for a 30 month period.\nOTHER LITIGATION\nLodgistix is the Plaintiff in an action presently pending before the United States District Court for the District of Kansas against Total Technical Services (TTS). Lodgistix is claiming damages in the amount of $796,000 arising from a breach by TTS of an equipment maintenance service agreement entered into between the parties. TTS has filed a counterclaim against Lodgistix in the amount of $800,000. Lodgistix denies that they breached the equipment maintenance service agreement or that they charged the Defendant for services beyond the scope of the aforesaid Agreement. It is the opinion of Lodgistix's counsel, David L. Nelson,\nEsquire, Wichita, Kansas, that the counterclaim as filed against Lodgistix by TTS is without merit and the probability of any liability to the Company is remote. The efforts of Lodgistix to pursue its claim have been stayed because of a Chapter 11 bankruptcy filing by the Defendant.\n---------\nSulcus and Jeffrey S. Ratner were Defendants in an action filed in June 1994, in the Superior Court of Fulton County of the State of Georgia by Raymond D. Schoenbaum, Theodore J. Munchak, and Nathan I. Lipson. Plaintiffs had alleged that Sulcus and Mr. Ratner made fraudulent misrepresentations and that Sulcus and Mr. Ratner breached the Stock Purchase Agreement entered into between Sulcus and Squirrel Companies, Inc., in March 1992, by failing to make certain payments of stock regarding the earn-out provision of the Agreement. The plaintiffs sought damages of $5,000,000.\nOn March 20, 1996, the Company, Mr. Ratner and the Plaintiffs agreed to resolve this dispute. The Company agreed to deliver 498,488 shares of Sulcus Common Stock having an aggregate value of $1,246,220. These shares will represent the entire earn-out for the years ended December 31, 1992, 1993 and 1994, and, therefore, the Company has cancelled 120,488 shares previously issued and tendered but not accepted by Plaintiffs. The Court dismissed the Plaintiff's claims and Sulcus' counterclaims on March 21, 1996.\n---------\nSulcus Computer Corporation, NRG Management Systems, Inc., Jeffrey S. Ratner and Frank Morrisroe are Defendants in an action filed in January 1995, in the Fort Bend County Court in Texas, by Walter Lipski, Jr. (\"Lipski\"), a former executive with the Company's Hospitality Group. Lipski has claimed that Defendants breached the Employment Agreement and Stock Purchase Agreement entered into between the parties and seeks unspecified damages. Defendants believe that there were no breaches and that Mr. Lipski was terminated with cause for failing to fulfill his job duties and responsibilities, failing to achieve financial projections for NRG Management Systems, Inc., misrepresentation of the assets of NRG Management Systems, Inc. and further violations of the employment agreement and Stock Purchase Agreement Mr. Lipski executed as a part of his employment with the Company. Defendants have filed a response to Lipski's complaint. This matter is in its earliest stages and the ultimate outcome cannot be predicted. Based on information collected by the Company from the individual defendants, for the reasons stated above, the Company believes that it has meritorious defenses and intends to vigorously defend the action.\n---------\nOther suits arising in the ordinary course of business are pending against the Company and its subsidiaries. The Company cannot predict the ultimate outcome of these actions or the ones above-described but believes they will not 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\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRICE RANGE OF SECURITIES\nOn May 19, 1992, Sulcus Common Stock began trading on the American Stock Exchange under the symbol SUL. Previously on November 19, 1991, Sulcus' securities were included on the NASDAQ National Market System. Sulcus' Common Stock was traded on the over-the-counter market on the National Association of Securities Dealers Automated Quotations (\"NASDAQ\") National Market System under the symbol SULC.\nOn April 10, 1996, the high and low prices for the Common Stock were $3 3\/16 and $2 7\/8, and respectively.\nAs of April 10, 1996, there were approximately 3,290 record holders of Sulcus' Common Stock.\nITEM: 6 SULCUS COMPUTER CORPORATION Selected Financial Data\nThe following table sets forth selected consolidated financial data of the Company for the five years ended December 31, 1991 through 1995. 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 notes thereto included elsewhere herein.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1995 AS COMPARED TO 1994\nThe significant improvement in 1995 when compared to 1994 is primarily the result of a 7% increase in sales and an improvement in gross margins of 8 percentage points, which together accounted for a $4,428,378 improvement in gross margins, a $1,492,214 reduction in selling, general and administrative expenses and $3,323,408 in portfolio unrealized market changes (from an unrealized loss of $1,861,403 in 1994 to an unrealized gain of $1,462,005 in 1995). During 1995, the Company settled certain shareholder litigation which resulted in provisions of $2,919,333 and wrote-off certain capitalized software development costs totaling $514,694 representing the end of the estimated useful lives of certain systems. Primarily as a result of the above, the Company's net loss in 1995 was ($1,368,956) as compared to a loss of ($11,668,013) in 1994.\nNet sales for the year ended December 31, 1995 were $44,693,302, representing an increase of $2,805,986 (7%) when compared to net sales of $41,887,316 for the same period of 1994. Net system sales for the year ended December 31, 1995 were $27,645,389 as compared to $25,893,783 for the same period of 1994, an increase of $1,751,606 (7%) due primarily to increased sales of the Company's Point of Sale Systems. Support revenues for the year ended December 31, 1995 were $17,047,913 as compared to $15,993,533 for the same period of 1994, an increase of $1,054,380 (7%) due primarily to an increased base of Point of Sale installations. Support revenues are billed and collected in advance for periods of one to twelve months and are recognized as support revenues ratably over the contract period. Sales by offices and distributors of the Company were $35,777,862 (80%) and $8,915,440 (20%), respectively, of net sales for the year ended December 31, 1995 as compared to $31,705,933 (76%) and $10,181,383 (24%) for the comparable 1994 period. The Company previously reported in two industry groups (the Real Estate\/Hospitality Group and the Legal Group). The Legal Group is not material (less than 3% of total sales) to the consolidated operations of the Company, accounting for sales of $1,074,202 in 1995 and $1,185,910 in 1994. Therefore, this discussion and analysis is made on the basis of one industry category.\nCost of goods sold for the year ended December 31, 1995 decreased to $18,965,582 from $20,587,974, a decrease of $1,622,392 (8%) over the comparable 1994 period. As a consequence, cost of goods sold as a percentage of net sales improved for the year ended December 31, 1995 to 42%, as compared to 50% for the same period of 1994. Gross margins of the Company increased to $25,727,720 from $21,299,342, an increase of $4,428,378 (21%) over the year ended December 31, 1994. Cost of system sales for the year ended December 31, 1995 was $14,351,669 (52% of system sales) as compared to $15,078,349 (58% of system sales) for the same period of 1994, a decrease of $726,680 (5%), due primarily to the mix of software and hardware sales and the ability of the Company to control hardware costs. Cost of sales is also lower in 1995 as compared to 1994 because 1994 included amortization of $358,500 related to certain capitalized software development costs written-off in 1994. Cost of support for the year ended December 31, 1995 was $4,613,913 (27% of support revenues) as compared to $5,509,625 (34% of support revenues) for the same period of 1994, a decrease of $895,712 (16%), primarily as the result of the Company's ability to control such costs.\nSelling, general, and administrative expenses decreased in 1995 when compared to 1994. For the year ended December 31, 1995, these expenses were $22,895,996 as compared to $24,388,210 a decrease of $1,492,214 (6%) over the same period of 1994. Selling, general, and administrative expenses as a percentage of net sales decreased to 51% for the year ended December 31, 1995, a 7 percentage point decrease from the\nyear ended December 31, 1994. The reduction in expense is primarily in the areas of bad debts on accounts receivable ($770,000), payroll related costs ($218,000) and travel related expenses ($115,000). Reduction in bad debt expense is the result of changes in Company procedures in extending credit and collections.\nResearch and development expense for the year ended December 31, 1995 decreased to $1,198,999 from $1,596,515, a decrease of $397,516 (25%), as compared to the year ended December 31, 1994. Total amounts expended on research and development (including amounts expensed and amounts capitalized) was $2,201,853 and $3,153,403 for the years ended December 31, 1995 and 1994, respectively. Management believes that these reduced expenditures do not negatively impact the Company's competitive position in the marketplace. The Company continuously evaluates the anticipated future sales of the software systems, and concluded, during the fourth quarter of 1995 that certain systems would have only nominal future sales and, therefore, should be written-off. This write-off (recorded in the fourth quarter of 1995) amounted to $514,694 and is reported in the income statement as a separate component of expenses. In 1994, the Company wrote-off $1,820,246 related to capitalized software costs.\nDepreciation and amortization expense for the year ended December 31, 1995 decreased to $1,520,033 from $2,157,857 for the same period of 1994, a decrease of $637,824 (30%). In 1994, the Company wrote-off certain goodwill associated with the Company's Hong Kong and Singapore subsidiaries which resulted in a $344,000 reduction in 1995 goodwill amortization when compared to that of 1994.\nInterest income for the year ended December 31, 1995 was $1,290,691 as compared to $1,255,848 for the same period of 1994, an increase of $34,843 (3%), due primarily to higher average invested balances.\nInterest expense for the year ended December 31, 1995 increased to $597,672 from $556,269 for the same period of 1994, an increase of $41,403 (7%) due to higher outstanding borrowings.\nDuring 1995, the Company made a provision for the settlement of a shareholder class action suit and increased the estimated cost of the 1993 settlement of a previous shareholder action. On December 27, 1995, the Company settled with the plaintiffs in the action known as \"IN RE: SULCUS COMPUTER CORPORATION SECURITIES LITIGATION, II\". This settlement provided for a settlement fund of $800,000 in cash and 1,400,000 Sulcus Common Shares having a value of $2,800,000 at the time of settlement. The cash portion of the settlement will be paid by insurance ($666,000) and the Company ($134,000). At December 31, 1995, the Company recorded a provision of $2,861,118 which, together with amounts accrued in 1994, represents costs which the Company expects to incur in connection with this settlement. Additionally, in connection with the conclusion of the 1993 settlement action known as \"IN RE: SULCUS COMPUTER CORPORATION SECURITIES LITIGATION\", the Company expects to incur costs of $58,215 in addition to those previously accrued.\nDuring 1995, the Company recorded tax expense of $202,645, representing an estimate of current and deferred taxes attributable to that year. These taxes are incurred in jurisdictions where loss carryforwards are not available. Due to losses from operations and loss carryforwards, the Company incurred no expense in 1994 and 1993. The Company had a net deferred tax asset amounting to $2,099,753, net of valuation allowances of $10,534,223 at December 31, 1995 and $11,058,609 at December 31, 1994. The valuation allowance was decreased in the year ended December 31, 1995 by $524,386 reflecting the Company's estimate of the valuation allowance necessary to reduce the net deferred tax asset to the net recoverable amount. The realizability of this deferred tax asset is contingent upon a number of factors including the ability of the Company to attain a level of operations that will generate taxable income. Management believes that it is more likely than not that it will generate taxable income sufficient to realize a portion of the tax benefits associated with net operating losses and tax credit carryforwards prior to their expiration. This belief is based upon the Company's view of expected profits in 1996 and the next several years. If the Company is unable to generate sufficient taxable income in the future through operating results, increases in the valuation\nallowance will be required through a non-cash charge to expense. However, if the Company achieves sufficient profitability to utilize a greater portion of the deferred tax asset, the valuation allowance will be reduced through a non-cash credit to income.\n1994 AS COMPARED TO 1993\nFor the year ended December 31, 1994, the Company reported net loss of ($11,668,013) as compared to a net loss of ($3,050,100) for the year ended December 31, 1993. For the year ended December 31, 1994, the Company's sales and gross margins decreased from those reported in the same period of 1993. Additionally, the 1994 results included a write-off of software development costs ($1,820,246), the write-off of an investment in an unconsolidated subsidiary ($336,703), the write-off of goodwill ($1,256,000) and a provision for litigation settlement ($250,000) as compared to the 1993 write-off of assets ($970,184) and provision for litigation settlement ($2,237,310). Primarily as a result of the above, the Company's net loss in 1994 was ($11,668,013) as compared to ($3,050,100) in 1993.\nNet sales for the year ended December 31, 1994 were $41,887,316, representing a decrease of $5,458,515 or 12% when compared to net sales of $47,345,831 for the same period of 1993. Net system sales for the year ended December 31, 1994 were $25,893,783 as compared to $32,944,045 for the same period of 1993, a decrease of $7,050,262 (21%) due primarily to a sales decline in the Company's Hong Kong subsidiary, decreases of the Company's Property Management Systems domestic sales and the loss in 1993 of a distribution agreement by the Company's Craftech subsidiary in Hong Kong. Support revenues for the year ended December 31, 1994 were $15,993,533 as compared to $14,401,786 for the same period of 1993, an increase of $1,591,747 (11%) due primarily to increased sales of the Company's Point of Sale Systems and increased support provided under a contract with Holiday Inn Worldwide. Support revenues are billed and collected in advance for periods of one to twelve months and are recognized as support revenues ratably over the contract period. Sales by offices and distributors of the Company were $31,705,933 (76%) and $10,181,383 (24%), respectively, of net sales for the year ended December 31, 1994 as compared to $38,045,473 (80%) and $9,300,358 (20%) for the comparable 1993 period.\nCost of goods sold for the year ended December 31, 1994 decreased to $20,587,974 from $23,084,752, a decrease of $2,496,778 (11%) over the comparable 1993 period. Cost of goods sold as a percentage of net sales remained relatively constant for the year ended December 31, 1994 at 50%, as compared to 49% for the same period of 1993. As a result, gross margins of the Company decreased to $21,299,342 from $24,261,079, a decrease of $2,961,737 (12%) over the year ended December 31, 1993. Cost of system sales for the year ended December 31, 1994 was $15,078,349 (58% of system sales) as compared to $19,126,487 (58% of system sales) for the same period of 1993, a decrease of $4,048,138 (21%). Cost of support for the year ended December 31, 1994 was $5,509,625 (34% of support revenues) as compared to $3,958,265 (27% of support revenues) for the same period of 1993, an increase of $1,551,360 (39%) primarily as the result of increased costs of fulfilling support contracts for existing and acquired customers in connection with hardware and software systems sold.\nSelling, general, and administrative expenses increased in 1994 when compared to 1993. For the year ended December 31, 1994, these expenses were $24,388,210 as compared to $21,726,463 an increase of $2,661,747 (12%) over the same period of 1993. Selling, general, and administrative expenses as a percentage of net sales increased to 58% for the year ended December 31, 1994, a 12 percentage point increase from the year ended December 31, 1993. This increase in costs occurred primarily in the area of payroll and related costs ($2,346,655), legal, professional and auditing ($497,797) and was partially offset by declines in travel related costs ($391,397).\nResearch and development expense for the year ended December 31, 1994 decreased to $1,596,515 from $1,877,628, a decrease of $281,113 (15%) as compared to the year ended December 31, 1993. Total amounts expended on research and development (including amounts expensed and amounts capitalized) was $3,153,403 and $4,346,965 for the years ended December 31, 1994 and 1993, respectively. Management believes that these reduced expenditures do not negatively impact the Company's competitive position in the marketplace. During the third quarter of 1994, the Company wrote-off capitalized software costs of $1,820,246, representing the assessment that certain customer related software would no longer benefit future periods. This write-off is presented in the income statement as a separate component of expenses.\nDepreciation and amortization expense for the year ended December 31, 1994 increased to $2,157,857 from $2,034,144 for the same period of 1993, an increase of $123,713 (6%).\nInterest income for the year ended December 31, 1994 was $1,255,848 as compared to $1,937,314 for the same period of 1993, a decrease of $681,466 (35%), due primarily to lower average invested balances.\nInterest expense for the year ended December 31, 1994 increased to $556,269 from $402,764 for the same period of 1993, an increase of $153,505 (38%) due to higher outstanding borrowings and higher interest rates.\nDuring 1994 and 1993, the Company did not record a provision for income tax expense, based upon estimates of the impact of losses for tax purposes, changes in deferred tax assets and the availability of loss carryforwards.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's liquidity is dependent upon its ability to generate sufficient working capital through profitable operations. Management believes that in order to sustain profitability, it must continue to increase sales and improve productivity related to selling, general and administrative expenses. In order to increase sales, the Company believes that it must increase its distribution channels, introduce additional developed or acquired competitive products in its current market segment.\nCurrent short-term capital needs will be funded primarily through internal working capital and anticipated operating revenues from new sales, continuing and new support services revenue, and a backlog of orders received and pending. The Company has no significant unused lines of credit at either December 31, 1995 or December 31, 1994. To date, bank credit lines have not been a significant component of the Company's liquidity and capital resources.\nAt December 31, 1995, Sulcus' cash and cash equivalents decreased to $1,202,325 from $1,933,895 at December 31, 1994, a decrease of $731,570 (38%). Since the Company operates in a number of countries, cash and cash equivalents are maintained by the various operating subsidiaries in the local currencies of these countries for the purpose of paying expenses as they are due.\nThe Company maintains a portfolio of short-term investments (primarily in the form of preferred stocks) which may be used for the purpose of providing liquidity. At December 31, 1995, the Company's short-term investment portfolio increased to $12,408,075 from $10,324,740 at December 31, 1994, an increase of $2,083,335 (20%). This increase consisted primarily of unrealized appreciation of $1,457,728. These investments are subject to risk, most notably the risk that the market value of these assets will decline as the result of general market fluctuations, increases in interest rates or changes in the underlying operations of the investee. Company policy does not require temporary investments to be investment grade as determined by a nationally recognized statistical rating organization nor does it require that such investments have any\nadditional safety feature such as insurance. Through the first five months of 1995, the Company maintained its investment philosophy of actively buying and selling investments with the objective of generating profits of short-term differences in price (\"Trading\"). Management sold a portion of these investments in May and June of 1995 and invested the proceeds of these sales in securities which will be held for the generation primarily of dividend and interest income (\"Available for Sale\"). Additionally, the remaining investments were reclassified in 1995 from Trading to Available for Sale. The Company had borrowings at December 31, 1995, and December 31, 1994, of $6,062,905 and $5,145,753 respectively, on margin against its investments at the brokers internally established floating interest rate which was 8.375% at December 31, 1995.\nAt December 31, 1995, accounts receivable decreased to $11,134,576, as compared to $11,639,243 at December 31, 1994, a decrease of $504,667 (4%) primarily due to increased collections on support contracts. The Company's gross accounts receivable includes hardware and software support contracts as well as amounts due on system installations which may take several months to modify and complete. The Company records a provision for amounts which it estimates may ultimately be uncollectible from customers. The allowance for uncollectible accounts remained relatively constant at December 31, 1995, decreasing slightly to $2,581,020 at December 31, 1995 as compared to $2,597,088 at December 31, 1994.\nThe Company purchases computer hardware and other equipment from vendors under open accounts payable for the purpose of including these items in systems sold to customers. Hardware and equipment are readily available in the marketplace and therefore it is not necessary for the Company to maintain large quantities of inventories to meet customer needs. Inventories of computers, computer components and computer peripherals increased to $2,573,826 at December 31, 1995 as compared to $2,393,563 at December 31, 1994, an increase of $180,263 (8%). Accounts payable decreased to $4,352,408 at December 31, 1995 as compared to $5,836,482 at December 31, 1994, a decrease of $1,484,074 (25%).\nThe Company leases facilities under operating lease agreements of varying terms. Properties and equipment consist primarily of leasehold improvements and equipment used in the conduct of business. Property and equipment, net of accumulated depreciation and amortization, decreased to $2,015,816 at December 31, 1995 from $2,301,263 at December 31, 1994, a decrease of $285,447.\nIn addition to borrowings on margin against its investments, the Company has outstanding short and long-term borrowings from various financial institutions. At December 31, 1995, the Company had short-term borrowings (excluding borrowings under margin) of $319,805 as compared to $1,037,242 at December 31, 1994, a decrease of $717,437 (69%). At December 31, 1995, the Company had long-term borrowings (including current and noncurrent portions) of $73,888 as compared to $554,526 at December 31, 1994, a decrease of $480,638 (87%).\nThe backlog of hardware and software orders at December 31, 1995 is expected to be filled within one year and amounted to $3,353,000 at December 31, 1995 as compared to $3,264,000 at December 31, 1994.\nThe Company's ability to develop and expand its presence in the hospitality industry and expand existing business lines for its other markets depends, in a large part, on the availability of adequate funds. Management believes that anticipated revenues from the operations together with available capital will be sufficient to support the anticipated operating and capital requirements of the Company for at least 12 months. Nonetheless, if technological changes render Sulcus' products uncompetitive or obsolete, or, if the Company incurs operating losses, it may be forced to seek additional financing. There can be no assurance that any financing will be available when needed, or, if available, that it can be obtained on terms satisfactory to the Company.\nOther suits arising in the ordinary course of business are pending against the Company and its subsidiaries. The Company believes that the ultimate outcome of these actions and those described in the paragraphs above will not result in a material adverse effect on the Company's consolidated financial position and liquidity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated financial statements and the Report of Independent Auditors thereon are listed under Item 14(a) (1) of this Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn March 20, 1995, and March 22, 1995, the Company filed current reports on Form 8-K with the Securities and Exchange Commission reporting respectively, the resignation of its previous accountants, Ferraro, Krebs & McMurtry, and the engagement of Crowe, Chizek and Company. These reports are incorporated herein by reference.\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 Sulcus are as follows:\nEach director is elected for a period of one year at the Company's annual meeting of Stockholders and serves until his successor is duly elected by the Stockholders. Officers are appointed and serve at the will of the Board of Directors subject in certain cases to the terms of employment agreements.\nJEFFREY S. RATNER is a co-founder of the Company and has served as Chief Executive Officer and Chairman of the Board of Directors since the Company's inception in 1979. In September 1995, Mr. Ratner vacated the Chief Executive Officer position. Since 1975, Mr. Ratner has owned Ratner Real Estate and Ratner Development Corporation and is the Chief Executive Officer and Chairman of the Board of both companies. In 1992, he became Chief Executive Officer and Chairman of the Board of City Rentals, Inc., and is its sole shareholder. These companies purchase, develop, lease and manage commercial and residential real estate. Mr. Ratner does not devote substantial time to these companies.\nROBERT D. GRIES has been a Director of the Company since 1983. From 1964 through the present, Mr. Gries has been President of the Gries Companies and has been engaged in venture capital financing. From 1966 to 1995 he was Vice President, director and a major shareholder of the Cleveland Browns Football Company, Inc., a professional National Football League team.\nHERBERT G. RATNER was elected as a Director of the Company in October 1988. Until he retired in 1992, Mr. Ratner was the Chairman of the Board and principal shareholder of City Industries, Inc., City Rental, Inc., Supermarket Realty, Inc. and Key Motors, Inc., since founding these companies in 1965. He is also a member of the Board of Directors of Holy Cross Hospital in Florida. Mr. Ratner is the father of Jeffrey S. Ratner.\nJOHN W. RYBA joined the Company in September 1987 as its General Counsel and is presently its General Counsel and Vice President, Administration. Mr. Ryba was elected a director in May 1989. Mr. Ryba was engaged in the private practice of law in Pittsburgh, Pennsylvania, from 1984 until joining the Company. His firm represented computer software and hardware companies.\nDAVID H. ADLER was appointed a Director of the Company in August 1993. Mr. Adler has been Chief Executive Officer and majority shareholder of a group of privately-owned companies since 1985, including the Adler Financial Group, David H. Adler Real Estate Enterprises and PEBECO (Pennsylvania Bedding Incorporated) of Scranton, Pennsylvania, a manufacturer of King Koil and other private labelled mattresses and sleep products.\nJOEL B. NAGELMANN joined the Company in April 1995 as its President. Previously, from March 1994, until joining the Company, he was hired to create and was Vice President and General Manager of Enterprise Information Solutions Group of Amdahl Corporation (AMEX:AMH), which develops and markets computer systems and services. Prior to joining Amdahl Corporation, from 1988 to 1993, he was President of Xerox Services (XCS), a division of Xerox Computer Corporation (NYSE:XEROX). XCS develops and markets specialized software applications domestically and internationally.\nH. RICHARD HOWIE joined the Company in July 1994, as Chief Financial Officer\/Vice President-Finance and Treasurer. Previously, from January 1994 to June 1994, he was Chief Financial Officer at Central Blood Bank, Inc. From 1987 to November 1993, he was Vice President Finance and Chief Financial Officer of Stuart Medical, Inc., a nationwide hospital distributor of medical and surgical supplies.\nDELMER C. GOWING III joined the Company in July 1994, as its Chief Legal Officer. He had been a partner at the law firm of Honigman, Miller, Schwartz and Cohn, in their West Palm Beach, Florida office from 1991 to July 1994. From 1989 to 1991, he held the position of Executive Counsel of Finalco Group, Inc., an equipment leasing company. From June 1995 to date, he is a partner at Hertz, Schram & Saretsky in their West Palm Beach office while still serving as Chief Legal Officer of the Company.\nMARGARET SANTONE joined the Company in 1979 as Corporate Secretary and Office Manager. From 1975 to the present, she has also served as the Corporate Secretary of Ratner Development Corporation and Ratner Real Estate. Ms. Santone does not devote substantial time to these companies.\nWILLIAM F. MCLAY joined the Company in 1990 as its Chief Financial Officer until January 1991, when he left to serve as a Financial Advisor to Foster Industries, Inc. through 1992. Mr. McLay rejoined the Company in 1993, as Director of Corporate Planning and Development, later becoming Managing Director. Mr. McLay was Vice-President and Controller of American Equity Corporation from 1984 to 1989. Prior thereto, from 1976 to 1984, he served as Controller and Treasurer of Woodings-Verona Tool Works, Inc., a subsidiary of The Budd Company (formerly NYSE:BF).\nBARRY LOGAN was promoted to Vice President, General Manager-Restaurant Division of Sulcus Hospitality Group in 1994. He joined the Company as Vice President of Research and Development of Squirrel at the time of its acquisition by the Company in March 1992. Prior thereto, he was responsible for the evolution of the Squirrel product line from its inception in 1984. Prior to joining Squirrel in November 1984, he developed a time sharing system operation and has been involved in a variety of computer-oriented organizations since 1972.\nGARY CAMPBELL joined the Company in November 1993, as President of a then newly formed subsidiary, Revenue Management Systems, Inc. In June 1995, he was appointed Vice President for International Operations of Sulcus Hospitality Group. From 1991 until joining the Company, Mr. Campbell was a founder and President of Revenue Technology Services, Inc., a software company. Before founding Revenue Technology Services, Inc., from 1973, he served as the Director of Business Information Services, a subsidiary of Control Data Corporation.\nBERNHARD MANTEL joined the Company following the acquisition of its subsidiary, Techotel, Inc. in January 1993, as the Managing Director of Techotel, Inc. (now Sulcus Hospitality Group EMEA, A.G.) and Lodgistix (International), AG, a wholly-owned subsidiary of Techotel. From 1983 until joining Sulcus, he founded Techotel, Inc. (\"Techotel\") and Lodgistix (International), AG and served in the same capacities for each. He also serves as a Director of Techotel's subsidiary Sulcus (U.K.), Ltd. (since its inception in 1987).\nJAPPE KJAER joined the Company in January 1994, as President of the Company's subsidiary, Sulcus Scandinavia A.S. (formerly Lodgistix Scandinavia A.S.), upon its acquisition by Sulcus. Mr. Kjaer founded Lodgistix Scandinavia A.S., a Lodgistix distributor in Norway, Sweden, and Denmark, in 1987, and served as its General Manager.\nTHOMAS CAUDILL was promoted to Vice President, General Manager--Lodging Division of Sulcus Hospitality Group in 1994. Previously he had been Vice President Sales-Eastern Region. Prior to joining the Company, from 1986 to 1993, he was a Director of Sales for Covia, a partnership of seven airlines, which developed and marketed the Apollo reservation system.\nGERRY LAU joined the Company on February 1995 as Chairman of Sulcus Hospitality Limited. Prior thereto, Mr. Lau served as a Managing Director of Data General Corporation (NYSE:DGN), from March 1994 until February 1995, as a partner of TASA International (a Swiss consulting firm), from 1993 to March 1994, and as Group Managing Director of Innovest Systems and Services Private Limited, from 1986 to 1993.\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 officers and directors, and persons who own more than ten percent of the Company's common stock to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the \"SEC\") and the American Stock Exchange. Such persons are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on review of the copies of such forms furnished to the Company, or written representation that no other reports were required, the Company believes that during 1995 all Section 16(a) filing requirements applicable to its officers and directors were complied with except for Victor Nightscales, who made one late filing with regard to shares of stock issued to him under the terms of a Stock Purchase Agreement regarding Sulcus' acquisition of Squirrel Companies, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following tables present certain information concerning the cash compensation and stock options provided to the named executive officers during the years ended December 31, 1995, 1994 and 1993. More specific information regarding compensation is provided in the notes accompanying the tables.\nSUMMARY COMPENSATION TABLE\nThe following table reflects the total compensation paid during 1995, 1994 and 1993, for services in all capacities to the Company by the Chairman and each of the other four most highly compensated executive officers of the Company during 1995 (the \"Named Officers\").\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table summarizes the aggregate amount of shares subject to stock options granted, for the period January 1, 1995, through December 31, 1995, to the Chairman and each of the Named Officers. No gain on these options will be realized by the Named Officers without an increase in the price of Company Common Stock from the date of grant, which will benefit all stockholders proportionately.\nAGGREGATED OPTION\/SAR EXERCISED IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION\/SAR VALUES\nThe following table sets forth information concerning the net value realized on the exercise of stock options in 1995 by the Chairman and each of the Named Officers as of December 31, 1995.\nCOMPENSATION OF DIRECTORS\nDirectors who are not officers or employees of Sulcus (\"Outside Directors\") are reimbursed for their direct expenses incurred in attending a meeting.\nEMPLOYMENT ARRANGEMENTS\nThe Company entered into an employment agreement with each of Messrs. Ratner and Ryba in August 1994, and Mr. Gowing in July 1994. Among other things, each agreement provides that if the executives' employment is terminated after a change in control of Sulcus, he may receive, under the agreement, certain benefits including monthly salary payments and acceleration of portions of unexercised stock options. Mr. Ratner may receive twice his then existing salary, benefits and all options granted to him for 36 months if his employment is terminated other than for cause (as defined in the agreement), either voluntarily or involuntarily or due to a change in control. Benefits include insurance, medical and other similar benefits which could otherwise be lost due to termination. Benefits would be substantially reduced if termination for cause occurs. If there is a \"change in control\" (as defined in the agreement), Mr. Ryba may receive his then existing salary for 12 months. On October 16, 1995, Mr. Gowing's employment agreement was revised reducing his salary, cancelling all 150,000 stock options previously granted and granting 50,000 options at $2.25, one-half exercisable on April 17, 1996, and one-half exercisable on December 31, 1996.\nThe agreements provide for an annual salary of $345,000 for Mr. Ratner, and $104,000 for Mr. Ryba. Mr. Gowing received a salary of $15,000 per month until November 1994, $7,500 per month until October 1995 and $1,000 per month thereafter. Mr. Gowing may continue to work on legal matters unrelated to the Company so long as they do not conflict with his Company duties.\nBernhard Mantel entered into an employment agreement with Techotel and its wholly owned subsidiary Lodgistix (International) AG effective January 1, 1993, the effective date of the Company's acquisition of Techotel, now known as Sulcus Hospitality Group EMEA, A.G. and Sulcus (International) AG, respectively. Mr. Mantel serves as Managing Director (President) of both companies, positions he held previously. The agreement, which expired December 31, 1995, provided for an annual salary of Swiss Francs 110,625 (equivalent to U.S. $86,089 at the exchange rate of 1.1446 as of April 30, 1995). Mr. Mantel can earn incentive compensation based on the consolidated pre-tax earnings of these companies subject to a maximum of $139,100, such compensation to be payable one half in cash and one half in incentive stock options of Sulcus at a price determined by dividing one half of such compensation by the average closing price of Company Common Stock on the first ten trading days of December of the year of the earnings. In 1993, he earned no incentive compensation. In 1994 he earned $30,203 of incentive compensation and received options to purchase 6,749 shares of Common Stock at a price of $2.23 per share under the incentive compensation provisions in the agreement. Either Techotel\/Lodgistix or Mr. Mantel may terminate the employment agreement at any time with 14 days written notice, and Lodgistix may terminate immediately with \"cause.\" \"Cause\" encompasses a breach of the employment agreement by the employee, the conviction of the employee of a felony or the commission by the employee of a fraud against the Company.\nH. Richard Howie joined the Company in July 1994, as Chief Financial Officer pursuant to an employment agreement providing for an annual salary of $120,000. Mr. Howie was granted an option to purchase 30,000 shares of Company Common Stock at a price of $3.375 per share. These options were cancelled and new options of 36,000 shares were granted on March 25, 1996, at a price of $2.43, twenty percent of which were immediately exercisable and the rest vesting over four years at twenty percent per year beginning in March 1997. This employment agreement can be terminated by the Company or Mr. Howie on 14 days notice without cause.\nJoel Nagelmann joined the Company in April 1995, as President of the Company pursuant to an employment agreement providing for an annual salary of $200,000. Mr. Nagelmann is entitled to receive\nannual bonuses as of December 31 in each year of his employment, commencing in 1995, based upon a percentage of after-tax earnings of from 3% to 5% (depending on total revenues), subject to limits of from $200,000 to $343,200, to be paid one-half in cash and one-half in stock options. These bonus options vest one-half on the date of grant and one-half one year later. Mr. Nagelmann was also granted an option to purchase 200,000 shares of Common Stock of the Company at $2.50 per share vesting over five years at the rate of 20 percent per year beginning April 1996. Mr. Nagelmann may retain all options granted and all other rights for two years if his employment is terminated without cause. See \"Certain Relationships and Related Transactions.\"\nThe Company's employment agreements impose non-competition and confidentiality obligations and provide for the assignment to the Company of all rights to any technology developed by the executive during the term of his employment. The Company has or is obtaining \"key man\" insurance policies in the face amount of $200,000 on the life of Mr. Howie and $500,000 on the life of Mr. Nagelmann under which the Company is, in each case, the beneficiary.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe following persons participated in compensation decisions made during 1995: Jeffrey S. Ratner, John W. Ryba, Herbert G. Ratner, Robert D. Gries, David H. Adler and Gerald J. Voros (who did not stand for re-election at the annual meeting held on August 29, 1995). There are no interlocking relationships, as defined in the regulations of the Securities and Exchange Commission, involving any of these individuals. See \"Certain Relationships and Related Transactions\" for a description of certain transactions entered into by the Company and Jeffrey S. Ratner.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information as of April 10, 1996, with respect to shares of Common Stock of the Company beneficially owned by each Director and by all officers and Directors as a group, and by persons known to the Company to be beneficial owners of more than 5% of Company Common Stock. As of such date, 14,763,120 shares of Common Stock were outstanding.\n(2) Includes 25,000 shares currently owned of record and 30,000 shares subject to a currently exercisable option.**\n(3) Includes 58,000 shares subject to currently exercisable options.**\n(4) Includes 18,000 shares owned of record and 37,500 shares subject to a currently exercisable option.**\n(5) Includes 10,500 shares owned of record and 30,000 shares subject to a currently exercisable option.**\n(6) Includes 4,500 shares currently owned of record and 87,789 shares subject to a currently exercisable option.**\n(7) Includes 7,200 shares subject to a currently exercisable option.**\n(8) Includes 25,000 shares subject to a currently exercisable option.**\n(9) Includes 20,000 shares subject to a currently exercisable option.**\n(10) Includes 13,175 shares currently owned of record and 32,000 shares subject to currently exercisable options.**\n(11) Includes 20 shares currently owned of record and 4,000 shares subject to a currently exercisable option.**\n(12) Includes 900 shares currently owned of record and 45,616 shares subject to currently exercisable options.**\n(13) Includes 2,750 shares currently owned of record and 16,000 shares subject to currently exercisable options.**\n(14) Includes 189,708 shares currently owned of record.\n(15) Includes 120,000 shares currently owned of record and 8,000 shares subject to a currently exercisable option.**\n(16) Includes 8,000 shares subject to a currently exercisable option.**\n* Less than 1% issued and outstanding.\n** A currently exercisable option is one which is exercisable within 60 days from the date hereof.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company has agreed, under certain circumstances, to provide loans to Joel Nagelmann, its President, in a gross amount of up to $197,000 for up to three years at the rate of 5% per annum. On October 27, 1995, the Company made a loan in the principal amount of $100,000 at 5% interest. The loan is secured by real estate, proceeds from its sale and other assets. The principal is payable on either October 27, 1996, or upon the sale of a former residence, whichever first occurs.\nIn July 1994, the Company loaned Mr. Jappe Kjaer $50,000, pending the registration of the stock of the Company issuable to Mr. Kjaer under the terms of the agreement for the purchase of Lodgistix Scandinavia A\/S (now known as Sulcus Scandinavia A\/S). Mr. Kjaer was the principal shareholder of Lodgistix Scandinavia A\/S and remains its President. The note will be repaid from the proceeds of a sale of Mr. Kjaer's shares of the Company. Prior to the Company's acquisition of Lodgistix Scandinavia A\/S, Mr. Kjaer borrowed $20,000 from Lodgistix Scandinavia A\/S, all of which remains outstanding. These loans do not bear interest.\nIn December 1990, Frank Morrisroe, President of Sulcus Hospitality Group through January 1996, purchased 250,000 shares of Lodgistix's, Inc. Common Stock from Bernhard Mantel, then a European distributor for Lodgistix, Inc., at a price of $0.50 per share for an aggregate of $125,000. Sulcus lent Mr. Morrisroe $101,250 in January 1991 to assist him in the purchase of such shares which was to be repaid over a four-year period with interest at 6% per year. Upon completion of the merger of Lodgistix, Inc., into Sulcus, he received 37,094 shares of Sulcus Common Stock and Class A Warrants to purchase 37,094 additional shares in exchange for his shares of Lodgistix, Inc. These securities were held as collateral for such loans. On January 30, 1996, Mr. Morrisroe repaid all loans in full.\nIn September 1993, the Company loaned Mr. Bernhard Mantel $500,000, pending the registration of the stock of the Company issuable to Mr. Mantel under terms of the agreement for the purchase of Techotel. Mr. Mantel was the principal shareholder of Techotel and remains its Managing Director. The note bears no interest and will be repaid from the proceeds of a sale of Mr. Mantel's shares of the Company.\nSulcus' principal executive, and administrative operations are located at Sulcus Centre, 41 N. Main Street, Greensburg, Pennsylvania 15601, in a facility containing approximately 10,000 square feet. Sulcus leases this building under several leases, with a trust established by Sulcus' principal stockholder and Chairman, Jeffrey S. Ratner, expiring on various dates through September 30, 2001. Rent expense under these agreements was $225,391; $185,251 and $161,700 for the years ended December 31, 1995, 1994 and 1993, respectively. The annual rental commitment under these leases are $229,111 in 1996, $138,105 in 1997, $85,860 in 1998 and $90,144 in 1999, $91,947 in 2000, and $91,947 thereafter. The leases renew automatically for additional two-year terms at a minimum rental rate of 2% over the prior year's amount, unless canceled by either party.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS\n*REPORTS OF INDEPENDENT AUDITORS *CONSOLIDATED BALANCE SHEETS - Years Ended 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\n2. FINANCIAL STATEMENT SCHEDULES ATTACHED HERETO ARE AS FOLLOWS:\nSchedule VIII - Valuation and Qualifying Accounts\nAll other Schedules are omitted since the required information is not present in amount sufficient to require submission of the Schedules, or because the information is included in the Consolidated Financial Statements and Notes thereto.\n3. EXHIBITS INDEX\n(2)(a) Agreement and Plan of Reorganization between Lodgistix and Sulcus.** (a) (i) Amendment 1. to Agreement and Plan of Reorganization.** (ii) Amendment 2. to Agreement and Plan of Reorganization.** (b) Agreement of Merger between Lodgistix and Sulcus.** (b) (i) Amendment 1. to Agreement of Merger.** (b) (ii) Amendment 2. to Agreement of Merger.** (c) (i) Certificate of Merger - Delaware *** (c) (ii) Certificate of Merger - Kansas *** (d) Stock Purchase Agreement among Sulcus, Squirrel and shareholders of Squirrel ***** (e) Stock Purchase Agreement and Plan of Reorganization among Sulcus, NRG and shareholders of NRG ***** (f) Stock Purchase Agreement among Sulcus, JBA and shareholders of JBA++ (g) Stock Purchase Agreement among Sulcus, Techotel and shareholders of Techotel****** (h) Stock Purchase Agreement among Sulcus, Lodgistix Scandinavia and shareholders of Lodgistix Scandinavia*******\n(3)(a) Articles of Incorporation+ (b) Certificate of Amendment to Articles of Incorporation+ (c) Form of Proposed Amendments to Articles of Incorporation*** (d) By-Laws*\n(4)(a) Form of Common Stock Certificate+ (a) (i) Form of Class A Redeemable Warrant* (b) Form of Underwriter's Warrant* (c) Form of Warrant Agreement* (d) Form of Preferred Stock Certificate*** (e) Form of Class B Warrant*** (f) Form of Class B Warrant Agreement***\n(10)(a) Incentive Stock Option Plan, as amended* (a) (i) Form of 1991 Incentive Stock Option Plan*** (b) Director's Stock Option Plan* (b) (ii) Form of 1991 Directors Stock Option Plan*** (c) Form of Incentive Stock Option Agreement* (d) Form of Directors Stock Option Agreement* (e) Exclusive License Agreement between Registrant and Data Source One, Inc., dated May 12, 1988* (f) License agreement between Registrant and San Francisco Legal Systems and Christopher N. Visher, dated November 16, 1988* (g) Exclusive License Agreement between Registrant and Hugh Haggerty, dated December 23, 1988* (h) Management Agreement between Hospitality Management Systems, Inc. and CompuSolv, Inc., dated March 1, 1989* (i) Exclusive License Agreement between Hospitality Management Systems, Inc. and CompuSolv, Inc., dated July 14, 1989* (j) Form of Distributor Agreement* (k) Form of Regional Representative Agreement* (l) Form of Reseller Agreement (Software)* (m) Form of Sales Order* (n) Form of Support, Maintenance & Enhancement Agreement* (o) Form of Hardware Service Agreement* (p) Software Supplier Agreement between Registrant and Hewlett-Packard Company (\"H- P\")* (q) Purchase Agreement between Registrant and H-P* (r) H-P Terms and Conditions of Sale* (s) H-P OEM Certification* (t) H-P OEM\/VAR Warranty* (u) H-P Software License Terms* (v) H-P Warranty and Installation Terms* (w) H-P OEM Products Subject to Discount*\n(x) Form of Purchase\/License Agreement between Hospitality Management Systems, Inc. and Purchaser* (y) Lease for premises at 41 N. Main Street, Greensburg, PA* (z) (i) Employment Agreement with Paul E. Hammar** (ii) Employment Agreement with Frank A. Morrisroe** (iii) Employment Agreement with Alan Ellenbogen** (iv) Employment Agreement with Jeffrey B. Edwards** (v) Amendment to Edwards Employment Agreement*** (vi) Employment Agreement with John Picardi*** (vii) Amendment to Picardi Employment Agreement*** (viii) Employment Agreement with Jeffrey S. Ratner ******** (viii)(a) Amendment to Employment Agreement with Jeffrey S. Ratner********* (ix) Employment Agreement with John W. Ryba ******** (x) Employment Agreement with Delmer C. Gowing, III ******** (xi) Employment Agreement with H. Richard Howie ******** (xii) Employment Agreement with George A. Socher ******** (xiii) Employment Agreement with Joel Nagelmann x\n(aa) Citibank Agreement* (bb) Radix Agreement** (cc) Agreement with Chi Chi's Restaurants+++ (dd) Agreement with Canadian Pacific Hotels++++\n(11) Statement RE: Computation of Per Share Earnings********* _________________\n+ Incorporated by reference to Form S-18 Registration Statement (No. 2-91055-W) of Registrant filed on May 10, 1984.\n++ Filed with Amendment No. 1 to Registration Statement 33-48682 filed on June 16, 1992.\n+++ Filed with Amendment No. 2 to Registration Statement 33-48682 filed on June 16, 1992.\n++++ Filed with Amendment No. 3 to Registration Statement 33-48682 filed on June 16, 1992.\n* Incorporated by reference to Form S-1 Registration Statement (No. 33-32469) of Registrant filed on December 7, 1989.\n** Incorporated by reference to Form S-4 Registration Statement (No. 33-37923) of Registrant filed on November 23, 1990.\n*** Incorporated by reference to Form 10-K Annual Report (No. 0-13226) filed on May 15, 1994.\n**** Incorporated by reference to Definitive Proxy Statement For 1994 Annual Meeting (File No. 013226), Filed on August 31, 1994.\n***** Incorporated by reference to Form 8-K current report for March 1992.\n****** Incorporated by reference to Form 8-K current report for February 1993.\n******* Incorporated by reference to Form 8-K current report for November 1993.\n******** Incorporated by reference to Form S-1 Registration Statement (No. 33-85244), filed on October 14, 1994.\n********* Incorporated by reference to Amendment No. 1 to Form S-1 Registration Statement (No. 33-85244), filed on January 19, 1995.\nx Filed herewith\n22. SUBSIDIARIES OF SULCUS COMPUTER CORPORATION\nSulcus Investment Corporation Delaware\nSulcus Law Management Services, Inc. Maryland\nKeystone Credit Corporation Pennsylvania\nSulcus Hospitality Group, Inc. Pennsylvania\nRadix Systems, Inc. Pennsylvania\nLodgistix, Inc. Delaware\nSulcus (Australia) Pty. Ltd. Australia\nSquirrel Companies, Inc. Georgia\nSquirrel Companies of Canada, Ltd. Canada\nNRG Management Systems, Inc. Texas\nSulcus Hospitality Limited Hong Kong\nSulcus Singapore, Pte. Ltd. Singapore\nSulcus (Malaysia) SDN BHD Malaysia\nSulcus Hospitality Group EMEA, AG Switzerland Sulcus (International) AG Switzerland Sulcus Hospitality (U.K.) Ltd. United Kingdom\nSulcus Scandinavia, A.S. Scandinavia\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 Greensburg, Commonwealth of Pennsylvania, on March 27, 1996.\nSULCUS COMPUTER CORPORATION\nBy: \/s\/ Joel Nagelmann ----------------------------------- Joel Nagelmann President and Principal Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on March 27, 1996.\nSignature and Title Date ------------------- ----\n\/s\/ Jeffrey S. Ratner March 27, 1996 - ----------------------------------- ------------------ Jeffrey S. Ratner Chairman of the Board and Director\n\/s\/ John W. Ryba March 27, 1996 - ----------------------------------- ------------------ John W. Ryba, General Counsel and Director\n\/s\/ Robert D. Gries March 27, 1996 - ----------------------------------- ------------------ Robert D. Gries, Director\n\/s\/ Herbert G. Ratner March 27, 1996 - ----------------------------------- ------------------ Herbert G. Ratner, Director\n\/s\/ David Adler March 27, 1996 - ----------------------------------- ------------------ David Adler, Director\n\/s\/ Joel Nagelmann March 27, 1996 - ----------------------------------- ------------------ Joel Nagelmann, President and Principal Executive Officer\n\/s\/ H. Richard Howie March 27, 1996 - ----------------------------------- ------------------ H. Richard Howie, Chief Financial Officer and Chief Accounting Officer\n[LOGO] CROWE CHIZEK\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Sulcus Computer Corporation\nWe have audited the accompanying consolidated balance sheet of Sulcus Computer Corporation 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. The financial statements of Sulcus Computer Corporation as of December 31, 1993 and the year then ended were audited by other auditors whose report dated May 13, 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 1995 and 1994 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sulcus Computer Corporation 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 3 to the consolidated financial statements, the Company adopted the provisions of a new accounting pronouncement, Statement of Financial Accounting Standards No. 115, effective January 1, 1994.\nOur audits referred to above also included the financial schedule listed in answer to item 14(a)(2). In our opinion, such financial schedule presents fairly the information required to be set forth therein.\n\/s\/ CROWE, CHIZEK AND COMPANY LLP ---------------------------------- CROWE, CHIZEK AND COMPANY LLP\nColumbus, Ohio March 1, 1996, except for Note 2, as to which the date is March 21, 1996 and Note 20, as to which the date is April 10, 1996\nREPORT OF INDEPENDENT AUDITORS\nMay 13, 1994\nThe Board of Directors and Shareholders Sulcus Computer Corporation\nWe have audited the consolidated balance sheet of Sulcus Computer Corporation as of December 31, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows 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, based on our audit, the consolidated financial statements present fairly, in all material respects, the financial position of Sulcus Computer Corporation at December 31, 1993, and the consolidated results of their operations and cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nOur audit referred to above also included the financial schedules listed in answer to item 14(a)(2). In our opinion, such financial schedules present fairly the information required to be set forth therein.\n\/s\/ FERRARO + MCMURTRY -------------------------- Ferraro + McMurtry\nPittsburgh, Pennsylvania\nSULCUS COMPUTER CORPORATION CONSOLIDATED BALANCE SHEETS\nSee notes to the consolidated financial statements.\nSULCUS COMPUTER CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to the consolidated financial statements.\nSULCUS COMPUTER CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to the consolidated financial statements.\nSULCUS COMPUTER CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1995, 1994, and 1993\nSee notes to the consolidated financial statements.\nSULCUS COMPUTER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995, 1994, And 1993\nNOTE 1. LINE OF BUSINESS\nSulcus Computer Corporation (the Company) develops, installs, and markets turnkey computer systems with specific software through its subsidiaries. The Company also markets support services in conjunction with the placement of software systems and provides trade credit to its customers.\nNOTE 2. LEGAL PROCEEDINGS AND LITIGATION SETTLEMENTS\nIn April 1994, various individual Sulcus shareholders filed 12 lawsuits in the U.S. District Court for the Western District of Pennsylvania asserting federal securities fraud claims against Sulcus and certain officers, directors and others. These lawsuits were consolidated under the caption \"IN RE: SULCUS COMPUTER CORPORATION SECURITIES LITIGATION,II.\"\nOn December 27, 1995, the parties entered into a settlement agreement (which was approved on a preliminary basis by the Court on February 23, 1996) which established a settlement fund of $800,000 in cash and 1,400,000 Sulcus Common Shares with a value of $2,800,000. The cash portion of the settlement will be paid by insurance ($666,000) and the Company ($134,000). At December 31, 1995, the Company recorded a provision of $2,861,118 which, together with amounts accrued in 1994, represents costs which the Company expects to incur in connection with this agreement.\n____________\nSulcus and certain of its officers, directors and a former director had been named as defendants in six class action Complaints designated by the Court as IN RE: SULCUS COMPUTER CORPORATION SECURITIES LITIGATION. In December 1993, the parties entered into a settlement agreement which established a settlement fund of $600,000 in cash and 250,000 Sulcus Common Shares with a value of $1,625,000. The Company has also agreed to pay up to $75,000 of expenses for administering the settlement. The cash portion of the settlement was covered entirely by insurance, which was received and distributed in June, 1994.\nOn September 16, 1994, the court formally approved the settlement agreement and the number of shares to be issued were increased to 530,612, effective October 16, 1994. These shares were reflected as issued and outstanding at December 31, 1994.\n____________\nSulcus and Jeffrey S. Ratner were defendants in an action filed in June 1994, in the Superior Court of Fulton County of the State of Georgia by Raymond D. Schoenbaum, Theodore J. Munchak, and Nathan I. Lipson. The action alleged that Sulcus and Mr. Ratner made fraudulent misrepresentations and that Sulcus and Mr. Ratner have breached the Stock Purchase Agreement entered into between Sulcus and Squirrel Companies, Inc., in March 1992, by failing to make certain payments of stock.\nOn March 20, 1996, the Company, Mr. Ratner and the Plaintiffs agreed to resolve this dispute. Under the terms of this agreement, the Company agreed to deliver 498,488 shares of Sulcus Common Shares. These shares will represent the entire earn-out for the years ended December 31, 1992, 1993 and 1994 and, therefore, the Company will cancel 120,488 shares previously issued. At December 31, 1995, the Company recorded an increase in goodwill and capital stock in the amount of $391,193 to reflect this settlement. On March 21, 1996, the court dismissed the claims and counterclaims.\n____________\nOther suits arising in the ordinary course of business are pending against the Company and its subsidiaries. The Company believes that the ultimate outcome of these actions and those described above will not result in a material adverse effect on the Company's consolidated financial position.\nNote 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\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, including contingencies, as well as the reported amounts of revenues and expenses during the financial statement period. Actual results could differ from those estimates. Examples of significant estimates include the collectability of receivables, the future benefit of capitalized computer software costs, lives assigned to goodwill, the net recoverability of deferred tax assets and contingencies relating to sales-type financed leases. These estimates are particularly susceptible to material changes in the near term.\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Sulcus Computer Corporation and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated. 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.\nCASH AND CASH EQUIVALENTS The Company considers as cash and cash equivalents certificates of deposit and commercial paper with original maturities of less than three months which consists of deposits in commercial banks in the U.S. and abroad. The Company limits the amount of money placed in any one bank in order to reduce credit risk.\nSHORT-TERM INVESTMENTS During 1995, the Company changed its investment philosophy and consequently bought and sold certain investments to realign its investment portfolio. From January 1, 1994 (effective date of current accounting standards) through June 5, 1995, the Company actively bought and sold investments in corporate preferred stocks and mutual funds consisting primarily of corporate and U.S. government securities with the objective of generating profits on short-term differences in price, and accordingly, classified its investments as \"Trading Securities\" whereby they were carried at market with unrealized gains or losses reflected in current earnings. During the second quarter of 1995, the Company restructured its investments in short-term marketable securities and changed its investment philosophy to one of holding securities for the generation primarily of dividend and interest income. As a result, investments and changes in the market value of the investments arising subsequent to this change (June 5, 1995) are accounted for as \"Available for Sale\". This accounting treatment will mean that investments are carried at market value with unrealized gains and losses on investments treated as a component of Stockholders' Equity. Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the consolidated statement of operations.\nPrior to the effective date of current accounting standards (prior to January 1, 1994), the Company's short-term investments were carried at the lower of cost or market. The cumulative effect of adopting the new accounting standards (Statement of Financial Accounting Standard No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\") was not material and accordingly, no cumulative effect of accounting change was reported.\nRESTRICTED CASH\nThe restricted cash at December 31, 1995, represents cash collateral for a deposit received on a significant contract in December 1995. As security for product delivery and for the deposit received under the contract, the Company issued a letter of credit of $550,000, which expires on December 31, 1996. At the customer's direction, upon the delivery of systems, a draw down is permitted at the rate of 25% of the value of the equipment delivered. As of February 29, 1996, approximately $172,000 of restricted cash was released for general purposes. The restricted cash at December 31, 1994, represents a customer deposit received on a significant contract which was held in escrow with a financial institution. As security for performance and the advances received under the contract, the Company issued a letter of credit, as amended, of $500,000. The $500,000 remaining in restricted cash at December 31, 1994 was offset by customer deposits in the same amount. In January 1995, the Company had fulfilled substantially all obligations under this contract and the cash was released for general purposes and the letter of credit expired.\nINVENTORIES Inventories consist substantially of software and hardware products in finished form and are valued at the lower of cost or market. Cost is determined by the specific identification method. Market is net realizable value.\nSOFTWARE DEVELOPMENT Software development costs incurred prior to establishing technological feasibility are charged to operations and included in research and development costs. Software development costs incurred after establishing technological feasibility, together with purchased software, are capitalized. Amortization of software development costs is provided for when the product is available for general release to customers over the greater of the amount computed using the remaining estimated economic life of the product or the ratio that current gross revenues for a product bear to the total of current and anticipated revenues for that product. The products are generally being amortized over 3 to 5 years.\nPROPERTY AND EQUIPMENT Property and equipment is comprised of office furniture, fixtures, service equipment, leasehold improvements, and land and building and are recorded at cost. Depreciation is based upon the straight-line method over the estimated useful lives of the related assets. Maintenance and repairs are charged to expense as incurred.\nGOODWILL Goodwill, which represents the excess of the cost of purchased companies over the fair value of their net assets at the date of acquisition, is being amortized on a straight-line basis over lives ranging from 10 to 20 years. The Company annually evaluates the carrying value of goodwill based on current operating results and forecasts of the specific businesses acquired.\nINCOME TAXES Income tax expense includes U.S. and international income taxes. Certain items of income and expense are not reported in tax returns and financial statements in the same year. The tax effect of the difference is reported as deferred income taxes and these amounts are adjusted to reflect tax rates that will be in effect in the years in which these differences are expected to reverse. A valuation allowance is provided\nto reduce deferred tax assets to an amount more likely than not to be realized. Non-U.S. subsidiaries compute taxes in effect in the various countries. Earnings of these subsidiaries may also be subject to additional income and withholding taxes when they are distributed as dividends. Undistributed earnings of non-U.S. subsidiaries are not material.\nREVENUE RECOGNITION The Company recognizes revenue on sales of systems including software and hardware upon delivery or installation and when all obligations of the respective contract have been fulfilled. Support services revenue are billed in advance and recorded as deferred revenue and recognized as income ratably over the service period of the Software Support and Hardware Maintenance Agreement.\nTRANSLATION ON NON-U.S. CURRENCY AMOUNTS For non-U.S. subsidiaries which operate in a local currency environment, assets and liabilities are translated to U.S. dollars at the current exchange rates at the balance sheet date. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated in a separate component of stockholders' equity.\nEARNINGS (LOSS) PER SHARE Primary earnings (loss) per share is computed based on the number of common shares outstanding, adjusted for the assumed conversion of shares available upon the exercise of dilutive options, after the assumed repurchase of common shares with the related proceeds. Fully diluted earnings (loss) per share is not presented as it is either anti-dilutive or not different from primary earnings (loss) per share.\nRECLASSIFICATION Certain prior year amounts have been reclassified to conform with current year reporting practices.\nNOTE 4. SHORT-TERM INVESTMENTS\nSecurities available for sale at December 31, 1995 are summarized as follows:\nTrading securities at December 31, 1994 are summarized as follows:\nEffective June 5, 1995, the Company restructured its investments as short-term marketable securities and changed its investment philosophy to one of holding securities for the generation of dividend and interest income. As a result, investments and changes in market value of the investments arising subsequent to this\ndate are accounted for as \"Available for Sale\". At June 5, 1995, the market value of the securities was below cost by $185,803.\nProceeds, realized gains and realized losses from the sales of securities classified as available for sale for the year ended December 31, 1995 were $4,758,359, $130,000 and $2,441, respectively. Proceeds, realized gains and realized losses from the sales of securities classified as trading securities for the year ended December 31, 1995 were $2,190,926, $76,211 and $13,112, respectively. Unrealized gains on trading securities amounted to $1,271,347 through June 5, 1995.\nNOTE 5. PURCHASED AND CAPITALIZED SOFTWARE\nPurchased and capitalized software consists of the following:\nThe Company capitalized software development costs of $1,002,854, $1,556,888 and $2,469,337 during the years ended December 31, 1995, 1994 and 1993, respectively. Amortization for the years ended December 31, 1995, 1994, and 1993 was $2,447,296, $2,388,804, and $2,078,614, respectively. Software amortization is included in cost of sales.\nThe Company wrote off capitalized software costs of $514,694 during the fourth quarter of 1995 and $1,820,246 during the third quarter of 1994. These write-offs were based on the Company's assessment of its capitalized software and the conclusion that these costs would not benefit future periods.\nNOTE 6. PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\nNOTE 7. LEASES\nAS LESSOR Included in \"Other Current Assets\" and \"Other Noncurrent Assets\" are amounts receivable under lease programs to customers. Classification as to current or noncurrent is determined based upon scheduled payment by customers in the case of sales-type lease receivables and lease maturity dates in the case of net investment in financed leases. The Company, during 1993 and 1992, leased its products to customers under sales-type leases. The Company's investment in these sales-type leases is as follows:\nThe scheduled maturities for sales-type lease receivables at December 31, 1995 are $54,046 in 1996 and $17,228 in 1997. The lease receivable proceeds and the leased property are pledged as collateral under an April 30, 1993 loan agreement with a financial institution (See \"Long-Term Debt\").\nIn 1993 the Company modified its sales-type lease program by entering into an agreement with a finance company whereby it receives 100% of the discounted minimum lease payments at inception of the lease, assigns the lease payments to the finance company, grants the finance company a security interest in the leased equipment and accepts certain recourse liability in event of default by the lessee. The Company retains ownership in the residual value of the leased property and has recorded a reserve for the estimated liability under the recourse agreement. At December 31, 1995 and December 31, 1994, the Company had the following net investment in these financed sales-type leases:\nAt December 31, 1995, the Company was contingently liable for approximately $874,000 related to sales-type leases financed under this agreement. To date, actual losses from recourse provisions have not been material.\nAS LESSEE The Company has operating leases with third parties for primary office space in various locations. The future annual rental commitments under these leases are $948,000 in 1996; $708,500 in 1997; $332,000 in 1998; $269,000 in 1999; $256,000 in 2000 and $1,332,200 thereafter. Rent expense under these agreements and other operating leases was $1,611,081, $1,491,615 and $1,698,119, for the years ended December 31, 1995, 1994, and 1993. See \"Related Party Transactions\" for additional operating leases.\nNOTE 8. LONG TERM DEBT\nThe Company's and subsidiaries' long-term debt consists of the following:\nThe Lodgistix note payable was secured by certain inventories, accounts receivables, equipment and software programs of Lodgistix, Inc. The note was paid in 1995.\nThe Sulcus Hospitality Group borrowings were made pursuant to an April 1993 loan agreement with a financial institution. The debt is secured by certain sales-type leases of the Company and principal payments are required based upon customer lessee payments received under the sales type leases.\nScheduled maturities of long-term debt at December 31, 1995 are $46,713 in 1996 and $27,175 in 1997.\nNOTE 9. SHORT-TERM BORROWINGS\nThe Company's short-term borrowings consists of the following:\nThe brokerage margin account borrowings are secured by the Company's short-term investment portfolio, having a market value of $11,914,274 at December 31, 1995. Interest is charged and paid monthly based on the broker's internally established rate which was 8.375% at December 31, 1995.\nThe Company's Swiss subsidiary (Lodgistix International, AG) has a line of credit with a bank totaling $127,000 (150,000 Swiss francs). The line of credit is cancelable at any time and is secured by deposits with the bank which approximated $58,467 at December 31, 1995. At December 31, 1995, interest was 7.00%.\nNOTE 10. INCOME TAXES\nThe provision for income taxes consists of the following:\nA reconciliation between the Company's effective tax rate and the U.S. statutory rate is as follows:\nThe Company's U.S. federal effective rate is generally unaltered by the rates applicable to its foreign operations as a U.S. foreign tax credit would be generated for taxes paid in those jurisdictions. Foreign taxes are recognized on foreign taxable income for which no foreign tax credit is generated.\nPermanent differences include tax-free dividend income and amortization of goodwill. No tax benefits were recorded for non-deductible write-offs of goodwill and certain other expenses. Due to the net operating losses, no material tax payments have been made.\nThe following summarizes the significant components of the Company's deferred tax assets and liabilities:\nManagement believes that it is more likely than not that it will generate taxable income sufficient to realize a portion of the tax benefits associated with net operating losses and tax credit carryforwards prior to their expiration. This belief is based upon the Company's view of expected profits in 1996 and the next several years. The Company believes that the results of 1995 were affected by a write-off of software and a shareholder litigation settlement. Without these items, which are not expected to repeat in the future, the Company would have generated net income in 1995. Furthermore, the Company expects increased sales and only slight increases in expenses in 1996.\nTherefore, management believes that the valuation allowance is appropriate given the current estimates of future taxable income. If the Company is unable to generate sufficient taxable income in the future through operating results, increases in the valuation allowance will be required through a charge to expense. However, if the Company achieves sufficient profitability to utilize a greater portion of the deferred tax asset, the valuation allowance will be reduced through a credit to income.\nThe Company has approximately $29,846,000 of net operating losses, a portion of which are subject to certain limitations under the Internal Revenue Code Section 382, and $1,800,000 of tax credits available to offset future federal tax liabilities. The net operating loss carryforwards expire as follows:\nNOTE 11. RELATED PARTY TRANSACTIONS\nThe Company leases office space in Greensburg, Pennsylvania from a trust established by a major stockholder. The leases commenced on various dates from March 1, 1983 and expire on various dates through September 30, 2001. The leases may be renewed for additional two-year terms at the rate of 2% over the prior year's amount unless specifically canceled by either party. Rent expense under these agreements was $225,391, $185,251 and $161,700 for the years ended December 31, 1995, 1994, and 1993, respectively. The future annual rental commitments under these leases are $229,111 in 1996, $138,105 in 1997, $85,860 in 1998, $90,144 in 1999, $91,947 in 2000 and $91,947, thereafter.\nThe Company has made a relocation loan to its President in the amount of $100,000 which is secured by real estate and bears interest at the rate of 5%. Interest is payable quarterly and the principal is payable on the earlier of the sale of a former residence or October 27, 1996.\nNOTE 12. COMMITMENTS AND CONTINGENCIES\nAt December 31, 1995, the Company had contractual commitments to purchase certain electronic and other materials used to manufacture systems for the restaurant management and energy management products. Based on the contract provisions, these obligations totalled $1,924,000, and are expected to be fulfilled as follows:\nThe Company has employment agreements with certain of its executive officers and management personnel. These agreements generally continue until terminated by either party. The agreements contain certain change in control provisions.\nNote 13. Incentive Stock Option Plans\nThe Company maintains three stock option plans at December 31, 1995: the 1983 Incentive Stock Options Plan (1983 plan), the 1991 Incentive Stock Option Plan (1991 Plan), and the Directors Plan. Options can no longer be granted under the 1983 Plan. The 1991 Plan (as amended) allows for 3,000,000 stock options available for grant under the plan, which extends through January 1, 2001. The 1991 Plan allows for all of the future stock options to be granted at any time prior to the termination of the plan. The option price may not be less that the fair market value at date of grant. Options granted under the 1991 plan become available to be exercised based upon a five year vesting schedule.\nThe employee stock option plan activity for the years ended December 31, 1995, 1994, and 1993 is as follows:\nThe Company has authorized 500,000 Nonqualified 1991 Directors Options under the 1991 Directors Plan. The board of directors on August 20, 1993 and the stockholders on October 12, 1993 approved the amendment to the Company's Nonqualified 1991 Director Option Plan to increase the number of shares under the plan to 1,000,000. During the year ended December 31, 1993, 70,000 director options were granted at prices ranging from $6.625 to $6.875. During 1993, 20,000 director options were exercised. During the year ended December 31, 1994, 50,000 director options were granted at $3.00. During the year ended December 31, 1995, 83,333 director options were granted at $2.50 and 60,000 options were cancelled at prices ranging from $3.00 to $5.625. No options were exercised in 1994 or 1995. All options are granted at prices not less than fair market value.\nDuring March 1992, approximately 388,516 and 11,484 options were granted to Squirrel shareholders and advisors, respectively, at $4.25 per share in connection with the acquisition of Squirrel. At December 31, 1992, 87,500 options were exercisable and the balance are exercisable after March 25, 1993. During the year ended December 31, 1994, 40 options granted to Squirrel shareholders and advisors were exercised. During 1995, 75,000 options were cancelled.\nThe Company periodically grants options to consultants and advisors. During the year ended December 31, 1995, a total of 50,000 options were granted at $2.50. All options are granted at prices not less than fair market value.\nAt December 31, 1995, under all plans, options for approximately 1,199,553 and 1,971,115 shares were exercisable and outstanding, respectively, at prices ranging from $1.000 to $9.250.\nThe Financial Accounting Standards Board issued a statement in October 1995 entitled \"Accounting for Stock-Based Compensation\" which will be effective for the Company in 1996. This statement establishes an accounting method based on the fair value of equity instruments awarded to employees as compensation, however, companies are permitted to continue applying previous accounting standards in the determination of net income with disclosure in the notes to the financial statements of the differences between previous accounting measurements and those formulated by the new accounting standard. Beginning in 1996, the Company intends to determine net income using previous accounting standards and to make the appropriate disclosures in the notes to the financial statements as permitted by the standard.\nNOTE 14. NOTE RECEIVABLE FROM STOCKHOLDER\nDuring the year ended December 31, 1993, the Company extended a loan to the former principal stockholder and current president of Techotel AG (now Sulcus Hospitality Group EMEA AG) in the amount of $500,000, pending the registration of the stock of the Company issuable to him under terms of the agreement for the purchase of Techotel. The note will be repaid upon the registration by the Company for the stock issuable to him. Based on the nature of the note, it has been reflected as a reduction of equity.\nNOTE 15. ACQUISITIONS\nIn October of 1993, the Company completed its acquisition of Lodgistix Scandinavia A.S., a distributor of Lodgistix systems in Norway, Sweden and Denmark. The purchase price consisted of Sulcus Common Stock having a value of $300,000. In addition, the former stockholders of Lodgistix Scandinavia receive additional shares of the Company's stock up to a value of $675,000 contingent upon attaining certain earnings over a three year period. Lodgistix Scandinavia achieved such earnings for 1993 and 1995. As a result, the Company will issue to the former stockholders of Lodgistix Scandinavia 5,808 and 111,801 shares of Sulcus common stock for an aggregate value of $44,864 ($7.725 per share) and $225,000 ($2.0125 per share) for 1993 and 1995, respectively. This additional consideration has been recorded as goodwill at December 31, 1995. Lodgistix Scandinavia did not achieve required earnings for 1994.\nEffective January 1, 1993, Sulcus acquired Techotel AG of Switzerland. The purchase agreement (as amended) provided for the issuance of $1,000,000 of Common Stock. In addition, the shareholders were entitled to receive shares of Sulcus based upon a multiple of 1.30 times earnings up to an aggregate value of $2,890,000 over a three-year period ending December 31, 1995. Techotel achieved such earnings for 1993 and 1995. As a result, the Company will issue to the former stockholders of Techotel 90,517 and 83,676 shares of Sulcus common stock for an aggregate value of $698,110 ($7.7125 per share) and $168,399 ($2.0125 per share) for 1993 and 1995, respectively. This additional consideration has been recorded as goodwill at December 31, 1995. Techotel did not achieve the required earnings for 1994.\nIn 1992, Sulcus acquired Sulcus Hospitality Limited and Sulcus Singapore PTE. LTD., sales offices located in Hong Kong and Singapore, respectively for $1,450,000 in cash. In addition, the shareholders were entitled to receive shares of Sulcus based upon a multiple of 2.75 times earnings up to an aggregate value of $8,855,000 contingent upon attaining after tax earnings over a three-year period. The only year that these subsidiaries achieved earnings sufficient to entitle the former shareholders to contingent payments was 1992 and, as a result, the Company issued to the former shareholders (as amended) 320,827 shares of Sulcus common stock for an aggregate value of $3,047,852 ($9.50 per share). Subsequent to this determination Sulcus withheld 23,175 shares with an aggregate value of $220,161 with regard to the write off of the Craftech subsidiary. As a result of the 1992 restatement of earnings, the Company revised the contingent earnout calculation based on the restatement adjustments that affected it. The Company reduced the number of shares of stock issued as a result of the original calculation, all of which are restricted. As a result, the Company reduced goodwill at December 31, 1994 by approximately $2,168,000, reduced equity by\napproximately $912,000, the estimated current value of the shares to be canceled, and expensed the difference of $1,256,000 in 1994.\nEffective March 1, 1992, Sulcus acquired all of the outstanding stock of Squirrel Companies, Inc. (\"Squirrel\"). The purchase price consisted of $500,000 in cash and 401,260 shares (at $5.75 per share) of the Company's stock having a value of $1,955,500, net of issuance costs of approximately $351,745, in exchange for all of the outstanding common stock of Squirrel. In addition, the shareholders of Squirrel were entitled to receive additional shares of Sulcus up to an aggregate value of $4,065,000 as well as 225,000 of the Company's options contingent upon Squirrel's attaining after tax earnings over a three-year period ending in 1994. Squirrel achieved such earnings for 1992 and 1994 and, as a result, the Company issued to the former shareholders of Squirrel 53,212 shares for an aggregate value of $703,198 for 1992 and 70,836 shares for an aggregate value of $177,090 for 1994. These additional amounts are recorded as a component of goodwill. On March 20, 1996, the Company resolved disputes with the former owners of Squirrel with regard to the calculation of earnouts in 1992 through 1994. The Company will issue 498,488 shares under the terms of the agreement and will cancel 120,488 earnout shares which are a portion of the 124,048 earnout shares described above. To reflect this settlement, the Company recorded an increase in goodwill and capital stock in the amount of $391,193.\nNOTE 16. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nNOTE 17. SEGMENT REPORTING\nThe Company conducts its worldwide operations through separate geographic area organizations which represent major markets or combinations of related markets. Transfers between markets are valued at cost.\nFinancial information by geographic area for years ended December 31, 1995, 1994, and 1993 is summarized as follows:\nThe 1995 North American segmental operating income includes the $2,919,333 litigation settlement provision and $514,694 write-off for software costs developed and capitalized for the U.S. markets. The 1994 North American segmental loss includes a $1,647,808 unrealized loss on short-term investments, a $1,820,246 write off of capitalized software and a $250,000 provision for litigation.\nThe 1994 Pacific Region operating losses include $336,703 to write off investments in two affiliates and a net charge of $1,256,000 to write off goodwill.\nThe 1994 European operating loss includes approximately $400,000 related to a French subsidiary.\nOther than short-term investments in marketable securities, which are generally available for working capital, there are no significant non-operating corporate assets.\nSales between geographic areas and export sales are not material.\nIdentifiable assets by geographic area exclude intercompany loans, advances and investments in affiliates. Intercompany trade receivables have been eliminated. Corporate assets are principally cash, trade receivables and intangibles.\nNOTE 18. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following table sets forth certain unaudited quarterly financial data for the years ended December 31, 1995 and 1994. The Company believes this information has been prepared on the same basis as the\nConsolidated Financial Statements and that all necessary adjustments (consisting only of normal recurring adjustments) have been included in the amounts as stated below to present fairly the selected quarterly information when read in conjunction with its Consolidated Financial Statements and Notes thereto.\nThe Company's results for the first quarter 1995 include $881,683, which relates to the unrealized gain on investments. The Company's results for the fourth quarter 1995, include the provision for litigation settlement of $2,919,333 and write off of capitalized software of $514,694.\nThe Company's results for the fourth quarter of 1994 include a provision of $336,703 to write off an investment in two unconsolidated affiliates in Singapore and Hong Kong, referred to as Guthrie Retail Systems and a provision of approximately $400,000 to write down the assets and provide for expenses related to the disposition of its wholly-owned French subsidiary. Management reached a decision in the fourth quarter of 1994 to dispose of the companies because anticipated future revenues did not justify further investments in these operations. Total 1994 sales of these companies included in the consolidated statement of operations were approximately $800,000. In addition, the results of the fourth quarter includes a charge of $1,256,000 to write off goodwill related to the acquisition of Hong Kong and Singapore (See Note 14).\nNOTE 19. FAIR VALUE OF FINANCIAL INSTRUMENTS\nEstimates of fair value are made at a specific point in time, based on relevant market prices and information about the financial instrument. The estimated fair values of financial instruments presented below are not necessarily indicative of the amounts the Company might realize in actual market transactions.\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\nCASH (INCLUDING RESTRICTED CASH): The carrying amounts reported in the balance sheet for cash and restricted cash approximates their fair value.\nSHORT-TERM INVESTMENTS: Short-term investments consists of stocks, mutual funds and debt securities. Fair values are based on quoted market prices.\nSHORT- AND LONG-TERM DEBT: The carrying amount of the Company's borrowings under margin accounts and floating rate debt approximates its fair value. Long-term fixed rate debt is not material.\nSHAREHOLDER LITIGATION LIABILITY: Portions due in the form of stock for settlement of shareholder litigation liability is valued based upon quoted market prices.\nThe carrying amounts of trade payables and receivables approximate their fair value and have been excluded from the accompanying table.\nThe carrying amounts and fair value of the Company's financial instruments are as follows at December 31:\nNOTE 20. SECURITIES AND EXCHANGE COMMISSION INVESTIGATION\nOn April 10, 1996, the Company entered into an agreement in principle with the staff of the Securities and Exchange Commission (\"Commission\"), resolving an investigation which commenced in 1993. This agreement is subject to approval of the full Commission. During 1994, in response to views expressed by the Commission's staff, the Company reviewed and restated its financial statements for the years ended December 31, 1992 and 1991 with respect to accounting for costs and revenue associated with various acquisition transactions and with respect to the adoption of accounting principles related to income taxes. Under the terms of the April 10, 1996 agreement, without admitting or denying any wrongdoing, the Company agreed that it would not in the future violate Sections 17(a)(2) and 17(a)(3) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, and 13a-13 promulgated thereunder. With respect to certain press releases issued during 1991 and 1992, the proposed Order Instituting Proceedings makes findings against Sulcus under Section 10(b) and Rule 10b-5. The proposed Order Instituting Proceedings does not make findings against Sulcus under Section 10(b) or Rule 10b-5 with regard to accounting practices. In addition, a former accounting officer of the Company and the Company's Chairman, without admitting or denying any wrongdoing agreed that they would not in the future violate Sections 17(a)(2) and (a)(3) of the Securities Act; Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13, and 13b 2-1 promulgated thereunder. There were no fines or other penalties imposed upon the Company or its Chairman. The Company's former accounting officer agreed not to practice before the Commission as an accountant for a 30 month period.\nSULCUS COMPUTER CORPORATION STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS FOR THE THREE YEARS ENDED DECEMBER 31, 1995\nSULCUS COMPUTER CORPORATION\nSCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS","section_15":""}
{"filename":"276437_1995.txt","cik":"276437","year":"1995","section_1":"ITEM 1. BUSINESS --------\nA. General Development of Business -------------------------------\nRule Industries, Inc. (The Company) was incorporated under Massachusetts law in 1965 and presently develops and manufactures products for industrial and consumer hardware markets and recreational marine markets which are sold through both domestic and international distribution channels.\nEffective January 2, 1991, the Company acquired certain assets of RemGrit Corporation of Bridgeport, Connecticut. The RemGrit product line consists of tungsten carbide abrasive cutting tool products for use in cutting difficult materials such as composites, tile, masonry and cast iron. The RemGrit product line has been integrated into the Company's South Deerfield facility and is marketed by the Company's Hardware Division.\nEffective April 15, 1993, the Company divested the assets and business of Silver Metal Products, Inc. of Livermore, California. The Silver Metal Products subsidiary manufactured an extensive line of metal connectors for residential and commercial construction.\nEffective August 1, 1993, the Company divested the assets and business of Phillips Screw Company. The Phillips Screw subsidiary licensed patents and trademarks related to threaded fastener products.\nOn May 20, 1994, the Company completed its acquisition of certain assets of The Disston Company (Disston) of Danville, Virginia. The Disston product line consists of a broad range of consumer hardware products, primarily power tool accessories, hand tools, and lawn and garden products. During fiscal 1994, the Disston manufacturing operations were integrated into the Company's South Deerfield facility and Disston's results of operations have been included in the Company's Hardware segment since March 1, 1994 (See Note 2 to Consolidated Financial Statements).\nProposed Merger with Greenfield Industries, Inc. (Greenfield) -------------------------------------------------------------\nOn August 11, 1995, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Greenfield and Rule Acquisition Corporation (a wholly owned subsidiary of Greenfield), whereby the Company will become a wholly owned subsidiary of Greenfield. In connection with the Merger Agreement, Greenfield was granted an option to purchase 630,000 shares of the Company's common stock for a purchase price of $8 per share. Under the terms of the Merger Agreement, each share of Rule common stock outstanding will be entitled to receive $15.30 in cash and a beneficial interest in a Liquidating Trust (other than shares owned by Greenfield, Excluded Shares and Dissenting Shares as defined in the Merger Agreement). Prior to the effective time of the Merger, a Liquidating Trust will be established to receive the net proceeds, if any, relating to arbitration proceedings between Disston and a former owner of Disston. Management currently estimates the value of the Liquidating Trust to be $.15 per share; however, a recovery, if any, is dependent on the favorable resolution of many complex factual and legal issues.\nOn September 15, 1995, Greenfield exercised its option to purchase 630,000 shares of Rule common stock. The proceeds of $5,040,000 from the exercise were used to reduce the Company's outstanding senior indebtedness.\nThe Merger Agreement is subject to approval by the holders of at least two- thirds of the outstanding shares of Rule common stock. The Merger Agreement may be canceled by the mutual agreement of Greenfield and the Company, and by the Company or Greenfield if certain conditions are not met, as\ndiscussed in the Merger Agreement. If the Merger Agreement is terminated under certain circumstances, the Company has agreed to reimburse Greenfield for up to $450,000 of expenses incurred by Greenfield in connection with the Merger Agreement (see Note 14 of the Consolidated Financial Statements).\nB. Financial Information by Industry Segments ------------------------------------------\nReference is made to Industry Segment and Geographic Area Information presented in the Financial Statements in Item 8.\nC. Description of Business -----------------------\n1. Hardware\na. Operations\nThe Company manufactures and markets an extensive line of hardware products, primarily stationary and portable power tool accessories, handsaws and hand tools, and lawn and garden products to industrial and consumer markets.\nPower tool accessories consist of a broad line of bandsaw, holesaw, circular saw and reciprocating blades used in power tool applications, including products which have tungsten-carbide grit cutting edges. These produces are marketed under the tradestyles Capewell(R), Aggressor(R), Widder(R), Blu-Mol(R), RemGrit(R), Grit-Edge(R) and Disston(R). Power tool accessories also include wood-boring bits-marketed under the trademarks Planetor(R), and Turbo-Bit(R), and a broad range of drills, counterbores, wire brushes, doweling, grinding wheels and stones, sanding and polishing discs, and rotary shaping tools sold under the Disston(R) tradename. Handsaws consist of a variety of products for cutting primarily wood, including traditional handsaws, coping saws, hacksaws, keyhole saws and specialty saws. Hand tools include masonry products and files. The Company's lawn and garden products include cordless grass shears, rakes, pruning saws, sump and utility pumps, and chain saw accessories. Handsaws, hand tools and lawn and garden products are marketed under the Disston(R) tradestyle.\nProducts marketed under the Disston tradestyle are sold primarily to consumers and tradesmen through home centers, retail chains and buying cooperatives. Products marketed under other tradestyles are marketed primarily to industrial users, tradesmen and private label customers. All products are sold throughout the world through independent manufacturer's representatives and direct sales personnel.\nb. Competition\n(1) The Company competes with numerous companies that sell power tool accessories, several of which are larger and have a greater market share. Management believes it competes effectively through the quality and breadth of its product lines, its primary manufacturing capabilities and competitive pricing.\n(2) Handsaws and hand tools, which are used by tradesmen and consumers and are marketed under the Disston(R) tradename, compete with product lines of several companies who are larger than the Company. The Company competed effectively with these products because of its recognized manufacturing experience in these products, its reputation for quality, and the breadth of these products lines.\n(3) The Company, under the Disston tradename and private label brands, competes with numerous companies that market lawn and garden products, many of whom sell broader lines in these product areas. However, the Company believes it maintains a strong market position due to innovative marketing and packaging of these products to customers who also purchase other product lines from the Company.\n(4) The RemGrit(R)\/Grit-Edge(R) product line is sold to industrial, consumer and tradesmen markets. The Company believes its tungsten carbide abrasive product line has a leading market position due to the breadth of the line, manufacturing technology, and its quality reputation.\nc. Patents and Trademarks\nThe Company holds several U.S. patents (expiring at various dates through the year 2010) on its hardware products, but management does not believe its patents materially affect its ability to compete in the various hardware markets.\nThe Company holds numerous trademarks, both domestic and foreign, which management believes to be significant in the marketing of its hardware product lines.\n2. Marine\na. Operations\nThe Company's marine products include submersible pumps (automatic and non-automatic), activating switches and related accessory items (e.g., hose and fittings) for recreational and small commercial boats. The pumps range in capacity from 360 to 8,000 gallons per hour and are sold under the Rule(R) trademark. Pumps, switches and related accessories represented approximately 72%, 71% and 70% of total marine revenues for the years ended August 31, 1995, 1994, and 1993, respectively.\nThe Company also manufactures extensive lines of marine paints, coatings, sealants and protective products. The paints and coatings are for both topside and antifouling applications and are marketed primarily under the trademarks Gloucester(R) and KL-990(R). The sealants and protective products (e.g., waxes, cleaners and repair products) are sold under the Rule (R) trademark. Sudbury(R) specialty chemical products are also a part of Rule's marine chemical product line.\nThe Company also manufactures, under the Rule(R) trademark, a line of DC- powered winches and accessories primarily for use on boat trailers. Lightweight marine anchors are sold under the Danforth(R) and Hooker(R) tradenames. Magnetic compasses are marketed under the Danforth(R), Freedom(R) and Aqua Meter(R) tradenames. In addition, the Company markets various electronic instruments and gauges under the Aqua Meter(R) tradename.\nMarine products are sold to both boat manufacturers and distributors throughout the United States and the world by independent manufacturers' representatives and direct sales personnel.\nb. Competition\nManagement believes that on a worldwide basis, Rule has a leading market position in marine submersible bilge pumps and switches, and in magnetic compasses. The Company believes that it is one of the largest suppliers of lightweight marine anchors in the United States and Canada. In most types of lightweight anchors, Rule competes with domestic and foreign companies, both large and small. Some of these companies supply several lines of products, while others supply limited product lines. In the paint and coatings lines, the Company is aware of only two companies which have a greater position in the domestic recreational marine paint market. In marine sealants and protective products, there are many companies, both larger and smaller than Rule, that compete in this market. However, in contrast with Rule's broad chemical line, these companies manufacture either a single product or a limited product line. The Company competes primarily with one company in the powered marine winch business on the basis of quality and performance.\nc. Patents and Trademarks\nThe Company holds many U.S. patents relating to its marine products and management believes that certain patents enhance the Company's ability to compete in the marine market. The patents currently issued to the Company on its marine products expire at various times through the year 2014.\nThe Company holds numerous trademarks, both domestic and foreign, which management believes to be significant in the marketing of its marine product lines.\n3. Other Revenues\na. Other\n(1) Operations\nThe Company produces a line of winches for the utility, farm and off-road vehicle markets sold under the Rule(R) tradename. The line consists of various models, both DC and gasoline-powered, with operating capacities from 900 to 8,400 pounds. In addition, the Company manufactures a line of sump pumps and utility pumps for various applications.\nIn the United States and throughout the world, these products are sold primarily to jobbers, distributors and original equipment manufacturers via a direct sales force.\n(2) Competition\nRule is aware of several winch and sump\/utility pump manufacturers, a number of whom are substantially larger and more established in these markets than Rule. However, management believes a combination of factors, including unique products, certain exclusive design features, and product quality, enable its products to effectively compete in these markets.\nD. Seasonality -----------\nThe Company's various businesses are subject to certain seasonal fluctuations.\nE. Raw Material Availability -------------------------\nMany of the raw materials and parts used in the manufacture of the Company's products are presently available from more than one vendor. However, the Company frequently elects to purchase from a single source.\nF. Backlog -------\nProducts are manufactured to maintain inventory levels necessary to meet reasonable customer demand. Consequently, backlogs are normally less than one month's sales.\nG. Engineering and Development ---------------------------\nThe Company's expenditures for engineering and development during fiscal 1995 amounted to $1,294,000 compared to $1,186,000 and $1,125,000 in 1994 and 1993, respectively, and are expensed when incurred. The portion which relates to research and development is included in selling, general and administrative expenses and the portion relating to manufacturing engineering is included in cost of sales.\nH. Compliance with Environmental Regulations -----------------------------------------\nCompliance with federal, state and local environmental regulations has not had, and is not anticipated to have, a material effect upon capital expenditures, earnings or competitive position.\nI. Employees ---------\nAs of August 31, 1995, the Company had approximately 637 employees, all of which are non-unionized.\nJ. Financial Information About Foreign and Domestic Operations -----------------------------------------------------------\nReference is made to Industry Segment and Geographic Area Information presented in the Financial Statements in Item 8.\nK. Governmental Contracts ----------------------\nIn fiscal 1995, the Company did not generate any revenues from government contracts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe Company's general and executive offices are located in Burlington, Massachusetts. The offices consist of approximately 18,000 square feet and are leased until 1999.\nThe Company leases a facility in Gloucester, Massachusetts from an affiliated party (see Item 13, CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS), under a lease agreement which has been extended to expire on May 25, 1996. The facility consists of 87,500 square feet and is the primary manufacturing facility for marine and other products.\nThe Company leases a facility in South Deerfield, Massachusetts from an affiliated party (see Item 13, CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS), under a lease agreement entered into on June 15, 1995 which expires in the year 2010. The building contains 275,000 square feet of space which the Company uses for manufacturing hardware products.\nThe Company also leases office space in Greensboro, North Carolina and warehouse space in Anaheim, California and Mississauga, Ontario under short-term leases. These facilities are utilized by the Company's hardware segment.\nThe Company owns a 20,250 square foot vacant building on approximately two acres in Gloucester, Massachusetts which is currently for sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nIn November 1986, a suit was instituted against the Company alleging illegal pricing and marketing practices in connection with the Company's marine anchor products. In November 1993, the U.S. Court of Appeals for the Eleventh Circuit reversed the previous jury verdict against the Company, and entered judgement in favor of the Company on all federal antitrust issues. During the quarter ended November 30, 1993, the Company reversed its previously recorded liability for this matter and increased pre-tax income by $2,463,000. Certain issues of Georgia state law, which were originally decided in favor of the Company and were reversed during the appeal process, are being pursued by the plaintiff and are under consideration by the United States District Court for the Northern District of Georgia. In addition, the court has lifted the stay on the Company's previously filed antitrust action against the plaintiff.\nThere was no other significant litigation outstanding against the Company at August 31, 1995.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nThere were no matters submitted to security holders, either by proxy or otherwise, during the quarter ended August 31, 1995.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED ---------------------------------------------------- STOCKHOLDER MATTERS -------------------\nThe Common Stock of the Registrant is traded in the Over-the-Counter market. The table below reflects high and low closing prices as reported in the National Association of Securities Dealers' Automated Quotation approximately 492 record holders of the Common Stock of the Registrant.\nThe Registrant has never paid cash dividends on its Common Stock. In addition, the Company's borrowing arrangement with its senior institutional lender restricts the payment of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (000's Omitted Except for Per Share ----------------------------------------------------------- Data) -----\nNo cash dividends on common stock were declared or paid during these periods. Income (loss) from continuing operations includes an accrual for U.S. Anchor litigation of $4,347,000 in fiscal 1991 and the reversal of $2,463,000 in fiscal 1994. See Note 10 to the financial statements for the discussion of legal proceedings.\nThe selected financial information should be read in conjunction with \"Management's Discussion and Analysis of Financial Conditions and Results of Operations\" and the consolidated financial statements and the notes thereto included elsewhere in this Report, which have also been restated to reflect discontinued operations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nRESULTS OF OPERATIONS\nFiscal Year 1995 Compared with Fiscal Year 1994 - -----------------------------------------------\nIn the first complete year after the Disston consolidation, fiscal 1995 net consolidated revenues increased 7% to $68,458,000. Hardware product revenues, which now account for 66% of consolidated revenues, were responsible for most of this increase with a 35% gain in consumer hardware market shipments and continued growth in international hardware markets. Marine product revenues rose a nominal 2% to $20,772,000, but international revenues from all market segments increased 14% to $17,828,000, which represented 26% of consolidated revenues. Plagued with Disston consolidation inefficiencies and capacity constraints at the Deerfield plant, hardware customer service levels declined. Anticipated orders were cancelled and consolidated gross profits shrank $1,000,000 to $19,303,000 which represented a 28% gross margin, down 3.5% from the prior fiscal year. Despite an additional six months of Disston related operating expenses, consolidated selling, general and administrative expenses rose less than 5% to $15,874,000 and remained relatively unchanged as a percentage of revenues. Ignoring the effect of reversal of the U.S. Anchor litigation reserve in 1994, consolidated operating income declined 33% to $3,429,000, only a 5% return on net revenues. Behind this sharp margin decline, the marine products segment increased its operating profit by 19% to $4,721,000 while the hardware segment incurred an operating loss of $547,000. Other expenses rose less than 5% to $3,661,000, largely because the $864,000 non-recurring gain from the sale of Datamarine International common stock offset most of the 25% increase in interest expense, dictated by higher average borrowings related to the Disston consolidation and expansion of the Deerfield plant capacities. During its fourth quarter, Rule executed a definitive agreement to merge the Company with Greenfield Industries, Inc. and the other expense category includes $454,000 of non-recurring, fourth quarter professional fees relating to the transaction. In September 1994, when the Company restructured its senior institutional indebtedness, it incurred an extraordinary $613,000 expense, net of $316,000 in tax benefits, relating to the write off of certain deferred finance charges and the payment of an early termination fee. The significant decline in preferred stock dividends reflected the Company's redemption of preferred stock in exchange for the issuance of 401,129 shares of common stock during the first quarter of fiscal 1995.\nFiscal Year 1994 Compared with Fiscal Year 1993 - -----------------------------------------------\nFiscal 1994 operations reflect the initial impact of consolidating the operations of Disston into the Company's existing manufacturing and administrative operations, a process which began in January 1994 and was completed during the Company's fiscal fourth quarter. The Company began shipping Disston products from its Deerfield, Massachusetts manufacturing facility on March 1, 1994 and accordingly, the financial statements reflect the operating results of Disston for six months.\nConsolidated revenues of $63,919,000 for 1994 increased by $15,585,000, 32% over the prior fiscal year primarily as a result of the addition of Disston's consumer hardware revenues. Hardware revenues grew 55% over fiscal 1993, led by the addition of Disston's consumer hardware products and a 5% growth in industrial hardware products. Marine revenues of $20,448,000 reflected a 6% increase over the prior fiscal year and continued a positive momentum in both domestic and international recreational marine markets. As a result of the significant addition of domestic consumer hardware revenues, export revenues declined 5% to 25% of\nconsolidated revenues from the prior year. Reflecting the initial benefits of the consolidation of Disston's manufacturing operations and higher marine revenues, consolidated gross margins increased almost 2% to 32%. Selling, general and administrative expenses in fiscal 1994 increased from the previous year due to the Disston operations, but remained constant at 24% of consolidated revenues. Operating income, which included a $2,463,000 pre-tax reversal of the U.S. Anchor litigation accrual, increased to 12% of revenues for fiscal 1994, as compared to 6% for the prior fiscal year. Without the benefit of this reversal, fiscal 1994 operating income increased 73% to 8% of revenues.\nIn spite of significantly lower institutional borrowings in the first half of fiscal 1994, the funding of the Disston consolidation that began in January 1994, coupled with higher variable interest rates, caused interest expenses to increase 4% to $3,290,000. The $208,000 net other expense includes a $225,000 write-down of the Company's investment in Datamarine International, Inc. (Datamarine), which was sold in September 1994. The sale of the Datamarine securities will generate a pre-tax profit of $864,000 in the first quarter of fiscal 1995. The 1994 effective tax rate of 22% contains the impact of the reversal of litigation reserves, a portion of which was not taxable. Net income of $3,180,000 reflects the end of the legal problems confronting the Company since fiscal 1991 and improving operating margins. Preferred stock dividends increased $14,000 to $289,000 as a result of 5,000 additional preferred shares sold in the second quarter of fiscal 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nIgnoring the non-cash effect of the 1994 litigation reserve reversal, 1995 operating cash flow declined $1,883,000 from the prior fiscal year, reflecting this past year's disappointing operating results. The 1995 first quarter restructuring of senior institutional indebtedness and sale of the Datamarine International investment for $1,397,000 materially enhanced working capital funds and provided $2,500,000 of borrowing availability to fund on-going expansion of manufacturing capacities at the outset of the year. However, the below budget first half operating results required the Company to request an increase in its working capital revolving credit limit to $17,500,000 in March in order to accomodate seasonal operating requirements. In conjunction with this increase, the Company accelerated its efforts to raise at least $10,000,000 of additional equity before the end of June to reduce indebtedness, related to the acquisition and consolidation of the Disston Company's operations. During June and early July, the Company received several proposals for additional equity and an unsolicited proposal from Greenfield Industries, Inc. to acquire the stock of the Company in a cash transaction. On July 20, 1995, the Company agreed to be merged into Greenfield. In conjunction with the merger and the Company's continuing need for additional equity, in September, 1995 Greenfield purchased 630,000 shares of common stock for $5,040,000 and certain warrant and option holders exercised their rights to purchase stock for $2,434,000, the proceeds of which were used to reduce senior indebtedness and provide needed working capital. With this equity infusion and the continuing support of its institutional senior lender, the Company is adequately positioned to finance its operations during fiscal 1996. If the merger with Greenfield is not consummated, the Company believes there are various financing alternatives to address future capital funding requirements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nSee Item 14 (Page 15).\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ------------------------------------------------------------ AND FINANCIAL DISCLOSURE ------------------------\nIn June 1995, the Company terminated Deloitte & Touche LLP (D&T) as its principal accountants and engaged KPMG Peat Marwick LLP (KPMG). In September 1995, in connection with the merger with Greenfield, the Company terminated KPMG as its principal accountants and engaged Price Waterhouse LLP. There were no disagreements with either D&T or KPMG.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. --------------------------------------------------\nEach of the persons named in the following table has furnished the respective information shown:\nUnder federal securities laws, the Company's directors and executive officers and any other persons holding more than ten percent (10%) of the Company's Common Stock are required to report their initial ownership of the Company's Common Stock and any subsequent changes in their ownership to the Securities and Exchange Commission. During the fiscal year ended August 31, 1995, all of these filing requirements were satisfied. In making these disclosures, the Company has relied solely on written representations of its directors, executive officers, and ten percent stockholders, and copies of reports that they filed with the Securities and Exchange Commission.\n(1) Unless otherwise specified, each individual has had the same principal employment during the past five years as indicated above. Directors hold office until the third annual meeting of stockholders, or special meeting held in lieu thereof, following the meeting at which they were elected, and thereafter until their successors are chosen and qualified. Officers hold office until the next annual meeting of\ndirectors following the meeting at which they were elected, and thereafter until their successors are chosen and qualified.\n(2) During its last fiscal year, the Company paid consulting fees to Industrials, Inc., a corporation in which a revocable trust established by Mr. Anastos for the benefit of his family is the sole stockholder. See Item 11","section_11":"ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION --------------------------------------------\n1. Executive Compensation\nThe following table shows, for the fiscal years ending August 31, 1995, 1994 and 1993, the cash compensation paid by the Company and its subsidiaries, as well as certain other compensation paid accured for those years, to each of the executive officers of the Company in all capacities in which they served:\n(1) Includes (a) $900 accrued under the Company's Profit Sharing and Savings Plan (the Plan), and (b) consulting fees of $58,200 which were paid to Industrials, Inc. (Industrials), a corporation in which a revocable trust established by Mr. Anastos for the benefit of his family is the sole stockholder. See Item 10, DIRECTORS AND EXECUTIVE OFFICERS, Note (2).\n(2) Includes (a) $1,500 accrued under the Plan, and (b) consulting fees of $52,800 which were paid to Industrials. See Item 10, DIRECTORS AND EXECUTIVE OFFICERS, Note (2).\n(3) Includes (a) $1,400 accrued under the Plan, and (b) consulting fees of $47,960 which were paid to Industrials. See Item 10, DIRECTORS AND EXECUTIVE OFFICERS, Note (2).\n(4) Includes (a) $800 accrued under the Plan, and (b) $178,750 in net value from the exercise of stock options for 20,000 shares during fiscal 1995.\n(5) Amounts accrued under the Plan\n(6) Consulting fees which were paid to The Krew Team, Inc., a corporation in which Mr. Geishecker is a principal stockholder. See Item 10, DIRECTORS AND EXECUTIVE OFFICERS, Note (4).\n(7) Mr. Libby joined the Company as Vice-President on May 20, 1994, in conjunction with the Company's acquisition of the business of Disston. Prior to that date, Mr. Libby was the President and principal shareholder of Disston.\nThe Plan is a qualified, defined contribution plan under the Internal Revenue Code and all full-time, non- union Employees of the Company are eligible to participate in the Plan. The Company contributes a percentage of its net profits to the Plan as determined by the Board of Directors, and each participating Employee may voluntarily contribute up to a maximum specified dollar amount to the Plan to be held in separate account for his\/her benefit. Two-thirds of each Company contribution is allocated to the accounts of participating Employees based on relative compensation and one-third of such contribution is allocated to such accounts based on relative voluntary Employee contributions.\n2. Stock Options and Warrants\nThe following table sets forth information with respect to the named executives concerning unexercised options held and such fiscal year: their net values as of the fiscal year ended August 31, 1995 and options exercised during\n(1) On December 21, 1987, the Board of Directors adopted the 1987 Non- Statutory Stock Option Plan (the \"Non-Statutory Plan\") covering up to 200,000 shares of Common Stock of the Company. The purpose of the Non- Statutory Plan is to provide a long-term incentive to certain key employees to remain in the employ of the Company. No option granted under the Non-Statutory Plan shall be vested during the initial five years of its term. Thereafter, provided the optionee remains in the continuous employment of the Company, the option shall become vested over the subsequent five years at an annual rate of 20% of the aggregate shares issued under the option. The Board of Directors may accelerate vesting of any option upon the occurrence of certain events, including acquisition of the assets of the Company by an unrelated person or entity, the acquisistion of 20% or more of the then outstanding voting securities of the Company by an unrelated person or entity, or changes in a majority of directors of the Company. Options are to be granted at not less than the fair market value of such shares at the time of grant. Both treasury shares and authorized but unissued shares may be issued upon exercise of options granted under the Non-Statutory Plan. Shares subject to options which expire or are terminated shall be available for re-optioning under the Non-Statutory Plan. On December 21, 1987, options for 200,000 shares were granted to Messrs. Anastos, Geishecker and Sable under the 1987 Non-Statutory Plan at an exercise price of $11.50 per share. The reported bid price for shares of the Company's Common Stock at the date of grant was $6.75 per share.\n(2) The closing price on August 31, 1995 of the Company's Common Stock on the NASDAQ National Market System was $14.125 per share.\n(3) In connection with the Disston acquisition, the Company granted Henry G. Libby, a vice president of the Company, a non-qualified stock option to purchase up to 100,000 shares of the Company's Common Stock at the exercise price of $5.00 per share. The purpose of this option was to provide\na long-term incentive to Mr. Libby to remain in the employ of the Company. The option provides for annual vesting over five years and expires after eight years, subject to continuous employment with the Company. In addition, the Company entered into a non-competition agreement with Mr.\nLibby which provided for the issuance of an immediately exercisable warrant to purchase up to 100,000 shares of the Company's common stock at an exercise price of $10 per share. No options were exercised by Mr. Libby during fiscal 1995.\nSubsequent to August 31, 1995 in connection with the proposed merger with Greenfield, the Board of Directors accelerated the vesting of all non-vested shares under the above plans.\n3. Compensation Committee, Interlocks and Insider Participation in Compensation Decisions\nInasmuch as a majority of the Company's executive officers are represented and constitute a majority of the Board of Directors, the Board has not established a separate compensation committee. Mr. Geishecker is a member of the Board compensation committee of Gelman Sciences, Inc.\n4. Termination of Employment and Change of Control Arrangements\nUnder certain circumstances, the exercisability of certain options granted to named executives is accelerated in the event of certain changes in corporate control, including changes in the composition of the Board of Directors. See Note 2, Stock Options and Warrants.\nIn May, 1994, the Company entered into an employment agreement with Mr. Libby which became effective on July 21, 1995 as a result of certain changes in the Company's management, and will continue until May, 1999 or such later date on which the Company's subordinated debentures held by Mr. Libby and The Disston Company are paid in full. Under the employment agreement, Mr. Libby will continue to receive an annual base salary at the rate in effect on the effective date of such agreement and participate in such employee plans as the Company maintains.\n5. Director Compensation\nDirectors, who are not officers or employees of the Company, are paid fees of $10,000 per annum.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nAs of October 31, 1995, the only stockholders known to the Company to be the beneficial owners of more than 5% of the Company's outstanding shares of Common Stock were William N. Anastos, Henry G. Libby and Greenfield Industries, Inc. The number of shares owned beneficially by Messrs. Anastos and Libby and the Company's other directors and executive officers, and the percentage of the outstanding Common Stock represented by such shares is set forth in tabular form in Item 10. DIRECTORS AND EXECUTIVE OFFICERS. Greenfield Industries, Inc., a Delaware corporation whose principal office is located at 470 Old Evans Road, Evans, Georgia 30803, was the beneficial owner of 630,000 shares (17.6%) of the Company's common stock as of such date. In addition, Mr. Anastos granted Greenfield Industries, Inc. a proxy for 611,000 shares (16.8%) on November 20, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nA. Gloucester Premises\nThe Company leases all of the space in a building in Gloucester, Massachusetts from RAGS III, a Massachusetts general partnership comprised of Messrs. Anastos, Geishecker and Sable. Such building contains 87,500 square feet of space which is utilized by the Company for manufacturing operations. Under the terms of the lease, which originally expired on November 25, 1995 and has been extended to May 25, 1996, the Company is responsible for real estate taxes, building maintenance and all operating expenses with respect to the premises. The Company has a right of first refusal and a fair market value option to purchase the premises at any time during the lease term,\nincluding the extension period. Pursuant to an agreement between RAGS III and the Company, and subject to the completion of the merger with Greenfield, the Company will purchase the Gloucester premises from RAGS III for an aggregate purchase price of $2.4 million, which represents fair market value as determined by an independent appraiser.\nDuring fiscal 1995, the Company made lease payments to RAGS III of $519,427.\nB. South Deerfield Premises\nThe Company leases all of the space in a building located in South Deerfield, Massachusetts from RAGS II, a Massachusetts general partnership comprised of Messrs. Anastos, Geishecker and Sable. Such building contains 275,000 square feet of space which is utilized by the Company for its hardware operations. On June 15, 1995, the Company entered into a new lease which expires in 2010. Under the terms of the lease, the Company is responsible for real estate taxes, building maintenance and all operating expenses with respect to the premises. The Company has a right of first refusal to purchase the premises during the lease term.\nDuring fiscal 1995, the Company made lease payments to RAGS II of $365,000.\nC. Other Transactions\nFor information with respect to certain other transactions with management, see Item 10, DIRECTORS AND EXECUTIVE OFFICERS.\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 report on Form 10-K:\n1.Financial Statements\nIndependent Auditors' Reports\nConsolidated Statement of Operations - Years Ended August 31, 1995, 1994 and 1993\nConsolidated Balance Sheet - August 31, 1995 and 1994\nConsolidated Statement of Common Stockholders' Equity - Years Ended August 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows - Years Ended August 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2.Financial Statement Schedules\nReport of Independent Accountants on Financial Statement Schedule\nSchedule VIII - Valuation and Qualifying Accounts\nFinancial statement schedules not included in this Form 10-K have been omitted because the required information either is not applicable or is presented in the consolidated financial statements or notes thereto.\n3. Exhibits\n3.1 Restated Articles of Organization, as amended - filed as an exhibit to the Company's Registration on Form S-3, SEC Registration No. 33-82458 (the \"1994 Form S-3\") and incorporated herein by this reference.\n3.2 By-laws, as amended - filed as an exhibit to the 1994 Form S-3 and incorporated herein by this reference.\n4.1 Form of Stock Certificate for the Company's Common Stock, par value $.01 per share - filed as an exhibit to the Company's Registration Statement on Form S-14, SEC Registration No. 2-60857 (the \"Form S-14') and incorporated herein by this reference.\n4.2 Indenture dated as of June 1, 1987 with Manufacturers Hanover Trust Company, as Trustee (including form of 12 1\/2% Senior Subordinated Note due June 1, 1987) - filed as an exhibit to the Company's Registration Statement on Form S-2, SEC Registration No. 33-13587 (The \"1987 Form S-2\") and incorporated herein by this reference.\n4.3 Form of Stock Certificate for the Company's Preferred Stock, par value $100 per share-filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1991 and incorporated herein by this reference.\n4.4 Warrant Agreement dated as of May 31, 1994 and form of Common Stock Purchase Warrant Certificate - filed as exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1994 (the \"May, 1994 Form 10-Q\") and incorpoated herein by this reference.\n10.1 Lease dated November 25, 1985 with RAGS III - filed as an exhibit to the Company's Current Report on Form 8-K dated December 11, 1985 (the \"December, 1985 Form 8-K\") and incorporated herein by this reference.\n10.2 First Amended and Restated Lease dated as of May 1, 1990 with RAGS II - filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended August 31, 1990 and incorporated herein by this reference.\n10.3 Assignment and Assumption Agreement dated December 31, 1984 with RAGS II - filed as an exhibit to the Company's Current Report on Form 8-K dated January 4, 1985 (the \"January, 1985 Form 8-K\") and incorporated herein by this reference.\n10.4 Assignment and Assumption Agreement dated December 31, 1984 with RAGS II - filed as an exhibit to the January, 1985 Form 8-K and incorporated herein by this reference.\n10.5 Assignment and Assumption Agreement dated October 31, 1985 with RAGS III - filed as an exhibit to the December, 1985 Form 8-K and incorporated herein by this reference.\n10.6 License Agreement dated April 24, 1985 with Sudbury Laboratories, Inc.-filed as an exhibit to the 1987 Form S-2 and incorporated herein by this reference.\n10.7 1987 Incentive Stock Option Plan - filed as an exhibit to the Company's Registration Statement on Form S-8 dated August 2, 1994 (the \"Form S-8\") and incorporated herein by this reference.\n10.8 Form of Incentive Stock Option Agreement - filed as an exhibit to the Form S-8 and incorporated herein by this reference.\n10.9 1987 Non-Statutory Stock Option Plan - filed as an exhibit to the Form S-8 and incorporated herein by this reference.\n10.10 Form of Non-Statutory Stock Option Agreement - filed as an exhibit to the Form S-8 and incorporated herein by this reference.\n10.11 License Agreement dated January 2, 1991 with RemGrit Corporation - filed as an exhibit to the Company's Current Report on Form 8-K dated January 16, 1991 (the \"January, 1991 Form 8-K\") and incorporated herein by this reference.\n10.12 Security Agreement dated January 2, 1991 with RemGrit Corporation - filed as an exhibit to the January, 1991 Form 8-K and incorporated herein by this reference.\n10.13 Senior Subordinated Promissory Note dated March 1, 1992 to RemGrit Corporation - filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 29, 1992 and incorporated herein by this reference.\n10.14 Agreement dated December 4, 1992 with Paul Morigi & Company, Inc. and incorporated herein by this reference.\n10.15 Agreement dated February 17, 1993 between Phillips Screw Company and WKM Investments - filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1993 and incorporated herein by this reference.\n10.16 Asset Purchase Agreement dated March 16, 1993 between Silver Metal Products, Inc. and SMP Acquisition Corporation, including exhibits - filed as an exhibit to the Company's Current Report on Form 8-K dated May 17, 1993 (the \"May, 1993 Form 8-K\") and incorporated herein by this reference.\n10.16.1 Agreement for the Modification and Amendment of Asset Purchase Agreement dated as of April 15, 1993 between Silver Metal Products, Inc. and SMP Acquisition Corporation - filed as an exhibit to the May, 1993 Form 8-K and incorporated herein by this reference.\n10.17 Asset Purchase Agreement dated as of July 8, 1993 between Phillips Screw Company and Phillips One Acquisition Corporation including Guaranty and Indemnity Agreement from the Company - filed as an exhibit to the Company's Current Report on Form 8-K dated September 2, 1993 and incorporated herein by this reference.\n10.18 Asset Purchase Agreement dated as of November 22, 1993 between Rule Manufacturing, Inc. and The Disston Company, including exhibits - filed as an exhibit to the Company's Current Report on Form 8-K dated January 20, 1994 (the \"January, 1994 Form 8-K\") and incorporated herein by this reference.\n10.19 Non-Competition Agreement dated May 20, 1994 with Henry G. Libby - filed as an exhibit to the Company's Current Report on Form 8-K dated June 3, 1994 (the \"June, 1994 Form 8-K\") and incorporated herein by this reference.\n10.20 $2,000,000 Subordinated Debenture dated May 20, 1994 payable to The Disston Company - filed as an exhibit to the June 20, 1994 Form 8-K and incorporated herein by this reference.\n10.20.1 Guaranty of the Company dated May 20, 1994 to The Disston Company - filed with the exhibits in the January, 1994 Form 8-K and incorporated herein by this reference.\n10.21 $1,600,000 Subordinated Debenture dated May 20, 1994 payable to Henry G. Libby - filed as an exhibit to the June, 1994 Form 8-K and incorporated herein by this reference.\n10.21.1 Guaranty of the Company dated May 20, 1994 to Henry G. Libby - filed with the exhibits in the January, 1994 Form 8-K and incorporated herein by this reference.\n10.22 Common Stock Purchase Warrant dated May 20, 1994 with Henry G. Libby - filed as an exhibit to the June, 1994 Form 8-K and incorporated herein by this reference.\n10.23 Non-Qualified Stock Option Agreement dated April 1, 1994 with Henry G. Libby - filed as an exhibit to the June, 1994 Form 8-K and incorporated herein by this reference.\n10.24 Employment Agreement dated May 20, 1994 with Henry G. Libby - filed with the exhibits in the January, 1994 Form 8-K and incorporated herein by this reference.\n10.25 Agreement for Assumption of Liabilities dated May 20, 1994 with The Disston Company - filed as an exhibit to the June, 1994 Form 8-K and incorporated herein by this reference.\n10.26 Assignment of Lease dated August 5, 1994 with The Disston Company and incorporated herein by this reference.\n10.27 Securities Purchase Agreement for Notes and Warrants dated as of May 31, 1994 - filed as an exhibit to the May, 1994 Form 10-Q and incorporated herein by this reference.\n10.28 Warrant dated as of June 30, 1994 with The CIT Group\/Credit Finance Inc. - filed as an exhibit to the 1994 Form S-3 and incorporated herein by this reference.\n10.29 Credit Agreement dated as of September 21, 1994 with BayBank - filed as an exhibit to the Company's Current Report on Form 8-K dated September 26, 1994 (the \"September, 1994 Form 8-K\") and incorporated herein by this reference.\n10.30 Revolving Note dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.31 Term Note dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.32 Equipment Note dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.33 Security Agreement dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.34 Security Agreement - Intellectual Property dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.35 Pledge and Security Agreement dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.36 Specimen form of Subsidiary Guaranty dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.37 Specimen form of Subsidiary Security Agreement dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.38 Specimen form of Subsidiary Security Agreement - Intellectual Property dated as of September 21, 1994 with BayBank - filed as an exhibit to the September, 1994 Form 8-K and incorporated herein by this reference.\n10.39 First Amendment to Credit Agreement and Amended and Restated Note with BayBank dated March 31, 1995 - filed as an exhibit to the February 28, 1995 Form 10-Q and is incorporated herein by this reference.\n10.40 Agreement and Plan of Merger with Greenfield Industries, Inc. and Rule Acquisition Corporation dated August 11, 1995 - filed as an exhibit to the August, 1995 Form 8-K and incorporated herein by this reference.\n10.41 Lease dated June 15, 1995 with RAGS II (filed herewith).\n10.42 First Lease Amendment dated October 18, 1995 with RAGS III (filed herewith).\n10.43 Purchase and Sale Agreement dated October 18, 1995 between RAGS III and Rule Industries, Inc. (filed herewith).\n10.44 Settlement Agreement dated November 20, 1995 between the Company, Greenfield, Messrs. Geishecker, Sable, Libby and Anastos (filed herewith).\n10.45 Amendment No. 1 dated November 21, 1995 to the Agreement and Plan of Merger with Greenfield Industries, Inc. (filed herewith).\nAll of the subsidiaries listed above are included in the Company's consolidated financial statements.\n23.1 Consent of Deloitte & Touche LLP regarding Form S-8 and Form S-3 Registration Statements incorporated herein by this reference.\n23.2 Consent of Price Waterhouse LLP regarding Form S-8 and Form S-3 Registration Statements (filed herewith).\n27 Financial Data Schedule (EX-27)\nB. Reports on Form 8-K\n1. The Company filed a Report on Form 8-K dated August 11, 1995 which reported under Item 5 that the Company had entered into an Agreement and Plan of Merger with Greenfield Industries, Inc.\n2. The Company filed a Report on Form 8-K\/A (Amendment No. 1) dated September 1, 1995 which reports that the Company had terminated KPMG Peat Marwick LLP and engaged Price Waterhouse LLP as auditors.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 and 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.\nDate: December 4, 1995 RULE INDUSTRIES, INC. ------------------------\nBy: \/s\/ Gary M. Sable -------------------------------------- Gary M. Sable Vice President Chief Operating Officer\nBy: \/s\/ John A. Geishecker, Jr. -------------------------------------- John A. Geishecker, Jr. Vice President Chief Financial Officer\nBy: \/s\/ Albert J. Sabbag -------------------------------------- Albert J. Sabbag 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 and on the dates indicated.\n\/s\/ Gary M. Sable Date: December 4. 1995 - -------------------------------------- --------------------------------- Gary M. Sable, Director\n\/s\/ John A. Geishecker, Jr. Date: December 4, 1995 - -------------------------------------- --------------------------------- John A. Geishecker, Jr., Director\n\/s\/ Owen B. Lynch Date: December 4, 1995 - -------------------------------------- --------------------------------- Owen B. Lynch, Director\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Rule Industries, Inc.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of common stockholders' equity and of cash flows present fairly, in all material respect, the financial position of Rule Industries, Inc. and its subsidiaries at August 31, 1995, and the result of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our 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 managements, and evaluating the overall financial statement presentation. We believe that our audits provides a reasonable basis for the opinion expressed above. The consolidated financial statements of Rule Industries, Inc. as of August 31, 1994 and for each of the two years in the period ended August 31, 1994 were audited by other independent accountants whose report dated December 12, 1994 expressed an unqualified opinion on those statements.\nAs explained in Note 14, on August 11, 1995, Rule Industries, Inc. entered into an Agreement and Plan of Merger with Greenfield Industries, Inc. whereby Rule Industries, Inc. will become a wholly owned subsidiary of Greenfield Industries, Inc., subject to approval by Rule Industries, Inc. common shareholders.\nPRICE WATERHOUSE LLP St. Louis, Missouri October 27, 1995, except for Note 5 which is as November 30, 1995\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Directors of Rule Industries, Inc.:\nWe have audited the accompanying consolidated balance sheet of Rule Industries, Inc. and its subsidiaries as of August 31, 1994, and the related consolidated statements of operations, common stockholders' equity, and cash flows for each of the two years in the period ended August 31, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Rule Industries, Inc. and its subsidiaries at August 31, 1994, and the results of their operations and their cash flows for each of the two years in the period ended August 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1994.\nDELOITTE & TOUCHE LLP Boston, Massachusetts December 12, 1994\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET AUGUST 31, 1995 AND 1994\nThe accompanying notes are an integral part of these consolidated financial statements\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET AUGUST 31, 1995 AND 1994\nThe accompanying notes are an integral part of these consolidated financial statements\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS' EQUITY YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these consolidated financial statements.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Principles of Consolidation ---------------------------\nThe consolidated financial statements include the accounts of Rule Industries, Inc. and its subsidiaries (the Company), all of which are wholly owned. Significant intercompany transactions and balances have been eliminated in consolidation.\nb. Inventories ----------- Inventories are stated at the lower of cost or market, based on the first-in, first-out (FIFO) method. Inventory cost includes the cost of materials, direct labor and manufacturing overhead.\nc. Other Current Assets -------------------- Other current assets in 1994 include the Company's investment of 171,983 shares of common stock of Datamarine International Inc., (Datamarine), a publicly owned company. The cost of the Company's investment in Datamarine was $1,143,000. The carrying value of this investment was $533,000 and $758,000 at August 31, 1994 and 1993, respectively, and represented the Company's underlying equity in the net assets of Datamarine. In September 1994, the Company sold its investment in Datamarine for $1,397,000, resulting in a pre-tax gain of $864,000 which was recognized in the first quarter of fiscal 1995.\nd. Property and Equipment ----------------------\nProperty and equipment are carried at cost. Depreciation is computed using the straight-line method over 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. The cost of maintenance and repairs is charged to income as incurred. Significant renewals and betterments are capitalized.\ne. Financing Costs ---------------\nDeferred finance charges consist of costs incurred in obtaining debt financing and issuing redeemable preferred stock. Such amounts are carried at cost, less accumulated amortization of $826,000 and $1,212,000 at August 31, 1995 and 1994, respectively. Deferred finance charges are amortized over the terms of the related agreements (Notes 5 and 6). As discussed in Note 5, the Company refinanced its term loan and revolver debt on September 23, 1994. As of August 31, 1994, the unamortized deferred finance charges related to the refinanced debt totaled $459,000, which amount was charged as an extraordinary expense, along with an early termination fee of $470,000, in the first quarter of fiscal 1995 (Note 5).\nf. Goodwill, Patents, Licenses, Formulas, Trademarks and Other Intangibles -----------------------------------------------------------------------\nGoodwill, patents, licenses, formulas, trademarks and other intangibles consisted of the following at August 31:\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nSuch costs are amortized using the straight-line method over their legal or estimated useful lives, generally 5 to 17 years. The Company periodically evaluates the recoverability of the above intangible assets based upon the anticipated cash flows of the related product lines. Management believes that there has been no impairment in value as of August 31, 1995.\ng. Other Non-Current Assets ------------------------\nOther non-current assets include real property held for sale at August 31, 1995 with a net book value of $525,000. Management believes that, based upon recent studies, the estimated realizable value is in excess of net book value.\nh. Income Taxes ------------\nThrough August 31, 1993, income taxes have been determined for financial reporting purposes using the provisions of Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes\".\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", effective September 1, 1993. This statement required the Company to adopt an asset and liability approach to accounting for income taxes, whereby deferred tax assets or liabilities are based on the future expected values of the related assets and liabilities. The adoption of FASB No. 109, which was applied prospectively, did not have a material effect on the Company's financial statements.\ni. Engineering and Development Expenses ------------------------------------\nEngineering and development expenses are expensed when incurred. The portion which relates to research and development is included in selling, general and administrative expenses, and the portion relating to manufacturing engineering is included in cost of revenues. The following summarizes the amount of engineering and development expenses reflected in the financial statements:\nj. Net Income (Loss) Per Common Share ----------------------------------\nPrimary earnings (loss) per share are computed using the weighted average number of common and common equivalent shares (dilutive options and warrants) outstanding. In addition to the inclusion of common and common equivalent shares, the calculation of fully diluted earnings (loss) per share includes the 401,129 shares issuable through the date of conversion of the preferred stock. Fully diluted earnings (loss) per share assumes that the preferred stock was converted into common stock as of the beginning of the fiscal year and reflects the elimination of dividends.\nk. Cash Flow Information --------------------- See Note 6 for information regarding the exchange of redeemable convertible preferred stock for common stock.\nCash payments for interest and income taxes were as follows:\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994, AND 1993\nl. Concentrations of Credit Risk -----------------------------\nFinancial instruments that potentially subject the Company to credit risk consist principally of trade accounts receivable for which collateral is generally not required. The Company's customers are primarily in the hardware and marine industries, with no significant concentrations of credit risk due to the large number of customers in each industry. Management maintains reserves for potential credit losses and historically such losses have been within management's expectations. In addition, the Company maintains credit insurance on accounts receivable from most international customers.\nm. Revenue Recognition -------------------\nRevenue is recognized when products are shipped.\nn. Foreign Currency Translation ----------------------------\nAssets and liabilities of the Company's Canadian subsidiary are translated into U.S. dollars at year-end rates; revenues and expenses are translated at average rates of exchange prevailing during the year. Foreign currency transaction gains and losses are recognized in income currently. For the years ended August 31, 1995 and 1994, transaction gains and losses were not material to the consolidated financial statements. The Company has had no foreign currency transactions in prior years.\no. Fair Value of Financial Instruments -----------------------------------\nFor purposes of financial reporting, the Company has determined that the fair value of financial instruments approximates book values at August 31, 1995, based on terms currently available to the Company in financial markets.\np. Reclassifications -----------------\nCertain prior year amounts have been reclassified to conform to the current year presentation.\n2. ACQUISITION\nIn November 1993, the Company's subsidiary, Rule Manufacturing, Inc., entered into an agreement to acquire certain assets of The Disston Company (Disston). This agreement was subject to the completion of financing arrangements which occurred on January 6, 1994. Under the terms of the agreement, the assets were acquired at various dates during the period January 6 to May 20, 1994, at which time the acquisition was completed. On March 1, 1994, the Company began selling Disston products and, accordingly, the results of operations of Disston are included from that date.\nThe acquisition has been accounted for as a purchase with an aggregate purchase price of $36,750,000. The purchase price consisted of the following:\nAt August 31, 1995, other current liabilities include amounts payable to Disston and the principal shareholder of Disston totaling $930,000 and $150,000, respectively, excluding the Subordinated Debentures (Note 5c). Subsequent to May 20, 1994, the principal shareholder of Disston became an officer of the Company and is deemed to be a related party. In addition, the Company entered into a non-competition agreement with the principal shareholder of Disston which provided for the issuance of a warrant to purchase up to 100,000 shares of the Company's common stock at an exercise price of $10 per share (Note 9b).\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nThe principal shareholder of Disston also received a non-qualified stock option to purchase up to 100,000 shares of the Company's common stock over an eight year period at an exercise price of $5 per share, subject to continuous employment with the Company (Note 9a).\nThe purchase price included approximately $3,056,000 of estimated future costs related to arbitration proceedings between Disston and a former owner of Disston. The Company is not a party to the arbitration proceedings nor the action that gave rise to these proceedings. In connection with the pending merger with Greenfield, a Liquidating Trust will be established which may receive certain proceeds in the event of a favorable outcome of the arbitration proceedings (Note 14).\nThe cost of the acquisition has been allocated based upon the estimated fair values of the assets acquired and the liabilities assumed. After allocating $6,420,000 to tradenames, the excess of cost over net assets acquired amounted to $8,350,000, which has been recorded as goodwill and is being amortized over 15 years.\nThe following unaudited pro forma information has been prepared as if the operations of Disston had been included at the beginning of the periods presented. These amounts are not necessarily indicative of the actual results of operations had Disston been combined with Rule for the periods presented.\n3. INVENTORIES\nInventories consisted of the following at August 31:\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n4. PROPERTY AND EQUIPMENT\nProperty and equipment, at cost, and their estimated economic useful lives were as follows at August 31:\n5. LONG TERM DEBT AND DEMAND NOTES PAYABLE\nLong term debt and demand notes payable at August 31:\n(a) On December 24, 1992, the Company entered into a long-term senior credit agreement with an initial maturity in December 1994. On January 6, 1994, the Company entered into a revised credit agreement with the same senior lender which increased the revolving debt by approximately $6,000,000, the proceeds of which were used to acquire certain tangible assets of Disston. In addition, the maturity of the credit agreement was extended to December 1995. The agreement provided for total borrowings which were based upon eligible assets that included inventories, trade accounts receivable, and machinery and equipment (borrowing base) and, at August 31, 1994, borrowings under the agreement approximated the borrowing base. Borrowings under the agreement bore interest at prime plus 2% and were collateralized by substantially all of the assets of the Company not pledged under other debt agreements. The Company paid an annual facility fee of $150,000 plus 1\/2 of 1% of the average outstanding daily balance.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nOn September 23, 1994, the Company entered into a long-term credit agreement with a new senior lender, the proceeds of which were used to repay the existing revolving debt, certain term loans, and retire the balance remaining on the 10% Notes issued in June 1994 (Note 5 (d)). The Company paid an early termination fee of $470,000 to its previous senior lender as a result of refinancing this debt prior to its maturity. This amount, in addition to the unamortized deferred finance costs on the refinanced debt, was charged as an extraordinary expense in the first quarter of fiscal 1995. The new agreement provides for total borrowings of up to $26,000,000 based upon eligible assets including inventories, trade accounts receivable, and machinery and equipment. The credit facility is collateralized by substantially all assets of the Company and consists of a $17,500,000 three-year revolving loan, a $6,000,000 term loan, and a $2,500,000 term loan available for new equipment financing. At August 31, 1995, borrowings under the revolving and term credit agreements approximated the borrowing base, and availability under the equipment financing facility was approximately $1,480,000. Term borrowings under the agreement are to be repaid quarterly over five years and bear interest at prime plus 3\/4%. Revolver borrowings bear interest at prime plus 1\/2% or LIBOR plus 2 1\/2%. The revolving credit facility expires September 15, 1996 and the term loan with the same senior lender expires on December 31, 1999. Under the terms of the credit agreement, the Company, among other things, is restricted from paying dividends and is required to meet certain financial covenants. As of August 31, 1995, the Company was not in compliance with certain financial covenants under the new credit agreement, and such non-compliance was waived by the Company's senior lender.\n(b) In June, 1987 the Company publicly issued $15,000,000 of senior subordinated notes. The notes are redeemable at the option of the Company, in whole or in part, at face value plus interest accrued to the redemption date. The Company is required to redeem $1,875,000 of the principal amount of the notes on June 1 of each year with the balance due on June 1, 1997. The balance outstanding under the notes was $9,375,000 and $11,250,000 at August 31, 1995 and 1994, respectively. The notes bear interest at 12 1\/2% per annum payable semi-annually, and are subordinated to all present and future senior indebtedness, as defined.\n(c) Consideration for the Disston acquisition (Note 2) included the issuance of a $2,000,000 subordinated debenture to Disston and a $1,600,000 subordinated debenture to the principal shareholder of Disston in connection with a non-competition agreement. Both debentures bear interest at 6 1\/2% per annum and are to be repaid in five equal annual installments. Prior to the scheduled May, 1995 principal payments, the parties agreed to defer such principal payments and make the notes payable on demand. In addition, the interest rate increased to 8.125% per annum. In November, 1995 the terms of the notes were further amended whereby the May 20, 1995 principal payments of $720,000 were rescheduled to September 15, 1996 and the interest rate on both notes remained at 8.125% per annum. All other terms of the original subordinated debentures, including other scheduled principal payments, remain unchanged. The Company recorded related party interest expense of $341,000 and $92,000 for the years ended August 31, 1995 and 1994, respectively.\n(d) In June, 1994 the Company's wholly-owned subsidiary, Rule Cutting Tools, Inc., issued $2,180,000 of 10% Notes due May 31, 1995 with immediately exercisable warrants for the purchase of 54,500 shares of Rule common stock. The warrants are exercisable until May 31, 1997 at a price of $10 per share. In September, 1994 the Company repaid the Notes in their entirety from the proceeds of the sale of Datamarine common stock (Note 1c) and the refinancing of senior indebtedness. The Notes were guaranteed by Rule Industries, Inc. and were collateralized by 171,983 shares of Datamarine common stock.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n(e) In December, 1991 the Company entered into an installment note agreeement with a bank collateralized by certain equipment. The note bears interest, payable monthly, at the bank's base floating rate plus 1 1\/2% and is payable in monthly principal installments of $9,173 with a final installment of $220,143 due on September 4, 1998. The principal balance outstanding as of August 31, 1995 was $550,000.\nAnnual maturities of debt long term debt during the next five years are as follows:\n(f) In conjunction with the 1991 acquisition of RemGrit, the Company's RemGrit Abrasive Tools, Inc. subsidiary issued notes to the seller totaling $6,400,000, of which $2,000,000 and $3,399,000 were outstanding at August 31, 1995 and 1994 respectively. These notes have been renegotiated periodically and were scheduled to mature in December 1994. In November 1994, the Company made a $1,149,000 payment to the holder and issued a new note for the balance outstanding of $2,000,000. This note, which originally matured on February 1, 1996, was subsequently replaced with a new note payable on demand which bears interest payable quarterly at the annual rate of prime plus 1 1\/2%, and is included in demand notes payable on the August 31, 1995 Consolidated Balance Sheet.\nIn September 1995, senior indebtedness was reduced by approximately $5,040,000 with funds received from the exercise of a stock option granted to Greenfield Industries, Inc. (Greenfield) in connection with the merger (Note 14). In addition, the Company received approximately $2,434,000 in September, 1995 from the exercise of stock options and warrants, which was used for working capital purposes (Note 14). These capital infusions have improved the Company's short-term cash position and have alleviated the need to further finance additional working capital requirements. If the merger with Greenfield is not consummated, the Company believes various, reasonable alternatives are available to address its future capital funding requirements.\nUnder the terms of the Company's borrowing arrangements, the Company is subject to various restrictive financial covenants. Additionally, the Company is precluded from paying dividends on common stock, selling certain assets, acquiring treasury stock or incurring certain additional indebtedness, without the permission of its lenders.\n6. REDEEMABLE CONVERTIBLE PREFERRED STOCK\nIn December 1991, the shareholders of the Company approved the creation of a new class of preferred stock, and the Company privately placed 31,100 shares of Series A, 8% cumulative, convertible redeemable preferred stock, $100 par value, for an aggregate price of $3,110,000. On December 24, 1992, the Company privately placed an additional 5,000 shares of Series B, 8% cumulative, convertible redeemable preferred stock of $100 par value for an aggregate price of $500,000. In November 1994, the Company exercised its conversion option and redeemed all preferred shares outstanding in exchange for the issuance of 401,129 shares of the Company's common stock, thereby increasing common stock and additional paid-in capital by $3,488,000 (the carrying value of the preferred shares, immediately prior to conversion, less the related unamortized deferred financing fees).\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n7. INCOME TAXES\nThe provision (benefit) for income taxes under SFAS 109 in fiscal 1995 and 1994 and under Accounting Principles Board Opinion No. 11 (APB 11) in fiscal 1993 consisted of the following:\nSignificant components of the Company's deferred tax asset and liabilities consisted of the following as of August 31:\nA reconciliation between the statutory and effective income tax rates is as follows:\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nAt August 31, 1995, the Company had a net operating loss carryforward available for federal and state income tax purposes of approximately $6,126,000, expiring through 2010. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation to the amount of its carryforwards which can be utilized. In addition, the Company has alternative minimum tax credit carryforwards of approximately $755,000 which may be used to offset future federal income taxes, if any. In accordance with SFAS 109, a valuation allowance had been provided to reduce certain deferred tax assets to an amount that management believes is likely to be realized. For the year ended August 31, 1995, the valuation allowance was unchanged.\n8. PROFIT SHARING PLAN\nSubstantially all full-time employees of the Company are eligible to participate in a qualified profit sharing plan. Company contributions are at the discretion of the Board of Directors. The Company's contributions for the years ended August 31, 1995, 1994 and 1993 were $93,000, $81,000 and $42,000, respectively.\n9. COMMON STOCKHOLDERS' EQUITY\na. Options\nThe Company has an Incentive Stock Option Plan (the \"Plan\") authorizing the issuance of up to 250,000 shares of common stock of the Company for the granting of options to key employees. No options may be granted under the Plan after December 18, 1997. As of August 31, 1995, 197,000 shares remain available for future grant under the Plan.\nThe following summarizes the transactions relating to the Company's qualified stock option plans for the years ended August 31, 1995, 1994 and 1993, including options outstanding under previously expired plans:\nIn December 1987, the Company adopted the 1987 Non-Statutory Stock Option Plan and granted options to key personnel for the purchase of up to 200,000 shares of common stock at an exercise price of $11.50 per share. The options are exercisable over a ten-year period and may be accelerated by the Board of Directors upon the occurrence of certain events, including the merger of the Company with and into another entity . No expiration date for the options has been established and, at August 31, 1995, 80,000 shares were exercisable under this plan.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nIn connection with the Disston acquisition (Note 2), the Company granted the president of Disston a non-qualified stock option to purchase up to 100,000 shares of the Company's common stock at the exercise price of $5 per share. The purpose of this option is to provide a long-term incentive to remain in the employ of the Company. The option provides for annual vesting and shall become 100% vested over five years, subject to continuous employment with the Company. The Company has calculated the compensatory amount relating to the option as the difference between the fair market value and the option exercise price on the measurement date, of which $25,000 representing those shares immediately vested was recorded as part of the Disston purchase price. Unrecognized compensation expense at August 31, 1995 was $80,000. As of August 31, 1995, 36,000 shares were exercisable under this option.\nSubsequent to August 31, 1995, in connection with the proposed merger with Greenfield (Note 14), the Board of Directors voted to accelerate the vesting of 210,100 shares under the above plans. In September, 1995, optionees exercised options for 201,000 shares.\nb. Warrants\nIn connection with the acquisition of Disston (Note 2), the Company issued a warrant to the president of Disston for the purchase of up to 100,000 shares of the Company's common stock at $10 per share. Such warrant was immediately exercisable for 100,000 shares and was exercised in September, 1995.\nUpon completion of the Disston financing, the Company issued a warrant to its senior lender to purchase 10,000 shares of common stock at $10 per share. Such warrant is immediately exercisable and expires in June 1997. In conjunction with the issuance of $2,180,000 of Senior Notes in June 1994 (Note 5d), the Company issued immediately exercisable warrants to purchase 54,500 shares of common stock at $10 per share. These warrants expire in May 1997.\nAll of the above warrants have been appraised and recorded at an estimated market value of $.25 each.\n10. COMMITMENTS AND CONTINGENCIES\nIn November 1986, a suit was instituted against the Company alleging illegal pricing and marketing practices in connection with the Company's marine anchor products. In March 1991, the Company was found liable in proceedings in the United States District Court for the Northern District of Georgia. In November 1993, the U.S. Court of Appeals for the Eleventh Circuit reversed the previous jury verdict against the Company, and entered judgement in favor of the Company on all federal antitrust issues. During the quarter ended November 30, 1993, the Company reversed its previously recorded liability for this matter and increased pre-tax income by $2,463,000. Certain issues of Georgia state law, which were originally decided in favor of the Company and were reversed during the appeal process, are being pursued by the plaintiff and are under consideration by the United States District Court for the Northern District of Georgia. In addition, the court has lifted the stay on the Company's previously filed antitrust action against the plaintiff.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n11. LEASES\nThe Company leases its manufacturing facilities, warehouses and offices under operating leases which expire at various dates through the year 2010. Two of the leases are with partnerships consisting of three officers\/directors\/stockholders (related parties) of the Company.\nApproximate aggregate minimum future rental commitments required under non- cancelable operating leases are as follows:\nRent expense during the years ended August 31, 1993, 1994, and 1995 was as follows:\nRent paid to related parties is included in cost of revenues in the Consolidated Statement of Operations.\n12. INDUSTRY SEGMENT AND GEOGRAPHIC AREA INFORMATION\nThe operations of the Company are categorized into the following industry segments:\nHardware Products - consists of an extensive line of power tool ----------------- accessories, handsaws and hand tools, and lawn and garden products sold to industrial, tradesmen and consumer markets. Also included are winch and pump products sold to this market.\nMarine Products - consists of pumps and switches, lightweight anchors, --------------- winches, magnetic compasses and other instruments, and chemical and paint products for recreational and commercial marine markets.\nOther Revenues - primarily consists of a broad line of electric and -------------- gasoline powered winches for the off-road, utility and vehicle markets, and sump\/utility pumps.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nInformation pertaining to each industry segment and geographic area information for the years ended August 31, 1995, 1994 and 1993 are summarized as follows:\nSegment profit consists of total net revenues less related operating costs and expenses. General corporate expenses include general and administrative costs which cannot be specifically allocated to the Company's industry segments. Intersegment sales area ccounted for at prices which are comparable to prices charged to unaffiliated customers.\nRULE INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\nCorporate assets consist of cash and certain other assets which cannot be identified by industry segment.\nGeographic Area Information ---------------------------\nThe Company has no facilities outside the United States, except for a warehouse in Canada. Export revenues by major geographic concentrations are summarized below:\n13. DISCONTINUED OPERATIONS In 1993, the Company sold substantially all of the assets of two subsidiaries, Silver Metal Products, Inc. and Phillips Screw Company, for a total price of $11,072,000. The loss from discontinued operations of $74,000 includes a net loss from discontinued operations of $187,000 and a net gain on the asset sales of $113,000. The transactions were recorded as disposals of segments of the business and accordingly, their operating results were classified as discontinued operations in 1993. In fiscal 1993, net revenues of the discontinued operations prior to disposition were $6,667,000.\n14. PROPOSED MERGER WITH GREENFIELD INDUSTRIES, INC. On August 11, 1995, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Greenfield and Rule Acquisition Corporation (a wholly owned subsidiary of Greenfield), whereby the Company will become a wholly owned subsidiary of Greenfield. In connection with the Merger Agreement, Greenfield was granted an option to purchase 630,000 shares of the Company's common stock for a purchase price of $8 per share. Under the terms of the Merger Agreement, each share of Rule common stock outstanding will be entitled to receive $15.30 in cash and a beneficial interest in a Liquidating Trust (except for shares owned by Greenfield, Excluded Shares and Dissenting Shares as defined in the Merger Agreement). Prior to the effective time of the Merger, a Liquidating Trust will be established to receive the net proceeds, if any, relating to arbitration proceedings between Disston and a former owner of Disston. Management currently estimates the value of the Liquidating Trust to be $.15 per share; however, a recovery, if any, is dependent on the favorable resolution of many complex factual and legal issues.\nOn September 15, 1995, Greenfield exercised its option to purchase 630,000 shares of Rule common stock. The proceeds of $5,040,000 from the exercise were used to reduce the Company's outstanding senior indebtedness. Furthermore, outstanding options and warrants for 311,500 shares of common stock were exercised in September, 1995, including 301,000 shares exercised by Company management. The proceeds of $2,434,000 from the exercise of these options and warrants were used for working capital purposes.\nThe Merger Agreement is subject to approval by the holders of at least two-thirds of the outstanding shares of Rule common stock. The Merger Agreement may be canceled by the mutual agreement of Greenfield and the Company, and by the Company or Greenfield if certain conditions are not met, as discussed in the Merger Agreement. If the Merger Agreement is terminated under certain circumstances, the Company has agreed to reimburse Greenfield for up to $450,000 of expenses incurred by Greenfield in connection with the Merger Agreement.\nThe Consolidated Statement of Operations for the year ended August 31, 1995 reflects $454,000 of merger related costs incurred by the Company.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Rule Industries, Inc.\nOur audit of the consolidated financial statements of Rule Industries, Inc., and its subsidiaries, referred to in our report dated October 27, 1995, except for Note 5 which is as of November 30, 1995 (the Report), appearing on page of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedule listed as item 14(2) of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nAs explained in the Report, the consolidated financial statements of Rule Industries, Inc. as of August 31, 1994 and for each of the two years in the period ended August 31, 1994 were audited by other independent accountants whose report dated December 12, 1994 expressed an unqualified opinion on those statements.\nPRICE WATERHOUSE LLP St. Louis, Missouri October 27, 1995\nRULE INDUSTRIES, INC. AND SUBSIDIARIES SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED AUGUST 31, 1995, 1994 AND 1993\n(1) Amounts represent uncollectible accounts written off, net of recoveries.\n(2) Represents balances acquired in connection with the Disston acquisition.","section_15":""}
{"filename":"768532_1995.txt","cik":"768532","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nFirst Commerce Bancshares, Inc. (referred to herein as \"First Commerce\") is a bank holding company having its principal place of business in the NBC Center, 13th & O Streets, Lincoln, Nebraska 68508. First Commerce was incorporated under the laws of the State of Nebraska on May 2, 1985. First Commerce owns the following number of shares (excluding directors' qualifying shares held by Directors of the Banks, as to which shares First Commerce is required to repurchase upon the resignation of the individual director in accordance with a repurchase agreement) and percentage of outstanding shares of the following banks:\nNo. of Shares Percent ------------- ---------\nNational Bank of Commerce Trust & Savings Association, Lincoln, Nebraska 499,000 99.80% First National Bank & Trust Co. of Kearney, Nebraska 19,747.5 98.74% Overland National Bank of Grand Island, Nebraska 87,960 97.73% Western Nebraska National Bank, North Platte, Nebraska 30,696 99.21% City National Bank and Trust Co., Hastings, Nebraska 9,900 99.00% First National Bank of West Point, Nebraska 4,790 95.80% The First National Bank of McCook, Nebraska 5,950 99.16%\nAs of December 31, 1995, First Commerce reported consolidated total assets of $1,815,575,000, total deposits of $1,463,205,000 and total stockholders' equity of $180,021,000.\nAs of December 31, 1995 First Commerce and its subsidiaries had a staff of approximately 1,019 employees on a full-time equivalent basis. First Commerce considers its employee relations to be good.\nThe National Bank of Commerce Trust and Savings Association offers trust services to each of the communities in which First Commerce subsidiary banks are located under the trade name of First Commerce Trust Services.\nAcquisitions - ------------\nAs of the close of business on September 30, 1994, the Company acquired Lincoln Bank South, a suburban Lincoln bank with assets as of the effective date of the acquisition of $33,927,000. Lincoln Bank South was merged into National Bank of Commerce Trust and Savings Association, and the stockholders of Lincoln Bank South were issued a total of 324,871 shares of First Commerce Class B Common Stock. The merger was accounted for as a purchase and not as a pooling of interests.\nAs of the close of business March 31, 1995, the Company acquired Western Banshares, Inc. (Western) in Alliance and Bridgeport, Nebraska. Western's subsidiary bank was immediately merged into the North Platte National Bank with the two facilities being operated as branches starting April 1, 1995. The name of North Platte National Bank was changed to Western Nebraska National Bank. The Company issued 309,266 shares of First Commerce Bancshares Class B common stock (fair value of $3,904,483) and paid $1,989,317 in cash and cash in lieu of fractional shares, for all the outstanding common stock of Western. The transaction has been accounted for as a purchase with resulting goodwill of $2,883,000 being amortized over 15 years. As of the close of business on March 31, 1995, Western had total assets of $41 million.\nNational Bank of Commerce Trust & Savings Association (the `Lincoln Bank'') - --------------------------------------------------------------------------- The Lincoln Bank traces its origin through mergers and acquisitions to 1902, and has been engaged in the banking business continuously since that date. The Lincoln Bank conducts a general commercial banking business from its offices in the NBC Center in Lincoln, Nebraska. The Lincoln Bank's business includes the usual banking functions of accepting demand and time deposits, and the extension of personal, agricultural, commercial, installment and mortgage loans. In addition, the Bank operates a Trust Department, which provides both personal trust and corporate financing services; a Correspondent Bank Department, which serves approximately 300 banks in the surrounding area; and a MasterCard\/VISA Credit Card Department. To accommodate its customers, the Lincoln Bank operates six detached facilities and 50 automated \"Bank In The Box\" teller machines located throughout the Lincoln area.\nThe Lincoln Bank has five active non-banking subsidiaries. The Lincoln Bank owns all of the issued and outstanding stock of (1) First Commerce Technologies, Inc.(formerly NBC Computer Services Corp.), which provides data processing services to the Lincoln Bank, to the other subsidiary banks, and to approximately 283 other banks; (2) Peterson Building Corporation, which owns and operates the Rampark Parking Garage located adjacent to the NBC Center; (3) Commerce Court, Inc., which owns the Commerce Court building located adjacent to the NBC Center; (4) First Commerce Mortgage Company, a company engaged in the purchasing of residential loans to be packaged for resale as mortgage-backed securities, while retaining the servicing rights of the underlying mortgages; and (5) Cabela's LLC (80% ownership of voting stock; 50% total ownership), a company formed in 1995 with Cabela's, a catalog sales company, for the purpose of issuing a \"co-branded\" credit card. This joint venture has been successful in obtaining 75,000 credit card accounts from Cabela's clients.\nLincoln is the capital city of the State of Nebraska, and the second largest city in the state. The population of Lincoln according to the 1990 census was 192,600. The Lincoln Bank is one of four commercial banks located in the central business district of the city. Being the capital city of the State of Nebraska, Lincoln is the site of most state agencies, and Lincoln is also the site of the University of Nebraska-Lincoln, Nebraska Wesleyan University, and Union College. The largest single employment category in Lincoln is governmental service.\nFirst National Bank & Trust Co. of Kearney (the \"Kearney Bank\") - --------------------------------------------------------------- The Kearney Bank traces its origin through mergers and acquisitions to 1917, and has engaged in the banking business continually since that date. The Kearney Bank conducts a general commercial banking business from its offices in Kearney, Nebraska. The Kearney Bank's business includes the usual banking functions of accepting demand and time deposits, the extension of personal , agricultural, commercial, installment and mortgage loans. The Trust Department of the Kearney bank was acquired by the Lincoln bank in November of 1993.\nThe Kearney Bank is located on the northeast corner of First Avenue and 21st Street in the southern part of the central business district of Kearney. The main banking premises was constructed in 1976. The Kearney Bank presently operates three detached facilities and twelve automated \"Bank In The Box\" teller machines located throughout the Kearney area.\nOverland National Bank of Grand Island (the \"Grand Island Bank\") - ---------------------------------------------------------------- The Grand Island Bank was granted a national charter in 1934, and has been engaged in the banking business continuously since that date. The Grand Island Bank conducts a general commercial banking business from its offices in Grand Island, Nebraska, including the usual banking functions of accepting demand and time deposits, and the extension of personal, installment, agricultural, commercial and mortgage loans. The Trust Department of the Grand Island bank was acquired by the Lincoln bank in November of 1993.\nThe Grand Island Bank is located on the northwest corner of Third and Wheeler Streets in the center of the downtown business district of Grand Island. The building housing the main banking offices was constructed in 1959. Additionally, the Grand Island Bank owns and operates two detached drive-up facilities. All facilities are owned by the Bank. The Grand Island Bank operates ten automated \"Bank In The Box\" teller machines located in Grand Island.\nWestern Nebraska National Bank (the \"North Platte Bank\") - -------------------------------------------------------- The North Platte Bank opened for business on September 17, 1963, and since that time has conducted a general commercial banking business from its banking office in North Platte, Nebraska. The North Platte Bank's business includes the usual banking functions of accepting demand and time deposits and the extension of personal, agricultural, commercial, installment and mortgage loans.\nThe North Platte Bank is located at the corner of Third and Dewey Streets in the downtown business district of North Platte. The North Platte Bank owns the land and building composing the banking premises. The North Platte Bank owns and operates three detached facilities in North Platte.\nOn March 31, 1995, the Company acquired Western Banshares, Inc. with offices in Alliance and Bridgeport, Nebraska. The two offices were merged into North Platte National Bank. The name of the bank was changed to Western Nebraska National Bank. The two offices in Alliance and Bridgeport now operate as branches of the Western Nebraska National Bank.\nThe North Platte Bank has ten automated `Bank In The Box'' teller machines in North Platte, one in Alliance, one in Bridgeport and one in Thedford, Nebraska.\nDuring 1995, the North Platte Bank built a new facility in Bridgeport at a cost of approximately $1,250,000. Plans call for building a new main bank facility in downtown North Platte during 1996.\nCity National Bank and Trust Co. (the \"Hastings Bank\") - ------------------------------------------------------ The Hastings Bank opened for business in January of 1934, and has been engaged in the banking business continuously since that date. The Hastings Bank conducts a general commercial banking business from its offices in Hastings, Nebraska, including the usual banking functions of accepting demand and time deposits and the extension of personal, installment, agricultural, commercial, and mortgage loans.\nThe Hastings Bank is located on the northwest corner of Third and Lincoln Streets in the northwest part of the downtown business district of Hastings. The building housing the main banking offices is owned by the Hastings Bank and was constructed in 1969. The Hastings Bank also owns and operates one detached banking facility which is located near the city's only retail shopping center approximately three miles to the north, and ten automated \"Bank In The Box\" teller machines.\nFirst National Bank of West Point (the \"West Point Bank\") - --------------------------------------------------------- The West Point Bank was chartered in 1885, and has been engaged in the banking business continuously since that date. The West Point Bank conducts a general commercial banking business from its office at 142 South Main Street, West Point, Nebraska, including the usual banking functions of accepting demand and time deposits, and the extension of personal, installment, agricultural, commercial, and mortgage loans. The West Point Bank operates one automated \"Bank In The Box\" teller machine.\nThe West Point Bank is located in the central business district of West Point. The building which houses the main offices was constructed in 1964 and was added on to in 1993, and is owned by the West Point Bank.\nThe First National Bank of McCook (the \"McCook Bank\") - ----------------------------------------------------- The McCook Bank was chartered in 1885, and has been engaged in the banking business continuously since that date. The McCook Bank conducts a general commercial banking business from its office at 108 West D Street, McCook, Nebraska, including the usual banking functions of accepting demand and time deposits, and the extension of personal, installment, agricultural, commercial, and mortgage loans. The McCook Bank has no detached drive-up facility, but operates five automated \"Bank In The Box\" teller machines in McCook and one in Culbertson, Nebraska.\nThe McCook Bank is located in the downtown business district of McCook. The building which houses the Bank's offices was constructed in 1975, and is owned by the McCook Bank.\nNon Bank Subsidiaries - --------------------- First Commerce is the owner of the NBC Center. Construction of the eleven-story building was completed in March of 1976. The Lincoln Bank leases the lower level and five floors of the building. The remaining area of the building is leased to the public.\nFirst Commerce owns 6,000 shares, or 100%, of the issued shares of Commerce Affiliated Life Insurance Company, a company engaged in underwriting, as reinsurer, credit insurance sold in connection with the extensions of credit by bank subsidiaries.\nFirst Commerce owns all the stock of First Commerce Investors, Inc. First Commerce Investors, Inc. was incorporated in 1987 to provide investment advisory services in connection with the management and investment of assets held by the Company's subsidiary banks in a fiduciary capacity and to provide other investment advisory services.\nFirst Commerce owns 50% of the stock of Community Mortgage Corporation, a loan origination company in Lincoln Nebraska. Woods Brothers Realty, a real estate company, owns the other 50%. The loan originators are housed in the offices of Woods Brothers Realty.\nCOMPETITION\nFirst Commerce faces intense competition in all of its activities from other commercial banks. In addition, other financial institutions compete throughout Nebraska and the Midwest for most of the services First Commerce provides, particularly as a result of recent legislation and technological developments. Thrift institutions, as well as finance companies, leasing companies, insurance companies, mortgage bankers, investment banking firms, pension trusts and others provide competition for certain banking and financial services. First Commerce's subsidiary banks also compete for interest-bearing funds with money market mutual funds and issuers of commercial paper and other securities.\nThe Nebraska Bank Holding Company Act permits bank holding companies to own and operate more than one subsidiary bank. Under the law, an acquisition by a bank holding company of additional subsidiary banks is permitted so long as after consummation of the acquisition, the subsidiary banks of such bank holding company do not exceed nine in number (subject to certain statutory exceptions) and do not have deposits greater than 14% of total deposits of all banks, thrift institutions and savings and loan associations in the State of Nebraska as determined by the Nebraska Director of Banking and Finance as of the most recent calendar year end. At December 31, 1995, First Commerce had total deposits of approximately $1,463,205,000 which is below the limitation.\nThe Nebraska Banking Act permits statewide branching, but only if the branch bank is established through the acquisition of or merger with another bank which has been chartered for more than eighteen months, and if the acquired bank is converted to a branch bank. Branches may be established de novo but only if located within the city or town in which the Bank's main office is located (except in Sarpy and Douglas Counties). Effective March 27, 1992, banks located in Sarpy and Douglas Counties, Nebraska, may establish an unlimited number of branches in and between both counties; banks in Lancaster County (which includes NBC) may establish up to nine branches within the city limits of the community in which the main office is located; and banks in all other counties may establish up to six branches within the city limits of their respective community.\nOut-of-state bank holding companies located anywhere in the United States may acquire Nebraska banks or Nebraska bank holding companies so long as the state in which the acquiring company is located has laws no more restrictive than those of Nebraska relative to the bank acquisitions in their states. (See \"Recently Enacted Federal Legislation\" below)\nIn early 1996, First Bank Systems, a Minnesota based banking organization, will complete its announced purchase of Firstier Financial, Inc., one of the Company's major competitors in the Lincoln and Nebraska markets. The Company feels the instability created by this merger, could give the Company a competitive advantage for a short period of time. The Company will step up its advertising campaigns and officer call programs to try and capitalize on this competitive advantage.\nRECENTLY ENACTED FEDERAL LEGISLATION\nThe recently enacted federal Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 will increase the ability of bank holding companies, including First Commerce, to make interstate acquisitions and to operate their subsidiary banks. Commencing on September 29, 1995, adequately capitalized and adequately managed bank holding companies are permitted to make acquisitions of banks located anywhere in the United States without regard to the provisions of any state laws that may presently prohibit such acquisitions. Interstate acquisitions are not permitted, however, if the potential acquirer would control more than 10 percent of the insured deposits in the United States or more than 30 percent of insured deposits in the home state of the bank to be acquired or in any state in which such bank has a branch. States may enact statutes increasing the 30 percent limit and may also lower such limit if they do so on a non-discriminatory basis. States will also be permitted to prohibit acquisitions of banks that have been established for fewer than five years. The Board of Governors of the Federal Reserve System is required to consider the applicant's record under the federal Community Reinvestment Act in determining whether to approve an interstate banking acquisition.\nThe new statute also permits, after June 1, 1997, interstate branch banking in all states by adequately capitalized and adequately managed banks, but a state may enact specific legislation before June 1, 1997, prohibiting interstate branch banking in that state, in which event banks headquartered in the state will not be permitted to branch into other states. A state may also enact legislation permitting non-discriminatory interstate branch banking in such state before June 1, 1997. Applications for interstate branching authority will be subjected to regulatory scrutiny of compliance with both federal and state community reinvestment statutes with respect to all of the banks involved in the proposed transaction.\nThe effect of this may be to permit the further consolidation of the Nebraska banking community and the acquisition of Nebraska banks and bank holding companies by larger regional bank systems or major money center banks. This may result in increased competition for deposits and profitable loans. Further, the regional bank systems and major money center banks may be able to offer a broader variety of services than those presently offered by Nebraska banks.\nSUPERVISION AND REGULATION; EFFECT OF GOVERNMENT POLICIES\nBanking is a highly regulated industry, with numerous federal and state laws and regulations governing the organization and operation of banks and their affiliates. As a bank holding company, First Commerce is subject to regulation under the Bank Holding Company Act of 1956, which requires First Commerce to register with the Federal Reserve Board and subjects First Commerce to the Board's examination and reporting requirements. The Act requires prior approval of the Federal Reserve Board for bank acquisitions (which includes the acquisition of substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if, after such acquisition, a bank holding company would own, directly or indirectly, more than five percent of the voting shares of such bank). The Act further restricted until December 29, 1995, the acquisition of voting shares of out-of-state banks (unless such acquisition was specifically authorized by the statute laws of the state in which the bank to be acquired is located), and limits the ability of First Commerce to engage in, or to acquire direct or indirect control of the voting shares of any company engaged in any non-banking activity. One of the principal exceptions to this limitation is for activities--such as making or servicing loans, performing certain data processing services, providing certain trust, fiduciary and investment services, and engaging in certain leasing transactions- - -found by the Federal Reserve Board by order or regulation to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nFirst Commerce is also registered as a bank holding company under the Nebraska Bank Holding Company Act.\nFederal law also regulates transactions among First Commerce and its subsidiaries, including the amount of a banking affiliate's loans to, or investments in, an affiliate and the amount of advances to third parties collateralized by securities of an affiliate. In addition, various requirements and restrictions under federal law regulate the operations of First Commerce and its subsidiaries. These laws, among other things, require the maintenance of reserves against deposits, impose certain restrictions on the nature and terms of loans, restrict investments and other activities, regulate mergers, the establishment of branches and related operations, and subject the Subsidiary Banks to regulation and examination by the FDIC and the Comptroller of the Currency. Banks organized under federal law are limited in the amount of dividends which they may declare--depending upon the amount of their capital, surplus, income and retained earnings--and, in certain instances, such national banks must obtain regulatory approval before declaring any dividends. In addition, under the Bank Holding Company Act of 1956 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, lease or furnishing of services.\nThe banking industry also is affected by the monetary and fiscal policies of regulatory authorities, including the Federal Reserve Board. Through open market securities transactions, variations of the discount rate, and the establishment of reserve requirements, the Federal Reserve Board exerts considerable influence over the cost and availability of funds obtained for lending and investing, and the rates of interest paid by banks on their time and savings deposits.\nThe monetary policies of the Federal Reserve Board have had a significant effect on the operating results of bank holding companies and their subsidiary banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and in the money markets, 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, or loan demand or as to the impact of such changes on the business and earnings of any bank or bank holding company.\nThe Company's seven subsidiary banks are all chartered as national banks and, therefore, fall under the supervision and regulation of both the Comptroller of the Currency and the Federal Deposit Insurance Corporation. The Federal Deposit Insurance Corporation Act of 1991 (FDICIA) includes a variety of supervisory measures. FDICIA prescribed a system of prompt regulatory action when any financial institution falls below minimum capital standards. FDICIA also requires regulatory agencies to prescribe standards related to internal operations and management, including \"internal controls information and audit systems\", \"loan documentation\", \"credit underwriting\", \"interest rate exposure\", \"asset growth\", and such other operational and management standards as the agencies deem appropriate. FDICIA also requires that regulatory agencies prescribe compensation standards for executive officers, employees, directors, and principal shareholders of insured depository institutions. FDICIA authorizes regulatory agencies to treat as an \"unsafe and unsound practice\" any failure by an institution to correct a deficiency that leads to a \"less-than- satisfactory\" examination rating for asset quality, management, earnings, or liquidity. This permits the agencies to bring an enforcement action against the institution and impose sanctions.\nFederal Reserve Board's Regulation O governs loans to directors, officers and principal shareholders of member banks and their related interests. FDICIA imposed a cap on total extensions of credit to insiders equal to 100 percent of the institution's capital, although the Federal Reserve has recently increased the cap to 200 percent of capital for adequately capitalized banks with less than $100 million in deposits.\nIncorporated in FDICIA was the Truth-in-Savings Act which applies to depository accounts offered by depository institutions. This act imposes requirements concerning disclosure of terms, conditions, fees, and yields to advertisements and general solicitations, to periodic account statements, and to certain dealings between customers or potential customers and a depository institution. The Act aims to achieve standardization of the method of calculating an \"annual percentage yield\" and provides for civil liability and administrative enforcement mechanisms.\nFrom time to time, various proposals are made in the United States Congress and the Nebraska Legislature, and before various bank regulatory authorities which would, among other things, alter the powers of, and restrictions on, different types of banking organizations, expand the authority of regulators over certain activities of bank holding companies, require the application of more stringent standards with respect to the acquisition of banks, expand the powers of bank holding companies with respect to interstate acquisitions, affect the non- banking and securities activities permitted to banks or bank holding companies, or restructure part or all of the existing regulatory framework for banks, bank holding companies and other financial institutions. It is impossible to predict whether new legislation or regulations will be adopted and the impact, if any, on the business of First Commerce.\nDIVIDENDS\nUnder applicable federal statutes, the approval of the Comptroller is required if the total of all dividends declared by a national bank in a calendar year exceeds the aggregate of the Bank's \"net profits\", as defined, for that year and its retained net profits for the two preceding years. Under this formula, First Commerce's subsidiary banks could declare aggregate dividends as of December 31, 1995, without the further approval of the Comptroller, of approximately $17,359,000.\nUnder Federal Reserve Board policy, First Commerce is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support such banks in circumstances where it might not do so absent such policy.\nThe FDIC and the Comptroller have authority under federal law to take certain enforcement actions against a national bank found to be engaged in conduct which, in their opinion, constitutes an unsafe or unsound banking practice. Depending upon the financial condition of the bank in question, and other factors, the payment of dividends or other payments might under some circumstances be considered by the FDIC and\/or the Comptroller to be an unsafe or unsound banking practice. In such case, the Comptroller could, among other things, commence cease and desist proceedings and the FDIC could commence a proceeding to terminate deposit insurance.\nCAPITAL REQUIREMENTS\nThe Federal Reserve Board has issued risk-based and leverage capital guidelines for bank holding companies like First Commerce. The risk-based guidelines define a two-tier capital framework. Generally, Tier 1 capital consists of common and qualifying preferred shareholders' equity, less goodwill. Generally, Tier 2 capital consists of mandatory convertible debt, subordinated and other qualifying term debt, preferred stock not qualifying for Tier 1 and the allowance for loan losses, subject to certain limitations. The regulatory minimum ratio for qualifying total capital is 8 percent, of which 4 percent must be Tier 1 capital. On December 31, 1995, First Commerce's total capital ratio was 14.82 percent and its Tier 1 ratio was 13.39 percent.\nWhile the Federal Reserve Board's stated minimum leverage ratio of Tier 1 capital to quarterly average assets less goodwill is 3 percent, most bank holding companies such as First Commerce will be required to maintain ratios of at least 100 to 300 basis points above 3 percent. First Commerce's leverage ratio at December 31, 1995, was 9.16 percent. The Comptroller of the Currency, which regulates all of First Commerce's banking subsidiaries, has promulgated substantially similar capital guidelines. The Federal Reserve Board and the Comptroller of the Currency, may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth.\nFOREIGN OPERATIONS\nThe Company and its subsidiaries do not engage in any material foreign activities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFirst Commerce owns its headquarters building, the NBC Center, which is located at 1248 O Streets, Lincoln, Nebraska, in the downtown central business district of the city. Construction of the eleven-story building was completed in March 1976. The Lincoln Bank leases the lower level and five additional floors of the building. The remaining area of the building is leased to the public.\nAt December 31, 1995, First Commerce's subsidiary financial institutions operated a total of seven main banking houses (including the Lincoln Bank's NBC Center location), 17 detached facilities, and 101 automated teller machines. All of the facilities are owned by the respective banks, with the exception of the Lincoln Bank which is housed in the First Commerce owned NBC Center.\nAdditional information with respect to premises and equipment is presented on Page 20 of the Notes to Financial Statements in First Commerce's 1995 Annual Report to Shareholders, which is incorporated herein by reference.\nFor additional description of property owned and operated by First Commerce and each subsidiary, see Item 1.\nIn the opinion of management, the physical properties of First Commerce and its subsidiaries are suitable and adequate and are being fully utilized, except for the former First Commerce Savings, Inc. facility which was vacated April 1, 1994 after the merger with NBC. This facility may be utilized in the future as a NBC drive-up facility or it may be sold.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and certain subsidiaries have been engaged in prolonged litigation concerning the failure of an unrelated Nebraska industrial loan and investment company. The same plaintiffs brought all of these cases. All of these cases have been dismissed and the dismissals have been affirmed by the appellate courts. The United States Court of Appeals affirmed the last of these dismissals on December 6, 1995, and the time for plaintiffs to petition the United States Supreme Court for a writ of certiorari will not expire until March of 1996. Since plaintiffs unsuccessfully sought Supreme Court review in their previous federal case, they may attempt to obtain a writ of certiorari in this case as well. If the Supreme Court were to grant certiorari and reverse the decision of dismissal and if a trial ultimately resulted in an unfavorable outcome, it could have a significant effect on the Company's financial position, since the action sought $58 million damages, which could have been tripled according to the Racketeer Influenced and Corrupt Organizations (RICO) Act, under which the suit was brought. Legal counsel for the company is of the opinion, however, that even if plaintiffs were to petition for a writ of certiorari it is unlikely the Supreme Court would accept the case for review. It therefore appears that the action has been successfully concluded.\nThe nature of the business of First Commerce involves, at times, a certain amount of litigation against First Commerce and its subsidiaries involving matters arising in the ordinary course of business; however, in the opinion of the management of First Commerce, there are no other proceedings pending to which First Commerce or any of its subsidiaries is a party, or which its property is subject, which, if determined adversely, would be material in relation to the financial condition of First Commerce.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of First Commerce's security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe present executive officers of First Commerce, their respective ages and the year each was first elected an officer, are set forth in the following table:\nPresent Office Year First Name Age or Position Elected Officer ---- --- --------------- ---------------\nJames Stuart, Jr. 53 Chairman and Chief 1973 Executive Officer\nBrad Korell 47 Executive Vice President 1990\nStuart Bartruff 41 Executive Vice President- 1987 and Secretary\nMark Hansen 40 Senior Vice President 1994\nDonald Kinley 45 Vice President and Treasurer 1977 (Chief Accounting Officer)\nThe occupations of the executive officers for the last five years are as follows:\nJames Stuart, Jr. was elected Chairman of the Board and Chief Executive Officer on January 19, 1988. Mr. Stuart, Jr. had served as President and Chief Executive Officer of First Commerce since May 3, 1985. Mr. Stuart, Jr. also serves as Chairman and Chief Executive Officer of the Lincoln Bank, and as a director of the remaining Subsidiary banks except the West Point Bank.\nBrad Korell has served as Executive Vice President of First Commerce and as President of the Lincoln Bank since March 7, 1990. Prior to March 1990, Mr. Korell had served as Executive Vice President and Senior Loan Officer of the Lincoln Bank since December 1987.\nStuart Bartruff has served as Senior Vice President-Loan Services since 1985 and was elected Secretary in May of 1992. He joined the Company in May of 1979.\nMark Hansen was elected Senior Vice President of First Commerce on June 21, 1994. Mr. Hansen has been an employee of the National Bank of Commerce since 1977, beginning as a Loan Analyst and being promoted to Corporate Lending Officer in 1980, Corporate Banking Manager in 1986, Senior Lender Officer in 1990, and Executive Vice President of National Bank of Commerce in 1992, a title he still holds.\nDonald Kinley was elected as Vice President and Treasurer in April 1993. Prior to that Mr. Kinley served as Vice President and Assistant Treasurer for more than five years. He joined the Company in 1977.\nNo family relationships exist between any of the executive officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference from the First Commerce Annual Report to Shareholders for the Year Ended December 31, 1995, Page 1 and Page 31.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference from the First Commerce Annual Report to Shareholders for the Year Ended December 31, 1995, Pages 32-35.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Incorporated by reference from the First Commerce Annual Report to Shareholders for the Year Ended December 31, 1995, Pages 36 through 48, and captioned as \"Management's Discussion and Analysis\". ------------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference from the First Commerce Annual Report to Shareholders for the Year Ended December 31, 1995, Pages 12 through 30.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 First Commerce Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, under the caption \"1. Election of Directors\" commencing on Page 2.\nFor information concerning the Executive Officers, see Item 4 at Page 11.\nITEM 11.","section_11":"ITEM 11.EXECUTIVE COMPENSATION\nIncorporated by reference from the First Commerce Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, under the caption \"Executive Compensation and Other Information\".\nITEM 12.","section_12":"ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from the First Commerce Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, under the captions \"Principal Shareholders\" and \"1. Election of Directors\".\nITEM 13.","section_13":"ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from the First Commerce Annual Report to Shareholders for the Year Ended December 31, 1995, Page 24, Footnote N and incorporated by reference from the First Commerce Proxy Statement for the Annual Meeting of Shareholders to be held April 16, 1996, under the caption \"Executive Compensation and Other Information\".\nPART IV\nITEM 14.","section_14":"ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS PAGE REFERENCE IN ANNUAL REPORT TO SHAREHOLDERS* ---------------------------------\nConsolidated Balance Sheets as of December 31, 1995 and 1994 12 Consolidated Statements of Income for the Three Years Ended December 31, 1995......................... 13 Consolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1995 ........................ 14 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995 ...............................15 Notes to Consolidated Financial Statements ........... 16 Independent Auditors' Report ......................... 30\nCondensed financial statements for parent company only may be found in the Notes to Consolidated Financial Statements, Pages 25 through 27. All other schedules have been omitted because the required information is presented in the financial statements or in the notes thereto, the amounts involved are not significant or the required subject matter is not applicable.\n*These items are included in First Commerce's 1995 Annual Report to Shareholders on the pages indicated and are hereby incorporated by reference in this Form 10- K. First Commerce's 1995 Annual Report to Shareholders is an integral part of this Form 10-K.\nREPORTS ON FORM 8-K\nThe Company filed a report on Form 8-K dated December 15, 1995, reporting on Item 5, Other events. The Company announced the adoption of a `Dividend Reinvestment Plan and an Employee Stock Purchase Plan'.\nEXHIBITS\nThe following Exhibit Index lists the Exhibits to Form 10-K.\n[CAPTION]\nFINANCIAL STATEMENT SCHEDULES\nNone.\nSIGNATURES\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.\nFIRST COMMERCE BANCSHARES, INC.\nBy:James Stuart, Jr. Date:March 18, 1996 --------------------------- ------------------ James Stuart, Jr. Chairman, Chief Executive Officer and Director\nBy:Stuart Bartruff Date: March 18, 1996 --------------------------- ------------------ Stuart Bartruff Executive Vice President and Secretary (Principal Financial Officer)\nBy:Donald Kinley Date: March 18, 1996 --------------------------- ------------------ Donald Kinley Vice President and Treasurer (Principal Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDavid T. Calhoun Date: March 19, 1996 - ------------------------------ ------------------ David T. Calhoun, Director\nConnie Lapaseotes Date: March 19, 1996 - ------------------------------ ------------------ Connie Lapaseotes, Director\nDate: - ------------------------------ ------------------ John G. Lowe, III, Director\nDate: - ------------------------------ ------------------ John C. Osborne, Director\nRichard C. Schmoker Date: March 19, 1996 - ------------------------------ ------------------ Richard C. Schmoker, Director\nKenneth W. Staab Date: March 19, 1996 - ------------------------------ ------------------ Kenneth W. Staab, Director\nJames Stuart Date: March 19, 1996 - ------------------------------ ------------------ James Stuart, Director\nJames Stuart, Jr. Date: March 19, 1996 - ------------------------------ ------------------ James Stuart, Jr., Director\nScott Stuart Date: March 19, 1996 - ------------------------------ ------------------ Scott Stuart, Director","section_15":""}
{"filename":"757546_1995.txt","cik":"757546","year":"1995","section_1":"ITEM 1. BUSINESS\nBusiness of the Biltmore Bank Corp. and Biltmore Investors Bank\nBiltmore Bank Corp. (\"The Company\") was incorporated under the laws of the State of Arizona on March 19, 1984 to operate as the holding company for Biltmore National Bank, predecessor to Biltmore Investors Bank (\"Bank\"). The Bank, organized as a nationally chartered bank, opened August 22, 1985. The Bank engages in the commercial banking business. The Bank accepts checking and savings deposits, makes a full range of commercial, installment and real estate loans, and provides other customary banking services, including consumer loans, brokerage and trust services. The Bank has two banking offices, and one administrative office. The main office is at 2425 E. Camelback Road in Phoenix, Arizona. The second branch is at 8700 E. Pinnacle Peak Road in Scottsdale, Arizona. Both offices provide banking, trust and investment services for its primary service area. The Company has no definite plans to engage in any other business at this time. Federal law prohibits bank holding companies from engaging in activities other than banking or bank-related services.\nMarketing and Business Plans\nThe Bank's business plan emphasizes personalized service combined with a full range of banking services for executives, professionals and entrepreneurs. The Bank markets its services to professional firms, including law firms, accounting firms, physicians and dentists, manufacturing and distribution businesses, service firms, and individuals living or working in the Bank's primary service area. The Board of Directors and Advisory Directors of the Bank assist in business development efforts through referrals obtained by the Directors' personal contacts and participation in activities in the community in which the Bank is located. The Board of Directors of the Bank also attempts, on a constant basis, to develop methods that will better serve the financial needs of the Bank's primary service area. The Bank seeks to differentiate itself from other large commercial banks and savings and loan associations by a marketing plan that emphasizes personalized, friendly service from professional staff members, access to Bank management, prompt loan decisions, and customized products.\nThe Bank's real estate lending philosophy and direction now emphasizes owner-occupied permanent real estate lending and residential real estate construction loans, with permanent take-out commitments from either the Bank or other financial institutions.\nIn conjunction with the Bank's business plan to provide a full range of banking services, the Bank introduced a securities brokerage office in 1990 and trust services in 1991. The securities brokerage office, which is located at the Bank, is operated under an agreement between the Bank and LINK Investment Services, a national non-affiliated securities brokerage firm. The trust office, which is also located at the Bank, offers a full range of employee benefit, personal trust, custody, and asset management services.\nOn February 1, 1994 Biltmore Investors Bank consummated a purchase and assumption agreement with Sears, Roebuck and Co. to acquire substantially all of the assets and liabilities of American National Bank, which operated at the Pinnacle Peak site.\nThe acquisition of ANB assets allowed Biltmore Investors Bank to establish an operation in a strategically desirable market area without incurring significant start-up costs and to provide a high quality of banking service to the North Scottsdale area. This acquisition allows the Bank to provide additional services to the former clients of American National Bank such as trust, financial planning and a higher lending limit. These additional services more effectively meet the needs of the market area.\nCompetition\nThe banking business in Arizona generally, and in the Bank's primary service area in particular, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks which have many offices throughout the State of Arizona. As of December 31, 1995, according to the Arizona State Banking Department, there were twenty (20) state chartered banks and nine (9) national banks for a total of twenty- nine (29) banks.\nThe Bank competes for deposits and loans principally with these banks, as well as with other financial intermediaries including credit unions, mortgage companies, insurance companies, stock brokerage firms, and other lending institutions. These larger institutions are able to undertake large advertising campaigns and to allocate their investment assets in areas of highest yield and demand. In competing for deposits, the Bank also is subject to certain limitations not applicable to non-bank financial institutions.\nIn order to compete with the other financial institutions within the Bank's primary service area, the Bank relies on personal contacts by its officers, Directors, members of the Advisory Board, employees and the shareholders of the Company. The Bank's promotional activities emphasize the advantages of dealing with a locally-managed institution that is sensitive to the special needs of the community. The Bank provides a courier service to clients in order to compete with other institutions who have multiple locations.\nEmployees\nAs of December 31, 1995, the Bank employed forty-five (45) full-time employees and three (3) part time employees. Of these, fourteen (14) were management personnel.\nProfitability\nThe Company and the Bank have been operating since 1985. Because the Company's principal activity for the foreseeable future will be to act as the holding company of the Bank, its profitability depends on the Bank's profitability. For the year ended December 31, 1995, the Company recorded consolidated net income of $715,281 compared with a consolidated net income of $1,357,375 in 1994.\nSUPERVISION AND REGULATION\nThe Company\nThe Common Stock is subject to the registration requirements of the Securities Act of 1933, as amended. The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, which includes, but is not limited to, the filing of annual, quarterly and other reports with the Securities and Exchange Commission.\nThe Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"Holding Company Act\"), and is subject to supervision by the Federal Reserve Board. As a bank holding company, the Company is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board requires pursuant to the Holding Company Act. The Federal Reserve Board also makes examinations of the Company and its subsidiary.\nThe Holding Company Act requires prior approval of the Federal Reserve Board for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than five percent (5%) of the voting shares, or substantially all the assets of any bank, or for a merger or consolidation by a bank holding company with any other bank holding company. The Holding Company Act also prohibits the acquisition by a bank holding company or any of its subsidiaries of joint shares or substantially all the assets of any bank located in a state other than the state in which the operations of the bank holding company's banking subsidiaries are principally conducted, unless the statutes of the state in which the bank to be acquired is located expressly authorize such an acquisition. Beginning October 1, 1986, out-of-state banks and bank holding companies were allowed to acquire banks, bank holding companies, or both, in Arizona.\nWith certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than five percent (5%) of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking, managing or controlling banks or performing services for its authorized subsidiaries. A bank holding company, however, may engage in activities which the Federal Reserve Board has determined to be closely related to banking. In making that determination, the Federal Reserve Board is required to consider whether the performance of these activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern. The Federal Reserve Board has determined that mortgage banking is an activity which, in general, can be engaged in by a subsidiary of a banking holding company. However, should the Company decide to establish or acquire a mortgage banking subsidiary, it would be required to obtain the prior approval of the Federal Reserve Board.\nAdditional statutory provisions prohibit a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, a subsidiary bank may not extend credit, lease or sell property, furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or service from or to, such bank other than a loan, discount, deposit or trust service; or (ii) the customer may not obtain some other credit, property or service from competitors, except reasonable requirements to assure soundness of credit extended.\nThe federal banking agencies have also adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a leverage ratio of at least 3% Tier 1 capital to adjusted total assets, while lower rated banking organizations must maintain a ratio of at least 4% to 5%. In all cases, banking institutions are expected to hold capital commensurate with the level and nature of risks. The Company's leverage ratios for the years ended December 31, 1995 and 1994 were 8.88% and 7.12%, respectively.\nThe Bank\nThe Bank is a national banking association whose depositors are insured by the Federal Deposit Insurance Corporation (the \"FDIC\") up to the maximum legal limits of the FDIC ($100,000) and is subject to regulation, supervision, and regular examination by the Comptroller of the Currency. The Bank is a member of the Federal Reserve System and is subject to certain provisions of the Federal Reserve Act and to regulations promulgated from time to time by the Federal Reserve Board. The Bank also is subject to applicable provisions of Arizona state law, insofar as those laws do not conflict with, or are not preempted by, federal law. The regulations of these various agencies govern most aspects of the Bank's business, including reserve against deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices.\nThe Bank is required to maintain adequate capital ratios. The Federal Reserve Board has adopted a risk-based capital measurement to assist in the determination of capital adequacy. The guidelines divide holding companies into two categories: (1) above 150 million dollars in consolidated assets, in which case the guidelines are applied on a consolidated basis for all banks under the holding company, and (2) holding companies below 150 million dollars in consolidated assets level, in which case the guidelines are applied on a bank-by-bank basis. The Bank falls in the second category as of December 31, 1995.\nThe Federal Reserve Board has adopted capital regulations which require the Bank to maintain two separate minimum capital ratios: the Tier 1 Capital Ratio and the Total Risk-Weighted Capital Ratio. The Bank's capital ratios are shown, along with the minimum required ratios as of December 31, 1995, and 1994 respectively, in the following table:\nTotal Risk- Tier 1 Weighted Capital Capital ------- -------\nCapital Ratio at December 31, 1995 13.57% 16.16% Capital Ratio at December 31, 1994 12.96% 14.23% Regulatory Capital Requirement 4.00% 8.00%\nThe Depository Institutions Deregulation and Monetary Control Act of 1980 specifies that any reserve requirement to maintain non-interest bearing reserves with the Federal Reserve Bank will be uniformly applied to all depository institutions that maintain transaction accounts (demand deposit accounts, NOW accounts and savings accounts subject to automatic transfers) or non-personal time deposits.\nIn August 1989, the Financial Institution Reform, Recovery and Enforcement Act (\"FIRREA\") was enacted into law. FIRREA provides, in part, for the recapitalization of the savings association and bank insurance funds, the restructuring of the federal agencies that insure and supervise savings institutions, and the implementation of a number of changes to federal statutes governing not only savings institutions, but also banking organizations. Provisions of FIRREA which affect the Company and the Bank include, without limitation, the enhancement of the FDIC's enforcement powers, an increase in banks' deposit insurance premiums and the basing of a bank's deposit insurance premium on the type of investments held by the Bank.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"Act\") modified FIRREA in several material respects and set forth certain changes in the legal environment for insured banks. The Act, among other provisions, reduced insurance coverage for certain kinds of deposits, increased consumer-oriented requirements, and revised the process of supervision and examination of depository institutions.\nSpecifically (but not exclusively) the Act provided for recapitalization of the Bank Insurance Fund, created additional controls on brokered deposits, tightened controls on extensions of credits to directors and executive officers and accelerated regulatory action for underperforming or under capitalized institutions.\nLegislative and regulatory proposals which could affect the Bank specifically and the banking business in general may be introduced before the United States Congress and other governmental bodies. These proposals may further alter the structure, regulation and competitive relationship of financial institutions if they become law, and may subject the Bank to increased regulation, disclosure and reporting requirements. In addition, various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such legislation or regulations will be enacted or the extent to which the business of the Bank would be affected thereby.\nBanking is a business which depends on interest rate margins. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on loans extended to its customers and on securities held in its investment portfolio, comprise the major portion of a Bank's earnings. Thus, the earnings and growth of the Bank are subject to the influences of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board, which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of future changes in the policies and their impact on the Bank cannot be predicted.\nINDUSTRY SEGMENTS AND FOREIGN OPERATIONS\nIndustry segment information and foreign operations disclosures are not applicable to the Company since the Company's only activity is ownership of the Bank which has no foreign operations.\nSELECTED BANKING INFORMATION\nSet forth below is information relating to the Bank's financial position as of December 31, 1995 and 1994, and relating to the Bank's operations for the years ended December 31, 1995, 1994 and 1993.\nI. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential\nA. Schedule of Assets, Liabilities and Shareholders' Equity and Interest Income\nThe following schedule shows the average balances of the Bank's assets, liabilities and shareholders' equity accounts and the percentage distribution of the items using the average month-end balances for the periods indicated.\nB. Interest Income\nThe following table shows the average balances, the average month-end yields and the dollar amounts of interest earned or paid for each of the Bank's major categories of interest-earning assets and interest-bearing liabilities for the period indicated.\nYear ended December 31, 1995 ---------------------------------- Average Average Interest Rate Balance(1) Earned\/Paid Earned\/Paid ------------ ------------ -----------\nLoans (net of allowance) $ 88,166,000 $ 7,888,928 8.95% Taxable investment securities 36,372,000 2,042,226 5.61 Other investments 391,000 22,143 5.66 Federal funds sold 6,000 216,886 ------------ ------------ ---- Total Average Interest- Earning Assets $124,935,000 $ 10,170,183 8.14% ============ ============ ==== Deposits, interest-bearing: Interest-bearing demand $ 28,913,000 $ 911,151 3.15 Other time certificates 44,005,000 2,539,071 5.77 Savings deposits 21,164,000 867,790 4.10 Repurchase agreements 3,960,000 81,018 2.05 ------------ ------------ ---- Total Average Interest- Bearing Liabilities $ 98,042,000 $ 4,399,030 4.49% ============ ============ ====\nNet Net Interest Interest Earnings Earnings -------- -------- Net yield on interest-earning assets $5,771,153 4.62%\n- ------------------------------ (1) Includes non-accrual loans.\nThe following table shows the average balances, the average month-end yields and the dollar amounts of interest earned or paid for each of the Bank's major categories of interest-earning assets and interest-bearing liabilities for the period indicated.\nYear ended December 31, 1994 ---------------------------------- Average Average Interest Rate Balance(1) Earned\/Paid Earned\/Paid ------------ ------------ -----------\nLoans (net of allowance) $ 81,116,000 $ 6,229,328 7.68% Taxable investment securities 37,905,000 2,093,653 5.52 Other investments 319,000 19,161 6.01 Federal funds sold 3,565,000 141,807 3.98 ------------ ------------ ---- Total Average Interest- Earning Assets $122,905,000 $ 8,483,94 6.90% ============ ============ ==== Deposits, interest-bearing: Interest-bearing demand $ 37,008,000 $ 822,909 2.22 Other time certificates 40,981,000 1,993,637 4.86 Savings deposits 20,587,000 548,490 2.66 Repurchase agreements 205,000 4,832 2.36 ------------ ------------ ---- Total Average Interest- Bearing Liabilities $ 98,781,000 $ 3,369,868 3.41% ============ ============ ====\nNet Net Interest Interest Earnings Earnings -------- -------- Net yield on interest-earning assets $5,114,081 4.16%\n- ------------------------------- (1) Includes non-accrual loans.\nC. Net Interest Volume and Rate Variances\nThe following tables set forth the dollar amounts of the changes in net interest income (before provision for credit losses) and the extent to which such changes were attributable to changes in volume, changes in rates and changes in rate\/volume for each of the Bank's major categories of interest-earning assets and interest-bearing liabilities for the year ended December 31, 1995 as compared with the year ended December 31, 1994, and for the year ended December 31, 1994 as compared with the year ended December 31, 1993. Changes allocable to volume and rate have been allocated in proportion to the relationship of the absolute dollar amounts of the change in each category.\nYear ended December 31, 1995 --------------------------------------- (000's omitted) Change Change Change Total in Volume in Rate Rate\/Volume Change ------- ------- ------- ------- Interest Income: Loans (Less Allowance) $ 164 $ 1,457 $ 38 $ 1,659 Taxable Invest Sec (83) 34 (2) (51) Other Investments (168) 1,631 (1,385) 78 ------- ------- ------- ------- Total Interest Income ($ 87) $ 3,122 ($1,349) $ 1,686 ------- ------- ------- -------\nInterest Expense: Interest Bearing Demand ($ 236) $ 780 ($ 140) $ 404 Other Time Certificates 37 500 9 546 Savings Deposits (7) 11 (1) 3 Repurchase Agreements 46 3 27 76 ------- ------- ------- ------- Total Interest Expense (160) 1,294 (105) 1,029 ------- ------- ------- ------- Change in Net Interest Income $ 73 $ 1,828 ($1,244) $ 657 ======= ======= ======= =======\nYear ended December 31, 1994 --------------------------------------- (000's omitted) Change Change Change Total in Volume in Rate Rate\/Volume Change ------- ------- ------- ------- Interest Income: Loans (Less Allowance) $ 1,047 $ 723 $ 177 $ 1,947 Taxable Invest Sec 491 (202) (53) 236 Other Investments (4) 44 (3) 37 ------- ------- ------- ------- Total Interest Income $ 1,534 $ 565 $ 121 $ 2,220 ------- ------- ------- -------\nInterest Expense: Interest Bearing Demand $ 336 $ 26 $ 20 $ 382 Other Time Certificates 13 (359) (2) (348) Savings Deposits 47 3 -- 50 Repurchase Agreements 3 (1) (1) 1 ------- ------- ------- ------- Total Interest Expense 399 (331) 17 85 ------- ------- ------- ------- Change in Net Interest Income $ 1,135 $ 896 $ 104 $ 2,135 ======= ======= ======= =======\nD. Investment Securities\nAll of the Bank's investment securities consist of securities of the U.S. Treasury and other governmental agencies, Certificates of Deposit, Corporate Bonds, and Federal Reserve Bank stock. The following schedule summarizes the book value and the distribution of the Bank's investment securities held as of the dates indicated below. Investment securities are carried at market as of December 31, 1995 and 1994.\nDecember 31, ------------------------- 1995 1994 ----------- ----------- U.S. Treasury Notes $20,054,063 $19,199,000 U.S. Agencies 15,762,224 16,297,000 Federal Reserve Bank Stock 390,850 354,000 Certificates of Deposit 98,866 100,000 Corporate Bonds 502,350 493,000 ----------- ----------- Total $36,808,353 $36,443,000 =========== ===========\nE. Maturity of Investment Securities\nThe following tables summarize the maturity of the Bank's investment securities distribution and their weighted-average yields for the periods listed.\nDecember 31, 1995 Investment Yields --------------------------------------- Less than One to Over 1 Year Five Years Five Years ----- ----- -----\nU.S. Treasuries 4.90% 5.79% -- U.S. Agencies 5.30% 6.18% 4.80% Federal Reserve Bank Stock -- -- 6.00% Certificates of Deposit 2.75% -- -- Corporate Bonds 6.95% -- -- ----- ----- ----- Total 5.26% 5.94% 5.03% ===== ===== =====\nDecember 31, 1994 Investment Yields Less than One to Over 1 Year Five Years Five Years ----- ----- -----\nU.S. Treasuries 5.43% 5.97% -- U.S. Agencies -- 5.76% 4.63% Federal Reserve Bank Stock -- -- 6.00% Certificates of Deposit 2.75% -- -- Corporate Bonds -- 6.95% -- ----- ----- ----- Total 5.38% 5.88% 4.84% ===== ===== =====\nF. Distribution of Loans\nThe following table shows the distribution of the Bank's total loans as of the dates indicated below. All loans arise from domestic operations.\nDecember 31, 1995 December 31, 1994 -------------------- -------------------- Amount Percentage Amount Percentage -------------------- --------------------\nCommercial and Industrial $45,379,732 49.46% $42,243,000 47.20% Real Estate Construction 2,158,172 2.35 1,135,000 1.27 Consumer Installment 3,313,321 3.61 4,049,000 4.52 Residential Mortgage 40,896,989 44.58 42,083,000 47.01 ----------- ------ ----------- ------ Total $91,748,214 100.00% $89,510,000 100.00% =========== ====== =========== ======\nAs of December 31, 1995, $2,265,571 of total loans were unsecured. Of those unsecured loans, $9,264 were classified as non-performing.\nG. Loan Maturities and Sensitivity of Changes in Interest Rates\nThe following tables set forth the maturity distribution of the Bank's total loans by category as of December 31, 1995 and 1994. In addition, the tables show the distribution between those loans with predetermined (fixed) interest rates and those with variable (floating) interest rates. Floating rates generally fluctuate with changes in the Bank's interest cost.\nLoan maturities and rate sensitivity of the loan portfolio are as follows:\nDecember 31, 1995 Loan Maturities ----------------------------------------------------- Over One Year One to Over or Less Five Years Five Years Total ----------- ----------- ----------- ----------- Commercial and Industrial $24,030,515 $15,269,285 $ 6,079,932 $45,379,732 Real Estate Construction 2,158,172 -- -- 2,158,172 Consumer Loans 2,521,639 780,917 10,765 3,313,321 Residential Mortgages 1,279,656 2,315,781 37,301,552 40,896,989 ----------- ----------- ----------- ----------- Total $29,989,982 $18,365,983 $43,392,249 $91,748,214 =========== =========== =========== ===========\nLoans with Variable Rates $76,014,590 Loans with Fixed Rates 15,733,624 ----------- Total $91,748,214 ===========\nDecember 31, 1994 Loan Maturities ----------------------------------------------------- Over One Year One to Over or Less Five Years Five Years Total ----------- ----------- ----------- ----------- Commercial and Industrial $20,751,000 $15,493,000 $ 5,999,000 $42,243,000 Real Estate Construction 1,135,000 -- -- 1,135,000 Consumer Loans 2,898,000 1,095,000 56,000 4,049,000 Residential Mortgages 147,000 1,940,000 39,996,000 42,083,000 ----------- ----------- ----------- ----------- Total $24,931,000 $18,528,000 $46,051,000 $89,510,000 =========== =========== =========== ===========\nLoans with Variable Rates $75,782,000 Loans with Fixed Rates 13,728,000 ----------- Total $89,510,000 ===========\nH. Credit Risk Management\nThe Bank charges off that portion of any loan which management or bank examiners consider to represent a loss. A loan is generally considered by management to represent a loss in whole or in part when an exposure beyond any collateral value is apparent, servicing of the unsecured portion has been discontinued or collection is not anticipated based on the borrower's financial condition and general economic conditions in the borrower's industry. The principal amount of any loan which is declared a loss is charged against the Bank's allowance for credit losses.\nThe following details loans that were nonaccrual or were accrual loans which were contractually past due 90 days or more as to principal or interest payments at December 31, 1995 and 1994:\nDecember 31, ------------------------------ 1995 1994 -------- -------- Non-Accrual Loans $109,988 $507,000 90 days past due but accruing -- 100,000 -------- -------- Total $109,988 $607,000 ======== ========\nThe Bank's policy of placing a loan on non-accrual requires that all loans 90 days or more past due are to be placed on \"non-accrual\" status unless the loan is well secured and in the process of active collection. This is in conformance with the guidelines for non-accrual loans of the Office of the Comptroller of the Currency. A loan is considered well secured if the verified value of the collateral meets normal loanable margin requirements for those collateral assets, considering principal and interest over the period it can reasonably be expected to liquidate the asset.\nFor the case of real estate collateral, independent \"fair value\" appraisals, including professional estimates of marketing time, are used to judge whether a loan meets this criteria.\nAdditionally, the following schedule details the Bank's potential future problem loans:\nDecember 31, 1995 ------------------------------ Watch Alert List List Total ---------- ---- ----------\nCommercial Loans $3,473,452 $ -- $3,473,452 Real Estate Construction -- -- -- Consumer Installment 14,286 -- 14,286 Residential Mortgage 616,874 -- 616,874 ---------- ---- ---------- Total $4,104,612 $ -- $4,104,612 ========== ==== ==========\nAs of December 31, 1995, there was no concentration of loans exceeding ten percent (10%) of total loans which were not otherwise disclosed as a category in the loan portfolio table. As of December 31, 1995, there were no other interest-bearing assets that would be required to be in the Credit Risk Management section above if such assets were classified as loans.\nThe Watch List includes loans which may or may not be performing according to original terms, or are to clients operating in a weak industry or in an industry currently negatively impacted by the economy. These loans have a well-defined weakness which jeopardizes the orderly liquidation of the debt. Such loans are inadequately protected by the current sound net worth and paying capacity of the obligor, or there are questions as to the value of pledged collateral, if any. They are characterized by a degree of risk which poses a distinct possibility that the Bank could maintain some loss if the deficiencies are not corrected in a timely manner. These loans are reported to the Board of Directors.\nOther loans which may be included in the Watch List are those collateralized within policy guidelines or as exceptions to policy, with historical and\/or current trends of only adequate earnings. Net worth is likely not to possess strong liquidity. These loans do not presently expose the Bank to a sufficient degree of risk to warrant adverse classification; however, they possess credit deficiencies deserving of management's close attention. Failure to correct such deficiencies could result in a loan of greater risk in the future.\nLoans included in the Alert List have a weakness found in Watch List loans, with the added aspect that the weakness is pronounced to a point where, on the basis of current facts, conditions and values, there is a clearly identifiable element of potential loss exposure contained therein. These loans are also reported to the Board of Directors.\nI. Summary of Loan Loss Experience\nThe Bank has established an allowance for credit losses to provide for losses which can be reasonably anticipated. The allowance for credit losses is periodically provided for through charges to operating expenses in the form of provisions for credit losses. Actual credit losses or recoveries are charged or credited, respectively, directly to the allowance for credit losses. The amount of the allowance is determined by management of the Bank. Among the factors considered in determining the allowance for credit losses are the current financial conditions of the Bank's borrowers and the value of the security, if any, for their loans. Estimates of the effect of current economic conditions and their impact on various industries and individual borrowers are also taken into consideration, as are the Bank's historical credit loss experience and reports rendered by governmental regulators.\nBecause these estimates and evaluations are primarily judgmental factors, no assurance can be given that the Bank may not sustain credit losses substantially higher than the allowance for credit losses or that subsequent evaluation of the loan portfolio may not require substantial changes in such allowance. As of December 31, 1995, the credit loss allowance of $2,362,310 was believed to be sufficient to cover all potential loan problems.\nManagement reviews the provisions for credit losses on a quarterly basis. This review process includes the grading or regrading for each commercial credit. Those determined to have a strong possibility of loss for the subsequent quarter or year are segregated and a provision is made for potential loss in addition to the normal credit loss provision.\nThe Bank's loan portfolio is divided into ten categories: Construction and related, Medical and Dental, Personal Households, Manufacturing, Business Services, other Industries, Installment\/VIP, VIP-Plus Home Equity, First Residential Permanent, and Business\/Personal Credit Cards. Based upon historical information and banking experience, each category is given a certain credit loss allowance. A higher provision is used for installment and consumer loans.\nAll commercial loans are reviewed and regraded quarterly. Installment and consumer loans are not. Any commercial loan graded in a lower category is reviewed for potential dollar loss and provided for in the credit loss provision. Additionally, all loan commitments (unfunded) and standby letters of credit are reviewed monthly. Also, the concentration of loans by category and general economic trends are reviewed quarterly to determine if any other adjustments to the credit loss provision need be made.\nThe Bank also reviews collateral values pursuant to a written appraisal policy and procedure. The Bank's appraisal policy and procedure (\"Policy\") includes policies and procedures governing appraisals of residential single family detached dwellings, one-to-four family dwellings, multi-family dwellings, commercial real estate consisting of retail centers, office buildings, industrial buildings, land acquisition and development loans for both residential and commercial purposes, developed residential building lots and residential and commercial construction loans. In practice, lending now is limited to owner-occupied residential property and owner-occupied office facilities or industrial buildings. The policy requires an appraisal on any real property securing loans above $250,000.\nThe Policy sets forth the required content and form of the appraisal report, including definitions of \"market value\" and \"fair value\" as specified in 12 CFR Sec. 7.3025(d), time adjustments (if applicable) and obvious environmental considerations.\nThe appraiser is required to utilize three approaches to value. The policy also sets forth definitive requirements as to age, distance and adjustment percentages of comparable properties. Residential real estate appraisals are designed to conform to the policies of the Federal Home Loan Mortgage Corporation. All appraisers used must be approved by the Bank's Board of Directors after completing a detailed application and screening process. Approved appraiser lists are reviewed annually.\nBank Policy dictates that a \"fair value\" appraisal from a Bank-approved appraiser be obtained on all real property within 60 days of acquisition as OREO. In addition, a new \"fair value\" appraisal will be obtained no less often than annually until the OREO property has been disposed of. Appraisals may be ordered more frequently depending on economic conditions and projected property value declines.\nThe following provides an analysis of the Bank's loan loss experience for the years ended December 31, 1995 and 1994.\nYears ended December 31, --------------------------- 1995 1994 ----------- ----------- Balance Beginning of Period $ 2,422,513 $ 1,776,129 Acquired as result of purchase of American National Bank -- 806,141 Charge Offs: Commercial and Industrial -- (126,534) Real Estate Construction -- -- Consumer Installment (46,996) (15,288) Mortgage Loans (19,517) -- Recoveries: Commercial and Industrial 96,462 51,760 Consumer Installment 1,841 5,937 Mortgage Loans 6,875 -- ----------- ----------- Net (charge offs) recoveries 38,665 (84,125) Amounts credited to operations (98,868) (75,632) ----------- ----------- Balance End of Period $ 2,362,310 $ 2,422,513 =========== =========== Ratio of net (charge offs) recoveries to loans outstanding .04% (.09%)\nYear ended December 31, 1995 ----------------------------- Allowance for Loan Loss As a % of Total Specific and General Reserve: Total Loan Category - ----------------------------- ---------- --------------\nCommercial & Industrial $ 835,856 1.8% Real Estate Construction 74,484 3.5 Consumer Loans 69,971 2.1 Residential mortgage 789,225 1.9 Reserve for unfunded commitments 41,143 Reserve for general economic conditions 551,631 ---------- Total $2,362,310 ==========\nYear ended December 31, 1994 ------------------------------ Allowance for Loan Loss As a % of Total Specific and General Reserve: Total Loan Category\nCommercial & Industrial $ 396,913 2.1% Real Estate Construction 93,445 2.3 Consumer Loans 349,449 1.8 Residential mortgage 748,178 1.5 Reserve for unfunded commitments 65,117 .3 Reserve for general economic conditions 769,411 ---------- Total $2,422,513 ==========\nJ. Deposits\nThe following table sets forth information for the periods indicated regarding the average month-end balances of the Bank's deposits by category and as a percentage of total average daily deposits.\nNoninterest Interest Bearing Bearing Demand Demand Savings Time Deposits Deposits Deposits Deposits -------- -------- -------- --------\nDecember 1995 - ------------- Average Balance $22,575,000 $28,913,000 $21,164,000 $44,005,000 Percent of Total 19.35% 24.79% 18.14% 37.72% Average Rate Paid -- 3.15% 4.10% 5.77%\nDecember 1994 - ------------- Average Balance $22,055,000 $37,008,000 $20,587,000 $40,981,000 Percent of Total 18.28% 30.68% 17.07% 33.97% Average Rate Paid -- 2.22% 2.66% 4.86%\nThe following table indicates the maturity of the Bank's time certificates of deposit.\nK. Short-Term Borrowings\nThe Bank had Fed Funds Purchased of $1,200,000 and Repurchase Agreements of $5,140,500 at December 31, 1995. There were no Fed Funds Purchased at December 31, 1994, and Repurchase Agreements were $603,000.\nL. Certain Ratios\nThe following table sets forth annualized information with regard to the Company's consolidated return on average assets, consolidated return on average equity, and ending equity to assets ratio for the periods indicated.\nYears ended December 31, -------------------------- 1995 1994 -------- ----------\nReturn on Average Assets .53% 1.02% Return on Average Equity 5.53% 11.85% Ending Equity to Assets Ratio 10.01% 8.29% Net Income $715,281 $1,357,375\nM. Rate Sensitivity Report\nThe following Rate Sensitivity Report sets forth the listing of investments, loans and deposits as of December 31, 1995.\nThe above Rate Sensitivity Report shows that the Bank's gap position for 30 days or less is negative. This means that if interest rates increase, short term earnings will be negatively impaired. The Bank's gap position for a one year time frame is \"asset sensitive.\" If interest rates increase during this time frame, net income would be favorably impacted. This is due to assets being repriced at the higher rate faster than the liabilities. If interest rates decreased during this period, net income would be adversely affected.\nThe one to five years cumulative gap position is also \"asset sensitive.\" If interest rates increase, net income would be favorably impacted. If interest rates decrease during this period, net income would be adversely affected.\nThe book value and market value of investment securities at December 31, 1995 was $36,808,000.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company and the Bank offices are located at 2425 East Camelback Road, Phoenix, Arizona 85016. The Bank is obligated under a lease agreement for its approximate 11,697 square-foot office space until June 30, 1999. The lease requires the Bank to pay an allotted percentage of the direct expenses of the building and project in excess of specified levels. The lease agreement grants the Bank renewal options for two five-year periods at the fair market rent at the renewal date.\nOn February 2, 1994, the Bank acquired substantially all the assets and liabilities of American National Bank. As a result of the acquisition, the Bank signed a five year lease on the office at 8700 E. Pinnacle Peak Road, Scottsdale, Arizona. The building is a two-story building with rentable space of 12,217 square feet. The lease agreement provides renewal options for two five-year periods. The Bank has subleased approximately 3,150 square feet of the second floor space under similar terms.\nTotal rental expense under the aforementioned leases for the twelve months ended December 31, 1995 was approximately $573,000. Future minimum rental payments required under the lease agreements at December 31, 1996, were approximately as follows:\nYear Ending December 31,\n1996 616,116 1997 616,116 1998 618,223 1999 210,636 Thereafter -- ---------- $2,061,091 ==========\nThe Bank acquired one acre of real estate and a building located at 13648 N. Tatum in Phoenix, Arizona as part of the American National Bank purchase. During 1995, the building housed the Accounting department. Management intends to use the building as an operations center in 1996. Approximately, 2,000 square feet of the building is leased to an insurance agency.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material legal proceedings pending against the Company or its subsidiary, the Bank.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters have been submitted to a vote of security holders during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nCurrently, there is no established public trading market for the Company's Common Shares.\nThe Company's book value per share as of December 31, 1995 is $.83.\nThe number of shareholders of record as of December 31, 1995 is 337.\nThe Company's ability to pay dividends is dependent upon the receipt of dividends from the Bank. Currently, the Company has no other sources of revenue. No common stock dividends have been declared or paid by the Bank or the Company since inception, and management of the Bank and the Company intends to follow a policy of retaining earnings for the purpose of increasing shareholders' equity in the Bank. Approval of the Comptroller of Currency may be required prior to payment of dividends under certain circumstances.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected consolidated financial data for the Company for the five years ended December 31, 1995, 1994, 1993, 1992, and 1991 has been derived from the audited consolidated financial statements for those periods and should be read in connection with the 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.\nResults of Operations\nIn 1995, Biltmore Bank Corp. reported consolidated net income of $715,000, after provision for taxes of $255,000 versus net income in 1994 of $1,357,000, after a tax credit of $219,000 and consolidated net income of $1,449,000 in 1993. Pre-tax income from operations was $970,000 in 1995 compared with $1,138,000 in 1994 and $749,254 in 1993. The tax credit in 1994 arose from application of FAS 109, \"Accounting for Income Taxes\" which requires the current recognition of tax-loss carry forward benefits as more completely explained in footnote 16 to the financial statements.\nNet Interest Income\nNet interest income increased $657,000, or 12.8%, in 1995 as compared to 1994. This increase primarily resulted from the company's ability to shift assets deployed from lower yielding investments to higher yielding loans in 1995 and the inclusion of the purchased loans from American National Bank for the full year 1995. Average loans increased $7,050,000, or 8.7% in 1995.\nNet interest margin increased to 4.62% in 1995, from 4.16% in 1994 as the interest rate environment (rising rates) boosted yields on the loan portfolio, especially residential mortgage loans, to a greater degree than deposit costs.\nProvision for Loan Losses\nThe loan portfolio of the Company's subsidiary, Biltmore Investors Bank, is subject to twice a year review by an internal loan review group of Johnson International, Inc., the majority shareholder. A large sample of all loans over a minimum size are reviewed in a manner similar to bank regulatory examiners, including an estimate of possible loss. This group prepares a report to management on the results of their loan evaluation and that report, along with management's quarterly internal review and annual reviews by the Office of the Comptroller of the Currency, are used to determine the adequacy of the allowance for loan losses. Based on this information and analysis, management believes the reserve at year end, $2,362,000 is adequate to provide for potential loan losses.\nAdditionally, as the Allowance for Loan Loss Reserve stood at 2.71% at 12\/31\/94 and 2.57% at 12\/31\/95, and recoveries exceeded charge-offs by $38,665, no provision for loan losses was made in 1995.\nTotal non-accrual loans were $110,000 at year end 1995, an improvement of $497,000, over 1994. Total potential future problem loans totaled $4.1 million at 12\/31\/95, or 4.4% of loans and 29.7% capital, versus $3.5 million, or 3.9% and 29.7% of total loans and capital, respectively, at 12\/31\/94.\nNon-Interest Income\nOther income increased $130,000 or 18%, on a year to year basis primarily as a result of greater service fees and increased trust revenues.\nNon-Interest Expenses\nThese expenses increased $977,000 in the year 1995, or 20.5%. Of this increase, $614,000 was in salaries and benefits as the Company's subsidiary added staff to build a proper infrastructure for future growth, meet new bank regulatory challenges and prepare for the expected growth in the Maricopa County economy. Management fee expense increased $152,000 under an arrangement whereby the Bank makes payment for allocable services provided by our majority owner, Johnson International (See footnote 20 of financial statements for detailed explanation). Finally, other expenses were up $167,000 primarily as a result of accrual for costs to restructure and move certain operations and recognize a check fraud loss early in the year on which we are recovering in installments from a former depositor.\nLoans\nThe loan portfolio increased from $89,510,000 at December 31, 1994 to $91,748,000 at December 31, 1995. All of the increase is attributable to a $3,136,000 year to year rise in commercial and industrial loans.\nUnsecured loans, which are primarily classified in the commercial and industrial category, stood at $2,266,000 at year end 1995 and $2,513,000 at year end 1994.\nThe Bank's asset\/liability and liquidity policies set a guideline whereby the Bank will maintain a loan portfolio not to exceed 80% of total deposits. The actual percentage of outstanding loans is based on total deposit duration and foreseen liquidity needs. The loan to deposit ratio at year end 1995 and 1994 stood are 79% and 69%, respectively.\nDeposits\nThe Bank's deposits decreased $12.8 million from year end 1994 to 1995. Average deposits year to year decreased $4.0 million, or 3.3%. The drop was attributable entirely to an $8.0 million drop in interest sensitive, interest bearing demand accounts, as all of the other categories of deposits increased on average $4.1 million in 1995 compared to 1994. Management believes the decrease was primarily driven by our clients managing their cash assets more closely, using liquidity to finance a portion of their growth in 1995, as well as the attractiveness in 1995 of alternative investments, primarily the domestic equities markets.\nLiquidity\nLiquid assets, which include Federal Funds sold, investment securities, and cash and due from banks equalled 37% of total deposits as of December 31, 1995 and 39% as of December 31, 1994.\nThe Bank also makes use of securities under agreement to repurchase as a short term borrowing tool as the need arises.\nAsset\/Liability Management\nThis involves funding and investment strategies necessary to maintain an appropriate balance between interest-sensitive assets and liabilities to produce adequate earnings, as well as reasonable liquidity. The Bank maintains active management of the balance sheet position to confine the risk of interest rate swings on earnings. Adequate funding sources are maintained through a full line of competitively priced deposit products and short-term borrowing facilities and asset diversification is assured through using both variable and fixed rate loan products and investments.\nThe Bank maintains $6,000,000 in Federal Fund borrowing lines of credit with local correspondent banks for short term liquidity needs. The Bank also has a Letter of Credit line of $750,000 available from a local correspondent bank.\nAt December 31, 1995, the Bank's short term gap (30 days or less) is a negative $5.6 million, 4.0% of total assets, which means if interest rates increase, short term earnings will be negatively impacted. The cumulative gap for a one year period is \"asset sensitive\" - $1.8 million or 1.3% of total assets which would reflect in net income being favorably impacted over the next year should interest rates rise. This is due to the fact assets would be repriced at a somewhat faster pace than deposits. Management believes this is a reasonable position to be in given the current interest rate and economic environment.\nCapital Resources\nShareholders equity at 12\/31\/95 was $13.7 million compared to $11.8 million at 12\/31\/94. During 1995, 37% of the increase resulted from full retention of earnings, while the remainder reflected an increase in the market value of our investment portfolio resulting from the general rise of interest rates in the U.S. government securities market.\nCapital ratios of the Company and the Bank remain well in excess of regulatory requirements. The Bank's Tier one capital ratio at December 31, 1995 was 13.57% (Regulatory requirement - 4%), while the Risk-Weighted capital ratio was 16.16% (Regulatory requirement - 8%).\nDue to Office of the Comptroller of the Currency regulation, the Bank had no retained earnings available for distribution to the Company at December 31, 1995 and 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and schedules are set forth following Part IV.\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were no changes in accountants during the last three fiscal years of the Company and its Subsidiary. Arthur Andersen, L.L.P. has performed the 1993, 1994, and 1995 audits and management has had no disagreements with the accountant regarding accounting and financial disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table sets forth certain information concerning the Directors and executive officers of the Company and the Bank.\nPosition With Term Name Company (1) Position With Bank (2) Expires ---- ----------- ---------------------- -------\nDIRECTORS OF THE COMPANY AND OF THE BANK:\nLeRoy C. Gust Director, President Chairman of the Board of 1998 Chief Executive Directors, President and Officer Chief Executive Officer\nWilliam G. Ridenour Director Director 1997\nLawrence L. Stuckey Director Director 1996\nPhilip B. Bell Director Director 1998 and Treasurer Kimberley A. Gill-Rimsza Director Director 1996\nJohn L. Heath Director Director 1996\nCarrie Louis-Hulburd Director Director 1997\nL. Robert Peterson Director Director 1998\nKEY EMPLOYEES\/EXECUTIVE OFFICERS:\nJames E. Chappell Secretary Secretary and -- Vice President\nRichard Dunseath Vice President President, Phoenix -- Division\nScott R. Essex Vice President Vice President and -- Manager Trust Department\nGeorge P. Tyson -- President, Scottsdale -- Division - --------------------------------\n(1) All officer positions with the Company and the Bank are held for one-year terms.\n(2) The term of each Director of the Bank extends from the Annual Meeting of the Company for a period of one year.\nNo Director or executive officer of the Company is a party to any litigation or legal proceedings whereby such Director or executive officer is a party adverse to the Company or has a material interest adverse to the Corporation.\nOn January 23, 1996, Richard A. Hansen was elected Chairman of the Board of Directors of the Company.\nOn February 15, 1996, George P. Tyson assumed the position of Real Estate Executive. The position of President, Scottsdale Division was eliminated.\nNon-employee directors of the Company and the Bank are paid $250 per board meeting attended. Members of the CRA, Audit, Investment and Personnel Committees are paid $100 for each committee meeting they attend. Loan Committee members are paid $150 for each committee meeting they attend.\nBUSINESS BACKGROUND AND EXPERIENCE OF DIRECTORS AND EXECUTIVE OFFICERS\nThe following sets forth brief summaries of the backgrounds and business experiences, including the principal occupations, of the Directors and executive officers of the Company and the Directors and executive officers of the Bank.\nLEROY C. GUST, age 54, served as a management consultant and interim Chief Operating Officer for the Bank from June 1989 until January 1990. On January 16, 1990, Mr. Gust was named President and Chief Executive Officer of the Bank. Effective the same date he was also elected to serve as President and Director of both the Company and Bank. He also is a Senior Vice President of Johnson International, Inc. and has over twenty-five years of banking experience. His prior experience includes four years (1985-1989) as an Executive Vice President - Retail Banking at Marshall & Ilsley Bank, Milwaukee, Wisconsin; eight years as President of Heritage Banks in Beloit and Milwaukee, Wisconsin and a Director and member of the Management Committee of Heritage Wisconsin Corp., Milwaukee, Wisconsin, and thirteen years of commercial lending, primarily at The Northern Trust Company, Chicago, Illinois. Mr. Gust obtained a B.A. degree in Economics, and a Master of Science Degree in Finance, from the University of Illinois in 1965 and 1966, respectively.\nWILLIAM G. RIDENOUR, age 51, is a practicing attorney in Phoenix, Arizona, and a senior partner in the law firm of Ridenour, Swenson, Cleere & Evans, P.C. Mr. Ridenour received a Bachelor of Arts degree from the University of Arizona in 1966. In 1967, Mr. Ridenour received a Master of Arts in Political Science from Rutgers University, New Brunswick, New Jersey. Mr. Ridenour received his law degree from the University of Arizona in 1970. From 1980 to 1982, Mr. Ridenour was Secretary and General Counsel for Greater Arizona Savings and Loan Association, a savings and loan association located in Phoenix, Arizona. Since 1980, he has acted as pro tem judge for the Maricopa County Superior Court. Mr. Ridenour has been Director of the Company since 1985.\nLAWRENCE L. STUCKEY, age 49, is the president and owner of Stuckey Insurance Agency, a general insurance agency specializing in property and casualty insurance in Phoenix, Arizona. Mr. Stuckey became president and owner of Stuckey Insurance Agency in 1979 after working for the company since 1967. Mr. Stuckey also is a partner in Financial Innovations, a partnership established in 1975 to develop and broker commercial real estate in Phoenix, Arizona. Mr. Stuckey graduated in 1967 from the University of Arizona with a Bachelor of Science Degree in Business. Mr. Stuckey has been Director of the Company since 1985.\nPHILIP B. BELL, age 59, is chairman, president and owner of P.B. Bell & Associates, Inc., a real estate management and development firm. Before forming his own company in 1975, Mr. Bell served in executive capacities with Ramada Inns, L.B. Nelson Corp., and Kaufman & Broad, Inc. Mr. Bell is a CPA and was a supervisor with the accounting firm of Coopers & Lybrand. Mr. Bell is a graduate of Dartmouth College, and has an MBA from Amos Tuck School of Business Administration. Mr. Bell has been Director and Treasurer of the Company since March 1986.\nJOHN L. HEATH, age 60, is the retired Chairman of the Board of L.S. Heath & Sons, Inc. in Robinson, Illinois. He served as Senior Vice President of L.S. Heath & Sons, Inc. from 1969 to 1971 and as Chairman, President and Chief Executive Officer from 1971 to 1982. In 1958, he received his Bachelor of Science Degree in Social Science from Eastern Illinois University, Charleston, Illinois. Mr. Heath has been Director of the Company since March 1988.\nL. ROBERT PETERSON, age 72, is a retired Executive Vice President and Member of the Office of the Chairman of S. C. Johnson Wax Co., Inc., where he was employed for 39 years. He is also a former Director of Racine Environment Committee and Heritage Bank and Trust, and has served as President of the Racine Area United Way. Mr. Peterson attended Utah State Agricultural College and the University of Wisconsin. He was appointed Director of the Company in January 1993.\nKIMBERLEY A. GILL-RIMSZA, age 33, is President and C.E.O. of Gill Group, Inc., a food service equipment company located in Phoenix, Arizona. Mrs. Gill-Rimsza graduated in 1984 from Rollins College with a Bachelor of Arts Degree in Business Administration and Economics. She is a Certified Food Service Professional (CFSP). Mrs. Gill-Rimsza has been a Director of the Company since 1995.\nCARRIE LOUIS-HULBURD, age 36, formerly served as a Law Intern with the Arizona Attorney General's Office, Child Support Collection Division in Phoenix, Arizona. Mrs. Hulburd is a graduate of Colorado College and the American Graduate School of International Management. She has a J.D. from Arizona State University Law School. Mrs. Hulburd has been a Director of the Company since 1995.\nJAMES E. CHAPPELL, age 36, is Secretary of Biltmore Bank Corp, and Secretary and Trust Officer of Biltmore Investors Bank. Mr. Chappell is a graduate of Iowa State University.\nRICHARD D. DUNSEATH, age 49, is President of the Phoenix Division. He joined the bank in September of 1994. Mr. Dunseath's previous career included entrepreneurial pursuits in equipment leasing and homebuilding, Senior Vice President and Manager of Citibank's Community Banking Division and as a Manager of the Phoenix Region and the Scottsdale Region of United Bank of Arizona. Mr. Dunseath has an MBA degree from Arizona State University and is a graduate of the Pacific Coast Banking School.\nSCOTT R. ESSEX, age 43, is Vice President and Manager of the Trust Department of the Bank. He joined the Bank in June of 1991. He previously was Business Development Officer, Trust Officer of Northern Trust Bank of Arizona. He has a masters degree in Business Administration from University of Michigan.\nGEORGE P. TYSON, age 58, is President of the Scottsdale Division. He joined the Bank in February of 1994. He previously served as Senior Vice President, Financial Institutions Division for Citibank, Senior Vice President, Branch Administration with United Bank of Arizona and founding President of The Bank of Northern Arizona in Flagstaff, Arizona.\nADVISORY BOARD\nIn addition to the Board of Directors, the Bank has established an Advisory Board consisting of up to fifty (50) persons who represent the various markets which the Bank expects to serve. The Advisory Board is composed of individuals from the local business and professional community of Phoenix, Arizona, who can and are expected to contribute to the Bank's development and to its success through their expertise and experience.\nITEM 11.","section_11":"ITEM 11. SUMMARY COMPENSATION TABLE. ---------------------------\n- ---------------------- (1) The salary of Mr. Gust is based on a recommendation by the Compensation Committee of Johnson International. The committee considers the overall performance of the Bank and Mr. Gust's activities within the Bank in making their recommendation, which is then presented to the Board of Directors for approval.\n(2) While the President and Chief Executive Officer enjoys certain perquisites, such perquisites do not exceed the lessor of $50,000 or 10% of his salary and bonus.\n(3) These amounts represent the Company's contribution to defined benefit retirement plan and 401k plan for the benefit of the President and Chief Executive Officer.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth information as of December 31, 1994, concerning shares of the Company's Common Stock beneficially owned by each Director of the Company and the Bank, by all Executive Officers and Directors as a group, and by each stockholder known by the Company to be the beneficial owner of more than five percent (5%) of any class of the Corporation's voting securities, as required by 17 CFR 229.403.\nAmount and Title of Name of Nature of Beneficial Percent Class Beneficial Owner Ownership of class ----- ---------------- --------- --------\nCommon William G. Ridenour 10,400 (1) * Common Lawrence L. Stuckey 12,100 (1) * Common Philip B. Bell 5,000 * Common John L. Heath 10,500 * Common LeRoy C. Gust 4,650 (2) * Common Carrie Louis-Hulburd 2,000 * Common L. Robert Peterson 2,000 * Common Kimberley A. Gill-Rimsza 2,000 * ------- ---- Executive Officer and Directors as a group 48,650 * ======= ====\nCommon Johnson International, Inc. 16,010,045 96.9% 4041 North Main Street ========== ==== Racine, WI 53402\n- ------------------------------------- * The percentage of shares beneficially owned by each Director individually, and all Directors and Executive Officers as a group, does not exceed one percent of the issued and outstanding shares of the Company. (1) This figure does not include 10,000 shares that may be purchased under the 1984 Founding Directors' Nonstatutory Stock Option Plan. All of these options are currently unexercisable. (2) This figure does not include 58,366 shares which Mr. Gust may be granted under the terms of the Stock Purchase and Investment Agreement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThere are no existing or proposed material transactions between the Company or the Bank and any of their Executive Officers or Directors, except as indicated herein. All transactions with affiliates, Company Executive Officers or Directors and\/or Shareholders must be approved by a majority of disinterested Directors.\nThe law firm of Ridenour, Swenson, Cleere & Evans, P.C., of which William G. Ridenour, a Director of the Company and the Bank is a partner, has provided legal and organizational services to the Company and the Bank. Also, Mr. Ridenour's law firm has, in the past, acted as general counsel for the Company and the Bank and will continue to do so in the future and paid for those general counsel services as and when rendered.\nThe Company currently pays management fees to JI for services provided to the company. Services provided include: management consulting, internal audit, compliance and loan review, payroll and personnel, group purchasing, and risk management. The cost of JI services is allocated using acceptable and recognized cost accounting techniques. In 1995, the Company paid approximately $428,111 to JI for such services, which represented 88% of the costs allocable to the Company. Amounts charged in the future will be 100% of costs allocable to the Company in 1996. The estimated expense for management fees in 1996 will be approximately $456,000.\nMany of the Directors and Executive Officers of the Company, and the business and professional organizations with which they are associated, have banking transactions with the Bank in the ordinary course of business. The ratio of the total amount of loans made to Directors to the total amount of Bank equity as of December 31, 1995 is $624,704 to $13,714,000, or 4.6% of Bank equity. It is the Bank's policy that any loans and commitments to loan funds included in such transactions will be made in accordance with applicable laws and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness. Although the Bank does not have any limits on the aggregate amount it would be willing to lend to its and the Company's Directors and Executive Officers as a group, loans to individual Directors and officers must comply with the Bank's lending policies and statutory lending limits, as provided by federal statutes and regulations. Directors with a personal interest in any loan application are excluded from the consideration of that loan application and only a majority of disinterested Directors can approve such a loan. Also, loans to such persons are not made and cannot be made, pursuant to federal regulations, on terms more favorable than those afforded to other borrowers.\nMany of these loan transactions have been renewed or extended from time to time. All renewals and extension requests by Directors or Executive Officers are treated no more favorably than any such request by other borrowers.\nAll renewals and extension requests are reported to the Board of Directors along with all other loans made. All renewals and extension requests must be, pursuant to the Bank's lending policy, reviewed and approved by way of the same process and procedures utilized in making a determination to make the loan initially.\nThe following, in summary format, are the transactions with or involving management of the Company and the Bank in excess of $60,000. \"Management\" in this context, is defined as directors, executive officers, greater than 5% stockholders, or any member of their immediate family (which includes in-laws) as per Item 404 of Regulation S-K. In the following summary of transactions, the current status discussed is as of December 31, 1995.\nWilliam G. Ridenour, Director of the Company and of the Bank:\n(1) A $100,000 revolving line of credit secured by a time certificate of deposit with a current maturity date of February 5, 1997. The loan, originally established in December 1985, is at the rate of two percent (2%) over the certificate of deposit rate. As of December 31, 1995, the certificate of deposit rate was 6.44% and the loan was current with a principal balance of $98,974.\n(2) A $173,000 mortgage loan secured by Mr. Ridenour's principal residence was made on December 13, 1993. The interest rate is a fixed rate at 6.25%. Maturity is January 1, 2004, and the principal balance outstanding as of December 31, 1995 is $115,075.\nLawrence L. Stuckey, Director of the Company and of the Bank:\n(1) A $50,000 revolving line of credit for Stuckey Insurance Agency, of which Mr. Stuckey is the owner, was established April 29, 1994; maturing March 31, 1996, at 7.68% fixed. The loan is collateralized by a certificate of deposit. The principal balance outstanding as of December 31, 1995 is zero.\n(2) A $22,000 automobile loan for Stuckey Insurance Agency was made January 10, 1992. The loan matures on January 10, 1997, and is collateralized by a 1991 Chevrolet Suburban. The interest rate is 12% and the principal balance outstanding as of December 31, 1995 was $5,734.\nCarrie Louis-Hulburd, Director of the Company and the Bank:\n(1) A $393,750 mortgage loan secured by a second residence was made on December 14, 1993. The interest rate is fixed at 6.625%. The loan matures January 1, 2009, and the outstanding principal balance at December 31, 1995 was $362,371.\nKimberley A. Gill-Rimsza, Director of the Company and the Bank:\n(1) A $90,000 commercial loan secured by the first deed of trust on investment property was made on June 16, 1994. The interest rate is 1% over the prime rate, which was 9.5% at December 31, 1995. The outstanding balance at December 31, 1995 was $29,720.\n(2) A $500,000 unsecured line of credit for Gill Group, of which Mrs. Gill-Rimsza is President and C.E.O., was opened May 2, 1994. The interest rate is at the prime rate plus 1%. The commitment matures June 1, 1996. The outstanding balance at December 31, 1995 was zero.\n(3) An $80,000 unsecured line of credit for Gill Group was opened June 14, 1994. The interest rate is at the prime rate plus 1%. The commitment matures June 1, 1996. The outstanding balance at December 31, 1995 was zero.\n(4) The Gill Group has a business VISA with a line of credit of $57,500. The outstanding balance at December 31, 1995 was $7,759. The interest rate is 12%.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. ----------------------------------------------------------------\n(a) FINANCIAL STATEMENTS\nBiltmore Bank Corp. Reports of Independent Public Accountants Page Financial Statements- Consolidated Balance Sheets - December 31, 1995 and 1994 Page Consolidated Statements of Income - For the Years Ended December 31, 1995, 1994 and 1993 Page Consolidated Statements of Shareholders' Equity - For the Years ended December 31, 1995, 1994 and 1993 Page Consolidated Statements of Cash Flows - For the Years Ended December 31, 1995, 1994 and 1993 Page Notes to Consolidated Financial Statements - December 31, 1995, 1994 and 1993 Page\n(b) REPORTS ON FORM 8-K\nNone.\n(d) FINANCIAL STATEMENT SCHEDULES\nAll schedules have been omitted because of the absence of conditions under which they are required or because the required material information is included in the Financial Statements or Notes to the Financial Statements included in Item 14(a).\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 on March 22, 1996.\nBILTMORE BANK CORP.\nBy \/s\/ LeRoy C. Gust ------------------ LeRoy C. Gust 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 Company and in the capacities and on the date indicated.\nSignature\n\/s\/ LeRoy C. Gust Director, President and Date March 22, 1996 - ---------------------- -------------- LeRoy C. Gust Chief Executive Officer\n\/s\/ Philip B. Bell Director and Treasurer Date March 22, 1996 - ---------------------- -------------- Philip B. Bell\n\/s\/ William G. Ridenour Director Date March 22, 1996 - ---------------------- -------------- William G. Ridenour\n\/s\/ L. Robert Peterson Director Date March 22, 1996 - ---------------------- -------------- L. Robert Peterson\n\/s\/ Lawrence L. Stuckey Director Date March 22, 1996 - ---------------------- -------------- Lawrence L. Stuckey\nSupplemental Information to be Furnished with Prospectus 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 or proxy materials have been sent to shareholders as of the date hereof. The annual report and proxy information will be mailed subsequent to this filing.\n[ARTHUR ANDERSEN LETTERHEAD]\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and the Board of Directors of Biltmore Bank Corp.:\nWe have audited the accompanying consolidated balance sheets of Biltmore Bank Corp. and subsidiary (the \"Company\") 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 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 Biltmore Bank Corp. and subsidiary as of December 31, 1995 and 1994, and the 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.\nAs discussed in Note 16 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes. As discussed in Note 2 to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for certain investments in debt and equity securities.\n\/s\/ Arthur Andersen LLP ----------------------- ARTHUR ANDERSEN LLP\nMilwaukee, Wisconsin, February 23, 1996\nThe accompanying notes are an integral part of these consolidated balance sheets.\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated statements.\nBILTMORE BANK CORP. ------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ DECEMBER 31, 1995, 1994 AND 1993 -------------------------------- (1) ORGANIZATION:\nBiltmore Bank Corp. (the Company), the holding company for Biltmore Investors Bank (the Bank) (formerly Biltmore National Bank), was incorporated in Arizona on March 19, 1984. On August 22, 1985, the Company acquired all of the issued stock of the Bank and the Bank commenced banking operations. In 1989, Johnson International Inc. (JI), a Wisconsin-based company owned primarily by Samuel C. Johnson and family members, acquired approximately 76% of the Company's outstanding common stock. As a result, the Company became a subsidiary of JI. In a November 26, 1990 stock offering, JI acquired shares which increased its ownership percentage to approximately 93%.\nAs per the 1989 Stock Purchase and Investment Agreement, based primarily upon the level of loan losses from the time of its acquisition in 1989 through December 31, 1991, JI was entitled to and did receive 7,570,896 additional shares of stock in 1993. This transaction, combined with purchases of shares of stock from other shareholders, increased JI's ownership to approximately 97%. Since JI's effective ownership exceeded 95%, the goodwill recorded by JI at the time of its acquisition of the Company was required to be \"pushed down\" to the Company. Therefore, goodwill was recorded on the Company's Balance Sheet as of January 1, 1992. Additional disclosure of this transaction is included in footnotes (11) and (12).\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All material intercompany accounts and transactions have been eliminated in the consolidated financial statements.\nThe consolidated financial statements of the Company are prepared in accordance with generally accepted accounting principles. The following is a description of the Company's significant accounting policies.\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 disclosure or contingent assets and\nliabilities 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, for purposes of reporting cash flows, include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.\nInvestment Securities-\nIn May 1993, the FASB issued Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (SFAS 115). SFAS 115 requires, among other things, that securities classified as available for sale be carried at market value, however, market value adjustments and the related income tax effects, are excluded from earnings and reported separately as a component of stockholders' equity. This new standard was adopted by the Company on January 1, 1994. Prior to this, investment securities available for sale were carried at the lower of cost or market value.\nSecurities, when purchased, are designated as 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. The Company does not engage in the trading of securities, and does not hold any securities classified as held to maturity.\nInvestment securities available for sale are carried at market value, determined on an aggregate basis. While the Company has no current intention to sell these securities, they may not be held to maturity.\nLoans-\nLoans are reported at the principal amount outstanding, net of deferred loan origination fees and costs. Interest income on loans is credited to operating income as earned based on the principal amount outstanding. Accrual of interest is suspended on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful.\nLoan Fees-\nLoan origination fees and certain related direct loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the related loans as an adjustment to the yield of such loans.\nIn addition, commitment fees are offset against related loans and amortized as a yield adjustment if the commitment is exercised or, if the commitment expires unexercised, it is recognized upon expiration of the commitment.\nAllowance for Credit Losses-\nThe loan portfolio and other extensions of credit are regularly reviewed to determine the adequacy of the allowance for credit losses which is established through a provision for credit losses charged to expense. The impact of economic conditions on the credit worthiness of borrowers is given major consideration in determining the adequacy of the reserve.\nA charge against the allowance for credit losses is made when management believes that the collectability of the loan principal is unlikely. Management believes the allowance is adequate to absorb losses inherent in existing loans and commitments to extend credit, based on evaluations of the collectability 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 and anticipated economic conditions that may affect the borrower's ability to pay. Ultimate losses may vary from current estimates and the amount of the provision, which is a current expense, may be either greater or less than actual net charge-offs. Recoveries of loans previously charged off are added back to the allowance.\nPremises and Equipment-\nPremises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is charged to expense over the estimated useful life of the asset computed on the straight-line method. Leasehold improvements are amortized over the life of the lease, including optional renewal periods, or the estimated useful life of the asset, whichever is shorter.\nOther Real Estate Owned-\nOther real estate owned, which represents real estate acquired in settlement of loans, is initially recorded at the lower of the recorded investment in the loan or the fair value of the real estate.\nPrior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for credit losses, if necessary. Any subsequent write downs to reflect declines, if any, in net realizable value of the property are charged to expense.\nNet Income Per Common Share-\nNet income per common share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during the year. These shares give consideration to outstanding stock options when such effect is dilutive.\nReclassifications-\nCertain reclassifications have been made to conform to the classifications used in the 1995 financial statements.\n(3) CASH AND DUE FROM BANKS:\nCash includes deposits with the Federal Reserve Bank of $758,648 and $343,000 maintained to satisfy federal regulatory requirements at December 31, 1995 and 1994, respectively.\n(4) INVESTMENT SECURITIES:\nThe amortized cost and market value of investment securities available for sale as of December 31 were as follows:\nAt December 31, 1995, and 1994 the Company's investment portfolio included unrealized gains of approximately $347,000 and $5,000 respectively, and unrealized losses of approximately $101,000 and $1,589,000 respectively.\nGross realized gains and losses amounted to $34,527 and $6,266 in 1995, and $27,249 and $16,534 in 1994, and $6,607 and $0 in 1993, respectively.\nThe following table presents the amortized cost and carrying amounts by maturity distribution of the investment portfolio for investments with a stated maturity date:\nThe Company had $6,000,000 available under federal funds lines of credit with correspondent banks as of both December 31, 1995 and 1994. The Company has assigned a United States Treasury security with a carrying value of $1,982,500 to secure a portion of one of the federal funds lines of credit. There were no borrowings under this line at December 31, 1995 or 1994.\nThe Company has a Letter of Credit Line of $750,000 available with a correspondent bank as of December 31, 1995 and 1994. There were no borrowings under this line.\nAt December 31, 1995, the Company had assigned a United States Treasury security with a carrying value of $1,013,750 to secure a Treasury, Tax and Loan account with the Federal Reserve Bank. Also at December 31, 1995, the Company had assigned a United States Treasury Security with a carrying value of $1,006,562 to secure trust account deposits.\n(5) LOANS:\nLoans, which all arise from domestic operations, are summarized as of December 31 as follows:\n1995 1994 ------------ ------------\nCommercial and industrial $ 45,379,732 $ 42,243,407 Real estate - construction 2,158,172 1,134,611 Consumer loans 3,313,321 4,049,441 Residential mortgage 40,896,989 42,082,311 ------------ ------------ 91,748,214 89,509,770 Less - Allowance for credit losses (2,362,310) (2,422,513) Deferred loan origination fees (233,655) (224,680) ------------ ------------ $ 89,152,249 $ 86,862,577 ============ ============\nAt December 31, 1995 and 1994, the Company had outstanding $624,704 and $244,090, respectively, of loans made to directors, executive officers and related parties. All such loans were made in the ordinary course of business.\nThe activity in related party loans for the years ended December 31 is summarized as follows:\n1995 1994 --------- ---------\nBalance, beginning of year $ 244,090 $ 275,577 Loan disbursements 521,639 166,662 Loan payments received (141,025) (198,149) --------- --------- Balance, end of year $ 624,704 $ 244,090 ========= =========\nThe Company has evaluated its loan portfolio as of December 31, 1995 in accordance with its normal practices and has given consideration to the factors creating potential credit losses. While management believes that the allowance for credit losses provides for all currently anticipated problems, management recognizes that the Company may incur additional losses which cannot currently be estimated, but which may be substantial.\nChanges in the allowance for credit losses for the years ended December 31 were as follows:\n1995 1994 1993 ----------- ----------- -----------\nBalance, beginning of year $ 2,422,513 $ 1,776,129 $ 1,913,793 Reserve acquired in acquisition -- 806,141 -- Provision credited to operations (98,868) (75,632) (218,573) Loans charged off (66,513) (141,822) (21,157) Recoveries 105,178 57,697 102,066 ----------- ----------- ----------- Balance, end of year $ 2,362,310 $ 2,422,513 $ 1,776,129 =========== =========== ===========\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 the loan is impaired and loss is probable. At December 31, 1995, the Corporation's recorded investment in impaired loans is approximately $110,000. Management has determined that the entire amount of impaired loans will be excluded from evaluation under SFAS 114 as these are smaller-balance homogeneous loans. This amount is net of previous direct writedowns and applications of cash interest payments against the loan balance outstanding.\nThe average recorded investment in total impaired loans and leases for the year ended December 31, 1995, was not material.\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 was not material. The gross income that would have been recognized had such loans and leases been performing in accordance with their original terms would have not been material for the same period.\nAt December 31, 1995, there were no commitments to lend additional funds to borrowers whose loans are classified as nonaccrual or renegotiated. Substantially all the loans contained in the portfolio are to individuals and businesses located in the Phoenix metropolitan area.\n(6) PREMISES AND EQUIPMENT:\nMajor classifications of premises and equipment as of December 31 were as follows:\n1995 1994 ----------- -----------\nLand $ 400,000 $ 400,000 Building 193,299 65,000 Equipment and furniture 1,288,483 940,248 Leasehold improvements 762,471 895,950 ----------- ----------- 2,644,253 2,301,198 Less- Accumulated depreciation and amortization (1,027,842) (695,745) ----------- ----------- $ 1,616,411 $ 1,605,453 =========== ===========\n(7) DEPOSITS:\nTime certificates of deposit with balances of $100,000 and over and their remaining maturities as of December 31 were as follows:\n1995 1994 ----------- -----------\nLess than three months $ 3,497,647 $ 2,086,262 Three to twelve months 7,326,066 4,609,937 One year to five years 2,866,197 7,393,387 Over five years -- -- ----------- ----------- $13,689,910 $14,089,586 =========== ===========\n(8) SHORT TERM BORROWINGS:\nShort term borrowings at December 31, were as follows:\n1995 1994 ---------- ----------\nFederal funds purchased $1,200,000 $ -- Securities sold under agreement to repurchase 5,140,500 603,000 ---------- ---------- $6,340,500 $ 603,000 ========== ==========\nAs of December 31, 1995, securities sold under agreement to repurchase of $5,000,000 were with Heritage Bank and Trust, Racine, WI, a Johnson International Company.\n(9) COMMITMENTS AND CONTINGENCIES:\nIn 1988, the Company signed a ten-year lease agreement to lease approximately 10,300 square feet for its current banking offices. The lease was subsequently amended to commence on October 15, 1989 and terminate on June 30, 1999. The Company assigned the lease to the Bank effective December 29, 1989. The lease agreement requires rental payments to be escalated in the seventh year of the lease by a minimum of 20% and a maximum of 30% as determined by a formula based upon the consumer price index, and then to remain constant through the remaining term of the lease. Additionally, the lease requires the Bank to pay an allocated percentage of the direct expenses of the building and project in excess of specified levels. The lease agreement provides renewal options for two five-year periods at fair-market rent at the renewal date.\nOn February 2, 1994, Biltmore Investors Bank acquired substantially all the assets and liabilities of American National Bank (See note 18). As a result of the acquisition, Biltmore Investors Bank signed a five year lease for a branch location in Scottsdale, Arizona. The lease agreement provides renewal options for two five-year periods.\nTotal rental expense under the aforementioned leases for the years ended December 31, 1995, 1994 and 1993 was approximately $573,000, $522,000, and $314,000, respectively. Future minimum rental payments required under the lease agreements at December 31, 1995 were as follows:\nYear Ending December 31,\n1996 616,116 1997 616,116 1998 618,223 1999 210,636 Thereafter -- ---------- $2,061,091 ==========\nIn the normal course of business, the Company makes various commitments and incurs certain contingent liabilities which are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities include various guarantees and commitments to extend credit arising from normal business activities. At December 31, 1995 and 1994, commitments to extend credit under loan agreements, net of participations sold, aggregated approximately $28,770,000 and $24,745,000, respectively. Commitments to extend credit under letter of credit agreements, net of participations sold, aggregated approximately $567,000 and $495,000 at December 31, 1995 and 1994, respectively. The Bank does not anticipate any material loss as a result of these transactions.\n(10) STOCK OPTIONS:\nThe Company has adopted four stock option plans, the terms of which are summarized as follows:\nThe 1984 Nonstatutory Stock Option Plan (the \"Nonstatutory Plan\") provides for the issuance of a maximum of 20,000 options for the purchase of one share of common stock each. All full-time salaried officers, key employees and directors are eligible to receive options under the Nonstatutory Plan. The option price is $10 per share. Options are exercisable in 25% increments each year subsequent to the first anniversary of the date of grant and expire six years from the date of grant.\nThe Incentive Stock Option Plan (the \"Incentive Plan\") provides for the issuance of a maximum of 40,000 options for the purchase of one share of common stock each. The exercise price of the option may not be less than the fair market value of the stock at the date of grant. Options may be granted under the Incentive Plan to any director, officer or employee of the Company or the Bank. Options granted under the Incentive Plan expire ten years from date of grant and are exercisable at the option of the holder. All options under this plan were forfeited in 1994.\nThe Founding Directors Nonstatutory Stock Option Plan (the \"Founding Directors Plan\") provides for the issuance of a maximum of 60,000 options for the purchase of one share of common stock each. The six founding directors are the only participants in the Founding Directors Plan. Each founding director has been granted options to purchase 10,000 shares of common stock at a purchase price of $12 per share. All options under this plan expired in 1994.\nOn September 26, 1989, the Company executed an amendment to the Stock Purchase Agreement with JI (see Note 10) which included an agreement to issue an additional $150,000 in options to a new employee of the Bank, at the per share investment price of the JI transaction. The option plan was approved in 1990 as the 1990 Incentive Stock Option Plan. The JI transaction closed on December 29, 1989 at $2.57 per share which equated to 58,366 shares under the option agreement. As of December 31, 1995, 390 of the options had been granted and exercised.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\") was issued in October 1995 by the Financial Accounting Standards Board and is required to be adopted in 1996. FAS 123 establishes financial accounting and reporting standards for stock-based employee compensation. Currently the Company does not recognize compensation cost on options issued under Accounting Principal Board Opinion No. 25 \"Accounting For Stock Issued to Employees\" (\"APB 25\") as the exercise price is the same as or higher than the fair market value at time of issuance. FAS 123 permits the Company to continue to follow this treatment as long as pro-forma disclosures of net income and earnings per share are presented as if the fair value based method of accounting defined in FAS 123 had been applied. The fair value based method requires measurement of compensation cost on the grant date based on the fair value of the award using an option pricing model. Management has not yet determined whether it will adopt the fair value based method defined by FAS 123 or continue to use the APB 25 method.\nThe following summarizes the activity in stock options under the four plans for each of the years in the two-year period ended December 31, 1995 and 1994: Outstanding Option Exercisable Options Price Options ------- ----- -------\nBALANCE, December 31, 1993 71,400 $10 - $13 11,400\nOptions expired (60,000) $12 - Options forfeited (9,400) $13 (9,400) ------- ------- BALANCE, December 31, 1994 2,000 $10 2,000 Options expired (2,000) $10 (2,000) ------- ------- BALANCE, December 31, 1995 0 0 ======= =======\n(11) STOCK OFFERINGS AND COMMON STOCK:\nOn March 2, 1989, the Company signed a definitive agreement with JI which allowed them to acquire a controlling interest in the Company (Note 1). The agreement was to purchase approximately $3,000,000 of newly-issued stock at the December 31, 1988, book value per share. In September 1989, an amendment was signed by the Company and JI to change the price per share to the unaudited book value per share of the Company's common shares as of the end of November, 1989, which both parties agreed was $2.57. The purchase, which was consummated on December 29, 1989 and which required regulatory approval, gave JI ownership of approximately 76% of the Company's outstanding stock.\nThe definitive agreement contained a warrant purchase agreement granting to JI the right to purchase warrants at the price of $.01 per warrant and to purchase common stock equal in number and option price with respect to other shares eligible to be purchased under all of the Company's option plans. The warrants contain anti-dilution provisions providing for the issuance of additional warrants or changes to the warrant prices, as the case may be, should the Company take any action in the future to issue options, rights, warrants or other securities convertible into common stock, or take any other action which will or may have the effect of diminishing JI's proportionate interest in the Company's common stock.\nDuring 1990, pursuant to the terms of the agreement, the Company issued a common stock offering to its stockholders. As a result of this offering, 7,414,345 shares of stock were sold for $8,600,640. JI purchased 7,181,106 shares in the 1990 offering, increasing its ownership of the Company from 76% to 93%. In addition to the stock offering, 390 stock options were exercised at $2.57 per share by an employee of the Bank.\nUnder the terms of the 1989 definitive agreement, JI would pay additional cash to the Company or receive additional shares of common stock of the Company depending primarily upon losses in the loan portfolio from the date of the agreement in 1989 through December 31, 1991. Based upon actual loan losses incurred, 7,570,896 additional shares were due and payable to JI as of December 31, 1991. The shares were issued to JI on April 30, 1992. A reclassification was made to Common Stock from Additional Paid-in Capital for the stated value of the shares.\nThis transaction, combined with purchases of shares of common stock from other shareholders, increased JI's ownership of the Company to approximately 97%.\n(12) INTANGIBLE ASSETS:\nBecause the stock to be issued under the terms of the 1989 definitive agreement was due and payable as of December 31, 1991, JI's effective ownership exceeded 95%. Therefore, the remaining unamortized goodwill, which was originally recorded by JI at the time of JI's acquisition of the Company, was required to be \"pushed down\" to the Company.\nAccordingly, goodwill in the amount of $640,094 was recorded on the Company's Balance Sheet as of January 1, 1992 with an offsetting amount recorded to retained earnings. The goodwill is being amortized using the straight-line method over 25 years, and had approximately 23 years remaining when it was \"pushed down\" to the Company from JI.\nAs per Accounting Principles Board Opinion No. 16 (APB 16), retained earnings of the Company was required to be restated on the date of application of pushdown accounting. The restated retained earnings included the remaining minority ownership's percentage of the retained earnings (accumulated deficit at the time), plus JI's recorded equity in the income and losses of the Company from the time of the original acquisition, less all amortization of the goodwill recorded by JI relating to the acquisition of the Company. Therefore, a reclassification of $2,639,069 was made from retained earnings to additional paid-in capital on January 1, 1992\nAdditional goodwill in the amount of $10,431 was \"pushed down\" to the Company from JI in 1992 relating to additional shares purchased by JI from other shareholders during the year.\nGoodwill was $114,059 and $65,294 at December 31, 1995 and 1994 respectively. The core deposit intangible resulting from the acquisition of ANB, as described in note 17, was $1,384,584 and $1,611,300 at December 31, 1995 and 1994 respectively. The core deposit intangible is amortized over 10 years.\nNegative goodwill generated from a previous acquisition was $163,449 and $224,773 at December 31, 1995 and 1994, respectively.\n(13) REGULATORY MATTERS:\nThe activities of the Bank are regulated by the Office of the Comptroller of the Currency (the OCC). Approval by the OCC may be required prior to payment of dividends by the Bank to the Company under certain circumstances. Additionally, regulations prevent the Bank from transferring funds to the Company for reasons other than the payment of dividends or the purchase of services and supplies.\nTherefore, included in the balance sheet at December 31, 1995 and 1994, are $13,714,000 and $11,527,000 respectively, of net assets restricted to use by the Bank only.\nThe Federal Reserve Board has adopted capital regulations which require the Bank to maintain two separate minimum capital ratios. Included are the Tier 1 Capital Ratio and the Total Risk-Weighted Capital Ratio. The Bank's capital ratios are shown, along with the minimum required ratios as of December 31, 1995, and 1994 respectively, in the following table:\nTotal Risk- Tier 1 Weighted Capital Capital ------- -------\nCapital Ratio at December 31, 1995 13.57% 16.16% Capital Ratio at December 31, 1994 12.96% 14.23% Regulatory Capital Requirement 4.00% 8.00%\nThe federal banking agencies have also adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a 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%. The Bank's leverage ratios for the years ended December 31, 1995 and 1994 were 8.88% and 7.12% respectively.\nAt December 31, 1995 and 1994, due to OCC Regulations, the Bank had no retained earnings available for distribution as dividends to the Company.\n(14) OTHER INTEREST INCOME:\nOther interest income for the years ended December 31 is summarized as follows: 1995 1994 1993 ---------- ---------- ----------\nInterest on federal funds sold $ 216,886 $ 142,360 $ 106,913 Interest on deposits in other financial institutions 2,775 2,500 2,329 Interest on investment securities 2,061,594 2,109,761 1,872,207 ---------- ---------- ---------- $2,281,255 $2,254,621 $1,981,449 ========== ========== ==========\n(15) INTEREST EXPENSE:\nInterest expense for the years ended December 31 is summarized as follows:\n1995 1994 1993 ---------- ---------- ----------\nDemand deposits and savings $1,778,941 $1,371,399 $ 939,280 Time certificates of deposit, $100,000 and over 824,972 604,580 521,449 Other time deposits 1,714,099 1,389,057 1,820,239 Securities sold under agreement to repurchase 59,883 4,832 3,527 Federal funds purchased 21,135 -- -- ---------- ---------- ---------- $4,399,030 $3,369,868 $3,284,495 ========== ========== ==========\n(16) INCOME TAXES:\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), which was issued by the Financial Accounting Standards Board. Under this method, deferred tax assets and liabilities are recognized for future tax consequences relating to differences between the book and tax accounting treatment of existing assets and liabilities as of the balance sheet dates. Deferred tax assets and liabilities are calculated using enacted tax rates expected to apply to taxable income in the years in which the book-to-tax accounting differences are expected to be reversed.\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 of 34% for each year:\n1995 1994 ----------- ---------\nTax computed at statutory rate $ 329,926 $ 386,900 Other (74,837) (42,333) Adjustment of valuation allowance - (564,000) ----------- --------- Total income tax expense (benefit) $ 255,089 $(219,433) =========== =========\nThe tax effects of temporary differences that give rise to significant elements of the deferred tax assets and deferred tax liabilities for each year, are as follows:\n1995 1994 ----------- ----------- Deferred tax assets:\nAllowance for credit losses $ 803,185 $ 549,576 Mortgage loan premium 13,283 168,960 Net deferred loan fees 79,443 76,392 Net operating loss carryforwards 377,526 847,676 Net unrealized depreciation on investment securities available for sale -- 538,560 Other 16,229 90,049 ----------- ----------- Total deferred tax assets $ 1,289,666 $ 2,271,213 ----------- -----------\nDeferred tax liabilities:\nFixed assets, primarily due to depreciation $ (31,516) $ (100,713) Discount accretion on bonds (71,120) (43,120) Net unrealized depreciation on investment securities available for sale (83,800) -- Other (301,162) (42,120) ----------- ----------- Total deferred tax liabilities (487,598) (185,953) ----------- -----------\n802,068 2,085,260 Valuation Allowance -- (352,000) ----------- ----------- Net deferred tax assets $ 802,068 $ 1,733,260 =========== ===========\nChanges in the valuation allowance were as follows:\n1995 1994 ----------- -----------\nBalance, beginning of year $ 352,000 $ 1,817,000 Expiration of State NOL (352,000) (624,000) Recognition of previously generated federal NOLs -- (841,000) ----------- ----------- Balance, end of year $ -- $ 352,000 =========== ===========\nThe Company has a tax NOL carryforwards of approximately $1.1 million for federal income taxes as of December 31, 1995. The $1.1 million federal NOL carryforward is comprised of prechange NOLs (before JI purchased a 76% ownership on December 29, 1989) and postchange NOLs (from December 29, 1989 to November 26, 1990 when JI became a 93% owner of the Company).\nThe federal prechange NOL approximates $201,000, and must be utilized by the Company (it cannot be used by JI) no later than the year 2003. The postchange federal NOL, which approximates $910,000, must be utilized by the Company (but not by JI) in full by no later than the year 2004. The Company has fully benefitted all NOL's existing at December 31, 1995.\nThe cumulative effect of adopting SFAS 109 at January 1, 1993, was $700,000 representing the recognition of the net deferred tax assets at January 1, 1993 plus the Company's estimate of the amount of postchange NOLs it reasonably expected to realize at the time.\n(17) NEW PRONOUNCEMENTS:\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 to 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.\n(18) BUSINESS COMBINATION:\nOn February 1, 1994, the Bank acquired substantially all of the assets and liabilities of American National Bank (ANB), which had one office in Scottsdale, Arizona and one office in Phoenix, Arizona. The acquisition was funded through available capital of the Bank at a cost of approximately $1.1 million.\nThe transaction was accounted for as a purchase and is included in the Company's results of operations as of February 1, 1994. The following table shows the fair value of assets acquired, fair value of liabilities assumed, and net cash paid:\nFair Value of Assets Acquired $32,422,667 Fair Value of Liabilities Assumed 31,335,419 ------------ Cash Paid for Acquisitions 1,087,248 Cash Received in Acquisition (7,549,416) ----------- Net Cash and Cash Equivalents Received $6,462,168 ===========\nThe pro-forma impact on the Company's results of operations for the year ended December 31, 1994, assuming ANB had been acquired as of the beginning of the year, are not materially different than the Company's actual results. The unaudited pro-forma impact on the Company's results of operation for the year ended December 31, 1993 had the ANB transaction described above been consummated January 1, 1993 is as follows:\nFor the Year Ended December 31, 1993 (Unaudited)\nNet Interest Income $4,253,000\nProvision for Loan Losses $ 219,000\nNet Income $1,119,000\nNet Income per Share $ .07\n(19) FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe following tables present the estimated fair values of financial instruments as of December 31, 1995 and 1994:\n--------------------------- Carrying Fair Value Value ------------ ------------ Financial Assets: Cash and Cash Equivalents $ 6,337,000 $ 6,337,000 Investments Securities Available for Sale 36,808,000 36,808,000 Net Loans 89,152,000 89,199,000 Interest Receivable 1,109,000 1,109,000\nFinancial Liabilities: Deposits 116,357,000 116,919,000 Short Term Borrowings 6,341,000 6,201,000 Interest Payable 199,000 199,000\n--------------------------- Carrying Fair Value Value ------------ ------------ Financial Assets: Cash and Cash Equivalents $ 13,560,000 $ 13,560,000 Investments Securities Available for Sale 36,443,000 36,443,000 Net Loans 86,863,000 81,382,000 Interest Receivable 1,018,000 1,018,000\nFinancial Liabilities: Deposits 129,228,000 121,281,000 Short Term Borrowings 603,000 603,000 Interest Payable 219,000 219,000\nWhere readily available, quoted market prices were utilized by the Company. If quoted market prices were not available, fair values were based on estimates using present value or 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 may not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.\nThe following methods and assumptions were used in estimating the fair value for financial instruments.\nCash and cash equivalents, interest receivable, securities sold under agreements to repurchase, and interest payable\nThe carrying amounts reported for these financial instruments are a reasonable estimate of fair value.\nInvestment securities available for sale\nFair value is based on quoted market prices or dealer quotes.\nLoans\nLoans that reprice or mature within three months of year end were assigned fair values based on their carrying values. For remaining loans, fair value was estimated by discounting the expected future cash flows using current interest rates at which similar loans would be made to borrowers of comparable creditworthiness.\nDeposits\nThe fair value of fixed-maturity time deposits was estimated based on discounted cash flows using rates currently offered for deposits of similar remaining maturities.\nThough demand and savings deposits may have duration characteristics which could justify fair value estimation using methods similar to those used for fixed-maturity time deposits, their fair value was considered to be carrying value pursuant to the disclosure requirements.\n(20) MANAGEMENT FEE:\nThe Company pays its allocable portion of expenses to JI in an arrangement similar to all of JI's subsidiaries. The arrangement calls for partial payment of allocable expenses in the early years after becoming a subsidiary of JI.\nIn 1993, the Company paid $175,783 in management fees, equalling 63% of its allocable portion of expenses. In 1994, the Company paid $275,520 in management fees, equalling 83% of its allocable portion of expenses. In 1995, the Company paid $428,111 in management fees, equaling 88% of its allocable portion of expenses.\nFuture payments as a percentage of the Company's allocable portion of expenses are expected to be 100% in 1996.\n(21) CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY\nCONDENSED BALANCE SHEETS DECEMBER 31 1995 1994 ----------- -----------\nASSETS:\nCASH $ 424 $ 120 DEFERRED TAXES -- 257,173 INVESTMENT IN BILTMORE INVESTORS BANK 13,714,165 11,527,411 PREPAID EXPENSES 1,826 2,160 GOODWILL 64,019 65,294 ----------- ----------- TOTAL ASSETS $13,780,434 $11,852,158 =========== ===========\nLIABILITIES AND SHAREHOLDERS' EQUITY:\nOTHER LIABILITIES $ 9,756 $ 5,830 ----------- ----------- TOTAL SHAREHOLDER'S EQUITY 13,770,678 11,846,328 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $13,780,434 $11,852,158 =========== ===========","section_15":""}
{"filename":"95045_1995.txt","cik":"95045","year":"1995","section_1":"ITEM 1. BUSINESS\nSTV Group, Inc. provides engineering and architectural consulting and design services on a variety of projects for the federal government, local, state and foreign governments and private industry. STV Group, Inc. consists of the following wholly-owned subsidiaries: Sanders & Thomas, Inc., Seelye Stevenson Value & Knecht, Inc., Lyon Associates, Inc., STV Architects, Inc., STV Environmental, Inc. and STV Construction Services. In June of 1995, the names of Sanders & Thomas, Inc., Seelye Stevenson Value & Knecht, Inc., and Lyon Associates, Inc., were changed to STV Incorporated. STV and its subsidiaries are hereinafter collectively referred to as the \"Company\".\nThe Company's projects frequently require the service of a firm with diverse capabilities. For example, a particular project may require electrical engineers, civil engineers, draftsmen and other professional personnel. Each of STV Group, Inc.'s subsidiaries customarily staffs a particular project with personnel from the respective firm's offices. Where appropriate, however, multifirm project teams are formed with qualified professionals drawn from the entire Company. Management believes that close cooperation among the STV Group, Inc. subsidiaries, under its management, assures proper control and support for all Company activities. As of September 30, 1995, the Company employed 998 people.\nServices\nThe principal areas in which the Company provides services and the approximate percentage of the Company's revenue attributable to each service area are set forth below:*\nYear Ended September 30, 1995 1994 1993\nArchitectural Engineering 27% 27% 30% Civil, Highway, Bridge, Airport and Port Engineering 35 36 38 Defense Systems Engineering 5 4 4 Industrial Process Engineering 2 2 2 Transportation Engineering 29 28 24 Other Engineering Services 2 3 2\n________________ * The Company does not record revenue data according to each service area. However, to provide an approximation of the revenue attributable to each service area, the Company has analyzed contract revenue in the fiscal year according to its principal service area. The aggregate revenue each year of these contracts is at least 75% of the consolidated revenue for these fiscal years.\nArchitectural Engineering\nArchitectural engineering generally involves consulting and design services, as well as construction inspection services, for the construction of commercial, industrial and governmental buildings, medical and educational facilities, laboratories, recreational, religious and cultural centers, military installations, penal institutions, and public utility facilities. As part of its services, the Company has designed and developed systems for heating, ventilation, cooling, refrigeration, fire protection, lighting, power generation and distribution and communications. In addition, the Company has performed energy conservation audits and has recommended and designed programs, including computerized control programs for multi-building complexes, for the conservation of fuel and electrical energy.\nCivil, Highway, Bridge, Airport and Port Engineering\nThis area of engineering generally involves consulting and design services for the construction of highways (including interchange ramps and secondary roads), bridges, airports and marine ports. Services performed by the Company have included site selection and development (including economic evaluations and feasibility reports), design and development of specifications, and construction inspection. As part of these services, the Company has designed lighting, toll and service facilities, drainage and erosion control systems, and has performed mapping and landscaping, hydraulic and hydrologic studies, soils engineering, traffic studies and surveys. In addition, the Company has designed and inspected the construction of airport terminals, runways, aircraft maintenance hangars, fuel systems, control towers and marine ports.\nDefense Systems Engineering\nDefense systems engineering involves consulting and design services for the development of equipment and special hardware for the Department of Defense. Services performed by the Company have included the design, development and testing for systems relating to naval aircraft, weapons systems, aircraft carriers, support ships, land-based operations and support missions. The Company has prepared analytical support studies for aircraft carriers, support ships, land-based operations and support missions, analytical support studies for aircraft catapults and arresting systems, jet blast deflectors, shipboard weapons, loading and transfer systems, ship- weapon compatibility, mobile weapon loaders, munition trailers, launch and recovery television systems, lighting and marking systems, parachutes, life rafts and personnel life-support systems. In addition, the Company has prepared operation and maintenance manuals, technical reports, specifications and other documents describing equipment and hardware. The Company has the capacity to provide all of the services necessary to prepare these publications, including layout, artwork composition, photography and reproduction.\nIndustrial Process Engineering\nThis area involves consulting and design services for the development of various manufacturing equipment and process systems. Services performed by the Company have included technical analyses, feasibility studies, plant layouts and machinery and construction inspection services. The Company has provided these services in connection with systems for the manufacture of paper, plastics, bulk chemicals, flooring, steel, rubber, telephone equipment, television sets, ammunition, foods and automotive production equipment. In addition, the Company has provided services for various waste-to-energy engineering projects such as municipal and industrial incinerators designed to convert various forms of waste into marketable energy and for various environments, sanitary and water pollution control projects, including water supply systems, storm and sanitary sewage collection systems.\nTransportation Engineering\nTransportation engineering involves consulting and design services, as well as construction supervision services, for various transportation facilities, including the planning and design of track, terminals, stations, yards and shops for the railway industry. This area also involves evaluation and inspection of rolling stock for intercity rail lines, light rail, commuter line and urban mass transit systems and design and construction inspection of maintenance and storage facilities.\nCustomers\nThe following table sets forth the percentage of contract revenues derived from each of the following customers for the periods indicated:\nYear Ended September 30, 1995 1994 1993\nU.S. Government Contracts.............................. 19% 22% 23%\nState and Local Government Contracts.............................. 50 49 50\nForeign Government Contracts.............................. 2 1 2\nPrivate Contracts............................... 29 28 25\n_______________ In fiscal years 1995, 1994, and 1993 the Company's business activities in countries other than the United States accounted for approximately 4%, 5%, and 5% of total revenues,\nrespectively. Due to the fact that virtually all of the Company's international business is funded through United States or international development agencies, management believes that there are no unusual risks attendant to obtaining payment for services rendered under its foreign contracts.\nContracts\nIn recent years, many of the Company's contracts have been awarded on a cost-plus, as opposed to a fixed-price, basis. Under cost-plus contracts, the Company is reimbursed for its allowable costs (direct labor plus overhead rate) and is paid a negotiated fixed fee. Under fixed-price contracts, the Company is paid an agreed-upon price for services rendered. Under fixed-price contacts, the Company bears any risk of increased or unexpected costs that may reduce its profit or cause it to sustain a loss. The majority (approximately 75%) of the Company's contracts are cost-plus contracts.\nGovernment Contracts\nMany of the government programs in which the Company participates as a contractor may extend for several years but may be funded on an annual basis. The Company's government contracts are subject to termination, reduction or modification as a result of changes in the government's requirements or budgetary restrictions. In addition, government contracts are subject to termination at the convenience of the government. If a contract were to be terminated for convenience, the Company would be reimbursed for its allowable costs to the date of termination and would be paid a proportionate amount of the stipulated profits or fees attributable to the work actually performed. To date, no government agency has terminated for convenience any significant contracts with the Company.\nUnder certain circumstances, the government can suspend or debar individuals or firms from obtaining future contracts with the government. While the Company has not experienced such a suspension or debarment and considers the possibility of any suspension or debarment to be remote, any such suspension or debarment would have a materially adverse effect upon the Company.\nThe books and records of the Company are subject to audits by a number of federal, state and local government agencies, including the Defense Contract Audit Agency. Such audits could result in adjustments to contract costs and fees. To date, no material audit adjustments have been made in the Company's contracts, although no assurances can be given that future adjustments will not be required. All contract revenues are recorded in amounts which are expected to be realized upon final settlement and the Company does not anticipate material audit adjustments.\nAccounts Receivable and Costs and Estimated Profits of Uncompleted Contracts in Excess of Related Billings\nAccounts receivable and costs and estimated profits of uncompleted contracts in excess of related billings represented 83% and 85% of total assets as of September 30, 1995 and 1994, respectively. Accounts receivable are comprised of billed receivables while costs and estimated profits of uncompleted contracts in excess of related billings are essentially unbilled receivables. Unbilled receivables represent payment obligations for which invoices have not or cannot be presented until a later period. The reasons for which invoices are not presented may include normal invoice preparation lag, lack of billable documents to be supplied by the client, and excess of actual direct and indirect costs over amounts currently billable under cost reimbursement contracts to the extent they are expected to be billed and collected. The financing of receivables requires bank borrowings and the payment of associated interest expense. Interest expense is a business expense not permitted as a reimbursable item of cost under any government contracts.\nBacklog\nBacklog represents the value of existing contracts less the portion of such contracts included in revenues on the basis of percentage-of-completion. The Company's backlog for services as of September 30, 1995 and 1994 was approximately $129,000,000 and $110,000,000, respectively. The Company's backlog includes anticipated pass through cost such as reimbursement for travel, purchase of supplies and sub-contracts. Over the last three years, pass through costs, as a percent of total revenues, have been 22.2% in 1995, 26.5% in 1994 and 28.2% in 1993.\nA majority of the Company's customer orders or contract awards and additions to contracts previously awarded are received or occur at random during the year and may have varying periods of performance. The comparison of backlog amounts on the same date in successive years is not necessarily indicative of trends in the Company's business or future revenues.\nThe major component of the Company's operating costs are payroll and payroll-related costs. Since the Company's business is dependent upon the reputation and experience of its personnel and adequate staffing, a reasonable backlog is important for the scheduling of operations and for the maintenance of a fully staffed level of operation.\nCompetition\nThe Company has numerous competitors in all areas in which it does business. Some of its competitors are large, diversified firms having substantially greater financial resources and larger technical staffs than the Company. It is not possible to predict the extent of competition which the Company will encounter in the future because of changing customer requirements in terms of types of projects and technological developments. It has been the Company's\nexperience that the principal competitive factors for the type of service business in which the Company engages are a firm's demonstrated ability to perform certain types of projects, the client's own previous experience with the competing firms, a firm's size and financial condition, and the cost of the particular proposal.\nIt is Management's belief that the diversified scope of the services offered by the Company is a positive competitive factor. Among other things, the wide range of expertise which the Company possesses permits it to remain competitive in obtaining federal government contracts despite shifts in federal spending emphasis. Management believes that the national and international scope of the Company is a positive factor in attracting and retaining clients which have the need for engineering services in different regions of the country and the world.\nMarketing\nMarketing activities are conducted by key operating and executive personnel, including specifically assigned sales personnel, as well as through professional personnel who maintain existing and develop new client relationships. The Company's ability to compete successfully in the industry is largely dependent on aggressive marketing, the development of information regarding client requirements, the submission of responsive cost-effective proposals and the successful completion of contracts. Information concerning private and governmental requirements is obtained during the course of contract performance, from formal and informal briefings, from participation in activities of professional organizations, and from literature published by the government and other organizations.\nPersonnel\nAs of September 30, 1995, the Company had 998 employees, of whom 885 were engaged in engineering and architectural services, 85 were engaged in administration and 28 in marketing.\nBecause of the nature of services provided, many employees are professional or technical personnel having specialized training and skills, including engineers, architects, analysts, management specialists, technical writers and skilled technicians. Although many of the Company's personnel are highly specialized in certain areas the Company is not currently experiencing any material difficulty in obtaining the personnel it requires to perform under its contracts. Management believes that the future growth and success of the Company will depend, in part, upon its continued ability to retain and attract highly qualified personnel. The Company believes its employee relations to be good.\nEnvironmental Compliance\nThe Company's facilities are subject to federal, state and local authorities environmental control regulations. The Company believes it is in compliance with these numerous regulations and that it is not exposed to any material liability as it relates to contamination of the environment. To date, compliance with these environmental regulations has not had a material\neffect on the Company's earnings nor has it required the Company to expend significant capital expenditures.\nExecutive Officers of the Registrant\nPosition with STV Group, Inc. Business Name Age Experience During the Past 5 Years ---- --- ------------------------------------\nMichael Haratunian (1) 62 Chairman of the Board and Chief Executive Officer of STV Group, Inc.\nDominick M. Servedio (2) 55 Director, President and Chief Operating Officer of STV Group, Inc. and President and Chief Operating Officer of STV Incorporated\nFrank E. Lyon, Jr. (3) 67 Senior Vice President of STV Incorporated\nW. A. Sanders II (4) 48 Senior Vice President of STV Incorporated\nPeter W. Knipe (5) 46 Secretary\/Treasurer of STV Group, Inc.\n_______________ (1) Mr. Haratunian has been associated with the Company continuously since 1972 in various capacities and was appointed President of Seelye, Stevenson, Value & Knecht, Inc. in 1977 and Director and Executive Vice-President of Engineering of STV Group, Inc. in 1981 and assumed the Presidency of STV Group, Inc. in 1988. He was appointed Chief Executive Officer in 1991 and Chairman of the Board in 1993. Mr. Haratunian is a registered professional engineer.\n(2) Mr. Servedio joined the Company is 1977 as Vice President of Seelye, Stevenson, Value & Knecht, Inc. and was appointed Executive Vice President in 1982. He was appointed President of Seelye, Stevenson, Value & Knecht, Inc. and Executive Vice President of STV Group, Inc. in 1988. Mr. Servedio was elected President of STV Group, Inc. in 1993. Mr. Servedio is a registered professional engineer.\n(3) Mr. Lyon was the President and Chairman of the Board of Lyon Associates, Inc. for more than five years prior to the acquisition of certain of its assets by a subsidiary of the Company in 1983. Mr. Lyon currently is President of the Company's Lyon Associates, Inc. subsidiary. Mr. Lyon is a registered professional engineer.\n(4) Mr. Sanders has been associated with the Company continuously since 1968 in various capacities and was appointed Executive Vice President of Sanders & Thomas in 1991. Mr. Sanders is a registered professional engineer.\n(5) Mr. Knipe joined the Company in 1979, was appointed Controller in 1983 and was elected Treasurer in 1987 and Secretary in 1993. In addition to his position with the Company, he serves as a director and officer of certain subsidiaries of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices and a principal engineering office are located in a modern 42,700 square foot building leased by the Company in Pottstown, Pennsylvania, pursuant to a lease which expires in May 1996 with an option to renew for a five-year period.\nThe Company leases office facilities in a number of other locations both in the United States and overseas, at which it performs engineering and architectural consulting and design services, including a facility of approximately 55,000 square feet in New York, New York, pursuant to a 15 year lease which expires in December, 2006.\nThe Company believes that its facilities are adequate to meet the current and foreseeable needs of the Company. The Company does not expect to experience any difficulty in securing additional space should that become necessary.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is the subject of various claims, legal actions and complaints arising in the ordinary course of business. In most cases, the Company is one of several named defendants or third-party defendants. In the opinion of management, most of these matters are without merit or are of such a nature or involve such amounts that an unfavorable disposition would not have a material adverse effect on the financial condition of the Company.\nIn order to meet its contractual professional liability insurance requirements, for the policy years beginning March 1993, the Company's professional liability insurance arrangement provides for an annual aggregate $5,000,000 of coverage with a $250,000 deductible. For the policy year beginning in March 1992, the Company made an arrangement with its professional liability insurance carrier whereby the carrier issues a policy with the agreement the Company indemnify the insurer for claims properly paid under this policy. The insurance coverage is for $1,000,000 per occurrence and $1,000,000 in the aggregate with a $500,000 deductible. As agreed, the Company has funded this indemnification requirement in its entirety. The Company also has a standard professional liability insurance policy in the amount of $4,000,000 for operating subsidiaries in excess of the $1,500,000 primary coverage and deductible. From October 1985 to March 1992, the Company had the same professional liability insurance arrangement with limits of $5,000,000 per occurrence and $5,000,000 in the aggregate for operating subsidiaries and $1,000,000 per occurrence and in the aggregate for coverage related to an acquisition. To satisfy the indemnification requirement, the Company had a cash reserve of $4,000,000 held by the insurance company and has posted a $1,500,000 irrevocable letter of credit in favor of the insurance company. From October 1, 1983 to September 30, 1985, the Company maintained professional liability insurance in the annual amount of $10,000,000 per\noccurrence and $10,000,000 in the aggregate, with a deductible per loss of $500,000. During the ten years prior to October 1, 1983, the Company maintained professional liability insurance in annual amounts ranging from $1,000,000 to $5,000,000 with a deductible per occurrence of between $100,000 to $500,000.\nOn January 20, 1992 the Company, together with its insurers, settled a personal injury lawsuit (Skinner v. Seelye Stevenson, et al.). The Company had been found by a jury to be 70 percent liable for negligence. The case was settled for $5.4 million. There is a declaratory judgment action pending as to whether coverage is provided by the Company's general liability insurance carrier, Reliance Insurance Company, or its professional liability insurance carrier, National Union Fire Insurance Company. While the action is pending, the court has required that the limits of the National Union Fire Insurance coverage be reserved to pay this claim if it is found that coverage was properly provided by National Union Fire Insurance Company. The Company believes that coverage is properly provided by its general liability insurance carrier, Reliance Insurance Company, and intends to vigorously pursue this matter, including the Company's own claims against the general liability insurer and others arising from the handing of the defense.\nOn July 29, 1992, the Supreme Court of New York entered an order granting summary judgment against the Company's former professional liability insurance carrier, National Union Fire Insurance Company, in the approximate amount of $4,000,000. That judgment arose from a prior proceeding in which a developer, American Continental Properties, alleged that Michael Lynn & Associates, P.C. (MLA), from which the Company made an asset acquisition, made certain measurement errors in the process of providing consulting services in connection with a condominium conversion. The Company and National Union have denied that there existed insurance coverage under the National Union policy. The judgement was reversed on appeal in 1994.\nIf the outcome of all of the aforementioned litigation is adverse to the Company and the Company is required to pay additional amounts, it could have a material adverse effect on the earnings and financial condition of the Company in the year such determination is made; however, management believes that the final resolution of these legal matters will not have a material adverse effect on the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information contained under the caption \"Common Stock Market Prices\" from the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1995, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information contained under the caption \"Financial Highlights for the Fiscal Year Ended September 30,\" 1991 through 1995 in the Company's Annual Report to Shareholders 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 OPERATION.\nResults of Operation\nThe Company's contracts have been awarded on a cost-plus or fixed-price basis. See Part I, Item 1, \"BUSINESS - Contracts\". As a service business, the Company's profitability is directly affected by the degree to which its professional staff is fully utilized on existing contracts.\nFiscal Year 1995 Compared to Fiscal Year 1994\nTotal revenues for the fiscal year ended September 30, 1995 decreased, 0.3% to $89,232,000. This is down from a 2.4% increase in fiscal 1994 and a 15.3% increase in fiscal 1993. The reduction in total revenues in fiscal 1995 was the result of a 16.4% reduction in subcontract and procurement mainly in the transportation area. Revenues from U. S. Government contracts decreased 13% in fiscal 1995 as compared to fiscal 1994 and 15.8% as compared to fiscal 1993. This decrease is attributable to the Government's spending reduction, particularly in overseas infrastructure projects. Operating revenues (total revenues excluding pass-through costs) increased 5.6% to $69,397,000 compared to a 4.9% increase in fiscal 1994 and a 13.5% increase in fiscal 1993. While there was a reduction in the international region, we continue to see an increased demand for facilities and transportation engineering. United States defense work has decreased slightly but there is continued demand for services in other areas of the U. S. Government.\nPass-through costs, expressed as a percentage of total revenue, decreased to 22.2% in fiscal 1995 compared to 26.5% in fiscal 1994 and 28.2% in fiscal 1993. Costs will vary from year to year depending on the need for specialty subconsultants and governmental subcontract requirements.\nCost of services, expressed as a percentage of operating revenues, was 89.3% in fiscal 1995, which is comparable to the 89.2% in fiscal 1994, but is an increase from the 88.0% in fiscal 1993. In fiscal 1995, costs increased from $58,614,000 in fiscal 1994 to $61,942,000. This increase is due to increased international marketing efforts and increased labor and labor-related expenses due to increased workload. The increase in fiscal 1994 was due in part to a transfer of certain costs from general and administrative expense to cost of services. Without this transfer, cost of services expressed as a percentage of revenue was comparable to fiscal 1993 at 87.7%. Total costs in fiscal 1994 (excluding the transfer of $1.0 million) increased to $57,614,000 from $55,173,000. This increase was due to increased post retirement benefit costs, increased international marketing efforts and increased labor and labor-related expenses due to an increased workload.\nGeneral and administrative expense, expressed as a percentage of operating revenues, was 7.1% in fiscal 1995 and 1994 and decreased from 8.3% in fiscal 1993. Total general and administrative costs increased 6.3% in fiscal 1995 from $4,657,000 to $4,952,000. This increase is due mainly to an increase in legal fees. The decrease in fiscal 1994 was due to the above mentioned reclassification of costs from general and administrative expense to cost of services.\nInterest, expressed as a percentage of operating revenues, was 2.2% in fiscal 1995 and 1994 and decreased from 2.3% in fiscal 1993. While interest rates increased in fiscal 1995, the average amount of the bank loan outstanding decreased by 7% as compared to fiscal 1994.\nThe company had a pre-tax profit of $949,000. Income tax expense was 58% of pre-tax income compared to 45% in fiscal 1994 and 46% in fiscal 1993. The variance in the rate is due to an increase in non-deductible expenses and the recognition of income in the various states in which we do business and their tax rates.\nIn the fourth quarter the Company had a pre-tax profit of $286,000 as compared to $144,000 in fiscal 1994 and $152,000 in fiscal 1993.\nFiscal Year 1994 Compared to Fiscal Year 1993\nTotal revenues for the fiscal year ended September 30, 1994 increased 2.4% to $89,465,000. This is down from a 15.3% increase in fiscal 1993 and a 6.4% increase in fiscal 1992. The increased revenues in fiscal 1994 were the result of increased demand for transportation engineering services. In fiscal 1993, U. S. government contracts accounted for 47 percent of the total increase in revenues as compared to fiscal 1992, while revenues for U. S. government contracts were comparable in fiscal 1994 versus fiscal 1993. The balance of the fiscal 1993 increase was also due to increased demand for transportation engineering services. Operating revenues (total revenues excluding pass-through costs) increased 4.9% to $65,746,000 compared to a 13.5% increase in fiscal 1993 and a 1.6% decrease in fiscal 1992. The increase in operating revenues reflects continued demand for transportation engineering services as well as the results of increased marketing effort. While there have been decreases in the U.S. Government spending for defense, there has been significant demand for services in other\ndepartments of the U. S. government as well as demand by non U. S. government clients for transportation and infrastructure.\nPass-through costs, expressed as a percentage of total revenue, decreased to 26.5% in fiscal 1994 compared to 28.2% in fiscal 1993 and 27.1% in fiscal 1992. Costs will vary from year to year depending on the need for specialty subconsultants and governmental subcontract requirements.\nCost of services, expressed as a percentage of operating revenues, increased to 89.2% in fiscal 1994 from 88.0% in fiscal 1993 and decreased from 89.6% in fiscal 1992. The increase in fiscal 1994 is due in part to a transfer of certain costs from general and administrative expense to cost of services. Without this transfer, cost of services expressed as a percentage of revenue would be comparable to fiscal 1993 at 87.7%. Total costs (excluding the transfer of $1.0 million) increased from $55,173,000 to $57,614,000. This increase is due to increased post retirement benefit costs, increased international marketing efforts and increased labor and labor related expenses due to an increased workload. The decrease in fiscal 1993 from fiscal 1992 was due to an increase in revenue and the Company's cost containment strategy.\nGeneral & administrative expense, expressed as a percentage of operating revenues, decreased to 7.1% in fiscal 1994 from 8.3% in fiscal 1993 and 8.9% in fiscal 1992. This reduction was due to the above mentioned reclassification of costs from general and administrative expense to cost of services and without this reclassification, would have been comparable to previous years at 8.6%.\nInterest, expressed as a percentage of operating revenues, decreased to 2.2% in fiscal 1994 from 2.3% in fiscal 1993 and 2.5% in fiscal 1992. This decrease was the result of the increase in revenues.\nThe company had a pre-income tax profit of $1,028,000 due to the increase in revenues. Income tax expense was 45% of pre-tax income compared to 46% in fiscal 1993 and an income tax benefit of 37% in fiscal 1992. Included in the 1994 tax rate was a favorable adjustment of $45,000 due to the adoption of FASB 109. The variance in the rate is primarily due to the recognition of income in the various states in which we do business and their tax rates.\nIn the fourth quarter the Company had a pre-tax profit of $144,000. This profit was impacted by higher than anticipated legal expenses.\nFiscal Year 1993 Compared to Fiscal Year 1992\nTotal revenues for the fiscal year ended September 30, 1993 increased 15.3% to $87,361,000. This is up from a 6.4% increase in fiscal 1992 and a 6.7% decrease in fiscal 1991. Operating revenues (total revenues excluding pass-through costs) increased 13.5% to $62,692,000 compared to a 1.6% decrease in fiscal 1992 and a 11.9% decrease in fiscal 1991. The increase\nin operating revenues reflects the results of the increased marketing efforts in transportation and infrastructure.\nPass-through costs, expressed as a percentage of total revenue, increased to 28.2% in fiscal 1993 compared to 27.1% in fiscal 1992 and 21.2% in fiscal 1991. This increase in pass-through costs is primarily due to the need for specialty subconsultants and governmental subcontract requirements.\nCost of services, expressed as a percentage of operating revenues decreased to 88.0% in fiscal 1993 from 89.6% in fiscal 1992 and increased from 87.2% in fiscal 1991. This decrease is due to the increase in revenue and the Company's cost containment strategy. Total cost of services increased 11.5% from $49,493,000 to $55,173,000. This increase is due to increased labor and labor related expenses resulting from the Company's increased workload. The increase in fiscal 1992 from fiscal 1991 was due to increased professional liability insurance costs and a reclassification of costs from general and administrative costs to cost of services.\nGeneral & administrative expense, expressed as a percentage of operating revenues decreased to 8.3% in fiscal 1993 from 8.9% in fiscal 1992 and 10.0% in fiscal 1991. This reduction is due to the increase in revenue. Total general and administrative costs increased by 5.3% from $4,934,000 to $5,197,000. This increase is due to increased legal fees due to on-going litigation.\nInterest, expressed as a percentage of operating revenues decreased to 2.3% in fiscal 1993 from 2.5% in fiscal 1992 and 2.9% in fiscal 1991. This decrease was primarily the result of the increase in revenues.\nThe Company had a pre-income tax profit of $983,000 due to the increase in revenues and its cost containment strategy. Income tax expense was 46% of income compared to an income tax benefit of 37% in fiscal 1992 and an expense of 48% of income in fiscal 1991. The variance in the rate is primarily due to the recognition of income in the various states in which the Company does business and their tax rates.\nIn the fourth quarter the Company had a pre-tax profit of $152,000. This profit was impacted by lower than anticipated legal and insurance costs which was more than offset by a change in estimates on two contracts, all which had an after tax effect of a reduction to income of $156,000.\nLiquidity, Capital Resources and Financing Agreements.\nCash provided in operating activities was $1,109,000 in fiscal 1995 compared to cash used in operating activities of $184,000 in fiscal 1994. This increase was due mainly to a decrease in accounts receivable. Working capital increased $1,386,000 to $8,570,000 in fiscal 1995 compared to a $554,000 increase in 1994 and a $275,000 increase in 1993. Investing activities included $951,000 for the continued purchase of computer hardware and software. Financing activities\nconsisted of a $139,000 net reduction in short term borrowing due to the reduction in accounts receivable.\nCapital resources available to the Company include an existing line of credit for working capital. The current line is a maximum of $16,500,000 based on accounts receivable and work-in-progress, of which approximately $1,300,000 is currently available. The line of credit is a demand note and requires the Company to maintain certain financial covenants. To date, the Company has maintained these covenants and believes that its working capital and existing line of credit are adequate to meet current fiscal year requirements. If the Company should fail to meet these covenants or should the bank demand payment on the note, there would be a material adverse financial impact. The Company is not aware of any reason for the bank to demand payment and does not expect that it would do so in the future. The Company is planning to continue its program of purchasing computer-assisted design and drafting equipment.\nIn the long term, the Company relies on the ability to generate sufficient cash flows from operating activities to fund investing and financing requirements. If demand for services should increase sharply, additional sources of financing may be required.\nThe Company is currently involved in two lawsuits, Skinner and American Continental Properties. If the outcome of these lawsuits is adverse, the Company may be required to pay substantial deductibles or indemnification. The Company believes that it will be able to finance any adverse finding through the use of an income tax carryback of the resulting loss in combination with the line of credit, existing resources, and additional borrowings. The Company is vigorously pursuing its defenses, and management believes the final resolution of these legal matters will not have a material adverse effect on the Company's financial statements.\nImpact of Inflation\nBecause the Company's business is essentially the supplying to customers of the expertise of its employees, there are certain factors which significantly reduce the impact of inflation. One such factor is that the Company has a comparatively small investment in property and equipment as a percentage of total assets. In addition, a substantial percentage of the Company's contracts are under cost reimbursement contract provisions or fixed-price contracts which include inflation assumptions when bid upon.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe report of the independent auditors and consolidated financial statements included in the Company's Annual Report to Shareholders for the year ended September 30, 1995, are included in Part IV, Item 14 of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information contained under the caption \"Election of Directors\" in the company's 1995 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information contained under the caption \"Executive Compensation\" in the Company's 1995 Proxy Statement 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\" in the Company's 1995 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS.\nThe information contained under the caption \"Certain Transactions\" in the Company's 1995 Proxy Statement is incorporated herein by reference.\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:\nReport of Independent Auditors\nConsolidated Balance Sheets - September 30, 1995 and 1994\nConsolidated Statements of Income - Years ended September 30, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity - Years ended September 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years ended September 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements - September 30, 1995\n(2) Financial Statements schedules required by Item 8.\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.\n(B) Reports on Form 8-K.\nThere were no reports on Form 8-K for the fiscal year ended September 30, 1995.\n(C) Exhibits filed pursuant to Item 601 of Regulation S-K:\n****** 3.1 Amended and restated Articles of Incorporation of the Company.\n****** 3.2 By-Laws of the Company, as amended.\n*** 3.3 Amendment to Section 1.04 of the By-Laws of the Company.\n* 4.0 Specimen Common Stock Certificate of the Company.\n* 10.2 Loan Agreement, undated, between the Company and Richard L. Holland, relating to the purchase of 48,779 shares of Common Stock.\n*** 10.3 Asset Acquisition Agreement, dated September 22, 1987, between STV\/WAI, Inc. and Michael Lynn Assoc., P.C. relating to the acquisition by STV\/Michael Lynn Associates, Inc. of certain assets of Michael Lynn Assoc., P.C.\n* 10.4 Lease, dated October 3, 1980, between the Company and Montco Investors Realty Company, relating to the Company's executive and engineering offices in Pottstown, Pennsylvania\n* 10.5 Lease, dated August 30, 1983, between the Company and Montco Investors Realty Company, relating to the addition to the Company's offices in Pottstown, Pennsylvania and granting the Company an option to extend its lease for such facility for two additional five-year periods.\n* 10.6 Lease, dated November 22, 1983, accompanying Workletter, dated October 12, 1983, and letters (2) dated November 22, 1983 between the Company and 225 Fourth Company, providing for the renovation and use of office space at 225 Park Avenue South, New York, New York.\n* 10.7 STV Engineers, Inc. Employee Stock Ownership Plan, dated January 7, 1982, and STV Engineers Employee Stock Ownership Plant Trust Agreement, dated January 7, 1982, and Amendment No. 1 thereto, dated May 14, 1982.\n* 10.8 STV Revised Pension Plan.\n* 10.9 STV, Inc. Money Purchase Pension Plan.\n10.10 Officers' and Directors' Liability Policy.\n*** 10.11 Employment Agreement of Richard L. Holland\n**** 10.12 Stipulation of Amendment to Employee Stock Ownership Plan effective October 1, 1984.\n*** 10.13 Loan Agreement, dated February 28, 1986, between the Company and First Pennsylvania Bank, N.A., relating to the Company's $13,000,000 line of credit.\n*** 10.14 Amendment, dated November 26, 1986, to the Loan Agreement between the company and First Pennsylvania Bank, N.A., increasing the limit of standby letters of credit in the Agreement to $3,500,000.\n*** 10.15 STV Engineers, Inc. 1985 Stock Option Plan.\n*** 10.16 Lease, dated January 27, 1986, and Amendments thereto, between Company and 225 Fourth Company providing for the use of office space at 233 Park Avenue, New York, New York.\n*** 10.17 Amendment, dated May 28, 1987, between the Company and First Pennsylvania Bank, N.A., decreasing the interest rate for short term borrowings and the creation of a $1,500,000 term loan.\n*** 10.18 Amendment, dated November 12, 1987, increasing the line of credit to $17,000,000.\n*** 10.19 Employment Agreement of Whitney A. Sanders, II.\n*** 10.20 Employment Agreement of Dominick M. Servedio.\n*** 10.21 Employment Agreement of Michael Haratunian.\n***** 10.22 Amendment, dated June 1, 1990 between the Company and First Pennsylvania Bank, NA increasing the interest rate for short term borrowings.\n****** 10.23 Extension of Employment Agreement of Whitney A. Sanders, II.\n****** 10.24 Extension of Employment Agreement of Dominick M. Servedio.\n****** 10.25 Extension of Employment Agreement of Michael Haratunian.\n****** 10.26 Amendment dated September 30, 1991, between the company and CoreStates Bank, N.A., decreasing the maximum amount of the line of credit and increasing the charge for issuing letters of credit.\n******* 10.27 Lease extension dated March 13, 1992 between the Company and 225 Fourth Company relating to an extension of seven years, four months for use of office space at 225 Park Avenue South, New York, New York.\n******* 10.28 Agreement effective January 1, 1992 relating to ACEC medical and life insurance.\n******* 10.29 Agreement dated August 29, 1991 relating to U. S. Healthcare medical insurance.\n******** 10.30 Minutes from October 28, 1993 Board of Directors meeting extending the employment agreements of M. Haratunian, D. Servedio and W. A. Sanders for three months ending December 31, 1993.\n********* 10.31 Employment Agreement of Dominick M. Servedio.\n********* 10.32 Employment Agreement of Michael Haratunian.\n10.33 Amendment to the STV Group Incorporated Employee Stock Ownership Plan\n11 Statement Re: Computation of Per Share Earnings.\n13.1 \"Common Stock Market Prices\" from Company's Annual Report to Shareholders.\n13.2 \"Financial Highlights for the Fiscal Year Ended September 30,\" 1991 through 1995 from Company's Annual Report to Shareholders.\n21.1 Subsidiaries of the Company from the Company's Annual Report to Shareholders.\n____________________ * Incorporated by reference from the Annual Report and Form 10-K for the year ended September 30, 1984.\n** Incorporated by reference from Registration Statement No. 2-88904.\n*** Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1987.\n**** Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1989.\n***** Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1990.\n****** Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1991.\n******* Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1992.\n******** Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1993.\n********* Incorporated by reference from Form 10-K and the Annual Report for the year ended September 30, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: December 29, 1995 STV GROUP, INCORPORATED ------------------------- (Registrant)\nBy: \/s\/ Michael Haratunian ------------------------- MICHAEL HARATUNIAN, Chairman of the Board, Chief Executive Officer 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.\nSIGNATURE CAPACITY DATE\n\/s\/ Michael Haratunian December 29, 1995 - ------------------------------- Chairman of the Board, MICHAEL HARATUNIAN Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Dominick M. Servedio December 29, 1995 - ------------------------------- President, Chief DOMINICK M. SERVEDIO Operating Officer and Director\n\/s\/ Peter W. Knipe December 29, 1995 - ------------------------------- Secretary\/Treasurer PETER W. KNIPE (Principal Accounting and Financial Officer)\n\/s\/ Richard L. Holland - ------------------------------- Director December 29, 1995 RICHARD L. HOLLAND\n\/s\/ Harry Prystowsky - ------------------------------- Director December 29, 1995 HARRY PRYSTOWSKY\n\/s\/ Joseph H. Santarlasci, Jr. - ------------------------------- Director December 29, 1995 JOSEPH H. SANTARLASCI, JR.\n\/s\/ Maurice L. Meier - ------------------------------- Director December 29, 1995 MAURICE L. MEIER\n\/s\/ William J. Doyle - ------------------------------- Director December 29, 1995 WILLIAM J. DOYLE\nFINANCIAL STATEMENTS\nIndex\nReport of Independent Auditors 22\nConsolidated Balance Sheets 23\nConsolidated Statements of Stockholders' Equity 24\nConsolidated Statements of Cash Flows 25\nNotes to Consolidated Financial Statements 26\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors STV Group, Incorporated\nWe have audited the accompanying consolidated balance sheets of STV Group, Incorporated and Subsidiaries 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 about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 STV Group, Incorporated 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.\n\/s\/ ERNST & YOUNG LLP\nReading, Pennsylvania November 17, 1995\nCONSOLIDATED BALANCE SHEETS STV Group and Subsidiaries.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME STV Group and Subsidiaries.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY STV Group and Subsidiaries.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS STV Group and Subsidiaries.\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS STV Group and Subsidiaries\n1. Significant Accounting Policies\nBasis of Presentation\nThe Company and its subsidiaries consider themselves in a single line of business: consulting engineering, architectural, surveying and related services.\nCertain amounts in the 1994 financial statements have been reclassified to conform to their 1995 presentation.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company, its subsidiaries, and the 50% interest in an architectural joint venture. All significant intercompany transactions and balances have been eliminated.\nRevenue Recognition\nContract revenue is determined on the percentage-of-completion method based upon incurred costs. The asset, \"Cost and estimated profits of uncompleted contracts in excess of related billings,\" represents revenues recognized in excess of amounts billed. The liability, \"Billings on uncompleted contracts in excess of related costs and estimated profits,\" represents billings in excess of revenues recognized. Significant changes in contract terms affecting the results of operations are recorded and recognized in the period in which the revisions are determined.\nDepreciation\nDepreciation is primarily on the straight-line method over the estimated useful lives of the assets. Depreciation of assets recorded under capital leases is included in depreciation expense. For income tax purposes, accelerated depreciation methods are used by certain subsidiaries and deferred income taxes are provided, when applicable.\n2. Accounting Changes\nEffective October 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires accrual accounting for nonaccumulating postemployment benefits, such as the Company's disability benefits, instead of recognizing an expense for those benefits when paid. This accounting change had no material effect on net income or net worth.\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which requires the liability method of accounting. This accounting change had no material effect on net income or net worth.\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Em-\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\nployers' Accounting for Postretirement Benefits Other Than Pensions.\" The new standard requires the cost of providing postretirement health care be recognized over the employment period on a prospective basis as a part of the future annual benefit cost as opposed to when the benefits are paid. The effect of adopting the new rules increased 1994 net periodic postretirement benefit cost approximately $300,000 to a total cost of $381,000 and decreased net income by approximately $151,000, or $.09 per share, which included amortization of the transition obligation as of October 1, 1993, of $2.5 million over an elected 20-year period. Postretirement benefit cost of $98,000, decreased net income by $53,000 for fiscal 1993 and was recorded on the basis of benefits paid.\n3. Costs and Estimated Profits of Uncompleted Contracts in Excess of Related Billings\nCosts and estimated profits of uncompleted contracts at September 30, 1995 and 1994, respectively, are as follows:\n1995 1994 Costs and estimated earnings on uncompleted contracts $294,418,000 $273,210,000 Less billings to date 284,786,000 263,965,000 ------------ ------------ $ 9,632,000 $ 9,245,000\nCosts and estimated profits of uncompleted contracts are included in the accompanying balance sheet under the following captions:\n1995 1994 Costs and estimated profits of uncompleted contracts in excess of related billings $12,976,000 $13,045,000\nBillings on uncompleted contracts in excess of related costs and estimated profits 3,344,000 3,800,000 ----------- ----------- $9,632,000 $9,245,000\nIncluded in accounts receivable are retainages related to uncompleted contracts in the amount of $3,245,000 in 1995 and $3,492,000 in 1994. The collection of retainages generally coincides with final project acceptance.\n4. Property and Equipment\nProperty and equipment, at cost, are as follows:\n1995 1994\nLand $ 54,000 $ 54,000\nEquipment 5,616,000 4,687,000\nLeased equipment 1,227,000 1,536,000\nFurniture and fixtures 2,334,000 2,273,000\nLeased furniture and fixtures 271,000 271,000\nLeasehold improvements 2,566,000 2,553,000 ----------- ----------- $12,068,000 $11,374,000 Less: Accumulated depreciation and amortization 10,185,000 9,282,000 ----------- ----------- $ 1,883,000 $ 2,092,000\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\n5. Note Payable\nThe note payable on demand with the Company's bank is with interest at 1-1\/2% above the prime rate and is secured by substantially all assets. The bank also provides letters of credit which incur a charge of 2-1\/2% of the face value. Currently, $1,895,000 letters of credit are outstanding. The face value of the letters of credit and note payable cannot exceed a maximum of $16,500,000 based on the accounts receivable and contracts in progress.\nAn agreement with this bank contains restrictive covenants regarding additional debt and stockholders' equity. The restrictions include maintaining a minimum tangible net worth, a maximum total debt to tangible net worth ratio, and a minimum working capital amount.\n6. Income Taxes\nEffective October 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 (SFAS) No. 109, \"Accounting for Income Taxes\" (see Note 2 - Accounting Changes).\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, are as follows:\nDeferred tax assets: Vacation accruals $ 580,000 Deferred compensation 606,000 Litigation 282,000 State income taxes 60,000 Postemployment benefits 27,000 Postretirement medical benefits 264,000 ---------- Total deferred tax assets 1,819,000 Deferred tax liabilities: Retainage 158,000 Accrual to cash adjustment 470,000 ---------- Total deferred tax liabilities 628,000 Net deferred tax assets $1,191,000\nSignificant components of the provision (benefit) for income taxes are as follows:\nLiability Method Deferred Method 1995 1994 1993\nCurrent: Federal $ 520,000 $ 600,000 $ 434,000 State 200,000 90,000 80,000 --------- --------- --------- Total current $ 720,000 $ 690,000 $ 514,000\nDeferred: Federal $(100,000) $(172,000) $ (56,000) State (65,000) (53,000) (4,000) --------- --------- --------- Total deferred $(165,000) $(225,000) $ (60,000)\nIncome tax expense $ 555,000 $ 465,000 $ 454,000\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\nThe components of the (benefit) provision for deferred income taxes for the year ended September 30, 1993 is as follows:\nDepreciation $ 9,000 Vacation accruals and deferred compensation (34,000) Litigation (235,000) Rent expense -- Other 200,000 -------- $(60,000)\nA reconciliation of federal income taxes at the statutory rate to the Company's income tax provision follows:\n1995 1994 1993\nFederal income tax rate 34.0% 34.0% 34.0%\nNon-deductible expenses and other 14.6 7.0 6.9\nState taxes, net of federal tax effect 9.4 4.0 5.1 ---- ---- ----\n58.0% 45.0% 46.0%\nThe Company made income tax payments of $1,014,000, $881,000, and $951,000 in 1995, 1994, and 1993, respectively. The Company received income tax refunds of $92,000 in 1995, $225,000 in 1994, and $702,000 in 1993.\n7. Amounts per Common Share\nEarnings per common share is based on the weighted-average number of shares outstanding during the periods presented after giving effect to the potential dilutive effect, if any, of the exercise of stock options. Earnings per common share are based upon 1,832,000 shares in 1995, 1,754,000 shares in 1994, and 1,626,000 shares in 1993.\n8. Commitments and Contingencies\nFor policy years beginning March 4, 1993, the Company's professional liability insurance arrangement provides for an annual aggregate $5,000,000 of coverage with a $250,000 deductible per occurrence. For the policy year beginning March 4, 1992, the Company's professional liability insurance arrangement provides for an aggregate $5,000,000 of coverage. There was a $500,000 deductible and a requirement to indemnify the insurer for an additional aggregate $1,000,000. The Company had a similar arrangement for professional liability coverage for the period October 1, 1986, to March 3, 1992, providing an aggregate $5,000,000 of professional liability coverage. The Company has recognized the indemnity obligation by charges of $4,000,000 to operations in prior years and the posting of a $1,500,000 letter of credit. In addition to the professional liability coverage, the Company has general liability insurance of $10,000,000 per occurrence and in the aggregate.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\nDuring 1992, the Company and its insurers settled a personal injury lawsuit for $5,400,000, of which $2,700,000 was paid by the Company's professional liability insurer from the funded indemnity and $2,700,000 by the general liability insurer. There remains a declaratory judgement action pending as to whether insurance coverage was to be provided under the previous general liability policy or professional liability policy then in effect. In this proceeding, the court has required that the limits of the Company's insured coverage be reserved to pay this claim if the insurer is found liable. The Company and its professional liability insurer believe that this matter should be covered under its general liability policy in which case the $2,700,000 would be repaid to the professional liability insurer to replenish the indemnity.\nIn addition, in 1992 the Company's former professional liability insurer was found liable for approximately $4,000,000 due to a previous arbitration proceeding allegedly relating to an asset acquisition. The judgement was reversed on appeal in 1994. If the Company's professional liability insurer is found ultimately liable under both of these actions, the Company may be required to indemnify the professional liability insurer to the extent of the policy limit of $5,000,000 as described above. Such payments would constitute a charge to operations in the year the determination is made. The Company and the Company's professional liability insurer continue to deny liability and intend to vigorously pursue defenses available to them.\nThe Company is also involved in various other litigation arising out of the ordinary course of business, which may require the payment of additional amounts. The Company's management believes that the final resolution of the above legal matters will not have a material adverse effect on the Company's financial statements.\nThe Company has noncancellable lease agreements for the use of office space and equipment. These agreements expire on varying dates and in some instances contain renewal options. In addition to the base rental costs, occupancy lease agreements generally provide for rent escalations resulting from increased assessments for real estate taxes and other charges. Future minimum lease payments under noncancellable leases (excluding automobile leases) with remaining terms of more than one year are due as follows:\nCapital Leases Operating Leases\n1996 $ 675,000 $ 2,236,000 1997 $ 555,000 $ 1,775,000 1998 $ 228,000 $ 1,605,000 1999 $ $ 1,574,000 2000 $ $ 1,093,000 Thereafter $ $ 5,968,000\nTotal minimum lease payments $ 1,458,000 $14,251,000\nLess amount representing interest $ 153,000\nPresent value of net minimum lease payments $ 1,305,000\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\nRental expense under operating leases amounted to $2,705,000, $2,713,000, and $2,633,000 in 1995, 1994, and 1993, respectively.\n9. Stock Plans\nOn October 1, 1981, the Company initiated an Employee Stock Ownership Plan (ESOP) which covers substantially all of its employees. Contributions to the plan are based on a percentage of eligible salaries. The total retirement expense for the years 1995, 1994, and 1993 was $989,000, $918,000, and $877,000, respectively. The liability is funded through either the issuance of shares of Company stock (at fair market value on date of issuance) or a cash payment for future stock purchases. The Company will fund the 1995 contribution with a cash payment of approximately $512,000 by December 31, 1995. At September 30, 1995, 1,168,000 shares of Company stock are held by the ESOP and are included in the earnings per share computation.\nThe Company adopted the 1985 Stock Option Plan which reserves 300,000 shares of its common stock for grants of options to officers and key employees. The plan requires that option prices be at least equal to the fair market value of the common stock at the date of grant. In fiscal 1995, 80,000 options were granted, 5,000 options were terminated, 45,000 options expired, and no options were exercised. Options to purchase 190,000 shares at $4.12 to $5.12 per share have been granted.\nOn October 20, 1995, certain Company officers borrowed $125,000 from the Company to purchase 25,000 shares of common stock from an outside director of the Company. The five-year term loan, secured by a stock pledge agreement, is payable at the term with interest at the Company bank borrowing rate currently at 1-1\/2 percent above prime rate.\n10. Postretirement Benefit Plan\nThe Company sponsors a defined benefit health care plan that provides postretirement medical benefits to all current and retired officers and their spouses upon attaining age 65, or age 55 with 10 years of service. The plan is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. The accounting for the plan anticipates future cost-sharing changes to the written plan that are consistent with the Company's expressed intent to increase the retiree contribution rate annually for the expected general inflation rate for that year.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\nIn fiscal 1994, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note 2 -- Accounting Changes).\nThe following table presents the plan's status reconciled with amounts recognized in the Company's balance sheets:\n1995 1994 Accumulated postretirement benefit obligation: Retirees $ (728,000) $ (706,000) Fully eligible active plan participants (1,071,000) (1,046,000) Other active plan participants (790,000) (874,000) ----------- ----------- Accumulated postretirement benefit obligation $(2,589,000) $(2,626,000) Unrecognized net gain (250,000) (18,000) Unrecognized transition obligation 2,220,000 2,344,000 ----------- ----------- Accrued postretirement benefit cost $ (619,000) $ (300,000)\nNet periodic postretirement benefit costs include the following components:\n1995 1994 1993 Service cost $ 67,000 $ 70,000 Interest cost 185,000 187,000 Amortization of transition obligation over 20 years 124,000 124,000 ------- ------- Net periodic postretirement benefit cost $376,000 $381,000 $ 98,000\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is 12 percent for 1995 (12.5 percent in 1994, 13 percent in 1993) and is assumed to decrease gradually to 6 percent in 2008 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated post retirement benefit obligation as of September 30, 1995, 1994 and 1993 by $330,000, $334,000 and $298,000, respectively, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1995 and 1994 by $34,000 and $36,000, respectively.\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.75 percent at September 30, 1995 and 1994.\n11. Major Customers\nThe percentage of total revenues derived from contracts with the United States government for fiscal years 1995, 1994 and 1993 were 19 percent, 22 percent and 23 percent, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\n12. Long-Term Debt\nLong-term debt consists of the following:\n1995 1994\nCapital leases with various maturities, the latest to September 1998, rates ranging from 8% to 11%, and monthly installments ranging from $974 to $15,897 $1,305,000 $1,071,000\nDeferred compensation liability payable in fixed monthly installments of $12,000 through September 2006 with interest imputed at 16% 715,000 737,000\nExecutive deferred compensation liability for certain executives with annual interest at 1% above prime rate as of November 1 payable upon the termination of employment or approval of the Board of Directors 499,000 445,000\nDeferred compensation liability payable in fixed monthly installments of $6,000 through September 1996 with interest imputed at 20% 65,000 114,000\nSupplemental executive retirement agreements for two current executives payable in monthly installments upon retirement with interest imputed at 7% (1) 193,000 96,000\nOther 584,000 628,000 ---------- ---------- 3,361,000 3,091,000 Less: Current portion 1,340,000 1,152,000 ---------- ----------\n$2,021,000 $1,939,000\n(1) These agreements for two current executives provide for future cash payments of $73,000 and $136,000 annually, based on salary at retirement commencing September 2003 and September 2005, respectively. If maximum Company performance goals are achieved, these amounts would be increased 100 percent starting in September 2003, or at a prorated rate based on the levels of performance achieved.\nInterest paid during 1995, 1994, and 1993 amounted to $1,517,000, $1,423,000, and $1,368,000, respectively.\nThe company incurred capital lease obligations of $804,000 in 1995, $613,000 in 1994, and $554,000 in 1993 to acquire equipment.\nAnnual maturities of long-term debt are as follows:\nYear ending September 30\n1996 $1,340,000 1997 $ 540,000 1998 $ 254,000 1999 $ 359,000 2000 $ 49,000 Thereafter $ 819,000\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STV Group and Subsidiaries\n13. Quarterly Results (unaudited) (All dollar amounts omit 000 except per share data.)\nQuarter Year First* Second* Third* Fourth Revenue from services: 1995 $22,817 $21,092 $23,187 $22,136 $89,232 1994 $21,808 $20,687 $23,439 $23,531 $89,465\nOperating revenue: 1995 $17,353 $17,519 $17,358 $17,167 $69,397 1994 $16,381 $15,928 $16,496 $16,941 $65,746\nGross profit: 1995 $ 1,885 $ 1,871 $ 1,835 $ 1,864 $ 7,455 1994 $ 1,777 $ 1,353 $ 1,643 $ 2,359 $ 7,132\nNet income: 1995 $ 102 $ 95 $ 79 $ 118 $ 394 1994 $ 237 $ 144 $ 160 $ 22 $ 563\nEarnings per share: 1995 $ .05 $ .05 $ .05 $ .07 $ .22 1994 $ .14 $ .08 $ .09 $ .01 $ .32\n*Net income and earnings per share for the first three quarters of fiscal year 1995 have been restated from the amounts previously reported. The restatements reflect a correction in the effective annual income tax rate which has been applied to the respective fiscal year quarters. The effects of the restatements were reductions to net income of $30,000, $29,000 and $24,000, or $.02, $.02 and $.01 per share in the quarters ended December 31, 1994, March 30 and June 30, 1995, respectively.\nEXHIBITS\nIndex\nExhibit 10.10 - Officers' and Directors' Liability Policy\nExhibit 10.33 - Amendment to the STV Group Incorporated Employee Stock Ownership Plan\nExhibit 11 - Statement Re: Computation of Per Share Earnings\nExhibit 13.1 - \"Common Stock Market Prices\" from Company's Annual Report to Shareholders.\nExhibit 13.2 - \"Financial Highlights for the Fiscal Year Ended September 30,\" 1991 through 1995 from Company's Annual Report to Shareholders.\nExhibit 21.1 - Subsidiaries of the Company from the Company's Annual Report to Shareholders.","section_15":""}
{"filename":"810827_1995.txt","cik":"810827","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company - -----------\nFaircom Inc., a Delaware corporation (\"Faircom\" or the \"Company\"), owns and operates three radio stations, WFNT-AM and WCRZ-FM in Flint, Michigan, and WWBN-FM in Tuscola, Michigan, a community north of Flint.\nIn August 1994, the Company sold WHFM-FM, its station in Southampton, Long Island, New York, and purchased WWBN-FM. The Company is actively pursuing acquisitions of additional radio stations.\nThe Company was founded by Joel M. Fairman in April 1984 and began operations with the objective of acquiring broadcasting properties at prices considered attractive by the Company, financing them on terms satisfactory to the Company, managing them in accordance with the Company's operating strategy and building a significant broadcasting group. The Company has sought to acquire radio properties which have a history of growing revenues and broadcast cash flow, capable operating management and are in communities with good growth prospects or which have attractive competitive environments. Faircom has not purchased, and does not foresee purchasing in the near future, properties with negative cash flows, or so-called \"under-performing\" or \"turnaround\" properties.\nThe Company continuously reviews radio properties for possible acquisition, and several acquisitions are currently being actively pursued. No assurance can be given that the Company will successfully consummate any of such acquisitions.\nThe Company's predecessor was founded in April 1984. In July 1984, a plan of merger was consummated pursuant to which the Company became the surviving entity of a merger between its predecessor and Comtron, Inc., a public company incorporated in December 1982.\nThe Company's executive offices are located at 333 Glen Head Road, Suite 220, Old Brookville, New York 11545 and its telephone number is (516) 676-2644. All of the Company's properties are owned and operated through subsidiary corporations, and references to the term \"Faircom\" or \"Company\" herein include such subsidiaries unless the context otherwise requires.\nRestructuring and Refinancing of the Company - --------------------------------------------\nDuring 1992 and 1994, the Company restructured its senior debt and preferred stock. The Company is examining various alternatives for obtaining funds\nfor station acquisitions. No assurance can be given that the Company will successfully consummate any such financing.\nAcquisitions and Dispositions of Radio Stations - -----------------------------------------------\nThe Company was a development stage company until June 1985, when it acquired through a subsidiary its first broadcasting property, WHFM-FM, Southampton, Long Island, for $2.1 million in cash. In August 1985, a subsidiary of the Company acquired WTMA-AM and WSSX-FM in Charleston, South Carolina for $6.4 million, of which $6.2 million was in cash and $200,000 was in the form of a 10% three year secured subordinated note issued to the seller. In December 1986 a subsidiary of the Company acquired WKMF-AM and WCRZ-FM in Flint, Michigan for $7.3 million. WKMF-AM changed its call letters to WFNT-AM in October 1993. The purchase price consisted of $6.3 million in cash and a $1.0 million 8% secured subordinated note to the sellers due October 1, 1991. Both the Charleston and Flint seller notes were subsequently paid in full. In August 1994, the Company purchased WKMF-FM for $450,000, consisting of $400,000 cash and an 8% note for $50,000 payable in 16 monthly installments. The final installment of the 8% seller note was paid in December 1995. WKMF-FM changed its call letters to WWBN-FM in September 1994.\nThe Company's Charleston stations, WTMA-AM and WSSX-FM, were sold in 1989 and 1993 for $458,000 and $1,125,000 cash, respectively. In August 1994, the Company sold its Southampton station for $1,850,000 cash, reduced by credits of $150,000 for certain payments made by the purchaser prior to closing.\nOperating Strategy - ------------------\nThe Company's strategy has been to purchase radio properties that exhibit growing revenues and broadcast cash flow, and have experienced, in-place operating personnel. After acquiring a radio station, the Company reviews the station's operations and attempts to realize economies associated with ownership of multiple stations by centralizing such functions as accounting and other administrative activities. A minimal staff is maintained at the corporate level reflecting the Company's strategy of minimizing corporate expenses while giving considerable autonomy to its station managers.\nThe Company relies on experienced station managers who are given the authority for decision making at the station level, subject to guidance by the Company's management. The Company's station managers are partially compensated on the basis of their ability to meet or exceed budgeted operating results. Consequently, operating personnel can benefit by meeting the revenue and expense objectives of the Company.\nEach station targets specific demographic groups based upon advertiser demand, the format of the station and the competition in the market. Through\nprogram selection, promotion, advertising and the use of selected on-air personnel, each station attempts to attract a target audience which it believes is attractive to advertisers. The Company retains consultants to assist the Company's programming personnel by evaluating and suggesting improvements for programming. The Company also conducts research through outside consultants to evaluate and improve its programming and also uses its own personnel for such research.\nThe Radio Broadcasting Industry and Company Operations - ------------------------------------------------------\nAt January 31, 1996, there were approximately 4,909 commercial AM and 5,306 commercial FM stations authorized and operating in the United States. An increasing number of persons listen to FM radio because of clearer sound characteristics and stereo transmission. In the spring of 1995, FM listenership was about 76% of total radio audience.\nRadio station revenue is derived predominantly from local and regional advertising and to a lesser extent from national advertising. Network compensation also provides some revenue. Virtually all of the Company's broadcasting revenues are derived from the sale of advertising. In 1995, approximately 76% of the Company's consolidated station advertising revenues were from local and regional sales, 23% from national sales and about 1% from network or syndication compensation. Local and regional sales generally are made by a station's sales staff. National sales are made by \"national rep\" firms, specializing in radio advertising sales on the national level. These firms are compensated on a commission-only basis. Local and regional sales are made primarily to businesses in the market covered by a station's broadcast signal and to some extent to businesses in contiguous or nearby markets. Such businesses include auto dealers, soft drink, beer and wine distributors, fast food outlets and financial institutions. National sales are made to larger, nationwide advertisers, such as soft drink producers, automobile manufacturers and airlines. Most advertising contracts are short-term, generally running only for a few weeks. Advertising rates charged by a radio station are based primarily on the station's ability to attract audiences in the demographic groups which advertisers wish to reach and on the number of stations competing in the market area. Rating service surveys quantify the number of listeners tuned to the station at various times. Rates are generally highest during morning and evening drive-time hours. The Company's stations' advertising sales are made by its sales staff under the direction of the general manager or sales managers. The sales staffs utilize written sales presentations, some of which incorporate computer-generated visual and statistical materials. Television, billboard, newspaper and direct mail advertising, as well as special events and promotions, are used to supplement direct contact by the sales staff in developing advertising clients.\nThe primary costs incurred in operating a radio station are salaries, programming, promotion and advertising expenditures, occupancy costs of premises for studios and offices, transmitting and other equipment expenses and music license royalty fees.\nRadio broadcasting revenues are spread over the calendar year. The first quarter generally reflects the lowest and the third and fourth quarters the highest revenues for the year, due in part to increases in retail advertising in the summer and in the fall in preparation for the holiday season and, in election years, to political advertising.\nThe radio industry is continually faced with technological changes and innovations, the possible rise in popularity of competing entertainment and communications media, changes in labor conditions, governmental restrictions and actions of federal regulatory bodies, including the Federal Communications Commission (\"FCC\"), any of which could have a material effect on the Company's business. However, broadcasting stations have generally enjoyed growth in listeners and value within the past several decades. Population increases and greater availability of radios, particularly car and portable radios, have contributed to this growth.\nCompetition - -----------\nThe Company's radio broadcasting stations compete with the other broadcasting stations in their respective market areas, as well as with other advertising media such as newspapers, television, magazines, outdoor advertising, transit advertising and mail marketing. Competition within the radio broadcasting industry occurs primarily in the individual market areas so that a station in one market does not generally compete with stations in other market areas. In addition to management experience, factors which are material to competitive position include the station's ratings in its market, rates charged for advertising time, broadcast signal coverage, assigned frequency, audience characteristics, the ability to create and execute promotional campaigns for clients and for the station, local program acceptance and the number and characteristics of other stations in the market area. The Company attempts to improve its competitive position by continuously reviewing its programming and the programming of its competitors, upgrading its technical facilities where appropriate, attempting to expand sales to its existing advertising clients and developing new client relationships, and by promotional campaigns aimed at the demographic groups targeted by its stations.\nIn order to provide additional opportunity for persons interested in obtaining radio broadcasting licenses, including minorities, the FCC in 1984 proposed new licenses for new full service FM broadcast stations in 684 communities. This FCC program is referred to as the \"Docket 80-90\" proceeding. Where these stations have commenced commercial broadcasting, they have increased competition in these markets. Also, it has been customary in the industry for experienced operators to buy stations in markets they consider attractive and attempt to improve the performance of these stations by additional investment and better management, thus increasing competition in these markets.\nFCC Regulation - --------------\nThe FCC regulates radio stations under the Communications Act of 1934, as amended (the \"Communications Act\") which, together with FCC rules and policies promulgated thereunder, governs the issuance, renewal and assignment of licenses, technical operations, employment practices and, to a limited extent, business and program practices of radio stations and other communications entities. Radio station licenses are renewable for terms of seven years upon the grant by the FCC of an application for renewal. Any person is entitled to challenge license renewals and may file applications that compete with an incumbent's renewal application. The FCC may be required to hold hearings to resolve such conflicts.\nIn August 1992, the FCC voted to adopt revisions to its broadcast multiple ownership rules that permit a single licensee to own up to 18 AM stations and 18 FM stations nationwide. It further voted to relax, to a certain degree, the local ownership restrictions of its multiple ownership rules in a manner which is keyed to the number of stations in a local market area. In markets with fewer than 15 stations, the revised rules allow a single licensee to own up to three stations, no more than two of which are FM stations, provided that the licensee owns fewer than 50% of the stations in the market. AM-FM combinations are allowed. In markets with 15 or more stations, the revised rules allow a single licensee to own up to two AM stations and two FM stations, provided that the combined audience share of stations owned by the licensee in the market does not exceed 25%. The rule revisions became effective in September 1992. In September 1994, permissible nationwide ownership by a single licensee was increased to 20 AM and 20 FM stations.\nThe rules also generally prohibit the acquisition of ownership in, or control of, a television station and either an AM or an FM radio station serving the same market. Such prohibition is subject to waiver for stations in the 25 largest television markets under certain conditions. There are also prohibitions relating to ownership in or control of a daily newspaper and a broadcast station in the same market and limitations on the extent to which aliens may own an interest in broadcast stations.\nOver the past four years, a number of radio stations, including the Company's stations, have entered into what have commonly been referred to as \"Local Market Agreements\", or \"LMAs\". While these agreements may take varying forms, under a typical LMA, separately owned and licensed radio stations agree to enter into cooperative arrangements of varying sorts, subject to compliance with the requirements of antitrust laws and with the FCC's rules and policies. Under these types of arrangements, separately owned stations could agree to function cooperatively in terms of programming, advertising sales, etc., subject to the licensee of each station maintaining independent control over the programming and station operations of its own station. One typical type of LMA is a programming agreement among two separately owned radio stations serving a common service area, whereby the licensee of one station programs substantial portions of the broadcast day on the other\nlicensee's station, subject to ultimate editorial and other controls being exercised by the latter licensee, and sells advertising time during such program segments. Such arrangements are an extension of the concept of \"time brokerage\" agreements, under which a licensee of a station sells blocks of time on its station to an entity or entities which program the blocks of time and which sell their own commercial advertising announcements during the time periods in question.\nIn the past, the FCC has determined that issues of joint advertising sales should be left to antitrust enforcement and has specifically revised its so-called \"cross-interest\" policy to make that policy inapplicable to time brokerage arrangements. Under the cross-interest policy, the FCC may prohibit one party from acquiring certain economic interests in two broadcast stations in the same market. Furthermore, the staff of the FCC's Mass Media Bureau has, over the past four years, held that LMAs are not contrary to the Communications Act provided that the licensee of the station which is being substantially programmed by another entity maintains complete responsibility for and control over operations of its broadcast station and assures compliance with applicable FCC rules and policies.\nOn February 8, 1996, the President signed into law the Telecommunications Act of 1996 (the \"Telecom Act\"). This legislation (a) permits foreign nationals to serve as officers and directors of broadcast licensees and their parent companies, (b) directs the FCC to eliminate its national ownership limits on radio station ownership, (c) requires the FCC to relax its numerical restrictions on local radio ownership, (d) extends the FCC's radio and television common ownership waiver policy to the top 50 markets, (e) extends the license renewal period for radio and television stations to eight years and (f) affords renewal applicants significant new protections from competing applications for their broadcast licenses.\nThe Telecom Act's provisions regarding local radio ownership limits would create a sliding scale of permissible ownership, depending on market size. In radio markets with 45 or more commercial radio stations, a licensee may own up to eight stations, no more than five of which can be in a single radio service (i.e. no more than five AM or five FM). In radio markets with 30 to 44 commercial radio stations, a licensee may own up to seven stations, no more than four of which are in a single radio service. In radio markets having 15 to 29 commercial radio stations, a licensee may own up to six radio stations, no more than four of which are in a single radio service. Finally, with respect to radio markets having 14 or fewer commercial radio stations, a licensee may own up to five radio stations, no more than three of which are in the same service; provided that the licensee may not own more than one half of the radio stations in the market.\nThe Telecom Act affords renewal applicants additional protection from renewal challenges by (a) changing the standard for grant of license renewal and (b) precluding the FCC from considering the relative merits of a competing applicant in connection with making its determination on a licensee's renewal application. The new standard for license renewal is that a station's license will be renewed if (x) the station\nhas served the public interest, convenience and necessity, (y) there have been no serious violations of the Communications Act or FCC rules by the licensee and (z) there have been no other violations of the Communications Act or FCC rules which, taken together, would establish a pattern of abuse by the licensee.\nThe Company's Flint AM and FM licenses expire October 1, 1996. The Company does not anticipate any material difficulty in renewing the licenses of these stations.\nThe foregoing does not purport to be a complete summary of all of the provisions of the Communications Act, the Telecom Act or the regulations or policies of the FCC thereunder. Reference is made to such Acts, regulations, and policies for further information.\nEmployees - ---------\nAt the corporate level, the Company employs its President and Treasurer, Mr. Fairman, and its Senior Vice President, who also utilize the services of consultants, a bookkeeping service and the Company's attorneys. The Company's President and Senior Vice President assist the general managers of the Company's stations in developing strategies to increase the profitability of the Company's broadcasting properties and in the operation of the stations. The Company plans to continue its present policy of utilizing only a small number of persons at the corporate level. Each market in which the Company owns and operates radio stations has its own complement of employees, including a general manager, a sales manager, a business manager, advertising sales staff, on-air personalities and engineering and operating personnel. In the aggregate, the Company's subsidiaries employ 32 people on a full-time basis and 24 people on a part-time basis.\nThe Company has never experienced a strike or work stoppage and believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases approximately 800 square feet of office space for its corporate offices in Old Brookville, New York. The lease expires November 1996. Annual rental is approximately $20,400. The Company is negotiating an extension of this lease and a new lease in the same building for additional space of approximately the same size as its present space.\nThe Flint stations occupy studio and office space in a building of approximately 6,000 square feet located on 10 acres in southeastern Flint, Michigan. The AM towers and antennas are also located on this land. An FM tower, antenna,\ntransmitter building and equipment are located on 19 acres of land located nearby. The land, buildings, towers and antennas are owned by a subsidiary of the Company.\nThe Tuscola station occupies studio and office space in leased premises in Frankenmuth, Michigan, at an annual rental of $1,920 under a lease that expires June 1997. The station's tower, antenna and transmitter building are owned by a subsidiary of the Company. Those facilities are located on leased land in Millington, Michigan. The lease expires in June 1997 and has renewal options through June 2042. Current rental is $1,920 annually.\nThe Company owns substantially all of its studio and general office equipment. The Company believes that its properties are in good condition and are adequate for its operations, although opportunities to upgrade facilities are constantly reviewed.\nAll the tangible and intangible property of the Company's subsidiaries is pledged as security for senior debt of the subsidiaries. See Notes 2 and 4 to the Company's 1995 Consolidated Financial Statements for a description of encumbrances against the Company's properties and the Company's rental obligations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any lawsuit or legal proceeding that, in the opinion of the Company, is likely to have a material adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket For Common Stock - -----------------------\nThe Company's Common Stock was admitted to trading on the Boston Stock Exchange (the \"Exchange\") on December 30, 1987. Prior to that date, the Company's Common Stock was traded in the over-the-counter market, and stock price quotations appeared in the \"pink sheets\" published by the National Quotation Bureau, Inc. In April 1993, the Exchange changed its requirements for continued listing with respect to stockholders' equity. In December 1993, the Exchange notified the Company that it was not in compliance with the stockholders' equity requirement. The Company requested a waiver of this requirement based on the nature of the Company's business. The Exchange denied the Company's request and trading on the Exchange in the Company's common stock ceased on May 23, 1994.\nOn March 2, 1994, the Company's common stock was listed for trading on the National Association of Securities Dealers, Inc. Over-the-Counter Bulletin Board (the \"OTC Bulletin Board\") with the symbol \"FXCM.\"\nThe following table reflects the high and low prices of the Common Stock on the Exchange for the first quarter of 1994 and on the OTC Bulletin Board for the remaining quarters in 1994 and each quarter during 1995.\nFiscal Year High Low ----------- ---- ---- First Quarter....................... 3\/16 1\/16 Second Quarter...................... 1\/8 3\/32 Third Quarter....................... 1\/8 3\/32 Fourth Quarter...................... 5\/32 3\/32\nFirst Quarter....................... 1\/8 3\/32 Second Quarter...................... 7\/32 3\/32 Third Quarter....................... 10\/32 3\/32 Fourth Quarter...................... 10\/32 4\/32\nOn March 15, 1996, the bid and asked prices of the Company's Common Stock on the OTC Bulletin Board were 5\/32 and 7\/32, respectively. There were 370 holders of record of the Company's Common Stock on March 15, 1996.\nDividend Policy - ---------------\nThe Company has never paid dividends on its Common Stock. It is the Company's current policy to retain future earnings for the capital requirements of its business. The Company and its subsidiaries are subject to certain restrictions under existing agreements with their lenders which limit dividends on their Common Stock. See Note 2 to the Company's 1995 Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe Company has not declared or paid Common Stock cash dividends since inception.\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 Company's net broadcasting revenues increased 2.6% in 1995 compared to 1994 (to $5,114,000 from $4,984,000). Increased net revenues at the Company's Flint, Michigan radio stations in 1995 more than offset the absence of any net revenues in 1995 from a radio station in Southampton, New York, formerly owned by the Company and sold in August 1994. Net revenues increased in the Flint stations as a result of higher local and national advertising revenues generated by increased economic activity in the market and nationally.\nOperating expenses before depreciation, amortization and corporate expenses increased by 3.3% in 1995 compared to 1994 (to $2,946,000 from $2,853,000). Expenses increased as a result of increased operating expenses at the Flint stations, offset in part by the absence of operating expenses in the Southampton station formerly owned by the Company. The increases in Flint operating expenses consist principally of increases in promotion and advertising expense, the cost of new syndicated programming and higher sales and administrative expense.\nNet broadcasting revenues in excess of operating expenses before depreciation, amortization and corporate expenses (\"broadcast cash flow\") increased 1.7% (to $2,167,000 from $2,131,000) in 1995 compared to 1994. This increase resulted from higher broadcast cash flow in Flint, offset by the absence of any broadcast cash flow from Southampton in 1995.\nCorporate expenses increased by 12.4% in 1995 from 1994 (to $305,000 from $271,000) primarily as a result of higher payments for employee compensation, including incentive compensation.\nInterest expense increased by 5.4% in 1995 from 1994 (to $811,000 from $770,000) due to higher principal amounts of interest bearing debt outstanding and higher interest rates during 1995.\nThe year 1995 contained no gain from sale of radio stations. Such gain, in the amount of $965,000, was contained in the year 1994, reflecting the sale in August 1994 of the Southampton radio station formerly owned by the Company.\nPreferred stock dividend requirement of subsidiaries decreased by 100.0% in 1995 from 1994 (to zero from $149,000) as a consequence of the extinguishment of\nthe preferred stock in a former subsidiary of the Company resulting from the sale of the Company's former station in Southampton in August 1994.\nAs a result principally of the absence in 1995 of the $965,000 gain from sale of a radio station and the $787,000 gain from troubled debt restructuring recognized in 1994, net income declined to $245,000 in 1995 from $1,779,000 in 1994. The gain from sale of a radio station and the gain from troubled debt restructuring accounted for $.13 and $.11 of the primary and $.06 and $.05 of the fully diluted per share earnings, respectively, in 1994.\nYear ended December 31, 1994 compared to year ended December 31, 1993 ---------------------------------------------------------------------\nThe Company's net broadcasting revenues declined slightly by 0.6% in 1994 compared to 1993 (to $4,984,000 from $5,015,000). Net revenues decreased as a result of the absence in 1994 of any net revenues from a radio station in Charleston, South Carolina, formerly owned by the Company and sold in September 1993 and the sale of the Company's Southampton, New York radio station in August 1994. The absence of the Charleston and Southampton net revenues for all and a portion of 1994, respectively, was almost totally offset by increased net revenues at the Company's Flint, Michigan radio stations. Net revenues increased in the Flint stations as a result of higher local and national advertising revenues generated by increased economic activity in the market.\nOperating expenses before depreciation, amortization and corporate expenses decreased by 18.1% in 1994 compared to 1993 (to $2,853,000 from $3,483,000). Expenses decreased as a result of the absence of operating expenses in the Charleston and Southampton stations formerly owned by the Company, offset in part by increased operating expenses at the Flint stations. The increases in Flint operating expenses consist principally of increases in programming personnel and promotional expenses.\nNet broadcasting revenues in excess of operating expenses before depreciation, amortization and corporate expenses (\"broadcast cash flow\") increased 39.0% (to $2,131,000 from $1,532,000) in 1994 compared to 1993. This increase resulted from the above-described increases in net broadcasting revenues in the Flint stations, which exceeded the operating expense increases of those stations, and the absence in 1994 of the former Charleston station operations, which incurred operating losses in 1993. This increase was offset somewhat by the absence of operating profits from the former Southampton station after its sale.\nInterest expense decreased by 12.2% in 1994 from 1993 (to $770,000 from $877,000). This decrease resulted from lower average principal amounts of interest bearing debt outstanding during 1994.\nPreferred stock dividend requirement of subsidiaries decreased by 84.3% in 1994 from 1993 (to $149,000 from $949,000). These decreases resulted from the extinguishment of the preferred stock in former subsidiaries of the Company as a result of the sale of the Company's former stations in Charleston and Southampton.\nProvision for appraisal rights increased 49.9% in 1994 from 1993 (to $402,000 from $268,000) as a result of the estimated increase in the value of the Company's Flint stations and changes in other components of the computation of such provision.\nAs a result principally of the above-described increases in net revenues in Flint, gain from the sale of the Company's Southampton radio station, elimination of operations in Charleston, and lower preferred stock dividend requirement and interest expense, offset by higher provision for an appraisal right, income before extraordinary item increased to $992,000 in 1994 from a loss of $(797,000) in 1993.\nLiquidity and Capital Resources - -------------------------------\nIn 1995, net cash provided by operating activities was $820,000 compared with $621,000 in 1994. Net increase in cash and cash equivalents was $111,000 in 1995 compared with a net increase of $41,000 in 1994.\nBased upon current interest rates, the Company believes its interest expense for 1996 will be approximately $865,000. Scheduled debt principal payments are $493,000. Corporate expenses and capital expenditures for 1996 are estimated to be approximately $360,000 and $80,000, respectively. The Company expects to be able to meet such interest expense, debt repayment, corporate expenses and capital expenditures, aggregating $1,798,000, from net cash provided by operations and current cash balances.\nThe Company is examining various alternatives for obtaining funds for station acquisitions. No assurance can be given that the Company will successfully consummate any such financing.\nInflation - ----------\nThe Company does believe the effects of inflation have had a significant impact on its consolidated financial statements.\nRecent Accounting Standards Pronouncements - -------------------------------------------\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\" (\"SFAS No. 121\"). SFAS No. 121 requires, among other things, that losses resulting from impairment of assets expected to be held, and gains or losses from assets expected to be disposed of, be included as a component of income from continuing operations before taxes on\nincome. The Company will adopt SFAS No. 121 in Fiscal 1996 and its implementation is not expected to have a material effect on its consolidated financial statements.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123, \"Accounting for Stock Based Compensation\" (\"SFAS No. 123\"). SFAS No. 123 encourages entities to adopt that 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 instruments 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 SFAS No. 123 and will continue to account for such transactions in accordance with APB No. 25.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and supplementary data required pursuant to this Item begin on page 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 names of the directors and executive officers of Faircom Inc. (the \"Company\") and certain information about them are set forth below:\nDirectors of the Company are elected annually and hold office until the Annual Meeting of stockholders or until their successors have been elected and have duly qualified.\nExecutive officers of the Company are elected annually and hold office until the first meeting of the Board of Directors following the Annual Meeting of stockholders or until their successors have been elected and have duly qualified.\nCompensation Pursuant to Stock Option Plan - ------------------------------------------\nOn September 18, 1984 the Board of Directors of the Company adopted a stock option plan (the \"Plan\"), which was subsequently approved by the stockholders of the Company on September 12, 1985. The Plan provides for the granting of incentive stock options as well as options not qualifying as incentive stock options (non-statutory stock options). Under the terms of the Plan, the Company's right to grant additional incentive stock options terminated September 18, 1994, ten years from the date the Plan was adopted by the Company's Board of Directors.\nThe Plan was adopted for the purpose of advancing the interests of the Company and furthering its growth and development by encouraging and enabling directors, officers and key employees of the Company and its subsidiaries and other persons, who are presently making and are expected to continue to make substantial contributions to the successful growth of the Company, to acquire an increased and proprietary interest in its continued success and progress. Incentive stock options granted pursuant to the Plan provide certain restrictions concerning to whom and upon what basis the grant and exercise of options may be made and on the disposition of stock issued upon exercise of options as required by the tax laws.\nAn aggregate of 900,000 shares of the Common Stock, par value $.01 per share, is available and reserved for issuance under the Plan.\nEligibility - -----------\nEmployees (either full or part-time), directors and consultants to the Company and its subsidiaries, who are deemed to have the potential to contribute to the future success of the Company, are eligible to receive non-statutory stock options under the Plan. Until September 1994, full-time and part-time employees (including employees who are also directors of the Company or a subsidiary) and salaried directors, were eligible to receive incentive stock options. Approximately 57 employees of the Company and its subsidiaries are entitled to participate in the Plan.\nAdministration of the Plan - --------------------------\nThe Plan may be administered by the Board of Directors or by a committee appointed by the Board of Directors of the Company (the \"Committee\"). Currently, the Board of Directors is administering the Plan. Subject to the provisions of the Plan, either the Board of Directors or the Committee, whichever is then acting with respect to the Plan, possesses the authority in its discretion (i) to determine, upon review of relevant information, the fair market value of the Common Stock; (ii) to determine the exercise price per share of stock options to be granted; (iii) to determine the Eligible Participants to whom, and time or times at which, awards shall be granted and the number of shares to be represented by each stock option; (iv) to construe and interpret the Plan; (v) to prescribe, amend and rescind rules and regulations relating to the Plan; (vi) to determine the terms and provisions of each award (which need not be identical) and (vii) to make all other determinations necessary to or advisable for the administration of the Plan.\nThe Plan provides for the issuance of shares of Common Stock for any nature of consideration, including a promissory note, as determined by the Board of Directors or the Committee. The Board of Directors or the Committee may also determine the conditions which it deems appropriate to assure that such consideration will be received by, or accrued to, the Company. The consideration may be different for different options.\nGrants and Exercises - --------------------\nDuring the fiscal year ended December 31, 1995, options to purchase an aggregate of 309,318 shares of Common Stock at an exercise price of $.156 per share were granted pursuant to the Plan. As of March 15, 1996, no options granted pursuant to the Plan had been exercised. On that date the bid and asked prices for the Common Stock on the OTC Bulletin Board were $.156 and $.219, respectively.\nCompliance with Section 16(a) of the Exchange Act - -------------------------------------------------\nSection 16(a) of the Securities Exchange Act of 1934 requires that the Company's directors and certain officers and persons who own more than ten percent (10%) of a registered class of the Company's equity securities 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. Stephen C. Eyre, Joel M. Fairman, John C. Jansing, Anthony Pantaleoni and John E. Risher each failed to timely file a Report on Form 5 with respect to options granted to each of them on May 23, 1995 pursuant to the Plan. Each of them is preparing the required Report and the Company expects that all such Reports will be filed shortly.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION\nSummary of Cash and Certain Other Compensation - ----------------------------------------------\nThe following table sets forth certain summary information concerning compensation paid or accrued by the Company and its subsidiaries to, or on behalf of, the Company's Chief Executive Officer for the fiscal years ended December 31, 1993, 1994 and 1995.\n- -------------\n(1) Represents grant of stock options under the Company's Stock Option Plan.\nThe following table sets forth certain information concerning stock options granted to Joel M. Fairman under the Company's Stock Option Plan in the fiscal year ended December 31, 1995.\nThe following table sets forth certain information concerning unexercised stock options granted to Joel M. Fairman under the Company's Stock Option Plan:\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of March 15, 1996, the number of shares of Common Stock of the Company and the percentage owned beneficially, within the meaning of Securities and Exchange Commission Rule 13d-3, by (i) all stockholders known by the Company to own more than 5% of the Common Stock; (ii) all directors of the Company who are stockholders; and (iii) all directors and officers as a group. Except as otherwise specified, the named beneficial owner has sole voting and investment power.\nNumber of Shares Name and Address of Beneficially Beneficial Owners Owned Percent of Class -------------------- ---------------- ---------------- Joel M. Fairman 333 Glen Head Road Old Brookville, New York 11545 1,500,000(1) 19.5%\nAnthony Pantaleoni 666 Fifth Avenue New York, New York 10103 125,000(2) 1.7%\nStephen C. Eyre 55 East 59th Street New York, New York 10022 154,500(2) 2.1%\nJohn C. Jansing 162 South Beach Road Hobe Sound, FL 33455 168,500(2) 2.2%\nDon G. Hoff and Sandra Hoff 1 Via Capistrano Tiburon, CA 94920 430,000 5.8%\nIdo Klear 111 Great Neck Road Great Neck, New York 11021 380,000 5.2%\nCiticorp Venture Capital, Ltd. 399 Park Avenue New York, New York 10043 9,081,502(3) 55.2%\nAll officers and directors as a group (five (5) persons) 2,015,400(4) 24.9%\n- -------------------------\n(1) Includes 300,000 shares issuable pursuant to currently exercisable stock options held by Mr. Fairman under the Company's Stock Option Plan (\"Plan\").\n(2) Includes 115,000 shares issuable pursuant to currently exercisable stock options held by each of Messrs. Eyre, Jansing and Pantaleoni under the Plan.\n(3) Represents 9,081,502 shares issuable upon conversion of the Company's 8.65% Senior Convertible Note.\n(4) Includes 706,000 shares issuable pursuant to currently exercisable stock options under the Plan held by officers and directors of the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring the fiscal year ended December 31, 1995, Anthony Pantaleoni, Secretary and a Director of the Company, was a partner in the law firm of Fulbright & Jaworski L.L.P., which firm was retained by the Company during such fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1 and 2. Index to financial statements and related schedules.\nSee the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules beginning on page of this report.\n(a) 3. Exhibits.\n* 3.1 Certificate of Incorporation, as amended.\n* 3.2 By-Laws of the Company.\n11.1 Computation of Net Income (Loss) Per Common Share.\n* 21 Subsidiaries of the registrant.\n27 Financial Data Schedule.\n(b) No reports on Form 8-K were filed during the period October 1, 1995 through December 31, 1995.\n- -------- * Previously filed as an exhibit to the Company's registration of securities on Form 10, dated February 12, 1987, pursuant to Section 12(g) 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.\nFAIRCOM INC.\nBy s\/ Joel M. Fairman ----------------------------------- Joel M. Fairman President\nMarch 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.\nSignature Title Date --------- ----- ---- By s\/ Joel M. Fairman President, Treasurer March 26, 1996 ----------------------- and Chairman of the Joel M. Fairman Board (Chief Executive, Financial and Accounting Officer)\nBy s\/ Anthony Pantaleoni Secretary and Director March 26, 1996 ------------------------ Anthony Pantaleoni\nBy s\/ Stephen C. Eyre Director March 26, 1996 ------------------------ Stephen C. Eyre\nBy s\/ John C. Jansing Director March 26, 1996 ------------------------ John C. Jansing\nFAIRCOM INC.\n===============================================================================\nCONSOLIDATED FINANCIAL STATEMENTS Form 10-K - Item 8 and Items 14(a)(1) and (2) Year Ended December 31, 1995\nFAIRCOM INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nCONSOLIDATED BALANCE SHEETS: December 31, 1995 and 1994\nCONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED DECEMBER 31, 1995: Statements of income Statements of capital deficit Statements of cash flows\nSUMMARY OF ACCOUNTING POLICIES -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Board of Directors and Stockholders Faircom Inc.\nWe have audited the consolidated balance sheets of Faircom Inc. as of December 31, 1995 and 1994 and the related consolidated statements of income, 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 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 Faircom 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.\ns\/BDO Seidman, LLP -------------------- BDO Seidman, LLP\nMitchel Field, New York January 16, 1996\nFAIRCOM INC.\nSUMMARY OF ACCOUNTING POLICIES\n===============================================================================\nORGANIZATION AND BUSINESS\nFaircom Inc. (the \"Company\") owns and operates radio stations through its wholly-owned subsidiary in Flint, Michigan.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements of the Company include the accounts of Faircom Inc. and its subsidiaries, Faircom Flint Inc. (\"Flint\"), and Faircom Evansville Inc., all of whose common stock is owned by the Company. All intercompany accounts and transactions are eliminated. Faircom Evansville Inc. is currently inactive. The assets of Faircom Charleston Inc. (\"Charleston\") were sold in 1993 (see Note 8). The assets of Faircom Southampton Inc. (\"Southampton\") were sold in 1994 (see Note 9). Charleston and Southampton, which were wholly-owned subsidiaries of the Company, were both dissolved in 1994.\nUSE OF ESTIMATES\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCASH AND CASH EQUIVALENTS\nFor purposes of the statement 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. The carrying amount reported in the consolidated balance sheets for cash and cash equivalents approximates its fair value.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. For financial reporting purposes, depreciation is determined using the straight-line method based upon the estimated useful lives of the various classes of assets, ranging from three to nineteen years. Leasehold improvements are amortized over the shorter of their useful lives or the terms of the related leases. Both straight-line and accelerated methods are used for federal and state income tax purposes.\nFAIRCOM INC.\nSUMMARY OF ACCOUNTING POLICIES\n===============================================================================\nINTANGIBLE ASSETS\nIntangible assets consist of the excess of the purchase price (including related acquisition costs) over the fair value of tangible assets of acquired radio stations, a substantial portion of which represents the value of Federal Communications Commission licenses. These assets are amortized on a straight-line basis over forty years. Management evaluates the continuing realizability of the intangible assets by assessing projected future cash flows and obtaining independent appraisals of the value of its radio stations.\nDEFERRED FINANCING COSTS\nDeferred financing costs are amortized on a straight-line basis over the term of the related debt.\nREDEEMABLE PREFERRED STOCK AND APPRAISAL RIGHTS\nThe Company carried the redeemable preferred stock of its former subsidiaries (see Note 9) at their redemption values. Dividends on such stock were accrued currently and charged to operations. At such time that the appraisal rights of the preferred stockholders had greater than a nominal value, an accrual and corresponding charge to preferred stock requirements were reflected in the consolidated financial statements. Adjustments were made to this accrual based on the passage of time and change in appraisal values.\nThe value of the appraisal right given to Citicorp Venture Capital, Ltd. (\"CVC\") for its guaranty of certain debt interest (see Note 2 (d)) was accounted for in a manner similar to the appraisal rights of the preferred stockholders.\nThe value of the appraisal right given to CVC in connection with its subordinated exchangeable note (see Note 2 (d)) is accrued at a discounted amount, based on the interest rate of the related note and the date on which the appraisal right becomes exercisable. Adjustments are made to this accrual based on the passage of time and change in appraisal values.\nTAXES ON INCOME\nIncome taxes are calculated using the liability method specified by Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\".\nFAIRCOM INC.\nSUMMARY OF ACCOUNTING POLICIES\n===============================================================================\nREVENUE RECOGNITION\nRevenue from radio advertisements, including barter transactions (advertising provided in exchange for goods and services), is recognized as income when the advertisements are broadcast. The merchandise or services received as barter for advertising are charged to expense when used or provided.\nADVERTISING COSTS\nCosts Advertising costs are charged to expense as incurred and amounted to $149,469, $118,770 and $113,429 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNET INCOME PER COMMON SHARE\nNet income per common share is based on the weighted average number of shares of common stock outstanding during each period. The effect on per share data from the assumed exercise of outstanding options or conversion of preferred stock was not dilutive or material for 1993. In 1994 and 1995, the effects of the assumed conversion of a convertible note on per share data have been reflected in the fully diluted calculation only (see Note 2 (c)). The effects of the assumed exercise of outstanding options were not dilutive and, accordingly, have been excluded from both the primary and fully diluted per share calculations (see Notes 6 and 7).\n- ------------------------------------------------------------------------------\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\n1. PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\n1995 1994 - ------------------------------------------------------------------------------- Land $ 116,000 $ 116,000 Buildings and building improvements 626,722 494,566 Leasehold improvements 3,445 3,445 Towers and antenna systems 1,180,620 1,010,620 Studio, technical and transmitting equipment 3,422,652 3,419,074 Office equipment, furniture and fixtures 933,850 896,780 - ------------------------------------------------------------------------------- 6,283,289 5,940,485 Less: accumulated depreciation and amortization (4,956,222) (4,758,483) - ------------------------------------------------------------------------------- Net property and equipment $ 1,327,067 $1,182,002 ================================================================================\n2. LONG-TERM DEBT\nLong-term debt consists of the following:\n1995 1994 - -------------------------------------------------------------------------------- Senior secured term note (see (a) below) $6,131,916 $6,509,317\nSenior secured term note (see (b) below) 834,000 900,000\nSenior secured time note (see (b) below) 673,337 700,000\nSubordinated senior convertible note (see (c) below) 181,630 181,630\nSubordinated senior exchangeable note (see (d) below) 500,000 500,000\nNotes payable for purchase of radio station 1,250 46,742 - -------------------------------------------------------------------------------- 8,322,133 8,837,689\nLess: Current portion of long-term debt (493,250) (490,142) - -------------------------------------------------------------------------------- $7,828,883 $ 8,347,547 ================================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\n(a) Senior secured term note\nOn December 22, 1994, Flint entered into an amended and restated loan agreement (the \"1994 loan agreement\"), under which certain existing indebtedness was consolidated, creating three new loans (see also Note 2 (b)). A portion of the \"first loan\" proceeds under the 1994 loan agreement was used to repay in full two existing term loans, with the balance used to fund loan closing costs and certain capital expenditures. The \"first loan\" is evidenced by a term note for $6,509,317, with interest payable monthly at the prime rate plus 2-3\/4% (base rate), which may be reduced if certain conditions are met. The base rate can also be increased by a maximum of 4% if Flint is in default for non-payment of principal or interest. The principal balance is payable in varying monthly installments, ranging from $31,450 to $48,450, from January 1, 1995 through November 1, 1999, with the balance due on December 1, 1999. Flint has the option, subject to certain terms and conditions, to extend the \"first loan\" maturity date for an additional 60 months beyond December 1, 1999.\nThe borrowings are secured by all tangible and intangible property of Flint and all outstanding Flint common stock held by the Company, and are guaranteed by the Company.\nThe 1994 loan agreement contains certain financial and restrictive covenants, including maintenance of minimum operating income levels and debt coverage ratios, and limitations on capital expenditures, additional indebtedness, mergers and dividend payments.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\n(b) Senior secured term note and time note\nUnder the 1994 loan agreement described in Note 2 (a), Flint became obligated for a term note of $900,000 under the \"second loan\" and a time note of $700,000 under the \"third loan\". The \"second loan\" and \"third loan\" arose from the acquisition by Flint's senior lender of the $3,180,564 subordinated secured claim against Flint, which Flint had recorded in connection with its guaranty of certain indebtedness of Charleston (see Note 8). The senior lender, which had acquired the claim from the Resolution Trust Corporation at a discounted amount, forgave all but $1,600,000 of this claim and recast it as senior secured indebtedness of Flint. An extraordinary gain of $787,201 was recorded in 1994 by Flint in connection with this troubled debt restructuring (see Note 11). The gain represents the principal amount of the subordinated secured claim which was forgiven, less the estimated interest of $793,363 payable over the term of the \"second loan\" and \"third loan\", assuming a prime rate of 8.5%.\nThe principal balance of the term note under the \"second loan\" is payable in varying monthly installments, ranging from $5,500 to $8,550, from January 1, 1995 through November 1, 1999, with the balance due on December 1, 1999. Flint has the option, subject to certain terms and conditions, to extend the \"second loan\" maturity date for an additional 60 months beyond December 1, 1999. Interest on the term note is payable monthly at the prime rate plus 2-3\/4% (base rate), which may be reduced if certain conditions are met. The base rate can also be increased by a maximum of 4% if Flint is in default for non-payment of principal or interest.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nBoth principal and interest, at the prime rate plus 3%, on the time note under the \"third loan\" are payable in a single payment on December 1, 1999. However, to the extent that Flint has excess cash flow, as defined in the 1994 loan agreement, a quarterly payment is required, to be applied first to accrued interest and then to principal. Flint made a required quarterly principal payment of $26,663 on March 1, 1995. Flint was also required to make quarterly payments from excess cash flow as of September 1 and December 1, 1995, but such payments were waived by the lender.\nThe collateral and covenants in connection with the \"second loan\" and \"third loan\" are the same as those described for the \"first loan\" in Note 2 (a).\n(c) Subordinated senior convertible note\nThe Company and Flint entered into a securities exchange agreement with Citicorp Venture Capital, Ltd. (\"CVC\") on December 22, 1994 (the \"1994 CVC agreement\"). Under the 1994 CVC agreement, the Company issued a senior convertible note to CVC for $181,630, with interest payable quarterly at a rate of 8.65% per annum. The interest rate may be increased to 10% per annum if the Company is in default for non-payment of principal or interest. Principal is payable on December 1, 2004.\nThe senior convertible note, which is subordinated to the debt described in Notes 2 (a) and 2 (b), was issued in exchange for the extinguishment of a subordinated claim payable to CVC in the amount of $1,899,555 related to the former Charleston Preferred Stock (extinguished and credited against deficit in 1993 in the amount of its liquidation value), which CVC had the option of converting into 6,963,733 shares of the Company's common stock; and the extinguishment in 1994 of the former Southampton Preferred Stock, with a liquidation value of $2,117,769, which CVC had the option of converting into 2,117,769 shares of the Company's common stock (see Notes 8 and 9). The liquidation value of the former Southampton Preferred Stock, and the difference between the subordinated claim and the principal amount of the new senior convertible note, were credited against deficit in 1994.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nCVC has the option at any time prior to December 1, 2004 to convert all or any portion of the senior convertible note into up to 9,081,502 shares of the Company's common stock, at a conversion rate of 50,000 shares of stock for each $1,000 of note principal, equivalent to a conversion price of $.02 per share, subject to antidilution adjustments upon stock splits and other events.\nThe senior convertible note contains certain restrictive covenants, including limitations on capital expenditures, additional indebtedness, mergers and dividend payments.\n(d) Subordinated senior exchangeable note\nUnder the 1994 CVC agreement (see Note 2 (c)), the Company also issued a senior exchangeable note to CVC for $500,000, with interest payable quarterly at a rate of 10% per annum. The interest rate may be increased to 12% per annum if the Company is in default for non-payment of principal or interest. Principal is payable on December 1, 2004.\nThe senior exchangeable note, which is subordinated to the debt described in Notes 2 (a) and 2 (b), was issued in exchange for the extinguishment of an appraisal right with respect to Flint held by CVC, valued for purposes of the exchange at $310,000 at December 31, 1993 and $350,000 at December 22, 1994, the date of the 1994 CVC agreement; and for the extinguishment of the Company's subordinated obligation to CVC, valued at $150,000 at December 22, 1994, which was related to CVC's payment of certain accrued interest under an interest guaranty on one of the Company's notes payable.\nAt any time after December 1, 1999, CVC may request a determination of the appraised value (as defined in the 1994 CVC agreement) of Flint, and elect to exchange $350,000 of the principal amount of the senior exchangeable note for a payment of 19.99% of such appraised value. Management estimates that the present value of this appraisal right at December 31, 1995 and 1994 was approximately $800,000 and $362,000, respectively, net of the $350,000 principal amount that would be exchanged at each such date and based on a 10% discount rate. If at any time Flint is disposed of by the Company, CVC is entitled to elect to exchange $350,000 of the principal amount of the senior exchangeable note for a payment of 19.99% of the net proceeds (as defined) received.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nDuring the fourth quarter of 1995, a review of the calculation of the December 31, 1994 appraisal right liability discovered that such liability was overstated by $350,000 for the purposes of the Company's 1994 consolidated financial statements, as it did not reflect the debt cancellation that would occur if CVC were to elect to exercise its appraisal right. Accordingly, the 1994 consolidated financial statements have been restated to reduce the 1994 year-end appraisal right liability to $362,000 from $712,000 and increase both 1994 income before extraordinary item and net income by $350,000. Such restatement increased primary and fully diluted net income per common share by $.05 and $.02, respectively. There was no income tax effect from this restatement, as the provision for appraisal right is a non-deductible expense.\nThe senior exchangeable note has the same restrictive covenants as described in Note 2 (c) for the senior convertible note.\nMinimum annual maturities of the Company's long-term debt for the next five years and thereafter are approximately as follows: 1996 - $493,000; 1997 - $552,000; 1998 - $612,000; 1999 - $5,983,000; 2000 - $0; and $682,000 thereafter.\nThe Company estimates that the carrying amount of its long-term debt approximates its fair value.\n3. DEFERRED RENTAL INCOME\nEffective January 1995, Flint, as lessor, entered into an operating lease agreement with a telecommunications company. The lessee agreed to arrange for the construction of a new radio tower and antenna at one of Flint's tower sites, at lessee's expense, and transfer title to those assets to Flint, in exchange for the right to use a portion of the new tower and related building facilities in its operations on a rent-free basis for five years. The lessee has three successive five-year renewal options, providing for no rent in the sixth year, a total of $18,000 rent in the seventh year, and annual increases of 4% beginning with the eighth year.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nFlint has recorded as an advance minimum lease payment an amount equal to the fair value of the tower and antenna constructed for its benefit, based on the lessee's construction costs, aggregating approximately $170,000. The assets received were capitalized, the advance lease payment is being amortized as rental income on a straight-line basis over the five year initial lease term, and the unamortized portion of the lease payment is recorded as deferred rental income.\n4. COMMITMENTS\nThe Company has entered into operating lease agreements for office space and certain equipment. The Company also obtained equipment under capital leases.\nThe following is a schedule of approximate future minimum lease payments required under these leases:\nOperating Capital - ------------------------------------------------------------------------------- 1996 $18,700 $22,527 Less amount representing interest - 1,727 - ------------------------------------------------------------------------------- Present value of net minimum lease payments $18,700 $20,800 ===============================================================================\nRent expense was approximately $32,000, $54,000 and $133,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n5. RETIREMENT PLANS\nEffective January 1, 1995, the Company established a qualified salary reduction plan under Section 401(k) of the Internal Revenue Code for eligible employees. Under the plan, the Company may, but is not required to, make matching and discretionary contributions to participants' accounts. Matching contributions charged against operations amounted to $4,600 for the year ended December 31, 1995.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\n6. STOCK OPTION PLAN\nThe Company has a stock option plan (the \"Plan\") under which 900,000 shares of common stock have been reserved for issuance. Under this Plan, the Company may grant options to purchase up to 900,000 shares of common stock in the form of either nonqualified stock options or incentive stock options (\"ISOs\"). The Plan provides that the option price for the nonqualified options be determined by the Board of Directors at or prior to the time the option is granted (but in no event at a price below par value of the common stock) and for ISOs, at a price not less than 100% of the fair market value of the common stock at the date the option is granted, except for those individuals possessing more than 10% of the total combined voting power of all classes of stock of the Company or its subsidiaries, for which the price is not less than 110% of the fair market value of the common stock.\nThe term of each option granted shall be determined by the Board of Directors, provided that the term for each ISO granted under the Plan not be more than 10 years from the date of the grant and the term for each option granted to an individual owning more than 10% of the combined voting power, as described above, not be more than five years.\nUnder the terms of the Plan, the Company's right to grant additional ISOs terminated September 18, 1994, ten years from the date the Plan was adopted by the Company's Board of Directors.\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\nTransactions involving options granted under the Plan are summarized below:\nOf the 800,000 options outstanding at December 31, 1995, 589,318 are nonqualified options and 210,682 are ISOs.\n7. COMMON STOCK SHARES RESERVED\nAt December 31, 1995, shares of the Company's authorized and unissued common stock were reserved for issuance upon conversion of a subordinated senior convertible note and exercise of options, as follows:\nSubordinated senior convertible note (Note 2 (c)) 9,081,502\nStock option plan (Note 6) 900,000 - ----------------------------------------------------------------------------- 9,981,502 =============================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n===============================================================================\n8. SALE OF CHARLESTON RADIO STATION\nIn September 1993, Charleston exchanged substantially all of its assets for another station, which was then sold by Charleston. The aggregate consideration received by Charleston for the exchange and sale was $1,125,000, of which $813,500 was used to repay a portion of Charleston's existing revolving credit\/term loan and accrued interest. The Charleston Preferred Stock was extinguished because there were no funds for payment to the Charleston preferred stockholder available from the sale of Charleston. All funds derived by Charleston from the exchange and sale were disbursed to secured and judgment creditors of Charleston in February 1994, and Charleston was subsequently dissolved in the same month. The remaining balance of $3,180,564 of the revolving credit\/term loan, after giving effect to accrued interest through the date of fund disbursement and payment of $825,000 in reduction of the loan, became a subordinated secured claim against the assets of Flint and Southampton, payable if Flint or Southampton was sold. As the proceeds of the 1994 sale of Southampton were insufficient to satisfy this claim, the entire liability was recorded by Flint. In December 1994, this claim was purchased from the Resolution Trust Corporation by Flint's senior lender and recast as senior secured indebtedness of Flint at a discount from its face value, resulting in an extraordinary gain of approximately $787,000 (see Notes 2 (b) and 11).\nThe operations of the Charleston subsidiary prior to the sale of the radio station were included in the statement of operations for 1993 and the sale resulted in a gain of $504,356. The Charleston operations which were included in the 1993 statement of operations are summarized as follows:\nNet broadcasting revenues $ 515,000 Total operating expenses 1,062,000 - --------------------------------------------------------------------------- Loss from operations (547,000) Interest expense (8,000) Gain from sale of station 504,000 Other expenses (34,000) - --------------------------------------------------------------------------- Loss before preferred stock dividend requirement and extraordinary item (85,000) Preferred stock dividend requirement (738,000) Extraordinary item - gain from troubled debt restructuring 396,000 - --------------------------------------------------------------------------- Net loss $ (427,000) ===========================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\nThe gain from sale of the Charleston radio station was calculated as follows:\nProceeds from sale of station $1,125,000 Net assets sold: Broadcasting property, net $101,000 Intangible assets 877,000 (978,000) - ---------------------------------------------------------------------- 147,000 Other expenses (10,000) Write-off of remaining liabilities 367,000 - ---------------------------------------------------------------------- Gain from sale of station $ 504,000 ======================================================================\n9. SALE OF SOUTHAMPTON RADIO STATION\nIn January 1994, Southampton entered into a contract to sell substantially all of its assets. The Southampton Preferred Stock was extinguished because there were no funds for payment to the Southampton preferred stockholder available from the sale of Southampton.\nThe operations of the Southampton subsidiary prior to the sale of the radio station, which closed in August 1994, were included in the statement of operations for 1994 and the sale resulted in a gain of $964,859. The Southampton operations which were included in the statement of operations are summarized as follows:\nNet broadcasting revenues $269,000\nTotal operating expenses 165,000 - -------------------------------------------------------------------------------- Income from operations 104,000\nInterest expense (122,000)\nGain from sale of station 965,000\nOther income 10,000 - -------------------------------------------------------------------------------- Income before preferred stock dividend requirement and taxes on income 957,000\nPreferred stock dividend requirement (149,000)\nTaxes on income (39,000) - -------------------------------------------------------------------------------- Net income $769,000 ================================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\nThe gain from sale of the Southampton radio station is calculated as follows:\nProceeds from sale of station $1,700,000 Net assets sold:\nBroadcasting property, net $272,000 Intangible assets 407,000 (679,000) - -------------------------------------------------------------------------------- 1,021,000 Capital lease assumed by buyer 44,000 Other expenses (86,000) Write-off of remaining assets (14,000) - -------------------------------------------------------------------------------- Gain from sale of station $ 965,000 ================================================================================\n10. TAXES ON INCOME\nThe provision for federal and state income taxes consists of the following:\n1995 1994 1993 - -------------------------------------------------------------------------------- Current: Federal $157,000 $1,021,000 $ 765,000 State 70,000 97,156 323,747 - -------------------------------------------------------------------------------- 227,000 1,118,156 1,088,747 Benefits of net operating loss carryforwards 199,000 980,000 1,055,000 - -------------------------------------------------------------------------------- $ 28,000 $ 138,156 $ 33,747 ================================================================================\nThe net deferred tax asset consists of the following:\n1995 1994 - -------------------------------------------------------------------------------- Gross deferred asset for: Net operating loss carryforwards $ 2,502,000 $2,800,000 Excess gain on debt restructuring for tax reporting purposes 274,000 303,000 Alternative minimum tax credit carryforwards 35,000 87,000 - -------------------------------------------------------------------------------- Subtotal 2,811,000 3,190,000 Less: valuation allowance (2,811,000) (3,190,000) - -------------------------------------------------------------------------------- Net $ - $ - ================================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\nThe Company has provided valuation allowances equal to its deferred tax assets because of the uncertainty as to future utilization.\nThe Company and Flint file consolidated federal and separate state income tax returns. At December 31, 1995, consolidated net operating loss carryforwards (\"NOL's\") for income tax purposes were $6,950,000. The tax NOL's expire during the years 1999 to 2008.\nThe difference between the Company's effective tax rate on income (loss) before taxes on income and extraordinary item and the federal statutory tax rate arises from the following:\n(As restated) 1995 (Note 2(d)) 1993 - ------------------------------------------------------------------------------- Federal tax expense (benefit) at statutory rate 34.0% 34.0% (34.0)%\nOperating losses which did not provide a tax benefit - - 34.0%\nFederal taxes, based on alternative minimum calculation 1.8% 7.7% -\nNon-deductible expenses 47.6% 26.7% -\nBenefit of net operating losses (72.8)% (61.9)% -\nState taxes, net of federal benefit 16.9% 5.7% 4.4%\nPrior year's federal tax overaccrual (17.2)% - - - ------------------------------------------------------------------------------- Effective tax rate 10.3% 12.2% 4.4% ===============================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n11. GAIN FROM TROUBLED DEBT RESTRUCTURING\nGain from troubled debt restructuring consists of the following:\n1995 1994 1993 - -------------------------------------------------------------------------------- Gain from restructuring of subordinated secured claim (see Note 2 (b)) $ - $787,201 $ -\nGain from restructuring of subordinated note (see (a) below) - - 2,820,888\nGain from restructuring of revolving credit\/term loan agreement (see (b) below) - - 395,717 - ------------------------------------------------------------------------------- $ - $787,201 $3,216,605 ===============================================================================\n(a) In 1993, the Company paid $100,000 to settle in full both the principal of $2,000,000 and the accrued interest of $920,888 on a note payable to Price Communications Corporation that had arisen from 1986 borrowings. As a result, the Company recognized a gain of $2,820,888 from this troubled debt restructuring.\n(b) In 1993, as a result of the sale of the Charleston station, the remaining balance of a credit\/term loan agreement became a subordinated secured claim against the assets of Flint and Southampton, payable if Flint or Southampton were sold (see Notes 8 and 9). The remaining estimated interest payable was reversed and resulted in a gain of $395,717 from this troubled debt restructuring.\n12. SUPPLEMENTAL CASH FLOW INFORMATION\n(a) Supplemental disclosure of cash flow information:\nYear ended December 31, 1995 1994 1993 - ------------------------------------------------------------------------------- Interest paid during the year $873,276 $788,746 $890,736 =============================================================================== Income taxes paid during the year $133,257 $ 15,429 $ 35,131 ===============================================================================\nFAIRCOM INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n(b) Supplemental disclosures of non-cash investing and financing activities:\nIn December 1994, the subordinated claim against Flint of $1,899,555 and a related stock option were extinguished and exchanged as partial consideration for the Company's $181,630 subordinated senior convertible note. The difference of $1,717,925 was credited against deficit (see Note 2 (c)). In December 1994, the former Southampton Preferred Stock and a related stock conversion right were extinguished and exchanged as partial consideration for the above-mentioned convertible note (see Note 2 (c)).\nIn December 1994, the Company issued a $500,000 subordinated senior exchangeable note in exchange for the extinguishment of CVC's appraisal right to Flint, valued at $350,000, and the extinguishment of the Company's $150,000 subordinated obligation to CVC (see Note 2 (d)).\nIn December 1994, a $3,180,564 subordinated secured claim against Flint was acquired by Flint's senior lender from the Resolution Trust Corporation, reduced to $1,600,000, and recast as senior secured indebtedness of Flint, resulting in an extraordinary gain of $787,201 (see Notes 2 (b), 8 and 11).\nIn January 1995, Flint received a tower and antenna, valued at $170,000, as an advance lease payment under the terms of an operating lease agreement (see Note 3).\nFAIRCOM INC.\n================================================================================\nCONSOLIDATED FINANCIAL STATEMENT SCHEDULES Form 10-K Item 14(d) - December 31, 1995\nS-1\nFAIRCOM INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\n================================================================================\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS S-3\nConsolidated financial statement schedules:\nSchedule I - Condensed financial information of registrant S-4 - S-7\nSchedule II - Valuation and qualifying accounts S-8\nS-2\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Stockholders Faircom Inc.\nThe audits referred to in our report dated January 16, 1996, relating to the consolidated financial statements of Faircom Inc., 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 these financial statement schedules based upon our audits.\nIn our opinion such financial statement schedules present fairly, in all material respects, the information set forth therein.\nS\/BDO Seidman, LLP ------------------ BDO Seidman, LLP\nMitchel Field, New York January 16, 1996\nS-3\nFAIRCOM INC.\nSCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS (COMPANY ONLY)\n================================================================================\nS-4\nFAIRCOM INC.\nSCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS (COMPANY ONLY)\n================================================================================\nS-5\nFAIRCOM INC.\nSCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (COMPANY ONLY)\n================================================================================\nS-6\nFAIRCOM INC.\nSCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT\n================================================================================\n1. INVESTMENTS IN SUBSIDIARIES\nThe financial statements account for the Company's investment in its subsidiaries on the equity method of accounting and have been prepared for the purpose of presenting the financial position and operating results of the Company as a separate entity. The Company has also prepared consolidated financial statements of the Company and its subsidiaries which represent the primary financial statements.\n2. NOTE RECEIVABLE FROM SUBSIDIARY\nIn connection with the Company's borrowing of $2,000,000 from Price Communications Corporation (\"Price\") (see Note 4 below), the Company advanced $2,000,000 to Flint in exchange for Flint's 14% exchangeable subordinated note (\"Note\"), which is due January 31, 1997. The Note was pledged to Citicorp Venture Capital, Ltd. (\"CVC\") in connection with CVC's guaranty of interest payments on the Price note. In connection with a securities exchange agreement entered into in December 1994 by the Company and Flint with CVC, the pledge of the Note was cancelled and all rights and claims of CVC with respect to the Note were extinguished. At December 31, 1995 and 1994, the principal balance of the Note was $1,243,000.\n3. MANAGEMENT FEES\nThe Company received $354,328, $335,000 and $373,155 from its subsidiaries for management and administrative services for the years ended December 31, 1995, 1994, and 1993, respectively.\n4. EXTRAORDINARY ITEM\nOn December 31, 1986, the Company borrowed $2,000,000 from Price in the form of a 14% Subordinated Note. Such note was due on January 31, 1990 and was extended to August 1, 1990. Interest was payable quarterly commencing on March 31, 1987.\nInterest installments on such note through January 31, 1990 were guaranteed by CVC.\nIn 1993, the Company paid $100,000 to settle in full both the Price note and the accrued interest of $920,888 on the note. As a result, the Company recognized an extraordinary gain of $2,820,888 from troubled debt restructuring.\nS-7\nFAIRCOM INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n================================================================================\n(*) Represents accounts written off against the reserve.\nS-8\nEXHIBIT INDEX\nExhibit No. Description - ---------- -----------\n*3.1 Certificate of Incorporation, as amended.\n*3.2 By-Laws of the Company.\n11.1 Computation of Net Income (Loss) Per Common Share.\n*21 Subsidiaries of the registrant.\n27 Financial Data Schedule.\n- --------------------\n* Previously filed as an exhibit to the Company's registration of securities on Form 10, dated February 12, 1987, pursuant to Section 12(g) of the Securities Exchange Act of 1934.","section_15":""}
{"filename":"808851_1995.txt","cik":"808851","year":"1995","section_1":"ITEM 1 Business\nStructured Asset Securities Corporation (the \"Company\") was incorporated in Delaware on January 2, 1987 as a limited- purpose finance corporation. All of the outstanding capital stock is owned by Lehman Commercial Paper Inc. (\"LCPI\"), an indirect wholly owned subsidiary of Lehman Brothers Holdings Inc. (\"Holdings\").\nThe Company's activities consist of the issuance and sale of debt securities (the \"Bonds\") collateralized by mortgages and\/or mortgage-backed securities or serving as the depositor for one or more trusts (the \"Trust(s)\") which will issue pass-through certificates representing an undivided interest in such mortgage collateral. The Company may also serve as seller to, depositor of or sponsor for any Trust issuing Pass-through Certificates of interest (including stripped participation interests) in a pool of mortgage collateral or interest therein. The mortgage collateral may consist of \"fully modified pass-through\" mortgage-backed certificates guaranteed as to full and timely payment of principal and interest by the Government National Mortgage Association, which guaranty is backed by the full faith and credit of the United States Government, mortgage participation certificates issued and guaranteed as to the full and timely payment of interest and ultimate payment of principal by the Federal Home Loan Mortgage Corporation, guaranteed mortgage pass-through certificates issued and guaranteed as to the full and timely payment of principal and interest by the Federal National Mortgage Association, conventional mortgage pass-through certificates or mortgage-backed bonds issued with respect to or secured by a pool of mortgage loans, or a combination of such certificates.\nThe Company has filed registration statements on Form S-3 with the Securities and Exchange Commission (\"the Commission\") which permit the Company to issue from time to time, Bonds and Pass-through Certificates in the principal amount not to exceed $11.7 billion. The Company has also filed registration statements on Form S-3 for the issuance of $6 billion principal amount of Bonds. As of November 30, 1995, approximately $11.4 billion was available for issuance under the registration statements referred to above.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 Properties\nThe Company owns no physical properties.\nITEM 3","section_3":"ITEM 3 Legal Proceedings\nThere are no pending legal proceedings.\nITEM 4","section_4":"ITEM 4 Submission of Matters to a Vote of Security Holders\nPursuant to General Instruction J of Form 10-K, the information required by Item 4 is omitted.\nPART II\nITEM 5","section_5":"ITEM 5 Market for Registrant's Common Stock and Related Stockholder Matters\nThe Company's sole class of capital stock is its $1.00 par value common stock which is all owned by LCPI. There is no public market for the Company's common stock.\nITEM 6","section_6":"ITEM 6 Selected Financial Data\nPursuant to General Instruction J of Form 10-K, the information required by Item 6 is omitted.\nITEM 7","section_7":"ITEM 7 Management's Discussion and Analysis of Financial Condition and Liquidity and Capital Resources and Results of Operations\nSet forth below is management's discussion and analysis of financial condition and liquidity and capital resources and results of operations for the twelve months ended November 30, 1995, the eleven months ended November 30, 1994 and the twelve months ended December 31, 1993.\nFinancial Condition and Liquidity and Capital Resources\nThe Company's assets increased from $18.2 million at November 30, 1994 to $153.0 million at November 30, 1995 primarily related to the increase in financial instruments owned. Financial instruments owned at November 30, 1995 aggregated $146.0 million and represent the portion of issued securities retained by the Company and are carried at market or fair value, as appropriate.\nStockholder's equity increased from $9.0 million at November 30, 1994 to $149.0 million at November 30, 1995 as a result of net capital contributions from LCPI and income earned during the twelve months ended November 30, 1995. Capital contributions from LCPI are made to fund securities retained by the Company from new issuances. The Company continually monitors its capital position and makes capital distributions to LCPI as excess funds are realized from securities related transactions.\nResults of Operations\nFor the twelve months ended November 30, 1995 and eleven months ended November 30, 1994:\nDuring the twelve months ended November 30, 1995 the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-C1 totaling approximately $394.3 million principal amount, Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-3 totaling approximately $99.5 million principal amount, Structured Asset Securities Corporation Mortgage Pass-through Certificates, Series 1995-1 totaling approximately $73.2 million principal amount, Structured Asset Securities Corporation Mortgage Pass-through Certificates, Series 1995-2, Group II, totaling approximately $74.1 million principal amount, Structured Asset\nITEM 7 Management's Discussion and Analysis of Financial Condition and Liquidity and Capital Resources and Results of Operations (continued)\nSecurities Corporation Mortgage Pass-through Certificates, Series 1995-2, Group I, totaling approximately $174.2 million principal amount, LB Commercial Conduit Mortgage Trust Multiclass Pass-through Certificates, Series 1995-C2 totaling approximately $217.0 million principal amount, and Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-C4 totaling approximately $179.6 million principal amount. In addition, the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-C3 totaling approximately $322.8 million principal amount in a private placement.\nTrading revenues totaled $9,579,548 for the twelve months ended November 30, 1995 and $7,674,075 for the eleven months ended November 30, 1994. Trading revenues are attributable to the issuance and sale of securities and valuing financial instruments owned at market or fair value.\nInterest income increased from $5,868,153 during the eleven months ended November 30, 1994 to $11,998,933 during the twelve months ended November 30, 1995, attributable principally to the greater amount of interest earning securities held during 1995. Management fees increased from $3,395,253 during the eleven months ended November 30, 1994 to $5,407,152 during the twelve months ended November 30, 1995, reflecting the increased trading and operating activities of the Company. Management fees are the principal component of general and administrative expenses in the accompanying Statements of Operations.\nFor the eleven months ended November 30, 1994 and twelve months ended December 31, 1993:\nDuring 1994, the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1994-C1 totaling approximately $421.9 million principal amount, of which approximately $333.3 million principal amount were offered pursuant to one of the Company's public registration statements and $88.6 million principal amount were offered in private placements. During 1993, the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1993-C1 totaling approximately $451.0 million principal amount. In addition, Structured Asset Securities Corporation Trust III, a trust established by the Company, issued Collateralized Mortgage Obligations, Series 1993-C2 totaling approximately $121.3 million principal amount. Also during 1993, the Company issued, through a trust, $79.3 million of securities, collateralized by a mortgage, in a private placement. In December 1992, the Company purchased a 25% partnership interest in Structured Asset Securities Corporation Trust II (\"Trust II\"). The Company acted as general partner of Trust II. An affiliate of the Company owned the remaining 75% as limited partner. On May 28, 1993, Trust II's assets were sold to an affiliate of the Company at current market value. For financial reporting purposes, the assets of Trust II have been consolidated with those of the Company and minority interest has been established for the affiliate's limited partner interest.\nITEM 7 Management's Discussion and Analysis of Financial Condition and Liquidity and Capital Resources and Results of Operations (continued)\nTrading revenues totaled $7,674,075 for the eleven months ended November 30, 1994 and $419,283 for the twelve months ended December 31, 1993. Trading revenues are attributable to the issuance and sale of securities and valuing financial instruments owned at market or fair value.\nInterest income decreased from $8,611,171 during the twelve months ended December 31, 1993 to $5,868,153 during the eleven months ended November 30, 1994, attributable principally to the sale of interest earning securities owned during the second quarter of 1994. Management fees increased from $1,196,023 during the twelve months ended December 31, 1993 to $3,395,253 during the eleven months ended November 30, 1994, reflecting the increased trading and operating activities of the Company. Management fees are the principal component of general and administrative expenses in the accompanying Statements of Operations.\nITEM 8","section_7A":"","section_8":"ITEM 8 Financial Statements and Supplementary Data\nThe financial statements required by this Item and included in this Report are referenced in the index appearing 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\nPursuant to General Instruction J of Form 10-K, the information required by Item 10 is omitted.\nITEM 11","section_11":"ITEM 11 Executive Compensation\nPursuant to General Instruction J of Form 10-K, the information required by Item 11 is omitted.\nITEM 12","section_12":"ITEM 12 Security Ownership of Certain Beneficial Owners and Management\nPursuant to General Instruction J of Form 10-K, the information required by Item 12 is omitted.\nITEM 13","section_13":"ITEM 13 Certain Relationships and Related Transactions\nPursuant to General Instruction J of Form 10-K, the information required by Item 13 is omitted.\nPART IV\nITEM 14","section_14":"ITEM 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) and (2) Financial Statements and Schedules\nSee Index to Financial Statements appearing on Page\n(3) Exhibits\nNot applicable.\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.\nSTRUCTURED ASSET SECURITIES CORPORATION (Registrant)\nBy: THEODORE P. JANULIS Theodore P. Janulis President\nDate: February 23, 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 .................... POSITION DATE\nTHEODORE P. JANULIS .......... President February 23, 1996 Theodore P. Janulis\nDAVID GOLDFARB ............... Controller February 23, 1996 David Goldfarb\nBRIAN R. ZIPP ................ Director February 23, 1996 Brian R. Zipp\nMICHAEL J. O'HANLON .......... Chairman and Director February 23, 1996 Michael J. O'Hanlon\nSTRUCTURED ASSET SECURITIES CORPORATION\nNOTES to FINANCIAL STATEMENTS\nReport of Independent Auditors .......................................\nStatements of Operations for the twelve months ended November 30, 1995, eleven months ended November 30, 1994 and twelve months ended December 31, 1993 ..................................................\nStatements of Financial Condition as of November 30, 1995 and 1994 .........................................\nStatements of Changes in Stockholder's Equity for the twelve months ended November 30, 1995, eleven months ended November 30, 1994 and twelve months ended December 31, 1993 ..............................\nStatements of Cash Flows for the twelve months ended November 30, 1995, eleven months ended November 30, 1994 and twelve months ended December 31, 1993 ..................................................\nNotes to Financial Statements ................................. to\nConsent of Independent Auditors ......................................\nReport of Independent Auditors\nThe Board of Directors and Stockholder of Structured Asset Securities Corporation\nWe have audited the accompanying statements of financial condition of Structured Asset Securities Corporation as of November 30, 1995 and November 30, 1994, and the related statements of operations, changes in stockholder's equity and cash flows for the year ended November 30, 1995, for the eleven-month period ended November 30, 1994 and 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 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 Structured Asset Securities Corporation at November 30, 1995 and November 30, 1994, and the results of its operations and its cash flows for the year ended November 30, 1995, for the eleven month period ended November 30, 1994 and for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nJanuary 10, 1996\nSTRUCTURED ASSET SECURITIES CORPORATION STATEMENTS of OPERATIONS\nSee notes to financial statements\nSTRUCTURED ASSET SECURITIES CORPORATION STATEMENTS of FINANCIAL CONDITION\nASSETS\nSee notes to financial statements\nSee notes to financial statements.\nSee notes to financial statements\nSTRUCTURED ASSET SECURITIES CORPORATION\nNOTES to FINANCIAL STATEMENTS\n1. Organization:\nStructured Asset Securities Corporation (\"the Company\") is a limited-purpose finance corporation. All of the outstanding capital stock is owned by Lehman Commercial Paper Inc.(\"LCPI\"), an indirect wholly owned subsidiary of Lehman Brothers Holdings Inc. (\"Holdings\").\nThe Company's activities consist of the issuance and sale of debt securities (the \"Bonds\") collateralized by mortgages and\/or mortgage-backed securities or serving as the depositor for one or more trusts (the \"Trust(s)\") which will issue Pass-through Certificates, representing an undivided interest in such mortgage collateral.\nThe Company has filed registration statements on Form S-3 with the Securities and Exchange Commission which permit the Company to issue, from time to time, Bonds and Pass-through Certificates in principal amount not to exceed $11.7 billion. The Company has also filed registration statements on Form S-3 for the issuance of $6 billion principal amount of Bonds. During the twelve months ended November 30, 1995, the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-C1 totaling approximately $394.3 million principal amount, Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-3 totaling approximately $99.5 million principal amount, Structured Asset Securities Corporation Mortgage Pass-through Certificates, Series 1995-1 totaling approximately $73.2 million principal amount, Structured Asset Securities Corporation Mortgage Pass-through Certificates, Series 1995-2, Group II, totaling approximately $74.1 million principal amount, Structured Asset Securities Corporation Mortgage Pass-through Certificates, Series 1995-2, Group I, totaling approximately $174.2 million principal amount, LB Commercial Conduit Mortgage Trust Multiclass Pass-through Certificates, Series 1995-C2 totaling approximately $217.0 million principal amount, and Multiclass Pass-through Certificates, Series 1995-C4 totaling approximately $179.6 million principal amount. In addition, the Company issued Structured Asset Securities Corporation Multiclass Pass-through Certificates, Series 1995-C3 totaling approximately $322.8 million principal amount in a private placement. As of November 30, 1995, approximately $11.4 billion was available for issuance under the registration statements referred to above.\nThe Company has issued Bonds and acted as depositor for various Trusts which have issued Pass-through Certificates collateralized by mortgages and\/or mortgage securities. The Company has surrendered to the Trusts all future economic interests in the Bonds, Pass-through Certificates and related collateral. According to the terms of the various Trust agreements, the security holders can look only to the related collateral for repayment of both principal and interest. In accordance with generally accepted accounting principles, the Bonds, Pass-through Certificates, and related collateral have been removed from the accompanying Statements of Financial Condition.\nDuring the twelve months ended November 30, 1995, LCPI contributed $234.3 million in capital to the Company, and the Company made capital distributions to LCPI of $102.9 million.\nThe December 31, 1993 Statement of Operations includes the consolidated accounts of the Company and those of Structured Asset Securities Corporation Trust II (\"Trust II\"), a partnership in which the Company had a 25% ownership interest and acted as general partner. An affiliate of the Company owned the remaining 75% interest in Trust II as a limited partner. On May 28,\n1. Organization (continued):\n1993, Trust II's assets, which primarily consisted of approximately $99 million in mortgage loans, were sold to an affiliate of the Company at current market value. The accompanying December 31, 1993 Statement of Operations reflects the affiliate's minority interest share in earnings in Trust II.\n2. Summary of Significant Accounting Policies:\nDeferred registration costs:\nDeferred registration costs relate to filing fees and other related costs paid by the Company in connection with filings for the registration of the securities which were or are to be issued by the Company. These costs are deferred in anticipation of future revenues upon the issuance of securities from the respective shelf that has been established. Amortization of the costs is based upon the percentage of issued securities to the respective shelf from which the securities are issued and is included as a component of trading revenue in the Statements of Operations.\nFinancial instruments owned, at fair value:\nFinancial instruments owned principally represent subordinated interests in pools of mortgage loans, with the remaining instruments representing the right to receive certain future interest payments on the underlying loans. Financial instruments owned are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in trading revenue in the Statements of Operations. Market value is generally based on listed market prices. If listed market prices are not available, fair value is determined based on other relevant factors, including broker or dealer price quotations, and valuation pricing models which take into account time value and volatility factors underlying the financial instruments.\nAll securities transactions are recorded in the accompanying financial statements on a trade date basis.\nIncome taxes:\nThe Company is included in the consolidated U.S. federal income tax return of Holdings and in combined state and local returns with other affiliates of Holdings. The Company computes its income tax provision on a separate return basis in accordance with the terms of a tax allocation agreement between Holdings and its subsidiaries. The income tax provision is greater than that calculated by applying the statutory federal income tax rate principally due to state and local taxes.\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. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates.\n3. Investment in Collateralized Mortgage Obligation Trusts:\nThe investment consists of seventeen $10 deposits made with an owner trustee to establish the Trusts pursuant to deposit trust agreements.\n4. Related Party Transactions:\nIn connection with the Company's activities, mortgage collateral is purchased from and recorded at an affiliate's carrying value, which for such broker\/dealer affiliates represents market value.\nCertain directors and officers of the Company are also directors and officers of Lehman Brothers Inc., LCPI and\/or other affiliates of the Company.\nPursuant to a management agreement (the \"Agreement\"), the Company is charged a management fee for various services rendered on its behalf by LCPI. The Agreement provides for an allocation of costs based upon the level of activity processed by LCPI on behalf of the Company. Management fees of $5,407,152 for the twelve months ended November 30, 1995, $3,395,253 for the eleven months ended November 30, 1994 and $1,196,023 for the twelve months ended December 31, 1993 are the principal component of general and administrative expenses in the Statements of Operations. The Agreement is renewable each year unless expressly terminated or renegotiated by the parties.\nCompensation expense represents amounts allocated to the Company by LCPI for compensation paid to certain common officers and directors of the Company.\nIncome taxes of $15,854,753 were paid by the Company to LCPI in accordance with the terms of the Company's tax allocation agreement during the twelve months ended November 30, 1995. No income taxes were paid by the Company during 1994 and 1993.\nThe Company believes that amounts arising through related party transactions, including the fees referred to above, are reasonable and approximate the amounts that would have been recorded if the Company operated as an unaffiliated entity.\n5. Financial Instruments with Off-Balance Sheet Risk and Concentration of Credit Risk:\nCertain of the Company's activities are principally conducted with financial institutions. At November 30, 1995, the Company had no material individual counterparty concentration of credit risk, or any financial instruments with off-balance sheet risk.\n6. Fair Value of Financial Instruments:\nStatement of Financial Accounting Standards (SFAS) No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of the fair values of most on- and off-balance sheet financial instruments, for which it is practicable to estimate that fair value. The scope of SFAS No. 107 excludes certain financial instruments, such as trade receivables and payables when the carrying value approximates the fair value, employee benefit obligations and all non-financial instruments, such as fixed assets. The fair value of the Company's assets and liabilities which\n6. Fair Value of Financial Instruments (continued):\nqualify as financial instruments under SFAS No. 107 approximate the carrying amounts presented in the Statements of Financial Condition.\nFinancial instruments owned principally represent subordinated interests in pools of mortgage loans, with the remaining instruments representing the right to receive certain future interest payments on the underlying loans. These financial instruments are generally non-rated or rated as non-investment grade by recognized rating agencies. Changes in interest rates could potentially have an adverse impact on the future cash flows for financial instruments owned. In addition, for certain securities, defaults on the mortgage loans underlying these instruments could have a greater than proportional impact on their fair value since the payments of principal and interest are subordinate to other securities issued in the same series. These risks, among other risks, are incorporated in the determination of fair value of financial instruments owned.\n7. Change of Fiscal Year-End:\nDuring 1994, the Company changed its fiscal year-end from December 31 to November 30. Such a change to a non-calendar cycle shifts certain year-end administrative activities to a time period that conflicts less with the business needs of institutional customers.\nThe following is selected financial data for the eleven-month transition period ending November 30 and the comparable prior year period:\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Form S-11 Nos. 33-11126, 33-13826, 33-31337, 33-13986, 33-17503 and 33-48771 and Form S-3 File Nos. 33-43825 and 33-50210) of Structured Asset Securities Corporation of our report dated January 10, 1996, with respect to the financial statements of Structured Asset Securities Corporation included in this Annual Report (Form 10-K) for the year ended November 30, 1995.\nNew York, New York ERNST & YOUNG LLP February 23, 1996","section_15":""}
{"filename":"23657_1995.txt","cik":"23657","year":"1995","section_1":"ITEM 1. BUSINESS General\nCFI Industries, Inc. (the \"Company\" or \"CFI\") , a Delaware corporation, is a fully integrated custom thermoformer of plastic packaging for the hospital\/medical, consumer products, electronics and cosmetics markets.\nThe Company designs, markets and manufactures functional and innovative packaging for its customers through its wholly owned subsidiary, Plastofilm Industries, Inc. (\"Plastofilm\"). For a discussion of other operations which the Company sold in prior years see \"Operations Sold in Prior Years\" located elsewhere in this business section.\nThe Company's and Plastofilm's executive offices are located at 935 W. Union Avenue, Wheaton, Illinois 60187 and its telephone number is (708) 668-2838. The Company was organized in 1972.\nOperations\nPlastofilm produces custom thermoformed packaging, point of purchase displays and a variety of disposable packaging products for the hospital\/medical, consumer products, electronics and cosmetics industries. Most applications involve design of custom molds or dies by Plastofilm's design and engineering departments.\nThe Company's primary production process includes the extrusion of purchased plastic resins into roll stock, thermoforming roll stock into finished product and performing various secondary operations such as punching, assembly, sealing and packaging. Production equipment includes extruders and thermoforming machines. A Class 100,000 clean room is maintained for the production of certain medical and electronic packaging products. Support for production include a computer aided design equipment based staff, a production tool design and maintenance shop, and a prototype model shop.\nManufacturing is conducted in two facilities. An owned 120,000 square foot manufacturing facility in Wheaton, Illinois includes four extrusion lines and sixteen thermoforming machines, including the Class 100,000 clean room operation. A leased 40,000 square foot production facility in Sparks, Nevada, started in June, 1992, includes four thermoforming machines.\nPlastofilm has a nation-wide customer base, the majority of which are located in the Midwest and West. A majority of its customers are in the hospital\/medical, consumer products, electronics and cosmetics markets. Plastofilm markets its products primarily through its own national sales force who are supported by the design and product development team and the customer service organization located in Wheaton, Illinois. The Sparks, Nevada facility products for the West Coast market and allows Plastofilm to more effectively compete against other West Coast plastic thermoformers. Expansion of this Strategy will be evaluated in 1996 to include production facilities in Texas and Puerto Rico to meet the growing business opportunities in these regions.\nPlastofilm's customers are continuing to become more directed to oversee product development. To serve this product migration the Company is pursuing the establishment of production capability in Ireland. This facility will support sales to the entire European Economic Community.\nDuring fiscal years 1995, 1994 and 1993, sales to Baxter International, Inc. and its affiliates accounted for approximately 17%, 16% and 12%, respectively, of the total net sales of the Company.\nPlastofilm purchases its raw material in roll stock and pellet form from several suppliers and an adequate supply of raw material is available. Plastofilm also recycles most of its scrap plastic by regrinding and reprocessing it. During fiscal 1995 and 1994, the Company experienced price increases for its purchased plastic resins. In accordance with its standard selling terms and conditions, the Company has increased the price of its products to reflect this increased cost.\nOperations Sold in Prior Years\nFrom June 1989 to April 1991, the Company also manufactured thermoformed packaging products for the food service industry through its indirect wholly owned subsidiary, Form-Fit, Inc. (\"Form-Fit\"), which was acquired June 8, 1989. On April 15, 1991, the Company sold 100% of the capital stock of Form-Fit to Detroit Forming, Inc. (\"Detroit Forming\") and entered into a noncompetition agreement with Detroit Forming for an aggregate purchase price of $3.9 million.\nCompetition\nPlastofilm operates in a highly competitive industry. The Company estimates that there are approximately 750 companies engaged in the production of thermoformed plastic packaging, the great majority of which are smaller than Plastofilm. The Company believes its principal competitive strengths include its design abilities, its manufacturing facilities and equipment, a reputation for quality thermoforming derived from more than 50 years in the plastic thermoforming industry and its in-house extrusion capabilities which allow it to maximize material utilization and provide rapid response time to customer requirements.\nGovernment Regulation\nThe Company's plastic thermoforming operations are not subject to any comprehensive federal laws or regulations which relate specifically to such activities. However, in the past ten years, certain municipalities have passed laws which regulate the chemical properties (such as recyclability or biodegradability) of plastic packaging products. To date, these laws have not had any adverse affect on the Company's operations.\nBacklog\nOrder backlog for thermoformed plastic products was approximately $7.1 million at June 30, 1995 and $6.8 million at June 26, 1994.\nEmployees\nAs of June 30, 1995, the Company employed approximately 250 persons. The Company believes that it has good relations with its employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPlastofilm's administrative headquarters and principal manufacturing operations are located in an owned facility in Wheaton, Illinois, a leased warehouse facility in Batavia, Illinois, and a second manufacturing operation, located in leased facilities in Sparks, Nevada, which services customers located on the West Coast. Current plans anticipate additional facilities in Ireland, Puerto Rico and Texas. This expanded operating base will enable the Company to better serve its present base of multinational customers.\nTesting has revealed soil conditions at Plastofilm's Wheaton, Illinois facility which require remediation. During fiscal 1993 the Illinois Environmental Protection Agency (\"IL-EPA\") requested certain additional testing to be performed before approval of the Company's voluntary clean-up plan. These tests were conducted in fiscal 1994 and submitted to the IL-EPA in Fiscal 1995 for approval. The approval of the Company's voluntary clean-up plan is pending. (See Note 10 to the Consolidated Financial Statements.)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the ordinary course of business, the Company and its subsidiaries may from time to time be involved as plaintiffs or defendants in various legal proceedings. It is the opinion of the Company, based in part upon the advice of its counsel, that any lawsuits not provided for in the Consolidated Financial Statements are either without merit, are covered by insurance, or are otherwise of such a nature that their ultimate disposition will not be material in relation to the Company's consolidated results of operations or financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\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 over-the-counter, listed and quoted on the NASDAQ National Market System under the symbol CFIB. The following table sets forth, for the fiscal quarters indicated, the high and low sales prices per share of the Company's common stock:\nThere were approximately 1,900 record holders of the Company's common stock at August 31, 1995.\nThe Company has not paid dividends on its common stock since its organization and has no current intention to pay dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nData for the fiscal year ended June 30, 1995 is not comparable to data for prior years due to:\n1. Operating (Loss) for 1994 excludes non-recurring severance costs of $370,000.\n2. 1992 and 1991 Net (Loss) included a provision for soil remediation of $1.0 million in each year.\n3. 1991 results included the operations of Form-Fit until date of sale (April 15, 1991).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nThe Company manufactures and markets thermoformed plastic products.\nSales of thermoformed plastic products were $31.3 million in fiscal 1995, compared to $28.7 million and $30.2 million in fiscal 1994 and 1993, respectively. The sales increase in fiscal 1995 was a result of increased demand in the medical supply market, the Company's principal market. The sales decrease in fiscal 1994 as compared to fiscal 1993 was a result of depressed conditions in the medical supply market.\nThe gross profit percentage was 25.9% in fiscal 1995, compared to 23.0% and 21.9% in fiscal 1994 and 1993, respectively. The increase in gross profit for fiscal 1995 over 1994 and fiscal 1994 over 1993 was due to reductions in direct labor costs and continued improvements in operating efficiencies.\nSelling expenses were $4.0 million in fiscal 1995, compared to $4.2 million and $4.1 million in fiscal 1994 and 1993, respectively. The decrease in fiscal 1995 as compared to fiscal 1994 and 1993 was primarily due to labor cost reductions.\nGeneral and administrative expenses were $2.3 million, $2.2 million and $2.5 million in fiscal 1995, 1994 and 1993, respectively. The decreases in fiscal 1995 and 1994 as compared to fiscal 1993 were primarily due to reductions in personnel and the impact of cost savings programs.\nOperating income for fiscal 1995 was $1.8 million as compared to losses of $216,000 and $49,000 in fiscal 1994 and 1993, respectively. Included in the operating loss for fiscal 1994 was $370,000 of non-recurring severance costs. The $1.65 million improvement in operating income, after adjustment for the non-recurring severance costs, was a result of increased gross margins due to higher sales volume, increased operating efficiencies and the impact of ongoing cost reduction programs. The reduction in operating losses of $203,000, after adjustment for non-recurring severance costs, for fiscal 1994 as compared to 1993 was a result of increased operating efficiencies.\nNet interest expense was $0.4 million in fiscal 1995 and 1994 compared to $0.2 million in fiscal 1993. The increase in fiscal 1995 and 1994 over 1993 was principally due to higher average debt levels, higher interest rates and reduced cash and marketable securities balances resulting in lower interest income.\nDuring fiscal 1991 soil conditions at Plastofilm's Wheaton, Illinois facility were discovered which need remediation. At June 30, 1991 a pre-tax provision of $1.0 million was recorded for the estimated costs of testing and remediation. Fiscal 1992 expenditures for testing and remediation were approximately $535,000. At June 28, 1992, an additional pre-tax provision of $1.0 million was recorded to reflect the then currently estimated costs to complete the soil remediation. Expenditures during fiscal 1995, 1994 and 1993 were approximately $78,000, $67,000 and $127,000, respectively. During fiscal 1993, the Illinois Environmental Protection Agency requested certain additional testing be performed before approval of the Company's voluntary clean-up plan. These tests were conducted in fiscal 1994 and submitted to the Illinois Environmental Protection Agency in fiscal 1995 for approval. The approval of the Company's voluntary clean-up plan is pending.\nOrder backlog for thermoformed plastic products was $7.1 million at June 30, 1995 as compared to $6.8 million at June 26, 1994 and $7.6 million at June 27, 1993. The decrease in backlog at June 26, 1994 as compared to June 27, 1993 was a reflection of shortening lead times between customer's orders and shipments.\nLiquidity and Capital Resources\nWorking capital and related current ratios are shown in the following table (amounts in thousands):\nWorking capital of $2,073,000 at June 30, 1995 was up $1,804,000 from the prior year end. The increase in net working capital was primarily attributable to a reduction in short-term debt and an increase in deferred tax benefits. Working capital of $269,000 at June 26, 1994 was down $879,000 from the prior year as a result of using short-term debt to finance capital expenditures.\nExpenditures for replacement and refurbishment of property and equipment were $0.9 million in each of the last three fiscal years. Principal expenditures for fiscal 1995 included the upgrade of manufacturing equipment and management information systems. The majority of the fiscal 1995 expenditures were financed through borrowings under Plastofilm's capital expenditure line and operating cash flow. The 1994 and 1993 capital expenditures were financed through draws on Plastofilm's short-term credit facility. As of June 30, 1995, there was $1.7 million available under Plastofilm's short-term credit facility and $0.5 million under Plastofilm's capital expenditure facility. The Company was in compliance with the covenants of its credit agreement.\nPlastofilm's liquidity and capital needs through fiscal 1996 include the anticipated establishment of additional production facilities in east central Texas and Northern Ireland, the upgrade and replacement of existing equipment, as well as to finance the soil remediation expenditures at its Wheaton, Illinois facility. The funds required to finance these items are expected to be provided by operating cash flow, the Company's existing credit facilities grants which are expected to be made available from the Industrial Development Board of Northern Ireland and\/or from other credit facilities which may become available to the Company.\nThe Company has received a demand for payment of withdrawal liability in the amount of approximately $360,000 from a multi-employer pension plan to which the Company made contributions in connection with a discontinued business. The Company disputes that it has any withdrawal liability to the plan and, in accordance with the applicable provisions of the Employee Retirement Income Security Act, has demanded that this dispute be resolved through arbitration. The Company is making quarterly contributions of approximately $10,000 as required by law pending arbitration. Through June 30, 1995, the Company has made payments of approximately $95,000. These payments will be returned to the Company, with interest, if it is ultimately determined that the Company has no liability.\nThe Company, in connection with a discontinued business, has been named by the United States Environmental Protection Agency (\"US-EPA\") as a potentially responsible party in a Superfund Proceeding. The US-EPA has determined the Company to be a de minimus contributor and has offered a settlement agreement to all de minimus parties. The Company has accepted the settlement agreement which will require total payments of $80,586, which will be made in two equal installments on January 16, 1996 and July 16, 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll other schedules have been omitted because they are inapplicable, not required or the information is included in the financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF CFI INDUSTRIES, INC. WHEATON, ILLINOIS\nWe have audited the accompanying consolidated balance sheets of CFI Industries, Inc. and subsidiaries as of June 30, 1995 and June 26, 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. 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 CFI Industries, Inc. and subsidiaries at June 30, 1995 and June 26, 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 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 Chicago, Illinois August 23, 1995\nCFI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 1995 AND JUNE 26, 1994 (AMOUNTS IN THOUSANDS, EXCEPT COMMON SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCFI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1995, JUNE 26, 1994 AND JUNE 27, 1993 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCFI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, 1995, JUNE 26, 1994 AND JUNE 27, 1993 (AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCFI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 1995, JUNE 26, 1994 AND JUNE 27, 1993 (AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCFI INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1995, JUNE 26, 1994 AND JUNE 27, 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFISCAL YEAR -- The Company's fiscal year ends on the last day in June. Prior to fiscal 1995 the Company's fiscal year ended the last Sunday in June.\nPRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of CFI Industries, Inc. and subsidiaries (the \"Company\" or \"CFI\"). All significant intercompany accounts and transactions have been eliminated.\nMARKETABLE SECURITIES -- Marketable securities, which were carried at the lower of cost or market, consisted of a mutual fund invested primarily in 100% government backed mortgage securities. Unrealized losses on such securities in fiscal 1994 of $77,000 were offset against interest income.\nREVENUE RECOGNITION -- Revenue from product sales is recognized at the time the product is shipped.\nINVENTORIES -- Inventories, which consist of roll stock and pelletized or thermoformed plastics, are carried at the lower of cost or net realizable value using the first-in, first-out or weighted average cost methods. Cost includes raw material, labor and manufacturing overhead.\nInventories at June 30, 1995 and June 26, 1994 consisted of the following (amounts in thousands):\nDEPRECIATION -- Depreciation for financial reporting purposes is provided by using the straight-line method based upon the estimated useful lives of the assets as follows: buildings, 10 to 40 years; equipment, 3 to 20 years; and furniture and fixtures, 4 to 10 years.\nINTANGIBLE ASSETS -- Intangible assets consist of goodwill, the cost in excess of net asset value of an acquired business, which is being amortized on a straight-line basis over a period of 40 years. The Company reviews the recoverability of goodwill based upon anticipated future operating results, on a nondiscounted basis, of the acquired business compared with the scheduled goodwill amortization.\nCALCULATION OF NET INCOME (LOSS) PER COMMON SHARE -- The number of shares used in the net income (loss) per common share calculation is the weighted average number of shares of common stock and common stock equivalents outstanding during each period. Common stock equivalents, in the form of stock options, have been included in the fiscal 1995 calculation of weighted average shares outstanding using the treasury stock method. There were no common stock equivalents included in the calculation of net loss per common share for fiscal 1994 and 1993 as outstanding options were antidilutive during such periods.\nSTATEMENTS OF CASH FLOWS -- For purposes of the Statements of Cash Flows, the Company considers all highly liquid investment instruments purchased with a maturity of three months or less to be cash equivalents.\n2. TRANSACTIONS WITH RELATED PARTIES\nFor fiscal 1995, 1994 and 1993, the Company paid $23,000, $32,000 and $20,000, respectively, for legal services rendered by Rosenberg & Liebentritt, P.C., a law firm whose two shareholders are members of the Company's Board of Directors. The Company believes that these fees are no less favorable than could be obtained from an outside party.\nIn addition, individuals and companies affiliated with Equity Group Investments, Inc. (\"EGI\"), a related party, provide services to the Company and its subsidiaries relating to corporate planning, tax advice and other matters. Amounts paid to EGI or its affiliates for such services in fiscal 1995, 1994 and 1993 were $46,000, $69,000 and $42,000, respectively. The Company believes that these fees are no less favorable than could be obtained from an outside party.\n3. PROPERTY AND EQUIPMENT\nComponents of property and equipment at June 30, 1995 and June 26, 1994 were as follows (amounts in thousands):\nIncluded in the above amounts are items under capitalized leases as follows (amounts in thousands):\nMaintenance and repair expense during fiscal 1995, 1994 and 1993 was $1.7 million, $1.7 million and $1.6 million, respectively.\n4. SHORT-TERM DEBT\nPlastofilm Industries, Inc. (\"Plastofilm\"), a wholly owned subsidiary of the Company, has a secured loan agreement (the \"Agreement\") with a financial institution pursuant to which it has borrowings under a revolving line of credit, a term loan and a capital expenditure line. The Agreement is secured by substantially all of Plastofilm's assets. (See Note 5.)\nThe $2.5 million line of credit bears interest at the prime rate plus 1\/4% (9.25% at June 30, 1995) and is renewable at the option of such financial institution on November 30, 1995. Plastofilm anticipates that this line of credit will be renewed. During the fiscal year ended June 30, 1995, maximum borrowings under this line were $2.0 million and borrowings under this line at June 30, 1995 were $0.8 million. During the fiscal year ended June 26, 1994, Plastofilm's line of credit was $2.0 million, maximum borrowings under this line were $2.0 million and $2.0 million was outstanding at June 26, 1994. Average borrowings were $1,625,000 and $1,643,000 for the fiscal years ended June 30, 1995 and June 26, 1994, respectively. The weighted average interest rate was 8.61% in fiscal 1995 and 6.46% in fiscal 1994.\n5. LONG-TERM DEBT\nLong-term debt consisted of the following as of June 30, 1995 and June 26, 1994 (amounts in thousands):\nThe long-term debt matures as follows: $742,000 in 1996, $1,687,000 in 1997, $326,000 in 1998, $96,000 in 1999, $96,000 in 2000 and $24,000 thereafter.\nThe Agreement between Plastofilm and its lender restricts the transfer of funds between Plastofilm and the Company through the imposition of tangible net worth requirements, debt to equity ratios and cash flow requirements. As a result of these restrictions, approximately 75% of the consolidated net assets of Plastofilm were restricted from being transferred to the Company as of June 30, 1995.\n6. COMMITMENTS\nThe Company and its subsidiaries lease certain facilities and equipment under various lease agreements. Total minimum commitments payable under these leases at June 30, 1995 were (amounts in thousands):\nRent expense for operating leases was $364,000, $279,000 and $305,000 for fiscal 1995, 1994 and 1993, respectively.\n7. INCOME TAXES\nThe provision (benefit) for income taxes was as follows:\nThe income tax benefit differed from the federal statutory rate as detailed below (amounts in thousands):\nAt June 30, 1995 and June 26, 1994 the components of deferred income taxes were as follows (amounts in thousands):\nA valuation reserve is provided to reduce the deferred tax assets to a level which management expects will be realized in the future. The valuation reserve for deferred tax assets as of June 26, 1994 was $3,715,000. The net change in the total valuation reserve for the year ended June 30, 1995 was a decrease of $1,033,000. Of this amount $457,000, resulted from the utilization of $487,000 of net operating loss carryforwards net of $30,000 of alternative minimum tax credits generated. The remaining $576,000 decrease resulted primarily from the Company's reevaluation of the realizability of future income tax benefits based on the Company's increased future profit expectations and improving business conditions.\nAt June 30, 1995, for income tax purposes the Company had net operating loss carryforwards of $6.7 million and general business credits carryforwards of $.7 million. The net operating loss carryforwards expire in years 2001 to 2009; the general business credits carryforwards expire in years 1999 and 2000.\n8. EMPLOYEE RETIREMENT PLANS\nUntil December 31, 1991, Plastofilm had a non-contributory profit sharing plan and a non-contributory pension plan. On November 12, 1991, the Board of Directors of Plastofilm adopted a resolution to curtail future benefit accruals in both plans as of December 31, 1991 and effective May 31, 1995 the pension plan was terminated. The pension plan obligation was not settled as of June 30, 1995. The settlement is not expected to have a material effect on the fiscal 1996 financial statements. The vested benefits in the profit sharing plan were placed in a new cash or deferred arrangement pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended (the \"Code\"), the Plastofilm Employee Savings Plan (\"Savings Plan\"), which became effective on January 1, 1992.\nThe Savings Plan is for all employees. Plastofilm's contributions to the savings plan are at the discretion of Plastofilm's Board of Directors. It is currently Plastofilm's policy to contribute from 1% to 3% of each participant's compensation by matching 50% of employee voluntary salary deferrals of the first 6% of an employee's salary. A participant's contribution may not exceed 15% of annual compensation, or the maximum amount allowable as determined by the Code, if less than 15% of compensation. The amounts expensed under the Savings Plan for fiscal 1995, 1994 and 1993 were $238,000, $252,000 and $208,000, respectively.\nPlastofilm's net periodic pension credit included the following components (amounts in thousands):\nThe funded status of Plastofilm's retirement plan at June 30, 1995 and June 26, 1994 was as follows (amounts in thousands):\nIn determining the net periodic pension credit, the weighted average discount rate used was 6.5% in fiscal 1995 and 6.0% in fiscal 1994 and 1993. The weighted average expected long-term rate of return on assets was 7.50% in fiscal 1995 and 1994 and 6.75% in fiscal 1993.\n9. STOCK OPTIONS\nThe Company had originally reserved 100,000 shares of its common stock for issuance to Directors, officers, key employees and consultants of the Company through incentive stock options, non-qualified stock options and stock appreciation rights to be granted under the Company's 1991 Stock Option Plan (the \"Plan\"). In April 1994, the Company's Board of Directors approved a proposed amendment to the Company's Plan which would increase the number of common shares issuable upon exercise of stock options by 500,000 common shares. The proposed amendment was approved by stockholders at the Company's Annual Meeting of Stockholders held on December 6, 1994. The plan is administered by the Compensation Committee (the \"Committee\") consisting of three members of the Board of Directors. The option price is determined by the Committee, but cannot be less than the fair market value of the common stock of the Company at the date of grant. The options generally vest, in equal cumulative installments, after three years and expire ten years after the date of grant.\nTransactions involving the plan are summarized as follows:\nIncluded in the fiscal 1994 options outstanding and exercisable were 172,000 shares and 100,000 shares, respectively, which were subject to stockholder approval.\n10. CONTINGENT LIABILITIES\nDuring fiscal 1991 soil conditions at Plastofilm's Wheaton, Illinois facility were discovered which need remediation. At June 30, 1991, a pre-tax provision of $1.0 million was recorded for the estimated costs of testing and remediation. Fiscal 1992 expenditures for testing and remediation were approximately $535,000. At June 28, 1992, an additional pre-tax provision of $1.0 million was recorded to reflect the then currently estimated costs to complete the soil remediation. Expenditures during fiscal 1995, 1994 and 1993 for testing and remediation were approximately $78,000, $67,000 and $127,000, respectively. During fiscal 1993 the Illinois Environmental Protection Agency requested certain additional testing to be performed before approval of the Company's voluntary clean-up plan. These tests were conducted in fiscal 1994 and submitted to the Illinois Environmental Protection Agency in fiscal 1995 for approval. The approval of the Company's voluntary clean-up plan is pending.\nThe Company has received a demand for payment of withdrawal liability in the amount of approximately $360,000 from a multi-employer pension plan to which the Company made contributions in connection with a discontinued business. The Company disputes that it has any withdrawal liability and, in accordance with the applicable provisions of the Employee Retirement Income Security Act, has demanded that this dispute be resolved through arbitration. The Company is making quarterly contributions of approximately $10,000 as required by law pending arbitration. Through June 30, 1995 the Company has made payments of approximately $95,000. These payments will be returned to the Company, with interest, if it is ultimately determined that the Company has no liability.\nThe Company, in connection with a discontinued business, has been named by the United States Environmental Protection Agency (\"US-EPA\") as a potentially responsible party in a Superfund Proceeding. The US-EPA has determined the Company to be a de minimus contributor and has offered a settlement agreement to all de minimus parties. The Company has accepted the settlement agreement which will require total payments of $80,586. Payments will be made in two equal installments on January 16, 1996 and July 16, 1996. The settlement amount has been provided for in the financial statements.\n11. MAJOR CUSTOMERS\nDuring fiscal years 1995, 1994 and 1993, net sales to Baxter International, Inc. and its affiliates accounted for approximately $5.2 million (17%), $4.6 million (16%) and $3.6 million (12%), respectively, of the total net sales of the Company.\nSCHEDULE I CFI INDUSTRIES, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) BALANCE SHEETS (AMOUNTS IN THOUSANDS)\nSCHEDULE I CFI INDUSTRIES, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) STATEMENTS OF OPERATIONS AND DEFICIT (AMOUNTS IN THOUSANDS)\nSCHEDULE I CFI INDUSTRIES, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)\nSCHEDULE II CFI INDUSTRIES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JUNE 30, 1995, JUNE 26, 1994 AND JUNE 27, 1993 (AMOUNTS IN THOUSANDS)\nPART III\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT, MANAGEMENT REMUNERATION AND TRANSACTIONS, SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by Item 10, Item 11, 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(b) Reports on Form 8-K: None\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCFI Industries, Inc. (Registrant)\nDate: 9\/28\/95 By: \/s\/ Robert W. George Robert W. George Principal Executive Officer\nDate: 9\/28\/95 By: \/s\/ Robert W. Zimmer Robert W. Zimmer, 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 the capacities and on the dates indicated:","section_15":""}
{"filename":"948042_1995.txt","cik":"948042","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNo material legal proceedings are pending other than routine litigation incidental to the business of the Company. The company believes that such proceedings will not have any material adverse effect on it or its operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to shareholders during the last quarter of the fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a)The principal market for the Certificates is the over the counter market.\n(b)As of March 15, 1996 there were:\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.\nNot applicable.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND FORM 8-K.\n(a)The Annual Statement of compliance and Independent Accountant's Annual Servicing Report are attached.\n(b)Reports on Form 8-K.\nDATES ITEMS REPORTED FINANCIAL STATEMENTS FILED\n01\/09\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n02\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n03\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n04\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n05\/08\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n06\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n07\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n08\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n09\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n10\/09\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n11\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n12\/07\/95 Chemical Bank, as Trustee, made the monthly None distribution to the holders of the Vanderbilt Mortgage and Finance, Inc. Manufactured Housing Senior\/Subordinated certificates, Series 1995-A.\n(c) 3.1 *,** Articles of Incorporation\n3.2 *,** By-Laws\n4.1 ** Pooling and Servicing Agreement, including form of Certificates\n4.2 * Form of Limited Guarantee\n* Previously filed pursuant to Registration Statement on form S-3 (Commission file number 33-80304) and incorporated by reference thereto.\n** Previously filed pursuant to form 8-K, dated February 24,1995, and incorporated by reference 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, in the City of Knoxville, State of Tennessee, on March 15, 1996.\nVanderbilt Mortgage and Finance, Inc.\nBy:\/s\/Kevin C. Clayton Kevin C. Clayton 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.\ns\/Kevin C. Clayton March 15, 1996 President (Principal Executive Officer and Director)\ns\/David R. Jordan March 15, 1996 Controller, Acting Principal Financial Officer (Principal Accounting Officer)\ns\/Joseph H. Stegmayer March 15, 1996 Executive Vice President and Director\ns\/James L. Clayton March 15, 1996 Director","section_15":""}
{"filename":"354707_1995.txt","cik":"354707","year":"1995","section_1":"ITEM 1. BUSINESS\nHEI - ---\nHEI was incorporated in 1981 under the laws of the State of Hawaii and is a holding company with subsidiaries engaged in the electric utility, savings bank, freight transportation, real estate development and other businesses, primarily in the State of Hawaii. HEI's predecessor, HECO, was incorporated under the laws of the Kingdom of Hawaii (now the State of Hawaii) on October 13, 1891.\nAs a result of a 1983 corporate reorganization, HECO became an HEI subsidiary and common shareholders of HECO became common shareholders of HEI. HECO and its subsidiaries, MECO and HELCO, are regulated operating public utilities providing the only public utility electric service on the islands of Oahu, Maui, Lanai, Molokai and Hawaii. HEI also owns directly or indirectly the following subsidiaries which comprise its diversified companies: HEIDI and its subsidiary, ASB and its subsidiaries; HTB and its subsidiary; MPC and its subsidiaries; HEIIC; LVI; PECS (an inactive company) and HEIPC.\nASB, acquired in 1988, is the fourth largest financial institution in the state based on total assets and the third largest financial institution based on deposits, in each case as of September 30, 1995, and has 47 retail branches as of December 31, 1995. HTB was acquired in 1986 and provides ship assist and charter towing services and owns YB, a regulated intrastate public carrier of waterborne freight among the Hawaiian Islands. MPC was formed in 1985 and develops and invests in real estate. HEIIC was formed in 1984 and is a passive investment company which primarily holds investments in leveraged leases and currently plans no new investments. HEIPC was formed in March 1995 to pursue independent power projects and energy conservation projects in Asia and the Pacific.\nPrior to August 16, 1994, HEIDI was the holder of record of the common stock of HIG, which was acquired in 1987 and provided property and casualty insurance primarily in Hawaii. In March of 1993, pursuant to the decision made in 1992, the stock of HERS, formerly an HEI wind energy subsidiary, was sold to The New World Power Corporation and LVI became a direct subsidiary of HEI. HEI is attempting to transfer LVI's windfarm to HELCO, at no cost to electric customers. For information about the discontinued operations of HIG and HERS, see Note 2 to HEI's Consolidated Financial Statements which is incorporated herein by reference to page 45 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nThe financial information about the Company's industry segments is incorporated herein by reference to page 26 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nFor additional information about the Company, reference is made to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (MD&A), incorporated herein by reference to pages 27 to 36 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nELECTRIC UTILITY - ----------------\nHECO AND SUBSIDIARIES AND SERVICE AREAS\nHECO, MECO and HELCO are regulated operating electric public utilities engaged in the production, purchase, transmission, distribution and sale of electricity on the islands of Oahu; Maui, Lanai and Molokai; and Hawaii, respectively. HECO was incorporated under the laws of the Kingdom of Hawaii (now State of Hawaii) on October 13, 1891. HECO acquired MECO in 1968 and HELCO in 1970.\nIn 1995, the electric utilities contributed approximately 76% of HEI's consolidated revenues from continuing operations and approximately 85% of HEI's consolidated operating income from continuing operations. At December 31, 1995, the assets of the electric utilities represented approximately 36% of the total assets of the Company. For additional information about the electric utilities, see MD&A and Note 4, incorporated herein by reference to pages 27 to 36 and 46 to 48 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13, and the MD&A for the electric utilities (HECO MD&A) and HECO consolidated financial statements incorporated by reference to pages 3 to 30 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nThe islands of Oahu, Maui, Lanai, Molokai and Hawaii have a combined population estimated at 1,130,000, or approximately 95% of the population of the State of Hawaii, and cover a service area of 5,766 square miles. The principal communities served include Honolulu (on Oahu), Wailuku and Kahului (on Maui) and Hilo and Kona (on Hawaii). The service areas also include numerous suburban communities, resorts, U.S. Armed Forces installations and agricultural operations.\nHECO, MECO and HELCO have nonexclusive franchises from the state covering certain areas and authorizing them to construct, operate and maintain facilities over and under public streets and sidewalks. HECO's franchise covers the City & County of Honolulu, MECO's franchises cover the County of Maui and the County of Kalawao on the islands of Maui, Lanai and Molokai and HELCO's franchise covers the County of Hawaii. Each of these franchises will continue in effect for an indefinite period of time until forfeited, altered, amended or repealed.\nSALES OF ELECTRICITY\nHECO, MECO and HELCO provide the only electric public utility service on the islands they serve. The following table sets forth the number of their electric customer accounts as of December 31, 1995, 1994 and 1993 and their electric sales revenues for each of the years then ended:\nRevenues from the sale of electricity in 1995 were from the following types of customers in the proportions shown:\nApproximately 10% of consolidated operating revenues of HECO and its subsidiaries was derived from the sale of electricity to various federal government agencies in 1995, 1994 and 1993. One of HECO's larger customers, the Naval Base at Barbers Point, Oahu, is expected to be closed within the next few years. However, HECO anticipates that the base closure will ultimately result in little, if any, loss in aggregate KWH sales, if, as currently anticipated, the Navy continues to occupy portions of Barbers Point and if much of the surplus facilities and land currently not utilized by the Navy is occupied by state agencies. On March 8, 1994, President Clinton signed an Executive Order which mandates that each federal agency develop and implement a program with the intent of reducing energy consumption by 30% by the year 2005 to the extent that these measures are cost-effective. The 30% reductions will be measured relative to the agency's 1985 energy use. HECO is working with various federal government agencies such as the Department of Defense to implement demand-side management programs which will help them achieve their energy reduction objectives. In November 1995, HECO and the U.S. General Services Administration entered into a Basic Ordering Agreement (BOA) under which HECO would provide for financing and installation of energy conservation projects at federal facilities in Hawaii. The first project to be undertaken under the umbrella BOA is a $4 million air conditioning upgrade at the federal office building in downtown Honolulu. Neither HEI nor HECO management can predict with certainty the impact of President Clinton's Executive Order on the Company's or consolidated HECO's future results of operations.\n(1) Sum of the peak demands on all islands served, noncoincident and nonintegrated. (2) Includes the one-time effect of a change in the method of estimating unbilled KWH sales and revenues. (3) Excluding the effect of a change in the method of estimating unbilled KWH sales and revenues, losses and system uses would have been 5.6%.\nGENERATION STATISTICS\nThe following table contains certain generation statistics as of December 31, 1995, and for the year ended December 31, 1995. The capability available for operation at any given time may be less than the generating capability shown because of capability restrictions or temporary outages for inspection, maintenance, repairs or unforeseen circumstances.\n(1) HECO units at normal ratings, and MECO and HELCO units at reserve ratings. (2) Noncoincident and nonintegrated. (3) Independent power producers--180 MW (Kalaeloa), 180 MW (AES-BP) and 46 MW (H-Power). (4) Nonutility generation--MECO: 16 MW (Hawaiian Commercial & Sugar Company) and HELCO: 25 MW (PGV) and 22 MW (HCPC).\nINTEGRATED RESOURCE PLANNING AND REQUIREMENTS FOR ADDITIONAL GENERATING CAPACITY\nAs a result of a proceeding initiated in January 1990, the PUC issued an order in March 1992 (as revised in May 1992) requiring that the energy utilities in Hawaii develop integrated resource plans (IRPs). The goal of integrated resource planning is the identification of the demand-side and supply-side resources and the integration of these resources for meeting near- and long-term consumer energy needs in an efficient and reliable manner at the lowest reasonable cost. In the first phase of the IRP proceeding, the PUC adopted a \"framework\", which establishes both the process for developing IRPs and guidelines for the development of such plans. The PUC's framework directs that each plan cover a 20-year planning\nhorizon with a five-year program implementation schedule and states that the planning cycle will be repeated every three years. Under the framework, the PUC may approve, reject or require modifications of the utilities' IRPs.\nThe framework also states that utilities are entitled to recover all appropriate and reasonable integrated resource planning and implementation costs, including the costs of planning and implementing demand-side management (DSM) programs. Under appropriate circumstances, the utilities may recover net lost revenues resulting from DSM programs and earn shareholder incentives.\nThe PUC will determine the appropriate cost recovery mechanism when a specific DSM program application is filed. The PUC has approved IRP cost recovery provisions (IRP Clauses) for HECO, MECO and HELCO. Pursuant to the IRP Clauses, the electric utilities may recover through a surcharge the costs for approved DSM programs, and other IRP costs incurred and approved by the PUC, to the extent the costs are not included in their base rates.\nEach electric utility has been assigned an individual IRP docket in which the specific issues relative to each company's IRP can be addressed. The PUC provides for public participation in the planning process by requiring each utility to form an advisory group and by holding hearings to review each plan. Any IRP developed will require PUC approval prior to implementation. Management cannot predict, until the completion and approval of the IRPs, what effect, if any, integrated resource planning may eventually have on HECO, MECO and HELCO.\nIn July 1993, HECO filed with the PUC its 20-year (1994-2013) IRP for the island of Oahu, together with a five-year (1994-1998) implementation schedule. HELCO filed its plan in October 1993. MECO filed its plan in December 1993. These plans identified and evaluated a mix of resources to meet near- and long-term consumer energy needs in an efficient and reliable manner at the lowest reasonable cost. The IRPs include DSM programs to reduce load and fuel consumption and consider the impact on the environment, culture, community lifestyles and economy of the state. The PUC must review and approve major elements of the resource plans before the utilities may implement them. The utilities proposed modifications to their plans during the course of PUC proceedings to review the plans.\nThe utilities have characterized their proposed IRPs as planning strategies, rather than fixed courses of action, and the resources ultimately added to their systems may differ from those included in the 20-year plan. Under the IRP framework, the utilities are required to submit annual evaluations of their plans (including a revised five-year program implementation schedule) and to submit new plans on a three-year cycle.\nPrior to proceeding with the DSM programs, separate PUC approval proceedings must be completed, in which the PUC will further review the details of the proposed programs and the utilities' proposals for the recovery of DSM program expenditures, net lost revenues and shareholder incentives. HECO has filed separate applications for approval of its five proposed DSM programs, and evidentiary hearings on these applications were held in January, February and May 1995. In June and July 1995, MECO and HELCO, respectively, filed four separate DSM applications for PUC approval.\nHECO's IRP. The PUC issued its final decision and order in HECO's IRP proceeding on March 31, 1995. The PUC found that HECO's proposed 20-year IRP \"is in the public interest, is consistent with the goals and objectives of integrated resource planning, and represents a reasonable course for meeting the energy needs of its customers.\" In addition, the PUC found that HECO's IRP \"identifies the resources or the mix of resources for meeting near and long term consumer energy needs in an efficient and reliable manner at the lowest reasonable cost.\" HECO's plan includes proposals for five energy efficiency DSM programs beginning in 1995, which are designed to reduce the rate of increase in Oahu's energy use (allowing HECO to delay construction of power plants), to reduce the state's dependence on oil and to achieve savings for its utility customers who take advantage of the programs, and two load management DSM programs beginning in the year 2000. The DSM programs include several proposed incentives to customers to install efficient lighting, refrigeration, water- heating and air-conditioning equipment and industrial motors. The supply-side programs proposed in the HECO plan include the addition of a \"clean coal\" technology unit in 2005, following the retirement of HECO's Honolulu power plant (which is assumed, for planning purposes, to be retired at the end of 2004), the repowering of two existing units at its Waiau power plant, and the addition of two oil-fired combustion turbines at the end of the first decade in the new century. HECO is still awaiting PUC approval for its five DSM programs. Depending on the timing of the PUC decisions, HECO expects to begin program\nimplementation in 1996, one year later than what HECO was projecting in its five-year implementation schedule.\nHECO proposes to file with the PUC by July 1996 its first annual evaluation of its approved 20-year IRP. The annual evaluation will include a revised five-year implementation schedule, and will assess the continuing validity of the forecasts and assumptions upon which its IRP and program implementation schedule were fashioned. HECO's latest sales, peak load and fuel price forecasts may have an impact on the supply-side and demand-side resources currently proposed for implementation over the 1994-2013 IRP planning horizon. Management cannot predict at this time what effect, if any, these forecasts may eventually have on HECO's approved IRP.\nMECO's IRP. MECO's 20-year IRP includes proposals for four energy efficiency DSM programs beginning in 1995 similar to those developed for HECO. The supply- side programs proposed by MECO include installing approximately 199 MW of additional generation through the year 2013 on the island of Maui, approximately 11 MW through the year 2001 on the island of Lanai and approximately 13 MW through the year 2013 on the island of Molokai. Approximately 20 MW of additional generation are currently scheduled to be placed in service on Maui in 1997, 4.4 MW on Lanai in 1996 and 6.6 MW on Molokai in 1996. Hearings on MECO's 20-year IRP have been completed and MECO is awaiting the PUC's decision. MECO is also awaiting PUC approval for its four DSM programs. Depending on the timing of the PUC decisions, MECO expects to begin program implementation in 1996, one year later than what MECO was projecting in its five-year implementation schedule.\nHELCO's IRP. HELCO's 20-year IRP includes proposals for four energy efficiency DSM programs beginning in 1995 similar to those developed for HECO. In addition to the full-scale DSM programs, HELCO is planning an interruptible load pilot program. The supply-side programs proposed in HELCO's five-year plan include installing a 58-MW dual-train combined-cycle unit at HELCO's Keahole plant site, undertaking transmission and distribution efficiency improvement projects and conducting alternate energy generation resource studies. HELCO's 20-year plan includes adding another diesel-fired dual-train combined-cycle unit and a combustion turbine (first phase of a dual-train combined-cycle unit) at a new West Hawaii site by the year 2009. Hearings on HELCO's 20-year IRP have been completed and HELCO is awaiting the PUC's decision. HELCO filed applications to approve its four DSM programs with the PUC on July 6, 1995. Although hearings have not yet been held on these applications, on October 26, 1995, HELCO received from the PUC interim approval to implement the DSM programs as part of HELCO's contingency plan to address HELCO's capacity situation. See \"HELCO power situation\" below. HELCO projects that the DSM programs will reduce HELCO's peak load by 1.5 megawatts one year after implementation of the DSM programs.\nHELCO POWER SITUATION\nIn 1991, HELCO identified the need for additional generation beginning in 1994 to provide for forecasted load growth while maintaining a satisfactory generation reserve margin, to address uncertainties about future deliveries of power from existing firm power producers (see \"Nonutility generation\") and to permit the retirement of older generating units. HELCO added firm capacity to its system in August 1992 (a 20-MW HELCO-owned unit) and in June 1993 (pursuant to a power purchase agreement for 25 MW of firm capacity). Also, HELCO proceeded with plans to install two 20-MW combustion turbines, followed by an 18-MW heat steam recovery generator, at which time these units would be converted to a 56- MW (net) combined-cycle unit. In January 1994, the PUC approved expenditures for the first combustion turbine, which HELCO had planned to install in late 1994, and in September 1995, the PUC conditionally approved expenditures for the second combustion turbine and the steam recovery generator.\nDespite HELCO's best efforts to install the necessary additional generation in time to meet the forecasted load, the schedule for the installation of HELCO's phased combined-cycle unit (CT-4, CT-5 and ST-7) at HELCO's Keahole power plant site was revised due to delays in obtaining approval of the Prevention of Significant Deterioration\/Covered Source Permit (PSD) and the Conservation District Use Permit amendment (CDUP) for the Keahole power plant site. The proposed service date for CT-4 has most recently been revised to February 1997 followed by CT-5 in April 1997, if approvals of the CDUP and PSD are received by the end of March 1996. The conversion to a combined-cycle unit with the installation of ST-7 remains scheduled for October 1997.\nIn late 1995, a contested case hearing with respect to the CDUP was conducted and the hearing officer recommended denial of the CDUP application. The Hawaii Board of Land and Natural Resources\n(BLNR) may decide to adopt, modify, or reject the hearing officer's recommendation. The BLNR was scheduled to make a decision on HELCO's CDUP application by February 26, 1996. On February 23, 1996, however, the BLNR informed HELCO that it was continuing deliberations on the application and extended the application expiration period from February 26, 1996 to March 27, 1996. If the BLNR denies HELCO's CDUP application, this would delay, if not prevent, installation of HELCO's project at the 15-acre Keahole site.\nThe Hawaii Department of Health (DOH) forwarded HELCO's air permit to the Environmental Protection Agency (EPA) for its approval. In a November 1995 letter to the DOH, the EPA declined to sign HELCO's air permit. HELCO requested that the EPA reconsider this decision and the EPA agreed to reconsider based on additional information supplied by HELCO. In a second letter dated February 6, 1996, the EPA set forth information to be considered by HELCO which it feels may address HELCO's concerns regarding the emission control technology to be used, and stated that it would continue discussions with HELCO at a later date. HELCO responded specifically to the EPA's positions by letter dated March 8, 1996, and discussions are ongoing. If the EPA does not sign the permit forwarded by the DOH, this would delay, if not prevent, HELCO's project.\nTwo independent power producers (IPPs) filed separate complaints against HELCO with the PUC, alleging that they are entitled to power purchase contracts to provide HELCO with additional capacity which, under HELCO's current estimates of generating capacity requirements, would be in place of the planned 56-MW addition by HELCO. In July 1995, the PUC issued a decision and order in a docket involving one of the IPPs, Kawaihae Cogeneration Partners (KCP). In the order, the PUC stated its position on various issues affecting HELCO's avoided cost calculations (several of which were contrary to HELCO's recommendations). In September 1995, HELCO provided proposals to the two IPPs, and further negotiations have been undertaken. Status reports on the negotiations with the two IPPs were filed with the PUC at the end of September and October 1995.\nIn September 1995, the PUC allowed HELCO to continue to pursue construction of and commit expenditures for the second combustion turbine and the steam recovery generator for its planned combined-cycle unit, stating in its order that \"no part of the project may be included in HELCO's rate base unless and until the project is in fact installed, and is used and useful for utility purposes.\" In view of permitting delays and the need for power, the PUC also ordered HELCO to continue negotiating with the IPPs and directed that the facility to be built should be the one that can be most expeditiously put into service at \"allowable cost.\"\nOn January 26, 1996, the PUC ordered that the KCP docket be reopened and that HELCO and KCP continue in good faith to negotiate a power purchase agreement, file a list of unresolved issues requiring PUC guidance and meet with the PUC on March 27, 1996. The other IPP has requested similar assistance from the PUC. HELCO has opposed reopening of that docket for this purpose.\nIf HELCO's negotiations with the IPPs result in a power purchase agreement and\/or if HELCO's combined-cycle unit is not installed, HELCO may be required to write off a portion of the costs incurred in its efforts to put into service its combined-cycle unit ($43 million as of December 31, 1995) if such costs ultimately are not recoverable from customers or others. Such a write-off could have a material adverse effect on consolidated HECO's and the Company's financial condition and results of operations.\nIn June 1995, HELCO filed with the PUC its generation resource contingency plan detailing alternatives and mitigation measures to address possible further delays in obtaining the permits necessary to construct its combined-cycle unit. HELCO has arranged for additional firm capacity to be provided by its existing firm power producers (see \"Nonutility generation\"), obtained contracts shifting loads to off-peak hours, begun in January 1996 implementing its energy- efficiency DSM programs based on interim PUC approval (see \"Integrated resource planning and requirements for additional generating capacity\") and deferred generation unit retirements. These measures have helped HELCO maintain its reserve margin and reduce the risk of capacity shortages. HELCO is also proposing installation of up to 6 MW of dispersed generation diesel units that could provide power by late 1996. In January 1996, the PUC opened a generic docket relating to HELCO's contingency plan, which had been submitted to the PUC in June 1995. Pursuant to the PUC order, HELCO submitted updated information to the PUC on March 18, 1996 and addressed comments by the Consumer Advocate on the June 1995 contingency plan.\nNONUTILITY GENERATION\nThe Company has supported state and federal energy policies which encourage the development of alternate energy sources that reduce dependence on fuel oil. Alternate energy sources range from wind, geothermal and hydroelectric power, to energy produced by the burning of bagasse. Other non-oil projects include a generating unit burning municipal waste and a fluidized bed unit burning coal.\nThe \"Power purchase agreements\" section in Note 4 to HEI's Consolidated Financial Statements is incorporated herein by reference to page 47 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nHECO power purchase agreements. HECO currently has three major power purchase agreements. In March 1988, HECO entered into a power purchase agreement with AES Barbers Point, Inc. (AES-BP), a Hawaii-based cogeneration subsidiary of Applied Energy Services, Inc. (AES) of Arlington, Virginia. The agreement with AES-BP, as amended in August 1989, provides that, for a period of 30 years, HECO will purchase 180 MW of firm capacity, under the control of HECO's system dispatcher. The AES-BP 180-MW coal-fired cogeneration plant, which became operational in September 1992, utilizes a \"clean coal\" technology. The facility is designed to sell sufficient steam to be a \"Qualifying Facility\" under the Public Utility Regulatory Policies Act of 1978 (PURPA).\nIn October 1988, HECO entered into an agreement with Kalaeloa Partners, L.P. (Kalaeloa), a limited partnership whose sole general partner is an indirect, wholly owned subsidiary of ASEA Brown Boveri, Inc., which has guaranteed certain of Kalaeloa's obligations and, through affiliates, has contracted to design, build, operate and maintain the facility. The agreement with Kalaeloa, as amended, provides that HECO will purchase 180 MW of firm capacity for a period of 25 years. The Kalaeloa facility, which was completed in the second quarter of 1991, is a combined-cycle operation, consisting of two oil-fired combustion turbines and a steam turbine which utilizes waste heat from the combustion turbines. The facility is designed to sell sufficient steam to be a \"Qualifying Facility\" under PURPA.\nHECO also entered into a power purchase contract and a firm capacity amendment with the City and County of Honolulu, which has built a 60-MW refuse-fired plant (H-Power). The H-Power facility began to provide firm energy in the second quarter of 1990 and currently supplies HECO with 46 MW of firm capacity.\nThe PUC has approved and allowed rate recovery for the costs related to HECO's three major power purchase agreements, which provide a total of 406 MW of firm capacity, representing 24% of HECO's total generating and firm purchased capability on the island of Oahu as of December 31, 1995.\nHERS owned and operated a windfarm on the island of Oahu and sold the electricity it generated to HECO. In March 1993, HEI sold the stock of HERS to The New World Power Corporation with the power purchase agreements between HERS and HECO continuing in effect.\nHELCO and MECO power purchase agreements. As of December 31, 1995, HELCO and MECO had power purchase agreements for 47 MW and 16 MW of firm capacity, respectively, representing 23% and 7% of their respective total generating and firm purchased capabilities.\nHELCO has a power purchase agreement with PGV for 25 MW of firm capacity. PGV, an independent geothermal power producer which experienced substantial delays in commencing commercial operations, passed an acceptance test in June 1993. Although a problem with one of its wells reduced production during 1994, it is now considered to be a firm capacity source for 25 MW. HELCO filed suit against PGV in 1993 for penalties and other relief related to PGV's failure to provide power to HELCO by October 3, 1991. HELCO recognized energy and capacity purchased from PGV as expenses, but withheld certain firm capacity and energy payments to PGV. On March 7, 1995, HELCO and PGV executed a Settlement Agreement. As to the part of the settlement agreement dealing with penalties, it was agreed that HELCO would keep $3.2 million of the amount previously withheld by HELCO. In 1995, HELCO refunded to customers approximately $0.8 million of the $3.2 million withheld and is awaiting the PUC's decision on whether any additional amounts are required to be refunded. In addition, PGV agreed to provide additional energy in the amount of $2.3 million to HELCO above PGV's current firm capacity obligation. In 1995, PGV provided HELCO with $1.0 million of the $2.3 million additional energy, and HELCO reduced its energy cost adjustment charges to customers by $1.0 million. On February 12, 1996, HELCO and PGV executed an amendment to the existing power purchase agreement, under which PGV would be obligated to provide an additional 5 MW of firm capacity to\nHELCO commencing in late 1996. The amendment has been submitted to the PUC for approval. Such additional capacity will assist HELCO in addressing its capacity situation.\nIn December 1994, at a time when the Hilo Coast Processing Company (HCPC) contract was for delivery of 18 MW, HCPC filed a Chapter 11 bankruptcy petition. In July 1995, the bankruptcy court approved an amended and restated HELCO and HCPC power purchase agreement for 22 MW of firm capacity and the dismissal of HCPC from bankruptcy, subject to a condition that was satisfied.\nThe stock of LVI was transferred to HEI prior to the sale of HERS to The New World Power Corporation. As of December 31, 1995, LVI's windfarm on the island of Hawaii consisted of wind turbines with a total operating capacity of 1.6 MW. LVI sells its electricity to HELCO and the Hawaii County Department of Water Supply.\nHamakua Sugar Company terminated power delivery to HELCO on October 5, 1994, upon completion of the bankruptcy court-approved final harvest plan. As a result, HELCO's system capability was reduced by 8 MW.\nMECO has a power purchase agreement with Hawaiian Commercial & Sugar Company for 16 MW of firm capacity through December 31, 1999.\nFUEL OIL USAGE AND SUPPLY\nAll rate schedules of the Company's electric utility subsidiaries contain energy cost adjustment clauses whereby the charges for electric energy (and consequently the revenues of the electric utility subsidiaries generally) automatically vary with the weighted average price paid for fuel oil and certain components of purchased energy costs, and the relative amounts of company- generated power and purchased power. Accordingly, changes in fuel oil and certain purchased energy costs are passed on to customers. See discussion below under \"Rates.\"\nHECO's steam power plants burn low sulfur fuel oil (LSFO). HECO's combustion turbine peaking units on Oahu burn Number 2 diesel fuel (diesel). MECO and HELCO consume medium sulfur fuel oil (MSFO) in their steam generating plants and consume diesel in the operation of their combustion turbine and diesel engine generating units. The LSFO consumed by HECO in its Oahu generating units is primarily derived from Indonesian and other Far East crude oils processed in island refineries. The MSFO supplied to MECO and HELCO is derived from the local refining of U.S. domestic crude oil.\nIn the second half of 1995, HECO executed new contracts for the purchase of LSFO and use of certain fuel distribution facilities with Chevron, U.S.A., Inc. (CUSA) and BHP Petroleum Americas Refining Inc. (BHP). These fuel supply and facilities operations contracts have a term of two years commencing January 1, 1996. The PUC approved the contracts and issued final orders in December 1995 and January 1996 that permit the inclusion of costs incurred under these contracts in HECO's energy cost adjustment clause. HECO pays market-related prices for fuel supplies purchased under these agreements.\nHECO, MECO, HELCO and affiliates, HTB and YB, executed new joint fuel supply contracts with CUSA and BHP to provide for the purchase of diesel and MSFO supplies and for the use of certain petroleum distribution facilities for a period of two years commencing January 1, 1996. The PUC subsequently approved these contracts and issued final orders in December 1995 and January 1996 that permitted the electric utilities to include fuel costs incurred under these contracts in their respective energy cost adjustment clauses. The electric utilities pay market-related prices for diesel and MSFO supplied under these agreements.\nThe diesel supplies obtained by the Lanai Division of MECO are purchased under an arrangement with a CUSA-branded jobber (wholesale merchant) on Lanai. The Molokai Division of MECO purchases diesel under the joint fuel supply contract with CUSA referred to above.\nThe fuel oil commitments information set forth in the \"Fuel contracts and other purchase commitments\" section in Note 11 to HECO's Consolidated Financial Statements is incorporated herein by reference to page 25 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nThe following table sets forth the average cost of fuel oil used to generate electricity in the years 1995, 1994 and 1993:\nThe average per-unit cost of fuel oil consumed to generate electricity for HECO, MECO and HELCO reflects a different volume mix of fuel types and grades. In 1995, 99.8% of HECO's generation fuel consumption consisted of LSFO. The balance of HECO's fuel consumption was diesel. Diesel also made up approximately two thirds of MECO's and one third of HELCO's fuel consumption. The remainder of the fuel consumption of MECO and HELCO consisted of MSFO. In general, MSFO is the least costly fuel, diesel is the most expensive fuel and the price of LSFO falls between the two on a per barrel basis. The average prices of LSFO, MSFO and diesel in 1995 were higher than the respective average prices in 1994. However, the average prices of LSFO and diesel remained below the respective price levels prevailing in 1993.\nHTB was contractually obligated to ship heavy fuel oil for HELCO and MECO through December 1993. Effective December 31, 1993, HTB exited the heavy fuel oil shipping business. See \"Regulation and other matters--Environmental regulation--Water quality controls.\" HELCO and MECO carried out a bidding process to determine who would ship heavy fuel oil beyond 1993. Several bids were received and evaluated and two contracts were signed with Hawaiian Interisland Towing, Inc., subject to PUC approval. The PUC approved these contracts and issued a final order in June 1994 that permitted HELCO and MECO to include the costs of fuel transportation and related costs incurred under the contracts in their respective energy cost adjustment clause. Freight rates charged under the contracts are related to published indices for industrial commodities prices and labor costs. In December 1995, HELCO and MECO exercised an option to extend for two years their existing contracts with Hawaiian Interisland Towing, Inc. for the shipment of MSFO and diesel supplies from their fuel supplier's facilities on Oahu to storage locations on the islands of Hawaii and Maui, respectively. These contracts include options for two additional two- year extensions.\nIn 1996, the Company estimates that 76% of the net energy generated and purchased by HECO and its subsidiaries will come from oil. This percentage is down from 87% in 1992, due largely to the purchases from independent power producers whose fuel sources are primarily coal, and to a lesser extent, geothermal, solid waste and bagasse (sugarcane waste). Failure by the Company's oil suppliers to provide fuel pursuant to the supply contracts and\/or substantial increases in fuel prices could adversely affect consolidated HECO's and the Company's financial condition and results of operations. HECO and its subsidiaries, however, maintain an inventory of fuel oil approximating a month's supply, which may be used in the event fuel suppliers are not able to provide fuel pursuant to the contracts for this period of time, and increases in fuel oil prices would be passed on to customers through the electric utility subsidiaries' energy cost adjustment clauses.\nRATES\nHECO, MECO and HELCO are subject to the regulatory jurisdiction of the PUC with respect to rates, standards of service, issuance of securities, accounting and certain other matters. See \"Regulation and other matters--Electric utility regulation.\"\nAll rate schedules of HECO and its subsidiaries contain an energy cost adjustment clause to reflect changes in the weighted average price paid for fuel oil and certain components of purchased energy costs, and the relative amounts of company-generated power and purchased power. Under current law and practices, specific and separate PUC approval is not required for each rate change pursuant to automatic rate adjustment clauses previously approved by the PUC. Rate increases, other than pursuant to such automatic adjustment clauses, require the prior approval of the PUC after public and contested case hearings. PURPA requires the PUC to periodically review the energy cost adjustment clauses of electric and gas utilities in the state, and such clauses, as well as the rates charged by the utilities generally, are subject to change.\nThe \"Regulation of electric utility rates\" and \"Recent rate requests\" sections in MD&A are incorporated herein by reference to pages 29 and 30 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nIn March 1996, HELCO received an interim decision and order authorizing a 4.8%, or $6.8 million, increase in annual revenues, based on a 11.65% return on average common equity. Interim increases are subject to refund with interest, pending the final outcome of the case.\nHECO and its subsidiaries participated in the PUC's generic docket to determine whether Statement of Financial Accounting Standards (SFAS) No. 106 should be adopted for rate-making purposes. The information on postretirement benefits other than pensions in MD&A and in the \"Postretirement benefits other than pensions\" section in Note 17 to HEI's Consolidated Financial Statements is incorporated herein by reference to pages 29, 58 and 59 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nWAIAU-CAMPBELL INDUSTRIAL PARK TRANSMISSION LINES\nIn 1993, the PUC held hearings concerning Part 2 of the Waiau-Campbell Industrial Park (CIP) 138-kilovolt transmission lines. These lines are part of a second transmission corridor in West Oahu, running approximately 15 miles between CIP and HECO's Waiau power plant. The new lines were needed (1) to increase system reliability, (2) to provide additional transmission capacity to meet expected load growth and (3) to provide transmission capacity for existing and new power generation projects planned for West Oahu. HECO experienced community opposition over the proposed placement of portions of these lines based in part on the potential effects of the lines on aesthetics and the concern of some that the electric and magnetic fields (EMF) from the power lines may have adverse health effects. HECO witnesses addressed EMF, the route selection process (which involved extensive public input), as well as engineering and related subjects.\nOne proposal by those who oppose the route of the overhead lines was to place Part 2 of the Waiau-CIP lines underground. HECO estimated that this proposal would cost approximately $100 million more than the cost of overhead lines. In April 1994, the PUC issued a decision which permitted HECO to construct the lines above ground. While the PUC recognized the concerns of aesthetics and EMF, it felt that neither concern was sufficient to justify the added cost of undergrounding the lines. In May 1994, appeals to the state Supreme Court were filed by intervenors in the PUC proceeding requesting that the Court overturn the PUC's ruling that allowed HECO to construct the lines above ground. Management cannot predict with certainty the final outcome of the appeals. No stay of the PUC order has been entered. HECO completed construction of the overhead lines which were placed in service in August 1995.\nSAVINGS BANK--AMERICAN SAVINGS BANK, F.S.B. - -------------------------------------------\nGENERAL\nASB was granted a charter as a federal savings bank in January 1987. Prior to that time, ASB operated as the Hawaii division of American Savings & Loan Association of Salt Lake City, Utah since 1925. As of September 30, 1995, ASB was the fourth largest financial institution in the state based on total assets of $3.3 billion and the third largest financial institution based on deposits of $2.2 billion.\nHEI agreed with the Office of Thrift Supervision's (OTS) predecessor regulatory agency that ASB's regulatory capital would be maintained at a level of at least 6% of ASB's total liabilities, or at such greater amount as may be required from time to time by regulation. Under the agreement, HEI's obligation to contribute additional capital was limited to a maximum aggregate amount of approximately $65.1 million. HEI elected to contribute additional capital of $12.0 million, $1.0 million and $0.8 million to ASB during 1995, 1994 and 1993, respectively. Most of the additional capital contribution to ASB in 1995 was contributed in anticipation of legislative proposals in Congress to make a one-time assessment of thrifts to fully capitalize the Savings Association Insurance Fund (SAIF). See \"Savings bank regulation, Deposit Insurance, Deposit Insurance Assessment\" for a further description of the legislative proposals and their potential impact. ASB is subject to the OTS regulations for dividends and other distributions applicable to financial institutions regulated by the OTS.\nASB's earnings depend primarily on its net interest income--the difference between the interest income earned on interest-earning assets (loans receivable, mortgage-backed securities and investments) and the interest expense incurred on interest-bearing liabilities (deposit liabilities and borrowings). Deposits\ntraditionally have been the principal source of ASB's funds for use in lending, meeting liquidity requirements and making investments. ASB also derives funds from receipt of interest and principal on outstanding loans receivable, borrowings from the Federal Home Loan Bank (FHLB) of Seattle, securities sold under agreements to repurchase and other sources, including collateralized medium-term notes. In recent years, securities sold under agreements to repurchase and advances from the FHLB of Seattle have become more significant sources of funds.\nFor additional information about ASB, reference is made to \"Savings Bank\" under MD&A and to Note 5 to HEI's Consolidated Financial Statements, incorporated herein by reference to pages 31 to 32, 35 to 36 and 49 to 52 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nThe following table sets forth selected data for ASB for the periods indicated:\n(1) Net income includes amortization of goodwill and core deposit intangibles. Average balances for each period have been calculated using the average month-end balances during the period.\nCONSOLIDATED AVERAGE BALANCE SHEET\nThe following table sets forth average balances of major balance sheet categories for the periods indicated. Average balances for each period have been calculated using the average month-end or daily average balances during the period.\nASSET\/LIABILITY MANAGEMENT\nInterest rate sensitivity refers to the relationship between market interest rates and net interest income resulting from the repricing of interest-earning assets and interest-bearing liabilities. Interest rate risk arises when an interest-earning asset matures or when its interest rate changes in a time frame different from that of the supporting interest-bearing liability. Maintaining an equilibrium between rate sensitive interest-earning assets and interest-bearing liabilities will reduce some interest rate risk but it will not guarantee a stable net interest spread because yields and rates may change simultaneously or at different times and such changes may occur in differing increments. Market rate fluctuations could materially affect the overall net interest spread even if interest-earning assets and interest-bearing liabilities were perfectly matched. The difference between the amounts of interest-earning assets and interest-bearing liabilities that reprice during a given period is called \"gap.\" An asset-sensitive position or \"positive gap\" exists when more assets than liabilities reprice within a given period; a liability-sensitive position or\n\"negative gap\" exists when more liabilities than assets reprice within a given period. A positive gap generally produces more net interest income in periods of rising interest rates and a negative gap generally produces more net interest income in periods of falling interest rates.\nAs rates increased during 1994 and part of 1995, the gap in the near term (0-6 months) was a negative 7.6% of total assets as compared to a cumulative one-year negative gap position of 2.6% of total assets as of December 31, 1995. The negative near-term gap position reflects increases in short-term certificate of deposits and other borrowings to support investment activities. The lower cumulative one-year 1995 negative gap was primarily due to investments in adjustable rate loans and mortgage-backed securities. The following table shows ASB's interest rate sensitivity at December 31, 1995:\n(1) The table does not include $183 million of noninterest-earning assets and $57 million of noninterest-bearing liabilities.\n(2) The difference between the total interest-earning assets and the total interest-bearing liabilities.\nINTEREST INCOME AND INTEREST EXPENSE\nThe following table sets forth average balances, interest and dividend income, interest expense and weighted average yields earned and rates paid, for certain categories of interest-earning assets and interest-bearing liabilities for the periods indicated. Average balances for each period have been calculated using the average month-end or daily average balances during the period.\n(1) ASB has no material amount of tax-exempt investments for periods shown. Investments include interest-bearing deposits, marketable securities and investments in regulatory agencies.\n(2) Includes interest-bearing deposits in the Federal Home Loan Bank of Seattle.\nThe following table shows the effect on net interest income of (1) changes in interest rates (change in weighted average interest rate multiplied by prior period average portfolio balance) and (2) changes in volume (change in average portfolio balance multiplied by prior period rate). Any remaining change is allocated to the above two categories on a pro rata basis.\nOTHER INCOME In addition to net interest income, ASB has various sources of other income, including fee income from servicing loans, fees on deposit accounts, rental income from premises and other income. Other income totaled approximately $17.9 million in 1995, compared to $12.2 million in 1994 and $11.1 million in 1993. The increase in other income during 1995 was primarily due to a $3.9 million one-time gain on sale of trading account securities. In November 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 connection with the guidance provided in the special report, the FASB indicated that an enterprise may reassess the appropriateness of the classifications of all securities held at that time and account for any resulting reclassifications at fair value in accordance with the requirements of SFAS No. 115. Such reclassifications were required to occur no later than December 31, 1995. The guidance indicated that reclassifications from the held- to-maturity category that resulted from this one-time reassessment would not call into question the intent of an enterprise to hold other debt securities to maturity in the future. In accordance with the implementation guidance provided in the special report, ASB transferred approximately $49.5 million of mortgage- backed securities previously classified as held-to-maturity securities to trading account securities on November 28, 1995. All such securities were then sold prior to the end of 1995.\nLENDING ACTIVITIES\nGeneral. ASB's net loan and mortgage-backed securities portfolio totaled approximately $3.1 billion at December 31, 1995, representing 91.8% of its total assets, compared to $2.9 billion, or 92.8%, and $2.4 billion, or 90.3%, at December 31, 1994 and 1993, respectively. ASB's loan portfolio consists primarily of conventional residential mortgage loans which are not insured by the Federal Housing Administration nor guaranteed by the Veterans Administration.\nThe following tables set forth the composition of ASB's loan and mortgage-backed securities portfolio:\n(1) Includes renegotiated loans.\n(1) Includes renegotiated loans.\nOrigination, purchase and sale of loans. Generally, loans originated and purchased by ASB are secured by real estate located in Hawaii. As of December 31, 1995, approximately $55.5 million of loans purchased from other lenders were secured by properties located in the continental United States. For additional information, including information concerning the geographic distribution of ASB's mortgage-backed securities portfolio and the geographic concentration of credit risk, reference is made to Note 19 to HEI's Consolidated Financial Statements, incorporated herein by reference to page 59 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nThe amount of loans originated during 1995, 1994, 1993, 1992 and 1991 were $382 million, $523 million, $564 million, $601 million and $387 million, respectively. The decrease in loans originated in 1995 from 1994 was due in part to lower refinancings and the weak economy.\nResidential mortgage lending. During the last half of 1995, interest rates along with the demand for adjustable rate mortgage (ARM) loans over fixed rate loans decreased compared with 1994. ARM loans carry adjustable interest rates which are typically set according to a short-term index. Payment amounts may be adjusted periodically based on changes in interest rates. ARM loans represented approximately 27.7% of the total originations of first mortgage loans in 1995, compared to 46.3% and 24.7% in 1994 and 1993, respectively. ASB intends to continue to emphasize the origination and purchase of ARM loans to further improve its asset\/liability structure.\nASB is permitted to lend up to 100% of the appraised value of the real property securing a loan. Its general policy is to require private mortgage insurance when the loan-to-value ratio of owner-occupied property exceeds 80% of the lower of the appraised value or purchase price. On nonowner-occupied residential properties, the loan-to-value ratio may not exceed 80% of the lower of the appraised value or purchase price.\nConstruction and development lending. ASB provides both fixed and adjustable rate loans for the construction of one-to-four residential unit and commercial properties. Construction and development financing generally involves a higher degree of credit risk than long-term financing on improved, occupied real estate. Accordingly, all construction and development loans are priced higher than loans secured by completed structures. ASB's underwriting, monitoring and disbursement practices with respect to construction and development financing are designed to ensure sufficient funds are available to complete construction projects. As of December 31, 1995, 1994 and 1993, construction and development loans represented 1.2%, 1.7% and 1.5%, respectively, of ASB's gross loan portfolio. See \"Loan portfolio risk elements.\"\nMulti-family residential and commercial real estate lending. Permanent loans secured by multi-family properties (generally apartment buildings), as well as commercial and industrial properties (including office buildings, shopping centers and warehouses), are originated by ASB for its own portfolio as well as for participation with other lenders. In 1995, 1994 and 1993, loans on these types of properties accounted for approximately 5.9%, 6.6% and 6.0%, respectively, of ASB's total mortgage loan originations. The objective of commercial real estate lending is to diversify ASB's loan portfolio to include sound, income-producing properties.\nConsumer lending. ASB offers a variety of secured and unsecured consumer loans. Loans secured by deposits are limited to 90% of the available account balance. ASB also offers VISA cards, automobile loans, general purpose consumer loans, second mortgage loans, home equity lines of credit, checking account overdraft protection and unsecured lines of credit. In 1995, 1994 and 1993, loans of these types accounted for approximately 11.5%, 6.2% and 4.3%, respectively, of ASB's total loan originations.\nCorporate banking\/commercial lending. ASB is authorized to make both secured and unsecured corporate banking loans to business entities. This lending activity is designed to diversify ASB's asset structure, shorten maturities, provide rate sensitivity to the loan portfolio and attract business checking deposits. As of December 31, 1995, 1994 and 1993, corporate banking loans represented 1.7%, 1.3% and 1.2%, respectively, of ASB's total net loan portfolio.\nLoan origination fee and servicing income. In addition to interest earned on loans, ASB receives income from servicing of loans, for late payments and from other related services. Servicing fees are received on loans originated and subsequently sold by ASB through a securitization process and also on loans for which ASB acts as collection agent on behalf of third-party purchasers.\nASB generally charges the borrower at loan settlement a loan origination fee ranging from 2% to 3% of the amount borrowed. Loan origination fees (net of direct loan origination costs) are deferred and recognized as an adjustment of yield over the life of the loan. Nonrefundable commitment fees (net of direct loan origination costs, if applicable) to originate or purchase loans are deferred. The nonrefundable commitment fees are recognized as an adjustment of yield over the life of the loan if the commitment is exercised. If the commitment expires unexercised, nonrefundable commitment fees are recognized in income upon expiration of the commitment.\nLoan portfolio risk elements. When a borrower fails to make a required payment on a loan and does not cure the delinquency promptly, the loan is classified as delinquent. If delinquencies are not cured promptly, ASB normally commences a collection action, including foreclosure proceedings in the case of secured loans. In a foreclosure action, the property securing the delinquent debt is sold at a public auction in which ASB may participate as a bidder to protect its interest. If ASB is the successful bidder, the property is classified in a real estate owned account until it is sold. At December 31, 1995, there were nine residential properties acquired in settlement of loans totaling $2.7 million or 0.08% of total assets. At December 31, 1994, there were three residential properties acquired in settlement of loans totaling $0.8 million or 0.03% of total assets. At December 31, 1993, there was one residential property acquired in settlement of a loan totaling $0.2 million, or 0.01% of total assets.\nIn addition to delinquent loans, other significant lending risk elements include: (1) accruing loans which are over 90 days past due as to principal or interest, (2) loans accounted for on a nonaccrual basis (nonaccrual loans), and (3) loans on which various concessions are made with respect to interest rate, maturity, or other terms due to the inability of the borrower to service the obligation under the original terms of the agreement (renegotiated loans). ASB has no loans which are over 90 days past due on which interest is being accrued for the years presented in the table below. The level of nonaccrual and renegotiated loans represented 1.7%, 1.4%, 0.5%, 1.0% and 0.1%, of ASB's total net loans outstanding\nat December 31, 1995, 1994, 1993, 1992 and 1991, respectively. The following table sets forth certain information with respect to nonaccrual and renegotiated loans for the dates indicated:\nASB's policy generally is to place mortgage loans on a nonaccrual status (interest accrual is suspended) when the loan becomes more than 90 days past due or on an earlier basis when there is a reasonable doubt as to its collectability. Loans on nonaccrual status amounted to $27.1 million (1.6% of total loans) at December 31, 1995, $23.8 million (1.3% of total loans) at December 31, 1994, $5.7 million (0.3% of total loans) at December 31, 1993, $14.2 million (0.9% of total loans) at December 31, 1992 and $1.0 million (0.1% of total loans) at December 31, 1991.\nThe significant increase in loans on nonaccrual status from yearend 1991 to 1992 was primarily due to the effects of Hurricane Iniki on the island of Kauai, such as higher unemployment. As of December 31, 1992, real estate loans with remaining principal balances of $8.9 million were restructured to defer monthly contractual principal and interest payments for three months with repayments of the entire deferred amounts due at the end of the three-month period. These loans had been classified as nonaccrual loans as of December 31, 1992. Substantially all of these loans have resumed their normal repayment schedule and are classified as performing loans.\nIn 1994, the $18 million increase in nonaccrual real estate loans was a result of Hawaii's weak economy. A rising trend of delinquencies resulted in a $3.8 million increase in nonaccrual residential loans. The $14 million increase in nonaccrual income property loans was primarily due to three commercial real estate loans with principal balances totaling $11.8 million that were restructured\/renegotiated to defer monthly principal and interest payments for three to six months. Based on evaluations of collection prospects, a specific loss reserve of $1.6 million was established in 1994 for one of the loans secured by a commercial retail\/office building located on the island of Oahu. In 1995, the $3.3 million increase in nonaccrual loans was a result of Hawaii's continued weak economy.\nAllowance for loan losses. The provision for loan losses is dependent upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of future losses inherent in the loan portfolio. While management attempts to use the best information available to make evaluations, future adjustments may be necessary as circumstances change and additional information becomes available.\nThe following table presents the changes in the allowance for loan losses for the periods indicated.\nASB's ratio of provisions for loan losses during the period to average loans outstanding was 0.28%, 0.21%, 0.05%, 0.11% and 0.06% for the years ended December 31, 1995, 1994, 1993, 1992 and 1991, respectively. The increase in provisions for loan losses during 1992 was primarily due to the 27% increase in average loans outstanding and a $0.6 million additional provision for Kauai loans anticipated to be affected by Hurricane Iniki. In 1994 and 1995, to establish additional specific loss reserves and in response to a rising trend of delinquencies caused by Hawaii's weak economy, ASB increased its loss reserve by $3.5 million and $4.1 million, respectively.\nINVESTMENT ACTIVITIES\nIn recent years, ASB's investment portfolio has consisted primarily of stock of the FHLB of Seattle, federal agency obligations and mortgage-backed securities. In response to the then increasing interest rate environment, management decided to liquidate ASB's portfolio of securities held for trading and the liquidation was completed in October 1994. Also, see the prior discussion under \"Other income\" of the one-time gain on sale of trading account securities in 1995.\nThe following table sets forth the composition of ASB's investment portfolio, excluding mortgage-backed securities to be held-to-maturity, at the dates indicated:\n(1) On investments during the year ended December 31.\nDEPOSITS AND OTHER SOURCES OF FUNDS\nGeneral. Deposits traditionally have been the principal source of ASB's funds for use in lending, meeting liquidity requirements and making investments. ASB also derives funds from receipt of interest and principal on outstanding loans receivable and mortgage-backed securities, borrowings from the FHLB of Seattle, securities sold under agreements to repurchase and other sources. ASB borrows on a short-term basis to compensate for seasonal or other reductions in deposit flows. ASB also may borrow on a longer-term basis to support expanded lending or investment activities. In the last few years, securities sold under agreements to repurchase and advances from the FHLB have become a more\nsignificant source of funds as the demand for deposits has decreased. Using higher cost sources of funds puts downward pressure on ASB's net interest income.\nDeposits. ASB's deposits are obtained primarily from residents of Hawaii. In 1995, ASB had average deposits aggregating $2.1 billion, with a net savings inflow of $15.0 million, excluding interest credited to deposit accounts. Net savings outflows for 1994 and 1993 were approximately $32 million and $9 million, respectively, excluding interest credited to deposit accounts. The net savings outflow for 1994 was due primarily to the effects of rising interest rates and increased competition. The net savings outflow for 1993 was due primarily to the withdrawal of a trust company deposit account of $92 million. The trust company had been acquired by another financial institution. The weighted average rate paid on deposits during 1995 was 4.15%, compared to 3.59% and 3.74% in 1994 and 1993, respectively. In the three years ended December 31, 1995, ASB had no deposits placed by or through a broker.\nThe following table shows the distribution of ASB's average deposits and average daily rates by type of deposit for the years indicated. Average balances for a period have been calculated using the average of month-end balances during the period.\nAt December 31, 1995, ASB had $267.9 million in certificate accounts of $100,000 or more, maturing as follows:\nBorrowings. ASB obtains advances from the FHLB of Seattle, provided certain standards related to credit-worthiness have been met. Advances are secured under a blanket pledge of the common stock ASB owns in the FHLB of Seattle and each note or other instrument held by ASB and the mortgage securing it. FHLB advances generally are available to meet seasonal and other withdrawals of deposit accounts, to expand lending and to assist in the effort to improve asset and liability management. FHLB advances are made pursuant to several different credit programs offered from time to time by the FHLB of Seattle.\nAt December 31, 1995, 1994 and 1993, advances from the FHLB amounted to $501 million, $616 million and $290 million, respectively. The weighted average rates on the advances from the FHLB outstanding at December 31, 1995, 1994 and 1993 were 6.52%, 6.17% and 6.24%, respectively. The maximum amount outstanding at any month-end during 1995, 1994 and 1993 was $618 million, $616 million and $290 million, respectively. Advances from the FHLB averaged $559 million, $453 million and $210 million during 1995, 1994 and 1993, respectively, and the approximate weighted average rate thereon was 6.55%, 5.77% and 6.84%, respectively. During 1994, increased advances from the FHLB were needed to support investment activities as the effects of rising interest rates and increased competition slowed deposit growth. During 1995, advances decreased as securities sold under agreements to repurchase provided a lower cost funding source.\nAt December 31, 1995 and 1994, securities sold under agreements to repurchase consisted of mortgage-backed securities sold to brokers\/dealers under fixed- coupon agreements. The agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheets. The dollar amount of securities underlying the agreements remains in the asset accounts. At December 31, 1995 and 1994, $412.5 million (including accrued interest of $2.5 million) and $123.3 million (including accrued interest of $1.0 million) of the agreements were to repurchase identical securities, respectively. There were no outstanding securities sold under agreements to repurchase as of December 31, 1993. The weighted average rates on securities sold under agreements to repurchase outstanding at December 31, 1995 and 1994 were 5.84% and 6.22%, respectively. The maximum amount outstanding at any month-end during 1995, 1994 and 1993 was $413 million, $123 million and $27 million, respectively. Securities sold under agreements to repurchase averaged $277 million, $21 million and $20 million during 1995, 1994 and 1993, respectively, and the approximate weighted average interest rate thereon was 6.08%, 5.14% and 3.39%, respectively. During 1995, increased securities sold under agreements to repurchase were needed to support investment activities as the effects of rising interest rates and increased competition slowed deposit growth.\nSubject to obtaining certain approvals from the FHLB of Seattle, ASB may offer collateralized medium-term notes due from nine months to 30 years from the date of issue and bearing interest at a fixed or floating rate established at the time of issue. At December 31, 1995, 1994 and 1993, ASB had no outstanding collateralized medium-term notes.\nThe following table sets forth information concerning ASB's advances from FHLB and other borrowings at the dates indicated:\n(1) On borrowings at December 31.\nCOMPETITION\nThe primary factors in competing for deposits are interest rates, the quality and range of services offered, marketing, convenience of office locations, office hours and perceptions of the institution's financial soundness and safety. Competition for deposits comes primarily from other savings institutions, commercial banks, credit unions, money market and mutual funds and other investment alternatives. Additional competition for deposits comes from various types of corporate and government borrowers, including insurance companies. To meet the competition, ASB offers a variety of savings and checking accounts at competitive rates, convenient business hours, convenient branch locations with interbranch deposit and withdrawal privileges at each office and conducts advertising and promotional campaigns.\nThe primary factors in competing for first mortgage and other loans are interest rates, loan origination fees and the quality and range of lending services offered. Competition for origination of first mortgage loans comes primarily from other savings institutions, mortgage banking firms, commercial banks, insurance companies and real estate investment trusts. ASB believes that it is able to compete for such loans primarily through the interest rates and loan fees it charges, the type of mortgage loan programs it offers and the efficiency and quality of the services it provides its borrowers and the real estate business community.\nOTHER - -----\nFREIGHT TRANSPORTATION -- HAWAIIAN TUG & BARGE CORP. AND YOUNG BROTHERS, LIMITED - --------------------------------------------------------------------------------\nGENERAL\nHTB and its wholly owned subsidiary, YB, were acquired in 1986. HTB provides marine transportation services in Hawaii and the Pacific area, including charter tug and barge and harbor tug operations. YB,\nwhich is a regulated interisland cargo carrier, transports general freight and containerized cargo by barge on a regular schedule between all major ports in Hawaii. YB moved 3.2 million revenue tons of cargo between the islands in 1995, compared to 3.0 million revenue tons in 1994.\nA substantial portion of the state's commodities are imported, and almost all of Hawaii's overseas inbound and outbound cargo moves through Honolulu. Cargo destined for the neighbor islands is trans-shipped through the Honolulu gateway.\nYB has a nonexclusive Certificate of Public Convenience and Necessity from the PUC to operate as an intrastate common carrier by water. The Certificate will remain in effect for an indefinite period unless suspended or terminated by the PUC. YB encounters competition from, among others, interstate carriers and unregulated contract carriers.\nYB RATES\nYB generally must accept for transport all cargo offered. YB rates and charges must be approved by the PUC and the PUC has broad discretion in its regulation of the rates charged by YB.\nYB filed an application on May 16, 1994 requesting PUC approval to increase its general freight rates by 5.9% and its Minimum Bill of Lading charge from $18.00 to $20.93 to be effective July 1, 1994. On June 17, 1994, the PUC suspended YB's application for a period of six months to and including December 31, 1994. On September 26, 1994, YB filed with the PUC a Stipulation indicating YB and the Consumer Advocate had agreed to stipulate to a 6% general rate increase to be effective upon PUC approval. On December 12, 1994, the PUC granted YB approval to increase its rates 6% across-the-board (including the Minimum Bill of Lading), which became effective on December 15, 1994.\nOn November 29, 1994, the PUC allowed the utility companies to record postretirement benefits other than pension costs on the accrual basis and to increase rates to recover such costs on January 1, 1995. After submission of certain information required by the PUC, the PUC issued a letter to YB authorizing a 2.66% increase in rates across-the-board effective January 1, 1995.\nOn February 3, 1995, YB filed an application with the PUC to revise its tariff and rate schedules to: 1) streamline the existing tariff in order to minimize rate subsidization and encourage efficient cargo flow; 2) simplify the existing rules and regulations which were cumbersome to administer; and 3) rebalance the rates to reflect the differences in costs to handle and transport the various cargo offerings and to price competitively within YB's market while remaining revenue neutral. On March 24, 1995, the PUC suspended YB's application for a period of six months to and including September 30, 1995 and placed YB's proposed tariff changes under investigation. An evidentiary hearing was held on August 2, 1995. On September 29, 1995, the PUC authorized YB to implement Hawaii and Kauai county rates and to separate and revise the Maui county rates for the ports of Maui, Lanai, and Molokai. The new tariff became effective on October 10, 1995.\nREAL ESTATE--MALAMA PACIFIC CORP. - ---------------------------------\nGENERAL\nMPC was incorporated in 1985 and engages in real estate development activities, both directly and through joint ventures.\nMPC's real estate development investments and residential projects are targeted for Hawaii's owner-occupant market. MPC is currently involved in the development of five residential projects (Kipona Hills, Kua' Aina Ridge, Westpark and Westhills at Makakilo Heights, Piilani Village Phase 1 and Sunrise Estates) on approximately 316 acres of land on the islands of Oahu, Maui and Hawaii encompassing approximately 580 homes or lots, of which approximately 400 have been completed and sold. MPC and its joint ventures own approximately 424 acres of land for future residential development.\nResidential development generally requires a long lead time to obtain necessary zoning changes, building permits and other required approvals. MPC's projects are subject to the usual risks of real estate development, including fluctuations in interest rates, the receipt of timely and appropriate state and local zoning and other necessary approvals, possible cost overruns and construction delays, adverse changes in general commerce and local market conditions, compliance with applicable environmental and other regulations, and potential competition from other new projects and resales of existing residences.\nIn 1995, MPC and its subsidiaries continued to experience slow sales in their real estate projects. Although interest rates declined, sales were dampened by declining consumer confidence caused in large part by perceived lack of job security.\nJOINT VENTURE DEVELOPMENTS\nMakakilo Cliffs. In 1990, Malama Development Corp. (MDC) and JGL Enterprises Inc. formed Makakilo Cliffs Joint Venture for the development of a 280-unit multi-family residential project on approximately 26 acres in Makakilo, Hawaii (island of Oahu). MDC's partnership interest was assigned to Malama Makakilo Corp., another wholly owned subsidiary of MPC, in August 1990. Sales of the first 81 units closed in 1991 and all remaining units closed in 1992. The joint venture was dissolved in December 1993.\nSunrise Estates. In 1990, MDC and HSC, Inc. formed Sunrise Estates Joint Venture to develop and sell 165 one-acre house lots in Hilo, Hawaii (island of Hawaii). In 1993 and 1992, sales of three lots and 153 lots closed, respectively. There were no sales in 1994 and 1995. Subdivision approval for the remaining nine lots was received in 1995.\nIn 1991, HSC, Inc. and Malama Elua Corp., a wholly owned subsidiary of MPC, formed Sunrise Estates II Joint Venture to develop and sell approximately 140 one-acre house lots in Hilo, Hawaii, adjacent to the Sunrise Estates Joint Venture project. Rezoning was completed in 1993 and subdivision approval is expected to be obtained in 1996.\nAinalani Associates. Malama Mohala Corp. (MMO) and MDT-BF Limited Partnership (MDT) were partners in a joint venture known as Ainalani Associates. In 1992, MMO acquired MDT's 50% interest in Ainalani Associates, and the partnership was dissolved. MMO is completing the development and sale of three projects on the islands of Maui and Hawaii, described below under \"MMO projects\" and is a 50% partner in Palailai Associates, a partnership with Palailai Holdings, Inc.\nBaldwin*Malama. In 1990, MDC acquired a 50% general partnership interest in Baldwin*Malama, a partnership with Baldwin Pacific Properties, Inc. (BPPI), established to acquire approximately 172 acres of land for potential development of about 780 single and multi-family residential units in Kihei on the island of Maui. In 1994, the project received approval to increase density to approximately 1,000 units. The project has completed site work for the first phase of single family units. At December 31, 1995, 51 homes were completed and sold and two completed units were available for sale.\nIn May 1993, Baldwin*Malama was reorganized as a limited partnership in which MDC is the sole general partner and BPPI is the sole limited partner. In conjunction with the dissolution of the Baldwin*Malama general partnership and formation of the limited partnership, MPC agreed to loan $1.6 million to BPPI and up to $15 million to the limited partnership. Through 1995, MPC agreed to increase the maximum loan amount to Baldwin*Malama up to $22.5 million. As of December 31, 1995, the outstanding balances on MPC's loans to BPPI and Baldwin*Malama were $1.0 million and $20.6 million, respectively. Beginning in May 1993, MDC consolidated the accounts of Baldwin*Malama. Previously, MDC accounted for its investment in Baldwin*Malama under the equity method.\nPalailai Associates. MMO assumed Ainalani Associates' 50% interest in Palailai Associates in 1992 upon acquiring MDT's 50% interest in Ainalani Associates. In 1993, Palailai Associates completed the development and sale of the first increment of 107 homes and lots and completed the bulk sale of its 38.8 acres of multi-family zoned land in Makakilo, Oahu. The second increment of 69 single family homes is completed, with 66 homes sold as of December 31, 1995. The third increment of 100 single family homes is in progress with 44 homes completed and sold as of December 31, 1995. Palailai Associates owns approximately 42 acres of adjacent land zoned for residential development.\nMMO PROJECTS\nIn 1992, MMO acquired the Kipona Hills, Kua' Aina Ridge and Kehaulani Place projects of Ainalani Associates as a result of MMO's acquisition of MDT's 50% interest in Ainalani Associates and Ainalani Associates' subsequent dissolution.\nKipona Hills is a 66-unit subdivision located in Waikoloa on the island of Hawaii. Through December 31, 1995, 65 homes or lots were completed and sold, and one lot was available for sale.\nKua' Aina Ridge is a 92-lot subdivision in Pukalani, Maui. Subdivision improvements have been completed and sales closings commenced in 1993. As of December 31, 1995, 62 lots were available for sale, three homes were under construction and one completed unit was available for sale.\nKehaulani Place, consisting of approximately 50 acres of land in Pukalani, Maui, is currently zoned for agriculture. Rezoning and land-use reclassification will be required before development can commence. Land planning and presentations to local community groups commenced in 1993 and are ongoing.\nPROJECT FINANCING\nAt December 31, 1995, MPC or its subsidiaries were directly liable for $12.6 million of outstanding loans and had additional loan facilities of $1.1 million. In addition, at December 31, 1995, MPC or its subsidiaries had issued (i) guaranties under which they were jointly and severally contingently liable with their joint venture partners for $2.0 million of outstanding loans and $0.3 million of additional undrawn loan facilities and (ii) payment guaranties under which MPC or its subsidiaries were severally contingently liable for $5.6 million of outstanding loans and $4.6 million of additional undrawn loan facilities. In total, at December 31, 1995, MPC or its subsidiaries were liable or contingently liable for $20.2 million of outstanding loans and $6.0 million in undrawn loan facilities. All such loans are collateralized by real property. At December 31, 1995, HEI had agreed with the lenders of construction loans and loan facilities, of which approximately $10.3 million was outstanding and $5.7 million was undrawn, that it will maintain ownership of 100% of the stock of MPC and that it intends, subject to good and prudent business practices, to keep MPC financially sound and responsible to meet its obligations. MPC or its subsidiaries may enter into additional commitments in connection with the financing of future phases of development of MPC's projects and HEI may enter into similar agreements regarding the ownership and financial condition of MPC.\nHEI INVESTMENT CORP. - --------------------\nHEIIC was incorporated in May 1984 primarily to make passive, tax-advantaged investments in corporate securities and other long-term investments. HEIIC is not an \"investment company\" under the Investment Company Act of 1940 and has no direct employees.\nHEIIC's long-term investments consist primarily of investments in leveraged leases. HEIIC has a 15% ownership interest in an 818-MW coal-fired generating unit in Georgia, which is subject to a leveraged lease agreement entered into in 1985 and expiring in 2013. The lessee has options to renew the lease at fixed rentals for at least 8.5 additional years, and thereafter at fair market rentals. In the fall of 1987, HEIIC purchased commercial buildings on leasehold properties located in the continental United States, along with the related lease rights and obligations. These leveraged, purchase-leaseback investments included two major buildings housing operations of Hershey Foods in Pennsylvania and six supermarkets leased to The Kroger Co. in various states. In 1995, HEIIC sold one supermarket to the lessee pursuant to the provisions of the leveraged lease agreement and recorded a net loss of $1.3 million on the sale. HEIIC's investments in leveraged leases amounted to $53.4 million and $54.4 million at December 31, 1995 and 1994, respectively. For further information concerning HEIIC's investments in leveraged leases, see Note 8 to HEI's Consolidated Financial Statements, incorporated herein by reference to page 53 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13. No new investments are currently planned by HEIIC.\nHEI POWER CORP. - ---------------\nHEIPC was formed in March 1995 to pursue independent power projects and energy conservation projects in Asia and the Pacific. For a further description of HEIPC, including its $1.7 million operating loss in the first year of operation, see the discussion under \"Other\" in MD&A, incorporated herein by reference to page 32 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nIn February 1996, HEIPC signed a \"Memorandum of Understanding\" with Massachusetts-based Beacon Hill Associates, Inc. for the development of a 60 MW naphtha-fueled combined-cycle power plant in Phnom Penh, Cambodia.\nDISCONTINUED OPERATIONS - -----------------------\nFor information concerning the Company's discontinued operations formerly conducted by HIG and HERS, see Note 2 to HEI's Consolidated Financial Statements, incorporated herein by reference to page 45 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nREGULATION AND OTHER MATTERS - ----------------------------\nHOLDING COMPANY REGULATION\nHEI and HECO are holding companies within the meaning of the Public Utility Holding Company Act of 1935 (1935 Act). However, under current rules and regulations, they are exempt from the comprehensive regulation of the Securities and Exchange Commission (SEC) under the 1935 Act except for Section 9(a)(2) (relating to the acquisition of securities of other public utility companies) through compliance with certain annual filing requirements under the 1935 Act for holding companies which own utility businesses that are primarily intrastate in character. The exemption afforded HEI and HECO may be revoked if the SEC finds that such exemption \"may be detrimental to the public interest or the interest of investors or consumers.\" HEI and HECO may own or have interests in foreign utility operations without adversely affecting this exemption so long as the requirements of other exemptions under the 1935 Act are satisfied. HEI has obtained the PUC certification which is a prerequisite to obtaining an exemption for foreign utility operations and to the Company's maintenance of its exemption under the 1935 Act if it acquires such ownership interests.\nLegislation has been introduced in Congress that would repeal the 1935 Act leaving the regulation of utility holding companies to be governed by other federal and state laws. Management cannot predict if this legislation will be enacted or the final form it might take.\nHEI is subject to an agreement entered into with the PUC (the PUC Agreement) when HECO became a wholly owned subsidiary of HEI. The PUC Agreement, among other things, requires HEI to provide the PUC with periodic financial information and other reports concerning intercompany transactions and other matters. It prohibits the electric utilities from loaning funds to HEI or its nonutility subsidiaries and from redeeming common stock of the electric utility subsidiaries without PUC approval. Further, the PUC could limit the ability of the electric utility subsidiaries to pay dividends on their common stock. See \"Restrictions on dividends and other distributions\" and \"Electric utility regulation\" (regarding the PUC review of the relationship between HEI and HECO).\nAs a result of the acquisition of ASB, HEI and HEIDI are subject to OTS registration, supervision and reporting requirements as savings and loan holding companies.\nIn the event the OTS has reasonable cause to believe that the continuation by HEI or HEIDI of any activity constitutes a serious risk to the financial safety, soundness, or stability of ASB, the OTS is authorized under the Home Owners' Loan Act of 1933, as amended, to impose certain restrictions in the form of a directive to HEI and any of its subsidiaries, or HEIDI and any of its subsidiaries. Such possible restrictions include limiting (i) the payment of dividends by ASB; (ii) transactions between ASB, HEI or HEIDI, and the subsidiaries or affiliates of ASB, HEI or HEIDI; and (iii) the activities of ASB that might create a serious risk that the liabilities of HEI and its other affiliates, or HEIDI and its other affiliates, may be imposed on ASB. Theoretically, this authority would allow the OTS to prohibit dividends, limit affiliate transactions or otherwise restrict activities as a result of losses suffered by HEI, HEIDI or their other subsidiaries, and thus conceivably may be an indirect means of limiting affiliations between ASB and affiliates engaged in nonfinancial activities. See \"Restrictions on dividends and other distributions.\"\nOTS regulations also generally prohibit savings and loan holding companies and their nonthrift subsidiaries from engaging in activities other than those which are specifically enumerated in the regulations. Such restrictions, if applicable to HEI and HEIDI, would significantly limit the kinds of activities in which HEI and HEIDI and their subsidiaries may engage. However, the OTS regulations provide for an exemption which is available to HEI and HEIDI if ASB satisfies the \"qualified thrift lender\" test discussed below. See \"Savings bank regulation--FDIC Improvement Act of 1991 and implementing regulations--Qualified thrift lender test.\" ASB currently meets the qualified thrift lender test and must continue to meet the test in order to avoid restrictions on the activities of HEI and HEIDI and their subsidiaries which could result in a need to divest ASB.\nHEI and HEIDI are prohibited, directly or indirectly, or through one or more subsidiaries, from (i) acquiring control of, or acquiring by merger or purchase of assets, another insured institution or holding company thereof, without prior written OTS approval; (ii) acquiring more than 5% of the voting shares of another savings association or savings and loan holding company which is not a subsidiary; or (iii) acquiring or retaining control of a savings association not insured by the FDIC. No director or officer of HEI or HEIDI, or person beneficially owning more than 25% of such holding company's\nvoting shares, may, except with the prior approval of the OTS, (a) also serve as director, officer, or employee of any insured institution or (b) acquire control of any savings association not a subsidiary of such holding company.\nRESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS\nHEI is a legal entity separate and distinct from its various subsidiaries. As a holding company with no significant operations of its own, the principal sources of its funds are dividends or other distributions from its operating subsidiaries, borrowings and sales of equity. The rights of HEI and, consequently, its shareholders, to participate in any distribution of the assets of any of its subsidiaries is subject to the prior claims of the creditors and preferred stockholders of such subsidiary, except to the extent that claims of HEI in its capacity as a creditor are recognized.\nThe ability of certain of HEI's subsidiaries to pay dividends or make other distributions to HEI is subject to contractual and regulatory restrictions. By agreement with the PUC, in the event that the consolidated common stock equity of the electric utility subsidiaries falls below 35% of total electric utility capitalization, these companies would be restricted, unless they obtained PUC approval, in their payment of cash dividends to 80% of the earnings available for the payment of dividends in the current fiscal year and preceding five years, less the amount of dividends paid during that period. The PUC Agreement also provides that the foregoing dividend restriction shall not be construed to relinquish any right the PUC may have to review the dividend policies of the electric utility subsidiaries. The consolidated common stock equity of HEI's electric utility subsidiaries was 53% of their total capitalization (including the current maturities of long-term debt and preferred stock sinking fund requirements due within one year but excluding short-term borrowings) as of December 31, 1995. At December 31, 1995, HECO and its subsidiaries had net assets of $697 million, of which approximately $327 million were not available for transfer to HEI without regulatory approval.\nThe ability of ASB to make capital distributions to HEI and other affiliates is restricted under federal law. Subject to a limited exception for stock redemptions that do not result in any decrease in ASB's capital and would improve ASB's financial condition, ASB is prohibited from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, ASB would be deemed to be under-capitalized, significantly under-capitalized or critically under-capitalized. See \"Savings bank regulation--FDIC Improvement Act of 1991 and Implementing Regulations--Prompt corrective action.\"\nAs a Tier-1 institution (one that meets its fully phased-in capital requirements and has not been notified by the OTS that it is in need of more than normal supervision), ASB may make capital distributions without OTS approval in amounts up to one-half of ASB's surplus capital ratio (the amount of its capital in excess of its fully phased-in capital requirement) at the beginning of a calendar year, plus its net income for that calendar year to date. The term \"fully phased-in capital requirements\" means the institution's capital requirements under the statutory and regulatory standards applicable as of December 31, 1994, as modified by any individual minimum capital requirements applicable to the institution. ASB, as a Tier-1 institution, may exceed the foregoing limits if ASB provides a thirty-day advance notice to the OTS and receives no objection within thirty days. Even in the case of distributions within the permissible limits, however, a thirty day advance notice to the OTS is required.\nHEI and its subsidiaries are also subject to debt covenants, preferred stock resolutions and guaranties that could limit their respective abilities to pay dividends. The Company does not expect that the regulatory and contractual restrictions applicable to HEI or its direct and indirect subsidiaries will significantly affect the operations of HEI or its ability to pay dividends on its common stock.\nELECTRIC UTILITY REGULATION\nThe PUC regulates the rates, standards of service, issuance of securities, accounting and certain other aspects of the operations of HEI's electric utility subsidiaries. See \"Electric Utility--Rates.\"\nIn addition, the PUC has ordered the electric utility subsidiaries to develop plans for the integration of demand-side and supply-side resources available to meet consumer energy needs efficiently, reliably and at the lowest reasonable cost. The PUC may approve, reject or require modifications of these plans. See \"Electric Utility--Integrated Resource Planning and requirements for additional generating capacity.\"\nIn March 1995, the PUC opened a generic docket to investigate whether Hawaii public utilities should be allowed to establish property damage reserves to recover the cost of damage to their facilities and equipment caused by catastrophic disasters. See \"Property damage reserve\" in MD&A, incorporated herein by reference to page 30 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nAny adverse decision or policy made or adopted by the PUC, or any prolonged delay in rendering a decision, could have a material adverse effect on consolidated HECO's and the Company's financial condition or results of operations.\nCertain transactions between HEI's public utility subsidiaries (HECO, MECO and HELCO) and HEI and affiliated interests, are subject to regulation by the PUC. Under the law, all contracts (including summaries of unwritten agreements), made on or after July 1, 1988 of $300,000 or more in a calendar year for management, supervisory, construction, engineering, accounting, legal, financial and similar services and for the sale, lease or transfer of property between a public utility and affiliated interests must be filed with the PUC to be effective, and the PUC may issue cease and desist orders if such contracts are not filed. All such affiliated contracts for capital expenditures (except for real property) must be accompanied by comparative price quotations from two nonaffiliates, unless the quotations cannot be obtained without substantial expense. Moreover, all transfers of $300,000 or more of real property between a public utility and affiliated interests require the prior approval of the PUC and proof that the transfer is in the best interest of the public utility and its customers. If the PUC, in its discretion, determines that an affiliated contract was unreasonable or otherwise contrary to the public interest, the utility must either revise the contract or risk disallowance of the payments for rate-making purposes. In rate- making proceedings, a utility must also prove the reasonableness of payments made to affiliated interests under any affiliated contracts of $300,000 or more by clear and convincing evidence. An \"affiliated interest\" is defined by statute and includes officers and directors of a public utility, every person owning or holding, directly or indirectly, 10% or more of the voting securities of a public utility, and corporations which have in common with a public utility more than one-third of the directors of that public utility.\nTo address community concerns, HECO proposed by letter dated January 25, 1993, that the PUC initiate a review of the relationship between HEI and HECO and the effects of that relationship on the operations of HECO. By an order dated January 26, 1993, the PUC opened a docket and initiated such a review to determine whether the HEI-HECO relationship, HEI's diversified activities, and HEI's policies, operations and practices have resulted in or are having any negative effects on HECO, its electric utility subsidiaries and ratepayers. In May 1994, a consultant, Dennis Thomas and Associates, was selected by the PUC to perform the review. In early 1995, Dennis Thomas and Associates issued its report to the PUC. The report concluded that \"on balance, diversification has not hurt electric ratepayers.\" Other major findings of the study were that no utility assets have been used to fund HEI's nonutility investments or operations, HEI has not denied needed capital to the electric utilities and management processes within the electric utilities operate without interference from HEI. The report also included a number of recommendations, most of which the Company has implemented. The PUC has not issued a final order in the docket. See also \"Holding company regulation.\"\nHECO and its subsidiaries are not subject to regulation by the Federal Energy Regulatory Commission (FERC) under the Federal Power Act, except under Sections 210 through 212 (added by Title II of PURPA), which permit the FERC to order electric utilities to interconnect with qualifying cogenerators and small power producers, and to wheel power to other electric utilities. Title I of PURPA, which relates to retail regulatory policies for electric utilities, also applies to HECO and its subsidiaries. Title VII of the Energy Policy Act of 1992, which creates \"exempt wholesale generators\" (EWGs) as a category that is exempt from the 1935 Act and which addresses transmission access, also applies to HECO and its subsidiaries. The Company cannot predict the extent to which cogeneration, EWGs, or transmission access, will reduce its electrical loads, reduce its current and future generating and transmission capability requirements, or affect its financial condition or results of operations.\nBecause they are located in the State of Hawaii, HECO and its subsidiaries are exempt by statute from limitations set forth in the Powerplant and Industrial Fuel Act of 1978 on the use of petroleum as a primary energy source.\nSAVINGS BANK REGULATION\nASB, a federally-chartered savings bank, and its holding companies are subject to the regulatory supervision of the OTS and, in certain respects, the Federal Deposit Insurance Corporation (FDIC). In addition, ASB must comply with Federal Reserve Board reserve requirements and OTS liquidity requirements. See \"Liquidity and capital resources-savings bank\" in MD&A and \"Proposed legislation affecting financial institutions\" in Note 5 to HEI's Consolidated Financial Statements, incorporated herein by reference to pages 36 and 52 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nDeposit insurance - -----------------\nDeposit insurance assessments. FIRREA provides for separately funded and maintained deposit insurance funds administered by the FDIC for savings associations and banks. SAIF generally insures the deposits of savings associations. The Bank Insurance Fund (BIF) generally insures the deposits of commercial banks. In 1991, the FDIC adopted a risk-based deposit insurance assessment system. Under this system, the actual assessment rate for a particular institution depends in part upon the supervisory risk rating the FDIC assigns to the institution.\nSavings associations and banks have in the past paid assessments ranging from 23 to 31 cents per $100 of deposits to capitalize the SAIF and BIF. However, under existing law, the FDIC may reduce these assessment rates when the SAIF and BIF individually reach a designated 1.25% reserve ratio. In 1995, the BIF reached the designated reserve ratio and the FDIC, therefore, reduced the assessment rates for banks. Effective in January 1996, well-capitalized banks pay only the legally required annual minimum of $2,000 for BIF insurance. For all other BIF members, the assessment rates range from 3 to 27 cents per $100 of deposits, depending on their risk classification.\nThere is no reasonable likelihood that, under current conditions, the SAIF will achieve the designated 1.25% reserve ratio before the next century. Although the FDIC reduced the assessments paid by banks, it maintained the assessment rates of 23 to 31 cents per $100 of deposits for SAIF members. The disparity between the BIF and SAIF assessment rates places ASB (which paid an assessment rate of 23 cents per $100 of deposits in 1995) and other SAIF members at a disadvantage in competing against commercial banks.\nThere have been a number of legislative proposals in Congress to address this situation, including making a one-time or phased-in assessment of thrifts to fully capitalize the SAIF, followed by a merger of the SAIF and the BIF; eliminating or reducing the disparity in the assessment rates paid by banks or thrifts if the SAIF is recapitalized through the assessment; and merging bank and thrift charters. Certain of these proposals, if adopted, could have a material adverse effect on the Company and ASB. For example, if a one-time assessment of 85 cents for every $100 of deposits is imposed, it is estimated that ASB would be assessed approximately $18 million on a pretax basis ($11 million after-tax), based on ASB's deposit liabilities as of March 31, 1995. If bank and thrift charters are merged, HEI and its other subsidiaries might become subject to the restrictions on the permissible activities of a bank holding company. While certain of the proposals under consideration would grandfather the activities of existing savings and loan holding companies, management cannot predict whether or in what form any of these proposals might ultimately be adopted or the extent to which the business of the Company or ASB might be affected.\nDeposit insurance coverage. FDIC Improvement Act of 1991 (FDICIA) amended various provisions of the Federal Deposit Insurance Act governing deposit insurance coverage. FDICIA, as further implemented by amendments to the FDIC's deposit insurance regulations, made certain significant changes relating to pro rata or \"pass through\" insurance coverage for employee benefit plan participants and beneficiaries, and insurance coverage for certain retirement accounts and trust funds. (The term \"pass-through\" insurance means that the insurance coverage passes through to each owner\/beneficiary of the applicable deposit.) Although the vast majority of the FDIC's deposit insurance regulations, such as the basic rules providing that individual accounts are insured to $100,000 separately from qualifying joint accounts, remain unchanged, several important changes were made.\nEffective December 19, 1993, an individual's interest in deposits at the same institution in any combination of certain retirement accounts will be added together and insured up to $100,000 in the aggregate. This is a reduction from the maximum of $400,000 in insurance coverage formerly provided if deposits were made in four different types of retirement plan accounts.\n\"Pass-through\" insurance coverage for the deposits of most employee benefit plans (i.e., $100,000 per individual participating, not $100,000 per plan) generally continues only for institutions that are well-capitalized under the FDIC's prompt corrective action regulations. The FDIC has amended its deposit insurance regulations to require financial institutions to provide employee benefit plan depositors information, not otherwise available, on the institution's capital category and whether \"pass-through\" deposit insurance is available. As of December 31, 1995, ASB was well-capitalized.\nFinancial Institutions Reform, Recovery, and Enforcement Act of 1989 and - ------------------------------------------------------------------------ implementing regulations - ------------------------\nCapital requirements. Under Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), the OTS set three capital standards for thrifts, each of which must be no less stringent than those applicable to national banks. The three standards provide: (1) a leverage limit which requires a savings association to maintain core capital in an amount of not less than 3% of the association's adjusted total assets; (2) a tangible capital requirement of not less than 1.5% of an association's adjusted total assets; and (3) an 8% risk-based capital requirement, which may deviate from national bank standards to reflect interest rate risk or other risks, but such deviations may not result in materially lower levels of capital than would be required under risk-based capital standards applicable to national banks. Generally, the OTS must restrict the asset growth of an association that fails to meet the capital requirements. As of December 31, 1995, ASB was in compliance with all of the minimum standards with a core capital ratio of 5.4%, a tangible capital ratio of 5.2% and risk- based capital ratio of 12.9% (based on risk-based capital of $193.4 million, $73.9 million in excess of the requirement).\nThe OTS has adopted a rule that adds an interest rate risk (IRR) component to the existing risk-based capital requirement. Institutions with an \"above normal\" level of IRR exposure will be required to hold additional capital. \"Above normal\" IRR is defined as any decline in market value of an institution's portfolio equity in excess of 2% of the market value of its assets, which would result from an immediate 200 basis point change in interest rates. The OTS rule requires a savings association with an \"above normal\" level of IRR exposure to hold one-half of the \"above normal\" IRR times the market value of its assets as capital, in addition to its existing 8% risk-based capital requirement. Although the rule generally became effective January 1, 1994, the OTS intends to delay implementation of the IRR capital deduction (which was to become effective with the September 1994 Thrift Financial Report) pending the testing of an OTS appeals process for certain institutions subject to such deductions. This means that in calculating the risk-based capital requirement, ASB was not required to deduct capital for IRR, and did not report such a deduction for the December 1995 Thrift Financial Report. However, if the rule adding the IRR component had been implemented, ASB would not have been required to deduct an amount from total capital or to hold additional capital as of December 31, 1995.\nIn August 1995, the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Comptroller of the Currency adopted a regulation that stipulates IRR will be taken into account when determining a bank's capital adequacy. These banking agencies have also solicited comments on a proposed supervisory policy statement that describes the process they will use to assess the exposure of a bank's economic value to changes in interest rates. After these banking agencies gain experience with this process, they contemplate issuing standards establishing an explicit capital charge for IRR. FIRREA requires that the capital standards for thrifts be no less stringent than those applicable to national banks. Although the OTS has indicated that it will review any differences between its approach and that of the other federal banking agencies for the purpose of achieving greater consistency and uniformity among all four agencies, the impact of the proposed supervisory policy statement on ASB cannot be predicted at this time.\nAffiliate transactions. Significant restrictions apply to certain transactions between ASB and its affiliates, including HEI and its direct and indirect subsidiaries. FIRREA significantly altered both the scope and substance of such limitations on transactions with affiliates and provides for thrift affiliate rules similar to, but more restrictive than, those applicable to banks. For example, ASB is prohibited from making any loan or other extension of credit to an entity affiliated with ASB unless the affiliate is engaged exclusively in activities which the Federal Reserve Board has determined to be permissible for bank holding companies. There are also various other restrictions which apply to loans and other transactions between ASB and certain executive officers, directors and insiders of ASB. ASB is also barred from making a purchase of or any investment in securities issued by an affiliate, other than with respect to shares of a subsidiary of ASB.\nFDIC Improvement Act of 1991 and implementing regulations - ---------------------------------------------------------\nFDICIA subjects the banking and thrift industries to heightened regulation and supervision. FDICIA makes a number of reforms addressing the safety and soundness of the deposit insurance system, supervision of domestic and foreign depository institutions and improvement of accounting standards. FDICIA also limits deposit insurance coverage, implements changes in consumer protection laws and calls for least-cost resolution and prompt corrective action with regard to troubled institutions.\nPursuant to FDICIA, the federal banking agencies have promulgated regulations which may affect the operations of ASB and its holding companies. Such regulations address, for example, standards for safety and soundness, real estate lending, accounting and reporting, transactions with affiliates, and loans to insiders. See also \"Deposit Insurance.\"\nPrompt corrective action. FDICIA establishes a statutory framework that is triggered by the capital level of a savings association and subjects it to progressively more stringent restrictions and supervision as capital levels decline. The OTS rules implement the system of prompt corrective action. In particular, the rules define the relevant capital measures for the categories of well-capitalized, adequately capitalized, under-capitalized, significantly under-capitalized and critically under-capitalized.\nA savings association that is under-capitalized or significantly under- capitalized is subject to additional mandatory supervisory actions and a number of discretionary actions if the OTS determines that any of the actions is necessary to resolve the problems of the association at the least possible long- term cost to the SAIF. A savings association that is critically under- capitalized must be placed in conservatorship or receivership within 90 days, unless the OTS and the FDIC concur that other action would be more appropriate.\nInterest rates. FDIC regulations restrict the ability of financial institutions that are not well-capitalized to offer interest rates on deposits that are significantly higher than the rates offered by competing institutions. To be a well-capitalized institution not subject to these interest rate restrictions, an institution must have a leverage ratio of 5.0%, a Tier-1 risk-based ratio of 6.0%, a total risk-based ratio of 10% and not be in a \"troubled condition.\" As of December 31, 1995, ASB was well-capitalized with a leverage ratio of 5.4%, a Tier-1 risk-based ratio of 12.2% and a total risk-based ratio of 12.9%.\nQualified thrift lender test. The FDICIA amends the qualified thrift lender (QTL) test provisions of FIRREA by reducing the percentage of assets thrifts must maintain in housing-related loans and investments from 70% to 65%, and changing the computation period to require that the percentage be reached on a monthly average basis in nine out of the previous 12 months. Savings associations that fail to satisfy the QTL test by not holding the required percentage of housing-related investments are subject to various penalties, including limitations on their activities and restrictions on their FHLB advances. Failure to satisfy the QTL test would also bring into operation restrictions on the activities that may be engaged in by HEI, HEIDI and their other subsidiaries and could effectively result in the required divestiture of ASB. At all times during 1995, ASB was in compliance with the QTL test. See \"Holding company regulation.\"\nFederal Home Loan Bank System - -----------------------------\nASB is a member of the FHLB System which consists of 12 regional FHLBs. The FHLB System provides a central credit facility for member institutions. ASB, as a member of the FHLB of Seattle, is required to own shares of capital stock in the FHLB of Seattle in an amount equal to the greater of 1% of ASB's aggregate unpaid residential loan principal at the beginning of each year, 0.3% of total assets or 5% of FHLB advances outstanding. The FHLBs serve as the central liquidity facilities for savings associations and resources of long-term funds for financing housing. Long-term advances may only be made for the purpose of providing funds for financing residential housing. Additionally, at such time as an advance is made or renewed, it must be secured by collateral from one of the following categories: (1) fully disbursed, whole first mortgages on improved residential property, or securities representing a whole interest in such mortgages; (2) securities issued, insured or guaranteed by the U.S. Government or any agency thereof; (3) FHLB deposits; and (4) other real estate-related collateral that has a readily ascertainable value and with respect to which a security interest can be perfected. The aggregate amount of outstanding advances secured by such other real estate-related collateral may not exceed 30% of the member's capital.\nOther laws, regulations and proposed legislation - ------------------------------------------------\nOther laws. ASB is subject to federal and state consumer protection laws which affect lending activities, such as the Truth-in-Lending Law, the Truth in Savings Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and several federal and state financial privacy acts. These laws may provide for substantial penalties in the event of noncompliance. Management of ASB believes that its lending activities are in compliance with these laws and regulations.\nThe Community Reinvestment Act (CRA) was enacted by Congress in 1977 to ensure that banks and thrifts help meet the credit needs of their communities, including low- and moderate-income areas, consistent with safe and sound lending practices. The OTS will consider ASB's CRA record in evaluating an application for a new deposit facility, including the establishment of a branch, the relocation of a branch or office, or the acquisition of an interest in another bank or thrift. ASB received a CRA rating of \"outstanding\" in its OTS examination report dated October 2, 1995.\nThe Reigle-Neal Interstate Banking and Branching Act of 1994 (Interstate Banking Act) was signed into law on September 29, 1994. Beginning September 29, 1995, and subject to certain limits, adequately capitalized and adequately managed bank holding companies will be permitted to acquire control of banks in any state, including Hawaii. Beginning on June 1, 1997 or earlier if expressly permitted by Hawaii law, and subject to certain limits, an adequately capitalized and adequately managed bank may apply for permission to merge with an out-of-state bank and convert all branches of both banks into branches of a single bank. The State of Hawaii retains the authority to prohibit such mergers if, between September 29, 1994 and June 1, 1997, it enacts a law expressly prohibiting such mergers. Out-of-state banks may also be permitted to open new branches in Hawaii if Hawaii law so authorizes. Management cannot predict whether or in what form the Hawaii Legislature might adopt interstate branching legislation during the 1996 legislative session or the extent to which the business of the Company or ASB might be affected. Although the Interstate Banking Act applies only to banks, it could result in greater competitive pressures on savings associations such as ASB.\nPending legislation. Bills are now pending or expected to be introduced in the United States Congress that contain proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. If enacted into law, these pending bills could have the effect of increasing or decreasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance among banks, thrifts and other financial institutions. Some of these bills would realign the structure and jurisdiction of various financial institution regulatory agencies and the FHLB system. Whether or in what form any such legislation may be adopted or the extent to which the business of the Company or ASB might be affected thereby cannot be predicted. See also \"Deposit insurance--Deposit insurance assessments.\"\nFREIGHT TRANSPORTATION REGULATION\nThe PUC has broad authority in its regulation of the intrastate business and operations of YB. See \"Other--Freight transportation--Hawaiian Tug & Barge Corp. and Young Brothers, Limited.\" In particular, the PUC has the authority to review and modify YB's intrastate rates and charges under the Hawaii Water Carrier Act. In all rate proceedings under such act, YB has the burden of proving the reasonableness of expenditures, contracts, leases or other transactions. An adverse decision or policy adopted by the PUC, or a delay in granting requested rate or other relief, could have a material effect on the financial condition or results of operations of YB.\nENVIRONMENTAL REGULATION\nHEI and its subsidiaries are subject to federal and state statutes and governmental regulations pertaining to water quality, air quality and other environmental factors.\nWater quality controls. As part of the process of generating electricity, water used for condenser cooling of the electric utility subsidiaries' steam electric generating stations is discharged into ocean waters or into underground injection wells. The subsidiaries are required periodically to obtain permits from the DOH in order to be allowed to discharge the water. The electric utility subsidiaries must obtain National Pollutant Discharge Elimination System (NPDES) permits from the DOH to allow wastewater discharges into ocean waters for each of five generating stations (three at HECO and one each at MECO and HELCO) and Underground Injection Control (UIC) permits for wastewater discharge to underground injection wells for several HELCO facilities and one MECO facility.\nDuring 1995, the DOH issued NPDES permit renewals for MECO's Kahului generating station and for HECO's Kahe, Waiau and Honolulu generating stations. Only HELCO's Shipman generating station has yet to receive its NPDES permit renewal and is continuing to operate on an administrative extension of the previously expired permit. The DOH is preparing a draft permit, but is awaiting additional requested storm water information from HECO\/HELCO.\nIn September 1994, the DOH determined that MECO's Maalaea facility requires a NPDES permit for industrial-related storm water runoff. A storm water permit application was submitted to the DOH on April 18, 1995. Application processing by the DOH is on hold until baseline storm water data are submitted. The DOH also promulgated regulations that require storm water runoff and dewatering permits for construction-related projects. These construction-related permits require discharge monitoring and implementation of best management practices during construction activities to comply with state water quality standards. To date, HECO has submitted several Notices of Intent (NOI) for both construction storm water discharge permits and dewatering permits. A NOI was also submitted in June 1995 for construction-related activities at MECO's Maalaea generation expansion project. HECO is also working cooperatively with the City & County of Honolulu Department of Public Works to obtain a blanket NPDES permit to discharge water removed from utility manholes into municipal storm drain systems.\nOn August 15, 1995, the DOH issued a notice of apparent violation of NPDES permit requirements to HELCO's Shipman generating station. The violation was for the failure to periodically calibrate temperature recording equipment. By letter dated September 5, 1995, HECO's Environmental Department informed the DOH that immediate corrective actions were taken by HELCO. The DOH was satisfied with the response and will not take further action. All HECO and MECO facilities were in compliance with NPDES permit conditions during 1995.\nDue to the proposed addition of generating units at MECO's Maalaea Generating Station, a UIC permit application was submitted to the DOH in September 1994 to install another injection well system to handle wastestreams that might be generated from the new generating units. The DOH approved MECO's construction of the new wells in December 1994, and injection well construction commenced at Maalaea in December 1995. The DOH also issued new UIC permits for HELCO's Puna (February 1995) and Keahole (March 1995) generating stations. As a result, HELCO has now received operating permits for all its facilities. HELCO and MECO are in compliance with new UIC monitoring requirements, including effluent monitoring and well status investigations. The DOH issued a notice of apparent violation to HELCO in August 1994 for failing to provide advanced notice of modification of the Hill No. 6 drainage well. The DOH requested additional information related to the drainage well modification in October 1994 and HECO responded on behalf of HELCO via letter in January 1995. In August 1995, the DOH issued a final notice and finding of violation, and assessed HELCO a $15,500 penalty, which HELCO paid to close the investigation. No further action is anticipated by the DOH.\nIn August 1993, MECO and HELCO were informed by the EPA that federal UIC permits would be required for all existing and proposed injection wells. Under the most recent agreement between the EPA and DOH, the EPA will allow the DOH to continue operation of its state UIC permit program. Hence, all affected injection wells (including dry wells) will be regulated by both federal and state UIC permits. MECO and HELCO facilities submitted completed UIC applications to the EPA in July 1994. A UIC application was also submitted for the proposed injection well system at Maalaea in November 1994. The EPA issued draft UIC permits and related public notices for the Keahole and Hill injection wells on May 22, 1995. HECO submitted comments on the draft permits in late June 1995. Final permits have not been issued. The EPA issued a letter to HECO in October 1995 confirming that the DOH-permitted wells may continue to operate without new EPA UIC permits. Currently, the EPA and DOH are discussing the possibility of consolidating federal requirements into the DOH UIC permits. Negotiations have been ongoing for several months.\nThe Federal Oil Pollution Act of 1990 (OPA) governs actual or threatened oil releases in navigable U.S. waters (inland waters and up to three miles offshore) and waters of the U.S.' exclusive economic zone (up to 200 miles to sea from the shoreline). Responsible parties under OPA are jointly, severally and strictly liable for oil removal costs incurred by the federal government or the state and damages to natural resources and real or personal property. Responsible parties include vessel owners and operators. OPA imposes fines and jail terms ranging in severity depending on how the release was caused. OPA also requires that responsible parties submit certificates of financial responsibility sufficient to meet the responsible party's maximum limited liability. Protection and Indemnity Insurance Clubs (mutual\ninsurance pools) have refused to issue these certificates because OPA provides for direct liability against guarantors. The Coast Guard issued interim guidelines in September 1992, which included the requirement that a spill response plan be submitted by February 18, 1993, and be finalized by August 18, 1993. The EPA and Hawaii Department of Transportation (DOT) also have similar requirements for submission of spill response plans. The EPA issued its proposed rules and guidelines on this matter in February 1993. With HTB exiting the fuel transportation business at the end of 1993, the Company's freight transportation operations subject the Company to significantly lessened environmental risks. HTB's fuel and lubricating oil and the other cargo carried in its barges may be accidentally discharged into ocean waters causing a pollution hazard, but the quantities carried do not pose a major environmental hazard. HTB and YB employees are trained to respond to oil or other spills that occur. The utilities filed preliminary plans on February 18, 1993 with regard to the following facilities: to the Coast Guard for the Kahului Harbor terminaling facility and pipeline; to the EPA for the Honolulu, Waiau, Kahe, Shipman and Kahului power plants, the Iwilei fuel storage facility, and the Ward Avenue facility; and to the DOT for the pipelines between Honolulu power plant and the Iwilei fuel storage facility and between the Chevron fuel storage facility in Hilo and the Shipman and Hill power plants, respectively. The EPA, DOT and Coast Guard promulgated regulations implementing OPA in July 1994, January 1993 and February 1993, respectively.\nRevised Facility Spill Response Plans (FSRPs) for the HECO Generating Stations (Kahe, Waiau, and Honolulu) and the Iwilei fuel storage facility were submitted to the EPA on January 12, 1995. HECO is awaiting the EPA's review and approval of these FSRPs. The HECO FSRP for the Kahe Generating Station was modified to include the Kahe pipeline, and was submitted to the DOT on February 15, 1995. The HECO pipeline connecting the Iwilei fuel storage facility and the Honolulu Generating Station was determined not to meet the DOT's definition of \"significant and substantial harm\". Thus, the DOT approval of the Honolulu- Iwilei pipeline FSRP is not required at this time in order to continue pipeline operations. The HECO Ward Avenue facility does not store more than one million gallons of oil, and is therefore not required to have an EPA approved response plan in order to continue storing\/handling oil. Instead, HECO completed a Certification of the Applicability of the Substantial Harm Criteria for the Ward Avenue Complex in June 1995. A revised Kahului response plan was submitted to the EPA and Coast Guard in January 1995. The Coast Guard and EPA approved the Kahului FSRP. In September 1994, it was determined that MECO's Maalaea power plant was also required to develop an oil spill response plan. The Maalaea FSRP was submitted to the EPA on August 31, 1994. HECO submitted the revised HELCO Hilo Area Pipeline FSRP to the DOT on February 12, 1995. The DOT approved the HELCO Hilo Area Pipeline FSRP on February 15, 1995, with the condition that additional clarification be provided on some areas of the plan (which has been done). HELCO's Shipman facility does not store more than one million gallons of oil, and is therefore not required to have an EPA approved response plan in order to continue storing\/handling oil. HELCO also completed a Certification of the Applicability of the Substantial Harm Criteria for the Shipman power plant, which was submitted in December 1995.\nAir quality controls. The generation stations of the utility subsidiaries operate under air pollution control permits issued by the DOH and, in a limited number of cases, by the EPA. The entire electric utility industry is being affected by the 1990 Amendments to the Clean Air Act. Hawaii utilities may be affected by the air toxics provisions (Title III) when the Maximum Allowable Control Technology (MACT) emission standards are proposed for generation units. Hawaii utilities are affected by the operating permit provisions (Title V). The DOH adopted implementing regulations on November 26, 1993 which required submission of permit applications for existing sources during 1994. All applications were filed in 1994 as required and supplementary information was filed in 1995. Results of further air quality analyses could trigger requirements to mitigate emission impacts. Reports on emissions of air toxics could trigger requirements to conduct risk assessments. Hawaii utilities are also affected by the enforcement provisions (Title VII) which require the EPA to promulgate new regulations which mandate \"enhanced monitoring\" of emissions from many generation units. In response, the EPA proposed rules on October 1, 1993 which allow for cost effective alternatives to costly continuous emission monitoring systems. The EPA withdrew that proposal in April 1995 for revision. A new draft rule is expected in early 1996 and, as ordered by federal court, a final rule is expected by July 1996.\nOn November 1, 1989, the DOH issued a Notice and Finding of Violation and Order indicating that Maalaea units X-1 and X-2 had exceeded operating limitations of 12 hours per day at various times in 1988. These incidents resulted from unscheduled unit outages and resulted in no net increase in emissions by MECO. Subsequently, MECO took steps to preclude future violations. An application for a\npermit modification was submitted to the EPA, revising the operating hour limitation to annual rather than daily. Approval was received from the EPA in July 1992. Settlement discussions as to the Notice of Violation have been unsuccessful to date. The DOH has not yet set a hearing on the Notice of Violation. Units X-1 and X-2 continue to operate in compliance with the revised permit.\nInitial source tests for HELCO's CT-2 generating unit in December 1989 indicated particulate emissions above permitted levels. Subsequent retesting confirmed earlier results. Following analysis, HECO (on behalf of HELCO) proposed in November 1990 that the permitted particulate limit be increased. By letter dated April 13, 1992, the EPA concurred that revision is warranted. HECO and HELCO worked with the DOH, the manufacturer and a consultant to determine an appropriate new emission limit for particulates as well as oxides of nitrogen. A comprehensive emission test program has been completed and on April 14, 1994, a final report was submitted to the DOH for its review. On May 5, 1994, a petition was submitted to the DOH to revise NOx limits, and an application to revise the particulate limit was submitted to the DOH on August 30, 1994. Follow-up questions from the DOH were received in October 1994 and were responded to in November 1994 and in February 1995. The DOH had issued a Notice of Violation on August 17, 1992 for the non-complying emissions. In accordance with discussions with the DOH, CT-2 continues to operate pending issuance of the revised permit.\nEmission tests conducted by MECO in January 1992 on the six diesel units at Miki Basin, Lanai were consistent with earlier indications that emissions were above permit limits. Those tests results were submitted to the DOH. After unit adjustments and improvements in measurements of hourly fuel usage, additional tests were conducted in July and September 1993 which indicated that all six units are in compliance with permit limits. A report on these tests was submitted to the DOH. After reviewing the report, the DOH concluded in a letter dated December 13, 1993 that all six units are operating in compliance with permit limits. The DOH will determine what action, if any, would be appropriate for the previous indications of violation.\nA Notice and Finding of Violation and Order was issued by the DOH to HELCO on July 8, 1993 for excessive visible emissions from Shipman Unit 1 on September 23, 1991 and on January 31, 1992. The DOH ordered HELCO to come into compliance. HELCO's written response to the DOH dated July 29, 1993 stated that HELCO had come into compliance and identified the cause of the problem as corroded air heater tubes that were replaced in February 1993. The repairs were necessarily delayed for approximately one year until there was sufficient island-wide generation to allow Unit 1 to be shutdown. No further action has been required by the DOH.\nHazardous waste and toxic substances controls. The operations of the electric utility and freight transportation subsidiaries are subject to regulations promulgated by the EPA to implement the provisions of the Resource Conservation and Recovery Act (RCRA), the Superfund Amendments and Reauthorization Act (SARA) and the Toxic Substances Control Act (TSCA). The DOH has been working towards obtaining primacy to operate state-authorized RCRA (hazardous waste) programs. The DOH finalized RCRA administrative rules in mid-June 1994, with the rules becoming effective on June 18, 1994. The DOH's state contingency plan and the state Environmental Response Law (ERL) rules were adopted in August 1995.\nWhether on a federal or state level, RCRA provisions identify certain wastes as hazardous and set forth measures that must be taken in the transportation, storage, treatment and disposal of these wastes. Some of the wastes generated at steam electric generating stations possess characteristics which make them subject to these EPA regulations. Since October 1986, all HECO generating stations have operated RCRA-exempt wastewater treatment units to treat potentially regulated wastes from occasional boiler waterside and fireside cleaning operations. Steam generating stations at MECO and HELCO also operate similar RCRA-exempt wastewater management systems. In March 1990, the EPA changed RCRA testing requirements used to characterize a waste as hazardous which potentially affected the hazardous waste generating status of all facilities. A new and more stringent Toxicity Characteristic Leaching Procedure replaced the former Extraction Procedure toxicity test and included additional testing requirements for 25 organic compounds. HECO's continuing program to recharacterize all HECO, MECO and HELCO wastestreams using the Toxicity Characteristic Leaching Procedure has demonstrated the adequacy of the existing treatment systems and identified other potential compliance requirements. Waste recharacterization studies indicate that treatment facility wastestreams are nonhazardous and no change in RCRA generator status is required.\nThe RCRA still regulates most generating stations as RCRA small quantity generators (SQGs). All Company facilities listed with the DOH and EPA as SQGs are believed to be in compliance with RCRA requirements. In July 1994, the DOH conducted hazardous waste compliance evaluation inspections at MECO's Kahului and Maalaea power plants to review facility status as SQGs. On October 20, 1994, the DOH issued warning letters and inspection reports to the Kahului and Maalaea facilities. Potential RCRA violations and areas of concern were listed for both facilities. HECO submitted responses to the DOH on December 5, 1994, contesting most of the potential violations cited by the DOH. With the exception of some solvent handling concerns, which have been corrected, all other areas of DOH concern were not RCRA hazardous waste violations. On February 20, 1995, the DOH favorably acknowledged HECO's response and issued MECO a \"Return to Compliance Letter\" for both facilities.\nRCRA underground storage tank (UST) regulations require all facilities with USTs used to store petroleum products to comply with costly leak detection, spill prevention and new tank standard retrofit requirements within a specified compliance period based on tank age. All HECO, MECO and HELCO USTs were in compliance with the DOH and EPA standards during 1995.\nThe Emergency Planning and Community Right-to-Know Act (EPCRA) under SARA Title III requires HECO, MECO and HELCO to report hazardous chemicals present in their facilities in order to provide the public with information on these chemicals so that emergency procedures can be established to protect the public in the event of hazardous chemical releases. HECO has six facilities, MECO five facilities and HELCO seven facilities that qualify as \"reporting facilities\" under EPCRA. All HECO, MECO and HELCO facilities are in compliance with applicable reporting requirements, which are made annually to the State Emergency Planning Commission, the Local Emergency Planning Committee and local fire departments. In September 1995, the EPA published a notice of proposed rule making to expand the types of industries required to file annual Toxic Release Inventory reports (i.e., to report facility releases of toxic chemicals). The proposed rule includes the steam electric category, which is currently exempt from Toxic Release Inventory reporting requirements. The EPA tentatively has scheduled the issuance of the proposed rule in April 1996.\nThe TSCA regulations specify procedures for the handling and disposal of polychlorinated biphenyl (PCB), a compound found in transformer and capacitor dielectric fluids. HECO and its subsidiaries have instituted procedures to monitor compliance with these regulations. In addition, HECO has implemented a program to identify and replace PCB transformers and capacitors in the HECO system. All HECO, MECO and HELCO facilities are currently believed to be in compliance with PCB regulations. In December 1994, the EPA published in the Federal Register a Proposed Rule to amend PCB disposal regulations. The proposed rule calls for changes in determining PCB concentrations, and in marking, storage and disposal requirements. The final rule is anticipated to be issued in June 1996.\nBy letter dated August 21, 1992 the EPA provided MECO with a notice of potential liability and request for information relating to a federal Superfund closure investigation at the North American Environmental, Inc. (NAE) storage facility in Clearfield, Utah. MECO was identified by the EPA as a potentially responsible party for three PCB capacitors originally contracted for disposal by Westinghouse. Although Westinghouse has already disposed of the capacitors, MECO was obligated to comply with the information requests attached to the EPA notice. A preliminary response to the EPA's information request was submitted to the EPA on October 5, 1992. MECO has since received confirmation from Westinghouse that the three capacitors were removed from the NAE facility and incinerated at Aptus (an EPA-approved facility in Kansas) on September 16, 1992. By letter dated December 2, 1992, the EPA notified MECO that a draft Administrative Order on Consent for the cleanup of the NAE facility had been sent to potentially responsible parties that have waste remaining at the NAE site and to parties that have expressed a desire to participate in the cleanup. MECO did not receive a draft Administrative Order on Consent because the three PCB capacitors were removed from the NAE facility and incinerated. By letter dated February 8, 1993, Westinghouse confirmed that it would indemnify MECO pursuant to its contract for this matter. In early 1995, the EPA issued an Administrative Order on Consent to the Freeport Center and the Defense Logistics Agency. Both agencies are responding to the AOC and are initiating corrective actions. Recovery of cleanup costs may fall back on other potentially responsible parties once cleanup is completed and costs have been determined.\nThe state ERL, as amended, governs releases of hazardous substances, including oil, in areas within the state's jurisdiction. Responsible parties under the state ERL are jointly, severally and strictly liable for a release of a hazardous substance into the environment. Responsible parties include owners or operators\nof a facility where a hazardous substance comes to be located and any person who at the time of disposal of the hazardous substance owned or operated any facility at which such hazardous substance was disposed. The DOH issued final rules (or State Contingency Plan) implementing the state ERL on August 17, 1995. Potential exposure to liability under the state ERL\/State Contingency Plan is associated with the release of regulated substances, including oil, to the environment.\nBy letters in January and February 1995, the DOH advised HECO, HTB, YB and others that the DOH was conducting an investigation to determine the nature and extent of actual or potential releases of hazardous substances, oil, pollutants or contaminants at or near Honolulu Harbor. The DOH letter to HECO requested information regarding past hazardous substances and oil spills that may have occurred at HECO's Honolulu power plant and nearby fuel storage and pipeline facilities, which are located near Honolulu Harbor. HECO submitted a response to the DOH on April 28, 1995. The DOH letters to HTB and YB requested information regarding past hazardous substances and oil spills that may have occurred at Pier 21 and Piers 24-29 in Honolulu Harbor. HTB and YB provided responses to the DOH letters. Based on a limited review of the responses received from HECO, HTB, YB and others, the DOH issued letters on December 18, 1995, indicating that the DOH has identified a number of parties, including HECO, HTB and YB, who appear to be either potentially responsible for the contamination and\/or operate their facilities upon contaminated land. The DOH met with these identified parties on January 24, 1996 to inform them of its findings and to establish the framework to determine remedial and cleanup requirements. The DOH's goal is the formation of a voluntary response group comprised of these identified parties. The Honolulu Harbor area of investigation was divided into four units, with the highest priority area (Iwilei Area) to be addressed first. The DOH met a second time with the identified parties on March 14, 1996, and additional meetings are being scheduled. Because the process for determining appropriate remedial and cleanup action, if any, is at an early stage, management cannot predict at this time the costs of future site analysis, remediation and cleanup requirements, if any, nor can it estimate when such costs, if any, would be incurred.\nBy letter dated December 15, 1994, the DOH advised MECO that the DOH was conducting an investigation to determine the nature and extent of actual or potential releases of hazardous substances, oil, pollutants or contaminants at Kaunakakai, Molokai, Hawaii. The DOH letter requested information regarding past hazardous substances and oil spills that may have occurred in the area of a former Molokai Electric Company, Limited's (MOECO) power plant site which had been located at Kaunakakai. Operations at this MOECO power plant were terminated in 1985, prior to MECO acquiring MOECO in 1989. In February 1995, HECO filed its initial response to the DOH's request for information, and filed additional information in March 1995. The DOH was contacted in December 1995 for an update of its investigation. According to the DOH, investigations in the near future will primarily focus on past pipeline releases that occurred near the Kaunakakai Harbor and will not involve the old power plant area. However, investigations around the old power plant may be renewed should future soil sampling indicate a problem.\nBoth HTB and YB generate small quantities of hazardous wastes as a result of operations and equipment maintenance activities and have contracted with a firm to dispose of these wastes in compliance with the EPA regulations and the RCRA provisions. YB, as a public carrier, also moves hazardous wastes and explosives for customers. Employees are trained in the applicable handling methods to assist in the safe movement of these cargoes. Both HTB and YB are subject to the jurisdiction of the Coast Guard which monitors ocean activities to ensure compliance with federal regulations.\nFinally, ASB may be subject to the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and regulations promulgated thereunder. CERCLA imposes liability for environmental cleanup costs on certain categories of responsible parties, including the current owner and operator of a facility and prior owners or operators who owned or operated the facility at the time the hazardous substances were released or disposed. CERCLA exempts persons whose ownership in a facility is held primarily to protect a security interest, provided that they do not participate in the management of the facility. Although there may be some risk of liability for ASB for environmental cleanup costs, the Company believes the risk is not as great for ASB, which specializes in residential lending, as it may be for other depository institutions which have a larger portfolio of commercial loans.\nRATING AGENCIES' ACTIONS\nAs of March 19, 1996, the Standard & Poor's (S&P), Moody's Investors Service (Moody's) and Duff & Phelps Credit Rating Co.'s (Duff & Phelps) ratings of HEI's and HECO's securities were as follows:\nThe Company has been informed by such rating agencies that each of the ratings referenced above is within a category that signifies \"investment grade.\" However, each such rating reflects only the view of the applicable rating agency at the time the rating is issued, from whom an explanation of the significance of such ratings may be obtained. Each rating should be evaluated independently of any other rating. There is no assurance that any such credit rating will remain in effect for any given period of time or that such rating will not be lowered, suspended or withdrawn entirely by the applicable rating agency if, in such rating agency's judgment, circumstances so warrant. Any such lowering, suspension or withdrawal of any rating may have an adverse effect on the market price or marketability of HEI's and\/or HECO's securities and serve to increase the cost of capital of HEI and HECO.\nNeither HEI nor HECO management can predict with certainty future rating agency actions or their effects on the future cost of capital of HEI or HECO.\nRESEARCH AND DEVELOPMENT - ------------------------\nHECO and its subsidiaries expensed approximately $2.2 million, $2.4 million and $2.3 million in 1995, 1994 and 1993, respectively, for research and development. Contributions to the Electric Power Research Institute accounted for most of the expenses. There were also expenses in the areas of energy conservation, environmental control, emissions control and for other similar studies relative to technologies with the potential of being specifically applicable to HECO, its subsidiaries and its customers.\nEMPLOYEE RELATIONS - ------------------\nAt December 31, 1995, the Company's continuing operations had 3,384 full-time and part-time employees, compared with 3,386 at December 31, 1994.\nHECO\nAt December 31, 1995, HECO and its subsidiaries had 2,208 employees, compared with 2,219 employees at December 31, 1994.\nThe current collective bargaining agreement between the International Brotherhood of Electrical Workers (IBEW), Local 1260, and HECO, MECO and HELCO, covering approximately 63% of the total employees of these companies, was extended in November 1995 for a two-year period from November 1, 1996 through October 31, 1998. The extension provides for noncompounded wage increases of 3% on November 1 of each year during the term of the agreement.\nThe current benefits agreement between IBEW Local 1260 and HECO, MECO and HELCO was also extended for a two-year period and will be in effect until October 31, 1998.\nHTB\nHTB and YB have a collective bargaining agreement with the Inlandboatmen's Union of the Pacific (IBU) effective from July 26, 1995 through July 25, 1998. A 2.5% across-the-board wage increase was effective for the first year, with 3% in the second and third years. Journeyman craftsmen were not included in this new contact but were covered in YB's contract with the International Longshoremen's and Warehousemen's Union (ILWU), Hawaii Division, Local 142. The agreement covers all employees of HTB and YB employed on ocean, inter-island and harbor tug operations and dispatchers. It excludes office clerical employees, confidential employees, professional and management employees, guards and watchmen.\nYB has a collective bargaining agreement covering the period of July 1, 1993 through June 30, 1996 with the, ILWU, Hawaii Division, Local 142. The agreement was ratified on December 23, 1994 after ten months of negotiation. The agreement covers all full-time and part-time receiving and delivery clerks working on the docks loading and discharging vessels, all maintenance personnel, documentation clerks and customer service representatives employed by YB in the state. The agreement excludes confidential employees, professional employees, supervisory employees, guards and other clerical personnel.\nOTHER\nThe employees of HEI and its direct and indirect subsidiaries are not covered by any collective bargaining agreement, except as identified above.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nHEI leases office space in downtown Honolulu. The leases expire at various dates - --- from March 31, 1996 to April 30, 1999 (with an option for HEI to extend one of the leases on most of the office space to March 31, 2001). HEI also leases office space from HECO in downtown Honolulu. The properties of HEI's subsidiaries are as follows:\nELECTRIC UTILITY - ----------------\nSee page 4 for the \"Generation statistics\" of HECO and its subsidiaries, such as generating and firm purchased capability, reserve margin and annual load factor.\nHECO owns and operates three generating plants on the island of Oahu at - ---- Honolulu, Waiau and Kahe, with an aggregate generating capability of 1,263 MW at December 31, 1995. The three plants are situated on HECO-owned land having a combined area of 535 acres. In addition, HECO owns a total of 124 acres of land on which are located substations, transformer vaults, distribution baseyards and the Kalaeloa cogeneration facility.\nElectric lines are located over or under public and nonpublic properties. Most of HECO's leases, easements and licenses have been recorded.\nHECO owns overhead transmission lines, overhead distribution lines, underground cables, fully-owned or jointly-owned poles and steel or aluminum high voltage transmission towers. The transmission system operates at 46,000 and 138,000 volts. The total capacity of HECO's transmission and distribution substations was 5,736,000 kilovoltamperes at December 31, 1995.\nHECO owns a building and approximately 11.5 acres of land located in Honolulu which houses its operating, engineering and information services departments and a warehousing center. It also leases an office building and certain office spaces in Honolulu. The lease for the office building expires in November 2002, with an option to further extend the lease to November 2012. The leases for certain office spaces expire on various dates through November 30, 2004 with options to extend to various dates through November 30, 2014.\nHECO owns 19.2 acres of land at Barbers Point used to situate fuel oil storage facilities with a combined capacity of 970,700 barrels. HECO also owns fuel oil tanks at each plant site with a total maximum usable capacity of 844,600 barrels.\nThe properties of HECO are subject to a first mortgage securing HECO's outstanding first mortgage bonds.\nA brief description of the properties of HECO's two electric utility subsidiaries follows:\nMECO owns and operates two generating plants on the island of Maui, at Kahului - ---- and Maalaea, with an aggregate capability of 201.3 MW. The plants are situated on MECO-owned land having a combined area of 28.6 acres. MECO also owns fuel oil storage facilities at these sites with a total maximum usable capacity of 145,300 barrels.\nMECO's administrative offices and engineering and distribution departments are located on 9.1 acres of MECO-owned land in Kahului.\nMECO also owns and operates smaller distribution and generation systems on the islands of Lanai and Molokai.\nThe properties of MECO are subject to a first mortgage securing MECO's outstanding first mortgage bonds.\nHELCO owns and operates five generating plants on the island of Hawaii. These - ----- plants at Hilo (2), Waimea, Kona and Puna have an aggregate generating capability of 154.6 MW (excluding two small run-of-river hydro units). The plants are situated on HELCO-owned land having a combined area of approximately 43 acres. HELCO owns 6.0 acres of land in Kona, which are used for a baseyard, and it leases 4.0 acres of land for its baseyard in Hilo. The lease expires in 2030. The deeds to the sites located in Hilo contain certain restrictions which do not materially interfere with the use of the sites for public utility purposes.\nThe properties of HELCO are subject to a first mortgage securing HELCO's outstanding first mortgage bonds.\nSAVINGS BANK - ------------\nASB owns its executive office building located in downtown Honolulu and land and - --- an office building in the Mililani Technology Park on Oahu.\nThe following table sets forth certain information with respect to branches owned and leased by ASB and its subsidiaries at December 31, 1995.\nThe net book value of branches and office facilities is approximately $40 million. Of this amount, $33 million represents the net book value of the land and improvements for the branches and office facilities owned by ASB and $7 million represents the net book value of ASB's leasehold improvements.\nOTHER - -----\nFREIGHT TRANSPORTATION - ----------------------\nHTB owned seven tugboats ranging from 1,430 to 2,668 HP, two tenders (auxiliary boats) of 500 HP and two flatdecked barges as of December 31, 1995.\nHTB owns no real property, but rents on a month-to-month basis its pier property used in its operations from the State of Hawaii under a revocable permit.\nYB, HTB's subsidiary, owned four tugboats, two doubledecked and six flatdecked barges and most of its shoreside equipment, including 20-foot containers, chassis, 20-foot and 40-foot refrigerated containers, container vans, hi-lifts, flatracks, automobile racks and other related equipment as of December 31, 1995.\nYB owns no real property, but rents on a month-to-month basis or leases various pier properties and warehouse facilities from the State of Hawaii under a revocable permit, or under a five-year lease. All lease terms began on January 1, 1992. It is expected that expiring leases will be renewed as necessary.\nREAL ESTATE DEVELOPMENT - -----------------------\nMPC. See Item 1, \"Business--Other--Real estate--Malama Pacific Corp.\" MDC, MPC's subsidiary owns 1.27 acres of land adjacent to HECO's Ward Avenue facility on Oahu. As of December 31, 1995, there is an agreement to sell 0.23 acres of the property. The remaining property is leased to HECO and other commercial tenants.\nOTHER - -----\nHEIIC. See Item 1, \"Business--Other--HEI Investment Corp.\"\nLVI operates a windfarm on the island of Hawaii with a generating capability of 1.6 MW. LVI leases 78 acres of land for its windfarm.\nAs of March 19, 1996, HEIPC leases office space in downtown Honolulu.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nExcept as provided for below and in \"Item 1. Business,\" there are no known material pending legal proceedings, other than ordinary routine litigation incidental to their respective businesses, to which HEI or any of its subsidiaries is a party or of which any of their property is the subject.\nDISCONTINUED OPERATIONS - -----------------------\nSee \"The Hawaiian Insurance & Guaranty Company, Limited\" in Note 2 to HEI's Consolidated Financial Statements, incorporated herein by reference to page 45 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nIn December 1994, five insurance agencies, which had served as insurance agents for HIG and its subsidiaries, filed a complaint against HEI, HEIDI and others. The complaint set forth several causes of action, including breach of contract and piercing the corporate veil. The plaintiffs asked for relief from the defendants, including compensatory damages for lost commissions, lost business and lost profits in an amount to be proven at trial and punitive damages. In August 1995, the court granted defendants' motions for summary judgment and in February 1996, the court directed that final judgment be entered.\nHECO POWER OUTAGE - -----------------\nSee \"HECO power outage\" in Note 4 to HEI's Consolidated Financial Statements, incorporated herein by reference to page 48 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nHELCO POWER SITUATION - ---------------------\nSee \"HELCO power situation\" on pages 6 and 7 of this report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nHEI AND HECO:\nDuring the fourth quarter of 1995, no matters were submitted to a vote of security holders of the Registrants.\nEXECUTIVE OFFICERS OF HEI\nThe following persons are, or may be deemed, executive officers of HEI. Their ages are given as of February 28, 1996 and their years of company service are given as of December 31, 1995. Officers are appointed to serve until the meeting of the HEI Board of Directors following the next Annual Meeting of Stockholders (which will occur on April 23, 1996) and\/or until their successors have been appointed and qualified (or until their earlier resignation or removal). Company service includes service with an HEI subsidiary.\nBusiness experience HEI Executive Officers for past five years - -------------------------------------------------------------------------------- Robert F. Clarke, age 53 President and Chief Executive Officer................... 1\/91 to date Director................................................ 4\/89 to date (Company service: 8 years)\nT. Michael May, age 49 Senior Vice President................................... 9\/95 to date Director................................................ 9\/95 to date (Company service: 3 years) T. Michael May is also President of HECO and served as HECO Senior Vice President from 2\/92 to 8\/95. Prior to joining HECO, he was a principal partner in Management Assets Group (a general management consulting practice) from 9\/89 to 1\/92.\nRobert F. Mougeot, age 53 Financial Vice President and Chief Financial Officer.... 4\/89 to date (Company service: 7 years)\nPeter C. Lewis, age 61 Vice President - Administration......................... 10\/89 to date (Company service: 27 years)\nCharles F. Wall, age 56 Vice President and Corporate Information Officer........ 7\/90 to date (Company service: 5 years)\nAndrew I. T. Chang, age 56 Vice President - Government Relations................... 4\/91 to date Manager, Government Relations........................... 8\/90 to 3\/91 (Company service: 11 years)\nConstance H. Lau, age 43 Treasurer............................................... 4\/89 to date (Company service: 11 years)\nCurtis Y. Harada, age 40 Controller.............................................. 1\/91 to date Auditor, HECO........................................... 7\/89 to 1\/91 (Company service: 6 years)\nBetty Ann M. Splinter, age 50 Secretary............................................... 10\/89 to date (Company service: 21 years)\nWayne K. Minami, age 53 President and Chief Executive Officer, American Savings Bank, F.S.B. ................. 1\/87 to date (Company service: 9 years)\nHEI's executive officers, with the exception of Charles F. Wall and Andrew I. T. Chang, are officers and\/or directors of one or more of HEI's subsidiaries. Mr. Minami is deemed an executive officer of HEI under the definition of Rule 3b-7 of the SEC's General Rules and Regulations under the Securities Exchange Act of 1934.\nThere are no family relationships between any executive officer of HEI and any other executive officer or director of HEI, or any arrangement or understanding between any executive officer and any person pursuant to which the officer was selected.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nHEI:\nThe information required by this item is incorporated herein by reference to pages 59 and 61 (Note 18, \"Regulatory restrictions on net assets\" and Note 21, \"Quarterly information (unaudited)\" to HEI's Consolidated Financial Statements) and page 25 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13. Certain restrictions on dividends and other distributions of HEI are described in this report under \"Item 1. Business-- Regulation and other matters--Restrictions on dividends and other distributions.\" The total number of holders of record of HEI common stock as of March 15, 1996, was 22,672.\nHECO:\nThe information required with respect to \"Market information\" and \"holders\" is not applicable. Since the corporate restructuring on July 1, 1983, all the common stock of HECO has been held solely by its parent, HEI, and is not publicly traded.\nThe dividends declared and paid on HECO's common stock for the four quarters of 1995 and 1994 were as follows:\nThe regulatory restrictions on net assets are incorporated herein by reference to page 27 (Note 12 to HECO's Consolidated Financial Statements, \"Regulatory restrictions on distributions to parent\") of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nHEI:\nThe information required by this item is incorporated herein by reference to page 25 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nHECO:\nThe information required by this item is incorporated herein by reference to page 2 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nHEI:\nThe information required by this item is set forth in MD&A, incorporated herein by reference to pages 27 to 36 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nHECO:\nThe information required by this item is set forth in HECO MD&A, incorporated herein by reference to pages 3 to 10 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nHEI:\nThe information required by this item is incorporated herein by reference to the section entitled \"Segment financial information\" on page 26 and to pages 38 to 61 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13.\nHECO:\nThe information required by this item is incorporated herein by reference to pages 11 to 30 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nHEI AND HECO:\nNone\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nHEI:\nInformation for this item concerning the executive officers of HEI is set forth on pages 41 and 42 of this report. The list of current directors of HEI is incorporated herein by reference to page 62 of HEI's 1995 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13. Information on the current directors' business experience and directorships is incorporated herein by reference to pages 3 to 6 of the registrant's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nThere are no family relationships between any director of HEI and any other executive officer or director of HEI, or any arrangement or understanding between any director and any person pursuant to which the director was selected.\nThe information required under this item by Item 405 of Regulation S-K is incorporated by reference to page 11 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHECO:\nThe following persons are, or may be deemed, executive officers of HECO. Their ages are given as of February 28, 1996 and their years of company service are given as of December 31, 1995. Officers are appointed to serve until the meeting of the HECO Board of Directors following the next HECO Annual Meeting and\/or until their respective successors have been appointed and qualified (or until their earlier resignation or removal). Company service includes service with HECO affiliates.\nHECO's executive officers, Robert F. Clarke, T. Michael May, Edward Y. Hirata, Paul A. Oyer and Molly M. Egged, are officers of one or more of the affiliated HEI companies.\nThere are no family relationships between any executive officer or director of HECO and any other executive officer or director of HECO, or any arrangement or understanding between any director and any person pursuant to which the director was selected.\nThe list of current directors of HECO is incorporated herein by reference to page 33 of HECO's 1995 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13. Information on the business experience and directorships of directors of HECO who are also directors of HEI is incorporated herein by reference to pages 3 through 6 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nMildred D. Kosaki, age 71, and Paul C. Yuen, age 67, as of February 28, 1996 are the only outside directors of HECO who are not directors of HEI. Mrs. Kosaki has been a director of HECO since 1973. She resigned from the HEI Board in 1987. She was also a director of the International Pacific University from 1989 to 1991. She is a specialist in education research. Dr. Yuen, who was elected a director of HECO in April 1993, is Dean of the College of Engineering at the University of Hawaii-Manoa. In the past five years, he has held various administrative positions at the University of Hawaii-Manoa. He also serves on the boards of Cyanotech Corporation and the Pacific International Center for High Technology Research. Information on Mr. Oyer's business experience and directorship is indicated above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nHEI:\nThe information required under this item for HEI is incorporated by reference to pages 8 and 9, 12 to 18 and 23 and 24 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHECO:\nThe following tables set forth the information required for the chief executive officers of HECO and the four other most highly compensated HECO executive officers serving at the end of 1995. All executive compensation amounts presented for Harwood D. Williamson and T. Michael May are the same amounts presented in HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nSUMMARY COMPENSATION TABLE - --------------------------\nThe following is the summary compensation table which sets forth the annual and long-term compensation of the chief executive officers of HECO and the four other most highly compensated executive officers of HECO serving at the end of 1995.\nSUMMARY COMPENSATION TABLE\n(1) Mr. Williamson retired as President and CEO effective September 1, 1995 and Mr. May succeeded Mr. Williamson effective the same date. (2) Includes a one-time lump sum transitional payment of $49,000 for Mr. Williamson and $9,800 for Mr. Oyer in 1994, representing two years of \"normalized\" insider directors' fees following a decision by the Compensation Committee of the HEI Board of Directors (the Committee) to discontinue all insider directors' fees, effective May 1, 1994. Also includes directors' fees of $7,700 for the period January 1 through April 30, 1994 and $28,000 for 1993 for Mr. Williamson and directors' fees of $1,400 for the period January 1 through April 30, 1994 and $5,600 for 1993 for Mr. Oyer. (3) The named executive officers are eligible for an incentive award under the Company's annual Executive Incentive Compensation Plan (EICP). EICP bonus payouts are reflected for the year earned. (4) Covers perquisites of $105,138 for Mr. May for 1993 which he recognized as imputed income under the Internal Revenue Code, including $40,026 for moving expenses grossed up for taxes and $63,282 for closing costs on the sale of his San Diego home grossed up for taxes. Covers interest earned on deferred compensation by Mr. Williamson at above-market interest rates on deferred annual and Long-Term Incentive Plan (LTIP) payouts as well as interest earned at market rates on deferred LTIP payouts in the amount of $86,184 for 1995, $76,465 for 1994 and $68,544 for 1993. Amounts for Mr. Oyer and Mr. Hirata represent above-market earnings on deferred annual payouts. (5) Except for Mr. Williamson, options granted did not include dividend equivalents. (6) LTIP payouts are determined in April each year for the three-year cycle ending on December 31 of the previous calendar year; if there is a payout, the amount is reflected as LTIP compensation in\nthe table for the previous year for the named executive officers. In April 1994, LTIP payouts were made for the 1991-1993 performance cycle and are reflected as LTIP compensation in the table for 1993. In April 1995, no LTIP payouts were made for the 1992-1994 performance cycle for the named executive officers. The determination of whether there will be a payout under the 1993-1995 LTIP will not be made until later this year.\n(7) Represents amounts accrued by the Company for certain death benefits provided to the named executive officers. Additional information is incorporated by reference to \"Other Compensation Plans\" on page 21 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nOPTION GRANTS IN LAST FISCAL YEAR - ---------------------------------\nThe following table shows the HEI stock options which were granted in 1995 to the executives named in the HECO Summary Compensation Table, all of which are nonqualified stock options. The practice of granting stock options, which may include dividend equivalent shares, has been followed each year since 1987.\n(1) For the 15,000 option shares granted with an exercise price of $32.83 per share to Mr. Williamson, additional dividend equivalent shares were granted at no additional cost throughout the four-year vesting period (vesting in equal installments) which began on the date of grant. Dividend equivalents are computed, as of each dividend record date, both with respect to the number of shares under the option and with respect to the number of dividend equivalent shares previously credited to the participant and not issued during the period prior to the dividend record date. No dividend equivalents were granted to the other named executive officers besides Mr. Williamson. Accelerated vesting is provided in the event a Change-in-Control occurs. No stock appreciation rights have been granted under the Company's current benefit plans.\n(2) Based on a Binomial Option Pricing Model which is a variation of the Black-Scholes Option Pricing Model. For the stock options granted on April 18, 1995, with a 10-year option period, an exercise price of $32.83, and with additional dividend equivalent shares granted for the first four years of the option (for Mr. Williamson only), the Binomial Value adjusted for forfeiture risk is $6.82 per share. The following assumptions were used in the model: Stock Price: $32.83; Exercise Price: $32.83; Term: 10 years; Volatility: 0.333; Interest Rate: 6.25%; and Dividend Rate: 6.57%. The following were the valuation results: Binomial Option Value: $2.82; Dividend Credit Value: $4.00; and Total Value $6.82.\nAGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES - -------------------------------------------------------------\nThe following table shows the stock options, including dividend equivalents, exercised by the named executive officers in 1995. Also shown is the number of unexercised options and the value of unexercised in the money options, including dividend equivalents, at the end of 1995. Under the Stock Option and Incentive Plan, dividend equivalents have been granted to Mr. Williamson as part of the stock option grant, except for the one-time, premium-priced grant to Mr. Williamson in May 1992.\nDividend equivalents permit a participant who exercises a stock option to obtain at no additional cost, in addition to the option shares, the amount of dividends declared on the number of shares of common stock with respect to which the option is exercised during the period between the grant and the exercise\nof the option. Dividend equivalents are computed, as of each dividend record date throughout the four-year vesting period (vesting in equal installments), which begins on the date of grant, both with respect to the number of shares underlying the option and with respect to the number of dividend equivalent shares previously credited to the executive officer and not issued during the period prior to the dividend record date.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n(1) Includes exercisable dividend equivalents of $27,900 for Mr. Oyer. All options were in the money (where the option price is less than the closing price on December 29, 1995) except the 1992 premium-priced stock option grant to Mr. Williamson without dividend equivalents with an exercise price of $41.00 per share. Value based on closing price of $38.75 per share on the New York Stock Exchange on December 29, 1995.\nLONG-TERM INCENTIVE PLAN AWARDS TABLE - -------------------------------------\nA Long-Term Incentive Plan award was made to one of the named executive officers in the HECO Summary Compensation Table, Mr. May. Additional information required under this item is incorporated by reference to page 15 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nPENSION PLAN - ------------\nThe Retirement Plan for Employees of Hawaiian Electric Industries, Inc. and Participating Subsidiaries (the Retirement Plan) provides a monthly retirement pension for life. Additional information required under this item is incorporated by reference to \"Pension Plans\" on pages 16 and 17 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996. As of December 31, 1995, the named executive officers in the HECO Summary Compensation Table had the following number of years of credited service under the Retirement Plan: Mr. Williamson, 39 years (as of September 1, 1995); Mr. May, 3 years; Mr. Oyer, 29 years; Mr. Iwahiro, 36 years; Mr. Hirata, 9 years; and Mr. Joaquin, 22 years.\nCHANGE-IN-CONTROL AGREEMENTS - ----------------------------\nMr. May is the only named executive officer in the HECO Summary Compensation Table with whom HEI has a currently applicable Change-in-Control Agreement. Additional information required under this item is incorporated by reference to \"Change-in-Control Agreements\" on pages 17 and 18 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHEI COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION - ---------------------------------------------------------------\nDecisions on executive compensation for the named HECO executive officers are made by the Committee which is composed of five independent nonemployee directors. All decisions by the Committee concerning HECO officers are reviewed by the full HEI Board of Directors except for decisions about HEI's stock-based plans, which are made solely by the Committee in order to satisfy Securities Exchange Act Rule 16b-3, and are reviewed and approved by the HECO Board of Directors. Information required under this item is incorporated by reference to pages 23 and 24 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHECO BOARD OF DIRECTORS - -----------------------\nCommittees of the HECO Board - ----------------------------\nDuring 1995, the Board of Directors of HECO had only one standing committee, the Audit Committee, which was comprised of four nonemployee directors: Ben F. Kaito, Chairman, and Mildred D. Kosaki, Diane J. Plotts and Paul C. Yuen. In 1995, the Audit Committee held five meetings to review with management, the internal auditor and HECO's independent auditors the activities of the internal auditor, the results of the annual audit by the independent auditor and the financial statements which are included in HECO's 1995 Annual Report to Stockholder. On December 31, 1995, Ben F. Kaito retired, and on January 16, 1996, Edwin L. Carter was elected a HECO director and was appointed Chairman of the HECO Audit Committee. The Audit Committee holds such meetings as it deems advisable to review the financial operations of HECO.\nRemuneration of HECO Directors and attendance at meetings - ---------------------------------------------------------\nIn 1995, Mildred D. Kosaki and Paul C. Yuen were the only nonemployee directors of HECO who were not also directors of HEI. They were paid a retainer of $12,000, one-half of which was distributed in the common stock of HEI pursuant to the HEI Nonemployee Director Stock Plan and one-half of which was distributed in cash. The number of shares of stock distributed was based on a price of $34.375 per share, which is equal to the closing sales price of HEI common stock on the New York Stock Exchange on April 18, 1995, as quoted in \"Composite Transactions\" in The Wall Street Journal, divided into $6,000, with a cash payment made in lieu of any fractional share. The nonemployee directors of HECO who were also nonemployee directors of HEI did not receive a separate retainer from HECO. In addition, a fee of $700 was paid in cash to each nonemployee director (including nonemployee directors of HECO who are also nonemployee directors of HEI) for each Board and Committee meeting attended by the director. The Chairman of the Audit Committee was paid an additional $100 for each Committee meeting attended. Effective May 1, 1994, employee members of the Board of Directors were no longer compensated for attendance at any meeting of the Board or committees of the Board.\nIn 1995, there were six regular bi-monthly meetings and one special meeting of the Board of Directors. All incumbent directors, attended at least 75% of the combined total number of meetings of the Board and Committee on which they served.\nHECO participates in the Nonemployee Director Retirement Plan, a description of which is incorporated by reference to page 8 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nHEI:\nThe information required under this item is incorporated by reference to pages 10 and 11 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHECO:\nHEI owns all of the common stock of HECO, which is HECO's only class of voting securities. HECO has also issued and has outstanding various series of preferred stock, the holders of which, upon certain defaults in dividend payments, have the right to elect a majority of the directors of HECO.\nThe following table shows the shares of HEI common stock beneficially owned by each HECO director (other than those who are also directors of HEI), named HECO executive officers as listed in the\nSummary Compensation Table on pages 47 and 48 and by HECO directors and officers as a group, as of February 14, 1996, based on information furnished by the respective individuals.\n* Also a named executive officer listed in the Summary Compensation Table on pages 47 and 48.\n** HECO directors Messrs. Carter, Clarke, Henderson and May and Ms. Plotts, who also serve on the HEI Board of Directors are not shown separately, but are included in the total amount. The information required as to these directors is incorporated by reference to pages 10 and 11 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996. Messrs. Clarke and May are also named executive officers listed in the Summary Compensation Table incorporated by reference to pages 12 and 13 of the above-referenced Definitive Proxy Statement of HEI. The number of shares of common stock beneficially owned by any HECO director or by all HECO directors and officers as a group does not exceed 1% of the outstanding common stock of HEI. (a) Sole voting and investment power. (b) Shared voting and investment power (shares registered in name of respective individual and spouse). (c) Shares owned by spouse, children or other relatives sharing the home of the director or an officer in the group and in which personal interest of the director or officer is disclaimed. (d) Stock options, including accompanying dividend equivalents shares, exercisable within 60 days after February 14, 1996, under the 1987 Stock Option and Incentive Plan, as amended in 1992.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nHEI:\nThe information required under this item is incorporated by reference to pages 23 to 25 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders to be held on April 23, 1996.\nHECO:\nThe information required under this item is incorporated by reference to pages 23 to 25 of HEI's Definitive Proxy Statement, prepared for the Annual Meeting of Stockholders 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\n(a)(1) FINANCIAL STATEMENTS\nThe following financial statements contained in HEI's 1995 Annual Report to Stockholders and HECO's 1995 Annual Report to Stockholder, portions of which are filed by HEI as Exhibit 13 and, portions of which are filed by HECO as Exhibit 13, respectively, are incorporated by reference in Part II, Item 8, of this Form 10-K:\n(a)(2) FINANCIAL STATEMENT SCHEDULES\nThe following financial statement schedules for HEI and HECO are included in this Report on the pages indicated below:\nCertain Schedules, other than those listed, are omitted because they are not required, or are not applicable, or the required information is shown in the consolidated financial statements or notes included in HEI's 1995 Annual Report to Stockholders and HECO's 1995 Annual Report to Stockholder, which financial statements are incorporated herein by reference.\n(A)(3) EXHIBITS\nExhibits for HEI and HECO and their subsidiaries are listed in the \"Index to Exhibits\" found on pages 60 through 66 of this Form 10-K. The exhibits listed for HEI and HECO are listed in the index under the headings \"HEI\" and \"HECO,\" respectively, except that the exhibits listed under \"HECO\" are also considered exhibits for HEI.\n(B) REPORTS ON FORM 8-K\nHEI AND HECO:\nDuring the fourth quarter of 1995, HEI and HECO filed Current Reports, Forms 8-K, with the SEC dated December 11, 1995 and December 13, 1995. These reports contained information under Item 5, Other events, regarding HECO's receipt of a 1995 final rate order (Form 8-K dated December 11, 1995) and regarding an update of the HELCO power situation and discontinued operations (Form 8-K dated December 13, 1995).\n[KPMG Peat Marwick letterhead]\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders Hawaiian Electric Industries, Inc.:\nUnder date of January 25, 1996, we reported on the consolidated balance sheets of Hawaiian Electric Industries, Inc. 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 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 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.\n\/s\/ KPMG Peat Marwick LLP\nHonolulu, Hawaii January 25, 1996\n[KPMG Peat Marwick letterhead]\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholder Hawaiian Electric Company, Inc.:\nUnder date of January 25, 1996, we reported on the consolidated balance sheets and consolidated statements of capitalization of Hawaiian Electric Company, Inc. (a wholly owned subsidiary of Hawaiian Electric Industries, Inc.) 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 years in the three-year period ended December 31, 1995, as contained in the 1995 annual report to stockholder. 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. 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\nHonolulu, Hawaii January 25, 1996\nHawaiian Electric Industries, Inc. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT HAWAIIAN ELECTRIC INDUSTRIES, INC. (PARENT COMPANY) CONDENSED BALANCE SHEETS\nAs of December 31, 1995, HEI guaranteed debt of its subsidiaries and affiliates amounting to $10 million.\nThe aggregate payments of principal required on long-term debt subsequent to December 31, 1995 are $42 million in 1996, $51 million in 1997, $1 million in 1998, $41 million in 1999, $10 million in 2000 and $79 million thereafter.\nHawaiian Electric Industries, Inc. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) HAWAIIAN ELECTRIC INDUSTRIES, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF INCOME\nHawaiian Electric Industries, Inc. SCHEDULE I-- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) HAWAIIAN ELECTRIC INDUSTRIES, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS\nSupplemental disclosures of noncash activities: In 1995 and 1994, $1.3 million and $16.9 million, respectively, of HEI advances to HEIDI were converted to equity in a noncash transaction. Common stock dividends reinvested by stockholders in HEI common stock in noncash transactions amounted to $20 million in 1995, $18 million in 1994 and $17 million in 1993.\nHawaiian Electric Industries, Inc. and Hawaiian Electric Company, Inc. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1995, 1994 and 1993\n(a) Primarily bad debts recovered. (b) Bad debts charged off.\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. A copy of any exhibit may be obtained upon written request for a $0.20 per page charge from the HEI Stock Transfer Division, P.O. Box 730, Honolulu, Hawaii 96808-0730.\nHEI Exhibit 11\nHawaiian Electric Industries, Inc. COMPUTATION OF EARNINGS PER SHARE OF COMMON STOCK Years ended December 31, 1995, 1994, 1993, 1992 and 1991\nNote: The dilutive effect of stock options is not material.\nHEI Exhibit 12 (page 1 of 2)\nHawaiian Electric Industries, Inc. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Years ended December 31, 1995, 1994, 1993, 1992 and 1991\n(1) Excluding interest on ASB deposits.\n(2) Including interest on ASB deposits.\n(3) Total interest charges exclude interest on nonrecourse debt from leveraged leases which is not included in interest expense in HEI's consolidated statements of income.\nHEI Exhibit 12 (page 2 of 2)\nHawaiian Electric Industries, Inc. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Years ended December 31, 1995, 1994, 1993, 1992 and 1991--Continued\n(1) Excluding interest on ASB deposits.\n(2) Including interest on ASB deposits.\n(3) Total interest charges exclude interest on nonrecourse debt from leveraged leases which is not included in interest expense in HEI's consolidated statements of income.\nHECO Exhibit 12\nHawaiian Electric Company, Inc. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Years ended December 31, 1995, 1994, 1993, 1992 and 1991\nHEI Exhibit 21\nHawaiian Electric Industries, Inc. SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of all subsidiary corporations of the registrant as of March 19, 1996:\nHECO Exhibit 21\nHawaiian Electric Company, Inc. SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of all subsidiary corporations of the registrant as of March 19, 1996:\n[KPMG Peat Marwick letterhead] HEI Exhibit 23\nThe Board of Directors Hawaiian Electric Industries, Inc.:\nWe consent to incorporation by reference in Registration Statement Nos. 33-56561 and 33-58820 on Form S-3 and in Registration Statement Nos. 33-65234 and 33- 52911 on Form S-8 of Hawaiian Electric Industries, Inc. of our report dated January 25, 1996, relating to the consolidated balance sheets of Hawaiian Electric Industries, Inc. 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 years in the three-year period ended December 31, 1995, which report is incorporated by reference in the 1995 annual report on Form 10-K of Hawaiian Electric Industries, Inc. We also consent to incorporation by reference of our report dated January 25, 1996 relating to the financial statement schedules of Hawaiian Electric Industries, Inc. in the aforementioned 1995 annual report on Form 10-K, which report is included in said Form 10-K.\n\/s\/ KPMG Peat Marwick LLP\nHonolulu, Hawaii March 19, 1996\nHECO Exhibit 99\nHawaiian Electric Company, Inc. RECONCILIATION OF ELECTRIC UTILITY OPERATING INCOME PER HEI AND HECO CONSOLIDATED STATEMENTS OF INCOME\nYears ended December 31, ----------------------------------- (in thousands) 1995 1994 1993 - ---------------------------------------------------------------------------\n[S] [C] [C] [C] Operating income from regulated and nonregulated activities before income taxes (per HEI Consolidated Statements of Income).... $159,043 $136,628 $119,565\nDeduct: Income taxes on regulated activities.. (50,719) (43,820) (37,007) Revenues from nonregulated activities. (6,732) (6,411) (5,100)\nAdd: Expenses from nonregulated activities. 1,130 915 627 -----------------------------------\nOperating income from regulated activities after income taxes (per HECO Consolidated Statements of Income)............................ $102,722 $ 87,312 $ 78,085 ===================================\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized. The signatures of the undersigned companies shall be deemed to relate only to matters having reference to such companies and any subsidiaries thereof.\nHAWAIIAN ELECTRIC INDUSTRIES, INC. HAWAIIAN ELECTRIC COMPANY, INC. (Registrant) (Registrant)\nBy \/s\/ Robert F. Mougeot By \/s\/ Paul Oyer ---------------------- --------------------- Robert F. Mougeot Paul A. Oyer Financial Vice President and Financial Vice President, Chief Financial Officer of HEI Treasurer and Director (Principal Financial Officer of HEI) of HECO (Principal Financial Officer of HECO)\nDate: March 19, 1996 Date: March 19, 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 indicated on March 19, 1996. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named companies and any subsidiaries thereof.\nSIGNATURE TITLE - ------------------------ --------------------------------------------\n\/s\/ Robert F. Clarke President and Director of HEI - ------------------------ Chairman of the Board of Directors of HECO Robert F. Clarke (Chief Executive Officer of HEI)\n\/s\/ T. Michael May Director of HEI - ------------------------ President and Director of HECO T. Michael May (Chief Executive Officer of HECO)\n\/s\/ Robert F. Mougeot Financial Vice President and - ------------------------ Chief Financial Officer of HEI Robert F. Mougeot (Principal Financial Officer of HEI)\n\/s\/ Curtis Y. Harada Controller of HEI - ------------------------ (Principal Accounting Officer of HEI) Curtis Y. Harada\n\/s\/ Paul Oyer Financial Vice President, Treasurer and - ------------------------ Director of HECO Paul A. Oyer (Principal Financial Officer of HECO)\nSIGNATURES (CONTINUED)\nSIGNATURE TITLE - ------------------------ -----------------------------------------\n\/s\/ Ernest T. Shiraki Controller of HECO - ------------------------ (Principal Accounting Officer of HECO) Ernest T. Shiraki\n\/s\/ Don E. Carroll Director of HEI - ------------------------ Don E. Carroll\n\/s\/ Edwin L. Carter Director of HEI and HECO - ------------------------ Edwin L. Carter\n\/s\/ John D. Field Director of HEI - ------------------------ John D. Field\n\/s\/ Richard Henderson Director of HEI and HECO - ------------------------ Richard Henderson\n\/s\/ Mildred D. Kosaki Director of HECO - ------------------------ Mildred D. Kosaki\nDirector of HEI - ------------------------ Victor Hao Li\n\/s\/ Bill D. Mills Director of HEI - ------------------------ Bill D. Mills\nDirector of HEI - ------------------------ A. Maurice Myers\n\/s\/ Ruth M. Ono Director of HEI - ------------------------ Ruth M. Ono\nSIGNATURES (CONTINUED) ----------------------\nSIGNATURE TITLE - -------------------------- -----------------------------\n\/s\/ Diane J. Plotts Director of HEI and HECO - -------------------------- Diane J. Plotts\n\/s\/ James K. Scott Director of HEI - -------------------------- James K. Scott\nDirector of HEI - -------------------------- Oswald K. Stender\n\/s\/ Kelvin H. Taketa Director of HEI - -------------------------- Kelvin H. Taketa\n\/s\/ Jeffrey N. Watanabe Director of HEI - -------------------------- Jeffrey N. Watanabe\n\/s\/ Paul C. Yuen Director of HECO - -------------------------- Paul C. Yuen","section_15":""}
{"filename":"719152_1995.txt","cik":"719152","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nMedar, Inc. (\"The Company\") develops, manufactures and markets microprocessor-based process monitoring and control systems for use in industrial manufacturing environments. The principal applications for the Company's products include optical inspection systems and resistance welding controls. In 1978, Maxco Inc., a publicly-held, Michigan-based holding company (\"Maxco\") formed the Company under Michigan law for the purpose of acquiring the Company's predecessor. The predecessor company was incorporated under Delaware law in 1969 and was also called Medar, Inc. From 1978 to 1983, the Company was 100% owned by Maxco. In June of 1983, the Company issued to the public 800,000 shares of Common Stock, reducing Maxco's ownership to 80%. In July 1985, the Company issued 1,131,250 additional shares, and Maxco sold 881,250 shares, of Common Stock in a public offering, reducing Maxco's ownership to 39%. In May 1994, the Company issued 1,300,000 shares, and Maxco sold 145,000 shares of common stock in a public offering, further reducing Maxco's ownership to 22%. As of February 29, 1996, Maxco's ownership of the Company's Common Stock was just below 20%.\nMost of the Company's Canadian sales of resistance welding controls are effected through its wholly-owned subsidiary, Medar Canada Ltd., located in Oshawa, Ontario, Canada. In 1987, the Company acquired 80% of the outstanding stock of Integral Vision-AID, Inc. (\"AID\"), formerly Automatic Inspection Devices, Inc., a developer and manufacturer of optical inspection devices, from Owens-Illinois, Inc. In 1991, the Company acquired the remaining 20% of such stock. Most of the Company's development and sales of certain optical inspection products are effected through AID.\nIn 1994, the Company formed a joint venture with Shanghai Electric Welding Machine Works and Lida, USA called Shanghai Medar Welding Equipment Corp., Ltd., a manufacturer of resistance welding controls located in China. The Company owns 21.3% of this joint venture.\nIn February 1995, the Company acquired 100% of the common stock and preference shares of Integral Vision Ltd. (\"Integral\"), an English corporation, for 654,282 previously unissued shares of Medar, Inc. common stock. Integral is a machine vision company which develops and manufactures solutions for OEM's and end-users.\nWhen used herein, unless the context indicates otherwise, \"Medar\" or the \"Company\" also refers to the Company's predecessor and subsidiaries. The Company's principal offices are located at 38700 Grand River Avenue, Farmington Hills, Michigan 48335 and its telephone number is (810) 471-2660.\nINDUSTRY BACKGROUND\nProcess monitoring and inspection for quality control are critical aspects of virtually every manufacturing process. Prior to the advent of microprocessor-based controls, most monitoring and inspection procedures were performed manually, often resulting in the interruption of continuous production lines. Manual inspection is generally less reliable than machine-based methods and is subject to limitations in accuracy and precision. In many cases manual inspection is performed on a random sampling basis and can result in the failure to detect defects on a timely basis. The introduction of microprocessor-based control systems for manufacturing environments has enabled high-quality monitoring and inspection without delaying continuous production. These systems have been developed to control and automate a variety of manufacturing tasks including resistance welding and product inspection.\nOptical Inspection Equipment\nSophisticated manufacturing techniques often require high-speed inspection that is difficult and time-consuming to evaluate using conventional manual and visual methods. Human visual inspection is further limited by physical endurance and often results in inconsistent interpretations of quality.\nRecent advancements in microprocessor-based systems and other technologies enhance the use of optics to identify defects and determine dimensional attributes. Which technology is deployed will depend on the types of materials to be inspected, the physical size and shape of manufactured products, the nature of defects and the speed with which the inspection must be performed. Optical inspection systems use an illumination source, data collection sensors and data analysis software. Proper illumination is a critical factor and can be achieved using a variety of sources such as white light or lasers. Light is projected through or reflected from an object and is collected by sensors, such as cameras and photo-electric cells. Software processes the resulting data and compares it to established acceptable patterns and tolerances. Based on this comparison, the part may be rejected or other corrective actions implemented.\nThere are two major technologies currently used for optical inspection. In \"matrix technology,\" sensors are arranged in a two-dimensional grid, gathering two-dimensional data from a surface in a single frame. Also, when working in conjunction with a form of structured lighting, these two-dimensional images can be processed to form three dimensional data. In \"linear array technology,\" sensors are arranged in a single line, can assemble a two-dimensional image from a series of single-line scans and are capable of much higher resolutions. The Company has the capability of providing both \"matrix technology\" and \"linear array technology\".\nResistance Welding Controls and Systems\nResistance welding is a commonly used process for joining metals. Materials to be welded are mechanically forced together while a controlled amount of electrical current is passed through them. The materials' resistance to the conduction of current generates sufficient heat at the point of contact to create a semi-molten state. As the metals cool, they are fused together. The welding process is difficult to monitor due to the high levels of electrical current required and the inability to examine a weld in process. Defective welds generate higher manufacturing costs due to increased rejects, downtime, and use of redundant welds. Improper welds can also create problems ranging from annoying squeaks and broken parts to significant safety hazards.\nThe major challenge in controlling the resistance welding process is properly regulating the electrical current required to create a high-quality weld. Insufficient current results in inadequate melting of metal, while excessive current results in unwanted expulsion of molten metal, increasing costs and lowering weld quality. Variations in welding conditions further complicate the process. For example, copper electrodes used to deliver current to the weld spot become distorted over time, altering their conductive properties and requiring changes in the amount of current needed to assure a high-quality weld. In addition, factory voltage fluctuations and differing metal conditions alter the delivery of current to the weld. Trends toward higher quality, lighter weight materials and extended warranty periods have demanded the use of coated metals, aluminum and alloys with unique conductive properties. All of these factors contribute to the need for more sophisticated welding controls.\nMicroprocessor-based welding controls, introduced in the late 1970s, improved weld quality by continuously monitoring and automatically adjusting the current, compensating for numerous variations in welding conditions. Controls are typically used in conjunction with portable welding guns, robotic welders and fixed-machine welders. Creation of a weld involves several steps organized in a \"weld sequence,\" including delivery of a single pulse or multiple pulses of current at specified intervals. The function of a control is primarily to provide specified amounts of electrical current for precise durations in a weld sequence after certain conditions have been met.\nThe base of suppliers to the worldwide market for resistance welding controls is highly fragmented, with demand concentrated in the automotive and appliance industries. The primary geographic markets for resistance welding controls are in North America, Europe and Japan. While the Company believes the welding controls market in North America is mature, recent growth in the welding control industry has resulted from improvements in welding control technology, re-tooling associated with introduction of new automobile body styles and improved business conditions for U.S. automobile manufacturers. In addition, the Company believes that higher demand for welding controls will result from industrial modernization in China, India, Russia, South America and Southeast Asian countries.\nTHE MEDAR SOLUTION\nMedar develops, manufactures, and markets microprocessor-based process monitoring and control products for use in manufacturing environments. The Company focuses its efforts on resistance welding controls and optical inspection and gauging equipment. The Company's welding controls monitor and automatically regulate electrical current for industrial resistance welding applications. The majority of the Company's optical inspection equipment is used to detect manufacturing defects in various optical storage media such as audio compact discs (\"Audio CDs\") and compact discs-read only memory (\"CD-ROM's\").\nOptical Inspection\nThe Company has developed optical inspection systems that utilize white-light or laser illumination, linear-array or matrix technologies, and sophisticated analytical software. The cornerstone of the Company's optical inspection capability is its expertise in linear array technology, which it began developing in 1985. In 1987, the Company significantly strengthened its linear array capabilities with the acquisition of AID from Owens-Illinois, Inc. At that time, AID had developed linear array technology for on-line detection of imperfections in glass containers, which the Company then adapted for inspection of various optical media such as Audio CDs and CD-ROM's.\nIn the Company's linear array optical disc inspection systems, a line of white light is projected onto the disc using specially-developed optics and collected with a linear array camera. Image processing software then analyzes and compares collected data to customer quality specifications. This collected data may also be used for statistical analysis and process control. The Company's systems can be integrated into production lines and are capable of completing an inspection cycle in less than one second. The Company believes its products provide a more cost-effective solution to optical disc inspection than laser-based systems.\nOptical discs, made of a translucent plastic raw material, are molded with microscopic pits that represent digital information. A thin layer of reflective aluminum is applied, followed by a protective lacquer coating and a silk-screened printed label. Discs are generally marked with a bar code or alphanumeric code for identification purposes. The Company offers optical inspection systems for 130 millimeter, 120 millimeter, 80 millimeter and 65 millimeter optical disc formats. Medar's standard defect inspection equipment can detect surface scratches, bubbles, black specks, pin holes, disc warp and other imperfections down to resolutions of 40 microns. Customers can specify optional features for reading bar codes, inspecting lacquer coatings, and birefringence measurement. Inspection systems can be configured to achieve resolutions to 20 microns to satisfy the demanding tolerances of higher-density optical storage media such as \"write-once\" Recordable Compact Discs (\"CD-R\") and \"multiple write\" Magneto-Optical (\"MO\") discs. Replacement of existing Audio CDs as a principal medium for music or the failure of one or more of CD-ROM, CD-R, or MO storage technologies to gain widespread acceptance could adversely affect the markets for the Company's products.\nThe Company's current family of optical inspection equipment is sold primarily to original equipment manufacturers (\"OEMs\") and end-users of Audio CD and CD-ROM manufacturing equipment. For sales to OEMs, the Company's products are typically integrated directly into optical disc production equipment. The Company believes that its inspection systems are the systems of choice for most of the major OEMs worldwide that sell optical disc manufacturing equipment.\nThe acquisition of Integral in 1995 provides the Company with additional inspection products to its existing matrix product line as well as synergies with its existing optical inspection product line, including systems which inspect the printed surface of a compact disc to verify label quality and another which reads and identifies alphanumeric catalog identification codes to prevent mislabeling.\nResistance Welding Controls\nThe Company markets a full line of welding controls. These controls monitor and automatically regulate electrical current passing through materials being welded, compensating for variations in materials, coatings and certain other welding system characteristics. Many of the Company's products are fully programmable, allowing users to tailor welding sequences to particular applications using one welding control. The Company has designed two levels of \"integration,\" combining its controls with other forms of factory automation as follows: \"Level 1\" integration replaces\n\"hard-wired\" connections between the welding control and other equipment (\"discrete input\/output\") with a serial communications link; \"Level 2\" integration allows customers to incorporate the welding controls directly into existing microprocessor-based factory floor automation system control racks. This approach reduces overall system complexity, manufacturing floor space requirements, and total welding system cost.\nThe Company's products range from the low-end MedWeld 200 Series to the high-end MedWeld 700 and 3000 Series. The MedWeld 200 Series are low-cost, stand-alone systems for fixed weld sequences targeted at industrial manufacturers in emerging markets as well as domestic appliance manufacturers. The MedWeld 700 Series controls, also stand-alone systems, are capable of Level 1 integration and feature fully-programmable weld sequences and serial communications capabilities. This series is used by automotive and aerospace manufacturers in North America. The Company provides Level 1 integration with robotic equipment manufacturers including Fanuc Robotics North America, Inc. and Kawasaki Robotics USA. The MedWeld 3000 Series, are welding subsystems that permit Level 2 integration with programmable controllers and robotic welding systems. The MedWeld 3000 Series is currently integrated with equipment manufactured by Allen-Bradley Company, Inc., ABB Robotics, Inc. and Nachi Robotics Systems, Inc. The Company believes that its integrated approach continues to represent a significant market opportunity.\nThe Company's product line uses common design elements, incorporates communications links and includes sophisticated feedback systems. The Company has developed a \"weld kernel\" that consists of core hardware and software needed for production of a wide range of welding controls in a single modular design. This weld kernel, which results in significantly reduced manufacturing and service costs as well as faster product design cycles, is currently being incorporated into the Company's welding control products under development. The Company's communications products, including Weld Information Centers and Weld Support Systems, link multiple controls with customers' computer systems in order to program weld sequences and archive data for trend analysis and substantiation of weld quality, all from a central location.\nMedar's feedback systems include SureWeld Stepper, which regulates current to compensate for electrode wear, and the Thermal Force Feedback System, which monitors the expansion of parts as they are welded to determine when a high-quality weld has been formed.\nBUSINESS STRATEGY\nThe Company intends to maintain and enhance its position in both the resistance welding control and optical inspection equipment markets by providing technically innovative products, expanding applications for its existing technologies and providing comprehensive customer service and support. Key elements of the Company's business strategy include the following:\nBroaden Applications and Technology Base. The Company actively seeks to develop additional applications for its existing technologies. Medar also intends to continue to acquire or develop new technologies and introduce cost effective products with higher performance and functionality. For example, the Company's mid-frequency welding control, which the Company began shipping in early 1996, provides customers with more efficient and higher quality welds for aluminum and heavy thicknesses of steel. In addition, the Company believes its VisionBlox software introduced in February 1996 has a wide range of use in many vision applications.\nExpand International Sales. The Company continually seeks to increase the markets for its products outside of the United States. Although the vast majority of the Company's welding control sales have historically been derived in North America, the Company believes that its low-cost MedWeld 200 Series will provide significant opportunities for sales outside of North America. The Company has established international distribution relationships for welding controls in Mexico and Southeast Asia and in 1994 formed a joint venture with Shanghai Electric Welding Machine Works, one of two primary manufacturers of welding equipment in China. The Company is expanding its marketing efforts for optical disc inspection systems through both direct sales efforts and a network of sales agents in Japan, Western Europe and Southeast Asia. The acquisition of Integral also gives the Company a base of operations in Europe.\nIntegrate With Other Manufacturers' Products. The Company intends to continue the integration of its products with other manufacturers' factory automation systems. Integration offers many advantages to customers, including lower costs, ease of maintenance, and reduced manufacturing floor space requirements. Welding controls have been integrated with products from major programmable controller manufacturers and several robotics manufacturers. Additionally, the Company has integrated its optical inspection equipment into various optical disc manufacturing lines. This integration approach allows the Company to leverage the sales and marketing capabilities of OEMs such as Allen-Bradley Company, Inc., ABB Robotics, Inc., Nachi Robotics Systems, Inc., ROBI-Systemtechnik A.G., and Origin Electric Co., Ltd. The Company believes there are additional opportunities to further integrate its products with those of other manufacturers.\nProvide Comprehensive Customer Service and Support. The Company believes that providing a high level of service and support has been and will continue to be a significant factor in its continued success. The Company actively seeks qualified employees who can provide effective solutions to customer problems. The Company also exploits its technologies to address customer needs. For example, Medar's networked welding control systems can be accessed remotely to provide on-line diagnostic services via modem in the event of product failures. The Company believes it has a solid understanding of the markets it serves through close association with its customers. Customer feedback regarding product performance, desired features and emerging industry trends have helped the Company maintain its focus on customer needs. The Company plans to continue expanding its customer support organization.\nAs part of its business strategy, the Company intends to pursue rapid growth. This growth strategy will require expanded customer services and support, increased personnel throughout the Company, expanded operational and financial systems and the implementation of additional control procedures. There is no assurance that the Company will be able to attract qualified personnel or successfully manage expanded operations. Failure to manage growth effectively could adversely affect the Company's financial condition and results of operations.\nPRODUCTS\nOptical Disc Inspection Equipment\nThe Company markets a full line of inspection systems primarily used to detect manufacturing defects in various optical storage media, including Audio CDs, CD-ROM's, CD-R, Digital Video Disc (DVD), Phase Differential (PD), and MO. The Company's standard inspection systems can detect surface scratches, bubbles, black specks, pinholes, disc warp, and other imperfections at resolutions down to 40 microns. In addition, the Company has developed and markets optical disc inspection systems configured to achieve resolutions down to 20 microns. These systems satisfy the more demanding tolerances of emerging higher density optical storage media such as CD-R, DVD and MO. Optical disc inspection products accounted for 30.9%, 26.0% and 27.9% of the Company's total net sales in 1995, 1994, and 1993, respectively. The following table summarizes key features of the Company's optical disc inspection products.\nThe Company also offers numerous options for its optical disc inspection products, including:\nBar Code Reader. Automated reader that prevents mislabeling of batch manufactured discs by verifying bar codes prior to labeling.\nLacquer Inspection. Verifies uniform application of protective lacquer coating. This system can also be purchased as a stand-alone system.\nBirefringence Inspection. Detects aberrant stresses in plastic substrate that can cause read errors.\nDark Field Channel. Used to detect low contrast defects.\nSoftware Products\nThe Company markets a software package, called VisionBlox, which allows system integrators, OEMs and volume end users to quickly develop powerful and custom machine vision applications without spending time developing core vision algorithms. VisionBlox uses standard PC hardware and a frame grabber or vision processor, while providing a Windows user interface. This product, which was introduced in February 1996, lists for $9,000, with discounting available for volume purchases.\nOther Products. The Company offers several additional stand-alone optical inspection systems including:\nPrinted Label Inspection Systems. High-speed, in-line, matrix-based system that inspects the printed surface of a disc to verify label quality.\nCatalog ID. High-speed, in-line, matrix-based system that reads and identifies alphanumeric catalog identification codes to prevent mislabeling.\nDisc Counter. Automated off-line linear-based system for counting batch processed discs.\nBirefringence Tester. Detection of birefringence in compact discs.\nResistance Welding Control Systems\nThe Company markets a full line of resistance welding controls that assure weld quality and collect data for trend analysis. The Company's products incorporate a number of common features designed to ensure weld quality, including: \"Automatic Voltage Compensation\", which maintains weld heat during changes in line voltage; \"Steppers\", which compensate for electrode tip degradation; and \"Dynamic Power Factor Compensation\", which optimizes accuracy in heat control. Resistance welding products accounted for 58.7%, 65.2% and 63.5% of the Company's total net sales in 1995, 1994, and 1993, respectively. The following table summarizes key features of the Company's resistance welding products.\nThe Company also offers numerous weld control options, including:\nSureWeld Steppers. Software that replaces \"fixed steppers\", automatically increasing current to compensate for electrode wear and adjusting current as needed to compensate for long-term variations in materials and welding machine characteristics.\nDynamic Squeeze\/Closed-Loop Pressure Control. Software and hardware that monitor welding pressure and initiate a weld based on programmed pressure conditions, reducing weld cycle times.\nHand-held Terminal (\"HHT\"). A portable means for programming and accessing information for any welding control attached to the Company's serial communications network.\nWeld Information Center (\"WIC\"). Hardware and PC-based graphical software that link communications between weld controls and customers' computer systems.\nWeld Support System (\"WSS\"). Communications software for UNIX-based welding control systems.\nOther Products. The Company sells a limited number of butt welding control systems, used primarily in the manufacture of automotive wheel rims. In addition, the Company offers a Thermal Force Feedback system that measures and automatically adjusts for the deflection of electrode arms due to thermal expansion and contraction during welding. To date, the Company has not sold any Thermal Force Feedback Systems.\nPRODUCT DEVELOPMENT\nThe markets in which the Company competes are characterized by rapid technological change. The Company's continued success will depend in large part upon its ability to develop and successfully introduce new products and product enhancements. For example, improvements in Audio CD and CD-ROM manufacturing systems, as well as the introduction of new optical storage formats such as CD-R and MO, require the Company to continually improve its optical inspection systems to decrease inspection time. The Company has devoted and will continue to devote substantial resources to research and development. There can be no assurance that the Company will be able to successfully develop, introduce and market new products or enhancements, or that new products or enhancements will meet the requirements of the marketplace and achieve market acceptance. If the Company is unable to develop and introduce new products and enhancements in a timely manner in response to changing market conditions or\ncustomer requirements, the Company's results of operations will be materially and adversely affected. In addition, technological developments have resulted and may continue to result in the obsolescence of components and subassemblies the Company holds as inventory.\nAs of December 31, 1995, the Company employed 121 persons in its engineering and product development efforts. The Company is continually investigating new techniques and applications building on its existing technology base and expertise. For welding controls, the Company's goal is to increase integration efforts and improve weld quality. For optical inspection, the Company intends to develop products with higher resolution and decreased inspection cycle times.\nThe following table sets forth for the periods indicated certain amounts relating to the Company's product development activities.\nThe Company's product development efforts have resulted in numerous technical achievements. Recent innovations include:\n-Introduction of a new generation of the iNSPECt series of optical inspection systems which inspect compact discs at high speeds;\n-Development of the Thermal Force Feedback System, which monitors the expansion of parts as they are welded to determine when a high-quality weld has been formed;\n-Continued development of a \"weld kernel\", resulting in significantly reduced manufacturing and service costs and faster product design cycles;\n-Development of VisionBlox, a rapid application development tool for machine vision applications; and\n-Development of an optical disc inspection system which meets specifications that allow the Company continued access to the European Common Market.\nThe Company is developing a distributed processing scheme for high-performance optical disc inspection based on multiple cameras, networked microprocessors and graphical user interface software. Management believes this approach will result in higher resolutions, lower inspection cycle times and reduced manufacturing costs. In addition, the Company is developing a gauging system that combines the Gauging Software with its existing gauging sensors in order to provide an advanced, non-contact gauging system.\nSALES AND MARKETING; CUSTOMERS\nAs of December 31, 1995 the Company employed a full-time direct sales force of 40 persons, 23 of whom were located at Medar headquarters in Farmington Hills, Michigan, 6 at Integral, 3 at Medar Canada, and 8 at AID. The Company markets its products to both end-users and OEMs, and utilizes agents for the distribution of its products in Europe, Asia and Mexico. The Company integrates its welding control and optical inspection products with other manufacturers' factory automation systems. Management believes this approach allows the Company to leverage the sales and marketing capabilities of equipment manufacturers such as Allen-Bradley Company, Inc., ABB Robotics, Inc., ROBI-Systemtechnik A.G., Origin Electric Co., Ltd., and Toolex Alpha. The Company participates in approximately 20 trade shows each year and regularly advertises in various trade magazines.\nPricing for the Company's products generally is determined by competitive bidding followed by negotiations with the client. Pricing for the Company's systems is based on features, system configuration and the customer's volume requirements. The Company generally provides a one-year warranty for all products sold. For sales to OEMs and agents, the Company offers discounts from list pricing.\nFor the years ended December 31, 1995, 1994 and 1993, sales to Chrysler Corporation accounted for approximately 9%, 14% and 29%, respectively, of the Company's net sales. Sales to General Motors Corporation for the same periods accounted for approximately 21%, 23% and 11% of net sales, respectively. At December 31, 1995, approximately 62% and 4% of the Company's backlog was attributable to GM and Chrysler, respectively. The loss of either of these customers or cancellation of orders by them could have a material adverse effect on the Company's results of operations. The Company anticipates that in the near term it will continue to be dependent upon certain large customers for a significant portion of its revenues.\nBecause a significant portion of the Company's resistance welding controls sales are to domestic automotive manufacturers, the cyclical nature of the U.S. automotive industry significantly affects the Company's revenues and operating results. The Company's dependence on a few large customers in its resistance welding business, together with its reliance on large orders, have also contributed to the variability of the Company's operating results. In the past, downturns in the U.S. automotive industry have negatively affected the Company's resistance welding control sales, most recently in 1990. There can be no assurance that the Company will not be affected by future downturns in the U.S. automotive manufacturing industry.\nExport sales accounted for 21%, 27% and 21% of the Company's net sales in 1995, 1994 and 1993, respectively. The Company expects that such sales will continue to represent a significant percentage of its net sales. In addition, the Company conducts sales and service operations for its welding control products in Canada through a wholly-owned Canadian subsidiary and in 1994 entered into a joint venture agreement with Shanghai Electric Welding Machine Works for production of resistance welding control equipment in China. Non-U.S. sales involve a number of risks, including fluctuations in exchange rates, changes in trade policies, tariff regulations and changes in governments. Most of the Company's international sales are denominated in U.S. dollars, although Integral generally quotes sales in Pounds Sterling, Canadian sales are quoted in Canadian dollars and Japanese sales of optical inspection equipment are quoted in yen. For certain non-U.S. sales, the Company markets and sells its products through independent sales representatives in Western Europe, Asia and Latin America. The loss of a key foreign sales agent or OEM could have a material adverse effect on the Company's non-U.S. sales and, accordingly, the Company's results of operations.\nSee Note J to the Consolidated Financial Statements (Item 8) for details of geographic area information.\nCOMPETITION\nThe markets for microprocessor-based manufacturing control and optical inspection equipment are highly competitive. For welding controls, the Company's primary competitors include Weltronic Company, Robotron Corporation, Robert Bosch GmbH, and Square D Company. To a lesser extent, the Company also competes with, among others, Dengensha America Corp.\/Dengensha Mfg. Co., Ltd., Nadex Co., Ltd.\/Nagoya Dengensha Co., Ltd. and Miyachi Technos Corporation. The Company believes competition for welding controls is based primarily upon price, performance, technical expertise, customer support and durability. For optical inspection, the Company's primary competitors are Dr. Schenk GmbH and Basler GmbH. The Company believes the principal competitive factors for optical inspection are quality, price, cycle times, and features. While the Company believes it currently competes favorably with respect to the above factors, there can be no assurance that it will be able to continue to do so or that competition will not have a material adverse effect on the Company's results of operations and financial condition. While the Company may face competition from additional sources in all aspects of its business, the Company believes that competition in the optical disc inspection industry in particular may intensify, and that companies with significantly greater technical, financial and marketing resources than the Company may enter its markets.\nMANUFACTURING AND SUPPLIERS\nThe Company manufactures its products primarily at its headquarters in Farmington Hills, Michigan. Manufacturing consists primarily of assembling components and subassemblies purchased from suppliers into finished products. The Company also utilizes outside vendors to manufacture certain subassemblies and finished products. All products are tested for functionality before shipment. The Company's products are assembled primarily with standard electrical and electronic components and hardware.\nThe Company designs printed circuit boards for its hardware products as needed. In most cases, the Company purchases components for circuit boards directly and forwards them to outside contractors for assembly, although in certain limited circumstances, the Company performs in-house circuit board assembly.\nThe Company generally does not rely on a single source for parts or subassemblies, unless design alternatives exist that permit use of other parts should single source supply be interrupted. Certain of the components and subassemblies included in the Company's products may be obtained from a limited number of suppliers. Although the Company believes it will be able to develop alternative sources for any of the components used in its products, significant delays or interruptions in the delivery of components by suppliers or difficulties or delays in shifting manufacturing capacity to new suppliers could have a material adverse effect on the Company.\nBACKLOG\nAs of December 31, 1995, the Company had an order backlog of approximately $12.9 million, compared to approximately $7.9 million as of December 31, 1994. The Company's dependence on a few large customers in its resistance welding business, together with its reliance on large orders, have contributed to variability in the Company's backlog. For the years 1995, 1994 and 1993, approximately 9%, 14% and 29%, respectively, of the Company's net sales were attributable to sales to Chrysler Corporation (\"Chrysler\") and approximately 21%, 23% and 11%, respectively, were attributable to sales to General Motors Corporation (\"GM\"). At December 31, 1995 and 1994, approximately 62% and 34%, respectively, of the Company's backlog was attributable to GM and approximately 4% and 5%, respectively, of the Company's backlog was attributable to Chrysler. The loss of either of these customers or cancellation of orders by them could have a material adverse effect on the Company's results of operations. The Company anticipates that in the near term it will continue to be dependent upon certain large customers for a significant portion of its revenues. The Company's production schedule is generally based on a combination of sales forecasts and the receipt of specific customer orders, and typically no advance or progress payments are required from customers unless the system ordered includes custom features. Purchase orders are generally cancelable, although the company may assess penalties. The Company expects to be able to ship products representing all of this backlog before the end of the current fiscal year, although there is no assurance that the Company will be able to do so. The amount of backlog at any date does not necessarily indicate revenues in any future period.\nPATENTS AND PROPRIETARY RIGHTS\nThe Company believes that technology incorporated in its resistance welding control and optical inspection products give it advantages over its competitors and prospective competitors. The Company attempts to protect its technology through a combination of patents, confidentiality agreements and trade secrets.\nThe Company has nine U.S. patents on technology involved in its resistance welding controls as well as one patent application pending in the U.S., two in Germany, and two in Japan. In addition, one more welding related patent application has been allowed in the U.S. and simply awaits final action by the patent office. The Company also has a U.S. patent application pending on technology relating to the Company's optical inspection equipment. AID has a license to use certain patents originally developed by Owens-Illinois, Inc. relating to optical inspection technology and the Company is seeking a license as to certain other patents for use in gauging products under development. Medar is also the owner of all rights to two patents purchased from Chesapeake Laser Systems, Inc. which relate to optical inspection technology.\nGenerally, the Company has not applied for patent protection of the software components of its products. There can be no assurance that any patents applied for will be granted or that patents the Company holds will be considered valid if challenged or sufficiently broad to protect the proprietary nature of the Company's technology. In addition, the software technology of the Company's products is advancing so quickly that in the 2-3 years it takes to get a patent issued in the U.S. and the up to ten years in some foreign countries, the technology becomes obsolete before the patent issues.\nThe Company also relies on trade secrets and proprietary know-how that it seeks to protect through confidentiality agreements with certain employees and suppliers and has established procedures to maintain confidentiality of sensitive information. There can be no assurance that confidentiality agreements will not be breached, that the Company would have adequate remedies for any breach, or that others will not develop substantially equivalent technology and techniques or otherwise gain access to the Company's trade secrets. In addition, the laws of foreign countries may not protect the Company's proprietary rights to its technology, including patent rights, to the same extent as the laws of the U.S.\nAlthough the Company believes it has independently developed its technology and attempts to assure that its products do not infringe the proprietary rights of others, if infringement were proven, there can be no assurance that the Company could obtain necessary licenses on terms and conditions that would not have an adverse affect on the Company. In the event of a dispute concerning the Company's technology, including an alleged infringement by a competitor, litigation could become necessary. Adverse findings in any proceeding could subject the Company to liability to third parties, require the Company to seek licenses from third parties, or otherwise adversely affect the Company's ability to manufacture and sell affected products.\nIn July 1995, the Company settled its patent litigation with Square D Company. The terms of the settlement provide for a cross licensing agreement on all single phase welding patents held by either company.\nSee Note I to the Consolidated Financial Statements (Item 8) for further discussion of settlement of patent litigation.\nENVIRONMENTAL COMPLIANCE\nThe costs to the Company of complying with federal, state and local provisions regulating protection of the environment are not material.\nEMPLOYEES\nAs of February 29, 1996, the Company had approximately 325 permanent employees, as compared to 214 at February 28, 1995 and 182 at February 28, 1994. The Company also engages a limited number of contract workers, primarily for assembly operations, the number of which varies, depending upon production requirements. None of the Company's employees is represented by a labor union.\nThe continued success of the Company is dependent in large part on certain key management and technical personnel, the loss of one or more of whom could adversely affect the Company's business. In particular, the Company relies upon the services and expertise of its President, Charles J. Drake, and its product development and engineering staff. The Company maintains a key man life insurance policy on Mr. Drake in the amount of $1.0 million. The Company believes that its future success will depend significantly upon its ability to attract, retain and motivate skilled technical, sales and management employees. The Company could encounter competition for these personnel.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nManufacturing, engineering and administrative functions of Medar are performed at two facilities owned by the Company in Farmington Hills, Michigan which total approximately 100,000 square feet. In addition, Medar leases approximately 7,000 square feet of warehouse space in another location in Farmington Hills, Michigan with a lease which expires in less than one year. Accounting and administrative functions of Medar Canada, Ltd. and AID are consolidated at the Company's corporate facility. Integral leases two facilities located in Bedford, United Kingdom approximating 5,000 square feet each to perform manufacturing, engineering and administrative functions. These leases expire through 2015. Sales and service functions principally for Canadian sales are performed at Medar Canada, Ltd., which currently leases a 4,000 square foot facility with a lease term expiring within a year in Oshawa, Ontario, Canada. AID currently utilizes an 11,000 square foot leased facility in Toledo, Ohio for sales, engineering and service activities. The Company anticipates moving out of this facility during the second quarter of 1996 and performing these activities in the Farmington Hills locations in the future. The AID lease will be terminated without further charge upon the Company's abandonment of the facility.\nThe Company believes its facilities are suitable for their respective activities. Although the Company believes its facilities are adequate for its current operations, the Company may require additional space as operations expand. The Company believes that adequate space at reasonable terms is readily available in each of the areas in which the Company may seek to expand.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not currently involved in any material litigation. See the Notes to the Consolidated Financial Statements (Item 8) for a discussion of settlement of patent 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\nThe Company's common stock is traded on the over-the-counter market (NASDAQ) as a National Market Issue under the symbol MDXR. As of February 29, 1996, there were approximately 4,000 stockholders of the Company including individual participants in security position listings.\nThe table below shows the high and low sales prices for the Company's common stock for each quarter in the past two years. The closing sales price for the Company's common stock on February 29, 1996 was $8 1\/16 per share.\nThe market for securities of small market-capitalization companies has been highly volatile in recent years, often for reasons unrelated to a company's results of operations. Management believes that factors such as quarterly fluctuations in financial results, changes in the automotive, audio electronics, and optical storage media industries, sales of common stock by existing shareholders and substantial product orders may contribute to the volatility of the price of the Company's common stock. General economic trends such as recessionary cycles and changing interest rates may also adversely affect the market price of the Company's Common Stock.\nThe Company has never paid a dividend and does not anticipate doing so in the foreseeable future. The Company expects to retain earnings to finance the expansion and development of business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n* Tax benefit resulting from utilization of net operating loss carryforward.\nThe above selected financial data should be read in conjunction with consolidated financial statements, including the notes thereto (Item 8) and Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7). The Company has never paid a dividend and does not anticipate doing so in the foreseeable future. The Company expects to retain earnings to finance the expansion and development of business.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nMedar develops, manufactures and markets microprocessor-based process monitoring and control products for use in industrial manufacturing environments. The Company's revenues are primarily derived from the sale of optical inspection equipment and resistance welding controls. Optical inspection equipment is principally sold to suppliers of audio compact disc (\"Audio CD\") and compact disc-read only memory (\"CD-ROM\") manufacturing equipment. Resistance welding control products are currently marketed primarily to automobile manufacturers and suppliers of industrial automation equipment. For the years of 1995, 1994 and 1993, approximately 9%, 14% and 29%, respectively, of the Company's net sales were attributable to sales to Chrysler Corporation and approximately 21%, 23% and 11%, respectively, of the Company's net sales were attributable to General Motors Corporation. The Company began manufacturing resistance welding controls in the early 1970s. In March of 1987, the Company acquired 80% of Integral Vision-AID, Inc. (\"AID\"), formerly Automatic Inspection Devices, Inc., a manufacturer of optical inspection equipment, from Owens-Illinois, Inc. The Company acquired the remaining 20% in October of 1991.\nThe Company typically manufactures and sells its products subject to customer specifications. For most orders, revenue is recognized upon shipment. For orders that are considered long-term contracts under applicable accounting standards, revenue is recognized using the percentage-of-completion method. Long-term contracts include a relatively high engineering content. For such long-term contracts, customers generally are not billed and payment is not received until products are shipped. Revenues recognized on long-term contracts in excess of amounts billed to customers are classified as current assets, as these contracts are expected to be completed within one year.\nMost of the Company's international sales are denominated in U.S. dollars, although Integral generally quotes sales in Pounds Sterling, Canadian welding sales are quoted in Canadian dollars and Japanese sales of optical inspection equipment are quoted in yen. The impact of foreign currency fluctuations has historically not been significant. For additional information on export sales, see Note J to the Consolidated Financial Statements.\nThe markets in which the Company competes are technologically advanced and highly competitive. Accordingly, the Company's continued success requires substantial research and development expenditures. While developing new products, the Company attempts to be cognizant of inventory currently in its possession in order to help mitigate inventory becoming obsolete. Software development expenditures that are not chargeable to specific customer orders are expensed as research and development until technical feasibility is established. Thereafter, such expenditures are capitalized, reflected as other assets at the lower of cost or net realizable value, and amortized over the shorter of the remaining estimated economic life of the related products or five years. Capitalized software development costs were $3.3 million, $2.5 million and $2.1 million in 1995, 1994 and 1993, respectively. Amortization of capitalized software included in cost of sales was $2.3 million, $1.6 million and $1.2 million in 1995, 1994 and 1993, respectively. Engineering and development expenditures relating to certain orders are incorporated in the price charged to customers and are reflected in cost of sales. Those costs were $1.8 million, $0.4 million and $0.7 million in 1995, 1994 and 1993, respectively. The Company expects to continue its commitment to research and development in the future.\nIn February 1995, the Company acquired 100% of the common stock and preference shares of Integral Vision Ltd. (Integral), an English corporation, for 654,282 previously unissued shares of Medar, Inc. common stock. Integral is a machine vision company which develops and manufactures solutions for OEMs and end-users. See Note B to the Consolidated Financial Statements (Item 8) for further information.\nRESULTS OF OPERATIONS\nThe following table sets forth for the periods indicated certain items from the Company's Statements of Operations as a percentage of net sales. Years ended December 31, 1994 and 1993 have been restated to reflect the effect of the pooling with Integral Vision Ltd. The impact of inflation for the periods presented was not significant.\nYEAR ENDED DECEMBER 31, 1995, COMPARED TO DECEMBER 31, 1994\nNet sales remained relatively the same in 1995 when compared to 1994. This was a result of an increase in sales volume of vision products being offset by a decrease in sales volume of welding products. The increase in vision sales was comprised of an increase in shipments of the Company's optical disc inspection system and related equipment. The decrease in welding sales was due to a decrease in sales to the Company's two largest customers.\nCost of sales increased to $30.1 million from $26.8 million and as a percentage of net sales to 75.7% from 66.6%. The increase is due to after-sale costs, manufacturing inefficiencies and higher levels of overhead which were added in anticipation of higher sales volume, and in some lines, more competitive pricing of products.\nMarketing expense increased to $5.0 million from $3.8 million and as a percentage of net sales to 12.6% from 9.5%. The increase was primarily the result of allocating more resources to market and promote newer vision products. One of the primary new products being marketed is VisionBlox, a rapid application development tool for machine vision applications.\nGeneral and administrative expense increased to $3.4 million from $2.7 million and as a percentage of net sales to 8.6% from 6.8%. The increase was due to additional costs associated with the acquisition of the Company's U.K. subsidiary, and an increase in the Company's infrastructure.\nYEAR ENDED DECEMBER 31, 1995, COMPARED TO DECEMBER 31, 1994 (CONT)\nResearch and development expense decreased to $2.1 million from $2.4 million and as a percentage of net sales to 5.2% from 5.9%. The decrease resulted from engineering resources which were directed towards resolving manufacturing issues in two of the Company's new product lines which were introduced over the past two years.\nPatent litigation costs increased to $5.5 million from $0.7 million and as a percentage of net sales to 13.7% from 1.6%. The increase was the result of the settlement with Square D Company related to the use of technology in prior years as well as legal and other costs to defend the case. The Company, in addition, will make yearly payments related to the use of future technology in accordance with the cross license agreement which was part of the settlement.\nExcess product quality, warranty and other costs relate to costs incurred in connection with after-sale and other costs experienced with recent product introductions. These accounts receivable, inventory, warranty and other costs, while not all directly related to the fourth quarter of 1995, were identified at such time, following an extensive review of these areas.\nInterest expense increased to $0.6 million from $0.3 million and as a percentage of net sales to 1.5% from 0.6%. The increase was due to additional borrowings associated with the revolving note payable to bank, the patent license payable and an additional term note related to the addition of a new building to add capacity. The increase in the revolving note was principally the result of the net loss incurred in 1995.\nThe credit for income taxes in 1995 was due to the net loss experienced in 1995. There was income tax expense in 1994 due to the profitability during that year.\nYEAR ENDED DECEMBER 31, 1994, COMPARED TO DECEMBER 31, 1993\nNet sales increased $11.5 million (40.2%) to $40.2 million in 1994 from $28.7 million in 1993. The majority of the increase was due to higher volume of resistance welding control sales, primarily as a result of the continuation of retooling programs for new automobile body styles introduced by General Motors Corporation and Chrysler Corporation. Sales of optical inspection products also increased in 1994 from 1993 as the introduction of an advanced optical inspection system for detection of smaller defects at higher speeds generated additional sales volumes. The Company's U.K. subsidiary also experienced an increase in sales volume of vision equipment.\nCost of sales increased to $26.8 million from $18.3 million and as a percentage of net sales to 66.6% from 63.7%. One of the reasons for the increase was due to more competitive pricing of product sold to the automotive industry. In addition, the Company sold certain products at lower margin percentages in order to increase volume and incurred additional costs upon introduction of new vision and welding products.\nMarketing expense increased to $3.8 million from $3.2 million, but decreased as a percentage of net sales to 9.5% from $11.1%. The increase is a result of committing additional resources to support the higher sales volume.\nGeneral and administrative expense increased to $2.7 million from $2.0 million, but decreased as a percentage of net sales to $6.8% from $7.1%. The major reasons for this increase were an increase in bad debt expense, stockholder relation costs and additional costs to support the growth of the Company's U.K. subsidiary.\nResearch and development expense increased to $2.4 million from $1.3 million and as a percentage of net sales to 5.9% from 4.4%. The increase resulted from continued development of new products and the enhancement of existing products.\nThe patent litigation costs in 1994 primarily relate to legal fees incurred to defend the Company in a patent litigation suit.\nInterest expense decreased to $0.3 million from $0.5 million and as a percentage of net sales to 0.6% from 1.8%.\nYEAR ENDED DECEMBER 31, 1994, COMPARED TO DECEMBER 31, 1993 (CONT)\nThe decrease is the result of gains realized upon the sale of interest rate swaps and the elimination of a portion of interest expense upon paying off the Company's revolving credit note with stock offering proceeds from the sale of 1,300,000 shares of the Company's common stock to the public effective May 24, 1994.\nInterest income in 1994 was generated from the investment of the stock offering proceeds not utilized to pay off debt.\nQUARTERLY INFORMATION\nThe following table sets forth consolidated statements of operations data for each of the eight quarters in the two year period ended December 31, 1995. 1994 data has been restated to include the effect of the pooling with Integral Vision, Ltd. The unaudited quarterly information has been prepared on the same basis as the annual information and, in management's opinion, includes all adjustments necessary for a fair presentation of the information for the quarters presented.\nSEASONALITY AND QUARTERLY FLUCTUATIONS\nThe Company's sales and operating results have varied substantially from quarter to quarter. Net sales and earnings are typically lower in the fourth and first quarters. The most significant factors affecting these fluctuations are the seasonal buying patterns of the Company's customers. The principal customers for the Company's resistance welding control products traditionally make purchases in connection with re-tooling for new automobile body styles and tend to purchase the Company's equipment in the second and third quarters. The end users of the Company's optical inspection products typically add manufacturing capacity in the second and third quarters in anticipation of higher production requirements in the fourth quarter resulting in a higher level of sales for the Company. The Company expects its net sales and earnings to continue to fluctuate from quarter to quarter.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has a revolving note payable to its bank with a maximum balance of $10 million. This note expires August 10, 1997 and has advances which bear interest at the bank's prime rate or a choice of other rates made available under terms of the agreement. The availability on this note at December 31, 1995 was $0.2 million. As of March 29, 1996, the Company has negotiated an amendment to its revolving note payable which provides for advances of up to $16 million based on certain percentages of eligible accounts receivable and inventory. The amendment also changed certain financial covenants of the agreement. Accounts receivable and inventory are specifically collateralized under the terms of the amendment and the Company may borrow only at the prime rate.\nThe Company utilized proceeds from long-term debt borrowings, the sale of short-term investments and the decrease in accounts receivable to fund the net loss experienced in 1995, the purchase of property and equipment and the investment in capitalized software. A significant portion of the purchase of property and equipment relates to the acquisition of an additional building to give the Company additional capacity. Accounts receivable decreased due to decreased invoicing activity at the end of 1995. The Company believes increased invoicing in the future will not increase accounts receivable to prior levels (as a percentage of net sales) as a result of closer management.\nLIQUIDITY AND CAPITAL RESOURCES (CONT)\nThe increase in patents primarily relates to the cross license agreement which was part of the patent litigation settlement finalized in 1995. There is also a component of debt which was set up to reflect future payments to be made under this agreement.\nThe Company believes that current financial resources (working capital and its ability to obtain additional financing, if needed), together with cash generated from operations, will be adequate to meet cash needs through 1996.\nNo significant commitments for capital expenditures existed as of December 31, 1995. The Company expects to capitalize approximately $3,000,000 of software development costs in 1996 and has no other plans for any significant capital expenditures.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and quarterly results of operations are submitted in separate sections of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information contained in the Medar, Inc. proxy statement (to be filed within 120 days of December 31, 1995), with respect to directors and executive officers of the Company, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained in the Medar, Inc. proxy statement (to be filed within 120 days of December 31, 1995), with respect to directors and executive officers of the Company, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained in the Medar, Inc. proxy statement (to be filed within 120 days of December 31, 1995), with respect to directors and executive officers of the Company, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained in the Medar, Inc. proxy statement (to be filed within 120 days of December 31, 1995), with respect to directors and executive officers of the Company, 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 (3) separate section of this report. Listing of Exhibits\nExhibit Number Description of Document - ------- ----------------------- 2.1 Stock Purchase Agreement of Integral Vision effective January 1, 1995 (filed as Exhibit 2.1 to the registrant's Form 8-K dated March 2, 1995, SEC file 0-12728, and incorporated herein by reference).\n2.2 Stock Purchase Agreement for Preference Shares of Integral Vision effective January 1, 1995 (filed as Exhibit 2.2 to the registrant's Form 8-K dated March 2, 1995, SEC file 0-12728, and incorporated herein by reference).\n3.1 Articles of Incorporation, as amended.\n3.2 Bylaws of the Registrant, as amended (filed as Exhibit 3.1 to the registrant's Form 10-K for the year ended December 31, 1994, SEC file 0-12728, and incorporated herein by reference).\n10.1 Incentive Stock Option Plan of the Registrant as amended (filed as Exhibit 10.4 to the registrant's Form S-1 Registration Statement effective July 2, 1985, SEC File 2-98085, and incorporated herein by reference).\n10.2 Second Incentive Stock Option Plan (filed as Exhibit 10.2 to the registrant's Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).\n10.3 Amendment to Medar, Inc. Incentive Stock Option Plan dated May 10, 1993 (filed as Exhibit 10.3 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.4 Non-qualified Stock Option Plan (filed as Exhibit 10.3 to the registrant's Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).\n10.5 Medar, Inc. Employee Stock Option Plan (filed as Exhibit 10.5 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC file 0-12728, and incorporated herein by reference).\n10.6 Form of Confidentiality and Non-Compete Agreement Between the Registrant and its Employees (filed as Exhibit 10.4 to the registrant's Form 10-K for the year ended December 31, 1992, SEC File 0-12728, and incorporated herein by reference).\n10.7 Contract between Shanghai Electric Welding Machine Works, Medar, Inc. and Lida U.S.A. dated August 30, 1993, related to joint venture agreement (both the original Chinese version and the English translation) (filed as Exhibit 10.7 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.8 Asset Purchase Agreement between Medar, Inc. and Air Gage Company dated February 28, 1994 (filed as Exhibit 10.8 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.9* License Agreement number 9303-004 between Medar, Inc. and Allen-Bradley Company, Inc. dated April 12, 1993 (filed as Exhibit 10.9 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.10* License Agreement number 9304-009 between Medar, Inc. and Allen-Bradley Company, Inc. dated May 10, 1993 (filed as Exhibit 10.10 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.11 Agreement by and between Medar, Inc. and ABB Robotics, Inc. dated December 1992 regarding joint development to integrate a weld controller into the S3 robot control (filed as Exhibit 10.11 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.12 1993 Incentive Program (filed as Exhibit 10.14 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.13 1994 Incentive Program (filed as Exhibit 10.12 to the registrant's Form 10-K for the year ended December 31, 1994, SEC file 0-12728, and incorporated herein by reference).\n10.14 Term Note dated June 29, 1993 by and between Medar, Inc. and NBD Bank, N.A. (filed as Exhibit 4.2 to the Registrant's Form 10-Q for the quarter ended June 30, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.15 Amended and Restated Mortgage and Security Agreement dated June 29, 1993 by and between Medar, Inc. and NBD Bank, N.A. (filed as Exhibit 4.5 to the registrant's Form 10-K for the year ended December 31, 1993, SEC File 0-12728, and incorporated herein by reference).\n10.16 Revolving Credit and Loan Agreement dated August 10, 1995 by and between Medar, Inc., Automatic Inspection Devices, Inc. and Integral Vision, Ltd. and NBD Bank (filed as Exhibit 10.1 to the registrant's Form 10-Q for the quarter ended June 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.17 Amendment No. 2 to Loan and Credit Agreement and Term Note dated August 10, 1995 by and between Medar, Inc., Automatic Inspection Devices, Inc. and NBD Bank (filed as Exhibit 10.2 to the registrant's Form 10-Q for the quarter ended June 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.18 First Amendment to Revolving Credit and Loan Agreement dated October 12, 1995, by and between Medar ,Inc., Automatic Inspection Devices, Inc. and Integral Vision, Ltd. and NBD Bank (filed as Exhibit 10.18 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.19 Second Amended and Restated Revolving Note dated October 12, 1995, by and between Medar, Inc., Automatic Inspection Devices, Inc. and Integral Vision, Ltd. and NBD Bank (filed as Exhibit 10.19 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.20 Second Amendment to Revolving Credit and Loan Agreement dated October 31, 1995, by and between Medar ,Inc., Automatic Inspection Devices, Inc. and Integral Vision, Ltd. and NBD Bank (filed as Exhibit 10.20 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.21 Mortgage dated October 31, 1995 by and between Medar, Inc. and NBD Bank (filed as Exhibit 10.21 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.22 Installment Business Loan Note dated October 31, 1995, by and between Medar, Inc. and NBD Bank (filed as Exhibit 10.22 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.23 Guarantee and Postponement of Claim dated August 10, 1995 between Medar Canada, Ltd. and NBD Bank (filed as Exhibit 10.23 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n10.24* Patent License Agreement dated October 4, 1995 by and between Medar, Inc. and Square D Company (filed as Exhibit 10.24 to the registrant's Form 10-Q for the quarter ended September 30, 1995, SEC File 0-12728, and incorporated herein by reference).\n11 Calculation of Earnings per Share.\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n27 Financial Data Schedule\n(b) There were no reports on Form 8-K filed in 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.\n(d) Financial Statement Schedules - The response to this portion of Item 14 is submitted as a separate section of this report.\n* The Company has been granted confidential treatment with respect to certain portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 MEDAR, INC.\nBy:\/s\/Charles J. Drake ------------------------------------ Charles J. Drake, President, Chairman of the Board (Principal Executive Officer)\nBy:\/s\/Richard R. Current ------------------------------------ Richard R. Current, Executive Vice President of Finance and Operations (Principal Financial and Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\/s\/CHARLES J. DRAKE President, Chairman of the - ----------------------------------- Board (Principal Charles J. Drake Executive Officer) and Director\n\/s\/MAX A. COON Vice Chairman, Secretary - ----------------------------------- and Director Max A. Coon\n\/s\/RICHARD R. CURRENT Executive Vice President of - ----------------------------------- Finance and Operations Richard R. Current (Principal Financial and Accounting Officer) and Director\n\/s\/VINCENT SHUNSKY Treasurer and Director - ----------------------------------- Vincent Shunsky\n\/s\/WILLIAM B. WALLACE Director - ----------------------------------- William B. Wallace\n\/s\/STEPHAN SHARF Director - ----------------------------------- Stephan Sharf\n- ----------------------------------- Director Stephen Zynda\n- ----------------------------------- Director Frederico de Magalhaes\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\nMEDAR, INC.\nFARMINGTON HILLS, MICHIGAN\nFORM 10-K - ITEM 14(a)(1) and (2) MEDAR, INC. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\n(a)(1) The following consolidated financial statements of Medar, Inc. and subsidiaries are included in Item 8:\nReport of independent auditors 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-December 31, 1995\n(2) The following consolidated financial statement schedule of Medar, Inc. and subsidiaries is submitted herewith:\nSCHEDULE II Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Medar, Inc.\nWe have audited the consolidated balance sheets of Medar, 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. Our audits 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 Medar, 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 a whole, presents fairly in all material respects the information set forth therein.\nErnst & Young LLP\nDetroit, Michigan February 14, 1996\nCONSOLIDATED BALANCE SHEETS MEDAR, INC. AND SUBSIDIARIES\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF OPERATIONS MEDAR, INC. AND SUBSIDIARIES\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY MEDAR, INC. AND SUBSIDIARIES\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF CASH FLOWS MEDAR, INC. AND SUBSIDIARIES\nSee accompanying notes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS MEDAR, INC. AND SUBSIDIARIES\nNOTE A\nSIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its three 100% owned subsidiaries; Integral Vision-AID, Inc., Toledo, Ohio; Integral Vision Ltd., Bedford, United Kingdom; and Medar Canada Ltd., Oshawa, Ontario. Upon consolidation, all significant intercompany accounts and transactions are 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. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nTRANSLATION OF FOREIGN CURRENCIES\nThe financial statements of Integral Vision Ltd. and Medar Canada Ltd. are translated into United States dollar equivalents at exchange rates as follows: balance sheet accounts at year-end rates; income statement accounts at average exchange rates for the year. Transaction gains and losses are reflected in net earnings and are not significant.\nCASH AND CASH EQUIVALENTS\nCash equivalents consist of highly liquid investments, which mature within three months or less, other than U.S. government securities.\nSHORT-TERM INVESTMENTS\nShort-term investments consist of U.S. government securities and are carried at cost which approximates market value.\nACCOUNTS RECEIVABLE\nTrade accounts receivable primarily represent amounts due from automobile and other equipment manufacturers located in North America.\nThe Company's primary products are computer integrated quality control and inspection devices which are sold as capital goods. The activities of the Company and its subsidiaries are conducted in one product line.\nCustomers which accounted for 10% or more of the Company's sales in any of the three years ended December 31, 1995 and the respective sales in each year are:\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONT)\nINVENTORIES\nInventories are stated at the lower of first-in, first-out cost or market, and at December 31 consisted of the following (net of an obsolescence reserve of $154,000 in 1995 and $463,000 in 1994):\nPROPERTY AND EQUIPMENT\nProperty and equipment is stated on the basis of cost. Equipment capitalized under lease agreements and the related accumulated amortization is included in property and equipment. Expenditures for normal repairs and maintenance are charged to operations as incurred.\nDepreciation, including amortization of assets recorded under capital lease obligations, is computed by the straight-line method based on the estimated useful lives of the assets (buildings-40 years, other property and equipment-3 to 10 years).\nCAPITALIZED COMPUTER SOFTWARE DEVELOPMENT COSTS\nComputer software development costs are capitalized after the establishment of technological feasibility of the related technology. These amounts are stated at the lower of cost or net realizable value. These costs are amortized following general release of products based on current and estimated future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product (not to exceed 5 years). Amortization of the capitalized costs amounted to $2,314,000, $1,638,000 and $1,235,000 in 1995, 1994 and 1993, respectively. Total accumulated amortization at December 31, 1995 and 1994, was $ 7,371,563 and $5,176,291 respectively.\nPATENTS\nPatents are stated at cost less accumulated amortization of $343,000 and $139,000 at December 31, 1995 and 1994, respectively. These costs are amortized on a straight-line basis over the estimated useful lives of the assets.\nREVENUE RECOGNITION\nRevenues are recorded at the time services are performed or when products are shipped, except for long-term contracts. Revenues on long-term contracts are recognized using the percentage of completion method . The effects of changes to estimated total contract costs are recognized in the year determined and losses, if any, are fully recognized when identified. Costs and estimated earnings recognized in excess of amounts billed are classified under current assets as costs and estimated earnings in excess of billings on incomplete contracts. Long-term contracts include a relatively high percentage of engineering costs and are generally less than one year in duration.\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONT)\nRESEARCH AND DEVELOPMENT EXPENSES\nResearch and development costs not recovered from customers are expensed as incurred.\nINCOME TAXES\nDeferred income taxes are provided when necessary to recognize the effect of temporary differences between financial and income tax accounting related principally to contract revenues, depreciation and capitalized computer software development costs.\nEARNINGS PER SHARE\nEarnings per share is based on the weighted average number of shares of common stock outstanding and, to the extent dilutive, stock options outstanding during the period. The weighted average number of shares of common stock and common stock equivalents utilized in the computation of net earnings per share was 8,691,750 shares for the year ended December 31, 1995, 8,523,715 for the year ended December 31, 1994 and 7,529,366 shares for the year ended December 31, 1993.\nNOTE B\nACQUISITION OF INTEGRAL VISION LTD.\nEffective January 1, 1995, the Company acquired 100% of the common stock and preference shares of Integral Vision Ltd. (Integral) for 654,282 previously unissued shares of Medar, Inc. common stock. Integral is a machine vision company located in the United Kingdom, which develops and manufactures solutions for OEM's and end-users. This transaction has been accounted for as a pooling of interests and accordingly, the consolidated financial statements for all periods presented have been restated to include the accounts of Integral.\nCombined and separate results of Medar and Integral prior to combination are as follows:\nNOTE C\nCOSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON INCOMPLETE CONTRACTS\nCosts and estimated earnings in excess of billings on incomplete contracts at December 31 are summarized as follows:\nThe Company anticipates that the majority of costs incurred on long-term contracts at December 31, 1995, will be billed and collected in 1996.\nNOTE D\nLONG-TERM DEBT AND OTHER FINANCING ARRANGEMENTS\nLong-term debt at December 31 consists of the following:\nThe revolving note payable to bank has a maximum balance of $10,000,000. This note expires August 10, 1997 and has advances which bear interest at bank's prime rate (8.5% at December 31, 1995 and 1994) or other rates made available under the terms of the agreement. In connection with this note, as amended, the Company has agreed, among other covenants, to maintain net worth and debt to equity, as defined, at specified levels.\nThe Company has two term notes payable to bank. One note is payable in quarterly installments of $62,500 plus interest at the bank's prime rate, with the balance becoming due June 29, 1998. The second note is payable in monthly installments of $14,111 plus interest at the bank's prime rate or other rates made available under the terms of the agreement, with the balance becoming due September 30, 2000. The notes are collateralized by the Medar office and production facilities in Farmington Hills, Michigan, and machinery and equipment, inventory and accounts receivable at all North American locations.\nNOTE D - LONG-TERM DEBT AND OTHER FINANCING ARRANGEMENTS (CONT)\nThe patent license payable relates to future payments to be made to Square D Company related to the settlement of patent litigation. The payments are due in ten equal installments and have been discounted at 8%.\nThe fair values of these financial instruments approximates their carrying amounts at December 31, 1995.\nMaturities of long-term debt and capitalized lease obligations are $10,394,000 in 1997; $1,714,000 in 1998; $352,000 in 1999; $2,032,000 in 2000; and $1,193,000 thereafter.\nNOTE E\nSTATEMENT OF CASH FLOWS\nAcquisitions of property and equipment utilizing capital leases were $326,292 in 1993.\nThe Company paid interest on its debt instruments of $356,000, $384,000 and $514,000 in 1995, 1994 and 1993, respectively. Payments for income taxes were $125,000 and $113,000 in 1994 and 1993, respectively. There were no income tax payments in 1995.\nNOTE F\nINCOME TAXES\nAs of December 31, 1995, the Company has cumulative net operating loss carryforwards approximating $14,200,000 for tax purposes available for reduction of taxable income of future periods through 2010 and unused investment and research and development tax credits approximating $870,000 which expire through the same year. For financial reporting purposes, the net operating losses have been offset against net deferred tax liabilities based upon their expected amortization during the loss carryforward period. The valuation allowance increased $3,896,000 in 1995 and decreased $944,000 and $1,098,000 in 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 liabilities and assets as of December 31, 1995 are as follows:\nSignificant components of the provision (credit) for income taxes are as follows:\nThe reconciliation of income taxes computed at the U.S. federal statutory tax rates to income tax expense is as follows:\nNOTE G\nEMPLOYEE SAVINGS PLAN\nThe Company has an Employee Savings Plan covering substantially all United States' employees. The Company contributes $.20 to the Plan for every dollar contributed by the employees up to 6% of their compensation. The Plan also provides for discretionary contributions by the Company as determined annually by the Board of Directors. Company contributions charged to operations under the Plan were $61,000, $87,000 and $76,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE H\nSTOCK OPTIONS\nThe terms of the Company's qualified incentive stock option plan provide for the issuance of options for the purchase of up to 800,000 shares of the Company's common stock at market value at the date of the option grant. Options are granted with various vesting requirements established by the Compensation Committee of the Board of Directors and expire ten years from the date of grant. There were 21,700 and 60,000 options granted under this plan during 1994 and 1993 respectively. No options were granted under this plan during 1995. Options for 378,738 shares were outstanding and exercisable at December 31, 1995.\nUnder the Company's non-qualified stock option plan, options to purchase 200,000 shares were available to grant at option prices set by the Compensation Committee of the Board of Directors. There were 19,000 and 6,000 options granted under this plan during 1994 and 1993, respectively. No options were granted under this plan during 1995. Options for 198,000 shares were outstanding and exercisable at December 31, 1995.\nThe Company also has a third stock option plan under which it may issue qualified or non-qualified options for the purchase of up to 500,000 shares at option prices set by the Compensation Committee of the Board of Directors. There were 211,000 options granted under this plan in 1995. All 211,000 of these options were outstanding at December 31, 1995 and none were exercisable.\nThe Financial Accounting Standards Board issued Statement No. 123, \"Accounting for Stock Based Compensation\" in October 1995 and is effective for 1996 financial statements. The Company does not intend to adopt the recognition provisions of the Statement, but will continue accounting for stock options in accordance with Accounting Principles Board Opinion No. 25 \"Accounting for Stock issued to Employees\" as permitted by the new Statement. Therefore, adoption will not materially impact the Corporation.\nA summary of option activity under all plans follows:\nNOTE I\nCOMMITMENTS AND CONTINGENCIES\nIn July 1995, Medar, Inc. reached a settlement of its patent litigation which was initiated by Square D Company in April 1994 in the Federal District Courts in Eastern District of Michigan and in Delaware. This resolution also settles claims made by Medar against Square D. The terms of the settlement made under the auspices of the Federal District Court in Delaware provide for a cross license agreement on all single phase welding patents held by either company and call for a single payment related to use of technology in prior years as well as yearly payments for the use of technology in the future.\nThe single payment was recorded as an expense in 1995. The future payments have been reflected as a noncash transaction which increased both long-term debt and other assets by $2,000,000. The costs of this cross-licensing agreement will be amortized over the life of the agreement.\nNOTE I - COMMITMENTS AND CONTINGENCIES (CONT)\nThe Company and its subsidiaries use equipment under long-term operating lease agreements requiring rental payments approximating $254,000 in 1996, $139,000 in 1997, and $99,000 in 1998. Rent expense charged to operations approximated $380,000, $390,000 and $308,000 in 1995, 1994 and 1993, respectively.\nNOTE J\nGEOGRAPHIC AREA\nNet sales to unaffiliated customers, earnings (loss) before income taxes, identifiable assets and liabilities, classified by geographic areas in which the Company operates, and net export sales by domestic operations, were as follows:\nNOTE K\nRELATED PARTY TRANSACTIONS AND OTHER MATTERS\nTwo individuals who are officers and directors of the Company receive no compensation from the Company, but are compensated by Maxco, Inc., a major shareholder of the Company.\nExcess product quality, warranty and other costs relate to costs incurred in 1995 in connection with quality and other problems experienced with new product introductions.\nSCHEDULE II - Valuation And Qualifying Accounts\nMedar, Inc. And Subsidiaries\n(in thousands)\n(1) Net change in deferred tax valuation allowance.\n(2) Net accounts receivable write-offs.\n(3) Write-off obsolete inventory.\nEXHIBITS TO FORM 10-K\nMEDAR, INC.\nYEAR ENDED DECEMBER 31, 1995\nCOMMISSION FILE NUMBER 0-12728\nEXHIBIT INDEX\nExhibit No. Description Page - ------- ----------- ---- 3.1 Articles of Incorporation, as amended\n11 Calculation of Earnings Per Share\n21 Subsidiaries of the Registrant\n23 Consent of Independent Accountants\n27 Financial Data Schedule","section_15":""}
{"filename":"65291_1995.txt","cik":"65291","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrants are comprised of Homefree Village Resorts, Inc. (the \"Company\") and Homefree Investors L.P. (the \"Partnership\"), a limited partnership formed by the Company in 1987.\nThe shares of common stock, par value of $.001 per share, of the Company (the \"Common Stock\") and the assignee limited partnership interests, par value of $.001 per unit (\"Assignee Limited Partnership Interest\"), are \"paired\" on a one-for-one basis and may only be transferred in units (\"Paired Shares\") consisting of one share of Common Stock and one Assignee Limited Partnership Interest.\nBUSINESS OF THE COMPANY\nGENERAL\nThe Company is engaged primarily in the development and operation of adult recreational communities containing rental sites for manufactured homes and recreational homes. In recent years, the Company has focused on the development of recreational resort communities in Mesa, Arizona which offer extensive recreational facilities and social activities designed to appeal to active pre- retirement and retirement age people. During 1995 the Company operated and had interests in one community containing a total of approximately 832 rental sites located in Arizona. The Company also has interests in two communities containing approximately 2,300 rental sites located in Arizona. The Company has interests in such communities through Aristek Properties, Ltd., Aristek Western Properties Limited Partnership, and other affiliated partnerships in which the Company is the General Partner. The Company's objectives are to create and participate, through such partnerships, in the cash flow from these communities and share in appreciation in the value of such properties. The Company also receives income from development, management and administrative services.\nRECENT DEVELOPMENTS\nThe Company has filed a Transaction Statement on Schedule 13E-3 and a related Information Statement under Regulation 14(c) in connection with a proposed going private transaction and related one-for-100,000 reverse stock split of the Company's Paired Shares. The Company is in the process of responding to written comments received from the Securities and Exchange Commission (\"SEC\"). The Company's Board of Directors has approved the proposed going private transaction and the stockholders have approved the reverse stock split by the written consent of Craig M. Bollman, Jr., the Company's majority stockholder. The Company's Board of Directors, however, may postpone or abandon the proposed going private transaction and related reverse stock split at any time prior to its consummation, for any reason, including without limitation, if in the Directors' sole judgment, consummation of the reverse stock split would unduly deplete the Company's working capital.\nIf the proposed reverse stock split is effected, it is anticipated that the Company will cease to be a reporting company under the Exchange Act. As a result, the Company would no longer file annual and quarterly reports, proxy statements, and other documents with the SEC. In addition, the Company would no longer be required to comply with the proxy rules of Regulation 14A promulgated under Section 14 of the Exchange Act, and its officers, directors, and 10%-or-greater stockholders would no longer be subject to the reporting requirements and \"short-swing\" security trading restrictions under Section 16 of the Exchange Act. Continuing stockholders will no longer be entitled to receive annual reports and proxy statements and will no longer have the benefit of a public market for their shares of the Company's stock.\nORGANIZATION\nThe Company is a Delaware corporation which was organized in February 1972. The Company has been engaged in the business of operating manufactured home communities since its organization. In 1977, the Company, then called Metrix, Inc., acquired all of the capital stock of Aristek Real Estate Corporation in exchange for 6,230,000 shares of Common Stock of the Company which were issued to the stockholders of that corporation, including 4,449,600 shares to Craig M. Bollman, Jr. and Phyllis A. Bollman. The name of the Company was changed to \"Aristek Corporation\" and subsequently changed in 1981 to \"Aristek Communities, Inc.\" In November\n1986 the name was again changed to \"Homefree Village Resorts, Inc.\" Aristek Real Estate Corporation itself was engaged in the development and operation of manufactured home communities from 1974 to 1977. Since 1977, the business of the Company has continued to consist primarily of the development and operation of such communities. However, in recent years, the Company has refocused its business on adult recreational communities containing rental sites for manufactured homes. The Company conducts a substantial portion of its business through the affiliated limited partnerships described below.\nThe Company owns 100% of the capital stock of Resortparks of America, Inc. (\"Resortparks\"), a Delaware corporation organized in September 1982 to engage in the design, development and management of adult recreational communities offering extensive recreational facilities and social activities to pre-retirement and retirement age people. References herein to the Company include the Company and Resortparks.\nIn July 1987, the Company formed Homefree Investors L.P., a Delaware limited partnership. The general partner of Homefree Investors L.P. is Homefree General Partners, a Delaware general partnership, comprised of the Company and Bollman Associates, Inc., a Delaware corporation, all of the capital stock of which is owned by Craig M. Bollman, Jr., President and Chairman of the Board of the Company. The shares of Common Stock of the Company and assignee limited partnership interests in Homefree Investors L.P. have been \"paired\" to trade only as a unit. When it formed the Partnership, the Company intended to conduct its business in conjunction with the Partnership. However, the Partnership never commenced operations.\nAFFILIATED PARTNERSHIPS\nAristek Properties, Ltd. The principal affiliated partnership of the Company is Aristek Properties, Ltd. (\"Aristek Properties\"). Aristek Properties was formed as a Colorado limited partnership in June 1976. The Company holds a 1% interest in Aristek Properties as sole General Partner and an additional 1% interest as a limited partner. Resortparks also owns a 1.3% interest as a limited partner. The remaining 96.7% of limited partnership interests is held by individual limited partners. The Company also held a 30% residual interest in Aristek Properties, which it recently relinquished. See BUSINESS -Residual Interests in Affiliated Partnerships.\nAlthough Aristek Properties has provided significant income tax benefits to its limited partners, Aristek Properties' primary objective is to create significant long-term capital appreciation which may be realized by the limited partners and the Company, as General Partner, through net proceeds from refinancing of the properties and, ultimately, net proceeds from the sale of such properties or the conversion of such properties to other residential or commercial uses and the distribution of the resulting cash to the partners. The Company, as General Partner of Aristek Properties, is also entitled to receive an annual administrative fee (currently an amount equal to 2.5% of the capital contributions of the partners), leasing commissions, management fees and development fees. However, this fee has not been paid since 1993.\nAristek Properties has a 99% interest in Monte Vista I Joint Venture, an Arizona joint venture (\"MVI\"). The remaining interest in MVI is owned by the Company. Previously, Aristek Properties owned 60% and Aristek Western Properties Limited Partnership (\"Aristek Western\") owned 40% of MVI. Aristek Western transferred to Aristek Properties and to the Company its 40% interest in MVI, 39% to Aristek Properties, and 1% to the Company.\nThe interests in MVI were modified again in connection with a restructuring of certain loans owed by Aristek Properties and MVI to the Company. The obligors on such loans were not able to make principal and interest payments. With the consent of most of the limited partners of Aristek Properties, the Company agreed to extend these loans until June 30, 1998 in return for a 7% annual interest rate and a 75% participation in MVI's operating cash flow, and in its net sale or refinancing proceeds after all liabilities (including those payable to the Company) are satisfied. At the time of the restructuring, the net amounts owed to the Company by MVI were approximately $4,053,341. The Company believes that such amount exceeded the value of the net assets of MVI, after payment of MVI's other liabilities. Aristek Properties has no material assets other than its interest in MVI. Since the Company is a creditor of both Aristek Properties and MVI as described above, the Company expects to be entitled to substantially all of the equity value of MVI in excess of MVI's existing first mortgage.\nIn connection with obtaining such consent of the limited partners of Aristek Properties, such consenting limited partners granted to the Company, or its designee, an option to purchase their limited partnership interests\nin Aristek Properties. The option may be exercised by the Company between January 1, 1997 and November 30, 1998; in any event, the Company is required to exercise the option by November 30, 1998. The purchase price will be equal to the greater of $20,000 per limited partner Unit (an original $100,000 investment) or the fair market value (based on appraisal) of such limited partnership unit. Holders of twenty-six and one-half (26.5) Units granted the above described option, which would result in a minimum total purchase price for all such Units of $530,000.\nAristek Western Properties Limited Partnership. The Company formed Aristek Western Properties Limited Partnership (\"Aristek Western\"), a Massachusetts limited partnership, in October 1984 for the purpose of acquiring, financing and developing or redeveloping adult recreational communities with affordable rental homesites for manufactured homes, located primarily in the Western and Southwestern United States. The Company has a 1% interest in Aristek Western as the General Partner, a 1.625% limited partnership interest and has residual equity interests as the General Partner and as a Special Limited Partner. See BUSINESS - Residual Interests in Affiliated Partnerships.\nAristek Western purchased a 50% interest in a joint venture with an unaffiliated third party in July 1985. The joint venture purchased two adult recreational communities in Mesa, Arizona, named Good Life and Towerpoint. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2 - PROPERTIES. In September 1985, Aristek Western acquired from the Partnership a 30% interest in Monte Vista I Joint Venture. This interest was increased to 40% in July 1986. This 40% interest was transferred to Aristek Properties and the Company. See Item 1 - BUSINESS OF THE COMPANY -Affiliated Partnerships; Aristek Properties, Ltd.\nRESIDUAL INTERESTS IN AFFILIATED PARTNERSHIPS\nAristek Properties, Ltd. Prior to the restructuring described above, as General Partner of Aristek Properties, the Company had a residual interest in Aristek Properties which entitled it to receive 30% of all excess cash flow from operations and net proceeds from the refinancing and sale of properties after distributions have been made to the limited partners in an amount equal to their initial capital investments. The Company relinquished its residual interest in Aristek Properties as part of the loan restructuring described above. As a result, the limited partners of Aristek Properties will be entitled to all distributions, but only after the Company receives its loan repayment and participating interest as described above.\nAristek Western Properties Limited Partnership. The Company has a direct residual interest in Aristek Western which entitles the Company to 30% of the excess cash flow from operations, refinancings and sales of properties when Aristek Western has made cash distributions to the limited partners of at least $65,000 per unit and the sum of the cash distributions per unit plus the product of the highest marginal Federal income tax rate in effect for each year times the aggregate net tax losses allocated per unit in each year equal the initial capital investment. Aristek Western has not yet made any cash distributions to its limited partners. The Company cannot presently predict when distributions will be made to the limited partners.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nFor the last five fiscal years, the revenues, operating profit and identifiable assets of the Company have been attributable to one industry segment--real estate investment, management and development--conducted by the Company for its own account and on behalf of affiliated partnerships, joint ventures and unaffiliated third parties.\nDEVELOPMENT ACTIVITIES\nThe Company, through Aristek Properties and in conjunction with Resortparks, developed a community for recreational homes and park model travel trailers in Mesa, Arizona, a city 20 miles east of Phoenix. The community, called Monte Vista, is designed to appeal to active adults in the pre-retirement and retirement age groups and is recreation-oriented.\nThe Company planned a two-stage development process for Monte Vista. During the first stage, the Company developed 832 recreational home rental sites and extensive common facilities, including a 35,600 square\nfoot social and recreation complex. This first stage is on 80 acres owned by MVI. Construction began in 1983 and was substantially completed in December 1984. Monte Vista opened for occupancy in January 1985.\nDuring the second stage, the Company plans to develop additional manufactured home sites on a portion of 80 acres conveyed by Aristek Properties to MVI, but such development is subject to the Company's ability to obtain financing for this development. There can be no assurance that the Company can obtain such financing. See Item 2 - PROPERTIES.\nCOMPETITION\nThe Company competes generally with all companies engaged in community development and home construction.\nThe three properties in Mesa, Arizona compete in what is regarded as a competitive market for adult recreation manufactured housing communities. The Company continues to compete in this market by offering special amenities and adult recreational and educational services.\nEach of the Company's geographic markets includes competitors which are larger and have greater financial and other resources than the Company.\nPERSONNEL\nDuring 1995 the Company employed two full-time employees. During 1995, the Company also employed between 27 and 55 additional full-time persons responsible for property operations. The compensation of these additional persons is borne by affiliated partnerships.\nBUSINESS OF THE PARTNERSHIP\nHomefree Investors L.P. (the \"Partnership\"), a Delaware limited partnership, was formed on July 20, 1987 for the purpose of engaging in certain aspects of future business opportunities of the type presently conducted by the Company. The general partner of the Partnership is Homefree General Partners, a Delaware general partnership comprised of Bollman Associates, Inc., a Delaware corporation organized in June 1987, all of the capital stock of which is owned by Craig M. Bollman, Jr., President and Chairman of the Board of the Company, and the Company.\nTo date, specific business plans for the Partnership have not been formulated, and the Partnership has generated no revenues. The Company anticipates that, where possible, in future real estate acquisitions the Partnership will acquire an ownership interest and the Company will manage operations. The Company has no plans to transfer the Company's assets to the Partnership.\nThe Agreement of Limited Partnership for the Partnership (the \"Partnership Agreement\") provides that it may engage in virtually any business activity, although the primary focus of its business is intended to be investment in real estate related activities, which may include, for example, investing in securities of other real estate companies and participating in condominium conversion programs. If the Partnership generates capital to invest, Homefree General Partners, the general partner of the Partnership, anticipates making investments in such areas. Although the Partnership has the power under state law to make investments in securities of other entities, the Partnership cannot be engaged primarily in the business of investing, reinvesting or trading in securities without subjecting itself to regulation under the Investment Company Act of 1940. In such event, the Partnership would be subject to the limitations and disclosure requirements of such act. The Partnership has no present intention to engage in activities which would cause it to become subject to regulation under the Investment Company Act of 1940 or to engage in non-real estate related activities.\nThe Partnership currently has no employees. The Partnership intends to utilize employees of the Company on an as-needed basis, and to contribute to the compensation of such persons on a pro-rata basis.\nITEM 2. PROPERTIES.\nTHE COMPANY\nThe Company, through Aristek Properties and other related limited partnerships, has ownership interests in the properties described below. The Company operates the Monte Vista property described below.\nMonte Vista. Monte Vista is an adult recreational community located in Mesa, Arizona containing 832 sites for recreational homes. Most sites are leased on an annual basis to residents who leave their homes at the site year-round. Remaining sites are reserved for monthly and weekly rentals. Most residents and guests stay at the community during the months from November through April. During the peak months of January through March, Monte Vista reached 90% occupancy for the past five years. The effective average occupancy based on annual rental income was approximately 95% during 1995. Monte Vista is owned by MVI, which is owned 99% by Aristek Properties and 1% by the Company. At December 31, 1995 the property was subject to a mortgage in the amount of $5,015,345 held by a commercial lender.\nMonte Vista II. In December 1983, the Company sold to Resortparks an 80-acre parcel on which the development of Monte Vista II is planned. See Item 1 - BUSINESS -Development Activities. This land was transferred in April 1990 to Aristek Properties. This land was transferred to MVI in October, 1991 and is subject to the above described mortgage.\nGood Life Travel Trailer Resort. Good Life is an adult recreational community located in Mesa, Arizona containing 1,198 sites for recreational vehicles. Most sites are rented on an annual basis with the remainder rented on a monthly or weekly basis. Most residents stay at the community during the months from November through April. Good Life is owned by H-H Resorts Joint Venture, which is owned 50% by Aristek Western and 50% by Hankins Enterprises, an unaffiliated third party. Good Life is managed by Hankins Enterprises and has historically been 100% occupied from January through April and the effective average occupancy based on annual rental income was 97% in 1995. At December 31, 1995, Good Life, together with the Towerpoint property described below, was subject to a mortgage in the principal amount of $9,122,124 held by a commercial lender.\nTowerpoint Travel Trailer Resort. Towerpoint is an adult recreational community located in Mesa, Arizona containing 1,115 sites for recreational vehicles. Most sites are rented on an annual basis with the remainder rented on a monthly or weekly basis. Most residents stay at the community during the months from November through April. Towerpoint is owned by H-H Resorts Joint Venture and is managed by Hankins Enterprises. Towerpoint has historically been 100% occupied from November through April and the effective average occupancy based on annual rental income was 98% in 1995. At December 31, 1995, Towerpoint, together with the Good Life property described above, was subject to a mortgage in the amount of $9,122,124 held by a commercial lender.\nTHE PARTNERSHIP\nThe Partnership neither owns nor leases any properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Company nor the Partnership is the subject of any 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 REGISTRANTS' \"PAIRED SHARES\" AND RELATED STOCKHOLDER MATTERS.\nThe Registrants' \"Paired Shares\"(symbol HMFRZ) are no longer traded in the over-the-counter market of the National Association of Securities Dealers Automated Quotation System (NASDAQ). The Registrant no longer receives information on the trading activity for the \"Paired Shares.\"\nThere were approximately 548 record holders of the \"Paired Shares\" on December 31, 1995, as reported by the Registrants' transfer agent.\nDuring the two years ended December 31, 1995, the Company declared no dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following data has been extracted from the combined annual financial statements of the Company and the Partnership. Such selected financial data should be read in conjunction with the registrants' financial statement and related notes incorporated by reference into \"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\nLIQUIDITY AND CAPITAL RESOURCES\nTHE COMPANY\nHistorically, the Company has not required large amounts of working capital because the properties in which the Company has interests have been acquired, financed and improved by related entities.\nDuring the past three years, the Company has used cash of $176,500 to $413,300 per year in connection with the Company's operating activities. In each of the last three years, cash used for operating activities has included amounts ranging from $62,500 to $210,200 in connection with loans to the Company's President. During 1995, amounts aggregating $433,200 were applied as repayment of these loans. See Note 8 to the Financial Statements for a summary of loan activity and further discussion.\nDuring the three-year period, the Company has also used cash of $4,800 to $10,600 per year to repay principal on long- term debt, and a total $27,700 in 1993 and $88,400 in 1994 under financing arrangements related to a land option contract. The remaining payment of $44,000 to exercise the option to acquire a parcel of land has been deferred until 1997. Cash generated from financing activities totalled $150,500 in 1995. Pursuant to an agreement between Aristek Western and the Company, the partnership borrowed this amount from Aristek Western and loaned the proceeds to the Company. It is anticipated that this obligation will be repaid prior to end of the 1996 second quarter.\nThe Company's investing activities have generated cash through the net collection of receivables from unconsolidated entities in each of the past three years, including $299,000 in 1995. Other uses of cash over the past three years have consisted of $35,000 to obtain the land option in 1993, $50,000 for a residual interest in Aristek Properties during 1994, and $29,700 for the purchase of office equipment from a third party. Management does not expect that the Company will be required to provide capital in 1996 for the Company's investments in Aristek Properties and Aristek Western, since both entities recently refinanced their debt obligations.\nThe Company believes that it will be able to continue as a going concern. The Company is presently completing a response to the SEC's comments to its \"going private\". If completed this transaction will result in the Company's savings of approximately $50,000 per year in direct accounting, legal and administrative costs, along with a savings of considerable management time, thereby improving the Company's cash flow and efficiency of management. Further, the Company expects that improved operations of the Monte Vista project will generate additional cash flow, thereby resulting in additional repayment of the Company's loans to Aristek Properties and MV I. MV I also recently restructured its first mortgage debt, and generated additional financing, which will improve the Company's liquidity. The Company will also continue to reduce personnel and administrative costs, so as to minimize cash outflow until new sources of revenues can be obtained. The Company itself does not have long term debt and therefore, has no long term liquidity requirements. Aristek Properties Ltd. and Aristek Western Properties, in which the Company has an interest, are separate entities and have long term debt which the Company believes can be satisfied from the assets of the two entities.\nThe Company's debt from affiliated entities was restructured in 1994. See Note 3 to the Financial Statements for a discussion of the provisions of such restructuring.\nTHE PARTNERSHIP\nAt present, the Partnership has no liabilities and conducts no business and thus has no capital needs. While future business of the Partnership has not been determined, availability of capital will be considered if and when such business is determined.\nRESULTS OF OPERATIONS\nTHE COMPANY\nThe Company and its affiliates serve as a real estate advisor, developer, manager and marketing agent and perform certain administrative functions for related entities. Principal sources of revenues are management and administrative fees, commissions, and cash flow participation from properties under its direction. See \"Consolidated Statement of Operations\" included in the financial statements included with this report.\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nThe Company incurred a $231,600 loss for the year ended December 31, 1995.\nTotal revenues for the year ended December 31, 1995 were $268,500 as compared to $270,700 for the year ended December 31, 1994.\nThe decrease ($2,200) was attributable principally to a reduction in interest income partially offset by nominal increases in management and administrative fees and equity in earnings of unconsolidated entities.\nManagement and administrative fees earned by the Company during 1995 are summarized below:\nManagement fees earned by the Company during 1995 in connection with H-H Resorts' operation were calculated at 1.5% of the property's gross annual receipts ($5,491,900). Management fees earned by the Company during 1995 in connection with Monte Vista operations are calculated at 3.0% of the property's gross annual receipts ($2,051,100). Administrative fees earned during 1995 totalled $100,000 and were related to administrative functions for Aristek Western.\nManagement and administrative fees earned by the Company during 1994 are summarized below:\nManagement and administrative fees for 1994 were calculated on the same basis as those for 1995. Gross receipts for H-H Resorts and Monte Vista totaled $5,435,800 and $2,081,700 respectively for 1994.\nSee (Item 2 PROPERTIES) for a discussion concerning occupancy rates for the properties.\nTotal expenses for the year ended December 31, 1995 were $700,100 as compared to $593,700 for the previous year. The increase in expenses resulted principally from losses of $93,600 recorded in connection with related party receivables and administrative fees. The receivables from officer and administrative fees are more fully described in Note 8 to the Financial Statements.\nThe effective tax rate used to calculate the net income tax benefit for 1995 was 49%. See Note 4 to the Financial Statements for a summary of income taxes.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nThe Company incurred a $236,000 loss for the year ended December 31, 1994.\nTotal revenues for the year ended December 31, 1994 were $270,700 as compared to $285,100 for the year ended December 31, 1993. This decrease was attributable principally to a management decision not to accrue management fees owed by APL in connection with management of the Monte Vista property because of the uncertainty of subsequent collection.\nManagement and administrative fees for 1994 ($244,600) were $8,800 below 1993 levels principally because of a decision not to accrue management fees owed by APL. Gross receipts from operations of the H-H Resorts and Monte Vista properties totalled $5,255,100 and $1,969,300 respectively for 1993.\nTotal expenses for the year ended December 31, 1994 were $593,700 as compared to $477,100 for the previous year. The increase in expenses resulted principally from an additional provision for loss on receivables ($53,100) and an increase in general and administrative expenses of $45,900 and an increase in equity in losses of APL ($13,000). The increase in general and administrative expenses includes an increase in accounting services and external audit fees of $33,000.\nThe effective tax rate used to calculate the net income tax benefit for 1994 was 27%. See Note 4 to the financial statements for a summary of income taxes.\nEFFECTS OF INFLATION\nInflation has not had a material impact on the operations of the Company and management believes it will not have a material impact on future operations.\nTHE PARTNERSHIP\nThe Partnership has not commenced its planned operations.\nIMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS\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 establishes standards for determining impairment of long-lived assets, such as the Company's land option costs. Although the Company has not performed a detailed analysis of the impact of this new standard on the Company's financial statements, management estimates that the application of the new standard would not have a material impact on the Company's 1995 financial statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFinancial statements and supplementary data are included in Part IV 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.\nThe Company's and the Partnership's 1990 financial statements were audited by Deloitte & Touche, independent certified public accountants. In 1994, the Company changed its auditors to HEIN + ASSOCIATES LLP, which audited the 1991 and 1992, and the 1993, 1994 and 1995 financial statements included in this report.\nThere were no disagreements between management and the Company's independent auditors.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nTHE COMPANY\n(A) IDENTIFICATION OF DIRECTORS\nThe following table sets forth the names, ages, positions, and periods of service of the directors of the Company. There are no arrangements or understandings pursuant to which any of the directors was or is to be selected as a director.\nAll directors are elected to serve until the next annual meeting of stockholders or until their successors are chosen and qualify, or until they resign or are replaced.\nDuring the year 1995, the Company had a Board of Directors consisting of Craig M. Bollman, Jr., Phyllis A. Bollman, W. Phillip Marcum, Michael T. Oliver and Anthony B. Petrelli. Messrs. Marcum, Oliver and Petrelli resigned from the Board as of February 18, 1996, at which time the Board was reduced to three members and Taylor M. Bollman was elected as the third director.\n(B) IDENTIFICATION OF EXECUTIVE OFFICER\nThe name and age of the only executive officer of the Company, the position and office with the Company held by such person, and the periods served are as follows:\nAll officers are elected to serve until their successors are duly elected and qualified or until they resign or are replaced.\n(C) FAMILY RELATIONSHIPS\nCraig M. Bollman, Jr. and Phyllis A. Bollman are married, Taylor M. Bollman is Mr. and Mrs. Bollman's son. No other family relationship exists among the directors or executive officers.\n(D) BUSINESS EXPERIENCE\nThe following is a brief account of the business experience of each executive officer and director for the past five or more years:\nCRAIG M. BOLLMAN, JR. Mr. Bollman has been the Chairman of the Board of Directors of the Company since February 24, 1977. He served as President from February 24, 1977 to December 1, 1984 and resumed such office as of July 1986. In September 1974, Mr. Bollman founded Aristek Corporation (then called Aristek Real Estate Corporation), which specialized in working out distressed loan situations for major national institutional lenders. On February 24, 1977, Metrix, Inc., a publicly-held corporation engaged primarily in the business of operating manufactured home communities, acquired all of the capital stock of Aristek Corporation in exchange for 6,230,000 shares of its Common Stock. The name of Metrix, Inc. was changed to Aristek Corporation, then to Aristek Communities, Inc. and in 1987 to Homefree Village Resorts, Inc.\nPHYLLIS A. BOLLMAN. Mrs. Bollman has served as a director of the Company since February 24, 1977. Mrs. Bollman served as the president and a director of a departmental advisory board at Denver's University Hospital from 1982 until 1986. Neither of these organizations is a parent, subsidiary or other affiliate of the Company.\nTAYLOR M. BOLLMAN. Mr. Bollman will attend Harvard college in the fall of 1996.\nTHE PARTNERSHIP\nThe general partner of the Partnership is Homefree General Partners, a Delaware general partnership comprised of Bollman Associates, Inc., and the Company. See DIRECTORS AND EXECUTIVE OFFICERS - THE COMPANY for information with respect to the directors and executive officers of the Company. Craig M. Bollman, Jr. is the sole director and executive officer of Bollman Associates, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nTHE COMPANY\n(A) EXECUTIVE COMPENSATION\nSet forth below is a summary of the compensation paid to Craig M. Bollman, the Company's only executive officer, in each of the last three years:\n(1) Cost of health and life insurance.\n(2) Represents payments by Bollman Associates, Inc. to Mr. Bollman of accrued administrative fees payable by the Partnership to Homefree General Partners.\n(B) COMPENSATION OF DIRECTORS\nPhyllis A. Bollman, a current director, and Messrs. Marcum, Oliver and Petrelli, former directors, each received directors fees of $2,000 during the twelve months ended December 31, 1995. Taylor M. Bollman was not a director in 1995, and received no fees of any type. One meeting was held in the twelve months ended December 31, 1995. In addition, all directors receive $200 for each meeting of the Board of Directors they attend and are reimbursed for travel expenses incurred in attending such meetings. One meeting was held in the twelve months ended December 31, 1995. Directors are expected to receive similar compensation in 1996.\nTHE PARTNERSHIP\nThe Partnership presently has no executive officers. Homefree General Partners will be responsible for the duties customarily associated with the duties of executive officers of a corporation. Homefree General Partners is entitled to receive an annual administrative fee from the Partnership. Bollman Associates, Inc., all of the capital stock of which is owned by Craig M. Bollman, Jr., the President and Chairman of the Board and principal stockholder of the Company, is entitled to receive the annual $75,000 administrative fee when payable by the Partnership to Homefree General Partners for providing administrative services to the Partnership. Such fee is not payable until such time as there is available cash or upon liquidation of the Partnership.\nCOMPENSATION TO HOMEFREE GENERAL PARTNERS\nThe Partnership Agreement provides for the payment of an administrative fee to Homefree General Partners of $75,000 per annum. This fee is subject to adjustment by the Board of Directors of the Company and may be canceled in any year by the Board of Directors in its capacity as a general partner of Homefree General Partners. In return for this fee, Homefree General Partners will attempt to locate and negotiate investment opportunities for the Partnership, will attempt to arrange financing for such investments and will administer the affairs of the Partnership. The agreement of Homefree General Partners provides that the annual administrative fee will be payable to Bollman Associates, Inc. for providing services to the Partnership, as compensation for its role as a general partner of Homefree General Partners and for assuming the risks incident to such role. Such fees aggregating $210,200 were paid for the twelve months ended December 31, 1995. The Partnership Agreement also provides for reimbursement to Homefree General Partners of all expenses incurred by it in connection with the Partnership. To the extent that Bollman Associates, Inc. incurs expenses, it will be reimbursed by Homefree General Partners, which in turn will be reimbursed by the Partnership. Homefree General Partners has not incurred any expenses on behalf of the Partnership for which it would be entitled to reimbursement.\nThe agreement of Homefree General Partners provides that the Company will be entitled to 90% and Bollman Associates, Inc. will be entitled to 10% of Homefree General Partners' 1% interest in the Partnership.\nIn addition to the annual administrative fee and reimbursement of expenses, Homefree General Partners may enter into contracts with or perform other services for the Partnership. The partnership agreement between the partners of Homefree General Partners provides that no additional compensation will be payable to Bollman Associates, Inc. and that the Company in its capacity as a general partner of Homefree General Partners is entitled to all compensation for such additional services. The only compensation to be received by Bollman Associates, Inc. in connection with the Partnership Agreement is the reimbursement of expenses, the annual administrative fee and its share of profits and losses.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nTHE COMPANY\n(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nAs of May 19, 1996, persons or groups known to the Company to own beneficially more than five percent of the issued and outstanding shares of Common Stock, which is the only class of voting securities of the Company, are set forth in the following table:\n(1) The percentages shown are based upon 10,483,982 issued and outstanding shares of Common Stock as of May 19, 1996. Craig M. Bollman, Jr. is not a holder of any option to purchase shares of Common Stock of the Company.\n(2) With respect to shares held by The Aristek Foundation, Mr. Bollman has sole voting and investment power, but in which he has no pecuniary interest. Mr. Bollman disclaims beneficial ownership of the shares held by The Aristek Foundation.\n(B) SECURITY OWNERSHIP OF MANAGEMENT\nThe following table sets forth the shares of Common Stock of the Company beneficially owned by each director and by the directors and officers of the Company as a group as of May 19, 1996, and their percentage ownership thereof:\n(1) The percentages shown for all directors and the directors and officers as a group are based upon 10,483,982 shares issued and outstanding as of May 19, 1996.\n(2) With respect to shares held by The Aristek Foundation, Mr. Bollman has sole voting and investment power, but in which he has no pecuniary interest. Mr. Bollman disclaims beneficial ownership of the shares held by The Aristek Foundation.\nTHE PARTNERSHIP\nThe following table sets forth the assignee limited partnership interests of the Partnership beneficially owned by each director and by the directors and officers of the Company as a group as of May 19, 1996, and their percentage ownership thereof:\nASSIGNEE LIMITED PARTNERSHIP INTEREST BENEFICIALLY OWNED ON MAY 19, 1996\n(1) The percentages shown for all other directors and the directors and officers as a group are based upon 10,483,982 assignee limited partnership interests issued and outstanding as of May 19, 1996.\n(2) With respect to shares held by The Aristek Foundation, Mr. Bollman has sole voting and investment power, but in which he has no pecuniary interest. Mr. Bollman disclaims beneficial ownership of the shares held by The Aristek Foundation.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(A) CERTAIN BUSINESS RELATIONSHIPS\nBollman Associates, Inc. and the Company are the general partners of Homefree General Partners. Homefree General Partners is the general partner of the Partnership. Bollman Associates, Inc. is entitled to receive a $75,000 annual administrative fee to be paid by the Partnership to Homefree General Partners for administrative services, when and if such fee is paid by the Partnership. See Item 11, EXECUTIVE COMPENSATION - THE PARTNERSHIP. The aggregate amount owed by the Partnership to Bollman Associates, Inc. as of December 31, 1995 is $240,845. This amount has not been accrued as of December 31, 1995 inasmuch as there can be no assurance that the Partnership will have sufficient funds to meet the obligation. Craig M. Bollman, Jr., a director, President and Chairman of the Board of the Company, is the sole stockholder of Bollman Associates, Inc.\n(B) INDEBTEDNESS OF MANAGEMENT\nThe Company holds an interest-bearing note from Craig M. Bollman, Jr., President and Chairman of the Board, in the aggregate amount of $310,000 at December 31, 1995. This indebtedness was incurred in connection with personal loans. This note bears interest at the \"Applicable Federal Rate\" which is the lowest rate permitted by the Internal Revenue Service without imputing interest on a transaction. The largest amount outstanding under these notes during fiscal 1995 was $310,000.\nPART IV\nB. FINANCIAL STATEMENT SCHEDULES.\nNone\nSchedules have been omitted because they are not required or the information is included in the financial statements or notes thereto.\nC. REPORTS ON FORM 8-K.\nNone\nD. EXHIBITS.\nTHE COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each of the Registrants has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nHOMEFREE VILLAGE RESORTS, INC. HOMEFREE INVESTORS L.P.\n\/s\/ CRAIG BOLLMAN, JR. \/s\/ CRAIG M. BOLLMAN, JR. - ----------------------------------- ------------------------------------- By: (s) Craig Bollman, Jr. By: Homefree General Partners, Craig M. Bollman, Jr. its General Partner Chairman of the Board (Principal Executive Officer) By Homefree Village Resorts, Inc., a General Partner Date: June 14, 1996 By: (s) Craig M. Bollman, Jr. Craig M. Bollman, Jr. President\nDate: June 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 Registrants and in the capacities and on the dates indicated:\nCraig M. Bollman, Jr. Craig M. Bollman, Jr. Chairman of the Board Sole Director, (Principal Executive and Financial Officer) Bollman Associates, Inc. a General Partner of Dated: June 14, 1996 Homefree General Partners, General Partner of Homefree Investors L.P. (Principal Executive and Financial Officer)\nDate: June 14, 1996\nMAJORITY OF THE BOARD OF DIRECTORS\nCraig M. Bollman, Jr. Director\nDate: June 14, 1996\nPhyllis A. Bollman Director\nDate: June 14, 1996\n[ARTICLE] 5 [CIK] 0000065291 [NAME] HOMEFREE VILAGE RESORTS, INC.\n[ARTICLE] 5 [CIK] 0000820889 [NAME] HOMEFREE INVESTORS LP\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors Homefree Village Resorts, Inc. Denver, Colorado\nTo the Partners Homefree Investors L.P. Denver, Colorado\nWe have audited the accompanying combined balance sheets of Homefree Village Resorts, Inc. (a Delaware Corporation) and subsidiaries and Homefree Investors L.P. (a Massachusetts limited partnership) as of December 31, 1995 and 1994, and the related combined statements of operations, stockholders' equity and partners' deficit, and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Company's and 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 combined financial position of Homefree Village Resorts, Inc. and subsidiaries and Homefree Investors L.P. as of December 31, 1995 and 1994, and the 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.\nThe accompanying financial statements have been prepared assuming that the Company and the Partnership will continue as a going concerns, which contemplate the realization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 1 to the financial statements, the Company and the Partnership have suffered substantial operating losses, and anticipate the need for additional cash to fund operations. These conditions raise substantial doubt about the ability of the Company and the Partnership to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ HEIN + ASSOCIATES LLP\nHEIN + ASSOCIATES LLP\nDenver, Colorado June 12, 1996\nS-1 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nCOMBINED BALANCE SHEETS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-2 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nCOMBINED STATEMENTS OF OPERATIONS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-3 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nCOMBINED STATEMENTS OF STOCKHOLDERS' EQUITY AND PARTNERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nHOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nCOMBINED STATEMENTS OF CASH FLOWS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-5 INDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors Homefree Village Resorts, Inc. Denver, Colorado\nWe have audited the accompanying consolidated balance sheets of Homefree Village Resorts, 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 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 Homefree Village Resorts, Inc. and subsidiaries as of December 31, 1995 and 1994, and the 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 1 to the financial statements, the Company has suffered substantial operating losses and anticipates the need for additional cash to fund operations. These conditions raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ HEIN + ASSOCIATES LLP\nHEIN + ASSOCIATES LLP\nDenver, Colorado June 12, 1996\nS-6 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-7 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-8 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-9 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-10 INDEPENDENT AUDITOR'S REPORT\nTo the Partners Homefree Investors L.P. Denver, Colorado\nWe have audited the accompanying balance sheets of Homefree Investors L.P. (a Massachusetts 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 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 Homefree Investors L.P. as of December 31, 1995 and 1994, and the results of its operations and cash flows for the years ended December 31, 1995, 1994, and 1993 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 1 to the financial statements, the Partnership has suffered losses from inception, and anticipates the need for additional cash to fund operations. These conditions raise substantial doubt about the ability of the Partnership to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ HEIN + ASSOCIATES LLP\nHEIN + ASSOCIATES LLP\nDenver, Colorado June 12, 1996\nS-11 HOMEFREE INVESTORS L.P.\nBALANCE SHEETS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-12 HOMEFREE INVESTORS L.P.\nSTATEMENTS OF OPERATIONS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-13 HOMEFREE INVESTORS L.P.\nSTATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n________________________ * The General Partner's capital account is eliminated for purposes of the combined financial statements.\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-14 HOMEFREE INVESTORS L.P.\nSTATEMENTS OF CASH FLOWS\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nS-15 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND NATURE OF OPERATIONS:\nNature of Operations - The Company is engaged primarily in the development and operation of adult recreational communities containing rental sites for manufactured homes and recreational homes. The Company has interests in such communities through Aristek Properties, Ltd., and Aristek Western Properties Limited Partnership, in which the Company is the general partner. The Company's objectives are to create and participate, through such partnerships, in the cash flow from these communities and share in appreciation in the value of such properties. The Company also receives income from development, management, and administrative services.\nPaired Shares - Effective May 2, 1988, Homefree Village Resorts, Inc. and subsidiaries (the Company) and Homefree Investors L.P. (the Partnership), entered into a Pairing Agreement (the Agreement) which provided for the pairing of assignee limited partnership interests of the Partnership with shares of common stock of the Company. Subsequently, the Company funded a distribution of one assignee limited partnership interest of the Partnership for each share of common stock of the Company.\nThe shares of the Company's common stock, par value of $.001 per share, and the assignee limited partnership interests, par value of $.001 per unit, are \"paired\" on a one-for-one basis and may only be transferred in units (Paired Shares) consisting of one share of common stock and one limited partnership interest.\nContinuing Operations - The accompanying financial statements have been prepared on a going concern basis which contemplates the realization of assets and liquidation of liabilities in the ordinary course of business. The Company has experienced a significant decrease in revenues over the last several years due to cash flow difficulties experienced by Aristek Properties Limited (APL), an investment of the Company of which it is also general partner (see Note 3). APL has been unable to pay its management fee to the Company; as a result, the Company ceased accruing management fee revenues due from APL. The Company also has extended loans to help finance APL's operations, which has severely impacted the Company's liquidity. During 1994, the Company restructured debt arrangements with APL which provides that all of APL's available cash flow will be utilized to repay advances to the Company (see Note 8). As of December 31, 1995, the Company has a significant net receivable due from APL and is obligated to purchase the limited partners' interests in APL at a future date for a minimum of $530,000. Recovery of the Company's net receivable from and investment in APL is dependent upon further development of APL's underlying properties and for APL to ultimately achieve profitable operations or the sale of APL at a price in excess of its liabilities and partners investments.\nThese conditions raise substantial doubt about the ability of the Company to continue as a going concern. The accompanying financial statements do not include any adjustments which might result from the outcome of this uncertainty.\nManagement has also taken action in recent years to reduce costs, including staff reductions, relocation of the corporate offices, and contracting out its accounting and administrative support functions. In addition, the principal operating property of APL, Monte Vista I Joint Venture (Monte Vista), recently obtained an additional $525,000 in bank financing, and deferred the due date on its total bank debt of $5,015,000 until December 1998. Management believes that these actions will enable the Company to continue as a going concern.\nS-16 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nCombined and Consolidated Financial Statements - The accompanying consolidated financial statements include the Company and its majority-owned subsidiaries. The combined financial statements include the accounts of the Partnership and the Company. All material intercompany balances and transactions have been eliminated. The Company's majority-owned subsidiaries are Resortparks of America, Inc. (RPA), which is 100% owned, and Homefree General Partners (HGP), which is 90% owned. The minority interest in HGP is not material.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nProperty and Equipment - Property and equipment is recorded at cost. Depreciation is provided utilizing accelerated methods over the estimated useful lives of the related assets.\nInvestments in Unconsolidated Entities - Investments in unconsolidated entities, which are all less than 20% owned, are accounted for by the equity method because of the significance of the Company's influence as general partner over operating and financial policies of its investees.\nIncome Taxes - The Company accounts for income taxes under the liability method of SFAS No. 109, whereby current and deferred tax assets and liabilities are determined based on tax rates and laws enacted as of the balance sheet date. The deferred tax benefit represents the net change in the deferred tax asset and liability accounts.\nNo provision for Federal and state income taxes or related benefits has been made for the Partnership since the Partnership's taxable income or loss is required to be reported in the income tax returns of the partners. The provision for income taxes will not bear a normal relationship to pre-tax operating results on a combined basis, since no provision for income taxes has been made for the Partnership.\nLoss Per Share - The computation of net loss per share is based on the weighted average number of shares of common stock and equivalent paired shares outstanding during the respective years. The effect of outstanding stock options on the computation of net loss per share is antidilutive for all periods presented.\nCash and Equivalents - For purposes of the Statements of Cash Flows, the Company and the Partnership consider cash and equivalents to include all highly liquid debt instruments purchased with an original maturity of three months or less.\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 realizability of the Company's investments and receivables due from unconsolidated entities, and the realizability of land option costs.\nS-17 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nReclassifications - Certain reclassifications have been made to the 1994 and 1993 financial statements to conform to the presentation in 1995. The reclassifications had no effect on the net loss for 1994 and 1993.\n3. INVESTMENTS IN UNCONSOLIDATED ENTITIES:\nAPL was formed in 1976 and the Company is the sole general partner with a 1% general partner interest and a 2.3% limited partner interest. As general partner of APL, the Company has a 30% residual interest which entitles it to receive 30% of all excess cash flow from operations and net proceeds from the refinancing or sale of properties. APL's principal asset was a 60% joint venture interest in the Monte Vista I Joint Venture (\"MVIJV\"). Aristek Western Properties Limited Partnership (\"AWP\") owned the remaining 40% joint venture interest until December 1993 when APL increased its ownership to 99% and the Company acquired the remaining 1% interest. MVIJV owns an adult recreational community containing 832 sites for recreational homes. Due to APL's controlling interest, the accounts of MVIJV are consolidated in APL's financial statements.\nAs summarized in Notes 5 and 8, the Company has entered into significant transactions with APL, resulting in $8.6 million of net receivables and $7.2 million of long-term debt at December 31, 1995. Due to significant uncertainties about the collectibility of the net receivables from APL, the Company suspended recording interest income, interest expense, and management fees effective January 1, 1992. As of December 31, 1995, APL owed the Company an additional $1.5 million, which represents the net amount of such items which are not recorded in the accompanying financial statements.\nEffective June 30, 1994, the partners of APL consented to a restructuring of the intercompany loans whereby all of APL's excess cash flow will be utilized to repay outstanding advances. The interest rate was reduced from 8.1% to 7%, and the maturity date was extended to June 30, 1998. The parties to the intercompany loans agreed to provide set-off rights in the event of a default with respect to either the restructured notes or the underlying debt of MVIJV. APL also agreed to pay additional interest equal to 75% of the net proceeds from a refinancing or sale of the Monte Vista property, after repayment of all liabilities. In connection with the restructuring, the holders of 26.5 limited partner units of APL agreed to provide the Company with an option to purchase their units for a minimum purchase price of $20,000 per unit or a total of approximately $530,000. Based on an appraisal of the Monte Vista property which is required to be prepared at the date the Company exercises its option, the Company may be required to pay a higher price per unit. The Company is required to exercise its option between January 1, 1997 and November 30, 1998. No gain or loss was recognized on this restructuring transaction.\nS-18 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nCondensed balance sheets and operating statements of APL are presented below (in thousands).\nBALANCE SHEETS\nS-19 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nPresented below is a reconciliation of APL's net loss to the Company's equity in the losses of APL:\nThe Company also owns a 2.6% interest in AWP and is the general partner. AWP is a limited partnership with investments in real estate. Until 1994, the Company owned a 2.0% general partner interest in Grandview Club Ltd. (Grandview Club). The primary property held by Grandview Club was foreclosed on by a bank in 1991 and the partnership's affairs were concluded in 1994 when all remaining assets were liquidated.\n4. INCOME TAXES:\nDeferred income taxes relate exclusively to long-term assets and liabilities and consist of the following as of December 31, 1995 and 1994:\nS-20 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nFor income tax reporting purposes, the Company and RPA file a consolidated return. The composition of the income tax benefit for the years ended December 31, 1995, 1994, and 1993 is as follows:\nFollowing is a reconciliation of the Company's effective tax rate on the consolidated loss to the statutory U.S. Federal income tax rate for the years ended December 31, 1995, 1994, and 1993:\nAs of December 31, 1995, the Company and RPA had a tax net operating loss carryforward of approximately $500,000. This loss carryforward will expire in 2009 and 2010 if not previously utilized to offset taxable income of the Company and RPA.\nDuring 1993 and 1994, the Company provided a valuation allowance for a portion of the Company's deferred tax assets since the treatment of certain items reported on the Company's income tax returns was uncertain. During 1995, the Internal Revenue Service completed an examination of the Company's Federal income tax returns for 1992 through 1994 and it became apparent that the items were properly reported. Accordingly, a portion of the valuation allowance provided in prior years was reversed in 1995. The valuation allowance also increased due to 1995 losses.\nS-21 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\n5. LONG-TERM DEBT:\nLong-term debt consists of the following:\nThe scheduled annual principal reductions of long-term debt are as follows:\n6. STOCK INCENTIVE PLANS:\nThe Company has a stock option plan which enables officers and employees of the Company to purchase shares of common stock at its fair market value on the date of the grant. The Company has reserved a total of 1,250,000 shares for options which may be granted under the plan. Options may be exercised for a maximum term of ten years after the date of grant. At December 31, 1995, all options previously granted under the Plan had expired.\nThe Company also has a stock appreciation rights plan, whereby up to 250,000 rights may be awarded to certain directors, officers and employees. The plan entitles the holder of the rights to receive upon redemption, the increase, if any, of the market value of the Company's common stock at the redemption date over the market value at date of grant. Each right has a maximum term of ten years after the date of grant. One right is deemed the equivalent of one share of common stock. No rights have been granted as of December 31, 1995.\nS-22 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\n7. LAND OPTION COSTS:\nIn October 1993, the Company entered into an option agreement for the purchase of a parcel of land which is adjacent to property owned by APL. Under the option agreement, the Company paid $38,200 for the option and agreed to loan an additional $125,000 to the seller. The option was originally exercisable until April 1, 1995 through the payment of an additional $46,800 and the application of the $125,000 loan to the purchase price. During 1996, the parties agreed to extend the exercise period through July 1, 1997.\nAt December 31, 1995 and 1994, the Company recorded the total payments required to purchase the land as land option costs in the accompanying balance sheets. The required payments were discounted at 12% to arrive at a total cost for the land of $195,600.\n8. RELATED-PARTY TRANSACTIONS:\nReceivables from unconsolidated entities consist of the following:\nIn 1990, the Company entered into two separate like-kind exchange transactions with APL. In one transaction, the Company conveyed land to APL in return for cash and a note receivable for $3,317,800. The Company has deferred the gain of $488,500 on this transaction until sufficient cash payments are received by the Company on the note to qualify the transaction as a sale. In the second transaction, APL conveyed land to the Company in return for cash and a note payable of $7,154,500 (see Note 5). Also, in connection with this second transaction, the Company advanced (by delivering a certificate of deposit) $5,300,000 in the form of a note receivable to APL to enable APL to pay off bank debt it had on this property. The Company also made advances to APL to enable it to finance its operating needs.\nThe collection of notes receivable and advances from APL is dependent upon future events, including the ability of Monte Vista to develop certain additional land in a manner which will provide APL with a return of its capital\nS-23 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nafter the repayment of loans made to Monte Vista. At December 31, 1990, management provided an allowance of $1,400,000 and $900,000 against these notes receivable and advances, respectively, due to the uncertainty of the successful outcome of this development project. In 1991, because of reservations regarding the ability of APL to continue operations with its existing debt level, $1,300,000 of the obligation from APL was forgiven by the Company with a corresponding reduction in the allowance previously provided.\nReceivable from Officer and Administrative Fees - Pursuant to the Homefree Investors Limited Partnership Agreement, the Partnership is liable to pay an annual administrative fee of $75,000 per year to HGP, which in turn pays this fee to a general partner of HGP, which is an entity owned 100% by the president of the Company. Such administrative fee is not payable until the earlier of the date that, in the opinion of the general partners, the Partnership has sufficient cash to pay the fee without jeopardizing the Partnership or the Company, or upon liquidation of the Partnership. Due to the lack of operations and cash flows of the Partnership, no amounts are accrued in the accompanying financial statements.\nOver the past several years, the Company has made a series of cash advances to, and on behalf of, the Company's president. These advances are evidenced by formal notes which bear interest at approximately 3.8% as of December 31, 1995. The following is a summary of activity during the years ended December 31, 1995, 1994, and 1993:\nThe president has always intended to repay the notes from the annual administrative fee discussed above. Accordingly, since the Company would be required to fund the administrative fee in order to collect the receivable, the Company recorded a provision for loss as cash advances were made to the president. During 1995, a total of $433,200 was designated for the deemed payment of administrative fees and related repayment of notes receivable with no effect on the Company's cash flows. Without regard to this transaction, through December 31, 1995, the Company has recognized cumulative losses on the notes receivable of $743,200 compared to cumulative administrative fees of $674,000. Accordingly, the Company's financial statements include recognition of $69,200 of expenses in excess of the contractual amount of the administrative fee.\nRevenues - The Company and its corporate subsidiaries serve as a real estate advisor, developer, manager and marketing agent and perform certain administrative functions for related entities. The Company's principal\nS-24 HOMEFREE VILLAGE RESORTS, INC. AND SUBSIDIARIES AND HOMEFREE INVESTORS L.P.\nNOTES TO FINANCIAL STATEMENTS\nsources of revenue are fees, commissions and cash flow participation from properties under its supervision (see Note 3).\n9. FINANCIAL INSTRUMENTS:\nStatement 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 cash and equivalents, contract payable, and accounts payable and accrued expenses approximates fair value due to the short maturity of these instruments. Due to uncertainty about the fair value of the properties owned by APL and AWP, it is not practicable to estimate the fair value of the Company's investment and receivables due from these entities. However, management believes that fair value exceeds the carrying value as of December 31, 1995.\n10. SIGNIFICANT CONCENTRATIONS:\nThe Company has an investment of $18,100, receivables of $8,613,800, and long-term debt of $7,154,500 which is payable to APL and its subsidiary. Due to the Company's current general and limited partner interests in APL and the commitment described in Note 3 to purchase an additional 26.5 limited partner units, the Company has a substantial concentration of its net assets which are dependent upon the future success of APL.\nSubstantially all of the Company's receivables, investments in partnerships, and land option costs relate to properties which are located in the Phoenix, Arizona metropolitan area. This concentration may impact the Company's ability, either positively or negatively, to realize the carrying value of these assets.\nThe Company earns substantially all of its management and administrative fees from APL and Aristek Western Properties Limited Partnership.\n11. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS:\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 establishes standards for determining impairment of long-lived assets, such as the Company's land option costs. Although the Company has not performed a detailed analysis of the impact of this new standard on the Company's financial statements, management estimates that the application of the new standard would not have a material impact on the Company's 1995 financial statements. The Company will adopt the new standard in the first quarter of 1996.\nS-25 INDEPENDENT AUDITOR'S REPORT\nTo the Partners Aristek Properties, Ltd. Denver, Colorado\nWe have audited the accompanying consolidated balance sheets of Aristek Properties, Ltd. (a limited partnership) and its subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in 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 the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aristek Properties, Ltd., and its 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 financial statements have been prepared assuming that the Partnership will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 1 to the financial statements, the Partnership has suffered substantial operating losses, and anticipates the need for additional cash to fund operations. These conditions raise substantial doubt about the ability of the Partnership to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nHEIN + ASSOCIATES LLP\nDenver, Colorado June 12, 1996\nS-26 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY (A LIMITED PARTNERSHIP)\nCONSOLIDATED BALANCE SHEETS\nSEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.\nS-27 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY (A LIMITED PARTNERSHIP)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.\nS-28 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY (A LIMITED PARTNERSHIP)\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.\nS-29 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY (A LIMITED PARTNERSHIP)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nS-30 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY (A LIMITED PARTNERSHIP)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.\nS-31 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION AND NATURE OF OPERATIONS:\nOrganization - Aristek Properties, Ltd. (\"the Partnership\") is a Colorado limited partnership formed on June 29, 1976. At December 31, 1995, the sole general partner is Homefree Village Resorts, Inc. (the \"General Partner\"). In accordance with the terms of the Partnership Agreement, the partnership was extended by the General Partner to December 31, 1998. The Partnership Agreement provides that partnership profit and loss, after adjustment for certain gains earned solely by the General Partner, shall be allocated 1% to the General Partner and 99% to the Limited Partners, in direct proportion to their respective ownership of limited partnership units. Under the terms of the agreement, as amended, distributions may be made to the General Partner based on the adjusted cash flow from operations, sales and refinancing of the Partnership's properties.\nPursuant to the partnership agreement, the General Partner earns an annual administrative fee of $94,750. In addition, the Partnership Agreement provides for additional compensation to the General Partner for certain services rendered and payment of costs and expenses incurred by the General Partner on behalf of the Partnership.\nEffective June 30, 1994, the partners of the Partnership consented to a restructuring of the intercompany loans whereby all of the Partnership's excess cash flow will be utilized to repay outstanding debt to the General Partner. The interest rate was reduced from 8.1% to 7%, and the maturity date was extended to June 30, 1998. The parties to the loans agreed to provide set-off rights in the event of a default with respect to either the restructured notes or the underlying debt of MVIJV. The Partnership also agreed to pay additional interest equal to 75% of the net proceeds from a refinancing or sale of the Monte Vista property, after repayment of all liabilities. In connection with the restructuring, the holders of 26.5 limited partner units of the Partnership agreed to provide the General Partner with an option to purchase their units for a minimum purchase price of $20,000 per unit or a total of approximately $530,000. Based on an appraisal of the Monte Vista property which is required to be prepared at the date the Company exercises its option, the General Partner may be required to pay a higher price per unit. The General Partner is required to exercise its option between January 1, 1997 and November 30, 1998. No gain or loss was recognized on this restructuring transaction. When this option is exercised, there will be a change in control of the Partnership to the General Partner. However, the General Partner does not presently have sufficient liquidity to exercise the option.\nNature of Operations - The Partnership is engaged primarily in the development and operation of an adult recreational community containing 832 rental sites for manufactured homes and recreational homes. This community is located in Mesa, Arizona and offers extensive recreational facilities and social activities designed to appeal to active pre-retirement and retirement age people. The rental operations generally include operating leases which do not extend beyond one year.\nGoing Concern - The accompanying financial statements have been prepared on a going concern basis which contemplates the realization of assets and liquidation of liabilities in the ordinary course of business. At December 31, 1995, the Partnership has approximately $5 million of debt (net of receivables) payable to the General Partner and a partners' deficit of approximately $3.6 million. The Partnership has experienced operating losses in each of the past three years and the Partnership's operating activities have not generated net cash flow in either of the past two years. Due to the Partnership's lack of liquidity, it was necessary to restructure outstanding debt payable to the General Partner during 1994 and, as a result, the Partnership is required to pay all excess cash flow to the General Partner until maturity of the debt in 1998. However, the\nS-32 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nGeneral Partner has also experienced financial difficulties over the past several years and is not presently expected to be capable of providing capital to support operations.\nThese conditions raise substantial doubt about the ability of the Partnership to continue as a going concern. The accompanying financial statements do not include any adjustments which might result from the outcome of this uncertainty.\nIn addition to financial support from the General Partner, in recent years the Partnership has relied on debt financing from a commercial lender to support operations and the commercial lender has extended the due date until December 1998. However, management believes that the ultimate success of the Partnership is dependent upon the ability to obtain additional funding to develop its 75-acre parcel of land which is adjacent to the Monte Vista property. Management believes the Partnership has financing arrangements in place to allow it to continue in operation through 1997 and efforts are continuing to obtain additional financing to fully develop the project.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation - The financial statements include the accounts of the Partnership and its affiliate, Monte Vista I Joint Venture (MVIJV). All material intercompany transactions and balances have been eliminated. Through 1993, AWP owned a 40% minority interest in MVIJV. In December 1993, the Partnership acquired 97.5% of AWP's interest and the General Partner acquired the remaining 2.5%. No amounts are reflected in the accompanying financial statements for the General Partner's minority interest since MVIJV incurred losses in each of the past two years and HVR is not funding its share of the losses. The General Partner's share of such losses is approximately $15,000 through December 31, 1995.\nProperty and Equipment - Property is recorded at cost, which does not exceed the estimated fair market value. Depreciation is provided using the straight-line method over estimated useful lives, as follows:\nThe 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.\nPartnership Accounting - All income or loss is allocated to the partners in accordance with the Partnership Agreement. The accompanying financial statements do not include any assets, liabilities or operations attributable to the partners' individual activities and no provision has been made for income taxes (credits), as they are the responsibility of the partners.\nS-33 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCash Equivalents - For purposes of the statements of cash flows, the Partnership considers cash and equivalents to include cash on hand and all highly liquid debt instruments purchased with an original maturity of three months or less.\nDeferred Loan Costs - Deferred loan costs were incurred in connection with the origination of the mortgage note discussed in Note 4. These costs are being amortized using the interest method.\nUnearned Rental Income - Rental income is typically received in advance for a one year period. The Partnership recognizes rental income ratably over the period for which the payment relates.\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 Partnership's financial statements are based on a number of significant estimates including the realizability of net operating properties and land held for development, selection of depreciation methods and estimated useful lives, and the realization of receivables which affects recognition of profit on the sale of real estate.\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 Partnership's method of determining impairment of long- lived assets. Although the Partnership has not performed a detailed analysis of the impact of this new standard on the Partnership's financial statements, the Partnership does not believe that adoption of the new standard will have a material effect on the financial statements.\n3. NOTE RECEIVABLE:\nThe note receivable of $7,154,529 at December 31, 1995 is due from the General Partner and bears interest at 7%. Principal and interest are due at the maturity date in June 1998.\n4. MORTGAGE AND NOTES PAYABLE:\nAt December 31, 1995 and 1994, the Partnership has a mortgage note payable with an outstanding principal balance of $5,015,346 and $4,492,913, respectively. This note bears interest at 4% above the published LIBOR rate (total of $9.9% at December 31, 1995) and requires minimum monthly payments at 10%. Payments that exceed the monthly interest rate are applied to principal. The borrower also covenants that, so long as any of the indebtedness remains outstanding, as of May 31 of any given loan year, borrower shall have cash balances in its bank accounts for the trust property that equal the greater of $400,000, or an amount sufficient to cover property operations and debt service during the months of June, July, and August of said loan year. The note is collateralized by operating properties and land held for development.\nNotes payable to the General Partner amount to $11,207,870 at December 31, 1995 and 1994. These notes bear interest at 7% and no principal or interest payments are due until the maturity date in June 1998.\nS-34 ARISTEK PROPERTIES, LTD. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAssuming the interest rate in effect under the mortgage note payable does not change after December 31, 1995, the aggregate maturities of debt are as follows:\n5. FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK:\nAt December 31, 1995, the Partnership had cash and money market investments with a single bank which totaled approximately $560,000. The Company has mortgage debt with a single lender and substantially all of the Company's tangible assets are pledged as collateral for this obligation.\nAt December 31, 1995, the Partnership had a note receivable from the General Partner for $7,154,529 and notes payable to the General Partner for $11,207,870. A right of set-off exists between these instruments but none of the notes are collateralized. Management does not believe it is practicable to estimate the fair value of the parables and receivables from the General Partner due to the financial interest of the General Partner. Management believes that the fair value of the bank debt is equivalent to the carrying value due to the floating interest rate. Management believes that the fair value and carrying value are approximately the same for all other financial instruments due to the relatively short maturities.\nS-35 EXHIBIT INDEX","section_14":"","section_15":""}
{"filename":"772197_1995.txt","cik":"772197","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nIVAX Corporation is a holding company with subsidiaries involved in generic and branded pharmaceuticals, intravenous solutions and related products, in vitro diagnostics, personal care products, and specialty chemicals. IVAX' principal business is the research, development, manufacture, marketing and distribution of health care products. IVAX was incorporated in Florida in 1993, as successor to a Delaware corporation formed in 1985, and its principal executive offices are located at 4400 Biscayne Boulevard, Miami, Florida 33137; its telephone number is (305) 575-6000. All references to \"IVAX\" in this Form 10-K mean IVAX Corporation and its subsidiaries unless the context otherwise requires.\nPHARMACEUTICALS\nIVAX' pharmaceutical operations accounted for approximately 62%, 57%, and 55% of its consolidated net revenues during the years ended December 31, 1995, 1994 and 1993, respectively. Since its inception, IVAX' pharmaceutical business has grown through the development and acquisition of brand name, generic and over-the-counter pharmaceutical products, the license of technology and products from third parties, and the acquisition of other businesses. IVAX presently markets several brand name pharmaceutical products and a wide variety of generic and over-the-counter pharmaceutical products primarily in the United States and the United Kingdom. IVAX also maintains direct operations in Argentina, Canada, the Czech Republic, Hong Kong, Ireland, Germany, Poland, Russia, the Slovak Republic, and Uruguay, and markets its products through distributors or joint ventures in other foreign markets, including China. IVAX also markets a line of veterinary products primarily in the United States.\nBRAND NAME PRODUCTS\nIVAX markets brand name products under the Baker Norton(TM) name, including the following products which are marketed primarily in the United States: Proglycem(R), used to treat hyperinsulinemia; and the urological medications Bicitra(R), Polycitra(R), Polycitra-K Crystals(R), Polycitra-LC(TM), Neutra-Phos(R), Neutra-Phos-K(TM), Prohim(R), and Urotrol(R). Also under the Baker Norton(TM) name, IVAX markets the following products primarily in the United Kingdom: the cardiovascular medications Cordilox(TM), Triam-Co(TM), Amil-Co(TM), Spiro-Co(TM), Fru-Co(TM) and Cardilate(TM); Diasorb(TM), an antidiarrhoeal product; Terfenor(TM), an antihistamine; Pro-Banthine(TM), an anticholinergic useful as adjunctive therapy in the treatment of peptic ulcers; Serenace(TM), a neuroleptic used for psychiatric disorders; the respiratory medications Cromogen(TM), Salamol(TM) and Beclazone(TM) metered dose inhalers and Easi-Breathe(TM) breath activated inhalers and the Steri-Neb(TM) line of nebulization products; and the ophthalmic medications Hay-Crom(TM) and Glaucol(TM). These products are marketed by IVAX' direct sales force to physicians, pharmacies, hospitals, managed health care organizations and government agencies, and are sold primarily to wholesalers, distributors, hospitals and physicians. In addition, IVAX has sublicensed its marketing rights for the sedative Doral(R) to Carter-Wallace, Inc. in the United States.\nUnder the Baker Cummins Dermatologicals(R) name, IVAX manufactures and markets various dermatological products, including the X-Seb(R) and P&S(R) line of psoriasis, seborrhea and dandruff preparations, Acno(R) acne preparation, the Aquaderm(R), Ultra Derm(R) and Ultramide-25(R) lines of dry skin preparations, and the Baker's(R) disposable biopsy punch and dermatophyte testing medium. These products are marketed primarily in the United States and Canada to physicians, pharmacies, hospitals,\nmanaged health care organizations and government agencies through IVAX' direct sales force, and are sold primarily to wholesalers, distributors and physicians.\nGENERIC PRODUCTS\nGeneric drugs are therapeutically equivalent to their brand name counterparts, but are generally sold at lower prices as alternatives to the brand name products. Approximately 51%, 49%, and 51% of IVAX' consolidated net revenues for the years ended December 31, 1995, 1994, and 1993, respectively, were attributable to worldwide sales of generic prescription and over-the-counter drugs and vitamin supplements.\nDOMESTIC. IVAX manufactures and markets in the United States approximately 100 generic prescription and over-the-counter drugs in liquid, capsule or tablet forms in an aggregate of approximately 170 dosage strengths. IVAX distributes in the United States (but does not manufacture) approximately 700 additional generic prescription and over-the-counter drugs and vitamin supplements, in various dosage forms, dosage strengths and package sizes, constituting an aggregate of approximately 1,500 products. IVAX' domestic generic drug distribution network encompasses most classes of the pharmaceutical market, including wholesalers, retail drug chains, retail pharmacies, hospital groups and nursing home providers.\nThe more significant generic drugs manufactured and marketed by IVAX include: verapamil HCl ER tablets, the generic equivalent of Calan(R) SR marketed by G.D. Searle & Co. and Isoptin(R) SR marketed by Knoll Pharmaceutical Company, a sustained release pharmaceutical product used to treat hypertension, which accounted for $96.5 million, or 7.7%, of IVAX' 1995 consolidated net revenues; cefaclor oral suspension and capsules, the generic equivalent of Eli Lilly and Company's Ceclor(R), an antibiotic indicated for the treatment of various infections, which was approved and launched in April 1995 and accounted for $70.0 million, or 5.6%, of IVAX' 1995 consolidated net revenues; and albuterol metered dose inhaler, the generic equivalent of Glaxo Inc.'s Ventolin(R) Inhalation Aerosol, used to control bronchospasm in patients with asthma and other diseases, which was approved and launched in late December 1995 and accounted for $8.6 million of IVAX' 1995 consolidated net revenues.\nOf the generic drugs for which IVAX received regulatory approval during 1995, IVAX sold ten generic drugs in an aggregate of 23 dosage forms and strengths, including cefaclor and albuterol metered dose inhaler, described above, and triamterene\/hydrochlorothiazide capsules, the generic equivalent of SmithKline Beecham Pharmaceuticals' Dyazide(R) (Original Formulation); guanabenz acetate tablets, the generic equivalent of Wyeth-Ayerst Laboratories' Wytensin(R); bumetanide tablets, the generic equivalent of Hoffmann LaRoche, Inc.'s Bumex(R); cimetidine tablets, the generic equivalent of SmithKline Beecham Pharmaceuticals' Tagamet(R); naproxen tablets, the generic equivalent of Syntex's Naprosyn(R); flurbiprofen tablets, the generic equivalent of The Upjohn Company's Ansaid(R); indapamide tablets, the generic equivalent of Rhone-Poulenc Rorer Pharmaceuticals Inc.'s Lozol(R); and glipizide tablets, the generic equivalent of Pratt Pharmaceuticals' Glucotrol(R). These products accounted for approximately $107.1 million in net revenues during 1995.\nINTERNATIONAL. IVAX is the largest manufacturer and distributor of generic pharmaceuticals in the United Kingdom. IVAX manufactures and markets under the \"Norton\" trade name approximately 150 generic prescription and over-the-counter drugs in various dosage forms, dosage strengths and package sizes, constituting an aggregate of approximately 300 products, primarily in the United Kingdom. Such products are marketed to wholesalers, retail pharmacies, hospitals, physicians and\ngovernment agencies. In addition, IVAX manufactures and markets primarily in the United Kingdom various \"blow-fill-seal\" pharmaceutical products, such as contact lens solutions, unit dose eye drops, solutions for injection or irrigation, and unit dose vials for nebulization to treat respiratory disorders. IVAX also contract manufactures pharmaceutical products in the United Kingdom and Ireland for other companies.\nIVAX owns a controlling interest in Galena a.s. (\"Galena\"), one of the oldest and more established pharmaceutical companies based in the Czech Republic. Galena develops, manufactures and markets a variety of pharmaceuticals and veterinary products, as well as raw materials used in the manufacture of pharmaceuticals, including cyclosporin and ergot alkaloids. Galena sells its products primarily in Eastern European countries, including Russia. As part of the acquisition, IVAX contributed to Galena rights to manufacture and market certain products and products under development in certain countries.\nIVAX is a 50% partner in two Chinese joint ventures, one with the Peoples Republic of China named Beijing JiAi Pharmaceuticals Limited Liability Company, which manufactures and markets inhalation products for respiratory ailments, and the other with Kunming Pharmaceutical Factory named Kunming Baker Norton Pharmaceutical Co., Ltd., which manufactures and markets a variety of pharmaceutical products.\nIVAX has sought to internationalize its business by either acquiring pharmaceutical companies operating in important markets, forming strategic alliances with other pharmaceutical companies in such markets, or establishing offices in important markets.\nIn March 1995, IVAX and Knoll AG (\"Knoll\"), a wholly-owned subsidiary of BASF Aktiengesellschaft, established a joint venture to market generic pharmaceutical products in Europe. The joint venture company, called Knoll Norton GmbH, is owned 50% by Knoll and 50% by IVAX. The joint venture company's initial efforts have focused solely on marketing generic pharmaceuticals in Germany, where its operations are conducted through a subsidiary called BASF Generics GmbH. Knoll contributed to the joint venture the capital stock of BASF Generics GmbH and rights to certain generic pharmaceutical products, many of which are already licensed and marketed in Germany. IVAX contributed to the joint venture rights to certain generic pharmaceutical products, most of which are currently manufactured and marketed by Norton Healthcare Limited, IVAX' principal United Kingdom subsidiary (\"Norton Healthcare\"), as well as rights to certain products under development.\nIn September 1995, IVAX acquired Pharmatop Limited, a company engaged in the distribution and marketing in Poland of certain pharmaceutical products manufactured by Norton Healthcare. In February 1996, IVAX entered into a distribution agreement with Hafslund Nycomed ASA (\"Hafslund\"), pursuant to which Hafslund was appointed as IVAX' exclusive distributor for Norton Healthcare's line of respiratory products in certain European countries. In March 1996, IVAX acquired three affiliated pharmaceutical companies, Elvetium S.A. (Argentina) and Alet Laboratorios S.A.E.C.I. y E., both headquartered in Buenos Aires and engaged in the business of manufacturing and marketing pharmaceuticals in Argentina, and Elvetium S.A. (Uruguay), headquartered in Montevideo and engaged in the business of manufacturing and marketing pharmaceuticals in Uruguay.\nVETERINARY PRODUCTS\nIVAX formulates, packages and distributes under the \"DVM Pharmaceuticals\" trade name various veterinary products primarily in the United States, including topical dermatological agents (OxyDex(R), SulfOxyDex(R), Relief(R), SebaLyt(R), NuSal-T(R)); ectoparasiticidals (SynerKyl(R), EctoKyl(R), DuraKyl(R)); essential fatty acid nutritional supplements (DermCaps(R), 3V Caps(TM)); topical and premise antiseptics (ChlorhexiDerm(TM)); wound healing dressings (BioDres(R)); otics (OtiCalm(R), Clearx(R)); and cleansing and grooming formulations (HyLyt(R), D-Basic(TM)). These products are marketed through IVAX' direct sales force and a national network of ethical veterinary distributors primarily to the small animal practitioners, and are manufactured to IVAX' specifications mostly by third parties.\nINTRAVENOUS PRODUCTS\nIVAX' intravenous products group manufactures and markets a broad line of basic and specialty intravenous solutions, irrigation solutions, intravenous administration sets, infusion pumps and other infusion supplies and equipment, primarily to hospitals and alternate site health care locations in the United States and, through independent distributors, in various foreign markets, including Australia, Canada, China, Europe, Hong Kong, Mexico, New Zealand, Saudi Arabia, South America and Taiwan. IVAX' intravenous products operations accounted for 27%, 30% and 31% of IVAX' consolidated net revenues for the years ended December 31, 1995, 1994, and 1993, respectively.\nBASIC INTRAVENOUS SOLUTIONS AND SETS. IVAX manufactures and sells a broad line of basic large and small volume parenteral solutions. Basic parenteral solutions are used to correct fluid and electrolyte imbalance, treat dehydration, irrigate wounds and facilitate urological procedures. IVAX packages many of its solutions in its patented EXCEL(R) flexible plastic container, which IVAX believes offers certain advantages over competitive containers which are made of polyvinylchloride (\"PVC\"), a material that has been shown to emit toxic hydrogen chloride gas when incinerated. EXCEL(R) bags are made with a plastic film that can be incinerated without toxic emission, weigh from 25% to 45% less than comparable PVC containers, and have been shown to be compatible with certain medications that cannot be administered in PVC containers because of potentially harmful interactions that occur between the intravenous solution and PVC.\nIVAX' basic intravenous solutions are typically sold under contracts that also provide for the sale of disposable administration sets. These sets generally consist of tubing, filters and flow control devices that transfer the solutions from their containers to the catheter used to access the patient's venous system. IVAX develops, manufactures, markets and distributes a full line of administration sets used as primary lines or secondary lines, filtered sets and blood sets, together with accessories such as catheter plugs, spike adapters and protected needles. Such sets can be used with a variety of manufacturers' products.\nBASIC AND SPECIALTY NUTRITION SOLUTIONS. Nutrition solutions consist of sterilized water mixed with dextrose, amino acids, lipids, electrolytes, vitamins and minerals in various concentrations. Parenteral nutrition therapy is used to intravenously supply nutrition to patients who are unable to ingest sufficient nutrients orally. IVAX manufactures and sells a full line of products used in providing basic parenteral nutrition therapy. IVAX also manufactures and sells a number of specialized parenteral and enteral (oral) nutrition products that have been specially formulated to meet the unique metabolic needs of specific groups of patients, such as those with kidney and liver disease, infants and children and immuno-suppressed patients.\nINFUSION PUMPS AND OTHER EQUIPMENT. Infusion pumps are used to administer, measure and control the flow of solutions and drugs into a patient's bloodstream. IVAX offers a line of infusion pumps used in both the hospital and alternate site health care markets. The majority of IVAX' infusion pumps are designed specifically for use, and are sold together, with its intravenous sets. The Horizon(R) infusion pump incorporates innovations in microprocessor and electromechanical technologies to increase functionality while reducing instrument size and weight. IVAX believes that the Horizon(R) pump is especially well suited for critical care use in the hospital. IVAX is also the leading distributor of single and variable speed syringe pumps, and distributes a single dose, disposable ambulatory infusion pump specifically designed for home infusion pursuant to an alliance with another pump manufacturer.\nOTHER PHARMACY PRODUCTS. IVAX sells several products to hospital and home health care pharmacies for use in the formulation and administration of intravenous solutions. These products include systems such as the HyperFormer(R) computerized compounding and filling system for nutrition formulations, devices that combine drugs in vials with solutions in bags, and pre-mixed antibiotics. In addition, IVAX manufactures, and co-markets through a marketing agreement with DuPont Merck Pharmaceutical Company, the product Hespan(R) in the United States. Hespan(R) is a product derived from hydroxyethyl starch (\"HES\") powder that is mixed with certain solutions to create a blood plasma expander for administration to patients suffering from substantial blood loss and shock. HES has been shown to be clinically equivalent to, is less expensive than, and does not have the risk of infection inherent in, blood-derived plasma expanders.\nCENTRAL ADMIXTURE PHARMACY SERVICE. Hospital pharmacies regularly use large quantities of commercially manufactured nutrients, drugs and solutions to \"admix\" a therapeutically effective final intravenous solution suitable for the particular patient to whom they are to be administered. The admixture process is very costly, requiring special equipment, trained personnel, inventory maintenance, and quality assurance procedures. To address the cost containment needs of hospital pharmacies, IVAX offers comprehensive and cost-effective pharmacy admixture services. IVAX presently operates eight pharmacy facilities serving more than 200 hospital and alternate site customers which admix and deliver prescription-specific total parenteral nutrition solutions, intravenous antibiotic therapies and other selected drug solutions.\nDIAGNOSTICS\nIVAX' in vitro diagnostics group, which develops, manufactures and markets diagnostic products, accounted for approximately 1%, 2% and 2% of IVAX' consolidated net revenues for the years ended December 31, 1995, 1994 and 1993, respectively. IVAX manufactures and markets a line of enzyme immunoassays under the Microassay(TM) name which are used to detect the presence of infectious diseases, such as measles, herpes and other viral diseases, and auto-immune diseases, such as systemic lupus erythematosus, rheumatoid arthritis and scleroderma, and a line of auto-immune antigens, reagents and other diagnostic products. IVAX also manufactures and markets a line of products used to identify elements of the human complement system. Complement is part of the natural defense of the body against infectious disease as well as a major mediator of inflammation, and deficiencies in complement components often lead to or are symptoms of chronic infections. The diagnostic group's products are marketed to clinical reference laboratories, hospital laboratories and research institutions in the United States through IVAX' direct sales force. IVAX also markets these products, as well as diagnostic products manufactured by others, in Italy through a direct sales force to public hospitals and private medical laboratories. Sales of IVAX' diagnostic products are also made\nthrough independent distributors in various other foreign markets, including Central and South America, the Far East, and certain Western European countries.\nPERSONAL CARE PRODUCTS\nIVAX' personal care products group develops, manufactures and markets a variety of personal care products, primarily within the United States. IVAX markets over 250 products in three principal areas: hair care products designed primarily for African American consumers, cosmetic products designed primarily for dark-skinned women and corrective cosmetics. This business segment accounted for 5%, 6% and 6% of IVAX' consolidated net revenues for the years ended December 31, 1995, 1994 and 1993, respectively.\nHAIR CARE PRODUCTS. IVAX develops, manufactures and markets hair care products designed primarily for African American consumers. Its product lines are primarily hair relaxers, conditioners and shampoos designed for both retail consumers and professional hair-care customers, and are marketed under brand names such as Ultra Sheen(R), Classy Curl(R), Gentle Treatment(TM), Afro Sheen(R), Soft Touch(R), Sta-Sof-Fro(R), Ultra Star(R), Bantu(R) and Ultra Sheen's Precise(R). Products for the retail consumer market are sold principallY through national and regional drug, grocery and mass merchandising chains. Professional products are sold mainly through distributors serving beauty salons and barber shops.\nCOSMETICS. IVAX sells a line of cosmetics for African American women under the name Flori Roberts(R), which is marketed through department stores and major retailers; a line of cosmetics for African American women under the name Posner(R), which is marketed in drug stores, mass merchandisers and food stores, as well as through distributors; a line of cosmetics designed primarily for dark-skinned women under the name Iman(TM) Cosmetics, which is sold in major department stores; and Glamatone(R), a line of cosmetics for women of all skin types, which is marketed through independent chain drug stores and mass merchandising outlets. These products are manufactured to IVAX' specifications by third parties.\nCORRECTIVE COSMETICS. IVAX sells a unique line of makeup designed to conceal skin blemishes and other imperfections under the name Dermablend(R) Corrective Cosmetics, which is marketed to dermatologists, plastic surgeons and other physicians, and is sold in major department stores. These products are manufactured to IVAX' specifications by third parties.\nSPECIALTY CHEMICALS\nIVAX' specialty chemicals group manufactures and markets, primarily in the United States and Canada, several hundred chemical products in three distinct market segments: vacuum pump fluids, textile and denim products, and cleaning products. This business segment accounted for approximately 5%, 6% and 6% of IVAX' consolidated net revenues for the years ended December 31, 1995, 1994 and 1993, respectively.\nVACUUM PUMP FLUIDS. IVAX manufactures and markets specialized fluids for all types of vacuum pump systems and distributes high vacuum greases and synthetic lubricants manufactured by others for use in the semiconductor, aerospace, food processing, pharmaceutical, metallurgical and other industries. Sales are made through a direct sales force and a network of manufacturers' representatives.\nTEXTILES AND DENIM PRODUCTS. IVAX manufactures and markets: specialty chemicals such as scouring, wetting, sizing, anti-slip and anti-static agents, dye bath additives and softeners to textile mills for use in the preparation, dying and finishing of textiles; and specialty chemicals such as strippers, agers, conditioners, brighteners and enzymes under the Blue-J(R) and STONE-EZE(R) names to denim processors and blue jean manufacturers to facilitate the process of imparting a worn, soft, or abraded appearance to denim fabrics. Sales of these products are made through IVAX' direct sales force.\nCLEANING PRODUCTS. IVAX manufactures and markets a complete line of industrial floor and carpet care products, germicidal cleaners, deodorants and hand soaps, and a variety of industrial metal and synthetic cleaning pads. The complete line of products is sold through a national network of over 1,300 distributors under the Franklin(R) and Brillo(R) brand names. Floor care products and maintenance services are also sold to national and regional account chains on a direct basis and through selected companies with national distribution capabilities under the Masury-Columbia(TM) and Brillo(R) brand names and under private labels.\nRESEARCH AND DEVELOPMENT\nFor the years ended December 31, 1995, 1994 and 1993, IVAX spent $64.6 million, $48.7 million, and $43.9 million, respectively, for company-sponsored research and development activities. Approximately 94%, 92%, and 90% of such amounts were devoted to pharmaceutical and intravenous related research and development for the years 1995, 1994 and 1993, respectively. From time to time, IVAX may supplement its research and development efforts by entering into research and development agreements, joint ventures and other collaborative arrangements with other companies to defray the cost of product development. IVAX engages in product development activities in three primary areas: proprietary pharmaceuticals, generic pharmaceuticals, and specialized drug delivery systems.\nStatements in this Form 10-K concerning the timing of regulatory filings and approvals are forward looking statements which are subject to risks and uncertainties. The length of time necessary to complete clinical trials and from submission of an application for market approval to a final decision by a regulatory authority varies significantly. No assurance can be given that IVAX will successfully complete the development of products under development, that IVAX will be able to obtain regulatory approval for any such product, or that any approved product may be produced in commercial quantities, at reasonable costs, and successfully marketed.\nPROPRIETARY PHARMACEUTICALS\nIVAX is committed to the cost effective development of proprietary pharmaceuticals directed primarily towards indications having relatively large patient populations or for which limited or inadequate treatments are available. IVAX seeks to accelerate product development and introduction by in-licensing compounds, especially after clinical testing has begun, and by developing new dosage forms of existing products or new therapeutic indications for existing products. IVAX has programs for the development of a variety of proprietary pharmaceuticals in varying stages of development.\nAs part of its ongoing evaluation of the optimum utilization of IVAX' development resources, during 1995 IVAX analyzed the status of each proprietary drug project in its portfolio, the likelihood of receiving regulatory approval within a reasonable time, the costs associated with completion of each project, and the potential market for the product. Following this analysis, IVAX determined to\nconcentrate the majority of its proprietary drug development resources on the completion of its Elmiron(R), Cervene(R) and paclitaxel projects, described below.\nELMIRON(R). Elmiron(R) is an oral form of pentosan polysulfate sodium indicated for the treatment of interstitial cystitis, a chronic, progressive and debilitating urinary bladder disease afflicting primarily women and characterized by severe bladder and pelvic pain and urinary frequency. At present there is no effective orally-administered treatment for the disease. Elmiron(R) has demonstrated an ability to provide safe and effective relief from the pain and discomfort of interstitial cystitis. The drug was approved for marketing in Canada in 1993, and has been available in the United States on a compassionate use basis for several years. IVAX filed a New Drug Application (\"NDA\") for the drug in 1991 and, in March 1996, received an approvable letter from the United States Food and Drug Administration (the \"FDA\"). Although an approvable letter does not constitute final approval to market a drug, it does indicate that the FDA is prepared to approve the NDA upon the satisfaction of specified conditions. In the case of the approvable letter for Elmiron(R), IVAX has been asked to provide certain data and other information regarding the compound and related clinical studies, to address FDA comments regarding labeling and package inserts, and to agree to carry out Phase IV clinical studies after the product is approved. IVAX has licensed rights to a patent covering use of the compound for the treatment of interstitial cystitis in the United States until the year 2010. IVAX is continuing to study Elmiron(R) for other indications.\nCERVENE(R). Cervene(R) is IVAX' trade name for an intravenous form of the compound nalmefene indicated for the mitigation of central nervous system damage following the occurrence of ischemic stroke. Nalmefene was originally developed to reverse the effects of narcotic analgesia and drug overdoses, and IVAX licensed this indication of the compound in the United States and Canada to Ohmeda, Inc., which commenced to sell the compound in the United States following approval of its NDA in April 1995. IVAX believes that nalmefene may have significantly broader applications, holds or is licensed under patents in the United States and certain other countries covering the use of nalmefene for a variety of indications, and is investigating different uses of the compound, with particular emphasis on nalmefene for the treatment of ischemic stroke. A pilot clinical trial completed in 1994 indicated the clinical effectiveness of Cervene(R) in the recovery of acute ischemic stroke patients. IVAX is in the process of completing the first of two pivotal registration seeking studies for Cervene(R), and is in the process of enrolling sites for the final phase III study. Although there can be no assurance, IVAX believes that it may be able to file an NDA for Cervene(R) during 1997.\nPACLITAXEL. Paclitaxel is an off-patent compound which, in clinical trials sponsored by the National Cancer Institute, exhibited promising results in the treatment of ovarian, breast and other cancers. Bristol-Myers Squibb Company currently markets a product containing paclitaxel under the brand name Taxol(R) for the treatment of ovarian and breast cancer, and under applicable law, the FDA will not accept an ANDA for a generic version of this product until December 1997. IVAX has entered into an exclusive agreement with NaPro BioTherapeutics, Inc. (\"NaPro\") to develop and market in certain territories paclitaxel supplied by NaPro, and IVAX is presently engaged in phase III clinical trials with respect to paclitaxel for breast and ovarian cancers and for other tumors. Although there can be no assurance, IVAX believes it may be able to submit an NDA for paclitaxel for at least one of these indications during 1997. IVAX is also conducting research involving analogues of paclitaxel and novel delivery systems for this class of drugs. Taxol(R) is a registered trademark of Bristol-Myers Squibb Company.\nGENERIC PHARMACEUTICALS\nIVAX also focuses on the development of generic pharmaceutical products with an emphasis on those products which are difficult to replicate or which are used to treat large patient populations. By including development of difficult to replicate generic products, IVAX seeks to minimize competition and obtain higher margin sales for its generic products. In addition, in evaluating which product development projects to undertake, IVAX considers whether the new product, once developed, will complement other IVAX products in the same therapeutic family, or will otherwise assist in making IVAX' product line more complete.\nDuring 1995, IVAX received FDA approval of 18 Abbreviated New Drug Applications (\"ANDAs\") relating to 12 different chemical compounds, and approval of 21 Abridged Product License Applications (\"APLAs\"), the United Kingdom equivalent of an ANDA, from the United Kingdom Medicines Control Agency (the \"MCA\") relating to 13 chemical compounds. As of March 20, 1996, IVAX had 21 ANDAs relating to 18 chemical compounds pending at the FDA, and 21 APLAs relating to 13 chemical compounds pending at the MCA.\nDRUG DELIVERY SYSTEMS\nIn addition to its activities relating to the development of proprietary and generic pharmaceuticals, IVAX seeks to utilize its drug delivery system and drug formulation expertise to develop new and more effective uses for existing pharmaceutical products. IVAX believes that certain of its delivery systems may increase the benefits of certain products by providing sustained action, allowing for a more convenient or appealing mode of administration, or decreasing toxicity. Presently, IVAX is focusing its development efforts in this area in four categories of products.\nBREATH ACTIVATED METERED DOSE INHALERS. IVAX holds patents on a breath activated metered dose inhaler designed to overcome the difficulty many persons experience in attempting to coordinate their inhalation with the emission of the medication from a conventional metered dose inhaler. IVAX' device, called Easi-Breathe(TM), emits the medication automatically upon inhalation, minimizing coordination problems and better insuring that the medication is delivered to the lungs. During 1995, IVAX commenced marketing the asthma drugs albuterol and beclomethasone in the Easi-Breathe(TM) inhaler in the United Kingdom and Ireland, and is presently developing Easi-Breathe(TM) for use with albuterol and beclomethasone for registration in the United States. IVAX is also developing Easi-Breathe(TM) for use with other active ingredients.\nNON-CFC AND DRY POWDER INHALERS. IVAX' existing inhalation aerosol products, including Easi-Breathe(TM), use chlorofluorocarbons (\"CFCs\") as a propellant. In light of international agreements calling for the eventual phase out of CFCs, IVAX is developing non-CFC containing aerosol products for inhalation. IVAX is also developing a multi-dose dry powder inhaler.\nDUPLEX(TM) ADMIXTURE SYSTEM. A wide variety of drugs administered intravenously are not stable in solution. As a result, these drugs are typically mixed with diluent just prior to administration or are mixed at the site of manufacture, frozen for shipment, then thawed at the site of administration. IVAX is in the advanced stages of developing what it believes will be a more convenient and cost effective delivery system for this class of drugs. The system, called Duplex(TM), is a proprietary two compartment intravenous bag using a sophisticated seal to hold the drug separate from the diluent until just prior to administration. The nurse, physician or alternate site administrator then breaks the seal, shakes the bag and administers the drug. IVAX expects to utilize a form of its EXCEL(R) plastic container,\ndescribed under \"Intravenous Products\" above, in the manufacture of Duplex(TM). Prior to marketing in the United States, each drug delivered in the Duplex(TM) system will require FDA approval. Although there can be no assurance, IVAX believes that it may be able to submit the first of its drug approval applications for drugs to be delivered in the Duplex(TM) system beginning in late 1997.\nEXCEL(R) EXTENSIONS. IVAX is in the advanced stages of developing new product lines, including larger volume EXCEL(R) containers, nutrition solutions packaged in EXCEL(R) containers, and additional premixed drugs. Prior to marketing in the United States, each of these solutions will require FDA approval. Although there can be no assurance, IVAX believes that it may be able to submit the first of its drug approval applications for these products beginning in late 1996.\nGOVERNMENTAL REGULATION\nIVAX' pharmaceutical, intravenous and diagnostic operations are subject to extensive regulation by governmental authorities in the United States and other countries with respect to the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical, intravenous and diagnostic products. IVAX devotes significant time, effort and expense addressing the extensive government regulations applicable to its business, and in general, the trend is towards more stringent regulation.\nThe FDA requires extensive testing of new pharmaceutical products to demonstrate that such products are both safe and effective in treating the indications for which approval is sought. Testing in humans may not be commenced until after an Investigational New Drug exemption is granted by the FDA. An NDA must be submitted to the FDA for new drugs that have not been previously approved by the FDA and for new combinations of, and new indications and new delivery methods for, previously approved drugs. Three phases of clinical trials must be successfully completed before an NDA is approved: phase I clinical trials, which involve the administration of the drug to a small number of healthy subjects to determine safety, tolerance, absorption and metabolism characteristics; phase II clinical trials, which involve the administration of the drug to a limited number of patients for a specific disease to determine dose response, efficacy and safety; and phase III clinical trials, which involve the study of the drug to gain confirmatory evidence of efficacy and safety from a wide base of investigators and patients. In the case of a new formulation of a drug that has been previously approved by the FDA, an abbreviated approval process is available. For such drugs an ANDA may be submitted to the FDA for approval. For an ANDA to be approved, the drug must be shown to be bioequivalent to the previously approved drug. The NDA and ANDA approval process generally takes a number of years and involves the expenditure of substantial resources. IVAX' parenteral solutions, including its nutrition solutions and Duplex(TM) system products, as well as the use of a different packaging material, such as EXCEL(R), for existing approved parenteral solutions, also require FDA approval.\nIVAX' diagnostic products and substantially all of IVAX' infusion instruments, administration sets and filling and admixture accessories are considered medical devices, which require either a 510(k) premarket notification clearance (\"510(k)\") or an approved Premarket Approval Application (\"PMA\") from the FDA prior to marketing. A product qualifies for a 510(k) if it is substantially equivalent to another medical device that was on the market prior to May 28, 1976 and does not now have a PMA or has previously received 510(k) premarket notification clearance and is lawfully on the market. The 510(k) approval process can take several months and may involve the submission of limited chemical data together with other supporting information. An approved PMA application indicates that the FDA has determined that a device has been proven to be safe and effective for its\nintended use. The PMA process typically can last several years and requires the submission of significant quantities of preclinical and clinical data as well as manufacturing and other information.\nIVAX' enteral nutrition products are currently classified as medical foods, which are exempt from the NDA and ANDA approval process, and which are regulated as food products under applicable federal law. Accordingly, these products must conform to food safety and labeling requirements. IVAX' pharmacy admixture services are, in general, regulated under the pharmacy laws and regulations of the states in which such services are provided. Each facility operates as a licensed pharmacy under the applicable pharmacy laws of the state in which it is located and is also registered with the FDA.\nOn an ongoing basis, the FDA reviews the safety and efficacy of marketed pharmaceutical and intravenous products and products considered medical devices and monitors labeling, advertising and other matters related to the promotion of such products. The FDA also regulates the facilities and procedures of IVAX used to manufacture pharmaceutical, intravenous and diagnostic products in the United States or for sale in the United States. Such facilities must be registered with the FDA and all products made in such facilities must be manufactured in accordance with \"good manufacturing practices\" established by the FDA. The FDA periodically inspects IVAX' manufacturing facilities and procedures to assure compliance. The FDA may cause the recall or withdraw approvals of products if regulatory standards are not maintained. FDA approval to manufacture a drug is site specific. In the event an approved manufacturing facility for a particular drug becomes inoperable, obtaining the required FDA approval to manufacture such drug at a different manufacturing site could result in production delays.\nIn connection with its activities outside the United States, IVAX is also subject to regulatory requirements governing the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical, intravenous and diagnostic products, which requirements vary from country to country. Whether or not FDA approval has been obtained for a product, approval of the product by comparable regulatory authorities of foreign countries must be obtained prior to marketing the product in those countries. The approval process may be more or less rigorous from country to country, and the time required for approval may be longer or shorter than that required in the United States. No assurance can be given that clinical studies conducted outside of any country will be accepted by such country, and the approval of any pharmaceutical, intravenous or diagnostic product in one country does not assure that such product will be approved in another country.\nThe federal and state governments in the United States, as well as many foreign governments, including the United Kingdom, are exploring ways to reduce medical care costs through health care reform. This effort has resulted in, among other things, government policies that encourage the use of generic drugs rather than brand name drugs to reduce drug reimbursement costs. Virtually every state in the United States has a generic substitution law which permits the dispensing pharmacist to substitute a generic drug for the prescribed brand name product. The debate to reform the United States' health care system is expected to be protracted and intense. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, IVAX cannot predict what impact any reform proposal ultimately adopted may have on the pharmaceutical, intravenous or diagnostic industries or IVAX.\nRAW MATERIALS\nRaw materials essential to IVAX' business segments are generally readily available from multiple sources. However, some raw materials used in the manufacture of IVAX' pharmaceutical and intravenous products are currently available from only one or a limited number of suppliers. Any curtailment in the availability of such raw materials could be accompanied by production or other delays as well as increased raw material costs, with consequent adverse effects on IVAX' business and results of operations. Furthermore, because the FDA requires that raw material suppliers be specified in applications for drug approvals, changes in raw material suppliers could result in production delays. IVAX did not experience any significant restrictions on the raw materials necessary to produce its products during 1995.\nCOMPETITION\nThe pharmaceutical industry is highly competitive and includes numerous established pharmaceutical companies, many of which have considerably greater financial, technical, clinical, marketing and other resources and experience than IVAX. The markets in which IVAX competes are undergoing, and are expected to continue to undergo, rapid and significant technological change, and IVAX expects competition to intensify as technological advances are made. IVAX intends to compete in this marketplace by developing or licensing pharmaceutical products that are either patented or proprietary and which are primarily for indications having relatively large patient populations or for which limited or inadequate treatment are available, and, with respect to generic pharmaceuticals, by developing therapeutic equivalents to previously patented products which are difficult to duplicate or which are used to treat large patient populations. There can be no assurance, however, that developments by others will not render IVAX' pharmaceutical products or technologies obsolete or uncompetitive. In addition to product development, other competitive factors in the pharmaceutical industry include product quality and price, reputation and dissemination of technical information.\nRevenues and gross profit derived from generic pharmaceutical products tend to follow a pattern based on regulatory and competitive factors unique to the generic pharmaceutical industry. As patents for brand name products and related exclusivity periods mandated by regulatory authorities expire, the first generic manufacturer to receive regulatory approval for generic equivalents of such products is usually able to achieve relatively high market share, revenues and gross profit. As other generic manufacturers receive regulatory approvals on competing products, market share and prices typically decline. Accordingly, the level of revenues and gross profit attributable to generic products developed and manufactured by IVAX is dependent, in part, on IVAX' ability to develop and rapidly introduce new products, the timing of regulatory approval of such products, and the number and timing of regulatory approvals of competing products. In addition, competition in the United States generic pharmaceutical market continues to intensify as the pharmaceutical industry adjusts to increased pressures to contain health care costs. Brand name companies are increasingly selling their products into the generic market directly by acquiring or forming strategic alliances with generic pharmaceutical companies. No regulatory approvals are required for a brand name manufacturer to sell directly or through a third party to the generic market, nor do such manufacturers face any other significant barriers to entry into such market. In addition, brand name companies are increasingly pursuing strategies to prevent or delay the introduction of generic competition. These strategies include, among other things, seeking to establish regulatory obstacles to demonstrate the bioequivalence of generic drugs to the brand name products, and instituting legal actions based on process or other patents that allegedly are infringed by the generic products.\nCompetition among suppliers of intravenous solutions and related products to hospitals and alternate site providers has historically been intense and, accordingly, IVAX' intravenous products group faces substantial competition in its markets for all its products. There are three major suppliers of intravenous solutions and related sets in the hospital and alternate site health care markets: Baxter International, Inc. (\"Baxter\"), Abbott Laboratories (\"Abbott\") and IVAX. According to industry sources, based upon hospital census beds under full line contract, the 1995 market shares of Baxter, Abbott and IVAX were approximately 44%, 37% and 19%, respectively. Baxter and Abbott are major diversified health care companies and have greater financial, research and development, marketing and human resources than IVAX. Baxter and Abbott also offer a broad range of medical products in addition to intravenous solutions, sets and related products, which can be combined into more comprehensive bundles than IVAX is able to offer. Competition in the intravenous products industry is primarily based on quality of products and services, price, reputation with group purchasing organizations, hospital administrators, materials managers, pharmacists and nurses, and technological innovation and development.\nPATENTS AND TRADEMARKS\nIVAX seeks to obtain patent protection on its products and products under development where possible. IVAX currently owns or is licensed under various United States, United Kingdom and other foreign patents and patent applications covering certain of its products, products under development, product uses and manufacturing processes. Protection for individual products, product uses or manufacturing processes extend for varying periods in accordance with the date of grant and the legal life of the patents in the various countries. The protection afforded, which may also vary from country to country, depends on the type of patent and its scope of coverage. There is no assurance that patents will be issued on pending applications or as to the scope or degree of protection patents will afford IVAX. Although IVAX believes that its patents and licenses are important to its business, no single patent or license is currently material in relation to IVAX' business as a whole. IVAX believes that the patents relating to EXCEL(R) are of material importance to the intravenous products group.\nIVAX sells certain of its products under trademarks and seeks to obtain protection for its trademarks by registering them in the United States, United Kingdom and other countries where the products are marketed. At present, IVAX does not consider its trademarks, individually or in the aggregate, to be material in relation to its business as a whole. The trademarks of the specialty chemicals group and personal care products group, however, are well established and recognized within their respective industries and IVAX believes that in the aggregate such trademarks are of material importance to the specialty chemicals group and personal care products group, respectively.\nLICENSING\nIVAX has obtained licenses from various inventors, universities and the United States Government and will continue to seek new licenses from such parties and others, including pharmaceutical companies, to promising technology and compounds for development into new pharmaceutical products. Generally, these licenses grant IVAX the right to complete development efforts initiated by others and to market any resulting products. IVAX generally is required to pay a royalty based on sales of the product. IVAX also grants licenses to other pharmaceutical companies relating to technologies or compounds under development and, in some cases, finished products. Generally, these licenses grant the licensees the right to complete development work of the technology or compound, or obtain regulatory approvals of a product, and thereafter market the product in specified territories. These licenses often involve the payment of an up-front fee and fees upon\ncompletion of certain development milestones, and also provide for the payment of royalties based on sales of the product. IVAX often retains the right to supply the product to the licensees.\nSEASONALITY\nWhile certain of IVAX' individual products may have a degree of seasonality, there are no significant seasonal aspects to IVAX' business segments, except that sales of pharmaceutical products indicated for colds and flu symptoms are higher during the fourth quarter as customers supplement inventories in anticipation of the cold and flu season, and IVAX' personal care products group has historically experienced significant sales increases during the third quarter as retailers supplement inventories in anticipation of increased consumer purchasing during the holidays.\nENVIRONMENT\nIVAX believes that its operations comply in all material respects with applicable laws and regulations concerning the environment. Compliance with such laws is not expected to require significant capital expenditures and has not had, and is not presently expected to have, a material adverse affect on IVAX' earnings or competitive position.\nEMPLOYEES\nAs of February 29, 1996, IVAX had approximately 7,893 full time employees, of which 5,536 were engaged in research and development, production and associated support, 1,275 were engaged in sales, marketing and distribution, and 1,082 were engaged in finance and general administration. By industry segment, the employees were divided as follows: 1,904 in domestic pharmaceuticals, 2,343 in international pharmaceuticals, 2,836 in the intravenous products group, 282 in the personal care products group, 319 in specialty chemicals, 106 in diagnostics, and 103 in corporate. The foregoing information includes 1,101 employees of Galena, which is owned 64% by IVAX.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS AND FOREIGN AND DOMESTIC OPERATIONS\nSpecific financial information with respect to IVAX' industry segments and foreign and domestic operations is provided in Note 10, Business Segment and Geographic Information, in the Notes to Consolidated Financial Statements included in this Form 10-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIVAX owns or leases an aggregate of approximately 4.8 million square feet of space in Argentina, Canada, the Czech Republic, Germany, Hong Kong, Ireland, Italy, Poland, Russia, the Slovak Republic, the United Kingdom, the United States, and Uruguay, which is used by the pharmaceutical group (58%), the intravenous group (22%), the personal care products group (6%), the diagnostics group (2%), and the specialty chemicals group (12%). IVAX believes its facilities are in satisfactory condition, are suitable for their intended use and have capacities considered appropriate to meet IVAX' present needs.\nIVAX operates eighteen pharmaceutical manufacturing facilities, three of which are located in Waterford, Ireland; two of which are located in each of Miami, Florida and London, England; and one of which is located in each of Buenos Aires, Argentina; Northvale, New Jersey; St. Croix, Virgin Islands; Cidra, Puerto Rico; Opava, Czech Republic; Shreveport, Louisiana; Syosset, New York;\nFalkenhagen, Germany; Harlow, England; Runcorn, England; and Montevideo, Uruguay. IVAX' personal care products manufacturing facility is located in Chicago, Illinois. IVAX' intravenous manufacturing facilities are located in Irvine, California; Sabana Grande, Puerto Rico; and Carrollton, Texas. IVAX' specialty chemicals manufacturing facilities are located in Churchville, New York; Rock Hill, South Carolina; Lawrence, Massachusetts; and Marion, Ohio. IVAX' diagnostics manufacturing facilities are located in Miami, Florida and Springdale, Arkansas. IVAX owns all of the Miami and Chicago manufacturing facilities, and the Buenos Aires, Cidra, Shreveport, Syosset, Falkenhagen, Opava, Churchville, Rock Hill, and Marion facilities, and leases its remaining manufacturing facilities.\nIVAX maintains sales offices and distribution centers in Argentina, Canada, China, the Czech Republic, Hong Kong, Italy, Poland, Russia, the Slovak Republic, Uruguay, and various parts of the United States and the United Kingdom, most of which are held pursuant to leases. None of such leases are material to IVAX.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn late April 1995, Zenith Laboratories, Inc., a wholly owned subsidiary of IVAX (\"Zenith\"), received approvals from the FDA to manufacture and market the antibiotic cefaclor in capsule and oral suspension formulations. Cefaclor is the generic equivalent of Ceclor(R), a product of Eli Lilly and Company (\"Lilly\"). On April 27, 1995, Lilly filed a lawsuit against Zenith and others styled Eli Lilly and Company v. American Cyanamid Company, Biocraft Laboratories, Inc., Zenith Laboratories, Inc. and Biochimica Opos S.p.A. in the United States District Court for the Southern District of Indiana, Indianapolis Division. In general, the lawsuit alleges that Zenith's cefaclor raw material supplier, a third party unaffiliated with IVAX, manufactures cefaclor raw material in a manner which infringes two process patents owned by Lilly, and that Zenith and the other named defendants have knowingly and willfully infringed and induced the supplier to infringe the patents by importing the raw material into the United States. The lawsuit seeks to enjoin Zenith and the other defendants from infringing or inducing the infringement of the patents and from making, using or selling any product incorporating the raw material provided by such supplier, and seeks an unspecified amount of monetary damages and the destruction of all cefaclor raw material manufactured by the supplier and imported into the United States. In August 1995, the Court denied Lilly's motion for preliminary injunction which sought to prevent Zenith from selling cefaclor until the merits of Lilly's allegations could be determined at trial. Lilly has appealed such ruling, which appeal has been briefed and argued and remains pending. IVAX intends to defend this lawsuit vigorously. Although IVAX believes Lilly's allegations are without merit, if determined adversely to IVAX, the lawsuit would likely have a material adverse effect on IVAX' financial position and results of operations.\nIn September 1994, individuals purporting to be shareholders of IVAX filed a class action complaint against IVAX and all but one of its directors as of that date and certain of its officers in the United States District Court for the Southern District of Florida which consolidates, amends and supplements a number of similar complaints filed earlier in 1994. The consolidated lawsuit is styled Harvey M. Jasper Retirement Trust and Harvey M. Jasper Individual Retirement Account et al. vs. IVAX Corporation and Phillip Frost et al. Plaintiffs seek to act as representatives of a class consisting of all purchasers of IVAX' common stock between January 14 and May 2, 1994, including as a subclass parties who exchanged their shares of common stock of McGaw, Inc. (\"McGaw\") for IVAX' common stock in connection with IVAX' acquisition of McGaw in March 1994. In general, the complaints allege violations of Sections 10(b), 14(a) and 20(a) of the Securities Exchange Act of 1934, as amended, and the rules promulgated thereunder, and Sections 11, 12(2) and 15 of the Securities Act\nof 1933, as amended (the \"Securities Act\"), as well as a claim for negligent misrepresentation. The complaint alleges that IVAX made untrue statements of material fact and\/or omitted to state material facts necessary to make statements made not misleading in its public disclosure documents, in communications to securities analysts and the public, and in IVAX' registration statement and proxy statement-prospectus distributed in connection with the acquisition of McGaw, relating primarily to net revenues and earnings, verapamil sales, and the effects of competition in the verapamil market on IVAX' net revenues and earnings. The complaint seeks an unspecified amount of compensatory and recessionary damages, equitable and\/or injunctive relief, interest, litigation costs and attorneys' fees. The outside directors of IVAX initially named as defendants in the suit were dismissed without prejudice from the consolidated actions pursuant to a stipulation filed in January 1995. In November 1995, the defendants' motion to dismiss the consolidated amended complaint was denied. IVAX intends to defend this lawsuit vigorously. Although IVAX believes that this lawsuit is without merit, its outcome cannot be predicted. If determined adversely to IVAX, the lawsuit would likely have a material adverse effect on IVAX' financial position and results of operations.\nIn June 1994, the former chairman and chief executive officer of McGaw filed, in his individual capacity, an action styled James M. Sweeney vs. IVAX Corporation and Phillip Frost, M.D. against IVAX and Dr. Frost, the Chairman of the Board and Chief Executive Officer of IVAX, in the United States District Court for the Central District of California. The complaint alleges essentially the same securities laws violations and negligent misrepresentation claim as alleged in the consolidated class action suit described above, as well as certain additional state law claims. The complaint seeks up to $21 million in compensatory damages (and up to $48 million in rescissionary damages upon tender of IVAX shares held by plaintiff), as well as punitive damages, litigation costs and attorneys' fees. This action has been transferred to the United States District Court for the Southern District of Florida. Although the lawsuit was initially consolidated for all purposes with the class action suit described above, in August 1995, the Court entered an order allowing the former McGaw chairman to opt out of the class action and to proceed under his separate complaint.\nIn April 1995, an action styled Ventana Partnership III, L.P. and Ventana Equity Expansion Partnership IV, L.P. vs. IVAX Corporation, Phillip Frost, M.D., Isaac Kaye and Andrew Zinzi was filed against IVAX and certain of its officers in the United States District Court for the Southern District of California. The complaint alleges essentially the same securities laws violations as well as negligent misrepresentation claim as alleged in the consolidated class action suit described above. The complaint seeks in excess of $21 million in compensatory, consequential, rescissionary and punitive damages, as well as litigation costs. This action has been transferred to the United States District Court for the Southern District of Florida and is expected to be consolidated with the class action suit described above.\nIn July 1994, an action styled ABS MB Investment Limited Partnership and ABS MB Ltd. vs. IVAX Corporation was filed against IVAX in the United States District Court for the District of Maryland. Plaintiffs, shareholders of McGaw at the time of its acquisition by IVAX, alleged that IVAX violated Sections 11 and 12(2) of the Securities Act, as well as certain state securities laws, and that it breached certain provisions of the merger agreement and IVAX' bylaws, by issuing to plaintiffs shares of IVAX' common stock subject to the restrictions imposed by Rule 145 promulgated under the Securities Act and Accounting Series Release 135. The plaintiffs claim that, as a result of the restrictions imposed on the certificates issued to them, they suffered damages from the loss of value of their shares, and seek damages of $11 million, plus expenses and attorneys' fees. In June 1995, the Court entered an order denying plaintiffs' motion for summary judgment with respect to the claims alleging that IVAX breached certain provisions of the merger agreement and IVAX' bylaws and\ngranted IVAX' motion to dismiss such counts. The Court denied IVAX' motion to dismiss the counts relating to alleged violation of Sections 11 and 12(2) of the Securities Act and alleged violations of certain state securities laws, as well as its motion to transfer venue. In October 1995, the Court entered an order granting the plaintiffs' motion to amend their complaint to assert new causes of action under the Uniform Commercial Code and granting the plaintiffs' motion for reconsideration of the dismissal of the claims alleging breach of IVAX' bylaws, and ordered that such counts be reinstated.\nIVAX intends to continue to vigorously defend each of the Sweeney, Ventana and ABS MB Investment lawsuits described above. Although IVAX believes such lawsuits are without merit, their respective outcomes cannot be predicted. Any of such lawsuits, if determined adversely to IVAX, could have a material adverse effect on IVAX' results of operations.\nIn October 1995, five class action complaints were filed by individuals purporting to be shareholders of IVAX, in the Circuit Court of the Eleventh Judicial Circuit in Dade County, Florida, against IVAX, its Board of Directors and Hafslund Nycomed AS, in connection with IVAX' proposed merger with Hafslund Nycomed. The complaints were voluntarily dismissed without prejudice in February 1996.\nGoldline Laboratories, Inc. (\"Goldline\"), a wholly-owned subsidiary of IVAX, has been either a named defendant, or has assumed the defense of a customer which was a named defendant, in approximately 110 lawsuits filed since March 1990 in both state and federal courts relating to injuries allegedly suffered as a result of the ingestion of L-Tryptophan, an over-the-counter food supplement previously distributed by Goldline in the United States. Generally, the lawsuits allege personal injury, wrongful death and loss of support and consortium, under a variety of liability theories, including strict products liability, breach of warranty and negligence. A majority of the lawsuits also seek punitive damages. As of March 20, 1996, 105 of the L-Tryptophan lawsuits filed against Goldline have been settled, and 5 remain pending. Goldline did not formulate or manufacture any L-Tryptophan products; it purchased only finished products in bulk and then bottled, labeled and distributed the products in the United States. Goldline and IVAX entered into certain agreements with the manufacturer of bulk L-Tryptophan and its United States subsidiary pursuant to which such companies agreed to pay Goldline's defense costs relating to the L-Tryptophan litigation and to indemnify Goldline for settlements or judgments (other than punitive damages), in exchange for Goldline agreeing not to assert claims against the manufacturer or its United States subsidiary. The agreements may be terminated at any time by either party. As a result of the agreements, to date, Goldline has not paid any settlement amounts or appreciable legal fees with respect to any of the lawsuits. In addition, when IVAX acquired Goldline in 1991, 165,000 shares of IVAX' common stock issued in the acquisition were pledged until December 1996 by the former owner of Goldline as collateral against future claims regarding this product. Goldline also has available to it limited insurance coverage with respect to the currently pending L-Tryptophan lawsuits. IVAX' ultimate liability with respect to the L-Tryptophan litigation, if any, is not presently determinable. In the event that the manufacturer of the product and its United States subsidiary do not continue to provide the indemnity described above, the aggregate liability of Goldline to plaintiffs in these lawsuits is likely to exceed available insurance coverage and the indemnity provided by the former owner of Goldline, and could have a material adverse impact upon the financial position and results of operations of IVAX.\nIVAX is involved in various other legal proceedings arising in the ordinary course of business, some of which involve substantial amounts. While it is not feasible to predict or determine the outcome of these proceedings, in the opinion of management, based on a review with legal counsel,\nany losses resulting from such legal proceedings will not have a material adverse impact on the financial position or results of operations of IVAX.\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\nIVAX' common stock is listed on the American Stock Exchange and is traded under the symbol IVX. The following table sets forth the high and low closing prices of IVAX' common stock as reported on the composite tape of the American Stock Exchange and the cash dividends paid by IVAX for each of the quarters indicated:\n----------------------------------- Quarter High Low Dividend ---------- ---------- ---------- First $ 37.50 $ 24.25 $ -- Second 26.88 15.00 .03 Third 21.88 15.25 -- Fourth 21.00 17.75 .03\n----------------------------------- Quarter High Low Dividend ---------- ---------- ---------- First $ 26.00 $ 19.50 $ -- Second 27.50 23.25 .04 Third 31.13 23.88 -- Fourth 31.38 22.75 .04\nAs of the close of business on February 29, 1996, there were approximately 6,719 record holders of IVAX' common stock.\nThe declaration and payment of dividends is made at the discretion of IVAX' Board of Directors. IVAX paid its first cash dividend in the second quarter of 1993, and it presently intends to continue paying a semi-annual cash dividend.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL DATA\nYEAR ENDED DECEMBER 31, ----------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ---------- ---------- --------- --------- (in thousands, except per share data) (1) OPERATING DATA Net Revenues $ 1,259,766 $1,134,806 $1,062,945 $ 853,497 $600,766 Income before extraordinary items 114,801 89,872 107,982 37,410 15,647 Net income 114,835 89,049 99,354 29,820 17,850 Earnings per common share: Primary: Earnings before extraordinary items .96 .77 .94 .37 .17 Net earnings .96 .76 .87 .29 .19 Fully Diluted: Earnings before extraordinary items .95 .77 .93 .37 .17 Net earnings .95 .76 .86 .29 .19 Weighted average number of common shares outstanding: Primary 119,253 116,339 114,722 99,642 91,714 Fully diluted 120,365 116,792 115,504 99,928 92,927 Cash dividends per common share $ .08 $ .06 $ .04 $ - $ -\nBALANCE SHEET DATA Working capital $ 470,905 $ 332,818 $ 295,413 $ 214,479 $199,910 Total assets 1,335,310 1,106,704 1,001,279 848,075 812,484 Total long-term debt, net of current portion 298,857 253,839 278,708 334,722 313,951 Shareholders' equity 789,172 634,456 527,772 339,657 295,969 Book value per common share (2) 6.69 5.56 4.65 3.05 2.71\n- ---------\n(1) Figures have been restated to reflect the acquisition of the following companies, each of which was accounted for under the pooling of interests method of accounting: Zenith Laboratories, Inc. (\"Zenith\") and McGaw, Inc. in 1994; Johnson Products Co., Inc. in 1993; Willen Drug Company, DVM Pharmaceuticals, Inc., Waverley Pharmaceutical Limited, and H N Norton Co in 1992. Figures include the results of the following businesses acquired by purchase since the respective acquisition dates: ImmunoVision, Inc. on July 17, 1995; 60% of the shares of Galena a.s., on July 25, 1994 (subsequently increased to 62% effective June 14, 1995); certain assets and the assumption of certain liabilities of Elf Atochem North America, Inc. on June 7, 1993; Flori Roberts, Inc. on July 28, 1992; and Goldline Laboratories, Inc. and Bioline Laboratories, Inc. effective December 1, 1991.\n(2) Assumes conversion of Zenith's cumulative convertible preferred stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes to Consolidated Financial Statements. Except for historical information contained herein, the matters discussed below are forward looking statements that involve risks and uncertainties, including but not limited to economic, competitive, governmental and technological factors affecting IVAX' operations, markets, products and prices, and other factors discussed elsewhere in this report and the documents filed by IVAX with the Securities and Exchange Commission.\nRESULTS OF OPERATIONS OVERVIEW\nIVAX' operations are conducted through subsidiaries involved in pharmaceuticals, intravenous products, in vitro diagnostics, personal care products and specialty chemicals. Information regarding the results of operations and financial position of IVAX' principal business segments is set forth in Note 10, Business Segment and Geographic Information, in the Notes to Consolidated Financial Statements.\nHistorically, IVAX' revenues and profits have increased primarily as a result of the acquisition of other businesses and the successful development and marketing of generic pharmaceutical products. IVAX' future success is largely dependent upon its ability to develop, manufacture and market, in the short-term, commercially viable generic pharmaceutical products, and in the long term, commercially viable generic and proprietary pharmaceutical products. In the short term, IVAX' revenues and profits from its pharmaceutical operations may vary significantly from period to period, as well as in comparison to corresponding prior periods, as a result of regulatory and competitive factors unique to the generic pharmaceutical industry. Such factors include the timing of new generic drug approvals received by IVAX, the number and timing of generic drug approvals for competing products, the timing of IVAX' initial shipments of newly-approved generic drugs, strategies adopted by brand name companies to maintain market share, and the effects of sales promotion programs.\nThe first company to receive regulatory approval for and to introduce a generic drug is usually able to capture significant market share from the branded drug and to achieve relatively high revenues and gross profits from sales of the drug. As other generic versions of the same drug enter the market, however, market share, prices, revenues and gross profits decline, sometimes significantly. In addition, the initial shipments by the first company to introduce a generic drug are often significant as customers fill their initial inventory requirements.\nCompetition in the United States generic pharmaceutical market has continued to intensify as the pharmaceutical industry adjusts to increased pressures to contain health care costs. As a result, brand name companies are increasingly selling their products into the generic market directly by acquiring or forming strategic alliances with generic pharmaceutical companies. No regulatory approvals are required for a brand name manufacturer to sell directly or through a third party to the generic market, nor do such manufacturers face any other significant barriers to entry into such market. In addition, brand name companies are increasingly pursuing strategies to prevent or delay the introduction of generic competition. These strategies include, among other things, seeking to establish regulatory obstacles to demonstrate the bioequivalence of generic drugs to the brand name products,\nand instituting legal actions based on process or other patents that allegedly are infringed by the generic products.\nIVAX' pharmaceutical revenues and profits may also be affected by other factors. Certain raw materials and components used in the manufacture of IVAX' products are available from limited sources, and in some cases, a single source. Furthermore, because raw material sources for pharmaceutical products must generally be approved by regulatory authorities, changes in raw materials suppliers could result in production delays and higher raw material costs. In addition, FDA approval to manufacture a drug is site specific. In the event an approved manufacturing facility for a particular drug becomes inoperable, obtaining the required FDA approval to manufacture such drug at a different manufacturing site could also result in production delays.\nPolitical, economic and regulatory influences are resulting in fundamental changes in the health care industry in the United States. Numerous legislative proposals have been introduced or proposed in Congress and in some state legislatures that would effect major changes in the United States health care system nationally and at the state level. Proposals have included fundamental changes to the health care delivery and payment systems designed to, among other things, increase access to, and decrease the cost of, health care. IVAX anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery systems and payment methods and that public debate of these issues will likely continue in the future. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, IVAX cannot predict which, if any, reform proposals will be adopted, when they may be adopted or what impact they may have on IVAX. There can be no assurance that such reforms, if enacted, will not have a material adverse effect on IVAX.\nIVAX regularly reviews potential acquisitions and business alliances, some of which could result in material changes to IVAX' financial condition and results of operations. Historically, IVAX has generally acquired other businesses through the issuance of common stock. As consideration for any future acquisition, IVAX may, among other things, pay cash, contribute assets, incur indebtedness or issue debt or equity securities.\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994\nIVAX reported net income of $114.8 million for the year ended December 31, 1995, an increase of $25.8 million from the $89.0 million of net income in 1994. Primary and fully diluted earnings per common share were $.96 and $.95, respectively, for the year ended December 31, 1995, as compared to $.76 per common share on both a primary and fully diluted basis reported for 1994.\nNET REVENUES AND GROSS PROFIT BY BUSINESS SEGMENT: (In thousands) 1995 1994 ------------------------- ------------------------- Net Gross Net Gross Revenues Profit Revenues Profit ----------- ----------- ------------ ----------- Pharmaceuticals $ 774,240 $ 326,625 $ 643,496 $ 273,260 Intravenous products 339,978 133,067 337,884 139,931 Other operations 147,045 64,038 153,641 68,254 Intersegment eliminations (1,497) - (215) - ----------- ----------- ------------ ----------- Total $ 1,259,766 $ 523,730 $ 1,134,806 $ 481,445 =========== =========== ============ ===========\nNet revenues totalled $1,259.8 million for 1995, an increase of $125.0 million, or 11%, from the $1,134.8 million reported in the prior year. Consolidated gross profit increased $42.3 million, or 9%, as compared to 1994. Gross profit totalled $523.7 million (41.6% of net revenues) for the year ended December 31, 1995, compared to $481.4 million (42.4% of net revenues) for the prior year.\nNet revenues of IVAX' pharmaceutical operations, which represented approximately 62% of 1995 consolidated net revenues, increased $130.7 million from 1994. Net revenues of IVAX' domestic and international pharmaceutical operations increased $65.8 million and $64.9 million, respectively. The 1995 market introduction of and related promotional programs for new generic products manufactured by IVAX was the principal factor leading to the rise in the net revenues of IVAX' domestic pharmaceutical operations from $440.4 million in 1994 to a total of $506.2 million in 1995.\nDuring April 1995, IVAX received FDA approval to market cefaclor, the generic equivalent of Eli Lilly and Company's Ceclor(R), an antibiotic indicated for the treatment of a variety of infections. Net revenues attributable to sales of cefaclor totalled $70.0 million in 1995. Competition in the generic cefaclor market is likely to result in lower cefaclor net revenues and gross profit for IVAX in 1996. In addition, the principal raw material used in the manufacture of cefaclor is presently available to IVAX from only one source. Changes in the availability of or the price charged for the raw material may affect IVAX' future net revenues or gross profit attributable to cefaclor. Furthermore, IVAX' sale of cefaclor is the subject of a patent infringement action brought by Eli Lilly and Company, as discussed in Note 11, Commitments and Contingencies, in the Notes to Consolidated Financial Statements.\nDuring the latter part of the third quarter and throughout the fourth quarter of 1995, IVAX commenced domestic sales of nine other recently approved generic products, contributing an additional $37.1 million in net revenues to its domestic pharmaceutical operations. These new products included the December introduction of IVAX' albuterol metered dose inhaler, the generic equivalent of Glaxo Inc.'s Ventolin(R) Inhalation Aerosol, used in the treatment of asthma, which contributed $8.6 million to 1995 net revenues. Although sales of these new products were a significant factor contributing to the overall increase in net revenues of the domestic pharmaceutical operations compared to 1994, the levels of revenues generated during the introduction period of a new generic drug are often higher than the levels experienced for routine inventory replenishment by customers in the months following the drug's introduction.\nNet revenues attributable to sales of verapamil HCl ER tablets manufactured by IVAX totalled $96.5 million in 1995 compared to $119.1 million in 1994. The decline in net revenues was due primarily to a reduction in the net selling price of verapamil caused by competition, offset in part by increased unit volume caused by an increase in the substitution rate of generic verapamil for brand name verapamil. IVAX had been the sole United States supplier of generic verapamil until March 1994, when Zenith Laboratories, Inc. (\"Zenith\") began distribution of generic verapamil supplied by a company marketing brand name verapamil. Notwithstanding IVAX' pooling of interests acquisition of Zenith in December 1994, competition in the generic verapamil market has continued because Zenith's former verapamil supplier commenced distribution of generic verapamil through another generic pharmaceutical company. In addition, in March 1996, another generic manufacturer received regulatory approval for one of the dosage strengths of verapamil sold by IVAX. Competition in the generic verapamil market is likely to result in lower verapamil net revenues and gross profit for IVAX in 1996.\nAs noted in the \"Overview,\" other manufacturers may obtain regulatory approvals or otherwise determine to market generic products equivalent to IVAX' manufactured generic products, such as cefaclor, albuterol and verapamil, in 1996 and thereafter. As additional competitors enter the generic pharmaceutical market with products similar to those manufactured by IVAX, the resulting competition is likely to reduce IVAX' net revenues and gross profit generated from those products.\nIVAX' international pharmaceutical operations generated net revenues of $268.0 million in 1995 compared to $203.1 million in 1994. The $64.9 million increase in international pharmaceutical net revenues included an increase of $40.4 million attributable to the operations of Galena a.s. (\"Galena\"). The July 1994 acquisition of a majority interest in Galena was accounted for as a purchase, and accordingly, Galena's results of operations are included in IVAX' consolidated financial statements only since the acquisition date. The remaining $24.5 million increase in net revenues of IVAX' international pharmaceutical operations was primarily due to higher sales of branded respiratory products in the United Kingdom accompanied by the favorable impact of exchange rate differences in comparison to the prior year. Net revenues attributable to sales of branded respiratory products represented approximately 27% of the total net revenues of the international pharmaceutical operations in 1995 as compared to approximately 19% of the total during the prior year.\nThe gross profit percentage of IVAX' pharmaceutical operations was 42.2% in 1995 as compared to 42.5% in 1994. The gross profit percentage remained relatively constant in comparison to the prior year due primarily to domestic sales of the recently approved generic products manufactured by IVAX, which are sold at a higher margin, in combination with a shift in sales mix to higher margin branded products manufactured by IVAX' international pharmaceutical operations. The margin contribution of these products almost entirely offset the decrease in the gross profit margin resulting from the competition in the domestic generic pharmaceutical distribution business experienced during 1995.\nNet revenues of the intravenous products division totalled approximately $340.0 million in 1995, an increase of $2.1 million from the $337.9 million reported for 1994. The increase in net revenues resulted primarily from higher sales of infusion pumps and needlefree intravenous sets and increased revenues from admixture services, partially offset by lower net revenues attributable to both Hespan(R), McGaw's brand name blood plasma expansion product, and specialty nutrition solutions. Net revenues for 1994 also included a $2.0 million one-time settlement of a contractual obligation. Gross profit was $133.1 million in 1995 compared to $139.9 million in 1994. The gross profit percentage of the intravenous products division decreased from 41.4% in 1994 to 39.1% in 1995. The reduction in gross profit and the decrease in the gross profit percentage were primarily due to the reduction in the net selling price of Hespan(R) caused by new competition and the decrease in selling prices of the specialty nutrition solutions. In February 1995, another pharmaceutical company introduced a generic version of Hespan(R) in the United States resulting in both lower prices and a reduction in the intravenous products division's share of the market. Net revenues and gross profit derived from Hespan(R) are expected to continue to decrease in 1996 as compared to 1995 due in part to additional competition from other companies expected to begin marketing a generic version of the product.\nNet revenues and gross profit of IVAX' personal care products, diagnostics and specialty chemicals operations, excluding intersegment eliminations, represented approximately 12% of consolidated net revenues and consolidated gross profit in 1995. Combined net revenues of these other operations decreased $6.6 million from 1994 primarily as a result of lower net revenues attributable to textile and denim product sales of IVAX' specialty chemicals group. Declines in gross profit were\nexperienced by each of IVAX' other operations during 1995, resulting in a decrease in combined gross profit of $4.2 million compared to 1994.\nOPERATING EXPENSES BY BUSINESS SEGMENT: (In thousands)\nSelling expenses totalled $181.4 million (14.4% of net revenues) in 1995 compared to $167.8 million (14.8% of net revenues) in 1994, an increase of $13.6 million. An increase in selling expenses of IVAX' international pharmaceutical operations, due primarily to the rise in its net revenues, accounted for approximately 87% of this increase, or $11.9 million.\nGeneral and administrative expenses totalled $117.4 million (9.3% of net revenues) in 1995 compared to $99.2 million (8.7% of net revenues) for the prior year. The $9.6 million increase in general and administrative expenses of IVAX' pharmaceutical operations, in comparison to the prior year, was principally the result of increased general and administrative expenses of the international pharmaceutical operations primarily due to higher facilities and personnel related expenditures, the impact of a full twelve months of general and administrative expenses of Galena during 1995, and the unfavorable effect of exchange rate differences. The intravenous products division reported an increase of $7.4 million in this expense category compared to 1994 principally as a result of a $4.9 million adverse arbitration award during the 1995 fourth quarter related to a contract dispute, in combination with increased legal expenses incurred throughout the year. Corporate general and administrative expenses increased $3.2 million from the prior year primarily due to increases in personnel, travel and facilities costs.\nResearch and development expenses for 1995 rose $15.9 million, or 33%, in comparison to the prior year, to a total of $64.6 million. Over 75% of the growth in this expense category was concentrated in IVAX' pharmaceutical operations. The increase in research and development expenses in comparison to the prior year reflects IVAX' continuing focus on the development of new and improved products. Management intends to continue to increase the level of its research and development efforts. Actual expenditures will depend on, among other things, the outcome of clinical testing of products under development, delays or changes in government required testing and approval procedures, technological and competitive developments, and strategic marketing decisions.\nAmortization expense decreased $2.4 million compared to 1994 as a result of the write-off of deferred financing costs associated with the March 1994 retirement of debt by the intravenous products division, in combination with the effect of the amortization of the excess of the fair value of assets acquired from Galena over the purchase price paid.\nThe $3.4 million of merger expenses reported for 1995 were primarily related to a proposed merger with Hafslund Nycomed which was abandoned in November 1995. The $13.0 million of merger expenses incurred during the prior year were principally attributable to the December 1994 acquisition of Zenith.\nOther income, net, increased $17.4 million compared to 1994 primarily due to the sale of IVAX' investment in preferred stock of North American Vaccine, Inc. which resulted in a pre-tax gain of $12.8 million. Higher licensing and grant revenues of IVAX' international pharmaceutical operations and a gain on the sale of certain trademarks by IVAX' personal care products group, contributed to the remaining $4.6 million increase in other income, net, as compared to 1994.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO THE YEAR ENDED DECEMBER 31, 1993\nIVAX reported net income of $89.0 million for the year ended December 31, 1994, a decrease of $10.3 million from the $99.4 million of net income in 1993. Income before extraordinary items was $89.9 million for 1994 compared to $108.0 million for 1993, a decline of $18.1 million. Results for both 1994 and 1993 included net extraordinary losses from the early extinguishment of debt of $823,000 in 1994 and $8.6 million in 1993.\nBoth primary and fully diluted earnings per common share in 1994 were $.76 compared to primary and fully diluted earnings per common share for 1993 of $.87 and $.86, respectively. Earnings before extraordinary items, on both a primary and fully diluted basis, were $.77 in 1994, compared to primary and fully diluted earnings before extraordinary items for 1993 of $.94 and $.93, respectively.\nNET REVENUES AND GROSS PROFIT BY BUSINESS SEGMENT: (In thousands)\n1994 1993 ------------------------- ------------------------- Net Gross Net Gross Revenues Profit Revenues Profit ----------- ----------- ------------ ----------- Pharmaceuticals $ 643,496 $ 273,260 $ 587,412 $ 288,132 Intravenous products 337,884 139,931 330,792 131,865 Other operations 153,641 68,254 147,003 72,535 Intersegment eliminations (215) - (2,262) (71) ----------- ----------- ------------ ----------- Total $ 1,134,806 $ 481,445 $ 1,062,945 $ 492,461 =========== =========== ============ ===========\nNet revenues totalled $1,134.8 million for 1994, an increase of $71.9 million, or 7%, from 1993. Consolidated gross profit totalled $481.4 million (42.4% of net revenues) for 1994, a decrease of $11.0 million, or 2%, from the $492.5 million (46.3% of net revenues) in 1993.\nNet revenues of IVAX' pharmaceutical operations, which represented approximately 57% of 1994 consolidated net revenues, increased $56.1 million, or 10%, from 1993. Increases of $59.0\nmillion in net revenues of IVAX' international pharmaceutical operations and $6.0 million in domestic net sales of verapamil were partially offset by a decline of $8.9 million in domestic net sales of other pharmaceutical products.\nIVAX' international pharmaceutical operations generated net revenues of $203.1 million in 1994. Approximately $27.5 million of the total $59.0 million increase in international pharmaceutical net revenues resulted from the July 1994 acquisition of a majority interest in Galena. The remaining $31.5 million increase in net revenues of IVAX' international pharmaceutical operations was primarily due to higher sales of both branded and generic products in the United Kingdom.\nExcluding the impact of IVAX' acquisition of Zenith, 1994 net revenues attributable to sales of verapamil manufactured by IVAX were $119.1 million, a decline of $26.8 million from 1993. The December 1994 acquisition of Zenith contributed an additional $32.9 million to IVAX' 1994 consolidated verapamil net revenues.\nDomestic pharmaceutical net revenues, exclusive of verapamil, were approximately $288.5 million in 1994 compared to $297.4 million in 1993. During the first quarter and part of the second quarter of 1994, the domestic pharmaceutical operations were adversely impacted by delays in processing and shipment of customer orders and the loss of customer orders as a result of the conversion to a new computer software system designed to integrate sales order entry, inventory control and product delivery functions. Prior to the close of the second quarter of 1994, IVAX had resolved most of the system conversion problems and had significantly increased its promotional efforts as a means to restore customer relationships affected by the system conversion problems.\nThe gross profit percentage of IVAX' pharmaceutical operations declined from 49.1% in 1993 to 42.5% in 1994. The decline was primarily attributable to the reduction of verapamil unit sales prices, in combination with competition in the domestic generic pharmaceutical distribution business, partially offset by a shift in sales mix to higher margin branded products by IVAX' international pharmaceutical operations.\nNet revenues of the intravenous products division totalled $337.9 million in 1994, an increase of $7.1 million from the $330.8 million reported in 1993. Higher net revenues from specialty intravenous solutions and sets, in combination with an increase in the admixture services business, primarily accounted for the rise in net revenues. The increase from 1993 also included a $2.0 million one-time payment received in 1994 by McGaw from a customer in settlement of a contractual obligation. Gross profit of the intravenous products division rose $8.1 million from 1993, to a total of $139.9 million. The increase in gross profit was principally the result of increased revenues, a more favorable product mix, the revenues associated with the settlement of the contractual obligation referenced above and improved product pricing combined with stable product costs.\nNet revenues of IVAX' personal care products, diagnostics and specialty chemicals operations, excluding intersegment eliminations, represented approximately 14% of consolidated net revenues in both 1994 and 1993. Net revenues of these other operations increased $6.6 million, while gross profit of these operations decreased $4.3 million as compared to 1993. The specialty chemicals group reported both higher net revenues and gross profit in comparison to 1993, or increases of $10.9 million and $1.5 million, respectively. These increases were principally attributable to sales generated by the businesses acquired from Elf Atochem North America, Inc. (\"Elf Atochem\") in June 1993. The acquisition of the businesses was accounted for using the purchase method of accounting and, accordingly, the results of operations of the acquired businesses were included in IVAX' consolidated financial statements only since the date of acquisition.\nOPERATING EXPENSES BY BUSINESS SEGMENT: (In thousands)\nSelling expenses totalled $167.8 million (14.8% of net revenues) in 1994 compared to $159.2 million (15.0% of net revenues) in 1993. An increase in selling expenses of IVAX' pharmaceutical operations accounted for approximately 94% of the $8.6 million increase in total selling expenses as compared to 1993. Increased personnel costs, primarily within IVAX' domestic pharmaceutical operations, in combination with higher advertising and promotional costs in both the domestic and international operations, were the primary factors contributing to the $8.1 million increase in selling expenses of the pharmaceuticals group.\nGeneral and administrative expenses totalled $99.2 million (8.7% of net revenues) in 1994, an increase of $15.8 million in comparison to the $83.5 million (7.9% of net revenues) reported for 1993. The $6.8 million increase in general and administrative expenses of IVAX' pharmaceuticals operations resulted primarily from increased facilities and personnel expenditures, and the inclusion of $1.7 million of general and administrative expenses of Galena. Higher corporate expense levels required as a result of IVAX' growth contributed $6.5 million to the total rise in general and administrative expenses as compared to 1993. General and administrative expenses of IVAX' other operations increased $2.5 million in comparison to 1993, primarily due to $2.0 million in costs related to charges of the specialty chemicals group in connection with, primarily, the closing of certain facilities.\nMerger expenses were $13.0 million in 1994 compared to $9.2 million in 1993. Approximately $12.5 million of the merger expenses incurred in 1994 were attributable to the acquisition of Zenith, including $5.0 million paid by Zenith in connection with the termination of its distribution agreement with its former generic verapamil supplier.\nInterest expense declined $3.5 million in comparison to 1993, primarily due to the March 1993 redemption of McGaw's $46.1 million of 15% subordinated notes and the March 1994 repayment of McGaw's $52.5 million of term (floating rate) debt, partially offset by increased interest expense associated with borrowings under IVAX' revolving credit facility. Other income, net, decreased $2.6 million compared to 1993 principally due to lower licensing and grant revenues of IVAX' international\npharmaceutical operations, in combination with increased losses on the disposal of plant and equipment.\nCURRENCY FLUCTUATIONS\nFor 1995, 1994 and 1993, approximately 22%, 19% and 15%, respectively, of IVAX' net revenues were attributable to operations which principally generated revenues in currencies other than the United States dollar. Fluctuations in the value of foreign currencies relative to the United States dollar impact the reported results of operations for IVAX. If the United States dollar weakens relative to the foreign currency, the earnings generated in the foreign currency will, in effect, increase when converted into United States dollars and vice versa. As a result of exchange rate differences, net revenues increased by $6.4 million in 1995 as compared to 1994, and increased by $2.7 million in 1994 as compared to 1993.\nAs of December 31, 1995, IVAX Corporation (the \"Parent Company\") had a net \\British pound sterling\\47.6 million (approximately $74.0 million) short-term intercompany receivable. IVAX seeks to reduce the effects of foreign exchange fluctuations in short-term intercompany balances, and on December 4, 1995 the Parent Company entered into foreign currency forward contracts totalling \\British pound sterling\\30.0 million. Costs associated with these contracts are being amortized over the contracts' lives. The contracts expire on March 29, 1996.\nNorton Healthcare uses forward exchange contracts to hedge its exposure to currency fluctuations on certain of its raw material inventory purchases. As the commitments made by the contracts represent offsetting exposure to commitments to purchase inventory at specified amounts payable in other currencies, exposure to foreign currency losses is eliminated. The contract amounts of these instruments at year-end 1995 and 1994 were approximately $5.2 million and $4.4 million, respectively.\nINCOME TAXES\nIVAX' effective tax rate was 19%, 25% and 35% in 1995, 1994 and 1993, respectively. For the three years ended December 31, 1995, the effective tax rate for IVAX' foreign subsidiaries was 22%, 19% and 14%, respectively. IVAX' consolidated effective tax rate in 1995 and 1994 was substantially lower than the effective tax rate in 1993 primarily as a result of a higher proportion of income generated by IVAX' operations in Ireland, Puerto Rico and the U.S. Virgin Islands, which are taxed at lower statutory rates. Additionally, during 1995, IVAX' consolidated tax provision was reduced by $6.5 million as a result of the release of valuation allowances associated with the realization of the benefits of available net operating loss carryforwards and other temporary differences. During 1994, IVAX' consolidated tax provision was reduced by $6.6 million as a result of the release of valuation allowances associated with the realization of the benefits of available net operating loss carryforwards. Certain subsidiaries of IVAX, including McGaw and Zenith, have net operating loss carryforwards which are subject to certain limitations. For further information see Note 7, Income Taxes, in the Notes to Consolidated Financial Statements. IVAX' future consolidated effective tax rate will, to a large extent, depend on the mix between foreign and domestic taxable income and the statutory tax rates of the related tax jurisdictions. The mix between IVAX' foreign and domestic taxable income may be significantly affected by the jurisdictions in which new products are manufactured.\nIVAX receives a U.S. tax credit under Section 936 of the Internal Revenue Code for certain income generated by its Puerto Rican and Virgin Island operations. For 1995, this credit was $17.3 million and completely offset the entire U.S. tax liability of such operations. No assurance can be given that Congress will not eliminate the Section 936 tax credit in the future.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, IVAX' working capital totalled $470.9 million, compared to $332.8 million and $295.4 million at year-end 1994 and 1993, respectively. Cash and cash equivalents were $14.7 million at December 31, 1995 compared to $37.0 million at year-end 1994 and $91.5 million on the same date in 1993.\nIVAX generated $16.4 million in cash from operating activities during 1995, representing declines of $77.7 million from 1994 and $89.2 million from 1993. The decline in cash generated from operating activities as compared to both 1994 and 1993 was primarily due to a higher rate of growth in accounts receivable, partially offset by increased net income. The increase in accounts receivable during 1995 was primarily due to the launch of new manufactured generic products by the domestic pharmaceutical operations during the 1995 third and fourth quarters and the extension of credit terms in connection with the launch of those products. The comparison of cash generated by operations in 1995 versus 1994 was also affected by lower growth in inventories and significant gains from the disposal of assets.\nNet cash of $97.3 million was used for investing activities in 1995, a decrease of $13.8 million from 1994 and an increase of $36.1 million from 1993. Cash utilized for capital expenditures increased from $93.9 million and $49.7 million in 1994 and 1993, respectively, to a total of $103.4 million in 1995. Approximately 89% of the total capital expenditures made in 1995 were devoted to IVAX' pharmaceuticals and intravenous products operations. During 1995, IVAX sold its investment in preferred stock of North American Vaccine, Inc. for approximately $16.3 million in cash. IVAX used $4.8 million in cash to acquire businesses in 1995, representing a decline from both 1994 and 1993. IVAX used $11.8 million in cash, including the payment of acquisition related expenses and net of cash acquired, to obtain a majority ownership interest in Galena during 1994. During 1993, IVAX used $16.0 million of cash to acquire businesses, including approximately $13.0 million of cash to acquire certain businesses from Elf Atochem. Prior to the close of 1993, two of the businesses acquired from Elf Atochem were sold for a business valued at $4.2 million and $10.0 million in cash.\nOn March 25, 1994, IVAX established a revolving credit facility permitting borrowings of up to $100 million, secured by a pledge of the stock of McGaw and an agreement not to pledge or dispose of certain of IVAX' significant subsidiaries. In November 1995, the credit facility was amended, increasing permitted borrowings to $130 million. As of December 31, 1995, $99.0 million in borrowings were outstanding under this facility, an increase of $54.0 million from the prior year-end. The credit facility contains various financial covenants, including a restriction on the payment of dividends by IVAX during any fiscal year in excess of 35% of IVAX' consolidated net income. IVAX is in compliance with all such covenants. During 1995, amounts borrowed under the revolving credit facility were primarily used to fund working capital requirements and to fund capital expenditure programs within IVAX' pharmaceuticals and intravenous products operations. During 1994, borrowings under the revolving credit facility were used, in part to finance IVAX' acquisition of a controlling interest in Galena and to repay McGaw's $52.5 million of term (floating rate) notes and the amounts borrowed under McGaw's revolving facility which totalled $11.1 million as of December 31, 1993. McGaw's credit facility was terminated in June 1994. In November 1995, IVAX obtained an\nunsecured floating rate overdraft facility which provides for advances of up to $10 million. As of December 31, 1995, $528,000 was outstanding under the overdraft facility. The revolving credit facility providing for borrowings of up to $10.0 million previously maintained by Zenith expired in June 1995.\nDuring 1995 and 1994, IVAX redeemed a total of $1.0 million and $18.5 million, respectively, face value of its 6-1\/2% Convertible Subordinated Notes Due 2001. Additionally, during 1995 and 1994, McGaw repurchased $3.4 million and $2.0 million, respectively, face value of its 10-3\/8% Senior Notes due 1999 (\"Senior Notes\") at a purchase price of 101% of the outstanding principal amount plus accrued and unpaid interest. On January 16, 1996, McGaw repurchased $200,000 face value of its Senior Notes at a purchase price of 101% of the outstanding principal amount plus accrued and unpaid interest. The indenture governing the Senior Notes contains certain covenants applicable to McGaw, including limitations on restricted payments, dividends and additional borrowings. As of December 31, 1995, McGaw was either in compliance with these covenants or had received a waiver from the Trustee.\nOn March 15, 1996, IVAX' revolving line of credit was amended to provide for an additional $45 million in borrowings for a period of ninety days. The amendment also changed the expiration date of the revolving line of credit from March 24, 1997 to May 24, 1997. IVAX is seeking to enter into a new revolving line of credit in the amount of $350 million with a bank syndicate. Proceeds from the new line of credit will be used to refinance the existing line of credit and the Senior Notes, and for general corporate purposes, including to fund working capital requirements and to finance acquisitions.\nProceeds from the exercise of stock options and warrants totalled $24.6 million in 1995, increases of $18.5 million from 1994 and $22.0 million from 1993. In March 1993, McGaw completed a public offering of its common stock resulting in net proceeds of $41.7 million. McGaw used the net proceeds from its stock offering, plus an additional $10.3 million borrowed under its $30 million revolving credit facility, to redeem $46.1 million of McGaw's 15% Subordinated Notes due 1999 at a contractually required premium of $3.5 million. A portion of the proceeds were also used by McGaw to pay a cancellation fee and accrued interest related to an interest rate swap agreement totalling $2.4 million.\nDuring 1995, IVAX paid total cash dividends of $9.3 million, or $.08 per share on its common stock. This represented increases from the $5.2 million, or $.06 per share, and the $2.8 million, or $.04 per share, in dividends paid on IVAX' common stock during 1994 and 1993, respectively. Immediately prior to its acquisition by IVAX in December 1994, Zenith paid all outstanding cumulative dividends on its preferred stock or a total of $2.1 million.\nIVAX issued 350,000 shares of its common stock valued at approximately $11 million as of the acquisition date and paid approximately $4.9 million in cash during 1995 in connection with three acquisitions. See Note 3, Acquisitions, in the Notes to Consolidated Financial Statements for further information concerning these acquisitions. During 1994, IVAX issued an aggregate of approximately 41 million shares of common stock having a value of $923 million at the respective issuance dates to consummate the acquisition of McGaw and Zenith. In addition, during 1994, IVAX acquired a majority ownership interest in Galena for approximately $15.5 million in cash. During 1993, IVAX issued an aggregate of 4.3 million shares of common stock having a value of approximately $106.2 million at the respective issuance dates, and paid an aggregate of approximately $16.0 million in cash, to consummate four acquisitions. IVAX intends to continue to expand through the acquisition of other\nbusinesses, as well as internal growth. Certain acquisitions could result in material changes in IVAX' financial condition and results of operations.\nIVAX believes it has adequate capital and sources of financing to support its ongoing operational requirements. These funds will be derived from IVAX' existing working capital, the increased revolving credit facility currently under negotiation and cash flow from operations. For the long term, IVAX presently believes it will be able to obtain long-term capital to the extent necessary to support its growth objectives.\nIVAX plans to spend substantial amounts of capital in 1996 to continue the research and development of its pharmaceutical and intravenous products. Although combined research and development expenditures of the pharmaceutical and intravenous operations are planned to increase by approximately 40% to 50% in comparison to 1995, actual expenditures will depend on, among other things, the outcome of clinical testing of products under development, delays or changes in government required testing and approval procedures, technological and competitive developments and strategic marketing decisions. In addition, IVAX plans to spend substantial amounts of capital in 1996 to improve and expand its pharmaceutical and intravenous related facilities, with higher levels of capital expenditures devoted to these operations in comparison to 1995.\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\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is a list of the names, ages, positions held, and business experience during the past five years of the persons serving as directors and executive officers of IVAX as of March 29, 1996. Each director holds office until the next annual meeting of shareholders or until his successor is elected and qualified. Officers serve at the discretion of the Board of Directors.\nDIRECTORS\nMark Andrews. Mr. Andrews, age 45, has served as a director of IVAX since 1987. He has served as the Chairman of the Board of Directors and Chief Executive Officer of American Exploration Company (oil and gas exploration and production) since 1980, and was its President from 1980 to 1988.\nLloyd Bentsen. Mr. Bentsen, age 75, has served as a director of IVAX since February 1995. He served as the 69th Secretary of the Treasury of the United States from January 1993 until December 1994. From 1971 until his appointment as Secretary of the Treasury, he served as a United States Senator from the State of Texas. He is a director of Panhandle Eastern, Inc. (natural gas) and American International Group, Inc. (insurance).\nErnst Biekert, Ph.D. Dr. Biekert, age 71, has served as a director of IVAX since 1991. He is a professor at the University of Heidelberg in Germany. He was the Chairman of the Board and Chief Executive Officer of Knoll A.G. (pharmaceuticals) from 1968 to 1985. Dr. Biekert was a consultant to BASF A.G. (chemicals and pharmaceuticals) from 1985 to 1987 and was Chairman of its pharmaceutical division from 1975 to 1985.\nDante B. Fascell. Mr. Fascell, age 79, has served as a director of IVAX since 1993. He has been a partner of Holland & Knight, a Florida law firm, since May 1994. He was of counsel to Fine Jacobson Schwartz Nash & Block, P.A., a Florida law firm, from 1993 to 1994. From 1955 to 1993, he served as a member of the United States House of Representatives, and was Chairman of the House Foreign Affairs Committee from 1984 to January 1993.\nJack Fishman, Ph.D. Dr. Fishman, age 65, has served as a director of IVAX since 1987 and as a Vice Chairman of the Board of Directors of IVAX since 1991. From 1991 to February 1995, he served as IVAX' Chief Scientific Officer. He is an Adjunct Professor at The Rockefeller University and Director of Research of Strang Cornell Cancer Research Laboratory, a non-profit entity associated with Cornell University Medical College. Dr. Fishman was President of IVAX from 1988 to 1991, and served as a Research Professor of Biochemistry and Molecular Biology at the University of Miami from 1988 to 1992.\nPhillip Frost, M.D. Dr. Frost, age 59, has served as Chairman of the Board of Directors and Chief Executive Officer of IVAX since 1987. He served as IVAX' President from July 1991 until January 1995. He was the Chairman of the Department of Dermatology at Mt. Sinai Medical Center of Greater Miami, Miami Beach, Florida from 1972 to 1990. Dr. Frost was Chairman of the Board of Directors of Key Pharmaceuticals, Inc. from 1972 to 1986. He is Chairman of the Board of Directors of Whitman Education Group, Inc. (proprietary education), Vice Chairman of the Board of Directors of North American Vaccine, Inc., and a director of Northrop Grumman Corp. (aerospace), American\nExploration Company (oil and gas exploration and production), and NaPro BioTherapeutics, Inc. (biopharmaceutical research and development). He is a trustee of the University of Miami and a member of the Board of Governors of the American Stock Exchange.\nHarold S. Geneen. Mr. Geneen, age 86, has served as a director of IVAX since 1992. He has served as the Chairman of the Board of Directors of Gunther International Ltd. (automated document assembly systems) since September 1993. He also serves on the boards of a number of privately-held companies. He was Chairman of the Board of Directors of Finlay Enterprises, Inc. (retail jewelry) from 1988 through 1993. Mr. Geneen was Chairman of the Board of Directors of ITT Corporation from 1965 until 1979, remained on the Board of Directors of ITT Corporation until 1983, and presently is Chairman Emeritus of ITT Corporation. Mr. Geneen is also Chairman Emeritus of ITT Hartford Group, Inc. and ITT Industries, Inc. He is a member of the Board of Trustees of New York University, the Board of Trustees of the Salk Institute, and the Board of Governors of the University of Miami School of Medicine.\nJane Hsiao, Ph.D. Dr. Hsiao, age 48, has served as a director of IVAX and as IVAX' Vice Chairman-Technical Affairs since February 1995. From 1992 until February 1995, she served as IVAX' Chief Regulatory Officer and Assistant to the Chairman, and as Vice President-Quality Assurance and Compliance of Baker Norton Pharmaceuticals, Inc., IVAX' principal proprietary pharmaceutical subsidiary. From 1987 to 1992, Dr. Hsiao was Vice President-Quality Assurance, Quality Control and Regulatory Affairs of Baker Norton Pharmaceuticals, Inc.\nLyle Kasprick. Mr. Kasprick, age 63, has served as a director of IVAX since 1987. Mr. Kasprick is a private investor. He has served as a director of North American Vaccine, Inc. since 1989, and served as its Chairman from June 1991 to January 1995. Mr. Kasprick is a member of the Board of Directors of the University of North Dakota Foundation.\nIsaac Kaye. Mr. Kaye, age 66, has served as Deputy Chief Executive Officer and a director of IVAX since 1990, and as Chief Executive Officer of Norton Healthcare Limited, IVAX' principal United Kingdom pharmaceutical subsidiary, since 1990. Mr. Kaye is a director of Whitman Education Group, Inc. (proprietary education).\nHarvey M. Krueger. Mr. Krueger, age 66, has served as a director of IVAX since 1991. He has served as a Senior Managing Director of Lehman Brothers since 1991. For more than five years prior thereto, he was a Managing Director of Lehman Brothers and its predecessor companies. He is a director of Automatic Data Processing, Inc. (computing services), R.G. Barry Corp. (footwear), Chaus, Inc. (women's clothing), and Electric Fuel Corp. (batteries for electric automobiles). Mr. Krueger is also on the International Advisory Board of Club Mediteranee, S.A. (resorts).\nJohn H. Moxley III, M.D. Dr. Moxley, age 61, has served as a director of IVAX since 1989. He has served as Vice President of Korn\/Ferry International (executive recruiting firm) since 1989. From 1987 to 1989, he was a self-employed medical consultant. From 1981 to 1987, Dr. Moxley served as Senior Vice President of Corporate Planning and Alternative Services for American Medical International, Inc. (hospitals).\nM. Lee Pearce, M.D. Dr. Pearce, age 65, has served as a director of IVAX since 1989. Dr. Pearce is a private investor. He is a director of OrNda Healthcorp (hospitals).\nMichael Weintraub. Mr. Weintraub, age 57, has served as a director of IVAX since 1987. Mr. Weintraub is a private investor. Since 1979, he has been a director of Gibson Security Corp., a privately owned investment company, and has served as its Chairman and President since 1990. Mr. Weintraub was a director of The Continental Corporation (insurance holding company) from 1976 until May 1995 and NationsBank Corporation (bank holding company) from 1985 until August 1995.\nEXECUTIVE OFFICERS WHO ARE NOT DIRECTORS\nSamuel Broder, M.D. Dr. Broder, age 51, has served as IVAX' Senior Vice President-Research and Development and Chief Scientific Officer since March 1995. He held various positions at the National Cancer Institute since 1972, serving as its Director from 1989 until February 1995.\nMichael W. Fipps. Mr. Fipps, age 53, has served as IVAX' Chief Financial Officer since July 1994. From 1973 to June 1994, he held various positions at Bergen Brunswig Corporation (pharmaceutical wholesaler), serving as its Vice President and Treasurer from 1985 to June 1994.\nNorwick B.H. Goodspeed. Mr. Goodspeed, age 46, has been President and Chief Executive Officer of McGaw, Inc., IVAX' intravenous products subsidiary, since December 1993. From May 1991 until December 1993, Mr. Goodspeed was Senior Vice President, Sales and Marketing of McGaw, Inc. From September 1988 to May 1991, he was the President and Chief Executive Officer of Vical, Inc. (gene therapy).\nRichard C. Pfenniger, Jr. Mr. Pfenniger, age 40, has served as IVAX' Chief Operating Officer since May 1994. He served as Senior Vice President-Legal Affairs and General Counsel of IVAX from 1989 to May 1994, and as Secretary from 1990 to 1994. Prior to joining IVAX, Mr. Pfenniger was engaged in private law practice, most recently as a member of the law firm of Greer, Homer & Bonner, P.A. in Miami, Florida. Mr. Pfenniger is a director of NaPro BioTherapeutics, Inc. (biopharmaceutical research and development), Whitman Education Group, Inc. (proprietary education) and North American Vaccine, Inc.\nCOMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\nSection 16(a) of the Securities Exchange Act of 1934 requires IVAX' directors, executive officers and 10% shareholders to file initial reports of ownership and reports of changes in ownership of IVAX' common stock and other equity securities with the Securities and Exchange Commission and the American Stock Exchange. Directors, executive officers and 10% shareholders are required to furnish IVAX with copies of all Section 16(a) forms they file. Based on a review of the copies of such reports furnished to IVAX and written representations from IVAX' directors and executive officers that no other reports were required, IVAX believes that during 1995 IVAX' directors, executive officers and 10% shareholders complied with all Section 16(a) filing requirements applicable to them, except that Jack Fishman, Ph.D., a director of IVAX, filed one late report relating to the transfer of 79,207 shares of IVAX' common stock into an exchange fund; Norwick Goodspeed, an executive officer of IVAX, filed one late report relating to the cancellation of employee stock options and the grant of replacement options in exchange therefor; and Samuel Broder, M.D., an executive officer of IVAX, filed one late report relating to the purchase of 100 shares of IVAX' common stock through a pension plan.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table contains certain information regarding aggregate compensation paid or accrued by IVAX during 1995 to the Chief Executive Officer and to each of the four highest paid executive officers other than the Chief Executive Officer.\n- --------- (1) Except for Messrs. Kaye, Goodspeed and Klein, the amounts included in the \"All Other Compensation\" column represent matching contributions made by IVAX under the IVAX Corporation Employee Savings Plan, an employee retirement plan maintained under Section 401(k) of the Internal Revenue Code. For Mr. Goodspeed, for 1993 and 1994, such amounts represent matching contributions made by McGaw under McGaw's employee savings plan, which was merged into the IVAX Corporation Employee Savings Plan effective January 1, 1995, and for 1995 represent matching contributions made by IVAX under the IVAX Corporation Employee Savings Plan. For Mr. Klein, such amounts consist of use of an automobile, reimbursement for automobile related expenses and payment of term life insurance premiums, all of which were paid pursuant to Mr. Klein's employment agreement, described below, and, for 1993 also include matching contributions made by Zenith under Zenith's employee savings plan, and for 1995 also include matching contributions made by IVAX under the IVAX Corporation Employee Savings Plan. For Mr. Kaye, such amounts consist of the use of an automobile and reimbursement for a chauffeur, parking and other automobile related expenses, all of which were paid pursuant to Mr. Kaye's employment agreement, described below.\n(2) Mr. Kaye's salary and other compensation is paid in British pounds, and the information in the table is based on the average exchange rate during the applicable year.\n(3) Mr. Klein served as the President of IVAX' North American Multi-Source Pharmaceutical Group from January 1, 1995 until his resignation effective January 17, 1996.\n(4) These options were granted to Mr. Klein pursuant to his employment agreement, described below, and were assumed by IVAX in connection with IVAX' acquisition of Zenith in December 1994. The number of options are adjusted based upon the Zenith acquisition conversion ratio.\n(5) This amount includes a $125,000 retention bonus paid by IVAX to Mr. Goodspeed on March 25, 1995 for continuing to serve as McGaw's President during the year following the McGaw acquisition.\n(6) This amount includes payment to or on behalf of Mr. Goodspeed totalling $254,373 for relocation expenses, and payments totalling $15,162 to cover Mr. Goodspeed's tax liability on the relocation expenses paid directly to him.\n(7) These options were assumed by IVAX in connection with IVAX' acquisition of McGaw in March 1994. The number of options are adjusted based upon the McGaw acquisition conversion ratio.\nMr. Kaye was a party to an employment agreement with IVAX and Norton Healthcare which expired on December 28, 1995. Pursuant to the agreement, Mr. Kaye was entitled to receive an annual salary of at least 150,000 British pounds and certain benefits for serving as Deputy Chief Executive Officer of IVAX and Chief Executive Officer of Norton Healthcare. The agreement restricts Mr. Kaye from competing with IVAX, Norton Healthcare and certain other affiliated entities during his employment and for a period of 12 months from the date of expiration of the employment agreement. In connection with the acquisition of Norton Healthcare, IVAX agreed to cause the nomination of Mr. Kaye for successive terms as a director for so long as he is an employee of IVAX or any of its subsidiaries pursuant to the employment agreement.\nMr. Klein was a party to an employment agreement with Zenith Laboratories, Inc. (\"Zenith\") which was entered into in November 1993 prior to IVAX' acquisition of Zenith and which was terminated by the mutual agreement of the parties effective January 17, 1996. See \"Certain Relationships and Related Transactions.\" Pursuant to the employment agreement, Mr. Klein was entitled to receive an annual salary of at least $400,000 and certain benefits for serving as the President and Chief Executive Officer of Zenith.\nThe following table sets forth information concerning stock option grants made during 1995 to the executive officers named in the \"Summary Compensation Table.\"\n- -------------------- (footnotes on next page)\n(1) No stock options were granted to Mr. Klein or Mr. Goodspeed during 1995.\n(2) All options are nonqualified options and vest in equal portions over four years.\nThe following table sets forth information concerning stock option exercises during 1995 by each of the executive officers named in the \"Summary Compensation Table\" and the year-end value of unexercised options held by such officers.\nDIRECTOR COMPENSATION\nEach director who is not employed by IVAX receives $10,000 per year for his service as a director and is reimbursed for expenses incurred in attending board and committee meetings. Pursuant to IVAX' 1994 Stock Option Plan, non-employee directors automatically are granted each year, on the first business day following IVAX' annual meeting of shareholders, non-qualified options to purchase 5,000 shares of IVAX' common stock at an exercise price equal to the fair market value of the common stock on the date of the grant, and having a term of ten years.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring 1995, the following directors served on the Compensation and Stock Option Committee of the Board of Directors: John H. Moxley III, M.D., M. Lee Pearce, M.D. and Michael Weintraub. None of such persons are or have been executive officers of IVAX, and no interlocking relationships exists between such persons and the directors or executive officers of IVAX.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPRINCIPAL SECURITY HOLDERS\nThe following table sets forth certain information with respect to the only persons known by IVAX to own beneficially in excess of five percent of the outstanding shares of IVAX' common stock as of February 29, 1996.\nNUMBER PERCENT NAME AND ADDRESS OF BENEFICIAL OWNER OF SHARES OF CLASS ------------------------------------ --------- --------\nPhillip Frost, M.D. 14,226,015 (1) 11.8% 4400 Biscayne Boulevard Miami, Florida 33137\nAzure Limited 7,958,492 (2) 6.6% c\/o Charter Management, Ltd. Town Mills Trinity Square St. Peter Port Guernsey, Channel Islands - --------- (1) Includes 65,250 shares held directly, 547 shares held for Dr. Frost's benefit under the IVAX Corporation Employee Savings Plan, 193,750 shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996, 13,950,720 shares held by Frost-Nevada Limited Partnership (\"FNLP\"), and 15,748 shares which may be acquired by FNLP upon conversion of $500,000 in principal amount of IVAX' 6-1\/2% Convertible Subordinated Notes Due 2001. Dr. Frost is the sole limited partner of FNLP and the sole shareholder, officer and director of Frost-Nevada Corporation, the general partner of FNLP. Dr. Frost disclaims beneficial ownership of an additional 123,034 shares held of record by his wife. Dr. Frost is a director and executive officer of IVAX.\n(2) Azure Limited holds the shares as trustee for Charter Trust Company, the trustee of the I. Kaye Family Trust, created by Mr. Isaac Kaye in 1988. The beneficiaries of the I. Kaye Family Trust may include, among others, Mr. Kaye's children. Mr. Kaye is neither a beneficiary nor a trustee of such trust, and he disclaims beneficial ownership of all of the shares owned by Azure Limited. Mr. Kaye is a director and executive officer of IVAX.\nSTOCK OWNERSHIP OF MANAGEMENT\nThe following table indicates, as of February 29, 1996, the number of shares of IVAX' common stock beneficially owned by each director, each executive officer named in the \"Summary Compensation Table,\" and by all directors and executive officers as a group, and the percentage such shares represent of the total outstanding shares of IVAX' common stock. All shares were owned directly with sole voting and investment power unless otherwise indicated.\nSHARES NAME OR IDENTITY BENEFICIALLY PERCENT OF OF GROUP OWNED (1) CLASS --------------- --------- -----\nMark Andrews 25,000 (2) * Lloyd Bentsen 29,000 (2) * Ernst Biekert, Ph.D. 25,000 (2) * Dante B. Fascell 20,000 (2) * Jack Fishman, Ph.D. 2,172,753 (3) 1.8% Phillip Frost, M.D. 14,226,015 (4) 11.8% Harold S. Geneen 30,500 (2) * Jane Hsiao, Ph.D. 3,076,549 (5) 2.6% Lyle Kasprick 212,751 (2) * Isaac Kaye 223,750 (2) * Harvey M. Krueger 26,500 (2) * John H. Moxley III, M.D. 34,450 (2) * M. Lee Pearce, M.D. 306,250 (6) * Michael Weintraub 65,000 (7) * John H. Klein 921,747 (8) * Norwick B.H. Goodspeed 40,640 (2) * Richard C. Pfenniger, Jr. 239,539 (9) *\nAll directors and executive 21,738,115 (10) 17.8% officers as a group (19 persons) - --------------------\n* Represents beneficial ownership of less than 1%.\n(1) For purposes of this table, beneficial ownership is computed pursuant to Rule 13d-3 under the Securities Exchange Act of 1934; the inclusion of shares as beneficially owned should not be construed as an admission that such shares are beneficially owned for purposes of Section 16 of the Securities Exchange Act of 1934.\n(2) Includes shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996 as follows: Mr. Andrews (25,000), Mr. Bentsen (25,000), Dr. Biekert (25,000), Mr. Fascell (18,750), Mr. Geneen (25,000), Mr. Kasprick (25,000), Mr. Kaye (193,750), Mr. Krueger (25,000), Dr. Moxley (25,000), and Mr. Goodspeed (17,021).\n(3) Includes 10,468 shares held by a child. Dr. Fishman disclaims beneficial ownership of an additional 60,000 shares held as co-trustee of certain trusts for the benefit of certain family members.\n(4) Includes 65,250 shares held directly, 547 shares held on Dr. Frost's behalf under the IVAX Corporation Employee Savings Plan, 193,750 shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996, 13,950,720 shares held by Frost-Nevada Limited Partnership (\"FNLP\"), and 15,748 shares which may be acquired by FNLP upon conversion of $500,000 in principal amount of IVAX' 6-1\/2% Convertible Subordinated Notes Due 2001. Dr. Frost is the sole limited partner of FNLP and the sole shareholder, officer and director of Frost-Nevada Corporation, the general partner of FNLP. Dr. Frost disclaims beneficial ownership of an additional 123,034 shares held of record by his wife.\n(5) Includes 984,285 shares held as trustee for the benefit of certain family members, 81,250 shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996, 1,600 shares\nheld by her children and 475 shares held on Dr. Hsiao's behalf under the IVAX Corporation Employee Savings Plan.\n(6) Excludes 200,000 shares donated by Dr. Pearce to a charitable institution, of which he may be deemed to be the beneficial owner; Dr. Pearce disclaims beneficial ownership of such shares.\n(7) Includes 25,000 shares which may be acquired pursuant to currently exercisable options. Mr. Weintraub disclaims beneficial ownership of an additional 311,649 shares held by Gibson Security Corp., of which Mr. Weintraub is Chairman, President, and co-trustee of a trust which owns 97.6% of the shares of Gibson Security Corp.\n(8) Includes 692,100 and 229,647 shares which may be acquired pursuant to stock options held by Mr. Klein and Mr. Klein's wife, respectively, which are excercisable within 60 days of February 29, 1996.\n(9) Includes 117,500 shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996, 574 shares held on his behalf under the IVAX Corporation Employee Savings Plan, and 30 shares held by Mr. Pfenniger's wife under the IVAX Corporation Employee Savings Plan.\n(10) Includes shares noted in footnotes (2) through (9) as beneficially owned and 62,500 additional shares which may be acquired pursuant to stock options exercisable within 60 days of February 29, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDr. Fishman, a director of IVAX, is entitled to receive $87,500 upon the first commercial sale of a product covered by the patents relating to nalmefene, a compound under development by IVAX. The payment was authorized in connection with the purchase of certain patents relating to nalmefene, as partial consideration to Dr. Fishman for the waiver of certain rights as the inventor under such patents.\nIVAX owns common stock and warrants to acquire common stock constituting an aggregate of approximately 13% of the outstanding common stock of NaPro BioTherapeutics, Inc. (\"NaPro\"), and is a party to an exclusive agreement with NaPro to develop and market in certain territories paclitaxel supplied by NaPro. Certain executive officers and directors of IVAX are directors of NaPro. See \"Item 10 - Directors and Executive Officers of the Registrant.\"\nIn November 1995, IVAX sold its investment in 1,000,000 shares of North American Vaccine, Inc. (\"NAVA\") Series A Convertible Preferred Stock (the \"Preferred Stock\") to Frost-Nevada Limited Partnership, a limited partnership beneficially owned by Dr. Frost, for $16,250,000 in cash. The purchase price was determined based upon a discount from the market price of the NAVA common stock into which the Preferred Stock is convertible. IVAX received an opinion of an independent valuation firm that the discount was reasonable, and the Board of Directors of IVAX, with the interested directors abstaining, approved the sale. Certain executive officers and directors of IVAX serve as directors of NAVA. See \"Item 10 - Directors and Executive Officers of the Registrant.\" In addition, Dr. Frost is a principal shareholder of NAVA.\nFrost-Nevada Limited Partnership, a limited partnership beneficially owned by Dr. Frost, held $1,000,000 in principal amount of certain convertible subordinated debentures issued by IVAX in 1990. The debentures bore interest at 9% and were due on October 9, 1995. The debentures were converted in October 1995 pursuant to their terms into IVAX common stock at the conversion price of $5.20 per share, which was a 20% premium over the market price of the IVAX common stock on the date the debentures were issued.\nWhitman Education Group, Inc. (\"Whitman\") is currently negotiating with IVAX to lease approximately 5,500 square feet of office space in Miami, Florida from IVAX. Certain executive officers and directors of IVAX serve as directors of Whitman. See \"Item 10 - Directors and Executive Officers of the Registrant.\" In addition, Dr. Frost is a principal shareholder of Whitman.\nIVAX is a party to a consulting agreement with Mr. Bentsen, a director of IVAX, pursuant to which he receives each year (1) $25,000, less any fees paid for his service as a director of IVAX, and (2) options to purchase 25,000 shares of IVAX common stock, less any options received for his service as a director of IVAX. The agreement has a term of one year, and automatically renews for successive one year terms unless terminated by either party.\nEffective January 17, 1996, Mr. Klein and Zenith agreed to terminate the employment agreement described under \"Executive Compensation.\" As part of the agreement's termination, the vesting period of certain options granted to Mr. Klein pursuant to the agreement were accelerated, and Mr. Klein agreed to continue to serve as a non-executive employee of Zenith until December 31, 1996 and as a consultant to Zenith from January 1, 1997 to December 31, 1998. Mr. Klein will receive an annual salary of $400,000 through December 31, 1996 and an annual consulting fee of $400,000 through December 31, 1998. In addition, Mr. Klein is entitled to continue to receive certain employee benefits until January 1, 1997. Mr. Klein also agreed to refrain from competing with Zenith through January 1, 1999.\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 filed as a part of this report:\nReport of Independent Certified Public Accountants Consolidated Balance Sheets at December 31, 1995 and 1994 Consolidated Statements of Operations for the three years ended December 31, 1995 Consolidated Statements of Shareholders' 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\n(a)(2) FINANCIAL STATEMENT SCHEDULE\nThe following financial statement schedule of IVAX is filed as a part of this report:\nSchedule II Valuation and Qualifying Accounts for the three years ended December 31, 1995\nAll other schedules have been omitted because the required information is not applicable or the information is included in the consolidated financial statements or notes thereto.\n(a)(3) EXHIBITS\n(b) REPORTS ON FORM 8-K.\nIVAX filed a Current Report on Form 8-K dated October 18, 1995 reporting the execution of a Transaction Agreement with Hafslund Nycomed AS and a Current Report on Form 8-K dated November 15, 1995 reporting the termination of such Transaction 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.\nIVAX CORPORATION\nDated: April 1, 1996 By: \/s\/ Phillip Frost, M.D. ----------------------------- Phillip Frost, M.D. Chairman of the Board 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 the capacities and on the dates indicated.\nNAME CAPACITY DATE - ---- -------- ---- \/s\/ Phillip Frost, M.D. Chairman of the Board and April 1, 1996 - --------------------------- Chief Executive Officer Phillip Frost, M.D (Principal Executive Officer)\n\/s\/ Michael W. Fipps Chief Financial Officer April 1, 1996 - ----------------------------- (Principal Financial Michael W. Fipps Officer)\n\/s\/ Salomon Sredni Vice President - Accounting April 1, 1996 - ----------------------------- and Corporate Controller Salomon Sredni (Principal Accounting Officer)\n\/s\/ Mark Andrews Director April 1, 1996 - ----------------------------- Mark Andrews\n\/s\/ Lloyd Bentsen Director April 1, 1996 - ----------------------------- Lloyd Bentsen\n\/s\/ Ernst Biekert, Ph.D. Director April 1, 1996 - ----------------------------- Ernst Biekert, Ph.D.\n\/s\/ Dante B. Fascell Director April 1, 1996 - ----------------------------- Dante B. Fascell\n\/s\/ Jack Fishman, Ph.D. Director and Vice Chairman April 1, 1996 - ----------------------------- of the Board Jack Fishman, Ph.D.\n\/s\/ Harold S. Geneen Director April 1, 1996 - ----------------------------- Harold S. Geneen\n\/s\/ Jane Hsiao, Ph.D. Director and Vice Chairman - April 1, 1996 - ----------------------------- Technical Affairs Jane Hsiao, Ph.D.\n\/s\/ Lyle Kasprick Director April 1, 1996 - ----------------------------- Lyle Kasprick\n\/s\/ Isaac Kaye Director and Deputy Chief April 1, 1996 - ----------------------------- Executive Officer Isaac Kaye\n\/s\/ Harvey M. Krueger Director April 1, 1996 - ----------------------------- Harvey M. Krueger\n\/s\/John H. Moxley III, M.D. Director April 1, 1996 - ----------------------------- John H. Moxley III, M.D.\n\/s\/ M. Lee Pearce, M.D. Director April 1, 1996 - ----------------------------- M. Lee Pearce, M.D.\n\/s\/ Michael Weintraub Director April 1, 1996 - ----------------------------- Michael Weintraub\nIVAX CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPAGE ----\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Operations for the Three Years Ended December 31, 1995\nConsolidated Statements of 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\nSchedule II - Valuation and Qualifying Accounts for the Three Years Ended December 31, 1995\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of IVAX Corporation:\nWe have audited the accompanying consolidated balance sheets of IVAX Corporation (a Florida corporation) and subsidiaries (the \"Company\") 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 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. We did not audit the 1993 financial statements of McGaw, Inc. or Zenith Laboratories, Inc., companies acquired during 1994 in transactions accounted for as poolings of interests, as discussed in Note 3. Such statements are included in the consolidated financial statements of the Company and reflect total revenues of 42% of the related consolidated total for the year ended December 31, 1993. These statements were audited by other auditors whose reports have been furnished to us and our opinion, insofar as it relates to amounts included for McGaw, Inc. and Zenith Laboratories, Inc., 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IVAX 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 consolidated financial statements taken as a whole. The schedule listed in the index to 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. The schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, based on our audits and the reports of other auditors, 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, February 26, 1996 (except with respect to the matters discussed in Note 13, as to which the date is March 15, 1996).\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)\nASSETS\nDECEMBER 31, ---------------------------- 1995 1994\n------------ ------------\nCURRENT ASSETS: Cash and cash equivalents, including interest bearing deposits of $12,821 and $34,440 in 1995 and 1994, respectively................. $ 14,720 $ 37,045\nAccounts receivable, net of allowances for doubtful accounts of $14,260 and $10,940 in 1995 and 1994, respectively ................... 359,165 219,717 Inventories .................................... 242,260 221,520 Other current assets ........................... 60,673 46,060 ---------- ----------\nTotal current assets ........................ 676,818 524,342 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT: Land ............................................ 45,635 44,832 Buildings and improvements ...................... 178,575 143,670 Machinery and equipment ......................... 285,728 232,458 Furniture and fixtures .......................... 24,990 18,510 ---------- ---------- 534,928 439,470 Less - Accumulated depreciation and amortization 149,509 119,598 ---------- ----------\nProperty, plant and equipment, net ........... 385,419 319,872 ---------- ---------- OTHER ASSETS: Cost in excess of net assets of acquired companies, net .................................. 138,423 138,433 Patents, trademarks, licenses and other intangibles, net ................................ 50,859 53,446 Investments in and advances to affiliated companies ....................................... 13,348 8,631 Other ............................................ 70,443 61,980 ---------- ---------- Total other assets ................... 273,073 262,490 ---------- ---------- $1,335,310 $1,106,704 ========== ==========\n(Continued)\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)\n(Continued)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nDECEMBER 31, --------------------------- 1995 1994 ---------- ------------\nCURRENT LIABILITIES: Loans payable $ 4,807 $ 5,006 Current portion of long-term debt 3,521 5,454 Accounts payable 92,343 91,704 Accrued payroll costs 11,196 13,599 Accrued income taxes payable 8,632 8,308 Accrued expenses and other current liabilities 85,414 67,453 ----------- ----------- Total current liabilities 205,913 191,524 ----------- ----------- LONG-TERM DEBT, net of current portion 298,857 253,839 ----------- ----------- OTHER LONG-TERM LIABILITIES 26,314 16,502 ----------- ----------- MINORITY INTEREST 15,054 10,383 ----------- ----------- SHAREHOLDERS' EQUITY: Common stock, $.10 par value: Authorized Outstanding 1995 250,000 118,026 1994 250,000 114,046 11,803 11,405 Capital in excess of par value 461,603 417,734 Retained earnings 322,117 216,156 Cumulative translation adjustment and other (6,351) (10,839) ----------- ----------- Total shareholders' equity 789,172 634,456 ----------- ---------- $ 1,335,310 $ 1,106,704 =========== ===========\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)\nYEAR ENDED DECEMBER 31, ------------------------------------- 1995 1994 1993 ------ ------ ------- NET REVENUES....................... $ 1,259,766 $ 1,134,806 $ 1,062,945\nCOST OF SALES ..................... 736,036 653,361 570,484 ------------- ----------- ----------- Gross profit...................... 523,730 481,445 492,461 ------------- ----------- -----------\nOPERATING EXPENSES: Selling........................... 181,427 167,782 159,221 General and administrative ....... 117,384 99,242 83,450 Research and development.......... 64,602 48,661 43,856 Amortization of intangible assets........................... 9,498 11,885 12,411 Merger expenses .................. 3,392 13,049 9,150 ------------- ----------- ----------- Total operating expenses .. 376,303 340,619 308,088 ------------- ----------- ----------- Income from operations..... 147,427 140,826 184,373\nOTHER INCOME (EXPENSE): Interest income ............... 1,909 2,056 2,297 Interest expense .............. (19,289) (21,481) (25,001) Other income, net ............. 18,394 948 3,505 ------------- ----------- ----------- 1,014 (18,477) (19,199) ------------- ----------- -----------\nIncome before income taxes, minority interest and extraordinary items .......... 148,441 122,349 165,174\nPROVISION FOR INCOME TAXES ........ 28,338 30,322 57,192 ------------- ----------- ----------- Income before minority interest and extraordinary items ........................ 120,103 92,027 107,982\nMINORITY INTEREST ................. (5,302) (2,155) -- ------------- ------------ ----------- Income before extraordinary items ........................ 114,801 89,872 107,982\nEXTRAORDINARY ITEMS: Gains (losses) on extinguishment of debt, net of a tax provision of $29 in 1995 and $114 in 1994 ..... 34 (823) (8,628) ------------- ------------ -----------\nNET INCOME......................... $ 114,835 $ 89,049 $ 99,354 ============= ============ =========== EARNINGS PER COMMON SHARE: Primary: Earnings before extraordinary items ....................... $ .96 $ .77 $ .94 Extraordinary items .......... -- (.01) (.07) ------------- ------------ ----------- Net earnings $ .96 $ .76 $ .87 ============= ============ =========== Fully diluted: Earnings before extraordinary items.......... $ .95 $ .77 $ .93 Extraordinary items .......... -- (.01) (.07) ------------- ------------ ----------- Net earnings ................ $ .95 $ .76 $ .86 ============= ============ =========== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Primary ..................... 119,253 116,339 114,722 ============= ============ =========== Fully diluted ................ 120,365 116,792 115,504 ============= ============ ===========\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\n(Continued)\nIVAX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)\nSupplemental schedule of noncash investing and financing activities:\nInformation with respect to IVAX' acquisitions which were accounted for under the purchase method of accounting, net of the businesses sold, are summarized as follows (in thousands, except share information):\nThe excess of the fair value of assets acquired from Galena a.s. in 1994 over the purchase price was used to first reduce long-term assets and the remainder used to reduce cost in excess of net assets of acquired companies, net.\nDuring the year ended December 31, 1995, common stock was issued upon the conversion of $1,500,000 in debentures.\nContributions to the 401(k) retirement plan resulted in the issuance of common stock totalling $781,000, $895,000 and $511,000 in the years ended December 31, 1995, 1994 and 1993, respectively.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nIVAX CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ORGANIZATION:\nIVAX Corporation is a holding company with subsidiaries engaged primarily in the research, development, manufacture, marketing and distribution of health care products, including generic and branded pharmaceuticals, intravenous solutions and related products, and in vitro diagnostics. These health care products are sold primarily to customers within the United States and the United Kingdom. IVAX Corporation also has subsidiaries which manufacture, market and distribute personal care products and specialty chemicals. All references to \"IVAX\" mean IVAX Corporation and its subsidiaries unless otherwise required by the context.\nIVAX' future revenues and profitability are largely dependent upon its ability to continue to develop, manufacture and market pharmaceutical and intravenous products. Revenues and profits derived from generic pharmaceuticals, which presently constitute IVAX' principal business, can be significantly affected by a variety of factors, including the timing of new product approvals, the timing of initial shipments of newly-approved products, and the number and timing of approvals for competing products. Certain raw materials and components used in the manufacture of IVAX' products are available from limited sources, and in some cases, a single source. In addition, because raw material sources for pharmaceutical and intravenous products must generally be approved by regulatory authorities, changes in raw material suppliers could result in delays in production and higher raw material costs.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation - The consolidated financial statements include the accounts of IVAX Corporation and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts presented in the consolidated financial statements for prior periods have been reclassified for comparative purposes.\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 certain assets, liabilities, revenues and expenses. IVAX' actual results in subsequent periods may differ from the estimates and assumptions used in the preparation of the accompanying consolidated financial statements.\nForeign Currencies - IVAX' operations include subsidiaries which are located outside of the United States. Assets and liabilities as stated in the local reporting currency are translated at the rate of exchange prevailing at the balance sheet date. The gains or losses that result from this process are shown in the cumulative translation adjustment and other caption in the shareholders' equity section of the accompanying consolidated balance sheets. Statement of operations amounts are translated at the average rates for the period.\nCash and Cash Equivalents - IVAX considers all investments with a maturity of three months or less as of the date of purchase to be cash equivalents.\nInventories - Inventories are stated at the lower of cost (first-in, first-out) or market. Components of inventory cost include materials, labor and manufacturing overhead. Inventories consist of the following (in thousands):\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:\nLeasehold improvements are amortized on a straight-line basis over the shorter of the term of the lease or their estimated useful lives. Costs of major additions and improvements are capitalized and expenditures for maintenance and repairs which do not extend the life of the assets are expensed. Upon sale or disposition of property, plant and equipment, the cost and related accumulated depreciation or amortization are eliminated from the accounts and any resultant gain or loss is credited or charged to income.\nOther Assets - Cost in excess of net assets of acquired companies is amortized on the straight-line method over periods not exceeding 40 years. Following any acquisition, IVAX continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of the intangible may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors indicate that goodwill may be impaired, IVAX uses an estimate of the related business segment's undiscounted net income over the remaining life of the intangible in measuring whether the cost in excess of net assets of acquired companies is recoverable; any excess will be charged to operations. Amortization of the cost in excess of net assets of acquired companies during the years ended December 31, 1995, 1994, and 1993 was $2,305,000, $3,673,000 and $3,249,000, respectively. Accumulated amortization of cost in excess of net assets of acquired companies was approximately $15,106,000 and $12,832,000 at December 31, 1995 and 1994, respectively.\nPatents, trademarks, licenses and other intangibles are amortized on the straight-line method over the estimated lives of the respective patents, trademarks, licenses and other intangibles (ranging from 1-25 years). The related accumulated amortization was approximately $41,120,000 and $33,485,000 at December 31, 1995 and 1994, respectively.\nMinority Interest - Minority interest represents the minority shareholders' proportional share of the equity in the income and the net assets of Galena a.s. (\"Galena\") (See Note 3).\nFinancial Instruments - The carrying amounts of cash and cash equivalents, accounts receivable, investment in sales-type leases, accounts payable, and loans payable approximate fair value due to the short maturity of the instruments and the provision for what management believes to be adequate reserves for potential losses. The fair value of other assets and long-term debt is estimated using quoted market prices, whenever available, or an appropriate valuation method. (See Note 6).\nAs of December 31, 1995, IVAX Corporation (the \"Parent Company\") had a net \\pound sterling\\47,638,000 (approximately $73,983,000) short-term intercompany receivable. IVAX seeks to reduce the effects of foreign exchange fluctuations in short-term intercompany balances, and on December 4, 1995 the Parent Company entered into foreign currency forward contracts totalling \\pound sterling\\30,000,000. Costs associated with these contracts are being amortized over the contracts' lives. The contracts expire on March 29, 1996.\nNorton Healthcare Limited (\"Norton Healthcare\"), a wholly-owned subsidiary of IVAX based in the United Kingdom, enters into forward exchange contracts to reduce its exposure to fluctuations in foreign currencies. The commitments outstanding at year-end relate to offsetting commitments on inventory purchases, thus eliminating currency fluctuation exposure. The contract amounts of these instruments at December 31, 1995 and 1994 were approximately $5,232,000 and $4,400,000, respectively.\nRevenue Recognition - Revenue and the related cost of sales are recognized at the time a sale is effected or services are provided. Royalty income is recognized when obligations associated with royalty agreements have been satisfied and is included in net revenues in the consolidated statements of operations.\nResearch and Development Costs - IVAX-sponsored research and development costs related to future products are expensed currently.\nIncome Taxes - The provision for income taxes is based on the consolidated United States entities' and individual foreign companies' estimated tax rates for the applicable year. IVAX utilizes the liability method, and deferred taxes are determined based on the estimated future tax effects of differences between the financial accounting and tax bases of assets and liabilities using the applicable tax laws. Deferred income tax provisions and benefits are based on the changes in the deferred tax asset or tax liability from period to period.\nEarnings Per Common Share - Primary earnings per common share is computed by dividing net income by the weighted average number of common and dilutive common equivalent shares outstanding for each period. Common stock equivalents include the dilutive effect of all outstanding stock options and warrants using the treasury stock method. Fully diluted earnings per common share assumes the maximum dilutive effect from stock options and warrants, and if applicable, the conversion equivalents of the 6-1\/2% Convertible Subordinated Notes due 2001 and the 9.00% Convertible Subordinated Debentures due 1995. As described in Note 3, the acquisition of Zenith Laboratories, Inc. (\"Zenith\") was accounted for as a pooling of interests. The conversion equivalent of Zenith's outstanding cumulative convertible preferred stock is included in the calculation of weighted average shares if dilutive.\nRecently Issued Accounting Standards - In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based\nCompensation (\"SFAS 123\"), which requires proforma disclosures of net income and earnings per share using a fair value based method of accounting for all employee stock options or similar equity instrument plans. IVAX will implement the disclosure provisions of SFAS 123 effective December 31, 1996.\nIVAX 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 establishes accounting standards for recording the impairment of long-lived assets, certain identifiable intangibles and goodwill. Management does not believe the adoption of SFAS 121 will have a material impact on IVAX' financial position or the results of its operations.\n(3) ACQUISITIONS:\nOn September 30, 1995, IVAX acquired Pharmatop Limited, a company engaged exclusively in the distribution and marketing of Norton Healthcare's products in Poland, in consideration for 350,000 shares of IVAX' common stock. Although the acquisition was accounted for using the pooling of interests method of accounting, the accompanying consolidated financial statements have not been restated to give retroactive effect to the acquisition due to the immateriality of the related amounts.\nOn July 17, 1995, IVAX paid approximately $2,783,000 in cash to acquire ImmunoVision, Inc. (\"ImmunoVision\"), a company engaged in the manufacture and sale of certain diagnostic products. The acquisition was accounted for using the purchase method of accounting. The historical operations of ImmunoVision, when compared to the historical operations of IVAX, were not significant.\nIn December 1994, IVAX acquired Zenith in consideration for 27,173,140 shares of IVAX' common stock. The acquisition was accounted for using the pooling of interests method of accounting. Net revenues and net income generated by Zenith prior to the date of acquisition and included in the accompanying consolidated statement of operations for the year ended December 31, 1994 were approximately $122.0 million and $1.1 million, respectively. Zenith's 1994 net revenues included intercompany sales of approximately $6.0 million to another subsidiary of IVAX and were eliminated in consolidation.\nIn July 1994, IVAX completed the acquisition of 60% of the shares of Galena, a pharmaceutical company based in the Czech Republic. Pursuant to the acquisition agreement, IVAX paid $12,950,000 in cash to The National Property Fund of the Czech Republic, and contributed approximately $2,050,000 in cash and $6,600,000 in equipment directly to Galena. In addition, IVAX granted to Galena licenses to manufacture and distribute in certain territories certain of IVAX' pharmaceutical products and products under development. In June 1995, IVAX increased its ownership interest to 62%. The 1994 acquisition was accounted for as a purchase and the consolidated financial statements of IVAX reflect the full consolidation of the accounts of Galena since the acquisition date. The minority shareholders' interest in Galena's net assets and net earnings since the acquisition date are reflected as minority interest in the accompanying consolidated financial statements. The historical operations of Galena, when compared to the historical operations of IVAX, were not significant.\nIn March 1994, IVAX acquired McGaw, Inc. (\"McGaw\") in consideration for 13,985,854 shares of IVAX' common stock. The acquisition was accounted for using the pooling of interests method of accounting. Net revenues and net income generated by McGaw prior to the date of merger and included in the accompanying consolidated statement of operations for the year ended December 31, 1994 totalled approximately $82.6 million and $4.0 million, respectively.\nIn August 1993,IVAX acquired Johnson Products Company,Inc. in consideration for 2,539,060 shares of IVAX' common stock. The acquisition was accounted for using the pooling of interests method of accounting.\nIn June 1993, IVAX acquired certain assets and assumed certain liabilities of the United States and Canadian janitorial, textiles, commercial laundry and food sanitation chemicals businesses of Elf Atochem North America, Inc. (\"Elf Atochem\"). The purchase price was $57.0 million, paid $13.0 million in cash and $44.0 million in shares of IVAX' common stock. A total of 1,687,036 common shares were ultimately issued in connection with the acquisition. The acquisition was accounted for using the purchase method of accounting. In December 1993, IVAX sold the assets and certain liabilities of the commercial laundry and food sanitation chemicals businesses acquired from Elf Atochem. The total consideration consisted of $10.0 million in cash and the acquisition of assets and the assumption of certain liabilities of a fashion processing chemicals business with a fair value of approximately $4.2 million. The excess of the total consideration received over the net assets sold was applied to reduce the goodwill which arose from the original acquisition of businesses from Elf Atochem.\n(4) INVESTMENTS IN AND ADVANCES TO AFFILIATED COMPANIES:\nIn November 1995, IVAX sold its investment in 1,000,000 shares of North American Vaccine, Inc. (\"NAVA\") Series A Convertible Preferred Stock at fair value to a limited partnership beneficially owned by the chairman and chief executive officer of IVAX for $16,250,000 in cash. The investment had been recorded at $3,415,000, the historical cost of the preferred shares, less $272,000 which represented IVAX' interest in shares of IVAX' common stock held by NAVA. The pre-tax gain of $12,835,000 resulting from the sale of the preferred shares is included in other income, net, in the accompanying consolidated statement of operations for the year ended December 31, 1995.\nIn March 1995, IVAX and Knoll AG (\"Knoll\"), a wholly-owned subsidiary of BASF Aktiengesellschaft, established a joint venture for the marketing of generic pharmaceutical products in Europe. The joint venture company, called Knoll Norton GmbH, is owned 50% by Knoll and 50% by IVAX. The joint venture company's initial efforts have focused solely on marketing generic pharmaceuticals in Germany, where its operations are conducted through a subsidiary called BASF Generics GmbH. Knoll contributed to the joint venture the capital stock of BASF Generics GmbH and rights to generic pharmaceutical products, many of which are already licensed and marketed in Germany. IVAX contributed to the joint venture rights to generic pharmaceutical products, most of which are currently manufactured and marketed by Norton Healthcare, as well as rights to certain products under development. The results of the joint venture to date and IVAX' equity in its earnings, have not been material to IVAX.\nIVAX has ownership interests ranging from approximately 10% to 50% in various other unconsolidated affiliates. Undistributed earnings of these affiliates, as well as IVAX' equity in their earnings, were not significant in each of the periods presented in the accompanying consolidated financial statements. Unrealized gains and losses on the securities underlying IVAX' investment in certain of these affiliates have been excluded from earnings and are reported as a component of shareholders' equity, net of applicable income taxes, until realized. As of December 31, 1995, a net unrealized gain of $4,805,000, net of income taxes of $2,703,000, was included in cumulative translation adjustment and other in the accompanying consolidated financial statements.\n(5) INVESTMENT IN SALES-TYPE LEASES:\nMcGaw leases biomedical equipment under sales-type lease arrangements with terms generally ranging from three to five years at rates of interest ranging from 11% to 17%. McGaw generally does not require collateral, but it retains an interest in the leased equipment. Interest income on sales-type leases is included in net revenues in the consolidated statements of operations and totalled $1,621,000, $1,916,000 and $2,053,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Following is a summary of the net investment in sales-type leases (in thousands):\n(6) DEBT:\nLong-term debt consists of the following (in thousands):\nDuring November 1995, borrowings permitted under IVAX' revolving line of credit which expires May 24, 1997 were increased from $100,000,000 to $130,000,000. Amounts outstanding under the revolving line of credit are secured by a pledge of the stock of McGaw and an agreement not to pledge or dispose of certain of IVAX' significant subsidiaries. Borrowings under the line of credit accrue interest at IVAX' option at LIBOR plus 1\/2% or at the greater of the lender's prime rate or the Federal funds rate plus 1\/2%. Commitment fees are charged at a rate of 1\/8% of the unused portion of the line of credit and totalled $64,000 and $36,000 for the years ended December 31, 1995 and 1994, respectively. The line of credit contains various financial covenants, including a restriction on the payment of dividends by IVAX during any fiscal year in excess of 35% of IVAX' consolidated net income.\nMcGaw may at its option prepay the 10-3\/8% Senior Notes due 1999 (\"Senior Notes\") provided that prior to April 1, 1997 such prepayment is not made with funds borrowed at an interest rate of less than 10-3\/8%. Prepayment is subject to a penalty of 4.15% through April 1, 1996 and 2.075% thereafter through April 1, 1997. The indenture governing the Senior Notes contains certain covenants\napplicable to McGaw, including limitations on restricted payments, dividends and additional borrowings. During 1995 and 1994, in accordance with the indenture, McGaw repurchased $3,355,000 and $2,025,000, respectively, face value of its Senior Notes at a purchase price of 101% of the outstanding principal amount plus accrued and unpaid interest. Additionally, on January 16, 1996, in accordance with the indenture, McGaw repurchased $200,000 face value of its Senior Notes at a purchase price of 101% of the outstanding principal amount plus accrued and unpaid interest.\nDuring 1995 and 1994, IVAX redeemed a total of $1,000,000 and $18,500,000, respectively, face value of its 6-1\/2% Convertible Subordinated Notes due 2001.\nCertain of IVAX' international subsidiaries maintain agreements with foreign banks providing lines of credit in the aggregate amounts of approximately $14,000,000 and $17,800,000 at December 31, 1995 and 1994, respectively. Outstanding borrowings under these lines of credit totalled $4,279,000 and $5,006,000 at December 31, 1995 and 1994, respectively, and are included as loans payable in the accompanying consolidated balance sheets. Loans payable at December 31, 1995 also includes $528,000 of amounts advanced under a domestic floating rate overdraft facility due on demand which provides for advances of up to $10,000,000 to fund working capital requirements.\nThe estimated fair values of IVAX' long-term debt are as follows (in thousands):\nFair value of the 6-1\/2% Convertible Subordinated Notes due 2001 and the 10-3\/8% Senior Notes due 1999 are based on available quoted market prices. Management believes that the carrying amounts of other debt approximate the fair value.\nThe stated maturities of all long-term debt for the years 1996 through 2000 are approximately $3.5 million, $105.0 million, $1.8 million, $88.9 million and $1.2 million, respectively.\n(7) INCOME TAXES:\nThe provision for income taxes consists of the following (in thousands):\nThe components of income before income taxes, minority interest and extraordinary items are as follows (in thousands):\nA reconciliation of the difference between the expected provision for income taxes using the statutory Federal tax rate and IVAX' actual provision is as follows (in thousands):\nDuring 1995 and 1994, IVAX released $6,938,000 and $11,831,000 of valuation allowances, respectively, which had been recorded to fully reserve the deferred tax asset related to the future benefit of McGaw's net operating loss carryforwards. The release of the valuation allowances and realization of the benefits of other temporary differences reduced IVAX' consolidated tax provision for the year ended December 31, 1995 by $6,452,000 and decreased intangible assets by $486,000. The release of the valuation allowances reduced the consolidated tax provision for the year ended December 31, 1994 by $6,627,000 and decreased intangible assets by $5,204,000.\nDeferred taxes arise due to timing differences in reporting of certain income and expense items for book purposes and income tax purposes. A detail of the significant components of deferred tax balances included in other current assets and other assets is as follows (in thousands):\nIncome from McGaw's Puerto Rican manufacturing operations is subject to certain tax exemptions under the terms of a grant from the Puerto Rican government which expires in 2002. The grant reduced tax expense by approximately $7,500,000, $8,500,000 and $2,800,000 for the years ended December 31, 1995, 1994, and 1993, respectively. Under the terms of the grant, McGaw is required to maintain certain Puerto Rican employment levels; endeavor to purchase raw materials, machinery and equipment from local suppliers; and notify local authorities of changes in products or manufacturing processes.\nIncome from Zenith's Puerto Rican manufacturing operations is subject to certain tax exemptions under the terms of a grant from the Puerto Rican government which expires in 1999. The grant reduced tax expense by approximately $11,171,000, $4,300,000 and $8,600,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Under the terms of the grant, Zenith is required to maintain certain Puerto Rican employment levels.\nAt December 31, 1995, McGaw had $57,800,000 of net operating loss carryforwards which will begin to expire in 2002. The utilization of the net operating losses is subject to limitations of $21,000,000 per year which are cumulative to the extent not utilized by IVAX. The deferred tax asset related to the benefit of these net operating loss carryforwards has been reduced to zero by a valuation allowance. Approximately $35,000,000 of McGaw's net operating loss carryforwards relate to McGaw's predecessor and are subject to a further annual limitation of $3,000,000 which is cumulative to the extent not utilized by IVAX. Any future benefits recognized from the reduction of the valuation\nallowances related to McGaw's predecessor's losses will first reduce McGaw's acquired noncurrent assets and then reduce income tax expense.\nAt December 31, 1995, Zenith had net operating loss carryforwards of $20,500,000 which will begin to expire in 2004. The deferred tax asset related to the future benefit of these net operating loss carryforwards has been reduced to zero through a valuation allowance. Approximately $8,000,000 of the net operating loss carryforwards relate to Zenith's predecessor and are subject to an annual limitation of $1,700,000 which is cumulative to the extent not utilized by IVAX. Approximately $13,100,000 of the net operating loss carryforwards relate to the exercise of certain stock options. Any future benefits recognized from the reduction of the valuation allowances related to these net operating loss carryforwards will increase paid in capital by approximately $4,500,000.\nMinority interest included in the accompanying consolidated statements of operations is net of a provision for income taxes of $1,692,000 and $1,132,000 for the years ended December 31, 1995 and 1994, respectively.\n(8) BENEFIT PLANS:\n401(k) Plans - IVAX' employees within the United States and the U.S. Virgin Islands and certain of its employees in Puerto Rico are eligible to participate in 401(k) retirement plans, which permit pre-tax employee payroll contributions (subject to certain limitations) and discretionary employer matching contributions. Total matching contributions for the years ended December 31, 1995, 1994 and 1993 were $3,125,000, $2,771,000 and $2,578,000, respectively, a portion of which was made in IVAX' common stock.\nDefined Benefit Plans - McGaw maintains a noncontributory defined benefit pension plan covering substantially all employees of its Puerto Rican subsidiary, and a frozen defined benefit pension plan covering its United States employees in which benefits no longer accrue. Under the Puerto Rican plan, a participating employee's annual post-retirement pension benefit is determined based on years of credited service and compensation, averaged either over the participant's employment or the final years before retirement. McGaw's funding policy under both plans is to make the minimum annual contributions required by applicable regulations.\nIn accordance with the provisions of Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions, McGaw recognized a minimum liability totalling $1,040,000 in 1992 which represented the excess of the unfunded accumulated benefit obligation over previously accrued pension cost related to the frozen defined benefit pension plan. This additional minimum liability was offset by an intangible asset. During 1994, IVAX recorded an additional minimum liability in excess of previously unrecognized prior service cost which was recorded as a $471,000 reduction of shareholders' equity, net of income tax benefits of $312,000. During 1995, the fair market value of the plan's assets exceeded the accumulated benefit obligation resulting in the write-off of the intangible asset and the reversal of the minimum liability.\nThe following table sets forth the funded status and amount recognized for these plans (in thousands):\nNet pension cost included the following components (in thousands):\nSignificant actuarial assumptions used during each plan year for the discount rate, rate of increase in compensation levels, and expected long-term rate of return on assets were 8.5%, 6.0% and 8.5%, respectively.\n(9) SHAREHOLDERS' EQUITY:\nStock Option Plans - IVAX administers and has stock options outstanding under IVAX' 1994 Stock Option Plan (\"1994 Plan\"), IVAX' 1985 Stock Option Plan (\"1985 Plan\"), and certain stock option plans assumed in the acquisitions of Zenith and McGaw. The options outstanding under the plans assumed in the Zenith and McGaw acquisitions were converted into options to acquire IVAX' common stock using the applicable acquisition conversion ratios. The 1994 Plan permits the issuance of options to purchase up to 3,000,000 shares of IVAX' common stock, with an exercise price no less than the fair market value of the common stock on the date of grant and an option term not to exceed ten years. IVAX' Board of Directors has approved an amendment to the 1994 Plan increasing the shares available under the Plan by 4,000,000, subject to shareholder approval. No additional stock options may be issued under the 1985 Plan or the plans assumed in the Zenith and McGaw acquisitions.\nThe following table presents additional information concerning the activity in the stock option plans:\nNumber of Option Price Shares Per Share ---------------- -------------- Options outstanding, January 1, 1994 11,031,570 $ .48-36.38 Granted 4,763,776 11.85-34.88 Exercised (1,413,182) .48-26.75 Terminated (2,075,348) .48-36.38 ---------------- Options outstanding, December 31, 1994 12,306,816 .48-36.38 Granted 2,247,050 20.00-30.13 Exercised (2,974,788) .48-25.50 Terminated (1,381,163) .48-36.38 ---------------- Options outstanding, December 31, 1995 10,197,915 $ .48-36.38 ================ Options exercisable at: December 31, 1994 4,759,362 $ .48-36.38 December 31, 1995 4,012,149 $ .48-36.38\nWarrants - At December 31, 1994, IVAX had warrants outstanding for the purchase of up to 337,500 shares of common stock at an exercise price of $5.00 per share. These warrants were exercised in January 1995 resulting in proceeds of $1,687,500. No warrants were issued or exercised during the year ended December 31, 1994. A total of 54,681 warrants were exercised during 1993 resulting in proceeds of approximately $133,000 to IVAX. At December 31, 1993, McGaw had warrants outstanding to purchase 171,457 shares of its common stock, all of which were exercised prior to the March 1994 merger.\nConvertible Debt - At December 31, 1995, IVAX had outstanding $91,025,000 of 6-1\/2% Convertible Subordinated Notes due 2001 (See Note 6). The notes are convertible at the option of the holders into 2,866,929 shares of IVAX' common stock at a conversion rate of $31.75 per share. During 1995, the $1,500,000 of 9.00% Convertible Subordinated Debentures due 1995 were converted by the debenture holders into a total of 286,371 shares of IVAX common stock at conversion rates ranging from $5.20 to $5.31.\nPreferred Stock - Immediately prior to the December 1994 acquisition of Zenith, all outstanding shares of Zenith's 10.00% cumulative convertible preferred stock were converted into Zenith's common stock, which were exchanged in the merger into 8,049,749 shares of IVAX common stock. Prior to the conversion, Zenith's Board of Directors declared and paid a dividend on its preferred stock equal to the amount of all accrued and unpaid dividends, which totalled $2,082,000.\nDividends - During the years ended December 31, 1995, 1994 and 1993, IVAX paid cash dividends of $.08, $.06 and $.04 per share with respect to its common stock, totalling approximately $9,347,000, $5,173,000 and $2,798,000, respectively.\n(10) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION:\nIVAX has two principal business segments, pharmaceuticals and intravenous products. IVAX also operates in three other business segments, in vitro diagnostics, personal care products and specialty chemicals, which are included below under \"Other operations.\" No single customer accounted for 10% or more of IVAX' consolidated net revenues for any of the three years ended December 31, 1995. Identifiable assets by segment include assets directly identified with those operations. Corporate assets consist primarily of cash and cash equivalents, property, equipment and investments in affiliated companies. Information about each of IVAX' principal business segments and domestic and foreign operations as of and for the three years ended December 31, 1995 follows (in thousands):\n(a) substantially all in Europe.\n(11) COMMITMENTS AND CONTINGENCIES:\nLeases - IVAX leases office, plant and warehouse facilities and automobiles under noncancellable operating leases. Motor vehicles, production equipment and certain manufacturing facilities are also leased under capital leases. Rent expense for the three years ended December 31, 1995 totalled approximately $11,991,000, $10,028,000 and $8,547,000, respectively. The future minimum lease payments under noncancellable leases with initial or remaining terms of one year or more at December 31, 1995, were as follows (in thousands):\nAssets recorded under capital leases consists of (in thousands):\nLegal Proceedings - In late April 1995, Zenith received approvals from the FDA to manufacture and market the antibiotic cefaclor in capsule and oral suspension formulations, the generic equivalent of Eli Lilly and Company's (\"Lilly\") Ceclor(R). On April 27, 1995, Lilly filed a lawsuit against Zenith and others in Federal Court alleging that Zenith's cefaclor raw material supplier, a third party unaffiliated with IVAX, manufactures cefaclor raw material in a manner which infringes two process patents owned by Lilly, and that Zenith and the other named defendants have knowingly and willfully infringed and induced the supplier to infringe the patents by importing the raw material into the United States. The lawsuit seeks to enjoin Zenith and the other defendants from infringing or inducing the infringement of the patents and from making, using or selling any product incorporating the raw material provided by such supplier, and seeks an unspecified amount of monetary damages and the destruction of all cefaclor raw material manufactured by the supplier and imported into the United States. In August 1995, the Court denied Lilly's motion for preliminary injunction which sought to prevent Zenith from selling cefaclor until the merits of Lilly's allegations could be determined at trial. Lilly has appealed such ruling, which appeal has been briefed and argued and remains pending. IVAX intends to defend this lawsuit vigorously. Although IVAX believes Lilly's allegations are without merit, if determined adversely to IVAX, the lawsuit would likely have a material adverse effect on IVAX' financial position and results of operations.\nIn September 1994, individuals purporting to be shareholders of IVAX filed a class action complaint against IVAX and all but one of its directors as of that date and certain of its officers in Federal Court which consolidates, amends and supplements a number of similar complaints filed earlier in 1994. Plaintiffs seek to act as representatives of a class consisting of all purchasers of IVAX' common stock between January 14 and May 2, 1994, including as a subclass parties who exchanged their shares of McGaw common stock for IVAX' common stock in connection with IVAX' acquisition of McGaw in March 1994. In general, the complaints allege that IVAX violated applicable securities laws by making untrue statements of material fact and\/or omitting to state material facts necessary to make statements made not misleading in its public disclosure documents, in communications to\nsecurities analysts and the public, and in IVAX' registration statement and proxy statement-prospectus distributed in connection with the acquisition of McGaw, relating primarily to net revenues and earnings, verapamil sales, and the effects of competition in the verapamil market on IVAX' net revenues and earnings. The complaint seeks an unspecified amount of compensatory and recessionary damages, equitable and\/or injunctive relief, interest, litigation costs and attorneys' fees. The outside directors of IVAX initially named as defendants in the suit were dismissed without prejudice from the consolidated actions in January 1995. In November 1995, the defendants' motion to dismiss the consolidated amended complaint was denied. IVAX intends to defend this lawsuit vigorously. Although IVAX believes that this lawsuit is without merit, its outcome cannot be predicted. If determined adversely to IVAX, the lawsuit would likely have a material adverse effect on IVAX' financial position and results of operations.\nIn June 1994, the former chairman and chief executive officer of McGaw individually filed a similar complaint against IVAX and Dr. Frost alleging essentially the same securities laws violations as alleged in the consolidated class action suit described above, as well as certain additional state law claims. The complaint seeks up to $21 million in compensatory damages (and up to $48 million in rescissionary damages upon tender of IVAX shares held by plaintiff), as well as punitive damages, litigation costs and attorneys' fees.\nIn April 1995, a complaint alleging essentially the same securities laws violations as alleged in the consolidated class action suit described above was filed in Federal Court against IVAX, and certain of its officers. The complaint seeks in excess of $21 million in compensatory, consequential, rescissionary and punitive damages, as well as litigation costs. This action is expected to be consolidated with the class action suit described above.\nIn July 1994, an action was filed in Federal Court against IVAX, in which plaintiffs, shareholders of McGaw at the time of its acquisition by IVAX, alleged that IVAX violated Sections 11 and 12(2) of the Securities Act of 1993, as well as certain state securities laws, and that it breached certain provisions of the merger agreement and IVAX' bylaws, by issuing to plaintiffs shares of IVAX' common stock subject to the restrictions imposed by Rule 145 promulgated under the Securities Act and Accounting Series Release 135. The plaintiffs claim that, as a result of the restrictions imposed on the certificates issued to them, they suffered damages from the loss of value of their shares, and seek damages of $11 million, plus expenses and attorneys' fees. In June 1995, the Court entered an order denying plaintiffs' motion for summary judgment with respect to the claims alleging that IVAX breached certain provisions of the merger agreement and IVAX' bylaws and granted IVAX' motion to dismiss such counts. The Court denied IVAX' motion to dismiss the counts relating to alleged securities laws violations, as well as its motion to transfer venue. In October 1995, the Court granted the plaintiffs' motion to amend their complaint to assert new causes of action under the Uniform Commercial Code and granted the plaintiffs' motion for reconsideration of the dismissal of the claims alleging breach of IVAX' bylaws, and ordered that such counts be reinstated.\nIVAX intends to continue to vigorously defend each of the three foregoing lawsuits. Although IVAX believes such lawsuits are without merit, their respective outcomes cannot be predicted. Any of such lawsuits, if determined adversely to IVAX, could have a material adverse effect on IVAX' results of operations.\nGoldline Laboratories, Inc. (\"Goldline\"), a wholly-owned subsidiary of IVAX, has been either a named defendant, or has assumed the defense of a customer which was a named defendant, in approximately 110 lawsuits regarding a product previously distributed by Goldline in the United States and it may be named in additional lawsuits relating to the product in the future. As of February 26,\n1996, 105 of such lawsuits have been settled, and 5 remain pending. Goldline did not formulate or manufacture the product; it purchased only finished product in bulk and then bottled, labeled and distributed the product. Goldline and IVAX entered into certain agreements with the manufacturer of the product and its United States subsidiary pursuant to which such companies agreed to pay Goldline's defense costs relating to the lawsuits and to indemnify Goldline for settlements or judgments (other than punitive damages), in exchange for Goldline agreeing not to assert claims against the manufacturer or its United States subsidiary. The agreements may be terminated at any time by either party. As a result of the agreements, to date, Goldline has not paid any settlement amounts or appreciable legal fees with respect to any of the lawsuits. In addition, when IVAX acquired Goldline in 1991, 165,000 shares of IVAX' common stock issued in the acquisition were pledged until December 1996 by the former owner of Goldline as collateral against any future claims regarding this product. Goldline also has available to it limited insurance coverage with respect to the currently pending claims. IVAX' ultimate liability with respect to this matter if any, is not presently determinable. In the event that the manufacturer and its United States subsidiary do not continue to provide the indemnity described above, the aggregate liability of Goldline to plaintiffs in these lawsuits is likely to exceed available insurance coverage and the indemnity provided by the former owner of Goldline, and could have a material adverse impact upon the financial position and results of operations of IVAX.\nIVAX is involved in various other legal proceedings arising in the ordinary course of business, some of which involve substantial amounts. While it is not feasible to predict or determine the outcome of these proceedings, in the opinion of management, based on a review with legal counsel, any losses resulting from such legal proceedings will not have a material adverse impact on IVAX' financial position or results of operations.\n(12) QUARTERLY FINANCIAL INFORMATION (UNAUDITED):\nThe following tables summarize selected quarterly data of IVAX for the years ended December 31, 1995 and 1994 (in thousands, except per share data):\n(13) SUBSEQUENT EVENTS: - -----------------------\nOn March 1, 1996, IVAX acquired Elvetium S.A. (Argentina), Alet Laboratorios S.A.E.C.I. y E. and Elvetium S.A. (Uruguay), three affiliated companies engaged in the manufacture and marketing of pharmaceuticals in Argentina and Uruguay, in exchange for 1,490,909 shares of IVAX' common stock. Although the acquisition will be accounted for as a pooling of interests, IVAX' consolidated financial statements will not be restated to reflect this acquisition due to its immateriality.\nOn March 15, 1996, IVAX' revolving line of credit was amended to provide for an additional $45,000,000 in borrowings for a period of ninety days. The amendment also changed the expiration date of the revolving line of credit from March 24, 1997 to May 24, 1997. IVAX is seeking to enter into a new revolving line of credit in the amount of $350,000,000 with a bank syndicate. Proceeds from the new line of credit will be used to refinance the existing line of credit and the Senior Notes, and for general corporate purposes, including to fund working capital requirements and to finance acquisitions.\nSCHEDULE II\nIVAX CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1995 (In thousands)\n(A) Represents additions to the accounts receivable allowances as a result of the acquisition of ImmunoVision, Inc. (B) Represents additions to the accounts receivable allowances as a result of the acquisition of Galena a.s. (C) Represents additions to the accounts receivable allowances as a result of various acquisitions, including the acquisition of certain assets and the assumption of certain liabilities of Elf Atochem North America, Inc.'s janitorial and textile chemicals businesses in the United States and Canada.\nEXHIBIT INDEX\n- ------------------- * Certain exhibits and schedules to this document have not been filed. The Registrant agrees to furnish a copy of any omitted schedule or exhibit to the Securities and Exchange Commission upon request.","section_15":""}
{"filename":"711310_1995.txt","cik":"711310","year":"1995","section_1":"ITEM 1 - BUSINESS\nMay Drilling Partnership 1983-3 (the \"Drilling or General Partnership\") and May Limited Partnership 1983-3 (the \"Limited Partnership\") were organized by May Petroleum Inc. (\"May\") to explore for and develop oil and gas reserves primarily in Texas, Oklahoma and Louisiana. Funds received from the sale and production of oil and gas reserves are used to pay the obligations of the Limited Partnership. Funds not required by the Limited Partnership as working capital are distributed to the participants in the Drilling Partnership and the general partner.\nThe general partner of the Limited Partnership is EDP Operating, Ltd., which is one of the operating partnerships for Hallwood Energy Partners, L. P. (\"HEP\"). The Drilling Partnership is the sole limited partner of the Limited Partnership. The Limited Partnership does not have any subsidiaries, nor does it engage in any other kind of business. The Limited Partnership has no employees and is operated by Hallwood Petroleum, Inc. (\"HPI\"), a subsidiary of HEP. In February 1996, HPI employed 133 full-time employees.\nPursuant to the terms of the general partnership agreement and the limited partnership agreement, HEP is obligated, from time to time, to contribute certain amounts, in property, cash or unreimbursed services, to the Limited Partnership. As of December 31, 1995, all such required contributions had been made.\nPARTICIPATION IN EXPENSES AND REVENUES\nThe principal expenses and revenues of the Limited Partnership are shared by the general partner and the Drilling Partnership as set forth in the following table. The charges and credits to participants in the Drilling Partnership are shared among the participants in proportion to their ownership of units of participation.\nIn 1996, the sharing ratio will be 57.7% to the limited partner and 42.3% to the general partner.\nTo the extent that the characterization of any expense of the Limited Partnership depends on its deductibility for federal income tax purposes, the proper characterization is determined by the general partner (according to its intended characterization on the Limited Partnership's federal income tax return) in good faith at the time the expense is to be charged or credited. Such characterization will control related charges and credits to the partners regardless of any subsequent determination by the Internal Revenue Service or a court of law that the reported expenses should be otherwise characterized for tax purposes.\nCOMPETITION\nOil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy. See also \"Marketing\" for a discussion of the market structure for oil and gas sales.\nREGULATION\nProduction and sale of oil and gas is subject to federal and state governmental regulations in a variety of ways including environmental regulations, labor law, interstate sales, excise taxes and federal, state and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases.\nThe production of oil and gas is subject to regulation by the state regulatory agencies in the states in which the Limited Partnership does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas.\nFEDERAL INCOME TAX CONSIDERATIONS\nThe Limited Partnership and the General Partnership are partnerships for federal income tax purposes. Consequently, they are not taxable entities; rather, all income, gains, losses, deductions and credits are passed through and taken into account by the partners on their individual federal income tax returns. In general, distributions are not subject to tax so long as such distributions do not exceed the partner's adjusted tax basis. Any distributions in excess of the partner's adjusted tax basis are taxed generally as capital gains.\nMARKETING\nThe oil and gas produced from the properties owned by the Limited Partnership has typically been marketed through normal channels for such products. Oil has generally been sold to purchasers at field prices posted by the principal purchasers of crude oil in the areas where the producing properties are located. The majority of the Limited Partnership's gas production is sold on the spot market and is transported in intrastate and interstate pipelines. Both oil and natural gas are purchased by refineries, major oil companies, public utilities and other users and processors of petroleum products.\nFactors which, if they were to occur, might adversely affect the Limited Partnership include decreases in oil and gas prices, the availability of a market for production, rising operational costs of producing oil and gas, compliance with and changes in environmental control statutes and increasing costs and difficulties of transportation.\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nENVIRONMENTAL CONSIDERATIONS\nThe exploration for, and development of, oil and gas involve the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the present general interest in environmental problems, the general partner cannot predict what effect possible future public or private action may have on the business of the Limited Partnership. The general partner is continually taking all action necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations and does not presently anticipate that the compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, earnings or the competitive position of the Limited Partnership in the oil and gas industry.\nINSURANCE COVERAGE\nThe Limited Partnership is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. The Limited Partnership maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to the Limited Partnership's, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon the Limited Partnership's earnings and financial position.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Limited Partnership's oil and gas reserves are concentrated in prospects in south Louisiana. The Limited Partnership's reserves are predominantly natural gas, which accounts for 86% of estimated future gross revenues in the Limited Partnership's reserve report as of December 31, 1995.\nSIGNIFICANT PROSPECTS\nAt December 31, 1995, the following prospects accounted for approximately 97% of the Limited Partnership's proved oil and gas reserves. Reserve quantities were obtained from the December 31, 1995 reserve report prepared by HPI's petroleum engineers.\nBOUDREAUX PROSPECT. The Boudreaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 36,800 bbls of oil and 1,711,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest in this prospect ranges up to 3.5%.\nMEAUX PROSPECT. The Meaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 800 bbls of oil and 77,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest in this prospect is 19.8%.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor a description of legal proceedings affecting the Limited Partnership, please refer to Item 8 - Note 3.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNo matter was submitted to a vote of participants during the fourth quarter of 1995.\nPART II -------\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\na) The registrant's securities consist of partnership interests which are not traded on any exchange and for which no established public trading market exists.\nb) As of December 31, 1995, there were approximately 776 holders of record of partnership interests in the Drilling Partnership.\nc) Distributions paid by the Limited Partnership were as follows (in thousands):\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\nMaterial changes in the Limited Partnership's cash position for the years ended December 31, 1995 and 1994 are summarized as follows:\nCash provided by operating activities in 1995 was used for distributions to the partners and additions to oil and gas properties. The Limited Partnership has net working capital of $316,000. This working capital, together with future net cash flows generated from operations may be used to fund future distributions. Future distributions depend on, among other things, continuation of current or higher oil and gas prices, markets for production and future development costs, and the outcome of the litigation described in Item 8, Note 3.\nThe Limited Partnership's ability to generate funds adequate to meet its future needs will be largely dependent upon its ability to continue to develop further its existing reserves. Proved reserves and discounted future net revenues (discounted at 10% and before general and administrative expenses) from proved reserves were estimated at 39,000 bbls and 1,844,000 mcf valued at $3,206,000 in 1995 and 39,000 bbls and 1,870,000 mcf valued at $2,872,000 in 1994. The increase in discounted future net revenues and the fluctuation in the quantities resulted from an increase in year end oil and gas prices as well as changes in the estimated rates of production on certain wells.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nRESULTS OF OPERATIONS - ---------------------\n1995 COMPARED TO 1994 - ---------------------\nOIL REVENUE\nOil revenue increased $11,000 during 1995 as compared with 1994. The increase is comprised of an increase in the average oil price from $16.03 per barrel in 1994 to $17.68 per barrel in 1995 combined with a 2% increase in production as shown in the table below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and sale of another during the second quarter of 1994.\nGAS REVENUE\nGas revenue decreased $40,000 during 1995 as compared with 1994. The decrease is due to a decrease in the average gas price from $2.15 per mcf during 1994 to $1.84 per mcf during 1995, partially offset by an 8% increase in production as shown below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and the sale of another during the second quarter of 1994.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1995 and 1994.\nLEASE OPERATING\nLease operating expense decreased $23,000 during 1995 as compared with 1994 primarily due to the sale of the Warwick Richard #1 during the second quarter of 1994 and the temporary abandonment of the Duhon #1.\nPRODUCTION TAXES\nProduction taxes increased $16,000 during 1995 as compared with 1994 as a result of the settlement of a lawsuit which resulted in lower production taxes during 1994.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $27,000 during 1995 as compared with 1994 due to a decrease in the allocation of overhead from the general partner.\nDEPLETION\nDepletion expense increased $12,000 during 1995 as compared with 1994 due to a higher depletion rate caused by the 8% increase in oil and gas production during 1995.\nLITIGATION SETTLEMENT\nLitigation settlement expense during 1995 primarily represents amounts paid in connection with the settlement of a royalty dispute on the Duhon #1 well.\n1994 COMPARED TO 1993 - ---------------------\nOIL REVENUES\nOil revenues decreased $61,000 in 1994 as compared to 1993. The average oil price decreased from $17.88 per barrel in 1993 to $16.03 per barrel in 1994. Oil production decreased 36% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines. GAS REVENUES\nGas revenues decreased $461,000 as compared to 1993. The average gas price decreased from $2.26 per mcf in 1993 to $2.15 per mcf in 1994. Gas production decreased 42% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1994 and 1993.\nLEASE OPERATING\nLease operating expense decreased $14,000 as compared to 1993, primarily due to the sale of the Warwick Richard #1 during the second quarter of 1994.\nPRODUCTION TAXES\nProduction taxes decreased $45,000 in 1994 as compared to 1993, primarily due to the decrease in revenues mentioned previously.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $26,000 in 1994 as compared to 1993, due to a decrease in allocation of overhead from the general partner.\nDEPLETION\nDepletion expense decreased $68,000 as compared to 1993, primarily due to a lower depletion rate. LITIGATION SETTLEMENT\nLitigation settlement expense during 1993 represents the costs of a lawsuit settlement which is discussed in Item 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE ----\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report 12\nBalance Sheets at December 31, 1995 and 1994 - May Drilling Partnership 1983-3 13\nBalance Sheets at December 31, 1995 and 1994 - May Limited Partnership 1983-3 14\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 15\nStatements of Changes in Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 16\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-3 17\nNotes to Financial Statements - May Drilling Partnership 1983-3 and May Limited Partnership 1983-3 18-21\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 22\nINDEPENDENT AUDITORS' REPORT ----------------------------\nDRILLING PARTNERSHIP 1983-3 AND MAY LIMITED PARTNERSHIP 1983-3:\nWe have audited the financial statements of May Drilling Partnership 1983-3 (\"General Partnership\") and May Limited Partnership 1983-3 (\"Limited Partnership\") as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, listed in the accompanying index at Item 8. 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 the General Partnership and the Limited Partnership at December 31, 1995 and 1994, and the results of operations and cash flows of the Limited Partnership for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDenver, Colorado February 27, 1996\nMAY DRILLING PARTNERSHIP 1983-3 BALANCE SHEETS (In thousands)\nNote: The statements of operations and cash flows for May Drilling Partnership 1983-3 are not presented because such information is equal to the Limited Partners' share of such activity as presented in the May Limited Partnership 1983-3 financial statements. The May Drilling Partnership carries its investment in May Limited Partnership 1983-3 on the equity method. The May Limited Partnership 1983-3 financial statements should be read in conjunction with this balance sheet.\nMAY LIMITED PARTNERSHIP 1983-3 BALANCE SHEETS (In thousands)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands, except for Units)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nMAY LIMITED PARTNERSHIP 1983-3 STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nThe accompanying notes are an integral part of the financial statements.\nMAY DRILLING PARTNERSHIP 1983-3 AND MAY LIMITED PARTNERSHIP 1983-3\nNOTES TO FINANCIAL STATEMENTS\n(1) ACCOUNTING POLICIES AND OTHER MATTERS\nGENERAL PARTNERSHIP\nMay Drilling Partnership 1983-3, a Texas general partnership (the \"General Partnership\"), was organized by May Petroleum Inc. (\"May\") for the purpose of oil and gas exploration through May Limited Partnership 1983-3 (the \"Limited Partnership\"). The General Partnership was formed on November 7, 1983, with investors (\"Participants\") subscribing an aggregate of $11,629,000 in assessable $1,000 units. After the expenditure of the initial contributions of the Participants, additional mandatory assessments from each Participant are provided for under the terms of the general partnership agreement in an amount up to 25% of the initial contribution of the Participant. No additional assessments were made.\nThe general partnership agreement requires that the manager, Hallwood Energy Partners, L. P. (\"HEP\"), offer to repurchase partnership interests from Participants for cash at amounts to be determined by appraisal of the Limited Partnership's net assets no later than December 31, 1988, and during the two succeeding years, if such net assets are positive. The manager has made repurchase offers in all years since 1989 and intends to make a repurchase offer in 1996.\nAs the General Partnership is the sole limited partner of the Limited Partnership, its results of operations, cash flows and changes in partners' capital are equal to the limited partner's share of the Limited Partnership's results of operations, cash flows and changes in partners' capital as set forth herein. Therefore, separate statements of operations, cash flows and changes in partners' capital are not presented for the General Partnership.\nLIMITED PARTNERSHIP\nThe Limited Partnership, a Texas limited partnership, was organized by May and the General Partnership, for the purpose of oil and gas exploration and the production of crude oil, natural gas and petroleum products. The Limited Partnership's oil and gas reserves are located in prospects in south Louisiana. Among other things, the terms of the Limited Partnership agreement (the \"Agreement\") give the general partner the authority to borrow funds. The Agreement also requires that the general partner's total capital contributions to the Limited Partnership as of each year end, including unrecovered general partner acreage and equipment advances, must be compared to total Limited Partnership expenditures from inception to date, and if such contributions are less than 15% of such expenditures, an additional contribution in the amount of the deficiency is required. At December 31, 1995, no additional contributions were necessary to comply with this requirement.\nOn June 30, 1987, May sold to HEP all of its economic interest in the Limited Partnership and account receivable balances due from the Limited Partnership. HEP became the general partner of the Limited Partnership in 1988.\nSHARING OF COSTS AND REVENUES\nCapital costs, as defined by the Agreement, for commercially productive wells and the costs related to the organization of the Limited Partnership are borne by the general partner. Noncapital costs and direct expenses, as defined by the Agreement, are charged 1% to the general partner and 99% to the limited partner. Oil and gas sales, operating expenses and general and administrative overhead are shared so that the general partner's allocation will equal the percentage that the amount of Limited Partnership expenses, as defined, allocated to the general partner bears to the aggregate amount of Limited Partnership expenses allocated to the general partner and the limited partner, plus 15 percentage points, but in no event will the general partner's allocation exceed 50%. The sharing ratio for each of the last three years was as follows:\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nINCOME TAXES\nNo provision for federal income taxes is included in the financial statements of the Limited Partnership or the General Partnership because, as partnerships, they are not subject to federal income tax and the tax effects of their activities accrue to the partners. The partnerships' tax returns, the qualification of the General and Limited Partnerships as partnerships for federal income tax purposes, and the amount of taxable income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes to the partnerships' taxable income or loss, the tax liability of the partners could change accordingly.\nOIL AND GAS PROPERTIES\nThe Limited Partnership follows the full cost method of accounting for oil and gas properties and, accordingly, capitalizes all costs associated with the exploration and development of oil and gas reserves.\nThe capitalized costs of evaluated properties, including the estimated future costs to develop proved reserves, are amortized on the unit of production basis. Full cost amortization per dollar of gross oil and gas revenues was $.21 in 1995, $.18 in 1994 and $.16 in 1993.\nCapitalized costs are limited to an amount not to exceed the present value of estimated future net cash flows. No valuation adjustment was required in 1995, 1994 or 1993. Significant price declines in the future could cause the Limited Partnership to experience valuation adjustments and could reduce the amount of future cash flow available for distributions and operations.\nGenerally no gains or losses are recognized on the sale or disposition of oil and gas properties. Maintenance and repairs are charged against income when incurred.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nGAS BALANCING\nThe Limited Partnership uses the sales method for accounting for gas balancing. Under this method, the Limited Partnership recognizes revenue on all of its sales of production, and any over production or under production is recovered at a future date.\nAs of December 31, 1995, the net imbalance to the Limited Partnership interest is not considered material. Current imbalances can be made up with production from existing wells or from wells which will be drilled as offsets to current producing wells.\nUSE OF ESTIMATES\nThe preparation of the financial statements for the Limited Partnership and General Partnership 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.\nRELATED PARTY TRANSACTIONS\nHallwood Petroleum, Inc. (\"HPI\"), a subsidiary of the general partner, pays all costs and expenses of operations and receives all revenues associated with the Limited Partnership's properties. At month end, HPI distributes revenues in excess of costs to the Limited Partnership.\nThe amounts due from HPI were $39,000 and $11,000 as of December 31, 1995 and 1994, respectively. These balances represent net revenues less operating costs and expenses.\nCASH FLOWS\nAll highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior years' amounts to conform to the classifications used in the current year.\n(2) GENERAL AND ADMINISTRATIVE OVERHEAD\nHPI conducts the day to day operations of the Limited Partnership and other affiliated partnerships of HEP. The costs of operating the entities are allocated to each partnership based upon the time spent on that partnership. General and administrative overhead allocated by HPI to the Limited Partnership totaled $80,000 in 1995, $103,000 in 1994 and $143,000 in 1993.\n(3) LEGAL PROCEEDINGS\nIn June 1993, 14 lawsuits were filed against the Limited Partnership in the 15th Judicial District Court, Lafayette Parish, Louisiana, Docket Nos. 93-2332-F through 93-2345-F, styled Lamson Petroleum Corporation v. Hallwood Petroleum, Inc. et al. The plaintiffs in the lawsuits claim that they have valid leases covering streets and roads in the units of the A. L. Boudreaux #1 well, G. S. Boudreaux #1 well, Mary Guilbeau #1 well and Duhon #1 well, which represents approximately 3% to 4% of the Limited Partnership's interest in these properties, and are entitled to a portion of the production from the wells dating from February 1990. The Limited Partnership has not recognized revenue attributable to the contested leases since January 1993. These revenues, totaling $61,000 at December 31, 1995, have been placed in escrow pending resolution of the lawsuits. At this time, the Limited Partnership believes that the difference between the escrowed amount and the amount of any liability that may result upon resolution of this matter will not be material.\nIn February 1994, the Limited Partnership and the other parties to the lawsuit styled SAS Exploration, Inc. v. Hall Financial Group, Inc. et al. settled the lawsuit. The plaintiffs alleged that certain leases in the A. L. Boudreaux #1 and A. M. Duhon #1 wells expired and terminated at the end of their primary terms as a result of production being from the Bol Mex 4 Sand rather than the A. B. Sand. In the settlement, the Limited Partnership and the plaintiffs cross- conveyed interests in certain leases to one another and the Limited Partnership paid the plaintiffs $306,000. The cash paid by the Limited Partnership was reflected as litigation settlement expense in the December 31, 1993 financial statements. The interest conveyance resulted in a decrease in the Limited Partnership's reserves as of December 31, 1993 totaling 197,000 mcf of gas, 4,100 barrels of oil and $371,000 in future net revenues, discounted at 10%.\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited)\nThe following tables contain certain costs and reserve information related to the Limited Partnership's oil and gas activities. The Limited Partnership has no long-term supply agreements and all reserves are located within the United States.\nCOSTS INCURRED -\nCertain reserve value information is provided directly to partners pursuant to the Agreement. Accordingly, such information is not presented herein.\n(a) See Note 3 to 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 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Drilling Partnership and Limited Partnership are managed by affiliates of HEP and do not have directors or executive officers.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe partnerships pay no salaries or other direct remuneration to officers, directors or key employees of the general partner or HPI. The Limited Partnership reimburses the general partner for general and administrative costs incurred on behalf of the partnerships. See Note 2 to the Financial Statements.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo the knowledge of the general partner, no person owns of record or beneficially more than 5% of the Drilling Partnership's outstanding units, other than HEP, the address of which is 4582 S. Ulster Street Parkway, Denver, Colorado 80237, and which beneficially owns approximately 37.2% of the outstanding units. The general partner of HEP is Hallwood Energy Corporation.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information with respect to the Limited Partnership and its relationships and transactions with the general partner, see Part I, Item 1 and Part II, Item 7.\nPART IV -------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. Financial Statements and Schedules: See Index at Item 8.\nb. Reports on Form 8-K - None.\nc. Exhibits:\n3.1 The General Partnership Agreement and the Limited Partnership Agreement filed as an Exhibit to Registration Statement No. 0-11313, are incorporated herein by reference.\nSIGNATURES - ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Partnerships have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.\nMAY DRILLING PARTNERSHIP 1983-3 MAY LIMITED PARTNERSHIP 1983-3 BY: EDP OPERATING, LTD., GENERAL PARTNER\nBY: HALLWOOD G.P., INC. GENERAL PARTNER\nBy: \/s\/William L. Guzzetti -------------------------- William L. Guzzetti 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.\nSignature Title Date --------- ----- ----\n\/s\/Robert S. Pfeiffer Vice President February 29, 1996 --------------------------- (Principal ----------------- Robert S. Pfeiffer Accounting Officer)","section_15":""}
{"filename":"351346_1995.txt","cik":"351346","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nBiomet, Inc., an Indiana corporation incorporated in 1977 (\"Biomet\"), and its subsidiaries design, manufacture and market products used primarily by orthopedic medical specialists in both surgical and non-surgical therapy, including reconstructive and trauma devices, electrical bone growth stimulators, orthopedic support devices, operating room supplies, powered surgical instruments, general surgical instruments, arthroscopy products and oral-maxillofacial products and instruments. Biomet has corporate headquarters in Warsaw, Indiana and manufacturing and\/or office facilities in more than fifteen locations worldwide. Biomet markets its products in the United States through independent commission sales representatives, in the United Kingdom and Germany primarily through direct factory sales representatives, and in other international markets through both independent and direct factory sales representatives and specialty medical product dealers. Electro-Biology, Inc. (\"EBI\"), Biomet's principal domestic subsidiary, sells electrical stimulation and external fixation devices through direct factory sales representatives in the United States and the United Kingdom and through specialty medical product dealers in the remainder of its markets. Biomet and its subsidiaries currently distribute products in approximately 100 countries.\nUnless the context otherwise requires, the term \"Company\" as used herein refers to Biomet and all of its subsidiaries.\nThe merger of Kirschner Medical Corporation (\"Kirschner\") into a wholly owned subsidiary of the Company was consummated on November 4, 1994. The total purchase price for all of the issued and outstanding common shares of Kirschner was $38,900,000. As consideration for their Kirschner shares, each Kirschner shareholder, at their individual election, received $10.75 for each Kirschner share, either in cash, Biomet common shares or a combination of cash and such shares. Kirschner is based in Hunt Valley, Maryland with manufacturing facilities in Hunt Valley, Maryland; Fair Lawn, New Jersey; Marlow, Oklahoma; Delray Beach, Florida; and Valencia, Spain. Kirschner designs, develops, manufactures, markets and distributes reconstructive implant devices and related instrumentation and fracture fixation devices. Kirschner's AOA Division (\"AOA\") manufactures, markets and distributes a broad line of musculoskeletal orthopedic support products. Kirschner's Spanish subsidiary, Industrias Quirurgicas de Levante, s.a. (\"IQL\"), manufactures, markets and distributes reconstructive implant and fracture fixation products.\nPRODUCTS\nThe Company's products can be divided into three groups: Reconstructive Products, EBI Products and Other Products. The Company's Reconstructive Products (principally hips, knees and shoulders) and its Other Products (fixation and trauma devices, orthopedic support devices, operating room supplies and arthroscopy products) are designed, manufactured and marketed under the Biomet, Kirschner, AOA, Arthrotek, IQL, and Effner trade names (the \"Biomet Products\"). Also included in Other Products are oral-maxillofacial products and instruments and general surgical instruments which are marketed under the Walter Lorenz trade name. Through EBI, the Company develops, manufactures and markets non-invasive and implantable electrical bone growth and spinal fusion stimulators and external fixation devices (the \"EBI Products\"). The following table shows the net sales and percentages of net sales contributed by each of these product groups for each of the three most recent fiscal years ended May 31, 1995:\nRECONSTRUCTIVE PRODUCTS\nReconstructive Products are used to replace joints which have deteriorated as a result of disease (various forms of arthritis and osteoporosis) or injury. Reconstructive joint surgery involves the modification of the area surrounding the affected joint and the insertion of one or more manufactured components. The Company's primary reconstructive joints are the hip, knee and shoulder, but it also has the capability of producing other peripheral joints (including the ankle, elbow and great toe). The Company also produces the associated instruments required by the orthopedic surgeon to implant the Company's Reconstructive Products.\nAll femoral hip prostheses produced by the Company consist of a femoral head, neck and stem, which can be forged or machined depending on the design and material used. Because of variations in human anatomy and differing design preferences among surgeons, femoral prostheses are manufactured by the Company in a variety of head sizes, neck lengths, stem lengths, stem cross-sections and configurations. The Company currently offers several total hip systems, most of which utilize titanium or cobalt chromium alloy femoral components and ultra-high molecular weight polyethylene-lined acetabular components. Many of the femoral prostheses utilize a porous coating either to enhance the attachment of bone cement to the stem or with a press-fit configuration which allows the component's use without bone cement.\nIn February 1994, the United States Food and Drug Administration (\"FDA\") cleared several of Biomet's porous-coated hip components for cementless use. This clearance to market was granted pursuant to Section 510(k) of the Federal Food, Drug and Cosmetic Act and is specifically for noncemented applications in skeletally mature patients undergoing primary hip replacement surgery as a result of noninflammatory degenerative joint diseases including osteoarthritis, avascular necrosis, traumatic arthritis, slipped capital epiphysis, fused hip, fracture of the pelvis and diastrophic variant. The 510(k) cleared hip components include the Mallory-Head Porous Primary Femoral Components, Bi-Metric Porous Primary Femoral Components, Integral Porous Primary Femoral Components, Taperloc Porous Primary Femoral Components, Ranawat\/Burstein Porous Primary Femoral Components, Impact Modular Femoral Components, Mallory-Head Modular Femoral Components, PMI Primary Femoral Components, Mallory-Head Acetabular Components, Universal\/QSAC Acetabular Components, Ranawat\/Burstein\/Rx90 Acetabular Components and Impact Acetabular Components.\nIn July 1993, the Company received FDA clearance to market and sell ArCom, a new manufacturing method for polyethylene, for use in all of its hip and knee polyethylene components. ArCom devices are machined from uniform compression molded bar stock, manufactured by Biomet, or molded directly from high molecular weight polyethylene resin. The processes used to mold devices and manufacture bar stock are designed to maximize mechanical and wear properties of the polyethylene bearing material. In addition, the finished components are packaged in argon, an inert gas, to avoid oxidative degradation during and after sterilization.\nIn September 1994, the Company received 510(k) clearance from the FDA for the Rx90 and Impact cobalt chrome stems for use with bone cement. These stems feature PMMA (Polymethyl Methacrylate) cement spacers proximally to provide greater centralization of the stem. These cement spacers are designed to ease intraoperative alignment.\nSince 1985, one of Biomet's largest selling reconstructive systems has been the Mallory-Head Total Hip System. The Mallory-Head Hip System is designed to meet surgeon needs for both primary and revision total hip arthroplasty. The primary femoral components feature a specific proximal finned geometry for cementless indications and a slightly different proximal ribbed geometry for those patients requiring fixation with bone cement. The goal of each of these primary femoral stems is to ensure proximal loading of the femur to recreate near-normal bone stresses.\nThe Mallory-Head revision femoral components provide innovative solutions for difficult revision cases. The long stem revision components feature the primary proximal finned geometry with additional stem lengths to bridge cortical bone defects and to provide increased stability. The head\/neck porous revision components feature multiple resection levels to compensate for proximal bone deficiencies. An optional trochanteric bolt provides additional rotational stability and implant fixation. In May 1995, the FDA approved for cemented use the Mallory-Head Modular Calcar System. This system provides the surgeon with intraoperative flexibility to independently match femoral geometry with the appropriate implant size and shape, even in cases of severe bone deficiency.\nThe Mallory-Head acetabular component is designed with Biomet's RingLoc technology to maximize inter-component congruency. The acetabular component is hemispherical in shape and utilizes four peripheral fins to enhance rim fixation and prevent rotation. A solid finned shell without screw holes is also available for the surgeon who prefers not to supplement component fixation with bone screws but instead to maximize bone-to-implant contact.\nThe Alliance Family is designed to address the growing trend of standardization of total hip systems within hospitals and across surgeon groups. The Alliance provides the largest selection of primary and revision stems available using a single set of instrumentation. The Alliance family includes the Integral, Bi-Metric, Answer, Hip Fracture and Rx90 Hip Systems.\nThe Maxim Total Knee System incorporates primary, posterior stabilized and revision components with state-of-the-art biomaterials and competes in the revision constrained knee market segment, addressing surgical situations where the surgeon is required to replace a knee that has a compromised posterior cruciate ligament. The Company has also developed supporting instrumentation for the implantation of the Maxim Total Knee System components. The Maxim Total Knee System continued to expand into new accounts during fiscal year 1994 and became the Company's largest selling knee system during fiscal year 1995.\nThe Company's AGC Total Knee System, with its wide variety of options and features, is one of the most versatile and comprehensive total knee systems in the orthopedic industry. The AGC Total Knee System consists of left and right femoral components, matching reinforced tibial components and appropriately sized reinforced patella components for patellar resurfacing. AGC components are available either with or without a porous titanium alloy surface designed to enhance the attachment of bone cement to the implant surfaces. The Company has also developed surgical techniques and supporting implantation instruments for the AGC and its other knee systems. These instruments allow for accurate implantation of the components and improved ligament and tendon balance in the knee following the surgical procedure. The Company has expanded its total knee product line to include the Finn Knee Replacement System. This system offers both resurfacing and segmental component options in a wide range of sizes to address severe bone loss due to a previous failure or tumor resections.\nBiomet's Patient-Matched Implant (\"PMI\") services group expeditiously designs, manufactures and delivers one-of-a-kind reconstructive and trauma devices to orthopedic specialists. This service continues to enhance Biomet's reconstructive market sales. In order to assist orthopedic surgeons and their surgical teams in preoperative planning, Biomet's PMI group utilizes a three-dimensional (\"3-D\") bone and soft tissue reconstruction imaging system. A patented technology owned by the Company allows the use of CT or MRI data to produce 3-D reconstructions for the design and manufacture of PMIs. With this imaging technology, Biomet's PMI group is able to assist the physician, prior to surgery, by recreating electronic 3-D models. Within strict deadlines, the model is translated into a PMI design for the actual manufacturing of the custom implant for the patient. Biomet continues to advance the application of imaging technology for the design and production of reconstructive devices for various joints of the body.\nThe Company manufactures and distributes the patented Ultra-Drive Bone Cement Removal System (\"Ultra-Drive\") which utilizes ultrasonic technology to safely and effectively remove bone cement during revision arthroplasty procedures. This system reduces the amount of time the orthopedic surgeon would usually spend removing an implant and cement during revision procedures. Additionally, the Ultra-Drive reduces the possibility of accidental bone trauma associated with conventional methods addressing bone cement removal. The Company is engaged in ongoing research and development efforts to enhance the use of the Ultra-Drive in other orthopedic applications.\nKirschner offers a variety of reconstructive products to meet the growing demands of the market, including several knee, shoulder and hip systems. Kirschner's Performance Knee provides a full range of implant components designed to meet the wide variety of surgical indications seen in today's total knee patient population. The TC-IV Knee meets the demands of cost containment while the Hybridfit Knee combines features of the Performance Knee femoral component with modified tibial components of the TC-IV Knee for additional versatility. Kirschner's current shoulder product line is comprised of the Neer II, Kirschner II-C and Modular II-C shoulder implant devices. The Modular II-C and the Kirschner II-C have a proximal plasma spray coating to enhance fixation. As with all prostheses, because of the variation in patient anatomy, Kirschner offers an array of prosthesis sizes and configurations allowing the surgeon to select the most appropriate prosthesis for each patient. Kirschner plans to introduce the Atlas Modular prosthesis to further augment the surgeon's ability to match the prosthesis to the individual patient. It incorporates a modular stem as well as a modular head to reduce the inventory required to support a shoulder procedure. The Atlas will be introduced once FDA 510(k) clearance has been obtained. Kirschner manufactures and markets various femoral, acetabular and bipolar hip prostheses which address a wide range of patient demands and market requirements. Kirschner's femoral stems are available in a variety of geometric designs and in smooth, porous coated and textured surfaces. These products allow for press fit and cemented applications. Kirschner's C-2 femoral stem has been demonstrated to resist rotational forces in a superior manner. These varied products allow the orthopedic surgeon to select various surfaces and designs to meet the diverse needs of individual patients.\nReconstructive devices contributing to the Company's sales growth include the Maxim Total Knee System, the Bio-Modular Shoulder, the Mallory-Head Total Hip System, the Integral 180 and 225 Revision Total Hips, ArCom polyethylene products and the Alliance Family of products.\nIn fiscal year 1996, the Company's product expansion will include new lines of acetabular components, new cemented and cementless hip stems and expanded product offerings for total shoulders. The Company also plans to extend the distribution of its BIOS (Biomet Intra-Operative Sensor) system for evaluating the kinematics of total knee systems. The BIOS System should provide a much higher level of precision in total joint implantation and soft tissue management, while also providing immediate feedback.\nEBI PRODUCTS\nEBI's primary product categories consist of invasive and non-invasive electrical stimulation devices used in the treatment of recalcitrant bone fractures (nonunions), spinal fusion stimulation devices used as an adjunctive treatment in spinal fusion procedures, external fixation devices and a controlled cold therapy unit to aid in the reduction of postoperative pain, edema and blood loss. The FDA has defined a \"nonunion\" as a case in which nine months have elapsed from the date of a fracture with no sign of healing for three months. EBI's non-invasive devices generally provide an alternative to surgical intervention in the treatment of recalcitrant bone fractures and failed joint fusions.\nOne of EBI's primary products, the EBI Bone Healing System, is a non-invasive device which produces low-energy pulsed electromagnetic field (\"PEMF\") signals that induce weak pulsing currents in living tissues exposed to the signals. These pulses, when suitably configured in amplitude, repetition rate and duration, affect bone cells. EBI's non-invasive stimulator has two components: treatment heads and a control unit. The treatment heads contain electrical coils and are connected to the control unit. The control unit transforms household current or battery power into a predetermined sequence of pulsed currents that are induced into the fracture site through the treatment heads which may be placed over a patient's cast, incorporated into the cast, or worn over the skin.\nEBI's Model 1020 Bone Healing System utilizes household current or a rechargeable power supply and allows for complete patient ambulation during treatment. This model usually incorporates the treatment coil into the patient's cast or the coil can be worn over the skin if required. The coil design is capable of treating the vast majority of nonunion fracture locations. The device can be pre-programmed as to duration of daily treatment and for patient compliance history. The Model 1200 Bone Healing System, introduced during fiscal year 1994, is a light-weight, smaller and easier to use unit, which was designed to encourage patient compliance and enhance clinical success.\nEBI also manufactures the FLX Flexible Treatment Coils for use with the EBI Bone Healing System. The FLX Flexible Treatment Coils are extremely lightweight and provide a slim profile that enhances patient comfort and compliance during bone healing treatment regimens. When used conjunctively with the EBI Bone Healing System, the FLX Flexible Treatment Coils afford higher bone healing success rates. Additionally, EBI offers a series of coils to address shoulder, foot, ankle, clavicle and metatarsal site applications and an elliptical coil to be used with external fixation.\nThe invasive electrical stimulation devices provide an adjunct to surgical intervention in the treatment of nonunions and spinal fusions. Spinal fusions are surgical procedures undertaken to establish bony union between adjacent vertebrae. EBI's SpF-4 Implantable Spinal Fusion Stimulator is used in conjunction with bone grafting to increase the probability of fusion success. In addition, EBI's SpF-2, a two lead supplement to its SpF implantable spinal product line, allows EBI to offer orthopedic surgeons the SpF spinal fusion technology for the growing bilateral\/lateral procedure market. Another SpF product, the SpF-T Implantable Spinal Fusion Stimulator, incorporates a telemetry device which emits a signal to allow device monitoring after implantation. The compact design of the SpF-T provides easier surgical implantation and explantation while increasing patient comfort. The implantable devices consist of a generator providing a constant direct current to a titanium cathode placed where bone growth is required. Over the years EBI has developed new techniques and device modifications for the SpF product line. These techniques and modifications address the anterior and posterior lumbar interbody fusion market segments.\nEBI's arrangement with Orthofix s.r.l. (\"Orthofix\") of Verona, Italy, to distribute the Orthofix Dynamic Axial External Fixation System in the United States, Canada and the Caribbean Island Basin expired on May 31, 1995 and will not be renewed. EBI, with the support of Biomet, began the development of its own advanced fixation system in order to remain a market leader in the fixation industry. EBI believes that it will be able to satisfy customer demand until the launch of its advanced fixation system. EBI expects no material adverse impact on its external fixation sales.\nEBI also distributes the Temptek product line, a controlled cold therapy unit used to aid in the reduction of postoperative pain, edema and blood loss. The application of controlled cold therapy has recently expanded into spinal treatment. This product is currently manufactured by Temptek, Inc. of Dallas, Texas. The terms of the distribution arrangement between Temptek, Inc. and EBI have recently been renegotiated. EBI will continue to distribute the Temptek units purchased and EBI will market and distribute its own line of controlled cold therapy units in 1996.\nOTHER PRODUCTS\nThe Company also manufactures and distributes several other products including fixation and trauma devices, orthopedic support devices, operating room supplies, arthroscopy products and oral-maxillofacial products. Biomet Medical Products, a separate operating division of the Company, was established during fiscal year 1993 to focus on the expansion of the Company's \"other products,\" except oral-maxillofacial products, and to further penetrate these markets with new products. Kirschner manufactures and distributes an extensive orthopedic support product line through its AOA Division. Walter Lorenz Surgical, Inc. (\"Lorenz Surgical\") manufactures and markets the oral-maxillofacial product line.\nFIXATION AND TRAUMA DEVICES. The Company's fixation and trauma devices include internal and external bone fixation devices. Internal fixation devices manufactured by the Company include nails, plates, screws, pins and wires designed to temporarily stabilize traumatic bone injuries. These devices are used by orthopedic surgeons to provide an accurate means of setting and stabilizing fractures. These implants are intended as aids to healing and not as a replacement of normal body structures, and may be removed when healing is completed.\nThe Uniflex Nailing System, which is the Company's largest selling fixation system, addresses a wide range of fractures utilizing one product system. The Uniflex Femoral Nailing System is used for internal fixation of femoral fractures and the flexibility of the system enhances the load transfer to the bone to further aid in the healing of the fracture. The Uniflex Nailing System also includes tibial and humeral nailing systems. In addition, the S.S.T. small bone locking nail and the Vector Intertrochanteric Nail, a compression nailing system, continue to enhance the Company's fracture fixation family.\nIn fiscal year 1995, the Biomet Retrograde Femoral Nail was introduced as a clinical option for femoral fractures that occur below mid-shaft. The Retrograde Femoral Nail completes the Company's line of nailing systems by allowing for the treatment of distal femoral fractures.\nThe Compression Hip Screw System was designed to provide strong and stable internal fixation for a variety of intertrochanteric, subtrochanteric and basilar neck fractures. The BMP Cable System is used intraoperatively, often as part of revision hip surgery, to reduce the risk of fracture or to repair existing femoral fractures. System specific instrumentation for the BMP Cable System is precise and allows reproducible results.\nORTHOPEDIC SUPPORT DEVICES. The Company produces an extensive line of standard orthopedic support devices, many of which are sold under the CTN and START trademarks. These devices include elbow, wrist, abdominal, thigh and ankle supports, in addition to a wide variety of knee immobilizers and braces. The CTN product line primarily addresses the sports medicine market. CTN compression wraps with Soft-Ice are used in compression cold-therapy treatment, both post-operative and during rehabilitation. The Company also distributes the Active Ankle, a unique ankle stirrup brace which addresses the sports rehabilitation market.\nAOA's line of orthopedic support devices include traction framing equipment, back supports, wrist and forearm splints, cervical collars, shoulder immobilizers, slings, abdominal binders, wrist and forearm splints, back supports, knee braces and immoblizers, rib belts, ankle supports and a variety of other orthopedic splints. In addition to these products, AOA manufactures and distributes a variety of casting products for use in the application and removal of orthopedic casts and splints. Included are both synthetic casting tape and synthetic splints fabricated using an advanced fiberglass\/polyester substrate material impregnated with a polymer resulting in casting and splinting products that are lightweight, high strength and available in a variety of colors.\nAOA has recently launched several new products including the Performance Neoprene System of ankle, knee, thigh and wrist supports and the Ascend Ankle Bracing System which is designed for use in treatment of both acute and chronic ankle injury and can also be used by athletes prophylactically to prevent ankle injury.\nOPERATING ROOM SUPPLIES. The Company's principal products in the operating room supplies category are surgical suction devices, filters and drapes. The Redi-Vacette Closed Wound Suction System provides post-operative wound suction drainage following both orthopedic and nonorthopedic surgical procedures. The Redi-Flow Filter automatically strains the flow of body liquids during surgery. The filter collects fine bone chips and tissue for subsequent pathological evaluation and saves operating room time by reducing suction clogs in surgical procedures. The Redi-Drape protects the sterile operating field from contamination, and provides a drainage bag and built-in instrument pouches to assist the surgeon.\nThe Company's patented Blockaid cut-resistant glove liner continues to enhance the Company's operating room supply product line. The construction of the glove liner represents a break-through in continuous filament knitting technology allowing stainless steel to be encased in synthetic fibers, providing the most cut-resistant fabric in the market today. Unlike thicker, spun fibers, these glove liners are thin enough to allow increased tactile sensitivity. This product reduces the risk of exposure of operating room personnel to infectious diseases.\nARTHROSCOPY PRODUCTS. Arthroscopy is a less-invasive orthopedic surgical procedure in which an arthroscope is inserted through a small incision to allow the surgeon direct visualization of the joint. This market is comprised of five product categories: power instruments, manual instruments, visualization products, soft tissue anchors and procedure specific instruments and implants. Arthrotek' s principal products currently include the Harpoon Soft Tissue Anchor System, the IES 1000 System, the PowerPump 800, the Tunneloc ACL Fixation System and manual instruments featuring the Ellipticut and BackBiter instruments. The Harpoon line was expanded during fiscal year 1995 to include the Mini-Harpoon and the Lactosorb Harpoon, a resorbable suture anchor developed by Poly-Medics (discussed below) and currently in clinical trials. Arthrotek also offers the IES 1000 System, a fully-integrated arthroscopy system consisting of a camera, light source, shaver, pump, monitor, printer and VCR maintained in a pre-wired cart. The PowerPump 800 provides the ability for surgeons to independently control flow and pressure and use the pump in conjunction with other arthroscopy shaver systems. The Tunneloc System was augmented with the Bone Mulch Screw, which recently received 510(k) clearance from the FDA.\nORAL-MAXILLOFACIAL PRODUCTS. The Company manufactures and distributes oral-maxillofacial, craniofacial and neurosurgical titanium implants, along with surgical instrumentation, principally marketed to oral-maxillofacial, neurosurgical and craniofacial surgeons through its Lorenz Surgical subsidiary headquartered in Jacksonville, Florida. Orthognathic surgical instruments, craniofacial instruments, rigid fixation plating systems, TMJ instruments, exodontia instruments and Hard Tissue Replacement Polymer are among the products offered by Lorenz Surgical. Lorenz Surgical recently began marketing powered surgical instruments for use in cranio-maxillofacial and small bone surgery. Additionally, Lorenz Surgical is currently developing resorbable plates and screws in conjunction with Poly-Medics which will be marketed by Lorenz Surgical domestically upon receiving FDA clearance or approval. Clearance has been granted to market the resorbable plates and screws in numerous international markets. Lorenz Surgical has received 510(k) clearance for its dental implants and is currently evaluating entry into the dental implant market.\nPRODUCT DEVELOPMENT\nFor the years ended May 31, 1995, 1994 and 1993, the Company expended approximately $21,770,000, $20,521,000 and $17,995,000 respectively, on research and development, and it is expected that research and development expenses will continue to increase. The Company's principal research and development efforts relate to its reconstructive devices, electrical stimulation products and arthroscopy products.\nThe Company's research and development efforts contributed to the introduction in fiscal year 1995 of the following products: Mallory-Head Modular Calcar Hip System, Posterior Stabilized AGC Knee System, Modular Acetabular Revision System, Constrained Cup System, Freeman\/Samuelson Knee System, Lateralized Integral Hip System and Index Cup System.\nEBI conducts a program of research and development intending to maintain its proprietary position and to expand the range of conditions treatable with its electrical stimulation products. This program includes clinical investigations and providing equipment and\/or funding basic research to study cells and simple biological systems. Typically, EBI receives proprietary rights with respect to the data developed as the result of research sponsored by it. EBI has completed clinical trials to investigate the application of its products in the treatment of avascular necrosis (\"AVN\") of the femoral head, a debilitating and degenerative disease. In May 1994, EBI received notice from the FDA that it has completed its initial review of EBI's pre-market approval application (\"PMA\"). The FDA is in the process of formally reviewing the PMA, however, based on discussions with the FDA, EBI has no reason to believe approval is imminent. EBI also currently has clinical trials underway to develop new indications with PEMF technology for the treatment of fresh fractures.\nIn July 1991, the Company and United States Surgical Corporation (\"U.S. Surgical\") entered into a cooperative effort to develop and market a line of state-of-the-art bioresorbable orthopedic and oral-maxillofacial implants. The cooperative effort has been named Poly-Medics. The Company is contributing its product development, marketing and distribution capabilities while U.S. Surgical is contributing its expertise in polymer technology and product development that led to its successful development of resorbable staples and sutures. Poly-Medics is focusing on three primary areas: bone replacement and augmentation; fracture healing; and musculoskeletal soft tissue repair and reattachment. Poly-Medics' Hard Tissue Replacement Polymer Facial Implants and custom craniofacial implants are being distributed through Lorenz Surgical. Clinical studies utilizing Poly-Medics' resorbable polymers are currently in process for maxillofacial, trauma and soft tissue reattachment applications.\nThe Company is continuing its work to develop hydroxyapatite (\"HAP\"), a bioactive surface, to be applied to orthopedic implants which, by eliminating the fibrous tissue interface between the implant and the bone, would improve apposition and attachment to the implant and bone ingrowth into the porous surface of implants. Clinical trials are currently being conducted with three of the Company's hip systems, in which a surface coating is applied over the systems' porous coating. HAP is believed to bond directly to bone at a cellular level.\nThe Company has a 51% equity interest in Polymers Reconstructive A\/S (\"Polymers\") and holds exclusive worldwide distribution rights, with the exception of Scandinavia, for the Vacuum Pac Cement System. The patented Vacuum Pac Cement System is a proprietary method of mixing bone cement within and delivering it from a single self-contained unit. At the present time, Polymers is considering several organizational and development changes with clinical trials and test marketing to begin in certain international markets sometime in calendar year 1996.\nOn May 30, 1995, the Company and Hercules Incorporated (\"Hercules\") agreed to terminate the BHC Laboratories, Inc. joint venture and enter into a supply agreement whereby Hercules will supply consolidated laminated composite materials to the Company for orthopedic applications.\nThe Company has a minority equity interest in Catheter Research, Inc. (\"CRI\"), the developer of the CRI Vessel Occlusion System. The Company's Vascu-Med subsidiary has obtained exclusive distribution rights to the CRI Vessel Occlusion System in performing peripheral bypass grafting. CRI has received approval from the FDA to market the Vessel Occlusion System, and Vascu-Med has conducted market evaluations to determine market acceptance and distribution strategies of the product. While the product has functioned well clinically, the market's response to this new technology has been disappointing. It is not clear whether a large enough market can be developed to create a meaningful distribution effort in the future for the product. Biomet continues its financial support of CRI as it explores other applications for its guidable catheter technology.\nGOVERNMENT REGULATION\nThe developing, testing, marketing and manufacturing of medical devices - - such as arthroscopy products and reconstructive, electrical stimulation and internal fixation devices - are regulated under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act (the \"1976 Amendments\") and additional regulations promulgated by the FDA. In general, these statutes and regulations require that manufacturers adhere to certain standards designed to ensure the safety and effectiveness of medical devices.\nUnder the 1976 Amendments, each medical device manufacturer must be a \"registered device manufacturer\" and must comply with regulations applicable generally to labeling, quality assurance, manufacturing practices and clinical investigations involving humans. The FDA is authorized to obtain and inspect devices, their labeling and advertising, and the facilities in which they are manufactured in order to assure that a device is not improperly manufactured or labeled. Biomet, EBI, Lorenz Surgical, Arthrotek, Kirschner, AOA, Biomet Ltd. and Vascu-Med are registered with the FDA.\nIn addition, the sale and marketing of specific medical devices are regulated by the FDA under the 1976 Amendments, which classify medical devices based upon the degree of regulation deemed appropriate and necessary. A device is classified as a Class I, II or III device based on recommendations of advisory panels appointed by the FDA. Class I devices are subject only to general controls. Class II devices, in addition to general controls, are subject to additional controls. Class III devices, including most devices used or implanted in the body, require FDA pre-market approval before they may be distributed other than in clinical trials.\nThe Company's reconstructive and trauma products are regulated as Class II or Class III medical devices. The Company's electrical stimulation products are regulated as Class III medical devices. The procedure for obtaining approval to commercially market a device involves the submission of a pre-market notification under Section 510(k) of the 1976 Amendments. If the FDA determines that the device is substantially equivalent to a pre-enactment device or to a device subsequently classified in Class I or Class II, it will grant clearance to commercially market the device. If the FDA determines the device is not substantially equivalent to a pre-enactment device, it is automatically placed into Class III, and will either require reclassification or the submission of valid scientific evidence to prove the device is safe and effective for human use. For Class III devices, in order to conduct clinical trials the manufacturer must submit to the FDA an application for an Investigational Device Exemption (\"IDE\"). An approved IDE exempts the manufacturer from certain otherwise applicable FDA regulations and grants approval for a clinical investigation, or human study, to generate clinical data to prove safety and efficacy. In addition, the possibility exists that certain devices marketed prior to 1976, or devices substantially equivalent thereto, may be placed into Class III by the FDA. In this event, the manufacturer will be required to submit proof of safety and efficacy for these devices within 30 months of the Class III determination.\nWhen a manufacturer believes that sufficient clinical data has been generated to prove the safety and efficacy of the device, it may submit a pre-market approval application (\"PMA\") to the FDA. The FDA reviews the PMA and determines whether it is in submittable form and all key elements have been included. Following acceptance of the PMA, the FDA continues its review process which includes submission of the PMA to a panel of experts appointed by the FDA to review the PMA and to recommend appropriate action. The panel then recommends that the PMA be approved, not approved or approved subject to conditions. The FDA may act according to the panel's recommendations, or it may overrule the panel. In approving a PMA, the FDA may require some form of post-market surveillance whereby the manufacturer follows certain patient groups for two or more years, making periodic reports to the FDA.\nThe Safe Medical Device Act of 1990 (the \"Act\") affects medical device manufacturers in several areas, including post-market surveillance and device tracking procedures. The Act is the first major change to the Federal Food, Drug and Cosmetic Act since the 1976 Amendments. The Act gives the FDA expanded emergency recall authority, requires that a summary be made available of the safety and effectiveness in the 510(k) process and adds design validation as a requirement of Good Manufacturing Practices. The Act also grants the FDA the authority to require manufacturers to conduct post-market surveillance on most permanent implants and devices that potentially present a serious risk to human health, and further grants the FDA the authority to require manufacturers of certain devices to adopt device tracking methods to enable patients to receive required notices pertaining to the devices they receive. The Act increases the importance of tracking products and will most likely add additional administrative requirements pertaining to the sale of many of the Company's implants. Although the precise impact on the Company is currently unknown because the FDA has not yet promulgated all of the regulations needed to fully implement the Act, management does not believe the Act will have a material adverse effect on the Company or its operations.\nThe medical device industry extensively utilizes the pre-market notification procedures under Section 510(k) of the 1976 Amendments in bringing new products to the market. The Company currently has approximately nine Section 510(k) notifications pending with the FDA and is experiencing delays in the clearance of new products by the FDA. While these delays have improved recently, they are expected to continue through fiscal year 1996. Although the delays experienced to date have not had a material adverse impact on the operations of the Company, management is unable to assess the impact of such delays on the future operations of the Company.\nThe Company is currently positioning itself for the changing regulatory environment internationally. \"ISO 9000\" is an internationally recognized set of guidelines that are aimed at ensuring the manufacture of quality products. A company that passes an ISO audit becomes internationally recognized as being well run and functioning under a quality system. Seventeen countries have adopted ISO 9000 for medical products. ISO 9000 registered companies are able to sell their products in these countries without the added burden of individual country regulations. Although not required until 1998, the Company has taken the first steps in obtaining this registration. The Company's United Kingdom and Spain facilities have passed this audit and are registered. EBI has established themselves in the international market through product registration. The Company's other facilities are preparing for their registration audits in fiscal year 1996.\nSALES AND MARKETING\nBiomet Products are distributed in the United States through approximately 322 independent commission sales representatives (\"distributors\") and sales associates engaged principally in the business of supplying orthopedic products to hospitals in their geographic areas. Some of these distributors have formal contractual arrangements with Biomet which limit Biomet's right to terminate the distributor and provide certain long-term benefits to the distributor upon termination.\nKirschner's products are distributed in the United States through its AOA and Orthopedics Divisions. AOA and Orthopedics are separate and distinct sales and marketing organizations. AOA markets and distributes Kirschner's soft goods through a direct sales force of approximately 46 persons. Orthopedics markets and distributes Kirschner's orthopedic reconstructive implant devices through an independent agency system. The agency system consists of approximately 73 manufacturer's representatives who collectively employ approximately 181 sales representatives.\nEBI's products are distributed in the United States through EBI's wholly-owned subsidiary, EBI Medical Systems, Inc. (\"EBIMS\"), a Delaware corporation with offices in Parsippany, New Jersey. EBIMS maintains a 140 person direct sales force which operates in assigned territories throughout the United States and through a growing international distribution network in Central and South America, Canada, Asia and Europe.\nLorenz Surgical products are distributed in the United States through its direct sales force of approximately 40 sales consultants operating in assigned territories throughout the United States and through a growing international distribution network in Central and South America, Canada, Australia, Asia and Europe.\nElective surgery-related products appear to be influenced to some degree by seasonal factors, as the number of elective procedures decline during the summer months and the holiday seasons.\nThe Company's customers are the hospitals, surgeons and other physicians who employ its products in the course of their practices. The business of the Company is dependent upon the relationships maintained by its distributors and salespersons with these customers as well as the Company's ability to design and manufacture products which will meet the physicians' technical requirements at a competitive price.\nBiomet Products are marketed internationally primarily through direct factory sales representatives in the United Kingdom, Italy and Germany and through both independent and direct factory sales representatives and specialty medical product\ndealers in other international markets. EBI products are sold internationally by EBI's wholly-owned subsidiary, EBI Medical Systems Ltd., (\"EBIMSL\") a United Kingdom corporation. EBIMSL utilizes the direct sales force of Biomet Ltd., a United Kingdom corporation and wholly owned subsidiary of the Company. Kirschner products are sold internationally through independent sales representatives. The Company's products are distributed in approximately 100 countries worldwide.\nFor the fiscal years ended May 31, 1995, 1994 and 1993, the Company's foreign sales were $108,461,000, $85,079,000 and $78,274,000 respectively, or 24%, 23% and 23% of net sales, respectively. Additional data concerning operating income and identifiable assets by geographic areas are set forth in Note I of the Notes to Consolidated Financial Statements included in Item 8 of this Report.\nThe Company consigns inventory to its United States distributors and direct salespersons for their use in marketing its products and in filling customer orders. The Company also consigns inventory to hospitals in the United Kingdom, Italy and Germany. As of May 31, 1995, inventory of approximately $43,692,000 was consigned to these distributors, salespersons and hospitals.\nUnder Title VI of the Social Security Amendments of 1983 (the \"1983 Amendments\"), hospitals receive a predetermined amount of Medicare reimbursement for treating a particular patient based upon the patient's type of illness identified with reference to the patient's diagnosis under one or more of several hundred diagnosis-related groups (\"DRG\"). Other factors which affect a specific hospital's reimbursement rate include the size of the hospital, its teaching status and its geographic location.\nThe Prospective Payment Assessment Commission acts for Congress in evaluating, redefining and adjusting DRGs to encompass technology changes and efficiencies experienced by hospitals. Biomet Products are primarily covered by DRG 209 (Major Joint and Limb Reattachment Procedures) and DRG 210 (Hip and Femur Procedures).\nThe 1983 Amendments have not adversely affected the Company's reconstructive device or electrical stimulation business. However, the Company is experiencing pricing pressure in orthopedic support devices and operating room supplies and in some generic internal fixation device products. The DRG-based prospective payment system may increase the future importance of price as a competitive factor within the orthopedic products and implantable bone growth stimulation markets. Other effects of the prospective payment system on the industry and on the Company cannot be estimated at the present time.\nDuring fiscal year 1994, the Company initiated \"value added\" services and programs collectively referred to as Health Care Initiatives (formerly the Large Account Management Program). A group of individuals from the Warsaw, Indiana office work directly with the sales force, orthopedic surgeons, clinics and hospital administrators to address various concerns, as they arise, in the providing of health care.\nCOMPETITION\nThe business of the Company is highly competitive. Approximately seven other manufacturers offer orthopedic implant products which compete with the Biomet Products. Major companies in this industry include Zimmer, Inc., a subsidiary of Bristol-Myers Squibb Company; Howmedica, Inc., a subsidiary of Pfizer, Inc.; DePuy, a subsidiary of Boehringer-Mannheim Corporation; Richards Manufacturing Co., Inc., a subsidiary of Smith & Nephew Ltd.; Osteonics, Inc., a subsidiary of Stryker Corporation; Johnson & Johnson Orthopaedics, Inc., a subsidiary of Johnson & Johnson; and Intermedics Orthopedics, Inc., a division of Sulzermedica. Management believes these seven companies together with Biomet have the predominant share of the orthopedic implant market. Competition within the orthopedic implant industry is primarily on the basis of service and product design, although price competition has become increasingly important in recent years as the orthopedic industry becomes more mature and as health care providers become more concerned with health care costs. At the present time, price is a factor in the sale of generic internal fixation devices, orthopedic support devices and operating room supplies. In addition, as health care providers become more cost-conscious, they have increasingly limited the use of higher-cost reconstructive devices to younger, more active patients. Biomet's prices are at approximately the same or slightly lower levels as those of its major competitors. Biomet believes its future success will depend upon its service and responsiveness to distributors and orthopedic specialists, and upon its ability to design and market innovative products which meet the needs of the marketplace. As discussed above, the Company has initiated Health Care Initiatives to enhance the Company's offerings of products, services and programs.\nIn the past, new technologies and product concepts in the industry (principally in reconstructive products) have been introduced and applied at extremely rapid rates. New developments in implant systems are frequently introduced into the market before earlier concepts can be fully absorbed. It is management's opinion that this evolution in advanced technology products will continue for the foreseeable future.\nEBI's electrical stimulation products compete with conventional surgical procedures and non-invasive electrical stimulation devices manufactured by others. EBI has the predominant share of the bone growth stimulation market. Other\ncompanies offering products in the electrical stimulation market include American Medical Electronics, Inc.; Biolectron, Inc.; OrthoLogic Corp.; and Exogen. Competition in the electrical stimulation market is on the basis of product design, service and success rates of various treatment alternatives. EBI's non-invasive stimulators offer advantages over conventional surgery or invasive products in that their use eliminates hospital, surgeon and operating room costs, and these products can be used in the presence of infection without creating a risk of additional infection. EBI's invasive stimulators offer the advantage of conformance to surgical practice and do not require patient compliance. EBI's external fixation devices will compete with other external fixation devices primarily on the basis of ease of application and clinical results.\nArthrotek products compete in the areas of power instruments, visualization products, accessories and manual instruments. Competitors include Linvatec Corp., a subsidiary of Bristol-Myers Squibb Company; Stryker Corporation; Dyonics, Inc., a subsidiary of Smith & Nephew Ltd.; Baxter Health Care Corporation; Acufex Microsurgical, Inc.; Olympus; Richard Wolf; and Karl Storz, a business group of American Cyanamid Company.\nThe Company's trauma and fixation product lines compete with those of ACE Orthopedics, a division of DePuy; Zimmer, Inc., a subsidiary of Bristol-Myers Squibb Company; Richards Manufacturing Co., Inc., a subsidiary of Smith & Nephew Ltd.; and Synthes USA.\nLorenz Surgical primarily competes in the surgical instrumentation and oral-maxillofacial markets. Its competitors include Synthes USA; Howmedica, Inc., a subsidiary of Pfizer, Inc.; Leibinger LP; ACE Surgical Supply Company, Inc.; and Karl Storz.\nRAW MATERIALS AND SUPPLIES\nThe raw materials used in the manufacture of the Biomet Products are principally nonferrous metallic alloys, stainless steel, polyethylene powder and fabrics. With the exception of cobalt alloy, none of Biomet's raw material requirements are limited by critical supply or single origins to any material extent. Biomet purchases its cobalt alloy from two outside suppliers and is aware of at least three additional suppliers of cobalt alloy. EBI purchases all components of its electrical stimulators from approximately 250 outside suppliers, approximately 15 of whom are the single source of supply for their particular product. In most cases, EBI believes that all components are replaceable with similar components. In the event of a shortage, there are alternative sources of supply available for all components, but some time would likely elapse before EBI's orders could be filled. The results of the Company's operations are not materially dependent on raw material costs.\nEMPLOYEES\nAs of May 31, 1995, the Company's domestic operations (including Puerto Rico) employed 1,882 persons, of whom 1,071 were engaged in production and 811 in sales, marketing, administrative and clerical efforts. The Company's European subsidiaries employed 687 persons, of whom 476 were engaged in production and 211 in sales, marketing, administrative and clerical efforts. None of the Company's principal domestic manufacturing employees are represented by a labor union; the production employees at its Bridgend, South Wales, facility are organized. Employees working at the Berlin, Germany facility are represented by a statutory Workers' Council which negotiates labor hours and termination rights. The Workers' Council does not represent such employees with regard to collective bargaining of wages or benefits. The Company believes that its relationship with all of its employees is satisfactory. The establishment of Biomet's domestic operations in north central Indiana, near other members of the orthopedic industry, provides excellent access to the highly skilled machine operators required for the manufacture of Biomet Products. The Company's European locations at Bridgend, South Wales; Swindon, England; Valencia, Spain; and Berlin and Ansbach, Germany, also provide good sources for skilled manufacturing labor. EBI's Puerto Rican operations principally involve the assembly of purchased components into finished products using skilled labor.\nPATENTS AND TRADEMARKS\nAs a result of the rapid rate of development of reconstructive products, patents have not historically been a major factor in the orthopedic industry. However, patents on specific designs and processes can provide a competitive advantage. Biomet has applied for and been issued patents on certain aspects of several of its major product offerings and has patent applications pending on several products. Management believes that patent protection of products will become more significant as the industry matures.\nEBI holds a United States Patent which covers the manufacture, use and sale of its primary product, the EBI Bone Healing System, which expires in November 1995. The Company does not anticipate any adverse material financial impact as a result of the expiration of this patent. In connection with the 1988 settlement of certain litigation against American Medical Electronics, Inc. (\"AME\"), EBI has granted to AME a license under this patent to make, use and sell certain products.\nBIOMET, EBI, W. LORENZ, KIRSCHNER, POLYMEDICS, AOA, IQL and ARTHROTEK are the Company's principal registered trademarks in the United States, and federal registration has been obtained or is in process with respect to various other trademarks associated with the Company's products. The Company holds or has applied for registrations of various trademarks in its principal foreign markets.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company has the following properties:\nITEM 2. PROPERTIES (continued)\nThe Company believes that its facilities are adequate, well maintained and suitable for the development, manufacture and marketing of all its products.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn February 9, 1990, Pedro A. Ramos, M.D. filed a complaint in the United States District Court for the Southern District of Florida naming the Company as a defendant. The plaintiff alleges the Company has infringed his patent. In April 1993, the matter was tried before Judge Aronovitz of the Southern District of Florida. Judge Aronovitz issued a memorandum opinion in August 1993, finding that U.S. Patent No. 4,383,090 was willfully infringed. On September 10, 1993 the trial court entered a final judgment and permanent injunction in favor of Dr. Ramos. An amended final judgment was entered on November 30, 1993 awarding Dr. Ramos a permanent injunction and $6,008,000. The Company, after consultation with legal counsel, believes the Court erred in its finding and that the judge's opinion is contrary to the facts and applicable law. The Company filed Notices of Appeal to the final judgment and amended final judgment on September 20, 1993 and December 13, 1993, respectively. The Company filed its appeal brief with the Court of Appeals for the Federal Circuit on March 3, 1994 and Dr. Ramos filed his Response Brief on April 12, 1994. Oral arguments were heard on September 8, 1994. The Company has negotiated a license under the Ramos patent to continue selling its old bipolar design while it introduces a new bipolar product. Management continues to conduct a vigorous defense of this matter. Although the ultimate outcome of this matter cannot be determined, management of the Company, after consultation with legal counsel, believes the judgment against the Company will be reversed on appeal. Accordingly, no provision for any liability (except for accrued legal costs) that might result from this matter has been made in the consolidated financial statements.\nThere are various other claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against the Company incident to the operation of its business. The results of litigation proceedings cannot be predicted with certainty, however, management believes the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot Applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe name, age, business background, positions held with the Company and tenure as an executive officer of each of the Company's executive officers are set forth below. No family relationship exists among any of the executive officers. Except as otherwise stated, each executive officer has held the position indicated during the last five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe following table shows the quarterly range of high and low sales prices for the Company's Common Shares as reported by the NASDAQ-NMS for each of the three most recent fiscal years ended May 31. They reflect inter-dealer prices, without retail mark-up, mark-down or commission. The approximate number of recordholders of outstanding Common Shares as of May 31, 1995 was 13,341.\nThe Company has not paid any dividend within the last three years and the Company does not anticipate that any dividends will be paid in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nIncome Statement Data (in thousands, except earnings per share)\nBALANCE SHEET DATA (in thousands)\n- - The selected consolidated financial information includes the operations of Kirschner Medical Corporation from November 4, 1994, Lorenz Surgical from June 1, 1992 and Biomet Deutschland GmbH from March 21, 1991. - - Earnings per share data have been adjusted to give effect to all stock splits. - - The Company paid no cash dividends during any of the periods presented.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following table shows the percentage relationship to net sales of items derived from the Consolidated Statements of Income and the percentage change from year to year.\n1995 COMPARED TO 1994 The Company achieved record net sales, net income and earnings per share in fiscal year 1995. Net sales increased 21% to $452,272,000 as compared to $373,295,000 in fiscal year 1994. The Company's U.S.-based revenue increased 19% to $343,811,000 in 1995, while foreign sales increased 27% to $108,461,000. Biomet's worldwide reconstructive device sales during fiscal 1995 increased by 25% to $272,643,000 compared to last fiscal year. This increase in revenue is primarily a result of Biomet's continued penetration into the reconstructive device market but also reflects the acquisition of Kirschner. EBI's product sales increased 11% over last year to $98,490,000 in fiscal 1995. This increase was largely attributable to the resurgence in the bone healing market and increased sales in external fixation devices. The Company's \"Other Products\" revenues totaled $81,139,000, representing a 22% increase over fiscal 1994, primarily as a result of the inclusion of seven months of revenues of AOA, a division of Kirschner.\nCost of sales increased slightly as a percentage of net sales to 31.4% for 1995 compared to 30.8% for 1994 due to the acquisition of Kirschner. Kirschner's cost of sales historically has been higher than Biomet's due to its relatively higher levels of outsourcing for product manufacturing. The Company's selling, general and administrative expenses increased to 37.5% of net sales. The major cause of this increase is the inclusion of Kirschner's relatively higher selling, general and administrative costs, and expenses incurred in the reconfiguration of the combined sales forces of the two companies. Research and development expense increased to $21,770,000, but decreased as a percentage of net sales to 4.8%, principally as the result of Kirschner's lower expenditures on research and development. The Company remains committed to maintaining its competitive position in the orthopedic market through technological advancements and to capitalizing on future opportunities available within the orthopedic market. The increase in other income is a result of income earned on higher investment balances throughout most of fiscal 1995, although at the end of fiscal 1995 investment balances were lower than at the beginning of the year. The effective income tax rate increased to 36.6% in fiscal 1995 from 34.8% in fiscal 1994. This increase is due to the changes in the Puerto Rico local tax structure and the reduction of U.S. tax benefits from operating in Puerto Rico. The Company's effective tax rate will continue to increase in future years as the full impact of these tax changes takes effect. These factors resulted in a 13% increase in net income and earnings per share for fiscal year 1995 as compared to fiscal year 1994, increasing from $69,818,000 to $79,200,000 and $.61 to $.69, respectively.\nDuring the past year, the health care climate underwent numerous changes. With the threat of health care legislation, market forces began to change the health care industry. It appears that patients postponed procedures to some degree, expecting a change in service delivery. Hospitals curtailed purchases of capital equipment due to uncertainty with respect to reimbursement. Cost containment concerns have caused health care providers to become more selective in the use of higher-cost reconstructive devices, which are increasingly limited to younger, more active patients. Additional changes are likely to occur; however, it appears that the decline in the growth rate in the U.S. orthopedic market has stabilized. With the Company's Team concept including employee, salesman and surgeon, current product selections, proven track record for innovative product introductions and financial strength, the Company is well positioned to take advantage of these changes in the orthopedic market.\nEBI's exclusive right to distribute the Orthofix Dynamic Axial External Fixation System (\"Orthofix\") in the United States, Canada and the Caribbean Island Basin expired on May 31, 1995. EBI has developed its own advanced external fixation system which will be released to the market in fiscal 1996. EBI believes that it will be able to satisfy customer demand until the launch of its advanced fixation system.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash and investments decreased $16,367,000 to $124,475,000 at May 31,1995. The decrease results from the purchase of Kirschner (as more fully disclosed in Note B of the Notes to Consolidated Financial Statements), the expansion of manufacturing capacities through facilities and equipment purchases, and the acquisition of EBI's leased office building.\nCash flows provided by operating activities were $52,596,000 in 1995 compared to $65,743,000 in 1994. The primary source of 1995 cash flows from operating activities were profits from operations and an increase in accounts payable, partially offset by increases in accounts and notes receivable and inventories. Accounts and notes receivable increased 45% from $96,800,000 last year to $140,283,000 at May 31, 1995, as a result of the Kirschner acquisition and increases in net sales for the current fiscal year. Inventories increased 53% to $140,885,000 at May 31, 1995 from $92,263,000 at May 31, 1994, reflecting the Kirschner acquisition, an increase in the number of units on consignment to support the current level of sales and the support of the recent introduction of several new products including the Mallory-Head and Impact Modular Total Hip Systems, the Maxim Total Knee System and Arthrotek's Integrated Endoscopy System (IES 1000). Of the increases in accounts and notes receivable and inventories, approximately $1,813,000 and $2,708,000, respectively, were attributable to the increase from May 31, 1994 to May 31, 1995 in the exchange rates used to convert the financial statements of the Company's foreign subsidiaries from their functional currency to the U.S. Dollar. These increases did not affect the Company's earnings during the year because foreign currency translation adjustments to balance sheet items are recognized as a component of shareholders' equity in the Company's consolidated balance sheet. The Company will continue to be exposed to the effects of foreign currency translation adjustments.\nCash flows used in investing activities were $73,755,000 in 1995 compared to $26,979,000 in 1994. The primary uses of cash flows from investing activities include purchases of investments, capital expenditures and the purchase of Kirschner. The Company increased its investments by $19,933,000 due to more attractive investment yields on longer-term investments. The Company's capital expenditures have increased as mentioned above, with the major expenditure being the acquisition of EBI's previously leased building for $9.9 million.\nCash flows used in financing activities were $14,290,000 in 1995 compared to $12,440,000 in 1994. The primary use of cash flows from financing activities was the repayment of the Kirschner debt acquired in the acquisition and the common share repurchase program. On September 16, 1994 the Company's Board of Directors authorized the investment of up to $25 million in the outstanding common shares of the Company in open market or privately negotiated transactions through the close of business on September 22, 1995. During fiscal 1995, the Company purchased 1,120,000 of its common shares for $15,219,000, of which $10,406,000 was not paid until the settlement date in June 1995. Future purchases, if any, will be dependent upon market conditions.\nCurrently available funds, together with the anticipated cash flows generated from future operations, are believed to be adequate to cover the Company's anticipated capital needs and research and development costs during the next two fiscal years. The Company expects to spend approximately $74 million during the next two fiscal years for capital expenditures and research and development, and anticipates using a portion of its cash reserves to fund future acquisitions and other business development activities.\n1994 COMPARED TO 1993 In fiscal year 1994, net sales increased 11% to $373,295,000 as compared to $335,373,000 in 1993. The Company's U.S.-based revenue increased 12% to $288,216,000 in 1994, while foreign sales increased 9% to $85,079,000. For fiscal year 1994, Biomet's foreign sales were adversely affected by approximately $6,500,000 due to a stronger U.S. Dollar relative to the British Pound Sterling. Biomet's worldwide reconstructive device sales during fiscal 1994 were $218,145,000, representing a 15% increase compared to fiscal 1993. This increase was primarily a result of Biomet's continued penetration of the reconstructive device market led by the Maxim Total Knee System introduced in late fiscal 1993. Sales of Electro-Biology, Inc.'s products were $88,714,000 in fiscal 1994, representing an 8% increase over fiscal 1993. These increases in revenue were largely attributable to increased demand for external fixation devices. The Company's \"other products\" revenues totaled $66,436,000, representing a 3% increase over fiscal year 1993, primarily as a result of increased sales of Arthrotek's IES 1000 System and Lorenz's oral-maxillofacial implants.\nCost of sales decreased as a percentage of net sales to 30.8% for 1994 compared to 31.2% for 1993 due to the continued shift in the Company's sales mix to reconstructive devices. The Company's selling, general and administrative expenses slightly increased to 36.5% of net sales in 1994 compared to 36.4% in 1993. Research and development expense slightly increased from 5.4% of net sales in 1993 to 5.5% in 1994. The effective income tax rate increased from 32.2% in fiscal 1993 to 34.8% in fiscal 1994. This increase is due to the increase in the U.S. corporate income tax rate and changes in the Puerto Rico local tax structure resulting from the reduction of tax benefits from operating in Puerto Rico. These factors resulted in a 9% increase in net income and earnings per share in fiscal 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee Index to Consolidated Financial Statements and Schedule which appears on page 21 herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot Applicable\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information included under the caption \"Election of Directors\" in the Company's definitive Proxy Statement filed pursuant to Regulation 14A in connection with its 1995 Annual Meeting of Shareholders (the \"Proxy Statement\") is incorporated herein by reference in response to this item.\nInformation regarding executive officers of the Company is included in Part I of this Report under the caption \"Executive Officers of the Registrant\" on page 13.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information included under the captions \"Election of Directors - Compensation of Directors\" and \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference in response to this item.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information contained under the captions \"Principal Shareholders\" and \"Share Ownership of Directors and Executive Officers\" in the Proxy Statement is incorporated herein by reference in response to this item.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information contained under the caption \"Certain Transactions\" in the Proxy Statement is incorporated herein by reference in response to this item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(A) (1 AND 2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nSee Index to Consolidated Financial Statements and Schedule which appears on page 21 herein.\n(3) EXHIBITS.\nSee Index 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.\nBIOMET, INC.\nBy: \/s\/ DANE A. MILLER --------------------------- Dane A. Miller 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 17, 1995.\nBy: \/s\/ NILES L. NOBLITT --------------------------- Niles L. Noblitt, Director\nBy: \/s\/ DANE A. MILLER --------------------------- Dane A. Miller, Director (Principal Executive Officer)\nBy: \/s\/ JERRY L. FERGUSON --------------------------- Jerry L. Ferguson, Director\nBy: \/s\/ M. RAY HARROFF --------------------------- M. Ray Harroff, Director\nBy: \/s\/ KENNETH V. MILLER --------------------------- Kenneth V. Miller, Director\nBy: \/s\/ JERRY L. MILLER --------------------------- Jerry L. Miller, Director\nBy: \/s\/ L. GENE TANNER --------------------------- L. Gene Tanner, Director\nBy: \/s\/ THOMAS F. KEARNS, JR --------------------------- Thomas F. Kearns, Jr., Director\nBy: \/s\/ CHARLES E. NIEMIER --------------------------------- Charles E. Niemier, Director\nBy: \/s\/ DANIEL P. HANN --------------------------------- Daniel P. Hann, Director\nBy: \/s\/ MARILYN TUCKER QUAYLE --------------------------------- Marilyn Tucker Quayle, Director\nBy: \/s\/ RONALD R. FISHER --------------------------------- Ronald R. Fisher, Director\nBy: \/s\/ C. SCOTT HARRISON --------------------------------- C. Scott Harrison, Director\nBy: \/s\/ GREGORY D. HARTMAN --------------------------------- Gregory D. Hartman, Vice President - Finance (Principal Financial Officer)\nBy: \/s\/ JAMES W. HALLER --------------------------------- James W. Haller, Controller (Principal Accounting Officer)\nBIOMET, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nREPORT OF INDEPENDENT ACCOUNTANTS\n|Coopers | Coopers & Lybrand L.L.P. |& Lybrand | a professional services firm\nTo the Shareholders and Board of Directors of Biomet, Inc.:\nWe have audited the financial statements and the financial statement schedule of Biomet, Inc. and subsidiaries listed on Page 21 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 Biomet, Inc. and subsidiaries as of May 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 May 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referrred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material aspects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P.\nSouth Bend, Indiana June 30, 1995\nBIOMET,INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are a part of the consolidated financial statements.\nBIOMET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are a part of the consolidated financial statements.\nBIOMET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY\nThe accompanying notes are a part of the consolidated financial statements.\nBIOMET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are a part of the consolidated financial statements.\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for the years ended May 31, 1995, 1994 and 1993\nNote A: Accounting Policies.\nThe following is a summary of the accounting policies adopted by Biomet, Inc. and subsidiaries which have a significant effect on the consolidated financial statements.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Biomet, Inc. and its subsidiaries (individually and collectively, the \"Company\"). All intercompany accounts and transactions have been eliminated in the consolidated financial statements. All foreign subsidiaries are consolidated on the basis of an April 30 fiscal year. Investments in less than 20% owned affiliates are accounted for on the cost method, the carrying amount of which approximates market. Investments in more than 20% owned affiliates are accounted for on the equity method. The equity in losses of affiliates aggregated $1,815,000, $1,579,000 and $143,000 for the years ended May 31, 1995, 1994 and 1993, respectively, and consist primarily of research and development expense. Accordingly, these amounts are included in research and development expense in the consolidated statements of income.\nTranslation of Foreign Currency - Assets and liabilities of foreign subsidiaries are translated at rates of exchange in effect at the close of their fiscal year. Revenues and expenses are translated at the weighted average exchange rates during the year. Translation gains and losses are accumulated as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in other income, net.\nCash and Cash Equivalents - The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Investments which do not meet the definition of cash equivalents are classified as marketable securities.\nInventories - Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method.\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost less accumulated depreciation. Depreciation is computed based on the estimated useful lives using the straight-line method. Gains or losses on the disposition of property, plant and equipment are included in income. Maintenance and repairs are expensed as incurred.\nIntangible Assets - Intangible assets consist primarily of patents, trademarks, product technology and acquired license agreements and are carried at cost less accumulated amortization. Amortization of intangibles is computed based on the straight-line method over periods ranging from eight to twelve years.\nExcess Acquisition Costs Over Fair Value of Acquired Net Assets - Excess acquisition costs over fair value of acquired net assets (goodwill) are amortized using the straight-line method over periods ranging from eight to fifteen years.\nShort-Term Borrowings - Certain of the Company's foreign subsidiaries had short-term borrowings of $3,518,000 and $1,606,000 as of May 31, 1995 and 1994, respectively.\nIncome Taxes - As discussed in Note H, effective June 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\") which requires recognition of deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities, measured using the enacted tax rates in effect for the years in which the differences are expected to reverse. Prior to the adoption of SFAS No. 109, deferred income taxes were determined using the deferred method.\nRevenue Recognition, Concentrations of Credit Risk and Allowance for Doubtful Receivables - Revenue is recognized when the product is shipped to the health care provider. The Company provides credit, in the normal course of business, to hospitals, private and governmental institutions and health-care agencies, insurance providers and physicians. The Company maintains an allowance for doubtful receivables and charges actual losses to the allowance when incurred. The Company invests the majority of its excess cash in certificates of deposit with financial institutions, money market securities, short-term municipal securities and common stocks. The Company does not believe it is exposed to any significant credit risk on its cash and cash equivalents and marketable securities. At May 31, 1995 and 1994, cash and cash equivalents and marketable securities included $48 million and $51 million, respectively, of cash deposits and certificates of deposit with financial institutions in Puerto Rico. Also, at May 31, 1995 and 1994, marketable securities included $24 million and $21 million, respectively, of municipal bonds issued by state and local subdivisions in Puerto Rico.\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended May 31, 1995, 1994 and 1993\nNote B: Acquisitions.\nOn August 12, 1994, the Company, through a wholly-owned subsidiary, purchased 685,222 common shares of Kirschner Medical Corporation (\"Kirschner\") and a promissory note in the amount of 329.5 million Spanish pesetas (approximately $2.5 million) issued to Kirschner's Spanish subsidiary from Figgie International Inc. for $8,700,000. On November 4, 1994, the Company, through the same wholly-owned subsidiary, acquired all of the remaining issued and outstanding common shares of Kirschner, in exchange for 1,384,309 of the Company's common shares and $16,245,981 cash. Kirschner, headquartered in Hunt Valley, Maryland, designs, develops, manufactures and markets orthopedic devices and musculoskeletal orthopedic support products. The $13.3 million excess of acquisition cost over the fair value of acquired net assets is being amortized on a straight-line basis over 15 years. The acquisition has been accounted for using the purchase method of accounting, with the operating results of Kirschner included in the Company's consolidated financial statements from the date of acquisition.\nThe following unaudited pro forma financial information reflects the acquisition as if it had occurred at the beginning of each year. The unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated as of the above dates, nor are they necessarily indicative of future operating results.\nDuring the year ended May 31, 1994, the Company increased its ownership in Polymers Reconstructive A\/S (\"Polymers\"), a Dutch company involved in the manufacturing and distribution of a proprietary bone cement system, to 51% in several transactions. Upon exceeding 20% ownership, the Company began accounting for this investment under the equity method, and upon achieving majority ownership, the Company began consolidating Polymers. Goodwill recognized in the consolidation of Polymers aggregates $3.6 million and is being amortized over a ten-year period. Also during the year ended May 31, 1994, the Company began accounting for its investment in Catheter Research, Inc. (\"CRI\"), a company involved in various research and development activities, using the equity method to reflect its increased ownership. The retroactive application of the equity method of accounting for Polymers and CRI resulted in a decrease in the Company's investment in Polymers and CRI of $492,000 and $814,000, respectively, which was charged against retained earnings (the prior years' consolidated financial statements were not restated to reflect the retroactive application of the equity method, since the amounts were immaterial to prior years' consolidated statements).\nNote C: Marketable Securities.\nAs of May 31, 1995, the Company's marketable securities were classified as follows:\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) for the years ended May 31, 1995, 1994 and 1993\nNote C: Marketable Securities, Concluded.\nEffective June 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). SFAS No. 115 requires certain securities to be categorized as either trading, available-for-sale or held-to-maturity. Trading securities are carried at fair value with unrealized gains and losses included in income. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders' equity. Held-to-maturity securities are carried at amortized cost. The impact of adopting SFAS No. 115 was to increase shareholders' equity by $2,800,000 at May 31, 1995. The Company has no trading securities. Proceeds from sales of available-for-sale securities were immaterial. The cost of marketable securities sold is determined by the specific identification method. Gross realized gains and losses on these sales were immaterial. Dividend and interest income are accrued as earned. At May 31, 1995, the Company's marketable securities include $33,100,000 of certificates of deposit, $14,609,000 of debt securities, $4,222,000 of equity securities and $4,422,000 of mortgage-backed obligations all maturing within one year and $14,837,000 of debt securities, $3,352,000 of equity securities and $15,842,000 of mortgage-backed obligations all maturing past one year.\nAt May 31, 1994, marketable securities consisted of $22,600,000 of certificates of deposit, $41,283,000 of debt securities and $6,568,000 of equity securities, and the aggregate market value of debt and equity securities exceeded the aggregate cost by $2,687,000.\nInvestment income included in other income, net consists of the following:\nNote D: Inventories.\nInventories at May 31, 1995 and 1994 consisted of the following:\nNote E: Team Member Benefit Plans\nThe Company has an Employee Stock Bonus Plan for eligible Team Members of the Company and certain subsidiaries. The amounts expensed under this plan for the years ended May 31, 1995, 1994 and 1993 were $1,573,000, $1,546,000 and $1,322,000, respectively.\nThe Company also has a defined contribution profit sharing plan which covers substantially all of the Team Members within the continental U.S. and allows participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. The Company may match up to 50% of the Team Member's contribution up to a maximum of 5% of the Team Member's compensation. The amounts expensed under this profit sharing plan for the years ended May 31, 1995, 1994 and 1993 were $1,148,000, $1,075,000 and $922,000, respectively.\nBiomet Ltd., a subsidiary based in the United Kingdom, has a defined benefit pension plan for all of its salaried Team Members. Pension expense and related pension amounts are immaterial to the consolidated financial statements.\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended May 31, 1995, 1994 and 1993\nNote F: Stock Option Plans.\nThe Company has three stock option plans: the 1984 Employee Stock Option Plan, as amended, the 1992 Employee and Non-Employee Director Stock Option Plan (the \"Employee Plans\") and the 1992 Distributor Stock Option Plan (the \"Distributor Plan\").\nUnder the Employee Plans, options may be granted to key employees, at the discretion of the stock option committee, and generally become exercisable in annual increments beginning one year after the date of grant. In the case of options granted to an employee of the Company who is a 10% or more shareholder, the option price is an amount per share of not less than 110% of the fair market value per share on the date of granting the option, as determined by the stock option committee. No options have been granted to employees who are 10% or more shareholders. The option price for options granted to all other employees is an amount per share of not less than the fair market value per share on the date of granting the option. The term of each option granted expires within the period prescribed by the stock option committee, but shall not be more than five years from the date the option is granted if the optionee is a 10% or more shareholder, and not more than ten years for all other optionees.\nAn aggregate of 9,680,000 common shares had been reserved for granting under the 1984 Employee Stock Option Plan. This plan expired on September 15, 1994 which has no effect on unexpired shares. An aggregate of 3,000,000 common shares have been reserved for granting under the 1992 Employee and Non-Employee Director Stock Option Plan. The 1992 Plan does not affect options granted under the 1984 Plan.\nThe Distributor Plan provides for granting of options to purchase common shares of the Company to persons who serve as distributors of the Company's products. An aggregate of 4,000,000 common shares have been reserved for granting under this plan. Under the Distributor Plan, options may be granted from time to time at the discretion of the stock option committee, and become exercisable in full at any time or on a cumulative basis from time to time, in accordance with the stock option agreement prescribed by the stock option committee. The option price is determined by the stock option committee, but shall not be less than the fair market value of such shares on the date of grant, as determined by the stock option committee. All rights under the option terminate upon the termination of an optionee's distributorship with the Company unless such termination results from retirement, disability or death. No option may have a term longer than ten years from the date the option is granted.\nThe transactions for common shares under options for the years ended May 31, 1995 and 1994 were as follows:\nOptions outstanding at May 31, 1995 which are currently exercisable represent 837,000 shares. The remaining options become exercisable in fiscal years 1996 (580,000 shares); 1997 (593,000 shares); 1998 (547,000 shares); 1999 (457,000 shares); 2000 (157,000 shares) and 2001 through 2002 (55,644 shares). As of May 31, 1995, 5,409,361 shares were reserved for future options, compared with 6,956,092 shares at May 31, 1994. No adjustment was made to the weighted average number of shares outstanding to reflect the exercise of outstanding stock options since the effect would be immaterial.\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended May 31, 1995, 1994 and 1993\nNote G: Shareholders' Equity.\nIn September 1994, the Board of Directors authorized the Company to repurchase up to $25 million of the issued and outstanding common shares of the Company in open market purchases or privately negotiated transactions through the close of business on September 22, 1995. During the year ended May 31, 1995, the Company purchased 1,120,000 shares of its common stock at an aggregate cost of $15,219,000. At May 31, 1995, the Company has recorded a liability of $10,406,000 for purchased common shares for which the settlement date was subsequent to May 31, 1995. During the year ended May 31, 1994, the Company purchased 1,260,000 shares of its common stock at an aggregate cost of $12,276,000.\nOn December 2, 1989, the Board of Directors of the Company approved the adoption of a Shareholder Rights Plan (the \"Plan\") under which the Company declared a dividend of one common share purchase right for each common share outstanding to shareholders of record on December 26, 1989 (the \"Right\"). Each Right entitles the shareholder to purchase from the Company one common share at a price of $37.50 per common share, subject to adjustment. The Rights will not be exercisable or separable from the common shares until ten business days after a person or group acquires 15% or more or tenders for 30% or more of the Company's outstanding common shares. The Plan also provides that if any person or group becomes an \"Acquiring Person\", each Right, other than Rights beneficially owned by the Acquiring Person (which will thereafter be void), will entitle its holder to receive upon exercise that number of common shares having a market value of two times the exercise price of the Right. In the event the Company is acquired in a merger or other business combination transaction, each Right will entitle its holder to receive upon exercise of the Right, at the Right's then current exercise price, that number of the acquiring company's common shares having a market value of two times the exercise price of the Right. The Company is entitled to redeem the Rights at a price of one cent per Right at any time prior to them becoming exercisable, and the Rights expire on December 2, 1999. The Plan was designed to protect the interests of the Company's shareholders against certain coercive tactics sometimes employed in takeovers.\nNote H: Income Taxes.\nEffective June 1, 1993, the Company adopted SFAS No. 109, (see Note A). As permitted by SFAS No. 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of the change in the method of accounting did not have a material effect on the consolidated financial statements.\nThe components of income before income taxes are as follows:\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) for the years ended May 31, 1995, 1994 and 1993\nNote H: Income Taxes, Concluded.\nA reconciliation of the statutory federal income tax rate to the Company's effective tax rate follows:\nThe components of the net deferred tax asset and liability at May 31, 1995 and 1994 are as follows:\nNo provision has been made for U.S. federal and state income taxes or foreign taxes of the undistributed earnings ($37,759,000 at May 31, 1995) of foreign subsidiaries because it is expected that such earnings will be reinvested overseas indefinitely. Determination of the amount of any unrecognized deferred income tax liability on these undistributed earnings is not practical.\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended May 31, 1995, 1994 and 1993\nNote I: Industry Segment and Geographic Information.\nThe Company operates in one dominant industry segment which includes the designing, manufacturing and marketing of reconstructive and trauma devices, electrical bone growth and neuromuscular stimulators, orthopedic support devices, operating room supplies, powered surgical instruments, general surgical instruments, arthroscopy products and oral-maxillofacial implants and instruments used primarily by orthopedic medical specialists in both surgical and non-surgical therapy.\nNet sales, operating income and identifiable assets by geographic area are presented in the following table. The Company's major identifiable assets are located in the United States (North America) and the United Kingdom, Germany, Italy and Spain (Europe).\nIntercompany transfers, primarily from North America to Europe, are made at agreed-upon prices which include a profit element. Domestic export sales, primarily to European countries, aggregated $34,112,000, $28,720,000 and $25,929,000 for the years ended May 31, 1995, 1994 and 1993, respectively.\nSelected financial data of the Company's foreign subsidiaries is as follows:\nBIOMET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended May 31, 1995, 1994 and 1993\nNote J: Commitments and Contingencies.\nMedical Insurance Plan - The Company maintains a self-insurance program for covered medical expenses for all Team Members within the continental U.S. The Company is liable for claims up to $125,000 per Team Member annually. Self-insurance costs are accrued based upon the aggregate of the liability for reported claims and a management determined estimated liability for claims incurred but not reported.\nLiability Insurance - Since 1989, the Company has self-insured against product liability claims, up to $2,000,000 per occurrence and $4,000,000 aggregate per year. Liabilities in excess of these amounts are the responsibility of the Company's insurance carrier. Self-insurance costs are accrued based on reserves set in consultation with the insurance carrier for reported claims and a management-determined estimated liability for claims incurred but not reported. Based on historical experience, management does not anticipate that incurred but unreported claims would have a material impact on the Company's consolidated financial position.\nLitigation - On February 9, 1990, Pedro A. Ramos, M.D. filed a complaint in the United States District Court for the Southern District of Florida naming the Company as a defendant. The plaintiff alleges the Company has infringed his patent. In April 1993, the matter was tried before Judge Aronovitz of the Southern District of Florida. Judge Aronovitz issued a memorandum opinion in August 1993, finding that U.S. Patent No. 4,383,090 was willfully infringed. On September 10, 1993 the trial court entered a final judgment and permanent injunction in favor of Dr. Ramos. An amended final judgment was entered on November 30, 1993 awarding Dr. Ramos a permanent injunction and $6,008,000. The Company, after consultation with legal counsel, believes the Court erred in its finding and that the judge's opinion is contrary to the facts and applicable law. The Company filed Notices of Appeal to the final judgment and amended final judgment on September 20, 1993 and December 13, 1993, respectively. The Company filed its appeal brief with the Court of Appeals for the Federal Circuit on March 3, 1994 and Dr. Ramos filed his Response Brief on April 12, 1994. Oral arguments were heard on September 8, 1994. The Company has negotiated a license under the Ramos patent to continue selling its old bipolar design while it introduces a new bipolar product. Management continues to conduct a vigorous defense of this matter. Although the ultimate outcome of this matter cannot be determined, management of the Company, after consultation with legal counsel, believes the judgment against the Company will be reversed on appeal. Accordingly, no provision for any liability (except for accrued legal costs) that might result from this matter has been made in the consolidated financial statements.\nThere are various other claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against the Company incident to the operation of its business. The results of litigation proceedings cannot be predicted with certainty, however, management believes the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position of the Company.\nBIOMET, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nfor the years ended May 31, 1995, 1994 and 1993 (in thousands)\nNotes: (A) Uncollectible accounts written off (B) Collection of previously written off accounts (C) Effect of foreign currency translation adjustment (D) Allowance of Kirschner Medical Corporation at date of acquisition.\nBIOMET, INC. FORM 10-K May 31, 1995\nINDEX TO EXHIBITS","section_15":""}
{"filename":"826931_1995.txt","cik":"826931","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business\nAMERICAN INCOME PARTNERS IV-C LIMITED PARTNERSHIP (the \"Partnership\") was organized as a limited partnership under the Massachusetts Uniform Limited Partnership Act (the \"Uniform Act\") on December 29, 1988 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 Managing General Partner (AFG Leasing IV Incorporated) and $100 from the Initial Limited Partner (AFG Assignor Corporation). The common stock of the Managing General Partner is owned by AF\/AIP Programs Limited Partnership, of which American Finance Group (\"AFG\"), a Massachusetts partnership, and a wholly-owned affiliate, are the 99% limited partners and AFG Programs, Inc., a Massachusetts corporation wholly-owned by Geoffrey A. MacDonald, is the 1% general partner. On March 30, 1989, the Partnership issued 1,270,622 units, representing assignments of limited partnership interests (the \"Units\") to 2,157 investors. Unitholders and Limited Partners (other than the Initial Limited Partner) are collectively referred to as Recognized Owners. Subsequent to the Partnership's Closing, the Partnership had three General Partners: AFG Leasing IV Incorporated, a Massachusetts corporation, Daniel J. Roggemann, and Geoffrey A. MacDonald (collectively, the \"General Partners\"). Mr. Roggemann subsequently elected to withdraw as an Individual General Partner. The General Partners, each of whom are affiliated with AFG, are not required to make any other capital contributions except as may be required under the Uniform Act and Section 6.1(b) of the Amended and Restated Agreement and Certificate of Limited Partnership (the \"Restated Agreement, as amended\").\n(b) Financial Information About Industry Segments\nThe Partnership is 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 are to acquire and lease equipment which will:\n1. Generate quarterly cash distributions;\n2. Preserve and protect invested capital; and\n3. Maintain substantial residual value for ultimate sale.\nThe Partnership has the additional objective of providing certain federal income tax benefits.\nThe Closing Date of the Offering of Units of the Partnership was March 30, 1989. The initial purchase of equipment and the associated lease commitments occurred on March 30, 1989. The acquisition of the equipment and its associated leases is described in detail in Note 3 to the financial statements included in Item 14, herein. The Partnership is expected to terminate no later than December 31, 2000.\nThe Partnership has no employees; however, it entered into a Management Agreement with AF\/AIP Programs Limited Partnership. At the same time, AF\/AIP Programs Limited Partnership entered into an identical Management Agreement with AFG (the \"Manager\") (collectively, the \"Management Agreement\"). The Manager's role, among other things, is 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 is compensated for such services as described in 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 is, and will continue to be, subject to various risks, including physical deterioration, technological obsolescence and defaults by lessees. A principal business risk of owning and leasing equipment is the possibility that aggregate lease revenues 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 is largely dependent upon the ability of the Managing 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.\nIn addition, the leasing industry is very competitive. Although all funds available for acquisitions have been invested in equipment, subject to noncancellable lease agreements, the Partnership will encounter considerable competition when equipment is re-leased or sold at the expiration of primary lease terms. The Partnership will compete with lease programs offered directly by manufacturers and other equipment leasing companies, including limited partnerships and trusts organized and managed similarly to the Partnership and including other AFG sponsored partnerships and trusts, which may seek to re-lease or sell equipment within their own portfolios to the same customers as the Partnership. Many competitors have greater financial resources and more experience than the Partnership, the General Partners and the Manager.\nGenerally, the Partnership is prohibited from reinvesting the proceeds generated by refinancing or selling equipment. Accordingly, it is anticipated that the Partnership will begin to liquidate its portfolio of equipment at the expiration of the initial and renewal lease terms and to distribute the net liquidation proceeds. As an alternative to sale, the Partnership may enter re-lease agreements when considered advantageous by the Managing General Partner and the Manager. In accordance with the Partnership's stated investment objectives and policies, the Managing General Partner is also considering winding-up the Partnership's operations, including the liquidation of its entire portfolio.\nRevenue 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.\nDefault by a lessee under a lease may cause equipment to be returned to the Partnership at a time when the Managing General Partner or the Manager is unable to arrange for the re-lease or sale of such equipment. This could result in the loss of a material portion of anticipated revenue and significantly weaken the Partnership's ability to repay related debt.\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.\nIncorporated herein by reference to Note 3 to the financial statements in the 1995 Annual Report.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIncorporated herein by reference to Note 7 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 1,958 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 are determined and distributed to the Partners quarterly. Each quarter's distribution may vary in amount. Distributions may be made to the Managing General Partner prior to the end of the fiscal quarter; however, the amount of such distribution reflects only amounts to which the Managing General Partner is entitled at the time such distribution is made. Currently, there are no restrictions that materially limit the Partnership's ability to distribute Distributable Cash From Operations and Distributable Cash From Sales or Refinancings or that the Partnership believes are likely to materially limit the future distribution of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings. The Partnership expects to continue to distribute all Distributable Cash From Operations and Distributable Cash From Sales or Refinancings on a quarterly basis.\nDistributions payable were $802,160 at December 31, 1995 and 1994.\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 Managing General Partner, and increased by any portion of such reserves deemed by the Managing 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 Managing 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 Managing 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 Managing General Partner, or (b) the proceeds from the sale of an interest in equipment pursuant to any agreement governing a joint venture which the Managing 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 Partners, 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 Managing General Partner and (ii) increased by any portion of such reserves deemed by the Managing 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 Recognized Owners and 1% to the General Partners until Payout and 85% to the Recognized Owners and 15% to the General Partners after Payout.\n\"Payout\" is defined as the first time when the aggregate amount of all distributions to the Recognized Owners of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings equals the aggregate amount of the Recognized Owners' original capital contributions plus a cumulative annual return of 10.75% (compounded quarterly 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 Recognized Owners exceed the amount required to satisfy the cumulative annual return of 10.75% (compounded quarterly) on the Recognized Owners' aggregate unreturned capital contributions, such calculation to be based on the aggregate unreturned capital contributions outstanding on the first day of each fiscal quarter.\nDistributable Cash From Operations and Distributable Cash From Sales or Refinancings (\"Distributions\") are distributed within 45 days after the completion of each quarter, beginning with the first full fiscal quarter following the Partnership's Closing Date. Each Distribution is described in a statement sent to the Recognized Owners.\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.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated herein by reference to the financial statements and supplementary data included in 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 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 IV Incorporated is the Managing General Partner of the Partnership. Under the Restated Agreement, as amended, the Managing General Partner is responsible for the operation of the Partnership's properties and the Recognized Owners have no right to participate in the control of such operations. The names, titles and ages of the Directors and Executive Officers of the Managing General Partner as of March 15, 1996 are as follows:\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 Managing General Partner or its Affiliates. There is no plan at the present time to make any officers or employees of the Managing 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 Managing General Partner or its Affiliates.\n(b) Compensation Pursuant to Plans\nNone.\n(c) Other Compensation\nAlthough the Partnership has no employees, as discussed in Item 11(a), pursuant to section 10.4 of the Restated Agreement, as amended, the Partnership incurs 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 services 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 the Individual General Partners, the Managing 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 Recognized Owners have voting rights with respect to:\n1. Amendment of the Restated Agreement;\n2. Termination of the Partnership;\n3. Removal of General Partners; and\n4. Approval or disapproval of the sale of all, or substantially all, of 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 Managing General Partner of the Partnership is AFG Leasing IV Incorporated, an affiliate of AFG.\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 the years ended December 31, 1995, 1994 and 1993 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 is compensated for its services to the Partnership. Such services include all aspects of acquisition, management and sale of equipment. For acquisition services, AFG is compensated by an amount equal to 4.75% of Equipment Base Price paid by the Partnership. For management services, AFG is compensated by an amount equal to the lesser of (i) 5% of gross lease rental revenue earned by the Partnership or (ii) fees which the Managing General Partner reasonably believes to be competitive for similar services for similar equipment. Both of these fees are subject to certain limitations defined in the Management Agreement. Compensation to AFG for services connected to the sale of equipment is calculated as the lesser of (i) 3% of gross sale proceeds or (ii) one-half of reasonable brokerage fees otherwise payable under arm's length circumstances. Payment of the remarketing fee is subordinated to Payout and is subject to certain limitations defined in the Management Agreement.\nAdministrative charges represent amounts owed to AFG, pursuant to Section 10.4 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 purchased 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 are paid directly to either AFG or to a lender. AFG temporarily deposits collected funds in a separate interest bearing escrow owner account prior to remittance to the Partnership. At December 31, 1995, the Partnership was owed $377,124 by AFG for such funds and the interest thereon. These funds were remitted to the Partnership in January 1996.\nOn August 18, 1995, Atlantic Acquisition Limited Partnership (\"AALP\"), a newly formed Massachusetts limited partnership owned and controlled by certain principals of AFG, commenced a voluntary cash Tender Offer (the \"Offer\") for up to approximately 45% of the outstanding units of limited partner interest in this Partnership and 20 affiliated partnerships sponsored and managed by AFG. The Offer was subsequently amended and supplemented in order to provide additional disclosure to unitholders; increase the offer price; reduce the number of units sought to approximately 35% of the outstanding units; and extend the expiration date of the Offer to October 20, 1995. Following commencement of the Offer, certain legal actions were initiated by interested persons against AALP, each of the general partners (4 in total) of the 21 affected programs, and various other affiliates and related parties. One action, a class action brought in the United States District Court for the District of Massachusetts (the \"Court\") on behalf of the unitholders (Recognized Owners), sought to enjoin the Offer and obtain unspecified monetary damages. A settlement of this litigation was approved by the Court on November 15, 1995. A second class action, brought in the Superior Court of the Commonwealth of Massachusetts (the \"Superior Court\") seeking to enjoin the Offer, obtain unspecified monetary damages, and intervene in the first class action, was dismissed by the Superior Court. The Plaintiffs have filed an appeal in this matter. The Recognized Owners of the Partnership tendered approximately 103,351 units or 8.13% of the total outstanding units of the Partnership to AALP. The operations of the Partnership are not expected to be adversely affected by these proceedings or settlements.\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.\n99 (b) Lease agreement with Northwest Airlines, Inc. was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 as Exhibit 99(b) and is incorporated herein by reference.\n99 (c) Lease agreement with The Kendall Company is filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 and is included herein.\n(b) Reports on Form 8-K\nNone.\nExhibit 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of American Income Partners IV-C Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to the Partners of American Income Partners IV-C 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 Recognized Owners. A report will be furnished to the Recognized Owners subsequent to the date hereof.\nNo proxy statement has been or will be sent to the Recognized Owners.","section_14":"","section_15":""}
{"filename":"844780_1995.txt","cik":"844780","year":"1995","section_1":"ITEM 1. BUSINESS\nBusiness Prior to Transactions in April of 1995. Fronteer Directory Company, Inc. (the \"Company\") is a corporation which was organized under the laws of the state of Colorado on September 14, 1988. The Company was formed for the purpose of assuming all of the assets and liabilities of a North Dakota corporation with the same name as the Company, incorporated on April 1, 1977. The focus of the Company's business changed in April of 1995, following the Company's acquisition of the assets of the holding company of a Denver, Colorado based securities broker dealer and the sale of 10 of the Company's 20 telephone directories to a third party. Before April of 1995, the Company's primary business was publishing telephone directories covering areas in the states of North Dakota, South Dakota, Montana, Idaho, Utah, Wyoming and Minnesota. The Company's primary source of revenue prior to April of 1995, was selling display advertisements in the yellow pages, selling bold and color listings in the white pages, selling advertisements on the back cover page, and selling discount coupons included as part of the telephone directories published by the Company.\nAcquisition of RAFCO. On April 26, 1995, the Company signed a Plan of Reorganization and Exchange Agreement (\"RAFCO Agreement\") with RAFCO, Ltd., a Nevada corporation (\"RAFCO\"), whereby the Company acquired all of the assets of RAFCO in exchange for which the Company (i) assumed some of RAFCO's liabilities; (ii) issued 7,223,871 shares of the Company's $.01 par value common stock (\"Common Stock\") to RAFCO; and (iii) issued 87,500 shares of the Company's $.10 par value Series A Voting Cumulative Preferred Stock (\"Preferred Stock\") to RAFCO. RAFCO distributed the shares of the Company's Common Stock and the Preferred Stock to those persons who had been RAFCO shareholders prior to April 26, 1995, and shortly afterwards, RAFCO dissolved and ceased to exist as a corporation. Following compliance with Rule 14f-1 of the Securities Exchange Act of 1934, as amended, (\"1934 Act\"), all of the officers and directors of the Company, except the president, Dennis W. Olson, resigned, the size of the Company's Board of Directors was reduced to three, and Robert A. Fitzner, Jr. and Robert L. Long were appointed as directors. Dennis W. Olson continued serving as the president and director of the Company, but no other officers were appointed.\nThe transactions which occurred under the terms of the RAFCO Agreement were accounted for as a \"reverse acquisition\" of the Company by RAFCO using the purchase method of accounting. The Company's assets and liabilities were adjusted to their fair market value at the date of the business combination. The Company's operations are included in the consolidated financial statements beginning May 1, 1995, the effective date of the business combination. See \"Financial Statements and Supplementary Data\" for more information.\nAs a result of the transactions which occurred under the terms of the RAFCO Agreement and because Mr. Fitzner owned a majority of the outstanding shares of RAFCO before the RAFCO Agreement was signed, Mr. Fitzner owns 4,784,705 shares of the Company's Common Stock and 5,000 shares of the Preferred Stock or 37.9% of the outstanding voting securities of the Company. Mr. Fitzner's mother, Earlene E. Fitzner, owns 2,500 shares of the Company's Preferred Stock. Mr. Fitzner may be deemed to be in control of the Company due to his position as a director and his ownership of 37.9% of the Company's outstanding voting securities. The other persons who received shares of the Company's Common Stock following the signing of the RAFCO Agreement and, because they were shareholders of RAFCO before it dissolved, are : Kanouff Corporation (1,558,078 shares); Dorothy K. Englebrecht (220,272 shares); Steven Fishbein (220,272 shares); Peter O'Leary (220,272 shares); and Arlene Wilson (220,272 shares). Mr. Fitzner has entered into voting agreements with Ms. Englebrecht, Mr. Fishbein, Mr. O'Leary and Ms. Wilson (collectively \"RAFCO Shareholders\") which give Mr. Fitzner an irrevocable proxy to vote all of the shares of Common Stock owned by the RAFCO Shareholders until July 16, 1997. These voting agreements also give Mr. Fitzner the right to buy some or all of the shares of the Common Stock owned by the RAFCO Shareholders during the period from July 16, 1997 to September 15, 1997. Each of the RAFCO Shareholders has agreed not to sell or pledge any of their shares of Common Stock until after September 15, 1997, the expiration date of the voting agreements. The irrevocable proxies expire on July 16, 1997.\n- 2 -\nUnder the RAFCO Agreement, the Company acquired all of the outstanding stock of RAF Financial Corporation, a Colorado corporation (\"RAF\"), and approximately 50% of the outstanding stock of Secutron Corp., a Colorado corporation (\"Secutron\"), along with furniture, fixtures and equipment which was used by RAFCO in its businesses and which the Company has continued to use in operating the businesses acquired under the RAFCO Agreement. RAF and Secutron became subsidiaries of the Company when the Company acquired the assets of RAFCO. See \"Business -- Description of Businesses -- RAF Financial Corporation\" and \"Description of Businesses -- Secutron Corp.\" for further information about the businesses conducted by RAF and Secutron.\nSale of Directories to Telecom. On April 27, 1995, the Company signed a Sale and Purchase Agreement (\"Telecom Agreement) with Telecom *USA Publishing Company, an Iowa corporation (\"Telecom\"). Under the terms of the Telecom Agreement, the Company sold 10 of its telephone directories located in the states of Idaho, Montana, South Dakota and Wyoming and certain equipment to Telecom for a total price of $2,189,846, some of which was paid to the Company in April of 1995, some in August of 1995, and the remainder of which was paid to the Company in October of 1995. The Telecom Agreement contemplated the sale of one additional directory for Bridgerland, Utah to Telecom, but the Company was unable to obtain an assignment to Telecom of the telephone publishing contract with the owners of the Bridgerland directory, and as a result, this directory was not sold to Telecom. As part of the Telecom Agreement, the Company agreed not to compete with Telecom's business in the states of Iowa, Minnesota, Michigan, Missouri, Nebraska, South Dakota, Colorado, Wyoming, Idaho, Montana, Illinois, Indiana and Wisconsin. However, if Telecom does not exercise its option to buy the Company's North Dakota directories, then the Company's noncompete agreement will be restricted to only those areas in which Telecom is actually conducting business on the date the option expires. See \"Business -- Sale of Option to Telecom\" for further information. In addition, nine of the Company's employees signed agreements not to compete with Telecom and Telecom agreed to pay these nine employees a total of $800,000 as consideration for signing these noncompete agreements. Four of the nine employees who signed noncompete agreements with Telecom were officers. Dennis W. Olson, who signed a noncompete agreement, is an officer and a director of the Company.\nSale of Option to Telecom. On April 27, 1995, the Company signed an option agreement with Telecom (\"Option\") which granted Telecom an option to buy the Company's nine North Dakota telephone directories. The consideration for this Option was a $500,000 loan from Telecom to the Company. Telecom agreed not to charge the Company any interest on the loan. Telecom may exercise its option between June 1, 1997 and June 1, 1999. If Telecom exercises its option, it has agreed to pay the Company a purchase price equal to the total net cash revenue less telephone company commissions for the most recent edition of each of the nine directories published and distributed before the date of the closing of the purchase under the Option. This purchase price is subject to adjustment under certain circumstances as described in the Option. If Telecom exercises its option, the full amount of the $500,000 loan made by Telecom to the Company will be deducted from the purchase price of the directories. If Telecom does not exercise its option, Telecom will forgive repayment of the full amount of the $500,000 loan made to the Company. Nine of the Company's employees will be required to sign agreements not to compete with Telecom if Telecom exercises its option to buy the North Dakota directories. One of these employees, Dennis W. Olson, is the president and also a director of the Company. In consideration for agreeing not to compete with Telecom, these nine employees of the Company will receive approximately 25% of the purchase price paid by Telecom for the nine North Dakota directories.\nDESCRIPTION OF BUSINESSES\nDIRECTORY DIVISION.\nFormation. Prior to the Company's acquisition of RAFCO and the sale of certain of the Company's directories to Telecom in April of 1995, the Company's primary business was the publication of telephone directories covering areas in the states of North Dakota, South Dakota, Montana, Idaho, Utah, Wyoming and Minnesota. See \"Business -- Business Prior to Transactions in April of 1995.\" Currently, the Company publishes 10 telephone directories, nine of which cover areas located in North Dakota and one of which covers an area in Utah. All nine of the North Dakota directories are included in an Option granted to Telecom in April of 1995.\n- 3 -\nSee \"Business -- Acquisition of RAFCO, -- Sale of Directories to Telecom, and -- Sale of Option to Telecom\" for further information about these transactions. Under the terms of the RAFCO Agreement, the Company formed a Directory Division in which the Company's telephone directory publishing business and the business of two of its subsidiaries, Fronteer Personnel Services, Inc. (\"FPS\") and Fronteer Marketing Group, Inc. (\"FMG\") are conducted. The Directory Division is managed by an advisory board consisting of seven members, six of whom are former members of the Company's board of directors and the seventh member is Dennis W. Olson, president and a director of the Company.\nDirectory Business. The Company's directory business currently publishes and distributes telephone directories covering nine areas in North Dakota and one directory in Utah. In the areas covered by the Company's telephone directories, consumers often receive two telephone directories which contain the same telephone listings, one of which is published by the local telephone company and one of which is published by the Company's directory business. The Company's directory business competes directly with the directories published by local telephone companies and with other independent directory publishers. In some cases, there may be more than one independent directory publisher covering the same area. In the areas served by the Company's 10 directories, there are 17 competing directories, of which 15 are published by local telephone companies and two are published by other independent directory publishers. The Company's directory business publishes directories under contract with 13 small independent telephone companies, several of which are consolidated into larger directories. The Company published a total of 19 directories in fiscal year 1995. The table below shows information regarding the directories published by the Company during the last three fiscal years.\nThe Company's directory business derives revenue by selling advertisements in the yellow pages portion of its directories, selling bold listings, selling color listings in the white pages, selling advertisements on the back cover page, and selling discount coupons for goods and services. The Company's directory business employs 56 persons, including 14 full time salespersons, who are compensated on a commission basis. The directory business owns its own typesetting equipment which allows it to produce camera ready copies of its directories. The camera ready copy is then printed by third party printers who bid on each printing job. During fiscal year 1995, the directory business utilized three different printers, with approximately 70% of the printing work performed by one printer. If this one printer were to go out of business, this event would not have a material adverse effect on the directory business. All of the raw materials used by the directory business are generally available and the directory business is not dependent on any single supplier. During fiscal year 1995, a worldwide paper shortage caused a 20% to 30% increase in the cost of the paper used in the directories published by the Company, but paper prices are not expected to rise significantly in the foreseeable future.\nThe Company anticipates that its existing directory business will expand as a result of the sale by U.S. West Communications of 68 of its North Dakota telephone exchanges to 15 different small telephone companies. The Company's directory business currently has publishing contracts with 11 telephone companies which are buying a total of 43 exchanges from U.S. West Communications. The Company anticipates that the sale of exchanges by\n- 5 -\nU.S. West Communications will result in five of the Company's existing directories becoming the official directories for the new local telephone companies in these areas, leading to decreased competition and increased revenue for the Company's directory business.\nFronteer Personnel Services, Inc. Since October of 1992, the Company has performed payroll and benefits administration for small businesses through its wholly owned subsidiary, Fronteer Personnel Services, Inc., a North Dakota corporation (\"FPS\"), which was formed on October 30, 1992. FPS markets its services to small businesses in and around the Bismarck, North Dakota metropolitan area. FPS had four employees as of December 1, 1995, and its office is located at 2208 East Broadway, Bismarck, North Dakota, 58501. FPS had revenues of $66,374 for the period from May 1, 1995 to September 30, 1995, compared with net revenues of $72,934 and $24,198 in fiscal years 1994 and 1993, respectively. Also, FPS had operating losses of $31,249 for the period from May 1, 1995 to September 30, 1995, compared with operating losses of $53,216 and $149,012 in fiscal years 1994 and 1993, respectively. On December 7, 1994, FPS acquired 49% of the outstanding stock of Native American Document Conversion Services, LLC, a North Dakota limited liability company (\"NADCOS\"). American Indian Services, Inc., an Illinois corporation (\"AISI\"), is the majority shareholder of NADCOS. NADCOS is currently developing its business which it anticipates will consist primarily of document imaging and conversions. During fiscal year 1995, the business activities of NADCOS consisted of AISI marketing its services to the public.\nFronteer Marketing Group, Inc. On April 3, 1995, the Company formed a new wholly owned subsidiary, Fronteer Marketing Group, Inc., a North Dakota corporation (\"FMG\"), which engages in the outbound telemarketing business. In April of 1995, FMG acquired the assets of a telemarketing business which had ceased operations due to financial difficulties. FMG conducts outbound telemarketing which consists of soliciting consumers and businesses by telephone. FMG has 24 full time and six part time employees. FMG markets its services nationwide primarily through the services of a telemarketing trade association. FMG's office is located at Highway 49 South, Beulah, North Dakota, 58523. FMG had revenues of $149,780 and operating losses of $103,244 for the period from May 1, 1995 to September 30, 1995.\nFinancial Information. The Directory Division, including the Company's directory business, FPS and FMG, recognized $3,702,849 in revenue for the period May 1, 1995 through September 30, 1995, compared with $9,158,922 and $8,522,898 in fiscal years 1994 and 1993, respectively. The Directory Division experienced operating profits\/losses of ($389,559) for the period from May 1, 1995 to September 30, 1995, as compared with $325,800 and ($205,018) in fiscal years 1994 and 1993, respectively.\nRAF FINANCIAL CORPORATION.\nGeneral. RAF was incorporated in 1974 to engage in the retail stock brokerage business in the Rocky Mountain Area of the United States. RAF is registered as a broker dealer with the Securities and Exchange Commission (\"Commission\"), is a member of the National Association of Securities Dealers, Inc. (\"NASD\") and the Boston Stock Exchange, is an associated member of the American Stock Exchange, and is registered as a securities broker dealer in all 50 states. RAF is a member of the Securities Investor Protection Corporation (\"SIPC\") and other regulatory and trade organizations. RAF's securities business consists of providing securities transaction clearing services for other broker dealers on a fully disclosed basis, providing retail securities brokerage and investment services, trading fixed income and equity securities, providing investment banking services to corporate and municipal clients, managing and participating in underwriting corporate and municipal securities, and distributing mutual fund shares. During 1989, RAF registered the mark \"RAF Financial Corporation\" with the United States Patent and Trademark Office, and RAF has registered this name in 32 states. RAF intends to maintain all of its service mark registrations for the indefinite future in order to protect the goodwill associated with the mark. RAF conducts its business in five operating divisions. RAF's principal executive office is located at One Norwest Center, 1700 Lincoln Street, 32nd Floor, Denver, Colorado, 80203. RAF has branch offices located in Colorado Springs, Colorado; Fort Collins, Colorado; Atlanta, Georgia; Albany, New York; Reston, Virginia; and Chicago, Illinois.\n- 6 -\nCorrespondent Clearing Division. The Correspondent Clearing Division provides clearing services on a fully disclosed basis to other broker dealers (\"Correspondents\") under the name of RFC Clearing Services. In a fully disclosed clearing transaction, the Correspondent's customer's identity is known to RAF, RAF physically maintains the customer's account, and RAF performs a variety of services for the customer as agent for the Correspondent. RAF receives service charges and fees from the Correspondent for performing these services. Electronic data processing is an integral part of RAF's clearing operations. RAF operates all of the data processing hardware and software necessary to input trading and back office data. RAF utilizes a proprietary software system which was developed in a joint effort between Secutron and RAF and uses IBM hardware. RAF's clearing division business diminished during the first nine months of 1995 as compared with the period January 1, 1994, through December 31, 1994, due to increased competition.\nRetail Securities Brokerage Division. RAF conducts its retail brokerage business through its Retail Securities Brokerage Division. As of December 31, 1995, RAF had 115 account executives. At December 31, 1995, RAF had approximately 12,000 customer accounts, not including Correspondent customer accounts. RAF generates commission revenue when it acts as a broker on an agency basis, or as a dealer on a principal basis, to effect securities transactions for individual and institutional investors. RAF executes both listed and over the counter agency transactions for customers, executes transactions and puts and calls on options exchanges as agent for its customers, and sells a number of professionally managed mutual funds.\nCorporate Finance Division. The Corporate Finance Division provides financial advisory and capital raising services to corporate clients. Financial advisory services involve advising clients in mergers and acquisitions and in various types of corporate valuations. RAF acts as an underwriter, dealer, and selling group member in public and private offerings of equity and debt securities. During the first nine months of 1995, RAF raised approximately $6,000,000 for four companies through its investment banking activities, which included two public offerings and two private placements.\nTrading Division. Trading securities involves the purchase and sale of securities by RAF for its own account. Profits and losses are derived from the spread between bid and ask prices and market increases or decreases for the individual security during the holding period. RAF makes markets in corporate equities and trades in municipal and corporate bonds and various government securities. As of December 31, 1995, RAF made markets in 50 stocks.\nPublic Finance Division. The Public Finance Division of RAF provides professional financial advisory services to public entities, participates in underwriting and selling both negotiated and competitive bid municipal bond offerings, and structures and participates in municipal bond refinancings. During the first nine months of 1995, RAF's participation in offerings of municipal securities was approximately $26,000,000 as manager of seven offerings.\nFinancial Information. For the nine months ended September 30, 1995, RAF's revenues of $9,854,160 accounted for 57.4% of the Company's total operating revenues of $17,169,754 for the same period. RAF's revenues for the years ended December 31, 1994 and 1993 were $12,713,456 and $14,044,465 respectively. Also for the nine months ended September 30, 1995, RAF incurred a net loss of $809,790.\nRAF Regulatory Net Capital. As a registered broker dealer in securities, RAF is subject to the net capital rule (\"Rule\") of the Commission. Under this Rule, RAF is required to maintain net capital, as computed under the Rule, equal to the greater of $100,000 or 2% of aggregate debit items, as determined under the Rule. The purpose of this Rule is to establish minimum net capital deemed necessary for a broker dealer to meet its commitments to its customers and to provide a measurement standard of financial integrity and liquidity of broker dealers. The Rule also contains provisions which limit the withdrawal of equity capital from a registered broker dealer such as RAF by shareholders such as the Company and limits unsecured advances from a registered broker dealer to its shareholders, employees or affiliates. Equity capital may not be withdrawn if the resulting net capital would be less than 5% of aggregate debits. RAF's net capital at September 30, 1995, as computed under the Rule,\n- 7 -\nwas $1,988,915; RAF's minimum net capital requirement was $250,000 on such date; and RAF's excess net capital was $1,738,915 on such date. On September 30, 1995, RAF's ratio of net capital to aggregate debits was 41%. At September 30, 1995, RAF's stockholders' equity was $7,090,567. There are numerous deductions which must be made from the net worth of a broker dealer in computing its regulatory net capital under the Rule. RAF's net capital deductions relate primarily to equipment, facilities, and advances to affiliates.\nSale of Bank Services Division. During the years 1991 through 1994, RAF directly invested in excess of $3,000,000 in the development of its Bank Services Division. These funds were utilized to develop computer software systems and to develop an organization consisting of data processing and marketing personnel. As a result, RAF's Bank Services Division operated at a loss during the development period in the amount of approximately $1,000,000. The services offered by this division to financial institutions, including banks, were designed to provide up to date information on the financial institution's liabilities, assets and business which would permit the client to make decisions in the areas of interest rate risk, liquidity, investment planning, annual budgets, strategic plans, and capital plans. During September of 1993, RAFCO entered into an agreement with Sheshunoff Information Services, Inc. (\"SIS\"), Trepp & Company, Inc. (\"Trepp\") and the Asset Backed Securities Group, a division of TFS Database Group, Inc., which is affiliated with Thomson Financial Networks Inc. (\"Thomson\") to form the STAR Alliance (\"Alliance Agreement\") to jointly market, prepare, and deliver specialized data and reports to the banking industry. Prior to July 1, 1995, RAFCO's primary responsibilities to the Alliance were the collection of data via modem or tape and the use of its proprietary software systems to make certain calculations and prepare reports for clients of the Alliance. From September of 1993, to June of 1994, the Bank Services Division of RAF performed these services for the Alliance on behalf of RAFCO. As of June 30, 1994, RAFCO transferred all of the business and ownership of the software systems to its wholly owned subsidiary, Risk Analytics, Inc. (\"RAI\"), and on July 1, 1994, RAI began performing services for the Alliance on behalf of RAFCO. As of January 1, 1995, RAFCO transferred ownership of RAI to RAF. Effective July 1, 1995, the members of the STAR Alliance signed a Termination Agreement in which RAI terminated its participation in the STAR Alliance. Simultaneously, RAI sold SIS all of the rights to its software (\"STAR Software\") and related products to enable SIS to assume RAI's former duties to the STAR Alliance. Under a Bill of Sale and a Services Agreement, both dated July 1, 1995, SIS purchased the STAR Software and agreed to pay RAF fees to use some of RAF's office space and related facilities for the transition period from July 1, 1995 through December 31, 1995, while SIS assumes RAI's former responsibilities to the STAR Alliance. RAI is bound by a covenant not to compete in the United States with the services offered by the remaining members of the STAR Alliance for two years after termination of the Alliance Agreement.\nBank Loan. In March of 1993, RAFCO sold $775,000 of 10% Senior Subordinated Promissory Notes (\"Notes\") to two Illinois banks (\"Banks\"). The obligations represented by the Notes were assumed by the Company when it acquired the assets of RAFCO on April 27, 1995. In August of 1995, the Banks requested that the Company substitute conventional loans for the obligations represented by the Notes. The Company agreed to retire the Notes held by the Banks by entering into loan agreements with the Banks. RAI assigned its right to receive payments from SIS under the Termination Agreement discussed above to the Company and the Company then pledged this right to the Banks as collateral for the loans. In December of 1995, the Company executed promissory notes totalling $775,000, payable to the Banks in installments on each July 15 beginning in 1996 and ending in 1999. Under the Termination Agreement, the Company is entitled to receive a total of $1,625,150 payable in installments. The first installment of $475,150 was paid to RAI on July 1, 1995, and subsequent installments are due on each June 30 beginning in 1996 and ending in 1999.\nSECUTRON CORP.\nGeneral. Secutron was incorporated under Colorado law on May 11, 1979. The Company owns 47.5% of the outstanding stock of Secutron and Mr. Anthony R. Kay owns approximately 47% of the outstanding stock of Secutron. Secutron's business consists of designing, developing, installing, marketing, and supporting software systems for the securities brokerage industry. Secutron markets hardware and software to securities brokerage firms as an IBM business partner. Secutron's IBM business partner relationship is as an industry remarketer affiliate\n- 8 -\nthrough Real Applications Ltd., located in Woodland Hills, California. Secutron's wholly owned subsidiary, MidRange Solutions Corp., is a Colorado corporation formed on January 1, 1993 (\"MSC\"). MSC is in the business of selling IBM hardware and hardware manufactured by competitors of IBM, and MSC acts as a distributor for software products which are proprietary to third parties. MSC sells hardware and software to businesses in several different industries, including manufacturers, distributors and health care providers. MSC also has a contract with a software company under which it markets sophisticated financial accounting software to manufacturers and distribution companies located in specific areas in which MSC is the exclusive distributor of this software.\nProducts and Services. Secutron offers the following software products to the securities brokerage industry. The STARS software system is offered to broker dealers who clear their own transactions, and is a totally integrated software system which performs all of the functions required by self clearing broker dealers. The BCATS software system is offered to broker dealers who clear their securities transactions on a fully disclosed basis through a clearing broker dealer such as RAF, and is also a fully integrated software system which performs all of the accounting functions required by a fully disclosed broker dealer. The BCATS-MF software system is designed for use by broker dealers engaging in transactions in mutual funds. All of such software systems are designed to run on IBM computers. Both Secutron and MSC provide consulting, programming and facilities management services to their respective clients to support the software and hardware sold by them.\nFUTURE BUSINESS PLANS\nThe Company's general business strategy is to expand the businesses conducted by RAF and Secutron, while maintaining the business conducted by the Company's Directory Division at its present size. The Company plans to keep the number of directories published by its directory business constant, pending the sale of nine out of its ten directories to Telecom between June 1, 1997 and June 1, 1999, under the terms of Telecom's Option. See \"Business -- Sale of Option to Telecom\" for further information. Due to decreased competition in its existing directory markets, the Company anticipates that revenues from its existing directories will increase in fiscal year 1996. See \"Business -- Competition -- Directory Business.\" FMG plans to open several new telemarketing centers throughout North Dakota during 1996. FMG anticipates that a new telemarketing center with 24 telephone stations will be opened in Bismarck in March of 1996, and FMG plans to open another center of the same size in different communities around North Dakota every 60 to 90 days during the next two years. FMG has a working relationship with a coalition of economic development organizations from nine small North Dakota communities, whereby the communities will provide office space at a nominal monthly rental charge as an incentive to bring the telemarketing centers and jobs to their areas. FMG has contracted with a consultant to help with FMG's purchase and installation of the technology which will allow FMG to tie all of its separate sites together to act as one large center. With the installation of new telemarketing centers, FMG will pursue large inbound telemarketing contracts. FMG hopes to have five centers operational with a total of approximately 150 employees by the end of fiscal year 1996. FPS anticipates revenue and income growth primarily through increased insurance commissions from its insurance division in fiscal year 1996. The Company also expects growth in its payroll services business in conjunction with the anticipated expansion of FMG, which is under contract with FPS for its payroll services.\nThe volume of business conducted by RAF's clearing division in the first nine months of 1995 diminished due to increased competition and the Company's inability to match lower prices charged by the Company's clearing division competitors. The Company anticipates that the business conducted by RAF's clearing division will continue to diminish in fiscal year 1996. See \"Business -- Description of Businesses -- RAF Financial Corporation -- Correspondent Clearing Division\" for further information about this division. Management of the Company believes it is in the best interest of the entire Company to pursue a reduction in the clearing division business in order to decrease losses experienced and anticipated to be experienced by the clearing division. The Company plans to focus its efforts on increasing RAF's regulatory net capital and increasing the volume of business conducted by RAF's retail securities brokerage division. Management believes that increasing RAF's capital will give RAF the potential ability to expand its securities business which could make RAF more profitable and ultimately benefit all of the Company's businesses.\n- 9 -\nEMPLOYEES AND EMPLOYEE RELATIONS\nEmployees. As of December 15, 1995, the Company had 287 full time employees, 84 of whom worked for the Directory Division in the Company's North Dakota offices and 172 of whom worked for RAF. As of December 15, 1995, Secutron had 31 employees. RAF's headquarters is located in Denver, Colorado, but 72 of RAF's employees work in branch offices of RAF located in Colorado Springs, Colorado; Fort Collins, Colorado; Reston, Virginia; Atlanta, Georgia; Albany, New York; and Chicago, Illinois. The Company considers its relations with its employees to be good.\nCOMPETITION\nDirectory Business. The Company's directory business competes primarily with U.S. West Direct, which publishes telephone directories in many of the same markets in which the directory business publishes directories. U.S. West Direct has several advantages that the Company's directory business does not possess, including greater financial resources, name recognition and an affiliation with U.S. West, a large telephone company. Management believes the Company's directory business is able to compete effectively with U.S. West Direct in obtaining contracts with independent telephone companies due to the following factors: (i) some of the Company's directories are so small they may not be of interest to U.S. West Direct; (ii) the Company's directory business maintains good relations with the telephone companies for which it publishes directories; and (iii) management believes that the Company's directory business publishes directories which are superior to U.S. West Direct's directories with respect to including information about the community and offering more types of advertisements. In addition, management believes the Company's directory business competes effectively with U.S. West Direct in obtaining advertisements for its directories for the following reasons: (i) in some markets, the Company's directories list special telephone numbers for certain advertisers which consumers can call to obtain community information and a message from the advertisers; and (ii) the Company's directories usually charge lower advertising rates than U.S. West Direct. The Company's directory business also competes less directly with other forms of advertising media such as newspapers, magazines, television and radio, although it is difficult to assess how the Company's directory business is affected by other forms of advertising.\nRAF. The securities industry has become considerably more concentrated and more competitive in recent periods as numerous securities firms have either ceased operation or have been acquired by or merged into other firms. In addition, companies not engaged primarily in the securities business, but having substantial financial resources, have acquired securities firms. The securities industry is now dominated by relatively few very large securities firms offering a wide variety of investment related services nationally and internationally. Numerous commercial banks have petitioned and received approval from the Board of Governors of the Federal Reserve System to enter into a variety of new securities activities. Various legislative proposals, if enacted, would permit commercial banks to engage in other types of securities related activities. These developments or other developments of a similar nature may lead to the creation of integrated financial service firms that offer a broader range of financial services than those offered by RAF. These developments have created large, well capitalized, integrated financial service firms with which RAF must compete. The securities industry has also experienced substantial commission discounting by broker dealers competing for institutional and individual brokerage business. An increasing number of specialized firms now offer \"discount\" services to individual customers. These firms generally effect transactions for their customers on an \"execution only\" basis without offering other services such as investment recommendations and research. Such discounting and an increase in the number of new and existing firms offering such discounts could adversely affect RAF's retail securities business.\nThe correspondent clearing business has become considerably more competitive over the past few years as numerous highly visible, large, well financed securities firms either have begun offering clearing services or have attempted to increase their securities clearing business. These developments have increased competition from firms with capital resources greater than those of RAF. Partially in response to this increase in competition, RAF has entered into negotiations with a large investment banking firm to sell its clearing division. The outcome of these negotiations is uncertain at this time.\n- 10 -\nSecutron. Secutron competes with numerous software and hardware distribution firms, and hardware manufacturers, some of which are larger than Secutron with greater financial resources than Secutron. Secutron also competes with firms that specialize in industry specific software and those that offer a variety of software products to businesses in various industries. MSC competes with hardware manufacturers and other licensed distributors of IBM hardware and distributors of hardware manufactured by competitors of IBM. Many of MSC's competitors are larger than MSC and have greater financial resources.\nREGULATION\nDirectory Business. The Company's directory business is not subject to regulation by federal, state or local governments. The directory business is a member of the Yellow Pages Publishers Association (\"Association\") which has its own Code of Ethics which regulates the business practices of its members with respect to solicitation and billing of advertisers. If the directory business were to violate this Code of Ethics, it could be expelled from membership in the Association and lose national advertising accounts.\nRAF. The securities industry in the United States is subject to extensive regulation under federal and state laws. The Securities and Exchange Commission (\"Commission\") is a federal agency charged with administration of the federal securities laws. Much of the regulation of brokers and dealers has been delegated to self regulatory organizations, principally the NASD and the exchanges. These self regulatory organizations adopt rules (which are subject to approval by the Commission) for governing the industry and conduct periodic examinations of member broker dealers. Securities firms are also subject to regulation by state securities commissions in the states in which they do business. Broker dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trading practices among broker dealers, capital structure of securities firms, record keeping, and the conduct of directors, officers, and employees. Additional legislation, changes in rules promulgated by the Commission and by self regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules often directly affect the method of operation and profitability of broker dealers. The Commission, the self regulatory authorities, and the state securities commissions may conduct proceedings which can result in censure, fine, suspension, or expulsion of a broker dealer, its officers, or employees.\nRAF is required by federal law to belong to SIPC. When the SIPC fund falls below a certain minimum amount, members are required to pay annual assessments. 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.\nRAF is subject to the Commission's Uniform Net Capital Rule which is designed to measure the financial integrity and liquidity of a broker dealer and the minimum net capital deemed necessary to meet its commitments to its customers. RAF is in compliance with the Rule. Failure to maintain the required net capital may subject RAF to suspension by the Commission or other regulatory bodies and may ultimately require its liquidation. The Company is not itself a registered broker dealer and is not subject to the Net Capital Rule. However, under the Rule, the Company could be affected by the requirement that a broker dealer such as RAF under certain circumstances is prohibited, and under other circumstances may be temporarily restricted, by the Commission from the withdrawal of equity capital by a stockholder such as the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nDirectory Division Properties. The directory business maintains its administrative offices and production facilities in a 9,400 square foot building owned by the Company at 216 North 23rd Street, Bismarck, North Dakota 58501. The Company is acquiring the property on which the building is located for $115,000 pursuant to a contract for deed with a nonaffiliated party. Since entering into the contract for deed, improvements totaling $122,519 have been made by the Company to the building. In October 1991, the Company completed renovation of 3,000 square feet of office space in this building. The improvements have been made with borrowed funds, and have been made part of the original contract for deed. The directory business also has a branch office at 1323 23rd Street South, Suite E, Fargo, North Dakota. FPS rents approximately 2,200 square feet of office space in a\n- 11 -\nbuilding located at 2208 East Broadway, Bismarck, North Dakota, 58501. FMG leases approximately 3,300 square feet of office space in a building located at Highway 49 South, Beulah, North Dakota.\nRAF Properties. RAF's principal offices are located at One Norwest Center, 1700 Lincoln Street, 32nd Floor, Denver, Colorado, 80203, which consist of approximately 47,071 square feet of office space leased from Norwest Bank of Colorado, National Association and Norwest Corporation for the 31st and 32nd floors, respectively, of One Norwest Center in Denver, Colorado. RAFCO was the original lessee in two subleases, one with United Bank of Denver National Association for the 31st floor and one with Norwest Corporation for the 32nd floor, both of which were effective on January 30, 1992. Both of the subleases will expire on April 30, 2007. United Bank of Denver, National Association subsequently assigned its interest in the sublease for the 31st floor to Norwest Bank of Colorado, National Association, following the acquisition of United Bank of Colorado by Norwest Bank. RAFCO subsequently assigned its interest in both of the subleases to the Company, which then signed subleases with RAF under the same terms and conditions set forth in the original subleases. RAF pays the Company monthly rent of $27,147 and $26,788 for the 31st and 32nd floors, respectively.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nLegal Proceedings Against the Directory Division. There are no pending material legal proceedings against the Company's directory business, FMG or FPS.\nLegal Proceedings Against RAF. During 1994, a lawsuit was filed against RAF in Case No. 94-2235- CA-B, in the Circuit Court for the Fifth Judicial Circuit in Marion County, Florida. The complaint alleges damages against RAF and others in excess of $10,000,000 arising out of the alleged improper handling of securities by RAF and other defendants. The claims asserted against RAF are breach of contract, negligent misrepresentation, breach of fiduciary duty, and joint and several liability of all defendants. RAF is vigorously defending this lawsuit on the basis that, as clearing agent for a Correspondent, which is one of the other defendants, RAF owed no duty to the plaintiff and was legally required to follow the Correspondent's instructions with respect to the securities at issue. In November of 1995, the court issued an injunction pursuant to which the securities which are the subject of the lawsuit were returned to the custody of the plaintiff, an action which, at a minimum, management believes will greatly mitigate any alleged damages. RAF has and will continue to vigorously contest this matter. In addition, RAF is currently a defendant or codefendant in seven arbitrations involving former customers, each alleging compensatory damages of $25,000 or less; RAF is currently a defendant or codefendant in seven arbitrations with former customers and one arbitration in which RAF acted as the clearing agent, each alleging compensatory damages of $300,000 or less; RAF has brought an arbitration action against former customers in response to informal customer complaints against RAF for compensatory damages of approximately $527,000; RAF is a defendant or codefendant in three additional arbitrations in which former customers are alleging compensatory damages ranging from $488,000 to $914,000; and RAF is a defendant or codefendant in two civil lawsuits brought by former customers, one alleging $35,000 in damages, and one alleging an unspecified amount of damages. RAF is currently appealing a judgment against RAF entered in a civil lawsuit in November of 1995 for $190,000. RAF has also been asked by a party in a legal proceeding to turn over approximately $690,000 allegedly held by RAF on behalf of a debtor in a pending lawsuit, and a former employee has brought suit against RAF for $11,000 in compensatory damages. Management believes that while the outcome of these matters may have some effect on earnings in an interim reporting period, the outcome of these matters will not have a significant adverse effect on any annual reporting period or on the overall financial condition of the Company. From time to time, RAF has claims asserted against it by its customers and customers of its Correspondents. This is common in the industry and RAF views it as a recurrent factor. There are no other pending material legal proceedings to which the Company or any of its subsidiaries are a party, or of which any of their respective properties is the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of the Company's security holders during the Company's fiscal quarter ended September 30, 1995.\n- 12 -\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 has been traded on the Nasdaq Small Cap Market under the symbol FDIR, since March 27, 1989. The following table shows the range of high and low bid quotations for the Common Stock, for each quarterly period since October 1, 1993, as reported by the NASD. These quotations represent prices between dealers and do not include retail markups, markdowns, or commissions and may not necessarily represent actual transactions.\n(b) Holders. As of December 1, 1995, the Company had approximately 174 holders of record of its Common Stock and 19 holders of record of its Preferred Stock.\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. The Company is precluded from paying dividends on its Common Stock so long as shares of Preferred Stock are outstanding and if dividends have not been paid in full on the Preferred Stock. Holders of Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors out of funds at the time legally available therefor, cash dividends at an annual rate of 9% (equal to $.90 per share annually), payable quarterly in arrears. Cumulative dividends accrue and are payable to holders of record as they appear on the stock books of the Company on record dates which shall be the last day of the last calendar quarter ending prior to the dividend payment date. Preferred Stock dividends are payable quarterly at a rate of $0.23 per share ($.90 per share annually). The Preferred Stock was issued in April 1995 and the Company declared and paid two consecutive dividends for the quarters ended June 30, 1995 and September 30, 1995. Management currently believes that the Company will be able to pay the next quarterly dividend due in January 1996. The Preferred Stock has priority as to dividends over the Common Stock and any other stock of the Company ranking junior to or on a parity with the Preferred Stock and no dividend may be declared, paid or set aside for payment or other distribution declared or made upon the Common Stock or any other stock of the Company ranking junior to or on a parity with the Preferred Stock, nor shall funds be set aside for the purchase or redemption of any such stock, through a sinking fund or otherwise, unless all accrued and unpaid dividends on the Preferred Stock have been paid or declared and set aside for payment.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nAs a result of the transaction described in the RAFCO Agreement, the former shareholders of RAFCO acquired a 55% interest in the Company. Accordingly, the transaction has been accounted for as a \"reverse acquisition\" of the Company by RAFCO using the purchase method of accounting and the Company's assets and liabilities prior to the transaction described in the RAFCO Agreement have been adjusted to their market value as of the date of the business combination. The adjustment to market value resulted in an intangible asset, directory publishing rights, which was recorded at $6,972,468. The Company's operations are included in the consolidated financial statements beginning May 1, 1995, the effective date of the business combination. As a result of the reverse acquisition accounting, historical financial statements presented for periods prior to the business combination date include the consolidated assets, liabilities, equity, revenues, and expenses of RAFCO only.\n- 13 -\nThe following is selected consolidated financial information for the Company as of September 30, 1995 and for the nine months ended September 30, 1995, and for RAFCO as of December 31, 1994, 1993, 1992, 1991 and for each of the years in the four year period ended December 31, 1994. This information should be read in conjunction with the consolidated financial statements appearing in Item 8 of this Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFinancial Condition\nAt September 30, 1995, shareholders' equity was $5,441,590 up $4,253,155 or 358%, over year end December 31, 1994. This increase was due to the shares issued in connection with the acquisition of RAFCO by the Company in April of 1995. The ratio of current assets to current liabilities at September 30, 1995, was 1.40 to 1, an increase from 1.14 to 1 at December 31, 1994.\n- 14 -\nRESULTS OF OPERATIONS\nNine Months Ended September 30, 1995 Compared With 12 Months Ended December 31,\nThe Company's acquisition of RAFCO under the terms of the RAFCO Agreement described in \"Business - - Acquisition of RAFCO,\" has been accounted for as a reverse acquisition of Fronteer Directory Company, Inc. (\"Fronteer\") by RAFCO using the purchase method of accounting. This resulted in Fronteer adjusting its assets and liabilities to their fair market value at the effective date of the acquisition, or May 1, 1995. The enclosed financial statements show RAFCO and its subsidiaries for the years ended December 31, 1994 and 1993, and the nine months ended September 30, 1995, while the Company and subsidiaries, including RAFCO, are consolidated from May 1, 1995 to September 30, 1995, in accordance with the purchase method of accounting.\nOn April 27, 1995, the Company entered into the Telecom Agreement whereby the Company sold 10 of its telephone directories to Telecom. See \"Business -- Sales of Directories to Telecom.\" The transactions under the Telecom Agreement were accounted for in May of 1995, subsequent to the effective date of the business combination. The Company also granted an Option to Telecom on the same date whereby Telecom made a noninterest bearing and nonrecourse $500,000 loan to the Company in exchange for the Option to acquire the Company's nine North Dakota telephone directories. See \"Business -- Sale of Option to Telecom.\" Because the Company adjusted its directories to their fair market value at the time of the acquisition of RAFCO, no gain or loss was recognized on the sale of the directories to Telecom. The book value of the directory publishing rights after the sale to Telecom was $4,692,769. This amount is being amortized over 10 years with amortization totalling $161,886 for the nine month period ended September 30, 1995.\nThe Company incurred a net loss for the nine months ended September 30, 1995, of $1,891,873 which compares to a net loss of $353,426 for the 12 months ended December 31, 1994.\nRevenues for the nine months ended September 30, 1995 totalled $17,169,754, an increase of $910,854 over revenues of $16,258,900 for the year ended December 31, 1994. Directory revenues during the nine months ended September 30, 1995 totalled $3,625,038, which includes only five months of revenues for the directory business due to the business combination. Computer revenues from Secutron for the nine months ended September 30, 1995 were 92% of total revenues for the year ended December 31, 1994, an increase of 22% on an annualized basis. Broker dealer revenues for the nine months ended September 30, 1995 totalled $9,729,223 as compared to $12,713,456 for the year ended December 31, 1994. Broker dealer revenues for the nine months ended September 30, 1995 annualized for the year total $12,972,297, which is comparable to 1994.\nBroker dealer revenues generated by RAF are made up of several components, which have changed in their makeup and materiality from 1994. Broker commissions of $7,051,366 for the nine months ended September 30, 1995 exceeded last year's annual total of $5,792,268. This amounts to an increase of $1,259,098, or 62%, over 1995 annualized revenues. This increase resulted in large part from RAF's new sales offices in Reston, Virginia and Atlanta, Georgia, which were opened in the summer of 1994, as well as from the addition of brokers in existing sales offices. RAF plans to increase its sales force and number of sales offices in 1996 and has already opened a new sales office in Chicago, Illinois since September 30, 1995, the end of the fiscal year.\nVarious changes in the way the Company evaluates its business opportunities took place in fiscal 1995. RAF's bank services division was sold to Sheshunoff Information Services, Inc. during the year. This completely eliminated bank services as a revenue source in 1995, while the bank services division produced revenue of over $1,150,000 during fiscal year 1994. Revenues from clearing operations also declined significantly during the nine months ended September 30, 1995 from $1,079,931 in 1994 to $182,215 in the nine months ended September 30, 1995. Factors specifically related to the clearing business and its capital requirements made the Company's clearing business uncompetitive during fiscal year 1995. The Company believes that its clearing operations will continue to decline in fiscal year 1996 due to its inability to compete in the clearing industry.\n- 15 -\nThe corporate and public finance divisions of RAF had significantly lower revenues in fiscal 1995 as compared to fiscal 1994 due to a decrease in activity subsequent to an active fourth quarter in 1994, the continued unpredictable impact of interest rate fluctuation, and an amendment to the Colorado State Constitution, which placed many restrictions on public financing in the State of Colorado. Revenues for 1994 of $3,032,968 decreased to $1,340,573 for the nine months ended September 30, 1995.\nBroker dealer commissions increased during the nine months ended September 30, 1995 by $785,543 over the year ended December 31, 1994, which coincides with an increase in commission revenues. However, commission revenues were up 22% over 1994, while commission expense was up only 18%. Not included in these percentages is a total of over $244,000 in advances to brokers which was forgiven and expensed during the nine months ended September 30, 1995. In order to attract broker dealers to RAF's two new offices in Reston, Virginia and Atlanta, Georgia, the former RAFCO made loans to its new salespeople. As the salespeople meet certain length of employment and sales goals, the loans are forgiven. A total of over $244,000 of these loans was expensed during 1995, while $180,000 remaining is being amortized over the employment period.\nGeneral and administrative expenses (G & A) totalled $6,550,305 for the nine months ended September 30, 1995. This compares to $8,829,454 for the year ended December 31, 1994. A total of approximately $75,000 in expenses related to the Company's acquisition of RAFCO was incurred during the year and is included in G & A. During 1995, the Company wrote down a note receivable due from a former RAFCO employee in the amount of $338,000, which has been in G & A. G & A includes no expenses for the Company's directory business prior to May 1, 1995. Fixed operating expenses for both RAF and the Company's directory business are in a state of decline due to the reorganization, and the sale of RAF's bank services division and the sale of certain of the Company's directories.\nInterest income for the nine months ended September 30, 1995 totalled $496,316, a decline of $586,260 from the year ended December 31, 1994. This decrease is attributable to a large decline in the Company's margin debit interest, which is associated with the decline in the Company's clearing business and revenues during the period.\nOther revenues increased from $30,214 during fiscal 1994 to $579,337 in the nine months ended September 30, 1995. Revenues of $149,780 and $66,374 for FMG and FPS, respectively, are included for the nine months ended September 30, 1995. In addition, a gain on the sale of a condominium of $96,094 is included in the nine months ended September 30, 1995.\nThe minority interest reflected in the financial statements relates to the approximately 52% of Secutron stock not owned by the Company.\nYear Ended December 31, 1994 Compared With Year Ended December 31, 1993\nFiscal 1994 operating revenues decreased by 10% ($1,897,710) compared with revenues in fiscal 1993. The revenues for RAF declined 9% in fiscal year 1994, while those of Secutron declined 13% from fiscal 1993. RAF commissions, clearing fees, and transactional charges declined in 1994 and there was no offset to these declines by corporate or public finance, nor by the bank services division. In particular, decreasing clearing revenues were of concern, because these were not anticipated to recover without acquiring greater financial resources to become \"balance sheet competitive\" with other broker dealers offering similar services. Finally, in 1994, Secutron hardware and software sales declined faster and further on a percentage basis than did the revenues of RAF. Secutron, however, was undergoing a transition in 1994 of shifting its own customer base to the sale and service of IBM products as well as software sales to the brokerage community. Only net interest income showed an increase in 1994, increasing $69,358, or 16% over fiscal 1993.\n1994 operating expenses decreased by $1,581,394, or 8%, a decrease similar to the decrease in operating revenues. Support personnel and related\n- 16 -\nexpenses at RAF were reduced and various departments decreased expenses, including cost of sales in 1994 compared with 1993. Expenses related to additional administrative costs, or the Correspondent clearing division, declined materially in 1994 compared with 1993.\nLiquidity and Capital Resources\nAt September 30, 1995, the Company had working capital of $4,130,358, up from $2,442,283 on December 31, 1994.\nThe Company currently has a line of credit with its primary lender whereby the Company may borrow up to 75% of its billed directory accounts receivable under 60 days old. The Company currently has over $1,300,000 available on this line. The Company also has credit agreements with the Pershing Division of Donaldson, Lufkin & Jenrette, which includes a broker loan line of finance securities owned, securities held for correspondent accounts, and receivables in customer margin accounts. This line may also be used to release pledged collateral against day loans. Outstanding balances under these credit arrangements are adequate to meet the short term operating needs of RAF. Liquidity is expected to be adequate in fiscal 1996.\nInflation\nThe effects of inflation on the Company's operations is not material and is not anticipated to have any material effect in the future.\nNew Accounting Standards\nStatement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long Lived Assets to Be Disposed Of (SFAS 121) was issued in March, 1995, by the Financial Accounting Standards Board. It 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. SFAS 121 is required to be adopted for fiscal years beginning after December 15, 1995. Adopting this statement by the Company is not expected to have a significant effect on the consolidated financial statements.\nStatement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (SFAS 123), was issued by the Financial Accounting Standards Board in October, 1995. SFAS 123 establishes financial accounting and reporting standards for stock based employee compensation plans as well as transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. This statement defines a fair value based method of accounting for 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. Entities electing to remain with the accounting in Opinion 25 must make proforma disclosures of net income and, if presented, earnings per share, as if the fair value based method of accounting defined by SFAS 123 had been applied. SFAS 123 is applicable to fiscal years beginning after December 15, 1995. The Company currently accounts for its equity instruments using the accounting prescribed by Opinion 25. The Company does not currently expect to adopt the accounting prescribed by SFAS 123; however, the Company will include the disclosures required by SFAS 123 in future consolidated financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements and Supplementary Data that constitute Item 8 are included at the end of this report beginning on page.\n- 17 -\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 year ended September 30, 1994.\nOn September 1, 1995, the Company's former accountant, Eide Helmeke & Co. (\"Eide\"), located in Bismarck, North Dakota, resigned as the Company's principal accountant. Eide's report on the Company's consolidated financial statements for the fiscal year ended September 30, 1994 did not contain an adverse opinion or a disclaimer of opinion, nor was it qualified or modified as to any uncertainty, audit, scope or accounting principles. Following the Company's acquisition of RAFCO in April 1995, the Board of Directors recommended and approved a change in accountants from Eide to KPMG Peat Marwick, LLP. During the Company's fiscal years ended September 30, 1993, and 1994, and during the interim period from October 1, 1994 through April 30, 1995, there were no disagreements with Eide on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement, if not resolved to Eide's satisfaction, would have caused it to make a reference to the subject matter of the disagreement in connection with its report. The Company engaged KPMG Peat Marwick, Denver, Colorado, as its principal accountant on September 29, 1995.\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 and when his successor has been elected and qualified. The name, position with the Company, age of each director and the period during which each director has served are as follows:\nUnder the terms of the RAFCO Agreement, six of the seven members of the Board of Directors of the Company agreed to resign within 15 days after the date the RAFCO Agreement was signed and Dennis W. Olson, the seventh member of the Board, agreed to accept the resignations of the other six members and to appoint Robert A. Fitzner, Jr. and Robert L. Long as directors to fill two of the vacancies created by such resignations. Effective May 23, 1995, the resignations agreed to in the RAFCO Agreement were accepted, Messrs. Fitzner and Long were appointed as directors of the Company to fill two of the vacancies, and the size of the board of directors was set at three members. Other than the foregoing, there 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 death, 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:\n- 18 -\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:\nDirectorships.\nNo director of the Company is a director of any other entity that has its securities registered pursuant to Section 12 of the 1934 Act.\n(f) Involvement in Certain Legal Proceedings.\nNo event required to be reported hereunder has occurred during the past five years.\n- 19 -\n(g) Promoters and Control Persons.\nDisclosure under this paragraph is not applicable to the Company.\nCompliance With Section 16(a) of the Securities Exchange Act of 1934.\nTo the Company's knowledge, during the Company's fiscal year ended September 30, 1995, the only directors, officers or more than 10% shareholders of the Company that failed to timely file a Form 3, Form 4 or Form 5 were Dennis W. Olson, Marlow Lindblom, Roland Haux and Larry Scott, each of whom filed late Forms 5 reporting the following number of transactions involving stock ownership which was the result of participation in the Company's ESOP and 401(k) retirement plans: Dennis W. Olson: nine transactions reported on five Forms 5; Marlow E. Lindblom: nine transactions reported on five Forms 5; Larry Scott: nine transactions reported on five Forms 5; and Roland Haux: four transactions reported on three Forms 5.\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 by Dennis W. Olson, the President of the Company, Robert A. Fitzner, Jr., the president of RAF, and Robert L. Long, the senior vice president of RAF. RAF became a subsidiary of the Company in April of 1995.\nEffective September 30, 1988, the Company adopted an Incentive Stock Option Plan (\"Plan\"). The purpose of the Plan is to secure and retain key employees of the Company. The Plan authorizes the granting of options to officers, directors, and employees of the Company to purchase 600,000 shares of the Company's Common Stock subject to adjustment for various forms of recapitalization that may occur. No options may be granted after September 30, 1998, and fair value of options granted to each optionee cannot exceed $100,000 per year.\nAn employee must have six months of continuous employment with the Company before he or she may exercise an option granted under the Plan. Options under the Plan may not be granted at less than fair market value at the date of the grant. Options granted under the Plan are nonassignable and terminate three months after the optionee's employment ceases, except in the case of employment termination due to disability of the optionee, in which event the option expires twelve months from the date employment ceases. The Plan is administered by a committee selected by the Company's Board of Directors.\nEffective December 12, 1988, the Company granted options under the Plan to 37 individuals, which included 32 employees, the Company's three officers, and two outside directors, for each such individual to purchase 4,000 shares at $.70 per share through December 12, 1993. Such grants involved an aggregate of 148,000 shares. Employees hired after December 12, 1988, and with the Company for six consecutive months, were each granted options to purchase 4,000 shares of the Company's stock at the closing price on the date of the grant, limited to a floor of $.70 per share. At September 30, 1995, options to purchase 43,000 shares under the Plan had been exercised and other options previously granted to purchase 342,000 shares had expired. Currently there are no options outstanding and 557,000 shares remain in the Plan.\nOPTION GRANTS IN LAST FISCAL YEAR\nNo options were granted by the Company to Robert A. Fitzner, Jr., Dennis W. Olson or Robert L. Long during the Company's fiscal year ended September 30, 1995.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES\nThe following table sets forth information with respect to Dennis W. Olson and Robert L. Long concerning the exercise of options and underwriter's warrants during the Company's last fiscal year ended September 30, 1995, and unexercised options and warrants held as of September 30, 1995. Robert A. Fitzner, Jr. does not own any options or warrants to purchase securities of the Company.\n- 21 -\nCompensation of Directors--Standard Arrangement.\nPrior to the change in the members of the Board of Directors in May of 1995, directors of the Company who were not employees or officers received $1,000 per quarter. Since May of 1995, directors receive no compensation. Directors of Secutron who are not also officers or employees of Secutron receive $30,000 annually.\nLong Term Incentive Plans - Awards in Last Fiscal Year.\nDuring the year ended September 30, 1995, the executive officers of the Company earned or were awarded shares pursuant to the Company's Employee Stock Ownership Plan and the Company's 401(k) Plan as follows:\nOn September 22, 1989, the Company's Board of Directors adopted an Employee Stock Ownership Plan (\"ESOP Plan\") which provides in pertinent part that the Company may annually contribute tax deductible funds to the ESOP Plan, at its discretion, which are then allocated to the Company's employees based upon the employees' wages in relation to the total wages of all employees in the ESOP Plan.\nThe ESOP Plan provides that more than half of the assets in the ESOP Plan must consist of the Company's Common Stock. The ESOP Plan is administered by a board of trustees under the supervision of an advisory committee, both of which are appointed by the Company's board of directors. At September 30,1995, the ESOP Plan owned 493,900 shares of the Company's Common Stock and no other marketable securities. The ESOP Plan also had an outstanding bank loan of $350,000, which was secured by the stock in the ESOP Plan and was guaranteed by the Company. Employees become vested in the shares of the Company's Common Stock after six years in the ESOP Plan. Executive officers participate in the ESOP Plan in the same manner as other employees. Employees are 20% vested after two years, vesting an additional 20% each year up to 100% after six years in the ESOP Plan.\nOn April 1, 1991, the Company initiated a 401(k) plan, which provides in pertinent part that the Company's employees may deduct money from their paychecks on a pretax basis, which is invested into any of six investment choices provided by the 401(k) Plan. Taxes on funds invested in the 401(k) Plan are deferred until the money is drawn out, usually at retirement. All employees as of April 1, 1991, were eligible for the 401(k) Plan and new employees after that date become eligible for the 401(k) Plan on the April 1 or October 1 immediately following the completion of one year of employment. As an incentive, the Company provides a matching contribution of shares of the Company's Common Stock at the end of the year. This matching goes to all employees who are with the Company on September 30 and is a dollar for dollar matching up to the first $312.\n- 22 -\nEmployees become vested in this matching at the rate of 20% per year, commencing two years after employment begins, and they are 100% vested after six years with the Company. At September 30, 1995, 254,800 shares of the Company's Common Stock had been purchased by the 401(k) Plan. Officers participate in the Plan in the same manner as other employees.\nThe Company has no other bonus, profit sharing, pension, retirement, stock purchase, deferred compensation, or other incentive plans.\nEmployment Contracts and Termination of Employment and Change-In-Control Arrangements.\nThere is no employment contract between the Company or RAF and Robert A. Fitzner, Jr. Robert L. Long and RAF have an oral agreement whereby Mr. Long receives commissions based on a percentage of the dollar amount of his clients' transactions and the dollar amount of all RAF corporate finance transactions and he receives one half of all warrants received by RAF as compensation for corporate finance transactions.\nLegally effective as of January 1, 1995, the Company entered into an employment agreement with its president, Dennis W. Olson. The employment agreement is for a term of three years ending January 1, 1998; provides for annual compensation and benefits, provides that upon full disability, Mr. Olson will be entitled to full salary for three months, two thirds salary for three months, and one half salary for six months; provides that the employment agreement shall be binding upon any successor to the Company; and the agreement provides that, upon the expiration of the employment agreement, the Company shall be required, at Mr. Olson's option, to purchase from him up to 500,000 shares of the Company's Common Stock at $1.00 per share.\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 December 1, 1995, the number of shares of the Company's outstanding Common Stock and Preferred 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 and Preferred 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 and Preferred 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 and Preferred Stock respectively:\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.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a)(b) Transactions With Management and Others and Certain Business Relationships.\nCertain officers and directors of the Company have in the past made personal loans to the Company when it was in need of short term financing. At September 30, 1995, such loans from affiliates were as follows:\nThis loan is unsecured, at a rate that would generally be available from local banking institutions for good customers and is subordinated to then outstanding bank loans to the Company. All loan transactions with related persons have been on terms no less favorable than those available from third parties. It is probable that the Company will continue to engage in such borrowing activities in the future; however, there are currently no specific plans to do so.\nRobert A. Fitzner, Jr. became a director of the Company as a result of the reorganization transaction set forth in the RAFCO Agreement. See \"Business -- Acquisition of RAFCO.\" As a result of such reorganization\n- 24 -\ntransaction, Mr. Fitzner received 4,784,705 shares of the Company's Common Stock and 5,000 shares of the Company's Preferred Stock. As a result of such reorganization transaction, the Company assumed the obligation to Mr. Fitzner on a 10% senior subordinated note due December 31, 2003 in the amount of $50,000. As a result of such reorganization transaction, the Company issued 2,500 shares of Preferred Stock to Earlene E. Fitzner, Mr. Fitzner's mother, and the Company has assumed the obligation to pay a 10% senior subordinated note due December 31, 2003 in the principal amount of $150,000 to Mr. Fitzner's mother and has assumed the obligation to pay a 10% senior subordinated note due December 31, 2003 in the principal amount of $50,000 to Mr. Fitzner's father, Robert A. Fitzner, Sr.\nAs a result of the reorganization transaction set forth in the RAFCO Agreement, Kanouff Corporation became the beneficial owner of approximately 12.4% of the Company's outstanding stock. See \"Business -- Acquisition of RAFCO.\" Patricia M. Kanouff is an officer, director, and sole shareholder of Kanouff Corporation and John P. Kanouff, the husband of Patricia M. Kanouff, is an officer of Kanouff Corporation. John P. Kanouff is an officer, director, and shareholder of Hopper and Kanouff, P.C., a company providing legal services to clients, including the Company, RAF, and Secutron. During the period from October 1, 1994, to September 30, 1995, an aggregate of $316,000 was paid by the Company, RAF, and Secutron to Hopper and Kanouff, P.C. for legal services.\nRobert L. Long became a director of the Company as a result of the reorganization transaction set forth in the RAFCO Agreement. See \"Business -- Acquisition of RAFCO.\" During 1992, the Company entered into an investment banking agreement with RAF. As of April 26, 1995, RAF became a wholly owned subsidiary of the Company. One of the terms of Mr. Long's employment by RAF is that he will receive a percentage of any investment banking fees received by RAF. Under the investment banking agreement, the Company would be obligated to pay a fee to RAF as a result of the reorganization transaction between the Company and RAFCO which is described in \"Business -- Acquisition of RAFCO.\" RAF has agreed to waive its portion of any such investment banking fee. On April 26, 1995, the Company agreed to pay a merger and acquisition fee to Mr. Long in an amount to be determined by negotiation within a reasonable time after April 26, 1995. Dennis W. Olson, Robert A. Fitzner, Jr., and Robert L. Long are in the process of negotiating the amount of such fee.\nDennis W. Olson is currently an officer and a director of the Company. On April 27, 1995, the Company entered into an agreement to sell certain of its assets to Telecom as described in \"Business -- Sale of Directories to Telecom.\" Pursuant to the Telecom Agreement, Mr. Olson and certain other employees of the Company entered into agreements not to compete with Telecom. As compensation for this noncompetition agreement, Telecom has paid $100,000 out of the total of $250,000 to Mr. Olson. On April 27, 1995, the Company granted an option to Telecom to purchase additional assets of the Company, as described in \"Business - -- Sale of Option to Telecom.\" This option is exercisable for a period of two years beginning on June 1, 1997. If Telecom exercises this option, Mr. Olson and certain other employees of the Company will be obligated to enter into additional noncompete agreements with Telecom and will be paid additional amounts in consideration for such noncompete agreements. The amount of such noncompetition payments will not be determined until after Telecom exercises its option.\nOn March 22, 1995, Marlow E. Lindblom exercised a stock option and purchased 20,000 shares of Common Stock of the Company at $0.54 per share, and on April 28, 1995, Roland Haux exercised a stock option and purchased 70,000 shares of Common Stock of the Company at $0.58 per share. The Company has repaid the following loans to the president and former officers and directors: Dennis W. Olson was repaid $20,000 on April 18, 1995; Marlow E. Lindblom was repaid $10,000 on March 21, 1995; and Roland Haux was repaid $40,000 on April 27, 1995.\n- 25 -\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 Consolidated Balance Sheets--September 30, 1995 and 1994 Consolidated Statements of Operations--Nine Months Ended September 30, 1995 and Years Ended December 31, 1994 and 1993 Consolidated Statement of Changes in Stockholders' Equity--Nine Months Ended September 30, 1995 and Years Ended December 31, 1994 and 1993 Consolidated Statements of Cash Flows--Nine Months Ended September 30, 1995 and Years Ended December 31, 1994 and 1993 Notes to Consolidated Financial Statements\n(a)(2) Financial Statement Schedules.\nNone\n(b) Current Reports on Form 8-K:\nDuring the fiscal quarter ended September 30, 1995, one Current Report on Form 8-K was filed on July 10, 1995, amending a Current Report filed on May 9, 1995. The amended Current Report contained consolidated financial statements for RAFCO, Ltd. as of December 31, 1994 and 1993 and for the years ended December 31, 1992, 1993 and 1994, unaudited financial statements for RAFCO for the three months ended March 31, 1995, unaudited pro forma financial information for the Company as of March 31, 1995, for the six months ended March 31, 1995 and for the year ended September 30, 1994, and an auditor's report.\n(c) Exhibits.\nExhibit 2.1 Plan of Reorganization and Exchange Agreement dated April 26, 1995 with Exhibits A, B, C, F and I (incorporated by reference to Exhibit 2.1 to Registrant's 8-K dated May 9, 1995).\nExhibit 2.2 Sale and Purchase Agreement dated April 27, 1995, with Exhibits A and J (incorporated by reference to Exhibit 2.2 to Registrant's 8-K dated May 9, 1995).\nExhibit 2.3 Option Agreement dated April 27, 1995, with Exhibits A, B, and D (incorporated by reference to Exhibit 2.3 to Registrant's 8-K dated May 9, 1995).\nExhibit 3.0 Articles of Incorporation of Registrant.\nExhibit 3.0(i) Articles of Amendment to the Registrant's Articles of Incorporation dated April 28, 1995 (incorporated by reference to Exhibit 3.0(i) to Registrant's 8-K dated May 9, 1995).\nExhibit 3.2 Bylaws of Registrant.\nExhibit 9.1 Voting Trust Agreement between Robert A. Fitzner, Jr. and Dorothy K. Englebrecht dated June 2, 1995.\nExhibit 9.2 Voting Trust Agreement between Robert A. Fitzner, Jr. and Steven M. Fishbein dated June 2, 1995.\nExhibit 9.3 Voting Trust Agreement between Robert A. Fitzner, Jr. and Peter K. O'Leary dated June 2, 1995.\n- 26 -\nExhibit 9.4 Voting Trust Agreement between Robert A. Fitzner, Jr. and Arlene M. Wilson dated June 2, 1995.\nExhibit 10.1 Incentive Stock Option Plan as amended January 15, 1992.\nExhibit 10.2 Employee Stock Ownership Plan.\nExhibit 10.3 401(k) Plan.\nExhibit 10.4 Employment Agreement between Dennis W. Olson and the Regis- trant dated January 1, 1995.\nExhibit 10.5 Employees\/Officers\/Directors Form of Non-Competition Agreement; Covenant Not to Compete and Confidentiality Agreement (incorporated by reference to Exhibit 2.2 to Registrant's 8-K dated May 9, 1995).\nExhibit 16 Letter Re Change in Certifying Accountant.\nExhibit 21 Subsidiaries of the Registrant.\nExhibit 27 Financial Data Schedule\n- 27 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: January 16, 1996 FRONTEER DIRECTORY COMPANY, INC. a Colorado corporation\nBy: \/s\/ Dennis W. Olson ----------------------------------- Dennis W. Olson, President and Chief Executive Officer\nBy: \/s\/ Lance Olson ------------------------------------ Lance Olson, Principal Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nDate Name and Title Signature - ---- -------------- ---------\nJanuary 16, 1996 Dennis W. Olson, Director \/s\/ Dennis. W. Olson ------------------------\nJanuary 16, 1996 Robert A. Fitzner, Jr. \/s\/ Robert A. Fitzner, Jr. Director -------------------------\nJanuary 16, 1996 Robert L. Long, Director \/s\/ Robert L. Long ------------------------\n- 28 -\nSee accompanying notes to consolidated financial stateme\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nFRONTEER DIRECTORY COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. ORGANIZATION, BUSINESS COMBINATION, AND PRINCIPLES OF CONSOLIDATION - On April 26, 1995, Fronteer Directory Company, Inc. (Fronteer or the Company) entered into a Plan of Reorganization and Exchange Agreement (the Agreement) with RAFCO, Ltd. (RAFCO). Under the Agreement, Fronteer acquired all of the assets of RAFCO in exchange for the assumption by Fronteer of the liabilities of RAFCO and the issuance by Fronteer to RAFCO of 7,223,871 shares of $.01 par value common stock and 87,500 shares of $.10 par value series A voting cumulative preferred stock ($10.00 per share redemption value). RAFCO has dissolved as a corporation and has distributed Fronteer's common and preferred stock to the shareholders of RAFCO. As a result of the transaction, the former shareholders of RAFCO acquired a 55% interest in Fronteer. Accordingly, the transaction has been accounted for as a \"reverse acquisition\" of Fronteer by RAFCO using the purchase method of accounting and Fronteer's assets and liabilities have been adjusted to their market value as of the date of the business combination. The adjustment to market value resulted in an intangible asset, directory publishing rights, which was recorded at $6,972,468 (see note 6). Fronteer's operations have been included in the accompanying consolidated financial statements beginning May 1, 1995, the effective date of the transaction. As a result of the reverse acquisition accounting, historical financial statements presented for periods prior to the business combination date include the consolidated assets, liabilities, equity, revenues, and expenses of RAFCO only.\nThe consolidated financial statements include the Company and the accounts of Fronteer Directory (Fronteer) and its wholly-owned subsidiaries, Fronteer Personnel Services, Inc. (FPS), Fronteer Marketing Group, Inc. (FMG), and RAF Financial Corporation (RAF). They also include a majority-owned subsidiary, Secutron Corporation (Secutron). All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements.\nFronteer is engaged in the publishing and distribution of telephone directories, while FPS is engaged in employee leasing, and FMG is engaged in the telemarketing business. RAF operates as a registered securities broker\/dealer. Secutron is engaged in industry specific software development and provides consulting services.\nB. CASH EQUIVALENTS - For purposes of reporting cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nC. ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS - Fronteer grants credit to customers throughout the directory market, primarily in North Dakota. Although Fronteer has a diversified customer base, a substantial portion of its debtors' ability to honor their contract is dependent upon the economic conditions in North Dakota. Broker dealer customer receivables include amounts due on cash transactions and margin accounts.\nAmounts due to or from directors or officers of the Company, related to normal cash accounts, are not classified as customer related in accordance with the rules of the Securities and Exchange Commission.\nThe allowance for doubtful accounts is maintained at a level adequate to absorb probable losses and credit losses inherent in the business based upon Fronteer's prior history of credit losses. Management determines the adequacy of the allowance based upon reviews of individual accounts, recent loss experience, current economic conditions, the risk characteristics of the various categories of accounts and other pertinent factors. Fronteer establishes payment terms with customers ranging from a single payment due upon publication of the directory to twelve equal monthly payments commencing upon publication of the directory. Any accounts remaining on Fronteer's books fifteen months following publication of the directory, due to additional payment arrangements made with Fronteer outside of the original contract, are charged to the allowance for doubtful accounts.\nSecurities owned by customers are held as collateral for substantially all of the broker dealer customer receivables. An allowance for doubtful accounts has been established for all unsecured broker dealer customer receivables.\nD. SECURITIES - Securities transactions are recorded on a settlement-date basis, usually the third business day following the trade date. The effect of using settlement date rather than trade date for the recording of securities transactions is not significant.\nStatement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" requires that trading securities be recorded at market value. In accordance with financial reporting requirements for broker\/dealers, the Company's financial instruments, including securities, are all recorded at market value. Securities without a readily available market value are recorded at estimated fair value. Securities are valued monthly and the resulting unrealized appreciation or depreciation is included in operations as trading profit or loss. Realized gains and losses are determined using the average cost method.\nIn October 1994, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (FASB) No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\" which prescribes disclosure requirements for transactions in certain derivative financial instruments including futures, forward, swap, and option contracts, and other financial instruments with similar characteristics. Although RAF is authorized to enter into such transactions in the ordinary course of business, and may do so in the future, no such transactions were consummated during the nine months ended September 30, 1995.\nE. REVENUE AND COST RECOGNITION - Revenues from advertising sales are recognized at the point individual directories are published. Costs of selling and production are recorded as deferred directory costs when incurred and charged to cost of sales in the period during which the related directory is published. Deferred directory costs are allocated to incomplete directories based upon the relative percentage of contracts sold as of year-end on incomplete directories to total current year earned revenues. Printing costs are charged to cost of sales in the period during which the related directory is published. Costs of distribution are charged to cost of sales as incurred. General administrative costs are charged to expenses as incurred.\nRevenue from the sale of computer equipment and installation of software is generally recognized when the equipment and related software is installed and accepted by the customer.\nCosts incurred in researching, designing, and planning for the development of new software are included in computer hardware and software operations in the accompanying consolidated financial statements. All amounts are charged to operations as incurred until such time as the costs meet the criteria for capitalization. Such costs were not significant in 1995, 1994, or 1993.\nF. PROPERTY, FURNITURE, AND EQUIPMENT - Property and equipment are stated at cost. Additions, renewals and betterments are capitalized, whereas expenditures for maintenance and repairs are charged to expense. The cost and related accumulated depreciation of assets retired or sold are removed from the appropriate asset and depreciation accounts, and the resulting gain or loss is reflected in income.\nIt is the policy of the Company to provide depreciation using the accelerated and straight-line methods based on the estimated useful lives of the assets as follows: Estimated Description Useful Life ----------- -----------\nBuilding 40 years Vehicles & Furniture 3-5 years Equipment 5-10 years\nG. AMORTIZATION - Directory publishing rights are amortized over ten years using the straight-line method.\nH. INCOME TAXES - The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", which prescribes the use of the asset and liability method of accounting for income taxes.\nI. DESCRIPTION OF LEASING ARRANGEMENTS - The Company leases office space under operating leases from which its business is conducted in certain branches under short-term leasing arrangements. In addition, the Company leases equipment under leases classified as capital leases. All leases expire over the next year.\nJ. LOSS PER COMMON SHARE - Loss per common share has been calculated based upon the net loss available to common shareholders divided by the weighted average number of common shares outstanding during the period. Common stock equivalents, including outstanding options and warrants, are considered in determining the weighted average number of common shares outstanding during the period unless antidilutive.\nNOTE 2 - STOCKHOLDERS' EQUITY\nIn conjunction with the Agreement, the Company issued 87,500 shares of $.10 par value per share, Series A Voting Cumulative Preferred Stock (\"Series A Preferred\"). The stated value of the Series A Preferred is $10 per share and has a liquidation preference of $10 per share plus accrued and unpaid dividends. Regular dividends are 9% per annum payable quarterly. If the Company is for any reason unable to pay cash dividends, such unpaid dividends will accumulate without interest until the Company can legally pay such dividends. The Company has the option to redeem all or part of the Series A Preferred on a pro rata basis upon 90 days prior written notice at December 31, 1995, and at December 31 or each year thereafter at $11 per share plus unpaid dividends.\nNOTE 3 - SEGREGATED CASH\nPursuant to Rule 15c3-3 of the Securities and Exchange Commission, RAF is required to maintain cash or cash equivalents on deposit in special reserve bank accounts for the exclusive benefit of its customers. At September 30, 1995, RAF had balances in such accounts of approximately $296,000. All of this amount is in excess of the reserve requirement.\nNOTE 4 - SECURITIES OWNED\nSecurities owned by the Company as of September 30, 1995 and December 31, 1994, consist of the following:\nNOTE 5 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK\nAs a securities broker and dealer, RAF is engaged in various securities trading and brokerage activities. A portion of RAF's transactions are collaterized and are executed with and on behalf of institutional investors including other brokers and dealers.\nRAF's exposure to credit risk associated with the nonperformance of these customers in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile trading markets which may impair the customers' ability to satisfy their obligations to RAF. RAF's principal activities are also subject to the risk of counterparty nonperformance.\nIn the normal course of business, RAF's customer and correspondent clearance activities involve the execution, settlement, and financing of various customer securities transactions. These activities may expose RAF to off-balance sheet credit risk in the event the customer is unable to fulfill its contractual obligations.\nRAF's customer securities activities are transacted on either a cash or margin basis. In margin transactions, RAF extends credit and monitors cash and securities collateral in customers' accounts, subject to various regulatory margin requirements. In connection with these activities, RAF executes and clears customer transactions involving the sale of securities not yet purchased. Such transactions may expose RAF to off-balance sheet risk in the event margin requirements are not sufficient to fully cover losses which customers may incur. In the event the customer fails to satisfy it obligations, RAF may be required to purchase or sell financial instruments at prevailing market prices in order to fulfill the customer's obligations.\nNOTE 6 - INTANGIBLE ASSET AND SALE OF DIRECTORIES\nIn connection with the business combination discussed in note 1, Fronteer 's assets were adjusted to their fair market value pursuant to the purchase method of accounting, which resulted in an intangible asset, directory publishing rights, which was recorded at $6,972,468. Immediately thereafter, Fronteer sold ten of its directories to Telecom*USA Publishing. As a result of the purchase price allocation to the sold directories of $2,279,699, no gain or loss was recorded on the sale.\nNOTE 7 - LONG-TERM NOTES RECEIVABLE\nNotes receivable consist of the following:\nNOTE 8 - DEFERRED REVENUE\nSales contracts for advertising in directories not published totaled approximately $2,200,000 as of September 30, 1995. This amount will be recorded as revenue upon publication of the directories. The deferred revenue balance of $639,184 as of September 30, 1995, represents advance payments received on these contracts. These amounts together with the balances of the contracts will be recognized as revenue when the directories are published.\nNOTE 9 - PROPERTY, FURNITURE AND EQUIPMENT\nProperty, furniture and equipment is comprised of the following:\nDepreciation expense totaled $402,525 for the nine months ended September 30, 1995, and $395,572 and $493,772 for the years ended December 31, 1994 and 1993, respectively.\nNOTE 10 - NOTES PAYABLE TO RELATED PARTIES\nThe Company has various notes payable to related parties in the amount of $548,900 at September 30, 1995. Such notes payable are unsecured, payable on demand, and bear interest at a variable rate not to exceed the interest rate on the Company's line of credit with BNC National Bank. At September 30, 1995, the interest rate was 11.5%.\nNOTE 11 - LONG-TERM DEBT\nLong-term debt is comprised of the following:\nA line of credit agreement has been executed with BNC National Bank providing the Company with loans in the total amount of $1,300,000 on a revolving basis. The line of credit is due April 7, 1996 at which time all unpaid principal is due and payable. Interest on unpaid principal is payable monthly at the Wall Street Journal Prime Rate plus 2.75%. At September 30, 1995, no balances were outstanding under the line of credit.\nThe BNC National Bank loan agreement includes various restrictions affecting the conduct of Fronteer's business while the agreement is in force, including limited expansion. It also requires maintenance of net income of 2.5% of sales, equity to total assets of not less than 35%, and cash flow coverage of at least 100% of all debt service, and limiting the outstanding line of credit to 75% of accounts receivable less than 60 days old. Fronteer was in compliance with all provisions of the loan agreement as of September 30, 1995.\nMinimum principal payments required on long-term debt during the next five years are as follows: 1996 -$589,706; 1997 - $128,556; 1998 - $7,075; 1999 - $506,501; 2000 - $7,094; thereafter -$1,325,000.\nNOTE 12 - BROKER DEALER PAYABLES\nBroker dealer payables includes amounts due on customer margin debits collateralized by customer securities. Such amounts bear interest at a fluctuating rate that generally corresponds to the broker call money rate (7.5% at September 30, 1995).\nNOTE 13 - INCOME TAXES\nIncome tax benefit for the year ended December 31, 1993, consisted of the following:\nCurrent $ 15,264 Deferred 118,305 -------- $ 133,569 ======== Income tax benefit in 1993 differs from the amount computed by applying the federal statutory tax rate to loss before income taxes and cumulative effect of change in accounting for income taxes primarily due to state income taxes.\nTemporary differences between financial statement carrying amounts and the tax bases of assets and liabilities that result in significant deferred tax assets and liabilities at September 30, 1995 and December 31, 1994, are as follows:\nThe net deferred tax liability is presented in the accompanying consolidated balance sheets as follows:\nIn assessing the realizability of deferred tax assets, management considers whether it is more likely than not that the deferred tax asset will be realized. The ultimate realization of the deferred tax asset is dependent on the generation of future taxable income in the period in which the 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 on these considerations, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at September 30, 1995. In 1994, the change in the valuation allowance was an increase of $91,915.\nNet operating loss carryforwards for income tax purposes of approximately $165,000 will be available to offset future taxable income through 2010. Contribution carryforwards of approximately $158,000 expire in varying amounts through 2000.\nEffective January 1, 1993, the Company adopted the provisions of SFAS No. 109 on a prospective basis. The cumulative effect of this change in the method of accounting for income taxes was to decrease the net loss by $141,080. The adoption of SFAS No. 109 did not have a significant impact on the Company's 1993 provision for income taxes.\nNOTE 14 - LEASES\nOPERATING LEASES: Fronteer and RAF lease office space under long-term noncancelable operating leases. The leases for office space provide for annual escalations for utilities, taxes, and service costs, as well as escalating rental rates over the term of the leases. Minimum future rental payments required by such leases are as follows:\nYear ending September 30, 1996 $ 921,442 1997 940,593 1998 1,015,652 1999 990,649 2000 869,803 Thereafter 5,920,044\nRental expense included in the statement of operations totaled $917,963 for the nine months ended September 30, 1995, and $1,018,131 and $1,140,248 for the years ended December 31, 1994 and 1993, respectively.\nCAPITAL LEASES:\nThe Company has leased equipment under leases classified as capital leases. The following is a schedule of future minimum lease payments under the capital leases, as well as the present value of the net minimum lease payments as of September 30, 1995:\nYear ending September 30, 1996 $ 60,407 Less amount representing interest (3,235) --------\nPresent value of net minimum lease payments $ 57,172 =========\nNOTE 15 - EMPLOYEE STOCK OWNERSHIP AND EMPLOYEE BENEFIT PLANS\nThe Company has adopted an employee stock ownership plan (ESOP) for its employees. Contributions to the plan are at the discretion of the Company. All employees as of October 1, 1989 are eligible to participate in the plan and new employees after that date become eligible on April 1 or October 1 which follows the completion of one year of employment. The plan provides that more than half of the assets in the plan must consist of the Company's common stock. The plan has certain debt of $350,000 which has been used to purchase the Company's common stock. Such debt is guaranteed by the Company and accordingly has been recorded in the accompanying consolidated financial statements. During the nine months ended September 30, 1995, the Company contributed $10,000 to the plan.\nThe Company has a retirement savings plan covering all employees who are over 21 years of age and have completed one year of eligibility service. Persons employed as of April 1, 1991, the inception date of the plan, were included. The plan meets the qualifications of Section 401(k) of the Internal Revenue Code. Under this plan, eligible employees can contribute through payroll deductions up to 15% of their base compensation. The Company will make a discretionary matching contribution equal to a percentage of the employee's contribution. The Company contributed $44,934 during the nine months ended September 30, 1995.\nThe Company does not provide any post employment benefits to retired or terminated employees.\nNOTE 16 - STOCK OPTIONS\nAt September 30, 1995, the Company had 420,000 stock options outstanding, which were granted to certain officers and an outside public relations firm during 1992 and 1993. The exercise prices range from $.70 to $.95 per share. Of the total number of options outstanding, 80,000 expire March 6, 1996, and 340,000 expire August 26, 1997.\nThe Company has 156,250 warrants outstanding at September 30, 1995. Each warrant allows the holder to purchase one share of common stock at $.96 per share. The warrants can be exercised between June 26, 1993 and June 26, 1997.\nNOTE 17 - MINIMUM NET CAPITAL REQUIREMENTS\nThe Company, as a registered securities broker\/dealer, is subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1) (the Rule). The Company has elected to operate pursuant to the alternative computation provided by the Rule.\nUnder the alternative computation, the Company is required to maintain \"net capital\" equal to the greater of $250,000 or 2% of \"aggregate debit\" items (primarily customer-related receivables) included in the formula for Determination of Reserve Requirements for Brokers and Dealers, as those terms are defined in the Rule. In addition, equity capital may not be withdrawn if resulting \"net capital\" would be less than 5% of \"aggregate debits\". At September 30, 1995, the Company had a ratio of net capital to aggregate debits of 41%, a \"net capital\" requirement of $250,000, and actual \"net capital\" of $1,988,915.\nNOTE 18 - OFFICER LIFE INSURANCE\nAs of September 30, 1995, the Company is the owner-beneficiary of term life insurance policies on the lives of two officers:\nName Face Amount of Policy\nDennis Olson $ 1,000,000 Robert A. Fitzner 2,500,000\nNOTE 19 - SUPPLEMENTAL DISCLOSURES RELATED TO STATEMENTS OF CASH FLOWS Supplemental disclosures of cash flow information:\nNOTE 20 - SEGMENT REPORTING\nInformation regarding business segments is summarized below. Operations for Fronteer are for the period from the date of the business combination, May 1, 1995, to September 30, 1995. Operations for RAF and Secutron are for the nine months ended September 30, 1995.\nIdentifiable assets by industry are those assets that are used in the Company's operations in each industry.\nNOTE 21 - COMMITMENTS AND CONTINGENCIES\nThe Company has guaranteed a promissory note of the Fronteer Directory Company, Inc. Employee Stock Ownership Plan. The unpaid balance on this note totalled $350,000 as of September 30, 1995.\nThe Company is a defendant in certain arbitration and litigation matters arising from its activities as a broker\/dealer and underwriter. In the opinion of management, these matters have been adequately provided for in the accompanying financial statements, and the ultimate resolution of the arbitration and litigation will not have a significant adverse effect on the financial condition of the Company.\nEXHIBIT INDEX","section_15":""}
{"filename":"826930_1995.txt","cik":"826930","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business\nAMERICAN INCOME PARTNERS IV-B LIMITED PARTNERSHIP (the \"Partnership\") was organized as a limited partnership under the Massachusetts Uniform Limited Partnership Act (the \"Uniform Act\") on September 29, 1988 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 Managing General Partner (AFG Leasing IV Incorporated) and $100 from the Initial Limited Partner (AFG Assignor Corporation). The common stock of the Managing General Partner is owned by AF\/AIP Programs Limited Partnership, of which American Finance Group (\"AFG\"), a Massachusetts partnership, and a wholly-owned affiliate, are the 99% limited partners and AFG Programs, Inc., a Massachusetts corporation wholly-owned by Geoffrey A. MacDonald, is the 1% general partner. On December 29, 1988, the Partnership issued 873,935 units, representing assignments of limited partnership interests (the \"Units\"), to 1,331 investors. Unitholders and Limited Partners (other than the Initial Limited Partner) are collectively referred to as Recognized Owners. Subsequent to the Partnership's Closing, the Partnership had four General Partners: AFG Leasing IV Incorporated, a Massachusetts corporation, Daniel J. Roggemann, Martin F. Laughlin, and Geoffrey A. MacDonald (collectively, the \"General Partners\"). Pursuant to Section 7.6 of the Amended and Restated Agreement and Certificate of Limited Partnership (the \"Restated Agreement, as amended\"), the General Partners agreed to the withdrawal of Messrs. Laughlin and Roggemann as Individual General Partners. The General Partners are not required to make any other capital contributions except as may be required under the Uniform Act and Section 6.1(b) of the Restated Agreement, as amended.\n(b) Financial Information About Industry Segments\nThe Partnership is 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 are to acquire and lease equipment which will:\n1. Generate quarterly cash distributions;\n2. Preserve and protect invested capital; and\n3. Maintain substantial residual value for ultimate sale.\nThe Partnership has the additional objective of providing certain federal income tax benefits.\nThe Closing Date of the Offering of Units of the Partnership was December 29, 1988. The initial purchase of equipment and the associated lease commitments occurred on December 30, 1988. The acquisition of the equipment and its associated leases is described in Note 3 to the financial statements included in Item 14, herein. The Partnership will terminate no later than December 31, 1999.\nThe Partnership has no employees; however, it entered into a Management Agreement with AF\/AIP Programs Limited Partnership. At the same time, AF\/AIP Programs Limited Partnership entered into an identical Management Agreement with AFG (the \"Manager\") (collectively, the \"Management Agreement\"). The Manager's role, among other things, is 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 is compensated for such services as described in 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 is, and will continue to be, subject to various risks, including physical deterioration, technological obsolescence and defaults by lessees. A principal business risk of owning and leasing equipment is the possibility that aggregate lease revenues 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 is largely dependent upon the ability of the Managing 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.\nIn addition, the leasing industry is very competitive. Although all funds available for acquisitions have been invested in equipment, subject to noncancellable lease agreements, the Partnership will encounter considerable competition when equipment is re-leased or sold at the expiration of primary lease terms. The Partnership will compete with lease programs offered directly by manufacturers and other equipment leasing companies, including limited partnerships and trusts organized and managed similarly to the Partnership and including other AFG sponsored partnerships and trusts, which may seek to re-lease or sell equipment within their own portfolios to the same customers as the Partnership. Many competitors have greater financial resources and more experience than the Partnership, the General Partners and the Manager.\nGenerally, the Partnership is prohibited from reinvesting the proceeds generated by refinancing or selling equipment. Accordingly, it is anticipated that the Partnership will begin to liquidate its portfolio of equipment at the expiration of the initial and renewal lease terms and to distribute the net liquidation proceeds. As an alternative to sale, the Partnership may enter re-lease agreements when considered advantageous by the Managing General Partner and the Manager. In accordance with the Partnership's stated investment objectives and policies, the Managing General Partner also is considering winding-up the Partnership's operations, including the liquidation of its entire portfolio.\nRevenue 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.\nDefault by a lessee under a lease may cause equipment to be returned to the Partnership at a time when the Managing General Partner or the Manager is unable to arrange for the re-lease or sale of such equipment. This could result in the loss of a material portion of anticipated revenues and significantly weaken the Partnership's ability to repay related debt.\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 a 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.\nIncorporated herein by reference to Note 3 to the financial statements in the 1995 Annual Report.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIncorporated herein by reference to Note 7 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 1,200 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 are determined and distributed to the Partners quarterly. Each quarter's distribution may vary in amount. Distributions may be made to the Managing General Partner prior to the end of the fiscal quarter; however, the amount of such distribution reflects only amounts to which the Managing General Partner is entitled at the time such distribution is made. Currently, there are no restrictions that materially limit the Partnership's ability to distribute Distributable Cash From Operations and Distributable Cash From Sales or Refinancings or that the Partnership believes are likely to materially limit the future distribution of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings. The Partnership expects to continue to distribute all Distributable Cash From Operations and Distributable Cash From Sales or Refinancings on a quarterly basis.\nDistributions payable at December 31, 1995 and 1994 were $275,863 and $441,381, respectively.\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 Managing General Partner, and increased by any portion of such reserves deemed by the Managing 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 Managing 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 Managing 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 Managing General Partner, or (b) the proceeds from the sale of an interest in equipment pursuant to any agreement governing a joint venture which the Managing 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 Partners, 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 Managing General Partner and (ii) increased by any portion of such reserves deemed by the Managing 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 Recognized Owners and 1% to the General Partners until Payout and 85% to the Recognized Owners and 15% to the General Partners after Payout.\n\"Payout\" is defined as the first time when the aggregate amount of all distributions to the Recognized Owners of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings equals the aggregate amount of the Recognized Owners' original capital contributions plus a cumulative annual return of 10.5% (compounded quarterly 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 Recognized Owners exceed the amount required to satisfy the cumulative annual return of 10.5% (compounded quarterly) on the Recognized Owners' aggregate unreturned capital contributions, such calculation to be based on the aggregate unreturned capital contributions outstanding on the first day of each fiscal quarter.\nDistributable Cash From Operations and Distributable Cash From Sales or Refinancings (\"Distributions\") are distributed within 45 days after the completion of each quarter, beginning with the first full quarter following the Partnership's Closing Date. Each Distribution is described in a statement sent to the Recognized Owners.\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.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated herein by reference to the financial statements and supplementary data included in 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 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 IV Incorporated is the Managing General Partner of the Partnership. Under the Restated Agreement, as amended, the Managing General Partner is responsible for the operation of the Partnership's properties and the Recognized Owners have no right to participate in the control of such operations. The names, titles and ages of the Directors and Executive Officers of the Managing General Partner as of March 15, 1996 are as follows:\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 Managing General Partner or its Affiliates. There is no plan at the present time to make any officers or employees of the Managing 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 Managing General Partner or its Affiliates.\n(b) Compensation Pursuant to Plans\nNone.\n(c) Other Compensation\nAlthough the Partnership has no employees, as discussed in Item 11(a), pursuant to section 10.4 of the Restated Agreement, as amended, the Partnership incurs 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 services 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 the Individual General Partners or the Managing 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 Recognized Owners have voting rights with respect to:\n1. Amendment of the Restated Agreement;\n2. Termination of the Partnership;\n3. Removal of the General Partners; and\n4. Approval or disapproval of the sale of all, or substantially all, of 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 Managing General Partner of the Partnership is AFG Leasing IV Incorporated, an affiliate of AFG.\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 the years ended December 31, 1995, 1994 and 1993 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 is compensated for its services to the Partnership. Such services include all aspects of acquisition, management and sale of equipment. For acquisition services, AFG is compensated by an amount equal to 4.75% of Equipment Base Price paid by the Partnership. For management services, AFG is compensated by an amount equal to the lesser of (i) 5% of gross lease rental revenue earned by the Partnership or (ii) fees which the Managing General Partner reasonably believes to be competitive for similar services for similar equipment. Both of these fees are subject to certain limitations defined in the Management Agreement. Compensation to AFG for services connected to the sale of equipment is calculated as the lesser of (i) 3% of gross sale proceeds or (ii) one-half of reasonable brokerage fees otherwise payable under arm's length circumstances. Payment of the remarketing fee is subordinated to Payout and is subject to certain limitations defined in the Management Agreement.\nAdministrative charges represent amounts owed to AFG, pursuant to Section 10.4 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 purchased 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, Equipment on Lease.\nAll rents and proceeds from the sale of equipment are paid directly to either AFG or to a lender. AFG temporarily deposits collected funds in a separate interest-bearing escrow account prior to remittance to the Partnership. At December 31, 1995, the Partnership was owed $119,651 by AFG for such funds and the interest thereon. These funds were remitted to the Partnership in January 1996.\nOn August 18, 1995, Atlantic Acquisition Limited Partnership (\"AALP\"), a newly formed Massachusetts limited partnership owned and controlled by certain principals of AFG, commenced a voluntary cash Tender Offer (the \"Offer\") for up to approximately 45% of the outstanding units of limited partner interest in this Partnership and 20 affiliated partnerships sponsored and managed by AFG. The Offer was subsequently amended and supplemented in order to provide additional disclosure to unitholders; increase the offer price; reduce the number of units sought to approximately 35% of the outstanding units; and extend the expiration date of the Offer to October 20, 1995. Following commencement of the Offer, certain legal actions were initiated by interested persons against AALP, each of the general partners (4 in total) of the 21 affected programs, and various other affiliates and related parties. One action, a class action brought in the United States District Court for the District of Massachusetts (the \"Court\") on behalf of the unitholders (Recognized Owners), sought to enjoin the Offer and obtain unspecified monetary damages. A settlement of this litigation was approved by the Court on November 15, 1995. A second class action, brought in the Superior Court of the Commonwealth of Massachusetts (the \"Superior Court\") seeking to enjoin the Offer, obtain unspecified monetary damages, and intervene in the first class action, was dismissed by the Superior Court. The Plaintiffs have filed an appeal in this matter. The Recognized Owners of the Partnership tendered approximately 77,141 units or 8.83% of the total outstanding units of the Partnership to AALP. The operations of the Partnership are not expected to be adversely affected by these proceedings or settlements.\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 Number\n99 (b) Lease agreement with Kristian Gerhard Jebsen Skipsrederi A\/S was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 as Exhibit 28(b) and is incorporated herein by reference.\n99 (c) Lease agreement with Northwest Airlines, Inc. was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 as Exhibit 28(c) and is incorporated herein by reference.\n99 (d) Lease agreement with Bally's Health and Tennis Corporation was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 as Exhibit 28(d) and is incorporated herein by reference.\n99 (e) Lease agreement with Building Materials Corporation of America was filed in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 as Exhibit 99(e) and is incorporated herein by reference.\n(b) Reports on Form 8-K\nNone.\nExhibit 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of American Income Partners IV-B Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to the Partners of American Income Partners IV-B 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 Recognized Owners. A report will be furnished to the Recognized Owners subsequent to the date hereof.\nNo proxy statement has been or will be sent to the Recognized Owners.","section_14":"","section_15":""}
{"filename":"927627_1995.txt","cik":"927627","year":"1995","section_1":"Item 1. BUSINESS\nMain Place Funding Corporation (MPFC) was incorporated on June 24, 1994 in the state of Delaware. MPFC is a wholly owned, limited-purpose, finance subsidiary of NationsBank of Texas, N.A. (Parent), which is an indirect, wholly owned subsidiary of NationsBank Corporation (Corporation), a multi-bank holding company organized in 1968 under the laws of North Carolina. MPFC's sole purpose is to issue and sell mortgage-backed bonds and subordinated indebtedness and to acquire, own, hold and pledge the related mortgage notes and other assets serving as collateral in connection therewith. Its operations commenced on September 20, 1994 (Inception). For information regarding issuances of mortgage-backed bonds and subordinated indebtedness, see Note 4 to the Financial Statements at page.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nMPFC does not own or lease any physical property.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nMPFC has no legal actions or proceedings pending.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOmitted in accordance with General Instruction J to Form 10-K.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nAll of MPFC's outstanding Common Stock, its sole class of common equity on the date hereof, is owned by the Parent. Accordingly, there is no public trading market for MPFC's Common Stock. During 1995, MPFC paid cash dividends of $27.7 million to the Parent. MPFC paid no cash dividends during 1994.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nOmitted in accordance with General Instruction J to Form 10-K.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nNet income for the year ended December 31, 1995 was $31.2 million. Net income for the period from Inception through December 31, 1994 was $3.5 million.\nMPFC's net income reflects the impact of several factors such as the levels and the average interest rates of the mortgage loan portfolio and issuances of mortgage-backed bonds and subordinated notes, including securities market conditions and the volatility of interest rates.\nThe average yield on the mortgage loan portfolio for the year ended December 31, 1995 was 7.34 percent. The average yield on the mortgage loan portfolio for the period from Inception through December 31, 1994 was 7.32 percent. Changes in such average yield are primarily related to the mix between fixed- and adjustable-rate loans, the repricing terms of adjustable-rate loans, the impact of the general level of interest rates, the levels of prepayments of mortgage loans and normal scheduled amortization of the portfolio as a whole. For the year ended December 31, 1995, the average interest rates on the outstanding mortgage-backed bonds and subordinated notes were 6.27 percent and 7.90 percent, respectively.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements required by this Item are listed in the Index to Financial Statements on page.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes in or disagreements with accountants on accounting and financial disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOmitted in accordance with General Instruction J to Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nOmitted in accordance with General Instruction J to Form 10-K.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOmitted in accordance with General Instruction J to Form 10-K.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOmitted in accordance with General Instruction J to Form 10-K.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. The financial statements required by this Item are listed in the Index to Financial Statements on page.\nb. The following report on Form 8-K has been filed by the registrant during the quarter ended December 31, 1995:\nCurrent Report on Form 8-K dated October 31, 1995 and filed November 13, 1995, Item 7.\nc. The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are listed in the Index to Exhibits to this Annual Report on Form 10-K.\nd. All schedules are omitted because they are not applicable or the required information is shown 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.\nMain Place Funding Corporation ---------------------------------\nDate: March 25, 1996 \/s\/ Joe L. Price --------------------------------- Joe L. Price Senior Vice President--Accounting\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ John E. Mack President, Treasurer March 25, 1996 - ----------------------------- John E. Mack and Director (Principal Executive and Financial Officer)\n\/s\/ Joe L. Price Senior Vice President - March 25, 1996 - ----------------------------- Joe L. Price Accounting (Principal Accounting Officer)\n\/s\/ F. William Vandiver, Jr. Chairman and Director March 25, 1996 - ----------------------------- F. William Vandiver, Jr.\n\/s\/ James H. Luther Vice President and March 25, 1996 - ----------------------------- James H. Luther Director\n\/s\/ William L. Maxwell Director March 25, 1996 - ----------------------------- William L. Maxwell\nMAIN PLACE FUNDING CORPORATION\nPage ----\nReport of Independent Accountants.......................................\nFinancial Statements:\nBalance Sheet on December 31, 1995 and 1994........................\nStatement of Income for the Year Ended December 31, 1995 and for the Period from Inception through December 31, 1994....................\nStatement of Cash Flows for the Year Ended December 31, 1995 and for the Period from Inception through December 31, 1994................\nStatement of Changes in Shareholder's Equity for the Year Ended December 31, 1995 and for the Period from Inception through December 31, 1994..................................................\nNotes to Financial Statements...........................................\nReport of Independent Accountants\nTo the Board of Directors and Shareholder of Main Place Funding Corporation\nIn our opinion, the accompanying balance sheet and related statements of income, of changes in shareholder's equity and of cash flows present fairly, in all material respects, the financial position of Main Place Funding Corporation at December 31, 1995 and 1994, and results of its operations and its cash flows for the year ended December 31, 1995 and for the period from inception through 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 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\nCharlotte, North Carolina March 20, 1996\nMain Place Funding Corporation Notes to Financial Statements\nNote 1 - Accounting Policies\nBasis of Presentation\nMain Place Funding Corporation (MPFC) was incorporated on June 24, 1994. It is a wholly owned, limited-purpose, finance subsidiary of NationsBank of Texas, N.A. (Parent), which is an indirect, wholly owned subsidiary of NationsBank Corporation (Corporation). MPFC's sole purpose is to issue and sell mortgage-backed bonds and subordinated indebtedness and to acquire, own, hold and pledge the related mortgage notes and other assets serving as collateral in connection therewith. Its operations commenced on September 20, 1994 (Inception).\nThe accompanying financial statements have been prepared in accordance with generally accepted accounting principles.\nThe preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and disclosures. Significant estimates made by management are discussed in these footnotes as applicable.\nCash and Cash Equivalents\nCash and cash equivalents includes cash items in the process of collection and amounts due from affiliated banks.\nLoans\nLoans are reported at their outstanding principal balances, net of any charge- offs and unamortized premiums or discounts. Discounts and premiums are amortized to income using methods that approximate the interest method.\nNonperforming Loans\nLoans that are past due 120 days or more as to principal or interest, or where reasonable doubt exists as to timely collection, are generally classified as nonperforming loans unless well secured and in the process of collection. Generally, loans which are past due 180 days or more as to principal or interest are classified as nonperforming regardless of collateral or collection status.\nInterest collections on nonperforming loans for which the ultimate collectibility of principal and interest is uncertain are applied as reductions in book value. Otherwise, such collections are credited to income when received.\nAllowance for Credit Losses\nThe allowance for credit losses is available to absorb losses inherent in the credit extension process. Credit exposures deemed to be uncollectible are charged against the allowance for credit losses. Recoveries of previously charged-off amounts are credited to the allowance for credit losses.\nMPFC's process for determining an appropriate allowance for credit losses includes management judgment and use of estimates. The adequacy of the allowance for credit losses is reviewed regularly by management. Additions to the allowance for credit losses are made by charges to the provision for credit losses. On a quarterly basis, a comprehensive review of the adequacy of the allowance for credit losses is performed. This assessment is made in the context of historical losses, as well as existing economic conditions.\nOther Real Estate Owned\nLoans are classified as other real estate owned when MPFC forecloses on a property or when physical possession of the collateral is taken regardless of whether foreclosure proceedings have taken place. Other real estate owned is carried at the lower of (1) the recorded amount of the loan for which the foreclosed property previously served as collateral or (2) the fair value of the property minus estimated costs to sell. Prior to foreclosure, the recorded amount of the loan is reduced, if necessary, to the fair value, minus estimated costs to sell, of the real estate to be acquired by charging the allowance for credit losses.\nSubsequent to foreclosure, gains or losses on the sale of and losses on the periodic revaluation of other real estate owned are credited or charged to expense. Net costs of maintaining and operating foreclosed properties are expensed as incurred.\nIncome Taxes\nThere are two components of income tax provision: current and deferred.\nCurrent income tax provisions approximate taxes to be paid or refunded for the applicable period.\nBalance sheet amounts of deferred taxes are recognized on the temporary differences between the bases of assets and liabilities as measured by tax laws and their bases as reported in the financial statements. Deferred tax expense or benefit is then recognized for the change in deferred tax liabilities or assets between periods.\nRecognition of deferred tax balance sheet amounts is based on management's belief that it is more likely than not that the tax benefit associated with certain temporary differences, tax operating loss carryforwards and tax credits will be realized.\nMPFC's operating results are included in the consolidated federal income tax return of the Corporation. The method of allocating federal income tax expense is determined under a tax allocation agreement. This agreement specifies that income tax expense will be computed for all subsidiaries on a separate company method, taking into account tax planning strategies and the tax position of the consolidated group.\nNote 2 - Mortgage Loans\nOn December 31, 1995, nonperforming loans totaled $188 thousand. There were no nonperforming loans on December 31, 1994.\nOther real estate owned amounted to $763 thousand on December 31, 1995. There was no other real estate owned on December 31, 1994.\nNote 3 - Affiliate Transactions\nIn conjunction with establishing MPFC, the Parent contributed $1.6 billion of mortgage loans to MPFC, net of an allowance for credit losses of $11.0 million. During 1995, additional mortgage loans totaling $3.4 billion, net of an allowance for credit losses of $6.9 million, were contributed by the Parent to MPFC.\nOn February 1, 1996, the Parent contributed an additional $501 million of mortgage loans to MPFC.\nMPFC has entered into an agreement with NationsBanc Mortgage Corporation, a subsidiary of the Parent, for the servicing and administration of its mortgage portfolio. Servicing expense for the year ended December 31, 1995 approximated $7.7 million.\nMPFC maintains its cash and cash equivalent accounts primarily with the Parent.\nNote 4 - Long-Term Debt\nIn September 1994, the Securities and Exchange Commission declared effective MPFC's shelf registration statement (Registration Statement) to issue up to $4 billion of Mortgage-Backed Bonds (Bonds). The Bonds, which are issuable in series pursuant to separate indentures, will be generally subject to the following terms. The Bonds, collateralized primarily by 1 to 4 family mortgage loans, will be obligations solely of MPFC. The Bonds will not be prepayable at the option of MPFC, but will be subject to redemption in whole or in part under certain circumstances. Under the terms of an indenture relating to a series of Bonds, MPFC must maintain a minimum amount of eligible collateral, which is determined on a discounted basis and may consist of mortgage loans, certain U.S. agency mortgage pass-through certificates, U.S. government securities and cash held by a trustee (the Trustee). The types, characteristics and permitted amounts of eligible collateral are subject to change from time to time without the consent of the bondholders if such changes would not adversely affect the ratings assigned to the Bonds. In the event such collateral requirements are not met with respect to any series, MPFC must provide additional or substitute mortgage loans or other acceptable collateral with respect to such series to meet the required amount of eligible collateral and\/or repurchase Bonds in an amount sufficient to meet collateral requirements. If sufficient eligible collateral is not supplied and\/or sufficient Bonds are not repurchased, MPFC must redeem a portion of the outstanding Bonds of such series such that the existing amount of eligible collateral meets the collateral requirements of the indenture relating to the Bonds of such series that remain outstanding after the redemption.\nOn July 18, 1995, MPFC issued $1.5 billion of Mortgage-Backed Bonds, Series 1995-1, due 1998 (Series 1995-1 Bonds), bearing interest at the one-month London interbank offered rate (LIBOR) plus 21 basis points with a maximum interest rate of 12 percent. The proceeds from the issuance of the Series 1995-1 Bonds were used to return to the Parent approximately $982 million of capital and to repay a portion of the October 1994 subordinated note discussed below. On October 31, 1995, MPFC issued $1.5 billion of Mortgage-Backed Bonds, Series 1995-2, due 2000 (Series 1995-2 Bonds), bearing interest at the three-month LIBOR plus 17 basis points. The proceeds from the issuance of the Series 1995- 2 Bonds were used to return to the Parent approximately $1.5 billion of capital. On December 31, 1995, all of the Series 1995-1 and 1995-2 Bonds were outstanding with interest rates of 5.96 percent and 6.1075 percent, respectively, based on the rate in effect on December 31, 1995, and were collateralized by mortgage loans with a book value of approximately $2.2 billion and $2.3 billion, respectively. On January 5, 1996, the discounted value of the eligible collateral for the Series 1995-1 and 1995-2 Bonds, as computed by the Trustee, was approximately $1.6 billion and $1.8 billion, respectively, and exceeded the amount required by the terms of the related indentures by approximately $98 million and $261 million, respectively.\nOn October 2, 1994, MPFC borrowed $1.3 billion under a subordinated note from the Parent. On November 30, 1995, MPFC borrowed $925 million under an additional subordinated note from the Parent, which note subsequently was increased to $934 million. The proceeds from the notes were used to return capital to the Parent. The subordinated notes bear interest at 8.0% and 6.5%, respectively, which is payable quarterly in arrears. The notes mature on September 25, 1999 and September 25, 2000, respectively, and are subordinated to all of MPFC's senior debt, including the Bonds. MPFC may repay amounts, from time to time, owed under the subordinated notes from funds which are not subject to the lien of any indenture relating to any senior debt. On December 31, 1995, $594 million and $726 million, respectively, was owed on the subordinated notes.\nInterest expense on the subordinated notes for the year ended December 31, 1995 and for the period from Inception through December 31, 1994 was $87.8 million and $25.7 million, respectively. Interest expense on the Series 1995-1 and Series 1995-2 Bonds for the year ended December 31, 1995 was $59.0 million.\nAs of March 25, 1996, MPFC had $1 billion of remaining shelf capacity under the Registration Statement.\nNote 5 - Income Taxes\nCurrent income tax expense is determined as if MPFC filed a separate tax return and the amount so determined is payable to or receivable from the Corporation. Current federal taxes payable to the Corporation of $18.7 million and $1.9 million are included in the balance sheet on December 31, 1995 and 1994, respectively.\nDeferred income tax expense or benefit is determined by the change in the deferred tax asset or liability between periods. The deferred tax asset or liability balance at the end of any period is determined by the tax effect of MPFC's cumulative temporary differences to the extent recognized by the Corporation. Deferred tax assets of $6.2 million and $3.8 million on December 31, 1995 and 1994, respectively, represent amounts established in conjunction with the loan contributions from the Parent, as discussed more fully in Note 3, and are included in the balance sheet. The most significant component of MPFC's deferred tax asset is the loan loss reserve.\nCurrent income tax expense was $16.8 million for the year ended December 31, 1995. For the period from Inception through December 31, 1994, current income tax expense was $1.9 million.\nNote 6 - Fair Values of Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments,\" requires the disclosure of the estimated fair values of financial instruments. The fair value of an instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices, if available, are utilized as estimates of the fair values of financial instruments. Fair values of items for which no quoted market price is available have been derived based on management's assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. The estimation methods for individual classifications of financial instruments are more fully described below. Different assumptions could significantly affect these estimates. Accordingly, the net realizable values could be materially different from the estimates presented below.\nIn addition, the estimates are only indicative of individual instruments' values and should not be considered an indication of the fair value of MPFC.\nShort-Term Financial Instruments\nThe carrying value of short-term financial instruments, including cash and cash equivalents and amounts due from the Trustee, approximates the fair value. These financial instruments generally expose MPFC to limited credit risk and have no stated maturities or maturities of less than 30 days.\nMortgage Loans\nFair values were estimated for the mortgage loans based on credit quality and maturity. The fair value of fixed-rate loans was estimated by discounting estimated future cash flows using the December 31 origination rate for similar loans. Contractual cash flows were adjusted for prepayments using published industry data. For variable-rate loans, the carrying amount was considered to approximate fair value. Where credit deterioration has occurred, cash flows for fixed- and variable-rate loans have been reduced to incorporate estimated losses. Where quoted market prices were available, such market prices were utilized as estimates of fair value.\nLong-Term Debt\nThe fair value of the subordinated notes was estimated by using the December 31 market rates on similar debt. The book value was considered to approximate fair value for the Series 1995-1 and Series 1995-2 Bonds.","section_15":""}
{"filename":"60086_1995.txt","cik":"60086","year":"1995","section_1":"Item 1. Business.\nLoews Corporation is a holding company. Its subsidiaries are engaged in the following lines of business: property, casualty and life insurance (CNA Financial Corporation, an 84% owned subsidiary); the production and sale of cigarettes (Lorillard, Inc., a wholly owned subsidiary); the operation of hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary); the operation of oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 70% owned subsidiary); and the distribution and sale of watches and clocks (Bulova Corporation, a 97% owned subsidiary).\nUnless the context otherwise requires, the terms \"Company\" and \"Registrant\" as used herein mean Loews Corporation and its subsidiaries, on a consolidated basis.\nInformation relating to the major business segments from which the Company's consolidated revenues and income are derived is contained in Note 21 of the Notes to Consolidated Financial Statements, included in Item 8.\nCNA FINANCIAL CORPORATION\nCNA Financial Corporation (\"CNA\") was incorporated in 1967 as the parent company of Continental Casualty Company (\"CCC\"), incorporated in 1897, and Continental Assurance Company (\"CAC\") incorporated in 1911. In 1975, CAC became a wholly owned subsidiary of CCC. On May 10, 1995, CNA acquired all of the outstanding shares of The Continental Corporation (\"CIC\") for approximately $1.1 billion, or $20 per CIC share. The Continental Corporation, a New York corporation incorporated in 1968, is an insurance holding company. Its principal subsidiary, The Continental Insurance Company, was organized in 1853. Its principal business is the ownership of a group of property\/casualty insurance companies.\nCNA's property\/casualty insurance operations are conducted by CCC and its property\/casualty insurance affiliates, and CIC and its property\/casualty insurance affiliates. Life insurance operations are conducted by CAC and its life insurance affiliate. As a multiple-line insurer, CNA underwrites property, casualty, life, and accident and health coverages. CNA's principal market for insurance is the United States. CNA accounted for 78.75%, 81.27% and 80.32% of the Company's total revenue for the years ended December 31, 1995, 1994, and 1993, respectively.\nThe following provides information regarding CNA's property\/casualty insurance and life insurance operations.\nPROPERTY\/CASUALTY INSURANCE\nCNA's property\/casualty operations market commercial and personal lines of property\/casualty insurance through independent agents and brokers.\nCNA and its property\/casualty insurance subsidiaries write primarily commercial lines coverages. Customers include large national corporations, small- and medium-sized businesses, groups and associations, and professionals. Coverages are written primarily through traditional insurance contracts under which risk is transferred to the insurer. Many large commercial account policies are written under retrospectively-rated contracts which are experience-rated. Premiums for such contracts may be adjusted, subject to limitations set by contract, based on loss experience of the insureds. Other experience-rated policies include provisions for adjustments to dividends based on loss experience. Experience-rated contracts reduce but do not eliminate risk to the insurer. Approximately 12% of CNA's property\/casualty insurance is written on an experience-rated basis.\nCNA also provides loss control, policy administration and claim administration services under service contracts for fees. Such services are provided primarily in the workers' compensation market where retention of more risk by the employer through self-insurance or high-deductible programs has become increasingly prevalent.\nCommercial business includes such lines as workers' compensation, general liability, professional and specialty, multiple peril, and accident and health coverages. Professional and specialty coverages include liability coverage for architects and engineers, lawyers, accountants, medical and dental professionals; directors and officers liability; and other specialized coverages. CNA also assumes commercial risks from other insurers. The major components of CNA's commercial business are workers' compensation, general liability and professional and specialty coverages, which accounted for 19%, 19% and 18%, respectively, of 1995 premiums earned.\nCNA is required by the various states in which it does business to provide coverage for risks that would not otherwise be considered under CNA's underwriting standards. CNA's share of involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state. Premiums for involuntary risks result from mandatory participation in residual markets.\nCNA also markets personal lines of insurance, primarily automobile and homeowners coverages sold to individuals under monoline and package policies. The CIC meger made CNA the market leader in package personal lines products.\nThe following table sets forth supplemental data for the property\/casualty business:\n- ---------------- (a) Premiums earned, net investment income and underwriting loss includes the results of CIC since May 10, 1995.\n(b) Property\/casualty involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other involuntary charges.\n(c) GAAP trade ratios reflect the results of CCC and its property\/casualty insurance subsidiaries for the whole year, along with the results of CIC since May 10, 1995. Statutory trade ratios reflect the results of CCC, its property\/casualty insurance subsidiaries and CIC for the entire year of 1995. Prior year ratios have not been restated to include CIC. Trade ratios are industry measures of property\/casualty underwriting results. The loss ratio is the percentage of incurred claim and claim adjustment expenses to premiums earned. Under generally accepted accounting principles, the expense ratio is the percentage of underwriting expenses, including the change in deferred acquisition costs, to premiums earned. Under statutory accounting principles, the expense ratio is the percentage of underwriting expenses (with no deferral of acquisition costs) to premiums written. The combined ratio before policyholder dividends is the sum of the loss and expense ratios. The policyholder dividend ratio is the ratio of dividends incurred to premiums earned.\n(d) Other data is determined on the basis of statutory accounting practices and reflects a capital contribution from CNA of $475 million in 1993. In addition, dividends of $325, $175 and $150 million were paid to CNA by CCC in 1995, 1994 and 1993, respectively. Property\/casualty insurance subsidiaries have received reimbursement from CNA for general management and administrative expenses, unallocated loss adjustment expenses and investment expenses of $197.0, $169.6 and $167.5 million in 1995, 1994 and 1993, respectively.\nThe following table displays the distribution of domestic written premium by state:\nThe growth and profitability of CNA's property\/casualty insurance business is dependent on many factors, including competitive and regulatory influences, the efficiency and costs of operations, underwriting quality, the level of natural disasters, and investment results.\nCNA's property\/casualty operations continued to show significant improvement in profitability during 1995, reflecting both improved investment income and improved underwriting results. Contributing to the improved underwriting results were continued favorable claim frequency (rate of claim occurrence) and severity (average cost per claim) in the workers' compensation line. Legislative reforms have cut costs in some states, residual market losses have dropped, and the insurance regulators have sharpened their focus on workers' compensation fraud.\nIn an effort to maintain growth, CNA has intensified efforts in the political arena to achieve a more predictable and equitable insurance marketing climate. CNA's marketing strategies include emphasizing responsible pricing over premium growth and aggressively adapting to changes in markets such as those in which self-insurance has become important. CNA has also initiated wide-scale cost management measures. CNA has continued actions to reduce or stabilize the cost of doing business, including costs of health care, fraud and tort liability. Programs include managed health care programs and intensified efforts of fighting fraud.\nProperty\/Casualty Claim and Claim Expenses: Property\/casualty claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims, are based on undiscounted (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of losses on assumed insurance, and (d) estimates of future expenses to be incurred in settlement of claims. In establishing these estimates, consideration is given to current conditions and trends as well as past CNA and industry experience. The schedule on page 4 provides information on mix of business.\nStructured settlements have been negotiated for claims on certain property\/casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from CAC. Related annuity obligations are carried in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at discounted values which approximate the alternative cost of annuity purchases. Such reserves, discounted at interest rates ranging from 6.3% to 7.5%, totaled $897.0 and $839.0 million at December 31, 1995 and 1994, respectively. Ultimate payouts under all structured settlements, funded or unfunded, at December 31, 1995 and 1994 will approximate $3.0 and $2.4 billion, respectively.\nThe loss reserve development table below illustrates the change over time of reserves established for property\/casualty claim and claim expenses at the end of various calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows reestimates of the original recorded reserve as of the end of each successive year which is the result of CNA's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest reestimated reserve to the reserve originally established, and indicates whether or not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims.\nThe loss reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.\n* Represents CIC reserves acquired on May 10, 1995 and subsequent development thereon, through December 31, 1995. This balance needs to be combined with balances reflected in the 1994 column to determine development recorded for the consolidated CNA property\/casualty subsidiaries.\nMost of CNA's unfavorable reserve development has been due to asbestos and environmental claims. See Note 10 of the Notes to Consolidated Financial Statements, included in Item 8, for information regarding property\/casualty claim and claim expenses including reserve development for asbestos and environmental claims. A discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims can be found in Note 19 of the Notes to Consolidated Financial Statements, included in Item 8.\nLIFE INSURANCE\nCNA's life insurance operations market individual and group insurance products through licensed agents, most of whom are independent contractors, who sell life and\/or group insurance for CNA and for other companies on a commission basis.\nIndividual insurance products include life and annuity products, which are sold to individuals and small businesses. The individual life products currently being marketed consist primarily of term, universal and participating life policies and annuities. The individual accident and health policies currently being marketed are long-term disability products. Individual annuity products consist of both single premium annuities and periodic payment annuities.\nGroup insurance products include life, accident and health and pension products which are sold to employers, employer associations and trusts, ranging in size from small local employers to large multinational corporations. The group accident and health plans are primarily major medical and hospitalization. Most of the major medical and hospitalization plans are written under experience-rated contracts or contracts to provide claim administrative services only. The growth in premium and life insurance in-force is attributable to new term and permanent life products, as well as annuities.\nCNA's products are designed and priced using assumptions CNA management believes to be reasonably conservative for mortality, morbidity, persistency, expense levels and investment results. Underwriting practices that CNA management believes are prudent are followed in selecting the risks that will be insured. Further, actual experience related to pricing assumptions is monitored closely so that prospective adjustments to these assumptions may be implemented as necessary. CNA mitigates the risk related to persistency by including contractual surrender charge provisions in its ordinary life and annuity policies in the first five to ten years, thus providing for the recovery of acquisition expenses. The investment portfolios supporting interest sensitive products, including universal life and individual annuities, are managed separately to minimize disintermediation and interest rate risk.\nProfitability in the health insurance business continues to be impacted by intense competition and rising medical costs. CNA has aggressively pursued expense reduction through increases in automation and other productivity improvements. Further, increasing costs of health care have resulted in a continued market shift away from traditional forms of health coverage toward managed care products and experience-rated plans. CNA's ability to compete in this market will be increasingly dependent on its ability to control costs through managed care techniques, innovation, and quality customer focused service in order to properly position CNA in the evolving health care environment.\nAlthough comprehensive health care reforms were not enacted in 1995, some health care initiatives could emerge in 1996. CNA has urged a meaningful role for the private sector in any proposed plan. The present health care system is clearly in need of reform, and CNA has emphasized that the competitive strengths of the insurance industry must be an integral part of a workable solution.\nThe following table sets forth supplemental data for the life insurance business:\nGuaranteed Investment Contracts\nCAC writes the majority of its group pension products as guaranteed investment contracts (\"GIC's\") in a fixed Separate Account, which is permitted by Illinois insurance statutes. CAC guarantees principal and a specified return to GIC contract holders. This guarantee affords the contract holders additional security, in the form of CAC's general account surplus, which supports the principal and interest payments.\nCNA manages the liquidity and interest rate risks on the GIC portfolio by matching the duration of fixed maturity securities included in the guaranteed investment contract portfolio with the corresponding payout pattern of the contracts, and assessing market value surrender charges on the majority of the contracts.\nThe table below shows a comparison of the duration of assets and contracts, weighted average investment yield, weighted average interest crediting rates and withdrawal characteristics of the GIC portfolio.\nAs shown above, the investment yields at December 31, 1995 and 1994 were more than the average crediting rate. The investment yield at December 31, 1993 was less than the average crediting rate. This resulted from the reinvestment of proceeds from security sales that generated substantial gains, at rates that were lower than those of the securities sold. However, because the security sales created a larger asset base to reinvest, the aggregate future cash flows from interest and principal were substantially unchanged and sufficient to meet the contract obligations.\nINVESTMENTS\nCNA's general account investment portfolio is managed to maximize after tax investment return, while minimizing credit risks with investments concentrated in high quality securities to support its insurance underwriting operations. CNA has the capacity to hold its fixed maturity portfolio to maturity. However, securities may be sold as part of CNA's asset\/liability strategies or to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed maturity securities are classified as available-for-sale. CNA's portfolio is managed based on the following investment strategies: (i) diversification is used to limit exposures to any one issue or issuer, and (ii) in general, the public market is used in order to provide liquidity.\nHistorically, CNA has maintained short-term assets at a level that provided for liquidity to meet its short-term obligations, principally anticipated claim payments. At December 31, 1995, short-term investments primarily consisted of U.S. treasury bills and high-grade commercial paper. The major components of the short-term investment portfolio were $0.8 billion of collateral for securities sold under agreements to repurchase, $1.0 billion in an escrow account (see Note 1 of the Notes to Consolidated Financial Statements, included in Item 8) and approximately $1.9 billion of other short-term investments.\nThe following summarizes CNA's distribution of general account investments:\nCNA's general account fixed income portfolio has consistently been of high quality as illustrated in the following table using the Standard & Poor's ratings convention (see Note below).\nCNA's Separate Account investment portfolio is managed to specifically support the underlying insurance products (see the discussion of GIC's in \"Life Insurance\" above). Approximately 85%, or $5.0 billion, of Separate Account investments are used to fund GIC's; the remaining investments are used to fund variable products. Approximately 96% of the GIC investment portfolio is comprised of taxable fixed income securities. The quality of the GIC fixed maturity portfolio is as follows (see Note below):\nNote: The bond ratings shown in the two tables above are primarily from Standard & Poor's (93% of the general account portfolio and 95% of the GIC portfolio in 1995). In the case of private placements and other unrated securities, comparable internal ratings are developed by CNA. These ratings are derived by management using available information on the issuer to assess the credit risk. Reference also may be made to similar instruments of the issuer that are rated by Standard & Poor's. In the case of unrated municipal bonds, an AAA rating may be assigned to issues with financial guarantee insurance.\nHigh yield securities generally involve a greater degree of risk than that of investment grade securities. Expected returns should, however, compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. CNA's concentration in high yield bonds including Separate Accounts was approximately 4.7% of its total assets. In 1995, the level of high yield investments within the GIC portfolio decreased $158 million to $944 million at year end. This decrease is a result of the relative attractiveness of other investment opportunities in comparison to the high yield investment market during the year.\nAt December 31, 1995 and 1994, high yield securities within the general and GIC portfolios were carried at fair value and amounted to $2.8 and $2.1 billion, respectively. Market value exceeded amortized cost for high yield securities by approximately $53 million at December 31, 1995 compared to December 31, 1994 when amortized cost exceeded market value by $138 million.\nIncluded in CNA's 1995 AAA-rated fixed income securities (general and GIC portfolios) are $8.5 billion of asset-backed securities, consisting of approximately 57% in U.S. government agency issued pass-through certificates, 32% in collateralized mortgage obligations (\"CMO's\") and 11% in corporate asset-backed obligations. The majority of CMO's held are U.S. government agency issues which are actively traded in liquid markets and are priced by broker-dealers. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in planned amortization classes with relatively short principal repayment windows. CNA generally does not invest in complex mortgage derivatives without readily ascertainable market prices.\nCNA invests from time to time in certain derivative financial instruments to increase investment returns and to eliminate the impact of changes in interest rates on certain corporate borrowings. Financial instruments used for such purposes include interest rate swaps, put and call options, commitments to purchase securities, and short sale of common stock. The gross notional principal or contractual amounts of these instruments at December 31, 1995, totaled $2,769.8 million compared to $127.9 million at December 31, 1994. See Note 4 of the Notes to the Consolidated Financial Statements, included in Item 8, for further discussion.\nOTHER\nCompetition: All aspects of the insurance business are highly competitive. CNA's insurance operations compete with a large number of stock and mutual insurance companies and other entities for both producers and customers and must continuously allocate resources to refine and improve insurance products and services. There are approximately 3,300 companies that sell property\/casualty insurance in the United States, approximately 900 of which operate in all or most states. CNA's consolidated property\/casualty subsidiaries (including CIC on a proforma basis) would have been ranked as the third largest property\/casualty insurance organization based on statutory premiums written in 1994. There are approximately 1,800 companies selling life insurance (including health insurance and pension products) in the United States. CAC is ranked as the twenty-fourth largest life insurance organization based on consolidated statutory premium volume in 1994.\nDividends by Insurance Subsidiaries: The payment of dividends to CNA by its insurance affiliates without prior approval of the affiliate's domiciliary state insurance commissioners is limited to amounts determined by formula in accordance with the accounting practices prescribed or permitted by the states' insurance departments. This formula varies by state. The formula for the majority of states is the greater of 10% of prior year statutory surplus or prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to the date of payment. Some states, however, have an additional stipulation that dividends cannot exceed prior year earned surplus. Based upon the various states formulas, approximately $860 million in dividends could be paid to CNA by its insurance affiliates in 1996 without prior approval. All dividends must be reported to the insurance department prior to declaration and payment.\nRegulation: The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative power relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports, regulating solvency and the type and amount of investments permitted. Regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries discussed above, intercompany transfers of assets may be subject to prior notice or approval, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer.\nThere has been a growing legislative trend, particularly for personal lines products and workers' compensation, directly impacting insurance rate development, rate application and the ability of insurers to cancel or renew insurance policies.\nInsurers are also required by the states to provide coverage to insureds who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage which must be provided to such involuntary risks. CNA's insurance subsidiaries' share of these involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state.\nIn recent years, insolvencies of a few large insurers previously believed to be on solid financial ground by many rating agencies and state regulators led to increased scrutiny of state regulated insurer solvency requirements by certain members of the U.S. Congress. Had Congress formally adopted initiatives in the 103rd Congress, insurers would have been subject to federal solvency regulation. In response to this challenge, the National Association of Insurance Commissioners (\"NAIC\") developed industry minimum Risk-Based Capital (\"RBC\") requirements, established a formal state accreditation process designed to more closely regulate for solvency, minimize the diversity of approved statutory accounting and actuarial practices, and increased the annual statutory statement disclosure requirements.\nThe RBC formulas are designed to identify an insurer's minimum capital requirements based upon the inherent risks (e.g., asset default, credit and underwriting) of its operations. In addition to the minimum capital requirements, the RBC formula and related regulations identify various levels of capital adequacy and corresponding actions that the state insurance departments should initiate. The level of capital adequacy below which insurance departments would take action is defined as the Company Action Level. As of December 31, 1995, all of CNA's life insurance affiliates and property\/casualty affiliates have adjusted capital amounts in excess of Company Action Levels.\nThe NAIC also maintains the Insurance Regulatory Information System (\"IRIS\"), which assists state insurance departments in overseeing the financial condition of both life and property\/casualty insurers through application of a number of financial ratios. These ratios have a range of results characterized as \"usual\" by the NAIC. The NAIC IRIS user guide regarding these ratios specifically states that \"Falling outside the usual range is not considered a failing result...\" and \"...in some years it may not be unusual for financially sound companies to have several ratios with results outside the usual range.\" It is important, therefore, that IRIS ratio test results be reviewed carefully in conjunction with all other financial information.\nCCC had no IRIS ratios with unusual values in 1995. The one ratio with an unusual value in 1994 was the two-year overall operating ratio. The three IRIS ratios with unusual values in 1993 were the two-year overall operating, investment yield, and the two-year reserve development ratios. Catastrophe losses and reserve increases associated with Fibreboard Corporation litigation (see Note 19 of the Notes to Consolidated Financial Statements included in Item 8) recorded in 1992 and 1993 triggered the unusual values for the operating ratios generated in 1993 and 1994 and reserve development ratios generated in 1993. Additionally, lower interest rates in 1993, coupled with a proportionately large short-term investment portfolio, triggered the unusual value for the investment yield ratio.\nCIC had three IRIS ratios with unusual values in 1995. These ratios were change in writings, two-year overall operating ratio, and the two-year reserve development to surplus. The overall decline in premiums written is attributable to CIC's efforts to shift its business mix towards more profitable lines. The two-year overall operating and the two-year reserve development to surplus ratios were adversely impacted by the establishment of environmental reserves of $400 million for incurred but not reported losses in 1994 and $200 million in other loss reserve development, principally in workers' compensation. Further, in 1994, results were adversely affected by catastrophe losses.\nCAC had no IRIS ratios with unusual values in 1995 or 1994. CAC had two unusual values for IRIS ratios in 1993, which were net gain to total income and change in net written premium. CAC's reported statutory net income was adversely affected in 1993 by depressed investment earnings. The unusual value for the change in premium ratio primarily related to decreases in the Separate Account annuity products fund deposits.\nThe potential for health care reform had been widely publicized and debated in 1994. Although these legislative reforms failed in 1994, and none were enacted in 1995, some federal or state health care reform could emerge in the future. Federal regulation of the insurance industry and repeal of the McCarran-Ferguson anti-trust exemptions for the insurance industry were widely discussed topics in the 103rd Congress but have not been of interest in the first session of the 104th Congress in 1995, and are not anticipated to be of interest in the second session in 1996.\nAlthough the courts and legislatures are often asked to expand liability, there is a growing trend among business and professional organizations to wage campaigns, which in several instances have been successful, aimed at limiting their liability risks. A number of states have adopted some \"tort reform\" measures which, among other things, limit non-economic and punitive damages and otherwise limit damage awards in product liability and malpractice cases. Illinois and Texas adopted substantial tort reform in 1995 limiting non-economic damages and the amount of punitive damages in all civil actions. Arizona, Colorado, Connecticut, Indiana, Michigan, Montana, New Jersey, North Carolina, North Dakota, Oklahoma, Oregon, South Dakota and Wisconsin all adopted some measure of tort reform.\nEnvironmental clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues, judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. See Note 10 of the Notes to Consolidated Financial Statements, included in Item 8, for further discussion.\nReinsurance: CNA assumes and cedes insurance with other insurers and reinsurers. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk and to minimize aggregate exposures. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk.\nThe ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in its states of domiciles, CNA receives collateral, primarily in the form of bank letters of credit, securing a large portion of the recoverables. Such collateral totaled approximately $1,300 and $165 million at December 31, 1995 and 1994, respectively. CNA's largest billed recoverable from a single reinsurer, including prepaid reinsurance premiums, was approximately $435 and $348 million with Lloyd's of London at December 31, 1995 and 1994, respectively.\nProperties: CNA leases office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to the principal office buildings owned or leased by CNA:\nLORILLARD, INC.\nThe Company's wholly owned subsidiary, Lorillard, Inc. (\"Lorillard\"), is engaged, through its subsidiaries, in the production and sale of cigarettes. The principal cigarette brand names of Lorillard are Newport, Kent and True. Lorillard's largest selling brands are the Newport and Kent brands, which accounted for approximately 70% and 11%, respectively, of Lorillard's sales in 1995.\nIn 1996, Lorillard entered into an agreement with Brown & Williamson Tobacco Corporation (\"B&W\") to acquire certain of B&W's discount cigarette brands. Together, these brands represented approximately 1% of the U.S. cigarette market in 1995, according to the Maxwell Consumer Report. This acquisition is subject to approval by the Federal Trade Commission and there can be no assurance that such approval will be obtained.\nSubstantially all of Lorillard's sales are in the United States. Lorillard's major trademarks outside of the United States were sold in 1977. Lorillard accounted for 11.00%, 14.29% and 13.95% of the Company's total revenue for the years ended December 31, 1995, 1994 and 1993, respectively.\nSmoking and Health and Related Matters: For a number of years reports of the asserted harmful health effects of cigarette smoking have engendered significant adverse publicity for the cigarette industry, have caused a decline in the social acceptability of cigarette smoking and have resulted in the implementation of numerous restrictions on the marketing, advertising and use of cigarettes. Along with significant increases in federal and state excise taxes on cigarettes, these actions have, and are likely to continue to have, an adverse effect on cigarette sales.\nLitigation: A large number of lawsuits, including lawsuits brought by individual plaintiffs and purported class actions, and lawsuits brought on behalf of states and state agencies (\"State Reimbursement Cases\"), have been commenced against Lorillard and other tobacco manufacturers seeking substantial compensatory and punitive damages for adverse health effects claimed to have resulted from cigarette smoking or exposure to tobacco smoke. For information with respect to such litigation pending as of February 1996, see Note 19 of the Notes to Consolidated Financial Statements included in Item 8 of this Report and incorporated herein by reference.\nIn March 1996 there have been the following additional developments:\nOn March 13, 1996 the Attorney General of Louisiana commenced Ieyoub v. The American Tobacco Company, et al., (District Court, Calcasieu Parish, Louisiana). This is the sixth action by a state or state agency seeking recovery of funds expended to provide health care to individuals with injuries or other health effects allegedly caused by use of tobacco products or exposure to cigarette smoke. Lorillard understands that additional attorneys general may file similar actions in the near future.\nOn March 15, 1996 a jury returned a verdict against Lorillard in a case seeking damages for cancer and other health effects claimed to have resulted from exposure to asbestos fibers which were incorporated, for a limited period of time ending 40 years ago, into the filter material used in one of the brands of cigarettes manufactured by Lorillard. The jury awarded plaintiff damages of $140,000. The time for Lorillard to notice an appeal from or otherwise seek review of this judgment has not expired.\nIn March 1996 Liggett Group Inc. (\"Liggett Group\"), the smallest of the major U.S. cigarette manufacturers, reported that it had entered into settlement agreements with plaintiffs in Castano v. The American Tobacco Company, et al., one of the purported class actions referred to in Note 19 of the Notes to Consolidated Financial Statements, and with plaintiffs in five of the six State Reimbursement Cases. Lorillard understands that, as part of the settlement Liggett Group agreed to comply with certain features of the proposed rulemaking by the federal Food and Drug Administration (the \"FDA\"); see \"Legislation and Regulation,\" below. In the settlement of Castano, Liggett Group also agreed (1) to pay half of the cost of certain smoking cessation programs for purported class members; (2) to pay \"reasonable\" attorneys fees and expenses; and (3) to pay the named plaintiffs an \"appropriate and reasonable amount.\" Lorillard understands that no monies are to be paid to other members of the purported class and that Liggett Group may withdraw from the agreement for a number of reasons. The settlement agreement in Castano is subject to court approval. In settling the State Reimbursement Cases, Lorillard understands Liggett Group also agreed (1) to pay $5 million over the next nine years to defray the taxpayer costs of treating state Medicaid patients with allegedly smoking-related illnesses; (2) to make annual payments to the states amounting to 2.5 percent of its pretax profits over the next twenty-five years; and (3) if there is no merger\nbetween Liggett Group and another tobacco company, to make an additional payment to the states of $5 million over a twenty-five year period.\nIn connection with the settlements, Lorillard understands Liggett has agreed to withdraw from Coyne Beahm, Inc., et al v. United States Food & Drug Administration, et al, a lawsuit challenging the FDA's proposed regulation of tobacco products; see \"Legislation and Regulation,\" below. In so doing, however, Liggett Group did not agree that such assertion of jurisdiction was legal or proper.\nLorillard has stated that it has no plans to settle any cigarette product liability litigation and will continue to vigorously defend all product liability claims against it.\nOther Legal Proceedings: In addition to the litigation referred to above, Lorillard has been notified of several governmental investigations pending against Lorillard and other tobacco manufacturers, which are described below.\nA grand jury investigation commenced in 1992 by the United States Attorney's Office for the Eastern District of New York regarding possible fraud by Lorillard and other tobacco companies relating to smoking and health research undertaken or administered by the Council for Tobacco Research - USA, Inc. Although there has been a recent press report that this investigation has been reactivated, Lorillard does not in fact know whether the investigation is still continuing, and is unable to predict its outcome. An adverse outcome of this investigation could result in criminal, administrative or other proceedings against Lorillard.\nLorillard received Civil Investigative Demands (\"CIDs\") in January, June and November 1994 from the Antitrust Division of the United States Department of Justice. The CIDs, which request certain information, documents and testimony, were issued in the course of an antitrust investigation to determine whether Section 1 of the Sherman Act, 15 U.S.C. Section 1, may have been violated by joint activity to restrain competition in the manufacture and sale of cigarettes with reduced ignition propensity (so-called \"fire safe\" cigarettes), including joint activity to limit or restrain research and development or product innovation. Lorillard has responded or is in the process of responding to the CIDs. It is impossible at this time to predict the ultimate outcome of this investigation. An adverse outcome in this investigation could result in other proceedings against Lorillard.\nIn March 1996, the Company and Lorillard each received a grand jury subpoena duces tecum from the United States Attorney's Office for the Southern District of New York seeking documents, advertisements or related materials distributed by the Company and Lorillard to members of the general public relating to, among other things, the health effects of cigarettes, nicotine or tobacco products, the addictiveness of such products, and Congressional hearings relating to cigarettes or the tobacco industry. The Company and Lorillard intend to respond to and comply with the subpoena. It is impossible at this time to predict the ultimate outcome of this investigation.\nLegislation and Regulation: The Federal Comprehensive Smoking Education Act, which became effective in 1985, requires the use on cigarette packaging and advertising of one of the following four warning statements, on a rotating basis: (1) \"SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, and May Complicate Pregnancy.\" (2) \"SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health.\" (3) \"SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth Weight.\" (4) \"SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide.\" Four shortened versions of these statements are required, on a rotating basis, for use on billboards. This law also requires that each person who manufactures, packages or imports cigarettes shall annually provide to the Secretary of Health and Human Services a list of the ingredients added to tobacco in the manufacture of cigarettes. Such list of ingredients may be submitted in a manner which does not identify the company which uses the ingredients or the brand of cigarettes which contains the ingredients.\nPrior to the effective date of the Comprehensive Smoking Education Act, federal law had, since 1965, required that cigarette packaging bear a warning statement which from 1971 to 1985 was as follows: \"Warning: The Surgeon General Has Determined That Cigarette Smoking Is Dangerous To Your Health.\" In addition, in 1972 Lorillard and other cigarette manufacturers had agreed, pursuant to consent orders entered into with the Federal Trade Commission (\"FTC\"), to include this health warning statement in print advertising, on billboards and on certain categories of point-of-sale display materials relating to cigarettes. In addition, advertising of cigarettes has\nbeen prohibited on radio and television since 1971.\nStudies with respect to the alleged health risk to nonsmokers of environmental tobacco smoke (\"ETS\") have received significant publicity. In 1986, the Surgeon General of the United States and the National Academy of Sciences reported that ETS puts nonsmokers at an increased risk of lung cancer and respiratory illness. In January 1993, the United States Environmental Protection Agency released a report (the \"EPA Risk Assessment\") concluding that ETS is a human lung carcinogen in adults, causes increased respiratory tract disease, middle ear disorders and increases the severity and frequency of asthma in children.\nIn recent years, many federal, state, local and municipal governments and agencies, as well as private businesses, have adopted legislation or regulations which prohibit or restrict, or are intended to discourage, smoking, including legislation or regulations prohibiting or restricting smoking in various places such as public buildings and facilities, stores and restaurants, on domestic airline flights and in the workplace, and the sale of cigarettes in vending machines. This trend has increased significantly since the release of the EPA Risk Assessment. Additional laws, regulations and policies intended to prohibit, restrict or discourage smoking are being proposed or considered by various federal, state and local governments, agencies and private businesses with increasing frequency.\nIn 1994, the Occupational Safety and Health Administration published proposed rule making on air quality in indoor workplaces. The proposed rule would require employers in the United States to prohibit smoking indoors or to restrict smoking to a separate room with outside exhaust and negative air pressure. A period of public comment on the proposed rules has ended. Hearings on the proposed rules were conducted in late 1994 and early 1995. It is impossible at this time to predict whether or in what form the proposed rules will be adopted.\nFrom time to time, bills have been introduced in Congress, among other things, to end or limit the price supports for leaf tobacco; to prohibit all tobacco advertising and promotion; to require new health warnings on cigarette packages and advertising; to subject cigarettes generally to regulation under the Consumer Products Safety Act or the Food, Drug and Cosmetics Act; to authorize the establishment of various anti-smoking education programs; to provide that current federal law should not be construed to relieve any person of liability under common or state law; to permit state and local governments to restrict the sale and distribution of cigarettes and the placement of billboard and transit advertising of tobacco products; to provide that cigarette advertising not be deductible as a business expense; to prohibit the mailing of unsolicited samples of cigarettes and otherwise to restrict the sale or distribution of cigarettes; to impose an additional excise tax on cigarettes; to require that cigarettes be manufactured in a manner that will cause them, under certain circumstances, to be self-extinguishing; and to subject cigarettes to regulation in various ways by the U.S. Department of Health and Human Services, including regulation by the Food and Drug Administration.\nA 1984 federal law established a Technical Study Group to conduct a study and report to the Congress regarding the technical and commercial feasibility of developing cigarettes that will have a minimum propensity to ignite upholstered furniture or mattresses. The Technical Study Group concluded in 1987 that it was technically feasible and may be commercially feasible to develop such cigarettes. In accordance with a 1990 federal law the Consumer Product Safety Commission issued a report in August 1993, concluding that, while it is practicable to develop a performance standard to reduce cigarette ignition propensity, it is unclear that such a standard will effectively address the number of cigarette ignited fires. Several states also are considering legislation in this area.\nIn 1995, Congress passed legislation prohibiting the sale of cigarettes by vending machines on certain federal property, and the General Services Administration has published implementing regulations. In January 1996, the Substance Abuse and Mental Health Services Administration(\"SAMHSA\") issued final regulations implementing a 1992 law (Section 1926 of the Public Health Service Act), which requires the states to enforce their minimum sales-age laws as a condition of receiving federal substance abuse block grants.\nEarly in 1994, the Energy and Commerce Subcommittee on Health and the Environment of the U.S. House of Representatives (the \"Subcommittee\") launched an oversight investigation into tobacco products, including possible regulation of nicotine-containing cigarettes as drugs. During the course of such investigation, the Subcommittee held hearings at which executives of each of the major tobacco manufacturers testified. Following the November 1994 elections, the incoming Chairman of the Energy and Commerce Committee indicated that this investigation by the Subcommittee would not continue, and on December 20, 1994, the outgoing majority staff of the Subcommittee issued two final reports. One of these reports questioned the scientific practices of what it\ncharacterized as the tobacco industry's \"long-running campaign\" related to ETS, but reached no final conclusions. The second report asserted that documents obtained from American Tobacco Company, a competitor of Lorillard's, \"reflect an intense research and commercial interest in nicotine.\"\nIt has been reported that the U.S. Department of Justice is investigating allegations of perjury in connection with the testimony provided by one or more tobacco industry executives to the Subcommittee. It is impossible at this time to predict the outcome of this investigation.\nOn August 10, 1995 President Clinton announced that he had authorized the FDA to assert regulatory jurisdiction over cigarettes and smokeless tobacco products for the purpose of curbing tobacco use among children and teenagers. On August 11, the FDA issued a notice of proposed rule making. Among other things, the FDA's proposed rules would severely restrict cigarette advertising and promotion, limit the manner in which tobacco products can be sold and require cigarette manufacturers to finance anti-smoking education programs. Lorillard, the four other major cigarette manufacturers and the Tobacco Institute filed joint comments with the FDA on January 2, 1996.\nLorillard and four other cigarette manufacturers also have filed a lawsuit in the United States District Court for the Middle District of North Carolina challenging the FDA's assertion of jurisdiction over cigarettes and seeking both preliminary and permanent injunctive relief (as noted above, Liggett Group has agreed to withdraw from this lawsuit). The complaint in the case, Coyne Beahm, Inc., et al. v. United States Food & Drug Administration, et al., asserts that the FDA lacks authority to regulate cigarettes and that the proposed rules violate the Federal Food, Drug and Cosmetic Act, the Federal Cigarette Labeling and Advertising Act and the United States Constitution. Lawsuits challenging the FDA's rule making also have been filed in the same court by several smokeless tobacco manufacturers, several national advertising trade associations and the National Association of Convenience Stores.\nThe cigarette manufacturers and smokeless tobacco manufacturers have moved for summary judgment, and the government has moved to dismiss the complaints. The court has granted the government's request to stay briefing on the summary judgment motions until it has ruled on the government's motions to dismiss.\nAccordingly, any impact on Lorillard from any regulations which may ultimately be issued by the FDA cannot be predicted at this time. In addition, it is uncertain whether the proposed regulations will be modified before they are promulgated in final form, whether Congress will pass legislation that would moot the proposed regulations and whether the manufacturers will succeed in securing judicial relief.\nCertain of these and other similar laws, regulations and policies being proposed or considered by various federal, state and local governments and agencies could, if adopted, have a material adverse effect on the financial condition and results of operations of the Company.\nAdvertising and Sales Promotion: Lorillard's principal brands are advertised and promoted extensively. Introduction of new brands, brand extensions and packings require the expenditures of substantial sums for advertising and sales promotion, with no assurance of consumer acceptance. The advertising media presently used by Lorillard include magazines, newspapers, out-of-home advertising, direct mail and point-of-sale display materials. Sales promotion activities are conducted by distribution of samples and store coupons, point-of-sale display advertising, advertising of promotions in print media, and personal contact with distributors, retailers and consumers.\nDistribution Methods: Lorillard distributes its products through direct sales to distributors, who in turn service retail outlets, and through chain store organizations and vending machine operators, many of whom purchase their requirements directly, and by direct sales to the U.S. Armed Forces. Lorillard's tobacco products are stored in public warehouses throughout the country to provide for rapid distribution to customers.\nLorillard has approximately 1,500 direct customers and is not dependent on any one customer or group of customers. Lorillard does not have any backlog orders.\nTobacco and Tobacco Prices: The two main classes of tobacco grown in the United States are flue-cured tobacco, grown mostly in Virginia, North Carolina, South Carolina, Georgia and Florida; and burley, grown mostly in Kentucky and Tennessee. Lorillard purchases flue-cured tobacco and burley tobacco for use in cigarettes. Most of the tobacco of these classes used by Lorillard is purchased by commission buyers at tobacco auctions. Lorillard also purchases various types of Near Eastern tobacco, grown in Turkey and eight other Near Eastern countries. In addition, Lorillard purchases substantial quantities of aged tobacco from various sources, including cooperatives financed under the Commodity Credit Corporation program, to supplement tobacco inventories.\nDue to the varying size and quality of annual crops and other economic factors, tobacco prices in the past have been subject to fluctuation. Among the economic factors are federal government control of acreage and poundage in the flue-cured producing areas and poundage control in the burley areas. These controls together with support prices have substantially affected the market prices of tobacco. The approximate average auction prices per pound for flue-cured tobacco were $1.698 in 1994 and $1.794 in 1995 and for burley tobacco were $1.841 in 1994 and $1.854 in 1995. The prices paid by Lorillard have generally been consistent with this trend. Lorillard believes that its current leaf inventories are adequately balanced for its present production requirements. Because the process of aging tobacco normally requires approximately two years, Lorillard at all times has on hand large quantities of leaf tobacco. See Note 1 of the Notes to Consolidated Financial Statements, included in Item 8, for inventory costing method.\nPrices: In May 1995 Lorillard increased the wholesale price of its king size and 100\/120 millimeter cigarettes by $1.50 per thousand in the aggregate.\nTaxes: Federal excise taxes included in the price of cigarettes are $12.00 per thousand cigarettes. Excise taxes, which are levied upon and paid by the distributors, are also in effect in the fifty states, the District of Columbia and many municipalities. The state taxes generally range from 2.5 cents to 81.5 cents per package of twenty cigarettes.\nProperties: The properties of Lorillard are employed principally in the processing and storage of tobacco and in the manufacture and storage of cigarettes. Its principal properties are owned in fee. With minor exceptions, all machinery used by Lorillard is owned by it. All properties are in good condition. Lorillard's manufacturing plant is located on approximately 79 acres in Greensboro, North Carolina. This 942,600 square foot plant contains modern high speed cigarette manufacturing machinery. A warehouse was added in early 1995 with shipping and receiving areas totaling 54,800 square feet. Lorillard also has facilities for receiving and storing leaf tobacco in Danville, Virginia, containing approximately 1,500,000 square feet. A modern research facility containing approximately 82,000 square feet is also located at Greensboro.\nLorillard leases a corporate office in Orangeburg, New York, an executive office in New York City and sales offices in major cities throughout the United States. In March 1996, Lorillard announced that it would relocate its New York executive office to Greensboro, North Carolina. This move will allow Lorillard to consolidate its operations in Greensboro, the site of its manufacturing facility. Lorillard plans to build a 125,000 square foot office building for this purpose.\nCompetition: Substantially all of Lorillard's products are sold within the United States in highly competitive markets where its principal competitors are the four other major U.S. cigarette manufacturers (Philip Morris, R.J. Reynolds (\"RJR\"), Brown & Williamson and Liggett Group). According to the Maxwell Consumer Report, a quarterly statistical survey of the cigarette industry, in calendar year 1995 Lorillard ranked fourth in the industry with an 8.0% share of the market. Philip Morris and RJR accounted for approximately 46.1% and 25.7%, respectively, of the U.S. cigarette market, according to the Maxwell Consumer Report.\nThe following table sets forth cigarette sales in the United States by the industry and by Lorillard, as reported in the Maxwell Consumer Report. This table indicates the relative position of Lorillard in the industry:\n- --------------- The Bureau of Alcohol, Tobacco and Firearms reports Lorillard's share of total taxable factory removals of all cigarettes to be 7.5% and 7.1% for 1994 and 1993, respectively. Data for 1995 is not currently available.\nThe Maxwell Consumer Report divides the cigarette market into two price segments, the premium price segment and the discount or reduced price segment. According to the Maxwell Consumer Report the reduced price segment decreased in 1995 to approximately 30.0% from approximately 32.5% of the market in 1994. Virtually all of Lorillard's sales are in the premium price segment where Lorillard's share increased from 10.6% in 1994 to 10.9% in 1995, according to the Maxwell Consumer Report.\nLOEWS HOTELS HOLDING CORPORATION\nThe subsidiaries of Loews Hotels Holding Corporation (\"Loews Hotels\"), a wholly owned subsidiary of the Company, presently operate the following 14 hotels. Loews Hotels accounted for 1.17%, 1.61% and 1.35% of the Company's total revenue for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe hotels which are operated by Loews Hotels contain shops, a variety of restaurants and lounges, and some contain parking facilities, swimming pools, tennis courts and access to golf courses.\nThe hotels owned by Loews Hotels are subject to mortgage indebtedness aggregating approximately $42.7 million at December 31, 1995 with interest rates ranging from 9% to 11%, and maturing between 1998 and 1999. In addition, certain hotels are held under leases which are subject to formula derived rental increases, with rentals aggregating approximately $7.5 million for the year ended December 31, 1995.\nCompetition from other hotels, motor hotels and inns, including facilities owned by local interests and by national and international chains, is vigorous in all areas in which Loews Hotels operates. The demand for hotel rooms in many areas is seasonal and dependent on general and local economic conditions. Loews Hotels properties also compete with facilities offering similar services in locations other than those in which the company's hotels are located. Competition among luxury hotels is based primarily on location and service. Competition among resort and commercial hotels is based on price as well as location and service. Because of the competitive nature of the industry, hotels must continually make expenditures for updating, refurnishing and repairs and maintenance, in order to prevent competitive obsolescence.\nDIAMOND OFFSHORE DRILLING, INC.\nDiamond Offshore Drilling Inc. (\"Diamond Offshore\"), is engaged, through its subsidiaries, in the business of owning and operating drilling rigs that are used primarily in drilling of oil and gas wells on a contract basis for companies engaged in exploration and production of hydrocarbons. The Company entered the drilling business in 1989 and, through a series of acquisitions, operates 37 offshore rigs and 10 land rigs. Diamond Offshore accounted for 1.82%, 2.25% and 2.11% of the Company's total revenue for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn October 1995 Diamond Offshore sold 14,950,000 shares of its common stock through an initial public offering at $24 per share. As a result of the offering, the Company's ownership interest in Diamond Offshore declined to approximately 70% and the Company recorded a pre-tax gain of approximately $192.9 million.\nOn February 9, 1996 Diamond Offshore and Arethusa (Off-Shore) Limited (\"Arethusa\"), executed a definitive agreement to merge the two companies. The agreement provides that holders of Arethusa stock will receive 17.9 million shares of common stock to be issued by Diamond Offshore based on a ratio of .88 shares for each share of Arethusa common stock. The merger is subject to requisite shareholder approval and is anticipated to close in the spring of 1996. Upon consummation of the merger, the Company would recognize a gain of approximately $187 million and its interest in Diamond Offshore would decline to approximately 52%. Arethusa owns and\/or operates a fleet of thirteen mobile offshore drilling rigs and provides drilling services worldwide to domestic, international and state-owned oil and gas companies. The fleet consists of eight semisubmersible rigs located in the Gulf of Mexico and South America and five jackup rigs located in India, Indonesia, Egypt, the Dutch sector of the North Sea, and the Gulf of Mexico.\nDrilling Units and Equipment: Diamond Offshore currently owns and operates 37 mobile offshore drilling rigs (14 jackup rigs, 22 semisubmersible rigs and one drillship), 10 land rigs and related equipment. One additional semisubmersible rig, which is inactive, is currently held for sale. Offshore rigs are mobile units that can be relocated via either self propulsion or by the use of tugs enabling them to be repositioned based on market demand.\nJackup rigs stand on the ocean floor with their drilling platforms \"jacked up\" on support legs above the water. They are best suited for drilling in water depths of less than 300 feet. Nine of Diamond Offshore's jackup rigs are cantilevered rigs capable of over platform development drilling and workover as well as exploratory drilling. Of Diamond Offshore's 14 jackup rigs, 13 are currently located in the Gulf of Mexico and one is currently in South America.\nSemisubmersible rigs are supported by large pontoons and are partially submerged during drilling for greater stability. They are generally designed for deep water depths of up to 6,000 feet. Diamond Offshore operates three of the world's thirteen fourth-generation semisubmersible rigs. These rigs are equipped with advanced drilling equipment, are capable of operations in ultra deep waters in severe weather environments, and command high premiums from operators. Diamond Offshore's 22 semisubmersible rigs are currently located as follows: 11 in\nthe Gulf of Mexico, five in the North Sea, three in Southeast Asia, two in Brazil and one in Nigeria.\nDiamond Offshore's drillship is self-propelled and designed to drill in deep water. Shaped like a conventional vessel, it is the most mobile of the major rig types. Diamond Offshore's drillship is located in the Red Sea.\nDiamond Offshore's land rigs are all located in Texas and are also capable of mobilizing to different drilling sites.\nDrilling Contracts and Rig Utilization: Contracts for Diamond Offshore's drilling rigs are offered worldwide for either a fixed term, which may range from a few months to several years, or on a well-to-well basis.\nThe following table sets forth the size and utilization rate of Diamond Offshore's fleet for the years ended December 31, 1995, 1994 and 1993. The utilization rate for a period is based on the ratio of days in the period during which the rigs were earning revenues to the total days in the period during which the rigs were available to work.\nCompetition: The contract drilling industry is highly competitive. Customers often award contracts on a competitive bid basis, and although a customer selecting a rig may consider, among other things, a contractor's safety record, crew quality and quality of service and equipment, the oversupply of rigs has created an intensely competitive market in which price is the primary factor in determining the selection of a drilling contractor. Diamond Offshore believes that competition for drilling contracts will continue to be intense for the foreseeable future because of the worldwide oversupply of drilling rigs and the ability of contractors to move rigs from areas of low utilization and dayrates to areas of greater activity and relatively higher dayrates. In addition, there are inactive non-marketed rigs that could be reactivated to meet an increase in demand for drilling rigs in any given market. Such movement or reactivation or a decrease in drilling activity in any major market could depress dayrates and could adversely affect utilization of Diamond Offshore rigs.\nOperating Risks and Regulation: Diamond Offshore's operations are subject to the usual hazards incident to the drilling of oil and gas wells, such as blowouts, cratering and fires. Diamond Offshore's offshore operations are also subject to perils peculiar to marine operations, such as capsizing, collision, grounding and adverse weather and seas. Any of these hazards can seriously damage or destroy equipment, suspend drilling operations, and, through oil spillage, cause pollution damage to offshore or inland waters or the property of others. Diamond Offshore currently maintains insurance covering these risks, including expropriation, confiscation and nationalization of certain equipment in foreign waters. There is no assurance that insurance coverage will continue to be available at rates considered reasonable or that the insurance will be adequate to protect against liability and loss or damage resulting from all the consequences of a significant incident.\nDiamond Offshore is subject to stringent laws relating to the equipment and operation of vessels and drilling practices and methods. Additional governmental legislation and regulations involving the petroleum industry could significantly affect Diamond Offshore's operations.\nProperties: Diamond Offshore owns an eight-story office building located in Houston, Texas containing approximately 182,000 net rentable square feet, which is used for its corporate headquarters. A portion of the building is currently occupied by other tenants under leases which expire through 2005. Diamond Offshore also\nowns an 18,000 square foot building and 20 acres of land in New Iberia, Louisiana for its offshore drilling warehouse and storage facility, a 13,000 square foot building and five acres of land in Aberdeen, Scotland for its North Sea operations and a 15,000 square foot building and 10 acres of land in Alice, Texas for its onshore drilling office, warehouse and storage facility. In addition, Diamond Offshore leases additional office, warehouse and storage facilities and lots in Louisiana, Scotland, Australia and Brazil to support its offshore drilling operations.\nBULOVA CORPORATION\nBulova Corporation (\"Bulova\") is engaged in the distribution and sale of watches, clocks and watch parts for consumer use. Bulova accounted for .59%, 1.12% and 1.12% of the Company's total revenue for the years ended December 31, 1995, 1994 and 1993, respectively.\nBulova distributes and sells analog and analog-digital quartz crystal watches, jewelry and various types of clocks. All watches and clocks are purchased from foreign suppliers. Watches are sold by Bulova principally in the United States and Canada. In most other areas of the world Bulova has appointed licensees who market watches under Bulova's trademarks in return for a royalty. The business is seasonal, with the greatest sales coming in the third and fourth quarters in expectation of the holiday selling season. The business is intensely competitive. The principal methods of competition are price, styling, aftersale service, warranty and product performance.\nProperties: Bulova leases its facilities which consist of an 80,000 square foot plant in Woodside, New York for its principal executive and sales office, watch distribution, service and warehouse purposes, a 71,000 square foot plant in Maspeth, New York for clock service and warehouse purposes and a 25,000 square foot plant in Toronto, Canada for watch and clock sales and service.\nOTHER INTERESTS\nThe Company owns a 49% common stock interest in a joint venture which is engaged in the business of owning and operating six large crude oil tankers that are used primarily to transport crude oil from the Persian Gulf to a limited number of ports in the Far East, Northern Europe and the United States.\nEMPLOYEE RELATIONS\nThe Company, inclusive of its operating subsidiaries as described below, employed approximately 34,700 persons at December 31, 1995 and considers its employee relations to be satisfactory.\nLorillard employed approximately 3,500 persons at December 31, 1995. Approximately 1,400 of these employees are represented by labor unions under separate contracts with many local unions expiring at varying times and severally renegotiated and renewed.\nLorillard has collective bargaining agreements covering hourly rated production and service employees at various Lorillard plants with the Tobacco Workers International Union, the International Brotherhood of Firemen and Oilers, and the International Association of Machinists. Lorillard has experienced satisfactory labor relations and provides a retirement plan, a deferred profit sharing plan, and other benefits for its hourly paid employees who are represented by the foregoing unions.\nLoews Hotels employed approximately 2,900 persons at December 31, 1995, approximately 770 of whom are union members covered under collective bargaining agreements. Loews Hotels has experienced satisfactory labor relations and provides comprehensive benefit plans for its hourly paid employees.\nThe Company maintains a retirement plan, group life, disability and health insurance program and a savings plan for salaried employees. Lorillard and Loews Hotels salaried employees also participate in these benefit plans.\nCNA and its subsidiaries employ approximately 25,000 full-time equivalent persons and has experienced satisfactory labor relations. CNA and its subsidiaries have comprehensive benefit plans for substantially all of their employees, including a retirement plan, a savings plan, a disability program, a group life program and a group health care program.\nDiamond Offshore employed approximately 2,500 persons at December 31, 1995, approximately 260 of whom are union members. Diamond Offshore has experienced satisfactory labor relations and provides comprehensive benefit plans for its employees.\nBulova and its subsidiaries employ approximately 430 persons, approximately 120 of whom are union members. Bulova and its subsidiaries have experienced satisfactory labor relations. Bulova has comprehensive benefit plans for substantially all employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nInformation relating to the properties of Registrant and its subsidiaries is contained under Item 1.\nItem 3.","section_3":"Item 3. Legal Proceedings.\n1. CNA is involved in various lawsuits involving environmental pollution claims and litigation with Fibreboard Corporation. Information involving such lawsuits is incorporated by reference to Notes 10 and 19 of the Notes to Consolidated Financial Statements included in Item 8.\n2. Lorillard is involved in various lawsuits involving tobacco products seeking damages for cancer and other health effects claimed to have resulted from the use of cigarettes or from exposure to tobacco smoke. Information regarding such lawsuits is contained in Note 19 of the Notes to Consolidated Financial Statements included in Item 8. Information regarding other legal proceedings involving Lorillard is contained in the section entitled Lorillard, Inc. in Item 1, which is incorporated herein by refernece.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nLaurence A. Tisch and Preston R. Tisch are brothers. Andrew H. Tisch and James S. Tisch are sons of Laurence A. Tisch and Jonathan M. Tisch is a son of Preston R. Tisch. None of the other officers or directors of Registrant is related to any other.\nAll executive officers of Registrant have been engaged actively and continuously in the business of Registrant for more than the past five years.\nMr. Momeyer served as Director of Personnel Services for more than five years prior to his appointment as Vice President-Human Resources. Andrew H. Tisch served as Chairman of the Board and Chief Executive Officer of Lorillard Tobacco Company from December 29, 1989 to May 31, 1995. Prior thereto he had served as Vice President-Strategic Planning since 1985.\nOfficers are elected and hold office until their successors are elected and qualified, and are subject to removal by the Board of Directors.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nPrice Range of Common Stock*\nLoews Corporation's common stock is listed on the New York Stock Exchange. The following table sets forth the reported consolidated tape high and low sales prices in each calendar quarter of 1995 and 1994:\nDividend Information*\nThe Company has paid quarterly cash dividends on its common stock in each year since 1967. Regular dividends of $.12 1\/2 per share of common stock outstanding were paid in each calendar quarter of 1994 and in each of the first three quarters of 1995. In the fourth quarter of 1995 the Company increased its dividend to $.25 per share.\nApproximate Number of Equity Security Holders\nThe Company has approximately 3,700 holders of record of Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data.*\nIn 1993 the Company changed its method of accounting for certain investments in debt and equity securities. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8.\n- --------------- *Per share amounts have been adjusted to give retroactive effect to the two-for-one stock split effective December 1, 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nInsurance\nProperty and casualty and life insurance operations are wholly owned subsidiaries of CNA Financial Corporation (\"CNA\"). CNA is an 84% owned subsidiary of the Company.\nAs previously reported, on May 10, 1995, CNA consummated the acquisition of all the outstanding shares of The Continental Corporation (\"CIC\") for approximately $1.1 billion, or $20 per CIC share. As a result of the acquisition, CNA became the sixth largest U.S. insurance organization, the third largest U.S. property and casualty organization and the largest U.S. commercial lines insurance group, based on 1994 premiums.\nCNA has financed the transaction (including the refinancing of $205 million of CIC debt) through a five-year $1.3 billion revolving credit facility (the \"Bank Facility\") involving 16 banks led by The First National Bank of Chicago and The Chase Manhattan Bank, N.A. The interest rate is based on the one, two, three or six month London Interbank Offered Rate (\"LIBOR\"), as elected, plus 25 basis points. Additionally, there is a facility fee of 10 basis points. The average interest rate at December 31, 1995 was 6.12%. Under the terms of the Bank Facility, CNA may prepay the debt without penalty, giving CNA flexibility to arrange longer-term financing on more favorable terms.\nTo offset the variable rate characteristics of the Bank Facility, CNA entered into five year interest rate swap agreements with several banks. These agreements effectively convert variable rate debt into fixed rate debt on notional amounts aggregating $1.2 billion. The weighted average fixed swap rate at December 31, 1995 was 6.29%.\nOn August 10, 1995, to take advantage of favorable interest rate spreads, CNA established a commercial paper program, borrowing $500 million from investors to replace a like amount of the Bank Facility. The weighted average yield on commercial paper at December 31, 1995 was 6.05%. The commercial paper borrowings are classified as long-term debt, as $500 million of the committed Bank Facility will support the commercial paper program (at an undrawn cost of 10 basis points). Standard and Poor's and Moody's issued short-term debt ratings of A2 and P2, respectively, for CNA's commercial paper program.\nThe weighted average interest rate on the acquisition debt, which includes the Bank Facility, commercial paper and the effect of the interest rate swaps, was 6.50% at December 31, 1995.\nAs a result of the CIC acquisition, A.M. Best, Moody's, Standard and Poor's and Duff & Phelps issued revised ratings for CNA's Continental Casualty Company (\"CCC\") Intercompany Pool, Continental Insurance Company (\"CIC\") Intercompany Pool and Continental Assurance Company (\"CAC\") Intercompany Pool. Also rated were the senior debt of both CNA and CIC, and CNA's preferred stock.\nIn some cases the rating agencies affirmed the previous ratings. In others, the ratings were lowered because of the increased level of debt associated with the CIC acquisition.\nThe chart below lists the current ratings:\nCNA's property and casualty insurance subsidiaries' statutory surplus grew from $3.1 billion in 1992 to $5.7 billion in 1995. In 1993, property and casualty surplus rose to approximately $3.6 billion due to substantial capital gains and a capital contribution by CNA of $475 million, offset by a $500 million increase in asbestos reserves relating to the Fibreboard litigation (see Note 19 of the Notes to Consolidated Financial Statements included in Item 8). In 1994, surplus declined to $3.4 billion, primarily attributable to realized investment losses. In 1995, surplus rose $2.3 billion to $5.7 billion due to the acquisition of CIC ($1.7 billion) and improved net income. Dividends of $325, $175 and $150 million were paid to CNA by CCC in 1995, 1994 and 1993, respectively.\nStatutory surplus of CNA's life insurance subsidiaries grew from $1,003 million at December 31, 1992 to $1,128 million at December 31, 1995.\nCNA's investment portfolio increased by $8.9 billion, or 33.2%, over the 1994 level of $26.9 billion including $7.4 billion related to CIC.\nThe liquidity requirements of CNA, excluding the acquisition of CIC, have been met primarily by funds generated from operations. The principal cash flow sources of CNA's property and casualty and life insurance subsidiaries are premiums, investment income and sales and maturities of investments. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses.\nFor the year ended December 31, 1995, CNA's operating activities generated net cash flows of $875.0 million compared to $982.2 million in 1994 and $1,272.1 million in 1993. CNA believes that future liquidity needs will be met primarily from operations.\nNet cash flows are invested in marketable securities. Investment strategies employed by CNA's insurance subsidiaries consider the cash flow requirements of the insurance products sold, and the tax attributes of the various types of marketable securities.\nCigarettes\nLorillard, Inc. and subsidiaries (\"Lorillard\"). Lorillard is a wholly owned subsidiary of the Company.\nFunds from operations continue to exceed operating requirements. Lorillard generated net cash flow from operations of approximately $319 million for the year ended December 31, 1995, compared to $364 million for the prior year. Lorillard's cash flow from operations declined in 1995 due primarily to its decision to contribute $183.8 million to fund completely a pension\nplan which had been underfunded.\nIn 1996, Lorillard entered into an agreement with Brown & Williamson Tobacco Corporation (\"B&W\") to acquire certain of B&W's discount cigarette brands. Together, these brands represented approximately 1% of the U.S. cigarette market in 1995. This acquisition is subject to approval by the Federal Trade Commission and there can be no assurance that such approval will be obtained. The funds required for this acquisition will be provided by operations. No other material capital expenditures are anticipated during 1996.\nVirtually all of Lorillard's sales are in the full price brand category. With the industry-wide list price reduction of full price brands, effective August 9, 1993, the market share of discount brands has declined and Lorillard's product line has benefited in terms of unit sales. Discount brand sales have decreased from an average of 37% of industry sales during 1993 to an average of 30% during 1995. At December 31, 1995, they represented 29.2% of industry sales. In May 1995, Lorillard increased its wholesale prices by $1.50 per thousand cigarettes, or 2.7%.\nNumerous lawsuits have been filed against Lorillard and other manufacturers of tobacco products seeking damages for cancer and other health effects claimed to have resulted from the use of cigarettes or exposure to tobacco smoke. In a number of these cases the Company is named as a defendant. Pending litigation includes conventional smoking and health cases, purported class actions, state attorney general\/medicaid reimbursement actions, and filter cases, most of which claim very substantial damages. These actions are described in Note 19 of the Notes to Consolidated Financial Statements included in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nNotes to Consolidated Financial Statements (Dollars in millions, except per share data)\nNote 1. Summary of Significant Accounting Policies -\nPrinciples of consolidation - The consolidated financial statements include all significant subsidiaries and all material intercompany accounts and transactions have been eliminated. The equity method of accounting is used for investments in associated companies in which the Company generally has an interest of 20% to 50%.\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.\nAccounting changes - Effective December 31, 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 investments in debt and equity securities classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of aggregate amortized cost or fair value. Unrealized gains and losses are reflected as a separate component of shareholders' equity, net of deferred income taxes, participating policyholders' and minority interests. The effect of adopting this Statement was to increase shareholders' equity by $367.9 (net of $294.0 in deferred income taxes, participating policyholders' and minority interests). The adoption of this Statement did not impact net income. Separate Account assets invested in debt securities have also been classified as available for sale and are carried at fair value.\nInvestments - Investments in securities, which are held principally by insurance subsidiaries of CNA Financial Corporation (\"CNA\"), an 84% owned subsidiary, are carried as follows:\nThe Company believes it has the ability to hold all fixed income investments until maturity. However, securities may be sold to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, as part of the Company's asset\/liability strategy, or for other similar factors. As a result, the Company considers its fixed maturity securities (bonds and redeemable preferred stocks) and equity securities as available for sale and they are carried at fair value. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Effective January 1, 1996, equity securities added to the parent company's investment portfolio will be classified as trading securities in order to reflect the Company's investment philosophy. These investments will be carried at fair value with the net unrealized gain or loss included in the income statement.\nDerivative instruments are generally held for trading purposes and as such, are marked to market and gains or losses are included in realized investment gains or losses. Interest rate swaps which are used to manage the Company's exposure to variable rate long-term debt are not considered held for trading purposes. Such swaps are accounted for as an adjustment to interest expense. Mortgage loans are carried at unpaid principal balances, including unamortized premium or discount. Real estate is carried at depreciated cost. Policy loans are carried at unpaid balances. Short-term investments include U.S. government securities, commercial paper and time deposits and are carried at fair value, which approximates amortized cost.\nAll securities transactions are recorded on the trade date. The cost of securities sold is determined by the identified certificate method. Unrealized appreciation (depreciation) in shareholders' equity reflects the unrealized gain or loss on investments which are available for sale and carried at fair value, net of applicable deferred income taxes and participating policyholders' and minority interests. Investments are written down to estimated fair values and losses are charged to income when a decline in value is considered to be other than temporary.\nSecurities sold under agreements to repurchase - The Company has a securities lending program where securities are loaned to third parties, primarily major brokerage firms. Borrowers of these securities must deposit 100% of the market value of these securities if\nthe collateral is cash, or 102% if the collateral is securities. Cash deposits from these transactions have been invested in short-term investments (primarily U.S. government securities and commercial paper). Securities sold under repurchase agreements are recorded at their contracted repurchase amounts. The Company continues to receive the interest on the loaned debt securities, as beneficial owner, and accordingly, the loaned debt securities are included in fixed maturity securities.\nInsurance Operations - Premium revenue - Insurance premiums on property and casualty and health insurance contracts (included in life premiums) are earned ratably over the terms of the policies after provision for estimated adjustments on retrospectively rated policies and deductions for ceded insurance. Revenues on universal life type contracts comprise contract charges and fees which are recognized over the coverage period. Other life insurance premiums are recognized as revenue when due after deductions for ceded insurance.\nClaim and claim expense reserves - Claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims, are based on undiscounted (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of losses on assumed insurance, and (d) estimates of future expenses to be incurred in settlement of claims. In establishing these estimates, consideration is given to current conditions and trends as well as past company and industry experience.\nClaim and claim expense reserves are based on estimates and the ultimate liability may vary significantly from such estimates. CNA regularly reviews its reserves, and any adjustments that are made to the reserves are reflected in operating income in the period the need for such adjustments become apparent. See Note 10 for a further discussion of claim and claim expense reserves.\nStructured settlements have been negotiated for claims on certain property and casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from CNA's life insurance subsidiary. Related annuity obligations are carried in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at discounted values which approximate the alternative cost of annuity purchases. Such reserves, discounted at interest rates ranging from 6.3% to 7.5%, totaled $897.0 and $839.0 at December 31, 1995 and 1994, respectively.\nWorkers' compensation lifetime claims and accident and health disability claim reserves are discounted at interest rates ranging from 3.5% to 6.0% with mortality and morbidity assumptions reflecting CNA's and current industry experience. Such discounted reserves totaled $2,688.2 and $1,114.9 at December 31, 1995 and 1994, respectively.\nFuture policy benefits reserves - Reserves for traditional life insurance products are computed based upon net level premium methods using actuarial assumptions as to interest rates, mortality, morbidity, withdrawals and expenses. Actuarial assumptions include a margin for adverse deviations and generally vary by plan, age at issue and policy duration. Interest rates range from 3% to 10.5%, and mortality, morbidity and withdrawal assumptions reflect CNA and industry experience prevailing at the time of issue. Renewal expense estimates include the estimated effects of inflation and expenses beyond the premium paying period.\nInvoluntary risks - CNA's share of involuntary risks is mandatory and generally a function of its share of the voluntary market by line of insurance in each state. CNA records the estimated effects of its mandatory participation in residual markets on an accrual basis. CNA records assessments for insolvencies as they are paid. Accrual of such assessments is not practical, as past experience is not a reliable indicator of future activity.\nReinsurance - CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, provide greater diversification of risk and minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of\ncoverage. Generally, reinsurance coverage for property risks is on excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability.\nDeferred policy acquisition costs - Costs of acquiring property and casualty insurance business, which vary with and are primarily related to the production of such business, are deferred and amortized ratably over the period the related premiums are recognized. Such costs include commissions, premium taxes, and certain underwriting and policy issuance costs. Anticipated investment income is considered in the determination of the recoverability of deferred policy acquisition costs. Life acquisition costs are capitalized and amortized based on assumptions consistent with those used for computing policy benefit reserves. Acquisition costs on ordinary life business are amortized over the assumed premium paying periods. Universal life and investment annuity acquisition costs are amortized in proportion to the present value of estimated gross profits over the products' assumed durations, which are regularly evaluated and adjusted, as appropriate. To the extent that unrealized gains or losses on securities available for sale would result in an adjustment of deferred policy acquisition costs had those gains or losses actually been realized, the related unamortized deferred policy acquisition costs are recorded as an adjustment of the unrealized gains or losses included in shareholders' equity.\nRestricted investments - On December 30, 1993, CNA deposited $986.8 in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note 19. The funds are included in short-term investments and are invested in U.S. treasury securities. The escrow account amounted to $1,044.6 and $1,009.9 at December 31, 1995 and 1994, respectively.\nParticipating business - Participating business represented 0.6%, 0.9% and 1.1% of CNA's gross life insurance in force and 0.8%, 1.0% and 1.1% of life insurance premium income for 1995, 1994 and 1993, respectively. Participating policyholders' equity is determined by allocating 90% of related net income or loss and unrealized investment gains or losses to such business, less dividends determined by CNA's Board of Directors. In the accompanying Statements of Consolidated Income, revenues and benefits and expenses include amounts related to participating policies; the net income or loss allocated to participating policyholders' equity is a component of insurance claims and policyholders' benefits.\nSeparate Account business - CNA's life insurance subsidiary, Continental Assurance Company (\"CAC\"), issues certain investment and annuity contracts, the assets and liabilities of which are legally segregated and reflected in the accompanying Consolidated Balance Sheets as assets and liabilities of Separate Account business. CAC guarantees principal and a specified return to the contract holders of approximately 85% of the Separate Account business. Substantially all assets of the Separate Accounts are carried at fair value.\nStatutory capital and surplus - Statutory capital and surplus and net income, determined in accordance with accounting practices prescribed by the regulations and statutes of various state insurance departments, for property and casualty and life insurance subsidiaries are as follows:\nStatutory accounting practices - CNA's insurance affiliates are domiciled in various states including Illinois, California, Connecticut, Delaware, Hawaii, Indiana, Massachusetts, Missouri, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Puerto Rico and Texas. These affiliates prepare their statutory financial statements in accordance with accounting practices specifically \"prescribed\" or otherwise permitted by the respective state's insurance department. Prescribed statutory accounting practices are set forth in a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. CNA has no material permitted accounting practices.\nInventories -\nTobacco products - These inventories, aggregating $192.2 and $171.5 at December 31, 1995 and 1994, respectively, are stated at the lower of cost or market, using the last-in, first-out (LIFO) method.\nWatches and clocks - These inventories, aggregating $38.9 and $57.0 at December 31, 1995 and 1994, respectively, are stated at the lower of cost or market, using the first-in, first-out (FIFO) method.\nProperty, Plant and Equipment - Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over the estimated useful lives of the various classes of properties. Leaseholds and leasehold improvements are depreciated or amortized over the terms of the related leases (including optional renewal periods where appropriate) or the estimated lives of improvements, if less than the lease term.\nThe principal service lives used in computing provisions for depreciation are as follows:\nGoodwill and other intangible assets - Goodwill, representing the excess of the purchase price over the fair value of the net assets of the acquired entities, is generally amortized on a straight-line basis over the period of expected benefit of twenty years. Other intangible assets are amortized on a straight-line basis over their estimated economic lives. Accumulated amortization at December 31, 1995 and 1994 was $207.1 and $181.5, respectively. Amortization expense amounted to $25.6, $9.1 and $8.8 for the years ended December 31, 1995, 1994 and 1993, respectively. Intangible assets are periodically reviewed to determine whether an impairment in value has occurred.\nResearch and Development Costs - Research and development costs are charged to expense as incurred and amounted to $11.8, $11.8 and $11.9 for the years ended December 31, 1995, 1994 and 1993, respectively.\nReclassification - Certain amounts applicable to prior periods have been reclassified to conform to the classifications followed in 1995.\nThe carrying value of investments (other than equity securities) that have not produced income for the last twelve months is $98.3 at December 31, 1995.\nInvestment gains of $1,135.2, $322.4 and $1,020.7 and losses of $369.0, $760.3 and $161.6 were realized on securities available for sale for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe amortized cost and market values of securities available for sale are as follows:\nThe amortized cost and market value of fixed maturities at December 31, 1995 and 1994 are shown below by contractual maturity. Actual maturities differ from contractual maturities because securities may be called or prepaid with or without call or prepayment penalties.\nNote 3. Fair Value of Financial Instruments -\nIn cases where quoted market prices are not available, fair values may be based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. Accordingly, the estimates presented herein are subjective in nature and are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The amounts reported in the balance sheet for fixed maturities securities, equity securities, derivative instruments, short-term investments and securities sold under agreements to repurchase are at fair value. As such, these financial instruments are not shown in the table above. See Note 4 for the fair value of derivative instruments. Since the disclosure excludes certain financial instruments and all nonfinancial instruments such as real estate and insurance reserves, the aggregate fair value amounts cannot be summed to determine the underlying economic value of the Company.\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\nFixed maturity securities, equity securities and separate account securities are based on quoted market prices, where available. For securities not actively traded, fair values are estimated using values obtained from independent pricing services or quoted market prices of comparable instruments adjusted for differences between the quoted instruments and the instruments being valued.\nFair value for mortgage loans and notes receivable and policy loans are estimated using discounted cash flow analyses, at interest rates currently being offered for similar loans to borrowers with comparable credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.\nOther investments and other Separate Account assets consist of investments in limited partnerships and various miscellaneous assets. Valuation techniques to determine fair value consist of discounted cash flows and quoted market prices of (a) the investments, (b) comparable instruments or (c) underlying assets of the investments.\nPremium deposits and annuity contracts are valued based on cash surrender values and the outstanding fund balances.\nThe fair value of the liability for financial guarantee contracts is based on discounted cash flows utilizing interest rates currently being offered for similar contracts or spot interest rates.\nGuaranteed investment contracts and deferred annuities of the Separate Accounts are estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with similar maturities. The fair value of the liabilities for variable Separate Accounts are based on the quoted market values of the underlying assets of each variable Separate Account. The fair value of other Separate Account liabilities approximates carrying value.\nFair value of long-term debt traded on securities exchanges is based on quoted market prices. The fair values for other long-term debt are based on quoted market prices of comparable instruments adjusted for differences between the quoted instruments and the instruments being valued or are estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.\nNote 4. Off-Balance-Sheet and Derivative Financial Instruments -\nThe Company enters into various transactions involving off-balance-sheet financial instruments through a variety of futures, swaps, options, forwards and other contracts (the \"Contracts\") as part of its investing activities. These Contracts are commonly referred to as derivative instruments since their underlying values may be linked to interest rates, exchange rates, prices of securities and financial or commodity indexes. The Company uses these Contracts for its asset and liability management activities as well as income enhancements for its portfolio management strategy. Entering into these Contracts involves not only the risk of dealing with counterparties and their ability to meet the terms of the Contracts but also the market risk associated with those positions where the Company does not hold an offsetting security. Exposure to market risk is managed in accordance with risk limits set by senior management by buying or selling instruments or entering into offsetting positions.\nThe notional amounts of derivatives shown in the following table does not represent amounts exchanged in these transactions and, therefore, are not a measure of the exposure the Company has through its use of derivative instruments. In addition, notional amounts are presented gross and do not reflect the net effect of offsetting positions. The amounts exchanged are calculated on the basis of the notional amounts and the other terms of the derivative instruments.\nThe credit exposure associated with these instruments is generally limited to the positive market value of the instruments and will vary based on changes in market prices. The Company enters into these Contracts with large financial institutions and considers the risk of nonperformance to be remote. In addition, the amounts subject to credit risk are substantially mitigated by many of the Contracts' collateral requirements.\nThe Company's investments in derivative instruments are as follows:\nThe notional values presented in the tables above include purchased options of $3,324.1 and $475.8 at December 31, 1995 and 1994, respectively.\nThe Company's measure of exposure represents an estimate of net losses that would be recognized on each class of derivative instrument held by the Company at December 31, assuming immediate adverse market movements of the magnitude described above. The Company believes that the various rates of adverse market movements represent a measure of exposure to loss under hypothetically assumed adverse conditions. The estimated market exposure represents the hypothetical loss to future earnings and does not represent the maximum possible loss nor any expected actual loss, even under adverse conditions, because actual adverse fluctuations would likely differ. In addition, since the Company's investment portfolio is subject to change based on its portfolio management strategy as well as in response to changes in the market, these estimates are not necessarily indicative of the actual results which may occur.\nCNA has entered into interest rate swap agreements to convert the variable rate of the borrowing under the bank credit facility and the commercial paper program to a fixed rate. Since these interest rate swaps are not held for trading purposes, they are not included in the preceding tables. At December 31, 1995, CNA had outstanding interest rate swap agreements with several banks having a total notional principle amount of $1,200 and a fair value liability of $28.7. Those agreements, which terminate from May 2000 to December 2000, effectively fix the Company's interest rate exposure on $1,200 of variable rate debt.\nThe Company also enters into short sales as part of its portfolio management strategy. These sales resulted in proceeds of $182.4 and $117.9 with fair value liabilities of $188.5 and $144.5 at December 31, 1995 and 1994, respectively. Estimated fair values approximate carrying values and are based on quoted market prices, where available.\nFor securities not actively traded, fair values are estimated using values obtained from independent pricing services, quoted market prices of comparable instruments or present value models.\nThrough August 1, 1989, CNA's property and casualty operations wrote financial guarantee insurance contracts. These contracts primarily represent industrial development bond guarantees and equity guarantees typically extending from ten to thirteen years. For these guarantees, CNA received an advance premium which is recognized over the exposure period and in proportion to the underlying exposure insured.\nAt December 31, 1995 and 1994, gross exposure of financial guarantee insurance contracts amounted to $707 and $630, respectively. The degree of risk attached to this exposure is substantially reduced through reinsurance, collateral requirements and diversification of exposures. At December 31, 1995 and 1994, collateral consisting of letters of credit and debt service reserves amounted to $39 and $45, respectively. In addition, security interests in real estate are also obtained. Approximately 44% and 38% of the risks were ceded to reinsurers at December 31, 1995 and 1994, respectively. Total exposure, net of reinsurance, amounted to $395 and $393 at December 31, 1995 and 1994, respectively. Gross unearned premium reserves for financial guarantee contracts were $17 and $22 at December 31, 1995 and 1994, respectively. Gross claim and claim expense reserves totaled $463 and $420 at December 31, 1995 and 1994, respectively.\nNote 5. Purchase of Business -\nOn May 10, 1995, CNA acquired all the outstanding shares of The Continental Corporation (\"CIC\") for approximately $1,100, or $20 per CIC share. To finance the acquisition, CNA entered into a five year $1,325 revolving credit facility (see Note 13). CIC is an insurance holding company principally engaged through subsidiaries in the business of property and casualty insurance.\nThe acquisition of CIC has been accounted for as a purchase, and CIC's operations are included in the Consolidated Financial Statements as of May 10, 1995. The purchase of CIC reflects goodwill of approximately $366 which will be amortized over twenty years at an annual charge of $18.3.\nThe pro forma consolidated condensed results of operations presented below assume the above transaction had occurred at the beginning of the periods presented.\nThe pro forma consolidated condensed financial information is not necessarily indicative either of the results of operations that would have occurred had these transactions been consummated at the beginning of the periods presented or of future operations of the combined companies.\nNote 6. Investment in CBS Inc. -\nOn November 24, 1995, Westinghouse Electric Corporation completed its acquisition of CBS Inc. (\"CBS\") for cash consideration of $82.06 per share. The Company received proceeds of $901.7 for its CBS shares and recorded (as part of its realized investment gains) a pre-tax and after tax gain of $579.2 and $376.5, respectively, in the fourth quarter of 1995. Previously, the Company held approximately 18% of the outstanding common shares of CBS and accounted for it on the equity method.\nThe Company's equity in the earnings of CBS after giving effect to purchase value adjustments amounted to $15.7, $45.8 and $59.0 before taxes and $11.3, $30.8 and $52.6 after taxes for the years ended December 31, 1995, 1994 and 1993, respectively. Dividends received amounted to $4.4, $5.2 and $3.8 for the respective periods.\nAt December 31, 1994, the Company's carrying value, included in other assets, and market value for its investment in CBS was $294.3 and $607.0, respectively.\nAt September 1, 1994, CBS completed a cash tender offer at an amount exceeding its net book value per share for repurchase of its common stock aggregating approximately $1,137.5, or 22% of its common shares. The Company tendered its shares and received cash amounting to $270.4, comprised of $86.4 realization of previously undistributed earnings and $184.0 representing a return of the Company's investment. As a result of the tender, the Company's ownership in CBS decreased from approximately 20% to 18% and the Company's additional paid-in capital increased by $11.5.\nIn May 1993, $389.6 of CBS 5% convertible debentures were converted for 1,947,975 shares of common stock. The difference between the amount of debt converted and the average cost of the treasury shares issued, net of unamortized issue costs related to this debt, was credited to additional paid-in capital. As a result, the Company's ownership in CBS decreased from approximately 23% to 20% and the Company's additional paid-in capital increased by $58.9.\nNote 7. Receivables -\nNote 8. Property, Plant and Equipment -\nDepreciation and amortization expense and capital expenditures, by business segment, are as follows:\nNote 9. Inventories -\nInventories, included in other assets, are as follows:\nIf the average cost method of accounting had been used for tobacco inventories instead of the LIFO method, such inventories would have been $203.3 and $190.7 higher at December 31, 1995 and 1994, respectively.\nNote 10. Liability for Unpaid Claims and Claim Adjustment Expenses -\nCNA's property and casualty insurance claims and claims expense reserve represents the estimated amounts necessary to settle all outstanding claims, including claims which are incurred but not reported, as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, CNA's experience with similar cases, and various historical development patterns. Consideration is given to such historical patterns as field reserving trends, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these can affect the estimation of reserves. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance. Reserves are not present valued except in the case of workers' compensation lifetime claims and accident and health disability claims where the reserves are explicitly discounted at rates allowed by insurance regulators that range from 3.5% to 6.0% and structured settlements where such reserves are discounted at interest rates ranging from 6.3% to 7.5%.\nEstimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail claims, such as general liability and professional liability claims.\nThe table below provides a reconciliation between beginning and ending claim and claim expense reserve balances for 1995, 1994 and 1993:\nEnvironmental Pollution and Asbestos - The CNA property\/casualty insurance companies have potential exposures related to environmental pollution, other toxic tort and asbestos-related claims.\nEnvironmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies.\nThe Comprehensive Environmental Response Compensation and Liability Act of 1980 (\"Superfund\") and comparable state statutes (\"mini-Superfund\") govern the clean-up and restoration of abandoned toxic waste sites and formalize the concept of legal liability for clean-up and restoration by potentially responsible parties (\"PRP's\"). Superfund and the mini-Superfunds (Environmental Clean-up Laws or \"ECLs\") establishes a mechanism to pay for clean-up of waste sites if PRP's fail to do so, and to assign liability to PRP's. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency on its National Priorities List. On the other hand, the Congressional Budget Office estimates that there will be 4,500 National Priority List sites, and other estimates project as many as 30,000 sites that will require clean-up under ECLs. Very few sites have been subject to clean-up to date. The extent of clean-up necessary and the assignment of liability has not been established.\nCNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether Superfund response costs are considered damages under the policies, trigger of coverage, applicability of pollution exclusions, the potential for joint and several liability and definition of an occurrence. Similar coverage issues exist for clean-up of waste sites not covered under Superfund. To date, courts have been inconsistent in their rulings on these issues.\nA number of proposals to reform Superfund have been made by various parties. Despite Superfund taxing authority expiring at the end of 1995, no reforms have been enacted by Congress. While the next Congress may address this issue, no predictions can be made as to what positions the Congress or the Administration will take and what legislation, if any, will result. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean-up may be materially reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental clean-up statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result.\nDue to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate exposure to CNA for environmental pollution claims cannot be meaningfully quantified. Claim and claim expense reserves represent management's estimates of ultimate liabilities based on currently available facts and law. However, in addition to the uncertainties previously discussed, additional issues related to, among other things, specific policy provisions, multiple insurers and allocation of liability among insurers, consequences of conduct by the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult and subject to later adjustment based on new data. As of December 31, 1995 and 1994, CNA carried approximately $1,177 and $516, respectively, of claim and claim expense reserves, before reinsurance recoverable, for reported and unreported environmental pollution claims. Unfavorable reserve development for the years ended December 31, 1995 and 1994 totaled $241 and $181, respectively. The foregoing reserve information includes claims for accident years 1988 and prior, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form which included an absolute pollution exclusion.\nCNA has exposure to asbestos-related claims, including those attributable to the litigation with Fibreboard Corporation (see Note 19). Estimation of asbestos-related claim reserves encounter many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, multiple insurers and allocation of liability\namong insurers, missing policies and proof of coverage. As of December 31, 1995 and 1994, CNA carried approximately $2,322 and $2,068, respectively, of claim and claim expense reserves, before reinsurance recoverable, for reported and unreported asbestos-related claims. Unfavorable reserve development for the years ended December 31, 1995 and 1994 totaled $258 and $37, respectively.\nThe results of operations in future years may continue to be adversely affected by environmental pollution claim and claim expenses. Management will continue to monitor potential liabilities and make further adjustments as warranted.\nCNA, consistent with sound reserving practices, regularly adjusts its reserve estimates in subsequent reporting periods as new facts and circumstances emerge that indicate the previous estimates need to be modified. The following tables provides additional data related to CNA's environmental pollution, other toxic tort and asbestos-related claims activity. Claims activity for CIC is included for the period May 10, 1995 through December 31, 1995.\nThe following tables summarize activity for environmental pollution, other toxic tort and asbestos claims.\nReserve Recapitulation:\nEnvironmental Pollution and Other Toxic Tort:\nAsbestos:\nNote 11. Income Taxes -\nDeferred tax assets (liabilities) are as follows:\nGross deferred tax assets amounted to $2,449.1, $2,290.3 and $1,895.7 and liabilities amounted to $1,243.9, $611.1 and $821.3, for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995, the Company has net operating loss carryforwards of $850 for income tax purposes that expire in years 2000 through 2010. Those carryforwards resulted from CNA's 1995 acquisition of CIC.\nThe Company has a past history of profitability and anticipates sufficient future taxable income to fully support recognition of its deferred tax balance at December 31, 1995, including but not limited to the reversal of existing temporary differences and the implementation of tax planning strategies, if needed.\nA valuation allowance is maintained due to the uncertainty regarding the realization of deferred tax assets related to the acquisition of CIC. Accordingly, any subsequent adjustment of the valuation allowance will be reflected as an adjustment to intangible assets.\nTotal income tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993 was different than the amounts of $993.8, $93.1 and $241.3, computed by applying the statutory U.S. federal income tax rate of 35% to income before income taxes and minority interest for each of the years.\nA reconciliation between the statutory federal income tax rate and the Company's effective income tax rate as a percentage of income before income taxes and minority interest is as follows:\nFederal, foreign, state and local income tax payments, net of refunds, amounted to approximately $386.5, $194.9 and $10.3 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company has entered into separate tax allocation agreements with Bulova and CNA, majority-owned subsidiaries in which its ownership exceeds 80% (the \"Subsidiaries\"). Each agreement provides that the Company will (i) pay to the Subsidiary the amount, if any, by which the Company's consolidated federal income tax is reduced by virtue of inclusion of the Subsidiary in the Company's return, or (ii) be paid by the Subsidiary an amount, if any, equal to the federal income tax which would have been payable by the Subsidiary if it had filed a separate consolidated return. Under these agreements, the federal income tax (expense) benefit to CNA amounted to approximately $(35.0), $84.0 and $17.0 for the years ended December 31, 1995, 1994 and 1993, respectively, and the federal income tax benefit to Bulova amounted to approximately $0.8, $0.1 and $2.5 for the years ended December 31, 1995, 1994 and 1993, respectively. Each agreement may be cancelled by either of the parties upon thirty days' written notice.\nThe Company's federal income tax returns have been examined through 1990 and settled through 1986, and the years 1991 through 1994 are currently under examination. While tax liabilities for subsequent years are subject to audit and final determination, in the opinion of management the amount accrued in the consolidated balance sheet is believed to be adequate to cover any additional assessments which may be made by federal, state and local tax authorities and should not have a material effect on the financial condition or results of operations of the Company.\nIn 1993 the Company increased its deferred tax asset by $31.6 due to a 1% increase in the corporate tax rate.\nNote 12. Leases -\nThe Company's hotels in some instances are constructed on leased land or are leased. Other leases cover office facilities, computer and transportation equipment. Rent expense amounted to $118.9, $78.1 and $84.9 for the years ended December 31, 1995, 1994 and 1993, respectively. It is expected, in the normal course of business, that leases which expire will be renewed or replaced by leases on other properties; therefore, it is believed that future minimum annual rental commitments will not be less than the amount of rental expense incurred in 1995. At December 31, 1995 future aggregate minimum rental payments approximated $633.0.\nNote 13. Long-Term Debt -\nTo finance the acquisition of CIC, CNA entered into a five-year $1,325 revolving credit facility (the \"Bank Facility\") involving 16 banks led by The First National Bank of Chicago and The Chase Manhattan Bank, N.A. The interest rate is based on the one, two, three or six month London Interbank Offered Rate (\"LIBOR\"), as elected, plus 25 basis points. Additionally, there is a facility fee of 10 basis points. The average interest rate on the borrowings under the Bank Facility at December 31, 1995 was 6.1%. Under the terms of the facility, CNA may prepay the debt without penalty.\nTo offset the variable rate characteristics of the Bank Facility, CNA entered into five year interest rate swap agreements with several banks. These agreements which terminate from May 2000 to December 2000 effectively convert variable rate debt into fixed rate debt resulting in fixed rates on notional amounts aggregating $1,200. The weighted average fixed swap rate at December 31, 1995 was 6.3%.\nOn August 10, 1995, to take advantage of favorable interest rate spreads, CNA established a commercial paper program borrowing $500 from investors to replace a like amount of bank financing. The weighted average yield on commercial paper at December 31, 1995 was 6.1%. The commercial paper borrowings are classified as long-term debt as $500 of the committed Bank Facility will support the commercial paper program. Standard and Poor's and Moody's issued short-term debt ratings of A2 and P2, respectively, for CNA's commercial paper program.\nThe weighted average interest rate (interest and facility fees) on the acquisition debt, which includes the Bank Facility, commercial paper and the effect of the interest rate swaps, was 6.5% on December 31, 1995.\nThe aggregate of long-term debt maturing in each of the next five years is approximately as follows: $297.9 in 1996, $62.9 in 1997, $322.6 in 1998, $191.8 in 1999 and $1,388.3 in 2000. The Company paid interest expenses of approximately $276.0, $168.9 and $219.1 for the years ended December 31, 1995, 1994 and 1993, respectively.\nPayment of dividends by insurance subsidiaries of CNA without prior regulatory approval is limited to certain formula-derived amounts. At December 31, 1995, $1,137.4 of retained earnings of subsidiaries was not available for dividends to the Company.\nNote 14. Benefit Plans -\nPension Plans - The Company and its subsidiaries have several non-contributory defined benefit plans for eligible employees. The benefits for certain plans which cover salaried employees and certain union employees are based on formulas which include among others, years of service and average pay. The benefits for one plan which covers union workers under various union contracts and certain salaried employees are based on years of service multiplied by a stated amount.\nPension cost includes the following components:\nThe following table sets forth the funded status of the Company's pension plans:\nAt December 31, 1994, the Company's minimum pension liability exceeded its unrecognized prior service cost and net transition obligation by $30.7. This excess is recorded as a reduction to shareholders' equity of $20.0, net of tax benefits of $10.7.\nThe rates used in the actuarial assumptions were:\nThe Company's funding policy is to make contributions in accordance with applicable governmental regulatory requirements. The assets of the plans are invested primarily in interest-bearing obligations and for one plan with an insurance subsidiary of the Company, in its Separate Account business. In 1995, the Company made contributions totaling approximately $186.0 to fund completely certain plans which had been underfunded.\nOther Postretirement Benefit Plans - The Company and its subsidiaries have several postretirement benefit plans covering eligible employees and retirees. Participants generally become eligible after reaching age 55 with required years of service. Actual requirements for coverage vary by plan. Benefits for retirees who were covered by bargaining units vary by each unit and contract. Benefits for certain retirees are in the form of a company health care account.\nBenefits for retirees reaching age 65 are generally integrated with Medicare. Other retirees, based on plan provisions, must use Medicare as their primary coverage, with the Company reimbursing a portion of the unpaid amount; or are reimbursed for the Medicare Part B premium or have no Company coverage. The benefits provided by the Company are basically health and, for certain retirees, life insurance type benefits.\nThe Company does not fund any of these benefit plans and accrues postretirement benefits during the active service of those employees who would become eligible for such benefits when they retire.\nThe rates used in the actuarial assumptions were:\nThe following table sets forth the postretirement benefit plans' status:\nPostretirement benefit cost includes the following components:\nFor measurement purposes, a trend rate for covered costs of 13.0% pre-65 and 10.0% post-65, was used. These trend rates are expected to decrease gradually to 5% and 6.5% at rates from 0.5% to 1.0% per annum. An increase of one percentage point in assumed health care cost trend rates would increase the accumulated postretirement benefit obligation by approximately $34.2 and the net periodic postretirement benefit cost by approximately $3.5.\nSavings Plans - The Company and its subsidiaries have several contributory savings plans which allow employees to make regular contributions based upon a percentage of their salary. The Company's contributions to these plans amounted to $25.9, $21.2 and $21.1 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote 15. Capital Stock and Earnings Per Share -\nIn addition to its common stock, the Company has authorized 25,000,000 shares of preferred stock, $.10 par value.\nOn October 17, 1995, the Board of Directors declared a two-for-one stock split, by way of a stock dividend, effective December 1, 1995. Accordingly, certain share and per share data has been restated to retroactively reflect the stock split.\nEarnings per share are based on the weighted average number of shares outstanding during each year (117,835,000, 120,383,000 and 128,217,000 for the years ended December 31, 1995, 1994 and 1993, respectively).\nNote 16. Gain on Sale of Subsidiary's Stock -\nIn October 1995 the Company's wholly owned subsidiary, Diamond Offshore Drilling, Inc. (\"Diamond Offshore\"), sold 14,950,000 shares of its common stock through an initial public offering at $24 per share. Diamond Offshore used the net proceeds of approximately $338.4 to fund the repayment of its intercompany debt as well as a dividend to the Company. As a result of the offering, the Company's ownership interest in Diamond Offshore declined to approximately 70.1% and the Company recorded a gain of approximately $192.9 ($125.4 after provision for deferred income taxes) in the fourth quarter of 1995.\nNote 17. Quarterly Financial Data (Unaudited) -\nNote 18. Reinsurance -\nThe ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in its states of domiciles, CNA receives collateral, primarily in the form of bank letters of credit, securing a large portion of the recoverables. Such collateral totaled approximately $1,300 and $165 at December 31, 1995 and 1994, respectively. CNA's largest billed recoverable from a single reinsurer, including prepaid reinsurance premiums, was approximately $435 and $348 with Lloyd's of London at December 31, 1995 and 1994, respectively. Insurance claims and policyholders' benefits are net of reinsurance recoveries of $934.8, $827.9 and $177.6 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote 19. Legal Proceedings and Contingent Liabilities -\nFibreboard Litigation - CNA's primary property and casualty subsidiary, Continental Casualty Company (\"Casualty\"), is party to litigation with Fibreboard Corporation (\"Fibreboard\") involving coverage for certain asbestos-related claims and defense costs (San Francisco Superior Court, Judicial Council Coordination Proceeding 1072). As described below, Casualty, Fibreboard, another insurer (Pacific Indemnity, a subsidiary of the Chubb Corporation), and a negotiating committee of asbestos claimant attorneys (collectively referred to as \"Settling Parties\") have reached a Global Settlement (the \"Global Settlement\") to resolve all future asbestos-related bodily injury claims involving Fibreboard, which is subject to court approval. Casualty, Fibreboard and Pacific Indemnity have also reached an agreement (the \"Trilateral Agreement\"), which is subject to court approval, on a settlement to resolve the coverage litigation in the event the Global Settlement does not obtain final court approval or is subsequently successfully attacked. The implementation of the Global Settlement or the Trilateral Agreement would have the effect of settling Casualty's litigation with Fibreboard.\nOn July 27, 1995, the United States District Court for the Eastern District of Texas entered judgment approving the Global Settlement Agreement and the Trilateral Agreement. As expected, appeals were filed as respects both of these decisions. The last briefs have been filed with the United States Fifth Circuit Court of Appeals in New Orleans on December 18, 1995, and the Court heard oral arguments on March 5 and 6, 1996. Decisions regarding these appeals are possible by the third quarter of 1996.\nCoverage Litigation - Between 1928 and 1971, Fibreboard manufactured insulation products containing asbestos. Since the 1970's, thousands of claims have been filed against Fibreboard by individuals claiming bodily injury as a result of asbestos exposure.\nCasualty insured Fibreboard under a comprehensive general liability policy between May 4, 1957, and March 15, 1959. Fibreboard disputed the coverage positions taken by its insurers and, in 1979, Fireman's Fund, another of Fibreboard's insurers, brought suit with respect to coverage for defense and indemnity costs. In January 1990, the San Francisco Superior Court (Judicial Council Coordination Proceeding 1072) rendered a decision against the insurers including Casualty and Pacific Indemnity. The court held that the insurers owed a duty to defend and indemnify Fibreboard for certain of the asbestos-related bodily injury claims asserted against Fibreboard (in the case of Casualty, for all claims involving exposure to Fibreboard's asbestos products if there was exposure to asbestos at any time prior to 1959 including years prior to 1957, regardless of when the claims were asserted or injuries manifested) and, although the policies had a $0.5 per person limit and a $1.0 per occurrence limit, they contained no aggregate limit of liability in relation to such claims. The judgment was appealed.\nThe Court of Appeal entered an opinion on November 15, 1993, as modified on December 13, 1993, which substantially affirmed the lower court's decisions on scope of coverage and trigger of coverage issues, as described below. The Court of Appeal withheld its ruling on the issues discrete to Casualty and Pacific Indemnity pending final court approval of either the Global Settlement or the Trilateral Agreement described below. On January 27, 1994, the California Supreme Court granted a Petition for Review filed by several insurers, including Casualty, of, among other things, the trigger and scope of coverage issues. The order granting review had no effect on the Court of Appeal's order severing the issues unique to Casualty and Pacific Indemnity. On October 19, 1995 the California Supreme Court transferred the case back to the Court of Appeal with directions to vacate its decision and reconsider the case in light of the Supreme Court's decision in Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645, where the Court adopted a continuous trigger in litigation over the duty to defend bodily injury and property damage due to exposure to D.D.T. Additional briefs were filed in the Court of Appeal on December 20, 1995 and a decision by the court is expected by the end of May, 1996. Casualty cannot predict the time frame within which the issues before the California courts will finally be resolved. The appeal of issues such as trigger of coverage and scope of coverage are in process notwithstanding the pending proceedings to approve the Global and Trilateral Agreements. If neither the Global\nSettlement nor the Trilateral Agreement is finally approved, it is anticipated that Casualty and Pacific Indemnity will resume the coverage appeal process of the issues discrete to them. Casualty's appeal of the coverage judgment raises many legal issues. Key issues on appeal under the policy are trigger of coverage, scope of coverage, dual coverage requirements and number of occurrences:\n. The trial court adopted a continuous trigger of coverage theory under which all insurance policies in effect at any time from first exposure to asbestos until the date of the claim filing or death are triggered. The Court of Appeal endorsed the continuous trigger theory, but modified the ruling to provide that policies are triggered by a claimant's first exposure to the policyholder's products, as opposed to the first exposure to any asbestos product. Therefore, an insurance policy is not triggered if a claimant's first exposure to the policyholder's product took place after the policy period. The court, however, placed the burden on the insurer to prove the claimant was not exposed to its policyholder's product before or during the policy period.\n. Casualty's position is that its policy is triggered under California law by manifestation of appreciable harm during the policy period. The bodily injury cannot be said to occur within the meaning of the policy until actual physical symptoms and associated functional impairment manifest themselves. Thus, Casualty's position is that there would be no coverage under Casualty's policy for injuries which were first manifest outside the policy period.\n. The scope of coverage decision imposed a form of \"joint and several\" liability that makes each triggered policy liable in whole for each covered claim, regardless of the length of the period the policy was in effect. This decision was affirmed by the Court of Appeal, but is now again before the Court due to the Supreme Court's transfer order. Casualty's position is that liability for asbestos claims should be shared not jointly, but severally and on a pro rata basis between the insurers and insured. Under this theory, Casualty would only be liable for that proportion of the bodily injury that occurred during the 22-month period its policy was in force.\n. Casualty maintains that both the occurrence and the injury resulting therefrom must happen during the policy period for the policy to be triggered. Consequently, if the court holds that the occurrence is exposure to asbestos, Casualty's position is that coverage under the Casualty policy is restricted to those who actually inhaled Fibreboard asbestos fibers and suffered injury from May 4, 1957 to March 15, 1959. The Court of Appeal withheld ruling on this issue, as noted above.\n. Casualty's policy had a $1.0 per occurrence limit. Casualty contends the number of occurrences under California law must be determined by the general cause of the injuries, not the number of claimants, and that the cause of the injury was the continuous manufacture and sale of the product. Because the manufacture and sale proceeded from two locations, Casualty maintains that there were only two occurrences and thus only $2.0 of coverage under the policy. However, the per occurrence limit was interpreted by the trial court to mean that each claim submitted by each individual constituted a separate occurrence. The Court of Appeal withheld ruling on this issue, as noted above.\nEven if Casualty were successful on appeal on the dual coverage requirements or the number of occurrences and were thereby to limit its liability, if the final decision in the coverage case affirms the trial court's decision on the existence of the Pacific Indemnity policy, then Casualty would still have obligations under the Casualty and Pacific Indemnity Agreement described below.\nUnder various reinsurance agreements, Casualty has asserted a right to reimbursement for a portion of its potential exposure to Fibreboard. The reinsurers have disputed Casualty's right to reimbursement and have taken the position that any claim by Casualty is subject to arbitration under provisions in the reinsurance agreement. A Federal court has ruled that the dispute must be resolved by arbitration. There can be no assurance that Casualty will be successful in obtaining a significant recovery under its reinsurance agreements.\nOn April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants.\nThrough 1995, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 137,700 claims, subject to resolution of the coverage issues, for an estimated settlement amount of approximately $1,620 plus any applicable interest. If neither the Global Settlement nor the Trilateral Agreement receives final court approval, Casualty's obligation to pay under these settlements will be partially subject to the results of the pending appeal in the coverage litigation. Minimum amounts payable under all such agreements, regardless of the outcome of coverage litigation, may total as much as approximately $788, of which approximately $582 was paid through 1995. Casualty may negotiate other agreements with various classes of claimants including groups who may have previously reached agreement with Fibreboard.\nCasualty will continue to pursue its appeals in the coverage litigation and all other litigation involving Fibreboard if the Global Settlement or the Trilateral Agreement cannot be implemented.\nGlobal Settlement - On August 27, 1993, Casualty, Pacific Indemnity, Fibreboard and a negotiating committee of asbestos claimant attorneys reached an agreement in principle for an omnibus settlement to resolve all future asbestos-related bodily injury claims involving Fibreboard. The Global Settlement Agreement was executed on December 23, 1993. The agreement calls for contribution by Casualty and Pacific Indemnity of an aggregate of $1,525 to a trust fund for a class of all future asbestos claimants, defined generally as those persons whose claims against Fibreboard were neither filed nor settled before August 27, 1993. An additional $10 is to be contributed to the fund by Fibreboard. As indicated above, the Global Settlement approval has been appealed and oral arguments were heard on March 5 and 6, 1996. As noted below, there is limited precedent with settlements which determine the rights of future claimants to seek relief.\nSubsequent to the announcement of the agreement in principle, Casualty, Fibreboard and Pacific Indemnity entered into the Trilateral Agreement, subject to court approval which would, among other things, settle the coverage case in the event the Global Settlement approval by the trial court is not upheld on appeal. In such case, Casualty and Pacific Indemnity would contribute to a settlement fund an aggregate of $2,000, less certain adjustments. Such fund would be devoted to the payment of Fibreboard's asbestos liabilities other than liabilities for claims settled before August 23, 1993. Casualty's share of such fund would be $1,440 reduced by a portion of an additional payment of $635 which Pacific Indemnity has agreed to pay for claims either filed or settled before August 27, 1993. Casualty has agreed that if either the Global Settlement or the Trilateral Agreement is finally approved, it will assume responsibility for the claims that had been settled before August 27, 1993. A portion of the additional $635 to be contributed by Pacific Indemnity would be applied to the payment of such claims as well. As a part of the Global Settlement and the Trilateral Agreement, Casualty would be released by Fibreboard from any further liability under the comprehensive general liability policy written for Fibreboard by Casualty, including but not limited to liability for asbestos-related claims against Fibreboard. As noted above, the Trilateral Agreement approval by the trial court has also been appealed as noted above and oral arguments were heard on March 5 and 6, 1996.\nCasualty and Fibreboard have entered into a supplemental agreement (the \"Supplemental Agreement\") which governs the interim arrangements and obligations between the parties until such time as the coverage case is finally resolved, either through final court approval of one or both of the Global Settlement Agreement and Trilateral Agreement or through a final decision in the California courts. It also governs certain obligations between the parties in the event the Global Settlement is upheld on appeal including the payment of claims which are not included in the Global Settlement.\nIn addition, Casualty and Pacific Indemnity have entered into an agreement (the \"Casualty-Pacific Agreement\") which sets forth the parties' agreement with respect to the means for allocating among themselves responsibility for payments arising out of the Fibreboard insurance policies whether or not the Global Settlement or the Trilateral Agreement is finally approved. Under the Casualty-Pacific Agreement, Casualty and Pacific Indemnity have agreed to pay 64.71% and 35.29%, respectively, of the $1,525 to be used to satisfy the claims of future claimants, plus certain expenses. The $1,525 has already\nbeen deposited into an escrow for such purpose. If neither the Global Settlement nor the Trilateral Agreement is finally approved, Casualty and Pacific Indemnity would share, in the same percentages, most but not all liabilities and costs of either insurer including, but not limited to, liabilities for unsettled present claims and presently settled claims (regardless of whether either such insurer would otherwise have any liability therefor). If either the Trilateral Agreement or the Global Settlement is finally approved, Pacific Indemnity's share for unsettled present claims and presently settled claims will be $635.\nReserves - In the fourth quarter of 1992, Casualty increased its reserve with respect to potential exposure to asbestos-related bodily injury cases by $1,500. In connection with the agreement in principle announced on August 27, 1993, Casualty added $500 to such claim reserve in the third quarter of 1993. The Fibreboard litigation represents the major portion of Casualty's asbestos-related claim exposure.\nThere are inherent uncertainties in establishing a reserve for complex litigation of this type. Courts have tended to impose joint and several liability, and because the number of manufacturers who remain potentially liable for asbestos-related injuries has diminished on account of bankruptcies, as has the potential number of insurers due to operation of policy limits, the liability of the remaining defendants is difficult to estimate. Further, a recent trend by courts to consolidate like cases into mass tort trials limits the discovery ability of insurers, generally does not allow for individual claim adjudication, restricts the identification of appropriate allocation methods and thereby results in an increasing likelihood for fraud and disproportionate and potentially excessive judgments. Additionally, management believes that recent court decisions would appear to be based on social or other considerations irrespective of the facts and legal issues involved.\nThe Global Settlement and the Trilateral Agreement approved by the trial court have been appealed as noted above and oral arguments were heard on March 5 and 6, 1996. There is limited precedent with settlements which determine the rights of future claimants to seek relief. It is extremely difficult to assess the magnitude of Casualty's potential liability for such future claimants if neither the approval of the Global Settlement nor the Trilateral Agreement is upheld on appeal, keeping in mind that Casualty's potential liability is limited to persons exposed to asbestos prior to the termination of the policy in 1959.\nProjections by experts of future trends differ widely, based upon different assumptions with respect to a host of complex variables. Some recently published studies, not specifically related to Fibreboard, conclude that the number of future asbestos-related bodily injury claims against asbestos manufacturers could be several times the number of claims brought to date. Such studies include claims asserted against asbestos manufacturers for all years, including claims filed or projected to be filed for exposure starting after 1959. As indicated above, as of December 31, 1995, Casualty, Fibreboard and plaintiff attorneys have reached settlements with respect to approximately 137,700 claims, subject to the resolution of coverage issues. Such amount does not include presently pending or unsettled claims, claims previously dismissed or claims settled pursuant to agreements to which Casualty is not a party.\nAnother aspect of the complexity in establishing a reserve arises from the widely disparate values that have been ascribed to claims by courts and in the context of settlements. Under the terms of a settlement reached with plaintiffs' counsel in August 1993, the expected settlement for approximately 49,500 claims for exposure to asbestos both prior to and after 1959 is currently averaging approximately thirteen thousand three hundred dollars per claim for the before 1959 claims processed through December 31, 1995. Based on reports by Fibreboard, between September 1988 and April 1993, Fiberboard resolved approximately 40,000 claims, approximately 45% of which involved no cost to Fibreboard other than defense costs, with the remaining claims involving the payment of approximately eleven thousand dollars per claim. On the other hand, a trial court in Texas in 1990 rendered a verdict in which Fibreboard's liability in respect of 2,300 claims was found to be approximately $0.3 per claim including interest and punitive damages. Fibreboard entered into a settlement of such claims by means of an assignment of its potential proceeds from its policy with Casualty. Casualty intervened and settled these claims for approximately seventy seven thousand dollars on average, with a portion of the payment contingent on final\napproval on appeal of the Global Settlement or the Trilateral Agreement, and if neither is finally approved, subject to resolution of the coverage appeal.\nCasualty believes that as a result of the Global Settlement and the Trilateral Agreement it has greatly reduced the uncertainty of its exposure with respect to the Fibreboard matter. However, if neither the Global Settlement, nor the Trilateral Agreement is upheld on appeal, in light of the factors discussed herein the range of Casualty's potential liability cannot be meaningfully estimated and there can be no assurance that the reserves established would be sufficient to pay all amounts which ultimately could become payable in respect of asbestos-related bodily injury liabilities.\nWhile it is possible that the ultimate outcome of this matter could have a material adverse impact on the equity of the Company, management does not believe that a further loss material to equity is probable. Management will continue to monitor the potential liabilities with respect to asbestos-related bodily injury claims and will make adjustments to the claim reserves if warranted.\nTobacco Litigation - A number of lawsuits have been filed against Lorillard and other manufacturers of tobacco products seeking damages for cancer and other health effects claimed to have resulted from an individual's use of cigarettes or exposure to tobacco smoke. Plaintiffs have asserted claims based on, among other things, theories of negligence, fraud, misrepresentation, strict liability, breach of warranty, enterprise liability, civil conspiracy, intentional infliction of harm, and failure to warn of the allegedly harmful and\/or addictive nature of tobacco products. Plaintiffs seek unspecified amounts in compensatory and punitive damages in many cases, and in other cases damages are stated to amount to as much as $100 in compensatory damages and $600 in punitive damages.\nConventional smoking and health cases have been brought by plaintiffs against Lorillard and other manufacturers of tobacco products for many years. Two hundred eleven such cases are pending in the United States federal and state courts against manufacturers of tobacco products generally, up from 54 last year; Lorillard is a named defendant in 57 of these cases, up from 17 last year. The Company is a defendant in two of these cases. A large portion of the increase in this category of cases is attributable to two plaintiffs' law firms in Florida.\nFive purported class actions are pending against Lorillard and other cigarette manufacturers, and the Company is a defendant in one of these cases. Plaintiffs in four of the purported class actions seek damages for alleged nicotine addiction and health effects claimed to have resulted from the use of cigarettes, and plaintiffs in one of the purported class actions allege health effects from exposure to tobacco smoke. Theories of liability include a broad range of product liability theories, theories based upon consumer protection statutes and fraud and misrepresentation. These purported class actions are described below.\nBroin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County, Florida, filed October 31, 1991). The purported class consists of flight attendants claiming injury as a result of exposure to environmental tobacco smoke in the cabins of aircraft. Plaintiffs seek an unspecified amount in compensatory damages and $5,000 in punitive damages. The trial court granted plaintiffs' motion for class certification on December 12, 1994. Defendants' appeal of this ruling to the Florida Court of Appeal has been denied. Defendants have asked the court to reconsider its ruling or to certify it to the Florida Supreme Court.\nCastano v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed March 29, 1994). The purported class consists of individuals in the United States who are allegedly nicotine dependent and their estates and heirs. Plaintiffs are represented by a well-funded and coordinated consortium of over 60 law firms from around the United States. Plaintiffs seek unspecified amounts in actual damages and punitive damages. The court issued an order on February 17, 1995 that granted in part plaintiffs' motion for class certification. The United States Court of Appeals for the Fifth Circuit granted defendants' motion for leave to file an interlocutory appeal from this order and defendants' appeal is pending.\nGranier v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed September 26, 1994). Plaintiffs seek certification of a\nclass comprised of all residents of the United States who are addicted to nicotine, and of survivors who claim their decedents were addicted to nicotine. Plaintiffs seek unspecified actual damages and punitive damages and the creation of a medical monitoring fund to monitor the health of individuals allegedly injured by their addiction to nicotine. Plaintiffs' motion to consolidate this action with Castano, above, has not been decided by the court.\nEngle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida, filed May 5, 1994). The purported class consists of citizens and residents of the United States, and their survivors, who have or who have died from, diseases and medical conditions allegedly caused by smoking cigarettes containing nicotine. Plaintiffs in this case seek actual and punitive damages in excess of $200,000, and the creation of a medical fund to compensate individuals for future health care costs. Plaintiffs' motion for class certification was granted by the court on October 31, 1994. Defendants' appeal of this ruling to the Florida Court of Appeal was denied, although the court has modified the class certification order and has limited plaintiffs' class to citizens or residents of Florida. Defendants have asked the Florida Court of Appeal to reconsider this ruling or to certify it to the Florida Supreme Court.\nLacey v. Lorillard Tobacco Company, et al. (U.S. District Court, Northern District, Alabama, filed March 15, 1994). Plaintiff alleges that the defendants, Lorillard and two other cigarette manufacturers, did not disclose to the plaintiff or other cigarette smokers in the State of Alabama the nature, type, extent and identity of additives that the defendants allegedly caused or allowed to be made a part of cigarettes or cigarette components. Plaintiff requests injunctive relief requiring defendants to list the additives that defendants have caused or allowed to be placed in cigarettes sold in Alabama. Plaintiff seeks monetary damages not to exceed forty-eight thousand five hundred dollars for any individual.\nIn addition to the foregoing cases, five actions have been initiated in which states or state agencies seek recovery of funds expended by the states or state agencies, and in one case health insurers, to provide health care to individuals with injuries or other health effects allegedly caused by use of tobacco products or exposure to cigarette smoke. These cases are based on, among other things, equitable claims including indemnity, restitution, unjust enrichment and public nuisance, and claims based on antitrust laws and state consumer protection acts. Lorillard is named as a defendant in each of these five actions and the Company is named as a defendant in two of them. These cases are described below.\nMoore v. The American Tobacco Company, et al. (Chancery Court, Jackson County, Mississippi, filed May 23, 1994), filed by the Attorney General of Mississippi. In February 1996, the Governor of Mississippi petitioned the Supreme Court of Mississippi for a writ of mandamus, claiming the Attorney General had no authority to bring a lawsuit against Lorillard and the other manufacturers of tobacco products without approval by the Governor.\nMcGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha County, West Virginia, filed September 20, 1994), filed by the Attorney General of West Virginia. In this case the court entered an order during June 1995 that granted defendants' motion to dismiss eight of the ten counts of the complaint. The motion to dismiss was not directed to plaintiff's two remaining claims of antitrust and consumer fraud. Plaintiff has filed a petition for appeal to the West Virginia Supreme Court of Appeals.\nState of Minnesota v. Philip Morris Incorporated, et al. (District Court, Ramsey County, Minnesota, filed August 17, 1994), filed by the Attorney General of Minnesota and Blue Cross and Blue Shield of Minnesota. The Minnesota Supreme Court has agreed to hear defendants' appeal contending that plaintiff Blue Cross and Blue Shield of Minnesota lacks standing to assert claims and to seek damages from the defendants.\nCommonwealth of Massachusetts v. Philip Morris Inc., et al. (U.S. District Court, Massachusetts, filed December 19, 1995), filed by the Attorney General of Massachusetts.\nThe State of Florida, et al. v. The American Tobacco Company, et al. (Circuit Court, Palm Beach County, Florida, filed February 22, 1995), filed by the State of Florida, the Governor of Florida, and two state agencies. This case has been brought under a Florida statute that\npermits the state to sue a manufacturer to recover Medicaid costs incurred by the state that are claimed to result from the use of the manufacturer's product. The statute permits causation and damages to be proven by statistical analysis, abrogates all affirmative defenses, adopts a \"market share\" liability theory, applies joint and several liability and eliminates the statute of repose. An action for declaratory judgment has been commenced in Florida state court by companies and trade associations in several potentially affected industries challenging this statute. In June 1995, a ruling was issued by a Florida state court that granted in part this motion for declaratory judgment. The ruling declared that certain portions of this statute on which the lawsuit against cigarette companies was based violates the constitution of the State of Florida. Both parties have appealed the order of the Florida Court of Appeal. The Florida Supreme Court heard argument in the appeals on November 6, 1995. The Florida legislature has passed legislation repealing this statute, but the Governor of the State of Florida has vetoed the repeal. Lorillard understands that several other states, and the Congress, have considered or are considering legislation similar to that passed in Florida.\nThe states pursuing the foregoing efforts are doing so at the urging and with the assistance of well known members of the plaintiffs bar and these lawyers have been meeting with attorneys general in other states to encourage them to file similar suits.\nLorillard, other cigarette manufacturers and others have commenced suits in three states that seek declaratory judgment or injunctive relief as to the authority of the states or state agencies to commence actions seeking recovery of funds expended to provide health care for citizens with injuries allegedly caused by cigarette smoking, or to retain private counsel under a contingent fee contract to pursue such actions. The case of Philip Morris Incorporated, et al. v. Harshbarger was filed on November 28, 1995 in the U.S. District Court of Massachusetts. The case of Philip Morris Incorporated, et al. v. Morales, et al., was filed on November 28, 1995 in the District Court of Travis County, Texas. The case of Philip Morris Incorporated, et al. v. Glendening, et al. was filed on January 22, 1996 in the Circuit Court of Talbot County, Maryland.\nIn addition to the foregoing cases, several cases have been filed against Lorillard seeking damages for cancer and other health effects claimed to have resulted from exposure to asbestos fibers which were incorporated, for a limited period of time, ending forty years ago, into the filter material used in one of the brands of cigarettes manufactured by Lorillard. Fourteen such cases are pending in federal and state courts against Lorillard. Allegations of liability against Lorillard include negligence, strict liability, fraud, misrepresentation and breach of warranty. Plaintiffs seek unspecified amounts in compensatory and punitive damages in many cases, and in other cases damages are stated to amount to as much as $10 in compensatory damages and $100 in punitive damages. Trials were held in three cases of this type during 1995. In two of the cases, the juries returned verdicts in favor of Lorillard. In the third case, the jury returned a verdict in favor of plaintiffs. The verdict requires Lorillard to pay an amount between $1.8 and $2.0 in actual and punitive damages. The precise amount to be paid by Lorillard will be determined at a later date if the verdict withstands review by appellate courts. Lorillard has noticed an appeal from the judgment in plaintiffs' favor.\nIn addition to the foregoing litigation, one pending case, Cordova v. Liggett Group, Inc., et al. (Superior Court, San Diego County, California, filed May 12, 1992), alleges that Lorillard and other named defendants, including other manufacturers of tobacco products, engaged in unfair and fraudulent business practices in connection with activities relating to the Council for Tobacco Research-USA, Inc., of which Lorillard is a sponsor, in violation of a California state consumer protection law by misrepresenting to or concealing from the public information concerning the health aspects of smoking. Plaintiff seeks an injunction ordering defendants to undertake a \"corrective advertising campaign\" in California to warn consumers of the health hazards associated with smoking, to provide restitution to the public for funds \"unlawfully, unfairly, or fraudulently\" obtained by defendants, and to \"disgorge\" all revenues and profits acquired as a result of defendants' \"unlawful, unfair and\/or fraudulent business practices.\"\nOne of the defenses raised by Lorillard in certain cases is preemption by the Federal Cigarette Labeling and Advertising Act (the \"Labeling Act\"). In the case of Cipollone v. Liggett Group, Inc., et al., the United States\nSupreme Court, in a plurality opinion issued on June 24, 1992, held that the Labeling Act as enacted in 1965 does not preempt common law damage claims but that the Labeling Act, as amended in 1969, does preempt claims against tobacco companies arising after July 1, 1969, which assert that the tobacco companies failed to adequately warn of the alleged health risks of cigarettes, sought to undermine or neutralize the Labeling Act's mandatory health warnings, or concealed material facts concerning the health effects of smoking in their advertising and promotion of cigarettes. The Supreme Court held that claims against tobacco companies based on fraudulent misrepresentation, breach of express warranty, or conspiracy to misrepresent material facts concerning the alleged health effects of smoking are not preempted by the Labeling Act. The Supreme Court in so holding did not consider whether such common law damage actions were valid under state law. The effect of the Supreme Court's decision on pending and future cases against Lorillard and other tobacco companies will likely be the subject of further legal proceedings. Additional litigation involving claims such as those held to be preempted by the Supreme Court in Cipollone could be encouraged if legislative proposals to eliminate the federal preemption defense, pending in Congress since 1991, are enacted. It is not possible to predict whether any such legislation will be enacted.\nIn addition to the defenses based on preemption under the Supreme Court decision referred to above, Lorillard believes that it has a number of other valid defenses to pending cases. These defenses, where applicable, include, among others, statutes of limitations or repose, assumption of the risk, comparative fault, the lack of proximate causation, and the lack of any defect in the product alleged by a plaintiff. Lorillard believes, and has been so advised by counsel, that some or all of these defenses may, in any of the pending or anticipated cases, be found by a jury or court to bar recovery by a plaintiff. Application of valid defenses, including those of preemption, are likely to be the subject of further legal proceedings in the class action cases and in the actions brought by states or state agencies.\nSmoking and health related litigation has been brought by plaintiffs against Lorillard and other manufacturers of tobacco products for many years. While Lorillard intends to defend vigorously all such actions which may be brought against it, it is not possible to predict the outcome of any of this litigation. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the commencement of additional similar litigation.\nManagement is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation. It is possible that the Company's results of operations or cash flows in a particular quarterly or annual period or its financial position could be materially affected by an ultimate unfavorable outcome of certain pending litigation. Management believes, however, that the ultimate outcome of pending litigation should not have a material adverse effect on the Company's financial position.\nOther Litigation - The Company and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of this other litigation will not, in the opinion of management, materially affect the Company's results of operations or equity.\nNote 20. Supplemental Financial Statements Schedules including CNA on the Equity Method -\nThe following supplemental financial statements schedules reflect the financial position, results of operations and cash flows of the Company with its investment in CNA accounted for under the equity method of accounting. Because the Company's insurance operations, conducted through CNA, are different in nature from the Company's other business, management believes this additional disclosure enhances a financial statement user's understanding and analysis of the Company.\nCondensed Balance Sheet Information Loews Corporation and Subsidiaries (Including CNA on the Equity Method)\nCondensed Statements of Income Information Loews Corporation and Subsidiaries (Including CNA on the Equity Method)\nCondensed Statements of Cash Flow Information Loews Corporation and Subsidiaries (Including CNA on the Equity Method)\nNote 21. Business Segments -\nLoews Corporation is a holding company. Its subsidiaries are engaged in the following lines of business: property, casualty and life insurance (CNA Financial Corporation, an 84% owned subsidiary, \"CNA\"); the production and sale of cigarettes (Lorillard, Inc., a wholly owned subsidiary, \"Lorillard\"); the operation of hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary, \"Loews Hotels\"); the operation of oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 70% owned subsidiary, \"Diamond Offshore\"); and the distribution and sale of watches and clocks (Bulova Corporation, a 97% owned subsidiary, \"Bulova\").\nAs multiple-line insurers, CNA's insurance operations underwrite property, casualty, life, and accident and health coverages. Their principal market for insurance is the United States. Foreign operations are not significant. Insurance products are marketed by CNA through independent agents and brokers.\nLorillard's principal products are marketed under the brand names of Newport, Kent and True with substantially all of its sales in the United States.\nLoews Hotels properties consist of 14 hotels, 11 of which are in the United States, two are in Canada and one is located in Monte Carlo.\nDiamond Offshore's business primarily consists of 37 offshore drilling rigs that are used on a contract basis by companies engaged in exploration and production of hydrocarbons. Offshore rigs are mobile units that can be relocated based on market demand. Currently 65% of these rigs operate in the Gulf of Mexico, 11% operate in the North Sea and the remaining 24% are located in various foreign markets.\nBulova distributes and sells watches and clocks under the brand names of Bulova, Caravelle and Accutron with substantially all of its sales in the United States and Canada. All watches and clocks are purchased from foreign suppliers.\nThe following table sets forth the major sources of the Company's consolidated revenues, income and assets.\nNote 22. Subsequent Event -\nOn February 9, 1996 Diamond Offshore and Arethusa (Off-Shore) Limited (\"Arethusa\"), executed a definitive agreement to merge the two companies. The agreement provides that holders of Arethusa stock will receive 17.9 million shares of common stock to be issued by Diamond Offshore based on a ratio of .88 shares for each share of Arethusa common stock. The merger is subject to requisite shareholder approval and is anticipated to close in the spring of 1996. Upon consummation of the merger, the Company would recognize a gain of approximately $187 and its interest in Diamond Offshore would decline to approximately 52%.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nInformation called for by Part III has been omitted as Registrant intends to file with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year a definitive Proxy Statement 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. Financial Statements:\nThe financial statements appear above under Item 8. The following additional financial data should be read in conjunction with those 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 consolidated financial statements or notes to consolidated financial statements.\n* Filed herewith\n(b) Reports on Form 8-K:\nThere were no reports filed for 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.\nLOEWS CORPORATION\nDated: March 28, 1996 By \/s\/ Roy E. Posner --------------------------------- (Roy E. Posner, 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.\nDated: March 28, 1996 By \/s\/ Laurence A. Tisch --------------------------------- (Laurence A. Tisch, Co-Chairman of the Board and Principal Executive Officer)\nDated: March 28, 1996 By \/s\/ Roy E. Posner --------------------------------- (Roy E. Posner, Senior Vice President and Chief Financial Officer)\nDated: March 28, 1996 By \/s\/ Guy A. Kwan --------------------------------- (Guy A. Kwan, Controller)\nDated: March 28, 1996 By \/s\/ Charles B. Benenson --------------------------------- (Charles B. Benenson, Director)\nDated: March 28, 1996 By \/s\/ John Brademas --------------------------------- (John Brademas, Director)\nDated: March 28, 1996 By \/s\/ Dennis H. Chookaszian --------------------------------- (Dennis H. Chookaszian, Director)\nBy --------------------------------- (Bernard Myerson, Director)\nDated: March 28, 1996 By \/s\/ Edward J. Noha --------------------------------- (Edward J. Noha, Director)\nBy --------------------------------- (Gloria R. Scott, Director)\nDated: March 28, 1996 By \/s\/ Andrew H. Tisch --------------------------------- (Andrew H. Tisch, Director)\nDated: March 28, 1996 By \/s\/ James S. Tisch --------------------------------- (James S. Tisch, Director)\nDated: March 28, 1996 By \/s\/ Jonathan M. Tisch --------------------------------- (Jonathan M. Tisch, Director)\nDated: March 28, 1996 By \/s\/ Preston R. Tisch --------------------------------- (Preston R. Tisch, Director)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders of Loews Corporation:\nWe have audited the accompanying consolidated balance sheets of Loews Corporation and its 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 schedules listed in the Index at Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Loews 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. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for certain investments in debt and equity securities in 1993.\nDeloitte & Touche LLP\nNew York, New York February 14, 1996\nL-1\nSCHEDULE I\nCondensed Financial Information of Registrant\nLOEWS CORPORATION\nBALANCE SHEETS\nASSETS\nL-2\nSCHEDULE I (Continued)\nCondensed Financial Information of Registrant\nLOEWS CORPORATION\nSTATEMENTS OF INCOME\nL-3\nSCHEDULE I (Continued)\nCondensed Financial Information of Registrant\nLOEWS CORPORATION\nSTATEMENTS OF CASH FLOWS\nL-4\nSCHEDULE I (Continued)\nCondensed Financial Information of Registrant\n- -------------- Notes:\n(a) In addition to its common stock, the Company has authorized 25,000,000 shares of preferred stock, $.10 par value.\n(b) Long-term debt consisted of:\nThe aggregate of long-term debt maturing in the year ending December 31, 1998 is approximately $117.8.\n(c) The Company is included in a consolidated federal income tax return with certain of its subsidiaries and, accordingly, participates in the allocation of certain components of the consolidated provision for federal income taxes. Such taxes are generally allocated on a separate return bases. The Company has entered into separate tax allocation agreements with Bulova and CNA, majority-owned subsidiaries in which its ownership exceeds 80% (the \"Subsidiaries\"). Each agreement provides that the Company will (i) pay to the Subsidiary the amount, if any, by which the Company's consolidated federal income tax is reduced by virtue of inclusion of the Subsidiary in the Company's return, or (ii) be paid by the Subsidiary an amount, if any, equal to the federal income tax which would have been payable by the Subsidiary if it had filed a separate consolidated return. Under these agreements, the federal income tax (expense) benefit to CNA amounted to approximately $(35.0), $84.0 and $17.0 for the years ended December 31, 1995, 1994 and 1993, respectively, and the federal income tax benefit to Bulova amounted to approximately $0.8, $0.1 and $2.5 for the years ended December 31, 1995, 1994 and 1993, respectively. Each agreement may be canceled by either of the parties upon thirty days' written notice. See Note 11 of the Notes to Consolidated Financial Statements of Loews Corporation and subsidiaries.\n(d) Cash dividends paid to the Company by affiliates amounted to $1,085.7, $265.3 and $505.7 for the years ended December 31, 1995, 1994 and 1993, respectively.\nL-5\nSCHEDULE II\nLOEWS CORPORATION AND SUBSIDIARIES\nValuation and Qualifying Accounts\nL-6\nSCHEDULE V\nLOEWS CORPORATION AND SUBSIDIARIES\nSupplemental Information Concerning Property\/Casualty Insurance Operations","section_15":""}
{"filename":"83612_1995.txt","cik":"83612","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nThe operating subsidiaries of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and its wholly-owned subsidiary, RJR Nabisco, Inc. (\"RJRN\") (collectively the \"Registrants\"), comprise one of the largest tobacco and food companies in the world. In the United States, the tobacco business is conducted by R. J. Reynolds Tobacco Company (\"RJRT\"), the second largest manufacturer of cigarettes, and the packaged food business is conducted by Nabisco Holdings Corp. (\"Nabisco Holdings\") through its wholly-owned subsidiary, Nabisco, Inc. (\"Nabisco\"), the largest manufacturer and marketer of cookies and crackers. Outside the United States, the tobacco operations are conducted by R. J. Reynolds Tobacco International, Inc. and beginning on January 1, 1996, R.J. Reynolds International (collectively \"Reynolds International\"), and the food operations are conducted by Nabisco International, Inc. (\"Nabisco International\") and Nabisco Ltd (formerly Nabisco Brands Ltd). RJRT's and Reynolds International's tobacco products are sold around the world under a variety of brand names. Nabisco's food products are sold in the United States, Canada, Latin America, certain European countries and certain other international markets. For financial information with respect to RJRN's industry segments, lines of business and operations in various geographic locations, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 16 to the consolidated financial statements, and the related notes thereto, of RJRN Holdings and RJRN as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995 (the \"Consolidated Financial Statements\").\nRJRN Holdings was organized as a Delaware corporation in 1988 at the direction of Kohlberg Kravis Roberts & Co., L.P. (\"KKR\"), a Delaware limited partnership, to effect the acquisition of RJRN, which was completed on April 28, 1989 (the \"Acquisition\"). As a result of the Acquisition, RJRN became an indirect, wholly owned subsidiary of RJRN Holdings. After a series of holding company mergers completed on December 17, 1992, RJRN became a direct, wholly owned subsidiary of RJRN Holdings. The business of RJRN Holdings is conducted through RJRN.\nRJRN was incorporated as a holding company in 1970. RJRT can trace its origins back to its formation in 1875. Activities were confined to the tobacco industry until the 1960's, when diversification led to investments in transportation, energy and food. With the acquisition of Del Monte Corporation (\"Del Monte\") in 1979 (which was sold in 1989), RJRN began to concentrate its focus on consumer products. This strategy led to the acquisition of Nabisco Holdings Corp. (formerly Nabisco Brands, Inc.) in 1985.\nIn recent years subsidiaries of RJRN Holdings and RJRN have completed a number of acquisitions and have divested certain businesses. In 1995, these acquisitions included (i) certain trademark and other assets of Kraft Foods' U.S. and Canadian margarine and tablespreads business; (ii) certain trademarks and other assets of Primo Foods Limited, a Canadian manufacturer of dry pasta, canned tomatoes and pasta and pizza sauces; (iii) a 50% interest in Royal Beech-Nut (pty) Ltd., a South African subsidiary of Del Monte Royal Foods, Ltd; (iv) the assets of Avare and Gumz, two Brazilian milk product companies; (v) O.y. P.c. Rettig Ab, Finland's second largest tobacco company and (vi) a significant interest and management control of the Tanzania Tobacco Company. The 1995 divestitures included (i) the sale of the Ortega Mexican Food business and (ii) the sale of New York Style Bagel Chip business.\nIn 1994, acquisitions included (i) the KNOX gelatin brand; (ii) an approximately 99% interest in Establecimiento Modelo Terrabusi S.A., Argentina's second largest biscuit and pasta maker; (iii) a 76% interest in the Yelets tobacco processing plant in Russia; (iv) a controlling interest in a cigarette manufacturer in the Krasnodar region of southern Russia; and (v) a 90% interest in Shimkent Confectionery Enterprises and a site for a new cigarette factory in Kazakhstan.\nRJRN will continue to assess its businesses to evaluate their consistency with strategic objectives. Although RJRN may acquire and\/or divest additional businesses in the future, no other decisions have been made with respect to any such acquisitions or divestitures. RJRN Holdings' and RJRN's credit agreement, dated as of April 28, 1995, as amended (the \"1995 RJRN Credit Agreement\"), and credit agreement, dated as of April 28, 1995, as amended (the \"RJRN Commercial Paper Facility\" and, together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"), prohibit the sale of all or any substantial portion of certain assets of RJRN Holdings or its subsidiaries.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its initial borrowing under its credit agreement, dated as of December 6, 1994 (the \"1994 Nabisco Credit Agreement\"). RJRN owns 100% of the outstanding Class B Common Stock of Nabisco Holdings, which represents approximately 80.5% of the economic interest in Nabisco Holdings and approximately 97.6% of the total voting power of Nabisco Holdings' outstanding common stock. In connection with the offering, RJRN Holdings, RJRN and Nabisco Holdings entered into agreements to exchange certain services, to establish tax sharing arrangements and to provide RJRN with certain preemptive and registration rights with respect to Nabisco Holdings and Nabisco securities.\nIn 1995, RJRN and Nabisco engaged in a series of related transactions that were designed, among other things, to enable Nabisco to obtain long term debt financing independent of RJRN and to repay its intercompany debt to RJRN. Specifically, on April 28, 1995, Nabisco Holdings and Nabisco entered into a credit agreement with various financial institutions (as amended, the \"1995 Nabisco Credit Agreement\") to replace the 1994 Nabisco Credit Agreement. Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On June 5, 1995, RJRN and Nabisco consummated offers to exchange approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\"). As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN also obtained consents to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\").\nDuring 1994, the percentage voting power of RJRN Holdings held by partnerships affiliated with KKR (the \"KKR Partnerships\") decreased substantially and in 1995 the KKR Partnerships divested their remaining interests in RJRN Holdings voting securities primarily in connection with the acquisition of Borden, Inc. by certain of the KKR Partnerships.\n(b) Financial Information about Industry Segments\nDuring 1995, 1994 and 1993, RJRN's industry segments were tobacco and food.\nFor information relating to industry segments for the years ended December 31, 1995, 1994 and 1993, see Note 16 to the Consolidated Financial Statements.\n(c) Narrative Description of Business\nTOBACCO\nThe tobacco line of business is conducted by RJRT and Reynolds International, which manufacture, distribute and sell cigarettes. Cigarettes are manufactured in the United States by RJRT and in over 40 foreign countries and territories by Reynolds International and subsidiaries or licensees of RJRT and are sold throughout the United States and in more than 170 markets around the world. In 1995, approximately 58% of total tobacco segment net sales (after deducting excise taxes) and approximately 69% of total tobacco segment operating income (before amortization of trademarks and goodwill) were attributable to domestic tobacco operations.\nDOMESTIC TOBACCO OPERATIONS\nThe domestic tobacco business is conducted by RJRT which is the second largest cigarette manufacturer in the United States. RJRT's largest selling cigarette brands in the United States include WINSTON, DORAL, CAMEL, SALEM, MONARCH and VANTAGE. RJRT's other cigarette brands, including MORE, NOW, BEST VALUE, STERLING, MAGNA and CENTURY, are marketed to meet a variety of smoker preferences. All RJRT brands are marketed in a variety of styles. Based on data collected for RJRT by an independent market research firm, RJRT had an overall share of retail consumer cigarette sales during 1995 of 27%, a decrease of approximately 1 share point from 1994. During 1995, RJRT and the largest domestic cigarette manufacturer, Philip Morris Incorporated, together sold, on a shipment basis, approximately 72% of all cigarettes sold in the United States.\nIn November 1994, RJRT confirmed press reports that it was developing ECLIPSE, a cigarette that primarily heats rather than burns tobacco and thereby substantially reduces second-hand smoke. The cigarette remains under development and RJRT continues to assess a possible market introduction of an ECLIPSE cigarette.\nA primary long-term objective of RJRT is to increase earnings and cash flow through selective marketing investments in its key brands and continual improvements in its cost structure and operating efficiency. Marketing programs for full-price brands are designed to build brand awareness and add value to the brands by building brand loyalty among current adult smokers and attracting adult smokers of competitive brands. In 1995, these efforts included the continuation and refinement of conversion, continuity and relationship-building programs such as the CAMEL Genuine Taste Mission, the expanded regional introduction of the SALEM Preferred line extension and the introduction of a line of cigarette brands from a new operating unit, Moonlight Tobacco. RJRT believes it is essential to compete in all segments of the cigarette market, and accordingly it offers a range of lower-priced brands including DORAL, MONARCH and BEST VALUE, intended to appeal to more cost-conscious adult smokers. For a discussion on competition in the tobacco business, see \"Business--Tobacco-- Competition\" in this Item 1.\nRJRT's domestic manufacturing facilities, consisting principally of factories and leaf storage facilities, are located in or near Winston-Salem, North Carolina and are owned by RJRT. Cigarette production is conducted at the Tobaccoville cigarette manufacturing plant (approximately two million square feet) and the Whitaker Park cigarette manufacturing complex (approximately one and one-half million square feet). RJRT believes that its cigarette manufacturing facilities are among the most technologically advanced in the United States. RJRT also has significant research and development facilities in Winston-Salem, North Carolina.\nRJRT's cigarettes are sold in the United States primarily to chain stores, other large retail outlets and through distributors to other retail and wholesale outlets. Except for McLane Company, Inc., which represented approximately 13% of RJRT's sales, no RJRT customers accounted for more than 10% of sales for 1995. RJRT distributes its cigarettes primarily to public warehouses located throughout the United States that serve as local distribution centers for RJRT's customers.\nRJRT's products are sold to adult smokers primarily through retail outlets. RJRT employs a decentralized marketing strategy that permits its sales force to be flexible in responding to local market dynamics by designing individual in-store programs to fit varying consumption patterns. RJRT uses print media, billboards, point-of-sale displays and other methods of advertising. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States.\nINTERNATIONAL TOBACCO OPERATIONS\nReynolds International operates in over 170 markets around the world. Although overall foreign cigarette sales (excluding China, in which production data indicates an approximate 2% per annum growth rate) have increased at a rate of only 1% per annum in recent years, Reynolds International believes that the American Blend segment, in which Reynolds International primarily competes, is growing significantly faster. Although Reynolds International is the second largest of two international cigarette producers that have significant positions in the American Blend segment, its share of sales in this segment is approximately one-third of the share of Philip Morris International Inc., the largest American Blend producer.\nReynolds International has strong brand presence in Western Europe and is well established in its other key markets in the Middle East\/Africa, Asia and Canada. Reynolds International is aggressively pursuing development opportunities throughout the world.\nReynolds International markets nearly 100 brands of which WINSTON, CAMEL and SALEM, all American Blend cigarettes, are its international leaders. WINSTON, Reynolds International's largest selling international brand, has a significant presence in Puerto Rico and has particular strength in the Western Europe and Middle East\/Africa regions. CAMEL is sold in approximately 140 markets worldwide and is Reynolds International's second largest selling international brand. SALEM is the world's largest selling menthol cigarette and is particularly strong in Far East markets. Reynolds International also markets a number of local brands in various foreign markets. None of Reynolds International's customers accounted for more than 10% of sales in 1995.\nMore than 20% of Reynolds International's 1995 volume was U.S.-made product, with the remainder manufactured outside the U.S. Reynolds International brands are manufactured in owned or joint-venture facilities in 19 locations outside the United States, and through licensing agreements in about 20 other countries. Reynolds International owned or joint-venture manufacturing locations include Canada, the Canary Islands, China, the Czech Republic, Finland, Germany, Hong Kong, Hungary, Indonesia, Kazakhstan, Malaysia, Poland, Portugal, Romania, Russia, Switzerland, Tanzania, Turkey, Ukraine and Vietnam.\nCertain of Reynolds International's foreign operations are subject to local regulations that set import quotas, restrict financing flexibility, affect repatriation of earnings or assets and limit advertising. In recent years, certain trade barriers for cigarettes, particularly in Asia and Eastern Europe, have been liberalized. This may provide opportunities for all international cigarette manufacturers, including Reynolds International, to expand operations in such markets; however, there can be no assurance that the liberalizing trends will be maintained or extended or that Reynolds International will be successful in pursuing such opportunities.\nRAW MATERIALS\nIn its domestic production of cigarettes, RJRT primarily uses domestic burley and flue cured leaf tobaccos purchased at domestic auction. RJRT also purchases oriental tobaccos, grown primarily in Turkey and Greece, and certain other non-domestic tobaccos. Reynolds International uses a variety of tobacco leaf from both United States and international sources. RJRT and Reynolds International believe there is a sufficient supply of tobacco in the worldwide tobacco market to satisfy their current production requirements.\nTobacco leaf is an agricultural commodity subject in the United States to government production controls and price supports that can affect market prices substantially. The tobacco leaf price support program is subject to Congressional review and may be changed at any time. In addition, Congress enacted the Omnibus Budget Reconciliation Act of 1993, which assesses financial penalties against manufacturers if cigarettes produced in the United States do not contain at least 75% (by weight) domestically grown flue cured and burley tobaccos. In December 1994, Congress enacted the Uruguay Round Agreements Act to replace this domestic content requirement with a tariff rate quota system that keys tariffs to import volumes. The tariff rate quotas have been established by the United States with overseas tobacco producers and became effective on September 13, 1995. Compliance with domestic content restrictions increased raw material costs slightly in 1994 but these costs were down slightly in 1995 during the period when the domestic content requirement was not applicable.\nCOMPETITION\nGenerally, the markets in which RJRT and Reynolds International conduct their businesses are highly competitive, with a number of large participants. Competition is conducted on the basis of brand recognition, brand loyalty, quality and price. For most of RJRT's and Reynolds International's brands, substantial advertising and promotional expenditures are required to maintain or improve a brand's market position or to introduce a new brand. Anti-smoking groups have undertaken activities designed to inhibit cigarette sales, the form and content of cigarette advertising and the testing and introduction of new cigarette products.\nBecause television and radio advertising for cigarettes is prohibited in the United States and brand loyalty has tended to be higher in the cigarette industry than in other consumer product industries, established cigarette brands in the United States have a competitive advantage. RJRT has repositioned or introduced brands designed to appeal to adult smokers of the largest selling cigarette brand in the United States, but there can be no assurance that such efforts will be successful.\nIn addition, increased selling prices and taxes on cigarettes have resulted in additional price sensitivity of cigarettes at the consumer level and in a proliferation of discounted brands in the savings segment of the market. Generally, sales of cigarettes in the savings segment are not as profitable as those in other segments.\nLEGISLATION AND OTHER MATTERS AFFECTING THE CIGARETTE INDUSTRY\nThe advertising, sale and use of cigarettes has been under attack by government and health officials in the United States and in other countries for many years, principally due to claims that cigarette smoking is harmful to health. This attack has resulted in: a number of substantial restrictions on the marketing, advertising and use of cigarettes; diminishing social acceptability of smoking; and activities by anti-smoking groups designed to inhibit cigarette sales, the form and content of cigarette advertising and the testing and introduction of new cigarette products. Together with manufacturers' price increases in recent years and substantial increases in state and federal excise taxes on cigarettes, this has had and will likely continue to have an adverse effect on cigarette sales.\nCigarettes are subject to substantial excise taxes in the United States and to similar taxes in many foreign markets. The federal excise tax per pack of 20 cigarettes was last increased in January 1993 to its current rate of 24 cents per pack. In addition, all states and the District of Columbia impose excise taxes at levels ranging from a low of 2.5 cents to a high of 81.5 cents per pack of cigarettes. Increases in these state excise taxes could also have an adverse effect on cigarette sales. In 1994, five states enacted excise tax increases ranging from 7.5 cents to 50 cents per pack. In 1995, the cigarette excise tax in four states was increased by amounts which ranged from 5 cents to 24 cents per pack. In one state, a temporary 10 cent tax, scheduled to expire in 1995, was extended through 1997.\nIn January 1993, the U.S. Environmental Protection Agency (the \"EPA\") released a report on the respiratory effects of environmental tobacco smoke (\"ETS\") which concludes that ETS is a known\nhuman lung carcinogen in adults and in children causes increased respiratory tract disease and middle ear disorders and increases the severity and frequency of asthma. RJRT has joined other parties from the tobacco and distribution industries in a lawsuit against the EPA seeking a determination that the EPA did not have the statutory authority to regulate ETS, and that, given the current body of scientific evidence and the EPA's failure to follow its own guidelines in making the determination, the EPA's classification of ETS was arbitrary and capricious.\nIn February 1994, the Commissioner of the U.S. Food and Drug Administration (the \"FDA\"), which historically has refrained from asserting jurisdiction over cigarette products, stated that he intended to cause the FDA to work with the U.S. Congress to resolve the regulatory status of cigarettes under the Food, Drug and Cosmetic Act. During the second quarter of 1994, hearings were held in this regard, and RJRT and other members of the United States cigarette industry were asked to provide voluntarily certain documents and other information to Congress. In August 1995, the Commissioner of the FDA, with the support of the Clinton Administration, announced that he was asserting jurisdiction over cigarettes and certain other tobacco products and issued a notice and request for comments on proposed regulations. The proposed regulations would prohibit or impose stringent limits on a broad range of sales and marketing practices, including bans on sampling, sponsorship by brand name, and distribution of non-tobacco items carrying brand names. The FDA's proposed rule would also limit advertising in print and on billboards to black and white text, impose new labeling language, and require cigarette manufacturers to fund a $150 million-a-year campaign to discourage minors from using tobacco products. RJRT and other cigarette manufacturers have submitted responses to the proposed rules.\nThe purported purpose of the FDA's assertion of jurisdiction was to curb the use of tobacco products by underage youth. RJRT believes, however, that the assertion of jurisdiction and the scope of the proposed rules would materially restrict the availability of cigarettes and RJRT's ability to market its cigarette products to adult smokers. RJRT, together with the other four major domestic cigarette manufacturers and an advertising agency, filed suit on the day of the Commissioner's announcement in the U.S. District Court for the Middle District of North Carolina seeking to enjoin the FDA's assertion of jurisdiction (Coyne Beahm v. United States Food & Drug Administration). Similar suits have been filed in the same court by manufacturers of smokeless tobacco products, by operators of retail stores and by advertising interests. RJRT is unable to predict whether or when the FDA will adopt final rules asserting jurisdiction over cigarettes or the scope of such final rules if adopted, but such rules could have an adverse effect on cigarette sales and RJRT. It is also unable to predict the outcome of the litigation seeking to enjoin the FDA's rulemaking.\nIn March 1994, the U.S. Occupational Safety and Health Administration (\"OSHA\") announced proposed regulations that would restrict smoking in the workplace to designated smoking rooms that are separately exhausted to the outside. Although RJRT cannot predict the form or timing of any regulations that may be finally adopted by OSHA, if the proposed regulations are adopted, RJRT expects that many employers who have not already done so would prohibit smoking in the workplace rather than make expenditures necessary to establish designated smoking areas to accommodate smokers. RJRT submitted comments on the proposed regulations during the comment period which closed in February 1996. Because many employers currently do not permit smoking in the workplace, RJRT cannot predict the effect of any regulations that may be adopted, but incremental restrictions on smokers could have an adverse effect on cigarette sales and RJRT.\nIn July 1994, an amendment to a Florida statute became effective which allows the state of Florida to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action, and eliminates the comparative negligence and assumption of risk defenses. The Florida statute is being challenged on state and federal constitutional grounds in a\nlawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets, and National Association of Convenience Stores in June 1994. On June 26, 1995, the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the statute unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida supreme court accepted for direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether other states will enact similar legislation and whether lawsuits will be filed under these statutes or their outcome, if filed. A suit against the tobacco industry was filed under the Florida statute on February 21, 1995. See \"Business--Tobacco--Litigation Affecting the Cigarette Industry\" below in this Item 1.\nLegislation imposing various restrictions on public smoking has also been enacted in forty-eight states and many local jurisdictions, and many employers have initiated programs restricting or eliminating smoking in the workplace. Seventeen states have enacted legislation designating a portion of increased cigarette excise taxes to fund either anti-smoking programs, health care programs or cancer research. Federal law prohibits smoking on all domestic airline flights of six hours duration or less and the U.S. Interstate Commerce Commission has banned smoking on buses transporting passengers inter-state. Certain common carriers have imposed additional restrictions on passenger smoking.\nA number of foreign countries have also taken steps to discourage cigarette smoking, to restrict or prohibit cigarette advertising and promotion and to increase taxes on cigarettes. Such restrictions are, in some cases, more onerous than restrictions imposed in the United States. In June 1988, Canada enacted a ban on cigarette advertising, which was struck down on grounds of constitutionality by the Supreme Court of Canada in 1995.\nIn 1990, RJRT and other U.S. cigarette manufacturers, through The Tobacco Institute, announced a tobacco industry initiative to assist retailers in enforcing minimum age laws on the sale of cigarettes, to support the enactment of state laws requiring the adult supervision of cigarette vending machines in places frequented by minors, to seek the uniform establishment of 18 as the minimum age for the purchase of cigarettes in all states, to distribute informational materials to assist parents in combatting peer pressure on their children to smoke and to limit voluntarily certain cigarette advertising and promotional practices. In 1995, wholesalers, retailers and the tobacco industry including RJRT formed the Coalition for Responsible Tobacco Retailing and launched a new program (We Card) focused on stopping underage access to cigarettes. In 1992, the Alcohol, Drug Abuse and Mental Health Act was signed into law. This act requires states to adopt a minimum age of 18 for purchases of tobacco products and to establish a system to monitor, report and reduce the illegal sale of tobacco products to minors in order to continue receiving federal funding for mental health and drug abuse programs. In January, 1996, regulations implementing this legislation were announced by the Department of Health and Human Services.\nIn 1964, the Report of the Advisory Committee to the Surgeon General of the U.S. Public Health Service concluded that cigarette smoking was a health hazard of sufficient importance to warrant appropriate remedial action. Since 1966, federal law has required a warning statement on cigarette packaging. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States. Cigarette advertising in other media in the United States is required to include information with respect to the \"tar\" and nicotine yield content of cigarettes, as well as a warning statement.\nDuring the past three decades, various laws affecting the cigarette industry have been enacted. In 1984, Congress enacted the Comprehensive Smoking Education Act (the \"Smoking Education Act\"). Among other things, the Smoking Education Act: (i) establishes an interagency committee on smoking and health that is charged with carrying out a program to inform the public of any dangers to human health presented by cigarette smoking; (ii) requires a series of four health warnings to be printed on cigarette packages and advertising on a rotating basis; (iii) increases type size and area of the warning required in cigarette advertisements; and (iv) requires that cigarette manufacturers provide annually, on a confidential basis, a list of ingredients used in the manufacture of cigarettes to the Secretary of Health and Human Services. The warnings currently required on cigarette packages and advertisements (other than billboards) are as follows: (i) \"Surgeon General's Warning: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy\"; (ii) \"Surgeon General's Warning: Quitting Smoking Now Greatly Reduces Serious Risks To Your Health\"; (iii) \"Surgeon General's Warning: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth Weight\"; and (iv) \"Surgeon General's Warning: Cigarette Smoke Contains Carbon Monoxide.\" Similar warnings are required on outdoor billboards. In 1990, the Fire Safe Cigarette Act of 1990 was enacted, which directed the Consumer Product Safety Commission to conduct and oversee research begun under the direction of the Cigarette and Little Cigar Fire Safety Act of 1984 to assess the practicability of developing a performance standard to reduce cigarette ignition propensity. The Commission presented a final report to Congress in 1993 describing the results of the research. The Commission concluded that, while \"it is practicable to develop a performance standard to reduce cigarette ignition propensity, it is unclear that such a standard would effectively address the number of cigarette-ignited fires.\" The Commission further found that additional work would be required before the actual development of a performance standard. Nevertheless, the Commission reported that a test method developed by the National Institute of Standards and Technology was valid and reliable within reasonable limits and could be suitable for use in a performance standard. Although RJRT cannot predict whether further legislation on this subject may be enacted, some form of regulation of cigarettes based on their propensity to ignite soft furnishings may result.\nSince the initial report in 1964, the Secretary of Health, Education and Welfare (now the Secretary of Health and Human Services) and the Surgeon General have issued a number of other reports which purport to find the nicotine in cigarettes addictive and to link cigarette smoking and exposure to cigarette smoke with certain health hazards, including various types of cancer, coronary heart disease and chronic obstructive lung disease. These reports have recommended various governmental measures to reduce the incidence of smoking.\nIn addition to the foregoing, legislation and regulations potentially detrimental to the cigarette industry, generally relating to the taxation of cigarettes and regulation of advertising, labeling, promotion, sale and smoking of cigarettes, have been proposed from time to time at various levels of the federal government. During the last Congress, the Clinton administration and federal legislators introduced bills that would have significantly increased the federal excise tax on cigarettes, eliminated the deductibility of the cost of tobacco advertising, banned smoking in public buildings and on any scheduled airline flight, and given the Food and Drug Administration authority to reduce and eliminate nicotine in tobacco products. This legislation was not enacted.\nIt is not possible to determine what additional federal, state, local or foreign legislation or regulations relating to smoking or cigarettes will be enacted or to predict any resulting effect thereof on\nRJRT, Reynolds International or the cigarette industry generally, but such legislation or regulations could have an adverse effect on RJRT, Reynolds International or the cigarette industry generally.\nLITIGATION AFFECTING THE CIGARETTE INDUSTRY\nVarious legal actions, proceedings and claims are pending or may be instituted against RJRT or its affiliates or indemnitees, including those claiming that lung cancer and other diseases have resulted from the use of or exposure to RJRT's tobacco products. During 1995, 101 new actions were filed or served against RJRT and\/or its affiliates or indemnitees and 22 such actions were dismissed or otherwise resolved in favor of RJRT and\/or its affiliates or indemnitees without trial. A total of 132 such actions in the United States and two against RJRT's Canadian subsidiary were pending on December 31, 1995. As of February 16, 1996, 144 active cases were pending against RJRT and\/or its affiliates or indemnitees, 142 in the United States and two in Canada. The United States cases are in 22 states and are distributed as follows: 90 in Florida; 10 in Louisiana; 5 in Texas; 4 in each of Indiana, Kansas and Tennessee; 3 in each of Mississippi, California, Pennsylvania; 2 in each of Alabama, Colorado, Massachusetts and Minnesota; and one in each of Missouri, Nevada, New Hampshire, New Jersey, New York, North Carolina, Rhode Island, South Carolina and West Virginia. Of the 142 active cases in the United States, 116 are pending in state court and 26 in federal court.\nFive of the 142 active cases in the United States involve alleged non-smokers claiming injuries resulting from exposure to environmental tobacco smoke. Six cases, which are described more specifically below, purport to be class actions on behalf of thousands of individuals. Purported classes include individuals claiming to be addicted to cigarettes and flight attendants alleging personal injury from exposure to environmental tobacco smoke in their workplace. Four of the active cases were brought by state attorneys general seeking, inter alia, recovery of the cost of Medicare funds paid by their states for treatment of citizens allegedly suffering from tobacco related diseases or conditions. In addition, one case was brought by the State of Florida seeking similar rulings under a special state statute.\nThe plaintiffs in these actions seek recovery on a variety of legal theories, including strict liability in tort, design defect, negligence, breach of warranty, failure to warn, fraud, misrepresentation, unfair trade practices, conspiracy, unjust enrichment, indemnity and common law public nuisance. Punitive damages, often in amounts ranging into the hundreds of millions of dollars, are specifically pleaded in 20 cases in addition to compensatory and other damages. The defenses raised by RJRT and\/or its affiliates, where applicable, include preemption by the Federal Cigarette Labeling and Advertising Act, as amended (the \"Cigarette Act\") of some or all such claims arising after 1969; the lack of any defect in the product; assumption of the risk; comparative fault; lack of proximate cause; and statutes of limitations or repose. Juries have found for plaintiffs in two smoking and health cases in which RJRT was not a defendant, but in one such case, which has been appealed by both parties, no damages were awarded. The jury awarded plaintiffs $400,000 in the other such case, Cipollone v. Liggett Group, which award was overturned on appeal and the case was subsequently dismissed.\nOn June 24, 1992, the United States Supreme Court in Cipollone held that claims that tobacco companies failed to adequately warn of the risks of smoking after 1969 and claims that their advertising and promotional practices undermined the effect of warnings after that date were preempted by the Cigarette Act. The Supreme Court also held that claims of breach of express warranty, fraud, misrepresentation and conspiracy were not preempted. The Supreme Court's decision was announced through a plurality opinion, and further definition of how Cipollone will apply to other cases must await rulings in those cases.\nCertain legislation proposed in recent years in Congress, among other things, would eliminate any such preemptive effect on common law damage actions for personal injuries. RJRT is unable to predict whether such legislation will be enacted and, if so, in what form, or whether such legislation would be\nintended by Congress to apply retroactively. The passage of such legislation could increase the number of cases filed against cigarette manufacturers, including RJRT.\nSet forth below are descriptions of the class action lawsuits, a suit in which plaintiffs seek to act as private attorneys general, actions brought by state attorneys general in Massachusetts, Minnesota, Mississippi and West Virginia, an action brought by the State of Florida and pending investigations relating to RJRT's tobacco business.\nIn 1991, Broin v. Philip Morris Company, a purported class action against certain tobacco industry defendants, including RJRT, was brought by flight attendants claiming to represent a class of 60,000 individuals, alleging personal injury caused by exposure to environmental tobacco smoke in their workplace. In December 1994, the Florida state court certified a class consisting of \"all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from diseases and disorders caused by their exposure to secondhand cigarette smoke in airline cabins.\" The defendants appeal of this certification to the Florida Third District Court of Appeal was denied on January 3, 1995. A motion for rehearing has been filed.\nIn March 1994, Castano v. The American Tobacco Company, a purported class action, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT, seeking certification of a class action on behalf of all United States residents who allegedly are or claim to be addicted, or are the legal survivors of persons who allegedly were addicted, to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in their tobacco products to induce addiction in smokers. Plaintiffs' motion for certification of the class was granted in part on February 17, 1995. The district court certified core liability issues (fraud, negligence, breach of warranty, both express and implied, intentional tort, strict liability and consumer protection statutes), and punitive damages. Not certified were issues of injury-in-fact, proximate cause, reliance, affirmative defenses, and compensatory damages. In July 1995, the Fifth Circuit Court of Appeals agreed to hear defendants' appeal of this class certification. A decision is expected in 1996.\nIn March 1994, Lacey v. Lorillard Tobacco Company, a purported class action, was filed in Circuit Court, Fayette County, Alabama against three cigarette manufacturers, including RJRT. Plaintiff, who claims to represent all smokers who have smoked or are smoking cigarettes manufactured and sold by defendants in the state of Alabama, seeks compensatory and punitive damages not to exceed $48,500 per class member and injunctive relief arising from defendants' alleged failure to disclose additives used in their cigarettes. In April 1994, defendants removed the case to the United States District Court for the Northern District of Alabama.\nIn May 1994, Engle v. R.J. Reynolds Tobacco Company, was filed in Circuit Court, Eleventh Judicial District, Dade County, Florida against tobacco manufacturers, including RJRT, and other members of the industry, by plaintiffs who allege injury and purport to represent a class of all United States citizens and residents who claim to be addicted, or who claim to be legal survivors of persons who allegedly were addicted, to tobacco products. On October 28, 1994, a state court judge in Miami granted plaintiffs' motion to certify the class. The defendants appealed that ruling to the Florida Third District Court of Appeal which, on January 31, 1996, decided to certify a class limited to Florida citizens or residents. The defendants are considering seeking a rehearing.\nIn September 1994, Granier v. American Tobacco Company, a purported class action apparently patterned after the Castano case, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT. Plaintiffs seek certification of a class action on behalf of all residents of the United States who have used and purportedly became addicted to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in tobacco products for the purpose of addicting\nconsumers. By agreement of the parties, all action in this case is stayed pending determination of the motion for class certification in the Castano case.\nIn January 1995, a purported class action was filed in the Ontario Canada Court of Justice against RJR-MacDonald, Inc. and two other Canadian cigarette manufacturers. The lawsuit, then captioned Le Tourneau, v. Imperial Tobacco Company, seeks certification of a class of persons who have allegedly become addicted to the nicotine in cigarettes or who had such alleged addiction heightened or maintained through the use of cigarettes, and who have allegedly suffered loss, injury, and damage in consequence, together with persons with Family Law Act claims in respect to the claims of such allegedly addicted persons, and the estates of such allegedly addicted persons. Theories of recovery pleaded include negligence, strict liability, failure to warn, deceit, negligent misrepresentation, breach of implied warranty and conspiracy. The relief sought consists of damages of one million dollars for each of the three named plaintiffs, punitive damages, funding of nicotine addiction rehabilitation centers, interest and costs. On June 2, 1995, the plaintiffs, on consent, were granted leave to file an amended statement of claim to remove Le Tourneau as representative plaintiff and add two additional representative plaintiffs. The case is now captioned Caputo v. Imperial Tobacco Limited.\nIn June 1994, in Mangini v. R.J. Reynolds Tobacco Company, the California Supreme Court ruled that the plantiffs' claim that an RJRT advertising campaign constitutes unfair competition under the California Business and Professions Code was not preempted by the Cigarette Act. The plantiffs are acting as private attorneys general. This opinion allows the plaintiffs to pursue their lawsuit which had been dismissed at the trial court level. The defendants' Petition for Certiorari to the United States Supreme Court was denied in December 1994. The case has been remanded to the trial court.\nIn June 1994, in Moore v. The American Tobacco Company, RJRN and RJRT were named along with other industry members as defendants in an action brought by the Mississippi state attorney general on behalf of the state to recover state funds paid for health care and medical and other assistance to state citizens allegedly suffering from diseases and conditions allegedly related to tobacco use. This suit, which was brought in Chancery (non-jury) Court, Jackson County, Mississippi also seeks an injunction from \"promoting\" or \"aiding and abetting\" the sale of cigarettes to minors. Both actual and punitive damages are sought in unspecified amounts. Motions by the defendants to dismiss the case or to transfer it to circuit (jury) court were denied on February 21, 1995 and the case will proceed in Chancery Court. RJRN and other industry holding companies have been dismissed from the case.\nIn August 1994, RJRT and other U.S. cigarette manufacturers were named as defendants in an action instituted on behalf of the state of Minnesota and of Blue Cross and Blue Shield of Minnesota to recover the costs of medical expenses paid by the state and by Blue Cross\/Blue Shield that were incurred in the treatment of diseases allegedly caused by cigarette smoking. The suit, Minnesota v. Philip Morris, alleges consumer fraud, unlawful and deceptive trade practices, false advertising and restraint of trade, and it seeks injunctive relief and money damages, trebled for violations of the state antitrust law. Motions by the defendants to dismiss all claims of Blue Cross\/Blue Shield and certain substantive claims of the State of Minnesota, and by plaintiffs to strike certain of the defendants' defenses, were denied on May 19, 1995. An intermediate appeals court declined to hear the defendants' appeal from the ruling denying the motion to dismiss all claims of Blue Cross\/Blue Shield on the ground that it lacks standing to bring the action, but the Minnesota Supreme Court has agreed to do so. Oral argument was heard January 29, 1996 and a decision is pending.\nIn September 1994, the Attorney General of West Virginia filed suit against RJRT, RJRN and twenty-one additional defendants in state court in West Virginia. The lawsuit, McGraw v. American Tobacco Company, is similar to those previously filed in Mississippi and Minnesota. It seeks recovery for medical expenses incurred by the state in the treatment of diseases statistically associated with cigarette smoking and requests an injunction against the promotion and sale of cigarettes and tobacco products to minors. The lawsuit also seeks a declaration that the state of West Virginia, as plaintiff, is\nnot subject to the defenses of statute of repose, statute of limitations, contributory negligence, comparative negligence, or assumption of the risk. On May 3, 1995, the judge granted defendants' motion to dismiss eight of the ten causes of action pleaded. The defendants have filed motions to dismiss the remaining two counts. On October 20, 1995, at a hearing on the defendants' joint motion to prohibit prosecution of the action due to plaintiff's unlawful retention of counsel under a contingent fee arrangement, in a ruling from the bench, the contingent fee agreement between the West Virginia Attorney General and private attorneys preparing the case was held to be void on the grounds that the Attorney General has no constitutional, legislative, or statutory authority for entering into such an agreement.\nOn February 21, 1995, the state of Florida filed a suit under a special state statute against RJRT and RJRN, along with other industry members, their holding companies and other entities. The state is seeking Medicaid reimbursement under various theories of liability and injunctive relief to prevent the defendants from engaging in consumer fraud and to require that defendants: disclose and publish all research conducted directly or indirectly by the industry; fund a corrective public education campaign on the issues of smoking and health in Florida; prevent the distribution and sale of cigarettes to minors under the age of eighteen; fund clinical smoking cessation programs in the state of Florida; dissolve the Council for Tobacco Research and the Tobacco Institute or divest ownership, sponsorship, or membership in both; and disgorge all profits from sales of cigarettes in Florida. On defendants' motion, the case was stayed until July 7, 1995 and that stay has been extended pending appeals by the plaintiffs and the defendants in connection with the constitutional challenge to the Florida statute discussed above. See \"Business--Tobacco-- Legislation and Other Matters Affecting the Cigarette Industry\" in this Item 1.\nOn November 28, 1995, RJRT and other domestic cigarette manufacturers filed petitions for declaratory judgment in Massachusetts (Federal Court) and Texas (State Court, Austin Texas) as to potential Medicaid reimbursement suits that had been threatened by the Attorneys General of those states. On January 22, 1996, a similar petition for declaratory judgement was filed in Maryland (State Court).\nOn December 19, 1995, the Commonwealth of Massachusetts filed suit against cigarette manufacturers including RJRT and additional defendants including trade associations and wholesalers, seeking reimbursement of Medicaid and other costs incurred by the state in providing health care to citizens allegedly suffering from diseases or conditions purportedly caused by cigarette smoking. The complaint also seeks orders requiring the manufacturing defendants to disclose and disseminate prior research; fund a corrective campaign and smoking cessation program; disclose nicotine yields of their products; and pay restitution.\nRJRT understands that a grand jury investigation being conducted in the Eastern District of New York is examining possible violations of criminal law in connection with activities relating to the Council for Tobacco Research--USA, Inc., of which RJRT is a sponsor. RJRT is unable to predict the outcome of this investigation.\nRJRT received a civil investigative demand dated January 11, 1994 from the U.S. Department of Justice requesting broad documentary information from RJRT. Although the request appears to focus on tobacco industry activities in connection with product development efforts, it also requests general information concerning contacts with competitors. RJRT is unable to predict the outcome of this investigation.\n-------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or\nits affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nFOOD\nThe food line of business is conducted by operating subsidiaries of Nabisco Holdings. RJRN owns 100% of the outstanding Class B Common Stock of Nabisco Holdings, which represents approximately 80.5% of the economic interest in Nabisco Holdings and approximately 97.6% of the total voting power of Nabisco Holdings' outstanding common stock. Nabisco's businesses in the United States are comprised of the Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's companies (collectively, the \"Domestic Food Group\"). Nabisco's businesses outside the United States are conducted by Nabisco Ltd and Nabisco International (collectively, the \"International Food Group\"). Nabisco Ltd was recently shifted from the Domestic Food Group (formerly the North American Food Group) to the International Food Group.\nFood products are sold under trademarks owned or licensed by Nabisco and brand recognition is considered essential to their successful marketing. None of Nabisco's customers accounted for more than 10% of sales for 1995.\nDOMESTIC FOOD GROUP OPERATIONS\nNabisco Biscuit Company. Nabisco Biscuit Company is the largest manufacturer and marketer in the United States cookie and cracker industry with nine of the ten top selling brands, each of which had annual net sales of over $100 million in 1995. Overall, in 1995, Nabisco Biscuit had a 40.8% share of the domestic cookie category and a 55.3% share of the domestic cracker category, in the aggregate more than three times the share of its closest competitor. Leading Nabisco Biscuit cookie brands include OREO, CHIPS AHOY!, NEWTONS and SNACKWELL'S. Leading Nabisco Biscuit cracker brands include RITZ, PREMIUM, NABISCO HONEY MAID GRAHAMS, WHEAT THINS and TRISCUIT.\nOREO and CHIPS AHOY! are the two largest selling cookies in the United States. OREO, the leading sandwich cookie, is Nabisco Biscuit's largest selling cookie brand. Line extensions such as OREO DOUBLE STUF, FUDGE COVERED OREO and Reduced Fat OREO continue to increase the brand's appeal to targeted consumer groups. CHIPS AHOY! is the leader in the chocolate chip cookie segment with line extensions such as CHUNKY CHIPS AHOY! and CHEWY CHIPS AHOY! broadening its appeal and adding incremental sales.\nNEWTONS, the oldest Nabisco Biscuit cookie brand, is the fourth leading cookie brand in the United States. The introduction of FAT FREE FIG and APPLE NEWTONS in 1992, FAT FREE CRANBERRY, STRAWBERRY and RASPBERRY NEWTONS in 1993 and FAT FREE REDUCED CALORIE CRANBERRY and BLUEBERRY, as well as NEWTONS COBBLERS in 1995 have expanded the appeal of NEWTONS and added incremental sales.\nNabisco Biscuit's cracker business is led by RITZ, the largest selling cracker in the United States, as well as RITZ BITS, RITZ BITS SANDWICHES and REDUCED FAT RITZ successful product line extensions which, together with RITZ, accounted for 13.2% of cracker sales in the United States in 1995. In addition, PREMIUM, the oldest Nabisco cracker brand and the leader in the saltine cracker segment, is joined by NABISCO HONEY MAID GRAHAMS, WHEAT THINS and TRISCUIT to comprise, along with RITZ, five of the six largest selling cracker brands in the United States.\nIn 1992, Nabisco Biscuit became the leading manufacturer and marketer of no fat\/reduced fat cookies and crackers with the introduction of the SNACKWELL'S line, which is now the third largest cookie brand in the U.S. Nabisco Biscuit also acquired Stella D'oro, a leading producer of breadsticks, breakfast biscuits, specialty cakes, pastries and snacks. This line of specialty items gave Nabisco Biscuit access to new areas within supermarkets, further broadening Nabisco's cookie and cracker portfolio.\nNabisco Biscuit's other cookie and cracker brands, which include NUTTER BUTTER, NILLA WAFERS, BARNUM'S ANIMAL CRACKERS, BETTER CHEDDARS, HARVEST CRISPS, CHICKEN IN A BISKIT and CHEESE NIPS, compete in consumer niche segments. Many are the first or second largest selling brands in their respective segments.\nIn 1994, Nabisco entered the breakfast snack aisle with the launch of SNACKWELL'S cereal bars and granola bars and the repositioning of TOASTETTES toaster pastries.\nNabisco Biscuit's products are manufactured in 14 Nabisco Biscuit owned bakeries and in 16 facilities with which Nabisco Biscuit has production agreements. These facilities are located throughout the United States. Nabisco Biscuit is in the process of modernizing certain of its facilities. Nabisco Biscuit also operates a flour mill in Toledo, Ohio which supplies over 85% of its flour needs.\nNabisco Biscuit's products are sold to major grocery and other large retail chains through Nabisco Biscuit's direct store delivery system. The system is supported by a distribution network utilizing 10 major distribution warehouses and 129 shipping branches where shipments are consolidated for delivery to approximately 119,000 separate delivery points. Nabisco believes this sophisticated distribution and delivery system provides it with a significant service advantage over its competitors.\nSpecialty Products Company. The Specialty Products Company manufactures and markets a broad range of food products, with sauces and condiments, pet snacks, hot cereals and dry mix desserts representing the largest categories. Many of its products are first or second in their product categories. Well-known brand names include A.1. steak sauces, GREY POUPON mustards, MILK-BONE pet snacks, CREAM OF WHEAT hot cereals and ROYAL desserts. In September 1995, Specialty Products exited the Mexican food category, with the sale of its Ortega Mexican food business.\nSpecialty Products' primary entries in the sauce and condiment segments are A.1. and A.1. BOLD steak sauces, the leading lines of steak sauces, and GREY POUPON mustards, which include the leading Dijon mustard. Specialty Products also markets REGINA wine vinegar, the leader in its segment of the vinegar market.\nSpecialty Products is the second largest manufacturer of pet snacks in the United States with MILK-BONE dog biscuits. MILK-BONE products include MILK-BONE ORIGINAL BISCUITS, FLAVOR SNACKS, DOG TREATS and BUTCHER'S CHOICE.\nSpecialty Products participate in the dry mix dessert category with ROYAL and SNACKWELL'S brand gelatins and puddings. Specialty Products also participates in the non-dessert gelatin category with KNOX unflavored gelatins and has lines of regional products including COLLEGE INN broths, VERMONT MAID syrup, MY-T-FINE puddings, DAVIS baking powder and BRER RABBIT\nmolasses and syrup.\nNabisco, through the Specialty Products Company, manufactures hot cereals, participating in the cook-on-stove and mix-in-bowl segments of the category. CREAM OF WHEAT, the leading wheat-based hot cereal, and CREAM OF RICE participate in the cook-on-stove segment and eight varieties of INSTANT CREAM OF WHEAT participate in the mix-in-bowl segment. Quaker Oats Company is the most significant participant in the hot cereal category.\nSpecialty Products manufactures its products in four plants as well as in six facilities with which it has production agreements. Specialty Products sells to retail grocery chains through independent brokers and to drugstores, mass merchandisers and other major retail outlets through a direct sales force. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group.\nLifeSavers Company. The LifeSavers Company manufactures and markets non-chocolate candy and gum primarily for sale in the United States. LifeSavers' well-known brands include LIFE SAVERS candy, BREATH SAVERS sugar free mints, BUBBLE YUM bubble gum, FRUIT STRIPE gum, CARE*FREE sugarless gum, NOW & LATER fruit chewy taffy and GUMMI SAVERS fruit chewy candy. LIFE SAVERS is the largest selling non-chocolate candy brand in the United States, with a 1995 share of 4.9% of the non-chocolate candy category. BREATH SAVERS is the largest selling sugar free breath mint in the United States and BUBBLE YUM is the largest selling chunk bubble gum in the United States. LifeSavers' products are seasonally strongest in the fourth quarter.\nLifeSavers sells its products in the United States primarily to grocery stores, drug stores, mass merchandisers, convenience stores, membership club stores and food service, military and vending machine suppliers. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group. LifeSavers currently owns and operates four manufacturing facilities.\nPlanters Company. The Planters Company produces and\/or markets nuts and snacks largely for sale in the United States, primarily under the PLANTERS trademark. Planters is the clear leader in the packaged nut category, with a market share of seven times that of its nearest competitor. Planters' products are commodity oriented and are seasonally strongest in the fourth quarter.\nPlanters sells its products in the United States primarily to grocery stores, drug stores, mass merchandisers, convenience stores, membership club stores and food service, military and vending machine suppliers. The products are sold and distributed by Nabisco's Sales & Integrated Logistics Group. Planters currently owns and operates two manufacturing facilities.\nFood Service Company. The Food Service Company sells through non-grocery channels a variety of specially packaged food products of the Domestic Food Group, including cookies, crackers, hot cereals, sauces and condiments for the food service and vending machine industry. Food Service is also a leading regional supplier of premium frozen pies to in-store supermarket bakeries, wholesale clubs and food service accounts through Plush Pippin. The Food Service products are distributed by Nabisco's Sales & Integrated Logistics Group.\nFleischmann's Company. The Fleischmann's Company manufactures and markets various margarines and spreads as well as no-fat egg products and non-fat chocolate yogurt.\nFleischmann's is the second largest margarine producer in the United States. Fleischmann's participates in all segments of the margarine category, with the FLEISCHMANN'S, BLUE BONNET and MOVE OVER BUTTER brands. Fleischmann's Company strengthened its position in the margarine category in 1995, with the purchase of the Kraft margarine business which includes the PARKAY, TOUCH OF BUTTER and CHIFFON brands acquired from Kraft Foods, Inc. in October, 1995. Fleischmann's margarines are currently manufactured in two owned facilities and in six facilities\nwith which Fleischmann's has production agreements. Fleischmann's is the market leader in the healthy packaged egg category with EGG BEATERS and in 1995, introduced SNACKWELL'S Nonfat Chocolate Yogurt. Distribution for Fleischmann's is principally direct from plant to retailer warehouses through Nabisco's Sales & Integrated Logistics Group and with respect to the 1995 acquired products, for a temporary period through Kraft's distribution system.\nSales & Integrated Logistics Group. The Sales & Integrated Logistics Group handles sales and distribution for the Specialty Products, LifeSavers, Planters and Fleischmann's Companies and distribution for the Food Service Company. It sells to retail grocery chains through independent brokers and a direct sales force, and to drug stores, mass merchandisers and other major retail outlets through its direct sales force. The products are distributed from twenty-one distribution centers located throughout the United States.\nINTERNATIONAL FOOD GROUP OPERATIONS\nNabisco Ltd. Nabisco Ltd conducts Nabisco's Canadian operations through a biscuit division, a grocery division and a food service division. Excluding private label brands, the biscuit division produced nine of the top ten cookies and nine of the top ten crackers in Canada in 1995. Nabisco Ltd's cookie and cracker brands in Canada include OREO, CHIPS AHOY!, FUDGEE-O, PEEK FREANS, DAD'S, DAVID, PREMIUM PLUS, RITZ, TRISCUIT and STONED WHEAT THINS. These products are manufactured in five bakeries in Canada and are sold through a direct store delivery system, utilizing 11 sales offices and distribution centers and a combination of public and private carriers. Nabisco Ltd also markets a variety of single-serve cookies, crackers and salty snacks under such brand names as MINI OREO, RITZ BITS SANDWICHES and CRISPERS.\nNabisco Ltd's grocery division produces and markets canned fruits and vegetables, fruit juices and drinks and pet snacks. The grocery division is the leading canned fruit producer in Canada and is the second largest canned vegetable producer in Canada. Canned fruits, vegetables, soups and fruit juices and drinks are marketed under the DEL MONTE trademark, pursuant to a license from the Del Monte Corporation, and under the AYLMER trademark. The grocery division also markets MILK-BONE pet snacks and MAGIC baking powder, each a leading brand in Canada. Nabisco Ltd's grocery division operated six manufacturing facilities in 1995, five of which were devoted to canned products, principally fruits and vegetables, and one of which produced pet snacks. The grocery division's products are sold directly to retail chains and are distributed through five regional warehouses. In 1995, Nabisco Ltd acquired the PRIMO brand of dry pasta, canned tomatoes and other Italian food products which are manufactured in two facilities and sold and distributed by a direct store delivery system.\nIn 1995, Nabisco Ltd re-entered the margarine and tablespread business with its acquisition of the PARKAY, TOUCH OF BUTTER and CHIFFON brands from Kraft Canada Inc. These products are currently manufactured and distributed under agreements with Kraft Canada.\nNabisco Ltd's food service division sells a variety of specially packaged food products including cookies, crackers and canned fruits and vegetables as well as condiments to non-grocery outlets. The food service division has its own sales and marketing organization and sources product from Nabisco Ltd's other divisions.\nNabisco International. Nabisco International is a leading producer of biscuits, powdered dessert and drink mixes, baking powder, pasta, milk products and other grocery items, industrial yeast and bakery ingredients. Nabisco International also exports a variety of Domestic Food Group products to markets in Europe and Asia from the United States and is one of the largest multinational packaged food businesses in Latin America.\nNabisco International manufactures and markets biscuits and crackers under the NABISCO brand, yeast, baking powder and bakery ingredients under the FLEISCHMANN'S and ROYAL brands, desserts and drink mixes under the ROYAL brand, processed milk products under the GLORIA brand and canned fruits and vegetables under the DEL MONTE brand pursuant to a license from the Del Monte Corporation. Nabisco International's largest market is Brazil, where it operates 16 plants. Nabisco International is the market leader in powdered desserts in Spain and most of Latin America, in the yeast category in Brazil and certain other Latin American countries, in biscuits in Peru, Spain, Venezuela and Uruguay, and in canned vegetables in Venezuela. Nabisco International also maintains a strong position in the processed milk category in Brazil and expanded its market share through the 1995 acquisitions of Avare and Gumz. In Argentina, Nabisco International acquired 71% of Establecimiento Modelo Terrabusi S.A. in April 1994 and increased its interest in the Argentine biscuit and pasta company to approximately 99% in October and November 1994. Nabisco International has operations in 17 Latin American countries.\nNabisco International significantly increased its presence in Europe through its 1993 and 1994 100% acquisition of Royal Brands S.A. in Spain and Royal Brands Portugal. Nabisco International's products in Spain include biscuits marketed under the ARTIACH and MARBU trademarks, powdered dessert mixes marketed under the ROYAL trademark and various other foods, including canned meats and juices.\nNabisco International reentered the South African market through the acquisition of 50% of Royal Beech-Nut (Pty) Ltd., which it previously owned. Royal Beech-Nut markets baking powder and powdered dessert mixes under the ROYAL brand, chewing gum under the BEECHIES and CARE*FREE brands and candy under the LIFESAVERS and BEECH-NUT brands.\nNabisco International's grocery products are sold to retail outlets through its own sales forces and independent wholesalers and distributors. Industrial yeast and bakery products are sold to the bakery trade through Nabisco International's own sales forces and independent distributors.\nRAW MATERIALS\nVarious agricultural commodities constitute the principal raw materials used by Nabisco in its food businesses. These raw materials are purchased on the commodities market and through supplier contracts. Prices of agricultural commodities tend to fluctuate due to various seasonal, climatic and economic factors which generally also affect Nabisco's competitors. Nabisco believes that all of the raw materials for its products are in plentiful supply and are readily available from a variety of independent suppliers.\nCOMPETITION\nGenerally, the markets in which the Domestic Food Group and the International Food Group conduct their business are highly competitive. Competition consists of large domestic and international companies, local and regional firms and generic and private label products of food retailers. Competition is conducted on the basis of brand recognition, brand loyalty, quality and price. Substantial advertising and promotional expenditures are required to maintain or improve a brand's market position or to introduce a new product.\nThe trademarks under which the Domestic Food Group and the International Food Group market their products are generally registered in the United States and other countries in which such products are sold and are generally renewable indefinitely. Nabisco and certain of its subsidiaries have from time to time granted various parties exclusive licenses to use one or more of their trademarks in particular\nlocations. Nabisco does not believe that such licensing arrangements have a material effect on the conduct of its domestic or international business.\nOTHER MATTERS\nENVIRONMENTAL MATTERS\nThe U.S. Government and various state and local governments have enacted or adopted laws and regulations concerning protection of the environment. The regulations promulgated by the Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and will likely continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities.\nIn April 1995, RJRN Holdings was named a potentially responsible party (a \"PRP\") with certain third parties under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to a superfund site at which a former subsidiary of RJRN had operations. Certain subsidiaries of the Registrants have also been named as PRPs with third parties or may have indemnification obligations under CERCLA with respect to an additional thirteen sites.\nRJRN Holdings' subsidiaries have been engaged in a continuing program to assure compliance with U.S., state and local laws and regulations. Although it is difficult to identify precisely the portion of capital expenditures or other costs attributable to compliance with environmental laws and to estimate the cost of resolving these CERCLA matters, RJRN Holdings and RJRN do not expect such expenditures or other costs to have a material adverse effect on the financial condition of either RJRN Holdings or RJRN.\nEMPLOYEES\nAt December 31, 1995, RJRN Holdings together with its subsidiaries had approximately 76,000 full time employees. None of RJRT's operations are unionized. Most of the unionized workers at Nabisco's operations are represented under a national contract with the Bakery, Confection and Tobacco Workers Union, which was ratified in September 1992 and which will expire in September 1996. Other unions represent the employees of a number of Nabisco's operations and several of Reynolds International's operations are unionized. RJRN believes that its relations with these employees and with their unions are good.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\nFor information about foreign and domestic operations and export sales for the years 1993 through 1995, see \"Geographic Data\" in Note 16 to the Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFor information pertaining to the RJRN Holdings' and RJRN's assets by lines of business and geographic areas as of December 31, 1995 and 1994, see Note 16 to the Consolidated Financial Statements.\nFor information on properties, see Item 1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the fourth quarter of 1995, purported RJRN Holdings stockholders for themselves and derivatively for RJRN Holdings and Nabisco Holdings filed three putative class and derivative actions in the Court of Chancery of the State of Delaware in and for New Castle County against members of\nRJRN Holdings Board of Directors. The actions were consolidated in December 1995. The plaintiffs allege, among other things, that the individual defendants breached their fiduciary duty and wasted corporate assets by undertaking the Exchange Offer and Consent Solicitations completed by RJRN and Nabisco in June 1995 and by amending, in August 1995, RJRN Holdings By-Law provisions concerning the calling of shareholder meetings and procedures for shareholder action by written consent. The plaintiffs allege that management took these and other actions to wrongfully obstruct a spin-off of Nabisco, to enrich the defendants at the expense of RJRN Holdings, its shareholders and Nabisco Holdings and to entrench the defendants in the management and control of RJRN Holdings. RJRN Holdings believes that these allegations are without merit and is defending the consolidated action vigorously.\nFor information about other litigation and legal proceedings, see \"Business--Tobacco--Litigation Affecting the Cigarette Industry\" and \"Other Matters--Environmental Matters\" in Item 1.\n------------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or its affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn January, 1996, Brooke Group Ltd. commenced a solicitation of consents from the shareholders of RJRN Holdings to (i) a non-binding resolution seeking the immediate spin-off of the shares of Nabisco Holdings, and (ii) certain changes to the By-laws of RJRN Holdings which would allow holders of not less than 25% of its Common Stock to require a special meeting and would delete By- law provisions establishing certain administrative procedures for actions by written consent. The consent solicitation closed on February 15, 1996. A ministerial review of the validity of the consents by an independent inspector of elections had not been completed as of February 22, 1996. On February 20, 1996, however, Brooke Group Ltd. declared that it had received consents from holders of 50.4 percent of the voting stock with respect to a spin-off and 53.8 percent of such holders with respect to By-law changes.\nEXECUTIVE OFFICERS OF THE REGISTRANTS EXECUTIVE OFFICERS OF RJRN HOLDINGS\nThe executive officers of RJRN Holdings are Charles M. Harper (Chairman of the Board), Steven F. Goldstone (Chief Executive Officer and President), Gerald I. Angowitz (Senior Vice President, Human Resources and Administration), John J. Delucca (Senior Vice President and Treasurer), Robert S. Roath (Senior Vice President and Chief Financial Officer), Richard G. Russell (Senior Vice President and Controller), Robert F. Sharpe Jr. (Senior Vice President and General Counsel), and H. Colin McBride (Vice President, Assistant General Counsel and Secretary). Mr. Roath is married to Jo-Ann Ford who was, until December 31, 1995, Senior Vice President, Law and Secretary. The following table sets forth certain information regarding such officers.\nEXECUTIVE OFFICERS OF RJRN HOLDINGS OR ITS SUBSIDIARIES NOT LISTED ABOVE\nSet forth below are the names, ages, positions and offices held and a brief account of the business experience during the past five years of certain executive officers of RJRN Holdings or its subsidiaries, other than those listed above.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of RJRN Holdings, par value $.01 per share (the \"Common Stock\"), is listed and traded on the New York Stock Exchange (the \"NYSE\"). Since completion of the Acquisition there has been no public trading market for the common stock of RJRN.\nAs of January 31, 1996, there were approximately 65,000 record holders of the Common Stock. All of the common stock of RJRN is owned by RJRN Holdings. The Common Stock closing price on the NYSE for February 20, 1996 was $32 5\/8.\nThe following table sets forth, for the calendar periods indicated, the high and low sales prices per share for the Common Stock on the NYSE Composite Tape, as reported in the Wall Street Journal: HIGH LOW ---- --- 1995: First Quarter*.................................. $ 32 1\/2 $25 Second Quarter*................................. 31 1\/4 25 1\/4 Third Quarter................................... 33 1\/4 26 3\/8 Fourth Quarter.................................. 33 3\/8 27 7\/8\nHIGH LOW ---- --- 1994: First Quarter*.................................. $ 40 5\/8 $28 1\/8 Second Quarter*................................. 35 27 1\/2 Third Quarter*.................................. 35 5\/8 28 1\/8 Fourth Quarter*................................. 36 1\/4 26 9\/16\n- ------------\n* Adjusted to reflect a one-for-five reverse stock split\nThe Board of Directors of RJRN Holdings declared an initial quarterly cash dividend of $.375 per share payable on April 1, 1995. During 1995, RJRN Holdings continued to pay such a quarterly cash dividend on the Common Stock, adjusted to take into account the one-for-five reverse split of the Common Stock described below. Cash dividends paid by RJRN to RJRN Holdings are set forth in the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.\nThe operations of RJRN Holdings and RJRN are conducted through RJRN's subsidiaries and, therefore, RJRN Holdings and RJRN are dependent on the earnings and cash flow of RJRN's subsidiaries to satisfy their respective obligations and other cash needs. Certain Nabisco credit facilities limit the amount of dividends, distributions and advances by Nabisco Holdings and its subsidiaries to RJRN Holdings and its non-Nabisco subsidiaries. Moreover, the New RJRN Credit Agreements and certain policies adopted by the Board of Directors of RJRN Holdings limit the payment by RJRN Holdings of dividends on the Common Stock in excess of certain specific amounts. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Financial Condition\" and \"RJRN Holdings' Board of Directors Policies\" and Note 11 to the Consolidated Financial Statements. RJRN Holdings does not believe that the provisions of the New RJRN Credit Agreements or its adopted policies concerning distributions to stockholders will limit its ability to pay its anticipated quarterly dividends.\nA one-for-five reverse split of the Common Stock of RJRN Holdings was approved by its stockholders on April 12, 1995. The reverse stock split resulted in a dividend and earnings per share five times higher with a corresponding reduction in the number of shares outstanding.\nRJRN Holdings has indicated that, under normal circumstances, it does not plan to issue additional equity securities for purposes of balance sheet improvement.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") presented below as of December 31, 1995 and 1994 and for each of the years in the three-year period ended December 31, 1995 was derived from the consolidated financial statements of RJRN Holdings (the \"Consolidated Financial Statements\"), which have been audited by Deloitte & Touche LLP, independent auditors. In addition, the consolidated financial data of RJRN Holdings presented below as of December 31, 1993, 1992 and 1991 and for each of the years in the two year period ended December 31, 1992 was derived from the audited consolidated financial statements of RJRN Holdings as of December 31, 1993, 1992 and 1991 and for the years ended December 31, 1992 and 1991, which are not presented herein. The data should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information included herein.\n(Footnotes on following page)\n(Footnotes from preceding page)\n- ------------\n(1) The 1995 amount includes approximately $49 million for the consolidation and relocation of the international tobacco headquarter's operations and certain of its sales facilities. The 1992 amount includes a gain of $98 million on the sale of the ready-to-eat cold cereal business.\n(2) The 1995 amount includes approximately $103 million for fees and expenses incurred in connection with certain debt refinancings by RJRN, Nabisco Holdings and Nabisco.\n(3) On September 21, 1995, RJR Nabisco Holdings Capital Trust I (the \"Trust\") exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The sole asset of the Trust is junior subordinated debentures of RJRN Holdings. Upon redemption of the junior subordinated debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The outstanding junior subordinated debentures have an aggregate principal amount of approximately $978 million and an annual interest rate of 10%.\n(4) On November 8, 1991, RJRN Holdings issued 52,500,000 shares of Series A Conversion Preferred Stock, par value $.01 per share (\"Series A Preferred Stock\"), and sold 210,000,000 $.835 depositary shares (the \"Series A Depositary Shares\"), each of which represented one-quarter of a share of Series A Preferred Stock. On May 6, 1994, RJRN Holdings issued 26,675,000 shares of Series C Conversion Preferred Stock, par value $.01 per share (the \"Series C Preferred Stock\"), and sold 266,750,000 Series C Depositary Shares (the \"Series C Depositary Shares\"), each of which represented one-tenth of a share of Series C Preferred Stock. On November 15, 1994, each outstanding Series A Depositary Share converted into one share of RJRN Holdings' Common Stock.\n(5) The loss before extraordinary item per common and common equivalent share reported for the year ended December 31, 1993 would have increased by $.82 per share if the weighted average number of shares of Series A Depositary Shares outstanding during the period had been excluded from the earnings per share calculation.\n(6) Working capital at December 31, 1994 included $1.35 billion of borrowings under the 1994 Nabisco Credit Agreement, a substantial portion of which was used in connection with the refinancing of certain debt. On January 26, 1995, such borrowings were substantially reduced through the application of approximately $1.2 billion of net proceeds received from the initial public offering of 51,750,000 shares of Nabisco Holdings' Class A Common Stock.\n(7) RJRN Holdings' stockholders' equity at December 31 of each year from 1995 to 1991 includes non-cash expenses related to accumulated trademark and goodwill amortization of $4.280 billion, $3.644 billion, $3.015 billion, $2.390 billion and $1.774 billion respectively.\nSee Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe operating subsidiaries of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and its wholly-owned subsidiary, RJR Nabisco, Inc. (\"RJRN\"), comprise one of the largest tobacco and food companies in the world. In the United States, the tobacco business is conducted by R. J. Reynolds Tobacco Company (\"RJRT\"), the second largest manufacturer of cigarettes, and the packaged food business is conducted by Nabisco Holdings Corp. (\"Nabisco Holdings\") through its wholly-owned subsidiary, Nabisco, Inc. (\"Nabisco\"), the largest manufacturer and marketer of cookies and crackers (the \"Domestic Food Group\"). Outside the United States, the tobacco operations are conducted by R.J. Reynolds Tobacco International, Inc. and beginning on January 1, 1996, R.J. Reynolds International (collectively \"Reynolds International\"), and the food operations are conducted by Nabisco International, Inc. and Nabisco Ltd (collectively, the \"International Food Group\").\nThe following is a discussion and analysis of the consolidated financial condition and results of operations of RJRN Holdings. The discussion and analysis should be read in connection with the consolidated financial statements and the related notes thereto of RJRN Holdings as of December 31, 1995 and 1994 and for each of the years in the three year period ended December 31, 1995 (the \"Consolidated Financial Statements\").\nRESULTS OF OPERATIONS\nSummarized financial data for RJRN Holdings is as follows:\n(Footnotes on following page)\nINDUSTRY SEGMENTS\nThe percentage contributions of each of RJRN Holdings' industry segments to net sales and operating company contribution during the last five years were as follows:\n- ------------\n(1) Operating company contribution represents operating income before amortization of trademarks and goodwill and exclusive of restructuring expenses. Restructuring expenses amounted to $154 million for 1995 (RJRT-$100 million, Reynolds International-$54 million) and $730 million for 1993 (RJRT-$355 million, Reynolds International-$189 million, Domestic Food Group-$132 million, International Food Group-$21 million and Headquarters-$33 million.)\n(2) Contributions by industry segments were computed without effects of Headquarters' expenses.\nTOBACCO\nThe tobacco business is conducted by RJRT and Reynolds International.\n1995 vs. 1994. The worldwide tobacco business reported net sales of $7.71 billion in 1995, an increase of 1% from the 1994 level of $7.67 billion. The net sales increase in 1995 resulted primarily from a higher proportion of domestic full price sales, higher selling prices worldwide and favorable foreign currency developments that more than offset the impact of an overall worldwide tobacco volume decline. Worldwide tobacco volume for 1995 decreased 2% from the prior year. Operating company contribution for the worldwide tobacco business of $2.06 billion in 1995 declined 6% from the 1994 level of $2.20 billion due to lower operating company contribution at both the domestic tobacco business and the international tobacco business. Operating income for the worldwide tobacco business in 1995 of $1.50 billion declined 17% from the 1994 level of $1.80 billion, reflecting the lower operating company contribution and a 1995 restructuring expense related to the domestic and international tobacco businesses of $100 million and $54 million, respectively.\nNet sales for RJRT amounted to $4.48 billion in 1995, a decline of 2% from the 1994 level of $4.57 billion. The decline in net sales in 1995 resulted primarily from an overall volume loss of 5% (approximately $320 million), partially offset by a higher proportion of full price sales (approximately $140 million) and higher selling prices in both the full price and savings segments (approximately $67 million). RJRT's volume declined slightly in the full price segment during 1995 despite an industry average increase of approximately 2% due to the pattern of wholesale purchases and the erosion of market share of certain brands during the first six months of 1995. However, RJRT's share of full price segment stablized during the third and fourth quarters of 1995. RJRT's volume in the savings segment declined by 13% during 1995 which exceeded industry average, reflecting an erosion of market share of certain brands in the segment due to RJRT's decision to be more selective in its participation in that segment. RJRT's full price volume as a percentage of total volume in 1995 and 1994 amounted to 63% and 60%, respectively. Comparable figures for the domestic cigarette market in 1995 and 1994 amounted to 70% and 67%, respectively.\nRJRT's operating company contribution was $1.42 billion in 1995, a 2% decline from the 1994 level of $1.45 billion, as lower manufacturing costs (approximately $67 million), the higher proportion\nof full price sales (approximately $118 million), reduced merchandising costs (approximately $13 million), lower administrative expenses (approximately $14 million) and higher selling prices (approximately $67 million) were more than offset by the decline in overall volume (approximately $196 million) and an increase in marketing expenses (approximately $97 million). RJRT's operating income was $954 million in 1995, a decline of 12% from the 1994 level of $1.09 billion. The decline in operating income for 1995 reflected the lower RJRT operating company contribution and a restructuring expense in 1995 of $100 million.\nReynolds International recorded net sales of $3.23 billion in 1995, an increase of 4% from the 1994 level of $3.10 billion. The increase in net sales for 1995 primarily resulted from favorable foreign currency developments (approximately $113 million) and higher pricing (approximately $42 million), offset in part by unfavorable mix (approximately $17 million). Overall volume increased by 1%. Reynolds International's operating company contribution of $643 million in 1995 decreased 15% from the 1994 level of $755 million primarily due to costs and expenses incurred in connection with the consolidation and relocation of its headquarter's operations and certain sales facilities (approximately $49 million), trade stock realignment (approximately $22 million), write-off of certain export receivables (approximately $16 million), higher administrative costs (approximately $19 million), higher promotional and selling expenses (approximately $25 million), higher manufacturing costs (approximately $13 million) and unfavorable mix (approximately $10 million), which were partially offset by higher pricing (approximately $42 million). The decline in operating income for 1995 reflected the lower Reynolds International operating company contribution and a restructuring expense in 1995 of $54 million.\n1994 vs. 1993. Despite declines in net sales for both the domestic and international tobacco businesses, the worldwide tobacco business reported profit gains for 1994. RJRT's net sales decline resulted principally from overall lower pricing and volume which more than offset the impact of a higher proportion of sales from full price brands. Reynolds International's net sales decline was primarily attributable to a reduction in trade inventory levels and price repositioning in Canada and Puerto Rico which more than offset higher selling prices and volume. Overall, net sales from the worldwide tobacco business amounted to $7.67 billion in 1994, a decline of 5% from the 1993 level of $8.08 billion. Worldwide volume for 1994 was flat compared to 1993. Operating company contribution for the worldwide tobacco business grew to $2.21 billion in 1994 from $1.82 billion in 1993, an increase of 21% that resulted from improved margins in both the domestic and international businesses. Operating income for the worldwide tobacco business rose to $1.80 billion in 1994, an increase of 108% from the 1993 level of $866 million, as a result of the increase in operating company contribution discussed above and the 1993 restructuring expense of $544 million.\nNet sales for RJRT amounted to $4.57 billion in 1994, a decrease of 8% from the 1993 level of $4.95 billion. The decrease primarily reflects the impact of industry-wide price reductions on full price brands (approximately $500 million) which went into effect during the second half of 1993, lower volume in the savings segment (approximately $60 million) primarily due to RJRT's decision to be more selective in its participation in that segment and lower volume in the full price segment (approximately $300 million) primarily due to increased competitor activities during the second half of 1994. These factors more than offset the impact of a higher proportion of sales from full price brands (approximately $400 million), higher selling prices in the savings segment (approximately $60 million) and higher selling prices in the full price segment during the fourth quarter of 1994 as compared to the fourth quarter of 1993 (approximately $40 million). RJRT's full price volume as a percentage of total volume amounted to 60% in 1994 versus 56% in 1993. RJRT's operating company contribution was $1.45 billion in 1994, a 24% increase from the 1993 level of $1.17 billion, as reduced promotional and selling expenses (approximately $650 million) more than offset the decline in net sales. RJRT's operating income was $1.09 billion in 1994, an increase of 140% from the 1993 level of $453 million. The increase in operating income for 1994 from the prior year reflects the increase in RJRT's operating company contribution discussed above and the 1993 restructuring expense of $355 million.\nReynolds International recorded net sales of $3.10 billion in 1994, a decrease of 1% from the 1993 level of $3.13 billion. The net sales decrease for 1994 primarily resulted from a reduction in trade\ninventory levels (approximately $75 million), repositioning of prices in Canada and Puerto Rico to enhance brand competitiveness (approximately $60 million), and unfavorable foreign exchange developments, primarily in Europe and the Middle East (approximately $30 million), which were offset in part by higher selling prices throughout Reynolds International's markets (approximately $70 million) and an increase in volume in certain regions (approximately $60 million). Reynolds International's operating company contribution rose to $755 million in 1994, an increase of 17% compared to the 1993 level of $644 million. The increase in operating company contribution for 1994 was due to lower product costs in all regions (approximately $100 million), reduced promotional expenses (approximately $70 million), the higher selling prices (approximately $70 million) and higher volume (approximately $15 million), which more than offset price repositioning in Canada and Puerto Rico (approximately $50 million), the reduction in trade inventories (approximately $30 million), higher operating expenses to support expansion of business activity primarily in Eastern Europe (approximately $30 million) and unfavorable foreign exchange developments (approximately $20 million). Reynolds International's operating income was $716 million in 1994, an increase of 73% from the 1993 level of $413 million. The increase in operating income reflects the increase in Reynolds International's operating company contribution discussed above and the 1993 restructuring expense of $189 million.\n1995 Governmental Activity\nCongress enacted legislation effective January 1, 1994 (the Omnibus Budget Reconciliation Act of 1993) that assesses financial penalties against manufacturers if cigarettes produced in the United States do not contain at least 75% (by weight) domestically grown flue cured and burley tobaccos. In December 1994, Congress enacted the Uruguay Round Agreements Act to replace this domestic content requirement with a tariff rate quota system that keys tariffs to import volumes. The tariff rate quotas have been established by the United States with overseas tobacco producers and became effective on September 13, 1995. Domestic content requirements and tariff rate quotas increased raw material costs slightly in 1994 but these costs were down slightly in 1995 during the period when the domestic content requirement was not applicable.\nIn February 1994, the Commissioner of the U.S. Food and Drug Administration (the \"FDA\"), which historically has refrained from asserting jurisdiction over cigarette products, stated that he intended to cause the FDA to work with the U.S. Congress to resolve the regulatory status of cigarettes under the Food, Drug and Cosmetic Act. During the second quarter of 1994, hearings were held in this regard, and RJRT and other members of the United States cigarette industry were asked to provide voluntarily certain documents and other information to Congress. In August 1995, the Commissioner of the FDA, with the support of the Clinton Administration, announced that he was asserting jurisdiction over cigarettes and certain other tobacco products and issued a notice and request for comments on proposed regulations. The proposed regulations would prohibit or impose stringent limits on a broad range of sales and marketing practices, including bans on sampling, sponsorship by brand name, and distribution of non-tobacco items carrying brand names. The FDA's proposed rule would also limit advertising in print and on billboards to black and white text, impose new labeling language, and require cigarette manufacturers to fund a $150 million-a-year campaign to discourage minors from using tobacco products. RJRT and other cigarette manufacturers have submitted responses to the proposed rules.\nThe purported purpose of the FDA's assertion of jurisdiction was to curb the use of tobacco products by underage youth. RJRT believes that the assertion of jurisdiction and the scope of the proposed rules would materially restrict the availability of cigarettes and RJRT's ability to market its cigarette products to adult smokers. RJRT, together with the other four major domestic cigarette manufacturers and an advertising agency, filed suit on the day of the Commissioner's announcement in the U.S. District Court for the Middle District of North Carolina seeking to enjoin the FDA's assertion of jurisdiction (Coyne Beahm v. United States Food & Drug Administration). Similar suits have been filed in the same court by manufacturers of smokeless tobacco products, by operators of retail stores and by advertising interests. RJRT is unable to predict whether the FDA will adopt final rules asserting\njurisdiction over cigarettes or the scope of such final rules, if adopted. It is also unable to predict the outcome of the litigation seeking to enjoin the FDA's rulemaking.\nIn March 1994, the U.S. Occupational Safety and Health Administration (\"OSHA\") announced proposed regulations that would restrict smoking in the workplace to designated smoking rooms that are separately exhausted to the outside. Although RJRT cannot predict the form or timing of any regulations that may be finally adopted by OSHA, if the proposed regulations are adopted, RJRT expects that many employers who have not already done so would prohibit smoking in the workplace rather than make expenditures necessary to establish designated smoking areas to accommodate smokers. RJRT submitted comments on the proposed regulations during the comment period which closed in February, 1996. Because many employers currently do not permit smoking in the workplace, RJRT cannot predict the effect of any regulations that may be adopted, but incremental restrictions on smokers could have an adverse effect on cigarette sales and RJRT.\nIn July 1994, an amendment to a Florida statute became effective which allows the state of Florida to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action and eliminates the comparative negligence and assumption of risk defenses. The Florida statute is being challenged on state and federal constitutional grounds in a lawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets, and National Association of Convenience Stores in June 1994. On June 26, 1995, the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the act unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida supreme court accepted for direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether other states will enact similar legislation and whether lawsuits will be filed under these statutes or their outcome, if filed. A suit against the tobacco industry under the Florida statute was filed on February 21, 1995.\nVarious states and local jurisdictions have enacted legislation imposing restrictions on public smoking, increasing excise taxes and designating a portion of the increased cigarette excise taxes to fund anti-smoking programs, health care programs or cancer research. Many employers have also initiated programs restricting or eliminating smoking in the workplace.\nIt is not possible to determine what additional federal, state or local legislation or regulations relating to smoking or cigarettes will be enacted or to predict any resulting effect thereof on RJRT, Reynolds International or the cigarette industry generally, but such legislation or regulations could have an adverse effect on RJRT, Reynolds International or the cigarette industry generally.\nFor a description of certain litigation affecting RJRT and its affiliates, see Item 1, \"Business-- Tobacco-- Litigation Affecting the Cigarette Industry\" and Note 12 to the Consolidated Financial Statements.\nFOOD\nThe food business is conducted by the Domestic Food Group and the International Food Group. The Domestic Food Group is comprised of the Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's companies.\n1995 vs. 1994. Nabisco Holdings reported net sales of $8.29 billion in 1995, an increase of 8% from the 1994 level of $7.70 billion, with the Domestic Food Group up 5% and the International Food Group up 15%. The Domestic Food Group's increase was primarily attributable to volume gains at\nNabisco Biscuit (approximately $228 million), reflecting new product introductions and product line extensions, volume gains at Food Service (approximately $37 million), volume gains at Fleischmann's (approximately $18 million) and the impact of the October, 1995 acquisition of the Parkay margarine brand (approximately $64 million), which were offset in part by volume declines at Planters (approximately $40 million) and the impact of the September, 1995 sale of the Ortega brand (approximately $39 million). The International Food Group's net sales increase for 1995 was primarily due to improved results in Brazil (approximately $120 million), reflecting a continuation of the country's economic recovery, the favorable impact of recent business acquisitions (approximately $112 million) and the favorable performance from businesses in Iberia, Canada and Venezuela (approximately $65 million), partially offset by lower net sales in Mexico (approximately $30 million) due to the devaluation of the peso.\nNabisco Holdings' operating company contribution was $1.13 billion in 1995, an increase of 2% from the 1994 level of $1.11 billion, with the International Food Group higher by 35% and the Domestic Food Group lower by 5%. The 1995 period includes a net pre-tax gain of $11 million from the sale of the Ortega Mexican food ($18 million gain) and New York Style Bagel Chip ($7 million loss) businesses, and the favorable impact of recent business acquisitions (approximately $18 million). Excluding these items and the results of operations from the business disposals in both years, Nabisco Holdings' operating company contribution was $14 million lower than the 1994 level, with the International Food Group higher by 32% and the Domestic Food Group lower by 8%. The Domestic Food Group's adjusted operating company contribution decrease for 1995 (approximately $70 million) reflects investment spending behind new product initiatives and intense competitive conditions in biscuits and nuts. The International Food Group's adjusted operating company contribution increase for 1995 (approximately $56 million) was primarily due to the profit impact of increased sales in Brazil, Iberia, Canada and Venezuela (approximately $34 million).\nNabisco Holdings' operating income was $902 million in 1995, an increase of 2% from the 1994 level of $887 million, as a result of the changes in operating company contribution discussed above.\n1994 vs. 1993. Nabisco Holdings reported net sales of $7.70 billion in 1994, an increase of 10% from the 1993 level of $7.03 billion, with the Domestic Food Group up 4% and the International Food Group up 28%. The Domestic Food Group's increase was primarily attributable to significant volume gains at Nabisco Biscuit, reflecting the success of new product introductions and product line extensions in the U.S. biscuit market (approximately $215 million) and volume increases from Specialty Products (approximately $13 million). The International Food Group's increase was primarily the result of the favorable impact of recent acquisitions (approximately $345 million) and improved business conditions in Brazil (approximately $70 million) as a result of its second-half 1994 economic recovery.\nNabisco Holdings' operating company contribution was $1.11 billion in 1994, an increase of 17% from the 1993 level of $949 million, with the Domestic Food Group up 15% and the International Food Group up 30%. The Domestic Food Group's increase for 1994 was primarily due to the increase in net sales (approximately $40 million) and savings from productivity programs (approximately $135 million), including previously established restructuring programs, which were offset in part by competitive pricing pressures (approximately $35 million) and the absence of a 1993 gain on the sale of certain assets (approximately $17 million). The International Food Group's increase in operating company contribution for 1994 was primarily due to recent acquisitions (approximately $40 million) and strong results in Canada (approximately $7 million), partially offset by unfavorable business results in Mexico (approximately $7 million). The devaluation of the Mexican peso was not material to earnings in 1994.\nNabisco Holdings' operating income was $887 million in 1994, an increase of 53% from the 1993 level of $578 million, as a result of the increase in operating company contribution discussed above and the 1993 restructuring expense of $153 million.\nRESTRUCTURING EXPENSE\nRJRN Holdings recorded a pre-tax restructuring expense of $154 million in the fourth quarter of 1995 ($104 million after tax) related to a program announced on October 13, 1995 to reorganize its worldwide tobacco operations. The 1995 restructuring program was primarily undertaken in order to streamline operations and improve profitability. The 1995 restructuring program was implemented in the latter part of 1995 and will be substantially completed during 1996. A significant portion of the 1995 restructuring program will be a cash expense. The major components of the 1995 restructuring program were workforce reductions totaling 1,260 employees (approximately $132 million), the rationalization and closing of facilities relating to the international tobacco operations (approximately $8 million) and equipment and lease abandonments at the domestic tobacco operations (approximately $14 million). At December 31, 1995, approximately $102 million of severance pay and benefits remained to be paid. Anticipated annual future cash savings from the plan are estimated to be in excess of approximately $70 million after tax.\nRJRN Holdings recorded a pre-tax restructuring expense of $730 million in the fourth quarter of 1993 ($467 million after tax) related to a program announced on December 7, 1993. The 1993 restructuring program was undertaken to respond to a changing consumer product business environment and to streamline operations and improve profitability. The 1993 program, which was implemented in the latter part of 1993 and substantially completed during 1995, consisted of workforce reductions, reassessment of raw material sourcing and production arrangements, contract termination costs, abandonment of leases and the rationalization and closing of manufacturing and sales facilities. Approximately 75% of the restructuring program required cash outlays. At December 31, 1995, approximately $21 million for severance pay and benefits remained to be paid.\nDuring 1994, a change in the estimated cost of the 1993 restructuring program resulted in a credit to income of $23 million related to changes in the number of workforce reductions and an increase in cost of $21 million associated with the rationalization and abandonment of manufacturing and sales facilities. The net adjustment during 1994 of the above changes was reflected in selling, advertising, administrative and general expenses.\nINTEREST AND DEBT EXPENSE\n1995 vs. 1994. RJRN and Nabisco manage interest rate exposure by adjusting their mix of floating rate debt and fixed rate debt. As part of managing such interest rate exposure, RJRN and Nabisco enter into various interest rate arrangements from time to time.\nFollowing adoption of a policy change in 1994, RJRN canceled all of its financial interest rate arrangements with optionality. During 1994, as part of its current strategy to manage interest rate exposure, RJRN effectively neutralized the effects of any future changes in market interest rates on the remainder of its outstanding interest rate swaps, options, caps and other financial instruments through the purchase of offsetting positions. Net unrealized gains and losses on the remaining interest rate instruments at the time such instruments were neutralized are being amortized as additional interest expense during 1995, 1996 and 1997 of approximately $39 million, $28 million and $5 million, respectively.\nDuring 1995, Nabisco began managing its own interest rate exposure. As part of managing its interest rate exposure, Nabisco entered into interest rate swaps and caps to effectively fix a portion of its interest rate exposure on its floating rate debt. The impact of these agreements was not significant.\nConsolidated interest and debt expense amounted to $899 million in 1995, a decrease of 16% from 1994. The decline is primarily due to refinancings completed during 1994 and repayments of debt with the proceeds from the issuances of preferred stock during 1994 and Nabisco Holdings Class A Common Stock during the first quarter of 1995. These factors more than offset the impact of higher market interest rates.\n1994 vs. 1993. Consolidated interest and debt expense of $1.06 billion in 1994 decreased 12% from 1993, primarily as a result of refinancings of debt during 1993 and 1994 and lower debt levels resulting primarily from the application of proceeds from the issuance of preferred stock. These factors more than offset the impact of higher market interest rates during 1994, including the effects thereof on RJRN's interest rate instruments described below.\nAs mentioned above, RJRN entered into interest rate arrangements to manage its interest rate exposure. The impact on interest expense from the utilization of interest rate instruments by RJRN in 1994 resulted in additional interest expense of $22 million, which includes $45 million associated with the written instruments. The impact of interest rate instrument utilization in 1993 included gains which lowered interest expense by approximately $70 million.\nOTHER INCOME (EXPENSE), NET\nConsolidated other income (expense), net for 1995 includes a pre-tax charge of approximately $103 million for fees and expenses incurred in connection with (i) the exchange of approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\") and (ii) the solicitation of consents by RJRN to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\"). The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nINCOME TAXES\nRJRN Holdings' provision for income taxes for 1993 was increased by $96 million as a result of the enactment of certain federal tax legislation during the third quarter of 1993 which increased federal corporate income tax rates to 35% from 34%, retroactively to January 1, 1993. The components of this increase to RJRN Holdings' provision for income taxes included an $86 million non-cash charge resulting primarily from the remeasurement of the balance of deferred federal income taxes at the date of enactment of the new federal tax legislation for the change in the income tax rates, and a $10 million charge resulting from the increase in current federal income taxes accrued for the change in the income tax rates and other effects of the new tax legislation. Also during 1993, RJRN Holdings' provision for income taxes was decreased by a $108 million credit primarily resulting from a change in the functional currency, for U.S. federal income tax purposes, relating to foreign branch operations.\nNET INCOME\n1995 vs. 1994. RJRN Holdings reported net income of $611 million in 1995, $92 million higher than the $519 million reported in 1994. The increase in net income for 1995 primarily reflects the impact in 1995 of lower interest and debt expense and a lower amount of loss from early extinguishment of debt which more than offset the impact in 1995 of lower operating company contribution, the domestic and international tobacco restructuring expenses, the fees and expenses incurred in connection with the Exchange Offers and the Consent Solicitations and the minority interest in income of Nabisco.\n1994 vs. 1993. RJRN Holdings' net income of $519 million in 1994 includes an after-tax extraordinary loss of $245 million related to the repurchase and redemption of debt during the year. Excluding the extraordinary loss in 1994, as well as a similar extraordinary item which resulted in a $142 million after-tax loss in 1993, RJRN Holdings would have reported net income of $764 million for\n1994, an increase of $767 million from 1993. The increase resulted primarily from the improvement in operating company contribution by both the Tobacco and Food operations, the impact of lower interest expense and the 1993 restructuring expense of $730 million, offset in part by a $65 million charge related to the realignment of Headquarters' functions at the holding company discussed below.\nDuring the fourth quarter of 1994, RJRN Holdings approved and adopted a plan to realign Headquarters' functions, transferring certain responsibilities to the operating companies and significantly streamlining the holding company. The plan reflected expectations of a lower level of financings and other activities at the holding company as RJRN Holdings concludes the post-LBO period. The costs and expenses associated with this decision resulted in a charge of approximately $65 million before tax, a significant portion of which was a cash expense. The majority of the charge was related to accrued employee termination benefits for the 25% of Headquarters' employees terminated (approximately $40 million). This cost was incurred pursuant to a continuing plan for employee termination benefits that provided for the payment of specified amounts of severance and benefits to terminated employees. The remainder of the charge (approximately $25 million) was related to the abandonment of leases of certain corporate office facilities as a result of the realignment and streamlining and the reduced need for office space. The plan was implemented in the first quarter of 1995 and was substantially completed during 1995. At December 31, 1995, approximately $14 million of severance pay and benefits remained to be paid.\nRJRN Holdings' net income (loss) applicable to its common stock for 1995, 1994 and 1993 of $501 million, $388 million and ($213) million, respectively, includes a deduction for preferred stock dividends of $110 million, $131 million and $68 million, respectively.\nIMPACT OF NEW 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 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. SFAS No. 121 requires that (i) 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 and (ii) long-lived assets and certain identifiable intangibles to be disposed of generally be reported at the lower of carrying amount or fair value less cost to sell. SFAS No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995. The adoption of the SFAS No. 121 is not expected to materially effect the financial position or results of operations of RJRN Holdings and RJRN.\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 financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 encourages all entities to adopt a fair value based method of accounting for stock-based compensation plans in which compensation cost is measured at the date the award is granted based on the value of the award and is recognized over the employee service period. However, SFAS No. 123 allows an entity to continue to use the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (\"APB No. 25\"), with proforma disclosures of net income and earnings per share as if the fair value based method had been applied. APB No. 25 requires compensation expense to be recognized over the employee service period based on the excess, if any, of the quoted marked price of the stock at the date the award is granted or other measurement date, as applicable, over an amount an employee must pay to acquire the stock. SFAS No. 123 is effective for financial statements for fiscal years beginning after December 15, 1995. RJRN Holdings and RJRN currently plan to continue to apply the methods prescribed by APB No. 25.\nLIQUIDITY AND FINANCIAL CONDITION\nDECEMBER 31, 1995\nNet cash flows from operating activities for 1995 were $1.67 billion, a decrease of $89 million from the 1994 level of $1.75 billion. The decrease in net cash flows from operating activities reflects lower income before extraordinary item which more than offsets the impact of lower working capital requirements and lower interest paid.\nThe components of net cash flows from operating activities are as follows:\nFree cash flow, another measure used by management to evaluate liquidity and financial condition and which represents cash available for the repayment of debt and certain other corporate purposes before the consideration of any debt and equity financing transactions, acquisition expenditures and divestiture proceeds, resulted in inflows of $348 million and $769 million for 1995 and 1994, respectively. The lower level of free cash flow in 1995 compared with 1994 primarily reflects lower operating company contribution, higher operating working capital requirements, capital expenditures, tax and dividend payments and the payment of fees and expenses for the Exchange Offers and the Consent Solicitations, which more than offset the impact of lower interest paid.\nThe components of free cash flow are as follows:\n- ------------\n* Operating cash flow, which is used internally to evaluate business performance, includes, in addition to net cash flows from (used in) operating activities as recorded in the Consolidated Statement of Cash Flows, proceeds from the sale of capital assets less capital expenditures, and is adjusted to exclude income taxes paid and items of a financial nature (such as interest paid, interest income, and other miscellaneous financial income or expense items).\n------------\nDuring 1995, RJRN Holdings, RJRN, Nabisco Holdings and Nabisco entered into a series of transactions designed to refinance long-term debt, lower debt levels, manage interest rate exposure and refinance certain preferred securities. At December 31, 1995, the effective interest rate on RJRN Holdings' consolidated long-term debt increased to 8.0% from 7.7% at December 31, 1994, primarily due to a lower proportion of consolidated indebtedness subject to floating interest rates and higher average market interest rates for 1995. Future effective interest rates may vary as a result of RJRN's and Nabisco's ongoing management of their respective interest rate exposure, changing market interest rates, refinancing activities and changes in the ratings assigned to RJRN's and Nabisco's debt securities by independent rating agencies. RJRN Holdings' total debt (notes payable and long-term debt, including current maturities) and total capital (total debt, obligations on redeemable preferred securities of subsidiary trust and total stockholders' equity) levels at December 31, 1995 amounted to approximately $9.8 billion and $21.1 billion, respectively, of which total debt and total capital were approximately $1.3 billion and $927 million lower, respectively, than the corresponding amounts at December 31, 1994. The lower debt and capital levels were primarily due to the application of approximately $1.2 billion of net proceeds from the Nabisco Holdings' initial public offering to repay debt. RJRN Holdings' ratio of total debt and obligations on redeemable preferred securities of subsidiary trust to total stockholders' equity at December 31, 1995 and 1994 was 1.0-to-1.\nRJRN's ratio of total debt to common equity was 0.8-to-1.0 at December 31, 1995 compared with 1.0-to-1 at December 31, 1994.\nCurrently, RJRN and its subsidiaries have four principal committed credit facilities. On April 28, 1995, RJRN Holdings and RJRN entered into a new $2.75 billion three year revolving bank credit agreement with various financial institutions (as amended, the \"1995 RJRN Credit Agreement\") and a new $750 million 364 day credit facility to support RJRN commercial paper (as amended, the \"RJRN Commercial Paper Facility,\" and together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"). Among other things, the New RJRN Credit Agreements were designed to remove restrictions on the ability of Nabisco Holdings and its subsidiaries to incur or prepay debt and allow RJRN to reduce the aggregate amount of commitments under its banking facilities from $6 billion to $3.5 billion by replacing its $5.0 billion revolving bank credit facility dated December 1, 1991 (as amended, the \"1991 RJRN Credit Agreement\"), and its $1.0 billion commercial paper facility dated as of April 5, 1993 (as amended and together with the 1991 RJRN Credit Agreement, the \"Old RJRN Credit Agreements\").\nOn April 28, 1995, Nabisco Holdings and Nabisco entered into a credit agreement with various financial institutions (as amended, the \"1995 Nabisco Credit Agreement\") to replace the credit agreement dated as of December 6, 1994 between Nabisco and various financial institutions (the \"1994 Nabisco Credit Agreement\"). Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On November 3, 1995, the 1995 Nabisco Credit Agreement was amended to, among other things, reduce the committed facility to $2.0 billion from $3.5 billion. Also on November 3, 1995, Nabisco Holdings and Nabisco entered into a 364 day credit facility (the \"Nabisco Commercial Paper Facility,\" and together with the 1995 Nabisco Credit Agreement, the \"1995 Nabisco Credit Agreements\") for $1.5 billion primarily to support the issuance of Nabisco commercial paper borrowings.\nThe 1995 RJRN Credit Agreement provides for the issuance of up to $800 million of irrevocable letters of credit. Availability is reduced by the aggregate amount of borrowings outstanding and letters of credit issued under the 1995 RJRN Credit Agreement and by the amount of outstanding RJRN commercial paper in excess of $750 million. At December 31, 1995, there were no borrowings outstanding and approximately $496 million stated amount of letters of credit issued under the 1995 RJRN Credit Agreement and approximately $224 million in RJRN commercial paper outstanding. Accordingly, the amount available under the 1995 RJRN Credit Agreement at December 31, 1995 was approximately $2.3 billion.\nThe RJRN Commercial Paper Facility provides a 364 day back-up line of credit to support RJRN commercial paper issuances of up to $750 million. Availability is reduced by an amount equal to the aggregate amount of outstanding RJRN commercial paper. At December 31, 1995, there was approximately $224 million of RJRN commercial paper outstanding, leaving approximately $526 million available under the facility to support the issuance of additional RJRN commercial paper.\nThe 1995 Nabisco Credit Agreement provides for the issuance of up to $300 million of irrevocable letters of credit. Availability is reduced by the aggregate amount of borrowings outstanding and letters of credit issued under the 1995 Nabisco Credit Agreement and by the amount of outstanding Nabisco commercial paper in excess of $1.5 billion. At December 31, 1995, there were no borrowings outstanding and no letters of credit issued under the 1995 Nabisco Credit Agreement and approximately $1.3 billion in Nabisco commercial paper outstanding. Accordingly, the amount available under the 1995 Nabisco Credit Agreement at December 31, 1995 was approximately $2.0 billion.\nThe Nabisco Commercial Paper Facility is a 364 day facility that primarily supports Nabisco commercial paper issuances of up to $1.5 billion. Availability is reduced by an amount equal to the aggregate amount of outstanding Nabisco commercial paper. At December 31, 1995, there was\napproximately $1.3 billion of Nabisco commercial paper outstanding, leaving approximately $200 million available under the facility to support the issuance of additional Nabisco commercial paper.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock, par value $.01 per share (\"Class A Common Stock\"), at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its borrowings under the 1994 Nabisco Credit Agreement. The completion of Nabisco Holdings' initial public offering and the corresponding reduction in RJRN's proportionate economic interest in Nabisco Holdings from 100% to approximately 80.5% resulted in an adjustment of approximately $401 million to the carrying amount of RJRN's investment in Nabisco Holdings. Such adjustment was reflected as additional paid-in capital by RJRN Holdings and RJRN.\nOn April 1, July 1 and October 1, 1995 and January 1, 1996, RJRN Holdings paid a quarterly dividend on its common stock, par value $.01 per share (the \"Common Stock\"), of $.375 per share. RJRN Holdings expects to continue to pay a quarterly cash dividend on the Common Stock equal to $.375 per share or $1.50 per share on an annualized basis. RJRN Holdings believes that its ability to pay these dividends will not be limited by the restrictions under the New RJRN Credit Agreements and the 1995 Nabisco Credit Agreements or by the policies of its Board of Directors described below.\nOn April 12, 1995, the stockholders of RJRN Holdings approved a one-for-five reverse stock split and the corresponding reduction in the number of authorized shares of Common Stock from 2,200,000,000 to 440,000,000. Accordingly, the rates at which shares of ESOP Convertible Preferred Stock, par value $.01 per share, and Series C Conversion Preferred Stock, par value $.01 per share, will convert into shares of Common Stock have been proportionately adjusted.\nOn June 5, 1995, RJRN and Nabisco consummated the Exchange Offers. As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN consummated the Consent Solicitations. The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nOn June 5, 1995, RJRN applied the approximately $2.3 billion that it received from Nabisco and Nabisco Holdings in repayment of the intercompany notes to repay a portion of its borrowings under the 1991 RJRN Credit Agreement. RJRN used an additional approximately $330 million of borrowings under the 1995 RJRN Credit Agreement to repay the balance of its obligations under the Old RJRN Credit Agreements and to pay certain expenses associated with the Exchange Offers, the Consent Solicitations and related transactions.\nOn June 28, 1995 Nabisco issued $400 million principal amount of 6.70% Notes Due 2002, $400 million principal amount of 6.85% Notes Due 2005 and $400 million principal amount of 7.55% Debentures Due 2015. On July 14, 1995, Nabisco issued $400 million principal amount of 7.05% Notes Due 2007. The net proceeds from the issuance of such debt securities were used to repay a portion of the borrowings under the 1995 Nabisco Credit Agreement.\nOn July 1 and October 1, 1995 and January 1, 1996, Nabisco Holdings paid a quarterly dividend on its common stock of $.1375 per share. Nabisco Holdings expects to continue to pay a quarterly cash\ndividend on its common stock equal to $.1375 per share or $.55 per share on an annualized basis (approximately $146 million). RJRN would receive approximately $117 million of the annualized Nabisco Holdings dividend.\nOn July 17, 1995, Nabisco redeemed its outstanding 8 5\/8% Sinking Fund Debentures Due March 15, 2017 at a price of $1,051.75 for each $1,000 principal amount of debentures, plus accrued interest. The aggregate redemption price and accrued interest on these debentures was approximately $442 million. The redemption resulted in an extraordinary loss of approximately $29 million ($16 million after tax and minority interest).\nOn July 24, 1995, RJRN issued $400 million aggregate principal amount of 8% Notes Due 2001 and $250 million aggregate principal amount of 8 3\/4% Notes Due 2007 under a $1.0 billion debt shelf registration statement filed during 1995. Approximately $352 million of debt securities remains unissued under the shelf as of December 31, 1995. The net proceeds from the issuance of these securities have been or will be used to repay borrowings under the 1995 RJRN Credit Agreement, to retire RJRN commercial paper and for general corporate purposes.\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its 10% Junior Subordinated Debentures due 2044 (the \"Junior Subordinated Debentures\") to a newly formed controlled affiliate, RJR Nabisco Holdings Capital Trust I (the \"Trust\"). The Trust, in turn, exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par value $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The sole asset of the Trust is the Junior Subordinated Debentures. Upon redemption of the Junior Subordinated Debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The transaction resulted in a charge of approximately $5 million to RJRN Holdings' paid in capital as the fair value of the Trust Preferred Securities issued exceeded the book carrying value of the retired Series B Preferred Stock.\nOn November 14, 1995, Nabisco filed a shelf registration statement with the Securities and Exchange Commission for $1.0 billion of debt.\nAt December 31, 1995, RJRN had outstanding interest rate instruments with a notional principal amount of $0, net.\nAt December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates occurring within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter.\nAt December 31, 1995, the aggregate amount of consolidated indebtedness subject to floating interest rates approximated $642 million. This represents a decrease of $3.7 billion from the year end 1994 level of $4.3 billion, primarily due to the application of approximately $1.2 billion of the net proceeds from the Nabisco Holdings' initial public offering to repay a portion of Nabisco's borrowing under the 1994 Nabisco Credit Agreement, Nabisco's interest rate instruments entered into during 1995 and the issuance of $1.6 billion of fixed rate debt by Nabisco and $650 million of fixed rate debt by RJRN to refinance bank and commercial paper borrowings.\nAs a result of the level of market interest rates at December 31, 1995 and 1994 compared with the interest rates associated with RJRN Holdings' consolidated debt obligations, the estimated fair value amounts of RJRN Holdings' long-term debt reflected in its Consolidated Balance Sheets is higher by $246 million and lower by $444 million than the carrying amounts (book values) of such debt at December 31, 1995 and 1994, respectively. For additional disclosures concerning the fair value of\nRJRN Holdings' consolidated indebtedness as well as the fair value of its interest rate arrangements at December 31, 1995 and 1994, see Notes 11 and 12 to the Consolidated Financial Statements.\nThe payment of dividends and the making of distributions by RJRN Holdings to its stockholders are subject to direct and indirect restrictions under certain financing agreements and debt instruments of RJRN Holdings and RJRN and their subsidiaries. The New RJRN Credit Agreements generally restrict cumulative common and preferred dividends and distributions by RJRN Holdings after April 28, 1995 to $1 billion, plus 50% of cumulative consolidated net income, as defined in the New RJRN Credit Agreements, after January 1, 1995, plus the aggregate cash proceeds of up to $250 million in any twelve month period from issuances of equity securities. The New RJRN Credit Agreements and certain other financing agreements also limit the ability of RJRN Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock, issue certain equity securities and engage in certain mergers or consolidations.\nAmong other things, the 1995 Nabisco Credit Agreements generally restrict common and preferred dividends and distributions after April 28, 1995 by Nabisco Holdings to its stockholders, including RJRN, to $300 million plus 50% of Nabisco Holdings' cumulative consolidated net income, as defined in the 1995 Nabisco Credit Agreements, after January 1, 1995. In general, loans and advances by Nabisco Holdings and its subsidiaries to RJRN are effectively subject to a $100 million limit and may only be extended to RJRN's foreign subsidaries. The 1995 Nabisco Credit Agreements also limit the ability of Nabisco Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock and engage in certain mergers or consolidations. These restrictions have not had and are not expected to have a material effect on the ability of Nabisco Holdings to pay its anticipated dividends, or on the ability of RJRN to meet its obligations.\nManagement of RJRN Holdings and its subsidiaries are continuing to review various strategic transactions, including but not limited to, acquisitions, divestitures, mergers and joint ventures. No assurance may be given that any such transactions will be announced or completed.\nRJRN Holdings has indicated that, under normal circumstances, it does not plan to issue additional equity securities for purposes of balance sheet improvement.\nCapital expenditures were $744 million, $670 million and $615 million for 1995, 1994 and 1993, respectively. The current level of expenditures planned for 1996 is expected to be in the range of approximately $700 million to $750 million (approximately 60% Food and 40% Tobacco), which will be funded primarily by cash flows from operating activities. Management expects that its capital expenditure program will continue at a level sufficient to support the strategic and operating needs of RJRN Holdings' operating subsidiaries.\nRJRN Holdings' subsidiaries have operations in many countries, utilizing many different functional currencies in its foreign subsidiaries and branches. Significant foreign currency net investments are located in Germany, Canada, Hong Kong, Brazil, Argentina and Spain. Changes in the strength of these countries' currencies relative to the U.S. dollar result in direct charges or credits to equity for non-hyperinflationary countries and direct charges or credits to the income statement for hyperinflationary countries. Translation gains or losses resulting from foreign-denominated borrowings that are accounted for as hedges of certain foreign currency net investments, also result in charges or credits to equity. RJRN Holdings' subsidiaries also have significant exposure to foreign exchange sale and purchase transactions in currencies other than its functional currency. The exposures include the U.S. dollar, German mark, Japanese yen, Swiss franc, Hong Kong dollar, Singapore dollar and cross-rate exposure among the French franc, British pound, Italian lira and the German mark. These exposures are managed to minimize the effects of foreign currency transactions on its cash flows.\nRJRN HOLDINGS' BOARD OF DIRECTORS POLICIES\nIn November 1994, the Board of Directors of RJRN Holdings adopted a policy stating that RJRN Holdings will limit, until December 31, 1998, the aggregate amount of cash dividends on its capital stock. Under this policy, during that period RJRN Holdings will not pay any extraordinary cash dividends and will limit the aggregate amount of its cash dividends, cash distributions and repurchases for cash of capital stock and subordinated debt to an amount equal to the sum of $500 million plus (i) 65% of RJRN Holdings' cumulative consolidated net income before extraordinary gains or losses and restructuring charges subsequent to December 31, 1994 and (ii) net cash proceeds of up to $250 million in any year from the sale of capital stock of RJRN Holdings or its subsidiaries (other than proceeds from the Nabisco Holdings initial public offering) to the extent used to repay, purchase or redeem debt or preferred stock.\nAlso in November 1994, the Board of Directors of RJRN Holdings adopted a policy providing that RJRN Holdings will not declare a dividend or distribution to its stockholders of the shares of capital stock of a subsidiary before December 31, 1996. RJRN Holdings has also adopted a policy setting forth its intention not to make such a distribution prior to December 31, 1998 if that distribution would cause the ratings of the senior indebtedness of RJRN to be reduced from investment grade to non-investment grade or if, after giving effect to such distribution, any publicly-held senior indebtedness of the distributed company would not be rated investment grade. The Board of Directors of RJRN Holdings is committed to effecting a spin-off of Nabisco Holdings at the appropriate time. There is no assurance that any such distribution will take place. Additional policies provide that an amount equal to the net cash proceeds from any issuance and sale of equity by RJRN Holdings or from any sale outside the ordinary course of business of material assets owned or used by subsidiaries in the tobacco business, in each case before December 31, 1998, will be used either to repay, purchase or redeem consolidated indebtedness or to acquire properties, assets or businesses to be used in existing or new lines of business and that an amount equal to the net cash proceeds of any secondary sale of shares of Nabisco Holdings before December 31, 1998 will be used to repay, purchase or redeem consolidated debt. No assurance can be given that RJRN Holdings will issue or sell any equity or sell any material assets outside the ordinary course of business.\nENVIRONMENTAL MATTERS\nThe U.S. Government and various state and local governments have enacted or adopted laws and regulations concerning protection of the environment. The regulations promulgated by the Environmental Protection Agency and other governmental agencies under various statutes have resulted in, and will likely continue to result in, substantial expenditures for pollution control, waste treatment, plant modification and similar activities.\nIn April 1995, RJRN Holdings was named a potentially responsible party (a \"PRP\") with certain third parties under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to a superfund site at which a former subsidiary of RJRN had operations. Certain subsidiaries of RJRN Holdings and RJRN have also been named as PRPs with third parties or may have indemnification obligations under CERCLA with respect to an additional thirteen sites.\nRJRN Holdings' and RJRN's subsidiaries have been engaged in a continuing program to assure compliance with U.S., state and local laws and regulations. Although it is difficult to identify precisely the portion of capital expenditures or other costs attributable to compliance with environmental laws and to estimate the cost of resolving these CERCLA matters, RJRN Holdings and RJRN do not expect such expenditures or other costs to have a material adverse effect on the financial condition of either RJRN Holdings or RJRN.\n-------------------------\nThe foregoing discussion in \"Management's Discussion and Analysis of Financial Condition 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, the effects on financial performance and future events, competitive pricing for products, success of new product innovations and acquisitions, local economic conditions and the effects of currency fluctuations in countries in which RJRN Holdings and its subsidiaries do business, domestic and foreign government regulation, ratings of RJRN Holdings' or its subsidiaries' securities and, in the case of the tobacco business, litigation. For additional information concerning factors affecting future events and policies and RJRN Holdings' performance, see Part I, Items 1 through 3 and Part II Item 5 of this report. 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nRefer to the Index to Financial Statements and Financial Statement Schedules on page 47 for the required 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 REGISTRANTS\nItem 10 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996. Reference is also made regarding the executive officers of the Registrants to \"Executive Officers of the Registrants\" following Item 4 of Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nItem 11 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem 12 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nItem 13 is hereby incorporated by reference to RJRN Holdings' Definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 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, in the City of New York, State of New York on February 22, 1996.\nRJR NABISCO HOLDINGS CORP.\nBy: \/s\/ STEVEN F. GOLDSTONE ................................ (Steven F. Goldstone) 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 February 22, 1996.\nSIGNATURE TITLE --------- ----- \/s\/ CHARLES M. HARPER Chairman of the Board and ................................ Director (Charles M. Harper)\nPresident and Chief Executive \/s\/ STEVEN F. GOLDSTONE Officer (principal executive ................................ officer) (Steven F. Goldstone)\nSenior Vice President and Chief \/s\/ ROBERT S. ROATH Financial Officer (principal ................................ financial officer) (Robert S. Roath)\n\/s\/ RICHARD G. RUSSELL Senior Vice President and ................................ Controller (principal (Richard G. Russell) accounting officer)\n* Director ................................ (John T. Chain, Jr.)\n* Director ................................ (Julius L. Chambers)\n* Director ................................ (John L. Clendenin)\n* Director ................................ (H. John Greeniaus)\n* Director ................................ (Ray J. Groves)\n* Director ................................ (James W. Johnston)\n* Director ................................ (John G. Medlin, Jr.)\n* Director ................................ (Rozanne L. Ridgway)\n*By: \/s\/ ROBERT F. SHARPE, JR. ............................. (Robert F. Sharpe, Jr.) Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York on February 22, 1996.\nRJR NABISCO, INC.\nBy: \/s\/ STEVEN F. GOLDSTONE ................................ (Steven F. Goldstone) 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 February 22, 1996.\nSIGNATURE TITLE --------- ----- \/s\/ CHARLES M. HARPER Chairman of the Board and ................................ Director (Charles M. Harper)\nPresident and Chief Executive \/s\/ STEVEN F.GOLDSTONE Officer (principal executive ................................ officer) (Steven F. Goldstone)\nSenior Vice President and Chief \/s\/ ROBERT S. ROATH Financial Officer (principal ................................ financial officer) (Robert S. Roath)\n\/s\/ RICHARD G. RUSSELL Senior Vice President and ................................ Controller (principal (Richard G. Russell) accounting officer)\n* Director ................................ (John T. Chain, Jr.)\n* Director ................................ (Julius L. Chambers)\n* Director ................................ (John L. Clendenin)\n* Director ................................ (H. John Greeniaus)\n* Director ................................ (Ray J. Groves)\n* Director ................................ (James W. Johnston)\n* Director ................................ (John G. Medlin, Jr.)\n* Director ................................ (Rozanne L. Ridgway)\n*By: \/s\/ ROBERT F. SHARPE, JR. .............................. (Robert F. Sharpe, Jr.) Attorney-in-Fact\n[THIS PAGE INTENTIONALLY LEFT BLANK]\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nREPORT OF DELOITTE & TOUCHE LLP, INDEPENDENT AUDITORS\nRJR Nabisco Holdings Corp.: RJR Nabisco, Inc.:\nWe have audited the accompanying consolidated balance sheets of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and RJR Nabisco, Inc. (\"RJRN\") 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 schedules of RJRN Holdings and RJRN 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 accompanying index to financial statements and financial statement schedules. These financial statements and financial statement schedules are the responsibility of the companies' management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of RJRN Holdings and RJRN 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, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nNew York, New York January 29, 1996 (February 16, 1996 as to Note 12)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS)\n- ------------\n* The sole asset of the subsidiary trust is the junior subordinated debentures of RJRN Holdings. Upon redemption of the junior subordinated debentures, which have a final maturity of December 31, 2044, the preferred securities will be mandatorily redeemed. The outstanding junior subordinated debentures have an aggregate principal amount of approximately $978 million and an annual interest rate of 10%.\nSee Notes to Consolidated Financial Statements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThis Summary of Significant Accounting Policies is presented to assist in understanding the consolidated financial statements of RJR Nabisco Holdings Corp. (\"RJRN Holdings\") and RJR Nabisco, Inc. (\"RJRN\") (the \"Consolidated Financial Statements\") included in this report. These policies conform to generally accepted accounting principles.\nConsolidation\nConsolidated Financial Statements include the accounts of RJRN Holdings and RJRN and their subsidiaries.\nCash Equivalents\nCash equivalents include all short-term, highly liquid investments that are readily convertible to known amounts of cash and so near maturity (three months or less) that they present an insignificant risk of changes in value because of changes in interest rates.\nInventories\nInventories are stated at the lower of cost or market. Various methods are used for determining cost. The cost of U.S. tobacco inventories is determined principally under the LIFO method. The cost of remaining inventories is determined under the FIFO, specific lot and weighted average methods. In accordance with recognized trade practice, stocks of tobacco, which must be cured for more than one year, are classified as current assets.\nDepreciation\nProperty, plant and equipment are depreciated principally by the straight-line method over the estimated useful lives of the assets as follows: 13-25 years for land improvements, 20-50 years for buildings and leasehold improvements and 3-20 years for machinery and equipment.\nTrademarks and Goodwill\nValues assigned to trademarks are amortized on the straight-line method over a 40 year period. Goodwill is also amortized on the straight-line method over a 40 year period.\nIn evaluating the value and future benefits of trademarks and goodwill, the recoverability from operating income is measured. Under this approach, the carrying value of goodwill and trademarks would be reduced if it is probable that management's best estimate of future operating income before amortization of trademarks and goodwill from related operations, on an undiscounted basis, will be less than the carrying amount of trademarks and goodwill over the remaining amortization period.\nOther Income (Expense), Net\nInterest income, gains and losses on foreign currency transactions and other items of a financial nature are included in \"Other income (expense), net\".\nIncome Taxes\nIncome taxes are calculated for RJRN on a separate return basis.\nExcise Taxes\nExcise taxes are excluded from \"Net sales\" and \"Cost of products sold\".\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)\nReclassifications and Restatements\nCertain prior years' amounts have been reclassified to conform to the 1995 presentation. In addition, financial data of the prior years has been restated and financial data of the current year presented to give effect to the one-for-five reverse stock split discussed in Note 3 to the Consolidated Financial Statements.\nAdvertising\nAdvertising costs are generally expensed as incurred.\nInterest Rate Arrangements\nWhen interest rate swaps and purchased options and other interest rate arrangements effectively hedge interest rate exposures, the differential to be paid or received is accrued and recognized in interest expense and may change as market interest rates change. If an arrangement is terminated or effectively terminated prior to maturity, then the realized or unrealized gain or loss is effectively recognized over the remaining original life of the agreement if the hedged item remains outstanding, or immediately, if the underlying hedged instrument does not remain outstanding. If the arrangement is not terminated or effectively terminated prior to maturity, but the underlying hedged instrument is no longer outstanding, then the unrealized gain or loss on the related interest rate swap, option or other interest rate arrangement is recognized immediately. In addition, for written options and other financial instruments (or components thereof) having a risk profile substantially similar to written options, changes in market value result in the current recognition of any related gains or losses.\nForeign Currency Arrangements\nForward foreign exchange contracts and other hedging arrangements entered into generally mature at the time the hedged foreign currency transactions are settled. Gains or losses on forward foreign exchange transactions are determined by changes in market rates and are generally included at settlement in the basis of the underlying hedged transaction. To the extent that the underlying hedged foreign currency transaction does not occur, gains and losses are recognized immediately.\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 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. See Note 12 to the Consolidated Financial Statements for discussion of significant commitments and contingencies.\nNew 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 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. SFAS No. 121 requires that (i) 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\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)\ncarrying amount of an asset may not be recoverable and (ii) long-lived assets and certain identifiable intangibles to be disposed of generally be reported at the lower of carrying amount or fair value less cost to sell. SFAS No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995. The adoption of the SFAS No. 121 is not expected to materially effect the financial position or results of operations of RJRN Holdings and RJRN.\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 financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 encourages all entities to adopt a fair value based method of accounting for stock-based compensation plans in which compensation cost is measured at the date the award is granted based on the value of the award and is recognized over the employee service period. However, SFAS No. 123 allows an entity to continue to use the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (\"APB No. 25\"), with proforma disclosures of net income and earnings per share as if the fair value based method had been applied. APB No. 25 requires compensation expense to be recognized over the employee service period based on the excess, if any, of the quoted marked price of the stock at the date the award is granted or other measurement date, as applicable, over an amount an employee must pay to acquire the stock. SFAS No. 123 is effective for financial statements for fiscal years beginning after December 15, 1995. RJRN Holdings and RJRN currently plan to continue to apply the methods prescribed by APB No. 25.\nNOTE 2--OPERATIONS\nNet sales and cost of products sold exclude excise taxes of $3.832 billion, $3.578 billion and $3.757 billion for 1995, 1994 and 1993, respectively.\nConsolidated other income (expense), net for 1995 includes a pre-tax charge of approximately $103 million for fees and expenses incurred in connection with (i) the exchange of approximately $1.8 billion aggregate principal amount of newly issued notes and debentures (the \"New Notes\") of Nabisco, Inc. (\"Nabisco\") for the same amount of notes and debentures (the \"Old Notes\") issued by RJRN (the \"Exchange Offers\") and (ii) the solicitation of consents by RJRN to certain indenture modifications from holders of the Old Notes and holders of approximately $3.58 billion of its other outstanding debt securities (the \"Consent Solicitations\"). The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nRJRN Holdings recorded a pre-tax restructuring expense of $154 million in the fourth quarter of 1995 ($104 million after tax) related to a program announced on October 13, 1995 to reorganize its worldwide tobacco operations. The 1995 restructuring program was primarily undertaken in order to streamline operations and improve profitability. The 1995 restructuring program was implemented in the latter part of 1995 and will be substantially completed during 1996. A significant portion of the 1995 restructuring program will be a cash expense. The major components of the 1995 restructuring program were work force reductions totaling 1,260 employees (approximately $132 million), the rationalization and closing of facilities relating to the international tobacco operations (approximately $8 million) and equipment and lease abandonments at the domestic tobacco operations (approximately\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2--OPERATIONS--(CONTINUED)\n$14 million). At December 31, 1995, approximately $102 million of severance pay and benefits remained to be paid. Anticipated annual future cash savings from the plan are estimated to be in excess of approximately $70 million after tax.\nDuring the fourth quarter of 1994, RJRN Holdings approved and adopted a plan to realign Headquarters' functions, transferring certain responsibilities to the operating companies and significantly streamlining the holding company. The plan reflected expectations of a lower level of financings and other activities at the holding company as RJRN Holdings concludes the post-LBO period. The costs and expenses associated with this decision resulted in a charge of approximately $65 million before tax, a significant portion of which was a cash expense. The majority of the charge was related to accrued employee termination benefits for the 25% of Headquarters' employees terminated (approximately $40 million). This cost was incurred pursuant to a continuing plan for employee termination benefits that provided for the payment of specified amounts of severance and benefits to terminated employees. The remainder of the charge (approximately $25 million) was related to the abandonment of leases of certain corporate office facilities as a result of the realignment and streamlining and the reduced need for office space. The plan was implemented in the first quarter of 1995 and was substantially completed during 1995. At December 31, 1995, approximately $14 million of severance pay and benefits remained to be paid.\nRJRN Holdings recorded a pre-tax restructuring expense of $730 million in the fourth quarter of 1993 ($467 million after tax) related to a program announced on December 7, 1993. The 1993 restructuring program was undertaken to respond to a changing consumer product business environment and to streamline operations and improve profitability. The 1993 program, which was implemented in the latter part of 1993 and substantially completed during 1995, consisted of workforce reductions, reassessment of raw material sourcing and production arrangements, contract termination costs, abandonment of leases and the rationalization and closing of manufacturing and sales facilities. Approximately 75% of the restructuring program required cash outlays. At December 31, 1995, approximately $21 million for severance pay and benefits remained to be paid.\nDuring 1994, a change in the estimated cost of the 1993 restructuring program resulted in a credit to income of $23 million related to changes in the number of workforce reductions and an increase in cost of $21 million associated with the rationalization and abandonment of manufacturing and sales facilities. The net adjustment during 1994 of the above changes was reflected in selling, advertising, administrative and general expenses.\nNOTE 3--EARNINGS PER SHARE\nEarnings per share is based on income applicable to the consolidated group, including the portion of income of Nabisco Holdings Corp. (\"Nabisco Holdings\") applicable to the consolidated group based on RJRN's approximately 80.5% economic ownership interest in Nabisco Holdings and Nabisco Holdings' primary earnings per share. Earnings per share is also based on the weighted average number of shares of RJRN Holdings' common stock, par value $.01 per share (the \"Common Stock\"), $.835 Depositary Shares (\"Series A Depositary Shares\") and Series C Depositary Shares (\"Series C Depositary Shares\") outstanding during the period and Common Stock assumed to be outstanding to reflect the effect of dilutive options. RJRN Holdings' other potentially dilutive securities are not included in the earnings per share calculation because the effect of excluding interest and dividends on such securities for the period would exceed the earnings allocable to the Common Stock into which such securities would be\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 3--EARNINGS PER SHARE--(CONTINUED)\nconverted. Accordingly, RJRN Holdings' earnings per share and fully diluted earnings per share are the same. The net loss per common and common equivalent share reported for the year ended December 31, 1993 would have increased by $.91 per share if the weighted average number of shares of Series A Depositary Shares outstanding during the period had been excluded from the earnings per share calculation.\nNet income per common and common equivalent share, including the average number of common and common equivalent shares outstanding, reflects a one-for-five reverse stock split approved by the RJRN Holdings' stockholders on April 12, 1995.\nNOTE 4--INCOME TAXES\nThe provision for income taxes consisted of the following:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nThe components of the deferred income tax liability disclosed on the Consolidated Balance Sheet at December 31, 1995 and 1994 included the following:\nPre-tax income (loss) for domestic and foreign operations is shown in the following table:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nThe differences between the provision for income taxes and income taxes computed at statutory U.S. federal income tax rates are explained as follows:\nAt December 31, 1995, there was $1.752 billion of accumulated and undistributed income of foreign subsidiaries. These earnings are intended by management to be reinvested abroad indefinitely. Accordingly, no applicable U.S. federal deferred income taxes or foreign withholding taxes have been provided nor is a determination of the amount of unrecognized U.S. federal deferred income taxes practicable.\nRJRN Holdings' provision for income taxes for 1993 was increased by $96 million as a result of the enactment of certain federal tax legislation during the third quarter of 1993 which increased federal corporate income tax rates to 35% from 34%, retroactively to January 1, 1993. The components of this increase to RJRN Holdings' provision for income taxes included an $86 million non-cash charge resulting primarily from the remeasurement of the balance of deferred federal income taxes at the date of enactment of the new federal tax legislation for the change in the income tax rates, and a $10 million charge resulting from the increase in current federal income taxes accrued for the change in the income tax rates and other effects of the new tax legislation. Also during 1993, RJRN Holdings' provision for income taxes was decreased by a $108 million credit primarily resulting from a change in the functional currency, for U.S. federal income tax purposes, relating to foreign branch operations.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nDuring 1993, $101 million of previously recognized deferred income tax benefits for operating loss carryforwards ($36 million), minimum tax credit carryforwards ($44 million) and other carryforward items ($21 million) were realized for federal tax purposes.\nNOTE 5--EXTRAORDINARY ITEM\nEarly extinguishment of debt resulted in the following extraordinary losses:\nSee Note 11 to the Consolidated Financial Statements for further discussion of early extinguishments of debt.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--SUPPLEMENTAL CASH FLOWS INFORMATION\nA reconciliation of net income (loss) to net cash flows from operating activities follows:\nCash payments for income taxes and interest were as follows:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--SUPPLEMENTAL CASH FLOWS INFORMATION--(CONTINUED)\nCash equivalents at December 31, 1995 and 1994, valued at cost (which approximates market value), totaled $115 million and $364 million, respectively, and consisted principally of domestic and Eurodollar time deposits and certificates of deposit.\nAt December 31, 1995 and 1994, cash of $17 million and $60 million, respectively, was held in escrow as collateral for letters of credit issued in connection with certain foreign currency debt.\nOn February 7, 1990, RJRN entered into an arrangement in which it agreed to sell for cash substantially all of its subsidiaries' domestic trade accounts receivable generated during a five-year period to a financial institution. Pursuant to amendments entered into in 1992, the length of the receivable program was extended an additional year. During 1995, the arrangement was further amended to October 1996 for only domestic trade accounts receivable generated by Nabisco. The accounts receivable have been and will continue to be sold with limited recourse at purchase prices reflecting the rate applicable to the cost to the financial institution of funding its purchases of accounts receivable and certain administrative costs. During 1995, 1994 and 1993, total proceeds of approximately $8.0 billion, $7.9 billion and $8.2 billion, respectively, were received in connection with this arrangement. The amount of total proceeds received applicable to Nabisco's domestic trade accounts receivable generated during 1995, 1994 and 1993 were approximately $5.5 billion, $5.3 billion and $4.9 billion, respectively. At December 31, 1995 and 1994, the accounts receivable balance has been reduced by approximately $418 million and $391 million, respectively, due to the receivables sold.\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE 7--INVENTORIES\nThe major classes of inventory are shown in the table below:\nAt December 31, 1995 and 1994, approximately $1.0 billion and $1.2 billion, respectively, of domestic tobacco inventories was valued under the LIFO method. The current cost of LIFO inventories at December 31, 1995 and 1994 was greater than the amount at which these inventories were carried on the Consolidated Balance Sheets by $146 million and $141 million, respectively.\nFor the years ended December 31, 1995, 1994 and 1993, net income was increased by $29 million, $10 million and $6 million, respectively, as a result of LIFO inventory liquidations. The LIFO liquidations resulted from programs to reduce leaf durations consistent with forecasts of future operating requirements.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8--PROPERTY, PLANT AND EQUIPMENT\nComponents of property, plant and equipment were as follows:\nNOTE 9--NOTES PAYABLE\nNotes payable consisted of the following:\nWeighted average interest rate for notes payable consisted of the following:\nNOTE 10--ACCRUED LIABILITIES\nAccrued liabilities consisted of the following:\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE\nInterest and debt expense consisted of the following:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nLong-term debt consisted of the following:\n- ------------\n(1) The payment of debt through December 31, 2000 is due as follows (in millions): 1997--$61; 1998--$31; 1999--$1,944 and 2000--$1,319.\n(2) Nabisco maintains a revolving credit facility of $2.0 billion (as amended, the \"1995 Nabisco Credit Agreement\"), of which $2.0 billion is unused at December 31, 1995. Availability of the unused portion is reduced by the aggregate amount of letters of credit issued under the 1995 Nabisco Credit Agreement and by the amount of outstanding Nabisco commercial paper in excess of $1.5 billion. At December 31, 1995, there were no letters of credit issued under the 1995 Nabisco Credit Agreement. A commitment fee of .15% per annum is payable on the total facility.\n(3) Nabisco maintains a 364-day revolving credit facility primarily to support Nabisco commercial paper issuances of up to $1.5 billion (the \"Nabisco Commercial Paper Facility\"). Availability is reduced\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nby an amount equal to the aggregate amount of outstanding Nabisco commercial paper. A commitment fee of .1% per annum is payable on the total facility.\n(4) RJRN maintains a revolving credit facility of $2.75 billion (as amended, the \"1995 RJRN Credit Agreement\"), of which $2.75 billion was unused at December 31, 1995. Availability of the unused portion is reduced by $496 million for the extension of irrevocable letters of credit issued under the 1995 RJRN Credit Agreement and by the amount of outstanding RJRN commercial paper in excess of $750 million. A commitment fee of .225% per annum is payable on the total facility.\n(5) RJRN maintains a 364-day back-up line of credit to support RJRN commercial paper issuances of up to $750 million (as amended, the \"RJRN Commercial Paper Facility\"), which expires in April 1996. Availability is reduced by an amount equal to the aggregate amount of outstanding RJRN commercial paper. A commitment fee of .175% per annum is payable on the total facility.\n-------------------\nBased on RJRN's and Nabisco's intention and ability to continue to refinance, for more than one year, the amount of their respective commercial paper borrowings in the commercial paper market or with additional borrowings under their respective credit agreements, domestic commercial paper borrowings have been included under \"Long-term debt.\"\nDuring 1993, RJRN repurchased for approximately $1.0 billion in cash certain of its subordinated debentures consisting of $153 million aggregate principal amount of its 15% Payment-in-Kind Debentures due May 15, 2001 (the \"15% Subordinated Debentures\"), $82 million aggregate principal amount of its 13 1\/2% Subordinated Debentures due May 15, 2001 (the \"13 1\/2% Subordinated Debentures\") and $768 million aggregate principal amount (approximately $671 million accreted amount) of its Subordinated Discount Debentures due May 15, 2001 (the \"Subordinated Discount Debentures\"). The principal or accreted amounts of such debentures was refinanced from proceeds of debt securities maturing after 1998, including debt securities issued during 1993. The purchase of most of such amount had been temporarily funded with borrowings under RJRN's revolving credit facility (as amended, the \"1991 RJRN Credit Agreement\").\nThe remaining portion of a participation in an employee stock ownership plan established by RJRN Holdings (the \"ESOP\") was repurchased on January 15, 1993 for cash, plus accrued and unpaid interest thereon.\nRJRN Holdings redeemed on May 1, 1993, 100% of the aggregate principal amount of its outstanding Senior Converting Debentures due 2009 (the \"Converting Debentures\") at a price of $1,000 for each $1,000 principal amount of Converting Debentures, plus accrued and unpaid interest thereon, for the period from February 9, 1989 through April 30, 1993, of $937.54 for each $1,000 principal amount of Converting Debentures.\nDuring 1993, RJRN issued $750 million principal amount of 8% Notes due 2000, $500 million principal amount of 8 3\/4% Notes due 2005 and $500 million principal amount of 9 1\/4% Debentures due 2013. Also during 1993, RJRN issued medium-term notes maturing in the years 1995-1998 having an aggregate initial offering price of approximately $230 million. The net proceeds from the sale of these debt securities and the Series B Preferred Stock Offering (as hereinafter defined) were used for general corporate purposes, which included refinancings of indebtedness, working capital, capital expenditures, acquisitions and repurchases and redemptions of securities. Pending such uses, proceeds were used to repay indebtedness under the 1991 RJRN Credit Agreement or for short-term liquid investments.\nA portion of the net proceeds collected from the sale of RJRN Holdings' ready-to-eat cold cereal business during 1992 was used on February 5, 1993 to redeem $216 million principal amount of\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nRJRN's 9 3\/8% Sinking Fund Debentures due 2016 (the \"9 3\/8% Debenture\") at a price of $1,065.63 for each $1,000 principal amount of 9 3\/8% Debentures, plus accrued and unpaid interest thereon.\nOn May 15, 1994, RJRN redeemed substantially all of its approximately $2 billion in outstanding subordinated debentures. The subordinated debentures redeemed consisted of the Subordinated Discount Debentures, the 15% Subordinated Debentures and the 13 1\/2% Subordinated Debentures at redemption prices of 107 1\/2%, 107 1\/2% and 106 3\/4%, respectively, plus accrued interest. Approximately $1.2 billion principal or accreted amount of such debentures was refinanced with proceeds of debt securities maturing after 1998 that were issued during 1993. Such proceeds had been used to temporarily reduce indebtedness under the 1991 RJRN Credit Agreement. In addition, the redemption of such debentures was funded with approximately $900 million of net proceeds from the sale of 266,750,000 Series C Depositary Shares completed on May 6, 1994 in connection with the issuance of 26,675,000 shares of Series C Conversion Preferred Stock, par value $.01 per share (\"Series C Preferred Stock\").\nOn November 30, 1994, RJRN redeemed $1.5 billion of 10 1\/2% Senior Notes due 1998 (the \"10 1\/2% Senior Notes\"); $373.5 million of 8 3\/8% Sinking Fund Debentures due 2017 and approximately $24.8 million of 7 3\/8% Sinking Fund Debentures due 2001. On December 2, 1994, RJRN redeemed $100 million of the 13 1\/2% Subordinated Debentures. The redemption price for the 10 1\/2% Senior Notes was equal to $1,071 plus accrued interest for each $1,000 principal amount of notes. The redemption price for the 8 3\/8% Sinking Fund Debentures due 2017 was equal to $1,054.44 plus accrued interest for each $1,000 principal amount of debentures. The redemption price for the 7 3\/8% Sinking Fund Debentures due 2001 was equal to $1,005.60 plus accrued interest for each $1,000 principal amount of debentures. The redemption price for the 13 1\/2% Subordinated Debentures was equal to $1,067.50 plus accrued interest for each $1,000 principal amount of debentures. These redemptions were funded with borrowings under the 1991 RJRN Credit Agreement, internally generated cash flow, and, in the case of the 8 3\/8% Sinking Fund Debentures due 2017, proceeds from RJRN Holdings' Series C Preferred Stock Offering (as hereinafter defined).\nOn December 7, 1994, Nabisco borrowed $1.35 billion under its credit agreement dated as of December 6, 1994 (the \"1994 Nabisco Credit Agreement\") to repay a portion of Nabisco's intercompany indebtedness to RJRN. RJRN used the proceeds of the repayment to reduce borrowings under the 1991 RJRN Credit Agreement.\nOn January 26, 1995, Nabisco Holdings completed the initial public offering of 51,750,000 shares of its Class A Common Stock, par value $.01 per share (\"Class A Common Stock\"), at an initial offering price of $24.50 per share. Nabisco used all of the approximately $1.2 billion of net proceeds from the initial public offering to repay a portion of its borrowings under the 1994 Nabisco Credit Agreement.\nOn April 28, 1995, RJRN entered into the 1995 RJRN Credit Agreement and the RJRN Commercial Paper Facility (together with the 1995 RJRN Credit Agreement, the \"New RJRN Credit Agreements\"). Among other things, the New RJRN Credit Agreements were designed to remove restrictions on the ability of Nabisco Holdings and its subsidiaries to incur or prepay debt and to allow RJRN to reduce the aggregate amount of commitments under its banking facilities from $6 billion to $3.5 billion by replacing its 1991 RJRN Credit Agreement and its $1.0 billion commercial paper\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nfacility dated as of April 5, 1993 (as amended and together with the 1991 RJRN Credit Agreement, the \"Old RJRN Credit Agreements\").\nOn April 28, 1995, Nabisco Holdings and Nabisco entered into the 1995 Nabisco Credit Agreement with various financial institutions to replace the 1994 Nabisco Credit Agreement. Among other things, the 1995 Nabisco Credit Agreement was designed to permit Nabisco to prepay intercompany debt and incur long-term debt, to increase Nabisco's committed facility from $1.5 billion to $3.5 billion and to extend its term from 364 days to five years. On November 3, 1995, the 1995 Nabisco Credit Agreement was amended to, among other things, reduce the committed facility to $2.0 billion from $3.5 billion. Also on November 3, 1995, Nabisco Holdings and Nabisco entered into a 364 day credit facility (the \"Nabisco Commercial Paper Facility\" and together with the 1995 Nabisco Credit Agreement, the \"1995 Nabisco Credit Agreements\") for $1.5 billion primarily to support the issuance of commercial paper borrowings.\nOn June 5, 1995, RJRN and Nabisco consummated the Exchange Offers. As part of the transaction, RJRN returned to Nabisco approximately $1.8 billion of intercompany notes that had been issued by Nabisco and were held by a non-Nabisco affiliate of RJRN. The New Notes issued by Nabisco in the Exchange Offers have interest rates, principal amounts, maturities and redemption provisions identical to the corresponding Old Notes issued by RJRN. Nabisco subsequently borrowed approximately $2.4 billion under the 1995 Nabisco Credit Agreement to (a) repay or repurchase an additional $2.1 billion of intercompany notes of Nabisco and its subsidiaries; (b) repay approximately $125 million of outstanding borrowings under the 1994 Nabisco Credit Agreement; (c) repay approximately $89 million of an intercompany note from Nabisco to Nabisco Holdings; and (d) pay a $79 million dividend to Nabisco Holdings. Nabisco Holdings used the payments it received to repay the balance of a $168 million intercompany note to RJRN. Concurrently with the Exchange Offers, RJRN consummated the Consent Solicitations. The Exchange Offers, the Consent Solicitations and certain related transactions were designed, among other things, to enable Nabisco to obtain long-term debt financing independent of RJRN and to repay its intercompany debt to RJRN.\nOn June 5, 1995, RJRN applied the approximately $2.3 billion that it received from Nabisco and Nabisco Holdings in repayment of the intercompany notes to repay a portion of its borrowings under the 1991 RJRN Credit Agreement. RJRN used an additional approximately $330 million of borrowings under the 1995 RJRN Credit Agreement to repay the balance of its obligations under the Old RJRN Credit Agreements and to pay certain expenses associated with the Exchange Offers, the Consent Solicitations and the related transactions.\nOn June 28, 1995, Nabisco issued $400 million principal amount of 6.70% Notes Due 2002, $400 million principal amount of 6.85% Notes Due 2005 and $400 million principal amount of 7.55% Debentures Due 2015. On July 14, 1995, Nabisco issued $400 million principal amount of 7.05% Notes Due 2007. The net proceeds from the issuance of such debt securities were used to repay a portion of the borrowings under the 1995 Nabisco Credit Agreement.\nOn July 17, 1995, Nabisco redeemed its outstanding 8 5\/8% Sinking Fund Debentures Due March 15, 2017 at a price of $1,051.75 for each $1,000 principal amount of debentures, plus accrued interest. The aggregate redemption price and accrued interest on these debentures was approximately $442 million. The redemption resulted in an extraordinary loss of approximately $29 million ($16 million after tax and minority interest).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nOn July 24, 1995, RJRN issued $400 million aggregate principal amount of 8% Notes Due 2001 and $250 million aggregate principal amount of 8 3\/4% Notes Due 2007 under a $1.0 billion debt shelf registration statement. Approximately $352 million of debt securities remains unissued under the shelf as of December 31, 1995. The net proceeds from the issuance of these securities have been or will be used to repay borrowings under the 1995 RJRN Credit Agreement, to retire RJRN commercial paper and for general corporate purposes.\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its 10% Junior Subordinated Debentures due 2044 (the \"Junior Subordinated Debentures\") to a newly formed controlled affiliate, RJR Nabisco Holdings Capital Trust I (the \"Trust\"). The Trust, in turn, exchanged approximately $949 million of its preferred securities (the \"Trust Preferred Securities\"), representing undivided interests in 97% of the assets of the Trust, for 37,956,060 of the 50,000,000 Series B Depositary Shares (the \"Series B Depositary Shares\") outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of RJRN Holdings' Series B Cumulative Preferred Stock, par value $.01 per share (the \"Series B Preferred Stock\"). RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. The transaction resulted in a charge of approximately $5 million to RJRN Holdings' paid-in capital as the fair value of the Trust Preferred Securities issued, which was the book carrying value assigned to these securities, exceeded the book carrying value of the retired Series B Preferred Stock. The difference between the assigned value of the Trust Preferred Securities and its redemption value will be amortized to interest expense over its term. The sole asset of the Trust is the Junior Subordinated Debentures. Upon maturity or redemption of the Junior Subordinated Debentures, which have a final maturity of December 31, 2044, the Trust Preferred Securities will be mandatorily redeemed. The Junior Subordinated Debentures are redeemable at the option of RJRN Holdings, in whole or in part, on or after August 19, 1998, at a redemption price equivalent to $25 per Junior Subordinated Debenture to be redeemed, plus accrued and unpaid interest thereon, to the redemption date. Upon the repayment of the Junior Subordinated Debentures, whether at maturity, upon redemption or otherwise, the proceeds thereof will be promptly applied to redeem the Trust Preferred Securities. Holders of Trust Preferred Securities have no right to require the Trust to redeem the Trust Preferred Securities at the option of the holders. Cash distributions on the Trust Preferred Securities are cumulative at an annual rate of 10% of the liquidation amount of $25 per security and are payable quarterly in arrears, but only to the extent that interest payments are made on the Junior Subordinated Debentures. Cash distributions in arrears for more than one quarter will bear interest at 10% of the liquidation amount per security compounded quarterly.\nOn November 14, 1995, Nabisco filed a shelf registration statement with the Securities and Exchange Commission for $1.0 billion of debt.\nAt December 31, 1995, RJRN had outstanding interest rate instruments with a notional principal amount of $0, net. (See Note 12 to the Consolidated Financial Statements for additional disclosures regarding interest rate arrangements).\nAt December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates occurring within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter. (See Note 12 to the Consolidated Financial Statements for additional disclosures regarding interest rate arrangements).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nThe estimated fair value of RJRN Holdings' consolidated long-term debt as of December 31, 1995 and 1994 was approximately $10.1 billion and $10.7 billion, respectively, based on available market quotes, discounted cash flows and book values, as appropriate. The estimated fair value is higher by $246 million and lower by $444 million than the carrying amounts (book values) of RJRN Holdings' long-term debt at December 31, 1995 and 1994, respectively, as a result of the level of market interest rates at December 31, 1995 and 1994 compared with the interest rates associated with RJRN Holdings' debt obligations. Considerable judgment was required in interpreting market data to develop the estimates of fair value. In addition, the use of different market assumptions and\/or estimation methodologies may have had a material effect on the estimated fair value amounts. Accordingly, the estimated fair value of RJRN Holdings' consolidated long-term debt as of December 31, 1995 and 1994 is not necessarily indicative of the amounts that RJRN Holdings could realize in a current market exchange.\nThe payment of dividends and the making of distributions by RJRN Holdings to its stockholders are subject to direct and indirect restrictions under certain financing agreements and debt instruments of RJRN Holdings and RJRN and their subsidiaries. The New RJRN Credit Agreements generally restrict cumulative common and preferred dividends and distributions by RJRN Holdings after April 28, 1995 to $1 billion, plus 50% of cumulative consolidated net income, as defined in the New RJRN Credit Agreements, after January 1, 1995, plus the aggregate cash proceeds of up to $250 million in any twelve month period from issuances of equity securities. The New RJRN Credit Agreements and certain other financing agreements also limit the ability of RJRN Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock, issue certain equity securities and engage in certain mergers or consolidations.\nAmong other things, the 1995 Nabisco Credit Agreements generally restrict common and preferred dividends and distributions after April 28, 1995 by Nabisco Holdings to its stockholders, including RJRN, to $300 million plus 50% of Nabisco Holdings' cumulative consolidated net income, as defined in the 1995 Nabisco Credit Agreement, after January 1, 1995. In general, loans and advances by Nabisco Holdings and its subsidiaries to RJRN are effectively subject to a $100 million limit and may only be extended to RJRN's foreign subsidiaries. The 1995 Nabisco Credit Agreements also limit the ability of Nabisco Holdings and its subsidiaries to incur indebtedness, engage in transactions with stockholders and affiliates, create liens, sell or dispose of certain assets and certain subsidiaries' stock and engage in certain mergers or consolidations. These restrictions have not had and are not expected to have a material effect on the ability of Nabisco Holdings to pay its anticipated dividends, or on the ability of RJRN to meet its obligations.\nIn November 1994, the Board of Directors of RJRN Holdings adopted a policy stating that RJRN Holdings will limit, until December 31, 1998, the aggregate amount of cash dividends on its capital stock. Under this policy, during that period RJRN Holdings will not pay any extraordinary cash dividends and will limit the aggregate amount of its cash dividends, cash distributions and repurchases for cash of capital stock and subordinated debt to an amount equal to the sum of $500 million plus (i) 65% of RJRN Holdings' cumulative consolidated net income before extraordinary gains or losses and restructuring charges subsequent to December 31, 1994 and (ii) net cash proceeds of up to $250 million in any year from the sale of capital stock of RJRN Holdings or its subsidiaries (other than\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--LONG-TERM DEBT AND INTEREST AND DEBT EXPENSE--(CONTINUED)\nproceeds from the Nabisco Holdings initial public offering) to the extent used to repay, purchase or redeem debt or preferred stock.\nAlso in November 1994, the Board of Directors of RJRN Holdings adopted a policy providing that RJRN Holdings will not declare a dividend or distribution to its stockholders of the shares of capital stock of a subsidiary before December 31, 1996. RJRN Holdings has also adopted a policy setting forth its intention not to make such a distribution prior to December 31, 1998 if that distribution would cause the ratings of the senior indebtedness of RJRN to be reduced from investment grade to non-investment grade or if, after giving effect to such distribution, any publicly-held senior indebtedness of the distributed company would not be rated investment grade. The Board of Directors of RJRN Holdings is committed to effecting a spin-off of Nabisco Holdings at the appropriate time. There is no assurance that any such distribution will take place. Additional policies provide that an amount equal to the net cash proceeds from any issuance and sale of equity by RJRN Holdings or from any sale outside the ordinary course of business of material assets owned or used by subsidiaries in the tobacco business, in each case before December 31, 1998, will be used either to repay, purchase or redeem consolidated indebtedness or to acquire properties, assets or businesses to be used in existing or new lines of business and that an amount equal to the net cash proceeds of any secondary sale of shares of Nabisco Holdings before December 31, 1998 will be used to repay, purchase or redeem consolidated debt. No assurance can be given that RJRN Holdings will issue or sell any equity or sell any material assets outside the ordinary course of business.\nNOTE 12--COMMITMENTS AND CONTINGENCIES\nTOBACCO-RELATED LITIGATION\nVarious legal actions, proceedings and claims are pending or may be instituted against R.J. Reynolds Tobacco Company (\"RJRT\") or its affiliates or indemnitees, including those claiming that lung cancer and other diseases have resulted from the use of or exposure to RJRT's tobacco products. During 1995, 101 new actions were filed or served against RJRT and\/or its affiliates or indemnitees and 22 such actions were dismissed or otherwise resolved in favor of RJRT and\/or its affiliates or indemnitees without trial. A total of 132 such actions in the United States and two against RJRT's Canadian subsidiary were pending on December 31, 1995. As of February 16, 1996, 144 active cases were pending against RJRT and\/or its affiliates or indemnitees, 142 in the United States and two in Canada. The United States cases are in 22 states and are distributed as follows: 90 in Florida; 10 in Louisiana; 5 in Texas; 4 in each of Indiana, Kansas and Tennessee; 3 in each of Mississippi, California and Pennsylvania; 2 in each of Alabama, Colorado, Massachusetts and Minnesota; and one in each of Missouri, Nevada, New Hampshire, New Jersey, New York, North Carolina, Rhode Island, South Carolina and West Virginia. Of the 142 active cases in the United States, 116 are pending in state court and 26 in federal court.\nFive of the 142 active cases in the United States involve alleged non-smokers claiming injuries resulting from exposure to environmental tobacco smoke. Six cases, which are described more specifically below, purport to be class actions on behalf of thousands of individuals. Purported classes include individuals claiming to be addicted to cigarettes and flight attendants alleging personal injury from exposure to environmental tobacco smoke in their workplace. Four of the active cases were brought by state attorneys general seeking, inter alia, recovery of the cost of Medicare funds paid by their states for\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\ntreatment of citizens allegedly suffering from tobacco related diseases or conditions. In addition, one case was brought by the State of Florida seeking similar rulings under a special state statute.\nThe plaintiffs in these actions seek recovery on a variety of legal theories, including strict liability in tort, design defect, negligence, breach of warranty, failure to warn, fraud, misrepresentation, unfair trade practices, conspiracy, unjust enrichment, indemnity and common law public nuisance. Punitive damages, often in amounts ranging into the hundreds of millions of dollars, are specifically pleaded in 20 cases in addition to compensatory and other damages. The defenses raised by RJRT and\/or its affiliates, where applicable, include preemption by the Cigarette Act of some or all such claims arising after 1969; the lack of any defect in the product; assumption of the risk; comparative fault; lack of proximate cause; and statutes of limitations or repose. Juries have found for plaintiffs in two smoking and health cases in which RJRT was not a defendant, but in one such case, which has been appealed by both parties, no damages were awarded. The jury awarded plaintiffs $400,000 in the other such case, Cipollone v. Liggett Group, Inc., which award was overturned on appeal and the case was subsequently dismissed.\nOn June 24, 1992, the United States Supreme Court in Cipollone held that claims that tobacco companies failed to adequately warn of the risks of smoking after 1969 and claims that their advertising and promotional practices undermined the effect of warnings after that date were preempted by the Cigarette Act. The Supreme Court also held that claims of breach of express warranty, fraud, misrepresentation and conspiracy were not preempted. The Supreme Court's decision was announced through a plurality opinion, and further definition of how Cipollone will apply to other cases must await rulings in those cases.\nCertain legislation proposed in recent years in Congress, among other things, would eliminate any such preemptive effect on common law damage actions for personal injuries. RJRT is unable to predict whether such legislation will be enacted and, if so, in what form, or whether such legislation would be intended by Congress to apply retroactively. The passage of such legislation could increase the number of cases filed against cigarette manufacturers, including RJRT.\nSet forth below are descriptions of the class action lawsuits, a suit in which plaintiffs seek to act as private attorneys general, actions brought by state attorneys general in Massachusetts, Minnesota, Mississippi and West Virginia, an action brought by the State of Florida and pending investigations relating to RJRT's tobacco business.\nIn 1991, Broin v. Philip Morris Company, a purported class action against certain tobacco industry defendants, including RJRT, was brought by flight attendants claiming to represent a class of 60,000 individuals, alleging personal injury caused by exposure to environmental tobacco smoke in their workplace. In December 1994, the Florida state court certified a class consisting of \"all non-smoking flight attendants who are or have been employed by airlines based in the United States and are suffering from diseases and disorders caused by their exposure to secondhand cigarette smoke in airline cabins.\" The defendants appeal of this certification to the Florida Third District Court of Appeal was denied on January 3, 1995. A motion for rehearing has been filed.\nIn March 1994, Castano v. The American Tobacco Company, a purported class action, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT, seeking certification of a class action on behalf of all United States\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nresidents who allegedly are or claim to be addicted, or are the legal survivors of persons who allegedly were addicted, to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in their tobacco products to induce addiction in smokers. Plaintiffs' motion for certification of the class was granted in part on February 17, 1995. The district court certified core liability issues (fraud, negligence, breach of warranty, both express and implied, intentional tort, strict liability and consumer protection statutes), and punitive damages. Not certified were issues of injury-in-fact, proximate cause, reliance, affirmative defenses, and compensatory damages. In July 1995, the Fifth Circuit Court of Appeals agreed to hear defendants, appeal of this class certification. A decision is expected in 1996.\nIn March 1994, Lacey v. Lorillard Tobacco Company, a purported class action, was filed in Circuit Court, Fayette County, Alabama against three cigarette manufacturers, including RJRT. Plaintiff, who claims to represent all smokers who have smoked or are smoking cigarettes manufactured and sold by defendants in the state of Alabama, seeks compensatory and punitive damages not to exceed $48,500 per class member and injunctive relief arising from defendants' alleged failure to disclose additives used in their cigarettes. In April 1994, defendants removed the case to the United States District Court for the Northern District of Alabama.\nIn May 1994, Engle v. R.J. Reynolds Tobacco Company, was filed in Circuit Court, Eleventh Judicial District, Dade County, Florida against tobacco manufacturers, including RJRT, and other members of the industry, by plaintiffs who allege injury and purport to represent a class of all United States citizens and residents who claim to be addicted, or who claim to be legal survivors of persons who allegedly were addicted, to tobacco products. On October 28, 1994, a state court judge in Miami granted plaintiffs' motion to certify the class. The defendants appealed that ruling to the Florida Third District Court of Appeal which, on January 31, 1996, decided to certify a class limited to Florida citizens or residents. The defendants are considering seeking a rehearing.\nIn September 1994, Granier v. American Tobacco Company, a purported class action apparently patterned after the Castano case, was filed in the United States District Court for the Eastern District of Louisiana against tobacco industry defendants, including RJRT. Plaintiffs seek certification of a class action on behalf of all residents of the United States who have used and purportedly became addicted to tobacco products manufactured by defendants. The complaint alleges that cigarette manufacturers manipulated the levels of nicotine in tobacco products for the purpose of addicting consumers. By agreement of the parties, all action in this case is stayed pending determination of the motion for class certification in the Castano case.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nIn January 1995, a purported class action was filed in the Ontario Canada Court of Justice against RJR-MacDonald, Inc. and two other Canadian cigarette manufacturers. The lawsuit, then captioned Le Tourneau v. Imperial Tobacco Company seeks certification of a class of persons who have allegedly become addicted to the nicotine in cigarettes or who had such alleged addiction heightened or maintained through the use of cigarettes, and who have allegedly suffered loss, injury, and damage in consequence, together with persons with Family Law Act claims in respect to the claims of such allegedly addicted persons, and the estates of such allegedly addicted persons. Theories of recovery pleaded include negligence, strict liability, failure to warn, deceit, negligent misrepresentation, implied warranty and conspiracy. The relief sought consists of damages of one million dollars for each of the three named plaintiffs, punitive damages, funding of nicotine addiction rehabilitation centers, interest and costs. On June 2, 1995, the plaintiffs, on consent, were granted leave to file an amended statement of claim to remove Le Tourneau as representative plaintiff and add two additional representative plaintiffs. The case is now captioned Caputo v. Imperial Tobacco Limited.\nIn June 1994, in Mangini v. R.J. Reynolds Tobacco Company, the California Supreme Court ruled that the plantiffs' claim that an RJRT advertising campaign constitutes unfair competition under the California Business and Professions Code was not preempted by the Cigarette Act. The plantiffs are acting as private attorneys general. This opinion allows the plaintiffs to pursue their lawsuit which had been dismissed at the trial court level. The defendants' Petition for Certiorari to the United States Supreme Court was denied in December 1994. The case has been remanded to the trial court.\nIn June 1994, in Moore v. The American Tobacco Company, RJRN and RJRT were named along with other industry members as defendants in an action brought by the Mississippi state attorney general on behalf of the state to recover state funds paid for health care and medical and other assistance to state citizens allegedly suffering from diseases and conditions allegedly related to tobacco use. This suit, which was brought in Chancery (non-jury) Court, Jackson County, Mississippi also seeks an injunction from \"promoting\" or \"aiding and abetting\" the sale of cigarettes to minors. Both actual and punitive damages are sought in unspecified amounts. Motions by the defendants to dismiss the case or to transfer it to circuit (jury) court were denied on February 21, 1995 and the case will proceed in Chancery Court. RJRN and other industry holding companies have been dismissed from the case.\nIn August 1994, RJRT and other U.S. cigarette manufacturers were named as defendants in an action instituted on behalf of the state of Minnesota and of Blue Cross and Blue Shield of Minnesota to recover the costs of medical expenses paid by the state and by Blue Cross\/Blue Shield that were incurred in the treatment of diseases allegedly caused by cigarette smoking. The suit, Minnesota v. Philip Morris, alleges consumer fraud, unlawful and deceptive trade practices, false advertising and restraint of trade, and it seeks injunctive relief and money damages, trebled for violations of the state antitrust law. Motions by the defendants to dismiss all claims of Blue Cross\/Blue Shield and certain substantive claims of the State of Minnesota, and by plaintiffs to strike certain of the defendants' defenses, were denied on May 19, 1995. An intermediate appeals court declined to hear the defendants' appeal from the ruling denying the motion to dismiss all claims of Blue Cross\/Blue Shield on the ground that it lacks standing to bring the action, but the Minnesota Supreme Court has agreed to do so. Oral argument was heard January 29, 1996 and a decision is pending.\nIn September 1994, the Attorney General of West Virginia filed suit against RJRT, RJRN and twenty-one additional defendants in state court in West Virginia. The lawsuit, McGraw v. American\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nTobacco Company, is similar to those previously filed in Mississippi and Minnesota. It seeks recovery for medical expenses incurred by the state in the treatment of diseases statistically associated with cigarette smoking and requests an injunction against the promotion and sale of cigarettes and tobacco products to minors. The lawsuit also seeks a declaration that the state of West Virginia, as plaintiff, is not subject to the defenses of statute of repose, statute of limitations, contributory negligence, comparative negligence, or assumption of the risk. On May 3, 1995, the judge granted defendants' motion to dismiss eight of the ten causes of action pleaded. The defendants have filed motions to dismiss the remaining two counts. On October 20, 1995, at a hearing on the defendants' joint motion to prohibit prosecution of the action due to plaintiff's unlawful retention of counsel under a contingent fee arrangement, in a ruling from the bench, the contingent fee agreement between the West Virginia Attorney General and private attorneys preparing the case was held to be void on the grounds that the Attorney General has no constitutional, legislative, or statutory authority for entering into such an agreement.\nOn February 21, 1995, the state of Florida filed a suit against RJRT and RJRN, along with other industry members, their holding companies and other entities. The state is seeking Medicaid reimbursement under various theories of liability and injunctive relief to prevent the defendants from engaging in consumer fraud and to require that defendants: disclose and publish all research conducted directly or indirectly by the industry; fund a corrective public education campaign on the issues of smoking and health in Florida; prevent the distribution and sale of cigarettes to minors under the age of eighteen; fund clinical smoking cessation programs in the state of Florida; dissolve the Council for Tobacco Research and the Tobacco Institute or divest ownership, sponsorship, or membership in both; and disgorge all profits from sales of cigarettes in Florida. On defendants' motion, the case was stayed until July 7, 1995 and that stay has been extended pending appeals by the plaintiffs and the defendants in connection with the constitutional challenge to the Florida statute discussed below.\nThe suit by the state of Florida was brought under a statute which was amended effective July 1994 to allow the state to bring an action in its own name against the tobacco industry to recover amounts paid by the state under its Medicaid program to treat illnesses statistically associated with cigarette smoking. The amended statute does not require the state to identify the individual who received medical care, permits a lawsuit to be filed as a class action and eliminates the comparative negligence and assumption of risk defenses. The Florida statute was challenged on state and federal constitutional grounds in a lawsuit brought by Philip Morris Companies Inc., Associated Industries of Florida, Publix Supermarkets and National Association of Convenience Stores in June 1994. On June 26, 1995 the trial court judge granted in part the plaintiffs' motion for summary judgment finding portions of the statute unconstitutional. Both plaintiffs and defendants appealed this decision which the Florida Supreme Court accepted for a direct appeal. Oral argument was heard on November 6, 1995.\nThe Florida House and Senate passed a bill that would repeal the Florida statute retroactively which, on June 15, 1995, was vetoed by the Governor. The Florida House and Senate have indicated that they are considering action to override that veto. Similar legislation, without Florida's elimination of defenses, has been introduced in the Massachusetts and New Jersey legislatures. RJRT is unable to predict whether legislation will be enacted in these states, whether other states will introduce and enact similar legislation, whether lawsuits will be filed under statutes, if enacted, or the outcome of any such lawsuits, if filed.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nOn November 28, 1995, RJRT and other domestic cigarette manufacturers filed petitions for declaratory judgment in Massachusetts (Federal Court) and Texas (State Court, Austin Texas) as to potential Medicaid reimbursement suits that had been threatened by the Attorneys General of those states. On January 22, 1996, a similar petition for declaratory judgement was filed in Maryland (State Court).\nOn December 19, 1995, the Commonwealth of Massachusetts filed suit against cigarette manufacturers including RJRT and additional defendants including trade associations and wholesalers, seeking reimbursement of Medicaid and other costs incurred by the state in providing health care to citizens allegedly suffering from diseases or conditions purportedly caused by cigarette smoking. The complaint also seeks orders requiring the manufacturing defendants to disclose and disseminate prior research; fund a corrective campaign and smoking cessation program; disclose nicotine yields of their products; and pay restitution.\nRJRT understands that a grand jury investigation being conducted in the Eastern District of New York is examining possible violations of criminal law in connection with activities relating to the Council for Tobacco Research--USA, Inc., of which RJRT is a sponsor. RJRT is unable to predict the outcome of this investigation.\nRJRT received a civil investigative demand dated January 11, 1994 from the U.S. Department of Justice requesting broad documentary information from RJRT. Although the request appears to focus on tobacco industry activities in connection with product development efforts, it also requests general information concerning contacts with competitors. RJRT is unable to predict the outcome of this investigation.\n-------------------\nLitigation is subject to many uncertainties, and it is possible that some of the tobacco-related legal actions, proceedings or claims could be decided against RJRT or its affiliates or indemnitees. Determinations of liability or adverse rulings against other cigarette manufacturers that are defendants in similar actions, even if such rulings are not final, could adversely affect the litigation against RJRT or its affiliates or indemnitees and increase the number of such claims. Although it is impossible to predict the outcome of such events or their effect on RJRT, a significant increase in litigation activities could have an adverse effect on RJRT. RJRT believes that it has a number of valid defenses to any such actions, including but not limited to those defenses based on preemption under the Cipollone decision, and RJRT intends to defend vigorously all such actions.\nRJRN Holdings and RJRN believe that the ultimate outcome of all pending litigation matters should not have a material adverse effect on the financial position of either RJRN Holdings or RJRN; however, it is possible that the results of operations or cash flows of RJRN Holdings or RJRN in particular quarterly or annual periods or the financial condition of RJRN Holdings and RJRN could be materially affected by the ultimate outcome of certain pending litigation matters. Management is unable to derive a meaningful estimate of the amount or range of any possible loss in any particular quarterly or annual period or in the aggregate.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nCOMMITMENTS\nAt December 31, 1995, other commitments totalled approximately $777 million, principally for minimum operating lease commitments, the purchase of leaf tobacco inventories, the purchase of machinery and equipment and other contractual arrangements.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND SIGNIFICANT CONCENTRATIONS OF CREDIT RISK\nCertain financial instruments with off-balance sheet risk have been entered into by RJRN and Nabisco to manage their interest rate and foreign currency exposures.\nRJRN and Nabisco have each adopted policies to utilize interest rate instruments that will adjust the mix of floating rate debt and fixed rate debt on a one for one basis.\nInterest Rate Arrangements\nDuring 1995, Nabisco began managing its own interest rate exposure by adjusting its mix of floating rate debt and fixed rate debt. As part of managing its interest rate exposure, Nabisco entered into interest rate swaps and caps during 1995 to effectively fix a portion of its interest rate exposure on its floating rate debt. The impact of these arrangements was not significant. At December 31, 1995, Nabisco had outstanding fixed interest rate swaps with an aggregate notional principal amount of $1.0 billion and expiration dates within six months. Also at December 31, 1995, Nabisco had outstanding interest rate caps with an aggregate notional principal amount of $1.0 billion, all with future effective dates commencing within six months and with expiration dates one year thereafter.\nRJRN also manages its interest rate exposure by adjusting its mix of floating rate debt and fixed rate debt. During 1994, RJRN cancelled all of its financial interest rate arrangments with optionality. Such cancelled instruments increased 1994 interest expense by $45 million. Also during 1994, as part of its current strategy to manage interest rate exposure, RJRN effectively neutralized the effects of any future changes in market interest rates on the remainder of its outstanding interest rate swaps, options, caps and other financial instruments through the purchase of offsetting positions. Net unrealized gains and losses on the remaining interest rate instruments at the time such instruments were neutralized are currently being amortized to interest expense through 1997. As a result of the 1994 activity, the net notional principal amount of outstanding interest rate instruments has been $0. The impact to interest expense from the utilization of interest rate instruments by RJRN has resulted in additional interest expense during 1995 and 1994 of approximately $39 million and $22 million (which included the $45 million stated above), respectively, and lower interest expense during 1993 of approximately $70 million. In addition, additional interest expense will be recorded during 1996 and 1997 of approximately $28 million and $5 million, respectively, in connection with the 1994 activity. At December 31, 1995, RJRN had outstanding interest rate swaps, options, caps and other interest rate arrangements with\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nfinancial institutions having a total gross notional principal amount of $2.8 billion and a net notional amount of $0. These arrangements entered into by RJRN mature as follows:\nForeign Currency Arrangements\nRJRN Holdings' subsidiaries have operations in many countries, utilizing many different functional currencies in its foreign subsidiaries and branches. Significant foreign currency net investments are located in Germany, Canada, Hong Kong, Brazil, Argentina and Spain. Changes in the strength of these countries' currencies relative to the U.S. dollar result in direct charges or credits to equity for non-hyperinflationary countries and direct charges or credits to the income statement for hyperinflationary countries. Translation gains or losses resulting from foreign-denominated borrowings that are accounted for as hedges of certain foreign currency net investments, also result in charges or credits to equity. RJRN Holdings' subsidiaries also have significant exposure to foreign exchange sale and purchase transactions in currencies other than its functional currency. The exposures include the U.S. dollar, German mark, Japanese yen, Swiss franc, Hong Kong dollar, Singapore dollar, Spanish peseta and cross-rate exposure among the French franc, British pound, Italian lira and the German mark. These exposures are managed to minimize the effects of foreign currency transactions on its cash flows.\nAt December 31, 1995 and 1994, RJRN had outstanding forward foreign exchange contracts with banks to purchase or sell an aggregate notional principal amount of $959 million and $713 million, respectively. The weighted average maturity of the arrangements outstanding at December 31, 1995 approximated four months. Such contracts were primarily entered into to hedge future commitments. The purpose of RJRN's foreign currency hedging activities is to protect RJRN from risk that the eventual dollar cash flows resulting from transactions with international parties will be adversely affected by changes in exchange rates.\nAt December 31, 1995 and 1994, Nabisco had outstanding forward foreign exchange contracts with banks to purchase or sell an aggregate notional principal amount of $142 million and $94 million, respectively. Such contracts were primarily entered into to hedge future commitments. The purpose of Nabisco's foreign currency hedging activities is to protect Nabisco from risk that the eventual dollar cash flows resulting from transactions with international parties will be adversely affected by changes in exchange rates.\nThe above interest rate and foreign currency arrangements entered into by RJRN and Nabisco involve, to varying degrees, elements of market risk as a result of potential changes in future interest and foreign currency exchange rates. To the extent that the financial instruments entered into remain outstanding as effective hedges of existing interest rate and foreign currency exposure, the impact of\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nsuch potential changes in future interest and foreign currency exchange rates on the financial instruments entered into would offset the related impact on the items being hedged. Also, RJRN and Nabisco may be exposed to credit losses in the event of non-performance by the counterparties to these financial instruments. However, RJRN and Nabisco continually monitor their positions and the credit ratings of their counterparties and therefore, do not anticipate any non-performance.\nThere are no significant concentrations of credit risk with any individual counterparties or groups of counterparties as a result of any financial instruments entered into including those financial instruments discussed above.\nSUMMARY FINANCIAL INSTRUMENTS FAIR VALUE INFORMATION\nAt December 31, 1995 and 1994, the carrying amounts and estimated fair values of financial instruments entered into by RJRN and Nabisco were as follows:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL\nThe changes in Common Stock and paid-in capital are shown as follows:\nAt December 31, 1995, RJRN Holdings' outstanding classes of capital stock consisted of the following: the Common Stock, the Series B Preferred Stock, the Series C Preferred Stock and the ESOP Convertible Preferred Stock, stated value of $16.00 per share and par value of $.01 per share (the \"ESOP Preferred Stock\"). In addition, RJRN Holdings had its Cumulative Convertible Preferred Stock, stated value of $25 per share and par value of $.01 per share (the \"Cumulative Convertible Preferred Stock\"), outstanding until the fourth quarter of 1993 and its Series A Conversion Preferred Stock, par value $.01 per share (the \"Series A Preferred Stock\"), outstanding until the fourth quarter of 1994. All of the classes of preferred stock of RJRN Holdings rank senior to the Common Stock as to dividends and preferences in liquidation. RJRN Holdings' charter authorized 150,000,000 preferred shares at December 31, 1995 and 1994.\nOn November 1, 1990, RJRN Holdings issued and\/or registered 72,032,000 shares of the Cumulative Convertible Preferred Stock. The Cumulative Convertible Preferred Stock paid cash dividends at a rate of 11.5% of stated value per annum, payable quarterly in arrears commencing January 15, 1991. The Cumulative Convertible Preferred Stock was convertible after May 1, 1991 into shares of Common Stock at a conversion price of $45 of stated value per share of Common Stock. Holders of the Cumulative Convertible Preferred Stock converted 379 shares of the stock into 210 shares of Common Stock during 1992 and another 123,523 shares into 68,595 shares of Common Stock during 1993. On December 6, 1993, the outstanding Cumulative Convertible Preferred Stock was redeemed at a redemption price of $27.0125 per share plus accrued and unpaid dividends.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nOn April 10, 1991, the ESOP borrowed $250 million from RJRN Holdings (the \"ESOP Loan\") to purchase 15,625,000 shares of ESOP Preferred Stock. The ESOP Loan, which was renegotiated in 1993, has a final maturity in 2006 and bears interest at the rate of 8.2% of its stated value per annum. At December 31, 1995, the ESOP Preferred Stock is convertible into 2,998,135 shares of Common Stock, subject to adjustment in certain events, and bears cumulative dividends at a rate of 7.8125% of stated value per annum at least until April 10, 1999, payable semi-annually in arrears commencing January 2, 1992, when, as and if declared by the board of directors of RJRN Holdings. The ESOP Preferred Stock is redeemable at the option of RJRN Holdings, in whole or in part, at any time on or after April 10, 1999, at an initial optional redemption price of $16.25 per share. The initial optional redemption price declines thereafter on an annual basis in the amount of $.125 a year to $16 per share on April 10, 2001, plus accrued and unpaid dividends. Holders of ESOP Preferred Stock have voting rights with respect to certain matters submitted to a vote of the holders of the Common Stock. Effective January 1, 1992, RJRN's matching contributions to eligible employees under its Capital Investment Plan are being made in the form of ESOP Preferred Stock. RJRN's matching contribution obligation in respect of each participating employee is equal to $.50 for every pre-tax dollar contributed by the employee, up to 6% of the employee's pay. The shares of ESOP Preferred Stock are allocated at either the floor value of $16 a share or the fair market value of one-fifth of a share of Common Stock, whichever is higher. During 1995, 1994 and 1993, approximately $23 million, $22 million and $29 million, respectively, was contributed to the ESOP by RJRN or RJRN Holdings and approximately $19 million, $19 million and $20 million, respectively, of ESOP dividends were used to service the ESOP's debt to RJRN Holdings.\nOn November 8, 1991, RJRN Holdings issued 52,500,000 shares of Series A Preferred Stock and sold 210,000,000 Series A Depositary Shares, each of which represented one-quarter of a share of Series A Preferred Stock. Each share of Series A Preferred Stock paid cash dividends at a rate of $3.34 per annum, payable quarterly in arrears commencing February 18, 1992. On November 15, 1994, the 210,000,000 Series A Depository Shares converted automatically into 42,000,000 shares of Common Stock.\nOn August 18, 1993, RJRN Holdings issued 50,000 shares of Series B Preferred Stock, and sold 50,000,000 Series B Depositary Shares at $25 per Series B Depositary Share ($1.25 billion) in connection with such issuance (the \"Series B Preferred Stock Offering\"). Each share of Series B Preferred Stock bears cumulative cash dividends at a rate of $2,312.50 per annum, or $2.3125 per Series B Depositary Share, and is payable quarterly in arrears commencing December 1, 1993. Each Series B Depositary Share represents .001 ownership interest in a share of Series B Preferred Stock of RJRN Holdings. At RJRN Holdings' option, on or after August 19, 1998, RJRN Holdings may redeem shares of the Series B Preferred Stock (and the Depositary will redeem the number of Series B Depositary Shares representing the shares of Series B Preferred Stock) at a redemption price equivalent to $25 per Series B Depositary Share plus accrued and unpaid dividends thereon. RJRN Holdings' ability to redeem the Series B Preferred Stock is subject to certain restrictions in its credit agreements. On September 21, 1995, RJRN Holdings retired approximately 76% of the outstanding Series B Preferred Stock in connection with the exchange of approximately $949 million amount of Trust Preferred Securities for 37,956,060 of the 50,000,000 Series B Depositary Shares. (See Note 11 to the Consolidated Financial Statements.)\nOn May 6, 1994, RJRN Holdings completed the issuance of 26,675,000 shares of Series C Preferred Stock in connection with the sale of 266,750,000 Series C Depositary Shares at $6.50 per\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\ndepositary share. Approximately $900 million of the net proceeds from the sale of the Series C Depositary Shares was applied to the redemption of RJRN's subordinated debentures on May 15, 1994. The remaining proceeds from the sale of the Series C Depositary Shares were used to repay indebtedness under the 1991 RJRN Credit Agreement and for short-term liquid investments until they were applied to redeem certain of RJRN's sinking fund debentures. Each share of Series C Preferred Stock bears cumulative cash dividends at a rate of $6.012 per annum, or $.6012 per Series C Depositary Share, payable quarterly in arrears. Each Series C Depositary Share represents a one-tenth ownership interest in a share of Series C Preferred Stock of RJRN Holdings. Each share of Series C Preferred Stock will mandatorily convert into two shares of Common Stock on May 15, 1997, subject to adjustment in certain events, plus accrued and unpaid dividends thereon. In addition, at RJRN Holdings' option, RJRN Holdings may redeem shares of the Series C Preferred Stock (and the Depositary will redeem the number of Series C Depositary Shares representing such shares of Series C Preferred Stock) at a redemption price to be paid in shares of Common Stock (or, following certain circumstances, other consideration), plus accrued and unpaid dividends. The optional redemption price declines from $112.286 per share by $.01656 per share on each day following May 6, 1994 to $95.246 per share on March 15, 1997 and is $94.25 thereafter.\nThe completion on January 26, 1995 of the Nabisco Holdings' initial public offering of 51,750,000 shares of its Class A Common Stock and the corresponding reduction in RJRN's proportionate economic interest in Nabisco Holdings from 100% to approximately 80.5% resulted in an adjustment of approximately $401 million to the carrying amount of RJRN's investment in Nabisco Holdings. Such adjustment was reflected as additional paid-in capital by RJRN Holdings and RJRN.\nOn April 1, July 1 and October 1, 1995 and January 1, 1996, RJRN Holdings paid a quarterly dividend on the Common Stock of $.375 per share. RJRN Holdings expects to continue to pay at least a quarterly cash dividend on the Common Stock equal to $.375 per share or $1.50 per share on an annualized basis.\nOn April 12, 1995, the stockholders of RJRN Holdings approved a one-for-five reverse stock split and the corresponding reduction in the number of authorized shares of Common Stock from 2,200,000,000 to 440,000,000. Accordingly, the rates at which shares of ESOP Preferred Stock and Series C Preferred Stock convert into shares of Common Stock were proportionately adjusted.\nOn July 1 and October 1, 1995 and January 1, 1996, Nabisco Holdings paid a quarterly dividend on its common stock of $.1375 per share. Nabisco Holdings expects to continue to pay a quarterly cash dividend on its common stock equal to at least $.1375 per share or $.55 per share on an annualized basis (approximately $146 million). RJRN would receive approximately $117 million of the annualized Nabisco Holdings dividend.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nThe changes in stock options are shown as follows:\nAt December 31, 1995, options were exercisable as to 3,437,549 shares, compared with 8,794,841 shares at December 31, 1994, and 4,003,608 shares at December 31, 1993. As of December 31, 1995, options for 7,374,069 shares of Common Stock were available for future grant.\nTo provide an incentive to attract and retain key employees responsible for the management and administration of the business affairs of RJRN Holdings and its subsidiaries, on June 15, 1989 the board of directors of RJRN Holdings adopted the Stock Option Plan for Directors and Key Employees of RJR Nabisco Holdings Corp. and Subsidiaries (the \"Stock Option Plan\") pursuant to which options to purchase Common Stock may be granted. On June 16, 1989, the Stock Option Plan was approved by the written consent of the holders of a majority of the Common Stock. Non-employee directors or key employees of RJRN Holdings or any subsidiary of RJRN Holdings are eligible to be granted options under the Stock Option Plan. A maximum of 6,000,000 shares of Common Stock (which may be adjusted in the event of certain capital changes) may be issued under the Stock Option Plan. The options to key employees granted under the Stock Option Plan generally vest over a three year period and the exercise price of such options is generally the fair market value of the Common Stock on the date of grant. On March 1, 1994, the Stock Option Plan was amended to satisfy the requirements of a nondiscretionary formula plan for stock option grants to directors. Each eligible director is, upon becoming a director, granted an option under the Stock Option Plan to purchase 6,000 shares of Common Stock. The options have an exercise price equal to the fair market value of the Common Stock on the date of grant. They cannot be exercised for six months following the date of grant but, thereafter, are exercisable for ten years from the date of grant. In addition, each eligible director receives an annual grant of stock options which is made on the date of the director's election or re-election to the Board of Directors. The annual grant is intended to deliver a predetermined value, and the number of shares of Common Stock subject to the option is determined based on an internal valuation methodology. In 1995 and 1994, each eligible director received a stock option to purchase 1,400 shares and 1,180 shares, respectively, of Common Stock. The annually granted stock options have a ten year term and vest over three years (33% on the first and second anniversaries of the date of grant and 34% on the third anniversary).\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\nOn August 1, 1990, the board of directors of RJRN Holdings adopted the 1990 Long Term Incentive Plan (the \"1990 LTIP\") which was approved on such date by the written consent of the holders of a majority of the Common Stock. The 1990 LTIP authorizes grants of incentive awards (\"Grants\") in the form of \"incentive stock options\" under Section 422 of the Internal Revenue Code, other stock options, stock appreciation rights, restricted stock, purchase stock, dividend equivalent rights, performance units, performance shares or other stock-based grants. Awards under the 1990 LTIP may be granted to key employees of, or other persons having a unique relationship to, RJRN Holdings and its subsidiaries. Directors who are not also employees of RJRN Holdings and its subsidiaries are ineligible for Grants. A maximum of 21,000,000 shares of Common Stock (which may be adjusted in the event of certain capital changes) may be issued under the 1990 LTIP pursuant to Grants. The 1990 LTIP also limits the amount of shares which may be issued pursuant to \"incentive stock options\" and the amount of shares subject to Grants which may be issued to any one participant. As of December 31, 1995, purchase stock, stock options other than incentive stock options, restricted stock, performance shares, performance units and other stock-based grants have been granted under the 1990 LTIP. The options granted before July 1, 1993 under the 1990 LTIP generally will vest over a three year period ending each December 31. Options granted on and after July 1, 1993, vest over a three year period beginning from the date of grant. The exercise prices of outstanding LTIP options are between $22.60 and $57.80 per share. On April 27, 1995, employees of RJRN, RJRT and R.J. Reynolds Tobacco International, Inc. (\"Reynolds International\") with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 100% of their outstanding LTIP and Stock Option Plan stock options (less the stock options permitted to be exchanged for Nabisco LTIP options, as described below) in exchange for a new grant of options under the LTIP. Options to purchase 8,389,656 shares of Common Stock were surrendered and 8,389,656 were reissued pursuant to this program. These options have an exercise price of $27.00 and are 100% vested but not exercisable for three years. On April 27, 1995 and on June 13, 1995, certain key employees were granted premium options to purchase shares of Common Stock. These options have an exercise price that is 10% above the fair market value on the date of the grant ($29.70 and $28.88, respectively) and vest over a three year period. In connection with the purchase stock grants awarded during 1995, 1994 and 1993, 16,529 shares, 0 shares and 124,444 shares, respectively, of Common Stock were purchased and options to purchase a specified number of shares were granted upon the optionee purchasing a stated dollar amount of Common Stock. In addition, an arrangement was made in 1995 to enable a purchaser to borrow on a secured basis from RJRN Holdings the price of the stock purchased. The current annual interest rate on the 1995 arrangement, which was set in December 1995 at the then applicable federal rate for long-term loans, is 6.26%. These borrowings plus accrued interest and taxes must generally be repaid within two years following termination of active employment. During 1995 and 1994, 30,000 shares and 884,100 shares, respectively, of Common Stock were awarded in connection with restricted stock grants made. These shares are subject to restrictions that will lapse 3 years from the date of grant (or earlier under certain circumstances). Other stock-based awards were made in 1995 and 1994 under the 1990 LTIP to individuals who previously acquired certain purchase stock under the 1990 LTIP. Under this program, such individuals receive grants of Common Stock or cash at the Company's election on either three or four annual grant dates beginning July 1994 and ending either July 1, 1996 or July 1, 1997. The fair market value of Common Stock to be awarded on each grant date is equal to the excess, if any, of (i) 33% or 25%, respectively, of the maximum amount the individual could have borrowed to acquire purchase stock, over (ii) the then fair market value of the same percentage of such individual's purchase stock. The grant is increased by the amount of presumed borrowing costs and the\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--CAPITAL STOCK AND PAID-IN CAPITAL--(CONTINUED)\namount necessary to hold the individual harmless from income taxes due as a result of the grant. No grant will be made on a grant date if, on such grant date, the amount determined under clause (ii) above equals or exceeds the amount determined in clause (i) above.\nIn connection with the initial public offering of shares of Nabisco Holdings in January 1995, the board of directors of Nabisco Holdings adopted the Nabisco Holdings Corp. 1994 Long Term Incentive Plan (the \"Nabisco LTIP\") which is substantially similar to the LTIP except that stock-based awards are denominated in shares of Class A Common Stock of Nabisco Holdings. On January 19, 1995, January 27, 1995 and March 31, 1995, employees of Nabisco with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 100% of their outstanding LTIP and the Stock Option Plan stock options in exchange for the grant of options under the Nabisco LTIP. Charles M. Harper, as chairman of the board of directors of Nabisco Holdings, was permitted to surrender 50% of his outstanding LTIP options on January 19, 1995 in exchange for Nabisco LTIP options. Options to purchase a total of 5,119,884 shares of Common Stock were surrendered pursuant to this program. Also on March 31, 1995 and for one employee on June 16, 1995, employees of RJRN with outstanding stock options under the LTIP and the Stock Option Plan were permitted to elect to surrender 20% of their outstanding LTIP and Stock Option Plan stock options in exchange for the grant of options under the Nabisco LTIP. Options to purchase a total of 103,319 shares of Common Stock were surrendered pursuant to this program. Also on January 19, 1995, RJRN Holdings purchased one-half of Mr. Harper's restricted LTIP purchase shares (62,222 shares) at the then fair market value ($28.125 per share), and he used the proceeds to acquire similarly restricted shares of Class A Common Stock of Nabisco Holdings.\nNOTE 14--RETAINED EARNINGS AND CUMULATIVE TRANSLATION ADJUSTMENTS\nRetained earnings (accumulated deficit) at December 31, 1995, 1994 and 1993 includes non-cash expenses related to accumulated trademark and goodwill amortization of $4.280 billion, $3.644 billion and $3.015 billion, respectively.\nThe changes in cumulative translation adjustments are shown as follows:\nNOTE 15--RETIREMENT BENEFITS\nRJRN and its subsidiaries sponsor a number of non-contributory defined benefit pension plans covering most U.S. and certain foreign employees. Plans covering regular full-time employees in the tobacco operations as well as the majority of salaried employees in the corporate groups and food operations provide pension benefits that are based on credits, determined by age, earned throughout an employee's service and final average compensation before retirement. Plan benefits are offered as lump sum or annuity options. Plans covering hourly as well as certain salaried employees in the corporate groups and food operations\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nprovide pension benefits that are based on the employee's length of service and final average compensation before retirement. RJRN's policy is to fund the cost of current service benefits and past service cost over periods not exceeding 30 years to the extent that such costs are currently tax deductible. Additionally, RJRN and its subsidiaries participate in several (i) multi-employer plans, which provide benefits to certain union employees, and (ii) defined contribution plans, which provide benefits to certain employees in foreign countries. Employees in foreign countries who are not U.S. citizens are covered by various post-employment benefit arrangements, some of which are considered to be defined benefit plans for accounting purposes.\nA summary of the components of pension expense for RJRN-sponsored plans follows:\nThe principal plans used the following actuarial assumptions for accounting purposes:\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nThe following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets at December 31, 1995 and 1994 for RJRN's defined benefit pension plans.\n- ------------\n(1) Of the net pension liability, $(292) million and $2 million were related to qualified plans at December 31, 1995 and 1994, respectively.\nAt December 31, 1995, approximately 97 percent of the plans' assets were invested in listed stocks and bonds and other highly liquid investments. The balance consisted of various income producing investments.\nIn addition to providing pension benefits, RJRN provides certain health care and life insurance benefits for retired employees and their dependents. Substantially all of its regular full-time employees, including certain employees in foreign countries, may become eligible for those benefits if they reach retirement age while working for RJRN. Effective January 1, 1992, RJRN adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS No. 106\"). Under SFAS No. 106, RJRN is required to accrue the costs for retirees' health and other postretirement benefits other than pensions and recognize the unfunded and unrecognized accumulated benefit obligation for these benefits. RJRN had previously accrued a liability for postretirement benefits other than pensions and as a result, SFAS No. 106 did not have a material impact on the financial statements of either RJRN Holdings or RJRN.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--RETIREMENT BENEFITS--(CONTINUED)\nNet postretirement health and life insurance benefit cost consisted of the following:\nRJRN's postretirement health and life insurance benefit plans currently are not funded. The status of the plans was as follows:\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8% in 1995 and 7% in 1996 gradually declining to 5% by the year 2000 and remaining at that level thereafter. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 and the aggregate of the service and interest cost components of the net postretirement benefit cost for the year then ended by approximately $54.5 million and $4.7 million, respectively.\nThe assumed discount rate used in determining the accumulated postretirement benefit obligation was 7% and 8.75% as of December 31, 1995 and 1994, respectively.\nEffective January 1, 1993, RJRN adopted Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (\"SFAS No. 112\"). Under SFAS No. 112, RJRN is required to accrue the costs for preretirement postemployment benefits provided to former or inactive employees and recognize an obligation for these benefits. The adoption of SFAS No. 112 did not have a material impact on the financial statements of either RJRN Holdings or RJRN.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--SEGMENT INFORMATION\nIndustry Segment Data\nRJRN is engaged principally in the manufacture, distribution and sale of tobacco products, cookies, crackers and other food products. Cigarettes are manufactured in the United States by RJRT and in over 40 foreign countries and territories by Reynolds International and subsidiaries or licensees of RJRT and are sold throughout the United States and in more than 170 markets around the world including Western Europe, the Middle East, Africa, Asia and Canada. RJRN, through its 80.5% owned subsidiary Nabisco Holdings, also manufactures and markets cookies, crackers, non-chocolate candy and gum products, nuts and snacks, various margarines and spreads and other specialty products under several brand names in the United States, Canada, Europe, Asia and Latin America. See the Management's Discussion and Analysis of Financial Condition and Results of Operations, appearing elsewhere herein, for further discussion of RJRN's operations. Summarized financial information for these operations is shown in the following tables.\n- ------------\n(1) Includes amortization of trademarks and goodwill for Tobacco and Food for the year ended December 31, 1995, of $409 million and $227 million, respectively; for the year ended December 31, 1994, of $404 million and $225 million, respectively; and for the year ended December 31, 1993, of $407 million and $218 million, respectively.\n(Footnotes continued on following page)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 16--SEGMENT INFORMATION--(CONTINUED)\n(Footnotes continued from preceding page) (2) The 1995 and 1993 amounts include the effects of a restructuring expense at Tobacco (1995-- $154 million; 1993--$544 million), Food (1993--$153 million) and Headquarters (1993--$33) (See Note 2 to the Consolidated Financial Statements).\n(3) Cash and cash equivalents for the domestic tobacco operations are included in Headquarters' assets.\nGeographic Data\nThe following tables show certain financial information relating to RJRN's continuing operations in various geographic areas.\n- ------------\n(1) Transfers between geographic areas (which consist principally of tobacco transferred principally from the United States to Europe) are generally made at fair market value.\n(2) The 1995 and 1993 amounts include the effects of restructuring expenses of $154 million and $730 million, respectively (see Note 2 to the Consolidated Financial Statements).\n(3) Includes amortization of trademarks and goodwill of $636 million, $629 million and $625 million for the 1995, 1994 and 1993 periods, respectively.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.\nThe food segment of RJRN Holdings is conducted through the operating subsidiaries of Nabisco Holdings. Nabisco Holdings' domestic operations consist of Nabisco Biscuit, Specialty Products, LifeSavers, Planters, Food Service and Fleischmann's Companies (the \"Domestic Food Group\"). Nabisco Holdings' operations outside the United States consists of Nabisco International, Inc. and Nabisco Ltd (collectively, the \"International Food Group\").\nConsolidated condensed financial information of Nabisco Holdings at December 31, 1995 and 1994, and for each of the years in the three year period ended December 31, 1995 is as follows:\nNABISCO HOLDINGS CORP. CONSOLIDATED CONDENSED STATEMENTS OF INCOME\n(DOLLARS IN MILLIONS)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.--(CONTINUED) CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW\n(DOLLARS IN MILLIONS)\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--CONDENSED FINANCIAL INFORMATION OF NABISCO HOLDINGS CORP.--(CONTINUED) CONSOLIDATED CONDENSED BALANCE SHEETS\n(DOLLARS IN MILLIONS)\n- --------------\n* The 1994 amounts for current and non-current maturities of long-term debt include intercompany indebtedness with RJRN or one of its subsidiaries of approximately $297 million and $3.8 billion, respectively.\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 18--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a summary of the quarterly results of operations and per share data for RJRN Holdings for the quarterly periods of 1995 and 1994:\n(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\n- ------------\n(1) Earnings per share is computed independently for each of the periods presented; therefore, the sum of the earnings per share amounts for the quarters may not equal the total for the year.\n----------------------------\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-1\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-2\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-3\nSCHEDULE I\nRJR NABISCO HOLDINGS CORP. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION\nNOTE A--SUPPLEMENTAL CASH FLOWS INFORMATION\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE B--JUNIOR SUBORDINATED DEBENTURES\nOn September 21, 1995, RJRN Holdings issued approximately $978 million aggregate principal amount of its Junior Subordinated Debentures to the Trust. The Trust, in turn, exchanged approximately $949 million of its Trust Preferred Securities for 37,956,060 of the 50,000,000 Series B Depositary Shares outstanding, each representing one-tenth of a share of the 50,000 outstanding shares of Series B Preferred Stock. RJRN Holdings retired the exchanged shares, leaving 12,043.94 shares of the Series B Preferred Stock outstanding. See Note 11 to the Consolidated Financial Statements for additional information regarding this transaction.\nThe obligations of RJRN Holdings under the Junior Subordinated Debentures are unsecured obligations and will be subordinate and junior in right of payment to all senior indebtedness of RJRN Holdings, but senior to all future stock issuances and to any future guarantee entered into by RJRN Holdings in respect of its capital stock. As of December 31, 1995, RJRN Holdings had no senior indebtedness other than its guarantee of RJRN's obligations under the New RJRN Credit Agreements. The payment of distributions out of moneys held by the Trust and payments on liquidation of the Trust and the redemption of Trust Preferred Securities are guaranteed by RJRN Holdings on a subordinated basis. RJRN Holdings' guarantee is subordinate and junior in right of payment to any senior indebtedness of RJRN Holdings and to the Junior Subordinated Debentures, and senior to all capital stock now or hereafter issued by RJRN Holdings and to any guarantee now or hereafter entered into by RJRN Holdings in respect of its capital stock.\nInterest on the Junior Subordinated Debentures is payable quarterly in arrears. RJRN Holdings has the right to extend the interest payment period under certain circumstances. RJRN Holdings has the right to redeem the Junior Subordinated Debentures, in whole or in part, on or after August 19, 1998, upon not less than 30 nor more than 60 days notice. Certain covenants of RJRN Holdings applicable to the Junior Subordinated Debentures limit the ability of RJRN Holdings to declare or pay any dividends on, or redeem, purchase, acquire or make a distribution or liquidation payment with respect to any of its common or preferred stock, or make any guarantee payment, if RJRN Holdings is in default of any of its payments or guarantees with respect to the Junior Subordinated Debentures.\nNOTE C--COMMITMENTS AND CONTINGENCIES\nRJRN Holdings has guaranteed the indebtedness of RJRN under the New RJRN Credit Agreements.\nFor disclosure of additional contingent liabilities, see Note 12 to the Consolidated Financial Statements.\nNOTE D--STOCKHOLDERS' EQUITY\nRJRN Holdings' stockholders approved a one-for-five reverse split of the Common Stock on April 12, 1995. For additional information, see Note 13 to the Consolidated Financial Statements.\nS-4\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-5\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-6\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (DOLLARS IN MILLIONS)\nSee Notes to Condensed Financial Information.\nS-7\nSCHEDULE I\nRJR NABISCO, INC. SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION\nNOTE A--SUPPLEMENTAL CASH FLOWS INFORMATION\nFor information regarding certain non-cash financing activities, see Notes 11 and 13 to the Consolidated Financial Statements.\nNOTE B--COMMITMENTS AND CONTINGENCIES\nFor disclosure of contingent liabilities, see Note 12 to the Consolidated Financial Statements.\nS-8\nSCHEDULE II\nRJR NABISCO HOLDINGS CORP. RJR NABISCO, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS)\n- ------------\n(A) Miscellaneous adjustments. (B) Principally charges against the accounts. (C) Excludes valuation allowance accounts for deferred tax assets.\nS-9\nEXHIBIT INDEX\nEXHIBIT NO. - ---------\n- ---------------\n* Filed herewith.","section_15":""}
{"filename":"22698_1995.txt","cik":"22698","year":"1995","section_1":"Item 1. Business\nGENERAL INFORMATION\nBusiness Segments\nCOMSAT Corporation (COMSAT, the corporation or Registrant) reported operating results and financial data for 1995 in four business segments: International Communications, Mobile Communications, Technology Services and Entertainment.\nIn 1995, the International Communications segment consisted of activities undertaken by the corporation in its COMSAT World Systems (CWS) and COMSAT International Ventures (CIV) businesses. CWS provides voice, data, video and audio communications services between the U.S. and other countries using the satellite system of the International Telecommunications Satellite Organization (INTELSAT). CIV develops, acquires and manages telecommunications companies in emerging overseas markets which, in its view, present the potential for high growth. These ventures provide a wide array of private-line and public-switched communications services and equipment installations. The Mobile Communications segment consists of activities undertaken by the corporation in its COMSAT Mobile Communications (CMC) business. CMC provides voice, data, fax, telex and information services for ships, aircraft and land mobile applications throughout the world primarily using the satellite system of the International Mobile Satellite Organization (Inmarsat). The Technology Services segment consists of the financial results of COMSAT RSI, Inc. (CRSI) and COMSAT Laboratories, which include the design and manufacture of voice and data communications networks and products, system integration services, and applied research and technology services for worldwide users. The Entertainment segment consists of the financial results of Ascent Entertainment Group, Inc. (Ascent). Ascent, through its subsidiaries, provides on-demand entertainment programming and information services primarily to the domestic lodging industry, owns a professional basketball team and a professional hockey team, owns a film and television production company, and provides satellite distribution support services to the National Broadcasting Company (NBC).\nThe revenues, operating income (loss) and assets of the corporation, by business segment, for each of the last three years are shown in Note 17 to the financial statements.\nThe corporation had 2,991 employees on December 31, 1995. None of the employees is represented by a labor union, except for approximately 37 employees working for CRSI on a 100- meter radio telescope.\nCommunications Satellite Act of 1962\nCOMSAT was incorporated in 1963 under District of Columbia law, as authorized by the Communications Satellite Act of 1962 (the Satellite Act). Effective June 1, 1993, COMSAT changed its corporate name from \"Communications Satellite Corporation\" to \"COMSAT Corporation.\" COMSAT is not an agency or establishment of the U.S. Government. The U.S.\nGovernment has not invested funds in COMSAT, guaranteed funds invested in COMSAT or guaranteed the payment of dividends by COMSAT.\nAlthough COMSAT is a private corporation, the Satellite Act governs certain aspects of COMSAT's structure, ownership and operations, including the following: three of COMSAT's 15 directors are appointed by the President of the United States with the advice and consent of the United States Senate; COMSAT's issuances of capital stock and borrowings of money must be authorized by the Federal Communications Commission (FCC); there are limitations on the classes of persons that may hold shares of COMSAT's common stock and on the number of shares a person or class of persons may hold; and, on matters that may affect the national interest and foreign policy of the United States, COMSAT's representatives to INTELSAT and Inmarsat receive instructions from the U.S. Government. Congress has reserved the right to amend the Satellite Act, and amendments, if any, could materially affect the corporation.\nGovernment Regulation\nUnder the Satellite Act, the International Maritime Satellite Telecommunications Act of 1978 (the Inmarsat Act) and the Communications Act of 1934, as amended (the Communications Act), COMSAT is subject to regulation by the FCC with respect to its capital and organizational structure, as well as CWS's and CMC's plant, operations, services and rates. FCC decisions and policies have had and will continue to have a significant impact on the corporation. For a discussion of these matters, see Notes 10 and 11 to the financial statements.\nINTERNATIONAL COMMUNICATIONS\nCOMSAT World Systems\nServices. COMSAT World Systems (CWS) provides satellite capacity for telephone, data, video and audio communications services between the United States and the rest of the world using the global network of INTELSAT satellites. CWS's customers include U.S. international communications common carriers, private network providers, multinational corporations, U.S. and international broadcasters, news-gathering organizations, digital audio companies and the U.S. government.\nThe largest portion of CWS's revenues comes from leasing full-time voice grade half- circuits (two-way communications links between an earth station and an INTELSAT satellite) to U.S. international communications common carriers. The three largest carrier customers are AT&T Corp. (AT&T), MCI International Inc. (MCI) and Sprint Communications Company (Sprint). CWS offers significant discounts to customers entering into long-term commitments for full-time voice-grade half-circuits. More than 95.2% of all eligible voice-grade half-circuits are now under such commitments.\nCWS's voice and data services are primarily digital, which provides higher quality transmissions than analog services. CWS International Digital Route (IDR) service, for example, makes it possible for communications carriers to provide digital public-switched telephone\nnetwork circuits. The carriers apply techniques to such circuits that permit a single digital circuit to handle multiple telephone calls simultaneously.\nFor private-line customers, CWS offers an all-digital International Business Service (IBS), as well as an international VSAT (Very Small Aperture Terminal) service. IBS offers customers high-speed, digital communications for voice, data, facsimile and video conferencing using on- premise earth stations that eliminate the need for costly land-line connections. At year-end 1995, approximately 44% of CWS IBS traffic was covered by long-term commitments. CWS's customers have established international VSAT networks to both Latin America and Europe. Using on-premise antennas as small as 1.8 meters in combination with the high-power satellites in the INTELSAT network, corporations doing business internationally can deliver communications to multiple sites. Used primarily for data transmissions, VSATs can also accommodate voice and video communications.\nTo the growing international broadcasting community, CWS provides both digital and analog transmission services on a long-term, short-term or occasional as-needed basis. With the launch of the INTELSAT K satellite and the INTELSAT VII and VIIA satellites (see \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCOMSAT Properties\nAt year end 1995, the headquarters of the corporation and the headquarters of the International Communications, Mobile Communications and Entertainment segments were located in a building in Bethesda, Maryland, which the corporation leases from a limited partnership in which it holds a 50% interest, primarily as a limited partner. The managing general partner also owns a 50% interest in the partnership. An affiliate of the managing general partner owns the building site and has leased this site to the partnership. The corporation has entered into a 15- year lease with the partnership for the new building (see Note 9 to the financial statements). In 1995, the corporation relocated the headquarters for the Mobile Communications segment from Clarksburg, Maryland to Bethesda, Maryland. In 1995, Ascent's headquarters were located in Bethesda, Maryland in space leased from the corporation. Ascent relocated its headquarters to Denver, Colorado in 1996.\nThe corporation owns buildings and land at Clarksburg, Maryland that serve as the headquarters of COMSAT Laboratories, as well as offices for certain operations of CRSI and CMC. The corporation also owns two manufacturing facilities in Dulles, Virginia, one of which serves as the headquarters of CRSI, and land located nearby that is used as an antenna test range by CRSI. Further, the corporation owns or leases 14 other properties in the United States and leases two properties in England and a sales office in the United Arab Emirates for the operations of CRSI's business units.\nCOMSAT General owns 86.3% of the MARISAT Joint Venture, which operates three satellites launched in 1976 -- the capacity of which is leased to Inmarsat, the U.S. Navy and the U.K. Navy. COMSAT General also owns the SBS-2 satellite launched in 1981, which is primarily leased to NBC, and the COMSTAR D-4 satellite launched in 1981, which is used by CMC and is scheduled to be decommissioned in 1996.\nThe corporation leases earth stations in Turkey and Malaysia, and owns earth stations at Santa Paula, California and Southbury, Connecticut that are used by CMC to provide mobile communications services. The California and Connecticut earth stations are also used by CRSI to provide communications services and TT&C services. The corporation owns earth stations at Clarksburg, Maryland and Paumalu, Hawaii that are used by CWS to provide TT&C services to INTELSAT.\nThe corporation's properties are suitable and adequate for the corporation's business operations.\nINTELSAT Satellites\nThe corporation's property accounts include CWS's pro-rata share of INTELSAT satellites. The INTELSAT satellites currently used and under construction are described below.\nThe INTELSAT V series consists of six satellites constructed by Space Systems\/Loral (formerly Ford Aerospace and Communications Company) having an average capacity of at least 15,000 voice-grade bearer circuits or 51 television channels. The INTELSAT V-A series consists of five satellites constructed by Space Systems\/Loral having an average capacity of at least 16,000 bearer circuits or 57 television channels.\nThe INTELSAT VI series consists of five satellites, constructed by Hughes Aircraft Company, a subsidiary of General Motors Corporation, having an average capacity of at least 24,000 bearer circuits or 87 television channels.\nThe INTELSAT-K satellite, constructed by General Electric Technical Services Company, Inc., a subsidiary of General Electric Company, which was launched in 1992, has an average capacity of 7,000 bearer circuits or 32 television channels.\nThe INTELSAT VII series consists of six satellites constructed or being constructed by Space Systems\/Loral. These satellites have an average capacity of at least 17,050 bearer circuits or 62 television channels. To date, five INTELSAT VII satellites have been launched, in October 1993, June 1994, October 1994, January 1995 and March 1995.\nThe INTELSAT VII-A series, also being constructed by Space Systems\/Loral, consists of three satellites having an average capacity of at least 19,250 bearer circuits or 70 television channels. The first INTELSAT VII-A satellite was successfully launched in May 1995; the launch of the second VII-A, in February 1996, was a failure (see Note 4 to the financial statements); and the third VII-A was successfully launched in March 1996.\nThe INTELSAT VIII series consists of four satellites that are being constructed by Lockheed Martin Astro Space, a division of the Lockheed Martin Corporation. These satellites will have an average capacity of 21,000 bearer circuits or 76 television channels. The first INTELSAT VIII satellite is expected to be launched in 1996.\nCOMSAT has applied to the FCC for authorization to participate in the procurement of two INTELSAT VIII-A spacecraft. These satellites, which are being constructed by Lockheed Martin Astro Space, will have an average capacity of at least 11,600 bearer circuits, or 38 television channels, and are expected to be launched in 1997.\nThe corporation has purchased insurance to cover the launch phase of the INTELSAT VII, VII-A, VIII and VIII-A satellites. Total loss in-orbit insurance for the first five INTELSAT VII satellites has been purchased for 360 days with a one satellite loss deductible. Total loss in-orbit\ninsurance for the remaining INTELSAT VII, VII-A, VIII and VIII-A satellites has been purchased for 365 days with a one satellite loss deductible.\nInmarsat Satellites\nThe corporation's property accounts include CMC's pro-rata share of Inmarsat satellites. The Inmarsat satellites currently used and under construction are described below.\nThe first-generation Inmarsat satellite system, which is now used primarily for backup capacity, leases, and specialized services, consists of satellite capacity leased from INTELSAT, the European Space Agency and the MARISAT Joint Venture through year-end 1996 with various early termination and extension options.\nThe second-generation Inmarsat satellite system, known as the Inmarsat-2 series, consists of four satellites constructed by an international consortium led by British Aerospace Dynamics Corporation.\nThe third-generation Inmarsat satellite system, known as the Inmarsat-3 series, consists of five satellites which are being constructed by Lockheed Martin Astro Space. These satellites will use spot-beam technology, which allows reuse of the scarce frequency resources allocated for mobile satellite communications. The Inmarsat-3s will have more than 20 times the capacity of the largest satellites in the first-generation Inmarsat system and will be about eight times more powerful than the Inmarsat-2 series. Inmarsat has purchased an insurance policy for launch failures with a one-loss deductible and 365 day in-orbit coverage. In the event of a first loss, Inmarsat will use the insurance proceeds to fully fund the insurance of the remaining launches and 365 day coverage. The first Inmarsat-3 satellite is scheduled to be launched in April 1996. A financing arrangement with respect to the Inmarsat-2 and -3 satellites is discussed in Note 8 to the financial statements.\nIn October 1995, COMSAT filed applications for authority to: (i) participate in the launch of the Inmarsat-3 (F-1) satellite, which is currently scheduled for April 1996; (ii) modify its U.S. Inmarsat earth stations to operate via the Inmarsat-3 satellites; and (iii) provide service using those satellites. The FCC has approved the launch application but has not acted on the other applications (see Note 11 to the financial statements).\nEntertainment Properties\nAscent leased its principal offices from COMSAT in 1995 under a short-term lease. Ascent relocated its principal offices to Denver, Colorado in 1996. Ascent leases facilities in Denver, Colorado and Bethesda, Maryland, facilities for OCV in Santa Clara, California, facilities for Beacon in Los Angeles, California, and facilities for ANS in Palm Bay, Florida.\nThe Nuggets and the Avalanche currently play their home games in Denver's McNichols Arena, an indoor sports arena located in downtown Denver that has a seating capacity of approximately 17,000 for basketball games and approximately 16,000 for hockey games. McNichols Arena is owned by the City and County of Denver (the \"City\") and is made available to the Nuggets under a lease agreement which extends until the conclusion of the 2007-2008\nseason. McNichols Arena is made available to the Avalanche under a lease agreement which extends until the conclusion of the 1996-1997 season, subject to renewals for two one-year terms. Pursuant to an amendment to the Nuggets lease agreement, the term of the Nuggets' lease will decrease by one year for each of the first two years that the Avalanche play in McNichols Arena.\nThe Nuggets' and the Avalanche's leases with the City require the teams to pay rent to the City for use of McNichols Arena equal to a percentage of the teams' net income from ticket sales, subject to certain minimum annual payments. The City is generally responsible for maintaining McNichols Arena and providing administrative personnel such as ushers, electricians, janitors, technicians and engineers. The Nuggets and the Avalanche are responsible for providing ticket takers, police and security personnel, announcers, timers, scorers and statisticians. The Nuggets and the Avalanche also share in revenue from food and beverage concessions and parking rights at McNichols Arena.\nAscent is currently developing and reviewing several options for a privately financed arena for the Nuggets, the Avalanche and other entertainment events, including, among other things, concerts, college sporting events, ice and dance performances, comedy shows and circuses. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Outlook.\" Under current plans, the proposed arena would seat approximately 19,000 for Nuggets games, approximately 18,000 for Avalanche games and approximately 20,000 for concerts and other events and would have approximately 84 luxury suites and 1,500 luxury seats. Ascent anticipates that financing for the arena may be raised through a partnership with other regional investors and will likely include corporate sponsorship. The Company estimates that the cost of a new arena would be approximately $150 million.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither COMSAT nor any of its subsidiaries is a party to, and none of their property is the subject of, material pending legal proceedings, and no such proceedings are known to be contemplated by governmental authorities, except for the matters described in Notes 10 and 11 to the financial statements and as discussed below.\nIn 1995, the corporation entered into a five-year agreement with News Corporation to provide satellite services beginning in 1996. In March 1996, News Corporation rescinded this agreement. The corporation has commenced a lawsuit against News Corporation and other parties to recover damages arising out of News Corporation's breach of obligation to COMSAT.\nCOMSAT and certain of its subsidiaries are parties to other pending legal proceedings arising in the ordinary course of business. While the outcome of such proceedings cannot be predicted with certainty, the corporation believes that the resolution of such proceedings will not have a material effect on the financial condition of the corporation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nExecutive Officers of The Registrant Age as of Name Officer March 31, 1996 ---- ------- -------------- Bruce L. Crockett....President and Chief Executive Officer 52 Betty C. Alewine.....President, COMSAT International 47 Communications Steven F. Bell.......Vice President, Human Resources and 46 Organization Development James M. Carroll.....Vice President, Government Relations 33 Janet L. Dewar.......Vice President, Corporate Affairs 46 John V. Evans........President, COMSAT Laboratories 62 Allen E. Flower......Vice President, Chief Financial Officer 52 and Acting Treasurer Alan G. Korobov......Controller 47 Charles Lyons........President, Ascent Entertainment Group, Inc. 41 Ronald J. Mario......Senior Vice President, Business Development 52 Richard E. Thomas... President, COMSAT RSI, Inc. 69 Warren Y. Zeger..... Vice President, General Counsel and 49 Secretary\nNormally, the officers are elected annually by the Board of Directors, at its first meeting following the Annual Meeting of Shareholders, to serve until their successors are elected and qualified.\nThere is no family relationship between an officer and any other officer or director and no arrangement or understanding between an officer and any other person pursuant to which he or she was selected as an officer.\nThe following is a brief account of each executive officer's experience for the past five years:\nMr. Crockett has been President and Chief Executive Officer and a director of COMSAT since February 1992. He was President and Chief Operating Officer of the corporation from April 1991 to February 1992. He has been an employee of the corporation since 1980 and has held various operational and financial positions. He also is a director of Ascent, ACE Limited and Augat, Inc. and a director or trustee of funds of AIM Management Group, Inc. He also is a member of the Board of Trustees of the University of Rochester.\nMs. Alewine has been President, COMSAT International Communications since January 1995, and was President, CWS, from May 1991 to May 1994. She was Vice President and General Manager, INTELSAT Satellite Services from January 1989 to May 1991.\nMr. Bell has been Vice President, Human Resources and Organization Development since October 1993. Prior to joining the corporation, he was with American Express Worldwide Technologies, serving as Vice President of Human Resources from September 1992 to September\n1993; and with US Sprint, serving as Regional Director of Human Resources from October 1987 to August 1992.\nMr. Carroll has been Vice President, Government Relations since November 1995. He served as Director of Government Relations from 1993 to 1995. He joined COMSAT in 1990 as manager of government relations after serving as legislative assistant to U.S. Senator Warren B. Rudman.\nMs. Dewar has been Vice President, Corporate Affairs since November 1995. She joined the corporation in 1991 in marketing communications at CWS and became Director, Marketing Communications in 1992. She previously worked at Mobil Oil Corporation in international public affairs and strategic planning.\nDr. Evans has been President, COMSAT Laboratories since September 1991. He was Vice President and Director, COMSAT Laboratories from October 1983 to September 1991.\nMr. Flower has been Vice President, Chief Financial Officer and Acting Treasurer since November 1995. He was Controller and Acting Chief Financial Officer from April 1995 through November 1995, Controller from June 1992 to May 1995 and Vice President, Finance and Administration, CVE from May 1990 to June 1992.\nMr. Korobov has been Controller since November 1995. He was Vice President, Finance for CMC from January 1993 to September 1995; Vice President, Finance for CVE from June 1992 to January 1993; and the Controller for CVE from March 1992 to June 1992. He was the Financial Controller for Inmarsat, based in London, from April 1990 to March 1992.\nMr. Lyons has been President, Chief Executive Officer and a director of Ascent since October 1995, and prior to that was President and a director of Ascent's predecessors since February 1992. He was Vice President and General Manager of COMSAT Video Enterprises, Inc. (CVE) from October 1990 to February 1992.\nMr. Mario has been Senior Vice President, Business Development since July 1995. He was President, CMC from May 1991 to July 1995 and Vice President and General Manager, CMC from April 1988 to May 1991.\nMr. Thomas has been President, COMSAT RSI, Inc. since June 1994. Prior to the merger of Radiation Systems, Inc. (RSi), a communications and radar systems manufacturing company, with COMSAT, he was with RSi since 1965, serving as President, Chairman of the Board, and Chief Executive Officer from June 1978 to June 1994.\nMr. Zeger has been Vice President, General Counsel and Secretary since August 1994. He was Vice President and General Counsel from March 1992 to August 1994. He was Acting General Counsel from September 1991 to March 1992 and Associate General Counsel of the corporation and Vice President, Law, World Systems Division from February 1988 to September 1991.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nAs of December 31, 1995, there were 47,754,557 shares of common stock, without par value, of the corporation (COMSAT Common Stock) outstanding: 47,733,733 were Series I shares, held by approximately 37,000 holders of record other than communications common carriers; and 20,824 were Series II shares, held by 35 common carriers.\nThe principal market for COMSAT Common Stock is the New York Stock Exchange, where it is traded under the symbol \"CQ.\" COMSAT Common Stock is also listed on the Chicago Stock Exchange and the Pacific Stock Exchange in the United States and on the Basel, Geneva and Zurich Stock Exchanges in Switzerland.\nThe corporation's Transfer Agent, Registrar and Dividend Disbursing Agent is The Bank of New York, 101 Barclay Street, New York, New York.\nThe high and low sales prices of, and the dividends declared on, each share of COMSAT Common Stock for the last two years are as follows:\nCOMSAT Common Stock ------------------------------------------ Calendar Year 1995 High Low Dividend - ------------------ ---- --- -------- First Quarter 21 5\/8 17 5\/8 .195 Second Quarter 21 18 1\/4 .195 Third Quarter 24 5\/8 19 1\/2 .195 Fourth Quarter 22 5\/8 18 1\/4 .195\nCalendar Year 1994 First Quarter 30 24 7\/8 .185 Second Quarter 26 1\/2 20 1\/2 .185 Third Quarter 26 1\/2 23 .195 Fourth Quarter 25 5\/8 17 1\/2 .195\nItem 6:","section_6":"Item 6: Selected Financial Data for the Registrant for Each of the Last Five Fiscal Years.\nNotes - ----- As discussed in Note 6 to the financial statements, the corporation consummated its merger with Radiation Systems, Inc. (RSi) in June 1994. The merger has been treated as a pooling of interests for accounting purposes. Accordingly, information for all periods prior to the merger has been restated to include RSi.\nItem 7:","section_7":"Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations.\nANALYSIS OF OPERATIONS\nConsolidated Operations\nConsolidated revenues for 1995 were a record $852 million, an increase of $25 million over the previous year. Revenues increased in the International Communications and Entertainment segments, while declining in the Mobile Communications and Technology Services segments. The largest improvement was in the Entertainment segment, where On Command Video continued to have substantial growth in its hotel room base. Within International Communications, International Ventures revenues almost doubled, in large part because of significant growth in its Latin American ventures.\nConsolidated revenues in 1994 increased $73 million over 1993 with revenue increases in all business segments. The largest improvements were in the Entertainment and International Communications segments. Substantial growth in system installations at On Command Video and improvements from the Denver Nuggets were responsible for the favorable increase in Entertainment segment revenues. Revenues increased more than threefold in International Ventures over 1993.\nOperating income in 1995 was $96 million, a decline of $55 million from 1994. During 1995 the corporation took actions to restructure elements of all of its business segments, and recorded a $20 million restructuring provision (see Note 16 to the financial statements). Exclusive of the 1995 restructuring charge and the Radiation Systems, Inc. (RSi) merger and integration costs recorded in 1994, operating income was $116 million, or $42 million below 1994. All business segments reported lower operating income in 1995, as compared to 1994, except Mobile Communications, where operating income was unchanged from the prior year.\nOperating income for 1994 was $1 million lower than in 1993. Improved performances from the Entertainment and Technology Services segments were offset by non-recurring merger and integration costs of $7 million associated with the acquisition of RSi in June 1994. The merger was accounted for as a pooling of interests. Accordingly, the 1993 financial statements were restated to include RSi (see Note 6 to the financial statements).\nOther income (expense) decreased in 1995 by $5 million from 1994 levels. The corporation, through a subsidiary, issued $200 million of Monthly Income Preferred Securities (MIPS) in July 1995 (see Note 9 to the financial statements). Dividends on these securities of $7 million were the primary cause of the increased expense in 1995. Other income (expense) declined by $7 million in 1994 from 1993 because of proceeds of corporate-owned life insurance policies received in 1993 which did not recur in 1994 and because of lower equity profits associated with unconsolidated businesses.\nInterest costs increased by $11 million in 1995 as compared to 1994 and by $3 million for 1994 over 1993 as a result of increases in both interest rates and borrowings. Interest capitalized, primarily on satellite construction projects, declined in 1995 by $3 million compared to 1994 due to the completion of several INTELSAT satellites, and increased slightly from 1993 to 1994 as levels of property under construction grew during that period.\nThe corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109 in 1993. This standard requires that deferred tax assets and liabilities be adjusted to reflect current tax rates. The cumulative effect of adopting this standard was to increase income by $2\nmillion in 1993. In addition, the corporation recorded a charge to income tax expense of $3 million in 1993 under the new standard to reflect the impact on the prior year's deferred tax accounts of the change in the Federal income tax rate to 35% from 34%.\nThe initial public offering of common stock of Ascent Entertainment Group, Inc. (Ascent) was completed in December 1995. As a result of the offering, the corporation now owns 80.67% of Ascent's common stock. The corporation recognized a $19 million pre-tax gain as a result of the public offering (see Note 5 to the financial statements).\nNet income was $38 million in 1995, a reduction of $40 million from the prior year. Earnings per share for 1995 were $0.79, down $0.85 from 1994.\nIncome for 1995 was $50 million, or $1.04 per share excluding the gain on the initial public offering of Ascent, the provision for restructuring and certain non-recurring items. These non-recurring items include one-time charges primarily related to the restructuring.\nFor 1994, net income was $78 million or $7 million lower than in 1993. Earnings per share were $1.64, or $0.15 lower than in the previous year. Merger and integration costs reduced income in 1994 by $6 million, net of taxes, or $0.13 per share. Excluding these costs, income was $84 million or $1.77 per share in 1994, versus $82 million or $1.75 per share in 1993 before the cumulative effect of the accounting change.\nSegment Operating Results\nInternational Communications\nInternational Communications includes COMSAT International Ventures (CIV) and the FCC-regulated and non-regulated businesses of COMSAT World Systems (CWS). CWS provides international voice, data, video and audio communications as the statutory-designated U.S. participant in the global INTELSAT satellite system. CIV invests in and operates telecommunications businesses internationally.\nCWS's 1995 revenues increased 1% from 1994. Revenues from expanded service offerings such as VSAT leases, digital audio and wide-band mobile increased by 55%. These increases were partially offset by reduced revenues from voice circuits, which declined 6% due to rate reductions and the anticipated conversion of analog circuits to more efficient digital\nservice. The rate reductions relate to agreements with AT&T, MCI and Sprint, CWS's three largest international carrier customers. CWS's share of revenues from the INTELSAT system also declined with the 1% reduction in the corporation's ownership share in 1995.\nCWS's revenues in 1994 increased 3% over 1993, driven by a 29% increase in video services and a doubling of expanded service offerings such as VSAT leases, digital audio and wide-band mobile. These increases were partly offset by reduced revenues from voice circuits which declined 7% for the reasons indicated above.\nCWS's 1995 operating income increased 8% from 1994. The increase was due to decreased operating expenses within the division and CWS's lower share of INTELSAT's costs. These savings were partially offset by increased depreciation expense from the launch of three INTELSAT VII satellites in 1995.\nCWS's 1994 operating income declined 3% from 1993. The decrease was the result of increased operating expenses, primarily depreciation, which increased as a result of the launch of three new satellites that went into service in late 1993 and 1994.\nCIV has 13 business ventures providing telecommunication services in Latin America, Asia and Europe. CIV owns a controlling interest in 10 of these ventures. In 1995, revenues grew to $38 million due to growth in Latin American ventures and the consolidation of the results of Belcom, CIV's Russian venture, for a full year. In 1994, CIV revenues grew more than threefold over 1993 to $19 million.\nIn 1995, CIV experienced an operating loss of $21 million, primarily due to operating problems in Belcom. Despite these operational problems, CIV's total backlog of revenue under contract grew from roughly $50 million at the end of 1994 to over $100 million by the end of 1995. In 1994, CIV incurred an operating loss of $5 million, which was $1 million better than 1993.\nMobile Communications\nThis segment consists of COMSAT Mobile Communications (CMC), which provides maritime, aeronautical and land mobile communications services as the statutory-designated U.S. participant in the Inmarsat satellite system.\nRevenues in 1995 declined 7% from the prior year due to rate reductions and the migration of traffic to less expensive, more efficient digital services such as Standard-M. However, CMC's telephone traffic minutes increased 2% in 1995 as the lower-cost digital Standard-M service dominated new terminal commissionings during the year. The number of Standard-M digital terminals in the marketplace doubled, totaling 7,900 by the end of the year.\nTelephone revenues declined 11% from 1994 due to lower average rates. Telex revenues also declined 11% from 1994. However, this decline was partially offset by revenue growth of almost 40% in Standard-C services, which operate in smaller and less expensive digital terminals.\nRevenues from service contracts with IDB Mobile Communications, Inc. (IDB) and American Mobile Satellite Corporation (AMSC) increased 3% over 1994 due principally to additional capacity requirements. A contract under which CMC provided Inmarsat with satellite control services terminated at the end of 1994.\nCMC's operating income for 1995 was unchanged from 1994. Lower revenues were offset by a reduction in operating expenses and an increase in CMC's share of Inmarsat's operating results. The decline in operating expenses was due in part to lower CMC operating costs and the reversal of Inmarsat-related costs which were over-accrued in 1994.\nRevenue increases of 2% in 1994 over 1993 occurred across a broad range of services. Operating expenses increased by 1%, largely attributable to higher depreciation on earth station upgrades. Operating income was flat in 1994 compared to 1993.\nTechnology Services\nThe Technology Services segment includes COMSAT Laboratories and COMSAT RSI (CRSI), which designs, manufactures and integrates a range of turnkey systems, subsystems and components for advanced microwave, cellular, personal communication services and networks (PCS\/PCN), wireless local loop communication networks, satellite communication, radar and other services. In addition, this segment provides operations and maintenance, satellite construction monitoring and applied research services.\nRevenues for this segment declined in 1995 by $13 million from the prior year. The decrease was caused by the completion in 1994 of several large international and U.S. Government contracts which were not replaced in 1995. Offsetting the decline, in part, were increases in revenues from satellite services for classified government customers, earth station component sales and the acquisitions of three companies - Intelesys, Plexsys and Jefa - that are involved in the manufacture, integration and installation of various wireless components and systems. In addition, the revenue decline was in part the result of a $5 million insurance settlement recorded in 1994 at CRSI, as well as downsizing of one of the Laboratories' divisions.\nRevenues in 1994 increased by $17 million over 1993. Improvements came primarily from continued work on the VSAT rural telephony program in Guatemala and the television and radio distribution network in Cote d'Ivoire (Ivory Coast), as well as from new projects to install cellular antennas in Argentina and to provide digital upgrades to telephony equipment at a number of earth stations internationally. Revenues were lower at COMSAT Laboratories primarily due to the sale of a microwave electronics group in 1993.\nOperating income in 1995 declined $7 million from 1994. The decline was primarily due to the lower revenues as well as new product development costs associated with VSAT and cellular products. Operating profit in 1994 improved slightly as compared to the prior year, as a result of higher revenues and insurance income, offset in part by the costs associated with the cancellation of a large infrastructure project in Kuwait.\nEntertainment\nThe Entertainment segment is comprised of Ascent Entertainment Group, Inc. (Ascent). As discussed in Note 5 to the financial statements, the initial public offering of Ascent was completed in December 1995 and COMSAT Corporation now owns 80.67% of Ascent.\nAscent, through On Command Video Corporation (OCV) and Ascent Network Services, Inc. (ANS), formerly COMSAT Video Enterprises, Inc., provides video distribution and on- demand video entertainment services to the hospitality industry and video distribution services for the National Broadcasting Company (NBC). This segment also includes the Denver Nuggets National Basketball Association (NBA) franchise, the Colorado Avalanche National Hockey League (NHL) franchise and Beacon Communications Corp. (Beacon), a producer of theatrical films and television programming.\nIn the third quarter of 1995, ANS contributed substantially all of its pay-per-view video systems in hotels and related assets to OCV for OCV common stock. This transaction raised Ascent's ownership of OCV to approximately 85%. OCV now owns and manages all of Ascent's hotel video systems. Certain Satellite Cinema hotel properties are being converted to services provided by OCV and Ascent has terminated or sold Satellite Cinema operations at the remaining hotel properties.\nIn July 1995, Ascent acquired the Quebec Nordiques NHL franchise and related player contracts. After the acquisition, Ascent relocated the team to Denver, Colorado for the 1995- 1996 season, and the franchise is now known as the Colorado Avalanche (see Note 7 to the financial statements). In December 1994, ANS purchased substantially all of the assets of Beacon (see Note 7 to the financial statements).\nAscent's revenues increased in 1995 by $35 million over the previous year. This increase in revenues was the result of a significant growth in the OCV installed room base, the inclusion of the Colorado Avalanche revenues for the last half of 1995 and Beacon revenues for the full year, and NBA expansion revenues. Offsetting these increases were lower revenues from the NBC contract, which entered an option phase in 1995.\nRevenues increased in 1994 from 1993 by $35 million. The increase was caused by OCV room growth in newly contracted hotels, the conversion of existing ANS rooms to the OCV system, and improved results by the Denver Nuggets following their playoff participation and higher paid attendance and sponsor revenues.\nAscent incurred a $15 million operating loss in 1995 as compared to operating income of $14 million in 1994. The decline was a result of lower revenues from the NBC contract, losses from the Colorado Avalanche for the last half of 1995 and full-year costs for Beacon. Additionally, the 1995 results include one-time charges recorded in connection with the Ascent public offering. These losses were partially offset by receipt of NBA expansion fees and improvement in OCV operations.\nOperating income in 1994 grew 42% over 1993. Gains in operating results from the Denver Nuggets led to the improved performance. Results from video programming and distribution were unchanged from 1993.\nOutlook\nMany of the statements that follow are forward-looking and relate to anticipated future operating results. Statements which look forward in time are based on management's current expectations and assumptions, which may be affected by subsequent developments and business conditions, and necessarily involve risks and uncertainties. Therefore, there can be no assurance that actual future results will not differ materially from anticipated results. Although the corporation has attempted to identify some of the important factors that may cause actual results to differ materially from those anticipated, those factors should not be viewed as the only factors which may affect future operating results.\nThe corporation continues to promote efforts to restructure INTELSAT and Inmarsat as privatized commercial enterprises to enhance prospects that services offered on the INTELSAT and Inmarsat systems remain competitive in tomorrow's marketplace. In the corporation's view, the rapid evolution of telecommunications technology and increased competition have made privatization necessary so that these treaty-based organizations can become more cost-effective and responsive to customer needs. The corporation, as a minority shareholder and the U.S. signatory to both organizations, lacks the ability to independently effect a restructuring of either\norganization. The success of the corporation's privatization efforts will depend on the corporation's ability to achieve a consensus among other signatories and participating member governments.\nThe corporation announced in February 1996 that it had reached agreement with the U.S. Government concerning a joint proposal that would transfer approximately 50% of INTELSAT's assets, including satellites, to a new commercial affiliate. The existing intergovernmental organization would continue to provide basic public network services. The proposal also contemplates that a majority of the affiliate's stock would be sold to external investors. The corporation's objective is to build a consensus on the proposal that can be considered for adoption at the next INTELSAT Assembly of Parties to be held in 1997. A vote of two-thirds of the 137 governments that are members of the INTELSAT consortium is necessary for approval.\nIn early 1996, the corporation retained an investment banker to assess strategic alternatives for enhancing shareholder value and to analyze the capital needs of its businesses for continued expansion. As part of that effort, the corporation is examining a number of options with a view toward enhancing the ability of its various businesses to continue to accelerate their strategic investment programs, while permitting COMSAT as a parent organization to reduce debt, strengthen its balance sheet and improve liquidity.\nInterest costs are expected to significantly increase in 1996 due to increased borrowings primarily for capital expenditures, including investments in ICO (see Note 10 to the financial statements). The corporation anticipates that the amount of interest capitalized will decrease significantly as several INTELSAT and Inmarsat satellites are expected to be placed in service during 1996.\nCOMSAT World Systems and INTELSAT are faced with increased competition for the provision of satellite services from new and existing satellites launched by separate systems such as Pan American Satellite (PanAmSat) and Orion Network Systems, Inc. In late 1993, the Federal Communications Commission (FCC) substantially eliminated prior restrictions on access of separate system satellite operators to the public switched telephone network. This action, along with the FCC's stated goal of eliminating all restrictions on separate satellite systems by 1997, will increase competition.\nOver the next few years, continuing increases in satellite competition and the expected doubling of fiber optic cable capacity available in the marketplace will put increased pressure on service revenues and operating margins and could result in loss of market share. In addition, under CWS's long-term service contracts, carrier customers may cancel certain circuits upon paying a termination charge.\nIn 1995, the corporation signed a five-year agreement with News Corporation to provide satellite services beginning in 1996. In March 1996, News Corporation rescinded this agreement. The corporation has commenced a lawsuit against News Corporation and other parties to recover damages arising out of News Corporation's breach of obligation to COMSAT.\nThe corporation believes that CWS continues to be well-positioned with long-term agreements with major international carriers to provide cost-competitive services for bulk usage beyond the year 2000. In addition, CWS expects continued growth in several emerging markets, particularly in international television distribution, where new opportunities are being created in the marketplace. Opportunities are also expanding for international VSAT services.\nIn addition to the seven satellites currently on order, INTELSAT has signed a lease for capacity aboard the INSAT-2E satellite in the Asia-Pacific region, planned for launch in 1997. INTELSAT launched three satellites in 1995 and plans five launches for 1996. In February 1996, there was a launch failure of the INTELSAT 708 satellite aboard a China Long March vehicle. The corporation's investment in the satellite, including capitalized interest, was fully insured against the loss. Receipt of the insurance proceeds will reduce the corporation's rate base for jurisdictional rate-making purposes, resulting in a potential reduction of earnings capacity. The new INTELSAT VII and INTELSAT VIII series satellites will offer higher-power capabilities.\nCOMSAT International Ventures plans to continue to make further investments in its current international businesses and may form new ventures in selected markets. CIV plans to target those markets where the telecommunications environment is liberalizing and where CIV's core strengths can be used to capture an early position in rapidly growing markets.\nIn 1995, CIV experienced difficulties in the operations of two ventures, Belcom (Russia) and Philcom (Philippines). CIV expects improved performance in both of these ventures during 1996. It is expected that profits from existing ventures in 1996 will likely be offset by CIV's expansion in newer ventures, which typically yield losses in their formative stages. Those losses, coupled with CIV's overhead and management costs, are expected to result in continued losses for CIV as a whole.\nCOMSAT Mobile Communications plans to continue to expand its service offerings and value-added products to meet anticipated growth in customers' needs. The increasing number of digital terminals with improved operating efficiency and reduced service charges are expected to continue to provide traffic growth in land mobile, small commercial and pleasure boat, and business traveler markets. CMC expects to continue to face increasing competition from existing Inmarsat service providers, other wireless communications services including C- Band, and other potential market entrants such as AT&T, which recently obtained FCC approval to resell ship-to-shore service. As a result, expected increases in revenues due to traffic growth would be partially offset by a reduction in service charges caused by competitive pressures and lower-priced digital versus analog telephone service charges.\nThe service contract with AMSC expired at the end of 1995 as AMSC began using its own satellite. The IDB contract was extended during 1995 to provide service through September 1999.\nCMC plans to build on its established position of leadership in mobile satellite communications as it evolves toward handheld satellite service. The first generation of personal satellite communications will be a six-pound, laptop computer-sized satellite terminal named Planet 1TM. CMC announced this product in January 1996 with expected service commencement in 1996 utilizing the Inmarsat-3 satellites which are scheduled to begin launching in April 1996. This product is expected to address the demand for global personal communications ahead of the availability of handheld satellite systems.\nA major part of the corporation's international telecommunications strategy is the investment of approximately $150 million in ICO (see Note 10 to the financial statements). This newly created company was formed outside the Inmarsat organization to allow a more commercial and market-driven focus on the development of handheld satellite service. ICO's intermediate circular orbit satellite system will have 12 satellites and is scheduled to become operational by the year 2000. ICO users are expected to communicate worldwide using handheld units similar to cellular phones. The units are expected to cost less than $1,000 and will operate through both satellite and cellular links.\nAs with any new product, there are a number of factors that may affect the corporation's ability to offer Planet 1SM and ICO services on a profitable basis. Such factors include the ability to meet commercial deployment schedules, the level of consumer acceptance and demand, the quality and pricing of competitive services, and the performance of ground and space systems and customer terminals. In order to offer Planet 1SM and ICO services, the corporation must obtain certain regulatory approvals (see Notes 10 and 11 to the financial statements). In addition, ICO must receive the funding required to complete its satellite system.\nCOMSAT RSI has been successful in winning new contracts in 1995 totaling $254 million, including two programs of strategic significance. The first is the Commercial Satellite Communications Initiative (CSCI) contract from the U. S. Department of Defense to provide domestic and international satellite capacity and associated equipment and network management services over a 10-year period. The second is the Asia Cellular Satellite System (ACeS) contract from Lockheed Martin to provide equipment and services for this regional mobile satellite system.\nCRSI's backlog rose to $212 million at the end of 1995 as compared to $152 million at the end of 1994. Of the December 31, 1995 backlog, approximately $140 million is expected to be recognized as sales in 1996 and approximately $57 million is unfunded. Included in this order backlog is approximately $114 million of U.S. Government contracts. As is customary, these contracts include provisions for cancellation at the convenience of the U.S. Government or the prime contractor. If such a provision were exercised, CRSI would have a claim for reimbursement of costs incurred and a reasonable allowance for profit thereon.\nThe corporation believes that CRSI's acquisition of three companies in 1995 has positioned CRSI for future growth in the VSAT, cellular and PCS markets. Earnings growth at CRSI, however, will continue to depend upon CRSI's ability to contain costs and complete projects with favorable margins.\nAscent is expected to continue to derive a majority of its revenues from the hospitality industry video distribution business. Revenue and income growth are expected from the continued installation of OCV systems for new customers.\nContracted revenues for video distribution services provided to NBC entered an option phase in 1995 which resulted in lower revenues and operating income. It is expected that revenues and operating income will remain at such levels until the end of the contract in 1999.\nThe financial performance of the Denver Nuggets and the Colorado Avalanche are, to a large extent, dependent on their performance in their respective leagues. In addition, due to the limitations of the facilities available at McNichols Arena where both teams currently play, Ascent believes that projected increases from facilities-based revenues will not keep pace with increases in players' salaries, which could result in operating losses for as long as they play in McNichols Arena. Ascent plans to construct a new arena and entertainment complex which is expe ted to result in improved operating results for both teams. It is estimated that the arena will cost approximately $150 million.\nIn March 1996, Ascent entered into an agreement with The Anschutz Corporation (TAC), with which Ascent had been jointly developing the proposed arena project, to purchase TAC's interests and assets related to the project for $11.6 million. As part of the agreement, TAC agreed to use reasonable efforts to facilitate the development of the proposed arena. In connection with this agreement, Ascent also purchased TAC's limited partnership interest in New Elitch Gardens, Ltd. (Elitch Gardens), which owns an amusement park in downtown Denver, for $4.1 million. The purchase of TAC's interest in Elitch Gardens increased Ascent's interest from 13% to 26%. Additionally, in March 1996, Ascent entered into an agreement with Southern Pacific Transportation Company to purchase land in downtown Denver for $20 million for the proposed arena site. The land purchase agreement is subject to several conditions including obtaining reasonable financing and the release of the teams from their current lease at McNichols Arena.\nBeacon is to begin production on two to three feature films during 1996, one of which may be released in the second half of 1996. There is a significant degree of unpredictability and risk associated with theatrical films.\nANALYSIS OF BALANCE SHEETS\nConsolidated Balance Sheets\nAssets. The corporation ended 1995 with $2,314 million of assets, a 17% increase over 1994.\nInternational Communications assets excluding unconsolidated investments increased $65 million during 1995 to end the year at $950 million. Of the total increase, International Ventures invested $41 million in new communications property and equipment. These additions are needed to meet specific customer requirements for technically advanced applications in developing countries. The corporation expects to expend up to an additional $50 million in 1996 to meet anticipated customer demand in existing ventures and may invest additional amounts if warranted by new opportunities.\nCWS's assets increased slightly during 1995. Additions to property and equipment of $138 million, which were principally related to CWS's share of INTELSAT's satellite programs for the VII, VII-A and VIII series of satellites, were offset by a 1% decrease in ownership of INTELSAT, plus higher accumulated depreciation.\nAssets in Mobile Communications decreased slightly during 1995, ending the year at $419 million. Property and equipment additions of $40 million primarily relate to Inmarsat's third-generation satellites currently under construction and CMC's increased ownership of Inmarsat. Offsetting this increase was a decline in accounts receivable because of lower sales and an increase in accumulated depreciation. The Inmarsat-3 satellite launch program is scheduled to begin in early 1996. These satellites will provide increased global capacity to meet anticipated growing demand for services, which includes the commencement of Planet 1SM service.\nTotal assets for Technology Services increased in 1995 by $30 million. This change was the result of an increase in accounts receivable, because of stronger sales in the fourth quarter, and an increase in assets because of CRSI's acquisitions of Intelesys, Plexsys and Jefa.\nEntertainment assets at year end were $484 million, an increase of $115 million over 1994. Property and equipment additions of $85 million were primarily related to installations of OCV's on-demand video entertainment systems for new hotel customers. At December 31, 1995, OCV had a backlog of 113,000 rooms and expects to continue to make additional investments in these systems during 1996. Additionally, the increase in assets reflects the acquisition of the Colorado Avalanche (see Note 7 to the financial statements).\nCorporate and other assets include cash and cash equivalents, investments in unconsolidated businesses, corporate-owned life insurance policies and certain land, property and equipment. During 1995, such assets increased by $131 million. The primary reason for this change was an increase in cash and cash equivalents of $105 million. Additionally, the corporation invested $26 million in ICO (see Note 7 to the financial statements).\nLiabilities. The corporation's total liabilities increased in 1995 by $326 million. This increase was primarily the result of the issuance of $200 million of preferred securities by a subsidiary (see Note 9 to the financial statements), the corporation's share of long-term debt issued by INTELSAT of $38 million, four notes totaling $42 million issued under the corporation's medium-term note program and Ascent's long-term borrowings of $70 million.\nANALYSIS OF CASH FLOWS, LIQUIDITY AND CAPITAL RESOURCES\nCash Flows\nCash from operating activities for 1995 was $251 million, a 3% increase over 1994. The International Communications, Mobile Communications and Entertainment segments generated the majority of the corporation's cash from operations. The corporation made interest payments, net of amounts capitalized, of $37 million and tax payments of $21 million.\nDuring 1995, the corporation used $411 million in investing activities, a 16% increase over last year. Included under purchases of subsidiaries in 1995 was Ascent's $76 million purchase of the National Hockey League franchise now known as the Colorado Avalanche. The increase in 1995 in property and equipment came primarily from the International Communications businesses, as CWS continued to make capital investments equal to its share of INTELSAT's satellite program, and CIV purchased communications plant and equipment, predominantly for Latin America ventures. Cash invested in unconsolidated businesses in 1995 was primarily the result of the corporation's investment in ICO.\nThe corporation expects to make additional investments in property and equipment in 1996. Increases are expected in both CIV and CMC while lower expenditures are planned for CWS. Investments in unconsolidated businesses are expected to increase because of anticipated payments related to the corporation's commitment to invest in ICO. The corporation expects to receive insurance proceeds of approximately $54 million in the second quarter of 1996 related to the February 1996 launch failure of an INTELSAT satellite.\nCash proceeds from financing activities in 1995 were $266 million, a $152 million increase from the previous year. This increase came from the proceeds from the issuance of $200 million of preferred securities by a subsidiary, increase in long-term debt of $154 million and the proceeds of the public offering of Ascent stock. This was offset by the repayment of short-term borrowings of $121 million. Dividends of $37 million were paid during the year as compared to $34 million in 1994. The quarterly dividend was increased in the second half of 1994 from $0.185 per share to $0.195 per share.\nLiquidity and Capital Resources\nThe corporation's working capital improved from a deficit of $19 million at year-end 1994 to a positive $221 million at year-end 1995. This improvement was caused by the increase in cash and cash equivalents of $105 million and the reduction in commercial paper borrowings of $121 million. The change came primarily from the proceeds from the issuance of preferred securities by a subsidiary and the proceeds from the initial public offering of Ascent.\nThe corporation has access to short- and long-term financing at favorable rates. The corporation's current long-term debt ratings were downgraded one level in early 1996 to A- by Standard and Poor's and to A3 by Moody's. The corporation's $200 million commercial paper program had no borrowings outstanding as of December 31, 1995. A $200 million credit agreement, expiring in 1999, backs up this commercial paper program. The corporation's current commercial paper ratings were also downgraded one level in early 1996 to A2 by Standard and Poor's and to P2 by Moody's.\nThe corporation had $26 million remaining at year-end 1995 under a $100 million medium-term note program. The medium-term note program is part of a $200 million debt securities shelf registration program initiated in 1994.\nThe corporation's debt-financing activities are regulated by the FCC. The corporation submits its financing plans to the FCC for review annually. Under existing FCC guidelines, the corporation is subject to a maximum long-term debt to total capital ratio of 45%, a limit of $200 million in short-term debt and an interest coverage ratio of 2.3 to 1. At December 31, 1995, the corporation had long-term debt to total capital of 44%, no short-term debt outstanding, and was in compliance with the interest coverage ratio. The corporation expects that cash flows from operations and its short-term borrowing capacity will be sufficient to fund its cash requirements in 1996.\nItem 8:","section_7A":"","section_8":"Item 8: Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders of COMSAT Corporation:\nWe have audited the accompanying consolidated balance sheets of COMSAT Corporation and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flow for each of the three years in the period ended December 31, 1995. Our audit also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and the financial statement schedules 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 the 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. 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 15 to the consolidated financial statements, in 1993 the corporation changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\nDeloitte & Touche LLP Washington, D.C. February 15, 1996\nCOMSAT CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these financial statements.\nCOMSAT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nThe accompanying notes are an integral part of these financial statements.\nCOMSAT CORPORATION AND SUBSIDIARIES CONSOLIDATED CASH FLOW STATEMENTS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these financial statements.\nCOMSAT CORPORATION AND SUBSIDIARIES STATEMENTS OF CHANGES IN CONSOLIDATED STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these financial statements.\nCOMSAT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For Each of the Three Years in the Period Ended December 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThese financial statements have been prepared in conformity with generally accepted accounting principles (GAAP). Certain amounts reported in the financial statements and related notes have required the use of management's estimates. Actual results could differ from those estimates. The significant accounting policies that have guided the preparation of these financial statements are:\nPrinciples of Consolidation. Accounts of COMSAT Corporation and its majority-owned subsidiaries (COMSAT or the corporation) have been consolidated. Significant intercompany transactions have been eliminated. Minority interest on the balance sheet is primarily comprised of the interest of other shareholders in Ascent Entertainment Group, Inc. (Ascent) (see Note 5). As of December 31, 1995, the corporation owned 80.67% of Ascent. The minority interest share of the net income of consolidated businesses is included in \"Other income (expense), net.\"\nThe corporation has consolidated its shares of the accounts of the International Telecommunications Satellite Organization (INTELSAT) and the International Mobile Satellite Organization (Inmarsat). The corporation's ownership interests in INTELSAT and Inmarsat are based primarily on the corporation's usage of these systems. As of December 31, 1995, the corporation owned 19.1% of INTELSAT and 24.0% of Inmarsat.\nRevenue Recognition. Revenue from satellite services is recognized over the period during which the satellite services are provided. Revenue from long-term product, system integration and related services contracts is accounted for using the percentage-of- completion (cost-to-cost) method. Revenue from other services is recorded as services are provided.\nIncome Taxes and Investment Tax Credits. The corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. This accounting standard requires the use of the asset and liability approach for financial accounting and reporting for income taxes.\nThe provision for income taxes includes taxes currently payable and those deferred because of differences between the financial statement and tax bases of assets and liabilities. The corporation has earned investment tax credits on certain INTELSAT and Inmarsat satellite costs. These tax credits have been deferred and are being recognized as reductions to the tax provision over the estimated service lives of the related assets.\nEarnings Per Share. Earnings per share are computed using the average number of shares outstanding during each period, adjusted for outstanding stock options, restricted stock units and unissued restricted stock awards. The weighted average number of shares used in the computation of earnings per share for each year was 47,998,000 for 1995, 47,356,000 for 1994 and 47,095,000 for 1993.\nGoodwill. The balance sheet includes goodwill related to the acquisitions of On Command Video Corporation, the Denver Nuggets Limited Partnership (the Nuggets), Beacon (see Note 7) and other ventures. Goodwill is amortized over 10 to 25 years. Accumulated goodwill amortization was $12,671,000 and $7,302,000 at December 31, 1995 and 1994, respectively. The corporation reviews annually the balance of goodwill for potential impairment and, if necessary, adjusts the balance to its estimated net realizable value based on discounted cash flows.\nFranchise Rights and Other Assets. Franchise rights were recorded in connection with the acquisition of the Nuggets beginning in 1989 and the Avalanche in 1995 (see Note 7). These rights are being amortized over 25 years. The amounts shown on the balance sheets are net of accumulated amortization of $8,317,000 and $4,920,000 at December 31, 1995 and 1994, respectively.\nThe cash surrender values of life insurance policies (net of loans) totaling $12,879,000 and $12,784,000 at December 31, 1995 and 1994, respectively, are included in \"Other assets.\" In January 1996, the corporation repaid loans totaling $51,175,000. Other income on the income statement includes the increases in the cash surrender values of these policies. Additionally, other income for 1993 included income of $4,131,000 ($3,137,000 net of tax) from the death benefit proceeds of corporate-owned policies.\nCash Flow Information. The corporation considers highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.\nNew Accounting Pronouncements. 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,\" were issued in 1995 and will be adopted by the corporation in 1996. The corporation has elected not to adopt the recognition and measurement provisions of SFAS No. 123. The effect of adopting these statements in 1996 is not expected to be material to the corporation.\nStatement Presentation. Certain prior period amounts have been reclassified to conform with the current year's presentation.\n2. RECEIVABLES\nReceivables at each year end are composed of:\nUnbilled amounts represent accumulated costs and accrued profits that will be billed at future dates in accordance with contract terms and delivery schedules. All but approximately $5,933,000 of these amounts are expected to be collected within one year. Unbilled amounts are net of progress payments of $74,677,000 in 1995 and $55,563,000 in 1994. U.S. Government receivables include $11,500,000 at December 31, 1995, for estimated recoveries on claims in excess of committed contract amounts. Revenues related to claims for constructive change orders on long-term contracts are recorded at the estimated amount of recoverable costs incurred. These estimates could change in the near term as the claims are settled with the U.S. Government.\n3. INVENTORIES\nInventories, stated at the lower of cost (first-in, first-out) or market, consist of the following at each year end:\n4. PROPERTY AND EQUIPMENT\nProperty and equipment include the corporation's shares of INTELSAT and Inmarsat property and equipment.\nDepreciation is calculated using the straight-line method over the estimated service life of each asset. The service lives for property and equipment are: satellites, 10 to 13 years; furniture, fixtures and equipment, 3 to 15 years; buildings and improvements, 3 to 40 years.\nCosts of satellites that are lost at launch or that fail in orbit are carried, net of any insurance proceeds, in the property accounts. The remaining net amounts are depreciated over the estimated service life of a satellite of the same series.\nOn February 14, 1996, the launch of the INTELSAT 708 satellite failed. The corporation's share of the construction and capitalized interest costs was fully insured. Insurance proceeds totaling approximately $54 million are expected to be received in the second quarter of 1996.\n5. ASCENT ENTERTAINMENT GROUP, INC.\nAscent Entertainment Group, Inc. (Ascent) consists of Ascent Network Services, Inc. (ANS), formerly COMSAT Video Enterprises, Inc., and ANS's ownership of On Command Video Corporation (OCV), the Denver Nuggets Limited Partnership, Beacon Communications Corp. and the Colorado Avalanche (see Note 7). In December 1995, Ascent completed a public offering of 5,750,000 shares of its common stock at an offering price of $15.00 per share. COMSAT retains 24,000,000 shares, or 80.67% of Ascent. Concurrent with the public offering, Ascent repaid a $140,000,000 intercompany note payable to COMSAT. COMSAT recognized a $19,286,000 pre-tax gain as a result of the public offering.\nIn the third quarter of 1995, ANS contributed substantially all of its pay-per-view video systems in hotels and related assets to OCV for OCV common stock. This transaction raised Ascent's ownership of OCV to 85%, an increase of 5%.\n6. MERGER WITH RADIATION SYSTEMS, INC.\nOn June 3, 1994, the corporation consummated its merger with Radiation Systems, Inc. (RSi), based in Sterling, Virginia. RSi designs, manufactures and integrates satellite earth stations, advanced antennas and other turnkey systems for telecommunications, radar, air traffic control and military uses.\nEach share of RSi's common stock was converted into 0.78 of a share of the corporation's common stock. A total of 6,147,000 shares of the corporation's common stock were issued for RSi's common stock.\nThe merger was accounted for as a pooling of interests. Accordingly, financial statements for periods prior to the merger were restated to include RSi. The corporation recorded nonrecurring charges to operations in 1994 totaling $7,367,000 ($6,269,000 net of taxes or $0.13 per share) for merger and integration costs. These charges consisted of $4,446,000 for investment banking, legal and other professional fees, $2,226,000 for the costs associated with closing a former RSi division, and $695,000 for severance and related costs.\n7. ACQUISITIONS AND INVESTMENTS\nColorado Avalanche. In July 1995, Ascent acquired a National Hockey League franchise and related player contracts, management contracts and certain other assets from Le Club de Hockey Les Nordiques in Quebec, Canada for $75,840,000. The cost of this acquisition was allocated primarily to \"franchise rights\" (see Note 1). As part of the purchase, the corporation assumed contractual commitments to players aggregating $24,625,000 over the next three years. The franchise, which was known as the Quebec Nordiques, has been relocated to Denver, Colorado and is known as the Colorado Avalanche (the Avalanche).\nBeacon Communications Corp. In December 1994, Ascent acquired the assets of Beacon Communications Corp. (Beacon), a film and television production company based in Los Angeles. The cost of this acquisition was $29,133,000 which consisted of $16,180,000 in cash and liabilities assumed of $12,953,000. The purchase agreement calls for future cash consideration of up to $16,900,000 which is contingent on the production and performance of motion pictures over the next five years. If Beacon had been acquired as of January 1, 1993, the corporation's consolidated revenues would have\nbeen $853,394,000 and $772,425,000 for 1994 and 1993, respectively, and the consolidated net income would have been $61,969,000 and $80,377,000 for 1994 and 1993, respectively (unaudited).\nInvestments. In June 1994, the corporation acquired an interest of approximately 17% in Philippine Global Communications, Inc. (PhilCom), a provider of international communications services in the Philippines, for $42,141,000. The corporation's share of PhilCom's income or losses is recorded using the \"equity method\" of accounting and is included in \"Other income (expense), net\" on the income statement.\nIn 1995, the corporation made direct cash investments totaling $11,350,000 in a new company, I-CO Global Communications (Holdings) Limited (ICO), that will own and operate a satellite system. The accompanying balance sheet also includes the corporation's $14,226,000 share of Inmarsat's investment in ICO as of December 31, 1995 (see Note 10).\nThe corporation has investments in other businesses that are accounted for using the equity and cost methods of accounting. These investments (including PhilCom and ICO) totaled $88,378,000 and $69,541,000 at December 31, 1995 and 1994, respectively.\n8. DEBT\nThe corporation, as regulated by the Federal Communications Commission (FCC), is allowed to undertake long-term borrowings of up to 45% of its total capital (long-term debt plus equity) and $200,000,000 in short-term borrowings. The corporation also has a requirement to maintain an interest expense coverage ratio, as defined, of 2.3 to 1.\nCommercial Paper. The corporation issues short-term commercial paper as needed with repayment terms of 90 days or less under a $200,000,000 program. The corporation had no outstanding borrowings at December 31, 1995, and $121,356,000 in borrowings outstanding at December 31, 1994. The weighted average interest rate on these borrowings was 6.1% at December 31, 1994.\nCredit Facilities. The corporation has a $200,000,000 revolving credit agreement, which expires in December 1999, as a backup to the commercial paper program. There have been no borrowings under this agreement.\nAscent has a $175,000,000 bank credit agreement which consists of a $70,000,000 five-year facility and a $105,000,000 one-year facility. The agreement requires compliance with financial covenants including the maintenance of certain financial ratios and precludes the payment of cash dividends by Ascent. The corporation's share of Ascent's net assets as of December 31, 1995, was approximately $244,000,000. At December 31, 1995, $70,000,000 was outstanding under the five-year facility and is classified as long-term debt. The weighted average interest rate on these borrowings was 6.2% at December 31, 1995.\nLong-Term Debt. Long-term debt including the corporation's share of INTELSAT and Inmarsat debt at each year end consists of:\nIn July 1994, the corporation filed a shelf registration statement with the Securities and Exchange Commission (SEC) to issue up to $200,000,000 of debt securities. The corporation also filed a prospectus supplement with the SEC to issue up to $100,000,000 of such securities under a \"medium-term note program.\" The corporation issued four notes totaling $42,000,000, which are due in 2007, with rates of 7.7% to 8.5% during 1995 under this program. The corporation also issued two medium-term notes totaling $32,000,000 in 1994, which are due in 2006, with rates of 8.05% to 8.66%. The $26,000,000 remaining under the medium-term note program may be issued from time to time, at fixed or floating interest rates, as determined at the time of issuance.\nThe principal amount of debt (excluding the Inmarsat lease financing obligation) maturing over the next five years is $1,313,000 in 1996, $773,000 in 1997, $1,910,000 in 1998, $305,000 in 1999 and $98,964,000 in 2000.\nInmarsat Lease Financing Obligations. Inmarsat borrowed (pound)140,400,000 sterling under a capital lease agreement to finance the construction of second-generation Inmarsat satellites. Inmarsat also entered into another capital lease arrangement to finance the construction costs of its third-generation satellites. As of December 31, 1995, (pound)102,900,000 sterling of the (pound)197,000,000 sterling available for this purpose has been borrowed. The corporation's share of these lease obligations is included in long-term debt. Inmarsat has hedged its obligations through various foreign exchange transactions to minimize the effect of fluctuating interest and exchange rates (see Note 18).\nThe corporation's share of the payments under these lease obligations for each of the next five years is $17,047,000 in 1996, $19,080,000 in 1997, $19,868,000 in 1998, $21,288,000 in 1999, $22,553,000 in 2000 and $71,171,000 thereafter. These payments include interest totaling $58,804,000 and a current maturity of $10,376,000.\n9. MONTHLY INCOME PREFERRED SECURITIES\nIn July 1995, COMSAT Capital I, L.P. (COMSAT Capital) issued $200,000,000 of Monthly Income Preferred Securities (MIPS). COMSAT Capital is a limited partnership formed for the sole purpose of issuing the MIPS and loaning the proceeds to COMSAT, the managing general partner. The MIPS were issued at a par value of $25 per share, and dividends are payable monthly at an annual rate of 8.125%. The MIPS are callable by the issuer after July 2000 at par value. The proceeds of the MIPS were loaned to COMSAT\nunder the terms of a 8.125%, 30-year subordinated debenture agreement. This agreement allows COMSAT to extend the maturity of the debentures until 2044, provided that COMSAT satisfies certain financial covenants. The proceeds were used to repay commercial paper borrowings and a $75,000,000 bank loan incurred in the acquisition of the NHL franchise and related assets discussed in Note 7. COMSAT Capital has been consolidated in the financial statements of the corporation since the third quarter of 1995. The loan between the partnership and COMSAT has been eliminated in consolidation. The $200,000,000 of MIPS is shown on the corporation's consolidated balance sheet as \"preferred securities issued by subsidiary.\" The dividends on these securities are recorded as minority interest expense of $7,358,000 in 1995 and are included in \"Other income (expense), net\" in the consolidated financial statements.\n10. COMMITMENTS AND CONTINGENCIES\nProperty and Equipment. As of December 31, 1995, the corporation had commitments to acquire property and equipment totaling $300,714,000. Of this total, $278,200,000 is payable over the next three years. These commitments are related principally to the corporation's share of INTELSAT and Inmarsat satellite acquisition programs.\nEmployment and Consulting Agreements. The corporation has employment and consulting agreements with certain officers, coaches and players. Virtually all of these agreements provide for guaranteed payments. Other contracts provide for payments contingent upon the fulfillment of certain terms and conditions, which generally relate only to normal performance of employment duties. Amounts required to be paid under such agreements (including approximately $92,115,000 relating to player agreements) total approximately $50,624,000 in 1996, $39,151,000 in 1997, $23,535,000 in 1998, $10,464,000 in 1999, $4,468,000 in 2000 and $3,154,000 thereafter.\nLeases. The corporation leases its headquarters building from a partnership in which the corporation owns a 50% interest. The initial term of the lease expires in 2008. The annual rent expense under this lease is $4,119,000. In addition to lease payments, the corporation is responsible for taxes, insurance and maintenance of the building. The corporation also has leases of other property and equipment. Rental expense under operating leases was $10,182,000 in 1995, $8,381,000 in 1994 and $7,993,000 in 1993. The future rental payments under operating leases are $8,452,000 in 1996, $8,380,000 in 1997, $7,855,000 in 1998, $6,880,000 in 1999 and $5,706,000 in 2000.\nGovernment Contracts. The corporation is subject to audit and investigation by various agencies which oversee contract performance in connection with the corporation's contracts with the U.S. Government. If the corporation is found liable for wrongdoing as a result of such an audit or investigation, the corporation could be fined or subjected to other punitive actions. Management believes that potential claims from such audits and investigations will not have a material adverse effect on the corporation's financial statements.\nEnvironmental Issue. The corporation is engaged in a program to monitor a toxic solvent spill of limited scope at the site of its former manufacturing subsidiary in California. The corporation believes that it has complied with the directions of state authorities to date, including removing approximately 458 cubic yards of soil from the site soon after the leak was discovered in 1986 and conducting ongoing groundwater monitoring at the site. The corporation has accruals to cover monitoring costs over the near term, but it is unclear at this time whether or to what extent groundwater remediation may be required.\nInvestment in ICO. In 1994, the corporation and Inmarsat committed to invest in ICO (see Note 7). ICO plans to build and operate spacecraft and related terrestrial facilities for the provision of worldwide mobile communications via handheld devices. As of December 31, 1995, the corporation's cash contributions totaled $11,350,000, and the corporation's share of Inmarsat's contributions totaled $14,226,000. In January 1996, the corporation invested an additional $29,200,000 and has committed to invest $73,250,000 in two installments due in December 1996, and December 1997. The corporation's share of Inmarsat's future commitments to ICO totaled approximately $23,400,000 as of December 31, 1995.\nThe corporation has applied to the FCC for authority to participate as an investor and service provider in ICO. In acting on the application, which is being opposed by ICO's competitors, the FCC will determine whether the corporation satisfies the requisite legal and policy criteria to participate in ICO. The corporation believes that all necessary operating authorizations with respect to ICO will be obtained.\n11. REGULATORY ENVIRONMENT AND LITIGATION\nRegulatory Environment. Under the Communications Act of 1934 and the Satellite Act, as amended, the corporation is subject to regulation by the FCC with respect to communications facilities and services provided through the INTELSAT and Inmarsat systems and to the rates charged for those services.\nUntil 1985, the corporation was, with minor exceptions, the sole U.S. provider of international satellite communications services using the INTELSAT system. Since then, the FCC has authorized several international satellite systems separate from INTELSAT. These separate U.S. systems currently compete against the corporation for voice, video and data traffic. In 1993, the FCC substantially eliminated prior restrictions on the ability of separate systems to offer public switched telephony services, thereby increasing competition to the corporation in the voice market. The U.S. Government has established a goal of eliminating all restrictions on competitive systems by 1997.\nThe corporation has received FCC authorization to participate in the construction of four third-generation Inmarsat satellites, with an application relating to a fifth satellite pending (see Note 4). The first Inmarsat-3 satellite is scheduled to be launched in the first half of 1996. The corporation has applied for authority to provide services via those satellites. Those applications, which have been opposed by certain of the corporation's competitors, are pending before the FCC. The corporation believes that all requisite operating authorizations with respect to these satellites will be obtained.\nLitigation. The corporation is defending an antitrust suit brought by PanAmSat against the corporation, alleging interference with PanAmSat's efforts to compete in the international satellite communications market, and seeking trebled damages of approximately $1.5 billion. In 1991, a U.S. Court of Appeals ruled that the corporation is immune from antitrust suits in its role as a signatory to INTELSAT. An amended complaint was filed alleging that the corporation violated antitrust laws in its business activities purportedly outside of its role as a signatory to INTELSAT. In February 1994, PanAmSat submitted a report estimating its alleged damages (before trebling) at a 1994 present value of $227,436,000. Discovery in the suit ended in November 1994; however, PanAmSat has motions pending which, if granted, would result in additional discovery. In December 1994, the corporation filed a motion which is pending before the court for summary judgment directed to dismissal of all claims in the complaint. In the opinion of management, the complaint against the corporation is without merit, and the ultimate disposition of this matter will not have a material adverse effect on the corporation's financial statements.\n12. STOCKHOLDERS' EQUITY\nTreasury Stock. The corporation acquired 404,500 shares of RSi common stock in 1993 for $5,098,000. Additionally, RSi acquired 80,000 shares of its own common stock for $870,000. These shares, which were equivalent to 378,000 shares of COMSAT common stock, were accounted for as treasury stock transactions as of December 31, 1993. These shares, in addition to RSi's other treasury shares, were retired upon consummation of the merger discussed in Note 6. Accordingly, 683,000 shares of the corporation's common stock, with a total cost of $8,163,000, were retired in 1994.\nInvestors' Plus Plan. The corporation has a plan that allows investors to purchase shares of common stock directly from the corporation. In 1995, 145,000 shares were issued with total proceeds of $3,027,000 and in 1994, 76,000 shares were issued with total proceeds of $977,000.\n13. STOCK INCENTIVE PLANS\nThe corporation has stock incentive plans that provide for the issuance of stock options, restricted stock awards, stock appreciation rights and restricted stock units. A total of 8,099,000 shares of common stock may be granted under the current plans. As of December 31, 1995, 849,000 shares of the corporation's treasury stock and 750,000 unissued common shares were reserved for these plans. As of December 31, 1995, no stock appreciation rights were outstanding.\nStock Options. Under the current plans, the exercise price for stock options may not be less than the fair market value of the stock when granted. Options vest over three years and expire after 10 to 15 years. Stock option activity was as follows:\nThe exercise price of certain options granted prior to 1993 is equal to 50% of the market price on the grant date. The cost of these awards, which is the 50% discount to market when granted, was recorded as unearned compensation and is shown as a separate component of stockholders' equity. This unearned compensation has been amortized to expense over the three-year vesting period. The exercise price for options awarded after 1992 is equal to the fair market value on the grant date. Accordingly, no expense is recorded for these options.\nRestricted Stock Awards. Restricted stock awards are shares of stock that are subject to restrictions on their sale or transfer. During 1993, 348,000 restricted stock awards were granted, net of awards forfeited. The market value of the shares awarded was recorded as unearned compensation and is being amortized to expense over the six-year vesting period.\nIn 1995, 91,000 \"performance-based\" restricted stock awards were granted and in 1994, 265,000 awards were granted. With respect to the 1995 awards, grantees have record ownership of the underlying securities. However, all such securities are subject to forfeiture at the end of a two-year performance period. With respect to the 1994 awards, grantees did not have record ownership of the underlying shares of stock until the end of a two-year performance period. The actual shares awarded are based upon the achievement of the applicable financial performance targets during the relevant performance period. As of December 31, 1995, the end of the performance period with respect to the 1994 awards, 116,000 shares of stock, net of amounts forfeited, were eligible to be issued in connection with these awards. The shares to be issued are subject to restrictions on their sale or transfer for three additional years. The expected cost of these grants is being amortized over five years. The amortization was recorded as compensation expense of $1,009,000 in 1995 and $1,420,000 in 1994, and a corresponding increase to stockholders' equity.\nRestricted Stock Units. Restricted stock units entitle the holder to receive a combination of stock and cash equal to the market price of common stock for each unit, when vested. These units vest over three years. During 1995, 1994 and 1993, respectively, 71,000, 115,000 and 49,000 restricted stock units were granted. Partially vested restricted stock units outstanding totaled 202,000 at December 31, 1995 and 189,000 at December 31, 1994. The cost of these awards, which is the market value of the units when vested, is amortized to expense over the three-year vesting period. The amounts amortized to expense in 1995, 1994 and 1993 were $1,286,000, $335,000 and $1,538,000, respectively.\nEmployee Stock Purchase Plan. Employees may purchase stock at a discount through the corporation's Employee Stock Purchase Plan. The purchase price of the shares is the lower of 85% of the fair market value of the stock on the offering date, or 85% of the fair market value of the stock on the last business day of each month throughout the one-year offering period. The offering date for 1996 purchases was November 17, 1995, when 85% of the fair market value was $16.04.\nAs of December 31, 1995, a total of 2,012,000 shares of the corporation's unissued common stock has been reserved for this plan.\nEmployee Stock Ownership Plan. A subsidiary of the corporation has an Employee Stock Ownership Plan (ESOP) which was established for the benefit of eligible employees. The ESOP acquired 714,000 shares of common stock in 1988 with bank loan proceeds. The corporation makes periodic contributions to the ESOP at least sufficient to make principal and interest payments when they are due. Contributions to the ESOP charged to expense totaled $800,000 in 1995, $864,000 in 1994 and $1,049,000 in 1993. The corporation has guaranteed the ESOP's bank notes payable and has reported the unpaid balance of these loans as long-term debt of the corporation. An unearned ESOP compensation amount, which is equal to the unpaid bank loans, has been recorded as a reduction to stockholders' equity.\n14. PENSION AND OTHER BENEFIT PLANS\nThe corporation has a non-contributory, defined benefit pension plan for qualifying employees. Pension benefits are based on years of service and compensation prior to retirement.\nThe components of net pension expense for each year are:\nThe corporation recognized a $1,380,000 curtailment gain in the second quarter of 1995 which arose from the reduction of pension benefits for a group of employees. Additionally, the provision for restructuring recorded in 1995 (see Note 16) is net of a $925,000 curtailment gain resulting from workforce reductions.\nThe following table shows the pension plan's obligations and assets as well as the liability recorded in the corporation's balance sheet at each year end.\nThe plan's assets consist primarily of common stock, corporate and government bonds and short-term investments. The corporation's policy is to fund the minimum actuarially computed contributions required by law. The corporation made a $102,000 cash contribution to the plan in 1994. No contribution was required for 1995.\nSupplemental Executive Retirement Plan. The corporation has an unfunded supplemental pension plan for executives. The expense for this plan was $2,505,000, $2,976,000 and $2,058,000 for 1995, 1994 and 1993, respectively.\nIn accordance with the provisions of Financial Accounting Standard No. 87, the corporation recorded a minimum plan liability for the excess of the accumulated benefit obligation over the accrued plan liability. This was reported as a reduction to stockholders' equity of $3,563,000 as of December 31, 1995 and $1,557,000 as of December 31, 1994. These amounts are net of deferred income taxes and net of an intangible asset recorded for the unrecognized transition obligation.\nThe following table shows the plan's obligations as well as the liability recorded in the corporation's balance sheet at each year end.\n401(k) Plan. The corporation has a 401(k) plan for qualifying employees. A portion of employee contributions is matched by the corporation. The corporation's matching contribution for the year ended December 31, 1993 was $3,237,000. Since 1994, the matching contributions have been made in shares of the corporation's common stock. In 1995, 177,000 shares of common stock with a total market value of $3,391,000 were\ncontributed to the plan. In 1994, 79,000 shares with a total market value of $1,941,000 were contributed to the plan.\nPostretirement Benefits. The corporation provides health and life insurance benefits to qualifying retirees. The expected cost of these benefits is recognized during the years in which employees render service.\nThe components of the net postretirement benefit expense for each year were:\nThe corporation recognized a $1,300,000 curtailment gain in the second quarter of 1995 which arose from the elimination of postretirement health care benefits for a group of employees. Additionally, the provision for restructuring recorded in 1995 (see Note 16) is net of a $993,000 curtailment gain resulting from workforce reductions.\nThe following table shows the plan's obligations as well as the liability recorded in the corporation's balance sheet at each year end.\nA 10.0% increase in health care costs was assumed for 1995 with the rate decreasing 0.5% each year to an ultimate rate of 5.5%. Increasing the assumed trend rate by 1.0% each year would have increased the accumulated postretirement benefit obligation as of December 31, 1995 by $3,858,000 and the benefit expense for 1995 by $507,000.\n15. INCOME TAXES\nThe corporation adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. This accounting statement changed the method for the recognition and measurement of deferred tax assets and liabilities. The cumulative effect of adopting SFAS No. 109 on the corporation's financial statements was to increase income by $1,925,000 ($0.04 per share) and was recorded in the first quarter of 1993. Prior year financial statements were not restated.\nThe components of income tax expense for each year are:\nThe difference between tax expense computed at the statutory Federal tax rate and the corporation's effective tax rate is:\nThe current and net non-current components of deferred tax accounts as shown on the balance sheet at December 31, 1995 and 1994 are:\nThe deferred tax assets and liabilities at December 31, 1995 and 1994 are:\nThe Internal Revenue Service (IRS) has completed examinations of the Federal income tax returns of the corporation through 1989 and is currently examining Federal income tax returns for 1990 through 1994. The corporation has also amended its returns and filed claims for refunds for 1979 through 1987. The IRS has denied these claims. The corporation is contesting this denial by the IRS. In the opinion of the corporation, adequate provision has been made for income taxes for all periods through 1995.\n16. PROVISION FOR RESTRUCTURING\nIn the third quarter of 1995, the corporation took actions to strategically restructure elements of all its business units to lower costs and improve competitiveness for the long term. The corporation recorded a $20,044,000 provision for these restructuring actions. This provision includes $1,858,000 for employee severance costs in COMSAT World Systems (CWS) and COMSAT Mobile Communications (CMC), $10,866,000 to restructure COMSAT's entertainment businesses, and $7,320,000 to restructure several businesses within COMSAT RSI (CRSI) and for actions taken in COMSAT Laboratories.\nThe actions taken in CWS and CMC were associated with the consolidation of the management and administration of these two businesses into one business unit. As a result, various administrative, marketing and other positions were eliminated.\nIn the third quarter of 1995, management decided to discontinue the Satellite Cinema scheduled movie operations. The corporation is converting certain Satellite Cinema hotel properties to services provided by On Command Video Corporation and has discontinued or sold Satellite Cinema operations at the remaining hotel properties. The restructuring charge included a provision of $5,140,000 to write down property and inventory to estimated realizable value, an accrual of $1,010,000 for employee severance costs and a charge of $4,716,000 for costs related principally to settling contractual commitments incurred to support the Satellite Cinema business that will not be fulfilled. Additional charges related to the discontinued Satellite Cinema operations may be recorded based upon actual salvage values or severance costs for additional personnel. Revenues for the Satellite Cinema operations were $25,036,000, $34,753,000 and $41,325,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Operating income (loss) before allocation of general and administrative expenses was $(16,591,000), $3,897,000 and $2,017,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nWithin CRSI, the corporation combined the management and administration of four of its business units into two businesses and decided to discontinue certain product lines in another business unit. The corporation also downsized one of the divisions of its Laboratories business. These actions were substantially completed by the end of 1995. The restructuring provision included $1,920,000 for employee severance costs associated with these actions and $5,400,000 primarily to write down inventory to its estimated realizable value.\n17. BUSINESS SEGMENT INFORMATION\nThe corporation reports operating results and financial data in four business segments: International Communications, Mobile Communications, Technology Services and Entertainment. The International Communications segment consists of activities undertaken by the corporation in its COMSAT World Systems (CWS) and COMSAT International Ventures (CIV) businesses. CWS provides voice, data, video and audio communications services between the U.S. and other countries using the INTELSAT satellite network. CIV develops, acquires and manages telecommunications companies in high-growth emerging markets overseas. These ventures provide a wide array of private line and public switched communications services and equipment installations. The Mobile Communications segment consists of activities undertaken by the corporation in its COMSAT Mobile Communications (CMC) business. CMC provides voice, data, fax, telex and information services for ships, aircraft and land mobile applications throughout the world using the Inmarsat satellite system. The Technology Services segment consists of the financial results of COMSAT RSI and COMSAT Laboratories, which include the design and manufacture of voice and data communications networks and products,\nsystems integration services, and applied research and technology services for worldwide users. The Entertainment segment consists of the financial results of Ascent (see Note 5). Ascent provides on-demand entertainment programming and information services primarily to the domestic hospitality industry, owns a professional basketball team and a professional hockey team, and owns a film and television production company.\nSegment Information\n(1) Technology Services segment revenues include intersegment sales totaling $9,960,000 in 1995, $8,625,000 in 1994 and $10,132,000 in 1993. Intersegment sales for other segments are not significant. Revenues and operating income reported for the Technology Services segment include business interruption insurance proceeds of $4,835,000 in 1994 and $3,021,000 in 1993. (2) The method of allocating indirect corporate costs was changed in 1995. Segment operating results for 1994 and 1993 have been restated for this change. (3) If the 1995 provision for restructuring (see Note 16) had been charged to segment operating income, the amounts allocated to each segment would have been: International Communications, $515,000; Mobile Communications, $1,343,000; Entertainment, $10,866,000; and Technology Services, $7,320,000. (4) The corporation's investments in unconsolidated businesses are included in Corporate and other assets.\nRelated Party Transactions. The corporation provides support services to INTELSAT and support services and satellite capacity to Inmarsat. The revenues from these services were $25,190,000 in 1995, $26,162,000 in 1994 and $23,190,000 in 1993. These revenues were recorded primarily in the International Communications and Technology Services segments.\nSignificant Customers. Revenues in 1995,1994 and 1993, respectively, included sales to the U.S. Government of $121,152,000, $121,715,000 and $115,446,000, and to AT&T of $81,866,000, $100,096,000 and $117,582,000. Substantially all of the U.S. Government sales are reported in the Mobile Communications and Technology Services segments. Substantially all of the sales to AT&T are reported in the International Communications and Mobile Communications segments.\n18. FINANCIAL INSTRUMENTS AND OFF-BALANCE-SHEET RISKS\nThe corporation owns a 50% interest in a partnership which owns the headquarters building leased by the corporation (see Note 10). The corporation has guaranteed repayment of a portion of the partnership's construction loan. The balance of the guarantee was $2,396,000 as of December 31, 1995. The guarantee will be reduced as the loan's principal balance is repaid. The corporation was also contingently liable to banks for $13,731,000 as of December 31, 1995, for outstanding letters of credit securing performance of certain contracts. The estimated fair value of these instruments is not significant.\nInmarsat has entered into foreign currency contracts designed to minimize exposure to exchange rate fluctuations on fixed operating expenses denominated primarily in British pounds sterling. At December 31, 1995, Inmarsat had several contracts maturing in 1996 to purchase foreign currency for a total of $87,200,000. The corporation's share of the estimated fair value of these contracts, as determined by a bank, is an unrealized loss of approximately $400,000 at December 31, 1995.\nInmarsat has entered into interest rate and foreign currency swap arrangements to minimize the exposure to interest rate and foreign currency exchange fluctuations related to its satellite financing obligations. Inmarsat borrowed and is obligated to repay pounds sterling. The pounds sterling borrowed were swapped for U.S. dollars with an agreement to exchange the dollars for pounds sterling in order to meet the future lease payments. Inmarsat pays interest on the dollars at an average fixed rate of 8.8%, and it receives variable interest on the sterling amounts based on short-term LIBOR rates. The differential to be paid or received is accrued as interest rates change and is recognized over the life of the agreements. The currency swap arrangements have been designated as hedges, and any gains or losses are included in the measurement of the debt. The effect of these swaps is to change the sterling lease obligation into fixed-interest-rate dollar debt. As of December 31, 1995, Inmarsat had $406,900,000 of swaps to be exchanged for (pound)249,500,000 sterling at various dates through 2006. Inmarsat is exposed to loss if one or more of the counterparties defaults. However, Inmarsat does not anticipate non-performance by the counterparties as all are major financial institutions. The corporation's share of the estimated fair value of these swaps is an unrealized loss of $10,000,000 at December 31, 1995. The fair value was estimated by computing the present value of the dollar obligations using current rates available for issuance of debt with similar terms, and the current value of the sterling at year-end exchange rates.\nThe fair value of long-term debt (excluding capitalized leases) was estimated by obtaining a yield-adjusted price as of December 31, 1995 for each obligation from an investment banker. Book In thousands Amount Fair Value ---------------------------------------------------------------------- 8.125% notes due 2004 $ 160,000 $ 178,112 8.95% notes due 2001 75,000 85,470 INTELSAT bonds 181,507 199,108 Medium-term notes 74,000 83,227\nThe fair values of the remaining long-term debt not itemized above and the corporation's other financial instruments are approximately equal to their carrying values.\n19. QUARTERLY FINANCIAL INFORMATION (Unaudited)\n(1) Revenues include the corporation's share of NBA expansion fees totaling $8,802,000 in the second quarter of 1995 and $367,000 in the fourth quarter of 1995. (2) The third quarter of 1995 includes a $20,044,000 provision for restructuring (see Note 16 to the financial statements). (3) The fourth quarter of 1995 includes a $19,286,000 pre-tax gain as a result of the public offering of the common stock of Ascent (see Note 5 to the financial statements). Additionally, the corporation recorded accounting charges to operating income totaling $2,265,000 net of tax, to conform the corporation's consolidation of Ascent to Ascent's externally reported financial results. (4) Revenues include business interruption insurance income of $4,835,000 in the second quarter of 1994. (5) Operating income is net of nonrecurring charges for merger and integration costs totaling $4,264,000, $477,000 and $2,626,000 in the second, third and fourth quarters of 1994, respectively. (6) The fourth quarter of 1994 includes nonrecurring charges of $1,049,000 for employee severance costs related to a reduction in force and $7,206,000 for the corporation's share of costs related to an early retirement program offered by INTELSAT.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. None.\nPART III\nExcept for the portion of Item 10","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Officers of the Registrant. Item 11.","section_11":"Item 11. Executive Compensation. Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) Documents filed as part of this Report.\n1. Consolidated Financial Statements and Supplementary Data of Registrant.\na. Independent Auditors' Report b. Consolidated Financial Statements of COMSAT Corporation and Subsidiaries\n(i) Consolidated Income Statements for the Years Ended December 31, 1995, 1994 and 1993\n(ii) Consolidated Balance Sheets as of December 31, 1995 and 1994\n(iii) Consolidated Cash Flow Statements for the Years Ended December 31, 1995, 1994 and 1993\n(iv) Statements of Changes in Consolidated Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993\n(v) Notes to Consolidated Financial Statements for Each of the Three Years in the Period Ended December 31,\n2. Financial Statement Schedules Relating to the Consolidated Financial Statements of COMSAT Corporation for Each of the Three Years in the Period Ended December 31, 1995.\na. Schedule I -- Condensed Financial Information of Registrant b. Schedule II -- Valuation and Qualifying Accounts\nAll Schedules except those listed above have been omitted because they are not applicable or not required or because the required information is included elsewhere in the financial statements in this filing.\n(b) Reports on Form 8-K.\nNone.\n(c) Exhibits (listed according to the number assigned in the table in Item 601 of Regulation S-K).\nExhibit No. 3 - Articles of Incorporation and By-laws.\n3.1 Articles of Incorporation of Registrant, composite copy, as amended through June 1, 1993. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Registration Statement on Form S-3 (No. 33-51661) filed on December 22, 1993).\n3.2 By-laws of Registrant, as amended through February 16, 1996.\n3.3 Regulations adopted by Registrant's Board of Directors pursuant to Section 5.02(c) of Registrant's Articles of Incorporation. (Incorporated by reference from Exhibit No. 3(c) to Registrant's Report on Form 10-K for the fiscal year ended 1992.)\nExhibit No. 4 - Instruments defining the rights of security holders, including indentures.\n4.1 Specimen of a certificate representing Series I shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934, which are held by citizens of the United States. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n4.2 Specimen of a certificate representing Series I shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934, which are held by aliens. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1982.)\n4.3 Specimen of a certificate representing Series II shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1982.)\n4.4 Standard Multiple-Series Indenture Provisions, dated March 15, 1991. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Registration Statement on Form S-3 (No. 33-39472) filed on March 15, 1991.)\n4.5 Indenture dated as of March 15, 1991 between Registrant and The Chase Manhattan Bank, N.A. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Registration Statement on Form S-3 (No. 33-39472) filed on March 15, 1991.)\n4.6 Supplemental Indenture, dated as of June 29, 1994, from the Registrant to The Chase Manhattan Bank, N. A. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Registration Statement on Form S-3 (No. 33-54369) filed on June 30, 1994.)\n4.7 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $75,000,000 aggregate principal amount of Registrant's 8.95% Notes Due 2001 (with form of Note attached). (Incorporated by reference from Exhibit No. 4 to Registrant's Current Report on Form 8-K filed on May 15, 1991.)\n4.8 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $160,000,000 aggregate principal amount of Registrant's 8.125% Debentures Due 2004 (with form of Debenture attached). (Incorporated by reference from Exhibit No. 4 to Registrant's Current Report on Form 8-K filed on April 9, 1992.)\n4.9 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, as supplemented by the Supplemental Indenture, dated as of June 29, 1994, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $100,000,000 aggregate principal amount of Registrant's Medium Term Notes, Series A (with forms of Notes attached). (Incorporated by reference from Exhibit No. 4(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n4.10 Limited Partnership Agreement of COMSAT Capital I, L.P., dated as of July 18, 1995, relating to issuance of monthly income preferred securities. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n4.11 Guarantee Agreement for Preferred Securities of COMSAT Capital I, L.P., dated as of July 18, 1995. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n4.12 Indenture between Registrant and the First National Bank of Chicago, as Trustee, dated as of July 18, 1995. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\nExhibit No. 10 - Material Contracts\n10.1 Agreement Relating to the International Telecommunications Satellite Organization (INTELSAT) by Governments, which entered into force on February 12, 1973. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.2 Operating Agreement Relating to INTELSAT by Governments which entered into force on February 12, 1973. (Incorporated by reference from Exhibit No. 10(b) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.3 Agreement dated August 15, 1975, among COMSAT General Corporation, RCA Global Communications, Inc., Western Union International, Inc. and ITT World Communications, Inc. relating to the establishment of a joint venture for the purpose of participating in the ownership and operation of a maritime communications satellite system and Amendment Nos. 1-4 and Amendment No. 5 dated March 24, 1980. (Incorporated by reference from Exhibit No. 10(p) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.4 Amendment No. 6 to Exhibit 10.3 dated September 1, 1981. (Incorporated by reference from Exhibit No. 10(p)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1981.)\n10.5 Convention on the International Maritime Satellite Organization (INMARSAT) dated September 3, 1976. (Incorporated by reference from Exhibit No. 11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1978.)\n10.6 Operating Agreement on INMARSAT dated September 3, 1976. (Incorporated by reference from Exhibit No. 12 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1978.)\n10.7* Registrant's 1982 Stock Option Plan. (Incorporated by reference from Exhibit No. 10(x) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1981.)\n10.8 Agreement dated October 6, 1983, between COMSAT General Corporation and National Broadcasting Company for the provision of satellite distribution network programming. (Incorporated by reference from Exhibit No. 10(r) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1983.)\n10.9 Amendment to Exhibit 10.8 dated September 1, 1992. (Incorporated by reference from Exhibit No. 10(j)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.10* Registrant's Insurance and Retirement Plan for Executives, as amended and restated by the Board of Directors on June 21, 1985, as amended by the Board of Directors\non July 15, 1993. (Incorporated by reference from Exhibit No. 10(h) to the Registrant's Form 10-K for the fiscal year ended December 31, 1993.)\n10.11* Registrant's 1986 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 10(g) to Registrant's Registration Statement on Form S-4 (File No. 33-9966) filed on November 4, 1986.)\n10.12* Registrant's Non-Employee Directors Stock Option Plan. (Incorporated by reference from Exhibit No. 10(h) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987.)\n10.13 Amendment No. 1 to Exhibit 10.12 dated March 16, 1990. (Incorporated by reference from Exhibit No. 10(g)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.14 Amendment No. 2 to Exhibit 10.12 dated January 15, 1993. (Incorporated by reference from Exhibit No. 10(k)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.15 Memorandum of Understanding between Registrant and National Aeronautics and Space Administration (NASA), dated July 21, 1988 and amended through February 22, 1990. (Incorporated by reference from Exhibit No. 10(aa) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.16 Agreement to Acquire and Lease (and Supplemental Agreements thereto) dated September 28 and October 10, 1988, respectively, among the International Maritime Satellite Organization (Inmarsat), the North Sea Marine Leasing Company, British Aerospace Public Limited Company, the European Investment Bank, Kreditanstalt Fuer Wiederaufbau, European Investment Bank (as Agent and as Trustee), Instituto Mobiliare Italiano, Credit National, Hellenic Industrial Development Bank, and Society Nationale de Credit a L'Industrie relating to the financing of three Inmarsat spacecraft. (Incorporated by Reference from Exhibit No. 3(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988.)\n10.17 Service Agreement, dated September 14, 1989, between Registrant and Aeronautical Radio, Inc. relating to satellite-based communications services. (Incorporated by reference from Exhibit No. 10(y) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.18 Agreement, dated January 22, 1990, between Registrant and Kokusai Denshin Denwa Co., Ltd. for provision of aeronautical services. (Incorporated by reference from Exhibit No. 10(z) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.)\n10.19 Amendment No. 1 to Exhibit 10.18 dated May 20, 1993. (Incorporated by reference from Exhibit No. 10(q)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.20* Registrant's 1990 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 10 (p) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.21* Amendment No. 1 to Exhibit 10.20 dated January 15, 1993. (Incorporated by reference from Exhibit No. 10(r)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.22* Amendment No. 2 to Exhibit 10.20 dated January 16, 1994. (Incorporated by reference from Exhibit No. 10(o)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.23 Amended and Restated Agreement, dated November 14, 1990, of Limited Partnership of Rock Spring II Limited Partnership. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.24 Amended and Restated Lease Agreement, dated November 14, 1990, of Limited Partnership of Rock Spring II Limited Partnership. (Incorporated by reference from Exhibit No. 10(b) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.25 Amended and Restated Ground Lease Indenture, dated November 14, 1990, between Anne D. Camalier (Landlord) and Rock Spring II Limited Partnership (Tenant). (Incorporated by reference from Exhibit No. 10(c) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.26 Finance Facility Contract (and Supplemental Agreements thereto), dated December 20, 1991, among the International Maritime Satellite Organization (Inmarsat), Abbey National plc, General Electric Technical Services Company, Inc., European Investment Bank, Kreditanstalt Fuer Wiederaufbau, Instituto Mobiliare Italiano S.p.A., Credit National, Societe Nationale de Credit a L'Industrie, Finansieringsinstituttet for Industri OG Haandvaerk A\/S, De Nationale Investeringsbank NV, and Osterreichische Investitionkredit Aktiengesellschaft relating to the financing of three Inmarsat spacecraft. (Incorporated by reference from Exhibit No. 10 (dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991.)\n10.27* Registrant's Directors and Executives Deferred Compensation Plan, as amended by the Board of Directors on July 15, 1993. (Incorporated by reference from Exhibit No. 10(v) to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.28 Service Agreement, dated September 12, 1990, between Registrant and GTE Airfone, Incorporated, for the provision of aeronautical satellite services. (Incorporated by reference from Exhibit No. 10(r) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.)\n10.29 Fiscal Agency Agreement, dated as of August 6, 1992, between International Telecommunications Satellite Organization and Morgan Guaranty Trust Company of New York. (Incorporated by reference from Exhibit No. 10 (dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.30 Fiscal Agency Agreement, dated as of January 19, 1993, between International Telecommunications Satellite Organization and Morgan Guaranty Trust Company of New York. (Incorporated by reference from Exhibit No. 10 (ee) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.31 Lease Agreement, dated June 8, 1993, between GTE Airfone, Incorporated, United Airlines, Inc. and Registrant for the provision and financing of aeronautical satellite equipment. (Incorporated by reference from Exhibit No. 10(aa) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.32 Agreement dated July 1, 1993, between Registrant and AT&T Easylink Services relating to exchange of telex traffic. (Incorporated by reference from Exhibit No. 10(bb) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.33 Agreement dated July 27, 1993, between the Registrant and American Telephone & Telegraph Company relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(cc) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.34 Amendment to Exhibit 10.33 dated as of December 1, 1995.\n10.35 Agreement dated September 1, 1993, between Registrant and MCI International, Inc. relating to exchange of traffic. (Incorporated by reference from Exhibit No. 10(dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.36 Agreement dated November 30, 1993, between the Registrant and Sprint Communications Company L.P. relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(ee) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.37 Amendment to Exhibit 10.36 dated April 7, 1995. (Incorporated by reference from Exhibit No. 10(a)(i) to Registrant's Report on Form 10-Q\/A Amendment No. 2 dated June 29, 1995 for the quarter ended March 31, 1995.)\n10.38 Agreement dated December 10, 1993, between Registrant and Sprint International relating to the exchange of traffic. (Incorporated by reference from Exhibit No. 10(ff) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.39 Credit Agreement dated as of December 17, 1993 among Registrant, NationsBank of North Carolina, N.A., Bank of America National Trust and Savings Association, The First National Bank of Chicago, The Chase Manhattan Bank, N.A., The Sumitomo Bank, Limited, New York Branch, Swiss Bank Corporation, New York Branch, as lenders, and NationsBank of North Carolina, N.A., as agent. (Incorporated by reference from Exhibit No. 10(gg) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.40 Amendment No. 1 to Exhibit 10.39 dated as of December 17, 1994. (Incorporated by reference from Exhibit No. 10(cc)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.41 Agreement dated January 24, 1994, between MCI International, Inc. and Registrant relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.42 Amendment to Exhibit 10.41 dated as of July 1, 1995.\n10.43 Agreement dated February 18, 1994, between Registrant and AT&T relating to exchange of traffic. (Incorporated by reference from Exhibit No. 10(jj) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.44 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Bankers Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 22 March 1994. (Incorporated by reference from Exhibit No. 10(kk) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.45 Distribution Agreement dated July 11, 1994 between Registrant and CS First Boston Corporation, Salomon Brothers Inc and Nationsbanc Capital Markets, Inc., as Distributors, of Registrant's Medium-Term Notes, Series A. (Incorporated by reference from Exhibit No. 10(ff) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.46 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Morgan Guaranty Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 14 October 1994. (Incorporated by reference\nfrom Exhibit No. 10(gg) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.47* Registrant's Annual Incentive Plan. (Incorporated by reference from Exhibit No. 10(hh) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.48 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Morgan Guaranty Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 28 February 1995. (Incorporated by reference from Exhibit No. 10(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.49 Asset Purchase Agreement, dated as of May 24, 1995, between COMSAT Video Enterprises, Inc. and Le Club de Hockey Les Nordiques, Societe en Commandite (Limited Partnership). (Incorporated by reference from Exhibit No. 10(a) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n10.50* Employment Agreement, dated as of December 18, 1995, between Ascent and Charles Lyons. (Incorporated by reference from Exhibit No. 10.16 to the Report on Form 10-K filed by Ascent Entertainment Group, Inc. for the fiscal year ended December 31, 1995.)\n10.51* Agreement, dated as of December 5, 1995, between the Registrant and Ronald J. Mario.\n10.52* Employment Agreement, dated as of January 30, 1994, by and among the Registrant, CTS America, Inc. and Richard E. Thomas. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Registration Statement on Form S-4 (File No. 33-53437) filed on May 3, 1994.)\n10.53* Registrant's 1995 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 99 to the Registrant's definitive Proxy Statement on Schedule 14A filed on April 7, 1995).\n10.54 Corporate Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to certain matters arising in connection with Ascent's initial public offering.\n10.55 Intercompany Services Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to the provision of certain services subsequent to Ascent's initial public offering.\n10.56 Tax Sharing Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to certain tax matters arising subsequent to Ascent's initial public offering.\nExhibit No. 11 - Statement re computation of per share earnings.\nExhibit No. 21 - Subsidiaries of the Registrant as of March 31, 1996.\nExhibit No. 23 - Consents of experts and counsel. Consent of Independent Auditors dated March 29, 1996.\nExhibit No. 27 - Financial Data Schedule.\n*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.\nCOMSAT CORPORATION (Registrant)\nDate: March 29, 1996 By \/s\/ Alan G. Korobov (Alan G. Korobov, Controller)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by each of the following persons on behalf of the Registrant and in the capacity and on the date indicated.\n(1) Principal executive officer\nDate: March 29, 1996 By \/s\/ Bruce L. Crockett ---------------------- (Bruce L. Crockett, President and Chief Executive Officer)\n(2) Principal financial officer\nDate: March 29, 1996 By \/s\/ Allen E. Flower -------------------- (Allen E. Flower, Vice President and Chief Financial Officer)\n(3) Principal accounting officer\nDate: March 29, 1996 By \/s\/ Alan G. Korobov -------------------- (Alan G. Korobov, Controller)\n(4) Board of Directors\nDate: March 29, 1996 By \/s\/ Melvin R. Laird (Melvin R. Laird, Chairman and Director)\nBy \/s\/ Lucy Wilson Benson (Lucy Wilson Benson, Director)\nBy \/s\/ Edwin I. Colodny (Edwin I. Colodny, Director)\nBy \/s\/ Bruce L. Crockett (Bruce L. Crockett, Director)\nBy \/s\/ Lawrence S. Eagleburger (Lawrence S. Eagleburger, Director)\nBy \/s\/ Neal B. Freeman (Neal B. Freeman, Director)\nBy \/s\/ Barry M. Goldwater (Barry M. Goldwater, Director)\nBy \/s\/ Arthur Hauspurg (Arthur Hauspurg, Director)\nBy \/s\/ Peter S. Knight (Peter S. Knight, Director)\nBy \/s\/ Peter W. Likins (Peter W. Likins, Director)\nBy \/s\/ Howard M. Love (Howard M. Love, Director)\nBy \/s\/ Charles T. Manatt (Charles T. Manatt, Director)\nBy \/s\/ Robert G. Schwartz (Robert G. Schwartz, Director)\nBy \/s\/ C. J. Silas (C. J. Silas, Director)\nBy \/s\/ Dolores D. Wharton (Dolores D. Wharton, Director)\nCOMSAT CORPORATION (PARENT COMPANY) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT For the Years Ended December 31, 1995, 1994 and 1993\n1. BASIS OF PRESENTATION\nPursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Statements of the Registrant do not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles. These Condensed Financial Statements should be read in conjunction with the Consolidated Financial Statements, and Notes thereto included in the accompanying Annual Report on Form 10-K, Part II, Item 8.\n2. LONG-TERM DEBT\nThe components of long-term debt are as follows:\nThe principal amount of debt (excluding the Inmarsat lease financing obligation) maturing over the next five years is none in 1996 through 1999 and $28,659,000 in 2000. See Note 8 to the Consolidated Financial Statements on Form 10-K, Part II, Item 8, for a discussion of the Inmarsat lease financing obligation.\n3. NOTE PAYABLE TO SUBSIDIARY\nIn 1995, COMSAT Corporation borrowed $206,200,000 from a subsidiary, COMSAT Capital I, L.P. (see Note 9 to the Consolidated Financial Statements on Form 10-K, Part II, Item 8). Interest of 8.125% per annum is payable monthly. The entire principal amount is due in July 2025. The maturity may be extended to a date not later than July 2044 at the election of the borrower, provided that certain financial covenants are satisfied.\nEXHIBIT INDEX\nExhibit No. Description\n3.1 Articles of Incorporation of Registrant, composite copy, as amended through June 1, 1993. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Registration Statement on Form S-3 (No. 33-51661) filed on December 22, 1993).\n3.2 By-laws of Registrant, as amended through February 16, 1996.\n3.3 Regulations adopted by Registrant's Board of Directors pursuant to Section 5.02(c) of Registrant's Articles of Incorporation. (Incorporated by reference from Exhibit No. 3(c) to Registrant's Report on Form 10-K for the fiscal year ended 1992.)\n4.1 Specimen of a certificate representing Series I shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934, which are held by citizens of the United States. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n4.2 Specimen of a certificate representing Series I shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934, which are held by aliens. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1982.)\n4.3 Specimen of a certificate representing Series II shares of COMSAT Common Stock, without par value, registered under Section 12 of the Securities Exchange Act of 1934. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1982.)\n4.4 Standard Multiple-Series Indenture Provisions, dated March 15, 1991. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Registration Statement on Form S-3 (No. 33-39472) filed on March 15, 1991.)\n4.5 Indenture dated as of March 15, 1991 between Registrant and The Chase Manhattan Bank, N.A. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Registration Statement on Form S-3 (No. 33-39472) filed on March 15, 1991.)\n4.6 Supplemental Indenture, dated as of June 29, 1994, from the Registrant to The Chase Manhattan Bank, N. A. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Registration Statement on Form S-3 (No. 33-54369) filed on June 30, 1994.)\n4.7 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $75,000,000 aggregate principal amount of Registrant's 8.95% Notes Due 2001 (with form of Note attached). (Incorporated by reference from Exhibit No. 4 to Registrant's Current Report on Form 8-K filed on May 15, 1991.)\n4.8 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $160,000,000 aggregate principal amount of Registrant's 8.125% Debentures Due 2004 (with form of Debenture attached). (Incorporated by reference from Exhibit No. 4 to Registrant's Current Report on Form 8-K filed on April 9, 1992.)\n4.9 Officers' Certificate pursuant to Section 3.01 of the Indenture, dated as of March 15, 1991, as supplemented by the Supplemental Indenture, dated as of June 29, 1994, from the Registrant to the Chase Manhattan Bank (National Association), as Trustee, relating to the authorization of $100,000,000 aggregate principal amount of Registrant's Medium Term Notes, Series A (with forms of Notes attached). (Incorporated by reference from Exhibit No. 4(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n4.10 Limited Partnership Agreement of COMSAT Capital I, L.P., dated as of July 18, 1995, relating to issuance of monthly income preferred securities. (Incorporated by reference from Exhibit No. 4(a) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n4.11 Guarantee Agreement for Preferred Securities of COMSAT Capital I, L.P., dated as of July 18, 1995. (Incorporated by reference from Exhibit No. 4(b) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n4.12 Indenture between Registrant and the First National Bank of Chicago, as Trustee, dated as of July 18, 1995. (Incorporated by reference from Exhibit No. 4(c) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n10.1 Agreement Relating to the International Telecommunications Satellite Organization (INTELSAT) by Governments, which entered into force on February 12, 1973. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.2 Operating Agreement Relating to INTELSAT by Governments which entered into force on February 12, 1973. (Incorporated by reference from Exhibit No. 10(b) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.3 Agreement dated August 15, 1975, among COMSAT General Corporation, RCA Global Communications, Inc., Western Union International, Inc. and ITT World Communications, Inc. relating to the establishment of a joint venture for the purpose of participating in the ownership and operation of a maritime communications satellite system and Amendment Nos. 1-4 and Amendment No. 5 dated March 24, 1980. (Incorporated by reference from Exhibit No. 10(p) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1980.)\n10.4 Amendment No. 6 to Exhibit 10.3 dated September 1, 1981. (Incorporated by reference from Exhibit No. 10(p)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1981.)\n10.5 Convention on the International Maritime Satellite Organization (INMARSAT) dated September 3, 1976. (Incorporated by reference from Exhibit No. 11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1978.)\n10.6 Operating Agreement on INMARSAT dated September 3, 1976. (Incorporated by reference from Exhibit No. 12 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1978.)\n10.7* Registrant's 1982 Stock Option Plan. (Incorporated by reference from Exhibit No. 10(x) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1981.)\n10.8 Agreement dated October 6, 1983, between COMSAT General Corporation and National Broadcasting Company for the provision of satellite distribution network programming. (Incorporated by reference from Exhibit No. 10(r) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1983.)\n10.9 Amendment to Exhibit 10.8 dated September 1, 1992. (Incorporated by reference from Exhibit No. 10(j)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.10* Registrant's Insurance and Retirement Plan for Executives, as amended and restated by the Board of Directors on June 21, 1985, as amended by the Board of Directors on July 15, 1993. (Incorporated by reference from Exhibit No. 10(h) to the Registrant's Form 10-K for the fiscal year ended December 31, 1993.)\n10.11* Registrant's 1986 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 10(g) to Registrant's Registration Statement on Form S-4 (File No. 33-9966) filed on November 4, 1986.)\n10.12* Registrant's Non-Employee Directors Stock Option Plan. (Incorporated by reference from Exhibit No. 10(h) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987.)\n10.13 Amendment No. 1 to Exhibit 10.12 dated March 16, 1990. (Incorporated by reference from Exhibit No. 10(g)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.14 Amendment No. 2 to Exhibit 10.12 dated January 15, 1993. (Incorporated by reference from Exhibit No. 10(k)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.15 Memorandum of Understanding between Registrant and National Aeronautics and Space Administration (NASA), dated July 21, 1988 and amended through February 22, 1990. (Incorporated by reference from Exhibit No. 10(aa) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.16 Agreement to Acquire and Lease (and Supplemental Agreements thereto) dated September 28 and October 10, 1988, respectively, among the International Maritime Satellite Organization (Inmarsat), the North Sea Marine Leasing Company, British Aerospace Public Limited Company, the European Investment Bank, Kreditanstalt Fuer Wiederaufbau, European Investment Bank (as Agent and as Trustee), Instituto Mobiliare Italiano, Credit National, Hellenic Industrial Development Bank, and Society Nationale de Credit a L'Industrie relating to the financing of three Inmarsat spacecraft. (Incorporated by Reference from Exhibit No. 3(a) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988.)\n10.17 Service Agreement, dated September 14, 1989, between Registrant and Aeronautical Radio, Inc. relating to satellite-based communications services. (Incorporated by reference from Exhibit No. 10(y) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.18 Agreement, dated January 22, 1990, between Registrant and Kokusai Denshin Denwa Co., Ltd. for provision of aeronautical services. (Incorporated by reference from Exhibit No. 10(z) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.)\n10.19 Amendment No. 1 to Exhibit 10.18 dated May 20, 1993. (Incorporated by reference from Exhibit No. 10(q)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.20* Registrant's 1990 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 10 (p) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.)\n10.21* Amendment No. 1 to Exhibit 10.20 dated January 15, 1993. (Incorporated by reference from Exhibit No. 10(r)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.22* Amendment No. 2 to Exhibit 10.20 dated January 16, 1994. (Incorporated by reference from Exhibit No. 10(o)(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.23 Amended and Restated Agreement, dated November 14, 1990, of Limited Partnership of Rock Spring II Limited Partnership. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.24 Amended and Restated Lease Agreement, dated November 14, 1990, of Limited Partnership of Rock Spring II Limited Partnership. (Incorporated by reference from Exhibit No. 10(b) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.25 Amended and Restated Ground Lease Indenture, dated November 14, 1990, between Anne D. Camalier (Landlord) and Rock Spring II Limited Partnership (Tenant). (Incorporated by reference from Exhibit No. 10(c) to Registrant's Current Report on Form 8-K filed on February 24, 1992.)\n10.26 Finance Facility Contract (and Supplemental Agreements thereto), dated December 20, 1991, among the International Maritime Satellite Organization (Inmarsat), Abbey National plc, General Electric Technical Services Company, Inc., European Investment Bank, Kreditanstalt Fuer Wiederaufbau, Instituto Mobiliare Italiano S.p.A., Credit National, Societe Nationale de Credit a L'Industrie, Finansieringsinstituttet for Industri OG Haandvaerk A\/S, De Nationale Investeringsbank NV, and Osterreichische Investitionkredit Aktiengesellschaft relating to the financing of three Inmarsat spacecraft. (Incorporated by reference from Exhibit No. 10 (dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991.)\n10.27* Registrant's Directors and Executives Deferred Compensation Plan, as amended by the Board of Directors on July 15, 1993. (Incorporated by reference from Exhibit No. 10(v) to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.28 Service Agreement, dated September 12, 1990, between Registrant and GTE Airfone, Incorporated, for the provision of aeronautical satellite services. (Incorporated by reference from Exhibit No. 10(r) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.)\n10.29 Fiscal Agency Agreement, dated as of August 6, 1992, between International Telecommunications Satellite Organization and Morgan Guaranty Trust Company of New York. (Incorporated by reference from Exhibit No. 10 (dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.30 Fiscal Agency Agreement, dated as of January 19, 1993, between International Telecommunications Satellite Organization and Morgan Guaranty Trust Company of New York. (Incorporated by reference from Exhibit No. 10 (ee) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.31 Lease Agreement, dated June 8, 1993, between GTE Airfone, Incorporated, United Airlines, Inc. and Registrant for the provision and financing of aeronautical satellite equipment. (Incorporated by reference from Exhibit No. 10(aa) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.32 Agreement dated July 1, 1993, between Registrant and AT&T Easylink Services relating to exchange of telex traffic. (Incorporated by reference from Exhibit No. 10(bb) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.33 Agreement dated July 27, 1993, between the Registrant and American Telephone & Telegraph Company relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(cc) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.34 Amendment to Exhibit 10.33 dated as of December 1, 1995.\n10.35 Agreement dated September 1, 1993, between Registrant and MCI International, Inc. relating to exchange of traffic. (Incorporated by reference from Exhibit No. 10(dd) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.36 Agreement dated November 30, 1993, between the Registrant and Sprint Communications Company L.P. relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(ee) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.37 Amendment to Exhibit 10.36 dated April 7, 1995. (Incorporated by reference from Exhibit No. 10(a)(i) to Registrant's Report on Form 10-Q\/A Amendment No. 2 dated June 29, 1995 for the quarter ended March 31, 1995.)\n10.38 Agreement dated December 10, 1993, between Registrant and Sprint International relating to the exchange of traffic. (Incorporated by reference from Exhibit No. 10(ff) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.39 Credit Agreement dated as of December 17, 1993 among Registrant, NationsBank of North Carolina, N.A., Bank of America National Trust and Savings Association, The First National Bank of Chicago, The Chase Manhattan Bank, N.A., The Sumitomo Bank, Limited, New York Branch, Swiss Bank Corporation, New York Branch, as lenders, and NationsBank of North Carolina, N.A., as agent. (Incorporated by reference from Exhibit No. 10(gg) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.40 Amendment No. 1 to Exhibit 10.39 dated as of December 17, 1994. (Incorporated by reference from Exhibit No. 10(cc)(i) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.41 Agreement dated January 24, 1994, between MCI International, Inc. and Registrant relating to utilization of space segment. (Incorporated by reference from Exhibit No. 10(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.42 Amendment to Exhibit 10.41 dated as of July 1, 1995.\n10.43 Agreement dated February 18, 1994, between Registrant and AT&T relating to exchange of traffic. (Incorporated by reference from Exhibit No. 10(jj) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.44 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Bankers Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 22 March 1994. (Incorporated by reference from Exhibit No. 10(kk) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.45 Distribution Agreement dated July 11, 1994 between Registrant and CS First Boston Corporation, Salomon Brothers Inc and Nationsbanc Capital Markets, Inc., as Distributors, of Registrant's Medium-Term Notes, Series A. (Incorporated by reference from Exhibit No. 10(ff) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.46 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Morgan Guaranty Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 14 October 1994. (Incorporated by reference from Exhibit No. 10(gg) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.47* Registrant's Annual Incentive Plan. (Incorporated by reference from Exhibit No. 10(hh) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.48 Fiscal Agency Agreement between International Telecommunications Satellite Organization, Issuer, and Morgan Guaranty Trust Company, Fiscal Agent and Principal Paying Agent, dated as of 28 February 1995. (Incorporated by reference from Exhibit No. 10(ii) to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994.)\n10.49 Asset Purchase Agreement, dated as of May 24, 1995, between COMSAT Video Enterprises, Inc. and Le Club de Hockey Les Nordiques, Societe en Commandite (Limited Partnership). (Incorporated by reference from Exhibit No. 10(a) to Registrant's Report on Form 10-Q for the quarter ended June 30, 1995.)\n10.50* Employment Agreement, dated as of December 18, 1995, between Ascent and Charles Lyons. (Incorporated by reference from Exhibit No. 10.16 to the Report on Form 10-K filed by Ascent Entertainment Group, Inc. for the fiscal year ended December 31, 1995.)\n10.51* Agreement, dated as of December 5, 1995, between the Registrant and Ronald J. Mario.\n10.52* Employment Agreement, dated as of January 30, 1994, by and among the Registrant, CTS America, Inc. and Richard E. Thomas. (Incorporated by reference from Exhibit No. 10(a) to Registrant's Registration Statement on Form S-4 (File No. 33-53437) filed on May 3, 1994.)\n10.53* Registrant's 1995 Key Employee Stock Plan. (Incorporated by reference from Exhibit No. 99 to the Registrant's definitive Proxy Statement on Schedule 14A filed on April 7, 1995).\n10.54 Corporate Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to certain matters arising in connection with Ascent's initial public offering.\n10.55 Intercompany Services Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to the provision of certain services subsequent to Ascent's initial public offering.\n10.56 Tax Sharing Agreement, dated as of December 18, 1995, between the Registrant and Ascent relating to certain tax matters arising subsequent to Ascent's initial public offering.\n11 Statement re computation of per share earnings.\n21 Subsidiaries of the Registrant as of March 31, 1996.\n23 Consents of experts and counsel. Consent of Independent Auditors dated March 29, 1996.\n27 Financial Data Schedule.\n*Compensatory plan or arrangement.","section_15":""}
{"filename":"75072_1995.txt","cik":"75072","year":"1995","section_1":"Item 1. BUSINESS\nO'Sullivan Corporation (\"O'Sullivan\" or the \"Corporation\") is a Virginia corporation originally organized in 1896 as O'Sullivan Rubber Company. In 1932 the Corporation was moved to Winchester, Virginia. In 1970 the corporate name was changed from O'Sullivan Rubber Corporation to O'Sullivan Corporation to acknowledge the increasing importance of plastics manufacturing to the Corporation's operations.\nSubsequent to the Corporation's name change through the early 1990's, the Corporation concentrated on expansion of its plastics manufacturing operations, both calendering and injection-molding. The expansion was accomplished by adding additional capacity within the Corporation and the acquisition or creation of several subsidiaries to gain facilities in other regions of the United States. In 1986, the Corporation divested itself of its rubber operations.\nIn 1994, the Corporation sold the injection-molding operations portion of its plastics products segment. The sale involved primarily the inventories and fixed assets of the Corporation associated with injection-molding operations and the stock of a subsidiary corporation also involved in injection-molding operations. The sale was for approximately $50 million net of certain liabilities assumed by the purchaser. The disposal of this portion of the Corporation's operations has been treated as a discontinued operation in the accompanying financial statements.\nIn 1992, the Corporation created a subsidiary, Melnor Inc. (\"Melnor\"), to acquire substantially all the assets of a corporation engaged in the water sprinkler and lawn and garden business.\nThe Corporation's activities are now conducted in two business segments: (i) calendered plastics products which manufactures calendered plastics products for the automotive and specialty plastics manufacturing industries and (ii) lawn and garden consumer products which is involved with the manufacture and distribution of a wide range of lawn and garden products.\nFor financial information with respect to industry segments, see \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 13 of \"Notes to Consolidated Financial Statements\" included elsewhere in this Form 10-K.\nPLASTICS PRODUCTS BUSINESS\nThe Corporation's Plastics Products segment manufactures calendered plastics products for the automotive and specialty plastics manufacturing industries. Calendered plastics products manufactured include vinyl sheeting for vehicular dashboard pads and door panels, swimming pool liners and covers, notebook binders, luggage, upholstered furniture, golf bags, floor tile, pond liners, protective clothing, mine curtains, boat and automobile windows and medical grade materials. The Plastics Products segment products are sold in markets in which there is competition from many plastic manufacturers, both domestic and foreign. While no single competitor offers all of the products produced by this segment, there are\nmany competitors for any single product. Major competitors include; Canadian General Tower, Gencorp Inc., Achilles USA Inc., Nanya Plastics Corporation, Intex Plastics Corporation, Borden, Inc. and HPG International, Inc.\nDistribution of the segment's products is by direct sales to other manufacturers.\nThe normal production backlog of the Plastic Products segment is approximately thirty to forty-five days. The Corporation has various long- term contracts totaling several million dollars applicable to this segment, but such contracts are not considered as firm orders until production releases are received from customers. The business of the segment is not seasonal.\nAll essential raw materials are readily available to the Plastics Products segment. For critical raw materials, secondary sources of supply are available if required. Major suppliers of raw materials to this segment include the following companies; Geon Company, Occidental Chemical, Aristech Chemicals, Witco Corporation, Goodyear Tire and Rubber Company, Penn Colors and Toray.\nThis segment of the Corporation possesses significant technology in the compounding, formulation and manufacture of its products.\nA significant customer of the Plastics Products segment accounting for ten percent or more of the segment's 1995 sales was Ford Motor Company.\nCONSUMER PRODUCTS BUSINESS\nThe Corporation's Consumer Products segment has as a primary activity the manufacture, assembly, sale and distribution of lawn and garden products. The products produced and sold by this segment include; oscillating, rotary and traveling sprinklers, hose storage units, watering timers, aqua guns, air spray tanks and snow shovels. Secondary product lines representing less than ten percent of sales volumes include humidification systems and buy-sell distribution of ceiling fans and thermostats. The products of its segment are sold in markets in which there is intense competition from many lawn and garden products suppliers. While it is believed that no one competitor offers the array of products offered by the segment, there are numerous competitors for specific products. Major competitors include; Rain Bird Corporation, Suncast Company, Gilmour Corporation and Nelson Company.\nAll essential raw materials utilized by this segment are readily available. Some raw materials are obtained from foreign sources and can be obtained from secondary sources, if necessary. Purchased components are generally designs that are readily available from several suppliers. Major suppliers to this segment include; Computime, Ltd., Stax Ltd., Landen Enterprises, Eurotec De Mexico, S.A. DE C.V., Montoi, S.A. DE C.V., and CPC of Vermont.\nThe business in which this segment is involved is highly seasonal in nature. Lawn and garden products are traditionally shipped to distribution and retail outlets beginning in late-December or early-January and continuing through the following May.\nThis segment holds many patents and trademarks for products produced and sold. However, due to the rapidly changing nature of the segment's business activity, the Corporation does not believe that the patents and trademarks have any significant long-term value or provide any material benefit to the long-term success of the segment's business operations.\nHome Depot, Inc. was the only customer of the Consumer Products segment accounting for ten percent or more of the segment's sales for 1995.\nGENERAL\nThe Corporation anticipates no material effects on the capital expenditures, earnings or competitive position of the Corporation's businesses from the enactment or adoption of federal, state or local environmental regulations. The Corporation has several ongoing environmental programs, including recycling, waste reduction and environmental audits. The Corporation also has proactive dialogues with federal and state environmental agencies to insure continuing compliance with environmental regulations.\nThe Corporation and its Subsidiaries currently have approximately 1,100 employees.\nThe Corporation and its Subsidiaries are not engaged in any material transactions with customers or suppliers located outside North America.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Corporation owns approximately 663,000 square feet of manufacturing, warehouse and office space on approximately 123 acres in Winchester, Virginia; 76,000 square feet of manufacturing, warehouse and office space on approximately six acres in Lebanon, Pennsylvania; 110,000 square feet of manufacturing and warehouse space on approximately five acres in Newton Upper Falls, Massachusetts; 85,000 square feet of manufacturing and warehouse space on approximately thirteen acres in Yerington, Nevada; 82,000 square feet of manufacturing, warehouse and office space in Brantford, Ontario, Canada.\nThe Corporation leases 29,250 square feet of warehouse space in St. Louis, Missouri; 10,000 square feet of warehouse space in Yerington, Nevada and 347,000 square feet of manufacturing, warehouse and office space in Moonachie, New Jersey. Operations formerly housed in the New Jersey location were substantially relocated to Winchester, Virginia during 1995. The Corporation also has sales offices located in Chicago, Illinois and Bloomfield Hills, Michigan.\nManagement of the Corporation believes that unused capacity existed in both segments of the Corporation's operations during 1995. Percentage utilization of the Corporation's facilities is difficult to accurately measure due to the Corporation's policy of adding facilities as required by business conditions.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nAs of December 31, 1995, the Corporation and its Subsidiaries had no material proceedings pending to which the corporations were a party or of which any of their property was the subject.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were voted upon during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSee information provided under Part III, item 10, included in this Form 10-K.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe principal market in which the Corporation's common stock is traded is the American Stock Exchange. The stock is traded under the symbol OSL.\nThe quarterly price range of common stock and the quarterly dividends per share for 1995 and 1994 are included as part of Note 19 of \"Notes to Consolidated Financial Statements\" included elsewhere in this Form 10-K.\nAt December 31, 1995 the number of owners of the Corporation's common stock was 3,000.\nNo change is anticipated regarding the Corporation's dividend policy.\nThere are no restrictions on the payment of dividends at the current time.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA (FROM CONTINUING OPERATIONS)\n1995 1994 1993 1992 1991 ------------ ------------ ------------ ------------ ------------ Net sales $209,723,562 $194,974,264 $173,345,501 $125,776,914 $114,368,326\nNet income 14,032,063 10,974,970 10,382,400 8,407,638 8,498,059\nNet income per common share .85 .67 .63 .51 .52\nTotal assets 149,996,525 144,528,888 144,365,419 121,996,656 101,144,600\nLong-term debt 51,745 1,652,996 1,501,834 4,871,664 19,719\nTotal debt 1,717,193 1,705,069 13,518,543 12,132,365 248,197\nCash dividends per common share .31 .28 .28 .28 .28\nReturn on equity 13.2% 10.1% 10.0% 8.6% 8.5%\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS 1995 VERSUS 1994\nConsolidated net sales from continuing operations for 1995 were $209.7 million compared to $195.0 million for 1994. Consolidated net income from continuing operations for 1995 was $14.0 million, $ .85 per share, compared to $11.0 million, $ .67 per share, for 1994.\nIncome tax expense for continuing operations was $9.6 million for 1995 compared to $7.1 million for 1994. The increase is due to higher pre-tax income and an increase in the Corporation's effective tax rate from 39.4% for 1994 to 40.7% for 1995. The increase in the effective tax rate is primarily due to charges for state income taxes.\nOther income increased by $929 thousand over 1994. The increase was primarily due to additional interest income generated from investment of funds received from the sale of the Corporation's Gulfstream Division. Interest expense declined by approximately $750 thousand. The reduction in interest expense was a result of the payoff in December, 1994 of several debt instruments utilizing a portion of the funds received from the 1994 sale of the Gulfstream Division.\nPlastics Products Segment\nNet sales for the Plastics Products segment were $169.5 million for 1995 as compared to $149.4 million for 1994. The 1995 net sales represent an increase of $20.1 million or 13.4%. Approximately 70% of the sales increase was from automotive-related products. The sales increase in the automotive-related component of this segment was substantially a result of product mix changes to shipments of products with greater incremental prices. Competitive pressures in both automotive and industrial sales components of this segment continue to preclude unit price increases except for negotiated pass-throughs of raw material price increases. Approved increases frequently lag several months behind increased costs incurred by the Corporation.\nThe gross margin for this segment improved to 20.3% in 1995 from 18.7% in 1994. The margin improvement is a result of higher sales volumes and reductions in variable manufacturing expenses.\nOperating income for the segment increased by $7.8 million for the year from $21.6 million for 1994 to $29.4 million for 1995. The increase is primarily a result of the volume sales increases experienced in 1995 aided by the improvements in gross margin and the significant reduction in selling expenses.\nSelling expenses for this segment were $4.9 million or 2.9% as a percent of net sales for 1995, compared to $6.2 million or 4.2% as a percent of net sales for 1994. The reduction in selling expenses is a result of consolidations made within the selling area following the disposal of the Corporation's Gulfstream Division in December of 1994 along with a significant reduction in charges for doubtful accounts. General and\nadministrative expenses were $5.7 million or 3.4% of net sales for 1995, compared to $5.2 million or 3.5% of net sales for 1994.\nManagement anticipates continuing sales volume increases for the Plastics Products segment in 1996 due to increased market share rather than an increase in the economy. Automotive-related products will likely provide the greatest opportunity for increased sales.\nConsumer Products Segment\nNet sales for the Consumer Products segment were $40.2 million for 1995 compared to $45.5 million for 1994. The 1995 sales represent a decrease of $5.3 million. Changes in customer purchasing patterns and dramatically unfavorable weather conditions during 1995 caused sales to fall considerably below sales levels expected by management.\nThis segment experienced a significant decline in its gross margin for 1995 as compared to 1994. The gross margin declined from 22.3% to 17.9%. The decline was due to excess rework costs for purchased components, increases in raw material prices over those anticipated and excess freight costs for product deliveries from off-shore sources. Operating income for this segment decreased by $3.1 million for 1995. The decrease can be directly attributed to the substantial sales volume reductions experienced by this segment during 1995.\nSelling and warehousing expenses were $5.3 million for 1995 and $5.9 million for 1994. These amounts represent 13.0% and 12.9% of sales for 1995 and 1994, respectively. The dollar decrease in these costs is a result of lower sales commission and advertising costs that are directly related to sales volumes. General and administrative expenses for this segment were $2.4 million for 1995 and $2.1 million for 1994. During 1995 this segment incurred charges of $756 thousand in connection with the relocation of US operations.\nManagement expects improved results for this segment in 1996 due to significant cost containment, productivity improvements and new product introductions.\nRESULTS OF OPERATIONS 1994 VERSUS 1993\nConsolidated net sales from continuing operations for 1994 of $195.0 million were an increase of $21.7 million or 12.5% over 1993 net sales of $173.3 million. Consolidated net income from continuing operations for 1994 was $11.0 million , $ .67 per share, compared to $10.4 million, $ .63 per share for 1993.\nIncome tax expense for continuing operations was $7.1 million for 1994 and $6.9 million for 1993. The effective tax rate fell slightly from 1993 (from 40.1% to 39.4%) due to a reduced level of state income tax expense.\nOther income was substantially unchanged from 1993 to 1994. Interest expense for 1994 declined by $66 thousand. In December, 1994 the Corporation used a portion of the funds received from the sale of the Gulfstream Division to retire several debt instruments. The full effect of the debt reduction, in the form of reduced interest expense, was realized in 1995.\nPlastics Products Segment\nNet sales for the Plastics Products segment increased by 12.5% from $132.8 million in 1993 to $149.4 million in 1994. Sales increases experienced by this segment were primarily volume related since competitive and contractual restrictions prohibited significant price increases during 1994.\nThe gross profit margin for the segment declined to 18.6% for 1994 from 20.8% for 1993. The margin was adversely affected by raw material prices and mixed compound costs that increased at a rate greater than could be recovered through pass throughs to customers and start up costs associated with new and improved flexible vinyl sheeting compounds associated with new programs to be launched in 1995.\nOperating income for this segment declined by $1.5 million or 6.3% in 1994. The decline was a result of the factors described in the preceding paragraph along with increases in selling costs described below.\nSelling expenses for 1994 were $6.2 million, 4.2% as a percent of sales and $5.0 million, 3.8% as a percent of sales for 1993. The major cause of the increased expense for 1994 was a substantial increase in charges for doubtful accounts resulting from the financial failure of two customers of the industrial component of the Plastics Product segment. General and administrative expenses were $5.2 million or 3.5% of net sales for 1994 and $4.7 million or 3.5% for 1993.\nConsumer Products Segment\nNet sales for the Consumer Products segment were $45.5 million for 1994, an increase of $5.0 million or 12.4% over net sales of $40.5 million for 1993. Net sales increases for 1994 were primarily due to volume increases for products sold to the markets served. Unit price increases were negligible for the period due to competitive market pressures.\nThe gross profit margin for this segment improved during 1994 from 20.4% to 22.3%. Operating efficiency improvements during 1994 were primarily responsible for the improved margin.\nOperating income for this segment improved by $2.2 million for 1994. The increase was a result primarily of the 12.4% net sales increase for the year. Also contributing to the increase were the improvements in the gross margin and reductions in general and administrative costs.\nSelling and warehousing expenses were $5.9 million for 1994 and $5.7 million for 1993. The expenses represented 12.9% and 14.1% of net sales for 1994 and 1993, respectively. General and administrative costs for the segment were $2.1 million or 4.6% of net sales for 1994 and $2.5 million or\n6.3% of net sales for 1993. The improvement in this area can be directly attributed to reductions in administrative personnel with resulting reductions in salaries, benefits and other associated overhead expense.\nDISCONTINUED OPERATIONS\nOn December 2, 1994 the Corporation sold the portion of its business identified as the Gulfstream Division. The assets sold consisted primarily of those assets included with the former injection-molding part of the Plastics Products segment. Those assets were the inventories and property, plant and equipment of the injection-molding operations along with the capital stock of Capital Plastics of Ohio, Inc., a subsidiary also involved in the injection-molding business. Additional information regarding discontinued operations is included with footnote number 16 of these financial statements.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash flow for 1995 was approximately $700 thousand. Cash flows from operating activities were $16.8 million for 1995. Increases in inventories of both segments of the Corporation during 1995 were the major factor in the minimal net cash flow for the year. Throughout 1995 the Plastics Product segment increased certain elements of its inventories to enhance machine utilization and to meet requirements for the launch of various automotive-related production programs. The Consumer Products segment experienced increased inventory levels due to changes in customer purchasing patterns and reductions in customer demand due to weather- related causes.\nCapital expenditures for property, plant and equipment for 1995 were $10.2 million compared to $8.8 million for 1994. 1996 capital expenditures are projected to be comparable to 1995. At December 31, 1995, the majority of the projected outlay was uncommitted. Presently, the Corporation has unused capacity in both business operating segments. Future capital expenditures for the Corporation would be to provide additional capacity or modernize equipment to meet customer demands for new or improved products or production processes.\nTotal corporate debt was $1.7 million at both December 31, 1995 and 1994. The Corporation has in place a $35 million line of credit that expires in June, 1997. At December 31, 1995 the line of credit was unused except for a $850 thousand letter of credit commitment.\nThe Corporation's Board of Directors has authorized the repurchase of up to 800 thousand shares of the Corporation's common stock as market conditions permit.\nManagement of the Corporation believes that net cash flow from operating activities, along with available financing capabilities will be adequate to meet the Corporation's funding requirements for 1996.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThis page left blank intentionally. See following pages for financial statements.\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ------------- ------------- ASSETS Current Assets Cash and cash equivalents $ 10,400,583 $ 9,701,801 Receivables 30,458,872 40,367,968 Inventories 42,196,303 32,475,205 Deferred income tax assets 2,262,636 2,642,523 Other current assets 3,562,325 3,485,292 ------------- ------------- Total current assets $ 88,880,719 $ 88,672,789 ------------- ------------- Property, Plant and Equipment $ 48,027,329 $ 44,605,639 ------------- ------------- Intangibles $ 497,251 $ 751,609 ------------- ------------- Other Assets $ 12,591,226 $ 10,498,851 ------------- ------------- Total assets $ 149,996,525 $ 144,528,888 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current portion of long-term debt $ 1,665,448 $ 52,073 Accounts payable 15,714,112 16,729,891 Accrued expenses 10,574,317 13,941,121 ------------- ------------- Total current liabilities $ 27,953,877 $30,723,085 ------------- ------------- Long-Term Debt $ 51,745 $ 1,652,996 ------------- ------------- Other Long-Term Liabilities $ 2,708,799 $ 2,006,974 ------------- ------------- Deferred Income Tax Liabilities $ 3,519,139 $ 3,503,530 ------------- ------------- Commitments and Contingencies $ -- -- $ -- -- ------------- ------------- Shareholders' Equity Common stock, par value $1.00 per share; authorized 30,000,000 shares $ 16,510,402 $ 16,484,831 Additional paid-in capital 10,182,295 9,963,516 Retained earnings 89,453,514 80,539,058 Cumulative translation adjustments (220,566) (345,102) Unrecognized pension costs, net of deferred tax effect (162,680) -- -- ------------- ------------- Total shareholders' equity $ 115,762,965 $ 106,642,303 ------------- ------------- Total liabilities and shareholders' equity $ 149,996,525 $ 144,528,888 ============= =============\nThe accompanying notes are an integral part of the consolidated financial statements.\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Net sales $209,723,562 $194,974,264 $173,345,501 Cost of products sold 168,142,885 156,984,225 137,453,119 ------------ ------------ ------------ Gross profit $ 41,580,677 $ 37,990,039 $ 35,892,382 ------------ ------------ ------------ Operating expenses Selling and warehousing $ 10,161,297 $ 12,077,019 $ 10,750,183 General and administrative 8,170,944 7,289,802 7,184,538 Relocation charge 755,930 -- -- -- -- ------------ ------------ ------------ $ 19,088,171 $ 19,366,821 $ 17,934,721 ------------ ------------ ------------ Income from operations $ 22,492,506 $ 18,623,218 $ 17,957,661 ------------ ------------ ------------ Other income (expense) Interest income $ 863,530 $ 180,217 $ 105,982 Interest expense (59,753) (811,676) (877,834) Other, net 364,320 118,720 143,341 ------------ ------------ ------------ $ 1,168,097 $ (512,739) $ (628,511) ------------ ------------ ------------ Income from continuing operations before income taxes and cumulative effect of accounting changes $ 23,660,603 $ 18,110,479 $ 17,329,150 Income taxes 9,628,540 7,135,509 6,946,750 ------------ ------------ ------------ Income from continuing operations before cumulative effect of accounting changes $ 14,032,063 $ 10,974,970 $ 10,382,400 ------------ ------------ ------------ Discontinued operations: Loss from discontinued operations, net of taxes $ -- -- $ (125,126) $ (673,282) Loss on disposal of discontinued operations, net of taxes -- -- (8,220,000) -- -- ------------ ------------ ------------ $ -- -- $ (8,345,126) $ (673,282) ------------ ------------ ------------ Income before cumulative effect of accounting changes $ 14,032,063 $ 2,629,844 $ 9,709,118\nCumulative effect of accounting changes -- -- -- -- 305,338 ------------ ------------ ------------ Net income $ 14,032,063 $ 2,629,844 $ 10,014,456 ============ ============ ============\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1995, 1994 and 1993 (continued)\n1995 1994 1993 ------------ ------------ ------------ Net income per common share: Income from continuing operations $ .85 $ .67 $ .63 Loss from discontinued operations -- -- (.01) (.04) Loss on disposal of discontinued operations -- -- (.50) -- -- Cumulative effect of accounting changes -- -- -- -- .02 ------------ ------------ ------------ Net income per common share $ 0.85 $ .16 $ .61 ============ ============ ============\nThe accompanying notes are an integral part of the consolidated financial statements.\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Cash Flows from Operating Activities Net income $ 14,032,063 $ 2,629,844 $ 10,014,456 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,820,128 10,867,275 11,438,370 Provision for doubtful accounts 439,480 1,138,617 209,719 Deferred income taxes 486,782 (6,064,033) 938,091 (Gain) loss on disposal of assets (38,090) 10,964,763 210,128 Interest accrual on zero coupon notes payable 163,246 138,864 116,657 Interest accrual on zero coupon notes receivable (196,025) 25,191 -- -- Cumulative effect of accounting changes -- -- -- -- (305,338) Foreign currency exchange rate (gains) losses (237,018) 37,336 39,808 Unremitted loss from joint venture 209,825 -- -- -- -- Provision for restructuring and withdrawal of non -productive assets -- -- -- -- (969,251) Changes in operating assets and liabilities net of effect of business acquisition: Receivables 9,469,616 8,340,071 (14,970,510) Inventories (9,721,098) (2,702,071) (4,192,871) Other current assets (77,033) (1,169,491) (967,404) Accounts payable (1,015,779) (4,791,149) 3,601,697 Accrued expenses (3,532,609) 4,023,149 (545,949) ------------ ------------ ------------ Net cash provided by operating activities $ 16,803,488 $ 23,438,366 $ 4,617,603 ------------ ------------ ------------\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 ------------ ------------ ------------ Cash Flows from Investing Activities Purchase of property, plant and equipment $(10,172,585) $ (8,751,196) $(16,631,214) Investment in and loan to joint venture (1,128,362) -- -- -- -- Decrease in deposits 463,328 -- -- -- -- Purchase of intangible assets -- -- (211,275) (249,723) Acquisition of business, less cash acquired -- -- -- -- (1,153,643) Disbursements on non-operating notes receivable -- -- (150,000) -- -- Payments received from non- operating notes receivable -- -- 250,894 729,176 Proceeds from disposal of assets 138,127 46,655,229 127,917 Other, net (652,530) 362,766 (284,421) ------------ ------------ ------------ Net cash provided by (used in) investing activities $(11,352,022) $ 38,156,418 $(17,461,908) ------------ ------------ ------------ Cash Flows from Financing Activities Changes in short-term debt $ -- -- $ (8,483,977) $ 1,734,995 Net change in line of credit borrowings -- -- (13,000,000) (7,500,000) Proceeds from long-term debt -- -- -- -- 25,000,000 Repayment of long-term debt (46,322) (28,622,307) (2,217,750) Cash dividends paid (4,950,712) (4,615,539) (4,615,743) Issuance of common stock 246,985 -- -- -- -- Purchase of common stock (2,635) (1,175) (3,504) ------------ ------------ ------------ Net cash provided by (used in) financing activities $ (4,752,684) $(54,722,998) $ 12,397,998 ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents $ 698,782 $ 6,871,786 $ (446,307) ------------ ------------ ------------ Cash and cash equivalents at beginning of year $ 9,701,801 $ 2,830,015 $ 3,545,943 Less cash and cash equivalents of discontinued operations -- -- -- -- (269,621) ------------ ------------ ------------ Cash and cash equivalents of continuing operations at beginning of year $ 9,701,801 $ 2,830,015 $ 3,276,322 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 10,400,583 $ 9,701,801 $ 2,830,015 ============ ============ ============\nThe accompanying notes are an integral part of the consolidated financial statements.\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 1995, 1994 and 1993\nAdditional Common Paid-in Retained Stock Capital Earnings ------------ ------------ ------------ Balance at January 1, 1993 $ 16,485,268 $ 9,967,758 $ 77,126,131 Net income -- -- -- -- 10,014,456 Purchase of common stock (320) (3,184) -- -- Dividends declared, $.28 per share -- -- -- -- (4,615,718) Translation adjustments -- -- -- -- -- -- Unrecognized pension costs -- -- -- -- -- -- ------------ ------------ ------------ Balance at December 31, 1993 $ 16,484,948 $ 9,964,574 $ 82,524,869 Net income -- -- -- -- 2,629,844 Purchase of common stock (117) (1,058) -- -- Dividends declared, $.28 per share -- -- -- -- (4,615,655) Translation adjustments -- -- -- -- -- -- Unrecognized pension costs -- -- -- -- -- -- ------------ ------------ ------------ Balance at December 31, 1994 $ 16,484,831 $ 9,963,516 $ 80,539,058 Net income -- -- -- -- 14,032,063 Issuance of common stock 25,811 221,174 -- -- Purchase of common stock (240) (2,395) -- -- Dividends declared, $.31 per share -- -- -- -- (5,117,607) Translation adjustments -- -- -- -- -- -- Unrecognized pension costs -- -- -- -- -- -- ------------ ------------ ------------ Balance at December 31, 1995 $ 16,510,402 $ 10,182,295 $ 89,453,514 ============ ============ ============\nO'SULLIVAN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 1995, 1994 and 1993 (Continued)\nCumulative Unrecognized Translation Pension Shareholders' Adjustments Costs Equity ------------ ------------ ------------ Balance at January 1, 1993 $ 34,085 $ -- -- $103,613,242 Net income -- -- -- -- 10,014,456 Purchase of common stock -- -- -- -- (3,504) Dividends declared, $.28 per share -- -- -- -- (4,615,718) Translation adjustments (135,817) -- -- (135,817) Unrecognized pension costs -- -- (119,296) (119,296) ------------ ------------ ------------ Balance at December 31, 1993 $ (101,732) $ (119,296) $108,753,363 Net income -- -- -- -- 2,629,844 Purchase of common stock -- -- -- -- (1,175) Dividends declared, $.28 per share -- -- -- -- (4,615,655) Translation adjustments (243,370) -- -- (243,370) Unrecognized pension costs -- -- 119,296 119,296 ------------ ------------ ------------ Balance at December 31, 1994 $ (345,102) $ -- -- $106,642,303 Net income -- -- -- -- 14,032,063 Issuance of common stock -- -- -- -- 246,985 Purchase of common stock -- -- -- -- (2,635) Dividends declared, $.31 per share -- -- -- -- (5,117,607) Translation adjustments 124,536 -- -- 124,536 Unrecognized pension costs -- -- (162,680) (162,680) ------------ ------------ ------------ Balance at December 31, 1995 $ (220,566) $ (162,680) $115,762,965 ============ ============ ============\nThe accompanying notes are an integral part of the consolidated financial statements.\nO'Sullivan Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Accounting Policies\nPrinciples of Consolidation-The consolidated financial statements include the accounts and transactions of the Corporation and all of its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.\nInvestments in affiliates in which the Corporation has a 20% to 50% interest are carried at cost, adjusted for the Corporation's proportionate share of the affiliate's undistributed earnings or losses.\nCash and Cash Equivalents-The Corporation considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.\nReceivables and Concentration of Credit Risk-Receivables from trade customers are generally due within thirty to sixty days. The Corporation conducts periodic reviews of its major customers' financial condition and grants trade credit based upon evaluations of the credit worthiness of each customer. Management performs regular assessments of receivables and makes estimates as to the adequacy of the allowance for doubtful accounts based on historical data and knowledge of customers' financial condition. Credit losses have been within the expectations of management. Receivable are presented net of an allowance for doubtful accounts of $898,648 at December 31, 1995 and $884,467 at December 31, 1994. Accounts receivable balances for automotive related business at December 31, 1995 and 1994 were $13,825,514 and $9,507,357, respectively.\nInventories-Inventories are valued at the lower of cost or market, with cost being determined substantially by the first-in, first-out or average cost method.\nProperty, Plant and Equipment and Depreciation-Property, plant and equipment are stated at historical cost, adjusted to current exchange rates where applicable. Depreciation is computed primarily by the straight-line method over the estimated useful lives of assets. The estimated useful lives are twenty to forty years for buildings and three to fourteen years for machinery and other equipment. Accelerated methods of depreciation are utilized for tax purposes. Expenditures for repairs and maintenance are charged to operations as incurred. Betterments and improvements that extend the useful life of an asset are capitalized. Upon sale and other dispositions of assets, the cost and related accumulated depreciation is removed from the accounts and the resulting gain or loss is reflected in operations.\nIntangibles-Intangible assets are stated at historical cost less accumulated amortization. Amortization is determined on a straight-line basis over the estimated useful lives of the assets that have been determined to range from two to seven years. Amortization expense for 1995, 1994 and 1993 was $266,718, $447,770 and $197,224, respectively.\nIncome Taxes-Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences 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.\nAdvertising Costs-Costs incurred for producing and communicating advertising are expensed when incurred, including costs incurred in connection with cooperative advertising programs with distributors and other customers. Advertising costs were $1,203,141 for 1995, $1,649,788 for 1994 and $1,216,008 for 1993.\nResearch and Development-Product and process research and development are charged to expense as incurred.\nPer Share Information-Net income and dividends per share were calculated on the weighted average common shares outstanding for 1995, 1994 and 1993 which were 16,503,877, 16,484,879 and 16,485,103, respectively. Stock options were not dilutive for 1995, 1994 or 1993.\nForeign Currency Translation-Financial statements for the Corporation's foreign subsidiary are translated into US dollars at year-end exchange rates as to assets and liabilities and weighted average exchange rates as to revenues and expenses. The resulting translation adjustments are recorded in shareholders' equity. Transaction gains and losses are reflected in net income.\nPension Plans-The Corporation and its subsidiaries have retirement plans that cover substantially all employees who meet certain eligibility requirements. Employees not covered under a retirement plan maintained by the Corporation and its subsidiaries are generally participants in multiemployer plans sponsored by other entities. The plans include non- contributory defined benefit plans providing benefits to certain salaried employees based on years of service and final years' average earnings and to certain hourly employees based on a dollar unit multiplied by years of eligible service. The Corporation's policy is to fund at least the minimum amounts required by the applicable governing bodies.\nThe Corporation also maintains a Retirement Savings Plan (\"Plan\") to provide retirement benefits to employees not covered by a defined benefit plan. The Plan provides that the Corporation will make a basic contribution of three percent of eligible compensation for participants. The Plan also provides that the Corporation will make an additional contribution of up to two percent of eligible compensation if the participant is making voluntary contributions to the Plan. Participants may generally contribute up to five percent of their eligible compensation. The Corporation is not required to make any contributions during a plan year if it elects to not do so.\nPostretirement Benefits-The Corporation provided health care benefits to certain of its retired employees under a plan which was terminated January 1, 1993. Upon termination of the plan this group of retired employees was allowed to continue to be covered by the Corporation's group insurance plan. Effective January 1, 1993 the Corporation adopted Financial Accounting Standards Board Statement No. 106 to account for its share of the costs of benefits provided to this group. To effect adoption of Statement No. 106, the Corporation accrued as of January 1, 1993 its share of the estimated costs to insure this group of retirees. Prior to January 1, 1993, the Corporation expensed its share of these expenses as they were incurred.\nReclassification of Amounts-Certain amounts for 1994 and 1993 have been reclassified to reflect comparability with account classifications for 1995.\n2. Nature of Operations, Risks and Uncertainties\nThe Corporation and its subsidiaries are manufacturers and distributors of calendered plastics products and lawn and garden products. A significant portion of the Corporation's businesses are conducted in North America. Reference should be made to Note 13 which provides further information as to the Corporation's operations.\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.\n3. Inventories\nInventories at December 31 were composed of the following:\n1995 1994 ------------ ------------ Finished goods $ 11,801,242 $ 8,848,411 Work in process 10,754,865 7,581,465 Raw materials 16,373,017 13,163,840 Supplies 3,267,179 2,881,489 ------------ ------------ $ 42,196,303 $ 32,475,205 ============ ============\nSlow-moving inventories at December 31, 1995 amounted to $1,268,587, less a reserve of $98,959. At December 31, 1994 slow-moving inventories amounted to $1,044,138 less a reserve of $329,906. Slow-moving inventories is an estimate of inventory held in excess of one year's requirements, based on historical sales volumes.\n4. Property, Plant and Equipment\nProperty, plant and equipment at December 31 were composed of the following:\n1995 1994 ------------ ------------ Land $ 1,262,754 $ 1,243,761 Buildings 26,898,482 23,980,895 Machinery and equipment 67,730,663 61,457,280 Transportation equipment 3,626,921 3,533,039 ------------ ------------ $ 99,518,820 $ 90,214,975 Less accumulated depreciation 51,491,491 45,609,336 ------------ ------------ $ 48,027,329 $ 44,605,639 ============ ============\nDepreciation expense totaled $6,553,410, $10,419,505 and $11,241,146 in 1995, 1994 and 1993, respectively.\n5. Accrued Expenses\nAccrued expenses at December 31 were composed of the following:\n1995 1994 ------------ ------------ Accrued compensation $ 2,633,871 $ 2,368,084 Employee benefits 1,447,905 1,983,227 Contingency reserve for discontinued operations 2,417,252 5,543,042 Dividends payable 1,319,419 1,153,614 Other accrued expenses 2,755,870 2,893,154 ------------ ------------ $ 10,574,317 $ 13,941,121 ============ ============\nThe contingency reserve for discontinued operations is an allowance for potential adjustments relating to the ultimate outcome of the Corporation's sale of the Gulfstream Division.\n6. Debt\nDecember 31, 1995 1994 Long-Term Debt ------------ ------------\nUnsecured non-interest bearing promissory note payable to Melnor Industries, Inc. discounted at 9.0% due on November 24, 1996. The principal amount of the note is $ 1,463,037. $ 1,340,738 $ 1,360,945\nDecember 31, 1995 1994 ------------ ------------ Non-interest bearing obligation payable to Melnor Industries, Inc. discounted at 9.0%. Payment is contingent upon Melnor Industries, Inc. satisfying its obligation under the New Jersey Environmental Cleanup Responsibility Act and the release by the State of the escrow fund of $300,000 established to fund environmental cleanup activities. 276,331 252,632\nNotes payable from Melnor Inc. to equipment finance companies due in monthly payments totaling $223 including interest at rates from 4.9% to 5.1%. The notes are secured by equipment with a book value of $9,600. 5,687 7,754\nCapital lease obligations 94,437 83,738 ------------ ------------ $ 1,717,193 $ 1,705,069 Less current maturities 1,665,448 52,073 ------------ ------------ $ 51,745 $ 1,652,996 ============ ============\nLong-term debt matures as follows: 1996 $ 1,665,448 1997 35,955 1998 15,790 ------------ $ 1,717,193 ============\nInterest incurred and capitalized are as follows:\n1995 1994 1993 --------- --------- --------- Interest incurred $ 143,825 $ 914,211 $ 959,226 Less interest capitalized 84,072 102,535 81,392 --------- --------- --------- $ 59,753 $ 811,676 $ 877,834 ========= ========= =========\nThe Corporation has a $35,000,000 unsecured line of credit through First Union National Bank of Virginia to support general corporate activities. Interest rates for the line of credit vary based on the Corporation's choice of rate options provided by the lender. All available rates are at or below prevailing prime interest rates. The line of credit matures June 30, 1997. At December 31, 1995 the Corporation has utilized $850,000 of the line of credit to provide a standby letter of credit in that amount for a subsidiary corporation. The Corporation is also the guarantor of a commercial letter of credit for a subsidiary corporation in the amount of $371,674.\n7. Investment in Unconsolidated Joint Venture\nThe Corporation acquired a 49% equity interest in Keifel Technologies, Inc. (\"Keifel\") during 1995. Keifel designs, manufactures and distributes thermoforming and radio frequency welding machines and related machinery and tools. Financial information for Keifel is as follows:\nIncome Statement Data For The Period August 9, 1995 Through December 31, 1995 Net Sales $ 213,312 Gross Loss $ (27,439) Net Loss $ (428,214)\nCorporation's share of net loss $ (209,825)\nBalance Sheet Data at December 31, 1995\nAssets Current assets $ 736,317 Property, plant and equipment, net 1,525,028 Other assets 9,500 ------------ Total assets $ 2,270,845 ============\nLiabilities and Equity Current liabilities $ 399,059 Notes payable 1,800,000 Shareholders' equity 71,786 ------------ Total liabilities and equity $ 2,270,845 ============\nCorporation's share of equity $ 35,175 ============\n8. Income Tax Matters\nPretax income from operations for the years ended December 31, 1995, 1994 and 1993 was taxed by the following jurisdictions:\n1995 1994 1993 ------------ ------------ ------------ Domestic $ 22,800,687 $ 16,934,578 $ 15,741,703 Foreign 859,616 1,175,901 1,587,447 ------------ ------------ ------------ $ 23,660,303 $ 18,110,479 $ 17,329,150 ============ ============ ============\nEffective January 1, 1993, the Corporation adopted Statement of Financial Standards No. 109, Accounting for Income Taxes. The adoption of Statement No. 109 changes the Corporation's method of accounting for income taxes from the deferred method to a liability method. Under the deferred method the Corporation deferred the past tax effects of a timing difference between financial reporting and tax reporting. 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.\nThe cumulative effect of the adoption of Statement No. 109 was to increase net income determined for 1993 by $680,488. Financial statements for prior years have not been restated.\nNet deferred tax liabilities at December 31, 1995 and 1994 consisted of the following components:\n1995 1994 ------------ ------------ Deferred tax assets: Provision for doubtful accounts $ 279,344 $ 277,708 Employee benefits 1,580,115 1,487,986 Inventory basis differences 191,775 189,615 Contingency reserve- discontinued operations 966,901 1,330,621 Other 328,796 308,348 ------------ ------------ $ 3,346,931 $ 3,594,278 ------------ ------------ Deferred tax liabilities: Property, plant and equipment $ 4,181,375 $ 4,093,935 Like-kind exchange 254,856 254,856 Other 167,203 106,494 ------------ ------------ $ 4,603,434 $ 4,455,285 ------------ ------------\n$ (1,256,503) $ (861,007) ============ ============\nThe deferred tax amounts mentioned above have been classified on the accompanying balance sheets as of December 31, 1995 and 1994 as follows:\nNoncurrent (liabilities) $ (3,519,139) $ (3,503,530) Current assets 2,262,636 2,642,523 ------------ ------------ $ (1,256,503) $ (861,007) ============ ============\nThe provision for income taxes charged to operations for the years ended December 31, 1995, 1994 and 1993 consists of the following:\n1995 1994 1993 ------------ ------------ ------------ Current: Federal $ 6,728,076 $ 5,478,787 $ 4,807,962 Foreign 301,072 472,492 611,451 State 2,112,610 960,462 1,449,583 ------------ ------------ ------------ $ 9,141,758 $ 6,911,741 $ 6,868,996 ------------ ------------ ------------ Deferred: Federal $ 403,589 $ 190,369 $ 29,886 Foreign 28,853 21,387 - - State 54,340 12,012 47,868 ------------ ------------ ------------ $ 486,782 $ 223,768 $ 77,754 ------------ ------------ ------------ $ 9,628,540 $ 7,135,509 $ 6,946,750 ============ ============ ============\nThe income tax provision differs from the amount of income tax determined by applying the US federal income tax rate to pretax income for the years ended December 31, 1995, 1994 and 1993 due to the following:\n1995 1994 1993 % Income % Income % Income Before Before Before Taxes Taxes Taxes -------- -------- -------- Computed \"expected\" tax expense 35.0% 35.0% 35.0% Increases (reductions) in taxes resulting from: Income taxed at lower US federal rate -- -- (.6%) (.6%) State taxes, net of federal benefit 6.0% 3.5% 5.6% Higher rate on earnings of foreign operations .1% .5% .3% Federal tax credits -- -- (.4%) (.4%) Other (.4%) 1.4% .2% -------- -------- -------- 40.7% 39.4% 40.1% ======== ======== ========\n9. Benefit Plans\nDefined Benefit Plans\nThe net pension cost for defined benefit plans included the following components: 1995 1994 1993 ----------- ----------- ----------- Benefits earned during the year $ 100,835 $ 228,417 $ 242,837 Interest cost on projected benefit obligation 607,454 678,236 654,682 Actual (return) on assets (1,082,007) (222,158) (592,401) Net amortization and deferral 549,493 (312,142) 94,403 Settlement (gain) (81,954) (92,961) -- -- ----------- ----------- ----------- Net pension cost $ 93,821 $ 279,392 $ 399,521 =========== =========== =========== The funded status of the defined benefit pension plans as of December 31, 1995 was as follows: Overfunded Underfunded ------------ ------------ Actuarial present value: Vested benefit obligation $ 2,334,090 $ 6,193,084 Nonvested benefit obligation -- -- 101,795 ------------ ------------ Accumulated benefit obligation $ 2,334,090 $ 6,294,879 Effect of projected compensation increases -- -- 269,707 ------------ ------------ Projected benefit obligation $ 2,334,090 $ 6,564,586 Fair value of plan assets 2,860,196 5,288,778 ------------ ------------ Plan assets in excess of (less than) projected benefit obligation $ 526,106 $ (1,275,808) Unrecognized net loss 144,980 80,676 Unrecognized prior service costs -- -- 594,823 Unrecognized net (asset) obligation at initial adoption of FAS 87 (253,080) (3,268) Adjustment required to recognize minimum liability -- -- (691,139) ------------ ------------ Prepaid (accrued) pension cost $ 418,006 $ (1,294,716) ============ ============\nThe funded status of the defined benefit pension plans as of December 31, 1994 was as follows: Overfunded Underfunded ------------ ------------ Actuarial present value: Vested benefit obligation $ 2,792,538 $ 4,968,242 Nonvested benefit obligation -- -- 196,544 ------------ ------------ Accumulated benefit obligation $ 2,792,538 $ 5,164,786 Effect of projected compensation increases -- -- 312,964 ------------ ------------ Projected benefit obligation $ 2,792,538 $ 5,477,750 Fair value of plan assets 3,572,189 4,553,633 ------------ ------------ Plan assets in excess of (less than) projected benefit obligation $ 779,651 $ (924,117) Unrecognized net (gain) (141,839) (363,643) Unrecognized prior service costs -- -- 567,526 Unrecognized net (asset) obligation at initial adoption of FAS 87 (371,578) 26,921 Adjustment required to recognize minimum liability -- -- (142,333) ------------ ------------ Prepaid (accrued) pension cost $ 266,234 $ (835,646) ============ ============\nDiscount rates for the plans ranged from 7% to 8%. The assumed long-term rates of return on plan assets were also 7% to 8%. The assumed rate of increase in future compensation levels was 7%. The unrecognized asset (liability) at the initial adoption of FAS 87 is being amortized on a straight-line basis over the average remaining service period of plan participants. Plan assets consist of listed common stocks, corporate and government bonds and short-term investments.\nRetirement Savings Plan\nThe expense associated with the Retirement Savings Plan was $1,312,222 for 1995, $1,268,087 for 1994 and $1,152,278 for 1993.\nDeferred Compensation Plan\nDuring 1985, the Corporation initiated a deferred compensation program for key employees of the Corporation. Under this program, the Corporation has agreed to pay each covered employee a certain sum annually for fifteen years upon their retirement or, in the event of their death, to their designated beneficiary. A benefit is also paid if the employee terminates employment (other than by his voluntary action or discharge for cause) before they attain age 65. In that event, the amount of the benefit depends on the employee's years of service with the Corporation (with full benefit paid only if the employee has completed 25 years of service). The Corporation has purchased individual life insurance contracts with respect to each employee covered by this program. The Corporation is the owner and beneficiary of the insurance contracts. The employees are general creditors of the Corporation with respect to these benefits. The expense associated with the Deferred Compensation plan was $397,798 for 1995, $295,299 for 1994 and $196,064 for 1993.\nPostretirement Benefit Plan\nAt January 1, 1993 the Corporation adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This statement requires the Corporation to recognize the estimated costs of providing certain postretirement benefits to former employees of the Corporation. The Corporation elected to recognize the transition obligation immediately as the effect of an accounting change. This change resulted in a one-time charge to income in 1993 of $375,150, net of deferred income taxes of $239,850.\nAnnual net postretirement benefit costs are determined on an actuarial basis. Net periodic postretirement benefit cost included the following components for the years ended December 31, 1995, 1994 and 1993:\n1995 1994 1993 ---------- ---------- ---------- Interest expense on accumulated postretirement benefit obligation $ 27,000 $ 29,000 $ 40,000 Other amortization and deferrals (16,000) (12,000) (95,000) ---------- ---------- ---------- $ 11,000 $ 17,000 $ (55,000) ========== ========== ==========\nPostretirement benefit obligations at December 31, 1995 and 1994, none of which are funded, are summarized as follows: 1995 1994 ------------ ------------ Accumulated postretirement benefit obligation, retirees $ 394,000 $ 387,000 Plan assets -- -- -- -- ------------ ------------ Accumulated postretirement benefit obligation in excess of plan assets $ 394,000 $ 387,000 Unrecognized transition obligation -- -- -- -- Unrecognized net experience losses (gains) -- -- -- -- ------------ ------------ Accrued postretirement benefit obligation $ 394,000 $ 387,000 ============ ============\nFor measurement purposes, a 14% annual rate of increase in per capita health care costs of covered benefits was assumed for 1995, with such annual rate of increase gradually declining to 6% in 2003.\n10. Leases\nThe Corporation and its subsidiaries lease various plant and warehouse facilities along with various equipment. Leases for the plant and warehouse facilities and capitalized leases for machinery and equipment generally require the payment of appropriate taxes, insurance and maintenance costs. Most noncapitalized leases, except for the lease of facilities in New Jersey by a subsidiary, are cancelable within a limited period of time. The facility in New Jersey is leased under a noncancelable agreement that expires June 30, 1998. Minimum Rental Capitalized Commitments Leases ------------ ------------ 1996 $ 6,050 $ 56,245 1997 151,564 38,720 1998 69,507 16,102 ------------ ------------ $ 227,121 $ 111,067 ============ Less amount representing interest 16,630 ------------ Present value of net minimum lease payments $ 94,437 ============\nNet rental expense for all non-capitalized leases for the years ended 1995, 1994, and 1993 was $738,588, $858,213 and $849,963, respectively.\n11. Research and Development\nResearch and development costs charges to expense were $3,545,330 in 1995, $3,423,175 in 1994 and $3,331,796 in 1993.\n12. Commitments and Contingencies\nEnvironmental Matters\nThe Corporation continues to modify, on an ongoing, regular basis, certain of its processes which may have an environmental impact. The Corporation's efforts in this regard include the removal of many of its underground storage tanks and the reduction or elimination of certain chemicals and wastes in its operations. Although it is very difficult to quantify the potential impact of compliance with environmental protection laws, the Corporation's financial statements reflect the cost of these ongoing modifications. Management believes that the continuing costs to the Corporation of environmental compliance will not result in a material adverse effect on its future financial condition or results of operations.\n13. Business Segment Information\nThe Corporation's operations are classified principally into two business segments; Calendered Plastics Products (\"Plastics Products\") and Lawn and Garden Consumer Products (\"Consumer Products\"). The Plastics Products segment primarily involves the manufacture of calendered plastics products for the automotive and specialty plastics manufacturing industries. The Consumer Products segment primarily involves the manufacture and distribution of a wide range of lawn and garden products. Operating profit represents net sales less operating expenses for each segment and excludes general corporate expenses and non-operating revenues and expenses. Identifiable assets for each segment represent those assets used in the Corporation's operations and exclude general corporate assets. General corporate assets include cash, investments and other non-operating assets.\nNet sales for the Plastics Products segment to the divisions and subsidiaries of Ford Motor Company amounted to $40,622,615 (19.4% of net sales) in 1995, $24,385,299 (12.5% of net sales) in 1994 and $13,374,601 (7.7% of net sales) in 1993.\nReceivables at December 31, 1995, 1994 and 1993 from Ford Motor Company were $6,275,579, $3,396,054 and $2,085,303, respectively.\nBusiness Segment Information 1995 1994 1993 Net Sales By Classes of Similar ------------ ------------ ------------ Products Plastics Products $169,455,886 $149,438,108 $132,832,228 Consumer Products 40,267,676 45,536,156 40,513,273 ------------ ------------ ------------ Total Net Sales $209,723,562 $194,974,264 $173,345,501 ============ ============ ============ Operating Profit Plastics Products $ 29,443,430 $ 21,630,468 $ 23,085,147 Consumer Products 1,200,708 4,282,552 2,057,052 ------------ ------------ ------------ Total Operating Profit $ 30,644,138 $ 25,913,020 $ 25,142,199 General Corporate Expenses 7,957,829 7,289,802 7,184,538 Non-Operating Revenue (Expense) 974,294 (512,739) (628,511) ------------ ------------ ------------ Income From Continuing Operations Before Income Taxes and Cumulative Effect of Accounting Changes $ 23,660,603 $ 18,110,479 $ 17,329,150 ============ ============ ============\nIdentifiable Assets Plastics Products $ 91,139,594 $ 92,203,867 $ 99,706,260 Consumer Products 30,056,412 27,318,222 25,394,702 ------------ ------------ ------------ Total Identifiable Assets $121,196,006 $119,522,089 $125,100,962 General Corporate Assets 28,800,519 25,006,799 19,264,457 ------------ ------------ ------------ Total Assets-Continuing Operations $149,996,525 $144,528,888 $144,365,419 ============ ============ ============\nCapital Expenditures Plastics Products $ 7,617,926 $ 7,477,833 $ 15,193,167 Consumer Products 2,382,011 1,205,377 1,351,516 General Corporate 172,648 67,986 86,531 ------------ ------------ ------------ Total Capital Expenditures $ 10,172,585 $ 8,751,196 $ 16,631,214 ============ ============ ============\nDepreciation and Amortization Plastics Products $ 4,391,048 $ 8,644,205 $ 9,651,506 Consumer Products 1,958,777 1,719,307 1,402,596 General Corporate 470,303 503,763 384,268 ------------ ------------ ------------ Total Depreciation and Amortization $ 6,820,128 $ 10,867,275 $ 11,438,370 ============ ============ ============\n14. Incentive Stock Option Plan\n1985 Incentive Stock Option Plan\nThe Corporation has an incentive stock option plan begun January 29, 1985 under which options were granted to certain key employees for the purchase of the Corporation's common stock. The plan expired on January 28, 1995. The original number of shares authorized under the plan totaled 50,000 shares. Antidilutive provisions in the plan required an increase in authorized shares to 165,886 shares for stock dividends and distributions that occurred during 1989, 1988, 1987, 1986 and 1985. The option price covered by an option could not be less than 100% of fair market value of the common stock on the date of grant.\nAs of December 31, 1995, options for 96,965 shares remain unexercised. No options were granted in 1995 or 1994. Options for 1,000 shares at an exercise price of $10.50 per share were granted during 1993. Options for 25,811 at an average price of $9.57 were exercised during 1995. No options were exercised during 1994 or 1993. Options for 30,286 shares during 1995, 7,956 shares during 1994 and 2,000 shares during 1993 were forfeited. Since the plan expired on January 28, 1995 all shares reserved for future option grants were canceled. Although the 1985 incentive stock option plan has expired, those options previously granted may be exercised by the individual recipients until the options expire, normally ten years after the date of the original grant.\n1995 Stock Option Plan\nDuring 1995 the Corporation adopted a new incentive stock option plan under which options may be granted to certain key employees for the purchase of the Corporation's common stock. The effective date of the Plan was February 7, 1995 with an expiration date of February 6, 2005. The Plan reserves for issuance an aggregate of 200,000 shares of the Corporation's common stock. The option price for options granted cannot be less than 100% of fair market value of the common stock on the date of the grant. The Plan contains an antidilutive provision providing for adjustments to the options previously granted in the event of changes in the Corporation's capital structure.\nOptions for 102,000 shares at an exercise price of $10.31 were issued during 1995. No options were exercised during 1995. At December 31, 1995 98,000 shares were reserved for the grant of future options.\n1995 Outside Directors Stock Option Plan\nDuring 1995 the Corporation adopted an incentive stock plan under which options may be granted to members of the Corporation's Board of Directors for the purchase of the Corporation's common stock. The effective date of the Plan was April 25, 1995 with an expiration date of April 24, 2005. The Plan reserves for issuance an aggregate of 200,000 share of the Corporation's common stock. Each eligible director received an option for 10,000 shares common stock on the effective date of the Plan. On each April 25 thereafter each eligible director will receive an option for 1,000 shares of common stock. Directors who become eligible after April 25, 1995 will receive an option for 10,000 shares as of the date they become\neligible for the Plan and will receive an option for 1,000 shares on each April 25 thereafter. The option price for options granted cannot be less than 100% of fair market value of the common stock on the date of the grant. The plan contains an antidilutive provision providing for adjustments to the options previously granted in the event of changes in the Corporation's capital structure.\nOptions for 80,000 shares at an exercise price of $10.31 were issued during 1995. No options were exercised during 1995. At December 31, 1995 120,000 shares were reserved for the grant of future options.\n15. Fair Value of Financial Instruments\nThe Corporation estimates that each category of financial instruments; including cash, trade receivables and payables, investments and debt instruments, approximate current value at December 31, 1995 and 1994.\n16. Discontinued Operations\nOn December 2, 1994 the Corporation sold certain specified assets of the Corporation's Gulfstream Division, which was part of the Corporation's plastics products business segment, to Automotive Industries Holding, Inc. The assets sold consisted primarily of property, plant and equipment, inventories and the capital stock of Capitol Plastics of Ohio, Inc., a subsidiary of O'Sullivan Corporation. In addition, certain specified liabilities, consisting primarily of employee compensation payables were assumed by Automotive Industries Holding, Inc. The Corporation received $46,656,382 in cash and $4,000,000 in an unsecured promissory note.\nThe loss on disposal of the division of $8,220,000 (net of income tax benefit of $5,480,000) represented the loss on disposal of the assets of the division, along with expenses associated with disposal activities, including severance costs, environmental clean-up costs, professional fees and various other costs associated with the disposal, net of the operating income of $1,289,064, during the phase-out period.\nIncome (loss) from the discontinued operations of the Gulfstream Division is shown separately in the accompanying income statements. The income statement for the year ended December 31, 1993 has been restated to show the results of the Gulfstream Division separately from continuing operations. Income taxes (benefit) applicable to the years ended December 31, 1994 and 1993 were $(86,439) and $141,614.\nNet sales of the Gulfstream Division were $149,595,597 and $118,910,213 for the years ended December 31, 1994 and 1993. These amounts are not included in net sales in the accompanying income statements.\n17. Supplemental Cash Flow Information\nSupplemental Disclosure of Cash Flow Information\n1995 1994 1993 ------------ ------------ ------------ Cash payments for interest, net of interest capitalized $ 59,753 $ 3,199,018 $ 2,028,606 ------------ ------------ ------------\nCash payments for income taxes $ 8,373,829 $ 8,797,775 $ 7,964,853 ------------ ------------ ------------\nSupplemental Schedule of Noncash Investment Activities\nThe Corporation's 1993 business acquisition involved the following:\nFair value of assets acquired, other than cash and cash equivalents $ 8,173,416 Liabilities assumed 7,019,773 ------------ Cash payments made $ 1,153,643 ------------\nIn 1994, the Corporation received a note receivable of $4,000,000 as part of the proceeds from the sale of assets of discontinued operations.\n18. Supplemental Financial Data (Unaudited)\nQUARTER ENDED ------------------------------------------------------ 1995 March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ Net sales $ 55,052,191 $ 57,070,658 $ 48,551,668 $ 49,049,045 Gross profit $ 12,191,603 $ 11,280,312 $ 8,736,647 $ 9,372,115 Net income $ 4,083,884 $ 3,963,481 $ 2,784,742 $ 3,199,956 Earnings per share $ .25 $ .24 $ .17 $ .19 Dividends declared $ .07 $ .08 $ .08 $ .08 Market price per share: High 10 5\/8 12 3\/8 12 11 7\/8 Low 9 1\/4 9 7\/8 10 3\/8 9 7\/8\nQUARTER ENDED ------------------------------------------------------ 1994 March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ Net sales $ 47,405,015 $ 57,027,493 $ 44,696,455 $ 45,845,301 Gross profit $ 9,664,206 $ 11,506,661 $ 8,552,102 $ 8,267,070 Income (loss) from: Continuing operations $ 2,837,888 $ 3,826,222 $ 2,408,003 $ 1,902,857 Discontinued operations (226,823) 1,072,996 (9,191,299) - - ------------ ------------ ------------ ------------ Net income $ 2,611,065 $ 4,899,218 $ (6,783,296) $ 1,902,857 ------------ ------------ ------------ ------------ Earnings (loss) per share: Continuing operations $ .17 $ .23 $ .15 $ .12 Discontinued operations (.01) .07 (.57) - - ------------ ------------ ------------ ------------ Earnings (loss) per share $ .16 $ .30 $ (.42) $ .12 ------------ ------------ ------------ ------------ Dividends declared $ .07 $ .07 $ .07 $ .07 ------------ ------------ ------------ ------------ Market price per share: High 10 5\/8 10 5\/8 10 5\/8 10 3\/8 Low 8 7\/8 8 7\/8 8 7\/8 8 7\/8\n19. New 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,\" establishes 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\nentity 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 fiscal years beginning after December 15, 1995. The Statement is not expected to have a material impact on the Corporation.\nStatement of Financial Accounting Standards no. 123, \"Accounting for Stock- Based Compensation,\" establishes financial accounting and reporting standards for stock-based employee compensation plans. Those plans include arrangements by which employees receive shares of stock of the Corporation, primarily stock options and stock appreciation rights in the case of O'Sullivan Corporation.\nThis Statement also applies to transactions in which an entity issues equity instruments to acquire goods or services from nonemployees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured.\nThis Statement 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 of their employee stock compensation plans. However, it also allows the Corporation 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\". 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 by this Statement had been applied.\nUnder the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, normally the vesting period. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date over the amount an employee must pay to acquire the stock. The plans in effect for the Corporation have no intrinsic value at the grant date since the grant price is the quoted market price at the grant date.\nThe Statement is effective for fiscal years beginning after December 15, 1995. It is anticipated that the Corporation will continue to measure compensation costs in accordance with APB Opinion No. 25 providing the pro forma data required by FAS No. 123. The Statement is not expected to have a material impact on the Corporation.\nINDEPENDENT AUDITOR'S REPORT\nTo the Stockholders and Board of Directors of O'Sullivan Corporation\nWe have audited the accompanying consolidated balance sheets of O'Sullivan 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 ended December 31, 1995, 1994 and 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the accounting principles used and significant estimates made by management, as 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 O'Sullivan Corporation and Subsidiaries as of December 31, 1995 and 1994 and the 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.\n\/s\/ YOUNT, HYDE & BARBOUR, P.C.\nWinchester, Virginia February 2, 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\nFor information with respect to the Corporation's Directors and Director nominees, see pages 3 through 6 of the Corporation's definitive Proxy Statement dated March 29, 1996 which pages are incorporated herein by reference.\nExecutive Officers of the Registrant\nThe names, ages of and positions of the executive officers of O'Sullivan Corporation as December 31, 1995 are listed below. All officers are elected by the Board of Directors for a one year term. There are no family relationships among officers or any other arrangement or understanding between any officer and any other person pursuant to which the officer was elected.\nServed As Name Age Office Officer Since - --------------------- ---- --------------------- ------------- James T. Holland 55 President 1976 C. Bryant Nickerson 49 Secretary & Treasurer 1986 Phillip S. Griffin 57 Vice President 1975 John S.Campbell 45 Vice President 1986\nMr. Holland has served in the following capacities for the Corporation; Treasurer, 1976-1979, Vice President and Treasurer, 1979-1984, Executive vice President and Chief Operating Officer, 1984-1986, President and Chief Operating Officer, 1986-1995, President and Chief Executive Officer, 1995- Present.\nMr. Nickerson has been employed by the Corporation since 1973 serving in various capacities within the corporate financial area. He has served as Controller and Treasurer and Chief Accounting Officer before being elected as Secretary, Treasurer and Chief Financial Officer in 1995.\nMr. Griffin has served the Corporation in various capacities in sales, manufacturing and corporate management since 1968. He has served as a Vice President since 1975 and also serves as the President of Melnor Inc., a subsidiary of the Corporation.\nMr. John S. Campbell has served as a Vice President since 1986. He has been employed by the Corporation since 1973 and has been involved in both the sales and manufacturing operations of the calendered plastics products business of the Corporation.\nOther Officers of the Registrant Served As Name Age Office Officer Since - --------------------- ---- --------------------- ------------- William O. Bauserman 52 Vice President 1987 Ewen A. Campbell 48 Vice President 1993 Dee S. Johnston 59 Vice President 1992 Michael J. Meissner 56 Vice President 1995 James L. Tremoulis 42 Vice President 1986 Robert C. Westfall 53 Vice President 1979\nMr. Bauserman has been employed by the Corporation since 1968 and has served as a Vice President since 1987. Mr. Bauserman has been employed in various capacities within the data processing and management information services areas during his tenure with the Corporation.\nMr. Ewen A. Campbell has an extensive background in chemistry and plastics compounding. He has been employed by the Corporation since 1991 in the areas of compounding and research and development activities. He has served as a Vice President since 1993. Mr. Ewen Campbell and Mr. John Campbell are not related.\nMrs. Johnston has been employed by the Corporation since 1976 and has served as a Vice president since 1992. Mrs. Johnston has been involved in all phases of the Corporation's purchasing function during her employment.\nMr. Meissner has been employed by the Corporation since 1995. Prior to that time he was employed by and was a principal with a business that served as a manufacturers' representative to the automotive industry for the Corporation.\nMr. Tremoulis has served in various capacities in the sales area for calendered plastics products since his employment by the Corporation in 1980. He was elected as a Vice President in 1986.\nMr. Westfall has been employed by the Corporation since 1965. He was a chemist, the Quality Control Director and a Plant Manager for the Corporation prior to being elected as a Vice President of Research and Development in 1979.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nSee Pages 6 through 10 of the Corporation's Proxy Statement dated March 29, 1996, which pages are incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee Pages 3 through 6 of the Corporation's Proxy Statement dated March 29, 1996, which pages are incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no transactions during 1995 that would be applicable for disclosure under this item.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a). (1) Financial Statements Page\nIncluded in Part II, Item 8, of this report:\nReport of Independent Auditors 37\nConsolidated Balance Sheets at December 31, 1995 and 1994 12\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 13-14\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 15-16\nConsolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 17-18\nConsolidated Notes to Financial Statements 19-36\n(a). (2) Financial Statement Schedules\nIncluded in part IV of this report:\nReport of Independent Auditors on Financial Statement Schedule 43\nSchedule II - Valuation and Qualifying Accounts and Reserves for the Years Ended December 31, 1995, 1994 and 1993 44\n(a). (3) Exhibits 3.1 O'Sullivan Corporation Amended and Restated Articles of Incorporation, including the Articles of Amendment, dated April 30, 1985, filed with the State Corporation Commission of Virginia on May 6, 1985, adopted by shareholders of O'Sullivan Corporation at the annual meeting held April 30, 1985. (Incorporated by reference to the March 31, 1985, Quarterly Report on Form 10-Q of the Corporation.)\n3.2 O'Sullivan Corporation Bylaws as amended to January 29, 1985. (Incorporated by reference to the March 31, 1985, Quarterly Report on Form 10-Q of the Corporation.)\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (continued)\nPage 3.3 O'Sullivan Corporation Amended and Restated Articles of Incorporation dated April 29, 1989, filed with the State Corporation Commission dated April 29, 1989, adopted by shareholders of O'Sullivan Corporation at the annual meeting held April 25, 1989. (Incorporated by reference to the March 31, 1989 Quarterly Report on Form 10-Q of the Corporation.)\n10. Compensatory arrangement with executive officers of the registrant. See Pages 9 and 10 of the Corporation's Proxy Statement dated March 29, 1996 which pages are incorporated herein by reference.\n21. Subsidiaries of the Registrant - filed herewith.\n23. Consent of Independent Auditors - filed herewith.\n24. Powers of Attorney - filed herewith.\n27. Financial Data Schedule - filed herewith.\n99.1 The O'Sullivan Corporation 1995 Stock Option Plan filed as exhibit 99.1 to the Corporation's Form S-8 registration statement (Registration Number 033-58895) filed with the Commission on April 28, 1995 and incorporated herein by reference.\n99.2 The O'Sullivan Corporation 1995 Outside Directors Stock Option Plan filed as exhibit 99.2 to the Corporation's Form S-8 registration statement (Registration Number 033-58895) filed with the Commission on April 28, 1995 and incorporated herein by reference.\n99.3 1985 Incentive Stock Option Plan. Amended and Restated as of July 27, 1993. (Incorporated by reference to the Annual report on form 10-K for the Year Ended December 31, 1994.)\n(b). Reports on Form 8-K\nThere were no reports filed on Form 8-K for the quarter ended December 31, 1995.\n(c). Index to Exhibits. 47\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENT SCHEDULE\nTo the Shareholders and Board of Directors of the O'Sullivan Corporation\nThe examination referred to in our opinion dated February 2, 1996 of the consolidated financial statements as of December 31, 1995 and 1994 and for the three years ended December 31 ,1995, 1994 and 1993 included the related supplemental financial schedule as listed in Item 14(a) 2, which, when considered in relation to the basis financial statements, present fairly in all material respects the information shown therein.\n\/s\/ YOUNT, HYDE & BARBOUR, P.C.\nO'SULLIVAN CORPORATION AND SUBSIDIARIES Schedule II VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1995, 1994 and 1993\nColumn A Column B Column C Column D Column E - ---------- ---------- ----------------------------- ----------- ---------- Additions ----------------------------- (1) (2) (3) Balance Charged Charged Additions Balance at to costs to From at Beginning and Other Business End Description of Year Expense Accounts Acquisition Deductions of Year - ---------- ---------- ---------- ------- ------- ----------- ---------- 1995: Allowance for Doubtful Accounts $ 884,467 $ 439,480 $ -- -- $ -- -- $ 425,299(B)$ 898,648 ========== ========== ======= ======= ========== ========== 1994: Allowance for Doubtful Accounts $1,133,793 $1,138,617 $ -- -- $ -- -- $1,387,943(B)$ 884,467 ========== ========== ======= ======= ========== ========== 1993: Allowance for Doubtful Accounts $1,804,676 $ 209,719 $ -- -- $27,013(A)$ 907,615(B)$1,133,793 ========== ========== ======= ======= ========== ==========\nNote (A) - Allowance for doutful accounts established at acquisition date for businesses acquired in 1993.\nNote (B) - Write-offs of uncollectible accounts, net of recoveries. Column D for 1994 also includes a reduction of $27,013 for a bad debt allowance pertaining to a subsidiary disposed of during 1994.\nSIGNATURES\nPursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934 ,the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMarch 26, 1996 O'SULLIVAN CORPORATION - -------------- By: \/s\/ C.Bryant Nickerson Date -------------------------- C. Bryant Nickerson Secretary, Treasurer 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 Registrant and in the capacities indicated on the dates given.\nArthur H. Bryant, II * March 26, 1996 - ------------------------ -------------- Arthur H. Bryant, II Chairman and Director Date\n\/s\/ James T. Holland March 26, 1996 - ------------------------ -------------- James T. Holland President, Chief Executive Date Officer and Director\n\/s\/ C. Bryant Nickerson March 26, 1996 - ------------------------ -------------- C. Bryant Nickerson Secretary, Treasurer and Date Chief Financial Officer\nJohn J. Armstrong * March 26, 1996 - ------------------------ -------------- John J. Armstrong Director Date\nC. Hugh Bloom * March 26, 1996 - ------------------------ -------------- C. Hugh Bloom Director Date\nMagalen O. Bryant * March 26, 1996 - ------------------------ -------------- Magalen O. Bryant Director Date\nRobert L. Burrus, Jr. * March 26, 1996 - ------------------------ -------------- Robert L. Burrus, Jr. Director Date\nMax C. Chapman, Jr. * March 26, 1996 - ------------------------ -------------- Max C. Chapman, Jr. Director Date\nR. Michael McCullough * March 26, 1996 - ------------------------ -------------- R. Michael McCullough Director Date\nStephen P. Munn * March 26, 1996 - ------------------------ -------------- Stephen P. Munn Director Date\n* By: \/s\/ James T. Holland --------------------- James T. Holland Attorney-In-Fact\nEXHIBIT INDEX\nPage 21. Subsidiaries of the Registrant 48\n23. Consent of Experts 49\n24. Powers of Attorney 50-57\n27. Financial Data Schedule 58","section_15":""}
{"filename":"19150_1995.txt","cik":"19150","year":"1995","section_1":"Item 1. Business\nGeneral\nChampion International Corporation was incorporated under the laws of the State of New York on April 28, 1937. References to the \"Company\" include Champion International Corporation and its subsidiaries at December 31, 1995, unless the context otherwise requires.\nThe Company is one of the leading domestic manufacturers of paper for business communications, commercial printing, publications and newspapers. In addition, the Company has significant market pulp, plywood and lumber manufacturing operations and owns or controls approximately 5,300,000 acres of timberlands in the United States. The Company's Canadian and Brazilian subsidiaries also own or control significant timber resources supporting their operations.\nThe Company's business segments are paper and wood products. See Note 14 of \"Notes to Financial Statements\" on pages 52 and 53 of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (the \"Company's 1995 Annual Report\"), which Note is incorporated by reference herein, for information concerning the Company's business segments and operations in different geographic areas for 1993, 1994 and 1995.\nPaper\nSee the \"Paper Net Sales\" table on page 32 of the Company's 1995 Annual Report, which table is incorporated by reference herein, for information concerning the net sales to unaffiliated customers of the various products of the paper business for 1993, 1994 and 1995.\nPrinting and Writing Papers\nThe printing and writing papers business manufactures and sells printing and writing papers, bleached paperboard and pulp. The principal domestic manufacturing properties of this operation consist of integrated pulp and paper mills at Courtland, Alabama; Canton, North Carolina; and Pensacola, Florida; and a paper mill at Hamilton, Ohio. As of December 31, 1995, these mills had an annual capacity of approximately 1,944,000 tons of pulp and 2,113,000 tons of printing and writing papers and bleached paperboard.\nMost of the pulp produced by the printing and writing papers business is used in its own paper mills; approximately 6%, produced at the Pensacola and Courtland mills, was sold in the open market in 1995. A portion of the fiber requirements of this business also is supplied by other Company pulp mills, and approximately 4% of its fiber requirements in 1995 were purchased from third- party suppliers.\nUncoated papers produced by the printing and writing papers business are used for computer forms, copier paper and envelope papers. Coated papers are used in catalogs, magazines, brochures, labels and annual reports.\nIn 1995, 63% of this operation's bleached paperboard production was used by the Company's DairyPak unit, which converts polyethylene-coated paperboard into milk and juice cartons and ovenable packaging. The balance either was sold to independent purchasers, primarily for conversion to cups, or was exported.\nThe Company leases substantial portions of the Courtland mill under 14 long- term net leases which expire between 2007 and 2029. Each of these leases provides for rental payments over its term sufficient to pay interest on and to retire the industrial development or pollution control revenue bonds issued in connection with the financing of the property subject to such lease. The Company is required to purchase, or has the option to purchase, the property subject to each such lease for a nominal sum at the time the related bonds are retired.\nThe Company leases a printing facility at the Athens, Georgia DairyPak plant until 2015. The lease provides for rental payments over its term sufficient to pay interest on and to retire the industrial development revenue bonds issued to finance the acquisition of that facility. The Company has the option to purchase the facility for a nominal sum at the time the bonds are retired.\nThe domestic printing and writing papers business and the publication papers business jointly maintain 16 sales offices in various parts of the United States, as well as an order services office in Hamilton, Ohio, for the sale of their products to direct purchasers and through paper merchants. Certain of these sales offices are shared with the newsprint and kraft operations.\nChampion Papel e Celulose Ltda., a 99.78%-owned subsidiary (\"Champion Papel\"), is a major integrated manufacturer of pulp and printing and writing papers in Brazil with net sales to unaffiliated customers of $404,083,000 in 1995. As of December 31, 1995, its mill had an annual capacity of approximately 338,000 tons of pulp and 381,000 tons of paper. In addition to being a leading supplier of printing and writing papers in Brazil, Champion Papel exports a substantial portion of its paper production.\nPublication Papers\nThe publication papers business manufactures and sells coated and uncoated publication papers and pulp. The manufacturing properties of this operation consist of integrated pulp and paper mills at Bucksport, Maine; Deferiet, New York; Quinnesec, Michigan; and Sartell, Minnesota. As of December 31, 1995, these mills had an annual capacity of approximately 874,000 tons of pulp and 1,292,000 tons of publication papers.\nA significant portion of the fiber requirements of the publication papers business is supplied by its own mills. In addition, a portion of its fiber requirements is supplied by other Company pulp mills, and approximately 29% of its fiber requirements in 1995 were purchased from third-party suppliers.\nThe Company manufactures pulp for sale in the open market at the Quinnesec mill. In 1995, approximately 53% of the pulp production of this mill, or 215,000 tons, was sold in the open market through the Company's headquarters in Stamford, Connecticut, as well as a sales office in Appleton, Wisconsin. The balance was used in the production of paper at the Quinnesec mill and at the Company's printing and writing papers mills.\nThe Company's publication papers are used primarily for consumer magazines, direct mail catalogs, directories, textbooks and coupons. Sales are made to direct purchasers and through paper merchants and brokers from the 16 sales offices jointly maintained by the publication papers operation and the printing and writing papers operation, and from the Hamilton, Ohio order services office.\nThe Company leases the building which houses one of the paper machines at the Sartell mill until 2008. Thereafter, the Company has options to renew the lease for five terms of five years each. The Company also has the option to purchase the building at its then-current market value at the end of the initial term in 2008 or at the end of each five-year renewal term.\nNewsprint\nThe newsprint business manufactures and sells newsprint, directory paper, groundwood specialties and pulp. The manufacturing properties of this operation consist of integrated pulp and paper mills at Lufkin and Sheldon, Texas. As of December 31, 1995, these mills had an annual capacity of approximately 1,126,000 tons of pulp (which includes 165,000 tons of recycled pulp) and 971,000 tons of newsprint, directory paper and groundwood specialties.\nMost of the newsprint operation's pulp production is used in its own paper mills; approximately 4%, produced at the Sheldon mill, was sold in the open market in 1995.\nA portion of the newsprint produced by the Company is sold in the Southwest, Southeast and Midwest, and the balance is exported. In general, sales are made directly to publishers and printers through five sales offices, three of which are shared with the printing and writing papers and publication papers operations, and one order services office.\nPulp\nFor information concerning market pulp produced at the Pensacola and Courtland mills, see the section captioned \"Printing and Writing Papers\" above; for information concerning market pulp produced at the Quinnesec mill, see the section captioned \"Publication Papers\" above; and for information concerning market pulp produced at the Sheldon mill, see the section captioned \"Newsprint\" above.\nWeldwood of Canada Limited, a Canadian subsidiary in which the Company has approximately 84% ownership (\"Weldwood\"), manufactures bleached softwood kraft pulp at its mill in Hinton, Alberta, Canada. As of December 31, 1995, this mill had an annual capacity of approximately 452,000 tons. In 1995, approximately 29% of the mill's pulp production was used in the Company's own publication papers and printing and writing papers mills. The balance was sold in the open market through the Company's headquarters in Stamford, Connecticut, a Company sales office in Appleton, Wisconsin and a Weldwood sales office in Bad Homburg, Germany.\nCariboo Pulp & Paper Company, a joint venture owned equally by Weldwood and Daishowa-Marubeni International Limited, operates a bleached softwood kraft pulp mill in Quesnel, British Columbia, Canada. As of December 31, 1995, this mill had an annual capacity of approximately 353,000 tons. In 1995, approximately 23% of Weldwood's 50% share of the mill's pulp production was used in the Company's own publication papers and printing and writing papers mills. The balance of Weldwood's share was sold in the open market through the Company's headquarters in Stamford, Connecticut, a Company sales office in Appleton, Wisconsin and a Weldwood sales office in Bad Homburg, Germany.\nWhile certain of the Company's mills purchase pulp in the open market, the Company and Weldwood overall are net sellers of pulp. In 1995, the Company and Weldwood in the aggregate produced approximately 861,000 tons of pulp for sale to unaffiliated purchasers, while the Company used approximately 291,000 tons of pulp purchased from third-party suppliers, resulting in net market pulp of approximately 570,000 tons.\nKraft\nThe Company produces pulp, unbleached linerboard and kraft paper for multiwall and grocery bags at its mill in Roanoke Rapids, North Carolina. As of December 31, 1995, this mill had an annual capacity to produce approximately 499,000 tons of pulp, 376,000 tons of linerboard and 130,000 tons of kraft paper. All of this mill's pulp production is used at the mill. In addition, approximately 6% of its fiber requirements in 1995 were purchased from third- party suppliers. The linerboard and kraft paper produced at the Roanoke Rapids mill are sold to converters through three sales offices, two of which are shared with the printing and writing papers and publication papers operations, and one order services office.\nPaper Distribution Operation\nNationwide Papers, a unit of the Company, is a distributor of paper and paper products. Its marketing operations are carried out through 30 wholesale warehouse facilities in 19 states. In addition, Nationwide Papers operates a facility which converts rolls of bleached paperboard into sheets for sale primarily to textile, apparel and furniture producers. In 1995, approximately 74% of its sales were attributable to merchandise purchased from numerous manufacturers other than the Company. However, Nationwide Papers is not dependent on any single supplier for such merchandise.\nWood Products\nThe Company is a major producer of plywood and lumber. The Company's wood products business is conducted through its domestic wood products operations and through the wood products operations of Weldwood.\nThe principal wood products manufacturing facilities operated by the Company and by Weldwood are summarized under Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nIn 1995, the Company's domestic and foreign manufacturing facilities operated at approximately full capacity.\nReference is made to Item 1 of this Report for information concerning the general character, adequacy and capacity of the principal plants, timber properties and other materially important physical properties of the Company. The following lists show the location, nature and ownership of the Company's principal plants. None of these plants is subject to a mortgage and, except as indicated, all are owned in fee.\nPaper\nPrinting and Writing Papers\n(a) Integrated pulp and printing and writing papers mills:\n(i) Courtland, Alabama\/1\/; (ii) Canton, North Carolina; (iii) Pensacola, Florida; and (iv) Mogi Guacu, Brazil.\n(b) The Company operates a printing and writing papers mill in Hamilton, Ohio.\n(c) The Company operates a plant in Waynesville, North Carolina which applies polyethylene coating to bleached paperboard and which also converts roll stock into cut-size paper.\n(d) The Company operates five plants which convert polyethylene-coated paperboard into milk and juice cartons and one plant which converts polyethylene-coated paperboard into ovenable packaging. All of these plants are located in the United States\/2\/.\nPublication Papers\n(e) Integrated pulp and publication papers mills:\n(i) Bucksport, Maine; (ii) Deferiet, New York; (iii) Quinnesec, Michigan; and (iv) Sartell, Minnesota\/3\/.\nNewsprint\n(f) Integrated pulp and newsprint mills:\n(i) Lufkin, Texas; and (ii) Sheldon, Texas.\n_________________________ \/1\/For Courtland, Alabama mill lease information, see Item 1 - \"Paper\" of this Report. \/2\/For lease information regarding one of these plants, located in Athens, Georgia, see Item 1 - \"Paper\" of this Report. \/3\/For Sartell, Minnesota mill lease information, see Item 1 - \"Paper\" of this Report.\nPulp\n(g) The Company's printing and writing papers mills in Pensacola, Florida and Courtland, Alabama, publication papers mill in Quinnesec, Michigan and newsprint mill in Sheldon, Texas also produce market pulp.\n(h) Weldwood operates a pulp mill in Hinton, Alberta, Canada and owns 50% of a joint venture which operates a pulp mill in Quesnel, British Columbia, Canada.\nKraft\n(i) The Company operates an integrated pulp, unbleached linerboard and kraft paper mill in Roanoke Rapids, North Carolina.\nWood Products\n(a) The Company operates three softwood plywood plants in the United States.\n(b) Weldwood operates two softwood plywood plants in Canada. One of these plants is located on leased land.\n(c) Weldwood operates one hardwood plywood plant, in Canada, which Weldwood has agreed to sell as discussed above in the section captioned \"Wood Products\".\n(d) The Company operates five softwood lumber mills in the United States.\n(e) Weldwood operates three softwood lumber mills in Canada. One of these mills is located on leased land.\n(f) Each of Babine Forest Products Company and Houston Forest Products Company, joint ventures in which Weldwood has an interest, operates a mill for the production of softwood lumber in Canada. One of these mills is located on leased land.\n(g) Weldwood operates one waferboard plant, in Canada, which Weldwood has agreed to sell as discussed above in the section captioned \"Wood Products\".\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn November 9, 1992, an action was brought against the Company in the Circuit Court for Baldwin County, Alabama, on behalf of a class consisting of all persons who own land along Perdido Bay in Florida and Alabama. The action originally sought $500 million in compensatory and punitive damages for personal injury, intentional infliction of emotional distress and diminution in property value allegedly resulting from the purported discharge of hazardous substances, including dioxin, from the Company's Pensacola, Florida mill into Eleven Mile Creek, which flows into Perdido Bay. However, in February 1994, the plaintiffs reduced their demand to not more than $50,000 for each class member, and in June 1994, the personal injury claims were dismissed. It is anticipated that the class, which was certified by the court in June 1994, will consist of approximately 2,000 members. The Company and the plaintiffs have entered into an agreement dated March 13, 1996 to settle the action, pursuant to which the Company would pay $5 million to the plaintiffs. The settlement is subject to court approval.\nIn February 1994, the Company received a notice of violation from the Texas Natural Resources Conservation Commission (\"TNRCC\") alleging unauthorized air emissions from the Company's Sheldon, Texas mill. The notice of violation alleged several violations, all but two of which have been resolved without penalty. In October 1995, the Company received a letter from the Enforcement Division of the TNRCC stating that it has recommended to the TNRCC Litigation Support Division that the two remaining violations be settled for a penalty of $470,400. The letter\nnotes that the Company may receive a credit against the recommended penalty if the Company undertakes an environmental project in Texas. The Company currently is considering whether to accept the proposed settlement and is discussing with the TNRCC possible environmental projects and the amount of the credit.\nThe Company also is involved in other legal and administrative proceedings and claims of various types. While any litigation contains an element of uncertainty, management, based upon the opinion of the Company's General Counsel, presently believes that the outcome of each such proceeding or claim which is pending or known to be threatened (including the actions described above), or all of them combined, will not have a material adverse effect on the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nExecutive Officers of the Registrant\/1\/\nJohn A. Ball (age 67) is a Senior Vice President of the Company, a position which he has held since March 1983. He has responsibility for corporate and marketing communications, governmental affairs, public affairs and facilities services.\nL. Scott Barnard (age 53) is an Executive Vice President of the Company, a position which he has held since August 1992. He has responsibility for sales and marketing for the printing and writing papers and publication papers businesses. From February 1989 to August 1992, he was Vice President-Sales and Marketing for the printing and writing papers and publication papers businesses.\nWilliam H. Burchfield (age 60) is an Executive Vice President of the Company, a position which he has held since November 1982. He has responsibility for the domestic printing and writing papers business.\nMark V. Childers (age 43) is Senior Vice President-Organizational Development and Human Resources of the Company, a position which he has held since August 1992. From June 1991 to August 1992, he was Vice President-Organizational Development Project of the Company. From August 1988 to June 1991, he was Manager-Organizational Development at the Lufkin, Texas mill.\nRichard J. Diforio, Jr. (age 60) is a Senior Vice President of the Company, a position which he has held since November 1992. He has responsibility for environmental, health and safety affairs. From September 1990 to November 1992, he was Vice President-Environment, Health and Safety of the Company.\nJoe K. Donald (age 53) is an Executive Vice President of the Company, a position which he has held since August 1989. He has responsibility for the publication papers business.\nMark A. Fuller, Jr. (age 63) is an Executive Vice President of the Company, a position which he has held since August 1980. He has responsibility for the Company's overall marketing program as well as for Nationwide Papers, Champion Export, pulp sales, and sales of wood chemicals and by-products.\nMarvin H. Ginsky (age 65) is Senior Vice President and General Counsel of the Company. He was elected a Senior Vice President in May 1981. He has been the General Counsel since 1973.\nL.C. Heist (age 64) is President and Chief Operating Officer and a director of the Company, positions which he has held since December 1987. _______________________________ \/1\/The term of office for each executive officer expires at the Annual Meeting of the Board of Directors of the Company scheduled to be held on May 16, 1996.\nFrank Kneisel (age 58) is Senior Vice President-Finance of the Company, a position which he has held since January 1995. From November 1975 to December 1994, he was Treasurer of the Company. From May 1981 to December 1994, he was a Vice President.\nBurton G. MacArthur, Jr. (age 49) is an Executive Vice President of the Company, a position which he has held since January 1990. He has responsibility for the newsprint and kraft business.\nKenwood C. Nichols (age 56) is Vice Chairman and a director of the Company, positions which he has held since August 1989. He has been the principal accounting officer of the Company since July 1983. He also has responsibility for internal audit, corporate analysis, tax affairs, management information services, mineral resources, corporate security and the Company's real estate subsidiaries.\nRichard E. Olson (age 58) is an Executive Vice President of the Company, a position which he has held since December 1987. He has responsibility for engineering, technology, manufacturing support and major projects.\nRichard L. Porterfield (age 49) is an Executive Vice President of the Company, a position which he has held since August 1992. He heads the forest products unit, which consists of domestic timberlands operations and the domestic wood products business. From January 1990 to August 1992, he was Senior Vice President- Organizational Development and Human Resources of the Company.\nAndrew C. Sigler (age 64) is Chairman of the Board of Directors and Chief Executive Officer of the Company. He was elected Chairman of the Board effective January 1, 1979. He has served as Chief Executive Officer since 1974 and has been a director since 1973.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Company had 20,902 record holders of its Common Stock as of February 29, 1996.\nThe Company's Common Stock is traded on the New York Stock Exchange.\nRestrictions on the ability of the Company to pay cash dividends are included in several of the Company's debt instruments and the Company's Restated Certificate of Incorporation. At December 31, 1995, the most restrictive of these limitations required the Company to maintain tangible net worth (as defined below) of at least $2.53 billion. As a result of this requirement, such amount is unavailable for the payment of dividends. Approximately $1.1 billion of tangible net worth at December 31, 1995 was free of such restrictions. Tangible net worth is defined as shareholders' equity minus goodwill, unamortized debt discount and other like intangibles, all determined on a consolidated basis for the Company.\nFor information concerning the high and low sales prices of the Company's Common Stock for each quarterly period during the last two years and the amount of dividends paid on the Company's Common Stock in each quarterly period during the last two years, see the section on the inside back cover of the Company's 1995 Annual Report captioned \"Common Stock Prices and Dividends Paid\". Said section is incorporated by reference herein.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThere is incorporated by reference herein the table on pages 64 and 65 of the Company's 1995 Annual Report captioned \"Eleven-Year Selected Financial Data\".\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThere is incorporated by reference herein the section on pages 57 to 63 of the Company's 1995 Annual Report captioned \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nThere is incorporated by reference herein the first paragraph of the section captioned \"Legal Proceedings\" in Part I of this Report, which updates certain information set forth in \"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\nThere is incorporated by reference herein the sections of the Company's 1995 Annual Report captioned \"Consolidated Income\", \"Consolidated Retained Earnings\", \"Consolidated Balance Sheet\", \"Consolidated Cash Flows\", \"Notes to Financial Statements\" and \"Report of Independent Public Accountants\", which sections are on pages 37, 38, 39, 40, 41 to 55 and 56, respectively, of the Company'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\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nSee the section captioned \"Executive Officers of the Registrant\" under Part I of this Report for information concerning the Company's executive officers.\nFor information concerning the directors of the Company, see the sections therein captioned \"The Board of Directors -The Nominees\", \"Information on the Nominees and Directors\", and \"Committees\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 16, 1996. Said sections are incorporated by reference herein.\nItem 11.","section_11":"Item 11. Executive Compensation\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 16, 1996 the sections therein captioned \"The Board of Directors-Directors' Compensation\"; and \"Executive Compensation-Summary Compensation Table\", \"Option\/SAR Grant Table\", \"Option\/SAR Exercise and Year-End Values Table\", \"Pension Plan Table\", and \"Employment and Severance Agreements\".\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 16, 1996 the sections therein captioned \"Principal Shareholders\" and \"Stock Ownership by Nominees, Directors and Named Executive Officers\".\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual\nMeeting of Shareholders scheduled to be held on May 16, 1996 the section therein captioned \"Transactions\".\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements. The following Consolidated Financial Statements of Champion International Corporation and Subsidiaries, Notes to Financial Statements and Report of Independent Public Accountants are incorporated by reference herein from the Company's 1995 Annual Report:\n(b) Financial Statement Schedules. All Financial Statement Schedules have been omitted since the information is not applicable, is not required or is included in the Consolidated Financial Statements or Notes to Financial Statements listed under section (a) of this Item 14.\n(c) Exhibits. Each Exhibit is listed according to the number assigned to it in the Exhibit Table of Item 601 of Regulation S-K. The Exhibit numbers preceded by an asterisk (*) indicate Exhibits physically filed with this Annual Report on Form 10-K. All other Exhibit numbers indicate Exhibits filed by incorporation by reference herein. Exhibit numbers 10.1 through 10.35, which are preceded by a plus sign (+), are management contracts or compensatory plans or arrangements.\nExhibit Number Description - -------------- -----------\n3.1 Restated Certificate of Incorporation of the Company, filed in the State of New York on October 20, 1986 (filed by incorporation by reference to Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended December 31, 1986, Commission File No. 1-3053).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on July 18, 1988 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n3.3 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 6, 1989 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 8-K dated December 14, 1989, Commission File No. 1-3053).\n3.4 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 21, 1989 (filed by incorporation by reference to Exhibit 3.4 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n3.5 By-Laws of the Company (filed by incorporation by reference to Exhibit 3(ii).1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n4 Letter agreement dated March 29, 1991 of the Company to furnish to the Commission upon request copies of certain instruments with respect to long-term debt (filed by incorporation by reference to Exhibit 4 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.1 Champion International Corporation 1986 Management Incentive Program, consisting of the 1986 Stock Option Plan and the 1986 Contingent Compensation Plan (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1986, Commission File No. 1-3053).\n+10.2 Amendment to Champion International Corporation 1986 Management Incentive Program (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n+10.3 Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n+10.4 Amendment dated as of January 1, 1994 to Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.6 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.5 Champion International Corporation Nonqualified Supplemental Savings Plan (filed by incorporation by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1994, Commission File No. 1-3053).\n+10.6 Supplemental Retirement and Death Payments Agreement dated as of August 1, 1964, as amended by letter agreement dated January 9, 1965, between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.8 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.7 Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987, providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.8 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 19.2 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.9 Amendment dated as of April 21, 1988 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to\nExhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.10 Amendment dated as of August 18, 1988 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.10 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.11 Amendment dated as of August 18, 1988 to Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.11 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.12 Amendment dated as of September 19, 1991 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.12 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.13 Amendment dated as of November 17, 1994 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.14 Agreement dated November 17, 1994 between the Company and Mr. Sigler relating to post-employment consulting services (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.15 Agreement dated as of August 18, 1988 between the Company and Mr. Heist providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.16 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Heist providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.17 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Heist (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.18 Agreement dated as of October 18, 1990 between the Company and Mr. Nichols providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.19 Agreement Relating to Legal Expenses dated October 18, 1990 between the Company and Mr. Nichols providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.20 Amendment dated as of September 19, 1991 to Agreement dated as of October 18, 1990 between the Company and Mr. Nichols (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.21 Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.22 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Burchfield providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.23 Amendment dated as of April 21, 1988 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 19.5 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.24 Amendment dated as of September 19, 1991 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 10.22 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.25 Agreement dated as of August 18, 1988 between the Company and Mr. Olson providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.23 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.26 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Olson providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.24 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.27 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Olson (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.28 Trust Agreement dated as of February 19, 1987 between the Company and Fleet National Bank of Connecticut securing certain payments under the contracts listed as Exhibit Numbers 10.7 through 10.27, among others, following a change in control of the Company (filed by incorporation by reference to Exhibit 19.11 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.29 Amendment dated as of August 18, 1988 to Trust Agreement dated as of February 19, 1987 between the Company and Fleet National Bank of Connecticut (filed by incorporation by reference to Exhibit 10.29 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.30 Champion International Corporation Executive Life Insurance Plan (filed by incorpor-\nation by reference to Exhibit 10.27 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.31 Amendment dated as of January 1, 1994 to Champion International Corporation Executive Life Insurance Plan (filed by incorporation by reference to Exhibit 10.33 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.32 Extract from the minutes of the meeting of the Board of Directors of the Company held on October 18, 1979 relating to the $50,000 of group term life insurance provided by the Company for non- employee directors (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.33 Resolutions of the Board of Directors of the Company adopted on September 19, 1991 relating to the compensation of directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1991, Commission File No. 1-3053).\n+10.34 Resolutions of the Board of Directors of the Company adopted on August 18, 1994 relating to the compensation of directors (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 1994, Commission File No. 1-3053).\n+10.35 Retirement Plan for Outside Directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1992, Commission File No. 1-3053).\n*11 Schedule showing calculation of primary earnings per common share and fully diluted earnings per common share.\n*13 Portions of the Company's 1995 Annual Report which are specifically incorporated by reference herein.\n*21 List of significant subsidiaries of the Company.\n*23.1 Opinion and Consent of the Senior Vice President and General Counsel of the Company.\n*23.2 Consent of Arthur Andersen LLP.\n*24 Power of Attorney relating to the execution and filing of this Annual Report on Form 10-K and all amendments hereto.\n*27 Financial Data Schedule.\n(d) Reports on Form 8-K. The Company filed a Current Report on Form 8-K dated October 9, 1995 reporting the issuance of a press release announcing certain unaudited consolidated financial results of the Company for the three months and nine months ended September 30, 1995, with the consolidated statement of income for the three months and nine months ended September 30, 1995 and September 30, 1994 and consolidated balance sheet as of September 30, 1995 and December 31, 1994 as exhibits thereto. The Company filed a Current Report on Form 8-K dated November 7, 1995 reporting the sale of $200,000,000 principal amount of the Company's 7.35% Debentures due November 1, 2025, pursuant to the Company's shelf registration statement (No. 33-51217).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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.\nCHAMPION INTERNATIONAL CORPORATION (Registrant)\nBy \/s\/ Lawrence A. Fox ------------------------------- (Lawrence A. Fox) Vice President and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nA power of attorney authorizing Lawrence A. Fox, Marvin H. Ginsky and Andrew C. Sigler and each of them to sign this Report and all amendments hereto as attorneys-in-fact for officers and directors of the registrant is filed as Exhibit 24 hereto.\nEXHIBIT INDEX\nEach Exhibit is listed according to the number assigned to it in the Exhibit Table of Item 601 of Regulation S-K. The Exhibit numbers preceded by an asterisk (*) indicate Exhibits physically filed with this Annual Report on Form 10-K. All other Exhibit numbers indicate Exhibits filed by incorporation by reference herein. Exhibit numbers 10.1 through 10.35, which are preceded by a plus sign (+), are management contracts or compensatory plans or arrangements.\nExhibit Number Description - -------------- -----------\n3.1 Restated Certificate of Incorporation of the Company, filed in the State of New York on October 20, 1986 (filed by incorporation by reference to Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended December 31, 1986, Commission File No. 1-3053).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on July 18, 1988 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n3.3 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 6, 1989 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 8-K dated December 14, 1989, Commission File No. 1-3053).\n3.4 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 21, 1989 (filed by incorporation by reference to Exhibit 3.4 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n3.5 By-Laws of the Company (filed by incorporation by reference to Exhibit 3(ii).1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n4 Letter agreement dated March 29, 1991 of the Company to furnish to the Commission upon request copies of certain instruments with respect to long-term debt (filed by incorporation by reference to Exhibit 4 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.1 Champion International Corporation 1986 Management Incentive Program, consisting of the 1986 Stock Option Plan and the 1986 Contingent Compensation Plan (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1986, Commission File No. 1-3053).\n+10.2 Amendment to Champion International Corporation 1986 Management Incentive Program (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n+10.3 Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n+10.4 Amendment dated as of January 1, 1994 to Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.6 to the Company's Form 10-K for the fiscal year ended December 31, 1994,\nExhibit Number Description - -------------- -----------\nCommission File No. 1-3053).\n+10.5 Champion International Corporation Nonqualified Supplemental Savings Plan (filed by incorporation by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1994, Commission File No. 1-3053).\n+10.6 Supplemental Retirement and Death Payments Agreement dated as of August 1, 1964, as amended by letter agreement dated January 9, 1965, between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.8 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.7 Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987, providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.8 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 19.2 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.9 Amendment dated as of April 21, 1988 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.10 Amendment dated as of August 18, 1988 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.10 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.11 Amendment dated as of August 18, 1988 to Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.11 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.12 Amendment dated as of September 19, 1991 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.12 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.13 Amendment dated as of November 17, 1994 to Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.14 Agreement dated November 17, 1994 between the Company and Mr. Sigler relating to post-employment consulting services (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\nExhibit Number Description - -------------- -----------\n+10.15 Agreement dated as of August 18, 1988 between the Company and Mr. Heist providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.16 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Heist providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.17 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Heist (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.18 Agreement dated as of October 18, 1990 between the Company and Mr. Nichols providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.19 Agreement Relating to Legal Expenses dated October 18, 1990 between the Company and Mr. Nichols providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.20 Amendment dated as of September 19, 1991 to Agreement dated as of October 18, 1990 between the Company and Mr. Nichols (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.21 Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.22 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Burchfield providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.23 Amendment dated as of April 21, 1988 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 19.5 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.24 Amendment dated as of September 19, 1991 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 10.22 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\nExhibit Number Description - -------------- -----------\n+10.25 Agreement dated as of August 18, 1988 between the Company and Mr. Olson providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.23 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.26 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Olson providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.24 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.27 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Olson (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.28 Trust Agreement dated as of February 19, 1987 between the Company and Fleet National Bank of Connecticut securing certain payments under the contracts listed as Exhibit Numbers 10.7 through 10.27, among others, following a change in control of the Company (filed by incorporation by reference to Exhibit 19.11 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.29 Amendment dated as of August 18, 1988 to Trust Agreement dated as of February 19, 1987 between the Company and Fleet National Bank of Connecticut (filed by incorporation by reference to Exhibit 10.29 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.30 Champion International Corporation Executive Life Insurance Plan (filed by incorporation by reference to Exhibit 10.27 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.31 Amendment dated as of January 1, 1994 to Champion International Corporation Executive Life Insurance Plan (filed by incorporation by reference to Exhibit 10.33 to the Company's Form 10-K for the fiscal year ended December 31, 1994, Commission File No. 1-3053).\n+10.32 Extract from the minutes of the meeting of the Board of Directors of the Company held on October 18, 1979 relating to the $50,000 of group term life insurance provided by the Company for non- employee directors (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.33 Resolutions of the Board of Directors of the Company adopted on September 19, 1991 relating to the compensation of directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1991, Commission File No. 1-3053).\n+10.34 Resolutions of the Board of Directors of the Company adopted on August 18, 1994 relating to the compensation of directors (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 1994, Commission File No. 1-3053).\nExhibit Number Description - -------------- -----------\n+10.35 Retirement Plan for Outside Directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1992, Commission File No. 1-3053).\n*11 Schedule showing calculation of primary earnings per common share and fully diluted earnings per common share.\n*13 Portions of the Company's 1995 Annual Report which are specifically incorporated by reference herein.\n*21 List of significant subsidiaries of the Company.\n*23.1 Opinion and Consent of the Senior Vice President and General Counsel of the Company.\n*23.2 Consent of Arthur Andersen LLP.\n*24 Power of Attorney relating to the execution and filing of this Annual Report on Form 10-K and all amendments hereto.\n*27 Financial Data Schedule.","section_15":""}
{"filename":"865937_1995.txt","cik":"865937","year":"1995","section_1":"ITEM 1. BUSINESS\nCatellus Development Corporation (the Company) was organized in the state of Delaware in 1984 as an indirect, wholly-owned subsidiary of Santa Fe Pacific Corporation (SFP) to conduct the non-railroad real estate activities of Santa Fe Industries and Southern Pacific Company. In December 1989, SFP sold 19.9% of the Company to Bay Area Real Estate Investment Associates, L.P. (BAREIA), a California limited partnership whose general partner was JMB\/Bay Area Partners and whose limited partner was the California Public Employees' Retirement System (CALPERS). In December 1990, SFP distributed its remaining 80.1% interest in the Company to its stockholders in the form of a stock dividend. In November 1995, BAREIA was liquidated and CALPERS became the sole holder of BAREIA's stock. As of December 31, 1995, CALPERS owns 41.1% of the Company's common stock and 40.7% of the Company's Series A preferred stock.\nThe Company's principal office is located at 201 Mission Street, San Francisco, California, 94105; its telephone number is (415) 974-4500.\nThe Company is a full service real estate company that, as of December 31, 1995 owned 855,170 acres of land, 14.1 million square feet of income producing property, 5,400 acres of land leases and interests in eight joint ventures. Approximately 80% of the Company's assets are located in California, with the balance mainly concentrated in Dallas, metropolitan Chicago and Phoenix.\nCOMPANY STRATEGIES - OVERVIEW\nDuring late 1994 and continuing in 1995, the Company undertook a comprehensive review of its operations and activities with the primary goals being to increase cash flow and return on stockholders' equity. In particular, the Company focused its efforts on reducing costs, selling non-strategic land assets, reducing debt, increasing development activity, increasing third party fee management revenue and minimizing the development costs and time frames for its major development projects. The Company has taken the following specific actions:\n. In November 1994, the Company implemented significant staff reductions to reduce costs and reorganized to focus on increasing operating earnings. These reductions, when combined with other cost-reduction measures, resulted in annual cost savings for 1995 of approximately $10.1 million. General and administrative costs declined by $3.7 million; overhead associated with operating the portfolio declined by $3.4 million and overhead associated with selling properties declined by $1.5 million. In addition, the Company has benefited by a $1.5 million reduction in overhead costs associated with the Company's development activities.\n. In October 1995, the Company began the process of substantially increasing its asset sales activity, with the primary focus on its non-strategic land assets. Sales proceeds will be applied to a combination of debt reduction, in order to reduce interest costs, and reinvestment in activities that could generate increased operating earnings. The Company's goal is to sell $100 million of non-strategic land assets over a 15-month period ending December 31, 1996. Sales totaling $47.1 million closed in the fourth quarter of 1995.\n. During 1995, the Company reduced its total debt by a net $34.5 million. This net reduction represents the difference between $68.5 million of principal reductions on existing borrowings and $34 million of new borrowings which funded the development of pre-leased industrial and retail buildings. It is expected that the debt service on the new borrowings will be covered by the cash flow from the completed buildings; therefore, the Company's future operations should be improved by the interest savings on the $68.5 million of principal reductions.\n. During 1995 and continuing into 1996, the Company has placed a greater emphasis on increasing its development and fee development businesses. During 1995, the Company commenced construction on 910,000 square feet of new development, compared to 381,000 in 1994. In addition, at December 31, 1995, the Company had signed leases for new development totalling 648,000 square feet for which construction will commence in 1996. In March 1996, the Company acquired The Akins Companies to better position itself to pursue existing\nresidential development opportunities on certain of its land holdings, as well as to pursue fee development opportunities on land not currently owned by the Company.\n. During 1995 and continuing into 1996, the Company has also placed a greater emphasis on increasing its third party management business. In January 1996, the Company announced a new five-year contract to manage the non railroad real estate assets for the Burlington Northern Santa Fe Corporation.\n. Beginning in 1994 and continuing throughout 1995, the Company undertook a review of its major land development projects with the goal of increasing profitability, minimizing up front capital requirements and shortening the time required to develop the properties. As a result of this review, the decision was made to modify certain of the entitlements, abandon others and sell one property that management believed could not be developed in a reasonable time frame. It is management's expectation that these decisions will both accelerate the time frame in which the projects will be developed and minimize the up front cash requirements associated with development.\nThe Company's long-term financial goal is to increase its return on stockholder equity. In order to accomplish this, the Company will continue with the revenue enhancement and cost reduction initiatives discussed above and will seek opportunities to reduce its capital commitment to projects through joint ventures, where the Company would seek financial partners to participate in some of its more capital intensive businesses. In addition, as the Company completes its disposition program of non-strategic land assets, it will evaluate opportunities to increase stockholder returns through strategic reinvestment and\/or stock repurchases.\nPORTFOLIO SUMMARY - -----------------\nThe following tables provide information on the Company's income producing assets, land assets and joint venture investments. In addition, supplemental current value information is provided for the Company's land assets and joint venture investments. Current value information is provided in recognition of the significance of the Company's land assets in relation to its total assets and the lack of traditional cash flow or earnings measures available to evaluate the land portfolio. Current value does not represent the net realizable value of the Company's portfolio as a whole, nor does it contemplate liquidation or a distressed sale of the Company's assets. Current value accounting continues to represent an experimental approach; authoritative criteria have not been established for its preparation and presentation. The Company engaged Landauer and Associates to provide a concurring appraisers report on its estimate of values, which is included in an exhibit to this 10-K.\nPORTFOLIO BY ASSET CATEGORY\nINCOME PRODUCING PROPERTIES\nJOINT VENTURES\nLAND DEVELOPMENT AND LAND HOLDINGS\nNotes: - ------ (1) Net operating income represents rental revenue, less property operating costs. (2) Current value at December 31, 1994 represents the value of those assets still owned at December 31, 1995.\nNotes (cont.) - ---------------\n(3) The Company estimates the current value of its land assets primarily using the direct sales comparison method. However, in cases where relevant comparable sales data is not available, current value is estimated using the residual land analysis method. Under the direct sales comparison approach, recent sales of similar properties are used as a basis for estimated current value. Current value estimates for large contiguous parcels include a discount to reflect current market absorption rates for undeveloped land. Under the residual land analysis approach, current value is derived based on anticipated future cash flows associated with the Company's intended development plan. Infrastructure costs, development costs (including costs to remediate known environmental contamination), operating cash flow and residual sales amounts are projected over an assumed period of development and operation. These amounts are discounted to the balance sheet date using a discount rate the Company believes is appropriate given the level of project risk. Current values for investments in joint ventures represent the Company's proportionate equity in the underlying net assets of the ventures. The current values of assets and liabilities of joint ventures were based on methods and assumptions similar to those used to estimate the current values of similar assets and liabilities of the Company. Current values calculated using the above methods are adjusted to reflect the estimated costs to remediate known environmental contamination.\nThe following summarizes leasing statistics for the Company's operating properties (square feet in thousands).\n* Square feet owned and occupied, as well as net operating income, excludes approximately 1.4 million square feet of existing buildings, primarily at Mission Bay. These buildings will be razed as development proceeds.\nFor the five years from 1996 through 2000, leases for 20.1%, 14.0%, 7.4%, 8.7%, and 10.1% of total rentable square footage are scheduled to expire.\nINDUSTRIAL INCOME PRODUCING PROPERTIES - --------------------------------------\nAs of the end of 1995, the Company's industrial income producing portfolio included 11.4 million square feet in 163 buildings. At the year end, these buildings were 95.8% leased. The portfolio also included 5,239 acres of land leased for industrial uses.\nAt the end of 1995, the Company also had 642,000 square feet under construction and leases signed for an additional 648,000 square feet to be constructed in 1996. When these buildings are completed, the Company's industrial income producing portfolio will be expanded to 12.7 million square feet and 169 buildings.\nNet Operating Income - The net operating income for the industrial portfolio increased from $40.6 million in 1994 to $41.5 million in 1995. This increase resulted primarily from the addition of new industrial buildings. The decrease in 1994 compared to 1993 was due to the sale of 1.1 million square feet of properties near the end of 1993 and in 1994. The following table summarizes net operating income for the industrial portfolio (in thousands):\nLocation - The following table summarizes the Company's industrial buildings by region as of December 31, 1995.\nLease Expirations - The following table summarizes the lease expirations in the industrial portfolio as of December 31, 1995.\nLeases totalling 20% of the Company's industrial square footage expire in 1996. Of this, 38% are located in Southern California, where economic conditions continue to improve, 20% represent month to month leases in multi- tenant buildings, 17% are located in Phoenix, Arizona, and the balance is spread throughout the portfolio.\nRETAIL INCOME PRODUCING PROPERTIES - ----------------------------------\nAs of the end of 1995, the Company's retail income producing portfolio consisted of 957,000 square feet of existing buildings and 53.3 acres of land leased for retail uses. The existing income-producing retail portfolio consisted of 29 buildings which were 92.3% leased as of December 31, 1995.\nThe Company's retail properties are located primarily in Northern and Southern California with one complex each in Colorado and Oregon. The largest retail project, East Baybridge Center, is located on 40 acres just across the Bay from San Francisco in the cities of Emeryville and Oakland. The 270,000 square foot Phase I of this project opened in mid-1994 and was pre-leased to such national retailers as Home Depot, Sportmart, OfficeMax, Safeway's Pak 'n Save and CompUSA. A 117,000 square foot building for Kmart was added to the center in 1995.\nNet Operating Income - Net operating income for the Company's retail building portfolio rose from $5.0 million in 1994 to $8.4 million in 1995, due to the East Baybridge Center in Emeryville, California. The following table summarizes net operating income for the retail portfolio (in thousands):\nLocation - The following table summarizes the Company's retail buildings by region as of December 31, 1995.\nLease expirations - The following table summarizes the lease expirations in the retail portfolio as of December 31, 1995.\nDevelopment - The following table summarizes the Company's retail development completed during the past three years.\n1995 1994 1993 ---- ---- ----\nCompleted projects (square feet) 117,000 269,310 -\nOFFICE INCOME PRODUCING PROPERTIES - ----------------------------------\nAt the end of 1995, the Company's office income producing portfolio consisted of 1.7 million square feet of office buildings and 105.9 acres of land leased for office purposes. At year-end 1995, this portfolio of 32 office buildings was 92.1% leased. The most significant office projects owned by the Company are the South Bay Center in San Jose, California, 424,192 square feet, and the Railway Exchange Building in Chicago, Illinois, 374,929 square feet.\nNet Operating Income - The Company experienced a decline in net operating income from office buildings in 1995. This decline is related primarily to the Railway Exchange Building in Chicago, Illinois. An increase in property taxes in Chicago and the replacement of a major tenant with lower rent tenants caused the building to contribute less to office net operating income than in previous years. The following table summarizes net operating income for the office portfolio (in thousands):\nLocation - The following table summarizes the Company's office property by region as of December 31, 1995.\nLease expirations - The following table summarizes the lease expirations in the office portfolio as of December 31, 1995.\nLAND DEVELOPMENT - MIXED USE PROJECTS - -------------------------------------\nThe Company's land portfolio includes four major mixed use development sites consisting of 1,156 acres which had a current value of $310 million at December 31, 1995. An additional site located in Santa Fe, New Mexico was sold to the City of Santa Fe in 1995.\nMission Bay, San Francisco, CA. The Company's property in San Francisco is part of a 313 acre mixed-used development which was the subject of a 1991 Development Agreement between Catellus and the City and County of San Francisco. After a thorough analysis of the 1991 Development Agreement in light of current and anticipated market conditions, management terminated this agreement and decided to seek a revised entitlement package.\nThe revised plan will include more housing and retail and less office space; a phased development approach which would include less upfront investment; and the use of tax increment financing, as provided by redevelopment law. As a result of this decision, the Company took an $84.8 million charge against fourth quarter earnings. (See \"Managements Discussion and Analysis of Financial Condition and Results of Operations,\" and Note 7 to the Consolidated Financial Statements).\nPacific Commons, Fremont, CA. In March 1995, the Company announced its intention to pursue a retail, industrial and commercial development rather than a previously proposed golf course residential community on its 600-acre vacant site bordering Interstate 880 in Fremont, California. These are uses which were called for by the City's General Plan designation prior to the approval of the golf course residential project, and they are consistent with the current land uses of adjacent property.\nThe Company has moved to re-entitle Pacific Commons to include approximately 700,000 square feet of \"power center\" retail and more than 7.5 million square feet of office, R&D, industrial and warehouse product. The vacancy rate of these uses continues to decline in Fremont and the inventory of land for development is low.\nUnion Station, Los Angeles, CA. The Company owns 51 acres which surround and include the historic Los Angeles Union Station. The Company completed the acquisition of this site in early 1990 and is proceeding with plans to develop it as a regional transportation center and mixed-use complex of office buildings and retail space. Amtrak, the region's commuter rail system, suburban bus lines and the City's new subway system serve this station daily. The site currently is entitled for government uses. A revised entitlement package is being processed which will allow a total of 7 million square feet of office development but has the flexibility to substitute other uses such as retail, a sports arena and housing based upon an impacts \"equivalency\" formula.\nConstruction of the first building on the site, the 626,000 square foot headquarters facility owned and occupied by the Metropolitan Transportation Authority (MTA), was started in 1993 and completed in late 1995. In addition, the innovative multi-modal Patsaouras Transit Plaza which now serves as the center for bus and rail service to downtown Los Angeles, was completed in 1995. The MTA building and the Patsaouras Transit Plaza were the first two components of Gateway Center (part of the Union Station project), a multi-phased project that consists of two office towers comprising over 1.2 million square feet, the 3.5-acre regional public transit center and bus plaza, 20,000 square feet of service retail, an underground parking garage and a new transit concourse connecting the bus and train terminals.\nUnion Station has also been selected as the site of the new headquarters facility for the Metropolitan Water District (MWD). An agreement has been signed under which Catellus will sell a 4.2 acre site to MWD and construct a 550,000 square foot, 12 story office building for the MWD on the site. Construction is scheduled to begin in mid-1996 with building completion and occupancy targeted for late 1998.\nSanta Fe Depot, San Diego, CA. The Company owns 17 acres on the waterfront in downtown San Diego, California. The site is currently entitled for a mixture of office, hotel, retail and housing development. Management is re-evaluating the approved plan in light of current and projected market conditions.\nINDUSTRIAL DEVELOPMENT - ----------------------\nThe Company's plans call for expanding development activity beyond the levels of the last two years. Approximately 1,700 acres in 15 separate locations will be retained which will support the development of over 30 million square feet of industrial development. The Company's goal is to develop approximately 20 million square feet over the next 5 to 7 years. The balance of the acreage will be reserved for sale.\nIn 1995, the Company completed approximately 490,000 square feet of industrial construction. At December 31, 1995, Catellus had 692,000 square feet under construction and had signed leases for 648,000 square\nfeet of new industrial development. This backlog will be enhanced during 1996 by the Company's efforts to obtain additional build-to-suit opportunities and limited speculative development, in order to take advantage of local market conditions.\nProperty - The following table summarizes selected industrial development properties, including some held for sale at December 31, 1995:\nDevelopment - The following table summarizes the Company's industrial development activities, in square feet, during the past three years.\nRESIDENTIAL DEVELOPMENT - -----------------------\nIn March 1996, the Company concluded the acquisition of The Akins Companies, a residential real estate company, consisting of a diversified group of entities involved in home building, community development and project management services. The Akins Companies have developed more than 10,000 homes throughout Southern California in the past 47 years.\nThe new entity, now called the Catellus Residential Group, will develop the Company's residential land holdings, projects previously started by Akins and new development activities on property owned by others.\nThe Company formed an Urban Housing division in 1995 to develop rental housing with an affordable component on urban in-fill locations in California. The new urban housing team within Catellus Residential Group gives the Company the core competencies that will allow it to pursue additional higher yielding development opportunities.\nProperty - The following table summarizes the Company's residential properties, including those acquired as part of the Akins acquisition:\nNotes: - -----\n(1) Owned (2) Managed (3) Joint venture\nJOINT VENTURES AND OTHER INVESTMENTS - ------------------------------------\nThe Company's joint venture interests provided net distributions to the Company of $8.3 million in 1995 and had a current value at December 31, 1995 of $104.3 million. Joint ventures will continue to play an important role in allowing the Company to accelerate the development of its land assets without having to fund 100% of the required capital. In addition to its joint ventures, the Company owns Golden Gate Fields, a racetrack leased to Ladbroke Racing.\nThe following is a description of some of the Company's joint ventures and other investments:\nNew Orleans Hilton. The Company owns a 25.2% interest in the 1,602-room New Orleans Hilton Hotel. This property is strategically located between the dock for the Flamingo Riverboat Casino and the land based Harrahs Casino.\nSan Diego Embassy Suites. The Company owns a 50% interest in this 337-room hotel overlooking the San Diego Bay near the convention center. The property generates positive cash flow, however the existing loan requires substantial principal paydown and prohibits cash flow distributions to the partners. Negotiations are underway to refinance the property.\nSeabridge Apartments. The Company owns a 50% interest in this 387-unit apartment building located one block east of the San Diego Bay. Although the property is performing well (occupancy is consistently in the 95% range), it is substantially overleveraged which results in nominal cash flow.\nGolden Gate Fields. The Company owns 100% of this 230-acre race track property in Albany, California, across the Bay from San Francisco, and leases it to the Ladbroke Racing Company. Discussions are underway to either split cash flow 50\/50, including the card club revenue, or sell the property while retaining the right to participate in future cash flow.\nLa Mirada. CDC owns a 37.8% interest in this master planned business park located on a major distribution artery. Thirty acres from the 82-acre development remain available for build-to-suit or sale. Recent activity includes a 278,000 square foot build-to-suit for lease on 10.4 acres of land and a sale of 3.3 acres of land. Land sales are expected to be completed in 1997 with build-to-suit leases providing ongoing cash flow.\nNATURAL RESOURCE LAND - ---------------------\nCatellus owns more than 790,000 acres of land in the Southern California desert regions of Los Angeles, Kern, San Bernardino, Riverside, and Imperial Counties, and more than 25,000 acres in the state's Central Valley.\nThe Company plans to aggressively maximize the value of its \"outlying\" lands. The Catellus Resources Group was created in 1995 to focus on the potential represented by the desert and Central Valley portfolios.\nThe hydrology, climate, geology and location of certain of these properties may afford substantial water marketing, agricultural, telecommunications, energy, and waste management opportunities for Catellus. In addition, a major portion of the land is well suited for environmental mitigation purposes and for strategic trades with federal and state entities to favorably enhance the Company's development options with other locations.\nThe Resources Group will also coordinate the Company's in-house environmental cost recovery, remediation and management activities.\nConsistent with Catellus' commitment to leverage its core competencies beyond increasing the value of its current assets, the Resources Group will spearhead efforts to identify additional environmentally-related business opportunities.\nREAL ESTATE SERVICES - --------------------\nManagement Services\nCatellus, through its wholly owned subsidiary Catellus Management Corporation (CMC), has entered into a five year contract with the Burlington Northern Santa Fe Corporation (BNSF), which owns the nation's largest railroad, to provide management and disposition services for their real property assets. The assets include approximately 19,000 leases and are located in 28 states and 2 Canadian provinces.\nThe Company intends to aggressively pursue additional management service agreements to increase recurring earnings.\nDesign Build Services\nCatellus was the developer on a \"design build\" basis in partnership with Charles Pankow Builders, for the construction of the MTA Headquarters building and the multi-model Patsaouras Transit Plaza at Los Angeles Union Station. The Company intends to pursue additional design build opportunities to increase recurring earnings. The Company is concluding final documentation with the Metropolitan Water District for the development of their new headquarters facility on a design build basis, again in partnership with Charles Pankow Builders.\nPROPERTY SALES - --------------\nHistorically, the Company has sold land to cover some of the costs associated with pre-development, operating and holding the Company's substantial real estate assets and paying preferred stock dividends. Sales included mountain, desert, agricultural and other non-strategic lands, as well as lands that the Company feels might be developable in the future. The Company has also sold income-producing properties to cover such costs. The Company's sales consisted of the following over the past three years (in thousands):\nIn September 1995, the Company established a goal of selling $200 million of non-strategic land assets within a 30-month period. Proceeds would be applied to a combination of debt reduction, in order to reduce interest costs, and reinvestment in activities that could generate increased operating earnings. The Company's goal is to complete $100 million of these sales by December 31, 1996. Sales totaling $47.1 million closed in the fourth quarter of 1995.\nENVIRONMENTAL MATTERS - ---------------------\nVarious federal, state and local laws and regulations covering the discharge of materials into the environment, or otherwise relating to the protection of the environment, may affect the Company's operations and costs. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Environmental Matters.\" Such regulations can increase the cost of planning, designing, developing, managing and maintaining the Company's properties. The Company has expended and will continue to expend significant financial and managerial resources to comply with environmental regulations and local permitting requirements. While the Company or outside consultants have evaluated the environmental liabilities associated with most of the Company's properties, any evaluation necessarily is based upon then prevailing law and identified site conditions. In addition, many of the Company's properties are in the early stages of development and the environmental studies and investigations which have been performed are preliminary. It is possible that significant unknown costs and liabilities may arise in the future relating to these properties and that certain development projects may be significantly delayed, modified or cancelled as a result of associated remediation costs. In addition, other properties presently or formerly owned by the Company or its corporate predecessors have required or may require remediation. Although there can be no assurance, the Company does not believe that such costs will have a material adverse effect on its business, financial condition or results of operations.\nThe Company has been or may be named a defendant or a potentially responsible party (\"PRP\") under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (\"CERCLA\"), or analogous state statutes. At the Marina Bay site in the City of Richmond, the Company has been sued by the City of Richmond and others in a CERCLA cost recovery action. This action is more fully described in Item 3 \"Legal\nProceedings\". With respect to a site in Livermore, California, the Regional Water Quality Control Board has issued a Tentative Site Cleanup Order naming the Company as one of 11 responsible parties. In February 1994, the Company reached a settlement with plaintiffs and all of the other potentially responsible parties pursuant to which the Company paid $67,650 into a fund covering certain past and future remediation costs in exchange for a qualified release of liability. The Company has been named a PRP with respect to several additional sites. Remediation of those sites has been completed by the Company or is being completed by third parties at their expense. The Company does not expect to incur material additional costs with respect to those sites.\nCOMPETITION - ------------\nReal estate markets are regional, and levels of competition vary by market. The Company encounters significant competition for leasing and sales of real estate in each of its market areas, but no one competitor is dominant. The Company is not dependent on any one customer for a significant portion of its revenues.\nEMPLOYEES - ----------\nAt December 31, 1995, the Company had 121 employees, including 22 employees of the management subsidiary which now manages certain BNSF properties.\nThe Company engages third parties to manage properties in locations which are not in close proximity to the Company's regional or field offices. In addition, the Company engages outside consultants such as architects and design firms in connection with its pre-development activities. The Company also employs third party contractors on development projects for infrastructure and building construction.\nRISK FACTORS - ------------\nThis Annual Report on Form 10-K contains statements which, to the extent that they are not recitations of historical fact, constitute \"forward looking statements\" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. All forward looking statements involve risks and uncertainties. The forward looking statements in this document are intended to be subject to the safe harbor protection provided by Sections 27A and 21E. Factors that most typically impact the Company's operating results include (i) changes in general economic conditions in regions in which the Company's projects are located, (ii) the availability and cost of capital and project financing, (iii) the receipt of government approvals and entitlements for development projects, (iv) land and building material costs, (v) supply and demand for office, industrial and residential space, (vi) competition from other property managers, (vii) liability for environmental remediation at the Company's properties, (viii) ability to sell non-strategic land assets, and (ix) ability to increase development fees. For discussions identifying other important factors that could cause actual results to differ materially from those anticipated in the forward looking statements, see the Company's Securities and Exchange Commission filings; \"Managements's Discussion and Analysis of Financial Condition and Results of Operations\" of this Form 10-K and Note 14 to the Consolidated Financial Statements included in this Form 10-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's real estate projects are generally described in Item 1 above, which descriptions are incorporated in this Item by reference. Catellus' principal executive office is located in San Francisco, and it has regional or field offices in 6 other locations in the United States. Catellus believes that its property and equipment are generally well maintained, in good condition and adequate for its present needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCatellus, its subsidiaries and other related companies are named defendants in several lawsuits arising from normal business activities, are named parties in certain governmental proceedings (including environmental actions)\nand are the subject of various environmental remediation orders of local governmental agencies arising in the ordinary course of its business. The matters described below may involve substantial claims for damages. While the outcome of these lawsuits or other proceedings against the Company and the cost of compliance with any governmental order cannot be predicted with certainty, management does not expect any of these matters to have a material adverse effect on the business or financial condition of the Company.\nIn City of Richmond, et al. v. United States of America, et al. (United ------------------------------------------------------------ States District Court, Northern District of California; filed August 1989) the City of Richmond and Richmond Redevelopment Agency (collectively, \"Richmond\") and various developers sued the Company and others for more than $48.6 million in environmental cleanup costs, other damages and related relief arising out of contamination at property formerly owned by the Company's predecessor, Santa Fe Land Improvement Company. The United States and United States Maritime Administration were also named defendants and Kaiser Aluminum & Chemical Corporation (\"Kaiser\") and James L. Ferry & Son, Inc. (\"Ferry\") were named as third party defendants. All parties asserted indemnity claims against each other.\nIn 1992, plaintiffs also filed a related action regarding the same property, seeking similar relief on similar grounds from Kaiser: The City of ----------- Richmond, et al. v. Kaiser Aluminum & Chemical Corp., (United States District - ----------------------------------------------------- Court, Northern District of California). Again, all parties asserted indemnity claims against each other.\nPrior to trial, plaintiffs reached a settlement agreement with the United States pursuant to which the United States agreed to pay $3.6 million plus 35% of future cleanup costs.\nTrial began March 17, 1995 and concluded on April 28, 1995. On April 13, 1995, the Company reached a settlement agreement with plaintiffs whereby plaintiffs agreed to release all claims against the Company in exchange for $3.25 million to be paid over time with the final payment to be made by July 15, 1997.\nOn December 7, 1995, the Court issued a Final Judgment awarding plaintiffs $1,703,780 on their claims against Kaiser for past costs and declaring that Kaiser is liable to plaintiffs for 50% of certain future cleanup costs. The Court also awarded the Company $506,654 plus attorneys' fees associated with its contractual indemnity claim against Kaiser. The Court did not grant relief on any other claim.\nOn January 8, 1996, the Company filed an appeal of the judgment, and Kaiser cross-appealed shortly thereafter. On February 5, 1996, the Company filed a motion to fix the amount of attorney's fees recoverable from Kaiser. It is not possible now to predict reliably the outcome of either the appeal or the attorneys' fees motion. Settlement discussions with Kaiser are on-going.\nThe Company tendered defense of this action to its insurer, Employers Casualty Insurance Company (Employers). However, on January 6, 1994, Employers was placed into receivership. The Company, Employers and its receiver entered into a settlement agreement pursuant to which the Company has received $300,000 and the receiver and Employers stipulated that the Company has a valid claim for an additional $700,000 for past defense costs against Employers' assets in the receivership. The Company does not know the extent of other claims which will be made against the assets in receivership or the extent of the assets which will be available to satisfy such claims. Therefore, the Company does not know how much, if any, of the $700,000 or future defense costs will be paid out of the assets in receivership.\nEfforts are being made to recover additional sums from other insurers, including those who provided excess coverage and insurers who issued policies to the Company's former tenants, which policies named the Company's predecessor as an additional insured. The Company has received from insurers payments totaling $2,635,689 plus commitments to pay 100% of future litigation defense costs. It is not clear at this time whether or how much additional monies will be obtained from insurers. Negotiations are continuing.\nThe Atchison, Topeka & Santa Fe Railway Co. v. The Testate and Intestate ------------------------------------------------------------------------ Successors of Grace Richards, et al. (Superior Court of California, County of - ------------------------------------ San Diego; filed May 1983) and Herbert Lincoln Hubbard, et al. v. The Atchison, ------------------------------------------------ Topeka & Santa Fe Railway Company, Santa Fe Land Improvement Company, et al. - ---------------------------------------------------------------------------- (Superior Court of California, County of San Diego; filed January 1988) are consolidated cases in which both the Company and the opposing litigants claim title to a 550 foot by 75 foot strip of property located on the Santa Fe Depot site in San Diego, CA. The opposing litigants also seek damages for alleged fraud, interference with prospective economic advantage, and inverse condemnation. The trial court ruled that the Company and some of the opposing litigants each own an undivided one-half fee interest in the property, subject to a perpetual railroad easement in favor of The Atchison, Topeka & Santa Fe Railway Company. The trial court also rejected all of the opposing litigants' damage claims.\nThe Company appealed the portion of the trial court's judgment granting the opposing litigants a one-half undivided fee interest in the property and the opposing litigants appealed all other aspects of the judgment. In July, 1995 the California Court of Appeal ruled for the Company on every issue. Specifically, the Court of Appeals determined that the Company's predecessor-in- interest had acquired fee title to the property in the original condemnation proceeding (which occurred in 1886). This ruling eliminated the opposing litigants' claim that the Company's predecessor-in-interest had lost its right of way by abandonment or extinguishment and this had no interest left to convey to the Company.\nThe opposing litigants petitioned the California Supreme Court for review, which was granted in October, 1995. The Supreme Court has deferred any briefing and has not scheduled a hearing.\nKhachaturian v. Catellus Development Corporation, et al. (Superior Court of -------------------------------------------------------- California, County of Alameda; filed April 1991) is an action by an auto dealer who contracted to purchase land from the Company in an auto mall in Fremont, California, in June 1990. The complaint alleged the Company had reneged on an oral agreement to pay the plaintiff a 3% commission on each land transaction in the auto mall, and stated breach of contract, fraud, false promise, bad faith denial of contract, and quantum meruit causes of action. The Company asserted, among other things, that no such agreement existed and that it denied plaintiff's claim in good faith and with probable cause.\nIn November 1993, a jury found for plaintiff on his breach of contract and bad faith denial claims, awarding him $441,781 in compensatory damages and $7.6 million in punitive damages on the bad faith claim. The Company believed these verdicts were not supported by the evidence or the law, and that numerous errors at trial substantially prejudiced it. The Company filed its notice of appeal on February 3, 1994, and briefing was completed on February 7, 1995. In September, the California Supreme Court, in an unrelated lawsuit in which the Company filed an amicus brief, repudiated California's tort of bad faith denial of contract, on which punitive damages against the Company were premised.\nThe parties recently agreed to a settlement pursuant to which the Company has paid plaintiff $850,000 in complete settlement of all issues.\nTruck Insurance Exchange v. City of Ontario, et al. (Superior Court of --------------------------------------------------- California, San Bernardino County, Case No. RCY050056) involves a subrogation claim by insurance companies for the Ontario Auto Center dealerships against adjacent property owners, including the Company, for damages of approximately $4.5 million caused by sand blowing onto auto dealers' properties. The parties reached agreement upon a settlement pursuant to which Santa Fe Pacific Corporation has paid plaintiffs the total amount of $25,000, which represents the amount of the self-insured retention under the Employers' policy, in exchange for a release and dismissal of this lawsuit against Santa Fe Pacific Corporation and 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 quarter ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY - ---------------------------------\nThe following persons are the executive officers of Catellus.\nAdditional information concerning the business background of each executive officer of Catellus is set forth below:\nMr. Rising has served as President and Chief Executive Officer and a Director of Catellus since September 1994. For more than five years prior to joining Catellus, Mr. Rising was a Senior Partner with Maguire Thomas Partners, a Los Angeles-based commercial developer with projects in Southern California, Dallas and Philadelphia.\nMr. Wallace was elected as Senior Vice President and Chief Financial Officer in July 1995. Mr. Wallace was previously the Senior Vice President and Chief Financial Officer at Castle & Cooke Homes, Inc. from May 1993. Prior to that Mr. Wallace served as the Chief Financial Officer at A.M. Homes in Newport Beach, California.\nMr. Beaudin was elected Senior Vice President Property Operations in January 1996. Prior to this appointment, Mr. Beaudin served as Vice President Property Operations since February 1995. For more than five years prior to that, Mr. Beaudin served as Senior Vice President - Managing Officer of the Financial Services Group at CB Commercial Real Estate Group, a national real estate brokerage firm.\nMs. Sullivan was elected Vice President Law, General Counsel and Secretary in March 1990. For five years prior to that, Ms. Sullivan was a partner in the real estate department of the law firm of Brobeck, Phleger and Harrison.\nMr. Lockie joined Catellus as Vice President and Controller in February 1996. Prior to joining Catellus Mr. Lockie served as the Chief Financial Officer for Kimball Small Properties, Inc., a San Jose, California real estate development and management company.\nMr. Antenucci was elected Vice President of Catellus in October 1995. Prior to joining Catellus, Mr. Antenucci served as Vice President at Omnitrax, a shortline rail carrier, for two years and as Vice President - Industrial Sales for CB Commercial Real Estate Group, Inc. for more than seven years.\nMr. Friedman has served as President of Catellus Resources Group since February 1996. For more than five years prior to joining Catellus, Mr. Friedman was an Associate Attorney and Partner in the Los Angeles law firm of Tuttle & Taylor representing, among other clients, major agriculture and resource interests and was a consultant specializing in California economic development research.\nMr. Parker was elected Vice President Bay Area Development in March 1995. From January 1994 to March 1995, Mr. Parker was the Executive Director of the Alameda Reuse and Redevelopment Authority for the conversion of the naval air station. For more than five years prior to that, Mr. Parker was a partner and project director of the Marina Village Mixed-Use Community in Alameda, California.\nMr. Stimpson was elected Vice President and Chief Financial Officer for Bay Area Development in January 1996. Prior to this appointment Mr. Stimpson served as Vice President Finance from February 1992; Assistant Vice President Finance from February 1990; and Director of Finance and Planning from June 1988.\nMr. Yellin joined Catellus in February 1996, as the Senior Vice President, Southern California Development. For more than five years prior to joining Catellus, Mr. Yellin served as President of the Yellin Company, a Los Angeles real estate investment, development and management company involved in the acquisition, restoration and redevelopment of historic buildings in the Historic Core of Downtown Los Angeles.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock commenced trading on December 5, 1990 and is traded on the New York Stock Exchange, the Chicago Stock Exchange and the Pacific Stock Exchange under the symbol \"CDX.\" The following table sets forth the high and low sale prices of the common stock, as reported on the New York Stock Exchange Composite Tape, during the periods indicated.\nNo cash dividends have been paid on the Company's common stock and the Company does not anticipate paying any cash dividends on its common stock in the foreseeable future. The most restrictive of the Company's loan agreements limit dividends to $27.6 million per year.\nAt March 15, 1996, there were approximately 38,271 holders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe following selected income statement and balance sheet data with respect to each of the years in the five-year period ended December 31, 1995 have been derived from the annual Consolidated Financial Statements. The operating and cash flow data have been derived from the Company's underlying financial and management records and are unaudited. This information should be read in conjunction with the Consolidated Financial Statements and related Notes thereto. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of results of operations for 1995, 1994 and 1993.\n- ----------------- (1) Net income in 1993 reflects extraordinary expense relating to a redemption premium paid to a lender and write-off of deferred financing costs on the Company's $388.2 million first mortgage loan. (2) Square feet owned excludes approximately 1.4 million square feet of existing buildings, primarily at Mission Bay. These buildings will be razed as development proceeds.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nHistorically, the aggregate costs of holding and operating the Company's real estate assets and paying preferred stock dividends have exceeded revenue from property operations, development and other recurring sources. In addition, the Company's cash requirements have been increased by the funds necessary to support the predevelopment and entitlement efforts for its major land development projects. The resulting cash flow deficits have been funded by borrowings, the issuance of preferred stock and the sale of sufficient assets to meet the Company's overall cash requirements.\nThe Company's short term financial goal is to eliminate the cash flow deficits resulting from interest and preferred stock dividends exceeding operating cash flow by the fourth quarter of 1996. To do this, the Company has taken the following steps:\n. In November 1994, the Company implemented significant staff reductions to reduce costs and reorganized to focus on increasing operating earnings. These reductions, when combined with other cost-reduction measures, resulted in annual cost savings for 1995 of approximately $10.1 million. General and administrative costs declined by $3.7 million; overhead associated with operating the portfolio declined by $3.4 million and overhead associated with selling properties declined by $1.5 million. In addition, the Company has benefited by a $1.5 million reduction in overhead costs associated with the Company's development activities.\n. In October 1995, the Company began the process of substantially increasing its asset sales activity, with the primary focus on its non-strategic land assets. Sale proceeds will be applied to a combination of debt reduction, in order to reduce interest costs, and reinvestment in activities that could generate increased operating earnings. The Company's goal is to sell $100 million of non-strategic land assets over a 15-month period ending December 31, 1996. Sales totaling $47.1 million closed in the fourth quarter of 1995.\n. During 1995, the Company reduced its total debt by a net $34.5 million. This net reduction represents the difference between $68.5 million of principal reductions on existing borrowings and $34 million of new borrowings which funded the development of pre-leased industrial and retail buildings. It is expected that the debt service on the new borrowings will be covered by the cash flow from the completed buildings; therefore, the Company's future operations should be improved by the interest savings on the $68.5 million of principal reductions.\n. During 1995 and continuing into 1996, the Company has placed a greater emphasis on increasing its development and fee development businesses. During 1995, the Company commenced construction on 910,000 square feet of new development, compared to 381,000 in 1994. In addition, at December 31, 1995, the Company had signed leases for new development totalling 648,000 square feet for which construction will commence in 1996. In March 1996, the Company acquired The Akins Companies to better position itself to pursue existing residential development opportunities on certain of its land holdings, as well as to pursue fee development opportunities on land not currently owned by the Company.\n. During 1995 and continuing into 1996, the Company has also placed a greater emphasis on increasing its third party management business. In January 1996, the Company announced a new five-year contract to manage the non-railroad real estate assets for the Burlington Northern Santa Fe Corporation.\n. Beginning in 1994 and continuing throughout 1995, the Company undertook a review of its major land development projects with the goal of increasing profitability, minimizing up front capital requirements and shortening the time required to develop the properties. As a result of this review, the decision was made to\nmodify certain of the entitlements, abandon others and sell one property that management believed could not be developed in a reasonable time frame. It is management's expectation that these decisions will both accelerate the time frame in which the projects will be developed and minimize the up front cash requirements associated with development.\nThe Company's long-term financial goal is to increase its return on stockholder equity. In order to accomplish this, the Company will continue with the revenue enhancement and cost reduction initiatives discussed above and will seek opportunities to reduce its capital commitment to projects through joint ventures, where the Company would seek financial partners to participate in some of its more capital intensive businesses. In addition, as the Company completes its disposition program of non-strategic land assets, it will evaluate opportunities to increase stockholder returns through strategic reinvestment and\/or stock repurchases.\nRESULTS OF OPERATIONS\nThe following table (in thousands) summarizes the Company's operating deficit after adjustment for fixed charges, leasing costs and joint venture cash flow. The Company believes that this presentation is meaningful in order to understand its progress in achieving its near-term goal of eliminating operating cash flow deficits by the fourth quarter of 1996.\nComparison of 1995 to 1994\nThe Company had 1995 operating income of $66.6 million compared to $59.3 million for 1994. This improvement resulted primarily from the overhead reduction program initiated at the end of 1994, as well as increased rental revenue.\nThe more significant changes in rental revenue and property operating costs are summarized below (in millions):\nThe increase in revenue for industrial buildings was due to new buildings completed in 1995 and the fourth quarter of 1994, and was partially offset by reduced rentals from existing properties. Operating costs for the industrial portfolio decreased due to the staff reductions described earlier. The increase in revenue and costs for retail buildings was primarily due to the completion of the East Baybridge shopping center in late 1994. Rental revenue for the Company's office portfolio decreased primarily due to the expiration of an above market lease in one building and a reduction in occupancy from 96% at the end of 1994 to 92% at the end of 1995. In addition, the Company's operating costs for its office portfolio increased $1 million due to increased property taxes resulting from the reassessment of an office building.\nLand holding costs decreased due to the sale of $62.2 million of non- strategic land assets and the overhead reduction program described above.\nJoint venture earnings decreased $.9 million. The decrease consists principally of $2.5 million in land sales in 1994 from one joint venture, partially offset by significantly improved operating results from a hotel joint venture.\nGeneral and administrative costs decreased in 1995 due to the staff reductions described earlier.\nNet interest costs increased $.6 million, representing the net effect of additional borrowings which funded the Company's development activity offset by a reduction in interest rates in 1995 as compared to 1994. As described earlier, the Company's future operations should be improved in 1996 by the interest savings on $68.5 million of principal reductions, $58 million of which occurred at year-end.\nDuring 1995, the Company capitalized $23.6 million of interest compared to $24 million in 1994. Of the interest capitalized in 1995, $16.3 million related to the Company's Mission Bay project. As described below, the Company took an $84.8 million charge in 1995 resulting from its decision to terminate the Development Agreement for Mission Bay. In the future, the Company will not capitalize interest and property taxes relating to Mission Bay until it has received revised entitlements and commences development.\nIn October 1995, the Company announced a goal of selling $100 million of non-strategic land assets over a 15 month period ending December 31, 1996. Sales totalling $47.1 million closed in the fourth quarter, and the Company had contracts for the sale of an additional $23.6 million at December 31, 1995. (One contract for $8 million was cancelled subsequent to year-end; however, the Company does not believe this will have a material\nimpact on its ability to meet its sales goals). Total asset sales in 1995 were $65.4 million, consisting of $62.2 million of non-strategic land assets and $3.2 million of developed industrial property. In 1994, total asset sales were $53.8 million, and included $21.5 million of income producing properties. In addition to its non-strategic land assets, the Company had open contracts for the sale of $21.1 million of other properties at December 31, 1995.\nDuring 1995, the Company took a non-cash, pre-tax charge of $102.4 million to adjust the carrying value of certain property, which included $84.8 million resulting from the Company's decision to terminate the 1991 Development Agreement for its Mission Bay project in San Francisco. This agreement provided for the development of 4.8 million square feet of office space, market rate and affordable housing, retail and industrial uses. The Company completed an analysis of the implications of the 1991 Development Agreement in light of current and anticipated market conditions and projected construction costs and concluded that the financial obligations imposed by that agreement render the project uneconomic. Management therefore elected to terminate the 1991 Development Agreement and seek approval of a revised entitlement package which would include: more housing and retail and less office space; a phased development approach which would require less upfront investment; and the use of tax increment financing, as provided by redevelopment law, to finance a significant portion of the public infrastructure and affordable housing.\nThe Company has taken an additional charge against earnings of $17.6 million relating to other property where the carrying costs exceed what management expects to recover through the anticipated sale of such property.\nIn addition to the charge against earnings discussed above, the 1995 results include income of $6.5 million for the favorable reversal of a litigation award and a $7.4 million charge to environmental expense as a result of management's reassessment of potential environmental exposures. The 1994 results included a $3.1 million restructuring charge and a $24.1 million property write-down.\nComparison of 1994 to 1993\nThe Company had 1994 operating income of $59.3 million compared to $59 million for 1993. This improvement resulted from increased joint venture earnings, offset by higher overhead costs.\nThe more significant changes in rental revenue and property operating costs are summarized below:\nRental revenue for the income producing portfolio decreased primarily due to the sale of 1.1 million square feet of industrial buildings, .2 million square feet of office buildings, .1 million square feet of retail buildings and 12 land leases in late 1993 and in 1994. Together, these sales had the impact of reducing rental income $5.3 million in 1994. The reductions were partially offset by rental income from industrial and retail buildings completed in 1994 and by an increase in occupancy from 91.6% at the end of 1993 to 95.9% at the end of 1994 in the office portfolio. Property operating costs for the income producing portfolio declined slightly due to the building and land lease sales referred to above.\nRental revenue from land holdings decreased principally due to leases for temporary rentals in 1993 that expired in 1994. Related operating costs decreased due to the sale of $32.3 million of non-strategic land assets.\nJoint venture earnings increased significantly in 1994 as a result of property sales by one joint venture and improved operating results of a hotel joint venture. The increase in general and administrative expenses was caused by executive severance and search costs, as well as increased use of outside professional services. Interest expense decreased principally because of the refinancing of the Prudential loan at a lower interest rate, as well as paydown of other loans and the conversion of the debenture.\nThe decrease in the gain on property sales resulted from both lower sales and higher cost basis in properties sold. Property sales in 1994 included $21.5 million from sales of buildings and land leases, which generated gross profit of $3 million, and land sales of $32.3 million which generated gross profit of $10.3 million. For 1993, sales and gross profit for buildings and land leases were $46.1 million and $22.7 million; land sales of $26.4 million generated gross profit of $10.5 million.\nDuring 1994, the Company also took a non-cash $24.1 million adjustment to the carrying value of property and a non-cash $3.1 million restructuring charge. The 1993 results included a $29.6 million charge for the conversion of a convertible debenture into common stock, an $11.9 million extraordinary expense in connection with the Prudential refinancing, an $8.3 million reserve for a litigation award, and a $32.5 million adjustment to the carrying value of property.\nLIQUIDITY AND FINANCIAL RESOURCES\nCash flow from operating activities\nCash provided by operating activities reflected in the statement of cash flows in 1995, 1994 and 1993 was $93.6 million, $51.1 million and $26.6 million. The increase in 1995 is primarily due to a higher level of land sales, an increase in cash from rental operations, and lower general and administrative costs. The increase in 1994 is primarily attributable to a decrease in interest costs from refinancing of the Company's debt.\nCash generated from sales of land was $55.3 million, $21.5 million and $17.8 million in 1995, 1994 and 1993. Cash generated from rental operations increased principally because of new buildings. For the five years from 1996 through 2000, leases for 20.1%, 14.0%, 7.4%, 8.7% and 10.1% of total square footage are scheduled to expire.\nCash flow from investing activities\nNet cash flow from investing activities reflected in the statement of cash flows increased $58.3 million from 1994 to 1995 and decreased $65.4 million from 1993 to 1994. The increase in 1995 resulted primarily from the conversion of short-term commercial paper and government securities into cash, offset by lower cash generated by the sale of investment and other properties. The decrease in 1994 is primarily attributable to the investment of cash into short-term commercial paper and government securities, a reduction in proceeds from sales of operating properties and an increase in capital expenditures. Net cash used for investing activities included the following capital expenditures (in millions):\nCash flow from financing activities\nNet cash used by financing activities reflected in the statement of cash flows in 1995 and 1994 was $60.7 million and $100.4 million; net cash provided by financing activities in 1993 was $120.2 million. These amounts reflect borrowing and repayment activity relating to operating properties (including principal amortization), capital expenditures and general corporate purposes. In 1995, the Company closed a $47 million secured term loan to refinance properties which were previously financed by loans which matured. The Company also closed a $33 million secured term loan which refinanced an existing maturing construction loan and reimbursed the Company for previously expended costs. In addition, the Company closed construction loans totalling $18.7 million. The 1994 and 1993 amounts reflect principally the net proceeds from the Series A and B preferred stock offerings, and the use of a part of those proceeds to repay debt, as described below.\nAt December 31, 1995, the Company had total outstanding debt of $496.2 million, of which 73% was non-recourse to the Company and secured by the underlying property only, 25% was recourse to the Company and also secured by underlying property, and 2% was unsecured. During the next twelve months, $85.1 million of debt matures; 77% of this amount is construction financing or intermediate term loans, which are expected to be extended, refinanced and converted into permanent loans or repaid.\nRefinancing of Prudential Mortgage Loan\nIn February 1994, the Company refinanced its $388.2 million mortgage loan from The Prudential Insurance Company of America with cash generated from the issuance of preferred stock and a $280 million mortgage loan due March 1, 2004. In connection with this refinancing, the Company also paid down $10 million of another mortgage loan from Prudential due January 1, 1996, and incurred an extraordinary expense of $11.9 million ($7.4 million, net of income tax benefits). This extraordinary expense consisted of a $10 million redemption premium paid to Prudential and the write-off of deferred financing costs associated with the $388.2 million loan. The reduced interest resulting from the above debt paydowns, as well as other debt paydowns in 1993 and 1994, was partially offset by the increased dividend requirements of the preferred stock sold in 1993.\nDebt covenants\nCertain of the Company's loan agreements contain restrictive financial covenants and several agreements are cross-defaulted. The most restrictive covenants limit annual dividends to $27.6 million and require stockholders' equity to be no less than $425 million. The stockholders' equity covenant was amended effective December 31, 1995, changing the requirement from $475 million to $425 million. As a result, at December 31, 1995, the Company had a cushion of $17.9 million under that covenant.\nCash balances and available borrowings\nAt December 31, 1995, cash and cash equivalents totalled $27.7 million. In addition, the Company had available $48 million under its working capital facility, $33.2 million under its construction facilities, and $.5 million under its secured term loan facilities.\nIn December 1995, the Company renewed its unsecured revolving facility which was due to expire on December 31, 1995. Upon renewal, the facility was reduced to $48 million from $62.5 million ($75 million at December 31, 1994) and the revolving period was extended to December 31, 1996.\nIn January 1995, the Company entered into an $85 million revolving construction line of credit and in July 1995 increased the line an additional $15 million. This credit facility renews and increases a $75.5 million credit line. In July 1995, the Company entered into another $25 million revolving construction line of credit. The credit facility will be used to fund new Company development in twelve states in the Southwest.\nIncome Taxes\nAt December 31, 1995, the Company's deferred tax liability consisted of deferred tax assets totalling $136 million and deferred tax liabilities of $226 million. Deferred tax assets included $13 million relating to net operating loss carryforwards (NOLs) of $35.8 million. NOLs of $12.1 million, $16.9 million, $6.5 million and $.3 million expire in 2006, 2007, 2008 and 2009. The Company's other deferred tax assets of $123 million relate primarily to differences between book and tax basis of properties. These deferred tax assets are not subject to expiration and will likely be realized at the time of taxable dispositions of the properties. Deferred tax liabilities in excess of deferred tax assets are often associated with the same property, with the result that the deferred tax asset will likely be realized in a taxable disposition, without regard to other taxable income. The Company believes it is more likely than not that it will realize the benefit of its deferred tax assets, and that no valuation allowance is required. In making this determination, the Company considered: the nature of its deferred tax assets (and liabilities); the amounts and expiration dates of its NOLs; the historical levels of taxable income; the significant unrealized appreciation of its properties, including surplus properties likely to be sold during the NOL carryforward periods; and its ability to control the timing of property sales in order to assure that deferred tax assets will be offset by deferred tax liabilities or realized appreciation.\nENVIRONMENTAL MATTERS\nMany of the Company's properties are in urban and industrial areas and may have been leased to commercial or industrial tenants who may have discharged hazardous materials. From 1993 to 1995, expensed and capitalized environmental costs, including legal fees, totalled $22.5 million. The Company expects to spend $6.7 million for such costs in 1996. These costs may increase as the Company develops its major projects.\nFuture environmental costs are difficult to estimate with certainty. The Company and outside consultants have evaluated the environmental liabilities associated with most of the Company's properties, however any evaluation necessarily is based on the prevailing law and identified site conditions at that time. Although the Company closely monitors its environmental costs, the size of the portfolio precludes extensive review of every property on a regular basis.\nEnvironmental costs incurred in connection with operating properties and properties previously sold are expensed. At December 31, 1995, management has provided a reserve of $13.8 million for such costs. These costs are expected to be incurred over an estimated ten-year period, with a substantial portion incurred over the next five years.\nCosts incurred for properties to be sold are deferred and will be charged to cost of sales when the properties are sold. Costs relating to undeveloped properties are capitalized as part of development costs. At December 31, 1995, the Company's estimate of its potential liability for identified environmental costs relating to properties to be developed or sold ranged from $18 million to $59 million. These costs generally will be capitalized as they are incurred, over the course of the estimated development period of approximately 20 years.\nAlthough an unexpected event could have a material impact on the results of operations for any period, the Company does not believe that such costs for identified liabilities will have a material adverse effect on its financial position, results of operations or cash flow. See Note 2 to the Consolidated Financial Statements.\nSUPPLEMENTAL CURRENT VALUE\nHistorically, the Company has provided an annual supplemental current value balance sheet in addition to historical cost financial statements. The Company discontinued this practice in 1995. In the past, this disclosure was an attempt to address the difference between the low historical cost of the Company's assets and their current value. However, the current value process is expensive and has significant limitations. In particular, short-term values can fluctuate resulting from changes in interest rates, capitalization rates and development assumptions that\nare not necessarily indicative of the long term value of the Company's portfolio. Management believes that, over time, a more relevant measure of the long-term value of the Company is its growth in cash flow.\nFor 1995, the Company has provided supplemental current value information on land assets and joint venture investments (along with an appraiser's opinion) and has also provided expanded financial data so that investors can better evaluate the performance of its income producing assets. In future years, the Company expects to discontinue current value reporting altogether.\nAs of December 31, 1995, the Company's land portfolio and joint venture portfolio had a current value of $1.039 billion compared to $1.037 billion for the same assets in 1994. Although the total value was relatively unchanged, the Company experienced increased values for its joint venture investments and portions of its industrial development portfolio. These increases were partially offset by reductions in certain of the Company's larger land parcels.\nRISK FACTORS\nThe statements contained herein which are not historical facts are forward- looking statements based on economic forecasts, strategic plans and other factors which, by their nature, involve risk and uncertainties. In particular, among the factors that could cause actual results to differ materially are the following: business conditions and general economy; competitive factors; political decisions affecting land use permits, interest rates and other risks inherent in the real estate business. For further information on factors which could impact the Company and the statements, reference is made to the Company's filings with the Securities and Exchange Commission.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and schedules required under Regulation S-X promulgated under the Securities Act of 1933 are identified in Item 14 and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nExcept for the information relating to the executive officers of the Company set forth in Part I of this Annual Report on Form 10-K, the information required by the following items in this Part III is hereby incorporated by reference to the relevant sections contained in the Company's definitive Proxy Statement (\"1996 Proxy Statement\") which will be filed with the Securities and Exchange Commission in connection with the 1996 Annual Meeting of Stockholders.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information in the section captioned \"Election of Directors\" in the 1996 Proxy Statement is incorporated herein by reference.\nThe information in the section captioned \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the 1996 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information in the sections captioned \"Election of Directors-- Directors' Compensation,\" \"Employment and Severance Agreements\" and \"Compensation of Executive Officers\" included in the 1996 Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information in the sections captioned \"Security Ownership of Directors, Nominees and Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\" in the 1996 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information in the section captioned \"Certain Transactions\" in the 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 (A)(2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nSee Index to Financial Statements and Financial Statement Schedules at herein.\nAll other Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(A)(3) EXHIBITS\nExhibit No. - -------\n3.1 Form of Restated Certificate of Incorporation of the Registrant (1) 3.1A Amendment to Restated Certificate of Incorporation of the Registrant (8) 3.3 Form of Certificate of Designations, Preferences and Rights of $3.25 Series A Cumulative Convertible Preferred Stock (2) 3.4 By-Laws, as amended* 3.5 Form of Certificate of Designations, Preferences and Rights of $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (8) 4.1 Form of stock certificate representing Common Stock (1) 4.9 Form of stock certificate representing $3.75 Series A Cumulative Convertible Preferred Stock (2) 4.10 Form of stock certificate representing $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (8) 4.11 Loan Agreement dated as of February 16, 1994 between the Registrant and The Prudential Insurance Company of America (9) 10.1 Exploration Agreement and Option to Lease dated December 28, 1989 between the Registrant and Santa Fe Pacific Minerals Corporation (1) 10.4 Registration Rights Agreement dated as of December 29, 1989 among the Registrant, BAREIA, O&Y and Itel (1) 10.4A Letter Agreement dated November 14, 1995 between the Registrant and California Public Employees' Retirement System 10.6 Restated Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and Santa Fe Pacific Corporation (\"SFP\") (1) 10.7 State Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and SFP (1) 10.13 Registrant's Incentive Stock Compensation Plan (3) 10.14 Management Agreement between ATSF and Catellus Management Corporation dated October 15, 1994 (10) 10.15 Termination, Substitution and Guarantee Agreement between ATSF and the Registrant dated December 21, 1990 (4) 10.16 Registrant's Stock Option Plan (4) 10.17 Development Agreement dated April 1, 1991 between the Registrant and the San Francisco Board of Supervisors (5) 10.21 Amended and Restated Executive Stock Option Plan (8) 10.26 Form of First Amendment to Registration Rights Agreement among the Registrant, BAREIA, O&Y and Itel (6) 10.29 Amended and Restated Executive Employment Agreement dated as of November 29, 1995 between the Registrant and Nelson C. Rising*\n10.30 Executive Employment Agreement dated February 10, 1995 between the Registrant and Timothy J. Beaudin (10) 10.31 Amended and Restated Stock Option Agreement dated March 22, 1996 between the Registrant and Joseph R. Seiger* 10.32 Special Severance Pay Plan and Summary Plan Description (10) 10.33 Form of Memorandum Regarding Reduction-In-Force Program (10) 10.34 Consulting Agreement dated December 23, 1994 between the Registrant and James G. O'Gara (10) 10.35 Memorandum of Understanding dated December 22, 1994, addressed to James W. Augustino (10) 10.36 Memorandum of Understanding dated December 19, 1994, addressed to Thomas W. Gille (10) 10.37 Employment Agreement dated July 24, 1996 between the Registrant and Stephen P. Wallace* 10.38 Letter Agreement dated March 24, 1995 between the Registrant and Donald M. Parker* 10.39 Stock Option Award Agreement dated as of January 1, 1996 between the Registrant and Joseph R. Seiger* 10.40 Revised Memorandum of Understanding dated November 15, 1995 between the Registrant and Theodore L. Tanner* 10.41 Memorandum of Understanding dated February 16, 1996 between the Registrant and Jeffrey K. Gwin* 10.42 Consulting Agreement dated February 25, 1996, between the Registrant and Jeffrey K. Gwin* 21.1 Subsidiaries of the Registrant* 23.1 Consent of Independent Accountants* 23.2 Consent of Independent Real Estate Appraisers* 24.1 Powers of Attorney from directors with respect to the filing of the Form 10-K* 27 Financial Data Schedule* 99.1 Report of the Independent Real Estate Appraisers dated March 12, 1996\nThe Registrant has omitted instruments with respect to long-term debt where the total amount of the securities authorized thereunder does not exceed 10 percent of the assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of such instrument to the Commission upon request.\n(b) Reports on Form 8-K\nNone.\n- ----------- * Filed with this report on Form 10-K.\n(1) Incorporated by reference to Exhibit of the same number of the Registration Statement on Form 10 (Commission File No. 0-18694) as filed with the Commission on July 18, 1990 (\"Form 10\"). (2) Incorporated by reference to Exhibit of the same number on the Form 8 constituting a Post-Effective Amendment No. 1 to the Form 8-A as filed with the Commission on February 19, 1993. (3) Incorporated by reference to Exhibit of the same number of the Form 8 constituting Post-Effective Amendment No. 1 to the Form 10 as filed with the Commission on November 20, 1990. (4) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990. (5) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990, referred to therein as \"Development Agreement dated February 19, 1991 between the Registrant and the San Francisco Board of Supervisors\". (6) Incorporated by reference to Exhibit of the same number of Amendment No. 2 to Form S-3 as filed with the Commission on February 4, 1993. (7) Incorporated by reference to Exhibit of the same number on the Form 10-Q for the quarter ended September 30, 1993. (8) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1993.\n(9) Incorporated by reference to Exhibit of the same number of Amendment No. 1 to the Form 10-K for the year ended December 31, 1993. (10) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Catellus Development Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCATELLUS DEVELOPMENT CORPORATION\nBy _______________________________ Nelson C. Rising 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 Catellus Development Corporation and in the capacities and on the date indicated.\nSignature Title Date - --------- ----- ----\n___________________________ President, Chief Executive March 30, 1996 Nelson C. Rising Officer and Director Principal Executive Officer\n___________________________ Senior Vice President March 30, 1996 Stephen P. Wallace and Chief Financial Officer Principal Financial Officer\n____________________________ Vice President and Controller March 30, 1996 Paul A. Lockie Principal Accounting Officer\nSignature Title Date - --------- ----- ----\n* Director March 30, 1996 - ----------------------------- Joseph F. Alibrandi\n* Director - ----------------------------- Daryl J. Carter\n* Director - ----------------------------- Christine Garvey\n* Chairman of the Board, - ----------------------------- Director Joseph R. Seiger\n* Director - ----------------------------- Jacqueline R. Slater\n* Director - ----------------------------- Thomas M. Steinberg\n* Director - ----------------------------- Tom C. Stickel\n* Director - ----------------------------- Beverly Benedict Thomas\nBy __________________________ Paul A. Lockie March 30, 1996 Attorney-in-fact\nAND FINANCIAL STATEMENT SCHEDULES (ITEMS 14(a)(1) AND (a)(2)) -------------------------------------\n(a)(2) FINANCIAL STATEMENT SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Catellus Development Corporation\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Catellus Development 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. The financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPrice Waterhouse LLP San Francisco, California February 12, 1996\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED BALANCE SHEET (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS-(CONTINUED) (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. DESCRIPTION OF BUSINESS\nHeadquartered in San Francisco, Catellus Development Corporation (the Company) is a full service real estate company that manages and develops real estate for its own account and others. The Company's portfolio of industrial, retail and office projects, undeveloped land and joint venture interests are located in major markets in California and 10 other states. The Company's operating properties consist primarily of industrial facilities, along with a number of office and retail buildings located in California, Arizona, Illinois, Texas, Colorado and Oregon. The Company also has substantial undeveloped land holdings primarily in these same states.\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation - The accompanying financial statements include the accounts of the Company and investees over 50% owned which are controlled by the Company. All other investees are accounted for using the equity method.\nRevenue recognition - Rental revenue, in general, is recognized when due from tenants; however, revenue from leases with rent concessions is recognized on a straight-line basis over the initial term of the lease. Direct costs of negotiating and consummating a lease are deferred and amortized over the initial term of the related lease.\nThe Company recognizes revenue from the sale of properties using the accrual method. Sales not qualifying for full recognition at the time of sale are accounted for under the installment method. In general, specific identification is used to determine the cost of sales. Estimated future costs to be incurred by the Company after completion of each sale are included in cost of sales.\nCash, restricted cash and short-term investments - The Company considers all highly liquid investments with a maturity of three months or less at time of purchase to be cash equivalents. Restricted cash in 1994 represents amounts held in escrow in connection with a property transaction. Short-term investments in 1994 represent primarily commercial paper and government securities which mature within one year from time of purchase and had an average yield of 5.42%.\nFinancial instruments - The cost basis of the Company's notes receivable and debt approximate fair value, based upon current market rates for commercial real estate loans of similar risks and maturities.\nProperty and deferred costs - Real estate is stated at the lower of cost or estimated fair value. In cases where the Company determines that the carrying costs for properties held for sale exceeds estimated fair value, or that an impairment has been sustained, a write-down to estimated fair value is recorded. A property is considered impaired when the property's estimated undiscounted future cash flow, before interest charges, is less than its book value. This evaluation is made on a property by property basis. The evaluation of fair value and undiscounted cash flow requires significant judgement; it is reasonably possible that a change in the estimate could occur. The adoption of Statement of Financial Accounting Standard No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" had no impact on the Company's financial statements.\nThe Company capitalizes construction and development costs. Costs associated with financing or leasing projects are also capitalized and amortized over the period benefitted by those expenditures.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDepreciation is computed using the straight-line method. Buildings and improvements are depreciated using lives of between 20 and 40 years. Tenant improvements are depreciated over the primary terms of the leases (generally 3- 15 years), while furniture and equipment are depreciated using lives ranging between 3 and 10 years.\nMaintenance and repair costs are charged to operations as incurred, while significant improvements, replacements and major renovations are capitalized.\nAllowance for uncollectible accounts - Accounts receivable are net of an allowance for uncollectible accounts totalling $1.8 million and $1.9 million at December 31, 1995 and 1994. The provision for uncollectible accounts in 1995, 1994 and 1993 totalled $.5 million, $1.0 million and $.1 million.\nEnvironmental costs - The Company incurs on-going environmental remediation costs, including clean-up costs, consulting fees for environmental studies and investigations, monitoring costs, and legal costs relating to clean-up, litigation defense, and the pursuit of responsible third parties. Costs incurred in connection with operating properties and properties previously sold are expensed. Costs relating to undeveloped land are capitalized as part of development costs. Costs incurred for properties to be sold are deferred and will be charged to cost of sales when the properties are sold. Environmental costs charged to operations, including amounts charged to cost of sales, for 1995, 1994 and 1993 totalled $8.1 million, $4.6 million and $5.5 million. Environmental costs capitalized in 1995, 1994 and 1993 were $1.7 million, $1.2 million and $1.4 million. The Company maintains a reserve, included in the caption \"deferred credits and other liabilities\", for known, probable costs of environmental remediation to be incurred in connection with operating properties and properties previously sold. This reserve was $13.8 million and $8.4 million at December 31, 1995 and 1994. When there is a legal requirement for environmental remediation of developable land, the Company will accrue for the estimated cost of remediation and capitalize that amount. Where there is no legal requirement for remediation, costs will be capitalized, as incurred, as part of the project costs.\nIncome taxes - Income taxes are recorded based on the future tax effects of the difference between the tax and financial reporting basis of the Company's assets and liabilities. In estimating future tax consequences, expected future events are considered except for potential income tax law or rate changes.\nLoss per share - Net loss per share of common stock is computed by dividing net loss, after reduction for preferred stock dividends, by the weighted average number of shares of common stock outstanding during the year. Fully diluted earnings per share amounts have not been presented because assumed conversion of the Series A and Series B preferred stock would be anti-dilutive for all relevant periods. Assuming conversion of the Debenture on January 1, 1993, the net loss and loss before extraordinary item for 1993 would have been $.93 and $.84 per share.\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, and the reported amounts of revenue and expenses. Actual results could differ from those estimates.\nReclassifications - Certain prior year amounts have been reclassified to conform with the current year financial statement presentation.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. RESTRUCTURING OF OPERATIONS\nIn November 1994, the Company announced a major restructuring to refocus the Company and to improve the Company's long-term cash position. This restructuring, which was implemented in 1995, resulted in a $3.1 million non- recurring operating expense in 1994. Costs associated with the restructuring included $1.9 million related to employee termination benefits, $.8 million related to lease cancellation fees and costs attributable to permanently idle leased facilities, and $.4 million for the consolidation of operations. As of December 31, 1995, $3 million of the restructuring charges had been paid.\nNOTE 4. MORTGAGE AND OTHER DEBT\nMortgage and other debt at December 31, 1995 and 1994 consisted of the following (in thousands):\n(a) The Company refinanced its $388.2 million first mortgage loan with The Prudential Insurance Company of America (Prudential) on February 18, 1994 with a $280 million first mortgage loan. In connection with this refinancing, the Company incurred an extraordinary expense of $11.9 million ($7.4 million, net of income tax benefits). This extraordinary expense, which was recognized in 1993, consisted primarily of a redemption premium paid to Prudential and the write-off of deferred financing costs associated with the $388.2 million loan. The loan is collateralized by a majority of the Company's operating properties and by an assignment of rents generated by the underlying properties. This loan has a penalty if paid prior to maturity.\n(b) These first mortgage loans are collateralized by certain of the Company's operating properties and by an assignment of rents generated by the underlying properties. A majority of these loans have penalties if paid prior to maturity.\n(c) The Company's secured term loans are collateralized by certain operating properties and by an assignment of rents generated by the underlying properties. At December 31, 1995, $.5 million was available for future borrowings.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n(d) The Company has a $48 million unsecured revolving facility and a $7 million unsecured term facility. In December 1995, the Company renewed its unsecured revolving facility which was due to expire on December 31, 1995. Upon renewal, the facility was reduced to $48 million from $62.5 million ($75 million at December 31, 1994) and the revolving period was extended to December 31, 1996. As of December 31, 1995, nothing was outstanding under the revolving facility, leaving the entire $48 million available for future borrowings.\n(e) The Company's construction loans are used to finance development projects and are secured by the related land and buildings and by an assignment of rents generated by the underlying properties. In January 1995, the Company entered into an $85 million revolving construction line of credit and in July 1995 increased the line an additional $15 million. This credit facility renews and increases a $75.5 million credit line. In July 1995, the Company entered into another $25 million revolving construction line of credit. The credit facility will be used to fund new Company development in twelve states in the Southwest. At December 31, 1995, $33.2 million was available for future borrowings under all construction lines.\n(f) The assessment district bonds are issued through local municipalities to fund the construction of public infrastructure and improvements which benefit the Company's properties. These bonds are secured by certain of the Company's properties.\nCertain loan agreements contain restrictive financial covenants. The most restrictive covenants limit annual dividends to $27.6 million and require stockholders' equity to be no less than $425 million. Other covenants accelerate payment upon certain change of control events and contain negative pledges with respect to certain of the Company's properties. The Company was in compliance with all such covenants at December 31, 1995.\nThe maturities of mortgage and other debt outstanding as of December 31, 1995 are summarized as follows:\nInterest costs incurred during 1995, 1994 and 1993 relating to mortgage and other debt totalled $46.5 million, $45.8 million and $64 million. Total interest costs, which also includes loan fee amortization and other interest costs, amounted to $49.3 million, $48.7 million and $69.6 million in 1995, 1994 and 1993. Of these amounts, $23.6 million, $24 million and $25.6 million were capitalized during 1995, 1994 and 1993.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 5. INCOME TAXES\nTotal income taxes (benefit) reflected in the consolidated statement of operations differs from the amounts computed by applying the federal statutory rate of 35% to income (loss) before extraordinary item as follows (in thousands):\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and for operating loss and tax credit carryforwards. Significant components of the Company's net deferred tax liability as of December 31, 1995 and 1994 are as follows (in thousands):\nDuring 1994 and 1993, the Company generated net operating loss carryforwards of $.3 million and $6.5 million for tax purposes which expire in 2009 and 2008. Deferred income tax expense was reduced to reflect the benefit of these amounts.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe Company increased its tax expense and related deferred tax liability by $3 million in 1993 as a result of legislation enacted in August 1993 increasing the federal tax rate from 34% to 35% commencing January 1, 1993.\nNOTE 6. JOINT VENTURE INVESTMENTS\nThe Company is involved in a variety of real estate-oriented joint venture activities. At December 31, 1995, these included two hotels, one office building, a 900,000 square foot trade mart center for the contract and home furnishing industries, an apartment complex and other projects in the early stages of development.\nThe Company had a loan outstanding to one of its joint ventures in the amount of $1.7 million at December 31, 1995 and 1994. The loan bears interest at one percentage point over the rate payable under the joint venture's note to its creditor bank (10.25% at December 31, 1995) and is secured by a second lien on the joint venture property. Principal and interest were due on or before February 1, 1996. The Company expects to convert this note to joint venture equity. At December 31, 1993, the Company had outstanding a loan and related accrued interest to a joint venture partner in the aggregate amount of $.6 million. During 1994, this amount was exchanged for additional ownership in the related joint venture.\nThe Company guarantees a portion of the debt and interest of certain of its joint ventures. At December 31, 1995, these guarantees totalled $8.9 million.\nThe condensed combined balance sheets and statements of income of the joint ventures, along with the Company's proportionate share, are summarized as follows (in thousands):\nThe Company's proportionate share of venturers' deficit is an aggregate amount for all ventures. Because the Company's ownership percentage differs from venture to venture, and certain ventures have accumulated deficits while others have accumulated equity, the Company's percentage of venturers' deficit is not reflective of the Company's ownership percentage of the ventures.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. PROPERTY\nNet book value by property type at December 31, 1995 and 1994 consisted of the following (in thousands):\nDuring 1995, the Company took a charge of $102.4 million to adjust the carrying value of certain property, which included $84.8 million resulting from the Company's decision to terminate the 1991 Development Agreement for its Mission Bay project in San Francisco. The Company completed an analysis of the implications of the 1991 Development Agreement in light of current and anticipated market conditions and projected construction costs and concluded that the financial obligations imposed by that agreement render the project uneconomic. Management therefore elected to terminate the 1991 Development Agreement and seek approval of a revised entitlement package. The revised carrying value of Mission Bay represents management's best estimate of its fair value, assuming the Company is successful in re-entitling the property, and approximates the amount included in the Company's current value reporting for December 31, 1994, less anticipated costs of obtaining new entitlements.\nThe Company has taken an additional charge against earnings of $17.6 million relating to other property where the carrying value exceeded what management expects to recover through the anticipated sale of such property.\nThe Company also took charges of $24.1 million and $32.5 million in 1994 and 1993 to adjust the carrying value of certain property.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 8. LEASES\nThe Company, as lessor, has entered into noncancelable operating leases expiring at various dates through 2052. Rental revenue under these leases totalled $106.8 million in 1995, $102.3 million in 1994 and $105.1 million in 1993. Included in this revenue are rentals contingent on lease operations of $2.1 million in 1995, $2.8 million in 1994 and $3.2 million in 1993. Future minimum rental revenue under existing noncancelable operating leases as of December 31, 1995 are summarized as follows (in thousands):\nThe book value of the Company's properties under operating leases or held for rent are summarized as follows (in thousands):\nThe Company, as lessee, has entered into noncancelable operating leases expiring at various dates through 2023. Rental expense under these leases totalled $1.7 million in 1995 and $2.8 million in 1994, rental expense and related sublease income totalled $4 million and $1.3 million in 1993. Future minimum lease payments as of December 31, 1995 are summarized as follows (in thousands):\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. RENTALS, COSTS AND NET OPERATING INCOME BY PROPERTY TYPE\nNet operating income before interest and depreciation is summarized by property type as follows (in thousands):\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 10. PROPERTY SALES\nThe Company's sales consist of the following (in thousands):\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 11. OTHER INCOME (EXPENSE)\nOther income (expense) is summarized as follows (in thousands):\nNOTE 12. EMPLOYEE BENEFIT AND STOCK OPTION PLANS\nThe Company has a profit sharing and savings plan for all employees. Funding consists of employee contributions along with matching and discretionary contributions by the Company. Total expense for the Company under this plan was $.2 million, $.6 million and $.6 million in 1995, 1994 and 1993.\nThe Company has various plans through which employees may purchase common stock of the Company.\nThe Incentive Stock Compensation Plan (Substitute Plan) was adopted to provide substitute awards to employees whose awards under certain plans of the former parent company, Santa Fe Pacific Corporation (SFP) were forfeited as a result of the Company's spin-off from SFP in 1990. The number of shares, exercise price and expiration dates of these awards were set so the participant retained the full unrealized potential value of the original SFP grant. Options became exercisable after March 5, 1992 and expire from 1997 through 1999. The Company also has two stock option plans under which the Board of Directors may issue options to purchase up to 500,000 shares of common stock at a price not less than the fair market value at the date of grant. Options are exercisable no earlier than six months from the date of grant and generally expire ten years after the date of grant. All options granted to date are exercisable in installments on a cumulative basis at a rate of 25% each year commencing on the first anniversary of the date of grant.\nUnder the Executive Stock Option Plan, the Board of Directors may issue non-qualified stock options to officers and directors to purchase up to 4,250,000 shares of common stock at a price not less than fair market value at the date of grant. Options are exercisable no earlier than six months from the date of grant and generally expire ten years after the date of grant. Each non- management director is automatically granted an option, upon initial election to the Board of Directors, to purchase 5,000 shares of common stock at a price of 127.63% of the fair market value on the date of grant, increasing 5% on each anniversary of the grant date commencing on the sixth anniversary. These options are exercisable in installments on a cumulative basis at a rate of 20% each year. The exercise price for all other options will be no less than the fair market value on the date of grant. Certain of these options are exercisable in increments based on stock price performance benchmarks, and others are exercisable based upon time vesting requirements.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nTransactions under these plans during 1994 and 1995 are summarized below:\nThe Company intends to adopt the disclosure requirements of Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" beginning in 1996.\nNOTE 13. CAPITAL STOCK\nThe Company has authorized the issuance of 50 million shares of $.01 par value preferred stock. As of December 31, 1995 and 1994, the Company has outstanding 3,449,999 shares of $3.75 Series A Cumulative Convertible Preferred Stock (Series A preferred stock). The Series A preferred stock has an annual dividend of $3.75 per share, a stated value of $50 per share and a liquidation preference of $50 per share plus accrued and unpaid dividends. It is convertible into common stock at a price of $9.06 per common share, subject to adjustment in certain events. It is also redeemable, at the option of the Company, at any time after February 16, 1996, at $52.625 per share and thereafter at prices declining to $50 per share on or after February 16, 2003.\nConcurrently with the issuance of the Series A preferred stock, the Company converted a convertible debenture (which had an accreted value of $111.4 million) into common stock with a value of $141 million. This was treated as a non-cash item in the 1993 statement of cash flows. At the time, the Company incurred a non-recurring non-cash expense of $29.6 million ($28.3 million net of income tax benefit) representing the excess of the value of the common stock issued over the accreted value of the debenture at the date of conversion.\nThe Company also has outstanding 3,000,000 shares $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (Series B preferred stock). The Series B preferred stock has an annual dividend of $3.625 per share, a stated value of $50 per share and a liquidation preference of $50 per share plus accrued and unpaid dividends. It is convertible into the Company's common stock at a price of $9.80 per common share, subject to adjustment in certain events. The Series B preferred stock is exchangeable, at the Company's option, at any time after November 15, 1995, into 7.25% Convertible Subordinated Debentures due November 15, 2018, at a rate of $50 of debentures for each share of Series B preferred stock. It is also redeemable, at the option of the Company, at any time after November 15, 1996, at $52.5375 per share and thereafter at prices declining to $50 per share on or after November 15, 2003.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe Company has authorized the issuance of 150 million shares of $.01 par value common stock. As of December 31, 1995 and 1994, the Company has 72,967,236 shares outstanding. The Company has reserved 19,040,000 and 15,306,000 shares of common stock for conversion of the Series A and Series B preferred stock, 8,875,000 shares pursuant to various compensation programs, and 2,000,000 shares for acquisitions.\nNOTE 14. COMMITMENTS AND CONTINGENCIES\nIn April 1991, a lawsuit was brought against the Company alleging breach of contract for a finder's fee in connection with an August 1990 sale of land in Fremont, California. On November 1, 1993, the jury returned a verdict in favor of the plaintiff and made an award of approximately $440,000 which, together with pre-judgment interest, totalled approximately $600,000. Additionally, the jury awarded approximately $7.7 million in punitive damages for what it found was the Company's bad faith denial of an alleged contract. While the Company was vigorously pursuing an appeal, it provided $8.3 million as an other expense in the 1993 consolidated statement of operations. In December 1995, the Company reached a settlement with the plaintiff and reversed $7.5 million of the expense in the 1995 consolidated statement of income.\nThe Company has obtained standby letters of credit and surety bonds in favor of local municipalities or financial institutions to guarantee performance on real property improvements or financial obligations. As of December 31, 1995, $21.3 million was outstanding, including a $12.4 million surety bond related to the lawsuit described above.\nThe Company, as a partner in certain joint ventures, has made certain financing guarantees (Note 6).\nThe Company is a party to a number of legal actions arising in the ordinary course of business. While the Company cannot predict with certainty the final outcome of these proceedings, considering the substantial legal defenses available, management believes that none of these actions, when finally resolved, will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.\nInherent in the operations of the real estate business is the possibility that environmental pollution conditions may relate to properties owned or previously owned. The Company may be required in the future to take action to correct or reduce the environmental effects of prior disposal or release of hazardous substances by third parties, the Company, or its corporate predecessors. Future environmental costs are difficult to estimate due to such factors as the unknown magnitude of possible contamination, the unknown timing and extent of the corrective actions which may be required, the determination of the Company's liability in proportion to other responsible parties, and the extent to which such costs are recoverable from insurance.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nAt December 31, 1995, management estimates that future costs for remediation of identified or suspected environmental contamination which will be treated as an expense will be approximately $13.8 million, and has provided a reserve for that amount. It is anticipated that such costs will be incurred over the next ten years. Management also estimates that similar costs relating to the Company's properties to be developed or sold may range from $18 million to $59 million. These amounts will be capitalized as components of development costs when incurred, which is anticipated to be over a period of twenty years, or will be deferred and charged to cost of sales when the properties are sold. These estimates were developed based on extensive reviews which took place over several years based upon then prevailing law and identified site conditions. Because of the breadth of its portfolio, the Company is unable to review extensively each property on a regular basis. Such estimates are not precise and are always subject to the availability of further information about the prevailing conditions at the site, the future requirements of regulatory agencies and the availability of other parties to pay some or all of such costs.\nNOTE 15. SUBSEQUENT EVENT\nIn March 1996, the Company acquired The Akins Companies, a residential real estate company involved in home building, community development and project management services, primarily in Southern California. The acquisition price will be paid in the form of Catellus common stock with a market value of approximately $9 million, and is expected to be accounted for as a pooling of interests.\nThe Company will form a new entity, Catellus Residential Group, that will develop the Company's residential land holdings, projects previously started by Akins, and new development activities on property owned by others.\nSUMMARIZED QUARTERLY RESULTS (UNAUDITED)\nThe Company's earnings and cash flow are determined to a large extent by property sales. Sales and net income have fluctuated significantly from quarter to quarter, as evidenced by the following summary of unaudited quarterly consolidated results of operations. Property sales fluctuate from quarter to quarter, reflecting general market conditions and the Company's intent to sell property when it can obtain attractive prices. Cost of sales may also vary widely because it is determined by the Company's historical cost basis in the underlying land.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Stockholders of Catellus Development Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 12, 1996, appearing on page of this Form 10-K of Catellus Development Corporation, also included an audit of the Financial Statement Schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPrice Waterhouse LLP San Francisco, California February 12, 1996\nS-1\nCATELLUS DEVELOPMENT CORPORATION\nSCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1995 (IN THOUSANDS)\n- --------------------- Notes: (1) Balances written off as uncollectible. (2) Costs of unsuccessful projects written off. (3) Environmental costs incurred.\nS-2\nCATELLUS DEVELOPMENT CORPORATION SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 (DOLLARS IN THOUSANDS)\n- ---------------------- Notes: (1) A reserve of $1,346,000 against predevelopment has been established for projects to be abandoned. (2) The aggregate cost for Federal income tax purposes is approximately $972,000,000. (3) See Attachment A to Schedule III for reconciliation of beginning of period total to total at close of period. (4) Excludes investments in joint ventures and furniture and equipment. (5) Reference is made to Note 2 to the Consolidated Financial Statements for information related to depreciation. (6) Reflects inclusion of an additional parcel into Mission Bay. (7) Net incremental revenues.\nS-3\nCATELLUS DEVELOPMENT CORPORATION ATTACHMENT A TO SCHEDULE III RECONCILIATION OF COST OF REAL ESTATE AT BEGINNING OF PERIOD WITH TOTAL AT END OF PERIOD (IN THOUSANDS)\nRECONCILIATION OF REAL ESTATE ACCUMULATED DEPRECIATION AT BEGINNING OF PERIOD WITH TOTAL AT END OF PERIOD (IN THOUSANDS)\nS-4","section_15":""}
{"filename":"771214_1995.txt","cik":"771214","year":"1995","section_1":"Item 1. Business - ------ --------\nGeneral - -------\nThe Company, located in Portland, Oregon, is a franchisor and operator of full-service, family-oriented restaurants under the names \"Elmer's Pancake & Steak House\" and \"Elmer's Colonial Pancake & Steak House.\" The Company is an Oregon corporation and was incorporated in 1983. The Company owns and operates eleven restaurants and franchises 18 restaurants.\nWalter Elmer opened the first Elmer's restaurant in Portland, Oregon in 1960, and the first franchised restaurant opened in 1966. The Company acquired the Elmer's franchising operation in January 1984 from the Elmer family. The Company franchises 18 restaurants in six Western states. Until August 1986 the Company owned and operated only one restaurant, at the Delta Park location in Portland, Oregon. Since that time the Company has constructed two restaurants and has acquired eight other restaurants formerly operated by franchisees. See \"Company-Owned Restaurants.\" Company-owned restaurants are located in the Delta Park section of Portland, Oregon; Beaverton, Gresham, Hillsboro, Medford, Albany and Grants Pass, Oregon; Palm Springs, California; Boise, Idaho; and Tacoma and Lynnwood, Washington.\nElmer's Pancake & Steak House - -----------------------------\nRestaurant Format and Menu The Company franchises -------------------------- or operates a total of 29 full-service, family-oriented restaurants, with a warm, friendly atmosphere and comfortable furnishings. Most of the restaurants are decorated in a colonial style with fireplaces in the dining rooms. They are free standing buildings, ranging in size from 4,600 to approximately 8,000 square feet with seating capacities ranging from 120 to 220. A portion of the dining room in most restaurants may also be used for private group meetings by closing it off from the public dining areas. Thirteen of the restaurants have a lounge with a seating capacity ranging from 15 to 75. The normal hours of operation are from 6 a.m. to 10 or 11 p.m. and to 12 midnight on weekends in restaurants with lounges.\nEach restaurant offers full service, with a host or hostess to seat guests and handle payments, wait staff to take and serve orders, and additional personnel to clear and reset tables.\nThe menu offers an extensive selection of items for breakfast, lunch, and dinner. The Elmer's breakfast menu, which is available all day, contains a wide variety of selections with particular emphasis on pancakes, waffles, omelettes, crepes, and other popular breakfast items. Each Elmer's restaurant makes all its breakfast batters and compotes from scratch and prepares its fruit sauces with fresh fruits when in season. The lunch menu includes soups made from scratch, french dips, hamburgers, and sandwiches. Customers at dinner may choose among steak, seafood, chicken, and, in most restaurants, filet mignon and prime rib. While most menu selections are standard to all Elmer's restaurants, restaurants in different areas include on their menus selections that appeal to local preferences. Breakfast and lunch selections generally range in price from $1.85 to $7.25; dinner selections generally range in price from $5.50 to $11.75. A special children's menu is offered in most restaurants.\nFranchise Operations - --------------------\nUnder a franchise agreement a franchisor grants to a franchisee the right to operate a business in a manner developed by the franchisor. The franchisee owns the franchised operation independently from the franchisor and, in effect, buys the right to use the franchisor's name, format, and operational procedures. Franchisees benefit from a common identification, standardized products, and the business reputation and services that a franchisor may provide, such as group advertising, management services, product enhancements, and group buying programs. The franchisor is able to capitalize on its business concept without, in many cases, having to invest substantial capital for expanded operations.\nExisting Franchisees The existing franchise -------------------- agreements grant to franchisees the right to operate an Elmer's restaurant in one specific location for 25 years, renewable generally for an additional 25-year period. When they entered into franchising agreements, the existing franchisees paid initial franchise fees of up to $25,000 plus additional fees of up to $10,000 if the restaurant had a lounge serving alcoholic beverages. They pay monthly franchise royalty fees ranging from one to four percent of the gross revenues of their restaurants. All but two restaurants must contribute one percent of gross revenues to a common advertising pool if required to do so by the Company.\nProspective Franchisees Prospective new franchisees ----------------------- will pay an initial franchise fee of $35,000. Initial franchise fees are payable in cash at the execution of the franchise agreement. Existing franchisees opening new franchised restaurants may pay a lower initial franchise fee than new franchisees. For new franchisees, the monthly\nfranchise royalty fee will be four percent of the gross revenues of the restaurant, with a minimum monthly fee of $500. A monthly advertising contribution equal to one percent of the gross revenues of the restaurant will be assessed. The Company has executed only two franchise agreements involving new franchisees since instituting the four percent royalty fee in March 1986, but management believes the fee is competitive with other similar restaurant franchise royalty fees and is appropriate in light of the Company's franchise services. It has been the practice of the Company in recent years to permit existing franchisees to open new franchises under the royalty rate that applied to the existing franchises owned by that franchise. See \"Services to Franchisees.\"\nA prospective franchisee who assumes operation of a previously unsuccessful franchised restaurant may be offered a reduced initial franchise fee, deferred payment of the franchise fee, or other concessions the Company deems appropriate. Pursuant to certain area franchise agreements, the Company will receive reduced initial franchise fees and monthly royalty fees from additional restaurants that may be opened in the areas covered by those agreements. See \"Area Franchise Agreements.\" In connection with the acquisition of the Elmer's franchising operation in 1984, the Company also granted Dale Elmer, a former director of the Company, and members of the Elmer family the right to operate a total of three additional restaurants at a franchise royalty fee of two percent; no restaurants are being operated on this basis.\nManagement estimates that construction costs for the standard free-standing building range from approximately $860,000 to $1,060,000, with actual costs dependent upon local building requirements and construction conditions, and further based on configuration and parking requirements. The cost of the land may vary considerably depending upon the quality and size of the site, surrounding population density and other factors. The cost of leasehold improvements and restaurant equipment, including kitchen equipment, furniture, and trade fixtures, is estimated by management to range from approximately $375,000 to $500,000. Inventory and miscellaneous items such as paper goods, food, janitorial supplies, and other small wares are estimated initially to cost between approximately $68,300 and $107,500.\nThere is no typical elapsed time from the signing of a franchise agreement until a restaurant is open for business, although it normally takes 120 days from the receipt of the building permits to construct a new restaurant facility. Most restaurants have opened within 12 months of the date of signing the franchise agreement. Franchisees bear all costs associated with the development and construction of their restaurants.\nThe Company has added three franchises since August 1987. The last currently operating franchise was added in November 1994.\nArea Franchise Agreements Under previous management, ------------------------- the Elmer's franchising operation granted exclusive area franchise agreements, whereby independent entities obtained the exclusive rights to develop Elmer's restaurants within their respective areas. Areas covered by these agreements are Clackamas County, Oregon; Vancouver, Washington; Idaho; and Montana. The area franchise agreements require the area franchisee to share with the Company the initial fees and the franchise royalty fees for each new restaurant in the area. The Company's share of the initial fees ranges from $2,500 to $12,500 per restaurant, and its share of the franchise royalty fees ranges from one to two percent of gross revenues per restaurant. There are currently two restaurants covered by area franchise agreements. Under the area franchise agreements, the Company reserves the right to approve each new restaurant franchisee. The area franchise agreements hinder or preclude the Company from opening Company-owned or franchised restaurants in the areas covered by the agreements. The Company is not seeking to grant these agreements in the future.\nServices to Franchisees The Company makes ----------------------- available to its franchisees various programs and materials. The Company provides several manuals to assist franchisees in ongoing operations, including a comprehensive operations manual describing kitchen operations, floor operations, personnel management, job descriptions, and other matters. The Company has prepared a recipe book for franchisees and maintains a complete file of menus from all franchised restaurants. The Company has also prepared a personnel handbook for its Company- owned restaurants. The Company has developed and maintains a menu cost-control program and a labor cost-control program at each of its Company-owned restaurants and has developed and implemented a training manual and programs for all positions within the restaurant.\nThe Company provides both formal and informal ongoing training. At least one two-day seminar is scheduled each year. At the seminars, franchisees attend lectures by Company personnel and guest speakers from the industry as well as participate in group workshops discussing such topics as cost control, promotion and food presentation.\nThe Company provides each franchisee with specifications for menu items selected by the franchisee for inclusion on restaurant menus. The Company, however, sells no food items or like products to the franchisees, except for certain minor supplies such as guest checks, gift certificates, and children's menus. The Company does not require franchisees\nto purchase products from designated or approved sources, other than requiring that Boyd's Blend Coffee be served in each restaurant. The Company, however, coordinates franchisees' purchases to obtain volume discounts. Franchisees bear all costs involved in the operation of their restaurants.\nPeriodic on-site inspections and audits are conducted to ensure compliance with Company standards and to aid franchisees in improving their sales and profitability.\nCompany-Owned Restaurants - -------------------------\nThe Company owns and operates eleven Elmer's restaurants, which it has acquired or built over the last several years. The Company has owned and operated a restaurant located in the Delta Park section of Portland, Oregon since January 1984. In August 1986, the Company opened a restaurant in Tacoma, Washington. In January 1987, the Company began operation of a restaurant in Lynnwood, Washington and assumed operation of an Elmer's restaurant in Grants Pass, Oregon that was in bank foreclosure. In fiscal 1988, the Company acquired from former franchisees restaurants in Gresham, Albany, and Medford, Oregon; and Boise, Idaho. In fiscal 1989, the Company purchased the land and buildings for the Boise and Gresham restaurants and also purchased, from a former franchisee, an additional restaurant in Hillsboro, Oregon. Effective May 1, 1989, the Company acquired a franchised Elmer's restaurant in Palm Springs, California. In July 1991, the Company acquired a franchised Elmer's restaurant in Beaverton, Oregon.\nEmployees - ---------\nAs of March 31, 1995, the Company employed 174 persons on a full-time basis, of whom 11 were corporate office personnel and 163 were restaurant personnel. At that date, the Company also employed 364 part-time restaurant personnel. Employees of franchised Elmer's restaurants are not included in these figures. None of the Company's employees is covered by collective bargaining agreements. The Company believes that its employee relations are satisfactory.\nTrademarks and Service Marks - ----------------------------\nThe Company has registered the trademarks and service marks \"Elmer's Pancake & Steak House\" and \"Elmer's Colonial Pancake & Steak House\" and the Elmer's logo with the U.S. Patent and Trademark Office. The service mark \"Elmer's Colonial Pancake & Steak House\" has also been registered in certain states.\nThe Company grants to each of its Elmer's restaurant franchisees a nonexclusive right to use the\ntrademarks and service marks in connection with and at each franchise location.\nAdvertising and Marketing - -------------------------\nWord-of-mouth advertising, new restaurant openings, and the on-premise sale of promotional products have historically been the primary methods of restaurant advertising. The Company employs an advertising consultant to assist in projecting the Elmer's restaurant concept to the general public in the Western states, primarily through magazines, newspapers, and radio and television commercials. The Company maintains a common advertising pool with its franchisees. After production costs for the advertising campaign have been paid out of the common pool, the remaining money is used for advertising in the various local areas of the franchised restaurants. The Company-owned restaurants and 16 of the 18 franchised restaurants are required to participate by contributing one percent of monthly gross revenues.\nCompetition - -----------\nThe restaurant industry is highly competitive and is often affected by changes in the tastes and eating habits of the public, by local and national economic conditions affecting spending habits, and by population and traffic patterns. The Company competes for potential franchisees with restaurant franchisors, company-owned restaurants, chains and others. The Company-owned Elmer's restaurants and the franchised Elmer's restaurants compete for customers with restaurants from national and regional chains to local establishments. Some of the Company's competitors are much larger than the Company, having at their disposal greater capital resources and greater abilities to withstand adverse business trends. The Company believes that the principal competitive factors in its favor for attracting both restaurant franchisees and restaurant customers are Elmer's extensive menu, quality of food, service, and reasonable prices.\nGovernment Regulations - ----------------------\nThe Company is subject to various federal, state, and local laws affecting its business. Its restaurants and those of its franchisees are subject to various health, sanitation, and safety standards; federal and state labor laws; zoning restrictions; and state and local licensing of the sale of alcoholic beverages, in some cases. Federal and state environmental regulations have not had a major effect on the Company's operations to date.\nThe Company is subject to a number of state laws regulating franchise operations and sales. For the most part,\nthose laws impose registration and disclosure requirements on the Company in the offer and sale of franchises but, in certain cases, also apply substantive standards to the relationship between the Company and the franchisees. The Company is also subject to Federal Trade Commission regulations covering disclosure requirements and sales of franchises.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------ ----------\nHeadquarters - ------------\nThe Company's corporate offices are located in Portland, Oregon and consist of an office facility of approximately 5,000 square feet rented from Dale Elmer, a former executive officer and director of the Company. Lease payments totaled $32,836 for fiscal 1995. The lease expires November 30, 1996.\nCompany-Owned Restaurants - -------------------------\nCompany-Owned Properties The Company owns the real ------------------------ property upon which the following four Company-owned restaurants are located. All of the properties are subject to encumbrances in favor of lending institutions.\nLeased Properties The Company leases the property ----------------- upon which the following seven Company-owned restaurants are located. Each lease contains specific terms relating to calculation of lease payment, renewal, purchase options, if any, and other matters.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------ -----------------\nOn April 19, 1994, a former director and employee of the Company filed a complaint with the Oregon Bureau of Labor and Industries alleging an unlawful practice on the basis of sex discrimination by the Company and seeking enforcement action. The Civil Rights Division of the Bureau commenced an investigation of the complaint. The former director and employee, however, subsequently requested a notice of right to sue from the Bureau, thereby terminating the Bureau's investigation. The notice of right to sue was issued by the Bureau on April 10, 1995. Under Oregon law, the former director and employee has 90 days from the date of the notice of right to sue to commence a legal action alleging state statutory discrimination claims. No such action has been commenced. On May 18, 1994, the former director and employee filed a similar, federal complaint with the Equal Employment Opportunity Commission. The Commission is investigating the complaint. The Company believes that these complaints are without merit and intends to defend these actions vigorously.\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 - --------- ------------------------------------\nAs of March 31, 1995, the executive officers and other key personnel of the Company were as set forth below.\nThe executive officers of the Company are appointed annually for one year and hold office until their successors are appointed.\nHerman Goldberg, the founder of the Company, has served as Chairman of the Board since the Company's organization in June 1983 and as President and Chief Executive Officer since March 1984.\nJuanita Nelson has served as Controller since March 1985. For more than five years prior to joining the Company, Mrs. Nelson was the Office Manager of the Red Lion Inns and Thunderbird Motor Inns corporate office.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and - ------ Related Stockholder Matters ---------------------------------------------\nThe information required by this item is included under \"Market Price and Dividends\" on page 4 of the Company's 1995 Annual Report to Shareholders and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------ -----------------------\nThe information required by this item is included under \"Selected Financial Data\" on page 2 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 -------------------------------------------------\nThe information required by this item is included under \"Management Discussion and Analysis of Financial Condition and Results of Operations\" on pages 2 and 3 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 information required by this item is incorporated by reference from the Company's 1995 Annual Report to Shareholders as listed in Item 14 of Part IV 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 - ------- --------------------------------------------------\nInformation with respect to directors of the Company is included under \"Election of Directors\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report and is incorporated herein by reference. Information with respect to executive officers of the Company is included under Item 4(a) of Part I of this Report. Information with respect to compliance with Section 16(a) of the Securities Exchange Act is included under \"Compliance with Section 16(a) of the Exchange Act\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation - ------- ----------------------\nInformation with respect to executive compensation is included under \"Compensation\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners - -------- and Management -----------------------------------------------\nInformation with respect to security ownership of certain beneficial owners and management is included under \"Voting Securities and Principal Shareholders\" and \"Election of Directors\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report and 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 with management is included under \"Certain Transactions\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report 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 and Schedules ----------------------------------\nThe following documents are included in the Company's 1995 Annual Report to Shareholders at the pages indicated and are incorporated herein by reference. These documents are included in Exhibit 13.1 to this Annual Report on Form 10-K.\nPage in 1995 Annual Report to Shareholders ---------------\nReport of Independent Accountants. . . . . . . . . . . .5\nConsolidated Statements of Income for years ended March 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . .5\nConsolidated Balance Sheets at March 31, 1995 and 1994. . . . . . . . . . . . . . . .6\nConsolidated Statements of Cash Flows for years ended March 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . .7\nConsolidated Statements of Changes in Shareholders' Equity for years ended March 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . .8\nNotes to Consolidated Financial Statements . . . . . . .8\nNo other schedules are included because the required information is inapplicable or is presented in the financial statements or related notes thereto.\n(a)(2) Exhibits --------\n3.1 Restated Articles of Incorporation of the Company. Incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1988 (the \"1988 Form 10-K\").\n3.2 Bylaws of the Company, as amended. Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1990.\n10.1 Area Franchisee - Unit Franchisee Agreement dated July 10, 1978 by and between Elmer's Colonial Pancake & Steak House, Inc. and Paul H. and Jacqueline M. Welch, Dale M. and Sandra Lee Elmer. Incorporated by reference to Exhibit 10.30 of the Company's Registration Statement on Form S-18, Registration No. 2-98298-S (the \"Form S-18 Registration\").\n10.2 Employment Agreement dated November 30, 1983 by and between EP Holding Company, Inc. and Herman Goldberg and amendments thereto.\n10.3 Lease Agreement dated June 18, 1987 by and between Dale M. Elmer and Sandra Lee Elmer and Elmer's Pancake & Steak House, Inc., and addenda thereto. Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1989 (the \"1989 Form 10-K\") and Exhibit 10.3 of the December 31, 1991 Form 10-Q.\n10.4 Agreement dated March 23, 1989 between Elmer's Restaurants, Inc. and Elmer's of Palm Springs, a California general partnership consisting of Larry Sloan, Suzanne Sloan, and Daniel B. Van Horst. Incorporated by reference to Exhibit 10.18 of the 1989 Form 10-K.\n10.5 Amended and Restated Loan Agreement, dated as of June 7, 1991, between the Company and First Interstate Bank of Oregon, N.A. and Seventh Amendment thereto, dated as of May 17, 1995, and Promissory Note, dated as of May 17, 1995, issued by the Company to First Interstate Bank of Oregon, N.A. in connection with the Seventh Amendment.\n10.6 Purchase Warrants exercisable to purchase 5,000 shares of Common Stock of the Company at $1.20 per share from July 1, 1988 to June 30, 1995, issued to Marvine Bonine, August F. Kalberer and Paul Welch, respectively. Incorporated by reference to Exhibit 10.20 of the 1989 Form 10- K.\n10.7 Franchise Agreement between the Company and Paul H. Welch and Jacqueline M. Welch dated March 23, 1993. Incorporated by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for\nthe fiscal year ended March 31, 1993 (the \"1993 Form 10-K\").\n10.8 Franchise Development Option Agreement between the Company and Paul H. Welch and Jacqueline M. Welch dated May 3, 1993. Incorporated by reference to Exhibit 10.10 of the 1993 Form 10- K.\n10.9 Commercial Loan Note, dated May 18, 1995, issued by the Company to The Bank of California, N.A. and addendum thereto.\n13.1 Portions of 1995 Annual Report to Shareholders incorporated herein by reference.\n22.1 List of Subsidiaries.\n27.1 Financial Data Schedule.\n(b) Reports on Form 8-K No reports on Form 8-K ------------------- were filed by the Company during the last quarter of the 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.\nELMER'S RESTAURANTS, INC.\nDate: June 28, 1995 By HERMAN GOLDBERG --------------------------------- Herman Goldberg, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on June 28, 1995.\nSignature Title --------- -----\n(1) Principal Executive and Financial Officer\nHERMAN GOLDBERG President, Chief ------------------------- Executive Officer, Herman Goldberg and Chairman of the Board\n(2) Principal Accounting Officer\nJUANITA NELSON Controller - -------------------------- Juanita Nelson\n(3) Directors\nHERMAN GOLDBERG Director - -------------------------- Herman Goldberg\nPAUL WELCH Director - -------------------------- Paul Welch\nZADOC (ZED) MERRILL Director - -------------------------- Zadoc (Zed) Merrill\nEXHIBIT INDEX Exhibit Sequential No. Description Page Nos. - ------- ----------- ----------\n3.1 Restated Articles of Incorporation of the Company. Incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1988 (the \"1988 Form 10-K\").\n3.2 Bylaws of the Company, as amended. Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1990.\n10.1 Area Franchisee - Unit Franchisee Agreement dated July 10, 1978 by and between Elmer's Colonial Pancake & Steak House, Inc. and Paul H. and Jacqueline M. Welch, Dale M. and Sandra Lee Elmer. Incorporated by reference to Exhibit 10.30 of the Company's Registration Statement on Form S-18, Registration No. 2- 98298-S (the \"Form S-18 Registration\").\n10.2 Employment Agreement dated November 30, 1983 by and between EP Holding Company, Inc. and Herman Goldberg and amendments thereto.\n10.3 Lease Agreement dated June 18, 1987 by and between Dale M. Elmer and Sandra Lee Elmer and Elmer's Pancake & Steak House, Inc., and addenda thereto. Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1989 (the \"1989 Form 10-K\") and Exhibit 10.3 of the December 31, 1991 Form 10-Q.\n10.4 Agreement dated March 23, 1989 between Elmer's Restaurants, Inc. and Elmer's of Palm Springs, a California general partnership consisting of Larry Sloan, Suzanne Sloan, and Daniel B. Van Horst. Incorporated by reference to Exhibit 10.18 of the 1989 Form 10-K.\nEXHIBIT INDEX Exhibit Sequential No. Description Page Nos. - ------- ----------- ----------\n10.5 Amended and Restated Loan Agreement, dated as of June 7, 1991, between the Company and First Interstate Bank of Oregon, N.A. and Seventh Amendment thereto, dated as of May 17, 1995, and Promissory Note dated as of May 17, 1995 issued by the Company to First Interstate Bank of Oregon, N.A. in connection with the Seventh Amendment.\n10.6 Purchase Warrants exercisable to purchase 5,000 shares of Common Stock of the Company at $1.20 per share from July 1, 1988 to June 30, 1995, issued to Marvin Bonine, August F. Kalberer, and Paul Welch, respectively. Incorporated by reference to Exhibit 10.20 of the 1989 Form 10-K.\n10.7 Franchise Agreement between the Company and Paul H. Welch and Jacqueline M. Welch dated March 23, 1993. Incorporated by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993 (the \"1993 Form 10-K\").\n10.8 Franchise Development Option Agreement between the Company and Paul H. Welch and Jacqueline M. Welch dated May 3, 1993. Incorporated by reference to Exhibit 10.10 of the 1993 Form 10-K.\n10.9 Commercial Loan Note, dated May 18, 1995, issued by the Company to The Bank of California, N.A. and addendum thereto.\n13.1 Portions of 1995 Annual Report to Shareholders incorporated herein by reference.\n22.1 List of Subsidiaries.\n27.1 Financial Data Schedule.","section_15":""}
{"filename":"354647_1995.txt","cik":"354647","year":"1995","section_1":"ITEM 1. BUSINESS\nCVB FINANCIAL CORP.\nCVB Financial Corp. (referred to herein on an unconsolidated basis as \"CVB\" and on a consolidated basis as the \"Company\") is a bank holding company incorporated in California on April 27, 1981 and registered under the Bank Holding Company Act of 1956, as amended. The Company commenced business on December 30, 1981 when, pursuant to a reorganization, it acquired all of the voting stock of Chino Valley Bank (the \"Bank\"), which is the Company's principal asset. The Company has one other operating subsidiary, Community Trust Deed Services (\"Community\").\nThe Company's principal business is to serve as a holding company for the Bank and Community and for other banking or banking related subsidiaries which the Company may establish or acquire. The Company has not engaged in any other activities to date. As a legal entity separate and distinct from its subsidiaries, CVB's principal source of funds is and will continue to be dividends paid by and other funds advanced from primarily the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to CVB. See \"Item 1. Business - Supervision and Regulation - Restrictions on Transfers of Funds to CVB by the Bank.\" At December 31, 1995, the Company had $936.9 million in total consolidated assets, $496.4 million in total consolidated net loans and $803.6 million in total consolidated deposits.\nThe principal executive offices of the Company and the Bank are located at 701 North Haven Avenue, Suite 350, Ontario, California.\nCHINO VALLEY BANK\nThe Bank was incorporated under the laws of the State of California on December 26, 1973, was licensed by the California State Banking Department and commenced operations as a California state chartered bank on August 9, 1974. The Bank's deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits. Like many other state chartered banks in California, the Bank is not a member of the Federal Reserve System. At December 31, 1995, the Bank had $932.6 million in assets, $498.9 million in net loans and $804.5 million in deposits.\nThe Bank currently has 19 banking offices located in San Bernardino County, Riverside County and the eastern portion of Los Angeles County in Southern California. Of the 19 offices, the Bank opened seven as de novo branches and acquired the other twelve in acquisition transactions. Since 1990, the Bank has added seven offices, two in 1990, two in 1993, two in 1994 and one in 1995.\nOn March 5, 1993, the Company completed its acquisition of Fontana First National Bank, a one-branch bank located in Fontana, California (\"Fontana\") for\nan aggregate cash purchase price of $5.0 million. As of December 31, 1992, Fontana had total assets of $26.3 million, net loans of $18.5 million, deposits of $22.8 million and shareholders' equity of $3.4 million.\nOn October 21, 1993, the Bank entered into an agreement with the Federal Deposit Insurance Corporation(the \"FDIC\") for the purchase of certain assets and the assumption of deposits and other liabilities of the failed Mid City Bank. The agreement provided the Bank with the ability to re-price the deposits assumed within specific time frames, regardless of the original terms of the deposit. Net of the deposits that were re-priced and allowed to withdraw, the Bank assumed approximately $20.0 million in deposits, $2.0 million in investments, and $18.0 million in loans.\nOn June 24, 1994, the Company completed its acquisition of Western Industrial National Bank, (\"WIN\") a two-branch bank located in El Monte, California for an aggregate cash purchase price of $14.8 million. The Company assumed approximately $43.5 million in deposits and acquired approximately $34.1 million in loans. On August 11,1995, and after regulatory approval, the Bank closed the branch located at 10602 Rush Street, El Monte.\nOn July 8, 1994, the Bank entered into an Insured Deposit Purchase and Assumption Agreement with the FDIC for the purchase of Pioneer Bank, Fullerton, California (\"Pioneer\"). The Bank assumed an aggregate of approximately $52.7 million in deposits and certain assets of Pioneer Bank that included approximately $12.3 million in loans and $8.2 million in investments and federal funds sold.\nOn October 20,1995, the Bank completed its acquisition of the Victorville office of Vineyard National Bank for an aggregate cash purchase price of $200,000. The Bank assumed approximately $4.1 million in deposits and $952,000 in loans.\nOn November 1,1995, the Bank, CVB and Citizens Commercial Trust and Savings Bank of Pasadena, California, (\"Citizens Bank of Pasadena\"), executed a definitive agreement and plan of reorganization pursuant to which the Bank will acquire Citizens Commercial Trust and Savings Bank by merger. The definitive agreement provides that the shareholders of Citizens Bank of Pasadena will receive $18,999,999, plus accrued net earnings, subject to adjustments, for the period from October 1,1995 until the acquisition is consummated. The transaction, which has been approved by the regulatory authorities and the shareholders of Citizens Bank of Pasadena, is expected to be completed either at the end of the first quarter of 1996 or during April of 1996 Citizens Bank of Pasadena had total assets of $146.0 million, deposits of $127.0 million, loans of $62.0 million and shareholders' equity of $15.7 million as of December 31, 1995. In addition, at December 31, 1995, Citizens Bank of Pasadena held trust assets of approximately $800,000,000 that were not included on the balance sheet of the bank. Upon consummation of the acquisition of Citizens Bank of Pasadena, the Bank intends to change its name to Citizens Business Bank.\nThrough its network of banking offices, the Bank emphasizes personalized service combined with offering a full range of banking services to businesses, professionals and individuals located in the service areas of its offices. Although the Bank focuses the marketing of its services to small- and medium-sized businesses, a full range of retail banking services are made available to the local consumer market.\nThe Bank offers a wide range of deposit instruments. These include checking, savings, money market and time certificates of deposit for both business and personal accounts. The Bank also serves as a federal tax depository for its business customers.\nThe Bank also provides a full complement of lending products, including commercial, agribusiness, installment and real estate loans. Commercial products include lines of credit and other working capital financing, accounts receivable lending and letters of credit. Financing products for individuals include automobile financing, lines of credit and home improvement and home equity lines of credit. Real estate loans include mortgage and construction loans.\nThe Bank also offers a wide range of specialized services designed for the needs of its commercial accounts. These services include cash management systems for monitoring cash flow, a credit card program for merchants, courier pick-up and delivery, payroll services and electronic funds transfers by way of domestic and international wires and automated clearing house. The Bank also makes available investment products to customers, including a full array of fixed income vehicles and a program pursuant to which it places its customers' funds in federally insured time certificates of deposit of other institutions. Although the Bank does not currently operate a trust department, it has, in anticipation of the acquisition of Citizens Bank of Pasadena, applied for trust powers and will provide full trust services following consumation of the acquisition.\nCOMMUNITY TRUST DEED SERVICES\nThe Company owns 100% of the voting stock of Community, which has one office. Community's services, which are provided to the Bank and non-affiliated persons, include preparing and filing notices of default, reconveyances and related documents and acting as a trustee under deeds of trust. At present, the assets, revenues and earnings of Community are not material in amount as compared to the Bank.\nCOMPETITION\nThe banking and financial services business in California generally, and in the Bank's market areas specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. The Bank competes for loans and deposits and customers for financial services with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage\ncompanies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets, and offer a broader array of financial services than the Bank. In order to compete with the other financial services providers, the Bank principally relies upon local promotional activities, personal relationships established by officers, directors and employees with its customers, and specialized services tailored to meet its customers' needs. In those instances where the Bank is unable to accommodate a customer's needs, the Bank will arrange for those services to be provided by its correspondents. The Bank has 19 offices located in San Bernardino, Riverside, northern Orange and eastern Los Angeles counties. Neither the deposits nor loans of the offices of the Bank exceed 1% of the aggregate deposits or loans of all financial services companies located in the counties in which the Bank operates.\nEMPLOYEES\nAt December 31, 1995, the Company employed 345 persons -- 217 on a full-time and 128 on a part-time basis. The Company believes that its employee relations are satisfactory.\nEFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION\nBanking is a business that depends on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's portfolio comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and\ngrowth of the Company are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.\nThe commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.\nFrom time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other\nfinancial 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, in the California legislature and before various bank regulatory and other professional agencies. The Financial Services Modernization Act recently proposed in the House of Representatives would generally permit banks to expand activities further into the areas of securities and insurance, and would reduce the regulatory and paperwork burden that currently affects banks. Additionally, the proposed legislation would force the conversion of savings and loan holding companies into bank holding companies, although unitary savings and loan holding companies authorized to engage in activities as of January 1, 1995 would be exempted. Similar legislation has also been proposed in the Senate. In addition, legislation was recently introduced in Congress that would merge the deposit insurance funds applicable to commercial banks and savings associations and impose a one-time assessment on savings associations to recapitalize the deposit insurance fund applicable to savings associations. The likelihood of any major legislative changes and the impact such changes might have on the Company are impossible to predict. See \"Item 1. Business - Supervision and Regulation.\"\nSUPERVISION AND REGULATION\nBank holding companies and banks are extensively regulated under both federal and state law. Set forth below is a summary description of certain laws which relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.\nTHE COMPANY\nThe Company, as a registered bank holding company, is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may conduct examinations of the Company and its subsidiaries.\nThe Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities.\nUnder the BHCA and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, the Company is required by the Federal Reserve Board to maintain certain levels of capital. See \"Item 1. Business - Supervision and Regulation - Capital Standards.\"\nThe Company is required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company.\nThe Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that 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 furnishing services to its subsidiaries. However, the Company, subject to the prior approval of the Federal Reserve Board, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making any such determination, the Federal Reserve Board is required to consider whether the performance of such activities by the Company or an affiliate can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between activities commenced de novo and activities commenced by acquisition, in whole or in part, of a going concern.\nUnder Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner.In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. This doctrine has become known as the \"source of strength\" doctrine. Although the United States Court of Appeals for the Fifth Circuit found the Federal Reserve Board's source of strength doctrine invalid in 1990,\nstating that the Federal Reserve Board had no authority to assert the doctrine under the BHCA, the decision, which is not binding on federal courts outside the Fifth Circuit, was reversed by the United States Supreme Court on procedural grounds. The validity of the source of strength doctrine is likely to continue to be the subject of litigation until definitively resolved by the courts or by Congress.\nThe Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the California State Banking Department.\nFinally, the Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, including but not limited to, filing annual, quarterly and other current reports with the Securities and Exchange Commission.\nTHE BANK\nThe Bank, as a California state chartered bank, is subject to primary supervision, periodic examination and regulation by the California Superintendent of Banks (\"Superintendent\") and the FDIC. If, as a result of an examination of a bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the bank's operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin \"unsafe or unsound\" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate a bank's deposit insurance, which for a California state-chartered bank would result in a revocation of the bank's charter. The Superintendent has many of the same remedial powers. The Bank has never been the subject of any such actions by the FDIC or the Superintendent.\nThe deposits of the Bank are insured by the FDIC in the manner and to the extent provided by law. For this protection, the Bank pays a statutory assessment. See \"Item 1. Business - Supervision and Regulation - Premiums for Deposit Insurance\" Although the Bank is not a member of the Federal Reserve System, it is nevertheless subject to certain regulations of the Federal Reserve Board.\nVarious requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices and capital requirements. Further, the Bank is required to maintain certain levels of capital. See \"Item 1. Business - Supervision and Regulation - Capital Standards.\"\nRESTRICTIONS ON TRANSFERS OF FUNDS TO CVB BY THE BANK\nCVB is a legal entity separate and distinct from the Bank. The Company's ability to pay cash dividends is limited by state law.\nThere are statutory and regulatory limitations on the amount of dividends which may be paid to CVB by the Bank. California law restricts the amount available for cash dividends by state chartered banks to the lesser of its retained earnings or its net income for its last three fiscal years (less any distributions to shareholders made during such period). Notwithstanding this restriction, a bank may, with the prior approval of the Superintendent, pay a cash dividend in an amount not exceeding the greater of the retained earnings of the bank, net income for such bank's last preceding fiscal year, and the net income of the bank for its current fiscal year.\nThe FDIC also has authority to prohibit the Bank from engaging in activities that, in the FDIC's opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or the Company may pay. See \"Item 1. Business - Supervision and Regulation - Prompt Corrective Regulatory Action and Other Enforcement Mechanisms\" and - \"Capital Standards\" for a discussion of these additional restrictions on capital distributions.\nAt present, substantially all of CVB's revenues, including funds available for the payment of dividends and other operating expenses, is, and will continue to be, primarily dividends paid by the Bank. At December 31, 1995, the Bank had 3.3 million in retained earnings available for the payment of cash dividends.\nThe Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, CVB or other affiliates, the purchase of or investments in stock or other securities thereof, the taking of such securities as collateral for loans\nand the purchase of assets of CVB or other affiliates. Such restrictions prevent CVB and such other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in CVB or to or in any other affiliate is limited to 10% of the Bank's capital and surplus (as defined by federal regulations) and such secured loans and investments are limited, in the aggregate, to 20% of the Bank's capital and surplus (as defined by federal regulations). California law also imposes certain restrictions with respect to transactions involving CVB and other controlling persons of the Bank. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See \"Item 1. Business - Supervision and Regulation - Prompt Corrective Regulatory Action and Other Enforcement Mechanisms.\"\nCAPITAL STANDARDS\nThe Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans.\nA banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%.\nIn addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is\n3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.\nIn August 1995, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. The final regulations, however, do not include a measurement framework for assessing the level of a bank's exposure to interest rate risk, which is the subject of a proposed policy statement issued by the federal banking agencies concurrently with the final regulations. The proposal would measure interest rate risk in relation to the effect of a 200 basis point change in market interest rates on the economic value of a bank. Banks with high levels of measured exposure or weak management systems generally will be required to hold additional capital for interest rate risk. The specific amount of capital that may be needed would be determined on a case-by-case basis by the examiner and the appropriate federal banking agency. Because this proposal has only recently been issued, the Bank currently is unable to predict the impact of the proposal on the Bank if the policy statement is adopted as proposed.\nIn January 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank's capital adequacy.\nIn December 1993, the federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (a) assets classified loss; (b) 50 percent of assets classified doubtful; (c) 15 percent of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming 12 months.\nFederally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. The federal banking agencies issued final rules governing banks and bank holding companies, which become effective April 1, 1995, which limit the amount of deferred tax assets that are allowable in computing an institutions regulatory\ncapital. The standard has been in effect on an interim basis since March 1993. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 capital and total assets and regulatory capital calculations.\nFuture changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends.\nAs of December 31, 1995, the Company and the Bank had total risk-based capital ratios of 13.06% and 12.39%, Tier 1 risk-based capital ratios of 11.79% and 11.12% and leverage ratios of 8.05% and 7.56%, respectively.\nPROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS\nFederal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.\nIn September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of federal law. An insured depository institution generally will be classified in the following categories based on capital measures indicated below:\n\"Well capitalized\" \"Adequately capitalized\"\nTotal risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; Tier 1 risk-based capital of 4% and Leverage ratio of 5%. and Leverage ratio of 4%.\n\"Undercapitalized\" \"Significantly undercapitalized\"\nTotal risk-based capital less than 8%; Total risk-based capital less than 6%; Tier 1 risk-based capital less than 4%; Tier 1 risk-based capital less than 3%; or Leverage ratio less than 4%. or Leverage ratio less than 3%.\n\"Critically undercapitalized\" Tangible equity to total assets less than 2%.\nAn institution that, based upon its capital levels, is classified as \"well capitalized\" \"adequately capitalized\" or \"undercapitalized\" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as \"critically undercapitalized\" unless its capital ratio actually warrants such treatment.\nThe law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt corrective action provisions.\nAn insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of\nsubsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized.\nFurther restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator.\nIn addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. See \"Item 1. Business - Supervision and Regulation -- Potential Enforcement Actions.\"\nSAFETY AND SOUNDNESS STANDARDS\nIn July 1995, the federal banking agencies adopted final safety and soundness guidelines for all insured depository institutions. The guidelines set forth operational and managerial standards relating to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the guidelines are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these guidelines, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan may result in enforcement\nproceedings. Additional guidelines on earnings and classified assets are expected to be issued in the near future.\nIn December 1992, the federal banking agencies issued final regulations prescribing uniform guidelines for real estate lending. The regulations, which became effective on March 19, 1993, require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations.\nAppraisals for \"real estate related financial transactions\" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for \"complex\" 1-4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with \"federally related transactions\" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities.\nPREMIUMS FOR DEPOSIT INSURANCE\nFederal law has established several mechanisms to increase funds to protect deposits insured by the Bank Insurance Fund (\"BIF\") administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the United States Treasury; up to 90% of the fair market value of assets of institutions acquired by the FDIC as receiver from the Federal Financing Bank; and from depository institutions that are members of the BIF. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. The result of these provisions is that the assessment rate on deposits of BIF members could increase in the future. The FDIC also has authority to impose special assessments against insured deposits.\nThe FDIC implemented a final risk-based assessment system, effective January 1,1994, under which an institution's premium assessment is based on the probability that the deposit insurance fund will incur a loss with respect to the institution, the likely amount of any such loss, and the revenue needs of the deposit insurance fund. As long as BIF's reserve ratio is less than a specified \"designated reserve ratio,\" 1.25%, the total amount raised from BIF members by the risk-based assessment system may not be less than the amount that would be raised if the assessment rate for all BIF members were .023% of\ndeposits. On August 8, 1995, the FDIC announced that the designated reserve ratio had been achieved and, accordingly, issued final regulations adopting an assessment rate schedule for BIF members of 4 to 31 basis points effective on June 1, 1995. On November 14, 1995, the FDIC further reduced deposit insurance premiums to a range of 0 to 27 basis points effective for the semi-annual period beginning January 1, 1996.\nUnder the risk-based assessment system, a BIF member institution such as the Bank is categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and one of three categories based on supervisory evaluations by its primary federal regulator (in the Bank's case, the FDIC). The three supervisory categories are: financially sound with only a few minor weaknesses (Group A), demonstrates weaknesses that could result in significant deterioration (Group B), and poses a substantial probability of loss (Group C). The capital ratios used by the FDIC to define well-capitalized, adequately capitalized and undercapitalized are the same in the FDIC's prompt corrective action regulations. The BIF assessment rates are summarized below; assessment figures are expressed in terms of cents per $100 in deposits.\nAssessment Rates Effective January 1, 1996\nGroup A Group B Group C\nWell Capitalized 0* 3 17 Adequately Capitalized 3 10 24 Undercapitalized 10 24 27\n*Subject to a statutory minimum assessment of $1,000 per semi-annual period (which also applies to all other assessment risk classifications).\nA number of proposals have recently been introduced in Congress to address the disparity in bank and thrift deposit insurance premiums. On September 19, 1995, legislation was introduced and referred to the House Banking Committee that would, among other things: (i) impose a requirement on all SAIF member institutions to fully recapitalize the SAIF by paying a one-time special assessment of approximately 85 basis points on all assessable deposits as of March 31, 1995, which assessment would be due as of January 1, 1996; (ii) spread the responsibility for FICO interest payments across all FDIC-insured institutions on a pro-rata basis, subject to certain exceptions; (iii) require that deposit insurance premium assessment rates applicable to SAIF member institutions be no less than deposit insurance premium assessment rates applicable to BIF member institutions; (iv) provide for a merger of the BIF and SAIF as of January 1, 1998; (v) require savings associations to convert to state of national bank charters by January 1, 1998; (vi) require savings associations to divest any activities not permissible for commercial banks within five years; (vii) eliminate the bad-debt reserve deduction for savings associations, although savings associations would not be required to recapture into income their accumulated bad-debt reserves; (viii) provide for the conversion of savings and loan holding companies into bank holding companies as of January 1,\n1998, although unitary savings and loan holding companies authorized to engage in activities as of September 13, 1995 would have such authority grandfathered (subject to certain limitations); and (ix) abolish the OTS and transfer the OTS' regulatory authority to the other federal banking agencies. The legislation would also provide that any savings association that would become undercapitalized under the prompt corrective action regulations as a result of the special deposit premium assessment could be exempted from payment of the assessment, provided that the institution would continue to be subject to the payment of semiannual assessments under the current rate schedule following the recapitalization of the SAIF. The legislation was considered and passed by the House Banking Committee's Subcommittee on Financial Institutions on September 27, 1995, and has not yet been acted on by the full House Banking Committee.\nOn September 20, 1995, similar legislation was introduced in the Senate, although the Senate bill does not include a comprehensive approach for merging the savings association and commercial bank charters. The Senate bill remains pending before the Senate Banking Committee.\nThe future of both these bills is linked with that of pending budget reconciliation legislation since some of the major features of the bills are included in the Seven-Year Balanced Budget Reconciliation Act. The budget bill, which was passed by both the House and Senate on November 17, 1995 and vetoed by the President on December 6, 1995, would: (i) recapitalize the SAIF through a special assessment of between 70 and 80 basis points on deposits held by institutions as of March 31, 1995; (ii) provide an exemption to this rule for weak institutions, and a 20% reduction in the SAIF-assessable deposits of so- called ``akar banks''; (iii) expand the assessment base for FICO payments to include all FDIC-insured institutions; (iv) merge the BIF and SAIF on January 1, 1998, only if no insured depository institution is a savings association on that date; (v) establish a special reserve for the SAIF on January 1, 1998; and (vi) prohibit the FDIC from setting semiannual assessments in excess of the amount needed to maintain the reserve ratio of any fund at the designated reserve ratio. The bill does not include a provision to merge the charters of savings associations and commercial banks.\nIn light of ongoing debate over the content and fate of the budget bill, the different proposals currently under consideration and the uncertainty of the Congressional budget and legislative processes in general, management cannot predict whether any or all of the proposed legislation will be passed, or in what form. Accordingly, the effect of any such legislation on the Bank cannot be determined.\nINTERSTATE BANKING AND BRANCHING\nIn September 1994, the Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") became law. Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain approval under the BHCA to\nacquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10% of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which the bank is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five year existence requirement.\nThe Interstate Act also permits, beginning June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may permit such combinations earlier than June 1, 1997, and may adopt legislation to prohibit interstate mergers after that date in that state or in other states by that state's banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirements and conditions as for a merger transaction.\nIn October 1995, California adopted \"opt in\" legislation under the Interstate Act that permits out-of-state banks to acquire California banks that satisfy a five-year minimum age requirement (subject to exceptions for supervisory transactions) by means of merger or purchases of assets, although entry through acquisition of individual branches of California institutions and de novo branching into California are not permitted. The Interstate Act and the California branching statute will likely increase competition from out-of-state banks in the markets in which the Company operates, although it is difficult to assess the impact that such increased competition may have on the Company's operations.\nCOMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS\nThe Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (\"CRA\") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities.\nIn May 1995, the federal banking agencies issued final regulations which change the manner in which they measure a bank's compliance with its CRA obligations. The final regulations adopt a performance-based evaluation system which bases CRA ratings on an institution's actual lending service and\ninvestment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements.\nIn March 1994, the federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact.\nPOTENTIAL ENFORCEMENT ACTIONS\nCommercial banking organizations, such as the Bank, and their institution- affiliated parties, which include the Company, may be subject to potential enforcement actions by the Federal Reserve Board, the FDIC and the Superintendent for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease- and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of the Bank), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of the FDIC Improvement Act. Additionally, a holding company's inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company. Neither the Company nor the Bank have been subject to any such enforcement actions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of the Company and the Bank are located at 701 N. Haven Avenue, Suite 350, Ontario, California. The office of Community is located at 125 East \"H\" Street, Colton, California.\nThe Bank occupies the premises for fourteen of its offices under leases expiring at various dates from 1995 through 2014. The Bank owns the premises for its six other offices.\nThe Company's total occupancy expense, exclusive of furniture and equipment expense, for the year ended December 31, 1994, was $3.2 million. Management believes that its existing facilities are adequate for its present purposes. However, management currently intends to increase the Bank's assets over the next several years and anticipates that a substantial portion of this growth will be accomplished through acquisition or de novo opening of additional banking offices. For additional information concerning properties, see Notes 6 and 10 of the Notes to the Consolidated Financial Statements included in this report. See \"Item 8. Financial Statements and Supplemental Data.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFrom time to time the Company and the Bank are party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company and the Bank management believes that the ultimate aggregate liability represented thereby, if any, 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 a Vote of Security Holders\nNo matters were submitted to shareholders during the fourth quarter of 1995.\nITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT\nAs of March 15, 1995, the principal excutive officers of the Company and Chino are:\nName Position Age\nGeorge A. Borba Chairman of the Board of 63 the Company and the Bank\nD. Linn Wiley President and Chief Executive 57 Officer of the Company and the Bank\nVincent T. Breitenberger Executive Vice President\/Senior 62 Loan Officer of the Bank\nJay W. Coleman Executive Vice President of the Bank 53\nRobert J. Schurheck Chief Financial Officer of 63 the Company and Executive Vice President and Chief Financial Officer of the Bank\nOther than George A. Borba, who is the brother of John A. Borba, a director of the Company and the Bank, there is no family relationship among any of the above-named officers or any of the Company's directors.\nMr. Borba has served as Chairman of the Board of the Company since its organization in April 1981 and Chairman of the Board of the Bank since its organization in December 1973. In addition, Mr. Borba is the owner of George Borba Dairy.\nMr. Wiley has served as President and Chief Executive Officer of the Company since October 4, 1991. Mr. Wiley joined the Company and Bank as a director and as President and Chief Executive Officer designate on August 21, 1991. Prior to that, Mr. Wiley served as an Executive Vice President of Wells Fargo Bank from April 1, 1990 to August 20, 1991. From 1988 to April 1, 1990 Mr. Wiley served as the President and Chief Administrative Officer of Central Pacific Corporation, and from 1983 to 1990 he was the President and Chief Executive Officer of American National Bank.\nMr. Breitenberger has served as Executive Vice President of the Bank since April 1982, and prior to that time was Senior Vice President of the Bank from November 1980 to March 1982. He has been the Senior Loan Officer of the Bank since November 1980.\nMr. Coleman assumed the position of Executive Vice President of the Bank on December 5, 1988. Prior to that he served as President and Chief Executive Officer of Southland Bank, N.A. from March 1983 to April 1988.\nMr. Schurheck assumed the position of Chief Financial Officer of the Company and Executive Vice President\/Chief Financial Officer of the Bank on March 1, 1990. He served as Senior Vice President of the Bank from September 11, 1989 to February 28, 1990. Prior to that he served as Senior Vice President of General Bank from June 1988 to September 1989. From July 1987 to June 1988 Mr. Schurheck was a self-employed consultant; from December 1973 to June 1987 he was Senior Vice President of Operations and Finance of State Bank in Lake Havasu City, Arizona.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nShares of CVB Financial Corp. common stock price decreased from an average price of $13.01 per share for the first quarter of 1995 to an average per share price of $12.80 for the fourth quarter of 1995. Fears regarding the economy, weak California real estate prices, and bank capital levels continued to dominate investors' perceptions of bank stocks in the region, regardless of the performance of CVB Financial Corp. The average per share price for the fourth quarter of 1995 represented a multiple of book value of approximately 1.46. The following table presents the high and low sales prices for the Company's common stock during each quarter for the past three years. The share prices and cash dividend per share amounts presented for all periods have been restated to give retroactive effect, as applicable, of the ten percent stock dividend declared on December 20, 1995 and stock dividends declared in 1994 and 1993. The Company had approximately 1,032 shareholders of record as of December 31, 1995.\nThree Year Summary of Common Stock Prices\nQuarter Ended High Low Dividends\n3\/31\/93 $10.14 $7.05 $.060 Cash Dividend 6\/30\/93 $9.44 $8.26 $.060 Cash Dividend 9\/30\/93 $11.08 $9.02 $.060 Cash Dividend 12\/31\/93 $11.17 $9.67 $.060 Cash Dividend 10% Stock Dividend\n3\/31\/94 $10.95 $9.40 $.066 Cash Dividend 6\/30\/94 $11.98 $9.71 $.066 Cash Dividend 9\/30\/94 $13.23 $11.67 $.066 Cash Dividend 12\/31\/94 $13.23 $11.15 $.066 Cash Dividend 10% Stock Dividend\n3\/31\/95 $14.09 $12.05 $.073 Cash Dividend 6\/30\/95 $12.73 $11.48 $.073 Cash Dividend 9\/30\/95 $11.93 $11.48 $.073 Cash Dividend 12\/31\/95 $13.75 $11.76 $.073 Cash Dividend 10% Stock Dividend\nThe Company lists its common stock on the American Stock Exchange under the symbol \"CVB.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS.\nManagement's discussion and analysis is written to provide greater detail of the results of operations and the financial condition of CVB Financial Corp. and its subsidiaries. This analysis should be read in conjunction with the audited financial statements contained within this report including the notes thereto. CVB Financial Corp., (CVB) is a bank holding company. Its primary subsidiary, Chino Valley Bank, (the Bank) is a state chartered bank with 19 branch offices located in San Bernardino, Riverside, east Los Angeles, and north Orange Counties. Community Trust Deed Services (CTD) is a nonbank subsidiary providing services to the Bank as well as nonaffiliated persons. For purposes of\nthis analysis, the consolidated entities are referred to as the \"Company\".\nDuring 1994 and 1993, the Company acquired two banks through merger and the Bank purchased assets and assumed deposits of two failed banks from the FDIC, as receiver of these banks. These acquisitions and mergers provided the Bank with four new branch offices and contributed significantly to the growth of the Company's deposits, loans, and assets during 1994 and 1993. On March 8, 1993, the Company acquired through merger Fontana First National Bank with deposits of approximately $23.7 million and loans of approximately $18.3 million. On October 21, 1993, the Bank assumed approximately $30.6 million in deposits and purchased $20.8 million in loans and $4.6 million in investments of the former Mid City Bank, N.A. from the FDIC.\nOn June 24, 1994, the Company acquired through merger Western Industrial National Bank (\"WIN\") with deposits of approximately $43.5 million, and loans of approximately $34.1 million. On July 8, 1994, the Bank entered into an Insured Deposit Purchase and Assumption Agreement with the FDIC in its capacity as receiver for Pioneer Bank (\"Pioneer\"), assuming approximately $52.7 million in deposits and purchasing approximately $12.3 million in loans, and $8.2 million in investments and federal funds sold.\nOn October 21, 1995, the Bank purchased a branch office from Vineyard National Bank with deposits of $4.1 million and loans of $952,000. In addition, on November 1, 1995, the Company and the Bank entered into a definitive agreement to acquire through merger Citizens Commercial Trust & Savings Bank of Pasadena (\"Citizens Bank of Pasadena\"). Citizens Bank of Pasadena has four banking offices and at December 31, 1995 had total assets of approximately $146.0 million, total deposits of approximately $127.0 million, total loans of approximately $62.0 million, and total shareholders' equity of approximately $15.7 million. At December 31, 1995, Citizens Bank of Pasadena held trust assets of approximately $800.0 million that are not included on the balance sheet of the bank. Pursuant to the definitive agreement, the Bank will pay $18 million plus an amount equal to the adjusted earnings of Citizens Bank of Pasadena between October 31, 1995 and the date of the consummation of the transaction to acquire Citizens Bank of Pasadena. The acquisition is subject to obtaining the necessary regulatory approvals and the approval of the shareholders of Citizens Bank of Pasadena. The acquisition is anticipated to close during April of 1996. If consummated, the acquisition of Citizens Bank of Pasadena will be accounted for under the purchase method of accounting and will provide significant growth in assets and liabilities and result in increases in the revenues and the expenses of the Company.\nANALYSIS OF THE RESULTS OF OPERATIONS\nThe Company reported net earnings of $11.5 million for the year ended December 31, 1995. This represented an increase of $1,023,000, or 9.80%, over earnings of $10.4 million for the year ended December 31, 1994. For the year ended December 31, 1993, the Company reported earnings of $9.5 million. Earnings\nper share, adjusted for the effects of a 10% stock dividend declared each year, were $1.22, $1.13, and $1.05 per share for 1995, 1994, and 1993, respectively.\nThe increase in earnings for 1995 compared to 1994 resulted primarily from the increase in net interest income and, to a lesser extent, the increase in other operating income. Increased net interest income for 1995 generally reflected the higher volume of average earning assets coupled with higher yields on these assets. The increases were partially offset by a higher provision for credit losses and increased other operating expenses.\nThe increase in earnings for 1994 compared to 1993 was also the result of an increase in net interest income due primarily to an increase in the volume of average earning assets and a lower cost of average deposits. A lower provision for credit losses also contributed to the increase in earnings for 1994 compared to the previous year. The lower provision for credit losses for 1994 compared to 1993 reflected nominal internal loan growth, net of acquired loans, and lower net charge offs for the year. Earnings for 1993 included a $3.7 million gain on the sale of investment securities that resulted from a restructure of the investment portfolio in anticipation of the adoption of SFAS No. 115.\nFor the year ended December 31, 1995, the Company's return on average assets was 1.39%, compared to a return on average assets of 1.40% for the year ended December 31, 1994, and 1.52% for the year ended December 1993. The decrease in the return on average assets for the last two years is primarily the result of decreases in the level of average earning assets in relation to average total assets. Increases in other real estate owned and goodwill contributed to the increase in nonearning assets. The Company's return on average stockholders' equity was 16.13% for the year ended December 31, 1995, compared to 16.84% for the year ended December 31, 1994, and 17.46% for the year ended December 31, 1993.\nNET INTEREST INCOME\nTable 1 presents the average yield on each category of earning assets, the average rate paid for each category of interest bearing liabilities, and the resulting net interest spread and net interest margin for the years indicated. Rates for tax preferenced investments are provided on a taxable equivalent basis using the federal marginal tax rate of 35.00%.\nTABLE 1 - Distribution of Average Assets, Liabilities, and Stockholders' Equity; Interest Rates and Interest Differentials (dollars in thousands)\nThe Company's operating results depend primarily on net interest income, the difference between the interest earned on loans and investments less the interest paid on deposit accounts and borrowed funds. Net interest income was $48.1 million for 1995, an increase of $5.3 million, or 12.4%, over net interest income of $42.8 million for 1994. Net interest income increased $6.9 million, or 19.30%, for 1994, from a total of $35.9 million for 1993. The increase in net interest income for 1995 was the result of higher yields on larger average balances of earning assets.\nThe net interest margin is net interest income measured as a percentage of average earning assets. The net interest margin can be affected by changes in the yield on earning assets and the cost of interest bearing liabilities, as well as changes in the level of interest bearing liabilities in proportion to earning assets. The Company's net interest margin was 6.78% for 1995, compared to 6.64% for 1994, and 6.56% for 1993. The ability to fund higher levels of earning assets with noninterest bearing demand deposits contributed to the increases in the net interest margin for each of the last three years. Average noninterest bearing deposits as a percentage of earning assets increased to 32.9% for 1995, from 32.37% for 1994, and 29.9% for 1993.\nThe net interest spread is the difference between the yield on average earning assets less the cost of average interest bearing liabilities. The Company's net interest spread was 5.64% for 1995. This represented a decrease from a net interest spread of 5.83% for 1994 and 5.82% for 1993. The decrease in the net interest spread for 1995 resulted from the cost of interest bearing liabilities increasing faster than the yield on earning assets.\nThe Company earned total interest income of $64.7 million for 1995. This represented an increase of $10.6 million, or 19.70%, from interest income of $54.0 million for 1994. Interest income totaled $45.8 million for 1993. The increases in interest income for 1995 compared to 1994 was the result of the combined effects of an increase in the level of average earning assets and a higher yield earned on these assets. The increase in interest income for 1994 compared to 1993 was primarily due to an increase in the level of average earning assets.\nThe Company paid total interest expense on deposits and other borrowed funds of $16.6 million for 1995. This represented an increase of $5.3 million, or 47.43%, over total interest expense of $11.2 million for 1994. For 1994, interest expense increased $1.3 million, or 13.68%, from $9.9 million for 1993. Greater levels of average interest bearing liabilities contributed to the increase for both years. For 1995, an increase in the cost of average interest bearing liabilities also contributed to the increase in interest expense.\nThe cost of average interest bearing deposits was 3.28% for 1995, compared to an average cost of 2.50% for 1994, and 2.54% for 1993. The increase for 1995 generally reflected higher interest rates paid for money market and time deposit accounts in response to increases in the market rates of interest. The Company's cost of average total deposits was 2.04% for 1995, compared to 1.61% for 1994, and 1.73% for 1993. The Company was able to offset, in part, the impact of the increased cost of interest bearing deposits in 1995 by obtaining a greater portion of its deposits from noninterest bearing demand deposits. As a percentage of total average deposits, average demand deposits were 37.73% for 1995, compared to 35.52% for 1994, and 31.99% for 1993.\nTable 2 presents a comparison of interest income and interest expense resulting from changes in the volumes and rates on average earning assets and average interest bearing liabilities for the years indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to changes in interest rates are calculated by multiplying the change in interest rate by the initial volume. The changes attributable to interest rate and volume changes are calculated by multiplying the change in rate times the change in volume.\nInterest and fees on loans, the Company's primary source of revenue, totaled $50.2 million for 1995. This represented an increase of $7.0 million, or 16.23%, from $43.2 million for 1994. For 1994, interest and fees on loans increased $6.1 million, or 16.52%, from $37.0 million for 1993.\nIn general, the Company stops accruing interest on a nonperforming loan after its principal or interest become 90 days or more past due, charging to earnings all interest previously accrued but not collected. There was no interest income that was accrued and not reversed on any nonperforming loan at December 31, 1995, 1994, or 1993. Had nonperforming loans for which interest was no longer accruing complied with the original terms and conditions of their notes, interest income would have been $988,000 higher in 1995, $1,363,000 higher in 1994, and $1,186,000 higher in 1993. Accordingly, yields on loans would have increased by 0.20%, 0.29%, and 0.28%, for 1995, 1994, and 1993, respectively.\nIncluded in Other Real Estate Owned at December 31, 1994, were two loans totaling $1.2 million which, although performing according to their original terms, were accounted for as other real estate owned as required under SFAS No. 66. As principal and interest payments on these loans were current at December 31, 1994, the average balance of the loans were included in total loans, and the yield on total loans was adjusted accordingly.\nFees collected on loans are an integral part of the loan pricing decision. Loan fees and the direct costs associated with origination of loans are deferred and netted against the loan balance. Deferred net loan fees are recognized in interest income over the term of the loan in a manner that approximates the level-yield method. For the year ended December 31, 1995, the Company recognized $2.7 million in loan fee income. This represented an increase of $524,000, or 24.51%, over loan fees of $2.1 million recognized for 1994. For 1993, the\nThe interest rates paid on deposit accounts do not always move in unison with the rates charged on loans. In addition, the magnitude of changes in the rates charged on loans is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest bearing liabilities. The fact that the Bank reported a negative gap at December 31, 1995, does not necessarily indicate that if interest rates decreased net interest income would increase, or if interest rates increased net interest income would decrease.\nCREDIT RISK\nImplicit in lending activities is the risk that losses will be experienced and that the amount of such losses will vary over time. Consequently, the Company maintains an allowance for credit losses by charging a provision for credit losses to earnings. Loans determined to be losses are charged against the allowance for credit losses. The Company's allowance for credit losses is maintained at a level considered by the Bank's management to be adequate to provide for estimated losses inherent in the existing portfolio, including commitments under commercial and standby letters of credit.\nIn evaluating the adequacy of the allowance for credit losses, the Bank's management estimates the amount of potential loss for each loan that has been identified as having greater than standard credit risk, including loans identified as nonperforming. Loss estimates also consider the borrowers' financial data and the current valuation of collateral when appropriate. In addition to the allowance for specific problem credits, an allowance is further allocated for all loans in the portfolio based on the risk characteristics of particular categories of loans including historical loss experience in the portfolio. Additional allowance is allocated on the basis of credit risk concentrations in the portfolio and contingent obligations under off-balance sheet commercial and standby letters of credit.\nEffective January 1, 1995, the Company adopted SFAS No. 114, \"Accounting by Creditors for the Impairment of a Loan.\", as amended by SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" The statements prescribe that a loan is impaired when principal and interest are deemed uncollectable according to the original contractual terms of the loan. Impairment is to be measured as either the expected future cash flows discounted at each loan's effective interest rate, the fair value of the loan's collateral, or an observable market price of the loan (if one exists). The amount of impairment is to be reported as a part of the Company's allowance for credit losses.\nAt December 31, 1995, the Company reported an allowance for credit losses of $9.6 million. Of this total, $3.0 million represented reserves for specific problem loans, $415,093 represented reserves for specific impaired loans, and $6.0 million represented that portion allocated to provide for general risks inherent in the loan portfolio.\nNonperforming loans totaled $26.8 million, or 5.30% of gross loans at December 31, 1995. Nonperforming loans totaled $21.6 million, or 4.37% of gross loans at December 31, 1994, and $13.3 million, or 2.94% of gross loans at December 31, 1993. Nonperforming loans include loans for which interest is no longer accruing. In addition, nonperforming loans include loans that have been renegotiated from their original contractual terms, even if the loan is paying as agreed under the renegotiated terms. The increase in nonperforming loans in 1995 was due to a $4.6 million increase in restructured loans and a $676,000 increase in nonaccrual loans. The increase in nonperforming loans for 1994 was the result of increases in restructured loans. All restructured loans were\npaying in accordance with the renegotiated terms at December 31, 1995. See Table 9 - Nonperforming Assets for additional information concerning nonperforming loans. While management believes that the allowance was adequate to provide for both recognized potential losses and estimated inherent losses in the portfolio, no assurances can be given that future events may not result in increases in the provision for credit losses.\nTable 5 presents a comparison of net credit losses, the provision for credit losses (including adjustments incidental to mergers), and the resulting allowance for credit losses for each of the years indicated.\nAt December 31, 1995, the allowance for credit losses was $9.6 million. This represented an increase of $154,850, or 1.6%, over the allowance for credit losses of $9.5 million at December 31, 1994. For 1994, the allowance for credit losses increased $621,294, or 7.02%, from $8.8 million at December 31, 1993. The allowance for credit losses increased for 1995 as net loans charged to the allowance of $2.4 million were lower than the provision for credit losses of $2.6 million. Similarly, the allowance for credit losses increased for 1994 as net loan losses of $853,000 charged to the allowance were lower than the provision of $350,000, when combined with adjustments incident to mergers of $1.1 million. As a percentage of total loans at the end of each period, the allowance for loan losses declined to 1.90% at December 31, 1995, from 1.92% at December 31, 1994, and 1.96% at December 31, 1993.\nThe provision for credit losses totaled $2.6 million for 1995, compared to $350,000 for 1994, and $1.7 million for 1993. The increased provision for credit losses for 1995 compared to 1994 was the result of increased loans charged to the allowance for credit losses. Net loans charged to the allowance for credit losses during 1995 included $2.1 million in real estate loans, compared to $355,000 in real estate loans charged to the allowance for credit losses during 1994. The increase reflects the continued soft Southern California economy and declining real estate values. The lower provision for credit losses for 1994, reflected a slower growth rate in loans net of acquisitions for that year. Loans acquired through merger for 1994 included an adjustment to the allowance for credit losses incidental to the merger of $1.1 million.\nWhile the Company's management believes that the allowance was adequate to provide for both recognized potential losses and estimated inherent losses in the portfolio, no assurances can be given that future events may not result in increases in the provision for credit losses. There is no precise method of predicting specific losses that ultimately may be charged against the allowance for credit losses. As such, the Company's management is unable to reasonably estimate the full amount of loans to be charged to the reserve in future periods.\nTable 6 provides a summary of the allocation of the allowance for credit losses for specific loan categories at the dates indicated. The allocations presented should not be interpreted as an indication that loans charged to the allowance for credit losses will occur in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amount available for future losses that may occur within these categories. There is a large unallocated portion of the allowance for credit losses and the total allowance is applicable to the entire loan portfolio.\nOTHER OPERATING INCOME\nOther operating income for the Company includes service charges and fees (primarily from deposit accounts), gains (net of losses) from the sale of investment securities, gains (net of losses) from the sale of other real estate owned, gains (net of losses) from the sale of fixed assets; gross revenue from CTD; and other revenues not included as interest on earning assets. Other operating income totaled $9.1 million for 1995. This represented an increase of\n$1.5 million, or 19.83%, over other operating income of $7.6 million for 1994. The increase was primarily due from increased service charges and fee income for 1995 compared to 1994.\nFor 1994, other operating income decreased $3.2 million, or 29.40%, from $10.7 million for 1993. The decrease was the result of gains on the sale of investment securities of $3.7 million in 1993 compared to a loss from the sale of investment securities of $128,000 for 1994. The gain for 1993 resulted from restructuring the investment portfolio in anticipation of adopting SFAS No. 115.\nOther income also includes revenue from CTD, a subsidiary of the Company. Total revenue from CTD was approximately $256,000, $274,000, and $271,000 for 1995, 1994, and 1993, respectively.\nOTHER OPERATING EXPENSES\nOther operating expenses totaled $35.1 million for 1995. This represented an increase of $2.6 million, or 8.07%, from total other operating expenses of $32.4 million for 1994. For 1994, other operating expenses increased $3.1 million, or 10.50%, from other operating expenses of $29.4 million for the year ended December 31, 1993.\nFor the most part, other operating expenses reflect the direct expenses and related administrative expenses associated with staffing, maintaining, promoting, and operating branch facilities. Consequently, other operating expenses have increased as the asset size of the Company and the number of branch offices have increased. Management's ability to control costs in relation to asset growth can be measured in terms of other operating expenses as a percentage of average assets. For 1995, operating expenses as a percentage of average assets totaled 4.25%, compared to 4.35% for 1994, and 4.68% for 1993. Management's ability to control costs in relation to the level of revenue can be measured in terms of operating expenses as a percentage of total revenue. For 1995, operating expenses as a percentage of total revenue declined to 47.51%, compared to 52.61% for 1994, and 51.94% for 1993. The decline in the percentage for 1995 reflects the ability to generate greater levels of revenue with proportionately lower levels of operating expenses.\nSalaries and related expenses comprise the greatest portion of other operating expenses. For 1995, salaries and related expenses totaled $16.5 million. This represented an increase of $1.3 million, or 8.22%, over salaries and related expenses of $15.2 million for 1994. Salaries and related expenses totaled $14.4 million for 1993. The increase primarily reflects an increase in average staffing levels during the year. Despite the increase in average staffing levels, at year end, full time equivalent employees decreased to 297 at December 31, 1995, compared to 321 at December 31, 1994, and 302 at December 31, 1993. As a percentage of average assets, salaries and related expenses totaled 2.00% for 1995, a decrease from 2.05% for 1994, and 2.30% for 1993.\nEquipment expense totaled $2.3 million for 1995, an increase of $309,000, or 15.70%, from $2.0 million for 1994. Equipment expense increased $443,000, or 29.02%, in 1994 from $1.5 million for 1993. Stationary and supplies totaled $1.8 million for 1995, an increase of $276,000, or 17.75%, from $1.6 million for 1994. Stationary and supplies increased $488,000, or 45.65% in 1994, from $1.1 million for 1993. The increases reflected the greater number of branch offices in 1994 and 1995. Professional expenses totaled $2.9 million for 1995, an increase of $1.0 million, or 54.62%, from total professional expenses of $1.9 million for 1994. Professional expenses increased $136,000, or 7.94%, in 1994, from $1.7 million for 1993. The increase in professional expenses for 1995 reflects increased litigation expense.\nIncluded as other operating expenses is a provision charged to earnings for potential losses from the sale of other real estate owned. This provision totaled $1.9 million, $2.4 million, and $2.8 million, for the years ended December 31, 1995, 1994, and 1993, respectively. These charges contributed to the increase in other operating expenses for each year. Additional expenses associated with the foreclosure, maintenance and disposition of other real estate owned totaled $1,360,000 for 1995, $908,000 for 1994, and $1,004,000 for 1993. Other real estate owned is property acquired by the Bank through foreclosure (See LOANS). Primarily as a result of the current economic climate in Southern California, real estate values have decreased significantly over the last three years. In anticipation of a possible continuation of this declining trend in both commercial and residential real estate values, the Bank's management has provided an allowance for potential declining values of real estate .\nOther operating expenses for 1995 were affected by a decrease in insurance premiums paid by the Company to the FDIC for the Bank Insurance Fund (the BIF). For 1995, the Company paid a total premium of $811,000, compared to a premium of $1.3 million for 1994, and $1.2 million for 1993. The decrease for 1995 reflects the reduction in premiums as the BIF attained target reserve levels.\nINCOME TAXES\nThe Company's effective tax rate for 1995 was 41.55%, compared to an effective tax rate of 40.80% for 1994, and 38.80% for 1993. These rates are below the nominal combined Federal and State tax rates as a result of tax preferenced income for each period. The increases in the combined effective tax rates each year resulted from increases in the Federal tax rate for revenues in excess of $10.0 million, and increases in the State tax rate.\nANALYSIS OF FINANCIAL CONDITION\nThe Company reported total assets of $936.9 million at December 31, 1995. This represented an increase of $100.8 million, or 12.06%, from total assets of $836.1 million at December 31, 1994. During 1994, total assets increased $148.7 million, or 21.63%, from total assets of $687.4 million at December 31, 1993. The level of assets at December 31, 1995, and 1994, included short term deposits of approximately $48.0 million and $40.0 million, respectively. These funds were\nreflected in the level of demand deposits and cash and due from banks at December 31, 1995, and 1994. Asset and deposit growth for 1994 was affected significantly by the acquisitions of Western Industrial National Bank and Pioneer Bank.\nA greater portion of the increase in assets for 1995 was allocated to investment securities. The increase in assets for 1994 was allocated approximately equally between loans and investment securities. Increases in assets for 1995 were funded by both increases in deposits and other borrowed funds. Increases in assets for 1994 were primarily funded by increased deposits.\nINVESTMENT SECURITIES\nThe Company maintains a portfolio of investment securities to provide income and serve as a source of liquidity for its ongoing operations. Note 2 of the Notes to the Consolidated Financial Statements sets forth information concerning the composition and the maturity distribution of the investment securities portfolio at December 31, 1995, and 1994. At December 31, 1995, the Company reported total investment securities of $284.6 million. This represented an increase of $92.4 million, or 48.05%, over total investment securities of $192.3 million at December 31, 1994. In addition, at December 31, 1995, federal funds sold totaled $7.0 million, compared to $15.0 million at December 31, 1994.\nThe Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" effective January 1, 1994. Under this standard, securities held as \"available for sale\" are reported at current market value for financial reporting purposes. The market value, less the amortized cost of investment securities, net of income taxes, is adjusted directly to stockholders' equity. At December 31, 1995, securities held as available for sale totaled $260.4 million, representing 91.47% of total investment securities of $284.6 million at December 31, 1995. At December 31, 1995, net unrealized gains on investment securities available for sale totaled $303,789, which includes the unamoritized loss on an investment security that was transferred from available for sale to held to maturity.\nLOANS\nAt December 31, 1995, the Company reported net loans of $496.4 million. This represented an increase of $11.8 million, or 2.44%, from net loans of $484.6 million at December 31, 1994. During 1994, net loans increased $42.5 million, or 9.62%, from $442.1 million at year ended December 31, 1993. Gross loans acquired through acquisitions totaled approximately $46.4 million for 1994, and approximately $39.1 million for 1993.\nTable 7 presents the distribution of the Company's loan portfolio at the dates indicated.\nTable 8 provides the maturity distribution for commercial and industrial loans as well as real estate construction loans as of December 31, 1995. Amounts are also classified according to repricing opportunities or rate sensitivity.\nAs a normal practice in extending credit for commercial and industrial purposes, the Bank may accept trust deeds on real property as collateral. In some cases, when the primary source of repayment for the loan is anticipated to come from cash flow from normal operations of the borrower, the requirement of real property as collateral is not the primary source of repayment but an abundance of caution. In these cases, the real property is considered a secondary source of repayment for the loan. Since the Bank lends primarily in\nSouthern California, its real estate loan collateral is concentrated in this region. At December 31, 1995, approximately 97.00% of the Bank's loans secured by real estate were collateralized by properties located in Southern California. This concentration is considered when determining the adequacy of the Company's allowance for credit losses.\nAt December 31, 1995, nonperforming assets, which included nonperforming loans (see CREDIT RISK) and other real estate owned, totaled $35.1 million. This represented an increase of $3.7 million, or 11.69%, from total nonperforming assets of $31.4 million at December 31, 1994. The increase in nonperforming assets for 1995 was the result of increased nonperforming loans. Other real estate owned declined 16.30%, to $8.3 million at December 31, 1995, compared to $9.9 million at December 31, 1994.\nAlthough management believes that nonperforming loans are generally well secured and that potential losses are provided for in the Company's allowance for credit losses, there can be no assurance that future deterioration in economic conditions or collateral values will not result in future credit losses. Table 9 provides information on nonperforming loans and other real estate owned at the dates indicated.\nAt December 31, 1995, the Company had loans for which interest was no longer accruing totaling $13.3 million. Approximately 40.00% of these nonaccrual loans were secured by real property which had a current appraisal that was less than one year old. The estimated ratio of the outstanding loan balances to the fair values of the related collateral for nonaccrual loans at December 31, 1995, ranged between approximately 26.00% to 103.00%. The Bank has allocated specific reserves included in the allowance for credit losses for potential losses on these loans.\nA restructured loan is a loan for which the Bank has reduced the rate of interest to a lower rate, forgiven all or a part of the interest income, or forgiven part of the principal balance of the loan, due to the borrower's financial condition. At December 31, 1995, the Company had a total of $13.6 million in loans that were classified as restructured.\nExcept for nonperforming loans as set forth in Table 9, and loans disclosed as impaired, the Bank's management is not aware of any loans as of December 31, 1995, for which known credit problems of the borrower would cause serious doubts as to the ability of such borrowers to comply with their present loan repayment terms, or any known events that would result in the loan being designated as nonperforming at some future date. The Bank's management cannot, however, predict the extent to which the current economic environment may persist or worsen or the full impact the current economic environment may have on the loan portfolio.\nAt December 31, 1995, the net book value of the 17 properties held as other real estate owned totaled $8.3 million. The Bank is actively marketing these properties. The Bank's management cannot predict when these properties will be sold or what the terms of sale will be when they are sold. While the Bank's management recognizes that the Southern California real estate market continues to remain weak, the Bank has recent appraisals on each property that support the carrying costs of these properties at December 31, 1995. No assurances can be given that further charges to earnings may not occur if Southern California real estate values continue to decrease, and the Bank cannot promptly dispose of the properties held.\nDEPOSITS\nThe Company reported total deposits of $803.6 million at December 31, 1995. This represented an increase of $40.9 million, or 5.37%, from total deposits of $762.6 million at December 31, 1994. Total deposits included approximately $48.0 million in short term demand deposits at December 31, 1995, and $40.0 million in short term demand deposits at December 31, 1994. At December 31, 1993, total deposits were $596.0 million. During 1994, deposits assumed through acquisitions totaled approximately $96.2 million. This represented 57.75% of the $166.7 million increase in deposits for that year.\nAverage noninterest bearing demand deposits totaled $268.7 million for the year ended December 31, 1995. This represented an increase of $31.7 million, or 13.41%, over average noninterest bearing demand deposits of $236.9 million for the year ended December 31, 1994. Noninterest bearing demand deposits averaged $178.5 million for the year ended December 31, 1993. The ability to fund greater portions of average assets with noninterest bearing demand deposits has contributed significantly to increases in the Company's net interest margin for each of the last three years.\nTable 10 provides the remaining maturities of large denomination ($100,000 or more) time deposits, including public funds, at December 31, 1995.\nTABLE 10 - Maturity Distribution of Large Denomination Time Deposits (amounts in thousands)\nDECEMBER 31, 1995\n3 months or less $ 61,940 Over 3 months through 6 months 18,778 Over 6 months through 12 months 23,705 Over 12 months 4,617 --------- Total $ 109,040 =========\nLIQUIDITY\nLiquidity is actively managed to ensure sufficient funds are available to meet the ongoing needs of both the Bank and CVB. Liquidity management includes projections of future sources and uses of funds to insure the availability of sufficient liquid reserves to provide for unanticipated circumstances.\nFor the Bank, sources of funds normally include principal payments on loans and investments, other borrowed funds, and growth in deposits. Uses of funds include withdrawal of deposits, interest paid on deposits, increased loan balances, purchases, and other operating expenses. The Bank maintains funds as overnight federal funds sold and other short term investment securities to provide for short term liquidity needs. In addition, the Bank maintains short term unsecured lines of credit with correspondent banks to provide for contingent liquidity needs.\nOther borrowed funds averaged $35.2 million for the year ended December 31, 1995. This represented an increase of $26.5 million over average borrowed funds of $8.7 million for the year ended December 31, 1994. The increased borrowing for 1995 is primarily the result of a secured short term loan from the Federal Home Loan Bank. Borrowed funds were used to purchase investment securities at a positive net interest spread.\nNet cash provided by operating activities, primarily representing net interest income, totaled $18.2 million for 1995, $9.5 million for 1994, and $10.6 million for 1993. Financing activities were primarily comprised of increased time certificates of deposits of $47.8 million, short term borrowed funds of $40.3 million, and a decrease in noninterest bearing deposits and money market and savings accounts of $11.0 million. Net cash provided by financing activities was $60.4 million for 1994, and $18.1 million for 1993. Cash and cash equivalents received as a result of acquisitions totaled $126,000 for 1995, $22.6 million for 1994 and $13.3 million for 1993. Net cash used in investing activities, primarily representing purchases of investments and to a lesser extent increases in loans, totaled $91.1 million for 1995, $43.6 million for 1994, and $52.4 million for 1993.\nAt December 31, 1995, the Bank reported liquid assets, including cash, federal funds sold, and unpledged investment securities of $280.1 million. Liquid assets represented 29.90% of total assets at December 31, 1995.\nSince the primary sources and uses of funds for the Bank are loans and deposits, the relationship between gross loans and total deposits provides a useful measure of the Bank's liquidity. Typically, the closer the ratio of loans to deposits is to 100%, the more reliant the Bank is on its loan portfolio to provide for short term liquidity needs. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan to deposit ratio the less liquid are the Bank's assets. For 1995, the Bank's loan to deposit ratio averaged 68.31%, compared to an average of 69.93% for 1994 and an average of 74.72% for 1993.\nThe liquidity ratio provides another measure of the Bank's liquidity. This ratio is calculated by dividing the difference between short term liquid assets less short term volatile liabilities by the sum of loans and long term investments. This ratio measures the percentage of illiquid long term assets that are being funded by short term volatile liabilities. At December 31, 1995, this ratio was 13.44%, compared to 4.48% at December 31, 1994, and 2.72%, at December 31, 1993.\nCVB is a company separate and apart from the Bank that must provide for its own liquidity. Substantially all of CVB's revenues are obtained from dividends declared and paid by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to CVB. At December 31, 1995, approximately $3.3 million of the Bank's equity was unrestricted and available to be paid as dividends to CVB. Management of CVB believes that such restrictions will not have an impact on the ability of CVB to meet its ongoing cash obligations. As of December 31, 1995, neither the Bank nor CVB had any material commitments for capital expenditures. The purchase of Citizens Bank of Pasadena will require approximately $18.0 million in cash from the Bank. Investment securities maturing in the first quarter of 1996, coupled with the projected cash and cash equivalents to be purchased from Citizens Bank of Pasadena will provide sufficient funds to provide for the required cash purchase price.\nCAPITAL RESOURCES\nHistorically, the primary source of capital for the Company has been the retention of operating earnings. In order to insure adequate levels of capital, the Company conducts an ongoing assessment of projected sources and uses of capital in conjunction with projected increases and mixes of assets.\nTier 1 capital, stockholders' equity less intangible assets, was $69.4 million at December 31, 1995. This represented an increase of $10.0 million, or 16.86%, over Tier 1 capital of $59.4 million at December 31, 1994. Total adjusted capital, Tier 1 capital plus the lesser of the reserve for credit losses or 1.25% of risk weighted assets, totaled $76.9 million at December 31,\n1995. This represented an increase of $10.6 million, or 15.97%, over total adjusted capital of $66.3 million at December 31, 1994.\nBank regulators have established minimum capital adequacy guidelines requiring that qualifying capital be at least 8.0% of risk-based assets, of which at least 4.0% must be Tier 1 capital (primarily stockholders' equity). These ratios represent minimum capital standards. Under Prompt Corrective Action rules, certain levels of capital adequacy have been established for financial institutions. Depending on an institution's capital ratios, the established levels can result in restrictions or limits on permissible activities. In addition to the aforementioned requirements, the Company and Bank must also meet minimum leverage ratio standards. The leverage ratio is calculated as Tier 1 capital divided by the most recent quarterly period's average total assets.\nThe highest level for capital adequacy under Prompt Corrective Action is \"Well Capitalized\". To qualify for this level of capital adequacy an institution must maintain a total risk-based capital ratio of at least 10.00% and a Tier 1 risk-based capital ratio of at least 6.00%.\nFor purposes of calculating capital ratios, Federal bank regulators have excluded adjustments to stockholders' equity that result from mark to market adjustments of available for sale investment securities. At December 31, 1995, the Company had an unrealized gain on investment securities net of taxes of $304,000, compared to a loss net of taxes of $6.6 million at December 31, 1994. At December 31, 1995, and 1994, the Company exceeded all of the minimum capital ratios required to be considered well capitalized.\nAt December 31, 1995, the Company's total risk-based capital ratio was 13.06%, compared to a ratio of 12.06% at December 31, 1994. The ratio of Tier 1 capital to risk weighted assets was 11.79%, compared to a ratio of 10.81% at December 31, 1994. At December 31, 1995, the Company's leverage ratio was 8.05%, compared to a ratio of 7.53% at December 31, 1994. (See NOTE 13 of the Notes to the Consolidated Financial Statements.)\nManagement has prepared calculations of the resulting capital ratios based on projected asset size and additional goodwill that will result from the purchase of Citizens Bank of Pasadena. Projected increases in goodwill were based on estimates of the market values of the assets to be purchased and liabilities assumed. Based on these projections, it is anticipated that the Company will continue to exceed all of the minimum capital ratios required to be considered well capitalized\nDuring 1995, the Board of Directors of the Company declared quarterly cash dividends that totaled 32 cents per share for the full year (29 cents per share after retroactive adjustment of the ten percent stock dividend declared on December 20, 1995). After retroactive adjustment, cash dividends declared during 1995 were the same as paid for 1994. Management does not believe that the\ncontinued payment of cash dividends will impact the ability of the Company to exceed the current minimum capital standards.\nIn October of 1995, the Financial Standards Accounting Board issued the SFAS No. 123, \"Accounting for Stock-Based Compensation\". SFAS No. 123 does not rescind or interpret the existing accounting rules for stock-based arrangements. The Company currently accounts for stock-based compensation under APB Opinion No. 25. The Company has unequivocally elected not to adopt SFAS No. 123 and continue to account for stock-based compensation as provided under APB Opinion No. 25.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCVB Financial Corp. Index to consolidated Financial Statements and Financial Statement Schedules\nConsolidated Financial Statements Page\nConsolidated Balance Sheets -- December 31, 1995 and 1994 44\nConsolidated Statements of Earnings Year Ended December 31, 1995, 1994 and 1993 45\nConsolidated Statements of Stockholders' Equity Year Ended December 31, 1995, 1994 and 1993 46\nConsolidated Statements of Cash Flows for the Year Ended December 31, 1995, 1994 and 1993 47\nNotes to Consolidated Financial Statements 48\nIndependent Auditors' Report 66\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.\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF EARNINGS THREE YEARS ENDED DECEMBER 31, 1995\nSee accompanying notes to consolidated financial statements. (Concluded)\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE-YEAR PERIOD ENDED DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accounting and reporting policies of CVB Financial Corp. and subsidiaries are in accordance with generally accepted accounting principles and conform to practices within the banking industry. A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:\nPrinciples of Consolidation - The consolidated financial statements include the accounts of CVB Financial Corp. (the \"Company\") and its wholly owned subsidiaries, Chino Valley Bank (the \"Bank\") and Community Trust Deed Services, after elimination of all material intercompany transactions and balances.\nNature of Operations - The Company's primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through the operations of the Bank. The Bank's customers consist of small to mid-sized businesses and individuals located in the Inland Empire, San Gabriel Valley and Orange County. The Bank operates 19 branches with the headquarters located in the City of Ontario.\nInvestment Securities - The Company classifies as held to maturity those debt securities that it has the positive intent and ability to hold to maturity. All other debt and equity securities are classified as available for sale. Securities held to maturity are accounted for at cost, adjusted for amortization of premiums and accretion of discounts. Securities available for sale are accounted for at fair value, with the net unrealized gains and losses (unless other than temporary), net of income tax effects, presented as a separate component of stockholders' equity. Realized gains and losses on sales of securities available for sale are recognized in earnings at the time of sale and are determined on a specific identification basis.\nLoans and Lease Finance Receivables - Loans and lease finance receivables are reported at the principal amount outstanding, less deferred net loan origination fees and the allowance for credit losses. Interest on loans and lease finance receivables is credited to income based on the principal amount outstanding. Interest income is not recognized on loans and lease finance receivables when collection of interest is deemed by management to be doubtful.\nThe Bank receives collateral to support loans, lease finance receivables and commitments to extend credit for which collateral is deemed necessary. The most significant category of collateral is real estate, principally\ncommercial and industrial income-producing properties.\nNonrefundable fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. The deferred net loan fees and costs are recognized in interest income over the loan term in a manner that approximates the level-yield method.\nProvision and Allowance for Credit Losses - The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio and reflects an amount that, in management's judgment, is adequate to provide for potential credit losses after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience and such other factors as deserve current recognition in estimating credit losses. The provision for credit losses is charged to expense.\nOn January 1, 1995, the Bank 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.\" This statement prescribes that a loan is impaired when it is probable that a creditor will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement and provides guidance concerning the measurement of impairment on such loans and the recording of the related reserves. The adoption of this statement did not have a material affect on the results of operations or the financial position of the Bank taken as a whole.\nPremises and Equipment - Premises and equipment are stated at cost less accumulated depreciation, which is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives using the straight-line method. Properties under capital lease and leasehold improvements are amortized over the shorter of their economic lives or the initial term of the lease.\nOther Real Estate Owned - Other real estate owned, shown net of an allowance for losses of $1,195,843 and $1,180,090 at December 31, 1995 and 1994, respectively, represents real estate acquired through foreclosure in satisfaction of commercial and real estate loans and is stated at fair value, minus estimated costs to sell (fair value at time of foreclosure). Loan balances in excess of fair value of the real estate acquired at the date of acquisition are charged against the allowance for credit losses. Any subsequent operating expenses or income, reduction in estimated values, and gains or losses on disposition of such properties are charged to current operations.\nBusiness Combinations and Intangible Assets - The Company has engaged in the acquisition of financial institutions and the assumption of deposits and purchase of assets from other financial institutions in its market area. The\nCompany has paid a premium on each transaction that has been determined to be an intangible asset, in the form of goodwill. These intangible assets are being amortized over a 15-year period on a straight-line basis.\nIncome Taxes - Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income.\nEarnings per Common Share - Earnings per common share are computed on the basis of the weighted average number of common shares outstanding during the year, plus shares issuable upon the assumed exercise of outstanding common stock options (common stock equivalents). The weighted average number of common shares outstanding and common stock equivalents was 9,322,681 (1995), 9,211,154 (1994) and 9,089,379 (1993). Earnings per common share and stock option amounts have been retroactively restated to give effect to all stock splits and dividends.\nStatement of Cash Flows- Cash and cash equivalents as reported in the statements of cash flows include cash and due from banks and federal funds sold.\nRecent Accounting Pronouncements - In 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which is effective for fiscal years beginning after December 15, 1995 and encourages companies to account for stock compensation awards based on their fair value at the date the awards are granted. This statement does not require the application of the fair value method and allows the continuance of the current accounting method, which requires accounting for stock compensation awards based on their intrinsic value as of the grant date. The Company has chosen not to adopt the fair value provisions of SFAS No. 123 and will continue accounting for stock compensation awards at their intrinsic value at the date of grant.\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 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.\nReclassifications - Certain amounts in previous years' financial statements and related footnote disclosures were reclassified to conform to the current year presentation.\n2. INVESTMENT SECURITIES\nThe amortized cost and estimated fair value of investment securities are shown below. All securities held are publicly traded, and estimated fair value was obtained from an independent pricing service.\nA mortgage-backed security classified as held to maturity at December 31, 1995 and 1994 was transferred from the available for sale portfolio in June 1994. The unrealized loss on this security was approximately $467,000 and $672,000, net of accretion, at December 31, 1995 and 1994, respectively.\nThe CMO\/REMIC securities noted above represent collateralized mortgage obligations and real estate mortgage investment conduits. All are issues of U.S. government agencies that guarantee payment of principal and interest of the underlying mortgages.\nAt December 31, 1995 and 1994, investment securities having an amortized cost of approximately $116,056,000 and $114,669,000, respectively, were pledged to secure public deposits, short-term borrowings, and for other purposes as required or permitted by law.\nThe amortized cost and fair value of debt securities at December 31, 1995, by contractual maturity, are shown below. Although mortgage-backed securities and CMO\/REMIC's have contractual maturities through 2022, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty.\n3. LOANS AND LEASE FINANCE RECEIVABLES\nThe Bank grants loans to its customers throughout its primary market in the San Gabriel Valley, Inland Empire and Orange County areas of Southern California, which have recently experienced adverse economic conditions, including declining real estate values. These factors have adversely affected certain borrowers' ability to repay loans. Although management believes the level of allowances for credit losses is adequate to absorb losses inherent in the loan portfolio, additional declines in the local economy and\/or increases in the interest rate charged on adjustable rate loans may result in increasing loan losses that cannot be reasonably predicted at December 31, 1995.\nThe Bank makes loans to borrowers in a number of different industries. No industry had aggregate loan balances exceeding 10% of the December 31, 1995 or 1994 loan and lease finance receivables balance, with the exception of loans made to the agribusiness industry, which represents 13% and 11% of net loans outstanding at December 31, 1995 and 1994, respectively. At December 31, 1995, the Bank's loan portfolio included approximately $326.7 million of loans secured by commercial and residential real estate properties where the borrowers are involved in several industries.\nAt December 31, 1995 the Bank held approximately $247.6 million of fixed rate loans.\n4. TRANSACTIONS INVOLVING DIRECTORS AND SHAREHOLDERS\nIn the ordinary course of business, the Bank has granted loans to certain directors, executive officers and the businesses with which they are associated. All such loans and commitments to lend were made under terms\nthat are consistent with the Bank's normal lending policies.\nThe following is an analysis of the activity of all such loans:\n5. ALLOWANCE FOR CREDIT AND OTHER REAL ESTATE OWNED LOSSES\nActivity in the allowance for credit losses was as follows:\nAt December 31, 1995, the Bank had classified $559,233 of its loans as impaired and recorded a specific reserve of approximately $415,093 on such loans. At December 31, 1995, the Bank also classified $29,676,000 of its loans impaired, however, these loans are collateral dependent and, because the estimated fair value of the collateral exceeds the book value of the related loans at the date of measurement, no specific loss reserve was recorded on these loans in accordance with SFAS No. 114 at that date. The average recorded investment in impaired loans during the year ended December 31, 1995, was approximately $30,459,000. Interest income of $2,267,300 was recognized on impaired loans during the year ended December 31, 1995.\nAt December 31, 1995, loans on nonaccrual status totaled $13,289,000, all of which are included in the impaired loans discussed above, compared to $12,613,000 at December 31, 1994.\nDue to financial difficulties encountered by certain borrowers, the Bank has restructured the terms of certain loans to facilitate loan payments. As of December 31, 1995 and 1994, loans with these restructured terms totaled $13,558,000 and $8,954,000, respectively. The balance of impaired loans disclosed above includes all troubled debt restructured loans that, as of December 31, 1995, are considered impaired.\nInterest foregone on nonaccrual and restructured loans outstanding during the years ended December 31, 1995, 1994 and 1993 amounted to approximately $988,000, $1,363,000, and $1,186,000, respectively.\nActivity in the allowance for other real estate owned losses was as follows:\nThe Company incurred additional expenses of $1,359,884 (1995), $908,133 (1994) and $1,004,015 (1993) related to the holding and disposition of other real estate owned.\n6. PREMISES AND EQUIPMENT\nPremises and equipment consist of:\n7. INCOME TAXES\nIncome tax expense (benefit) comprised the following:\nIncome tax liability (asset) comprised the following:\nThe components of the net deferred tax asset are as follows:\nA reconciliation of the statutory income tax rate to the consolidated effective income tax rate follows:\n8. DEPOSITS\nTime certificates of deposit with balances of $100,000 or more amounted to approximately $109,040,000 and $68,089,000 at December 31, 1995 and 1994, respectively. Interest expense on such deposits amounted to approximately $4,924,000 (1995), $2,471,000 (1994) and $1,804,000 (1993).\n9. SHORT-TERM BORROWINGS\nOn November 29, 1995, the Bank entered into a short-term borrowing agreement with the Federal Home Loan Bank (\"FHLB\") maturing on November 29, 1996. At December 31, 1995, the Bank had borrowed $40,000,000 at 5.5% annual interest. The FHLB is holding certain investment securities of the Bank as collateral for the borrowings.\n10. COMMITMENTS AND CONTINGENCIES\nThe Company leases land and buildings under operating leases for varying periods extending to 2014, at which time the Company can exercise options that could extend the leases to 2031. The future minimum annual rental payments required, which have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1995, excluding property taxes and insurance, are approximately as follows:\n1996 $ 1,198,000 1997 1,178,000 1998 1,062,000 1999 1,086,000 2000 1,060,000 Succeeding years 3,117,000 ----------- Total minimum payments required $ 8,701,000 ===========\nTotal rental expense for the Company was approximately $1,785,000 (1995), $1,670,000 (1994) and $1,449,000 (1993).\nAt December 31, 1995, the Bank had commitments to extend credit of approximately $79,373,000 and obligations under letters of credit of $8,871,000. Commitments to extend credit are agreements to lend to customers, provided 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. Commitments are generally variable rate, and many of these commitments are expected to expire without being drawn upon. As such, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit underwriting policies in granting or accepting such commitments or contingent obligations as it does for on-balance-sheet instruments, which consist of evaluating customers' creditworthiness individually.\nStandby letters of credit written are conditional commitments issued by the Company to guarantee the financial 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 loan facilities to customers. When deemed necessary, the Company holds appropriate collateral supporting those commitments. Management does not anticipate any material losses as a result of these transactions.\nIn the ordinary course of business, the Company becomes involved in litigation. In the opinion of management and based upon discussions with legal counsel, the disposition of such litigation will not have a material effect on the Company's consolidated financial position or results of operations.\n11. EMPLOYEE PROFIT SHARING PLAN\nThe Bank sponsors a 401(k) and profit-sharing plan for the benefit of its employees. Employees are eligible to participate in the plan after 12 months of consecutive service, provided they have completed 1,000 service hours in the plan year. Employees may make contributions to the plan under the plan's 401(k) component, and the Bank may make contributions under the plan's profit-sharing component, subject to certain limitations. The Bank's contributions are determined by the Board of Directors, and amounted to approximately $780,000 (1995), $715,000 (1994) and $680,000 (1993).\n12. STOCK OPTION PLANS\nThe Company has 1981 and 1991 plans under which options to purchase shares of the Company's common stock have been or may be granted to certain officers and directors. Under the 1981 plan, which expired in 1994, there are 84,795 options outstanding. No further grants can be made under this plan. Although no more options can be granted under this plan, the options granted thereunder will remain outstanding until they are exercised or canceled pursuant to their terms. The 1991 plan authorizes the issuance of\nup to 1,244,485 shares. Option prices under both plans are to be determined at the fair market value of such shares on the date of grant, and options are exercisable in such installments as determined by the Board of Directors. Each option shall expire no later than ten years from the grant date.\nAt December 31, 1995, options for the purchase of 711,271 shares of the Company's common stock were outstanding under both plans, of which options to purchase 538,528 shares were exercisable at prices ranging from $2.00 to $12.81; 545,452 shares of common stock were available for the granting of future options under the 1991 plan. The status of all optioned shares is as follows:\nIn 1995, 1994 and 1993, the Company granted to a key executive 13,310, 24,200, and 22,000 shares, respectively, of the Company's common stock in accordance with his compensation agreement. The agreement also provides for the granting of an additional 29,282 shares through 1996, for which the executive is entitled to receive stock and cash dividends.\n13. REGULATORY MATTERS\nThe Company is subject to various regulatory capital requirements administered by the federal banking agencies. Under capital adequacy guidelines, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off- balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier I capital (primarily common stock and retained earnings less goodwill) to risk-weighted assets, and of Tier I capital to average assets.\nThe Company meets all capital adequacy requirements to which it is subject as of December 31, 1995. The Company is considered well capitalized. To be categorized as well capitalized, the Company must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage (tangible Tier 1 capital divided by average total assets) ratios.\nThe Company's actual capital ratios at December 31 are as follows:\nIn addition, California Banking Law limits the amount of dividends a bank can pay without obtaining prior approval from bank regulators. Under this law, the Bank could, as of December 31, 1995, declare and pay additional dividends of approximately $3,278,000.\nBanking regulations require that all banks maintain a percentage of their deposits as reserves at the Federal Reserve Bank. On December 31, 1995, this reserve requirement was approximately $16,684,000.\n14. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY\nSTATEMENTS OF EARNINGS (IN THOUSANDS)\nSTATEMENTS OF CASH FLOWS (IN THOUSANDS)\n15. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data follows:\n16. FAIR VALUE INFORMATION\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, \"Disclosures about Fair Value of Financial Instruments.\" The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could have realized in a current market exchange as of December 31, 1995 and 1994. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value are explained below:\nFor federal funds sold and cash and due from banks the carrying amount is considered to be a reasonable estimate of fair value. For investment securities, fair values are based on quoted market prices, dealer quotes and prices obtained from an independent pricing service.\nThe carrying amount of loans and lease financing receivables is their contractual amounts outstanding, reduced by deferred net loan origination fees, and the allocable portion of the allowance for credit losses. Variable rate loans are composed primarily of loans whose interest rates float with changes in the prime interest rate. The carrying amount of variable rate loans, other than such loans in nonaccrual status, is considered to be their estimated fair value.\nThe fair value of fixed rate loans, other than such loans in nonaccrual status, was estimated by discounting the remaining contractual cash flows using the estimated current rate at which similar loans would be made to borrowers with similar credit risk characteristics and for the same remaining maturities, reduced by deferred net loan origination fees and the allocable portion of the allowance for credit losses.\nAccordingly, in determining the estimated current rate for discounting purposes, no adjustment has been made for any change in borrowers' credit risks since the origination of such loans. Rather, the allocable portion of the allowance for credit losses is considered to provide for such changes in estimating fair value.\nThe fair value of loans on nonaccrual status has not been specifically estimated because it is not practicable to reasonably assess the credit risk adjustment that would be applied in the market place for such loans. As such, the estimated fair value of total loans at December 31, 1995 and\n1994 includes the carrying amount of nonaccrual loans at each respective date.\nThe amounts payable to depositors for demand, savings, money market accounts, the demand note to the U.S. Treasury, and short-term borrowings with the FHLB are considered to be stated at fair value. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nThe fair value estimates presented herein are based on pertinent information available to management as of December 31, 1995 and 1994. 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 that date, and, therefore, current estimates of fair value may differ significantly from the amounts presented above.\n17. BUSINESS ACQUISITIONS\nOn November 3, 1995, the Board of Directors of the Company and Citizens Commercial Trust and Savings Bank of Pasadena (\"Citizens\"), announced the execution of a definitive agreement regarding the acquisition of Citizens by the Bank.\nThe transaction is subject to appropriate regulatory approvals and approval by the shareholders of Citizens. It is anticipated that the transaction will close during the second quarter of 1996, with Citizens being merged into the Bank.\nOn October 20, 1995, the Bank purchased the Victorville branch of Vineyard National Bank (\"VNB\"). On June 24, 1994, the Company purchased Western Industrial National Bank (\"WINB\") and contributed the assets and liabilities of WINB to the Bank. In addition, the Bank assumed deposits and purchased certain assets of a failed institution, Pioneer Bank (\"PB\"), as of July 8, 1994, from the Federal Deposit Insurance Corporation. The results of operations since the dates of these acquisitions are included in the accompanying consolidated statements of earnings. A summary of the significant components of these transactions are as follows:\nINDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of CVB Financial Corp. Ontario, California:\nWe have audited the accompanying consolidated balance sheets of CVB Financial Corp. 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 consolidated financial statements are the responsibility of CVB Financial Corp.'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, such consolidated financial statements present fairly, in all material respects, the financial position of CVB Financial Corp. 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.\n\/S\/Deloitte & Touche LLP Deloitte & Touche LLP January 26, 1996 Los Angeles, California\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 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 hereinafter noted, the information concerning directors and executive officers of the Company is incorporated by reference from the section entitled \"DIRECTORS AND EXECUTIVE OFFICERS - Election of Directors\" and \"COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\" of the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year. For information concerning executive officers of the Company, see \"Item 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT\" above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning management remuneration and transactions is incorporated by reference from the section entitled \"DIRECTORS AND EXECUTIVE OFFICERS -Compensation of Executive Officers and Directors - Executive Compensation, - Employment Agreements and Termination of Employment Arrangements, - Stock Options, - Option Exercises and Holdings and - Compensation Committee Interlocks and Insider Participation\" of the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning security ownership of certain beneficial owners and management is incorporated by reference from the sections entitled \"INTRODUCTION - -Principal Shareholders\" and \"DIRECTORS AND EXECUTIVE OFFICERS - Election of Directors\" of the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning certain relationships and related transactions with management and others is incorporated by reference from the section entitled \"DIRECTORS AND EXECUTIVE OFFICERS--Certain Transactions\" of the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements\nReference is made to the Index to Financial Statements at page 43 for a list of financial statements filed as part of this Report.\nExhibits\nSee Index to Exhibits at Page 71 of this Form 10-K.\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nThe following compensation plans and arrangements are filed as exhibits to this Form 10-K: 1981 Stock Option Plan, Exhibit 10.1; Agreement by and among D. Linn Wiley, CVB Financial Corp. and Chino Valley Bank dated August 8, 1991, Exhibit 10.2; Chino Valley Bank Profit Sharing Plan, Exhibit 10.3; 1991 Stock Option Plan, Exhibit 10.17; Severance Agreement between John Cavallucci, Chino Valley Bank and CVB Financial Corp. dated March 26, 1991 and Waiver Agreement dated October 4, 1991, Exhibit 10.18; Key Employee Stock Grant Plan, Exhibit 10.19. See Index to Exhibits at Page 71 to this Form 10-K.\nREPORTS ON FORM 8-K\nNone\nUNDERTAKING FOR REGISTRATION STATEMENT ON FORM S-8\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. 2-76121 (filed February 18, 1982): Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange 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\npayment 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 27th day of March, 1996.\nCVB FINANCIAL CORP. (Registrant)\nBy \/S\/D.Linn Wiley D. LINN WILEY 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.\nSignature Title Date\n\/S\/George A. Borba Chairman of the Board March 27, 1996 George A. Borba\n\/S\/John A. Borba Director March 27, 1996 John A. Borba\n\/S\/Ronald O. Kruse Director March 27, 1996 Ronald O. Kruse\n\/S\/John J. LoPorto Director March 27, 1996 John J. LoPorto\n\/S\/Charles M. Magistro Director March 27, 1996 Charles M. Magistro\n\/S\/John Vander Schaaf Director March 27, 1996 John Vander Schaaf\n\/S\/Robert J. Schurheck Chief Financial Officer March 27, 1996 Robert J. Schurheck (Principal Financial and Accounting Officer)\n\/S\/D. Linn Wiley Director, President and March 27, 1996 D. Linn Wiley Chief Executive Officer (Principal Executive Officer)\nINDEX TO EXHIBITS\nExhibit No. Page\n3.1 Articles of Company, as amended.(1) *\n3.2 Bylaws of Company, as amended.(2) *\n10.1 1981 Stock Option Plan, as amended.(1) *\n10.2 Agreement by and among D. Linn Wiley, CVB Financial Corp. and Chino Valley Bank dated August 8, 1991.(2) *\n10.3 Chino Valley Bank Profit Sharing Plan, as amended.(3) *\n10.4 Definitive Agreement by and between CVB Financial Corp. and Huntington Bank dated January 6, 1987.(4) *\n10.5 Transam One Shopping Center Lease dated May 20, 1986, by and between Transam One and Chino Valley Bank for the East Chino Office.(4) *\n10.6 Sublease dated November 1, 1986, by and between Eldorado Bank and Chino Valley Bank for the East Highland Office.(4) *\n10.7 Lease Assignment, Acceptance and Assumption and Consent dated December 23, 1986, executed by the FDIC, Receiver of Independent National Bank, Covina, California, as Assignor, Chino Valley Bank, as Assignee, and INB Bancorp, as Landlord under that certain Ground Lease dated September 30, 1983 by and between INB Bancorp and Independent National Bank for the Covina Office.(4) *\n10.8 Lease Assignment dated May 15, 1987 and Consent of Lessor dated April 21, 1987 executed by Huntington Bank, as Assignor, Chino Valley Bank as Assignee and Gerald G. Myers and Lynn H. Myers as Lessors under that certain lease dated March 1, 1979 between Lessors and Huntington Bank for the Arcadia Office.(5) *\n10.9 Lease Assignment dated May 15, 1987 and Consent of Lessor dated March 18, 1987 executed by Huntington Bank, as Assignor, Chino Valley Bank as Assignee and George R. Meeker as Lessor under that certain Memorandum of Lease dated May 1, 1982 between Lessor and Huntington Bank for the South Arcadia Office.(5) *\n10.10 Lease Assignment dated May 15, 1987 and Consent of Lessor dated March 17, 1987 executed by Huntington Bank, as Assignor, Chino Valley Bank as Assignee and William R. Hayden and Marie Virginia Hayden as Lessor under that Certain Lease and Sublease, dated March 1, 1983, as amended, between Lessors and Huntington Bank for the San Gabriel Office.(5) *\n10.11 Lease Assignment dated May 15, 1987 executed by Huntington Bank as Assignor and Chino Valley Bank as Assignee under that certain Shopping Center Lease dated June 1, 1982, between Anita Associates, a limited partnership and Huntington Bank for the Santa Anita ATM Branch.(5) *\n10.12 Office Building Lease between Havenpointe Partners Ltd. and CVB Financial Corp. dated April 14, 1987 for the Ontario Airport Office.(5) *\n10.13 Form of Indemnification Agreement.(7) *\n10.14 Office Building Lease between Chicago Financial Association I, a California Limited Partnership and CVB Financial Corp. dated October 17, 1989, as amended, for the Riverside Branch.(1) *\n10.15 Office Building Lease between Lobel Financial Corporation and Chino Valley Bank dated June 12, 1990, for the Premier Results data processing center.(3) *\n10.16 Office Space Lease between Rancon Realty Fund IV and Chino Valley Bank dated September 6, 1990, for the Tri-City Business Center Branch.(3) *\n10.17 1991 Stock Option Plan.(6) *\n10.18 Severance Agreement between John Cavallucci, Chino Valley Bank and CVB Financial Corp. dated March 26, 1991 and Waiver Agreement dated October 4, 1991.(2) *\n10.19 Key Employee Stock Grant Plan.(8) *\n10.20 Lease by and between Allan G. Millew and William F. Kragness and Chino Valley Bank dated March 5, 1993 for the Fontana Office. (9) *\n10.21 Office Lease by and between Mulberry Properties and Chino Valley Bank dated October 12, 1992. (9) *\n10.22 First Amended and Restated Agreement and Plan of Reorganization by and between CVB Financial Corp., Chino Valley Bank and Fontana First National Bank, dated October 8, 1992 (11) *\n10.23 Purchase and Assumption Agreement among FDIC receiver of Mid City Bank, National Association, FDIC and Chino Valley Bank, dated October 21, 1993 (10) *\n10.24 Agreement and Plan of Reorganization by and between CVB Financial Corp., Chino Valley Bank and Western Industrial National Bank, dated November 16, 1993 (11) *\n10.24.1 Amendment No. 1 to Agreement and Plan of Reorganization by and between CVB Financial Corp., Chino Valley Bank and Western Industrial National Bank dated February 14, 1994. (12) *\n10.24.2 Amendment No. 2 to Agreement and Plan of Reorganization by and between CVB Financial Corp., Chino Valley Bank and Western Industrial National Bank dated June 23, 1994.(12) *\n10.25 Lease by and between Bank of America and Chino Valley Bank dated October 15, 1993, for the West Arcadia Office.(11) *\n10.26 Lease be and between RCI Loring and CVB Financial Corp dated March 11, 1993, for the Riverside Office. (11) *\n10.27 Lease by and between 110 Wilshire Building Partners, a California Partnership and Chino Valley Bank dated October 21, 1994 for the Fullerton Office (13) *\n10.28 Agreement and Plan of Reorganization between Chino Valley Bank, CVB Financial Corp. and Citizens Commercial Trust & Savings Bank of Pasadena, dated November 1, 1995. (14) *\n22 Subsidiaries of Company. (9) *\n23 Consent of Independent Certified Public Accountants. 75\n27 Financial Data Schedule 76\n*Not applicable.\n(1) Filed as Exhibits 3.1, 10.1 and 10.14 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, Commission file number 1-10394, which are incorporated herein by this reference.\n(2) Filed as Exhibits 3.2, 10.2 and 10.18 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission file number 1-10394, which are incorporated herein by this reference.\n(3) Filed as Exhibits 10.3, 10.15 and 10.16 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission file number 1-10394, which are incorporated herein by this reference.\n(4) Filed as Exhibits 10.4, 10.5, 10.6 and 10.7 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986, Commission file number 1-10394, which are incorporated herein by this reference.\n(5) Filed as Exhibits 10.8, 10.9, 10.10, 10.11 and 10.12 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, Commission file number 1- 10394, which are incorporated herein by this reference.\n(6) Filed as Exhibit 4.1 to Registrant's Registration Statement on Form S-8 (33-41318) filed with the Commission on June 21, 1991, which is incorporated herein by this reference.\n(7) Filed as Exhibit 10.13 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, Commission file number 1-10394, which is incorporated herein by this reference.\n(8) Filed as Exhibit 4.1 to Registrant's Registration Statement on Form S-8 (33-50442) filed with the Commission on August 1, 1992, which is incorporated herein by this reference.\n(9) Filed as Exhibit 10.20, 10.21 and 22 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission file number 1-10394, which are incorporated herein by this reference.\n(10) Filed as Exhibit 99 to the Registrant's Current Report on Form 8-K filed with the Commission on November 4, 1993, which is incorporated herein by this reference.\n(11) Filed as Exhibit 10.22, 10.24, 10.25 and 10.26 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission file number 1-10394, which are incorporated herein by this reference.\n(12) Filed as Exhibit 10.24.1 and 10.24.2 to the Registrant's current report on Form 8-K filed with the Commission on July 8, 1994, which are incorporated herein by this reference.\n(13) Filed as Exhibit 10.27 to the Registrants Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission file number 1- 10394, which is incorporated herein by this reference.\n(14) Filed as Exhibit 10.28 to the Registrants Quarterly report on Form 10-Q filed with the Commission on November 13, 1995 which is incorporated herein by this reference.\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in the 1981 Stock Option Plan Registration Statement No. 2-76121 on Form S-8, the 1991 Stock Option Plan Registration Statement No. 33-41318 on Form S-8 and the Key Employee Stock Grant Plan Registration Statement No. 33-50442 on Form S-8 of our report dated January 26, 1996, appearing on page 66 in this Annual Report on Form 10-K of CVB Financial Corp. for the fiscal year ended December 31, 1995.\n\/S\/Deloitte & Touche LLP Deloitte & Touche LLP March 27, 1996 Los Angeles, California","section_15":""}
{"filename":"785562_1995.txt","cik":"785562","year":"1995","section_1":"ITEM 1. BUSINESS\nIntroduction\nCorrections Services, Inc. (the \"Company\") was incorporated in the State of Florida in 1984. The Company was organized for the purpose of developing and marketing a house arrest program (\"Program\") to relieve the need for incarceration in a jail or similar facility. The Program consists of computer-controlled, electronic signaling systems which permit continuous around the clock monitoring of a client\/inmate's presence or absence from his or her residence.\nBackground\nThe Company undertook to secure equipment which would be responsive to the needs of corrections authorities and began to market its Program with a new hardware system supplied by an independent manufacturer. During 1986, the Company secured registration of its trademark \"In-House-Arrest\" from the United States Patent and Trademark office (Registration No. 1,394,745).\nBeginning in 1988 the Company's system was manufactured by Marconi Electronic Devices, Ltd. (\"Marconi\") in the United Kingdom. Following a long period of difficulties and shortfall, the Company filed a federal lawsuit against Marconi for breach of contract and breach of warranty, seeking damages and ending its turbulent manufacturing and supply arrangement with Marconi. On July 28, 1993 a settlement agreement was entered into fully and finally terminating the litigation.\nPursuant to the settlement agreement, the Company transferred certain product equipment, intellectual property rights in the systems' equipment design and software and a three year covenant not to compete to Marconi. In exchange, the Company received extinguishment of its approximately $2.1 Million payable to Marconi and the sum of $250,000 in cash. Following closing of the settlement agreement the Company, within the bounds of its non- compete agreement, continued to service its existing customer base.\nSubsequent Developments\nSubsequent to the litigation settlement, Marconi sold all of its tangible and intangible assets related to the system's equipment production, sales and service to Aeroflex Laboratories, Inc. of Plainview, New York. After settlement of the litigation in mid-1993, neither Marconi nor Aeroflex had engaged in any operations in the monitoring systems marketplace. In late May 1994, the Company approached Aeroflex with a view toward purchase of all of the system assets and release from its non-compete\nagreement with Marconi.\nOn July 1, 1994, the Company both re-acquired from Aeroflex all of the system equipment it had relinquished in the litigation settlement agreement, and acquired all of the other tangible and intangible assets related to production, sales and service of the product line previously acquired by Aeroflex from Marconi, including completed parts and parts for construction of additional units, all of the related software, firmware, tooling, tools and test equipment and all intellectual property including patents and design and manufacturing drawings, schematics, information and records. The Company was also able to secure unconditional release from the non-compete agreement with Marconi.\nIn exchange, the Company paid Aeroflex Laboratories, Inc. the sum of $100,000 in cash and released Aeroflex Laboratories, Inc. and Marconi from liability for equipment field service obligations, including outstanding, unexpired manufacturer's equipment warranties, which obligations were assumed by the Company.\nWith completion of the Aeroflex transaction in mid-1994 the Company in effect, negated all of the limiting factors imposed encountered by settlement of the litigation against Marconi in mid- 1993. The Company re-entered the marketplace depending upon its newly acquired, finished equipment inventory, and continues on- going evaluation of manufacturing options for possible future implementation prior to potential exhaustion, if any, of its finished equipment inventory.\nEmployees\nIn addition to its officers, Mr. Norman H. Becker and Mr. Frank R. Bauer, who each currently devote approximately ten (10%) percent of their time to its activities, and Ms. Diane Martini, who currently devotes approximately eighty (80%) percent of her time to its activities, the Company currently has five (5) other full-time employees See Part III., Item 10, Directors and Executive Officers of the Registrant.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company occupies its principal offices and shop facilities space on a month-to-month basis at a combined rental and administrative charge of $2,600 per month ($31,200 per annum).\nThe Company also occupies warehouse space in the City of Pompano Beach, Florida on an annual lease basis at a rental of $791 per month ($9492 per annum).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not now a party to any litigation or, to its knowledge, threatened litigation, at March 11, 1996 other than the following:\nEstate of Holly Staker, et al vs. Correction Services, Inc., Lake County and Electronic Supervision Services Corp., Case No. 94-L- 141, Circuit Court of the Nineteenth Judicial Circuit In And For Lake County, Illinois.\nOn February 28, 1994, the Company was served with a wrongful death complaint arising from the violent death of Ms. Holly Staker on or about August 17, 1992 at the hands of an individual who was at the time assigned to the In-House Arrest system owned and operated, on the Company's information and belief, by the Lake County Sheriff's or Corrections Department.\nThe Complaint seeks money damages for Ms. Staker's wrongful death in an unspecified amount and is brought by the Decedent's estate and various individuals under Illinois wrongful death statutes. The Complaint was twice dismissed at the Company's instance. The Plaintiff has appealed the Court's dismissal of the suit. The appeal is currently in the pleading (brief) stage and no decision has been reached. The amended complaint alleged unspecified \"malfunction\" and sought to impose strict liability to the seller for consequences of the prisoner's subsequent illegal acts.\nThe Company's appellate counsel is unable to estimate the likely outcome of the appeal.\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 fiscal 1995, through solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe following table sets forth the range of bid and asked prices for the Company's Common Stock on the Over-The-Counter Market for the period indicated, as reported by the National Quotation Bureau, Inc. The Common Stock is traded on the electronic bulletin board under the symbol CRSI. The figures shown represent inter-dealer quotations without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\n(b) Holders. As of March 11, 1996, the approximate number of recordholders of Common Stock of the Registrant was 575.\nThe Company is unable to determine the actual number of beneficial holders of its Common Stock at March 11, 1996 due to Common Stock held for stockholders \"in street name\" but estimates the current total to be approximately 1,050.\n(c) Dividends. Registrant has paid no dividends since inception and does not now anticipate paying cash dividends in the foreseeable future. See Item 7.(a) Financial Condition.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\n(a) Financial Condition. As of December 31, 1995 the Company had current assets of $1,079,708 compared to $1,093,577 at December 31, 1994, total assets of $1,087,236 compared to $1,101,968 at December 31, 1994 and shareholders equity of $957,003 as compared to $979,720 as of December 31, 1994. The decrease of its current assets and total assets were primarily the result of the Company's decrease in accounts receivable and merchandise inventory. See Part I, Item 1., Business, Recent Developments. The decrease in shareholders equity at December 31, 1995 to $957,003, from $979,720 at December 31, 1994, was primarily the result of earnings of a net loss of $22,717 for the year ended December 31, 1995.\nAt December 31, 1995, the Company realized a net loss for the year then ended which decreased shareholders equity from $979,720 at year end 1994, to $957,003 at year end 1995.\nLiquidity. The Company had a net decrease in cash and cash equivalents for the year ended December 31, 1995 of $2,740, and cash and cash equivalents at the end of the year of $261,385 as compared to an increase in cash and cash equivalents of $90,129, and cash and cash equivalents of $264,125 for the year ended December 31, 1994. See Part II, Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee attached financial statements and supplementary data.\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)(b) Identification of Directors and Executive Officers\nName Age Offices Held\nNorman H. Becker 58 President\/Director\nFrank Bauer 51 Vice President\/ Director\nDiane Martini 48 Secretary\/Treasurer\/ Director\nEugene M. Kennedy 58 Director\nRobert B. Yeakle 57 Director\n(1)(c) Identification of Certain Significant Employees. In addition to its officers and directors, the Company has a continuing consulting arrangement with Vanderbilt Square Corp., a publicly held Florida corporation pursuant to which Vanderbilt Square provides management consultation, financial planning and day-to-day assistance and administrative support services on an as needed basis, primarily in this reporting period, as in previous periods, through the personal efforts and supervision of Ronald A. Martini, its Vice President and director, who devotes approximately 50% of his time to those activities. In the interest of maintaining management attention to the Company's operations, Martini, who is also a principal shareholder of the Company, took on a primary role with respect to the Company's management and administration of pending litigation matters. See Part I, Item 3., Legal Proceedings. See (1)(e) Business Experience. See Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management. Ronald A. Martini is the spouse of the Company's Secretary\/Treasurer and Director, Diane Martini.\nMr. Becker is also President and a Director of Vanderbilt Square Corp., Mr. Kennedy is legal counsel to the Company and has also provided legal services to Vanderbilt Square. Mr. Yeakle, who resigned the presidency of the Company on May 1, 1992, is also a principal stockholder of Vanderbilt Square Corp.\nThe Company's officers receive varying assistance and support in their respective areas from Vanderbilt Square Corp.. The formal arrangement between the Company and Vanderbilt Square Corp. expired by its terms during February, 1994 but has continued thereafter on an as-needed albeit reduced basis.\n(1)(e) Business Experience.\nNorman H. Becker has been a director of the Company since July 1, 1987. On January 15, 1993, Mr. Becker was appointed the Company's President. In addition he has, since its inception, been an officer and a director of Vanderbilt Square Corp., a publicly held Florida corporation. Since January, 1985, Mr. Becker has also been self-employed in the practice of public accounting in Hollywood, Florida. Mr. Becker is a graduate of City College of New York (Bernard Baruch School of Business) and is a member of a number of professional accounting associations including the American Institute of Certified Public Accountants, the Florida Institute of Certified Public Accountants and the Dade Chapter of Florida Institute of Certified Public Accountants.\nFrank R. Bauer has been an Officer and a director of the Company since February 15, 1988 and its Vice President since January 4, 1993. Mr. Bauer is also President and Chief Executive Officer of Specialty Device Installers, Inc., a Florida corporation engaged in outside plant utility and construction contracting. Mr. Bauer holds the Bachelor of Business Administration Degree from Stetson University.\nDiane Martini has been Secretary\/Treasurer and a director of the Company since January 12, 1993. Ms. Martini is also Secretary\/Treasurer of Vanderbilt Square Corp., an affiliate of the Company. Ms. Martini is also President and Chief Executive Officer of Financial Communications, Inc., a privately held Florida public relations and business consulting firm. Ms. Martini is married to the Company's principal shareholder, Ronald A. Martini. See Part IV., Item 12.\nEugene M. Kennedy has been a director of the Company since March 15, 1989. Mr. Kennedy has also been the Company's legal counsel since September, 1985. Mr. Kennedy operates his own private law practice in Fort Lauderdale, Florida. He holds the Bachelor of Science Degree in Physics from the City University of New York, has attended the Masters in Business Administration Program at Adelphi University, in Garden City, New York, and holds the Juris Doctor Degree from the University of Miami School of Law in Coral Gables, Florida.\nRobert B. Yeakle resigned as an officer of the Company on May 1, 1992. Until that point, he was the Company's President and a Director and had been since June 22, 1989 and continues as a member of the Board. In January, 1988 Mr. Yeakle retired from Alexander Proudfoot & Company in West Palm Beach, Florida, having spent the prior 21 years in various executive management positions within the Proudfoot organization, to manage his personal investments. Alexander Proudfoot & Co. is a $200 million, publicly held management consulting company which is traded on the London Stock Exchange. During April, 1991, Mr. Yeakle returned to Alexander\nProudfoot & Company in an executive capacity and currently devotes only a minimum of his time to the Company's affairs. Mr. Yeakle attended the School of Engineering at Rutgers University in New Brunswick, New Jersey.\nRonald A. Martini is Vice-President and a director of the Company's affiliate, Vanderbilt Square Corp., a publicly held Florida corporation. See (1)(c) Identification of Certain Significant Employees. He is also Vice-President and a director of Financial Communications, Inc., a privately held public relations and business consulting firm in Fort Lauderdale, Florida. Mr. Martini is married to the Company's Secretary\/Treasurer and director, Diane Martini. On April 24, 1990, Martini entered a guilty plea in the United States District Court for the District of New Jersey to violations of federal conspiracy, mail fraud and securities laws in connection with transactions in securities of public companies unrelated to the Company during a fifteen (15) month period of 1988 through 1989.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCompensation\nMessrs. Norman H. Becker and Frank Bauer, devote approximately 10% of their time, respectively, to the Company's affairs. Ms. Diane Martini currently devotes approximately 80% of her time to the Company's affairs. There are no employment agreements in effect or presently contemplated. The total compensation received by all Executive Officers of the Company during the year ended December 31, 1995 was received entirely by Diane Martini and amounted to $36,042.\n(1) Mr. Becker received a total of $11,157 in accounting fees from the Company during 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(1) Based upon 5,126,900 shares outstanding at March 11, 1996.\n(2) Vanderbilt Square Corp. owns 950,000 shares of the Company's Common Stock at March 11, 1996. Ronald A. Martini, Diane Martini and Norman H. Becker are also officers, directors and principal shareholders of Vanderbilt Square Corp. Diane Martini and Ronald A. Martini are married to each other. Robert B. Yeakle is also a principal shareholder of Vanderbilt Square Corp. See Part III, Item 10. \"Business Experience\". All four individuals disclaim any beneficial ownership interest in the Company's Common Stock owned by Vanderbilt Square Corp. See Item 8., Financial Statements - Notes to Consolidated Financial Statement, Note F.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nTransactions with Management and Others\nOn February 23, 1989, the Company and Vanderbilt Square Corp. entered into a continuing consulting arrangement pursuant to which Vanderbilt assisted the Company in its operations, provided access to potential financing sources if needed and provided consultation and services related to administrative, bookkeeping and accounting matters. The formal consulting agreement expired by its terms on February 23, 1994 and the arrangement has continued thereafter on an as-needed albeit reduced, basis. During 1995, the Company paid Vanderbilt Square Corp. a total of $18,000 for such services.\nIn addition, the Company paid a total of $79,800 to various affiliates of the Company's principal shareholder, Ronald A. Martini, in the nature of consulting fees, rentals and office and administrative services. See \"Financial Statements - Notes to Consolidated Financial Statements, Note G\".\nCertain Business Relationships\nDuring the year ended December 31, 1995, the Company paid its director, Eugene M. Kennedy, $4,471 in legal fees and costs reimbursement in connection with legal services rendered to the Company by his law firm.\nIn addition, the Company paid its President and director, Norman H. Becker accounting fees of $11,157.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\nFinancial Statements:\nReport of Independent Certified Public Accountant.\nConsolidated Balance Sheet - December 31, 1995 and December 31, 1994.\nConsolidated Statement of Operations - Three Years Ended December 31, 1995.\nConsolidated Statement of Shareholders' Equity - Three Years Ended December 31, 1995.\nConsolidated Statement of Cash Flows - Three Years Ended December 31, 1995.\nNotes to Consolidated Financial Statements.\n2. Schedules:\nSchedule I Marketable Securities - Other Investments\nSchedule II Amounts Receivable from Related Parties, Underwriters, Promoters and Employees other than Related Parties\nSchedule VIII Valuation and Qualifying Accounts\nSchedule X Supplementary Income Statement Information\nAll other financial statements 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.\nExhibits:\nArticles of Incorporation and By-Laws:\nArticles of Incorporation and By-Laws incorporated by reference to the filing of the original registration statement on Form S-18.\nInstruments defining the rights of security holders, including indentures:\nNot applicable.\nVoting Trust Agreement:\nNot applicable.\nMaterial Contracts:\nNot applicable.\nStatement Re: Computation of per share income (loss):\nSee Note \"A\"., Notes to Consolidated Financial Statements and Statement of Operations Three Years Ended December 31, 1995.\nStatements RE: Computation of Ratios:\nNot applicable.\nAnnual Report to Security Holders, Form 10-Q or quarterly report to security holders:\nNot applicable.\nLetter re: Change in accounting principles:\nNot applicable.\nPreviously unfiled documents:\nNot applicable.\nOther Documents or Statements to Security Holders:\nNot applicable.\nSubsidiaries of the Registrant:\nCorrections Services International, Inc.\nPublished report regarding matters submitted to vote of Security Holders:\nNot applicable.\nConsents of experts and counsel:\nNot applicable.\nPower of Attorney:\nNot applicable.\nAdditional Exhibits:\nThe Registrant filed no current reports on Form 8-K during the fourth quarter of 1995.\nSIGNATURES\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, in the City of Fort Lauderdale, State of Florida, on the 27th day of March, 1996.\nCORRECTIONS SERVICES, INC.\nBY:\/S\/ Norman H. Becker Norman H. Becker, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nSignatures Title Date\n(i) Principal Executive Officer President March 27, 1996\n\/S\/ Norman H. Becker Norman H. Becker\n(ii) Principal Financial and Secretary March 27, 1996 Accounting Officer\n\/S\/ Diane Martini Diane Martini\n(iii) A Majority of the Board Director March 27, 1996 of Directors\n\/S\/ Frank Bauer Director March 27, 1996 Frank Bauer\n\/S\/ Norman H. Becker Director March 27, 1996 Norman H. Becker\n\/S\/ Eugene M. Kennedy Director March 27, 1996 Eugene M. Kennedy\nDirector March 27, 1996 Robert B. Yeakle\nCONTENTS\nPAGE\nAUDITOR'S REPORT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1\nCONSOLIDATED BALANCE SHEET. . . . . . . . . . . . . . . . . . . . . . . . . 2\nCONSOLIDATED STATEMENT OF OPERATIONS. . . . . . . . . . . . . . . . . . . . 3\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) . . . . . . . . . . . . . . . . . . . . 4\nCONSOLIDATED STATEMENT OF CASH FLOWS. . . . . . . . . . . . . . . . . . . . 5\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . .6-12\nBoard of Directors and Shareholders Corrections Services, Inc. and Subsidiary Fort Lauderdale, Florida\nINDEPENDENT AUDITOR'S REPORT\nI have audited the accompanying consolidated balance sheets of Corrections Services, Inc. and Subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of operations and shareholders' equity and cash flows for each of the three years ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. My responsibility is to express an opinion on these consolidated 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 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. I believe that my audits provide a reasonable basis for my opinion.\nIn my opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Corrections Services, Inc. and Subsidiary as of December 31, 1995 and 1994, and the results of its consolidated operations and its consolidated cash flows for the three years ended December 31, 1995, in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that Corrections Services, Inc. and Subsidiary will continue as a going concern. As more fully described in Note B, the Company has incurred substantial operating losses in previous years. In addition, a substantial portion of the Company's sales were made to one customer. These conditions raise questions about the Company's ability to continue as a going concern. The Company's continued existence is dependent upon its ability to preserve its existing\nBoard of Directors and Shareholders Corrections Services, Inc. and Subsidiary Page Two\nworking capital, continue to successfully sell its products and continue to achieve profitable operations. The financial statements do not include any adjustments to reflect the possible future effects on the recovery and classification of assets or the amounts and classification of liabilities that may result from the possible inability of Corrections Services, Inc. and Subsidiary to continue as a going concern.\nThomas W. Klash Certified Public Accountant Hollywood, Florida February 7, 1996\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET DECEMBER 31, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\n-2(a)-\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET DECEMBER 31, 1995 AND 1994\n-2(b)-\nCORRECTIONS SERVICES, INC. CONSOLIDATED STATEMENT OF OPERATIONS THREE YEARS ENDED DECEMBER 31, 1995\n-3(a)-\nCORRECTIONS SERVICES, INC. CONSOLIDATED STATEMENT OF OPERATIONS THREE YEARS ENDED DECEMBER 31, 1994\nSee accompanying notes to consolidated financial statements.\n-3(b)-\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Deficiency) THREE YEARS ENDED DECEMBER 31, 1995\nSee accompanying notes to consolidated financial statements.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995\nContinued on next page\n-5(a)-\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995\nSee accompanying notes to consolidated financial statements.\n-5(b)-\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Capitalization\nCorrections Services, Inc. (the \"Company\") was incorporated under the laws of the State of Florida on September 14, 1984. The Company's articles of incorporation originally provided for the issuance of 100 shares of common stock, with a par value of $5 per share. On November 13, 1985, the authorized number of shares was increased to 10,000,000 shares, with a par value of $.0001 per share. In that connection, the 100 shares of common stock outstanding prior to that date were exchanged for 2,115,000 shares.\nGeneral\nThe Company commenced its operational activities for accounting purposes on February 5, 1985. Through December 31, 1986, the Company was principally engaged in organization, initial marketing, program design and implementation, as well as system hardware and software design activities and raising capital. Revenues earned through December 31, 1986, were primarily the result of test marketing sales to a limited number of customers. During 1987, the Company successfully installed its equipment in a number of sites throughout the country.\nBusiness Activity\nAs a result of agreements reached with its former manufacturing supplier, the Company sells in-house arrest systems and now provides maintenance, repair and replacement of in-house arrest systems previously sold to customers. The in-house arrest system consists of a computer controlled electronic signalling system to permit continuous monitoring of the user's presence or absence from his residence during the period of the individual's home restriction and confinement sentence.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiary, Corrections Systems International, Inc. All significant intercompany accounts and transactions have been eliminated.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nCash and Cash Equivalents - For purposes of the balance sheet and 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.\nInventory - Inventory which is comprised principally of computers, monitors, TX's and parts, is valued at the lower of cost or market using the first-in, first-out method.\nInvestment in Marketable Equity Securities - The Company's investment in marketable equity securities consists of trading securities as defined in FASB Statement No. 115. Trading securities are carried at market value in the accompanying balance sheets. Unrealized gains and losses resulting from fluctuations in the market price of the related securities are currently reflected in the statement of operations.\nProperty and Equipment - Property and equipment is recorded at cost. Expenditures for major betterments and additions are charged to the asset accounts, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are charged to expense currently.\nDepreciation is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives are as follows:\nComputer and monitor equipment 3 years Molds, dies and tooling costs 5 years Office furniture and equipment 5 years Software 3 years Leasehold improvements 3 years\nProduct Warranty - The Company warranties its products for a specified time after a sale. The Company's supplier warranties its product for a similar time period. Due to the nature of these warranties, all expenses relating to repair of units sold is expensed as incurred and, accordingly, no provision for warranty liability has been made.\nDeferred Revenue - Deferred revenue represents the unearned portion of customers' payments relating to equipment maintenance and leasing contracts.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nNet Income (Loss) Per Common Share - Net income (loss) per common share was computed by dividing the net income (loss) for each period by the weighted average number of common shares outstanding during each period.\nResearch and Development - The Company has expensed all costs incurred in establishing technological feasibility of computer software intended for sale to customers. Certain research and development costs incurred for computer software are capitalized, such as costs incurred for producing product masters, including costs for coding and testing. Such capitalized software costs are amortized over a three year period.\nRevenue Recognition - The Company recognizes revenue at the time merchandise is shipped to the customers. Installation and training costs associated with the sale are generally recorded in the same period.\nNOTE B - BASIS OF PRESENTATION\nThe Company's continued existence is dependent upon its ability to preserve working capital, obtain an alternative source of revenues sufficient to absorb operating expenses, and achieve profitable operations. The Company intends to reduce its operating expenses and hopes to realize increased revenues from its repair and maintenance operations.\nNOTE C - PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\n1995 1994\nLeasehold improvements $ 3,170 $ 1,679 Office furniture and equipment 56,427 56,143 Computer and monitoring equipment 113,834 113,167\n173,431 170,989\nLess accumulated depreciation and amortization 168,181 165,699\n$ 5,250 $ 5,290\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE D - INCOME TAXES\nThe components of the provisions for income taxes are as follows for the three years ended December 31, 1995:\n1995 1994 1993\nFederal $ - $61,110 $ - State - 11,328 - - 72,438 -\nSignificant components of deferred tax benefits are as follows:\nCurrent Tax Benefit Assets\nAllowance for market decline of equity securities $ 71,141 Allowance for doubtful accounts 850 Total Current Tax Benefit 71,991\nNon-Current Tax Benefit Assets\nTax loss carry forward at December 31, 1995 268,540 Capital loss carry forward at December 31, 1995 31,666 Total Non-current Benefit 300,206\nTotal Current and Noncurrent Tax Benefit 372,197 Valuation Allowance (372,197)\nNet Deferred Tax Assets $ -\nAt December 31, 1995, management is unable to predict profitable operations for the Company in the future.\nAt December 31, 1995, the Company had available net operating loss carryforwards for financial and tax reporting purposes of approximately $789,823 and capital loss carry- forward amounting to approximately $93,000 expiring at various times through 2006.\nThe Company adopted Statement of Financial Accounting Standards No. 109 in 1993. There was no effect on the 1993 financial statements as a result of adopting this statement. The Company has fully reserved for the benefit of the net operating loss carry-forwards.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE E - MAJOR CUSTOMERS\nSales to customers individually representing more than 10% of combined revenues amount to $244,622 in 1995, $432,796 in 1994, and $382,672 in 1993. In 1995, two customers accounted for 35% and 12% respectively. In 1994, two customers accounted for 49% and 10% respectively. In 1993, two customers accounted for 52% and 11% respectively.\nNOTE F - CONSULTING AGREEMENT\nOn February 23, 1989, the Company entered into a 5-year agreement with Vanderbilt Square Corp. The agreement provided that Vanderbilt Square Corp. assist the Company in its sales and marketing operation, provide access to potential lenders, provide assistance in administrative, bookkeeping, and accounting matters, provide in its sole discretion, up to $200,000 in lease financing, and guarantee in its sole discretion, payment for product equipment purchased by the Company. In consideration of the aforementioned services, the Company paid $233,333 represented by the issuance of 1,000,000 shares of the Company's restricted common stock during 1990 and 1989. The agreement expired by its terms on February 23, 1994.\nConsulting fees expense relating to this agreement amounted to a final payment of $3,940 in 1994, and to $46,656 in 1993. The Company paid Vanderbilt Square Corp. a total of $18,000 during 1995 for services on an as-needed basis.\nNOTE G - RELATED PARTY TRANSACTIONS\nProfessional and Consulting Fees - the Company paid officers, directors, shareholders and affiliates professional and consulting fees amounting to $82,228 in 1995, $123,136 in 1994 and $155,161 in 1993.\nProduct Repair - Amounts paid for repair of monitoring units, to a company owned by the Company's then secretary- treasurer amounted to -0- in 1994 and 1993.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE G - RELATED PARTY TRANSACTIONS (Contd..)\nOffice Expense - Office expenses were paid to shareholders and\/or entities affiliated through common officers, directors and shareholders amounting to $10,200 in 1995, $20,474 in 1994 and $21,824 in 1993.\nRent Expense - Rentals paid to entities having officers, directors and shareholders in common with the Company amounted to $21,000 in 1995, 1994 and 1993.\nNOTE H - LITIGATION\nThe Company was named as a party defendant in an Illinois action arising for the death of an individual at the hands of a house arrest detainee. The complaint alleged that the decedent's demise was a consequence of unspecified \"malfunction\" of equipment previously marketed by the Company. The lawsuit sought money damages in an unspecified amount. The complaint was twice dismissed at the Company's motion. The dismissal has been appealed. The Company's litigation counsel is unable to estimate the outcome of this suit. Management intends to continue to contest the suit vigorously.\nNOTE I - RENTAL COMMITMENTS\nRent expense incurred for the occupancy of general office and storage facilities amounted to $31,162 in 1995, $30,125 in 1994 and $27,363 in 1993. At December 31, 1995, there were no fixed annual rental commitments.\nNOTE J - INVESTMENTS IN MARKETABLE EQUITY SECURITIES\nAt December 31, 1995, the Company's investment in marketable equity securities consisted entirely of trading securities as follows:\nMarket Cost Value\nInvestments in corporate equity securities of related parties $ 56,884 $ 71,974 Investment in corporate equity securities - other 741,186 516,856 $798,070 $588,830\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE J - INVESTMENTS IN MARKETABLE EQUITY SECURITIES (Contd..)\nThe Company adopted FASB No. 115 on January 1, 1994. Prior to that date the Company's investment in marketable equity securities were carried at the lower of cost or market. At December 31, 1993, the Company's portfolio of equity securities was carried at market value, which was less than cost.\nUnrealized losses on changes in market values of marketable equity securities amounted to $30,801 in 1995, $138,115 in 1994 and $21,218 in 1993.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT ON FINANCIAL STATEMENTS SCHEDULES\nBoard of Directors and Shareholders Corrections Services, Inc. and Subsidiary Ft. Lauderdale, Florida\nI have examined the financial statements of Corrections Services, Inc. and Subsidiary as of December 31, 995 and 1994, and for each of the three years ended December 31, 1995 and have issued my report thereon dated February 7, 1995. In connection with my examination, I also examined the financial statement schedules listed in Item 14(a)(2). In my opinion, these schedules, when considered in relation to the basic financial statements, present fairly in all material respects the information set forth therein.\nThomas W. Klash Certified Public Accountant Hollywood, Florida February 7, 1996\nNote: Balance Sheet valuation based upon aggregated lower of cost or market\n* Companies affiliated through common management and principal shareholders\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY MARKETABLE SECURITIES - OTHER INVESTMENTS DECEMBER 31, 1994 SCHEDULE I\nNote: Balance Sheet valuation based upon aggregated lower of cost or market\n*Companies affiliated through common management and principal shareholders\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 31, 1995\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 31, 1994\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 31, 1993\nNotes\n(a) Written off to gain extinguishment of debt.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1995\nCharged to Costs Item and Expenses\n1. Maintenance and repairs $ 12,387\n2. Depreciation and amortization (1)\n3. Taxes, other than payroll and income taxes 6,639\n4. Royalties -\n5. Advertising -\n(1) Less than 1% of revenues.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1994\nCharged to Costs Item and Expenses\n1. Maintenance and repairs (1)\n2. Depreciation and amortization $ 10,282\n3. Taxes, other than payroll and income taxes (1)\n4. Royalties -\n5. Advertising -\n(1) Less than 1% of revenues.\nCORRECTIONS SERVICES, INC. AND SUBSIDIARY SCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION\nDECEMBER 31, 1993\nCharged to Costs Item and Expenses\n1. Maintenance and repairs (1)\n2. Depreciation and amortization $ 41,979\n3. Taxes, other than payroll and income taxes 12,224\n4. Royalties -\n5. Advertising -\n(1) Less than 1% of revenues.","section_15":""}
{"filename":"86144_1995.txt","cik":"86144","year":"1995","section_1":"ITEM 1. BUSINESS AND ITEM 2.","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation about legal proceedings appearing under the caption \"Legal Matters\" as reported in Note J to the consolidated financial statements on pages 35 and 36 of the Company's 1995 Annual Report to Stockholders is incorporated herein by this 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 stockholders during the fourth quarter of 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe names and ages of the current executive officers of the Company and their positions as of March 19, 1996, are set forth below. Unless otherwise indicated, each of the executive officers served in various managerial capacities with the Company over the past five years. None of the executive officers named below is related to any other executive officer or director by blood, marriage or adoption. Officers serve at the discretion of the Board of Directors.\nSAFEWAY INC. AND SUBSIDIARIES\nEXECUTIVE OFFICERS OF THE COMPANY (CONTINUED)\n- ---------------- (1) Previously the owner of Burd & Associates, a management consulting firm.\n(2) During 1994, Mr. Ching was the General Manager - North America for the British American Consulting Group. From 1979 to 1994, he was employed by Lucky Stores, Inc., where he was the Senior Vice President of Information Systems beginning in 1989.\n(3) Previously self-employed as an independent consultant.\n(4) Previously a partner at the law firm of Latham & Watkins.\nCompliance with Section 16(a) of the Exchange Act. Information appearing under the caption \"Compliance with Section 16(a) of the Exchange Act\" in the Company's 1996 Proxy Statement is incorporated herein by this reference.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock, $0.01 par value, is listed on the New York Stock Exchange and the Pacific Stock Exchange. Information as to quarterly sales prices for the Company's common stock appears in Note L to the consolidated financial statements on page 37 of the Company's 1995 Annual Report to Stockholders and is incorporated herein by this reference. There were 5,144 stockholders of record as of March 19, 1996; however, approximately 47% of the Company's outstanding stock is held in \"street name\" by depositories or nominees on behalf of beneficial holders. The price per share of common stock was $27.5 as of the close of business on March 19, 1996.\nSAFEWAY INC. AND SUBSIDIARIES\nHolders of common stock are entitled to receive dividends if, as, and when declared by the Board of Directors out of funds legally available therefor, subject to the dividend and liquidation rights of any preferred stock that may be issued and subject to the dividend restrictions in the Credit Agreement and the indentures relating to the Notes and Debentures. Information as to dividend restrictions is included in the first paragraph under the caption \"Restrictive Covenants\" in Note B to the consolidated financial statements on page 28 of the Company's 1995 Annual Report to Stockholders and is incorporated herein by this reference. The Company has not paid dividends on common stock through 1995 and has no current plans for dividend payments.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe \"Five-Year Summary Financial Information\" included on page 15 of the Company's 1995 Annual Report to Stockholders is incorporated herein by this reference. The Five-Year Summary should be read in conjunction with the Company's consolidated financial statements and accompanying notes included under Item 8, Consolidated Financial Statements and Supplementary Data.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation appearing under the caption \"Financial Review\" on pages 16 through 18 and under the caption \"Capital Expenditure Program\" on page 14 of the Company's 1995 Annual Report to Stockholders is incorporated herein by this reference.\nInformation appearing under the caption \"New Accounting Standards\" on page 27 of the Company's 1995 Annual Report to Stockholders is incorporated herein by this reference.\nInformation regarding the terms of outstanding indebtedness appearing in Note B to the consolidated financial statements on pages 27 through 29 of the Company's 1995 Annual Report to Stockholders is incorporated herein by this reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 19 through 39 of the Company's 1995 Annual Report to Stockholders, which include the consolidated financial statements, Computation of Earnings Per Common Share and Common Share Equivalent listed as Exhibit 11.1 to Item 14(a)3, and the Independent Auditors' Report as listed in Item 14(a)1, are incorporated herein by this reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nSAFEWAY INC. AND SUBSIDIARIES\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT\nDirectors of the Company. Information on the nominees for election as Directors and the continuing Directors of the Company, which appears under the caption \"Election of Directors\" in the Company's 1996 Proxy Statement, is incorporated herein by this reference.\nExecutive Officers of the Company. See PART I under the caption \"Executive Officers of the Company\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation appearing under the captions \"Executive Compensation\" and \"Pension Plans\" in the Company's 1996 Proxy Statement is incorporated herein by this reference. Information appearing under the captions \"Report of the Compensation and Stock Option Committee\" and \"Stock Performance Graph\" in the Company's 1996 Proxy Statement is not incorporated herein by this reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation appearing under the caption \"Beneficial Ownership of Securities\" in the Company's 1996 Proxy Statement is incorporated herein by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNote I to the consolidated financial statements, included on page 35 of the Company's 1995 Annual Report to Stockholders, and the captions \"Certain Relationships and Transactions\" and \"Compensation Committee Interlocks and Insider Participation\" in the Company's 1996 Proxy Statement contain information about certain relationships and related transactions and are incorporated herein by this reference.\nSAFEWAY INC. AND SUBSIDIARIES\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. Consolidated Financial Statements of the Company are incorporated by reference in PART II, Item 8:\nConsolidated Statements of Income for fiscal 1995, 1994, and 1993. Consolidated Balance Sheets as of the end of fiscal 1995 and 1994. Consolidated Statements of Cash Flows for fiscal 1995, 1994, and 1993. Consolidated Statements of Stockholders' Equity for fiscal 1995, 1994, and 1993. Notes to Consolidated Financial Statements. Independent Auditors' Report.\n2. Consolidated Financial Statement Schedules:\nNone required\n3. The following exhibits are filed as part of this report:\nExhibit 3.1 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to Registration Statement No. 33-33388).\nExhibit 3.2 Form of By-laws of the Company as amended (incorporated by reference to Exhibit 3.2 to Registration Statement No. 33-33388), and Amendment to the Company's By-laws effective March 8, 1993 (incorporated by reference to Exhibit 3.2 to Registrant's Form 10-K for the year ended January 2, 1993).\nExhibit 4(i).1 Form of Warrant Agreement between the Company and The First National Bank of Boston as Warrant Agent relating to Warrants to purchase shares of common stock of the Company (incorporated by reference to Exhibit 4.5 to Registration Statement No. 33-9913) and Amendment to the Warrant Agreement between the Company and The First National Bank of Boston as Warrant Agent relating to Warrants to purchase shares of common stock of the Company (incorporated by reference to Exhibit 4(i).6 to Registrant's Form 10-K for the year ended December 30, 1989).\nExhibit 4(i).2 Specimen Warrant (incorporated by reference to Exhibit 4(i).5 to Registration Statement No. 33-33388).\nExhibit 4(i).3 Specimen Common Stock Certificate (incorporated by reference to Exhibit 4(i).2 to Registration Statement No. 33-33388).\nExhibit 4(i).4 Registration Rights Agreement dated November 25, 1986 between the Company and certain limited partnerships (incorporated by reference to Exhibit 4(i).4 to Registration Statement No. 33-33388).\nExhibit 4(i).5 Indenture dated as of November 20, 1991 among the Company and The Bank of New York, as Trustee, relating to the Company's Senior Subordinated Debt Securities (incorporated by reference to Exhibit 4.1 of Registrant's Form 8-K dated November 13, 1991).\nSAFEWAY INC. AND SUBSIDIARIES\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\nExhibit 4(i).6 Form of Officers' Certificate establishing the terms of the 10% Senior Subordinated Notes due December 1, 2001, including the form of Note (incorporated by reference to Exhibit 4.4 of Registrant's Form 8-K dated November 13, 1991).\nExhibit 4(i).7 Form of Officers' Certificate establishing the terms of the 9.65% Senior Subordinated Debentures due January 15, 2004, including the form of Debenture (incorporated by reference to Exhibit 4.1 of Registrant's Form 8-K dated January 15, 1992).\nExhibit 4(i).8 Indenture dated as of February 1, 1992 between the Company and The First National Bank of Chicago, as Trustee, relating to the Company's 9.30% Senior Secured Debentures due 2007, including the form of Debenture and the forms of Deed of Trust and Environmental Indemnity Agreement attached as exhibits thereto (incorporated by reference to Exhibit 4(i).14 of Registrant's Form 10-K for the year ended December 28, 1991).\nExhibit 4(i).9 Indenture dated as of March 15, 1992 between the Company and Harris Trust and Savings Bank, as Trustee, relating to the Company's Senior Subordinated Debt Securities (incorporated by reference to Exhibit 4.1 of Registrant's Form 8-K dated March 17, 1992).\nExhibit 4(i).10 Form of Officers' Certificate establishing the terms of the 9.35% Senior Subordinated Notes due March 15, 1999 and the 9.875% Senior Subordinated Debentures due March 15, 2007, including the form of Note and form of Debenture (incorporated by reference to Exhibit 4.2 of Registrant's Form 8-K dated March 17, 1992).\nExhibit 4(i).11 Indenture dated as of September 1, 1992 between the Company and The Chase Manhattan Bank (National Association), as Trustee, relating to the Company's Debt Securities (incorporated by reference to Exhibit 4.1 of Registrant's Form 8-K dated September 16, 1992).\nExhibit 4(i).12 Form of Officers' Certificate relating to the Company's Fixed Rate Medium-Term Notes and the Company's Floating Rate Medium-Term Notes, form of Fixed Rate Note and form of Floating Rate Note (incorporated by reference to Exhibits 4.2, 4.3 and 4.4 of Registrant's Form 8-K dated September 16, 1992).\nExhibit 4(i).13 Form of Officers' Certificate establishing the terms of a separate series of Safeway Inc.'s Medium-Term Notes entitled 10% Senior Notes due November 1, 2002, including the form of Note (incorporated by reference to Exhibits 4.1 and 4.2 of Registrant's Form 8-K dated November 5, 1992).\nExhibit 4(i).14 Form of Officers' Certificate establishing the terms of a separate series of Safeway Inc.'s Medium-Term Notes entitled Medium-Term Notes due June 1, 2003 (Series OPR-1), including the form of Note (incorporated by reference to Exhibits 4.1 and 4.2 of Registrant's Form 8-K dated June 1, 1993).\nSAFEWAY INC. AND SUBSIDIARIES\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\nExhibit 4(i).15 Form of Common Stock Purchase Warrants dated November 25, 1986 to purchase 13,928,000 shares of Safeway Common Stock (incorporated by reference to Exhibit 4.7 to Registration Statement No. 33-9254).\nExhibit 4(i).16 Credit Agreement dated as of May 24, 1995 among Safeway Inc., Canada Safeway Limited, and Lucerne Foods Ltd., as Borrowers, Bankers Trust Company, as Administrative Agent, The Bank of Nova Scotia, as Documentation Agent, The Chase Manhattan Bank, N.A., Chemical Bank, and Citicorp USA, Inc., as Co-Agents, the Lead Managers listed therein, as Lead Managers, and the lenders listed therein, as Lenders (incorporated by reference to Exhibit 4(i).16 of the Registrant's Form 10-Q for the quarterly period ended June 17, 1995).\nExhibit 4(iii) Registrant agrees to provide the Securities and Exchange Commission, upon request, with copies of instruments defining the rights of holders of long-term debt of Registrant and all of its subsidiaries for which consolidated financial statements are required to be filed with the Securities and Exchange Commission.\nExhibit 10(iii).1* Safeway Inc. Outside Director Equity Purchase Plan (incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-36753), and First Amendment to the Safeway Inc. Outside Director Equity Purchase Plan dated as of July 5, 1994 (incorporated by reference to Exhibit 10(iii).1 to Registrant's Form 10-Q for the quarterly period ended September 10, 1994).\nExhibit 10(iii).2* Share Appreciation Rights Plan of Canada Safeway Limited (incorporated by reference to Exhibit 10(iii).17 to Registrant's Form 10-K for the year ended December 29, 1990) and Amendment No. 1 thereto dated December 13, 1991 (incorporated by reference to Exhibit 10(iii).17 to Registrant's Form 10-K for the year ended December 28, 1991).\nExhibit 10(iii).3* Share Appreciation Rights Plan of Lucerne Foods Ltd. (incorporated by reference to Exhibit 10(iii).18 to Registrant's Form 10-K for the year ended December 29, 1990) and Amendment No. 1 thereto dated December 13, 1991 (incorporated by reference to Exhibit 10(iii).18 to Registrant's Form 10-K for the year ended December 28, 1991).\nExhibit 10(iii).4* Letter Agreement dated March 24, 1993 between the Company and Peter A. Magowan (incorporated by reference to Exhibit 10(iii).6 to Registrant's Form 10-Q for the quarterly period ending June 19, 1993).\nExhibit 10(iii).5* Stock Option Plan for Consultants of Safeway Inc. (incorporated by reference to Exhibit 10(iii).7 to Registrant's Form 10-Q for the quarterly period ending June 19, 1993).\nExhibit 10(iii).6* First Amendment to the Stock Option Plan for Consultants of Safeway Inc. (incorporated by reference to Exhibit 10(iii).7 to Registrant's Form 10-K for the year ended January 1, 1994).\n* Management contract, or compensatory plan or arrangement.\nSAFEWAY INC. AND SUBSIDIARIES\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (CONTINUED)\nExhibit 10(iii).7* 1994 Amended and Restated Stock Option and Incentive Plan for Key Employees of Safeway Inc. (incorporated by reference to Exhibit 10(iii).8 to Registrant's Form 10-K for the year ended January 1, 1994) and First Amendment thereto dated March 1, 1995 (incorporated by reference to Exhibit 10(iii).7 of Registrant's Form 10-K\/A for the year ended December 31, 1994).\nExhibit 10(iii).8* Operating Performance Bonus Plan for Executive Officers of Safeway Inc. (incorporated by reference to Exhibit 10(iii).9 to Registrant's Form 10-K for the year ended January 1, 1994).\nExhibit 10(iii).9* Capital Performance Bonus Plan (incorporated by reference to Exhibit 10(iii).10 to Registrant's Form 10-K for the year ended January 1, 1994).\nExhibit 10(iii).10* Retirement Restoration Plan of Safeway Inc. (incorporated by reference to Exhibit 10(iii).11 to Registrant's Form 10-K for the year ended January 1, 1994).\nExhibit 10(iii).11* Deferred Compensation Plan for Safeway Directors (incorporated by reference to Exhibit 10(iii).11 of Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 11.1 Computation of Earnings Per Common Share and Common Share Equivalent (incorporated by reference to page 38 of the Company's 1995 Annual Report to Stockholders).\nExhibit 12.1 Computation of Ratio of Earnings to Fixed Charges.\nExhibit 13.1 Registrant's 1995 Annual Report to Stockholders (considered filed to the extent specified in Item 1, Item 2, Item 3, Item 5, Item 6, Item 7, Item 8, Item 13 and Exhibit 11.1 above).\nExhibit 22.1 Subsidiaries of Registrant.\nExhibit 23.1 Independent Auditors' Consent.\nExhibit 27 Financial Data Schedule (electronic filing only).\n- ------------------ * Management contract, or compensatory plan or arrangement.\n(b) REPORTS ON FORM 8-K:\nNone.\nSAFEWAY INC. AND SUBSIDIARIES\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBy: \/s\/ Steven A. Burd Date: -------------------- SAFEWAY INC. March 20, 1996 Steven A. Burd 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\/ Julian C. Day \/s\/ F. J. Dale - ----------------- -------------- Julian C. Day F. J. Dale Executive Vice President and Group Vice President Chief Financial Officer Finance Date: March 20, 1996 Date: March 20, 1996\nDirector Date -------- ----\n\/s\/Steven A. Burd March 20, 1996 - ------------------------ Steven A. Burd\n\/s\/ Sam Ginn March 20, 1996 - ------------------------ Sam Ginn\n\/s\/ James H. Greene, Jr. March 20, 1996 - ------------------------ James H. Greene, Jr.\n\/s\/ Paul Hazen March 20, 1996 - ------------------------ Paul Hazen\n\/s\/ Henry R. Kravis March 20, 1996 - ------------------------ Henry R. Kravis\n\/s\/ Robert I. MacDonnell March 20, 1996 - ------------------------ Robert I. MacDonnell\n\/s\/ Peter A. Magowan March 20, 1996 - ------------------------ Peter A. Magowan\n\/s\/ George R. Roberts March 20, 1996 - ------------------------ George R. Roberts\n\/s\/ Michael T. Tokarz March 20, 1996 - ------------------------ Michael T. Tokarz\nSAFEWAY INC. AND SUBSIDIARIES\nExhibit Index\nLIST OF EXHIBITS FILED WITH FORM 10-K FOR THE PERIOD ENDED DECEMBER 30, 1995\nExhibit 11.1 Computation of Earnings Per Common Share and Common Share Equivalent (incorporated by reference to page 38 of the Company's 1995 Annual Report to Stockholders).\nExhibit 13.1 Registrant's 1995 Annual Report to Stockholders (considered filed to the extent specified in Item 1, Item 2, Item 3, Item 5, Item 6, Item 7, Item 8, Item 13 and Exhibit 11.1 above).\nExhibit 12.1 Computation of Ratio of Earnings to Fixed Charges\nExhibit 22.1 Subsidiaries of Registrant.\nExhibit 23.1 Independent Auditors' Consent.\nExhibit 27 Financial Data Schedule (electronic filing only)","section_15":""}
{"filename":"778969_1995.txt","cik":"778969","year":"1995","section_1":"Item 1. Business.\nOrganization\nGuaranteed Hotel Investors 1985, L.P. (the \"Partnership\") was formed on July 22, 1985 under the Delaware Revised Uniform Limited Partnership Act to acquire three parcels of land located in Irving, Texas; Fort Lauderdale, Florida; and Tampa, Florida on which three hotels are situated. The Partnership leased each of the parcels to the hotel owners (the \"Woolley\/Sweeney Partnerships\") under separate ground leases and made separate participating, first mortgage loans for the permanent financing of the hotel buildings and the hotel furniture, fixtures and equipment. As described below, the hotels provide guest rooms and group meeting room facilities and currently operate as Doubletree Guest Suites. Each hotel property includes a restaurant; one of the hotels operates the restaurant within the hotel, whereas the other two hotels lease the restaurant to a third party operator. The general partner of the Partnership is FFCA Management Company Limited Partnership, a Delaware limited partnership (the \"General Partner\").\nFFCA Investor Services Corporation 85-A, a Delaware corporation and wholly-owned subsidiary of Perimeter Center Management Company (\"PCMC\"), was incorporated on June 28, 1985, to serve as the assignor and initial limited partner of the Partnership and as the owner of record of the limited partnership interests in the Partnership. The limited partnership interests are assigned by FFCA Investor Services Corporation 85-A to investors in the Partnership. FFCA Investor Services Corporation 85-A conducts no other business activity. The Partnership and FFCA Investor Services Corporation 85-A are referred to collectively as the \"Co-Registrants.\"\nOperations\nDuring 1991, the Woolley\/Sweeney Partnerships failed to comply with the terms of their lease and financing agreements with the Partnership. In order to obtain control of the hotel assets and, among other things, avoid prolonged litigation, the Partnership executed a settlement agreement (the \"Settlement Agreement\") dated as of April 8, 1992, with the Woolley\/Sweeney Partnerships. The Settlement Agreement provided that the Woolley\/Sweeney Partnerships convey to the Partnership the hotels and all personal property then owned by the Woolley\/Sweeney Partnerships related to the hotels. As a result, the Partnership no longer receives interest and rent payments under the mortgage and lease agreements related to the hotels, but owns the hotels and receives the actual hotel operating income (since April 9, 1992).\nManagement agreements were also entered into as of April 8, 1992 between the Partnership and Crown Sterling Management, Inc. (\"CSMI\"), an affiliate of the Woolley\/Sweeney Partnerships. The management agreements provided for management of the hotels for an eighteen-month period at which time the agreements terminated with no provision for extension. The management fee under the agreements was equal to 3% of revenue, as defined, and approximated $445,000 for the period from January 1, 1993 through October 8, 1993.\nThe Partnership entered into repurchase agreements with the Woolley\/Sweeney Partnerships, dated as of April 8, 1992, for the repurchase of the hotels (the \"Repurchase Agreements\") which were amended as of May 19, 1994. The amended Repurchase Agreements granted the Partnership an option to require the Woolley\/Sweeney Partnerships to repurchase the hotels and the land on which the hotels are located (the \"Parcels\") from the Partnership on or after October 20, 2001, and on or before April 20, 2002, at a price of $35,635,708 for the Fort Lauderdale, Florida hotel, $35,068,174 for the Tampa, Florida hotel and $41,425,776 for the Irving, Texas hotel, less any repurchase credits based upon payments by the Woolley\/Sweeney Partnerships under the Settlement Agreement.\nIn the opinion of the General Partner, the Settlement Agreement allowed the Partnership to avoid extended and costly litigation at the time of settlement while granting the Partnership the opportunity to obtain ownership and control of the hotel properties. In addition, by entering into the Settlement Agreement with the Woolley\/Sweeney Partnerships, the Partnership avoided the possibility of the Woolley\/Sweeney Partnerships filing for relief under Chapter 11 of the federal bankruptcy laws which would likely have resulted in substantial delays in obtaining ownership of the hotels and the risks of deterioration in the physical condition of the hotels.\nIn August 1993, CSMI and Messrs. Woolley and Sweeney, among others, commenced litigation in state court in Dallas, Texas against the Partnership and certain of its affiliates, Embassy Suites, Inc., and certain other individuals and entities. In connection with that litigation, CSMI alleged that, notwithstanding the October 8, 1993 expiration dates set forth in the written management agreements, the expiration dates were extended by three and one-half years through an oral agreement allegedly reached between representatives of CSMI and the Partnership. CSMI asserted in its lawsuit that, pursuant to the terms of the written management agreements, as allegedly extended, the Partnership was responsible for the payment to CSMI of its payroll expenses and management fees after October 8, 1993. The Partnership categorically denied the existence of any oral agreements to extend the terms of the management agreements beyond October 8, 1993, and contended that, since the management agreements expired by their terms on such date, no sums were due to CSMI for payroll, management fees or other expenses thereafter.\nThe Texas state court litigation was settled by the parties in 1994. In connection with the settlement, the parties agreed that neither CSMI nor any of its affiliates have any interest, legal or equitable, in any of the hotels, and CSMI delivered possession of the hotels to the Partnership on May 19, 1994. All agreements with CSMI have been terminated as of such date, except for the Repurchase Agreements which have been amended (as discussed earlier). The Partnership agreed to pay CSMI for management services through May 19, 1994 and to reimburse or be reimbursed by CSMI for certain expenses subject to verification and reconciliation by an outside independent accounting firm. At that time, the Partnership had accrued disputed items totaling $1.1 million. The independent accounting firm's report, in summary, concluded that no amount was owed by the Partnership to CSMI. CSMI disputed these findings and filed a motion to set aside the accounting firm's report. On June 10, 1995, the District Court disallowed a major portion of the accounting firm's report and ordered that the Partnership pay CSMI $772,043, at which time the Partnership reduced its outstanding liability for disputed items to this amount. After depositing approximately $850,000 into an escrow account with the Texas State court to cover the liability to CSMI, including other costs, the Partnership was granted its motion for a new trial on September 8, 1995. Thereafter, the Partnership began negotiations with CSMI related to property taxes on the hotels that the Partnership paid in 1991 which otherwise should have been paid by Woolley and Sweeney. The 1992 settlement documents between the Partnership and Woolley and Sweeney provided that, under certain circumstances, Woolley and Sweeney would be obligated to reimburse the Partnership for the property taxes in 1996. CSMI has agreed not to require the payment of the $772,043 to CSMI in exchange for the Partnership's agreement not to seek reimbursement of the property taxes. Accordingly, the Partnership reduced its liability by $772,043 which, together with prior reductions, is reflected as other revenue in the statement of income for the year ended December 31, 1995. Amounts recoverable from the Texas State court escrow account related to settlement of this dispute were received by the Partnership in February 1996. This concludes all outstanding items of dispute with CSMI.\nThe General Partner determined that it was in the best interest of the Partnership's investors that all three hotels be managed by Doubletree Hotels Corporation (Doubletree) and licensed as \"Doubletree Guest Suites.\" Management of the hotels was transferred to Doubletree Partners, an affiliate of Doubletree, on May 19, 1994 and the hotels currently operate as Doubletree Guest Suites. Management, accounting and data processing fees paid to Doubletree Partners for the year ended December 31, 1995 approximated $940,000 and for the period from May 19, 1994 through December 31, 1994 approximated $750,000.\nProposed Sale of the Hotels\nOn March 15, 1996, the Partnership's investors approved the sale, to an unaffiliated third party, of the three hotels owned by the Partnership. The Partnership had entered into an agreement on October 27, 1995 to sell, subject to the consent of the Partnership's investors and the satisfactory completion of due diligence by the potential purchaser, fee simple title to the three hotels, for a cash payment of $73,250,000. The general partner of the Partnership filed a proxy statement with the Securities and Exchange Commission and sent each investor in the Partnership a definitive proxy statement and consent card which contained the details of the proposed transaction, including an estimate of the amount and timing of cash distributions. Upon the sale of the hotels, which represent substantially all of the Partnership's assets, the Partnership will begin the process of liquidation and distribution of assets to the investors in accordance with the Partnership agreement. The investors also approved the payment of a fee in the amount of $982,620 to the General Partner for substantial and unanticipated services rendered to the Partnership from January 1, 1991 to the date of liquidation of the Partnership. The proposed sale and subsequent liquidation of the Partnership are expected to be completed in 1996.\nIndustry\nThe hotel industry is highly competitive. The principal areas of competition include the location of the hotel facility, the size and configuration of rooms or suites, the daily room rental rate, the quality of the furnishings, services and other amenities provided, public identification of the hotel chain and convenience of reservation confirmation services. The success of the Partnership is dependent upon the Partnership's and Doubletree Partners' ability to implement asset management procedures that will facilitate the professional management and control of the operations of the hotels. The success of the Partnership may also depend on the ability of each hotel to remain competitive in its room and occupancy rates, amenities, location and service, among other factors.\nAs a result of improving conditions in the hotel industry, the General Partner, on behalf of the Partnership, engaged a financial advisor in June 1995 to provide services to the Partnership in connection with a possible sale of the hotels. These conditions included increased liquidity for the financing of hotel acquisitions and the lack of substantial new construction of hotels. The market for hotel sales has also recently improved, as reflected by an increasing number of purchases of hotels and recent increases in both average daily room rates and occupancy rates for many hotels throughout the United States.\nIn 1995, operating statistics for the United States hotel industry indicated improvement over 1994. According to industry statistics as provided by Smith Travel Research, increasing demand in the hotel industry resulted in an average room occupancy for 1995 of 66%, an increase of 1% over the prior year. The Partnership's hotels' average room occupancy of 72% for 1995 is somewhat above the national average. The average room rate for all hotels in the United States for 1995 was $67, a 5% increase over 1994. The Partnership's hotels' average room rate decreased 2% in 1995 to $84.\nThe all-suite segment continues to be one of the top performing segments with 1995 rate increases of 5% over 1994. By comparison, the upscale segment showed rates increasing 4%. Reflecting both the change in occupancy and daily room rate, the revenue per available room\/suite (\"Revpar\") nationally increased 6% in 1995 to $44. The Partnership's hotels' average Revpar in 1995 was $60, compared to the average Revpar of $65 for all-suite properties.\nThe Partnership does not segregate revenues or assets by geographic region, and such a presentation is not applicable and would not be material to an understanding of the Partnership's business taken as a whole.\nCompliance with federal, state and local law regarding the discharge of materials into the environment or otherwise relating to the protection of the environment has not had, and is not expected to have, any material adverse effect upon capital expenditures, earnings or the competitive position of the Partnership. The Partnership is not presently a party to any litigation or administrative proceeding with respect to its compliance with such environmental standards. In addition, the Partnership does not anticipate being required to expend any funds in the near future for environmental protection in connection with its respective operations.\nThe hotel business, in general, fluctuates seasonally depending on the individual hotel's location and type of target market each property serves. The Partnership's hotel located in Irving, Texas is situated near an airport, primarily serves the business traveler market and its business is fairly consistent throughout the year. The Ft. Lauderdale hotel is impacted by the tourist market, while also focusing on the corporate market, and its busiest season is January through April due to the Florida climate. The hotel located in Tampa, Florida is also impacted cyclically by the Florida climate, however, it is located near the Tampa International Airport and therefore its cycles are less predominant.\nNo portion of the Partnership's business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the United States Government. The Partnership does not manufacture any products and therefore does not require any raw materials in order to conduct its business.\nThe Partnership and FFCA Investor Services Corporation 85-A have no employees. All personnel used to operate the hotels are employees of Doubletree. The Partnership reimburses Doubletree for payroll costs.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of December 31, 1995, the Partnership owned, unencumbered, a 7.14 acre parcel of land located in Irving, Texas, on which is situated a 312-unit, all-suite hotel purchased by the Partnership on February 27, 1986; a 3.09 acre parcel located in Tampa, Florida, on which is situated a 263-unit, all-suite hotel purchased by the Partnership on May 16, 1986; and a 5.11 acre parcel located in Fort Lauderdale, Florida, on which is situated a 258-unit, all-suite hotel purchased by the Partnership on November 5, 1986. The hotels provide guest rooms and group meeting facilities and currently operate as Doubletree Guest Suites. Each hotel property includes a restaurant; one of the hotels operates the restaurant within the hotel, whereas the other two hotels lease the restaurant to a third party operator. As discussed in Item 1 above, the Partnership entered into an agreement on October 27, 1995 to sell, subject to the consent of the Partnership's investors and the satisfactory completion of due diligence by the potential purchaser, fee simple title to the three hotels, for a cash payment of $73,250,000. Upon the sale of the hotels, which represent substantially all of the Partnership's assets, the Partnership will begin the process of liquidation and distribution of assets to the investors in accordance with the Partnership agreement. The proposed sale and subsequent liquidation of the Partnership are expected to be completed in 1996.\nIndependent of the Partnership, FFCA Investor Services Corporation 85-A has no interest in any real or personal property.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Co-Registrants and their properties are not parties to, or subject to, any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted to a vote of the Holders through the solicitation of proxies or otherwise during the fourth quarter of fiscal year 1995; however, a Consent Solicitation Statement dated January 29, 1996 was sent to the Holders. Voting was completed March 15, 1996. The following table sets forth each of the proposals that the Holders were asked to vote upon:\nProposal Results\n1. Consent to sell the hotels owned by the For 150,420 Partnership Against 4,975 Abstain 3,071\n2. Consent to pay a fee of $982,620 to the General Partner upon completion of the sale of the hotels and liquidation of the Partnership for substantial and For 106,132 unanticipated services to the Partnership Against 35,530 from January 1, 1991 to the date of Abstain 16,804 liquidation.\nPART II\nItem 5.","section_5":"Item 5. Market for Co-Registrants' Units and Related Security Holder Matters.\nDuring 1995, there was no established public trading market for the Units, and it is unlikely that an established public trading market for the Units will develop.\nAs of March 1, 1996, there were 13,661 record holders of the Units.\nFor the two most recent fiscal years, the Partnership made the following cash distributions to the Holders:\nPer Unit Distribution Total ------------ -----\nDate of Number Cash From Cash From Distribution of Units Operations Capital Operations Capital - ------------ -------- ---------- ------- ---------- -------\nMarch 31 200,000 $5.00 -- $1,000,000 -- June 30 200,000 5.00 -- 1,000,000 -- September 30 200,000 5.00 -- 1,000,000 -- December 31 200,000 5.00 -- 1,000,000 --\nPer Unit Distribution Total ------------ ----- Date of Number Cash From Cash From Distribution of Units Operations Capital Operations Capital - ------------ -------- ---------- ------- ---------- -------\nMarch 31 200,000 $5.00 -- $1,000,000 -- June 30 200,000 5.00 -- 1,000,000 -- September 30 200,000 5.00 -- 1,000,000 -- December 31 200,000 5.00 -- 1,000,000 --\nCash from operations, defined as cash return in the agreement of limited partnership which governs the Partnership, is distributed to the Holders. The Adjusted Capital Contribution per Unit of the Holders, as defined in the agreement of limited partnership which governs the Partnership, was $500 as of December 31, 1995. The Adjusted Capital Contribution of a Holder is generally the Holder's initial capital contribution reduced by cash distributions to the Holder of proceeds from the sale of Partnership assets.\nAny differences in the amounts of distributions set forth in the above tables from the information contained in Item 6","section_6":"Item 6. Selected Financial Data.\nThe following selected financial data should be read in conjunction with the Financial Statements and the related notes attached as an exhibit to this Report.\n- ---------------------- (1) In 1992, a Settlement Agreement was reached with the Woolley\/Sweeney Partnerships whereby the hotels were conveyed to the Partnership. As a result, the Partnership no longer receives interest and rent payments under the mortgage and lease agreements related to the hotels, but owns the hotels and receives the actual hotel operating income (since April 9, 1992).\n(2) Operations in 1991 were impacted by the failure of the Woolley\/Sweeney Partnerships to make their land lease and mortgage loan payments in the third quarter of 1991. A $33.5 million provision was made to write down mortgage loans receivable and land subject to operating leases to estimated realizable value.\n(3)Return of capital for financial reporting purposes is not determined in the same manner as return of capital for purposes of determining a Holder's Adjusted Capital Contribution.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Partnership received $100,000,000 in gross proceeds from its public offering of the Units. After deducting organizational and offering expenses, including selling expenses, the Partnership had $89,000,000 in net proceeds for investment in the hotels. The Partnership invested $86,538,035 of the net proceeds in the three hotels, and the Partnership does not intend to invest in any other properties. As of December 31, 1995, the Partnership had cash and marketable securities generally collateralized by United States government obligations aggregating $6,255,398 of which $1,000,000 was paid out to the Holders in January 1996 as their fourth quarter distribution for fiscal year 1995, and the remainder of which will be held by the Partnership for reserves, operations or future distributions. The Partnership generated net cash from operations of $5,924,325 for the year ended December 31, 1995 as compared to $5,082,390 for 1994, an increase of approximately $842,000. The difference between periods is due primarily to an increase in net income of approximately $2,152,000 from 1994 to 1995, partially offset by a decrease in disputed liabilities of approximately $1,113,000 in 1995 related to the settlement with Messrs. Woolley and Sweeney, discussed below. During 1995 and 1994, planned remodeling was performed in the hotels resulting in expenditures of $1,095,827 and $1,197,094, respectively, and a loss of $62,709 and $47,068, respectively, on the disposition of property during the remodeling. Cash used for financing activities consisted primarily of payments made on capital lease obligations totaling $184,888 and partner distributions of $4,040,404. Net cash flows for the year ended December 31, 1995 resulted in a net increase in cash and cash equivalents of approximately $603,000.\nSubsequent to December 31, 1995, the Partnership's investors approved the sale, to an unaffiliated third party, of the three hotels owned by the Partnership for a cash payment of $73,250,000. Upon the sale of the hotels, which represent substantially all of the Partnership's assets, the Partnership will begin the process of liquidation and distribution of assets to the investors in accordance with the Partnership agreement. The proposed sale and subsequent liquidation of the Partnership are expected to be completed in 1996.\nThe Partnership expects to continue making cash distributions to the Holders pursuant to the provisions of the limited partnership agreement of the Partnership for each full quarter in 1996 until the proposed sale of the hotels. Thereafter, in connection with the subsequent liquidation of the Partnership, the Holders will receive an initial distribution equal to the net proceeds from the sale of the hotels, plus other Partnership cash, less (1) cash needed to pay the Partnership's liabilities and the costs of liquidation and (2) a $2,000,000 cash reserve to be held in an interest bearing trust fund to satisfy claims made by the buyer, arising from the Partnership's obligations under the sales agreement during the one-year period commencing upon the date the buyer acquires the hotels. If, at the end of such one-year period, no claims have been made by the buyer or if final decisions have been rendered for all disputed claims, the remaining balance of the trust fund will be disbursed to the Holders. If, however, there exist disputed claims at the end of such one-year period, no disbursements will be made from the trust fund until a final decision has been reached as to all disputed claims; provided, however, that no later than three years after the acquisition of the hotels by the buyer the balance remaining in the trust fund after resolution of all disputed claims will be disbursed to the Holders, and the buyer will have no further recourse as to such disputed claims.\nDuring 1994, Doubletree Partners spent $1,425,000 for purposes of management assumption, brand conversion, and renovation of the three hotels owned by the Partnership in connection with the management agreements between Doubletree Partners and the Partnership. The management agreements provide that if the Partnership sells the hotels during years 1 through 5 of the agreements and Doubletree Partners is not retained by the new owners as manager of the hotels, all of the $1,425,000 is to be reimbursed to Doubletree Partners as a sale termination fee, and if the sale were to occur in years 6 through 10, fifty percent of the amount is to be reimbursed. In connection with the proposed sale of the hotels, the purchaser has agreed to assume this contingent liability.\nExcept as described above, the General Partner knows of no trends, demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the Partnership's liquidity increasing or decreasing in any material way.\nFFCA Investor Services Corporation 85-A serves as the initial limited partner of the Partnership and the owner of record of the limited partner interests in the Partnership, the rights and benefits of which are assigned by FFCA Investor Services Corporation 85-A to investors in the Partnership. FFCA Investor Services Corporation 85-A has no other business activity and has no capital resources.\nResults of Operations\nFiscal Year Ended December 31, 1995 Compared to Fiscal Year Ended December 31, 1994\nRoom revenue increased by $1,191,089 or 7% to $18,286,393 for the year ended December 31, 1995 as compared to $17,095,304 for 1994. This increase is primarily attributable to the Irving, TX hotel ($1,059,754). Percentage of occupancy at that hotel increased from 68% in 1994 to 79% in 1995 as the hotel began to regain some of the market share that was lost as a result of ongoing construction, renovations and the temporary interruption of marketing efforts as a result of the brand conversion of the hotel to Doubletree Guest Suites.\nFood and beverage revenue decreased by approximately $148,000 or 5% in 1995, with a corresponding decrease in food and beverage expense of approximately $90,000 or 4%. The decrease primarily related to the leasing of the Irving food and beverage facilities to a third party in April 1995 rather than operating the facilities directly, as was done for seven months in 1994.\nOther revenues increased from $1,688,809 in 1994 to $2,645,049 in 1995 due to the reversal, during 1995, of the disputed liabilities as discussed below under \"Litigation\".\nGeneral and administrative expenses decreased to $3,276,193 for the year ended December 31, 1995 from $5,540,773 during 1994. This decrease primarily resulted from disputed claims of approximately $2,345,000 included in the 1994 amount related to the litigation discussed below. If these costs had not been in dispute, this amount would have been included in property operating costs and expenses, advertising and promotion, and repairs and maintenance in 1994. Also contributing to the decrease was a reduction in legal expenses of approximately $400,000 as the litigation with CSMI was substantially over as of June 30, 1995 (see \"Litigation\" below). General and administrative expenses also include management, accounting and data processing fees paid to Doubletree Partners, which for the year ended December 31, 1995 approximated $940,000 and for the period from May 19, 1994 through December 13, 1994 approximated $750,000.\nAdvertising and promotion increased by $1,053,007 from the prior year to $2,154,845 for 1995 partially due to disputed costs in 1994 that were included in general and administrative expense rather than in advertising and promotion as discussed above. Doubletree Hotels instituted a national marketing plan in 1995 and, accordingly, the hotels now pay a percentage of room revenue for this new marketing program. Also, additional marketing personnel were hired to cultivate the market share that was lost as a result of the hotel renovations and brand conversion.\nProperty taxes and insurance decreased by $285,319 or 16% to $1,478,824 for 1995. The Partnership appealed the hotel property taxes which resulted in tax savings of approximately $165,000. In addition, certain of the hotel insurance policies were renewed under plans that Doubletree Hotels made available to the Partnership. These policies provided broader coverage than the previous policies at a reduced cost.\nThe average daily room rate (\"ADR\") and percent of occupancy for each of the hotels for 1995 and 1994, obtained from the unaudited financial statements of each of the hotels, were as follows:\nADR % of Occupancy --- -------------- 1995 1994 1995 1994 ---- ---- ---- ---- Fort Lauderdale, FL $77 $82 72% 65% Tampa, FL $84 $86 64% 63% Irving, TX $91 $91 79% 68%\nLitigation\nIn connection with the Texas state court litigation settlement in 1994, the Partnership agreed to pay CSMI for management services through May 19, 1994 and to reimburse or be reimbursed by CSMI for certain expenses subject to verification and reconciliation by an outside independent accounting firm. At that time, the Partnership had accrued disputed items totaling $1.1 million. The independent accounting firm's report, in summary, concluded that no amount was owed by the Partnership to CSMI. CSMI disputed these findings and filed a motion to set aside the accounting firm's report. On June 10, 1995, the District Court disallowed a major portion of the accounting firm's report and ordered that the Partnership pay CSMI $772,043, at which time the Partnership reduced its outstanding liability for disputed items to this amount. After depositing approximately $850,000 into an escrow account with the Texas State court to cover the liability to CSMI, including other costs, the Partnership was granted its motion for a new trial on September 8, 1995. Thereafter, the Partnership began negotiations with CSMI related to property taxes on the hotels that the Partnership paid in 1991 which otherwise should have been paid by Woolley and Sweeney. The 1992 settlement documents between the Partnership and Woolley and Sweeney provided that, under certain circumstances, Woolley and Sweeney would be obligated to reimburse the Partnership for the property taxes in 1996. CSMI has agreed not to require the payment of the $772,043 to CSMI in exchange for the Partnership's agreement not to seek reimbursement of the property taxes. Accordingly, the Partnership reduced its liability by $772,043 which, together with prior reductions, is reflected as other revenue in the statement of income for the year ended December 31, 1995. Amounts recoverable from the Texas State court escrow account related to settlement of this dispute are included in other receivables in the balance sheet at December 31, 1995 and were received by the Partnership in February 1996. This concludes all outstanding items of dispute with CSMI.\nFiscal Year Ended December 31, 1994 Compared to Fiscal Year Ended December 31, 1993\nIn connection with the termination of the CSMI hotel management agreements, the General Partner determined that it was in the best interest of the Partnership's investors that all three hotels be managed by Doubletree and licensed as Doubletree Guest Suites. Management of the hotels was transferred to Doubletree Partners, an affiliate of Doubletree, on May 19, 1994. The average room rates of the three hotels rose approximately 3%, while the average occupancy rates decreased approximately 10%, contributing to a decrease in room revenues and expenses from 1993 to 1994. The lower occupancy levels resulted from ongoing construction and renovations at the hotels and temporary interruption of marketing efforts as a result of brand conversion of the hotels to Doubletree Guest Suites during 1994. The lower occupancy levels contributed to decreased telephone and other revenues.\nFood and beverage revenues increased from $1,388,345 in 1993 to $2,859,000 in 1994 due to the Partnership's operation of restaurants in two of the hotels (as opposed to operating only one restaurant in 1993).\nAdministrative and general expenses of $5,540,773 in 1994 and $4,446,456 in 1993 include accruals for expenses related to disputed claims which arose during 1993 and 1994, as described under \"Litigation\" above.\nThe average daily room rate (\"ADR\") and percent of occupancy for each of the hotels for 1994 and 1993, obtained from the unaudited financial statements of each of the hotels, were as follows:\nADR % of Occupancy --- -------------- 1994 1993 1994 1993 ---- ---- ---- ---- Fort Lauderdale, FL $82 $81 65% 75% Tampa, FL $86 $82 63% 70% Irving, TX $91 $89 68% 72%\nInflation\nThe rate of inflation has been moderate in recent years and, accordingly, has not had a significant impact on the Partnership's business.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements of the Co-Registrants required by Regulation S-X are attached to this Report. Reference is made to Item 14 below for an index to the financial statements and financial statement schedules.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Co-Registrants.\nThe Partnership and the General Partner have no directors or executive officers. Perimeter Center Management Company (\"PCMC\") is the corporate general partner and M. H. Fleischer is an individual general partner of the General Partner. The General Partner has responsibility for all of the Partnership's operations. The directors and executive officers of PCMC are as follows:\nPCMC\nDirectors Name Position Held Since - ---- -------------------\nM. H. Fleischer 1993\nOfficers\nAssociated With Name Positions Held PCMC Since - ---- -------------- ----------\nM. H. Fleischer Chairman of the Board, President and Chief Executive Officer 1993 John R. Barravecchia Executive Vice President, Chief Financial Officer, Treasurer and Assistant Secretary 1993 Christopher H. Volk Executive Vice President, Chief Operating Officer, Secretary and Assistant Treasurer 1993 Robin L. Roach Senior Vice President - Corporate Finance 1993 Dennis L. Ruben Senior Vice President and General Counsel 1994 Stephen G. Schmitz Senior Vice President - Corporate Finance 1995 Catherine F. Long Vice President - Finance and Principal Accounting Officer, Assistant Secretary, Assistant Treasurer 1993\nFFCA INVESTOR SERVICES CORPORATION 85-A\nDirector Name Position Held Since - ---- -------------------\nM. H. Fleischer, Chairman 1986\nOfficers Position Held Name Positions Held Since - ---- -------------- -----\nM. H. Fleischer Chairman of the Board of Directors 1986 John R. Barravecchia President, Secretary and Treasurer 1990 Christopher H. Volk Vice President, Assistant Secretary and 1994 Assistant Treasurer\nAll of the foregoing directors and executive officers have been elected to serve a one year term and until their successors are elected and qualified. There are no arrangements or understandings between or among any of the officers or directors and any other person pursuant to which any officer or director was selected as such. There are no family relationships among any directors and officers.\nBusiness Experience\nThe business experience during the past five years of each of the above directors and executive officers is as follows:\nMorton H. Fleischer, age 59, has served as a director, President and Chief Executive Officer of PCMC since 1993, and as Chairman of the Board of FFCA Investor Services Corporation 85-A since 1986. Mr. Fleischer also serves as President, Chief Executive Officer and Chairman of the Board of Franchise Finance Corporation of America, a Delaware corporation (\"FFCA\") having previously served as a director, President and Chief Executive Officer of Franchise Finance Corporation of America I (\"FFCA I\"), a predecessor of FFCA, from 1980 to 1994. Mr. Fleischer is an individual general partner of the General Partner, and is a general partner (or general partner of a general partner) of the following limited partnerships: Participating Income Properties 86, L.P., Participating Income Properties II, L.P.; Participating Income Properties III Limited Partnership; and Scottsdale Land Trust Limited Partnership. Mr. Fleischer has been engaged in real estate development and corporate finance since 1967 and conducted business under the name Fleischer & Co. from 1972 until 1985. Mr. Fleischer received his Bachelor of Science degree from Washington University in 1958.\nJohn R. Barravecchia, age 40, has served as President, Secretary and Treasurer of FFCA Investor Services Corporation 85-A since 1990. He has served as Chief Financial Officer of PCMC since 1993 and as Senior Vice President and Treasurer since 1994. In 1995, Mr. Barravecchia was named Executive Vice President of PCMC. Mr. Barravecchia currently serves as Executive Vice President, Chief Financial Officer, Treasurer and Assistant Secretary of FFCA and served in various capacities for FFCA I from 1984 to 1994. He was appointed Vice President and Chief Financial Officer of FFCA I in December 1986, and Senior Vice President in October 1989. Mr. Barravecchia was elected as a director of FFCA I in March 1993 and Treasurer in December 1993. Prior to joining FFCA I, Mr. Barravecchia was associated with the international public accounting firm of Arthur Andersen LLP. Mr. Barravecchia received his Bachelor of Science degree from Fredonia State University in 1978.\nChristopher H. Volk, age 39, has served as Vice President, Assistant Secretary and Assistant Treasurer of FFCA Investor Services Corporation 85-A since 1994, and has served as Secretary of PCMC since 1993 and Senior Vice President--Underwriting and Research since 1994. In 1995, Mr. Volk was named Executive Vice President and Chief Operating Officer of PCMC. Mr. Volk currently serves as Executive Vice President, Chief Operating Officer, Secretary and Assistant Treasurer of FFCA. He joined FFCA I in 1986 and served in various capacities in FFCA I's capital preservation and underwriting areas prior to being named Vice President Research in October 1989. In December 1993, he was appointed Secretary and Senior Vice President\/Underwriting and Research of FFCA I, and he was elected as a director of FFCA I in March 1993. Prior to joining FFCA I, Mr. Volk was employed for six years with the National Bank of Georgia, where his last position was Assistant Vice President and Senior Correspondent Banking Credit Officer. Mr. Volk is a member of the Association for Investment Management and Research and the Phoenix Society of Financial Analysts. Mr. Volk received his Bachelor of Arts degree from Washington and Lee University in 1979 and his Masters of Business Administration Degree in Finance from Georgia State University in 1987.\nRobin L. Roach, age 43, served as Vice President--Portfolio Management and Operations of PCMC prior to being named Senior Vice President\/Corporate Finance. He served as Chief Operating Officer of PCMC from 1993 to 1994. Mr. Roach currently serves as Senior Vice President--Corporate Finance for FFCA, having previously served as an Executive Vice President of FFCA I from 1986 to 1993 and as Senior Vice President--Portfolio Management and Operations from 1993 to 1994. Prior to his association with FFCA I, Mr. Roach served as a commercial loan officer with the American Bank of Commerce from 1978 to 1980, and served as a commercial loan officer of the European-American Bank from 1976 to 1978. He received a Bachelor of Arts degree from Wabash College in 1975. On March 13, 1992, Mr. Roach filed a petition for relief under the federal bankruptcy laws, and an order of discharge was subsequently entered.\nDennis L. Ruben, age 43, has served as Senior Vice President and General Counsel for PCMC since 1994. Mr. Ruben currently serves in the same capacity for FFCA and served as attorney and counsel for FFCA I from 1991 to 1994. In December 1993, he was appointed Senior Vice President and General Counsel of FFCA I. Prior to joining FFCA I, Mr. Ruben was associated with the law firm of Kutak Rock from 1980 until March 1991. Mr. Ruben became a partner of Kutak Rock in 1984. Mr. Ruben has been admitted to the Iowa, Nebraska and Colorado bars. He received a Bachelor of Arts degree with high distinction from the University of Iowa in 1974 and a Juris Doctor with distinction from the University of Iowa in 1977.\nStephen G. Schmitz, age 41, has served as Senior Vice President\/Corporate Finance of PCMC since January 1996. He has served in the same capacity for FFCA since 1995. Mr. Schmitz served in various positions as an officer of FFCA I from 1986 to June 1, 1994. Prior to joining FFCA I, Mr. Schmitz was a commercial lender with Mellon Bank in Pittsburgh, where his last position was Vice-President and Section Manager. He received a Bachelor of Science degree in business from Franklin University in 1979 and a Masters of Business Administration from Pennsylvania State University in 1981.\nCatherine F. Long, age 39, has served as Vice President--Finance and Principal Accounting Officer of PCMC since 1994, and Vice President from 1993 to 1994. She currently serves as Vice President\/Finance, Principal Accounting Officer, Assistant Secretary and Assistant Treasurer of FFCA and served as Vice President\/Finance of FFCA I from 1990 to 1993. In December 1993, she was appointed Principal Accounting Officer of FFCA I. From December 1978 to May 1990, Ms. Long was associated with the international public accounting firm of Arthur Andersen LLP. Ms. Long is a certified public accountant and is a member of the Arizona Society of Certified Public Accountants. She received her Bachelor of Science degree in accounting from Southern Illinois University in 1978.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nBased solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Co-registrants during fiscal year 1995 and Forms 5 and amendments thereto furnished to the Co-Registrants with respect to fiscal year ended December 31, 1995 (the \"Forms\"), and any written representations by the directors and executive officers of PCMC, the Co-Registrants have not identified herein any such person that failed to file on a timely basis the Forms required by Section 16(a) of the Securities Exchange Act of 1934 for fiscal year 1995.\nItem 11.","section_11":"Item 11. Executive Compensation.\nPursuant to provisions contained in the agreement of limited partnership which governs the Partnership, the officers and directors of PCMC serve in such capacities without remuneration from the Partnership.\nThe Partnership is required to pay 1% of its cash flow to the General Partner and the General Partner is entitled to an allocation of 1% of profits, losses, deductions, credits and sale proceeds. The General Partner is also entitled to a subordinated real estate disposition fee under certain circumstances. Reference is made to Note (1) of the Notes to Financial Statements of the Partnership which are filed with this Report for a description of the fees and distributions paid in 1995.\nFFCA Investor Services Corporation 85-A serves as assignor and initial limited partner without compensation from the Partnership. It is not entitled to any share of the profits, losses or cash distributions of the Partnership. The director and officers of FFCA Investor Services Corporation 85-A serve without compensation from FFCA Investor Services Corporation 85-A or the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of December 31, 1995, the only person or group known by the Partnership to own directly or beneficially 5% or more of the outstanding Units of the Partnership was Pitt & Co., a nominee of Minneapolis Employees' Retirement Fund, P.O. Box 2444, Church Street Station, New York, New York 10008. As of that date, Pitt & Co. owned 10,000 Units, or 5% of the total number of Units.\nThe General Partner of the Partnership and its general partners owned no Units as of December 31, 1995. The directors and officers of PCMC, individually and as a group, owned less than 1% of the Units as of December 31, 1995. PCMC is owned 66.67% by M. H. Fleischer and 33.33% by R. W. Halliday.\nFFCA Investor Services Corporation 85-A has an interest in the Partnership as a limited partner and it serves as the owner of record of all of the limited partnership interests assigned by it to the Holders. However, FFCA Investor Services Corporation 85-A has no right to vote its interest on any matter and it must vote the assigned interests as directed by the Holders.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nSince the beginning of the Co-Registrants' last fiscal year, there have been no significant transactions or business relationships among the Co-Registrants and PCMC, its affiliates or their management other than those described in Items 10 and 11 above.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nThe following documents are filed as part of this Report:\n1. Financial Statements.\nThe Partnership\nReport of independent public accountants Balance Sheets as of December 31, 1995 and 1994 Statements of Income for the years ended December 31, 1995, 1994 and 1993 Statements of Changes In Partners' Capital 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\nFFCA Investor Services Corporation 85-A\nReport of independent public accountants Balance Sheet as of December 31, 1995 Notes to Balance Sheet\n2. Financial Statement Schedules.\nAll schedules are omitted since they are not required, are inapplicable, or the required information is included in the financial statements or notes thereto.\n3. Exhibits.\nThe following is a complete list of exhibits filed as part of this Form 10-K. For electronic filing purposes only, this report contains Exhibit 27, Financial Data Schedule.\n10.1 Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated October 27, 1995.\n10.2 First Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated November 7, 1995.\n10.3 Second Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated December 13, 1995.\n10.4 Third Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated December 22, 1995.\nPursuant to Rule 12b-32 under the Securities Exchange Act of 1934, as amended, the following documents, filed with the Securities and Exchange Commission as exhibits to the Co-Registrants' Form 10-K for the year ended December 31, 1986, are incorporated herein by this reference.\n1986 Form 10-K Exhibit No.\nThe Second Amended and Restated 3-A Certificate and Agreement of Limited Partnership which governs the Partnership, as filed with the Secretary of State of Delaware on May 9, 1986.\nThe Certificate of Incorporation which 3-B governs FFCA Investor Services Corporation 85-A, as filed with the Secretary of State of Delaware on June 28, 1985.\nBylaws of FFCA Investor Services Corporation 85-A. 3-C\nReports on Form 8-K.\nNo reports on Form 8-K were filed by the Co-Registrants 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, as amended, the Partnership has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGUARANTEED HOTEL INVESTORS 1985, L.P.\nBy FFCA MANAGEMENT COMPANY LIMITED PARTNERSHIP, General Partner\nDate: March 28, 1996 By \/s\/ M. H. Fleischer ---------------------- M. H. Fleischer, General Partner\nBy PERIMETER CENTER MANAGEMENT COMPANY, Corporate General Partner\nDate: March 28, 1996 By \/s\/ M. H. Fleischer ---------------------- M. H. Fleischer, 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 on behalf of the Partnership and in the capacities and on the dates indicated.\nSIGNATURES OF REQUIRED OFFICERS AND DIRECTORS OF PERIMETER CENTER MANAGEMENT COMPANY, CORPORATE GENERAL PARTNER OF FFCA MANAGEMENT COMPANY LIMITED PARTNERSHIP, GENERAL PARTNER OF GUARANTEED HOTEL INVESTORS 1985, L.P.\nDate: March 28, 1996 By \/s\/ M. H. Fleischer ---------------------- M. H. Fleischer, Chairman of the Board, President, and Chief Executive Officer\nDate: March 28, 1996 By \/s\/ John R. Barravecchia ------------------------- John R. Barravecchia, Executive Vice President, Chief Financial Officer, Treasurer and Assistant Secretary\nDate: March 28, 1996 By \/s\/ Catherine F. Long ---------------------- Catherine F. Long, Vice President-Finance and Principal Accounting Officer, Assistant Secretary, Assistant Treasurer\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the co-registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFFCA INVESTOR SERVICES CORPORATION 85-A\nDate: March 28, 1996 By \/s\/ M. H. Fleischer ------------------------------ M. H. Fleischer, Sole Director\nDate: March 28, 1996 By \/s\/ John R. Barravecchia ------------------------------------------ John R. Barravecchia, President, Secretary, Principal Financial Officer and Principal Accounting Officer\n[ARTHUR ANDERSEN LETTERHEAD]\nReport of Independent Public Accountants\nTo Guaranteed Hotel Investors 1985, L.P.:\nWe have audited the accompanying balance sheets of GUARANTEED HOTEL INVESTORS 1985, L.P. (a Delaware limited partnership) as of December 31, 1995 and 1994, and the related statements of income, 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 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, the financial statements referred to above present fairly, in all material respects, the financial position of Guaranteed Hotel Investors 1985, 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.\nArthur Andersen LLP\nPhoenix, Arizona, February 27, 1996.\nThe accompanying notes are an integral part of these balance sheets.\nThe accompanying notes are an integral part of these statements.\nGUARANTEED HOTEL INVESTORS 1985, L.P. ------------------------------------- STATEMENTS OF CHANGES IN PARTNERS' CAPITAL ------------------------------------------ FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 ----------------------------------------------------\nGeneral Limited Partner Partners Total ------------ ------------ ------------\nBALANCE, December 31, 1992 $ (302,830) $ 53,515,233 $ 53,212,403\nNet income 27,037 2,676,678 2,703,715\nDistributions to partners (39,775) (3,937,500) (3,977,275) ------------ ------------ ------------\nBALANCE, December 31, 1993 (315,568) 52,254,411 51,938,843\nNet income 24,952 2,470,272 2,495,224\nDistributions to partners (40,404) (4,000,000) (4,040,404) ------------ ------------ ------------\nBALANCE, December 31, 1994 (331,020) 50,724,683 50,393,663\nNet income 46,469 4,600,467 4,646,936\nDistributions to partners (40,404) (4,000,000) (4,040,404) ------------ ------------ ------------\nBALANCE, December 31, 1995 $ (324,955) $ 51,325,150 $ 51,000,195 ============ ============ ============\nThe accompanying notes are an integral part of these statements.\nThe accompanying notes are an integral part of these statements.\nGUARANTEED HOTEL INVESTORS 1985, L.P. ------------------------------------- Notes to Financial Statements ----------------------------- December 31, 1995 and 1994 --------------------------\n1) ORGANIZATION AND OPERATIONS:\nGuaranteed Hotel Investors 1985, L.P. (the Partnership) was formed on July 22, 1985 under the Delaware Revised Uniform Limited Partnership Act to acquire three parcels of land located in Irving, Texas; Fort Lauderdale, Florida; and Tampa, Florida on which three hotels are situated. The Partnership leased each of the parcels to the hotel owners (the Woolley\/Sweeney partnerships) under separate ground leases and made separate participating, first mortgage loans for the permanent financing of the hotel buildings and the hotel furniture, fixtures and equipment.\nDuring 1991, the Woolley\/Sweeney partnerships failed to comply with the terms of their lease and financing agreements with the Partnership. In order to obtain control of the hotel assets and, among other things, avoid prolonged litigation, the Partnership entered into and executed a settlement agreement on April 24, 1992 with the Woolley\/Sweeney partnerships. This agreement provided that the Woolley\/Sweeney partnerships convey to the Partnership the hotels and all personal property then owned by the Woolley\/Sweeney partnerships related to the hotels. As a result, the Partnership no longer receives interest and rent payments under the mortgage and lease agreements related to the hotels, but owns the hotels and receives the actual hotel operating income (since April 9, 1992). Management agreements were also entered into and executed by the Partnership with Crown Sterling Management, Inc. (CSMI), an affiliate of the Woolley\/Sweeney partnerships. The agreements provided for management of the hotels for an eighteen-month period, which expired on October 8, 1993 with no provision for extension (see Note 7). The management fee under the agreements approximated $445,000 for the period from January 1, 1993 through October 8, 1993.\nThe management of the hotels was transitioned to Doubletree Partners on May 19, 1994, and the hotels, which provide guest rooms and group meeting room facilities, currently operate as Doubletree Guest Suites. Each hotel property includes a restaurant; one of the hotels operates the restaurant within the hotel, whereas the other two hotels lease the restaurant to a third party operator. Management, accounting and data processing fees paid to Doubletree Partners for the year ended December 31, 1995 approximated $940,000 and for the period from May 19, 1994 through December 31, 1994 approximated $750,000.\nInvestors acquired units of assigned limited partnership interest (the limited partnership units) in the Partnership from FFCA Investor Services Corporation 85-A (the Initial Limited Partner), a Delaware corporation wholly-owned by Perimeter Center Management Company. Holders of the units have all of the economic benefits and substantially the same rights and powers as limited partners, therefore, they are referred to herein as \"limited partners\". The general partner of the Partnership is FFCA Management Company, L.P. (the General Partner) an affiliate of Perimeter Center Management Company. The Partnership will expire December 31, 2047, or sooner, in accordance with the terms of the Partnership agreement (see Note 9).\nThe Partnership agreement provides that all profits, losses and cash distributions be allocated 99% to the limited partners and 1% to the General Partner. The following is a reconciliation of net income to cash distributions from operations as defined in the Partnership agreement:\n2) SIGNIFICANT ACCOUNTING POLICIES:\nFinancial Statements - The financial statements of the Partnership are prepared on the accrual basis of accounting. 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ from those estimates.\nCash and Cash Equivalents - Investment securities that are highly liquid and have maturities of three months or less at the date of purchase are classified as cash equivalents. Cash equivalents include United States Treasury securities of $3,786,686 and $4,006,266 at December 31, 1995 and 1994, respectively. Short-term investments are recorded at cost plus accreted discount, which approximates market value.\nDepreciation - Depreciation on buildings, building improvements, furniture and equipment is provided using the straight-line method based upon the following estimated useful lives:\nBuildings and improvements 5-34 years Furniture and equipment 2-15 years\n3) PROPERTY AND EQUIPMENT:\nProperty and equipment was recorded at its fair value on the settlement date (see Note 1). There are no encumbrances on the property and equipment. The following is an analysis of the Partnership's investment in property and equipment by major class at December 31, 1995 and 1994:\n1995 1994 ------------ ------------ Land and improvements $ 5,396,153 $ 5,396,153 Buildings and improvements 41,350,548 40,870,254 Furniture and equipment 8,038,759 7,684,026 ------------ ------------ 54,785,460 53,950,433 Less-Accumulated depreciation and amortization (9,013,099) (6,750,120) ------------ ------------\n45,772,361 47,200,313 Operating stock 337,148 349,857 ------------ ------------\n$ 46,109,509 $ 47,550,170 ============ ============\n4) CAPITAL LEASE OBLIGATIONS:\nFor the years ended December 31, 1995, 1994 and 1993, amortization expense and accumulated amortization for equipment under capital leases are as follows:\n1995 1994 1993 --------- -------- -------- Amortization expense $ 47,000 $113,000 $311,000 Accumulated amortization 824,000 777,000 664,000\n5) INCOME TAXES:\nThe Partnership is not directly subject to income taxes; rather, each partner is subject to income taxes on his distributable share of taxable income. The Partnership tax returns and the amount of distributable partnership profits or losses are subject to examination by Federal and state taxing authorities. If examinations by taxing authorities result in changes to distributable partnership profits or losses, the tax liabilities of the partners could be changed accordingly.\nThe following is a reconciliation of net income for financial reporting purposes to income reported for Federal income tax purposes for the years ended December 31, 1995, 1994 and 1993:\nAt December 31, 1995, the tax bases of the Partnership's assets and liabilities exceed the amounts recorded for financial reporting purposes by $11,847,528. This difference results primarily from differences in the treatment of valuation reserves and the depreciation methods for financial reporting and tax reporting purposes.\n6) TRANSACTIONS WITH RELATED PARTIES:\nAn affiliate of the General Partner incurs expenses on behalf of the Partnership for maintenance of the books and records, and for computer, investor, legal and other services performed for the Partnership (including certain legal services related to the disputed liabilities discussed in Note 7). These expenses are reimbursable in accordance with the Partnership agreement and are less than the amount which the Partnership would have paid to independent parties for comparable services. The Partnership reimbursed the affiliate $133,105 in 1995, $77,662 in 1994, and $263,224 in 1993 for such expenses.\n7) SETTLEMENT OF DISPUTED LIABILITIES:\nIn connection with the Texas State court litigation settlement in 1994, the Partnership agreed to pay CSMI for management services through May 19, 1994 and to reimburse or be reimbursed by CSMI for certain expenses subject to verification and reconciliation by an outside independent accounting firm. At that time, the Partnership had accrued disputed items totaling $1.1 million. The independent accounting firm's report, in summary, concluded that no amount was owed by the Partnership to CSMI. CSMI disputed these findings and filed a motion to set aside the accounting firm's report. On June 10, 1995, the District Court disallowed a major portion of the accounting firm's report and ordered that the Partnership pay CSMI $772,043, at which time the Partnership reduced its outstanding liability for disputed items to this amount. After depositing approximately $850,000 into an escrow account with the Texas State court to cover the liability to CSMI, including other costs, the Partnership was granted its motion for a new trial on September 8, 1995. Thereafter, the Partnership began negotiations with CSMI related to property taxes on the hotels that the Partnership paid in 1991 which otherwise should have been paid by Woolley and Sweeney. The 1992 settlement documents between the Partnership and Woolley and Sweeney provided that, under certain circumstances, Woolley and Sweeney would be obligated to reimburse the Partnership for the property taxes in 1996. CSMI has agreed not to require the payment of the $772,043 to CSMI in exchange for the Partnership's agreement not to seek reimbursement of the property taxes. Accordingly, the Partnership reduced its liability by $772,043 which, together with prior reductions, is reflected as other revenue in the accompanying statement of income. Amounts recoverable from the Texas State court escrow account related to settlement of this dispute are included in other receivables in the accompanying balance sheet. This concludes all outstanding items of dispute with CSMI.\n8) CONTINGENCY:\nDuring 1994, Doubletree Partners, the hotels' management company, spent $1,425,000 for purposes of management assumption, brand conversion, and renovation of the three hotels owned by the Partnership in connection with the management agreements between Doubletree Partners and the Partnership. The management agreements provide that if the Partnership sells the hotels during years 1 through 5 of the agreements and Doubletree Partners is not retained by the new owners as manager of the hotels, all of the $1,425,000 is to be reimbursed to Doubletree Partners as a sale termination fee, and if the sale occurs in years 6 through 10, fifty percent of the amount is to be reimbursed. In connection with the proposed sale of the hotels referred to below, the purchaser has agreed to assume this contingent liability.\n9) EVENT SUBSEQUENT TO THE DATE OF REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (Unaudited) -- INVESTOR APPROVAL OF SALE OF HOTELS:\nOn March 15, 1996, the Partnership's investors approved the sale, to an unaffiliated third party, of the three hotels owned by the Partnership. The Partnership had entered into an agreement on October 27, 1995 to sell, subject to the consent of the Partnership's investors and the satisfactory completion of due diligence by the potential purchaser, fee simple title to the three hotels, for a cash payment of $73,250,000. Upon the sale of the hotels, which represent substantially all of the Partnership's assets, the Partnership will begin the process of liquidation and distribution of assets to the investors in accordance with the Partnership agreement. The investors also approved the payment of a fee in the amount of $982,620 to the General Partner for substantial and unanticipated services rendered to the Partnership from January 1, 1991 to the date of liquidation of the Partnership. The proposed sale and subsequent liquidation of the Partnership are expected to be completed in 1996.\nSet forth below is condensed historical and unaudited pro forma financial information of the Partnership as of December 31, 1995. The unaudited pro forma balance sheet information has been prepared assuming the sale of the hotels and liquidation of the Partnership occurred on December 31, 1995 and includes estimates of transaction costs and other costs to be incurred in connection with the liquidation of the Partnership.\nThe preparation of the unaudited pro forma information requires management to make estimates and assumptions that affect the reported pro forma amounts of assets and liabilities at December 31, 1995. Although management believes its estimates are reasonable, actual results could differ from those estimates.\n- -----------------------------\n(1) The pro forma effects of the proposed sale of the hotels and payment of the initial estimated liquidating distribution on partners' capital are as follows:\n(2) The pro forma adjustment to cash reflects the cash proceeds of $73,250,000 from the sale of the hotels net of an initial payment of approximately $74,112,000 made directly to the Limited Partners. This initial payment is estimated to be equal to the total cash held by the Partnership upon the sale of the hotels less (a) the amount of cash required to pay the Partnership's liabilities, including the costs of liquidating the Partnership and (b) $2,000,000 to be held and later distributed as described in footnote (6) below.\n(3) Accounts receivable, receivable from General Partner, and other assets will not be transferred to the buyer in connection with the sale of the hotels. The receivable from the General Partner represents the General Partner's negative capital account at December 31, 1995 which, pursuant to the Partnership Agreement, must be contributed by the General Partner to the Partnership as of the date of dissolution.\n(4) Represents the net book value of the hotels' assets to be sold.\n(5) The pro forma adjustments to liabilities reflect the accrual of costs relating to the proposed sale of the hotels and the liquidation of the Partnership, the accrual of financial advisory fees payable to Lehman Brothers for their services in connection with the sale of the hotels and the accrual of the General Partner's disposition fee, net of the liabilities related to the hotel operations assumed by the buyer. The General Partner fee represents a fee generated by the General Partner for additional services rendered to the Partnership as a result of the acquisition and management of the Hotels following the Woolley\/Sweeney Partnerships' default. The following are the pro forma adjustments to liabilities:\nTransaction and liquidation costs and related fees: Accrual of transaction and liquidation costs of the sale of the hotels and liquidation of the Partnership $ 500,000 Financial advisory fee 732,500 General Partner fee 982,620 ---------- 2,215,120 Capital lease obligations assumed by the buyer (111,689) ----------\nPro forma adjustment to liabilities $2,103,431 ==========\n(6) The pro forma balance in the Partners' Capital Accounts represents funds to be deposited in a $2,000,000 trust fund established by the Partnership immediately after closing of the proposed sale of the hotels. The Partnership and the buyer have agreed that the trust fund will be available only to satisfy claims made by the buyer, arising from the Partnership's obligations under the sales agreement during the one-year period commencing upon the date the buyer acquires the hotels. If, at the end of such one-year period, no claims have been made by the buyer or if final decisions have been rendered for all disputed claims, the remaining balance of the trust fund will be disbursed to the Limited Partners. If, however, there exist disputed claims at the end of such one-year period, no disbursements will be made from the trust fund until a final decision has been reached as to all disputed claims; provided, however, that no later than three years after the acquisition of the hotels by the buyer the remaining balance of the trust fund will be disbursed to the Limited Partners, and the buyer will have no further recourse as to such disputed claims.\n[ARTHUR ANDERSEN LETTERHEAD]\nReport of Independent Public Accountants\nTo FFCA Investor Services Corporation 85-A:\nWe have audited the accompanying balance sheet of FFCA INVESTOR SERVICES CORPORATION 85-A (a Delaware corporation) as of December 31, 1995. This financial statement is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement 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 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 financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of FFCA Investor Services Corporation 85-A as of December 31, 1995, in conformity with generally accepted accounting principles.\nArthur Andersen LLP\nPhoenix, Arizona, February 27, 1996.\nFFCA INVESTOR SERVICES CORPORATION 85-A ---------------------------------------\nBALANCE SHEET - DECEMBER 31, 1995 ---------------------------------\nASSETS\nCash $100 Investment in Guaranteed Hotel Investors 1985, L.P., at cost 100 ---\nTotal Assets $200 ====\nLIABILITY\nPayable to Parent (Note 2) $100 ----\nSTOCKHOLDER'S EQUITY\nCommon Stock; $l par value; 100 shares authorized, issued and outstanding 100 ---\nLiability and Stockholder's Equity $200 ====\nThe accompanying notes are an integral part of this balance sheet.\nFFCA INVESTOR SERVICES CORPORATION 85-A ---------------------------------------\nNOTES TO BALANCE SHEET ---------------------- DECEMBER 3l, l995 -----------------\n(l) Operations:\nFFCA Investor Services Corporation 85-A (a Delaware corporation) (85-A) was organized on June 28, l985 to act as the assignor limited partner in Guaranteed Hotel Investors 1985, L.P. (GHI-85).\nThe assignor limited partner is the owner of record of the limited partnership units of GHI-85. All rights and powers of 85-A have been assigned to the holders, who are the registered and beneficial owners of the units. Other than to serve as assignor limited partner, 85-A has no other business purpose and will not engage in any other activity or incur any debt.\n(2) Related Parties:\nPerimeter Center Management Company (a Delaware corporation) (PCMC) is the sole stockholder of 85-A. The general partner of GHI-85 is an affiliate of PCMC.\nGUARANTEED HOTEL INVESTORS 1985, L.P. and FFCA INVESTOR SERVICES CORPORATION 85-A\n- --------------------------------------------------------------------------------\nExhibit Index\n- --------------------------------------------------------------------------------\nExhibit -------\nThe following is a complete list of exhibits filed as part of this Form 10-K. For electronic filing purposes only, this report contains Exhibit 27, Financial Data Schedule.\n10.1 Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated October 27, 1995.\n10.2 First Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated November 7, 1995.\n10.3 Second Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated December 13, 1995.\n10.4 Third Amendment to Purchase Agreement Between the Partnership and SLT Realty Limited Partnership dated December 22, 1995.\nPursuant to Rule 12b-32 under the Securities Exchange Act of 1934, as amended, the following documents, filed with the Securities and Exchange Commission as exhibits to the Co-Registrants' Form 10-K for the year ended December 31, 1986, are incorporated herein by this reference.\n1986 Form 10-K Exhibit No. -----------\nThe Second Amended and Restated 3-A Certificate and Agreement of Limited Partnership which governs the Partnership, as filed with the Secretary of State of Delaware on May 9, 1986.\nThe Certificate of Incorporation which 3-B governs FFCA Investor Services Corporation 85-A, as filed with the Secretary of State of Delaware on June 28, 1985.\nBylaws of FFCA Investor Services 3-C Corporation 85-A.","section_15":""}
{"filename":"73515_1995.txt","cik":"73515","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nNVF Company, a Delaware corporation, was incorporated in 1904. Reference herein to \"NVF\" or the \"Company\" includes collectively NVF Company and its wholly-owned subsidiaries unless the context indicates otherwise.\nOn August 27, 1993, three creditors of NVF filed an involuntary bankruptcy petition against NVF under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\") in the United States Bankruptcy Court for the District of Delaware (\"Bankruptcy Court\"), Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nOn April 13, 1994, the Company filed its Disclosure Statement and Plan of Reorganization. The hearing on the adequacy of the Disclosure Statement was set for June 15, 1994. On June 6, 1994, the Disclosure Statement hearing was continued until June 30, 1994. The hearing was subsequently taken off calendar. On July 15, 1994, the Company filed its First Amended Disclosure Statement and First Amended Plan of Reorganization. A copy of the Plan was filed as Exhibit 2.1 to Form 8-K by the Company on August 4, 1994. A hearing on the adequacy of the First Amended Disclosure Statement was set for September 13, 1994. On September 7, 1994, the Company filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. On September 13, 1994, the hearing on the adequacy of the Second Amended Disclosure was taken off calendar due to the agreement (the \"Joint Agreement\") reached before the Bankruptcy Court between NVF and the Official Committee of Unsecured Creditors of NVF (the \"Committee\") to jointly retain an investment banking firm for the purpose of marketing and selling or recapitalizing the Company.\nThe investment banking firm, Alex. Brown & Sons Incorporated (\"Alex. Brown\"), made procedural recommendations that were agreed upon by NVF and the Committee and approved by the Bankruptcy Court. Alex. Brown implemented those procedures and recommended to NVF and the Committee what they believe to be the highest and best offer which would realize the greatest value to the creditors. In accordance with the procedures approved by the Bankruptcy Court, Alex. Brown contacted a total of 147 potential purchasers for NVF. On July 24, 1995 Alex. Brown submitted its recommendation to the Bankruptcy Court under seal. On August 3, 1995 a hearing was held in the Bankruptcy Court on an Emergency Motion of First Security and Investment Corporation (\"First Security\") and Security Management Corporation for Examination of Alex. Brown & Sons, Inc. Pursuant to Federal Rule of Bankruptcy Procedure 2004. As a result of this hearing, the Court had permitted the mover to review the findings and conclusions of Alex. Brown's decision. Eventually, Alex Brown determined that the bid by First Security was the highest and the best bid. On October 27, 1995, NVF and the Committee filed their motion with the Bankruptcy Court seeking approval to enter into and execute a stock purchase agreement with First Security. On December 29, 1995 the Bankruptcy Court signed an order approving the bid of First Security as the highest and best bid. On January 29, 1996 the Joint Plan of Reorganization of NVF Company and The Official Committee of Unsecured Creditors (\"the Plan\") and the Disclosure Statement was filed with the Bankruptcy Court (See Form 8-K dated January 29, 1996, Exhibits 2 and 99). On March 4, 1996 the Bankruptcy Court approved the Disclosure Statement. The Plan has been submitted to the creditors for ratification. A hearing date in Bankruptcy Court concerning confirmation of the Plan has been scheduled for April 25, 1996.\nOn June 25, 1993 an involuntary bankruptcy petition was filed against APL Corporation (\"APL\"), the Company's 68% owned subsidiary. On July 23, 1993, APL filed a motion in the Bankruptcy Court for the Southern District of Florida and obtained an order on July 27, 1993 converting the involuntary petition to a voluntary case under Chapter 11 of the Bankruptcy Code. On or about February 24, 1995, a Disclosure Statement For Creditors' Committee's Plan of Reorganization was filed in the APL bankruptcy case. A hearing on the Disclosure Statement in the APL case was held on April 6, 1995 and the Disclosure Statement was approved on April 15, 1995. The Plan was confirmed on June 8, 1995. Due to the fact that NVF no longer has control over APL, statements presented herein have been restated to reflect APL as a discontinued operation and to reflect the deconsolidation of APL effective June 30, 1993. The Company had approximately $2.5 million face value of APL's 10-3\/4% Subordinated Sinking Fund Debentures. However a settlement of litigation commenced by the Committee (See Note 18 of notes to consolidated financial statements) called for the holders of 11- 3\/4% Secured NVF Promissory Notes to return such notes in exchange for the return of the APL 10-3\/4% Subordinated Sinking Fund Debentures. Other income of approximately $2,609,000 was recognized in 1995 as a result of the settlement.\nAs part of a series of transactions on April 23, 1993 Insurance and Risk Management (\"IRM\") repurchased from DWG Corporation (\"DWG\") 25% of the issued and outstanding stock of IRM. As a result of this purchase, NVF's ownership of IRM increased from 45% to 60% as IRM recorded the purchase of the shares from DWG as treasury stock thus reducing the outstanding shares. In a related transaction IRM sold to DWG all of its 2.7% stake in CFC Holdings for $8.4 million resulting in an approximate $7 million gain on the sale. The result of this gain was IRM's equity went from negative to positive, therefore NVF, as a 60% owner, recorded its share of the equity in IRM, approximately $1.5 million. NVF's equity in IRM was then reduced by dividends paid by IRM in 1993, 1994 and 1995 of $1,066,667, $133,333 and $240,000, respectively. IRM, DWG and NVF were affiliated as a result of common ownership and control by Victor Posner. As a result of the April 23, 1993 transactions DWG was no longer affiliated with NVF and IRM.\nIRM is now in the process of being liquidated. The decision to liquidate IRM was due to the fact that IRM's business was almost entirely conducted with affiliated companies. With DWG, the largest of such affiliated companies, becoming disaffiliated and electing not to use IRM for insurance placements and claims management, IRM's business became too small to be useful or profitable, thus the decision to liquidate. The decision to liquidate did not have a material impact on the Company's financial statements. Due to the fact that IRM has not taken any new business after June 30, 1993 and will be liquidated as soon as is practicable, NVF has elected to continue to account for IRM under the equity method on a quarter lag basis.\nFor the year ended December 31, 1995 and 1994 NVF had no income from its equity investment in IRM and NVF has a carrying value of its investment in IRM at December 31, 1995 and December 31, 1994 of $102,000 and $342,000, respectively. NVF has also received liquidating dividends of $240,000, $133,333 and $1,066,667 in 1995, 1994 and 1993, respectively.\n(b) Financial Information About Industry Segments\nThe Company's business is presently carried out in two principal operating segments: Industrial laminated plastics and vulcanized fibre.\nThe Company does not have any customer that makes up 10% of the Company's total consolidated revenue.\nSegment information for the three years ended December 31, 1995 is set forth in Note 13 of the Notes to Consolidated Financial Statements.\n(c) Narrative Description of the Business\nThe Company is engaged in the manufacture and sale of vulcanized fibre (a converted cellulose product) and industrial laminated plastics. NVF is also engaged to a lesser extent in the manufacture and sale of material handling containers and correspondence and business papers.\nINDUSTRIAL LAMINATED PLASTICS SEGMENT\nThe industrial laminated plastic products segment manufactures products which have their principal application in the electronics field such as for printed circuit boards. In addition, this segment produces industrial plastic sheet and tube materials for use as electrical insulation and for other applications.\nIndustrial laminated plastics are marketed by manufacturer's representatives located in major commercial centers throughout the United States, who receive incentive compensation for sales. The plastic laminate industry is highly competitive and this segment has many competitors, none of which is dominant in the industry and many of which are larger than the Company. The principal elements of competition are price, quality and customer service. Research and development expenditures have been insignificant in the industrial laminated plastics segment.\nVULCANIZED FIBRE SEGMENT\nThe Company is the largest manufacturer of vulcanized fibre in the United States. Vulcanized fibre is an extremely sturdy and lightweight converted cellulose product widely used in such applications as backing for abrasive discs (consumed principally by the automotive industry) and in the manufacture of electrical insulation, such as railway track insulation, fuses and lightning arresters. Vulcanized fibre also serves as a structural material for such applications as textile bobbins, material handling containers and building construction. NVF is the exclusive producer of YorkiteTM, a vulcanized fibre product used for furniture surfaces, cross-banding and edge-banding.\nVulcanized fibre products are marketed by manufacturer's representatives, located in major commercial centers throughout the United States, who receive incentive compensation for sales. NVF has two foreign principal competitors in the vulcanized fibre industry. The vulcanized fibre industry, in turn, competes against numerous manufacturers of materials which may be alternatives to vulcanized fibre, many of which are larger than the Company. Research and development expenditures have been insignificant in the vulcanized fibre segment.\nOTHER SEGMENTS\nA division of NVF also manufacturers material handling containers used in a wide variety of applications including the transportation of components to assembly points in factories, the movement of goods in retail stores, reusable shipping containers and containers for shipping delicate instruments. The containers are fabricated from vulcanized fibre, plastic and steel. There are many competitors in the container segment, none of which is dominant.\nIn addition, NVF through Parsons Paper, a subsidiary 100% owned by NVF Canada, which in turn is a 100% owned subsidiary of NVF located in Toronto, Canada, manufacturers paper which includes, among other products, bond and writing papers for communication and correspondence; ledger paper for durable and\/or permanent records; index and bristol stock for record keeping and mechanized postings; and covers and text papers of Lunar LaidTM and parchment for distinctive announcements and presentations. There are many competitors in the paper segment, none of which is dominant. In 1995, one customer accounted for 19.7% of paper products sales. The Company does not believe that the loss of this customer would have a material adverse effect on the business of NVF taken as a whole.\nNVF Canada is also engaged in the warehousing, fabrication and sale of industrial laminated plastics and vulcanized fibre and in the manufacture and sale of material handling containers. NVF's foreign operations are not significant. Research and development expenditures have been insignificant in the container, paper and foreign segments.\nOTHER INFORMATION\nOther than its brand names and trademarks referred to above, patents, licenses, franchises and concessions are not material to the business of the Company. No portion of the Company's business is subject to renegotiation of profits or termination of contracts at the sole election of the Government. The business of the Company's industry segments is not seasonal. Most raw materials for the Company's business segments are available from a number of sources, however the plastic products segment uses production quantities of natural gas, fuel oil and electricity in their production processes and currently does not have significant emergency or alternative capability. Although the Company has increased energy storage capacity at all of its plants, prolonged energy shortages or marked price increases in energy supplies and materials could adversely affect operations in this segment. No segment of the Company's business is dependent upon a single customer or a few customers, the loss of any one or more of which would a have a material adverse effect on such segment, and no customer accounted for 10% or more of the Company's consolidated revenues in 1995.\nThe Company has taken steps to retrofit its boilers to burn gas and\/or oil at its two largest plants (Kennett Square, Pennsylvania and Yorklyn, Delaware) in an effort to protect its operations from variations in availability and prices for energy supplies and raw materials. The Kennett Square plant retrofit has been completed and the Yorklyn plant is to be completed in 1996.\nThe Company's backlog at December 31, 1995 and 1994 was as follows: 1995 1994 (thousands of dollars)\nIndustrial laminated plastics $ 7,162 5,736 Vulcanized fibre 6,855 14,421 Containers, papers and foreign segments 1,119 2,401 $ 15,136 22,558\nThe backlog represents approximately two months of production.\nLABOR RELATIONS\nAt December 31, 1995, NVF employed approximately 230 salaried and 543 hourly employees. The hourly employees are primarily represented by the United Paper Workers International (\"United Paper Workers\"). The contract between NVF and the hourly workers represented by the United Paper Workers expires April 28, 1996. NVF is currently in negotiations for a new contract with the United Paper Workers although no assurance can be given that such a contract will be negotiated or ratified or what the terms and conditions thereof will be. If such contract is not successfully negotiated, it could result in a strike which may have a material adverse effect on NVF. Group life insurance and medical benefits are in effect for most employees. NVF believes that relations with its employees are generally satisfactory. There have been no significant strikes or work stoppages during the past five years.\nENVIRONMENTAL MATTERS\nThe Company's operations are subject to regulation by all levels of government designed to protect the environment. NVF is engaged in a continuing program of installing environmental control equipment at its facilities to meet the requirement of applicable environmental quality regulations. For the five years from 1991 through 1995, NVF spent approximately $328,000 on environmental control equipment. NVF presently estimates that it will spend approximately $1,000,000 for such equipment during the three-year period 1996-1998. Additional expenditures, however, will or may be required in connection with the matters set forth below. As requirements for pollution control are subject to revision and control and technology is constantly evolving, it is not possible at this time to estimate the full extent of future expenditures which may be required for pollution abatement equipment or the resulting effect of such expenditures on earnings.\nAs discussed fully elsewhere herein (See \"Item 1 - Business - General Development\"), NVF has filed for bankruptcy protection which could affect certain environmental claims pending against the Company. The Company and the EPA, subject to obtaining necessary approvals, had reached agreement in principle with respect to treatment of environmental claims under the Debtor's plan. Under this agreement, among other things, if the purchase option of the plan is approved all prepetition environmental claims will be paid by the reorganized Company on an equal basis with the amount to be paid to the unsecured creditors.\nTybouts Corner Landfill\nIn October 1980, the Environmental Protection Agency (the \"EPA\") filed suit against New Castle County, Delaware and others with respect to the disposal of waste at the Tybouts Corner Landfill which is adjacent to the Army Creek Landfill described below. The EPA sought injunctive relief and recovery of its clean up costs. The Company and numerous other alleged potentially responsible parties (\"PRP\") were named in the suit as third party defendants in 1985. A Consent Decree was approved by the court resolving the Company's liability.\nThe Company was also named as a defendant in an action brought by certain residents in the vicinity of the Tybouts Corner Landfill arising out of the alleged contamination of the site. In November 1992, the Company entered into a settlement of such action with the Andrews Generator Settlement Group providing for the payment by the Company of approximately $122,000 in twelve equal monthly installments (of which three payments in the aggregate amount of $30,419.58 remain outstanding). The underlying action has been dismissed. In the event of nonpayment by the Company, the settlement with the Andrews Group provides for a lien on the Company's property in New Castle County as a remedy.\nArmy Creek Landfill\nIn a November 4, 1993 demand letter sent by the New Castle County Finance Legal Office to the Company and all other non- settling potentially responsible parties, New Castle County demanded $9 million for costs related to the installation and operation of a water treatment plant and oversight costs attributable to both the Army Creek Landfill and the Delaware Sand and Gravel Superfund sites which are located in close proximity to each other in New Castle County, Delaware. On January 27, 1994, the New Castle County Finance Legal Office filed an Addendum to Chapter 11 Proof of Claim of New Castle County, Delaware, against the Company for unliquidated costs attributable to both the Army Creek Landfill and the Delaware Sand and Gravel Superfund sites as follows:\n1) $3 million pursuant to the terms of a Consent Decree related to the clean up of both sites, and\n2) $6 million (exclusive of interest) in clean up costs at both sites prior to entry of the Consent Decree.\nFollowing court ordered mediation, the Company settled all of its liability in the Delaware Sand and Gravel Superfund site for $300,000. A Consent Decree incorporating the settlement was approved and signed by the court on June 14, 1995. By paying this amount, the Company received a complete release from liability related to this site. Further, the Delaware Sand and Gravel Consent Decree also released its signatories, including NVF, from any groundwater remedy costs associated with Army Creek. The County may or may not have additional liability claims related to the soil or other remedial activities at the Army Creek Landfill. However, at present no claim, demand or other notice has been issued by the County to the Company for any other costs related to the Army Creek Landfill.\nKennett Square Plant Site and Noznesky Junk Yard\nThe Company was notified in 1984 by the Pennsylvania Department of Environmental Resources (\"DER\") of a discharge containing PCBs from an outfall from its Kennett Square plant in Chester County, Pennsylvania to an unnamed tributory of the west branch of Red Clay Creek. The Company responded with an investigation and clean up of the potential source. The Company entered into a consent order and agreement with the EPA with respect to on-site clean up and the EPA advised the Company that it has fully complied with the order. The DER subsequently requested that the Company clean up PCBs in the unnamed tributory. With respect to alleged off-site contaminations, the EPA issued two unilateral orders requiring testing and removal by the Company of certain contaminated soils. The Company filed a final report with the EPA under the second unilateral order, which expressly superseded the first order, stating that the Company believed its terms had been complied with. The Company had remediated the swale by the removal of tons of soil, testing and developing a solution to the PCBs in the rail road ditch. The Company also discussed with the EPA a possible settlement with respect to additional elevated concentrations of PCBs that were detected in an off-site drainage ditch. On November 10, 1992, the EPA sent to the Company a unilateral order requiring the prompt development and implementation of a response action plan for (1) the evacuation and disposal of PCB contaminated soils, sediments and debris from the off-site drainage ditch and (2) the \"swale\/tributory PCB report\" described above. The Company declined to undertake the order for several reasons including financial and technical ones. Through September 23, 1994, the EPA reports it has incurred costs of approximately $2,298,189 in performing part or all of the work. $1,035,047 of those costs are reported to have been incurred prepetition with the remainder subsequent to the filing. The EPA could seek to impose fines of $25,000 per day and\/or treble damages for non-compliance with the order due to the Company's refusal to perform the work.\nThe EPA is evaluating possible investigation and cleanup of the site. In addition the EPA has suggested to the Company that it reclaim a sedimentation pond. Further, the EPA has advised the Company that it is reviewing Kennett Square and\/or adjacent areas for possible listing on the National Priorities List (\"NPL\") as a Superfund site. The EPA informed the Company that costs related to Kennett Square could be $10 million dollars or higher if Kennett Square is named as a Superfund site. The EPA has declined to provide any additional information other than such evaluation is ongoing.\nIn approximately March, 1995, the Company also received notice of violation letters and\/or information requests from governmental agencies regarding alleged hazardous waste management, air emission, and wastewater discharge violations. The Company is seeking to retain consultants to advise it about the substance of those claims and the potential compliance costs, if any.\nEPA recently investigated and cleaned up a site known as the Noznesky Junkyard which is adjacent to the Kennett Square Plant. EPA incurred costs of approximately $1.8 million in the clean up. Because EPA has not served demand letters on or proceeded with any formal action against potentially responsible parties, NVF is uncertain of its connection to this site.\nLipari Landfill\nThe three principal defendants\/third-party plaintiffs at the Lipari landfill site, Rohm & Haas, Owens-Illinois, and Manor Health Care, settled with the United States and the State of New Jersey in 1994 and agreed to pay most of the government's costs and to perform the remedy at the site. Additionally, numerous potentially responsible parties named as third-party defendants by the principal defendants settled their liability as well. Ten (10) third-party defendants remain in the litigation, including the Company, with the third-party plaintiffs. The third-party defendants generally are substantial companies. The three third- party plaintiffs and the ten third-party defendants participated in court ordered mediation to resolve the matter throughout much of 1994 and 1995. This mediation failed and trial schedule is expected to be set. The three third-party plaintiffs allege joint and several liability, and seek approximately $6 to $9 million from the third-party defendants.\nGEMS Landfill\nThe Company, along with the numerous other parties, is a recipient of a unilateral 106 order directing it to perform certain remedial actions at the GEMS Landfill site in New Jersey as a result of alleged waste disposal at such site. The Company has also been named a defendant in litigation commenced by NJDEP with respect to the GEMS site and had entered into a partial settlement with respect to Phase I of the GEMS site remediation, for which it paid approximately $150,000. Subsequently, New Jersey issued a directive to existing PRPs including the Company, relating to the GEMS site Phase II (final) remediation. The Company believes there may be a reallocation of waste volumes attributable to participating parties which could affect the Company's share for both Phase I and Phase II settlement cost. Additionally, a class action involving 200 to 900 property owners received class certification and litigation is proceeding against some PRPs at this site.\nHelen Kramer Landfill, Marvin Jones Transfer Station, P.J.P Landfill\nOn May 31, 1989, NJDEP issued a directive to 48 potentially responsible parties, including the Company, requesting reimbursement for the state's expected share of remedial and administrative costs at the Helen Kramer Landfill. Thereafter, both the United States and NJDEP filed separate complaints in October, 1989, alleging joint and several liability. U.S. v. Helen Kramer, Civil No. 89-4340(6) filed October 16, 1989; and New Jersey v. Almo Anti-pollution Services Corp., Civil No. 89-4380(6), filed October 10, 1989. Those actions were joined by the Court. New Jersey and the United States seek an alleged $184,373,549.18, plus interest and costs, against some 48 direct defendants, including the Company, and approximately 265 third-party defendants. Through court ordered mediation last year, the magistrate attempted to settle the case for substantially less than the government's demand. The settlement process failed and the magistrate has recently ruled that the direct defendants are to proceed in the litigation as jointly and severally liable, but that the third- party defendants may be only severally liable.\nIn May 1990, the NJDEP also issued a multi-site directive and notice to insurers under the New Jersey Spill Act to numerous parties with respect to the Helen Kramer Landfill, the so-called Marvin Jones Transfer Station in Sewell, New Jersey and the P.J.P. Landfill in Jersey City, New Jersey seeking reimbursement of New Jersey's expected share of costs to implement remedial actions at such sites as a result of the generation or transportation of hazardous substance allegedly disposed of at such sites by the parties named in such directive, including the Company.\nYorklyn Plant Site and Newark Site\nIn June 1993, the Company received notification from the State of Delaware regarding potential liability for zinc contamination of the Yorklyn plant site on the Red Clay Creek and adjacent area. The State contends that historical plant operations have contributed levels of zinc in the stream and sediment. The Company proposes to enter into a Consent Decree with the state to investigate the alleged contamination.\nThe NVF Newark site is located along the banks of the White Clay Creek in Newark, Delaware. NVF ceased all production operations at this facility in December 1991. In January 1989 the Delaware Department of Natural Resources and Environmental Control (\"DNREC\") conducted a \"Preliminary Assessment\" of the Newark facility. This was followed by a June 1989 \"Site Inspection\" (SI) conducted by DNREC in conjunction with EPA. EPA scored all data from the \"SI\" using the National Hazardous Ranking System model and concluded that the site scores below the minimum score requiring an \"Extensive Site Inspection\". The Newark site status with EPA is \"No Further Action\". The DNREC has included this Newark site on their list of \"Potential State Super Fund Sites\" (a listing of sites needing further investigation).\nBuzby Brothers Landfill\nIn October 1991, the NJDEP issued a directive to more than one hundred PRPs, including the Company, notifying them that they are responsible for cleanup of the Buzby Brothers Landfill in Voorhees, New Jersey, and ordering the PRPs, including the Company, to reimburse NJDEP for the estimated costs of the remedial investigation and feasibility study. The PRPs have discussed settlement of the directive, and an intra-group allocation has been proposed pursuant to which the Company paid $10,000 to settle its liability under the directive for reimbursement of the estimated costs of such investigation and feasibility study. To date, approximately $8.5 million has been spent by owner\/operators to remediate the site and there is pending Federal and state court litigation against some of the PRPs, not including the Company, in which those who incurred costs performing a remedy seek reimbursement from others. It is possible that such an action could be pursued against the Company.\nBoarhead Farms Site\nOn June 10, 1988 and May 26, 1993, the EPA sent the Company requests for information connecting the Company to the Boarhead Farms Site, Bridgeton Township, Bucks County Pennsylvania. The Company knows of no information directly linking it to this site and has provided a response to that effect to the EPA on August 8, 1994.\nSpectron Site\nThe EPA named 400 to 500 potentially responsible parties at this site, including the Company as a generator. Clean up of this site has been divided into three operable units, and the Company previously has settled all claims with respect to two of those units. On or about October 1, 1995, NVF received an EPA notice letter indicating the EPA's intention to proceed with a remedial investigation and feasibility study for the final unit and inviting the Company's participation. The Company is presently investigating this development and has no information about the extent of its additional liability, if any.\nMcAdoo Associates Site\nThe Company was named as a PRP at the McAdoo Associates Site in Pennsylvania and entered into a Consent Decree with 63 other PRPs on June 3, 1988 to settle its liability at the site. Clean up costs are estimated at $3.18 million, of which the Company agreed to pay .59% or $22,484.90.\nBolsenski Landfill, Mountaintop Landfill, and Rivere Chemical Site\nThe Company received PRP Notice letters from the EPA with respect to each of these three sites as follows:\n. Bolsenski Landfill Site, Chester County, PA, Sept. 6,\n. Mountaintop Landfill, Lancaster County, PA. March 4, 1988\n. Rivere Chemical Site, Bucks County, PA, Sept. 8, 1987 and April 12, 1988.\nThe Company responded to these notices denying liability.\nOther Sites\nThe Company may have been, or may in the future be, alleged to be liable for environmental costs at other sites in various states, including Pennsylvania, New Jersey, and Delaware, and such potential liability arises out of the Company's alleged use of waste hauling entities related to Marvin Jonas, whose waste disposal practices have caused both governmental and private parties to bring cost recovery actions against any and all former Jonas customers when there is an allegation that Jonas disposed of waste at a particular site.\nSummary\nThe Company's consolidated financial statements at December 31, 1995 included elsewhere herein, include accruals of approximately $6.8 million for costs in connection with the environmental matters described above. As detailed below, it is the Company's current belief that the referenced and known environmental proceedings will not have a material adverse effect on its financial position or its results of operations. The Company believes that the $6.8 million accrual should provide an adequate amount to resolve these known liabilities. However, because of the uncertain nature of its environmental liabilities, particularly those related to the Kennett Square facility and the Yorklyn Plant, the Company is unable to assure that the outcome of the environmental matters will not have a material adverse effect on its financial position or the results of operations.\nAt the off site areas, the Company belongs to PRP Groups which typically pay costs and expenses on a basis reflecting each individual PRP's allocated share. While the Company's allocated share varies from site to site, at most sites it is approximately 1% or less. To devise an estimated range for accrual purposes, the Company assessed its allocated share against the range of total site costs considered by the PRP Group for each site. Because literally hundreds of other PRPs exist at these other sites, and those companies are jointly and severally liable, the Company does not have the resources or the ability to assess the financial condition of these other parties. In light of the multiple parties, the Company does not believe that the financial condition of other companies will affect its liability.\nFor Company owned sites, the Company employed ranges of costs for known problems at Kennett Square and Yorklyn. As discussed below, those ranges do not include other speculative future environmental developments which could have a material impact on the Company. By applying this criterion for off site and owned sites, the Company estimated its environmental liabilities in the range of approximately $3 million to approximately $15 million. Based upon its settlement experience at certain sites and an internal assessment of the total clean up costs at each site, the Company determined an accrual amount for the range of potential environmental costs of $6.8 million. The Company's actual cost for these liabilities may well be closer to the lower end of the range due to the fact that the Company is in bankruptcy and due to the bankruptcy treatment of certain of these claims. The $6.8 million accrual does not include any offset for potential insurance recoveries. While the Company is hopeful that it will recover some funds for environmental expenses, it has not reached any agreements on its insurance claims. The Company has asserted claims against its insurers for all off site environmental liabilities and all environmental liabilities for the Kennett Square facility. In those actions, the Company seeks recovery of all costs incurred in connection with those environmental matters.\nFinally, future environmental matters could have a material impact on the Company. Specifically, the United States Environmental Protection Agency (\"EPA\") is evaluating the Kennett Square site and\/or surrounding areas for possible listing on the National Priorities Listing (\"NPL\"). However, the EPA has provided no indication of whether it intends to do so. If the EPA were to list the site and\/or surrounding areas on the NPL and a cleanup were to be required, such a development could have a material impact on the Company. Because of the wholly speculative nature of this issue, the Company has not considered it in the $6.8 million accrual.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries maintain a large number of diverse properties. Management believes that these properties, taken as a whole, are adequate for current and foreseeable business needs. The majority of the properties are owned. Substantially all of the Company's materially important physical properties are being fully utilized with the exception of inactive properties described below. Certain information about the major facilities maintained by each segment is set forth in the following table:\nOwned or Approximate Location leased Use square feet\nNVF FACILITIES\nMulti-Segment Facilities Kennett Square, PA (1)(3) Owned Manufacturing\/Fabrication 342,000 Yorklyn, DE (2) Owned Manufacturing\/Fabrication 552,000 Wilmington, DE (1)(2)(3) Owned Fabrication 186,000 Hartwell, GA (2)(5)(6) Owned Manufacturing\/Fabrication 144,000 Chicago, IL (1)(2) Owned Fabrication 27,000 Toronto, Canada (1)(2) (expires 4\/96) Manufacturing\/Fabrication 40,000\nPaper Products Segment\nHolyoke, MA Owned Manufacturing 313,000\nInactive Newark, DE (4) Owned Closed 356,000 Yorklyn, DE (3) Owned Unimproved Land 130 acres\nInvestment Property Kennett Township Owned Unimproved Land 88 acres\n(1) Industrial Laminated Plastic Segment\n(2) Vulcanized Fibre Segment\n(3) Subject to First Mortgage lien securing NVF's 10% Secured Notes.\n(4) Newark, DE operations were terminated in September, 1991 and such operations were transferred to the Yorklyn, DE facility.\n(5) Subject to First Mortgage lien securing NVF's UDAG loan.\n(6) Subject to Second Mortgage lien securing NVF's 10% Secured Notes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nBy order of the Bankruptcy Court all litigation against NVF has been stayed pursuant to 11 USC Section 362 and unless otherwise ordered such proceedings will be resolved in context of the bankruptcy case.\nOn August 27, 1993 three creditors of NVF filed an involuntary bankruptcy petition against NVF under the Bankruptcy Code Bankruptcy Court, Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nOn April 13, 1994, the Company filed its Disclosure Statement and Plan of Reorganization. The hearing on the adequacy of the Disclosure Statement was set for June 15, 1994. On June 6, 1994, the Disclosure Statement hearing was continued until June 30, 1994. The hearing was subsequently taken off calendar. On July 15, 1994, the Company filed its First Amended Disclosure Statement and First Amended Plan of Reorganization. A copy of the Plan was filed as Exhibit 2.1 to Form 8 by the Company on August 4, 1994. A hearing on the adequacy of the First Amended Disclosure Statement was set for September 13, 1994. On September 7, 1994, the Company filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. On September 13, 1994, the hearing on the adequacy of the Second Amended Disclosure was taken off calendar due to the agreement (the \"Joint Agreement\") reached before the Bankruptcy Court between NVF and the Official Committee of Unsecured Creditors of NVF (the \"Committee\") to jointly retain an investment banking firm for the purpose of marketing and selling or recapitalizing the Company.\nThe investment banking firm, Alex. Brown & Sons Incorporated (\"Alex. Brown\"), made procedural recommendations that were agreed upon by NVF and the Committee and approved by the Bankruptcy Court. Alex. Brown has implemented those procedures and recommended to NVF and the Committee what they believe to be the highest and best offer which will realize the greatest value to the creditors. In accordance with the procedures approved by the Bankruptcy Court, Alex. Brown contacted a total of 147 potential purchasers for NVF. On July 24, 1995 Alex. Brown submitted its recommendation to the Bankruptcy Court under seal. On August 3, 1995 a hearing was held in the Bankruptcy Court on an Emergency Motion of First Security and Investment Corporation (\"First Security\") and Security Management Corporation for Examination of Alex. Brown & Sons, Inc. Pursuant to Federal Rule of Bankruptcy Procedure 2004. As a result of this hearing, the Court had permitted the mover to review the findings and conclusions of Alex. Brown's decision. Eventually, Alex Brown determined that the bid by First Security was the highest and the best bid. On October 27, 1995, NVF and the Committee filed their motion with the Bankruptcy Court seeking approval to enter into and execute a stock purchase agreement with First Security. On December 29, 1995 the Bankruptcy Court signed an order approving the bid of First Security as the highest and best bid. On January 29, 1996 the Joint Plan of Reorganization (\"the Plan\") of NVF Company and The Official Committee of Unsecured Creditors and the Disclosure Statement was filed with the Bankruptcy Court (See Form 8-K dated January 29, 1996, Exhibits 2 and 99). On March 4, 1996 the Bankruptcy Court approved the Disclosure Statement. The Plan has been submitted to the creditors for ratification. A hearing date in Bankruptcy Court concerning confirmation of the Plan has been scheduled for April 25, 1996.\nOn June 25, 1993 an involuntary bankruptcy petition was filed against APL Corporation (\"APL\"), the Company's 68% owned subsidiary. On July 23, 1993, APL filed a motion in the Bankruptcy Court for the Southern District of Florida and obtained an order on July 27, 1993 converting the involuntary petition to a voluntary case under Chapter 11 of the Bankruptcy Code. On or about February 24, 1995, a Disclosure Statement For Creditors' Committee's Plan of Reorganization was filed in the APL bankruptcy case. A hearing on the Disclosure Statement in the APL case was held on April 6, 1995 and the Disclosure Statement was approved on April 15, 1995. The Plan was confirmed on June 8, 1995. Due to the fact that NVF no longer has control over APL, statements presented herein have been restated to reflect APL as a discontinued operation and to reflect the deconsolidation of APL effective June 30, 1993. The Company had approximately $2.5 million face value of APL's 10-3\/4% Subordinated Sinking Fund Debentures. However a settlement of litigation commenced by the Committee (See Note 18) called for the holders of 11-3\/4% Secured NVF Promissory Notes to return such notes for the return of the APL 10-3\/4% Subordinated Sinking Fund Debentures. Other income of approximately $2,609,000 was recognized in 1995 as a result of the settlement.\nOn December 1, 1993, in an action brought by the Securities & Exchange Commission not involving the Company, a judge in the United States District Court for the Southern District of New York issued a decision stating that the Court would issue a decree, among other things, barring Victor Posner and Steven Posner from serving as officers and directors of any reporting company under the Securities Exchange Act of 1934, as amended, and ordering that the stock Victor Posner and Steven Posner own in reporting companies which they control (as defined in that Act) be placed in voting trusts. On December 29, 1993 such decree was issued. On January 4, 1994 Victor Posner resigned his positions as Director, President and Chief Executive Officer of the Company. The United States Court of Appeals for the Second Circuit has affirmed the lower court's judgment and certiorari has been denied by the United States Supreme Court.\nOn June 8, 1994, Richard L. Beltzhoover, as Trustee of The Employees' Pension and Investment Plan of Insulation Represen- tatives, Inc. filed suit against NVF in the Court of Chancery of the State of Delaware In and For New Castle County. The suit requested that the Court of Chancery summarily order an annual meeting of the shareholders of the Debtor. On June 17, 1994, the plaintiff filed a Motion to Expedite the Proceeding on the grounds that it is a summary proceeding under 8 Del. C. 211(c) and based upon allegations in the complaint. Subsequently, Vice Chancellor Berger directed the Debtor to file its answer in the Chancery Court Action on or before June 27, 1994. On June 27, 1994, the Debtor filed its answer in the Chancery Court Action. On July 6, 1994, Beltzhoover filed a Motion for Relief From Stay, or in the Alternative, To Compel Annual Shareholders Meeting. Beltzhoover requested an expedited hearing on the matter. On July 19, 1994 Beltzhoover filed the same motion in Bankruptcy Court. It was then decided that this case would be heard in Bankruptcy Court rather than in Chancery Court where the action has been stayed. A trial to hear the Application to Compel an Annual Meeting of NVF Shareholders was scheduled for October 3, 1994, however Beltzhoover requested a continuance on that date and all parties agreed to adjourn such action until November 28, 1994. On December 5, 1994 the Board of Directors of the Company approved a settlement proposal whereby Beltzhoover withdrew his motions and covenants not to refile, initiate, commence or resurrect any of the motions at any time before July 31, 1995. Beltzhoover also agreed not to seek reimbursement from the Company for any expenses incurred as a result of his efforts. In turn, Richard Beltzhoover and Kim Del Fabro were elected to its Board of Directors effective December 5, 1994.\nOn June 4, 1993 Insurance Company of North America (\"INA\") filed suit against the Company claiming INA was indemnified by NVF on certain self insured workers compensation and mining reclamation obligations written for Sharon Steel Corporation and its subsidiaries. By virtue of NVF's bankruptcy action, this suit has been stayed. INA had filed a proof of claim against the Company in the amount of approximately $4,500,000 in the Bankruptcy Court which has been resolved by allowance of INA's unsecured claim in the amount of $4.385 million. The Company has accrued the entire amount of the claim under \"Liabilities Subject to Compromise\".\nOn March 17, 1993, New Castle County filed an action in the Superior Court of the State of Delaware against the Company claiming that the Company owed New Castle $1,566,956.81 for sewer service provided to the Company's Yorklyn, Delaware plant. New Castle County has agreed to the treatment of their claim as set forth in the Plan. Under this proposal an aggregate amount of $1,813,507.27 claim of principal and interest shall be recognized. Interest shall accrue at 9% per annum from November 1, 1995 until the consummation date of the Plan. On the consummation date, or as soon as practicable thereafter, the holder of the claim shall receive twelve payments at monthly intervals of interest only at 8% per annum on the sum of $1,813,507.27 plus interest accrued between November 1, 1995 and the date of the first payment. Thereafter the remaining balance will be amortized over forty-eight months at a rate of 8% per annum. The Company reserved the right to contest this claim under this proposal and has filed such with Court on .\nThe Company and the EPA, subject to obtaining necessary approvals, had reached agreement in principle with respect to treatment of environmental claims under the Debtor's plan. Under this agreement, among other things, if the purchase option of the plan is approved all prepetition environmental claims will be paid by the reorganized Company pari passu with the amount to be paid to the unsecured creditors.\nThe Creditor's Committee commenced an adversary action in the United States District Court for the District of Delaware against certain present and former directors of the Company (including Messrs. Victor and Steven Posner), Triarc Companies, Inc. (formerly known as DWG), RC\/Arby's Corporation, American Financial Corporation, Great American Insurance Company and Mid-Continent Casualty Company (the \"Litigation\"). The First Amended Complaint in the action alleged causes of action based on allegations of breach of fiduciary duty, waste, fraudulent transfers, preference payments, and violations of the Racketeer influence and Corrupt Organizations Act (\"RICO\"). The District Court subsequently dismissed the Committee's RICO claims on the grounds that defendants' alleged acts of mail and wire fraud did not proximately cause injury to NVF. The District Court also held that Delaware's three-year limitations period set forth in 10 Del. C. 8016 might apply to some causes of action and allowed the Committee to file a second amended complaint to plead facts showing why its claims are not time-barred. In its second amended complaint, the Committee named NVF Company as a nominal defendant. The Committee had also filed a motion seeking leave to file a third amended complaint and a motion seeking reconsideration of the order dismissing the RICO claims. Following extensive discovery and pre-trial preparation, on May 9, 1995, the parties to the litigation reached a settlement of their disputes before a United States Magistrate. Pursuant to the settlement, which is subject to approval by the Bankruptcy Court, the parties have agreed, among other things, to the following: A) Victor Posner has agreed to pay $20,750,000 to the NVF estate; B) the Committee has agreed that the claim of the 10% secured notes will be allowed in the approximate amount of $8.2 million; C) the holders of the 11-3\/4% Secured NVF notes have agreed to return such notes in exchange for the return of approximately $2,538,000 principal amount of the APL 10-3\/4% Subordinated Sinking Fund Debentures held by NVF; D) DWG will withdraw its unsecured claims of approximately $210,000; and E) the parties have agreed to exchange mutual releases. On November 22, 1995 an Order and Final Judgment approving the settlement was signed by the Bankruptcy Court. A Stipulation and Order of Dismissal was ordered by the United States District Court on December 15, 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 principal market for NVF's common stock was the Pacific Stock Exchange. In July 1992, NVF was informed that the Equity Listing Committee of the Pacific Stock Exchange voted unanimously to delist the securities of the Company and suspended its common stock from trading as of July 14, 1992. NVF is informed that such Committee based its decision upon the Company's failure to meet the Exchange's net tangible assets and \"going concern\" maintenance standards. Since then the Company's stock has been traded between brokers. To estimate the sales price of the Company's stock would be unreliable and not all inclusive of trading activity, therefore no estimate can be made.\nThe approximate number of equity security holders is as follows:\nNumber of Stockholders of Title of Class Record as of April 5, 1994\nCommon Stock, $.01 par value 14,227\nUnder the Delaware Corporation Law, dividends may be paid only out of surplus, or if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and\/or the preceding fiscal year. There were no cash dividends or stock distributions in 1995 or 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nYear Ended December 31, 1995 1994 1993(2) 1992(1) 1991(1) (In thousands of dollars except per share amounts)\nSelected Income Statement Information:\nNet sales and operating revenues $ 96,891 93,981 90,046 94,868 95,973 Operating income from continuing operations $ 1,165 4,616 2,133 3,676 88 Debt costs $ (1,116) (2,207) (5,599) (7,070) (7,474) Income (loss) from continuing operations $ 17,369 (10,813) (701) (6,088) (7,856) Loss from discontinued operations $ - - (5,304) (22,697) (22,803) Net income (loss) $ 17,369 (10,813) (6,005) (28,785) (30,659)\nPrimary per share data:\nIncome (loss) from continuing operations $ .19 (.12) (.01) (.07) (.09) Loss from discontinued operations $ - - (.06) (.24) (.24)\nNet income (loss) $ .19 (.12) (.07) (.31) (.33)\nMarket price at year-end $ N\/A N\/A N\/A .005 .016\nSelected Balance Sheet Information:\nYear Ended December 31, 1995 1994 1993 1992 1991\nCurrent assets $ 45,915 31,018 31,465 30,127 36,245 Current liabilities $ 22,319 24,327 21,460 80,375 30,748 Working capital (deficit) $ 23,596 6,691 10,005 (50,248) 5,497 Total assets $ 67,571 52,261 53,911 54,850 64,978 Long-term debt $ 176 35 36 10,090 10,423 Total stockholders' deficiency $(45,542) (63,220) (52,237) (122,514) (92,592)\nThe foregoing \"Selected Financial 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\nTRENDS\nThe vulcanized fibre segment declined during 1995 as a result of the main part of the plant being shutdown temporarily for a capital expansion project and higher cost of materials and benefits. The industrial laminated plastics segment rebounded due to a slight improvement in the economy, operating efficiencies and a lessening of competition.\nCAPITAL RESOURCES\nCapital expenditures for the years 1995, 1994 and 1993 were $180,000, $326,000 and $230,000, respectively, for the industrial laminated plastics segment; $2,418,000, $1,231,000 and $650,000, respectively, for the vulcanized fibre segment and $310,000, $109,000 and $460,000, respectively, for the Company's other operations. The Company presently anticipates capital expenditures for 1996 will be less than those in 1995. The Company anticipates financing its future capital expenditure through cash flow from operations, from capitalized leases, possible sales of assets and from its accounts receivable financing arrangements.\nOn September 20, 1994, the Company filed a Motion For Order Authorizing Debtor To Make Expenditures Pursuant to Section 363(b). The Company requested authority to spend $2.15 million to expand its production capacity for vulcanized fibre due to a serious backlog problem caused by increased demand for vulcanized fibre. The Committee agreed to the capital expenditure in the full amount and the Bankruptcy Court authorized the expenditures on October 27, 1994. The Company has completed the capital expenditure project.\nLIQUIDITY\nNVF's consolidated working capital at December 31, 1995 increased by approximately $16,905,000 from December 31, 1994. Proceeds from a settlement of litigation entitled the Official Creditors' Committee of NVF Company v. Victor Posner, et al. (See Note 18 of Notes to Consolidated Financial Statements) of $20,750,000 and other terms of such settlement, i.e., the return to the Company of its 11-3\/4% Secured Promissory Notes in exchange for previously written off APL 10-3\/4% Subordinated Sinking Fund Debentures, were principally responsible for the increase. However, terms of the settlement also dictate that such proceeds may only be used in matters relating to the bankruptcy, resulting in the restricted cash (See Note 2 of Notes to Consolidated Financial Statements) of $16,336,000.\nCash provided by operating activities and cash used for financing activities came principally from the settlement of the lawsuit entitled Official Creditors' Committee of NVF Company v. Victor Posner et al. (See Note 18 of Notes to Consolidated Financial Statements). Cash used for investing activities resulted from a capital expenditure program to increase vulcanized fibre production. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY (Contd.)\nOn August 27, 1993 three creditors of NVF filed an involuntary bankruptcy petition against NVF under Chapter 11 of the Bankruptcy Code in Bankruptcy Court, Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nOn April 13, 1994, the Company filed its Disclosure Statement and Plan of Reorganization. The hearing on the adequacy of the Disclosure Statement was set for June 15, 1994. On June 6, 1994, the Disclosure Statement hearing was continued until June 30, 1994. The hearing was subsequently taken off calendar. On July 15, 1994, the Company filed its First Amended Disclosure Statement and First Amended Plan of Reorganization. A copy of the Plan was filed as Exhibit 2.1 to Form 8-K by the Company on August 4, 1994. A hearing on the adequacy of the First Amended Disclosure Statement was set for September 13, 1994. On September 7, 1994, the Company filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. On September 13, 1994, the hearing on the adequacy of the Second Amended Disclosure was taken off calendar due to the agreement (the \"Joint Agreement\") reached before the Bankruptcy Court between NVF and the Official Committee of Unsecured Creditors of NVF (the \"Committee\") to jointly retain an investment banking firm for the purpose of marketing and selling or recapitalizing the Company.\nThe investment banking firm, Alex. Brown & Sons Incorporated (\"Alex. Brown\"), made procedural recommendations that were agreed upon by NVF and the Committee and approved by the Bankruptcy Court. Alex. Brown has implemented those procedures and recommended to NVF and the Committee what they believe to be the highest and best offer which will realize the greatest value to the creditors. In accordance with the procedures approved by the Bankruptcy Court, Alex. Brown contacted a total of 147 potential purchasers for NVF. On July 24, 1995 Alex. Brown submitted its recommendation to the Bankruptcy Court under seal. On August 3, 1995 a hearing was held in the Bankruptcy Court on an Emergency Motion of First Security and Investment Corporation (\"First Security\") and Security Management Corporation for Examination of Alex. Brown & Sons, Inc. Pursuant to Federal Rule of Bankruptcy Procedure 2004. As a result of this hearing, the Court had permitted the mover to review the findings and conclusions of Alex. Brown's decision. Eventually, Alex Brown determined that the bid by First Security was the highest and the best bid. On October 27, 1995, NVF and the Committee filed their motion with the Bankruptcy Court seeking approval to enter into and execute a stock purchase agreement with First Security. On December 29, 1995 the Bankruptcy Court signed\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY (Contd.)\nan order approving the bid of First Security as the highest and best bid. On January 29, 1996 the Joint Plan of Reorganization (\"the Plan\") of NVF Company and The Official Committee of Unsecured Creditors and the Disclosure Statement was filed with the Bankruptcy Court (See Form 8-K dated January 29, 1996, Exhibits 2 and 99). On March 4, 1996 the Bankruptcy Court approved the Disclosure Statement. The Plan has been submitted to the creditors for ratification. A hearing date in Bankruptcy Court concerning confirmation of the Plan has been scheduled for April 25, 1996.\nNVF did not make sinking fund payments of $4.8 million due on January 1, 1993 and $43.2 million due January 1, 1994 nor did it make $1.2 million interest payments due July 1, 1993 and January 1,1994 on its 5% Subordinated Debentures. NVF did not make sinking fund payments of approximately $284,375 on November 14, 1993, November 14, 1994 and November 14, 1995 nor did it make interest payments of $568,757 on its 10% Subordinated Debentures due November 14, 1993, May 14, 1994, November 14, 1994, May 14, 1995 and November 14, 1995. The Company did not make interest payments of approximately $373,000 due November 22, 1993, May 22, 1994, November 22, 1994, May 22, 1995 and November 22, 1995 on its 10% Secured Notes.\nThe Company reduced long-term debt by exchanging its APL 10- 3\/4% Subordinated Sinking Fund debentures for 11-3\/4% Secured NVF notes. During 1993 APL went into bankruptcy. The Company's investment in APL 10-3\/4% Subordinated Sinking Fund Debentures plus interest was deemed uncollectable and no determination could be made what part, if any, would be collected, therefore the entire $2,786,000 was written off in 1993. The above exchange provided approximately $2,609,000 of Other Income in 1995. The Company anticipates that the remainder of the current portion of long term debt will be restructured as part of its reorganization plan to emerge from bankruptcy. The 5% and 10% Subordinated Debentures and the remainder of the Company's unsecured debt are expected to be compromised within the course of the bankruptcy and paid from a pool created by the sale of the Company and the proceeds from litigation entitled as the Official Creditor's Committee of NVF Company v. Victor Posner, et al. The short-term financing needs of the Company will be satisfied by an accounts receivable financing facility which the Company is confident, but cannot assure, it will obtain.\nThe Company has an accounts receivable financing arrangement with CIT Group (\"CIT\") covering substantially all of its accounts receivable. Such arrangement provides the Company a line of credit up to the lesser of $8,000,000 or 80% of the eligible accounts receivable at an interest rate of prime (8.75% at December 31, 1995) plus 1\/2%, a line of credit fee of 1\/2% per annum on the unused balance and a $3,000 per month collateral management fee.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY (Contd.)\nAt December 31, 1995 the Company had open a balance of $3.6 million under this arrangement. On , 1996 CIT advised the Company that it would not be interested in financing arrangement after the Company emerges from bankruptcy. The Company believes it will be successful in finding alternative financing, however there can be no assurance that the Company will be able to obtain such financing or that it will be available on terms the Company deems acceptable.\nThe Company's consolidated financial statements at December 31, 1995 included elsewhere herein, include reserves of approximately $6.8 million for costs in connection with the known environmental matters except for future speculative matters relating to Kennett Square and Yorklyn. This accrual has been recorded on a gross basis and has not been adjusted for third party recoveries. However environmental liabilities are inherently uncertain and future events and\/or additional information may require adjustments to this reserve figure. In connection with the various claims asserted against NVF by the EPA and others in connection with environmental matters, NVF has commenced an action against various insurance carriers for coverage of some or all of the amount for which NVF might be held liable in connection therewith and the defense costs thereof. Except as noted above, NVF is unable at this time to predict the outcome of such action or the amounts, if any, which may be paid by such insurers. NVF believes that the outcome of such environmental matters described above will not have a material adverse effect on its financial position or its results of operations.\nFuture environmental matters though could have a material impact on the Company. The Company notes that (1) the Company was advised by the EPA that it is reviewing the Kennett Square Plant area and\/or adjacent areas for possible listing on the NPL as a Superfund Site (the \"Potential Superfund Area\") and (2) the Company has received notification from the EPA seeking information regarding potential liability for zinc contamination related to the Yorklyn Plant site (the \"Yorklyn Contamination\"). The Company further notes that in the event that (1) the Potential Superfund Area is, in fact, named as a Superfund Site or (2) remediation of the Yorklyn Contamination is required, and it is determined that the Company is liable for costs thereof, the Company would likely expect to incur significant additional expenses with respect to environmental matters for those areas. In a letter dated April 13, 1995, the EPA informed the Company that costs related to Kennett Square could be $10 million or higher if Kennett Square is named as a Superfund Site. The likelihood (1) that the Kennett Square and\/or adjacent areas will be named as a Superfund Site or (2) that remediation of the Yorklyn Contamination will be required and that a determination will be made that the Company is responsible for the costs therefore cannot be predicted with certainty at the present time. In connection with the various claims against the ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nLIQUIDITY (Contd.)\nCompany by the EPA and others in connection with environmental matters, the Company has commenced an action against various insurance carriers for coverage of some or all of the amount for which the Company might be held liable in connection therewith and the defense costs thereof. The Company is unable at this time to predict the outcome of such action or the amounts, if any, which may be paid by such carriers.\nNVF's ability to meet its cash requirements in the next twelve months is dependent upon increased cash flow being generated from NVF's operations, the continuing of financing of accounts receivable, available borrowings, the compromising of liabilities within the framework of bankruptcy and possible sale of any assets. No assurance can be given that any of such conditions can be achieved or, if achieved, what the terms and conditions thereof will be. NVF believes, but cannot assure, that cash generated from operations and funds from accounts receivable financing will be sufficient to enable NVF to maintain its operations until such time as a plan can be confirmed by the Bankruptcy Court. The financial statements included herein have been prepared on a going concern basis and, accordingly, do not include any adjustments relating to the recoverability and classification of recorded asset amounts nor the amounts and classification of liabilities that might be necessary should NVF be unable to continue in existence or be required to sell its assets. As a result of the uncertainties described above, reference is made to Note 16 included elsewhere herein for information concerning the estimated liquidation value of NVF on a consolidated basis.\nInflation and Changing Prices\nManagement believes that inflation did not have a significant effect on gross margins during the last three years through September 1995, since during such period inflation rates generally remained at relatively low historical levels. However, since then energy price increases have had a significant effect on gross margins. The Company is seeking to combat these higher energy prices by increasing energy storage capacity by retrofiting boilers at certain locations to use either oil or gas.\nThe Company has consolidated its raw material purchases among a few strong suppliers who in return for the increased volume have provided a specific warning period prior to price increases. At no time is the Company dependent on just one supplier base (wherever possible) for its critical material. However, certain raw materials (fiberglass, copperfoil) are presently being allocated to consumers world-wide and such demand has increased prices of this material, however the Company has so far successfully passed on such increases to its customers.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS\nYear Ended December 31, 1995 Compared with 1994\nNet Sales and Operating Revenues Operating Income (Loss) Percent Percent 1995 1994 Change 1995 1994 Change (thousands of dollars)\nIndustrial laminated plastics $ 55,258 47,667 15.9% 3,760 2,976 26.3% Vulcanized fibre 29,581 32,451 (8.8)% 4,371 7,397 (40.9)% Other segments 12,052 13,836 (13.1)% (1,973) (659) (199.4)% General corporate expenses - - - (4,993) (5,098) 0.0%\nNet sales and operating revenues $ 96,891 93,981 3.1%\nOperating income 1,165 4,616\nOther income (expense), net 24,644 (6,433) Debt costs (1,116) (2,207)\nIncome (loss) before reorganization items, taxes, equity in earnings of affiliates, and discontinued operations $ 24,693 (4,024)\nNet sales increased 3.1% or approximately $2,910,000 mainly due to better marketing conditions and effort in the industrial laminated plastics segment which increased sales 15.9% or approximately $7,591,000. Net sales declined in the vulcanized fibre segment 8.8% or approximately $2,870,000 as a plant shutdown for capital renovations caused reduced production. Container sales declined 25.8% or approximately $1,221,000 as a result of textile industries converting from fibre containers to less expensive plastic containers. Paper sales declined 10.6% or approximately $730,000 due to increased competition and depressed market conditions.\nOperating income declined approximately $3.5 million. Generally, higher energy and benefit (workmen's compensation, pension, medical) costs were attributable for such decline. Industrial laminated plastics segment operating profit increased 26.3% or approximately $784,000 due to increased volume and operating efficiencies. Vulcanized fibre segment operating profit declined 40.9% or approximately $3,026,000 due to decreased production caused by a plant shutdown for capital renovations and higher costs for raw materials. Container and paper losses increased by approximately $331,000 and approximately $408,000 respectively, mainly due to volume decreases.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS (continued)\nOther income (expense) was impacted by the settlement of the Creditors' Committee adversary action against Victor Posner, et al (See Note 19 of the Notes to Consolidated Financial Statements) which provided for payment by Victor Posner of $20,750,000 to the NVF estate. The settlement also provided that the holders of the 11-3\/4% Secured NVF notes exchange such notes for the previously written off APL 10-3\/4% Subordinated Sinking Fund Debentures held by NVF resulting in $2,609,000 of other income. In addition there was a favorable settlement with an insurance carrier for an environmental claim (approximately $1 million). Also losses incurred in 1994 for indemnification of workmen's compensation claims of companies formerly affiliated with NVF (approximately $4.5 million) and environmental accruals (approximately $1.2 million) did not recur.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS\nYear Ended December 31, 1994 Compared with 1993\nNet Sales and Operating Revenues Operating Profits (Loss) Percent Percent 1994 1993 Change 1994 1993 Change (thousands of dollars)\nIndustrial laminated plastics $ 47,667 46,561 2.4% 2,976 2,446 21.7% Vulcanized fibre 32,451 29,231 11.0% 7,397 6,722 10.0% Other segments 13,863 14,254 -2.7% (659) (4) - General corporate expenses - - - (5,098) (7,031) 68.6%\nNet sales and operating revenues $ 93,981 90,046 4.4%\nOperating profit 4,616 2,133\nOther income (expense), net (6,433) 4,805 Debt costs (2,207) (5,599)\nIncome (loss) before reorganization items, taxes, equity in earnings of affiliates, and discontinued operations $(4,024) (1,339)\nVulcanized fibre segment sales increased by $3,220,000 between 1993 and 1994. Volume represented $2,201,000 of such increase and price represented $1,019,000. Sales increases in the industrial laminated plastic segment were the result of marketing effort\/increased volume, not price increases. Paper segment sales decreased due to increased competition and depressed market conditions.\nOperating profits in the valcanized fibre segment increased by $675,000 between 1993 and 1994. Price increases as noted above directly increased profits by the same amount, $1,019,000. Volume increases contributed $901,000 to profits. However, these increases were partially offset by increased cost of $1,245,00. Union contracted labor rate increases for 1994 as well as benefit increases and increases in raw materials were the major components on the increased costs in 1994. Operating profits in the industrial laminated plastics segment increased as a result of the efficiency gained by increased volume. Operating profits in the paper segment decreased due to volume decrease. General corporate expense decreased as salaries, insurance, executive administration and bad debt expenses were reduced.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nRESULTS OF OPERATIONS (continued)\nIn 1993 Other Income (Expense) was positively impacted by non- recurring events, i.e., $3.6 million gain on proceeds from fire losses, $3.6 million gain on sale of CFC Holding stock and $.7 million gain on sale of property whereas in 1994 Other Income (Expense) was negatively impacted by non-recurring events, i.e., accrued reserves for a workmen's compensation indemnification claim by Insurance Company of the North America of $4.5 million and additional reserves provided for potential EPA liabilities of $2.8 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nNVF COMPANY AND SUBSIDIARIES\nPage\nReport of Independent Public Accountants\nConsolidated Balance Sheets December 31, 1995 and 1994\nConsolidated Statements of Operations Three Years Ended December 31, 1995\nConsolidated Statements of Cash Flows Three Years Ended December 31, 1995\nConsolidated Statements of Changes in Stockholders' Deficit Three Years Ended December 31, 1995\nNotes to Consolidated Financial Statements\nSchedules are omitted either because they are not applicable or because the information is included in the Consolidated Financial Statements or notes thereto.\nARTHUR ANDERSEN & COMPANY 101 Eisenhower Parkway Roseland, New Jersey 07068\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo NVF Company:\nWe have audited the accompanying consolidated balance sheets of NVF Company (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, cash flows and changes in stockholders' deficit 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 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 statements 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 NVF Company 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 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 15 to the consolidated financial statements, the Company suffered recurring losses from operations through 1994 and has a net capital deficiency. In addition, as described in Note 15 to the accompanying consolidated financial statements, in September 1993 the Company filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. Management's plans in regard to these matters including its submission of a plan of reorganization to the Bankruptcy Court and the Company's creditors are also described in Notes 1 and 15. In the event that this plan of reorganization is confirmed, continuation of the business thereafter is dependent on the Company's ability to achieve successful future operations. The\naccompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.\nRoseland, New Jersey April 5, 1996\nNVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Balance Sheets December 31, 1995 and 1994 (thousands of dollars)\nAssets 1995 1994 Current assets: Cash and equivalents $ 652 1,274 Restricted cash 16,336 - Receivables, less allowance for doubtful accounts of $366 and $380 13,583 14,884 Inventories 13,888 14,389 Other current assets 1,456 471 Total current assets 45,915 31,018\nInvestment in affiliate 102 342\nProperties, at cost 88,269 85,652 Less accumulated depreciation and amortization (69,465) (67,068) Net properties 18,804 18,584 Other assets 2,750 2,317\n$ 67,571 52,261\nLiabilities and Stockholders' Deficiency Current liabilities: Current portion of long-term debt $ 7,584 9,849 Accounts receivable financing 3,616 3,641 Accounts payable 2,700 1,558 Accrued professional liabilities 3,032 5,214 Accrued interest payable 1,385 1,336 Accrued taxes 1,502 - Accrued wages and other employee costs 2,074 1,865 Other current liabilities 426 864 Total current liabilities 22,319 24,327\nOther noncurrent liabilities 2,865 2,770 Long-term debt 176 35 Liabilities subject to compromise (A) 87,753 88,349\nStockholders' Equity: Common stock, $.01 par value; authorized 200,000,000 shares; issued 95,563,461 shares 956 956 Capital in excess of par value 234,943 234,943 Accumulated deficit (273,089) (290,767) Treasury common stock, 2,292,544 shares at cost (8,352) (8,352) Total stockholders' deficiency (45,542) (63,220)\n$ 67,571 52,261\nSee accompanying notes to consolidated financial statements\nNVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Balance Sheets December 31, 1995 and 1994 (thousands of dollars)\n1995 1994\n(A) Liabilities subject to compromise consist of the following:\nTrade and other miscellaneous claims $ 9,079 9,445 Accrued interest 2,076 2,076 Pension obligations 5,355 5,378 Post retirement benefit obligations, net 513 527 Subordinated debentures, 5% 48,046 48,046 Subordinated debentures, 10% 11,375 11,375 Other accrued liabilities 11,282 11,340 Current portion of long-term debt 16 39 Noncurrent portion of long term debt 11 123\n$ 87,753(B) 88,349(B)\n(B) Certain liabilities have been separately classified in the Plans of Reorganization filed on April 13, 1994 and July 14, 1994.\nNVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Statements of Operations Three Years Ended December 31, 1995 (thousands of dollars)\n1995 1994 1993\nNet sales and operating revenues $ 96,891 93,981 90,046\nCost of goods sold 81,546 75,904 72,786 Depreciation and amortization 2,597 2,828 3,099 Selling, general and administrative expenses 11,583 10,633 12,028 95,726 89,365 87,913 Operating income from continuing operations 1,165 4,616 2,133\nOther income (expense): Settlement with principal shareholder 23,359 - - Other income (expense), net 1,285 (6,433) 4,805 Debt costs, other (contractual interest of $4,656, $6,001 and $6,631) (1,116) (2,207) (5,599) 23,528 (8,640) (794) Income (loss) from continuing operations before reorganization items, taxes on income, equity in net earnings of affiliates and discontinued operations 24,693 (4,024) 1,339\nReorganization items: Professional fees 5,822 6,916 1,000 Bond discount - - 1,143 5,822 6,916 2,143 Income (loss) from continuing operations before taxes on income, equity in net earnings of affiliates and discontinued operations 18,871 (10,940) (804)\nProvision for (benefit from) taxes on income 1,502 (38) 77\nIncome (loss) from continuing operations before equity in net earnings of affiliates and discontinued operations 17,369 (10,902) (881)\nEquity in net earnings of affiliates - 89 180\nIncome (loss) from continuing operations before discontinued operations 17,369 (10,813) (701)\nLoss from discontinued operations - - (5,304)\nNet Income (Loss) $ 17,369 (10,813) (6,005)\nWeighted average number of common shares outstanding, in thousands of shares 93,271 93,271 93,271\nIncome (loss) per share: From continuing operations $ .19 (.12) (.01) Discontinued operations - - (.06)\nNet income (loss) per share $ .19 (.12) (.07)\nSee accompanying notes to consolidated financial statements. NVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Statements of Cash Flows Three Years Ended December 31, 1995 (thousands of dollars)\n1995 1994 1993\nCash flows from operations:\nNet income (loss) $ 17,369 (10,813) (6,005)\nLoss from discontinued operations - - 5,304\nIncome (loss) from continuing operations 17,369 (10,813) (701)\nAdjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 2,597 2,828 3,099 Reduction (Excess) of additional minimum liability over prior service cost 309 (170) (833) Amortization of deferred debt discount - - 1,511 Exchange of long term debt (2,305) - - Write-off of investment - - 2,786 Equity in earnings of affiliates - (89) (180)\nTotal Adjustments 601 2,569 6,383 17,970 (8,244) 5,682\n(Increase) decrease in assets: Receivables, net 1,301 (1,245) 632 Inventories 501 888 (1,411) Other current assets (985) 99 (355) Other assets long-term (433) 46 202\nIncrease (decrease) in liabilities: Accounts payable 751 (141) (922) Due to affiliates - - (3,381) Accrued interest payable 49 752 1,224 Accrued professional liabilities (2,182) 4,958 256 Accrued wages and other employee costs 2,044 206 (441) Accrued taxes 1,502 - - Other current liabilities (496) 7,507 510 Other noncurrent liabilities (1,752) (758) 883\nTotal 300 12,312 (2,803)\nNet cash provided by operating activities 18,270 4,068 2,879\nCash flows from investing activities: Capital expenditures (2,810) (1,614) (1,283) Net disposals: Proceeds from asset sales 7 47 753 Book value of assets sold (14) (15) (511) Net gain (loss) on disposal (7) 32 242 Liquidating dividends in affiliates 240 - -\nNet cash used for investing activities (2,577) (1,582) (1,041)\nSee accompanying notes to consolidated financial statements.\nNVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Statements of Cash Flows Three Years Ended December 31, 1995 (thousands of dollars)\n1995 1994 1993\nCash flows financing from activities: Proceeds (repayments) from accounts receivable financing (25) (3,232) (1,438) Payment of long term debt - - (376) New capital leases 98 106 137 Payment of capital leases (52) (52) (57) Retirement of capital leases - (13) (97) Proceeds from sale of CFC Holdings - - 197\nNet cash used for financing activities 21 (3,191) (1,634)\nNet (decrease) increase in cash and equivalents 15,714 (705) 204\nCash and equivalents at beginning of year 1,274 1,979 1,775\nCash and equivalents and restricted cash at end of year $ 16,988 1,274 1,979\nSupplemental disclosures of cash flow information: Cash (received) paid during the year for:\nInterest $ 811 1,472 3,923\nIncome taxes $ (40) (60) 258\nSupplemental schedule of noncash investing and financing activities: Capital expenditures, net of capitalized leases: Total capital expenditures $ 2,908 1,666 1,340\nAmounts representing capital leases (98) (52) (57)\nCapital expenditures paid in cash $ 2,810 1,614 1,283\nSee accompanying notes to consolidated financial statements.\nNVF COMPANY AND SUBSIDIARIES (Debtor-in-Possession) Consolidated Statements of Changes in Stockholder's Deficit Three Years Ended December 31, 1995 (thousands of dollars)\nCapital In Treasury Common Excess of Accumulated Common Stock Par Value Deficit Stock\nBalance at December 31, 1992 $ 956 234,943 (350,061) (8,352)\nReduction (excess) of additional minimum liability over unrecognized prior service cost - - (833) -\nNet effect of deconsolidation of APL - - 77,115 -\nNet loss - - (6,005) -\nBalance at December 31, 1993 $ 956 234,943 (279,784) (8,352)\nReduction (excess) of additional minimum liability over unrecognized prior service cost - - (170) -\nNet loss - - (10,813) -\nBalance at December 31, 1994 $ 956 234,943 (290,767) (8,352)\nReduction (excess) of additional minimum liability over unrecognized prior service cost - - 309 -\nNet income - - 17,369 -\nBalance at December 31, 1995 $ 956 234,943 (273,089) (8,352)\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995, 1994 and 1993\nNote 1 - Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of NVF Company and its wholly-owned subsidiaries, (\"NVF\" or the \"Company\") unless the context otherwise indicates. All significant intercompany accounts and transactions have been eliminated in consolidation.\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.\nBasis of Presentation\nOn August 27, 1993 three creditors of NVF filed an involuntary bankruptcy petition against NVF under Chapter 11 of the Bankruptcy Code in Bankruptcy Court, Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nThe accompanying financial statements have been prepared in accordance with AICPA Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\". The Company's subsidiaries, Parsons Paper and NVF Canada, are not part of the bankruptcy thus there was no change made in the manner they are accounted for. Stand alone statements for NVF can be found in Note 19.\nNVF's ability to meet its cash requirements in the next twelve months is dependent upon increased cash flow being generated from NVF's operations, the continuing of financing of accounts receivable, available borrowings, the compromising of liabilities within the framework of bankruptcy and possible sale of any assets. No assurance can be given that any of such conditions can be achieved or, if achieved, what the terms and conditions thereof will be. NVF believes, but cannot assure, that cash generated from operations and funds from the CIT Group revolving credit line facility (See Note 3) or alternate facility will be sufficient to enable NVF to maintain its operations until such time as a plan can be confirmed by the Bankruptcy Court. The consolidated financial\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued December 31, 1995, 1994 and 1993\nNote 1 - Summary of Significant Accounting Policies - (continued)\nstatements included herein have been prepared on a going concern basis and, accordingly, do not include any adjustments relating to the recoverability and classification of recorded assets amounts nor the amounts and classification of liabilities that might be necessary should NVF be unable to continue in existence or be required to sell its assets. As a result of the uncertainties described above, reference is made to Note 16 included elsewhere herein for information concerning the estimated liquidation value of NVF on a consolidated basis.\nOn April 23, 1993 Insurance and Risk Management (\"IRM\"), repurchased from DWG Corporation (\"DWG\") 25% of the issued and outstanding common stock of IRM. (See Note 5). As a result of such purchase, NVF's ownership of the issued and outstanding common stock of IRM increased from 45% to 60%. Due to the fact that IRM has not taken any new business after June 30, 1993 and will be liquidated as soon as is practicable, NVF has elected to continue to account for IRM under the equity method on a quarter lag basis.\nThe decision to liquidate IRM was due to the fact that IRM's business was almost entirely conducted with affiliated companies. With DWG, the largest of such affiliated companies, becoming disaffiliated and electing not to use IRM for insurance placements and claims management, IRM's business became too small to be useful or profitable, thus the decision to liquidate. The decision to liquidate did not have a material impact on the Company's financial statements.\nOn June 25, 1993 an involuntary bankruptcy petition was filed against APL Corporation (\"APL\"), the Company's 68% owned subsidiary. On July 23, 1993, APL filed a motion in the Bankruptcy Court for the Southern District of Florida and obtained an order on July 27, 1993 converting the involuntary petition to a voluntary case under Chapter 11 of the Bankruptcy Code. On or about February 24, 1995, a Disclosure Statement For Creditors' Committee's Plan of Reorganization was filed in the APL bankruptcy case. A hearing on the Disclosure Statement in the APL case was held on April 6, 1995 and the Disclosure Statement was approved on April 15, 1995. The Plan was confirmed on June 8, 1995. Due to the fact that NVF no longer has control over APL, statements presented herein have been restated to reflect APL as a discontinued operation and to reflect the deconsolidation of APL effective June 30, 1993. The Company had approximately $2.5 million face value of APL's 10-3\/4% Subordinated Sinking Fund Debentures as of December 31, 1994. However a November 1995 settlement of litigation commenced by the Committee (See Note 18) called for the holders of 11-3\/4% Secured NVF Promissory Notes to return such notes in exchange for the return of the APL 10-3\/4% Subordinated Sinking Fund Debentures. Other income of approximately $2,609,000 was recognized in 1995 as a result of the settlement.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued December 31, 1995, 1994 and 1993\nNote 1 - Summary of Significant Accounting Policies - (continued)\nInventories\nInventories are valued at the lower of average cost or market on a first-in, first-out (FIFO) basis. Inventory costs generally include materials, labor costs, manufacturing overhead and depreciation.\nDepreciation and Amortization\nIn general, depreciation and amortization of buildings, machinery and equipment is provided on the straight-line method over the estimated useful lives of depreciable properties, principally eleven years on equipment, forty-five years on buildings and ten years on building improvements.\nRetirement and Disposal of Properties\nThe cost of properties retired or otherwise disposed of is eliminated from the accounts. When units of depreciable property are retired or disposed of, the net gain or loss is recognized in other income.\nMaintenance and Repairs\nRoutine maintenance, repairs and replacements are charged to operations. Expenditures that materially increase values, change capacities or extend useful lives are capitalized. Capitalized renewals or replacements are charged to the property accounts. The properties that were renewed or replaced are correspondingly removed from the property accounts.\nRevenue Recognition\nRevenue from the sale of products is recognized upon passage of title to the customer, which in most cases coincides with shipment of the related products.\nRetirement and Pension Plans\nThe Company and its subsidiaries have non contributory pension plans covering substantially all its hourly employees. Company contributions are actuarially determined using the projected unit credit method, taking into consideration estimated future salary increases where applicable.\nIn December 1990, the Financial Accounting Standards Board issued a new standard on accounting for postretirement benefits other than pensions. This new standard requires that the expected cost of these benefits must be charged to expense during the years\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 1 - Summary of Significant Accounting Policies - (continued)\nthat employees render service. This was a significant change from the Company's policy of recognizing these costs on the cash basis. The Company adopted the new standard effective January 1, 1993. The Company is amortizing the discounted present value of the obligation, $4,851,259, to expense over a twenty year period of which seventeen years remain.\nIncome Taxes\nThe Financial Accounting Standards Board issued statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\") \"Accounting for Income Taxes\". The Company adopted the new standard effective January 1, 1993 and the new standard did not have a material effect on the Company's consolidated financial position.\nIncome (loss) Per Share\nIncome (loss) per share has been computed by dividing net income (loss) by the weighted average number of outstanding shares of common stock during each period. Common stock equivalents were not used to compute the loss per share in 1994 and 1993 because such inclusion would be antidilutive. Such common stock equivalents (options) expired in 1995. (See Note 11).\nCash and Equivalents\nThe Company classifies as cash and equivalents all highly liquid investments with a maturity of three months or less when purchased.\nLiquidity\nAs discussed more fully in Note 15 - Liquidity, the Company has sustained losses in each of the last seven years prior to 1995. For a discussion of the ability of the Company to meet its cash requirements see Note 15.\nReclassification\nCertain prior year amounts have been reclassified in order to conform to the current year presentation.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 2 - Restricted Cash\nRestricted cash of approximately $16,336,000 represents the settlement paid by the Company's principal shareholder of $20,750,000 (See Note 18) plus net interest accrued since payment (approximately $626,000) less payments made to professionals incurred in the bankruptcy matter (approximately $5,040,000). This cash is held in an escrow account which the Company can only access with approval of the Unsecured Creditors' Committee. The funds are restricted for use in resolving claims associated with the bankruptcy.\nNote 3 - Accounts Receivable\nThe Company has an accounts receivable financing arrangement with CIT Group (\"CIT\") covering substantially all of its accounts receivable. Such arrangement provides the Company a line of credit up to the lesser of $8,000,000 or 80% of the eligible accounts receivable at an interest rate of prime (8.75% at December 31, 1995) plus 1\/2%, a line of credit fee of 1\/2% per annum on the unused balance and a $3,000 per month collateral management fee. At December 31, 1995 the Company had open a balance of $3.6 million under this arrangement. On , 1996 CIT advised the Company that it would not be interested in financing arrangement after the Company emerges from bankruptcy. The Company believes it will be successful in finding alternative financing, however there can be no assurance that the Company will be able to obtain such financing or that it will be available on terms the Company deems acceptable.\nNote 4 - Inventories\nThe following is a summary of the major classifications of inventories: December 31, 1995 1994 (thousands of dollars)\nRaw materials and supplies $ 5,520 3,984 Work in process 2,023 3,177 Finished goods 6,345 7,228\n$ 13,888 14,389\nNote 5 - Investment in Affiliates\nOn April 23, 1993, the Company sold to DWG Corporation, which up until that date may have been deemed to be an affiliate of the Company as a result of common ownership and control by Victor Posner, all 141,000 shares of common stock of CFC Holdings Corp., a subsidiary of DWG, held by the Company representing 1.4% of the\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 5 - Investment in Affiliates (continued)\nissued and outstanding capital stock of CFC Holdings for $3.6 million. At December 31, 1992, the aggregate book value of the 141,000 shares of CFC Holdings Common Stock sold by the Company was approximately $270,000. DWG made payment of the purchase price to the Company. Substantially all of these proceeds were used to pay DWG amounts owed by the Company under cost sharing arrangements. A gain of approximately $3.4 million is recorded in Other Income (Expense) for 1993.\nThe Company's investment in CFC Holdings was accounted for on the equity method on a quarter lag basis. The Company's equity in net earnings of CFC Holdings amounted to $73,000 in 1993.\nAs part of a series of transactions on April 23, 1993, Insurance and Risk Management (\"IRM\") repurchased from DWG Corporation (\"DWG\") 25% of the issued and outstanding stock of IRM. As a result of this purchase, the Company's ownership of IRM increased from 45% to 60% as IRM recorded the purchase of the shares from DWG as treasury stock thus reducing the outstanding shares of IRM. In a related transaction, IRM sold to DWG all of its 2.7% stake in CFC Holdings for $8.4 million resulting in an approximate $7 million gain on the sale. The result of this gain was that IRM's equity went from negative to positive, therefore, the Company, as a 60% owner, recorded its share of the equity in IRM, approximately $1.5 million. The Company's equity in IRM was then reduced by dividends paid by IRM in 1993, 1994 and 1995 of $1,066,667, $133,333 and $240,000, respectively. As a result of the April 23, 1993 transactions, DWG is no longer affiliated with the Company and IRM.\nThe decision to liquidate IRM was due to the fact that IRM's business was almost entirely conducted with affiliated companies.With DWG, the largest of such affiliated companies, becoming disaffiliated and electing not to use IRM for insurance placements and claims management, IRM's business became too small to be useful or profitable, thus the decision to liquidate. The decision to liquidate did not have a material impact on the Company's financial statements\nFor the years ended December 31, 1995, 1994 and 1993 NVF had income of $-0-, $89,000 and $180,000 respectively, from its equity investment in IRM and NVF had a carrying value of its investment in IRM at December 31, 1995 and 1994 of $102,000 and $342,000, respectively. NVF has also received liquidating dividends of $1,066,667 in 1993, $133,333 in 1994 and $240,000 in 1995.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 6 - Properties\nProperties are recorded at cost, less accumulated depreciation. Management continuously reviews the carrying value of its properties based on its review of third party appraisals, market trends, changes in the way the property is used and physical changes in the property. If Management determines the property has been impaired the property is written down to a new carrying value and an impairment loss is recognized.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Standards No. 121 \"Accounting for the Impairment of Long Lived Assets to be Disposed Of\" (SFAS 121). SFAS 121 establishes accounting standards for the impairment of related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. SFAS 121 is effective for the year ended December 31, 1996. Management has not yet determined how the adoption of SFAS 121 will impact its financial statements.\nAt December 31, 1995 and 1994, the major classifications of properties (at cost) consisted of the following:\n1995 1994 (thousands of dollars)\nLand and land improvements $ 1,994 1,989 Buildings, machinery and equipment 85,047 82,443 Buildings, machinery and equipment under capitalized leases 305 247 Construction in progress 923 973\nTotal properties at cost $ 88,269 85,652\nAmortization of properties under capitalized leases is included with depreciation expense. At December 31, 1995 and 1994, the accumulated amortization of properties under capitalized leases was $89,000 and $78,000, respectively.\nNote 7 - Taxes on Income\nNVF and Parsons Paper file separate consolidated federal income tax returns. The difference between the reported provision and the computed expected tax (benefit) based on book income (loss) at the federal income tax rate for the three years ended December 31, 1995 are reconciled as follows:\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 7 - Taxes on Income (continued)\nYear Ended December 31, 1995 1994 1993 (thousands of dollars)\nFederal taxes (benefit) at statutory rates 6,168 (3,829) (2,137) Increase (decrease) in taxes resulting from: State taxes net of federal benefit 1,249 - - Net operating loss (utilized) not currently realizable (4,420) 3,829 2,137 Alternative minimum taxes 253 - - Contractual interest (1,225) - - Insurance settlement (350) - - Other, net (173) (38) -\nProvision for taxes on income $ 1,502 (38) 77\nAs described in Note 1, the Company adopted SFAS No. 109 effective January 1, 1993.\nAt December 31, 1995 and 1994, the deferred tax assets and liabilities are comprised of:\n12\/31\/94 12\/31\/95 Deferred Deferred Tax Tax (Benefit) Assets\/ Assets Expense (Liabilities) Current: Allowance for doubtful accounts $ 133 $ (7) $ 126 Inventory overhead capitalization 141 (42) 99 Unrealized loss on securities 104 - 104 Insurance recovery - (350) (350) Accrued vacation 337 9 346\nNoncurrent: Contractual interest - (1,225) (1,225) Pension costs 662 - 662 Accelerated depreciation 213 (426) (213) Environmental reserves 2,394 (174) 2,220 Contingency reserves 1,575 - 1,575 Net operating loss carryforward 37,987 (4,420) 33,567 Capital loss carryforward 33,064 - 33,064 ITC credit carryforward 531 - 531 Other, net - (173) (173) Less valuation reserve (77,142) 6,808 (70,334)\n$ 0 0 0\nBased on the weight of available evidence, management has determined that it is more likely than not that none of the deferred tax assets identified above will be realized and therefore has recorded a valuation allowance of $69,983 against the entire amount.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 7 - Taxes on Income (continued)\nIn June 1989, NVF obtained an appeal bond in favor of the Commonwealth of Pennsylvania in connection with certain taxes for the year 1985 in the amount of $1.3 million which was reduced subsequent to September 30, 1989 to $320,000. The taxes of approximately $250,000 were paid in May 1993 to facilitate the sale of the Company's Willow Grove property. In January, 1995, the Company resolved this matter with the Commonwealth and received an $82,000 refund.\nNote 8 - Notes Payable and Long-Term Debt\nAt December 31, 1995 and 1994, long-term debt consisted of the following: 1995 1994 (thousands of dollars) NVF Company: 11-3\/4% Secured amortizing promissory notes $ - 2,305 10% Secured notes payable 7,461 7,461 Capitalized lease obligations 210 164 Urban Development Action Grant 116 116 7,787 10,046 Less: Amounts included in liabilities subject to compromise 27 162 Current portion of long-term debt 7,584 9,849 Long-term debt $ 176 35\nA settlement of litigation commenced by the Committee (See Note 18) called for interest on the 10% Secured Notes to be fixed at $765,000 through September 30, 1995 plus additional interest at a rate of 10% per annum (simple interest with no compounding) from September 30, 1995 until (1) the consummation date of the plan which brings the Company out of bankruptcy or (2) May 22, 1996 which is the date the first semi-annual payment is due. As of December 31, 1995 the Company has accrued $951,000 of interest on the 10% Secured Notes in \"Accrued Interest Payable\". The settlement also called for the holders of 11-3\/4% Secured NVF Promissory Notes to return such notes for the return of the APL 10-3\/4% Subordinated Sinking Fund Debentures. Other income of approximately $2,609,000 was recognized in 1995 as a result of the settlement.\nThe scheduled principal payments on notes payable and long- term debt outstanding at December 31, 1995 (other than subordinated indebtedness) for each of the succeeding five years, without regard to bankruptcy proceedings, are as follows:\n1996 1997 1998 1999 2000\n$7,584 108 52 37 6\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 9 - Subordinated Indebtedness\nAt December 31, 1995 and 1994, subordinated indebtedness consisted of the following:\n1995 1994 (thousands of dollars) NVF Company: 5% Subordinated sinking fund debentures due 1994 less unamortized deferred discount of $-0- and $-0- $ 48,046 48,046 10% Subordinated sinking fund debentures due 2003 less unamortized deferred discount of $-0- and $-0- 11,375 11,375 59,421 59,421 Total subordinated indebtedness 59,421 59,421 Current portion of subordinated indebtedness 59,421 59,421\nLong term subordinated indebtedness $ - -\nNVF did not make sinking fund payments of $4.8 million due on January 1, 1993 and $43.2 million due January 1, 1994 nor did it make $1.2 million interest payments due July 1, 1993 and January 1, 1994 on its 5% Subordinated Debentures. According to the terms of the debentures, the debentures are in default and may be called for 100% of principal plus interest. The aggregate principal amount of the 5% Subordinated Notes at December 31, 1995 and 1994 was approximately $48,046,000. NVF did not make sinking fund payments of approximately $284,375 on November 14, 1993, November 14, 1994 and November 14, 1995 nor did it make interest payments of $568,757 on November 14, 1993, May 14, 1994, November 14, 1994, May 14, 1995 and November 14, 1995 on its 10% Subordinated Debentures. According to the terms of the debentures, the debentures are in default and may be called for 100% of principal plus interest. The aggregate principal amount of the 10% Subordinated Notes at December 31, 1995 and 1994 was approximately $11,375,000. The 5% and 10% Subordinated Debentures are expected to be compromised within the course of the bankruptcy and paid from a pool created by the sale of the Company and the proceeds from litigation entitled as the Official Creditor's Committee of NVF Company v. Victor Posner, et al.\nAmortization of deferred debt discount, amounting to $368,000 in 1993, is classified with \"debt costs\" in the Company's statements of operations. Amortization of deferred debt discount on the 5% and 10% Subordinated Debentures was on the \"Bonds outstanding\" method. In accordance with AICPA Statement of Position 90-7 the remaining unamortized deferred debt discount of $1,143,000 was expensed in 1993.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 9 - Subordinated Debentures (continued)\nThe scheduled principal payments on subordinated indebtedness outstanding at December 31, 1995 for each of the succeeding five years, without regard to bankruptcy proceedings, are as follows:\n1996 1997 1998 1999 2000\n$ 59,421 - - - -\nNote 10 - Stockholders' Equity\nNVF has authorized 10,000,000 shares of $1 par value preferred stock, with no shares issued or presently contemplated to be issued.\nNote 11 - Stock Option Plans\nAll options under the 1970 Stock Option Plan for officers and key employees of NVF and its subsidiaries have expired. No stock options remain outstanding at December 31, 1995.\nNote 12 - Retirement and Incentive Compensation Plans\nAt December 31, 1995 and 1994, the Company recorded additional minimum liabilities of $3,381,000 and $3,906,000, respectively, included in \"Liabilities subject to compromise\", and intangible assets of $1,851,000 and $2,067,000, respectively, included in noncurrent \"Other assets\", and a credit to equity of $309,000 and a charge to equity of $170,000 at December 31, 1995 and December 31, 1994, respectively. The additional minimum liabilities represent the excess of the estimated accumulated benefit obligations over the estimated fair value of plan assets and the unfunded accrued pension costs at December 31, 1995, 1994 and 1993. In general, the Company's funding policy is to contribute the minimum required by the Employee Retirement Income Security Act of 1974.\nThe components of the 1995, 1994 and 1993 pension expense are as follows: Year Ended December 31, 1995 1994 1993 (thousands of dollars)\nService cost $ 561 510 498 Interest cost on projected benefit obligation 2,367 2,350 2,381 Actual return on plan assets (1,879) 841 (2,302) Amortization and deferral 205 (2,780) 367\nNet periodic pension cost $ 1,254 921 944\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 12 - Retirement and Incentive Compensation Plans (continued)\nThe following table sets forth a reconciliation of the funding status of the plans as of December 31, 1995 and 1994:\nAggregate of Plans Whose Assets Exceed Accumulated Accumulated Benefits Benefits Exceed Assets 1995 1994 1995 1994 (thousands of dollars) Actuarial present value of service obligations: Vested benefit obligation $ 13,887 13,455 18,729 17,343 Projected (and accumulated) benefit obligation $ 13,991 13,556 19,139 17,661\nPlan assets at fair value 14,953 13,688 12,712 11,143\nReconciliation of funded status: Projected benefit obligation less than (in excess of) plan assets 962 132 (6,427) (6,518) Unrecognized prior service costs - - 400 436 Unrecognized net loss (gain) from plan experience (19) 910 1,513 1,819 Unamortized net (asset) obligation at transition (124) (140) 1,433 1,612\nPrepaid (accrued pension cost) $ 819 902 (3,081) (2,651)\nAn assumed discount rate of 7.5%, an expected long-term rate of return on assets of 8%, and a rate of increase in future compensation levels of 6% where applicable, were used in developing this data for 1995 and 1994. The actuary's calculations resulted in a $309,000 credit, $170,000 charge and a $333,000 charge to equity in 1995, 1994 and 1993, respectively. Plan assets are invested in a managed portfolio consisting primarily of corporate bonds and common stock of unaffiliated issuers.\nIncluded in the accompanying balance sheets under the captions \"Accrued wages and other employee costs\", \"Other noncurrent liabilities\" and \"Liabilities subject to compromise\" were pension liabilities of approximately $129,000, $159,000 and $5,355,000 respectively, at December 31, 1995 and $69,000, $207,000 and $5,378,000, respectively at December 31, 1994.\nNVF adopted a 401(k) defined contribution plan effective January 1, 1990 for eligible employees who elect to participate. Employees may contribute from 1% to 15% of their compensation subject to certain limitations. At its discretion, NVF will determine how much, if anything, it will contribute to such plan. In 1995 and 1994 the Company accrued a matching contribution of $.25 for each dollar contributed by employees at a cost of approximately $78,000 and $65,000, respectively. There were no contributions in 1993. NVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 12 - Retirement and Incentive Compensation Plans (continued)\nNVF provides certain health care and life insurance benefits for retired employees. Substantially all of the Company's employees may become eligible for those benefits if they reach normal retirement age while working for NVF. Postretirement medical benefits are self-insured by the Company and administered by Delaware Blue Cross and Blue Shield. Postretirement life insurance benefits are provided through an insurance company whose premiums are based on the benefits paid during the year. Prior to adopting FAS 106, the Company expensed the related cost on a pay- as-you-go basis. The Company has not funded the Accumulated Postretirement Benefit Obligation because the Plan is not pay- related there are no Plan assets.\nThe effect of a one-percentage point increase in the assumed health cost trend rates on the aggregate of the service and interest cost component of net periodic postretirement health care costs for 1995 would be an increase of approximately $38,000. The related effect on the accumulated postretirement benefit obligation for health care benefits would be an increase of approximately $43,000.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 12 - Retirement and Incentive Compensation Plans (continued)\nIn December 1990, the Financial Accounting Standards Board issued a new standard on accounting for postretirement benefits other than pensions. This standard requires that the expected cost of these benefits must be charged to expense during the years that employees render service. The Company adopted the new standard prospectively effective January 1, 1993. The Company is amortizing the discounted present value of the transition obligation, $4,851,259, to expense over a twenty year period of which seventeen years remain. At December 31, 1995 and 1994 a net liability of $564,000 and $551,000 respectively, is recorded in \"Liabilities subject to compromise\" on the balance sheet for postretirement benefits. The following table reconciles the plan's funded status to the accrued postretirement benefit cost liability as reflected on the consolidated balance sheet as of December 31, 1995 and 1994:\n1995 1994 (000's) (000's)\nAccumulated Postretirement Benefit Obligation: Retirees $ (2,659) (2,707) Other fully eligible participants (318) (836) Other active participants (1,215) (1,421) (4,192) (4,964)\nReduction of prior service cost (861) - Unrecognized actuarial loss 365 47 Unrecognized transition obligation 4,124 4,366\nAccrued postretirement health care cost liability $ (564) $ (551)\nNet postretirement health care cost included the following components: Service cost - benefits attributed to service during the period $ 69 109 Interest cost on accumulated postretirement benefit obligation 286 385 Amortization of transition obligation over 20 years 243 243 Amortization of unrecognized prior service cost (54) - Amortization of unrecognized net (gain)\/loss (5) -\nNet postretirement health care cost $ 539 $ 737\nFor measurement purposes, a twelve percent annual rate of increase in the per capita cost of covered health care claims was assumed for 1993; the rate was assumed to decrease gradually in increments of 1 percent per year to an ultimate rate of 6 percent and remain at that level thereafter.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 12 - Retirement and Incentive Compensation Plans (continued)\nIncentive Compensation\nIn October 1988, the new Ad Hoc Intercorporate Transactions and Common Officer Committee, NVF's Compensation Committee and NVF's Board of Directors approved, subject to the approval of stockholders, a new Management Incentive Plan of NVF, and terminated NVF's prior incentive compensation plans. The new plan, which was approved by the stockholders on December 28, 1990, became effective for the year ending December 31, 1988. The new plan provides for the establishment for each fiscal year for two separate incentive compensation funds, the first to be used primarily based on net operating earnings and not to exceed 10% of such earnings, and the second to be based on net earnings from sales or other disposition of assets, such as sales of subsidiaries, divisions, investments, and other assets not in the ordinary course of business, and not to exceed 10% of earnings from such sources. The new plan is to be administered by NVF's Compensation Committee and awards for elected corporate officers of NVF are to be approved by NVF's Board of Directors following review and recommendation by NVF's Compensation Committee after review by the new Ad Hoc Intercorporate Transactions and Common Officer Compensation Committee where such review is required. The new plan sets forth certain objective factors used in determining the allocation of awards to persons eligible to participate in such plan. Among such factors are experience, level of responsibility, efforts expended, participation in decision making, contribution of the employee to the achievement of profits, past performance, duties and responsibilities and length of employment. The objectives of the new plan are to encourage the development of aggressive, growth-oriented business plans and strategies consistent with philosophies of the Board of Directors, to motivate exemplary commitment and performance of managerial personnel, to provide a competitive level of remuneration to those managerial personnel who have made a meaningful contribution to NVF's financial results and business objectives and to provide NVF's stockholders with an optimum return on their investment by maximizing the long term growth and profitability of NVF. NVF did not accrue any amounts under such plan with respect to 1995, 1994 and 1993.\nNote 13 - Industry Segments\nThe Company is engaged in the manufacture and sale of industrial laminated plastic products which have their principal application in the electronic fields such as for printed circuit boards; manufacture and sale of vulcanized fibre which is an extremely sturdy and lightweight converted cellulose widely used in such applications as backing abrasive disks, electrical insulation, material handling containers and furniture surfaces and, to a lesser extent, the manufacture of material handling containers and\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 13 - Industry Segments (continued)\ncorrespondence and business papers. The Company principally markets its products in the North American market. Less than 10% is exported.\nYear ended December 31, 1995 1994 1993 (thousands of dollars) Amount % Amount % Amount % Net Sales and Operating Revenues Industrial laminated plastics $ 56,233 58 48,650 52 47,758 53 Vulcanized fibre 31,656 33 35,064 37 31,382 35 Other 12,052 12 13,836 15 14,254 16 Total segment net sales and operating revenues 99,941 97,577 93,394\nElimination of intersegment sales (transferred at market prices): Industrial laminated plastics $ (975)(1) (983)(1) (1,197)(1) Vulcanized fibre (2,075)(2) (2,613)(3) (2,151)(3)\nConsolidated net sales and operating revenues $ 96,891 100 93,981 100 90,046 100\nOperating Income (Losses): Industrial laminated plastics $ 3,760 2,976 2,446 Vulcanized fibre 4,371 7,397 6,722 Other (1,973) (659) (4) General corporate expenses, net (4,993) (5,098) (7,031)\nOperating income 1,165 4,616 2,133 Reorganization expenses (5,822) (6,916) (2,143) Adversary action settlement 23,359 - - Other income (expense) 1,285 (6,433) 4,805 Debt costs (1,116) (2,207) (5,599) Provision for taxes on income (1,502) - - Consolidated income (loss) before taxes on income, equity in net earnings (loss) of affiliates and discontinued operations $ 17,369 (10,940) (804)\nYear ended December 31, 1995 1994 1993 (thousands of dollars) Identifiable assets: Industrial laminated plastics $ 23,942 25,424 27,327 Vulcanized fibre 16,968 16,317 14,442 Other 7,253 8,630 9,307 Total identifiable assets 48,163 50,371 51,076\nGeneral corporate assets 21,599 4,440 5,107 Elimination of intersegment receivables (2,191) (2,550) (2,272)\nConsolidated assets $ 67,571 52,261 53,911\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 13 - Industry Segments (continued)\nYear ended December 31, 1995 1994 1993 (thousands of dollars) Capital expenditures: Industrial laminated plastics $ 180 326 230 Vulcanized fibre 2,418 1,231 650 Other 143 76 400 General corporate 167 33 60\n$ 2,908 1,666 1,340\nDepreciation and amortization: Industrial laminated plastics $ 1,358 1,687 1,880 Vulcanized fibre 770 648 684 Other 418 435 480 General corporate 51 58 55\n$ 2,597 2,828 3,099\nNVF's foreign operation (which is not significant) has been grouped with other segments in the foregoing industry segment data because it is not practical to isolate the industrial laminated plastics or vulcanized fibre portion of the foreign operation.\nNote 14 - Transactions with Related Parties\nPursuant to a Stock Purchase Agreement entered into by Victor Posner and certain entities controlled by him (collectively, the \"Sellers\") with respect to the sale and exchange of all of the shares of common stock of DWG owned by them, Sellers agreed to terminate or cause to be terminated all such cost sharing arrangements within six months after April 23, 1993 and agreed that DWG would be reimbursed for any space or service provided to Seller's affiliates, including the Company during the period from April 23, 1993 to the date of termination at commercially reasonable rates no less than the rate DWG would charge an unaffiliated third party. The sale and exchange of shares contemplated by the Stock Purchase Agreement was consummated on April 23, 1993 and as a result the Sellers ceased to hold any shares of DWG and DWG and its subsidiaries ceased on such date to be affiliates of the Company. DWG and NVF were affiliated as a result of common ownership and control by Victor Posner. DWG provided management services, office facilities (including the cost of space leased from a trust for the benefit of Victor Posner and his children) and other services to the Company in 1993 at a cost of approximately $529,000. In addition, the Company incurred interest expense to DWG of $73,000 in 1993.\nThe Company maintained certain insurance coverage with Chesapeake Insurance, a subsidiary of DWG with whom the Company was affiliated with until April 23, 1993. Premiums attributable to such insurance coverage which consisted principally of property\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 14 - Transactions with Related Parties (continued)\ncoverage amounted to approximately $70,000 in 1993. In addition, the Company maintained insurance coverage with unaffiliated insurance companies for which a subsidiary of Chesapeake Insurance reinsured a portion of the risk. Net premiums attributable to such reinsurance were approximately $1,465,000 in 1993. In addition, IRM acts as agent or broker in connection with insurance coverage obtained by the Company and provides claims processing services for the Company. The commissions and payments for services paid to such Company were $14,000 in 1993 after which the Company discontinued utilizing IRM. Included in \"Liabilities subject to compromise\" on the accompanying balance sheet was approximately $43,000 the Company owed IRM at December 31, 1995.\nNote 15 - Liquidity\nNVF's consolidated working capital at December 31, 1995 increased by approximately $16,905,000 from December 31, 1994. Proceeds from a settlement of litigation entitled as the Official Creditors' Committee of NVF Company v. Victor Posner, et al. (See Note 18) of $20,750,000 and other terms of such settlement, i.e., the return to the Company of its 11-3\/4% Secured Promissory Notes in exchange for previously written off APL 10-3\/4% Subordinated Sinking Fund Debentures, were principally responsible for the increase. However, the terms of the settlement also dictate that such proceeds may only be used in matters relating to the bankruptcy, which results in the restricted cash (See Note 2) of $16,336,000.\nOn August 27, 1993 three creditors of NVF filed an involuntary bankruptcy petition against NVF under Chapter 11 of the Bankruptcy Code in Bankruptcy Court, Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nOn April 13, 1994, the Company filed its Disclosure Statement and Plan of Reorganization. The hearing on the adequacy of the Disclosure Statement was set for June 15, 1994. On June 6, 1994, the Disclosure Statement hearing was continued until June 30, 1994. The hearing was subsequently taken off calendar. On July 15, 1994, the Company filed its First Amended Disclosure Statement and First Amended Plan of Reorganization. A copy of the Plan was filed as Exhibit 2.1 to Form 8-K by the Company on August 4, 1994. A hearing on the adequacy of the First Amended Disclosure Statement was set for September 13, 1994. On September 7, 1994, the Company filed NVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 15 - Liquidity (continued)\nits Second Amended Disclosure Statement and Second Amended Plan of Reorganization. On September 13, 1994, the hearing on the adequacy of the Second Amended Disclosure Statement was taken off calendar due to the agreement (the \"Joint Agreement\") reached before the Bankruptcy Court between NVF and the Official Committee of Unsecured Creditors of NVF (the \"Committee\") to jointly retain an investment banking firm for the purpose of marketing and selling or recapitalizing the Company.\nThe investment banking firm, Alex. Brown & Sons Incorporated (\"Alex. Brown\"), made procedural recommendations that were agreed upon by NVF and the Committee and approved by the Bankruptcy Court. Alex. Brown has implemented those procedures and recommended to NVF and the Committee what they believe to be the highest and best offer which will realize the greatest value to the creditors. In accordance with the procedures approved by the Bankruptcy Court, Alex. Brown contacted a total of 147 potential purchasers for NVF. On July 24, 1995 Alex. Brown submitted its recommendation to the Bankruptcy Court under seal. On August 3, 1995 a hearing was held in the Bankruptcy Court on an Emergency Motion of First Security and Investment Corporation (\"First Security\") and Security Management Corporation for Examination of Alex. Brown & Sons, Inc. Pursuant to Federal Rule of Bankruptcy Procedure 2004. As a result of this hearing, the Court had permitted the mover to review the findings and conclusions of Alex. Brown's decision. Eventually, Alex Brown determined that the bid by First Security was the highest and the best bid. On October 27, 1995, NVF and the Committee filed their motion with the Bankruptcy Court seeking approval to enter into and execute a stock purchase agreement with First Security. On December 29, 1995 the Bankruptcy Court signed an order approving the bid of First Security as the highest and best bid. On January 29, 1996 the Joint Plan of Reorganization (\"the Plan\") of NVF Company and The Official Committee of Unsecured Creditors and the Disclosure Statement was filed with the Bankruptcy Court (See Form 8-K dated January 29, 1996, Exhibits 2 and 99). On March 4, 1996 the Bankruptcy Court approved the Disclosure Statement. The Plan has been submitted to the creditors for ratification. A hearing date in Bankruptcy Court concerning confirmation of the Plan has been scheduled for April 25, 1996.\nNVF did not make sinking fund payments of $4.8 million due on January 1, 1993 and $43.2 million due January 1, 1994 nor did it make $1.2 million interest payments due July 1, 1993 and January 1,1994 on its 5% Subordinated Debentures. NVF did not make sinking fund payments of approximately $284,375 on November 14, 1993, November 14, 1994 and November 14, 1995 nor did it make interest payments of $568,757 on its 10% Subordinated Debentures due November 14, 1993, May 14, 1994, November 14, 1994, May 14, 1995 and November 14, 1995. The Company did not make interest payments\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 15 - Liquidity (continued)\nof approximately $373,000 due November 22, 1993, May 22, 1994, November 22, 1994, May 22, 1995 and November 22, 1995 on its 10% Secured Notes. The 5% and 10% Subordinated Debentures are expected to be compromised within the course of the bankruptcy and paid from a pool created by the sale of the Company and the proceeds from litigation entitled as the Official Creditor's Committee of NVF Company v. Victor Posner, et al.\nThe Company has an accounts receivable financing arrangement with CIT Group (\"CIT\") covering substantially all of its accounts receivable. Such arrangement provides the Company a line of credit up to the lesser of $8,000,000 or 80% of the eligible accounts receivable at an interest rate of prime (8.75% at December 31, 1995) plus 1\/2%, a line of credit fee of 1\/2% per annum on the unused balance and a $3,000 per month collateral management fee. At December 31, 1995 the Company had open a balance of $3.6 million under this arrangement. On , 1996 CIT advised the Company that it would not be interested in financing arrangement after the Company emerges from bankruptcy. The Company believes it will be successful in finding alternative financing, however there can be no assurance that the Company will be able to obtain such financing or that it will be available on terms the Company deems acceptable.\nNVF's ability to meet its cash requirements in the next twelve months is dependent upon increased cash flow being generated from NVF's operations, the continuing of financing of accounts receivable, available borrowings, the compromising of liabilities within the framework of bankruptcy and possible sale of any assets. No assurance can be given that any of such conditions can be achieved or, if achieved, what the terms and conditions thereof will be. NVF believes, but cannot assure, that cash generated from operations and funds from accounts receivable financing facility or alternative facility will be sufficient to enable NVF to maintain its operations until such time as a plan can be confirmed by the Bankruptcy Court. The financial statements included herein have been prepared on a going concern basis and, accordingly, do not include any adjustments relating to the recoverability and classification of recorded asset amounts nor the amounts and classification of liabilities that might be necessary should NVF be unable to continue in existence or be required to sell its assets. As a result of the uncertainties described above, reference is made to Note 16 included elsewhere herein for information concerning the estimated liquidation value of NVF on a consolidated basis.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 16 - Pro Forma Liquidating Balance Sheet - NVF (Unaudited)\nBecause of the uncertainties concerning the Company's ability to continue operations on a going concern basis described elsewhere herein, set forth below is certain unaudited pro forma information concerning the estimated liquidating value of the Company on a consolidated basis. Such estimated values are the Company's best estimates of the recoverability of asset amounts upon a liquidation. No assurance can be given that actual liquidation values will approximate those set forth below. Values obtainable upon liquidation can vary widely depending upon various factors, including general business and market conditions and the manner and time of sales. No adjustment has been made with respect to any liabilities for any compromise or other settlement thereof in connection with a liquidation or the related cost of such liquidation to reflect that the liabilities of the Company substantially exceed its assets.\nThe assumptions and methodology in estimating the liquidating value of NVF assets were as follows; Current assets are made up primarily of cash, accounts receivable and inventory. Most of the Company's inventory is either in process or finished goods. If liquidated, the Company would have difficulty selling the inventory without deep discounts. NVF's product is the base material in electrical components, etc. A large amount of NVF's inventory is in the circuit board industry. The Company believes customers are unlikely to purchase this inventory because it is technical in nature and requires tight compliance to military specifications. For these reasons, inventory was valued at 40% of book value. The majority of the receivables will be difficult to collect because of the simple fact that the Company is in liquidation, customers will not want to pay or may want to return materials, etc. Management feels that there would be a 75% recovery. Properties were valued at current market values and do not reflect a true liquidation valuation. Liabilities are recorded at book value.\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 16 - Pro Forma Liquidating Balance Sheet - NVF (Unaudited)\nDecember 31, 1995 Historical ProForma Assets (In thousands) Current assets $ 45,915 33,730 Properties, net 18,804 11,832 Other assets 2,852 -\n$ 67,571 45,562\nLiabilities and Stockholders' Deficiency Current liabilities 20,817 20,817 Long-term debt and other liabilities 90,794 90,794 Stockholders' deficiency (44,040) (66,049)\n$ 67,571 45,562\nNote 17 - Supplementary Income Statement Information\nYear Ended December 31, 1995 1994 1993 (In thousands)\nMaintenance and Repairs $ 5,651 5,561 4,908\nRent and Lease Commitments\nThe Company has capital leases for a manufacturing facility and certain manufacturing equipment. The Company is committed through 1997 on a lease for the manufacturing facility located in Canada at $32,000 per year.\nThe future minimum lease payments under capital leases at December 31, 1995 are as follows:\nYear Ending December 31, Capital Leases (In thousands)\n1996 $ 91 1997 78 1998 63 1999 41 Thereafter 5 Total minimum lease payments 278\nLess amounts representing interest 68\nPresent value of minimum lease payments $ 210\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters\nBy order of the Bankruptcy Court all litigation against NVF has been stayed pursuant to 11 USC Section 362 and unless otherwise ordered such proceedings will be resolved in the context of the bankruptcy case.\nOn August 27, 1993 three creditors of NVF filed an involuntary bankruptcy petition against NVF under the Bankruptcy Code Bankruptcy Court, Case No. 93-1020. On September 15, 1993, NVF filed its answer to the involuntary petition, and an order for relief was entered by the Bankruptcy Court. NVF continues to operate its business and is in possession of its assets as a debtor in possession in accordance with the Bankruptcy Code. No trustee or examiner has been appointed.\nOn April 13, 1994, the Company filed its Disclosure Statement and Plan of Reorganization. The hearing on the adequacy of the Disclosure Statement was set for June 15, 1994. On June 6, 1994, the Disclosure Statement hearing was continued until June 30, 1994. The hearing was subsequently taken off calendar. On July 15, 1994, the Company filed its First Amended Disclosure Statement and First Amended Plan of Reorganization. A copy of the Plan was filed as Exhibit 2.1 to Form 8-K by the Company on August 4, 1994. A hearing on the adequacy of the First Amended Disclosure Statement was set for September 13, 1994. On September 7, 1994, the Company filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. On September 13, 1994, the hearing on the adequacy of the Second Amended Disclosure was taken off calendar due to the agreement (the \"Joint Agreement\") reached before the Bankruptcy Court between NVF and the Official Committee of Unsecured Creditors of NVF (the \"Committee\") to jointly retain an investment banking firm for the purpose of marketing and selling or recapitalizing the Company.\nThe investment banking firm, Alex. Brown & Sons Incorporated (\"Alex. Brown\"), made procedural recommendations that were agreed upon by NVF and the Committee and approved by the Bankruptcy Court. Alex. Brown has implemented those procedures and recommended to NVF and the Committee what they believe to be the highest and best offer which will realize the greatest value to the creditors. In accordance with the procedures approved by the Bankruptcy Court, Alex. Brown contacted a total of 147 potential purchasers for NVF. On July 24, 1995 Alex. Brown submitted its recommendation to the Bankruptcy Court under seal. On August 3, 1995 a hearing was held in the Bankruptcy Court on an Emergency Motion of First Security and Investment Corporation (\"First Security\") and Security Management Corporation for Examination of Alex. Brown & Sons, Inc. Pursuant to Federal Rule of Bankruptcy Procedure 2004. As a result of this hearing, the Court had permitted the mover to review the findings and conclusions of Alex. Brown's decision. Eventually,\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters (continued)\nAlex Brown determined that the bid by First Security was the highest and the best bid. On October 27, 1995, NVF and the Committee filed their motion with the Bankruptcy Court seeking approval to enter into and execute a stock purchase agreement with First Security. On December 29, 1995 the Bankruptcy Court signed an order approving the bid of First Security as the highest and best bid. On January 29, 1996 the Joint Plan of Reorganization (\"the Plan\") of NVF Company and The Official Committee of Unsecured Creditors and the Disclosure Statement was filed with the Bankruptcy Court (See Form 8-K dated January 29, 1996, Exhibits 2 and 99). On March 4, 1996 the Bankruptcy Court approved the Disclosure Statement. The Plan has been submitted to the creditors for ratification. A hearing date in Bankruptcy Court concerning confirmation of the Plan has been scheduled for April 25, 1996.\nOn June 25, 1993 an involuntary bankruptcy petition was filed against APL Corporation (\"APL\"), the Company's 68% owned subsidiary. On July 23, 1993, APL filed a motion in the Bankruptcy Court for the Southern District of Florida and obtained an order on July 27, 1993 converting the involuntary petition to a voluntary case under Chapter 11 of the Bankruptcy Code. On or about February 24, 1995, a Disclosure Statement For Creditors' Committee's Plan of Reorganization was filed in the APL bankruptcy case. A hearing on the Disclosure Statement in the APL case was held on April 6, 1995 and the Disclosure Statement was approved on April 15, 1995. The Plan was confirmed on June 8, 1995. Due to the fact that NVF no longer has control over APL, statements presented herein have been restated to reflect APL as a discontinued operation and to reflect the deconsolidation of APL effective June 30, 1993. The Company had approximately $2.5 million face value of APL's 10-3\/4% Subordinated Sinking Fund Debentures. However a settlement of litigation commenced by the Committee (See Note 18) called for the holders of 11-3\/4% Secured NVF Promissory Notes to return such notes for the return of the APL 10-3\/4% Subordinated Sinking Fund Debentures. Other income of approximately $2,609,000 was recognized in 1995 as a result of the settlement.\nOn December 1, 1993, in an action brought by the Securities & Exchange Commission not involving the Company, a judge in the United States District Court for the Southern District of New York issued a decision stating that the Court would issue a decree, among other things, barring Victor Posner and Steven Posner from serving as officers and directors of any reporting company under the Securities Exchange Act of 1934, as amended, and ordering that the stock Victor Posner and Steven Posner own in reporting companies which they control (as defined in that Act) be placed in voting trusts. On December 29, 1993 such decree was issued. On January 4, 1994 Victor Posner resigned his positions as Director, President and Chief Executive Officer of the Company. The United\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters (continued)\nStates Court of Appeals for the Second Circuit has affirmed the lower court's judgment and centiorari has been denied by the United States Supreme Court.\nOn June 8, 1994, Richard L. Beltzhoover, as Trustee of The Employees' Pension and Investment Plan of Insulation Represen- tatives, Inc. filed suit against NVF in the Court of Chancery of the State of Delaware In and For New Castle County. The suit requested that the Court of Chancery summarily order an annual meeting of the shareholders of the Debtor. On June 17, 1994, the plaintiff filed a Motion to Expedite the Proceeding on the grounds that it is a summary proceeding under 8 Del. C. 211(c) and based upon allegations in the complaint. Subsequently, Vice Chancellor Berger directed the Debtor to file its answer in the Chancery Court Action on or before June 27, 1994. On June 27, 1994, the Debtor filed its answer in the Chancery Court Action. On July 6, 1994, Beltzhoover filed a Motion for Relief From Stay, or in the Alternative, To Compel Annual Shareholders Meeting. Beltzhoover requested an expedited hearing on the matter. On July 19, 1994 Beltzhoover filed the same motion in Bankruptcy Court. It was then decided that this case would be heard in Bankruptcy Court rather than in Chancery Court where the action has been stayed. A trial to hear the Application to Compel an Annual Meeting of NVF Shareholders was scheduled for October 3, 1994, however Beltzhoover requested a continuance on that date and all parties agreed to adjourn such action until November 28, 1994. On December 5, 1994 the Board of Directors of the Company approved a settlement proposal whereby Beltzhoover withdrew his motions and covenants not to refile, initiate, commence or resurrect any of the motions at any time before July 31, 1995. Beltzhoover also agreed not to seek reimbursement from the Company for any expenses incurred as a result of his efforts. In turn, the Company elected Richard Beltzhoover and Kim Del Fabro to its Board of Directors effective December 5, 1994.\nOn June 4, 1993 Insurance Company of North America (\"INA\") filed suit against the Company claiming INA was indemnified by NVF on certain self insured workers compensation and mining reclamation obligations written for Sharon Steel Corporation and its subsidiaries. By virtue of NVF's bankruptcy action, this suit has been stayed. INA has filed a proof of claim against the Company in the amount of approximately $4,500,000 in the Bankruptcy Court which has been resolved by allowance of INA's unsecured claim in the amount of $4.385 million. The Company has accrued the entire amount of the claim under \"Liabilities Subject to Compromise\".\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters (continued)\nOn March 17, 1993, New Castle County filed an action in the Superior Court of the State of Delaware against the Company claiming that the Company owed New Castle $1,566,956.81 for sewer service provided to the Company's Yorklyn, Delaware plant. New Castle County has agreed to the treatment of their claim as set forth in the Plan. Under this proposal an aggregate amount of $1,813,507.27 claim of principal and interest shall be recognized. Interest shall accrue at 9% per annum from November 1, 1995 until the consummation date of the Plan. On the consummation date, or as soon as practicable thereafter, the holder of the claim shall receive twelve payments at monthly intervals of interest only at 8% per annum on the sum of $1,813,507.27 plus interest accrued between November 1, 1995 and the date of the first payment. Thereafter the remaining balance will be amortized over forty-eight months at a rate of 8% per annum. The Company reserved the right to contest this claim under this proposal and has filed such with Court on .\nThe Company and the EPA, subject to obtaining necessary approvals, have reached agreement in principle with respect to treatment of environmental claims under the Plan. Under this agreement, among other things, environmental obligations will pass through to NVF after reorganization. The Company and the EPA, subject to obtaining necessary approvals, had reached agreement in principle with respect to treatment of environmental claims under the Debtor's plan. Under this agreement, among other things, if the purchase option of the plan is approved all prepetition environmental claims will be paid by the reorganized Company pari passu with the amount to be paid to the unsecured creditors.\nThe Creditor's Committee commenced an adversary action in the United States District Court for the District of Delaware against certain present and former directors of the Company (including Messrs. Victor and Steven Posner), Triarc Companies, Inc. (formerly known as DWG), RC\/Arby's Corporation, American Financial Corporation, Great American Insurance Company and Mid-Continent Casualty Company (the \"Litigation\"). The First Amended Complaint in the action alleged causes of action based on allegations of breach of fiduciary duty, waste, fraudulent transfers, preference payments, and violations of the Racketeer influence and Corrupt Organizations Act (\"RICO\"). The District Court subsequently dismissed the Committee's RICO claims on the grounds that defendants' alleged acts of mail and wire fraud did not proximately cause injury to NVF. The District Court also held that Delaware's three-year limitations period set forth in 10 Del. C. 8016 might apply to some causes of action and allowed the Committee to file a second amended complaint to plead facts showing why its claims are not time-barred. In its second amended complaint, the Committee named NVF Company as a nominal defendant. The Committee had also\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters (continued)\nfiled a motion seeking leave to file a third amended complaint and a motion seeking reconsideration of the order dismissing the RICOclaims. Following extensive discovery and pre-trial preparation, on May 9, 1995, the parties to the litigation reached a settlement of their disputes before a United States Magistrate. Pursuant to the settlement, which was approved by the Bankruptcy Court on November 22, 1995, the parties have agreed, among other things, to the following: A) Victor Posner has agreed to pay $20,750,000 to the NVF estate; B) the Committee has agreed that the claim of the 10% secured notes will be allowed in the approximate amount of $8.2 million; C) the holders of the 11-3\/4% Secured NVF notes have agreed to return such notes in exchange for the return of approximately $2,538,000 principal amount of the APL 10-3\/4% Subordinated Sinking Fund Debentures held by NVF; D) DWG will withdraw its unsecured claims of approximately $210,000; and E) the parties have agreed to exchange mutual releases. A stipulation and Order of Dismissal was ordered by the United States District Court on December 15, 1995.\nNVF is also involved in certain litigation and proceedings with respect to matters related to the environment (See \"Item 1 - Business - Environmental Matters\") and certain other litigation as either plaintiff or defendant as a result of claims that arise in the ordinary course of its business. NVF does not believe any of such litigation will have a material adverse effect on its consolidated financial position or results of operations.\nThe Company's consolidated financial statements at December 31, 1995 and December 31, 1994 included elsewhere herein, include accruals of approximately $6.8 million for costs in connection with the environmental matters. As detailed below, it is the Company's current belief that the referenced and known environmental proceedings will not have a material adverse effect on its financial position or its results of operations. The Company believes that the $6.8 million accrual should provide an adequate amount to resolve these known liabilities. However, because of the uncertain nature of its environmental liabilities, particularly those related to the Kennett Square facility and the Yorklyn Plant, the Company is unable to assure that the outcome of the environmental matters will not have a material adverse effect on its financial position or the results of operations. The amounts the Company will ultimately have to pay to resolve these matters could differ from the estimate in the near term.\nAt the off site areas, the Company belongs to (\"Potentially Responsible Party\") Groups which typically pay costs and expenses on a basis reflecting each individual PRP's allocated share. While the Company's allocated share varies from site to site, at most sites it is approximately 1% or less. To devise an estimated range\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 18 - Legal Matters (continued)\nfor accrual purposes, the Company assessed its allocated share against the range of total site costs considered by the PRP Group for each site. Because literally hundreds of other PRPs exist at these other sites, and those companies are jointly and severally liable, the Company does not have the resources or the ability to assess the financial condition of these other parties. In light of the multiple parties, the Company does not believe that the financial condition of other companies will affect its liability.\nFor Company owned sites, the Company employed ranges of costs for known problems at Kennett Square and Yorklyn. As discussed below, those ranges do not include other speculative future environmental developments which could have a material impact on the Company. By applying this criterion for off site and owned sites, the Company estimated its environmental liabilities in the range of approximately $3 million to approximately $15 million. Based upon its settlement experience at certain sites and an internal assessment of the total clean up costs at each site, the Company determined an accrual amount for the range of potential environmental costs of $6.8 million. The Company's actual cost for these liabilities may well be closer to the lower end of the range due to the fact that the Company is in bankruptcy and due to the bankruptcy treatment of certain of these claims. The $6.8 million accrual does not include any offset for potential insurance recoveries. While the Company is hopeful that it will recover some funds for environmental settlements, it has not reached any agreements on its insurance claims. The Company has asserted claims against its insurers for all off site environmental liabilities and all environmental liabilities for the Kennett Square facility. In those actions, the Company seeks recovery of all costs incurred in connection with those environmental matters.\nFinally, future environmental matters could have a material impact on the Company. Specifically, the United States Environmental Protection Agency (\"EPA\") is evaluating the Kennett Square site and\/or surrounding areas for possible listing on the NPL\". However, the EPA has provided no indication of whether it intends to do so. If the EPA were to list the site and\/or surrounding areas on the (\"National Priorities Listing\") and a cleanup were to be required, such a development could have a material impact on the Company. Because of the wholly speculative nature of this issue, the Company has not considered it in the $6.8 million accrual.\nNote 19 - NVF Stand Alone Financial Statements - Unaudited\nThe Company's subsidiaries, Parsons Paper and NVF Canada, are not part of the bankruptcy thus there was no change in the manner they are accounted for. The accompanying financial statements have been prepared in accordance with AICPA Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\". NVF COMPANY (Debtor-in-Possession) Balance Sheet December 31, 1995 (thousands of dollars) Unaudited December 31, Assets 1995 Current assets: Cash and equivalents $ 526 Restricted cash 16,336 Receivables, less allowance for doubtful accounts of $360 12,379 Intercompany receivables, net 8,159 Inventories 12,323 Other current assets 1,448 Total current assets 51,171 Investment in affiliate 102\nProperties, at cost 87,716 Less accumulated depreciation and amortization (68,941) Net properties 18,775 Other assets 2,662 $ 72,710 Liabilities and Stockholders' Deficiency Current liabilities not subject to compromise: Current portion of long-term debt $ 7,583 Accounts receivable financing 3,616 Accounts payable 1,679 Accrued interest payable 1,385 Accrued payroll and benefits 1,807 Accrued professional liabilities 3,032 Accrued taxes 1,502 Other current liabilities 293 Total current liabilities 20,897\nInvestment in subsidiaries 6,619 Other long-term liabilities 2,752 Long-term debt 176 Liabilities subject to compromise (A) 87,753 Stockholders' deficiency: Common stock, $.01 par value; authorized 200,000,000 shares; issued 95,563,461 shares 956 Capital in excess of par value 234,943 Accumulated deficit (273,034) Treasury common stock, 2,292,544 shares, at cost (8,352) Total stockholders' deficiency (45,487) $ 72,710\nNote 19 - NVF Stand Alone Financial Statements - Unaudited\nNVF COMPANY (Debtor-in-Possession) Balance Sheet December 31, 1995 (thousands of dollars) Unaudited\nDecember 31,\n(A) Liabilities subject to compromise consist of the following:\nTrade and other miscellaneous claims $ 9,079 Accrued interest 2,076 Pension obligations 5,355 Post retirement benefit obligations, net 513 Subordinated debentures, 5% 48,046 Subordinated debentures, 10% 11,375 Other accrued liabilities 11,282 Current portion of long-term debt 16 Noncurrent portion of long term debt 11\n$ 87,753 (B)\n(B) Certain liabilities have been separately classified in the Plan of Reorganization filed on April 13, 1994 and July 14, 1994.\nNote 19 - NVF Stand Alone Financial Statements - Unaudited\nNVF COMPANY (Debtor-in-Possession) Statements of Operations (In thousands except per share amounts) Unaudited\nTwelve Months Ended December 31, 1995\nNet sales and operating revenues $ 89,526\nCost of goods sold 74,339 Depreciation and amortization 2,585 Selling, general and administrative expenses 10,272 87,196\nIncome from operations 2,330\nOther income (expense): Settlement with principal shareholder 23,359 Other income (expense), net 2,346 Debt costs (1,005)\n24,700\nIncome from operations before reorganization items, taxes and equity in net loss of affiliates 27,030\nReorganization items:\nProfessional fees 5,822\nIncome (loss) before taxes and equity in net loss of affiliates 21,208\nTax provision 1,502\nIncome (loss) before equity in net loss of affiliates 19,706\nEquity in net loss of affiliates (2,337)\nNet income $ 17,369\nWeighted average number of common and common equivalent shares outstanding, in thousands of shares 93,271\nNet income per share 0.19\nNVF COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued\nNote 20 - Subsequent Events\nIn January 1996, a flooding of Red Clay Creek resulted in approximately four feet of water in certain plants and offices of the Company located in Yorklyn, Delaware. This caused numerous production delays including the shutdown of the papermill facility for approximately two months. Estimated damages are approximately $2 million. The Company has submitted approximately $2 million in claims to various insurance carriers and has received an advance of $250,000 from one such carrier.\nOn January 29, 1996 the Bankruptcy Court approved the First Amended Disclosure Statement to Accompany the First Amended Joint Plan of Reorganization of NVF Company and the Official Committee of Unsecured Creditors under Chapter 11 of the Bankruptcy Code.\nOn CIT has advised the Company that it would not be interested in this financing arrangement after the Company emerges from bankruptcy. The Company believes it will be successful in obtaining alternative financing, however there can be no assurance that the Company will be able to obtain such financing or that it will be available on terms the Company deems acceptable.\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 OF FORM 8-K\n(A) FINANCIAL STATEMENTS See INDEX TO FINANCIAL STATEMENTS - ITEM 8. for Financial Statements and Financial Statements Schedules.\n(B) REPORTS ON FORM 8-K - NONE\n(C) EXHIBITS Copies of the following exhibits are available at a charge of $.25 per page upon written request to the Secretary of the Company at 6917 Collins Avenue, Miami Beach, Florida 33141.\n3.1 - Composite Certificate of Incorporation, and all amendments thereto, of NVF Company, incorporated herein by reference to NVF Company Form 10-K for 1980, Exhibit 3.1. 3.2 - By-laws of NVF Company as amended to date, incorporated herein by reference to NVF Company Registration Statement on Form S-16 (No.2-57235), Exhibit 1(e). 4.1 - Indenture, dated as of November 15, 1973 between NVF Company and Sterling National Bank, as Trustee, relating to NVF's 10% Subordinated Debentures due November 15, 2003, incorporated herein by reference to NVF Company Form 10-K for 1986, Exhibit 4.1. 4.2 - Indenture, dated as of January 1, 1969 between NVF Company and Bankers Trust, as Trustee, relating to NVF's Subordinated Debentures due January 1, 1994, incorporated herein by reference to NVF Company Form 10-K for 1986, Exhibit 4.2. 10.1 - NVF Company 1970 Stock Option Plan, as amended, incorporated herein by reference to Appendix B of the NVF Company Proxy Statement dated May 29, 1980. 10.2 - Revolving Credit Agreement among NVF Company and The CIT Group\/Business Credit, Inc. dated as of April 27, 1995.* 10.3 - Agreement between Parsons Paper Division of NVF Company Hourly Workers and the United Paper Workers International Union, AFL-CIO and Its Affiliates dated June 1, 1993, incorporated herein by reference to NVF Company From 10-K for 1993, Exhibit 10.3. 10.4 - Agreement between NVF Company and the United Paper Workers International Union, AFL-CIO and Its Affiliates dated April 28, 1993, incorporated herein by reference to NVF Company From 10-K for 1993, Exhibit 10.4. 10.5 - Agreement between NVF Industries of Canada Ltd. and National Automobile, Aerospace and Agricultural Implement Workers Union of Canada dated .*\n(C) EXHIBITS (Continued)\n10.6 - NVF Management Incentive Plan, incorporated by reference to Appendix A to the Notice of Annual Meeting of Stockholders and Proxy Statement dated November 29, 1990, incorporated herein by reference to NVF Company Form 10- K for 1990, Exhibit 10.8. 22.1 - Listing of subsidiaries of NVF Company *\n* being filed separately on Form SE.\n(D) FINANCIAL STATEMENT SCHEDULES SEE INDEX TO FINANCIAL STATEMENTS - ITEM 8. for Financial Statements Schedules.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 12, 1996 NVF COMPANY\nBy:\/s\/ Robert W. Flack Robert W. Flack Acting Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on the 12th day of April, 1996 by the following persons on behalf of the registrant in the capacities indicated:\nSignatures Title\nPrincipal Financial Officer:\n\/s\/ Robert W. Flack Acting Chief Financial Officer and Robert W. Flack Principal Accounting Officer\n\/s\/ Richard L. Beltzhoover Director Richard L. Beltzhoover\n\/s\/ Brenda N. Castellano Executive Vice President and Director Brenda N. Castellano\n\/s\/ Melvin R. Colvin Director Melvin R. Colvin\n\/s\/ Kim Del Fabro Director Kim Del Fabro\n\/s\/ Marco B. Loffredo, Jr. Director Marco B. Loffredo, Jr.\n\/s\/ Bernard I. Posner Director Bernard I. Posner\n\/s\/ Martin J. Posner Executive Vice President and Director Martin J. Posner\n\/s\/ Willie C. Robinson Director Willie C. Robinson\n\/s\/ Thomas M. Thompson Director Thomas M. Thompson","section_15":""}
{"filename":"3845_1995.txt","cik":"3845","year":"1995","section_1":"ITEM 1. BUSINESS\nAllied Capital Corporation (the \"Company\") was incorporated under the laws of the District of Columbia in 1958 and was reorganized as a Maryland corporation in 1991. It is a closed-end management investment company that elected in 1991 to be regulated as a business development company (\"BDC\") under the Investment Company Act of 1940, as amended (the \"1940 Act\"). The Company has two active wholly owned subsidiaries, Allied Investment Corporation (\"Allied Investment\") and Allied Capital Financial Corporation (\"Allied Financial\"). Allied Investment and Allied Financial are Maryland corporations registered under the 1940 Act as closed-end management investment companies. Allied Investment is licensed by the U.S. Small Business Administration (the \"SBA\") as a small business investment company under Section 301(c) of the Small Business Investment Act of 1958 (an \"SBIC\"), and Allied Financial is licensed by the SBA as a specialized small business investment company under Section 301(d) of the Small Business Investment Act of 1958 (an \"SSBIC\"). As described below, the Company also has a significant ownership interest in Allied Capital Lending Corporation (\"Allied Lending\"), a closed-end management investment company that has elected to be regulated as a BDC and is an SBA-approved small business lending company. Allied Capital Advisers, Inc. (\"Advisers\") serves as the investment adviser to the Company under an investment advisory agreement.\nThe investment objective of the Company is to provide a high level of current income and long-term growth in the value of its net assets by providing debt, mezzanine, and equity financing primarily for small, privately owned companies. This objective may be changed by the Board of Directors of the Company without a \"vote of a majority of the outstanding voting securities\" (as defined in the 1940 Act) of the Company. To achieve its investment objective, the Company invests primarily in and lends primarily to small businesses, both directly and through its wholly owned subsidiaries (unless otherwise indicated, all further references herein to investments made by the Company include those made by its subsidiaries). The investments made by the Company include providing financing for growth, leveraged buyouts of such companies, for note purchases and loan restructurings, and for special situations, such as acquisitions, buyouts, recapitalizations, and bridge financings of such companies.\nThe Company's investments generally take the form of loans with equity features, such as warrants or conversion privileges, that entitle the Company to acquire a portion of the equity in the entity in which the investment is made. The typical maturity of such a loan made by the Company is seven years, with interest-only payments in the early years and payments of both principal and interest in the later years, although loan maturities and principal amortization schedules vary. The Company also makes senior loans without equity features. Loans generally bear interest at a fixed rate that the Company believes is competitive in the venture capital marketplace. Current income is derived primarily from interest earned on the loan element of the Company's investments. Generally, long-term growth in net asset value and realized capital gains, if any, from portfolio companies are achieved through the equity obtained as a result of the Company's growth financing and leveraged buyout activity. The Company seeks to structure its investments so that approximately one-half of the potential return is earned in the form of monthly or quarterly interest payments and the balance is derived from capital gains. The Company's investments may be secured by the assets of the entity in which the investment is made, which collateral interests may be subordinated in certain instances to institutional lenders, such as banks. The Company makes available significant managerial assistance to its portfolio companies. Pending investment of its assets, the Company's funds are generally invested in repurchase agreements fully collateralized by U.S. government securities.\nThe Company usually invests in privately held companies or small public companies that are thinly-traded and generally lack access to capital. These companies generally have been in business for at least one year, have a commercially proven product or service, and seek capital to finance expansion or ownership changes. The Company generally requires that the companies in which it invests demonstrate sales growth, positive cash flow, and profitability, although turnaround situations are also considered. The Company's emphasis is on low- to medium-technology businesses, such as broadcasting, manufacturing, environmental concerns, wholesale distribution, commodities storage, and retail operations. The Company emphasizes the quality of management of the companies in which it invests, and seeks experienced entrepreneurs with a management track record, relevant industry experience, and high integrity.\nHistorically, all of the investments of the Company have been made in domestic small businesses. However, the Company recently established a $20 million credit facility with the Overseas Private Investment Corporation (\"OPIC\"), pursuant to which it anticipates making investments in businesses that engage, in whole or in part, in overseas operations, usually in countries representing the world's emerging markets. OPIC is a self-sustaining federal agency the purpose of which is to promote economic growth in developing countries by encouraging U.S. private investment in those nations. Under OPIC regulations, investments generally may be made only in companies that have some affiliation with a U.S.-based business entity. The Company's first OPIC-related investment was made in February 1996 and consisted of an investment in a wireless communications company expanding operations into Latin America; that investment involved borrowing $5 million from the OPIC credit facility.\nIn January 1996, the Company registered 885,448 shares of its stock to be offered in connection with a rights offering to its existing shareholders. Pursuant to the rights offering, the Company issued to the common stockholders at the close of business on January 22, 1996, (the \"Record Date\"), one non-transferable subscription right (\"Subscription Right\") for each share held which entitled each record date stockholder to subscribe for and purchase from the Company up to one authorized, but theretofore unissued share of the Company's common stock for each seven Subscription Rights held (the \"Primary Subscription\"). Stockholders who fully exercised their Subscription Rights were entitled to the additional privilege of subscribing for shares from the offering not acquired by exercise of Subscription Rights (the \"Over-Subscription Privilege\"). In addition, the Company increased the number of shares subject to subscription by 15%, or 132,817 shares, for an aggregate total of 1,018,265 shares available under the offering.\nThe subscription price per common share was $13.11, which equaled 95% of the average of the last reported sale price of a share of common stock on the Nasdaq National Market on February 27, 1996 (the expiration date of the rights offering) and each of the four preceding business days. Stockholders participating in the offering subscribed for 404,767 shares through the Primary Subscription and 251,903 shares through the Oversubscription Privilege for a total of 656,670 shares. The Company received net proceeds of $8.2 million from the rights offering after estimated expenses of $458,000, including a 2.5% commission paid to eligible broker\/dealers on each share sold as a result of their soliciting efforts. In the registration statement relating to the rights offering, the Company retained the right to offer and sell any unsubscribed-for shares through a subsequent offering. Any such subsequent offering may be made only through the use of a prospectus included in a post-effective amendment to the registration statement.\nThe Company's Operation as a BDC\nAs a BDC, the Company may not acquire any assets other than \"Qualifying Assets\" unless, at the time the acquisition is made, Qualifying Assets represent at least 70% of the value of the Company's total assets (the \"70% test\"). The principal categories of Qualifying Assets relevant to the business of the Company are the following:\n(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer is an eligible portfolio company. An eligible portfolio company is defined to include any issuer that (a) is organized and has its principal place of business in the United States, (b) is not an investment company other than an SBIC wholly owned by the BDC (the Company's investments in and advances to Allied Investment and Allied Financial are Qualifying Assets, but its investment in Allied Lending, which is neither wholly owned nor an SBIC, is not) and (c) does not have any class of publicly traded securities with respect to which a broker may extend margin credit.\n(2) Securities received in exchange for or distributed with respect to securities described in (1) above, or pursuant to the exercise of options, warrants or rights relating to such securities.\n(3) Cash, cash items, government securities, or high quality debt securities (within the meaning of the 1940 Act) maturing in one year or less from the time of investment.\nIn addition, to treat securities described in (1) and (2) above as Qualifying Assets for the purpose of the 70% test, a BDC must make available to the issuer of those securities significant managerial assistance. Making available significant managerial assistance means, among other things, (i) any arrangement whereby the BDC, through its\ndirectors, officers or employees, offers to provide, and, if accepted, does provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company or (ii) in the case of an SBIC, making loans to a portfolio company. Managerial assistance is made available to the portfolio companies by the Company's directors and officers, who are employees of Advisers, which manages the Company's investments. Each portfolio company is assigned for monitoring purposes to an investment officer and its principals are contacted and counseled if the portfolio company appears to be encountering business or financial difficulties. The Company also provides managerial assistance on a continuing basis to any portfolio company that requests it, whether or not difficulties are perceived. The Company's officers and directors are highly experienced in providing managerial assistance to small businesses.\nThe Company may not change the nature of its business so as to cease to be, or withdraw its election as, a BDC unless authorized by vote of a \"majority of the outstanding voting securities,\" as defined in the 1940 Act, of the Company. Since the Company made its BDC election, it has not in practice made any substantial change in its structure or, on a consolidated basis, in the nature of its business, except for the disposition of its ownership interest in Allied Lending, as described below, which is not a change that results in the Company ceasing to be a BDC. As a BDC, the Company is entitled to borrow money and issue senior securities representing indebtedness as long as senior securities representing indebtedness have asset coverage of at least 200%. This limitation is not applicable to classes of senior securities representing indebtedness of the Company's SBIC and SSBIC subsidiaries.\nCo-Investment with Allied Capital Corporation II, Allied Venture Partnership, and Allied Technology Partnership\nIn accordance with the conditions of several exemptive orders of the Securities and Exchange Commission (the \"Commission\") permitting co-investments (the \"Co-investment Guidelines\"), most of the Company's acquisitions and dispositions of investments are made in participation with Allied Capital Corporation II (\"Allied II\"). In the past, the Company also acquired certain investments in participation with Allied Venture Partnership (\"Allied Venture\") and Allied Technology Partnership (\"Allied Technology\"), both private venture capital partnerships managed by Advisers, neither of which is now making new investments. Allied II is a closed-end management investment company that has elected to be regulated as a BDC and for which Advisers serves as its investment adviser. At December 31, 1995, Allied II had total consolidated assets of $107,169,000, compared to the Company's total consolidated assets of $148,268,000 at that date.\nThe Co-investment Guidelines generally provide that the Company and its wholly owned subsidiaries must be offered the opportunity to invest in any investment, other than in interim investments or marketable securities, that would be suitable for Allied II or its wholly owned subsidiaries and the Company to the extent proportionate to their respective consolidated total assets. Securities purchased by the Company or its wholly owned subsidiaries in a co-investment transaction with any of Allied II or its wholly owned subsidiaries, Allied Venture or Allied Technology, will consist of the same class of securities, will have the same registration rights, if any, and other rights related thereto, and will be purchased for the same unit consideration. Any such co-investment transaction must be approved by the Company's Board of Directors, including a majority of its independent directors. The Company will not make any investment in the securities of any issuers in which Allied II, Allied Venture or Allied Technology, but not the Company, has previously invested. The Co-investment Guidelines also provide that the Company will have the opportunity to dispose of any securities in which the Company or its wholly owned subsidiaries and any of Allied II or its wholly owned subsidiaries, Allied Venture or Allied Technology, have invested in proportion to their respective holdings of such securities, and that, in any such disposition, the Company will be required to bear no more than its proportionate share of the transaction costs.\nAllied Investment\nAllied Investment, as an SBIC, provides capital to privately owned small businesses primarily through loans, generally with equity features, and, to a lesser extent, through the purchase of common or convertible preferred shares. Loans with equity features are generally evidenced by a note or debenture that is convertible into common stock, requiring the holder to make a choice, prior to the loan's maturity, between accepting repayment and maintaining its equity position, or purchasing, frequently for a nominal consideration, common stock of the issuer even after the loan is repaid. Wherever possible, Allied Investment seeks collateral for its loans, but its security interest is usually subordinated to the security interest of other institutional lenders.\nAs an SBIC, Allied Investment currently has the opportunity to sell to the SBA subordinated debentures with a maturity of up to ten years up to an aggregate principal amount determined by a formula which applies a multiple to its private capital, but not in excess of $90 million (the \"$90 million limit\"). The $90 million limit generally applies to all financial assistance provided by the SBA to any licensee and its \"associates,\" as that term is defined in SBA regulations. For this purpose, Allied Investment and Allied Financial would be deemed to be \"associates\" of one another and both may be deemed to be \"associates\" of Allied Investment Corporation II (\"Allied Investment II\"), which is also an SBIC and is a subsidiary of Allied II. As a group, Allied Investment and Allied Financial have received $68,300,000 in subordinated debenture and preferred stock investments from the SBA as of December 31, 1995; as a result, this combined ability to apply for additional leverage from the SBA will be limited to $21,700,000 due to the $90 million limit. This combined ability to obtain additional leverage assumes that Allied Investment II does not obtain any SBA leverage. The Company is unable to predict the SBA's ability to meet demands for leverage on an ongoing basis, as such funding may be affected if Congress reduces appropriations for the SBA, which may compel the SBA to allocate leverage or to reduce the current limits on available leverage. Therefore, there is no guaranty that Allied Investment or Allied Financial will be able to obtain additional SBA leverage beyond what is currently held.\nAllied Investment provides managerial assistance to its portfolio companies by arranging syndicated financings, advising on major business decisions, furnishing one of its executives to serve as a director or otherwise participating in board meetings and assisting portfolio companies when they are having operating difficulties.\nAllied Financial\nAllied Financial, as an SSBIC, operates as a small business investment company specializing in the financing of small businesses controlled by socially or economically disadvantaged persons. To determine whether the owners of a small business are socially or economically disadvantaged, the SBA relies on a composite of factors. Business owners who are members of the following groups, among others, are considered socially disadvantaged: African Americans, Hispanic Americans, Native Americans and Asian Pacific Americans. In determining whether the owners of a small business are economically disadvantaged, consideration may be given to factors such as levels of income, location (for instance, urban ghettos, depressed rural areas and areas of high unemployment or underemployment), education level, physical or other special handicap, inability to compete in the marketplace because of prevailing or past restrictive practices or Vietnam-era service in the armed forces, or any other factors that may have contributed to disadvantaged conditions.\nAn SSBIC may sell preferred stock or long-term subordinated debt to the SBA in an amount of up to 200% of its private capital. Beginning with the SBA's 1996 fiscal year commencing on October 1, 1995, Congress has discontinued subsidized funding for the SBA's SSBIC program. Prior to this change, an SSBIC was able to sell preferred stock and debentures which were issued with a rate reduction or subsidy. Preferred stock sold to the SBA after November 1989 pays dividends at an annual rate of four percent (4%) of par value and must be redeemed within 15 years of issuance; preferred stock sold to the SBA before November 1989 pays dividends at an annual rate of three percent (3%) of par value and has no required redemption date. In addition to preferred stock, the SBA had provided leverage to SSBICs at a reduced rate through the purchase or guarantee of debentures. As of December 31, 1995, Allied Financial had unsubsidized capital in the aggregate amount of $2,000,000 and subsidized capital in the aggregate amount of $23,950,000, consisting of subordinated debentures to the SBA in the amount of $16,950,000, 3% preferred stock of $6,000,000 and 4% preferred stock of $1,000,000.\nAllied Financial provides managerial assistance to its portfolio companies by arranging syndicated financings, advising on major business decisions, furnishing one of its executives to serve as a director or otherwise participating in board meetings and assisting portfolio companies when they are having operating difficulties.\nThe Company's Interest in Allied Lending\nThe Company owned 2,380,000 shares, or all of the outstanding capital stock, of Allied Lending prior to consummation of the initial public offering of Allied Lending's common stock in November 1993. As a result of that initial public offering, the Company's ownership of Allied Lending's common stock was reduced to 1,580,000 shares, or 36.2% of the Allied Lending shares outstanding at December 31, 1993. The Company has agreed to\ndivest itself of all shares of Allied Lending by December 31, 1998 by public offerings, private placements, distributions to the Company's stockholders or otherwise. As part of this divestiture, the Company declared an extra distribution in December 1994 and distributed in early January 1995 an aggregate of 335,086 Allied Lending shares, which reduced its ownership of Allied Lending to 1,244,914 shares, or 28% of the Allied Lending common stock then outstanding.\nUntil 1995, the business of Allied Lending consisted solely of making small business loans which are partially guaranteed under the SBA's 7(a) Loan Program (\"7(a) guaranteed loans\"). Allied Lending has been an active non-bank lender in the 7(a) Loan Program. Most of the loans made by Allied Lending historically have been made for the purpose of allowing portfolio companies to acquire real estate-related assets, such as factories, workshops, or retail premises, or to refinance outstanding loans made to acquire such real estate; a smaller proportion of such loans has been made for the purpose of allowing portfolio companies to purchase or refinance machinery and equipment. Allied Lending, pursuant to stockholder approval at a Special Meeting of Stockholders on November 9, 1995, expanded its ability to make loans to include, in addition to 7(a) guaranteed loans, loans that are made in conjunction with 7(a) guaranteed loans, and loans pursuant to the SBA 504 program.\nInvestment Adviser\nAdvisers is the investment adviser to the Company pursuant to an investment advisory agreement. In May 1995, the Company's stockholders approved a new investment advisory agreement (the \"current agreement\"). The current agreement will remain in effect from year to year as long as its continuance is approved at least annually by the Board of Directors, including a majority of the disinterested directors, or by the \"vote of a majority of the outstanding voting securities\" (as defined in the 1940 Act), of the Company. The current agreement may, however, be terminated at any time on (60) sixty days' notice, without the payment of any penalty, by the Board of Directors or by vote of a majority of the Company's outstanding voting securities, as so defined, and will terminate automatically in the event of its assignment.\nThe terms of the current agreement are virtually identical to those of the investment advisory agreement between the Company and Advisers that it replaced (the \"former agreement\") except as to the calculation of the investment advisory fee and to the extent clarifying changes were made regarding the nature of professional or technical fees and expenses to be paid by the Company. The terms of the current agreement regarding calculation of the investment advisory fee are intended to reflect Advisers' practice of generally imposing a significantly lower fee on the Company's cash and cash equivalents and Interim Investments (i.e., U.S. government securities) than the fee applicable to the Company's invested assets, which Advisers has historically effected by waiving portions of the investment advisory fee applicable to the Company's cash and cash equivalents and Interim Investments. In the current agreement the provisions of the former agreement concerning the transaction costs to acquire or dispose of an investment were clarified to describe the nature of professional or technical fees and expenses to be paid by the Company and to provide that those fees and expenses included items such as credit reports, title searches, fees of accountants or industry-specific technical experts, and transaction-specific travel expenses. The effect of those clarifications and the replacement of the former agreement does not result in the imposition of any new fee or expense to be paid by the Company or its stockholders. Replacement of the former agreement with the current agreement is expected to result in an advisory fee that is lower than that provided under the former agreement (absent waiver by Advisers of any portion of its fee) and approximately the same as that provided in recent practice when Advisers waived a portion of its fee annually. The terms of the current agreement are summarized below.\nPursuant to the current agreement, Advisers manages the investments of the Company, subject to the supervision and control of the Board of Directors. Specifically, Advisers identifies, evaluates, structures, closes, and monitors the investments made by the Company. The Company will not make any investments that have not been recommended by Advisers as long as the current agreement remains in effect. Advisers has the authority to effect acquisitions and dispositions of investments for the Company's account, subject to approval by the Company's Board of Directors.\nThe current agreement provides that the Company will pay all of its own operating expenses, except those specifically required to be borne by Advisers. The expenses paid by Advisers include the compensation of its\nofficers and the cost of office space, equipment and other personnel required for the Company's day-to-day operations. The expenses that are paid by the Company include the Company's share of transaction costs incident to the acquisition and disposition of investments, legal and accounting fees, the fees and expenses of the Company's independent directors and the fees of its officer-directors, the costs of printing and mailing proxy statements and reports to stockholders, costs associated with promoting the Company's stock, and the fees and expenses of the Company's custodian and transfer agent. The Company is also required to pay expenses associated with litigation and other extraordinary or non-recurring expenses, as well as expenses of required and optional insurance and bonding. All fees paid by or for the account of an actual or prospective portfolio company in connection with an investment transaction in which the Company participates are treated as commitment fees or management fees and are received by the Company, pro rata to its participation in such transaction, rather than by Advisers. Advisers is entitled to retain for its own account any fees paid by or for the account of any company, including a portfolio company, for special investment banking or consulting work performed for that company which is not related to such investment transaction or management assistance. Advisers will report to the Board of Directors not less often than quarterly all fees received by Advisers from any source whatever and whether, in its opinion, any such fee is one that Advisers is entitled to retain under the provisions of the current agreement. In the event that any member of the Board of Directors should disagree, the matter will be conclusively resolved by a majority of the Board of Directors, including a majority of the independent Directors. If the Company uses the services of attorneys or paraprofessionals on the staff of Advisers for the Company's corporate purposes in lieu of outside counsel, the Company will reimburse Advisers for such services at hourly rates calculated to cover the cost of such services, as well as for incidental disbursements by Advisers in connection with such services.\nAs compensation for its services to and the expenses paid for the account of the Company, Advisers is paid quarterly, in arrears, a fee equal to 0.625% per quarter of the quarter-end value of the Company's consolidated total assets, less the value of the shares of Allied Lending owned by the Company, consolidated Interim Investments, cash and cash equivalents, plus 0.125% per quarter of the quarter-end value of consolidated Interim Investments, cash and cash equivalents. The current agreement provides specifically that the fee to Advisers will not apply to the Company's investment in Allied Lending, as required by the Commission's 1993 exemptive order permitting the spinoff of Allied Lending. Such fees on an annual basis are approximately 2.5% of the Company's consolidated total assets, less the Company's investment in Allied Lending and consolidated Interim Investments, cash and cash equivalents, and 0.5% of the Company's consolidated Interim Investments, cash and cash equivalents.\nThe fee to Advisers is substantially higher than that paid by most investment companies because of the efforts and resources devoted by Advisers to identifying, evaluating, structuring, closing, and monitoring the types of private investments in which the Company specializes. The rate of compensation paid by the Company to Advisers is substantially the same as that paid by Allied II, with which Advisers has also negotiated a new investment advisory agreement during 1995. The Company also understands that the fee to Advisers provided for by the current agreement is not in excess of that frequently paid by private investment funds engaged in similar types of investments. Such private funds also typically allocate to management a substantial participation in profits.\nEmployees\nThe Company has no employees, as all of its personnel are furnished by Advisers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company does not own or lease any properties or other tangible assets.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a defendant in any material pending legal proceeding, and no such material proceedings are known by the Company to be contemplated.\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, ages and positions of the executive officers of the Company as of March 1, 1996, as well as certain other information with respect to those persons:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation in response to this Item is incorporated by reference to the \"Investor Information\" section of, and to Notes 4 and 7 of the Notes to Consolidated Financial Statements contained in, the Company's Annual Report to Stockholders for the year ended December 31, 1995 (the \"1995 Annual Report\").\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nInformation in response to this Item is incorporated by reference to the table in the \"Consolidated Comparison of Financial Highlights\" section of the 1995 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nInformation in response to this Item is incorporated by reference to the \"Management's Discussion and Analysis\" section of the 1995 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nInformation in response to this Item is incorporated by reference to the Consolidated Financial Statements, notes thereto and Report of Independent Accountants thereon contained in 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.\nInformation in response to this Item is incorporated by reference to the identification of directors and nominees contained in the \"Election of Directors\" section and the subsection captioned \"Compliance with Reporting Requirements of Section 16(a) of the Securities Exchange Act of 1934\" of the Company's definitive proxy statement in connection with its 1996 Annual Meeting of Stockholders, scheduled to be held on May 6, 1996 (the \"1996 Proxy Statement\"). Information in response to this Item also is included under the caption \"Executive Officers of the Registrant\" included in Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation in response to this Item is incorporated by reference to the subsections captioned \"Compensation of Executive Officers and Directors,\" \"Incentive Stock Options\" and \"Compensation of Directors\" of the 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation in response to this Item is incorporated by reference to the subsection captioned \"Beneficial Ownership of Common Stock\" of the 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation in response to this Item is incorporated by reference to the subsections captioned \"Certain Transactions\" 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) Documents filed as part of this Report:\n1. A. The following financial statements are incorporated by reference from the 1995 Annual Report:\nConsolidated Balance Sheet at December 31, 1995 and 1994. Consolidated Statement of Operations for the years ended December 31, 1995, 1994 and 1993. Consolidated Statement of Changes in Net Assets for the years ended December 31, 1995, 1994 and 1993. Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993. Consolidated Statement of Loans to and Investments in Small Business Concerns at December 31, 1995. Notes to Consolidated Financial Statements.\nB. Report of Independent Accountants with respect to the financial statements listed in A. above is incorporated by reference from the 1995 Annual Report.\n2. No financial statement schedules are filed herewith because (i) such schedules are not required or (ii) the information required has been presented in the aforementioned financial statements.\n3. The following exhibits are filed herewith or incorporated by reference as set forth below:\n(3)(A)(1) The Company's Articles of Incorporation.\n(3)(B)(2) The Company's By-Laws.\n(4)(A) Instruments Defining the Rights of Security holders. See Exhibits 3(A) and 3(B).\n(4)(D)(3) Note Agreement between the Company and certain subsidiaries and Massachusetts Mutual Life Insurance Company, as amended, dated April 30, 1992.\n(4)(E)(2) Loan Agreement between the Company and Overseas Private Investment Corporation, dated April 10, 1995.\n(4)(F)(2) Unsecured Line of Credit Agreement between the Company and The Riggs National Bank of Washington, DC dated December 18, 1995.\n(10)(A)(4) Investment Advisory Agreement between the Company and Allied Capital Advisers, Inc. approved by the Company's stockholders on May 4, 1995.\n(10)(B)(i)(5) Letter Agreement dated November 16, 1993 among Allied Capital Lending Corporation, the Company and Lehman Brothers Inc.\n(10)(B)(ii)(6) Tax Indemnification Agreement dated November 12, 1993 between the Company and Allied Capital Lending Corporation.\n(10)(C)(iii)(7) The Company's Dividend Reinvestment Plan.\n(10)(E)(8) The Company's Incentive Stock Option Plan, as amended.\n(11)* Statement re computation of per share earnings.\n(13)(9)* 1995 Annual Report to Stockholders.\n(21) Subsidiaries of the Company and jurisdiction of incorporation.\n(23)* Consents of Matthews, Carter and Boyce, independent accountants.\n(27)* Financial Data Schedule.\n(28)* Financial statements as of and for the year ended December 31, 1995 of Allied Investment Corporation and Allied Capital Financial Corporation, in the form filed with the Small Business Administration.\n- ---------------------------------\n* Filed herewith.\n(1) Incorporated by reference to Exhibit D to the Company's definitive proxy statement filed on April 11, 1991.\n(2) Incorporated by reference to such Exhibit on Pre-Effective Amendment No. 2 filed with registration statement Form N-2 (File No. 33-64629) on January 24, 1996.\n(3) Incorporated by reference to Exhibit (4)(D)(i) filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1992. Amendments thereto are incorporated by reference to Exhibits (4)(D)(ii), (4)(D)(iii) and (4)(D)(iv) to the Company's Form 8-K filed on December 9, 1993.\n(4) Incorporated by reference to Exhibit A to the Company's definitive proxy statement relating to the meeting of its stockholders held on May 4, 1995.\n(5) Incorporated by reference to an exhibit of the same number filed with the Company's Form 8-K dated November 19, 1993.\n(6) Incorporated by reference to an exhibit of the same number filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n(7) Incorporated by reference to an exhibit of the same number filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(8) Incorporated by reference to Exhibit A to the Company's definitive proxy statement filed on March 30, 1994 with respect to an annual meeting of stockholders held on May 5, 1994.\n(9) Except to the extent that portions of this exhibit are incorporated herein by reference, this document shall not be deemed to have been filed pursuant to the Securities Exchange Act of 1934.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K have been filed for 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 on March 28, 1996.\n\/s\/ DAVID GLADSTONE ------------------------------------------------- David Gladstone 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 in the capacities and on the dates indicated.\nEXHIBIT INDEX","section_15":""}
{"filename":"707511_1995.txt","cik":"707511","year":"1995","section_1":"Item 1. Business\nGeneral\nAlpha 1 Biomedicals, Inc. (the \"Company\") is engaged in the development of pharmaceutical products. Since its inception in 1982, the Company's primary activities have consisted of research and development and the conduct of clinical trials involving several peptides to which the Company holds proprietary rights.\nThe current focus of the Company's research and development efforts is the evaluation of Thymosin beta 4. Recent results from preclinical experiments have indicated the potential for developing Thymosin beta 4 as a treatment for cystic fibrosis and possibly other diseases or conditions. In late 1994, the Company instituted a development program which has as its initial objective the initiation of one or more human clinical trials in cystic fibrosis patients. This program has been suspended pending the receipt of additional financing. See \"Thymosin Beta 4 Development Program.\"\nThe Company's earlier product development program involved primarily the evaluation of Thymosin alpha 1, either solely or in combination with other agents, as a treatment for a number of specific disease indications and as a vaccine adjuvant. As part of its development effort, the Company initiated, sponsored or provided drug for a number of clinical trials involving Thymosin alpha 1, including most significantly a Phase III multi-center trial to evaluate the efficacy of the drug as a treatment for chronic hepatitis B. This trial did not produce positive results. The Company's developmental activities involving Thymosin alpha 1 concluded in 1994 with the licensing by the Company of its proprietary rights to Thymosin alpha 1 to SciClone Pharmaceuticals, Inc. (\"SciClone\") as part of the settlement of an arbitration proceeding between the companies. See \"Licensing of Thymosin Alpha 1 Rights.\"\nOn September 19, 1995, the Company terminated the joint venture formerly established to develop certain discoveries for diagnosis or treatment of Acquired Immunodeficiency Syndrome (\"AIDS\"). The joint venture, Viral Technologies, Inc. (\"VTI\"), was 50% owned by the Company and 50% owned by CEL-SCI Corporation, a publicly-held biomedical company (\"CEL-SCI\"). On October 30, 1995, the Company sold its 50% interest in VTI to CEL-SCI. See \"Viral Technologies Joint Venture\".\nIn February 1996, the Board of Directors of the Company, due to the financial circumstances of the Company, approved a plan which provides for the termination of all ongoing research and development activities, a reduction in leased space, a reduction in certain salaries and the severance of administrative staff. The Company also has entered into negotiations with its major vendors in which it is seeking to defer payments that are due in exchange for a commitment to the vendors of revenues received by the Company in the future under its license agreement with SciClone. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition.\" In the event that sufficient funding is obtained for the Thymosin beta 4 program, all amounts then due would become payable immediately. If additional funding is not obtained, the Company estimates that its current financial resources are sufficient to fund its operations, on a substantially scaled-down basis, until the third quarter of 1996. If additional financing cannot be obtained prior to that time, the Company likely will be forced to discontinue operations.\nThymosin Beta 4 Development Program\nIn 1995, the Company directed its research and development efforts to an evaluation of the prospects for the commercialization of the human peptide Thymosin beta 4, to which the Company holds proprietary rights. See \"Proprietary Rights.\" This program has been suspended pending the receipt of additional financing.\nTechnology. Thymosin beta 4 is a chemically synthesized copy of a 43-amino acid peptide that is a constituent of Thymosin fraction 5, a thymic extract originally isolated by Dr. Allan L. Goldstein, the Company's Chairman and Chief Scientific Advisor. This peptide is found in high concentrations in blood platelets, white blood cells and various other human tissues. Indications for which Thymosin beta 4 may have a clinical benefit include sepsis, cystic fibrosis, chronic bronchitis, asthma and adult respiratory distress syndrome.\nImmune Regulation by Thymosin beta 4\nThymosin beta 4 demonstrates a number of immuno-regulatory activities when injected into experimental animals. Thymosin beta 4 has been shown to (i) stimulate T-lymphocyte terminal deoxynucleotide- transferase activity in bone marrow; (ii) enhance antigen presentation by macrophage; and (iii) inhibit macrophage migration. The experimental data from septic animals and the correlation with circulating Thymosin beta 4 levels in human subjects suggest a potential role for Thymosin beta 4 in treating septic shock and other related inflammatory diseases.\nActin-binding by Thymosin beta 4\nRecent studies have suggested that a principal biochemical activity of Thymosin beta 4 is binding to actin. Actin is a naturally occurring protein present in virtually all human cells. Studies over the last decade have demonstrated that when actin is released into the circulation by breakdown of cells during infection or disease, it is toxic. This toxicity may account for some of the various symptoms of several disease conditions. Actin-binding proteins, including Thymosin beta 4, have been shown in laboratory experiments to reduce or eliminate actin-associated pathology. These results suggest a number of clinical uses of Thymosin beta 4 in moderating the adverse consequences of extracellular actin.\nCystic Fibrosis\nCystic fibrosis is an inherited disease that affects approximately 1 in 2,500 Caucasian newborns in the United States and Europe. The disease is characterized by a defect in ion secretions by cells of the body, which manifests itself in two primary problems: pancreatic insufficiency and pulmonary bronchiectasis. The pancreatic insufficiency can be treated with enzymatic food supplements. However, the pulmonary defect, which is the most devastating manifestation of cystic fibrosis, generally leads to loss of lung function and eventually death in greater than 85% of patients. The average life expectancy of a cystic fibrosis patient is 29 years.\nOne symptom of cystic fibrosis is that the lungs of patients fill with sputum. Recent analysis has shown that the sputum from cystic fibrosis patients contains actin filaments, making it possible to theorize that Thymosin beta 4 could have beneficial effects on the ability of cystic fibrosis patients to clear sputum from their airways. The Company believes that the clinical development of Thymosin beta 4 as a sputum clearing agent (or \"mucolytic\") for the treatment of cystic fibrosis patients represents the best initial indication on which to focus its development program.\nProduct Development. The Company's developmental activities involving Thymosin beta 4 have consisted of efforts to evaluate its possible therapeutic uses. Because the Company does not maintain its own laboratory facilities, the Company expects, subject to the receipt of the necessary financing, to conduct the required research and development by funding research programs at academic institutions. In order to confirm initial findings concerning Thymosin beta 4, the Company in 1995 supported additional research projects at two universities aimed at further clarifying the mechanism of action of Thymosin beta 4. One research program at The George Washington University (\"GWU\") focused on the biochemical interaction of Thymosin beta 4 with actin. This program yielded important new information about the mechanism of action of Thymosin beta 4. The second research program, which was carried out in laboratories at St. Louis University School of Medicine, focused directly on the possible use of Thymosin beta 4 as a treatment for cystic fibrosis by studying the interaction of Thymosin beta 4 with sputum from cystic fibrosis patients. The preliminary results of this program, in the view of the Company and the researchers, appeared to support the possible clinical utility of Thymosin beta 4 in the treatment of cystic fibrosis.\nThe Company has conducted and plans to continue to conduct, subject to the receipt of the necessary financing, a portion of its Thymosin beta 4 research program by financially sponsoring research projects at GWU. Such sponsored research is governed by a research agreement between the Company and GWU whereby, in return for the funding by the Company of research, GWU has agreed to grant to the Company an exclusive worldwide license to any and all resulting patents, subject to specified royalty and commercialization obligations of the Company. See \"Proprietary Rights.\" Because of Dr. Goldstein's relationship with the Company as its Chairman of the Board and Chief Scientific Advisor and his position as Chairman of the Department of Biochemistry and Molecular Biology at GWU, the Company has not funded any research personally conducted by Dr. Goldstein, and anticipates that any future funding would also be limited to research projects performed by principal investigators at GWU other than Dr. Goldstein. The Company also may use the proceeds from any future financings to enter into similar arrangements with other academic institutions in connection with its efforts to develop Thymosin beta 4.\nThe Company has initiated efforts to obtaining the information required by the United Status Food and Drug Administration (the \"FDA\") in order to submit an Investigational New Drug (\"IND\") application for Thymosin beta 4. These efforts have included preliminary studies to evaluate the toxicity of Thymosin beta 4 in animals and the development of the analytical procedures necessary to validate the purity and integrity of the manufactured product before testing. In December 1994 and July 1995, the Company entered into a research agreement with commercial vendors to initiate toxicology studies with Thymosin beta 4. In January 1995, the Company entered into a purchase agreement with a commercial vendor to develop analytical assays necessary for the clinical testing of Thymosin beta 4.\nIn June 1995, the Company submitted a pre-clinical and clinical development plan to the FDA. In July 1995, Company executives, advisors and representatives from vendors supplying manufacturing and toxicology services met with the Division of Pulmonary Drugs at the FDA. Definitive toxicology studies were initiated in August 1995.\nSuspension of Product Development Program. The Company's product development program for Thymosin beta 4 was suspended in February 1996 following the publication of a U.S. patent belonging to a U.S. university and licensed to a U.S. pharmaceutical company. The decision to suspend the program was based in part on a concern that the commercialization of Thymosin beta 4 as a mucolytic to treat cystic fibrosis patients could infringe one or more of the claims under the issued patent. Resumption of the program is contingent on additional financing. At the present time, the Company is seeking the advice of its medical advisors and patent counsel in developing a new plan for the clinical development and subsequent commercialization of Thymosin beta 4. This plan may include treating diseases other than cystic fibrosis or cystic fibrosis using methods in a manner that does not infringe any existing patent. Such diseases may include sepsis, cystic fibrosis, chronic bronchitis, asthma and adult respiratory distress syndrome. Although management believes that several such alternatives are available, significant additional financing will be required before any work can begin on the Thymosin beta 4 development program. See \"Management Discussion and Analysis of Financial Condition and Results of Operations.\"\nManufacturing. Thymosin beta 4 is manufactured by means of chemical synthesis. In chemical synthesis, the peptide is created by chemically joining amino acids, the component building blocks. The principal advantages of chemical synthesis over other possible means of manufacture are manufacturing control, product specificity, high yield, purity and a ready supply of raw material from multiple commercial sources. The Company entered into contracts with three commercial manufacturers for the supply of Thymosin beta 4. In addition, the Company has contacted a number of potential manufacturers concerning the formulation and delivery of Thymosin beta 4. All manufacturing activity was suspended in February 1996. See \"Management Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition.\"\nClinical Trials. Thymosin beta 4 has not been tested in humans. Before it could be marketed as a therapeutic agent for a particular disease or indication, it must undergo a series of clinical trials in human patients to demonstrate safety and efficacy. See \"Government Regulations.\" Currently, the Company has inadequate financial resources to continue its preclinical development program. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" To fund human clinical trials will require significant additional financing.\nLicensing of Thymosin Alpha 1 Rights\nEffective September 30, 1994, the Company entered into a new license agreement with SciClone (the \"New SciClone License Agreement\") which supersedes the original license agreement between the parties entered into in 1990 (the \"Original SciClone License Agreement\"). Under the New SciClone License Agreement, the Company has granted to SciClone an exclusive license to the Company's patent and other proprietary rights with respect to Thymosin alpha 1 to develop, test, make, use and sell Thymosin alpha 1 and products containing Thymosin alpha 1 (collectively \"Licensed Products\") for all human and animal therapeutic and diagnostic uses. The license covers all countries of the world, except for Italy, Spain and Portugal.\nThe major focus of the Company's past activities was an effort to demonstrate the efficacy of Thymosin alpha 1 as a treatment for chronic hepatitis B in a Phase III multi-center clinical trial. The results of this trial, which were analyzed in April 1994, did not show a statistically significant difference between the response of the treatment group and the response of the placebo group. This led the Company to conclude that the Phase III trial efficacy results would not support a New Drug Application filing with the FDA for the approval of six months of therapy with Thymosin alpha 1 as a sole treatment for chronic hepatitis B. The Company concluded that additional trials were beyond its financial means.\nUnder the New SciClone License Agreement, the decision whether to continue the commercial development of Thymosin alpha 1 is at the sole discretion of SciClone. While the Company understands that SciClone currently is continuing with its efforts to commercialize Thymosin alpha 1, there is no assurance that SciClone will be successful. However, should SciClone be successful in its efforts, the Company will be entitled to receive a royalty on SciClone's net sales revenue from Licensed Products that ranges from 3% to 7% depending on whether SciClone's rights in the country in which the sales occur were acquired under the New SciClone License Agreement or under the Original SciClone License Agreement and on whether SciClone enjoys patent protection or comparable market exclusivity in such country. The Company's right to receive royalties continues at least until September 30, 2002. If at the end of this eight-year period the Company has not realized royalty payments in the amount of $35 million, then SciClone's royalty obligation will continue until the earlier of (i) the payment to the Company of royalties aggregating $35 million or (ii) September 30, 2009.\nThe rights to Thymosin alpha 1 in Italy, Spain and Portugal have been licensed by the Company to Sclavo, S.p.A., an Italian pharmaceutical company. In July 1991, Sclavo filed an application with the Italian Ministry of Health requesting regulatory approval to market Thymosin alpha 1 in Italy for several indications, including treatment of immune deficiencies and as a vaccine adjuvant. In May 1993, marketing approval was granted for the use of Thymosin alpha 1 as an adjuvant for influenza vaccine in immunocompromised patients. Under the terms of its license agreement with Sclavo, the Company is entitled to receive a royalty on product sales. Sclavo has advised the Company that due to the small patient population for the approved indication, it does not intend to commence commercial sales of Thymosin alpha 1 in Italy until the product is approved for additional indications. Although applications have been filed with the Italian Ministry of Health for the approval of Thymosin alpha 1 for other indications, Sclavo has offered no assurances as to whether or when any such approvals might be obtained. Accordingly, the Company is unable to predict when sales of Thymosin alpha 1 might commence in Italy for any indication. The license agreement with Sclavo extends until the later of (i) the expiration of the patent rights with respect to Thymosin alpha 1 in the particular country, and (ii) 15 years from the date of the first commercial sale of Thymosin alpha 1 in the covered territory. Should Sclavo's rights in any of the three countries terminate for any reason, the proprietary rights in that country automatically are conveyed to SciClone under the terms of the New SciClone License Agreement.\nProprietary Rights\nA United States composition of matter patent for Thymosin beta 4, which expires in 1998, is held by GWU. No corresponding foreign patent filings were made. The rights under the U.S. patent have been licensed by GWU to Hoffmann-La Roche Inc. (\"HLR\"), which in turn has licensed the U.S. patent rights to the Company on a sole and exclusive basis. Under its license agreement with HLR, the Company is obligated to pay HLR a royalty of 8% on net sales (excluding sales for research purposes) in the United States until the expiration of ten years from the date of the first commercial sale. If, during this period, the FDA approves Thymosin beta 4 for sale by a competitor, the royalty due HLR will be reduced to 4%. HLR is responsible for the royalty due GWU under the primary license agreement.\nIn January 1996, the Company learned of a U.S. patent issued to a U.S. university that made claim to a broad therapeutic area including the treatment of cystic fibrosis with any drugs like Thymosin beta 4. Although this patent does not specifically claim Thymosin beta 4, the broad claims, if valid, could prohibit the Company from commercializing Thymosin beta 4 as a new mucolytic for the treatment of cystic fibrosis. The Company has had discussions with the exclusive licensee of this U.S. patent to explore the possibility of a license or other business arrangements that would allow the Company to seek new funding for its cystic fibrosis development program. There is no assurance that any such license can be obtained on reasonable business terms. Without such a license, the Company anticipates that it will be extremely difficult to secure additional financing for the development of Thymosin beta 4 as a mucolytic for cystic fibrosis.\nUnder a research agreement with GWU, the Company has funded Thymosin beta 4 research at GWU and is entitled to a sole and exclusive worldwide license to any patents that result from such research. Under the research agreement, the Company is obligated to pay to GWU a royalty of 4% of net sales of Thymosin beta 4. Pursuant to the research agreement, patent applications were filed in 1993 in the United States and in 1994 in Europe covering the use of Thymosin beta 4 for the treatment of septic shock and in 1994 in the United States covering the use of Thymosin beta 4 for the treatment of certain respiratory disorders including cystic fibrosis.\nThere is no assurance that any of the Company's pending patent applications will result in the issuance of patents or that any patent issued will not be subject to challenge. In the case of a claim of patent infringement, there is no assurance that the Company will be able to afford the expense of any litigation that may be necessary to enforce its proprietary rights. Finally, there is no assurance that no additional patents may issue whose claims if valid would be infringed by certain uses of Thymosin beta 4.\nViral Technologies Joint Venture\nIn 1986, the Company made certain discoveries which the Company believes may be of clinical benefit in the prevention, diagnosis or treatment of AIDS. These proprietary discoveries involve peptides related to the p17 gag protein, a core protein of the AIDS virus. In April 1986, the Company sold a 50% interest in the rights pertaining to this technology to CEL-SCI. Immediately thereafter, the Company and CEL-SCI each transferred its interest in these discoveries to VTI, a joint venture in which the Company and CEL-SCI each own a 50% interest. The purpose of VTI was to provide the legal mechanism for joint control by the Company and CEL-SCI of the development of the discoveries.\nOn October 30, 1995, the Company sold its 50% interest in VTI to CEL-SCI. In consideration, the Company received 159,170 shares of CEL- SCI common stock. See \"Management Discussion and Analysis of Financial Condition and Results of Operations.\"\nMerger - Alpha 1 Acquisition Corp.\nOn November 13, 1995, the Company entered into an Agreement of Merger with Alpha 1 Acquisition Corp. (\"Acquisition\"), a corporation formed by affiliates of The Castle Group, Ltd. (\"Castle\"), pursuant to which Acquisition, subject to stockholder approval and upon the satisfaction of certain conditions precedent, would be merged into the Company. Among the conditions precedent was that Acquisition, which had no material assets, complete a financing which resulted in gross proceeds of at least $5 million to Acquisition.\nOn February 8, 1996, Acquisition and the Company by mutual agreement terminated this merger agreement. The parties took this action in part due to the identification of a U.S. patent to which a license may be required in order for the Company to commercialize Thymosin beta 4 as a mucolytic for the treatment of cystic fibrosis. See \"Proprietary Rights.\"\nCompetition\nThe Company is engaged in a business that is highly competitive. Research and development activities for new drugs to treat cystic fibrosis patients are being sponsored or conducted by private and public institutions and by major pharmaceutical companies located in the United States and a number of foreign countries. Many of these companies and institutions have financial and human resources that are substantially greater than those of the Company, and that have extensive experience in conducting research and development activities and clinical testing and in obtaining the regulatory approvals necessary to market pharmaceutical products.\nThe major effort in new drug research for cystic fibrosis patients has focused on pulmonary therapy. Standard treatment using antibacterial, bronchodilators, oxygen, physiotherapy and exercises is being supplemented by new approaches including gene therapy, ion modulators, transplantation, immune modulation, amiloride and protease inhibitors.\nIn December 1993, Genentech, Inc. obtained FDA approval for the commercial sale of Pulmozymer as a treatment for cystic fibrosis. This product is a human enzyme produced by recombinant DNA technology. Pulmozymer has been shown to moderately improve pulmonary function by reducing the viscosity of sputum in cystic fibrosis patients, and thereby reduces the incidence of pulmonary infections. In addition to Pulmozymer, other enzymatic mucolytics, such as proteases, have been tested as a treatment for cystic fibrosis patients, but with inconsistent results.\nIf a product developed by the Company for the treatment of cystic fibrosis is approved, that product can be expected to compete with other approved products for the same disease including Pulmozymer. The Company expects that this competition will be based primarily on clinical efficacy, relative toxicity and price. There is no assurance that Thymosin beta 4, if approved, would be competitive with Pulmozymer or any other product then approved on the basis of either efficacy or cost.\nIn addition to drugs that treat the progressive lung disease in cystic fibrosis patients, a number of companies are focusing on gene therapy with the goal of curing this disease. A number of these projects are supported by large pharmaceutical companies with substantial resources. If gene therapy is approved for the treatment of cystic fibrosis patients this could adversely effect the need for mucolytic agents such as Thymosin beta 4.\nGovernment Regulation\nIn the United States, the FDA has principal responsibility for reviewing and approving applications to market new products for therapeutic or diagnostic use in humans. The process of obtaining FDA approval is both expensive and time-consuming, and the development costs of a successful drug may take a number of years to recover. There can be no assurance as to the timing or ultimate FDA approval of any product of the Company.\nThe procedure for obtaining FDA approval of a new pharmaceutical product for use in humans involves a series of steps beginning with animal toxicology studies and continues through three stages of human clinical trials. Typically, after experimental toxicological and pharmacological and efficacy data have been obtained, the test results are submitted to the FDA along with an IND application which includes the protocol that will be followed in the initial human clinical trial. If the FDA does not object, the applicant can proceed with the Phase I trial. Phase I trials consist of pharmacological and safety studies in a relatively small number of patients under rigidly controlled conditions in order to establish lack of toxicity and a safe dosage range. After Phase I testing is completed, one or more Phase II trials are conducted in a limited number of patients to test for efficacy in treatment or prevention of a specific disease. The results of the Phase II trials are analyzed for both clinical efficacy and safety. If the results demonstrate efficacy and safety, the clinical trial and other data are submitted to the FDA along with the protocol for a Phase III trial. Phase III trials consist of extensive studies in large populations designed to assess the safety of the agent and the most desirable dosage and treatment regimen for a specific disease. If the Phase III trial meets acceptable criteria for efficacy and safety, a New Drug Application (an \"NDA\") may be filed with the FDA. The NDA constitutes a request for approval to market the agent for the disease indication evaluated in the Phase II and Phase III trials. Usually, the FDA requires two controlled trials for approval of an NDA, but in rare occasions the FDA has approved drugs for life-threatening conditions on the basis of one clinical trial.\nBased on the information contained in the NDA, the FDA determines whether to approve the product for commercial marketing and, if so, specifies how the product is to be labeled. FDA regulations also govern the manufacturing process. As a condition of NDA approval, the FDA may also require ongoing testing and surveillance to monitor the effects of a pharmaceutical product's use.\nCommercialization of the Company's products in countries outside the United States is subject to regulation by, including clinical testing under the supervision of, regulatory authorities in such foreign countries.\nEmployees\nThe Company currently employs three individuals of which two are Ph.D.'s. The Company is not a party to any collective bargaining agreement.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's corporate headquarters are located in Bethesda, Maryland where it leases approximately 7,800 square feet of office space. The lease expires in June 1997. Currently, all laboratory and manufacturing functions are outsourced. From 1986 through 1994, the Company conducted laboratory functions at a 3,000 square foot leased facility located in Foster City, California. When the Company relocated all laboratory activities to a 27,000 square foot facility in Sunnyvale, California, this space was subleased until the expiration of the lease on November 1995. The Company intended to use the Sunnyvale facility as a research and manufacturing facility for Thymosin alpha 1. As a consequence of the New SciClone License Agreement, the Company no longer required a facility to manufacture Thymosin alpha 1. Subsequently, the Company closed the facility, and effective March 1995, assigned the lease to a third party, but remains secondarily liable until expiration of the lease in January 2002. The assignment has primarily the same terms as the original lease agreement.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn April 29, 1994, a suit was filed in United States District Court for the District of Maryland against the Company, Dr. Allan Goldstein and Dr. Vincent F. Simmon, the Company's former President and Chief Executive Officer. The named plaintiff in the suit was Schulman, Rogers, Gandal, Pordy & Ecker, P.A. The suit, as to which the plaintiff sought certification as a class action, alleged that during the period May 11, 1993, through April 27, 1994, the Company and certain of its officers made or are responsible for certain false or misleading public statements regarding the Company, Thymosin alpha 1, the results of Thymosin alpha 1 in the treatment of chronic hepatitis B, and the prospects for success of Thymosin alpha 1 in clinical trials and the impact on the Company. The complaint contended that these alleged misleading statements violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder. The complaint further alleged that Dr. Goldstein and Dr. Simmon are liable for such statements by reason of their status as controlling persons of the Company. On May 26, 1994, a second suit was filed in the United States District Court for the District of Maryland by Harry T. Cole against the Company, Dr. Goldstein and Dr. Simmon. This suit, which also sought certification as a class action, alleged violations of Rule 10b-5, negligent representations and control person liability based on substantially the same facts alleged in the Schulman complaint. On May 27, 1994, a suit was filed in the United States District Court for the District of Maryland by Allison and Sidney Formal against the Company, Dr. Goldstein and Dr. Simmon. The allegations and the relief sought in this suit were identical to those in the Schulman complaint. The three suits have been consolidated as a single action captioned In re Alpha 1 Biomedicals, Inc. Securities Litigation. In a consolidated amended complaint, the plaintiffs expanded their claims to include the allegation that the Company made false or misleading public statements concerning its ability to satisfy its contractual obligation to supply product to SciClone. On March 13, 1995, the District Court issued an order dismissing all but one of the claims. On September 26, 1995, the parties filed a Stipulation of Settlement with the District Court under which the Company would issue 500,000 shares of its common stock and make a $100,000 payment in settlement of the remaining claim. The settlement is subject to the approval of the District Court which is pending. While the Company continues to believe that the remaining claim is without merit, it has entered into the settlement agreement covering this claim to avoid the continuing cost of litigation.\nIn March 1996, a complaint was filed against the Company by a former employee in the Circuit Court of Montgomery County, Maryland, alleging discrimination in employment, wrongful termination and breach of contract. The Company is evaluating the merits of this claim.\nIn March 1996, the Company received a complaint which was filed by a former consultant to the Company in the Circuit Court for Wayne County, Michigan, alleging negligence, fraud, statutory indemnification and detrimental reliance. The plaintiff is seeking legal expenses and related costs associated with the investigation of the consultant by the Securities and Exchange Commission. The Company is evaluating the merits of this claim.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone. PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters\nThe outstanding classes of the Company's equity securities consist of Common Stock and Class C Warrants. Each Class C Warrant is exercisable, at an exercise price of $19.00, to purchase one share of Common Stock and is redeemable by the Company for nominal consideration if the price of the Common Stock exceeds $25.00 per share for a period of 20 consecutive days. Since May 25, 1995, the Common Stock and the Class C Warrants, which are separately listed, have traded on the OTC Bulletin Board under the symbol ALBM and ALBML, respectively. Prior to that date, both issues traded on the NASDAQ National Market System. The Common Stock was initially issued to the public in 1986. The Class C Warrants were issued to the public in 1993.\nThe following table sets forth the high and low closing prices as reported by OTC Bulletin Board for the Common Stock and the Class C Warrants since May 25, 1995. Prior to that date, prices represent the high and low closing market prices reported by the NASDAQ National Market System.\nCommon Stock Class C Warrants High Low High Low For the year ended December 31, 1995: First Quarter 29\/32 1\/2 3\/16 3\/32 Second Quarter April 1-May 24 5\/8 15\/32 3\/32 3\/32 May 25 - June 30 9\/16 3\/10 1\/16 1\/50 Third Quarter 7\/10 15\/64 1\/50 1\/100 Fourth Quarter 13\/32 5\/32 1\/50 1\/100\nFor the year ended December 31, 1994: First Quarter 15-1\/4 10-3\/4 5 3-3\/8 Second Quarter 12 1-7\/8 4 5\/16 Third Quarter 2-3\/8 1 1\/2 3\/16 Fourth Quarter 1-7\/16 5\/8 1\/4 1\/8\nAs of March 6, 1996, there were 490 holders of record of the Common Stock and 22 holders of record of the Class C Warrants.\nThe Company has not paid a dividend on the Common Stock and does not anticipate that any cash dividends will be paid in the foreseeable future.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nOverview\nThe Company was organized to engage in the development of pharmaceutical products for the treatment of diseases or conditions that arise as the result of immune system disorders, chronic viral infections, cancer and autoimmune disease. Since it was founded in 1982 and through mid-1994, the primary focus of the Company was on efforts to commercialize Thymosin alpha 1 as a treatment for various disease indications or as a vaccine adjuvant. During this period, the Company's resources were primarily devoted to the evaluation of Thymosin alpha 1 as a treatment for chronic hepatitis B. In April 1994, the results of the Company's Phase III multicenter clinical trial for this indication were analyzed. These results did not show a statistically significant difference between the response of the treatment group and the placebo group. This led the Company to conclude that, without further testing, the results of the Phase III trial would not support a New Drug Application (an \"NDA\") to the U.S. Food and Drug Administration for approval of Thymosin alpha 1 as a sole treatment for chronic hepatitis B. Further testing, in the view of the Company, would be needed to support an NDA and would require a commitment of resources beyond its financial capacity.\nIn August 1994, the Company entered into a license agreement with SciClone Pharmaceuticals, Inc. (\"SciClone\") which became effective September 30, 1994 (the \"New SciClone License Agreement\") and which supersedes the original license agreement between the parties entered into in 1990 (the \"Original SciClone License Agreement\"). Under the New SciClone License Agreement, the Company granted to SciClone an exclusive license to the Company's patent and other proprietary rights with respect to Thymosin alpha 1 to develop, test, make, use and sell Thymosin alpha 1 and products containing Thymosin alpha 1 (collectively \"Licensed Products\") for all human and animal therapeutic and diagnostic uses. The license covers all countries of the world, except for several countries where the rights to Thymosin alpha 1 are held by other licensees of the Company.\nIn consideration for the license, the Company is entitled to receive a royalty on SciClone's net sales revenue from Licensed Products that ranges from 3% to 7% depending on whether SciClone's rights in the country in which the sales occur were acquired under the New SciClone License Agreement or the Original SciClone License Agreement and on whether SciClone enjoys patent protection or comparable market exclusivity in such country. The Company's right to receive royalties continues until September 30, 2002. If at the end of such period the Company has not realized royalty payments of at least $35 million, then SciClone's royalty obligation will continue until the earlier of (i) the payment to the Company of royalties aggregating $35 million or (ii) September 30, 2009.\nUnder the New SciClone License Agreement, the decision whether to continue the commercial development of Thymosin alpha 1 is at the sole discretion of SciClone. While the Company understands that SciClone is continuing with its efforts to commercialize Thymosin alpha 1, there is no assurance either that SciClone will be successful or as to the amount of the royalty payments that the Company would receive based on SciClone's commercial sales.\nAs a consequence of the New SciClone License Agreement, the Company is no longer engaged in the commercial development of Thymosin alpha 1. It is the Company's current intention, subject to the receipt of the necessary financing, to focus on the prospects for the commercialization of Thymosin beta 4, an actin-binding peptide to which the Company holds certain proprietary rights.\nIn November 1995, the Company entered into an Agreement of Merger with Alpha 1 Acquisition Corp., a corporation formed by affiliates of The Castle Group, Ltd. The completion of the merger agreement was contingent upon the private company raising at least $5 million in new financing. The merger agreement was terminated by mutual agreement in February 1996, in part due to the recent identification of a U.S. patent to which a license may be required in order for the Company to commercialize Thymosin beta 4 as a mucolytic for the treatment of cystic fibrosis.\nThe Company has delayed its development program for Thymosin beta 4 and has no products that have received regulatory approval. The Company has not generated significant revenues from operations and does not anticipate generating product revenues for the foreseeable future. The Company will require substantial funding in order to re-activate and conduct its research and development activities and to manufacture and market the products which the Company intends to develop. Management plans include strategic alliances or other partnership arrangements with entities interested in and with resources to develop Thymosin beta 4, or other business transactions which would allow the Company to generate resources to assure continuation of the Company's operations. Management believes that significant revenue may be generated under the license agreement with SciClone. However, existing financial resources will be exhausted before any such revenues are realized.\nResults of Operations\nRevenues for the year ended December 31, 1995 were $105,591, as compared to $720,383 for the year ended December 31, 1994, and $1,374,751 for the year ended December 31, 1993.\nRevenues in 1995 were attributable primarily to consulting services provided to SciClone, whereas revenues in the 1994 and 1993 periods were primarily the result of product sales and related charges to SciClone. In 1993, the Company also recorded revenue from milestone payments of $116,666 under the Original SciClone License Agreement. As a consequence of the New SciClone License Agreement, the Company will not realize any future revenue arising from product sales to SciClone or milestone payments relating to the development of Thymosin alpha 1.\nExpenses in 1995 totaled $4,812,635, as compared to $11,579,330 in 1994 and $7,002,707 in 1993. The decrease in expenses in 1995 from 1994 was attributable primarily to higher expenses in 1994 as a result of non-recurring general and administrative expenses incurred in connection with (i) the Company's arbitration proceeding with SciClone and negotiation of a New SciClone License Agreement and (ii) the closing of the Company's Sunnyvale, California facility. The 1995 expenses were reduced as a result of staff reductions and related costs.\nExpenses in 1993 were primarily attributable to the recognition of cost of goods sold and increased general and administrative expenses primarily reflecting increases in legal fees and other costs incurred in connection with arbitration proceedings with SciClone, which began in 1993.\nResearch and development expenses reflect a slight decrease in 1995 from 1994 reflecting the Company's redirection of its efforts from Thymosin alpha 1 to Thymosin beta 4 technology, whereas 1994 expense reflects an increase over 1993 expense as a result of increased costs incurred in connection with clinical trials.\nThe net effect of operating activities was a net operating loss of $4,707,044 in 1995, as compared to net operating losses of $10,858,947 in 1994 and $5,627,956 in 1993.\nThe 1995 increase in other income (expense) over 1994 expense is primarily a result of the partial recapture of the prior year's unrealized losses associated with short term investments, net of (i) interest income in 1995 which reflects a decrease from the prior year as a result of decreased cash and short term investment balances and (ii) a loss on the sale of CEL-SCI Common Stock acquired in the sale of the Company's 50% ownership of VTI, where 1994 and 1993 amounts consist of interest income only.\nDuring 1995, equity loss of VTI reflects the research payments to VTI for the conduct of clinical activities of $181,026, as compared to losses of $347,445 and $328,750 in 1994 and 1993, respectively. The gain on sale of VTI represents the proceeds of the sale of the Company's interest in VTI.\nOn January 1, 1994, the Company, as required, adopted SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" Under the requirement, short term investments must be stated at values which approximate current market. The SFAS No. 115 losses recorded for 1995 and 1994 were $37,091 and $386,995, respectively.\nCapital Resources and Liquidity\nSince its inception in 1982, the Company's efforts have been directed toward conducting research and development, sponsoring clinical trials of its proprietary products, the construction and equipping of laboratory and production facilities, and the manufacture of product for research, testing and clinical trials. The Company's accumulated deficit of $35,624,470 through December 31, 1995 has been primarily funded by the proceeds from the issuance of equity securities (and interest earned on such funds), the licensing of technology developed or acquired by the Company and limited product sales.\nDuring 1995, revenues consisted of consulting services and royalty income from SciClone. These revenue sources are substantially below the level required to cover fully the Company's expenses or to provide adequate cash flow. The Company currently has no other revenue-generating sources. Although the Company believes that royalty income from product sales of Thymosin alpha 1 by SciClone could be significant in the future, the Company does not have an adequate basis for estimating future royalty revenue that might be realized. The Company currently believes, based on its existing resources, that it will have sufficient cash to sustain its operations to the third quarter of 1996. If additional financing cannot be obtained prior to that time, the Company will likely be forced to discontinue operations.\nBeginning with the halting of Thymosin alpha 1 clinical studies and the licensing to SciClone of additional rights to Thymosin alpha 1 under the New SciClone License Agreement in 1994, the Company has undertaken a cost reduction program which continues to date. As a result, the Company has reduced staffing levels from 29 employees to its current three employees and has closed all facilities except for its headquarters space. The Company also is attempting to sublease its existing space which exceed the needs of its current staffing.\nDuring 1995, the Company refocused its research efforts to Thymosin beta 4. Research activities and pre-clinical studies were initiated and accelerated based on anticipated cash resources that the Company expected to realize from the proposed merger with a company affiliated with The Castle Group, Ltd. In anticipation of the merger and the cash that was to become available, the Company commenced placing orders for the conduct of research studies and for the purchase of Thymosin beta 4 material totaling $2,704,000. In January 1996, the Company learned of the issuance of a U.S. patent that could block the commercialization of Thymosin beta 4 as a mucolytic for the treatment for cystic fibrosis. Thereafter, the merger agreement was terminated by mutual agreement. The Company has delayed its development program for Thymosin beta 4, and has no products that have received regulatory approval. The Company has not generated significant revenues from operations and does not anticipate generating product revenues for the foreseeable future. The Company will require substantial funding in order to re-activate and conduct its research and development activities and to manufacture and market the products which the Company intends to develop.\nManagement's current plans include strategic alliances or other partnership arrangements with entities interested in and with resources to develop Thymosin beta 4, or other business transactions which would allow the Company to generate resources to assure continuation of the Company's operations. Management believes that significant revenue may be generated under the license agreement with SciClone. However, existing financial resources will be exhausted before any such revenues are realized. As of February 20, 1996, the board of directors approved a plan which provides for termination of all ongoing research and development activities, a reduction of leased space, a reduction of certain salaries and the severance of administrative staff.\nAs a result of the termination of research and development activities, the Company cancelled its research orders with certain vendors. The Company was able to cancel $1,204,000 of work not yet performed on outstanding orders of $2,704,000. Management has also entered into negotiations with these major vendors in which it is seeking to defer the remaining payments that are due ($1,500,000) in exchange for a commitment to the vendors of revenues received by the Company in the future under the SciClone license agreement until the full amounts of the liabilities have been liquidated. In the event that sufficient funding is obtained for the Thymosin beta 4 program, all amounts then due would become payable immediately. If substantial funding is not acquired, management estimates that the Company's financial resources would fund operations, on a substantially scaled- down basis, to the third quarter of 1996.\nIn November 1995, as a result of the Company's decision to concentrate its commercial efforts on Thymosin beta 4, the Company sold its 50% interest in VTI to CEL-SCI for which the Company received 159,170 shares of CEL-SCI common stock having a market value at the time of the transaction of $646,628. Prior to December 31, 1995, the Company sold 80,000 of the CEL-SCI shares realizing net proceeds of $259,387. The market value of the remaining shares at December 31, 1995 was $284,538. Subsequent to 1995, the remaining 79,170 shares were sold realizing net proceeds of $250,510.\nThe effect of inflation and changing prices on the continuing operations of the Company is not expected to be significant.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial Statements begin on the following page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders Alpha 1 Biomedicals, Inc.\nIn our opinion, the accompanying balance sheets and the related statements of operations, of stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Alpha 1 Biomedicals, 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 the 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and 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 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nPRICE WATERHOUSE LLP\nWashington, DC March 29, 1996\nALPHA 1 BIOMEDICALS, INC.\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION AND BUSINESS\nOrganization and Nature of Operations\nAlpha 1 Biomedicals, Inc. (the \"Company\"), a Delaware corporation, was incorporated in 1982. The Company operates predominantly in a single industry segment, the biotechnology industry, which consists of researching and developing new pharmaceutical products for the treatment of diseases or conditions that arise as a result of immune system disorders, including chronic viral infections, cancer and autoimmune disease.\nThe Company has delayed its development program for Thymosin beta 4 and has no products that have received regulatory approval. The Company has not generated significant revenues from operations and does not anticipate generating product revenues for the foreseeable future. The Company will require substantial funding in order to re-activate and conduct its research and development activities and to manufacture and market the products which the Company intends to develop. Management plans include strategic alliances or other partnership arrangements with entities interested in and with resources to develop Thymosin beta 4, or other business transactions which would allow the Company to generate resources to assure continuation of the Company's operations. Management believes that significant revenue may be generated under the license agreement with SciClone Pharmaceuticals, Inc. (\"SciClone\") However, existing financial resources will be exhausted before any such revenues are realized.\nCash and short-term investment balances at December 31, 1995 total $831,335. This amount, based on the Company's commitments, is insufficient to satisfy current requirements. As of February 20, 1996, the board of directors approved a plan which provides for termination of all ongoing research and development activities, a reduction of leased space, a reduction of certain salaries and the severance of administrative staff. The Company expects to expense approximately $175,000 in the first quarter of 1996 related to this plan. Management has also entered into negotiations with its major vendors in which it is seeking to defer approximately $1,500,000 in payments that are due in exchange for a commitment to the vendors of revenues to be received by the Company in the future under the SciClone license agreement until the full amount of the liabilities have been liquidated. In the event that substantial funding is not acquired, management estimates that the Company's financial resources would fund operations, on a substantially scaled-down basis, to the third quarter of 1996. If additional financing cannot be obtained prior to that time, the Company will likely be forced to discontinue operations.\nShould the Company obtain additional funding, other factors relating to competition, dependence on third parties, uncertainty regarding patents, protection of proprietary rights, manufacturing of peptides and technology obsolescence could have a significant impact on the Company and its operations.\nSignificant Events\nThymosin alpha 1. From 1982 to 1994 the Company sponsored and conducted research activities primarily on its product Thymosin alpha 1 as a potential treatment for chronic hepatitis B.\nDuring 1994 several events relating to Thymosin alpha 1 had a significant impact on the business and the future direction of the Company. These events included the results of a Phase III clinical study and a license agreement entered into with SciClone. As a consequence of these events, the Company substantially reduced its operations and eliminated its manufacturing capacity.\nIn April 1994, the Company's Phase III clinical study evaluating the use of Thymosin alpha 1 as a treatment for chronic hepatitis B was unblinded. The results from the trial did not appear to show statistically significant differences between the treatment and placebo groups. The Company concluded that the results of the trial would not support a New Drug Application to the U.S. Food and Drug Administration (\"FDA\") for the approval of six months of therapy with Thymosin alpha 1 as a sole treatment for chronic hepatitis B.\nEffective September 30, 1994, as part of the settlement of an arbitration proceeding, the Company entered into a new license agreement with SciClone expanding the scope of the exclusive license granted to SciClone to manufacture, use and sell Thymosin alpha 1 for all uses. As expanded, the license covers all countries of the world, except for Italy, Spain and Portugal (where the rights to Thymosin alpha 1 currently are held by other licensees of the Company). In consideration for the expanded license, the Company will be entitled to receive a royalty on SciClone's net sales revenue from products covered by the license that ranges from 3% to 7% depending on whether SciClone's rights in the country in which the sales occur were acquired under the new license agreement or the original license agreement and on whether SciClone enjoys patent protection or comparable market value exclusivity in such country. The Company's right to receive royalties continues until September 30, 2002, except that, if by September 30, 2002 the Company has not realized royalty payments of at least $35 million, SciClone's royalty obligation will continue until the earlier of (i) the payment to the Company of royalties aggregating $35 million or (ii) September 30, 2009. Under the new license agreement, the decision whether to continue the commercial development of Thymosin alpha 1 is at the sole discretion of SciClone.\nThe new license agreement was coupled with a release by each party of the other from any and all prior claims and a termination of the arbitration proceeding without any damages to either party. As a consequence of the new license agreement with SciClone, the Company no longer is engaged in the commercial development, manufacture or sale of Thymosin alpha 1. As a result, the Company closed its facilities in California. The Company subleased the Foster City facility and the Sunnyvale facility. In addition, the Company reduced its workforce from 29 to 5 employees and wrote-off its remaining Thymosin alpha 1 inventories. In connection with these activities, the Company for the year ended December 31, 1994, recognized general and administrative expenses of $1,559,000 from losses on the sale and write-down of fixed assets, $625,000 in termination benefits paid to employees, $540,000 from the write-down of inventory, and $400,000 in investment banking and consulting fees.\nThymosin beta 4. In December 1994, the Company reached a decision to focus its development efforts on Thymosin beta 4, a chemically synthesized copy of a natural hormone-like peptide that has shown promise in animal testing and laboratory studies as a treatment for cystic fibrosis. During mid-1995, the Company entered into agreements with peptide manufacturers to produce a small quantity of Thymosin beta 4 in order to provide material for the conduct of several preclinical studies to be performed by contract service organizations. Data from these preclinical studies was to support the submission of an Investigational New Drug (\"IND\") application for the treatment of cystic fibrosis. The Company concluded that in order to continue development of Thymosin beta 4 rapidly for the IND submission, additional capital would be required. In that regard, the Company identified an investment partner, and in November 1995, entered into a definitive merger agreement which, subject to stockholder approval and the satisfaction of other conditions precedent, was scheduled to close in the first part of 1996. Subsequent to December 31, 1995, the Company learned of an issued U.S. patent, licensed to another entity, to which a license may be required in order to commercialize Thymosin beta 4 as a treatment for cystic fibrosis. Thereafter, the merger agreement was terminated by mutual agreement and the Company suspended the further development of Thymosin beta 4. The Company has had discussions with the exclusive licensee of the patent in an effort to obtain the rights that would remove an impediment to the Company's ability to secure additional financing that will be necessary to enable the Company to move forward with a Thymosin beta 4 development program. However, there is no assurance that a satisfactory arrangement will be reached.\nAt the present time, the Company is seeking the advice of its medical advisors and patent counsel in developing a new plan for the clinical development and subsequent commercialization of Thymosin beta 4. This plan may include treating diseases other than cystic fibrosis or cystic fibrosis using methods in a manner that does not infringe any existing patent. Such diseases may include sepsis, cystic fibrosis, chronic bronchitis, asthma and adult respiratory distress syndrome. Although management believes that several such alternatives are available, significant additional financing will be required before any work can begin on the Thymosin beta 4 development program.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nUse of estimates in 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 expenses during the reporting period. Actual results could differ from those estimates. Estimates are used when accounting for research projects, depreciation and amortization, asset write-downs, employee benefit plans and income taxes.\nCash, cash equivalents and short term investments\nCash, cash equivalents and short term investments consist of highly liquid U.S. government and U.S. government-backed securities and securities received from the sale of Viral Technologies, Inc. (\"VTI\"). Securities with original maturities of three months or less are classified as cash equivalents. On January 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" As of December 31, 1995 and 1994, the Company maintained investments with an aggregate fair value of $285,000 and $3,747,000, respectively, and a cost of $322,000 and $4,134,000, respectively. The Company has recorded an unrealized loss of $37,000 and $387,000 associated with these investments which is included in the statement of operations for the year ended December 31, 1995 and 1994, respectively.\nInvestments\nThe Company sold its investment in VTI during 1995. During the period prior to such sale, the Company followed the equity method of accounting for the investment (Note 4).\nFixed assets\nFixed assets are stated at cost less accumulated depreciation. Expenditures for maintenance and repairs which do not significantly prolong the useful lives of the assets are charged to expense. Depreciation is computed using the straight-line method over estimated useful lives of two to ten years, or over the term of the lease (Note 5).\nProprietary rights\nProprietary rights, which consist of costs of rights purchased (Note 3) and patents obtained, are being amortized, on a straight-line basis, over periods up to 15 years (based on the estimated useful lives of the rights and patents acquired).\nDeferred compensation\nDeferred compensation is recorded as a liability when compensatory stock options vest (Note 6) in an amount equal to the excess of the market price of the Company's common stock over the option exercise price at the grant date. Upon exercise of vested stock options, corresponding amounts recorded as deferred compensation are transferred to additional paid-in capital.\nResearch and development\nResearch and development costs are expensed as incurred. Research and development performed by third parties is expensed based upon the third party's stage of product development.\nIncome taxes\nThe Company accounts for income taxes using the asset and liability approach (SFAS No. 109 \"Accounting for Income Taxes\") which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities.\nFair value of financial instruments\nOn January 1, 1995, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosures about Fair Value of Financial Instruments,\" as amended by SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" which requires the disclosure of estimated fair values of financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. SFAS No. 107 excludes certain financial instruments and all non-financial instruments. Accordingly, the estimated fair values are only indicative of individual financial instruments' values and should not be considered an indication of the fair value of the Company. The estimated fair values of the Company's cash and cash equivalents, due from related party, accounts payable and accrued expenses approximate their carrying values.\nLoss per share\nLoss per share is computed by dividing the net loss by the weighted average number of shares of Common Stock outstanding during the period. Common stock equivalent shares are not included in the calculation as their effect is antidilutive.\nReclassification\nCertain amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.\nNOTE 3 - PROPRIETARY RIGHTS AND LICENSES\nUnder a series of license agreements entered into since 1982 with Hoffmann-La Roche, Inc. and its foreign affiliate (\"HLR\") and with The George Washington University (\"GWU\"), the Company acquired certain proprietary rights to Thymosin alpha 1 both in the United States and a number of foreign countries. In 1994, the Company expanded the scope of its exclusive sublicense to SciClone, of the Company's rights with respect to Thymosin alpha 1, to cover all countries (other than Italy, Spain and Portugal) (Note 1). Under the SciClone license agreement, SciClone is responsible for payment on behalf of the Company of all royalties due to HLR, GWU and the University of Texas (from which HLR acquired certain rights to Thymosin alpha 1).\nThe Company recorded approximately $714,000 in product sales to SciClone in 1994. As a result of the amendment of the SciClone license, no product sales to SciClone were made in 1995 nor are any anticipated in the future.\nThe rights to Thymosin alpha 1 in Italy, Spain and Portugal have been sublicensed by the Company to Sclavo, S.p.A. (\"Sclavo\"). During 1994 and 1993, the Company recorded $4,000 and $250,000 in net product sales, respectively, to Sclavo. No such sales were recorded during 1995.\nThe Company holds the proprietary rights to Thymosin beta 4 in the United States under the license from HLR pursuant to which the Company is obligated to pay HLR a royalty of 8% on commercial sales (or 4% of commercial sales, if the FDA has approved Thymosin beta 4 for sale by a competitor) until the expiration of ten years from the date of the first commercial sale. The Company also has a worldwide license to certain uses of Thymosin beta 4 under a research agreement with GWU under which the Company is obligated to pay GWU a royalty of 4% on commercial sales.\nPayments made by the Company through December 31, 1995 to obtain its proprietary rights have totaled $1,327,295. Accumulated amortization of proprietary rights aggregated $1,262,623 and $1,003,937 at December 31, 1995 and 1994, respectively.\nNOTE 4 - RELATED PARTIES\nViral Technologies, Inc.\nIn April 1986, the Company sold 50% of its right, title and interest in a newly developed technology which may be useful in the diagnosis, prevention and treatment of Acquired Immune Deficiency Syndrome (\"AIDS\") to CEL-SCI Corporation (\"CEL-SCI\"), a publicly held company. Simultaneously with the sale of the technology, the Company entered into a joint venture with CEL-SCI whereby each party contributed its interests in the technology and $10,000 in cash to VTI, a newly created corporation, in exchange for a 50% interest each in VTI.\nDuring the fiscal years ended December 31, 1995, 1994 and 1993, the Company recognized $181,026, $347,455, and $328,750 in VTI losses, respectively. The Company fully reserved for all advances to VTI.\nIn November 1995, as a result of the Company's decision to concentrate its efforts on Thymosin beta 4 technology, the Company sold its 50% interest in VTI to CEL-SCI for which the Company received 159,170 shares of CEL-SCI common stock valued at the market price of $646,628. As of December 31, 1995, the Company has sold 80,000 of the CEL-SCI shares realizing net proceeds of $259,387. The market value of the remaining shares at December 31, 1995 is $284,538. Subsequent to 1995, the remaining 79,170 shares were sold realizing net proceeds of $250,510.\nNote Due from Related Party\nIn 1994, the Company entered into a note receivable agreement with Allan Goldstein, Chairman of the Board of Directors which accrues interest monthly at a rate of 11.5%. On February 27, 1996, the Company amended its note receivable with Dr. Goldstein to forgo principal payments for one year in exchange for a reduction in his salary. Interest on the note continues to accrue monthly.\nIn addition to his employment with the Company, Dr. Goldstein is also Chairman of the Department of Biochemistry and Molecular Biology at GWU. The Company has not funded any research personally conducted by Dr. Goldstein, and anticipates that any future funding will also be limited to research projects performed by principal investigators at GWU other than Dr. Goldstein. Payments made under the research agreement totaling $196,079, $275,457 and $196,884 were made during the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 5 - BALANCE SHEET INFORMATION\nFixed assets consist of the following (in thousands): December 31, 1995 1994\nFurniture and equipment $206 $387 Leasehold improvements 6 6 212 393 Less accumulated depreciation 152 132 $60 $261\nAccrued expenses consist of the following (in thousands):\nDecember 31, 1995 1994\nLease Termination $ $150 FDA consulting 120 Losses in VTI 91 Employee termination benefits 77 Litigation settlement 200 Research projects 741 Other 36 37 $977 $475\nNOTE 6 - STOCKHOLDERS' EQUITY\nCommon stock and warrants\nIn January 1993, the Company announced its intention to redeem all outstanding Class B Warrants and in connection therewith reduced the exercise price of the Class B Warrants from $12.00 to $10.00 per share and augmented the consideration to be received upon the exercise of each Class B Warrant by including a Class C Warrant in addition to one share of Common Stock. A total of 1,098,170 of the 1,100,000 Class B Warrants outstanding were exercised prior to redemption. Total proceeds from the exercise of the Class B Warrants were $10,981,700. Total costs associated with the exercise of the Class B Warrants were $203,558 and were charged to additional paid-in capital. Each Class C Warrant entitles the holder to purchase one share of Common Stock at a price of $19.00. All Class C Warrants expire February 28, 1997 and are redeemable by the Company after February 28, 1994 at a price of $0.10 per Class C Warrant, if the average of the closing price for the Company's Common Stock exceeds $25.00 per share for 20 consecutive business days.\nIn December 1993, the Company issued 440,000 shares of Common Stock to a foreign investor for an aggregate purchase price of $7,331,720. In addition, the investor acquired an option to purchase up to 440,000 additional shares of Common Stock. The option became exercisable in April 1994 and expired in June 1995. Total costs associated with the sale of stock were $11,500 and were charged to additional paid-in capital.\nIn April 1994, the Board of Directors adopted a Shareholders Rights Plan, pursuant to which it declared a dividend distribution of one Preferred Stock Purchase Right (Right) for each outstanding share of Common Stock. The dividend distribution was payable to stockholders of record at the close of business April 29, 1994.\nThe Rights can become exercisable only if a person or group acquires more than 5% of the Common Stock or announces a tender offer the consummation of which would result in ownership by a person or group of more than 25% of the Common Stock. Each Right would then entitle the holder to purchase one-thousandth (1\/1,000) of a share of new series of preferred stock at an exercise price of $16.00.\nIf the Company is acquired in a merger or other business combination transaction with, or a significant portion of the Company's business is acquired by, a person or group that has acquired more than 25% of its outstanding Common Stock, each Right will entitle its holder (other than such person or group or any of their affiliates or associates) to purchase, at the then-current exercise price of the Right, a number of the acquiring company's common shares having a value that is twice such exercise price. In addition, if a person or group acquires more than 25% of the Company's outstanding Common Stock, each Right will entitle its holder (other than such person or group or any of their affiliates or associates) to purchase, at the then-current exercise price of the Right, a number of shares of Common Stock having a market value that is twice such exercise price.\nPrior to the time that the Rights become exercisable, they are redeemable at the option of the Board of Directors at a redemption price of $.01 per Right. The Board of Directors is required to redeem the Rights in the event of an all-cash tender offer for all of the outstanding shares of the Common Stock that meets certain requirements. The Rights will expire on April 29, 2004.\nTreasury Stock\nIn January 1993, an employee tendered 1,000 shares of Common Stock of the Company in payment of the exercise price of options to purchase 10,727 shares of Common Stock issued under the Company's stock option plans. The Common Stock acquired by the Company was valued at its fair value on the date of surrender to the Company and was recorded as Treasury Stock. In December 1993, the Company authorized the retirement of all shares of Common Stock held as Treasury Stock.\nStock option plans\nIncentive Stock Option Plan\nThe Company has an Incentive Stock Option Plan established in 1986, and since amended from time to time, under which options to purchase shares of Common Stock of the Company may be granted by the Company to any employee. All options granted under the Plan are exercisable at a price equal to the fair market value of the Common Stock on the date of the grant. The Plan authorizes the issuance of up to 1,500,000 shares of Common Stock.\nThe following table summarizes option activity:\nShares Option Price Range\nOutstanding options at December 31, 1992 419,025 $1.00 to $15.00 (208,150 exercisable)\nOptions granted during the year101,900 10.75 to 16.25\nOptions exercised during the year(42,852) 1.00 to 12.50\nOptions canceled during the year(26,500) 8.125 to 12.50\nOutstanding options at December 31, 1993 451,573 1.00 to 16.25 (245,581 exercisable)\nOptions granted during the year20,000 1.00\nOptions canceled during the year(222,716) 1.00 to 16.25\nOutstanding options at December 31, 1994 248,857 1.00 to 16.25 (204,941 exercisable)\nOptions granted during the year640,000 .44 to .6875\nOptions canceled during the year(103,584) 3.19 to 16.25\nOutstanding options at December 31, 1995 785,273 .44 to 16.25 (232,148 exercisable)\nNon-vested options outstanding at December 31, 1995 become exercisable in varying amounts through October 2005. Options granted totaling 545,000, issued in October 1995, had vesting terms which were contingent upon shareholder approval of the proposed merger transaction (Note 1). Subsequent to December 31, 1995, these options were canceled due to the termination of the merger on February 8, 1996. At December 31, 1995, 267,160 shares were available for future grants under the Plan.\n1987 Non-Qualified Stock Option Plan\nThe 1987 Non-Qualified Stock Option Plan was adopted by the Board of Directors and approved by the stockholders in 1987. The Plan provides for grants of stock options to any employee. The Plan authorizes the issuance of up to 1,000,000 shares of Common Stock.\nGenerally, stock options granted under the Plan may not have an exercise price that is less than the fair market value of the Common Stock on the date of the grant. However, during the nine-month period ended December 1990, an option to purchase 200,000 shares of Common Stock under the Plan was granted, pursuant to stockholder approval, at an exercise price of $1.00 per share to an officer of the Company. The fair market value on the date of grant was $3.0625 per share. The difference between the fair market value and exercise price of the option was recognized as compensation over the vesting period. Compensation expense in the amount of $8,876 arising from the granting of these options was recognized during the year ended December 31, 1993. No compensation expense was recognized during 1995 and 1994 since the options were fully vested at December 31, 1993. During 1995, these options expired without being exercised, and accordingly, the liability has been reclassified to additional paid in capital.\nThe following table summarizes option activity:\nShares Option Price Range\nOutstanding options at December 31, 1992 516,000 $1.00 to $15.00 (233,000 exercisable)\nOptions granted during the year 30,400 10.25 to 16.25\nOptions exercised during the year (30,750) 1.00 to 9.625\nOptions canceled during the year (750) 9.625\nOutstanding options at December 31, 1993 514,900 1.00 to 16.25 (304,575 exercisable)\nOptions exercised during the year (10,000) 1.00\nOptions canceled during the year (31,250) 9.625 to 16.25\nOutstanding options at December 31, 1994 473,650 1.00 to 16.25 (336,650 exercisable)\nOptions granted during the year 700,000 .45\nOptions canceled during the year (363,250) 1.00 to 16.25\nOutstanding options at December 31, 1995 810,400 .45 to 16.25 (96,400 exercisable)\nNon-vested options outstanding at December 31, 1995 become exercisable in varying amounts through October 2005. The 700,000 options granted during 1995, had vesting terms contingent upon shareholder approval of the proposed merger transaction (Note 1). Subsequent to December 31, 1995, these options were canceled due to the termination of the proposed merger on February 8, 1996. At December 31, 1995, 50,266 shares were available for future grants under the Plan.\nDirectors Stock Option Plan\nThe Directors Stock Option Plan was adopted by the Board of Directors and approved by the stockholders in 1987. Under the Plan, options to purchase 10,000 shares of Common Stock are granted automatically to each person who becomes a director after April 10, 1987 and who, at the time such person becomes a director, is not an employee of the Company. Options granted under the Plan have an exercise price per share equal to the fair market value of the Common Stock on the date of the grant. In 1992, the Plan was amended, with the approval of stockholders at the 1992 Annual Meeting (i) to add an automatic annual grant to each non-employee director of an option to purchase 5,000 shares of Common Stock if the individual is reelected as a Director at the Annual Meeting, and (ii) to increase to 200,000 the number of shares of Common Stock issuable under the Plan. Options granted under the Plan have a ten-year term and become exercisable in 20% increments beginning on the date of the grant and on each anniversary date thereafter.\nAt December 31, 1995, options to purchase 40,000 shares have been granted, of which 26,000 are exercisable, at exercise prices ranging from $.53 to $10.50 per share.\nScientific Advisory Council Stock Option Plan\nIn 1986, the Board of Directors adopted the Scientific Advisory Council Stock Option Plan under which options to purchase 5,000 shares of Common Stock were granted to each person who was then a member of the Company's Scientific Advisory Council. The Plan authorized the issuance of options to purchase up to 50,000 shares of Common Stock. Options to purchase all 50,000 shares with a ten-year term were granted at an exercise price of $6.25 per share, the fair market value of the Common Stock on the date of grant, and become exercisable over a five-year period. On March 8, 1995, the Scientific Advisory Council was disbanded and the Plan was terminated. As of December 31, 1995, all outstanding options under the Plan had expired.\nWarrants\nA warrant to purchase 20,000 shares of the Company's common stock was issued in February 1995 in settlement of a suit filed against the Company. The warrant has an exercise of $1.00 per share and expires February 2, 1998.\nNOTE 7 - EMPLOYEE BENEFIT PLANS\nThe Company maintains a 401(k) retirement plan whereby the Company matches a portion of the employees' salary reduction contributions. Company contributions to the plan amounted to $21,152, $62,320 and $48,085 in 1995, 1994 and 1993, respectively.\nNOTE 8 - INCOME TAXES\nDeferred tax assets are comprised of the following (in thousands):\nDecember 31, December 31, 1995 1994\nNet operating loss carryforwards $14,193 $11,267 Equity in loss of VTI -- 567 Loss on write-down of fixed assets -- 532 Research and development tax credit 588 459 Other 166 474 14,947 13,299 Valuation allowance (14,947) (13,299) Net deferred tax assets $ -- $ --\nThe change in the valuation allowance is attributable to 1995 losses. The Company has provided a full valuation allowance for deferred tax assets since realization of these future benefits cannot be reasonably assured. If the Company achieves profitability, these deferred tax assets would be available to offset future income tax liabilities and expense, subject to certain limitations.\nAt December 31, 1995, the Company had net operating loss and research and development tax credit carryforwards of approximately $35,483,000 and $588,000, respectively, for income tax purposes which expire in various years through 2010. Certain substantial changes in the Company's ownership would result in an annual limitation on the amount of the net operating loss carryforwards which can be utilized.\nNOTE 9 - COMMITMENTS AND CONTINGENCIES\nIn July 1992, the Company commenced a five year operating lease for headquarters office space in Bethesda, Maryland. The Company has an operating lease for production facility space in Sunnyvale, California, which expires in January 2002. The Sunnyvale lease was assigned to a third party in March 1995 on the same terms for the remaining term of the underlying lease. Aggregate rent expense was $350,308, $462,567, and $389,771 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe following is a schedule of future minimum lease payments required under all operating leases, which have remaining non-cancelable lease terms in excess of one year as of December 31, 1995 (in thousands):\nYear ending December 31, Minimum lease payments 1996 $ 191 1997 97 $ 288\nAt December 31, 1995, the Company had commitments for the purchase of Thymosin beta 4 material and for the conduct of preclinical studies totaling $2,704,000, of which $1,204,000 was canceled subsequent to year-end. At December 31, 1995, $819,000 of these commitments had been incurred and expensed for the production of such material or studies. Subsequent to 1995 and prior to the decision to delay its development program in February 1996, the Company incurred and expensed the remaining $681,000 under the commitments.\nDuring 1994, several suits were filed against the Company, its Chairman, and former Chief Executive Officer, alleging the Company and certain of its officers made or are responsible for false or misleading public statements regarding the Company, Thymosin alpha 1, the results of Thymosin alpha 1 in the treatment of chronic hepatitis B, and the prospects for success of Thymosin alpha 1 in clinical trials and the impact on the Company. The suits were consolidated as a single action, and in a consolidated amended complaint, the plaintiffs expanded their claims to include the allegation that the Company made false and misleading public statements concerning its ability to satisfy its contractual obligation to supply product to SciClone. On March 13, 1995, the district court issued an order dismissing all claims except for the claim regarding a public statement made by the Company concerning its ability to supply product to SciClone. On September 26, 1995, the parties filed a Stipulation of Settlement with the District Court under which the Company would issue 500,000 shares of its Common Stock and make a $100,000 payment in settlement of the remaining claim. The $100,000 payment in settlement was placed in an escrow account in September 1995. The settlement is subject to the approval of the District Court which is pending. The Company has accrued $200,000 for the issuance of the 500,000 shares stipulated under the settlement. While the Company continues to believe that the remaining claim is without merit, it has entered into the settlement agreement covering this claim to avoid the continuing cost of litigation.\nIn March 1996, a complaint was filed against the Company by a former employee in the Circuit Court of Montgomery County, Maryland, alleging discrimination in employment, wrongful termination and breach of contract. The plaintiff is seeking actual damages of $200,000, consequential damages of $2 million, punitive damages of $100,000, and court costs. The Company is evaluating the merits of this claim.\nIn March 1996, the Company received a complaint which was filed by a former consultant to the Company in the Circuit Court for Wayne County, Michigan, alleging negligence, fraud, statutory indemnification and detrimental reliance. The plaintiff is seeking legal expenses and related costs in excess of $10,000 associated with the investigation of the consultant by the Securities and Exchange Commission. The Company is evaluating the merits of this claim.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(a) Identification of Directors. Information concerning each director of the Company, consisting of the nominee's age, period of service as a director of the Company, a brief description of his principal occupation and business experience during the past five years, and certain other directorships held is set forth below.\nAllan L. Goldstein, Ph.D., Age 58, Director since 1982\nDr. Goldstein has been the Chairman of the Board of the Company since its founding in May 1982. He is the Chairman of the Department of Biochemistry and Molecular Biology at The George Washington University School of Medicine and Health Sciences, a position he has held since 1978. Prior to July 1986, Dr. Goldstein served as Chief Executive Officer and Treasurer of the Company and currently is its chief scientific advisor.\nJoseph C. McNay, Age 62, Director since 1987\nMr. McNay has been the Chairman and director of Essex Investment Management Company, Inc., a registered investment adviser, since 1976. He is also a director of Softech, Inc.\nAlbert Rosenfeld, Age 75, Director since 1982\nMr. Rosenfeld has been a consultant on Future Programs for the March of Dimes Birth Defects Foundation since 1973 and Adjunct Professor in the Department of Human Biological Chemistry and Genetics at the University of Texas Medical Branch, Galveston, Texas since 1974. He is a frequent author and lecturer on scientific matters.\nMichael L. Berman, Ph.D., Age 46, Director since 1995\nDr. Berman was elected as President and Chief Executive Officer of the Company in November 1994. He joined the Company in early 1994 as Vice President for new commercial programs. From 1988 to 1993, Dr. Berman was Vice President and Scientific Director and then Director of Business Development with Oncologix, Inc. He is also a director of Prototek, Inc. and Peptomers, Inc.\n(b) Identification of Executive Officers. Information concerning each executive officer of the Company (other than executive officers who also are directors), consisting of such person's age, position, and offices held with the Company and the period for which such person has held such positions or offices and the business expertise of such person during the past five years is set forth below. Executive officers are elected annually by the Board of Directors and are subject to removal at the discretion of the Board of Directors.\nRobert J. Lanham, was appointed Chief Financial Officer in February 1995. Since 1987, he has served as Vice President, Finance and Administration and Secretary. He was elected Treasurer of the Company in December 1989.\n(c) Compliance with Section 16(a) of the Securities Exchange Act. Section 16(a) of the Securities Exchange Act\" of 1934, as amended, requires that each of the Company's directors and executive officers, and any beneficial owner of more than 10% of the Common Stock, file with the Securities and Exchange Commission (the \"SEC\") initial reports of beneficial ownership of the Common Stock and reports of changes in beneficial ownership of the Common Stock. Such persons also are required by SEC regulations to furnish the Company with copies of all such reports. Based solely on its review of the copies of such reports furnished to the Company for the year ended December 31, 1995, and on the written representations made by such persons that no other reports were required, the Company is not aware of any instances of noncompliance with Section 16(a) during 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth certain information concerning the compensation in each of the last three fiscal years of the Company's President and Chief Executive Officer and each other executive officer whose 1995 combined salary and bonus exceeded $100,000 (the \"named executive officers\").\n(1) None of the above-named executive officers received perquisites or other personal benefits in excess of the lesser of $50,000 or 10% of such individuals salary plus annual bonus.\n(2) Consists of options to purchase shares of Common Stock granted under the Company's employee stock option plans. During 1995, options issued to Dr. Goldstein, Dr. Berman and Mr. Lanham of 530,000, 500,000 and 200,000, respectively, were granted subject to shareholder approval of the merger with Alpha 1 Acquisition Corporation. The merger transaction was terminated by mutual agreement on February 8, 1996, and as a result, such options were canceled. Additionally, during 1995, Dr. Berman was issued an option to purchase 80,000 shares which vested in 12 equal monthly amounts, and Mr. Lanham was issued an option to purchase 15,000 shares, which vested in 36 equal monthly amounts. During 1994, Dr. Berman was issued an option to purchase 20,000 shares which vested immediately. During 1993, Mr. Lanham was issued an option to purchase 7,500 shares, which vests in annual increments of one third beginning on the date of grant.\n(3) Includes $70,250 paid to Dr. Goldstein in consideration for consulting services provided to SciClone. See \"Compensation Committee Interlocks and Insider Participation.\"\n(4) In 1995, consists of (i) $4,620 in matching contributions to the Company's 401(k) Plan and (ii) $5,002 of premiums paid by the Company for long-term disability and life insurance.\n(5) Dr. Berman was first employed by the Company in March 1994.\n(6) In 1995, consists of (i) $4,620 in matching contributions to the Company's 401(k) Plan and (ii) $2,745 of premiums paid by the Company for long-term disability insurance.\n(7) In 1995, consists of (i) $4,620 in matching contributions to the Company's 401(k) Plan, and (ii) $3,635 of premiums paid by the Company for long-term disability and life insurance.\nShares Value of Acquired Number of Unexercised Unexercised In-the on Value Options at Year-End Money Options at Year-End(1) Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable\nAllan L. Goldstein 0 0 140,000 540,000 0 0\nMichael L. Berman 0 0 100,000 500,000 0 0\nRobert J. Lanham 0 0 78,548 8,125 0 0\n(1) All options have an exercise price that exceeds the market price.\nEmployment Agreements\nIn January 1995, the Company entered into an employment agreement with Dr. Michael Berman pursuant to which he serves as the Company's President and Chief Executive Officer. The agreement was for a one- year term and provides for an annual salary of $150,000. Pursuant to the agreement, the Company issued to Dr. Berman a ten-year option to purchase 80,000 shares of Common Stock at an exercise price of $.69 per share (the market price of the Common Stock on the date of the grant), which vested in 12 equal monthly installments over the term of the employment agreement. Since January 1996, Dr. Berman has continued as the President and Chief Executive Officer of the Company without an employment agreement at an annual salary of $150,000.\nDr. Allan Goldstein is employed as the Company's chief scientific advisor under an employment agreement entered into effective December 1991. The agreement has a five-year term and provides for an initial annual salary of $90,000, with provision for annual increases of 7.5% if approved by the Board of Directors. Under the agreement, if Dr. Goldstein's employment is terminated without cause, he is entitled to a severance payment equal to the lesser of (i) two years' salary and (ii) the salary that he would have earned if his employment continued for the full terms of the agreement. Dr. Goldstein's employment agreement was amended in February 1996 to provide for an annual salary of $36,000. The employment agreement requires Dr. Goldstein to devote such time to the affairs of the Company as is necessary in his judgment to perform his duties under the agreement. The employment agreement also acknowledges his position at The George Washington University School of Medicine and Health Sciences and permits him to continue in that position so long as he is reasonably available to perform his duties to the Company. See also \"Compensation Committee Interlocks and Insider Participation.\"\nIn February 1995, the Company entered into an employment agreement with Mr. Robert J. Lanham with a one-year term and an annual salary of $115,000. As of February 1996, Mr. Lanham continues as Vice President and Chief Financial Officer, without an employment agreement at an annual salary of $57,500.\nCompensation Committee Interlocks and Insider Participation\nThe Board of Directors as a whole is responsible for determining the compensation payable to the chief executive officer and to other executive officers of the Company. When the Board gives consideration to the compensation of an executive officer who also is a director, that director does not participate in the Board's deliberations.\nIn May 1994, the Company extended a loan in the amount of $149,000 to Dr. Goldstein, the Company's Chairman of the Board, for the purpose of enabling Dr. Goldstein to meet a margin call on a brokerage account collateralized by the Common Stock of the Company at a time when the Board of Directors concluded that it would be contrary to the best interest of the Company for Dr. Goldstein to effect a sale of the shares. The loan was unsecured, and had an interest rate equal to the prime rate, with all principal and interest due on the December 31, 1994 maturity date. The loan was repaid on January 1, 1995, in part with the proceeds of a second unsecured loan to Dr. Goldstein from the Company in the amount of $115,617. This second loan has an interest rate of 11.5% and is to be repaid in 36 equal monthly installments. During February 1996, the parties amended the loan agreement to provide for the temporary suspension of installment payments for twelve months, with interest continuing to accrue, as a condition to amending the terms of his employment agreement. See \"Employment Agreements.\" At February 29, 1996, the outstanding principal balance was $74,562.\nIn November 1994, the Company entered into an agreement with SciClone Pharmaceuticals, Inc. (\"SciClone\") pursuant to which the Company agreed to make the services of Dr. Goldstein available to consult with SciClone concerning SciClone's efforts to commercialize Thymosin alpha 1. The agreement covered an initial one-year term and is automatically renewable annually for additional one-year terms unless terminated by either party upon 30 days' notice. Under the Agreement, the Company was paid an initial retainer of $50,000, and is entitled to receive an additional retainer of $50,000 payable upon the commencement of each successive one-year term. In addition, the Company is paid a consulting fee for Dr. Goldstein's services at the rate of $250 per hour, with a minimum, initial annual consulting fee of $50,000. The agreement was renewed in November 1995 for an additional year, but amending the terms to provide for a $25,000 retainer and minimum consulting fees of $25,000. In view of the additional demands on the time and attention of Dr. Goldstein required by reason of this consulting arrangement, the Company has agreed to pay Dr. Goldstein as compensation the annual retainer and all consulting fees earned by the Company under the agreement. Such payments are included as salary in the Summary Compensation Table.\nCompensation of Directors\nEach nonemployee director is paid an annual fee of $5,000, plus $1,250 per meeting for attendance at meetings in person and is reimbursed for expenses incurred in attending meetings of the Board of Directors. Each current nonemployee director and any new nonemployee director also is a participant in the Company's Directors Stock Option Plan pursuant to which (i) each nonemployee director at the time of his or her initial election or appointment is granted an option to purchase 10,000 shares of Common Stock and (ii) each nonemployee director received annually an option to purchase 5,000 shares of Common Stock at the time of his or her reelection as a director. Such options have an exercise price equal to the fair market value of the Common Stock on the date of the grant and vest in annual increments of 20% beginning on the date of the grant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth as of March 26, 1996, unless otherwise indicated, certain information concerning the beneficial ownership of Common Stock (i) by each director, (ii) by each named executive officer, and (iii) by all directors and executive officers of the Company as a group, in each case as reported to the Company by such persons. No person or group is known by the Company to own beneficially more than 5% of the outstanding Common Stock.\nPercentage of Name and Address of Outstanding Beneficial Owner (1) Number of Shares (2) Shares (3)\nAllan L. Goldstein 344,397 (4) 3.8% Joseph C. McNay 133,000 (5) 1.5% Albert Rosenfeld 21,100 (6) * Michael L. Berman 103,000 (7) 1.1% Robert J. Lanham 88,275 (8) 1.0% All directors and executive officers689,772 (9) 7.4%\n____________________ * Constitutes less than 1% of the outstanding shares of Common Stock.\n(1) Unless otherwise indicated, the address of the beneficial owner is c\/o Alpha 1 Biomedicals, Inc. Two Democracy Center, 6903 Rockledge Drive, Suite 1200, Bethesda, Maryland 20817.\n(2) A beneficial owner of a security includes a person who directly or indirectly has or shares voting or investment power with respect to such security. Voting power is the power to vote or direct the voting of the security and investment power is the power to dispose or direct the disposition of the security. Each person listed has advised the Company that, except as otherwise indicted below, such person has, or upon the exercise of the stock options or Class C Warrants indicated will have, sole voting power and sole investment power with respect to the shares indicated.\n(3) The percentages represent the total number of shares of Common Stock shown in the adjacent column divided by the sum of (i) the issued and outstanding shares of Common Stock as of March 26, 1996, and (ii) all shares of Common Stock, if any, issuable upon the exercise of stock options or Class C Warrants held by such person or group that were exercisable on March 26, 1996, or will become exercisable within 60 days thereafter.\n(4) Consists of (i) 90,285 shares of Common Stock owned directly by Dr. Goldstein and 140,000 shares of Common Stock which he has a right to acquire pursuant to the exercise of immediately exercisable options granted under the Company's 1986 Incentive Stock Option Plan and 1987 Non-Qualified Stock Option Plan over which Dr. Goldstein has, or upon exercise of such options will have, sole voting and sole investment power and (ii) 18,906 shares held in trust for the benefit of Dr. Goldstein's daughter, as to which he serves as a co-trustee, 51,103 shares held by Dr. Goldstein's wife and 44,103 shares held by Dr. Goldstein's wife as custodian for their minor child, all with respect to which Dr. Goldstein shares voting and investment power.\n(5) Includes 21,000 shares of Common Stock issuable upon the exercise of the immediately exercisable portion of options granted under the Company's Directors Stock Option Plan.\n(6) Includes 11,000 shares of Common Stock issuable upon the exercise of the immediately exercisable portion of options granted under the Company's Directors Stock Option Plan.\n(7) Consists of 3,000 shares of Common Stock owned directly by Dr. Berman and 100,000 shares issuable upon exercise of immediately exercisable stock options under the Company's 1986 Incentive Stock Option Plan.\n(8) Consists of 7,227 shares of Common Stock owned directly by Mr. Lanham and 81,048 shares issuable upon exercise of immediately exercisable stock options under the Company's 1986 Incentive Stock Option Plan and 1987 Non-qualified Stock Option Plan.\n(9) Includes 353,048 shares of Common Stock that all directors and executive officers of the Company as a group have the right to acquire through the exercise of stock options that were exercisable on March 26, 1996, or that will become exercisable within 60 days thereafter, and 114,112 shares of Common Stock owned by wives and children of directors and executive officers.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee \"Item 11 Executive Compensation -- Compensation Committee Interlocks and Insider Participation.\" PART 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 Financial Statements of the Company for the year ended December 31, 1995, filed as part of this Annual Report on Form 10- K, are on the pages set forth below:\nPage Number of this Form 10-K\nA. Report of Independent Accountants 19\nB. Balance Sheets at December 31, 1995 20 and 1994\nC. Statements of Operations 21 for the years ended December 31, 1995, 1994 and 1993\nD. Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 22\nE. Statements of Stockholders' Equity 23 (Deficit) for the years ended December 31, 1995, 1994, and 1993\nF. Notes to Financial Statements 24-36\n2. Financial Statement Schedules None are included because they are not applicable or not required, or because the required information is included in the Financial Statements or the Notes thereto.\n3. Exhibits Required by Item 601 of Securities and Exchange Commission Regulation S-K\nExhibit Description of Exhibit Reference ** No. 3.1 Restated Certificate of Exhibit 3.1 to Registration Incorporation of Company Statement No. 33-9370, Amendment No. 1 (filed 11\/26\/86)\n3.2 Amendment to Restated Exhibit 3.2 to the Company's Certificate of Incorporation Transitional Report on Form of Company 10-K, File No. 1-15070 (filed 3\/18\/91)\n3.3 Bylaws of Company Exhibit 3.2 to Registration Statement No. 33-9370 (filed 10\/8\/86)\n3.4 Amendment No. 1 to Bylaws of Exhibit 4.7, Registration Company adopted 8\/11\/89 Statement No. 33-34551, Amendment No. 3 (filed 6\/21\/90)\n3.5 Amendment No. 2 to Bylaws of Exhibit 4.8, Registration Company adopted 6\/18\/90 Statement No. 33-34551, Amendment No. 3 (filed 6\/21\/90)\n3.6 Amendment No. 3 to Bylaws of Exhibit 3.6 to the Company's Company adopted 11\/30\/90 Transitional Report on Form 10-K, File No. 1-15070 (filed 3\/18\/91)\n4.1 Form of Stock Certificate Exhibit 4.1 to Registration Statement No. 33-9370, Amendment No. 1 (filed 11\/26\/86)\n4.2 Class C Warrant Agreement Exhibit 2.1 to the Company's (including form of Class C Registration Statement on Warrant Certificate), dated Form 8-A for Class C as of January 29, 1993, Warrants (filed 1\/28\/93) between the Company and American Stock Transfer & Trust Company\n4.3 Amendment No. 1 to Class C Exhibit 2.2 to the Company's Warrant Agreement, dated as Amendment No. 1 on Form 8 to of February 23, 1993, a Registration Statement on between the Company and Form 8-A for Class C American Stock Transfer & Warrants (filed 3\/1\/93) Trust Company\n4.4 Rights Agreement, dated as Exhibit 1 to the Company's of April 29, 1994, between Registration Statement on the Company and American Form 8-K, dated May 2, 1994 Stock Transfer & Trust Company, as Rights Agent\n10.1 Commercial Text Agreement Exhibit 10.10, Registration between the Company and F. Statement No. 33-9370 (filed Hoffmann-La Roche, Inc., 10\/8\/86) dated September 15, 1982, and amended August 7, 1984 and September 18, 1986\n10.2 Thymosin Fraction 5 License Exhibit 10.11, Registration Agreement between the Statement No. 33-9370 (filed Company and F. Hoffmann-La 10\/8\/86) Roche & Co. Limited Company, dated January 1, 1985\n10.3 Thymosin Alpha 1 License Exhibit 10.12, Registration Agreement between the Statement No. 33-9370 (filed Company and F. Hoffmann-La 10\/8\/86) Roche & Co. Limited Company, dated August 5, 1986\n10.4 Thymosin Alpha 1 License Exhibit 10.19 to the Agreements between the Company's Annual Report on Company and F. Hoffmann-La Form 10-K, File No. 1-15070 Roche & Co. Limited Company, (filed 6\/29\/89) dated October 21, 1988\n10.5 Agreement between the Exhibit 10.19, Registration Company and Hoffmann-La Statement No. 33-34551 Roche, Inc., dated as of (filed 4\/25\/90) December 21, 1989\n10.6 Letter Agreement, dated Exhibit 10.29 to the March 4, 1991, between the Company's Annual Report on Company and F. Hoffmann-La Form 10-K, File No. 1-15070 Roche & Co. Limited Co. (filed 3\/25\/92)\n10.7 Agreement between the Exhibit 10.30 to the Company and Hoffmann-La Company's Annual Report on Roche, Inc., dated as of Form 10-K, File No. 1-15070 August 6, 1991 (filed 3\/25\/92)\n10.8* Employment Agreement, dated Exhibit 10.33 to the December 1, 1991, between Company's Annual Report on the Company and Allan L. Form 10-K (filed 3\/25\/92) Goldstein\n10.9* 1986 Incentive Stock Option Exhibit 10.23 to the Plan, as amended through May Company's Annual Report on 15, 1992 Form 10-K, File No. 1-15070 (filed 3\/26\/93)\n10.10* 1987 Non-Qualified Stock Exhibit 10.24 to the Option Plan, as amended Company's Annual Report on through May 15, 1992 Form 10-K, File No. 1-15070 (filed 3\/26\/93) 10.11* Amended and Restated Exhibit 10.25 to the Directors Stock Option Plan, Company's Annual Report on dated as of May 15, 1992 Form 10-K, File No. 1-15070 (filed 3\/26\/93) 10.12 Lease Agreement, dated as of Exhibit 10.27 to the April 9, 1992, between the Company's Annual Report on Company and Democracy Form 10-K, File No. 1-15070 Associates Limited (filed 3\/26\/93) Partnership (Bethesda, Maryland lease)\n10.13 Lease Agreement, dated Exhibit 10.28 to the February 10, 1993, between Company's Annual Report on the Company and John Form 10-K, File No. 1-15070 Arrillaga, Trustee, and (filed 3\/26\/93) Richard T. Perry, Trustee (Sunnyvale, California lease)\n10.14 Thymosin alpha 1 License Exhibit 10.29 to the Agreement, dated as of Company's Annual Report on February 12, 1993, between Form 10-K, File No. 1-15070 the Company and Sclavo, (filed 3\/26\/93) S.p.A. (with certain confidential information deleted)\n10.15 Lease Agreement Amendment Exhibit 10.24 to the Number 1, dated September 1, Company's Annual Report on 1993, and Amendment Number Form 10-K, File No. 1-15070 2, dated December 27, 1993 (filed 3\/28\/94) (Sunnyvale, California lease)\n10.16 Thymosin Alpha 1 License Exhibit 1 to a Current Agreement, dated as of Report on Form 8-K, File August 19, 1994, between No. 1-15070 (filed 8\/24\/94) SciClone Pharmaceuticals, Inc. and the Company (with certain confidential information omitted)\n10.17 Consulting Agreement, Exhibit 10.26 to the effective October 15, 1994, Company's Annual Report on between SciClone Form 10-K, File No. 1-15070 Pharmaceuticals, Inc. and (filed 3\/31\/95) the Company\n10.18* Employment Agreement, dated Exhibit 10.27 to the March 24, 1994, between the Company's Annual Report on Company and Michael L. Form 10-K, File No. 1-15070 Berman (filed 3\/31\/95)\n10.19 Lease Agreement Amendment Exhibit 10.28 to the Number 3, dated April 19, Company's Annual Report on 1994 (Sunnyvale, California Form 10-K, File No. 1-15070 Lease) (filed 3\/31\/95)\n10.20* Separation Agreement, dated Exhibit 10.29 to the November 1, 1994, between Company's Annual Report on the Company and Vincent F. Form 10-K, File No. 1-15070 Simmon (filed 3\/31\/95)\n10.21* Supplement to Employment Exhibit 10.30 to the Agreement, dated December 8, Company's Annual Report on 1994, between the Company Form 10-K, File No. 1-15070 and Allan L. Goldstein (filed 3\/31\/95)\n10.22* Employment Agreement, dated Exhibit 10.31 to the January 18, 1995, between Company's Annual Report on the Company and Michael L. Form 10-K, File No. 1-15070 Berman (filed 3\/31\/95)\n10.23* Employment Agreement, dated Filed herewith February 1, 1995, between the Company and Robert J. Lanham\n10.24 Assignment of Lease, dated Filed herewith March 22, 1995 from the Company to Scios Nova, Inc. (Sunyvale, California Lease)\n10.25 Consulting Agreement, Filed herewith effective October 15, 1995, between SciClone Pharmaceuticals, Inc. and the Company\n10.26 Termination Agreement of the Exhibit 1 to a Current Viral Technologies, Inc. Report on Form 8-K, File No. Joint Venture between CEL- 0-15070 (filed 11\/13\/95) SCI Corporation and the Company, dated October 30,\n10.27 Agreement of Merger, dated Exhibit (c)(1) to a Current November 13, 1995 between Report on Form 8-K File No. Alpha 1 Acquisition 0-15070 (filed 11\/13\/95) Corporation and the Company\n10.28* Supplement to Employment Filed herewith Agreement, dated Feburary 27, 1996, between the Company and Allan L. Goldstein\n24 Consent of Price Waterhouse Filed herewith LLP\n* Management contract or compensatory plan or arrangement\n** The exhibits referred to in this column have heretofore been filed with the Securities and Exchange Commission as exhibits to the documents indicated and are hereby incorporated by reference thereto. The Registration Statements referred to are Registration Statements of the Company.\n(b) Reports on Form 8-K\nCurrent Reports on Form 8-K were filed by the Company during the fiscal quarter ended December 31, 1995 as follows:\nNovember 13, 1995 (Items 2 and 5) November 22, 1995 (Items 5 and 7)\n(c) Exhibits Attached hereto See Index to Exhibits Page 50 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.\nALPHA 1 BIOMEDICALS, INC. (Registrant)\nBy: \/s\/ Michael L. Berman Michael L. Berman 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\/ Allan L. Goldstein Director and Allan L. Goldstein Chairman of the Board March 31, 1996\n\/s\/ Michael L. Berman President and Chief Michael L. Berman Executive Officer (Principal Executive Officer) March 31, 1996\n\/s\/ Robert J. Lanham Vice President and Chief Robert J. Lanham Financial Officer (Principal Financial Officer and Principal Accounting Officer) March 31, 1996\n\/s\/ Joseph C. McNay Director March 31, 1996 Joseph C. McNay\n\/s\/ Albert Rosenfeld Director March 31, 1996 Albert Rosenfeld Index to Exhibits\nExhibit Pages\n10.23 Employment Agreement, dated February 1, 1995, between the Company and Robert J. Lanham. 51-54\n10.24 Assignment of Lease, dated March 22, 1995 from the Company Scios Nova, Inc. (Sunnyvale, California). 55-58\n10.25 Consulting Agreement, dated October 15, 1995, between the Company and SciClone Pharmaceuticals, Inc. 59-65\n10.28 Supplement to Employment Agreement, dated February 27, 1996, between the Company and Allan L. Goldstein. 66\n24 Consent of Price Waterhouse LLP. 67\nEXHIBIT 10.23\nEMPLOYMENT AGREEMENT\nThis Agreement, dated as of this 1st day of February, 1995, is entered into by and between Alpha 1 Biomedicals, Inc., a Delaware corporation having offices at 6903 Rockledge Drive, Suite 1200, Bethesda, Maryland 20817 (\"Alpha\") and Robert J. Lanham, an individual residing at 2014 Gunnell Farms Drive, Vienna, Virginia 22181 (\"Mr. Lanham\").\nWHEREAS, Mr. Lanham has experience in the operation and administration of businesses and in financial matters related thereto;\nWHEREAS, Alpha wishes to continue to employ Mr. Lanham as Vice President and Chief Finance Officer, and Mr. Lanham wishes to continue in this capacity.\nNOW, THEREFORE, The parties hereto, intending to be legally bound, agree as follows:\n1. Engagement. Alpha hereby employs Mr. Lanham as Vice President and Chief Finance Officer, and Mr. Lanham hereby accepts such employment, pursuant to the terms and conditions hereinafter set forth.\n2. Term. This Agreement is for a one year term commencing on the date hereof.\n3. Duties. During the term of this Agreement and in accordance with the Bylaws of Alpha, the services to be performed by Mr. Lanham shall be as Vice President and Chief Finance Officer of Alpha. Mr. Lanham shall use his best efforts and shall act in good faith in performing all duties required to be rendered under this Agreement.\n4. Availability. Mr. Lanham shall devote his entire working time, attention and energies to the affairs of Alpha, and shall not during the term of this Agreement be engaged in any other business activities whether or not such business activity is pursued for gain, profit or other pecuniary advantage, without the express written concurrence of Alpha.\n5. Expenses. Alpha shall reimburse Mr. Lanham promptly upon the presentation of itemized vouchers for all ordinary and necessary business expenses incurred by him in the performance of his duties hereunder.\n6. Compensation. As compensation for the services to be rendered by Mr. Lanham, Alpha agrees to pay him at the annual salary of $115,000, payable in bi-weekly installments as well as such other compensation, including bonuses, that Alpha may approve from time to time. Salary and any other payments shall be subject to withholding and other applicable taxes. Mr. Lanham shall be entitled to participate in all employee benefits and insurance programs as are made available to employees of Alpha generally, however, as an exception to the general vacation policy, he will receive four weeks vacation with pay per year.\n7. Ownership of Material Information. All rights, title and interest of every kind and nature whatsoever in and to discoveries, inventions, improvements, patents (and applications therefor), copyrights, ideas, know-how, laboratory notebooks, creations, properties and all other proprietary rights arising from or, in any way related to, Mr. Lanham's services hereunder shall become and remain the exclusive property of the Company, and he shall have no interest therein.\n8. Trade Secrets. Mr. Lanham covenants and agrees with Alpha that he will not during the term of this Agreement or thereafter disclose to anyone (except to the extent reasonably necessary for him to perform his duties hereunder) any confidential information, including but not limited to list of customers, financial or cost information, and confidential scientific and clinical information concerning the business or affairs of Alpha or any of its affiliates or subsidiaries, which he may have acquired in the course of, or incident to, the performance of his duties pursuant to the terms of this Agreement or pursuant to any prior dealings with Alpha or with any of Alpha's affiliates or subsidiaries. In the event of a breach of threatened breach by Mr. Lanham of the provisions of this paragraph, Alpha shall be entitled to an injunction restraining him from disclosing, in whole or in part, such information of from rendering any services to any person, firm, corporation, association or other entity to whom such information has been disclosed or is threatened to be disclosed. Nothing herein shall be construed as prohibiting Alpha from pursuing any other remedies available to it for such breach or threatened breach, including the recovery of damages from Mr. Lanham.\n9. Termination for Cause. Mr. Lanham's employment hereunder may be terminated by Alpha in the event of any willful or unlawful act or course of action by him during the term of this Agreement which materially injures Alpha or any act which is criminal in nature or affects adversely the reputation of Alpha or its employees, unless such act is performed at the direction of the Board. If Mr. Lanham's employment hereunder is so terminated, it shall terminate immediately upon receipt of notice of termination, and he shall be entitled to compensation only through the date of such termination. Termination of him under this Section 9 shall not terminate his obligations under Sections 7, 8, and 13 of this Agreement.\n10. Termination Without Cause. Alpha may terminate this Agreement without any cause at any time upon two (2) week's written notice to Mr. Lanham. In that event, Mr. Lanham, if requested by Alpha, may continue to perform his duties under this Agreement and shall be paid his regular compensation up to the date of termination. Termination of Mr. Lanham under this Section 10 shall not terminate this obligations under Section 7 and 8 of this Agreement.\n11. Resignation. Mr. Lanham may resign his employment under this Agreement at any time. Such resignation by Mr. Lanham shall not terminate his obligations under Section 7, 8 and 13 of this Agreement.\n12. Death or Disability. In the event of the death or disability of Mr. Lanham during the term of this Agreement or any renewal term thereto, Alpha shall continue to pay him or his legal representative, as the case may be, compensation provided hereunder for a period, from his death or a determination by Alpha that his disability is such that he no longer can carry out his duties under this Agreement, equal to one month's salary. Disability for purpose of this Section 12 shall mean disability as defined in the long term disability insurance policy in effect at the time provided such policy exists, or inability to perform duties for greater than a six (6) period.\n13. Non-Competition. Following termination of employment, other than without cause, Mr. Lanham will not for a period of one year, without the consent of Alpha, directly or indirectly, own manage, operate, control, be employed by, participate in, or be connected in any manner with the ownership, management, operation, or control of any business engaged in research and development, production or sale of a thymic hormone product, or any other specific product being developed, produced or sold by Alpha at the time of such termination of employment. In the event of his actual or threatened breach of the provisions of this paragraph, Alpha shall be entitled to, and he hereby consents to an injunction restraining him therefrom. However, nothing herein shall be construed as prohibiting Alpha from pursuing any other available remedies for such breach or threatened breach, including the recovery of damages from him. Mr. Lanham agrees that the provision of this Section 13 are necessary and reasonable to protect Alpha in the conduct of its business. If any restriction contained in this Section 13 shall be deemed to be invalid or unenforceable by reason of the extent, duration or geographic scope thereof, then Alpha shall have the right to reduce such extent, duration, geographic scope or other provisions thereof; and in their reduced form such restrictions shall then be enforceable in the manner contemplated hereby.\n14. Insurance. Alpha will obtain and maintain for the benefit of Mr. Lanham, while he is employed under this Agreement, an insurance policy with a value of $350,000 payable to the estate of Mr. Lanham, provided that Alpha shall be bound by this provision only to the extent that Alpha's annual cost of such policy does not exceed $3,000. Mr. Lanham acknowledges that the cost of this premium will be defined as income for the purpose of reporting income as required by law.\n15. Arbitration. Except as provided otherwise in this Agreement, at the request of either party to this Agreement, all disputes arising under or in connection with this Agreement may be submitted to arbitration in Washington, D.C. under the rules of the American Arbitration Association, and the decision of the arbitrator shall be final and binding. Judgment upon the award rendered may be entered and enforced in any court having jurisdiction.\n16. Construction. This Agreement shall be governed by and construed in accordance with the laws of the State of Maryland.\n17. Completeness. This Agreement sets for all, and is intended by all parties to be an integration of all, of the promises, agreements and understandings among the parties hereto with respect to the subject matter hereof, and there are no promised, agreements or understandings, oral or written, expressed or implied, among them other than set for or incorporated by references herein.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement the day and year first above written.\nALPHA 1 BIOMEDICALS, INC.\n\/s\/ Robert J. Lanham \/s\/ Michael L. Berman Robert J. Lanham Michael L. Berman, Ph.D. President & CEO\nEXHIBIT 10.24\nASSIGNMENT OF LEASE\nThis ASSIGNMENT OF LEASE (hereinafter \"Assignment\") is made on March 22, 1995, between ALPHA 1 BIOMEDICALS, INC. (hereinafter \"Assignor\"), whose address is Two Democracy Center, 6903 Rockledge Drive, Suite 1200, Bethesda, Maryland 20817, and SCIOS NOVA INC. (hereinafter \"Assignee\"), whose address is 2450 Bayshore Parkway, Mountain View, California 94043, who agree as follows:\n1. Recitals. This Assignment is made with reference to the following facts and objectives:\n1.1 Assignor, as Tenant, entered into a written lease dated January 22, 1993, and subsequent Amendment Nos. 1, 2 and 3 (collectively the \"Master Lease,\" attached hereto as Exhibit A), in which Landlord (John Arrillaga. Trustee, or his Successor Trustee, UTA dated 7\/20\/77 [John Arrillaga Separate Property Trust] as amended, and Richard T. Peery, Trustee, or his Successor Trustee, UTA dated 7\/20\/77 [Richard T. Peery Separate Property Trust] as amended, collectively the \"Landlord\") leased to Assignor and Assignor leased from Landlord premises located in the City of Sunnyvale, County of Santa Clara, State of California (\"Premises\"), described as follows:\na portion of that certain 51,680 square foot, one-story building located at 820 West Maude Avenue, Suite 101, Sunnyvale, California 94086, consisting of approximately 26,920 square feet of space;\n1.2 Assignor desires to assign all its right, title, and interest in the Master Lease to Assignee.\n2. Effective Date of Assignment. This Assignment shall take effect on March 22, 1995, and Assignor shall give possession of the Premises to Assignee on that date.\n3. Assignment and assumption. Subject to the terms hereof and to obtaining the consent of Landlord to this Assignment in the form attached as Exhibit B. (the \"Landlord's Consent\"), Assignor assigns and transfers to Assignee all its right, title, and interest in the Master Lease, and Assignee accepts the assignment and assumes and agrees to perform, from the date this Assignment becomes effective, as a direct obligation to Landlord, all the provisions of the Master Lease as modified by the Landlord's Consent or this Assignment.\n4. Hazardous Materials. Assignor represents and warrants that, to the best of its knowledge and during the term of its occupancy: (i) no hazardous waste or substance was stored, treated or disposed of on the Premises, and that no underground tanks were placed on the Premises; (ii) the Premises is in complete compliance with all applicable statutes and regulations, including environmental, health and safety requirements; (iii) Assignor's business on the Premises disposed of its waste in accordance with all applicable statutes, ordinances and regulations; (iv) Assignor has had no notice of any pending or threatened action or proceeding arising out of the condition of the Premises or alleged violation of environmental, health or safety statutes, ordinances or regulations; (v) no condition exists which might threaten the ability of Assignee to acquire all governmental permits required to operate a business similar to the business of Assignor on the Premises. Assignor and Assignee agree that in terms of allocating their responsibility for Hazardous Materials under the Master Lease (including Section 48), Assignor shall remain responsible for all Hazardous Materials conditions relating to the Premises existing as of the Effective Date, and that Assignee shall be responsible only for changes in the hazardous materials condition of the Premises which result from the operations of Assignee after the Effective Date of this Assignment.\n5. Tenant Improvements; Furniture, Fixtures and Equipment. In exchange for $100,000.00 consideration to be paid to Assignor by Assignee upon commencement of and as a precondition to the assignment term, Assignor assigns and transfers to Assignee all its right, title and interest in all existing tenant improvements in the Premises, in their as-is condition, plus the list of existing furniture, fixtures and equipment listed on attached Exhibit C.\n6. Assignee to Hold Assignor Harmless. Subject to Sections 3 and 4, if Assignee defaults in its obligations under the Master Lease as modified by this Assignment or the Landlord's Consent and Assignor in its sole discretion pays rent to Landlord or fulfills any of Assignee's other obligations in order to prevent Assignee from being in default, Assignee immediately shall reimburse Assignor for the amount of rent or costs incurred by Assignor in fulfilling Assignee's obligations under this Assignment, together with interest on those sums at the rate of 10% per annum. Assignor and Assignee shall each indemnify and hold harmless the other and its employees, representatives, directors, officers and agents (collectively \"Agents\"), against and from any and all losses, claims, liabilities, judgments, costs, demands, causes of action, and expenses (including, without limitation, reasonable attorneys' fees and consultants' fees) (collectively \"Claims\") arising from or related to the following: (a) each such party's use of the Premises or from any activity done, permitted or suffered by such party in, on or about the Premises, the Building, or the Property; (b) any act or omission by such party and\/or their respective Agents in connection with or related to this Assignment, the Building, or the Property; (c) any breach or default of such party in the terms of this Assignment; and (d) any action or proceeding brought by Landlord pursuant to the parties' joint and several indemnification of Landlord pursuant to Section 5 of the Landlord's Consent arising as a result of the foregoing. If any action or proceeding is brought against a party for which it is entitled to be indemnified hereunder, (the \"Indemnified Party\"), upon notice from the other party (the \"Indemnifying Party\"), the Indemnifying Party shall defend the same at such party's expense with counsel reasonably satisfactory to the Indemnified Party. The obligations of Assignor and Assignee under this Section 6 shall survive any termination of the Assignment or the Master Lease.\n7. Default of Lease; Notice to Assignor\n7.1 Notice to Assignor. If Assignee or Assignor receives a notice of default from Landlord, each shall promptly send a copy to the other.\n7.2 Assignor's Remedies Against Assignee. If Assignee defaults under the Master Lease as modified by this Assignment or the Landlord's Consent, Assignor shall have the rights against Assignee that are available by law and those contained in the Master Lease, including, without limitation, Assignor's right to reenter and retake possession of the Premises from Assignee.\n8. Prepaid Rent: Security Deposit; Brokers: Prorations; Removal.\n8.1 Prepaid Rent: Security Deposit. The parties acknowledge that Landlord now holds the sum of $67,300.00 as a Security Deposit, to be applied subject to the provisions of the Master Lease. Upon commencement of and as a precondition to the assignment term, Assignee shall reimburse Assignor in said amount of $67,300.00 for the existing Security Deposit paid under the terms of the Master Lease. Assignor releases all claims to that sum currently held by Landlord, and the sum shall be held by Landlord for the benefit of Assignee, subject to the provisions of the Master Lease.\n8.2 Brokers. Assignor shall be responsible for all compensation of all brokers relating to this Assignment transaction, specifically including Comish & Carey, Catalyst Group and Northbridge Group.\n8.3 Prorations. Property taxes, property insurance and any other expenses billed by Landlord under the Master Lease shall be prorated between Assignor and Assignee as of the Effective Date.\n8.4 Removal of Property. Not later than March 21, 1995, Assignor shall remove from the Premises the items of personal property listed on Exhibit D.\n9. Insurance. Assignee shall carry insurance per the Master Lease and name Assignor as an additional insured. Assignee shall, within 10 days of the execution hereof, provide Landlord with a certificate of insurance from its insurer which confirms that the insurance coverage required to be carried by Tenant under the Master Lease is in full force and effect.\n10. Miscellaneous.\n10.1 Attorneys' Fees. If either party commences an action against the other party arising out of or in connection with this Assignment, the prevailing party shall be entitled to recover from the losing party reasonable attorneys' fees and costs of suit.\n10.2 Notice. Any notice, demand, request, consent, approval, or communication that either party desires or is required to give to the other party shall be in writing and either be served personally or sent by registered or certified prepaid, first-class mail. Any notice, demand, request, consent, approval, or communication that either party desires or is required to give to the other party shall be addressed to the other party at the address set forth in the introductory paragraph of this Agreement. Either party may change its address by notifying the other party of the change of address. Notice shall be deemed communicated upon receipt if mailed as provided in this paragraph.\n10.3 Successors. This Assignment shall be binding on and inure to the benefit of the parties and their successors.\n10.4 Governing Laws. This Assignment shall be interpreted and governed by the laws of the state of California as applied to contracts between residents of California that is to be performed in California.\nIN WITNESS WHEREOF, Assignor and Assignee have executed this Agreement as of the day and year first hereinabove set forth.\nASSIGNOR: ASSIGNEE:\nALPHA 1 BIOMEDICALS. INC. SCIOS NOVA INC.. a Delaware corporation a Delaware corporation\nBy \/s\/ Robert J. Lanham By \/s\/ Richard L.Casey Robert J. Lanham Richard L. Casey Vice President Chairman, President Finance & Administration Chief Executive Officer\nExhibits: A: Master Lease B: Landlord's Consent to Assignment C: Personal Property Sold to Assignee D: Personal Property to be Removed\nEXHIBIT 10.25\nAGREEMENT\nRECITALS\n1. SciClone Pharmaceuticals, Inc. (\"SciClone\") and Alpha 1 Biomedicals. Inc. (\"Alpha\") are parties to a Thymosin Alpha 1 License Agreement, dated as of August 19, 1994, pursuant to which Alpha has licensed to SciClone the worldwide rights (except for several countries) to Thymosin alpha 1 (as defined in Schedule A).\n2. Dr. Allan L. Goldstein (\"Goldstein\"), the chief. scientific advisor of Alpha has significant knowledge regarding the composition, activity, laboratory and clinical experience of Thymosin alpha 1.\n3. SciClone wishes to employ Goldstein to serve as a consultant to SciClone in connection with SciClone's development of Thymosin alpha 1, and Alpha wishes to make Goldstein's services available to SciClone.\nAGREEMENT\nIn consideration of the foregoing and of the promises herein contained, the parties hereto agree as follows:\n1. Scope of Service. The services performed by Goldstein for SciClone pursuant to this Agreement are described in Schedule A hereto (the \"Services\").\n2. Compensation. SciClone shall pay to Alpha for the Services performed by Goldstein the consideration specified in Schedule B hereto. Goldstein shall have no recourse against SciClone for any payments due or made hereunder.\n3. Term. This Agreement is for an initial term beginning on October 15, 1995 and ending on October 14, 1996, and shall be automatically renewable thereafter for successive one-year terms, unless terminated in accordance with paragraph 14 hereunder.\n4. Proprietary Information. (a) Goldstein agrees to maintain in confidence and not disclose or use, either during or after the term of this Agreement, without the prior express written consent of SciClone, any proprietary or confidential information or know-how disclosed to Goldstein by SciClone in Goldstein's capacity as consultant to SciClone hereunder (the \"Proprietary Information\"), whether or not such Proprietary Information is the property of SciClone or the property of a SciClone licensor or other third party that disclosed the same to SciClone, and whether or not it is in written form, except (i) to the extent required to perform duties on behalf of SciClone in Goldstein's capacity as a consultant hereunder and only if agreed to in advance by the SciClone officer designated on Schedule C hereto (the \"Designated Officer\") and (ii) to the extent that disclosure may be required by law or legal process. Such Proprietary Information includes, but is not limited to, technical and business information relating to SciClone's inventions or products, licensing agreements, patent applications relating to SciClone's inventions or licensed to SciClone, research and development, production processes, manufacturing and engineering processes, machines and equipment, finances, customers, marketing, production and business plans. Upon termination of this Agreement or at the request of SciClone before termination, Goldstein will deliver to SciClone all written and tangible material in his possession incorporating the Proprietary Information. These obligations with respect to Proprietary Information extend to information belonging to customers and suppliers of SciClone, who may have disclosed such information to Goldstein as a result of Goldstein's status as a consultant to SciClone hereunder. (b) Goldstein and Alpha acknowledge and understood that the foregoing provision prohibits Goldstein from disclosing Proprietary Information to Alpha or any of its officers, directors, employees or agents, or using Proprietary Information on behalf of or in connection with work performed for Alpha.\n5. Inventions.\n(a) Disclosure and Assignment. (i) Goldstein and Alpha each acknowledge and agree that, subject to the terms of any sponsored research agreement entered into between SciClone and The George Washington University or the Research Agreement (Moody), effective May 1 1990, entered into between Alpha and The George Washington University and assigned to SciClone, or the Research Agreement. effective May 1, 1990 entered into between Alpha and The George Washington University (Badamchian), any and all inventions, improvements, discoveries, technical developments and copyrighted works with respect to Thymosin alpha 1 (as defined on Schedule A hereto), whether or not patentable, which Goldstein conceives, develops or reduces to practice, solely or jointly with others and which result from any work Goldstein performs for SciClone hereunder (\"Inventions\") will become the sole and exclusive property of SciClone and will not be made available to others during or following the term of the Agreement without the advance written permission of the Designated Officer. (ii) Goldstein agrees to disclose promptly to the Designated Officer all matters which come to Goldstein's attention during the performance of Goldstein's activities pertaining to any and all Inventions.\n(b) Representations. Goldstein represents and warrants that his activities on behalf of SciClone will not conflict with the Faculty Guidelines or Patent Policy with The George Washington University. Both Alpha and Goldstein agree that Goldstein is acting under this Agreement in Goldstein's capacity as a consultant to SciClone. Goldstein further agrees that the ownership of Inventions and patent rights as set forth in Sections 5(a) and (c) herein are in accordance with Section VII B(3) and VII E of the Patent Policy of The George Washington University.\n(c) Assignment of Inventions. Subject to the terms of any sponsored research agreement entered into between SciClone and The George Washington University or the Research Agreement (Moody), effective May 1, 1990, entered into between Alpha and The George Washington University and assigned to SciClone, or the Research Agreement, effective May 1, 1990 entered into between Alpha and The George Washington University (Badamchian), Goldstein hereby assigns to SciClone his entire right to all the Inventions. Goldstein further agrees to cooperate with SciClone or its designee(s), both during and after the term of this Agreement, in the procurement and maintenance of SciClone's intellectual property rights as a result of Goldstein's work for SciClone with respect to Thymosin alpha i hereunder, and to sign all papers which SciClone may deem necessary and desirable for vesting SciClone or its designee(s) with such rights. Goldstein agrees to use his best efforts to keep and maintain adequate and current written records of any Inventions in the form of notes, sketches, drawings or reports relating to said Inventions, which records shall be and remain the property of SciClone. Goldstein agrees to execute, upon request by SciClone, signed transfer of copyright to SciClone when any copyrighted work is created by Goldstein in his capacity as a consultant to SciClone hereunder.\n(d) Royalties. Goldstein understands and acknowledges that he shall not be entitled to any royalty, commission or other payment or license or right with respect to the Inventions.\n(e) Future Patent Application or Copyright Registrations. If a patent application or copyright registration is filed by or on behalf of Goldstein within one (1) year after the termination of this Agreement describing an Invention within the scope of Goldstein's work for SciClone under this Agreement, Goldstein and Alpha agree that it is to be presumed that the Invention was conceived by Goldstein during the term of this Agreement.\n6. Publications. Goldstein and Alpha agree not to, and Alpha agrees not to cause Goldstein to, publish on the results of any work Goldstein performs for SciClone with respect to Thymosin alpha 1 under this Agreement without the prior written approval of the Designated Officer.\n7. Conflicting Obligations. (a) Goldstein and Alpha represent that each of them has advised SciClone in writing prior to the date of signing this Agreement of any relationship with third parties, including competitors of SciClone, which would present a conflict of interest with the rendering of the Services, or which would prevent Goldstein from carrying out the terms of the Agreement. Goldstein and Alpha agree to advise SciClone of any such relationships that arise during the term of this Agreement. SciClone will then have the option to terminate this Agreement without further obligation to Goldstein or Alpha, except to pay to Alpha the compensation earned through the date of termination. (b) Alpha consents and agrees to the performance of Services by Goldstein for SciClone hereunder. Alpha further acknowledges and agrees that the Services to be performed by Goldstein hereunder are of a unique and intellectual character and are capable of being performed only by Goldstein, and that no other officer, director, employee or agent of Alpha may be substituted for Goldstein hereunder.\n8. Confidential Information of Others. Goldstein agrees not to disclose to SciClone, or use in connection with his work for SciClone under this Agreement, any confidential or proprietary information or materials belonging to any third party, including without limitation that of Alpha, George Washington University or any prior employer.\n9. Written Materials. All records, reports, notes, compilations, or other recorded matter, and copies or reproduction thereof, relating to SciClone's operations, activities or business, made or received by Goldstein in his capacity as a consultant hereunder during the term of this Agreement (the \"Written Materials\") are and shall be SciClone's exclusive property. Goldstein agrees to keep the Written Materials subject to SciClone's control, and to surrender the Written Materials upon the termination of this Agreement or at the request of SciClone before termination.\n10. Prior Inventions. Goldstein agrees to notify SciClone and Alpha in writing before he makes any disclosure or performs any work on behalf of SciClone which appears to threaten or conflict with proprietary rights he or Alpha may claim in any invention or idea. The parties will endeavor to resolve any such conflict before any such work commences. Should the parties be unable to resolve such conflict amicably, SciClone reserves its right to resolve any such conflict with Goldstein or Alpha, as the case may be, in accordance with paragraph 15 herein.\n11. Irreparable Harm. Goldstein and Alpha acknowledge that Goldstein's obligations under this Agreement are of a unique and intellectual character which gives them particular value, that a breach of any such obligations will result in irreparable and continuing damage to SciClone for which there may be no adequate remedy at law, and that in the event of a breach by Goldstein or Alpha of their obligations under this Agreement, SciClone shall be entitled to injunctive relief and\/or a decree for specific performance and such other relief as may be deemed proper(including monetary damages, if appropriate) by a court of competent jurisdiction.\n12. Independent Contractor. Goldstein acknowledges that he is an independent contractor, not an employee or agent of SciClone. Nothing in this Agreement shall render Goldstein an employee or agent of SciClone, nor authorize or empower him to speak for, represent or obligate SciClone in any way.\n13. Limited Liability of Alpha. Except for its obligation to make Goldstein available to perform the Services contemplated by this Agreement and except for such other obligations as are specifically provided for herein, Alpha shall have no liability or obligation to SciClone or any other person under this Agreement in connection with or arising out of the Services to be provided hereunder, including without limitation any liability for any negligence or willful misconduct of Goldstein, and SciClone hereby waives and releases Alpha from any and all claims that it might otherwise have against Alpha with respect to the performance by Goldstein of the Services.\n14. Termination. SciClone and Alpha each shall have the right to terminate this Agreement at any time upon thirty (30) days prior written notice. Termination shall not affect SciClone's rights or Goldstein's obligations under paragraphs 4, 5, 6 and 9 or the obligations of Alpha under Sections 5(a) and (e) and 6 above. Upon termination, no further payment shall be due from SciClone, except (a) payment for services of Goldstein already rendered and (b) to the extent not paid. payment of a pro rata portion of the minimum annual consulting fee through the effective date of termination.\n15. Arbitration. In the event of any dispute, difference or question arising between the parties in connection with this Agreement, that dispute shall be resolved by arbitration between the parties before a single arbitrator jointly designated by the parties. The parties shall determine the place or places where the meetings are to be held in the counties of San Francisco or San Mateo, California, or the District of Columbia, or another mutually convenient location. The arbitrator must base his decision with respect to the difference before him on the content of this Agreement, and will be governed by the rules of the American Arbitration Association. His decision shall be binding on both parties. The fees of the arbitrator and any fees of the American Arbitration Association shall be paid by the party that does not prevail in the arbitration.\n16. Miscellaneous.\n(a) This Agreement represents the entire understanding of the parties as to the subject matter contained in it. This Agreement may not be modified except by a writing signed by each of the parties.\n(b) This Agreement may not be assigned by Goldstein or Alpha, without prior written consent of SciClone, or by SciClone without the prior written consent of Alpha; provided, however, that without any prior consent SciClone may assign the Agreement to (i) to any United States subsidiary or affiliate; (ii) in connection with the transfer of sale of all or substantially all of its business to a third party domiciled in the United States; (iii) in the event of its merger or consolidations with another company domiciled in the United States. In no case shall consent to assignment be unreasonably withheld. This Agreement shall be binding upon and inure to the benefits of the heirs, successors and assigns of the parties hereto.\n(c) No amendment of or waiver of any obligation under this Agreement will be enforceable unless set forth in a writing signed by the party against whom enforcement is sought. The waiver of any provision shall not be construed as a waiver of any other provision of this Agreement.\n(d) If any provision of this Agreement is held to be invalid, void or unenforceable for any reason, the remaining provisions shall nevertheless continue in full force and effect to the fullest extent permitted by law.\n(e) No party may disclose the contents or terms of this Agreement to third parties at any time, provided, however, that any party may disclose such contents or terms to employees, attorneys, or advisors, to the extent necessary to carry out its obligations herein and to the extent required to comply with applicable law.\n(f) This Agreement shall be construed in accordance with, and governed by, the laws of the State of California.\nSciClone: Goldstein: \/s\/ David S. Horwitz \/s\/ Allan L. Goldstein signature signature\nVice President Allan L. Goldstein title name\n10\/23\/95 Oct 9, 1995 date date\n###-##-#### social security number\nAlpha:\n\/s\/ R.J. Lanham signature\nVice President & CFO title\n10\/26\/95 date\nSchedule A\nDescription of Services:\n1. Thymosin alpha 1 is defined herein as that 28 amino-acid polypeptide commonly referred to as Thymosin alpha 1 in the existing scientific literature. any and all galenic improvements and\/or enhancements thereto. and all modifications, fragments. analogs and synthetic derivatives thereof.\n2. Consultation regarding Thymosin alpha 1. including basic. preclinical: and clinical studies. Also consultation regarding prior work with Thymosin alpha 1 to the extent permitted by prior. existing or future arrangements with Alpha 1 Biomedicals, Inc. Assistance in arranging collaboration with other Thymosin alpha 1 investigators.\n- - ---------------------------------------------------------------------- - - -- Schedule B\nFee Arrangements:\n(1) A $25.000 retainer. payable upon execution of this Agreement and additional $25,000 retainer payable on the commencement date of each successive one-year term.\n(2) A consulting fee of $250\/hour, with a guaranteed minimum annual consulting fee of . $25.000, payable whether or not the corresponding consulting services are utilized. Compensable time shall include all travel time.\n(3) Reimbursement for all out-of-pocket travel and related expenses, including business class air travel. - - ---------------------------------------------------------------------\nSchedule C\nSciClone Designated Officer:\nDr. David Horwitz. Vice-President\nEXHIBIT 10.28\nSupplement to\nEMPLOYMENT AGREEMENT\nAllan L. Goldstein\nThe Compensation section of the Employment Agreement, between Allan L. Goldstein and Alpha 1 Biomedicals, Inc. dated December 1, 1991, is hereby amended to reflect a change in the compensation for the remaining term of the Agreement to an amount equal to a rate of $36,000 per annum for the remaining term of the Employment Agreement.\nAccepted and agreed and to become effective the first payroll date in March 1996.\nFebruary 27,1996 \/s\/ Michael L. Berman Michael L. Berman, President and Chief Executive Officer\n\/s\/ Allan L. Goldstein Allan L. Goldstein\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-3 (No. 33- 57016) and in the Registration Statements on Form S-8 (Nos. 33-50332 and 33-60550) of Alpha 1 Biomedicals, Inc. of our report dated March 29, 1996 appearing on page 20 of this Form 10-K.\nPRICE WATERHOUSE LLP\nWashington, DC March 29, 1996","section_15":""}
{"filename":"826821_1995.txt","cik":"826821","year":"1995","section_1":"Item 1. Business ----------------- (a) General Development of Business\nCERBCO, Inc. (\"CERBCO\", the \"Company\" or \"Registrant\") [NASDAQ:CERB] is a parent holding company with controlling interests in Insituform East, Incorporated [NASDAQ:INEI] (excavationless sewer and pipeline rehabilitation), and Capitol Copy Products, Inc. [copier and facsimile (\"fax\") equipment sales, service and supplies].\nCERBCO was incorporated on December 23, 1987 in the State of Delaware. CERBCO was formed for the purpose of implementing a Plan of Reorganization and Merger (the \"Plan\"), whereby its then publicly-traded predecessor, CERBERONICS, Inc. (\"CERBERONICS\"), became a wholly-owned subsidiary of CERBCO. Under the Plan, owners of shares of stock previously held in CERBERONICS, by class, received ownership of an equivalent number of shares of stock, by class, in the parent holding company, CERBCO. In 1988, CERBERONICS transferred a material portion of its assets to CERBCO including all shares of stock held in Insituform East, Incorporated and Capitol Copy Products, Inc. CERBERONICS, which had been providing engineering, analytical and technical support services to the United States Government, discontinued operations in 1991.\nThe principal office and corporate headquarters of the Company are located in suburban Washington, D.C., collocated with the offices of the Company's subsidiary, Insituform East, Incorporated, at 3421 Pennsy Drive, Landover, Maryland 20785. The Company's telephone number is (301) 773-1784, its fax number is (301) 322-3041, and its twenty-four hour public information FaxVault number is (301) 773-4560.\n(b) Financial Information About Industry Segments\nFinancial information about the Registrant's industry segments is set forth below in tabular format. Information by industry segment is concomitant with financial information separately attributable to each of the member companies composing the Registrant's consolidated group, i.e., CERBCO, Inc. (the parent holding company), Insituform East, Incorporated and Capitol Copy Products, Inc. For additional information relating to industry segment information, see Part II, Item 8, \"Notes to Consolidated Financial Statements - Note 19: Segment Data and Reconciliation\"; also Part IV, Item 14, Exhibit 99, \"CERBCO, Inc. Consolidating Schedules: Statement of Earnings Information for the Year Ended June 30, 1995; Balance Sheet Information and Consolidating Elimination Entries as of June 30, 1995.\"\nc) Narrative Description of Business\nCERBCO, Inc. ------------\nGENERAL\nCERBCO, Inc. (\"CERBCO\" or the \"Company\") is a parent holding company with controlling interests in two principal subsidiaries, each of which is in a separate industry segment. Insituform East, Incorporated, operating pursuant to sublicense agreements, provides a patented process called \"Insituform\" primarily to municipal, Federal government and industrial customers for the repair and reconstruction of underground sewers and other types of pipelines. The Insituform\/R process creates a hard, jointless, and impact and corrosion-resistant Insitupipe\/R product inside deteriorating pipes, with a principal benefit that it can usually be installed without excavation. Capitol Copy Products, Inc. is in the business of selling, servicing and providing supply products for copier and facsimile equipment, operating pursuant to certain dealer agreements, primarily with Canon U.S.A., Inc.\nCERBCO officers participate both directly and indirectly on the management teams of its subsidiary corporations, in varying capacities and officerships, with a view to overseeing, protecting and developing the long-term values of the Company's holdings. By operating separate lines of business in the Federal\/municipal and commercial sectors, CERBCO is structured to enable effective response to changing markets through the combination of capital flexibility and strategic diversification.\nAs of June 30, 1995 the Company and its subsidiaries had a total of 222 employees (including four employees in the parent holding company).\nOTHER INFORMATION\nFor other information regarding a collective business description of CERBCO (e.g., material developments, operations, license agreements, backlog, marketing, competition, etc.), see specific detailed information by individual subsidiary company (i.e., industry segment) below.\nInsituform East, Incorporated -----------------------------\nGENERAL\nInsituform East, Incorporated (\"Insituform East\" or the \"Company\") was organized under the laws of the State of Delaware on February 26, 1970 under the name Universal Construction and Supply Company. Its present name was adopted on August 24, 1978. The Company was engaged in the business of underground conduit construction from inception until 1974 and construction equipment rental from 1974 to 1978. The Company then phased out these lines of business and entered into sublicensing agreements for the Insituform process, a patented technology for reconstructing pipelines with little or no excavation. Since July 1978, the Company has been primarily engaged in the business of rehabilitating underground sewers and other pipelines, the Company's only business segment.\nBetween 1982 and 1986, the Company added western Pennsylvania, Ohio, three Kentucky counties and West Virginia to its original Insituform process licensed territory of Maryland, Virginia, the District of Columbia, Delaware and eastern Pennsylvania.\nIn December 1985, MIDSOUTH Partners was organized as a Tennessee General Partnership with the Company holding 42.5% general partnership interest. MIDSOUTH Partners is the exclusive licensee for the Insituform process in Tennessee, the rest of Kentucky and northern Mississippi.\nIn September 1987, the Company established a branch facility in Cincinnati, Ohio, to support operating activities in the western region of its licensed territory.\nIn May 1989, the Company acquired an 80% interest in TRY TEK Machine Works, Inc. (\"TRY TEK\"). TRY TEK, located in Hanover, Pennsylvania, was founded in September 1985 to custom design and build special machinery, including machinery used in the Insituform process. The Company acquired an additional 10% interest in TRY TEK in February 1993 and the remaining 10% interest in March 1995.\nIn December 1990, the Company acquired an exclusive license for the sales and installation of preformed PVC thermoplastic pipe under the NuPipe\/R process and trademark for a sales region identical to the territories licensed to the Company for the Insituform process.\nIn September 1991, the Company added cement mortar lining of potable water lines to its service capability. On June 11, 1993, the Company adopted a formal plan to discontinue providing cement mortar lining services, primarily as a result of continuing operating losses and significant decreases in market prices in this already traditionally low margin industry. This formal plan, which consisted primarily of the completion of two contracts in progress and the disposal of remaining equipment and materials, was substantially completed by June 30, 1994.\nThe Company primarily rehabilitates and repairs underground sewers and other pipelines -- including waste water, storm water and industrial process pipelines -- using the Insituform process. The Insituform process utilizes a polyester fiber-felt material, the Insitutube\/R material, coated with polyurethane and impregnated with a liquid, thermosetting resin. The Insitutube material is inserted in the pipe through an existing manhole or other access point. By use of an inversion tube and cold water pressure, the Insitutube material is forced through the pipeline, turned inside out, and pressed firmly against the inner wall of the damaged pipeline. When the Insitutube material is fully extended, the cold water within the tube is recirculated through a boiler in a truck. The heated water cures the thermosetting resin to form a hard, jointless, impact and corrosion resistant Insitupipe product within the original pipe. Lateral or side connections are then reopened by use of the Insitucutter\/R device, a remote-controlled cutting machine.\nThe principal office and corporate headquarters of the Company are located at 3421 Pennsy Drive, Landover, Maryland 20785. The Company's telephone number is (301) 386-4100, and its fax number is (301) 386-2444.\nRELATIONSHIP WITH INSITUFORM TECHNOLOGIES, INC.\nOn December 9, 1992, Insituform Technologies, Inc. (formerly Insituform of North America, Inc., or \"INA\") through its acquisition of Insituform Group, Ltd., N.V., acquired the worldwide patent rights for the Insituform process. The Company is a sublicensee of Insituform Technologies, Inc. (\"ITI\"). The Company has entered into six sublicense agreements with ITI which grant the Company rights to perform the Insituform process in Virginia, Maryland, Delaware, Ohio, the District of Columbia, Pennsylvania, West Virginia, and three Kentucky counties. The Company can perform the Insituform process in other locations subject to payment of additional royalties.\nThe sublicense agreements require the Company to pay ITI a royalty of 8% of the revenue, excluding certain deductions, from all contracts using the Insituform process, with a minimum annual royalty requirement for each licensed territory. In the event the Company performs the Insituform process outside its territory, the sublicense agreements require it to pay a royalty of from 8% to 12% of the gross contract price to the independent sublicensee of such other territory, if any, in addition to all royalties due ITI.\nThe sublicense agreements extend for the life of the underlying patents or patent rights, including any improvements or modifications extending such life. The agreements may be terminated by the Company upon two calendar quarters written notice to ITI. The agreements may only be canceled by ITI in certain events. In addition, ITI has the right to approve the quality and specifications of equipment and materials not purchased directly from ITI.\nOn May 1, 1987, the Company entered into a supply agreement with ITI whereby the Company has committed to purchase 90% of its Insitutube material requirements from ITI. The agreement automatically renews annually unless notice of termination is provided by either party six months prior to the end of a renewal period. As a result of certain terms not previously fulfilled by ITI, the Company believes it is no longer required to purchase 90% of its Insitutube material requirements from ITI under the otherwise continuing agreement. The continuing agreement currently extends through April 30, 1996.\nIn December 1990, the Company entered into a license agreement with NuPipe, Inc., a wholly-owned subsidiary of ITI, for the sale and installation of preformed PVC thermoplastic pipe under the NuPipe process and trademark. The Company has committed to pay a royalty equal to 6.75% of gross contract revenue utilizing the process and to purchase certain installation equipment and installation materials from ITI.\nTRY TEK manufactures Insitucutter devices for sale to ITI and the Company under an agreement with ITI, the Insitucutter device patent holder. Unless otherwise terminated, this agreement will continue until April 14, 1997, the date of expiration of the Insitucutter device patent.\nIn 1981, the Company was assigned the rights to an agreement (the \"SAW Agreement\") regarding the introduction of potential Insituform process sublicensees to ITI. In connection with the introduction of current Insituform process sublicensees to ITI, the Company receives quarterly payments from ITI equal to 0.5% of contract revenue from Insituform process installations in the Company's licensed territory and the states of New York, New Jersey, North Carolina, South Carolina, Georgia and Alabama.\nPATENTS\nThe Insituform process was developed in the United Kingdom in 1971. The Company's rights to utilize the patents, trademarks and know-how related to the Insituform process are derived from its licensor, ITI. There are presently 53 United States patents which cover various aspects of the Insituform process and related installation techniques. The last patent to expire will remain in effect until 2013. Two initial method patents relating to the Insituform process (one of which covers material aspects of the inversion process) expired in 1994, a patent relating to the Insitutube material will expire in May 2001 and a primary method patent relating to the Insitutube material saturation process expires in February 2001.\nAlthough management of the Company believes these patents are important to the business of the Company, there can be no assurance that the validity of the patents will not be successfully challenged or that they are sufficient to afford protection against another company utilizing a process similar to the Insituform process. It is possible that the Company's business could be adversely affected upon expiration of the patents, or by increased competition in the event that one or more of the patents were adjudicated to be invalid or inadequate in scope to protect the Company's operations. Management of the Company believes, however, that while the Company has relied on the strength and validity of these patents, the Company's significant installation experience with the Insituform process and its degree of market penetration in its licensed territory should enable the Company to continue to compete effectively in the pipeline rehabilitation market in the future as older patents expire or become obsolete.\nCUSTOMERS\nThe Company performs services under contracts with governmental authorities, private industries and commercial entities. In each of the last three fiscal years, more than 65% of the Company's customers have been municipalities and state agencies. During the year ended June 30, 1995, Federal government contracts (collectively), the Metropolitan Sewer District (\"MSD\") of Greater Cincinnati, Ohio and Washington Metropolitan Area Transit Authority (\"WMATA\") accounted for 21%, 15% and 10%, respectively of the Company's sales. During the year ended June 30, 1994, Federal government contracts (collectively) accounted for 15% of the Company's sales. During the year ended June 30, 1993, contracts with the City of Richmond, Virginia; Fairfax County, Virginia and the Washington Suburban Sanitary Commission (\"WSSC\") accounted for 15%, 12% and 11%, respectively, of the Company's sales.\nSUPPLIERS\nMost of the Company's materials and equipment are generally available from several suppliers. However, the Company believes that ITI is presently the sole source of proprietary Insitutube material and, therefore, the Company is presently dependent upon ITI for its supply of Insitutube material. During the last three years the Company has not experienced any difficulty in obtaining adequate supplies of Insitutube material from ITI and, subject to ITI's right to approve the quality and specifications of material not purchased from ITI, the Company has the right to substitute an alternate polyester fiber-felt or other tube material available in the marketplace. The Company presently maintains an annually renewed supply agreement with ITI for Insitutube material (see \"Relationship With Insituform Technologies, Inc.\" above).\nREVENUE RECOGNITION AND BACKLOG\nThe Company recognizes sales revenue using the units of completion method as pipeline sections are rehabilitated using the Insituform process. An Insituform process installation is generally performed between manholes or similar access points within a twenty-four hour period. A rehabilitated pipeline section is considered completed work and is generally billable to the customer. In most cases, contracts consisting of individual line sections have a duration of less than one year.\nThe total value of all uncompleted and multi-year contract awards from customers was approximately $11.9 million at June 30, 1995, as compared to $17.0 million at June 30, 1994. The twelve-month backlog at June 30, 1995 was approximately $11.5 million as compared to $11.1 million at June 30, 1994. The total value of all uncompleted and multi-year contracts at June 30, 1995 and 1994 includes work not estimated to be released and installed within twelve months as well as potential work included in term contract awards which may or may not be fully ordered by contract expiration. Backlog figures at specific dates are not necessarily indicative of sales and earnings for future periods due to the irregular timing and receipt of larger annual term contract renewals and other large project awards.\nMIDSOUTH PARTNERS\nMIDSOUTH Partners was organized as a Tennessee general partnership in December 1985 and began operations February 1, 1986. The following corporations are its general partners:\nInterest in Profits and Losses\nInsitu, Inc. (a subsidiary of the Company) 42.5% E-Midsouth, Inc. (a subsidiary of Enviroq Corporation) 42.5% Insituform California, Inc. (a subsidiary of ITI) 15.0%\nMIDSOUTH Partners operates as the Insituform process sublicensee for Tennessee, most of Kentucky (excluding Boone, Kenton and Campbell counties) and northern Mississippi. MIDSOUTH Partners had a twelve-month backlog of approximately $4.1 million and $5.0 million at June 30, 1995 and 1994, respectively.\nCOMPETITION\nThe general pipeline replacement, rehabilitation and repair business is highly competitive. The Company faces conceptual and practical competition both from a number of contractors employing traditional methods of pipeline replacement and repair and from contractors offering alternative trenchless products and technologies.\nTraditional Methods. The Insituform process conceptually competes with traditional methods of pipe rehabilitation including full replacement, point repair and sliplining. The Company believes the Insituform process usually offers a cost advantage over full replacement as well as the practical advantage of avoiding excavation. In addition, the Insituform process also offers qualitatively better rehabilitation than sliplining which may significantly reduce the diameter of the pipe. Grouting is also undertaken in the United States. The Company considers grouting a short-term repair technique and not a long-term pipeline rehabilitation solution competitive with the Insituform process. As a practical matter, competition for the Company typically begins at the point an end user has conceptually determined to employ trenchless technology over traditional rehabilitation methods involving substantial excavation.\nCured-in-Place Trenchless Technologies. Over the years, the Company has witnessed a continuing introduction of alternative cured-in-place trenchless technologies, none of which the Company believes has been able to offer the quality or technical and other merits inherent in the Insituform process. The Company believes it remains the dominant provider of cured- in-place trenchless pipeline rehabilitation in its licensed territory.\nModified Sliplining Techniques. Several modified sliplining techniques have been introduced in the trenchless marketplace to include the use of \"fold and formed\" thermoplastic pipe. The NuPipe product offered by the Company is a folded thermoplastic product installed using modified sliplining techniques. The Company believes that the majority of customers will select the cured-in-place Insituform process over modified sliplining techniques due to the quality and longevity of the Insitupipe product, the proven performance record of the Company's Insituform process installations over the past seventeen years, and the broader range of design alternatives available with the Insituform process. The Company does offer its NuPipe product to customers in situations where, for budget restraints or other reasons, customers or consulting engineers consider a modified sliplining technique to be an acceptable rehabilitation alternative.\nOther Trenchless Technologies. The Company is aware of a number of other trenchless technologies both under development and from time to time introduced into the marketplace with mixed results. The Company believes that the successful, in the ground, over twenty year proven performance of the Insituform process presents a significant advantage over alternative trenchless products.\nThe principal areas of competition in pipeline replacement, rehabilitation and repair include the quality of the work performed, the ability to provide a long-term solution to the pipeline problems rather than a short-term repair, the amount of disruption to traffic and commercial activity, and the price. The Company believes that the Insituform process competes favorably in each of these areas with traditional replacement or repair methods. In particular, the ability to install Insitupipe products with little or no excavation at prices typically at or below traditional open trench replacement methods is of substantial competitive advantage. Further, and despite a small reduction in pipe diameter resulting from the installation of the Insitupipe product against the walls of the original pipe, the smooth finished interior reduces friction and generally increases flow capacity.\nThe Company believes the trenchless pipeline reconstruction marketplace is continuing to expand, enticing ever more entrants and products hoping that cheapest price alone will permit them to succeed in a market otherwise dominated by Insituform. The Company is encouraged that, in response, many of its municipal, Federal government and industrial customers are increasingly implementing improved procurement specifications and product evaluation criteria emphasizing technical value instead of simply low price. The Company continues to believe that customers and consulting engineers using such improved purchasing criteria help to ensure long term solutions to their infrastructure needs by clearly differentiating a proven product such as provided by the Insituform process from cheaply priced trenchless substitutes with quality, technical and other risks not equally tested by time or independent third parties.\nSALES AND MARKETING\nThe Company's sales and marketing effort is directed by its Vice President of Sales and Marketing. The Company's sales and marketing team includes five sales engineers primarily serving municipal and Federal government customers and one sales engineer primarily serving industrial market customers. Sales engineers are full-time employees compensated through a combination of salary and bonus. The Company also participates in seminars and trade shows, and produces and distributes technical video presentations, brochures and newsletters for current and prospective users of the Insituform process.\nRESEARCH AND DEVELOPMENT\nThe Company is confident of its present capability to provide pipeline rehabilitation services to its customers primarily using the Insituform process and relies on its licensor, ITI, for major research and development projects. On a continuing basis, however, the Company expends engineering efforts to improve installation methods and design techniques for specific customer applications.\nGOVERNMENTAL REGULATIONS\nThe Company does not anticipate any material impediments to the use of the Insituform process arising from existing or future regulations or requirements, including those regulating the discharge of materials into the environment.\nEMPLOYEES\nAt June 30, 1995, the Company employed 129 persons. None of the Company's employees are represented or covered by collective bargaining agreements.\nPROPERTIES\nThe Company owns four buildings totaling 76,700 square feet situated on a 15.45 acre site in the Ardwick Industrial Park, Prince George's County, Maryland. This facility houses the maintenance, operations, marketing, administration and executive offices of the Company.\nThe Company also leases a 13,000 square foot branch facility in the Cincinnati, Ohio, metropolitan area to service operations in the western region of its licensed territory.\nTRY TEK owns 13,885 square feet of land in Hanover, Pennsylvania, with 6,139 square feet of manufacturing, administration and storage facilities housed in three buildings.\nLEGAL PROCEEDINGS\nThere is no material legal proceeding to which the Company is a party or any such legal proceeding contemplated of which the Company is aware.\nCapitol Copy Products, Inc. ---------------------------\nGENERAL\nCapitol Copy Products, Inc. (\"Capitol Copy\" or the \"Company\") is in the business of selling, servicing and providing supply products for copier and facsimile (\"fax\") equipment. Capitol Copy was originally organized under the laws of the District of Columbia on May 4, 1976. The Company became a Delaware corporation on January 27, 1988. The Company's principal business territory comprises the greater metropolitan Washington, D.C. area. It will expand its principal business territory to include the greater metropolitan Baltimore area beginning in July, 1995.\nThe Company's primary business products are the Canon line of copiers and fax machines, which the Company is authorized to sell and service under written dealer agreements with the equipment manufacturer (see \"Dealer Agreements\" below). A material portion of the Company's business is involved in servicing this equipment.\nThe principal office, corporate headquarters and central distribution facility of the Company are located at 12000 Old Baltimore Pike, Beltsville, Maryland 20705. The Company's telephone number is (301) 937-5030, and its fax number is (301) 937-6031.\nDEALER AGREEMENTS\nCapitol Copy presently maintains copier and fax dealer agreements with its principal equipment vendor, Canon U.S.A., Inc. (\"Canon\"). The agreements formally permit Capitol Copy to represent the Company as an \"authorized\" dealer of each of the manufacturer's copier and fax products, and allows the Company to benefit from advertising, access to product, training, and various other support from the equipment manufacturer.\nThe Canon agreements authorize a primary sales and service area responsibility (\"territory\") for the Company to be comprised of the District of Columbia; the Maryland counties of Montgomery and Prince George's; the Virginia counties of Arlington and Fairfax; and the Virginia cities of Alexandria and Fairfax. Also included in the territory beginning in July, 1995 are the Maryland counties of Anne Arundel, Baltimore, Carroll, Harford and Howard; and the Maryland city of Baltimore.\nThe Canon agreements remain in effect until terminated by either party upon specified notice, or by failure to adhere to agreement provisions. The Company believes that its requirements under the Canon agreements have been and are being met, and that it maintains an excellent relationship with this principal vendor. While the Company's relationship with its customers may enable substitution of an alternate vendor line in the event of any unforeseen termination of the Canon agreements, the Company presently believes that any such termination could have a material adverse impact upon the Company.\nCUSTOMERS\nThe Company provides service and supply products to approximately 8,000 customers in the Washington, D.C. metropolitan area. More than 90% of its active customers are utilizing Canon products.\nThe majority of the Company's customers operate one to three copier or fax units, with fewer than forty active accounts operating ten or more machines. No single customer accounts for more than 5% of the Company's annual sales revenue.\nPROPERTIES\nAt June 30, 1995, Capitol Copy occupied two commercial sites in Maryland and Virginia. The Company leases all of its facilities which at year-end aggregated to approximately 18,000 square feet of office, showroom and warehouse space.\nThe Company believes that the space it occupies for its operations is adequate for its current and near-term requirements. As additions or reductions in space become required, the Company anticipates no material problems in securing in due course appropriate adjustments in occupied space.\nCOMPETITION\nCapitol Copy has several regional competitors in each of the Company's product lines. However, in the Company's principal product line, copiers and fax machines manufactured by Canon, the Company believes it presently is the largest full line dealer in the Washington, D.C. area.\nIt is possible that the Company's equipment vendors may authorize additional full line dealers in the Company's territory, or that the Company's vendors may themselves enter or expand their product distribution directly. The Company is not aware of any plans by Canon to market directly in the Company's territory (to other than government customers, or major, national accounts, which market segments they have traditionally reserved), or to authorize additional dealers. Based upon overall performance by existing dealers, the Company believes that the historical disinclination of Canon to authorize additional area dealers remains unchanged at present. The Company knows of no adverse developments regarding its dealer agreement with its principal vendor, Canon.\nThe principal competitive factors affecting the Company are product recognition, the ability to deliver an efficient service and repair capability, and price. As the Company's line of copiers is principally manufactured by an overseas vendor, there exists the risk of currency fluctuations or trade embargoes affecting the pricing or delivery of the Company's products.\nSALES AND MARKETING\nThe Company markets its products directly through its own selling organization consisting of twenty-two sales representatives, four sales managers and the Company President. The sales representatives are organized by geographic area. The sales representatives are full-time employees and are compensated through a combination of salary, commissions and bonuses for sales in excess of quotas.\nThe sales organization is supported by presentation materials, customer literature and media advertising in both radio and print. In addition, the Company's product lines are advertised on a national basis by the equipment manufacturers.\nLEGAL PROCEEDINGS\nThere is no material legal proceeding to which the Company is a party or any such legal proceeding contemplated of which the Company is aware.\nEMPLOYEES\nAt June 30, 1995, the Company employed 93 full-time persons. None of the Company's employees are represented or covered by collective bargaining agreements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties -------------------\nSee the \"Properties\" sections of Part I, Item 1(c), \"Narrative Description of Business\" for details concerning the properties of each subsidiary company comprising, in the aggregate, the properties of the Registrant.\nItem 3.","section_3":"Item 3. Legal Proceedings --------------------------\nThe only material pending legal proceedings to which the Company is a party or any such legal proceedings contemplated of which the Company is aware are (a) a previously disclosed lawsuit in the Court of Chancery of the State of Delaware currently on appeal, and (b) a previously disclosed lawsuit pending in the Superior Court of the District of Columbia.\n(a) As previously reported by the Company, on March 12, 1990, the controlling stockholders of the Company, George Wm. Erikson and Robert W. Erikson (together, the \"Eriksons\"), executed a letter of intent and subsequently executed four amendments thereto (collectively referred to herein as the \"Letter of Intent\") with Insituform Technologies, Inc. (\"ITI\") (formerly Insituform of North America, Inc. or \"INA\") to effect a sale of their controlling interest in the Company to ITI for $6,000,000 (the \"Proposed Transaction\"). The Proposed Transaction, if consummated, would have had the effect of making ITI the controlling stockholder of the Company, and, indirectly, of each of the Company's three direct subsidiaries at the time, Insituform East, Capitol Copy, and CERBERONICS. On September 19, 1990, the Eriksons informed the Company that the Letter of Intent had expired without consummation of any transaction, that it would not be further extended, that negotiations had ceased, and that the Eriksons had no further intention at the time of pursuing the proposed sale of their controlling interest in the Company to ITI.\nAs previously reported by the Company, on August 24, 1990, a complaint was filed in the Court of Chancery of the State of Delaware in and for New Castle County (the \"Court of Chancery\") by two stockholders of the Company, Merle Thorpe, Jr. and the Foundation for Middle East Peace. The complaint is captioned Merle Thorpe, Jr. and Foundation for Middle East Peace v. CERBCO, Inc., et al., C.A. No. 11713. The complaint, as amended, is hereinafter referred to as the \"Complaint.\" Defendants to the Complaint are the Company and the Eriksons.\nThe Complaint, which stated that it was filed by plaintiffs on their own behalf and derivatively on behalf of the Company, sought (i) damages against the individual defendants for alleged breach of fiduciary duties in an amount not less than $6,000,000, together with interest thereon from March 12, 1990; (ii) to permanently enjoin the Eriksons from completing any transaction between the Eriksons and ITI similar in substance to the Proposed Transaction; (iii) a declaration of the invalidity of the 1982 authorization for and issuance of the Company's Class B Common Stock, and, therefore, of the entitlement of holders of Class B Common Stock to elect any members of the Company's Board; (iv) a declaration of the invalidity of the 1990 election of the Company's directors and the issuance of new proxy materials that fully and fairly disclose all facts which plaintiffs claim are material to the election of directors; (v) an award to plaintiffs of their costs of bringing the action, including reasonable attorneys' fees; and (vi) an award to plaintiffs of such further relief as the Court of Chancery deemed appropriate. In addition, the Complaint asserted a claim against the individual defendants alleging that the Company has forgone a corporate opportunity by the continued failure to pursue a transaction with ITI.\nOn May 1, 1991, the Company and the Eriksons filed with the Court of Chancery a Motion to Dismiss the Complaint. Oral argument on the Motion to Dismiss was heard on November 7, 1991 and, on November 15, 1991, the Court issued its Memorandum and Order on the motion. The Court granted defendants' motion to dismiss some of the claims, but denied defendants' motion with respect to two of the counts in the litigation. The claims remaining in the litigation at that time were plaintiffs' allegations in Count I that the Proposed Transaction was an opportunity belonging to the Company and that the Eriksons breached their duty to the Company by precluding the Company from taking advantage of that opportunity so that the Eriksons might have a chance to do so, and in Count II that the Company's 1982 proxy statement was false or misleading and, as a result, the Company's recapitalization should be rescinded.\nFollowing receipt of the Court of Chancery's opinion and order, as part of the discovery process, the parties began responding to written interrogatories and producing documents. Plaintiffs began taking the oral depositions of witnesses, and the Eriksons took the oral deposition of plaintiffs. On September 16, 1992, the Company filed a Motion for Summary Judgment on Count II of the Complaint, which related to the 1982 recapitalization. The basis of this motion was that the plaintiffs lacked standing to make claims relating to the recapitalization since they were not stockholders at the time. The Eriksons also filed a Motion for Summary Judgment as to Count II of the Complaint on the same basis. Following briefing on the motions, the Court issued its Memorandum Opinion and Order on January 26, 1993. The Court granted Summary Judgment and dismissed Count II of the Complaint, which sought rescission of the Company's 1982 recapitalization.\nOn December 21, 1992, the Eriksons filed a Motion for Summary Judgment on Count I of the Complaint. The basis of this motion was that the plaintiffs are not proper derivative representatives and that their counsel, Hogan & Hartson, is not appropriate derivative counsel. The Eriksons also filed a Motion for Summary Judgment on the merits of Count I of the Complaint. The basis of this motion was that (i) there never was a corporate opportunity available to the Company to sell its controlling position in Insituform East to ITI; (ii) the Eriksons did not preclude a transaction between the Company and ITI or misuse their fiduciary positions; and (iii) plaintiffs have not shown any damages. The Company informed the Court of Chancery that it supported the Motion for Summary Judgment on the merits of Count I. Oral argument on both of the motions was held before the Court of Chancery on July 23, 1993.\nOn October 29, 1993, the Court of Chancery issued its Memorandum Opinion on the Eriksons' Motion for Summary Judgment on the merits of Count I. The Court of Chancery did not grant summary judgment, because it did not believe that the record was sufficiently established.\nOn November 1, 1993, plaintiffs served the Company and the Eriksons with additional discovery requests. On November 5, 1993, the Eriksons filed a Motion for Clarification, Reargument or Supplemental Briefing, together with a Motion to Stay the Discovery served by plaintiffs until the issues raised by their other motions were resolved. The Company informed the Court of Chancery that it supported the motions filed by the Eriksons.\nOn January 20, 1994, the Court of Chancery issued its opinion denying the Eriksons' Motion for Clarification, Reargument, or Supplemental Briefing. The Court reiterated its prior holding that the record was not sufficiently established to grant the Eriksons' Motion for Summary Judgment.\nOn May 6, 1994, the Eriksons filed a Motion for Summary Judgment on the issue of whether any corporate opportunity existed for the Company to enter into a transaction with ITI. On May 31, 1994, the Court of Chancery issued an opinion stating that a full factual record should be developed at trial before it ruled on the legal issues presented in the Eriksons' motion. Trial in this matter was held before Chancellor Allen beginning on February 21, 1995.\nFollowing post-trial briefing and argument, Chancellor Allen issued an opinion on August 9, 1995, in which he ruled in favor of the Eriksons. The court determined that, while the Eriksons failed in certain limited respects to meet the standards of loyalty required of them under Delaware corporate law, that \"deviation from proper corporate practice\" neither caused injury to CERBCO nor resulted in any substantial gain to the Eriksons. The Court also found that the Eriksons met their burden of showing that their conduct was \"wholly fair to the corporation.\" With this decision, all of the plaintiffs' claims have been resolved in favor of CERBCO and\/or the Eriksons.\nOn August 25, 1995, the Court of Chancery issued its Memorandum and Order on Final Judgment and a corresponding Final Order and Judgment, which latter document formally entered judgment in favor of the Eriksons and denied in toto the plaintiffs' request for legal fees and expenses totaling $1,513,499. The Court concluded that the litigation conferred no substantial benefit on CERBCO, so that it would be inappropriate to require CERBCO and its stockholders to share the costs that plaintiffs incurred.\nPlaintiffs filed a Notice of Appeal with the Delaware Supreme Court on August 30, 1995. Plaintiffs' opening Delaware Supreme Court brief is due on October 16, 1995.\n(b) As previously reported by the Company, on January 5, 1993, a separate lawsuit arising out of the subject matter of Count I of the Court of Chancery lawsuit was filed in the Superior Court of the District of Columbia (the \"Superior Court\"). The plaintiffs are Merle Thorpe, Jr. and the Foundation for Middle East Peace, the same two stockholders who filed the lawsuit in the Court of Chancery, and George Davies, a former director of the Company. The complaint is captioned Merle Thorpe, Jr., George Davies and Foundation for Middle East Peace v. John Paul Ketels, et al., C.A. No. 93-CA00051. That complaint is hereinafter referred to as the \"D.C. Complaint.\" Defendants to the D.C. Complaint are partners in the law firm of Rogers & Wells and the Company.\nThe D.C. Complaint, which states that it was filed on behalf of the Company, alleges that Rogers & Wells breached its duty of loyalty and care to the Company by representing allegedly conflicting interests of the Eriksons in the Proposed Transaction with ITI. The plaintiffs also claim that Rogers & Wells committed malpractice by allegedly making misrepresentations to the Company's Board and allegedly failing to properly inform the Company's Board. The plaintiffs claim that the conduct of Rogers & Wells caused the Company to lose an opportunity to sell its control of Insituform East to ITI, caused the Company to incur substantial expense, and unjustly enriched Rogers & Wells. The D.C. Complaint seeks to recover from Rogers & Wells (i) damages in an amount equal to all fees paid to Rogers & Wells, (ii) damages in an amount not less than $6,000,000 for the loss of the opportunity for the Company to sell its control of Insituform East to ITI, and (iii) punitive damages.\nThe plaintiffs did not make a demand on the Company's Board that the Company sue Rogers & Wells. The Company does not believe that Rogers & Wells should be sued on any of the claims set forth in the D.C. Complaint. On February 23, 1993, the Company filed a motion to dismiss the D.C. Complaint for failure of the plaintiffs to make a proper demand on the Company's Board. The Company also filed a motion to stay the proceedings to the Superior Court until the lawsuit pending in the Delaware Court of Chancery has been concluded. Similar motions were filed by Rogers & Wells. On March 14, 1993, the Superior Court denied the motions to dismiss, but granted a stay of the proceedings in that court until a ruling was made on the motions pending in the Delaware Court of Chancery.\nOn January 14, 1994, the plaintiffs and Rogers & Wells submitted status reports to the Superior Court. The Superior Court held a status conference on February 16, 1994 and established a tentative trial date for November 28, 1994. On July 28, 1994, in light of the scheduled trial in the Delaware Court of Chancery, the Superior Court stayed all proceedings in this case until further order. A status report on the Delaware action was submitted by the parties on April 3, 1995.\nAfter the Court of Chancery's August 9, 1995 opinion was rendered, the parties to the Superior Court action filed additional status reports. The Superior Court has scheduled the next status hearing for October 30, 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 Registrant's Common Equity and Related Stockholder Matters ----------------------------------------------------------\n(a) Market Information\n(i) Common Stock\nCERBCO's Common Stock is traded in the over-the-counter market and is included in the National Association of Securities Dealers (\"NASD\") National Market System (\"NMS\"). Quotations for such shares are reported in the National Association of Securities Dealers Automated Quotations (\"NASDAQ\") System under the trading symbol CERB. Holders of Common Stock have one vote per share on all matters on which stockholders are entitled to vote together. The following table shows the range of bid quotations for the period indicated as reported by NASDAQ:\nThe quotations in the above table represent prices between dealers, without retail mark-ups, mark-downs or commissions, and may not necessarily represent actual transactions.\n(ii) Class B Common Stock\nThere is no public trading market for shares of CERBCO's Class B Common Stock. Holders of shares of Class B Common Stock have ten votes per share on all matters with the exception of the election of directors and any other matter requiring the vote of stockholders separately as a class. Holders of Class B Common Stock are entitled to elect the remaining directors after election of not less than 25% of the directors by the holders of Common Stock, voting separately as a class. Shares of Class B Common Stock are convertible at any time to shares of Common Stock on a share-for-share basis.\n(b) Holders\nAs of September 13, 1995, the approximate number of holders of each class of common equity of CERBCO was as follows:\nCommon Stock 354 Class B Common Stock 140\n(c) Dividends\nNo dividends were declared in 1995 or 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data -------------------------------- The selected financial data set forth below should be read in conjunction with the Company's consolidated 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 -----------------------------------\nOverview and Outlook --------------------\nCERBCO experienced consolidated earnings of $1,391,039 ($.96) from continuing operations and overall net earnings of $1,542,388 ($1.06), including a gain on disposal of discontinued operations, for its fiscal year ended June 30, 1995. The Company recognized earnings from continuing operations and an overall net earnings of $518,817 ($.36) for its fourth quarter. Sales were $39.1 million and $10.2 million for the fiscal year and the fourth quarter, respectively.\nOf particular note, net earnings per share from continuing operations rose dramatically from $0.01 to $0.04 to $0.96 over fiscal years 1993, 1994 and 1995. However, while there can be no assurances, the Company presently anticipates fiscal 1996 earnings per share to level out at or near fiscal 1995 results, and to then experience modest growth into the foreseeable future in the course of ordinary business operations.\nThe Company attributed its increased results to the excellent results of its two operating subsidiaries, each of which is in a separate industry segment. Both of the Company's operating subsidiaries recognized record sales in fiscal year 1995. Insituform East, the Company's pipeline rehabilitation segment, saw the favorable results experienced in the fourth quarter of fiscal year 1994 continue throughout fiscal year 1995. Insituform East's sales increased $6.8 million (45.9%) to $21.6 million, as it witnessed restored market demand and expanded its production capacity. Insituform East contributed $678,435 (up $631,274) in net earnings to CERBCO's fiscal year results. Capitol Copy, the Company's copy machine products and services segment, continued to improve its financial performance in fiscal year 1995. Capitol Copy's sales increased $2.5 million (16.7%) to $17.5 million, as it continued to sell more high volume, higher priced units and expanded its service and supply customer base. Capitol Copy contributed $1,592,909 (up $482,726) in net earnings to CERBCO. The Company also benefited in fiscal year 1995 from a gain from discontinued operations of $151,349 obtained from final payment of the last few open government contracts of the Company's wholly-owned subsidiary, CERBERONICS, now no longer operating.\nSubsidiary contributions were offset by unallocated net general corporate expenses in the amount of $880,305, including $537,616 related to the demands made of, and litigation being continued against, the Company by two associated, minority stockholders in connection with the unconsummated private sale of a controlling interest in the Company abandoned in September 1990. From inception in 1990 through the year ended June 30, 1995, legal fees and expenses resulting from this litigation totaled approximately $2.0 million. In August 1995, a Final Order and Judgment was rendered by the Court in favor of the defendants which has been appealed to the Delaware Supreme Court by plaintiffs. In addition, in August 1995, plaintiffs in such litigation asserted a claim directly against the Company for $1,513,499 for their legal fees and expenses in the unsuccessful suit, subsequently denied in the Court's Final Order and Judgment, but reasserted in plaintiffs' appeal. The Company cannot, of course, predict the outcome of pending litigation, including appeals. Any outcome from the appeal resulting in an award to plaintiffs of their legal fees and expenses could have a material adverse effect on the earnings of the Company. For additional information on the status of this litigation, see Part I, Item 3, \"Legal Proceedings.\"\nFor financial information relating to CERBCO's two operating segments, see Part I, Item 1(b), \"Financial Information about Industry Segments.\"\nAfter experiencing two years of depressed sales in fiscal years 1993 and 1994, Insituform East saw a return in 1995 to a level of sales achieved during the four-year period from 1989 to 1992 when it recorded sales of $21.2 million, $19.5 million, $21.3 million and $19.4 million, respectively. While there can be no assurances regarding future operating performance, based on the volume and mix of Insituform East's present and expected backlog of customer orders, the favorable results experienced during fiscal 1995 are presently anticipated to continue through fiscal year 1996. Insituform East intends to further expand its production capabilities during fiscal year 1996 to both increase its Insituform installation capacity for the future and to extend further its ability to provide complimentary products and services to its trenchless rehabilitation customers.\nThe Company believes the trenchless pipeline reconstruction marketplace is continuing to expand, thereby enticing, however, the entry of ever more imitations and substitute products hoping that cheap price alone may permit them to succeed in a market otherwise dominated by the Insituform process. In those limited markets where the cheapest priced product may be deemed technically \"good enough,\" the Insituform process is at a disadvantage. Conversely, the Company is encouraged that a majority of its municipal, Federal government and industrial customers already use or are implementing ever-improving procurement specifications and contract award evaluation criteria emphasizing technical value instead of simply low price. In value and quality based procurements, the Insituform process remains at an advantage. The Company continues to believe that customers and consulting engineers using quality based purchasing criteria help to ensure long term solutions to their infrastructure needs by clearly differentiating proven products such as provided by the Insituform process from cheaply priced trenchless substitutes with technical, performance and installation risks not equally tested by time or independent third parties.\nThe principal factor affecting Insituform East's future performance remains the volatility of earnings as a function of sales volume at normal margins. Accordingly, because a substantial portion of Insituform East's costs are semi-fixed in nature, earnings can, at times, be severely reduced or eliminated during periods of depressed sales at normal margins or material increases in discounted sales, even where total revenues experience an apparent buoyancy or growth from the addition of discounted sales undertaken from time to time for strategic reasons. Conversely, at normal margins, increases in period sales typically leverage positive earnings significantly.\nCapitol Copy has increased sales in each of the last five years, growing from sales of $9.5 million in fiscal year 1991 to $17.5 million in fiscal year 1995, in a sales and service territory consisting of the cities and counties in the Washington, D.C. metropolitan area. The Company believes that the favorable results from this territory should continue into the next fiscal year. In July 1995, Capitol Copy expanded its territory to include the contiguous Baltimore metropolitan area. The Company anticipates that it will take approximately four years to adequately develop the additional territory. While it is estimated that sales in this new territory could reach approximately $2 million by June 30, 1996, start up costs and expenses are expected to exceed revenues by approximately $200,000 during the initial 1996 fiscal year. Development of the additional territory over the estimated four-year period is not anticipated to impact materially on continuing overall annual operating results.\nAs further discussed in Part II, Item 8, \"Notes to Consolidated Financial Statements - Note 13: Contingencies,\" the Company has filed a demand for arbitration and Insituform Technologies, Inc. (\"ITI\") has initiated litigation in connection with the acquisition of control of a 42.5% interest in MIDSOUTH Partners by Insituform Mid-America, Inc. (\"IMA\") on April 18, 1995. ITI has agreed to postpone its litigation in connection with a joint announcement by ITI and IMA on May 24, 1995 that they had entered into a definitive agreement providing for the combination of ITI and IMA which, if consummated, would result in IMA becoming a wholly-owned subsidiary of ITI. Although the Company cannot, at this time, predict the eventual outcome of these matters and their impact on the Company's interest in the Partnership, any potential outcome that resulted in the loss by the Company of its ability to recognize its share of the results of operations of MIDSOUTH Partners could have a material adverse effect on the future earnings of the Company.\nResults of Operations ---------------------\nThe following table sets forth, for the periods indicated, the relative percentages that certain items of expense and earnings bear to the sales of CERBCO and the percentage increases in the dollar amounts of each item from period to period.\n1995 vs 1994 ------------\nConsolidated sales increased $9.3 million (31.2%) in 1995 as compared to 1994 as sales increased in both of the Company's operating segments. Insituform East's sales increased $6.8 million (45.9%), primarily due to available work and expanded production capacity associated with the addition of another installation crew during the second quarter of fiscal year 1995. Insituform East achieved sales volume increases at normal margins in all three of its market sectors -- municipal, Federal government and industrial. Sales in these three areas were 65%, 21% and 14%, respectively, of Insituform East's fiscal year 1995 sales. Capitol Copy's sales increased $2.5 million (16.7%) in 1995. While equipment sales increased 8.5%, reflecting some increase in the sales of high volume machines which typically sell at higher prices, copier service and supply revenues increased 24.7% primarily due to an increase, net of cancellations, in service contracts resulting from an expanding customer base.\nOperating profit increased $3.3 million (149.9%) in 1995 as compared to 1994 due primarily to Insituform East achieving an operating profit of $2.5 million in 1995 after an operating loss of -$0.2 million in 1994. Insituform East's gross profit margin increased from 22.5% to 30.5% as its semi-fixed operating costs were absorbed over increased sales in 1995. Insituform East's selling, general and administrative costs increased 15.7%, a smaller percentage increase than sales, primarily as a result of costs associated with increased production activities. Capitol Copy's operating profit increased $1.1 million (35.0%) to $4.1 million, as overall gross profit increased slightly from 39.2% to 41.4% and general and administrative costs increased 11.3%, a smaller percentage increase than sales. The parent company's operating loss increased $0.4 million primarily due to an increase in corporate legal expenses.\nInsituform East's equity in the operating results of MIDSOUTH Partners increased $0.6 million (377.3%) in 1995 as compared to 1994, primarily as a result of a 43.5% increase in MIDSOUTH Partners' comparable period sales from $6.2 million to $8.9 million. The increase in sales was due to consistently high production levels throughout the year and increased sales to Federal government customers. The Partnership's gross profit margin increased from 21.1% in 1994 to 30.7% in 1995 due in part to improved production efficiency, the mix of contracts performed and the absorption of semi-fixed operating costs over increased sales.\nThe gain on disposal of discontinued operations decreased from $0.7 million in 1994 to $0.1 million in 1995, primarily due to the receipt of a substantial one-time payment in 1994 in connection with the discontinued operations of CERBERONICS resulting from the settlement of a lawsuit with the U.S. Navy (see Part II, Item 8, \"Notes to Consolidated Financial Statements -- Note 7: Discontinued Operations\").\n1994 vs 1993 ------------\nConsolidated sales increased $5.1 million (20.5%) in 1994 as compared to 1993 as sales increased in both of the Company's operating segments. Insituform East's sales increased $1.7 million (13.0%), primarily due to increased purchasing activity from its Federal government customers and increases in additional rehabilitation services performed in conjunction with contracted Insituform process installations. Capitol Copy's sales increased $3.4 million (28.9%)in 1994. Equipment sales increased 31.0%, primarily due to the placement of more machines in total and more high volume machines, which typically sell at higher prices. Copier service and supply revenues increased 26.9%, primarily due to an increase, net of cancellations, in service contracts resulting from an expanding customer base.\nThe Company had an operating profit of $2.2 million in 1994 as compared to an operating loss of -$0.7 million in 1993. Insituform East had an operating loss of -$0.2 million in 1994 as compared to an operating loss of -$2.0 million in 1993. While Insituform East's sales volume increased in 1994, its gross profit margin improved from 16.8% to 22.5%, and its selling, general and administrative expenses were reduced by $0.6 million, these improvements were not enough to offset the effect of semi-fixed operating costs on (still) reduced sales volume. Capitol Copy had an operating profit of $3.0 million (up 53.7%) in 1994, primarily due to its substantial increase in sales. While Capitol Copy's gross profit margin decreased from 40.2% in 1993 to 39.2% in 1994, its operating profit margin increased from 16.7% to 20.0%, primarily due to a much smaller increase in general and administrative expenses (5.3%) than its increase in sales. The parent company's operating loss decreased, primarily as a result in a decrease in allocated corporate legal expenses.\nInsituform East's equity in the operating results of MIDSOUTH Partners decreased $0.2 million in 1994 as compared to 1993 primarily due to a decrease in comparable period sales from $8.1 million to $6.2 million and the mix of contracts performed. Similar to the experience of Insituform East, MIDSOUTH Partners' earnings can be significantly reduced during periods of depressed sales due to the semi-fixed nature of a substantial portion of its operating costs.\nAs referred to above, the Company recognized a gain on disposal of discontinued operations of $0.7 million in 1994 in connection with its discontinued defense contract segment, CERBERONICS. In 1993, the Company recognized a loss of -$0.2 million from the discontinued cement mortar lining operations of Insituform East and an estimated loss or disposal of these operations of $0.1 million (see Part II, Item 8, \"Notes to Consolidated Financial Statements -- Note 7: Discontinued Operations\").\nLiquidity and Capital Resources -------------------------------\nLiquidity may be defined as the Company's ability to mobilize cash. Cash and cash equivalents increased $3.0 million in fiscal year 1995. Insituform East's cash and cash equivalents increased $2.0 million, and Capitol Copy's cash and cash equivalents increased $1.1 million. At the holding company level, CERBCO's cash and cash equivalents decreased $0.1 million. Consolidated cash and cash equivalents decreased $1.9 million and $0.3 million in fiscal years 1994 and 1993, respectively. However, CERBCO purchased temporary investments of $2.3 million in fiscal year 1994.\nThe Company's operating activities provided approximately $4.7 million in cash during fiscal year 1995, primarily due to the earnings of the Company's two operating subsidiaries and non-cash expenses by it and its subsidiaries for depreciation and amortization. Income taxes payable increased $0.4 million at June 30, 1995. Insituform East's income taxes payable increased $0.4 million as a result of the timing of payment of fiscal year 1995 estimated federal and state income tax deposits. Net cash provided by operating activities was approximately $1.9 million during fiscal year 1994, primarily due to the increased earnings of Capitol Copy, the receipt by CERBCO of the C-9 lawsuit settlement payment plus interest, and non-cash expenses for depreciation and amortization. These accounts were offset by an increase in accounts receivable at June 30, 1994. Insituform East's accounts receivable increased $2.6 million, primarily due to a $2.3 million increase in sales in the fourth quarter of fiscal year 1994 as compared with the fourth quarter of fiscal year 1993. Despite a net loss in fiscal year 1993, net cash provided by operating activities was approximately $0.8 million, primarily as a result of non-cash expenditures for depreciation and amortization and a decrease in accounts receivable at June 30, 1993. Insituform East's accounts receivable decreased $1.9 million, primarily due to a $2.2 million decrease in sales for the fourth quarter of fiscal 1993 as compared with the fourth quarter of fiscal 1992.\nNet cash used in investing activities was approximately $1.0 million, $2.8 million and $0.7 million in fiscal years 1995, 1994 and 1993, respectively. The primary use of such funds was for capital expenditures by Insituform East in each of the fiscal years and the purchase by the parent company of six- month treasury bills, accounted for as temporary investments, in fiscal year 1994. Insituform East's capital expenditures in fiscal year 1995 included purchases of vehicles and equipment to expand the Company's production capabilities, in addition to replacing aging units. Fiscal year 1994 and 1993 expenditures were primarily to replace aging units. Insituform East also received cash distributions of $123,250 and $340,000 from MIDSOUTH Partners in fiscal years 1995 and 1993, respectively.\nNet cash used in financing activities was $0.7 million, $0.9 million and $0.4 million in fiscal years 1995, 1994, and 1993, respectively, primarily as the result of paydowns by Capitol Copy on its line of credit in each of the three years and on long-term borrowings in fiscal years 1994 and 1993. During fiscal years 1995, 1994 and 1993, Insituform East paid cash dividends declared for fiscal years 1994, 1993 and 1992, respectively. During fiscal year 1993, Insituform East also expended $94,630 for the open-market purchase of shares of its Common Stock.\nCERBCO believes that its two principal operating subsidiaries, Insituform East and Capitol Copy, have cash reserves, existing open bank lines of credit or borrowing potential against unencumbered assets sufficient to meet the respective cash flow requirements for operating funds and capital expenditures of each operating company. Insituform East has available as undrawn the amount of $3.0 million on its individual line of credit. Capitol Copy did not deem it necessary to renew its line of credit which expired January 31, 1995. Its cash reserves were in excess of $1.0 million at June 30, 1995 and are expected to grow further in fiscal year 1996. The parent holding company, CERBCO, also does not have a separate bank line of credit, but has cash reserves in excess of $2.5 million which are believed to be adequate to meet its own cash flow requirements, or the requirements of its subsidiaries, in the foreseeable future, including continuing legal fees and expenses of the parent in connection with the stockholder litigation now on appeal to the Delaware Supreme Court. The Company cannot, of course, predict the outcome of pending litigation, including appeals. Any outcome that resulted in an award to plaintiffs of their legal fees and expenses, however, could have a material adverse effect on the future liquidity of the Company.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data ----------------------------------------------------\nSee financial statements and supplementary financial information provided following Item 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 of CERBCO, Inc.\nWe have audited the accompanying consolidated balance sheets of CERBCO, Inc. 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 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 CERBCO, 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.\n\/s\/ Deloitte & Touche LLP Deloitte & Touche LLP\nSeptember 15, 1995 Washington, D.C.\nCERBCO, Inc.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1995, 1994 AND 1993\n1. Summary of Significant Accounting Policies\nBasis of Presentation ---------------------\nThe consolidated financial statements include the accounts of the parent holding company, CERBCO, Inc. (\"CERBCO\"); its majority-owned subsidiary, Capitol Copy Products, Inc. (\"Capitol Copy\"); and its majority-controlled subsidiary, Insituform East, Incorporated (\"Insituform East\"). All significant intercompany balances and transactions have been eliminated in consolidation.\nReclassification ----------------\nInterest received during the fiscal year ended June 30, 1994, in connection with settlement of the lawsuit described in Note 7, has been reclassified to the gain from discontinued operations in the consolidated statement of operations for fiscal year 1994. Previously, this amount had been reported as investment income.\nBusiness Operations -------------------\nCERBCO is a parent holding company with controlling interests in two principal subsidiaries, each of which is in a separate industry segment. Insituform East, operating pursuant to sublicense agreements with Insituform Technologies, Inc. (\"ITI\"), provides a patented process called \"Insituform\" primarily to municipalities and state agencies for the repair and reconstruction of sewers and other types of pipelines. The Insituform\/R process creates a hard, jointless, impact and corrosion resistant Insitupipe\/R product inside deteriorating pipes, with a principal benefit that it can usually be installed without excavation. Capitol Copy is in the business of selling, servicing and providing supply products for copier and facsimile equipment, operating pursuant to certain dealer agreements, primarily with Canon, U.S.A., Inc.\nRevenue Recognition -------------------\nThe Company recognizes revenue under contracts to rehabilitate pipeline sections using the units of completion method. A rehabilitated pipeline section is considered completed work and is generally billable to the customer.\nSales of copier and facsimile equipment are recorded as revenue on the date the equipment is shipped. Revenue from maintenance contracts is recognized ratably over the terms of the agreements.\nCash and Cash Equivalents -------------------------\nCash and cash equivalents are composed of unrestricted checking accounts and short-term investments in repurchase agreements, money market funds, certificates of deposit and U.S. Treasury instruments. For purposes of the consolidated statements of cash flows, the Company considers only highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nTemporary Investments ---------------------\nTemporary investments are composed of U.S. Treasury instruments with maturities of greater than three months. Temporary investments are stated at cost plus accrued interest which approximates market.\nInventories -----------\nInventories are stated at the lower of cost or market. Cost for pipeline rehabilitation materials is determined by the first-in, first-out method. Cost for copier and facsimile equipment, supplies and parts is determined by the average cost method.\nProperty, Plant and Equipment -----------------------------\nProperty, plant and equipment are stated at cost. Depreciation has been provided in the financial statements using the straight-line or declining balance methods at rates which are based upon reasonable estimates of the properties' useful lives. These lives range from three to ten years for vehicles, equipment and furniture, and twenty to forty years for buildings. Leasehold improvements are amortized using the straight-line method over the life of the lease.\nBetterments or improvements which increase the estimated useful life of an asset are capitalized. Repairs and maintenance are charged directly to expense as incurred. The Company incurred repair and maintenance costs of $824,000, $567,000 and $771,000 in fiscal years 1995, 1994 and 1993, respectively.\nGoodwill --------\nThe excess of cost over the fair values of the Insituform East and Capitol Copy net tangible assets (\"goodwill\") acquired in 1985 and 1987, respectively, is amortized using the straight-line method over forty years. The Company annually reviews its goodwill recoverability by assessing the historical profitability of its segments and expectations as to future nondiscounted cash flows and operating income for each segment, as well as: the continued use of the segments' names; the continued use of Insituform East's license agreements and the status of various patents which govern the Insituform process; and the success of Capitol Copy in meeting its commitments under its dealer agreements. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at June 30, 1995.\nIncome Taxes ------------\nThe Company provides for federal and state income taxes at the statutory rates in effect on taxable income. Deferred income taxes result from recognizing certain items of income and expense in consolidated financial statements in different years from those in income tax returns. These temporary differences relate principally to use of accelerated depreciation methods for tax purposes; timing of the payment of compensated absences; timing of the recognition of income from the Company's investment in MIDSOUTH Partners (see Note 6: Investment in Unconsolidated Affiliate); and timing of the recognition of income from certain lease transactions and maintenance contracts.\nThrough September 30, 1992, CERBCO filed consolidated federal and state tax returns, which included the results of Capitol Copy. Beginning October 1, 1992, Capitol Copy filed separate federal and state tax returns. Taxes are reported in the financial statements for this subsidiary as if it filed separate returns for all periods through September 30, 1992. The difference between the total taxes so reported for the subsidiary and the consolidated expense was reported as part of the parent company's tax expense. The parent therefore received the benefit of, or charge for, any difference between the consolidated tax provision and separate return provisions.\nInsituform East files separate federal and state tax returns, and its provision is combined with CERBCO's consolidated provision. Capitol Copy's provisions for all periods beginning after September 30, 1992 are also combined with CERBCO's consolidated provisions.\n2. Accounts Receivable\n3. Inventories\n4. Equity in Insituform East\nAt June 30, 1995 and 1994, CERBCO beneficially held 1,100,000 shares of Insituform East Common Stock and 296,141 shares of convertible Insituform East Class B Common Stock representing approximately 27.1% of the Common Stock, 99.5% of the Class B Common Stock, 32.0% of the total equity and 57.7% of the total voting power of all outstanding classes of Insituform East stock. Holders of Class B Common Stock, voting separately as a class, have the right to elect the remaining members of the Board of Directors after election of not less than 25% of the directors by holders of shares of Common Stock, voting separately as a class.\nFrom time to time, Insituform East issues additional shares of stock as a result of stock dividends and exercised stock options. Changes in capital structure resulting from such additional stock issues decrease CERBCO's equity ownership. No additional shares were issued in 1995, 1994 or 1993. If all the options and warrants outstanding at June 30, 1995 were exercised, the resulting percentages of CERBCO's equity ownership and total voting power would be 29.7% and 55.0%, respectively.\nFrom time to time, Insituform East purchases shares of stock for treasury. Changes in capital structure resulting from such stock purchases increase CERBCO's equity ownership. Insituform East purchased 23,285 Common shares in 1993.\n5. Equity in Capitol Copy\nAt June 30, 1995 and 1994, CERBCO beneficially held 800 shares, and Capitol Copy's president held 400 shares, of Capitol Copy Class B Stock, representing 66 2\/3% and 33 1\/3%, respectively, of the one outstanding class of Capitol Copy stock.\n6. Investment in Unconsolidated Affiliate\nMIDSOUTH Partners was organized as a Tennessee general partnership in December 1985. The following corporations are its general partners:\nInterest in Profits and Losses\nInsitu, Inc. (a subsidiary of Insituform East) 42.5% E-Midsouth, Inc. (a subsidiary of Enviroq Corporation) 42.5% Insituform California, Inc. (a subsidiary of ITI) 15.0%\nMIDSOUTH Partners operates as the Insituform process sublicensee for Tennessee, Kentucky (excluding Boone, Kenton and Campbell counties) and northern Mississippi.\nThe following is condensed financial information of MIDSOUTH Partners at June 30, 1995, 1994 and 1993, and for each of the three years in the period ended June 30, 1995:\n7. Discontinued Operations\nOn June 11, 1993, the Company adopted a formal plan to discontinue providing cement mortar lining services conducted through its pipeline rehabilitation segment, Insituform East. This plan included declining to bid on future cement mortar lining contracts, fulfilling existing commitments and selling remaining equipment and materials associated with this service capability. The Company substantially completed two existing contracts in progress and sold substantially all remaining equipment and materials during the year ended June 30, 1994.\nOperating results from cement mortar lining activities for the years ended June 30, 1994 and 1993 are presented separately in the accompanying Consolidated Statements of Operations. Sales revenues from cement mortar lining activities for the years ended June 30, 1994 and 1993 were $1,080,773 and $1,460,334, respectively. These amounts are not included in sales in the accompanying Consolidated Statements of Operations.\nInsituform East's loss from cement mortar lining activities was -$572,461, net of an income tax benefit of $366,000, in the fiscal year ended June 30, 1993. CERBCO's losses as a result of these activities, net of non-owned interests, was -$183,188 for the fiscal year ended June 30, 1993.\nInsituform East's estimated loss on the disposal of discontinued operations in fiscal year 1993 was -$391,000, net of an income tax benefit of $250,000, which represents an estimated loss on the disposal of equipment and materials used to provide cement mortar lining services (-$192,000, net) and a provision for additional operating losses (-$199,000, net) anticipated for the fiscal 1994 phase out period. CERBCO's estimated loss on the disposal of this capability, net of non-owned interests, was -$125,120 in fiscal year 1993. During the year ended June 30, 1994, Insituform East incurred actual disposal costs equal to its estimate in total. Disposal costs consisted of a loss on disposal of equipment and materials of -$146,000 (net) and operating losses of -$245,000 (net).\nOn March 31, 1991, the Company adopted a formal plan to discontinue the operations of its defense contract services segment conducted through its wholly-owned subsidiary, CERBERONICS, Inc. (\"CERBERONICS\"). The segment did not operate subsequent to June 30, 1991.\nOn December 14, 1993, the Company obtained payment of $991,520, consisting of a judgment for $871,649 plus interest of $119,871, resulting from settlement of a lawsuit against the U.S. Navy in connection with open proposals under CERBERONICS's former C-9 contract. The payment resulted in a gain from discontinued operations of $730,337 for the fiscal year ended June 30, 1994. During fiscal year 1995, the Company obtained final payment from the Federal government on five contracts completed by CERBERONICS on or before June 30, 1991. These payments resulted in a gain from discontinued operations of $151,349 for the fiscal year ended June 30, 1995. There are no material open items remaining that pertain to other former contracts of CERBERONICS.\n8. Supplemental Executive Retirement Plan\nThe Company has an unfunded supplemental pension plan for its three executive officers, effected January 1, 1994. The expense for this plan was $67,932 and $31,740 for the fiscal years ended June 30, 1995 and 1994, respectively. The Company's accrued liability for this plan, shown as Other Long-term Liabilities, was $99,672 and $31,740 as of June 30, 1995 and 1994, respectively.\nTo facilitate the payment of benefits, the Company has established a trust. Funds in the trust are included in the Company's balance sheet as Other Assets in the amounts of $254,060 and $73,203 at June 30, 1995 and 1994, respectively. This trust is subject to the claims of the Company's creditors in the event of bankruptcy or insolvency.\n9. Loans Payable\nInsituform East maintains a $3,000,000 bank line of credit which is available to it through December 31, 1996. Interest on borrowings against this line of credit is payable monthly at the bank's prime rate. The line is unsecured; however, Insituform East must comply quarterly with financial liquidity, net worth, tangible net worth and debt to equity leverage covenants. At June 30, 1995, the amount available as undrawn on this line was $3,000,000. Capitol Copy had a $1,500,000 bank line of credit which expired January 31, 1995. Capitol Copy did not deem it necessary to renew such line, as both it and Insituform East have agreements in place with the parent company, CERBCO, whereby each may borrow up to $1,000,000 for operating purposes from CERBCO at interest rates not less than the subsidiary would pay to its respective bank. At June 30, 1995, neither subsidiary had amounts outstanding under these agreements. The weighted average interest rate on Capitol Copy's outstanding balance on its line at June 30, 1994 was 7.1%.\n10. Accounts Payable and Accrued Liabilities\n11. Long-Term Debt\n12. Commitments\nThe Company utilizes certain equipment and facilities under operating leases providing for payment of fixed rents and the pass-through of certain landlord expenses. Rental expense was approximately $480,000, $328,000 and $250,000 for the years ended June 30, 1995, 1994 and 1993, respectively. In addition, the Company obtains vehicles and computer and other office equipment under long-term capital leases. Accumulated amortization under capital leases was $74,782 and $40,019 as of June 30, 1995 and 1994, respectively. Minimum future rental commitments under long-term capital and operating leases in effect at June 30, 1995, are as follows:\nInsituform East operates under six sublicense agreements with ITI. The sublicenses grant Insituform East exclusive rights for use of the Insituform process in the states of Maryland, Virginia, Delaware, the District of Columbia, Pennsylvania, Ohio, West Virginia and three Kentucky counties. The agreements are for the life of the patents or the patent rights unless terminated sooner by a specified action of either party. The agreements obligate Insituform East to pay ITI a certain minimum annual royalty, as well as royalties based on the gross contract price of all contracts performed. Payments of minimum annual royalties for the years ended June 30, 1996 and 1995 have been waived by ITI. The total royalty expense was $1,354,000, $920,000 and $872,000 for the years ended June 30, 1995, 1994 and 1993, respectively.\nInsituform East has a supply agreement with ITI committing Insituform East to purchase 90% of its Insitutube\/R material requirements from ITI. As a result of certain terms not previously fulfilled by ITI, the Company believes it is no longer required to purchase 90% of its Insitutube material requirements from ITI under the otherwise continuing agreement. The agreement, which presently extends through April 30, 1996, is renewable annually unless notice of termination is provided by either party six months prior to the end of the current renewal period.\n13. Contingencies\nIn March 1990, the controlling stockholders of the Company, George Wm. Erikson and Robert W. Erikson (together, the \"Eriksons\"), executed a letter of intent and subsequently executed four amendments thereto (collectively referred to herein as the \"Letter of Intent\") with Insituform Technologies, Inc. (\"ITI\") to effect a sale of their controlling interest in the Company to ITI for $6,000,000 (the \"Proposed Transaction\"). The Proposed Transaction, if consummated, would have had the effect of making ITI the controlling stockholder of the Company, and, indirectly, of each of the Company's three direct subsidiaries at the time, Insituform East, Capitol Copy, and CERBERONICS. In September 1990, the Eriksons informed the Company that the Letter of Intent had expired without consummation of any transaction, that it would not be further extended, that negotiations had ceased, and that the Eriksons had no further intention at the time of pursuing the proposed sale of their controlling interest in the Company to ITI.\nIn August 1990, a complaint against the Company and the Eriksons was filed in the Delaware Court of Chancery by two stockholders of the Company, on their own behalf and derivatively on behalf of the Company, which sought (i) damages against the individual defendants for alleged breach of fiduciary duties in an amount not less than $6,000,000, together with interest thereon from March 12, 1990; (ii) to permanently enjoin the Eriksons from completing any transaction with ITI similar in substance to the Proposed Transaction; (iii) a declaration of the invalidity of the 1982 authorization for and issuance of the Company's Class B Common Stock, and, therefore, of the entitlement of holders of Class B Common Stock to elect any members of the Company's Board; (iv) a declaration of the invalidity of the 1990 election of the Company's directors and the issuance of new proxy materials that fully and fairly disclose all facts which plaintiffs claim are material to the election of such directors; (v) an award to the plaintiffs of their costs of bringing the action, including reasonable attorneys' fees; and (vi) an award to plaintiffs of such further relief as the Court of Chancery deemed appropriate. In addition, the Complaint asserted a claim against the individual defendants alleging that the Company had forgone a corporate opportunity by the continued failure to pursue a transaction with ITI.\nAll but one of the plaintiffs' claims subsequently were dismissed. The claim remaining in the litigation was plaintiffs' allegation that the Proposed Transaction was an opportunity belonging to the Company and that the Eriksons breached their duty to the Company by precluding the Company from taking advantage of that opportunity so that the Eriksons might have a chance to do so. Trial in this matter was held beginning February 21, 1995.\nFollowing post-trial briefing and argument, Chancellor Allen issued an opinion on August 9, 1995, in which he ruled in favor of the Eriksons. The court determined that, while the Eriksons failed in certain limited respects to meet the standards of loyalty required of them under Delaware corporate law, that \"deviation from proper corporate practice\" neither caused injury to CERBCO nor resulted in any substantial gain to the Eriksons. The Court also found that the Eriksons met their burden of showing that their conduct was \"wholly fair to the corporation.\" With the decision, all of the plaintiffs' claims have been resolved in favor of CERBCO and\/or the Eriksons.\nOn August 25, 1995, the Court of Chancery issued its Memorandum and Order on Final Judgment and a corresponding Final Order and Judgment, which latter document formally entered judgment in favor of the Eriksons and denied in toto the plaintiffs' request for legal fees and expenses totaling $1,513,499. The Court concluded that the litigation conferred no substantial benefit on CERBCO, so that it would be inappropriate to require CERBCO and its stockholders to share the costs that plaintiffs incurred.\nPlaintiffs filed a Notice of Appeal with the Delaware Supreme Court on August 30, 1995. Plaintiffs' opening Delaware Supreme Court brief is due on October 16, 1995.\nIn January 1993, a separate lawsuit against the partners in the law firm of Rogers & Wells and the Company, arising out of the subject matter of the Delaware litigation, was filed in the District of Columbia. The plaintiffs are the same two stockholders, and a former director of the Company, and have alleged that Rogers & Wells breached its duty of loyalty and care to the Company by representing allegedly conflicting interest of the Eriksons in the Proposed Transaction with ITI. The plaintiffs also claim that Rogers & Wells committed malpractice by allegedly making misrepresentations to the Company's Board and allegedly failing to properly inform the Company's Board. The plaintiffs claim that the conduct of Rogers & Wells caused the Company to lose an opportunity to sell its control of Insituform East to ITI, caused the Company to incur substantial expense, and unjustly enriched Rogers & Wells. The complaint seeks to recover from Rogers & Wells (i) damages in an amount equal to all fees paid to Rogers & Wells, (ii) damages in an amount not less than $6,000,000 for the loss of the opportunity for the Company to sell its control of Insituform East to ITI, and (iii) punitive damages. Although the complaint states that it was filed on behalf of the Company, management does not believe that Rogers & Wells should be sued on any of the claims set forth in the complaint.\nMotions to dismiss this case by the Company and Rogers & Wells were denied, but a stay in the proceedings was granted until after the Delaware trial. A status report on the Delaware action was submitted by the parties on April 3, 1995.\nAfter the Court of Chancery's August 9, 1995 opinion was rendered, the parties to the Superior Court action filed additional status reports. The Superior Court has scheduled the next status hearing for October 30, 1995.\nManagement believes there are valid defenses to all of plaintiffs' allegations in each of the above actions and that ultimate resolution of these matters will not have a material effect on the financial statements. Accordingly, no provision for these contingencies has been reflected therein.\nOn April 18, 1995, Insituform Mid-America, Inc. (\"IMA\") acquired the pipeline rehabilitation business of ENVIROQ Corporation (\"Enviroq\"), including Enviroq's 42.5% interest in MIDSOUTH Partners which is held through Enviroq's special purpose subsidiary, E-Midsouth, Inc. Under the MIDSOUTH Partners' Partnership Agreement, it is an event of default if, among other things, a change in the control of any partner occurs without the prior written consent of all the other partners. The IMA acquisition of Enviroq, which resulted in a change in the control of Enviroq and E-Midsouth, Inc., was made without the prior written consent of the Partnership's two other partners, special purpose subsidiaries of Insituform East and ITI.\nThe Partnership Agreement grants non-defaulting partners the right to require compliance with the agreement, enjoin any breach, seek dissolution of the partnership, replace Management Committee appointees of the defaulting partner, or exercise any combination of these and other remedies. Insituform East has filed with the American Arbitration Association a demand for arbitration alleging a breach of the Partnership Agreement by E- Midsouth, Inc. Separately, on April 4, 1995, ITI affiliated companies initiated action against Enviroq and IMA in Tennessee Chancery Court regarding ITI's rights as licensor to withhold consent to the assignment of Insituform and NuPipe license agreements. Simultaneously with the initiation of its suit, ITI entered into agreements with IMA and Enviroq to postpone, through April 30, 1995 (subsequently extended), the Tennessee court proceedings as well as any other assertion by ITI of its rights under Insituform and NuPipe license agreements and its rights under the MIDSOUTH Partners' Partnership Agreement.\nOn May 24, 1995, ITI and IMA jointly announced that they had entered into a definitive agreement providing for the combination of ITI and IMA which, if consummated, would result in IMA becoming a wholly-owned subsidiary of ITI. The arrangements between ITI and IMA further extend the postponement of further assertion of ITI's rights resulting from IMA's acquisition of the pipeline rehabilitation business of Enviroq without the consent of ITI, except for certain procedural steps to preserve the respective rights of the parties.\nAlthough the Company cannot, at this time, predict the outcome of the matters described herein, any potential outcome that resulted in the loss by the Company of its ability to recognize its share of the results of operations of MIDSOUTH Partners could have a material adverse effect on the future earnings of the Company.\nCERBCO is involved in other contingencies, none of which could, in the opinion of management, materially affect the Company's financial position or results of operations.\n14. Common Stock\nThe Company has two classes of Common Stock, which are designated as Common Stock and Class B Common Stock. Each share of Class B Common Stock can be converted into one share of Common Stock at any time. In 1995, no shares of Class B Common Stock were converted to Common Stock. In 1994 and 1993, 56 shares and 748 shares, respectively of Class B Common Stock were converted to Common Stock.\nEach share of Common Stock is entitled to one vote and each share of Class B Common Stock is entitled to ten votes, except with respect to the election of Directors and any other matter requiring the vote of shareholders separately as a class. The holders of Common Stock, voting as a separate class, are entitled to elect that number of Directors which constitutes twenty-five percent (25%) of the authorized number of members of the Board of Directors and, if such 25% is not a whole number, then the holders of Common Stock are entitled to elect the nearest higher whole number of Directors that is at least 25% of such membership The holders of Class B Common Stock, also voting as a separate class, are entitled to elect the remaining Directors. In addition, the holders of Common Stock have certain dividend preferences.\n15. Income Taxes\nThe Company has tax basis net operating losses of approximately $1,000,000 that may be carried forward to offset future income tax liabilities. These carryforwards will expire in fiscal years 2005 through 2010.\n16. Earnings (Loss) Per Share\nEarnings (loss) per share data have been computed based upon the weighted average number of common shares outstanding and common share equivalents (when dilutive) during each period. The following numbers of shares have been used in the computations:\n1995 1994 1993\n1,459,848 1,457,456 1,457,456\n17. Retirement Benefit Plans\nEmployees of Insituform East who meet certain minimum eligibility requirements and who are not covered by a collective bargaining agreement participate in a profit-sharing plan. No employee is covered by a collective bargaining agreement as of June 30, 1995. Contributions to the plan are determined annually by Insituform East's Board of Directors. Contributions to the plan were $183,489, $84,775 and $240,000 in fiscal years 1995, 1994 and 1993, respectively.\nEmployees of Capitol Copy who meet certain minimum eligibility requirements also participate in a profit-sharing plan. Contributions are determined annually by Capitol Copy's Board of Directors. Capitol Copy contributed $55,052, $48,864 and $43,765 to the plan in fiscal years 1995, 1994 and 1993, respectively.\n18. Stock Option Plans\nCERBCO granted options under the Directors' Stock Option Plan on 6,000 shares of CERBCO's Common Stock on December 16, 1994 and December 17, 1993, and options on 7,500 shares of CERBCO's Common Stock on December 18, 1992, at the option prices of $5.125, $3.50 and $3.25, respectively, per share, exercisable within three years of the date of the grant. The following is a summary of transactions:\nAt June 30, 1995, there were 3,000 shares reserved for future grants under the Directors' Stock Option Plan.\nOn June 6, 1987, CERBCO granted under the 1986 Employee Stock Option Plan options on 51,483 shares of Common Stock to its officers, and the officers and managers of CERBERONICS, at an option price of $7.00 per share exercisable within ten years of the date of the grant. There were no additional grants or exercise of options available under this plan in fiscal year 1995.\nAt June 30, 1995, there were 23,517 shares reserved for future grants under the Employee Stock Option Plan.\n19. Segment Data and Reconciliation\nCERBCO's operations are classified into two principal industry segments: pipeline rehabilitation and copier equipment products and services. The following is a summary of pertinent industry segment information. General corporate assets are principally intercompany receivables and investments that are owned by the holding company. General corporate expenses include items which are of an overall holding company nature and are not allocated to the segments.\nDuring the year ended June 30, 1995, the Federal government (collectively), the Metropolitan Sewer District (\"MSD\") of Greater Cincinnati, Ohio and Washington Metropolitan Area Transit Authority (\"WMATA\") accounted for 21%, 15% and 10%, respectively, of the Company's pipeline rehabilitation sales. During the year ended June 30, 1994, the Federal government (collectively) accounted for 15% of these sales. During the year ended June 30, 1993, the City of Richmond, Virginia; Fairfax County, Virginia and the Washington Suburban Sanitary Commission (\"WSSC\") accounted for 15%, 12% and 11%, respectively, of these sales. No single customer accounted for 10% or more of the Company's copier machine products and service sales during the last three fiscal years.\n20. Unaudited Quarterly Financial Data\nThe following table provides summarized quarterly results of operations for fiscal years 1995 and 1994 (in thousands, except per share information):\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(a) Identification of CERBCO Directors\nDirectors of CERBCO are elected at the Annual Meeting of Stockholders except that vacancies and newly created directorships may be filled by the directors then in office. Each director holds office until his successor is elected and qualified or until his earlier resignation or removal.\n(b) Identification of CERBCO Executive Officers and (Principal Officer of Each Subsidiary)\nEach officer holds office until his successor is elected and qualified or until his earlier resignation or removal.\n(c) Identification of Certain Significant Employees\nNot applicable.\n(d) Family Relationships\nMr. Robert Erikson, Director, President and Treasurer, and Mr. George Erikson, Director, Chairman and General Counsel are brothers.\n(e) Business Experience\n(1) Mr. Robert Erikson was a Supply Corps officer in the Navy from 1968 through 1972. Mr. Erikson joined CERBERONICS in December 1972. In May 1974, he was elected Vice President of Finance and Administration and, in December 1974, he became Executive Vice President, Treasurer and a Director. In October 1977, he was elected President. In February 1988, he was elected President and Treasurer of CERBCO. Mr. Erikson currently is a Director and Vice Chairman of Capitol Copy, a Director, Vice Chairman and President of Insituform East and serves as a member of the Chief Executive Officer Committee of Capitol Copy and Insituform East. He is a Director of Palmer National Bancorp, Inc. and The Palmer National Bank. Mr. Erikson holds a B.A. degree in Engineering and Economics from Brown University and an M.B.A. degree from The George Washington University.\nMr. George Erikson joined CERBERONICS in July 1976 as Vice President and General Counsel, and in August 1976, he was elected Secretary. He served as Executive Vice President until July 1987, at which time he was elected to the position of Chairman. He became a Director of CERBERONICS in November 1975 and served as Chairman of the Board of Directors from February 1979 to February 1988. In February 1988, he was elected Chairman and General Counsel of CERBCO. Mr. Erikson currently is a Director and Chairman of Capitol Copy and a Director and Chairman of Insituform East and serves as a member of the Chief Executive Officer Committee of Capitol Copy and Insituform East. From December 1972 to July 1976, he was employed as Vice President - Legal by National Securities & Research Corporation and, prior thereto, he was employed as an attorney to the Dreyfus Corporation. He is a member of the Bar of the State of New York, District of Columbia and Commonwealth of Virginia. Mr. Erikson holds a B.S. degree in Business Administration from Pennsylvania State University, an LL.B. degree from Fordham University Law School, and an LL.M. degree from New York University Law School.\nMr. Hartman joined CERBERONICS in August 1979 as Controller and Manager of the Accounting Department. In November 1981, he was elected Assistant Vice President and in April 1984, he was elected Vice President & Treasurer, in which positions he served until his departure from CERBERONICS in September 1985. From October 1985 to February 1988, Mr. Hartman was Controller of Dynamac International, Inc. He returned to CERBERONICS and his former positions in February 1988 and, in addition, was elected Vice President and Controller of CERBCO. In June 1991, he joined Insituform East as Vice President of Administration and was elected Secretary of CERBCO, Insituform East and Capitol Copy. From 1976 to 1977, Mr. Hartman was an accountant for Coopers & Lybrand, and from 1977 to 1979, he was a partner in the accounting firm of Hartman and Hartman. Mr. Hartman is a Certified Public Accountant and holds a B.S. degree form the United States Naval Academy, a B.A. degree from the University of South Florida and an M.B.A. degree from The George Washington University.\nMr. Manoogian holds a B.S. degree in Business Administration from Pennsylvania State University and an M.B.A. from Pace University. In October 1987, he was elected a Director and President of Capitol Copy and serves as a member of the Chief Executive Officer Committee. Immediately prior to joining Capitol Copy, Mr. Manoogian served as President and Chief Operating Officer of a publicly-traded East Coast computer retailing organization. His previous business experience includes 17 years with the Xerox Corporation, starting as a sales representative in 1966, progressing through numerous field and headquarters marketing assignments, and culminating in his final position as Region General Manager for the Mid-Atlantic Operations Group based in Washington, D.C.\nMr. Hayes has been Chairman, President and Chief Executive Officer of Palmer National Bancorp, Inc. and The Palmer National Bank since March 1985. Mr. Hayes serves as a Director of Insituform East and Capitol Copy. He is also a Director of Citizens Corporation in Eastman, Georgia, and is a member of the Board of Visitors of the University of North Carolina. In January 1995, he completed a three year term as a Director of the Federal Reserve Bank of Richmond. He holds a B.A. degree from the University of North Carolina and an executive management degree from Columbia University School of Business.\nMr. Kincheloe holds a B.A. degree from Randolph-Macon College and a J.D. degree from T.C. Williams School of Law, University of Richmond. He has been a practicing attorney and businessman in Fairfax County, Virginia, since 1967. He previously served on the Board of Herndon Federal Savings & Loan and then First Federal Savings & Loan of Alexandria. He currently serves on the Board, as Finance Chairman, of Flint Hill School in Oakton, Virginia, and on the Board of Trustees for Randolph-Macon College. Mr. Kincheloe serves as a Director of Insituform East and Capitol Copy.\n(2) Directorships. See Part III, Item 10 (e)(1), paragraphs 1, 2, 5 and 6, as to Messrs. Robert Erikson and George Erikson, Hayes and Kincheloe, respectively.\n(f) Involvement in Certain Legal Proceedings\nNot applicable.\nItem 11.","section_11":"Item 11. Executive Compensation\nCERBCO is a parent holding company with controlling interests in two principal subsidiaries, Insituform East (\"IEI\") and Capitol Copy Products (\"CCP\"). CERBCO officers participate also in the management of these subsidiaries. The following table sets forth information concerning the compensation paid to each of the named executive officers of the Company and\/or its subsidiaries for the fiscal years ended June 30, 1995, 1994 and 1993:\nCOMPENSATION PURSUANT TO PLANS\nCERBCO, Inc. Plans\nSupplemental Executive Retirement Plan\nDuring fiscal year 1994, CERBCO entered into Supplemental Executive Retirement Agreements with three executive officers pursuant to a Supplemental Executive Retirement Plan (the \"CERBCO Supplemental Retirement Plan\"). The agreements provide for monthly retirement benefits of 50% of the executive's final aggregate monthly salary from CERBCO and its subsidiaries as defined in and limited by the executive's agreement, for Messrs. Robert Erikson and George Erikson. In the case of Mr. Robert Hartman, the agreement provides for 25% of the executive's final aggregate monthly salary from CERBCO and its subsidiaries as defined in and limited by the executive's agreement.\nTo compute the monthly retirement benefits, the percentage of final monthly salary is multiplied by a ratio (not to exceed 1) of:\nthe completed years of employment by CERBCO after 1992 to the total number of years of employment after 1992 that the executive would have completed if he had continued in employment to age 65.\nIf the executive dies prior to retirement, the executive's beneficiary will receive a pre-retirement death benefit of a percentage (50% in the case of Messrs. Robert Erikson and George Erikson; 25% in the case of Mr. Robert Hartman) of the executive's final monthly salary for 180 months. If the executive dies after commencement of the payment of benefits, but before receiving 180 monthly payments, the executive's beneficiary will receive payments until the total payments received by the executive and\/or his beneficiary equal 180.\nThe CERBCO Supplemental Retirement Plan is technically unfunded, except as described below. CERBCO will pay all benefits from its general revenues and assets. To facilitate the payment of benefits and provide the executives with a measure of benefit security without subjecting the CERBCO Supplemental Retirement Plan to various rules under the Employee Retirement Income Security Act of 1974, CERBCO has established an irrevocable trust (the \"CERBCO, Inc. Supplemental Executive Retirement Trust Agreement\"). This trust is subject to the claims of CERBCO's creditors in the event of bankruptcy or insolvency. The trust has purchased life insurance on the lives of the executive officers covered by the Supplemental Executive Retirement Agreements to provide for CERBCO's financial obligations under the Plan. Assets in the trust consist of the cash surrender values of the executive life insurance policies and are carried on CERBCO's balance sheet as assets. The trust will not terminate until participants and beneficiaries are no longer entitled to benefits under the plan. Upon termination, all assets remaining in the trust will be returned to CERBCO. For additional information on the CERBCO Supplemental Retirement Plan, see \"Defined Benefit or Actuarial Plans.\"\n1988 Plan of Reorganization and Merger\nPursuant to the Plan of Reorganization and Merger, approved by CERBERONICS stockholder vote on February 26, 1988, CERBCO became a successor to the CERBERONICS, Inc. 1986 Employee Stock Option Plan and the 1986 Board of Directors' Stock Option Plan (now collectively the \"CERBCO Plans\") described below. The CERBCO Plans are now deemed to relate to stock options to purchase shares of CERBCO Common Stock. Each CERBERONICS stock option previously outstanding was converted into an option to purchase, upon the same terms, shares of CERBCO Common Stock in the same numbers as were provided by the option with respect to Class A Common Stock of CERBERONICS. The CERBCO Plans do not relate to shares of CERBCO Class B Common Stock. In all other respects, the terms of the CERBCO Plans and the options outstanding, or which may become outstanding, remain unchanged.\n1986 Employee Stock Option Plan\nCERBERONICS adopted, with stockholder approval at the 1986 Annual Meeting of Stockholders, the CERBERONICS, Inc. 1986 Employee Stock Option Plan (now called the \"CERBCO Employee Plan\"). The purpose of the CERBCO Employee Plan is to promote the growth and general prosperity of the Company by permitting key management employees to purchase shares, through the grant and exercise of options, of CERBCO's Common Stock. Under the terms of the CERBCO Employee Plan, which is administered by the Stock Option Committee appointed by and comprised of members of the Board of Directors, both incentive and nonstatutory stock options may be granted to eligible employees. Under the CERBCO Employee Plan, 75,000 shares of Common Stock were reserved for issuance upon the exercise of stock options granted.\nThe Stock Option Committee, in its sole discretion, has full power and authority to designate eligible employees to whom an incentive stock option or a nonstatutory stock option shall be granted, determine the number of shares to be made available under any option granted, determine the periods in which a participant may exercise his option (provided, however, no incentive stock option may be exercised more than ten years after the date of its grant), determine the option price and determine the date on which the option shall expire. The grant of a stock option under the CERBCO Employee Plan is contingent on the participant's continued services on behalf of CERBCO for a period of not less than 24 months from the date of grant of the option.\nDuring fiscal year 1995, no options were granted to executive officers of CERBCO, and no options available under this plan were exercised by executive officers of CERBCO.\n1986 Directors' Stock Option Plan\nCERBERONICS adopted, with stockholder approval at the 1986 Annual Meeting of Stockholders, the CERBERONICS, Inc. 1986 Board of Directors' Stock Option Plan (now called the \"CERBCO Directors' Plan\"). The purpose of the CERBCO Directors' Plan is to promote the growth and general prosperity of CERBCO by permitting the Company, through the granting of options to purchase shares of CERBCO's Common Stock, to attract and retain the best available persons as members of CERBCO's Board of Directors with an additional incentive for such persons to contribute to the success of the Company. A maximum of 75,000 shares of Common Stock may be made subject to options under the CERBCO Directors' Plan. Options may be granted to directors of CERBCO or any of its subsidiaries. Each option granted under the CERBCO Directors' Plan entitles each director to whom such option is granted the right to purchase shares of CERBCO's Common Stock at a designated option price, any time and from time to time, within three years from the date of grant.\nThe CERBCO Board of Directors administers the CERBCO Directors' Plan and has exclusive authority to interpret, construe and implement the provisions of the CERBCO Directors' Plan, except as may be delegated in whole or in part by the Board to a committee of the Board which may consist of three or more members of the Board. No such delegation of authority has been made. Each determination, interpretation or other action that may be taken pursuant to the CERBCO Directors' Plan by the Board is final and binding and conclusive for all purposes and upon all persons. The Board from time to time may amend the CERBCO Directors' Plan as it deems necessary to carry out the purposes thereof.\nThe terms of the CERBCO Directors' Plan contemplated that each director of the Company be granted an option to purchase 1,500 shares of the Company's Common Stock each year for five years, for a total of 7,500 shares of Common Stock per director, beginning in fiscal year 1986. On June 28, 1986, options on 1,500 shares of Common Stock were granted to each of the six CERBERONICS directors then in office. No additional options were granted until December 19, 1991. On December 19, 1991, the CERBCO Directors' Plan was amended by the CERBCO Board of Directors to ensure its original purpose by granting options to purchase 1,500 shares of Common Stock to CERBCO directors in fiscal 1992 and subsequent years, so that each director serving on the date of grant will receive options for a total amount of 7,500 shares over a five year period. Messrs. Robert Erikson and George Erikson, being the only current directors having received options in 1986, will each receive options for a total amount of 6,000 shares over a four year period, to the extent each is serving as a director on the date of grant.\nOn December 16, 1994, options on a total of 6,000 shares of Common Stock were granted to directors of the Company (options on 1,500 shares to each of four directors) at a per share option price of $5.125. Options on a total of 4,500 shares available under this plan were exercised by directors of the Company during fiscal year 1995.\nInsituform East, Incorporated Plans\nInsituform East Employee Advantage Plan\nDuring fiscal year 1995, as executive officers of Insituform East, Messrs. Robert Erikson, George Erikson and Robert Hartman participated in the Insituform East, Incorporated Employee Advantage Plan (the \"IEI Advantage Plan\"). The IEI Advantage Plan is a noncontributory profit sharing plan in which all employees not covered by a collective bargaining agreement and employed with Insituform East for at least one year are eligible to participate. No employee is covered by a collective bargaining agreement. The IEI Advantage Plan is administered by the Insituform East Board of Directors which determines, at its discretion, the amount of Insituform East's annual contribution. The Insituform East Board of Directors can authorize a contribution, on behalf of Insituform East, of up to 15% of the compensation paid to participating employees during the year. The plan is integrated with Social Security. Each participating employee is allocated a portion of Insituform East's contribution based on the amount of that employee's compensation plus compensation above FICA limits relative to the total compensation paid to all participating employees plus total compensation above FICA limits. Amounts allocated under the IEI Advantage Plan begin to vest after three years of service (at which time 20% of the contribution paid vests) and are fully vested after seven years of service.\nThe IEI Advantage Plan also includes a salary reduction profit sharing feature under Section 401(k) of the Internal Revenue Code. Each participant may elect to defer a portion of his compensation by any whole percentage from 2% to 16% subject to certain limitations. During the fiscal year ended June 30, 1995, Insituform East contributed an employer matching contribution equal to 25% of the participant's deferred compensation up to a maximum of 1.5% of the participant's total paid compensation for the fiscal year. Participants are 100% vested at all times in their deferral and employer matching accounts.\nInsituform East 1985 Employee Stock Option Plan\nInsituform East adopted, with stockholder approval at the 1985 Annual Meeting of Stockholders, the Insituform East, Incorporated 1985 Employee Stock Option Plan (the \"IEI Employee Plan\"). The purpose of the plan is to advance the growth and development of Insituform East by affording an opportunity to employees of Insituform East to purchase shares of Insituform East's Common Stock and to provide incentives for them to put forth maximum efforts for the success of Insituform East's business. Any employee of Insituform East who is employed on a full-time basis is eligible for participation. The IEI Employee Plan is administered by Insituform East's Stock Option Committee.\nDuring fiscal year 1995, no options were granted to executive officers of Insituform East. All options granted under this plan in past years expired prior to fiscal year 1995.\nInsituform East 1994 Board of Directors' Stock Option Plan\nInsituform East adopted, with stockholder approval at the 1994 Annual Meeting of Stockholders, the Insituform East, Incorporated 1994 Board of Directors' Stock Option Plan (the \"IEI 1994 Directors' Plan\"). The purpose of this plan is to promote the growth and general prosperity of Insituform East by permitting Insituform East, through the granting of options to purchase shares of its Common Stock, to attract and retain the best available persons as members of Insituform East's Board of Directors with an additional incentive for such persons to contribute to the success of Insituform East. The IEI 1994 Directors' Plan is administered and options are granted by the Insituform East Board of Directors. During fiscal year 1995, as directors of Insituform East, Messrs. Robert Erikson and George Erikson participated in this plan.\nEach grant of options under the IEI 1994 Directors' Plan will entitle each Insituform East director to whom such options are granted the right to purchase 15,000 shares of Insituform East's Common Stock at a designated option price, any time and from time to time, within five years from the date of grant. Options are granted under the IEI Directors' Plan each year for five years to each member of the Board of Directors of Insituform East serving as such on the date of grant, i.e., for each director serving for five years, a total of five options covering in the aggregate 75,000 shares of Common Stock (subject to adjustments upon changes in the capital structure of Insituform East) over a five year period.\nOn December 9, 1994, options on a total of 105,000 shares of Insituform East's Common Stock were granted to directors of Insituform East (options on 15,000 shares to each of seven directors, including Messrs. Robert Erikson and George Erikson) at a per share option price of $2.625. No options available under this plan were exercised by directors of Insituform East during fiscal year 1995. Under the terms of this plan, up to 525,000 shares of Insituform East's Common Stock have been reserved for the directors of Insituform East.\nInsituform East 1989 Board of Directors' Stock Option Plan\nInsituform East adopted, with stockholder approval at the 1989 Annual Meeting of Stockholders, the Insituform East, Incorporated 1989 Board of Directors Stock Option Plan (the \"IEI 1989 Directors' Plan\"). The purpose of this plan was the same as the IEI 1994 Directors' Plan. The term of the plan is for ten years, unless terminated sooner by the Board of Directors. Options were first granted to directors on December 1, 1989 and each of the four succeeding Board of Directors meetings following the Annual Meetings of Stockholders in 1990, 1991, 1992 and 1993. Each grant of options under the plan entitles each director to whom such options were granted the right to purchase 15,000 shares of Insituform East's Common Stock at a designated option price, any time and from time to time, within five years from the date of grant. Although no further options are anticipated to be granted under this plan, options previously granted, and which have not already been exercised or expired, will remain in effect until exercise or expiration, whichever comes first. No options available under the plan were exercised by directors of Insituform East during fiscal year 1995. Under the terms of this plan, up to 240,000 shares of Insituform East Common Stock remain reserved for the directors of Insituform East.\nCapitol Copy Products, Inc. Plans\nCapitol Copy Profit Sharing Plan\nDuring fiscal year 1995, as executive officers of Capitol Copy, Messrs. Robert Erikson, George Erikson and Armen Manoogian participated in the Capitol Copy Products, Inc. Profit Sharing Plan (the \"CCP Profit Sharing Plan\"). All full time employees who have been with Capitol Copy for at least one year are eligible to participate in this noncontributory plan. Contributions are made each year in an amount determined by Capitol Copy's Board of Directors. Each participating employee is allocated a portion of the contribution based on the amount of that employee's compensation relative to the total compensation paid to all participating employees. Amounts allocated under the CCP Profit Sharing Plan begin to vest after two years of service (at which time 20% of the contribution paid vests) and are fully vested after six years of service.\nCapitol Copy 1987 Incentive Stock Option Plan\nCapitol Copy adopted, with stockholder approval on October 1, 1987, the Capitol Copy Products, Inc. 1987 Incentive Stock Option Plan (the \"CCP Incentive Plan\"). The purpose of this plan is to advance the interests of Capitol Copy by providing key employees with additional incentive for them to promote the success of Capitol Copy, to increase their proprietary interest in Capitol Copy and to remain in its employ. The term \"key employee\" means those employees (including officers and directors who are also employees, but not including Messrs. George Erikson and Robert Erikson) who, in the judgment of the Capitol Copy Board of Directors, are important to the future of Capitol Copy. The CCP Incentive Plan is administered and options are granted by the Capitol Copy Board of Directors.\nEach grant of options under the CCP Incentive Plan will entitle the Capitol Copy key employee to whom such options are granted the right to purchase a designated number of shares of Class B Stock at a designated price for a designated option period. No part of any grant of options may be exercised until the optionee has remained in the employ of Capitol Copy for a period of time as specified by the Board of Directors in the option agreement.\nNo options were granted under this plan to executive officers of Capitol Copy during fiscal year 1994. All options granted under this plan in past years were exercised prior to fiscal year 1995.\nOPTION\/SAR GRANTS\nNo option or Stock Appreciation Right grants were made to any of the named executive officers during fiscal year 1995 under the CERBCO Employee Plan, the IEI Employee Plan, the IEI 1989 Directors' Plan or the CCP Incentive Plan. The following table sets forth information concerning options granted to each of the named executive officers during fiscal year 1995, under the CERBCO Directors' Plan and the IEI 1994 Directors' Plan:\nAGGREGATED OPTION\/SAR EXERCISES AND FISCAL YEAR-END OPTION\/SAR VALUE\nNo option or Stock Appreciation Right grants made under the CERBCO Employee Plan, or the IEI 1989 or 1994 Directors' Plans to any of the named executive officers were exercised during fiscal year 1995. During fiscal year 1995, Mr. George Erikson exercised an option to purchase 1,500 shares of CERBCO Common Stock granted under the CERBCO Directors' Plan. The following table sets forth information concerning option or Stock Appreciation Right grants held by each of the named executive officers under all plans as of June 30, 1995:\nREPRICING OF OPTIONS\/SARs\nNeither the Company nor its subsidiaries have adjusted or amended the exercise price of stock options or SARs previously awarded to any of the named executive officers during fiscal year 1995.\nLONG-TERM INCENTIVE PLAN AWARDS\nNeither the Company nor its subsidiaries have a long-term incentive plan.\nDEFINED BENEFIT OR ACTUARIAL PLANS\nThe Company maintains the CERBCO Supplemental Retirement Plan to provide annual retirement benefits to covered executives based on each executive's covered compensation. The following tables set forth the annual retirement benefits that would be received under the CERBCO Supplemental Retirement Plan at various compensation levels after the specified years of service:\nEach executive's covered compensation under the CERBCO Supplemental Retirement Plan is equal to his final base salary. The maximum covered compensation for Messrs. Robert Erikson and George Erikson is limited to $250,000 annually ($20,834 per month), increased 2% annually beginning in 1993. The maximum covered compensation for Mr. Robert Hartman is limited to $90,000 annually ($7,500 per month), increased 2% annually beginning in 1993.\nThe following table sets forth information concerning vested annual benefits as of June 30, 1995 for the executives listed in the Summary Compensation Table covered by the CERBCO Supplemental Retirement Plan:\nSee \"Compensation Pursuant to Plans, CERBCO, Inc. Plans, Supplemental Executive Retirement Plan\" as to the basis upon which benefits under the Plan are computed. Each covered executive's benefit under the Plan is payable in equal monthly amounts for the remainder of the covered executive's life beginning as of any date on or after his 62nd birthday (at the covered executive's election) but not before his termination of service. In the event of a covered executive's death, his beneficiary shall be entitled to receive monthly benefits equal to the covered executive's accrued monthly benefit, for up to a maximum of 180 months. Payments under the CERBCO Supplemental Retirement Plan are not subject to any reduction for Social Security or any other offset amounts but are subject to Social Security and other applicable tax withholding.\nEMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS\nThere are no employment contracts between the Company or its subsidiaries and any named executive officer. There are no arrangements between the Company or its subsidiaries and any named executive officer, or payments made to an executive officer, that resulted, or will result, from the resignation, retirement or other termination of employment with the Company or its subsidiaries, in an amount that exceeds $100,000.\nCOMPENSATION OF DIRECTORS\nEach non-officer director of the Company is paid an annual fee of $3,000 and an attendance fee of $500 for Board of Directors meetings where he attends in person. The attendance fee is $100 if he participates by telephone. Directors who are also officers of the Company do not receive separate fees for service as directors, but are eligible with all other directors to participate in the CERBCO Directors' Stock Option Plan, as described under the section entitled, \"Compensation Pursuant to Plans.\" All directors of the Company are reimbursed for Company travel-related expenses.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's Board of Directors does not have a compensation committee; the Board of Directors as a whole serves in that equivalent capacity. Messrs. George Erikson and Robert Erikson, both members of the Board of Directors and executive officers of the Company, holding the offices of Chairman & General Counsel and President & Treasurer, respectively, participate in, and during fiscal 1995 participated in, deliberations of the Board of Directors concerning executive officer compensation.\nMessrs. George Erikson and Robert Erikson are both members of the Board of Directors and executive officers of Insituform East and Capitol Copy. In their capacities as directors of these subsidiary companies, they participate in, and during fiscal 1995 participated in, deliberations of the respective subsidiaries' Boards of Directors concerning executive officer compensation.\nMr. Robert Erikson serves, and served during fiscal 1995, as a member of the Compensation Committee of the Board of Directors of Palmer National Bancorp, Inc. and The Palmer National Bank. Mr. Webb C. Hayes, IV, a director of the Company and a director of Insituform East and Capitol Copy who participates in, and during fiscal 1995 participated in, deliberations of the CERBCO Board of Directors and the Boards of Directors of its subsidiaries concerning executive officer compensation for CERBCO and its subsidiaries, respectively, is Chairman of the Board and an executive officer of Palmer National Bancorp, Inc. and The Palmer National Bank.\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 reflects, as of September 13, 1995, the only persons known to the Company to be the beneficial owners of more than five percent of any class of CERBCO's voting securities:\n(b) Security Ownership of Management\nThe following information is furnished with respect to all directors of CERBCO who were the beneficial owners of any shares of CERBCO's Common Stock and Class B Common Stock as of September 13, 1995, and with respect to all directors and officers of CERBCO as a group:\nThe following information is furnished with respect to all directors of Insituform East who were the beneficial owners of any shares of Insituform East's Common Stock and Class B Common Stock as of September 13, 1995, and with respect to all directors and officers of Insituform East as a group:\nThe following information is furnished with respect to all directors of Capitol Copy who were the beneficial owners of any shares of Capitol Copy's Class B Stock as of September 13, 1995, and with respect to all directors and officers of Capitol Copy as a group:\n(c) Changes in Control\nThere were no changes in control of the Company during the year ended June 30, 1995. However, in March 1990 George Wm. Erikson and Robert W. Erikson, the controlling stockholders of the Company, executed a letter of intent and subsequently executed four amendments thereto (collectively referred to herein as the \"Letter of Intent\") with Insituform Technologies, Inc. (\"ITI\") (formerly Insituform of North American, Inc. or \"INA\") to effect a sale of their controlling interest in the Company to ITI for $6,000,000 (the \"Proposed Transaction\"). The Proposed Transaction, had it been consummated, would have had the effect of making ITI the controlling stockholder of the Company and, indirectly, of each of the Company's three direct subsidiaries at the time, Insituform East, Capitol Copy and CERBERONICS. On September 19, 1990, however, the Company issued a press release announcing that the Eriksons had informed the Company that the Letter of Intent had expired without consummation of any transaction, that it would not be further extended, that negotiations had ceased and that the Eriksons had no further intention at the time of pursuing the proposed sale of their controlling interest in the Company to ITI.\nA lawsuit challenging the proposed, but unconsummated transaction brought by two of the Company's stockholders is described in Part I, Item 3, \"Legal Proceedings.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions --------------------------------------------------------\n(a) Transactions with Management and Others\nSee Item 13.(c) below.\n(b) Certain Business Relationships\nNot applicable.\n(c) Indebtedness of Management\nPursuant to authorizations by the Board of Directors on the dates indicated below, the Company has made certain advancements to Mr. George Erikson, Director, Chairman & General Counsel, and certain advancements to Mr. Robert Erikson, Director, President & Treasurer (together the \"Eriksons\") for their respective legal fees and expenses which each has incurred, and may incur in the future, for personal legal representation in connection with the stockholder lawsuit filed in August 1990 challenging a proposed but unconsummated transaction between each of the Eriksons and Insituform Technologies, Inc. (see Part I, Item 3, \"Legal Proceedings\").\nAs of September 26, 1995, pursuant to such Board authorizations, the Company has advanced and expensed in total $472,541 to Mr. George Erikson and has advanced and expensed in total $472,541 to Mr. Robert Erikson.\nWhile a decision has been rendered in favor of the Eriksons in the above-referenced lawsuit, it is currently on appeal. Pending a final outcome thereof, the Board of Directors has deferred consideration or ultimate determination of entitlement of Mr. George Erikson and\/or Mr. Robert Erikson to indemnification by the Company for such legal fees and expenses. If it is ultimately determined by the Board of Directors or otherwise in accordance with Section 145 of Delaware Corporation Law that Mr. George Erikson and\/or Mr. Robert Erikson are not entitled to indemnification for any such legal fees and expenses under Section 145 of Delaware Corporation Law, such advances shall be reimbursed by Mr. George Erikson and\/or Mr. Robert Erikson to the Company pursuant to an agreement with the Company executed by each of the Eriksons and delivered to the Board of Directors.\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\nThe following consolidated financial statements of CERBCO, Inc. and subsidiaries are included in PART II, Item 8:\nIndependent Auditors' Report on Consolidated Financial Statements\nConsolidated Statements of Operations for the Years Ended June 30, 1995, 1994 and 1993\nConsolidated Balance Sheets as of June 30, 1995 and 1994\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\n(2) Financial Statement Schedules\nSchedules have been omitted for the reason that they are not required, or are not applicable, or that the required information is given in the financial statements and notes thereto.\n(3) Exhibits\n27. Financial Data Schedule\n99. CERBCO, Inc. Consolidating Schedules: Statement of Earnings Information for the Year Ended June 30, 1995; Balance Sheet Information and Consolidating Elimination Entries as of June 30, 1995, and Related Independent Auditors' Report\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the last 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 report to be signed on its behalf by the undersigned, thereunto duly authorized, in Landover, Maryland, on September 26, 1995.\n\/s\/ ROBERT W. ERIKSON Robert W. Erikson President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nSignature & Title Capacity Date\n\/s\/ ROBERT W. ERIKSON Robert W. Erikson Director, Sept. 26, 1995 President Principal Executive Officer, Principal Financial Officer\n\/s\/ GEORGE Wm. ERIKSON George Wm. Erikson Director, Sept. 26, 1995 Chairman & General Counsel Principal Executive Officer\n\/s\/ ROBERT F. HARTMAN Robert F. Hartman Principal Sept. 26, 1995 Vice President, Secretary Accounting & Controller Officer\n\/s\/ WEBB C. HAYES, IV Webb C. Hayes, IV Director Sept. 26, 1995\n\/s\/ PAUL C. KINCHELOE, JR. Paul C. Kincheloe, Jr. Director Sept. 26, 1995\nExhibit 27. CERBCO, Inc. Financial Data Schedule\nExhibit 99. CERBCO, Inc. Consolidating Schedules - Statement of Earnings Information for the Year Ended June 30, 1995; Balance Sheet Information and Consolidating Elimination Entries as of June 30, 1995, and Related Independent Auditors' Report.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of CERBCO, Inc.\nWe have audited the consolidated financial statements of CERBCO, Inc. and subsidiaries for each of the three years in the period ended June 30, 1995, and our report thereon appears in Item 8 of this Report on Form 10-K. Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidating schedules for the year ended June 30, 1995 are presented for the purpose of additional analysis of the basic consolidated financial statements rather than to present the financial position and results of operations of the individual companies, and are not a required part of the basic consolidated financial statements. These schedules are the responsibility of the Company's management. Such schedules have been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, are fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.\n\/S\/ Deloitte & Touche LLP Deloitte & Touche LLP\nSeptember 15, 1995 Washington, D.C.","section_15":""}
{"filename":"752292_1995.txt","cik":"752292","year":"1995","section_1":"Item 1. Business\nGeneral\nPrudential Realty Acquisition Fund II, L.P. (the ``Registrant ''), a Delaware limited partnership, was formed on August 10, 1984 and will terminate on December 31, 2009 unless terminated sooner under the provisions of the Amended and Restated Agreement of Limited Partnership (the ``Partnership Agreement''). The Registrant was formed to acquire and manage income-producing commercial real estate with proceeds raised from the initial sale of 44,503 limited partnership units (``Units''). The Registrant's fiscal year for book and tax purposes ends on December 31.\nThe Registrant has invested in and operates a real estate investment portfolio consisting of four properties and a mortgage loan. These commercial real estate properties consist of an office building, a warehouse and two shopping centers. The shopping centers were acquired through a joint venture agreement with Prudential Acquisition Fund I, L.P., an affiliated limited partnership. The two shopping centers owned by the joint venture were sold on March 26, 1996 for a gross sales price of $15,500,000 less costs to sell. The Registrant is engaged solely in the business of real estate investment; therefore, presentation of industry segment information is not applicable. For more information regarding the Registrant's operations, see Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.\nAs the economy has improved in certain of the markets relating to the Registrant's properties, the market for commercial real estate has also generally improved. While property values continue to be below the levels reached in the mid-1980's, investment capital is more readily available and investor interest in acquiring certain types of real estate has increased. See Note C to the financial statements of the Registrant's Annual Report to Limited Partners for the year ended December 31, 1995 (``Registrant's Annual Report'') which is filed as an exhibit hereto for additional information.\nIn January 1996, the General Partners mailed to all limited partners a Consent Solicitation Statement (the ``Statement'') asking for their written consent to approve (i) a plan of sale of the remaining assets of the Registrant and (ii) the complete liquidation and dissolution of the Partnership, as more fully described in the Statement. On March 11, 1996, the limited partners holding a majority of the Units approved the plan of sale and complete liquidation and dissolution of the Registrant. Although no time schedule has been adopted for this plan, the Registrant does expect to begin to actively market all of its properties in 1996. It is not expected that the Registrant's eventual total distributions, including sales proceeds, will equal the partners' initial investments.\nThe mortgage loan is subject to an agreement effective March 6, 1996 by which a purchaser has agreed to purchase the mortgage loan for $400,000. See Notes D and J to the financial statements of the Registrant's Annual Report which is filed as an exhibit hereto.\nGeneral Partners\nThe general partners of the Registrant are Prudential-Bache Properties, Inc. (``PBP'') and Prudential Realty Partnerships, Inc. (``PRP'') (collectively, the ``General Partners'').\nCompetition\nThe General Partners and\/or their affiliates have formed, and may continue to form, various entities to engage in businesses which may compete with the Registrant while it continues to operate its properties.\nThe real estate industry is highly competitive. The Registrant's properties are subject to competition in connection with both their operation and sale from similar properties located in the immediate vicinity of these properties. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties.\nEmployees\nThe Registrant has no employees. Management and administrative services for the Registrant are performed by the General Partners and their affiliates pursuant to the Partnership Agreement. See Note H to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 2. Properties\nAs of December 31, 1995 the Registrant owns the following properties:\n- --------------- Square footage and average rental rates per square foot information reflects current data as obtained from third-party appraisals. Gross rental rates indicate the landlord pays the operating and fixed expenses and net rental rates indicate the tenant pays the operating and fixed expenses.\n** 46% interest held by the Registrant. These properties were sold on March 26, 1996.\nThe Registrant's warehouse in Rancho Cucamonga, California was leased to TASH Distribution (``TASH''). In December 1995, the Registrant was notified that TASH had made a general assignment for the benefit of creditors and would vacate the building, which it did, in March 1996. The Registrant is presently seeking to re-lease the property. Revenues from this property represented 54%, 57% and 56% of the Registrant's rental income from directly-owned properties for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Eight Forge Park industrial office building located in Franklin (suburban Boston), Massachusetts is leased to Thermo Instrument Systems, Inc. under a lease expiring in June 1997. One of two subsidiaries of the tenant, representing 70% of the leased space, vacated its space in the third quarter of 1995. However, the tenant continues to honor its lease commitment. Revenues from Eight Forge Park represented 46%, 43% and 44% of the Registrant's rental income from directly-owned properties for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn May 1985, the Prudential Acquisition Fund I, L.P. (``PAF''), an affiliated limited partnership, and The Prudential Insurance Company of America (``The Prudential''), through the Ridge Plaza Joint Venture (the ``Joint Venture''), acquired two shopping centers, Pine Island Ridge Plaza (``Pine Island'') and Ridge Plaza (collectively, the ``Joint Venture Properties''), located in Davie, Broward County, Florida. The Registrant purchased from The Prudential its 46% interest in the Joint Venture. The Registrant's share of the Joint Venture's net income (loss) is recorded as revenue (``Joint venture equity income (loss)'') in the Registrant's Statements of Operations. The carrying value of the Joint Venture's properties was reduced by $850,000 during the second quarter of 1995 to reflect an impairment in value resulting from lease defaults and market indications. In the fourth quarter of 1995, the Joint Venture recorded an additional provision for loss on impairment of assets of $1,500,000 to reflect the gross sales price less costs to sell from the sale of the two shopping centers on March 26, 1996. See Notes B and C to the Joint Venture's financial statements which\nare filed as an exhibit hereto for further information. One tenant at Pine Island, Builders Square (whose lease expires in 2003), accounted for 16%, 16% and 13% of the revenues of the Joint Venture for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe estimated fair value of the Registrant's properties, based on third-party appraisals as of December 31, 1995 and the Registrant's pro rata share of the estimated net proceeds from the sale of the Joint Venture's properties, was $16,700,000. Appraised values are only estimates of fair value and should not be relied on as a measure of immediately realizable value. Estimated values may fluctuate with changes in the real estate and financial markets, economic conditions and other factors including the anticipated performance of the properties, property type and geographic location.\nThe General Partners believe the Registrant's properties are adequately insured.\nFor additional information describing the Registrant's properties, see Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations and Schedule III-Real Estate and Accumulated Depreciation on page 13 in Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThis information is incorporated by reference to Note I to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Limited Partners\nThere were no matters which were submitted to limited partners during the quarter ended December 31, 1995. However, in January 1996, a Consent Solicitation Statement was sent to all limited partners. See Item 1 for further information.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Units and Related Limited Partner Matters\nAs of March 1, 1996, there were 5,966 holders of record owning 44,503 Units. A significant secondary market for the Units has not developed, and it is not expected that one will develop in the future. There are also certain restrictions set forth in the Partnership Agreement limiting the ability of a Limited Partner to transfer Units. Consequently, holders of Units may not be able to liquidate their investments in the event of an emergency or for any other reason.\nThe following per Unit cash distributions were paid to Limited Partners, during the quarter indicated:\nThere are no material restrictions upon the Registrant's present or future ability to make distributions in accordance with the provisions of the Registrant's Partnership Agreement. In December 1995, Tash Inc., the sole tenant of the warehouse facility in Rancho Cucamonga, became insolvent and closed its operations. As a result, the Registrant expects to have reduced cash flow in 1996 and unless a new tenant can be found in the near future, the Registrant may have to lower future distributions. Furthermore, as a result of the approval by the limited partners holding a majority of the Units of the plan of sale and liquidation of the Partnership and the sale of the two shopping center properties, future cash distributions may be significantly impacted. The distributions paid to limited partners during 1995 and 1994 represent a return of capital on a generally accepted accounting principles (GAAP) basis. (The return of capital on a GAAP basis is calculated as limited partner distributions less net income allocated to limited partners.) For a discussion of other factors that may affect future distributions, 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 presents selected financial data of the Registrant. This data should be read in conjunction with the financial statements of the Registrant and the notes thereto contained on pages 2 through 11 in the Registrant's Annual Report which is filed as an exhibit hereto.\n(a) Includes $1,081,000, $6,463,000 and $1,426,000 provisions for loss on impairment of assets in 1995, 1993 and 1992, respectively.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis information is incorporated by reference to pages 12 through 15 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements are incorporated by reference to pages 2 through 11 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThere are no directors or executive officers of the Registrant. The Registrant is managed by the General Partners.\nThe Registrant, the Registrant's General Partners and their directors and executive officers, and any persons holding more than ten percent of the Registrant's Units are required to report their initial ownership of such Units and any subsequent changes in that ownership to the Securities and Exchange Commission on Form 3, 4 and 5. Such executive officers, directors and persons who own greater than ten percent of the Registrant's Units are required by Securities and Exchange Commission regulations to furnish the Registrant with copies of all Forms 3, 4 or 5 they file. All of these filing requirements were satisfied on a timely basis. In making these disclosures, the Registrant has relied solely on written representations of the General Partners'\ndirectors and executive officers and persons who own greater than ten percent of the Registrant's Units, if any, or copies of the reports they have filed with the Securities and Exchange Commission during and with respect to its most recent fiscal year.\nPrudential-Bache Properties, Inc.\nThe directors and executive officers of PBP and their positions with regard to managing the Registrant are as follows:\nTHOMAS F. LYNCH, III, age 37, is the President, Chief Executive Officer, Chairman of the Board of Directors and a Director of PBP. He is a Senior Vice President of Prudential Securities Incorporated (``PSI''), an affiliate of PBP. Mr. Lynch also serves in various capacities for other affiliated companies. Mr. Lynch joined PSI in November 1989.\nBARBARA J. BROOKS, age 47, is the Vice President-Finance and Chief Financial Officer of PBP. She is a Senior Vice President of PSI. Ms. Brooks also serves in various capacities for other affiliated companies. She has held several positions within PSI since 1983. Ms. Brooks is a certified public accountant.\nEUGENE D. BURAK, age 50, is a Vice President of PBP. He is a First Vice President of PSI. Prior to joining PSI in September 1995, he was a management consultant for three years and was with Equitable Capital Management Corporation from March 1990 to May 1992. Mr. Burak is a certified public accountant.\nCHESTER A. PISKOROWSKI, age 52, is a Vice President of PBP. He is a Senior Vice President of PSI and is the Senior Manager of the Specialty Finance Asset Management area. Mr. Piskorowski has held several positions within PSI since April 1972. Mr. Piskorowski is a member of the New York and Federal Bars.\nFRANK W. GIORDANO, age 53, is a Director of PBP. He is a Senior Vice President of PSI and an Executive Vice President and General Counsel of Prudential Mutual Fund Management, Inc., an affiliate of PSI. Mr. Giordano also serves in various capacities for other affiliated companies. He has been with PSI since July 1967.\nNATHALIE P. MAIO, age 45, is a Director of PBP. She is a Senior Vice President and Deputy General Counsel of PSI and supervises non-litigation legal work for PSI. She joined PSI's Law Department in 1983; presently, she also serves in various capacities for other affiliated companies.\nJames M. Kelso ceased to serve as President, Chief Executive Officer, Chairman of the Board of Directors and Director effective June 30, 1995. Effective June 30, 1995, Thomas F. Lynch, III was elected President, Chief Executive Officer, Chairman of the Board of Directors and Director. Robert J. Alexander ceased to serve as Vice President effective August 25, 1995. Eugene D. Burak was elected Vice President effective October 9, 1995.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and executive officers have indefinite terms.\nPrudential Realty Partnerships, Inc.\nThe directors and executive officers of Prudential Realty Partnerships, Inc. and their positions are as follows:\nJOEL W. STOESSER, age 55, is a Managing Director of Prudential Real Estate Investors. He is head of Investment Advisory Services, which includes responsibility for portfolio management and asset management of separate accounts and certain co-investment programs and commingled funds. Prior to his current assignment, Mr. Stoesser served as a Senior Vice President of the Prudential Realty Group. Prior to joining Prudential in 1988, he also served as a Senior Vice President in Real Estate Investment Management at CIGNA Corporation and held assignments with Connecticut General Life Insurance Company as head of real estate operations and as Director of strategic planning for all investment operations.\nDAVID BRADFORD, age 42, is a Managing Director of Prudential Real Estate Investors. He is the portfolio manager of PRISA, a large commingled fund. Prior to joining Prudential in 1995, Mr. Bradford was a Senior Vice President in Portfolio Management at Equitable Real Estate. His 13-year tenure at Equitable included positions in pension investment marketing across all asset classes, real estate product management and portfolio operations and investment. Most recently (1991-1995), Mr. Bradford was Assistant Portfolio Manager for Equitable's $3.2 billion flagship equity real estate portfolio Prime Property Fund.\nKEVIN R. SMITH, age 38, is a Vice President of Prudential Real Estate Investors. He is a portfolio manager for four separate accounts and two commingled funds. Mr. Smith has been employed by The Prudential since 1981 and has experience in asset management, development, property acquisitions and sales, and mortgage loans as a result of field office assignments in Cleveland, Houston, and Northern New Jersey.\nJOSE GENER, age 45, is a Vice President with The Prudential Asset Management Group. In his present assignment, he is responsible for accounting policy and reporting as well as the control structure for the institutional real estate management arm of PAMG. Mr. Gener has been with the Prudential since 1977, serving in a series of comptrollership assignments. Since 1986 he has worked primarily with the investment management units of The Prudential.\nC. EDWARD CHAPLIN, age 39, is Vice President and Treasurer of the Prudential Insurance Company of America. He is responsible for all borrowings, cash management and securities custody activities of The Prudential. Mr. Chaplin joined Prudential in the Realty Group in August 1983. In May 1992, he transferred to the Treasurer's Department as Vice President and Assistant Treasurer, with responsibility for Banking and Cash Management. In October 1993, he was promoted to Managing Director and Assistant Treasurer, with responsibility for managing Prudential's debt issuance, its relationships with the major credit rating agencies and financial counterparty credit analysis. In November 1995, Mr. Chaplin was appointed to Vice President and Treasurer.\nROGER S. PRATT, age 43, is Managing Director of Prudential Real Estate Investors. He is the portfolio manager of PRISA II, a large commingled fund. Mr. Pratt joined the Prudential Realty Group in June 1982 as an asset manager in the Atlanta regional office and subsequently has served in a variety of positions for the company. Prior to assuming his current position in February 1992, Mr. Pratt was Vice President in charge of the New Jersey regional office.\nJOSEPH D. MARGOLIS, age 35, is Assistant General Counsel responsible for the provision and coordination of legal services to Prudential Real Estate Investors as well as other Prudential Asset Management Group Real Estate entities. His assignments with Prudential have included counsel to The Prudential Mortgage Capital Company, Inc. and Associate Regional Counsel in the Boston Realty Group office. Prior to joining Prudential, Mr. Margolis was employed by Nutter, McClennen & Fish in Boston, Massachusetts.\nClaude J. Zinngrabe, Jr. ceased to serve as director effective December 8, 1995. Effective August 7, 1995, Jose Gener was elected Vice President and Comptroller. Effective August 7, 1995, Steven B. Saperstein ceased to serve as Vice President and Comptroller. John C. Hoffman ceased to serve as Director and President and Martin Pfinsgraff ceased to serve as Treasurer effective December 11, 1995. Effective December 11, 1995, C. Edward Chaplin was elected Treasurer and David Bradford was elected Director and President.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing executive officers and directors have indefinite terms.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant does not pay or accrue any fees, salaries or any other form of compensation to directors and officers of the General Partners for their services. Certain executive officers and directors of the General Partners receive compensation from affiliates of the General Partners, not from the Registrant, for services performed for various affiliated entities, which may include services performed for the Registrant; however, the General Partners believe that any compensation attributable to services performed for the Registrant is immaterial. See Item 13 Certain Relationships and Related Transactions for information regarding compensation to the General Partners.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 1, 1996, no director or executive officer of either of the General Partners owns directly or beneficially any interest in the voting securities of the General Partners.\nAs of March 1, 1996, no director or executive officer of either of the General Partners owns directly or beneficially any of the Units issued by the Registrant.\nAs of March 1, 1996, no limited partner beneficially owns more than five percent (5%) of the outstanding Units issued by the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Registrant has and will continue to have certain relationships with the General Partners and their affiliates. However, there have been no direct financial transactions between the Registrant and the directors or executive officers of the General Partners.\nReference is made to Notes A and H to the financial statements of the Registrant's Annual Report which is filed as an exhibit hereto, which identify the related parties and discuss the services provided by these parties and the amounts paid or payable for their services. The Joint Venture's relationship with the General Partners is described in Notes A and F of the Joint Venture's financial statements and notes thereto on pages 15 through 21 herein.\nPART IV\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Prudential Realty Acquisition Fund II, L.P. New York, New York\nWe have audited the financial statements of Prudential Realty Acquisition Fund II, L.P. (a Delaware Limited 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 March 26, 1996; such financial statements and report thereon are included in your 1995 Annual Report to Limited Partners and are incorporated herein by reference. Our audits also included the financial statement schedules of Prudential Realty Acquisition Fund II, L.P., listed in Item 14.","section_14":"Item 14. These financial statement schedules are the responsibility of the General Partners. 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\nMarch 26, 1996\nPRUDENTIAL REALTY ACQUISITION FUND II, L.P. (a limited partnership) Schedule III--Real Estate and Accumulated Depreciation December 31, 1995\n(A) Initial cost represents the initial purchase price of the properties including acquisition fees.\n(B) There are no encumbrances against any of the properties.\n(C) The aggregate cost of the real estate owned for Federal income tax purposes is $14,280,868\n(D) Reconciliation of Real Estate Owned:\n(E) Reconciliation of Accumulated Depreciation:\n(F) Costs Capitalized Subsequent to Acquisition includes noncash write-downs of $2,400,000.\nPRUDENTIAL REALTY ACQUISITION FUND II, L.P. (a limited partnership) Schedule IV--Mortgage Loan on Real Estate December 31, 1995\nThe mortgage loan matured on May 15, 1993 with a balance due of $1,389,852. The borrower remains in default. The Registrant recorded allowances for loan losses of $884,852 in 1993 and $150,000 in the third quarter of 1995. The third quarter 1995 provision was reversed as of December 31, 1995 to reflect the estimated sales proceeds based upon an agreement effective March 6, 1996 by which a purchaser has agreed to purchase the mortgage loan for $400,000. Subject to the conditions in the agreement, the Partnership will assign the mortgage to the purchaser at closing, presently scheduled for March 29, 1996 but in no event later than April 4, 1996. The purchaser is accepting the assignment of the mortgage and any responsibility it may incur from such assignment for any further remediation costs at the underlying property. However, there is no assurance that the sale will be consummated.\n(a) Periodic Payment Terms--The mortgage loan plus interest was collected at level amounts over its life to maturity, with a balloon payment due and payable at maturity. The balance due at maturity (May 1993) was $1,389,852.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Ridge Plaza Joint Venture New York, New York\nWe have audited the accompanying statements of financial condition of Ridge Plaza Joint Venture 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 Joint Venture Partners. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, 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 Joint Venture 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, such financial statements present fairly, in all material respects, the financial position of Ridge Plaza Joint 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.\nDeloitte & Touche LLP\nMarch 26, 1996\nRIDGE PLAZA JOINT VENTURE STATEMENTS OF FINANCIAL CONDITION\nRIDGE PLAZA JOINT VENTURE STATEMENTS OF OPERATIONS\nRIDGE PLAZA JOINT VENTURE STATEMENTS OF CHANGES IN PARTNERS' CAPITAL\nRIDGE PLAZA JOINT VENTURE STATEMENTS OF CASH FLOWS\nRIDGE PLAZA JOINT VENTURE NOTES TO FINANCIAL STATEMENTS\nA. General\nRidge Plaza Joint Venture (the ``Joint Venture'') is a joint venture formed on May 8, 1985 which will terminate on May 8, 2025 unless ended sooner under the provisions of the joint venture agreement (the ``Joint Venture Agreement''). The Joint Venture was formed to acquire and manage two shopping centers, Ridge Plaza Shopping Center and Pine Island Ridge Plaza Shopping Center, located in Davie, Broward County, Florida. The co-venturers are Prudential Acquisition Fund I, L.P. (``PAF I'') and Prudential Realty Acquisition Fund II, L.P. (``PRAF II''). PAF I and PRAF II are Delaware limited partnerships of which Prudential-Bache Properties, Inc. (``PBP'') and Prudential Realty Partnerships, Inc. (``PRP'') are the co-general partners.\nThe two shopping centers owned by the Joint Venture were sold on March 26, 1996 for a gross sales price of $15,500,000 less costs to sell.\nB. Summary of Significant Accounting Policies\nBasis of accounting\nThe books and records of the Joint Venture are maintained 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 the co-venturers 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 as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nProperty\nEffective December 31, 1995, the Joint Venture adopted 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.'' Under SFAS No. 121, impairment of properties to be held and used is determined to exist when estimated amounts recoverable through future operations on an undiscounted basis are below the properties' carrying value. If a property is determined to be impaired, it should be recorded at the lower of its carrying value or its estimated fair value. For properties that are held for sale, SFAS No. 121 states that they should be recorded at the lower of carrying amount or estimated fair value less costs to sell. At December 31, 1995, the Joint Venture's properties are recorded at the gross sales price less costs to sell, and the Joint Venture has ceased depreciating the properties for financial statement purposes only.\nPrior to December 31, 1995, the Joint Venture carried its property investments at the lower of depreciated cost or estimated amounts recoverable through future operations and ultimate disposition of the property. Property investments were depreciated or amortized using the straight-line method over their estimated economic lives which ranged from 5 to 35 years depending on property type. A provision for loss on impairment of assets was recorded when estimated amounts recoverable through future operations and ultimate disposition of the property on a undiscounted basis were below depreciated cost. However, property investments were reduced to estimated fair value when the property was considered to be permanently impaired and the depreciated cost exceeded the estimated fair value.\nBuildings and improvements include furniture and fixtures, tenant improvements and capitalized leasing costs. Tenant improvements and capitalized leasing costs were amortized over the lives of their respective leases. Capitalized leasing costs, net of accumulated amortization were $107,438 and $130,733 at December 31, 1995 and 1994, respectively.\nCash and cash equivalents\nCash and cash equivalents include money market funds whose cost approximates market value.\nIncome taxes\nThe Joint Venture is not required to provide for, or pay, any Federal or state income taxes. Income tax attributes that arise from its operations are passed to the individual partners. The Joint Venture may be subject to other state and local taxes in jurisdictions in which it operates.\nProfit and loss allocations and distributions\nFor financial reporting purposes, net profits or losses are allocated 54% to PAF I and 46% to PRAF II.\nDistributions of cash are made in accordance with the Joint Venture Agreement and are allocated 54% to PAF I and 46% to PRAF II.\nC. Property\nThe Joint Venture's properties are comprised of the following:\nThe carrying value of the Joint Venture's properties were reduced by $850,000 during the second quarter of 1995 to reflect an impairment in value resulting from lease defaults and market indications. In the fourth quarter of 1995, the Joint Venture recorded a provision for loss on impairment of assets of $1,500,000 to reflect the estimated net proceeds received from the sale of the two shopping centers on March 26, 1996.\nThe Joint Venture's properties were considered to be impaired in 1993 because declines in net operating income had continued for an extended period of time and the trend was not expected to change in the foreseeable future. Accordingly, a write-down of $17,150,000 was recorded at December 31, 1993 to reduce the Joint Venture's properties to estimated fair value based on third party appraisals. This consisted of a provision for loss on impairment of $14,050,000 and the utilization of a $3,100,000 valuation allowance recorded in 1992.\nD. Income Taxes\nThe following is a reconciliation of net income (loss) for financial reporting purposes with net income (loss) for tax reporting purposes.\nThe differences between the tax basis and book basis of partners' capital are primarily attributable to the cumulative effect of the book-to-tax income (loss) adjustments.\nE. Leases\nThe Joint Venture has noncancellable operating leases at its two shopping centers. One tenant, Builders Square (whose lease expires in 2003) accounted for 16%, 16% and 13% of the revenues of the Joint Venture for the years ended December 31, 1995, 1994 and 1993, respectively. Future minimum base lease receipts at December 31, 1995 due under these noncancellable leases are as follows:\nIn addition, certain of the leases require the lessees to reimburse the Joint Venture for real estate taxes, insurance costs and other expenses.\nF. Related Parties\nThe general partners of the co-venturers and their affiliates perform services for the Joint Venture which include, but are not limited to: accounting and financial management, asset management and other administrative services. The amount of reimbursement from the Joint Venture is limited by the provisions of the Joint Venture Agreement. The costs and expenses incurred on behalf of the Joint Venture which are reimbursable to the general partners of the co-venturers and their affiliates were:\nExpenses payable to the general partners of the co-venturers and their affiliates (which are included in accrued expenses) as of December 31, 1995 and 1994 were $22,400 and $19,900, respectively.\nThe Joint Venture maintains an account with the Prudential Institutional Liquidity Portfolio Fund, an affiliate of the co-venturers, for investment of its available cash in short-term instruments pursuant to the guidelines established by the Joint Venture Agreement.\nG. Subsequent Event\nThe two shopping centers owned by the Joint Venture were sold on March 26, 1996 for a gross sales price of $15,500,000 less costs to sell.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPRUDENTIAL REALTY ACQUISITION FUND II, L.P.\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner By: \/s\/ Eugene D. Burak Date: March 29, 1996 ---------------------------------------- Eugene D. Burak 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 (with respect to the General Partners) and on the dates indicated.\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner By: \/s\/ Thomas F. Lynch, III Date: March 29, 1996 ---------------------------------------- Thomas F. Lynch, III President, Chief Executive Officer, Chairman of the Board of Directors and Director By: \/s\/ Barbara J. Brooks Date: March 29, 1996 ---------------------------------------- Barbara J. Brooks Vice President-Finance and Chief Financial Officer By: \/s\/ Eugene D. Burak Date: March 29, 1996 ---------------------------------------- Eugene D. Burak Vice President By: \/s\/ Frank W. Giordano Date: March 29, 1996 ---------------------------------------- Frank W. Giordano Director By: Nathalie P. Maio Date: March 29, 1996 ---------------------------------------- Nathalie P. Maio Director\nBy: Prudential Realty Partnerships, Inc. A Delaware corporation, General Partner By: \/s\/ Joel W. Stoesser Date: March 29, 1996 ---------------------------------------- Joel W. Stoesser Chairman of the Board of Directors By: \/s\/ David Bradford Date: March 29, 1996 ---------------------------------------- David Bradford President and Director By: \/s\/ Kevin R. Smith Date: March 29, 1996 ---------------------------------------- Kevin R. Smith Vice President and Director By: \/s\/ Jose Gener Date: March 29, 1996 ---------------------------------------- Jose Gener Vice President and Comptroller By: \/s\/ C. Edward Chaplin Date: March 29, 1996 ---------------------------------------- C. Edward Chaplin Treasurer By: \/s\/ Roger S. Pratt Date: March 29, 1996 ---------------------------------------- Roger S. Pratt Director By: \/s\/ Joseph D. Margolis Date: March 29, 1996 ---------------------------------------- Joseph D. Margolis Secretary","section_15":""}
{"filename":"810589_1995.txt","cik":"810589","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":"800266_1995.txt","cik":"800266","year":"1995","section_1":"ITEM 1. BUSINESS\nShorewood Packaging Corporation and its subsidiaries (collectively, \"Shorewood\" or the \"Company\") print and manufacture high quality paperboard packaging for the cosmetics, home video, music, software, tobacco and toiletries and general consumer markets in the United States and Canada. Shorewood was incorporated in November 1967. The Company's principal executive offices are located at 277 Park Avenue, New York, New York 10172 and its telephone number is (212) 371-1500.\nShorewood's strategic objectives are (i) the maintenance of its position as a leading paperboard packager to the tobacco industry and the home entertainment market, which includes the music and video industries; (ii) the further expansion of the Company's markets in the CD-ROM computer software and games industry and in the cosmetics and toiletries, food, liquor, consumer electronics, film and hosiery industries; and (iii) the identification of other areas in the general consumer packaging industry that can most benefit from the Company's ability to produce graphically enhanced high quality packaging. To achieve these objectives, the Company intends to continue expanding its printing, packaging and graphic arts capabilities, including the development and application of advanced manufacturing technologies.\nPackaging Products\nThe Company produces high quality specialized packaging, principally folding cartons and set up boxes, for its customers in the United States and Canada that require sophisticated precision graphic packaging for their products, including customers in the home entertainment industry, the tobacco industry, the software industry, the personal care, cosmetic and toiletries industries and in such general consumer industries as the food, liquor, film, hosiery, consumer electronics and pharmaceutical industries.\nIn January 1994, the Company acquired the assets comprising the \"Somerville Premium Packaging Business\" of Cascades Paperboard International, Inc. (the \"Premium Group\"). See \"Acquisitions\". As a result of its acquisition of the Premium Group, the Company has become a principal supplier of printed packaging products for the tobacco industry. For its tobacco industry customers, the Company produces the hard flip-top cigarette packages as well as the traditional slide and shell packages. These products are used to package many of the leading tobacco brands. The Company believes that through its acquisition of the Premium Group it has become the primary carton supplier to the Canadian tobacco industry and a leading manufacturer of paperboard packaging for the tobacco industry in the United States. See \"Tobacco Industry\". In the fiscal year ended April 29, 1995 (\"fiscal 1995\"), Philip Morris, one of Shorewood's tobacco industry customers, accounted for approximately 17% of the Company's consolidated net revenues. In addition, two other customers, who may be deemed to be affiliated with each other, accounted in the aggregate for approximately 13% of the Company's fiscal 1995 consolidated net revenues, albeit neither alone accounted for more than 10% of the Company's consolidated revenues in such fiscal year. Although Shorewood believes that its relationships with these customers are excellent, the Company does not have long-term supply agreements with them and there can be no assurance that their packaging requirements in the future will continue at the same levels as in fiscal 1995.\nFor its music and home entertainment industry customers, the Company manufactures compact disc packaging (including folders, booklets and liners), prerecorded cassette packaging (including folders and sleeves), and other printed material and paperboard packaging for all video cassette formats (including VHS and 8 millimeter). The Company's music industry customers include most of the major\nmusic production and distribution companies in the United States. The Company has long-standing relationships with many of these companies and in certain cases also has agreements, typically for three to five years, to supply their packaging products.\nIn March 1993, the manufacturers of prerecorded music discontinued the use of the long-box as a packaging medium for compact discs. During fiscal 1993, the Company realized revenues of approximately $20 million from the sales of the long-box. Revenues derived from the long-box were negligible during fiscal years 1994 and 1995. The revenue loss was mitigated as the Company's revenues increased in fiscal years 1994 and 1995, primarily as a result of its acquisition of the Premium Group. Additionally, the Company continues its efforts to market to music industry manufacturers and other users of compact discs different forms of compact disc packaging.\nThe Company has supplied a significant portion of the music packaging products required by Sony Music Entertainment, Inc., a wholly-owned subsidiary of Sony Corporation (\"Sony\") and, from time to time, has entered into supply agreements with Sony. Sony and its affiliates (including its Canadian operations) accounted for approximately 18% of the Company's net sales for fiscal 1993. Sony did not account for more than 10% of the Company's consolidated revenues in either fiscal 1994 or fiscal 1995. The Company cannot predict the packaging product requirements of Sony in the future.\nThe Company is a supplier of paperboard packaging for the cosmetics and toiletries industry and also produces a wide range of consumer packaging products. Additionally, as a result of the Company's acquisition of certain operating assets from Heminway Packaging Corporation (\"Heminway\") in January 1994, the Company manufactures and provides rigid set-up boxes, principally for customers in the cosmetics industry. See \"Acquisitions.\"\nAn emerging new market for the Company's products is the CD-ROM computer software and games industry. The Company is currently constructing a manufacturing facility in the Pacific Northwest, home of many leading software manufacturers, to better service this market. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns offices and manufacturing facilities in LaGrange, Georgia; Roanoke, Virginia; Danville, Virginia; Williamsburg, Virginia; Smiths Falls, Ontario; Brockville, Ontario and Andalusia, Alabama. Additionally, the Company is constructing a manufacturing facility in Springfield, Oregon which is scheduled to become operational in the Fall of 1995. Upon completion of the Oregon plant, the Company will own in the aggregate approximately 1.1 million square feet of office and manufacturing space. The Company also leases office, manufacturing and warehousing facilities at various locations in New York, Connecticut, California, Georgia, Illinois, North Carolina and Canada which leases expire at various times ending in the year 2002. The aggregate annual net rental cost, exclusive of real estate taxes, for a total of approximately 811,000 square feet of rental space, is approximately $3.5 million. In fiscal 1996, the Company will close the facility which it leases in Pittsford, New York. See \"Acquisitions\".\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n1. Shorewood Packaging Corporation of Connecticut and Shorewood Packaging Corporation v. Heminway Packaging Corporation, et al.\nIn April 1995, the Company and its wholly-owned subsidiary, Shorewood Packaging Corporation of Connecticut (\"SPCC\"), commenced a civil action in Supreme Court of the State of New York, New York County, against Heminway and certain of its affiliates seeking compensatory and punitive damages and other relief with regard to the acquisition of the Heminway Business. See \"Acquisitions.\" The suit contends that Heminway and the other defendants misrepresented the financial condition and operational capabilities of the Heminway Business. The Company is seeking damages in excess of $5 million.\nIn June 1995 Heminway filed an answer, affirmative defenses and counterclaim to the Company and SPCC's complaint. The counterclaim asserts claims for compensatory damages exceeding $10 million and punitive damages of $7.7 million. Heminway's counterclaim also seeks a declaratory judgment and damages with respect to SPCC's paying into escrow a portion of rent due and payable pursuant to a lease between Heminway and SPCC. The remaining two defendants moved to dismiss the complaint for failure to state a cause of action. On June 29, 1995, the Company and SPCC moved to dismiss the counterclaim and responded to the motion to dismiss the complaint. Management intends to vigorously pursue its claims against the defendants and to vigorously defend the counterclaim.\n2. Shorewood Packaging Corporation v. Newman Construction Company, et al.\nIn January 1990, the Company commenced a civil action in the United States District Court for the Northern District of Georgia, Atlanta Division, seeking in excess of $5 million of damages arising out of construction work performed by the defendant at Shorewood's LaGrange, Georgia manufacturing and warehouse facility. In November 1994, the Company accepted a cash settlement of $1.5 million to terminate the litigation. In addition, the defendant's counterclaim for approximately $300,000, representing the last payment due under the construction contract, was dismissed as part of the settlement.\nThe Company is not presently a party to any other material litigation. On a continuing basis, the Company monitors its compliance with applicable environmental laws and regulations. As part of this process, the Company cooperates with appropriate governmental authorities to perform any necessary testing and compliance procedures. The Company is not aware of any environmental compliance proceeding that will have a material effect on its consolidated financial statements. During fiscal 1995, the Company has been involved, at various locations, in the correction of certain violations of applicable environmental laws, rules or regulations. Amounts paid during fiscal 1995 to all governmental agencies aggregated less than $100,000.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere was no vote of security holders during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Market Information. The Company's Common Stock is traded in the over-the-counter market on the NASDAQ National Market System under the symbol SHOR. The following table sets forth, for the fiscal periods indicated, the high and low sales prices for the Common Stock on the National Market System, as reported by NASDAQ.\nThe last sale price of the Company's Common Stock on July 26, 1995 was $17.375.\nIn January 1993, the Company's Board of Directors authorized the purchase of up to 2.0 million shares of the Company's Common Stock from time to time in the open market. Pursuant to this authorization, through the end of fiscal 1995, the Company utilizing internally generated funds purchased 1.2 million shares of its Common Stock for approximately $12.6 million. The Company is restricted under the terms of its Senior Term Notes and long-term revolver agreements from purchasing shares of its Common Stock.\n(b) Holders. There were 301 record holders of the Company's Common Stock as of July 26, 1995. The Company believes that, as of such date, there were in excess of 1,000 beneficial holders of the Company's Common Stock, including those stockholders whose shares were held of record by certain depository companies.\n(c) Cash Dividends. The Company has not paid any cash dividends on its Common Stock during either of its two most recent fiscal years. The Company anticipates that its earnings for the foreseeable future will be utilized to reduce debt, to fund acquisitions or to purchase shares of its Common Stock, or will be retained for use in its business. Accordingly, the Company believes that it is now unlikely that any cash dividends will be paid on its Common Stock in the near future.\nThe Company's Senior Term Notes and long-term revolver agreements restrict the amount of retained earnings available for the payment of dividends (other than dividends payable in the Company's Common Stock). The amount of retained earnings free from such restrictions as of April 29, 1995 approximated $14.4 million.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial information set forth below for and as of the fiscal year ended April 29, 1995 and for and as of the end of each of the four preceding fiscal years is derived from, and qualified by reference to, the consolidated financial statements of Shorewood Packaging Corporation and subsidiaries which have been audited by Deloitte & Touche LLP, independent auditors whose report as of April 29, 1995 and April 30, 1994 and for the 52 weeks ended April 29, 1995, April 30, 1994 and May 1, 1993 is included elsewhere herein. Except for the Special Dividend of $3.25 per Common Share paid on July 2, 1991, cash dividends were not paid on the Company's Common Stock in any of the periods indicated below.\nSUMMARY FINANCIAL DATA (In thousands, except per share amounts)\n- --------------- (1) 53 week period\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview\nEffective January 1, 1994, the Company acquired certain operating assets of the Premium Packaging Group of Cascades Paperboard International, Inc. (The \"Premium Group\"), and on January 17, 1994, the Company purchased the operating assets of Heminway Packaging Corporation (\"Heminway\") (collectively \"the Acquired Companies\") (See Note 2 of Notes to Consolidated Financial Statements). The Premium Group manufactures and provides folding cartons to the tobacco, cosmetics and toiletries and general consumer industries while Heminway manufactures and provides rigid set-up boxes principally to the cosmetics industry. These acquisitions were recorded using the purchase method of accounting. Accordingly, the operating results related to the Acquired Companies were included in the Company's results of operations for the periods subsequent to each respective acquisition date. The historical results of operations of Heminway were not significant to the consolidated financial statements of the Company.\nThe fourth quarter of fiscal 1994 is the first quarter in which the operations of the Acquired Companies were included in the consolidated operating results of the Company for a full quarter. Fiscal 1995's results of operations represent the first year of operations in which the Acquired Companies and the Company's results are included for the full year.\nFiscal Year Comparisons\nNet Sales\nNet sales for fiscal 1995 were $357.0 million compared to net sales of $216.5 million for the corresponding prior period, an increase of 64.9%. Included in fiscal 1995 are sales of approximately $177.6 million produced by facilities of the Acquired Companies as compared to $47.7 million for the corresponding prior period (since the date of acquisition, January 1, 1994).\nNet sales for fiscal 1994 were $216.5 million compared to net sales of $184.1 million for the corresponding prior period, an increase of 17.6%. Included in the 1994 fiscal period are sales of approximately $47.7 million related to the operations of the Acquired Companies. Net sales for the 1994 fiscal year were adversely affected by the decision by the music industry to discontinue the use of the long-box as a packaging medium for compact discs. Revenues derived from the long-box were negligible during fiscal 1994 as compared with $20.0 million in fiscal 1993.\nThe Company believes that its future sales growth will be generated through continued penetration of its existing markets and the expanding market of CD Rom products. The Company expects its new facility in Oregon to begin production and provide additional sales growth during fiscal 1996.\nCost of Sales\nCost of sales as a percentage of sales was 77.3% in fiscal 1995 as compared with 77.2% in fiscal 1994. Cost of sales in fiscal 1995 was adversely affected by increased raw material costs which were unable to be immediately reflected in the selling price of the Company's products. In addition, the Company experienced some inefficiencies related to the installation of new production capacity in certain of its facilities.\nCost of sales as a percentage of sales was 77.2% in fiscal 1994 as compared with 73.9% in fiscal 1993. The increase in the cost of sales percentage in fiscal 1994 was primarily attributed to the discontinued use of the long-box for compact discs resulting in the related lower level of sales at the Company's Farmingdale, New York facility. In addition, the Company's cost of sales percentage increased due to the inclusion of the operations of the Acquired Companies whose margins have been historically lower than that of the Company.\nThe Company remains sensitive to the price competitiveness in the markets that it currently serves and in areas of its targeted growth. It believes that the labor and production efficiencies associated with the installation of additional state-of-the-art printing and manufacturing equipment, including the new facility in Oregon, will enable the Company to compete effectively.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses were 10.0%, 11.2%, and 10.9% of net sales for fiscal years 1995, 1994 and 1993, respectively. The amount of selling, general and administrative expenses for fiscal 1995 increased compared to fiscal 1994 and fiscal 1994 increased compared to fiscal 1993 due to the inclusion of such expenses of the Acquired Companies.\nPlant Closing and Restructuring\nDuring fiscal 1995 the Company completed its determination of the allocation of purchase price with respect to the Acquired Companies. In order to streamline the Company's operations and increase productivity, the Company will close the Pittsford, New York plant during fiscal 1996 and transfer the equipment located there to other Company facilities. Included in the final allocation of the purchase price is an estimate of the cost of closing this redundant facility (See Note 2 of Notes to Consolidated Financial Statements).\nAs a result of the discontinued use of the long-box as a packaging medium for compact discs and the related diminished level of sales, the Company decided at the end of the third quarter of fiscal 1994 to close its Farmingdale, New York facility effective as of April 30, 1994. In connection with the closing of this facility and the restructuring of the Company's operations relating thereto, the Company recorded a restructuring charge before provision for income taxes amounting to $3.4 million during the third quarter of fiscal 1994. Included in this charge are amounts provided for the termination of leases, disposal of equipment, severance payments and other related restructuring items. The impact on net earnings related to the restructuring charge was a loss of approximately $2.1 million or ($.12) per share.\nInvestment and Other Income\nInvestment and other income, net, decreased in fiscal 1995 as compared to fiscal 1994 primarily due to the change in the impact of foreign exchange gains and losses. For fiscal 1995 the Company had losses from foreign exchange transactions of approximately $270,000 while in fiscal 1994 the Company had gains of approximately $234,000. The foreign exchange impact was consistent in fiscal 1993 when compared to fiscal 1994.\nThe Company's exposure to foreign exchange transaction gains or losses relate to the Company's Canadian facilities which have U.S. dollar denominated net current assets. The Company believes that\nfluctuations in foreign exchange rates will not have a material impact on the operations or liquidity of the Company, based upon current and historical levels of working capital at the Canadian facilities.\nInvestment income representing interest on short-term deposits was approximately $320,000 in fiscal 1995 and fiscal 1994, and approximately $404,000 in fiscal 1993.\nInterest Expense\nInterest expense for fiscal 1995 increased compared to fiscal 1994, and fiscal 1994 increased compared to fiscal 1993 as a result of the additional borrowings required to finance the purchase of the Acquired Companies.\nCapitalized interest costs related to the construction of fixed assets were $377,000 in fiscal 1995 and $131,000 in fiscal 1994 and fiscal 1993. The Company anticipates additional capitalization of interest during fiscal 1996 in connection with the construction of the manufacturing facility in Oregon.\nIn October 1994, the Company assigned to a bank an interest rate swap agreement relating to $42 million of its Senior Term Notes for cash proceeds of approximately $1.3 million. The proceeds have been recorded as a deferred credit which is being amortized as a reduction of interest expense (amounting to $371,000 in fiscal 1995). At April 29, 1995 $913,000 of deferred gain remains which will be amortized: $510,000 in 1996; $289,000 in 1997; and $114,000 in 1998.\nThe Company has in the past, and may continue to in the future, use interest rate swaps and caps to manage its exposure to fluctuating interest rates under its debt agreements (See Note 6 of Notes to Consolidated Financial Statements).\nIncome Taxes\nThe effective income tax rate was 37.8% in fiscal 1995 as compared with 40.6% in fiscal 1994 and 37.6% in fiscal 1993. These rates reflect a blend of domestic and foreign taxes. (See note 7 of notes to Consolidated Financial Statements).\nDuring the first quarter of fiscal 1993, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 changed the method of accounting for income taxes from the deferred method to the liability method. Under the deferred method, deferred income taxes were recognized using the tax rates in effect when the tax was first recorded and not adjusted for subsequent changes in the tax rates until paid or recovered. Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial accounting and tax bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the currently enacted tax rate. Net earnings in fiscal 1993 increased by $1.15 million as a result of the cumulative effect of this change in accounting principle.\nThe increase in the effective tax rate in fiscal 1994 includes approximately $200,000 representing the effect of the income tax rate change enacted into law in August 1993.\nExtraordinary Item\nIn connection with the purchase of the Acquired Companies, the Company prepaid $31.9 million of Senior Notes. As a result of the prepayment, the Company recorded, in the third quarter of fiscal 1994, an extraordinary charge of $3.1 million (after related income tax benefit of $1.9 million) consisting of prepayment penalties and the write-off of deferred finance costs.\nImpact of Inflation\nThe Company from time to time experiences increases in the costs of materials and labor, as well as in other manufacturing and operating expenses. The Company's ability, consistent with that of its competitors, to pass on such increased costs through increased prices has been affected differently at various times.\nLiquidity and Capital Resources\nCash and cash equivalents at April 29,1995 totaled approximately $4.1 million and working capital at this date was $31.9 million as compared to $31.4 million at the end of fiscal 1994. The current ratio was 1.5 to 1 at April 29, 1995 compared with 1.7 to 1 at the end of fiscal 1994.\nCash flow provided from operating activities for fiscal 1995 approximated $40.0 million before changes in operating assets and liabilities, of which $13.2 million was invested in non-cash working capital, primarily inventories. The increase in inventories is primarily attributed to additional raw materials to support additional capacity (as well as sales volume) and increased raw material prices. Cash flows from operations were used to support approximately $15.6 million in capital expenditures with the balance primarily used to reduce the Company's long-term obligations. In connection with a planned expansion of the Company's facilities, the Company anticipates investing approximately $20.0 million in a new plant and new equipment in Oregon, of which $800,000 has been disbursed as of April 29, 1995. Funds for this expansion are to be provided from the Company's existing credit facility.\nNet capital expenditures primarily for manufacturing equipment, for the 52 week period ended April 29, 1995 were approximately $15.6 million. The Senior Term Note and Long-Term Revolver Agreement (the \"Loan Agreement\") limit capital expenditures by the Company to $15.0 million during fiscal 1996 (excluding capital expenditures related to the Company's investment in its Oregon facility, which are limited to $20.0 million).\nThe Loan Agreement provides for covenants related to levels of debt to cash flow, current assets to current liabilities, fixed charge coverage, net worth and investments (including investments in the Company's own common stock), and restricts the amount of retained earnings available for payment of dividends. Retained earnings free from restrictions at April 29, 1995 approximated $14.4 million. The Loan Agreement requires the Company to prepay the term notes to the extent of 50% of excess cash flow as defined. For the year ended April 29, 1995, there was no excess cash flow as defined.\nThe Company expects that cash flow from operations together with the borrowing capacity under the revolving credit facility will be sufficient to meet the needs of the business in the foreseeable future. The Company has a $50 million five-year revolving credit facility for its working capital requirements. Borrowings under this facility are limited to the sum of 80% of accounts receivable and 50% of inventories (the \"Borrowing Base\"). At April 29, 1995, the Company had borrowings under this facility of $12.2 million and was not limited by its Borrowing Base.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Shorewood Packaging Corporation\nWe have audited the accompanying consolidated balance sheets of Shorewood Packaging Corporation and subsidiaries as of April 29, 1995 and April 30, 1994 and the related consolidated statements of earnings, stockholders' equity and cash flows for the 52 weeks ended April 29, 1995, April 30, 1994 and May 1, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Shorewood Packaging Corporation and subsidiaries as of April 29, 1995 and April 30, 1994 and the results of their operations and their cash flows for the 52 weeks ended April 29, 1995, April 30, 1994 and May 1, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\n\/s\/ DELOITTE & TOUCHE LLP\nNew York, New York June 27, 1995\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (In thousands except share data)\nThe accompanying notes are an integral part of these financial statements.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF EARNINGS (In thousands except per share data)\nThe accompanying notes are an integral part of these financial statements.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nThe accompanying notes are an integral part of these financial statements.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands except share data)\nThe accompanying notes are an integral part of these financial statements.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Principles of consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation.\nb. Recognition of revenue\nThe Company reports revenue, with the related costs, in the accounting period in which goods are shipped to the customer.\nc. Statement of cash flows\nThe Company considers all highly liquid temporary investments with original maturities of three months or less to be cash equivalents.\nd. Inventories\nInventories are valued at the lower of cost or market. Cost is determined principally on the first-in, first-out (FIFO) method. Components of inventory include materials, labor and overhead costs.\ne. Depreciation and amortization\nThe Company computes depreciation and amortization of property, plant and equipment substantially by the straight-line method over the shorter of the estimated useful lives or lease periods of the respective assets. The excess of purchase price over the fair value of net assets of businesses acquired is amortized over periods ranging from 10 to 40 years on a straight-line basis.\nThe Company periodically evaluates the possible impairment of the excess of cost over the fair value of net assets acquired by comparing the undiscounted cash flows from the acquired operations to the net carrying value of the related asset.\nf. Income taxes\nThe Company and its domestic subsidiaries file a consolidated Federal income tax return. Deferred taxes are provided for the income tax effects of temporary differences in reporting transactions for financial reporting and tax purposes.\nThe Company adopted Statement of Financial Accounting Standards No.109 \"Accounting for Income Taxes\" (\"SFAS 109\") during the fiscal quarter ended August 1, 1992. SFAS 109 changed the method of accounting for income taxes from the deferred method to the liability method. Under the deferred method, deferred income taxes were recognized using the tax rates in effect when the tax liability was first recorded and not adjusted for subsequent changes in the tax rates until paid or recovered. Under\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nthe liability method, deferred tax assets and liabilities are determined based on the difference 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. The impact on the provision for income taxes for fiscal 1993 was not significant. The cumulative effect of this accounting change increased net earnings in 1993 by $1,150.\nUnited States (\"U.S.\") income taxes with respect to the undistributed earnings of the Company's foreign subsidiaries have not been provided since it is the intention of management that the undistributed earnings will be reinvested or transferred to the Company without giving rise to U.S. tax liabilities. The total amount of unremitted earnings of non-U.S. subsidiaries was approximately $24.9 million at April 29, 1995.\ng. Foreign currency translation\nAssets and liabilities of foreign subsidiaries are translated into U.S. dollars at fiscal period-end exchange rates and revenues and expenses are translated on a monthly basis at weighted average exchange rates for the respective month. Gains and losses arising from translation are recorded as foreign currency translation adjustments, a component of stockholders' equity. Foreign currency transaction gains and losses are included in determining net earnings.\nh. Share information\nWeighted average common and common equivalent shares outstanding include the dilutive effect of outstanding stock options and warrants for all periods presented.\nFully diluted earnings per share has not been presented as it is not materially different from primary earnings per share.\nWeighted average common and common equivalent shares for the 1995 period include the effect of the shares issued upon conversion of the Company's Convertible Subordinated Debentures since the date of conversion. Had these shares been issued as of May 1, 1994, earnings per share for the 1995 period would have been approximately $1.15.\ni. Business segment\nThe Company and its subsidiaries operate in one business segment, providing printed packaging products to the entertainment, cosmetic, tobacco and other consumer product industries.\nj. Fiscal periods\nReference to 1995, 1994, and 1993 in the accompanying notes to the consolidated financial statements refer to the fiscal periods ending April 29, 1995, April 30, 1994 and May 1, 1993, respectively.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nk. Reclassifications\nCertain reclassifications have been made to the prior years balances to conform with the current year's presentation.\n2. ACQUISITIONS\nEffective January 1, 1994, the Company purchased certain of the United States and Canadian assets of the Premium Packaging Group of Cascade Paperboard International, Inc. (the \"Premium Group\") for a cash purchase price of approximately $96.9 million plus the assumption of approximately $9.9 million of liabilities (primarily accounts payable) and transaction expenses. In addition, the Company is contingently liable for an additional $5.0 million of consideration if certain earnings levels related to the combined operations during the four-year period following the consummation of the transaction are attained. The Company has issued a warrant to the seller exercisable, subject to the above-described contingency, for 35,000 shares of Company Common Stock at an exercise price of $13.50 per share. At the time of the closing of the transaction, the Company prepaid a total of $31.9 million of Senior Notes. The transaction and prepayment of the Company's Senior Notes were financed with senior credit facilities including $120 million in five-year term loans and $24 million of borrowing under a $50 million five-year revolving credit facility. In connection with the prepayment of the Senior Notes, the Company recorded, in the third quarter of fiscal 1994, an extraordinary charge of $3.1 million (after related income tax benefit of $1.9 million) consisting of prepayment penalties and the write-off of deferred finance costs.\nOn January 17, 1994 the Company purchased the operating assets of Heminway Packaging Corporation for a cash purchase price of $3.7 million plus transaction expenses. This transaction was financed with funds from the Company's revolving credit facility referred to above. The historical results of operations of Heminway were not material to the operations of the Company.\nThese acquisitions were recorded using the purchase method of accounting and accordingly, the results of their operations are included in the consolidated results of operations of the Company since the dates of their respective acquisitions. The excess of cost over the estimated fair value of the net assets acquired approximated $2.2 million at April 30, 1994. During fiscal 1995, the Company completed its determination of the allocation of the purchase price with respect to the acquisitions. The result was to increase the excess of cost over the fair value of net assets acquired by $12.5 million, increase accrued expenses by $3.4 million and reduce property, plant and equipment by $9.1 million. Included in the final allocation of the purchase price is an estimate of the cost associated with closing one of the Premium Group's facilities. Accumulated amortization of the excess of cost over the fair value of net assets acquired approximated $543 in 1995 and $414 in 1994.\nThe following unaudited pro forma information for 1994 includes the operations of the Company inclusive of the operations of the Premium Group as if the acquisition had occurred at the beginning of the period presented, including the impact of the Company's new financing agreement described above, the amortization expense associated with intangible assets acquired, adjustments related to the fair market value of the assets and liabilities of the Premium Group as finally determined (including, among other things, adjustment of depreciation expense) and related income tax effects.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\n3. INVENTORIES\n4. PROPERTY, PLANT AND EQUIPMENT, AT COST-NET\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nDepreciation and amortization of property, plant and equipment amounted to $12,792 in 1995, $9,834 in 1994 and $7,888 in 1993. Capitalized interest costs related to the construction of fixed assets were $377 in 1995 and $131 in 1994 and 1993.\n5. ACCRUED EXPENSES\n6. LONG-TERM DEBT\/CONVERTIBLE SUBORDINATED DEBENTURES\n- --------------------- (a) In connection with the acquisition of the Premium Group and the prepayment of certain obligations, the Company entered into Term Note Agreements (totaling $96 million in the U.S. and the Canadian equivalent of $24 million in Canada) with a syndicate of banks. The notes are payable in quarterly installments beginning in August 1994, through May 1999. The notes bear interest, at the discretion of the Company, at either the bank's prime rate (9.00% at April 29, 1995) or at the LIBOR rate (maximum six-month term, 6.06% to 6.38% at April 29, 1995) plus 75 basis points (reduced from 125 basis points during the year as determined based upon the Company having attained certain financial ratios as defined). The effective interest rate on the Senior Term Notes ranged from 5.25% to 7.06% during 1995. The Company has pledged as collateral 100% and 66%, respectively, of the outstanding shares of its domestic and foreign subsidiaries.\n(b) Borrowings under this $50 million five-year revolving credit facility are limited to the sum of 80% of accounts receivable and 50% of inventories (the \"Borrowing Base\"). The revolving credit facility has interest terms and collateral similar to the Senior Term Notes and matures in May 1999. The interest rate on these borrowings ranged from 6.94% to 9.0% at April 29, 1995.\n(c) In September 1994, 100% of the Company's Convertible Subordinated Notes were converted at $13.00 per share into approximately 1.35 million shares of common stock.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nThe underlying loan agreement for the borrowings referred to in (a) and (b) above includes covenants related to levels of debt to cash flow, current assets to current liabilities, fixed charge coverage, net worth and investments (including investments in the Company's own common stock), and restricts the amount of retained earnings available for payment of dividends. Retained earnings free from restrictions at April 29, 1995 approximated $14.4 million. The agreement requires the Company to prepay the term notes to the extent of 50% of excess cash flow as defined. For the year ended April 29, 1995, there was no excess cash flow as defined.\nBased on the borrowing rates currently available to the Company for bank loans with similar terms, the fair value of the senior long-term debt approximates the carrying value.\nAggregate maturities of long-term debt are as follows:\nInterest Rate Swap\/Cap Agreements\nAt April 29, 1995, the Company had an outstanding intermediate-term interest rate swap agreement relating to approximately $33 million of its Senior Term Notes. Under the agreement, the Company pays a fixed rate of 6.45% and receives a floating rate based on LIBOR, as determined in 1-month intervals (ranging from 4.5% to 6.3% for 1995). The transaction effectively changes a portion of the Company's interest rate exposure from a floating-rate to a fixed-rate basis. The fair value of the interest rate swap agreement at April 29, 1995 was immaterial to the Company. The agreement terminates in February, 1997.\nAt April 29, 1995, the Company had an outstanding interest rate cap agreement relating to approximately $17 million of its Senior Term Notes. Under the agreement, the maximum LIBOR rate is 8.5%. The company paid $71 for this agreement, which is being amortized over the life of the agreement. The fair value of the interest rate cap agreement at April 29, 1995 was immaterial to the Company. The agreement terminates in February, 1997.\nIn October 1994, the Company assigned to a bank an interest rate swap agreement relating to $42 million of its Senior Term Notes for cash proceeds approximating $1.3 million. The proceeds have been recorded as a deferred credit on the accompanying balance sheet which is being amortized as a reduction of interest expense over the remaining life of the related swap agreement. At April 29, 1995, $913 of deferred gain remains which will be amortized: $510 in 1996; $289 in 1997; and $114 in 1998.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\n7. INCOME TAXES\nEarnings before provision for income taxes and extraordinary item is comprised of the following:\nThe provision for income taxes is comprised of the following:\nThe Company's effective income tax rate differs from the statutory U.S. Federal income tax rate as a result of the following:\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nThe tax effects of significant items comprising the Company's net deferred tax liability as of April 29, 1995 and April 30, 1994 are as follows:\nThe valuation allowance has been provided against state net operating loss and investment tax credit carryforwards to reduce them to the amount that will more likely than not be realized.\n8. COMMITMENTS AND CONTINGENCIES\na. Lease Agreements\nThe Company is committed for annual rentals under noncancellable operating leases for production and office facilities expiring on various dates through 2010. Several leases include one year renewal options. The minimum future rental commitments under noncancellable leases, exclusive of taxes and utilities, are as follows:\nRent expense under operating leases approximated $3,451 in 1995, $2,403 in 1994 and $2,125 in 1993.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nb. Treasury Stock\nIn January, 1993, the Company's Board of Directors authorized the purchase of up to 2.0 million shares of the Company's Common Stock from time to time in the open market. Pursuant to this authorization through April 29, 1995, the Company, utilizing internally generated funds, purchased approximately 1.2 million shares of its Common Stock for approximately $12.6 million.\nc. New Facility\nIn connection with a planned expansion of the Company's facilities, the Company anticipates investing approximately $20 million in a new plant and equipment, of which approximately $.8 million has been disbursed as of April 29, 1995. Funds for this expansion are to be provided from the Company's existing credit facilities.\nd. Legal Matters\nIn January 1995, the Company commenced a civil action in the Supreme Court of the State of New York against the former owners of Heminway Packaging Corporation and certain of its affiliates seeking compensatory and punitive damages and other relief. The suit contends that the defendants misrepresented the financial condition and operational capabilities of the acquired business. The Company is seeking damages in excess of $5.0 million. In June 1995, the defendants filed an answer and a counterclaim to the Company's complaint, seeking compensatory damages exceeding $10.0 million and punitive damages of $7.7 million. Management intends to pursue its claims against the defendants and to vigorously defend the counter claim, and believes that the ultimate outcome of these cases will not have a material adverse effect on the operations or financial condition of the Company.\ne. Other Matters\nOn a continuing basis, the Company monitors its compliance with applicable environmental laws and regulations. As part of this process the Company cooperates with appropriate governmental authorities to perform any necessary testing and compliance procedures. The purchase agreements relating to the acquisition of the Acquired Companies indemnify the Company from all costs and expenses relating to environmental matters which existed at the acquired facilities on or prior to the respective closing dates. The Company is not currently aware of any environmental compliance matters that it believes will have a material effect on the consolidated financial statements.\n9. STOCKHOLDERS' EQUITY\na. Stock Incentive Plans\nIn August 1986, the Company established a nonqualified stock option plan (the \"1986 Plan\") and authorized the issuance of options to purchase an aggregate 847,500 shares of common stock to key employees, officers and directors at the market price at the date of the grant. In October 1990, the\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nCompany made available for future grant options to acquire an additional 600,000 shares of common stock under a nonqualified 1990 Stock Option Plan (the \"1990 Plan\"). The 1990 Plan is in all material respects identical to the original nonqualified stock plan. In July 1993, the Company established the 1993 Incentive Program (the \"1993 Program\"). The 1993 Program permits the granting of any or all of the following types of awards: (1) stock options, including incentive stock options (\"ISO's\"), (2) stock appreciation rights (\"SAR's\"), in tandem with stock options or freestanding, (3) restricted stock, (4) directors' options to be issued pursuant to a prescribed formula and (5) restored options. Under the 1993 Program, an additional 1 million shares were made available for grant. Options become exercisable over four years from the date of grant at a rate of 25% each year, and expire five years from the date of grant. Future grants of options will be exercisable over five years from the date of grant at the rate of 20% of the grant each year and will expire 10 years from the date of grant.\nA summary of changes in stock options and awards follows:\nOptions previously authorized under the 1986 Plan which were not granted as of the end of fiscal 1993 were considered to have lapsed and no longer available for future grant. At April 29, 1995, options to purchase 361,554 shares were exercisable at prices ranging from $5.57 to $14.25 per share. During fiscal 1995 the Company issued a net 114,497 shares of restricted stock to certain key employees. A portion or all of the shares may vest at the end of fiscal 1997 based upon the market performance of the\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nCompany's common stock. Any shares that do not vest at such time will otherwise vest at the end of fiscal 2002 if the employee continues to be employed by the Company.\nb. Common Stock Purchase Warrants\nDuring fiscal 1993 and the fourth quarter of fiscal 1994, the Company issued Warrants to purchase 300,000 shares and 100,000 shares of its Common Stock at exercise prices of $6.88 and $13.50 per share, respectively, to a customer who concurrently entered into long-term supply agreements with the Company. The customer has the choice of either exercising the Warrants or receiving a cash volume discount based upon certain minimum levels of purchases from the Company during the terms of the supply agreements. The Warrants are exercisable immediately whereas the cash volume rebate, if any, is payable after the expiration of the supply agreements. The Warrants expire August 22, 1997 and August 31, 1998, respectively. At such time as the customer may choose to exercise either of the Warrants, the related accrued cash rebate will be transferred to additional paid in capital. The fair values of the Warrants at their dates of issuance were determined to be $855 and $502, respectively, and are included in the balance sheet net of a deferred contra account in like amount. As of April 29, 1995, the Company continues to believe that the customer will exercise the first Warrant and continues to accrue volume discounts based upon sales with respect to the second Warrant.\nc. Reserved Shares\nAt April 29, 1995, 2,073,149 common shares were reserved for issuance under the stock incentive plans and outstanding warrants .\nd. Preferred Stock Purchase Rights\nOn May 4, 1995, the Board of Directors declared a dividend of one preferred share purchase right (a \"Right\") for each outstanding share of common stock. Each Right entitles the holder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock at a price of $17.00 per one one-hundredth of a preferred share. The Rights are exercisable only if an acquiring person acquires, or announces the intention to acquire, 25% or more beneficial ownership of the outstanding common shares. The effect of the Rights plan is to provide to the Company's stockholders the right, upon the occurrence of an acquisition, tender offer or business combination transaction, to exchange the preferred shares for common stock at a fraction of the then-current market price of the common stock. The Rights expire on June 14, 2005 unless extended. The Rights are subject to other restrictions and terms as described in the Rights Agreement.\ne. Related Party Transactions\nCIGNA Corporation and its affiliates (\"CIGNA\"), was the holder of $15.0 million of the Company's debentures, which upon conversion represented 1.15 million shares of common stock. Accordingly, CIGNA has been considered a beneficial owner of more than 5% of the outstanding stock\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nof the Company for all of the periods presented. Amounts paid to CIGNA for interest and insurance costs for 1995 were $685, as compared to $2,918 in 1994, and $3,711 in 1993. In addition, in connection with the financing of the acquisition of the Premium Group in January, 1994, the Company prepaid $16.9 million of Senior Notes due to CIGNA, and incurred a pre-tax prepayment penalty to CIGNA of $2.3 million. This penalty is included in the 1994 financial statements as a part of the total extraordinary item of approximately $3.1 million (after income tax benefit of $1.9 million).\nIn connection with the acquisition of the Premium Group and related financing, the Company paid a fee of $1.5 million to a firm whose president and principal shareholder is a director of the Company. In addition, the firm holds an option to purchase 14,821 common shares at an exercise price of $5.02 per share.\n10. RESTRUCTURING CHARGE\nAs a result of the discontinued use of the long-box as a packaging medium for compact discs and the related diminished level of sales, the Company decided at the end of the third quarter of fiscal 1994 to close its Farmingdale, New York facility effective as of April 30, 1994. In connection with the closing of this facility and the restructuring of the Company's operations relating thereto, the Company recorded a restructuring charge before provision for income taxes amounting to $3.4 million during 1994. Included in this charge are amounts provided for the termination of leases ($530), disposal of equipment ($1,020), severance payments ($750) and other related restructuring items ($1,100). With the exception of the lease commitments, all of the respective cash outlays related to the closing of the facility were made by the end of 1995.\n11. EMPLOYEE BENEFIT PLANS\n(a) Defined Contribution Plans\nThe Company has profit sharing plans as well as employee savings plans. Based upon the provisions of each employee savings plan, the Company matches a portion of the employees' voluntary contributions. The amounts contributed to the profit sharing plan in the United States are at the discretion of the Board of Directors, whereas the amounts contributed to the profit sharing plans in Canada are at the percentages provided for by the respective plans. Total provisions with respect to defined contribution plans approximated $1,613, $977 and $824 in 1995, 1994 and 1993, respectively.\n(b) Defined Benefit Plans\nIn connection with the acquisitions of the Premium Group and Heminway, the Company assumed the obligations related to two defined benefit pension plans covering union employees. In addition, the Company established a frozen plan to accept assets to be transferred from a Premium Group defined benefit pension plan, which assets relate to non-union employees who have been transferred to and are now employees of the Company.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\nThe following table sets forth the funded status of the Plans as of April 29, 1995 and April 30, 1994:\n12. MAJOR CUSTOMER AND CREDIT CONCENTRATIONS\nApproximately 17% and 13% of net sales during 1995 were derived from sales to two customers and their affiliates. Approximately 18% of net sales during 1993 were derived from sales to one customer and its affiliates. No other customer accounted for more than 10% of net sales in any of the three fiscal years ended April 29, 1995.\nThe Company's customers are primarily large entertainment, tobacco and other consumer products companies who produce products in the United States and Canada. At April 29, 1995, approximately 43% and 14% of accounts receivable related to customers in the tobacco and music industries, respectively. Approximately 42% of accounts receivable are due from Canadian companies.\nSHOREWOOD PACKAGING CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except share data)\n13. GEOGRAPHIC OPERATIONS\nThe Company's foreign operations are conducted in Canada.\n(a) After an extraordinary charge of $3,098 in 1994 and a cumulative effect credit of $1,150 in 1993.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE\nPART III\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 October 19, 1995 annual meeting of stockholders.\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 \"Index to Financial Statements and Supplementary Data\" in Item 8.\n(a)(2) Financial Statements Schedules. The financial statement schedules have not been included because they are not applicable or the information is included in financial statements or notes thereto.\n(a)(3) Exhibits\nNUMBER DESCRIPTION - ------ -----------\n3.1 -- Certificate of Incorporation of the Company, as amended, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 3.2 -- Amended and Restated By-laws of the Company, incorporated by reference to the corresponding Exhibit item to Amendment No. 1 to Registration Statement on Form S-1, as filed with the Commission on October 20, 1986, Commission File No. 33-8490. 9.1 -- Intentionally Omitted. 10.1 -- through 10.4 Intentionally Omitted. 10.5 -- Agreement of Lease dated May 20, 1977 between Frank X. Mascioli and Shorewood Packaging Corporation, a New York corporation, relating to premises located at 55 Engineers Lane, Farmingdale, New York, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.6 -- and 10.7 Intentionally Omitted. 10.8 -- Lease dated June 13, 1979 between Ravin Investments Limited and Shorewood Packaging Corp. of Canada Limited, as amended as of March 14, 1983, between Pension Fund Realty Limited and Shorewood Packaging Corp. of Canada Limited, relating to premises located at 2220 Midland Avenue, Scarborough, Ontario, Canada, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.9 -- Lease Agreement dated November 1, 1984 between The Beneficiary Of Land Trust Established With American National Bank and Trust Company of Chicago and Shorewood Packaging Company of Illinois, Inc., relating to the Countryside Executive Center in Palatine, Illinois, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.10 -- through 10.39 Intentionally Omitted. 10.40 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Paul B. Shore, incorporated by reference to the\ncorresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.41 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Marc P. Shore, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.42 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Floyd Glinert, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.43 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Murray B. Frischer, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.44 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Charles Kreussling, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.45 -- Non-Competition Agreement dated as of June 20, 1985 between Shorewood Packaging Corporation of New York and Kenneth Rosenblum, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on September 4, 1986, Commission File No. 33-8490. 10.46 -- through 10.50 Intentionally Omitted. 10.51 -- Lease dated as of April 30, 1987 between Shorewood Packaging Corporation and Blamore Real Estate Company relating to the premises located at 10 East 53rd Street, New York, New York, incorporated by reference to the corresponding Exhibit item to Registration Statement on Form S-1, as amended, as filed with the Commission on June 5, 1987, Commission File No. 33-14395. 10.52 -- through 10.56 Intentionally Omitted. 10.57 -- Asset Purchase Agreement, dated as of August 1, 1988, by and among Goody Products, Inc., Southeastern Box Co., Inc., Shorewood Packaging Corporation and Shorewood Box Co., Inc., incorporated by reference to the corresponding Exhibit item to Quarterly Report on Form 10-Q for the quarter ended July 30, 1988 filed with the Commission on August 30, 1988, Commission file No. 0-15077. 10.58 -- Agreement, dated August 1, 1988, by and between Goody Products, Inc. and Shorewood Packaging Corporation, incorporated by reference to the corresponding Exhibit item to Quarterly Report on Form 10-Q for the quarter ended July 30, 1988 filed with the Commission on August 30, 1988. Commission file No. 0-15077. 10.59 -- through 10.77 Intentionally Omitted. 10.78 -- Asset Purchase Agreement dated December 23, 1993 by and among Shorewood Paperboard Corporation Limited, Shorewood Acquisition Corporation of Delaware, Paperboard Industries Corporation and Paperboard Industries Inc. incorporated by reference to the corresponding exhibit item to Form 8-K Current Report of Shorewood Packaging Corporation filed with the Commission on January 28, 1994, Commission File No. 0-15077. 10.79 -- Sheeter Purchase Agreement dated December 23, 1993 by and among Shorewood Acquisition Corporation of Delaware and Paperboard Industries Inc. incorporated by reference to the corresponding exhibit item to Form 8-K Current Report of Shorewood Packaging Corporation filed with the Commission on January 28, 1994, Commission File No. 0-15077. 10.80 -- Restated and Amended Credit Agreement dated February 25, 1994 between Shorewood Packaging Corporation, Shorewood Corporation of Canada Limited and NationsBank of North Carolina, N.A. and The Bank of Nova Scotia incorporated by reference to the\ncorresponding exhibit item to Shorewood Packaging Corporation's quarterly report on Form 10-Q for the fiscal quarter ended January 29, 1994, as filed with the Commission on March 15, 1994, Commission File No. 0-15077. 10.81 -- Trademark License Agreement dated January 14, 1994 between Paperboard Industries Inc. and Shorewood Acquisition Corporation of Delaware incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.82 -- Non-Competition Agreement dated January 14, 1994 between Cascades Inc., Cascades Paperboard International Inc., Paperboard Industries Corporation, Paperboard Industries Inc., Shorewood Packaging Corporation, Shorewood Paperboard Corporation Limited and Shorewood Acquisition Corporation of Delaware incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.83 -- First Amendment to Restated and Amended Credit Agreement dated July 18, 1994 between Shorewood Packaging Corporation, Shorewood Corporation of Canada Limited and NationsBank of North Carolina, N.A. and The Bank of Nova Scotia incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.84 -- Amendment, as of January 14, 1994, to Note Purchase Agreement dated as of June 27, 1991 between Shorewood Packaging Corporation and each of Connecticut General Life Insurance Company, Inc., Mezzanine Partners II, L.P., Life Insurance Company of North America and The Prudential Insurance Company of America incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.85 -- Asset Purchase Agreement dated January 17, 1994 between Shorewood\/Heminway Acquisition Corporation and Heminway Packaging Corporation (omitting schedules and exhibits) incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.86 -- Lease dated as of January 17, 1994 between Shorewood\/Heminway Acquisition Corporation and Heminway Packaging Corporation in respect of premises located at 155 South Leonard Street, Waterbury, Connecticut incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.87 -- Letter Agreement dated April 21, 1994 by and among SPC Corporation Limited, (formerly known as Shorewood Paperboard Corporation Limited), Shorewood Acquisition Corporation of Delaware, Paperboard Industries Corporation and Paperboard Industries Inc. in respect of working capital adjustment incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.88 -- Employment Agreement dated as of May 16, 1994 between Shorewood Packaging Corporation and Howard M. Liebman incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.89 -- Consultation and Termination Agreement dated May 6, 1994 between Shorewood Packaging Corporation and Murray B. Frischer incorporated by reference to the corresponding exhibit\nitem to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.90 -- Shorewood Packaging Corporation Retirement and Savings Plan, and Adoption Agreement, dated March 19, 1994 between Shorewood Packaging Corporation and its subsidiaries, as employer, and NationsBank of Georgia, N.A., as trustee incorporated by reference to the corresponding exhibit item to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, as filed with the Commission on July 29, 1994, Commission File No. O-15077. 10.91 (a) Stock Warrant Agreement to purchase 100,000 shares of Common Stock, dated as of January 13, 1994. 10.91 (b) Stock Warrant Agreement dated as of July 23, 1992 to purchase 300,000 shares of Common Stock. 21.1 -- Subsidiaries of Registrant. 23.1 -- Consent of Deloitte & Touche LLP. (b) Reports on Form 8-K No current 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 Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSHOREWOOD PACKAGING CORPORATION\nBy: \/s\/ Paul B. Shore ---------------------------------------------------- Paul B. Shore Chairman of the Board and Chief Executive Officer\nDate: July 27, 1995\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nEXHIBIT INDEX","section_15":""}
{"filename":"96223_1995.txt","cik":"96223","year":"1995","section_1":"Item 1. Business. ------ -------- THE COMPANY\nGENERAL\nThe Company is a diversified financial services holding company principally engaged in personal and commercial lines of property and casualty insurance, life and health insurance, banking and lending and manufacturing. The Company concentrates on return on investment and cash flow to build long-term shareholder value, rather than emphasizing volume or market share. Additionally, the Company continuously evaluates the retention and disposition of its existing operations and investigates possible acquisitions of new businesses in order to maximize shareholder value.\nShareholders' equity has grown from a deficit of $7,657,000 at December 31, 1978 (prior to the acquisition of a controlling interest in the Company by the Company's Chairman and President), to a positive shareholders' equity of $1,111,491,000 at December 31, 1995, equal to a book value per common share of negative $.11 at December 31, 1978 and $18.47 at December 31, 1995.\nThe Company's principal operations are its insurance businesses, where it is a specialty markets provider of property and casualty and life insurance products to niche markets. The Company's principal personal lines insurance products are automobile insurance, homeowners insurance, graded benefit life insurance marketed primarily to the age 50-and-over population and variable annuity products. The Company's principal commercial lines are property and casualty products provided for multi-family residential real estate, retail establishments and livery vehicles in the New York metropolitan area. For the year ended December 31, 1995, the Company's insurance segments contributed 78% of total revenue and, at December 31, 1995, constituted 77% of consolidated assets.\nThe Company's insurance subsidiaries have a diversified investment portfolio of securities, substantially all of which are issued or guaranteed by the U.S. Treasury or by U.S. governmental agencies or are rated \"investment grade\" by Moody's Investors Service Inc. (\"Moody's\") and\/or Standard & Poor's Corporation (\"S&P\"). Investments in mortgage loans, real estate and non-investment grade securities represented 2.5% of the insurance subsidiaries' portfolio at December 31, 1995.\nThe Company's banking and lending operations principally consist of making instalment loans to niche markets primarily funded by customer banking deposits insured by the Federal Deposit Insurance Company (the \"FDIC\"). One of the Company's principal lending activities is providing automobile loans to individuals with poor credit histories. The Company's manufacturing operations primarily manufacture products for the \"do-it-yourself\" home improvement market and for industrial and agricultural markets.\nStarting in 1994, the Company has made investments outside the United States in Russia and Argentina and expects to increase its investments in Russia in 1996. For more information concerning these investments see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" of this Report.\nThe Company and certain of its subsidiaries have substantial tax loss carryforwards. The amount and availability of the tax loss carryforwards are subject to certain qualifications, limitations and uncertainties as more fully discussed in the Notes to the Consolidated Financial Statements.\nOn November 15, 1995, the Company effected a two-for-one stock split of the common shares of the Company (the \"Common Shares\") in the form of a 100% stock dividend (the \"Stock Split\"). The dividend was paid to shareholders of record at the close of business on November 1, 1995. Per share amounts set forth in this Report have been adjusted to reflect the Stock Split.\nAs used herein, the term \"Company\" refers to Leucadia National Corporation, a New York corporation organized in 1968, and its subsidiaries, except as the context otherwise may require.\nFinancial Information About Industry Segments ---------------------------------------------\nCertain information concerning the Company's operations is presented in the following table.\nINSURANCE OPERATIONS\nGENERAL\nThe Company engages in the personal property and casualty and life and health insurance businesses on a nationwide basis and specializes in commercial property and casualty insurance business in the New York metropolitan area. The Company's principal property and casualty insurance subsidiaries are the Colonial Penn P&C Group, consisting of Colonial Penn Insurance Company (\"CPI\"), Colonial Penn Madison Insurance Company (\"Madison\"), Colonial Penn Franklin Insurance Company (\"Franklin\"), Bayside Casualty Insurance Company (\"Bayside\") and Bay Colony Insurance Company (\"Bay Colony\"), and the Empire Group, consisting of Empire Insurance Company (\"Empire\") and Allcity Insurance Company (\"Allcity\"). The Company's principal life insurance subsidiaries are Charter National Life Insurance Company (\"Charter\"), Colonial Penn Life Insurance Company (\"CPL\") and Intramerica Life Insurance Company (\"Intramerica\"). In conducting its insurance operations, the Company focuses primarily on profitability and persistency rather than volume.\nA.M. Best Company (\"Best\"), an independent rating agency, has rated CPL and Charter \"A\" (excellent) and CPI, Madison, Franklin, the Empire Group and Intramerica \"A-\" (excellent). Bayside and Bay Colony were not assigned ratings. Ratings are subject to change at any time.\nPROPERTY AND CASUALTY INSURANCE\nThe Colonial Penn P&C Group, which maintains its headquarters in Valley Forge, Pennsylvania, is licensed in all 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands and writes insurance throughout most of the United States. The Colonial Penn P&C Group has regional offices in Valley Forge, Pennsylvania, Tampa, Florida and Phoenix, Arizona. The Empire Group is licensed in six states and operates primarily in the New York metropolitan area.\nDuring the year ended December 31, 1995, 82%, 13% and 5% of net earned premiums of the Company's property and casualty insurance operations were derived from personal and commercial automobile lines, other commercial lines and other personal lines, respectively. Total property and casualty net earned premiums for the year ended December 31, 1995 were $816,600,000, of which $490,500,000 was attributable to the Colonial Penn P&C Group.\nSet forth below is certain statistical information for the Company's property and casualty operations prepared in accordance with generally accepted accounting principles (\"GAAP\") and statutory accounting principles (\"SAP\"). The Loss Ratio is the ratio of incurred losses and loss adjustment expenses to net premiums earned. The Expense Ratio is the ratio of underwriting expenses (policy acquisition costs, commissions, and a portion of administrative, general and other expenses attributable to underwriting operations) to net premiums written, if determined in accordance with SAP, or to net premiums earned, if determined in accordance with GAAP. A Combined Ratio below 100% indicates an underwriting profit and a Combined Ratio above 100% indicates an underwriting loss. The Combined Ratio does not include the effect of investment income.\nThe Colonial Penn P&C Group\nThe Colonial Penn P&C Group's primary business is providing private passenger automobile and homeowners insurance coverage to the mature adult population. Substantially all of the Group's policies are written for a one-year period. However, in many states CPI and Franklin offer a \"guaranteed lifetime protection\" provision to certain qualifying policyholders that ensures their policies will be renewed at rates then in effect for their classification. As of December 31, 1995, the Group had approximately 356,000 voluntary auto policies in force.\nIn 1995, for the first time since acquisition in 1991, the Colonial Penn P&C Group's voluntary automobile policies in force have grown during the year. The Company believes that this is attributable to its low cost direct response marketing methods. The Company believes the Colonial Penn P&C Group will continue to grow its voluntary automobile business during 1996, although the Company is unable to estimate the rate of growth or state with certainty that such growth will actually occur.\nThe Colonial Penn P&C Group primarily markets its insurance products to the standard and preferred risk market segments through direct response marketing methods. Direct response marketing includes any form of marketing in which a company and a customer deal directly with each other, rather than through an insurance agent. The Colonial Penn P&C Group has become a low cost provider of its products to its niche markets, enabling it to charge competitive rates.\nBased on published reports, the Colonial Penn P&C Group's SAP Expense Ratio for 1994, the last year for which annual industry data is available, is among the lowest in the industry.\nNet earned premiums for the Colonial Penn P&C Group for the year ended December 31, 1995 were concentrated in the states listed below:\nIn recent years, the Colonial Penn P&C Group has acquired blocks of private passenger automobile assigned risk business from other insurance companies. In addition to the premiums paid by policyholders, the Group also receives fee income from the insurance company from which the business was acquired. The Group's low expense ratio enables it to offer competitive rates for this business. The Colonial Penn P&C Group currently has contracts in force covering approximately $110,000,000 of annualized written premium.\nPrior to its acquisition by the Company, CPI wrote as primary insurer or as a reinsurer a variety of diverse commercial property and casualty insurance business known as \"Special Risks.\" The nature of most of this insurance, which was not written after 1988, involves exposures which can be expected to develop over a relatively long period of time before a definitive determination of ultimate losses and loss adjustment expenses can be established and the relevant reinsurance collected. Although losses with respect to this block of business are particularly difficult to predict accurately, the Company believes, based in part upon a recently completed independent actuarial review, that it has recorded adequate reserves as of December 31, 1995 ($59,400,000, before reinsurance).\nThe Empire Group\nThe Empire Group provides personal insurance coverage to automobile owners and homeowners and commercial insurance for residential real estate, restaurants, retail establishments, livery vehicles (both medallion and radio-controlled) and several types of service contractors.\nFor the years ended December 31, 1995, 1994 and 1993, net earned premiums and commissions for the Empire Group were $326,100,000, $299,200,000 and $259,400,000, respectively. Substantially all of the Empire Group policies are written in New York for a one-year period. The Empire Group is licensed in New York to write all lines of insurance that may be written by a property and casualty insurer, except residual value, credit, unemployment, animal and marine protection and indemnity insurance and ocean marine insurance.\nThe voluntary business of the Empire Group is produced through general agents, local agents and insurance brokers, who are compensated for their services by payment of commissions on the premiums they generate. There are five general agents, one of which is owned by Empire, and approximately 385 local agents and insurance brokers presently acting under agreements with the Empire Group. These agents and brokers also represent other competing insurance companies.\nLike the Colonial Penn P&C Group, the Empire Group also has acquired blocks of private passenger automobile and commercial automobile assigned risk business from other insurance companies. The Empire Group currently has contracts in force covering approximately $100,000,000 of annualized written premiums. In addition, the Empire Group receives a fee as a \"servicing carrier,\" providing administrative services, including claims processing, underwriting and collection activities, for the New York Public Automobile Pool and the Massachusetts Taxi and Limousine Pool. These latter arrangements do not involve the assumption of any material underwriting risk by the Empire Group.\nDuring 1995, the Empire Group strengthened reserves in certain lines of business, as more fully discussed in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" of this Report. As a result of the Empire Group's poor operating results in 1995, management is currently evaluating its operations, including policy pricing, underwriting, claims handling procedures and market segment profitability. The Empire Group intends to concentrate its efforts on the profitability of its products and, as a result, premium volume may decline.\nLosses and Loss Adjustment Expenses\nLiabilities for unpaid losses, which are not discounted (except for certain workers' compensation liabilities), and loss adjustment expenses (\"LAE\") are determined using case-basis evaluations, statistical analyses and estimates for salvage and subrogation recoverable and represent estimates of the ultimate claim costs of all unpaid losses and LAE. Liabilities include a provision for losses which have occurred but have not yet been reported. These estimates are subject to the effect of trends in future claim severity and frequency experience. Adjustments to such estimates are made from time to time due to changes in loss experience and are reflected in current earnings.\nThe Company's property and casualty insurance subsidiaries rely upon standard actuarial ultimate loss projection techniques to obtain estimates of liabilities for losses and LAE. These projections include the extrapolation of both losses paid and incurred by business line and accident year and implicitly consider the impact of inflation and claims settlement patterns upon ultimate claim costs based upon historical patterns. In addition, methods based upon average loss costs, reported claim counts and pure premiums are reviewed in order to obtain a range of estimates for setting the reserve levels. For further input, changes in operations in pertinent areas including underwriting standards, product mix, claims management and legal climate are periodically reviewed.\nIn the following table, the liability for losses and LAE of the Company's property and casualty insurance subsidiaries are reconciled for each of the three years ended December 31, 1995. Included therein are current year data and prior year development.\nThe Company's property and casualty insurance subsidiaries' liability for losses and LAE as of December 31, 1995 was $1,005,354,000 determined in accordance with SAP and $1,128,952,000 determined in accordance with GAAP. The difference principally relates to liabilities assumed by reinsurers, which are not deducted from GAAP liabilities.\nThe following tables present the development of balance sheet liabilities from 1985 through 1995 and include periods prior to acquisition for the Empire Group and the Colonial Penn P&C Group. Because of substantial differences in the development of reserves of the Empire Group and the Colonial Penn P&C Group, loss and LAE development data is presented separately for each group. The liability line at the top of each table indicates the estimated liability for unpaid losses and LAE recorded as of the dates indicated. The middle section of the table shows the re-estimated\namount of the previously recorded liability based on experience as of the end of each succeeding year. As more information becomes available and claims are settled, the estimated liabilities are adjusted upward or downward with the effect of decreasing or increasing net income at the time of adjustment. The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year.\nThe \"cumulative redundancy (deficiency)\" represents the aggregate change in the estimates over all prior years. For example, the initial 1985 liability estimate indicated on the Empire Group table ($165,713,000) has been re-estimated during the course of the succeeding ten years, resulting in a re-estimated liability at December 31, 1995 of $156,838,000, or a redundancy of $8,875,000. If the re-estimated liability exceeded the liability initially established, a cumulative deficiency would be indicated. The cumulative deficiencies reflected in the Colonial Penn P&C Group table are for periods prior to the Company's acquisition of that Group. The Company believes that the Colonial Penn P&C Group's conservatism and improved claims management procedures since acquisition in 1991 have contributed significantly to the creation of the redundancies included in its table below.\nIn evaluating this information, it should be noted that each amount shown for \"cumulative redundancy (deficiency)\" includes the effects of all changes in amounts for prior periods. For example, the amount of the redundancy (deficiency) related to losses settled in 1989, but incurred in 1985, will be included in the cumulative redundancy (deficiency) amount for 1985, 1986, 1987 and 1988. This table is not intended to and does not present accident or policy year loss and LAE development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it would not be appropriate to extrapolate future redundancies or deficiencies based on these tables.\nFor further discussion of the Company's loss development experience, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" of this Report.\nLIFE INSURANCE\nThe principal life insurance products offered during the three year period ended December 31, 1995 were \"Graded Benefit Life\" and a variable annuity product. Through its various subsidiaries, the Company is licensed in all 50 states, the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands and generally sells its products throughout most of the United States. Total direct life insurance in force as of December 31, 1995 was $2.2 billion.\nThe following table reflects premium receipts on variable annuity and other investment oriented products and premiums earned on other life and health insurance products. Variable annuity and other investment oriented product premium receipts are not recorded as revenue under GAAP but are recorded in a manner similar to a deposit, and are included below.\nLife and Health Insurance Products\nGraded Benefit Life. \"Graded Benefit Life\" is a guaranteed-issue product. These modified-benefit, whole life policies are offered on an individual basis primarily to persons age 50 to 80, principally in face amounts of $350 to $10,000, without medical examination or evidence of insurability. Premiums are paid as frequently as monthly. Benefits paid are less than the face amount of the policy during the first two years, except in cases of accidental death. Graded Benefit Life is marketed using direct response marketing techniques. New policyholder leads are generated primarily from television advertisements. The Company intends to continue to concentrate its marketing efforts towards soliciting new policyholders where the cost is justified, upgrading existing policyholders' policy packages and obtaining referrals from existing policyholders.\nInvestment Oriented Products. The principal investment oriented product (\"IOP\" product) offered is a no-load variable annuity (\"VA\") product. The VA product is marketed as an investment vehicle to individuals seeking to defer, for federal income tax purposes, the annual increase in their account balance. Premiums from this VA product either are invested at the policyholders' election in unaffiliated mutual funds where the policyholder bears the entire investment risk or in a fixed account where the funds earn interest at rates determined by the Company. The Company's VA product is currently marketed in conjunction with Scudder, Stevens and Clark, a mutual fund manager.\nMedicare Supplement Products. In 1992, the Company decided to discontinue actively marketing Medicare supplement products due to increased competition in this market. The increased competition resulted from federal and state regulation that mandated standardization of such products. The Company does continue to offer, on a profitable basis, renewals of its non-standardized products to existing policyholders. In addition, in 1996 the Company entered into an agreement to acquire a small block of Medicare supplement business; the Company will continue to explore the acquisition of additional blocks of this business on a profitable basis.\nINSURANCE OPERATIONS - GENERAL\nInvestments\nInvestment activities represent a significant part of the Company's insurance related revenues and profitability. Investments are managed by the Company's investment advisors under the direction of, and upon consultation with, the Company's several investment committees.\nThe Company's insurance subsidiaries have a diversified investment portfolio of securities, substantially all of which are rated \"investment grade\" by Moody's and\/or S&P or issued or guaranteed by the U.S. Treasury or by governmental agencies. The Company's insurance subsidiaries do not generally invest in less than \"investment grade\" or \"non-rated\" securities, real estate or mortgages, although from time to time they may make such investments in amounts not expected to be material.\nThe composition of the Company's insurance subsidiaries' investment portfolio as of December 31, 1995 and 1994 was as follows:\nReinsurance\nReinsurance is obtained for investment oriented products for face amounts in excess of $500,000 per life. The life insurance subsidiaries generally do not obtain reinsurance for the Graded Benefit Life products because these policies generally have a low face amount. The Colonial Penn P&C Group obtained reinsurance for casualty risks in excess of $2,000,000 in 1995, 1994 and 1993, although most Colonial Penn P&C Group automobile policies do not have policy limits in excess of $100,000 per risk and $300,000 per accident. The Empire Group's maximum retained limit for workers' compensation was $500,000 for 1995, 1994 and 1993; for other property and casualty lines, the\nEmpire Group's maximum retained limit was $225,000 for 1995, 1994 and 1993.\nAdditionally, the Company's property and casualty insurance subsidiaries have entered into certain excess of loss and catastrophe treaties to protect against certain losses. The Colonial Penn P&C Group's retention of lower level losses in such treaties was $15,000,000 in 1995 and $11,000,000 in 1994 and 1993. The Empire Group's retention of lower level losses in such treaties was $3,000,000 for 1995, 1994 and 1993.\nAlthough reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policy liability, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded. The Company's reinsurance generally has been placed with certain of the largest reinsurance companies, including (with their respective Best ratings) General Reinsurance Corporation (A++), Metropolitan Life Insurance Co. (A+), AXA Reinsurance Company (A), Zurich Reinsurance Center, Inc. (A) and Munich American Reinsurance Company (A+), each of which the Company believes to be financially capable of meeting its respective obligations. However, to the extent that any reinsuring company is unable to meet its obligations, the Company's insurance subsidiaries would be liable for the reinsured risks. The Company has established reserves, which the Company believes are adequate, for any nonrecoverable reinsurance.\nCompetition\nThe insurance industry is a highly competitive industry, in which many of the Company's competitors have substantially greater financial resources, larger sales forces, more widespread agency and broker relationships, and more diversified lines of insurance coverage. Additionally, certain competitors market their products with endorsements from affinity groups, while the Company's products are for the most part unendorsed, which may give such other companies a competitive advantage. Recent federal legislative and judicial activity may result in changes to federal banking laws that will enable banks to offer certain insurance products in direct competition with the Company. The Company is unable to determine what effect, if any, such changes may have on the Company's operations.\nThe Company believes that property and casualty insurers generally compete on the basis of price, customer service, consumer recognition and financial stability. The industry has historically been cyclical in nature, with periods of less intense price competi- tion generating significant profits, followed by periods of increased price competition resulting in reduced profitability or loss. The current cycle of intense price competition has continued for a longer period than in the past, suggesting that the significant infusion of capital into the industry in recent years, coupled with larger investment returns has been, and may continue to be, a depressing influence on policy rates. The profitability of the property and casualty insurance industry is affected by many factors, including rate competition, severity and frequency of claims (including catastrophe losses), interest rates, state regulation, court decisions and judicial climate, all of which are outside the Company's control.\nGovernment Regulation\nInsurance companies are subject to detailed regulation and supervision in the states in which they transact business. Such regulation pertains to matters such as approving policy forms and various premium rates, minimum reserves and loss ratio requirements, the type and amount of investments, minimum capital and surplus requirements, granting and revoking licenses to transact business, levels of operations and regulating trade practices. The majority of the Company's property and casualty insurance operations are in states requiring prior approval by regulators before proposed rates may be implemented. Certain states have indicated that they may change the bases (e.g., age, sex and geographic location) on which rates traditionally have been established. Rates proposed for life insurance generally become effective immediately upon filing. Insurance companies are required to file detailed annual reports with the supervisory agencies in each of the states in which they do business, and are subject to examination by such agencies at any time. Increased regulation of insurance companies at the state level and new regulation at the federal level is possible, although the Company cannot predict the nature or extent of any such regulation or what impact it would have on the Company's operations.\nThe National Association of Insurance Commissioners (\"NAIC\") has adopted model laws incorporating the concept of a \"risk based capital\" (\"RBC\") requirement for insurance companies. Generally, the RBC formula is designed to measure the adequacy of an insurer's statutory capital in relation to the risks inherent in its business. The RBC formula is used by the states as an early warning tool to identify weakly capitalized companies for the purpose of initiating regulatory action. Each of the Company's insurance subsidiaries' RBC ratio as of December 31, 1995 substantially exceeded minimum requirements.\nThe NAIC also has adopted various ratios for insurance companies which, in addition to the RBC ratio, are designed to serve as a tool to assist state regulators in discovering potential weakly capitalized companies or companies with unusual trends. The life insurance companies had certain \"other than normal\" NAIC ratios for the year ended December 31, 1995. The Company believes that there are no underlying problems or weaknesses at any of its life insurance subsidiaries and that it is unlikely that material adverse regulatory action will be taken.\nThe Company's insurance subsidiaries are members of state insurance funds which provide certain protection to policyholders of insolvent insurers doing business in those states. Due to insolvencies of certain insurers in recent years, the Company's insurance subsidiaries have been assessed certain amounts which have not been material and are likely to be assessed additional amounts by state insurance funds. The Company believes that it has provided for all anticipated assessments and that any additional assessments will not have a material adverse effect on the Company's financial condition or results of operations.\nBANKING AND LENDING\nDuring 1995 the Company's banking and lending operations principally were conducted through American Investment Bank, N.A. (\"AIB\"), its national bank subsidiary, American Investment Financial (\"AIF\"), an industrial loan corporation, and Transportation Capital Corp. (\"TCC\"), a specialized small business investment company. AIB and AIF take money market and other non-demand deposits that are eligible for insurance provided by the FDIC. AIB and AIF had deposits of $203,061,000 and $179,888,000 at December 31, 1995 and 1994, respectively. AIB and AIF currently have several deposit-taking and lending facilities in the Salt Lake City area. TCC makes collateralized loans to operators of medallion taxicabs and limousines. In February 1996, the Company entered into an agreement to sell TCC to an unrelated third party. The sale, which is subject to regulatory approval and certain other conditions, would result in a gain of approximately $1,600,000.\nThe Company's consolidated banking and lending operations had outstanding loans (net of unearned finance charges) of $278,391,000 and $264,196,000 at December 31, 1995 and 1994, respectively. At December 31, 1995, 48% were loans to individuals generally collateralized by automobiles; 15% were unsecured loans to individuals acquired from others in connection with investments in limited partnerships; 29% were unsecured loans to executives and professionals; 4% were loans to small business concerns collateralized principally by taxicab medallions and other personal property; and 4% were instalment loans to consumers, substantially all of which were collateralized by real or personal property.\nIt is the Company's policy to charge to income an allowance for losses which, based upon management's analysis of numerous factors, including current economic trends, aging of the loan portfolio and historical loss experience, is deemed adequate to cover reasonably expected losses on outstanding loans. At December 31, 1995, the allowance for loan losses for the Company's entire loan portfolio was $13,893,000 or 5% of the net outstanding loans, compared to $12,308,000 or 4.7% of net outstanding loans at December 31, 1994.\nThe funds generated by the deposits are primarily used to make instalment loans, including collateralized personal automobile loans to individuals who have difficulty in obtaining credit. These automobile loans are made at interest rates above those charged to individuals with good credit histories. In determining which individuals qualify for these loans, the Company takes into account a number of highly selective criteria with respect to the individual as well as the collateral to attempt to minimize the number of defaults. Additionally, the Company closely monitors these loans and takes prompt possession of the collateral in the event of a default. For the three year period ended December 31, 1995, the Company generated $231,825,000 of these loans ($79,481,000 during 1995). In 1995, primarily as a result of increased competition together with the Company's unwillingness to lower its underwriting standards and interest rate charges, the portfolio has not grown at the rate previously experienced and loan losses have increased. At December 31, 1995, the allowance for loan losses for this portfolio was $8,822,000 or 6.6% of net outstanding loans. The Company expects that the increased level of competition will continue and, together with the Company's unwillingness to lower rates, is likely to result in a contraction in the size of this portfolio in the future.\nThe Company's lending operations compete with banks, savings and loan associations, credit unions, credit card issuers and consumer finance companies, many of which are able to offer financial services on very competitive terms. Additionally, substantial national financial services networks have been formed by major brokerage firms, insurance companies, retailers and bank holding companies. Some competitors have substantial local market positions; others are part of large, diversified organizations.\nThe Company's principal lending operations are subject to detailed supervision by state authorities, as well as federal regulation pursuant to the Federal Consumer Credit Protection Act and regulations promulgated by the Federal Trade Commission. The Company's banking operations are subject to federal and state regulation and supervision by, among others, the Office of the Comptroller of the Currency (the \"OCC\"), the FDIC and the State of Utah. AIB's primary federal regulator is the OCC, while the primary federal regulator for AIF is the FDIC.\nThe Competitive Equality Banking Act of 1987 (\"CEBA\") places certain restrictions on the operations and growth of AIB and restricts further acquisitions of banks and savings institutions by the Company. CEBA does not restrict the growth of AIF as currently operated.\nMANUFACTURING\nThe Company's manufacturing operations consist primarily of the manufacture of bathroom vanities and related products for the \"do-it- yourself\" market, electrical products and proprietary plastic netting for various industrial and agricultural markets.\nBathroom vanities and related products are sold through manufacturers' representatives, primarily to home improvement centers. Principally due to operating inefficiencies and pricing pressures, this division has not operated profitably in recent years. In 1995, the Company completed a restructuring program at this division and, as a result, operating results were significantly improved, although the division had a loss for the year. The division is exploring new product opportunities to compensate for declining sales. The plastics division manufactures and markets plastic netting used for a variety of purposes including among other things, construction, packaging, agriculture, carpet backing and filtration. The electrical division primarily produces wire cable and power cords for industrial customers.\nThe manufacturing operations are subject to a high degree of competition, generally on the basis of price, service and quality. Additionally, certain of these manufacturing operations are dependent on cyclical industries, including the construction industry. Through its various manufacturing divisions, the Company holds patents on certain improvements to the basic manufacturing processes and on applications thereof. The Company believes that the expiration of these patents, individually or in the aggregate, is unlikely to have a material effect on manufacturing operations.\nOTHER OPERATIONS AND INVESTMENTS\nThe Company owns equity interests representing more than 5% of the outstanding capital stock of each of the following domestic public companies at December 31, 1995: Carmike Cinemas, Inc. (\"Carmike\") (approximately 6% of Class A shares), HomeFed Corporation (\"HFC\") (approximately 41%), Jordan Industries, Inc. (\"JII\") (approximately 11%), MK Gold Company (\"MK Gold\") (approximately 46%) and Rockefeller Center Properties, Inc. (\"RCP\") (approximately 7%).\nIn June 1995, the Company purchased a 46.4% common stock interest in MK Gold for an aggregate cash purchase price of $22,500,000. In addition, the Company purchased at par all of a lender's interest under a $20,000,000 revolving credit facility with MK Gold, of which $15,000,000 was outstanding. This amount was repaid during the third quarter of 1995. MK Gold is an international gold mining company whose shares are quoted on the Nasdaq National Market System.\nIn July 1995, pursuant to the chapter 11 reorganization of HFC, the Company acquired 41.2% of HFC's common stock for a net cash investment of approximately $4,200,000. As part of the reorganization plan, the Company provided HFC with a $20,000,000 eight year secured loan, which is convertible into additional shares of HFC common stock after three years (subject to certain conditions) and which bears interest at the rate of 12% per year. HFC is a public company whose subsidiaries develop real property.\nThe Company owns a 30% interest in Caja de Ahorro y Seguro S.A. (\"Caja\"), a holding company whose subsidiaries are engaged in property and casualty insurance, life insurance and banking in Argentina. Caja distributes its insurance products primarily on a direct basis, and therefore does not pay commissions to agents. Caja is the largest insurance company in Argentina, with total annual premium revenues of approximately $500,000,000 and total assets (including banking operations) of approximately $590,000,000. At December 31, 1995, the carrying amount of the Company's investment in Caja was $44,657,000. The Company's equity in Caja's earnings since acquisition has not been material.\nA subsidiary of the Company is a partner in The Jordan Company and Jordan\/Zalaznick Capital Company. These partnerships each specialize in structuring leveraged buyouts in which the partners are given the opportunity to become equity participants. Since 1982, the Company has invested an aggregate of $34,377,000 in these partnerships and related companies and, through December 31, 1995, has received $73,940,000 (including cash, interest bearing notes and other receivables) relating to the disposition of investments and management and other fees. At December 31, 1995, through these partnerships, the Company had interests in JII, Carmike and a total of twenty other companies (the \"Jordan Associated Companies\"), all of which are carried at cost in the Company's consolidated financial statements at $12,623,000.\nThe Company's real estate investments include a 615,000 square foot office building located near Grand Central Terminal in New York City (carried at $55,490,000 at December 31, 1995), and two luxury residential condominium towers in downtown San Diego, California (carried at $40,028,000 at December 31, 1995). The New York City office building has 355,000 square feet of contiguous space available for occupancy. After certain improvements to the building are completed, the Company intends to lease the available space to one or more entities and\/or sell the building. The San Diego towers consist of 201 residential units, 162 of which were available for sale at December 31, 1995, and 42,000 square feet of retail space.\nFor further information about the Company's business, reference is made to Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" of this report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ------ ---------- Through its various subsidiaries, the Company owns and utilizes in its operations the following significant properties: two office buildings located in Valley Forge, Pennsylvania used by the Colonial Penn P&C Group (totaling approximately 198,700 sq. ft.), one of which is located on land leased from a third party; two offices in Salt Lake City, Utah used for corporate and banking and lending activities (totaling approximately 77,000 sq. ft.); and an office building in Philadelphia, Pennsylvania used by the life insurance companies (approximately 127,000 sq. ft.). In addition, subsidiaries of the Company own eight facilities (totaling approximately 1,102,000 sq. ft.) primarily used for manufacturing and storage located in Georgia, New Jersey, New York, North Carolina, Pennsylvania and Canada.\nThe Company and its subsidiaries lease numerous manufacturing, warehousing, office and headquarters facilities. The facilities vary in size and have leases expiring at various times, subject, in certain instances, to renewal options. See Notes to Consolidated Financial Statements.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------ -----------------\nPINNACLE LITIGATION\nOn May 11, 1994, a shareholder of the Company filed a purported derivative action entitled Pinnacle Consultants, Ltd. v. Leucadia -------------------------- -------- National Corporation, et al. (C.A. No. 94 Civ. 3496) against the ---------------------------- Company's current Board of Directors and two former directors, John W. Jordan II and Melvin Hirsch. The action, which was filed in the United States District Court for the Southern District of New York, alleged certain Racketeer Influence and Corrupt Organizations Act, securities law, conversion and fraud claims that were dismissed with prejudice by the Court and two state law claims of waste and breach of fiduciary duty that were dismissed by the Court for lack of jurisdiction. On January 11, 1996, plaintiff filed a notice of appeal with the Second Circuit Court of Appeals.\nOTHER PROCEEDINGS\nIn addition to the foregoing, the Company and its subsidiaries are parties to legal proceedings that are considered to be either ordinary, routine litigation incidental to their business or not material to the Company's consolidated financial position.\nThe Company does not believe that any of the foregoing actions will have a material adverse effect on its consolidated financial position or consolidated results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ------ ---------------------------------------------------\nNot applicable.\nItem 10. Executive Officers of the Registrant. ------- ------------------------------------\nAll executive officers of the Company are elected at the organizational meeting of the Board of Directors of the Company held annually and serve at the pleasure of the Board of Directors. As of March 22, 1996, the executive officers of the Company, their ages, the positions held by them and the periods during which they have served in such positions were as follows:\nMr. Cumming has served as a director and Chairman of the Board of the Company since June 1978. In addition, he has served as a director of Allcity since February 1988 and MK Gold since June 1995. Mr. Cumming has also been a director of Skywest, Inc., a Utah-based regional air carrier, since June 1986.\nMr. Steinberg has served as a director of the Company since December 1978 and as President of the Company since January 1979. In addition, he has served as a director of Allcity since February 1988, as a director of MK Gold since June 1995 and as a director of JII since June 1988.\nMr. Mara joined the Company in April 1977 and was elected Vice President of the Company in May 1977. He has served as Executive Vice President of the Company since May 1980 and as Treasurer of the Company since January 1993. In addition, he has served as a director of Allcity since October 1994.\nMr. Orlando, a certified public accountant, has served as Comptroller of the Company since March 1994 and as Vice President of the Company since January 1994. Mr. Orlando previously served in a variety of capacities with the Company and its subsidiaries since 1987.\nMr. Borden joined the Company as Vice President in August 1988 and has served in a variety of other capacities with the Company and its subsidiaries.\nMr. Hornstein joined the Company as Vice President in July 1983 and has served in a variety of other capacities with the Company and its subsidiaries.\nMs. Klindtworth has been employed by the Company since July 1960 and has served as Secretary of the Company since February 1976 and as Vice President-Corporate Administrator of the Company since January 1990.\nMr. Sherman has served as Vice President of the Company since August 1992. For the five years prior, he served in a variety of capacities with the Company and its subsidiaries.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related ------ ------------------------------------------------- Stockholder Matters. -------------------\n(a) Market Information. ------------------\nThe Common Shares are traded on the New York Stock Exchange and Pacific Stock Exchange under the symbol LUK. The following table sets forth, for the calendar periods indicated, the high and low sales price per Common Share on the consolidated transaction reporting system, as reported by the Dow Jones Historical Stock Quote Reporter Service. As discussed in Part I of this Report, in November 1995, the Company effected the Stock Split. Per share amounts set forth in this Report have been adjusted to reflect the Stock Split.\n(b) Holders. ------- As of March 22, 1996, there were approximately 4,594 record holders of the Common Shares.\n(c) Dividends. --------- The Company paid dividends of $.25 per Common Share on December 29, 1995 and $.125 per Common Share on December 30, 1994. The payment of dividends in the future is subject to the discretion of the Board of Directors and will depend upon general business conditions, legal and contractual restrictions on the payment of dividends and other factors that the Board of Directors may deem to be relevant.\nIn connection with the declaration of dividends or the making of distributions on, or the purchase, redemption or other acquisition of Common Shares, the Company is required to comply with certain restrictions contained in certain of its debt instruments.\nItem 6.","section_6":"Item 6. Selected Financial Data. ------ -----------------------\nThe following selected financial data have been summarized from the Company's consolidated financial statements and are qualified in their entirety by reference to, and should be read in conjunction with, such consolidated financial statements and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" below.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition ------ ----------------------------------------------------------- and Results of Operations. -------------------------\nThe purpose of this section is to discuss and analyze the Company's consolidated financial condition, liquidity and capital resources and results of operations. This analysis should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Report.\nLIQUIDITY AND CAPITAL RESOURCES\nParent Company Liquidity. Leucadia National Corporation (the ------------------------ \"Parent\") is a holding company whose assets principally consist of the stock of its several direct subsidiaries. Additionally, the Parent continuously evaluates its existing operations and investigates possible acquisitions of new businesses and dispositions of businesses in order to maximize its ultimate economic value to shareholders. Accordingly, while the Parent does not have any material arrangement, commitment or understanding with respect thereto (except as disclosed in this Report), further acquisitions, divestitures, investments and changes in capital structure are possible. Its principal sources of funds are its available cash resources, bank borrowings, public financings, repayment of subsidiary advances, funds distributed from its subsidiaries as tax sharing payments, management and other fees, and borrowings and dividends from its regulated and non-regulated subsidiaries. It has no substantial recurring cash requirements other than payment of interest and principal on its debt, tax payments and corporate overhead expenses.\nThe Parent maintains the principal borrowings for the Company and its non-banking subsidiaries and has provided working capital to certain of its subsidiaries. These borrowings have primarily been made on an unsecured basis from banks through various credit agreement facilities and term loans, and through public financings. During the year ended December 31, 1995, the Company used a portion of its $150,000,000 bank credit agreement facilities in connection with the MK Gold transaction and to meet daily cash requirements. At December 31, 1995, there were no amounts outstanding under such bank credit agreement facilities. The Company's bank borrowings bear interest based on the prime rate or LIBOR. The Company is exposed to interest rate risk related to its variable rate borrowings. The Company has entered into interest rate swap and interest rate option agreements to reduce the impact of changes in interest rates on its variable rate debt. Counterparties to these agreements are major financial institutions, which the Company believes are able to fulfill their obligations; however, if they are not, the Company believes that any losses are unlikely to be material.\nIn June 1995, the Company sold $100,000,000 principal amount of its newly authorized 8 1\/4% Senior Subordinated Notes due 2005 in an underwritten public offering. A portion of the proceeds was used to repay indebtedness outstanding under the Company's bank credit agreement facilities incurred in connection with the MK Gold transaction. The remaining proceeds were added to working capital.\nOn September 13, 1995, Ian M. Cumming and Joseph S. Steinberg, Chairman of the Board and President of the Company, respectively, and certain members of Mr. Cumming's family exercised previously granted warrants to purchase an aggregate of 3,188,000 Common Shares and sold such shares in an underwritten public offering. In connection with such public offering, the Company granted the underwriters an over allotment option, which was exercised, for 478,200 Common Shares. Under the terms of the warrant agreement, the Company was required to pay expenses of the sale, other than underwriting discounts. As a result of the exercise of the warrants and the exercise of the over allotment option, the Company realized aggregate cash proceeds, net of expenses, of $43,736,000. For income tax purposes, the exercise of the warrants results in the Company receiving a current income tax deduction of $57,305,000. For financial reporting purposes, the benefit of such deduction ($20,057,000) was credited directly to shareholders' equity.\nAt December 31, 1995, a maximum of approximately $60,200,000 was available to the Parent as dividends from its regulated subsidiaries without regulatory approval. Additional amounts may be available to the Parent in the form of loans or cash advances from regulated subsidiaries, although no amounts were outstanding at December 31, 1995 or borrowed to date in 1996. There are no restrictions on distributions from the non-regulated subsidiaries; the Parent and its non-regulated subsidiaries had aggregate cash and temporary investments of approximately $164,400,000 at December 31, 1995. The Parent also receives tax sharing payments from subsidiaries included in its consolidated income tax return, including certain regulated subsidiaries. Because of the tax loss carryforwards available to the Parent and certain subsidiaries, together with current interest deductions and corporate expenses, the amount paid by the Parent for income taxes is substantially less than tax sharing payments received from its subsidiaries. In addition, the Parent receives payments from the regulated and non-regulated entities for services provided by the Parent. Payments from regulated subsidiaries for dividends, tax sharing payments and other services totaled approximately $64,900,000 during the year ended December 31, 1995.\nBased on discussions with commercial and investment bankers, the Company believes that it has the ability to raise additional funds under acceptable conditions for use in its existing businesses or for appropriate investment opportunities. Since 1993, the Company's senior debt obligations have been rated as \"investment grade\" by Moody's, S&P and Duff & Phelps Inc. Ratings issued by bond rating agencies are subject to change at any time.\nIn March 1996, the Company retired at maturity its 6% Swiss Franc Bond issue and underlying currency swap agreement, which had an outstanding principal balance of $27,255,000.\nConsolidated Liquidity. During each of the three years in the ---------------------- period ended December 31, 1995, the Company operated profitably and in the years ended December 31, 1995 and 1994, net cash was provided from operations. For the year ended December 31, 1993, in spite of increased earnings, net cash was used for operations, principally as a result of payments made in connection with a reinsurance transaction.\nIn June 1995, the Company purchased a 46.4% common stock interest in MK Gold for an aggregate cash purchase price of $22,500,000. In addition, the Company purchased at par all of a lender's interest under a $20,000,000 revolving credit facility with MK Gold, of which $15,000,000 was outstanding. This amount was repaid during the third quarter of 1995.\nDuring the second quarter of 1995, the Company purchased 2,365,200 common shares of RCP for approximately $11,130,000, which increased its equity interest in RCP to 2,714,000 shares (7.1%). RCP is a real estate investment trust, the principal asset of which is a $1.3 billion collateralized loan to the owners of the land and buildings known as Rockefeller Center in New York City. In March 1996, shareholders of RCP approved a merger transaction pursuant to which shareholders will receive $8.00 per share. If the merger is consummated, the Company expects to report a pre-tax gain of approximately $8,900,000 in 1996.\nIn July 1995, pursuant to the chapter 11 reorganization plan of HFC, the Company acquired 41.2% of HFC's common stock for a net cash investment of approximately $4,200,000. As part of the reorganization plan, the Company provided HFC with a $20,000,000 eight year secured loan, which is convertible into additional shares of HFC common stock after three years (subject to certain conditions) and which bears interest at the rate of 12% per year.\nThe Company has entered into a letter of intent with PepsiCo, Inc. for the formation of a joint venture (the \"JV\") that will be the exclusive bottler and distributor of PepsiCo beverages in a large portion of eastern Russia, Kyrgyzstan and Kazakhstan. The Company has agreed to invest approximately $79,000,000 in the JV, for which it will receive a 75% economic interest.\nIt is currently anticipated that the joint venture agreement will be executed during the second quarter of 1996.\nThe Company's investments in Russia and Argentina are subject to foreign exchange and other risks. Investing in the emerging markets of Russia is subject to political risk and uncertainty concerning the government's ability to succeed in its program to convert to a market economy, both of which are beyond the Company's control. In Argentina, the Company's investment is subject to the foreign currency exchange risk of a devaluation of the Argentine peso against the United States dollar, which the Argentine government has indicated is not being considered, the volatility of the Argentine banking system, the overall health of the Argentine economy and the usual competitive factors experienced by insurance companies.\nThe source of the funds for the investments described above is general corporate funds available to the Parent company.\nEffective as of December 31, 1995, control of the WMAC Companies was returned to the Company and such subsidiaries were consolidated. As a result, the Company recorded a gain of $41,030,000, representing the difference between the carrying amount of the Company's investment prior to consolidation and the net assets of such subsidiaries.\nThe investment portfolios of the Company's insurance subsidiaries are principally fixed maturity investments rated \"investment grade\" or U.S. governmental agency issued or guaranteed obligations, although limited investments in \"non rated\" or rated less than \"investment grade\" securities have been made from time to time. The investment strategy of the insurance subsidiaries has been to maintain a high quality portfolio of publicly traded, fixed income securities with a relatively short duration. Principally as a result of decreases in market interest rates during 1995, the unrealized loss on investments at the end of 1994 of approximately $41,309,000 (net of taxes) became an unrealized gain of approximately $30,086,000 (net of taxes) as of December 31, 1995. While this has resulted in an increase in shareholders' equity, it had no effect on results of operations or cash flows.\nAs a result of significant losses from natural disasters suffered by the property and casualty insurance industry in recent years, the Company has seen a notable decrease in the availability of reinsurance at reasonable rates, particularly at low levels of deductibility. The Company's insurance subsidiaries also suffered certain of such losses, although catastrophe reinsurance programs substantially reduced the economic losses in 1994. As a result of increased reinsurance rates, in 1995 the Company raised its retention of lower level losses from $11,000,000 to $15,000,000. The Company has benefited from a modest decline in reinsurance rates for its 1996 catastrophe reinsurance program and has not adjusted its retention of lower level losses.\nIn December 1995, the Company entered into an agreement with the California Department of Insurance to settle its Proposition 103 liability for $17,700,000. The settlement did not exceed reserves established in prior years. The Company paid the settlement amount during the first quarter of 1996.\nThe Company provides collateralized automobile loans to individuals with poor credit histories. In 1995, primarily as a result of increased competition together with the Company's unwillingness to lower its underwriting standards and interest rate charges, the loan portfolio did not grow at the rate previously experienced. Additionally, loan losses have increased but remain less than the 6.6% reserve maintained on this portfolio. The Company expects that the increased level of competition will continue, and, together with the Company's unwillingness to lower rates, is likely to result in a contraction in the size of this portfolio in the future. The Company's investment in these loans was $134,668,000, $129,512,000 and $73,321,000 at December 31, 1995, 1994 and 1993, respectively.\nThe Company and certain of its subsidiaries, including Phlcorp and its subsidiaries, have substantial loss carryforwards and other tax attributes (as more fully discussed in the Notes to Consolidated Financial Statements). The amount and availability of tax loss carryforwards are subject to certain qualifications, limitations and uncertainties, including, with respect to Phlcorp and its subsidiaries, tax sharing payments pursuant to a tax settlement agreement with the Internal Revenue Service and the Department of Justice. In order to reduce the possibility that certain changes in ownership could impose limitations on the use of these carryforwards, the Company's certificate of incorporation contains provisions which generally restrict the ability of a person or entity from accumulating at least five percent of the Common Shares and the ability of persons or entities now owning at least five percent of the Common Shares from acquiring additional Common Shares. The Company has recognized as an asset (net of reserves) certain of the benefits of such loss carryforwards and other tax attributes. However, the amount of the asset recognized only reflects the minimum Phlcorp tax loss carryforwards and is based, in part, on certain proposed regulations affecting the use of Phlcorp's tax loss carryforwards. As described in the Notes to the Consolidated Financial Statements, significant additional amounts may be available under certain circumstances.\nResults of Operations ---------------------\nThe Company's most significant operations are its insurance businesses, where it is a specialty markets provider of property and casualty and life insurance to its niche markets. For the year ended December 31, 1995, the Company's insurance segments contributed 78% of total revenues and, at December 31, 1995, constituted 77% of total assets.\nEarned premium revenues and commissions of the property and casualty insurance operations of the Empire Group were $326,100,000 in 1995, $299,200,000 in 1994 and $259,400,000 in 1993. The increase in 1995 principally was attributable to growth in policies in force and increased premium rates, while the increase in 1994 resulted from increased policies in force. The majority of the growth in each of 1995 and 1994 resulted from acquired blocks of assigned risk business from other insurance companies.\nEarned premium revenues of the Colonial Penn P&C Group were approximately $490,500,000 in 1995, $447,200,000 in 1994 and $452,600,000 in 1993. The growth in earned premiums in 1995 principally resulted from acquired blocks of assigned risk automobile business from other insurance companies and a modest increase in earned premiums related to voluntary automobile policies. Voluntary automobile policies in force at December 31, 1995 were almost 1% greater than the prior year end, and written premiums increased 5.7% from 1994. When the Colonial Penn P&C Group was acquired in 1991, the Company substantially reduced its existing marketing programs, which the Company believes were not justified by prior operating results, and instituted new low cost direct marketing methods. Prior to 1995, this strategy resulted in declining polices in force and earned premiums, as new business was not sufficient to offset the normal attrition of existing business. The Company believes that new business generated in 1996 will continue to exceed lapsed business and the rate of growth in policies in force will also increase, although there can be no assurance that this will be achieved. Earned premiums in 1994 also reflect an increase, as compared to the prior year, resulting from acquired blocks of automobile assigned risk business from other insurance companies.\nThe Company's property and casualty insurance operations combined ratios as determined under GAAP and SAP were as follows:\nYear Ended December 31, GAAP SAP ----------------------- ---- --- 1995 103.5% 101.2% 1994 99.1% 98.8% 1993 96.9% 93.7%\nThe provision for insurance losses and policy benefits includes catastrophe losses, net of reinsurance recoveries, estimated at approximately $4,600,000, $18,300,000 and $10,900,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The 1994 losses include approximately $11,700,000 related to the Northridge, California earthquake.\nThe increase in the combined ratios is primarily attributable to the Empire Group, which strengthened reserves in automobile and workers compensation lines by approximately $34,470,000. Actuarial studies conducted during 1995 have identified revised loss development patterns in automobile lines, which may indicate greater ultimate loss experience than previously expected. The Empire Group also reopened closed no-fault claims files during 1995 and made additional payments on prior years' claims. This, along with changes in claim handling practices, have increased the difficultly of estimating ultimate losses, and actual losses may be different than the studies indicated. However, the Empire Group strengthened reserves to the levels indicated in the actuarial studies. The Empire Group will continue to analyze loss development patterns on a quarterly basis and will evaluate the adequacy of its loss reserves.\nThe combined ratios for the Colonial Penn P&C Group increased slightly in 1995 as compared to 1994. The 1995 combined ratios reflect higher losses related to acquired blocks of automobile assigned risk business that are partially offset by increased service fee income. In addition, the combined ratios in 1995 were favorably affected by reduced catastrophe losses as compared to 1994. The combined ratios of the Colonial Penn P&C Group's core line of business, voluntary auto, were essentially unchanged. The Colonial Penn P&C Group believes that its strong underwriting procedures, emphasis on mature adult insureds, prior rate increases and claims handling and settlement practices have enabled it to record combined ratios that compare favorably with the industry.\nIn addition to higher catastrophe losses, the combined ratios for 1994 increased as compared to 1993 principally due to settlements in 1993 of Colonial Penn P&C Group prior years' claims at amounts less than provided.\nPremium revenue receipts on IOP products of the life insurance subsidiaries (which are not reflected as revenues) were $50,202,000 in 1995, $108,080,000 in 1994 and $88,312,000 in 1993. The principal IOP product sold during the three year period ended December 31, 1995 was a VA product marketed directly to consumers. The Company believes the decline in premium revenue receipts of the VA product is due to a combination of factors, including the public's perception of potential tax law changes, increased competition and the performance of the fund manager.\nEarned premium revenues of the life and health insurance operations were $165,800,000 for 1995, $172,400,000 for 1994 and $181,800,000 for 1993. The decline in earned premium revenues reflect the run-off of the agent sold Medicare supplement business, which the Company ceased marketing at December 31, 1992 due to inadequate profitability.\nEarned premiums revenues for the Company's Graded Benefit Life business were $117,700,000, $113,700,000 and $109,800,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The growth in earned premiums reflects the Company's increased marketing efforts with respect to this product, which have been conducted at acquisition cost levels that result in adequate profitability.\nInsurance losses, policy benefits and amortization of deferred acquisition costs of the life and health insurance operations were $133,200,000, $138,300,000 and $179,100,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The decrease in 1995 reflects the run-off of the agent sold Medicare supplement business, which had less favorable loss experience in 1995, reduced IOP insurance in force and a $3,500,000 gain recognized from the termination of a reinsurance agreement. The decrease in 1995 was partially offset by the growth of the Graded Benefit Life product. The decrease in 1994 as compared to the prior year primarily reflects the run-off of the agent sold Medicare supplement business and certain non-recurring transactions in 1993 which are described below.\nIn 1993, due to expectations of decreased or inadequate future profitability of its Single Premium Whole Life (\"SPWL\") products, the Company reinsured its SPWL business and recorded a net pre-tax gain of approximately $16,700,000. Such net pre-tax gain consists of the premium received on the transaction of $19,500,000, which is reflected as a credit in the caption \"Provision for insurance losses and policy benefits,\" and net security gains on investments sold in connection with the transaction of $24,100,000, reduced by the write-off of deferred policy acquisition costs of $26,900,000.\nDuring 1993, the Company reinvested proceeds from sales of certain securities at the lower prevailing interest rates. Since these reinvestment rates were, in certain instances, lower than had previously been expected on certain fixed rate annuity policies, the Company recorded an additional provision for insurance losses of $6,800,000.\nManufacturing revenues decreased in 1995 principally due to reduced demand from customers of the bathroom vanities division and a factory fire at the fibers division, offset in part by increased sales at the plastics division. The decrease in manufacturing gross profit in 1995 principally reflects the decrease in manufacturing sales, increased raw material costs at most divisions and the fire at the fibers division. Although manufacturing revenues increased in 1994 as compared to 1993, gross profit declined significantly, principally at the bathroom vanities division, which experienced manufacturing inefficiencies, pricing pressures and recorded provisions for obsolete inventory in 1994.\nAs a result of the factory fire at the fibers division and historical operating losses, in the fourth quarter of 1995 the Company decided to close the factory and recorded a loss of approximately $6,200,000 for shutdown expenses. In addition, during the third quarter of 1995, the Company sold a division that manufactured office furnishing systems and recognized a loss of $1,100,000. Such losses are reflected in the caption \"Selling, general and other expenses.\"\nFinance revenues reflect the level of consumer instalment loans, which have increased during 1995 and 1994 as discussed above. The operating profit applicable to this segment did not change significantly in 1995 as compared to 1994, principally due to increased interest expense on customer banking deposits and greater losses on automobile loans.\nInvestment and other income increased in 1995 principally due to the return of the WMAC Companies, which resulted in a gain of $41,030,000 as discussed above. Interest and dividend income increased in 1995 reflecting higher investment yields and increased funds available for investment. Investment and other income reflects increased fee income in 1995 related to acquired blocks of automobile assigned risk business.\nInvestment and other income in 1994 includes $8,458,000 related to the disposition of El Salvador government bonds and $14,490,000 related to the sale of the Company's remaining shares in Bolivian Power Company. Investment and other income in 1993 includes a $12,981,000 gain from the sale of a portion of the investment in Bolivian Power Company.\nNet securities gains (losses) were $20,027,000, ($12,004,000) and $51,923,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Realized security losses during 1994 principally reflected the Company's strategy to further shorten the duration of its investment portfolio during a time of rising interest rates. Security gains in 1993 were realized, in part, to effect the reinsurance and transfer of the SPWL business described above.\nHigher interest expense in each of 1995 and 1994 compared to the prior year principally reflects the increased level of outstanding debt. Interest expense also reflects the increased level of deposits at AIB and AIF and an increase in rates related to those deposits. Generally, interest rates on deposits are lower than on other available funds. Interest expense on deposits was $12,034,000 in 1995, $8,304,000 in 1994 and $9,001,000 in 1993.\nThe increase in selling, general and other expenses in 1995 principally reflects the losses recorded by the manufacturing segment as described above, operating expenses of real estate properties acquired during 1994, expenses relating to certain investing activities, including expenses related to exploring opportunities in Russia, and increased provisions for bad debts at the banking and lending segment.\nDuring each of the last three years, statistical studies and estimates of service costs indicated that the recorded liability for unredeemed trading stamps was in excess of the amount that ultimately would be required to redeem trading stamps outstanding. As a result, selling, general and other expenses applicable to the trading stamp operations include credits of $9,400,000, $11,700,000 and $11,900,000 for the years ended December 31, 1995, 1994 and 1993, respectively, reflecting adjustments made to the liability for unredeemed trading stamps. The Company's most recent analysis of the liability for unredeemed trading stamps has not identified any remaining excess as of December 31, 1995.\nThe provision for income taxes for 1995 is below the expected normal corporate income tax rate principally due to the gain related to the return of the WMAC Companies, which is not taxable, and the favorable resolution of certain contingencies. The provision for income taxes for 1994 and 1993 is below the expected normal corporate income tax rate principally because of a reduction in the valuation allowance applicable to the deferred tax asset due to the resolution of certain contingencies. In addition, the provision for income taxes for 1993 was reduced by approximately $4,215,000 as a result of changes in federal income tax rates.\nThe number of shares used to calculate primary earnings per share was 59,271,000, 58,202,000 and 58,539,000 for 1995, 1994 and 1993, respectively. The number of shares used to calculate fully diluted earnings per share was 62,807,000, 61,715,000 and 61,486,000 for 1995, 1994 and 1993, respectively. The increase in the number of shares utilized in calculating per share amounts in 1995 principally relates to the exercise of previously granted warrants to the Company's Chairman and President, the selling of such shares in an underwritten public offering and the exercise by the underwriters of the over allotment option, all as discussed above.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. ------ -------------------------------------------\nFinancial Statements and supplementary data required by this Item 8 are set forth at the pages indicated in Item 14(a) below.\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 to be included under the caption \"Nominees for Election as Directors\" in the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A of the 1934 Act in connection with the 1996 annual meeting of shareholders of the Company (the \"Proxy Statement\") is incorporated herein by reference. In addition, reference is made to Item 10 in Part I of this Report.\nItem 11.","section_11":"Item 11. Executive Compensation. ------- ----------------------\nThe information to be included 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 to be included under the caption \"Present Beneficial Ownership of Common Shares\" in the Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ------- ----------------------------------------------\nThe information to be included under the caption \"Executive Compensation - Certain Relationships and Related 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. ---\n(a)(1)(2) Financial Statements and Schedules. ---------------------------------- Report of Independent Accountants . . . . . Financial Statements: Consolidated Balance Sheets at December 31, 1995 and 1994 . . . . . . . . Consolidated Statements of Income 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 . . . . . Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . .\nFinancial Statement Schedules: Schedule II - Condensed Financial Information of Registrant . . . . . . . . Schedule III - Supplementary Insurance Information . . . . . . . . . . Schedule IV - Schedule of Reinsurance . . . . . . . . . . . . . . . Schedule V - Valuation and Qualifying Accounts . . . . . . . . . . . Schedule VI - Schedule of Supplemental Information for Property and Casualty Insurance Underwriters . . . . .\n(3) Executive Compensation Plans and Arrangements. --------------------------------------------- 1982 Stock Option Plan, as amended August 28, 1991 (filed as Annex B to the Company's Proxy Statement dated July 21, 1992).\n1992 Stock Option Plan (filed as Annex C to the Company's Proxy Statement dated July 21, 1992).\nAgreement made as of March 12, 1984 by and between Leucadia, Inc. and Ian M. Cumming (filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1983 (the \"1983 10-K\")).\nAgreement made as of March 12, 1984 by and between Leucadia, Inc. and Joseph S. Steinberg (filed as Exhibit 10.15 to the 1983 10-K).\nAgreement dated as of August 1, 1988 among the Company, Ian M. Cumming and Joseph S. Steinberg (filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (the \"1991 10-K\")).\nAgreement dated as of January 10, 1992 between Ian M. Cumming, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.7 to the 1991 10-K).\nAgreement dated as of January 10, 1992 between Joseph S. Steinberg, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.8 to the 1991 10-K).\nAgreement between Leucadia, Inc. and Ian M. Cumming, dated as of December 28, 1992 (filed as Exhibit 10.12(a) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (the \"1992 10-K\")).\nEscrow and Security Agreement by and among Leucadia, Inc., Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.12(b) to the 1992 10-K).\nAgreement between Leucadia, Inc. and Joseph S. Steinberg, dated as of December 28, 1992 (filed as Exhibit 10.13(a) to the 1992 10-K).\nEscrow and Security Agreement by and among Leucadia, Inc., Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.13(b) to the 1992 10-K).\nAgreement made as of December 28, 1993 by and between the Company and Ian M. Cumming (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (the \"1993 10-K\")).\nAgreement made as of December 28, 1993 by and between the Company and Joseph S. Steinberg (filed as Exhibit 10.18 to the 1993 10-K).\nAgreement between the Company and Ian M. Cumming dated as of December 28, 1993 (filed as Exhibit 10.19(a) to the 1993 10-K).\nEscrow and Security Agreement by and among the Company, Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.19(b) to the 1993 10-K).\nAgreement between the Company and Joseph S. Steinberg, dated as of December 28, 1993 (filed as Exhibit 10.20(a) to the 1993 10-K).\nEscrow and Security Agreement by and among the Company, Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.20(b) to the 1993 10-K).\nDeferred Compensation Agreement between the Company and Lawrence S. Hershfield, dated March 29, 1995 (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q For the Quarterly Period ended March 31, 1995).\nAgreement between the Company and Lawrence S. Hershfield, dated as of May 4, 1995 (filed as Exhibit 10.22(a) to this Report).\nEscrow and Security Agreement by and among the Company, Lawrence S. Hershfield and Weil, Gotshal & Manges, as escrow agent, dated as of May 4, 1995 (filed as Exhibit 10.22(b) to this Report).\n(b) Reports on Form 8-K. ------------------- Not applicable.\n(c) Exhibits. -------- 3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to the Company's Current Report on Form 8-K dated July 14, 1993).*\n3.2 By-laws (as amended) filed as Exhibit 4.5 to the Company's Registration Statement No. 33-57054).*\n4.1 The Company undertakes to furnish the Securities and Exchange Commission, upon request, a copy of all instruments with respect to long-term debt not filed herewith.\n10.1 1982 Stock Option Plan, as amended August 28, 1991 (filed as Annex B to the Company's Proxy Statement dated July 21, 1992).*\n___________________\n* Incorporated by reference.\n10.2 1992 Stock Option Plan (filed as Annex C to the Company's Proxy Statement dated July 21, 1992).*\n10.3(a) Restated Articles and Agreement of General Partnership, effective as of February 1, 1982, of The Jordan Company (filed as Exhibit 10.3(d) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1986).*\n10.3(b) Amendments dated as of December 31, 1989 and December 1, 1990 to the Partnership Agreement referred to in 10.3(a) above (filed as Exhibit 10.2(b) to the 1991 10-K).*\n10.3(c) Amendment dated as of December 17, 1992 to the Partnership Agreement referred to in 10.3(a) above (filed as Exhibit 10.3(c) to the 1992 10-K).*\n10.3(d) Articles and Agreement of General Partnership, effective as of April 15, 1985, of Jordan\/Zalaznick Capital Company (filed as Exhibit 10.20 to the Company's Registration Statement No. 33-00606).*\n10.4 Agreement made as of March 12, 1984 by and between Leucadia, Inc. and Ian M. Cumming (filed as Exhibit 10.14 to the 1983 10-K).*\n10.5 Agreement made as of March 12, 1984 by and between Leucadia, Inc. and Joseph S. Steinberg (filed as Exhibit 10.15 to the 1983 10-K).*\n10.6 Stock Purchase and Sale Agreement dated as of April 5, 1991, by and between FPL Group Capital Inc and the Company (filed as Exhibit B to the Company's Current Report on Form 8-K dated August 23, 1991).*\n10.7 Agreement dated as of August 1, 1988 among the Company, Ian M. Cumming and Joseph S. Steinberg (filed as Exhibit 10.6 to the 1991 10-K).*\n10.8 Agreement dated as of January 10, 1992 between Ian M. Cumming, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.7 to the 1991 10-K).*\n10.9 Agreement dated as of January 10, 1992 between Joseph S. Steinberg, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.8 to the 1991 10-K).*\n10.10(a) Agreement dated April 23, 1992 between AIC Financial Services, Inc. (an Alabama corporation), AIC Financial Services (a Mississippi corporation) and AIC Financial Services (a South Carolina corporation) (collectively, \"Seller\") and Norwest Financial Resources, Inc. (filed as Exhibit 10.10(a) to the 1992 10-K).*\n___________________\n* Incorporated by reference.\n10.10(b) Purchase Agreement between A.I.C. Financial Services, Inc., American Investment Bank, N.A., American Investment Financial and Terracor II d\/b\/a AIC Financial Fund, Seller, and Associates Financial Services Company, Inc., Buyer, dated November 5, 1992 (filed as Exhibit 10.10(b) to the Company's Registration Statement No. 33-55120).*\n10.11(a) Agreement and Plan of Merger, dated as of October 22, 1992, by and among the Company, Phlcorp Acquisition Company and PHLCORP, Inc. (filed as Exhibit 5.2 to the Company's Current Report on Form 8-K dated October 22, 1992).*\n10.11(b) Amendment dated December 10, 1992, to the Merger Agreement referred to in 10.11(a) above (filed as Exhibit 5.2 to the Company's Current Report on Form 8-K dated December 14, 1992).*\n10.12(a) Agreement between Leucadia, Inc. and Ian M. Cumming, dated as of December 28, 1992 (filed as Exhibit 10.12(a) to the 1992 10-K).*\n10.12(b) Escrow and Security Agreement by and among Leucadia, Inc., Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.12(b) to the 1992 10-K).*\n10.13(a) Agreement between Leucadia, Inc. and Joseph S. Steinberg, dated as of December 28, 1992 (filed as Exhibit 10.13(a) to the 1992 10-K).*\n10.13(b) Escrow and Security Agreement by and among Leucadia, Inc., Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.13(b) to the 1992 10-K).*\n10.14 Settlement Agreement between Baldwin-United Corporation and the United States dated August 27, 1985 concerning tax issues (filed as Exhibit 10.14 to the 1992 10-K).*\n10.15 Acquisition Agreement, dated as of December 18, 1992, by and between Provident Mutual Life and Annuity Company of America and Colonial Penn Annuity and Life Insurance Company (filed as Exhibit 10.15 to the 1992 10-K).*\n10.16 Reinsurance Agreement, dated as of December 31, 1991, by and between Colonial Penn Insurance Company and American International Insurance Company (filed as Exhibit 10.16 to the 1992 10-K).*\n10.17 Agreement made as of December 28, 1993 by and between the Company and Ian M. Cumming (filed as Exhibit 10.17 to the 1993 10-K).*\n___________________\n* Incorporated by reference.\n10.18 Agreement made as of December 28, 1993 by and between the Company and Joseph S. Steinberg (filed as Exhibit 10.18 to the 1993 10-K).*\n10.19(a) Agreement between the Company and Ian M. Cumming, dated as of December 28, 1993 (filed as Exhibit 10.19(a) to the 1993 10-K).*\n10.19(b) Escrow and Security Agreement by and among the Company, Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.19(b) to the 1993 10-K).*\n10.20(a) Agreement between the Company and Joseph S. Steinberg, dated as of December 28, 1993 (filed as Exhibit 10.20(a) to the 1993 10-K).*\n10.20(b) Escrow and Security Agreement by and among the Company, Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.20(b) to the 1993 10-K).*\n10.21 Deferred Compensation Agreement between the Company and Lawrence S. Hershfield, dated March 29, 1995 (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q For the Quarterly Period ended March 31, 1995).*\n10.22(a) Agreement between the Company and Lawrence S. Hershfield, dated as of May 4, 1995.\n10.22(b) Escrow and Security Agreement by and among the Company, Lawrence S. Hershfield and Weil, Gotshal & Manges, as escrow agent, dated as of May 4, 1995.\n21 Subsidiaries of the registrant.\n23 Consent of independent accountants with respect to the incorporation by reference into the Company's Registration Statements on Form S-8 (File No. 2- 84303), Form S-8 and S-3 (File No. 33-6054), Form S-8 and S-3 (File No. 33-26434), Form S-8 and S-3 (File No. 33-30277), Form S-8 (File No. 33-61680) and Form S-8 (File No. 33-61718).\n27 Financial Data Schedule.\n28 Schedule P of the 1995 Annual Statement to Insurance Departments of the Colonial Penn Insurance Company and Affiliated Property\/Casualty Insurers, the Empire Insurance Company, Principal Insurer, the WMAC Credit Insurance Corporation and the Commercial Loan Insurance Corporation. (P)\n___________________\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.\nLEUCADIA NATIONAL CORPORATION\nMarch 28, 1996 By: \/s\/ Joseph A. Orlando ----------------------------------- Joseph A. Orlando Vice President and Comptroller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the date set forth above.\nSignature Title --------- -----\n\/s\/ Ian M. Cumming Chairman of the Board ------------------------------ (Principal Executive Officer) Ian M. Cumming\n\/s\/ Joseph S. Steinberg President and Director ------------------------------ (Principal Executive Officer) Joseph S. Steinberg\n\/s\/ Joseph A. Orlando Vice President and Comptroller ------------------------------ (Principal Financial and Joseph A. Orlando Accounting Officer)\n\/s\/ Paul M. Dougan Director ------------------------------ Paul M. Dougan\n\/s\/ Lawrence D. Glaubinger Director ------------------------------ Lawrence D. Glaubinger\n\/s\/ James E. Jordan Director ------------------------------ James E. Jordan\n\/s\/ Jesse Clyde Nichols, III Director ------------------------------ Jesse Clyde Nichols, III\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Leucadia National Corporation:\nWe have audited the consolidated financial statements and the financial statement schedules of LEUCADIA NATIONAL CORPORATION and SUBSIDIARIES listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LEUCADIA NATIONAL 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 schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in the notes to the consolidated financial statements, in 1993 the Company changed its method of accounting for Income Taxes, Postretirement Benefits Other Than Pensions, Postemployment Benefits, Multiple-Year Retrospectively Rated Contracts, and Certain Investments in Debt and Capital Securities, all as set forth in various pronouncements of the Financial Accounting Standards Board and the Emerging Issues Task Force.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York March 22, 1996\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.\nThe accompanying notes are an integral part of these consolidated financial statements.\nLEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Nature of Operations: --------------------- The Company is a diversified financial services holding company engaged in personal and commercial lines of property and casualty insurance, life and health insurance, banking and lending and manufacturing, principally in markets throughout the United States. The Company's principal operations are its insurance businesses, where it is a specialty markets provider of property and casualty and life insurance products to niche markets. The Company's principal personal lines insurance products are automobile insurance, homeowners insurance, graded benefit life insurance marketed primarily to the age 50-and-over population and variable annuity products. The Company's principal commercial lines are property and casualty products provided for multi-family residential real estate, retail establishments and livery vehicles in the New York metropolitan area.\nThe Company's banking and lending operations principally consist of making instalment loans primarily funded by deposits insured by the Federal Deposit Insurance Company. The Company's manufacturing operations primarily manufacture products for the \"do-it-yourself\" home improvement market and for industrial and agricultural markets.\n2. Significant Accounting Policies: -------------------------------- (a) Use of Estimates in Preparing 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 in the financial statements and disclosures of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.\n(b) Consolidation Policy: The consolidated financial statements include the -------------------- accounts of the Company and all majority-owned subsidiaries. Two of the Company's legal subsidiaries (the \"WMAC Companies\") were not consolidated while under the control of the Wisconsin Insurance Commissioner. Effective as of December 31, 1995, control of the WMAC Companies was returned to the Company and such subsidiaries are included in the consolidated balance sheet as of December 31, 1995.\nInvestments in entities in which the Company owns less than 50% of the voting interest and has the ability to exercise significant influence are accounted for on the equity method of accounting.\nCertain amounts for prior periods have been reclassified to be consistent with the 1995 presentation.\n(c) Stock Split: On November 15, 1995, a two-for-one stock split was effected ----------- in the form of a 100% stock dividend. The financial statements (and notes\n2. Significant Accounting Policies, continued: ------------------------------- thereto) give retroactive effect to the stock split for all periods presented.\n(d) Statements of Cash Flows: The Company considers short-term investments, ------------------------ which have maturities of less than three months at the time of acquisition, to be cash equivalents. Cash and cash equivalents include short-term investments of $199,725,000 and $200,232,000 at December 31, 1995 and 1994, respectively.\nOn June 1, 1993, the Company received 448,350 of the Company's Common Shares (valued at $8,294,000) in settlement of a zero coupon note due from John W. Jordan II, a former director of the Company. The value of the shares received, which was based on the market price on the date of the transaction, was equal to the maturity value of the note.\n(e) Investments: Effective as of December 31, 1993, 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 reported shareholders' equity of $49,500,000 at December 31, 1993.\nAt acquisition, marketable debt and equity securities are designated as either i) held to maturity, which are carried at amortized cost, ii) trading, which are carried at estimated fair value with unrealized gains and losses reflected in results of operations, or iii) available for sale, which are carried at estimated fair value with unrealized gains and losses reflected as a separate component of shareholders' equity, net of taxes. Held to maturity investments are made with the intention of holding such securities to maturity, which the Company has the ability to do. Estimated fair values are principally based on quoted market prices.\nInvestments with an impairment in value considered to be other than temporary are written down to estimated net realizable values. The writedowns are included in \"Net securities gains (losses)\" in the Consolidated Statements of Income. The cost of securities sold is based on average cost.\nThe Company's investments in Russian equity securities ($39,700,000 and $19,600,000 as of December 31, 1995 and 1994, respectively), none of which is held by its insurance or banking subsidiaries, do not have readily determinable fair values. Given the uncertainties inherent in investing in the emerging markets of Russia, the Company is accounting for these investments under the cost recovery method, whereby all receipts are applied to reduce the investment. These investments are included in \"Other investments\" in the Consolidated Balance Sheets.\n(f) Property, Equipment and Leasehold Improvements: Property, equipment and ---------------------------------------------- leasehold improvements are stated at cost, net of accumulated depreciation and amortization ($101,568,000 and $87,067,000 at December 31, 1995 and 1994, respectively). Depreciation and amortization are provided principally on the straight-line method over the estimated useful lives of the assets or, if less, the term of the underlying lease.\n2. Significant Accounting Policies, continued: ------------------------------- (g) Income Recognition from Insurance Operations: Premiums on property and -------------------------------------------- casualty and health insurance products are recognized as revenues over the term of the policy using the monthly pro rata basis.\nPremiums for investment oriented insurance products (\"IOP products\") are reflected in a manner similar to a deposit; revenues reflect only mortality charges and other amounts assessed against the holder of the insurance policies and annuity contracts. The principal IOP product offered during the three year period ended December 31, 1995 was a variable annuity (\"VA\") product. Other life premiums are recognized as revenues over the premium paying period.\nPremiums for the VA product are directed by the policyholder to be invested in a unit trust solely for the benefit and risk of the policyholder. Policyholders' accounts are charged for the cost of insurance provided, administrative and certain other charges. The amount included in the balance sheet liability caption \"Separate and variable accounts\" represents the current value of the policyholders' funds.\n(h) Policy Acquisition Costs: Policy acquisition costs principally consist of ------------------------ direct response marketing costs, commissions, premium taxes and other underwriting expenses (net of reinsurance allowances). If recoverability of such costs from future premiums and related investment income is not anticipated, the amounts not considered recoverable are charged to operations. Deferred policy acquisition costs also have been charged to operations in connection with dispositions of blocks of business or reinvestment of proceeds from security sales at prevailing lower interest rates.\nPolicy acquisition costs applicable to the property and casualty insurance operations are deferred and amortized ratably over the terms of the related policies. Policy acquisition costs applicable to IOP products are deferred and amortized as a level percentage of the present value of expected gross profits over the estimated life of each policy. Policy acquisition costs applicable to other life insurance products are amortized over the expected premium paying period of the policies.\n(i) Reinsurance: In the normal course of business, the Company seeks to reduce ----------- the loss that may arise from catastrophes and to limit losses from large exposures by reinsuring certain levels of risk with other insurance enterprises. Catastrophe reinsurance treaties serve to reduce property and casualty insurance risk in geographic areas where the Company is exposed to natural disasters, principally Florida, California and the East Coast. The Company has also entered into reinsurance transactions in connection with dispositions of blocks of businesses. Reinsurance contracts do not necessarily legally relieve the Company from its obligations to policyholders.\nReinsurance recoverables are reported as assets net of provisions for uncollectible amounts. Premiums earned and other underwriting expenses are stated net of reinsurance.\n2. Significant Accounting Policies, continued: -------------------------------- (j) Policy Reserves and Unearned Premiums: Policy reserves and unearned premiums ------------------------------------- for life, health and traditional annuity policies are computed on a net level premium method based upon standard and Company developed tables with provision for adverse deviation and estimated withdrawals. Liabilities for unpaid losses and loss adjustment expenses applicable to the property and casualty insurance operations are determined using case basis evaluations, statistical analyses for losses incurred but not reported and estimates for salvage and subrogation recoverable and represent estimates of ultimate claim costs and loss adjustment expenses. As more information becomes available and claims are settled, the estimated liabilities are adjusted upward or downward with the effect of decreasing or increasing net income at the time of adjustment.\nEffective as of January 1, 1993, the Company adopted Financial Accounting Standards Board's Emerging Issues Task Force Consensus No. 93-6, \"Accounting for Multiple Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises\" (\"EITF 93-6\"), which specifies the accounting for certain retrospectively rated reinsurance agreements. As a result of the adoption of EITF 93-6, the Company reduced its premium payable at January 1, 1993 by $14,654,000 and recorded a credit of $9,672,000 (net of income taxes of $4,982,000) which is included in the caption \"Cumulative effects of changes in accounting principles.\"\n(k) Liability for Unredeemed Trading Stamps: The Company's liability for --------------------------------------- unredeemed trading stamps is estimated based upon recent experience, statistical evaluation and estimated costs to service redemptions of unredeemed trading stamps in the future. Recent statistical studies and current estimates of service costs have indicated that the recorded liability for unredeemed trading stamps was in excess of the amount that ultimately will be required to redeem trading stamps outstanding. As a result, selling, general and other expenses applicable to the trading stamp operations include credits of $9,400,000, $11,700,000 and $11,900,000 for the years ended December 31, 1995, 1994 and 1993, respectively, reflecting the adjustments made to the liability for unredeemed trading stamps. The Company's most recent analysis of the liability for unredeemed trading stamps has not identified any remaining excess as of December 31, 1995.\n(l) Pension, Postemployment and Postretirement Costs: The Company has ------------------------------------------------ non-contributory trusteed pension plans covering certain employees, which generally provide retirement benefits based on salary and length of service. The plans are funded in amounts sufficient to satisfy minimum ERISA funding requirements.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\") and Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"), which require accruals for benefits that previously had been expensed as incurred. The Company does not expect SFAS 106 and SFAS 112 to have a material effect on results of operations.\n2. Significant Accounting Policies, continued: -------------------------------- (m) Income Taxes: The Company provides for income taxes using the liability ------------ method. Effective as of January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). Under the liability method, deferred income taxes are provided at the statutorily enacted rates for differences between the tax and accounting bases of substantially all assets and liabilities and for carryforwards. The future benefit of certain tax loss carryforwards and future deductions is recorded as an asset and the provisions for income taxes are not reduced for the benefit from utilization of tax loss carryforwards. A valuation allowance is provided if deferred tax assets are not considered more likely than not to be realized.\n(n) Derivative Financial Instruments: The Company has entered into interest rate -------------------------------- swap and interest rate option agreements to reduce the impact of changes in interest rates on its variable rate debt. The difference between the amounts paid and received is accrued as an adjustment to interest expense over the term of the agreements. The premiums paid for interest rate option agreements are included in other assets and are amortized to expense over the term of the agreements. The Company does not have material derivative financial instruments for trading purposes.\n(o) Translation of Foreign Currency: Foreign currency denominated investments ------------------------------- which are not subject to hedging agreements and currency rate swap agreements not meeting the accounting requirements for hedges are converted into U.S. dollars at exchange rates in effect at the end of the period. Resulting net exchange gains or losses were not material.\n(p) Recently Issued Accounting Standards: Effective January 1, 1996, 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\"), will require the Company to review the recoverability of the carrying amount of long-lived assets and recognize an impairment loss under certain circumstances. The impact of implementation of SFAS 121 on the Company's financial position and results of operations is not expected to be material.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"), which is effective January 1, 1996, establishes a fair value method for accounting for stock-based compensation plans, either through recognition in the statement of operations or disclosure. The Company expects to implement SFAS 123 by providing the required disclosures in the notes to the financial statements.\n3. Acquisitions: ------------- The Company is a partner in The Jordan Company and Jordan\/Zalaznick Capital Company, private investment firms whose principal activity is structuring leveraged buy-outs in which the partners are given the opportunity to become equity participants. John W. Jordan II, a former director of the Company, is a Managing Partner of both firms. Since 1982, through such partnerships, the Company acquired interests in several companies (the \"Jordan Associated Companies\"), principally engaged in various aspects of manufacturing and distribution. The Company currently accounts for its interests in the Jordan Associated Companies on the cost method of accounting. The investments\n3. Acquisitions, continued: ------------ acquired as a result of the partnership interests are considered Associated Companies.\nIn April 1994, the Company acquired a 30% interest in Caja de Ahorro y Seguro S.A. (\"Caja\") from the government of Argentina for a purchase price of $46,000,000, including costs. Caja is a holding company whose subsidiaries are engaged in property and casualty insurance, life insurance and banking in Argentina. The difference between the Company's investment in Caja and its share of Caja's underlying net tangible assets is being amortized over 20 years.\nIn May 1994, the Company acquired a 615,000 square foot office building located near Grand Central Terminal in New York City for $50,800,000. The building has 355,000 square feet of contiguous space available for occupancy. After certain improvements to the building are completed, the Company intends to lease the available space to one or more entities and\/or sell the building. The investment is included in other assets.\nIn July 1994, the Company acquired two luxury condominium towers in downtown San Diego, California for $42,000,000. The property includes 201 residential units, of which 162 were available for sale at December 31, 1995, and 42,000 square feet of retail space. The investment is included in other assets.\nIn June 1995, the Company purchased a 46.4% common stock interest in MK Gold Company (\"MK Gold\") for an aggregate cash purchase price of $22,500,000. In addition, the Company purchased at par all of a lender's interest under a $20,000,000 revolving credit facility with MK Gold, of which $15,000,000 was outstanding. This amount was repaid during the third quarter of 1995. MK Gold is an international gold mining company whose shares are quoted on the Nasdaq National Market System.\nIn July 1995, pursuant to the chapter 11 reorganization of HomeFed Corporation (\"HFC\"), the Company acquired 41.2% of HFC's common stock for a net cash investment of approximately $4,200,000. As part of the reorganization plan, the Company provided HFC with a $20,000,000 eight year secured loan, which is convertible into additional shares of HFC common stock after three years (subject to certain conditions) and which bears interest at the rate of 12% per year. HFC is a public company whose subsidiaries develop real property.\nThe Company accounts for its investments in Caja, MK Gold and HFC under the equity method of accounting based on fiscal periods ended three months prior to the end of the Company's reporting period. The Company's investments in Caja, MK Gold and HFC are included in the caption \"Investments in associated companies.\"\n4. Investments in Associated Companies: ----------------------------------- The Company owns or held part interests in the following foreign power companies: Compania de Alumbrado Electrico de San Salvador, S.A. (\"CAESS\"), Compania Boliviana de Energia Electrica, S.A. - Bolivian Power Company Limited (\"Bolivian Power\") and, through the Canadian International Power Company Limited Liquidating Trust, The Barbados Light and Power Company Limited.\n4. Investments in Associated Companies, continued: ------------------------------------ In March 1993, in settlement of claims related to El Salvador's 1986 seizure of CAESS's assets, the Company received cash of $5,300,000 and $12,000,000 principal amount of 6% U.S. dollar denominated El Salvador Government bonds due in instalments through 1996. The Company has recognized the gain on the cash basis. During 1994, the Company disposed of the remaining bonds and reported a pre-tax gain of $8,458,000, which is included in the caption \"Investment and other income.\" Gains recognized in 1993 were not significant.\nDuring 1993, the Company sold 750,000 shares of Bolivian Power common stock in an underwritten public offering and realized a pre-tax gain of $12,981,000. During 1994, the Company sold its remaining interest in Bolivian Power to an unaffiliated party and realized a pre-tax gain of $14,490,000. The gains are reflected in the caption \"Investment and other income.\"\n5. Insurance Operations: --------------------- Premiums received on IOP products were $50,202,000, $108,080,000 and $88,312,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe changes in deferred policy acquisition costs were as follows (in thousands):\nOn June 23, 1993, the Company reinsured substantially all of its existing single premium whole life business (\"SPWL\") with a subsidiary of John Hancock Mutual Life Insurance Company (\"John Hancock\"), and realized a net pre-tax gain of approximately $16,700,000. Such net pre-tax gain consists of the premium received on the transaction of approximately $19,500,000, which is reflected as a credit in the caption \"Provision for insurance losses and policy benefits,\" and net security gains on investments sold in connection with the transaction of $24,100,000, reduced by the write-off of deferred policy acquisition costs of $26,900,000. For financial reporting purposes, the Company reflects the policy liabilities assumed by John Hancock in policy reserves, with an offsetting receivable from John Hancock of the same amount in reinsurance receivable, net, until the Company is legally relieved of its obligation to the SPWL policyholders. At December 31, 1995, reinsurance receivables, net includes $141,084,000 due from John Hancock.\n5. Insurance Operations, continued: -------------------- During 1993, the Company sold, at gains, substantial amounts of investments, including dispositions in connection with the transfer of blocks of business, and, in certain cases, reinvested proceeds at prevailing lower interest rates. Since certain of these rates were lower than had previously been expected on certain fixed rate annuity policies, the Company recorded an additional provision for insurance losses of $6,800,000.\nThe effect of reinsurance on premiums written and earned for the years ended December 31, 1995, 1994 and 1993 is as follows (in thousands):\nRecoveries recognized on reinsurance contracts were $28,900,000 in 1995, $44,300,000 in 1994 and $22,800,000 in 1993.\nNet income (loss) and statutory surplus as determined in accordance with statutory accounting principles as reported to the domiciliary state of the Company's insurance subsidiaries are as follows (in thousands):\nThe statutory net income (loss) of the life insurance subsidiaries is net of certain management and other fees paid to the Company or other subsidiaries of the Company. Under generally accepted accounting principles, the reported income of the life insurance segment is increased by these fees, since all intercompany transactions are eliminated in consolidation.\nCertain insurance subsidiaries are owned by other insurance subsidiaries. In the data above, investments in such subsidiary-owned insurance companies are reflected in statutory surplus of both the parent and subsidiary-owned insurance company. As a result, at December 31, 1995, 1994 and 1993, statutory surplus of $292,800,000, $252,800,000 and $246,600,000, respectively, related to property\n5. Insurance Operations, continued: -------------------- and casualty operations is also included in the statutory surplus of the life insurance parent, and statutory surplus of $29,300,000, $35,900,000 and $42,200,000, respectively, related to life operations is also included in the statutory surplus of the property and casualty insurance parent. The insurance subsidiaries are subject to regulatory restrictions which limit the amount of cash and other distributions available to the Company without regulatory approval. At December 31, 1995, $52,167,000 could be distributed to the Company without regulatory approval.\nIn December 1995, the Company entered into an agreement with the California Department of Insurance to settle its Proposition 103 liability for $17,700,000. The settlement did not exceed reserves established in prior years. The Company paid the settlement amount during the first quarter of 1996.\nThe Company's insurance subsidiaries are contingently liable for possible assessments under state regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have not been material.\nFor information with respect to the activity in property and casualty loss reserves, see \"Reconciliation of Liability for Losses and Loss Adjustment Expenses\" in Item 1 included elsewhere herein, which is incorporated by reference into these consolidated financial statements.\n6. Investments: ----------- The amortized cost, gross unrealized gains and losses and estimated fair value of investments classified as held to maturity and as available for sale at December 31, 1995 and 1994 are as follows (in thousands):\n6. Investments, continued: -----------\nThe amortized cost and estimated fair value of investments classified as held to maturity and as available for sale at December 31, 1995, by contractual maturity are shown below. Expected maturities are likely to differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\n6. Investments, continued: ----------- At December 31, 1995 and 1994 securities with book values aggregating $45,069,000 and $39,908,000, respectively, were on deposit with various regulatory authorities.\nAt December 31, 1995, the Company had common stock equity interests of 5% or more in the following domestic publicly owned non-consolidated companies, some of which are Associated Companies: Carmike Cinemas, Inc. (6% of Class A shares), HFC (41%), MK Gold (46%) and Rockefeller Center Properties, Inc. (7%).\nCertain information with respect to trading securities at December 31, 1995 and 1994 is as follows (in thousands):\n7. Trade, Notes and Other Receivables, Net: --------------------------------------- A summary of trade, notes and other receivables, net at December 31, 1995 and 1994 is as follows (in thousands):\n8. Prepaids and Other Assets: ------------------------- At December 31, 1995 and 1994, a summary of prepaids and other assets is as follows (in thousands):\n9. Trade Payables, Expense Accruals and Other Liabilities: ------------------------------------------------------ A summary of trade payables, expense accruals and other liabilities at December 31, 1995 and 1994 is as follows (in thousands):\n10. Long-term and Other Indebtedness: -------------------------------- The principal amount, stated interest rate and maturity of long-term debt outstanding at December 31, 1995 and 1994 are as follows (dollars in thousands):\n10. Long-term and Other Indebtedness, continued: -------------------------------- Credit agreements provide for aggregate contractual credit facilities of $150,000,000 and bear interest based on the prime rate or LIBOR, plus commitment and other fees. Such credit facilities were renewed in 1994 and expire in June 1997. No amounts were borrowed under these facilities as of December 31, 1995 and 1994. The term loans with banks also bear interest based on the prime rate or LIBOR.\nIn June 1995, the Company sold $100,000,000 principal amount of its newly authorized 8 1\/4% Senior Subordinated Notes due 2005 in an underwritten public offering.\nApproximately $9,525,000 of the manufacturing division's net property, equipment and leasehold improvements are pledged as collateral for the Industrial Revenue Bonds; and approximately $12,716,000 of other assets (primarily property) are pledged for other indebtedness aggregating approximately $7,585,000.\nInterest rate swap and interest rate option agreements are used to reduce the potential impact of increases in interest rates on term loans with banks, customer banking deposits and credit agreement borrowings. Under the interest rate swap agreements, the Company has agreed with other parties to pay fixed rate interest amounts and receive variable rate interest amounts calculated by reference to an agreed notional amount. The variable interest rate portion of the swaps is a specified LIBOR interest rate. Swaps that expire in 1996 require fixed rate payments of 7.23% on a $50,000,000 notional amount. Swaps that expire in 1999 require fixed rate payments of 7.33% on a $25,000,000 notional amount. The weighted average LIBOR rate at December 31, 1995 is 5.8%. Changes in LIBOR interest rates in the future will change the amounts to be received under the agreements as well as interest to be paid under the related variable debt obligations.\nIn 1994, the Company purchased an option for $2,564,000 to enter into an interest rate swap, which is exercisable in August 1996. If exercised, the Company would be required to make fixed rate payments of 7.64% in exchange for receiving a LIBOR based variable payment on a $50,000,000 notional amount for the subsequent eight year term.\nCounterparties to interest rate swap agreements are major financial institutions, which management believes are able to fulfill their obligations. However, any losses due to default by the counterparties are likely to be immaterial.\nDuring 1989, the Company entered into long-term hedging transactions whereby substantially all currency rate risk related to the Swiss Franc Bonds was eliminated and the cost of which increased the cost of the issue to approximately 10.4%.\nThe 5 1\/4% Convertible Subordinated Debentures due 2003 are convertible into Common Shares at $28.75 per Common Share, an aggregate of 3,478,261 Common Shares, subject to anti-dilution provisions.\nThe most restrictive of the Company's debt instruments require maintenance of minimum Tangible Net Worth and limit Indebtedness, as defined in the agreements. In addition, the debt instruments contain limitations on dividends, investments, liens, contingent obligations and certain other matters. As of January 1, 1996, cash dividends of $346,100,000 could be paid under the most restrictive covenants.\n10. Long-term and Other Indebtedness, continued: -------------------------------- The aggregate annual mandatory redemptions of debt during the five year period ending December 31, 2000 are as follows (in thousands): 1996 - $30,987; 1997 - $2,134; 1998 - $2,106; 1999 - $51,663; and, 2000 - $31,975.\nThe weighted average interest rate on short-term borrowings (primarily customer banking deposits) was 6.1% and 5.4% at December 31, 1995 and 1994, respectively.\n11. Common Shares, Stock Options, Warrants and Preferred Shares: ----------------------------------------------------------- The Board of Directors from time to time has authorized acquisitions of the Company's Common Shares. Pursuant to such authorization, during the three year period ended December 31, 1995, the Company acquired 618,066 Common Shares (29,276 shares in 1995, 23,972 shares in 1994 and 564,818 shares in 1993) at an average price of $19.39 per Common Share. The Common Shares acquired in 1993 include 448,350 Common Shares acquired from John W. Jordan II.\nA summary of activity with respect to the Company's stock options for the three years ended December 31, 1995 is as follows:\nThe options were granted under plans that provide for the issuance of stock options and stock appreciation rights at not less than the fair market value of the underlying stock at the date the options or rights are granted. Options granted under these plans generally become exercisable in five equal annual instalments starting one year from date of grant. No stock appreciation rights have been granted.\nAt December 31, 1995 and 1994, options to purchase 443,018 and 553,868 Common Shares, respectively, were exercisable.\nOn September 13, 1995, Ian M. Cumming and Joseph S. Steinberg, Chairman of the Board and President of the Company, respectively, and certain members of Mr. Cumming's family exercised previously granted warrants to purchase an aggregate of 3,188,000 Common Shares and sold such shares in an underwritten public offering. In connection with such public offering, the Company granted the underwriters an over allotment option, which was exercised, for 478,200 Common\n11. Common Shares, Stock Options, Warrants and Preferred Shares, continued: ---------------------------------------------------------- Shares. Under the terms of the warrant agreement, the Company was required to pay expenses of the sale, other than underwriting discounts. As a result of the exercise of the warrants and the exercise of the over allotment option, the Company realized aggregate cash proceeds, net of expenses, of $43,736,000. For income tax purposes, the exercise of the warrants results in a current income tax deduction of $57,305,000. For financial reporting purposes, the benefit of such deduction ($20,057,000) was credited directly to shareholders' equity.\nAt December 31, 1995 and 1994, the Company's Common Shares were reserved as follows:\nAt December 31, 1995 and 1994, 6,000,000 preferred shares (redeemable and non-redeemable), par value $1 per share, were authorized.\n12. Net Securities Gains (Losses): ----------------------------- The following summarizes net securities gains (losses) for each of the three years in the period ended December 31, 1995 (in thousands):\nProceeds from sales of investments classified as available for sale were $1,085,764,000 and $854,824,000 during 1995 and 1994, respectively. Gross gains of $22,766,000 and $8,461,000 and gross losses of $8,119,000 and $18,446,000 were realized on these sales during 1995 and 1994, respectively.\nProceeds from sales of fixed maturity investments were $1,171,574,000 during 1993. Gross gains of $51,839,000 and gross losses of $1,587,000 were realized on those sales during 1993.\n13. Other Results of Operations Information: --------------------------------------- Investment and other income for each of the three years in the period ended December 31, 1995 consist of the following (in thousands):\nEffective as of December 31, 1995, control of the WMAC Companies was returned to the Company and such subsidiaries were consolidated. The gain related to the return of the WMAC Companies reflects the difference between the carrying amount of the Company's investment prior to consolidation and the net assets of such subsidiaries.\nTaxes, other than income or payroll, included in operations amounted to $36,978,000 (including $21,687,000 of premium taxes) for the year ended December 31, 1995, $37,310,000 (including $21,330,000 of premium taxes) for the year ended December 31, 1994 and $36,839,000 (including $21,295,000 of premium taxes) for the year ended December 31, 1993.\nAdvertising costs amounted to $13,079,000, $12,541,000 and $10,394,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n14. Income Taxes: ------------ The principal components of the deferred tax asset at December 31, 1995 and 1994 are as follows (in thousands):\nThe valuation allowance principally relates to certain acquired tax loss carryforwards, the usage of which is subject to certain limitations and certain other matters which may restrict their availability, and unrealized capital losses.\nIn addition, the amounts reflected above are based on the minimum tax loss carryforwards of Phlcorp, Inc. (\"Phlcorp\") and certain proposed regulations affecting the use of Phlcorp's tax loss carryforwards. As described more fully herein, substantial additional amounts may be available under certain circumstances and as uncertainties are resolved. If these uncertainties are resolved in the Company's favor, the deferred tax asset related to tax loss carryforwards would increase by approximately $79,000,000, exclusive of any additional valuation allowance.\nThe Company believes it is more likely than not that the recorded deferred tax asset will be realized principally from taxable income generated by profitable operations.\nThe provision for income taxes for each of the three years in the period ended December 31, 1995 was as follows (in thousands):\n14. Income Taxes, continued: ------------ The table below reconciles expected statutory federal income tax to actual income tax expense (in thousands):\nThe valuation allowance applicable to the deferred income tax asset recorded upon adoption of SFAS 109 gave effect to the possible unavailability of certain income tax deductions. During 1994 and 1993 certain matters were resolved and the Company reduced the valuation allowance as reflected in the above reconciliation. Since the WMAC Companies have previously been included in the Company's consolidated federal income tax return, the gain recorded upon return of the WMAC Companies is not taxable.\nAdoption of SFAS 109 at January 1, 1993 was principally reflected as follows (in thousands):\nPhlcorp, in connection with its 1986 reorganization, entered into a tax settlement agreement (the \"Tax Settlement Agreement\") with the United States whereby, among other things, Phlcorp agreed that upon utilization of certain pre-reorganization tax loss carryforwards, it would pay 25% of any resultant tax savings to the government, subject to certain limitations. The Tax Settlement Agreement provides that post-reorganization tax attributes and net operating losses will be utilized prior to pre-reorganization operating losses in calculating tax sharing payments. Due to unresolved issues concerning certain post-reorganization deductions, Phlcorp is unable to state with certainty the\n14. Income Taxes, continued: ------------ amount of its available carryforwards. However, Phlcorp believes that it has minimum tax operating loss carryforwards of between $93,000,000 and $318,000,000 at December 31, 1995. The expiration dates for Phlcorp's carryforwards will depend on the outcome of the matters referred to above, although it is unlikely such carryforwards will begin to expire before 1999.\nAt December 31, 1995 the Company had tax loss carryforwards, which have been reflected in the deferred tax asset after applying the statutory federal income tax rate, as follows (in thousands):\nYear of Loss Expiration Carryforwards ---------- ------------- 1996 $ 11,887 1997 463 1998 1,311 1999 433 2000 21 2002 430 2003 17,318 2005 13,805 2010 2,918 -------- 48,586 Phlcorp minimum amount, as described above 93,000 -------- Total minimum tax loss carryforwards $141,586 ========\nLimitations exist under the tax law which may restrict the utilization of the Phlcorp carryforwards and the utilization of an aggregate of approximately $14,842,000 of non-Phlcorp tax loss carryforwards. Further, certain of the future deductions may only be utilized in the tax returns of certain life insurance subsidiaries. These limitations are considered in the determination of the valuation allowance.\nUnder certain circumstances, the value of the carryforwards available could be substantially reduced if certain changes in ownership were to occur. In order to reduce this possibility, the Company's certificate of incorporation was amended to include certain charter restrictions which prohibit transfers of the Company's Common Stock under certain circumstances.\nUnder prior law, Charter National had accumulated $15,447,000 of special federal income tax deductions allowed life insurance companies and the Colonial Penn life insurance subsidiaries had accumulated $161,000,000 of such special deductions. Under certain conditions, such amounts could become taxable in future periods. Except with respect to amounts applicable to Colonial Penn's life insurance subsidiaries, the Company does not anticipate any transaction occurring which would cause these amounts to become taxable. With respect to Colonial Penn's life insurance subsidiaries, the IRS has asserted that certain of such special federal income tax deductions should have been reflected in taxable income in prior years, and has assessed additional taxes (excluding interest) of $2,899,000 and $19,132,000, for 1989 and 1988, respectively.\n14. Income Taxes, continued: ------------ Under the terms of the purchase agreement whereby Colonial Penn was acquired from FPL Group Capital Inc (the \"Seller\"), the Seller assumed the obligation to reimburse the Company for any such taxes.\nPursuant to the purchase agreement, the Company complied with the Seller's instructions and agreed to the 1989 assessment. To date, Seller has failed to comply with its contractual obligation to reimburse the Company for payment of the 1989 assessment, the related interest and the loss of certain minimum tax credit carryforwards, an aggregate of $3,766,000, to which the Company is entitled under Seller's indemnification. In a response to a legal proceeding initiated by the Company to collect such amount due under the Seller's indemnification obligation, the Seller has alleged that the Company has breached the purchase agreement and, on that basis, Seller has denied liability for the 1989 assessment. The Company believes it has not breached the purchase agreement and the Seller remains liable for all such taxes and interest. The Seller is currently exercising its right under the purchase agreement to control the contest of the 1988 IRS assessment. If the Seller is unsuccessful in contesting the 1988 IRS assessment, no assurance can be given that the Seller will comply with its indemnification obligations under the purchase agreement. The Company intends to enforce its indemnification rights against the Seller and to seek other relief, including relief for Seller's bad faith.\nDuring 1995, the Company entered into an agreement with the Seller to settle a lawsuit initiated by the Company to collect certain amounts due from the Seller under a tax indemnification included in the purchase agreement for other taxable periods. The settlement required the Seller to pay certain amounts to the Company, which are reflected in investment and other income for the year ended December 31, 1995.\n15. Cumulative Effects of Changes in Accounting Principles: ------------------------------------------------------ A summary of the amounts included in cumulative effects of changes in accounting principles and related per share amounts for the year ended December 31, 1993 is as follows (in thousands, except per share amounts):\n16. Pension Plans and Other Postemployment and Postretirement Benefits: ------------------------------------------------------------------ Pension expense charged to operations included the following components (in thousands):\nThe funded status of the pension plans at December 31, 1995 and 1994 was as follows (in thousands):\nThe plans' assets consist primarily of U.S. government and agencies' bonds. The projected benefit obligation at December 31, 1995 and 1994 was determined using an assumed discount rate of 7.0% and 8.0%, respectively, and an assumed compensation increase rate of 5.6%. The assumed long-term rate of return on plan assets was 7.4% at December 31, 1995 and 1994.\nThe Company also has defined contribution pension plans covering certain employees. Contributions and costs are a percent of each covered employee's salary. Amounts charged to expense related to such plans were $2,262,000, $3,292,000 and $2,066,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nSeveral subsidiaries provide certain health care and other benefits to certain retired employees. SFAS 106 and SFAS 112 require companies to accrue the cost of providing certain postretirement and postemployment benefits during the employee's period of service. Amounts charged to expense (principally interest) related to such benefits were $1,679,000 in 1995, $1,762,000 in 1994 and $2,594,000 in 1993.\n16. Pension Plans and Other Postemployment and Postretirement Benefits, ------------------------------------------------------------------ continued:\nThe accumulated postretirement benefit obligation at December 31, 1995 and 1994 is as follows (in thousands):\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7% and 8% at December 31, 1995 and 1994, respectively. The assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation were between 7.6% and 14.0% for 1995 and 8.4% and 15% for 1994, declining to an ultimate rate of between 5.0% and 8.0% by 2006.\nIf the health care cost trend rates were increased by 1%, the accumulated postretirement obligation as of December 31, 1995 and 1994 would have increased by $1,317,000 and $1,335,000, respectively. The effect of this change on the aggregate of service and interest cost for 1995 and 1994 would be immaterial.\n17. Commitments: ----------- The Company and its subsidiaries rent office space and office equipment under non-cancelable operating leases with terms generally varying from one to fifteen years. Rental expense (net of sublease rental income) charged to operations was $14,461,000 in 1995, $16,566,000 in 1994 and $17,555,000 in 1993. Aggregate minimum annual rentals (exclusive of real estate taxes, maintenance and certain other charges) and related minimum sublease rentals relating to facilities under lease in effect at December 31, 1995 were as follows (in thousands):\nIn connection with the sale of certain subsidiaries, the Company has made or guaranteed the accuracy of certain representations given to the acquiror. No material loss is expected in connection with such matters.\n17. Commitments, continued: ----------- In connection with the return of the WMAC Companies, the WMAC Companies have guaranteed the collectibility of reinsurance agreements applicable to a block of mortgage reinsurance business. The maximum amount of such contingency is $42,147,000 at December 31, 1995, which amount has been placed on deposit with a trustee. The reinsurance agreements are with highly rated institutions and\/or are secured in part by letters of credit or trust funds; as a result the Company does not expect a material loss in connection with this guarantee.\nThe insurance and the banking and lending subsidiaries are limited by regulatory requirements and agreements in the amount of dividends and other transfers of funds that are available to the Company. Principally as a result of such restrictions, the net assets of subsidiaries which are subject to limitations on transfer of funds to the Company were approximately $847,300,000 at December 31, 1995.\n18. Litigation: ---------- The Company is subject to various litigation which arises in the course of its business. Based on discussions with counsel, management is of the opinion that such litigation will have no material adverse effect on the consolidated financial position of the Company or its consolidated results of operations.\n19. Earnings Per Common Share: ------------------------- Earnings per common and dilutive common equivalent share was calculated by dividing net income by the sum of the weighted average number of Common Shares outstanding and the incremental weighted average number of Common Shares issuable upon exercise of options and warrants for the periods they were outstanding. The number of common and dilutive common equivalent shares used for this calculation was 59,271,000 in 1995, 58,202,000 in 1994 and 58,539,000 in 1993.\nFully diluted earnings per share was calculated as described above except that in 1994 the incremental number of shares utilized the year end market price for the Company's Common Shares, since the year end market price was above the average for the year. In addition, the calculations assume the 5 1\/4% Convertible Subordinated Debentures had been converted into Common Shares for the period they were outstanding and earnings increased for the interest on such debentures, net of the income tax effect. The number of shares used for this calculation was 62,807,000 in 1995, 61,715,000 in 1994 and 61,486,000 in 1993.\n20. Fair Value of Financial Instruments: ----------------------------------- The following table presents fair value information about certain financial instruments, whether or not recognized on the balance sheet. 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. The fair value amounts presented do not purport to represent and should not be considered representative of the underlying \"market\" or franchise value of the Company.\n20. Fair Value of Financial Instruments, continued: ----------------------------------- The methods and assumptions used to estimate the fair values of each class of the financial instruments described below are as follows:\n(a) Investments: The fair values of marketable equity securities and fixed maturity securities are substantially based on quoted market prices, as disclosed in Note 6. It is not practicable to determine the fair value of policyholder loans since such loans generally have no stated maturity, are not separately transferable and are often repaid by reductions to benefits and surrenders.\n(b) Cash and cash equivalents: For cash equivalents, the carrying amount approximates fair value.\n(c) Loans receivable of banking and lending subsidiaries: The fair value of loans receivable of the banking and lending subsidiaries 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 for the same remaining maturities.\n(d) Separate and variable accounts: Separate and variable accounts assets and liabilities are carried at market value, which is a reasonable estimate of fair value.\n(e) Investments in associated companies: The fair values of a foreign power company are principally estimated based upon quoted market prices. The carrying value of the remaining investments in associated companies approximates fair value.\n(f) The WMAC Companies: In 1994, the fair value of the WMAC Companies was estimated based upon the Company's assessment of the fair value of their underlying net tangible assets to be received. Effective as of December 31, 1995, the WMAC Companies were returned to the Company and are included in the consolidated financial statements.\n(g) Derivatives: The fair values of derivatives generally reflect the amounts that the Company would receive or pay to terminate the interest rate and currency swap contracts.\n(h) Customer banking deposits: The fair value of customer banking deposits is estimated using rates currently offered for deposits of similar remaining maturities.\n(i) Long-term and other indebtedness: The fair values of non-variable rate debt are estimated using quoted market prices and estimated rates which would be available to the Company for debt with similar terms. The fair value of variable rate debt is estimated to be the carrying amount.\n(j) Investment contract reserves: Single premium deferred annuity reserves are carried at account value, which is a reasonable estimate of fair value. The fair value of other investment contracts is estimated by discounting the future payments at rates which would currently be offered for contracts with similar terms.\n20. Fair Value of Financial Instruments, continued: ----------------------------------- The carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 are as follows (in thousands):\n21. Segment Information: ------------------- For information with respect to the Company's business segments, see \"Financial Information about Industry Segments\" in Item 1 included elsewhere herein, which is incorporated by reference into these consolidated financial statements.\n22. Selected Quarterly Financial Data (Unaudited): ---------------------------------------------\nIn 1995 and 1994, the totals of quarterly per share amounts do not necessarily equal annual per share amounts.\nSCHEDULE II - Condensed Financial Information of Registrant LEUCADIA NATIONAL CORPORATION BALANCE SHEETS December 31, 1995 and 1994\nSee notes to this schedule.\nSCHEDULE II - Condensed Financial Information of Registrant, continued: LEUCADIA NATIONAL CORPORATION STATEMENTS OF INCOME For the years ended December 31, 1995, 1994 and 1993\nSee notes to this schedule.\nSCHEDULE II - Condensed Financial Information of Registrant, continued: LEUCADIA NATIONAL CORPORATION STATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994 and 1993\nSee notes to this schedule.\nSCHEDULE II - Condensed Financial Information of Registrant, continued: LEUCADIA NATIONAL CORPORATION NOTES TO SCHEDULE For the years ended December 31, 1995, 1994 and 1993\nA. The notes to consolidated financial statements of Leucadia National Corporation and Subsidiaries are incorporated by reference to this schedule.\nB. The statements of shareholders' equity are the same as those presented for Leucadia National Corporation and Subsidiaries.\nC. Equity in the income of the subsidiaries is after reflecting income taxes recorded by the subsidiaries. In 1995, 1994 and 1993, there was no provision for income taxes provided by the parent company. Tax sharing payments received from subsidiaries were $42,078,000 in 1995, $35,385,000 in 1994 and $64,566,000 in 1993.\nD. The deferred income tax asset of $103,466,000 and $144,631,000 at December 31, 1995 and 1994, respectively, had not been allocated to the individual subsidiaries.\nSCHEDULE III - Supplementary Insurance Information LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES For the years ended December 31, 1995, 1994 and 1993\nSCHEDULE IV - Schedule of Reinsurance LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES For the years ended December 31, 1995, 1994 and 1993\nSCHEDULE V - Valuation and Qualifying Accounts LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES For the years ended December 31, 1995, 1994 and 1993\nSCHEDULE VI - Schedule of Supplemental Information for Property and Casualty Insurance Underwriters LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES For the years ended December 31, 1995, 1994 and 1993\nEXHIBIT INDEX\nExhibit Exemption Number Description Indication ------ ----------- ----------\n3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to the Company's Current Report on Form 8-K dated July 14, 1993).*\n3.2 By-laws (as amended) (filed as Exhibit 4.5 to the Company's Registration Statement No. 33- 57054).*\n4.1 The Company undertakes to furnish the Securities and Exchange Commission, upon request, a copy of all instruments with respect to long-term debt not filed herewith.\n10.1 1982 Stock Option Plan, as amended August 28, 1991 (filed as Annex B to the Company's Proxy Statement dated July 21, 1992).*\n10.2 1992 Stock Option Plan (filed as Annex C to the Company's Proxy Statement dated July 21, 1992).*\n10.3(a) Restated Articles and Agreement of General Partnership, effective as of February 1, 1982, of The Jordan Company (filed as Exhibit 10.3(d) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1986).*\n10.3(b) Amendments dated as of December 31, 1989 and December 1, 1990 to the Partnership Agreement referred to in 10.3(a) above (filed as Exhibit 10.2(b) to the 1991 10-K).*\n10.3(c) Amendment dated as of December 17, 1992 to the Partnership Agreement referred to in 10.3(a) above (filed as Exhibit 10.3(c) to the 1992 10-K).*\n10.3(d) Articles and Agreement of General Partnership, effective as of April 15, 1985, of Jordan\/Zalaznick Capital Company (filed as Exhibit 10.20 to the Company's Registration Statement No. 33-00606).*\n10.4 Agreement made as of March 12, 1984 by and between Leucadia, Inc. and Ian M. Cumming (filed as Exhibit 10.14 to the 1983 10-K).*\n10.5 Agreement made as of March 12, 1984 by and between Leucadia, Inc. and Joseph S. Steinberg (filed as Exhibit 10.15 to the 1983 10-K).*\n10.6 Stock Purchase and Sale Agreement dated as of April 5, 1991, by and between FPL Group Capital Inc and the Company (filed as Exhibit B to the Company's Current Report on Form 8-K dated August 23, 1991).*\n10.7 Agreement dated as of August 1, 1988 among the Company, Ian M. Cumming and Joseph S. Steinberg (filed as Exhibit 10.6 to the 1991 10-K).*\n_________________________\n* Incorporated by reference.\nExhibit Exemption Number Description Indication ------ ----------- ----------\n10.8 Agreement dated as of January 10, 1992 between Ian M. Cumming, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.7 to the 1991 10-K).*\n10.9 Agreement dated as of January 10, 1992 between Joseph S. Steinberg, certain other persons listed on Schedule A thereto and the Company (filed as Exhibit 10.8 to the Company's 1991 10-K).*\n10.10(a) Agreement dated April 23, 1992 between AIC Financial Services, Inc. (an Alabama corporation), AIC Financial Services (a Mississippi corporation) and AIC Financial Services (a South Carolina corporation) (collectively, \"Seller\") and Norwest Financial Resources, Inc. (filed as Exhibit 10.10(a) to the 1992 10-K).*\n10.10(b) Purchase Agreement between A.I.C. Financial Services, Inc., American Investment Bank, N.A., American Investment Financial and Terracor II d\/b\/a AIC Financial Fund, Seller, and Associates Financial Services Company, Inc., Buyer, dated November 5, 1992 (filed as Exhibit 10.10(b) to the Company's Registration Statement No. 33- 55120).*\n10.11(a) Agreement and Plan of Merger, dated as of October 22, 1992, by and among the Company, Phlcorp Acquisition Company and PHLCORP, Inc. (filed as Exhibit 5.2 to the Company's Current Report on Form 8-K dated October 22, 1992).*\n10.11(b) Amendment dated December 10, 1992, to the Merger Agreement referred to in 10.11(a) above (filed as Exhibit 5.2 to the Company's Current Report on Form 8-K dated December 14, 1992).*\n10.12(a) Agreement between Leucadia, Inc. and Ian M. Cumming, dated as of December 28, 1992 (filed as Exhibit 10.12(a) to the 1992 10-K).*\n10.12(b) Escrow and Security Agreement by and among Leucadia, Inc., Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.12(b) to the 1992 10-K).*\n10.13(a) Agreement between Leucadia, Inc. and Joseph S. Steinberg, dated as of December 28, 1992 (filed as Exhibit 10.13(a) to the 1992 10-K).*\n10.13(b) Escrow and Security Agreement by and among Leucadia, Inc., Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1992 (filed as Exhibit 10.13(b) to the 1992 10-K).*\n10.14 Settlement Agreement between Baldwin-United Corporation and the United States dated August 27, 1985 concerning tax issues (filed as Exhibit 10.14 to the 1992 10-K).*\n_________________________\n* Incorporated by reference.\nExhibit Exemption Number Description Indication ------ ----------- ----------\n10.15 Acquisition Agreement, dated as of December 18, 1992, by and between Provident Mutual Life and Annuity Company of America and Colonial Penn Annuity and Life Insurance Company (filed as Exhibit 10.15 to the 1992 10-K).*\n10.16 Reinsurance Agreement, dated as of December 31, 1991, by and between Colonial Penn Insurance Company and American International Insurance Company (filed as Exhibit 10.16 to the 1992 10-K).*\n10.17 Agreement made as of December 28, 1993 by and between the Company and Ian M. Cumming (filed as Exhibit 10.17 to the 1993 10-K).*\n10.18 Agreement made as of December 28, 1993 by and between the Company and Joseph S. Steinberg (filed as Exhibit 10.18 to the 1993 10-K).*\n10.19(a) Agreement between the Company and Ian M. Cumming, dated as of December 28, 1993 (filed as Exhibit 10.19(a) to the 1993 10-K).*\n10.19(b) Escrow and Security Agreement by and among the Company, Ian M. Cumming and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.19(b) to the 1993 10-K).*\n10.20(a) Agreement between the Company and Joseph S. Steinberg, dated as of December 28, 1993 (filed as Exhibit 10.20(a) to the 1993 10-K).*\n10.20(b) Escrow and Security Agreement by and among the Company, Joseph S. Steinberg and Weil, Gotshal & Manges, as escrow agent, dated as of December 28, 1993 (filed as Exhibit 10.20(b) to the 1993 10-K).*\n10.21 Deferred Compensation Agreement between the Company and Lawrence S. Hershfield, dated March 29, 1995 (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q For the Quarterly Period ended March 31, 1995).*\n10.22(a) Agreement between the Company and Lawrence S. Hershfield, dated as of May 4, 1995.\n10.22(b) Escrow and Security Agreement by and among the Company, Lawrence S. Hershfield and Weil, Gotshal & Manges, as escrow agent, dated as of May 4, 1995.\n21 Subsidiaries of the registrant.\n_________________________\n* Incorporated by reference.\nExhibit Exemption Number Description Indication ------ ----------- ----------\n23 Consent of independent accountants with respect to the incorporation by reference into the Company's Registration Statements on Form S-8 (File No. 2-84303), Form S-8 and S-3 (File No. 33-6054), Form S-8 and S-3 (File No. 33-26434), Form S-8 and S-3 (File No. 33-30277), Form S-8 (File No. 33-61680) and Form S-8 (File No. 33- 61718).\n27 Financial Data Schedule.\n28 Schedule P of the 1995 Annual Statement to P Insurance Departments of the Colonial Penn Insurance Company and Affiliated Property\/Casualty Insurers, the Empire Insurance Company, Principal Insurer, the WMAC Credit Insurance Corporation and the Commercial Loan Insurance Corporation.\nNYFS04...:\\30\\76830\\0001\\1980\\FRM1176J.55H","section_15":""}
{"filename":"350024_1995.txt","cik":"350024","year":"1995","section_1":"Item 1. Business.\nGeneral Development of Business. Trinity Industries Leasing Company, (the \"Registrant\") was incorporated under the laws of the State of Texas in 1979. On April 4, 1988, the Registrant reorganized as a Delaware corporation by Registrant's merger into a wholly-owned subsidiary of the same name.\nNarrative Description of Business and Financial Information About Industry Segments. The Registrant is engaged in the business of leasing specialized types of railcars, consisting of both tank railcars and hopper railcars, the operation of river hopper barges, and the leasing of liquefied petroleum gas (\"LPG\") tanks, (the \"Equipment\"). The revenues and profits from LPG tank leases are not significant to the operations of the Registrant and are included in the Railcar Leasing segment for reporting purposes. At March 31, 1995, the Registrant had under lease 9,066 railcars, including 6,200 tank cars and 2,866 hopper cars. Included in railcars under lease are 2,028 railcars (1,400 tank cars and 628 hopper cars) that are owned by third parties and subleased to the Registrant's customers. Substantially all of the Equipment is manufactured by the Registrant's parent company, Trinity Industries, Inc. (\"Trinity\").\nIn addition to the overall condition of the United States economy, the volume of Equipment purchased and leased by the Registrant depends upon a number of factors, including the demand for Equipment manufactured by Trinity, the cost and availability of funds to finance the purchase of Equipment, Trinity's decisions to solicit orders for the purchase or lease of Equipment and factors which may affect the decisions of Trinity's customers as to whether to purchase or lease Equipment.\nBoth the decision by Trinity regarding whether to solicit orders from customers for the purchase or lease of Equipment and the customer's decision regarding whether to buy or lease the Equipment are influenced by the relative abilities of Trinity (on a total enterprise basis) and the customer to realize the benefit of accelerated tax depreciation associated with ownership of the Equipment. The decision is also influenced by the relative costs of funds to Trinity (on a total enterprise basis) and to the customer to finance the purchase of the Equipment and the relative perceptions by Trinity and the customer of the residual value of the Equipment at the end of the lease term.\nOther significant factors which may affect the decision of Trinity's customers whether to lease or buy Equipment include the willingness of the customer to commit its resources to finance the acquisition of the Equipment and whether the customer expects that its need for the Equipment will be short-term or long-term, which may be affected by the nature of its industry.\nAdditional information concerning the Registrant's business and financial information about industry segments is contained in this report under Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 6 through 8 and in the Financial Statements and Notes to Financial Statements on pages 9 through 15.\nTypes of Leases. The Registrant uses the operating method to account for its leases. The Registrant records its cost as an investment in the Equipment leased. Depreciation expense is provided for financial reporting purposes on the straight-line method over the estimated useful life of the Equipment. For federal income tax purposes, depreciation expense is provided using accelerated methods.\nOperating leases may be either \"full service\" or \"net\" leases. Under full service leases, the Registrant is responsible for the maintenance and repair of the Equipment, modifications required to meet governmental or industry safety or other standards, the costs of insuring the Equipment, and ad valorem and other taxes. Under full service leases, the Registrant bears the risk of an uninsured loss of the Equipment. Under net leases, these matters are the responsibility of the lessee.\nRailcar Leasing. The Registrant's railcars are leased to industrial companies in the petroleum, chemical, grain, food processing, fertilizer and other industries which supply their own railcars to the railroads. The practice of United States railroads using privately-owned railcars developed because many types of commodity shipments were best handled in specialized railcars. The railroads either did not or were not in a position to supply these specialized railcars to shippers, and railcar leasing companies have come into existence as a result. Federal laws and regulations provide that it is the duty of common carrier railroads to furnish such railcars as may be reasonably necessary for the transportation of all commodities they hold themselves out as carrying, except that they have no obligation to supply tank railcars and no right to exclude tank railcars provided to shippers for loading on the railroads' lines. Railroads also have the exclusive right to furnish railcars other than tank railcars. Use of other privately-owned railcars is, therefore, optional with the railroads, and they are not required to use them if they are able to furnish railcars of their own. The approval of the railroad on which privately-owned railcars (other than tank railcars) are to be used is required before such railcars may be placed in service or assigned to handle traffic. The approval, known as OT-5, is obtained fairly easily in periods of railcar shortages, but in periods of oversupply, railroads may cancel OT-5 approvals or decline to grant new approvals.\nThe number of railcars purchased in each of the last five fiscal years and all railcars purchased as a group prior to fiscal 1991 with the remaining economic life of the railcars in the lease fleet are detailed below. The remaining economic life for railcars purchased prior to fiscal 1991 is based on a weighted average. Some prior year totals have been adjusted to more accurately reflect amounts presented in the fiscal 1995 report.\nPrior to Year of purchase 1995 1994 1993 1992 1991 1991\nTank Cars 192 157 623 548 368 2,912 Remaining economic life 30 29 28 27 26 19\nHopper Cars 114 338 376 311 270 829 Remaining economic life 25 24 23 22 21 12\nThe terms of the Registrant's railcar leases predominantly vary from one to fifteen years and provide for fixed monthly rentals, with an additional mileage charge when usage exceeds a specified maximum. The average remaining lease term for the fleet is approximately 6 years for tank cars and 6 years for hopper cars. Under full service leases, if the Registrant makes a modification required by governmental or industry standards, the monthly car rental is increased on the basis of a prescribed formula.\nThe Registrant has the responsibility for maintaining its railcars in good condition and repair in accordance with the interchange rules of the Association of American Railroads (\"AAR\"). The AAR rules governing railroad equipment require the railroads to be responsible for the condition of railcars traveling on their lines and, accordingly, the railroads are entitled to make all repairs on such railcars. The cost of repairs is governed by AAR guidelines. Although most railroads generally have the capability to make repairs, they usually prefer to limit their involvement to routine maintenance. If a railroad chooses not to repair a car, the Registrant is notified and makes arrangements for one of its facilities or another private maintenance facility to perform the necessary repairs. Written estimates are required from all repair facilities prior to the repair being performed.\nMaintenance and repair of new railcars is normally minor in nature and cost. Typical repairs include replacement of brake shoes, repairs of safety equipment, testing of air brake equipment and replacement of wheels. As the railcars age, the frequency of repair and maintenance and the associated expenses normally increase. Most maintenance and repair expenses are a result of a combination of circumstances, including the number of miles traveled, condition of railroad tracks traveled, condition of the roadbed, terrain traveled, weight, nature and balance of cargo, train handling (including speed and coupling procedures) and loading and unloading methods. As the railcars age, increased maintenance and repair expenses may have an effect on the Registrant's results of operations.\nBarge Operations. Most freight moving on the more than 25,000 miles of United States inland waterways is carried in unmanned, non self-propelled river barges concentrated in groups or strings and either pushed by tugboat or pulled by towboat. Tank barges and hopper barges are the two principal types of barges in use on the inland waterways. Hopper barges are used to transport solid commodities in bulk or packages.\nIn February 1995, the Registrant divested its inventory of river hopper barges previously held for lease. The barges were operated under an agreement which provided for management of the barges. The barges were generally used for movement of commodities on the inland waterway system, primarily the Mississippi and Missouri Rivers. At this time, the Registrant has no intentions of entering into future barge leases. No employee of the Registrant or Trinity was affected by this transaction.\nMarketing. The Registrant generates its railcar leases through employees of Trinity who are employed to sell or lease railcars. Proposals are submitted to prospective customers on a basis which permits the customer to either purchase or lease the railcars.\nIn addition to the railcar marketing personnel, Trinity employs customer service, fleet management and accounting personnel on behalf of the Registrant.\nCompetition. The businesses in which the Registrant is engaged are highly competitive, and there are a number of well-established companies which actively compete with the Registrant in the business of owning and leasing railcars. There are also a number of banks, investment partnerships and other financial institutions which compete with the Registrant in railcar leasing. The principal competitive factors in leasing railcars include price and other terms of the lease, proximity of the manufacturing plant to the customer's loading point, quality of equipment, and delivery time.\nRegulations. The Registrant is not a common carrier and is not subject to the comprehensive federal and state regulation of common carriers as to rates and other matters. There are certain areas, however, in which the Registrant's operations are or can be affected by governmental regulation and by rules adopted as standards by the railroad industry.\nTo be eligible for operation on United States railroads, all railroad freight railcars must be built to meet construction specifications and standards of the AAR. In addition, all such railcars must meet certain federal regulations with respect to safety appliances and features which are promulgated and administered by the U.S. Department of Transportation (\"DOT\"). The manufacturer is obligated to make sure that its railcars meet such requirements.\nOperation of freight railcars in railroad interchange service is subject to the AAR Interchange Rules. These rules prescribe mechanical, maintenance and related standards and provide a method for placing responsibility for maintenance and repair on all railcars operated in interchange between railroads. Under its full-service leases, the Registrant is responsible for meeting the maintenance and repair standards of the AAR Interchange Rules.\nOperation and maintenance of freight railcars are also subject to federal regulation by DOT under the Federal Railroad Safety Act. DOT may periodically require modifications to existing railcars for safety reasons.\nRelationship of the Registrant with Trinity. The Registrant's business consists principally of leasing Equipment purchased from Trinity. Such Equipment is purchased at prices comparable to the prices for Equipment sold by Trinity to third parties. The determination of the price to be paid to Trinity is made by the Registrant's officers, all of whom are also officers of Trinity.\nAlthough Trinity is not contractually obligated to offer to the Registrant Equipment proposed to be leased by Trinity's customers, it is Trinity's intention to effect all such leasing transactions through the Registrant. Similarly, while the Registrant is not contractually obligated to purchase from Trinity any Equipment proposed to be leased, the Registrant intends to purchase and lease all Equipment which Trinity's customers desire to lease when the lease rentals and other terms of the proposed lease are satisfactory to the Registrant, subject to the availability and cost of funds to finance the acquisition of the Equipment.\nTrinity has entered into an agreement (the \"Fixed Charges Coverage Agreement\") with the Registrant whereby Trinity is obligated to make such payments to the Registrant as may be required to maintain the Registrant's net earnings available for fixed charges (as defined) at an amount equal to not less than one and one-half times the fixed charges (as defined) of the Registrant. The Fixed Charges Coverage Agreement will terminate in accordance with its terms at such time as the Registrant shall have delivered a certificate of its certified public accountants demonstrating that net earnings available for fixed charges, without considering any payments by Trinity, have been not less than 1.5 times fixed charges in each of the five then most recently completed fiscal years; provided that the Registrant and Trinity may agree in connection with \"Future Financing Agreements\" to maintain the Fixed Charges Coverage Agreement in force and effect during the term of such \"Future Financing Agreements.\" The Fixed Charges Coverage Agreement also provides that neither Trinity nor the Registrant will amend, modify or terminate or waive the observance of the Fixed Charges Coverage Agreement without the prior written consent of the holder of at least the requisite percentage of \"Benefitted Holders\" under \"Future Financing Agreements\". The Fixed Charges Coverage Agreement further provides that the holders of any other indebtedness incurred by the Registrant under any agreement designated by the Registrant as a \"Future Financing Agreement\" may be designated, with the acceptance of Trinity, \"Benefitted Holders\". Any Benefitted Holder may enforce the Fixed Charges Coverage Agreement directly against Trinity. (See 'Income maintenance fees from Trinity' in Statements of Income and Retained Earnings on page 10).\nThe holders of the 15.5% Equipment Trust Certificates due September 15, 1995, the holders of the 12.875% Equipment Trust Certificates due December 31, 1996, the holders of the 11.55% Equipment Trust Certificates due November 30, 1997, the holders of the 8.75% Equipment Trust Certificates due March 31, 1999, the holders of 10.25% Equipment Trust Certificates due January 31, 2000, the holders of the 10.2% Equipment Trust Certificates due October 31, 1998, the holders of the 9.44% Equipment Trust Certificates due September 3, 2001, the holders of the 8.24% Equipment Trust Certificates due June 30, 2002, the holders of the 7.65% Equipment Trust Certificates due December 31, 2002, the holders of the 6.96% Equipment Trust Certificates due June 24, 2003, the Trustee in the Leveraged Lease financing dated as of April 1, 1985, and Greyhound Leasing and Financial Corp. and CIT Group\/Equipment Financing, Inc. (Lessors in single investment leases) and Pitney Bowes Credit Corp. (Lessor in two investment leases) have been designated \"Benefitted Holders,\" and the requisite percentage of the holders of such Certificates for the aforementioned consent is 66 2\/3%.\nUnder a tax allocation agreement between Trinity and its subsidiaries, a consolidated federal income tax return is filed by the group, and it is agreed that each subsidiary will pay to Trinity an amount equal to its proportionate share of the consolidated federal income tax liability of the group, but not in excess of the amount that the subsidiary would pay if it were filing a separate federal income tax return. Similarly, if there is a tax benefit by virtue of a net operating loss, the entity to which such benefit is attributable is entitled to receive from all the other entities payment of an amount equal to the tax benefit within 90 days after the end of the applicable taxable year. Additionally, if Trinity is not able to fully recognize the benefit of a consolidated net operating loss, each entity contributing to the net operating loss will receive its proportionate share of the tax benefit recognized by Trinity.\nThe Registrant has an arrangement with Trinity whereby it pays Trinity for furnishing certain staff functions, including financial and data processing services. In addition, marketing and primary administration are provided by employees of Trinity. Such payments are based on Trinity's cost of providing such services, including allocation of overhead.\nEmployees. At March 31, 1995, approximately 25 persons participated in the Registrant's operations, all of whom were employees of Trinity.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Registrant owns no significant physical properties other than the Equipment it leases. All office space and equipment necessary to the Registrant's business are provided by Trinity.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Registrant is involved in various claims and lawsuits incidental to its business. In the opinion of management, these claims and suits in the aggregate will not have a material adverse effect on the Registrant'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 fourth quarter of fiscal 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nAll of the issued and outstanding shares of common stock of the Registrant are owned by Trinity Industries, Inc. and are not traded on any exchange or otherwise. No dividends were declared or paid during the last two fiscal years.\nItem 6.","section_6":"Item 6. Selected Financial Data. (in millions) Year Ended March 31 1995 1994 1993 1992 1991 Operating results: Revenues. . . . . . . . . . . . $156.9 $104.6 $ 79.6 $ 71.5 $ 64.3 Income maintenance fees from Trinity . . . . . . . . . $ - $ - $ 1.4 $ 0.5 $ - Net income. . . . . . . . . . . $20.8 $ 19.1 $ 11.7 $ 10.7 $ 8.9 At year-end: Total assets. . . . . . . . . . $471.9 $495.1 $490.6 $519.1 $463.4 Total long-term debt and obligation under capital lease. . . . . . . . . $205.2 $236.0 $244.0 $291.3 $244.1\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nFinancial Condition. The decrease in \"Equipment on Lease\" at March 31, 1995 compared to March 31, 1994 is the result of the sale of all of the registrant's barges in February 1995 and the sale of 1,373 railcars previously for lease. The railcars sold were older cars with an average age of approximately 14 years. The increase in 'Note receivable from Trinity' at March 31, 1995 compared to March 31, 1994 is due principally to cash, not required for normal operations, loaned to Trinity at prevailing market rates. The decrease in 'Long-term debt' at March 31, 1995 compared to March 31, 1994 is due to scheduled principal payments.\nOperations. The increase in revenues in fiscal 1995 compared to fiscal 1994 is due principally to the sale of the barges and sale of selected railcar types previously for lease. The increase in revenues in fiscal 1994 compared to fiscal 1993 is due principally to equipment additions in the railcar segment, coupled with sales of selected railcar types previously for lease. The increase was slightly offset by the loss of lease revenues associated with the railcar sales, and by an abatement in barge traffic caused by flooding in the Midwestern United States during the first and second quarters of fiscal 1994. Operating profit increased in fiscal 1995 compared to fiscal 1994 due to profits recorded on sales of railcars and barges, a decrease in interest expense caused by a decrease in the outstanding principal balance, as well as increased operating profit of the barge segment caused by a return of barge traffic in the Midwestern United States. Operating profit increased in fiscal 1994 compared to fiscal 1993 due principally to a decrease in interest expense resulting primarily from the conversion of the Registrant's 6.75 percent debentures into shares of Trinity's common stock in the fourth quarter of fiscal 1993, along with equipment additions in the railcar segment.\nRevenue data on the average number of railcars and barges owned during the last five fiscal years is shown below. Revenues exclude proceeds from the sale of railcars and barges, and lease revenues from railcars not owned by the Registrant.\nYear Ended March 31 1995 1994 1993 1992 1991 Average railcars owned 7,783 8,589 8,064 7,338 6,858 Average revenue per railcar $6,412 $6,578 $6,164 $6,106 $5,789\nAverage barges owned 219 219 220 221 222 Average revenue per barge $92,817 $84,475 $102,272 $94,570 $94,595\nInterest income increased in fiscal 1995 compared to fiscal 1994 due to an increase in the prime based lending rate and an increase in the Note Receivable from Trinity. Interest decreased in fiscal 1994 and fiscal 1993 compared to the preceding years principally due to a reduction in the prime- based lending rate.\nNeither the Railcar Leasing segment or the Barge Operations segment contributed in a materially disproportionate way to revenues, operating profit, or cash flows during fiscal 1995 as compared to prior years.\nThe provision for income taxes expressed as a percentage of income before taxes was 35.0% in fiscal 1995, 35.0% in fiscal 1994, and 34.0% in fiscal 1993. (See Income Taxes in Notes to Financial Statements).\nEffective April 1, 1993, the registrant adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" This statement requires a change from the deferred to the liability method of computing income taxes. As permitted by Statement No. 109, the Registrant elected not to restate the financial statements of any prior period. The cumulative effect of applying the change in accounting method is a decrease in the Registrant's deferred tax liability and a nonrecurring credit of $8.1 million.\nLiquidity and Financial Resources. Liquidity for the leasing business differs significantly from that of industrial companies. Inflows of cash including lease and rental revenue, investment income and other income, and outflows of cash, including interest, maintenance, insurance and other operating expenses are reasonably determinable. Generally, excluding acquisition of Equipment for lease, sufficient funds are generated from operations to meet liquidity requirements. Sources of funds are principally from operations, borrowings and when required, quarterly payments from Trinity under the Fixed Charges Coverage Agreement. To the extent that funds generated from operations cannot provide adequate funds for investment in new assets for lease objectives or the timing of funds cannot be satisfactorily matched, external short-term or long-term financing may be required. Short-term financing for working capital and to temporarily finance additional Equipment purchases is generally available from Trinity or from lines of credit from banks. Capital resources represent those funds available for long-term financing and major business commitments of the Registrant. For a leasing company, the capital assets available for lease are the principal resource of the business. For a leasing company to expand and grow, it is necessary to purchase additional capital assets.\nThe average age of the Registrant's railcar fleet is approximately 7.0 years. The average economic life of the fleet is expected to be twenty five to thirty years. As the railcars age, increased maintenance and repair expenses may have an effect on the Registrant's results of operations. Capital expenditures for fiscal 1995 were $28.7 million. Capital expenditures projected for fiscal 1996 are approximately $35.8 million. Long-term financing needs have been and are expected to be met through the issuance of equipment trust certificates, and from time to time, the public offering of debt securities.\nThe volume of Equipment purchased and leased by the Registrant is affected by the ability of the Registrant to obtain long-term external financing at satisfactory rates and on satisfactory terms and conditions. If the Registrant is unable to obtain satisfactory long-term financing from third parties, it is likely that the only other source of external funds available to the Registrant would be borrowings from Trinity. The Registrant was formed in large part to provide a vehicle to obtain financing for the lease of Equipment independent of Trinity. The need for Trinity to finance the Registrant's acquisition of Equipment may make it less desirable for Trinity to offer its customers the option of leasing rather than purchasing Equipment, and it may be expected that Trinity will be willing to provide only a limited amount of funds to the Registrant to meet the Registrant's financing requirements, except on an interim basis. The Registrant's results of operations in future periods will be affected by the volume of Equipment purchased and leased.\nInflation. Changes in price levels did not significantly affect the Registrant's operation in fiscal 1995, 1994, or 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. Page Report of independent auditors . . . . . . . . . . . . 8 Balance sheets . . . . . . . . . . . . . . . . . . . . 9 Statements of income and retained earnings . . . . . . 10 Statements of cash flows . . . . . . . . . . . . . . . 11 Notes to financial statements. . . . . . . . . . . . . 12 Supplemental information . . . . . . . . . . . . . . . 15\nReport of Independent Auditors\nBoard of Directors Trinity Industries Leasing Company\nWe have audited the accompanying balance sheets of Trinity Industries Leasing Company as of March 31, 1995 and 1994, and the related statements of income and retained earnings 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 Trinity Industries Leasing Company as of 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.\nAs more fully discussed in the Notes to Financial Statements, the Company changed its method of accounting for income taxes in 1994.\nERNST & YOUNG LLP\nDallas, Texas May 10, 1995 Trinity Industries Leasing Company Balance Sheets (in millions except share data)\nMarch 31 1995 1994 Assets\nCash and cash equivalents. . . . . . . . . . $ 0.2 $ 0.2\nNote receivable from Trinity . . . . . . . . 129.9 90.8\nEquipment on lease (predominantly long-term), at cost . . . . . . . . . . . . 431.0 536.1\nLess accumulated depreciation. . . . . . . . (95.4) (139.9)\nOther assets . . . . . . . . . . . . . . . . 6.2 7.9 $471.9 $495.1\nLiabilities and Stockholder's Equity\nAccounts payable and accrued liabilities . . $ 8.9 $ 3.9\nLong-term debt . . . . . . . . . . . . . . . 205.2 236.0\nDeferred federal income tax. . . . . . . . . 78.3 95.8\nOther liabilities. . . . . . . . . . . . . . 3.8 4.5 296.2 340.2 Stockholder's equity: Common stock $1.00 par; authorized 10,000 shares; issued 1,000 shares at March 31, 1995 and 1994, respectively . . . . . . . . . . . . - -\nAdditional paid-in capital . . . . . . . . 19.3 19.3 Retained earnings. . . . . . . . . . . . . 156.4 135.6 175.7 154.9 $471.9 $495.1\nSee accompanying notes to financial statements.\nTrinity Industries Leasing Company Statements of Income and Retained Earnings (in millions)\nYear Ended March 31 1995 1994 1993\nRevenues . . . . . . . . . . . . . . . $156.9 $104.6 $ 79.6\nOperating costs: Cost of revenues . . . . . . . . . . . 112.2 65.6 44.0 Interest expense . . . . . . . . . . . 21.1 23.7 28.1 133.3 89.3 72.1 Operating profit. . . . . . . . . . . . 23.6 15.3 7.5\nOther income: Interest income (including $8.1, $5.0, and $8.5 from Trinity in 1995, 1994, and 1993, respectively). . . . . . . . 8.2 5.0 8.6 Income maintenance fees from Trinity . - - 1.4 Other, net . . . . . . . . . . . . . . 0.2 0.6 0.3 8.4 5.6 10.3\nIncome before income taxes and cumulative effect of change in accounting for income taxes. . . . . . 32.0 20.9 17.8\nProvision (benefit) for income taxes: Current. . . . . . . . . . . . . . . . 28.7 4.0 (1.8) Deferred . . . . . . . . . . . . . . . (17.5) 3.3 7.9 Effect of statutory rate increase. . . - 2.6 - 11.2 9.9 6.1\nIncome before cumulative effect of change in accounting for income taxes. 20.8 11.0 11.7\nCumulative effect as of April 1, 1993 of change in accounting for income taxes . . . . . . . . . . . - 8.1 -\nNet income . . . . . . . . . . . . . . 20.8 19.1 11.7\nRetained earnings at beginning of year. 135.6 116.5 104.8\nRetained earnings at end of year. . . . $156.4 $135.6 $116.5\nSee accompanying notes to financial statements.\nTrinity Industries Leasing Company Statements of Cash Flows (in millions)\nYear Ended March 31 1995 1994 1993 Cash flows from operating activities: Net income . . . . . . . . . . . . . . $ 20.8 $ 19.1 $ 11.7\nAdjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization . . . 21.1 21.2 18.1 Deferred provision (benefit) for federal income tax . . . . . . . . (17.5) 3.3 7.9 Cumulative effect of change in accounting for income taxes. . . . - (8.1) - Effect of statutory rate increase. . . . . . . . . . . - 2.6 - Gain on sale or retirement of equipment . . . . . . . . . . . (8.1) (2.3) (0.3) Other (increase) decrease . . . . . 0.1 0.7 (0.1) Changes in assets and liabilities: (Increase) decrease in other assets . . . . . . . . . . . . . 1.7 0.2 (1.4) Increase (decrease) in accounts payable and accrued liabilities . 5.1 (4.2) 1.2 Increase (decrease) in other liabilities . . . . . . . . . . . (0.7) (0.2) 0.3 Total adjustments. . . . . . . . 1.7 13.2 25.7\nNet cash provided by operating activities . . . . . . . . . . . . 22.5 32.3 37.4\nCash flows from investing activities: Proceeds from retirement of equipment. 76.1 26.9 3.4 Capital expenditures . . . . . . . . . (28.7) (37.6) (74.5)\nNet cash provided (required) by investing activities . . . . . . . 47.4 (10.7) (71.1)\nCash flows from financing activities: Increase in note receivable from Trinity. . . . . . . . . . . . . (39.1) (13.6) (3.3) Proceeds from issuance of long-term debt. . . . . . . . . . . . . . . . . - 20.0 60.0 Payments to retire long-term debt. . . (29.9) (27.2) (22.2) Decrease in long-term obligation under capital lease . . . . . . . . . (0.9) (0.8) (0.7)\nNet cash provided (required) by financing activities. . . . . . (69.9) (21.6) 33.8\nTrinity Industries Leasing Company Statement of Cash Flows (in millions) (continued)\nYear Ended March 31 1995 1994 1993\nNet increase in cash and cash equivalents . . . . . . . . . . . - - 0.1\nCash and cash equivalents at beginning of year. . . . . . . . . . . 0.2 0.2 0.1\nCash and cash equivalents at end of year. . . . . . . . . . . . . . $ 0.2 $ 0.2 $ 0.2\nSee accompanying notes to financial statements.\nTrinity Industries Leasing Company Notes to Financial Statements March 31, 1995, 1994, 1993\nSummary of Significant Accounting Policies and Basis of Presentation (in millions)\nThe Registrant purchases railcars and river hopper barges manufactured by Trinity, of which the Registrant is a wholly-owned subsidiary, at market prices and leases the equipment to third parties. In addition, Trinity performs certain repairs and maintenance for the Registrant's equipment on lease. Costs and expenses include amounts paid or accrued to Trinity for repairs and maintenance of $0.9, $1.3, and $1.4, in fiscal 1995, 1994 and 1993, respectively. As described further in Income Taxes and Long-Term Debt, the Registrant has transactions with Trinity which are recorded on the bases determined by the parties.\nFor purposes of the Statement of Cash Flows, the Registrant considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nThe Registrant enters into predominantly long-term lease contracts with third parties wherein the equipment is leased for a specified type of service over the term of the contract. The Registrant accounts for its leases by the operating method. Generally, lease contracts have terms of one to fifteen years. Future minimum rentals on operating leases in each of the following five fiscal years are approximately $56.2 in 1996, $49.0 in 1997, $41.1 in 1998, $33.9 in 1999, $28.5 in 2000 and $295.2 in the aggregate.\nThe Registrant has future lease commitments of approximately $6.7 for fiscal 1996 and 1997, $7.4 in fiscal 1998, 1999 and 2000, and $72.2 in the aggregate under four operating leases. The railcars are leased by the Registrant to established lessees under normal leasing arrangements. Depreciation expense is provided for financial reporting by the straight-line method over the estimated useful lives of the assets ranging from twenty-five to thirty years. For federal income tax purposes, depreciation expense is provided using accelerated methods. Ordinary maintenance and repairs are charged to expense in the period incurred.\nUnder arrangements between the Registrant and Trinity, Trinity provides to or receives from the Registrant financing, with interest at market rates. The note receivable from Trinity is dated March 1, 1994 and will mature in fiscal 2001. The interest rate on the note at March 31, 1995 is currently 8.0 percent. The note is not collateralized.\nIncome Taxes (in millions)\nThe Registrant is included in the consolidated federal income tax return of Trinity. Trinity reimburses or charges the Registrant for current income tax benefits or expenses incurred from inclusion of the Registrant in Trinity's consolidated federal income tax return. The provision for income taxes reflected in the Statement of Income and Retained Earnings approximates the provision as if calculated on a separate return basis. Deferred taxes are provided for timing differences, principally depreciation, between financial and tax reporting.\nEffective April 1, 1993, the registrant adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" This statement requires a change from the deferred to the liability method of computing income taxes. As permitted by Statement No. 109, the Registrant has elected not to restate the financial statements of any prior period. The cumulative effect of applying the change in accounting method is a decrease in the Registrant's deferred tax liability and a nonrecurring credit of $8.1 million.\nThe net deferred tax liability at March 31, 1995 is $78.3 million and is comprised primarily of the excess of tax over book depreciation. All other items are not material.\nLong-term Debt (in millions)\nMarch 31 1995 1994 6.96 - 15.5 percent equipment trust certificates to institutional investors, generally payable in semi-annual installments of varying amounts through 2003 . . . . . . . . $193.6 $223.5\n11.3 percent notes payable monthly through 2003. . . . . . . 11.6 12.5\n$205.2 $236.0\nThe equipment trust agreements contain provisions which, among other things, prohibit the Registrant from incurring funded indebtedness, as defined, if, after giving effect to the funded indebtedness proposed, the total funded indebtedness of the Registrant would then exceed eighty percent of the total capitalization, as defined, of the Registrant. Titles to railcars with a cost of $382.4 at March 31, 1995 have been assigned for the life of the respective equipment trusts to the trustees of the equipment trusts. Leases relating to such railcars financed by equipment trust certificates have been assigned as collateral.\nTrinity is required to pay fees to the Registrant quarterly to maintain net earnings, as defined, at specified levels. Accordingly, $1.4 had been paid to the Registrant in fiscal 1993.\nInterest of $21.6, $23.8, and $28.4 was paid by the Registrant in fiscal 1995, 1994, and 1993, respectively.\nPrincipal payments due during each of the next five fiscal years are: 1996 - - $29.5; 1997 - $30.4; 1998 - $26.3; and 1999 - $26.1; and 2000 - $23.9\nThe fair value of non-traded, fixed rate outstanding debt, estimated using discounted cash flow analysis, approximates its carrying value.\nSegment Information\nThe Registrant is engaged in the business of (1) leasing specialized types of railcars (\"Railcar Leasing\"); (2) operation of river hopper barges (\"Barge Operations\"); and (3) the leasing of liquefied petroleum gas (\"LPG\") tanks. The revenues and profits from LPG tank leases are not significant to the operations of the Registrant and are included in the Railcar Leasing segment for reporting purposes. Corporate assets consist primarily of cash and cash equivalents and note receivable from Trinity.\n\tThe Barge and Railcar operations each include revenues from one customer which accounted for 20.3% and 26.6% of consolidated revenues in fiscal 1995.\nFinancial information for these segments is summarized in the following table. The Registrant operates principally in the continental United States.\nSegments of Business Railcar Barge Corporate (in millions) Leasing Operations Items Total Year ended March 31, 1995 Revenues . . . . . . . . . . . $104.8 52.1 - 156.9 Operating profit . . . . . . . $ 20.5 3.2 - 23.7 Identifiable assets. . . . . . $325.5 - 146.4 471.9 Depreciation . . . . . . . . . $ 18.1 2.1 - 20.2 Additions (net) to equipment . $ (8.6) (30.7) - (39.3)\nSegments of Business Railcar Barge Corporate (in millions) Leasing Operations Items Total Year ended March 31, 1994 Revenues . . . . . . . . . . . $ 85.9 18.7 - 104.6 Operating profit . . . . . . . $ 14.6 0.7 - 15.3 Identifiable assets. . . . . . $352.3 32.8 110.0 495.1 Depreciation . . . . . . . . . $ 17.7 2.5 - 20.2 Additions (net) to equipment . $ 12.8 - - 12.8\nSegments of Business Railcar Barge Corporate (in millions) Leasing Operations Items Total Year ended March 31, 1993 Revenues . . . . . . . . . . . $ 57.1 22.5 - 79.6 Operating profit . . . . . . . $ 5.2 2.3 - 7.5 Identifiable assets. . . . . . $356.9 35.5 98.2 490.6 Depreciation . . . . . . . . . $ 14.7 2.5 - 17.2 Additions (net) to equipment . $ 71.4 - - 71.4\nSupplemental Information\nSupplementary Unaudited Quarterly Data (in millions)\nFirst Second Third Fourth Quarter Quarter Quarter Quarter Year Year ended March 31, 1995: Revenues. . . . . . . . . . $ 19.9 32.1 35.7 69.2 156.9 Operating profit. . . . . . $ 3.2 6.0 8.6 5.9 23.7 Net income. . . . . . . . . $ 3.2 5.0 6.9 5.7 20.8 Year ended March 31, 1994: Revenues. . . . . . . . . . $ 20.4 18.6 24.4 41.2 104.6 Operating profit. . . . . . $ 3.1 2.5 5.4 4.3 15.3 Net income. . . . . . . . . $ 10.9 0.9 4.5 2.8 19.1\nItem 9.","section_9":"Item 9. Disagreements on Accounting Financial Disclosure.\nNo disclosure required.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe Registrant has three directors, all of whom are also executive officers of the Registrant. Messrs. W. Ray Wallace and K. W. Lewis became directors at the time of the organization of the Registrant. Mr. F. Dean Phelps, Jr. became a director on May 31, 1986.\nThe following table sets forth the names and ages of, and the positions and offices with the Registrant presently held by, all executive officers of the Registrant:\nName(1)(2) Age Office Principal Occupation\nW. Ray Wallace 72 President & President and Chief Director Executive Officer of Trinity since 1958\nRichard G. Brown 71 Executive Vice Senior Vice President President or Vice President of Trinity since 1979\nK. W. Lewis 56 Senior Vice Senior Vice President, President and Vice President, Director or Controller of Trinity since 1974\nF. Dean Phelps, Jr. 51 Vice President Vice President and Director or Controller of Trinity since 1979\nNeil O. Shoop 51 Treasurer Treasurer or Assistant Treasurer of Trinity since 1979\nJ. J. French, Jr. 64 Secretary Attorney, Joe French & Associates (a Professional Corporation)\n(1) Mr. Wallace is a director of Lomas Financial Corporation, a diversified financial services company engaged principally in mortgage banking and real estate lending.\n(2) Mr. French, an attorney, is President of Joe French & Associates (a Professional Corporation). For at least five years prior thereto, Mr. French was employed by Locke Purnell Rain Harrell (a Professional Corporation).\nItem 11.","section_11":"Item 11. Executive Compensation.\nAll of the officers and directors of the Registrant are employees of Trinity except Mr. French, an attorney who is President of Joe French & Associates (A Professional Corporation). The Registrant does not pay remuneration and\/or provide other benefits to its officers and directors in addition to the remuneration and benefits they receive from Trinity.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe Registrant is a wholly-owned subsidiary of Trinity. No officers or directors of the Registrant have beneficial ownership of the common stock nor an option or other right to acquire the common stock of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nMr. J. J. French, Jr., Secretary of the Registrant, is President and Owner of Joe French & Associates (a Professional Corporation) which is the general counsel for the Registrant.\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.\nThe financial statements listed in the accompanying index to financial statements are filed as part of this annual report.\n3 Exhibits.\nThe exhibits listed on the accompanying index to exhibits are filed as part of this annual report.\n(b) Reports on Form 8-K\nNo Form 8-K was filed during the fourth quarter of fiscal 1995.\nTrinity Industries Leasing Company (Item 14(a))\nPage\nBalance sheets at March 31, 1995 and 1994 . . . . . . . . 9\nFor each of the three years in the period ended March 31, 1995: Statements of income and retained earnings . . . . . . . 10 Statements of cash flows . . . . . . . . . . . . . . . . 11 Notes to financial statements . . . . . . . . . . . . . . 12\nSupplemental information: Supplementary unaudited quarterly data . . . . . . . . . 15\nAll other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the financial statements and notes thereto.\nTrinity Industries Leasing Company Index to Exhibits (Item 14(a))\nNO. DESCRIPTION PAGE (3.1) Articles of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 to Registration Statement No. 2-70378 filed January 29, 1981). *\n(3.2) By-Laws of Registrant (incorporated by reference to Exhibit 3.2 to Registration Statement No. 2-70378 filed January 29, 1981). *\n(10.1) Fixed Charges Coverage Agreement dated as of January 15, 1980, between Registrant and Trinity Industries, Inc. (incorporated by reference to Exhibit 10.1 to Registration Statement No. 2-70378 filed January 29, 1981). *\n(10.2) Tax Allocation Agreement dated as of January 22, 1980 between Registrant and Trinity Industries, Inc. (incorporated by reference to Exhibit 10.2 to Registration Statement No. 2-70378 filed January 29, 1981). *\n(27) Financial Data Schedules.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTrinity Industries Leasing Company Registrant\nBy: \/s\/ F. Dean Phelps, Jr. F. Dean Phelps, Jr. Vice President June 26, 1995\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:\n\/s\/ W. Ray Wallace W. Ray Wallace President and Director Principal Executive Officer June 26, 1995\n\/s\/ K. W. Lewis K. W. Lewis Senior Vice President and Director Principal Financial Officer June 26, 1995\n\/s\/ F. Dean Phelps, Jr. F. Dean Phelps, Jr. Vice President and Director Principal Accounting Officer June 26, 1995\nEXHIBIT 27\n[TYPE] EX-27 [DESCRIPTION] ART. 5 FDS FOR 4TH QUARTER 10K [ARTICLE] 5","section_15":""}
{"filename":"92103_1995.txt","cik":"92103","year":"1995","section_1":"Item 1. Business\nSouthern California Edison Company (\"SCE\") was incorporated under California law in 1909. SCE is a public utility primarily engaged in the business of supplying electric energy to a 50,000 square-mile area of central and southern California, excluding the City of Los Angeles and certain other cities. This area includes some 800 cities and communities and a population of more than 11 million people. SCE had an average of 15,490 full-time employees during 1995. During 1995, 38% of SCE's total operating revenue was derived from commercial customers, 37% from residential customers, 12% from industrial customers, 8% from public authorities, 4% from agricultural and other customers and 1% from resale customers. SCE comprises the major portion of the assets and revenue of Edison International, formerly SCEcorp, its parent holding company.\nOn March 22, 1996, SCE announced a voluntary early retirement program for full-time, non-union employees. SCE will record a charge of approximately $65,000,000 (pretax) against second quarter earnings to reflect the costs of this program. SCE expects to offset these costs with savings from the retirement program within a year. SCE is taking this action in response to the CPUC's 1995 General Rate Case decision and industry restructuring order, which make adjustments within its workforce inevitable. SCE designed the voluntary retirement plan as the best approach for meeting workforce needs, while maintaining commitments to customer service, system reliability and employee safety. To meet these staffing requirements, SCE will determine the number of employees in critical business functions who can accept the retirement offer. SCE anticipates negotiating a program for represented employees with its four labor unions later this year.\nCompetitive Environment\nSCE currently operates in a highly regulated environment in which it has an obligation to provide electric service to customers in return for an exclusive franchise within its service territory. This regulatory environment is changing. The generation sector has experienced competition from nonutility power producers, and regulators are restructuring California's electric utility regulation.\nOn December 20, 1995, the California Public Utilities Commission (\"CPUC\") issued its decision on restructuring California's electric industry, which it had been considering since April 1994. The new market structure would provide competition and customer choice. The transition to a competitive electric market would begin January 1, 1998, with all consumers participating by 2003. Key elements of the decision are: creation of an independent power exchange; creation of an independent system operator; implementation of greater customer choice; transition cost recovery by the utilities; and CPUC-established incentives to encourage utilities to voluntarily divest at least 50% of their fossil-fueled units within their service territory to address market power issues. On March 19, 1996, SCE filed its voluntary divestiture plans proposing the auction of 50% of its fossil-fueled units within its service territory, subject to certain conditions, including assured recovery of various costs. Also, under the decision the CPUC would regulate the rates, terms and conditions of utility services not subject to competition using Performance Based Ratemaking (\"PBR\") instead of cost-of-service regulation.\nThe independent power exchange, which would manage supply and demand through an economic auction, will be under Federal Energy and Regulatory Commission (\"FERC\") jurisdiction. Purchasing from and selling to the power exchange during the transition period, which runs for five years from the creation of the independent power exchange, will be mandatory for California's investor-owned utilities, while others can voluntarily participate. The independent system operator would have operational control of the utilities' transmission facilities and, therefore, would\ncontrol the scheduling and dispatch of all electricity on the state's power grid.\nThe new market structure would provide three avenues of customer choice. The first involves a continuation of utility-tariffed rates with customers choosing a monthly average rate or hourly time-of-use rates, which allows customers with specialized meters to access pricing information and alter their consumption accordingly. The second avenue involves customers continuing with utility-tariffed rates and entering into \"contracts for differences\" which manage risks associated with the market clearing prices published by the power exchange. The last avenue involves customers negotiating directly with generation providers and then arranging for transmission of the power with the transmission system operator (direct access).\nRecovery of costs to transition to a competitive market would be implemented through a non-bypassable competition transition charge (\"CTC\"). This charge would apply to all customers who currently use utility services or begin utility service after the restructuring decision is effective. SCE estimates its potential transition costs, through 2025 to be approximately $9.3 billion (net present value), based on incurred costs, and forecasts of future costs and assumed market prices. However, changes in the assumed market price could require material revisions to such estimates. The potential transition costs are comprised of $4.9 billion from SCE's qualifying facility (\"QF\") contracts, which are the direct result of legislative and regulatory mandates; and $4.4 billion from costs pertaining to certain generating plants and regulatory commitments consisting of costs incurred (whose recovery has been deferred by the CPUC) to provide service to customers. Such commitments include the recovery of income-tax benefits previously flowed- through to customers, postretirement benefit transition costs, accelerated recovery of nuclear plants (including San Onofre Nuclear Generating Station (\"San Onofre\") Unit 1 and San Onofre Units 2 and 3 as discussed below under \"1995 General Rate Case\"), nuclear decommissioning and certain other costs. The undepreciated book value of a utility's generation plant will be calculated on the amount in ratebase as of the decision date. Further, adverse financial consequences could result if an ambiguity in the CPUC's restructuring decision, as to recovery of capital expenditures made to SCE's fossil generation units in 1996 and beyond during the calculation of CTC, is not eliminated. SCE believes that recovery of such capital expenditures is consistent with the intent of the restructuring decision and has asked the CPUC to clarify the decision. If these efforts at clarification, consistent with the decision's intent, are unsuccessful then SCE estimates the effect would be to reduce 1996 earnings by more than $50,000,000 (before taxes), based on SCE's 1996 capital budget for its fossil generation units.\nBecause the restructuring of California's electric industry has widespread impact and the market structure requires the participation and oversight of the FERC, the CPUC has said it will seek to build a California consensus involving the legislature, governor, public and municipal utilities, and customers. FERC approval will be sought in a filing to be made on April 29, 1996, and both agencies would need to move forward to implement the new market structure. In addition, the CPUC plans to prepare an environmental impact report, which impacts when the CPUC proceeds with implementation of its decision. If the CPUC's restructuring decision is upheld and implemented as outlined in the restructuring decision, SCE would be allowed to recover its CTC (subject to a lower return on equity) and would continue to apply accounting standards that recognize the economic effects of rate regulation. The effect of such an outcome would not be expected to materially affect SCE's results of operations or financial condition during the transition period.\nIf revisions are made to the CPUC's restructuring decision that result in SCE no longer meeting the criteria to apply regulatory accounting standards to its generation operations, SCE may be required to write off\nits recorded generation-related regulatory assets. At December 31, 1995, these amounts totaled $1.4 billion (excluding balancing account overcollections of $237,000,000 to be refunded to customers in June 1996), primarily for the recovery of income-tax benefits previously flowed- through to customers, the Palo Verde Nuclear Generating Station (\"Palo Verde\") phase-in plan and unamortized loss on reacquired debt. Although depreciation-related differences could result from applying a regulatory prescribed depreciation method (straight-line, remaining-life method) rather than a method that would have been applied absent the regulatory process, SCE believes that the depreciable lives of its generation- related assets would not vary significantly from that of an unregulated enterprise, as the CPUC bases depreciable lives on periodic studies that reflect the assets' physical useful life. SCE also believes that any depreciation-related differences would be recovered through the CTC.\nAdditionally, if revisions are made to the CPUC's restructuring decision that result in all or a portion of the CTC not being probable of recovery, SCE could have additional write-offs associated with these costs if they are not recovered through another regulatory mechanism. At this time, SCE cannot predict when, or if, a consensus on restructuring will be reached, what revisions will ultimately be made in the CPUC's restructuring plan in subsequent proceedings or implementation phases, or the effect, after the transition period, that competition will have on its results of operations or financial condition.\nIn March 1995, the FERC proposed rules which would require utilities to provide wholesale open transmission access to the nation's interstate transmission grid, while allowing them to recover stranded costs associated with open access. The proposal defines stranded costs as legitimate, prudent and verifiable costs incurred to provide service to customers that would subsequently become unbundled wholesale transmission service customers of the utility. SCE supports the basic principles in the FERC's proposal and filed comments in August 1995. A final FERC decision is expected in mid-1996.\nRegulation\nSCE's retail operations are subject to regulation by the CPUC. The CPUC has the authority to regulate, among other things, retail rates, issuances of securities and accounting practices. SCE's wholesale operations are subject to regulation by the FERC. The FERC has the authority to regulate wholesale rates as well as other matters, including transmission service pricing, accounting practices and licensing of hydroelectric projects.\nSCE is subject to the jurisdiction of the Nuclear Regulatory Commission (\"NRC\") with respect to its nuclear power plants. NRC regulations govern the granting of licenses for the construction and operation of nuclear power plants and subject those power plants to continuing review and regulation.\nThe construction, planning and siting of SCE's power plants within California are subject to the jurisdiction of the California Energy Commission and the CPUC. SCE is subject to rules and regulations of the California Air Resources Board and local air pollution control districts with respect to the emission of pollutants into the atmosphere, the regulatory requirements of the California State Water Resources Control Board and regional boards with respect to the discharge of pollutants into waters of the state and the requirements of the California Department of Toxic Substances Control with respect to handling and disposal of hazardous materials and wastes. SCE is also subject to regulation by the U.S. Environmental Protection Agency (\"EPA\"), which administers certain federal statutes relating to environmental matters. Other federal, state and local laws and regulations relating to environmental protection, land use and water rights also affect SCE.\nThe California Coastal Commission has continuing jurisdiction over the coastal permit for San Onofre Units 2 and 3. Although the units are operating, the permit's mitigation requirements have not yet been fulfilled. California Coastal Commission jurisdiction may continue for several years due to implementation and oversight of permit mitigation conditions, including restoration of wetlands and construction of an artificial reef for kelp.\nThe Department of Energy has regulatory authority over certain aspects of SCE's operations and business relating to energy conservation, solar energy development, power plant fuel use and disposal, coal conversion, electric sales for export, public utility regulatory policy and natural gas pricing.\nRate Matters\nCPUC Retail Ratemaking\nThe rates for electricity provided by SCE to its retail customers comprise several major components established by the CPUC to compensate SCE for basic business and operational costs, fuel and purchased power costs, and the costs of adding major new facilities.\nBasic business and operational costs are recovered through base rates, which are determined in general rate case proceedings held before the CPUC every three years. CPUC decisions on SCE's PBR proposals (discussed below) and the ongoing electric industry restructuring (discussed above) could affect the need for future general rate case proceedings. During a general rate case, the CPUC critically reviews SCE's operations and general costs to provide service (excluding energy costs and, in certain instances, major plant additions). The CPUC then determines the revenue requirement to cover those costs, including items such as depreciation, taxes, operation, maintenance, and administrative and general expenses. The revenue requirement is forecasted on the basis of a specified test year. Following the revenue requirement phase of a general rate case, SCE and the CPUC proceed to a rate design phase which allocates revenue requirements and establishes rate levels for customers.\nSCE filed for a PBR mechanism in 1993, requesting a revenue-indexing formula to combine operating expenses and capital-related costs into a single index to determine most of its revenue (excluding fuel) from 1996- 2000. The filing was subsequently divided between transmission and distribution, and power generation. Hearings concluded on the transmission and distribution phase in December 1994. The CPUC's restructuring decision, as discussed above, requested comments addressing whether SCE's transmission and distribution PBR proposal should be amended or reviewed as filed. On January 19, 1996, SCE requested the CPUC approve its PBR as filed. SCE expects to file a proposal for the generation PBR mechanism phase in July 1996 which complies with the restructuring decision.\nSCE's fuel, purchased-power and energy-related costs of providing electric service are recovered through a balancing account mechanism called the Energy Cost Adjustment Clause (\"ECAC\"). Under the ECAC balancing account procedure, actual fuel, purchased power and energy-related revenue and costs are compared and the difference is recorded as either an undercollection or overcollection. The amount recorded in the balancing account is periodically amortized through rate changes which return overcollections to customers by reducing rates or collect undercollections from customers by increasing rates. The costs recorded in the ECAC balancing account are subject to reasonableness reviews by the CPUC. The reasonableness of execution and the ongoing administration of all purchased-power contracts including contracts with QFs is also reviewed in ECAC proceedings by the CPUC. The CPUC has not yet completed its review of all of SCE's energy and fuel related costs for the period April 1, 1990, to the present. Certain incentive provisions are included in the\nECAC that can affect the amount of fuel and energy-related costs actually recovered. SCE is required to make an ECAC filing for each calendar year, and must also make a second filing for a mid-year adjustment if it would result in an ECAC rate change exceeding 5% of total annual revenue.\nFor SCE's interest in the three units of Palo Verde, the CPUC authorized a 10-year rate phase-in plan which deferred collection of $200,000,000 of investment-related revenue during the first four years of operation for each of the three units, commencing on their respective commercial operation dates. Revenue collection deferred for each unit under the plan for years one through four was $80,000,000, $60,000,000, $40,000,000 and $20,000,000, respectively. The deferrals and related interest are being recovered evenly over the final six years of each unit's phase-in plan. The plans end in 1996 for Units 1 and 2, and in 1998 for Unit 3.\nThe CPUC has also adopted a Nuclear Unit Incentive Procedure (\"NUIP\") which provides for a sharing of additional energy costs or savings between SCE and its ratepayers when operation of any of the units of San Onofre or Palo Verde Units is outside a specified range (55% to 80% of each unit's rated capacity). The NUIP ended for San Onofre Units 2 and 3 at the end of fuel cycle number seven which occurred on May 23, 1995 and September 26, 1995, respectively.\nThe Electric Revenue Adjustment Mechanism reflects the difference between the recorded and authorized level of base rate revenue. The CPUC adopted this mechanism primarily to minimize the effect on earnings of fluctuations in retail kilowatt-hour sales.\n1995 General Rate Case (\"GRC\")\nOn January 10, 1996, the CPUC issued its decision on SCE's 1995 general rate case. The decision affirmed the CPUC's interim order to reduce 1995 operating revenue by $67,000,000, but decreased 1996 operating revenue by an additional $9,000,000, which includes a decrease of $44,000,000 for operating and maintenance expenses. The decision also rejected the original settlement's proposed new rate mechanism for San Onofre Units 2 and 3. However, the CPUC indicated approval of the general concept of recovery of SCE's remaining investment (approximately $2.7 billion) and operating costs of San Onofre Units 2 and 3 under a new rate mechanism. The decision proposed modifications to the San Onofre Units 2 and 3 portions of the settlement and gave SCE 25 days to accept or reject it. On February 5, 1996, SCE filed a revised San Onofre Units 2 and 3 proposal under which it accepted the CPUC's proposed modification. Under that proposal, SCE's San Onofre Units 2 and 3 investment will be recovered at a reduced rate of return (7.34% compared to the current 9.55%), over an eight-year period, beginning in the second quarter of 1996. Future operating costs and incremental capital expenditures at San Onofre are subject to an incentive pricing plan, where SCE receives about 4 cents per kilowatt-hour. Profits or losses resulting from cost differences from the incentive price will flow through to shareholders. Beginning in 2004, after SCE's investment is fully recovered, power from San Onofre Units 2 and 3 would be sold at the then-current market prices and ratepayers would receive 50% of the benefits of post-2003 operation. Final approval of the revised San Onofre Units 2 and 3 proposal is pending at the CPUC.\nEnergy Cost Adjustment Clause (\"ECAC\")\nA CPUC decision related to SCE's 1996 authorized revenue for fuel and purchased power was issued on February 23, 1996. At issue was the treatment of a $237,000,000 overcollection in ECAC. The CPUC ordered a one-time credit applied to customer bills in 1996. SCE's 1996 CPUC-authorized revenue, including the effects of other rate actions, will be reduced by $338,000,000, or 4.4%, and SCE is required to credit customer bills in June 1996 to refund the $237,000,000 overcollection referred to above. The reduction in authorized revenue resulting from the\n$237,000,000 refund will not impact 1996 earnings as these costs receive balancing account treatment; however, cash flows in 1996 will be affected. SCE believes it will have sufficient liquidity for the 1996 refund from cash provided by operating activities, projected investment balances and available lines of credit.\n1992 Annual ECAC Application\nSCE filed its testimony in the QF reasonableness phase of SCE's 1992 ECAC proceeding on September 1, 1992. On January 16, 1996, the CPUC's Division of Ratepayer Advocates (\"DRA\") released its report on QF reasonableness for both the 1992 record period and as to issues that had been reserved from the 1991 ECAC proceeding. The report recommends: (1) disallowances of $8,678,458 for the 1992 record period and $8,039,177 for the 1991 record period attributable to alleged deficiencies in how SCE administers the firm capacity payment provisions in its agreements with QFs; and (2) an as-yet-to-be-determined disallowance regarding QF sales of energy and as-available capacity that exceed the nameplate ratings specified by the QF in Interim Standard Offer No. 4 contracts and negotiated contracts containing similar payment provisions (the DRA indicates it has not yet received the data necessary to calculate the overpayments). The report requests that such disallowances be assessed on a continuing basis until SCE ends its challenged practices in these areas. No schedule has been set for further testimony or hearings on these issues.\n1994 Annual ECAC Application\nSCE filed its testimony in the non-QF phase of SCE's 1994 ECAC proceeding on May 27, 1994. On May 23, 1995, the DRA filed its report on the reasonableness of SCE's gas supply costs for both the 1993 and 1994 record periods. The report recommends a disallowance of $13,300,000 for excessive costs incurred from November 1993 through March 1994 associated with the SCE's Canadian gas purchase and supply contracts. The report requests that the CPUC defer finding the SCE Canadian supply and transportation agreements reasonable for the duration of their terms and that the costs procured under these contracts be reviewed on a yearly basis. SCE filed rebuttal testimony in December 1995 and DRA will file its rebuttal testimony in April 1996. SCE will then file its rebuttal testimony in May 1996 prior to hearings which are scheduled in June and July 1996.\nCPUC-Mandated Power Contracts\nIn 1994, the CPUC ordered the California utilities to proceed with an energy auction to solicit bids for new contracts with unregulated power producers. This decision would have forced SCE to purchase 686 MW of new power at fixed prices starting in 1997, costing SCE customers $14 billion over the lives of the contracts. SCE negotiated agreements, at substantially lower costs than those mandated by auction, with eight unregulated power producers, representing 648 MW of the 686 MW mandated. These agreements, which are subject to CPUC approval, would save SCE customers about 85% of anticipated overpayments compared with the mandated contracts. After extensive review by the CPUC and the FERC, the CPUC issued a ruling supporting resolution of the energy auction through negotiated settlements and set criteria to be used to evaluate the settlements. SCE has evaluated the impact of these criteria on its existing settlement agreements and, upon conclusion of settlement negotiations with the remaining parties, will file an application requesting CPUC approval (expected in 1996).\nMohave Order Instituting Investigation\nA 1994 CPUC decision stated that SCE was liable for expenditures related to a 1985 accident at the Mohave Generating Station. The CPUC ordered a second phase of this proceeding to quantify the disallowance. On December 22, 1995, SCE and the DRA filed a $38,000,000 settlement agreement subject\nto CPUC approval. This agreement has been fully reflected in the financial statements.\nFuel Supply and Purchased Power Costs\nFuel and purchased-power costs were approximately $3.2 billion in 1995, a 6% decrease from 1994.\nSCE's sources of energy during 1995 were: purchased power 41%; natural gas 20%; nuclear 18%; coal 13%; and hydro 8%.\nAverage fuel costs, expressed in cents per kilowatt-hour, for the year ended December 31, 1995, were: oil, 7.110 cents; natural gas, 2.192 cents; nuclear, 0.460 cents; and coal, 1.235 cents.\nNatural Gas Supply\nTwelve of SCE's major steam electric generating plants are designed to burn oil or natural gas as the primary boiler fuel. In 1990, SCE adopted an all-gas strategy to comply with air quality goals by eliminating burning oil in all but very extreme conditions. In August 1991, the CPUC adopted regulations which made SCE fully responsible for all natural gas procurement activities previously performed by local distribution companies.\nTo implement its all-gas strategy, SCE acquired a balanced portfolio of gas supply and transportation arrangements. Traditionally, natural gas needs in southern California were met from gas production in the southwest region of the country. To diversify its gas supply, SCE entered into four 15-year natural gas supply agreements with major producers in western Canada. These contracts, totaling 200,000,000 cubic feet per day, have market-sensitive pricing arrangements. This represents about 40% of SCE's current average annual supply needs. The rest of SCE's gas supply is acquired under short-term contracts from Texas, New Mexico and the Rocky Mountain region.\nFirm transportation arrangements provide the necessary long-term reliability for supply deliverability. To transport Canadian supplies, SCE contracted for 200,000,000 cubic feet per day of firm transportation arrangements on the Pacific Gas Transmission and Pacific Gas & Electric Expansion Project connecting southern California to the low-cost gas producing regions of western Canada. SCE has a 30-year commitment to this project, construction of which was completed in late 1993. In addition, SCE has a 15-year commitment with El Paso Natural Gas to transport 200,000,000 cubic feet per day (option to step down to 130,000,000 cubic feet per day in 1997) from the southwestern U.S.\nNuclear Fuel Supply\nSCE has contractual arrangements covering 100% of the projected nuclear fuel requirements for San Onofre through the years indicated below:\n_______________ (1) Assumes the San Onofre participants meet their supply obligations in a timely manner.\n(2) SCE is in the process of negotiating uranium, conversion, and enrichment contracts which will cover a majority of the San Onofre requirements through 2003.\n(3) Assumes full utilization of expanded on-site storage capacity and normal operation of the units, including interpool transfers and maintaining full-core reserve. To supplement existing spent fuel storage, a contingency plan is being developed to construct additional on-site storage capacity with initial operation scheduled for no later than 2002. The Nuclear Waste Policy Act of 1982 requires that the DOE provide for the disposal of utility spent nuclear fuel beginning in 1998. The DOE has stated that it is unlikely that it will be able to start accepting spent nuclear fuel at its permanent repository before 2010.\nParticipants in Palo Verde have purchased uranium concentrates sufficient to meet projected requirements through 1997. Independent of arrangements made by other participants, SCE will furnish its share of uranium concentrates requirements through at least 1996 from existing contracts. Contracts cover requirements to provide conversion and fabrication through 2000, and enrichment through 2002.\nPalo Verde on-site spent fuel storage capacity will accommodate needs through 1999 while maintaining full-core reserve. Planned modifications will extend storage capacities with full-core reserve through 2005 for Units 1 and 2 and through 2006 for Unit 3.\nEnvironmental Matters\nLegislative and regulatory activities in the areas of air and water pollution, waste management, hazardous chemical use, noise abatement, land use, aesthetics and nuclear control continue to result in the imposition of numerous restrictions on SCE's operation of existing facilities, on the timing, cost, location, design, construction and operation by SCE of new facilities required to meet its future load requirements, and on the cost of mitigating the effect of past operations on the environment. These activities substantially affect future planning and will continue to require modifications of SCE's existing facilities and operating procedures. SCE is unable to predict the extent to which additional regulations may affect its operations and capital expenditure requirements.\nThe Clean Air Act provides the statutory framework to implement a program for achieving national ambient air quality standards in areas exceeding such standards and provides for maintenance of air quality in areas already meeting such standards. The Clean Air Act was amended in 1990, giving the South Coast Air Quality Management District (\"SCAQMD\") 20 years to achieve the federal air quality standards for ozone. The SCAQMD's Air Quality Management Plan (\"AQMP\"), adopted in 1994, demonstrates a commitment to attain the federal ozone air quality standard by 2010. Consistent with the requirements of the AQMP and the Clean Air Act Amendments of 1990 (\"CAAA\"), the SCAQMD adopted rules to reduce emissions of oxides of nitrogen (\"NOx\") from combustion turbines, internal combustion engines, industrial coolers and utility boilers. On October 15, 1993, the SCAQMD adopted the Regional Clean Air Incentives Market (\"RECLAIM\") which replaces most of the previous rule requirements with a market mechanism for NOx emission trading (trading credits). RECLAIM will, however, require SCE to significantly reduce NOx emissions through retrofit or purchase of trading credits on all basin generation by 2003. In Ventura County, a NOx rule was adopted requiring more than an 88% NOx reduction by June 1996 at all utility boilers. SCE expects to spend a total of approximately $290,000,000 in capital expenditures by 2001 to meet these requirements.\nThe CAAA does not require any significant additional emissions control expenditures that are identifiable at this time. The amendments call for\na five-year study of the sources and causes of regional haze in the southwestern U.S. Also, the EPA and SCE will conclude a cooperative tracer study of SO2 emissions from the Mohave plant in late 1996 or early 1997. This study is evaluating potential impact from Mohave emissions on haze within Grand Canyon National Park. The extent to which these studies may require sulfur dioxide emissions reductions at the Mohave plant is not known. The acid rain provisions of the amended Clean Air Act also put an annual limit on sulfur dioxide emissions allowed from power plants. SCE has received more sulfur dioxide allowances than it requires for its projected operations. As a result of a petition by Mohave County in the State of Arizona, the Nevada Department of Environmental Protection (\"NDEP\") studied the impact of the plume from the Mohave plant on the Mohave area air quality. The regulatory outcome required SCE to meet a new lower opacity limit in early 1994. The NDEP reviewed SCE's performance relative to the opacity limit again in 1995 and determined to retain the current standard. Until more definitive information on tracer study results are available, SCE expects to meet all the present regulations through improved operations at the plant.\nThe CAAA also requires the EPA to carry out a three-year study of risk to public health from emissions of toxic air contaminants from power plants, and to regulate such emissions only if required. The study has not been completed to date.\nRegulations under the Clean Water Act require permits for the discharge of certain pollutants into waters of the U.S. Under this act, the EPA issues effluent limitation guidelines, pretreatment standards and new source performance standards for the control of certain pollutants. Individual states may impose even more stringent limitations. In order to comply with guidelines and standards applicable to steam electric power plants, SCE incurs additional expenses and capital expenditures. SCE presently has discharge permits for all applicable facilities.\nThe Safe Drinking Water and Toxic Enforcement Act prohibits the exposure to individuals of chemicals known to the State of California to cause cancer or reproductive harm and the discharge of such listed chemicals into potential sources of drinking water. Additional chemicals are continuously being put on the state's list, requiring constant monitoring by SCE.\nThe State of California has adopted a policy discouraging the use of fresh water for plant cooling purposes at inland locations. Such a policy, when taken in conjunction with existing federal and state water quality regulations and coastal zone land use restrictions, could substantially increase the difficulty of siting new generating plants anywhere in California.\nThe Resource Conservation and Recovery Act (\"RCRA\") provides the statutory authority for the EPA to implement a regulatory program for the safe treatment, recycling, storage and disposal of solid and hazardous wastes. There is an unresolved issue regarding the degree to which coal wastes should be regulated under RCRA. Increased regulation may result in an increase in expenses related to the operation of Mohave.\nThe Toxic Substance Control Act and accompanying regulations govern the manufacturing, processing, distribution in commerce, use and disposal of polychlorinated biphenyls, a toxic substance used in certain electrical equipment (\"PCB waste\"). Current costs for disposal of PCB waste are immaterial.\nSCE records its environmental liabilities when site assessments and\/or remedial actions are probable and a range of reasonably likely cleanup costs can be estimated. SCE reviews its sites and measures the liability quarterly, by assessing a range of reasonably likely costs for each identified site using currently available information, including existing technology, presently enacted laws and regulations, experience gained at similar sites, and the probable level of involvement and financial condition of other potentially responsible parties. These estimates include costs for site investigations, remediation, operations and\nmaintenance, monitoring and site closure. Unless there is a probable amount, SCE records the lower end of this reasonably likely range of costs (classified as other long-term liabilities at undiscounted amounts). While SCE has numerous insurance policies that it believes may provide coverage for some of these liabilities, it does not recognize recoveries in its financial statements until they are realized.\nSCE's recorded estimated minimum liability to remediate its 58 identified sites was $114,000,000, at December 31, 1995, and 1994. The ultimate costs to clean up SCE's identified sites may vary from its recorded liability due to numerous uncertainties inherent in the estimation process, such as: the extent and nature of contamination; the scarcity of reliable data for identified sites; the varying costs of alternative cleanup methods; developments resulting from investigatory studies; the possibility of identifying additional sites; and the time periods over which site remediation is expected to occur. SCE believes that, due to these uncertainties, it is reasonably possible that cleanup costs could exceed its recorded liability by up to $215,000,000. The upper limit of this range of costs was estimated using assumptions least favorable to SCE among a range of reasonably possible outcomes.\nThe CPUC allows SCE to recover environmental-cleanup costs at 24 of its sites, representing $90,000,000 of its recorded liability, through an incentive mechanism (SCE may request to include additional sites). Under this mechanism, SCE will recover 90% of cleanup costs through customer rates; shareholders fund the remaining 10%, with the opportunity to recover these costs through insurance and other third-party recoveries. SCE has settled insurance claims with several carriers, and is continuing to pursue additional recovery. Costs incurred at the remaining 34 sites are expected to be recovered through customer rates. SCE has filed a request with the CPUC to add 11 of these sites ($6,000,000 in estimated minimum liability) to the incentive mechanism. SCE has recorded a regulatory asset of $104,000,000 for its estimated minimum environmental cleanup costs expected to be recovered through customer rates.\nSCE's identified sites include several sites for which there is a lack of currently available information including, the nature and magnitude of contamination, and the extent, if any, that SCE may be held responsible for contributing to any costs incurred for remediating these sites. Thus, no reasonable estimate of cleanup costs can be made for these sites at this time.\nSCE expects to clean up its identified sites over a period of up to 30 years. Remediation costs in each of the next several years are expected to range from $4,000,000 to $8,000,000. Recorded costs for 1995 were $3,000,000.\nBased on currently available information, SCE believes it is not likely that it will incur amounts in excess of the upper limit of the estimated range and, based upon the CPUC's regulatory treatment of environmental- cleanup costs, SCE believes that costs ultimately recorded will not have a material adverse effect on its results of operations or financial condition. There can be no assurance, however, that future developments, including additional information about existing sites or the identification of new sites, will not require material revisions to such estimates.\nSCE's total capital expenditures for environmental protection for the years 1996 through 2000 are projected to be $1.2 billion. These expenditures are mainly for placing overhead distribution lines underground and reducing nitrogen oxides emissions from gas-fired generators.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nExisting Generating Facilities\nSCE owns and operates 12 oil- and gas-fueled electric generating plants, one diesel-fueled generating plant, 38 hydroelectric plants and an undivided 75.05% interest (1,614 MW net) in Units 2 and 3 at San Onofre. These plants are located in central and southern California. Palo Verde (15.8% SCE-owned, 579 MW net) is located near Phoenix, Arizona. SCE owns a 48% undivided interest (754 MW) in Units 4 and 5 at the Four Corners Generating Station (\"Four Corners Project\"), a coal-fueled steam electric generating plant in New Mexico. Palo Verde and the Four Corners Project are operated by other utilities. SCE operates and owns a 56% undivided interest (885 MW) in Mohave, which consists of two coal-fueled steam electric generating units in Clark County, Nevada. At year-end 1995, the existing SCE-owned generating capacity (summer effective rating) was comprised of approximately 65% gas, 15% nuclear, 11% coal, 8% hydroelectric and 1% oil.\nSan Onofre, the Four Corners Project, certain of SCE's substations and portions of its transmission, distribution and communication systems are located on lands of the United States or others under (with minor exceptions) licenses, permits, easements or leases or on public streets or highways pursuant to franchises. Certain of such documents obligate SCE, under specified circumstances and at its expense, to relocate transmission, distribution and communication facilities located on lands owned or controlled by federal, state or local governments.\nWith certain exceptions, major and certain minor hydroelectric projects with related reservoirs, currently having an effective operating capacity of 1,156 MW and located in whole or in part on lands of the U.S., are owned and operated by SCE under governmental licenses which expire at various times between 1996 and 2024. Such licenses impose numerous restrictions and obligations on SCE, including the right of the United States to acquire the project upon payment of specified compensation. When existing licenses expire, FERC has the authority to issue new licenses to third parties, but only if their license application is superior to SCE's and then only upon payment of specified compensation to SCE. Any new licenses issued to SCE are expected to be issued under terms and conditions less favorable than those of the expired licenses. SCE's applications for the relicensing of certain hydroelectric projects referred to above with an aggregate effective operating capacity of 95.9 MW are pending. Annual licenses issued for all SCE projects, whose licenses have expired and are undergoing relicensing, will be renewed until the new licenses are issued.\nIn 1995, SCE's peak demand was 17,548 MW, set on August 30, 1995. Total area system operating capacity of 21,603 MW was available to SCE at the time of the 1995 peak. SCE's record peak demand of 18,413 MW occurred on August 17, 1992.\nSubstantially all of SCE's properties are subject to the lien of a trust indenture securing First and Refunding Mortgage Bonds (\"Trust Indenture\"), of which approximately $4.1 billion principal amount was outstanding at December 31, 1995. Such lien and SCE's title to its properties are subject to the terms of franchises, licenses, easements, leases, permits, contracts and other instruments under which properties are held or operated, certain statutes and governmental regulations, liens for taxes and assessments, and liens of the trustees under the Trust Indenture. In addition, such lien and SCE's title to its properties are subject to certain other liens, prior rights and other encumbrances, none of which, with minor or unsubstantial exceptions, affects SCE's right to use such properties in its business, unless the matters with respect to SCE's interest in the Four Corners Project and the related easement and lease referred to below may be so considered.\nSCE's rights in the Four Corners Project, which is located on land of The Navajo Nation of Indians under an easement from the United States and a lease from The Navajo Nation, may be subject to possible defects. These defects include possible conflicting grants or encumbrances not ascertainable because of the absence of, or inadequacies in, the applicable recording law and the record systems of the Bureau of Indian Affairs and The Navajo Nation, the possible inability of SCE to resort to legal process to enforce its rights against The Navajo Nation without Congressional consent, possible impairment or termination under certain circumstances of the easement and lease by The Navajo Nation, Congress or the Secretary of the Interior and the possible invalidity of the Trust Indenture lien against SCE's interest in the easement, lease and improvements on the Four Corners Project.\nEl Paso Electric Company (\"El Paso\") Bankruptcy\nEl Paso owns and leases a combined 15.8% interest in Palo Verde and owns a 7% interest in Units 4 and 5 of the Four Corners Project. In January 1992, El Paso filed a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Western District of Texas. Pursuant to an agreement among the Palo Verde participants and an agreement among the participants in Four Corners Units 4 and 5, each participant is required to fund its proportionate share of operation and maintenance, capital and fuel costs of Palo Verde and Four Corners Units 4 and 5, respectively. The participation agreements provide that if a participant fails to meet its payment obligation, each non- defaulting participant must pay its proportionate share of the payments owed by the defaulting participant. In February 1992, the bankruptcy court approved a stipulation between El Paso and Arizona Public Service (\"APS\"), as the operating agent of Palo Verde, pursuant to which El Paso agreed to pay its proportionate share of all Palo Verde invoices delivered to El Paso after February 6, 1992. El Paso agreed to make these payments until such time, if ever, the bankruptcy court orders El Paso's rejection of the participation agreement governing the relations among the Palo Verde participants. The stipulation also specifies that approximately $9,200,000 of El Paso's Palo Verde payment obligations invoiced prior to February 7, 1992, are to be considered \"pre-petition\" general unsecured claims of the other Palo Verde participants.\nOn August 27, 1993, El Paso filed an Amended Plan of Reorganization and Disclosure Statement (\"Amended Plan\") that was contingent on a merger in which El Paso would have become a wholly-owned subsidiary of Central and South West Corporation (\"CSW\").\nOn November 19, 1993, the bankruptcy court approved a Cure and Assumption Agreement among El Paso and the Palo Verde Participants, in which El Paso shall (i) assume the Participation Agreement on the date the Amended Plan becomes effective, and (ii) cure its pre-petition default on the date the court approves the Order Confirming El Paso's Amended Plan. On December 8, 1993, the bankruptcy court confirmed El Paso's Amended Plan and subsequently, El Paso cured its pre-petition default.\nOn June 9, 1995, CSW notified El Paso and the Bankruptcy Court that the Merger Agreement by and among El Paso and CSW was terminated and the Amended Plan is revoked. In its notification, CSW stated as a basis for its action, the fact that a number of closing conditions were not fulfilled and certain material breaches had not been cured.\nSubsequently, El Paso filed a consensual Fourth Amended Stand Alone Plan of Reorganization, dated October 27, 1995. This Plan modifies the Fourth Amended Stand Alone Plan of Reorganization initially filed by El Paso on September 29, 1995. The Fourth Amended Plan proposes, among other things, (i) rejection of the El Paso leases and reacquisition by El Paso of the Palo Verde interests represented by the leases, and (ii) El Paso's assumption of the Four Corners Operating Agreement and the Arizona Nuclear\nPower Project Participation Agreement. The Fourth Amended Plan was confirmed on January 9, 1996, in the U.S. Bankruptcy Court for the Western District of Texas. El Paso emerged from bankruptcy when the Fourth Amended Plan became effective on February 12, 1996.\nConstruction Program and Capital Expenditures\nCash required by SCE for its capital expenditures totaled $773,000,000 in 1995, $982,000,000 in 1994 and $1.04 billion in 1993. Construction expenditures for the 1996-2000 period are forecasted at $3.5 billion. These estimates assume clarification of the ambiguity in the restructuring structure decision as to capital expenditures for fossil generation.\nIn addition to cash required for construction expenditures for the next five years as discussed above, $1.4 billion is needed to meet requirements for long-term debt maturities and sinking fund redemption requirements.\nSCE's estimates of cash available for operations for the five years through 2000 assume, among other things, the receipt of adequate and timely rate relief and the realization of its assumptions regarding cost increases, including the cost of capital. SCE's estimates and underlying assumptions are subject to continuous review and periodic revision.\nThe timing, type and amount of all additional long-term financing are also influenced by market conditions, rate relief and other factors, including limitations imposed by SCE's Articles of Incorporation and Trust Indenture.\nNuclear Power Matters\nSCE's nuclear facilities have been reliable sources of inexpensive, non- polluting power for SCE's customers for more than a decade. Throughout the operating life of these facilities, SCE's customers have supported the revenue requirements of SCE's capital investment in these facilities and for their incremental costs through traditional cost-of-service ratemaking.\nAs discovered above, on January 10, 1996, the CPUC issued its decision for SCE's Test Year 1995 GRC. The CPUC rejected the settlement agreement in its original form, but proposed modifications to certain terms and granted SCE the opportunity to accept the settlement agreement with the proposed modifications. The CPUC gave SCE 25 days to prepare a detailed proposal consistent with the policy adopted in its Decision. On February 5, 1996, SCE filed a revised San Onofre Unit 2 and 3 proposal in which it accepted the modifications to certain settlement agreement terms as proposed by the CPUC. Under this Proposal, SCE would recover its remaining investment in San Onofre Units 2 and 3 at a reduced rate of return (7.34% compared to the current 9.55%), but on an accelerated basis during the eight-year period from the effective date in 1996 through December 31, 2003. In addition, the traditional cost-of-service ratemaking for San Onofre Units 2 and 3 would be superseded by incremental cost incentive pricing, in which SCE's customers would pay a preset price for each kilowatt-hour of energy generated at San Onofre during the eight-year period. SCE would be compensated for the incremental costs required for the continued operation of San Onofre Units 2 and 3 only with revenues earned through the incremental cost incentive pricing. However, SCE would also retain the ability to request recovery of the cost of fuel consumed for generation of replacement energy for periods in which San Onofre is not generating power through future ECAC filings. SCE would also continue to collect funds for decommissioning expenses through traditional ratemaking treatment. In addition, SCE would continue to receive traditional cost- of-service ratemaking for its share of Palo Verde Units 1, 2, and 3. Intervenors filed comments on February 20, 1996, and a final CPUC decision is expected May 1, 1996.\nIn the restructuring decision, the CPUC ordered SCE to file an application by March 29, 1996, requesting a new rate mechanism for its share of the Palo Verde units to be effective January 1, 1997. On February 29, 1996, SCE filed its Palo Verde proposal application requesting adoption of a new rate mechanism for Palo Verde consistent with the San Onofre Units 2 and 3 rate mechanism.\nSCE cannot predict what other effects, if any, legislative or regulatory actions may have upon it or upon the future operation of the San Onofre or Palo Verde units, or the extent of any additional costs it may incur as a result thereof, except for those that follow.\nSan Onofre Unit 1\nIn August 1992, the CPUC approved a settlement agreement between SCE and the CPUC's DRA to discontinue operation of San Onofre Unit 1 at the end of its then-current fuel cycle because operation of the unit was no longer cost-effective. As part of the agreement, SCE will recover its investment, earning an 8.98% rate of return on rate base, by August 1996. In November 1992, SCE discontinued operation of San Onofre Unit 1.\nPalo Verde Nuclear Generating Station\nOn March 14, 1993, Arizona Public Service Company (\"APS\"), the operating agent for Palo Verde, manually shut down Unit 2 as a result of a steam generator tube leak. Unit 2 remained shut down and began its scheduled refueling outage on March 19, 1993.\nAPS performed an extensive inspection of the Unit 2 steam generators prior to the unit's return to service on September 1, 1993. APS determined that intergranular attack\/intergranular stress corrosion cracking was a major contributor to the tube leak. Subsequent inspections have revealed similar, though less severe, corrosion in the Unit 1 and Unit 3 steam generators. APS has taken, and indicates it will continue to take, remedial actions that it believes have slowed the rate of steam generator tube degradation in all three units.\nBased on latest available data, APS estimates that the Unit 1 and Unit 3 steam generators should operate for the 40 year licensed operating life of those units, although APS continues to monitor the situation. APS has disclosed that it believes it will be economically desirable to replace the Unit 2 steam generators, which have been most affected by tube cracking, in five to ten years. APS has indicated to the participants that it believes that replacement of the Unit 2 steam generators would cost between $100,000,000 and $150,000,000. SCE estimates that this cost could be higher, such that its share of this cost would be between $16,000,000 and $30,000,000, plus replacement power costs. Unanimous approval of the Palo Verde participants is required for capital improvements, including steam generator replacement. SCE is evaluating APS' analyses, conducting its own review, and has not yet decided whether it supports replacement of the steam generators.\nNuclear Facility Decommissioning\nSCE plans to decommission its nuclear generating facilities at the end of each facility's operating license by a prompt removal method authorized by the NRC. Decommissioning is estimated to cost $1.8 billion in current- year dollars based on site-specific studies performed in 1993 for San Onofre and 1992 for Palo Verde. This estimate considers the total cost of decommissioning and dismantling the plant, including labor, material, burial and other costs. The site specific studies are updated approximately every three years. Changes in the estimated costs, timing of decommissioning, or the assumptions underlying these estimates could cause material revisions to the estimated total cost to decommission in the near term. Decommissioning is scheduled to begin in 2013 at San Onofre and 2024 at Palo Verde. Currently, San Onofre Unit 1, which shut\ndown in 1992, is expected to be stored until decommissioning begins at the other San Onofre units.\nSCE is currently collecting $104,381,000 annually in rates for its share of decommissioning costs for San Onofre Units 1, 2, and 3, and Palo Verde Units 1, 2, and 3. As of December 31, 1995, SCE's decommissioning trust funds totaled approximately $1.260 billion (market value).\nNuclear Facility Depreciation\nIn October 1994, the CPUC authorized SCE to accelerate recovery of its nuclear plant investments by $75,000,000 per year through 2011, with a corresponding deceleration in recovery of its transmission and distribution assets through revised depreciation estimates over their remaining useful lives. Recovery of the San Onofre nuclear plant investment has been further accelerated by the 1995 GRC decision.\nNuclear Insurance\nSCE carries Nuclear Property Insurance well in excess of limits required by Federal law and in amounts determined adequate to protect against losses from damage to its nuclear units and to provide some of its replacement energy costs in the unlikely event of an accident at any of its nuclear units. A description of this insurance is included in Note 10 of \"Notes to Consolidated Financial Statements\" incorporated herein. Although SCE believes an accident at its nuclear units is extremely unlikely, in the event of an accident, regardless of fault, SCE's insurance coverage might be inadequate to cover the losses to SCE. In addition, such an accident could result in NRC action to suspend operation of the damaged unit. Further, the NRC could suspend operation at SCE's undamaged nuclear units and the CPUC and FERC could deny rate recovery of related costs. Such an accident, therefore, could materially and adversely affect the operations and earnings of SCE.\nItem 3.","section_3":"Item 3. Legal Proceedings\nQF Litigation\nOn May 20, 1993, four geothermal QFs filed a lawsuit against SCE in Los Angeles County Superior Court, claiming that SCE underpaid, and continues to underpay, the plaintiffs for energy. SCE denied the allegations in its response to the complaint. The action was brought on behalf of Vulcan\/BN Geothermal Power Company, Elmore L.P., Del Ranch L.P., and Leathers L.P., each of which is partially owned by a subsidiary of Edison Mission Energy (a subsidiary of Edison International). In October 1994, plaintiffs submitted an amended complaint to the court to add causes of action for unfair competition and restraint of trade. In July 1995, after several motions to strike had been heard by the court, the plaintiffs served a fourth amended complaint, which omitted the previous claims based on alleged restraint of trade. The plaintiffs allege in the fourth amended complaint that past underpayments have totaled at least $21,000,000. In other court filings, plaintiffs contend that additional contract payments owing from the beginning of the alleged underpayments through the end of the contract term could total approximately $60,000,000. Plaintiffs also seek unspecified punitive damages and an injunction to enjoin SCE from \"future\" unfair competition.\nAfter SCE's motion to strike portions of the fourth amended complaint was denied, SCE filed an answer to the fourth amended complaint which denies its material allegations. Trial on the fourth amended complaint is set for May 15 1996. The materiality of a judgment in favor of the plaintiffs would be largely dependent on the extent to which additional payments resulting from such a judgment are recoverable through SCE's ECAC.\nBetween January 1994 and October 1994, SCE was named as a defendant in a series of eight lawsuits brought by independent power producers of wind\ngeneration. Seven of the lawsuits were filed in Los Angeles County Superior Court and one was filed in Kern County Superior Court. The lawsuits allege SCE incorrectly interpreted contracts with the plaintiffs by limiting fixed energy payments to a single 10-year period rather than beginning a new 10-year period of fixed energy payments for each stage of development. In its responses to the complaints, SCE denied the plaintiffs' allegations. In each of the lawsuits, the plaintiffs seek declaratory relief regarding the proper interpretation of the contracts. Plaintiffs allege a combined total of approximately $189,000,000 in damages, which includes consequential damages claimed in seven of the eight lawsuits. On March 1, 1995, the court in the lead Los Angeles Superior Court case granted the plaintiffs' motion seeking summary adjudication that the contract language in question is not reasonably susceptible to SCE's position that there is only a single, 10-year period of fixed payments. Following the March 1 ruling, an eighth lawsuit was filed in the Los Angeles Superior Court raising claims similar to those alleged in the first seven. SCE subsequently responded to the complaint in the new lawsuit by denying its material allegations. On April 5, 1995, SCE filed a petition for Writ of Mandate, Prohibition of Other Appropriate Relief, requesting that the Court of Appeal of the State of California, Second Appellate District issue a writ directing the Los Angeles Superior Court to vacate its March 1 order granting summary adjudication. In a decision filed August 9, 1995, the Court of Appeal issued a writ directing that the order be overturned, and a new order be entered denying the motion. Trial is currently set in the single Kern County Superior Court case for April 22, 1996. In the Los Angeles Superior Court cases, the lead case is set for trial on June 26, 1996, although a motion to consolidate all of the Los Angeles cases for trial is before the court. The materiality of final judgments in favor of the plaintiffs would be largely dependent on the extent to which any damages or additional payments which might result from such judgments would be recoverable through SCE's ECAC.\nEnvironmental Litigation\nElectric and Magnetic Fields (\"EMF\")\nSCE is involved in three lawsuits alleging that various plaintiffs developed cancer as a result of exposure to EMF from SCE facilities. SCE denied the material allegations in its responses to each of these lawsuits.\nThe first lawsuit was filed in Orange County Superior Court and served on SCE in June 1994. There are five named plaintiffs and six named defendants, including SCE. Three of the five plaintiffs are presently or were formerly employed by Grubb & Ellis, a real estate brokerage firm with offices located in a commercial building known as the Koll Center in Newport Beach. Two of the named plaintiffs are spouses of the other plaintiffs. Grubb & Ellis and the owners and developers of the Koll Center are also named as defendants in the lawsuit. This lawsuit alleges, among other things, that the three plaintiffs employed by Grubb & Ellis developed various forms of cancer as a result of exposure to EMF from electrical facilities owned by SCE and\/or the other defendants located on Koll Center property. No specific damage amounts are alleged in the complaint, but supplemental documentation prepared by the plaintiffs indicates that plaintiffs allege compensatory damages of approximately $8 million, plus unspecified punitive damages. In December 1995, the court granted SCE's motion for summary judgment and dismissed the case. Plaintiffs have filed a Notice of Appeal.\nA second lawsuit was filed in Orange County Superior Court and served on SCE in January 1995. This lawsuit arises out of the same fact situation as the June 1994 lawsuit described above and involves the same defendants. There are four named plaintiffs, two of whom were formerly employed by Grubb & Ellis and now allegedly have various forms of cancer. The other two plaintiffs are the spouses of those two individuals. No specific\ndamage amounts are alleged in the complaint, but supplemental documentation prepared by the plaintiffs indicates that plaintiffs will allege compensatory damages of approximately $13,500,000, plus unspecified punitive damages. On April 18, 1995, Grubb & Ellis filed a cross- complaint against the other co-defendants, requesting indemnification and declaratory relief concerning the rights and responsibilities of the parties. Trial date in this case has been set for November 4, 1996.\nA third case was filed in Orange County Superior Court and served on SCE in March 1995. The plaintiff alleges, among other things, that he developed cancer as a result of EMF emitted from SCE distribution lines which he alleges were not constructed in accordance with CPUC standards. No specific damage amounts are alleged in the complaint but supplemental documentation prepared by the plaintiff indicates that plaintiff will allege compensatory damages of approximately $5,500,000, plus unspecified punitive damages. The trial date in this case has been continued to late 1996.\nSan Onofre Personal Injury Litigation\nAn engineer for two contractors providing services for San Onofre, was diagnosed with leukemia. On July 12, 1994, the engineer and his wife sued SCE and San Diego Gas & Electric Company (\"SDG&E\"), as well as Combustion Engineering, the manufacturer of the fuel rods for the plant, in the U.S. District Court for the Southern District of California. The plaintiffs alleged that the engineer's illness resulted from contact with the radioactive fuel particles released from failed fuel rods. Plant records showed that the engineer's exposure to radiation was well below NRC safety levels. Plaintiffs sought unspecified compensatory and punitive damages. SCE's December 23, 1994, answer to the complaint denied all material allegations. The trial began on August 3, 1995, and on October 12, 1995, an eight-member jury unanimously decided that radiation exposure at San Onofre was not the cause of the engineer's leukemia. The court entered the judgment for the defendants on October 24, 1995. Plaintiffs' motion for a new trial was denied on December 5, 1995. Plaintiffs have filed an appeal with the Ninth Circuit Court of Appeals. Oral argument on that appeal is scheduled for April 11, 1996.\nAn SCE engineer employed at San Onofre died in 1991 from cancer of the abdomen. On February 6, 1995, his children sued SCE and SDG&E, as well as Combustion Engineering, the manufacturer of the fuel rods for the plant, in the U.S. District court for the Southern District of California. Plaintiffs alleged that the former employee's illness resulted from, and was aggravated by, exposure to radiation at San Onofre, including contact with radioactive fuel particles released from failed fuel rods. Plaintiffs sought unspecified compensatory and punitive damages. On April 3, 1995, the court granted the defendants' motion to dismiss 14 of the plaintiffs' claims. SCE's April 20, 1995, answer to the complaint denied all material allegations. On October 10, 1995, the court granted plaintiffs' motion to include the Institute of Nuclear Power Operations (an organization dedicated to achieving excellence in nuclear power operations) as a defendant in the suit. On December 7, 1995, the judge granted SCE's motion for summary judgment on the sole outstanding claim against it, basing his ruling on the worker's compensation system being the exclusive remedy for the claim. Plaintiffs will appeal this ruling to the Ninth Circuit Court of Appeals. Trial of the case will be delayed pending the ruling of the Court of Appeals. The impact to SCE, if any, from further proceedings in this case against the remaining defendants cannot be determined at this time.\nOn July 5, 1995, a former SCE reactor operator and his wife sued SCE and SDG&E in the U.S. District court for the Southern District of California. Plaintiffs also named Combustion Engineering, the manufacturer of the fuel rods for the plant, and the Institute of Nuclear Power Operations as defendants. The former employee died of leukemia shortly after the complaint was filed. Plaintiffs allege that the former operator's illness\nresulted from, and was aggravated by, exposure to radiation at San Onofre, including contact with radioactive fuel particles released from failed fuel rods. Plaintiffs seek unspecified compensatory and punitive damages. On November 22, 1995, plaintiffs amended their complaint to allege wrongful death and added the former employee's two children as plaintiffs. On December 22, 1995, SCE filed a motion to dismiss or, in the alternative, for summary judgment based on worker's compensation exclusivity. This motion was heard on March 18, 1996. The court has not ruled on the motion. If SCE's motion is unsuccessful, it intends to deny plaintiffs' material allegations.\nOn August 31, 1995, the wife and daughter of a former San Onofre security supervisor sued SCE and SDG&E in the U.S. District court for the Southern District of California. Plaintiffs also named Combustion Engineering, the manufacturer of fuel rods for the plant, and the Institute of Nuclear Power Operations as defendants. The security officer worked for a contractor in 1982, worked for SCE as a temporary employee (1982-1984), and later worked as an SCE security supervisor (1984-1994). The officer died of leukemia in 1994. Plaintiffs allege that the former officer's illness resulted from, and was aggravated by, his exposure to radiation at San Onofre, including contact with radioactive fuel particles released from failed fuel rods. Plaintiffs seek unspecified compensatory and punitive damages. SCE's November 13, 1995, answer to the complaint denied all material allegations. A trial date will be set at the pretrial conference that is scheduled for October 7, 1996.\nOn November 17, 1995, an SCE employee and his wife sued SCE in the U.S. District Court for the Southern District of California. Plaintiffs also named Combustion Engineering, the manufacturer of the fuel rods for the San Onofre plant. The employee worked for SCE at San Onofre from 1981 to 1990. Plaintiffs allege that the employee transported radioactive byproducts on his person, clothing and\/or tools to his home where his wife was then exposed to radiation that caused her leukemia. Plaintiffs seek unspecified compensatory and punitive damages. SCE's December 19, 1995, partial answer to the complaint denied all material non-employment related allegations. SCE's motion to dismiss the employment related allegations was heard March 11, 1996. The court has not ruled on the motion. The plaintiffs' motion for an expedited trial date was denied by the court on January 16, 1996.\nOn November 28, 1995, a former contract worker at San Onofre, her husband, and her son, sued SCE in the U.S. District Court for the Southern District of California. Plaintiffs also named Combustion Engineering, the manufacturer of the fuel rods for the San Onofre plant. Plaintiffs allege that the former contract worker transported radioactive byproducts on her person and clothing to her home where her son was then exposed to radiation that caused his leukemia. Plaintiffs seek unspecified compensatory and punitive damages. SCE's January 2, 1996, answer denied all material allegations.\nEmployment Discrimination Litigation\nOn September 21, 1994, nine African-American employees filed a lawsuit against Edison International and SCE on behalf of an alleged class of African-American employees, alleging racial discrimination in job advancement, pay, training and evaluation. The lawsuit was filed in the United States District Court for the Central District of California. The plaintiffs seek injunctive relief, as well as an unspecified amount of compensatory and punitive damages, attorneys' fees, costs and interest. Edison International and SCE have responded by denying the material allegations of the complaint and asserting several affirmative defenses. The parties are engaged in discovery, and no trial date has been set.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nInapplicable.\nPursuant to Form 10-K's General Instruction (\"General Instruction\") G(3), the following information is included as an additional item in Part I:\nExecutive Officers(1) of the Registrant\n______________\n(1) R. H. Bridenbecker retired from his position as Senior Vice President, Customer Solutions, on December 31, 1995, and Margaret Jordan resigned as Vice President, Health Care and Employee Services on February 1, 1996. Georgia Nelson resigned from her position as Senior Vice President, Performance Support, on January 1, 1996, to become President of the Americas Division and Senior Vice President of World Wide Operations for Edison Mission Energy. C. Alex Miller resigned as Vice President and Treasurer on January 26, 1996, to become President of Edison Source. Effective January 1, 1996, former Corporate Secretary Kenneth S. Stewart became Assistant General Counsel and Assistant Secretary.\n(2) Executive officers Bryson, Danner, Fohrer, Banfield, Bushey, Robert Foster, Higgins, and Ryder hold the same positions with Edison International. Edison International is the parent holding company of SCE.\nNone of SCE's executive officers are related to each other by blood or marriage. As set forth in Article IV of SCE's Bylaws, the officers of SCE are chosen annually by and serve at the pleasure of SCE's Board of Directors and hold their respective offices until their resignation, removal, other disqualification from service, or until their respective successors are elected. All of the executive officers have been actively engaged in the business of SCE for more than five years except for Stephen E. Frank, Bryant C. Danner, Owens F. Alexander, Bruce C. Foster, Thomas J. Higgins, Dwight E. Nunn, and Beverly P. Ryder. Those officers who have not held their present position for the past five years had the following business experience:\n______________\n(1) Prior to leaving the law firm of Latham & Watkins, Mr. Danner was in the firm's environmental department.\n(2) As President of The Laurel Company, Thomas J. Higgins provided advice on planning and financing for mergers and acquisitions for clients in the managed health care business.\n(3) This entity is a division of SCE.\n(4) This entity is not a parent, subsidiary or other affiliate of SCE.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nCertain information responding to Item 5 with respect to frequency and amount of cash dividends is included in SCE's Annual Report to Shareholders for the year ended December 31, 1995, (\"Annual Report\") under \"Quarterly Financial Data\" on page 8 and is incorporated by reference pursuant to General Instruction G(2). As a result of the formation of a holding company described above in Item 1, all of the issued and outstanding common stock of SCE is owned by Edison International and there is no market for such stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation responding to Item 6 is included in the Annual Report under \"Selected Financial and Operating Data: 1991-1995\" on page 1 and is incorporated herein by reference pursuant to General Instruction G(2).\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition\nInformation responding to Item 7 is included in the Annual Report under \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 2 through 8 and is incorporated herein by reference pursuant to General Instruction G(2).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCertain information responding to Item 8 is set forth after Item 14 in Part IV. Other information responding to Item 8 is included in the Annual Report on page 8 under \"Quarterly Financial Data\" and on pages 9 through 26 and is incorporated herein by reference pursuant to General Instruction G(2).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation concerning executive officers of SCE is set forth in Part I in accordance with General Instruction G(3), pursuant to Instruction 3 to Item 401(b) of Regulation S-K. Other information responding to Item 10 is included in the Joint Proxy Statement (\"Proxy Statement\") filed with the Commission in connection with SCE's Annual Meeting of Shareholders to be held on April 18, 1996, under the heading \"Election of Directors of Edison International and SCE,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation responding to Item 11 is included in the Proxy Statement under the heading \"Election of Directors of Edison International and SCE,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation responding to Item 12 is included in the Proxy Statement under the headings \"Election of Directors of Edison International and SCE,\" and \"Stock Ownership of Certain Shareholders\" and is incorporated herein by reference pursuant to General Instruction G(3).\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation responding to Item 13 is included in the Proxy Statement under the heading \"Election of Directors of Edison International and SCE,\" and is incorporated herein by reference pursuant to General Instruction G(3).\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) Financial Statements\nThe following items contained in the 1995 Annual Report to Shareholders are incorporated by reference in this report.\nManagement's Discussion and Analysis of Results of Operations and Financial Condition Consolidated Statements of Income -- Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Retained Earnings -- Years Ended December 31, 1995, 1994 and 1993 Consolidated Balance Sheets -- December 31, 1995, and 1994 Consolidated Statements of Cash Flows -- Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements Responsibility for Financial Reporting Report of Independent Public Accountants\n(2) Report of Independent Public Accountants and Schedules Supplementing Financial Statements\nThe following documents may be found in this report at the indicated page numbers. Page ---- Report of Independent Public Accountants on Supplemental Schedule 25 Schedule II--Valuation and Qualifying Accounts for the Years Ended December 31, 1995, 1994 and 1993 26\nSchedules I through V, except those referred to above, are omitted as not required or not applicable.\n(3) Exhibits\nSee Exhibit Index on page 30 of this report.\n(b) Reports on Form 8-K November 22, 1995 Item 5: Other Events: Alternate Proposed General Rate Case Decision\nDecember 14, 1995 Item 5: Other Events: 1995 General Rate Case Proposal\nDecember 21, 1995 Item 5: Other Events: CPUC Restructuring Decision\nJanuary 11, 1996 Item 5: Other Events: CPUC 1995 General Rate Case Decision\nJanuary 17, 1996 Item 5: Other Events: Sale of 5-7\/8% Notes, Due 2001 and 6-3\/8% Notes, Due 2006\nFebruary 23, 1996 Item 5: Other Events: 1995 Financial Information\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nTo Southern California Edison Company:\nWe have audited in accordance with generally accepted auditing standards the consolidated financial statements included in the 1995 Annual Report to Shareholders of Southern California Edison Company (SCE), incorporated by reference in this Form 10-K, and have issued our report thereon dated February 2, 1996. Our audits of the consolidated financial statements were made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The supplemental schedule listed in Part IV of this Form 10-K which is the responsibility of SCE's management is presented for purposes of complying with the Securities and Exchange Commission's rules and regulations, and is not part of the basic consolidated financial statements. This supplemental 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 ARTHUR ANDERSEN LLP\nLos Angeles, California February 2, 1996\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1995\n_______________ (a) Accounts written off, net.\n(b) Represents revision to estimate based on actual billings.\n(c) Represents amounts paid.\n(d) Primarily represents transfers from the accrued paid absence allowance account for required additions to the comprehensive disability plan accounts.\n(e) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(f) Amounts charged to operations that were not covered by insurance.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1994\n________________ (a) Accounts written off, net.\n(b) Represents revision to estimate based on actual billings.\n(c) Represents amounts paid.\n(d) Primarily represents transfers from the accrued paid absence allowance account for required additions to the comprehensive disability plan accounts.\n(e) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(f) Amounts charged to operations that were not covered by insurance.\nSOUTHERN CALIFORNIA EDISON COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1993\n_______________ (a) Accounts written off, net.\n(b) Represents final settlement with the California Public Utilities Commission's Division of Ratepayer Advocates regarding affiliated company power purchases.\n(c) Represents revision to estimate based on actual billings.\n(d) Represents amounts paid.\n(e) Primarily represents transfers from the accrued paid absence allowance account for required additions to the comprehensive disability plan accounts.\n(f) Includes pension payments to retired employees, amounts paid to active employees during periods of illness and the funding of certain pension benefits.\n(g) Amounts charged to operations that were not covered by insurance.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHERN CALIFORNIA EDISON COMPANY\nBy Kenneth S. Stewart ---------------------------------- Kenneth S. Stewart Assistant General Counsel\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 the registrant and in the capacities and on the dates indicated.\nKenneth S. Stewart *By ----------------------------------------- Kenneth S. Stewart, Attorney-in-fact)\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n3.1 Restated Articles of Incorporation as amended through June 1, 1993 (File No. 1-2313)* 3.2 Bylaws as adopted by the Board of Directors on February 15, 4.1 Trust Indenture, dated as of October 1, 1923 (Registration No. 2-1369)* 4.2 Supplemental Indenture, dated as of March 1, 1927 (Registration No. 2-1369)* 4.3 Second Supplemental Indenture, dated as of April 25, 1935 (Registration No. 2-1472)* 4.4 Third Supplemental Indenture, dated as of June 24, 1935 (Registration No. 2-1602)* 4.5 Fourth Supplemental Indenture, dated as of September 1, 1935 (Registration No. 2-4522)* 4.6 Fifth Supplemental Indenture, dated as of August 15, 1939 (Registration No. 2-4522)* 4.7 Sixth Supplemental Indenture, dated as of September 1, 1940 (Registration No. 2-4522)* 4.8 Seventh Supplemental Indenture, dated as of January 15, 1948 (Registration No. 2-7369)* 4.9 Eighth Supplemental Indenture, dated as of August 15, 1948 (Registration No. 2-7610)* 4.10 Ninth Supplemental Indenture, dated as of February 15, 1951 (Registration No. 2-8781)* 4.11 Tenth Supplemental Indenture, dated as of August 15, 1951 (Registration No. 2-7968)* 4.12 Eleventh Supplemental Indenture, dated as of August 15, 1953 (Registration No. 2-10396)* 4.13 Twelfth Supplemental Indenture, dated as of August 15, 1954 (Registration No. 2-11049)* 4.14 Thirteenth Supplemental Indenture, dated as of April 15, 1956 (Registration No. 2-12341)* 4.15 Fourteenth Supplemental Indenture, dated as of February 15, 1957 (Registration No. 2-13030)* 4.16 Fifteenth Supplemental Indenture, dated as of July 1, 1957 (Registration No. 2-13418)* 4.17 Sixteenth Supplemental Indenture, dated as of August 15, 1957 (Registration No. 2-13516)* 4.18 Seventeenth Supplemental Indenture, dated as of August 15, 1958 (Registration No. 2-14285)* 4.19 Eighteenth Supplemental Indenture, dated as of January 15, 1960 (Registration No. 2-15906)* 4.20 Nineteenth Supplemental Indenture, dated as of August 15, 1960 (Registration No. 2-16820)* 4.21 Twentieth Supplemental Indenture, dated as of April 1, 1961 (Registration No. 2-17668)* 4.22 Twenty-First Supplemental Indenture, dated as of May 1, 1962 (Registration No. 2-20221)* 4.23 Twenty-Second Supplemental Indenture, dated as of October 15, 1962 (Registration No. 2-20791)* 4.24 Twenty-Third Supplemental Indenture, dated as of May 15, 1963 (Registration No. 2-21346)* 4.25 Twenty-Fourth Supplemental Indenture, dated as of February 15, 1964 (Registration No. 2-22056)*\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n4.26 Twenty-Fifth Supplemental Indenture, dated as of February 1, 1965 (Registration No. 2-23082)* 4.27 Twenty-Sixth Supplemental Indenture, dated as of May 1, 1966 (Registration No. 2-24835)* 4.28 Twenty-Seventh Supplemental Indenture, dated as of August 15, 1966 (Registration No. 2-25314)* 4.29 Twenty-Eighth Supplemental Indenture, dated as of May 1, 1967 (Registration No. 2-26323)* 4.30 Twenty-Ninth Supplemental Indenture, dated as of February 1, 1968 (Registration No. 2-28000)* 4.31 Thirtieth Supplemental Indenture, dated as of January 15, 1969 (Registration No. 2-31044)* 4.32 Thirty-First Supplemental Indenture, dated as of October 1, 1969 (Registration No. 2-34839)* 4.33 Thirty-Second Supplemental Indenture, dated as of December 1, 1970 (Registration No. 2-38713)* 4.34 Thirty-Third Supplemental Indenture, dated as of September 15, 1971 (Registration No. 2-41527)* 4.35 Thirty-Fourth Supplemental Indenture, dated as of August 15, 1972 (Registration No. 2-45046)* 4.36 Thirty-Fifth Supplemental Indenture, dated as of February 1, 1974 (Registration No. 2-50039)* 4.37 Thirty-Sixth Supplemental Indenture, dated as of July 1, 1974 (Registration No. 2-59199)* 4.38 Thirty-Seventh Supplemental Indenture, dated as of November 1, 1974 (Registration No. 2-52160)* 4.39 Thirty-Eighth Supplemental Indenture, dated as of March 1, 1975 (Registration No. 2-52776)* 4.40 Thirty-Ninth Supplemental Indenture, dated as of March 15, 1976 (Registration No. 2-55463)* 4.41 Fortieth Supplemental Indenture, dated as of July 1, 1977 (Registration No. 2-59199)* 4.42 Forty-First Supplemental Indenture, dated as of November 1, 1978 (Registration No. 2-62609)* 4.43 Forty-Second Supplemental Indenture, dated as of June 15, 1979 (File No. 1-2313)* 4.44 Forty-Third Supplemental Indenture, dated as of September 15, 1979 (File No. 1-2313)* 4.45 Forty-Fourth Supplemental Indenture, dated as of October 1, 1979 (Registration No. 2-65493)* 4.46 Forty-Fifth Supplemental Indenture, dated as of April 1, 1980 (Registration No. 2-66896)* 4.47 Forty-Sixth Supplemental Indenture, dated as of November 15, 1980 (Registration No. 2-69609)* 4.48 Forty-Seventh Supplemental Indenture, dated as of May 15, 1981 (Registration No. 2-71948)* 4.49 Forty-Eighth Supplemental Indenture, dated as of August 1, 1981 (File No. 1-2313)* 4.50 Forty-Ninth Supplemental Indenture, dated as of December 1, 1981 (Registration No. 2-74339)* 4.51 Fiftieth Supplemental Indenture, dated as of January 16, 1982 (File No. 1-2313)* 4.52 Fifty-First Supplemental Indenture, dated as of April 15, 1982 (Registration No. 2-76626)*\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n4.53 Fifty-Second Supplemental Indenture, dated as of November 1, 1982 (Registration No. 2-79672)* 4.54 Fifty-Third Supplemental Indenture, dated as of November 1, 1982 (File No. 1-2313)* 4.55 Fifty-Fourth Supplemental Indenture, dated as of January 1, 1983 (File No. 1-2313)* 4.56 Fifty-Fifth Supplemental Indenture, dated as of May 1, 1983 (File No. 1-2313)* 4.57 Fifty-Sixth Supplemental Indenture, dated as of December 1, 1984 (Registration No. 2-94512)* 4.58 Fifty-Seventh Supplemental Indenture, dated as of March 15, 1985 (Registration No. 2-96181)* 4.59 Fifty-Eighth Supplemental Indenture, dated as of October 1, 1985 (File No. 1-2313)* 4.60 Fifty-Ninth Supplemental Indenture, dated as of October 15, 1985 (File No. 1-2313)* 4.61 Sixtieth Supplemental Indenture, dated as of March 1, 1986 (File No. 1-2313)* 4.62 Sixty-First Supplemental Indenture, dated as of March 15, 1986 (File No. 1-2313)* 4.63 Sixty-Second Supplemental Indenture, dated as of April 15, 1986 (File No. 1-2313)* 4.64 Sixty-Third Supplemental Indenture, dated as of April 15, 1986 (File No. 1-2313)* 4.65 Sixty-Fourth Supplemental Indenture, dated as of July 1, 1986 (File No. 1-2313)* 4.66 Sixty-Fifth Supplemental Indenture, dated as of September 1, 1986 (File No. 1-2313)* 4.67 Sixty-Sixth Supplemental Indenture, dated as of September 1, 1986 (File No. 1-2313)* 4.68 Sixty-Seventh Supplemental Indenture, dated as of December 1, 1986 (File No. 1-2313)* 4.69 Sixty-Eighth Supplemental Indenture, dated as of July 1, 1987 (Registration No. 33-19541)* 4.70 Sixty-Ninth Supplemental Indenture, dated as of October 15, 1987 (Registration No. 33-19541)* 4.71 Seventieth Supplemental Indenture, dated as of November 1, 1987 (File No. 1-2313)* 4.72 Seventy-First Supplemental Indenture, dated as of February 15, 1988 (File No. 1-2313)* 4.73 Seventy-Second Supplemental Indenture, dated as of April 15, 1988 (File No. 1-2313)* 4.74 Seventy-Third Supplemental Indenture, dated as of July 1, 1988 (File No. 1-2313)* 4.75 Seventy-Fourth Supplemental Indenture, dated as of August 15, 1988 (File No. 1-2313)* 4.76 Seventy-Fifth Supplemental Indenture, dated as of September 15, 1988 (File No. 1-2313)* 4.77 Seventy-Sixth Supplemental Indenture, dated as of January 15, 1989 (File No. 1-2313)* 4.78 Seventy-Seventh Supplemental Indenture, dated as of May 1, 1990 (File No. 1-2313)* 4.79 Seventy-Eighth Supplemental Indenture, dated as of June 15, 1990 (File No. 1-2313)* 4.80 Seventy-Ninth Supplemental Indenture, dated as of August 15, 1990 (File No. 1-2313)* 4.81 Eightieth Supplemental Indenture, dated as of December 1, 1990 (File No. 1-2313)*\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n4.82 Eighty-First Supplemental Indenture, dated as of April 1, 1991 (File No. 1-2313)* 4.83 Eighty-Second Supplemental Indenture, dated as of May 1, 1991 (File No. 1-2313)* 4.84 Eighty-Third Supplemental Indenture, dated as of June 1, 1991 (File No. 1-2313)* 4.85 Eighty-Fourth Supplemental Indenture, dated as of December 1, 1991 (File No. 1-2313)* 4.86 Eighty-Fifth Supplemental Indenture, dated as of February 1, 1992 (File No. 1-2313)* 4.87 Eighty-Sixth Supplemental Indenture, dated as of April 1, 1992 (File No. 1-2313)* 4.88 Eighty-Seventh Supplemental Indenture, dated as of July 1, 1992 (File No. 1-2313)* 4.89 Eighty-Eighth Supplemental Indenture, dated as of July 15 1992 (File No. 1-2313)* 4.90 Eighty-Ninth Supplemental Indenture, dated as of December 1, 1992 (File No. 1-2313)* 4.91 Ninetieth Supplemental Indenture, dated as of January 15, 1993 (File No. 1-2313)* 4.92 Ninety-First Supplemental Indenture, dated as of March 1, 1993 (File No. 1-2313)* 4.93 Ninety-Second Supplemental Indenture, dated as of June 1, 1993* 4.94 Ninety-Third Supplemental Indenture, dated as of June 15, 1993 (File No. 1-2313)* 4.95 Ninety-Fourth Supplemental Indenture, dated as of July 15, 1993 (File No. 1-2313)* 4.96 Ninety-Fifth Supplemental Indenture, dated as of September 1, 1993 (File No. 1-2313)* 4.97 Ninety-Sixth Supplemental Indenture, dated as of October 1, 1993 (File No. 1-2313)* 10.1 1981 Deferred Compensation Agreement (File No. 1-2313)* 10.2 1985 Deferred Compensation Agreement for Executives (File No. 1-2313)* 10.3 1985 Deferred Compensation Agreement for Directors (File No. 1-2313)* 10.4 1987 Deferred Compensation Plan for Executives (File No. 1-2313)* 10.5 1988 Deferred Compensation Plan for Executives (File No. 1-2313)* 10.6 1989 Deferred Compensation Plan for Executives (File No. 1-2313)* 10.7 1990 Deferred Compensation Plan for Executives (File No. 1-2313)* 10.8 Annual Deferred Compensation Plan for Executives (File No. 1-2313)* 10.9 Director Deferred Compensation Plan 10.10 Director Grantor Trust Agreement 10.11 Executive Deferred Compensation Plan 10.12 Executive Grantor Trust Agreement 10.13 Executive Supplemental Benefit Program (File No. 1-2313)* 10.14 Executive Retirement Plan as amended January 1, 1995 10.15 Employment Agreement with Howard P. Allen (File No. 1-2313)*\nEXHIBIT INDEX\nExhibit Number Description - ------- -----------\n10.16 1994 Executive Incentive Compensation Plan (File No. 1-2313)* 10.17 1995 Executive Incentive Compensation Plan 10.18 Executive Disability and Survivor Benefit Program (File No. 1-2313)* 10.19 Retirement Plan for Directors (File No. 1-2313)* 10.20 Director Incentive Compensation Plan 10.21 Officer Long-Term Incentive Plan for Executive Officers (Registration No. 33-19541)* 10.21.1 Form of Agreement for 1989-1995 Awards under the Officer Long-Term Incentive Compensation Plan 10.22 Estate and Financial Planning Program as amended December 13, 1995 10.23 Consulting Agreement with Howard P. Allen (File No. 1-2313)* 10.24 Employment Agreement with Bryant C. Danner (File No. 1-2313)* 10.25 Employment Agreement with Stephen E. Frank 12. Computation of Ratios of Earnings to Fixed Charges 13. Selected portions of the Annual Report to Shareholders for year ended December 31, 1995 23. Consent of Independent Public Accountants - Arthur Andersen LLP 24.1 Power of Attorney 24.2 Certified copy of Resolution of Board of Directors Authorizing Signature 27. Financial Data Schedule\n____________ * Incorporated by reference pursuant to Rule 12b-32.\nPAGE\nEXHIBIT 3.2\nTo Holders of the Company's Bylaws:\nEffective February 15, 1996, Article III, Section 6, was amended to specify that regular Board meetings will not be held in June, August, October, and December.\nBEVERLY P. RYDER Corporate Secretary\nBYLAWS\nOF\nSOUTHERN CALIFORNIA EDISON COMPANY\nAS AMENDED TO AND INCLUDING\nFEBRUARY 15, 1996\nPAGE\nINDEX\nPage\nARTICLE I -- PRINCIPAL OFFICE\nSection 1. Principal Office 1\nARTICLE II -- SHAREHOLDERS\nSection 1. Meeting Locations 1 Section 2. Annual Meetings 1 Section 3. Special Meetings 2 Section 4. Notice of Annual or Special Meeting 2 Section 5. Quorum 3 Section 6. Adjourned Meeting and Notice Thereof 4 Section 7. Voting 4 Section 8. Record Date 6 Section 9. Consent of Absentees 7 Section 10. Action Without Meeting 7 Section 11. Proxies 7 Section 12. Inspectors of Election 8\nARTICLE III -- DIRECTORS\nSection 1. Powers 8 Section 2. Number of Directors 9 Section 3. Election and Term of Office 10 Section 4. Vacancies 10 Section 5. Place of Meeting 11 Section 6. Regular Meetings 11 Section 7. Special Meetings 11 Section 8. Quorum 12 Section 9. Participation in Meetings by Conference Telephone 12 Section 10. Waiver of Notice 12 Section 11. Adjournment 12 Section 12. Fees and Compensation 13 Section 13. Action Without Meeting 13 Section 14. Rights of Inspection 13 Section 15. Committees 13\n-i- PAGE\nARTICLE IV -- OFFICERS\nSection 1. Officers 14 Section 2. Election 14 Section 3. Eligibility of Chairman or President 15 Section 4. Removal and Resignation 15 Section 5. Appointment of Other Officers 15 Section 6. Vacancies 15 Section 7. Salaries 15 Section 8. Furnish Security for Faithfulness 16 Section 9. Chairman's Duties; Succession to Such Duties in Chairman's Absence or Disability 16 Section 10. President's Duties 16 Section 11. Chief Financial Officer 16 Section 12. Vice President's Duties 17 Section 13. General Counsel's Duties 17 Section 14. Associate General Counsel's and Assistant General Counsel's Duties 17 Section 15. Controller's Duties 17 Section 16. Assistant Controllers' Duties 17 Section 17. Treasurer's Duties 17 Section 18. Assistant Treasurers' Duties 18 Section 19. Secretary's Duties 18 Section 20. Assistant Secretaries' Duties 19 Section 21. Secretary Pro Tempore 19 Section 22. Election of Acting Treasurer or Acting Secretary 19 Section 23. Performance of Duties 19\nARTICLE V -- OTHER PROVISIONS\nSection 1. Inspection of Corporate Records 20 Section 2. Inspection of Bylaws 20 Section 3. Contracts and Other Instruments, Loans, Notes and Deposits of Funds 21 Section 4. Certificates of Stock 21 Section 5. Transfer Agent, Transfer Clerk and Registrar 22 Section 6. Representation of Shares of Other Corporations 22\n-ii- PAGE\nARTICLE V -- OTHER PROVISIONS (Cont.)\nSection 7. Stock Purchase Plans 22 Section 8. Fiscal Year and Subdivisions 23 Section 9. Construction and Definitions 23\nARTICLE VI -- INDEMNIFICATION\nSection 1. Indemnification of Directors and Officers 23 Section 2. Indemnification of Employees and Agents 25 Section 3. Right of Directors and Officers to Bring Suit 25 Section 4. Successful Defense 26 Section 5. Non-Exclusivity of Rights 26 Section 6. Insurance 26 Section 7. Expenses as a Witness 26 Section 8. Indemnity Agreements 27 Section 9. Separability 27 Section 10. Effect of Repeal or Modification 27\nARTICLE VII -- EMERGENCY PROVISIONS\nSection 1. General 27 Section 2. Unavailable Directors 28 Section 3. Authorized Number of Directors 28 Section 4. Quorum 28 Section 5. Creation of Emergency Committee 28 Section 6. Constitution of Emergency Committee 28 Section 7. Powers of Emergency Committee 29 Section 8. Directors Becoming Available 29 Section 9. Election of Board of Directors 29 Section 10. Termination of Emergency Committee 29\nARTICLE VIII -- AMENDMENTS\nSection 1. Amendments 30\n-iii- PAGE\nBYLAWS\nBylaws for the regulation, except as otherwise provided by statute or its Articles of Incorporation\nof\nSOUTHERN CALIFORNIA EDISON COMPANY\nAS AMENDED TO AND INCLUDING FEBRUARY 15, 1996\nARTICLE I -- PRINCIPAL OFFICE\nSection 1. Principal Office.\nThe Edison General Office, situated at 2244 Walnut Grove Avenue, in the City of Rosemead, County of Los Angeles, State of California, is hereby fixed as the principal office for the transaction of the business of the corporation.\nARTICLE II -- SHAREHOLDERS\nSection 1. Meeting Locations.\nAll meetings of shareholders shall be held at the principal office of the corporation or at such other place or places within or without the State of California as may be designated by the Board of Directors (the \"Board\"). In the event such places shall prove inadequate in capacity for any meeting of shareholders, an adjournment may be taken to and the meeting held at such other place of adequate capacity as may be designated by the officer of the corporation presiding at such meeting.\nSection 2. Annual Meetings.\nThe annual meeting of shareholders shall be held on the third Thursday of the month of April of each year at 10:00 a.m. on said day to elect directors to hold office for the year next ensuing and until their successors shall be elected, and to consider and act upon such other matters as may lawfully be presented to such meeting; provided, however, that should said day fall upon a legal holiday, then any such annual meeting of shareholders shall be held at the same time and place on the next day thereafter ensuing which is not a legal holiday.\nPAGE\nARTICLE II\nSection 3. Special Meetings.\nSpecial meetings of the shareholders may be called at any time by the Board, the Chairman of the Board, the President, or upon written request of any three members of the Board, or by the holders of shares entitled to cast not less than ten percent of the votes at such meeting. Upon request in writing to the Chairman of the Board, the President, any Vice President or the Secretary by any person (other than the Board) entitled to call a special meeting of shareholders, the officer forthwith shall cause notice to be given to the shareholders entitled to vote that a meeting will be held at a time requested by the person or persons calling the meeting, not less than thirty-five nor more than sixty days after the receipt of the request. If the notice is not given within twenty days after receipt of the request, the persons entitled to call the meeting may give the notice.\nSection 4. Notice of Annual or Special Meeting.\nWritten notice of each annual or special meeting of shareholders shall be given not less than ten (or if sent by third-class mail, thirty) nor more than sixty days before the date of the meeting to each shareholder entitled to vote thereat. Such notice shall state the place, date, and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, and no other business may be transacted, or (ii) in the case of an annual meeting, those matters which the Board, at the time of the mailing of the notice, intends to present for action by the shareholders, but, subject to the provisions of applicable law and these Bylaws, any proper matter may be presented at an annual meeting for such action. The notice of any special or annual meeting at which directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by the Board for election. For any matter to be presented by a shareholder at an annual meeting held after December 31, 1993, including the nomination of any person (other than a person nominated by or at the direction of the Board) for election to the Board, written notice must be received by the Secretary of the corporation from the shareholder not less than sixty nor more than one hundred twenty days prior to the date of the annual meeting specified in these Bylaws and to which the shareholder's notice relates; provided however, that in the event the annual meeting to which the shareholder's written notice relates is to be held on a date which is more than thirty days earlier than the date of the annual meeting specified in these Bylaws, the notice from a shareholder must be received by the Secretary not later than the close of business on the tenth day following the date on which public disclosure of the date of the annual meeting was made or given to the shareholders. The shareholder's notice to the Secretary shall set forth (a) a brief description of each matter to be presented at the annual meeting by the shareholder; (b) the name and address, as they appear on the corporation's books, of the shareholder; (c) the class and number of shares of the corporation ARTICLE II\nwhich are beneficially owned by the shareholder; and (d) any material interest of the shareholder in the matters to be presented. Any shareholder who intends to nominate a candidate for election as a director shall also set forth in such a notice (i) the name, age, business address and residence address of each nominee that he or she intends to nominate at the meeting, (ii) the principal occupation or employment of each nominee, (iii) the number of shares of capital stock of the corporation beneficially owned by each nominee, and (iv) any other information concerning the nominee that would be required under the rules of the Securities and Exchange Commission in a proxy statement soliciting proxies for the election of the nominee. The notice shall also include a consent, signed by the shareholder's nominees, to serve as a director of the corporation if elected. Notwithstanding anything in these Bylaws to the contrary, and subject to the provisions of any applicable law, no business shall be conducted at a special or annual meeting except in accordance with the procedures set forth in this Section 4.\nNotice of a shareholders' meeting shall be given either personally or by first-class mail (or, if the outstanding shares of the corporation are held of record by 500 or more persons on the record date for the meeting, by third-class mail) or by other means of written communication, addressed to the shareholder at the address of such shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice; or, if no such address appears or is given, at the place where the principal office of the corporation is located or by publication at least once in a newspaper of general circulation in the county in which the principal office is located. Notice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mails, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually transmitted by the person giving the notice by electronic means, to the recipient.\nSection 5. Quorum.\nA majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum at any meeting of shareholders. The affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by law or the Articles; provided, however, that the shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to have less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. ARTICLE II\nSection 6. Adjourned Meeting and Notice Thereof.\nAny shareholders' meeting, whether or not a quorum is present, may be adjourned from time to time by the vote of a majority of the shares, the holders of which are either present in person or represented by proxy thereat, but in the absence of a quorum (except as provided in Section 5 of this Article) no other business may be transacted at such meeting.\nIt shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted thereat, other than by announcement at the meeting at which such adjournment is taken. At the adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting. However, when any shareholders' meeting is adjourned for more than forty- five days or, if after adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given as in the case of an original meeting.\nSection 7. Voting.\nThe shareholders entitled to notice of any meeting or to vote at any such meeting shall be only persons in whose name shares stand on the stock records of the corporation on the record date determined in accordance with Section 8 of this Article.\nVoting shall in all cases be subject to the provisions of Chapter 7 of the California General Corporation Law, and to the following provisions:\n(a) Subject to clause (g), shares held by an administrator, executor, guardian, conservator or custodian may be voted by such holder either in person or by proxy, without a transfer of such shares into the holder's name; and shares standing in the name of a trustee may be voted by the trustee, either in person or by proxy, but no trustee shall be entitled to vote shares held by such trustee without a transfer of such shares into the trustee's name.\n(b) Shares standing in the name of a 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 the receiver's name if authority to do so is contained in the order of the court by which such receiver was appointed. ARTICLE II\n(c) Subject to the provisions of Section 705 of the California General Corporation Law and except where otherwise agreed in writing between the parties, a shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred.\n(d) Shares standing in the name of a minor may be voted and the corporation may treat all rights incident thereto as exercisable by the minor, in person or by proxy, whether or not the corporation has notice, actual or constructive, of the non-age unless a guardian of the minor's property has been appointed and written notice of such appointment given to the corporation.\n(e) Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent or proxyholder as the bylaws of such other corporation may prescribe or, in the absence of such provision, as the Board of Directors of such other corporation may determine or, in the absence of such determination, by the chairman of the board, president or any vice president of such other corporation, or by any other person authorized to do so by the chairman of the board, president or any vice president of such other corporation. Shares which are purported to be voted or any proxy purported to be executed in the name of a corporation (whether or not any title of the person signing is indicated) shall be presumed to be voted or the proxy executed in accordance with the provisions of this subdivision, unless the contrary is shown.\n(f) Shares of the corporation owned by any of its subsidiaries shall not be entitled to vote on any matter.\n(g) Shares of the corporation held by the corporation in a fiduciary capacity, and shares of the corporation held in a fiduciary capacity by any of its subsidiaries, shall not be entitled to vote on any matter, except to the extent that the settlor or beneficial owner possesses and exercises a right to vote or to give the corporation binding instructions as to how to vote such shares.\n(h) If shares stand of record in the names of two or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, husband and wife as community property, tenants by the entirety, voting trustees, persons entitled to vote under a shareholder voting agreement or otherwise, or if two or more persons (including proxyholders) have the same fiduciary relationship respecting the same shares, unless the secretary of the corporation is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein it is so provided, their acts with respect to voting shall have the following effect: ARTICLE II\n(i) If only one votes, such act binds all;\n(ii) If more than one vote, the act of the majority so voting binds all;\n(iii) If more than one vote, but the vote is evenly split on any particular matter, each faction may vote the securities in question proportionately.\nIf the instrument so filed or the registration of the shares shows that any such tenancy is held in unequal interests, a majority or even split for the purpose of this section shall be a majority or even split in interest.\nNo shareholder of any class of stock of this corporation shall be entitled to cumulate votes at any election of directors of this corporation.\nElections for directors need not be by ballot; provided, however, that all elections for directors must be by ballot upon demand made by a shareholder at the meeting and before the voting begins.\nIn any election of directors, the candidates receiving the highest number of votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares are elected.\nSection 8. Record Date.\nThe Board may fix, in advance, a record date for the determination of the shareholders entitled to notice of any meeting or to vote or entitled to receive payment of any dividend or other distribution, or any allotment of rights, or to exercise rights in respect of any other lawful action. The record date so fixed shall be not more than sixty days nor less than ten days prior to the date of the meeting nor more than sixty days prior to any other action. When a record date is so fixed, only shareholders of record at the close of business on that date are entitled to notice of and to vote at the meeting or to receive the dividend, distribution, or allotment of rights, or to exercise the rights, as the case may be, notwithstanding any transfer of shares on the books of the corporation after the record date, except as otherwise provided by law or these Bylaws. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting unless the Board fixes a new record date for the adjourned meeting. The Board shall fix a new record date if the meeting is adjourned for more than forty-five days.\nIf no record date is fixed by the Board, the record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business ARTICLE II\nday next preceding the day on which the meeting is held. The record date for determining shareholders for any purpose other than as set forth in this Section 8 or Section 10 of this Article shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth day prior to the date of such other action, whichever is later.\nSection 9. Consent of Absentees.\nThe transactions of any meeting of shareholders, however called and noticed, and wherever held, are as valid as though had at a meeting duly held after regular call and notice, if a quorum is present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice or a consent to the holding of the meeting or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Neither the business to be transacted at nor the purpose of any regular or special meeting of shareholders need be specified in any written waiver of notice, consent to the holding of the meeting or approval of the minutes thereof, except as provided in Section 601 (f) of the California General Corporation Law.\nSection 10. Action Without Meeting.\nSubject to Section 603 of the California General Corporation Law, any action which, under any provision of the California General Corporation Law, may be taken at any annual or special meeting of shareholders 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 shares entitled to vote thereon were present and voted. Unless a record date for voting purposes be fixed as provided in Section 8 of this Article, the record date for determining shareholders entitled to give consent pursuant to this Section 10, when no prior action by the Board has been taken, shall be the day on which the first written consent is given.\nSection 11. Proxies.\nEvery person entitled to vote shares has the right to do so either in person or by one or more persons, not to exceed three, authorized by a written proxy executed by such shareholder and filed with the Secretary. Subject to the following sentence, any proxy duly executed continues in full force and effect until revoked by the person executing it prior to the vote pursuant thereto by a writing delivered to the corporation stating that the proxy is revoked or by a ARTICLE III\nsubsequent proxy executed by the person executing the prior proxy and presented to the meeting, or by attendance at the meeting and voting in person by the person executing the proxy; provided, however, that a proxy is not revoked by the death or incapacity of the maker unless, before the vote is counted, written notice of such death or incapacity is received by this corporation. No proxy shall be valid after the expiration of eleven months from the date of its execution unless otherwise provided in the proxy.\nSection 12. Inspectors of Election.\nIn advance of any meeting of shareholders, the Board may appoint any persons other than nominees as inspectors of election to act at such meeting and any adjournment thereof. If inspectors of election are not so appointed, or if any persons so appointed fail to appear or refuse to act, the chairman of any such meeting may, and on the request of any shareholder or shareholder's proxy shall, make such appointments at the meeting. The number of inspectors shall be either one or three. If appointed at a meeting on the request of one or more shareholders or proxies, the majority of shares present shall determine whether one or three inspectors are to be appointed.\nThe duties of such inspectors shall be as prescribed by Section 707 (b) of the California General Corporation Law and shall include: determining the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity and effect of proxies; receiving votes, ballots or consents; hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating all votes or consents; determining when the polls shall close; determining the result; and doing such acts as may be proper to conduct the election or vote with fairness to all shareholders. If there are three inspectors of election, the decision, act or certificate of a majority is effective in all respects as the decision, act or certificate of all. Any report or certificate made by the inspectors of election is prima facie evidence of the facts stated therein.\nARTICLE III -- DIRECTORS\nSection 1. Powers.\nSubject to limitations of the Articles, of these Bylaws and of the California General Corporation Law relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate ARTICLE III\npowers shall be exercised by or under the direction of the Board. The Board may delegate the management of the day-to-day operation of the business of the corporation provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board. Without prejudice to such general powers, but subject to the same limitations, it is hereby expressly declared that the Board shall have the following powers in addition to the other powers enumerated in these Bylaws:\n(a) To select and remove all the other officers, agents and employees of the corporation, prescribe the powers and duties for them as may not be inconsistent with law, with the Articles or these Bylaws, fix their compensation and require from them security for faithful service.\n(b) To conduct, manage and control the affairs and business of the corporation and to make such rules and regulations therefor not inconsistent with law, or with the Articles or these Bylaws, as they may deem best.\n(c) To adopt, make and use a corporate seal, and to prescribe the forms of certificates of stock, and to alter the form of such seal and of such certificates from time to time as in their judgment they may deem best.\n(d) To authorize the issuance of shares of stock of the corporation from time to time, upon such terms and for such consideration as may be lawful.\n(e) To borrow money and incur indebtedness for the purposes of the corporation, and to cause to be executed and delivered therefor, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations or other evidences of debt and securities therefor.\nSection 2. Number of Directors.\nThe authorized number of directors shall be not less than fifteen nor more than twenty until changed by amendment of the Articles or by a Bylaw duly adopted by the shareholders. The exact number of directors shall be fixed, within the limits specified, by the Board by adoption of a resolution or by the shareholders in the same manner provided in these Bylaws for the amendment thereof. ARTICLE III\nSection 3. Election and Term of Office.\nThe directors shall be elected at each annual meeting of the shareholders, but if any such annual meeting is not held or the directors are not elected thereat, the directors may be elected at any special meeting of shareholders held for that purpose. Each director shall hold office until the next annual meeting and until a successor has been elected and qualified.\nSection 4. Vacancies.\nAny director may resign effective upon giving written notice to the Chairman of the Board, the President, the Secretary or the Board, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation is effective at a future time, a successor may be elected to take office when the resignation becomes effective.\nVacancies in the Board, except those existing as a result of a removal of a director, may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director, and each director so elected shall hold office until the next annual meeting and until such director's successor has been elected and qualified. Vacancies existing as a result of a removal of a director may be filled by the shareholders as provided by law.\nA vacancy or vacancies in the Board shall be deemed to exist in case of the death, resignation or removal of any director, or if the authorized number of directors be increased, or if the shareholders fail, at any annual or special meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be voted for at that meeting.\nThe Board may declare vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony.\nThe shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors. Any such election by written consent other than to fill a vacancy created by removal requires the consent of a majority of the outstanding shares entitled to vote. If the Board accepts the resignation of a director tendered to take effect at a future time, the Board or the shareholders shall have power to elect a successor to take office when the resignation is to become effective.\nNo reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of the director's term of office. ARTICLE III\nSection 5. Place of Meeting.\nRegular or special meetings of the Board shall be held at any place within or without the State of California which has been designated from time to time by the Board or as provided in these Bylaws. In the absence of such designation, regular meetings shall be held at the principal office of the corporation.\nSection 6. Regular Meetings.\nPromptly following each annual meeting of shareholders the Board shall hold a regular meeting for the purpose of organization, election of officers and the transaction of other business.\nRegular meetings of the Board shall be held at the principal office of the corporation without notice on the third Thursday of each month, except the months of June, August, October, and December, at the hour of 9:00 a.m. or as soon thereafter as the regular meeting of the Board of Directors of Edison International is adjourned. Call and notice of all regular meetings of the Board are not required.\nSection 7. Special Meetings.\nSpecial meetings of the Board for any purpose or purposes may be called at any time by the Chairman of the Board, the President, any Vice President, the Secretary or by any two directors.\nSpecial meetings of the Board shall be held upon four days' written notice or forty-eight hours' notice given personally or by telephone, telegraph, telex, facsimile, electronic mail or other similar means of communication. Any such notice shall be addressed or delivered to each director at such director's address as it is shown upon the records of the corporation or as may have been given to the corporation by the director for purposes of notice or, if such address is not shown on such records or is not readily ascertainable, at the place in which the meetings of the directors are regularly held. The notice need not specify the purpose of such special meeting.\nNotice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mail, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually ARTICLE III\ntransmitted by the person giving the notice by electronic means to the recipient. Oral notice shall be deemed to have been given at the time it is communicated, in person or by telephone, radio or other similar means to the recipient or to a person at the office of the recipient who the person giving the notice has reason to believe will promptly communicate it to the recipient.\nSection 8. Quorum.\nOne-third of the number of authorized directors constitutes a quorum of the Board for the transaction of business, except to adjourn as provided in Section ll of this Article. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board, unless a greater number is required by law or by the Articles; provided, however, that a meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting.\nSection 9. Participation in Meetings by Conference Telephone.\nMembers of the Board may participate in a meeting through use of conference telephone or similar communications equipment, so long as all members participating in such meeting can hear one another. Such participation constitutes presence in person at such meeting.\nSection 10. Waiver of Notice.\nThe transactions of any meeting of the Board, however called and noticed or wherever held, are as valid as though had at a meeting duly held after regular call and notice if a quorum is present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding such meeting or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting.\nSection 11. Adjournment.\nA majority of the directors present, whether or not a quorum is present, may adjourn any directors' meeting to another time and place. Notice of the time and place of holding an adjourned meeting need not be given to absent directors if the time and place is fixed at the meeting adjourned. If the meeting is adjourned for more than twenty-four hours, notice of any adjournment to another time or place shall be given prior to the time of the adjourned meeting to the directors who were not present at the time of the adjournment. ARTICLE III\nSection 12. Fees and Compensation.\nDirectors and members of committees may receive such compensation, if any, for their services, and such reimbursement for expenses, as may be fixed or determined by the Board.\nSection 13. Action Without Meeting.\nAny action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board shall individually or collectively consent in writing to such action. Such written consent or consents shall have the same force and effect as a unanimous vote of the Board and shall be filed with the minutes of the proceedings of the Board.\nSection 14. Rights of Inspection.\nEvery director shall have the absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation and also of its subsidiary corporations, domestic or foreign. Such inspection by a director may be made in person or by agent or attorney and includes the right to copy and make extracts.\nSection 15. Committees.\nThe Board may appoint one or more committees, each consisting of two or more directors, to serve at the pleasure of the Board. The Board may delegate to such committees any or all of the authority of the Board except with respect to:\n(a) The approval of any action for which the California General Corporation Law also requires shareholders' approval or approval of the outstanding shares;\n(b) The filling of vacancies on the Board or in any committee;\n(c) The fixing of compensation of the directors for serving on the Board or on any committee;\n(d) The amendment or repeal of Bylaws or the adoption of new Bylaws;\n(e) The amendment or repeal of any resolution of the Board which by its express terms is not so amendable or repealable; ARTICLE IV\n(f) A distribution to the shareholders of the corporation except at a rate or in a periodic amount or within a price range determined by the Board; or\n(g) The appointment of other committees of the Board or the members thereof.\nAny such committee, or any member or alternate member thereof, must be appointed by resolution adopted by a majority of the exact number of authorized directors as specified in Section 2 of this Article. The Board shall have the power to prescribe the manner and timing of giving of notice of regular or special meetings of any committee and the manner in which proceedings of any committee shall be conducted. In the absence of any such prescription, such committee shall have the power to prescribe the manner in which its proceedings shall be conducted. Unless the Board or such committee shall otherwise provide, the regular and special meetings and other actions of any such committee shall be governed by the provisions of this Article applicable to meetings and actions of the Board. Minutes shall be kept of each meeting of each committee.\nARTICLE IV -- OFFICERS\nSection 1. Officers.\nThe officers of the corporation shall be a Chairman of the Board, a President, a Chief Financial Officer, one or more Vice Presidents, a General Counsel, one or more Associate General Counsel, one or more Assistant General Counsel, a Controller, one or more Assistant Controllers, a Treasurer, one or more Assistant Treasurers, a Secretary and one or more Assistant Secretaries, and such other officers as may be elected or appointed in accordance with Section 5 of this Article. The Board, the Chairman of the Board or the President may confer a special title upon any Vice President not specified herein. Any number of offices of the corporation may be held by the same person.\nSection 2. Election.\nThe officers of the corporation, except such officers as may be elected or appointed in accordance with the provisions of Section 5 or Section 6 of this Article, shall be chosen annually by, and shall serve at the pleasure of the Board, and shall hold their respective offices until their resignation, removal, or other disqualification from service, or until their respective successors shall be elected. ARTICLE IV\nSection 3. Eligibility of Chairman or President.\nNo person shall be eligible for the office of Chairman of the Board or President unless such person is a member of the Board of the corporation; any other officer may or may not be a director.\nSection 4. Removal and Resignation.\nAny officer may be removed, either with or without cause, by the Board at any time or by any officer upon whom such power or removal may be conferred by the Board. Any such removal shall be without prejudice to the rights, if any, of the officer under any contract of employment of the officer.\nAny officer may resign at any time by giving written notice to the corporation, but without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 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 5. Appointment of Other Officers.\nThe Board may appoint such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in the Bylaws or as the Board may from time to time determine.\nSection 6. Vacancies.\nA vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled at any time deemed appropriate by the Board in the manner prescribed in these Bylaws for regular election or appointment to such office.\nSection 7. Salaries.\nThe salaries of the Chairman of the Board, President, Chief Financial Officer, Vice Presidents, General Counsel, Controller, Treasurer and Secretary of the corporation shall be fixed by the Board. Salaries of all other officers shall be as approved from time to time by the chief executive officer. ARTICLE IV\nSection 8. Furnish Security for Faithfulness.\nAny officer or employee shall, if required by the Board, furnish to the corporation security for faithfulness to the extent and of the character that may be required.\nSection 9. Chairman's Duties; Succession to Such Duties in Chairman's Absence or Disability.\nThe Chairman of the Board shall be the chief executive officer of the corporation and shall preside at all meetings of the shareholders and of the Board. Subject to the Board, the Chairman of the Board shall have charge of the business of the corporation, including the construction of its plants and properties and the operation thereof. The Chairman of the Board shall keep the Board fully informed, and shall freely consult them concerning the business of the corporation.\nIn the absence or disability of the Chairman of the Board, the President shall act as the chief executive officer of the corporation; in the absence or disability of the Chairman of the Board and the President, the next in order of election by the Board of the Vice Presidents shall act as chief executive officer of the corporation.\nIn the absence or disability of the Chairman of the Board, the President shall act as Chairman of the Board at meetings of the Board; in the absence or disability of the Chairman of the Board and the President, the next, in order of election by the Board, of the Vice Presidents who is a member of the Board shall act as Chairman of the Board at any such meeting of the Board; in the absence or disability of the Chairman of the Board, the President, and such Vice Presidents who are members of the Board, the Board shall designate a temporary Chairman to preside at any such meeting of the Board.\nSection 10. President's Duties.\nThe President shall perform such other duties as the Chairman of the Board shall delegate or assign to such officer.\nSection 11. Chief Financial Officer.\nThe Chief Financial Officer of the corporation shall be the chief consulting officer in all matters of financial import and shall have control over all financial matters concerning the corporation. ARTICLE IV\nSection 12. Vice Presidents' Duties.\nThe Vice Presidents shall perform such other duties as the chief executive officer shall designate.\nSection 13. General Counsel's Duties.\nThe General Counsel shall be the chief consulting officer of the corporation in all legal matters and, subject to the chief executive officer, shall have control over all matters of legal import concerning the corporation.\nSection 14. Associate General Counsel's and Assistant General Counsel's Duties.\nThe Associate General Counsel shall perform such of the duties of the General Counsel as the General Counsel shall designate, and in the absence or disability of the General Counsel, the Associate General Counsel, in order of election to that office by the Board at its latest organizational meeting, shall perform the duties of the General Counsel. The Assistant General Counsel shall perform such duties as the General Counsel shall designate.\nSection 15. Controller's Duties.\nThe Controller shall be the chief accounting officer of the Corporation and, subject to the Chief Financial Officer, shall have control over all accounting matters concerning the Corporation and shall perform such other duties as the Chief Executive Officer shall designate.\nSection 16. Assistant Controllers' Duties.\nThe Assistant Controllers shall perform such of the duties of the Controller as the Controller shall designate, and in the absence or disability of the Controller, the Assistant Controllers, in order of election to that office by the Board at its latest organizational meeting, shall perform the duties of the Controller.\nSection 17. Treasurer's Duties.\nIt shall be the duty of the Treasurer to keep in custody or control all money, stocks, bonds, evidences of debt, securities and other items of value that may belong to, or be in the possession or control of, the corporation, and to dispose of the same in such manner as the Board or the chief executive officer may direct, and to perform all acts incident to the position of Treasurer. ARTICLE IV\nSection 18. Assistant Treasurers' Duties.\nThe Assistant Treasurers shall perform such of the duties of the Treasurer as the Treasurer shall designate, and in the absence or disability of the Treasurer, the Assistant Treasurers, in order of election to that office by the Board at its latest organizational meeting, shall perform the duties of the Treasurer, unless action is taken by the Board as contemplated in Article IV, Section 22.\nSection 19. Secretary's Duties.\nThe Secretary shall keep or cause to be kept full and complete records of the proceedings of shareholders, the Board and its committees at all meetings, and shall affix the corporate seal and attest by signing copies of any part thereof when required.\nThe Secretary shall keep, or cause to be kept, a copy of the Bylaws of the corporation at the principal office in accordance with Section 213 of the California General Corporation Law.\nThe Secretary shall be the custodian of the corporate seal and shall affix it to such instruments as may be required.\nThe Secretary shall keep on hand a supply of blank stock certificates of such forms as the Board may adopt.\nThe Secretary shall serve or cause to be served by publication or otherwise, as may be required, all notices of meetings and of other corporate acts that may by law or otherwise be required to be served, and shall make or cause to be made and filed in the principal office of the corporation, the necessary certificate or proofs thereof.\nAn affidavit of mailing of any notice of a shareholders' meeting or of any report, in accordance with the provisions of Section 601 (b) of the California General Corporation Law, executed by the Secretary shall be prima facie evidence of the fact that such notice or report had been duly given.\nThe Secretary may, with the Chairman of the Board, the President, or a Vice President, sign certificates of ownership of stock in the corporation, and shall cause all certificates so signed to be delivered to those entitled thereto.\nThe Secretary shall keep all records required by the California General Corporation Law. ARTICLE IV\nThe Secretary shall generally perform the duties usual to the office of secretary of corporations, and such other duties as the chief executive officer shall designate.\nSection 20. Assistant Secretaries' Duties.\nAssistant Secretaries shall perform such of the duties of the Secretary as the Secretary shall designate, and in the absence or disability of the Secretary, the Assistant Secretaries, in the order of election to that office by the Board at its latest organizational meeting, shall perform the duties of the Secretary, unless action is taken by the Board as contemplated in Article IV, Sections 21 and 22 of these Bylaws.\nSection 21. Secretary Pro Tempore.\nAt any meeting of the Board or of the shareholders from which the Secretary is absent, a Secretary pro tempore may be appointed and act.\nSection 22. Election of Acting Treasurer or Acting Secretary.\nThe Board may elect an Acting Treasurer, who shall perform all the duties of the Treasurer during the absence or disability of the Treasurer, and who shall hold office only for such a term as shall be determined by the Board.\nThe Board may elect an Acting Secretary, who shall perform all the duties of the Secretary during the absence or disability of the Secretary, and who shall hold office only for such a term as shall be determined by the Board.\nWhenever the Board shall elect either an Acting Treasurer or Acting Secretary, or both, the officers of the corporation as set forth in Article IV, Section 1 of these Bylaws, shall include as if therein specifically set out, an Acting Treasurer or an Acting Secretary, or both.\nSection 23. Performance of Duties.\nOfficers shall perform the duties of their respective offices as stated in these Bylaws, and such additional duties as the Board shall designate. ARTICLE V\nARTICLE V -- OTHER PROVISIONS\nSection 1. Inspection of Corporate Records.\n(a) A shareholder or shareholders holding at least five percent in the aggregate of the outstanding voting shares of the corporation or who hold at least one percent of such voting shares and have filed a Schedule 14B with the United States Securities and Exchange Commission relating to the election of directors of the corporation shall have an absolute right to do either or both of the following:\n(i) Inspect and copy the record of shareholders' names and addresses and shareholdings during usual business hours upon five business days' prior written demand upon the corporation; or\n(ii) Obtain from the transfer agent, if any, for the corporation, upon five business days' prior written demand and upon the tender of its usual charges for such a list (the amount of which charges shall be stated to the shareholder by the transfer agent upon request), a list of the shareholders' names and addresses who are entitled to vote for the election of directors and their shareholdings, as of the most recent record date for which it has been compiled or as of a date specified by the shareholder subsequent to the date of demand.\n(b) The record of shareholders shall also be open to inspection and copying by any shareholder or holder of a voting trust certificate at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to such holder's interest as a shareholder or holder of a voting trust certificate.\n(c) The accounting books and records and minutes of proceedings of the shareholders and the Board and committees of the Board shall be open to inspection upon written demand on the corporation of any shareholder or holder of a voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holder's interests as a shareholder or as a holder of such voting trust certificate.\n(d) Any such inspection and copying under this Article may be made in person or by agent or attorney.\nSection 2. Inspection of Bylaws.\nThe corporation shall keep in its principle office the original or a copy of these Bylaws as amended to date, which shall be open to inspection by shareholders at all reasonable times during office hours.\nARTICLE V\nSection 3. Contracts and Other Instruments, Loans, Notes and Deposits of Funds.\nThe Chairman of the Board, the President, or a Vice President, either alone or with the Secretary or an Assistant Secretary, or the Secretary alone, shall execute in the name of the corporation such written instruments as may be authorized by the Board and, without special direction of the Board, such instruments as transactions of the ordinary business of the corporation may require and, such officers without the special direction of the Board may authenticate, attest or countersign any such instruments when deemed appropriate. The Board may authorize any person, persons, entity, entities, attorney, attorneys, attorney-in-fact, attorneys-in-fact, 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.\nNo loans shall be contracted on behalf of the corporation and no evidences of such indebtedness shall be issued in its name unless authorized by the Board as it may direct. Such authority may be general or confined to specific instances.\nAll checks, drafts, or other similar orders for the payment of money, notes, or other such 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 the Board or chief executive officer may direct.\nUnless authorized by the Board or these Bylaws, no officer, agent, employee or any other person or persons shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or amount.\nAll funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies, or other depositories as the Board may direct.\nSection 4. Certificates of Stock.\nEvery holder of shares of the corporation shall be entitled to have a certificate signed in the name of the corporation by the Chairman of the Board, the President, or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed\nARTICLE V\nupon 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 such person were an officer, transfer agent or registrar at the date of issue.\nCertificates for shares may be used prior to full payment under such restrictions and for such purposes as the Board may provide; provided, however, that on any certificate issued to represent any partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated.\nExcept as provided in this Section, no new certificate for shares shall be issued in lieu of an old one unless the latter is surrendered and canceled at the same time. The Board may, however, if any certificate for shares is alleged to have been lost, stolen or destroyed, authorize the issuance of a new certificate in lieu thereof, and the corporation may require that the corporation be given a bond or other adequate security sufficient to indemnify it against any claim that may be made against it (including expense or liability) on account of the alleged loss, theft or destruction of such certificate or the issuance of such new certificate.\nSection 5. Transfer Agent, Transfer Clerk and Registrar.\nThe Board may, from time to time, appoint transfer agents, transfer clerks, and stock registrars to transfer and register the certificates of the capital stock of the corporation, and may provide that no certificate of capital stock shall be valid without the signature of the stock transfer agent or transfer clerk, and stock registrar.\nSection 6. Representation of Shares of Other Corporations.\nThe chief executive officer or any other officer or officers authorized by the Board or the chief executive officer are each authorized to vote, represent and exercise on behalf of the corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of the corporation. The authority herein granted may be exercised either by any such officer in person or by any other person authorized so to do by proxy or power of attorney duly executed by said officer.\nSection 7. Stock Purchase Plans.\nThe corporation may adopt and carry out a stock purchase plan or agreement or stock option plan or agreement providing for the issue and sale for\nARTICLE VI\nsuch consideration as may be fixed of its unissued shares, or of issued shares acquired, to one or more of the employees or directors of the corporation or of a subsidiary or to a trustee on their behalf and for the payment for such shares in installments or at one time, and may provide for such shares in installments or at one time, and may provide for aiding any such persons in paying for such shares by compensation for services rendered, promissory notes or otherwise.\nAny such stock purchase plan or agreement or stock option plan or agreement may include, among other features, the fixing of eligibility for participation therein, the class and price of shares to be issued or sold under the plan or agreement, the number of shares which may be subscribed for, the method of payment therefor, the reservation of title until full payment therefor, the effect of the termination of employment and option or obligation on the part of the corporation to repurchase the shares upon termination of employment, restrictions upon transfer of the shares, the time limits of and termination of the plan, and any other matters, not in violation of applicable law, as may be included in the plan as approved or authorized by the Board or any committee of the Board.\nSection 8. Fiscal Year and Subdivisions.\nThe calendar year shall be the corporate fiscal year of the corporation. For the purpose of paying dividends, for making reports and for the convenient transaction of the business of the corporation, the Board may divide the fiscal year into appropriate subdivisions.\nSection 9. Construction and Definitions.\nUnless the context otherwise requires, the general provisions, rules of construction and definitions contained in the General Provisions of the California Corporations Code and in the California General Corporation Law shall govern the construction of these Bylaws.\nARTICLE VI -- INDEMNIFICATION\nSection 1. Indemnification of Directors and Officers.\nEach person who was or is a party or is threatened to be made a party to or is involved in any threatened, pending or completed action, suit or proceeding, formal or informal, whether brought in the name of the corporation or otherwise and whether of a civil, criminal, administrative or investigative nature (hereinafter a \"proceeding\"), by reason of the fact that he or she, or a person of whom he or ARTICLE VI\nshe is the legal representative, is or was a director or officer of the corporation or 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 employee benefit plans, whether the basis of such proceeding is an alleged action or inaction in an official capacity or in any other capacity while serving as a director or officer, shall, subject to the terms of any agreement between the corporation and such person, be indemnified and held harmless by the corporation to the fullest extent permissible under California law and the corporation's Articles of Incorporation, against all costs, charges, expenses, liabilities and losses (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith, and such indemnification shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that (A) the corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was authorized by the Board of the corporation; (B) the corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) other than a proceeding by or in the name of the corporation to procure a judgment in its favor only if any settlement of such a proceeding is approved in writing by the corporation; (C) that no such person shall be indemnified (i) except to the extent that the aggregate of losses to be indemnified exceeds the amount of such losses for which the director or officer is paid pursuant to any directors' and officers' liability insurance policy maintained by the corporation; (ii) on account of any suit in which judgment is rendered against such person for an accounting of profits made from the purchase or sale by such person of securities of the corporation pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any federal, state or local statutory law; (iii) if a court of competent jurisdiction finally determines that any indemnification hereunder is unlawful; and (iv) as to circumstances in which indemnity is expressly prohibited by Section 317 of the General Corporation Law of California (the \"Law\"); and (D) that no such person shall be indemnified with regard to any action brought by or in the right of the corporation for breach of duty to the corporation and its shareholders (a) for acts or omissions involving intentional misconduct or knowing and culpable violation of law; (b) for acts or omissions that the director or officer believes to be contrary to the best interests of the corporation or its shareholders or that involve the absence of good faith on the part of the director or officer; (c) for any transaction from which the director or officer derived an improper personal benefit; (d) for acts or omissions that show a reckless disregard for the director's or officer's duty to the corporation or its shareholders in circumstances in which the director ARTICLE VI\nor officer was aware, or should have been aware, in the ordinary course of performing his or her duties, of a risk of serious injury to the corporation or its shareholders; (e) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's or officer's duties to the corporation or its shareholders; and (f) for costs, charges, expenses, liabilities and losses arising under Section 310 or 316 of the Law. The right to indemnification conferred in this Article shall include the right to be paid by the corporation expenses incurred in defending any proceeding in advance of its final disposition; provided, however, that if the Law permits the payment of such expenses incurred by a director or officer in his or her capacity as a director or officer (and not in any other capacity in which service was or is rendered by such person while a director or officer, including, without limitation, service to an employee benefit plan) in advance of the final disposition of a proceeding, such advances shall be made only upon delivery to the corporation of an undertaking, by or on behalf of such director or officer, to repay all amounts to the corporation if it shall be ultimately determined that such person is not entitled to be indemnified.\nSection 2. Indemnification of Employees and Agents.\nA person who was or is a party or is threatened to be made a party to or is involved in any proceeding by reason of the fact that he or she is or was an employee or agent of the corporation or is or was serving at the request of the corporation as an employee or agent of another enterprise, including service with respect to employee benefit plans, whether the basis of such action is an alleged action or inaction in an official capacity or in any other capacity while serving as an employee or agent, may, subject to the terms of any agreement between the corporation and such person, be indemnified and held harmless by the corporation to the fullest extent permitted by California law and the corporation's Articles of Incorporation, against all costs, charges, expenses, liabilities and losses, (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith.\nSection 3. Right of Directors and Officers to Bring Suit.\nIf a claim under Section 1 of this Article is not paid in full by the corporation within 30 days after a written claim has been received by the corporation, the claimant may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall also be entitled to be paid the expense of prosecuting such claim. Neither the failure of the corporation (including its Board, independent legal counsel, or its shareholders) to have made a determination prior to the commencement of such action that indemnification of ARTICLE VI\nthe claimant is permissible in the circumstances because he or she has met the applicable standard of conduct, if any, nor an actual determination by the corporation (including its Board, independent legal counsel, or its shareholders) that the claimant has not met the applicable standard of conduct, shall be a defense to the action or create a presumption for the purpose of an action that the claimant has not met the applicable standard of conduct.\nSection 4. Successful Defense.\nNotwithstanding any other provision of this Article, to the extent that a director or officer has been successful on the merits or otherwise (including the dismissal of an action without prejudice or the settlement of a proceeding or action without admission of liability) in defense of any proceeding referred to in Section 1 or in defense of any claim, issue or matter therein, he or she shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred in connection therewith.\nSection 5. Non-Exclusivity of Rights.\nThe right to indemnification provided by this Article shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, bylaw, agreement, vote of shareholders or disinterested directors or otherwise.\nSection 6. Insurance.\nThe 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 Law.\nSection 7. Expenses as a Witness.\nTo the extent that any director, officer, employee or agent of the corporation is by reason of such position, or a position with another entity at the request of the corporation, a witness in any action, suit or proceeding, he or she shall be indemnified against all costs and expenses actually and reasonably incurred by him or her on his or her behalf in connection therewith. ARTICLE VII\nSection 8. Indemnity Agreements.\nThe corporation may enter into agreements with any director, officer, employee or agent of the corporation providing for indemnification to the fullest extent permissible under the Law and the corporation's Articles of Incorporation.\nSection 9. Separability.\nEach and every paragraph, sentence, term and provision of this Article is separate and distinct so that if any paragraph, sentence, term or provision hereof shall be held to be invalid or unenforceable for any reason, such invalidity or unenforceability shall not affect the validity or enforceability of any other paragraph, sentence, term or provision hereof. To the extent required, any paragraph, sentence, term or provision of this Article may be modified by a court of competent jurisdiction to preserve its validity and to provide the claimant with, subject to the limitations set forth in this Article and any agreement between the corporation and claimant, the broadest possible indemnification permitted under applicable law.\nSection 10. Effect of Repeal or Modification.\nAny repeal or modification of this Article shall not adversely affect any right of indemnification of a director or officer existing at the time of such repeal or modification with respect to any action or omission occurring prior to such repeal or modification.\nARTICLE VII -- EMERGENCY PROVISIONS\nSection 1. General.\nThe provisions of this Article shall be operative only during a national emergency declared by the President of the United States or the person performing the President's functions, or in the event of a nuclear, atomic or other attack on the United States or a disaster making it impossible or impracticable for the corporation to conduct its business without recourse to the provisions of this Article. Said provisions in such event shall override all other Bylaws of the corporation in conflict with any provisions of this Article, and shall remain operative so long as it remains impossible or impracticable to continue the business of the corporation otherwise, but thereafter shall be inoperative; provided that all actions taken in good faith pursuant to such provisions shall thereafter remain in full force and effect unless and until revoked by action taken pursuant to the provisions of the Bylaws other than those contained in this Article. ARTICLE VII\nSection 2. Unavailable Directors.\nAll directors of the corporation who are not available to perform their duties as directors by reason of physical or mental incapacity or for any other reason or who are unwilling to perform their duties or whose whereabouts are unknown shall automatically cease to be directors, with like effect as if such persons had resigned as directors, so long as such unavailability continues.\nSection 3. Authorized Number of Directors.\nThe authorized number of directors shall be the number of directors remaining after eliminating those who have ceased to be directors pursuant to Section 2, or the minimum number required by law, whichever number is greater.\nSection 4. Quorum.\nThe number of directors necessary to constitute a quorum shall be one-third of the authorized number of directors as specified in the foregoing Section, or such other minimum number as, pursuant to the law or lawful decree then in force, it is possible for the Bylaws of a corporation to specify.\nSection 5. Creation of Emergency Committee.\nIn the event the number of directors remaining after eliminating those who have ceased to be directors pursuant to Section 2 is less than the minimum number of authorized directors required by law, then until the appointment of additional directors to make up such required minimum, all the powers and authorities which the Board could by law delegate, including all powers and authorities which the Board could delegate to a committee, shall be automatically vested in an emergency committee, and the emergency committee shall thereafter manage the affairs of the corporation pursuant to such powers and authorities and shall have all other powers and authorities as may by law or lawful decree be conferred on any person or body of persons during a period of emergency.\nSection 6. Constitution of Emergency Committee.\nThe emergency committee shall consist of all the directors remaining after eliminating those who have ceased to be directors pursuant to Section 2, provided that such remaining directors are not less than three in number. In the event such remaining directors are less than three in number the emergency committee shall consist of three persons, who shall be the remaining director or directors and either one or two officers or employees of the corporation, as the remaining director or directors may in writing designate. If there is no remaining ARTICLE VII\ndirector, the emergency committee shall consist of the three most senior officers of the corporation who are available to serve, and if and to the extent that officers are not available, the most senior employees of the corporation. Seniority shall be determined in accordance with any designation of seniority in the minutes of the proceedings of the Board, and in the absence of such designation, shall be determined by rate of remuneration. In the event that there are no remaining directors and no officers or employees of the corporation available, the emergency committee shall consist of three persons designated in writing by the shareholder owning the largest number of shares of record as of the date of the last record date.\nSection 7. Powers of Emergency Committee.\nThe emergency committee, once appointed, shall govern its own procedures and shall have power to increase the number of members thereof beyond the original number, and in the event of a vacancy or vacancies therein, arising at any time, the remaining member or members of the emergency committee shall have the power to fill such vacancy or vacancies. In the event at any time after its appointment all members of the emergency committee shall die or resign or become unavailable to act for any reason whatsoever, a new emergency committee shall be appointed in accordance with the foregoing provisions of this Article.\nSection 8. Directors Becoming Available.\nAny person who has ceased to be a director pursuant to the provisions of Section 2 and who thereafter becomes available to serve as a director shall automatically become a member of the emergency committee.\nSection 9. Election of Board of Directors.\nThe emergency committee shall, as soon after its appointment as is practicable, take all requisite action to secure the election of a board of directors, and upon such election all the powers and authorities of the emergency committee shall cease.\nSection 10. Termination of Emergency Committee.\nIn the event, after the appointment of an emergency committee, a sufficient number of persons who ceased to be directors pursuant to Section 2 become available to serve as directors, so that if they had not ceased to be directors as aforesaid, there would be enough directors to constitute the ARTICLE VIII\nminimum number of directors required by law, then all such persons shall automatically be deemed to be reappointed as directors and the powers and authorities of the emergency committee shall be at an end.\nARTICLE VIII -- AMENDMENTS\nSection 1. Amendments.\nThese Bylaws may be amended or repealed either by approval of the outstanding shares or by the approval of the Board; provided, however, that a Bylaw specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable Board or vice versa may only be adopted by approval of the outstanding shares. The exact number of directors within the maximum and minimum number specified in these Bylaws may be amended by the Board alone.\nPAGE\nEXHIBIT 10.9\nSCEcorp\nDirector Deferred Compensation Plan\nAs Adopted Janury 19, 1995 Effective January 1, 1995\nSCEcorp DIRECTOR DEFERRED COMPENSATION PLAN\nSection Title Page - ------- ----- ----\nARTICLE 1 DEFINITIONS 1\nARTICLE 2 PARTICIPATION 4 2.01 Participant Election 4 2.02 Annual Deferral 4 2.03 Continuation of Participation 4\nARTICLE 3 DIRECTOR DEFERRALS 4 3.01 Participation Election 4 3.02 Minimum Annual Deferral 5 3.03 Maximum Annual Deferral 5 3.04 Vesting 5\nARTICLE 4 DEFERRAL ACCOUNTS 5 4.01 Deferral Accounts 5 4.02 Timing of Credits 5 A. Annual Deferrals 5 B. Interest Crediting Dates 5 C. Statement of Accounts 5\nARTICLE 5 RETIREMENT BENEFITS 5 5.01 Amount 5 5.02 Form of Retirement Benefits 6 5.03 Commencement of Benefits 6 5.04 Small Benefit Exception 6\nARTICLE 6 TERMINATION BENEFITS 7 6.01 Amount 7 6.02 Form of Termination Benefits 7\nARTICLE 7 SURVIVOR BENEFITS 7 7.01 Pre-Retirement Survivor Benefit 7 7.02 Post-Retirement Survivor Benefit 7 7.03 Post-Termination Survivor Benefit 7 7.04 Changing Form of Benefit 8 7.05 Small Benefit Exception 8\n-i-\nSCEcorp DIRECTOR DEFERRED COMPENSATION PLAN\nTABLE OF CONTENTS(cont.)\nSection Title Page - ------- ----- ----\nARTICLE 8 CHANGE OF CONTROL 8\nARTICLE 9 SCHEDULED AND UNSCHEDULED WITHDRAWALS 8 9.01 Scheduled Withdrawals 8 A. Election 8 B. Timing and Form of Withdrawal 9 C. Remaining Deferral Account 9 9.02 Unscheduled Withdrawals 9 A. Election 9 B. Withdrawal Penalty 9 C. Small Benefit Exception 9\nARTICLE 10 CONDITIONS RELATED TO BENEFITS 9 10.01 Nonassignability 9 10.02 Financial Hardship Distribution 10 10.03 No Right to Assets 10 10.04 Protective Provisions 10 10.05 Withholding 10\nARTICLE 11 PLAN ADMINISTRATION 11\nARTICLE 12 BENEFICIARY DESIGNATION 11\nARTICLE 13 AMENDMENT OR TERMINATION OF PLAN 11 13.01 Amendment of Plan 11 13.02 Termination of Plan 12 13.03 Amendment or Termination After Change of Control 12 13.04 Exercise of Power to Amend or Terminate 12 13.05 Constructive Receipt Termination 12\nARTICLE 14 CLAIMS AND REVIEW PROCEDURES 12 14.01 Claims Procedure 12 14.02 Review Procedure 13 14.03 Dispute Arbitration 13\nARTICLE 15 MISCELLANEOUS 15 15.01 Successors 15\n-ii-\nSCEcorp DIRECTOR DEFERRED COMPENSATION PLAN\nTABLE OF CONTENTS(cont.)\nSection Title Page - ------- ----- ----\n15.02 Trust 15 15.03 Service Not Guaranteed 15 15.04 Gender, Singular and Plural 15 15.05 Captions 15 15.06 Validity 15 15.07 Waiver of Breach 15 15.08 Applicable Law 15 15.09 Notice 16\n-iii-\nSCEcorp\nDIRECTOR DEFERRED COMPENSATION PLAN\nAs Adopted January 19, 1995, Effective January 1, 1995\nPREAMBLE\nEffective January 1, 1995, SCEcorp became the sponsor of the Southern California Edison Company Annual Deferred Compensation Plan For Directors with respect to participants in active service as of that date. The plan has been restated as the SCEcorp Director Deferred Compensation Plan effective January 1, 1995. Plan benefits are available to eligible directors of SCEcorp and its participating affiliates. Amounts of compensation deferred by participants pursuant to this Plan accrue as liabilities of the participating affiliate at the time of the deferral under the terms and conditions set forth herein. By electing to defer compensation under the SCEcorp Director Deferred Compensation Plan, participants consent to SCEcorp sponsorship of the plan, but acknowledge that SCEcorp is not a guarantor of the benefit obligations of other participating affiliates. Each participating affiliate is responsible for payment of the accrued benefits under the plan with respect to its own directors subject to the terms and conditions set forth herein.\nARTICLE 1 DEFINITIONS\nCapitalized terms in the text of the Plan are defined as follows:\n1.01 Administrator shall mean the Compensation and Executive Personnel Committee of the Board of Directors of the Company.\n1.02 Affiliate shall mean SCEcorp or any corporation or entity which (i) along with SCEcorp, is a component member of a \"controlled group of corporations\" within the meaning of Section 414(b) of the Code, and (ii) has approved the participation of its directors in the Plan.\n1.03 Annual Deferral shall mean the amount of Compensation which the Participant elects to defer for a Plan Year pursuant to Articles 2 and 3 of the Plan.\n1.04 Beneficiary shall mean the person or persons or entity designated as such in accordance with Article 12 of the Plan.\nPAGE\n1.05 Change of Control shall mean either: (i) the dissolution or liquidation of SCEcorp or a Company; (ii) a reorganization, merger or consolidation of SCEcorp or a Company with one or more corporations as a result of which SCEcorp or a Company is not the surviving corporation; (iii) approval by the stockholders of SCEcorp or a Company of any sale, lease, exchange or other transfer (in one or a series of transactions) of all or substantially all of the assets of SCEcorp or a Company; (iv) approval by the stockholders of SCEcorp or a Company of any merger or consolidation of SCEcorp or a Company, in which the holders of voting stock of SCEcorp or a Company immediately before the merger or consolidation will not own 50% or more of the outstanding voting shares of the continuing or surviving corporation immediately after the merger or consolidation; or (v) a change of at least 51% (rounded to the next whole person) in the membership of the Board of Directors of SCEcorp or a Company within a 24-month period, unless the election or nomination for election by stockholders of each new director within the period was approved by the vote of at least 85% (rounded to the next whole person) of the directors then still in office who were in office at the beginning of the twenty-four-month period, except that any replacement of directors who are employees of SCEcorp or a Company, with other employees of SCEcorp or a Company, shall be disregarded and not be considered a change in membership. Notwithstanding the foregoing, any reorganization, merger or consolidation of a Company with SCEcorp or another Company shall be disregarded and not be considered a Change of Control.\n1.06 Code shall mean the Internal Revenue Code of 1986, as amended.\n1.07 Company shall mean the Affiliate the Participant serves as a director.\n1.08 Compensation shall mean the sum of the all retainers and meeting fees which would be paid to a Participant as an Eligible Director for the Plan Year before reductions for deferrals under the Plan.\n1.09 Crediting Rate shall mean the rate at which interest will be credited to Participant Deferral Accounts. The rate will be determined annually in advance of the Plan Year and will be equal to 120 percent of the Index Rate. SCEcorp reserves the right to prospectively change the Crediting Rate or formula.\n1.10 Deferral Account shall mean the notional account established for record keeping purposes for a Participant pursuant to Article 5 of the Plan.\n1.11 Deferral Period shall mean the Plan Year covered by a valid Participation Election previously submitted by a Participant, or in the case of a newly eligible Participant, the balance of the Plan Year following the date of the Participation Election.\n1.12 Eligible Director shall mean a non-employee director of an Affiliate who (i) is a U.S. director or an expatriate who is based and paid in the U.S., and (ii) is designated by the Company as eligible to participate in the Plan (subject to the restrictions in Article 8 and Section 10.02 of the Plan).\n1.13 Financial Hardship shall mean an unexpected and unforeseen financial disruption arising from an illness, casualty loss, sudden financial reversal, or other such unforeseeable occurrence as determined by the Administrator or its designee. Needs arising from foreseeable events such as the purchase of a residence or education expenses for children shall not, alone, be considered a Financial Hardship.\n1.14 Index Rate shall mean the 120-month average rate of 10-year U.S. Treasury Notes determined for any Plan Year as of October 15th of the prior year.\n1.15 Participant shall mean an Eligible Director who has elected to participate and has completed a Participation Election pursuant to Article 2 of the Plan.\n1.16 Participation Election shall mean the Participant's written election to participate in the Plan submitted on the form prescribed by the Administrator for that purpose.\n1.17 Plan shall mean the SCEcorp Director Deferred Compensation Plan.\n1.18 Plan Year shall mean the calendar year.\n1.19 Retirement shall mean a separation from service under terms which constitute an eligible resignation or retirement for purposes of the nonqualified director retirement plan covering the Participant, or a successor plan.\n1.20 Scheduled Withdrawal shall mean a distribution of all or a portion of the entire amount of Annual Deferrals and earnings credited to the Participant's Deferral Account as elected by the Participant pursuant to the provisions of Article 9 of the Plan.\n1.21 Termination for Cause shall mean the Termination of Service of the Participant upon willful failure by the Participant to substantially perform his or her duties for the Company or the willful engaging by the Participant in conduct which is injurious to the Company, monetarily or otherwise.\n1.22 Termination of Service shall mean the voluntary or involuntary cessation of the Participant's service as a member of the Board of Directors of a Company for any reason other than Retirement or death. Termination of Service shall not be deemed to have occurred for purposes of this Plan if the Participant continues to serve on the Board of Directors of another participating Affiliate, or commences such service within 30 days.\n1.23 Unscheduled Withdrawal shall mean a distribution of all or a portion of the entire amount of Annual Deferrals and earnings credited to the Participant's Deferral Account as requested by the Participant pursuant to the provisions of Article 9 of the Plan.\n1.24 Valuation Date shall mean the last business day of the following month in which Termination of Service, retirement, death, Scheduled Withdrawal, or Unscheduled Withdrawal occurs.\n1.25 Vesting shall mean the Participant's right to receive any Compensation deferred and\/or earnings thereon as provided in Article 3.\nARTICLE 2 PARTICIPATION\n2.01 Participant Election\nAn Eligible Director shall become a Participant in the Plan on the first day of the month coincident with or next following the date the director becomes an Eligible Director, provided the Eligible Director has submitted to the Administrator a Participation Election prior to that date. Except for directors who become newly eligible during the Plan Year, the Participation Election must be submitted to the Administrator during the enrollment period designated by the Administrator which shall always be prior to the commencement of the Plan Year.\n2.02 Annual Deferral\nSubject to the restrictions in Article 3, the Eligible Director shall designate his or her Annual Deferral for the covered Plan Year on the Participation Election.\n2.03 Continuation of Participation\nAn Eligible Director who has elected to participate in the Plan by making an Annual Deferral shall continue as a Participant in the Plan until the Participant no longer has a Deferral Account balance under the Plan.\nARTICLE 3 DIRECTOR DEFERRALS\n3.01 Participation Election\nEligible Directors may elect to make an Annual Deferral under the Plan by submitting a Participation Election during the applicable enrollment period. The Participation Election shall designate the percentage of Compensation, in whole percentage increments, that the Participant wishes to defer pursuant to the terms of the Plan. Once made, a Participation Election shall continue to apply for subsequent Deferral Periods unless the Participant submits a new Participation Election form during a subsequent enrollment period changing the deferral amount or revoking the existing election. A Participation Election may be revoked by the Participant upon 30 days written notice to the Administrator; however, such Participant will be ineligible to make an Annual Deferral under the Plan for the following Plan Year.\n3.02 Minimum Annual Deferral\nThe minimum Annual Deferral for a Plan Year is 10% of the Participant's Compensation.\n3.03 Maximum Annual Deferral\nThe maximum Annual Deferral for a Plan Year is 100% of the Participant's Compensation.\n3.04 Vesting\nThe Participant's right to receive Compensation deferred under this Article 3 and any earnings thereon shall be 100% vested at all times.\nARTICLE 4 DEFERRAL ACCOUNTS\n4.01 Deferral Accounts\nSolely for record keeping purposes, the Administrator shall maintain a Deferral Account for each Participant with such subaccounts as the Administrator or its record keeper find necessary or convenient in the administration of the Plan.\n4.02 Timing of Credits\nA. Annual Deferrals\nThe Administrator shall credit the Annual Deferrals under Article 3 to the Participant's Deferral Account at the time the deferrals would otherwise have been paid but for the Participation Election.\nB. Interest Crediting Dates\nThe Administrator shall credit interest at the Crediting Rate to the Participant's Deferral Account on daily basis, compounded annually.\nC. Statement of Accounts\nThe Administrator shall periodically provide to each Participant a statement setting forth the balance of the Deferral Account maintained for the Participant.\nARTICLE 5 RETIREMENT BENEFITS\n5.01 Amount\nUpon Retirement, the Company shall pay to the Participant a retirement benefit in the form provided in Section 5.02, based on the balance of the Deferral Account as of the Valuation Date. If paid as a lump sum, the retirement benefit shall be equal to the Deferral Account balance. If paid in installments, the installments shall be paid in amounts that will amortize the Deferral Account balance with interest credited at the Crediting Rate over the period of time benefits are to be paid. For purposes of calculating installments, the Deferral Account shall be valued as of December 31 each year, and the subsequent installments will be adjusted for the next Plan Year according to procedures established by the Administrator to reflect changes in the Crediting Rate.\n5.02 Form of Retirement Benefits\nThe Participant may elect on the Participation Election form to have the retirement benefit paid:\n(i) In a lump sum,\n(ii) In installments paid monthly over a period of 60, 120, or 180 months, or\n(iii) In a lump sum of a portion of the Deferral Account upon Retirement with the balance in installments paid monthly over a period of 60, 120, or 180 months.\nIf no valid election is made, the Administrator shall pay the retirement benefit in installments over a 180 month period. Participants may change the form of payout by written election filed with the Administrator; provided, however, that if the Participant files the election less than 13 months prior to the date of Retirement, the payout election in effect 13 months prior to the date of Retirement will govern.\n5.03 Commencement of Benefits\nPayments will commence within 60 days after the date the Participant retires, or attains age 55, whichever is later.\n5.04 Small Benefit Exception\nNotwithstanding the foregoing, the Administrator may, in its sole discretion:\n(i) pay the benefits in a single lump sum if the sum of all benefits payable to the Participant is less than or equal to $3,500.00, or\n(ii) reduce the number of installments elected by the Participant to 120 or 60 if necessary to produce a monthly benefit of at least $300.00.\nARTICLE 6 TERMINATION BENEFITS\n6.01 Amount\nNo later than 60 days following a Termination of Service, the Administrator shall pay to the Participant a termination benefit equal to the vested balance of the Deferral Account as of the Valuation Date, or shall commence installments, as provided in Section 6.02.\n6.02 Form of Termination Benefits\nThe Administrator shall pay the termination benefits in a single lump sum unless the Participant has previously elected payment to be made in three annual installments. Installments paid under this Section 6.02 shall include interest at the Index Rate and shall be redetermined annually to reflect adjustments in that rate. Notwithstanding the foregoing, any Termination for Cause will result in an immediate lump sum payout.\nARTICLE 7 SURVIVOR BENEFITS\n7.01 Pre-Retirement Survivor Benefit\nIf the Participant dies while actively serving on the board of directors of an Affiliate, the Administrator shall pay a lump sum or commence monthly installments in accordance with the Participant's prior election within 60 days after the Participant's death. The payment(s) will be based on the Participant's Deferral Account balance as of the Valuation Date; provided however, that if the Participant's death occurs within ten years of (i) his or her initial Plan participation date, or (ii) January 1, 1995, whichever is later, then the Beneficiary's payment(s) will be based on twice the Participant's Deferral Account balance as of the Valuation Date.\n7.02 Post-Retirement Survivor Benefit\nIf the Participant dies after Retirement, the Administrator shall pay to the Participant's Beneficiary an amount equal to the remaining benefits payable to the Participant under the Plan over the same period the benefits would have been paid to the Participant; provided however, if the Participant's death occurs within ten years of (i) his or her initial Plan participation date, or (ii) January 1, 1995, whichever is later, then the Beneficiary's death benefit will be based on twice the Participant's Deferral Account balance as of the Valuation Date.\n7.03 Post-Termination Survivor Benefit\nIt the Participant dies following Termination of Service, but prior to the payment of all benefits under the Plan, the Beneficiary will be paid the remaining balance in the Participant's account in a lump sum. No double benefit will apply.\n7.04 Changing Form of Benefit\nBeneficiaries may petition the Administrator once, and only after the death of the Participant, for a change in the form of survivor Benefits. The Administrator may, in its sole and absolute discretion, choose to grant or deny such a petition.\n7.05 Small Benefit Exception\nNotwithstanding the foregoing, the Administrator may, in its sole discretion:\n(i) pay the benefits in a single lump sum if the sum of all benefits payable to the Beneficiary is less than or equal to $3,500.00, or\n(ii) reduce the number of installments elected by the Participant to 120 or 60 if necessary to produce a monthly benefit of at least $300.00.\nARTICLE 8 CHANGE OF CONTROL\nWithin two years after a Change of Control, any Participant or Beneficiary in the case of an SCEcorp Change of Control, or the affected Participants or Beneficiaries in the case of a Company Change of Control, may elect to receive a distribution of the balance of the Deferral Account. There shall be a penalty deducted from the Deferral Account prior to distribution pursuant to this Article 8 equal to 5% of the total balance of the Deferral Account (instead of the 10% reduction otherwise provided for in Section 9.02). If a Participant elects such a withdrawal, any on- going Annual Deferral shall cease, and the Participant may not again be designated as an Eligible Employee until one entire Plan Year following the Plan Year in which the withdrawal was made has elapsed.\nARTICLE 9 SCHEDULED AND UNSCHEDULED WITHDRAWALS\n9.01 Scheduled Withdrawals\nA. Election\nWhen making a Participation Election, a Participant may elect to receive a distribution of a specific dollar amount or a percentage of the Annual Deferral that will be made in the following Plan Year at a specified year in the future when the Participant will still be an active director. Such an election must be made on an In- Service Distribution Election Form and submitted concurrently with the Participation Election. The election of a Scheduled Withdrawal shall only apply to the Annual Deferral and related earnings for that Deferral Period, but not to previous or subsequent Annual Deferrals or related earnings. Elections under this Section shall be superseded by benefit payments due to the Retirement, Termination of Service or death of the Participant.\nB. Timing and Form of Withdrawal\nThe year specified for the Scheduled Withdrawal may not be sooner than the second Plan Year following the Plan Year in which the deferral occurs. The Participant will receive a lump sum distribution of the amount elected on January 1st of the Plan Year specified.\nC. Remaining Deferral Account\nThe remainder, if any, of the Participant's Deferral Account shall continue in effect and shall be distributed in the future according to the terms of the Plan.\n9.02 Unscheduled Withdrawals\nA. Election\nA Participant (or Beneficiary if the Participant is deceased) may request in writing to the Administrator an Unscheduled Withdrawal of all or a portion of the entire vested amount credited to the Participant's Deferral Account, including earnings, which shall be paid within 30 days in a single lump sum; provided, however, that (i) the minimum withdrawal shall be 25% of the Deferral Account balance, (ii) an election to withdraw 75% or more of the balance shall be deemed to be an election to withdraw the entire balance, and (iii) such an election may be made only once in a Plan Year.\nB. Withdrawal Penalty\nThere shall be a penalty deducted from the Deferral Account prior to an Unscheduled Withdrawal equal to 10% of the Unscheduled Withdrawal. If a Participant elects such a withdrawal, any on-going Annual Deferral shall cease, and the Participant may not again be designated as an Eligible Director until one entire Plan Year following the Plan Year in which the withdrawal was made has elapsed.\nC. Small Benefit Exception\nNotwithstanding any of the foregoing, if the sum of all benefits payable to the Participant or Beneficiary who has requested the Unscheduled Withdrawal is less than or equal to $3,500.00, the Administrator may, in its sole discretion, elect to pay out the entire Deferral Account (reduced by the 10% penalty) in a single lump sum.\nARTICLE 10 CONDITIONS RELATED TO BENEFITS\n10.01 Nonassignability\nThe benefits provided under the Plan may not be alienated, assigned, transferred, pledged or hypothecated by or to any person or entity, at any time or any manner whatsoever. These benefits shall be exempt from the claims of creditors of any Participant or other claimants and from all orders, decrees, levies, garnishment or executions against any Participant to the fullest extent allowed by law. Notwithstanding the foregoing, the benefit payable to a Participant may be assigned in full or in part, pursuant to a domestic relations order of a court of competent jurisdiction.\n10.02 Financial Hardship Distribution\nA participant may submit a hardship distribution request to the Administrator in writing setting forth the reasons for the request. The Administrator shall have the sole authority to approve or deny such requests. Upon a finding that the Participant or the Beneficiary has suffered a Financial Hardship, the Administrator may in its discretion, permit the Participant to cease any on-going deferrals and accelerate distributions of benefits under the Plan in the amount reasonably necessary to alleviate the Financial Hardship. If a distribution is to be made to a Participant on account of Financial Hardship, the Participant may not make deferrals under the Plan until one entire Plan Year following the Plan Year in which a distribution based on Financial Hardship was made has elapsed.\n10.03 No Right To Assets\nThe benefits paid under the Plan shall be paid from the general funds of the Company, and the Participant and any Beneficiary shall be no more than unsecured general creditors of the Company with no special or prior right to any assets of the Company for payment of any obligations hereunder. The Participant will have no claim to benefits from any other Affiliate.\n10.04 Protective Provisions\nThe Participant shall cooperate with the Administrator by furnishing any and all information requested by the Administrator, in order to facilitate the payment of benefits hereunder, taking such physical examinations as the Administrator may deem necessary and signing such consents to insure or taking such other actions as may be requested by the Administrator. If the Participant refuses to cooperate, the Administrator and the Employer shall have no further obligation to the Participant under the Plan.\n10.05 Withholding\nThe Participant or the Beneficiary shall make appropriate arrangements with the Administrator for satisfaction of any federal, state or local income tax withholding requirements and Social Security or other director tax requirements applicable to the payment of benefits under the Plan. If no other arrangements are made, the Administrator may provide, at its discretion, for such withholding and tax payments as may be required.\nARTICLE 11 PLAN ADMINISTRATION\nThe Administrator shall administer the Plan and interpret, construe and apply its provisions in accordance with its terms and shall provide direction and oversight as necessary to management, staff, or contractors to whom day-to-day Plan operations may be delegated. The Administrator shall establish, adopt or revise such rules and regulations as it may deem necessary or advisable for the administration of the Plan. All decisions of the Administrator shall be final and binding.\nARTICLE 12 BENEFICIARY DESIGNATION\nThe Participant shall have the right, at any time, to designate any person or persons as Beneficiary (both primary and contingent) to whom payment under the Plan shall be made in the event of the Participant's death. The Beneficiary designation shall be effective when it is submitted in writing to the Administrator during the Participant's lifetime on a form prescribed by the Administrator.\nThe submission of a new Beneficiary designation shall cancel all prior Beneficiary designations. Any finalized divorce or marriage of a Participant subsequent to the date of a Beneficiary designation shall revoke such designation, unless in the case of divorce the previous spouse was not designated as Beneficiary, and unless in the case of marriage the Participant's new spouse has previously been designated as Beneficiary. The spouse of a married Participant must consent in writing to any designation of a Beneficiary other than the spouse.\nIf a Participant fails to designate a Beneficiary as provided above, or if the Beneficiary designation is revoked by marriage, divorce, or otherwise without execution of a new designation, or if every person designated as Beneficiary predeceases the Participant or dies prior to complete distribution of the Participant's benefits, then the Administrator shall direct the distribution of the benefits to the Participant's estate. If a Beneficiary dies after commencement of payments to the Beneficiary, a lump sum of any remaining payments will be paid to that person's Beneficiary, if one has been designated, or to the Beneficiary's estate.\nARTICLE 13 AMENDMENT OR TERMINATION OF PLAN\n13.01 Amendment of Plan\nSubject to the terms of Section 13.03, SCEcorp may at any time amend the Plan in whole or in part, provided, however, that the amendment (i) shall not decrease the balance of the Participant's Deferral Account at the time of the amendment and (ii) shall not retroactively decrease the applicable Crediting Rates of the Plan prior to the time of the amendment. SCEcorp may amend the Crediting Rates of the Plan prospectively, in which case the Administrator shall notify the Participant of the amendment in writing within 30 days after the amendment.\n13.02 Termination of Plan\nSubject to the terms of Section 13.03, SCEcorp may at any time terminate the Plan. If SCEcorp terminates the Plan, the date of the termination shall be treated as the date of Termination of Service for the purpose of calculating Plan benefits, and the benefits the Participant is entitled to receive under the Plan shall be paid to the Participant in a lump sum within 60 days.\n13.03 Amendment or Termination After Change of Control\nNotwithstanding the foregoing, SCEcorp shall not amend or terminate the Plan without the prior written consent of affected Participants for a period of two calendar years following a Change of Control and shall not thereafter amend or terminate the Plan in any manner which affects any Participant (or Beneficiary of a deceased Participant) who commences receiving payment of benefits under the Plan prior to the end of the two- year period following a Change of Control.\n13.04 Exercise of Power to Amend or Terminate\nSCEcorp's power to amend or terminate the Plan shall be exercisable by the SCEcorp Board of Directors.\n13.05 Constructive Receipt Termination\nNotwithstanding anything to the contrary in this Plan, in the event the Administrator determines that amounts deferred under the Plan have been constructively received by Participants and must be recognized as income for federal income tax purposes, the Plan shall terminate and distributions shall be made to Participants in accordance with the provisions of Section 13.02 or as may be determined by the Administrator. The determination of the Administrator under this Section 13.05 shall be binding and conclusive.\nARTICLE 14 CLAIMS AND REVIEW PROCEDURES\n14.01 Claims Procedure\nThe Administrator shall notify a Participant in writing, within 90 days after his or her written application for benefits, of his or her eligibility or noneligibility for benefits under the Plan. If the Administrator determines that a Participant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for the denial, (2) a specific reference to the provisions of the Plan on which the denial is based, (3) a description of any additional information or material necessary for the claimant to perfect his or her claim, and a description of why it is needed, and (4) an explanation of the Plan's claims review procedure and other appropriate information as to the steps to be taken if the Participant wishes to have the claim reviewed. If the Administrator determines that there are special circumstances requiring additional time to make a decision, the Administrator shall notify the Participant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional 90-day period.\n14.02 Review Procedure\nIf a Participant is determined by the Administrator not to be eligible for benefits, or if the Participant believes that he or she is entitled to greater or different benefits, the Participant shall have the opportunity to have the claim reviewed by the Administrator by filing a petition for review with the Administrator within 60 days after receipt of the notice issued by the Administrator. Said petition shall state the specific reasons which the Participant believes entitle him or her to benefits or to greater or different benefits. Within 60 days after receipt by the Administrator of the petition, the Administrator shall afford the Participant (and counsel, if any) an opportunity to present his or her position to the Administrator orally or in writing, and the Participant (or counsel) shall have the right to review the pertinent documents. The Administrator shall notify the Participant of its decision in writing within the 60-day period, stating specifically the basis of its decision, written in a manner calculated to be understood by the Participant and the specific provisions of the Plan on which the decision is based. If, because of the need for a hearing, the 60-day period is not sufficient, the decision may be deferred for up to another 60-day period at the election of the Administrator, but notice of this deferral shall be given to the Participant. In the event of the death of the Participant, the same procedures shall apply to the Participant's Beneficiaries.\n14.03 Dispute Arbitration\nNotwithstanding the foregoing, and because it is agreed that time will be of the essence in determining whether any payments are due to Participant or his or her Beneficiary under the Plan, a Participant or Beneficiary may, if he or she desires, submit any claim for payment under the Plan to arbitration. This right to select arbitration shall be solely that of the Participant or Beneficiary and the Participant or Beneficiary may decide whether or not to arbitrate in his or her discretion. The \"right to select arbitration\" is not mandatory on the Participant or Beneficiary, and the Participant or Beneficiary may choose in lieu thereof to bring an action in an appropriate civil court. Once an arbitration is commenced, however, it may not be discontinued without the mutual consent of both parties to the arbitration. During the lifetime of the Participant only he or she can use the arbitration procedure set forth in this Section.\nAny claim for arbitration may be submitted as follows: if a Participant or Beneficiary has submitted a request to be paid under the Plan and the claim is finally denied by the Administrator in whole or in part, the claim may be filed in writing with an arbitrator of the Participant's or Beneficiary's choice who is selected by the method described in the next four sentences. The first step of the selection shall consist of the Participant or Beneficiary submitting a list of five potential arbitrators to the Administrator. Each of the five arbitrators must be either (1) a member of the National Academy of Arbitrators located in the State of California or (2) a retired California Superior Court or Appellate Court judge. Within one week after receipt of the list, the Administrator shall select one of the five arbitrators as the arbitrator for the dispute in question. If the Administrator fails to select an arbitrator within one week after receipt of the list, the Participant or Beneficiary shall then designate one of the five arbitrators for the dispute in question.\nThe arbitration hearing shall be held within seven days (or as soon thereafter as possible) after the picking of the arbitrator. No continuance of said hearing shall be allowed without the mutual consent of Participant or Beneficiary and the Administrator. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion when he or she decides he or she has heard sufficient evidence to satisfy issuance of an award.\nThe arbitrator's award shall be rendered as expeditiously as possible and in no event later than one week after the close of the hearing.\nIn the event the arbitrator finds that the Administrator or the Company has breached the terms of the Plan, he or she shall order the Company to pay to Participant or Beneficiary within two business days after the decision is rendered the amount then due the Participant or Beneficiary, plus, notwithstanding anything to the contrary in the Plan, an additional amount equal to 20% of the amount actually in dispute. This additional amount shall constitute an additional benefit under the Plan. The award of the arbitrator shall be final and binding upon the Parties.\nThe award may be enforced in any appropriate court as soon as possible after its rendition. The Administrator will be considered the prevailing party in a dispute if the arbitrator determines (1) that the Administrator or the Company has not breached the terms of the Plan and (2) the claim by Participant or his or her Beneficiary was not made in good faith. Otherwise, the Participant or his or her Beneficiary will be considered the prevailing party. In the event that the Administrator is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (excluding any attorneys' fees incurred by the Administrator) including stenographic reporter, if employed, shall be paid by the losing party. In the event that the Participant or his or her Beneficiary is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (including all attorneys' fees incurred by Participant or his or her Beneficiary in pursuing his or her claim), including the fees of a stenographic reporter, if employed, shall be paid by the Company.\nARTICLE 15 MISCELLANEOUS\n15.01 Successors\nThe rights and obligations of SCEcorp and the Companies under the Plan shall inure to the benefit of, and shall be binding upon, the successors and assigns of SCEcorp and the Companies, respectively.\n15.02 Trust\nThe Companies shall be responsible for the payment of all benefits under the Plan. At their discretion, the Companies may establish one or more grantor trusts for the purpose of providing for payment of benefits under the Plan. The trust or trusts may be irrevocable, but a Company's share of the assets thereof shall be subject to the claims of the Company's creditors. Benefits paid to the Participant from any such trust shall be considered paid by the Company for purposes of meeting the obligations of the Company under the Plan.\n15.03 Service Not Guaranteed\nNothing contained in the Plan nor any action taken hereunder shall be construed as a contract of service or as giving any Participant any right to continue in service as a director of SCEcorp or any other Affiliate.\n15.04 Gender, Singular and Plural\nAll pronouns and variations thereof shall be deemed to refer to the masculine, feminine, or neuter, as the identity of the person or persons may require. As the context may require, the singular may be read as the plural and the plural as the singular.\n15.05 Captions\nThe captions of the articles and sections of the Plan are for convenience only and shall not control or affect the meaning or construction of any of its provisions.\n15.06 Validity\nIf any provision of the Plan is held invalid, void or unenforceable, the same shall not affect, in any respect whatsoever, the validity of any other provisions of the Plan.\n15.07 Waiver of Breach\nThe waiver by the Administrator of any breach of any provision of the Plan by the Participant shall not operate or be construed as a waiver of any subsequent breach by the Participant.\n15.08 Applicable Law\nThe Plan shall be governed and construed in accordance with the laws of California.\n15.09 Notice\nAny notice or filing required or permitted to be given to the Administrator under the Plan shall be sufficient if in writing and hand- delivered, or sent by first class mail to the principal office of SCEcorp, directed to the attention of the Administrator. The notice shall be deemed given as of the date of delivery, or, if delivery is made by mail, as of the date shown on the postmark.\nIN WITNESS WHEREOF, SCEcorp has adopted this Plan effective the 1st day of January, 1995.\nSCEcorp\nAlan J. Fohrer ____________________________________________________ Executive Vice President and Chief Financial Officer\nPAGE\nEXHIBIT 10.10\nSCEcorp\nDirector Grantor Trust Agreement\nAugust, 1995\nSCEcorp DIRECTOR GRANTOR TRUST AGREEMENT\nTABLE OF CONTENTS (cont.)\nSection Title Page - ------- ----- ----\nPREAMBLE 1\nI. EFFECTIVE DATE AND DURATION 3\n1.01 Effective Date And Trust Year 3 1.02 Duration 3 1.03 Special Circumstances 4\nII. TRUST FUND AND FUNDING POLICY 5\n2.01 Contributions 5 2.02 Investment And Valuation 8 2.03 Subtrusts 12 2.04 Recapture Of Excess Assets 13 2.05 Substitution Of Other Property 13 2.06 Administrative Powers Of Trustee 14\nIII. ADMINISTRATION 17\n3.01 Committee; Company Representatives 17 3.02 Payment Of Benefits 17 3.03 Disputed Claims 18 3.04 Records 20 3.05 Accountings 20 3.06 Expenses And Fees 21\nIV. LIABILITY 21\n4.01 Indemnity 21 4.02 Bonding 21\nV. INSOLVENCY 22\n5.01 Determination of Insolvency 22 5.02 Insolvency Administration 22 5.03 Termination Of Insolvency Administration 23 5.04 Creditors' Claims During Solvency 23\nVI. SUCCESSOR TRUSTEES 23\n-i- PAGE\nSCEcorp DIRECTOR GRANTOR TRUST AGREEMENT\nTABLE OF CONTENTS (cont.)\nSection Title Page - ------- ----- ----\n6.01 Resignation And Removal 23 6.02 Appointment Of Successor 24 6.03 Accountings; Continuity 24\nVII. GENERAL PROVISIONS 24\n7.01 Interests Not Assignable 24 7.02 Amendment 25 7.03 Applicable Law 25 7.04 Agreement Binding On All Parties 25 7.05 Notices And Directions 25 7.06 No Implied Duties 26 7.07 Gender, Singular And Plural 26 7.08 Validity 27\nVIII. INSURER 26\n8.01 Insurer Not A Party 27 8.02 Authority Of Trustee 27 8.03 Contract Ownership 27 8.04 Limitation Of Liability 27 8.05 Change Of Trustee 27\n-ii- PAGE\nSCEcorp\nDIRECTOR GRANTOR TRUST AGREEMENT\nThis Director Grantor Trust Agreement (\"Trust Agreement\") is made and entered into by SCEcorp, Southern California Edison Company, The Mission Group, Mission Energy Company, Mission First Financial, Mission Land Company, all California corporations (\"Grantors\"), and U.S. Trust Company of California N. A. (\"Trustee\").\nThe Grantors hereby establish with the Trustee a master trust, with separate subtrusts for the interests of each Grantor, to hold all monies and other property, together with the income thereon, as shall be paid or transferred to it hereunder in accordance with the terms and conditions of this Trust Agreement. The Trustee hereby accepts the trust established under this Trust Agreement and agrees to hold, IN TRUST, all monies and other property transferred to it hereunder for the uses and purposes and upon the terms and conditions set forth herein, and the Trustee further agrees to discharge and perform fully and faithfully all of the duties and obligations imposed upon it under this Trust Agreement.\nPREAMBLE\nOn behalf of directors of the Grantors, SCEcorp has adopted the following plan which shall be subject to this trust and references to the \"Plan\" in this Trust Agreement shall refer to such plan:\nSCEcorp Director Deferred Compensation Plan\nThe Plan is administered by the SCEcorp Compensation and Executive Personnel Committee of the SCEcorp Board of Directors (\"Compensation Committee\"). This Trust Agreement shall be administered by the Compensation Committee, but day-to-day administration is delegated to the SCE Trust Investment Committee (\"Trust Committee\"). PAGE\nPlan participants and beneficiaries who are covered by this Trust Agreement (\"Participants\" and \"Beneficiaries\") shall be all persons who are participants or beneficiaries in the Plan. After a person becomes a Participant or a Beneficiary covered by this Trust Agreement, such status will continue until all Plan benefits payable to that person have been paid, that person ceases to be entitled to any Plan benefits, or that person dies, whichever occurs first.\nPrior to a Change in Control, SCEcorp may by written notice to the Trustee, cause additional plans to become subject to this Trust Agreement (any reference to the Plan herein also constitutes a reference to any such additional plans).\nSCEcorp shall provide the Trustee with copies of the following items: (i) the Plan documents; (ii) all Plan amendments promptly upon their adoption; and (iii) lists and specimen signatures of the members of the Trust Committee and any SCEcorp representatives authorized to take action in regard to the administration of the Plan and this trust, including any changes in the members of the Trust Committee and of such other representatives promptly following any such change. SCEcorp shall also provide the Trustee at least annually with a list of all Participants in each Plan who are covered by this Trust Agreement.\nThe purpose of this trust is to give Participants greater security by placing assets in trust for use only to pay Plan benefits to Participants or if one of the Grantors becomes insolvent, to pay its creditors from its portion of the trust assets. The Grantors shall continue to be liable to Participants to make all payments required under the terms of the Plan to the extent such payments are not made from this trust. Distributions made from this trust to Participants or their beneficiaries shall, to the extent of such distributions, satisfy the Grantors' obligations to pay benefits to Participants and their beneficiaries under the Plan.\nThe Grantors and the Trustee agree that the trust, comprised of one or more subtrusts for each Grantor, has been established to pay obligations of the Grantors pursuant to the Plan and each subtrust is subject to the rights of general creditors of the respective Grantor, and accordingly the trust is a grantor trust under the provisions of Sections 671 through 677 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Grantors hereby agree to report their allocable shares of all items of income, deductions and credits of the trust on their own income tax returns; and the Grantors shall have no right to any distributions from the trust or any claim against the trust for funds necessary to pay any income taxes which the Grantors are required to pay on account of reporting the income of the trust on their income tax returns. No contribution to or income of the trust is intended to be taxable to Participants until benefits are distributed to them. I. EFFECTIVE DATE AND DURATION\n1.01 Effective Date And Trust Year\nThis trust shall become effective when the Trust Agreement has been executed by the Grantors and the Trustee and one or more of the Grantors have made a contribution to the trust. For tax purposes the trust year shall be the calendar year.\n1.02 Duration\n1.02-1 This trust shall continue in effect until all assets of the trust fund are exhausted through distribution of benefits to Participants and their beneficiaries, payment to creditors in the event of insolvency, payment of fees and expenses of the Trustee, and return of remaining funds to the Grantors pursuant to 1.02-2. Notwithstanding the foregoing, this trust shall terminate on the day before twenty-one years after the death of the last survivor of all present or future Participants who are now living and those persons now living who are designated as beneficiaries of any such Participants in accordance with the terms of the Plan.\n1.02-2 Except as otherwise provided in 1.02, the trust shall be irrevocable until all benefits payable under the Plan to Participants and Beneficiaries who are covered by this Trust Agreement are paid. The Trustee shall then return to the Grantors any assets remaining in the trust in accordance with the allocations to their respective subtrusts.\n1.02-3 If the existence of this trust or any subtrust is determined to be Tax Funding (as such term is defined in 1.02-4) by the Compensation Committee, this trust or such subtrust shall terminate. The Compensation Committee may also terminate this trust or any subtrust if it determines, based on an opinion of legal counsel which is satisfactory to the Trustee, that either (i) judicial authority or the opinion of Treasury Department or Internal Revenue Service (as expressed in proposed or final regulations, advisory opinions or rulings, or similar administrative announcements) creates a significant risk that the trust or any subtrust will be held to be Tax Funding or (ii) the Code requires the trust or any subtrust to be amended in a way that creates a significant risk that the trust or such subtrust will be held to be Tax Funding, and failure to so amend the trust or such subtrust could subject the Grantors to material penalties. Upon any such termination, (i) the assets of each terminated subtrust shall be allocated and distributed to the Participants in proportion to the vested accrued benefits of Participants under the Plan and (ii) then, if any assets remain, the unvested (if any) accrued benefits of Participants under the applicable Plan shall be distributed to such Participants in lump sums in proportion to the unvested accrued benefits of the Participants under the Plan . Any assets remaining shall be distributed to the respective Grantor(s) in accordance with 2.04. Notwithstanding the foregoing, the Trustee shall distribute Plan benefits to a Participant to the extent that a federal court has held that the interest of the Participant in this trust causes such Plan benefits to be includable for federal income tax purposes in the gross income of the Participant prior to actual payment of such Plan benefits to the Participant and appeals from that holding are no longer timely or have been exhausted. The Trustee may also distribute Plan benefits to a Participant, upon direction of the Compensation Committee, based on an opinion of legal counsel which is satisfactory to the Trustee, that there is a significant risk that the Participant's interest in the trust fund will be held to be Tax Funding with respect to such Participant. The provisions of this paragraph shall also apply to any Beneficiary of a Participant.\n1.02-4 This trust is \"Tax Funding\" if it causes the interest of a Participant in this trust to be includable for federal income tax purposes in the gross income of the Participant prior to actual payment of Plan benefits to the Participant.\n1.02-5 \"Written Consent of Participants\" means, for the purposes of this Trust Agreement, consent in writing by Participants who (i) constitute a majority in number of all participants and (ii) have accrued benefits (whether vested or unvested) with a present value equal to more than fifty percent (50%) of the present value of the accrued benefits of all of the Participants in all of the subtrusts under this Trust Agreement on the date of such consent.\n1.03 Special Circumstances\n1.03-1 Upon the occurrence of a Special Circumstance as described in 1.03-2 with respect to any Grantor, the trust assets allocated to the affected Grantor shall be held for Participants in the Grantor's subtrusts who had accrued benefits before the Special Circumstance occurred and shall include those assets accrued for such Participants after the Special Circumstance.\n1.03-2 A \"Special Circumstance\" shall mean a Potential Change in Control of any Grantor (as defined in 2.01-7), a Change in Control of any Grantor (as defined in the Plan) or a Default of any Grantor (as defined in 1.03- 4).\n1.03-3 The Trust Committee or the Chief Executive Officer of the affected Grantor shall furnish written notice to the Trustee when a Change in Control occurs. For purposes of this Trust Agreement, a Change in Control of any Grantor shall be deemed to have occurred when the Trustee makes a determination to that effect on its own initiative or upon receipt by the Trustee of written notice to that effect from the Trust Committee or the Chief Executive Officer of the affected Grantor.\n1.03-4 A \"Default\" shall mean a failure by a Grantor to contribute to the trust, within 30 days of receipt of written notice from the Trustee, any of the following amounts:\n(a) The full amount of any insufficiency in assets of any subtrust that is required to pay any premiums or loan interest payments on insurance contracts which are held in the subtrust;\n(b) The full amount of any insufficiency in assets of any subtrust that is required to pay any Plan benefit that is payable upon a direction from the Trust Committee pursuant to 3.02-3 or upon resolution of a disputed claim pursuant to 3.03-2; or\n(c) Any contribution which is then required under 2.01.\nIf, after the occurrence of a Default, the Grantor at any time cures such Default by contributing to the trust all amounts which are then required under subparagraphs (a), (b) and (c) above, it shall then cease to be deemed that a Default has occurred or that a Special Circumstance has occurred by reason of such Default.\nII. TRUST FUND AND FUNDING POLICY\n2.01 Contributions\n2.01-1 All contributions to the trust by the Grantors shall be made through SCEcorp as agent for the Grantors. Each Grantor shall be liable to SCEcorp for its allocable share of any contribution made to the trust by SCEcorp on behalf of the Grantor. Each Grantor, through SCEcorp, shall contribute to the trust such amounts as are required to purchase or hold insurance contracts in the trust and to pay premiums and loan interest payments thereon. Each Grantor, through SCEcorp, shall also contribute to the trust such additional amounts as are necessary to fund all Plan benefits accrued by Participants while employed by such Grantor (unless the Grantor makes such payments directly) whenever the Trust Committee advises SCEcorp or the Grantor that the assets of the trust or subtrust, other than insurance contracts or amounts needed to pay future premiums or loan interest payments on insurance contracts, are, or in the future are likely to be, insufficient to make such payments. In its discretion, SCEcorp or any Grantor may contribute to the trust such additional amounts or assets as the Trust Committee may reasonably decide are necessary to provide security for all Plan benefits payable to Participants covered by this trust or any subtrust. SCEcorp or any Grantor may make contributions to a special reserve for payment of future fees and expenses of the Trustee and future trust fees and expenses for legal and administrative proceedings.\n2.01-2 Whenever SCEcorp makes a contribution to the trust on behalf of the Grantors, SCEcorp shall designate the Plan and subtrusts to which such contribution (or designated portions thereof) shall be allocated. If the contribution is for a special reserve for payment of future fees and expenses of the Trustee and future trust fees and expenses for legal and administrative proceedings, a separate subtrust shall be designated to receive such contributions, which shall be distinct from any subtrust established for the Plan or the Grantors.\n2.01-3 Following the occurrence of a Special Circumstance (as defined in 1.03-2) with respect to any Grantor, and at least annually thereafter while the Special Circumstance remains in effect, the Grantor shall contribute to the trust the sum of the following:\n(a) The amount by which the present value of all \"anticipated benefits\" (vested and unvested) payable under the Plan on a pre-tax basis to Participants or their beneficiaries whose benefits are funded by the Grantor's subtrust(s) exceeds the value of all of the Grantor's subtrust assets. For this purpose, each Participant's \"anticipated benefit\" under the Plan shall be the present value of highest benefit the Participant would have accrued under the Plan by the end of that year, assuming that the Participant's service continues at the same rate of compensation and that the Participant continues to make deferrals under the Plan for the balance of the year.\n(b) A reasonable estimate of the Trustee fees and expenses for the remaining duration of the trust which should be allocable to the Grantor's subtrust(s).\n2.01-4 The calculations required under 2.01-3 shall be based on the terms of the Plan.\n2.01-5 Whenever SCEcorp makes a contribution to the trust pursuant to 2.01-3 on its own behalf or on behalf of another Grantor, it shall furnish the Trustee with a written statement setting forth the computation of all required amounts contributed.\nWhenever a Special Circumstance occurs or a contribution is made pursuant to 2.01-3, SCEcorp or the Trust Committee shall deliver to the Trustee, contemporaneously with or immediately prior to such event, a schedule (the \"Payment Schedule\") indicating the amounts payable under the Plan in respect of each affected Participant, or providing a formula or instructions acceptable to the Trustee for determining the amounts so payable, the form in which such amounts are to be paid (as provided for or available under the Plan) and the time of commencement for payment of such amounts. The Payment Schedule shall include any other necessary instructions with respect to Plan benefits (including legal expenses) payable under the Plan and any conditions with respect to any Participant's entitlement to such benefits, and such instructions may be revised from time to time to the extent so provided under the Plan or this Trust Agreement.\nA modified Payment Schedule shall be delivered by SCEcorp or the Trust Committee to the Trustee at each time that (i) additional amounts are required to be paid to the Trustee pursuant to 2.01-3, (ii) Excess Assets are returned to the Grantors, or (iii) upon the occurrence of any event requiring a modification of the Payment Schedule. SCEcorp shall also furnish a Payment Schedule or modified Payment Schedule for any or all Plan upon request by the Trustee at any other time. Whenever SCEcorp or the Trust Committee is required to deliver to the Trustee a Payment Schedule or a modified Payment Schedule, SCEcorp shall also deliver at the same time to each Participant the respective portion of the Payment Schedule or modified Payment Schedule that sets forth the amount payable to that Participant.\n2.01-6 Any contribution to the trust which is made by a Grantor on account of a Potential Change in Control shall be returned to that Grantor following one year after delivery of such contribution to the Trustee unless a Change in Control of the Grantor shall have occurred during such one-year period, if the Grantor requests such return within 60 days after such one-year period. If no such request is made within this 60-day period, the contribution shall become a permanent part of the trust fund allocated to the Grantor's subtrust(s). The one-year period shall recommence in the event of and upon the date of any subsequent Potential Change in Control.\n2.01-7 A \"Potential Change in Control\" shall be deemed to occur with respect to a Grantor if:\n(a) Any person, as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the \"Act\"), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Grantor, delivers to the Grantor a statement containing the information required by Schedule 13-D under the Act, or any amendment to any such statement, that shows that such person has acquired, directly or indirectly, the beneficial ownership of (i) more than twenty- five (25%) percent of any class of equity security of the Grantor entitled to vote as a single class in the election or removal from office of directors, or (ii) more than twenty-five (25%) percent of the voting power of any group of classes of equity securities of the Grantor entitled to vote as a single class in the election or removal from office of directors;\n(b) The Grantor becomes aware that preliminary or definitive copies of a proxy statement and information statement or other information have been filed with the Securities and Exchange Commission pursuant to Rule 14a-6, Rule 14c-5, or Rule 14f-1 under the Act relating to a Potential Change in Control of the Grantor;\n(c) Any person delivers to the Grantor pursuant to Rule 14d-3 under the Act a Tender Offer Statement relating to Voting Securities of the Grantor;\n(d) Any person (other than the Grantor or an SCEcorp affiliate) publicly announces an intention to take actions which if consummated would constitute a Change in Control;\n(e) The Grantor enters into an agreement or arrangement, the consummation of which would result in the occurrence of a Change in Control;\n(f) The Grantor's Board approves a proposal, or the Grantor enters into an agreement, which if consummated would constitute a Change in Control; or\n(g) The Grantor's Board adopts a resolution to the effect that, for purposes of this Trust Agreement, a Potential Change in Control has occurred.\nNotwithstanding the foregoing, a Potential Change in Control shall not be deemed to occur as a result of any event described in (a) through (g) above, if directors who were a majority of the members of the Grantor's Board prior to such event determine that the event shall not constitute a Potential Change in Control and furnish written notice to the Trustee of such determination.\n2.01-8 The Trust Committee or the Chief Executive Officer of the affected Grantor shall furnish written notice to the Trustee when a Potential Change in Control occurs under 2.01-7. For purposes of this trust, a Potential Change in Control shall be deemed to have occurred when the Trustee makes a determination to that effect on its own initiative or upon receipt by the Trustee of written notice to that effect from the affected Grantor or the Trust Committee except as may be provided under 2.01-7.\n2.01-9 The Trustee shall accept the contributions made by SCEcorp on behalf of the Grantors and hold them as a trust fund for the payment of benefits under the Plan. The Trustee shall not be responsible for determining the required amount of contributions or for collecting any contribution not voluntarily paid, nor shall the Trustee be responsible for the adequacy of the trust fund to meet and discharge all liabilities under the Plan. Contributions may be in cash or in other assets specified in 2.02.\n2.02 Investment And Valuation\n2.02-1 The trust fund may be invested primarily in insurance contracts (\"Contracts\"). Such Contracts may be purchased by SCEcorp on behalf of the Grantors and transferred to the Trustee as in-kind contributions or may be purchased by the Trustee with the proceeds of cash contributions (or may be purchased upon direction by the Trust Committee pursuant to 2.02-2 or an Investment Manager pursuant to 2.02-4). Trust contributions shall include sufficient cash to make projected premium payments on such Contracts and payments of interest due on loans secured by the cash value of such Contracts, unless SCEcorp makes these payments directly on behalf of the Grantors or the Grantors make the payments directly. The Trustee shall have the power to exercise all rights, privileges, options and elections granted by or permitted under any Contract or under the rules of the insurance company issuing the Contract (\"Insurer\"), including the right to obtain policy loans against the cash value of the Contract. Prior to a Special Circumstance, the exercise by the Trustee of any incidents of ownership under any Contract shall be subject to the direction of the Trust Committee. The Trustee shall have no power to designate a beneficiary other than the trust, to assign a Contract other than to a successor trustee, or to loan proceeds of any Contract borrowings to any person other than the Grantors. The Trust Committee may from time to time direct the Trustee in writing as to the designation of beneficiary under such Contracts.\nNotwithstanding anything contained herein to the contrary, neither SCEcorp, nor any Grantor nor the Trustee shall be liable for the refusal of any Insurer to issue or change any Contract or Contracts or to take any other action requested by the Trustee; nor for the form, genuineness, validity, sufficiency or effect of any Contract or Contracts held in the trust; nor for the act of any person (other than itself) or persons that may render any such Contract or Contracts null and void; nor for failure of any Insurer to pay the proceeds of any such Contract or Contracts as and when the same shall become due and payable; nor for any delay in payment resulting from any provision contained in any such Contract or Contracts; nor for the fact that for any reason whatsoever (other than its own negligence or willful misconduct) any Contracts shall lapse or otherwise become uncollectable.\n2.02-2 Prior to a Special Circumstance, the Trustee shall invest the trust fund in accordance with written directions by the Trust Committee, including directions for exercising rights, privileges, options and elections pertaining to Contracts and for borrowing from Contracts or other borrowing by the Trustee. The Trustee shall act only as an administrative agent in carrying out directed investment transactions and shall not be responsible for the investment decision. If a directed investment transaction violates any duty to diversify, to maintain liquidity or to meet any other investment standard under this trust or applicable law, the entire responsibility shall rest upon the Trust Committee. The Trustee shall be fully protected in acting upon or complying with any investment objectives, guidelines, restrictions or directions provided in accordance with this paragraph.\nAfter a Special Circumstance with respect to a Grantor, the Trust Committee shall no longer be entitled to direct the Trustee with respect to the investment of that portion of the trust fund allocated to that Grantor's subtrust(s), unless the Written Consent of Participants of the affected subtrust(s) is obtained for the Trust Committee to continue to have this right pursuant to 2.02-2. If such Written Consent of Participants is not obtained, that portion of the trust fund shall be invested by the Trustee pursuant to 2.02-3 or by an Investment Manager pursuant to 2.02-4. The Trustee or Investment Manager shall have the right to invest the Trust Fund primarily in insurance contracts pursuant to 2.02-1.\nNotwithstanding the foregoing, after a Special Circumstance no new investments shall be made at any time in any securities, instruments, accounts or real property of the affected Grantor, and the Trustee may not loan trust fund assets to the affected Grantor, or permit the affected Grantor to pledge trust fund assets as collateral for loans to the affected Grantor without the Written Consent of all of the Participants.\nThe Trust Committee may not direct the Trustee to make any investments, and the Grantors may not make any contributions of property to the trust fund, which are not permissible investments under 2.02-1 and 2.02-3.\n2.02-3 If the Trustee does not receive instructions from the Trust Committee for the investment of part or all of the trust fund for a period of at least 60 days, the Trustee shall invest and reinvest the assets of the trust fund as the Trustee, in its sole discretion, may deem appropriate, in accordance with applicable law.\nPermissible investments shall be limited to the following:\n(a) Insurance or annuity contracts; (b) Preferred or common stocks, bonds, notes, debentures, commercial paper, certificates of deposit, money market funds, obligations of governmental bodies, or other securities;\n(c) Interest-bearing savings or deposit accounts with any federally-insured bank or savings and loan association (including the Trustee or an affiliate of the Trustee);\n(d) Shares or certificates of participation issued by investment companies, investment trusts, mutual funds, or common or pooled investment funds (including any common or pooled investment fund now or hereafter maintained by the Trustee or an affiliate of the Trustee); or\n(e) Real property, mortgages, deeds of trust, or notes secured by mortgages or deeds of trust.\n2.02-4 Prior to a Change in Control, the Trust Committee may appoint one or more investment managers (\"Investment Manager\") subject to the following provisions:\n(a) The Trust Committee may appoint one or more Investment Managers to manage (including the power to acquire and dispose of) a specified portion of the assets of the trust (hereinafter referred to as that Investment Manager's \"Segregated Fund\"). Any Investment Manager so appointed must be either (i) an investment adviser registered as such under the Investment Advisers Act of 1940, (ii) a bank, as defined in that Act, or (iii) an insurance company qualified to perform services in the management, acquisition or disposition of the assets of trusts under the laws of more than one state; and any Investment Manager so appointed must acknowledge in writing to the Trust Committee and to the Trustee that it is a fiduciary with respect to the trust assets. The Trustee, until notified in writing to the contrary, shall be fully protected in relying upon any written notice of the appointment of an Investment Manager furnished to it by the Trust Committee. In the event of any vacancy in the office of Investment Manager, the Trustee, upon seven days prior written notice of the vacancy in the office of Investment Manager shall be deemed to be the Investment Manager of that Investment Manager's Segregated Fund until an Investment Manager thereof shall have been duly appointed; and in such event, until an Investment Manager shall have been so appointed and qualified, references herein to the Trustee's acting in respect of that Segregated Fund pursuant to direction from the Investment Manager shall be deemed to authorize the Trustee to act in its own discretion in managing and controlling the assets of that Segregated Fund, and subparagraphs (b) and (c) below shall have no effect with respect thereto and shall be disregarded.\n(b) Each Investment Manager appointed pursuant to subparagraph (a) above shall have exclusive authority and discretion to manage and control the assets of its Segregated Fund and may invest and reinvest the assets of the Segregated Fund in any investments in which the Trustee is authorized to invest under 2.02-3, subject to the terms and limitations of any written instruments pertaining to its appointment as Investment Manager. Copies of any such written instruments shall be furnished to the Trustee. In addition, each Investment Manager from time to time and at any time may delegate to the Trustee (or in the event of any vacancy in the office of Investment Manager, the Trustee, upon seven days prior written notice of the vacancy in the office of Investment Manager, may, until an Investment Manager thereof shall have been duly appointed, exercise in respect of that Investment Manager's Segregated Fund) discretionary authority to invest and reinvest otherwise uninvested cash held in its Segregated Fund temporarily in bonds, notes or other evidences of indebtedness issued or fully guaranteed by the United States of America or any agency or instrumentality thereof, or in other obligations of a short-term nature, including prime commercial obligations or part interests therein.\n(c) Unless the Trustee knowingly participates in, or knowingly undertakes to conceal, an act or omission of an Investment Manager, knowing such act or omission to be a breach of the fiduciary responsibility of the Investment Manager with respect to the trust assets, the Trustee shall not be liable for any act or omission of any Investment Manager and shall not be under any obligation to invest or otherwise manage the assets of the Plan that are subject to the management of any Investment Manager. Without limiting the generality of the foregoing, the Trustee shall not be liable by reason of its taking or refraining from taking at the direction of an Investment Manager any action in respect of that Investment Manager's Segregated Fund. The Trustee shall be under no duty to question or to make inquiries as to any direction or order or failure to give direction or order by any Investment Manager; and the Trustee shall be under no duty to make any review of investments acquired for the trust at the direction or order of any Investment Manager and shall be under no duty at any time to make any recommendation with respect to disposing of or continuing to retain any such investment.\n2.02-5 The values of all assets in the trust fund shall be reasonably determined by the Trustee and may be based on the determination of qualified independent parties or Experts (as described in 2.06-2). At any time before or after a Special Circumstance, the Trustee shall have the right to secure confirmation of value by a qualified independent party or Expert for all property of the trust fund, as well as any property to be substituted for other property of the trust fund pursuant to 2.05. Before a Special Circumstance the Trust Committee may designate one or more independent parties, who are acceptable to the Trustee, to determine the fair market value of any notes, securities, real property or other assets.\nAny insurance or annuity contracts held in the trust fund shall be valued at their cash surrender value, except for purposes of substituting other property for such Contracts pursuant to 2.05-2. All securities shall be valued net of costs to sell, or register for sale, such securities. All real property shall be valued net of costs to sell such real property. All other assets of the trust fund shall be valued at their fair market value.\nSCEcorp shall pay on behalf of the Grantors all costs incurred in valuing the assets of the trust fund including any assets to be substituted for other assets of the trust fund pursuant to 2.05. If not so paid, these costs shall be paid from the trust fund. SCEcorp shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such costs paid out of the trust fund.\n2.02-6 Following a Change in Control of a Grantor, the Trustee shall be the Investment Manager of the assets of the affected subtrust(s). While the Trustee is the Investment Manager, any requirements in the Plan or Trust Agreement that the Investment Manager or the Trustee provide the other with prior written notice or other communication shall not apply.\n2.03 Subtrusts\n2.03-1 The Trustee shall establish a Grantor subtrust for each Plan in which a Grantor participates to which it shall credit contributions it receives which are earmarked for that Grantor. The Trustee shall also establish a separate subtrust to which it shall credit contributions it receives which are earmarked to the special reserve for payment of future fees and expenses of the Trustee. Each subtrust shall reflect an undivided interest in assets of the trust fund and shall not require any segregation of particular assets, except that an insurance contract covering benefits of a particular Plan shall be held in the subtrust for the Plan. All contributions shall be designated by SCEcorp for a particular subtrust. However, any contribution received by the Trustee which is not earmarked for a particular subtrust shall be allocated among the subtrusts as the Trustee may determine in its sole discretion. The Trust Committee may direct the Trustee, or the Trustee may determine on its own initiative, to maintain a separate sub-account within each subtrust for a Plan for each Participant who is covered by the subtrust. Each sub-account in a subtrust shall reflect an individual interest in assets of the subtrust and, as much as possible, shall operate in the same manner as if it were a separate subtrust.\n2.03-2 The Trustee shall allocate investment earnings and losses and expenses of the trust fund among the subtrusts in proportion to their balances, except that changes in the value of an insurance contract (including premiums and interest on loans on an insurance contract) shall be allocated to the subtrust for which it is held. Payments to creditors during Insolvency Administration under 5.02 shall be charged against the affected Grantor's subtrusts in proportion to their balances, except that payment of Plan benefits to a Participant as a general creditor shall be charged against the subtrust for that Plan.\n2.03-3 Assets allocated to a subtrust for one Plan may not be utilized to provide benefits under any other Plan until all benefits under such Plan have been paid in full, except that Excess Assets (as defined in 2.04-2) of a subtrust may be transferred to other subtrusts pursuant to 2.04-5.\n2.04 Recapture Of Excess Assets\n2.04-1 In the event the trust shall hold Excess Assets, the Trust Committee, at its option, may direct the Trustee to return part or all of such Excess Assets to the Grantors.\n2.04-2 \"Excess Assets\" are assets of the trust or a subtrust exceeding one hundred twenty-five percent (125%) of the amounts described in 2.01-3.\n2.04-3 The calculation required by 2.04-2 shall be based on the terms of the Plan. Before a Special Circumstance, the calculation shall be made by the Trust Committee or a qualified actuary or consultant selected by the Trust Committee. After a Special Circumstance, the calculation shall be made by a qualified actuary or consultant selected by the Trustee, provided the Trust Committee may select a qualified actuary or consultant with the Written Consent of Participants.\n2.04-4 Excess Assets shall be returned to the Grantors in any order of priority directed by the Trust Committee, unless the Trustee determines otherwise to protect the Participants.\n2.04-5 If any subtrust for a Grantor holds Excess Assets, the Trust Committee may direct the Trustee to transfer such Excess Assets to other subtrusts of the Grantor. After a Special Circumstance, the Trustee may also transfer Excess Assets of a subtrust for a Grantor to other subtrusts for that Grantor upon its own initiative in such amounts as it may determine in its sole discretion.\nExcess Assets of a subtrust for a Plan shall be determined in the same manner as Excess Assets of the trust are determined pursuant to 2.04-2 and 2.04-3. In making this determination, each subtrust for a Plan shall bear its allocable share of the amounts described in 2.01-3 which relate to that Plan. The Trustee, in its sole discretion, shall determine whether there are Excess Assets in the separate subtrust which constitutes the reserve for payment of future fees and expenses of the Trustee. Excess Assets for this subtrust shall be any amounts which the Trustee reasonably determines will not be needed in the future for payment of such fees and expenses.\n2.05 Substitution Of Other Property\n2.05-1 SCEcorp shall have the power to re-acquire on behalf of the Grantors part or all of the assets or collateral held in the trust fund at any time, by simultaneously substituting for it other readily marketable property of equivalent value, net of any costs of disposition; provided that, if the trust holds Excess Assets, the property which is substituted shall not be required to be of equivalent value, but only of sufficient value so that the trust will retain Excess Assets of not less than $10,000 after such substitution. The property which is substituted must be among the types of investments authorized under 2.02 and may not be less liquid or marketable or less well secured than the property for which it is substituted, as determined by the Trust Committee. Such power is exercisable in a nonfiduciary capacity and may be exercised without the approval or consent of Participants or any other person.\n2.05-2 Except for insurance contracts, the value of any assets re- acquired under 2.05-1 shall be determined as provided in 2.02-5. The value of any insurance contract re-acquired under 2.05-1 shall be the present value of future projected cash flow or benefits payable under the Contract, but not less than the cash surrender value. The projection shall include death benefits based on reasonable mortality assumptions, including known facts specifically relating to the health of the insured and the terms of the Contract to be re-acquired. Values shall be reasonably determined by the Trustee and may be based on the determination of qualified independent parties and Experts, as described in 2.02-5 and 2.06-2. The Trustee shall have the right to secure confirmation of value by a qualified independent party or Expert for all property to be substituted for other property.\n2.05-3 SCEcorp shall pay on behalf of the Grantors all costs incurred in valuing the assets of the trust fund, including any assets to be substituted for other assets of the trust fund pursuant to 2.05. If not so paid, these costs shall be paid from the trust fund. SCEcorp shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such costs paid out of the trust fund.\n2.06 Administrative Powers Of Trustee\n2.06-1 Subject in all respects to applicable provisions of this Trust Agreement, including limitations on investment of the trust fund, the Trustee shall have the rights, powers and privileges of an absolute owner when dealing with property of the trust, including (without limiting the generality of the foregoing) the powers listed below:\n(a) To sell, convey, transfer, exchange, partition, lease, and otherwise dispose of any of the assets of the trust at any time held by the Trustee under this Trust Agreement;\n(b) To exercise any option, conversion privilege or subscription right given the Trustee as the owner of any security held in the trust; to vote any corporate stock either in person or by proxy, with or without power of substitution; to consent to or oppose any reorganization, consolidation, merger, readjustment of financial structure, sale, lease or other disposition of the assets of any corporation or other organization, the securities of which may be an asset of the trust; and to take any action in connection therewith and receive and retain any securities resulting therefrom;\n(c) To deposit any security with any protective or reorganization committee, and to delegate to such committee such power and authority with respect thereto as the Trustee may deem proper, and to agree to pay out of the trust such portion of the expenses and compensation of such committee as the Trustee, in its discretion, shall deem appropriate;\n(d) To cause any property of the trust to be issued, held or registered in the name of the Trustee as trustee, or in the name of one or more of its nominees, or one or more nominees of any system for the central handling of securities, or in such form that title will pass by delivery, provided that the records of the Trustee shall in all events indicate the true ownership of such property, or to deposit any securities held in the trust with a securities depository;\n(e) To renew or extend the time of payment of any obligation due or to become due;\n(f) To commence or defend lawsuits or legal or administrative proceedings; to compromise, arbitrate or settle claims, debts or damages in favor of or against the trust; to deliver or accept, in either total or partial satisfaction of any indebtedness or other obligation, any property; to continue to hold for such period of time as the Trustee may deem appropriate any property so received; and to pay all costs and reasonable attorneys' fees in connection therewith out of the assets of the trust;\n(g) To foreclose any obligation by judicial proceeding or otherwise;\n(h) Subject to 2.02, to borrow money from any person in such amounts, upon such terms and for such purposes as the Trustee, in its discretion, may deem appropriate; and in connection therewith, to execute promissory notes, mortgages or other obligations and to pledge or mortgage any trust assets as security; and to lend money on a secured or unsecured basis to any person other than a party in interest;\n(I) To manage any real property in the trust in the same manner as if the Trustee were the absolute owner thereof, including the power to lease the same for such term or terms within or beyond the existence of the trust and upon such conditions as the Trustee may deem proper; and to grant options to purchase or acquire options to purchase any real property;\n(j) To appoint one or more persons or entities as ancillary trustee for the purpose of investing in and holding title to real or personal property or any interest therein; provided that any such ancillary trustee shall act with such power, authority, discretion, duties, and functions of the Trustee as shall be specified in the instrument establishing such ancillary trust, including (without limitation) the power to receive, hold and manage property, real or personal, or undivided interests therein; and the Trustee may pay the reasonable expenses and compensation of such ancillary trustees out of the trust;\n(k) To hold such part of the assets of the trust uninvested for such limited periods of time as may be necessary for purposes of orderly trust administration or pending required directions, without liability for payment of interest;\n(l) To determine how all receipts and disbursements shall be credited, charged or apportioned as between income and principal, and the decision of the Trustee shall be final and not subject to question by any Participant or Beneficiary of the trust;\n(m) To dispose of any property in the trust fund and to foreclose on any notes from a Grantor (and dispose of any collateral securing such notes, subject to the terms of any pledge agreement) upon any Default (as defined in 1.03-4), after 60 days written notice to the Grantor to permit the Grantor to cure any Default; and\n(n) Generally to do all acts, whether or not expressly authorized, which the Trustee may deem necessary or desirable for the orderly administration or protection of the trust fund.\n2.06-2 The Trustee may engage one or more qualified independent attorneys, accountants, actuaries, appraisers, consultants or other experts (an \"Expert\") with respect to its determination under the Trust, including the determination of Excess Assets pursuant to 2.04 or disputed claims pursuant to 3.03. The Trustee shall have no duty to oversee or independently evaluate the determination of the Expert. The Trustee shall be authorized to pay the fees and expenses of any Expert out of the assets of the trust fund.\n2.06-3 The Grantors shall from time to time pay taxes (references in this Trust Agreement to the payment of taxes shall include interest and applicable penalties) of any and all kinds whatsoever which at any time are lawfully levied or assessed upon or become payable in respect of their pro rata shares of the trust fund, the income or any property forming a part thereof, or any security transaction pertaining thereto. To the extent that any taxes levied or assessed upon the trust fund are not paid by the Grantors or contested by the Grantors pursuant to the last sentence of this paragraph, the Trustee shall pay such taxes out of the trust fund, and the Grantors shall upon demand by the Trustee, deposit into the trust fund, through their agent, SCEcorp, an amount equal to the amount paid from the trust fund to satisfy such tax liability. If requested by SCEcorp, the Trustee shall contest the validity of such taxes in any manner deemed appropriate by SCEcorp or its counsel, but only if it has received an indemnity bond or other security satisfactory to it to pay any expenses of such contest. Alternatively, SCEcorp may itself contest the validity of any such taxes, but any such contest shall not affect the Grantors' obligation to reimburse the trust fund for taxes paid from the trust fund.\n2.06-4 Notwithstanding any powers granted to Trustee pursuant to this Trust Agreement or to applicable law, Trustee shall not have any power that could give this Trust the objective of carrying on a business and dividing the gains therefrom, within the meaning of section 301.7701-2 of the Procedure and Administrative Regulations promulgated pursuant to the Code. III. ADMINISTRATION\n3.01 Committee; Company Representatives\n3.01-1 The Compensation Committee is the administrator of the Plan and has general responsibility to interpret the Plan and determine the rights of Participants and beneficiaries. Day-to-day administration of the Plan has been delegated to SCEcorp management. The Compensation Committee is the administrator of this Trust Agreement and shall act on behalf of all Grantors with respect to the Administration of this Trust Agreement; however, day-to-day administration of the Plan has been delegated to the Trust Committee. Notwithstanding any other provision of this Trust Agreement, each Grantor is responsible for contributions to fund benefits accrued by Participants while employed by the Grantor and for its pro rata share of expenses of the trust (based on the amount of assets allocated to the Grantor's subtrust(s)) and shall reimburse SCEcorp for payments advanced by SCEcorp on its behalf.\n3.01-2 The Trustee shall be given the names and specimen signatures of the members of the Trust Committee and any other SCEcorp representatives authorized to take action in regard to the administration of the Plan and this trust. The Trustee shall accept and rely upon the names and signatures until notified of any change. Instructions to the Trustee shall be signed for the Trust Committee by the chairman or such other person as the Trust Committee may designate.\n3.02 Payment Of Benefits\n3.02-1 The Trustee shall pay benefits to Participants and beneficiaries on behalf of the Grantors in satisfaction of their obligations under the Plan. Each Grantor shall contribute to the trust such amounts as are necessary to fund benefits accrued by Participants while in the active service of the Grantor and to enable the Trustee to make all such Plan benefit payments to Participants when due, whenever the Trustee advises the Trust Committee that the assets of the relevant subtrust, other than insurance contracts or amounts needed to pay future premiums or loan interest payments on insurance contracts, are insufficient to make such payments. Benefit payments from a subtrust shall be made in full until the assets of the subtrust are exhausted. Payments due on the date the subtrust is exhausted shall be covered pro rata. A Grantor's benefit payment obligation shall not be limited to the portion of the trust fund allocated to the Grantor's subtrust(s), and a Participant or Beneficiary shall have a claim against a Grantor for any payment not made by the Trustee.\nNotwithstanding the foregoing, and in the discretion of the Grantors, benefits payments may be paid directly to Participants at any time. Grantors shall pay benefits directly to Participants and beneficiaries in satisfaction of their obligations under a Plan whenever either (i) the assets of the subtrust are not then sufficient to satisfy any then applicable contribution or funding requirements imposed under 2.01, or (ii) there are no assets in the subtrust other than insurance contracts. If a Grantor fails to make any such required payments when due, after 60 days' written notice to the Grantor to permit the Grantor to make any such payments, the Trustee shall pay benefits to Participants and beneficiaries under any Plan from the assets of the subtrust for that Plan.\n3.02-2 A Participant's entitlement to benefits under the Plan shall be determined by the Compensation Committee. Any benefit enhancement or right with respect to the Plan which is provided under employment or severance agreements of Participants shall be taken into account in making the foregoing determination. Any claim for such benefits shall be considered and reviewed under the claims procedures established for that Plan.\n3.02-3 The Trustee shall make payments in accordance with written directions from the Trust Committee or its designee, except as provided in 3.03. The Trustee may request such directions from the Trust Committee or its designee. If the Trust Committee or its designee fails to furnish written directions to the Trustee within 60 days after receiving a written request for directions from the Trustee, the Trustee may make payments determined by the amounts due under the terms of the Plan in reliance upon the most recent Payment Schedule furnished to it by the Trust Committee.\nThe Trustee shall make provision for the reporting and withholding of any federal, state or local taxes that may be required prior to or coincident with making any benefit payments hereunder and shall pay amounts withheld to taxing authorities on the Grantor's behalf or determine that such amounts have been reported, withheld and paid by the Grantor.\n3.02-4 The Trustee shall use the assets of the trust or any subtrust to make benefit payments or other payments in such order of priority as the Trustee may determine, or as may be directed by the Trust Committee.\n3.03 Disputed Claims\n3.03-1 A Participant covered by this Trust whose claim has been denied by the Trust Committee, or who has received no response to the claim within 60 days after submission, may submit the claim to the Trustee. The Trustee shall give written notice of the claim to the Trust Committee. If the Trustee receives no written response from the Trust Committee within 60 days after the date the Trust Committee is given written notice of the claim, the Trustee shall pay the Participant the amount claimed, unless it determines in its sole discretion that a lesser amount is due under the terms of the Plan. If a written response is received within such 60 days, the Trustee shall consider the claim in its sole and absolute discretion, including the Trust Committee's response. If the merits of the claim depend on compensation, service or other data in the possession of SCEcorp or a Grantor and it is not provided, the Trustee may rely upon information provided by the Participant. Any benefit enhancement or right with respect to the Plan which is provided under employment or severance agreements of Participants shall be taken into account in making the foregoing determination.\n3.03-2 The Trustee shall give written notice to the Participant and the Trust Committee of its decision on the claim. If the decision is to grant the claim, the Trustee shall make payment to the Participant. The Trustee may decline to decide a claim and may file suit to have the matter resolved by a court of competent jurisdiction. All of the Trustee's expenses in the court proceeding, including attorneys fees, shall be allowed as administrative expenses of the trust.\nThe Participant, SCEcorp or the Grantor may challenge the Trustee's decision by filing suit in a court of competent jurisdiction. If no such suit is filed within 60 days after delivery of written notice of the Trustee's decision, the decision shall become final and binding on all parties.\nNotwithstanding the two preceding paragraphs, and because it is agreed that time will be of the essence in determining whether any payments are due a Participant or Beneficiary under the Trust, a Participant or Beneficiary may, if he or she desires, submit any claim for payment under the Trust to arbitration. This right to select arbitration shall be solely that of the Participant or Beneficiary and the Participant or Beneficiary may decide whether or not to arbitrate in his or her discretion. The \"right to select arbitration\" is not mandatory on the Participant or Beneficiary, and the Participant or Beneficiary may choose in lieu thereof to bring an action in an appropriate civil court. Once an arbitration is commenced, however, it may not be discontinued without the mutual consent of the parties to the arbitration. During the lifetime of the Participant only he or she can use the arbitration procedure set forth in this section.\nAny claim for arbitration may be submitted as follows: if a Participant or Beneficiary has submitted a request to be paid under the Trust and the claim is finally denied by the Trustee in whole or in part, the claim may be filed in writing with an arbitrator of the Participant's or Beneficiary's choice who is selected by the method described in the next four sentences. The first step of the selection shall consist of the Participant or Beneficiary submitting a list of five potential arbitrators to the Trust Committee. Each of the five arbitrators must be either (1) a member of the National Academy of Arbitrators located in the State of California or (2) a retired California Superior Court or Appellate Court judge. Within one week after receipt of the list, the Trust Committee shall select one of the five arbitrators as the arbitrator for the dispute in question. If the Trust Committee fails to select an arbitrator within one week after receipt of the list, the Participant or Beneficiary shall then designate one of the five arbitrators for the dispute in question.\nThe arbitration hearing shall be held within seven days (or as soon thereafter as possible) after the picking of the arbitrator. No continuance of said hearing shall be allowed without the mutual consent of the Participant or Beneficiary, the Trust Committee and the affected Grantor. Absence from or nonparticipation at the hearing by any party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion when he or she decides he or she has heard sufficient evidence to satisfy issuance of an award. The arbitrator's award shall be rendered as expeditiously as possible and in no event later than one week after the close of the hearing. In the event the arbitrator finds that the Trust Committee or the Grantor has breached the terms of the Trust, he or she shall order the Trustee to pay to the Participant or Beneficiary within two business days after the decision is rendered the amount then due the Participant or Beneficiary. The award of the arbitrator shall be final and binding upon the parties. The award may be enforced in any appropriate court as soon as possible after its rendition. The Trust Committee or the Grantor will be considered the prevailing party in a dispute if the arbitrator determines (1) that the Trust Committee or the affected Grantor has not breached the terms of the Trust and (2) the claim by the Participant or Beneficiary was not made in good faith. Otherwise, the Participant or Beneficiary will be considered the prevailing party. In the event that the Trust Committee or the Grantor is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (excluding any attorneys' fees incurred by Trust Committee or the Grantor) including stenographic reporter, if employed, shall be paid by the losing party. In the event that the Participant or Beneficiary is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (including all attorneys' fees incurred by the Participant or Beneficiary in pursuing his or her claim), including the fees of a stenographic reporter, if employed, shall be paid from trust assets. The affected Grantor shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such Participant's expenses which are reimbursed by the Trustee.\n3.04 Records\n3.04-1 The Trustee shall keep complete records on the trust fund open to inspection by the Grantors, the Compensation Committee and the Trust at all reasonable times. In addition to accountings required below, the Trustee shall furnish to the Grantors, the Compensation and Trust Committees any information reasonably requested about the trust fund.\n3.05 Accountings\n3.05-1 The Trustee shall furnish the Trust Committee with a complete statement of accounts annually within 60 days after the end of the trust year showing assets and liabilities and income and expense for the year of the trust and each subtrust. The Trustee shall also furnish the Trust Committee with accounting statements at such other times as the Trust Committee may reasonably request. The form and content of the statement of accounts shall be sufficient for each Grantor to include in computing its taxable income and credits the income, deductions and credits against tax that are attributable to the portion of the trust fund allocated to its subtrust(s). 3.05-2 The Trust Committee may object to an accounting within 180 days after it is furnished and require that it be settled by audit by a qualified, independent certified public accountant. The auditor shall be chosen by the Trustee from a list of at least five such accountants furnished by the Trust Committee at the time the audit is requested. Either the Trust Committee or the Trustee may require that the account be settled by a court of competent jurisdiction, in lieu of or in conjunction with the audit. All expenses of any audit or court proceedings, including reasonable attorneys' fees, shall be allowed as administrative expenses of the trust.\n3.05-3 If the Trust Committee does not object to an accounting within the time provided, the account shall be settled for the period covered by it.\n3.05-4 When an account is settled, it shall be final and binding on all parties, including all Participants and persons claiming through them.\n3.06 Expenses And Fees\n3.06-1 The Trustee shall be reimbursed for all reasonable expenses and shall be paid a reasonable fee fixed by agreement with the Trust Committee from time to time. No increase in the fee shall be effective before 60 days after the Trustee gives written notice to the Trust Committee of the increase. The Trustee shall notify the Trust Committee periodically of expenses and fees.\n3.06-2 SCEcorp shall pay Trustee and other administrative and valuation fees and expenses on behalf of the Grantors. If not so paid, these fees and expenses shall be paid from the trust fund.\nIV. LIABILITY\n4.01 Indemnity\nThe Trustee will have the duty to discharge its responsibilities under this Trust Agreement with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and aims. Subject to such limitations as may be imposed by applicable law, the Grantors shall indemnify and hold harmless the Trustee from any claim, loss, liability or expense arising from any action or inaction in administration of this trust based on direction or information from either SCEcorp, another Grantor, the Compensation or Trust Committees, any Investment Manager or any Expert, absent willful misconduct, negligence or bad faith.\n4.02 Bonding\nThe Trustee need not give any bond or other security for performance of its duties under this trust.\nV. INSOLVENCY\n5.01 Determination of Insolvency\n5.01-1 A Grantor is Insolvent for purposes of this trust if:\n(a) A Grantor is unable to pay its debts as they come due; or\n(b) A Grantor is the subject of a pending proceeding as a debtor under the federal Bankruptcy Code (or any successor federal statute).\n5.01-2 The Grantor shall promptly give notice to the Trustee when a Grantor becomes Insolvent. The Chief Executive Officer of the Grantor shall be obligated to give such notice. If the Trustee receives such notice or receives from any other person claiming to be a creditor of the Grantor a written allegation that the Grantor is Insolvent, the Trustee shall independently determine whether such insolvency exists. The Trustee may rely on such evidence concerning the Grantor's solvency as may be furnished to Trustee and that provides the Trustee with a reasonable basis for making a determination concerning the Grantor's solvency. The expenses of such determination shall be allowed as administrative expenses of the trust.\n5.01-3 Upon receipt of the notice or allegation described in 5.01-2, the Trustee shall discontinue making payments to Participants and beneficiaries under the Plan from the portion of the trust fund allocable to the affected Grantor's subtrusts and shall commence Insolvency Administration under 5.02.\n5.01-4 The Trustee shall have no obligation to investigate the financial condition of the Grantor prior to receiving a notice or allegation of insolvency under 5.01-2.\n5.02 Insolvency Administration\n5.02-1 During Insolvency Administration, the Trustee shall hold the Grantor's subtrust funds for the benefit of the creditors of the Grantor and make payments only in accordance with 5.02-2. The Trustee shall continue the investment of the trust fund in accordance with 2.02.\n5.02-2 The Trustee shall make payments out of the trust fund in accordance with instructions from a court, or a person appointed by a court, having jurisdiction over the Grantor's condition of insolvency to:\n(a) Creditors;\n(b) Participants and beneficiaries; or\n(c) The Trustee in payment of its fees or expenses.\n5.02-3 During Insolvency Administration, the Participants and beneficiaries shall have no greater rights than general creditors of the Grantor. Nothing in this Trust Agreement shall in any way diminish any rights of Plan Participants or their beneficiaries to pursue their rights as general creditors of the Grantor with respect to benefits due under the Plan or otherwise.\n5.03 Termination Of Insolvency Administration\n5.03-1 Insolvency Administration shall terminate when the Trustee determines that the Grantor:\n(a) Is not Insolvent, in response to a notice or allegation of insolvency under 5.01-2;\n(b) Has ceased to be Insolvent; or\n(c) Has been determined by a court of competent jurisdiction not to be Insolvent or to have ceased to be Insolvent.\n5.03-2 Upon termination of Insolvency Administration under 5.03-1, the affected subtrust(s) shall again be held for the benefit of the Participants and beneficiaries under the Plan. Benefit payments due during the period of Insolvency Administration shall be made as soon as practicable, together with interest from the due dates at the rate credited on the Participant's account under the Plan.\n5.04 Creditors' Claims During Solvency\n5.04.1 During periods of a Grantor's Solvency, the Trustee shall hold the Grantor's subtrust(s) exclusively to pay Plan benefits and the allocable fees and expenses of the trust until all benefits have been paid. Creditors of the Grantor shall not be paid during a Grantor's Solvency from the trust fund, which may not be seized by or subjected to the claims of such creditors in any way.\n5.04-2 A period of Solvency for a Grantor is any period not covered by 5.02.\nVI. SUCCESSOR TRUSTEES\n6.01 Resignation And Removal\n6.01-1 The Trustee may resign at any time by notice to the Trust Committee, which shall be effective in 60 days unless the Trust Committee and the Trustee agree otherwise.\n6.01-2 The Trustee may be removed by the Trust Committee on 60 days' written notice or shorter notice accepted by the Trustee.\nAfter a Special Circumstance, the Trustee may be removed only with the Written Consent of the Participants.\n6.01-3 When resignation or removal is effective, the Trustee shall begin transfer of assets to the successor Trustee immediately. The transfer shall be completed within 60 days, unless the Trust Committee extends the time limit.\n6.02 Appointment Of Successor\n6.02-1 If the Trustee resigns or is removed, the Trust Committee shall appoint a successor by the effective date of resignation or removal under 6.01-1 or 6.01-2. The Trust Committee may appoint any national or state bank or trust company that is unrelated to the Trust Committee as a successor to replace the Trustee upon resignation or removal. The appointment shall be effective when accepted in writing by the new Trustee, which shall have all of the rights and powers of the former Trustee, including ownership rights in the trust assets. The former Trustee shall execute any instruments necessary or reasonably requested by the Trust Committee or the successor Trustee to evidence the transfer. After a Special Circumstance, a successor Trustee may be appointed only with the Written Consent of Participants. If no such appointment has been made, the Trustee may apply to a court of competent jurisdiction for appointment of a successor or for instructions. All expenses of the Trustee in connection with the proceeding shall be allowed as administrative expenses of the trust.\n6.02-2 The successor Trustee need not examine the records and acts of any prior Trustee and may retain or dispose of existing trust assets, subject to Article II. The successor Trustee shall not be responsible for, and the Grantors shall indemnify and hold harmless the successor Trustee from any claim or liability because of, any action or inaction of any prior Trustee.\n6.03 Accountings; Continuity\n6.03-1 A Trustee who resigns or is removed shall submit a final accounting to the Trust Committee as soon as practicable. The accounting shall be received and settled as provided in 3.05 for regular accountings.\n6.03-2 No resignation or removal of the Trustee or change in identity of the Trustee for any reason shall cause a termination of the Plan or this trust.\nVII. GENERAL PROVISIONS\n7.01 Interests Not Assignable\n7.01-1 The interest of a Participant in the trust fund may not be anticipated, assigned, pledged or otherwise encumbered, seized by legal process, transferred or subjected to the claims of the Participant's creditors in any way. Notwithstanding the foregoing, the benefit payable to a Participant may be assigned in full or in part, pursuant to a domestic relations order of a court of competent jurisdiction.\n7.01-2 No Grantor may create a security interest in the trust fund in favor of any of its creditors. The Trustee shall not make payments from the trust fund of any amount to creditors of any Grantor, other than Participants, except as provided in 5.02.\n7.01-3 The Participants shall have no interest in the assets of the trust fund beyond the right to receive payment of Plan benefits subject to the restrictions during Insolvency referred to in 5.02. During Insolvency Administration, the Participants' rights to trust assets shall not be superior to those of any other general creditors of the affected Grantor.\n7.02 Amendment\nThe Grantors and the Trustee may amend this Trust Agreement at any time by a written instrument executed by the parties. Except as provided below, any such amendment may be made only with the Written Consent of Participants after a Special Circumstance. Notwithstanding the foregoing, any such amendment may be made by written agreement of the Grantors and the Trustee without the Written Consent of Participants if such amendment will not have a material adverse effect on the rights of any Participant hereunder or is necessary to comply with any laws, regulations or other legal requirements. No amendment will conflict with the terms of the Plan or make the trust revocable.\n7.03 Applicable Law\nThis trust shall be governed, construed and administered according to the laws of California.\n7.04 Agreement Binding On All Parties\nThis Trust Agreement shall be binding upon the heirs, personal representatives, successors and assigns of any and all present and future parties.\n7.05 Notices And Directions\nAny notice or direction under this Trust Agreement shall be in writing and shall be effective when actually delivered or, if mailed, when deposited postpaid as first-class mail. Mail to a party shall be directed to the address stated below or to such other address as any party may specify by notice to the other parties. Notices to the Trust Committee shall be sent to the address of SCEcorp. Notices to Participants who have submitted claims under 3.03 shall be mailed to the address shown in the claim submission. Until notice is given to the contrary, notices to the Grantors and the Trustee shall be addressed as follows: Grantors\nSCEcorp Southern California Edison Company Attention: Chief Financial Officer Attention: Chief Financial Officer 2244 Walnut Grove Avenue 2244 Walnut Grove Avenue Rosemead, CA 91770 Rosemead, CA 91770\nThe Mission Group Mission Energy Company Attention: Office of the President Attention: President 18101 Von Karman Avenue, Suite 1700 18101 Von Karman Avenue, Suite 1700 Irvine, CA 92715-1007 Irvine, CA 92715-1007\nMission First Financial Mission Land Company Attention: President Attention: President 18101 Von Karman Avenue, Suite 1700 18101 Von Karman Avenue, Suite 1700 Irvine, CA 92715-1007 Irvine, CA 92715-1007\nTrustee\nU.S. Trust Company of California N. A. Attention: Charles Wert 555 South Flower Street Los Angeles, CA 90071-2429\n7.06 No Implied Duties\nThe duties of the Trustee shall be those stated in this trust, and no other duties shall be implied.\n7.07 Gender, Singular And Plural\nAll pronouns and any variations thereof shall be deemed to refer to the masculine or feminine, as the identity of the person or persons may require. As the context may require, the singular may be read as the plural and the plural as the singular.\n7.08 Validity\nIf any provision of this Trust Agreement is held invalid, void or unenforceable, the same shall not affect the validity of any other provision.\nVIII. INSURER\n8.01 Insurer Not A Party\nThe Insurer shall not be deemed to be a party to this Trust Agreement, and its obligations shall be measured and determined solely by the terms of its Contracts and other agreements executed by it.\n8.02 Authority Of Trustee\nThe Insurer shall accept the signature of the Trustee on any documents or papers executed in connection with such Contracts. The signature of the Trustee shall be conclusive proof to the Insurer that the person on whose life an application is being made is eligible to have such Contract issued on his life and is eligible for a Contract of the type and amount requested.\n8.03 Contract Ownership\nThe Insurer shall deal with the Trustee as the sole and absolute owner of the trust's interests in such Contracts and shall have no obligation to inquire whether any action or failure to act on the part of the Trustee is in accordance with or authorized by the terms of the Plan or this Trust Agreement.\n8.04 Limitation Of Liability\nThe Insurer shall be fully discharged from any and all liability for any action taken or any amount paid in accordance with the direction of the Trustee and shall have no obligation to see to the proper application of the amounts so paid. The Insurer shall have no liability for the operation of this Trust Agreement or the Plan, whether or not in accordance with their terms and provisions.\n8.05 Change Of Trustee\nThe Insurer shall be fully discharged from any and all liability for dealing with a party or parties indicated on its records to be the Trustee until such time as it shall receive at its home office written notice of the appointment and qualification of a successor Trustee.\n\/\/\/ \/\/\/ \/\/\/\nIN WITNESS WHEREOF, the parties have caused this Trust Agreement to be executed by their respective duly authorized officers on the dates set forth below.\nGRANTORS:\nSCEcorp Southern California Edison Company By Alan J. Fohrer By Alan J. Fohrer ------------------------------ ---------------------------- Title: Executive Vice President Title: Executive Vice President and Chief Financial Officer and Chief Financial Officer ------------------------------ ---------------------------- Date: August 7, 1995 Date: August 7, 1995 ------------------------------ ----------------------------\nMission Energy Company Mission First Financial By Edward R. Muller By Thomas R. McDaniel ------------------------------ ---------------------------- Title: President and Chief Title: President and Chief Executive Officer Financial Officer ------------------------------ ---------------------------- Date: August 22, 1995 Date: August 10, 1995 ------------------------------ ----------------------------\nMission Land Company The Mission Group By Thomas R. McDaniel By Thomas R. McDaniel ------------------------------ ---------------------------- Title: President and Chief Title: Office of the President Financial Officer ------------------------------ ---------------------------- Date: August 10, 1995 Date: August 10, 1995 ------------------------------ ----------------------------\nTRUSTEE:\nU.S. Trust Company of California N.A. By Dennis M. Kunisaki ------------------------------ Title: Vice President ------------------------------ Date: August 27, 1995 ------------------------------\nPAGE\nEXHIBIT 10.11\nSCEcorp\nExecutive Deferred Compensation Plan\nAs Adopted December 14, 1994 Effective January 1, 1995 PAGE\nSCEcorp EXECUTIVE DEFERRED COMPENSATION PLAN\nSection Title Page - ------- ----- ----\nARTICLE 1 DEFINITIONS 1\nARTICLE 2 PARTICIPATION 4\n2.01 Participant Election 4 2.02 Annual Deferral 4 2.03 Continuation of Participation 5\nARTICLE 3 EMPLOYEE DEFERRALS 5\n3.01 Participation Election 5 3.02 Minimum Annual Deferral 5 3.03 Maximum Annual Deferral 5 3.04 Deferral of Special Awards 5 3.05 Benefit Adjustment 6 3.06 Vesting 6\nARTICLE 4 MATCHING CREDITS 6\n4.01 Amount 6 4.02 Vesting 6\nARTICLE 5 DEFERRAL ACCOUNTS 6\n5.01 Deferral Accounts 6 5.02 Timing of Credits 7 A. Annual Deferrals 7 B. Matching Credits 7 C. Interest Crediting Dates 7 D. Statement of Accounts 7\nARTICLE 6 RETIREMENT BENEFITS 7\n6.01 Amount 7 6.02 Form of Retirement Benefits 7 6.03 Commencement of Benefits 8 6.04 Small Benefit Exception 8\nARTICLE 7 TERMINATION BENEFITS 8\n7.01 Amount 8\n-i- PAGE\nSCEcorp EXECUTIVE DEFERRED COMPENSATION PLAN\nTABLE OF CONTENTS (cont.)\nSection Title Page - ------- ----- ----\n7.02 Form of Termination Benefits 8\nARTICLE 8 SURVIVOR BENEFITS 8\n8.01 Pre-Retirement Survivor Benefit 8 8.02 Post-Retirement Survivor Benefit 9 8.03 Post-Termination Survivor Benefit 9 8.04 Changing Form of Benefit 9 8.05 Small Benefit Exception 9\nARTICLE 9 DISABILITY 9\nARTICLE 10 CHANGE OF CONTROL 10\nARTICLE 11 SCHEDULED AND UNSCHEDULED WITHDRAWALS 10\n11.01 Scheduled Withdrawals 10 A. Election 10 B. Timing and Form of Withdrawal 10 C. Remaining Deferral Account 10 11.02 Unscheduled Withdrawals 11 A. Election 11 B. Withdrawal Penalty 11 C. Small Benefit Exception 11\nARTICLE 12 CONDITIONS RELATED TO BENEFITS 11\n12.01 Nonassignability 11 12.02 Financial Hardship Distribution 11 12.03 No Right to Assets 12 12.04 Protective Provisions 12 12.05 Withholding 12\nARTICLE 13 PLAN ADMINISTRATION 12\nARTICLE 14 BENEFICIARY DESIGNATION 13\nARTICLE 15 AMENDMENT OR TERMINATION OF PLAN 13\n15.01 Amendment of Plan 13 15.02 Termination of Plan 13\n-ii- PAGE\nSCEcorp EXECUTIVE DEFERRED COMPENSATION PLAN\nTABLE OF CONTENTS (cont.)\nSection Title Page - ------- ----- ----\n15.03 Amendment or Termination After Change of Control 14 15.04 Exercise of Power to Amend or Terminate 14 15.05 Constructive Receipt Termination 14\nARTICLE 16 CLAIMS AND REVIEW PROCEDURES 14\n16.01 Claims Procedure 14 16.02 Review Procedure 14 16.03 Dispute Arbitration 15\nARTICLE 17 MISCELLANEOUS 16\n17.01 Successors 16 17.02 ERISA Plan 16 17.03 Trust 17 17.04 Employment Not Guaranteed 17 17.05 Gender, Singular and Plural 17 17.06 Captions 17 17.07 Validity 17 17.08 Waiver of Breach 17 17.09 Applicable Law 17 17.10 Notice 17\n-iii- PAGE\nSCEcorp\nEXECUTIVE DEFERRED COMPENSATION PLAN\nAs Adopted December 14, 1994, Effective January 1, 1995\nPREAMBLE\nEffective January 1, 1995, SCEcorp became the sponsor of the executive annual deferred compensation plans of SCEcorp affiliates with respect to participants in active service as of that date. The plans have been consolidated and restated as the SCEcorp Executive Deferred Compensation Plan effective January 1, 1995. Plan benefits are available to eligible executives of SCEcorp and its participating affiliates. Amounts of compensation deferred by participants pursuant to this Plan accrue as liabilities of the participating affiliate at the time of the deferral under the terms and conditions set forth herein. By electing to defer compensation under the SCEcorp Executive Deferred Compensation Plan, eligible executives consent to SCEcorp sponsorship of the Plan, but acknowledge that SCEcorp is not a guarantor of the benefit obligations of other participating affiliates. Each participating SCEcorp affiliate is responsible for payment of the accrued benefits under the Plan with respect to its own executives subject to the terms and conditions set forth herein.\nARTICLE I DEFINITIONS\nCapitalized terms in the text of the Plan are defined as follows:\n1.01 Administrator shall mean the Compensation and Executive Personnel Committee of the Board of Directors of SCEcorp.\n1.02 Affiliate shall mean SCEcorp or any corporation or entity which (i) along with SCEcorp, is a component member of a \"controlled group of corporations\" within the meaning of Section 414(b) of the Code, and (ii) has approved the participation of its executives in the Plan.\n1.03 Annual Deferral shall mean the amount of Compensation which the Participant elects to defer for a Plan Year pursuant to Articles 2 and 3 of the Plan.\n1.04 Base Salary shall mean the Participant's annual basic rate of pay from the Employer (excluding Incentive Awards, special awards, commissions, severance pay, and other non-regular forms of compensation) before reductions for deferrals under the Plan or the SSPP.\n1.05 Beneficiary shall mean the person or persons or entity designated as such in accordance with Article 14 of the Plan.\n1.06 Change of Control shall mean either: (i) the dissolution or liquidation of SCEcorp or an Employer; (ii) a reorganization, merger or consolidation of SCEcorp or an Employer with one or more corporations as a result of which SCEcorp or an Employer is not the surviving corporation; (iii) approval by the stockholders of SCEcorp or an Employer of any sale, lease, exchange or other transfer (in one or a series of transactions) of all or substantially all of the assets of SCEcorp or an Employer; (iv) approval by the stockholders of SCEcorp or an Employer of any merger or consolidation of SCEcorp or an Employer, in which the holders of voting stock of SCEcorp or an Employer immediately before the merger or consolidation will not own 50% or more of the outstanding voting shares of the continuing or surviving corporation immediately after the merger or consolidation; or (v) a change of at least 51% (rounded to the next whole person) in the membership of the Board of Directors of SCEcorp or an Employer within a 24-month period, unless the election or nomination for election by stockholders of each new director within the period was approved by the vote of at least 85% (rounded to the next whole person) of the directors then still in office who were in office at the beginning of the twenty-four-month period, except that any replacement of directors who are employees of SCEcorp or an Employer, with other employees of SCEcorp or an Employer, shall be disregarded and not be considered a change in membership. Notwithstanding the foregoing, any reorganization, merger or consolidation of an Employer with SCEcorp or another Employer shall be disregarded and not be considered a Change of Control.\n1.07 Code shall mean the Internal Revenue Code of 1986, as amended.\n1.08 Compensation shall mean the sum of the Participant's Base Salary and Incentive Awards for a Plan Year before deferral under this Plan or the SSPP.\n1.09 Crediting Rate shall mean the rate at which interest will be credited to Participant Deferral Accounts. The rate will be determined annually in advance of the Plan Year and will be equal to 120 percent of the Index Rate. SCEcorp reserves the right to prospectively change the Crediting Rate or formula.\n1.10 Deferral Account shall mean the notional account established for record keeping purposes for a Participant pursuant to Article 5 of the Plan.\n1.11 Deferral Period shall mean the Plan Year covered by a valid Participation Election previously submitted by a Participant, or in the case of a newly eligible Participant, the balance of the Plan Year following the date of the Participation Election.\n1.12 Disability shall mean the permanent and total disability of the Participant as determined by the Employer.\n1.13 Eligible Employee shall mean a key employee of an Affiliate, who (i) is a U.S. employee or an expatriate who is based and paid in the U.S., (ii) is designated by the Administrator as eligible to participate in the Plan (subject to the restriction in Sections 10.02 and 12.02 of the Plan), and (iii) qualifies as a member of the \"select group of management or highly compensated employees\" under ERISA.\n1.14 Employer shall mean the Affiliate employing the Participant.\n1.15 ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended.\n1.16 Financial Hardship shall mean an unexpected and unforeseen financial disruption arising from an illness, casualty loss, sudden financial reversal, or other such unforeseeable occurrence as determined by the Administrator or its designee. Needs arising from foreseeable events such as the purchase of a residence or education expenses for children shall not, alone, be considered a Financial Hardship.\n1.17 Incentive Award shall mean the amount paid in cash to the Participant by the Employer in the form of an annual incentive bonus before reductions for deferrals under the Plan.\n1.18 Index Rate shall mean the 120-month average rate of 10-year U.S. Treasury Notes determined for any Plan Year as of October 15th of the prior year.\n1.19 Matching Credit shall mean the credit added to the Participant's Deferral Account under Article 4.\n1.20 Participant shall mean an Eligible Employee who has elected to participate and has completed a Participation Election pursuant to Article 2 of the Plan.\n1.21 Participation Election shall mean the Participant's written election to participate in the Plan submitted on the form prescribed by the Administrator for that purpose.\n1.22 Plan shall mean the SCEcorp Executive Deferred Compensation Plan.\n1.23 Plan Year shall mean the calendar year.\n1.24 Retirement shall mean a separation from service under terms constituting a retirement for purposes of the nonqualified executive retirement plan covering the Participant.\n1.25 Scheduled Withdrawal shall mean a distribution of all or a portion of the vested amount of Annual Deferrals and earnings credited to the Participant's Deferral Account as elected by the Participant pursuant to the provisions of Article 11 of the Plan.\n1.26 SSPP shall mean the Southern California Edison Company Stock Savings Plus Plan as amended from time-to-time.\n1.27 Termination for Cause shall mean the Termination of Employment of the Participant upon willful failure by the Participant to substantially perform his or her duties for the Employer or the willful engaging by the Participant in conduct which is injurious to the Employer, monetarily or otherwise.\n1.28 Termination of Employment shall mean the voluntary or involuntary cessation of the Participant's employment with the Employer for any reason other than death or Retirement. Termination of Employment shall not be deemed to have occurred for purposes of this Plan if the Participant is reemployed by an Affiliate within 30 days of ceasing work with the Employer.\n1.29 Unscheduled Withdrawal shall mean a distribution of all or a portion of the vested amount and earnings credited to the Participant's Deferral Account as requested by the Participant pursuant to the provisions of Article 11 of the Plan.\n1.30 Valuation Date shall mean the last business day of the following month in which Termination of Employment, Retirement, death, Scheduled Withdrawal, or Unscheduled Withdrawal occurs.\n1.31 Vesting shall mean the Participant's right to receive any Compensation deferred, Matching Credits, and\/or earnings thereon as provided in Article 4.\nARTICLE 2 PARTICIPATION\n2.01 Participant Election\nAn Eligible Employee shall become a Participant in the Plan on the first day of the month coincident with or next following the date the employee became an Eligible Employee, provided the Eligible Employee has submitted to the Administrator a Participation Election prior to that date. Except for employees who become newly eligible during the Plan Year, the Participation Election must be submitted to the Administrator during the enrollment period designated by the Administrator which shall always be prior to the commencement of the Plan Year. 2.02 Annual Deferral\nSubject to the restrictions in Article 3, the Eligible Employee shall designate his or her Annual Deferral for the covered Plan Year on the Participation Election.\n2.03 Continuation of Participation\nAn Eligible Employee who has elected to participate in the Plan by making an Annual Deferral shall continue as a Participant in the Plan until the Participant no longer has a Deferral Account balance under the Plan. A Participant may not elect to defer Compensation under the Plan unless the Participant is an Eligible Employee for the Plan Year for which the election is made. In the event a Participant is later employed by an affiliated company that does not participate in the Plan, the Participant's Annual Deferral shall cease, and the Participant's Deferral Account shall remain in effect until such time as the benefits are distributed as elected on the Participant's last valid Participation Election.\nARTICLE 3 EMPLOYEE DEFERRALS\n3.01 Participation Election\nEligible Employees may elect to make an Annual Deferral under the Plan by submitting a Participation Election during the applicable enrollment period. The Participant may designate a specified amount in $1,000 increments or a whole percentage of Base Salary to be deferred. The Participant may also designate a specified amount in $1,000 increments, a whole percentage, or a whole percentage in excess of a specified amount of Incentive Award to be deferred. Once made, this Participation Election shall continue to apply for subsequent Deferral Periods unless the Participant submits a new Participation Election form during a subsequent enrollment period changing the deferral amount or revoking the existing election. A Participation Election may be revoked by the Participant upon 30 days written notice to the Administrator; however, such Participant will be ineligible to make an Annual Deferral under the Plan for the following Plan Year.\n3.02 Minimum Annual Deferral\nThe minimum amount of Base Salary that may be designated for deferral is $2,000. The minimum amount of Incentive Award that may be designated for deferral is $2,000. There is no minimum percentage.\n3.03 Maximum Annual Deferral\nThe maximum Annual Deferral from Base Salary for a Plan Year is 75% of Base Salary. The maximum Annual Deferral from Incentive Award for a Plan Year is 100% of the Incentive Award.\n3.04 Deferral of Special Awards\nAt the discretion of the Employer, up to 100% of any special award made to an Employee for employment, retention, recognition, achievement, retirement, or severance may be deferred under this Plan subject to any additional terms and conditions the Employer may impose.\n3.05 Benefit Adjustment\nNotwithstanding the above maximum deferral limits, the Participant may elect to defer the receipt of additional amounts of Base Salary and Incentive Award calculated by the Administrator that would have been contributed to the SSPP but for the limits upon SSPP contributions and benefits established by Sections 401(a)(17), 402(g) and 415 of the Code. Such amounts will continue to be credited to the Participant's Deferral Account as long as the Participant's SSPP contributions are affected by the limitations.\n3.06 Vesting\nThe Participant's right to receive Compensation deferred under this Article 3 and any earnings thereon shall be 100% vested at all times. Notwithstanding the foregoing, any special award deferred under Section 3.04 and any earnings thereon may be subject to vesting terms.\nARTICLE 4 MATCHING CREDITS\n4.01 Amount\nA Matching Credit will be added by the Employer to the Participant's Deferral Account under this Plan equal to 3 percent of the amount of Base Salary and Incentive Award deferred under the Plan by the Participant.\n4.02 Vesting\nThe Participant's Matching Credits and earnings thereon for any Plan Year shall vest when the Participant has completed five years of service with an Affiliate, or upon the death, Retirement or Disability of the Participant.\nARTICLE 5 DEFERRAL ACCOUNTS\n5.01 Deferral Accounts\nSolely for record keeping purposes, the Administrator shall maintain a Deferral Account for each Participant with such subaccounts as the Administrator or its record keeper find necessary or convenient in the administration of the Plan.\n5.02 Timing of Credits\nA. Annual Deferrals\nThe Administrator shall credit to the Deferral Account the Annual Deferrals under Article 3 at the time the deferrals would otherwise have been paid to the Participant but for the Participation Election.\nB. Matching Credits\nUntil vested, Matching Credits under Article 4 shall be conditionally credited to the Deferral Account at the same time the related deferrals are credited to the Deferral Account.\nC. Interest Crediting Dates\nThe Administrator shall credit interest at the Crediting Rate to the Participant's Deferral Account on a daily basis, compounded annually.\nD. Statement of Accounts\nThe Administrator shall periodically provide to each Participant a statement setting forth the balance of the Deferral Account maintained for the Participant.\nARTICLE 6 RETIREMENT BENEFITS\n6.01 Amount\nUpon Retirement, the Employer shall pay to the Participant a retirement benefit in the form provided in Section 6.02, based on the balance of the Deferral Account as of the Valuation Date. If paid as a lump sum, the retirement benefit shall be equal to the Deferral Account balance. If paid in installments, the installments shall be paid in amounts that will amortize the Deferral Account balance with interest credited at the Crediting Rate over the period of time benefits are to be paid. For purposes of calculating installments, the Deferral Account shall be valued as of December 31 each year, and the subsequent installments will be adjusted for the next Plan Year according to procedures established by the Administrator.\n6.02 Form of Retirement Benefits\nThe Participant may elect on the Participation Election to have the retirement benefit paid:\n(i) In a lump sum,\n(ii) In installments paid monthly over a period of 60, 120, or 180 months, or\n(iii) In a lump sum of a portion of the Deferral Account upon Retirement with the balance in installments paid monthly over a period of 60, 120, or 180 months.\nIf no valid election is made, the Administrator shall pay the retirement benefit in installments over a 180-month period. Participants may change the form of payout by written election filed with the Administrator; provided, however, that if the Participant files the election less than 13 months prior to the date of Retirement, the payout election in effect 13 months prior to the date of Retirement will govern.\n6.03 Commencement of Benefits\nPayments will commence within 60 days after the date of Retirement.\n6.04 Small Benefit Exception\nNotwithstanding the foregoing, the Administrator may, in its sole discretion:\n(i) pay the benefits in a single lump sum if the sum of all benefits payable to the Participant is less than or equal to $3,500.00, or\n(ii) reduce the number of installments elected by the Participant to 120 or 60 if necessary to produce a monthly benefit of at least $300.00.\nARTICLE 7 TERMINATION BENEFITS\n7.01 Amount\nNo later than 60 days after Termination of Employment, the Administrator shall pay to the Participant a termination benefit equal to the vested balance of the Deferral Account as of the Valuation Date, or shall commence installments, as provided in Section 7.02.\n7.02 Form of Termination Benefits\nThe Administrator shall pay the termination benefits in a single lump sum unless the Participant has previously elected payment to be made in three annual installments. Installments paid under this Section 7.02 shall include interest at the Index Rate and shall be redetermined annually to reflect adjustments in that rate. Notwithstanding the foregoing, any Termination for Cause will result in an immediate lump sum payout.\nARTICLE 8 SURVIVOR BENEFITS\n8.01 Pre-Retirement Survivor Benefit\nIf the Participant dies while actively employed by an Affiliate, the Administrator shall pay a lump sum or commence monthly installments in accordance with the Participant's prior election within 60 days after the Participant's death. The payment(s) will be based on the Participant's Deferral Account balance as of the Valuation Date; provided however, that if the Participant's death occurs within ten years of (i) his or her initial Plan participation date, or (ii) January 1, 1995, whichever is later, then the Beneficiary's payment(s) will be based on twice the Participant's Deferral Account balance as of the Valuation Date.\n8.02 Post-Retirement Survivor Benefit\nIf the Participant dies after Retirement, the Administrator shall pay to the Participant's Beneficiary an amount equal to the remaining benefits payable to the Participant under the Plan over the same period the benefits would have been paid to the Participant; provided however, if the Participant's death occurs within ten years of (i) his or her initial Plan participation date, or (ii) January 1, 1995, whichever is later, then the Beneficiary's death benefit will be based on twice the Participant's Deferral Account balance as of the Valuation Date.\n8.03 Post-Termination Survivor Benefit\nIt the Participant dies following Termination of Employment, but prior to the payment of all benefits under the Plan, the Beneficiary will be paid the remaining balance in the Participant's account in a lump sum. No double benefit will apply.\n8.04 Changing Form of Benefit\nBeneficiaries may petition the Administrator once, and only after the death of the Participant, for a change in the form of survivor benefits. The Administrator may, in its sole and absolute discretion, choose to grant or deny such a petition.\n8.05 Small Benefit Exception\nNotwithstanding the foregoing, the Administrator may, in its sole discretion:\n(i) pay the benefits in a single lump sum if the sum of all benefits payable to the Beneficiary is less than or equal to $3,500.00, or\n(ii) reduce the number of installments elected by the Participant to 120 or 60 if necessary to produce a monthly benefit of at least $300.00.\nARTICLE 9 DISABILITY\nUpon determination that a Participant has suffered a Disability, deferrals under the Plan shall cease. The Administrator shall pay Plan benefits upon the Participant's Retirement or death according to the Participant's prior election.\nARTICLE 10 CHANGE OF CONTROL\nWithin two years after a Change of Control, any Participant or Beneficiary in the case of an SCEcorp Change of Control, or the affected Participants or Beneficiaries in the case of an Employer Change of Control, may elect to receive a distribution of the balance of the Deferral Account. There shall be a penalty deducted from the Deferral Account prior to distribution pursuant to this Article 10 equal to 5% of the total balance of the Deferral Account (instead of the 10% reduction otherwise provided for in Section 11.02). If a Participant elects such a withdrawal, any on- going Annual Deferral shall cease, and the Participant may not again be designated as an Eligible Employee until one entire Plan Year following the Plan Year in which the withdrawal was made has elapsed.\nARTICLE 11 SCHEDULED AND UNSCHEDULED WITHDRAWALS\n11.01 Scheduled Withdrawals\nA. Election\nWhen making a Participation Election, a Participant may elect to receive a distribution of a specific dollar amount or a percentage of the Annual Deferral that will be made in the following Plan Year at a specified year in the future when the Participant will still be an active employee. Such an election must be made on an In- Service Distribution Election Form and submitted concurrently with the Participation Election. The election of a Scheduled Withdrawal shall only apply to the Annual Deferral, Matching Credits and related earnings for that Deferral Period, but not to previous or subsequent Annual Deferrals, Matching Credits or related earnings. Elections under this Section shall be superseded by benefit payments due to the Retirement, Termination of Employment or death of the Participant.\nB. Timing and Form of Withdrawal\nThe year specified for the Scheduled Withdrawal may not be sooner than the second Plan Year following the Plan Year in which the deferral occurs. The Participant will receive a lump sum distribution of the amount elected on January 1st of the Plan Year specified.\nC. Remaining Deferral Account\nThe remainder, if any, of the Participant's Deferral Account shall continue in effect and shall be distributed in the future according to the terms of the Plan.\n11.02 Unscheduled Withdrawals\nA. Election\nA Participant (or Beneficiary if the Participant is deceased) may request in writing to the Administrator an Unscheduled Withdrawal of all or a portion of the entire vested amount credited to the Participant's Deferral Account, including earnings, which shall be paid within 30 days in a single lump sum; provided, however, that (i) the minimum withdrawal shall be 25% of the Deferral Account balance, (ii) an election to withdraw 75% or more of the balance shall be deemed to be an election to withdraw the entire balance, and (iii) such an election may be made only once in a Plan Year.\nB. Withdrawal Penalty\nThere shall be a penalty deducted from the Deferral Account prior to an Unscheduled Withdrawal equal to 10% of the Unscheduled Withdrawal. If a Participant elects such a withdrawal, any on- going Annual Deferral shall cease, and the Participant may not again be designated as an Eligible Employee until one entire Plan Year following the Plan Year in which the withdrawal was made has elapsed.\nC. Small Benefit Exception\nNotwithstanding any of the foregoing, if the sum of all benefits payable to the Participant or Beneficiary who has requested the Unscheduled Withdrawal is less than or equal to $3,500.00, the Administrator may, in its sole discretion, elect to pay out the entire Deferral Account (reduced by the 10% penalty) in a single lump sum.\nARTICLE 12 CONDITIONS RELATED TO BENEFITS\n12.01 Nonassignability\nThe benefits provided under the Plan may not be alienated, assigned, transferred, pledged or hypothecated by or to any person or entity, at any time or any manner whatsoever. These benefits shall be exempt from the claims of creditors of any Participant or other claimants and from all orders, decrees, levies, garnishment or executions against any Participant to the fullest extent allowed by law. Notwithstanding the foregoing, the benefit payable to a Participant may be assigned in full or in part, pursuant to a domestic relations order of a court of competent jurisdiction.\n12.02 Financial Hardship Distribution\nA participant may submit a hardship distribution request to the Administrator in writing setting forth the reasons for the request. The Administrator shall have the sole authority to approve or deny such requests. Upon a finding that the Participant or the Beneficiary has suffered a Financial Hardship, the Administrator may in its discretion, permit the Participant to cease any on-going deferrals and accelerate distributions of benefits under the Plan in the amount reasonably necessary to alleviate the Financial Hardship. If a distribution is to be made to a Participant on account of Financial Hardship, the Participant may not make deferrals under the Plan until one entire Plan Year following the Plan Year in which a distribution based on Financial Hardship was made has elapsed.\n12.03 No Right to Assets\nThe benefits paid under the Plan shall be paid from the general funds of the Employer, and the Participant and any Beneficiary shall be no more than unsecured general creditors of the Employer with no special or prior right to any assets of the Employer for payment of any obligations hereunder. The Participant will have no claim to benefits from any other Affiliate.\n12.04 Protective Provisions\nThe Participant shall cooperate with the Administrator by furnishing any and all information requested by the Administrator, in order to facilitate the payment of benefits hereunder, taking such physical examinations as the Administrator may deem necessary and signing such consents to insure or taking such other actions as may be requested by the Administrator. If the Participant refuses to cooperate, the Administrator and the Employer shall have no further obligation to the Participant under the Plan.\n12.05 Withholding\nThe Participant or the Beneficiary shall make appropriate arrangements with the Administrator for satisfaction of any federal, state or local income tax withholding requirements and Social Security or other employee tax requirements applicable to the payment of benefits under the Plan. If no other arrangements are made, the Administrator may provide, at its discretion, for such withholding and tax payments as may be required.\nARTICLE 13 PLAN ADMINISTRATION\nThe Administrator shall administer the Plan and interpret, construe and apply its provisions in accordance with its terms and shall provide direction and oversight as necessary to management, staff, or contractors to whom day-to-day Plan operations may be delegated. The Administrator shall establish, adopt or revise such rules and regulations as it may deem necessary or advisable for the administration of the Plan. All decisions of the Administrator shall be final and binding.\nARTICLE 14 BENEFICIARY DESIGNATION\nThe Participant shall have the right, at any time, to designate any person or persons as Beneficiary (both primary and contingent) to whom payment under the Plan shall be made in the event of the Participant's death. The Beneficiary designation shall be effective when it is submitted in writing to the Administrator during the Participant's lifetime on a form prescribed by the Administrator.\nThe submission of a new Beneficiary designation shall cancel all prior Beneficiary designations. Any finalized divorce or marriage of a Participant subsequent to the date of a Beneficiary designation shall revoke such designation, unless in the case of divorce the previous spouse was not designated as Beneficiary, and unless in the case of marriage the Participant's new spouse has previously been designated as Beneficiary. The spouse of a married Participant must consent in writing to any designation of a Beneficiary other than the spouse.\nIf a Participant fails to designate a Beneficiary as provided above, or if the Beneficiary designation is revoked by marriage, divorce, or otherwise without execution of a new designation, or if every person designated as Beneficiary predeceases the Participant or dies prior to complete distribution of the Participant's benefits, then the Administrator shall direct the distribution of the benefits to the Participant's estate. If a Beneficiary dies after commencement of payments to the Beneficiary, a lump sum of any remaining payments will be paid to that person's Beneficiary, if one has been designated, or to the Beneficiary's estate.\nARTICLE 15 AMENDMENT OR TERMINATION OF PLAN\n15.01 Amendment of Plan\nSubject to the terms of Section 15.03, SCEcorp may amend the Plan at any time in whole or in part, provided, however, that the amendment (i) shall not decrease the balance of the Participant's Deferral Account at the time of the amendment and (ii) shall not retroactively decrease the applicable Crediting Rates of the Plan prior to the time of the amendment. SCEcorp may amend the Crediting Rates of the Plan prospectively, in which case the Administrator shall notify the Participant of the amendment in writing within 30 days after the amendment.\n15.02 Termination of Plan\nSubject to the terms of Section 15.03, SCEcorp may terminate the Plan at any time. If SCEcorp terminates the Plan, the date of the Termination of Employment shall be treated as the date of Termination of Employment for the purpose of calculating Plan benefits, and the benefits the Participant is entitled to receive under the Plan shall be paid to the Participant in a lump sum within 60 days.\n15.03 Amendment or Termination After Change of Control\nNotwithstanding the foregoing, SCEcorp shall not amend or terminate the Plan without the prior written consent of affected Participants for a period of two calendar years following a Change of Control and shall not thereafter amend or terminate the Plan in any manner which affects any Participant (or Beneficiary of a deceased Participant) who commences receiving payment of benefits under the Plan prior to the end of the two year period following a Change of Control.\n15.04 Exercise of Power to Amend or Terminate\nExcept as provided in Section 15.03, SCEcorp's power to amend or terminate the Plan shall be exercisable by the Compensation and Executive Personnel Committee of the SCEcorp Board of Directors.\n15.05 Constructive Receipt Termination\nNotwithstanding anything to the contrary in this Plan, in the event the Administrator determines that amounts deferred under the Plan have been constructively received by Participants and must be recognized as income for federal income tax purposes, the Plan shall terminate and distributions shall be made to Participants in accordance with the provisions of Section 15.02 or as may be determined by the Administrator. The determination of the Administrator under this Section 15.05 shall be binding and conclusive.\nARTICLE 16 CLAIMS AND REVIEW PROCEDURES\n16.01 Claims Procedure\nThe Administrator shall notify a Participant in writing, within 90 days after his or her written application for benefits, of his or her eligibility or noneligibility for benefits under the Plan. If the Administrator determines that a Participant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for the denial, (2) a specific reference to the provisions of the Plan on which the denial is based, (3) a description of any additional information or material necessary for the claimant to perfect his or her claim, and a description of why it is needed, and (4) an explanation of the Plan's claims review procedure and other appropriate information as to the steps to be taken if the Participant wishes to have the claim reviewed. If the Administrator determines that there are special circumstances requiring additional time to make a decision, the Administrator shall notify the Participant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional 90-day period.\n16.02 Review Procedure\nIf a Participant is determined by the Administrator not to be eligible for benefits, or if the Participant believes that he or she is entitled to greater or different benefits, the Participant shall have the opportunity to have the claim reviewed by the Administrator by filing a petition for review with the Administrator within 60 days after receipt of the notice issued by the Administrator. Said petition shall state the specific reasons which the Participant believes entitle him or her to benefits or to greater or different benefits. Within 60 days after receipt by the Administrator of the petition, the Administrator shall afford the Participant (and counsel, if any) an opportunity to present his or her position to the Administrator orally or in writing, and the Participant (or counsel) shall have the right to review the pertinent documents. The Administrator shall notify the Participant of its decision in writing within the 60-day period, stating specifically the basis of its decision, written in a manner calculated to be understood by the Participant and the specific provisions of the Plan on which the decision is based. If, because of the need for a hearing, the 60-day period is not sufficient, the decision may be deferred for up to another 60-day period at the election of the Administrator, but notice of this deferral shall be given to the Participant. In the event of the death of the Participant, the same procedures shall apply to the Participant's Beneficiaries.\n16.03 Dispute Arbitration\nNotwithstanding the foregoing, and because it is agreed that time will be of the essence in determining whether any payments are due to Participant or his or her Beneficiary under the Plan, a Participant or Beneficiary may, if he or she desires, submit any claim for payment under the Plan to arbitration. This right to select arbitration shall be solely that of the Participant or Beneficiary and the Participant or Beneficiary may decide whether or not to arbitrate in his or her discretion. The \"right to select arbitration\" is not mandatory on the Participant or Beneficiary, and the Participant or Beneficiary may choose in lieu thereof to bring an action in an appropriate civil court. Once an arbitration is commenced, however, it may not be discontinued without the mutual consent of both parties to the arbitration. During the lifetime of the Participant only he or she can use the arbitration procedure set forth in this Section.\nAny claim for arbitration may be submitted as follows: if a Participant or Beneficiary has submitted a request to be paid under the Plan and the claim is finally denied by the Administrator in whole or in part, the claim may be filed in writing with an arbitrator of the Participant's or Beneficiary's choice who is selected by the method described in the next four sentences. The first step of the selection shall consist of the Participant or Beneficiary submitting a list of five potential arbitrators to the Administrator. Each of the five arbitrators must be either (1) a member of the National Academy of Arbitrators located in the State of California or (2) a retired California Superior Court or Appellate Court judge. Within one week after receipt of the list, the Administrator shall select one of the five arbitrators as the arbitrator for the dispute in question. If the Administrator fails to select an arbitrator within one week after receipt of the list, the Participant or Beneficiary shall then designate one of the five arbitrators for the dispute in question.\nThe arbitration hearing shall be held within seven days (or as soon thereafter as possible) after the picking of the arbitrator. No continuance of said hearing shall be allowed without the mutual consent of Participant or Beneficiary and the Administrator. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion when he or she decides he or she has heard sufficient evidence to satisfy issuance of an award.\nThe arbitrator's award shall be rendered as expeditiously as possible and in no event later than one week after the close of the hearing.\nIn the event the arbitrator finds that the Administrator or the Employer has breached the terms of the Plan, he or she shall order the Employer to pay to Participant or Beneficiary within two business days after the decision is rendered the amount then due the Participant or Beneficiary, plus, notwithstanding anything to the contrary in the Plan, an additional amount equal to 20% of the amount actually in dispute. This additional amount shall constitute an additional benefit under the Plan. The award of the arbitrator shall be final and binding upon the Parties.\nThe award may be enforced in any appropriate court as soon as possible after its rendition. The Administrator will be considered the prevailing party in a dispute if the arbitrator determines (1) that the Administrator or the Employer has not breached the terms of the Plan and (2) the claim by Participant or his or her Beneficiary was not made in good faith. Otherwise, the Participant or his or her Beneficiary will be considered the prevailing party. In the event that the Administrator is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (excluding any attorneys' fees incurred by the Administrator) including stenographic reporter, if employed, shall be paid by the losing party. In the event that the Participant or his or her Beneficiary is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (including all attorneys' fees incurred by Participant or his or her Beneficiary in pursuing his or her claim), including the fees of a stenographic reporter, if employed, shall be paid by the Employer.\nARTICLE 17 MISCELLANEOUS\n17.01 Successors\nThe rights and obligations of each Employer under the Plan shall inure to the benefit of, and shall be binding upon, the successors and assigns of the Employer.\n17.02 ERISA Plan\nThe Plan is intended to be an unfunded plan maintained primarily to provide deferred compensation benefits for \"a select group of management or highly compensated employees\" within the meaning of Sections 201, 301 and 401 of ERISA and therefore to be exempt from Parts 2, 3 and 4 of Title I of ERISA. SCEcorp is the named fiduciary.\n17.03 Trust\nThe Employers shall be responsible for the payment of all benefits under the Plan. At their discretion, the Employers may establish one or more grantor trusts for the purpose of providing for payment of benefits under the Plan. The trust or trusts may be irrevocable, but an Employer's share of the assets thereof shall be subject to the claims of the Employer's creditors. Benefits paid to the Participant from any such trust shall be considered paid by the Employer for purposes of meeting the obligations of the Employer under the Plan.\n17.04 Employment Not Guaranteed\nNothing contained in the Plan nor any action taken hereunder shall be construed as a contract of employment or as giving any Participant any right to continued employment with the Employer or any other Affiliate.\n17.05 Gender, Singular and Plural\nAll pronouns and variations thereof shall be deemed to refer to the masculine, feminine, or neuter, as the identity of the person or persons may require. As the context may require, the singular may be read as the plural and the plural as the singular.\n17.06 Captions\nThe captions of the articles and sections of the Plan are for convenience only and shall not control or affect the meaning or construction of any of its provisions.\n17.07 Validity\nIf any provision of the Plan is held invalid, void or unenforceable, the same shall not affect, in any respect whatsoever, the validity of any other provisions of the Plan.\n17.08 Waiver of Breach\nThe waiver by SCEcorp of any breach of any provision of the Plan by the Participant shall not operate or be construed as a waiver of any subsequent breach by the Participant.\n17.09 Applicable Law\nThe Plan shall be governed and construed in accordance with the laws of California except where the laws of California are preempted by ERISA.\n17.10 Notice\nAny notice or filing required or permitted to be given to SCEcorp under the Plan shall be sufficient if in writing and hand-delivered, or sent by first class mail to the principal office of SCEcorp, directed to the attention of the Administrator. The notice shall be deemed given as of the date of delivery, or, if delivery is made by mail, as of the date shown on the postmark.\nIN WITNESS WHEREOF, SCEcorp has adopted this Plan effective the 1st day of January, 1995.\nSCEcorp\nAlan J. Fohrer ____________________________________________________ Executive Vice President and Chief Financial Officer\nPAGE\nEXHIBIT 10.12\nSCEcorp\nEXECUTIVE GRANTOR TRUST AGREEMENT\nAugust, 1995 PAGE\nSCEcorp EXECUTIVE GRANTOR TRUST AGREEMENT\nSection Title Page - ------- ----- ----\nPREAMBLE 1\nI. EFFECTIVE DATE AND DURATION 3 1.01 Effective Date And Trust Year 3 1.02 Duration 3 1.03 Special Circumstances 4\nII. TRUST FUND AND FUNDING POLICY 5 2.01 Contributions 5 2.02 Investment And Valuation 8 2.03 Subtrusts 12 2.04 Recapture Of Excess Assets 13 2.05 Substitution Of Other Property 14 2.06 Administrative Powers Of Trustee 14\nIII. ADMINISTRATION 17 3.01 Committee; Company Representatives 17 3.02 Payment Of Benefits 17 3.03 Disputed Claims 18 3.04 Records 20 3.05 Accountings 21 3.06 Expenses And Fees 21\nIV. LIABILITY 21 4.01 Indemnity 21 4.02 Bonding 22\nV. INSOLVENCY 22 5.01 Determination of Insolvency 22 5.02 Insolvency Administration 22 5.03 Termination Of Insolvency Administration 23 5.04 Creditors' Claims During Solvency 23\nVI. SUCCESSOR TRUSTEES 24\n-i- PAGE\n6.01 Resignation And Removal 24 6.02 Appointment Of Successor 24 6.03 Accountings; Continuity 24\nVII. GENERAL PROVISIONS 25 7.01 Interests Not Assignable 25 7.02 Amendment 25 7.03 Applicable Law 25 7.04 Agreement Binding On All Parties 25 7.05 Notices And Directions 26 7.06 No Implied Duties 26 7.07 Gender, Singular And Plural 27 7.08 Validity 27\nVIII. INSURER 26 8.01 Insurer Not A Party 27 8.02 Authority Of Trustee 27 8.03 Contract Ownership 27 8.04 Limitation Of Liability 27 8.05 Change Of Trustee 28\n-ii- PAGE\nSCEcorp\nEXECUTIVE GRANTOR TRUST AGREEMENT\nThis Executive Grantor Trust Agreement (\"Trust Agreement\") is made and entered into by SCEcorp, Southern California Edison Company, The Mission Group, Mission Energy Company, Mission First Financial, Mission Land Company, all California corporations (\"Grantors\"), and U.S. Trust Company of California N. A. (\"Trustee\").\nThe Grantors hereby establish with the Trustee a master trust, with separate subtrusts for the interests of each Grantor, to hold all monies and other property, together with the income thereon, as shall be paid or transferred to it hereunder in accordance with the terms and conditions of this Trust Agreement. The Trustee hereby accepts the trust established under this Trust Agreement and agrees to hold, IN TRUST, all monies and other property transferred to it hereunder for the uses and purposes and upon the terms and conditions set forth herein, and the Trustee further agrees to discharge and perform fully and faithfully all of the duties and obligations imposed upon it under this Trust Agreement.\nPREAMBLE\nOn behalf of executives of the Grantors, SCEcorp has adopted the following plan which shall be subject to this trust and references to the \"Plan\" in this Trust Agreement shall refer to such plan:\nSCEcorp Executive Deferred Compensation Plan\nThe Plan is administered by the SCEcorp Compensation and Executive Personnel Committee of the SCEcorp Board of Directors (\"Compensation Committee\"). This Trust Agreement shall be administered by the Compensation Committee, but day-to-day administration is delegated to the SCE Trust Investment Committee (\"Trust Committee\").\nPlan participants and beneficiaries who are covered by this Trust Agreement (\"Participants\" and \"Beneficiaries\") shall be all persons who are participants or beneficiaries in the Plan. After a person becomes a Participant or a Beneficiary covered by this Trust Agreement, such status will continue until all Plan benefits payable to that person have been paid, that person ceases to be entitled to any Plan benefits, or that person dies, whichever occurs first.\nPrior to a Change in Control, SCEcorp may by written notice to the Trustee, cause additional plan to become subject to this Trust Agreement (any reference to the Plan herein also constitutes a reference to any such additional plan).\nSCEcorp shall provide the Trustee with copies of the following items: (i) the Plan documents; (ii) all Plan amendments promptly upon their adoption; and (iii) lists and specimen signatures of the members of the Trust Committee and any SCEcorp representatives authorized to take action in regard to the administration of the Plans and this trust, including any changes in the members of the Trust Committee and of such other representatives promptly following any such change. SCEcorp shall also provide the Trustee at least annually with a list of all Participants in each Plan who are covered by this Trust Agreement.\nThe purpose of this trust is to give Participants greater security by placing assets in trust for use only to pay Plan benefits to Participants or if one of the Grantors becomes insolvent, to pay its creditors from its portion of the trust assets. The Grantors shall continue to be liable to Participants to make all payments required under the terms of the Plans to the extent such payments are not made from this trust. Distributions made from this trust to Participants or their beneficiaries shall, to the extent of such distributions, satisfy the Grantors' obligations to pay benefits to Participants and their beneficiaries under the Plans.\nThe Grantors and the Trustee agree that the trust, comprised of one or more subtrusts for each Grantor, has been established to pay obligations of the Grantors pursuant to the Plans and each subtrust is subject to the rights of general creditors of the respective Grantor, and accordingly the trust is a grantor trust under the provisions of Sections 671 through 677 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Grantors hereby agree to report their allocable shares of all items of income, deductions and credits of the trust on their own income tax returns; and the Grantors shall have no right to any distributions from the trust or any claim against the trust for funds necessary to pay any income taxes which the Grantors are required to pay on account of reporting the income of the trust on their income tax returns. No contribution to or income of the trust is intended to be taxable to Participants until benefits are distributed to them.\nThe Plans are intended to be \"unfunded\" and maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. As such, the Plan is not intended to be covered by Parts 2 through 4 of Subtitle B of Title I of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\") which relate to participation and vesting, funding and fiduciary responsibility. The existence of this trust is not intended to alter this characterization of the Plan.\nI. EFFECTIVE DATE AND DURATION\n1.01 Effective Date And Trust Year\nThis trust shall become effective when the Trust Agreement has been executed by the Grantors and the Trustee and one or more of the Grantors have made a contribution to the trust. For tax purposes the trust year shall be the calendar year.\n1.02 Duration\n1.02-1 This trust shall continue in effect until all assets of the trust fund are exhausted through distribution of benefits to Participants and their beneficiaries, payment to creditors in the event of insolvency, payment of fees and expenses of the Trustee, and return of remaining funds to the Grantors pursuant to 1.02-2. Notwithstanding the foregoing, this trust shall terminate on the day before twenty-one years after the death of the last survivor of all present or future Participants who are now living and those persons now living who are designated as beneficiaries of any such Participants in accordance with the terms of the Plan.\n1.02-2 Except as otherwise provided in 1.02, the trust shall be irrevocable until all benefits payable under the Plan to Participants and Beneficiaries who are covered by this Trust Agreement are paid. The Trustee shall then return to the Grantors any assets remaining in the trust in accordance with the allocations to their respective subtrusts.\n1.02-3 If the existence of this trust or any subtrust is determined to be ERISA Funding or Tax Funding (as such terms are defined in 1.02-4) by the Compensation Committee, this trust or such subtrust shall terminate. The Compensation Committee may also terminate this trust or any subtrust if it determines, based on an opinion of legal counsel which is satisfactory to the Trustee, that either (i) judicial authority or the opinion of the U.S. Department of Labor, Treasury Department or Internal Revenue Service (as expressed in proposed or final regulations, advisory opinions or rulings, or similar administrative announcements) creates a significant risk that the trust or any subtrust will be held to be ERISA Funding or Tax Funding or (ii) ERISA or the Code requires the trust or any subtrust to be amended in a way that creates a significant risk that the trust or such subtrust will be held to be ERISA Funding or Tax Funding, and failure to so amend the trust or such subtrust could subject the Grantors to material penalties. Upon any such termination, (i) the assets of each terminated subtrust shall be allocated and distributed to the Participants in proportion to the vested accrued benefits of Participants under the Plan and (ii) then, if any assets remain, the unvested (if any) accrued benefits of Participants under the applicable Plan shall be distributed to such Participants in lump sums in proportion to the unvested accrued benefits of the Participants under the Plan . Any assets remaining shall be distributed to the respective Grantor(s) in accordance with 2.04.\nNotwithstanding the foregoing, the Trustee shall distribute Plan benefits to a Participant to the extent that a federal court has held that the interest of the Participant in this trust causes such Plan benefits to be includable for federal income tax purposes in the gross income of the Participant prior to actual payment of such Plan benefits to the Participant and appeals from that holding are no longer timely or have been exhausted. The Trustee may also distribute Plan benefits to a Participant, upon direction of the Compensation Committee, based on an opinion of legal counsel which is satisfactory to the Trustee, that there is a significant risk that the Participant's interest in the trust fund will be held to be ERISA Funding or Tax Funding with respect to such Participant or that a Participant will be determined not to be a \"management or highly compensated employee\" for purposes of ERISA. The provisions of this paragraph shall also apply to any Beneficiary of a Participant.\n1.02-4 This trust is \"Tax Funding\" if it causes the interest of a Participant in this trust to be includable for federal income tax purposes in the gross income of the Participant prior to actual payment of Plan benefits to the Participant.\nThis trust is \"ERISA Funding\" if it prevents the Plan from meeting the \"unfunded\" criterion of the exceptions to application of the provisions of Parts 2 through 4 of Subtitle B of Title I of ERISA for plan that are unfunded and maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.\n1.02-5 \"Written Consent of Participants\" means, for the purposes of this Trust Agreement, consent in writing by Participants who (i) constitute a majority in number of all participants and (ii) have accrued benefits (whether vested or unvested) with a present value equal to more than fifty percent (50%) of the present value of the accrued benefits of all of the Participants in all of the subtrusts under this Trust Agreement on the date of such consent.\n1.03 Special Circumstances\n1.03-1 Upon the occurrence of a Special Circumstance as described in 1.03-2 with respect to any Grantor, the trust assets allocated to the affected Grantor shall be held for Participants in the Grantor's subtrusts who had accrued benefits before the Special Circumstance occurred and shall include those assets accrued for such Participants after the Special Circumstance. 1.03-2 A \"Special Circumstance\" shall mean a Potential Change in Control of any Grantor (as defined in 2.01-7), a Change in Control of any Grantor (as defined in the Plan) or a Default of any Grantor (as defined in 1.03- 4).\n1.03-3 The Trust Committee or the Chief Executive Officer of the affected Grantor shall furnish written notice to the Trustee when a Change in Control occurs. For purposes of this Trust Agreement, a Change in Control of any Grantor shall be deemed to have occurred when the Trustee makes a determination to that effect on its own initiative or upon receipt by the Trustee of written notice to that effect from the Trust Committee or the Chief Executive Officer of the affected Grantor.\n1.03-4 A \"Default\" shall mean a failure by a Grantor to contribute to the trust, within 30 days of receipt of written notice from the Trustee, any of the following amounts:\n(a) The full amount of any insufficiency in assets of any subtrust that is required to pay any premiums or loan interest payments on insurance contracts which are held in the subtrust;\n(b) The full amount of any insufficiency in assets of any subtrust that is required to pay any Plan benefit that is payable upon a direction from the Trust Committee pursuant to 3.02-3 or upon resolution of a disputed claim pursuant to 3.03-2; or\n(c) Any contribution which is then required under 2.01.\nIf, after the occurrence of a Default, the Grantor at any time cures such Default by contributing to the trust all amounts which are then required under subparagraphs (a), (b) and (c) above, it shall then cease to be deemed that a Default has occurred or that a Special Circumstance has occurred by reason of such Default.\nII. TRUST FUND AND FUNDING POLICY\n2.01 Contributions\n2.01-1 All contributions to the trust by the Grantors shall be made through SCEcorp as agent for the Grantors. Each Grantor shall be liable to SCEcorp for its allocable share of any contribution made to the trust by SCEcorp on behalf of the Grantor. Each Grantor, through SCEcorp shall contribute to the trust such amounts as are required to purchase or hold insurance contracts in the trust and to pay premiums and loan interest payments thereon. Each Grantor shall also contribute to the trust such additional amounts as are necessary to fund all Plan benefits accrued by Participants while employed by such Grantor (unless the Grantor makes such payments directly) whenever the Trust Committee advises SCEcorp or the Grantor that the assets of the trust or subtrust, other than insurance contracts or amounts needed to pay future premiums or loan interest payments on insurance contracts, are, or in the future are likely to be, insufficient to make such payments. In its discretion, SCEcorp or any Grantor may contribute to the trust such additional amounts or assets as the Trust Committee may reasonably decide are necessary to provide security for all Plan benefits payable to Participants covered by this trust or any subtrust. SCEcorp or any Grantor may make contributions to a special reserve for payment of future fees and expenses of the Trustee and future trust fees and expenses for legal and administrative proceedings.\n2.01-2 Whenever SCEcorp makes a contribution to the trust on behalf of the Grantors, SCEcorp shall designate the Plan and subtrusts to which such contribution (or designated portions thereof) shall be allocated. If the contribution is for a special reserve for payment of future fees and expenses of the Trustee and future trust fees and expenses for legal and administrative proceedings, a separate subtrust shall be designated to receive such contributions, which shall be distinct from any subtrust established for the Plan or the Grantors.\n2.01-3 Following the occurrence of a Special Circumstance (as defined in 1.03-2) with respect to any Grantor, and at least annually thereafter while the Special Circumstance remains in effect, the Grantor shall contribute to the trust the sum of the following:\n(a) The amount by which the present value of all \"anticipated benefits\" (vested and unvested) payable under the Plans on a pre-tax basis to Participants or their beneficiaries whose benefits are funded by the Grantor's subtrust(s) exceeds the value of all of the Grantor's subtrust assets in this trust. For this purpose, each Participant's \"anticipated benefit\" under the Plan shall be the present value of highest benefit the Participant would have accrued under the Plan by the end of that year, assuming that the Participant's service continues at the same rate of compensation and that the Participant continues to make deferrals under the Plan for the balance of the year.\n(b) A reasonable estimate of the Trustee fees and expenses for the remaining duration of the trust which should be allocable to the Grantor's subtrust(s).\n2.01-4 The calculations required under 2.01-3 shall be based on the terms of the Plans.\n2.01-5 Whenever SCEcorp makes a contribution to the trust pursuant to 2.01-3 on its own behalf or on behalf of another Grantor, it shall furnish the Trustee with a written statement setting forth the computation of all required amounts contributed.\nWhenever a Special Circumstance occurs or a contribution is made pursuant to 2.01-3, SCEcorp or the Trust Committee shall deliver to the Trustee, contemporaneously with or immediately prior to such event, a schedule (the \"Payment Schedule\") indicating the amounts payable under the Plans in respect of each affected Participant, or providing a formula or instructions acceptable to the Trustee for determining the amounts so payable, the form in which such amounts are to be paid (as provided for or available under the Plans) and the time of commencement for payment of such amounts. The Payment Schedule shall include any other necessary instructions with respect to Plan benefits (including legal expenses) payable under the Plans and any conditions with respect to any Participant's entitlement to such benefits, and such instructions may be revised from time to time to the extent so provided under the Plans or this Trust Agreement.\nA modified Payment Schedule shall be delivered by SCEcorp or the Trust Committee to the Trustee at each time that (i) additional amounts are required to be paid to the Trustee pursuant to 2.01-3, (ii) Excess Assets are returned to the Grantors, or (iii) upon the occurrence of any event requiring a modification of the Payment Schedule. SCEcorp shall also furnish a Payment Schedule or modified Payment Schedule for any or all Plans upon request by the Trustee at any other time. Whenever SCEcorp or the Trust Committee is required to deliver to the Trustee a Payment Schedule or a modified Payment Schedule, SCEcorp shall also deliver at the same time to each Participant the respective portion of the Payment Schedule or modified Payment Schedule that sets forth the amount payable to that Participant.\n2.01-6 Any contribution to the trust which is made by a Grantor on account of a Potential Change in Control shall be returned to that Grantor following one year after delivery of such contribution to the Trustee unless a Change in Control of the Grantor shall have occurred during such one-year period, if the Grantor requests such return within 60 days after such one-year period. If no such request is made within this 60-day period, the contribution shall become a permanent part of the trust fund allocated to the Grantor's subtrust(s). The one-year period shall recommence in the event of and upon the date of any subsequent Potential Change in Control.\n2.01-7 A \"Potential Change in Control\" shall be deemed to occur with respect to a Grantor if:\n(a) Any person, as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the \"Act\"), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Grantor, delivers to the Grantor a statement containing the information required by Schedule 13-D under the Act, or any amendment to any such statement, that shows that such person has acquired, directly or indirectly, the beneficial ownership of (i) more than twenty-five (25%) percent of any class of equity security of the Grantor entitled to vote as a single class in the election or removal from office of directors, or (ii) more than twenty-five (25%) percent of the voting power of any group of classes of equity securities of the Grantor entitled to vote as a single class in the election or removal from office of directors;\n(b) The Grantor becomes aware that preliminary or definitive copies of a proxy statement and information statement or other information have been filed with the Securities and Exchange Commission pursuant to Rule 14a-6, Rule 14c-5, or Rule 14f-1 under the Act relating to a Potential Change in Control of the Grantor;\n(c) Any person delivers to the Grantor pursuant to Rule 14d-3 under the Act a Tender Offer Statement relating to Voting Securities of the Grantor;\n(d) Any person (other than the Grantor or an SCEcorp affiliate) publicly announces an intention to take actions which if consummated would constitute a Change in Control;\n(e) The Grantor enters into an agreement or arrangement, the consummation of which would result in the occurrence of a Change in Control;\n(f) The Grantor's Board approves a proposal, or the Grantor enters into an agreement, which if consummated would constitute a Change in Control; or\n(g) The Grantor's Board adopts a resolution to the effect that, for purposes of this Trust Agreement, a Potential Change in Control has occurred.\nNotwithstanding the foregoing, a Potential Change in Control shall not be deemed to occur as a result of any event described in (a) through (g) above, if directors who were a majority of the members of the Grantor's Board prior to such event determine that the event shall not constitute a Potential Change in Control and furnish written notice to the Trustee of such determination.\n2.01-8 The Trust Committee or the Chief Executive Officer of the affected Grantor shall furnish written notice to the Trustee when a Potential Change in Control occurs under 2.01-7. For purposes of this trust, a Potential Change in Control shall be deemed to have occurred when the Trustee makes a determination to that effect on its own initiative or upon receipt by the Trustee of written notice to that effect from the affected Grantor or the Trust Committee except as may be provided under 2.01-7.\n2.01-9 The Trustee shall accept the contributions made by SCEcorp on behalf of the Grantors and hold them as a trust fund for the payment of benefits under the Plans. The Trustee shall not be responsible for determining the required amount of contributions or for collecting any contribution not voluntarily paid, nor shall the Trustee be responsible for the adequacy of the trust fund to meet and discharge all liabilities under the Plans. Contributions may be in cash or in other assets specified in 2.02.\n2.02 Investment And Valuation\n2.02-1 The trust fund may be invested primarily in insurance contracts (\"Contracts\"). Such Contracts may be purchased by SCEcorp on behalf of the Grantors and transferred to the Trustee as in-kind contributions or may be purchased by the Trustee with the proceeds of cash contributions (or may be purchased upon direction by the Trust Committee pursuant to 2.02-2 or an Investment Manager pursuant to 2.02-4). Trust contributions shall include sufficient cash to make projected premium payments on such Contracts and payments of interest due on loans secured by the cash value of such Contracts, unless SCEcorp makes these payments directly on behalf of the Grantors or the Grantors make the payments directly. The Trustee shall have the power to exercise all rights, privileges, options and elections granted by or permitted under any Contract or under the rules of the insurance company issuing the Contract (\"Insurer\"), including the right to obtain policy loans against the cash value of the Contract. Prior to a Special Circumstance, the exercise by the Trustee of any incidents of ownership under any Contract shall be subject to the direction of the Trust Committee. The Trustee shall have no power to designate a beneficiary other than the trust, to assign a Contract other than to a successor trustee, or to loan proceeds of any Contract borrowings to any person other than the Grantors. The Trust Committee may from time to time direct the Trustee in writing as to the designation of beneficiary under such Contracts.\nNotwithstanding anything contained herein to the contrary, neither SCEcorp, nor any Grantor nor the Trustee shall be liable for the refusal of any Insurer to issue or change any Contract or Contracts or to take any other action requested by the Trustee; nor for the form, genuineness, validity, sufficiency or effect of any Contract or Contracts held in the trust; nor for the act of any person (other than itself) or persons that may render any such Contract or Contracts null and void; nor for failure of any Insurer to pay the proceeds of any such Contract or Contracts as and when the same shall become due and payable; nor for any delay in payment resulting from any provision contained in any such Contract or Contracts; nor for the fact that for any reason whatsoever (other than its own negligence or willful misconduct) any Contracts shall lapse or otherwise become uncollectable.\n2.02-2 Prior to a Special Circumstance, the Trustee shall invest the trust fund in accordance with written directions by the Trust Committee, including directions for exercising rights, privileges, options and elections pertaining to Contracts and for borrowing from Contracts or other borrowing by the Trustee. The Trustee shall act only as an administrative agent in carrying out directed investment transactions and shall not be responsible for the investment decision. If a directed investment transaction violates any duty to diversify, to maintain liquidity or to meet any other investment standard under this trust or applicable law, the entire responsibility shall rest upon the Trust Committee. The Trustee shall be fully protected in acting upon or complying with any investment objectives, guidelines, restrictions or directions provided in accordance with this paragraph.\nAfter a Special Circumstance with respect to a Grantor, the Trust Committee shall no longer be entitled to direct the Trustee with respect to the investment of that portion of the trust fund allocated to that Grantor's subtrust(s), unless the Written Consent of Participants of the affected subtrust(s) is obtained for the Trust Committee to continue to have this right pursuant to 2.02-2. If such Written Consent of Participants is not obtained, that portion of the trust fund shall be invested by the Trustee pursuant to 2.02-3 or by an Investment Manager pursuant to 2.02-4. The Trustee or Investment Manager shall have the right to invest the Trust Fund primarily in insurance contracts pursuant to 2.02-1.\nNotwithstanding the foregoing, after a Special Circumstance no new investments shall be made at any time in any securities, instruments, accounts or real property of the affected Grantor, and the Trustee may not loan trust fund assets to the affected Grantor, or permit the affected Grantor to pledge trust fund assets as collateral for loans to the affected Grantor without the Written Consent of all of the Participants.\nThe Trust Committee may not direct the Trustee to make any investments, and the Grantors may not make any contributions of property to the trust fund, which are not permissible investments under 2.02-1 and 2.02-3.\n2.02-3 If the Trustee does not receive instructions from the Trust Committee for the investment of part or all of the trust fund for a period of at least 60 days, the Trustee shall invest and reinvest the assets of the trust fund as the Trustee, in its sole discretion, may deem appropriate, in accordance with applicable law.\nPermissible investments shall be limited to the following:\n(a) Insurance or annuity contracts;\n(b) Preferred or common stocks, bonds, notes, debentures, commercial paper, certificates of deposit, money market funds, obligations of governmental bodies, or other securities;\n(c) Interest-bearing savings or deposit accounts with any federally- insured bank or savings and loan association (including the Trustee or an affiliate of the Trustee);\n(d) Shares or certificates of participation issued by investment companies, investment trusts, mutual funds, or common or pooled investment funds (including any common or pooled investment fund now or hereafter maintained by the Trustee or an affiliate of the Trustee); or\n(e) Real property, mortgages, deeds of trust, or notes secured by mortgages or deeds of trust.\n2.02-4 Prior to a Change in Control, the Trust Committee may appoint one or more investment managers (\"Investment Manager\") subject to the following provisions:\n(a) The Trust Committee may appoint one or more Investment Managers to manage (including the power to acquire and dispose of) a specified portion of the assets of the trust (hereinafter referred to as that Investment Manager's \"Segregated Fund\"). Any Investment Manager so appointed must be either (i) an investment adviser registered as such under the Investment Advisers Act of 1940, (ii) a bank, as defined in that Act, or (iii) an insurance company qualified to perform services in the management, acquisition or disposition of the assets of trusts under the laws of more than one state; and any Investment Manager so appointed must acknowledge in writing to the Trust Committee and to the Trustee that it is a fiduciary with respect to the trust assets. The Trustee, until notified in writing to the contrary, shall be fully protected in relying upon any written notice of the appointment of an Investment Manager furnished to it by the Trust Committee. In the event of any vacancy in the office of Investment Manager, the Trustee, upon seven days prior written notice of the vacancy in the office of Investment Manager shall be deemed to be the Investment Manager of that Investment Manager's Segregated Fund until an Investment Manager thereof shall have been duly appointed; and in such event, until an Investment Manager shall have been so appointed and qualified, references herein to the Trustee's acting in respect of that Segregated Fund pursuant to direction from the Investment Manager shall be deemed to authorize the Trustee to act in its own discretion in managing and controlling the assets of that Segregated Fund, and subparagraphs (b) and (c) below shall have no effect with respect thereto and shall be disregarded.\n(b) Each Investment Manager appointed pursuant to subparagraph (a) above shall have exclusive authority and discretion to manage and control the assets of its Segregated Fund and may invest and reinvest the assets of the Segregated Fund in any investments in which the Trustee is authorized to invest under 2.02-3, subject to the terms and limitations of any written instruments pertaining to its appointment as Investment Manager. Copies of any such written instruments shall be furnished to the Trustee. In addition, each Investment Manager from time to time and at any time may delegate to the Trustee (or in the event of any vacancy in the office of Investment Manager, the Trustee, upon seven days prior written notice of the vacancy in the office of Investment Manager, may, until an Investment Manager thereof shall have been duly appointed, exercise in respect of that Investment Manager's Segregated Fund) discretionary authority to invest and reinvest otherwise uninvested cash held in its Segregated Fund temporarily in bonds, notes or other evidences of indebtedness issued or fully guaranteed by the United States of America or any agency or instrumentality thereof, or in other obligations of a short-term nature, including prime commercial obligations or part interests therein.\n(c) Unless the Trustee knowingly participates in, or knowingly undertakes to conceal, an act or omission of an Investment Manager, knowing such act or omission to be a breach of the fiduciary responsibility of the Investment Manager with respect to the trust assets, the Trustee shall not be liable for any act or omission of any Investment Manager and shall not be under any obligation to invest or otherwise manage the assets of the Plans that are subject to the management of any Investment Manager. Without limiting the generality of the foregoing, the Trustee shall not be liable by reason of its taking or refraining from taking at the direction of an Investment Manager any action in respect of that Investment Manager's Segregated Fund. The Trustee shall be under no duty to question or to make inquiries as to any direction or order or failure to give direction or order by any Investment Manager; and the Trustee shall be under no duty to make any review of investments acquired for the trust at the direction or order of any Investment Manager and shall be under no duty at any time to make any recommendation with respect to disposing of or continuing to retain any such investment.\n2.02-5 The values of all assets in the trust fund shall be reasonably determined by the Trustee and may be based on the determination of qualified independent parties or Experts (as described in 2.06-2). At any time before or after a Special Circumstance, the Trustee shall have the right to secure confirmation of value by a qualified independent party or Expert for all property of the trust fund, as well as any property to be substituted for other property of the trust fund pursuant to 2.05. Before a Special Circumstance the Trust Committee may designate one or more independent parties, who are acceptable to the Trustee, to determine the fair market value of any notes, securities, real property or other assets.\nAny insurance or annuity contracts held in the trust fund shall be valued at their cash surrender value, except for purposes of substituting other property for such Contracts pursuant to 2.05-2. All securities shall be valued net of costs to sell, or register for sale, such securities. All real property shall be valued net of costs to sell such real property. All other assets of the trust fund shall be valued at their fair market value.\nSCEcorp shall pay on behalf of the Grantors all costs incurred in valuing the assets of the trust fund including any assets to be substituted for other assets of the trust fund pursuant to 2.05. If not so paid, these costs shall be paid from the trust fund. SCEcorp shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such costs paid out of the trust fund.\n2.02-6 Following a Change in Control of a Grantor, the Trustee shall be the Investment Manager of the assets of the affected subtrust(s). While the Trustee is the Investment Manager, any requirements in the Plans or Trust Agreement that the Investment Manager or the Trustee provide the other with prior written notice or other communication shall not apply.\n2.03 Subtrusts\n2.03-1 The Trustee shall establish a Grantor subtrust for each Plan in which a Grantor participates to which it shall credit contributions it receives which are earmarked for that Grantor. The Trustee shall also establish a separate subtrust to which it shall credit contributions it receives which are earmarked to the special reserve for payment of future fees and expenses of the Trustee. Each subtrust shall reflect an undivided interest in assets of the trust fund and shall not require any segregation of particular assets, except that an insurance contract covering benefits of a particular Plan shall be held in the subtrust for the Plan. All contributions shall be designated by SCEcorp for a particular subtrust. However, any contribution received by the Trustee which is not earmarked for a particular subtrust shall be allocated among the subtrusts as the Trustee may determine in its sole discretion.\nThe Trust Committee may direct the Trustee, or the Trustee may determine on its own initiative, to maintain a separate sub-account within each subtrust for a Plan for each Participant who is covered by the subtrust. Each sub-account in a subtrust shall reflect an individual interest in assets of the subtrust and, as much as possible, shall operate in the same manner as if it were a separate subtrust.\n2.03-2 The Trustee shall allocate investment earnings and losses and expenses of the trust fund among the subtrusts in proportion to their balances, except that changes in the value of an insurance contract (including premiums and interest on loans on an insurance contract) shall be allocated to the subtrust for which it is held. Payments to creditors during Insolvency Administration under 5.02 shall be charged against the affected Grantor's subtrusts in proportion to their balances, except that payment of Plan benefits to a Participant as a general creditor shall be charged against the subtrust for that Plan.\n2.03-3 Assets allocated to a subtrust for one Plan may not be utilized to provide benefits under any other Plans until all benefits under such Plan have been paid in full, except that Excess Assets (as defined in 2.04-2) of a subtrust may be transferred to other subtrusts pursuant to 2.04-5.\n2.04 Recapture Of Excess Assets\n2.04-1 In the event the trust shall hold Excess Assets, the Trust Committee, at its option, may direct the Trustee to return part or all of such Excess Assets to the Grantors.\n2.04-2 \"Excess Assets\" are assets of the trust or a subtrust exceeding one hundred twenty-five percent (125%) of the amounts described in 2.01-3.\n2.04-3 The calculation required by 2.04-2 shall be based on the terms of the Plans. Before a Special Circumstance, the calculation shall be made by the Trust Committee or a qualified actuary or consultant selected by the Trust Committee. After a Special Circumstance, the calculation shall be made by a qualified actuary or consultant selected by the Trustee, provided the Trust Committee may select a qualified actuary or consultant with the Written Consent of Participants.\n2.04-4 Excess Assets shall be returned to the Grantors in any order of priority directed by the Trust Committee, unless the Trustee determines otherwise to protect the Participants.\n2.04-5 If any subtrust for a Grantor holds Excess Assets, the Trust Committee may direct the Trustee to transfer such Excess Assets to other subtrusts of the Grantor. After a Special Circumstance, the Trustee may also transfer Excess Assets of a subtrust for a Grantor to other subtrusts for that Grantor upon its own initiative in such amounts as it may determine in its sole discretion.\nExcess Assets of a subtrust for a Plan shall be determined in the same manner as Excess Assets of the trust are determined pursuant to 2.04-2 and 2.04-3. In making this determination, each subtrust for a Plan shall bear its allocable share of the amounts described in 2.01-3 which relate to that Plan. The Trustee, in its sole discretion, shall determine whether there are Excess Assets in the separate subtrust which constitutes the reserve for payment of future fees and expenses of the Trustee. Excess Assets for this subtrust shall be any amounts which the Trustee reasonably determines will not be needed in the future for payment of such fees and expenses. 2.05 Substitution Of Other Property\n2.05-1 SCEcorp shall have the power to re-acquire on behalf of the Grantors part or all of the assets or collateral held in the trust fund at any time, by simultaneously substituting for it other readily marketable property of equivalent value, net of any costs of disposition; provided that, if the trust holds Excess Assets, the property which is substituted shall not be required to be of equivalent value, but only of sufficient value so that the trust will retain Excess Assets of not less than $10,000 after such substitution. The property which is substituted must be among the types of investments authorized under 2.02 and may not be less liquid or marketable or less well secured than the property for which it is substituted, as determined by the Trust Committee. Such power is exercisable in a nonfiduciary capacity and may be exercised without the approval or consent of Participants or any other person.\n2.05-2 Except for insurance contracts, the value of any assets re- acquired under 2.05-1 shall be determined as provided in 2.02-5. The value of any insurance contract re-acquired under 2.05-1 shall be the present value of future projected cash flow or benefits payable under the Contract, but not less than the cash surrender value. The projection shall include death benefits based on reasonable mortality assumptions, including known facts specifically relating to the health of the insured and the terms of the Contract to be re-acquired. Values shall be reasonably determined by the Trustee and may be based on the determination of qualified independent parties and Experts, as described in 2.02-5 and 2.06-2. The Trustee shall have the right to secure confirmation of value by a qualified independent party or Expert for all property to be substituted for other property.\n2.05-3 SCEcorp shall pay on behalf of the Grantors all costs incurred in valuing the assets of the trust fund, including any assets to be substituted for other assets of the trust fund pursuant to 2.05. If not so paid, these costs shall be paid from the trust fund. SCEcorp shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such costs paid out of the trust fund.\n2.06 Administrative Powers Of Trustee\n2.06-1 Subject in all respects to applicable provisions of this Trust Agreement, including limitations on investment of the trust fund, the Trustee shall have the rights, powers and privileges of an absolute owner when dealing with property of the trust, including (without limiting the generality of the foregoing) the powers listed below:\n(a) To sell, convey, transfer, exchange, partition, lease, and otherwise dispose of any of the assets of the trust at any time held by the Trustee under this Trust Agreement;\n(b) To exercise any option, conversion privilege or subscription right given the Trustee as the owner of any security held in the trust; to vote any corporate stock either in person or by proxy, with or without power of substitution; to consent to or oppose any reorganization, consolidation, merger, readjustment of financial structure, sale, lease or other disposition of the assets of any corporation or other organization, the securities of which may be an asset of the trust; and to take any action in connection therewith and receive and retain any securities resulting therefrom;\n(c) To deposit any security with any protective or reorganization committee, and to delegate to such committee such power and authority with respect thereto as the Trustee may deem proper, and to agree to pay out of the trust such portion of the expenses and compensation of such committee as the Trustee, in its discretion, shall deem appropriate;\n(d) To cause any property of the trust to be issued, held or registered in the name of the Trustee as trustee, or in the name of one or more of its nominees, or one or more nominees of any system for the central handling of securities, or in such form that title will pass by delivery, provided that the records of the Trustee shall in all events indicate the true ownership of such property, or to deposit any securities held in the trust with a securities depository;\n(e) To renew or extend the time of payment of any obligation due or to become due;\n(f) To commence or defend lawsuits or legal or administrative proceedings; to compromise, arbitrate or settle claims, debts or damages in favor of or against the trust; to deliver or accept, in either total or partial satisfaction of any indebtedness or other obligation, any property; to continue to hold for such period of time as the Trustee may deem appropriate any property so received; and to pay all costs and reasonable attorneys' fees in connection therewith out of the assets of the trust;\n(g) To foreclose any obligation by judicial proceeding or otherwise;\n(h) Subject to 2.02, to borrow money from any person in such amounts, upon such terms and for such purposes as the Trustee, in its discretion, may deem appropriate; and in connection therewith, to execute promissory notes, mortgages or other obligations and to pledge or mortgage any trust assets as security; and to lend money on a secured or unsecured basis to any person other than a party in interest;\n(I) To manage any real property in the trust in the same manner as if the Trustee were the absolute owner thereof, including the power to lease the same for such term or terms within or beyond the existence of the trust and upon such conditions as the Trustee may deem proper; and to grant options to purchase or acquire options to purchase any real property;\n(j) To appoint one or more persons or entities as ancillary trustee for the purpose of investing in and holding title to real or personal property or any interest therein; provided that any such ancillary trustee shall act with such power, authority, discretion, duties, and functions of the Trustee as shall be\nspecified in the instrument establishing such ancillary trust, including (without limitation) the power to receive, hold and manage property, real or personal, or undivided interests therein; and the Trustee may pay the reasonable expenses and compensation of such ancillary trustees out of the trust;\n(k) To hold such part of the assets of the trust uninvested for such limited periods of time as may be necessary for purposes of orderly trust administration or pending required directions, without liability for payment of interest;\n(l) To determine how all receipts and disbursements shall be credited, charged or apportioned as between income and principal, and the decision of the Trustee shall be final and not subject to question by any Participant or Beneficiary of the trust;\n(m) To dispose of any property in the trust fund and to foreclose on any notes from a Grantor (and dispose of any collateral securing such notes, subject to the terms of any pledge agreement) upon any Default (as defined in 1.03-4), after 60 days written notice to the Grantor to permit the Grantor to cure any Default; and\n(n) Generally to do all acts, whether or not expressly authorized, which the Trustee may deem necessary or desirable for the orderly administration or protection of the trust fund.\n2.06-2 The Trustee may engage one or more qualified independent attorneys, accountants, actuaries, appraisers, consultants or other experts (an \"Expert\") with respect to its determination under the Trust, including the determination of Excess Assets pursuant to 2.04 or disputed claims pursuant to 3.03. The Trustee shall have no duty to oversee or independently evaluate the determination of the Expert. The Trustee shall be authorized to pay the fees and expenses of any Expert out of the assets of the trust fund.\n2.06-3 The Grantors shall from time to time pay taxes (references in this Trust Agreement to the payment of taxes shall include interest and applicable penalties) of any and all kinds whatsoever which at any time are lawfully levied or assessed upon or become payable in respect of their pro rata shares of the trust fund, the income or any property forming a part thereof, or any security transaction pertaining thereto. To the extent that any taxes levied or assessed upon the trust fund are not paid by the Grantors or contested by the Grantors pursuant to the last sentence of this paragraph, the Trustee shall pay such taxes out of the trust fund, and the Grantors shall upon demand by the Trustee, deposit into the trust fund, through their agent, SCEcorp, an amount equal to the amount paid from the trust fund to satisfy such tax liability. If requested by SCEcorp, the Trustee shall contest the validity of such taxes in any manner deemed appropriate by SCEcorp or its counsel, but only if it has received an indemnity bond or other security satisfactory to it to pay any expenses of such contest. Alternatively, SCEcorp may itself contest the validity of any such taxes, but any such contest shall not affect the Grantors' obligation to reimburse the trust fund for taxes paid from the trust fund.\n2.06-4 Notwithstanding any powers granted to Trustee pursuant to this Trust Agreement or to applicable law, Trustee shall not have any power that could give this Trust the objective of carrying on a business and dividing the gains therefrom, within the meaning of section 301.7701-2 of the Procedure and Administrative Regulations promulgated pursuant to the Code.\nIII. ADMINISTRATION\n3.01 Committee; Company Representatives\n3.01-1 The Compensation Committee is the administrator of the Plans and has general responsibility to interpret the Plans and determine the rights of Participants and beneficiaries. Day-to-day administration of the Plans has been delegated to SCEcorp management. The Compensation Committee is the administrator of this Trust Agreement and shall act on behalf of all Grantors with respect to the Administration of this Trust Agreement; however, day-to-day administration of the Plans has been delegated to the Trust Committee. Notwithstanding any other provision of this Trust Agreement, each Grantor is responsible for contributions to fund benefits accrued by Participants while employed by the Grantor and for its pro rata share of expenses of the trust (based on the amount of assets allocated to the Grantor's subtrust(s)) and shall reimburse SCEcorp for payments advanced by SCEcorp on its behalf.\n3.01-2 The Trustee shall be given the names and specimen signatures of the members of the Trust Committee and any other SCEcorp representatives authorized to take action in regard to the administration of the Plans and this trust. The Trustee shall accept and rely upon the names and signatures until notified of any change. Instructions to the Trustee shall be signed for the Trust Committee by the chairman or such other person as the Trust Committee may designate.\n3.02 Payment Of Benefits\n3.02-1 The Trustee shall pay benefits to Participants and beneficiaries on behalf of the Grantors in satisfaction of their obligations under the Plans. Each Grantor shall contribute to the trust such amounts as are necessary to fund benefits accrued by Participants while employed by the Grantor and to enable the Trustee to make all such Plan benefit payments to Participants when due, whenever the Trustee advises the Trust Committee that the assets of the relevant subtrust, other than insurance contracts or amounts needed to pay future premiums or loan interest payments on insurance contracts, are insufficient to make such payments. Benefit payments from a subtrust shall be made in full until the assets of the subtrust are exhausted. Payments due on the date the subtrust is exhausted shall be covered pro rata. A Grantor's benefit payment obligation shall not be limited to the portion of the trust fund allocated to the Grantor's subtrust(s), and a Participant or Beneficiary shall have a claim against a Grantor for any payment not made by the Trustee.\nNotwithstanding the foregoing, and in the discretion of the Grantors, benefits payments may be paid directly to Participants at any time. Grantors shall pay benefits directly to Participants and beneficiaries in satisfaction of their obligations under a Plan whenever either (i) the assets of the subtrust are not then sufficient to satisfy any then applicable contribution or funding requirements imposed under 2.01, or (ii) there are no assets in the subtrust other than insurance contracts. If a Grantor fails to make any such required payments when due, after 60 days' written notice to the Grantor to permit the Grantor to make any such payments, the Trustee shall pay benefits to Participants and beneficiaries under any Plan from the assets of the subtrust for that Plan.\n3.02-2 A Participant's entitlement to benefits under the Plans shall be determined by the Compensation Committee. Any benefit enhancement or right with respect to the Plans which is provided under employment or severance agreements of Participants shall be taken into account in making the foregoing determination. Any claim for such benefits shall be considered and reviewed under the claims procedures established for that Plan.\n3.02-3 The Trustee shall make payments in accordance with written directions from the Trust Committee or its designee, except as provided in 3.03. The Trustee may request such directions from the Trust Committee or its designee. If the Trust Committee or its designee fails to furnish written directions to the Trustee within 60 days after receiving a written request for directions from the Trustee, the Trustee may make payments determined by the amounts due under the terms of the Plans in reliance upon the most recent Payment Schedule furnished to it by the Trust Committee.\nThe Trustee shall make provision for the reporting and withholding of any federal, state or local taxes that may be required prior to or coincident with making any benefit payments hereunder and shall pay amounts withheld to taxing authorities on the Grantor's behalf or determine that such amounts have been reported, withheld and paid by the Grantor.\n3.02-4 The Trustee shall use the assets of the trust or any subtrust to make benefit payments or other payments in such order of priority as the Trustee may determine, or as may be directed by the Trust Committee.\n3.03 Disputed Claims\n3.03-1 A Participant covered by this Trust whose claim has been denied by the Trust Committee, or who has received no response to the claim within 60 days after submission, may submit the claim to the Trustee. The Trustee shall give written notice of the claim to the Trust Committee. If the Trustee receives no written response from the Trust Committee within 60 days after the date the Trust Committee is given written notice of the claim, the Trustee shall pay the Participant the amount claimed, unless it determines in its sole discretion that a lesser amount is due under the terms of the Plans. If a written response is received within such 60 days, the Trustee shall consider the claim in its sole and absolute discretion, including the Trust Committee's response. If the merits of the claim depend on compensation, service or other data in the possession of SCEcorp or a Grantor and it is not provided, the Trustee may rely upon information provided by the Participant. Any benefit enhancement or right with respect to the Plans which is provided under employment or severance agreements of Participants shall be taken into account in making the foregoing determination.\n3.03-2 The Trustee shall give written notice to the Participant and the Trust Committee of its decision on the claim. If the decision is to grant the claim, the Trustee shall make payment to the Participant. The Trustee may decline to decide a claim and may file suit to have the matter resolved by a court of competent jurisdiction. All of the Trustee's expenses in the court proceeding, including attorneys fees, shall be allowed as administrative expenses of the trust.\nThe Participant, SCEcorp or the Grantor may challenge the Trustee's decision by filing suit in a court of competent jurisdiction. If no such suit is filed within 60 days after delivery of written notice of the Trustee's decision, the decision shall become final and binding on all parties.\nNotwithstanding the two preceding paragraphs, and because it is agreed that time will be of the essence in determining whether any payments are due a Participant or Beneficiary under the Trust, a Participant or Beneficiary may, if he or she desires, submit any claim for payment under the Trust to arbitration. This right to select arbitration shall be solely that of the Participant or Beneficiary and the Participant or Beneficiary may decide whether or not to arbitrate in his or her discretion. The \"right to select arbitration\" is not mandatory on the Participant or Beneficiary, and the Participant or Beneficiary may choose in lieu thereof to bring an action in an appropriate civil court. Once an arbitration is commenced, however, it may not be discontinued without the mutual consent of the parties to the arbitration. During the lifetime of the Participant only he or she can use the arbitration procedure set forth in this section.\nAny claim for arbitration may be submitted as follows: if a Participant or Beneficiary has submitted a request to be paid under the Trust and the claim is finally denied by the Trustee in whole or in part, the claim may be filed in writing with an arbitrator of the Participant's or Beneficiary's choice who is selected by the method described in the next four sentences. The first step of the selection shall consist of the Participant or Beneficiary submitting a list of five potential arbitrators to the Trust Committee. Each of the five arbitrators must be either (1) a member of the National Academy of Arbitrators located in the State of California or (2) a retired California Superior Court or Appellate Court judge. Within one week after receipt of the list, the Trust Committee shall select one of the five arbitrators as the arbitrator for the dispute in question. If the Trust Committee fails to select an arbitrator within one week after receipt of the list, the Participant or Beneficiary shall then designate one of the five arbitrators for the dispute in question.\nThe arbitration hearing shall be held within seven days (or as soon thereafter as possible) after the picking of the arbitrator. No continuance of said hearing shall be allowed without the mutual consent of the Participant or Beneficiary, the Trust Committee and the affected Grantor. Absence from or nonparticipation at the hearing by any party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion when he or she decides he or she has heard sufficient evidence to satisfy issuance of an award.\nThe arbitrator's award shall be rendered as expeditiously as possible and in no event later than one week after the close of the hearing.\nIn the event the arbitrator finds that the Trust Committee or the Grantor has breached the terms of the Trust, he or she shall order the Trustee to pay to the Participant or Beneficiary within two business days after the decision is rendered the amount then due the Participant or Beneficiary. The award of the arbitrator shall be final and binding upon the parties.\nThe award may be enforced in any appropriate court as soon as possible after its rendition. The Trust Committee or the Grantor will be considered the prevailing party in a dispute if the arbitrator determines (1) that the Trust Committee or the affected Grantor has not breached the terms of the Trust and (2) the claim by the Participant or Beneficiary was not made in good faith. Otherwise, the Participant or Beneficiary will be considered the prevailing party. In the event that the Trust Committee or the Grantor is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (excluding any attorneys' fees incurred by Trust Committee or the Grantor) including stenographic reporter, if employed, shall be paid by the losing party. In the event that the Participant or Beneficiary is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (including all attorneys' fees incurred by the Participant or Beneficiary in pursuing his or her claim), including the fees of a stenographic reporter, if employed, shall be paid from trust assets. The affected Grantor shall reimburse the trust fund within 30 days after receipt of a bill from the Trustee for any such Participant's expenses which are reimbursed by the Trustee.\n3.04 Records\n3.04-1 The Trustee shall keep complete records on the trust fund open to inspection by the Grantors, the Compensation Committee and the Trust at all reasonable times. In addition to accountings required below, the Trustee shall furnish to the Grantors, the Compensation and Trust Committees any information reasonably requested about the trust fund.\n3.05 Accountings\n3.05-1 The Trustee shall furnish the Trust Committee with a complete statement of accounts annually within 60 days after the end of the trust year showing assets and liabilities and income and expense for the year of the trust and each subtrust. The Trustee shall also furnish the Trust Committee with accounting statements at such other times as the Trust Committee may reasonably request. The form and content of the statement of accounts shall be sufficient for each Grantor to include in computing its taxable income and credits the income, deductions and credits against tax that are attributable to the portion of the trust fund allocated to its subtrust(s).\n3.05-2 The Trust Committee may object to an accounting within 180 days after it is furnished and require that it be settled by audit by a qualified, independent certified public accountant. The auditor shall be chosen by the Trustee from a list of at least five such accountants furnished by the Trust Committee at the time the audit is requested. Either the Trust Committee or the Trustee may require that the account be settled by a court of competent jurisdiction, in lieu of or in conjunction with the audit. All expenses of any audit or court proceedings, including reasonable attorneys' fees, shall be allowed as administrative expenses of the trust.\n3.05-3 If the Trust Committee does not object to an accounting within the time provided, the account shall be settled for the period covered by it.\n3.05-4 When an account is settled, it shall be final and binding on all parties, including all Participants and persons claiming through them.\n3.06 Expenses And Fees\n3.06-1 The Trustee shall be reimbursed for all reasonable expenses and shall be paid a reasonable fee fixed by agreement with the Trust Committee from time to time. No increase in the fee shall be effective before 60 days after the Trustee gives written notice to the Trust Committee of the increase. The Trustee shall notify the Trust Committee periodically of expenses and fees.\n3.06-2 SCEcorp shall pay Trustee and other administrative and valuation fees and expenses on behalf of the Grantors. If not so paid, these fees and expenses shall be paid from the trust fund.\nIV. LIABILITY\n4.01 Indemnity\nThe Trustee will have the duty to discharge its responsibilities under this Trust Agreement with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and aims. Subject to such limitations as may be imposed by applicable law, the Grantors shall indemnify and hold harmless the Trustee from any claim, loss, liability or expense arising from any action or inaction in administration of this trust based on direction or information from either SCEcorp, another Grantor, the Compensation or Trust Committees, any Investment Manager or any Expert, absent willful misconduct, negligence or bad faith.\n4.02 Bonding\nThe Trustee need not give any bond or other security for performance of its duties under this trust.\nV. INSOLVENCY\n5.01 Determination of Insolvency\n5.01-1 A Grantor is Insolvent for purposes of this trust if:\n(a) A Grantor is unable to pay its debts as they come due; or\n(b) A Grantor is the subject of a pending proceeding as a debtor under the federal Bankruptcy Code (or any successor federal statute).\n5.01-2 The Grantor shall promptly give notice to the Trustee when a Grantor becomes Insolvent. The Chief Executive Officer of the Grantor shall be obligated to give such notice. If the Trustee receives such notice or receives from any other person claiming to be a creditor of the Grantor a written allegation that the Grantor is Insolvent, the Trustee shall independently determine whether such insolvency exists. The Trustee may rely on such evidence concerning the Grantor's solvency as may be furnished to Trustee and that provides the Trustee with a reasonable basis for making a determination concerning the Grantor's solvency. The expenses of such determination shall be allowed as administrative expenses of the trust.\n5.01-3 Upon receipt of the notice or allegation described in 5.01-2, the Trustee shall discontinue making payments to Participants and beneficiaries under the Plans from the portion of the trust fund allocable to the affected Grantor's subtrusts and shall commence Insolvency Administration under 5.02.\n5.01-4 The Trustee shall have no obligation to investigate the financial condition of the Grantor prior to receiving a notice or allegation of insolvency under 5.01-2.\n5.02 Insolvency Administration\n5.02-1 During Insolvency Administration, the Trustee shall hold the Grantor's subtrust funds for the benefit of the creditors of the Grantor and make payments only in accordance with 5.02-2. The Trustee shall continue the investment of the trust fund in accordance with 2.02.\n5.02-2 The Trustee shall make payments out of the trust fund in accordance with instructions from a court, or a person appointed by a court, having jurisdiction over the Grantor's condition of insolvency to:\n(a) Creditors;\n(b) Participants and beneficiaries; or\n(c) The Trustee in payment of its fees or expenses.\n5.02-3 During Insolvency Administration, the Participants and beneficiaries shall have no greater rights than general creditors of the Grantor. Nothing in this Trust Agreement shall in any way diminish any rights of Plan Participants or their beneficiaries to pursue their rights as general creditors of the Grantor with respect to benefits due under the Plans or otherwise.\n5.03 Termination Of Insolvency Administration\n5.03-1 Insolvency Administration shall terminate when the Trustee determines that the Grantor:\n(a) Is not Insolvent, in response to a notice or allegation of insolvency under 5.01-2;\n(b) Has ceased to be Insolvent; or\n(c) Has been determined by a court of competent jurisdiction not to be Insolvent or to have ceased to be Insolvent.\n5.03-2 Upon termination of Insolvency Administration under 5.03-1, the affected subtrust(s) shall again be held for the benefit of the Participants and beneficiaries under the Plans. Benefit payments due during the period of Insolvency Administration shall be made as soon as practicable, together with interest from the due dates at the rate credited on the Participant's account under the Plan.\n5.04 Creditors' Claims During Solvency\n5.04.1 During periods of a Grantor's Solvency, the Trustee shall hold the Grantor's subtrust(s) exclusively to pay Plan benefits and the allocable fees and expenses of the trust until all benefits have been paid. Creditors of the Grantor shall not be paid during a Grantor's Solvency from the trust fund, which may not be seized by or subjected to the claims of such creditors in any way.\n5.04-2 A period of Solvency for a Grantor is any period not covered by 5.02. VI. SUCCESSOR TRUSTEES\n6.01 Resignation And Removal\n6.01-1 The Trustee may resign at any time by notice to the Trust Committee, which shall be effective in 60 days unless the Trust Committee and the Trustee agree otherwise.\n6.01-2 The Trustee may be removed by the Trust Committee on 60 days' written notice or shorter notice accepted by the Trustee.\nAfter a Special Circumstance, the Trustee may be removed only with the Written Consent of the Participants.\n6.01-3 When resignation or removal is effective, the Trustee shall begin transfer of assets to the successor Trustee immediately. The transfer shall be completed within 60 days, unless the Trust Committee extends the time limit.\n6.02 Appointment Of Successor\n6.02-1 If the Trustee resigns or is removed, the Trust Committee shall appoint a successor by the effective date of resignation or removal under 6.01-1 or 6.01-2. The Trust Committee may appoint any national or state bank or trust company that is unrelated to the Trust Committee as a successor to replace the Trustee upon resignation or removal. The appointment shall be effective when accepted in writing by the new Trustee, which shall have all of the rights and powers of the former Trustee, including ownership rights in the trust assets. The former Trustee shall execute any instruments necessary or reasonably requested by the Trust Committee or the successor Trustee to evidence the transfer. After a Special Circumstance, a successor Trustee may be appointed only with the Written Consent of Participants. If no such appointment has been made, the Trustee may apply to a court of competent jurisdiction for appointment of a successor or for instructions. All expenses of the Trustee in connection with the proceeding shall be allowed as administrative expenses of the trust.\n6.02-2 The successor Trustee need not examine the records and acts of any prior Trustee and may retain or dispose of existing trust assets, subject to Article II. The successor Trustee shall not be responsible for, and the Grantors shall indemnify and hold harmless the successor Trustee from any claim or liability because of, any action or inaction of any prior Trustee.\n6.03 Accountings; Continuity\n6.03-1 A Trustee who resigns or is removed shall submit a final accounting to the Trust Committee as soon as practicable. The accounting shall be received and settled as provided in 3.05 for regular accountings.\n6.03-2 No resignation or removal of the Trustee or change in identity of the Trustee for any reason shall cause a termination of the Plans or this trust.\nVII. GENERAL PROVISIONS\n7.01 Interests Not Assignable\n7.01-1 The interest of a Participant in the trust fund may not be anticipated, assigned, pledged or otherwise encumbered, seized by legal process, transferred or subjected to the claims of the Participant's creditors in any way. Notwithstanding the foregoing, the benefit payable to a Participant may be assigned in full or in part, pursuant to a domestic relations order of a court of competent jurisdiction.\n7.01-2 No Grantor may create a security interest in the trust fund in favor of any of its creditors. The Trustee shall not make payments from the trust fund of any amount to creditors of any Grantor, other than Participants, except as provided in 5.02.\n7.01-3 The Participants shall have no interest in the assets of the trust fund beyond the right to receive payment of Plan benefits subject to the restrictions during Insolvency referred to in 5.02. During Insolvency Administration, the Participants' rights to trust assets shall not be superior to those of any other general creditors of the affected Grantor.\n7.02 Amendment\nThe Grantors and the Trustee may amend this Trust Agreement at any time by a written instrument executed by the parties. Except as provided below, any such amendment may be made only with the Written Consent of Participants after a Special Circumstance. Notwithstanding the foregoing, any such amendment may be made by written agreement of the Grantors and the Trustee without the Written Consent of Participants if such amendment will not have a material adverse effect on the rights of any Participant hereunder or is necessary to comply with any laws, regulations or other legal requirements. No amendment will conflict with the terms of the Plans or make the trust revocable.\n7.03 Applicable Law\nThis trust shall be governed, construed and administered according to the laws of California except as preempted by ERISA or other Federal law.\n7.04 Agreement Binding On All Parties\nThis Trust Agreement shall be binding upon the heirs, personal representatives, successors and assigns of any and all present and future parties.\n7.05 Notices And Directions\nAny notice or direction under this Trust Agreement shall be in writing and shall be effective when actually delivered or, if mailed, when deposited postpaid as first-class mail. Mail to a party shall be directed to the address stated below or to such other address as any party may specify by notice to the other parties. Notices to the Trust Committee shall be sent to the address of SCEcorp. Notices to Participants who have submitted claims under 3.03 shall be mailed to the address shown in the claim submission. Until notice is given to the contrary, notices to the Grantors and the Trustee shall be addressed as follows:\nGrantors\nSCEcorp Southern California Edison Company Attention: Chief Financial Officer Attention: Chief Financial Officer 2244 Walnut Grove Avenue 2244 Walnut Grove Avenue Rosemead, CA 91770 Rosemead, CA 91770\nThe Mission Group Mission Energy Company Attention: Office of the President Attention: President 18101 Von Karman Avenue, Suite 1700 18101 Von Karman Avenue, Suite 1700 Irvine, CA 92715-1007 Irvine, CA 92715-1007\nMission First Financial Mission Land Company Attention: President Attention: President 18101 Von Karman Avenue, Suite 1700 18101 Von Karman Avenue, Suite 1700 Irvine, CA 92715-1007 Irvine, CA 92715-1007\nTrustee\nU.S. Trust Company of California N. A. Attention: Charles Wert 555 South Flower Street Los Angeles, CA 90071-2429\n7.06 No Implied Duties\nThe duties of the Trustee shall be those stated in this trust, and no other duties shall be implied.\n7.07 Gender, Singular And Plural\nAll pronouns and any variations thereof shall be deemed to refer to the masculine or feminine, as the identity of the person or persons may require. As the context may require, the singular may be read as the plural and the plural as the singular. 7.08 Validity\nIf any provision of this Trust Agreement is held invalid, void or unenforceable, the same shall not affect the validity of any other provision.\nVIII. INSURER\n8.01 Insurer Not A Party\nThe Insurer shall not be deemed to be a party to this Trust Agreement, and its obligations shall be measured and determined solely by the terms of its Contracts and other agreements executed by it.\n8.02 Authority Of Trustee\nThe Insurer shall accept the signature of the Trustee on any documents or papers executed in connection with such Contracts. The signature of the Trustee shall be conclusive proof to the Insurer that the person on whose life an application is being made is eligible to have such Contract issued on his life and is eligible for a Contract of the type and amount requested.\n8.03 Contract Ownership\nThe Insurer shall deal with the Trustee as the sole and absolute owner of the trust's interests in such Contracts and shall have no obligation to inquire whether any action or failure to act on the part of the Trustee is in accordance with or authorized by the terms of the Plans or this Trust Agreement.\n8.04 Limitation Of Liability\nThe Insurer shall be fully discharged from any and all liability for any action taken or any amount paid in accordance with the direction of the Trustee and shall have no obligation to see to the proper application of the amounts so paid. The Insurer shall have no liability for the operation of this Trust Agreement or the Plans, whether or not in accordance with their terms and provisions.\n8.05 Change Of Trustee\nThe Insurer shall be fully discharged from any and all liability for dealing with a party or parties indicated on its records to be the Trustee until such time as it shall receive at its home office written notice of the appointment and qualification of a successor Trustee.\nIN WITNESS WHEREOF, the parties have caused this Trust Agreement to be executed by their respective duly authorized officers on the dates set forth below.\nGRANTORS:\nSCEcorp Southern California Edison Company\nBy Alan J. Fohrer By Alan J. Fohrer ----------------------------- ----------------------------- Title: Executive Vice President Title: Executive Vice President and Chief Financial Officer and Chief Financial Officer ----------------------------- ----------------------------- Date: August 7, 1995 Date: August 7, 1995 ----------------------------- -----------------------------\nMission Energy Company Mission First Financial\nBy Edward R. Muller By Thomas R. McDaniel ----------------------------- ----------------------------- Title: President and Chief Title: President and Chief Executive Officer Executive Officer ----------------------------- ----------------------------- Date: August 22, 1995 Date: August 10, 1995 ----------------------------- -----------------------------\nMission Land Company The Mission Group\nBy Thomas R. McDaniel By Thomas R. McDaniel ----------------------------- ----------------------------- Title: President and Chief Title: Office of the President Executive Officer ----------------------------- ----------------------------- Date: August 10, 1995 Date: August 10, 1995 ----------------------------- -----------------------------\nTRUSTEE:\nU.S. Trust Company of California N.A.\nBy Dennis M. Kunisaki ------------------------------ Title: Vice President ------------------------------ Date: August 27, 1995 ------------------------------\nPAGE\nEXHIBIT 10.14\nSOUTHERN CALIFORNIA EDISON COMPANY\nEXECUTIVE RETIREMENT PLAN\nAs Amended Effective January 1, 1995\nPREAMBLE\nThe purpose of this Plan is to provide supplemental retirement benefits to Participants and surviving spouses or other designated beneficiaries of such Participants, whose retirement benefits under the Qualified Plan are reduced or limited on account of certain restrictions or limitations identified in this Plan that are imposed by (i) Section 415 or other sections of the Code, or (ii) the terms of the Qualified Plan.\nI. DEFINITIONS\nCapitalized terms in the text of the Plan are defined as follows:\n1.01 Administrator means the Compensation and Executive Personnel Committee of the Edison Board of Directors.\n1.02 Affiliate means SCEcorp or any corporation or entity which (i) along with SCEcorp, is a component member of a \"controlled group of corporations\" within the meaning of Section 414(b) of the Code, and (ii) has had its executives approved by the Administrator for participation in the Plan.\n1.03 Base Salary Component means the average of the Participant's annual basic rate of pay as fixed by the Employer (excluding Incentive Awards, deferred compensation under nonqualified plans, special awards, commissions, severance pay, and other non-regular forms of compensation) for his or her highest thirty-six consecutive months determined as of the last day of employment or the last day of eligibility under the Plan, whichever occurs earlier.\n1.04 Beneficiary means the person designated as such in accordance with Article IX of the Plan.\n1.05 Benefit Feature means one of the levels of benefit under the Plan as described in Section 3.02(a).\n1.06 Code means the Internal Revenue Code of 1986, as amended.\n1.07 Company means the Southern California Edison Company.\n1.08 Deferred Compensation Component means the Participant's average annual amount of base salary deferred under an Employer's nonqualified deferred compensation plan for the same 36-month period used to determine the Base Salary Component.\n1.09 ELP Level means the executive's classification under the Company's Executive Leadership Program as a Level 1, 2, 3, or 4, or an Employer's equivalent classification as determined by the Administrator.\n1.10 Employer means the Affiliate employing the Participant.\n1.11 ERISA means the Employee Retirement Income Security Act of 1974, as amended. PAGE\n1.12 Financial Hardship means an unexpected and unforeseen financial disruption arising from an illness, casualty loss, sudden financial reversal, or other such unforeseeable occurrence as determined by the Administrator or its designee. Needs arising from foreseeable events such as the purchase of a residence or education expenses for children will not, alone, be considered a Financial Hardship.\n1.13 Incentive Award Component means the dollar amount determined by multiplying the Participant's final annual salary by a factor calculated to be the average incentive award (expressed as a percentage of salary in the three highest years out of the last five years prior to retirement, death, or termination (except for periods of less than three years of eligibility, in which case the highest percentage incentive award received during that period will be used).\n1.14 Participant means a key employee of an Affiliate, who (i) is a U.S. employee or an expatriate who is based and paid in the U.S., (ii) is designated by the Administrator as eligible to participate in the Plan (subject to any applicable Plan restrictions), and (iii) qualifies as a member of the \"select group of management or highly compensated employees\" under ERISA.\n1.15 Plan means the Southern California Edison Company Executive Retirement Plan.\n1.16 Plan Year means the calendar year.\n1.17 Qualified Plan means the Southern California Edison Company Retirement Plan, or a successor plan, intended to qualify under Section 401(a) of the Code.\n1.18 SET means the Senior Executive Team of the Company.\n1.19 Termination of Employment means the voluntary or involuntary cessation of the Participant's employment with the Employer for any reason other than death or Retirement. Termination of Employment will not be deemed to have occurred for purposes of this Plan if the Participant is reemployed by an Affiliate within 30 days of ceasing work with the Employer.\n1.20 Total Compensation means the Base Salary Component for ELP Level 4 Participants. For ELP Level 3 Participants, Total Compensation means the Participant's Base Salary and Deferred Compensation Components. For ELP Level 1 and 2 Participants, Total Compensation means the Participant's Base Salary, Incentive Award and Deferred Compensation Components.\nII. PARTICIPATION\n2.01 Eligibility Individuals are eligible to participate in the Plan when they become key management employees, are classified as ELP Level 1, 2, 3 or 4 by the Administrator or the SET and are designated by the Administrator as eligible to participate in the Plan . Participation in the Plan will continue as long as the individual remains classified as ELP Level 1, 2, 3, 4 (subject to any applicable Plan restrictions).\n2.02 Pre-1993 Participation Employees who were Participants in the Plan on December 31, 1992, will continue to participate in the Plan as long as they remain classified as a salary grade 12 or higher employee, or the equivalent as determined by the Administrator.\nIII. BENEFIT DETERMINATION\n3.01 Overview Benefits under this Plan will be payable with respect to any Participant to whom, or on whose account, retirement benefits become payable under the Qualified Plan but are reduced or limited by virtue of provisions in that plan limiting benefits in accordance with currently applicable law or by the terms of the Qualified Plan. The amount payable under this Plan at retirement will be equal to the difference between the amount that would have been payable under the Qualified Plan were it not for such restrictions and limitations, and the amount that is actually payable under the Qualified Plan.\n3.02 Benefit Features (a) The Plan provides four Benefit Features for which Participants are eligible based on their ELP Level. The four Benefit Features are:\n(i) Recognition by the Plan of the amount of base salary that is not recognized for purposes of calculating benefits under the Qualified Plan due to limits imposed by the Code under Sections 415(b) or 401(a)(17).\n(ii) Recognition by the Plan of deferred salary that is not recognized for purposes of calculating benefits under the Qualified Plan.\n(iii) Recognition by the Plan of incentive awards that are not recognized for purposes of calculating benefits under the Qualified Plan.\n(iv) An additional 0.75% benefit accrual each year for the first ten years of service over that provided by the Qualified Plan.\n(b) ELP Levels 1 and 2 are eligible for all four Benefit Features. ELP Level 3 is eligible for Benefit Features (i) and (ii) only. ELP Level 4 is eligible for Benefit Feature (i) only.\n(c) Participants in the Plan on December 31, 1992, who elected to participate in the Executive Disability and Survivor Benefit Program, are eligible for all four Benefit Features regardless of their ELP Level unless and until they are reclassified as a Salary Grade 11 or lower level employee, or the equivalent as determined by the Administrator. Participants in the Plan on December 31, 1992 who did not elect to participate in the Executive Disability and Survivor Benefit Program are not eligible for Benefit Feature 4.\n3.03 Benefit Computation (a) The Company will calculate the amount of any benefits payable under the Plan for each Participant at the time of the Participant's retirement, death, or termination with a deferred vested benefit under the Qualified Plan. The amount payable under this Plan will be that dollar amount calculated pursuant to Section 3.03(b), reduced by the dollar amount that may be paid to the Participant (or spouse or contingent annuitant) under the terms of the Qualified Plan after taking into account any applicable restrictions or limitations as to such payments required by the Code or other applicable law or the terms of the Qualified Plan.\n(b) The Participant's Total Compensation will be applied to the applicable benefit formula for the Participant (or spouse or contingent annuitant) set forth in the Qualified Plan to calculate total benefits payable taking into consideration the Participant's ELP Level and the applicable Plan features for which the Participant is eligible under Section 3.02.\nIV. RETIREMENT BENEFITS\n4.01 Forms of Benefit Payment (a) The normal form of benefit payout under this Plan will be a joint and survivor annuity which will commence upon retirement of the Participant and be paid monthly concurrent with benefit payments under the Qualified Plan for the lifetime of the Participant. Upon the death of the Participant, the surviving spouse will be entitled to the benefits payments described in Article VI.\n(b) If, at least 90 days prior to his or her retirement, the Participant elects an alternative form of payout, upon retirement by the Participant (either early or normal retirement), the value of his or her benefits payable under this Plan as of the date of retirement will be paid in the manner elected by the Participant in (i) a single lump-sum payment calculated using the rate of interest determined pursuant to Section 4.02, and based upon the 1983 Group Annuity Mortality actuarial tables, (ii) in monthly installments (of principal, plus interest) over a period of 60 months, or (iii) in monthly installments (of principal, plus interest) over a period of 120 months.\n(c) If an Participant elects a payout in monthly installments of principal plus interest over a period of 60 months or 120 months, the value of the Participant's benefits will be calculated pursuant to Section 4.01(b), and an account balance established at the earlier of the Participant's retirement or death. Principal and interest will be paid in equal monthly installments during the year, and will be recomputed annually to reflect interest accrued in the prior year.\n4.02 Interest (a) Interest will be credited to account balances at the end of each calendar year. The Participant's average monthly closing balance for the year will be calculated. Interest will be applied to this average closing balance at a rate based on Moody's Corporate Bond Yield Average for Aa Public Utility Bonds. Each February 1st and August 1st, the Plan interest rate will be adjusted to reflect the average of Moody's bond yield for the prior six months. A ratable amount of interest will be credited for periods shorter than a calendar year.\n(b) Interest will continue to accrue on any remaining unpaid account balance during the payout period elected pursuant to Section 4.01(b) until all amounts credited to the account have been paid. Interest will be credited annually to the Participant's account at the end of each year, after giving effect to any reduction in the account as a result of benefit payments.\n4.03 Commencement of Payments\nPayments under this Plan on account of retirement will be paid in full if the lump-sum option is chosen, or will begin to be paid in monthly installments, if a monthly payment option is chosen, within 30 days of the date on which the Participant retires, or as soon thereafter as practicable. To the extent reasonably practicable, monthly payments under this Plan will be made at a time coincident with the payment of benefits under the Qualified Plan.\nV. TERMINATION BENEFITS\nIf the Participant terminates his or her employment with the Company prior to retirement (either early or normal), but with a deferred vested interest in the Qualified Plan, benefits will be payable under this Plan if the Qualified Plan benefit is reduced or limited as required by currently applicable law or by the terms of the Qualified Plan. Notwithstanding any other provision in the Plan to the contrary, any benefits payable under this Plan due to termination of employment will be paid as a joint and survivor annuity only, beginning at age 55 and calculated as of the Participant's Normal Retirement Age under the Qualified Plan, reduced by the early retirement factors applicable to vested terminees under the Qualified Plan.\nVI. SURVIVOR BENEFITS\n6.01 Overview In addition to the amount payable hereunder to a retired Participant, this Plan will pay a benefit, similarly computed, to an eligible surviving spouse or to a contingent annuitant under the \"Spouse's Pension\", the \"Pre-retirement Survivor Annuity Option\", or the \"Contingent Annuitant Option\" provisions of the Qualified Plan if such spouse's pension, survivor annuity or contingent annuity is reduced or limited as required by currently applicable law or the terms of the Qualified Plan.\n6.02 Alternative Forms of Payment (a) Upon the death of a Participant who has elected an alternative form of benefit payment under the Plan prior to the receipt of the full amount credited to his or her account, the balance of the account will be paid in accordance with the Participant's previously elected method of payment to the Participant's designated beneficiary or beneficiaries, as provided herein, over the remainder of the elected payout period until the full amount has been paid.\n(b) If the 60 or 120 month payout options have been chosen, and if no designated beneficiary or beneficiaries survive the Participant, or if a designated beneficiary dies before the balance of the account has been paid, the balance of the account of the Participant or of the designated beneficiary will be paid in one lump-sum payment to the estate of the Participant if no designated beneficiaries survive him or her, or if such designated beneficiaries survive the Participant, to the estate of whomever was last receiving benefit payments, as soon as practicable following the Participant's or the designated beneficiary's death.\nVII. PAYMENT TERMS AND CONDITIONS\n7.01 Benefits Nonassignable Benefits under this Plan will be binding upon and inure to the benefit of the heirs, legal representatives, successors and assigns of the parties. Notwithstanding the foregoing, the right to receive payment hereunder is hereby expressly declared to be personal, nonassignable and nontransferable, except by will, intestacy, or as otherwise required by law, and in the event of any attempted assignment, alienation or transfer of such rights contrary to the provisions hereof, the Company will have no further liability for payments hereunder.\n7.02 Incapacity If any person entitled to payments under this Plan is, in the opinion of the Administrator or its designee, incapacitated and unable to use such payments in his or her own best interest, the Administrator or its designee may direct that payments (or any portion) be made to that person's legal guardian or conservator, or that person's spouse, as an alternative to payment to the person unable to use the payments. The Administrator or its designee will have no obligation to supervise the use of such payments, and court-appointed guardianship or conservatorship may be required.\n7.03 Hardship Upon written application made to the Administrator, the Participant or his or her designated beneficiary or beneficiaries may request payment in some form other than the method of payment originally elected. Such request must establish to the satisfaction of the Administrator or its designee that special circumstances, such as financial hardship, exist which require such a variation in payment. The Administrator, or its designee, will exercise sole discretion in allowing or refusing such requests, and the decision of the Administrator or its designee on such requests will be final.\n7.04 No Fiduciary Relationship Nothing contained in this Plan, and no action taken pursuant to any of its provisions, will create or be construed to create a trust of any kind, or a fiduciary relationship, between the Company and the Participant, a designated beneficiary, or any other beneficiaries of the Participant, or any other person. To the extent that any person acquires a right to receive payments from the Company under the provisions hereof, such right will be no greater than the right of any unsecured general creditor of the Company.\nVIII. TAXES\n8.01 Taxes on Benefit Payments Any amounts paid under this Plan on account of termination, retirement, death or hardship (pursuant to Section 11) will be subject to any income tax withholding or other deductions as may be required by federal, state, or local law.\n8.02 Taxes on Benefit Accrual A Participant's annual benefit accrual may be subject to federal, state or local payroll taxes. Such taxes will be withheld from the Participant's salary as may be required by federal, state or local law.\nIX. BENEFICIARY\nAt the time the Eligible Employee elects his or her payout method under this Plan, he or she shall designate a beneficiary or beneficiaries. The designation may be changed at any time by the Eligible Employee; however, the consent of a spouse may be required.\nX. PLAN ADMINISTRATION\n10.01 Plan Interpretation The Administrator (either directly or through its designees) will have power and authority to interpret, construe, and administer this Plan; provided that, its authority to interpret this Plan will not cause its decisions in this regard to be entitled to a deferential standard of review in the event that an Participant or beneficiary seeks review of the Administrator's decision as described in Article XII.\n10.02 Day-to-Day Administration Day to day administration of the Plan has been delegated by the Administrator to the Company, under the direction of the officer responsible for Human Resources, or such other individuals as may be authorized by him or her to perform such duties. Such administration will include the power to interpret the Plan and make such equitable adjustments as may be necessary to effectuate the purposes thereof.\n10.03 Limited Liability Neither the Administrator, nor any of its members or designees, will be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Plan.\nXI. AMENDMENT OR TERMINATION\n11.01 Authority to Amend or Terminate The Administrator will have full power and authority to prospectively modify or terminate this Plan, and the Administrator's interpretations, constructions and actions, including any valuation of the Participant's account or benefits, or the amount or recipient of the payment to be made, will be binding and conclusive on all persons for all purposes. Absent the consent of the Participant, however, the Administrator will in no event have any authority to modify this section. However, no such amendment or termination will apply to any person who has then qualified for or is receiving benefits under this Plan.\n11.02 Limitations In the event of Plan amendment or termination which has the effect of eliminating or reducing a benefit under the Plan, the benefit payable on account of a retired Participant or survivor or other beneficiary will not be impaired, and the benefits of other Participants will not be less than the benefit to which each such Participant would have been entitled if he or she had retired immediately prior to such amendment or termination.\nXII. CLAIMS AND REVIEW PROCEDURES\n12.01 Right To Arbitration Because it is agreed that time will be of the essence in determining whether any payments are due to an Participant or his or her beneficiary under this Plan, an Participant or beneficiary may, if he or she desires, submit any claim for payment under this Plan to arbitration. This right to select arbitration will be solely that of the Participant or beneficiary and the Participant or beneficiary may decide whether or not to arbitrate in his or her discretion. The \"right to select arbitration\" is not mandatory on the Participant or beneficiary, and the Participant or beneficiary may choose in lieu thereof to bring an action in an appropriate civil court. Once an arbitration is commenced, however, it may not be discontinued without the mutual consent of both parties to the arbitration. During the lifetime of the Participant only he or she can use the arbitration procedure set forth in this section.\n12.02 Arbitration Procedures (a) Any claim for arbitration may be submitted as follows: if an Participant or beneficiary has submitted a request to be paid under this Plan and the claim is finally denied by the Company in whole or in part, such claim may be filed in writing with an arbitrator of the Participant's or beneficiary's choice who is selected by the method described in the next four sentences. The first step of the selection will consist of the Participant or beneficiary submitting a list of five potential arbitrators to the Company. Each of the five arbitrators must be either (1) a member of the National Academy of Arbitrators located in the State of California or (2) a retired California Superior Court or Appellate Court judge. Within one week after receipt of the list, the Company will select one of the five arbitrators as the arbitrator for the dispute in question. If the Company fails to select an arbitrator within one week after receipt of the list, the Participant or beneficiary will then designate one of the five arbitrators for the dispute in question.\n(b) The arbitration hearing will be held within seven days (or as soon thereafter as possible) after the picking of the arbitrator. No continuance of said hearing will be allowed without the mutual consent of the Participant or beneficiary and the Company. Absence from or nonparticipation at the hearing by either party will not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion when he or she decides he or she has heard sufficient evidence to satisfy issuance of an award. The arbitrator's award will be rendered as expeditiously as possible and in no event later than one week after the close of the hearing.\n(c) In the event the arbitrator finds that the Company has breached this Plan, he or she will order the Company to pay to the Participant or beneficiary within two business days after the decision is rendered the amount then due the Participant or beneficiary, plus, notwithstanding anything to the contrary in this Plan, an additional amount equal to 20% of the amount actually in dispute. This additional amount will constitute an additional benefit under this Plan. The award of the arbitrator will be final and binding upon the parties.\n12.03 Enforcement of Award and Fees The award may be enforced in any appropriate court as soon as possible after its rendition. The Company will be considered the prevailing party in a dispute if the arbitrator determines (1) that the Company has not breached this Plan and (2) the claim by the Participant or his or her beneficiary was not made in good faith. Otherwise, the Participant or his or her beneficiary will be considered the prevailing party. In the event that the Company is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (excluding any attorneys' fees incurred by the Company) including stenographic reporter, if employed, will be paid by the losing party. In the event that the Participant or his or her beneficiary is the prevailing party, the fee of the arbitrator and all necessary expenses of the hearing (including all attorneys' fees incurred by the Participant or his or her beneficiary in pursuing his or her claim), including the fees of a stenographic reporter if employed, will be paid by the Company.\nXIII. MISCELLANEOUS\n13.01 Participation in Other Plans The Participant will continue to be entitled to participate in all employee benefit programs of the Company as may, from time to time, be in effect. However, total compensation includable under this Plan will be deemed salary or other compensation to the Participant for the purpose of computing benefits under this Plan only, and will be used only under this Plan to calculate those benefits to which the Participant would otherwise be entitled under the Qualified Plan if such total compensation could have been included in the determination of benefits under that Plan.\n13.02 Relationship to Qualified Plan This Plan will to the full extent possible under currently applicable law be administered in accordance with, and where practicable according to the terms of the Qualified Plan. Notwithstanding the foregoing, the terms of this Plan shall control benefits payable under this Plan whenever the terms of the Qualified Plan differ from this Plan.\n13.03 No Right to Employment Nothing contained herein will be construed as conferring upon the Participant the right to continue in the employ of the Company or an Affiliate, in any particular salary grade or ELP Level, or in any other capacity. If the Participant ceases to be an Participant in the Plan but remains in the employ of the Company, any benefits due the Participant under the Plan will not be payable until such time as he or she retires, or ceases to be an employee of the Company, and then only subject to the terms and conditions contained in this Plan.\n13.04 Forfeiture The payments to be made by the Company pursuant hereto require the Participant, for so long as the Participant remains in the active employ of the Company, to devote substantially all of his or her time, skill, diligence and attention to the business of the Company, and not to actively engage, either directly or indirectly, in any business or other activity adverse to the best interests of the business of the Company. In addition, the Participant will remain available during retirement for consultation in any matter related to the affairs of the Company. Any breach of these conditions will result in complete forfeiture of any further benefits under the Plan. If the Participant will fail to observe any of the above conditions, or if he or she will be discharged by the Company for malfeasance or willful neglect of duty, then in any of said events, the payments under this Plan will not be paid, and the Company will have no further liability therefor.\n13.05 Benefits Unsecured All Plan benefits will be unsecured and will be paid in cash from the general funds of the Company. No special or separate fund will be established and no other segregation of assets will be made to assure the payment of any benefits hereunder. No person will have by virtue of the provisions of this Plan, any interest in such assets. In the event that, in its discretion, the Company purchases an insurance policy or policies insuring the life of the Participant to allow the Company to recover, in whole, or in part, the cost of providing the benefits hereunder, neither the Participant, the survivor or other designated beneficiary(ies) nor any other beneficiary will have any rights whatsoever therein; the Company will be the sole owner and beneficiary thereof and will possess and may exercise all incidents of ownership therein.\n13.06 Validity and Applicable Law If any of the provisions of this Plan will be held invalid, or be held to violate any law, the remainder of this Plan will not be affected thereby and will remain in full force and effect. This Plan will be governed by the laws of the State of California.\n13.07 Captions The captions of the articles and sections of the Plan are for convenience only and shall not control or affect the meaning or construction of any of its provisions.\nSOUTHERN CALIFORNIA EDISON COMPANY\nGeorgia R. Nelson _____________________________________ Georgia R. Nelson\nPAGE\nEXHIBIT 10.17\nSOUTHERN CALIFORNIA EDISON COMPANY\n1995 EXECUTIVE INCENTIVE COMPENSATION PLAN\nAs Adopted December 14, 1994\nWHEREAS, it has been determined that it is in the best interest of the Southern California Edison Company to offer and maintain competitive executive compensation programs designed to attract and retain qualified executives; and\nWHEREAS, it has been determined that providing financial incentives to executives that reinforce and recognize Company, organizational and individual performance and accomplishments will enhance the financial and operational performance of the Company; and\nWHEREAS, it has been determined that an incentive compensation program would encourage the attainment of short-term corporate goals and objectives;\nNOW, THEREFORE, the Southern California Edison Company 1995 Executive Incentive Compensation Plan has been established by the Compensation and Executive Personnel Committee of the Board of Directors effective January 1, 1995, and made available to eligible executives of the Company subject to the following terms and conditions:\n1. Definitions. When capitalized herein, the following terms are defined as indicated:\n\"Base Salary\" is defined to be the annual salary of the Participant on the last day of the year worked by the Participant.\n\"Board\" means the Board of Directors of the Company.\n\"Chairman\" means the Chairman of the Board and Chief Executive Officer of the Company.\n\"Code\" means the Internal Revenue Code of 1986, as amended.\n\"Company\" means the Southern California Edison Company.\n\"Committee\" means the Compensation and Executive Personnel Committee of the Board.\n\"Participant\" means the Chairman, officers serving on the SET, elected vice presidents, and senior managers whose participation in this Plan has been approved by the Chairman.\n\"Plan\" means the Southern California Edison Company 1995 Executive Incentive Compensation Plan.\n\"SET\" means the Senior Executive Team of the Company.\nPAGE\n2. Eligibility. To be eligible for the full amount of any incentive award, an individual must have been a participant for the entire calendar year. Pro-rata awards may be distributed to participants who are discharged for reasons other than incompetence, misconduct or fraud, or who resigned, retired or became disabled during the calendar year, or who were participants for less than the full year. A pro-rata award may be made to a participant's designated beneficiary in the event of death of a participant during a calendar year prior to an award being made.\n3. Company Performance Goals. The Chairman will furnish recommended Company achievement areas to the Committee, out of which the Committee will, in consultation with the Chairman, select those areas of achievement upon which they wish the Company to focus particular attention and identify performance goals for the year.\nThe performance goals must represent relatively optimistic, but reasonably attainable goals the accomplishment of which will contribute significantly to the attainment of Company objectives.\n4. Individual Incentive Award Levels. Company, organizational and individual performance relative to the pre-established goals will determine the award a Participant can receive.\nAlthough most performance goals will be stated in terms of results to be achieved during the calendar year, it is important that long-range goals and objectives be included. These long-range goals and objectives will have payoffs later than the year in question, but short-term sub- goals may be established for the calendar year.\nIf the Committee determines individual and Company performance goals have been substantially met, Participants will be eligible for individual incentive awards at the following target award percentages:\n70% of Base Salary for the Chairman;\n60% of Base Salary for each officer of SCEcorp serving on the SET, other than the Chairman;\n45% of Base Salary for each officer of the Company serving on the SET;\n35% of Base Salary for each elected vice president of the Company; and\n25-30% of Base Salary for each senior manager of the Company, as authorized by the SET.\nStretch-maximum awards of up to 150% of target may be earned on the basis of performance in excess of targets. All awards shall be made in the discretion of the Committee on the basis of its assessment of corporate and individual performance.\n5. Approval and Payment of Individual Awards. During the first quarter of the year following the completion of the calendar year, the Chairman will assess the degree to which individual and corporate goals and objectives have been achieved and will develop suggested incentive awards for eligible Participants other than the Chairman. The Committee will receive a report from the Chairman as to overall Company performance, will deliberate on the Chairman's recommendations, will develop an incentive award for the Chairman, and make its determination as to the approval of the recommended awards for officers. Awards to non-officers shall be determined and approved by the SET. All decisions of the Committee and the SET regarding individual incentive awards will be final and conclusive.\nIncentive award payments will be made as soon as practical following the Committee's approval. Payment will be made in cash except to the extent the Participant has previously elected to defer payment of some or all of the award pursuant to the terms of a deferred compensation plan of the Company or to the extent the Committee elects to defer some or all of the award. Awards (cash or deferred) made will be subject to any income or payroll tax withholding or other deductions as may required by Federal, State or local law.\nAwards under this Plan will not be considered to be salary or other compensation for the purpose of computing benefits to which the Participant may be entitled under any pension plan, stock bonus plan, including but not limited to the Southern California Edison Company Retirement Plan, Stock Savings Plus Plan, or other plan or arrangement of the Company for the benefit of its employees if such plan or arrangement is a plan qualified under Section 401(a) of the Code and is a trust exempt from Federal income tax under Section 501(a) of the Code.\nAwards owed to participants under this Plan shall constitute an unsecured general obligation of the Company, and no special fund or trust shall be created, nor shall any notes or securities be issued with respect to any awards.\n6. Plan Modifications and Adjustments. In order to ensure the incentive features of the Plan, avoid distortion in its operation and compensate for or reflect extraordinary changes which may have occurred during the calendar year, the Committee may make adjustments to the Plan's performance goals and percentage allocations before, during or after the end of the calendar year to the extent it determines appropriate in its sole discretion. Adjustments to the Plan shall be conclusive and binding upon all parties concerned. The Plan may be modified or terminated by the Committee at any time.\n7. Plan Administration. This Plan and any officer awards under it are to be approved by the Committee. The SET shall approve any non- officer awards. Administration of the Plan is otherwise delegated to management under the direction of the Chairman. The responsible vice president is authorized to approve ministerial amendments to the Plan, to interpret Plan provisions, and to approve changes as may be required by law or regulation. Neither the Company nor any member of the Committee or the Board shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of the Plan.\n8. Successors and Assigns. This Plan shall be binding upon and inure to the benefit of the heirs, legal representatives, successors and assigns of the Company and Participant. Notwithstanding the foregoing, any right to receive payment hereunder is hereby expressly declared to be personal, nonassignable and nontransferable, except by will, intestacy, or as otherwise required by law, and in the event of any attempted assignment, alienation or transfer of such rights contrary to the provisions hereof, the Company shall have no further liability for payments hereunder.\n9. Beneficiaries. In the event of the death of a Participant during a calendar year prior to the making of any individual incentive award, a pro-rata award may be made at the discretion of the Committee. Any such payment will be made to the Participant's most recently designated beneficiary or beneficiaries under the Long-Term Incentive Compensation Plan of the Company. If no such designated beneficiary or beneficiaries survive the Participant, or if a designated beneficiary should die before the award has been paid, any award will be paid in one lump-sum payment to his or her estate as soon as practicable following the Participant's or the designated beneficiary's death.\n10. Capacity. If any person entitled to payments under this Plan is incapacitated and unable to use such payments in his or her own best interest, the Company may direct that payments (or any portion) be made to that person's legal guardian or conservator, or that person's spouse, as an alternative to the payment to the person unable to use the payments. Court-appointed guardianship or conservatorship may be required by the Company before payment is made. The Company shall have no obligation to supervise the use of such payments.\n11. No Right of Employment. Nothing contained herein shall be construed as conferring upon the Participant the right to continue in the employ of the Company as an Officer or Manager of the Company or in any other capacity.\n12. Severability and Controlling Law. The various provisions of this Plan are severable in their entirety. Any determination of invalidity or unenforceability of any one provision will have no effect on the continuing force and effect of the remaining provisions. This Plan shall be governed by the laws of the State of California.\nSOUTHERN CALIFORNIA EDISON COMPANY\nGeorgia R. Nelson, Vice President _________________________________ Georgia R. Nelson, Vice President\nPAGE\nEXHIBIT 10.20 AMENDMENT NO. 1\nSCEcorp\nDIRECTOR INCENTIVE COMPENSATION PLAN\nEffective June 2, 1993\nWHEREAS, the Director Incentive Compensation Plan (\"Plan\"), approved by the shareholders of SCEcorp on April 16, 1992, provides that the maximum amount of SCEcorp Common Stock (\"Stock\") that may be issued under the Plan is 100,000 shares;\nWHEREAS, the award formula of the Plan currently provides for individual annual awards of 100 shares of Stock, which may be increased by the Board of Directors of SCEcorp (\"Board\") up to the award limitation of 500 shares of Stock;\nWHEREAS, SCEcorp has elected to split its Stock on a two-for-one basis effective with the close of business on June 1, 1992;\nWHEREAS, 3,200 shares of Stock have been issued under the Plan prior to the Stock split;\nWHEREAS, the Board has directed the Plan be amended to reflect the Stock split pursuant to its authority under the terms of the Plan and it is deemed desirable to restate;\nNOW, THEREFORE, the Plan is amended as follows:\no Section 1.3 is amended by substituting 196,800 in place of 100,000.\no Section 2.1 is amended by substituting 200 in place of 100.\no Section 2.2 is amended by substituting 1,000 in place of 500.\nSCEcorp\nKenneth S. Stewart _____________________________________ Kenneth S. Stewart Secretary\nPAGE\nSCEcorp DIRECTOR INCENTIVE COMPENSATION PLAN\nEffective (April 16, 1992)\nI. GENERAL\n1.1 PURPOSE\nThe purpose of the Director Incentive Compensation Plan (\"Plan\") is to foster and promote the long-term financial success of SCEcorp and its affiliates by attracting and retaining outstanding nonemployee directors by enabling them to participate in the corporation's growth through automatic, nondiscretionary awards of stock (\"Awards\").\n1.2 ELIGIBILITY\nEligibility in this Plan shall be limited to members of the Board of Directors of SCEcorp or, an SCEcorp affiliate, who at the time the Award is made are not employees or officers of SCEcorp or an SCEcorp affiliate.\n1.3 SHARES SUBJECT TO THE PLAN\nShares of stock covered by Awards under the Plan may be, in whole or in part, authorized and unissued shares of SCEcorp's common stock, or previously issued shares of common stock reacquired by SCEcorp including shares purchased on the open market, or such other shares as may be substituted pursuant to Section 3.3 (\"Common Stock\"). The maximum number of shares of Common Stock which may be issued for all purposes under the Plan shall be 100,000 (subject to adjustment pursuant to Section 3.3).\nII. STOCK AWARDS\n2.1 AWARD FORMULA\nEffective with a Director's election on April 16, 1992, and on each subsequent date a Director is elected or reelected to the Board of Directors of SCEcorp at an annual meeting of the stockholders, such Director will automatically be granted 100 shares of fully vested Common Stock, at no cost to the Director. Each stock certificate evidencing an Award shall be registered in the name of the Director and delivered to him or her on that date, or as soon thereafter as practicable. Directors serving on more than one Board will receive only one Award per year under the Plan.\n2.2 AWARD LIMITATION\nSubject to the limitations of Section 3.2, the award formula may be modified from time to time by the Board of Directors, with respect to pricing, timing and amount, but such formula will not be modified to provide an Award in excess of 500 shares of Common Stock per Director per year.\nPAGE\nIII. ADMINISTRATION\n3.1 ADMINISTRATION OF THE PLAN\nThe Plan shall be self-effectuating. Administrative determinations necessary or advisable for the administration or interpretation of the Plan in order to carry out its provisions and purposes shall be made by SCEcorp.\n3.2 AMENDMENT, SUSPENSION AND TERMINATION OF PLAN\nThe Board of Directors may suspend or terminate the Plan or any portion thereof at any time and may amend the Plan from time to time in such respects as the Board of Directors may deem advisable; provided, however, the Plan shall not be amended more than once every six months, other than to comport with changes in the Internal Revenue Code of 1986, as amended, or the rules promulgated thereunder; and provided further, the Plan shall not be amended, without shareholder approval to the extent required by law or the rules of any exchange upon which the Common Stock is listed, (a) to materially increase the number of shares of Common Stock which may be issued under the Plan, except as provided in Section 3.3, (b) to materially modify the requirements as to eligibility for participation in the Plan, or (c) to materially increase the benefits accruing to Directors under the Plan. No such amendment, suspension or termination shall make any change that would disqualify the Plan, or any other Plan of SCEcorp intended to be so qualified, from the exemption provided by Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended.\n3.3 CAPITAL ADJUSTMENTS\nIn the event of a stock dividend or stock split, combination or other reduction in the number of issued shares of Common Stock, a merger, consolidation, reorganization, recapitalization, sale or exchange of substantially all assets or dissolution of SCEcorp, the Board of Directors shall, in order to prevent the dilution or enlargement of rights under the Plan, make such adjustments in the number and type of shares authorized and the number and type of shares that may be awarded under this Plan as may be determined to be appropriate and equitable.\nIV. MISCELLANEOUS\n4.1 RIGHTS OF DIRECTORS\nNothing in the Plan shall confer upon any Director any right to serve as a Director for any period of time or to continue his or her present or any other rate of compensation.\n4.2 PLAN NOT EXCLUSIVE\nThe adoption of the Plan shall not preclude the adoption by appropriate means of a stock option or other incentive plan for Directors.\n4.3 REQUIREMENTS OF LAW; GOVERNING LAW\nThe granting of Awards and issuance of shares of Common Stock shall be subject to all applicable rules and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required. The Plan shall be construed in accordance with and governed by the laws of the State of California.\n4.4 TERM OF PLAN\nThis Plan shall become effective upon its approval by the stockholders of SCEcorp at their annual meeting on April 16, 1992, and shall continue in effect until terminated by the SCEcorp Board of Directors or the SCEcorp stockholders.\nPAGE\nEXHIBIT 10.21.1\nFORM OF AGREEMENTS FOR 1995 AWARDS UNDER OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN:\nSCEcorp\nOFFICER LONG-TERM INCENTIVE COMPENSATION PLAN\n1995 AWARD GRANT\nThis award is made by SCEcorp to -------------NAME----------------, (\"Employee\") as of January 3, 1995 pursuant to the Officer Long-Term Incentive Compensation Plan (\"OLTICP\") and subject to the conditions contained in the 1995 Statement of Terms and Conditions which is incorporated herein by reference and receipt of which is acknowledged by Employee. SCEcorp hereby grants to Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option to purchase the following:\nxxxxxxx shares of authorized SCEcorp Stock, coupled with dividend equivalents, at an exercise price of $14.5625 per share.\nIN WITNESS WHEREOF, SCEcorp and Employee have caused this instrument to be executed as of the day and year first written above .\nSCEcorp\nBy:_______________________________\nEmployee\n_______________________________ PAGE\nSCEcorp\nOFFICER LONG-TERM INCENTIVE COMPENSATION PLAN\n1995 AWARD GRANT\nThis award is made by SCEcorp to NAME , (\"Employee\") as of January 3, 1995 pursuant to the Officer Long-Term Incentive Compensation Plan and subject to the conditions contained in the 1995 Statement of Terms and Conditions which is incorporated herein by reference and receipt of which is acknowledged by Employee. SCEcorp hereby grants to Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option to purchase the following:\nxxxxxxx shares of Mission Energy Company phantom stock having a base price of $52.70 per share and the following exercise prices:\nPeriod Price $ Period Price $ ------ ------- ------ ------- 1996 59.024 2001 104.021 1997 66.107 2002 116.503 1998 74.040 2003 130.483 1999 82.925 2004 146.141 2000 92.875 2005 163.678\nIN WITNESS WHEREOF, SCEcorp and Employee have caused this instrument to be executed as of the day and year first written above .\nSCEcorp Employee\nBy:_______________________________ _______________________________ PAGE\nSCEcorp\nOFFICER LONG-TERM INCENTIVE COMPENSATION PLAN\n1995 AWARD GRANT\nThis award is made by SCEcorp to NAME , (\"Employee\") as of January 3, 1995 pursuant to the Officer Long-Term Incentive Compensation Plan and subject to the conditions contained in the 1995 Statement of Terms and Conditions which is incorporated herein by reference and receipt of which is acknowledged by Employee. SCEcorp hereby grants to Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option to purchase the following:\nxxxxxxx shares of Mission First Financial phantom stock having a base price of $76.40 per share and the following exercise prices:\nPeriod Price $ Period Price $ ------ ------- ------ ------- 1996 84.040 2001 135.347 1997 92.444 2002 148.882 1998 101.688 2003 163.770 1999 111.857 2004 180.147 2000 123.043 2005 198.162\nIN WITNESS WHEREOF, SCEcorp and Employee have caused this instrument to be executed as of the day and year first written above .\nSCEcorp Employee\nBy:_______________________________ _______________________________\nSCEcorp Officer and Management Long-Term Incentive Compensation Plans\n1995 Statement of Terms and Conditions\n1995 Award Grants made under the SCEcorp Officer and Management Long-Term Incentive Compensation Plans are subject to the following terms and conditions:\n1. PRICE (a) The exercise price for the option to purchase SCEcorp Common Stock (\"SCEcorp Stock\") stated in the Award Grant is the average of the high and low sales prices of SCEcorp Stock as reported in the Western Edition of The Wall Street Journal for the New York Stock Exchange Composite Transactions for the date of grant.\n(b) The exercise price for the Mission Energy Company (\"MEC\") Option will be the base price stated in the Award Grant escalated at a 12% rate, compounded annually.\n(c) The exercise price for the Mission First Financial (\"MFF\") Option will be the base price stated in the Award Grant escalated at a 10% rate, compounded annually.\n2. VESTING (a) Subject to the provisions of Section 3, options may only be exercised to the extent vested. The initial vesting date will be January 2nd of the year following the date of the Award Grant, or six months after the date of the Award Grant, whichever date is later. The options will vest as follows:\no On the initial vesting date, the options will vest as to 33-1\/3% of the covered shares.\no On January 2nd of the following year, the options will vest as to an additional 33-1\/3% of the covered shares.\no On January 2nd of the third year following the date of the Award Grant, the options will be fully vested.\n(b) The vested portions of the options will accumulate to the extent not exercised, and be exercisable by the Employee subject to the provisions of Section 3, in whole or in part, in any subsequent period but not later than the first business day of the 10th year following the date of the Award Grant, or, in the case of MEC or MFF Options, not later than the end of the final 60-day exercise period.\n(c) If an Employee is removed from a position entitling him\/her to benefits under the Plan, retires, dies or is permanently and totally disabled during the three-year vesting period, the options will vest and be exercisable to the extent of 1\/36th of the aggregate number of shares originally covered by the options for each full month of service during the vesting period. Notwithstanding the foregoing, the options of an officer who has served as a member of the Southern California Edison Company Management Committee will be fully vested and exercisable upon his\/her retirement, death or permanent and total disability.\n(d) Upon termination of an Employee for any reason other than those specified in Subsection (c), only that portion of the options which has vested on or before the anniversary date of the Award Grant preceding the date of termination may be exercised, and that portion, together with any earned dividend equivalents, will be forfeited unless exercised within 180 days following the date of termination, or in the case of MEC or MFF Options, the first 60-day exercise period following the date of termination. PAGE\n(e) Notwithstanding the foregoing, the options and earned dividend equivalents may vest in accordance with Section 15 of the Plan as a result of certain events, including liquidation of SCEcorp or merger, reorganization or consolidation of SCEcorp as a result of which SCEcorp is not the surviving corporation.\n3. OPTION EXERCISE (a) The Employee may exercise an option by providing written notice to SCEcorp on the form prescribed by SCEcorp for this purpose specifying the number of shares to be purchased, and accompanied by full payment of the exercise price for the shares. A sample notice is attached as Exhibit 1. Payment must be in cash, or its equivalent, such as SCEcorp Stock, acceptable to SCEcorp. A \"cashless\" exercise will be accommodated for all MEC and MFF Options, and may be accommodated for SCEcorp Options at the discretion of SCEcorp. Until payment is accepted, the Employee will have no rights in the optioned stock. If an SCEcorp Options are exercised, the Employee may elect to apply any earned dividend equivalents related to the shares for which the options are being exercised to the exercise price for such shares.\n(b) SCEcorp Options may be exercised at any time after they have vested through the first business day of the 10th year following the date of the Award Grant. MEC and MFF Options may be exercised after they have vested, but only during an annually specified 60-day period following the fiscal year end and the completion of an independently reviewed valuation report which indicates a share value for the fiscal year higher than the applicable MEC or MFF Option exercise price for that period. The final 60-day MEC or MFF exercise period will commence no later than the end of the second quarter of the 10th year following the date of the Award Grant. MEC and MFF Options are payable in cash upon exercise to the extent the actual value of an MEC or MFF share exceeds the applicable exercise price.\n(c) The Employee agrees that any securities acquired by him\/her hereunder are being acquired for his\/her own account for investment and not with a view to or for sale in connection with any distribution thereof and that he\/she understands that such securities may not be sold, transferred, pledged, hypothecated, alienated, or otherwise assigned or disposed of without either registration under the Securities Act of 1933 or compliance with the exemption provided by Rule 144 or another applicable exemption under such act.\n(d) In accordance with Section 17(d) of the Plan, the Employee will have no right or claim to any specific funds, property or assets of SCEcorp as a result of the Award Grant.\n4. SCEcorp OPTION DIVIDEND EQUIVALENTS (a) An SCEcorp Dividend Equivalent Account will be established on behalf of the Employee if SCEcorp Options have been granted pursuant to the Award Grant. This account may be credited with all or a portion of the dividends payable after the date of grant on the number of shares of stock covered by such SCEcorp Options depending upon SCEcorp's performance during the first three years of the option period as provided in Subsection (b). No amount will be credited prior to January 2nd of the third year following the date of grant. No dividend equivalent will accrue to any option exercised during that period regardless of SCEcorp performance. Dividend equivalents credited after that date, if any, will accumulate in this account without interest and will vest and become payable upon the exercise of the option to purchase the corresponding shares of SCEcorp Stock.\n(b) Dividend equivalents related to SCEcorp Options are subject to a performance measure based on the percentile ranking of SCEcorp's total shareholder return (\"TSR\") compared to the TSR for each stock in the Dow Jones Electric Utilities Group Index. The percentile ranking will be measured at the completion of the three-year period following the date of grant. If SCEcorp's average ranking is in the 60th percentile or higher for the 3-year period, 100% of the dividend equivalents will be earned from the date of grant through the date the options are exercised. If SCEcorp's average ranking is in the 25th percentile, 25% of the dividend equivalents will be earned. No dividend equivalents will be earned for performance below the 25th percentile, and a pro rata amount will be earned for performance between the 25th and 60th percentiles.\nDividend equivalents related to unexercised SCEcorp Options that were not earned due to the limitations of this Subsection (b) may be earned back as of the end of each of the last five years of the option period if it is determined at that point that the SCEcorp cumulative average TSR percentile ranking equals or exceeds the 60th percentile.\n5. MEC and MFF OPTION PERFORMANCE UNITS (a) The MEC Options are performance units under the Plan based on 100 million shares of artificial or \"phantom\" MEC stock created for this purpose only. The MEC Option exercise prices in the Award Grant were derived from the base price of a share of MEC stock by applying a 12% appreciation factor, compounded annually for the term of the Award Grant. Following the end of each calendar year during the term of the Award Grant, the actual MEC share value will be computed. If the actual MEC share value exceeds the MEC Option exercise price for that period, any portion of the vested MEC Option may be exercised by the Employee in accordance with Section 3 and the difference will be paid in cash to the Employee.\n(b) The MFF Options are performance units under the Plan based on 50 million shares of artificial or \"phantom\" MFF stock created for this purpose only. The MFF Option exercise prices in Section 1 were derived from the base price of a share of MFF stock by applying a 10% appreciation factor, compounded annually for the term of the Award Grant. Following the end of each calendar year during the term of the Award Grant, the actual MFF share value will be computed. If the actual MFF share value exceeds the MFF Option exercise price for that period, any portion of the vested MFF Option may be exercised by the Employee in accordance with Section 3 and the difference will be paid in cash to the Employee.\n6. TRANSFER AND BENEFICIARY The options will not be transferable by the Employee. During the lifetime of the Employee, the options will be exercisable only by him\/her. The Employee may designate a beneficiary who, upon the death of the Employee, will be entitled to exercise the then vested portion of the options during the remaining term of the Award Grant subject to the conditions of the Plan and the Award Grant.\n7. TERMINATION OF OPTIONS As set forth in Section 2(d), in the event of termination of the employment of the Employee for any cause, other than retirement, permanent and total disability or death of the Employee, the options will terminate 180 days from the date on which such employment terminated, or in the case of MEC or MFF Options, at the end of the first 60-day exercise period following the employment termination date. In addition, the options may be terminated if SCEcorp elects to substitute cash awards as provided under Section 11.\n8. TAXES SCEcorp will have the right to retain and withhold the amount of taxes required by any government to be withheld or otherwise deducted and remitted with respect to the exercise of any SCEcorp, MEC or MFF option, the receipt of cash, or the receipt or application by the Employee of any dividend equivalents under the Award Grant. In its discretion, SCEcorp may require the Employee to reimburse SCEcorp for any such taxes required to be withheld by SCEcorp and may withhold any distribution in whole or in part until SCEcorp is so reimbursed. In lieu thereof, SCEcorp will have the right to withhold from any other cash amounts due from SCEcorp to the Employee an amount equal to such taxes required to be withheld by SCEcorp to reimburse SCEcorp for any such taxes or to retain and withhold a number of shares of SCEcorp Stock having a market value equal to the taxes and cancel (in whole or in part) the shares in order to reimburse SCEcorp for the taxes.\nEach recipient of an SCEcorp Option must attach a statement to his\/her federal and state tax returns for the year in which the SCEcorp Option was granted containing certain information about the option. A sample statement is attached as Exhibit 2.\n9. CONTINUED EMPLOYMENT (a) In consideration of the granting of such options to him\/her, the Employee agrees that he\/she will remain in the continuous service of SCEcorp or an SCEcorp affiliate as an officer or employee during the term of the Award Grant. In the event employment is terminated, except as a result of death, disability, or retirement under the Southern California Edison Company Retirement Plan, or a successor plan, whether voluntarily or otherwise, the restrictions of Section 2(d) will apply.\n(b) Nothing in the Award Grant or this Statement of Terms and Conditions will be deemed to confer on the Employee any right to continue in the employ of SCEcorp or an SCEcorp affiliate or interfere in any way with the right of the employer to terminate his\/her employment at any time.\n10. NOTICE OF DISPOSITION OF SHARES Employee agrees that if he\/she should dispose of any shares of stock acquired on the exercise of the SCEcorp Options, including a disposition by sale, exchange, gift or transfer of legal title within six months from the date such shares are transferred to the Employee, the Employee will notify SCEcorp promptly of such disposition.\n11. AMENDMENT The Award Grant will be subject to the terms of the Plan as amended. SCEcorp reserves the right to substitute cash awards substantially equivalent in value to the options and dividend equivalents. The options and dividend equivalents which are the subject of the Award Grant may not otherwise be restricted or limited by any Plan amendment or termination approved after the date of the Award Grant without the Employee's written consent.\n12. FORCE AND EFFECT The various provisions of the Award Grant are severable in their entirety. Any determination of invalidity or unenforceability of any one provision will have no effect on the continuing force and effect of the remaining provisions.\n13. GOVERNING LAW This Award Grant will be construed under the laws of the State of California.\n14. NOTICE. Unless waived by SCEcorp, any notice required under or relating to the Award Grant will be in writing, with postage prepaid, addressed to: SCEcorp, Attn: Corporate Secretary, P.O. Box 800, Rosemead, CA 91770\nThe preceding 1995 Statement of Terms and Conditions is approved by the undersigned under authority of the SCEcorp Compensation Committee.\n___________________________________________________ G. R. Nelson, Vice President of Performance Support Southern California Edison Company\nPAGE\nFORM OF AGREEMENTS FOR 1994 AWARDS UNDER OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN:\n1994 LONG-TERM INCENTIVE AWARD AGREEMENT\nUNDER THE\nSCEcorp OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN\nThis AGREEMENT is made as of January 4, 1994 by and between SCEcorp and - ------------------------------------------ (\"Employee\").\nWHEREAS, SCEcorp maintains the Officer Long-Term Incentive Compensation Plan (the \"Plan\") under which the Compensation Committee of the Board of Directors of SCEcorp (the \"Committee\") may make Incentive Awards to such officers of SCEcorp or its affiliates as the Committee may determine, subject to any terms, conditions, or restrictions as it may deem appropriate; and\nWHEREAS, the Committee has determined that nonqualified stock options for SCEcorp Common Stock (\"SCEcorp Stock\") with corresponding dividend equivalents linked to either SCEcorp or Mission First Financial (\"MFF\") performance and\/or Mission Energy Company (\"MEC\") phantom stock option performance units will be the form of awards to be made under the Plan for 1994;\nNOW, THEREFORE, in consideration of the mutual promises and covenants contained herein, it is hereby agreed as follows:\n1. GRANT\nSCEcorp hereby grants to the Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option to purchase, on the terms and conditions herein set forth, the following:\nXXXXXX shares of authorized SCEcorp Stock coupled with dividend equivalents subject to the SCEcorp performance incentives described in Section 5(b).\nXXXXXX shares of authorized SCEcorp Stock coupled with dividend equivalents subject to the MFF performance incentives described in Section 5(c).\nXXXXXX shares of MEC phantom stock as described in Section 6.\n2. PRICE\n(a) The exercise price of the option to purchase SCEcorp Stock will be $20.1875 per share, such price being the average of the high and low sales prices of SCEcorp Stock as reported in the Western Edition of The Wall Street Journal for the New York Stock Exchange Composite Transactions for the date of grant.\n(b) The base price for the MEC Option is $5.51 per share. The exercise price of an MEC option will be the base price escalated at a 12% rate, compounded annually. This results in the following exercise prices during the term of the Agreement:\nPAGE\nMEC SHARE EXERCISE PRICES\nPeriod Price $ Period Price $ ------ ------- ------ ------- 1995 6.1712 2000 10.8758 1996 6.9117 2001 12.1809 1997 7.7412 2002 13.6426 1998 8.6701 2003 15.2797 1999 9.7105\n3. VESTING\n(a) Subject to the provisions of Section 4, options may only be exercised to the extent vested. The initial vesting date will be January 2nd of the year following the date of this Agreement, or six months after the date of this Agreement, whichever date is later. The options will vest as follows:\no On the initial vesting date, the options will vest as to 33-1\/3% of the covered shares.\no On January 2nd of the following year, the options will vest as to an additional 33-1\/3% of the covered shares.\no On January 2nd of the third year following the date of this Agreement, the options will be fully vested.\n(b) The vested portions of the options will accumulate to the extent not exercised, and be exercisable by the Employee subject to the provisions of Section 4, in whole or in part, in any subsequent period but not later than the first business day of the 10th year following the date of this Agreement, or, in the case of MEC Options, not later than the end of the final 60-day exercise period under this Agreement.\n(c) If an Employee is removed from a position entitling him\/her to benefits under the Plan, retires, dies or is permanently and totally disabled during the three-year vesting period, the options will vest and be exercisable to the extent of 1\/36th of the aggregate number of shares originally covered by the options for each full month of service during the vesting period. Notwithstanding the foregoing, the options of an officer who has served as a member of the Edison Management Committee will be fully vested and exercisable upon his\/her retirement, death or permanent and total disability.\n(d) Upon termination of an Employee for any reason other than those specified in Subsection (c), only that portion of the options which has vested on or before the anniversary date of this Agreement preceding the date of termination may be exercised, and that portion, together with any earned dividend equivalents, will be forfeited unless exercised within 180 days following the date of termination, or in the case of MEC Options, the first 60-day exercise period following the date of termination.\n(e) Notwithstanding the foregoing, the options and earned dividend equivalents may vest in accordance with Section 16 of the Plan as a result of certain events, including liquidation of SCEcorp or merger, reorganization or consolidation of SCEcorp as a result of which SCEcorp is not the surviving corporation.\n4. OPTION EXERCISE\n(a) The Employee may exercise an option by providing written notice to SCEcorp on the form prescribed by SCEcorp for this purpose specifying the number of shares to be purchased, and accompanied by full payment of the exercise price for the shares. A sample notice is attached as Exhibit 1. Payment must be in cash, or its equivalent, such as SCEcorp Stock, acceptable to SCEcorp. A \"cashless\" exercise will be accommodated for all MEC Options, and may be accommodated for SCEcorp Options at the discretion of SCEcorp. Until payment is accepted, the Employee will have no rights in the optioned stock. If an SCEcorp Option is exercised, the Employee may elect to apply any earned dividend equivalents related to the shares for which the option is being exercised to the exercise price for such shares.\n(b) SCEcorp Options may be exercised at any time after they have vested through the first business day of the 10th year following the date of this Agreement. MEC Options may be exercised after they have vested, but only during an annually specified 60-day period following MEC's fiscal year end and the completion of an audited valuation report which indicates an MEC share value for the fiscal year higher than the MEC Option exercise price for that period. The final 60-day MEC exercise period will commence during the second quarter of the 10th year following the date of this Agreement. The MEC Option is payable in cash upon exercise to the extent the actual value of an MEC share exceeds the applicable exercise price.\n(c) The Employee agrees that any securities acquired by him\/her hereunder are being acquired for his\/her own account for investment and not with a view to or for sale in connection with any distribution thereof and that he\/she understands that such securities may not be sold, transferred, pledged, hypothecated, alienated, or otherwise assigned or disposed of without either registration under the Securities Act of 1933 or compliance with the exemption provided by Rule 144 or another applicable exemption under such act.\n(d) In accordance with Section 17(d) of the Plan, the Employee will have no right or claim to any specific funds, property or assets of SCEcorp as a result of this Agreement.\n5. SCEcorp OPTION DIVIDEND EQUIVALENTS\n(a) An SCEcorp Dividend Equivalent Account will be established on behalf of the Employee if SCEcorp Options have been granted pursuant to this Agreement. Subject to the limitations of this Section 5, the account will be credited with amounts equivalent to the dividends payable after the date of grant on the number of shares of stock covered by such SCEcorp Options. Dividend equivalents subject to the SCEcorp performance measures will be credited quarterly, and those subject to the MFF performance measures will be credited annually. Amounts credited will accumulate in this account without interest and will vest and become payable upon the exercise of the option to purchase the corresponding shares of SCEcorp Stock.\n(b) Dividend equivalents related to SCEcorp Options subject to the SCEcorp performance measure are subject to the limitation determined pursuant to this Subsection (b). The SCEcorp performance measure is the percentile ranking of SCEcorp's total shareholder return (\"TSR\") compared to the TSR for each stock in the Dow Jones Electric Utilities Group Index. The percentile ranking will be measured quarterly, and these quarterly rankings will be averaged over a rolling 3-year period. If SCEcorp's average ranking is in the 60th percentile or higher for the 3-year period ending with the then current quarter, 100% of the dividend equivalents will be earned for that quarter. If SCEcorp's average ranking is in the 25th percentile, 25% of the dividend equivalents will be earned. No dividend equivalents will be earned for performance below the 25th percentile, and a pro rata amount will be earned for performance between the 25th and 60th percentiles. Performance prior to the year of grant will not be measured for purposes of this Agreement. The average TSR percentile ranking from January 1st of the year of grant through the then current quarter will be used as the performance measure during the first three calendar years. Thereafter, the average TSR percentile ranking will be determined based on a rolling three-year period. Any limitations determined to apply under this Subsection (b), will apply to dividends declared during the quarter.\nDividend equivalents related to unexercised SCEcorp Options that were not earned due to the limitations of this Subsection (b) may be earned back as of the end of each of the last five years of the option period if it is determined at that point that the SCEcorp cumulative average TSR percentile ranking equals or exceeds the 60th percentile.\n(c) Dividend equivalents related to SCEcorp Options subject to the MFF performance measure are subject to the limitation determined pursuant to this Subsection (c). The MFF performance measure will be MFF's 3-year compounded growth in economic value (\"GEV\"). Following receipt of audited MFF financial data for each calendar year during the option term, if it is determined that MFF's GEV equals or exceeds its cost of equity plus 200 basis points for the 3-year period ending with the most recent calendar year, then 100% of the dividend equivalents will be earned for that year. If the GEV is equal to MFF's cost of equity, 25% of the dividend equivalents will be earned for that year. No dividend equivalents will be earned if the GEV is less than MFF's cost of equity, and a pro rata amount will be earned if the GEV is between MFF's cost of equity and its cost of equity plus 200 basis points. For the first year of the option period, only performance data for that year will be measured. For the second year, performance data for the first two years will be measured.\nDividend equivalents related to unexercised SCEcorp Options that were not earned due to the limitations of this Subsection (c) may be earned back as of the end of each of the last five years of the option period if MFF's cumulative compounded annual GEV is determined at that point to equal or exceed MFF's cost of equity plus 200 basis points for the corresponding period.\nDividend equivalents subject to the limitations of this Subsection (c) related to that portion of the year preceding the exercise of the option will be paid following completion of the year if they are earned in accordance with the provisions of this Subsection (c).\n(d) Except as provided in Subsection (c), when the Employee exercises any portion of the SCEcorp Options granted by this Agreement, the earned dividend equivalents corresponding to the stock covered by the exercised options will be paid to the Employee in cash at the time the stock certificates are delivered to the Employee. The Employee may elect to apply this amount to the exercise price. If the SCEcorp Options granted hereby are not fully exercised by the first business day of the 10th year following the date of this Agreement, the dividend equivalents corresponding to the shares covered by the unexercised portion of the options will be forfeited.\n6. MEC OPTION PERFORMANCE UNITS\nThe MEC Options are performance units under the Plan based on 100 million shares of artificial or \"phantom\" MEC stock created for this purpose only. The base value of one share of MEC stock as of the grant date was approved by the Committee. The MEC Option exercise prices in Section 2 were derived from the base price of a share of MEC stock by applying a 12% appreciation factor, compounded annually for the term of this Agreement. Following the end of each calendar year during the term of this Agreement, the actual MEC share value will be computed. If the actual MEC share value exceeds the MEC Option exercise price for that period, any portion of the vested MEC Option may be exercised by the Employee in accordance with Section 4 and the difference will be paid in cash to the Employee.\n7. TRANSFER AND BENEFICIARY\nThe options will not be transferable by the Employee. During the lifetime of the Employee, the options will be exercisable only by him\/her. The Employee may designate a beneficiary who, upon the death of the Employee, will be entitled to exercise the then vested portion of the options during the remaining term of this Agreement subject to the conditions of the Plan and this Agreement.\n8. TERMINATION OF OPTIONS\nAs set forth in Section 3(d) of this Agreement, in the event of termination of the employment of the Employee for any cause, other than retirement, disability or death of the Employee, the options will terminate 180 days from the date on which such employment terminated, or in the case of MEC Options, at the end of the first 60-day exercise period following the employment termination date. In addition, the options may be terminated if SCEcorp elects to substitute cash awards as provided under Section 12 of this Agreement.\n9. TAXES\nSCEcorp will have the right to retain and withhold the amount of taxes required by any government to be withheld or otherwise deducted and remitted with respect to the exercise of any option or the receipt or application by the Employee of any dividend equivalent under this Agreement. In its discretion, SCEcorp may require the Employee to reimburse SCEcorp for any such taxes required to be withheld by SCEcorp and may withhold any distribution in whole or in part until SCEcorp is so reimbursed. In lieu thereof, SCEcorp will have the right to withhold from any other cash amounts due from SCEcorp to the Employee an amount equal to such taxes required to be withheld by SCEcorp to reimburse SCEcorp for any such taxes or to retain and withhold a number of shares of SCEcorp Stock having a market value equal to the taxes and cancel (in whole or in part) the shares in order to reimburse SCEcorp for the taxes.\nEach recipient of an SCEcorp Option must attach a statement to his\/her federal and state tax returns for the year in which the SCEcorp Option was granted containing certain information about the option. A sample statement is attached to this Agreement as Exhibit 2.\n10. CONTINUED EMPLOYMENT\n(a) In consideration of the granting of such options to him\/her, the Employee agrees that he\/she will remain in the continuous service of SCEcorp or an SCEcorp affiliate as an officer or employee during the term of this agreement except as he\/she may be prevented from doing so by death, permanent and total disability, or retirement under the Southern California Edison Company Retirement Plan, or a successor plan. In the event employment is terminated, voluntarily or otherwise, for reasons other than the foregoing, the restrictions of section 3(d) of this Agreement will apply.\n(b) Nothing in this option Agreement will be deemed to confer on the Employee any right to continue in the employ of SCEcorp or an SCEcorp affiliate or interfere in any way with the right of the employer to terminate his\/her employment at any time. 11. NOTICE OF DISPOSITION OF SHARES\nEmployee agrees that if he\/she should dispose of any shares of stock acquired on the exercise of the SCEcorp Options, including a disposition by sale, exchange, gift or transfer of legal title within six months from the date such shares are transferred to the Employee, the Employee will notify SCEcorp promptly of such disposition.\n12. AMENDMENT\nThis Agreement will be subject to the terms of the Plan as amended. SCEcorp reserves the right to substitute cash awards substantially equivalent in value to the options and dividend equivalents. The options and dividend equivalents which are the subject of this Agreement may not otherwise be restricted or limited by any Plan amendment or termination approved after the date of this Agreement without the Employee's written consent.\n13. FORCE AND EFFECT\nThe various provisions of this Agreement are severable in their entirety. Any determination of invalidity or unenforceability of any one provision will have no effect on the continuing force and effect of the remaining provisions.\n14. GOVERNING LAW\nThis option Agreement will be construed under the laws of the State of California.\n15. NOTICE\nUnless waived by SCEcorp, any notice required under or relating to this Agreement will be in writing, with postage prepaid, addressed to:\nSCEcorp Attn: Corporate Secretary P.O. Box 800 Rosemead, CA 91770 \/\/ \/\/ \/\/ \/\/ \/\/ IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written.\nSCEcorp\nBy:_______________________________\nEmployee\n_______________________________\nAttest:\n_____________________________\nFORM OF AGREEMENTS FOR 1993 AWARDS UNDER OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN:\n1993 NONQUALIFIED STOCK OPTION AGREEMENT\nUNDER THE\nSCEcorp OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN\nThis AGREEMENT is made as of January 4, 1993 by and between SCEcorp and ------------------------------------------ (\"Employee\").\nWHEREAS, SCEcorp maintains the Long-Term Incentive Compensation Plan (the \"Plan\") under which the Compensation Committee of the Board of Directors of SCEcorp (the \"Committee\") may make Incentive Awards to such officers of SCEcorp or its affiliates as the Committee may determine, subject to any terms, conditions, or restrictions as it may deem appropriate; and\nWHEREAS, pursuant to the Plan, the Committee has elected to award nonqualified stock options of SCEcorp Common Stock (\"Common Stock\") with corresponding dividend equivalents to certain corporate officers of SCEcorp and its affiliates;\nNOW, THEREFORE, in consideration of the mutual promises and covenants contained herein, it is hereby agreed as follows:\n1. GRANT SCEcorp hereby grants to the Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option, hereafter called the option, to purchase full shares of authorized Common Stock together with corresponding dividend equivalents on the terms and conditions herein set forth.\n2. PRICE The purchase price of said shares of Common Stock subject to the option shall be $43.875 DOLLARS per share, such price being the average of the high and low sales prices of the Common Stock as reported in the western edition of The Wall Street Journal for the New York Stock Exchange Composite Transactions for the date of grant.\n3. WHEN EXERCISABLE The option may only be exercised to the extent it has vested. The initial vesting date shall be January 2nd of the year following the date of this Agreement, or six months after the date of this Agreement, whichever date is later. Thereafter, the option shall be exercisable only as follows: (a) During the period between the initial vesting date and January 1st of the following year, the option may be exercised to the extent of 33-1\/3% of the aggregate number of shares originally covered by the option. (b) During the next twelve-months, the option may be exercised to the extent of an additional 33-1\/3% of the aggregate number of shares originally covered by the option, and to the extent the right to exercise the option has earlier vested and has not been exercised. (c) At any time on or after January 2nd of the third year following the date of this Agreement, the option shall be exercisable in full except to the extent it has been exercised earlier. (d) The vested portions of the option shall accumulate to the extent not exercised, and be exercisable by the Employee, in whole or in part, in any subsequent period but not later than January 2nd of the 10th year following the date of this Agreement. PAGE\n(e) If an Employee is removed from a position entitling him\/her to benefits under the Plan, retires, dies or is permanently and totally disabled during the three-year vesting period, the option shall vest and be exercisable to the extent of 1\/36th of the aggregate number of shares originally covered by the option for each full month of service during the vesting period. Notwithstanding the foregoing, the option of a member of the Edison Management Committee shall be fully vested and exercisable upon his\/her retirement, death or permanent and total disability regardless of whether or not he\/she was a member of that committee on the date of this Agreement. (f) Upon termination of an Employee for any reason other than those specified in subsection (e), only that portion of the option which has vested on or before the anniversary date of this Agreement prior to the date of termination may be exercised, and that portion, together with any accumulated dividend equivalents, will be forfeited unless exercised within 180 days following the date of termination. (g) Notwithstanding the foregoing, the option and dividend equivalents may vest in accordance with section 16 of the Plan as a result of certain events, including liquidation of SCEcorp or merger, reorganization or consolidation of SCEcorp as a result of which SCEcorp is not the surviving corporation.\n4. HOW EXERCISABLE (a) The Employee shall exercise the option by written notice to SCEcorp, on the form prescribed by SCEcorp for this purpose, which shall specify the number of shares to be purchased, and which shall be accompanied by full payment of the option price for such shares. Payment shall be in cash, or its equivalent, such as Common Stock, acceptable to SCEcorp. Until such payment, the Employee shall have no rights in the optioned stock. The Employee may elect to apply the accumulated dividend equivalents related to the shares for which the option is being exercised to the option price for such shares. (b) The Employee agrees that any securities acquired by him\/her hereunder are being acquired for his\/her own account for investment and not with a view to or for sale in connection with any distribution thereof and that he\/she understands that such securities may not be sold, transferred, pledged, hypothecated, alienated, or otherwise assigned or disposed of without either registration under the Securities Act of 1933 or compliance with the exemption provided by Rule 144 or another applicable exemption under such act.\n5. TRANSFER AND BENEFICIARY The option shall not be transferable by the Employee. During the lifetime of the Employee, the option shall be exercisable only by him\/her. The Employee may designate a beneficiary who, upon the death of the Employee, will be entitled to exercise the then vested portion of the option at any time up to 10 years following the date of this Agreement subject to the terms and conditions of the Plan and this Agreement.\n6. TERMINATION OF OPTION As set forth in Section 3(f) of this Agreement, in the event of termination of the employment of the Employee for any cause, other than retirement, disability or death of the Employee, the option shall terminate 180 days from the date on which such employment terminated. In addition, the option may be terminated if SCEcorp elects to substitute cash awards as provided under Section 11 of this Agreement.\n7. DIVIDEND EQUIVALENTS A Dividend Equivalent Account shall be established on behalf of the Employee which will be credited with amounts corresponding to the dividends which would be payable on the number of shares of Common Stock covered by the option granted to the Employee under this Agreement. Such amounts will accumulate in this account without interest. Dividend equivalents will vest and become payable upon the exercise of the option to purchase the corresponding shares of Common Stock. When the Employee exercises any portion of the option granted by this Agreement, the accumulated dividend equivalents corresponding to the stock covered by the exercised option will be paid to the Employee in cash at the time the stock certificates are delivered to the Employee. The Employee may elect to apply this amount to the option price. If the option granted hereby is not fully exercised by January 2nd of the 10th year following the date of this Agreement, the dividend equivalents corresponding to the shares covered by the unexercised portion of the option will be forfeited. In accordance with Section 17(d) of the Plan, the Employee shall have no right or claim to any specific funds, property or assets of SCEcorp as a result of this Agreement.\n8. TAXES SCEcorp shall have the right to retain and withhold the amount of taxes required by any government to be withheld or otherwise deducted and remitted with respect to the exercise of any option or the receipt or application by the Employee of any dividend equivalent under this Agreement. In its discretion, SCEcorp may require the Employee to reimburse SCEcorp for any such taxes required to be withheld by SCEcorp and may withhold any distribution in whole or in part until SCEcorp is so reimbursed. In lieu thereof, SCEcorp shall have the right to withhold from any other cash amounts due from SCEcorp to the Employee an amount equal to such taxes required to be withheld by SCEcorp to reimburse SCEcorp for any such taxes or retain and withhold a number of shares of Common Stock having a market value not less than the amount of such taxes and cancel (in whole or in part) any such shares so withheld in order to reimburse SCEcorp for such taxes.\n9. AGREEMENT TO CONTINUE IN EMPLOYMENT In consideration of the granting of such option to him\/her, the Employee agrees that he\/she will remain in the continuous service of SCEcorp or an SCEcorp affiliate as an officer or employee except as he\/she may be prevented from doing so by death, permanent and total disability, or retirement under the Southern California Edison Company Retirement Plan, or a successor plan. The restrictions of Section 3(f) of this Agreement shall apply upon termination of service for reasons other than the foregoing. Nothing in this option Agreement shall be deemed to confer on the Employee any right to continue in the employ of SCEcorp or an SCEcorp affiliate or interfere in any way with the right of the employer to terminate his\/her employment at any time.\n10. NOTICE OF DISPOSITION OF SHARES Employee agrees that if he\/she should dispose of any shares of stock acquired on the exercise of this option, including a disposition by sale, exchange, gift or transfer of legal title within six months from the date such shares are transferred to the Employee, the Employee will notify SCEcorp promptly of such disposition.\n11. AMENDMENT This Agreement shall be subject to the terms of the Plan as amended. SCEcorp reserves the right to substitute cash awards substantially equivalent in value to the option and dividend equivalents. The option and dividend equivalents which are the subject of this Agreement may not otherwise be restricted or limited by any Plan amendment or termination approved after the date of this Agreement without the Employee's written consent.\n12. FORCE AND EFFECT The various provisions of this Agreement are severable in their entirety. Any determination of invalidity or unenforceability of any one provision shall have no effect on the continuing force and effect of the remaining provisions.\n13. GOVERNING LAW This option Agreement shall be construed under the laws of the State of California.\n14. NOTICE Unless waived by SCEcorp, any notice required under or relating to this Agreement shall be in writing, with postage prepaid, addressed to:\nSCEcorp Attn: Corporate Secretary P.O. Box 800 Rosemead, CA 91770\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed on the day and year first above written.\nSCEcorp\nBy:_______________________________\nEmployee\n_______________________________\nAttest:\n_____________________________\nFORM OF AGREEMENTS FOR 1989-92 AWARDS UNDER OFFICER LONG-TERM INCENTIVE COMPENSATION PLAN:\nNONQUALIFIED STOCK OPTION AGREEMENT\nUNDER THE\nSOUTHERN CALIFORNIA EDISON COMPANY\nLONG-TERM INCENTIVE COMPENSATION PLAN\nThis AGREEMENT is made as of January 2, ____ by and between SOUTHERN CALIFORNIA EDISON COMPANY (\"Company\") and (\"Employee\") .\nWHEREAS, the Company maintains the Long-Term Incentive Compensation Plan (the \"Plan\") under which the Compensation Committee of the Board of Directors of the Company (the \"Committee\") may make Incentive Awards to such members of the Company's management team as the Committee may determine, subject to any terms, conditions, or restrictions as it may deem appropriate; and\nWHEREAS, pursuant to the Plan, the Committee has elected to award nonqualified stock options of SCEcorp Common Stock (\"Common Stock\") with corresponding dividend equivalents to certain corporate officers of the Company and its affiliates;\nNOW, THEREFORE, in consideration of the mutual promises and covenants contained herein, it is hereby agreed as follows:\n1. GRANT The Company hereby grants to the Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option, hereafter called the option, to purchase full shares of authorized Common Stock together with corresponding dividend equivalents on the terms and conditions herein set forth.\n2. PRICE The purchase price of said shares of Common Stock subject to the option shall be $_______ per share, such price being the average of the highest and lowest sale prices of the Common Stock as 'reported in the western edition of The Wall Street Journal for the New York Stock Exchange Composite Transactions on January 2, _____, the date of grant.\n3. WHEN EXERCISABLE The option is subject to a three-year vesting period commencing on the date of this Agreement. The option may not be exercised prior to one year from the date of this Agreement. Thereafter, the option shall be exercisable only as follows: (a) During the twelve-month period beginning one year from the date of this Agreement, the option may be exercised to the extent of 33-1\/3% of the aggregate number of shares originally covered by the option. (b) During the following twelve-month period, the option may be exercised to the extent of an additional 33-1\/3% of the aggregate number of shares originally covered by the option, and to the extent the right to exercise the option theretofore has vested and has not been exercised. (c) At any time after three years from the date of this Agreement, the option shall be exercisable in full except to the extent it theretofore shall have been exercised. (d) The vested portions of the option shall accumulate to the extent not exercised, and be exercisable by the Employee, in whole or in part, in any subsequent period but not later than ten years from the date of this Agreement. PAGE\n(e) If an Employee is removed from a position entitling him to benefits under the Plan, retires, dies or is permanently and totally disabled during the three-year vesting period, the option shall vest and be exercisable to the extent of 1\/36th of the grant for each full month of service during the vesting period. Notwithstanding the foregoing, the option shall be fully vested and exercisable upon the retirement, death or permanent and total disability of a member of the Management Committee of the Company regardless of whether or not he was a member of the Management Committee on the date of this Agreement. (f) Upon termination of an Employee for any reason other than those specified in subsection (e), only that portion of the option which has vested on or before the anniversary date of this Agreement prior to the date of termination may be exercised, and that portion, together with any accumulated dividend equivalents, will be forfeited unless exercised within 180 days following the date of termination. (g) Notwithstanding the foregoing, the option and dividend equivalents may vest in accordance with section 15(b) of the Plan as a result of certain events, including liquidation of the Company or merger, reorganization or consolidation of the Company as a result of which the Company is not the surviving corporation.\n4. HOW EXERCISABLE (a) The Employee shall exercise the option by written notice to the Company, on the form prescribed by the Company for this purpose, which shall specify the number of shares to be purchased, and which shall be accompanied by full payment of the option price for such shares. Payment shall be in cash, or its equivalent, such as Common Stock, acceptable to the Company. Until such payment, the Employee shall have no rights in the optioned stock. The Employee may elect to apply the accumulated dividend equivalents related to the shares for which the option is being exercised to the option price for such shares. (b) The Employee hereby acknowledges that the Securities being acquired by him hereunder may not be sold, transferred, pledged, hypothecated, alienated, or otherwise assigned or disposed of by him without either registration under the Securities Act of 1933 or compliance with the exemption provided by Rule 144 or another applicable exemption under such act.\n5. TRANSFER AND BENEFICIARY The option shall not be transferable by the Employee. During the lifetime of the Employee, the option shall be exercisable only by him. The Employee may designate a beneficiary who, upon the death of the Employee, will be entitled to exercise the then vested portion of the option at any time up to 10 years following the date of this Agreement subject to the terms and conditions of the Plan and this Agreement.\n6. TERMINATION OF OPTION As set forth in Section 3(f) of this Agreement, in the event of termination of the employment of the Employee for any cause, other than retirement, disability or death of the Employee, the option shall terminate 180 days from the date on which such employment terminated. In addition, the option may be terminated if the Company elects to substitute cash awards as provided under Section 11 of this Agreement.\n7. DIVIDEND EQUIVALENTS A Dividend Equivalent Account shall be established on behalf of the Employee which will be credited with amounts corresponding to the dividends which would be payable on the number of shares of Common Stock covered by the option granted to the Employee under this Agreement. Such amounts will accumulate in this account without interest. Dividend equivalents will vest and become payable upon the exercise of the option to purchase the corresponding shares of Common Stock. When the Employee exercises any portion of the option granted by this Agreement, the accumulated dividend equivalents corresponding to the stock covered by the exercised option will be paid to the Employee at the time the stock certificates are delivered to the Employee. Dividend equivalents are payable only in cash, although the Employee may elect to apply this amount to the option price. If the option granted hereby is not fully exercised within ten years of the date of this Agreement, the dividend equivalents corresponding to the shares covered by the unexercised portion of the option will be forfeited. In accordance with Section 16(d) of the Plan, the Employee shall have no right or claim to any specific funds, property or assets of the Company as a result of this Agreement.\n8. TAXES The Company shall have the right to retain and withhold the amount of taxes required by any government to be withheld or otherwise deducted and remitted with respect to the exercise of any option or the receipt or application by the Employee of any dividend equivalent under this Agreement. In its discretion, the Company may require the Employee to reimburse the Company for any such taxes required to be withheld by the Company and may withhold any distribution in whole or in part until the Company is so reimbursed. In lieu thereof, the Company shall have the right to withhold from any other cash amounts due from the Company to the Employee an amount equal to such taxes required to be withheld by the Company to reimburse the Company for any such taxes or retain and withhold a number of shares of Common Stock having a market value not less than the amount of such taxes and cancel (in whole or in part) any such shares so withheld in order to reimburse the Company for such taxes.\n9. AGREEMENT TO CONTINUE IN EMPLOYMENT In consideration of the granting of such option to him, the Employee to whom this option is granted agrees that he will remain in the continuous service of the Company as an officer or employee except as he may be prevented from doing so by death, permanent and total disability, or retirement under the Company's Retirement Plan. The restrictions of Section 3(f) of this Agreement shall apply upon termination of service for reasons other than the foregoing. Nothing in this option Agreement shall be deemed to confer on the Employee any right to continue in the employ of the Company or interfere in any way with the right of the Company to terminate his employment at any time.\n10. NOTICE OF DISPOSITION OF SHARES Employee agrees that if he should dispose of any shares of stock acquired on the exercise of this option, including a disposition by sale, exchange, gift or transfer of legal title within six months from the date such shares are transferred to the Employee, the Employee will notify the Company promptly of such disposition.\n11. AMENDMENT This Agreement shall be subject to the terms of the Plan as amended. The Company reserves the right to substitute cash awards substantially equivalent in value to the option and dividend equivalents. The option and dividend equivalents which are the subject of this Agreement may not otherwise be restricted or limited by any Plan amendment or termination approved after the date of this Agreement without the Employee's written consent.\n12. FORCE AND EFFECT The various provisions of this Agreement are severable in their entirety. Any determination of invalidity or unenforceability of any one provision shall have no effect on the continuing force and effect of the remaining provisions. 13. GOVERNING LAW This option Agreement shall be construed under the laws of the State of California.\n14. NOTICE Unless waived by the Company, any notice required under or relating to this Agreement shall be in writing, with postage prepaid, addressed to:\nSouthern California Edison Company Attn: Corporate Secretary P.O. Box 800 Rosemead, CA 91770\nIN WITNESS WHEREOF, parties hereto have caused the Agreement to be executed on the day and year first above written.\nSOUTHERN CALIFORNIA EDISON COMPANY\nBy: _______________________________\n_______________________________\nAttest:\n_______________________________\nPAGE\nEXHIBIT 10.22\nSOUTHERN CALIFORNIA EDISON COMPANY\nESTATE AND FINANCIAL PLANNING PROGRAM\nAs Amended December 13, 1995\nI. PURPOSE\nThe purpose of this Estate and Financial Planning Program (the \"Program\") is to provide independent professional estate planning, financial planning and income tax preparation services to executives of Southern California Edison Company (the \"Company\").\nII. PARTICIPATION\nParticipation in the Program is voluntary. Participants may elect to participate in the estate planning, the financial planning and\/or the income tax preparation portions of the Program.\nIII. ELIGIBILITY\n1. Eligibility for this Program is limited to the Executive Officers of the Company and such other Company executives whose participation has been approved by the Chairman of the Board and Chief Executive Officer. For purposes of this Program, \"Executive Officer\" means the Chairman of the Board and Chief Executive Officer, President, Executive Vice Presidents, Senior Vice Presidents, Corporate Vice Presidents and the Corporate Secretary. The spouse (other than the surviving spouse of a deceased retired Participant) of a Participant will receive services under this Program only to the extent that his\/her estate plan, financial plan, or tax plan or tax return is directly related to that of the Participant.\n2. Eligibility will continue as long as the Participant is an Executive Officer of the Company, or an otherwise qualified and approved Participant, and for five years after retirement as such.\n3. Eligibility for this Program will end and benefits will cease upon termination of employment with the Company, or resignation from the Company. If a Participant becomes disabled, and because of such disability is unable to continue to work as an executive of the Company, eligibility for this Program will continue throughout the period of disability.\nIV. SERVICES PROVIDED\n1. Services provided under this Program are paid for by the Company, including any start-up fees and expenses. Services provided will include, but not be limited to, all requested and necessary estate planning, preparation and implementation of will and trust plans, financial planning and counseling, and income tax and retirement tax planning and return preparation. The income tax returns of all Eligible Participants shall be reviewed by a provider designated by the Company regardless of who prepares the return.\n2. Services provided under this Program are the only services of this type paid for by the Company. The Company will not pay for any services in lieu of the services of this Program. A Participant may not elect to receive a cash payment in lieu of services under this Program. Services provided are only those services directly related to the estate planning, financial PAGE\nplanning and income tax needs of the Participant and his\/her spouse as set forth in Section III Paragraph 1 (above).\n3. Invoices for services performed under this Program must be submitted with an authorization for payment or reimbursement to the Company Controller.\nV. SERVICE PROVIDERS\n1. The Chairman of the Board and Chief Executive Officer of the Company will (a) designate the professional providers of services for the Program and\/or (b) establish the qualification requirements of professional providers for those instances when the Company gives Participants discretion to select their own.\n2. The Company will periodically inform Participants who the approved professional providers are under the Program. In addition, the Company will specify the qualification requirements which must be met by professional providers when Participants have selection discretion.\nVI. SERVICES FOLLOWING RETIREMENT\nServices under this Program to the Participant and his\/her surviving spouse will continue for five years after the retirement of the Participant, provided however, that the surviving spouse and the Participant must have been married on the date of the Participant's retirement. In the event of the re-marriage of the surviving spouse of the Participant during the five-year period following retirement, any benefits under this Program will cease as of the date of the re-marriage. All benefits under this Program will cease on the anniversary of the fifth year following the Participant's retirement from the Company.\nVII. TAXES\n1. Amounts paid on behalf of a Participant under this Program may be subject to income tax withholding or other deductions as may be required from time-to-time by federal, state or local law.\n2. Any taxes which may result because of the services provided under this Program are the sole responsibility of the Participant.\nVIII. CONFIDENTIALITY\nInformation obtained in the course of this Program will be held confidential between the professional service providers and their individual clients, and such information will not be made available to the Company unless required by a court of competent jurisdiction, or unless such information is required to be disclosed by law, or by the professional service provider's ethical standards of conduct.\nIX. ADMINISTRATION\n1. This Program is administered by the Compensation and Executive Personnel Committee of the Board of Directors or its designee. Day-to-day administration of the Program has been delegated to the Executive Compensation Division. The Committee will at all times have full power and authority to interpret, construe, administer, and prospectively to modify, amend, or terminate this Program. The Committee's interpretations, constructions and actions shall be binding and conclusive on all persons PAGE\nfor all purposes. No member of the Committee, nor its designee, shall be liable to any person for any action taken or omitted in connection with this Program.\n2. Questions as to the extent of covered services or other routine administrative matters, and questions regarding the scope of this Program will be decided by the Company General Counsel in consultation with the Company Controller, and as they deem necessary, with the Chairman of the Board and Chief Executive Officer.\nX. NO RIGHT TO CONTINUED EMPLOYMENT\nNothing contained in this document or the Program shall be construed as conferring upon a Participant the right to continue in the employ of the Company as an Executive Officer or in any other capacity. A Participant's eligibility to participate in this Program will continue only so long as the Participant remains an Executive Officer of the Company, an otherwise qualified and approved Participant, or a retired Participant subject to the limitations of the Program.\nXI. MISCELLANEOUS\n1. If any of the provisions of this Program are held invalid, or held to violate any law, the remainder of the Program may remain in full force and effect.\n2. Any right to receive services under this Program is hereby expressly declared to be a personal, nonassignable and nontransferable benefit of employment related to the Participant's status as an Executive Officer or other executive of the Company. In the event of any attempted assignment, alienation or transfer of such rights contrary to the provisions of this Program, or upon determination by the Chairman of the Board and Chief Executive Officer after consultation with the General Counsel and the Controller that in their good faith opinion the Participant has abused his\/her services under the Program, and after written notice of such determination has been given to the Participant, the Company will have no further liability for the provision of or payment for services hereunder.\n3. This Program shall be governed by the laws of the State of California.\n4. This Program is effective on September 21, 1989.\nSOUTHERN CALIFORNIA EDISON COMPANY\nEmiko Banfield _______________________________________\nPAGE\nEXHIBIT 10.25\nMay 16, 1995\nMr. Stephen E. Frank 164 Spyglass Lane Jupiter, FL 33477\nDear Steve:\nI am pleased to offer you the position of President and Chief Operating Officer and member of the Board of Directors of Southern California Edison Company.\nSpecifically, the offer of employment includes:\n1. You will have the title of President and Chief Operating Officer with a base salary of $500,000 per year for the first year of employment. Subsequent levels based on periodic performance reviews.\n2. For 1995, as President and Chief Operating Officer you will be eligible for a target annual incentive award of 60% of your annual salary, paid in February of the following year. You will receive $150,000. Annual incentive awards for subsequent years will be determined by the Compensation Committee. Target award level for 1996: 60% of base compensation. Under consideration for 1996: maximum award at 90% of base comp (1.5 times the target level). Actual awards to be based on meeting defined performance objectives.\n3. You will receive an initial Long-Term Incentive Award of 60,000 SCEcorp non-qualified stock options with dividend equivalents earned on a corporate performance basis. The current economic value of this grant is $300,000. For grants in early 1996 the target total option value would be 85% of base pay. For example, 85% of $500,000 equals $425,000. Options are valued using the Black-Scholes' method.\nIn the future, your annual salary, annual incentive awards, and long-term incentives will be reviewed on a regular basis at the same time and in the same manner as all other officers.\n4. As an offset to expenses incurred as a result of joining Southern California Edison, you will receive a one-time lump sum after-tax payment of $115,000. If you elect, you may defer the full value of this payment (including the gross-up for current taxes) to your Deferred Compensation Plan account, with immediate vesting.\n5. You will be credited with $250,000 in your Deferred Compensation Plan account effective on your date of employment, which will vest upon completion of five years of service. Interest will be credited according to the terms of the Plan. For 1995, interest will be credited at 9.72%.\n6. You will be credited with one-and-one-quarter additional years of service credit in the Executive Retirement Plan (\"ERP\") for each year of actual service -- up to ten years.\n7. You will be immediately credited with 15 days of vacation upon employment. You will continue to accrue 15 days per year until such time as service warrants additional vacation based on years of service. PAGE\n8. To assist you in establishing residence within reasonable commuting distance, you will receive our full relocation and moving expense package, including a Miscellaneous Expense Allowance of $20,000 paid upon completion of your move. We will purchase your home in Florida at appraised, fair market value of $1,315,000.\n9. As an employee of Edison you will be eligible for all programs offered to employees, subject to the eligibility rules of each program. In addition, you will receive all executive benefits, including the Executive Retirement Plan, Deferred Compensation Plan, Benefit Adjustment Account, Executive Supplemental Survivor Income Continuation Plan, Executive Supplemental Short-Term Disability Plan, and Estate and Financial Planning Program, and other executive perquisites as described.\n10. If service is terminated involuntarily (not for cause), you would receive severance payment equal to 100% of your then current annual base salary and an annual incentive award. No other severance payments or benefits except (a) the one-time Deferred Payment Plan credit ($250,000) would vest pro rata, i.e., 2\/5 vested if involuntary termination at end of second year, (b) the initial option on 60,000 shares would become fully exercisable if the involuntary termination takes place after one year of service, and (c) the additional \"service credit years\" that have been earned will count under the ERP in determining whether you have the necessary five years of service to be eligible to receive retirement benefits.\n11. To assist you with transition of your financial planning, tax and estate planning affairs you will receive a one-time lump sum payment of $10,000.\n12. Two club memberships will be included as an executive benefit.\nThis offer is contingent upon completion of a physical\/drug screen examination by a qualified medical facility, and completion of a background verification. This offer is subject to final approval by the SCE Board of Directors.\nI am personally delighted to have the opportunity to work closely with you, and look forward to our future together. Please feel free to call me at the office or my home to discuss this further.\nSincerely,\nJohn E. Bryson John E. Bryson\nAccepted: S. E. Frank --------------------\nDate: 5\/24\/95 ------------------------\nEXHIBIT 12 SOUTHERN CALIFORNIA EDISON COMPANY AND CONSOLIDATED UTILITY-RELATED SUBSIDIARIES RATIOS OF EARNINGS TO FIXED CHARGES (Thousands of Dollars)\n(1) Includes allowance for funds used during construction and accrual of unbilled revenue. (2) Includes allocation of federal income and state franchise taxes to other income. (3) Rentals include the interest factor relating to certain significant rentals plus one-third of all remaining annual rentals. (4) Allocable portion of interest included in annual minimum debt service requirement of supplier. (5) Includes fixed charges associated with Nuclear Fuel. (6) Represents interest on spent nuclear fuel disposal obligation.\nPAGE\nEXHIBIT 13\nSouthern California Edison Company\n1995 Annual Report PAGE\nA Profile of Southern California Edison Company\nSouthern California Edison Company (SCE) is the nation's second-largest electric utility, based on the number of customers. SCE, with headquarters in Rosemead, California, is a subsidiary of Edison International (formerly SCEcorp), which is primarily an energy-services company.\nSCE, a 109-year-old investor-owned utility, serves 4.2 million customers in Central and Southern California. Its 50,000-square-mile service territory has a population of more than 11 million.\nContents\n1 Selected Financial and Operating Data: 1991-1995 2 Management's Discussion and Analysis of Results of Operations and Financial Condition 8 Quarterly Financial Data 9 Consolidated Financial Statements 13 Notes to Consolidated Financial Statements 27 Responsibility for Financial Reporting 28 Report of Independent Public Accountants 29 Board of Directors 29 Executive Officers\nPAGE\nSelected Financial and Operating Data: 1991-1995 Southern California Edison Company\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\nResults of Operations\nEarnings\nSouthern California Edison Company's (SCE) 1995 earnings were $643 million, compared with $599 million in 1994, and $637 million in 1993. Earnings in 1995 increased $44 million over 1994, primarily due to a higher authorized return on common equity for 1995, partially offset by the financial effect of the 1995 general rate case settlement. SCE also recorded employee severance costs of $15 million after-tax in 1995, compared with $18 million after-tax in 1994. SCE's 1994 earnings decreased $38 million from 1993, due to employee severance expenses and a lower authorized return on common equity, partially offset by lower maintenance expenses at the San Onofre Nuclear Generating Station.\nOperating Revenue\nOperating revenue increased slightly over 1994, mainly due to a 2.6% California Public Utilities Commission (CPUC)-authorized rate increase, partially offset by a decrease in the volume of sales to resale cities and milder weather in 1995, compared with 1994. Operating revenue increased in 1994, mainly due to a 3.2% CPUC-authorized rate increase and a 6% increase in sales volume. Retail sales volume increased from warmer weather in the third quarter of 1994 compared with 1993. Wholesale volume increased, as SCE's power was priced lower than many other sources (see Operating Expenses). In 1995, over 98% of operating revenue was from retail sales. Retail rates are regulated by the CPUC and wholesale rates are regulated by the Federal Energy Regulatory Commission (FERC).\nDue to warm weather during the summer months, operating revenue during the third quarter of each year is materially higher than other quarters of the year.\nThe changes in operating revenue resulted from:\nIn March 1995, SCE announced that it intends to freeze average rates for residential, small business and agricultural customers through 1996, and announced a five-year goal to reduce system average rates by 25% (from 10.7 cents per kilowatt-hour to below 10 cents per kilowatt-hour), after adjusting for inflation, subject to CPUC approval. In July 1995, SCE filed expanded rate options and requested the CPUC expedite the filing in order to offer these services by 1996. SCE does not anticipate that these proposals will have a material effect on future earnings trends.\nOperating Expenses\nFuel expense decreased 27% in 1995, primarily reflecting a change in the fuel mix from 1994. Hydro generation was up significantly in 1995, due to greater rainfall, resulting in lower gas purchases compared with 1994. In addition, the San Onofre units were out of service a total of five months in 1995 for refueling and maintenance, causing a decrease in nuclear fuel expense. Lower overall gas prices also contributed to the decrease in energy costs. Fuel expense increased 6% in 1994. Although the overall cost per kilowatt-hour of gas decreased 16% in 1994, gas-powered generation increased 21% due to higher demand for SCE's lower-priced energy. The cost per kilowatt-hour of nuclear fuel decreased 4% in 1994, while nuclear generation increased 20% due to a higher than average operating capacity factor at San Onofre.\nPurchased-power expense increased slightly in 1995 and 1994. SCE makes federally required power purchases from nonutility generators based on contracts with CPUC-mandated pricing. Energy prices under these contracts are generally higher than other energy sources, and for 1995, SCE paid about $1.8 billion (including energy and capacity payments) more for these power purchases than the cost of power available from other sources.\nSouthern California Edison Company\nProvisions for regulatory adjustment clauses increased in 1995 and 1994, as CPUC-authorized fuel and purchased-power cost estimates exceeded actual energy costs. SCE's actual energy costs were lower than estimated in 1995 due to the increase in hydro generation and lower gas prices. In 1994, actual energy costs were lower than estimated due to lower overall gas prices and a higher than average operating capacity factor at San Onofre.\nOther operating expenses include employee severance charges of $25 million in 1995 and $30 million in 1994. As SCE positions itself for a more competitive operating environment, it is anticipated that workforce reductions will continue to occur. In 1995, SCE severed 567 employees, representing total annualized labor costs of about $42 million. SCE expects a substantial portion of these labor cost savings to reduce other operating expenses in 1996. Severance costs are comprised of cash payments for service and a non-cash benefit component. Excluding severance charges, other operating expenses decreased in 1995 primarily due to operating efficiencies.\nMaintenance expense increased 8% in 1995, due to the scheduled refueling and maintenance outages at San Onofre in 1995. Maintenance expense decreased 8% in 1994, primarily from the San Onofre units operating at a higher than average capacity factor in 1994.\nOther Income and Deductions\nThe provision for rate phase-in plan reflects a CPUC-authorized, 10-year rate phase-in plan for Palo Verde Nuclear Generating Station, as further discussed in Note 1 to the Consolidated Financial Statements. The provision is a non-cash offset to the collection of deferred revenue.\nInterest income increased 21% in 1995, primarily from higher interest rates and higher investment balances. The higher investment balances reflect the decline in dividend payments, which began in June 1994. Interest income increased 18% in 1994, mainly due to higher interest rates.\nOther nonoperating income decreased 29% in 1995 and increased 73% in 1994. In 1994, SCE received CPUC-authorized incentive awards of $5 million related to nuclear plant performance and $11 million for energy conservation programs, and an environmental insurance settlement. In addition, SCE realized a 1994 benefit resulting from the effect of a drop in Edison International's (formerly SCEcorp) stock price on it's stock option plan.\nInterest Expense\nOther interest expense increased 30% in 1995, mainly due to rising interest rates and higher balances in the regulatory balancing accounts. Other interest expense increased 21% in 1994, mainly due to higher interest rates and increased short-term borrowings.\nFinancial Condition\nSCE's liquidity is primarily affected by debt maturities, dividend payments and capital expenditures. Capital resources include cash from operations and external financings.\nIn June 1994, SCE lowered its quarterly common stock dividend to its parent, Edison International, by 30%, as the result of uncertainty of future earnings levels arising from the changing nature of California's electric utility regulation. The cash flow coverage of dividends increased to 3.5 times in 1995, from 3.1 times in 1994 and 3.2 times in 1993, primarily from the lower dividend rate.\nIn January 1995, Edison International authorized the repurchase of up to $150 million of its common stock. As excess cash becomes available, SCE intends to pay cash dividends to Edison International, while maintaining its CPUC authorized capital structure. Edison International repurchased 4.2 million shares ($70 million) through February 2, 1996, funded by dividends from Edison International subsidiaries.\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\nCash Flows from Operating Activities\nNet cash provided by operating activities totaled approximately $2.0 billion in 1995, $1.8 billion in 1994 and $1.7 billion in 1993. Cash from operations exceeded capital requirements for all years presented.\nCash Flows from Financing Activities\nShort-term debt was used to finance fuel inventories and general cash requirements. Long-term debt is used mainly to finance capital expenditures. External financings are influenced by market conditions and other factors, including limitations imposed by SCE's articles of incorporation and trust indenture. As of December 31, 1995, SCE could issue approximately $7.9 billion of additional first and refunding mortgage bonds and $4.2 billion of preferred stock at current interest and dividend rates.\nAt December 31, 1995, SCE had available lines of credit of $1.4 billion, with $900 million for short-term debt and $500 million for the long-term refinancing of its variable-rate pollution-control bonds. These unsecured revolving lines of credit are at negotiated or bank index rates with various expiration dates; the majority have five-year terms.\nCalifornia law prohibits SCE from incurring or guaranteeing debt for its nonutility affiliates. Additionally, the CPUC regulates SCE's capital structure, limiting the dividends it may pay Edison International. At December 31, 1995, SCE had the capacity to pay $528 million in additional dividends and continue to maintain its authorized capital structure.\nCash Flows from Investing Activities\nThe primary uses of cash for investing activities are additions to property and plant and funding of nuclear decommissioning trusts. As further discussed in Note 9 to the Consolidated Financial Statements, decommissioning costs are accrued and recovered in rates over the term of each nuclear generating facility's operating license through charges to depreciation expense. SCE estimates that it will spend approximately $12.7 billion to decommission its nuclear facilities, primarily between 2013-2070. This estimate is based on SCE's current-dollar decommissioning costs ($1.8 billion), escalated using a 6.65% rate and an earnings assumption on trust funds ranging from 5.5% to 5.75%. These amounts are expected to be funded from independent decommissioning trusts, which receive SCE contributions of approximately $100 million per year (until decommissioning begins). The Financial Accounting Standards Board has issued an exposure draft related to accounting practices for removal costs, including decommissioning of nuclear power plants. SCE does not expect that the accounting changes proposed in the exposure draft would have an adverse effect on its results of operations due to its current and expected future ability to recover these costs through customer rates.\nProjected Capital Requirements\nSCE's projected capital requirements for the next five years are: 1996--$746 million; 1997--$754 million; 1998--$647 million; 1999--$689 million; and 2000--$673 million.\nLong-term debt maturities and sinking fund requirements for the next five years are: 1996--$1 million; 1997--$501 million; 1998--$447 million; 1999--$155 million; and 2000--$325 million.\nRegulatory Matters\nOn January 10, 1996, the CPUC issued its decision on SCE's 1995 general rate case. The decision affirmed the CPUC's interim order to reduce 1995 operating revenue by $67 million, but decreased 1996 operating revenue by an additional $9 million, which includes a $44 million decrease for operating and maintenance expenses. The decision also authorized recovery of SCE's remaining investment (approximately $2.7 billion) in San Onofre Units 2 and 3 at a reduced rate of return (7.34% compared to the current 9.55%), over an eight-year period, beginning in the second quarter of 1996. Future operating costs and incremental capital expenditures at San Onofre are subject to an incentive pricing plan, where SCE receives about 4 cents per kilowatt-hour. Profits or losses resulting from cost differences from the incentive price will flow through to\nSouthern California Edison Company\nshareholders. Beginning in 2004, after SCE's investment is fully recovered, it would be required to share equally with ratepayers the benefits received from operation of the units.\nThe CPUC's 1996 cost-of-capital proceeding authorized an increase to SCE's equity ratio from 47.75% to 48% and authorized SCE an 11.6% return on common equity, compared with 12.1% for 1995 and 11% for 1994. This decision, excluding the effects of other rate actions, would reduce 1996 earnings by approximately $19 million.\nA CPUC decision related to SCE's 1996 authorized revenue for fuel and purchased power is pending. At issue is the treatment of a $237 million overcollection in the energy cost adjustment clause (ECAC). In SCE's May 1995 ECAC filing, it requested that refund of the overcollection be deferred until 1997 for rate- stabilization purposes. The CPUC's Division of Ratepayer Advocates (DRA) filed testimony requesting the overcollection be refunded over 12 months. Subsequent to its original filing, the DRA filed comments supporting refund of the overcollection by a one-time credit applied to customer bills in 1996. In January 1996, an administrative law judge (ALJ) proposed decision recommended that the ECAC overcollection be refunded over 12 months in 1996; however, a CPUC commissioner submitted an alternate proposal requesting adoption of the one-time credit. On February 6, 1996, SCE filed comments supporting the alternate proposal. If the CPUC adopts the alternate proposal, SCE's 1996 CPUC-authorized revenue, including the effects of other rate actions, would be reduced by $338 million, or 4.4%, and SCE would be required to credit customer bills in the second quarter of 1996. If the CPUC adopts the ALJ proposed decision, SCE's 1996 CPUC-authorized revenue would decrease by $575 million, or 7.5%. The reduction in authorized revenue resulting from this matter will not impact 1996 earnings as these costs receive balancing account treatment; however, cash flows in 1996 will be affected. Edison believes it will have sufficient liquidity for the 1996 refund from cash provided by operating activities, projected investment balances and available lines of credit. A final CPUC decision is expected in February 1996.\nA 1994 CPUC decision stated that SCE was liable for expenditures related to a 1985 accident at the Mohave Generating Station. The CPUC ordered a second phase of this proceeding to quantify the disallowance. On December 22, 1995, SCE and the DRA filed a $38 million settlement agreement, subject to CPUC approval. This agreement has been fully reflected in the financial statements.\nIn October 1994, the CPUC authorized SCE to accelerate recovery of its nuclear plant investments by $75 million per year. The rate impact of this accelerated cost recovery is offset by a corresponding deceleration in recovery of transmission and distribution facilities through revised depreciation estimates over their remaining useful lives. The 1995 general rate case decision authorized further accelerated recovery of San Onofre.\nIn 1994, the CPUC ordered the California utilities to proceed with an energy auction to solicit bids for new contracts with unregulated power producers. This decision would have forced SCE to purchase 686 MW of new power at fixed prices starting in 1997, costing SCE customers $14 billion more than other sources over the lives of the contracts. SCE negotiated agreements, at substantially lower costs than those mandated by auction, with eight unregulated power producers, representing 648 MW of the 686 MW mandated. These agreements, which are subject to CPUC approval, would save SCE customers about 85% of anticipated overpayments compared with the mandated contracts. After extensive review by the CPUC and the FERC, the CPUC issued a ruling supporting resolution of the energy auction through negotiated settlements and set criteria to be used to evaluate the settlements. SCE has evaluated the impact of these criteria on its existing settlement agreements and, upon conclusion of settlement negotiations with the remaining parties, will file an application requesting CPUC approval (expected in 1996).\nCompetitive Environment\nSCE currently operates in a highly regulated environment in which it has an obligation to provide electric service to customers in return for an exclusive franchise within its service territory. This regulatory environment is changing. The generation sector has experienced competition from nonutility power producers and regulators are restructuring California's electric utility regulation.\nAs further discussed in Note 2 to the Consolidated Financial Statements, on December 20, 1995, the CPUC issued its restructuring decision, which it had been considering since April 1994. The decision reforms\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\nCalifornia's electric utility regulation by creating a market structure that, over a transition period, would open the electric generation market to competition and offer customer choice. The transition period would begin January 1, 1998, with all consumers participating by 2003. Key elements of the decision include:\no Creation of an independent power exchange to manage electric supply and demand. California's investor-owned utilities would be required to purchase from and sell to the exchange, all of their power during the transition period, while other generators could voluntarily participate.\no Creation of an independent system operator to control intrastate transmission access.\no Availability of customer choice through time-of-use rates, direct customer access to generation providers with transmission arrangements through the system operator, and customer arranged \"contracts for differences\" to manage price fluctuations from the power exchange.\no Recovery of costs to transition to a competitive market (utility investments and obligations incurred to serve customers under the existing regulatory framework) through a non-bypassable charge, applied to all customers, called the competition transition charge (CTC).\no CPUC-established incentives to encourage voluntary divestiture (through spin-off or sale to an unaffiliated entity) of at least 50% of utilities' gas-fueled generation to address market power issues. SCE must file within 90 days its plan to address these issues.\no Performance-based ratemaking (PBR) for those utility services not subject to competition. SCE had originally filed for a PBR mechanism in 1993, requesting a revenue-indexing formula to combine operating expenses and capital-related costs into a single index to determine most of its revenue (excluding fuel) from 1996-2000. The filing was subsequently divided between transmission and distribution, and power generation. Hearings concluded on the transmission and distribution phase in December 1994. The CPUC's restructuring decision requested comments addressing whether SCE's transmission and distribution PBR proposal should be amended or reviewed as filed. On January 19, 1996, SCE requested the CPUC approve its PBR as filed. SCE expects to file its proposal for the power generation phase in July 1996.\nSCE estimates its potential costs to transition to a competitive market (CTC) at approximately $9.3 billion (net present value), based on incurred costs, and forecasts of future costs and assumed market prices. These costs are mainly for qualifying facility contracts, regulatory assets and other costs incurred (whose recovery has been deferred by the CPUC) to provide service to customers, and costs pertaining to certain generating plants. Changes in the assumed market price could require material revisions to SCE's estimated CTC.\nSince restructuring California's electric service industry will have widespread impact, federal participation and oversight will be required. The CPUC is seeking to build a California consensus involving the legislature, governor, public and municipal utilities, and customers, and to have this consensus in place when approval is sought from the FERC. In addition the CPUC will prepare an environmental impact report. If the CPUC's restructuring decision is upheld and implemented as outlined, SCE would be allowed to recover its CTC (subject to a lower return on equity) and would continue to apply accounting standards that recognize the economic effects of rate regulation. The effect of such an outcome would not be expected to materially affect SCE's results of operations or financial condition during the transition period.\nIf revisions are made to the CPUC's restructuring decision that result in SCE no longer meeting the criteria to apply regulatory accounting standards to its generation operations, SCE may be required to write off its recorded generation-related regulatory assets. At December 31, 1995, these amounts totaled $1.4 billion, excluding balancing account overcollections of $237 million, which are expected to be refunded to customers in the near term. Although depreciation-related differences could result from applying a regulatory prescribed depreciation method (straight-line, remaining-life method) rather than a method that would have been applied absent the regulatory process, SCE believes that the depreciable lives of its generation-related assets would not vary significantly from that of an unregulated enterprise, as the CPUC\nSouthern California Edison Company\nbases depreciable lives on periodic studies that reflect the assets' physical useful life. SCE also believes that any depreciation-related differences would be recovered through the CTC.\nAdditionally, if revisions are made to the CPUC's restructuring decision that result in all or a portion of the CTC not being probable of recovery, SCE could have additional write-offs associated with these costs if they are not recovered through another regulatory mechanism. At this time, SCE cannot predict when, or if, a consensus on restructuring will be reached, what revisions will ultimately be made in the CPUC's restructuring plan in subsequent proceedings or implementation phases, or the effect, after the transition period, that competition will have on its results of operations or financial condition.\nFERC Restructuring Proposal\nIn March 1995, the FERC proposed rules which would require utilities to provide wholesale open transmission access to the nation's interstate transmission grid, while allowing them to recover stranded costs associated with open access. The proposal defines stranded costs as legitimate, prudent and verifiable costs incurred to provide service to customers that would subsequently become unbundled wholesale transmission service customers of the utility. SCE supports the basic principles in the FERC's proposal and filed comments in August 1995. A final FERC decision is expected in mid-1996.\nEnvironmental Protection\nSCE is subject to numerous environmental laws and regulations, which require it to incur substantial costs to operate existing facilities, construct and operate new facilities, and mitigate or remove the effect of past operations on the environment.\nAs further discussed in Note 10 to the Consolidated Financial Statements, SCE records its environmental liabilities when site assessments and\/or remedial actions are probable and a range of reasonably likely cleanup costs can be estimated. SCE reviews its sites and measures the liability quarterly, by assessing a range of reasonably likely costs for each identified site. Unless there is a probable amount, SCE records the lower end of this reasonably likely range of costs.\nSCE's recorded estimated minimum liability to remediate its 58 identified sites was $114 million at December 31, 1995, and 1994. One of SCE's sites, a former pole-treating facility, is considered a federal Superfund site and represents 71% of its recorded liability. The ultimate costs to clean up SCE's identified sites may vary from its recorded liability due to numerous uncertainties inherent in the estimation process. SCE believes that due to these uncertainties, it is reasonably possible that cleanup costs could exceed its recorded liability by up to $215 million. The upper limit of this range of costs was estimated using assumptions least favorable to SCE among a range of reasonably possible outcomes.\nThe CPUC allows SCE to recover environmental-cleanup costs at 24 of its sites, representing $90 million of its recorded liability, through an incentive mechanism. Under this mechanism, SCE will recover 90% of cleanup costs through customer rates; shareholders fund the remaining 10%, with the opportunity to recover these costs through insurance and other third-party recoveries. SCE has settled insurance claims with several carriers, and is continuing to pursue additional recovery. Costs incurred at SCE's remaining 34 sites are expected to be recovered through customer rates. SCE has recorded regulatory assets of $104 million for its estimated minimum environmental-cleanup costs expected to be recovered through customer rates.\nSCE's identified sites include several sites for which there is a lack of currently available information, including the nature and magnitude of contamination and the extent, if any, that SCE may be held responsible for contributing to any costs incurred for remediating these sites. Thus, no reasonable estimate of cleanup costs can be made for these sites at this time.\nSCE expects to clean up its identified sites over a period of up to 30 years. Remediation costs in each of the next several years are expected to range from $4 million to $8 million. Recorded costs for 1995 were $3 million.\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\nBased on currently available information, SCE believes it is not likely that it will incur amounts in excess of the upper limit of the estimated range and, based upon the CPUC's regulatory treatment of environmental-cleanup costs, SCE believes that costs ultimately recorded will not have a material adverse effect on its results of operations or financial condition. There can be no assurance, however, that future developments, including additional information about existing sites or the identification of new sites, will not require material revisions to such estimates.\nThe 1990 federal Clean Air Act requires power producers to have emissions allowances to emit sulfur dioxide. Power companies receive emissions allowances from the federal government and may bank or sell excess allowances. SCE expects to have excess allowances under Phase II of the Clean Air Act (2000 and later). The act also calls for a study to determine if additional regulations are needed to reduce regional haze in the southwestern U.S. In addition, another study is underway to determine the specific impact of the effect of air contaminant emissions from the Mohave Coal Generating Station on visibility in Grand Canyon National Park. The potential effect of these studies on sulfur dioxide emissions regulations for Mohave is unknown.\nSCE's projected capital expenditures to protect the environment are $1.2 billion for the 1996-2000 period, mainly for aesthetics treatment, including undergrounding certain transmission and distribution lines.\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 is receiving increased attention. The scientific community has not yet reached a consensus on the nature of any health effects of EMF. However, the CPUC has issued a decision which provides for a rate-recoverable research and public education program conducted by California electric utilities, and authorizes these utilities to take no-cost or low-cost steps to reduce EMF in new electric facilities. SCE is unable to predict when or if the scientific community will be able to reach a consensus on any health effects of EMF, or the effect that such a consensus, if reached, could have on future electric operations.\nNew Accounting Standard\nEffective January 1996, SCE adopted a new accounting standard that requires impairment losses to be recognized when the book value of an asset exceeds its future cash flows (undiscounted). The standard also imposes stricter criteria for the retention of regulatory-created assets, requiring that they continue to be probable of recovery, rather than concluding they are not probable of loss. Adoption of this standard did not materially affect SCE's results of operations or financial condition.\nQuarterly Financial Data\nConsolidated Statements of Income Southern California Edison Company\nConsolidated Statements of Retained Earnings\nThe accompanying notes are an integral part of these financial statements. Consolidated Balance Sheets\nThe accompanying notes are an integral part of these financial statements. Southern California Edison Company\nThe accompanying notes are an integral part of these financial statements. Consolidated Statements of Cash Flows Southern California Edison Company\nThe accompanying notes are an integral part of these financial statements.\nNotes to Consolidated Financial Statements Southern California Edison Company\nNote 1. Summary of Significant Accounting Policies\nSouthern California Edison Company's (SCE) outstanding common stock is owned entirely by its parent company, Edison International (formerly SCEcorp). SCE is a public utility which produces and supplies electric energy for its 4.2 million customers in Central and Southern California. The consolidated financial statements include SCE and its subsidiaries. Intercompany transactions have been eliminated.\nSCE's accounting policies conform with generally accepted accounting principles (GAAP) including the accounting principles for rate-regulated enterprises which reflect the rate-making policies of the California Public Utilities Commission (CPUC) and the Federal Energy Regulatory Commission (FERC).\nSCE currently operates in a highly regulated environment in which it has an obligation to provide electric service to customers in return for an exclusive franchise within its service territory. This regulatory environment is changing, as further discussed in Note 2 to Consolidated Financial Statements. Financial statements prepared in compliance with GAAP require management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosure of contingencies. Actual results could differ from those estimates. Certain significant estimates related to the CPUC restructuring decision, decommissioning and contingencies, are further discussed in Notes 2, 9 and 10, respectively.\nCertain prior-year amounts were reclassified to conform to the December 31, 1995, financial statement presentation.\nDebt Issuance and Reacquisition Expense\nDebt premium, discount and issuance expenses are amortized over the life of each issue. Under CPUC rate-making procedures, debt reacquisition expenses are amortized over the remaining life of the reacquired debt or, if refinanced, the life of the new debt.\nFinancial Instruments\nSCE enters into interest rate swap and cap agreements to manage its interest rate exposure. Interest rate differentials and premiums for interest rate caps to be paid or received are recorded as adjustments to interest expense.\nFuel Inventory\nFuel inventory is valued under the last-in, first-out method for fuel oil and natural gas, and under the first-in, first-out method for coal.\nInvestments\nCash equivalents include tax-exempt investments ($235 million at December 31, 1995, and $132 million at December 31, 1994), and time deposits and other investments ($23 million at December 31, 1995, and $53 million at December 31, 1994) with maturities of three months or less.\nUnrealized gains (losses) on equity investments are recorded as regulatory liabilities (assets). Unrealized gains and losses on decommissioning trust funds are recorded in the accumulated provision for decommissioning.\nAll investments are classified as available-for-sale.\nNuclear\nA CPUC-authorized rate phase-in plan deferred the collection of $200 million in revenue for each unit at Palo Verde Nuclear Generating Station during the first four years of operation. The deferred revenue (including interest) is being collected evenly over the final six years of each unit's plan. The plans end in February and September 1996, respectively, for Units 1 and 2, and in 1998 for Unit 3. Notes to Consolidated Financial Statements\nThe cost of nuclear fuel, including disposal, is amortized to fuel expense on the basis of generation. Under CPUC rate-making procedures, nuclear- fuel financing costs are capitalized until the fuel is placed into production.\nDecommissioning costs are accrued and recovered in rates over the term of each nuclear facility's operating license through charges to depreciation expense (see Note 9).\nUnder the Energy Policy Act of 1992, SCE is liable for its share of the estimated costs to decommission three federal nuclear enrichment facilities (based on purchases). These costs, which will be paid over 15 years, are recorded as a fuel cost and recovered through customer rates.\nIn August 1992, the CPUC approved a settlement agreement between SCE and the CPUC's Division of Ratepayer Advocates (DRA) to discontinue operation of San Onofre Nuclear Generating Station Unit 1 at the end of its then- current fuel cycle because operation of the unit was no longer cost- effective. As part of the agreement, SCE will recover its remaining investment, earning an 8.98% rate of return on rate base, by August 1996. In November 1992, SCE discontinued operation of Unit 1.\nIn October 1994, the CPUC authorized accelerated recovery of SCE's nuclear plant investments by $75 million per year, with a corresponding deceleration in recovery of its transmission and distribution assets through revised depreciation estimates over their remaining useful lives. Recovery of the San Onofre nuclear plant investment has been further accelerated by the 1995 general rate case decision (see Note 2).\nRegulatory Balancing Accounts\nThe differences between CPUC-authorized and actual base-rate revenue from kilowatt-hour sales and CPUC-authorized and actual energy costs are accumulated in balancing accounts until they are refunded to, or recovered from, utility customers through authorized rate adjustments (with interest). Income tax effects on balancing account changes are deferred.\nCPUC-established target generation levels act as performance incentives for SCE's nuclear generating stations. Fuel savings or costs above or below these targets are shared equally by SCE and its customers through balancing account adjustments. With the implementation of San Onofre's incentive pricing plan (see Note 2) in the second quarter of 1996, these performance incentives were discontinued upon completion of the refueling outages in 1995.\nResearch, Development and Demonstration (RD&D)\nSCE capitalizes RD&D costs that are expected to result in plant construction. If construction does not result, these costs are charged to expense. RD&D expenses are recorded in a balancing account, and at the end of the rate-case cycle, any authorized but unspent RD&D funds are refunded to customers. RD&D expenses were $28 million in 1995, $63 million in 1994 and $49 million in 1993.\nRevenue\nOperating revenue includes amounts for services rendered but unbilled at the end of each year.\nUtility Plant\nPlant additions, including replacements and betterments, are capitalized. Such costs include direct material and labor, construction overhead and an allowance for funds used during construction (AFUDC). AFUDC represents the estimated cost of debt and equity funds that finance utility-plant construction. AFUDC is capitalized during plant construction and reported in current earnings. AFUDC is recovered in rates through depreciation expense over the useful life of the related asset. Depreciation of utility plant is computed on a straight-line, remaining-life basis.\nReplaced or retired property and removal costs less salvage are charged to the accumulated provision for depreciation. Depreciation expense stated as a percent of average original costs of depreciable utility plant was 3.6% for 1995, 1994 and 1993. Southern California Edison Company\nNote 2. Regulatory Matters\n1995 General Rate Case\nOn January 10, 1996, the CPUC issued its decision on SCE's 1995 general rate case. The decision affirmed the CPUC's interim order to reduce 1995 operating revenue by $67 million, but decreased 1996 operating revenue by an additional $9 million, which includes a decrease of $44 million for operating and maintenance expenses. The decision also authorized recovery of SCE's remaining investment (approximately $2.7 billion) in San Onofre Units 2 and 3 at a reduced rate of return (7.34% compared to the current 9.55%), over an eight-year period, beginning in the second quarter of 1996.\nFuture operating costs and incremental capital expenditures at San Onofre are subject to an incentive pricing plan, where SCE receives about 4 cents per kilowatt-hour. Profits or losses resulting from cost differences from the incentive price will flow through to shareholders. Beginning in 2004, after SCE's investment is fully recovered, it would be required to share equally with ratepayers the benefits received from operation of the units.\nPerformance-Based Ratemaking (PBR)\nSCE originally filed for a PBR mechanism in 1993, requesting a revenue- indexing formula to combine operating expenses and capital-related costs into a single index to determine most of its revenue (excluding fuel) from 1996-2000. The filing was subsequently divided between transmission and distribution, and power generation. Hearings concluded on the transmission and distribution phase in December 1994. The CPUC's restructuring decision, as further discussed below, requested comments addressing whether SCE's transmission and distribution PBR proposal should be amended or reviewed as filed. On January 19, 1996, SCE requested the CPUC approve its PBR as filed. SCE expects to file its proposal for the power generation phase in July 1996.\nCPUC Restructuring Decision\nOn December 20, 1995, the CPUC issued its decision on restructuring California's electric industry, which it had been considering since April 1994. The new market structure would provide competition and customer choice. The transition to a competitive electric market would begin January 1, 1998, with all consumers participating by 2003. Key elements of the decision are: creation of an independent power exchange; creation of an independent system operator; implementation of greater customer choice; transition cost recovery by the utilities; and CPUC-established incentives to encourage utilities to voluntarily divest at least 50% of their gas-fueled units to address market power issues. Within 90 days of the decision's effective date, SCE must file its plans to address divestiture issues. Also, under the decision the CPUC would regulate the rates, terms and conditions of utility services not subject to competition using PBR instead of cost-of-service regulation.\nThe independent power exchange, which would manage supply and demand through an economic auction, will be under FERC jurisdiction. Purchasing from and selling to the power exchange during the transition period will be mandatory for California's investor-owned utilities, while others can voluntarily participate. The independent system operator would have operational control of the utilities' transmission facilities and, therefore, would control the scheduling and dispatch of all electricity on the state's power grid.\nThe new market structure would provide three avenues of customer choice. The first involves a continuation of utility-tariffed rates with customers choosing a monthly average rate or hourly time-of-use rates, which allows customers with specialized meters to access pricing information and alter their consumption accordingly. The second avenue involves customers continuing with utility-tariffed rates and entering into \"contracts for differences\" which manage risks associated with the market clearing prices published by the power exchange. The last avenue involves customers negotiating directly with generation providers and then arranging for transmission of the power with the transmission system operator (direct access).\nRecovery of costs to transition to a competitive market would be implemented through a non-bypassable competition transition charge (CTC). This charge would apply to all customers who currently use utility services or begin utility service after this decision is effective. SCE estimates its potential transition costs Notes to Consolidated Financial Statements\n(CTC), through 2025 to be approximately $9.3 billion (net present value), based on incurred costs, and forecasts of future costs and assumed market prices. However, changes in the assumed market price could require material revisions to such estimates. The potential transition costs are comprised of $4.9 billion from SCE's qualifying facility contracts, which are the direct result of legislative and regulatory mandates; and $4.4 billion from costs pertaining to certain generating plants and regulatory commitments consisting of costs incurred (whose recovery has been deferred by the CPUC) to provide service to customers. Such commitments include the recovery of income-tax benefits previously flowed-through to customers, postretirement benefit transition costs, accelerated recovery of nuclear plants (including San Onofre Unit 1 as discussed in Note 1 and San Onofre Units 2 and 3 as discussed above), nuclear decommissioning and certain other costs.\nBecause the restructuring of California's electric industry has widespread impact and the market structure requires the participation and oversight of the FERC, the CPUC will seek to build a California consensus involving the legislature, governor, public and municipal utilities, and customers. Once the consensus is in place, FERC approval will be sought, and together both agencies would move forward to implement the new market structure. In addition, the CPUC will prepare an environmental impact report. As a result, the CPUC will not proceed with implementation of its decision until March 1996. If the CPUC's restructuring decision is upheld and implemented as outlined, SCE would be allowed to recover its CTC (subject to a lower return on equity) and would continue to apply accounting standards that recognize the economic effects of rate regulation. The effect of such an outcome would not be expected to materially affect SCE's results of operations or financial condition during the transition period.\nIf revisions are made to the CPUC's restructuring decision that result in SCE no longer meeting the criteria to apply regulatory accounting standards to its generation operations, SCE may be required to write-off its recorded generation-related regulatory assets. At December 31, 1995, these amounts totaled $1.4 billion (excluding balancing account overcollections of $237 million expected to be refunded to customers in the near term), primarily for the recovery of income-tax benefits previously flowed-through to customers, the Palo Verde phase-in plan and unamortized loss on reacquired debt. Although depreciation-related differences could result from applying a regulatory prescribed depreciation method (straight-line, remaining-life method) rather than a method that would have been applied absent the regulatory process, SCE believes that the depreciable lives of its generation-related assets would not vary significantly from that of an unregulated enterprise, as the CPUC bases depreciable lives on periodic studies that reflect the assets' physical useful life. SCE also believes that any depreciation-related differences would be recovered through the CTC.\nAdditionally, if revisions are made to the CPUC's restructuring decision that result in all or a portion of the CTC not being probable of recovery, SCE could have additional write-offs associated with these costs if they are not recovered through another regulatory mechanism. At this time, SCE cannot predict when, or if, a consensus on restructuring will be reached, what revisions will ultimately be made in the CPUC's restructuring plan in subsequent proceedings or implementation phases, or the effect, after the transition period, that competition will have on its results of operations or financial condition.\nFERC Restructuring Proposal\nIn March 1995, the FERC proposed rules which would require utilities to provide wholesale open transmission access to the nation's interstate transmission grid, while allowing them to recover stranded costs associated with open access. The proposal defines stranded costs as legitimate, prudent and verifiable costs incurred to provide service to customers that would subsequently become unbundled wholesale transmission service customers of the utility. SCE supports the basic principles in the FERC's proposal and filed comments in August 1995. A final FERC decision is expected in mid-1996.\nMohave Generating Station\nA 1994 CPUC decision stated that SCE was liable for expenditures related to a 1985 accident at the Mohave Generating Station. The CPUC ordered a second phase of this proceeding to quantify the disallowance. On December 22, 1995, SCE and the DRA filed a $38 million settlement agreement subject to CPUC approval. This agreement has been fully reflected in the financial statements. Southern California Edison Company\nNote 3. Financial Instruments\nLong-Term Debt\nCalifornia law prohibits SCE from incurring or guaranteeing debt for its nonutility affiliates.\nAlmost all SCE properties are subject to a trust indenture lien.\nSCE has pledged first and refunding mortgage bonds as security for borrowed funds obtained from pollution-control bonds issued by government agencies. SCE uses these proceeds to finance construction of pollution- control facilities. Bondholders have limited discretion in redeeming certain pollution-control bonds, and SCE has arranged with securities dealers to remarket or purchase them if necessary.\nLong-term debt maturities and sinking-fund requirements for the next five years are: 1996 $1 million; 1997 $501 million; 1998 $447 million; 1999 $155 million; and 2000 $325 million.\nLong-term debt consisted of:\nOn January 16, 1996, SCE issued $200 million of 5.875% notes, due 2001 and $200 million of 6.375% notes, due 2006.\nShort-Term Debt\nSCE has lines of credit it can use at negotiated or bank index rates. At December 31, 1995, available lines totaled $1.4 billion, with $900 million for short-term debt and $500 million available for the long-term refinancing of certain variable-rate pollution-control debt.\nShort-term debt consisted of commercial paper used to finance fuel inventories, and general cash requirements. Commercial paper outstanding at December 31, 1995, and 1994, was $433 million and $717 million, respectively. A portion of commercial paper intended to finance nuclear fuel scheduled to be used more than one year after the balance sheet date is classified as long-term debt in connection with refinancing terms under five-year lines of credit with commercial banks. Weighted-average interest rates were 5.8% and 5.9%, at December 31, 1995, and 1994, respectively.\nOther Financial Instruments\nSCE's risk management policy allows the use of derivative financial instruments to manage financial exposure on its investments and fluctuations in interest rates, but prohibits the use of these instruments for speculative or trading purposes. Notes to Consolidated Financial Statements\nInterest rate swaps and caps are used to reduce the potential impact of interest rate fluctuations on floating rate long-term debt. The interest rate swap agreement requires the parties to pledge collateral according to bond rating and market interest rates changes. At December 31, 1995, SCE had pledged $13 million as collateral due to a downgrade of its bond rating and a decline in market interest rates. SCE is exposed to credit loss in the event of nonperformance by counterparties to these agreements, but does not expect the counterparties to fail to meet their obligations.\nSCE had the following derivative financial instruments at December 31, 1995:\nFair values of financial instruments were:\nFinancial assets are carried at their fair value based on quoted market prices. Financial liabilities are recorded at cost. Financial liabilities' fair values were based on: termination costs for the interest rate swap; brokers' quotes for long-term debt, preferred stock and the cap; and discounted future cash flows for U.S. Department of Energy (DOE) decommissioning and decontamination fees. Amounts reported for cash equivalents and short-term debt approximate fair value, due to their short maturities.\nNote 4. Equity\nThe CPUC regulates SCE's capital structure, limiting the dividends it may pay Edison International. At December 31, 1995, SCE had the capacity to pay $528 million in additional dividends and continue to maintain its authorized capital structure.\nAuthorized common stock is 560 million shares with no par value. Authorized shares of preferred and preference stock are: $25 cumulative preferred--24 million; $100 cumulative preferred--12 million; and preference--50 million. All cumulative preferred stocks are redeemable. Mandatorily redeemable preferred stocks are subject to sinking-fund provisions. When preferred shares are redeemed, the premiums paid are charged to common equity. There are no preferred stock redemption requirements for the next five years. Southern California Edison Company\nCumulative preferred stock consisted of:\nChanges in preferred securities were:\nNote 5. Income Taxes\nSCE and its subsidiaries will be included in Edison International's consolidated federal income tax and combined state franchise tax returns. Under income tax allocation agreements, each subsidiary calculates its own tax liability.\nSCE adopted an income tax accounting standard in 1993 that requires the balance sheet method to account for income taxes. The cumulative effect of adoption increased 1993 earnings by $8 million and total assets and liabilities by about $2 billion.\nCurrent and Deferred Taxes\nIncome tax expense includes the current tax liability from operations and the change in deferred income taxes during the year. Investment tax credits are amortized over the lives of the related properties. Notes to Consolidated Financial Statements\nThe components of the net accumulated deferred income tax liability were:\nThe current and deferred components of income tax expense were:\nThe composite federal and state statutory income tax rate was 41.045% for all years presented. Southern California Edison Company\nThe federal statutory income tax rate is reconciled to the effective tax rate below:\nNote 6. Employee Benefit Plans\nPension Plan\nSCE has a noncontributory, defined-benefit pension plan that covers employees meeting minimum service requirements. Benefits are based on years of accredited service and average base pay. SCE funds the plan on a level-premium actuarial method. These funds are accumulated in an independent trust. Annual contributions meet minimum legal funding requirements and do not exceed the maximum amounts deductible for income taxes. Prior service costs from pension plan amendments are funded over 30 years. Plan assets are primarily common stocks, corporate and government bonds, and short-term investments.\nThe plan's funded status was:\nSCE recognizes pension expense calculated under the actuarial method used for ratemaking.\nThe components of pension expense were:\nNotes to Consolidated Financial Statements\nPostretirement Benefits Other Than Pensions\nEmployees retiring at or after age 55, with at least 10 years of service, are eligible for postretirement health care, dental, life insurance and other benefits. Health care benefits are subject to deductibles, copayment provisions and other limitations.\nIn 1993, SCE adopted a new accounting standard for these benefits, which requires their expected cost to be expensed during employees' years of service. SCE is amortizing its obligation related to prior service over 20 years. SCE funds these benefits (by contributions to independent trusts) up to tax-deductible limits, in accordance with rate-making practices. SCE began funding its liability for these benefits in 1991. Amounts funded prior to 1993 were amortized and recovered in rates over 12 months. Any difference between recognized expense and amounts authorized for rate recovery is not expected to be material and will be charged to earnings.\nTrust assets are primarily common stocks, corporate and government bonds, and short-term investments.\nThe components of postretirement benefits other than pensions expense were:\nThe funded status of these benefits is reconciled to the recorded liability below:\nThe assumed rate of future increases in the per-capita cost of health care benefits is 10% for 1996, gradually decreasing to 5% for 2003 and beyond. Increasing the health care cost trend rate by one percentage point would increase the accumulated obligation as of December 31, 1995, by $166 million and annual aggregate service and interest costs by $20 million.\nEmployee Savings Plan\nSCE has a 401(k) stock plan designed to supplement employees' retirement income. The plan received employer contributions of $20 million in 1995 and $21 million in both 1994 and 1993.\nSouthern California Edison Company\nNote 7. Jointly Owned Utility Projects\nSCE owns interests in several generating stations and transmission systems for which each participant provides its own financing. SCE's share of expenses for each project is included in the consolidated statements of income.\nThe investment in each project, as included in the consolidated balance sheet as of December 31, 1995, was:\nNote 8. Leases\nSCE has operating leases, primarily for vehicles, with varying terms, provisions and expiration dates.\nEstimated remaining commitments for noncancelable leases at December 31, 1995, were:\nYear ended December 31, In millions - ----------------------- ----------- 1996 $21 1997 18 1998 15 1999 10 2000 8 Thereafter 8 --- Total $80 ===\nNote 9. Commitments\nNuclear Decommissioning\nSCE plans to decommission its nuclear generating facilities at the end of each facility's operating license by a prompt removal method authorized by the Nuclear Regulatory Commission. Decommissioning is estimated to cost $1.8 billion in current-year dollars based on site-specific studies performed in 1993 for San Onofre and 1992 for Palo Verde. This estimate considers the total cost of decommissioning and dismantling the plant, including labor, material, burial and other costs. The site specific studies are updated approximately every three years. Changes in the estimated costs, timing of decommissioning, or the assumptions underlying these estimates could cause material revisions to the estimated total cost to decommission in the near term. Decommissioning is scheduled to begin in 2013 at San Onofre and 2024 at Palo Verde. Currently, San Onofre Unit 1, which shut down in 1992, is expected to be stored until decommissioning begins at the other San Onofre units.\nDecommissioning costs, which are recovered through customer rates, are recorded as a component of depreciation expense. Decommissioning expense was $151 million in 1995, $122 million in 1994 and $141 million in 1993. The accumulated provision for decommissioning was $823 million at December 31, 1995, Notes to Consolidated Financial Statements\nand $692 million at December 31, 1994. The estimated costs to decommission San Onofre Unit 1 ($247 million) are recorded as a liability.\nDecommissioning funds collected in rates are placed in independent trusts, which, together with accumulated earnings, will be utilized solely for decommissioning.\nTrust investments (in millions) include:\nMaturities by class of security are: municipal bonds--1998-2002; U.S. government issues--1997-2025; and other--1997-2045.\nTrust fund earnings (based on specific identification) increase the trust fund balance and the accumulated provision for decommissioning. Net earnings were $51 million in 1995, $26 million in 1994 and $45 million in 1993. Proceeds from sales of securities (which are reinvested) were $1.0 billion in 1995, $1.1 billion in 1994 and $372 million in 1993. Approximately 88% of the trust fund contributions were tax-deductible.\nThe Financial Accounting Standards Board has issued an exposure draft related to accounting practices for removal costs, including decommissioning of nuclear power plants. The exposure draft would require SCE to report its estimated decommissioning costs as a liability, rather than recognizing these costs over the term of each facility's operating license (current industry practice). SCE does not believe that the changes proposed in the exposure draft would have an adverse effect on its results of operations due to its current and expected future ability to recover these costs through customer rates.\nOther Commitments\nSCE has fuel supply contracts which require payment only if the fuel is made available for purchase.\nSCE has power-purchase contracts with certain qualifying facilities (cogenerators and small power producers) and other utilities. The qualifying facility contracts provide for capacity payments if a facility meets certain performance obligations and energy payments based on actual power supplied to SCE. There are no requirements to make debt-service payments.\nSCE has unconditional purchase obligations for part of a power plant's generating output, as well as firm transmission service from another utility. Minimum payments are based, in part, on the debt-service requirements of the provider, whether or not the plant or transmission line is operable. The purchased-power contract is not expected to provide more than 5% of current or estimated future operating capacity. SCE's minimum commitment under both contracts is approximately $225 million through 2017.\nCertain commitments for the years 1996 through 2000 are estimated below:\nSouthern California Edison Company\nNote 10. Contingencies\nIn addition to the matters disclosed in these notes, SCE is involved in legal, tax and regulatory proceedings before various courts and governmental agencies regarding matters arising in the ordinary course of business. SCE believes the outcome of these proceedings will not materially affect its results of operations or liquidity.\nEnvironmental Protection\nSCE is subject to numerous environmental laws and regulations, which require it to incur substantial costs to operate existing facilities, construct and operate new facilities, and mitigate or remove the effect of past operations on the environment.\nSCE records its environmental liabilities when site assessments and\/or remedial actions are probable and a range of reasonably likely cleanup costs can be estimated. SCE reviews its sites and measures the liability quarterly, by assessing a range of reasonably likely costs for each identified site using currently available information, including existing technology, presently enacted laws and regulations, experience gained at similar sites, and the probable level of involvement and financial condition of other potentially responsible parties. These estimates include costs for site investigations, remediation, operations and maintenance, monitoring and site closure. Unless there is a probable amount, SCE records the lower end of this reasonably likely range of costs (classified as other long-term liabilities at undiscounted amounts). While SCE has numerous insurance policies that it believes may provide coverage for some of these liabilities, it does not recognize recoveries in its financial statements until they are realized.\nSCE's recorded estimated minimum liability to remediate its 58 identified sites was $114 million, at December 31, 1995 and 1994. The ultimate costs to clean up SCE's identified sites may vary from its recorded liability due to numerous uncertainties inherent in the estimation process, such as: the extent and nature of contamination; the scarcity of reliable data for identified sites; the varying costs of alternative cleanup methods; developments resulting from investigatory studies; the possibility of identifying additional sites; and the time periods over which site remediation is expected to occur. SCE believes that, due to these uncertainties, it is reasonably possible that cleanup costs could exceed its recorded liability by up to $215 million. The upper limit of this range of costs was estimated using assumptions least favorable to SCE among a range of reasonably possible outcomes.\nThe CPUC allows SCE to recover environmental-cleanup costs at 24 of its sites, representing $90 million of its recorded liability, through an incentive mechanism (SCE may request to include additional sites). Under this mechanism, SCE will recover 90% of cleanup costs through customer rates; shareholders fund the remaining 10%, with the opportunity to recover these costs through insurance and other third-party recoveries. SCE has settled insurance claims with several carriers, and is continuing to pursue additional recovery. Costs incurred at the remaining 34 sites are expected to be recovered through customer rates. SCE has filed a request with the CPUC to add 11 of these sites ($6 million in estimated minimum liability) to the incentive mechanism. SCE has recorded a regulatory asset of $104 million for its estimated minimum environmental- cleanup costs expected to be recovered through customer rates.\nSCE's identified sites include several sites for which there is a lack of currently available information including, the nature and magnitude of contamination, and the extent, if any, that SCE may be held responsible for contributing to any costs incurred for remediating these sites. Thus, no reasonable estimate of cleanup costs can be made for these sites at this time.\nSCE expects to clean up its identified sites over a period of up to 30 years. Remediation costs in each of the next several years are expected to range from $4 million to $8 million. Recorded costs for 1995 were $3 million.\nBased on currently available information, SCE believes it is not likely that it will incur amounts in excess of the upper limit of the estimated range and, based upon the CPUC's regulatory treatment of environmental- cleanup costs, SCE believes that costs ultimately recorded will not have a material adverse effect on its results of operations or financial condition. There can be no assurance, however, that future developments, Notes to Consolidated Financial Statements\nincluding additional information about existing sites or the identification of new sites, will not require material revisions to such estimates.\nNuclear Insurance\nFederal law limits public liability claims from a nuclear incident to $8.9 billion. SCE and other owners of San Onofre and Palo Verde have purchased the maximum private primary insurance available ($200 million). The balance is covered by the industry's retrospective rating plan that uses deferred premium charges to every reactor licensee in the event that a nuclear incident at any licensed reactor in the U.S. results in claims\/costs which exceed the primary insurance at that plant site. Federal regulations require this secondary level of financial protection. The Nuclear Regulatory Commission exempted San Onofre Unit 1 from this secondary level, effective June 1994. The maximum deferred premium for each nuclear incident is $79 million per reactor, but not more than $10 million per reactor may be charged in any one year for each incident. Based on its ownership interests, SCE could be required to pay a maximum of $158 million per nuclear incident. However, it would have to pay no more than $20 million per incident in any one year. Such amounts include a 5% surcharge if additional funds are needed to satisfy public liability claims and are subject to adjustment for inflation. In the event that the public liability limit above is insufficient Federal Regulations will impose further revenue raising measures to pay claims, including a possible additional assessment upon all licensed reactor operators.\nProperty damage insurance covers losses up to $500 million, including decontamination costs, at San Onofre and Palo Verde. Decontamination liability and property damage coverage exceeding the primary $500 million also has been purchased in amounts greater than federal requirements. Additional insurance covers part of replacement power expenses during an accident-related nuclear unit outage. These policies are issued primarily by mutual insurance companies owned by utilities with nuclear facilities. If losses at any nuclear facility covered by the arrangement were to exceed the accumulated funds for these insurance programs, SCE could be assessed retrospective premium adjustments of up to $44 million per year. Insurance premiums are charged to operating expense. Responsibility for Financial Reporting\nThe management of Southern California Edison Company (SCE) is responsible for the integrity and objectivity of the accompanying financial statements. The statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis and are based, in part, on management estimates and judgment.\nSCE maintains systems of internal control to provide reasonable, but not absolute, assurance that assets are safeguarded, transactions are executed in accordance with management's authorization and the accounting records may be relied upon for the preparation of the financial statements. There are limits inherent in all systems of internal control, the design of which involves management's judgment and the recognition that the costs of such systems should not exceed the benefits to be derived. SCE believes its systems of internal control achieve this appropriate balance. These systems are augmented by internal audit programs through which the adequacy and effectiveness of internal controls, policies and procedures are monitored, evaluated and reported to management. Actions are taken to correct deficiencies as they are identified.\nSCE's independent public accountants, Arthur Andersen LLP, are engaged to audit the financial statements in accordance with generally accepted auditing standards and to express an informed opinion on the fairness, in all material respects, of SCE's reported results of operations, cash flows and financial position.\nAs a further measure to assure the ongoing objectivity of financial information, the audit committee of the board of directors, which is composed of outside directors, meets periodically, both jointly and separately, with management, the independent public accountants and internal auditors, who have unrestricted access to the committee. The committee recommends annually to the board of directors the appointment of a firm of independent public accountants to conduct audits of its financial statements; considers the independence of such firm and the overall adequacy of the audit scope and SCE's systems of internal control; reviews financial reporting issues; and is advised of management's actions regarding financial reporting and internal control matters.\nSCE maintains high standards in selecting, training and developing personnel to assure that its operations are conducted in conformity with applicable laws and is committed to maintaining the highest standards of personal and corporate conduct. Management maintains programs to encourage and assess compliance with these standards.\nRichard K. Bushey John E. Bryson Richard K. Bushey John E. Bryson Vice President Chairman of the Board and Controller and Chief Executive Officer\nFebruary 2, 1996 Report of Independent Public Accountants Southern California Edison Company\nTo the Shareholders and the Board of Directors, Southern California Edison Company:\nWe have audited the accompanying consolidated balance sheets of Southern California Edison Company (SCE, a California corporation) and its 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. These financial statements are the responsibility of SCE's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 SCE 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 Notes 5 and 6 to the financial statements, and as required by generally accepted accounting principles, SCE changed its methods of accounting for income taxes and postretirement benefits other than pensions in 1993.\nARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nLos Angeles, California February 2, 1996","section_15":""}
{"filename":"26987_1995.txt","cik":"26987","year":"1995","section_1":"Item 1. Business\nDDL Electronics, Inc. (\"DDL\" or the \"Company\") is an independent provider of electronic contract manufacturing (\"ECM\") services and a fabricator of printed circuit boards (\"PCB\") for use primarily in the computer, communications, and instrumentation industries. The Company provides ECM services for manufacturers of electronic equipment and fabricates multilayer PCBs at its operations in Northern Ireland primarily for customers in Europe.\nThe Company entered the ECM business by acquiring its domestic ECM operations in 1985 and by organizing its European ECM operations in 1990. In its PCB fabrication business, the Company manufactures PCBs ranging from simple single and double-sided boards to multilayer boards with more than 20 layers. Since the mid-1980s, the Company has increasingly focused on the fabrication of advanced multilayer PCBs. Management believes the market for these boards offers the opportunity for more attractive margins than the market for less complex, single and double-sided boards. Since 1985, the Company has made substantial capital expenditures in its Northern Ireland ECM and PCB fabrication facilities. In fiscal 1995, the Company liquidated or sold many assets associated with its United States PCB fabrication facility and its ECM operations. The Company maintains its corporate headquarters in Tigard, Oregon.\nThe Company also has divested its non-ECM and non-PCB businesses in recent years, including its communications business, its pressure gauge and hose manufacturing operations, its emergency lighting equipment manufacturing operations and its engineering services operations.\nRECENT DEVELOPMENTS\nThe Company incurred substantial operating losses in recent years that have impaired operations and positive cash flows. These losses totaled $4,970,000, $6,948,000, and $5,067,000, in the fiscal years ended June 30, 1995, 1994, and 1993, respectively. The Company realized net profits of $75,000 and $1,073,000 in 1995 and 1993, respectively, and incurred a net loss of $8,354,000 in the 1994 fiscal year. The fiscal 1995 net profit, however, included an extraordinary gain of $2,441,000 recognized as a result of the extinguishment of the Company's senior debt in fiscal year 1995, and a gain of $3,317 on a sale of assets in fiscal year 1995. The fiscal 1993 net profit included an extraordinary gains from exchanges of the Company's 7% and 8-1\/2% convertible subordinated debentures (\"CSDs\") for equity, and a $603,000 gain from the sale of a discontinued business.\nThe losses in the Company's ECM and PCB fabrication businesses have resulted from certain Company-specific factors, including yield and quality problems, facility underutilization, delays in meeting delivery schedules, collection problems and management turnover, as well as from excess production capacity in the industry putting extreme downward pressure on the Company's prices and production volume. As a result, the Company sold or liquidated its unprofitable United States operations and concentrated efforts on its profitable European operations.\nIn addition to improving its operations, the Company must also increase sales volume and improve margins in order to maintain its continuing operations in a profitable position. Notwithstanding the steps that have been taken to address the Company's operating problems during the past several years, the Company has only recently realized operating profits from its continuing operations and there can be no assurance that such profits will continue. Maintaining profitability while managing the Company's working capital is required in order to ensure the Company's liquidity and the Company's cash balances are at levels required to operate its business. For management's response to these operating issues, together with other significant events and conditions occurring during the last three years, see the 1995 Annual Report to Stockholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 3 to 12 thereto.\nIn December 1994, the Company successfully consummated an integrated plan retiring over $12,000,000 of its senior debt upon the sale of certain assets of the Company's Aeroscientifc Corp. subsidiary, located in Beaverton, Oregon, to Yamamoto Manufacturing (USA), Inc. In addition, the liens of the Company's two major senior lenders were contemporaneously eliminated. The release of liens was achieved by the Company concluding termination agreements with Sanwa Bank California (\"Sanwa\") which covered Sanwa's term loan to the Company, and with The Tokai Bank Ltd. (\"Tokai\") regarding its letter of credit issued to First Interstate Bank of Oregon, N.A. in connection with Industrial Revenue Bonds (\"IRBs\") issued by the State of Oregon.\nThe January 17, 1994 Los Angeles earthquake caused major structural damage to two leased buildings in Chatsworth, California housing the Company's subsidiary, A.J. Electronics, Inc. (A.J.). In August 1994, after three months of review, the Small Business Administration Disaster Assistance Division (\"SBA\") denied A.J.'s request for economic financial assistance regarding damage suffered in the Los Angeles earthquake. A.J. was unable to recover from the effects of the earthquake and incurred substantial operating losses and cash outlays since the January earthquake. In its financial plan, A.J. predicted that it would not recover economically until sometime in fiscal year 1996. Management concluded, after the SBA's decision to deny A.J. assistance, that A.J. would be a substantial economic burden on the consolidated group considering the limited working capital available to the Company. On January 17, 1995, the Company sold virtually all of A.J.'s operating assets to Raven Industries, Inc., an entity unaffiliated with the Company.\nA program of acquisitions and mergers is being pursued in an effort to accelerate the turnaround of the Company's operating position and to improve shareholder value. Given current and anticipated market conditions, management believes that the Company must develop faster ways of rebuilding and expanding its customer base to withstand the impact of continued downsizing at major customers. No assurance can be given that the revised strategic plan will be successful.\nFINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHICAL AREA\nThe Company is principally engaged in two lines of business, e.g., the provision of ECM services and the fabrication of PCBs. Information for each of the Company's last three fiscal years, with respect to the amounts of revenues from sales to unaffiliated customers, operating profit or loss and identifiable assets of these segments is set forth under the caption \"Selected Financial Data\" appearing on pages 2 and 33 of the Company's 1995 Annual Report to Shareholders. Such information is incorporated herein by this reference and is made a part hereof.\nELECTRONIC CONTRACT MANUFACTURING AND PRINTED CIRCUIT BOARD FABRICATION BUSINESSES\nThe ECM and PCB fabrication industries and the markets in which the Company's customers compete are characterized by rapid technological change and product obsolescence. As a result, the end services provided and products made by the Company's ECM and PCB fabrication customers have relatively short product lives. The Company believes that its future success in these industries is dependent on its ability to continue to incorporate new technology into its ECM and fabrication processes, to satisfy increasing customer demands for quality and timely delivery, and to be responsive to future changes in this dynamic market.\nThe PCB fabrication market is highly fragmented. Numerous factors, however, have caused a shift toward consolidation in the PCB fabrication industry, including extreme competition, substantial excess production capacity experienced by the industry prior to the current fiscal year, the greatly increased capital and technical requirements to service the advanced multilayer PCB fabrication market, and the inability of many PCB fabricators to keep up with the changing demands and expectations of customers on matters such as technical board characteristics, quality, and timely delivery of product.\nDescription of Products and Services--ECM. The Company's ECM operation provides turnkey ECM services using both surface mount and through-hole interconnection technologies. Under the turnkey process, the Company procures customer-specified components from suppliers, assembles the components onto PCBs, and performs post-assembly testing. The Company conducts the ECM portion of its business through its DDL Electronics Limited (\"DDL-E\") subsidiary servicing customers in Western Europe. DDL-E does not fabricate any of the components or PCBs used in these processes. However, it has, in the past, procured PCBs from the Company's PCB fabricator. The ECM business represented approximately 47%, 59% and 55% of the Company's consolidated sales for the fiscal years ended June 30, 1995, 1994, and 1993, respectively.\nSince turnkey electronic contract manufacturing may be a substitute for all or some portion of a customer's captive ECM capability, continuous communication between the Company and the customer is critical. To facilitate such communication, the Company maintains a customer service department whose personnel work closely with the customer throughout the assembly process. The Company's engineering and service personnel coordinate with the customer on the implementation of new and re-engineered products, thereby providing the customer with feedback on such issues as ease of assembly and anticipated production lead times. Component procurement is commenced after component specifications are verified and approved sources are confirmed with the customer. Concurrently, assembly routing and procedures for conformance with the workmanship standards of the Institute for Interconnecting and Packaging Electronic Circuits (\"IPC\") are defined and planned. Additionally, \"in-circuit\" test fixturing is designed and developed. \"In-circuit\" tests are normally performed on all assembled circuit boards for turnkey projects. Such tests verify that components have been properly inserted and meet certain functional standards and that electrical circuits are properly completed. In addition, under protocols specified by the customer, the Company performs customized functional tests designed to ensure that the board or assembly will perform its intended function. The Company's personnel monitor all stages of the assembly process in an effort to provide flexible and rapid responses to the customer's requirements, including changes in design, order size, and delivery schedule.\nThe materials procurement element of the Company's turnkey services consists of the planning, purchasing, expediting, and financing of the components and materials required to assemble a PCB or system-level assembly. Customers have increasingly required the Company and other independent providers of ECM services to purchase all or some components directly from component manufacturers or distributors and to finance the components and materials. In establishing a turnkey relationship with an independent provider of ECM services, a customer must incur expenses in qualifying that provider of ECM services and, in some cases, its sources of component supply, refining product design and ECM processes, and developing mutually compatible information and reporting systems. With this relationship established, the Company believes that customers experience significant difficulty in expeditiously and effectively reassigning a turnkey project to a new assembler or in taking on the project themselves. Alternatively, the Company faces the obstacle of attracting new customers away from existing ECM providers or from performing services in-house.\nProduction of product for a customer is only performed when a firm order is received. Revenue is recognized when product is shipped. Customer cancellation of orders are infrequent and are subject to cancellation charges. More often a customer will delay shipment of orders based on its actual or anticipated needs. Customer orders are produced based on one of two production methods, either \"Turnkey\" (where DDL-E provides all materials, labor and equipment associated with producing the customers' product) or \"Consigned\" (DDL-E provides labor and equipment only for manufacturing product). Material costs customarily represents 70% of the turnkey method's sales price. In other words, a change from turnkey to consigned orders at DDL-E can result in a decline in sales volume without a reduction in profit margin.\nDescription of Products and Services--PCB Fabrication. The Company fabricates and sells advanced, multilayer PCBs based on designs and specifications provided by the Company's customers. These specifications are developed either solely through the design efforts of the customer or through the design efforts of the customer working together with the Company's design and engineering staff. Customers submit requests for quotations on each job and the Company prepares bids based on its own cost estimates. The Company currently conducts the fabrication portion of its PCB business through its Northern Ireland, Irlandus Circuits Limited (\"Irlandus\") subsidiary. The Company's fabrication facilities in Anaheim, California were shut down in fiscal year 1992 and its Beaverton, Oregon facility was sold in the current fiscal year. The PCB fabrication business represented approximately 53%, 41% and 45% of DDL's consolidated sales for the fiscal years ended June 30, 1995, 1994, and 1993, respectively, with four or more layer boards constituting a substantial portion of those sales.\nPCBs range from simple single and double-sided boards to multilayer boards with more than 20 layers. When PCBs are joined with electronic components in the assembly process, they comprise the basic building blocks for electronic equipment. Single-sided PCBs are used in electronic games and automobile ignition systems, whereas multilayer PCBs are used in more advanced applications such as computers, office equipment, communications, instrumentation, and defense systems.\nPCBs consist of fine lines of a conductive material, such as copper, which are bonded to a non-conductive panel, typically rigid laminated epoxy glass. The conductive pathways in the PCBs form electrical circuits and replace wire as a means of connecting electronic components. On technologically advanced multilayer boards, conductive pathways between layers are connected with traditional plated through-holes and may incorporate surface mount technology. \"Through-holes\" are holes drilled entirely through the board that are plated with a conductive material and constitute the primary connection between the circuitry on the different layers of the board and the electronic components attached to the boards later. \"Surface mount\" boards are boards on which electrical components are soldered instead of being inserted into through-holes. Although substantially more complex and difficult to produce, surface mount boards can substantially reduce wasted space associated with through-hole technology and permit greatly increased surface and inner layer densities. Complex boards may also have \"via\" or \"blind-via\" holes that connect inner layers of multi-layer board or connect an inner layer to the outside of the board.\nThe development of increasingly sophisticated electronic equipment, which combines higher performance and reliability with reduced size and cost, has created a demand for increased complexity, miniaturization, and density in electronic circuitry. In response to this demand, multilayer technology is advancing rapidly on many fronts, including the widespread use of surface mount technology. More sophisticated boards are being created by decreasing the width of the tracks on the board and increasing the amount of circuitry that can be placed on each layer. Fabricating advanced multilayer PCBs requires high levels of capital investment and complex, rapidly changing production processes.\nAs the sophistication and complexity of PCBs increase, manufacturing yields typically fall. Historically, the Company relied on tactical quality procedures, in which defects are assumed to exist and quality inspectors examine product lot by lot and board by board to identify deficiencies, using automated optical inspection and electrical test equipment. This traditional approach to quality control is not adequate to produce acceptably high yields in an advanced multilayer PCB fabrication environment, as it focuses on identifying, rather than preventing, defects. In recognition of this limitation, Irlandus is striving to create a positive environment encompassing management's awareness, process understanding, and operator involvement in identifying and correcting production problems before defects occur.\nThe International Standards Organization (\"ISO\") has published internationally recognized standards of workmanship and quality. Both Irlandus and DDL-E, the Company's ECM and PCB operations in Northern Ireland, have achieved ISO 9002 certification which will be increasingly necessary to attract business.\nECM Facilities. DDL-E conducts its operations from a 67,000 square foot facility in Northern Ireland that was purchased in 1989. Prior to DDL-E commencing operations in the Spring of 1990, approximately 1,600,000 pounds sterling (approximately $2,700,000) was expended on auto-insertion equipment, surface mount device placement equipment, wave solder equipment, visual inspection equipment, and automated test equipment. The Company believes that this facility possesses the technology to compete effectively and that the facility is capable of supporting projected growth for up to the next two years.\nFabrication Facilities. Irlandus occupies a 63,000 square foot production facility and an adjacent 9,000 square foot office and storage facility. Irlandus' existing capacity is expected to be adequate to meet anticipated order levels for the next three years. Aeroscientific stopped recognizing revenue at its 44,000 square foot Beaverton, Oregon facility when it was sold to Yamamoto in December 1994.\nMarketing and Customers. The Company's sales in the ECM and fabrication businesses and the percentage of its consolidated sales to the principal end-user markets it serves for the last three fiscal years were as follows (dollars in thousands):\nYear Ended June 30,\nMarkets 1995 1994 1993\nComputer $7,115 24.1% $23,905 49.3% $25,479 44.0% Communications 6,926 23.4 8,396 17.3 14,881 25.7 Financial 2,067 7.0 - - - - Industrial & Instrumentation 6,044 20.4 6,196 12.8 6,555 11.3 Medical 4,668 15.8 6,533 13.4 6,582 11.4 Automotive 175 .6 889 1.8 1,035 1.8 Government\/ Military 1,362 4.6 1,411 2.9 1,509 2.6 Other 1,219 4.1 1,199 2.5 1,842 3.2\nTotal $29,576 100.0% $48,529 100.0% $57,883 100.0%\nThe Company markets its ECM and PCB fabrication services through both a direct sales force and independent manufacturers' representatives. The Company's marketing strategy is to develop close relationships with, and to increase sales to, certain existing and new major ECM and fabrication customers. This includes becoming involved at an early stage in the design of PCBs for these customers' new products. DDL believes that this strategy is necessary to keep abreast of rapidly changing technological needs and to develop new ECM and fabrication processes, thereby enhancing the Company's ECM and fabrication capabilities and its position in the industry. As a result of this strategy, however, fluctuations experienced by one or more of these customers in demand for their products may have and have had adverse effects on the Company's sales and profitability.\nAt the end of the fiscal year ended June 30, 1995, the Company's ECM business had approximately 16 customers, all of which were located in Western Europe, compared to 60 in fiscal 1994 and 37 in fiscal year 1993. At the end of fiscal year 1995, the Company fabricated PCBs for approximately 98 customers, substantially all of which are located in Western Europe, compared to 211 in fiscal year 1994 and 169 in fiscal year 1993. The Company's five largest customers accounted for 21%, 45% and 39% of consolidated sales during fiscal years 1995, 1994, and 1993, respectively. For all three fiscal years , no single PCB fabrication customer accounted for more than 4% of the Company's consolidated sales. The Company's largest European ECM customer accounted for approximately 8% of consolidated sales in fiscal year 1994. Dataproducts Corporation, the largest customer of the Company's former domestic ECM operation, accounted for 13% of consolidated sales in both fiscal years 1993 and 1994. No single customer of the Company's domestic PCB or ECM discontinued businesses accounted for more than 2% of consolidated sales in fiscal year 1995.\nTwo customers of the Company's European ECM operation made combined purchases equal to or in excess of 12% and 10% of consolidated sales during fiscal years 1995 and 1994, respectively. These two customers, GE Medical Systems, a General Electric Company (\"GE Medical\") and DeLaRue Fortronic, LTD, (\"Fortronic\") comprised almost 90% of the Company's European ECM sales in fiscal year 1994. This amount dropped in fiscal year 1995 to 36%. Sales to both of these customers diminished in the latter part of fiscal year 1994. Fortronic's purchases declined due to reduced orders of its magnetic card reader products in the European market, while orders from GE Medical have been reduced as that company relocated its headquarters to the United States. Weakness in orders from these two customers continued into the first half of fiscal year 1995, but orders increased in the last half of fiscal year 1995.\nThe decreased number of customers in both the ECM and PCB businesses reflects the impact of the Company's discontinuance of business at several of its subsidiaries. The number of European customers, however, has increased reflecting the Company's change in marketing activities to increase its customer base in smaller, higher margin entities and reduce the Company's dependency on large run volume, low margin customers.\nRaw Materials and Suppliers. In its ECM business, the Company uses numerous suppliers of electronic components and other materials. The Company's customers may specify the particular manufacturers and components, such as the Intel 80486 microprocessor, to be used in the ECM process. To the extent these components are not available on a timely basis or are in short supply because of allocations imposed by the component manufacturer, and the customer is unwilling to accept a substitute component, delays may occur. Such delays are experienced in the ECM business from time to time and have caused sales and inventory fluctuations at the Company's ECM business.\nThe principal materials used by the Company in its fabrication processes are copper laminate, epoxy glass, copper alloys, gold and various chemicals, all of which are readily available to the Company from various sources. The Company believes that its sources of materials for its fabrication business are adequate for its needs and that it is not substantially dependent upon any one supplier.\nIndustry Conditions and Competition. The markets in which the ECM and PCB fabrication businesses operate are intensely competitive and have experienced excess production capacity during the past few years. Seasonality is not a factor in the ECM and PCB fabrication businesses. There has been significant downward pressure on the prices that the Company is able to charge for its ECM and fabrication services. More recently, market conditions have improved which has resulted in an increase in product demand. While the Company believes that market conditions will continue to improve, it does not believe that prices will increase as quickly. ECM and fabrication customers are increasing their orders, but are reluctant to pay more for such services primarily due to the industry's excess capacity and price competition. Additionally, competition is principally based on price, product quality, technical capability, and the ability to deliver products on schedule. Both the price of and the demand for ECM services and PCBs are sensitive to economic conditions, changing technologies, and other factors. The technology used in the ECM services and fabrication of PCBs is widely available, and there are a large number of domestic and foreign competitors. Many of these firms are larger than the Company and have significantly greater financial, marketing, and other resources. In addition, the Company faces a competitive disadvantage against better financed competitors because the Company's current financial situation causes certain customers to be reluctant to do business with the Company's operating subsidiaries. Many of the Company's competitors have also made substantial capital expenditures in recent years and operate technologically advanced ECM and fabrication facilities. In addition, some of the Company's customers have substantial in-house ECM capability, and to a lesser extent, PCB fabrication capacity. There is a risk that when these customers are operating at less than full capacity they will use their own facilities rather than purchase from the Company. Despite this risk, management believes that the Company has not experienced a significant loss of business to in-house fabricators or assemblers. There also are risks that other customers, particularly in the ECM market, will develop their own in-house capabilities, that additional competitors will acquire the ability to produce advanced, multilayer boards in commercial quantities, or the ability to provide ECM services, and that foreign firms, including large, technologically advanced Japanese firms, will increase their share of the United States or European market.\nPrice competition in the computer marketplace which comprises the Company's largest market is intense. This has caused price erosion and lower margins, particularly in the Company's PCB fabrication business. Significant improvement in the Company's PCB gross margins may not be achieved in the near future due to excess PCB production capacity worldwide and substantial competitive pressures in the Company's principal market. Generally, the Company's customers are reducing inventory levels and seeking lower prices from their vendors, such as the Company, to compete effectively.\nGENERAL\nBacklog. At June 30, 1995, 1994, and 1993, the Company's ECM and PCB fabrication businesses had combined backlogs of $9,247,000, $6,902,000 and $19,612,000, respectively. Backlog is comprised of orders believed to be firm for products that have scheduled shipment dates during the next 12 months. Some orders in the backlog may be canceled under certain conditions. Historically, a substantial portion of the Company's orders have been for shipment within 90 days of the placement of the order and, therefore, backlog information as of the end of a particular period is not necessarily indicative of trends in the Company's business. In addition, the timing of orders from major customers may result in significant fluctuations in the Company's backlog and operating results from period to period.\nBacklog at June 30, 1995 included only the Company's European subsidiaries. The increase from fiscal year 1994 reflects higher order demand from existing ECM customers and new outstanding orders from new ECM customers. The Company's European PCB backlog increased slightly from the last fiscal year. The fabrication group has and is expected to further increase sales volume, but will not increase backlog as the sales increase is expected to come from quick turn orders that are completed within a one month accounting cycle and would, therefore, not be included in the period end backlog.\nBacklog at June 30, 1994 had declined from previous years primarily due to the following reasons:\n1. Loss of large customers and their projected orders in the Company's ECM business. Total backlog for the Company's ECM operations was $4,214,000 at fiscal year end 1994 versus $17,612,000 at fiscal year end 1993.\n2. Change in customer base in both the Company's ECM and PCB units to a larger customer base with smaller, higher margin purchase orders. Many of these customers have short notice, quick turn requirements, and few orders in the Company's backlog therefore extend beyond a one to two month period. Many of last year's backlogged orders covered an eight to 12 month period.\nOn July 1, 1993, the largest customer at the Company's domestic ECM operation in fiscal year 1993, Dataproducts Corporation, (\"Dataproducts\") issued a temporary stop work order on the bulk of its existing purchase orders. Dataproducts' total purchases for the year ended June 30, 1993, were approximately $7,703,000, or approximately 13% of the Company's consolidated revenues for the year and $6,322,000 or 13% of fiscal year 1994 consolidated sales. Dataproducts' order backlog as of June 30, 1993 was approximately $5,747,000 or approximately 29% of the Company's consolidated backlog at such date. Approximately $700,000 of the Dataproducts backlog was canceled as a result of the stop work order and the remaining orders were rescheduled for delivery during the first six months of fiscal year 1994. There were no Dataproducts orders in the fiscal year end 1994 backlog. Because of the Dataproducts cancellation and reschedules, the level of A.J.'s revenues were adversely affected in that year. Events of this nature can materially delay or undermine the Company's ability to complete a successful turnaround and achieve operating profitability which is critical to the Company's viability.\nEnvironmental Regulation. Federal, state, and local provisions relating to the protection of the environment affect the Company's ECM and PCB fabrication businesses. Aeroscientific has used or uses chemicals in the manufacture of their products that are classified by the Environmental Protection Agency (\"EPA\") as hazardous substances. In the past, some of these chemicals were either treated on site or removed from the Company's facilities and disposed of elsewhere by arrangement with the owners or operators of disposal sites. The Company's current operation treats all hazardous substances on site and reclaims, as reusable material, virtually 100% of the byproducts produced. In late 1982, Aeroscientific-Anaheim received notice from the EPA that it was regarded as a potentially responsible party (\"PRP\") under federal environmental laws in connection with a waste disposal site known as the \"Stringfellow Superfund Site\" in Riverside County, California, which is presently being considered by governmental authorities for remediation. Aeroscientific-Anaheim has been named as a third party defendant by other PRPs in a case brought in U.S. District Court for the Southern District of California in 1984, by the United States Government. The information developed during discovery and investigation thus far indicates that Aeroscientific-Anaheim supplied relatively small amounts of waste to the site as compared to the many other defendants. As part of the currently proposed Settlement Agreement, de minimis polluters would pay a fixed amount plus an amount that varies based on volume of material dumped at the site. Under these guidelines, the Company's probable liability will be $120,000. Final settlement and timing of payment are currently undeterminable, and no assurances can be given that any settlement will be achieved. The Company, however, has accrued sufficient liability reserves to cover the proposed settlement as of fiscal year end 1995. Any further remedial costs or damage awards in these cases may be significant and management believes that the Company's allocated share of such costs or damages could have a material adverse effect on the Company's business or financial condition. The actions are still in the pre-trial and discovery stages and a prediction of outcome is difficult. There is, as in the case of most environmental litigation, the theoretical possibility of joint and several liability being imposed upon Aeroscientific for damages which may be awarded. Total estimated cleanup costs for the Stringfellow site have been estimated at $600 million. The Company's possible range of liability is undeterminable, and the reliability and precision of estimated cleanup costs are subject to a myriad of factors which are not currently measurable.\nThe Company is aware of certain chemicals that exist in the ground at its previously leased facility at 1240-1244 South Claudina Street, Anaheim, California. The Company has notified the appropriate governmental agencies and is proceeding with remediation and investigative studies regarding soil and groundwater contamination. The Company believes that it will be required to implement a continuing remedial program for the site, the cost of which is currently unknown. The installation of water and soil extraction wells was completed in August 1994. A plan for soil remediation was completed about the same time and was submitted to regulatory authorities. The full extent of potential ground water pollution could not be determined given preliminary estimates. The Company retained the services of Harding Lawson and Associates in May 1995 to begin the vapor extraction of pollutant from the soil and to perform exploratory hydro-punch testing to determine the full extent and cost of the potential ground water contamination. These processes are in their preliminary stages and a complete and accurate estimate of the full and potential costs cannot be determined at this time. The Company believes that the resolution of these matters will require a significant cash outlay. Initial estimates from Harding Lawson indicate that it could cost as much as $3,000,000 for full remediation of the site and take over ten years to complete. The Company and Aeroscientific entered into an agreement to share the costs of environmental remediation with the landlord at the Anaheim facility. Under this agreement, the Company is obligated to pay 80% of the site's total remediation costs up to $725,000 (i.e., up to the Company's share of $580,000) with any costs above $725,000 being shared equally between the Company and the landlord. To date, the Company has paid $239,000 as its share of the remediation costs. The Company anticipates that its share of the final remediation cost should approximate the amount it has presently reserved. Under the current remediation agreement, the Company is making monthly payments of approximately $18,000 through the end of the current fiscal year. Management believes that the Company has the ability to make these payments when due.\nFrom time to time the Company is also involved in other waste disposal remediation efforts and proceedings associated with its other facilities. Based on information currently available to the Company, management does not believe that the costs of such efforts and proceedings will have a material adverse effect on the Company's business or financial condition.\nHeadquarters Operations\nThe Company maintains its corporate headquarters in a 3,000 square foot leased building located in Tigard, Oregon. In addition to executive officers, 5 employees work in the Company's headquarters. The Company's headquarters operations include the management of the Company's operating subsidiaries on a consolidated basis, the arranging of financing for those operations and capital expenditures and the management of the remaining assets of the Company's discontinued United States operations.\nEmployees. The Company currently employs approximately 340 persons.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table lists principal plants and properties of the Company and its subsidiaries: Owned Square or Location Footage Leased\nECM and PCB fabrication businesses:\nTigard, Oregon 3,000 Leased Chatsworth, California (sublet during fiscal 1995) 48,000 Leased Craigavon, Northern Ireland 63,000 Owned Craigavon, Northern Ireland 67,000 Owned Craigavon, Northern Ireland 9,000 Owned\nThe Northern Ireland properties are pledged as security for installment loans payable to the Industrial Development Board for Northern Ireland from which the properties were purchased. These loans had an aggregate outstanding balance of approximately $1,350,000 at June 30, 1995.\nThe Company's Tigard, Oregon headquarters facility is leased for a two year term expiring on January 6, 1997 from an unaffiliated third party. Rent on the headquarters is paid monthly in advance. Management believes that the Tigard facilities are adequate to meet the Company's needs for the foreseeable future.\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs to other litigation matters that are not specifically described under the caption \"General - Environmental Regulation', Item 1 above, no material legal proceedings are presently pending to which the Company or any of its property is subject, other than ordinary routine litigation incidental to the Company's business\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nAt the Annual Meeting of Shareholders on May 31, 1995, Bernee D.L. Strom and Erven Tallman were elected as Class II directors by the shareholders, replacing former Class II directors Rockell N. Hankin and John F. Coyne. Election of Directors was the only matter proposed at the Annual Meeting of Shareholders. The results of the election are as follows: FOR WITHHELD\nJohn F. Coyne 2,743,980 42,782 Rockell N. Hankin 2,744,980 41,782 Bernee D. L. Strom 9,988,812 28,458 Erven Tallman 9,988,812 28,458\nIn recognition of the shareholder vote, and prior to the certification of the results by the independent inspectors of election, John F. Coyne and Rockell N. Hankin resigned from the Board of Directors immediately following the Annual Meeting of Shareholders. At a meeting of the Board, the remaining Directors accepted these resignations and elected Bernee D. L. Strom and Erven Tallman to fill the vacancies and to serve as directors pending certification of the election results. Solicitation for election of Ms. Strom and Mr. Tallman as Class II Directors was made by an opposition shareholder committee known as \"Shareholders Committee to Remove a Moribund Management\" (\"SCRMM\"). A Settlement Agreement was entered into between the departing Board members of management and SCRMM that, among other things, provided for the election, without dispute, of Ms. Strom and Mr. Tallman as Directors, required the resignation, without dispute, of William E. Cook, the acceptance and recognition by SCRMM of prior company employment and severance agreements with management, and provision for payment of proxy solicitation expenses of DDL up to $150,000 paid by the Company and a similar amount paid for SCRMM's proxy solicitation expenses.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters\nThe information set forth under the caption \"Market Information\" on page 35 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference and made a part hereof.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth under the caption \"Selected Financial Data\" on page 2 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference and made a part hereof.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 3 through 12 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference and made a part hereof.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements set forth on page 14 through 34 of the Company's 1995 Annual Report to Shareholders, and the report of independent public accountants set forth on page 13 of said Annual Report, with respect to the consolidated financial statements, 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\nEffective June 13, 1994, Price Waterhouse was dismissed as DDL Electronic's Inc.'s independent accountants for fiscal year-end 1994.\nPrice Waterhouse's report on the financial statements for the fiscal years 1993 and 1992 contained no adverse opinion or disclaimer of opinion, nor was it qualified or modified as to audit scopes or accounting principles, except that as follows:\nPrice Waterhouse's report dated September 4, 1992 for the fiscal year ended June 30, 1992 included the following explanatory paragraph:\n\"The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations, has few alternative financing sources, 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 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\"\nThe Company's management was given approval by its Board of Directors and the Board's Audit Committee to retain another certified accountant after Price Waterhouse required an 80% increase in its annual service fees.\nThere has never been any and continues to be no disagreements between the Company and Price Waterhouse on any matter of accounting principles or practices, financial statement disclosure or audit scope or procedure, including up until the time of Price Waterhouse's dismissal. The Company has given Price Waterhouse unlimited authority to discuss its audit practices of the Company with the Company's successor auditor.\nThe Company retained KPMG Peat Marwick LLP as its new independent auditors effective June 13, 1994. The Company did not consult with KPMG Peat Marwick LLP on any accounting or tax matter prior to Peat Marwick's appointment.\nAttached to the Company's Form 8-K, filed June 13, 1994, was Price Waterhouse's letter addressed to the Commission regarding its response to Regulation S-K, Item 304. Furthermore, Price Waterhouse was informed that statements in the Company's 8-K\/A, Item 4(a)(1)(iv) included the period up until the time of Price Waterhouse's dismissal.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation called for in Item 10 is omitted because the Company intends to file with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended June 30, 1995 a definitive Proxy Statement pursuant to Regulation 14A of the Commission.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation called for in Item 10 is omitted because the Company intends to file with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended June 30, 1995 a definitive Proxy Statement pursuant to Regulation 14A of the Commission.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation called for in Item 10 is omitted because the Company intends to file with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended June 30, 1995 a definitive Proxy Statement pursuant to Regulation 14A of the Commission.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation called for in Item 10 is omitted because the Company intends to file with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year ended June 30, 1995 a definitive Proxy Statement pursuant to Regulation 14A of the Commission.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nReference (Page) Form 10K 1995 Annual Report to Stockholders (a)(1) List of Financial statements: List of data incorporated by reference:\nConsolidated balance sheet at June 30, 1995, and 1994* 14 Consolidated statement of operations for the years ended June 30, 1995, 1994, and 1993 15 Consolidated statement of stockholders' equity for the years ended June 30, 1995, 1994, and 1993 17 Consolidated statement of cash flows for the years ended June 30, 1995, 1994, and 1993 16 Notes to consolidated financial statements 18 Report of KPMG Peat Marwick LLP on consolidated financial statements 13\n* The Company utilizes a 52-53 week fiscal year ending on the Friday closest to June 30, which, for fiscal years 1995 and 1994, fell on June 30 and July 1, respectively. For 10K filing purposes, June 30, 1995, is utilized for the Company's fiscal year end.\n(a)(2) List of Financial statement schedules for the years ended June 30, 1995, 1994, and 1993:**\nReports of KPMG Peat Marwick LLP and Price Waterhouse on financial statement schedules 14\nVIII - Valuation and Qualifying Accounts and Reserves 15 IX - Short-Term Bank Borrowings None\n** Schedules other than those listed are omitted since they are not applicable, not required, or the information required to be set forth therein is included in the consolidated financial statements or in the notes thereto.\n(a)(3) List of Exhibits: Exhibit Index 17\n(b) Reports on Form 8-K:\nDuring the fourth fiscal quarter, the following reports on Form 8-K were filed:\nOn April 11, 1995, a Form 8-K\/A was filed pursuant to item 2, Acquisition or Disposition of Assets, for filing of pro forma financial information pursuant to Regulation S-X.\nOn April 20, 1995, a Form 8-K was filed pursuant to item 5, Other Events, for a press release announcing that William E. Cook, the Company's Chairman and CEO, had exercised stock options to purchase 300,000 shares of the Company's common stock.\nOn May 11, 1995, a Form 8-K was filed pursuant to item 5, Other Events, for a press release that announced the Company's fiscal third quarter ended March 31, 1995 operating results.\nOn June 7, 1995, a Form 8-K was filed pursuant to item 5, Other Events, for a press release issued June 1, 1995 announcing the resignation of William E. Cook, the Company's Chairman and CEO and the results of the Company's annual meeting of shareholders on May 31, 1995 in which five new directors were added to the board replacing Mr. Cook and two existing directors.\nOn June 21, 1995, a Form 8-K was filed pursuant to item 1, Changes in Control of Registrant, that announced the results of the Company's May 31, 1995 annual meeting of shareholders and the change in the Company's Board of Directors and management.\nREPORT OF INDEPENDENT AUDITORS' ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors DDL Electronics, Inc.\nUnder date of August 18, 1995, we reported on the consolidated balance sheets of DDL Electronics, Inc. and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations, stockholders equity, and cash flows for the years then ended, 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 10K for the year 1995. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in Item 14(a)(2) of this Form 10K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express and 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 Portland, Oregon August 18, 1995\nConsent of Independent Accountants\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 pertaining to the 1975 Nonqualified Stock Option Plan, the 1980 Employee Stock Option Plan, the 1981 Incentive Stock Plan, and the 1985 and 1987 Stock Incentive Plans (No. 33-18356) and the 1991 Nonstatutory Stock Option Plan (No. 33-45102) of DDL Electronics, Inc. of our Report dated August 20, 1993, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules, which appears in this Form 10-K\nPrice Waterhouse LLP September 28, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, DDL Electronics, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDDL Electronics, Inc.\nBy__\/s\/ Don A. Raig____________ Don A.Raig Date: September 28, 1995 Interim 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.\nBy___\/s\/ Don A. Raig_____________ Don A.Raig Date: September 28, 1995 Interim President and Chief Operating Officer and Director\n(Principal Financial and Accounting Officer)\n_\/s\/___Erven Tallman_______________ Erven Tallman Date: September 28, 1995 Acting Chairman, Chief Executive Officer and Director\n\/s\/___Rob Wilson____________________ Rob Wilson Date: September 28, 1995 Interim Vice President and Director\n\/s\/____Philip H. Alspach____________ Philip H. Alspach Date: September 28, 1995 Director\n\/s\/____Bernee D. L. Strom__________ Bernee D.L. Strom Date : September 28, 1995 Director\n\/s\/____Melvin Foster______________ Melvin Foster Date: September 28, 1995 Director\nEXHIBIT INDEX\n3-a Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-8, Commission File No. 33-7440)\n3-b Bylaws of the Company, amended and restated, effective March 1995\n3-c Certificate of Amendment of Certificate of Incorporation of the Company to increase authorized number of common shares (incorporated by reference to Exhibit 3-c of the Company's 1990 Annual Report on Form 10-K)\n3-d Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock of the Company (incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-8, Commission File No. 33-7440)\n3-e Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock of the Company (incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-8, Commission File No. 33-7440)\n4-a Indenture dated July 15, 1988, applicable to the Company's 8-1\/2% Convertible Subordinated Debentures due August 1, 2008 (incorporated by reference to Exhibit 4-c of the Company's 1988 Annual Report on Form 10-K)\n4-b Supplemental Indenture relating to the Company's 8-1\/2% Convertible Subordinated Debentures due August 1, 2008 (incorporated by reference to Exhibit 4-b of the Company's 1991 Annual Report on Form 10-K)\n4-c Indenture relating to the Company's 7% Convertible Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4-c of the Company's 1991 Annual Report on Form 10-K)\n4-d Rights Agreement dated as of June 10, 1989, between the Company and Bank of America, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated June 15, 1989)\n4-e Amendment to Rights Agreement dated as of February 21, 1991, amending the Rights Agreement dated as of June 10, 1989, between the Company and Bank of America, as Rights Agent (incorporated by reference to Exhibit 4.7 of Registration Statement No. 33-39115)\n10-a Intentionally not used\n10-b 1980 Employee Stock Option Plan (incorporated by reference to Exhibit 1 of Registration Statement No. 2-69580)\n10-c 1981 Incentive Stock Option Plan (incorporated by reference to Exhibit 4 of Registration Statement No. 2-79576)\n10-d 1985 Stock Incentive Plan (incorporated by reference to Exhibit 4a of Registration Statement No. 33-3172)\n10-e 1987 Stock Incentive Plan (incorporated by reference to Exhibit 4a of Registration Statement No. 33-18356)\n10-f Form of Indemnity Agreement with officers and directors (incorporated by reference to Exhibit 10-o of the Company's 1987 Annual Report on Form 10-K)\n10-g Consulting Agreement dated March 26, 1990, between the Company and Thomas C. Beiseker (incorporated by reference to Exhibit 10-s of the Company's 1990 Annual Report on Form 10-K)\n10-h Standard Industrial Lease-Net dated August 1, 1984, among the Company, Aeroscientific Corp., and Bradmore Realty Investment Company, Ltd. (incorporated by reference to Exhibit 10-w of the Company's 1990 Annual Report on Form 10-K)\n10-i Net Lease Agreement dated December 2, 1985, among the Company, Catel Telecommunications, Inc. and Phoenix Mutual life Insurance Company (incorporated by reference to Exhibit 10-x of the Company's 1990 Annual Report on Form 10-K)\n10-j Agreement dated March 10, 1992, between Irlandus Circuits Limited and the Industrial Development Board for Northern Ireland amending the Grant Agreement dated September 16, 1987, between Irlandus and the Industrial Development Board (incorporated by reference to Exhibit 10-br of the Company's 1992 Annual Report on Form 10-K)\n10-k Agreement dated September 10, 1991, between DDL Electronics Limited and the Industrial Development Board for Northern Ireland amending the Grant Agreement dated August 29, 1989, between DDL Electronics and the Industrial Development Board (incorporated by reference to Exhibit 10-bt of the Company's 1992 Annual Report on Form 10-K)\n10-l Agreement dated November 22, 1991, between DDL Electronics Limited and the Industrial Development Board for Northern Ireland amending the Grant Agreement dated August 29, 1989, between DDL Electronics and the Industrial Development Board (incorporated by reference to Exhibit 10-bu of the Company's 1992 Annual Report on Form 10-K)\n10-m Agreement dated March 9, 1992, between DDL Electronics Limited and the Industrial Development Board for Northern Ireland amending the Grant Agreement dated August 29, 1989, between DDL Electronics and the Industrial Development Board (incorporated by reference to Exhibit 10-bv of the Company's 1992 Annual Report on Form 10-K)\n10-n Agreement dated June 22, 1992, between DDL Electronics Limited and the Industrial Development Board for Northern Ireland amending the Grant Agreement dated August 29, 1989, between DDL Electronics and the Industrial Development Board (incorporated by reference to Exhibit 10-bw of the Company's 1992 Annual Report on Form 10-K)\n10-o Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated July 15, 1992, between Mark Lainer and\/or Nominee and the Company's A.J. Electronics, Inc. subsidiary (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended October 2, 1992)\n10-p Standard Industrial Lease - Net dated October 15, 1992, between L.N.M. Corporation-Desert Land Managing Corp. and the Company's A.J. Electronics, Inc. subsidiary (incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended October 2, 1993)\n10-q Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated October 19, 1992, between Business Ventures Corporation and the Company (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended January 1, 1993)\n10-r Form of Exchange Agreement between certain holders of the Company's 7% and 8-1\/2% Convertible Subordinated Debentures and the Company dated as of November 11, 1992 (incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended January 1, 1993)\n10-s Warrant Agreement by and between the Company and American Stock Transfer & Trust Company dated as of November 11, 1992 (incorporated by reference to Exhibit 28.2 of the Company's Current Report on Form 8-K dated January 7, 1993)\n10-t Lease Modification and Termination Agreement and Promissory Note, dated April 28, 1993, between the Company and Phoenix Home Life Mutual Insurance Company (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended April 2, 1993)\n10-u Form of Exchange Agreement between certain holders of the Company's 7% and 8-1\/2% Convertible Subordinated Debentures and the Company dated May 14, 1993 (incorporated by reference to Exhibit 28.2 of the Company's Current Report on Form 8-K dated May 19, 1993)\n10-v Amendment to Lease Modification and Termination Agreement, dated June 11, 1993, between the Company and Phoenix Home Life Mutual Insurance Company (incorporated by reference to Exhibit 10-bz of Registration Statement No 33-63618)\n10-w Form of Exchange Agreement between certain holders of the Company's 7% and 8-1\/2% Convertible Subordinated Debentures and the Company dated June 24, 1993 (incorporated by reference to Exhibit 10-ca of Registration Statement No. 33-63618)\n10-x Stock Purchase Agreement, dated July 7, 1993, between Meret Optical Communications, Inc. and the Company (incorporated by reference to Exhibit 10-cb of Registration Statement No. 33-63618)\n10-y Second Amendment to Lease among Bradmore Realty Investment Company, Ltd., the Company and the Company's Aeroscientific Corp. subsidiary, dated July 2, 1993 (incorporated by reference to Exhibit 10-cd of Registration Statement No. 33-63618)\n10-z 1991 General Nonstatutory Stock Option Plan adopted on December 31, 1991 (incorporated by reference to Exhibit 10-cf of the Company's 1993 Annual Report on Form 10-K)\n10-aa Form of Series B preferred Stock Purchase Agreement between the Company and the Industrial Development Board for Northern Ireland (incorporated by reference to Exhibit 10.2 to the Company's Report on Form 8-K dated October 22, 1993)\n10-ab Data-Design Laboratories, Inc. 1993 Stock Incentive Plan (incorporated by reference to Exhibit 4.7 of the Company's Registration Statement on Form S-8, Commission file No. 33-74400)\n10-ac Data-Design Laboratories, Inc. Non-Employee Directors Stock Option Plan (incorporated by reference to Exhibit 4.8 of the Company's Registration Statement on Form S-8, Commission File No. 33-74400)\n10-ad Form of Land Registry for the Company's Northern Ireland subsidiaries dated November 4, 1993 (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report of Form 10-Q for the quarter ended September 30, 1993)\n10-ae Form of Guaranty by the Company's Northern Ireland subsidiaries dated November 4, 1993 in favor of The Tokai Bank, Ltd. and First Interest Bank of Oregon (incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report of Form 10-Q for the quarter ended September 30, 1993)\n10-af Form of Guaranty by the Company's Northern Ireland subsidiaries dated November 4, 1993 in favor of Sanwa Bank California (incorporated by reference to Exhibit 10.3 of the Company's Quarterly Report of Form 10-Q for the quarter ended September 30, 1993)\n10-ag Form of Severance Agreement for Key Employees of the Company (incorporated by reference to the Company's 1994 Annual Report on Form 10-K)\n10-ah Subscription Agreement for 760,000 shares of DDL Electronics, Inc.'s Common Stock (incorporated by reference to Exhibit 10a of the Company's Quarterly Report of Form 10Q for the quarter ended September 30, 1994)\n10-ai Asset Purchase Agreement by and between Yamamoto Manufacturing USA Inc. (\"Buyer\") and Aeroscientific Corp. (\"Seller\") (incorporated by reference to Exhibit 10a of the Company's Report on Form 8K dated November 2, 1994)\n10-aj Asset Purchase Agreement by and between Raven Industries, Inc., A.J. Electronics, Inc. and DDL Electronics, Inc. (incorporated by reference to Exhibit 2.1 of the Company's Report on Form 8K dated January 17, 1995)\n10-ak Closing Settlement Statement executed by A.J. Electronics Inc., DDL Electronics, Inc. and Raven Industries, Inc. (incorporated by reference to Exhibit 2.2 of the Company's Report on Form 8K dated January 17, 1995)\n10-al Non-Competition and Non-Disclosure Agreement between A.J. Electronics and Raven Industries, Inc. (incorporated by reference to Exhibit 2.3 of the Company's Report of Form 8K dated January 17, 1995)\n10-am Payoff Agreement between Sanwa Bank California and the Company dated December 29, 1994\n10-an Termination Agreement between First Interstate Bank of Oregon, N.A., the Tokai Bank Ltd. and the Company dated December 29, 1994\n10-ao Employment Agreement between DDL Electronics, Inc. and William E. Cook\n10-ap Settlement Agreement between DDL Electronics, Inc. and opposition shareholders committee (SCRMM)\n11 Statement re: Computation of Per Share Earnings.\n13 Annual Report to security holders\n16 Letter from Price Waterhouse regarding dismissal as independent accountants (incorporated by reference to Exhibit 16 of the Company's 1994 Annual Report on Form 10K)\n21 Subsidiaries of the Registrant\n23a Consent of KPMG Peat Marwick, LLP\n23b Consent of Price Waterhouse, LLP\n27 Financial Schedule for electronic filers\n99 Undertaking for Form S-8 Registration Statement","section_15":""}
{"filename":"36090_1995.txt","cik":"36090","year":"1995","section_1":"ITEM 1 BUSINESS --------\nBANC ONE CORPORATION (\"Registrant\" or \"BANC ONE\") is a multi-bank holding company incorporated under the laws of the State of Ohio that, at December 31, 1995, operated 1,352 banking offices in Arizona, Colorado, Illinois, Indiana, Kentucky, Ohio, Oklahoma, Texas, Utah, West Virginia and Wisconsin. On January 2, 1996, BANC ONE added 150 banking offices with the acquisition of Premier Bancorp, Inc. of Baton Rouge, Louisiana. Its executive offices are located at 100 East Broad Street, Columbus, Ohio 43215, and its telephone number is (614) 248-5944. At December 31, 1995, BANC ONE had consolidated total assets of $90.5 billion, consolidated total deposits of $67.3 billion and consolidated total stockholders' equity of $8.2 billion (9.1% of its consolidated total assets). At December 31, 1995, BANC ONE ranked tenth among the nation's publicly owned bank holding companies in terms of consolidated average total assets and eighth in terms of consolidated average common equity. BANC ONE's 1995 consolidated net income of $1.3 billion ranked seventh among the nation's 50 largest publicly owned bank holding companies.\nAt December 31, 1995 BANC ONE's affiliate banks held the largest statewide share of total bank deposits in Arizona and Kentucky, the second largest share of such deposits in Indiana, Ohio and West Virginia, and the third largest share of such deposits in Colorado, Wisconsin and Texas. BANC ONE has smaller statewide market shares in the other states in which BANC ONE operates banks. At December 31, 1995, except for Bank One Texas, N.A., no single BANC ONE affiliate bank accounted for more than 20% of BANC ONE's consolidated total assets. BANC ONE also owns nonbank subsidiaries that engage in credit card and merchant processing, consumer finance, mortgage banking, insurance, trust and investment management, brokerage, investment and merchant banking, venture capital, equipment leasing and data processing.\nSince its formation in 1968, BANC ONE has acquired over 100 banking institutions and the number of banking offices of its affiliate banks has increased from 24 to over 1,300. BANC ONE continues to explore opportunities to acquire banks and nonbank companies permitted by the Bank Holding Company Act. Discussions are continually being carried on relating to such acquisitions. It is not presently known whether, or on what terms, such discussions will result in further acquisitions. BANC ONE's acquisition strategy is flexible in that it does not require BANC ONE to effect specific acquisitions so as to enter certain markets or to attain specified growth levels. Rather than being market driven or size motivated, BANC ONE's acquisition strategy reflects BANC ONE's willingness to consider potential acquisitions wherever and whenever such opportunities arise based on the then-existing market conditions and other circumstances. Banks to be acquired must be of sufficient size to support and justify having management of a caliber capable of making lending and other management decisions at the local level under BANC ONE's operating philosophy. BANC ONE also is willing from time to time to acquire a smaller bank when it can be acquired through a reorganization into an existing affiliate. BANC ONE's interest in the acquisition of nonbank companies has been limited to bank-related services with which BANC ONE already has familiarity. BANC ONE's acquisitions may be made by the exchange of stock, through cash purchases and with other consideration.\nBANC ONE is a legal entity separate and distinct from its affiliate banks and its nonbanking subsidiaries (collectively, the \"affiliates\"). Accordingly, the right of BANC ONE, and thus the right of BANC ONE's creditors and shareholders, to participate in any distribution of the assets or earnings of any affiliate is necessarily subject to the prior claims of creditors of the affiliate, except to the extent that claims of BANC ONE in its capacity as a creditor may be recognized. The principal sources of BANC ONE's revenues are dividends and fees from its affiliates. See \"Regulatory Matters--Dividend Restrictions\" for a discussion of the restrictions on the affiliate banks' ability to pay dividends to BANC ONE.\nFor a further description of BANC ONE's business, refer to the following sections of the 1995 Annual Report to Shareholders, which are expressly incorporated herein by reference:\n1. Location of Banking offices and list of subsidiaries on the inside back cover.\n2. Note 2, \"Affiliations, Pending Affiliations, and Divestitures,\" on page 54.\n3. \"Five Year Summary - Average Balances, Income and Expenses, Yields and Rates\" table on pages 24 and 25.\n4. \"Rate-Volume Analysis\" table on page 26.\n5. Note 3, \"Securities and Investment Products\", on pages 55 through 58.\n6. Loans and leases on pages 51, 52, 59 through 61, 32 and 33.\n7. \"Deposit Analysis\" on page 34.\n8. The Key Operating Ratios section of the \"Consolidated Quarterly Financial Data\" on page 44.\n9. Note 7, \"Short-term Borrowings\", on page 62.\n10. The portions of the feature section on pages 7 through 19 except for the information under the captions \"Our Affiliation Philosophy\", \"Measuring Financial Strength\", \"The Changing Role of the Branch Delivery System\" and the \"Conclusion\".\nBANC ONE cautions that any forward looking statements contained in this report, in a report incorporated by reference to this report or made by management of the company involve risks and uncertainties and are subject to change based on various important factors. The forward looking statements could cause actual results for 1996 and beyond to differ materially from those expressed or implied.\nCOMPETITION - -----------\nActive competition exists in all principal areas in which BANC ONE or one or more of its subsidiaries is presently engaged, not only with respect to commercial banks, but also with savings and loan associations, credit unions, finance companies, credit card issuers, mortgage companies, leasing companies, insurance companies, money market mutual funds and brokerage firms together with other domestic and foreign financial and non-financial institutions such as General Electric, General Motors and Ford.\nEMPLOYEES - ---------\nAs of December 31, 1995 BANC ONE and its consolidated subsidiaries had approximately 46,900 full-time equivalent employees.\nREGULATORY MATTERS\nGENERAL\nBANC ONE is subject to the supervision of, and to regular inspection by, the Board of Governors of the Federal Reserve System (the \"Federal Reserve\"). BANC ONE's principal bank affiliates are organized as national banking associations, which are subject to regulation and regular inspection by the Office of the Comptroller of the Currency (\"OCC\"). In addition, various state authorities regulate BANC ONE's state affiliate banks, and all of BANC ONE's affiliate banks are subject to regulation in some degree by the Federal Reserve and the Federal Deposit Insurance Corporation (the \"FDIC\").\nIn addition to banking laws, regulations and regulatory agencies, BANC ONE and its affiliates are subject to various other laws, regulations and regulatory agencies, all of which directly or indirectly affect BANC ONE's operations, management and ability to make distributions. For example, BANC ONE's affiliate banks are affected by various state and federal laws and by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve. An important purpose of these fiscal and monetary policies is to\ncurb inflation and control recessions through control of the supply of money and credit. The Federal Reserve uses its powers to regulate reserve requirements of its member banks, to set the discount rate on extensions of credit to insured depository institutions and to conduct open market operations in United States government securities so as to exercise control over the supply of money and credit. These policies directly affect the amount of, and the interest rates on, bank loans and deposits, and this materially affects bank earnings. Future policies of the Federal Reserve and other authorities cannot be predicted, nor can their effect on future bank earnings be predicted. Similarly, future changes in state and federal laws and wage, price and other economic restraints of the federal government cannot be predicted nor can their effect on future bank earnings be predicted.\nThe following discussion summarizes certain aspects of those laws and regulations that affect BANC ONE. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in the state legislatures and by the various bank regulatory agencies. The likelihood and timing of any legislative or regulatory changes and the impact such changes might have on BANC ONE and its affiliates are difficult to determine.\nHOLDING COMPANY STRUCTURE\nBANC ONE is a legal entity separate and distinct from its affiliates. However, the right of BANC ONE, and thus the rights of BANC ONE's creditors and shareholders, to participate in any distribution of the assets or earnings of any affiliate is necessarily subject to regulatory restrictions on such distributions and to the prior claims of creditors of such affiliate, except to the extent that claims of BANC ONE in its capacity as a creditor may be recognized.\nBANC ONE's affiliate banks are subject to restrictions under federal law which limit the transfer of funds by the affiliate banks to BANC ONE and its nonbanking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases. Such transfers by any affiliate bank to BANC ONE or any nonbanking subsidiary are limited in amount to 10% of the bank's capital and surplus and, with respect to BANC ONE and all such nonbanking subsidiaries, to an aggregate of 20% of such bank's capital and surplus. Furthermore, such loans and extensions of credit are required to be secured in specified amounts.\nThe Federal Reserve has a policy to the effect that a bank holding company is expected to act as a source of financial and managerial strength to each of its affiliate banks and to maintain resources adequate to support each such affiliate bank. This support may be required at times when BANC ONE may not have the resources to provide it. Any capital loans by BANC ONE to any of the affiliate banks are subordinate in right of payment to deposits and to certain other indebtedness of such affiliate bank. In addition, in the event of a bank holding company's bankruptcy any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of an affiliate bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.\nA depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC 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.\nFederal law (12 U.S.C. Section 55) permits the OCC to order the pro rata assessment of shareholders of a national bank whose capital stock has become impaired, by losses or otherwise, to relieve a deficiency in such national bank's capital stock. This statute also provides for the enforcement of any such pro rata assessment of shareholders of such national bank to cover such impairment of capital stock by sale, to the extent necessary, of the capital stock of any assessed shareholder failing to pay the assessment. Similarly, the laws of certain states provide for such assessment and sale with respect to banks chartered by such states. BANC ONE, as the sole shareholder of its affiliate national banks, is subject to such provisions.\nCAPITAL REQUIREMENTS\nBANC ONE is subject to capital ratios, requirements and guidelines imposed by the Federal Reserve, which are substantially similar to the ratios, requirements and guidelines imposed by the Federal Reserve, the OCC and the FDIC on the banks within their respective jurisdictions. These capital requirements establish higher capital standards for banks and bank holding companies that assume greater credit risks. For this purpose, a bank's or holding company's assets and certain specified off-balance sheet commitments are assigned to four risk categories, each weighted differently based on the level of risk that is ascribed to such assets or commitments. A bank's or holding company's capital, in turn, is divided into two tiers: core (\"Tier 1\") capital, which includes common equity, non-cumulative perpetual preferred stock and related surplus (excluding auction rate issues), and minority interests in equity accounts of consolidated subsidiaries, less goodwill, certain identifiable intangible assets and certain other assets; and supplementary (\"Tier 2\") capital, which includes, among other items, perpetual preferred stock not meeting the Tier 1 definition, mandatory convertible securities, subordinated debt and allowances for loan and lease losses, subject to certain limitations, less certain required deductions.\nBANC ONE, like other bank holding companies, currently is required to maintain Tier 1 and total capital (the sum of Tier 1 and Tier 2 capital) equal to at least 4% and 8% of its total risk-weighted assets, respectively. At December 31, 1995, BANC ONE met both requirements, with Tier 1 and total capital equal to 10.05% and 14.05% of its total risk-weighted assets, respectively.\nThe Federal Reserve also requires bank holding companies to maintain a minimum \"leverage ratio\" (Tier 1 capital to adjusted total assets) of 3%, if the holding company has the\nhighest regulatory rating and meets certain other requirements, or of 3% plus an additional cushion of at least 100 to 200 basis points if the holding company does not meet these requirements. At December 31, 1995, BANC ONE's leverage ratio was 8.87%.\nThe Federal Reserve may set capital requirements higher than the minimums noted above for holding companies whose circumstances warrant it. For example, holding companies experiencing or anticipating significant growth may be expected to maintain capital ratios including tangible capital positions well above the minimum levels. The Federal Reserve has not, however, imposed any such special capital requirement on BANC ONE.\nOn August 2, 1995, the Federal Reserve, the FDIC and the OCC jointly adopted a two-step approach to implementing minimum capital standards for interest rate risk exposures. First, the three agencies have revised their respective capital standards to include a bank's (or bank holding company's) exposure to declines in the economic value of its capital due to changes in interest rates as a factor that the agencies will consider in evaluating the bank's (or holding company's) capital. Second, after collecting industry data and evaluating the level of interest rate risk exposure in the banking industry generally, the agencies plan, at some future date, to issue a proposed rule that would establish an explicit minimum capital charge for interest rate risk.\nDIVIDEND RESTRICTIONS\nVarious federal and state statutory provisions limit the amount of dividends BANC ONE's affiliate banks can pay to BANC ONE without regulatory approval. The approval of the appropriate bank regulator is required for any dividend by a national bank or by a state-chartered bank that is a member of the Federal Reserve System (a \"state member bank\") if the total of all dividends declared by the bank in any calendar year would exceed the total of its net profits, as defined by regulatory agencies, for such year combined with its retained net profits for the preceding two years. In addition, a national bank or a state member bank may not pay a dividend in an amount greater than its net profits then on hand. At December 31, 1995, total stockholders' equity of the affiliate banks approximated $7.6 billion, of which $1.1 billion was available for payment of dividends without approval by the applicable regulatory authority.\nIn addition, federal bank regulatory authorities have authority to prohibit the affiliate banks from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending upon the financial condition of the bank in question, could be deemed to constitute such an unsafe or unsound practice. The ability of BANC ONE's affiliate banks to pay dividends in the future is presently, and could be further, influenced by bank regulatory policies and capital guidelines.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") significantly expanded the regulatory and enforcement powers of federal banking regulators, in particular the FDIC, and has important consequences for BANC ONE, its affiliate banks and other depository institutions located in the United States.\nA major feature of FDICIA is the comprehensive directions it gives to federal banking regulators to promptly direct or require the correction of problems at inadequately capitalized banks in the manner that is least costly to the federal deposit insurance funds. The degree of corrective regulatory involvement in the operations and management of banks and their holding companies is, under FDICIA, largely determined by the actual or anticipated capital positions of the subject institution.\nFDICIA established five tiers of capital measurement for regulatory purposes ranging from \"well capitalized\" to \"critically undercapitalized.\" Under regulations adopted by the federal banking agencies, a depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets each such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below any such measure and critically undercapitalized if, among other things, its tangible equity is not greater than 2% of total tangible assets. A depository institution may be deemed to be in a capitalization category lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. FDICIA requires banking regulators to take increasingly strong corrective steps, based on the capital tier of any subject bank, to cause such bank to achieve and maintain capital adequacy. Even if a bank is adequately capitalized, however, the banking regulators are authorized to apply corrective measures if the bank is determined to be in an unsafe or unsound condition or engaging in an unsafe or unsound activity.\nDepending on the level of capital of an insured depository institution, the banking regulatory agencies' corrective powers can include: requiring a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to reduce total assets; requiring the institution to issue additional stock (including voting stock) or to be acquired; placing restrictions on transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election for the institution's board of directors; requiring that certain senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; prohibiting the institution's parent bank holding company from making capital distributions without prior regulatory approval; and, ultimately, appointing a conservator or receiver for the institution.\nIf the insured depository institution is undercapitalized, the parent bank holding company is required to guarantee that the institution will comply with any capital restoration plan submitted to, and approved by, the appropriate federal banking agency in an amount equal to the lesser of (i) 5% of the institution's total assets at the time the institution became undercapitalized\nor (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution failed to comply with the capital restoration plan. If such parent bank holding company guarantee is not obtained, the capital restoration plan may not be accepted by the banking regulators. As a result, such institution would be subject to the more severe restrictions imposed on significantly undercapitalized institutions. Further, the failure of such a depository institution to submit an acceptable capital plan is grounds for the appointment of a conservator or receiver.\nFDICIA also contains a number of other provisions affecting depository institutions, including additional reporting and independent auditing requirements, the establishment of safety and soundness standards, the changing of FDIC insurance premiums from flat amounts to the system of risk-based assessments described below under \"Deposit Insurance Assessments\", a review of accounting standards, and supplemental disclosures and limits on the ability of all but well capitalized depository institutions to acquire brokered deposits. The Riegle Community Development and Regulatory Improvement Act of 1994, however, among other things, contains a number of specific provisions easing the regulatory burden on banks and bank holding companies, including some imposed by FDICIA, and making the bank regulatory system more efficient. Federal banking regulators are taking actions to implement these provisions.\nDEPOSIT INSURANCE ASSESSMENTS\nThe deposits of each of BANC ONE's affiliate banks are insured up to regulatory limits by the FDIC and, accordingly, are subject to deposit insurance assessments to maintain the Bank Insurance Fund (\"BIF\") and Savings Association Insurance Fund (\"SAIF\") administered by the FDIC. The FDIC has adopted regulations establishing a permanent risk-related deposit insurance assessment system. Under this system, the FDIC places each insured bank in one of nine risk categories based on (a) the bank's capitalization and (b) supervisory evaluations provided to the FDIC by the institution's primary federal regulator. Each insured bank's insurance assessment rate is then determined by the risk category in which it is classified by the FDIC.\nUntil June 1, 1995, there was an eight basis point spread between the highest and lowest assessment rates, with banks classified in the highest capital and supervisory evaluation categories being subject to a rate of $0.23 per $100 of deposits and banks classified in the lowest capital and supervisory evaluation categories being subject to a rate of $0.31 per $100 of deposits. These assessment rates reflected, in substantial part, the amount the FDIC had determined necessary to increase the reserve ratio of the BIF to 1.25% of total insured bank deposits. Under FDICIA, the FDIC was required to set deposit insurance premium rates at a level sufficient to achieve that ratio by 2006.\nOn August 8, 1995, having determined that the BIF had attained the required 1.25% reserve ratio during May 1995, the FDIC amended its regulations to adopt a new assessment rate schedule for BIF deposits, effective retroactively on June 1, 1995. This new schedule\nestablished a 27 basis point spread between the highest and lowest assessment rates, with banks classified in the highest capital and supervisory evaluation categories being subject to a rate of $0.04 per $100 of deposits and banks classified in the lowest capital and supervisory evaluation categories continuing to be subject to a rate of $0.31 per $100 of deposits.\nThe new regulations also authorized the FDIC to increase or reduce annual assessment rates by up to 5 basis points from those set forth in the new assessment rate schedule, without formal rulemaking, based on the amount of assessment revenue necessary to maintain the required 1.25% reserve ratio and the assessment schedule that would generate that amount of assessment revenue considering the risk profile of BIF members. On December 11, 1995, based on these factors, the FDIC made such an adjustment, reducing assessment rates by 4 basis points for the semiannual assessment period beginning January 1, 1996. For this six-month period, the annual assessment rate thus will range from $0.00 per $100 of deposits for banks classified in the highest capital and supervisory evaluation categories to $0.27 per $100 of deposits for banks classified in the lowest capital and supervisory evaluation categories subject to a $2,000 per bank minimum assessment. There can be no assurance, however, that this adjustment will continue in effect for subsequent assessment periods, or that the FDIC will not make further adjustments, up or down, in assessment rates.\nBecause the SAIF, which insures savings institution deposits, has not yet reached the required 1.25% reserve ratio, and is not projected to do so for several years, SAIF deposit insurance premium rates have not been lowered, and will continue to range from $0.23 per $100 of deposits for savings institutions classified in the highest capital and supervisory evaluation categories to $0.31 per $100 of deposits for savings institutions classified in the lowest capital and supervisory evaluation categories. However, Congress is considering proposals to recapitalize the SAIF and\/or merge the SAIF with the BIF. It is uncertain whether or when such proposals might be adopted, or what impact they might have on the BIF or on FDIC-insured institutions.\nSome BANC ONE affiliate banks hold deposits that were acquired from savings institutions and that, accordingly, are insured by SAIF. At December 31, 1995, BANC ONE's affiliate banks held $6.3 billion of such deposits. Deposit insurance premiums will be charged on these deposits at the higher SAIF rate.\nDEPOSITOR PREFERENCE STATUTE\nFederal legislation has been enacted providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such institution, including federal funds and letters of credit, in the \"liquidation or other resolution\" of the institution by any receiver.\nBROKERED DEPOSITS\nUnder FDIC regulations, no FDIC-insured bank or savings institution can accept brokered deposits unless it is (a) well capitalized or (b) adequately capitalized and receives a waiver from the FDIC. In addition, these regulations prohibit any bank or savings institution that is not well capitalized from (a) paying an interest rate on deposits in excess of 75 basis points over certain prevailing market rates or (b) offering \"pass through\" deposit insurance on certain employee benefit plan accounts unless it provides certain notice to affected depositors. At December 31, 1995, BANC ONE's affiliate banks had aggregate total brokered deposits of approximately $87 million.\nINTERSTATE BANKING\nUnder the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"Riegle-Neal\"), subject to certain concentration limits, (a) bank holding companies such as BANC ONE are permitted, beginning September 29, 1995, to acquire banks and bank holding companies located in any state; (b) any bank that is a subsidiary of a bank holding company is permitted, again beginning September 29, 1995, to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that holding company; and (c) banks are permitted, beginning June 1, 1997, to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states and establishing de novo branch offices in other states, provided that, in the case of any such purchase or opening of individual branches, the host state has adopted legislation \"opting in\" to those provisions of Riegle-Neal; and provided that, in the case of a merger with a bank located in another state, the host state has not adopted legislation \"opting out\" of that provision of Riegle-Neal. BANC ONE might use Riegle-Neal to acquire banks in additional states and to consolidate its affiliate banks under a smaller number of separate charters.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES ---------- BANC ONE leases its principal offices in Columbus, Ohio under several long-term leases. As of December 31, 1995 BANC ONE's affiliate banks had 1,352 banking offices located in Arizona, Colorado, Illinois, Indiana, Kentucky, Michigan, Ohio, Oklahoma, Texas, Utah, West Virginia and Wisconsin. BANC ONE and its subsidiaries own or lease various office space, computer centers and warehouses. For additional information see the following portions of the 1995 Annual Report to Shareholders, which are expressly incorporated herein by reference:\n1. Note 6, \"Bank Premises, Equipment and Leases\" on page 61.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS ----------------- In 1992, Bank One, Columbus, N.A. (\"Columbus\") was named a defendant in a purported class action lawsuit in Pennsylvania challenging whether Columbus can impose various types of fees, allowed by the state of Ohio, on credit cardholders residing in Pennsylvania (the \"Suit\"). The Suit seeks unquantified compensatory and triple damages and other equitable relief. The Suit is one of many similar class action lawsuits brought against credit card issuing banks throughout the United States. The dismissal of the Suit by the Court of Common Pleas of Philadelphia County, Pennsylvania, which had been upheld by a panel of the Pennsylvania Superior Court, was reversed by the entire Pennsylvania Superior Court in December 1994. Columbus has appealed the decision to the Pennsylvania Supreme Court, which has postponed oral argument pending a decision by the United States Supreme Court in a similar action entitled SMILEY V. CITIBANK, in which the California Supreme Court has affirmed the lower court's decision in favor of the bank. Legal counsel believes that the decision of the entire Pennsylvania Superior Court is contrary to the decisions of most state and federal courts outside Pennsylvania that have considered the issue, which have held that national banks may use the rates and fees of the bank's home state in contracts with cardholders from other states. There can be no assurance that bank affiliates of BANC ONE will not be named as defendants in future similar lawsuits.\nExcept as stated above, neither BANC ONE nor any of its subsidiaries is involved in any material pending legal proceedings other than ordinary routine litigation incident to the business. Similarly, no property owned by any of said entities is the subject of any material pending legal proceedings other than ordinary routine litigation incident to the business.\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 securityholders.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nExecutive officers as of January 1, 1996 are set forth below. Unless otherwise designated, they are officers of BANC ONE CORPORATION. Others hold the positions indicated in wholly owned subsidiaries. All of these executive officers, with the exception of Messrs. Chancey, Lehmann, Logan, Neubert and Steinhart, have been employed by BANC ONE in various capacities during the past 5 years.\n(1) From June 1981 to April 1985, Mr. McMennamin was the Vice Chairman of Bank One Columbus, N.A. and Chief Investment Officer of Banc One Corporation.\nMr. Chancey has served as Chairman and Chief Executive Officer of Banc One Kentucky Corporation since August 1994. From January 1993 until the acquisition of Liberty National Bancorp, Inc. by BANC ONE in August 1994, Mr. Chancey served as Chairman, President and Chief Executive Officer of Liberty National Bancorp. Inc. and as Chairman and Chief Executive Officer of Liberty National Bank and Trust Company of Kentucky. From February 1990 to December 1992, Mr. Chancey served as President of Liberty National Bancorp. Inc. and Liberty National Bank and Trust Company of Kentucky.\nMr. Logan has served as Chairman and Chief Executive Officer of Bank One, Arizona, N.A. since April 1995. From May 1993 to March 1995, Mr. Logan served as a director of Banc One Arizona Corporation. From January 1990 until the acquisition of Valley National Bank in April 1993, Mr. Logan served as President and Chief Operating Officer of Valley National Bank (now Bank One, Arizona, N.A.)\nMr. Neubert has served as Executive Vice President of BANC ONE since 1991. From 1974 to 1991, Mr. Neubert served in various positions with Citicorp.\nMr. Steinhart has served as Chairman and Chief Executive Officer of Bank One, Texas, N.A. since January 1995. From December 1992 to January 1995, Mr. Steinhart served as President and Chief Operating Officer of Bank One, Texas, N.A. From February 1988 until the acquisition of Team Bancshares, Inc. by BANC ONE in November 1992, Mr. Steinhart served as Chairman and Chief Executive Officer of Team Bancshares, Inc., a bank holding company.\nInformation regarding Mr. Lehmann's business experience during the past five years is set forth under the caption \"Election of Directors\" in the definitive Proxy Statement for the 1996 Annual Meeting of Shareholders to be held April 16, 1996 (the \"Proxy Statement\"), which information is expressly incorporated by reference herein.\nPART II -------\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER ---------------------------------------------------------------- MATTERS -------\nSTOCK LISTING\nCOMMON - ------ New York Stock Exchange: BancOne Ticker Symbol: ONE\nSERIES C PREFERRED - ------------------ NASD National Market Symbol: BancOne pfC Ticker Symbol: BONEO\nSee the following portions of the 1995 Annual Report to Shareholders which are expressly incorporated herein by reference: - - \"Financial Highlights\" on page 1. - - \"Consolidated Quarterly Financial Data\" on pages 44 and 45. - - Notes 8, 9, 10, and 15 on pages 63, 64 and 70. - - \"Five Year Performance Summary\" on page 22. - - \"Ten Year Performance Summary\" on pages 42 and 43.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA -----------------------\nSee the following portions of the 1995 Annual Report to Shareholders which are expressly incorporated herein by reference: - - \"Five Year Performance Summary\" on page 22. - - \"Ten Year Performance Summary\" on pages 42 and 43. - - Note 2 on page 54.\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nSee the following portions of the 1995 Annual Report to Shareholders which are expressly incorporated herein by reference: - - \"Management's Discussion and Analysis\" on pages 22 through 41. - - \"Five Year Summary-Average Balances, Income and Expense, Yields and Rates\" on pages 24 and 25. - - \"Rate-Volume Analysis\" on page 26. - - \"Allowance for credit loans\" on page 32. - - \"Loan and Lease Analysis\" on page 33. - - \"Consolidated Quarterly Financial Data\" on pages 44 and 45.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nSee the following portions of the 1995 Annual Report to Shareholders which are expressly incorporated herein by reference: - - \"Consolidated Financial Statements and footnotes\" on pages 46 through 74. - - \"Consolidated Quarterly Financial Data\" on pages 44 and 45.\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nRegistrant has had no disagreement on accounting and financial disclosure matters and has not changed accountants during the two year period ending December 31, 1995.\nPART III --------\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nThe information set forth under the captions \"Election of Directors\" and \"Certain Reports\" in the Proxy Statement is expressly incorporated herein by reference.\nReference is made to Part I of this Form 10-K for information as to the executive officers of the registrant.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION ----------------------\nThe information set forth under the captions \"Directors Fees and Compensation\" and \"Executive Compensation\" (excluding the information set forth under the caption \"Executive Compensation--Comparison of Five Year Cumulative Total Return\") and \"Compensation Committee Interlocks and Insider Participation\" in the Proxy Statement is expressly incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nInformation concerning the beneficial ownership of BANC ONE Common Stock as of January 1, 1996 by (i) each person who is known by the Registrant to own beneficially more than 5% of BANC ONE Common Stock (ii) all BANC ONE directors and executive officers (30 individuals) as a group as of January 1, 1996 and (iii) by the executive officers of BANC ONE named in the Summary Compensation Table (except with respect to Messrs. John B. McCoy and Lehmann whose share ownership is reported in the information on nominees for election as directors under \"Election of Directors\" in the Proxy Statement) is set forth under the caption \"Ownership of Shares\" in the Proxy Statement, which information is expressly incorporated herein by reference. Information concerning the beneficial ownership of BANC ONE Common Stock as of January 1, 1996 by each current director and each nominee for director is set forth under the caption \"Election of Directors\" in the Proxy Statement, which information is expressly incorporated herein by reference.\nNo shares of BANC ONE Preferred Stock are beneficially owned by any BANC ONE director or executive officer, except for 600 shares of BANC ONE Preferred Stock owned by one executive officer and constituting less than 1% of the outstanding shares of BANC ONE Preferred Stock.\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 \"Transactions with Management and Others\" in the Proxy Statement is expressly incorporated herein by reference.\nPART IV -------\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K INDEX ---------------------------------------------------------------------- TO FINANCIAL STATEMENTS AND SCHEDULES - -------------------------------------\nBANC ONE CORPORATION and Subsidiaries\nNo schedules are included because they are not required, not applicable, or the required information is contained elsewhere.\nINDEX TO EXHIBITS -----------------\nThere are no agreements with respect to long-term debt of the Registrant to authorize securities in an amount\nwhich exceeds 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of any agreement with respect to long-term debt of the Registrant to the Securities and Exchange Commission upon request.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBANC ONE CORPORATION\nBy: John B. McCoy March 28, 1996 -------------------------------------- --------------------------- John B. McCoy Date its Chairman\nBy: Michael J. McMennamin March 28, 1996 -------------------------------------- --------------------------- Michael J. McMennamin Date its Executive Vice President - Finance\nBy: William C. Leiter March 28, 1996 -------------------------------------- --------------------------- William C. Leiter Date its Controller Pursuant to the requirements of Securities Exchange Act of 1934, 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: Charles E. Exley, Jr March 28, 1996 -------------------------------------- --------------------------- Charles E. Exley, Jr., Director Date\nBy: E. Gordon Gee March 28, 1996 -------------------------------------- --------------------------- E. Gordon Gee, Director Date\nBy: John R. Hall March 28, 1996 -------------------------------------- --------------------------- John R. Hall, Director Date\nBy: Laban P. Jackson, Jr. March 28, 1996 -------------------------------------- --------------------------- Laban P. Jackson, Jr., Director Date\nBy: John W. Kessler March 28, 1996 -------------------------------------- --------------------------- John W. Kessler, Director Date\nBy: Richard J. Lehmann March 28, 1996 -------------------------------------- --------------------------- Richard J. Lehmann, Director Date\nBy: John B. McCoy March 28, 1996 -------------------------------------- --------------------------- John B. McCoy, Director Date\nBy: John G. McCoy March 28, 1996 -------------------------------------- --------------------------- John G. McCoy, Director Date\nBy: Richard L. Scott March 28, 1996 -------------------------------------- --------------------------- Richard L. Scott, Director Date\nBy: Thekla R. Shackelford March 28, 1996 -------------------------------------- --------------------------- Thekla R. Shackelford, Director Date\nBy: Alex Shumate March 28, 1996 -------------------------------------- --------------------------- Alex Shumate, Director Date\nBy: Frederick P. Stratton, Jr. March 28, 1996 -------------------------------------- --------------------------- Frederick P. Stratton, Jr., Director Date\nBy: Robert D. Walter March 28, 1996 -------------------------------------- --------------------------- Robert D. Walter, Director Date","section_15":""}
{"filename":"277925_1995.txt","cik":"277925","year":"1995","section_1":"ITEM 1. BUSINESS. -------- General - ------- Public Storage Properties V, Ltd. (the \"Partnership\") is a publicly held limited partnership formed under the California Uniform Limited Partnership Act in May, 1978. The Partnership raised $22,000,000 in gross proceeds by selling 44,000 units of limited partnership interests (\"Units\") in an interstate offering which commenced in March, 1979 and completed in October, 1979. The Partnership was formed to engage in the business of developing and operating self-storage facilities offering storage space for personal and business use (the \"mini-warehouses\").\nIn 1995, there were a series of mergers among Public Storage Management, Inc. (which was the Partnership's mini-warehouse operator), Public Storage, Inc. (which was one of the Partnership's general partners) (\"Old PSI\") and their affiliates (collectively, \"PSMI\"), culminating in the November 16, 1995 merger (the \"PSMI Merger\") of PSMI into Storage Equities, Inc., a real estate investment trust organized as a California corporation. In the PSMI Merger, Storage Equities, Inc.'s name was changed to Public Storage, Inc. (\"PSI\") and PSI acquired substantially all of PSMI's United States real estate operations and became a co-general partner of the Partnership and the operator of the Partnership's mini-warehouse properties.\nThe Partnership's general partners are PSI and B. Wayne Hughes (\"Hughes\") (collectively referred to as the \"General Partners\"). Hughes has been a general partner of the Partnership since its inception. Hughes is chairman of the board and chief executive officer of PSI, and Hughes and members of his family (the \"Hughes Family') are the major shareholders of PSI.\nThe 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 operation or conduct of its business and affairs.\nThe Partnership's objectives are to (i) maximize the potential for appreciation in value of the Partnership's properties and (ii) generate sufficient cash flow from operations to pay all expenses, including the payment of interest to Noteholders. All of the properties were financed in 1989.\nThe term of the Partnership is until all properties have been sold and, in any event, not later than December 31, 2038.\nInvestments in Facilities - ------------------------- At December 31, 1995, the Partnership owned 15 properties including one business park. Nine of the properties are located in California, three in Florida and three in Georgia. One of the mini-warehouses, the Miami\/Perrine, Florida facility, was destroyed by Hurricane Andrew in August 1992, and will not be reconstructed (see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ---------- The following table sets forth information as of December 31, 1995 about properties owned by the Partnership:\n(1) In August 1992, the facility's mini-warehouse buildings were destroyed by Hurricane Andrew. The General Partners have decided that it would be more beneficial to the Partnership, given the condition of the market area of the facility, to cease operations and not to reconstruct the facility. The General Partners are attempting to sell the land. (2) The project's net rentable area contains office space or a combination of office and light industrial space. (3) Business Park.\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 1995, the Partnership completed environmental assessments of its properties to evaluate the environmental condition of, and potential environmental liabilities of such properties. These assessments were performed by an independent environmental consulting firm. Based on the assessments, the Partnership has expensed, as of December 31, 1995, an estimated $27,000 for known environmental remediation requirements.\nThe properties are held subject to encumbrances which are described in this report under Note 7 of the Notes to the Financial Statements included in Item 14(a).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------------------ No material legal proceeding is pending against the Partnership.\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 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 Certificate and 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 the General Partners have 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 1,626 record holders of Units.\nIn April 1995, Old PSI completed a cash tender offer, in which Old PSI acquired 17,137 Units of the 44,000 outstanding limited Partnership Units in the Partnership at $250 per Unit (following acceptance of the Units in the tender offer by Old PSI, Old PSI transferred to Hughes 4,852 Units). As a result of the PSMI merger, PSI owns all of the Units that were owned by Old PSI, and PSI has an option to acquire all of the Units owned by Hughes. As of February 29, 1996, PSI and Hughes owned an aggregate of 21,035 Units (47.8% of the Units).\nDistributions to the general and limited partners of all \"Cash Available for Distribution\" have been made quarterly. Cash Available for Distribution is generally funds from operations of the Partnership, without deduction for depreciation, but after deducting funds to pay or establish reserves for all other expenses (other than incentive distributions to the general partner) and capital improvements, plus net proceeds from any sale or financing of the Partnership's properties. In the third quarter of 1991, quarterly distributions were discontinued to enable the Partnership to increase its reserves for principal repayments that commenced in 1991 and will continue through 1999, at which time the entire remaining principal balance will be payable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. -----------------------\n(1) Net income for 1993 includes a gain relating to a destroyed real estate facility totaling $1,369,000 ($30.81 per Unit). (2) Per unit data is based on the weighted average number of the limited partnership units (44,000) outstanding during the period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ----------------------------------------------------------------\nResults of Operations - --------------------- YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994:\nThe Partnership's net income was $1,426,000 in 1995 compared to $1,189,000 in 1994, representing an increase of $237,000. The increase was primarily attributable to an increase in property net operating income at the Partnership's mini-warehouse facilities combined with decreased interest expense and partially offset by environmental costs incurred on the Partnership's facilities in 1995 (see discussion below).\nDuring 1995, property net operating income (rental income less cost of operations, management fees paid to affiliates and depreciation expense) was $3,586,000 in 1995 compared to $3,515,000 in 1994, representing an increase of $71,000 or 2%. This increase was primarily attributable to an increase in rental income at the Partnership's mini-warehouse facilities partially offset by a decrease in rental income at the San Francisco business park facility and an increase in cost of operations and depreciation expense.\nRental income was $6,210,000 in 1995 compared to $6,012,000 in 1994, representing an increase of $198,000 or 3%. The increase was primarily attributable to an increase in rental income at the Partnership's mini-warehouse facilities due primarily to an increase in rental rates. Rental income at the San Francisco business park facility declined by $31,000 due to a 4 point decrease in occupancy. The weighted average occupancy levels for the mini-warehouse and business park facilities were 90% and 91%, respectively, in 1995 compared to 89% and 95%, respectively, in 1994. The monthly realized rent per occupied square foot for the mini-warehouse and business park facilities averaged $.76 and $1.04, respectively, in 1995 compared to $.74 and $1.10, respectively, in 1994.\nOther income increased $14,000 in 1995 compared to 1994. Other income includes business interruption insurance proceeds (net of certain costs and expenses of maintaining the Miami facility, discussed below in the results of operations for the year ended December 31, 1994), relating to the disposed facility, of $109,000 and $87,000 in 1995 and 1994, respectively.\nDividend income from marketable securities of affiliate increased $96,000 in 1995 compared to 1994. This increase was mainly attributable to an increase in the number of shares owned in 1995 compared to 1994 and an increase in the dividend rate from $.21 to $.22 per quarter per share.\nCost of operations (including management fees paid to affiliates) increased $57,000 or 3% to $1,936,000 in 1995 from $1,879,000 in 1994. This increase was primarily attributable to increases in payroll and repairs and maintenance offset by a decrease in property tax expense.\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 1995, the Partnership completed environmental assessments of its properties to evaluate the environmental condition of, and potential environmental liabilities of such properties. These assessments were performed by an independent environmental consulting firm. Based on the assessments, the Partnership has expensed, as of December 31, 1995, an estimated $27,000 for known environmental remediation requirements. 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.\nInterest expense was $2,598,000 and $2,677,000 in 1995 and 1994, respectively, representing a decrease of $79,000 or 3%. The decrease was primarily a result of a lower outstanding loan balance in 1995 compared to 1994.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993:\nThe Partnership's net income for 1994 was $1,189,000 compared to $2,144,000 in 1993, representing a decrease of $955,000. The 1993 net income includes a gain relating to a destroyed mini-warehouse facility, totaling $1,369,000, accordingly, income before the gain increased by $414,000 or 53% in 1994 compared to 1993. The increase was primarily due to an increase in property net operating income at the Partnership's mini-warehouse facilities combined with decreased interest expense.\nIn August 1992, the buildings at a mini-warehouse facility located in Miami, Florida (Miami\/Perrine) were completely destroyed by Hurricane Andrew. The facility was adequately insured with respect to business interruption and reconstruction of the facility. The General Partners and insurers reached a settlement whereby the Partnership would receive net insurance proceeds of approximately $2,881,000. The General Partners determined that it would be more beneficial to the Partnership, given the condition of the market area, to cease operations at this location and therefore decided not to reconstruct the buildings. Therefore, after allowing for demolition and clean up costs of $212,000 and an amount specified for business interruption insurance, the Partnership reduced (i) real estate facilities by $661,000, the net book value of the destroyed buildings, and (ii) other related net assets and liabilities of $7,000, and (iii) recognized a gain of $1,369,000 for the year ended December 31, 1993.\nProperty net operating income (rental income less cost of operations, management fees paid to affiliates and depreciation expense) was $3,515,000 in 1994 and $3,350,000 in 1993, representing an increase of $165,000 or 5%. The increase was primarily due to an increase in rental income at the Partnership's facilities offset by an increase in cost of operations and depreciation expense.\nRental income was $6,012,000 in 1994 compared to $5,770,000 in 1993, representing an increase of $242,000 or 4%. This increase was primarily attributable to increased rental rates at the Partnership's mini-warehouse facilities. The weighted average occupancy levels for the mini-warehouse and business park facilities remained stable at 89% and 95%, respectively, for 1994 and 1993. The average monthly realized rent per occupied square foot for the mini-warehouse and business park facilities was $.74 and $1.10, respectively, in 1994 compared to $.71 and $1.01 respectively, in 1993.\nCost of operations (including management fees paid to affiliates) was $1,879,000 in 1994 and $1,827,000 in 1993, respectively, representing an increase of $52,000 or 3%. The increase was primarily the result of increases in repairs and maintenance and payroll expense, partially offset by a decrease in advertising expense.\nOther income includes business interruption insurance proceeds (net of certain costs and expenses of maintaining the property), relating to the disposed facility, of $87,000 and $166,000 for 1994 and 1993, respectively.\nDividend income from marketable securities of affiliate increased $146,000 in 1994 compared to 1993. This increase was mainly attributable to an increase in the number of shares owned in 1994 compared to 1993.\nInterest expense was $2,677,000 and $2,836,000 in 1994 and 1993, respectively, representing a decrease of $159,000 or 6%. The decrease was primarily a result of a lower outstanding loan balance in 1994 compared to 1993 due to the prepayment of $1,530,000 of principal in February 1994 on the loan.\nLiquidity and Capital Resources - ------------------------------- Cash flows from operating activities ($1,626,000 for the year ended December 31, 1995) have been sufficient to meet all current obligations of the Partnership. During 1996, the Partnership anticipates approximately $464,000 of capital improvements. During 1995, the Partnership's property operator commenced a program to enhance the visual appearance of the mini-warehouse facilities operated 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 $60,000 for such enhancements.\nAt December 31, 1995, the Partnership held 440,584 (including the November 1995 purchase) shares of common stock (marketable securities) with a fair value totaling $8,371,000 (cost of $5,283,000 at December 31, 1995) in Public Storage, Inc. (PSI). In November 1995, the Partnership purchased an additional 22,456 shares of PSI common stock at a cost of $398,000. The Partnership recognized $373,000 in dividends during 1995.\nIn November 1995, the Management Agreement was amended to provide that upon demand from PSI or PSMI made prior to December 15, 1995, the Partnership agreed to prepay (within 15 days after such demand) up to 12 months of management fees (based on the management fees for the comparable period during the calendar year immediately preceding such prepayment) discounted at the rate of 14% per year to compensate for early payment. In December 1995, the Partnership prepaid, to PSI, 8 months of 1996 management fees at a cost of $229,000.\nThe aggregate amount of distributions paid to the Limited and General Partners each year since inception of the Partnership were as follows:\n1979 $ 338,000 1980 1,281,000 1981 1,449,000 1982 4,455,000 1983 2,737,000 1984 3,187,000 1985 3,868,000 1986 4,046,000 1987 3,506,000 1988 3,211,000 1989 26,253,000 1990 438,000 1991 146,000 1992 - 1993 - 1994 - 1995 -\nQuarterly distributions were reduced in 1990, and discontinued in 1991, to enable the Partnership to increase its cash reserves for principal payments that commenced in 1991, and are scheduled to increase in subsequent years through 1999, at which time the remaining principal balance is payable.\nDuring the third quarter of 1987, the limited partners recovered all of their initial investment thereby increasing the General Partners' share of cash distributions from 8% to 25% (see Item 13).\nDuring 1989, the Partnership financed all of its properties with a $26,250,000 loan with fixed interest of 10.75% per annum. Proceeds of $24,356,000 were distributed to the partners in June 1989 and are included in the 1989 distribution. In February 1994, the Partnership made a prepayment of principal totaling $1,530,000 on this note. As a result of the pre-payment, the monthly payment of principal and interest has been reduced from $257,000 to $242,000. At December 31, 1995, the outstanding balance of the mortgage note was $23,196,000, which matures on June 1, 1999.\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 Financial Statements and Financial Statement Schedule in 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 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.\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:\nName Positions with PSI - ------------------------- ---------------------------------------------------- B. Wayne Hughes Chairman of the Board and Chief Executive Officer Harvey Lenkin President and Director Ronald L. Havner, Jr. Senior Vice President and Chief Financial Officer Hugh W. Horne Senior Vice President Obren B. Gerich Senior Vice President Marvin M. Lotz Senior Vice President Mary Jayne Howard Senior Vice President David Goldberg Senior Vice President John Reyes Vice President and Controller Sarah Hass Vice President and Secretary Robert J. Abernethy Director Dann V. Angeloff Director William C. Baker Director Uri P. Harkham Director Berry Holmes Director\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. He is responsible for managing all aspects of property acquisition for PSI. Mr. Horne has been a Vice President of SPI since 1989, and of the Public Storage Properties REITs since 1993.\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 Officer 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 the Company 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 restaurants 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 Certificate and Agreement of Limited Partnership, a copy of which is included in the Partnership's Registration Statement File No. 2-63247, 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 the shareholders of 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 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.\nBased on a review of the reports filed under Section 16 (a) of the Securities and Exchange Act of 1934 with respect to the Units that were submitted to the Partnership, the Partnership believes that with respect to the fiscal year ended December 31, 1995, Old PSI (a former General Partner and owner of more than 10% of the Units) and Hughes (a General Partner and owner of more than 10% of the Units) each filed one report on Form 4 which disclosed (in addition to transactions that were timely reported) two transactions that were not timely reported.\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 its 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 persons beneficially owned more than 5% of the Units:\n(1) Includes (i) 16,183 Units owned by PSI as to which PSI has sole voting and dispositive power and (ii) 4,852 Units which PSI has an option to acquire (together with other securities) from B. Wayne Hughes as trustee of the B. W. Hughes Living Trust and as to which PSI has sole voting power (pursuant to an irrevocable proxy) and no dispositive power.\n(2) Units owned by B. Wayne Hughes as trustee of the B. W. Hughes Living Trust as to which Mr. Hughes has sole dispositive power and no voting power; PSI has an option to acquire these Units and an irrevocable proxy to vote these Units (see footnote 1 above).\n(b) The Partnership has no officers and directors. The General Partners have contributed $222,222 to the capital of the Partnership 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 the General Partners' capital contribution bears to the total capital contribution. Information regarding ownership of Units by PSI and Hughes, the General Partners, is set forth under section (a) above. Dann V. Angeloff, a director of PSI, beneficially owns 27 Units (0.06% of the Units). The directors and executive officers of PSI (including Hughes), as a group (15 persons), own an aggregate of 4,904 Units, representing 11.1% of the Units (including the 4,852 Units beneficially owned by Hughes as set forth 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 (the \"Partnership Agreement\"), a copy of which is included in the Partnership's prospectus included in the Partnership's Registration Statement File No. 2-63247. 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.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ----------------------------------------------\nThe Partnership Agreement provides that the General Partners will be entitled to cash incentive distributions in an amount equal to (i) 8% of distributions of cash flow from operations until the distributions to all partners from all sources equal their capital contributions; thereafter, 25% of distributions of cash flow from operations, and (ii) 25% of distributions from net proceeds from sale and financing of the Partnership's properties remaining after distribution to all partners of any portion thereof required to cause distributions to partners from all sources to equal their capital contributions. The partners received distributions equal to their capital contributions in 1987. The Partnership has not made any distributions since the third quarter of 1991.\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 and pays PSCP 5% of the gross revenue of the commercial property, respectively, operated for the Partnership. During 1995, the Partnership paid or accrued fees of $317,000 to PSMI, $45,000 to PSI and $9,000 to PSCP pursuant to the Management Agreements with respect to 1995 management fees (i.e., exclusive of the prepayment described below).\nIn November 1995, the Management Agreement was amended to provide that upon demand from PSI or PSMI made prior to December 15, 1995, the Partnership agreed to prepay (within 15 days after such demand) up to 12 months of management fees (based on the management fees for the comparable period during the calendar year immediately preceding such prepayment) discounted at the rate of 14% per year to compensate for early payment. In December 1995, the Partnership prepaid, to PSI, 8 months of 1996 management fees at a cost of $229,000.\nIn November 1995, the Partnership purchased 22,456 shares of common stock of PSI from affiliated partnerships for a purchase price of $398,000 (the purchase price per share was equal to the closing price of the PSI common stock on the New York Stock Exchange on the last trading day prior to the sale).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. ---------------------------------------------------------------\n(a) List of Documents filed as part of the Report.\n1. Financial Statements. See Index to Financial Statements and Financial Statement Schedule.\n2. Financial Statement Schedules. See Index to Financial Statements and Financial Statement Schedule.\n3. Exhibits: See Exhibit Index contained herein.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter of fiscal 1995.\n(c) Exhibits: See Exhibit Index contained herein.\nPUBLIC STORAGE PROPERTIES V, LTD.\nEXHIBIT INDEX (Item 14 (c))\n3.1 Amended Certificate and Agreement of Limited Partnership. Previously filed with the Securities and Exchange Commission as Exhibit A to the Registrant's Prospectus included in Registration Statement No. 2-63247 and incorporated herein by references.\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 Storage Equities, Inc.'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. and Public Storage Commercial Properties Group, Inc. Previously filed with the Securities and Exchange Commission as an exhibit to Storage Equities, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1994 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.\nPUBLIC STORAGE PROPERTIES V, LTD., a California Limited Partnership\nDated: March 26, 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.\nPUBLIC STORAGE PROPERTIES V, LTD.\nAND FINANCIAL STATEMENT SCHEDULE (Item 14 (a))\nPage References ----------\nReport of Independent Auditors...................................\nFinancial Statements and Schedule:\nBalance Sheets as of December 31, 1995 and 1994..................\nFor each of the three years in the period ended December 31, 1995:\nStatements of Income.........................................\nStatements of Partners' Deficit..............................\nStatements of Cash Flows .................................... -\nNotes to Financial Statements.................................... -\nSchedule for the years ended December 31, 1995, 1994 and 1993:\nIII - Real Estate and Accumulated Depreciation.............. -\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 financial statements or the notes thereto.\nReport of Independent Auditors\nThe Partners Public Storage Properties V, Ltd.\nWe have audited the accompanying balance sheets of Public Storage Properties V, Ltd. as of December 31, 1995 and 1994, and the related statements of income, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the schedule listed in the index at item 14(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Public Storage Properties V, Ltd. 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\nFebruary 27, 1996 Los Angeles, California\nPUBLIC STORAGE PROPERTIES V, LTD. BALANCE SHEETS December 31, 1995 and 1994\nPUBLIC STORAGE PROPERTIES V, LTD. STATEMENTS OF INCOME For the years ended December 31, 1995, 1994, and 1993\nPUBLIC STORAGE PROPERTIES V, LTD. STATEMENTS OF PARTNERS' DEFICIT For the years ended December 31, 1995, 1994, and 1993\nPUBLIC STORAGE PROPERTIES V, LTD. STATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994, and 1993\nPUBLIC STORAGE PROPERTIES V, LTD. STATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994, and 1993 (Continued)\nPUBLIC STORAGE PROPERTIES V, LTD. NOTES TO FINANCIAL STATEMENTS December 31, 1995\n1. Description of Partnership\nPublic Storage Properties V, Ltd. (the \"Partnership\") was formed with the proceeds of a public offering. The general partners in the Partnership are Public Storage, Inc., formerly known as Storage Equities, Inc. and B. Wayne Hughes (\"Hughes\"). In 1995, there were a series of mergers among Public Storage Management, Inc. (which was the Partnership's mini-warehouse property operator), Public Storage, Inc. (which was one of the Partnership's general partners) and their affiliates (collectively, \"PSMI\"), culminating in the November 16, 1995 merger of PSMI into Storage Equities, Inc., a real estate investment trust listed on the New York Stock Exchange. In the PSMI merger, Storage Equities, Inc.'s name was changed to Public Storage, Inc. (\"PSI\") and PSI became a co-general partner of the Partnership and the operator of the Partnership's mini-warehouse properties.\n2. Summary of Significant Accounting Policies and Partnership Matters\nBasis of Presentation:\nCertain prior years amounts have been reclassified to conform with the 1995 presentation.\nReal Estate Facilities:\nCost of land includes appraisal fees and legal fees related to acquisition and closing costs. Buildings and equipment reflect costs incurred through December 31, 1995 and 1994 to develop mini-warehouses and to a lesser extent, a business park facility. The mini-warehouse facilities provide self-service storage spaces for lease, usually on a month-to-month basis, to the general public. The buildings and equipment are depreciated on the straight-line basis over estimated useful lives of 25 and 5 years, respectively.\nIn August 1992, the buildings at a mini-warehouse facility located in Miami, Florida were completely destroyed by Hurricane Andrew. The Partnership received insurance proceeds totaling $2,881,000, which included an amount for the replacement cost of the destroyed buildings as well as for business interruption. In 1993, the General Partners decided that it would be more beneficial to the Partnership, given the condition of the market area of the mini-warehouse, to cease operations at this location, and, therefore, decided not to reconstruct the buildings. Accordingly, in 1993, the Partnership reduced real estate facilities by the net book value of the destroyed buildings, resulting in a gain of $1,369,000. The General Partners are attempting to sell the related land, and believe that the net realizable value of the land approximates its book value of $593,000. In December 1995, the Partnership entered into an option agreement with a buyer to sell the land for $850,000.\nIncluded in other income are $109,000, $87,000, and $166,000 of business interruption proceeds (net of certain costs and expenses of maintaining the property) for the years ended December 31, 1995, 1994, and 1993, respectively.\nAllocation of Net Income:\nThe general partners' share of net income consists of amounts attributable to their 1% capital contribution and an additional percentage of cash flow (as defined) which relates to the general partners' share of cash distributions as set forth in the Partnership Agreement (Note 4). All remaining net income is allocated to the limited partners.\nPer unit data is based on the weighted average number of the limited partnership units (44,000) outstanding during the period.\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. Summary of Significant Accounting Policies and Partnership Matters (Continued)\nMarketable Securities:\nMarketable securities at December 31, 1995 and 1994 consist of 440,584 (which includes the November 1995 purchase) and 418,128 shares of common stock of PSI, respectively. In November 1995, the Partnership purchased an additional 22,456 shares of PSI common stock at a cost of $398,000. The Partnership has designated its portfolio of marketable securities as being available for sale. Accordingly, at December 31, 1995 and 1994, the Partnership has recorded the marketable securities at fair value, based upon the closing quoted price of the securities at December 31, 1995 and 1994, and has recorded a corresponding unrealized gain totaling $1,962,000 and $1,126,000, respectively, as a credit to Partnership equity. The Partnership recognized dividends of $373,000, $277,000, and $131,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nOther Assets:\nIncluded in other assets is deferred financing costs of $279,000 ($361,000 at December 31, 1994). Such balance is being amortized in interest using the straight-line basis over the life of the loan.\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 1995, the Partnership completed environmental assessments of its properties to evaluate the environmental condition of, and potential environmental liabilities of such properties. These assessments were performed by an independent environmental consulting firm. Based on the assessments, the Partnership has expensed, as of December 31, 1995, an estimated $27,000 for known environmental remediation requirements. 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.\n3. Cash Distributions\nThe Partnership Agreement requires that cash available for distribution (cash flow from all sources less cash necessary for any obligations or capital improvement needs) be distributed at least quarterly. Cash distributions have been suspended since 1991.\n4. Partners' Equity\nThe general partners have a 1% interest in the Partnership. In addition, the general partners had an 8% interest in cash distributions attributable to operations (exclusive of distributions attributable to sale and financing proceeds) until the limited partners recovered all of their investment. Thereafter, the general partners have a 25% interest in all cash distributions (including sale and financing proceeds). During 1987, the limited partners recovered all of their initial investment. All subsequent distributions are being made 25.75% (including the 1% interest) to the general partners and 74.25% to the limited partners. Transfers of equity are made periodically to conform the partners' equity accounts to the provisions of the Partnership Agreement. These transfers have no effect on results of operations or distributions to partners.\nThe financing of the properties (Note 7) provided the Partnership with cash for a special distribution without affecting the Partnership's taxable income. Proceeds of approximately $24,356,000 were distributed to the partners in June 1989 resulting in a deficit in the limited and general partners' equity accounts.\n5. Related Party Transactions\nThe Partnership has Management Agreements with PSI (as successor-in-interest to PSMI) and Public Storage Commercial Properties Group, Inc. (PSCP). Under the terms of the agreements, PSI operates the mini-warehouse facilities and PSCP operates the business park facility for fees equal to 6% and 5%, respectively, of the facilities' monthly gross revenue (as defined). Hughes and members of his family (the \"Hughes Family\") are the major shareholders of PSI. PSI has a 95% economic interest and the Hughes family has a 5% economic interest in PSCP.\nIn November 1995, the Management Agreement was amended to provide that upon demand from PSI or PSMI made prior to December 15, 1995, the Partnership agreed to prepay (within 15 days after such demand) up to 12 months of management fees (based on the management fees for the comparable period during the calendar year immediately preceding such prepayment) discounted at the rate of 14% per year to compensate for early payment. In December 1995, the Partnership prepaid, to PSI, 8 months of 1996 management fees at a cost of $229,000. The amount is included in other assets in the Balance Sheet at December 31, 1995 and will be amortized as management fee expense in 1996.\n6. Taxes Based on Income\nTaxes based on income are the responsibility of the individual partners and, accordingly, the Partnership's financial statements do not reflect a provision for such taxes.\nTaxable net income was $1,427,000, $1,388,000 and $2,287,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The differences between taxable net income and net income is primarily related to depreciation expense resulting from differences in depreciation methods.\n7. Mortgage Note Payable\nOn June 8, 1989, the Partnership financed all of its projects with a $26,250,000 ten-year nonrecourse note secured by the Partnership's properties. The note provides for fixed interest of 10.75% per annum. Loan payments for the first two years consisted of interest only of approximately $235,000 per month. Beginning in 1991, principal was being amortized over a 23 year term with payments of interest and principal of $257,000 per month. On June 1, 1999, the maturity date, a balloon payment for accrued interest and any unpaid principal is due.\nThe principal repayment schedule as of December 31, 1995 of the note is as follows:\n1996 $ 426,000 1997 474,000 1998 528,000 1999 21,768,000 $23,196,000\nIn February 1994, the Partnership made a pre-payment of principal totaling $1,530,000 on the note. In connection with the pre-payment, effective April 1, 1994, the monthly payment of principal and interest was reduced from $257,000 to $242,000.\nInterest paid on the note was $2,516,000, $2,596,000 and $2,754,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nPublic Storage Properties V, Ltd. Schedule III - Real Estate and Accumulated Depreciation For the year ended December 31, 1995\nAccumulated Date Description Depreciation Completed ----------- ------------ --------- Mini-warehouses: CALIFORNIA\nBelmont $555,000 12\/79\nCarson Street 383,000 01\/80\nPalmdale 514,000 01\/80\nPasadena Fair Oaks 775,000 03\/80\nSacramento Carmichael 568,000 07\/80\nSacramento Florin 695,000 06\/80\nSan Jose Capitol Quimby 483,000 07\/80 San Jose Felipe 597,000 12\/80 So. San Francisco 997,000 11\/80 Spruce (1)\nFLORIDA Miami Perrine (3) - 01\/80 Miami 27th Avenue 620,000 05\/80 Miami 29th 393,000 10\/79\nGEORGIA Atlanta Montreal Road 573,000 06\/80 Atlanta Mountain 493,000 09\/80 Industrial Blvd. Marietta-Cobb Parkway 635,000 10\/79 -------\n$ 8,281,000 ===========\n(1) A portion of the property has been developed as a business park. (2) All fifteen mini-warehouse locations are encumbered by a promissory note. The $23,196,000 listed above is the principal balance remaining on the note at 12\/31\/95. (3) In 1993, the buildings and improvements at the Miami\/Perrine property that were destroyed by Hurricane Andrew were written off.\nPublic Storage Properties V, Ltd. Schedule III - Real Estate and Accumulated Depreciation (Continued)\nReconciliation of Real Estate and Accumulated Depreciation","section_15":""}
{"filename":"883905_1995.txt","cik":"883905","year":"1995","section_1":"ITEM 1. BUSINESS\nXircom, Inc. (\"Xircom\" or the \"Company\") develops, manufactures, sells and supports a comprehensive set of network access solutions for mobile and remote personal computer (PC) users. These products represent a market category recognized as mobile networking. The Company's principal products enable PC users to access information and resources found on local area networks (LANs) and online services such as the Internet. Xircom's products are recognized for innovative technology, high reliability and broad compatibility.\nXircom was founded in 1988 and pioneered the use of the universal PC parallel port to connect portable PCs to LANs. Xircom's Pocket LAN adapter established the mobile networking market and by 1992 had become the leading solution for portable PC-to-LAN connectivity. In late 1992, Xircom was the first company in the industry to ship an adapter compliant with the standards set by the Personal Computer Memory Card International Association (\"PCMCIA\" or \"PC Card\"). Through September 30, 1995, the Company has sold nearly two million PC Card or parallel port LAN adapters and remains the overall market leader in LAN adapters for portable PCs.\nIn 1994 and 1995 Xircom expanded its offerings to include products addressing wide area networking, which enable access to a LAN from a remote location. These products include combination LAN adapter and modem PC Cards, a modem-only PC Card and systems-level mobile networking solutions, including remote access server products. In 1995, the Company began shipping its wireless LAN products in volume.\nMARKET BACKGROUND\nGrowth in Client\/Server Computing. Local area networks offer greater productivity and lower systems costs by enabling workgroups and geographically dispersed organizations to share information, applications and resources such as printers, file servers and communication devices. LANs have enabled the widespread use of personal computers and servers in a client\/server network configuration, and wide area networking has created \"enterprise networks\" of broadly interconnected LANs which offer client PCs access to LANs from almost any location.\nTrends Toward Smaller, Mobile Computers. Simultaneous with the growth in LANs, continuing technological advances have been made in portable PCs, often referred to as laptop or notebook computers. Growing use of portable computers is being driven by an increasingly mobile workforce requiring a higher level of productivity, including field service personnel, salespeople, consultants, traveling executives, telecommuters and \"day extenders,\" who work at home in the evening or on weekends. An increasing number of workers are now utilizing portable computers as their primary PCs and more business applications are being developed specifically for portable PCs. According to independent market research, portable PC shipments worldwide will grow from 7.3 million in 1994 to over 16 million in 1999.(1) It is also projected that 47% of portable computers will be connected to a LAN by 1998 compared to 12% in 1994(2) and that 80% of portable PC users in the U.S. will use their portable as their primary PC by the year 2000.(3)\n- -------------------------\n(1) International Data Corporation, 1995\n(2) International Data Corporation, 1995\n(3) BIS Strategic Decision, 1995\nRemote Access. Over the last several years, there has been a significant increase in the number of PC users accessing a corporate LAN or an online service (e.g., America Online, Prodigy, CompuServe or the Internet) from a \"remote\" location. To do so requires a modem on the client PC and a modem \"on the LAN\" that serves as a communication gateway to the network (oftentimes referred to as a remote access server or communications server). The modem market has grown substantially over the last several years and today it is estimated that 91% of portable PCs are equipped with a modem. The market for PC Card modems is expected to grow from 1.6 million units in 1994 to 7.1 million units by 1998.(4) The remote access server market is also expected to grow from approximately 700,000 \"ports\" in 1994 to 7.0 million in 1998.(5) Integrated Services Digital Network (ISDN) usage is expected to become a larger proportion of such connections because ISDN enables higher speeds than analog modem-based connections and the telephone carriers are making ISDN service more broadly available. ISDN services are based on multiple 64 kilobits-per-second (Kbps) digital channels (two \"B\" channels for a basic rate interface and 23 to 30 \"B\" Channels for a primary rate interface) compared to 28.8 Kbps speeds for a V.34 analog modem.\nPRODUCTS\nIn 1995 the Company reorganized into Client and Systems Divisions, grouping its similar product lines together to achieve greater efficiencies and resource utilization.\nCLIENT PRODUCTS\nClient products include Ethernet and Token Ring LAN adapters, combination LAN adapters and modems, and modem-only products.\nWired LAN adapters for portable PCs. Xircom offers the broadest family of PC Card and parallel port (Pocket) LAN adapters that operate on Ethernet and Token Ring topologies and are compatible with all widely used wiring. Xircom LAN adapters also incorporate preconfigured software drivers that support over 48 different network operating systems and communication protocols. Most Xircom adapters include both DOS- and Windows-based menu-driven software for simple, fast installation.\nXircom shipped the industry's first external parallel port LAN adapter, the Pocket Ethernet Adapter, in May 1989. The second-generation product, Pocket Ethernet Adapter II, was first shipped in September 1991 and the third-generation Pocket Ethernet Adapter III was first shipped in March 1993. The Pocket Token Ring Adapter, first shipped in December 1989, was the first commercially available parallel port adapter for Token Ring networks. The second-generation Pocket Token Ring Adapter II was first shipped in February 1992, and the third-generation Pocket Token Ring Adapter III was first shipped in December 1993. Today Xircom remains the dominant supplier of Pocket LAN Adapters, with a market share estimated to be over 70%(6). BYTE magazine's 20th anniversary issue in September 1995 named Xircom's original Pocket LAN Adapter as one of the Most Important Networking Products of all time. Revenues from Pocket LAN adapters represented 34% of Xircom's total revenues in fiscal 1995 compared to 55% in 1994. This proportion had further declined to 26% in the fourth quarter of fiscal 1995 and is expected to continue to decline in 1996 and 1997 as the PC Card becomes the dominant form factor for connecting peripheral devices to portable PCs.\nDuring 1991, the PCMCIA defined certain dimensional interface standards for use by a variety of PC peripherals, including memory cards, fax\/modems, LAN adapters and disk drives. The\n- ------------------------------\n(4) International Data Corporation, 1995\n(5) International Data Corporation, 1995, and Xircom\n(6) Dataquest Incorporated, 1995\nPC Card interface, or slot, is now incorporated into most portable computers, allowing the PC Card peripheral device, which is the size of a thick credit card, to be inserted. Xircom was first to ship an Ethernet LAN adapter card compliant with the PCMCIA standard in late 1992 and began shipping its CreditCard Ethernet Adapter in February 1993. The Company commenced shipments of its CreditCard Token Ring Adapter in December 1993. The second-generation CreditCard Ethernet Adapter IIps and CreditCard Token Ring Adapter IIps were first shipped in June and July 1994, respectively. In August 1995, the Company announced support for Windows 95 for its entire line of Ethernet and Token Ring PC Card adapters and was an active participant in Microsoft's launch of Windows 95. Revenues from PC Card LAN adapters, including combination LAN adapters and modems, were 59% of the total in fiscal 1995.\nMultifunction Adapter\/Modem Cards. In February 1994, the Company began shipping the first PC Card offering a LAN adapter and a modem in a single PCMCIA card. The CreditCard Ethernet+Modem quickly achieved market acceptance and received a number of industry awards for technical excellence, including PC Magazine's \"1994 Technical Excellence Award\" in the Networking Hardware category. The Company commenced shipments of the second-generation CreditCard Ethernet+Modem II in September 1994 and in July 1995 was the first to ship in volume a combination PC Card product incorporating a V.34 modem with a LAN adapter. The Ethernet+Modem products accounted for 23% of revenue for all of fiscal 1995 and 34% in the fourth quarter of fiscal 1995.\nPC Card Modem. Xircom commenced shipment of the Company's first modem-only PC Card in September 1995. The CreditCard Modem 28.8 incorporates the latest V.34 standards and broadens Xircom's remote access solutions by adding a modem-only option for PC notebook users who require high- speed remote access to LANs, commercial online service, or the Internet.\nXircom expects customers for its PC Card client products to continue to demand higher speeds and bandwidth and is focusing its development efforts on new versions of its PC Card LAN adapters, and multifunction PC Cards that will combine LAN, modem and ISDN technologies for use with high-bandwidth applications.\nOther Client Products. Xircom also offers the Parallel Port Multiplexor, which allows a user to connect both a parallel port LAN adapter and a dedicated printer through a single parallel port. In September 1995, Pacific Data Products completed the purchase of Xircom's Pocket Print Server product line in an agreement that had no material financial impact on Xircom.\nSYSTEMS PRODUCTS\nXircom's systems solutions include remote access server products and wireless LAN products.\nRemote Access. Xircom's solutions in this market are based on an \"open systems\" approach to remote access. Industry analysts project that in the future the majority of dial-in remote access servers will be open systems much like LAN file servers are today. They will integrate a standard PC with remote access software from Novell or Microsoft and adapters like Xircom's MultiPort Modem Card. The MultiPort Modem Card, which was first shipped in March 1995, includes four or eight V.34 (28.8 Kbps) modems on a card.\nExperts predict that the latest analog modems have most likely reached the theoretical maximum speed except for the possible development of further data compression techniques. As a result, users are beginning to migrate to ISDN technology for higher-speed remote network and Internet connections. In addition, ISDN service is becoming more broadly\navailable and the costs of installation, service and equipment are priced more reasonably. Industry analysts project that ISDN basic rate terminal adapter shipments will grow from 225,000 units in 1995 to 550,000 units in 1999,(7) while ISDN server ports will increase from 345,000 to 1,023,000.(8)\nIn June 1995, Xircom entered the market for ISDN remote access through its acquisition of Primary Rate Incorporated (\"PRI\"). PRI, started in 1989, developed the industry's first primary rate interface to a computer for the computer telephony market. PRI's subsequent efforts were on developing ISDN solutions for OEM customers. Today, these OEM customers include AT&T, Xyplex, Ericsson, IBM, Bell Atlantic, BellSouth and other vendors who use Xircom ISDN technology as a component of their internetworking, telecommunications and remote access solutions.\nPrior to the acquisition, PRI had developed an ISA (Industry Standard Architecture) version of a primary rate interface card that runs under Windows NT and a first-generation basic rate interface card. These products are now being marketed as ISDN server cards complementing the analog MultiPort Modem Cards Xircom introduced earlier in 1995. Further development of these products will allow Xircom to offer a seamless dial-in server solution for both ISDN and analog users employing Windows NT or Netware Connect. PRI's experience in ISDN software development will also be utilized in development of new PC Card ISDN products.\nWireless LAN. In January 1995, the Company commenced volume shipments of Netwave, its wireless LAN product line that enables the user to establish a peer-to-peer network or maintain an Ethernet network connection while moving about the workplace unencumbered by wires and cables. Based on 2.4 GHz, spread spectrum, frequency hopping radio frequency (RF) technology, Netwave products include the CreditCard Netwave Adapter and the Netwave Access Point for Ethernet.\nThe Netwave adapter, radio and antenna are fully self-contained in a single PC Card, with no external circuitry. The companion Netwave Access Point for Ethernet is a Netwave-to-Ethernet bridge that attaches directly to the wired LAN, enabling a number of Netwave adapter users to access the network through one access point. With multiple access points installed throughout a facility, Netwave users can roam within the coverage area while maintaining real-time access to network services. Netwave can also be utilized in a simple peer-to-peer network configuration without access points.\nXircom shipped its Netwave Release 2.5 in July 1995, which offers improved throughput, seamless roaming capabilities and utilities for conducting site surveys and managing the wireless connection. At the same time, the Company announced a new aggressive pricing and seeding program and introduced a Netwave Starter Kit to promote trials and testing by potential users.\nNetwave supports a wide range of network operating systems and PC hardware and software. The Company is active on the Institute of Electronic and Electrical Engineers (\"IEEE\") 802.11 Wireless LAN Committee, which is developing an industry standard to assure interoperability among various vendors' products. While the market for wireless LAN has been small to date, industry analysts expect the market to grow more rapidly once a standard is issued sometime in 1996. In April 1995, Netwave passed European Telecommunications Standard testing and has gained approvals for sale in most major European countries.\n- -------------------------------------- (7) International Data Corporation, 1995\n(8) International Data Corporation, 1995\nNetwave contributed less than 5% of total revenues in fiscal 1995.\nRESEARCH AND DEVELOPMENT\nThe market for the Company's products is characterized by rapidly changing technology, short product life cycles and evolving industry standards. The Company believes that technical innovation in its products is required to make them more desirable than other portable LAN connectivity solutions. The Company's expertise lies in developing small form factor products which require a high degree of electronic component integration and careful circuitry design. In addition, use of Application Specific Integrated Circuits (\"ASIC\") reduces the number of semiconductor devices required in the Company's products resulting in lower manufacturing cost and higher product reliability. Because of the many variations of PCs that the Company's products are installed in, the Company's ASIC devices are designed so that they can be automatically reconfigured upon initialization by the Company's proprietary software.\nThe Company also utilizes an erasable programmable read-only memory (EPROM) in most of its products to allow certain changes, enhancements or error corrections to be implemented through a software download as opposed to a change in hardware.\nThe Company is a leader in simplifying the installation and configuration of a portable LAN adapter by incorporating certain proprietary software coding in its parallel port products. Subsequently, because of difficulties associated with installation of PC Cards, the Company developed a Windows-based installation utility in fiscal 1994, which now ships with most Xircom adapters. Although the new Windows 95 operating system, released in August 1995, improved the installation process for PC Cards and other peripherals, add-on hardware often requires driver updates to enhance features or performance. Therefore, installation utilities remain an important feature of the products.\nDevice driver software is also a key component of the Company's products. Device drivers allow the hardware and firmware (the software code which provides operating instructions to the hardware) to interact with the communications port on the PC that the LAN adapter or modem is being installed in (e.g., the parallel port or PCMCIA slot). While the Company's leading products are designed to operate with the major operating systems, including Microsoft Windows 3.1, Windows NT and Windows 95, the Company has also developed Driver Development Kits that include a library of software interfaces and source code examples to substantially reduce the time required for other network operating system vendors to develop drivers for Xircom adapters. The Company believes that its family of external LAN adapter products incorporates software drivers for a broader range of computers and network operating systems than any other family of external LAN adapters commercially available.\nSome of the Company's technical advancements and accomplishments since 1989 include:\no Pioneered the use of the PC parallel port for LAN connectivity; o Participated with Zenith Data Systems and Intel Corp. in the development of Enhanced Parallel Port (\"EPP\") technology; o Was first to ship an Ethernet LAN adapter; o Was first to ship a parallel port modem, which offers higher throughput than a serial port modem; o Was first to ship a PC Card combining a LAN adapter and a modem; o Was first to incorporate full-duplex Ethernet technology in its LAN adapters, which offers up to twice the data throughput on an Ethernet network;\no Developed the first wireless LAN adapter fully contained in a PC Card (with no external circuitry); o Developed block mode transfers for use in modems, allowing greater throughput than normally available.\nThe June 1995 acquisition of PRI provided the Company with faster entry to an emerging market for ISDN products. PRI developed ISDN protocol software, called Instant ISDN, with an open application programming interface, to simplify the incorporation of their ISDN products into other OEM solutions. PRI also provided experience in gaining approvals for the sale of ISDN products and technology (\"homologation\") in Europe, Japan and Canada.\nXircom has adopted a Distributed Development Environment (\"DDE\") to facilitate the remote physical location of some of its engineers. DDE provides structured development methodologies and high-speed network links into Xircom's corporate development network. A key component of DDE is the use of Xircom's products by the engineers that develop and support them. It is believed that DDE results in increased productivity and retention of key employees. At this time program participants include engineers located in Austin, Texas; Colorado Springs, Colorado; Provo, Utah; and Kontich, Belgium.\nThe Company's current research and development efforts include ongoing feature enhancement and cost reduction of current products, continued development of multifunction PC Cards, development of new versions of Netwave wireless LAN products, enhancement of remote access modem server products and ISDN server products, and support for the Company's OEM customers.\nThe Company has participated in leading industry standards committees such as the IEEE Working Group 1284 Committee for Parallel Port Standardization, the PCMCIA Committee for add-in cards for portable computers, the IEEE 802.11 Standards Committee for Wireless LANs, the Fast Ethernet Alliance for developing 100 megabit-per-second Ethernet technology and the National ISDN Users Forum. In 1995 Xircom co-founded the Mobile MIB Task Force, a group formed to extend existing standards to handle the unique issues of managing mobile computer users who connect to networks. Other participants include Compaq, IBM, Motorola, Zenith Data Systems and National Semiconductor.\nApproximately 19% of the company's 500 employees were engaged in research and development activities as of September 30, 1995. During fiscal years 1995, 1994 and 1993, the Company incurred research and development expenditures of $13,824,000, $11,613,000 and $6,882,000, respectively.\nMARKETING\nThe Company sells its products primarily through domestic and international distributors. U.S. distributors include major national distributors of computers and networking equipment such as Ingram Micro Inc., Tech Data Corporation and Merisel, Inc., and national reseller organizations such as IE Advanced Systems, Inc., Vanstar Corporation and MicroAge, Inc. The Company also sells directly to major domestic retail chains, such as Computer City Supercenter and CompUSA. The Company also sells its products to portable computer manufacturers and has a number of OEM customers for its ISDN products.\nInternationally the Company sells products through a worldwide network of distributors. In fiscal 1995, 1994 and 1993, international sales (sales to customers outside the U.S.) comprised 43%, 39% and 37%, respectively, of total net sales. All international sales are\ndenominated in U.S. dollars and may be subject to government controls and other risks, including, in some cases, export licenses, federal restrictions on export, currency fluctuations, political instability, trade restrictions, and changes in tariffs and freight rates. The Company has experienced no material difficulties to date as a result of these factors.\nXircom generally seeks to develop the markets for its products through marketing programs that promote end-user demand. The Company generates brand recognition through trade advertising, participation in trade shows and public relations activities. In 1995, the Company developed a small field sales organization and expanded its inside sales\/telemarketing function to create demand by calling directly on resellers, VARs and end-users interested in client or systems products. The Company also has field sales persons and support engineers to sell its products to OEMs.\nBACKLOG\nThe Company manufactures its products to its forecast of near-term demand and maintains inventories of finished goods and top-level subassemblies to satisfy customer orders. Product shipments are generally made within six weeks after receipt of orders although some OEM customers submit orders for scheduled deliveries over a longer period. Orders from distribution customers are cancelable without penalty and OEM customers may reschedule or cancel orders outside a certain minimum time period. Backlog was not significant at September 30, 1995 or 1994.\nCOMPETITION\nThe Company believes that the principal competitive factors in the market for external LAN adapters and indirectly competitive products are support of commonly used topologies, network wiring systems and network operating systems; performance (including data transfer speeds); compatibility with many brands of portable computers; quality and reliability; ease of use; size, especially with respect to the latest subnotebook and handheld portable PCs; customer support and service; brand name recognition; and price.\nSimilar to the market for external LAN adapters, the principal competitive factors for external modems are performance (primarily throughput, but also error control, connection maintenance and compression); compatibility with many brands of portable computers and software applications; support of industry standards; quality and reliability; ease of use; customer support and service; brand name recognition; and price.\nThe Company's direct competition for parallel port LAN adapters has primarily come from a small number of privately held companies, and Xircom has maintained a dominant market share in this market segment (i.e., over 70%). The PC Card LAN adapter market has become significantly more competitive, and the Company has a number of competitors that have substantially greater development, manufacturing and marketing resources than Xircom, including Fujitsu Microelectronics, Inc., International Business Machines Corp. (IBM), Motorola Inc., 3Com Corporation and U.S. Robotics Inc.'s Megahertz subsidiary. Other manufacturers of desktop LAN adapters offering PC Card adapters include Standard Microsystems Corporation, Madge Networks Limited and Olicom A\/S. In the multifunction PC Card market (Ethernet+Modem), the Company's closest competitor is Megahertz. Other smaller companies also offer Ethernet+Modem PC Cards including Ositech Communications Inc. and New Media. In addition, 3Com and Motorola have jointly developed and recently commenced shipments of a combination LAN+modem PC Card.\nThe Company also competes indirectly with companies that provide alternative means to\nconnect portable computers to LANs such as docking stations or port replicators with built-in networking capabilities. COMPAQ Computer Corporation, Toshiba Corporation (Toshiba), IBM, NEC Corporation (NEC) and others offer docking stations for certain of their portable computers. Although docking stations historically enjoyed some competitive advantage because they provide a broader range of functionality than just a LAN connection, the greater built-in capabilities of many new portable PCs and the standardization provided by PC Card slots reduce the demand for this additional functionality. In addition, the use of peripheral devices provides the PC user an upgrade path as speed or other enhancements to the network are developed.\nEthernet interface chipsets on PC system boards which eliminate the need for a LAN adapter have been offered only in a limited number of portable PCs to-date, generally because the chipset solution adds cost and complexity to the base PC and requires the PC manufacturer to provide networking technical support. As a result, the Company believes that PC Card solutions for networking portable computers will continue to dominate the market because of the performance, flexibility and range of choices they offer to both users and PC manufacturers.\nThe increased competition in the PC Card LAN market and the shift from the parallel port to PC Card form factor for portable LAN adapters resulted in a loss of overall market share, sales declines and lower gross margins for the Company in 1995. While the Company has taken steps to be more competitive, particularly on price, and believes it has recently stabilized in its market share, the significant level of competition could adversely affect sales and profitability in the future.\nFor the Company's recently introduced modem-only PC Card, the competition is significant. U.S. Robotics and its Megahertz subsidiary jointly hold a majority market share for PC Card modems and control a design feature called X-Jack which integrates the RJ-11 phone jack into the PCMCIA case. Other competitors in this market include Hayes Microcomputer Products, Boca Research, AT&T Paradyne (although AT&T has announced it is discontinuing its PCMCIA line of modems), TDK Systems, and many others, including manufacturers who may hold leading or significant market shares within specific countries. Xircom believes that it can leverage its engineering, sales and manufacturing resources with its V.34 PC Card modem because it already has modem technology and market recognition with its Ethernet+Modem PC Card products. Nevertheless, this market is historically very price-competitive, and some competitors, including U.S. Robotics, have proprietary designs which may result in lower manufacturing costs. In addition, because approximately 90% of portable PCs utilize a modem, there may be a greater likelihood that modem functionality could be included by the PC manufacturers, and some models include modems today. However, the Company believes that just as for LAN adapters, standard expansion slots like PCMCIA that allow the users of the PCs more flexibility in choice of modems and upgradeability as the technology advances will be the standard for some time to come. In addition, the Company has achieved significant market share in the combination Ethernet+Modem market segment and expects to offer other multifunction cards in the future as a way of differentiating its modem products.\nIn the wireless LAN market, the key competitive factors are range, ability to penetrate obstructions, power consumption, performance (principally data transmission speed), antenna configuration, price and compatibility with the PC platform. The Company's direct competition for wireless LAN products comes from an increasing number of radio-based system manufacturers, some of whom, such as Proxim, Inc. and Solectek Corp., are focused specifically in wireless technologies. Others, including AT&T, IBM Corporation and Symbol Technologies, Inc., have substantially greater research, manufacturing, and marketing resources than the Company. Others are known to be preparing products for entering in the\nwireless LAN market including 3Com Corporation, Telxon Corporation and Breeze Wireless Communications, Inc. In addition, the Company has licensed its Netwave technology to certain chipset manufacturers who may market such chipsets to others. The Company believes its Netwave product has a unique form factor with no antennae or other circuitry outside the PC Card adapter. Some competitors claim advantages in range and manageability. The Company also believes it has certain advantages in the software which operates on its access points although others offer similar functionality. Various components of Netwave are designed around specifications that served as a basis for parts of the standard being developed by the IEEE 802.11 Committee on wireless LAN standards. This could provide the Company some time-to-market advantage in introduction of standards-compliant products in 1996.\nThe Company competes directly with a wide variety of vendors offering remote access solutions. In ISDN, direct competitors include small, ISDN-focused manufacturers as well as divisions of larger, well-established companies such as 3Com Corporation and U.S. Robotics, Inc. For the MultiPort Modem Card, direct competition is primarily from RS232 interface board manufacturers such as Digi International Inc., which provides low-cost serial port cards that end users or integrators use with standard external modems. Indirect competitors such as Shiva Corp., Ascend Communications, Inc., and Telebit Corp. currently dominate the remote access market by providing stand-alone products that do not require integration with other hardware or software. In addition, major internetworking vendors including Cisco Systems, Inc., Bay Networks, Inc. and Cabletron Systems, Inc. have recently added remote access solutions. All of these indirect competitors have substantially greater development and marketing resources than the Company.\nMANUFACTURING\nThe Company believes that high-volume, low-cost manufacturing has become an important capability to compete effectively in the PC Card market. As a result, the Company commenced in-house manufacturing in September 1995 with a limited volume production run of PC Cards at new facilities in Penang, Malaysia. The Company expects to ramp its production through April 1996 when most of its PC Card and parallel port adapters will be built in Penang.\nTo-date, all the Company's PC Card products have been assembled by a single subcontractor on a turn-key basis. Components are purchased, warehoused, assembled and tested by such subcontractor before being sent to the Company for final packaging and shipping. The Company utilizes other subcontractors to assemble its parallel port adapters and cable assemblies.\nThe Company purchases certain key components directly from third-party suppliers. The Company inspects these components for quality and forwards them to the subcontractors as needed. In the future, most components will be purchased in Penang using current vendors with local representation. Final assembly, test, packaging and shipping, currently performed by the Company at its facility in Thousand Oaks, California, will be transitioned to the Penang operation during 1996.\nAlthough the Company generally uses standard parts and components for its products, certain key components used in the Company's products are currently available from only one source, and others are available from a limited number of sources. Components currently available from one source include a proprietary Ethernet chipset (used in the Pocket Ethernet Adapter) purchased from Fujitsu Microelectronics, a proprietary Ethernet chipset (used in the CreditCard Ethernet Adapter) purchased from SymBIOS Logic, a Token Ring chipset from Texas\nInstruments, an AT&T modem chipset (used in the modem products) and a standard Motorola microprocessor (used in the modem products). In addition, other components, including other semiconductor devices, transformers and plastic product housings, are available or acquired from a single source or a limited number of sources. Although the Company has not experienced any significant parts shortages over the past year, many of these components require long-lead purchase orders so that flexibility to change order quantities due to changes in demand is limited. Inability to obtain sufficient supplies of these components or develop alternative sources as needed could have a material adverse effect on the Company's operating results.\nPROPRIETARY RIGHTS AND LICENSES\nThe Company has applied for numerous patents relating to its external LAN adapters, parallel port multiplexor, parallel port and PC Card modems, and wireless LAN products. Patents covering the original parallel port adapter and the parallel port multiplexor were issued in March 1994 and January 1994, respectively. A patent covering the combination parallel port Ethernet and modem was issued in April 1995. The Company has entered into licensing agreements with three competitors related to the parallel port adapter technology. Additionally, the Company is currently reviewing the applicability of its parallel port adapter and combination parallel port Ethernet and modem patents to other competitive products. The Company also seeks to protect its proprietary rights through a combination of employee and third-party nondisclosure agreements as well as copyright and trademark protection. The Company is aware that competitors have duplicated certain functionality of the Company's products. There can be no assurance that the Company's patents, copyrights, trademarks and other efforts to protect its intellectual property will prevent duplication of the Company's technology or that they will provide competitive advantage. The Company believes that, due to the rapid pace of technological change in the LAN communications industry, the Company's success is likely to depend more upon continued innovation, technical expertise, marketing skills and customer support and service than legal protection of the Company's proprietary rights.\nThe Company currently includes software licensed from third parties in its Token Ring, Ethernet+Modem, modem-only, ISDN and remote access server products, which, in the aggregate, accounted for 43% of revenues in fiscal 1995. The Company's operating results could be adversely affected by a number of factors relating to this third-party software, including failure by the licensers to promote or support the software, delays in shipment of the Company's products as a result of delays in the introduction of licensed software or errors in the licensed software, excess customer support costs or product returns experienced by the Company due to errors in licensed software or termination of the Company's relationship with such licensers.\nMadge Networks Agreement. The Company entered into a Software License Agreement with Madge Networks Limited (\"Madge\") pursuant to which Madge and the Company jointly developed the SmartRing Token Ring Adapter software, based on proprietary Token Ring software of Madge. Madge has licensed its SmartRing Token Ring Adapter software to Xircom for use in LAN adapters. The Company paid Madge an initial development fee and up-front license fee, and pays an additional royalty to Madge on each Token Ring LAN adapter the Company sells. Royalty payments are subject to certain quarterly minimums, with any royalties in excess of the quarterly minimum credited against future minimums. The agreement terminates on the date when the Company ceases to market Token Ring LAN adapters or may be terminated earlier by Madge if the Company does not meet minimum royalty payments. In September 1993 the Company entered into a similar agreement for the license of the SmartRing software for use in the Xircom CreditCard Token Ring adapter.\nWillemijn License. The Company has entered into a nonexclusive patent license agreement with Willemijn Houdstermaatschappij BV (Willemijn) with respect to certain Token Ring technology for which Willemijn holds patents. Under this agreement, the Company pays a royalty on each Token Ring adapter sold by the Company. The agreement terminates in October 1998, upon expiration of the Willemijn U.S. patent.\nShiva License. The Company entered into a PPP Client Software License Agreement with Shiva Corporation for software to be included in Ethernet+Modem, modem-only, ISDN and remote access server products. Under this agreement, the Company pays a royalty on products sold incorporating the Shiva technology. The agreement is nonexclusive and expires in June 1997.\nTractor Grip License. The Company has licensed the use of the Tractor Grip device for attaching parallel port LAN adapters to PCs. The Company's license terminates upon the expiration of the United States patent in March 2009. Under this agreement, the Company pays a royalty on products sold incorporating the Tractor Grip technology.\nFax\/Modem License. The Company has entered into a nonexclusive license agreement for fax\/modem software used in Ethernet+Modem and modem-only products. Under this agreement, the Company pays a royalty on each copy of the software. The agreement has an initial term of two years and provides for renewals upon mutual agreement of the parties.\nThe Company has entered into additional license agreements that require the payment of per-unit royalties on wireless LAN products. To date, royalties paid under these agreements have not been material.\nEMPLOYEES\nAs of September 30, 1995, the Company employed a total of 500 persons, including 210 in sales, marketing and customer support; 97 in engineering and product development; 143 in operations; and 50 in finance and other administrative areas.\nThe Company's success depends on its continued ability to attract and retain qualified personnel. Competition for such personnel in the computer networking industry is intense and the Company must provide competitive salary, stock incentive and benefit packages to attract such personnel. The Company has development activities in Thousand Oaks, California, in Mountain View, California and Salem, New Hampshire. None of the Company's employees is represented by a collective bargaining arrangement. The Company believes that its relations with its employees are good.\nFACTORS AFFECTING STOCK PRICE\nThe market price of Xircom's common stock may fluctuate substantially over short periods of time due to a number of factors, including those factors that could affect Xircom's future financial performance as discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 18 to 24 of this document. The price may also be affected by factors which influence the overall market for stocks or the market for stocks of high-technology companies in particular.\nMANAGEMENT\nThe following sets forth certain information with respect to the executive officers of the Company and their ages as of December 1, 1995.\nMr. Gates has served as Chairman of the Board of the Company since January 1995 and as President and a Director of the Company since its incorporation in November 1988. He has also served as Chief Executive Officer since October 1991.\nMr. Bass has served as Vice President, Operations of the Company since January 1992. From September 1990 until joining the Company, Mr. Bass served as Vice President, Operations of Fibermux Corporation, a provider of intelligent hubs to the LAN market.\nMr. Brown has served as Vice President, Corporate Communications and Marketing of the Company since November 1994. He is currently on temporary assignment as Acting General Manager, Systems Division. From February 1991 until November 1994, he served as Vice President, Corporate Communications, and from October 1990 until February 1991 he was a consultant to the Company.\nMr. DeGennaro has served as Vice President, Finance and Chief Accounting Officer of the Company since May 1995. He had previously served since January 1994 as Corporate Controller and Chief Accounting Officer. Prior to joining the Company in 1993, Mr. DeGennaro was a senior manager at KPMG Peat Marwick, a big-six accounting firm. Mr. DeGennaro is a CPA.\nMr. Devis has served as Vice President, Europe and Asia-Pacific Sales and Marketing since January 1995. He had previously served, since June 1991, as Managing Director of\nXircom Europe N.V. From July 1989 to May 1991, Mr. Devis served as President and Chairman of Westex N.V., a distributor of computer equipment.\nMr. Holliday has served as General Counsel of the Company since January 1995. In December 1993, Mr. Holliday joined the Company as Corporate Counsel. From March 1990 to December 1993, Mr. Holliday was Division Counsel of Abex Aerospace Division, Pneumo Abex Corporation, an aircraft hydraulic components manufacturer.\nMr. Russo has served as Executive Vice President and General Manager, Client Division since April 1995. From January 1994 to March 1995, Mr. Russo held executive positions at Network Systems Corporation, a manufacturer of high-speed networking equipment and software, most recently as Senior Vice President, Channel Networking Group. From 1991 until 1993, Mr. Russo served as President of FTR, Inc., a professional motor sports team, which filed for liquidation under Chapter 7 of the U.S. Bankruptcy Code in December 1993. From 1985 until 1991, Mr. Russo held executive positions at AT&T Paradyne, a manufacturer of wide area networking products, most recently as Vice President and General Manager, Data Networking Products.\nMr. Ulrich has served as Chief Operating Officer and Chief Financial Officer of the Company since May 1995. He had previously served since December 1992 as Vice President, Finance and Administration and Chief Financial Officer and since March 1992 as Vice President, Finance. From 1991 until joining the Company, Mr. Ulrich was Corporate Controller for Adaptec, Inc., a manufacturer of hard disk controllers and small computer system interface (SCSI) host adapters. From 1989 to 1991, Mr. Ulrich served as Vice President, Finance and Chief Financial Officer of Pleion Corporation, a manufacturer of modular office furniture. Mr. Ulrich is a CPA.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters are located in 87,000 square feet of a leased facility in Thousand Oaks, California. This facility accommodates corporate administration, engineering, marketing, sales and customer support. Final assembly, test and shipping operations are conducted in an adjacent 50,000 square-foot leased facility. The Company also leases a facility that accommodates additional engineering, marketing, sales and customer support staff in Salem, New Hampshire; a manufacturing and distribution facility in Penang, Malaysia; a sales office in Washington, D.C.; a research and development facility in Mountain View, California; facilities for its European subsidiary in Kontich, Belgium; and facilities for its Asia-Pacific sales and marketing operations in Singapore and Sydney, Australia. In 1995, the Company opened sales offices in Paris, France; Basingstoke, England; Grassbrunn, Germany; and Stockholm, Sweden. The Company believes its existing facilities are adequate for its current needs and additional facilities proximate to its existing facilities are available for lease to meet future needs.\nFinancial information regarding leases and lease commitments are contained in Note Ten of Notes to Consolidated Financial Statements on page 38 of this document.\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\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nXircom Common Stock began trading on The Nasdaq Stock Market on March 31, 1992 under the symbol XIRC. The Company has not paid cash dividends on its Common Stock and does not plan to pay cash dividends for the foreseeable future. As of November 27, 1995, there were 426 holders of record of the Company's Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected balance sheet and statement of operations data as of and for the fiscal years ended September 30, 1991 through 1995.\n(1) Fiscal 1995 includes $43,942 (net of tax benefit of $2,184), or $2.57 per share, for write-off of in-process research and development and other nonrecurring charges.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nNet sales of LAN adapter products, which accounted for 93% of net sales in 1995 and nearly all of the net sales in 1994, decreased 11% due to the Company's efforts to reduce channel inventories that had built up in the second half of fiscal 1994 and due to a loss of market share in the PC Card market. Unit sales of LAN adapter products increased only 3% in 1995 compared to 1994, which was substantially below the market growth rate. In addition, overall average selling prices in 1995 declined 13% from 1994 due primarily to the increased competition in the PC Card LAN adapter market and to a shifting mix of products from parallel port versions to PC Card versions. The decline in average selling price was partially offset by an increase in revenues derived from the higher-priced combination Ethernet+Modem products. The Company's CreditCard Ethernet Adapter and Credit Card Ethernet+Modem accounted for 29% and 23%, respectively, of 1995 sales and 27% and 12%, respectively, of 1994 sales.\nThe Company believes it achieved some stabilization of its market share over the last four months of fiscal 1995. Expected market growth and stable market share would result in higher growth in unit shipments in fiscal 1996, as compared to fiscal 1995. Results for the first two months of fiscal 1996 were consistent with this expectation.\nThe systems products (wireless LAN, remote access and ISDN OEM products) contributed 7% of net sales in fiscal 1995. The Company believes revenues from ISDN OEM products will increase in fiscal 1996 (due in part to a growing customer base and because the results from the acquisition of Primary Rate Incorporated (\"PRI\") were included for only four months of fiscal 1995). Sales of the Company's remote access products and wireless LAN products are dependent on the Company's ability to create greater awareness of its products among value-added resellers, system integrators and end users. In addition, there can be no assurances that the Company will be able to devote adequate sales and marketing resources or further develop the products to achieve such awareness or acceptance in the case of wireless LAN. The Company expects that this market will continue to develop slowly until standards are finalized (now expected by mid-1996) and users become more aware of the types of applications that will make wireless LAN connections useful.\nNet sales increased in 1994 due primarily to higher unit shipments of both parallel port and PC Card versions of the Company's external LAN adapters, offset by lower average selling prices. The higher unit volume was attributable to growth in overall portable PC shipments and the percentage of those portable PCs connected to LANs and the introduction of new PC Card products, including the Company's combination LAN adapter and modem product.\nInternational sales (shipments to customers located outside the U.S.) increased as a percentage of total sales to 43% in 1995 from 39% in 1994. Sales in Europe and Asia-Pacific grew at a faster rate than in the U.S. during 1995 primarily because of greater market growth in Asia, commencement of shipments of an internationally approved version of the combination\nEthernet+Modem product and less effect from reduction of channel inventories as compared to the U.S.\nGross profit consists of net sales less cost of sales, which includes product costs (materials, subcontract assembly costs, labor, manufacturing overhead and royalty payments to licensers of software incorporated into the Company's products) and provisions for excess and obsolete inventory and warranty expense. The decline in gross profit as a percent of net sales in 1995 compared to 1994 was primarily attributable to product mix changes away from parallel port products and toward PC Card products, which have lower gross profit margins than parallel port products, as well as price reductions on the Company's CreditCard Ethernet and CreditCard Ethernet+Modem products. In addition, lower-than-expected revenues and the resulting greater portion of fixed cost of sales in relation to total cost of sales contributed to the decline in gross profit margins. The 1995 results also include an $8.7 million inventory reserve charged to cost of sales related primarily to excess wireless LAN and remote access products. The decline in gross profit margin in 1994 compared to 1993 was primarily attributable to the increased proportion of sales of PC Card adapters.\nExcluding nonrecurring charges, operating expenses in 1995 increased by 43% compared to 1994. While the Company took actions during the second half of 1995 to slow the growth in expenses, including a reduction in workforce in April of approximately 10% and deferral of most new hiring, expenses increased in general due to the significant expansion of the Company's product offerings and the acquisition of PRI in June 1995. Product line expansion efforts required more development expenditures as well as significant increases in sales and marketing expenditures. While the PRI acquisition caused further increases in expenses initially, the Company has taken measures to achieve a 15% - 20% reduction in operating expenses in the first quarter of fiscal 1996 as compared to the fourth quarter of fiscal 1995 ($18.2 million, excluding nonrecurring charges). These measures include staff attrition, focus on fewer product development activities and reductions in the level of sales, marketing and promotional activities for certain products. The Company is continuing to examine opportunities for cost reduction beyond its first quarter 1996 target.\nResearch and development expenses increased in 1995 and 1994 as the Company expanded headcount and expenditures for engineering materials, equipment, software development and outside services, all related to the development of a significant number of new products. Although the Company has reduced the planned breadth of certain product line expansion efforts, and the level of expenditures is expected to decline from the fourth quarter of fiscal 1995 to the first quarter of fiscal 1996, total expenditures for research and development expenses in all of fiscal 1996 are likely to increase in absolute dollars. They are currently expected to decline, however, as a percentage of net sales.\nSales and marketing expenses increased substantially in absolute dollars during 1995 and 1994 due primarily to additions in sales and marketing personnel, additional advertising for new products and higher promotional expenditures related to increased competition in the PC Card market, efforts to reduce higher-than-normal levels of channel inventories, and activities to launch new remote access and wireless LAN products. Sales and marketing for all of fiscal 1996 are currently planned to be about equal to fiscal 1995 and are expected to decline as a percentage of sales.\nGeneral and administrative expenses increased in absolute dollars in each of 1995 and 1994, primarily due to increased headcount, related expenses and expanded information systems and controls. Amortization of goodwill and other intangible assets related to the acquisition of PRI that is included in general and administrative expenses totaled approximately $519,000 during 1995 and is expected to be approximately $1,600,000 per year in future years. Therefore, total general and administrative expenses will increase in fiscal 1996 but are currently expected to decline as a percentage of sales.\nNonrecurring charges of $46,126,000 ($43,942,000, net of tax benefit of $2,184,000) consist primarily of $40,000,000 of in-process research and development purchased from PRI that had not yet reached technological feasibility and, therefore, is required to be written off under generally accepted accounting principles. Additional nonrecurring charges relate to the sale of certain assets, the write-off of lease obligations on excess and idle facilities and severance payments related to a reduction in workforce. Excluding nonrecurring charges, total operating expenses were $60,602,000 in 1995 compared to $42,298,000 in fiscal 1994 (a 43% increase). Net loss and net loss per share for fiscal 1995, excluding nonrecurring charges, was $14,862,000 and $0.87, respectively.\nNet other income or expense includes interest income from the investment of available cash, prompt payment discounts earned by the Company offset by prompt payment discounts taken by customers, foreign currency translation gains or losses, and interest expense on capital leases.\nInterest income in 1995 and 1994 of $1,700,000, and $1,562,000, respectively, resulted from investments of the proceeds from the Company's initial public offering of common stock and, in 1994, of cash generated from operations. Net other expense in 1994 includes a charge of $575,000 for the early termination of the lease on the Company's corporate headquarters facility.\nThe Company's effective tax benefit declined in 1995 due to the nondecuctibility of the write-off of in-process research and development and the amortization of goodwill related to the acquisition of Primary Rate Incorporated. Excluding the effect of the nondeductible items, the effective tax rate decreased to 28% due to the write-off of State deferred tax assets not allowable as a carryback to offset prior years' state tax liabilities. The Company's effective tax rate declined in 1994 primarily because of increased benefits realized from sales through Xircom FSC, Inc. (a foreign sales corporation) because the Company's PC Card products were manufactured in the United States. In addition, credits for research and development expense increased in 1994.\nFACTORS THAT MAY AFFECT FUTURE RESULTS\nThe market for portable PC LAN adapters has grown rapidly since the Personal Computer Memory Card International Association (PCMCIA) introduced a standard form factor for PC Card (originally \"PCMCIA\") LAN adapters in 1993. In 1994, the PC Card market overtook the market for parallel port adapters, and competition increased substantially in 1995. Companies with greater name recognition in the PC, desktop LAN adapter and PC Card modem industries and with greater financial resources gained market share during 1994 and 1995 and now have a significant presence in the PC Card LAN adapter market. In 1995, the Company's net sales and gross margin were adversely impacted by a combination of factors: increased price competition, loss of market share in the PC Card LAN adapter market, a lower proportion of sales from parallel port products, higher than normal levels of inventories in the Company's distribution channels and the related effect of reducing those channel inventory levels.\nThe Company also believes that the market for PC Card LAN adapters will be more price competitive for the long-term and thus result in lower gross profit margins than the Company\nhad earned from such products in the past. While the Company believes its current product costs are very competitive, it continues to redesign its products for cost savings. The Company expects to further reduce its manufacturing costs by manufacturing at its own facility beginning in fiscal 1996, although efficiencies related to the new manufacturing facility are not expected to be realized until at least the second fiscal quarter. There can be no assurances that such cost reductions will keep pace with competitors' cost reductions nor be sufficient to allow price reductions required to maintain market share without adversely affecting gross profit margins.\nThe Company generally ships products within one to six weeks after receipt of orders and therefore its sales backlog is typically minimal. Accordingly, the Company's expectations of future net sales are based largely on its own estimate of future demand and not on firm customer orders. The Company's expenditures are based in part on such estimates of future sales. If orders and net sales do not meet expectations, the Company may not be able to reduce expenses commensurately in the near-term, and profitability could be adversely affected.\nThe Company's net sales may also be affected by its distributors' decisions as to the quantity of the Company's products to be maintained in their inventories. The Company saw an increase in the level of channel inventories during the last half of fiscal 1994 as product sell-through slowed compared to the first half of fiscal 1994. The Company reduced the level of such channel inventories during the second half of fiscal 1995 by significantly reducing its shipments to its distributors.\nThere can be no assurances that the Company's new products will achieve market acceptance or sell through to end users in sufficient quantities to make them viable for the long-term. In addition, unless increases in sales allow the Company to make sufficient expenditures in the sales and marketing areas, the Company may have difficulty in establishing its presence in these new markets.\nThe Company expects that PC Card LAN adapters will continue to increase as a proportion of revenues when compared with parallel port LAN adapters, although the Company anticipates that the rate of growth will be slower than that experienced in the past. The Company's PC Card products generally sell for lower prices than the Company's comparable parallel port products and have lower gross profit margins. The Company introduced a line of modem-only PC Card products in the fourth fiscal quarter of 1995, utilizing existing technologies from its combination LAN and modem PC Cards and modem-based remote access products. The PC Card modems have gross profit margins lower than the Company's historical average overall gross profit margin, although it is presently anticipated that the increased volume will have a positive impact on coverage of fixed manufacturing costs. While new product areas such as remote access, ISDN and wireless LAN are expected to contribute higher gross profit margins, the level of sales to be achieved in these new areas is uncertain and such contributions are not currently expected to offset the decline in gross profit margins associated with the PC Card and modem product lines.\nThe Company established in-house manufacturing capabilities at the end of fiscal 1995. Although the Company commenced a gradual transition from manufacturing at its subcontractors to its own facilities at the end of fiscal 1995, interruptions in supply of products could occur if problems arise in this transition, which in turn could adversely affect future sales. Also, the Company will continue to incur start-up manufacturing costs in early fiscal 1996 which could adversely affect gross profit margins.\nIn summary, gross profit margins are impacted by a number of factors, including the rate of sales growth, competitive pricing pressures, the mix of product sales, component and manufacturing costs, and the shipments of new products, which often have lower margins until market acceptance and increased volumes permit component cost reductions and manufacturing efficiencies. Frequent product transitions also increase the risk of inventory obsolescence and interruptions of sales.\nAs discussed under Note Two in the Notes to Consolidated Financial Statements, the Company acquired PRI, an ISDN technology company in June 1995. Historically, PRI has focused its sales and development efforts on the OEM market and has recorded limited sales to date to the end-user market. There can be no assurances that the Company will be able to successfully develop the end-user market for ISDN products or be able to compete effectively with other companies that have significantly greater resources than the Company and which have recently entered the ISDN market. The acquisition required significant capital and equity investments and is expected to be dilutive to stockholders in the near-term. It will continue to be dilutive unless, and until, significantly increased revenues and profitability are attained by the ISDN product lines.\nThe Company's corporate headquarters, research and development facilities and other critical business operations are located near major earthquake faults. Operating results could be materially adversely affected in the event of a major earthquake.\nA number of additional factors could have an impact on the Company's future operating results. The industry in which the Company operates is characterized by rapid technological change and short product life cycles. Increased competition in the PC Card market has resulted in shorter product life cycles than in the past. While the Company has historically been successful in developing leading technology for its products, ongoing investment in research and development will be required to maintain the Company's technological position, and the Company could be required to increase the rate of such investments depending on competitive factors. It is also possible that networking capability could be included in the PC itself or in extension modules to PCs, which could cause a reduction in the demand for add-on networking devices. The Company's results are also dependent on continued growth in the underlying market for portable networking products as well as the Company's ability to retain its market share.\nBecause of frequent technology changes and rapid industry growth, the cost and availability of components used to manufacture the Company's products may fluctuate. Some components, including custom chipsets, are available from only one supplier. Any interruptions in these supply sources or limitations on availability could impact the Company's ability to deliver its products and in turn adversely affect future earnings.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's operating activities used cash of approximately $4.4 million in 1995 primarily as a result of losses from operations, net of the write-off of in-process research and development, and increases in inventory and income taxes receivable offset by a decrease in accounts receivable and increases in accounts payable and accrued liabilities. The Company also used approximately $24.4 million for the acquisition of PRI. Additional cash expenditures of approximately $1.2 million related to the acquisition are expected to occur in 1996. The Company's capital expenditures of $13.6 million were for leasehold improvements at new facilities, equipment related to increased headcount, manufacturing equipment and leasehold improvements at the new Malaysian manufacturing facility, and information systems hardware and software. The Company has no material fixed commitments for capital expenditures.\nEffective November 8, 1995, the Company entered into a credit agreement that permits borrowings up to $15.0 million at the prime rate plus 1-1\/4%. Advances under the agreement are based on eligible accounts receivable and inventory and are secured by all U.S.-based assets of the Company. Initial availability under the eligibility and borrowing formulas was approximately $9.0 million. The agreement expires in November 1996.\nThe Company believes that cash on hand, borrowings available under its new credit facility or from other financing sources and cash provided by operations will be sufficient to support its working capital and capital expenditure requirements for at least the next twelve months. During the second half of fiscal 1995, the Company experienced reduced revenue levels and losses from operations. While revenues are expected to increase and results of operations are expected to improve significantly in the December 1995 period, there can be no assurances that future cash requirements to fund operations will not require the Company to seek additional capital sooner than the twelve months or that such additional capital will be available on terms acceptable to the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nXIRCOM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\n(In thousands, except per share information)\nSee accompanying notes\nXIRCOM, INC. CONSOLIDATED BALANCE SHEETS\n(In thousands, except share and per share information)\nSee accompanying notes\nXIRCOM, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nSee accompanying notes\nXIRCOM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\n(In thousands)\nSee accompanying notes\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE ONE: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Xircom, Inc. (the \"Company\") and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.\nBUSINESS The Company designs, manufactures, markets and supports products that allow PCs to be connected locally or remotely to a network.\nCASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents and are carried at cost plus accrued interest. Investments with maturities of between three and twelve months are considered to be short-term investments and are carried at cost plus accrued interest, which approximates market. Interest income totaled $1,700,000, $1,562,000 and $1,082,000 for fiscal 1995, 1994 and 1993, respectively, and is included in Other income (expense), net in the accompanying Consolidated Statements of Operations. Effective October 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. (SFAS) 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Adoption of SFAS 115 had no effect on the accompanying consolidated financial statements.\nCONCENTRATION OF CREDIT RISK The Company makes periodic evaluations of the creditworthiness of its customers and generally does not require collateral. To date, the Company has not experienced any material bad debts or collection problems. As of September 30, 1995 and 1994, three distributors accounted for a total of 15% and 40%, respectively, of total trade receivables.\nINVENTORIES Inventories are carried at the lower of cost (determined on a first-in, first-out basis) or market.\nPROPERTY AND EQUIPMENT Equipment and improvements are stated at cost. Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the assets, ranging from one to seven years. Leasehold improvements are amortized using the straight-line method over the term of the related lease or the useful life of the asset, whichever is shorter.\nINTANGIBLE ASSETS Included in Other assets in the accompanying Consolidated Balance Sheets are goodwill and other intangibles associated with the acquisition of PRI as described in Note Two. Amortization of all intangible assets is provided on a straight-line basis over their estimated useful lives ranging from three to seven years. Accumulated amortization of all intangible assets was $534,000 as of September 30, 1995.\nREVENUE RECOGNITION The Company recognizes revenue from product sales when shipped. The Company generally provides a lifetime limited warranty against defects in the hardware component and a two-year limited warranty on the software component of its network adapters and modem products. Netaccess products have a five-year hardware warranty and a 90-day software warranty, and ISDN products have a two-year hardware and a one-year software\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nwarranty. In addition, the Company provides telephone support to purchasers of its products as needed to assist them in installation or use of the products. The Company makes provisions for these costs in the period of sale. The Company also has policies and\/or contractual agreements which permit distributors and dealers to return products under certain circumstances. The Company makes a provision for the estimated amount of product returns that may occur under these programs and contracts in the period of sale.\nNONRECURRING CHARGES The Company recorded charges to operations during the year related to the sale of certain assets, the write-off of excess and idle facilities and severance payments related to a reduction in workforce. The aggregate amount of these nonrecurring charges of $6,126,000 ($3,942,000, net of tax benefit) has been charged to the Company's operations along with the write-off of in-process research and development in connection with the purchase of PRI as described in Note Two.\nFOREIGN CURRENCY TRANSLATION The functional currency of the Company's foreign subsidiaries is the U.S. dollar. To date, substantially all of the Company's sales have been denominated in U.S. dollars. Gains and losses from re-measurement are recognized currently in the Consolidated Statements of Operations.\nRESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred.\nINCOME TAXES Effective October 1, 1993, the Company adopted the provisions of SFAS 109, \"Accounting for Income Taxes.\" Adoption of SFAS 109 did not have a material effect on the accompanying consolidated financial statements.\nThe Company has not provided U.S. income taxes on the undistributed income of its foreign subsidiaries. The cumulative amount of such income was not significant as of September 30, 1995. It is management's intent that such earnings will be permanently reinvested.\nNET INCOME (LOSS) PER SHARE Net income (loss) per share is computed using the weighted average number of shares of common stock and dilutive common stock equivalents (stock options) outstanding. Fully diluted amounts for each period do not materially differ from the amounts presented herein.\nLICENSING AGREEMENTS The Company has entered into agreements with third parties to license software and hardware that is incorporated into or sold with certain of the Company's products. Royalties associated with such licenses are accrued and expensed as cost of goods sold when the products are shipped.\nRECLASSIFICATIONS Certain reclassifications of prior year amounts have been made for purposes of consistent presentation.\nNOTE TWO: BUSINESS ACQUISITION\nIn June 1995, the Company acquired the assets and assumed the liabilities and outstanding stock options of Primary Rate Incorporated (PRI). PRI develops, manufactures, markets and supports standards-based Integrated Service Digital Network (ISDN) products which provide\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nconnectivity solutions for corporate information system departments, original equipment manufacturers and end-users. The purchase price, net of cash acquired and proceeds from exercise of options and warrants, totaled approximately $50,279,000 including the assumed stock options which had an associated value of $2,278,000. The balance of the purchase price was paid using funds from the Company's working capital and through the issuance of 2,049,019 shares of common stock which had a value at issuance of $22,283,000.\nThe acquisition was accounted for as a purchase and, accordingly, the acquired assets and liabilities were recorded at their estimated fair market values at the date of acquisition. The purchase price plus costs directly attributable to the completion of the acquisition have been allocated to the assets and liabilities acquired. Approximately $40,000,000 of the total purchase price represented the value of in-process research and development that had not yet reached technological feasibility and was charged to the Company's operations. In connection with the acquisition, the Company recorded goodwill and other intangible assets totaling $6,413,000 and a net deferred tax asset totaling approximately $2,301,000. The net deferred tax asset related primarily to the net operating loss carryforward discussed in Note Seven and deferred taxes related to other intangible assets pursuant to SFAS 109.\nThe Company's consolidated results of operations include the operating results of PRI from the acquisition date. The following unaudited pro forma information combines the consolidated results of operations of the Company and PRI as if the acquisition had occurred on October 1, 1994 and 1993. Adjustments have been made to reflect the amortization of goodwill and other intangibles identified in the purchase price allocation, the reduction in interest income earned due to the decrease in cash position resulting from the cash used as part of the acquisition consideration, the effects of the above-mentioned items on the provision for income taxes and the issuance of common stock as part of the acquisition consideration. The pro forma information is presented for illustrative purposes only, and is not necessarily indicative of what the actual results of operations would have been during such periods or representative of future operations (in thousands, except per share amounts):\nThe proforma information presented above does not reflect the write-off of in-process research and development costs of $40,000,000 which was included in the actual operating results for the year ended September 30, 1995.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE THREE: INVENTORIES\nInventories consist of the following (in thousands):\nNOTE FOUR: EQUIPMENT AND IMPROVEMENTS\nEquipment and improvements consist of the following (in thousands):\nAccumulated amortization related to capitalized leased equipment was $1,092,000 and $1,550,000 as of September 30, 1995 and 1994, respectively.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE FIVE: ACCRUED LIABILITIES\nAccrued liabilities consist of the following (in thousands):\nNOTE SIX: BANK BORROWINGS AND LONG-TERM OBLIGATIONS\nLong-term obligations consist of the following (in thousands):\nOn November 8, 1995, the Company entered into a one-year credit agreement with a financial institution for borrowings up to a maximum of $15,000,000 at the prime rate plus 1-1\/4 percent (10% as of November 8, 1995). Loans under the agreement are advanced based on the Company's accounts receivable and inventories, subject to borrowing formulas and are secured by all U.S.-based assets of the Company. Initial borrowings available under the line were approximately $9,000,000.\nThe Company has a credit facility with its bank in Malaysia that permits borrowings on a revolving credit and term loan basis at the bank's reference rate plus 1% (8.45% as of September 30, 1995). As of September 30, 1995, $600,000 was outstanding under both the revolving credit and term loan provisions of this agreement. Aggregate principal maturities on the note payable to bank and term loan outstanding at September 30, 1995 were $783,000 in 1996, $200,000 in 1997, and $217,000 in 1998. Interest expense totaled $68,000, $157,000 and $211,000 for fiscal 1995, 1994 and 1993, respectively.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE SEVEN: INCOME TAXES\nThe income tax provision (benefit) includes the following (in thousands):\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSignificant components of the Company's deferred tax assets and liabilities are as follows (in thousands):\nBalance sheet classification of the net deferred tax asset is as follows (in thousands):\nNoncurrent deferred tax assets are included in Other assets in the accompanying Consolidated Balance Sheets.\nAt September 30, 1995 the Company has net operating loss carryforwards for federal tax and state tax purposes of approximately $9,246,000 and $3,939,000, respectively, which expire during the period 2000 through 2010. The amount of the federal net operating loss and a portion of the state net operating loss that may be used to offset taxable income and income taxes in future years are subject to certain change in ownership and pre-acquisition loss limitations.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA valuation allowance for deferred tax assets was established in 1995 to reflect the uncertainty of the availability of the loss carryback generated in 1995, applicable to state income taxes. A reconciliation of the provision for income taxes with the tax computed by applying the federal statutory tax rate (35%, 35% and 34.75% for fiscal 1995, 1994 and 1993, respectively) is as follows (in thousands):\nNOTE EIGHT: COMMON STOCK AND RELATED PLANS\nThe Company's Stock Option Plan (1992 Plan), as amended in January 1992, 1994 and 1995, authorizes a total of up to 5,300,000 shares of Common Stock for issuance as either incentive stock options with exercise prices which may not be less than fair market value at the date of grant, or nonqualified stock options. The options generally vest over three to four years and expire after five years. The 1992 Director Stock Option Plan provides for the grant of nonqualified options for a total of up to 225,000 shares of Common Stock to non-employee members of the Board of Directors. The options are granted at the fair market value at the date of grant and vest over a four-year period. The Company established the 1995 Stock Option Plan (1995 Plan) in connection with the acquisition of PRI. Unvested options to purchase shares of PRI were converted into options to purchase shares of the Company's common stock with vesting rights similar to the 1992 Plan. Options to purchase 232,363 shares of the Company were granted under the 1995 Plan. The following table is a summary of activity for the Company's stock option plans:\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nOn August 3, 1995, upon approval by the Compensation Committee of the Board of Directors, the Company offered all holders of outstanding options under the 1992 Plan at exercise prices in excess of $10.00 per share the opportunity to exchange such options for new options at an exercise price of $10.00 per share, the fair market value of the Company's stock on such date. As a condition of the exchange, the program required a one-year delay in the vesting of the options exchanged. In connection with this repricing, an aggregate of 792,464 shares of Common Stock were repriced to an exercise price of $10.00 per share. The repriced options have been included in the preceding option table as both canceled and granted in fiscal 1995.\nAs of September 30, 1995, options for 602,899 shares were exercisable at an average price of $6.03 and 679,680 shares were available for future grants under the plans. Subsequent to the end of fiscal 1995, the Board of Directors approved the authorization of an additional 700,000 shares for issuance under the 1992 Plan, subject to shareholder approval at the next Annual Meeting of Shareholders.\nThe Company has established the 1994 Employee Stock Purchase Plan which allows employees to purchase Common Stock of the Company, through payroll deductions, at 85% of the market value of the shares at the beginning or end of the offering period, whichever is lower. The plan provides for the grant of rights to employees to purchase a maximum of 250,000 shares of common stock. During fiscal 1995, 57,537 shares were issued under the plan.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE NINE: SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nNOTE TEN: COMMITMENTS AND CONTINGENCIES\nThe Company leases its facilities and certain equipment under operating leases expiring on various dates through 2005. Rent expense was $1,790,000, $1,129,000 and $962,000 for fiscal 1995, 1994 and 1993, respectively. As of September 30, 1995, the minimum future rental payments under all noncancelable leases for facilities and equipment are as follows (in thousands):\nUnder certain license agreements (see Note One), the Company is required to pay specified amounts of per unit royalties based on sales of certain of its products. Some of these agreements also contain minimum quarterly and annual volume requirements. Certain of these agreements expire on specific dates, others continue in effect as long as the technology is incorporated into the Company's products, and some can be terminated by either party after specified notice periods. Royalties under these agreements amounted to $2,129,000, $2,843,000, and $2,574,000 for fiscal 1995, 1994 and 1993, respectively.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Company is involved in certain claims and legal proceedings which arise in the normal course of business. Management does not believe that the outcome of any of these matters will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.\nNOTE ELEVEN: SEGMENT AND GEOGRAPHIC INFORMATION\nThe Company operates in one industry segment: the design, development, manufacture, marketing and support of personal computer network connectivity products. Information about the Company's operations in the U.S., Europe and Asia is presented below.\nXIRCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTotal export sales (sales to unaffiliated foreign entities) were $20,069,000, $16,991,000 and $11,422,000 for fiscal 1995, 1994 and 1993, respectively. Sales to customers in excess of 10% of total sales are as follows:\nNOTE TWELVE: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n(1) In the fourth quarter of fiscal 1994, the Company reduced its tax rate for the fiscal year to 36.7% resulting in a tax rate of 31.0% for the fourth quarter. The Company also recorded a pretax charge of $575,000 in the fourth quarter of fiscal 1994 for the early termination of a lease.\n(2) In the third quarter of fiscal 1995, the net loss includes $41,337,000 or $2.43 per share for nonrecurring charges.\n(3) In the fourth quarter of fiscal 1995, the net loss includes $2,605,000 or $0.14 per share for nonrecurring charges. The Company also recorded a pretax charge of $8,700,000 in the fourth quarter of fiscal 1995 for additional inventory reserves.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Xircom, Inc.\nWe have audited the accompanying consolidated balance sheets of Xircom, Inc. 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. 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. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Xircom, 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, presents fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nWoodland Hills, California October 19, 1995, except for the second paragraph of Note Six, as to which the date is November 8, 1995\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to directors of Xircom is incorporated by reference from the information under the caption \"Election of Directors--Nominees\" in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders.\nInformation with respect to executive officers of Xircom is incorporated by reference to Item 1 of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference from the information under the captions \"Executive Officer Compensation\" and \"Certain Transactions\" in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from the information under the captions \"Principal Shareholders\" and \"Election of Directors--Nominees\" in the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from the information under the caption \"Certain Transactions\" in the Company'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) (1)The following consolidated financial statements of Xircom, Inc. and the Report of Independent Auditors, are included in Item 8 of this document:\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nSCHEDULE II\nXIRCOM, INC.\nVALUATION AND QUALIFYING ACCOUNTS (in thousands)\n(3) Exhibits included herein (numbered in accordance with Item 601 of Regulation S-K):\n(1) Incorporated by reference to corresponding exhibit number of the Company's registration statement on Form S-1, No. 33-45667\n(2) Confidential treatment granted as to certain portions of this Exhibit\n(b) Reports on Form 8-K:\nNone\nEXHIBIT 22.1\nSUBSIDIARIES OF THE COMPANY\nXircom Europe N.V.\nXircom Asia Pacific PTE LTD\nXircom FSC, Inc.\nPrimary Rate Incorporated\nXircom Operations (Malaysia) SDN. BHD.\nXircom U.K., Ltd.\nXircom France, S.A.R.L.\nXircom Deutschland GmbH\nXircom AB\nPrimary Rate Limited\nXircom Asia Limited\nEXHIBIT 23.1\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements pertaining to the Stock Option Plan, 1992 Director Stock Option Plan, 1994 Employee Stock Purchase Plan and 1995 Stock Option Plan and in the Registration Statement (Form S-3 No. 33-93972) and in the related Prospectus of Xircom, Inc. of our report dated October 19, 1995, except for the second paragraph of Note Six, as to which the date is November 8, 1995, with respect to the consolidated financial statements and schedule of Xircom, Inc., included in this Annual Report (Form 10-K) for the year ended September 30, 1995.\nERNST & YOUNG LLP\nWoodland Hills, California November 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.\nXIRCOM, INC.\nDate: November 30, 1995 By: \/s\/ DIRK I. GATES ---------------------------------- Dirk I. Gates 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 Dirk I. Gates and Jerry N. Ulrich, jointly and severally, his attorneys-in-fact, each with the power of substitution for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.\nEXHIBIT INDEX\n(1) Incorporated by reference to corresponding exhibit number of the Company's registration statement on Form S-1, No. 33-45667\n(2) Confidential treatment granted as to certain portions of this Exhibit","section_15":""}
{"filename":"96669_1995.txt","cik":"96669","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nTech-Sym Corporation (the \"Company\" or \"Registrant\") is a diversified electronics engineering and manufacturing company primarily involved in the design, development, and manufacture of products used for communications, the exploration and production of hydrocarbons, and defense systems.\nThe Company, incorporated in Nevada in 1944, is headquartered in Houston, Texas. The Company operates through seven principal subsidiaries: CogniSeis Development, Inc. (\"CogniSeis\") located in Houston, Texas; Continental Electronics Corporation (\"Continental\") located in Dallas, Texas; Enterprise Electronics Corporation (\"EEC\") located in Enterprise, Alabama; Metric Systems Corporation (\"Metric\") located in Fort Walton Beach, Florida; Syntron, Inc. (\"Syntron\") located in Houston, Texas; Tecom Industries, Incorporated (\"Tecom\") located in Chatsworth, California; and TRAK Microwave Corporation (\"TRAK\") located in Tampa, Florida. The business of the Company is conducted as one segment comprised of three product areas.\nCOMMUNICATIONS. The communications products include microwave components, antennas, broadcast transmitters, and weather information systems.\nThe microwave components and subsystems are used by customers to make communications and radar products. Microwave components include energy sources (oscillators and amplifiers), frequency multipliers, filters, ferrite isolators and circulators, and a broad range of passive components for modulation and control of microwave energy. Microwave subsystems consist of synthesizers, frequency converters, and microwave receiver assemblies. These microwave components and subsystems are used in such areas as wireless communications, satellite communications, aircraft instruments, radars, electronic warfare systems, and industrial microwave heating and cooking. Original equipment manufacturers purchase these products to integrate into systems.\nThe Company also builds extremely accurate timing systems for use by government and commercial organizations such as NASA, telephone companies, and electric power utilities.\nDuring 1995, the assets of two companies were acquired and combined to form Daden-Anthony Associates, Inc., in San Clemente, California. The new subsidiary designs and produces RF and microwave filters and has designed a specialized airborne filter amplifier assembly for GPS receivers.\nThe Company designs and produces antennas for wireless voice and data communication, satellite communication, surveillance, and range instrumentation. The Company also supplies antennas, fiber optic controllers, and positioners for information gathering by the U.S. surveillance community and high power antennas for jamming enemy radars during electronic warfare missions. Telemetry tracking systems and microprocessor-based antenna controllers are sold to the U.S. and foreign governments for use on test and training ranges. The Company has also designed and produces antennas for air and land mobile satellite communications systems. In the emerging wireless local loop market, the Company provides high performance base station and home subscriber antennas for telephony systems.\nBroadcast transmitter products include a complete line of transmitters and related equipment for the radio broadcast industry such as high power transmitters for use in the \"short\" and \"medium\" wave frequency bands as well as transmitters that operate at the radio broadcast frequencies commonly referred to as \"AM\" and \"FM\". High power radio frequency energy sources such as large particle accelerators are also made for medical and physics research installations. Communications and radar equipment for U.S. and foreign defense agencies have also been designed and manufactured. Customers include the commercial radio broadcast industry, private and government agencies that operate radio broadcast stations, and organizations or government funded operations that engage in scientific research.\nThrough its Continental-Lensa subsidiary in Santiago, Chile, the Company designs and manufactures solid state AM transmitters for sale in North and South America as well as Europe. The Company also participates in a joint manufacturing agreement with the Ministry of Film, Radio, and Television in the People's Republic of China. The agreement provides for the manufacture of FM and shortwave broadcast transmitters at the Company's facility in Dallas as well as in Beijing.\nEffective January 1, 1996, the Company acquired TELEFUNKEN Sendertechnik GmbH in Berlin, Germany. The company is a significant designer, manufacturer, and seller of broadcast transmitters and antennas in the world market. Its digital audio broadcast equipment produces CD quality sound for specially designed\nFM radios and is currently in use in several test markets. It also manufactures and sells solid state television transmitters which can be used for High Definition Television broadcasts.\nMeteorological agencies and television broadcasters use the Company's Doppler weather radars to forecast weather and provide severe weather warnings. The Doppler process measures both reflectivity and velocity of rain droplets and is used to detect, quantify and display precipitation intensity, velocity, and turbulence. It is extremely helpful in analyzing severe weather conditions such as hurricanes, tornadoes, thunderstorms, and wind shear. EEC has coupled the high performance Doppler radar with sophisticated data processing systems. These range from low-cost PC-based display and control systems through UNIX platform mid-range systems to larger scientific systems utilizing Hewlett Packard, IBM and the DEC-Alpha type computers and software.\nWith the development of powerful data processing systems known as Weather Windows(R) and EDGE(R) (Enterprise Doppler Graphics Environment), the products give meteorologists automated radar control as well as enhanced meteorological displays and image processing capabilities. The systems can be integrated into a network to obtain accurate weather information for a large geographic area. More than 600 weather radars have been installed in more than 60 countries.\nGEOSCIENCE. The Company designs and manufactures products that acquire, digitize, transmit, record, display, and analyze acoustic energy produced on the surface by air guns, dynamite, or other sound sources and reflected from underground or subsea geologic formations. After the stored data is processed, potential locations of hydrocarbon deposits can be determined. With the advent of more powerful computers, three dimensional (\"3-D\") seismic surveys have become more routine. The 3-D surveys result in higher resolution than two dimensional surveys and the success rate of oil and gas wells based on 3-D surveys is much greater. The demand for the Company's seismic equipment has increased with the demand for 3-D surveys.\nPrincipal seismic products include the SYNTRAK 480(R) Digital Streamer System consisting of one to twelve arrays, each up to 12,000 meters in length, containing sensors, electronic modules, and conductors. As the arrays are towed behind a boat, the acoustic energy is collected by the sensors, digitized and transmitted via a patented, low power telemetry communications scheme through the towed cable array to the boat. Once on board, the data is saved on magnetic tape by the Company's high-speed shipboard recording system.\nA related product is the Ocean Bottom Cable which is placed on the ocean floor instead of towed behind a boat. It is used in shallow water, congested areas, and transition zones where large seismic vessels cannot operate. It can also be used to monitor a reservoir as hydrocarbons are removed.\nBoth the SYNTRAK 480(TM) system and the Ocean Bottom Cable have been upgraded to integrate the latest technology. The amount of seismic data able to be acquired has been increased by the use of 24-bit integrated circuits and the volume of the modules reduced 60% through the use of hybrid technology which combined most of the discrete components.\nAnother seismic product recently introduced is the PolySeis(TM) system which the Company has developed with partial funding from the INSTITUTE FRANCAIS DU PETROLE. The PolySeis(TM) system is a 24-bit modular radio and\/or wireline telemetry\nseismic data acquisition system that can be easily configured by the user for most land or transition zone needs. The system is specifically adaptive to the unique requirements associated with exploration in transition zones or in areas that are inaccessible or difficult to reach such as lakes, swamps, or mountainous areas.\nThe Company maintains operations for the design, manufacture, and repair of seismic cables in England, Singapore, and Houston. The ability to design, manufacture and repair seismic cables enhances the Company's quality control over critical processes and its ability to provide needed services to its customers worldwide. In October of 1995, the Company expanded its product line to include fiber optic and copper wire seismic cables and associated connectors by acquiring the business and assets of Primatek Industries, Inc.\nIn 1995, the Company sold its Syntron Pressure Controls business to enable it to concentrate on its core businesses.\nThe Company's geoscientific software business was established in 1995 with the acquisition of CogniSeis Development, Inc., in Houston, Texas. The subsidiary's geoscientific software applications products are designed to process seismic data collected in the field in order to make the data interpretable and to interpret processed seismic data and other geological data to identify, define, and visualize subsurface geologic formations. Several of the applications utilize three dimensional (\"3-D\") displays to enable geologists and geophysicists to locate oil and gas reserves.\nIn August of 1995, the Company acquired the rights to develop and sell VoxelGeo, a computer software program used by geologists and geophysicists to interpret and visualize seismic data on a 3-D basis. In September of 1995, the Company acquired Photon Systems Ltd., a company that develops, markets and licenses seismic and geologic interpretation systems.\nThe Company is in the process of integrating its line of seismic processing, geological interpretation, and visualization applications into a comprehensive three dimensional earth model interpretation package called \"TerraCube.\" By linking the individual applications into a framework, TerraCube is expected to reduce the overall cycle time and expense involved in processing seismic data and interpreting geological data, as well as improve the quality of the data.\nDEFENSE SYSTEMS. The principal defense systems products include shipboard electronics, airborne training systems, range instrumentation systems, and mechanical systems.\nThe Company first became involved in shipboard electronics, when it received a contract for the design, development, and qualification testing of electronic control, monitoring, and power distribution equipment for the U.S. Navy's Vertical Launching System (VLS). Upon successful completion of this development effort, full scale production was initiated and has been continuous since. Utilizing the expertise gained during the VLS development effort, the Company expanded its business operations in this area to include subsystems for the AN\/SQQ-89 Surface Anti-Submarine Warfare Combat System, firing mechanisms for the submarine launched Tomahawk and Trident missiles, and radar cable assemblies for the AEGIS weapon system. In 1994, the Company acquired the Switchboard Systems Division of Ferranti Technologies, Inc., which produces electronic power switching and intercommunications equipment primarily for U.S. Navy ships.\nThe airborne training systems consist of pods which are attached to aircraft to collect data on the position, altitude, flight characteristics, and weapons systems of the aircraft during simulated combat. The data inputs are sent via telemetry to ground instrumentation equipment for display, debriefing, and subsequent analysis by the participants. The Company is producing airborne and ground equipment utilizing Global Positioning Systems (GPS) receivers to precisely locate and track aircraft operated on the training ranges. The use of this equipment will reduce the cost of operating Air Combat Maneuvering Instrumentation (ACMI) ranges since manned radar tracking sites and other equipment will become unnecessary.\nThe Company also designs and manufactures transportable radar systems used on military training ranges to replicate foreign military radars that control surface-to-air missiles (SAMs) and anti-aircraft artillery fire. These systems are used to train aircrews on defensive maneuvers and to test the effectiveness of electronic countermeasures.\nThe mechanical systems designed and manufactured by the Company include antenna support structures for large communications antennas, custom containers with environmental controls for sensitive electronics equipment such as satellites and missiles, and aircraft launcher rail assemblies for the AMRAAM missile. The Company has also developed and manufactures air cargo systems for airborne supply operations including on-board cargo roller\/restraint systems, air-drop platforms, and cargo handling equipment for many types of aircraft.\nThe Company manufactures a variety of other systems including memory expansion equipment for the FAA's air traffic control Interim Update Plan, TOW missile launchers used on the U.S. Army's Bradley Fighting Vehicle, custom automated test equipment for a variety of electronic equipment, and radar surveillance systems.\nGOVERNMENT CONTRACTS\nSales under contracts with or for the United States Government accounted for $81.3 million or 32% of the Company's sales in 1995. Most of the Company's Government contracts are fixed-price contracts. Under this type of contract, the price paid to the Company is not subject to adjustment by reason of the costs incurred by the Company in the performance of the contract, except that adjustments are made for costs incurred due to contract changes ordered by the Government. Cost overruns incurred in connection with fixed-price contracts, particularly those involving engineering and development, could substantially reduce the Company's profitability or cause losses.\nGovernment contracts may be terminated for the convenience of the Government at any time the Government believes that such termination would be in its best interests. Under contracts terminated for the convenience of the Government, the Company is entitled to receive payments for its allowable costs and, in general, a proportionate share of its fee or profit for the work actually performed. Under the Truth in Negotiations Act, the Government has a right for three years after final payment on substantially all negotiated Government contracts to examine all the Company's cost records with respect to such contracts in order to determine whether the Company used and made available to the Government, or to the prime contractor in the case of a subcontract, accurate, complete and current cost or pricing information in preparing bids and conducting negotiations on the contracts or any amendments thereto.\nThe Company recognizes revenue under its Government contracts on the percentage of completion method generally measured by the percentage of total costs incurred to date to estimated total costs for each contract. Estimated losses on contracts are provided for in full when they become apparent. Provided the job is on schedule, the Company normally recovers most of its costs on large contracts under a progress payment system whereby 75% to 80% of its allowable costs incurred in performing the contract, including applicable indirect costs such as general and administrative expenses, may be collected from the Government on a current basis, while related profit, if any, is billable only upon completion of the contract, or in certain instances, as delivery of units is made. The Company and Government representatives closely monitor the Company's performance against the overall budget of cost and profit for a job as the job progresses. Revisions of a budget may occur during the course of the work for many reasons, including increases or decreases in the scope of the work, change orders and funding adjustments, as well as for the Company's performance against such budget. Budget revisions forecasting profit reductions are recorded by the Company on a current basis, whereas forecasted profit increases are recorded over the remaining period of performance.\nThe Company believes that business done under Government contracts differs from ordinary commercial contracts in certain other ways. Capital requirements tend to be smaller because of the progress payment system. There is no significant bad debt loss risk and, in general, receivables are paid promptly. The Company has also found that, in the case of Department of Defense contracts, the contract dispute procedures are well defined and generally permit expeditious and inexpensive resolutions of contract problems.\nCOMPETITION AND BUSINESS CONDITIONS\nThe Company faces significant competition in most aspects of its business. Its principal competitors in each area of its activities include corporations with substantially greater assets and access to larger financial resources than the Company. The Company's products are of a highly technical nature and involve the use of techniques and materials similar to those used by its competitors. The principal competitive factors with respect to the Company's products are technological innovation, product quality, price, adherence to delivery schedules and product reliability. A significant portion of the Company's sales are made under Government contracts awarded on the basis of competitive proposals. In addition to price, the factors involved in the award of such contracts include the quality of the proposal and reputation of the bidder. While the Company faces competition with respect to each of its product lines, the Company believes it is a principal supplier of (i) meteorological radars to foreign government agencies, and (ii)marine seismic data acquisition systems to the petroleum industry.\nDemand for many of the products sold by the Company is dependent on the level and nature of the nation's defense expenditures. See \"Other Information\" included in Management's Discussion and Analysis set forth on pages 20 and 21 of the Company's Annual Report to Shareholders for the year ended December 31, 1995, which information is incorporated herein by reference. The defense-related electronic systems and components manufactured by the Company are sold primarily to the United States armed forces, defense contractors, and foreign countries for military and training use. General increases or decreases in the level of defense appropriations tend to affect demand for defense-related products, but do not necessarily have a corresponding effect on demand for the specialized products manufactured by the\nCompany. Due to the process by which appropriations and contracts are approved for defense projects, it is common for the Company to experience delays in the receipt of anticipated orders, which can adversely affect operating results by shifting operating revenues from one period to another. Because most of the Company's defense-related contracts are awarded on a fixed-price basis, cost overruns can affect the Company's profitability.\nMARKETING AND CUSTOMERS\nThe Company's products are primarily marketed directly by the sales force of each of its operating subsidiaries, with the assistance of domestic and international independent technical sales representatives who receive commissions on their sales. The principal customers for the communications products include the United States Government (primarily the armed services), government contractors, communication equipment manufacturers, government and commercial weather services, foreign government agencies, radio broadcast companies and organizations, and research organizations. The geoscience customers include major independent and foreign national oil and gas companies, seismic contractors, geophysical contractors and government agencies around the world. The defense systems products are sold to the armed forces of the United States and foreign governments, government contractors, and aircraft manufacturers.\nThe Company's largest customer is the United States Government, its agencies and contractors, whose purchases accounted for approximately 32% of the Company's consolidated sales in 1995. Of that amount, approximately 92% was attributable to purchases by the Department of Defense and its contractors. The loss of these Government contracts would have a material adverse effect on the Company as a whole. Contracts with or for the United States Government and most prime contractors may be terminated by the Government at will. See \"Government Contracts.\" The Company has not, however, experienced any significant problems with contract cancellations.\nPRODUCT DEVELOPMENT\nInformation concerning the amount spent during each of the last three years on Company-sponsored research and development activities is set forth in the Company's \"Consolidated Statement of Income\" on page 22 of the Company's Annual Report to Shareholders for the year ended December 31, 1995, which information is incorporated herein by reference. Certain of the Company's research and development activities are undertaken pursuant to Government contracts and subcontracts. The costs incurred under these contracts for product research and development are charged to cost of sales, rather than to product development costs.\nPATENTS\nAlthough TRAK, Tecom, Continental and Syntron hold a number of United States and foreign patents, the Company believes that its business is not materially dependent upon the protection afforded by patents, but primarily upon the experience and continued creative skills of its personnel. In many cases, because of rapidly changing technology and the need for confidentiality, the Company does not seek to obtain patents.\nBACKLOG\nThe backlog of unshipped orders was $121,293,000 and $138,221,000 as of December 31, 1994 and 1995, respectively. The backlog as of such dates which was reasonably expected to be filled within twelve months of such date was $104,402,000 and $128,035,000, respectively.\nThe backlog figures include only the sales value of the equipment or products for which the Company has received orders it believes to be firm. Contracts with or for the United States Government and most prime contractors may be terminated by the Government at will. See \"Government Contracts.\" The Company has not, however, experienced any significant problems with contract cancellations.\nMATERIALS AND SUPPLIES\nThe Company's operations require a wide variety of electronic and mechanical components and raw materials. Most of these items are available from several commercial sources. The Company does not depend on any single source for a significant portion of its supplies except for the 24-bit analog-to-digital converters and hybrid processors used in Syntron's new SYNTRAK 480-24 towed array system and ocean bottom cable.\nENVIRONMENTAL PROTECTION\nNo material effect on the operations of the Company is presently anticipated in the compliance with Federal, State and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, and the Company does not expect to make any material capital expenditures in the next year in order to comply with any such provisions.\nEMPLOYEES\nAs of December 31, 1995, the Company employed a total of 2,124 persons. None of the Company's domestic employees is represented by a labor union.\nPRODUCT LINE SALES\nInformation concerning the Company's product line sales is set forth under the caption \"Product Line Sales\" on page 20 of the Company's Annual Report to Shareholders for the year ended December 31, 1995, which information is incorporated herein by reference.\nEXPORT SALES\nInformation concerning the Company's export sales is set forth in Note 13 of the Notes to Consolidated Statements contained in the Company's Annual Report\nto Shareholders for the year ended December 31, 1995, which information is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters are located in Houston, Texas, in a company-owned building. The Company, through its Tech-Sym Management Corporation subsidiary, occupies approximately 7,500 square feet of the 20,000 square foot building. Approximately 7,500 square feet of the building is leased to third parties, with the remainder of the building available for lease or expansion.\nMetric's defense systems manufacturing operations are conducted from office and plant facilities comprising a total of 226,000 square feet located on three tracts totaling 38 acres owned by the Company in Fort Walton Beach, Florida. Metric also leases 10,000 square feet of manufacturing, office and storage space in several nearby facilities.\nEEC's weather information systems operations are conducted from office and plant facilities comprising 43,000 square feet located on an 11 acre tract owned by the Company in Enterprise, Alabama.\nThe electronic components manufacturing operation conducted by the Company's TRAK subsidiary consists of office and plant facilities located on ten acres owned by TRAK in Tampa, Florida, with combined square footage of approximately 123,000 square feet. TRAK'S subsidiary, TRAK Microwave Limited, leases plant and office facilities totaling 45,500 square feet in Dundee, Scotland. Daden-Anthony Associates, Inc., leases 14,500 square feet of plant and office facilities in San Clemente, California.\nTecom's antenna manufacturing operations are conducted in a 50,000 square foot leased facility located in Chatsworth, California.\nSyntron's seismic data acquisition systems operations are conducted from company-owned facilities comprising 79,000 square feet located on a 15.2 acre tract and leased facilities totaling 105,000 square feet, in Houston, Texas. Syntron's European subsidiary, Syntron Europe Limited, operates from a 52,000 square foot office and plant facility on a 2.8 acre tract owned by the Company in Derbyshire, England. Syntron's Asian subsidiary, Syntron Asia Pte. Ltd., has leased a 1.4 acre tract in Singapore and operates from a 33,300 square foot office and plant facility it constructed on the site.\nCogniSeis geoscientific software operations are conducted from 73,000 square feet of leased office space in Houston, Texas. Additional office space for development centers, service centers, and sales offices is leased in Colorado, Canada, England, The People's Republic of China, Russia, and Singapore.\nThe manufacturing operations for Continental's high power energy sources are conducted from office and plant facilities comprising 160,000 square feet on a 14 acre tract owned by the company in Dallas, Texas. Continental also leases an 80,000 square foot building on a 4 acre tract contiguous to the Continental property.\nContinental-Lensa S.A. of Santiago, Chile, leases 5,400 square feet for its assembly operations. TELEFUNKEN Sendertechnik GmbH operates from a leased facility of approximately 65,000 square feet in Berlin, Germany.\nThe Company is the developer of a 9,000 acre residential\/recreational project located near Concho, Arizona, in which Lake Investment Company, a wholly-owned subsidiary of the Company, owns a 100% interest. Approximately 900 acres of this development remains unsold. The Company intends to continue its efforts to liquidate its real estate operations and to use the proceeds in its manufacturing operations.\nCertain of the facilities of the Company and its subsidiaries are subject to mortgage debt as set forth in Note 7 of the Notes to Consolidated Financial Statements contained in the Company's Annual Report to Shareholders for the year ended December 31, 1995, which information is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs previously reported, the Company received notice on October 18, 1994, that Thomcast A.G. (\"Thomcast\") commenced an action in the United States District Court for the Northern District of Alabama, Southern Division, alleging that Continental Electronics Corporation (\"Continental\"), a wholly-owned subsidiary of the Company, and Eternal Word Television Network, Inc., a customer of Continental, have infringed and are infringing two claims of United States Patent No. 4,560,944 (the \"Patent\") assigned to Thomcast.\nThomcast has stated that its damages cannot presently be ascertained, but has computed its alleged damages on past sales at approximately $6,500,000 and has requested treble damages, prejudgment interest, costs and attorneys' fees. Although the Company believes it has meritorious defenses to such claims, it cannot predict the ultimate resolution of this matter. Trial on the matter is expected to occur during the first quarter of 1997.\nThere are various other lawsuits and claims pending against the Company's subsidiaries. In the opinion of Tech-Sym's management, based in part on advice of counsel, none of these actions will have a material adverse effect on the consolidated financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted during the fourth quarter of 1994 to a vote of the Company's security holders through the solicitation of proxies or otherwise.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information concerning the current executive officers (as defined by the Securities and Exchange Commission rules) of the Company. These officers serve at the discretion of the Board of Directors of the Company and of various subsidiaries of the Company, as the case may be.\nNAME AGE POSITIONS ---- --- --------- Wendell W. Gamel 66 Chairman of the Board, President and Director of the Company and officer and director of various subsidiaries of the Company\nCoy J. Scribner 64 Vice President and Director of the Company, President and Director of Metric, and Chairman of the Board of EEC\nRay F. Thompson 59 Vice President, Treasurer, Controller and Chief Financial Officer of the Company and officer and director of various subsidiaries of the Company\nJ. Rankin Tippins 43 Secretary and General Counsel of the Company and officer and director of various subsidiaries of the Company\nO. Dale Burris 59 President of TRAK Microwave Corporation\nRobert M. McDonald 65 President of Continental Electronics Corporation\nRichard F. Miles 47 Chairman of the Boards of Syntron, Inc., and CogniSeis Development, Inc.\nThere are no family relationships between any of the above persons. Executive officers are elected annually by the Board of Directors of the Company or a wholly-owned subsidiary of the Company, as the case may be, at their respective meetings of directors held immediately following the annual meeting of shareholders for such Company, to serve for the ensuing year or until their successors have been elected. The annual meeting of shareholders of the Company is normally held in April of each year and the annual meeting of each of the Company's principal subsidiaries, including Metric, TRAK, Syntron, CogniSeis, and Continental, are held in June of each year. There are no arrangements or understandings between any officer and any other person pursuant to which the officer was elected.\nMr. Gamel has been Chairman of the Board and President of the Company for more than the past five years. Mr. Gamel has served as a director of the Company continuously since 1966.\nMr. Scribner has been Vice President of the Company, President and a director of Metric, and Chairman of the Board of EEC, for more than the past five years. He has been a director of the Company continuously since 1983.\nMr. Thompson has been Treasurer, Controller and Chief Financial Officer of the Company for more than the past five years. In February of 1993, he was elected to the additional office of Vice President of the Company.\nMr. Tippins has been Secretary and General Counsel of the Company for more than the past five years.\nMr. Burris has served as President of TRAK for more than the past five years.\nMr. McDonald has served as President of Continental for more than the past five years.\nMr. Miles was elected President of Syntron on January 29, 1990. In December of 1995, he resigned as President of Syntron and was elected Chairman of the Boards of both Syntron and CogniSeis.\nPART II\nThe information called for by Items 5 through 8, inclusive, of Part II of this form is contained in the following sections of the Company's Annual Report to Shareholders for 1994, which sections are incorporated herein by reference:\nCaption and Page of Annual Report -------------------- Item 5.","section_5":"Item 5. Market for Registrant's \"Stockholder and Market Common Equity and Information\"; page 37 Related Stockholder Matters.\nItem 6.","section_6":"Item 6. Selected Financial Data \"Selected Financial Data\"; Item 7.","section_7":"Item 7. Management's Discussion \"Management's Discussion Financial Condition and and Analysis of and Results of Operations Analysis of Financial Condition and Results of Operations\"; pages 18-21, inclusive\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements Tech-Sym Corporation and and Supplementary Data Subsidiaries Consolidated Financial Statements pages 22 through 36, inclusive\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no such changes or disagreements.\nPART III\nThe information called for by Items 10, 11, 12 and 13 of Part III of this form (other than 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\nA list of the financial statements incorporated herein by reference is set forth in the Index to Financial Statements and Schedules submitted as a separate section of this report.\n(2) FINANCIAL STATEMENT SCHEDULES\nA list of the financial statement schedules included herein is contained in the accompanying Index to Financial Statements and Schedules.\n(3) EXHIBITS\nThe following documents are included as Exhibits to this report. An asterisk (*) before an Exhibit number denotes that such Exhibit has been incorporated by reference to the registration statement or report specified in the brackets thereafter.\n*3(a) Articles of Incorporation of Registrant, as amended [Registrant's 10-K (1989), SEC File No. 1-4371, Exhibit 3(a)]\n*3(b) By-Laws of Registrant, as amended [Registrant's 10-K (1993), SEC File No. 1-4371, Exhibit 3(b)]\n*4(a) Amended and Restated Rights Agreement dated as of June 1, 1988, between the Registrant and Continental Stock Transfer and Trust Company, as rights agent, relating to Common Stock Purchase Rights [Registrant's 10-K (1993), SEC File No. 1-4371, Exhibit 4(a)]\n*4(b) Note Agreement dated as of March 1, 1989, between the Registrant and Principal Mutual Life Insurance Company et al with respect to $20,000,000 principal amount of 10.28% Senior Notes due March 1, 2001 (excluding attachments) [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 4(b)]\n*4(c) 10.28% Note dated March 14, 1989, of Registrant due March 1, 2001 in the principal amount of $12 million and issued to Principal Mutual Life Insurance Company [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 4(c)]\n*4(d) 10.28% Note dated March 14, 1989, of Registrant due March 1, 2001 in the principal amount of $5 million and issued to Crown Life Insurance Company [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 4(d)]\n*4(e) 10.28% Note dated March 14, 1989, of Registrant due March 1, 2001 in the principal amount of $2 million and issued to Guarantee Mutual Life Company [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 4(e)]\n*4(f) 10.28% Note dated March 14, 1989, of Registrant due March 1, 2001 in the principal amount of $1,000,000 and issued to Security Mutual Life Insurance Company [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 4(f)]\n*10(a) 1980 Stock Option Plan of Registrant [Registration Statement No. 2-68084, Exhibit 1.1]\n*10(b) First Amendment to 1980 Stock Option Plan of Registrant dated February 23, 1982 [Registration Statement No. 2-77742, Exhibit 10(b)]\n*10(c) Second Amendment to 1980 Stock Option Plan of Registrant dated February 17, 1983 [Registration Statement No. 2-87064, Exhibit 10(c)]\n*10(d) 1990 Stock Option Plan of Registrant [Registration Statement No. 33-38208, Exhibit 28.1]\n*10(e) 1990 Stock Option Plan, as amended, effective February 21, 1991 [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(e)]\n*10(f) 1990 Stock Option Plan, as amended, effective February 17, 1994 [Registration No. 33-56535, Exhibit 4.1]\n*10(g) Written description of incentive bonus compensation plan effective February 20, 1992 [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(f)]\n*10(h) Deferred Compensation Agreement dated January 1, 1978, between the Registrant and Robert E. Moore with attached Amendments through January 1, 1991 [Registrant's 10-K (1990) SEC File No. 1-4371, Exhibit 10 (g)]\n*10(i) Consulting Agreement dated January 1, 1981, between TRAK Microwave Corporation and Rollin J. Sloan [Registration Statement No. 2-87064, Exhibit 10(p)]\n*10(j) First Amendment to Consulting Agreement dated January 1, 1984, between TRAK Microwave Corporation and Rollin J. Sloan [Registrant's 10-K (1983), SEC File No. 1-4371, Exhibit 10(t)]\n*10(k) Second Amendment to Consulting Agreement dated January 1, 1986, between TRAK Microwave Corporation and Rollin J. Sloan [Registrant's 10-K (1985), SEC File No. 1-4371, Exhibit 10(cc)]\n*10(l) Third Amendment to Consulting Agreement dated December 10, 1987, between Registrant and Rollin J. Sloan [Registrant's 10-K (1987), SEC File No. 1-4371, Exhibit 10(cc)]\n*10(m) Consulting Agreement dated January 1, 1988, between Registrant and Robert E. Moore [Registrant's 10-K (1987), SEC File No. 1-4371, Exhibit 10(dd)]\n*10(n) Form of Director's Stock Option Agreement dated as of December 10, 1987, entered into between Registrant and Keith R. Beeman (5,000 shares), A. A. Gallotta, Jr. (5,000 shares), Christopher C. Kraft, Jr. (5,000 shares), and Joal A. Teresko (5,000 shares) [Registrant's 10-K (1988), SEC File No. 1-4371, Exhibit 10(ii)]\n*10(o) Termination Agreement dated May 1, 1991, between the Registrant and Wendell W. Gamel [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(p)]\n*10(p) Termination Agreement dated May 1, 1991, between the Registrant and Coy J. Scribner [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(q)]\n*10(q) Termination Agreement dated May 1, 1991, between the Registrant and Ray F. Thompson [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(r)]\n*10(r) Termination Agreement dated May 1, 1991, between the Registrant and Richard F. Miles [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(s)]\n*10(s) First Amendment to Termination Agreement, dated April 26, 1994, between the Registrant and Richard F. Miles [Registration No. 33-56533, Exhibit 10(s)]\n*10(t) Termination Agreement dated May 1, 1991, between the Registrant and J. Rankin Tippins [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(t)]\n*10(u) Termination Agreement dated May 1, 1991, between the Registrant and O. Dale Burris [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(u)]\n*10(v) Termination Agreement dated May 1, 1991, between the Registrant and Robert M. McDonald [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(v)]\n*10(w) Trust Agreement dated June 11, 1991 between the Registrant and Texas Commerce Bank National Association [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(w)]\n*10(x) First Amendment dated June 1, 1992, to Trust Agreement dated June 11, 1991, between the Registrant and Texas Commerce Bank National Association [Registrant's 10-K (1992) SEC File No. 1-4371, Exhibit 10(x)]\n*10(y) Nonemployee Director Retirement Plan of the Registrant effective January 1, 1992 [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(x)]\n*10(z) Executive Retirement Agreement dated May 1, 1991, between the Registrant and Wendell W. Gamel [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(y)]\n*10(aa) Executive Retirement Agreement dated May 1, 1991, between the Registrant and Coy J. Scribner [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(z)]\n*10(bb) Executive Retirement Agreement dated May 1, 1991, between the Registrant and Ray F. Thompson [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(aa)]\n*10(cc) Executive Retirement Agreement dated May 1, 1991, between the Registrant and O. Dale Burris [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(bb)]\n*10(dd) Executive Retirement Agreement dated July 1, 1991, between Registrant and J. Rankin Tippins [Registrant's 10-K (1991) SEC File No. 1-4371, Exhibit 10(cc)]\n*10(ee) Executive Retirement Agreement dated April 26, 1994, between the Registrant and Richard F. Miles [Registration No. 33-56533, Exhibit 10(ee)]\n13 Pages 17-37 of the Annual Report to Shareholders of Registrant for the year ended December 31, 1994, are included as an Exhibit to this report for the information of the Securities and Exchange Commission, and, except for those portions thereof specifically incorporated by reference elsewhere herein, such pages of the Annual Report should not be deemed filed as a part of this report\n21 Subsidiaries of the Registrant\n23 Consent of independent accountants\n27 Financial Data Schedule which is deemed not to be filed for purposes of liability under the federal securities laws\n(B) REPORTS ON FORM 8-K\nNo reports on Form 8-K were required to be 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.\nTECH-SYM CORPORATION\nBy: \/s\/ RAY F. THOMPSON Ray F. Thompson, Vice President, Treasurer and Controller (Principal financial officer and principal accounting officer) Date: 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.\nBy: \/s\/ WENDELL W. GAMEL Wendell W. Gamel, Chairman of the Board, President and Director (Principal executive officer) Date: March 29, 1996\nBy: \/s\/ W. L. CREECH W. L. Creech Director Date: March 29, 1996\nBy: \/s\/ MICHAEL C. FORREST Michael C. Forrest Director Date: March 29, 1996\nBy: \/s\/ A. A. GALLOTTA, JR. A. A. Gallotta, Jr. Director Date: March 29, 1996\nBy: \/s\/ CHRISTOPHER C. KRAFT, JR. Christopher C. Kraft, Jr. Director Date: March 29, 1996\nBy: \/s\/ ROBERT E. MOORE Robert E. Moore Director Date: March 29, 1996\nBy: \/s\/ COY J. SCRIBNER Coy J. Scribner Director Date: March 29, 1996\nBy: \/s\/ ROLLIN J. SLOAN Rollin J. Sloan Director Date: March 29, 1996\nBy: \/s\/ JOAL A. TERESKO Joal A. Teresko Director Date: March 29, 1996\nBy: \/s\/ CHARLES K. WATT Charles K. Watt Director Date: March 29, 1996\nFINANCIAL STATEMENTS AND SCHEDULES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nPage in Annual Report* -------------- (a) The following documents are filed as part of this report:\n(1) Financial Statements:\nConsolidated Statements of Income for the three years ended December 31, 1995 22\nConsolidated Balance Sheets at December 31, 1995 and 1994 23\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995 24\nConsolidated Statements of Changes in Shareholders' Investment for the three years ended December 31, 1995 25\nNotes to Consolidated Financial Statements 26\nQuarterly Financial Information (Unaudited) 35\nReport of Independent Accountants 36\nPage in this Report on Form 10-K ------------- (2) Financial Statement Schedules:\nReport of Independent Accountants on Financial Statement Schedules S-2\nII Valuation and Qualifying Accounts and Reserves for the three years ended December 31, 1995 S-3\n*Incorporated by reference from the indicated pages of the 1995 Annual Report to Shareholders.\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 on Financial Statement Schedules\nTo the Board of Directors of Tech-Sym Corporation:\nOur audits of the consolidated financial statements referred to in our report dated February 22, 1996 appearing in the 1995 Annual Report to Shareholders of Tech-Sym Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ Price Waterhouse LLP PRICE WATERHOUSE LLP\nHouston, Texas February 22, 1996\nS-2\nTECH-SYM CORPORATION AND SUBSIDIARIES Valuation and Qualifying Accounts and Reserves (Schedule II) For the Three Years Ended December 31, 1995\nS-3","section_15":""}
{"filename":"769856_1995.txt","cik":"769856","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral Development of Business\nUniprop Manufactured Housing Communities Income Fund, a Michigan Limited Partnership (the \"Partnership\"), acquired, maintains, operates and ultimately will dispose of income producing residential real properties consisting of four manufactured housing communities (the \"Properties\"). The Partnership was organized and formed under the laws of the State of Michigan on May 16, 1985. Its principal offices are located at 280 Daines Street, Birmingham, Michigan 48009 and its telephone number is (810) 645-9261.\nThe Partnership filed an S-11 Registration Statement (Registration No. 2-98180) in June 1985 which was declared effective by the Securities and Exchange Commission on September 24, 1985. The Partnership thereafter offered a maximum of 30,000 units of limited partnership interest representing capital contributions by the limited partners to the Partnership of $1,000 per unit (the \"Units\"). The sale of all 30,000 Units was completed in March, 1986 generating $30 million of contributed capital to the Partnership.\nOn February 10, 1986, the Partnership acquired Aztec Estates, a 645-space manufactured housing community in Margate, Florida and Kings Manor, a 314-space manufactured housing community in Ft. Lauderdale, Florida. On March 4, 1986, the Partnership acquired Old Dutch Farms, a 293-space manufactured housing community in Novi, Michigan. On March 27, 1986, the Partnership acquired The Park of the Four Seasons, a 572-space manufactured housing community in Blaine, Minnesota.\nThe Partnership operates the Properties as manufactured housing communities with the primary investment objectives of: (1) obtaining net cash from operations; (2) obtaining capital appreciation; and (3) preserving capital. There can be no assurance that such objectives can be achieved.\nFinancial Information About Industry Segment\nThe Partnership's business and only industry segment is the operation of its four manufactured housing communities. Partnership operations commenced in February 1986 upon the acquisition of the first two Properties. The Partnership's first full year of operations was the fiscal year ended December 31, 1987. For a description of the Partnership's revenues, operating profit and assets, please refer to Items 6 and 8.\nNarrative Description of Business\nGeneral\nThe Properties were selected from 23 manufactured housing communities then owned by affiliates of P.I. Associates Limited Partnership, a Michigan limited partnership,\nthe General Partner (the \"General Partner\") of the Partnership. The Partnership rents space in the Properties to owners of manufactured homes thereby generating rental revenues. It is intended that the Partnership will hold the Properties for extended periods of time, originally anticipated to be seven to ten years after their acquisition, although a Property may be disposed of earlier or later, if in the opinion of the General Partner, it is in the best interest of the Partnership to do so. The determination of whether a particular Property should be disposed of will be made by the General Partner only after consultation with Manufactured Housing Services Inc. (the \"Consultant\") and after consideration of relevant factors, including, current operating results of the particular Property, prevailing economic conditions and with a view to achieving maximum capital appreciation to the Partnership considering relevant tax consequences and the Partnership's investment objectives.\nCompetition\nThe business of owning and operating residential manufactured housing communities is highly competitive, and the Partnership may be competing with a number of established companies having greater financial resources. Moreover, there has been a trend for manufactured housing community residents to purchase (where zoning permits) their manufactured homesites on a collective basis. This trend may result in increased competition with the Partnership for tenants. In addition, the General Partner, its affiliates or both, has participated, and may in the future participate, directly or through other partnerships or investment vehicles in the acquisition, ownership, development, operation and sale of projects which may be in direct competition with one or more of the Properties.\nEach of the Properties competes with numerous similar facilities located in its geographic area. The Margate\/Fort Lauderdale area contains approximately 15 communities offering approximately 6,165 housing sites competing with Aztec Estates. The Davie\/Fort Lauderdale area contains approximately seven communities offering approximately 3,483 housing sites competing with Kings Manor. Park of the Four Seasons competes with approximately 11 communities offering approximately 3,031 housing sites. Old Dutch Farms competes with approximately eight communities offering approximately 3,652 housing sites. The Properties also compete against other forms of housing, including apartment and condominium complexes.\nGovernmental Regulations\nThe Properties owned by the Partnership are subject to certain state regulations regarding the conduct of the Partnership operations. For example, the State of Florida regulates agreements and relationships between the Partnership and the residents of Aztec Estates and Kings Manor. Under Florida law, the Partnership is required to deliver\nto new residents of those Properties a prospectus describing the Property and all tenant rights, Property rules and regulations, and changes to Property rules and regulations. Florida law also requires minimum lease terms, requires notice of rent increases, grants to tenant associations certain rights to purchase the community if being sold by the owner and regulates other aspects of the management of such properties. The Partnership is required to give 90 days notice to the residents of Florida properties of any rate increase, reduction in services or utilities or change in rules and regulations. If a majority of the residents object to such changes as unreasonable, the matter must be submitted to the Florida Department of Business Regulations for mediation prior to any legal adjudication of the matter. In addition, if the Partnership seeks to sell Florida Properties to the general public, it must notify any homeowners association for the residents, and the association shall have the right to purchase the Property for the price, terms and conditions being offered to the public within 45 days of notification by the owner. If the Partnership receives an unsolicited bona fide offer to purchase the Property from any party that it is considering or negotiating, it must notify any such homeowners association that it has received an offer, state to the homeowners association the price, terms and conditions upon which the Partnership would sell the Property, and consider (without obligation) accepting an offer from the homeowners association. The Partnership has, to the best of its knowledge, complied in all material respects with all requirements of the States of Florida, Michigan and Minnesota, where its operations are conducted.\nEmployees\nThe Partnership employs three part-time employees to perform Partnership management and investor relations services. The Partnership retains an affiliate, Uniprop, Inc., as the property manager for each of its Properties. Uniprop, Inc. is paid a fee equal to the lesser of 5% of the annual gross receipts from each of the Properties or the amount which would be payable to unaffiliated third parties for comparable services. Uniprop, Inc. retains local managers on behalf of the Partnership at each of the Properties. Salaries and fringe benefits of such local managers are paid by the Partnership and are not included in any property management fee payable to Uniprop, Inc. Local managers are employees of the Partnership and are paid semi-monthly. The yearly salaries and expenses for local managers range from $20,000 to $40,000. Local managers have no direct management authority, make no decisions regarding operations and act only in accordance with instructions from the property manager. They are utilized by the Partnership to provide on-site maintenance and administrative services. Uniprop, Inc., as property manager, has overall management authority for each Property.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership purchased all four manufactured housing communities for cash and the Properties are unencumbered, except for normal zoning, building and use restrictions for properties of that kind. Each of the Properties is a modern manufactured housing community containing lighted and paved streets, side-by-side off-street parking and complete underground utility systems. The Properties consist of only the underlying real estate and improvements, not the actual homes themselves. Each of the Properties has a community center which includes offices, meeting rooms and game rooms. Each of the Properties, except Old Dutch Farms, has a swimming pool and tennis courts.\nOverall, as illustrated in the table below, the Properties reported, as of December 31, 1995, a combined occupancy of 95.1% and an average monthly homesite rent of $362.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the opinion of the Partnership and its legal counsel, there are no material legal proceedings pending except such ordinary routine matters as are incident to the kind of business conducted by the Partnership. To the knowledge of the Partnership and its counsel, no legal proceedings have been instituted or are being contemplated by any governmental authority against the Partnership.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe voting privileges of the limited partners are restricted to certain matters of fundamental significance to the Partnership. The limited partners must approve certain major decisions of the General Partner if the General Partner proposes to act without the approval of the Consultant. The limited partners also have a right to vote upon removal and replacement of the General Partner, dissolution of the Partnership, material amendments to the partnership agreement and the sale or other disposition of all or substantially all of the Partnership's assets, except in the ordinary course of the Partnership's disposing of the Properties. There have been no matters submitted to a vote of the limited partners during the last fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nThere is no established public trading market for the Units and it is not anticipated that one will ever develop. During the last two years, less than two percent of the Units have been transferred each year, excluding transfers on account of death or intra-family transfers. The Partnership believes there is no secondary market, or the substantial equivalent thereof, and none will develop.\nThe General Partner calculates the estimated net asset value of each Unit by dividing (i) the amount of distributions that would be made to the limited partners in the event of the current sale of the Properties at their current appraised value, less sales expenses (but without consideration to tax consequences of the sale), by (ii) 30,000. In March, 1996, the Properties were appraised at an aggregate fair market value of $51,400,000. Assuming a sale of the four properties in March 1996, at the appraised value, less payment of selling expenses, the contingent purchase price due to sellers, and after the 80\/20% split of sale or financing proceeds with the General Partner, the net aggregate proceeds available for distribution to the limited partners is estimated to be $43,110,400 or $1,437 per unit. There can be no assurance that the estimated net asset value could ever be realized. As of March 1st, 1996, the Partnership had approximately 2,720 limited partners holding Units.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes selected financial data for Uniprop Manufactured Housing Communities Income Fund, a Michigan Limited Partnership, for the periods ended December 31, 1995, 1994, 1993, 1992 and 1991:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nLiquidity\nThe Partnership has, since inception, generated adequate amounts of cash to meet its operating needs. The Partnership retains cash reserves which it considers adequate to maintain the Properties. All funds in excess of the operating needs and cash reserves have been distributed to the Partners, quarterly. While the Partnership is not required to maintain a working capital reserve, the Partnership has not distributed all the cash generated from operations in order to build cash reserves. For the year ended December 31, 1995 the Partnership added $178,017 to reserves. The amount of any funds placed in reserves is at the discretion of the General Partner. The Partnership expects to\ngenerate adequate amounts of cash to meet its operating needs during the next fiscal year.\nOn August 24, 1994, the Partnership obtained a $200,000 line of credit with Comerica Bank. On June 1, 1995, the line was increased to $400,000 to add additional models. This is a result of the existing homes being purchased quickly. Proceeds from the line of credit are being used to purchase new and used manufactured homes for resale in the communities owned by the Fund. As of December 31, 1995, the outstanding balance was $343,210.\nCapital Resources\nThe capital formation phase of the Partnership began on February 10, 1986, when Aztec Estates and Kings Manor were purchased by the Partnership and operations commenced. On March 4, 1986, and March 27, 1986, Old Dutch Farms and Park of the Four Seasons were purchased, respectively. From the $30,000,000 capital raised from the sale of the Units, $26,400,000 was used to purchase the four Properties after deducting sales commissions, advisory fees and other organization and offering costs. The Partnership had no capital expenditure commitments as of December 31, 1995 and does not anticipate any during the next fiscal year.\nResults of Operations\na. Distributions\nDuring the years ended December 31, 1995, 1994 and 1993, cash generated by operations, and available for distribution, was $3,773,017, $3,652,772 and $3,461,959 respectively. For the years ended December 31, 1995, 1994 and 1993, respectively, the Partnership made distributions to limited partners equal, on an annualized basis, to 10% of their original capital contributions. These distributions totaled $3,000,000 in each year. The General Partner received distributions totaling $595,000, $400,000 and $600,000 during the same periods. No distributions made to the limited partners to date constitute, in whole or in part, a return of their capital contributions.\nb. Net Income\nFor the years ended December 31, 1995, 1994 and 1993 net income was $2,989,190, $2,884,362 and $2,704,752 on total revenues of $7,502,221, $7,321,328 and $6,997,507.\nNet income plus depreciation and amortization less distributions to all Partners was $178,017, $252,772 and $(138,041), for the same periods. This fluctuation results from differences in the timing of distributions to the Partners and the fact that the Partnership had established cash reserves when deemed necessary from time to time.\nc. Partnership Management\nNet expenses for the management of the Partnership (i.e. gross expenses for such management, less transfer fees, interest on reserves and interest on funds awaiting distribution) were $249,760 in 1995, $266,907 in 1994 and $343,633 in 1993. The decrease in Partnership management expenses in 1995 versus 1994 was due to higher legal expenses.\nd. Property Operations\nOverall, the four Properties had a combined average occupancy of 95.1% (1,735\/1,824 sites) as of December, 1995; 94.8% as of December, 1994; and 94.9% as of December, 1993. The average collected monthly rent as of December, 1995 was approximately $362 per homesite versus $352 as of December, 1994 and $337 as of December, 1993, an increase each year of 2.8% and 4.4%, respectively.\nDuring the 1995, 1994 and 1993 fiscal years, the Properties generated a net operating income of $4,253,489 or 56.7% of total revenues; $4,140,507 or 56.6% of total revenues; and $3,975,678 or 56.8% of total revenues, respectively. Net operating income is computed before deduction of (i) certain non-recurring expenses of $230,712, $335,243 and $170,086, respectively, and (ii) depreciation and amortization of $783,827, $768,410, and $757,207. The large increase in non-recurring expense between 1994 and 1993 was the result of required capital improvements to the sewage treatment facility at Old Dutch Farms in Novi, MI.\nAztec Estates, in Margate, Florida, had an occupancy of 95.9% (619\/645 sites) as of December, 1995 compared to 98.4% as of December, 1994 and 98.9% in 1993. The average rent in December, 1995 was $395 per homesite versus $385 in December, 1994 and $363 in December, 1993, an increase each year of 2.6% and 6.0%, respectively.\nThe property's 1995 net operating income of $1,614,553 represented 53.7% of revenues versus $1,559,113 or 51.9% of revenues in 1994, and $1,543,235 or 54.2% of revenues in 1993. The increase in net operating income from 1994 to 1995 was due to higher average rents and lower operating expenses.\nKings Manor, in Fort Lauderdale, Florida, had an occupancy of 96.5% (303\/314 sites) as of December, 1995 compared to 99.0% as of December, 1994 and 99.0% in 1993. The average rent in December, 1995 was $372 per homesite versus $354 in December 1994 and $334 in December, 1993, an increase each year of 5.1% and 6.0% respectively.\nThe property's 1995 net operating income of $821,053 represented 60.6% of revenues, versus $781,390 or 59.5% in 1994, and $701,322 or 59.1% in 1993. The increase in income was the result of higher rental income.\nOld Dutch Farms, in Novi, Michigan, had an occupancy of 96.9% (284\/293 sites) as of December, 1995 compared to 94.2% in 1994 and 99.0% in 1993. The average rent in December, 1995 was $371 per homesite versus $359 in December, 1994 and $345 in December, 1993, an increase each year of 3.3% and 4.1%, respectively.\nThe property's 1995 net operating income of $731,943 represented 61.5% of revenues, versus $744,447 or 64.3% in 1994, and $721,439 or 63.0% in 1993. The decrease in income was the result of higher operating expenses.\nThe Park of the Four Seasons, in Blaine, Minnesota, had an occupancy of 92.5% (529\/572 sites) as of December, 1995 compared to 88.6% in 1994 and 86.2% in 1993. The average rent in December, 1995 was $312 per homesite versus $306 in December, 1994 and $302 in December, 1993, an increase each year of 2.0% and 1.3%, respectively.\nThe property's 1995 net operating income of $1,085,940 represented 56.1% of revenues versus $1,055,557 or 56.3% in 1994, and $1,009,682 or 55.9% in 1993. The increase in net operating income from 1994 to 1995 was primarily due to reduced operating expenses and increased rental rates. Vacancy in the area is still greater than 10% and the Partnership will continue offering some rental incentives during 1996.\nIn 1996 and for the foreseeable future, the Partnership expects to meet its expenditures from operating revenues and to distribute excess cash flow, after retention of an adequate cash reserve, to its partners.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Partnership's financial statements for the fiscal years ended December 31, 1995, 1994 and 1993, and supplementary data are filed with this Report under Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in the Partnership's independent public accountants nor have there been any disagreements during the past two fiscal years.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership, as an entity, does not have any officers or directors. The General Partner of the Partnership is P.I. Associates Limited Partnership. P.I. Associates is a Michigan limited partnership and its general partner is Paul M. Zlotoff.\nInformation concerning Mr. Zlotoff's age and principal occupations during the last five years or more is as follows:\nPaul M. Zlotoff, 46, is and has been an individual general partner of P.I. Associates since its inception in May 1985. Mr. Zlotoff became the Chairman and Chief Executive Officer of Uniprop, Inc. in May 1986 and has been its President since 1979. He is also an individual general partner of Genesis Associates Limited Partnership, the general partner of Uniprop Manufactured Housing Communities Income Fund II, a public limited partnership which owns and operates nine manufactured housing communities. Mr. Zlotoff currently, and in the past, has acted as the general partner for various other limited partnerships owning manufactured home communities, as well as some commercial properties.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no executive officers and therefore, no officers received a salary or remuneration exceeding $100,000 during the last fiscal year. The General Partner of the Partnership and an affiliate, Uniprop, Inc., received certain compensation and fees during the fiscal year in the amounts described in Item 13. The Partnership anticipates that it will provide similar compensation to the General Partner and Uniprop, Inc. during the next fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Partnership is a limited partnership formed pursuant to the Michigan Uniform Limited Partnership Act, as amended. The General Partner, P.I. Associates Limited Partnership, is vested with full authority as to the general management and supervision of the business and other affairs of the Partnership, subject to certain constraints in the partnership agreement and consulting agreement. Limited partners have no right to participate in the management of the Partnership and have limited voting privileges only on certain matters of fundamental significance. No person owns of record or beneficially, more than five percent of the Partnership's Units.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe following discussion describes all of the types of compensation, fees or other distributions paid by the Partnership or others to the General Partner or its affiliates from the operations of the Partnership during the last fiscal year, as well as certain of such items which may be payable during the next fiscal year. Certain of the following arrangements for compensation and fees were not determined by arm's length negotiations between the General Partner, its affiliates and the Partnership.\nPaul M. Zlotoff has an interest in the sellers of all the Properties acquired by the Partnership and may be entitled to share in a contingent purchase price with respect to each Property, when and if the Properties are sold and the sellers become entitled thereto. The maximum amounts which could be payable to the sellers are as follows: Aztec Estates, $1,374,323; Kings Manor, $529,724; Park of the Four Seasons, $1,113,594; and Old Dutch Farms, $452,359. The contingent purchase price for each Property was determined by reference to the average of two independent real estate appraisals which were obtained by the General Partner. Such appraisals are only estimates of value and are not necessarily indicative of the actual real estate value. Each seller will become entitled to any unpaid contingent purchase price upon the sale, financing or other disposition of one or more Properties, but, only after the receipt by each limited partner of any shortfall in his 9% cumulative preferred return plus the return of his adjusted capital contribution. The actual amounts to be received, if any, will depend upon the results of the Partnership's operations and the amounts received upon the sale, financing or other disposition of the Properties and are not determinable at this time. The Partnership does not anticipate any such amount will become payable during the next fiscal year.\nThe Partnership paid and will pay an incentive management interest to the General Partner for managing the Partnership's affairs, including: determining distributions, negotiating agreements, selling or financing properties, preparing records and reports, and performing other ongoing Partnership responsibilities. This incentive management interest could be up to 20% of the net cash from operations (cash revenues less cash operating expenses and specified reserves) in any taxable year. However, in each taxable year the General Partner's right to receive any net cash from operations is subordinated to the extent necessary to first provide each limited partner his 10% preferred return plus any shortfall in his 9% cumulative preferred return. During the last fiscal year, the General Partner was entitled to an incentive management interest of $773,017. The actual amount of incentive management interest paid to the General Partner during 1995 was $595,000. The actual amount to be received during the next fiscal year will depend upon the results of the Partnership's operations and is not determinable at this time. The General Partner also has a right to receive 20% of any sale or financing proceeds remaining after each limited partner has received an amount equal to any shortfall in his 9% cumulative preferred return, plus the return of his adjusted capital contribution.\nUniprop, Inc., an affiliate of the General Partner, received and will receive property management fees for each Property managed by it. Uniprop, Inc. is primarily responsible for the day-to-day management of the Properties and for the payment of the costs of operating each Property out of the rental income collected. The property management fees are equal to the lesser of 5% of the annual gross receipts from the Properties managed by Uniprop, Inc., or the amount which would be payable to an unaffiliated third party for comparable services. During the last fiscal year, Uniprop, Inc. received the following property management fees totaling $371,984: Aztec Estates, $149,006; Kings Manor, $67,569; Old Dutch Farms, $59,149; and Park of the Four Seasons, $96,260. In addition, certain employees of the Partnership are also employees of affiliates of the General Partner. During the last fiscal year, these employees received an aggregate of $105,798 for performing local property management, data processing and investor\nrelations services for the Partnership. The actual amounts to be received during the next fiscal year will depend upon the results of the Partnership's operations and are not determinable at this time.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Financial Statements\nThe following financial statements and related documents are filed with this Report:\n(1) Report of Independent Certified Public Accountants\n(2) Balance Sheets as of December 31, 1995 and 1994 and Statements of Income for the fiscal years ended December 31, 1995, 1994 and 1993\n(3) Statements of Partners' Equity for the fiscal years ended December 31, 1995, 1994 and 1993\n(4) Statements of Cash Flows for the fiscal years ended December 31, 1995, 1994 and 1993\n(5) Schedule III - Real Estate and Accumulated Depreciation for the fiscal years ended December 31, 1995, 1994 and 1993\n(b) Reports on Form 8-K\nThe Partnership did not file any Forms 8-K during the fourth quarter of 1995.\n(c) Exhibits\nThe following exhibits are incorporated by reference to the S-11 Registration Statement of the Partnership filed June 4, 1985, as amended on August 1, 1985 and September 11, 1985:\n3(a) Amended Certificate of Limited Partnership for the Partnership\n3(b) Agreement of Limited Partnership for the Partnership\n10(a) Form of Management Agreement between the Partnership and Uniprop, Inc.\n10(b) Form of Consulting Agreement between the Partnership, the General Partner and Consultant\nThe following exhibits are incorporated by reference to the Form 10-K for fiscal year ended December 31, 1992.\n3(c) Certificate of Amendment to the Certificate of Limited Partnership for the Partnership (originally filed with Form 10-Q for the fiscal quarter ended June 30, 1986).\n4 Form of Certificate of Limited Partnership Interest in the Partnership (originally filed with Form 10-K for the fiscal year ended December 31, 1986)\n10(c) Contingent Purchase Price Agreement between the Partnership, Aztec Estates\n10(d) Contingent Purchase Price Agreement between the Partnership and O.D.F. Mobile Home Park (originally filed with Form 10-K for the fiscal year ended December 31, 1987)\n10(e) Contingent Purchase Price Agreement between the Partnership and The Park of the Four Seasons (originally filed with Form 10-K for the fiscal year ended December 31, 1987)\nThe following exhibit is attached to this Report:\n27 Financial Data Schedule\n28 Letter summary of the estimated fair market values of the Partnership's four manufactured housing communities, as of March 23, 1996.\n(d) Other Financial Statements\nThere are no other financial statements required by the instructions contained in Regulation S-X or, the information is included elsewhere in the financial statements or the notes thereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Uniprop Manufactured Housing Communities Income Fund, a Michigan Limited Partnership, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUniprop Manufactured Housing Communities Income Fund, a Michigan Limited Partnership\nBY: P.I. Associated Limited Partnership, General Partner\nDated: March 29, 1996 BY: \/s\/ Paul M. Zlotoff ---------------------------------------- Paul M. Zlotoff, General Partner\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Partners Uniprop Manufactured Housing Communities Income Fund (a Michigan limited partnership)\nWe have audited the accompanying balance sheets of Uniprop Manufactured Housing Communities Income Fund (a Michigan 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. We have also audited the schedule listed under Item 14 of Form 10-K. These financial statements and the schedule 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 and the 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 the 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 financial statements and the schedule. We believe that our 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 Uniprop Manufactured Housing Communities Income Fund 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.\nAlso, in our opinion, the schedule listed under Item 14 of Form 10-K presents fairly, in all material respects, the information set forth therein.\nBDO SEIDMAN, LLP\nTroy, Michigan February 9, 1996\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nSTATEMENTS OF INCOME\nSee accompanying notes to financial statements.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to financial statements.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS\nSee accompanying notes to financial statements.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF ORGANIZATION AND BUSINESS ACCOUNTING POLICIES Uniprop Manufactured Housing Communities Income Fund, a Michigan Limited Partnership (the \"Partnership\") acquired, maintains, operates and will ultimately dispose of income producing residential real properties consisting of four manufactured housing communities (the \"properties\") located in Florida, Minnesota and Michigan. The Partnership was organized and formed under the laws of the State of Michigan on May 16, 1985.\nThe general partner of the Partnership is P. I. Associates Limited Partnership. Taxable investors acquired 20,230 Class A units, and 9,770 Class B units were acquired by tax exempt investors. Depreciation is allocated only to holders of Class A units and to the general partner.\nUSE OF ESTIMATES\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect (1) the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and (2) revenues and expenses during the reporting period. Actual results could differ from these estimates.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts of the Partnership's financial instruments, which consist of cash, its line of credit and accounts payable, approximate their fair values.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation is provided using the straight-line method over the following estimated useful lives:\nBuilding and improvements 30 years Manufactured homes and improvements 30 years Furniture and equipment 3-10 years\nAccumulated depreciation for tax purposes was $8,324,900 and $7,472,706 as of December 31, 1995 and 1994, respectively.\nINCOME TAXES\nFederal income tax regulations provide that any taxes on income of a partnership are payable by the partners as individuals. Therefore, no provision for such taxes has been made at the partnership level.\n2. OTHER ASSETS At December 31, 1995 and 1994, \"Other assets\" included cash of $171,000 and $137,000, respectively, in a security deposit escrow account for two of the Partnership's properties, as required by the laws of the state in which they are located, which is restricted from operating use.\n3. REVOLVING The Partnership currently has a $400,000 CREDIT revolving line of credit agreement with a bank. AGREEMENT Interest accrues on outstanding balances at 3\/4% above the bank's prime rate (prime was 8.5% at December 31, 1995). The amounts outstanding were $343,210 and $135,000 at December 31, 1995 and 1994, respectively.\n4. OTHER Other liabilities consisted of: LIABILITIES\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n5. RELATED PARTY MANAGEMENT AGREEMENT TRANSACTIONS The Partnership has an agreement with an affiliate of the general partner to manage the properties owned by the Partnership. The management agreement is automatically renewable annually, but may be terminated by either party upon sixty days written notice. The property management fee is the lesser of 5% of annual gross receipts from the properties managed, or the amount which would be payable to an unaffiliated third party for comparable services.\nREPORT OF FEES\nDuring the years ended December 31, 1995, 1994 and 1993, the affiliate earned property management fees of $371,984, $362,755, and $348,935, respectively, as permitted in the Agreement of Limited Partnership. These operating expenses are included with \"Administrative\" expenses in the respective statements of income. The Partnership was owed $8,415 and $8,042 by the affiliate at December 31, 1995 and 1994, respectively, for overpayments made.\nCertain employees of the Partnership are also employees of affiliates of the general partner. These employees were paid by the Partnership the amounts of $105,798, $120,876, and $120,205, in 1995, 1994 and 1993, respectively, to perform local property management and investor relations services for the Partnership.\nCONTINGENT PURCHASE PRICE\nThe general partner of P.I. Associates has an interest in the sellers of all the properties acquired by the Partnership and is entitled to share in a contingent purchase price with respect to each property, when and if the properties are sold and the sellers become entitled thereto. The actual amounts to be received, if any, will depend upon the results of the Partnership's operations and the amounts received upon the sale, financing or other disposition of the properties and are not determinable at this time. The Partnership does not anticipate any such amount will become payable during the next fiscal year.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n7. PARTNERS' Subject to the orders of priority under certain CAPITAL specified conditions more fully described in the Agreement of Limited Partnership, distributions of partnership funds and allocations of net income from operations are principally determined as follows:\nDISTRIBUTIONS\nNet cash from operations (generally defined in the Agreement as net income plus depreciation) is to be distributed to the limited partners until they have received their 10% preferred return plus any shortfall in their 9% cumulative return. Secondly, the general partner will receive 20% of net cash from operations. Thereafter, all remaining net cash from operations is to be distributed to the limited partners.\nALLOCATION OF NET INCOME\nNet income is to be allocated in the same manner as distributions except that:\na) Depreciation expense is allocated only to the general partner and the Class A (taxable) limited partners and,\nb) In all cases, the general partner is to be a alocated at least 1% of all Partnership items.\nSince inception, the Fund earned sufficient cash from operations to distribute the 10% preferred return to the limited partners and therefore, there has been no shortfall in the 9% cumulative return.\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nSCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nUNIPROP MANUFACTURED HOUSING COMMUNITIES INCOME FUND (A MICHIGAN LIMITED PARTNERSHIP)\nNOTES TO SCHEDULE III DECEMBER 31, 1995\n1. RECONCILIATION OF The following table reconciles buildings and improvements BUILDINGS AND from January 1, 1993 to December 31, 1995: IMPROVEMENTS\nThere were no additions to land during this three-year period.\n2. RECONCILIATION The following table reconciles the accumulated ACCUMULATED depreciation from January 1, 1993 to December 31, 1995: OF DEPRECIATION\n3. TAX BASIS OF The aggregate cost of buildings and improvements for BUILDINGS federal income tax purposes is equal to the cost basis AND IMPROVEMENTS used for financial statement purposes.\nEXHIBIT INDEX","section_15":""}
{"filename":"803605_1995.txt","cik":"803605","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nThe Marina Limited Partnership (the \"Partnership\") was organized as an Indiana limited partnership under the laws of the State of Indiana on October 7, 1986 for the purpose of reorganizing the business of The Marina Corporation (the \"Company\"). The Company was reorganized into a publicly traded limited partnership in order to eliminate the \"double\" federal income tax on its future earnings and distributions. The Partnership is the successor-issuer to the Company. On December 29, 1986, the shareholders of the Company approved the plan to reorganize the Company into the Partnership. On December 30, 1986, pursuant to the plan of reorganization, all of the assets and liabilities of the Company were transferred to the Partnership in exchange for a number of units of interest (\"Units\") in the Partnership equal to the number of outstanding shares of the Company's Common Stock, and the Company distributed the Units to or for the benefit of its shareholders. Units represent either general partner interests (\"General Partner Units\") or limited partner interests (\"Limited Partner Units\"). See Item 5, \"Market for Partnership's Common Equity and Related Security Holder Matters.\" Following the distribution of the Units, the Company was dissolved.\nThe Partnership's principal executive offices are located at 11691 Fall Creek Road, Indianapolis, Indiana 46256, and its telephone number is 317\/845-0270. The affairs of the Partnership are managed by its general partner, The Marina II Corporation (the \"General Partner\"), an Indiana corporation. The General Partner's principal executive offices and telephone number are the same as those of the Partnership.\nINVESTMENT REAL ESTATE\nOn December 31, 1995, the Partnership owned approximately 385 acres of investment real estate. Approximately 322 acres of this investment real estate are adjacent to Geist Lake, and approximately 63 acres are adjacent to Morse Lake. Substantially all of the properties consist of partially wooded, gently rolling\nland adjacent to the lakes. Homesite sales revenue accounted for 50 percent of the Partnership's revenues for 1995, 44 percent for 1994, and 40 percent for 1993. Gains on sale of investment land accounted for 5 percent of the Partnership's revenues for 1995, 1 percent for 1994, and 4 percent for 1993.\nGEIST LAKE. Geist Lake is an artificially created reservoir located within 15 to 20 miles driving distance of the downtown business district of Indianapolis, Indiana. On December 31, 1995, the Partnership's investment real estate at Geist Lake consisted of approximately 322 acres, which are zoned either for single- family residential use, multi-family residential use, commercial use, recreational use, or agricultural use. Approximately seventeen acres of the land at Geist Lake is being used for Geist Marina and Marina Village. See \"Marina Operations\" and \"Investment Real Estate -- Commercial Development,\" below.\nMORSE LAKE. Morse Lake is an artificially created reservoir located within 25 to 30 miles driving distance of the downtown business district of Indianapolis, Indiana. On December 31, 1995, the Partnership's investment properties at Morse Lake consisted of approximately 63 acres zoned for single-family residential, commercial, and agricultural use. Approximately twenty acres of the land at Morse Lake are being used for the Morse Marina. See \"Marina Operations,\" below.\nRESIDENTIAL DEVELOPMENT. Bridgewater, located near Geist Marina, was the Partnership's first single-family homesite project. It will include 81 homesites, of which 68 homesites have been developed in the first three phases. In 1995, the Partnership sold four homesites in Bridgewater. All but one of the eight finished homesites remaining to be sold from the first three phases are the more expensive waterfront sites. The fourth phase, Bridgewater Island, is planned for development in 1996 or 1997, and it is expected to include 13 exclusive waterfront homesites. The Partnership will spend approximately $540,000 to complete development of the island.\nThe Partnership sold 40 homesites from Cambridge, a single- family residential development located at Geist Lake. The Partnership completed development of 65 homesites in the fifth section of Cambridge. Of the 40 homesites sold in Cambridge in 1995, 31 homesites\nwere from the newly completed fifth section. This compares with 28 homesites sold in Cambridge by the Partnership in 1994. Marina I, a joint venture, sold 31 homesites in Cambridge in 1995, compared to 28 homesites sold in 1994. At December 31, 1995, the Partnership had 39 homesites remaining to be sold in sections one, two, and five of Cambridge, while Marina I had 82 homesites remaining to be sold in sections three and four of Cambridge. When complete, Cambridge will include more than 400 homesites.\nThe Partnership is developing Morse Overlook, a residential development near Morse Marina. It is expected to include approximately 50 homesites, of which nearly one-half will be waterfront. Homesites will be available for sale during the second quarter of 1996. The Partnership plans to spend approximately $675,000 in 1996 to complete development of Morse Overlook.\nThe Partnership's current land ownership and the land owned by Marina I will take a number of years to develop and sell under reasonable market conditions. However, due to a sand and gravel mining project in Geist Lake by Irving Materials, Inc. (\"Irving\"), the availability of some of the land for residential development by Marina I may be delayed for seven years or more. The Partnership may acquire additional land for development during this period to properly balance the mix of off-water homesites to waterfront homesites and to continue development until the balance of the Marina I land is available. See \"Investment Real Estate -- Marina I,\" below.\nHOMESITE FINANCING ARRANGEMENTS. The Partnership sells residential homesites for cash or contract. The Partnership finances homesite purchases, and requires a minimum down payment of 10% of the price of the homesite. The balance of the contract price, plus interest, is payable over seven years, although typically most contracts are paid in full within two years. In 1995, interest rates on homesites sold on contract were 9% the first year, 10% in the second year, and 12% in years three through seven. In 1994, interest rates on homesites sold on contract were 8% the first year, 10% in the second year, and 12% in years three through seven. Homesites sold on contract prior to October 1993 have interest rates of 9% in the first year, 12% in the second year, and 14% in years three through seven.\nMARKETING. The Partnership has a builder support program with limited financial incentives for builders who build in the Partnership's residential projects. The portion of the homesite sales price, which may be refundable under builder programs if the home remains on the market for four to eight months after completion, is deferred until the refund period expires. At December 31, 1995, $46,000 had been deferred for the builder support program. In 1995, $6,000 was paid to a builder under the builder support program.\nCOMMERCIAL DEVELOPMENT. The Partnership is developing and selling land at Geist Crossing, a shopping center site near Geist Lake. In January 1995, the Partnership sold 1.3 acres of commercial property at Geist Crossing to a national drug store chain for $675,000, which resulted in a gain of $217,000. In February 1995, the Partnership sold .5 acres of commercial property at Geist Crossing for $200,000 to a fast-food chain for additional parking. A gain of $11,000 was recognized on the sale. In March 1995, the Partnership sold 5 acres of commercial property at Geist Crossing for $803,000 for retail shops connected to the Kroger store. A gain of $79,000 was recognized. In May 1995, the Partnership sold 1.5 acres of commercial property at Geist Crossing for $600,000 for retail shops. A gain of $191,000 was recognized on the sale. The remaining land at Geist Crossing includes three less valuable outlots and a three acre parcel recently zoned retail, which is contiguous but more remote from the high traffic corner. The Partnership plans to spend approximately $200,000 in 1996 to complete development of these commercial sites.\nThe Partnership began operating a 20,000 square foot retail and office development known as Marina Village in 1995. This new building includes 12,000 square feet of retail space, of which 9,000 square feet has been leased, and 8,000 square feet of office space, of which 2,000 square feet is the office of the Partnership. The Partnership spent $1,013,000 in 1995 for construction of this building. The Partnership plans to spend approximately $160,000 for tenant finishings in 1996.\nMARINA I. The Partnership is the general partner of The Marina I L.P., an Indiana limited partnership (\"Marina I\"), which has a right to receive and develop\ninitially approximately 140 acres of land in the vicinity of Geist Lake. Irving Materials, Inc. (\"Irving\") is the sole limited partner of Marina I. Irving continues to mine and extract sand and gravel from the remaining property, and it contributes parcels of the land to Marina I when it has completed the extraction. In 1995, Irving increased its investments in Marina I with contributions of land in sections three and five in Cambridge. The Partnership is responsible for developing and selling the property for residential use.\nThe Partnership, as general partner, and Irving, as limited partner, received $810,200 and $789,800, respectively, in distributions during 1995. Marina I received $844,269 from the Partnership in 1995 as its share of profit earned on homesites sold by the Partnership in Cambridge, section 5, that were partially owned by Marina I. Additionally, the Partnership recognized $979,957 in equity earnings from Marina I for the 31 homesites sold in Cambridge and other related activities in 1995. See \"Investment Real Estate -- Residential Development,\" above.\nFLATFORK CREEK UTILITY. The Partnership and Irving are each 50 percent shareholders of Flatfork Creek Utility, Inc., an Indiana corporation (the \"Corporation.\") The Corporation was formed to complete the construction of and operate the wastewater treatment plant and interceptor sewer line to service land in the northeast Geist area. Construction of the interceptor sewer line and the first phase of the wastewater treatment plant was completed in the fourth quarter of 1994. The first phase of the plant will serve approximately 430 homes. The Corporation is subject to certain regulations of the Indiana Utility Regulatory Commission. The Corporation recorded a $112,000 net loss for 1995, of which the Partnership accounted for its 50% share of the Corporation's net loss against its investment in the Corporation. The Corporation expects operating losses for the next several years. The contributions received from developers requiring service are expected to be sufficient to fund debt service requirements and provide funds for operations. The Corporation has a $2,382,257 bank loan outstanding at December 31, 1995. The Partnership and Irving have each guaranteed the loan.\nDOCKSIDE CAFE. The Partnership is a limited partner of Dockside Cafe L.P., an Indiana limited partnership (\"Dockside Cafe\"), which operates the Blue Heron restaurant in Marina Village at Geist Lake and Carrigan Crossing at Morse Lake. The Partnership received $46,000 in distributions from Dockside Cafe in 1995. The Partnership has leased the restaurants to Dockside Cafe, and has recognized $267,667 in rental income in 1995.\nMARINA OPERATIONS\nThe Partnership owns two marinas located at Geist and Morse Lakes. The marinas consist of approximately 1,200 boat docks, two public access boat launching ramps, and several storage and other buildings. The operating season for the marinas depends upon weather conditions, but is typically from the middle of April through the middle of October. The marinas charge rental fees for the use of their docks; ramp fees for the use of their launching ramps; and fees for boat storage. The marinas also sell boats, gasoline, boating accessories, and boating supplies, and repair boats.\nThe operation of the marinas accounted for 30 percent of the Partnership's revenues in 1995, 40 percent in 1994, and 48 percent in 1993. The principal sources of revenues for the marinas are from the rental of boat docks, boat launching fees, boat sales, service repair work and, to a lesser extent, from winter boat storage, and the sale of gasoline, boating supplies, food items and miscellaneous services.\nThe operations of the marinas are affected by inclement weather, which tends to discourage boating and reduce revenues. Also, because Geist and Morse Lakes are reservoirs for the Indianapolis area water supply, the levels of the lakes may fall during drought periods, making boating hazardous and reducing recreational use.\nRECREATIONAL FACILITIES\nIn March 1995, the Partnership purchased the recreational facilities at Geist Lake for $425,000 from The New Shorewood Limited Partnership (\"Shorewood\"), the successor to The Shorewood Corporation. See \"Relationship Between the Partnership and Shorewood\" below. The recreational facilities include a clubhouse and three separate pools located near Geist Lake. The\nClubhouse is available for rental throughout the year. The operating season for the pools begins on the Memorial Day weekend and extends to the Labor Day weekend. The Partnership's residential developments have access to these recreational facilities, as do purchasers of Shorewood's remaining homesites and residents of Shorewood developments at Geist Lake.\nFUTURE OPERATIONS\nThe General Partner expects that the Partnership will continue to: (1) sell investment real estate from time to time depending on market conditions and other factors; (2) pursue development activities; (3) seek to enhance the value of the Partnership's investment real estate by making certain improvements and by acquiring additional surrounding real estate; and (4) acquire additional real estate for investment. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nCOMPETITION\nINVESTMENT REAL ESTATE. Although there are numerous real estate properties in the Indianapolis metropolitan area available for development of homesites, there are only a limited number of water-oriented properties. The Partnership believes that, of those water-oriented properties that are or will be economically suitable for development of homesites, the Partnership's properties are among those with the greatest long-term development potential, primarily because of the character of the lakes to which the Partnership's properties are adjacent and the extent and types of development at such lakes. There are, however, water- oriented properties owned by other developers that are available for development of homesites that are equally desirable. Shorewood continues to have a number of completed waterfront homesites for sale which competes directly with the Partnership's properties, and this inventory will have an impact on the Partnership's waterfront homesite sales to the extent they are more or less effective in marketing. It is expected that it will take approximately two years for Shorewood to liquidate its homesite inventory. See \"Relationship between the Partnership and Shorewood,\" below. Competition in commercial development has become more significant due to the increased zoning of land for commercial use in the area of Geist Lake.\nMARINAS. The Geist Marina provides the only boat docks, gas pumps and launching ramps on Geist Lake available to the general public. At Morse Lake, the Town of Cicero operates boat docks and gas pumps in competition with the Morse Marina.\nREGULATION\nThe Partnership's real estate is subject to governmental regulations, particularly zoning regulations, restrictions on construction in flood plains, wetlands protection, and restrictions on water and septic systems. To the extent applicable, any developer of the property must comply with such regulations, as well as the Federal Interstate Land Sales Full Disclosure Act, water pollution and water quality control regulations, and other miscellaneous regulatory requirements. The Partnership cannot predict the cost or effect of future regulations on the development potential of its real estate.\nEMPLOYEES\nThe Partnership has eighteen (18) full-time employees (most of whom are primarily engaged in the operation of the marinas) and a number of part-time employees who work on a seasonal basis. The General Partner is responsible for the management of the Partnership's affairs. There are four officers of the General Partner, who are employees of the General Partner. Two of the four officers devote their full-time duties to activities of the General Partner and the Partnership.\nRELATIONSHIP BETWEEN THE PARTNERSHIP AND SHOREWOOD\nThe Company was originally organized in 1982 as a wholly- owned subsidiary of The Shorewood Corporation (\"Shorewood\"). In 1985, Shorewood became a wholly-owned subsidiary of Meritor Savings Bank (\"Meritor\"), and divested itself of the Company by distributing shares of the Company to the former Shorewood shareholders. Meritor was taken over by the Federal Deposit Insurance Corporation (\"FDIC\") in late 1992 because of large continuing losses which impaired its capital. The Partnership made an unsuccessful bid in 1994 for the purchase of Shorewood. Shorewood was sold by the FDIC to another bidder and is now privately-held.\nSince 1985, there have been a number of business relationships between the Partnership and Shorewood. Currently, Shorewood's successor leases a portion of a building from the Partnership. In March 1995, the Partnership purchased the Shorewood recreational facilities at Geist Lake. See \"Recreational Facilities\" above.\nTAXATION OF INTERESTS IN PUBLICLY TRADED PARTNERSHIPS\nThe Omnibus Budget Reconciliation Act of 1987 (OBRA) changed provisions of the federal tax law to treat publicly traded partnerships (PTP) as if they were corporations for purposes of income taxation. PTP's existing as of December 17, 1987 remain exempt from income taxation as a corporation until their first taxable year beginning after 1997, unless a substantial new line of business is added. The General Partner believes that the Partnership's business is the holding of real estate for investment, the operation and sales activities of the marinas, and real estate development activities. However, no ruling has been received or requested from the Internal Revenue Service with regard to this issue.\nOBRA also provides that the passive loss rule of Internal Revenue Code Section 469 is to be applied separately for the tax attribute items of each PTP, and that a partner's share of net income from a PTP will generally not be treated as income from a passive activity but rather as portfolio income. In general, under these separate application rules, the income from the Partnership may not offset losses from a partner's other passive activities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Partnership's properties are substantially described in Item 1 of this Part I. See \"Investment Real Estate\" and \"Marina Operations.\"\nThe Partnership has title to all of its real estate, substantially all of which has been covered by blanket title insurance commitments. All of the properties are subject to certain telephone, highway, pipeline and electric power line easements. The Morse and Geist Lake properties are also subject to the easements and restrictions of the Indianapolis Water Company (\"IWC\"), which owns the reservoirs for water supply purposes. In connection with the maintenance,\nprotection and operation of its water supply reservoirs, IWC has retained a 20-foot easement around the shoreline of both reservoirs and has imposed restrictions on the adjacent land. IWC is permitted access to the lakes for all purposes reasonably necessary to their operation and maintenance as reservoirs, and certain uses of the land that could cause pollution of the lakes are prohibited. There are no mortgages on the Partnership's real estate properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere is no material proceeding in which any director, officer or affiliate of the Partnership, or any associate of any such director or officer, is a party, or has a material interest, adverse to the Partnership. The Partnership is not involved in any administrative or judicial proceedings arising under any federal, state or local provisions which have been enacted or adopted to regulate the discharge of materials into the environment or otherwise relating to the protection of the environment other than those normally encountered as part of the development business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted to a vote of security holders of the Partnership in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR PARTNERSHIP'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS.\nThe Partnership's Limited Partner Units trade on The NASDAQ SmallCap Market tier of The NASDAQ Stock Market under the symbol MRNCZ. The following table sets forth for the periods indicated the representative high and low bid prices of the Partnership's Limited Partner Units as reported by NASDAQ. Such prices represent quotations between dealers without adjustments for retail mark-up, mark-down, or commissions and do not necessarily represent actual transactions.\nOn March 22, 1996, the closing bid and asked prices of the Limited Partner Units were $30.00 bid and $35.50 asked, and there were approximately 523 record holders of Limited Partner Units of the Partnership.\nOn April 17, 1995, the Partnership made a cash distribution of $2.00 per unit. On April 18, 1994, the Partnership made a cash distribution of $1.00 per unit. No other cash distributions were made during 1994 and 1995.\nThe General Partner intends to cause the Partnership to make cash distributions from its net cash flow as often as the General Partner, in its discretion, believes it to be feasible and prudent for the Partnership. Although the number, amount, and timing of cash distributions in any given year may vary substantially, it is currently anticipated that the Partnership will make cash distributions in an amount sufficient to cover the tax liability incurred by Partners from Partnership operations. The preceding discussion regarding cash distributions are forward looking statements. There can be no assurance as to the amount or timing of Partnership cash distributions, and the Partnership is not obligated to make any such distributions.\nPursuant to the reorganization of the Company into the Partnership, Units in the Partnership received by the Company (and subsequently distributed to the shareholders of the Company) were divided between General Partner Units and Limited Partner Units. The economic interests in the Partnership represented by a General Partner Unit and Limited Partner Unit are identical. General Partner Units are vested with the authority to manage the affairs of the Partnership. Limited Partner Units carry no management authority.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data presented below for the years ended December 31, 1995, 1994, 1993, 1992, and 1991, are derived from the financial statements of the Partnership, which have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The financial statements for the years ended December 31, 1995, 1994, and 1993, and the auditors' report thereon, are included in Part II, Item 8.\n1. Earnings per unit and cash distribution per unit for 1995 and 1994 have been computed on the basis of 196,714 weighted average outstanding general partner units and 478,421 weighted average outstanding limited partner units. Earnings per\nunit for 1993 have been computed on the basis of 179,949 weighted average outstanding general partner units and 495,186 weighted average outstanding limited partner units from January 1, 1993 to June 30, 1993, and 196,714 weighted average outstanding general partner units and 478,421 weighted average outstanding limited partner units from July 1, 1993 to December 31, 1993. The cash distribution per unit for 1993 and earnings per unit and cash distribution per unit for 1992 and 1991, have been computed on the basis of 179,949 weighted average outstanding general partner units and 495,186 weighted average outstanding limited partner units.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion and analysis is intended to address the significant factors affecting the Partnership's results of operations and financial condition. It is designed to provide a more comprehensive review of the operating results and financial position than could be obtained from an analysis of the financial statements alone. It should, however, be read in conjunction with the financial statements and related notes, and the Selected Financial Data, included elsewhere herein.\nGENERAL\nNet earnings increased to $4,391,000 in 1995 compared to $2,705,000 in 1994. The increase in net earnings was principally due to earnings from homesite sales, gains on sale of investment land, and the equity in earnings recognized from Marina I. The Partnership's principal sources of revenue in 1995 were from homesite sales, marina operations, equity in earnings of investee companies, gains on sale of investment land, and interest and rental income.\nIn 1995, the Partnership's primary source of revenue was from homesite sales. Homesite sales revenue accounted for 50 percent of the Partnership's revenues for 1995, 44 percent for 1994, and 40 percent for 1993. In 1993, the Partnership's primary source of revenue was from the operations of marinas on Morse Lake and Geist Lake (respectively, the \"Morse Marina\" and \"Geist Marina\"). The operation of the marinas accounted for 30 percent of the Partnership's revenues\nin 1995, as compared to 40 percent in 1994 and 48 percent in 1993. Gains on sale of investment land accounted for 5 percent of the Partnership's revenues for 1995, and 1 percent in 1994, and 4 percent in 1993.\nThe Partnership's development or sales of investment real estate and residential homesites is affected by several factors such as economic conditions, interest rates, zoning, environmental regulation, availability of utilities, population growth in the area, and competition.\nThe principal sources of revenues for the marinas are from the rental of boat docks, boat launching fees, boat sales, and service repair work. Revenues generated to a lesser extent are from winter boat storage, and the sale of gasoline, boating supplies, food items and miscellaneous services. Most docks at the Morse Marina and Geist Marina are rented for the April to October boating season. Annual dock rental payments are due prior to the beginning of the boating season with the result that the majority of cash is received during the first six months of the year; most expenses, however, occur during the peak boating months of the summer. Boat dock revenues are deferred when received and recognized as earned during the boating season. Winter boat storage generates revenues for the October to April storage season, and is recognized as earned during the storage season.\nThe Partnership's marina operations are affected by weather conditions, since inclement weather tends to discourage boating and reduce revenues. Also, because Geist and Morse Lakes are reservoirs for the Indianapolis area water supply, the levels of the lakes may fall during drought periods, making boating hazardous. Marina operations are also affected by economic conditions, including inflation. During recessionary periods, recreational boating decreases and revenues from the operation of the marinas decrease accordingly. Increases in the cost of boating caused by inflation also adversely affect the Partnership.\nLIQUIDITY AND CAPITAL RESOURCES\nThe General Partner of the Partnership believes that current funds and funds generated by homesite sales, marina operations, land sales, and bank loans will be sufficient to satisfy its working capital requirements through the end of 1996. On December 31, 1995, the Partnership had cash and cash equivalents,\nincluding short-term investments, of $5,295,000. On December 31, 1995, the Partnership did not have any significant contractual commitments for capital expenditures to be made during 1996. During 1995, the Partnership expended approximately $2,538,000 for home and homesite development costs, $1,121,000 for the commercial properties, and $593,000 for improvements on land held for investment. In addition, approximately $689,000 was expended for marina property and equipment.\nOn a long-term basis, major sources of liquidity are expected to be revenues from marina operations, sales of homesites and investment land, and borrowings. The Partnership currently expects that funds from current reserves, operating cash flow, and normal short-term lines of credit will be sufficient to satisfy future capital needs.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994. Net earnings were $4,391,000 for 1995, as compared to $2,705,000 in 1994. The increase of net earnings of $1,686,000 was principally due to an increase in homesite sales less related direct costs of $787,000, an increase from gains on sales of investment land of $432,000, and an increase in equity earnings from Marina I of $255,000.\nThe Partnership sold four homesites from Bridgewater in 1995. Bridgewater, located near Geist Marina, was the Partnership's first single-family homesite development. The Partnership sold 40 homesites from Cambridge, a single-family homesite project located at Geist Lake. The Partnership completed development of 65 homesites in the fifth section of Cambridge. Of the 40 homesites sold in Cambridge in 1995, 31 homesites were from the newly completed fifth section. The Partnership paid $884,000 to Marina I in 1995 for Marina I's share of profit earned on homesites sold in the fifth section of Cambridge by the Partnership where the land was partially owned by Marina I. The 44 homesites sold in 1995 compares to 33 homesites sold by the Partnership in 1994, five of which were from Bridgewater and 28 of which were from Cambridge. Earnings from homesite sales were $2,400,000 in 1995, compared to $1,613,000 in 1994. The increase in net earnings per homesite sale in 1995 results from an increase in the number of waterfront homesites sold.\nThe Partnership is the general partner of Marina I which developed 29 of the 71 homesites in the first two sections of Cambridge (the Partnership developed the other 42 homesites). Marina I also developed 112 homesites in sections three and four of Cambridge. Marina I sold 31 homesites in Cambridge in 1995, compared to 28 homesites sold in 1994. The Partnership recognized $980,000 in equity earnings from Marina I in 1995, compared to $724,000 recognized as equity earnings in 1994. The Partnership received a distribution of $810,000 from Marina I in 1995.\nDuring 1995, the Partnership sold 8.3 acres of commercial property at Geist Crossing for a total of $2,278,000. Gains of $498,000 were recognized on these sales in 1995.\nInterest income increased by $178,000 to $398,000 in 1995, compared to $220,000 in 1994. The increase in interest income results from an increase of $143,000 in interest earned on the Partnership's investments, and an increase of $35,000 in interest earned on homesites sold on contract by the Partnership.\nIn March 1995, the Partnership purchased the recreational facilities at Geist Lake for $425,000. The Partnership's residential developments have access to the newly acquired recreational facilities. Net revenues generated by the recreational facilities were $77,000 in 1995.\nNet revenues from marina operations and boat sales increased by $71,000 to $840,000 in 1995, compared to $769,000 in 1994. The increase in net revenue results from a reduction in maintenance and depreciation expense at Morse Marina, and an increase in revenue at the Geist service department. The increase in net revenue is partially offset by a reduction of revenue earned by the boat sales department.\nFlatfork Creek Utility, Inc. (the \"Corporation\") was formed to construct and operate a wastewater treatment plant and interceptor sewer line to service land primarily in the Cambridge development. The Partnership recognized an equity loss from the Corporation in 1995 of $56,000. The Partnership and Irving Materials, Inc. are both guarantors of the Corporation's bank loan, of which $2,382,000 was outstanding at December 31, 1995.\nThe Partnership is not a taxable entity, and consequently, there are no income taxes reflected in the statements of earnings.\nOn April 17, 1995, the Partnership made a cash distribution of the partners of record on April 3, 1995, of $2.00 per unit of partnership interest, for a total of $1,350,000.\nPartners' equity increased by $3,041,000 during 1995 to $16,786,000. The increase was due to 1995 net earnings of $4,391,000, which were partially offset by the $2.00 per unit or $1,350,000 distribution to the partners.\n1994 COMPARED TO 1993. Net earnings were $2,705,000 for 1994 compared to $1,739,000 in 1993. The increase in net earnings was primarily due to an increase in homesite sales less related direct costs of $466,000, and equity in earnings from Marina I of $724,000.\nThe Partnership sold five homesites from Bridgewater, two of which included homes that the Partnership had used as sales offices. In 1994, the Partnership opened for sale 71 homesites in the first two sections of Cambridge. Twenty-eight homesites were sold in Cambridge, for a total of 33 homesites sold by the Partnership in 1994. This compares with 20 homesites sold in 1993. Earnings from homesite sales were $1,613,000 in 1994, compared to $1,147,000 in 1993. The decrease in net earnings per homesite sale was due to increased development costs, primarily in Cambridge.\nMarina I developed 29 of the 71 homesites in the first two sections of Cambridge. The Partnership received $233,000 from Marina I in 1994 as its share of profit earned on homesites sold in Cambridge by Marina I that were partially owned by the Partnership. In 1994, the Partnership recognized $724,000 in equity earnings from Marina I.\nIn September 1994, the Partnership sold a portion of its commercial site near Geist Lake to a fast-food chain for $380,000. Cash proceeds of $349,000, net of closing costs and realtor commissions, were received at the time of sale, which resulted in a gain of $57,000. The Partnership additionally recorded $10,000 to income for forfeiture of a down payment from a developer on a commercial site near Geist Lake.\nRevenues from the marina operations increased $611,000 in 1994 to $3,062,000, as compared to $2,451,000 in 1993. The increased revenue primarily results from increased boat sales of $409,000, and to a lesser extent, from increases in dock, service, and launching revenues. Operating expenses of the two marinas increased $484,000 in 1994. The increase results primarily from an increase in cost of boat sales of $371,000.\nInterest income increased to $220,000 in 1994 compared to $177,000 in 1993. The increase in interest income results from the an increase of $24,000 in interest earned on homesites sold on contract by the Partnership, and an increase of $19,000 in interest earned on the Partnership's investments.\nGeneral and administrative expenses increased by $148,000 to $787,000 in 1994, compared to $639,000 in 1993. This increase primarily results from an increase in salaries and wages of $64,000, an increase in legal fees of $45,000, and an increase in property taxes of $31,000.\nConstruction of the interceptor sewer line and first phase of Flatfork Creek Utility, Inc, (the \"Corporation\") was completed in the fourth quarter of 1994. The Partnership recognized an equity loss from the Corporation in 1994 of $11,000.\nOn April 18, 1994, the Partnership made a cash distribution to the partners of record on April 6, 1994, of $1.00 per unit of partnership interest, or a total of $675,000.\nPartners' equity increased by $2,036,000 during 1994 to $13,744,000. The increase was primarily due to 1994 net earnings of $2,705,000, which were partially offset by the $1.00 per unit or $675,000 distribution to the partners.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe following are the financial statements of the Partnership for the years ended December 31, 1995, 1994, and 1993, and the independent auditors' report thereon. A list of the reports and financial statements appears in response to Item 14 of this report:\n[LETTERHEAD OF KPMG PEAT MARWICK L.L.P.]\nINDEPENDENT AUDITORS' REPORT\nThe Partners THE MARINA LIMITED PARTNERSHIP:\nWe have audited the accompanying balance sheets of The Marina Limited Partnership as of December 31, 1995 and 1994, and the related statements of earnings, cash flows and partners' equity 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 The Marina Limited Partnership 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.\n\/s\/ KPMG Peat Marwick LLP\nIndianapolis, Indiana February 16, 1996\nSee accompanying notes to financial statements.\nSee accompanying notes to financial statements.\nSee accompanying notes to financial statements.\nSee accompanying notes to financial statements.\nTHE MARINA LIMITED PARTNERSHIP\nNotes to Financial Statements\nDecember 31, 1995, 1994 and 1993\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGeneral\nThe Marina Limited Partnership (the Partnership) became a publicly traded limited partnership on December 30, 1986. The limited partnership units are registered securities and currently represent approximately 71 percent of the total Partnership units. The remaining units are owned by Marina II Corporation, the general partner, which has the authority to manage the affairs of the Partnership. The economic interests in the Partnership represented by general partner units and limited partner units are identical.\nThe general partner receives management fees equal to three percent of the Partnership's gross margin on marina operations, rental income and recreational facilities.\nCash and Cash Equivalents\nCash and cash equivalents include cash balances and short-term certificates of deposit with maturities of three months or less. Also included are short-term U.S. Treasury bills with maturities of less than nine months.\nThe Partnership maintains a separate accounting of unclaimed limited partner unit distributions.\nHomesite Sales\nSales of residential homesites are for cash or on contract. Sales which satisfy minimum down- payment requirements are recorded as revenue at the time of closing. The portion of the sales price which may be refundable under builder programs is deferred until the refund period expires. Costs of homesites sold are determined by the relative sales value of the homesite to the total project.\nAt the time a lot is sold, the Partnership accrues a fee payable to Flatfork Creek Utility, Inc. for the cost of certain utility hook-up charges which is included in cost of sales.\nLand and Land Improvements\nCosts directly related to bringing land to a fully-improved saleable condition are capitalized. These costs include construction, excavation, engineering and other direct costs incurred during the improvement period. Land and land improvement costs are allocated to land sales and homesite projects by the specific identification method.\nMarina Property and Equipment and Recreational Facilities\nMarina property and equipment and recreational facilities are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.\nCommercial Properties\nCommercial properties represent developed restaurant and retail properties including the related development and construction costs. Completed properties are depreciated using the straight-line method based on their estimated useful lives.\nInvestments\nThe Partnership uses the equity method to account for its 50% general partner investment in The Marina I L.P. (Marina I), its 40% limited partner investment in Dockside Cafe, L.P. (Dockside Cafe), and its 50% corporate investment in Flatfork Creek Utility, Inc. The Partnership's share of the net earnings and losses of these businesses are included currently in earnings.\nUtility Refunds\nWhen the Partnership's predecessor was formed in April 1982, it acquired rights under utility refund agreements which were not recorded at that time as future receipts could not be estimated. As such, utility refunds are recorded as capital contributions when received.\nFinancial Instruments\nThe carrying amount of the contracts receivable approximate their fair value because the interest rates are at market rates. The carrying amounts of all other financial instruments approximate fair value because of the short-term maturity of these items.\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 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.\nThe Company evaluates all of its real estate investments periodically to assess whether any impairment indications are present, including recurring operating losses and significant adverse changes in legal factors or business climate that affect the recovery of recorded value. If any real estate investment is considered impaired, a loss is provided to reduce the carrying value of the property to its estimated fair value.\nIncome Taxes\nAs a partnership, the allocated share of income or loss of the Partnership is includable in the income tax returns of the partners; accordingly, income taxes are not reflected in the Partnership's financial statements.\n(2) Property and Equipment\nMarina property and equipment consist of land, land improvements, marina facilities, boat docks, and equipment used in the marina operations located on Morse and Geist Lakes. At December 31, marina property and equipment consisted of the following:\nRecreational facilities consist of land, buildings and related furnishings used in recreational facilities adjacent to homesite developments at Geist Lake. Residents of the developments pay a fee for the use of the facilities which were purchased by the Partnership in 1995. At December 31, 1995, recreational facilities consisted of the following:\nLand $ 65,000 Building and fixtures 367,653 432,653 Accumulated depreciation (11,162)\n$ 421,491\nCommercial properties represent various retail buildings which are held for investment and generally leased under short-term arrangements. At December 31, the properties consisted of the following:\n(3) Land and Land Improvements\nAt December 31, land and land improvements consisted of the following:\nIn 1995, the Partnership sold a total of 8.3 acres of a commercial site under development to unrelated parties for $2,278,000 in cash, which resulted in gains of $498,373.\nIn 1994, the Partnership sold 1.5 acres of a commercial site under development to an unrelated party for $380,000 in cash, which resulted in a gain of $56,814. Also in 1994, a gain of $10,000 was recognized when a potential buyer forfeited a land deposit.\nIn 1993, the Partnership sold 1.3 acres of a commercial site under development to an unrelated party for $350,000 in cash, which resulted in a gain of $83,234. Also, in 1993, the Partnership recognized a sale and related gain of $145,612 on the sale of a portion of a commercial site under development to an unrelated party for $1,300,000.\n(4) Other Investments\nMarina I\nThe Partnership is a general partner with Irving Materials, Inc. as limited partner for the development of certain land near Geist Lake. The Partnership increased its investment in 1994 with net cash contributions of $60,000 and a contribution of land of $427,296. Homesite sales activity began in 1994. The Partnership's equity in the earnings of Marina I amounted to $979,957 in 1995 and $724,499 in 1994.\nThe following is a summary of balance sheet and operating information (in thousands) of Marina I as of December 31, 1995 and 1994 and for the years then ended:\nDockside Cafe\nThe Partnership is a limited partner with Dockside Cafe, Inc. as general partner for the operation of a restaurant at the Geist Lake Marina. The Partnership constructed the restaurant, which began operations in April 1993. During 1994, the Partnership constructed a new restaurant at Morse Lake Marina, which began operations in June 1994.\nFlatfork Creek Utility, Inc.\nIn March 1990, the Partnership purchased 8.8 acres of land to construct a wastewater treatment plant to serve homesites to be developed in the Geist Lake area by the Partnership, Marina I, and other developers. In January 1993, Flatfork Creek Utility, Inc. (the Corporation) was formed to complete the construction of, and then operate, the wastewater water treatment plant (the Utility). The Partnership transferred $738,000 of assets and $424,000 of liabilities related to the Utility to the Corporation, as its sole shareholder. The Partnership then sold 50% of its interest in the Corporation to Irving Materials, Inc. for $157,000. The wastewater treatment plant became operational in November 1994. The Utility is subject to certain regulations of the Indiana Utility Regulatory Commission.\nThe Partnership, along with Irving Materials, Inc., are both guarantors of the Corporation's $2,500,000 loan, of which $2,382,257 was outstanding at December 31, 1995.\n(5) Notes Payable to Bank\nThe Partnership has a $2,000,000 unsecured line of credit which matures July 1, 1996 and bears interest at the bank's prime rate. There were no borrowings on the line of credit through December 31, 1995.\n(6) Rental Income\nIn April 1993, the Partnership completed construction of a restaurant facility at the Geist Lake Marina. The facility is leased to Dockside Cafe, L.P. under an operating lease with monthly minimum rentals of $8,543 plus a percentage of sales over stated bases. Overage rents of $94,233, $92,871 and $86,988 for 1995, 1994 and 1993 sales, respectively, are included in rental income.\nIn June 1994, the Partnership completed construction of a restaurant facility at Morse Lake Marina which is also leased to Dockside Cafe, L.P. under an operating lease with monthly minimum rentals of $5,000 plus a percentage of sales over stated bases. No overage rents were paid in 1995 or 1994.\nThrough March 1993, the Partnership had leased another restaurant facility at the Geist Lake Marina to an unrelated party under a short-term operating lease with annual minimum rentals of $10,500 plus a percentage of sales over a stated base. Overage rents of $10,353 for 1993 sales are included in rental income.\nDuring 1995, the Partnership began operating a 20,000 square foot retail and office development known as Marina Village. Included in rental income in 1995 is $29,932 from the retail tenants. At December 31, 1995, occupancy was 79%, and future minimum rents due from the tenants are $332,270 in 1996, $350,220 in 1997, $283,163 in 1998, $242,928 in 1999, $191,978 in 2000, and $11,951, thereafter.\nThe Partnership also leases certain buildings and real estate under short-term operating leases. Rental income includes $16,933, $16,167 and $43,645 in 1995, 1994 and 1993, respectively, relating to these leases.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere has been no change in the Partnership's independent certified public accountants within 24 months prior to, or subsequent to, the date of the most recent financial statements, nor has there been any disagreements with the accountants.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.\nThe following table presents certain information regarding the Directors and executive officers of the General Partner. Each person listed is a Director of the General Partner except for Mr. Hare and the Treasurer. Messrs. Rosenberg, Woolling and Ms. Shriner are the executive officers of the General Partner. Unless otherwise indicated in a footnote, the principal occupation of each Director or executive officer has been the same for the last five years.\nEach Director except Mr. Rosenberg receives a fee of $5,000 per year, plus $750 for each Board of Directors or Committee meeting attended. If, however, more than one meeting is held on the same day, a fee of $150 is paid for the subsequent meetings.\nROSENBERG BONUS PLAN\nThree percent of the proceeds or other revenues from sales of the Partnership's investment land have been paid to Mr. Rosenberg for his stewardship of the Partnership's land. Mr. Rosenberg received cash bonuses of $20,250 from the January 6, 1995 sale of the Partnership's land, $6,000 from the February 28, 1995 sale of the Partnership's land, $24,090 from the March 31, 1995 sale of the Partnership's land, and $18,000 from the May 4, 1995 sale of the Partnership's land. These amounts represent approximately three percent of the sale proceeds. In addition, five percent of the gross profit (net of development and selling costs) on the Partnership's individual lot sales and five percent of the Partnership's share of the income from The Marina I L.P. are paid to Mr. Rosenberg. A bonus of $64,992 was paid to Mr. Rosenberg in March 1996, and $112,000 was paid in December 1995, based on the 1995 lot sales and income recognized by Marina I. A bonus of $22,185 was paid to Mr. Rosenberg in February 1995, and $100,000 was paid in December 1994 based on the 1994 lot sales and income recognized by Marina I. A bonus of $61,875 was paid to Mr. Rosenberg in March 1994 based on the 1993 lot sales.\nMANAGEMENT FEES PAID TO THE GENERAL PARTNER\nIn addition to bonuses that may be paid from the proceeds or other revenues from sales of the Partnership's land (see \"Rosenberg Bonus Plan,\" above), the General Partner is permitted to receive management fees from the Partnership. The General Partner received management fees of $66,420 in 1995, which is equal to three percent of the Partnership's gross margin on marina operations, recreational facilities, and rental income. The management fee is not paid upon revenues from land sales and investment income.\nSECTION 16(A) COMPLIANCE\nBased solely upon (a) review of statements on Forms 3, 4 and 5 (and amendments thereto) filed by persons who were, at any time during 1995, a director or officer of the Company or a beneficial owner of greater than ten percent of the Company's shares, and (b) certain written representations received by the Company from such persons that no Form 5 is required, the Company is not aware of any such person who failed to file, on a timely basis, reports required by Section 16(a) of the Securities Exchange Act of 1934, as amended, during the most recent fiscal year or prior fiscal years.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSECURITY OWNERSHIP\nThe following table sets forth the number of Limited Partner Units of the Partnership beneficially owned by all Directors of the General Partner and by all Directors and officers of the General Partner as a group as of March 22, 1996.\n1. Includes 1,000 Units owned by Mr. Rosenberg's wife.\n2. Includes 6,296 Units owned by or with spouses or others. Also includes Units described in the above note.\nThe Partnership has concluded that Limited Partner Units do not constitute voting securities. Therefore, the Partnership does not report information on the number of Limited Partner Units beneficially owned by persons owning more than five percent of the Limited Partner Units.\nUpon the reorganization of the Company into the Partnership in 1986, five of the seven members of the Board of Directors of the Company (the \"Continuing Directors\") received all the General Partner Units in the Partnership. See \"General\" under Item 1. The Partnership disclaims that the General Partner Units are securities. General Partner Units are vested with authority to manage the affairs of the Partnership. The Continuing Directors, with the exception of Mr. Hare, are the current members of the Board of Directors of the General Partner. In exchange for the General Partner Units that they received in the reorganization, the Continuing Directors became the sole shareholders of the General Partner. The General Partner owns a 29 percent interest in the profits, losses, capital, and distributions of the Partnership, which percentage is equal to the percentage of the Common Stock of the Company owned directly by the Continuing Directors at the time the Company was reorganized into the\nPartnership plus the limited partner units subsequently acquired and converted into general partner units.\nThe Directors of the General Partner manage and control the overall business and affairs of the General Partner and, consequently, those of the Partnership. The Directors of the General Partner are elected by the shareholders of the General Partner (unless there is a vacancy on the Board, in which case the remaining Board members may fill the vacancy) without the approval of the Limited Partners. Allen E. Rosenberg owns approximately 65.3 percent of the shares of the General Partner. The remaining shares of the General Partner are owned by Patrick J. Bruggeman, who owns 22.6 percent, John L. Woolling, who owns 9.3 percent, John\nA. Hare, who owns 1.7 percent, and Lawrence L. Buell, who owns 1.1 percent.\nUpon the withdrawal or removal of the General Partner, its participation in the General Partner Units will cease. Thereafter, the General Partner Units owned by the withdrawn or removed General Partner will change to Limited Partner Units.\nCHANGES IN CONTROL\nThe Shareholders' Agreement (the \"Shareholders' Agreement\") dated December 2, 1986, among the shareholders of the General Partner, prescribes certain procedures for the sale or other transfer of shares of the General Partner and for the voting of certain shares, the operation of which may at a subsequent date result in a change of control of the General Partner and, consequently, a change of control of the Partnership. The Shareholders' Agreement is attached as Exhibit 28 to the Partnership's current report on Form 8-K dated January 12, 1987, which is incorporated herein by this reference. The Shareholders' Agreement provides certain restrictions on transfer, rights of first refusal, and options to purchase with respect to shares of the General Partner. The Shareholders' Agreement also provides certain voting arrangements in the event of the death or disability of Allen E. Rosenberg, the majority shareholder of the General Partner.\nThe following is a brief summary of the Shareholders' Agreement. This summary is not intended to be complete and is qualified in all respects by the more detailed provisions of the Shareholders' Agreement.\nIn general, the Shareholders' Agreement provides that a shareholder may transfer all or part of his shares of the General Partner to a party who is not a party to the Shareholders' Agreement only upon prior written approval by the General Partner and subject to any limitations that may be imposed by the General Partner. If, for any reason, a shareholder ceases to be a Director of the General Partner, the shareholder and his heirs, executors, administrators, successors, or assigns, subject to the rights of first refusal described below, has the right, but not the obligation, upon surrender of all of his shares of the General Partner, to cause the General Partner to (a) convert that portion of the General Partner Units attributable to all of such shareholder's shares into Limited Partner Units on the basis of one Limited Partner Unit for one General Partner Unit, (b) distribute such Limited Partner Units to the shareholder, and (c) cause the Partnership to register such Limited Partner Units under the Securities Act of 1933, as amended. Prior to such conversion of General Partner Units into Limited Partner Units, the shares of the General Partner the shareholder proposes to surrender in exchange for Limited Partner Units must first be offered to the remaining parties to the Shareholders' Agreement and the General Partner as provided in the Shareholders' Agreement. The exercise of any such rights of first refusal is contingent upon the exercise of rights of first refusal to purchase, in the aggregate, all shares held by the selling shareholder.\nIf a shareholder of the General Partner acquires, from time to time, Limited Partner Units, such Units shall be, at the option of the General Partner, changed to General Partner Units and contributed to the General Partner in return for additional shares of stock of the General Partner.\nThe Shareholders' Agreement also provides that, in the event of the death or disability of Allen E. Rosenberg, the majority shareholder of the General Partner, his shares of the General Partner will be voted by a committee consisting of four members, at least one of whom shall be a Director of the General Partner. The members of the voting committee are\nStanley E. Hunt, David M. Manischewitz, Allen E. Rosenberg II, and John L. Woolling. Vacancies on the voting committee will be filled by Allen E. Rosenberg, or, in the event of his death or disability, by a majority of the remaining members of the voting committee.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nAllen E. Rosenberg II, who is the Assistant Treasurer of the Partnership and the son of Allen E. Rosenberg, President of the General Partner, received $93,000 from the Partnership in 1995, of which $55,000 was paid for services as construction manager of Marina Village, and $20,000 was paid as a management fee for construction of the Partnership's sales office in Cambridge. Chesapeake Building Corporation, which is owned by Allen E. Rosenberg II, received $20,000 from the Partnership as a reimbursement for expenses incurred for the construction of Marina Village and the Partnership's sales office. The Board of Directors of the General Partner approved the transactions with Allen E. Rosenberg II.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) FINANCIAL STATEMENTS:\nThe following financial statements of the Partnership appear in Part II, Item 8.\nIndependent Auditors' Report.\nBalance Sheets -- December 31, 1995 and 1994.\nStatements of Earnings -- Years Ended December 31, 1995, 1994 and 1993.\nStatements of Cash Flows -- Years Ended December 31, 1995, 1994 and 1993.\nStatements of Partners' Equity -- Years Ended December 31, 1995, 1994 and 1993.\nNotes to Financial Statements.\n(a)(2) FINANCIAL STATEMENT SCHEDULES:\nAll schedules for which provision is made in the applicable regulations of the Commission have been omitted as the schedules are not required under the related instructions, or the required information is inapplicable, or the information is set forth in the financial statements included elsewhere herein.\na)(3) EXHIBITS:\nThe exhibits filed as a part of this Annual Report on Form 10-K, all of which are hereby incorporated by reference except financial statements and schedules and Exhibits 3.1, 3.2, 4.1 and 99.3, are:\n1. Registration Statement on Form S-4 (Reg. No. 33- 9367) filed by The Marina Limited Partnership on October 8, 1986.\n2. Registration Statement on Form S-14 (Reg. No. 2- 03600) filed by The Marina Corporation on October 3, 1984, as amended on November 13, 1984, and November 20, 1984.\n3. Annual Report on Form 10-K filed by The Marina Limited Partnership for 1993.\n(b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed in the fourth quarter of 1995 by the Partnership.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nThe Marina Limited Partnership\nDate: March 22, 1996 By: \/s\/ Allen E. Rosenberg Allen E. Rosenberg, President of The Marina II Corporation, the General Partner of The Marina Limited Partnership\nPursuant to the requirements of the Securities Exchange Act of 1934, this report had been signed below by the following persons on behalf of the Partnership and in the capacities and on the dates indicated.","section_11":"","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSECURITY OWNERSHIP\nThe following table sets forth the number of Limited Partner Units of the Partnership beneficially owned by all Directors of the General Partner and by all Directors and officers of the General Partner as a group as of March 22, 1996.\n1. Includes 1,000 Units owned by Mr. Rosenberg's wife.\n2. Includes 6,296 Units owned by or with spouses or others. Also includes Units described in the above note.\nThe Partnership has concluded that Limited Partner Units do not constitute voting securities. Therefore, the Partnership does not report information on the number of Limited Partner Units beneficially owned by persons owning more than five percent of the Limited Partner Units.\nUpon the reorganization of the Company into the Partnership in 1986, five of the seven members of the Board of Directors of the Company (the \"Continuing Directors\") received all the General Partner Units in the Partnership. See \"General\" under Item 1. The Partnership disclaims that the General Partner Units are securities. General Partner Units are vested with authority to manage the affairs of the Partnership. The Continuing Directors, with the exception of Mr. Hare, are the current members of the Board of Directors of the General Partner. In exchange for the General Partner Units that they received in the reorganization, the Continuing Directors became the sole shareholders of the General Partner. The General Partner owns a 29 percent interest in the profits, losses, capital, and distributions of the Partnership, which percentage is equal to the percentage of the Common Stock of the Company owned directly by the Continuing Directors at the time the Company was reorganized into the\nPartnership plus the limited partner units subsequently acquired and converted into general partner units.\nThe Directors of the General Partner manage and control the overall business and affairs of the General Partner and, consequently, those of the Partnership. The Directors of the General Partner are elected by the shareholders of the General Partner (unless there is a vacancy on the Board, in which case the remaining Board members may fill the vacancy) without the approval of the Limited Partners. Allen E. Rosenberg owns approximately 65.3 percent of the shares of the General Partner. The remaining shares of the General Partner are owned by Patrick J. Bruggeman, who owns 22.6 percent, John L. Woolling, who owns 9.3 percent, John\nA. Hare, who owns 1.7 percent, and Lawrence L. Buell, who owns 1.1 percent.\nUpon the withdrawal or removal of the General Partner, its participation in the General Partner Units will cease. Thereafter, the General Partner Units owned by the withdrawn or removed General Partner will change to Limited Partner Units.\nCHANGES IN CONTROL\nThe Shareholders' Agreement (the \"Shareholders' Agreement\") dated December 2, 1986, among the shareholders of the General Partner, prescribes certain procedures for the sale or other transfer of shares of the General Partner and for the voting of certain shares, the operation of which may at a subsequent date result in a change of control of the General Partner and, consequently, a change of control of the Partnership. The Shareholders' Agreement is attached as Exhibit 28 to the Partnership's current report on Form 8-K dated January 12, 1987, which is incorporated herein by this reference. The Shareholders' Agreement provides certain restrictions on transfer, rights of first refusal, and options to purchase with respect to shares of the General Partner. The Shareholders' Agreement also provides certain voting arrangements in the event of the death or disability of Allen E. Rosenberg, the majority shareholder of the General Partner.\nThe following is a brief summary of the Shareholders' Agreement. This summary is not intended to be complete and is qualified in all respects by the more detailed provisions of the Shareholders' Agreement.\nIn general, the Shareholders' Agreement provides that a shareholder may transfer all or part of his shares of the General Partner to a party who is not a party to the Shareholders' Agreement only upon prior written approval by the General Partner and subject to any limitations that may be imposed by the General Partner. If, for any reason, a shareholder ceases to be a Director of the General Partner, the shareholder and his heirs, executors, administrators, successors, or assigns, subject to the rights of first refusal described below, has the right, but not the obligation, upon surrender of all of his shares of the General Partner, to cause the General Partner to (a) convert that portion of the General Partner Units attributable to all of such shareholder's shares into Limited Partner Units on the basis of one Limited Partner Unit for one General Partner Unit, (b) distribute such Limited Partner Units to the shareholder, and (c) cause the Partnership to register such Limited Partner Units under the Securities Act of 1933, as amended. Prior to such conversion of General Partner Units into Limited Partner Units, the shares of the General Partner the shareholder proposes to surrender in exchange for Limited Partner Units must first be offered to the remaining parties to the Shareholders' Agreement and the General Partner as provided in the Shareholders' Agreement. The exercise of any such rights of first refusal is contingent upon the exercise of rights of first refusal to purchase, in the aggregate, all shares held by the selling shareholder.\nIf a shareholder of the General Partner acquires, from time to time, Limited Partner Units, such Units shall be, at the option of the General Partner, changed to General Partner Units and contributed to the General Partner in return for additional shares of stock of the General Partner.\nThe Shareholders' Agreement also provides that, in the event of the death or disability of Allen E. Rosenberg, the majority shareholder of the General Partner, his shares of the General Partner will be voted by a committee consisting of four members, at least one of whom shall be a Director of the General Partner. The members of the voting committee are\nStanley E. Hunt, David M. Manischewitz, Allen E. Rosenberg II, and John L. Woolling. Vacancies on the voting committee will be filled by Allen E. Rosenberg, or, in the event of his death or disability, by a majority of the remaining members of the voting committee.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nAllen E. Rosenberg II, who is the Assistant Treasurer of the Partnership and the son of Allen E. Rosenberg, President of the General Partner, received $93,000 from the Partnership in 1995, of which $55,000 was paid for services as construction manager of Marina Village, and $20,000 was paid as a management fee for construction of the Partnership's sales office in Cambridge. Chesapeake Building Corporation, which is owned by Allen E. Rosenberg II, received $20,000 from the Partnership as a reimbursement for expenses incurred for the construction of Marina Village and the Partnership's sales office. The Board of Directors of the General Partner approved the transactions with Allen E. Rosenberg II.\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 Partnership appear in Part II, Item 8.\nIndependent Auditors' Report.\nBalance Sheets -- December 31, 1995 and 1994.\nStatements of Earnings -- Years Ended December 31, 1995, 1994 and 1993.\nStatements of Cash Flows -- Years Ended December 31, 1995, 1994 and 1993.\nStatements of Partners' Equity -- Years Ended December 31, 1995, 1994 and 1993.\nNotes to Financial Statements.\n(a)(2) FINANCIAL STATEMENT SCHEDULES:\nAll schedules for which provision is made in the applicable regulations of the Commission have been omitted as the schedules are not required under the related instructions, or the required information is inapplicable, or the information is set forth in the financial statements included elsewhere herein.\na)(3) EXHIBITS:\nThe exhibits filed as a part of this Annual Report on Form 10-K, all of which are hereby incorporated by reference except financial statements and schedules and Exhibits 3.1, 3.2, 4.1 and 99.3, are:\n1. Registration Statement on Form S-4 (Reg. No. 33- 9367) filed by The Marina Limited Partnership on October 8, 1986.\n2. Registration Statement on Form S-14 (Reg. No. 2- 03600) filed by The Marina Corporation on October 3, 1984, as amended on November 13, 1984, and November 20, 1984.\n3. Annual Report on Form 10-K filed by The Marina Limited Partnership for 1993.\n(b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed in the fourth quarter of 1995 by the Partnership.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nThe Marina Limited Partnership\nDate: March 22, 1996 By: \/s\/ Allen E. Rosenberg Allen E. Rosenberg, President of The Marina II Corporation, the General Partner of The Marina Limited Partnership\nPursuant to the requirements of the Securities Exchange Act of 1934, this report had been signed below by the following persons on behalf of the Partnership and in the capacities and on the dates indicated.","section_15":""}
{"filename":"791905_1995.txt","cik":"791905","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company\nMiller Building Systems, Inc. (\"Miller\") is the parent of Miller Structures, Inc. (\"Structures\") and Miller Telecom Services, Inc. (\"Telecom\"). All operations of Miller are conducted through its two wholly-owned subsidiaries which design, manufacture, and market factory-built buildings. Miller ceased all operations at PME Pacific Systems, Inc. (\"PME\") after its final contract was completed in early 1994.\nMiller originally was organized as an Indiana corporation in November 1982 under the name of \"Graylyon Corp.\" and then merged, effective April 1983, into a Delaware corporation named \"Gray Lyon Company\". In November 1986, the Company amended its Certificate of Incorporation to change its name to \"Modular Technology, Inc.\" In November 1988, the Company again amended its Certificate of Incorporation to change its name to \"Miller Building Systems, Inc.\" All references to Miller herein refer to Miller Building Systems, Inc., a Delaware corporation, and its predecessor Indiana corporation.\nMiller maintains its Executive Offices at 58120 County Road 3 South, Elkhart, Indiana 46517; telephone number (219) 295-1214. The Executive Office is Miller's principal operating office from which it manages and coordinates the activities of Structures and Telecom.\nSTRUCTURES\nStructures is headquartered in Elkhart, Indiana and operates all administrative, sales and production from that location. The Structures office controls manufacturing facilities in Bennington, Vermont, Elkhart, Indiana, Leola, Pennsylvania, Sioux Falls, South Dakota and Patterson, California. A Residential division, which operated as Miller Residential (\"Residential\") a division of Structures was closed during the third quarter of fiscal 1995. Miller has discontinued all operations of the Residential division and the plant was closed with all substantially all assets disposed of by the end of fiscal 1995.\nStructures - Modular and Mobile Office Buildings\nProducts\nThe buildings produced by Structures are generally movable or relocatable and are composed of either single or multiple units often referred to as modular units. Individual units are either 8, 10, 12, or 14 feet in width and up to 80 feet in length. These individual units can be combined into buildings varying in size from several hundred to several thousand square feet. Although most buildings are one story, they can be built to be two or three stories high depending on user requirements.\nThe factory-built buildings produced by Structures meet the specialized needs of users, which include architectural and engineering firms, churches, construction companies, correctional or prison authorities, educational and financial institutions, libraries, medical and dental facilities, military installations, post offices, real estate firms, restaurants and retail businesses. The cost of the building varies depending on its application or its specifications and may, in certain instances, be less expensive than comparable conventional site-built buildings. Structures' cost portion of a completed building does not include transportation, site preparation, foundation and other installation work which is the responsibility of the user and is often provided and charged to the user by Structures' customer. In addition to all the aforementioned costs, the price charged to the user by Structures' customer will reflect a \"mark-up\" which is determined by Structures' customer and not by Structures.\nBuildings or units (modules) of buildings produced by Structures are usually built on a steel frame. Attached to the frame, customarily, is a chassis with wheels and axles. This chassis will either become a permanent portion of the building, permitting it to be easily transported to another site, or be removed at the building installation site. The chassis facilitates the transportation of the individual units over the highways from Structures' factory to either its customer's facilities or the user's installation site.\nThe floor, roof and walls of any building are constructed of conventional building materials, primarily wood or comparable materials. The building or module is fabricated in a process similar to conventional sitebuilt construction with appropriate variations. Structures also produces buildings utilizing non- combustible materials. For these types of buildings, the floor is made of concrete. The wall studs and roof frame are made of steel and other components. The buildings utilize various other non-combustible materials.\nInteriors and exteriors of the buildings are completed to customer specifications. Finished buildings or modules include required electrical wiring, plumbing, heating and air conditioning, and floor coverings. Exteriors are constructed of wood, aluminum or other specified exterior materials such as brick facing, etc.\nBuildings produced by Structures are designed and engineered before production. Detailed plans and other documentation prepared by Structures are submitted to its customers and users as well as to various regulatory agencies for approval prior to commencement of construction. Structures maintains its own engineering and design staff which is capable of handling virtually all types of building orders. On occasion, however, Structures may retain the services of outside engineering and design firms.\nMarketing\nStructures does not sell its buildings directly to ultimate users of the buildings. Structures' customers do not represent Structures on an exclusive basis. Structures competes for customer orders based on price, quality, timely delivery, engineering capability and general reputation for reliability. Structures sells its products to approximately 75 customers. Customers may be national, regional or local in nature. Customers will sell, rent or lease the buildings purchased from Structures to the users. Structures believes a significant portion of its product is either rented or leased by the users from its customers.\nStructures' sales staff calls on prospective customers in addition to maintaining continuing contact with existing customers. The sales staff assists its customers and their prospective customers in developing building specifications in order to facilitate the preparation by Structures of a quotation. The sales staff, in conjunction with the engineering staff, maintains ongoing contact with the customer base.\nCertain customers maintain rental fleets of standardized units such as construction-site buildings or buildings for general office space requirements. These buildings are generally rented or leased for a specific requirement, and when the requirement has been satisfied, the buildings are returned to Structures' customer for re-renting or leasing to other users. Other buildings are produced to a specific user's requirements and Structures' customer will either lease it to its customer or sell it outright. As a result of transportation costs, the effective distribution range of buildings produced by Structures is limited to an area within 400-600 miles from each manufacturing facility.\nStructures believes that the various leasing plans offered to the users by its customers are a significant benefit of factory-built buildings over similar conventional site-built buildings. Other significant benefits to the customer are the speed with which a factory-built building can be made available for use compared to on-site construction and the ability to relocate the building to another site if the customer's utilization requirements change.\nCertain companies within the industry served by Structures, including some who are customers of Structures, have their own manufacturing facilities to provide all or a portion of their building requirements. Structures does not believe there is any specific identifiable industry trend or direction of its customers having their own captive manufacturing capabilities. Certain customers have acquired or started their own manufacturing facilities and other customers have closed or reduced their manufacturing capability. Structures believes that its customers are best served by having the flexibility of outside product sources and avoiding the possible inefficiencies of captive manufacturing facilities.\nStructures is highly dependent on a limited number of customers, the loss of which could have a material adverse effect on the operations of Miller. For the fiscal years ended July 1, 1995 and July 2, 1994, the following customer represented 10% or more of net sales of Miller: Transport International Pool, Inc. d\/b\/a GE Capital Modular Space, a division of General Electric Capital Corporation, represented 23% and 21% respectively.\nCompetition\nCompetition in the factory-built building industry is intense and Structures competes with a number of entities, some of which may have greater financial resources than Miller and Structures. To the extent that factory-built buildings become more widely accepted as an alternative to conventional on-site construction, competition from local contractors and manufacturers of other pre- engineered building systems may increase. In addition to competition from firms designing and constructing on-site buildings, Structures competes with numerous factory-built building manufacturers that operate in particular geographical regions.\nStructures competes for orders from its customers primarily on the basis of price, quality, timely delivery, engineering capability and reliability. Structures believes that the principal basis on which it competes with on-site construction is the combination of the timeliness of factory versus on-site construction, the cost of its products relative to on-site construction, the quality and appearance of its buildings, its ability to design and engineer buildings to meet unique customer requirements (including local and state regulatory compliance) and reliability in terms of completion time. The manufacturing efficiencies and generally lower wage rates of factory construction, even with the added transportation expense, in many instances result in the cost of factory-built buildings being equal to or lower than the cost of on-site construction of comparable quality. Quality, reliability and the ability to comply with regulatory requirements in a large number of states and localities depend upon the engineering and manufacturing expertise of the management and staff of Structures. The relative importance of these factors varies from customer to customer. Most of Structures' orders are awarded by its customers on the basis of competitive bidding.\nTELECOM\nTelecom is located in Elkhart, Indiana and operates all administrative, sales and manufacturing activities from that location. Telecom manufactures specialized buildings which utilize modular construction techniques.\nProducts\nTelecom manufactures modular factory-built buildings using pre-cast concrete, steel, wood or fiberglass construction. Each building is custom-built to the end users specifications and is typically finished to include electrical, grounding, sensing alarm, mechanical and air conditioning systems.\nThe pre-cast concrete technology available through Telecom allows for vandal-proof and environmental protection necessary for the telecommunication industry. Telecom produces single and multiple module buildings with modules ranging in size from 8' x 10' to modules as large as 14' x 30'. Telecom has provided buildings, when assembled, consisting of a single module of 80 square feet to multiple module buildings ranging up to 1,440 square feet. Multiple story technology is currently being developed by Telecom. Telecom can provide complete site installation of the building, if required by the customer specifications. Opportunities in pre-cast concrete also exist for the containment of hazardous material in specialized shelters and in correctional facilities requiring pre-cast modular cells. The latter product can be provided to existing customers of Structures.\nMarketing\nTelecom generally sells its product directly to the end user of the buildings, which has been principally telecommunication and utility companies, military bases and municipalities. Telecom also provides building transportation and site placement services, if required by the scope of the work. Telecom generally competes for orders by providing a quotation developed from specifications received from the potential customer. While price is often a key factor in the potential customer's purchase decision, other factors may also apply, including delivery time, quality and prior experience with a certain manufacturer. Several customers have designated Telecom as their nationwide supplier. Telecom is prepared, if necessary, to provide a potential customer a bid or performance bond to ensure Telecom's performance. The potential shipping radius of these type of buildings is not as restrictive as that of Modular and Mobile Office buildings; however, Telecom has concentrated its marketing efforts in geographic areas where, Telecom believes, it has a freight advantage over a significant portion of its competitors.\nCompetition\nTelecom competes with a number of national and regional firms. Some of these competitor companies may have greater financial strength or capabilities than Miller and Telecom; however, Telecom believes Miller's financial strength, engineering capabilities and experience in producing other types of factory- built structures are elements in providing a competitive advantage to Telecom.\nGeneral (Applicable to all of Miller's principal markets)\nBacklog\nThe backlog of orders by market at August 31, 1995 and 1994 was as follows:\n1995 1994\nStructures $4,791,000 $7,699,000 Telecom 1,895,000 950,000\nBacklog is broadly defined as firm order commitments not yet produced into a final building product. The 38% decrease from the prior year's backlog position for the Structures' modular and mobile office buildings is a result of some slowness in certain parts of the economy and Miller's decision to shift sales toward the more profitable technical and specific use units. Structures' management believes it is to early to determine if the current decline in backlog related to the economic slowness will have a negative impact on future earnings. Telecom's backlog nearly doubled as this subsidiary continues to develop its reputation and customer base. The management of Telecom believes that their backlogs will continue to increase with the ongoing development of their customer bases.\nRegulation\nCustomers of Miller's factory-built buildings, or Miller's subsidiaries if they complete the on site work, are generally required to obtain building installation permits from applicable governmental agencies. In certain cases, however, conditional use permits may be obtained in lieu of installation permits. Conditional use permits usually are granted for a stated period and may be renewable. Buildings completed by Miller's subsidiaries are manufactured and installed in accordance with applicable building codes set forth by the applicable state or local regulatory agencies.\nState building code regulations applicable to factory-built buildings vary from state to state. Many states have adopted codes that apply to the design and manufacture of factory-built buildings, such as those manufactured by Miller's subsidiaries, even if the units are manufactured outside the state and delivered to a site within that state's boundaries. Obtaining state approvals is generally the responsibility of the manufacturer. Some states also require certain customers to be licensed in order to sell or lease factory-built buildings. Additionally, certain states require a contractor's license from customers for the construction of the foundation, building installation, and other on-site work when this work is completed by the customer.\nMiller's subsidiaries, on occasion, have experienced regulatory delays in obtaining the various required building plan approvals. Miller's subsidiaries, in addition to some of its customers, actively seek assistance from various regulatory agencies in order to facilitate the approval process and reduce the regulatory delays.\nRaw Materials\nRaw materials for products of Miller's subsidiaries are readily available from multiple sources and the subsidiaries have not experienced any difficulty in obtaining materials on a timely basis and in adequate quality and quantity. Miller's subsidiaries, in certain instances, have entered into national purchase arrangements with various suppliers. The benefit to Miller's subsidiaries of these type of arrangements is often lower material costs and a higher level of service and commitment.\nPatents and Trademarks\nMiller has a patent for non-combustible modular buildings.\nSeasonality\nMiller's subsidiaries historically have experienced greater sales during the first and fourth fiscal quarters with lesser sales during the second and third fiscal quarters. This reflects the seasonality of sales for products used in various applications, including classrooms and other educational buildings, and also the impact of weather on general construction related activities. See unaudited interim financial information contained in Note H of Notes to Consolidated Financial Statements.\nEmployees\nAs of August 31, 1995, Miller and its subsidiaries had approximately 325 employees of which approximately 240 were direct production employees.\nEngineering and Design\nMiller's subsidiaries engage in extensive engineering and design work to meet customers' requirements, as well as to prepare bid proposals for new projects. Engineering and design functions include structural, electrical, and mechanical design and specifications work.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal office and production facilities of Miller and its subsidiaries consist of the following:\nApproximate Square Footage\nLocation Total Production Office Owned or Leased\nElkhart, IN 77,500 61,500 16,000 Owned (1)\nElkhart, IN 54,800 50,600 4,200 Owned (2)\nLeola, PA 61,900 58,900 3,000 Owned\nSioux Falls, SD 36,100 34,200 1,900 Leased (3)\nPatterson, CA 44,600 41,400 3,200 Owned\nBennington, VT 28,900 27,000 1,900 Owned _______________ _______ ______ _______ Total approximate square footage 303,800 273,600 30,200\n(1) Structures' administrative, sales, engineering and manufacturing facility. The Executive offices of Miller are also at this location.\n(2) Telecom administrative, sales and manufacturing facility.\n(3) Leased until April 15, 1996 with three successive two-year renewal options.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNeither Miller, Structures, nor Telecom is subject to any material pending litigation other than ordinary routine litigation incidental to the business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS\nSteven F. Graver (age 43) has been a Director of Miller since April 1991 and was elected Chairman of the Board of Directors on August 11, 1994. Effective July 1, 1995, Graver, Bokhof & Goodwin (\"GraverBokhof\") became Graver, Bofhof, Goodwin & Sullivan (\"GBGS\") GBGS is a subsidiary of the Optimum Group which has over 800 million in assets under management. Mr. Graver is President and Chief Portfolio Manager of the Optimum Group. In July 1991, GraverReich & Company (\"GraverReich\"), merged with Graver, Bokhof & Goodwin, an investment management firm, and Mr. Graver became a General Partner of GraverBokhof. From December 1986 until July 1991, Mr. Graver was the President and Chief Executive Officer, and Executive Vice President from February 1981 until November 1986, of GraverReich, an investment management firm which Mr. Graver co-founded.\nEdward C. Craig (age 60) became the Chief Executive Officer of Miller and Vice Chairman of the Board of Directors of Miller effective on July 2, 1994. Mr. Craig was elected President of Miller on August 11, 1994. From July 1991 until April 1994, Mr. Craig was President and Chief Executive Officer of IBG, a modular housing company. From April 1986 to July 1991, Mr. Craig was President of Ryland Building Systems, a division of Ryland Homes, Inc. Mr. Craig is a Director of Regional Building Systems.\nThomas J. Martini (age 47) in April 1992 became the Secretary and Treasurer of Miller. Mr. Martini has been the Chief Financial Officer of Miller since February 1991. From May 1986 to February 1991, he was the Corporate Controller of Starcraft, Inc., a manufacturer of recreational vehicles.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMiller's Common Stock is quoted on the National Association of Securities Dealers' Automated Quotation (NASDAQ) system under the ticker symbol \"MTIK.\" The following table sets forth the quarterly range of high and low quotations for these securities as reported on the NASDAQ National Market System for the two most recent fiscal years.\nFiscal 1995 Fiscal 1994 High Low High Low\n1st Quarter 4 3 3 1\/4 2 3\/4 2nd Quarter 4 3 1\/8 4 2 1\/2 3rd Quarter 4 1\/4 3 1\/4 4 1\/4 3 4th Quarter 4 2 5\/8 3 3\/4 3\nAs of August 31, 1995, Miller estimates there were approximately 1,600 stockholders of Miller's Common Stock. Of this total, approximately 250 were stockholders of record and shares for approximately 1,350 stockholders were held in street name. Harris Trust & Savings Bank, Chicago, is Miller's Transfer Agent and Registrar.\nMiller did not pay dividends on its Common Stock in fiscal 1995 or fiscal 1994, as the Board of Directors ceased the payment of dividends in the third fiscal quarter of 1993. Miller does not intend to pay 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.\nYears Ended July 1, July 2, June 30, June 30, June 30, 1995 1994 1993 1992 1991 (In thousands, except per share data)\nNet sales $41,455 $38,569 $40,623 $40,757 $37,776 Net income (loss) 320(A) 312(A) (2,014)(A) (224) 1,951 Net income (loss) per share .10 .10 (.61) (.06) .52 Cash dividends per share - - .075 .10 .08 Total assets 16,522 15,308 16,411 17,954 17,491 Long-term debt, less current maturities 1,385 110 210 302 -\n(A) Miller's operating results were for fiscal years 1995, 1994 and 1993 were adversely impacted by nonrecurring items of $361,123, $159,252 and $2,345,363, respectively.\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 increased $2.9 million or approximately 7% in fiscal 1995 from the corresponding amount in fiscal 1994. Structures reported a $3.4 million or approximately an 11% increase in net sales. Net sales in the Eastern plants of Structures increased $4.4 million or approximately 20%, while net sales in the West decreased $1.0 million or approximately 14%. All Structures' Eastern plants experienced net sales growth as the economy in these markets remained strong. The decline in net sales in the West was the result of the continuing sluggishness in the California economy. Telecom recorded a $1.0 million or approximately 23% increase in net sales as this subsidiary continues to build its reputation and customer base. Net sales at the closed residential division of Structures was virtually unchanged.\nMiller's gross profit during the 1995 fiscal year approximated 15% of net sales compared to approximately 12% of net sales in fiscal 1994. During fiscal 1995 Miller was able to shift a portion of the sales from the low end fleet business to the more profitable technical and specific use applications. Miller plans to continue the expansion of the technical and specific use markets.\nSelling, general and administrative expenses increased $.7 million in fiscal 1995. These expenses were 12% of net sales in fiscal 1995 compared to 11% of net sales in fiscal 1994. The increase in administrative expenses was primarily the result of higher payroll and other administrative expenses related to the growth at both Structures and Telecom.\nDuring the year, Miller recorded nonrecurring items of $361,123. These nonrecurring items consist primarily of a $265,514 charge which resulted from the final resolution of disputed warranty issues with a customer, a charge of $186,198 for exit costs associated with the closing of the residential division, and the reversal of $90,589 of certain restructuring charges recorded in fiscal 1993. The earlier than anticipated exit from the lease at the Fontana plant, a favorable arbitration settlement and the reversal of warranty reserves at the closed PME operations, partially offset by additional interest expense for an IRS audit, were the principal causes for the reversal of restructuring costs.\nAt July 1, 1995, $239,639 in nonrecurring items remain outstanding of which $193,857 is a current liability. These items consist of severance and noncompete agreements with former officers, interest payable on the Internal Revenue audit and worker's compensation and relocation reserves related to the closed Western plants. $45,782 related to the noncompete agreement with a former officer is reflected as long-term. Of this total, approximately $4,000 will be paid in fiscal 1996, with the balance payable through fiscal 2004.\nThe increase in interest expense in fiscal 1995 compared to fiscal 1994 of $42,808 was the result of a $55,349 increase in interest expense for the industrial revenue bond issued to finance the plant expansion at Telecom. Lower debt outstanding on the revolving line of credit was the principal cause for a $12,541 offsetting decrease in interest expense.\nDuring fiscal 1995 Miller recorded an income tax provision of $189,000 or 37% of pre-tax profit. In fiscal 1994, Miller recorded an income tax credit of $66,000. A provision of $91,000 or 37% of the pre-tax profit was offset by a reversal of $157,000 for a provision of federal and state income taxes related to an Internal Revenue Service audit settled favorably by Miller.\nFiscal 1994 Compared to Fiscal 1993\nNet sales decreased $2.1 million in fiscal 1994 from the corresponding amount in fiscal 1993. Structures reported a $2.3 million or approximately a 7% decrease in net sales. Net sales in the Eastern plants of Structures remained virtually unchanged, while net sales in the West decreased $3.4 million or approximately 32%. The decline in net sales in the West was the result of closing the plants in Woodburn, Oregon and Fontana, California. Net sales in the residential division of Structures increased $1.2 million or approximately 68%. The increase at the residential division of Structures was the result of the development of the divisions' dealer\/builder customer base. Telecom recorded a $2.1 million or approximately 90% increase in net sales as this subsidiary continues to build its customer base. Net sales at PME decreased $1.9 million or approximately 55% as a result of the closing of the subsidiary.\nMiller's gross profit during the 1994 fiscal year approximated 12% of net sales compared to approximately 13% of net sales in fiscal 1993. During 1994, the Company experienced a shift in demand away from the more profitable technical and specific use applications.\nSelling, general and administrative expenses decreased $.9 million in fiscal 1994. These expenses were 11% of net sales in fiscal 1994 compared to 13% of net sales in fiscal 1993. The decrease in administrative expenses was primarily the result of reduced expenses related to the closed West Coast plants and the phase-out of PME's operations. These reductions were partially offset by increased administrative costs related to the growth at Structures' residential division and Telecom.\nDuring the year, Miller recorded nonrecurring items of $159,252. These nonrecurring items consisted of $264,150 for a severance agreement with a former officer and the reversal of $104,898 in certain restructuring charges recorded in fiscal 1993. The earlier than anticipated sale of the Woodburn plant, eliminating property taxes and costs for the maintenance of the building, and the elimination of the office lease at the PME operations were the principle causes for the reversal of restructuring costs. A $193,242 gain on the sale of the Woodburn plant was recorded during the current fiscal year and is reflected in the gain on sale of property and equipment.\nAt July 2, 1994, $612,594 in nonrecurring items remained outstanding of which $498,198 was classified as a current liability and $144,396 was reflected as long-term. These items consisted of severance and noncompete agreements with former officers, a lease commitment for the Fontana plant, warranty reserves related to the PME operations, interest payable on the Internal Revenue audit and worker's compensation and relocation reserves related to the closed Western plants.\nMiller recorded a $120,220 provision for doubtful receivables in fiscal 1994 (applicable to the closed PME operations). The allowance related to disputes over delays and change orders for the completed PME project at the Denver International Airport.\nThe increase in interest expense in fiscal 1994 compared to fiscal 1993 of $15,942 was the result of higher interest rates and higher debt outstanding on the revolving line of credit.\nDuring fiscal 1994, Miller recorded an income tax credit of $66,000. A provision of $91,000 or 37% of the pre-tax profit was offset by a reversal of $157,000 for a provision of federal and state income taxes related to an Internal Revenue Service audit settled favorably by Miller. In fiscal 1993, Miller recorded an income tax credit of $593,000 or 23% of the pre-tax loss which included $309,000 for federal and state income taxes resulting from an Internal Revenue Service audit, which was being appealed.\nLiquidity and Capital Resources\nMiller's working capital as of July 1, 1995 was $5,254,456 compared to $5,373,230 as of July 2, 1994. The working capital ratio as of July 1, 1995 and July 2, 1994 was 2.0 to 1.\nDuring fiscal 1995, operations provided cash flows of $66,335 consisting primarily of net income and certain noncash charges offset by reductions in accounts payable and other accrued liabilities. Miller utilized cash of $1,959,893 in investing activities, consisting of the Telecom plant expansion to support the subsidiary's growth and other purchases of plant and equipment. The investments made by Miller were financed through increased borrowings on the revolving line of credit and the proceeds from the industrial revenue bond.\nAn unsecured revolving credit agreement with a bank makes available advances up to $5,000,000 through November 30, 1995. There was $1,550,000 outstanding on the revolving credit line at July 1, 1995 and $525,000 at July 2, 1994. The $5,000,000 availability under the present loan agreement has been reduced by $134,344 for a standby letter of credit issued in connection with an obligation payable to a former officer.\nMiller believes it has adequate resources available to fund the continuation of its internal growth during the coming fiscal year. The unsecured revolving credit line assures that resources will be available for future growth.\nImpact of Inflation\nInflation has not had an identifiable effect on Miller's operating margins during the last three fiscal years. Product selling prices are quoted reflecting current material prices and other related costs and expenses. Accordingly, any impact of inflation is reflected in the product selling prices.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by Item 8 of Part II is incorporated herein by reference to the Consolidated Financial Statements filed with this report; see Item 14 of Part IV.\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) Identification of Directors\nInformation with respect to the Directors of Miller is set forth in the Election of Directors section of the Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.\n(b) Executive Officers\nInformation regarding the executive officers of Miller is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is set forth in the Compensation and Executive Officers section of the Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is set forth in the Principal Shareholder and Share Ownership of Director and Executive Officers section of the Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is set forth in the Transactions with Management and Others section of the Proxy Statement to be filed pursuant to Regulation 14A 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 of Miller Building Systems, Inc. and Subsidiaries\nReport of Independent Accountants........................................F-1\nConsolidated Balance Sheets as of July 1, 1995 and July 2, 1994..........F-2\nConsolidated Statements of Operations for the years ended July 1, 1995, July 2, 1994 and June 30,1993......................................F-3\nConsolidated Statements of Stockholders' Equity for the years ended July 1, 1995, July 2, 1994 and June 30, 1993.......................F-4\nConsolidated Statements of Cash Flows for the years ended July 1, 1994, July 2, 1994 and June 30, 1993.....................................F-5\nNotes to Consolidated Financial Statements...............................F-6\n(2) Financial Statement Schedule\nII - Valuation and Qualifying Accounts..................................F-13\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable, or the information is included in the Notes to Consolidated Financial Statements, and therefore have been omitted.\n(3) See Index to Exhibits\n(b) Reports on Form 8-K filed in the fourth quarter of fiscal 1995:\nThe following report on Form 8-K was filed during the three months ended July 1, 1995.\nMay 19, 1995, reporting a Resolution adopted by the Board of Directors on April 27, 1995 to amend the By-Laws which increased the number of Directors from seven (7) to eight (8); and elected Myron C. Noble to the Board of Directors on April 27, 1995 filling the vacancy created by the foregoing amendment.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMILLER BUILDING SYSTEMS, INC.\nSeptember 12, 1995 \\Edward C. Craig Edward C. Craig 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 Title Date\n\\Edward C. Craig President, Chief September 12, 1995 Edward C. Craig Executive Officer and Director (Principal Executive Officer)\n\\Thomas J. Martini Secretary and September 12, 1995 Thomas J. Martini Treasurer (Principal Financial and Accounting Officer)\n\\Ronald L. Chez Director September 12, 1995 Ronald L. Chez\n\\David E. Downen Director September 12, 1995 David E. Downen\n\\Steven F. Graver Director September 12, 1995 Steven F. Graver\n\\William P. Hall Director September 12, 1995 William P. Hall\n\\Myron C. Noble Director September 12, 1995 Myron C. Noble\n\\David H. Padden Director September 12, 1995 David H. Padden\n\\Jeffrey C. Rubenstein Director September 12, 1995 Jeffrey C. Rubenstein\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Miller Building Systems, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedule of Miller Building Systems, 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 standard. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Miller Buildings Systems, Inc. and subsidiaries as of July 1, 1995 and July 2, 1994, and the consolidated results of their operations and their cash flows for the years ended July 1, 1995, July 2, 1994 and June 30, 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.\n\\Coopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P.\nSouth Bend, Indiana August 15, 1995\nMILLER BUILDING SYSTEMS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nJuly 1, July 2, 1995 1994\nASSETS\nCURRENT ASSETS Cash and temporary cash investments $ 351,860 $ 132,084 Receivables, less allowance for doubtful receivables of $59,000 in 1995 and $120,000 in 1994 5,960,110 6,186,820 Inventories: Raw materials 2,945,366 2,933,238 Work in process 441,366 287,106 Finished goods 146,887 152,060\n3,533,619 3,372,404\nDeferred federal income taxes 320,000 399,000\nOther current assets 126,752 400,826\nTOTAL CURRENT ASSETS 10,292,341 10,491,134\nPROPERTY, PLANT AND EQUIPMENT Land 847,336 764,857 Buildings and leasehold improvements 5,357,144 4,208,163 Machinery and equipment 3,906,285 3,487,256\n10,110,765 8,460,276 Less, Accumulated depreciation and amortization 4,083,640 3,666,270\n6,027,125 4,794,006\nOTHER ASSETS 202,166 22,887\nTOTAL ASSETS $16,521,632 $15,308,027\nThe accompanying notes are a part of the consolidated financial statements.\nJuly 1, July 2, 1995 1994\nLIABILITIES AND STOCKHOLDERS' EQUITY\nCURRENT LIABILITIES Short-term borrowings $ 1,550,000 $ 525,000 Current maturities of long-term debt 224,925 100,481 Accounts payable 2,074,510 3,202,938 Accrued income taxes 89,827 140,542 Accrued expenses and other 904,766 680,745 Accrued nonrecurring items 193,857 468,198\nTOTAL CURRENT LIABILITIES 5,037,885 5,117,904\nLONG-TERM DEBT, less current maturities 1,385,000 109,925\nDEFERRED FEDERAL INCOME TAXES 134,000 146,000\nOTHER 45,782 144,396\nTOTAL LIABILITIES 6,602,667 5,518,225\nCOMMITMENTS AND CONTINGENCIES - Notes C and G\nSTOCKHOLDERS' EQUITY Common stock, $.01 par value, issued 4,023,548 shares 40,235 40,235 Additional paid-in capital 11,454,903 11,454,903 Retained earnings 1,563,201 1,250,434\n13,058,339 12,745,572\nLess, Treasury stock, at cost 3,139,374 2,955,770\nTOTAL STOCKHOLDERS' EQUITY 9,918,965 9,789,802\nTOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $16,521,632 $15,308,027\nMILLER BUILDING SYSTEMS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYears Ended\nJuly 1, July 2, June 30, 1995 1994 1993\nNet sales $41,454,500 $38,568,812 $40,622,923\nCosts and expenses: Cost of products sold 35,373,322 33,791,773 35,489,137 Selling, general and administrative 5,018,490 4,362,530 5,281,693 Nonrecurring items 361,123 159,252 2,345,363 Provision for doubtful receivables 67,528 120,220 49,361 (Gain) loss on sale property and equipment 3,379 (183,910) (3,485) Interest expense 134,833 92,025 76,083 Interest income (13,087) (18,938) (7,990)\nINCOME (LOSS) BEFORE INCOME TAX CREDIT 508,912 245,860 (2,607,239)\nIncome tax (credit) 189,000 (66,000) (593,000)\nNET INCOME (LOSS) $ 319,912 $ 311,860 $(2,014,239)\nEarnings (loss) per share of common stock, based upon weighted average number of common shares and equivalent shares outstanding $ .10 $ .10 $ (.61)\nWEIGHTED AVERAGE NUMBER OF COMMON SHARES AND EQUIVALENT SHARES OUTSTANDING 3,130,207 3,197,421 3,275,700\nThe accompanying notes are a part of the consolidated financial statements.\nMILLER BUILDING SYSTEMS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are a part of the consolidated financial statements.\nMILLER BUILDING SYSTEMS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are a part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nfor the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Miller Building Systems, Inc. and its subsidiaries, all of which are wholly-owned, (individually and collectively referred to herein as \"Miller\").\nFiscal Year - Effective July 1, 1993, Miller adopted a fiscal year ending on the Saturday closest to June 30. Prior to this change, Miller's fiscal year ended on June 30.\nRevenue Recognition - Miller generally recognizes revenues from the sales of its products upon the completion of manufacturing and the transfer of title.\nInventories - Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method.\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization of plant and equipment are computed using the straight- line method over the estimated useful lives of the assets. Costs of purchased software and, under certain conditions, internal software development costs are capitalized and the amortized over a future period. Capitalized software costs, for both internally developed and purchased software products, are amortized using the straight-line method over sixty months. As of July 1, 1995 and July 2, 1994, capitalized software costs, included with machinery and equipment, (and the related accumulated amortization) aggregated $199,007 ($8,251) and $148,010 ($27,222), respectively.\nBond Issuance Cost - Bond issuance costs aggregating $120,436, which related to issuance of the industrial revenue bond, are being amortized using the straight-line method over the term of the bond.\nIncome Taxes - Effective July 1, 1993, Miller adopted Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"), \"Accounting for Income Taxes,\" 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 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. As permitted by SFAS No. 109, Miller elected not to restate the financial statements of any prior years, and the adoption of SFAS No. 109 did not have a material effect on Miller's consolidated financial statements.\nPrior to July 1, 1993, the provision for income taxes was based on income and expenses included in the consolidated statements of operations. Differences between taxes so computed and taxes payable under applicable statutes and regulations were classified as deferred taxes arising from timing differences.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued for the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Concluded.\nEmployee Benefit Plan - Miller maintains a simplified 401(k) savings plan (the \"Plan\") for eligible participating employees of Miller. The Plan is a defined contribution plan under which employees may voluntarily contribute a percentage of their compensation. The Plan allows Miller to make discretionary matching contributions before the end of the Plan's calendar year-end. During the years ended July 1, 1995 and July 2, 1994, Miller expensed $17,237 and $17,017, respectively, under this Plan. No amounts were expensed for the fiscal year ended June 30, 1993.\nEarnings (Loss) Per Share - Per share amounts are based upon the weighted average number of common shares outstanding and common equivalent shares (dilutive stock options) assumed outstanding during each period. The common equivalent shares did not enter into the computation of loss per share for the year ended June 30, 1993 because their inclusion would have been antidilutive.\nConsolidated Statements of Cash Flows - Miller considers all highly liquid investments purchased with an original maturity of three months or less to be temporary cash investments for purposes of the consolidated statements of cash flows.\nNote B: NONRECURRING ITEMS.\nDuring the fiscal year ended July 1, 1995, Miller recorded a pre-tax charge of $265,514 which resulted from the final resolution of disputed warranty issues with a customer. Also, Miller recorded a pre-tax charge of $186,198 for exit costs associated with the closing of its residential division, which manufactured factory-built modular residential housing.\nDuring the fourth quarter of fiscal year ended July 2, 1994, Miller recorded a severance agreement with a former officer which consisted of seventeen months compensation and certain benefits. The agreement is payable monthly through December 31, 1995.\nDuring the fiscal year ended June 30, 1993, Miller commenced certain restructuring actions which resulted in a pre-tax restructuring charge of $2,345,363. The restructuring costs included the write-off of a non-compete agreement with a former officer and the closing of certain West coast operations. These included the plants in Woodburn, Oregon and Fontana, California and the termination of PME Pacific Systems, Inc. (\"PME\"). During fiscal 1995 and 1994 certain accruals for these restructuring costs, principally related to the closed Woodburn and Fontana plants and the PME operations were settled at amounts less than originally accrued.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued\nfor the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote B: NONRECURRING ITEMS, Concluded.\nYears Ended July 1, July 2, June 30, 1995 1994 1993\nSettled warranty issues $265,514 $ - $ - Residential exit costs 186,198 - - Severance agreement - 264,150 - Restructuring costs (90,589) (104,898) 2,345,363\n$361,123 $ 159,252 $2,345,363\nAt July 1, 1995, $45,782 ($144,396 at July 2, 1994) of the accrual for liabilities and costs associated with the nonrecurring items is reflected as a long-term liability and the remaining accrual is classified as a current liability.\nNote C: DEBT.\nShort-term borrowings\nMiller maintains an unsecured revolving line of credit with a bank. The loan agreement makes available up to $5 million through November 30, 1995. Interest is payable monthly at prime or a margin over the London Interbank Offering Rate, depending on the pricing option selected by Miller. At July 1, 1995 and July 2, 1994, the weighted average interest rate on outstanding borrowings was 8.68% and 7.25%, respectively. As of July 1, 1995 and July 2, 1994, outstanding borrowings under the loan agreement aggregated $1,550,000 and $525,000, respectively. The loan agreement contains, among other provisions, certain covenants including: maintenance of a required current ratio, tangible net worth and liabilities to tangible net worth ratio.\nLong-term debt\nLong-term debt consists of the following:\nJuly 1, July 2, 1995 1994 Industrial revenue bond, variable rate (4.15% at July 1, 1995), payable in annual installments of $115,000, with an installment of $120,000 at final maturity in November 2007. $1,500,000 $ -\nObligation payable to a former officer of Miller payable in semi-monthly installments of $4,798 through June 15, 1996. Interest at 9% imputed for financial reporting purposes. 109,925 210,406\nTotal 1,609,925 210,406\nLess, Current maturities 224,925 100,481\nLong-term debt $1,385,000 $109,925\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued\nfor the years ended July 1, 1995, July 4, 1994 and June 30, 1993\nNote C: Debt, Concluded.\nAggregate maturities of long-term debt for each of the next five years are as follows: 1996 - $224,925; 1997 - $115,000; 1998 - $115,000; 1999 -$115,000 and 2000 $115,000.\nIn connection with the industrial revenue bond obligation, Miller obtained, as a credit enhancement for the bondholders, an irrevocable letter of credit in favor of the bond trustee. Miller, at its discretion, can convert the industrial revenue bond from a variable rate to a fixed rate. The fixed rate would be determined contemporaneously with the decision to convert. Miller may redeem the bonds at any time in increments of $100,000. In the event the bonds have been converted to a fixed rate, such redemption is at a premium determined by the number of years from conversion to the original maturity. In addition, in connection with the note payable to a former officer, Miller obtained an irrevocable letter of credit in favor of that officer approximating the outstanding principal balance. Availability under the $5 million bank line of credit agreement is reduced by the amount of this standby letter of credit.\nNote D: STOCKHOLDERS' EQUITY.\nOn June 30, 1994, the Board of Directors adopted the Miller Building Systems, Inc. 1994 Stock Option Plan (the \"1994 Plan\") under which 300,000 shares of common stock were reserved for future grant. The 1994 Plan expires June 30, 2004. On August 26, 1991, the Board of Directors adopted the 1991 Stock Option Plan (the \"1991 Plan\") under which 250,000 shares of common stock were reserved for future grant. The 1991 Plan expires August 26, 2001. The 1994 Plan and 1991 Plan provide that options can be granted by Miller at a price not less than 100% of fair market value (or 110% of fair market value if the optionee owns 10% or more of Miller's common stock). The term of an option granted under the 1994 Plan and 1991 Plan cannot exceed ten years, and options are either exercisable upon grant or contain a specific vesting schedule, except in the event of a change of control, as defined, at which time all outstanding options become fully exercisable by the optionee.\nChanges in options are summarized as follows:\nNumber Per Share Of Shares Option Price\nOutstanding at July 1, 1992 129,500 $3.00 - $4.63 Granted 72,000 2.50 - 2.75\nOutstanding at June 30, 1993 201,500 2.50 - 4.63 Canceled (41,500) 3.00 - 4.25\nOutstanding at July 2, 1994 160,000 2.50 - 4.63 Granted 329,000 3.25 - 6.00 Exercised (7,000) 2.75 Canceled (88,000) 2.75 - 4.63\nOutstanding at July 1, 1995 394,000 $2.50 - $6.00\nExercisable at July 1, 1995 188,600\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued\nfor the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote E: INCOME TAXES.\nThe provision (credit) for income taxes is summarized as follows:\nYears Ended July 1, July 2, June 30, 1995 1994 1993 Current: Federal $ 72,000 $(18,000) $(349,000) State 50,000 (4,000) 53,000\n122,000 (22,000) (296,000) Deferred tax (credit) 67,000 (44,000) (297,000)\nTotal $189,000 $(66,000) $(593,000)\nThe provision (credit) for income taxes included in the consolidated statements of operations differs from that computed by applying the federal statutory tax rate (34%) to income (loss) before income taxes as follows:\nYears Ended July 1, July 2, June 30, 1995 1994 1993 Computed federal income tax (credit) $173,000 $ 83,600 $(886,500) Increase (decrease) resulting from: Federal income taxes recorded (reversed) for Internal Revenue Service exam- ination - (120,400) 251,000 State income taxes, net of federal income tax impact 33,000 (2,600) 35,000 Other, net (17,000) (26,600) 7,500\nTotal $189,000 $ (66,000) $(593,000)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued\nfor the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote E: INCOME TAXES, Continued\nDeferred income taxes reflect the estimated future 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 components of the net deferred tax asset and liability at July 1, 1995 and July 2, 1994 are as follows:\nJuly 1, July 2, 1995 1994 Current deferred tax asset: Inventories $ 140,000 $ 130,000 Accrued warranty 59,000 93,000 Accrued nonrecurring items 24,000 122,000 Allowance for doubtful receivables 76,000 49,000 Other 21,000 5,000\nTotal $ 320,000 $ 399,000\nLong-term deferred tax asset (liability): Property, plant and equipment $ (149,000) $(205,000) Accrued nonrecurring items 15,000 59,000\nTotal $ (134,000) $(146,000)\nDuring the year ended June 30, 1993, the Internal Revenue Service (\"IRS\") completed an audit for Miller's federal income tax returns for the fiscal years 1989, 1990 and 1991 and the revenue agent proposed adjustments related to the valuation and amortization of certain intangible assets. During fiscal 1994, Miller settled these audit issues with the IRS and, accordingly, a federal and state tax benefit (reversal of previously accrued income taxes) of $157,000 was recorded in the year ended July 2, 1994.\nNote F: MAJOR CUSTOMERS.\nMiller's primary business involves the design and manufacture of factory built buildings. Miller sells its products primarily to independent customers who, in turn, sell or lease to the end users.\nOne customer individually accounted for 23% of net sales in fiscal 1995, 21% of net sales in fiscal 1994 and 34% of net sales in fiscal 1993. At July 1, 1995, 15% of receivables is concentrated with this one customer and 37% concentrated in five other customers. At July 2, 1994, 28% of receivables was concentrated with this one customer and 33% was concentrated with five other customers.\nNote G: COMMITMENTS AND CONTINGENCIES.\nLease Commitments:\nMiller leases certain real estate under a noncancellable operating lease expiring April 1996. The lease may be extended at Miller's option. Miller generally is responsible for utilities, taxes and insurance on the leased facility. Future minimum lease payments under this noncancellable lease are $35,833 in fiscal year 1996 with no commitments thereafter.\nRental expense under all operating leases aggregated $159,225, $179,620 and $164,832 for the years ended July 1, 1995, July 2, 1994 and June 30, 1993, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Concluded\nfor the years ended July 1, 1995, July 2, 1994 and June 30, 1993\nNote H: UNAUDITED INTERIM FINANCIAL INFORMATION.\nPresented below is certain selected unaudited quarterly financial information for the years ended July 1, 1995 and July 2, 1994:\nEarnings Net Gross Net Income (Loss) Sales Profit (Loss) Per Share\n1995: Fourth $11,298,949 $1,899,047 $ 263,885 $ .08 Third 9,225,932 1,131,982 (370,960) (.12) Second 9,691,497 1,440,865 118,817 .04 First 11,238,122 1,609,284 308,170 .10\nTotal $41,454,500 $6,081,178 $ 319,912 $ .10\n1994: Fourth $10,804,983 $1,263,563 $ (87,561) $(.03) Third 8,279,366 773,141 23,624 .01 Second 7,232,812 973,156 53,351 .02 First 12,251,651 1,767,179 322,446 .10\nTotal $38,568,812 $4,777,039 $ 311,860 $ .10\nMILLER BUILDING SYSTEM, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nMILLER BUILDING SYSTEMS, INC., AND SUBSIDIARIES\nINDEX TO EXHIBITS\nExhibit Number Description of Exhibit\n23.3 Consent of Independent Accountants\n10.53 Employment agreement between Registrant and Edward C. Craig, dated July 1, 1994.\n10.54 Agreement between Registrant and Ronald L. Chez, dated September 9, 1994.\n10.55 Agreement to Terminate Lease between Miller Structures, Inc., an Indiana corporation, and Malcolm O. Koons dated June 12, 1995 with respect to property located at Elkhart, Indiana.\n11 Statement regarding computation of per share earnings.\nThe exhibits listed below are filed as part of this report and incorporated by reference as indicated.\n3.1 Certificate of Incorporation, as amended (a)\n3.2 By-Laws, as amended (a) (d) (f) (i) (k) (l) (n)\n4.1 Specimen Common Stock Certificate (e)\n4.2 Certificate of Incorporation, Articles Fourth, Eighth, and Tenth; By-Laws, Articles II, VII, and IX (a)\n10.9 Employee Incentive Stock Option Plan adopted by the Registrant's stockholders on April 11, 1983 and Form of Option Agreement (a) (b) (c)\n10.11 Lease Agreement between Sioux Falls Structures, Inc. (now known as Miller Structures, Inc.), a South Dakota corporation, and Toboll Corporation dated April 15, 1985 with respect to property located in Sioux Falls, South Dakota (a) and Amendments thereto dated February 3, 1988 and December 31, 1989 (h)\n10.12 Lease Agreement between Toboll properties and Miller Structures, Inc. (South Dakota) dated August 1, 1990 with respect to the lease of land in Sioux Falls, South Dakota (h)\n10.14 Lease between Miller Structures, Inc.), a California corporation, and C&W dated as of March 20, 1985 with respect to property located in Fontana, California (a)\n10.44 Employment Agreement between Registrant and John M. Davis, dated March 16, 1990 and effective as of February 1, 1990 (g)\n10.47 Agreement between Registrant and Frederick H. Goldberger, dated May 6, 1991, which replaces an employment agreement dated April 26, 1988 and amendments thereto which was to expire on June 30, 1995 (j)\n10.48 1991 Stock Option Plan adopted by the Registrant's stockholders on October 30, 1991 and Form of Option Agreement (m)\n10.49 Miller Building Systems, Inc. 401(k) Plan (o)\n10.50 Letter to Frederick H. Goldberger, dated April 28, 1993, declaring the non-competition covenant, of the Agreement of May 6, 1991, to have no value (o)\n10.51 First amendment to employment agreement between Registrant and John M. Davis, dated March 16, 1994 (q)\n10.52 Commercial Lease and Option to Purchase between Miller Structures, Inc., and Indiana corporation, and Malcolm O. Koons dated March 2, 1993 with respect to property located at Elkhart, Indiana (q)\n10.53 1994 Stock Option Plan adopted by the Registrant's stockholders on October 25, 1994 and For of Option Agreement (p)\n21.1 Subsidiaries of the Registrant (o) ______________\n(a) Registration Statement on Form S-1, as amended (File No. 0-14651) (b) Form S-8, Date of Report - October 28, 1987 (c) Form 8-K, Date of Report - November 1, 1988 (d) Form 8-K, Date of Report - July 20, 1989 (e) Form 10-K for year ended June 30, 1989 (f) Form 8-K, Date of Report - January 31, 1990 (g) Form 8-K, Date of Report - March 16, 1990 (h) Form 10-K for year ended June 30, 1990 (i) Form 8-K, Date of Report - April 23, 1991 (j) Form 8-K, Date of Report - May 6, 1991 (k) Form 8-K, Date of Report - July 25, 1991 (l) Form 8-K, Date of Report - August 26, 1991 (m) Form S-8, Date of Report - July 31,1992 (n) Form 8-K, Date of Report - April 22, 1993 (o) Form 10-K for year ended June 30, 1993 (p) Form S-8, Date of Report - Dated December 30, 1994 (q) Form 10-K, for year ended July 2, 1994","section_15":""}
{"filename":"701708_1995.txt","cik":"701708","year":"1995","section_1":"Item 1. - Business. - ------- ---------\nThe registrant, Caliber System, Inc. (formerly Roadway Services, Inc.), is a corporation organized under the laws of the State of Ohio in 1982 and is engaged through its subsidiaries in a broad range of transportation, logistics, and related information services. On December 14, 1995, the shareholders of the registrant approved the spin-off to the registrant's shareholders of approximately 95% of the stock of its wholly-owned subsidiary, Roadway Express, Inc., the registrant's national long haul, less-than-truckload (LTL) motor freight carrier. The spin-off was completed at the beginning of 1996. On November 6, 1995 the registrant announced plans to exit the air freight business served by Roadway Global Air, Inc., its worldwide air freight carrier. Additional information concerning the above transactions is set forth in the discussion contained on pages 4, 5 and 19, and pages 30 through 33 of the registrant's Annual Report to Shareholders for the year ended December 31, 1995, and is incorporated herein by reference. The registrant's remaining operations include a small-package carrier, a superregional freight carrier, a surface expedited carrier and a contract logistics provider. These operations provide services and solutions to meet customer requirements based upon shipment size, distance, time in transit, and distribution needs. The registrant conducts these operations principally through RPS, Inc. (\"RPS\", formerly Roadway Package System, Inc.), Viking Freight, Inc. (\"Viking\", formerly Viking Freight System, Inc.), Roberts Express, Inc. (\"Roberts\") and Caliber Logistics, Inc. (\"Caliber Logistics\", formerly Roadway Logistics Systems, Inc.).\nRPS serves customers in the small-package market throughout North America and between North America and Europe, focusing primarily on the business-to-business delivery of packages weighing up to 150 pounds. RPS provides service to 98% of the United States, and, through RPS, Ltd., its subsidiary, to 100% of Canada. RPS service extends to 27 European countries through a partnership with General Parcel Logistics GmbH. RPS also offers service offshore to Puerto Rico, Alaska and Hawaii via a ground\/air network operation. RPS provides other specialized transportation services to meet specific customer requirements in the small-package market. RPS conducts its operations primarily with owner-operated vehicles and, in addition, owns over 7,000 trailers. United Parcel Service is the dominant carrier in the portion of the industry in which RPS competes. Competition focuses largely on providing economical pricing and dependable service.\nViking is a superregional freight carrier, formed early in 1996 by the consolidation of the businesses of four regional carrier subsidiaries, Central Freight Lines Inc., Coles Express, Inc., Spartan Express, Inc., and Viking Freight System, Inc., with regional coverage across the country. Viking's primary business consists of handling shipments weighing less than 10,000 pounds each. Most of their shipments require less than the full cargo and\/or weight capacity of a trailer and are more efficiently transported by sharing trailer capacity with other shipments. Viking operates a dedicated trucking network principally serving its core geographic markets with next-day and second-day freight service. In addition, national service is provided\nto meet specific customer requirements. With a fleet of over 20,000 trucks, tractors and trailers, Viking serves 91% of the U.S. population in all 50 states and Puerto Rico; it also serves Canada through an arrangement with Interlink Freight Systems, Inc. The freight industry is extremely competitive. High levels of competition and periodic industry overcapacity continue to result in aggressive discounting and narrow margins. Viking competes primarily with other regional freight carriers and, to a lesser extent, national freight and small-package carriers.\nRoberts is the largest surface expedited carrier in North America, providing critical needs shipping and transportation for emergency shipments. Roberts also provides similar service in Europe. Utilizing over 2,000 vehicles, Roberts delivers shipments within 15 minutes of the promised delivery time in 96% of all cases. In addition to time-critical delivery, Roberts offers White Glove Services(R), requiring specially equipped vehicles and highly trained teams to handle such items as electronics, medical equipment, radioactive materials, pressurized gases, trade show exhibits and works of art. Roberts transports freight through independent owner-operators.\nCaliber Logistics is a contract logistics provider with expertise across the entire supply chain, from inbound materials management through distribution to the final consumer. Services provided include transportation management, dedicated transportation, warehouse operations and management, just-in-time delivery programs (including light assembly and manufacturing), customer order processing, returnable container management, freight bill payment and auditing and other management services outsourced by its customers. Caliber Logistics operates in a relatively new business area and further vigorous competition is expected from existing competitors and new entrants.\nAt the end of 1995, the registrant and its affiliates employed approximately 25,700 persons (on a full time equivalent basis) and utilized the services of approximately 10,500 independent contractors.\nAll of the registrant's domestic motor carrier subsidiaries are subject to regulation by the United States Department of Transportation.\nThe freight transportation industry is affected directly by the state of the overall economy. Seasonal fluctuations affect tonnage, revenues, and earnings, with the fall of each year being the busiest shipping period and the months of December and January the slowest.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. - Properties. - ------- -----------\nCaliber System, Inc. - --------------------\nCorporate offices of the registrant and its information systems subsidiary, Caliber Technology, Inc. (formerly Roadway Information Technology, Inc.) are located in Akron, Ohio in leased facilities. Limited additional corporate office space is located in nearby leased facilities.\nRPS, Inc. - ---------\nAs of December 31, 1995, RPS operated 339 terminals, including 23 hub facilities. Forty-six of the terminals, 19 of which are hub facilities, are owned; and 293 terminals, including the other four hub facilities, are leased, generally for terms of three years or less. Twelve of the terminals, including three hub facilities, are operated by RPS, Ltd., RPS' Canadian subsidiary. The 23 hub facilities are strategically located to cover the geographic area served by RPS. These facilities, averaging 97,500 square feet, range in size from 24,000 to 147,900 square feet.\nRPS' corporate offices and information and data centers are located in an approximately 350,000 square foot building owned by a subsidiary of the registrant in the Pittsburgh, Pennsylvania area.\nViking Freight, Inc. - --------------------\nAs of December 31, 1995, Viking operated 221 terminals. Eighty-four of the terminals, with 4,450 loading spaces, are owned; and the remaining 137 terminals, with 3,128 loading spaces, are leased. The largest terminal facility, located in Dallas, Texas, has 525 loading spaces and is owned by the company. The company's general offices are located in leased facilities in San Jose, California.\nRoberts Express, Inc. - -------------------------------------\nRoberts' general offices are located in Akron, Ohio in owned facilities. Roberts does not use terminal facilities in its business.\nCaliber Logistics, Inc. - -----------------------\nCaliber Logistics' general offices are located in Hudson, Ohio in leased facilities.\nItem 3.","section_3":"Item 3. - Legal Proceedings. - ------- ------------------\nThe registrant is involved in various lawsuits arising in the ordinary course of its business. In the opinion of management, the outcome of these matters will not have a material adverse effect on the financial condition or results of operations of the registrant.\nItem 4.","section_4":"Item 4. - Submission of Matters to a Vote of Security Holders. - ------- ----------------------------------------------------\nOn December 14, 1995, the registrant held a special meeting of shareholders at 901 Lakeside Ave., Cleveland, Ohio. The purpose of the meeting was to vote on the proposals recommended by the Board of Directors to approve the following:\nProposal One: The distribution by the registrant of at least 95% of the outstanding shares of common stock of Roadway Express, Inc. (\"REX\"), a then wholly-owned subsidiary of the registrant to the shareholders of record on December 29, 1995, on the basis of one share of common stock of REX for each two shares of common stock of the registrant. The results of the vote on Proposal One were as follows:\nProposal Two: An amendment to the Amended Articles of Incorporation of the registrant changing the name of the registrant to \"Caliber System, Inc.\" The results of the vote on Proposal Two were as follows:\nProposal Three: The adoption by REX, then a wholly-owned subsidiary of the registrant, of the REX Management Incentive Stock Plan. The results of the vote on Proposal Three were as follows:\nExecutive Officers of the Registrant. - -------------------------------------\nOfficers are elected to serve on a calendar year basis except for the Chairman, President, Treasurer and Secretary, who are elected for an annual term following the annual meeting of shareholders. No family relationships exist between any of the executive officers named above or between any executive officer and any director of the registrant.\nPART II\nItem 5.","section_5":"Item 5. - Market for Registrant's Common Equity and Related Stockholder - ------- ------------------------------------------------------------- Matters. --------\nIn response to the information called for by this Item, the material set forth under the heading \"Common Stock and Dividends\" on page 39 of the registrant'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. - ------- ------------------------\nIn response to the information called for by this Item, the historical data set forth for the years 1995, 1994, 1993, 1992 and 1991, and Notes (1), (2) and (3) on pages 42 and 43 of the registrant's Annual Report to Shareholders for the year ended December 31, 1995, are incorporated herein by reference.\nItem 7.","section_7":"Item 7. - Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations. ----------------------\nIn response to the information called for by this Item, the material set forth on pages 19 through 22 of the registrant'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 consolidated financial statements of the registrant and its subsidiaries set forth on pages 24 through 38 and the Report of Independent Auditors on page 23 of the registrant's Annual Report to Shareholders for the year ended December 31, 1995, are incorporated herein by reference.\nThe material set forth under the heading \"Summary of Quarterly Results of Operations\" on page 40 and 41 of the registrant's Annual Report to Shareholders for the year ended December 31, 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 the Registrant. - -------- ---------------------------------------------------\nIn response to the information called for by Item 401 of Regulation S-K with respect to directors of the registrant, the material set forth under the heading \"Information About Nominees for Directors\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 8, 1996, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nIn response to the information called for by Item 401 of Regulation S-K with respect to executive officers of the registrant, the material set forth under the heading \"Executive Officers of the Registrant\" in Part I of this Form 10-K Annual Report for the year ended December 31, 1995, is incorporated herein by reference.\nItem 11.","section_11":"Item 11. - Executive Compensation. - -------- -----------------------\nIn response to the information called for by this Item with respect to directors of the registrant, the material set forth under the heading \"Director Compensation\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 8, 1996, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nIn response to the information called for by this Item with respect to executive officers of the registrant, the material set forth under the heading \"Executive Compensation and Shareholdings by Executive Officers\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 8, 1996, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. - Security Ownership of Certain Beneficial Owners and Management. - -------- ---------------------------------------------------------------\nIn response to the information called for by this Item, the material set forth under the heading \"Principal Holders of Company Common Stock on February 29, 1996,\" including the notes thereto; the material set forth under the heading \"Information About Nominees for Directors,\" including the notes thereto; and the material set forth under the heading \"Ownership of Company Common Stock by Management,\" including the notes thereto, in the registrant's proxy statement for the annual meeting of shareholders to be held on May 8, 1996, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. - Certain Relationships and Related Transactions. - -------- -----------------------------------------------\nNone.\nPART IV\nItem 14.","section_14":"Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - -------- -----------------------------------------------------------------\n(a)(1) and (2) List of Financial Statements and Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report.\n(3) Exhibit Index--The response to this portion of Item 14 is submitted as a separate section of this report.\n(b) Reports on Form 8-K Filed in the Fourth Quarter of 1995--A report on Form 8-K dated November 17, 1995 was filed under:\n* Item 2, Acquisition or Disposal of Assets. - Announced plans to exit the air freight business served by its subsidiary Roadway Global Air, Inc. and to sell certain related assets.\n* Item 7, Financial Statements, Pro Forma Financial Information and Exhibits.-\nThe following pro forma financial information was incorporated by reference to note (b) on page 32 and to pages 33 through 38 of the registrant's Proxy Statement for the Special Meeting of Shareholders held on December 14, 1995.\nRoadway Services, Inc. Pro Forma Condensed Financial Statements:\n* Unaudited Pro Forma Condensed Balance Sheet, September 9, 1995\n* Unaudited Pro Forma Statement of Consolidated Income, Thirty-Six Weeks Ended September 9, 1995\n* Unaudited Pro Forma Statement of Consolidated Income, Year Ended December 31, 1994\n* Unaudited Pro Forma Statement of Consolidated Income, Thirty-Six Weeks Ended September 10, 1994\n(c) Exhibits--The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCALIBER SYSTEM, INC.\nDate March 12, 1996 By \/s\/ Daniel J. Sullivan -------------- ------------------------------------- Daniel J. Sullivan, Chairman, President and Chief Executive Officer\nDate March 12, 1996 By \/s\/ D. A. Wilson -------------- ------------------------------------- D. A. Wilson, Senior Vice President- Finance and Planning, Secretary and Chief Financial Officer\nDate March 12, 1996 By \/s\/ Kathryn W. Dindo -------------- ------------------------------------- Kathryn W. Dindo, 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.\nCALIBER SYSTEM, INC.\nDate March 12, 1996 By \/s\/ G. B. Beitzel -------------- ------------------------------------- G. B. Beitzel, Director\nDate March 12, 1996 By \/s\/ R. A. Chenoweth -------------- ------------------------------------- R. A. Chenoweth, Director\nDate March 12, 1996 By \/s\/ Charles R. Longsworth -------------- ------------------------------------- Charles R. Longsworth, Director\nDate March 12, 1996 By \/s\/ Daniel J. Sullivan -------------- ------------------------------------- Daniel J. Sullivan, Director\nDate March 12, 1996 By H. Mitchell Watson, Jr. -------------- ------------------------------------- H. Mitchell Watson, Jr., Director\nANNUAL REPORT ON FORM 10-K\nITEM 14(a) (1) AND (2), AND 14(d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nFINANCIAL STATEMENT SCHEDULE\nYEAR ENDED DECEMBER 31, 1995\nCALIBER SYSTEM, INC.\nAKRON, OHIO\nFORM 10-K--ITEM 14(a) (1) AND (2)\nCALIBER SYSTEM, INC. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements, included in the registrant's Annual Report to Shareholders for the year ended December 31, 1995, are incorporated by reference in Item 8:\nConsolidated Balance Sheets--December 31, 1995 and 1994--pages 24 and 25 Statements of Consolidated Income--Years ended December 31, 1995, 1994 and 1993--page 26 Statements of Consolidated Cash Flows--Years ended December 31, 1995, 1994 and 1993--page 27 Statements of Consolidated Shareholders' Equity--Years ended December 31, 1995, 1994 and 1993--pages 28 and 29 Notes to Consolidated Financial Statements--December 31, 1995--pages 30 through 38\nThe following consolidated financial statement schedule of Caliber System, Inc. and subsidiaries is included in Item 14(d):\nSchedule II-Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nCALIBER SYSTEM, INC.\nYears Ended December 31, 1995, 1994 and 1993\n(dollars in thousands)","section_15":""}
{"filename":"737561_1995.txt","cik":"737561","year":"1995","section_1":"Item 1. Business\nIntroduction\nThe consolidated financial statements of UCI Medical Affiliates, Inc. include the accounts of UCI Medical Affiliates, Inc. (\"UCI\"), its wholly owned subsidiary, UCI Medical Affiliates of SC, Inc. (\"UCI-SC\") and Doctor's Care, PA (the \"P.A.\"), collectively the \"Company\". The financial statements of the P.A. are consolidated with UCI because UCI-SC has unilateral control over the assets and operations of the P.A. and, notwithstanding the lack of technical majority ownership, consolidation of the P.A. with UCI is necessary to present fairly the financial position and results of operations of UCI. UCI-SC provides non-medical management and administrative functions for 25 medical clinics, operating as Doctor's Care (the \"Centers\"). All medical services at the Centers are provided by or under the supervision of the P.A., which has contracted with UCI-SC to provide the medical direction of the Centers. The medical directors operate the Centers under the financial and operational control of UCI-SC. However, medical supervision of the Centers is provided solely by the P.A. The P.A. remits to UCI-SC all medical service revenues generated by the Centers, net of expenses incurred by the P.A. This compensation is recorded in the accompanying financial statements as revenue. Control of the P.A. is perpetual and other than temporary because of the nature of this relationship and the management's agreements between the entities. The net assets of the P.A. are not material for any period presented and intercompany accounts and transactions have been eliminated. For the fiscal year ended September 30, 1995, the Company has shown a substantial increase in revenues and in medical centers under management. This growth is a direct result of actions taken by management to increase marketing efforts, to expand the state-wide network in South Carolina and to focus on the field of occupational and industrial medicine.\nGeneral\nUCI-SC provides nonmedical management and administrative services for freestanding medical centers. The Company as of September 1995 owns a network of medical centers consisting of 25 freestanding Centers located throughout South Carolina.\nIn order to comply with prohibitions against corporations, other than medical professional associations, providing medical care; all medical services at the Centers are provided by or under the supervision of the P.A., a South Carolina professional association.\nThe Centers are staffed by licensed physicians, other healthcare providers and administrative support staff. The medical support staff includes licensed nurses, certified medical assistants, laboratory technicians and x-ray technicians.\nThe Centers typically are open for extended hours (weekends and evenings) and out-patient care only. When hospitalization or specialty care is needed, referrals to appropriate specialists are made.\nThe Company's Centers are broadly distributed throughout the state of South Carolina. There are eleven primary care Centers in the Columbia region, four in the Charleston region, four in the Myrtle Beach region and four in the Greenville-Spartanburg region. In addition to these 23 Centers, the Company operates a surgical practice and an orthopedic practice, both of which are located in Columbia.\nThe Company's business, by its nature, is subject to various risks, including, but not limited to, difficulties in controlling health care costs, uncertainty of future expansion, availability of primary care physicians and possible negative effects of government regulation.\nThe health care industry is subject to extensive federal and state regulation. Changes in healthcare legislation or reinterpretations of existing regulations could significantly affect the business of the Company.\nMedical Services Provided at the Centers\nThe Company's Centers offer reasonably priced out-patient medical care, without appointment, for treatment of acute and episodic medical problems. The Centers provide a broad range of medical services which would generally be classified as within the scope of family practice and occupational medicine. The medical services are provided by licensed physicians, nurses and auxiliary support personnel. The services provided at the Centers include, but are not limited to the following:\n(bullet) Routine care of general medical problems, including colds, flu, ear infections, hypertension, asthma, pneumonia and other conditions typically treated by primary care providers;\n(bullet) Treatment of injuries, such as simple fractures, dislocations, sprains, bruises and cuts;\n(bullet) Minor surgery, including suturing of lacerations and removal of cysts and foreign bodies;\n(bullet) Diagnostic tests, such as x-rays, electrocardiograms, complete blood counts, urinalysis and various cultures; and,\n(bullet) Occupational and industrial medical services, including drug testing, worker's compensation and physical examinations.\nAt any of the Centers, a patient with a life-threatening condition would be evaluated by the physician, stabilized and immediately transferred to a nearby hospital.\nPatient Charges and Payments\nThe fees charged to a patient are determined by the nature of medical services rendered. Management of the Company believes that the charges at its Centers are significantly lower than the charges of hospital emergency departments and are generally competitive with the charges of local physicians and other providers in the area.\nThe Company's Centers accept payment from a wide range of sources. These include patient payments at time of service (by cash, check or credit card), patient billing and assignment of insurance benefits (including Blue Cross\/Blue Shield, Medicare, Worker's Compensation and other private insurance). Private pay billings represent the most significant source of revenues. The Company also provides services for members of three of the largest health maintenance organizations (\"HMOs\") operating in South Carolina - Companion HealthCare Corporation, HealthSource South Carolina, Inc., and Maxicare South Carolina (a division of Maxicare Southeast Health Plan, Inc.).\nMedical services traditionally have been provided on a fee-for-service basis with insurance companies assuming responsibility for paying all or a portion of such fees. The increase in medical costs under traditional indemnity health care plans has been caused by a number of factors. These factors include: (i) the lack of incentives on the part of health care providers to deliver cost-effective medical care; (ii) the absence of controls over the utilization of costly specialty care physicians and hospitals; (iii) a growing and aging population which requires increased health care expenditures; and (iv) the expense involved with the introduction and use of advanced pharmaceuticals and medical technology.\nAs a result of escalating health care costs, employers, insurers and governmental entities all sought cost-effective approaches to the delivery of and payment for quality health care services. HMOs and other managed health care organizations have emerged as integral components in this effort. HMOs enroll\nmembers by entering into contracts with employer groups or directly with individuals to provide a broad range of health care services for a capitation payment, with minimal or no deductibles or co-payments required of the members. HMOs, in turn, contract with health care providers like the Company to administer medical care to HMO members. These contracts provide for payment to the Company on either a discounted fee-for-service or through capitation payments based on the number of members covered, regardless of the amount of necessary medical care required within the covered benefit period.\nCertain third party payors are studying various alternatives for reducing medical costs, some of which, if implemented, could affect reimbursement levels to the Company. The Company cannot predict whether changes in present reimbursement methods or proposed future modifications in reimbursement methods will affect payments for services provided by the Centers and, if so, whether they will have an adverse impact upon the business of the Company.\nCompetition and Marketing\nAll of the Company's Centers face competition, in varying degrees, from hospital emergency rooms, private doctor's offices and other competing freestanding medical centers. Some of these providers have financial resources which are greater than those of the Company. In addition, traditional sources of medical services, such as hospital emergency rooms and private physicians, have had, in the past, a higher degree of recognition and acceptance by patients than Centers such as those operated by the Company. The Company's Centers compete on the basis of accessibility, including evening and weekend hours, a no-appointment policy, the attractiveness of its state-wide network to large employers and third party payors, and on a basis of a competitive fee schedule. In an effort to offset the competition's community recognition, the Company has substantially increased its marketing efforts. Regional marketing representatives have been added, focused promotional material has been developed and a newsletter for employers promoting the Company's activities has been initiated.\nGovernment Regulation\nSouth Carolina prohibits the corporate practice of medicine. By virtue of its relationship with the P.A., the Company believes that it is in full compliance with this law.\nThe health care industry is highly regulated, and there can be no assurance that the regulatory environment in which the Company operates will not change significantly in the future. Generally, regulation of health care companies is increasing.\nVarious proposals affecting federal and state regulation of the health care industry, including limitations on Medicare and Medicaid payments, have been introduced in the past, including provisions in legislation currently pending.\nEmployees\nAs of September 30, 1995 and 1994, the Company had 301 and 202 employees, respectively (270 and 170 , respectively, on a full-time equivalent basis).\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAll but one of the Company's primary care Centers are leased. The properties are generally located on well-traveled major highways, with easy access. Each property offers free, off-street parking immediately adjacent to the center. Four (4) Centers are leased from entities affiliated with the Company's Chairman and one (1) center is leased directly from the Chairman. Seven (7) Centers are leased from Companion HealthCare Corporation, a principal shareholder of the Company. See additional information regarding these leases at Item 13, \"Certain Relationships and Related Transactions.\"\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is party to various claims, legal activities and complaints arising in the normal course of business. In the opinion of management and legal counsel, there are no material pending legal proceedings to which the Company is party.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn September 13, 1995, the annual meeting of the shareholders of the Company was held and the following actions were taken:\n1. The shares of Common Stock represented at the meeting were voted to elect Charles M. Potok, Charles P. Cannon and Russell J. Froneberger to the Board of Directors for terms expiring in 1997, 1998 and 1998, respectively, as follows:\nTwo other Directors, M.F. McFarland, III, M.D. and Harold H. Adams, Jr., whose terms expire in 1997 and 1996, respectively, continued to serve as elected.\n2. The shares of Common Stock represented at the meeting were voted to approve an amendment to the 1994 Incentive Stock Option Plan to increase the number of shares of Common Stock that may be issued under the Stock Option Plan from 50,000 shares to 750,000 shares as follows:\nNumber Voting For Against Abstain\n2,578,837 2,552,639 24,339 1,859\n3. The shares of Common Stock represented at the meeting were voted to ratify the appointment of Price Waterhouse LLP as independent auditors for the Company as follows:\nNumber Voting For Against Abstain\n2,804,675 2,803,922 446 337\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 over-the-counter market. The prices set forth below indicate the high and low bid prices. All stock prices have been adjusted to reflect the Company's one for five reverse stock split effected on July 27, 1994.\nFrom October 1, 1992 through September 30, 1993, the Company's stock had been quoted at 5\/32.\nThe foregoing quotations reflect inter-dealer prices without retail markup, markdown or commission and may not necessarily reflect actual transactions.\nAs of September 30, 1995, there were 698 stockholders of record of the Company's Common Stock, excluding individual participants in security position listings.\nThe Company has not paid dividends on its Common Stock since inception and has no plans to declare cash dividends in the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data (In thousands, except per share data)\nThe following selected financial data should be read in conjunction with the Company's consolidated financial statements and the accompanying notes presented elsewhere herein.\nSTATEMENT OF OPERATIONS DATA\nBALANCE SHEET DATA\n(1) Effective October 1, 1993, the Company adopted Statement of Financial Standards No. 109, \"Accounting for Income Taxes.\" The effect of adopting SFAS 109 was to reduce income tax expense for 1994 by approximately $612,000 or $.26 per share.\n(2) The net income (loss) per share and the weighted average number of shares outstanding has been restated for all periods presented to reflect the one for five reverse stock split effected on July 27, 1994.\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 the Company believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto.\nResults of Operations for the Year Ended September 30, 1995 Compared to Year Ended September 30, 1994\nFor fiscal year 1995, revenues of $17,987,000 reflect an increase of 43% from the amount reported for fiscal year 1994. The following reflects revenue trends from fiscal year 1991 through fiscal year 1995:\nFor the year ended September 30, (in thousands)\n1995 1994 1993 1992 1991\nRevenues $17,987 $12,540 $9,799 $8,330 $8,542 Operating Costs 18,180 11,881 9,133 8,004 8,232 Operating Margin (193) 660 666 326 310\nThe increase in revenue for fiscal year 1995 is attributable to a number of factors. The Company engaged in a significant expansion, increasing the number of primary care medical Centers from 19 to 25. The expansion included the addition of two Centers each to the clusters in Columbia (bringing the total to eleven plus two specialty practices in this region), Greenville (bringing the total to four in this region) and Myrtle Beach (bringing the total to four in this region).\nThe Company, in fiscal year 1995, increased its services provided to members of HMOs. In these arrangements, the Company, through Doctor's Care, P.A., acts as the designated primary caregiver for members of the HMO who have selected Doctor's Care as their primary care provider. In fiscal year 1994, the Company began participating in an HMO operated by Companion HealthCare Corporation (\"Companion\"), a wholly owned subsidiary of Blue Cross Blue Shield of South Carolina. With its arrangement with Companion, the Company now participates in three HMOs and is the primary care \"gatekeeper\" for more than 11,000 capitated lives. While HMOs do not, at this time, have a significant penetration into the South Carolina market, the Company believes that HMOs and other managed care plans will experience a substantial increase in market share in the next few years, and the Company is therefore positioning itself for this possibility.\nIncreased revenues in fiscal year 1995 also reflect the Company's heightened focus on occupational medicine and industrial health services. Focused marketing materials, including quarterly newsletters for employers, were developed to spotlight the Company's services for industry. The Company also entered into an agreement with Companion Property and Casualty Insurance Company wherein the Company acts as the primary care provider for injured workers of firms insured through Companion Property and Casualty Insurance Company. Companion Property and Casualty Insurance Company is wholly owned by Blue Cross Blue Shield of South Carolina and is therefore affiliated with Companion HealthCare Corporation, a primary shareholder of the Company. See additional related information at Item 13, \"Certain Relationships and Related Transactions.\"\nPatient encounters increased to 283,000 in fiscal 1995 from 216,000 in fiscal 1994.\nEven with the positive effects of the factors mentioned above, revenues were short of goals for the year, due in part to the increased competition from hospitals and other providers in Greenville, Sumter and Myrtle Beach and to certain short-term disruptions related to the practices acquired during the year.\nOperating losses of $193,000 were realized in fiscal 1995 as compared to an operating margin of $660,000 in fiscal 1994. This is due, in part, to start-up costs being incurred at the six Centers added in fiscal 1995. Operating costs of $18,180,000 for fiscal 1995 exceeded management's budgets primarily in the areas of personnel costs and medical supplies. Management has aggressively addressed these areas, implementing significant cost cutting measures during the latter part of the third quarter. These include very substantial and across the board reductions in personnel costs, severe reductions in overtime and aggressive negotiations with vendors to obtain more substantial discounts on medical supplies.\nDepreciation and amortization expense increased to $579,000 in fiscal 1995, up from $320,000 in fiscal 1994. This increase reflects higher depreciation expense as a result of significant leasehold improvements and equipment upgrades at a number of the Company's medical centers, as well as an increase in amortization expense related to the intangible assets acquired from the Company's purchase of existing practices in Surfside Beach, Columbia, and Myrtle Beach. Interest expense increased from $164,000 in fiscal 1994 to $505,000 in fiscal 1995 primarily as a result of the interest costs associated with the indebtedness incurred in the Company's purchase of the Surfside Beach Center and in the leasehold improvements.\nIn the latter part of fiscal year 1994, the Company converted to a centralized computer system acquired from Companion Technologies. Companion Technologies is wholly owned by Blue Cross Blue Shield of South Carolina and is therefore affiliated with Companion HealthCare Corporation, a primary shareholder of the Company. See additional related information at Item 13, \"Certain Relationships and Related Transactions.\" This conversion was necessitated by the Company's expansion, the need for a centralized, specialized billings and collections unit, and by the Company's recognition that increased managed care participation required more exacting data. With billing done from a centralized location rather than from each medical center, the Company believes that both increased billing efficiency, and greater focus on collections, will result. The new computer system will also cause a reduction in computer-related expansion costs should the Company add additional Centers. In making this conversion, the Company traded in its old computer equipment, giving rise to a loss of approximately $69,000 in fiscal 1994.\nEffective October 1, 1993, the Company adopted Statement of Financial Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") which requires the use of an asset and liability approach to accounting for income taxes. The effect of adopting SFAS 109 was to reduce income tax expense for 1994 by approximately $612,000 or $.26 per share. Financial statements presented for 1993 and prior years reflected income taxes recorded under the deferred method previously required by previous accounting standards. As part of the adoption of SFAS 109, the Company has recognized a deferred tax asset relating to net operating loss carry forwards which are available to offset future taxable income. Under certain circumstances, a significant change in the Company's ownership could severely limit utilization of the Company's net operating loss carry forwards.\nFinancial Condition at September 30, 1995\nThe Company grew significantly during the year ending September 30, 1995.\nCash and cash equivalents have decreased from $210,000 at September 30, 1994 to $77,000 at September 30, 1995. Cash was utilized mainly for working capital needs and to fund the expansion previously discussed.\nAccounts receivables increased notably from fiscal year 1994. This was attributable to the opening of six additional primary care Centers and the overall growth in patient visits to existing Centers.\nThe increase in property and equipment is attributable to the purchase of the Donaldson Center, the equipment needs of new Centers and the up-grading of equipment at established Centers. The excess of cost over the net assets of acquired businesses (goodwill) totaled $3,578,000 at September 30, 1995 compared to $2,651,000 at the end of the previous fiscal year and reflects the medical practices acquired.\nThe current portion of debt increased in fiscal year 1995 to $1,245,000 from $543,000 at the end of fiscal year 1994. Long-term debt also increased. These increases are primarily the result of indebtedness incurred in the purchases of the Donaldson Center, in the purchase of Summit Medical, and in the utilization of an operating line of credit.\nAccounts payable increased $1,186,000 during 1995 to $1,653,000 as a result of the tight cash position of the Company and as a result of the accelerated growth of the Company during this period. Overall, the Company's current liabilities exceeded its current assets at September 30, 1995 by $383,000; working capital needs were funded, in part, by the sale of stock to Companion HealthCare (a private placement) for $600,000 on November 3, 1995 (see Subsequent Events section below.)\nLiquidity and Capital Resources\nThe Company requires capital principally to fund growth (acquire new Centers), for working capital needs and for the retirement of indebtedness. The Company's capital requirements and working capital needs have been funded through a combination of external financing (including bank debt and proceeds from the sale of common stock to Companion HealthCare Corporation), internally generated funds and credit extended by suppliers.\nOperating activities used $460,000 of cash during fiscal year 1995, compared with $744,000 used during fiscal year 1994. The decrease in operating cash used during fiscal 1995 is mainly the result of growth in accounts payable and accrued expenses. Some of these payables were reduced via utilization of the $600,000 from the November 3, 1995 common stock sale to Companion HealthCare (see Subsequent Events section below).\nInvesting activities used $642,000 of cash during fiscal year 1995 compared with $120,000 in 1994 as a result of expansion efforts. Continued growth is anticipated during 1996. (See \"Subsequent Events\" for acquisition activity in the first quarter of fiscal year 1996.)\nThe Company received $1,240,000 during fiscal 1995 in cash resulting from two private placements of stock with Companion HealthCare Corporation which was used in part to manage the Company's rapid growth and in part to reduce debt. Should additional needs arise, the Company may consider additional capital sources to obtain funding. There is no assurance that any additional financing, if required, will be available on terms acceptable to the Company.\nEarnings and Balance Sheet Analysis for Fiscal Year 1994 Compared to 1993\nTotal revenues for fiscal year 1994 increased by 28% to $12,540,000 from $9,799,000 for fiscal year 1993. The Company expanded from 14 to 19 Centers during this year and was able to hold gross profit margin at about $660,000 for both years. Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" was adopted at the start of fiscal 1994 with the result of reducing income tax expense for 1994 by approximately $612,000.\nSubsequent Events\nIn January 1995, the Company entered into an acquisition agreement for a medical practice in Myrtle Beach, South Carolina. The acquisition is expected to become effective prior to December 31, 1995, after certain conditions precedent occur.\nOn November 3, 1995, Companion purchased 218,180 shares of newly issued common stock of the Company for $2.75 a share, or $599,995. Subsequent to the transaction, Companion's ownership in the Company was approximately 45%. Companion has the option to purchase as many shares as may be necessary for Companion to maintain ownership of 47% of the outstanding common stock of the Company in the event that the Company issues additional stock to other parties (excluding shares issued to employees or directors of the Company).\nOn December 1, 1995, the Company acquired a medical practice in Greenville, South Carolina. The Company entered into an employment agreement with the physician who had been the sole shareholder of the acquired medical practice. The Company also entered into lease agreements for the facility occupied by and the computer system used by the acquired medical practice.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReference is made to the Index to Financial Statements on Page 20 .\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nOn July 27, 1995, the Company notified Scott and Holloway, LLP (formerly Moore Kirkland Scott & Beauston) that it would not be retained as the Company's independent accountants for the fiscal year ending September 30, 1995. The Company's decision not to retain Scott and Holloway, LLP was approved by the Board of Directors at a meeting held on July 26, 1995 and was not the result of any prior, existing or expected disagreement with the Company. The reports of Moore Kirkland Scott & Beauston on the financial statements of the Company for the fiscal years ended September 30, 1994 and 1993 contained no adverse opinion or disclaimer of opinion. The reports were modified because of an uncertainty as to the Company's ability to continue as a going concern as a consequence of losses incurred from continuing operations. This modification has been subsequently rescended and an unqualified opinion for the fiscal years ended September 30, 1994 and 1993 has been issued. In connection with its audits of financial statements of the Company for the fiscal years ended September 30, 1994 and 1993, and the interim period through July 27, 1995, the Company had no disagreement with Moore Kirkland Scott & Beauston on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement, if not resolved to the satisfaction of Moore Kirkland Scott & Beauston, would have caused them to make reference to the subject matter of the disagreement in connection with their report on the financial statements for such periods.\nScott and Holloway, LLP has furnished the Company with a letter addressed to the SEC stating that they agree with the statements made by the Company with respect to their dismissal.\nOn July 26, 1995, the Company engaged Price Waterhouse LLP as its independent accountants to audit the Company's financial statements for the fiscal year ending September 30, 1995. The decision to engage Price Waterhouse LLP was approved by the Board of Directors of the Company at a meeting held on July 26, 1995. During the Company's fiscal years ended September 30, 1994 and 1993, the Company did not consult with Price Waterhouse LLP regarding any matters (a) which were, or should have been, subject to SAS 50, or (b) concerning the subject matter of a disagreement or reportable event with the Company's former independent accountants (as described in Regulation S-B, Item 304(a)(2)).\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nDirectors\nThe Company's Restated Certificate of Incorporation provides for a classified Board of Directors so that, as nearly possible, one-third of the Company's Board of Directors is elected each year to serve a three-year term. Currently, the Board of Directors consists of five directorships with staggered terms expiring at the Annual Meetings of Shareholders in 1996, 1997 and 1998. The Company's Bylaws provide the Board of Directors with the power and authority to determine the number of directors constituting the entire Board of Directors. At a meeting of the Board of Directors on July 26, 1995, the Board of Directors voted to increase the size of the Board from three members to the current five members, with such increase to be effective immediately prior to the election of directors at the Annual Meeting, which was held September 13, 1995. To give effect to such increase, the Board of Directors approved the addition of one directorship to each of the classes of directors whose terms expire at the Annual Meetings of Shareholders\nin 1997 and 1998. Set forth below is the certain biographical information with respect to the directors of the Company.\nM.F. McFarland, III, M.D., 47, has served as Chairman of the Board, President and Chief Executive Officer of the Company since January 1987 and as a director of the Company since September 1984. From September 1984 until January 1987, he served as Vice President of the Company. He served as Associate Professional Director of the Emergency Department of Richland Memorial Hospital in Columbia, South Carolina from 1978 to 1981 and was President of the South Carolina Chapter of the American College of Emergency Physicians in 1979. Dr. McFarland is currently a member of the Columbia Medical Society, the South Carolina Medical Society and the American Medical Association. In November 1992, a voluntary proceeding under Chapter 11 of the United States Bankruptcy Code was filed with respect to Dr. McFarland.\nHarold H. Adams, Jr., 48, has served as Director of the Company since June 1994 and as President and owner of Adams and Associates, International, Adams and Associates, and Southern Insurance Managers since June 1992, and served as President of Adams Eaddy and Associates, an independent insurance agency, from 1980 to 1992. Mr. Adams has been awarded the Chartered Property Casualty Underwriter designation and is currently a member of the President's Board of Visitors of Charleston Southern University in Charleston, South Carolina. He has received numerous professional awards as the result of over 25 years of involvement in the insurance industry and is a member of many professional and civic organizations.\nCharles P. Cannon, 45, has served as Director of the Company since September 1995 and as Vice President, Corporate Controller and Assistant Treasurer for Blue Cross Blue Shield of South Carolina (\"Blue Cross\") since April 1988 and as Assistant Treasurer for its subsidiary, Companion HealthCare Corporation, since April 1988. Prior to joining Blue Cross in April 1988, he was a Senior Manager and consultant for Price Waterhouse LLP for eleven (11) years. Mr. Cannon is a member of the American Institute of Certified Public Accountants, the South Carolina Association of Certified Public Accountants, the Institute of Management Accountants, and the Tennessee Society of Certified Public Accountants.\nRussell J. Froneberger, 50, has served as Director of the Company since June 1994 and as President of Global Consulting, a multinational marketing and financial consulting firm, since 1991. Mr. Froneberger has over twenty-eight years of international corporate finance and marketing experience, having been associated with Manufacturers Hanover Trust Company from 1967 to 1972, and South Carolina National Bank, where he served as Senior Vice President of Marketing and Corporate Development Relations from 1972 to 1991. He has lectured on finance and capital formation at major universities and was the founder and first Chairman of the Midlands International Trade Association in Columbia, South Carolina.\nCharles M. Potok, 46, has served as Director of the Company since September 1995 and as Executive Vice President and Chief Operating Officer of Companion Property and Casualty Insurance Company (\"CPCIC\") since March 1984. Mr. Potok is an Associate of the Casualty Actuarial Society and a member of the American Academy of Actuaries. Prior to joining CPCIC, Mr. Potok served as Chief Property and Casualty Actuary and Director of the Property and Casualty Division of the South Carolina Department of Insurance.\nExecutive Officers\nThe names of the executive officers, who are not also directors of the Company, and certain other biographical information are as follows:\nStephen S. Seeling, 46, has served as Chief Operating Officer and Counsel and Corporate Secretary of the Company since he joined the Company in January 1994. Prior to that time, Mr. Seeling served as the Executive Director of the South Carolina State Board of Medical Examiners from 1987 to\nJanuary 1994, as the Assistant Attorney General for the South Carolina State Board of Medical Examiners from 1983 to 1987, and as Assistant District Attorney for Philadelphia, Pennsylvania from 1976 to 1981.\nJerry F. Wells, Jr., 33, has served as Chief Financial Officer of the Company since he joined the Company in February 1995. Prior to that time, he served as a Senior Manager and consultant for Price Waterhouse LLP from 1985 until February 1995. Mr. Wells is a certified public accountant and is a member of the American Institute of Certified Public Accountants, the South Carolina Association of Certified Public Accountants and the North Carolina CPA Association.\nD. Michael Stout, M.D., 50, has served as Vice President of Medical Affairs of the Company since 1985. He is Board Certified in Emergency Medicine and is a member of the American College of Emergency Physicians and the Columbia Medical Society. Dr. Stout is also a member of the American College of Physician Executives.\nJitendra S. Mehta, 44, has served as Vice President of Operations for the Company since November 1993. Mr. Mehta has an extensive background in hospital and medical personnel administration. He served as Business Director of Multispecialty Clinic in Maryland from 1985 to 1989 and served as Vice President and Partner of Citrus Diagnostic Center from 1990 to 1993. Mr. Mehta is currently a member of American Registry for Radiological Technology and the Nuclear Medicine Technologist Certification Board.\nSection 16(a) of the Securities and Exchange Act of 1934 requires the Company's directors and officers to file reports of holdings and transactions in the Company's common stock with the Securities and Exchange Commission (\"SEC\"). Based on Company records and other information, the Company believes that all SEC filing requirements applicable to its directors and officers were complied with in respect to the Company's fiscal year ending September 30, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nCompensation of Directors\nDirectors are paid a fee of $500 for attendance at each meeting of the Board of Directors. Directors of the Company are reimbursed by the Company for all out-of-pocket expenses reasonably incurred by them in the discharge of their duties as directors, including out-of-pocket expenses incurred in attending meetings of the Board of Directors.\nCompensation of Officers\nDuring each of the Company's three prior fiscal years, M.F. McFarland, III, M.D., the Company's Chief Executive Officer and President, and D. Michael Stout, M.D., the Company's Vice President of Medical Affairs, served without compensation from UCI-SC for their services in the executive offices they have held with the Company during such periods. No other executive officer of the Company earned compensation in excess of $100,000 for services provided to the Company in any of the Company's three prior fiscal years.\nDuring each of the Company's three prior fiscal years, Dr. McFarland and Dr. Stout have received compensation for the services they performed for the P.A. For services performed for the P.A. during each of the Company's fiscal years ended September 30, 1995, 1994 and 1993, Dr. McFarland was paid aggregate compensation, including bonuses, of $362,046, $343,500 and $253,603, respectively. For services performed for the P.A. during each of the Company's fiscal years ended September 30, 1995, 1994 and 1993, Dr. Stout was paid aggregate compensation, including bonuses, of $189,600, $180,394 and $169,665, respectively. See \"Certain Transactions - Agreements with Doctor's Care.\"\nEffective October 1, 1995 and November 1, 1995, Dr. McFarland and Dr. Stout, respectively, entered into new employment contracts with both the Company and the P.A., with the following terms:\nDr. McFarland: Effective October 1, 1995, Dr. McFarland entered into a five (5) year contract with UCI-SC that provides for annual compensation of $157,500, the use of one automobile, and an incentive bonus payable at the end of the Company's fiscal year subject to the Board of Directors' determination and based upon net income and gross revenue of the Company for the same year. Also, effective October 1, 1995, Dr. McFarland entered into a five (5) year contract with the P.A. that provides for annual compensation of $157,500.\nDr. Stout: Effective November 1, 1995, Dr. Stout entered into a five (5) year contract with UCI-SC that provides for annual compensation of $50,000. Also, effective November 1, 1995, Dr. Stout entered into a five (5) year contract with the P.A. that provides for annual compensation of $160,000.\nExisting Stock Option Plans\nPursuant to the Company's Incentive Stock Option Plan adopted in 1994, (the \"1994 Plan\"), \"incentive stock options\", within the meaning of Section 422 of the Internal Revenue Code, may be granted to employees of the Company. The 1994 Plan provides for the granting of options for the purchase of 750,000 shares at 100% of the fair market value of the stock at the date of grant. Options granted under the 1994 Plan vest at a rate of 33% in each of the three years following the grant. Vested options become exercisable one year after the date of grant and can be exercised within ten years of the date of grant, subject to earlier termination upon cessation of employment. During the year ended September 30, 1995, no options were exercised. At September 30, 1995, there were stock options outstanding under the 1994 Plan for 242,000 shares, all of which were granted in the year ended September 30, 1995.\nThe Incentive Stock Option Plan adopted in 1984 (the \"1984 Plan\") expired under its terms in December 1993. During the year ended September 30, 1995, no options were exercised and 5,100 options expired. At September 30, 1995, there were stock options outstanding under the 1984 Plan for 15,500 shares at $.25 per share, all of which were exercisable.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth certain information known to the Company regarding the beneficial ownership of the common stock of the Company as of September 30, 1995. Information is presented for (i) shareholders owning more than five percent of the outstanding common stock, (ii) each director and executive officer of the Company, individually, and (iii) all directors and executive officers of the Company, as a group. Except as otherwise specified, each of the shareholders named in the table has indicated to the Company that such shareholder has sole voting and investment power with respect to all shares of common stock beneficially owned by that shareholder. Beneficial ownership reflected in the table below is determined in accordance with the rules and regulations of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock issuable upon the exercise of options currently exercisable or convertible, or exercisable or convertible within sixty days, are deemed outstanding for computing the percentage ownership of the person holding such options, but are not deemed outstanding for computing the percentage ownership of any other person.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nAgreements with Doctor's Care\nGeneral. All of the Company's operations are conducted through its wholly-owned subsidiary, UCI-SC, which operates a network of twenty-five freestanding primary care medical Centers located throughout South Carolina, all of which conduct business under the name \"Doctor's Care.\" In order to comply with prohibitions of providing medical care, all medical services at these medical facilities are provided by or under the supervision of Doctor's Care, P.A., a South Carolina professional association (the \"P.A.\").\nFacilities Agreement. Pursuant to a Facilities Agreement between UCI-SC and the P.A. (the \"Facilities Agreement\"), UCI-SC supplies to the P.A. the facilities, equipment and assets of the Centers, as well as such non-medical personnel as are reasonably required by the P.A. in the operation of the Centers. In exchange, the P.A. provides the necessary staffing for the performance of medical services at the Centers, including a physician to serve as Executive Medical Director having overall responsibility for the operations of the Centers. Pursuant to an employment agreement between M.F. McFarland, III, M.D., President and Chief Executive Officer of the Company (\"Dr. McFarland\") and the P.A., Dr. McFarland serves as Executive Medical Director of the Centers. In September 1994, the Facilities Agreement was renewed for an additional five year term. In January 1995, the Facilities Agreement was modified to provide UCI-SC with certain rights to terminate the Facilities Agreement (a) upon the death of Dr. McFarland, (b) upon Dr. McFarland ceasing to own, either directly or indirectly, a controlling interest in the P.A., or (c) upon Dr. McFarland becoming a \"disqualified person\" as defined by the South Carolina Business Corporation Act of 1988, as amended.\nRefund Agreement. Pursuant to a Facilities Fee Refund Agreement (the \"Refund Agreement\"), entered into among UCI-SC and the P.A., the P.A. was entitled to receive a refund of a portion of the fees payable to UCI-SC under the Facilities Agreement with respect to certain Centers. This agreement was terminated effective October 1, 1995. During the year ended September 30, 1995, UCI-SC accrued total refunds payable to the P.A. under the Refund Agreement of $177,000 and made payments of $200,000 against accumulated payables. During the year ended September 30, 1994, UCI-SC accrued total refunds payable to the P.A. under the Refund Agreement of $131,000 and made payments of $213,500 against accumulated payables. At September 30, 1995 and 1994, UCI-SC had a refund payable to the P.A. of approximately $276,000 and $299,000, respectively.\nFacility Leases\nUCI-SC leases seven Centers from Companion HealthCare Corporation under operating leases with fifteen year terms expiring in 2008, 2009 and 2010. Each of these leases has a five year renewal option, and a rent guarantee by the P.A. One of the leases has a purchase option allowing UCI-SC to purchase the facility at fair market value after February 1, 1995. Total lease payments made by UCI-SC under these leases during the Company's fiscal years ended September 30, 1995, 1994 and 1993 were $271,100, $205,901 and zero, respectively.\nSeveral of the Centers operated by UCI-SC are leased from entities owned or controlled by certain principal shareholders and\/or members of the Company's management. The Doctor's Care-Northeast Center is leased from a partnership in which Dr. McFarland is a general partner. The lease was renewed in October 1994 for a five year term. The lease has two five year renewal options and provides UCI-SC with an option to purchase the facility at its fair market value after October 1995. Total lease payments made by UCI-SC under the lease during the Company's fiscal years ended September 30, 1995, 1994 and 1993 were $45,600, $42,696 and $39,554, respectively, plus utilities and real estate taxes. During the year ended September 30, 1995, the Doctor's Care-Lexington and the Doctor's Care-Forest Acres Centers were leased from a general partnership in which Dr. McFarland and Dr. Stout are general partners. The Doctor's Care-Lexington lease was renewed in October 1994 for a five year term. In August 1995, the Doctor's Care-\nForest Acres facility was sold to an unrelated third party who leases it to the Company. The Doctor's Care-Lexington lease has a five year renewal option and provides UCI-SC with an option to purchase the property at its fair market value at any time during the lease term. Total lease payments made by UCI-SC under these two leases during the Company's fiscal years ended September 30, 1995, 1994 and 1993 were $90,000, $75,166 and $78,012, respectively, plus utilities and real estate taxes. The Doctor's Care-West Columbia and the Doctor's Care-Beltline Centers are leased from a general partnership in which Dr. McFarland and Dr. Stout are general partners. These two leases expire in October 1998 and provide for a five year renewal option. Total lease payments made by UCI-SC under these two leases during the Company's fiscal years ended September 30, 1995, 1994 and 1993 were $84,000, $87,000 and $78,000, respectively, plus utilities and real estate taxes. In connection with its agreement to lease these two Centers, UCI-SC guaranteed the lessor's mortgage debt relating to the two Centers. At September 30, 1995, 1994 and 1993, the outstanding balance of such debt was $382,697, $386,110 and $395,000, respectively. The Doctor's Care-West Wateree Center is leased directly from Dr. McFarland. Total lease payments made by UCI-SC under this lease during the Company's fiscal years ended September 30, 1995, 1994 and 1993, were $24,666, $23,333 and $21,522, respectively.\nOther Transactions with Related Companies\nBlue Cross Blue Shield of South Carolina (\"Blue Cross\") owns 100% of Companion HealthCare Corporation, which owns approximately 45% of the Company's outstanding common stock. During the Company's fiscal year ended September 30, 1994, UCI-SC purchased a new billing and accounts receivable system from Companion Technologies, Inc., a wholly-owned subsidiary of Blue Cross for an aggregate purchase price of $504,000. The terms of the purchase agreement are believed to have been no more or less favorable to UCI-SC than the terms that would have been obtainable through arm's-length negotiations with unrelated third parties for a similar billing and accounts receivable system, which includes computer equipment. The Company has the option to purchase the equipment at the end of the five year lease term for $1. The lease obligation recorded at September 30, 1995 is $464,361 which includes lease addenda.\nDuring the Company's fiscal year ended September 30, 1994, UCI-SC entered into an agreement with Company Property and Casualty Insurance Company, a wholly-owned subsidiary of Blue Cross, pursuant to which UCI-SC acts as the primary care provider for injured workers of firms carrying worker's compensation insurance through Companion Property and Casualty Insurance Company (\"CP&C\"). Additionally, during the Company's fiscal year ended September 30, 1995, UCI-SC entered into a financing arrangement with CP&C for the purchase of the Doctor's Care-Donaldson facility, which consists of a note payable in monthly installments of $4,546 (including 11% interest) from April 1, 1995 to March 1, 2010, collateralized by certain accounts receivable. The terms of the agreement with Companion Property and Casualty Insurance Company are believed to be no more or less favorable to UCI-SC than those that would have been obtainable through arm's-length negotiations with unrelated third parties for similar arrangements.\nDuring the Company's fiscal year ended September 30, 1994, UCI-SC began providing services for a health maintenance organization (\"HMO\") operated by Companion HealthCare Corporation, pursuant to which UCI-SC, through the P.A., acts as the designated primary care provider for members of the HMO who have selected the P.A. as their primary care provider. The terms of the agreement with Companion HealthCare Corporation are believed to be no more or less favorable to UCI-SC than those that would have been obtainable through arm's - -length negotiations with unrelated third parties for similar arrangements.\nThe employees of the Company are offered health, life, dental and disability coverage at group rates from Blue Cross and its subsidiaries. The group rates offered to the employees of the Company are believed to be no more or less favorable to the Company than those that would have been obtainable through arm's-length negotiations with unrelated third parties for similar services.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) Reference is made to the Index to Financial Statements on page 21 .\n(2) A listing of the exhibits to the Form 10-KSB is set forth on the Exhibit Index which immediately precedes such exhibits in this Form 10-KSB.\n(b) Reports on Form 8-K\nThe Company filed a Form 8-K during the quarter ended September 30, 1995, which reported the acquisition of Summit Medical of Greenville, South Carolina.\nThe Company filed a Form 8-K during July 1995 which reported a change in the Company's independent accountants from Scott & Holloway, LLP to Price Waterhouse LLP.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page(s) Reports of Independent Accountants ......................................22-23\nConsolidated Balance Sheets at September 30, 1995 and 1994 ............ 24\nConsolidated Statements of Operations for the three years\nended September 30, 1995 ................................... 25\nConsolidated Statements of Changes in Stockholder's Equity\nfor the three years ended September 30, 1995 ......................26\nConsolidated Statements of Cash Flows for the three years\nended September 30, 1995 ....................................... 27\nNotes to Consolidated Financial Statements ............................. 28-39\nAll other schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\nUCI MEDICAL AFFILIATES, INC.\nCONSOLIDATED FINANCIAL STATEMENTS\nSEPTEMBER 30, 1995 AND 1994\nReport of Independent Accountants\nNovember 21, 1995\nTo the Board of Directors and Stockholders of UCI Medical Affiliates, 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 UCI Medical Affiliates, Inc. 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. These 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 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. The financial statements of UCI Medical Affiliates, Inc. at September 30, 1994 and for each of the two years in the period then ended were audited by other independent accountants whose report dated January 26, 1995 expressed an unqualified opinion on those statements with an explanatory paragraph that the Company prospectively changed its method of accounting for income taxes for the year ended September 30, 1994. This change is described in Notes 1 and 4 to the accompanying consolidated financial statements.\n\/s\/ Price Waterhouse LLP\nORIGINAL SIGNED OPINION ON PRICE WATERHOUSE LLP LETTERHEAD IS ON FILE WITH\nUCI MEDICAL AFFILIATES, INC.\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors UCI Medical Affiliates, Inc.\nWe have audited the accompanying balance sheet of UCI Medical Affiliates, Inc. as of September 30, 1994, and the related statements of income, retained earnings, and cash flows for each of the two years in the period then ended that appear in this annual report. These financial 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 UCI Medical Affiliates, Inc. as of September 30, 1994, and the results of its operations and its cash flows for each of the two years in the period then ended in conformity with generally accepted accounting principles.\n\/s\/ Moore Kirkland Scott & Beauston\nWest Columbia, South Carolina January 26, 1995\nORIGINAL SIGNED OPINION ON MOORE KIRKLAND SCOTT & BEAUSTON LETTERHEAD IS ON FILE WITH\nUCI MEDICAL AFFILIATES, INC.\nUCI Medical Affiliates, Inc.\nConsolidated Balance Sheets\nThe accompanying notes are an integral part of these consolidated financial statements.\nUCI Medical Affiliates, Inc.\nConsolidated Statements of Operations\nThe accompanying notes are an integral part of these consolidated financial statements.\nUCI Medical Affiliates, Inc.\nConsolidated Statements of Changes in Stockholders' Equity\nThe accompanying notes are an integral part of these consolidated financial statements.\nUCI Medical Affiliates, Inc.\nConsolidated Statements of Cash Flows\nThe accompanying notes are an integral part of these consolidated financial statements.\nUCI Medical Affiliates, Inc. Notes To Consolidated Financial Statements\nSeptember 30, 1995\n1. Significant Accounting Policies\nBasis of Presentation\nThe consolidated financial statements of UCI Medical Affiliates, Inc. include the accounts of UCI Medical Affiliates, Inc. (\"UCI\"), its wholly owned subsidiary, UCI Medical Affiliates of SC (\"UCI-SC\") and Doctor's Care, PA (\"the P.A.\"), collectively the \"Company\". The financial statements of the P.A. are consolidated with UCI because UCI-SC has unilateral control over the assets and operations of the P.A. and, notwithstanding the lack of technical majority ownership, consolidation of the P.A. with UCI is necessary to present fairly the financial position and results of operations of UCI. UCI-SC provides non-medical management and administrative functions for 25 medical clinics, operating as Doctor's Care (the \"Centers\"). All medical services at the Centers are provided by or under the supervision of the P.A., which has contracted with UCI-SC to provide the medical direction of the Centers. The medical directors operate the Centers under the financial and operational control of UCI-SC. However, medical supervision of the centers is provided solely by the P.A. The P.A. remits to UCI-SC all medical service revenues generated by the Centers, net of expenses incurred by the P.A. This compensation is recorded in the accompanying financial statements as revenue. Control of the P.A. is perpetual and other than temporary because of the nature of this relationship and the management agreements between the entities. The net assets of the P.A. are not material for any period presented and intercompany accounts and transactions have been eliminated.\nMedical Supplies Inventory\nThe inventory of medical supplies and drugs is carried at the lower of average cost or market.\nProperty and Equipment\nDepreciation is provided principally by the straight-line method over the estimated useful lives of the assets, ranging from three to twenty years.\nMaintenance, repairs and minor renewals are charged to expense. Major renewals or betterments, which prolong the life of the assets, are capitalized.\n1. Significant Accounting Policies (continued)\nUpon disposal of depreciable property, the asset accounts are reduced by the related cost and accumulated depreciation. The resulting gains and losses are reflected in the consolidated statements of operations.\nIntangible Assets\nThe excess of cost over fair value of assets acquired (goodwill) is amortized on the straight-line method over periods from 15 to 30 years. Subsequent to an acquisition, the Company continually evaluates whether later events and circumstances have occurred that indicate that the remaining balance of goodwill may not be recoverable or that the remaining useful life may warrant revision. When external factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related business segment's discounted cash flows over the remaining life of the goodwill and compares it to the business segment's goodwill balance to determine whether the goodwill is recoverable or if impairment exists, in which case an adjustment is made to the carrying value of the asset.\nRevenue Recognition\nRevenue is recognized at estimated net amounts to be received from employers, third party payors, and others at the time the related services are rendered. Capitation payments from payors are paid monthly and are recognized as revenue during the period in which enrollees are entitled to receive services.\nEarnings Per Share\nThe computation of income per common and common equivalent share is based on the weighted average number of common shares outstanding during the period plus (in periods in which they have a dilutive effect) the effect of common shares issuable from stock options, using the treasury stock method.\nIncome Taxes\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), as of October 1, 1993. Under the liability method specified by SFAS 109, deferred tax assets and liabilities are based on the difference between the financial statement and tax bases 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 (benefit) provision is the result of the net change in the deferred tax assets to amounts expected to be realized. Financial statements for the year ended September 30,1993 reflect income taxes recorded under the deferred method required under previous accounting standards.\n1. Significant Accounting Policies (continued)\nCash and Cash Equivalents\nThe Company considers all short-term deposits with a maturity of three months or less at acquisition date to be cash equivalents.\nReclassifications\nCertain 1994 and 1993 amounts have been reclassified to conform with the 1995 presentation.\n2. Property and Equipment\nProperty and equipment consists of the following at September 30:\nAt September 30, 1995 and 1994, capitalized leased equipment included above amounted to approximately $1,651,000 and $647,000, net of accumulated amortization of $203,000 and $18,000, respectively. Depreciation and amortization expense equalled $384,638, $196,756 and $114,949 for the years ended September 30, 1995, 1994 and 1993, respectively.\n3. Business Combinations\nIn August 1995, the Company acquired the net assets of Summit Medical and entered into an employment agreement with the physician owner of Summit Medical. The acquisition has been accounted for as a purchase, and the financial activity of Summit Medical has been included in the accompanying consolidated financial statements since the date of the acquisition.\n3. Business Combinations (continued)\nThe pro forma results listed below are unaudited and reflect purchase price accounting adjustments assuming the acquisition occurred at the beginning of each fiscal year presented.\n1995 1994 ------------------ --------------\nRevenue $ 18,393,000 $ 13,082,000\nNet Income (loss) $ (1,358,624) $ 645,875\nNet income (loss) per common and common equivalent share $ (.43) $ .28\nCertain other acquisition during fiscal year 1995 have not been included in this pro forma disclosure as the relevant information is not readily available. (Refer to note 12 for additional information provided on these acquisitions.)\n4. Income Taxes\nEffective October 1, 1993, the Company prospectively adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). As permitted under SFAS 109, prior years' financial statements have not been restated. As of October 1, 1993, the Company had a net deferred tax asset of $2,718,407, which was fully offset by a valuation allowance.\nThe components of the (benefit) provision for income taxes for the years ended September 30 are as follows:\n1995 1994 1993 ---------------------- ----------------- ---------------- Current:\nFederal $ -- $ -- $ 16,694 State -- -- 2,584 ---------------------- ----------------- -------------\n-- -- 19,278 ---------------------- ----------------- ------------- Deferred: -- Federal -- (530,120) 103,005 State -- (82,062) 15,945 ---------------------- ----------------- ------------- -- (612,182) 118,950 ---------------------- ----------------- ------------- Total (benefit) provision before extraordinary credit -- (612,182) 138,228 Extraordinary credit -- -- (138,228) ---------------------- ---------------- --------------\nTotal income tax benefit $ $ (612,182) $ -- ====================== ================= ============\n4. Income Taxes (continued)\nDeferred taxes result from temporary differences in the recognition of certain items of income and expense, and the changes in the valuation allowance attributable to deferred tax assets.\nThe principal sources of temporary differences and the related deferred tax effects as of September 30, were as follows:\n1995 1994 ------------- ------------ Allowance for doubtful accounts $ (169,043) $ (155,852)\nRelated party accruals 7,673 46,812\nOperating loss carryforwards 687,242 95,183\nAccumulated depreciation (58,324) 69,650 ------------- --------------\n467,548 55,793 Changes in valuation allowance (467,548) (667,975) ============= ============== $ -- $ (612,182) ============= ==============\nThe sources of significant timing differences for the year ended September 30, 1993 which gave rise to deferred taxes and their effects were as follows:\n------------------- Allowance for doubtful accounts $ 137,686 Related party accruals (20,480) Other 1,744 ------------------- $ 118,950 ===================\nAt September 30, 1995 and 1994, the Company's deferred tax assets (liabilities) and the related valuation allowances are as follows:\n1995 1994 ----------- ----------- Allowance for doubtful accounts $ $ 396,122\nRelated party accruals 227,079 95,421\nOperating loss carryforwards 103,094 2,248,121\nAccumulated depreciation 2,935,363\n(135,374) (77,050) ----------- ----------- $ 3,130,162 $ 2,662,614 =========== ===========\nValuation allowance $ 2,517,980 $ 2,050,432 =========== ===========\n4. Income Taxes (continued)\nThe principal reasons for the differences between the consolidated income tax benefit (expense) and the amount computed by applying the statutory federal income tax rate of 34% were as follows for the years ended September 30:\nAt September 30, 1995, the Company has net tax operating loss (NOL) carryforwards expiring in the following years ending September 30,\n2000 $ 1,347,851 2001 1,783,595 2002 1,802,220 2003 458,112 2005 470,006 2006 76,306 2010 1,931,517 --------------------- $ 7,869,607 =====================\nUnder certain circumstances, a significant change in the Company's ownership could severely limit utilization of the net operating loss carryforwards.\nThe Company has $7,800 and $8,450 of investment tax credit carryforwards which expire in 1999 and 2000, respectively.\n5. Long-Term Debt\nLong-term debt consists of the following at September 30:\n5. Long-Term Debt (continued)\nAggregate maturities of notes payable and capital leases in each of the five years 1996 through 2000 are as follows:\nYear ending September 30: Notes Payable Capital Leases Total ------------------- ------------------ ----------------- 1996 $ 878,399 $ 366,204 $ 1,244,603 1997 310,255 349,395 659,650 1998 145,207 340,483 485,690 1999 154,808 250,637 405,445 2000 141,678 67,862 209,540 Thereafter 1,351,182 9,591 1,360,773 =================== ================== ================= $ 2,981,529 $ 1,384,172 $ 4,365,701 =================== ================== =================\n6. Employee Benefit Plans\nPursuant to the Company's incentive stock option plan adopted in 1994, (the \"1994 Plan\"), \"incentive stock options\", within the meaning of Section 422 of the Internal Revenue Code, may be granted to employees of the Company. The 1994 Plan provides for the granting of options for the purchase of 750,000 shares at 100% of the fair market value of the stock at the date of grant. Options granted under the 1994 Plan vest at a rate of 33% in each of the three years following the grant. Vested options become exercisable one year after the date of grant and can be exercised within ten years of the date of grant, subject to earlier termination upon cessation of employment. During the year ending September 30, 1995, no options were exercised. At September 30, 1995, there were stock options outstanding under the 1994 plan for 242,000 shares, all of which were granted in the year ended September 30,1995.\nThe incentive stock option plan adopted in 1984 (the \"1984 Plan\") expired under its terms in December 1993. During the year ending September 30, 1995, no options were exercised and 5,100 options expired. At September 30, 1995, there were stock options outstanding under the 1984 Plan for 15,500 shares at $.25 per share, all of which were exercisable.\nThe Company has an employee savings plan ( the \"Savings Plan\") that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, participating employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. Effective in June 1995, the Company discontinued its matching contribution. Prior to that date, the company matched 50% of each employee's contributions up to a maximum of 2.5% of the employee's earnings. The company's matching contributions were $71,463, $50,805 and $35,788 in fiscal years 1995, 1994, and 1993, respectively.\n7. Stockholders' Equity\nOn June 30, 1994, the Company's shareholders approved an amendment to, and a restatement of, the Restated Certificate of Incorporation to provide for a 1 for 5 reverse stock split. The Amended and Restated Certificate of Incorporation increased the number of authorized shares of common stock from 4,000,000 to 10,000,000 ( as adjusted for the reverse stock split as discussed above) and increased the par value per share of common stock from one cent ($.01) to five cents ($.05). In addition, the Amended and Restated Certificate of Incorporation authorized the Company to issue up to 10,000,000 shares of $.01 par value preferred stock to be issued in one or more series. The Board of Directors is authorized, without further action by the stockholders, to designate the rights, preferences, limitations and restrictions of and upon shares of each series, including dividend voting, redemption and conversion rights. All references in the financial statements to average number of shares outstanding and related prices, per share amounts, common stock and stock option plan data have been restated to reflect the split .\nAt September 30, 1995, 257,500 shares of common stock were reserved for issuance under the Company's incentive stock option plans.\n8. Lease Commitments\nUCI-SC leases office and medical center space under various operating lease agreements. Certain operating leases provide for escalation payments, exclusive of renewal options.\nFuture minimum lease payments under noncancellable operating leases with a remaining term in excess of one year as of September 30, 1995, are as follows:\nOperating Leases Year ending September 30: 1996 $ 1,053,794 1997 1,029,697 1998 1,020,409 1999 900,476 2000 742,169 Thereafter 5,420,154 ----------------- Total minimum lease payments $ 10,166,699 ===================\nTotal rental expense under operating leases for 1995, 1994 and 1993 was approximately $923,000, $714,000, and $775,000, respectively.\n9. Related Party Transactions\nFacility Leases\nUCI-SC leases seven medical centers from Companion HealthCare Corporation under operating leases with fifteen year terms expiring in 2008, 2009 and 2010. At September 30,1995, Companion owned 1,460,991 shares or approximately 42% of the Company's outstanding common stock. Each of these leases has a five year renewal option, and a rent guarantee by Doctor's Care. One of the leases has a purchase option allowing UCI-SC to purchase the center at fair market value after February 1, 1995. Total lease payments made by UCI-SC under these leases during the Company's fiscal years ended September 30, 1995,1994, and 1993 were $271,100, $205,901, and zero, respectively.\n9. Related Party Transactions (continued)\nSeveral of the medical centers operated by UCI-SC are leased from entities owned or controlled by certain principal shareholders and\/or members of the Company's management. Total lease payments made by UCI-SC under these leases during the fiscal years ended September 30,1995, 1994 and 1993 were $244,300, $228,200 and $217,100, respectively.\nOther Transactions with Related Companies\nOn December 10, 1993, Companion HealthCare Corporation (\"Companion\") acquired 333,333 shares of the Company's common stock for $500,000. On June 8, 1994, Companion purchased an additional 333,333 shares for $1,000,000. On January 16, 1995, Companion purchased 470,588 shares for $1,000,000, and on May 24, 1995, Companion purchased 117,647 shares for $250,000. Including shares purchased by Companion from third parties, at September 30, 1995, Companion owned 1,460,991 shares, or approximately 42% of the Company's outstanding Common Stock. Companion purchased additional shares in November 1995, as discussed in note 12. The shares acquired by Companion from the Company were purchased pursuant to stock purchase agreements and were not registered. Companion has the right to require registration of the stock under certain circumstances as described in the agreement.\nBlue Cross Blue Shield of South Carolina (\"Blue Cross\") owns 100% of Companion HealthCare Corporation. During the Company's fiscal year ended September 30, 1994, UCI-SC purchased a new billing and accounts receivable system from Companion Technologies, Inc., a wholly-owned subsidiary of Blue Cross for an aggregate purchase price of $504,000. The Company entered into a capital lease agreement for this system, which includes computer equipment. The Company has the option to purchase the equipment at the end of the five year lease term for $1. The lease obligation recorded at September 30, 1995 is $464,361, which includes lease addendums.\nDuring the Company's fiscal year ended September 30, 1994, UCI-SC entered into an agreement with Companion Property and Casualty Insurance Company (\"CP&C\"), a wholly-owned subsidiary of Blue Cross, pursuant to which UCI-SC acts as the primary care provider for injured workers of firms carrying worker's compensation insurance through CP&C. Additionally, during the Company's fiscal year ended September 30, 1995, UCI-SC entered into a financing arrangement with CP&C for the purchase of the Doctor's Care - Donaldson facility, which consists of a note payable in monthly installments of $4,546 (including 11% interest) from April 1, 1995 to March 1, 2010, collateralized by certain accounts receivable.\nDuring the Company's fiscal year ended September 30, 1994, UCI-SC began providing services for a health maintenance organization (\"HMO\") operated by Companion HealthCare Corporation, pursuant to which UCI-SC, through Doctor's Care, acts as the designated primary care provider for members of the HMO who have selected Doctor's Care as their primary care provider.\nThe employees of the Company are offered health, life, dental and disability coverage at group rates from Blue Cross and its subsidiaries.\n10. Concentration of Credit Risk\nIn the normal course of providing health care services, the Company may extend credit to patients without requiring collateral. Each individual's ability to pay balances due the Company is assessed and reserves are established to provide for management's estimate of uncollectible balances.\nFuture revenues of the Company are largely dependent on third-party payors and private insurance companies, especially in instances where the Company accepts assignment.\n11. Commitments and Contingencies\nIn the ordinary course of conducting its business, the Company becomes involved in litigation, claims, and administrative proceedings. Certain litigation, claims, and proceedings were pending at September 30, 1995, and management intends to vigorously defend the Company in such matters. While the ultimate results cannot be predicted with certainty, management does not expect these matters to have a material adverse effect on the financial position or results of operations of the Company.\n12. Supplemental Cash Flow Information\nSupplemental Disclosure of Cash Flow Information\nThe Company made interest payments of $448,311, $147,208, and $53,507 for the years ended September 30, 1995, 1994, and 1993, respectively. There were no amounts paid for income taxes during the three years ended September 30, 1995.\nSupplemental Non-Cash Operating Activities\nIn July 1995, the Company paid for certain corporate expenses through an issuance of 6,000 shares of common stock of the Company in the amount of $16,500, of which $4,125 was expensed and the remainder classified as prepaid expenses.\nSupplemental Non-Cash Financing Activities\nCapital lease obligations of $1,069,915 and $683,119 were incurred in 1995 and 1994. Additionally, in February 1995, the Company acquired property which was financed through a note payable in the amount of $400,000.\nSupplemental Non-Cash Investing Activities\nIn February 1993, the Company acquired a medical facility in Surfside Beach, South Carolina for $1,697,000 including $50,000 in cash, a $1,600,000 note payable to the seller and the assumption of approximately $47,000 of trade accounts payable. Also, as part of the transaction the Company acquired a condominium for $250,000, which was financed by the seller.\nIn February 1994, the Company entered into a management agreement with an orthopedic practice and purchased the practice's accounts receivable and inventory for $56,873 and $15,000, respectively with a note payable to the seller.\nIn January 1995, the Company acquired certain assets of a medical practice in West Columbia, South Carolina for $291,000, consisting of 145,500 shares of common stock of the Company.\nIn May 1995, the Company acquired a medical practice in Cayce, South Carolina for $150,000, consisting of 46,153 shares of common stock of the Company.\nIn August 1995, the Company acquired certain assets of a medical practice in Greenville, South Carolina for $662,500, by financing $350,000 with the seller, and issuing 100,000 shares of common stock of the Company.\n13. Subsequent Events\nIn January 1995, the Company entered into an acquisition agreement for a medical practice in Myrtle Beach, South Carolina. The acquisition is expected to become effective prior to December 31, 1995, after certain conditions precedent occur.\nOn November 3, 1995, Companion purchased 218,180 shares of newly issued common stock of the Company for $2.75 a share, or $599,995. Subsequent to the transaction, Companion's ownership in the Company was approximately 45%. Companion has the option to purchase as many shares as may be necessary for Companion to maintain ownership of 47% of the outstanding common stock of the Company in the event that the Company issues additional stock to other parties (excluding shares issued to employees or directors of the Company).\nOn December 1, 1995, the Company acquired a medical practice in Greenville, South Carolina for $300,000. The Company entered into an employment agreement with the physician who had been the sole shareholder of the acquired medical practice. The Company also entered into lease agreements for the facility occupied by and the computer system used by the acquired medical practice.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUCI MEDICAL AFFILIATES, INC.\nDate: December 27, 1995 By: \/s\/ M. F. McFarland M.F. McFarland, III, M.D.\nChief Executive Officer\nBy: \/s\/ Jerry F. Wells, Jr. Jerry F. Wells, Jr. 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.\nDate: December 27, 1995 By: \/s\/ M.F. McFarland M.F. McFarland, III, M.D. Chairman of the Board\nBy: \/s\/ Harold H. Adams, Jr. Harold H. Adams, Jr. Director\nBy: \/s\/ Charles P. Cannon Charles P. Cannon Director\nBy: \/s\/ Russell J. Froneberger Russell J. Froneberger Director\nBy: \/s\/ Charles M. Potok Charles M. Potok Director\nUCI MEDICAL AFFILIATES, INC.\nEXHIBIT INDEX\nPAGE NUMBER OR\nEXHIBIT INCORPORATION BY NO. DESCRIPTION REFERENCE TO\n3.1 Amended and Restated Certificate of Incorporation .. 42\n3.2 Amended and Restated Bylaws ...................... 51\n10.1 Facilities Agreement .................................... 61 10.2 Facilities Fee Refund Agreement .................... 66\n10.3 Amendments to the Facilities Agreement and the Facilities Fee Refund Agreement ................ 68\n10.4 Employment Agreement Between\nUCI Medical Affiliates of South Carolina, Inc. and\nM.F. McFarland, III, M.D. ............................ 72\n10.5 Employment Agreement Between\nDoctor's Care, P.A. and M.F. McFarland, III, M.D. .. 80\n10.6 Employment Agreement Between\nUCI Medical Affiliates of South Carolina, Inc. and\nD. Michael Stout, M.D. ................. 87\n10.7 Employment Agreement Between\nDoctor's Care, P.A. and D. Michael Stout, M.D. ..... 93\n10.8 Lease and License Agreement with\nCompanion Technologies .......................... 102\n10.9 UCI Medical Affiliates, Inc.\n1994 Incentive Stock Option Plan ............... 112\n10.10 Consent of Independent Accountants ................ 120\n21 Subsidiaries of the Registrant ........... 122","section_15":""}
{"filename":"818089_1995.txt","cik":"818089","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3 Legal Proceedings 15 Item 4","section_4":"Item 4 Submission of Matters to a Vote of Security Holders 15\nPART II\nItem 5","section_5":"Item 5 Market for the Registrant's Limited Partnership Interests and Related Partner Matters 16 Item 6","section_6":"Item 6 Selected Financial Data 17 Item 7","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations - ---------------------\nThe occupancy levels at the Partnership properties as of December 31 were as follows:\nPercentage Ownership at 12\/31\/95 1995 1994 1993 -------- ---- ---- ----\nWholly-owned Property - ---------------------\nLakeshore Business Center Phase II N\/A See (1) below (1) 78% 75%\nProperty owned in Joint Venture with NTS-Properties V - ---------------------\nUniversity Business Center Phase II N\/A See (1) below (1) 100% 100%\nProperty owned in Joint Venture with NTS-Properties IV and NTS- Properties VII, Ltd. - --------------------\nBlankenbaker Business Center 1A 39% 100% 100% 100%\nProperties owned through Lakeshore\/University II Joint Venture (L\/U II Joint Venture) - ------------------------------\nLakeshore Business Center Phase I 12% 92% 80% 58% (2) (2)\nLakeshore Business Center Phase II 12% 72% See See above above (1) (1)\nUniversity Business Center Phase II 12% 100% See See above above (1) (1)\n(1) During the first quarter of 1995, the Partnership's ownership interest in the property changed. See pages 20 and 21 for a discussion regarding this change. (2) As of December 31, 1994 and 1993, the Partnership did not have an interest in this property. See pages 20 and 21 for a discussion regarding this change.\n- 18 -\nResults of Operations - Continued - ---------------------------------\nThe rental and other income generated by the Partnership's properties for the years ended December 31, 1995, 1994 and 1993 were as follows:\nPercentage Ownership at 12\/31\/95 1995 1994 1993 ----------- ---------- ----------- -----------\nWholly-owned Property - ---------------------\nLakeshore Business Center Phase II N\/A $ 98,182 $1,259,257 $1,221,550 (1)\nProperty owned in Joint Venture with NTS- Properties V - ------------\nUniversity Business Center II N\/A $ 82,183 $ 959,948 $ 964,826 (1)\nProperty owned in Joint Venture with NTS- Properties IV and NTS- Properties VII, Ltd. - --------------------\nBlankenbaker Business Center 1A 39% $ 363,172 $ 497,566 $ 564,649\nProperties owned through Lakeshore\/University II Joint Venture (L\/U II Joint Venture - -------------\nLakeshore Business Center Phase I 12% $ 135,055 N\/A (2) N\/A (2)\nLakeshore Business Center Phase II 12% $ 135,324 N\/A (3) N\/A (3)\nUniversity Business Center Phase II 12% $ 139,477 N\/A (3) N\/A (3)\nRevenues shown in the table above for properties owned through a joint venture represent only the Partnership's percentage interest in those revenues.\n(1) During the first quarter of 1995, the Partnership's ownership interest in the property changed. The Partnership's proportionate share of rental and other income from January 23, 1995 to December 31, 1995 is reflected below (see L\/U II Joint Venture). See pages 20 and 21 for a discussion regarding this change. (2) During 1994 and 1993, the Partnership did not have an interest in this property. See pages 20 and 21 for a discussion regarding the change which occurred during the first quarter of 1995. (3) During the first quarter of 1995, the Partnership's ownership interest in this property changed. Rental and other income for 1994 and 1993 is reflected above. See pages 20 and 21 for a discussion regarding this change.\n- 19 -\nResults of Operations - Continued - ---------------------------------\nOn August 16, 1994, Blankenbaker Business Center Joint Venture amended its joint venture agreement to admit NTS-Properties IV to the Joint Venture. In accordance with the Joint Venture Agreement, NTS-Properties IV contributed $1,100,000 and NTS-Properties VII, Ltd. contributed $500,000. Additional capital was needed by the Blankenbaker Business Center Joint Venture to fund the tenant finish and leasing costs connected with the project discussed in the following paragraph. However, the Partnership was not in a position to contribute additional capital, nor was NTS-Properties VII, Ltd. in a position to contribute all of the capital required for the project. NTS-Properties IV was willing to participate in the Joint Venture and to contribute, together with NTS-Properties VII, Ltd., the capital necessary with respect to the project. The general partner of the Partnership agreed to this admission of NTS-Properties IV to the Joint Venture, and to the capital contributions by NTS-Properties IV and NTS- Properties VII, Ltd. with the knowledge that the Partnership's joint venture interest would, as a result, decrease.\nThe need for additional capital by the Joint Venture was a result of the lease renewal and expansion which was signed April 28, 1994 between the Joint Venture and Prudential Service Bureau, Inc. (\"Prudential\"). The lease was a result of winning a competitive request for proposals issued by Prudential as it approached a decision regarding where it would locate its expanding Louisville operations following the expiration of its lease at Blankenbaker Business Center 1A. To meet the needs of the tenant, the lease expanded Prudential's leased space by approximately 15,000 square feet and extended its current lease term through July 2005. Approximately 12,000 square feet of the expansion was into new space which had to be constructed on the second level of the existing business center. With this expansion, Prudential now occupies 100% of the business center (approximately 101,000 square feet). The tenant finish and leasing costs connected with the lease renewal and expansion were approximately $1.4 million.\nIn order to calculate the revised joint venture percentage interests, the assets of the Joint Venture were revalued in connection with the admission of NTS-Properties IV as a joint venture partner and the additional capital contributions. The value of the Joint Venture's assets immediately prior to the additional capital contributions was $6,764,322 and its outstanding debt was $4,650,042, with net equity being $2,114,280. The difference between the value of the Joint Venture's assets and the value at which they were carried on the books of the Joint Venture was allocated to the Partnership and NTS-Properties VII, Ltd. in determining each Joint Venture partner's percentage interest.\nThe Partnership's interest in the Joint Venture decreased from 69% to 39% as a result of the capital contributions by NTS-Properties IV and NTS- Properties VII, Ltd. The respective percentage interests of NTS-Properties IV and NTS-Properties VII, Ltd. in the Joint Venture subsequent to these capital contributions are 30% and 31%.\nOn January 23, 1995, a new joint venture known as Lakeshore\/University II Joint Venture (L\/U II Joint Venture) was formed among the Partnership, NTS- Properties IV, NTS-Properties V and NTS\/Fort Lauderdale, Ltd., affiliates of the general partner of the Partnership, for purposes of owning Lakeshore Business Center Phases I and II, University Business Center Phase II and certain undeveloped tracts adjacent to the Lakeshore Business Center Development.\n- 20 -\nResults of Operations - Continued - ---------------------------------\nThe table below identifies which properties were contributed to the L\/U II Joint Venture and the respective owners of such properties prior to the formation of the joint venture.\nProperty Owner -------- -----\nLakeshore Business Center Phase I NTS-Properties IV and NTS- Properties V\nLakeshore Business Center Phase II NTS-Properties Plus Ltd.\nUndeveloped land adjacent to the NTS-Properties Plus Ltd. Lakeshore Business Center development (3.8 acres)\nUndeveloped land adjacent to the NTS\/Fort Lauderdale, Ltd. Lakeshore Business Center development (2.4 acres)\nUniversity Business Center Phase II NTS-Properties V and NTS-Properties Plus Ltd.\nEach of the properties were contributed to the L\/U II Joint Venture subject to existing indebtedness, except for Lakeshore Business Center Phase I which was contributed to the joint venture free and clear of any mortgage liens, and all such indebtedness was assumed by the joint venture. Mortgages have been recorded on Lakeshore Business Center Phase I in the amount of $5,500,000, and on University Business Center Phase II in the amount of $3,000,000, in favor of the banks which held the indebtedness on University Business Center Phase II, Lakeshore Business Center Phase II and the undeveloped tracts prior to the formation of the joint venture. In addition to the above, NTS-Properties IV contributed $750,000 to the L\/U II Joint Venture. As a result of the valuation of the properties contributed to the L\/U II Joint Venture, the Partnership obtained a 12% partnership interest in the joint venture.\nThe general partner of the Partnership believes that the results of operations for 1995 and 1994 are not comparable and therefore, a discussion comparing the results of operations for these periods is not included due to the fact that the Partnership's ownership interest in the Blankenbaker Business Center Joint Venture changed from 69% to 39% on August 16, 1994 as a result of capital contributions made by affiliates of the general partner of the Partnership (as discussed on page 19). Comparisons of the results of operations between 1995 and 1994 are also difficult because of the Partnership's investment in the L\/U II Joint Venture (as discussed above). These changes in the Partnership's investments are permanent changes and will effect future results of operations.\nDiscussions regarding the change in occupancy levels from 1994 to 1995 and from 1993 to 1994 along with a discussion comparing the results of operations from 1994 to 1993 follows.\nThe 6% decrease in year-ending occupancy at Lakeshore Business Center Phase II from 1994 to 1995 can be attributed to four tenant move-outs totalling approximately 9,600 square feet and a downsizing by a current tenant of its existing space of approximately 6,000 square feet. Two of the move-outs, totalling approximately 5,800 square feet, represent tenants who vacated the premises at the end of the lease term. The third tenant, who occupied approximately 1,400 square feet, vacated the premises and ceased making rental payments in breach of the lease terms due to bankruptcy. The write-off of accrued income connected with this lease was not significant. The\n- 21 -\nResults of Operations - Continued - ---------------------------------\nfourth tenant, who occupied approximately 2,400 square feet, vacated the premises prior to the end of the lease term but is continuing to pay rent through the end of the lease term. Partially offsetting the tenant move- outs are six new leases for a total of approximately 9,700 square feet. Average occupancy at Lakeshore Business Center Phase II decreased from 78% (1994) to 76% (1995).\nSubsequent to December 31, 1995, a new six-year lease was signed at Lakeshore Business Center Phase II for approximately 7,000 square feet. The tenant is expected to take occupancy during the second quarter of 1996. With this new lease, the buildings occupancy will increase to 79%.\nLakeshore Business Center Phase II's year-ending occupancy increased 3% from 1993 to 1994. The increase in occupancy can be attributed to three new leases for a total of approximately 10,000 square feet, an expansion of approximately 1,900 square feet by a current tenant and the fact that the business center's leasing office was relocated from Lakeshore Business Center Phase I (previously owned by a joint venture between NTS-Properties IV and NTS-Properties V, affiliates of the general partner) to an approximately 1,200 square foot suite in Lakeshore Business Center Phase II. The increases in occupancy are partially offset by an approximately 4,700 square foot downsizing by a current tenant. In accordance with the lease agreement, the tenant paid the Partnership a total of approximately $48,500 during the second and third quarters of 1994 to compensate the Partnership for lost rents and undepreciated renovation costs (recorded as lease buyout income). The increases in occupancy are also partially offset by an approximately 2,300 square foot move-out by a tenant who vacated before the end of the lease term, but continued to make rental payments through the end of the lease term. There was no write-off of accrued income in connection with this lease. Additionally, the increases in occupancy are partially offset by an approximately 3,600 square foot move-out by a tenant who vacated and ceased making rental payments in breach of the lease agreement. Accrued income associated with this lease of approximately $17,000 was written off as uncollectible after it was determined that there was no possible collection. The accrued income which was written off is attributed to the straight-line method of accounting for rental income. Average occupancy at Lakeshore Business Center Phase II increased from 75% in 1993 to 78% in 1994.\nRental and other income at Lakeshore Business Center Phase II increased from 1993 to 1994 as a result of the increase in average occupancy, a decrease in the provision for doubtful accounts, an increase in lease buyout income and an increase in common area expense reimbursements. Tenants reimburse the Partnership for common area expenses as a part of the lease agreement. The increase in rental and other income at Lakeshore Business Center Phase II from 1993 to 1994 is partially offset by the accrued income write-off of approximately $17,000 (as discussed above) and a decrease in rental rates.\nPhilip Crosby Associates, Inc. (\"PCA\") has leased 100% of University Business Center Phase II. The lease term is for seven years, and the tenant took occupancy in April 1991. The tenant has currently sub-leased approximately 50,000 square feet (or 64%) of University Business Center Phase II. Of the total being sub-leased, approximately 41,000 square feet (or 52%) is being leased by Full Sail Recorders, Inc. (a major tenant at University Business Center Phase I). Prior to December 31, 1995, Full Sail Recorders, Inc. (\"Full Sail\") signed a 33 month lease with the L\/U II Joint Venture for the approximately 41,000 square feet it currently sub-leases from PCA. The lease term commences April 1998 when PCA's lease ends. As part of the lease negotiations, Full Sail will receive a $200,000 tenant finish allowance in 1996, of which approximately $92,000 will be reimbursed by Full Sail over a 27-month period beginning January 1996. At this time, it is not known whether Philip Crosby Associates, Inc. or the other sub- lessee will renew the current lease with the business center when the\n- 22 -\nResults of Operations - Continued - ---------------------------------\noriginal lease expires in 1998. In August 1990, the tenant paid an $80,000 security deposit which was to be returned three years from the date of occupancy. The security deposit plus interest was returned to Philip Crosby Associates, Inc. in April 1994.\nThe decrease in rental and other income at University Business Center Phase II from 1993 to 1994 is due to a decrease in common area expense reimbursements. The tenant reimburses the Partnership for common area expenses as a part of the lease agreement. The decrease in rental and other income at University Business Center Phase II from 1993 to 1994 is partially offset by a rent escalation which is based on changes in the consumer price index.\nA wholly-owned subsidiary of The Prudential Insurance Company of America (Prudential Service Bureau, Inc.) has leased 100% of Blankenbaker Business Center 1A. During 1994, Prudential Service Bureau, Inc. signed a lease renewal and expansion. The renewal extends the current lease through July 2005. With the expansion, the tenant occupied 100% of the business center during the third quarter of 1994. See page 20 for a further discussion of the lease renewal and expansion. In addition to monthly rent payments, Prudential Service Bureau, Inc. is obligated to pay substantially all of the operating expenses attributable to its space. Blankenbaker Business Center 1A's rental and other income decreased from 1993 to 1994 as a result of the Partnership's decreased ownership in the Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.)\nThe 12% increase in year-ending occupancy at Lakeshore Business Center Phase I from 1994 to 1995 can be attributed to 11 new leases, totalling approximately 19,000 square feet which includes approximately 6,400 square feet in expansions by two current tenants. The new leases and expansion are partially offset by four tenant move-outs, who vacated at the end of the lease terms, totalling approximately 6,100 square feet. Average occupancy increased from 70% (1994) to 84% (1995).\nDuring January 1996, Lakeshore Business Center Phase I's occupancy increased to 98% as a result of approximately 6,400 square feet of expansions by two current tenants.\nThe 22% increase in year-ending occupancy at Lakeshore Business Center Phase I from 1993 to 1994 can be attributed to 12 new leases totalling approximately 32,700 square feet which includes approximately 3,100 square feet in expansions by three current tenants. Included in the new leases is a five-year, approximately 9,400 square foot lease which commenced during the second quarter of 1994 and a five-year, approximately 6,400 square foot lease which commenced during the third quarter of 1994. The new leases and expansions are partially offset by an approximately 1,200 square foot downsizing by an existing tenant and four tenants, who occupied approximately 7,300 square feet, vacating at the end of the lease terms. In addition to the move-outs and downsizing, the business center's leasing office of approximately 1,500 square feet was relocated to Lakeshore Business Center Phase II. The leasing office was relocated in order to accommodate an approximately 9,400 square foot new lease. Average occupancy at Lakeshore Business Center Phase I increased from 56% (1993) to 70% (1994).\nIn cases of tenants who cease making rental payments or abandon the premises in breach of their lease, the Partnership pursues collection through the use of collection agencies and other remedies available by law when practical.\nInterest and other income includes interest earned from short-term investments made by the Partnership with excess cash. The increase in interest income from 1993 to 1994 is the result of an increase in cash available for investment.\n- 23 -\nResults of Operations - Continued - ---------------------------------\nOperating expenses increased from 1993 to 1994 as a result of increased exterior painting costs at University Business Center Phase II, increased snow removal costs at Blankenbaker Business Center 1A and increased repair and maintenance costs at Lakeshore Business Center Phase II and University Business Center Phase II. The increases in operating expenses are partially offset by decreased landscaping costs at Lakeshore Business Center Phase II and University Business Center Phase II. The increase in operating expenses from 1993 to 1994 is net of the decrease caused by the Partnership's decreased ownership in the Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.)\nOperating expenses - affiliated increased from 1993 to 1994 as a result of increased leasing costs. The increase in operating expenses - affiliated from 1993 to 1994 is net of the decrease caused by the Partnership's decreased ownership in the Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.) Operating expenses - affiliated are expenses incurred for services performed by employees of NTS Development Company, an affiliate of the General Partner of the Partnership.\nThe 1994 write-off of unamortized tenant improvements is primarily a result of the lease renewal and expansion of Prudential Service Bureau, Inc., the tenant which occupies 100% of Blankenbaker Business Center 1A. As a condition of the lease renewal and expansion, it was agreed that the area into which the tenant expanded would be renovated. Changes to current tenant improvements are a typical part of any lease negotiation. Improvements generally include a revision to the current floor plan to accommodate a tenant's needs, new carpeting and paint and\/or wallcovering. In order to complete the renovations, it is sometimes necessary to replace improvements which had not been fully depreciated. This results in a write-off of unamortized tenant improvements.\nThe 1993 write-off of unamortized tenant improvements is the result of an approximately 3,400 square foot lease renewal plus an additional 2,000 square foot expansion by a current tenant at Lakeshore Business Center Phase II.\nAmortization of capitalized leasing costs represents the amortization of various costs which were capitalized during the initial leasing and start-up period of University Business Center Phase II. The amortization of these costs commenced when Philip Crosby Associates, Inc. occupied the building in April 1991. Amortization of capitalized leasing costs was fairly constant from 1993 to 1994.\nThe increase in interest expense from 1993 to 1994 is a result of increases in the Prime Rate from 6% at December 31, 1993 to 8.5% at December 31, 1994. The increase in interest expense is also a result of interest incurred in 1994 due to the non-payment of the 1993 real estate taxes associated with University Business Center Phase II, Lakeshore Business Center Phase II and land adjacent to the Lakeshore Business Center development by the March 31, 1994 due date. The University Business Center Phase II's taxes plus interest were paid during the second quarter of 1994. The 1993 real estate taxes associated with Lakeshore Business Center Phase II and land adjacent to the Lakeshore Business Center development were paid subsequent to December 31, 1994. The increase in interest expense from 1993 to 1994 is net of the decrease caused by the Partnership's decreased ownership in the Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.) See the Liquidity and Capital Resources section of this item for details regarding the Partnership's debt.\n- 24 -\nResults of Operations - Continued - ---------------------------------\nManagement fees are calculated based on cash collections; however, revenue for reporting purposes is on the accrual basis. As a result, the fluctuations between periods are not consistent with the fluctuations of management fee expense.\nThe increase in real estate taxes from 1993 to 1994 is the result of additional taxes being expensed in 1994 for the 1993 taxes of University Business Center Phase II, Lakeshore Business Center Phase II and the land adjacent to the Lakeshore Business Center development. The Partnership was unable to take advantage of available discounts due to the cash requirements of the Partnership. Real estate taxes for Blankenbaker Business Center 1A remained fairly constant. The increase in real estate taxes from 1993 to 1994 is also due to an increase in the 1994 property tax assessment for University Business Center Phase II. The increase in real estate taxes from 1993 to 1994 is net of the decrease caused by the Partnership's decreased ownership in the Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.)\nThe decrease in professional and administrative expenses from 1993 to 1994 is due to a decrease in outside legal costs and loan fees. In 1993, loan fees were paid to extend the maturity date of the $9,240,000, $1,270,000 and $470,000 (balances as of December 31, 1994) notes payable from December 31, 1992 to February 17, 1993. There was no similar expense in 1994. The decrease in professional and administrative expenses from 1993 to 1994 is partially offset by the write-off of unamortized loan costs which were associated with the Blankenbaker Business Center Joint Venture's notes payable. The loan fees were expensed due to the fact that the notes were retired during 1994.\nProfessional and administrative expenses - affiliated remained fairly constant from 1993 to 1994. Professional and administrative expenses affiliated are expenses incurred for services performed by employees of NTS Development Company, an affiliate of the General Partner.\nThe decrease in depreciation and amortization from 1993 to 1994 is a result of a portion of organizational and start up costs having become fully amortized during the fourth quarter of 1993 and a portion of Lakeshore Business Center Phase II's tenant finish assets having become fully depreciated. These decreases are partially offset by depreciation on new tenant finish improvements at Blankenbaker Business Center 1A and Lakeshore Business Center Phase II and by the amortization of additional loan costs incurred in connection with extending the maturity dates of the Partnership's notes payable. The decrease in depreciation and amortization from 1993 to 1994 is net of the decrease caused by the Partnership's decreased ownership in Blankenbaker Business Center Joint Venture. (See page 20 for a discussion regarding the change in ownership.) Depreciation is computed using the straight-line method over the estimated useful lives of the assets which are 5 - 30 years for land improvements, 30 years for buildings, 5 - 30 years for building improvements and 5 - 30 years for amenities. The aggregate cost of the Partnership's properties for Federal tax purposes is approximately $6,900,000.\nCapital Resources and Liquidity - -------------------------------\nCash (used in) provided by operations was $(242,385) (1995), $402,028 (1994) and $640,167 (1993). The Partnership has not made any cash distributions since the quarter ended June 30, 1991. Distributions will be resumed once the Partnership has established adequate cash reserves and is generating cash from operations which, in management's opinion, is sufficient to warrant future distributions. The primary source of future liquidity and distributions is expected to be derived from cash generated by the Partnership's properties after adequate cash reserves are established for future leasing costs, tenant finish costs and capital improvements. Cash reserves (which are unrestricted cash and equivalents as shown on the Partnership's balance sheet as of December 31) were $36,269, $244,288 and $156,081 at December 31, 1995, 1994 and 1993, respectively.\n- 25 -\nCapital Resources and Liquidity - Continued - -------------------------------------------\nOn January 20, 1995, the Partnership entered into debt refinancing agreements with the banks that held the following notes:\nNote Balance at 01\/20\/95 Encumbered Property ----------- -------------------\n$9,240,000 Lakeshore Business Center Phase II 1,270,000 Outparcel building sites (3.8 acres) 468,333 Outparcel building sites (3.8 acres) 5,776,000 University Business Center Phase II\nThe debt refinancing agreements extended the maturity date of all notes to January 31, 1998 and interest was fixed at 10.6%. In accordance with the debt refinancing agreements, principal payments required on the $9,240,000, $1,270,000 and $5,776,000 notes are as follows:\na) 12 monthly payments of $3,000 each , the first of which was due at closing. The second through 12th payments are due on the first day of February through December 1995. b) 12 monthly payments of $12,000 each, commencing on January 1, 1996 through December 1, 1996. c) 13 monthly payments of $15,000 each, commencing on January 1, 1997 through January 1, 1998. d) Balloon payment due at maturity on January 31, 1998.\nThe debt refinancing was concluded in conjunction with the formation of the Lakeshore\/University II Joint Venture. For a discussion regarding the new joint venture, see pages 20 and 21.\nAs of December 31, 1995, the L\/U II Joint Venture had notes payable to banks in the following amounts: $9,204,000, $5,740,000, $1,234,000, $468,333 and $340,000. The notes are a liability of the joint venture in accordance with the Joint Venture Agreement. The Partnership's proportionate interest in the notes at December 31, 1995 was $1,156,943, $721,518, $155,114, $58,869 and $42,738, respectively. As part of the loan agreements with the banks, the Joint Venture is required to place in escrow funds for capital expenditures, leasing commissions and tenant improvements at the properties owned by the Joint Venture. During the term of the loans, the Joint Venture is required to fund a total of $200,000 to the escrow account. As of December 31, 1995, the Joint Venture had met this funding requirement. The notes bear interest at a fixed rate of 10.6%, are due January 31, 1998 and are secured by the assets of the joint venture. See the discussion above regarding principal payments required on the $9,204,000, $5,740,000 and $1,234,000 notes.\nSubsequent to December 31, 1995, the L\/U II Joint Venture submitted an application with an insurance company for $17.4 million of debt financing. The proceeds from the loan will be used to pay off the Joint Venture's current debt financings of approximately $16.9 million. The remaining proceeds will be used to fund Joint Venture tenant finish improvements, leasing costs and loan closing costs. The Joint Venture anticipates that the financing will be completed during mid-1996.\nAs of December 31, 1995, the Blankenbaker Business Center Joint Venture had a mortgage payable with an insurance company (obtained November 1994) in the amount of $4,500,239. The mortgage is recorded as a liability of the Joint Venture and is secured by the assets of the Joint Venture. The Partnership's proportionate interest in the mortgage at December 31, 1995 is $1,736,192. The mortgage bears interest at a fixed rate of 8.5% and is due November 15, 2005. Currently monthly principal payments are based upon an 11-year amortization schedule. At maturity, the mortgage will have been repaid based on the current rate of amortization.\n- 26 -\nCapital Resources and Liquidity - Continued - -------------------------------------------\nThe majority of the Partnership's 1995 cash flows was derived from the use of cash reserves. The majority of the Partnership's 1994 and 1993 cash flow was derived from operating activities. Cash flows used in investing activities include tenant finish improvements. Changes to current tenant finish improvements are a typical part of any lease negotiation. Improvements generally include a revision to the current floor plan to accommodate a tenant's needs, new carpeting and paint and\/or wallcovering.\nThe extent and cost of these improvements are determined by the size of the space and whether the improvements are for a new tenant or incurred because of a lease renewal. Cash flows provided by (used in) investing activities also include an increase (decrease) in construction payables. Cash flows used in investing activities were funded by cash flow from operating activities and capital contributions (as discussed on pages 20 and 21). Cash flows provided by investing activities in 1994 and 1993 were the result of a release from the funds escrowed for tenant finish improvements at Lakeshore Business Center Phase II. Cash flows provided by investing activities in 1995 were also the result of a release from the funds escrowed for capital expenditures, leasing commissions and tenant finish improvements at the properties owned by the L\/U II Joint Venture partially offset by deposits made to the L\/U II Joint Venture escrow as required by the loan agreements (discussed on page 26). Cash flows used in investing activities (1993) also include cash which was escrowed for tenant improvements at Lakeshore Business Center Phase II as required by a July 1993 loan extension agreement. Cash flows provided by financing activities are derived from increases in the Partnership's debt level (1993) and the Blankenbaker Business Center Joint Venture's debt level (1994). Cash flows used in financing activities are for loan costs and principal payments on mortgage and notes payable. The capital contribution by a joint venture partner represents the Partnership's interest in the L\/U II Joint Venture's (1995) and Blankenbaker Business Center Joint Venture's (1994) increase in cash which resulted from a capital contribution. The Partnership utilizes the proportionate consolidation method of accounting for joint venture properties. The Partnership's interest in the joint venture's assets, liabilities, revenues, expenses and cash flows are combined on a line-by- line basis with the Partnership's own assets, liabilities, revenues, expenses and cash flows. The Partnership does not expect any material change in the mix and relative cost of capital resources except that which is discussed in the following paragraph.\nIn the next 12 months, the demand on future liquidity will increase as a result of cash requirements connected with the required principal payments of the L\/U II Joint Venture's notes payable (as discussed on page 26) and as a result of the Blankenbaker Business Center Joint Venture's permanent financing obtained November 1994 (see page 26). The Partnership also expects the demand on future liquidity to increase as a result of future leasing activity at Lakeshore Business Center Phases I and II. At this time, the future leasing and tenant finish costs which will be required to renew the current leases or obtain new tenants are unknown. It is anticipated that the cash flow from operations, cash reserves and the escrow funds as discussed on page 26 will be sufficient to meet the needs of the Partnership.\nDue to the fact that no distributions were made during 1995, 1994 or 1993, the table which presents that portion of the distribution that represents a return of capital on a Generally Accepted Accounting Principle basis has been omitted.\nAt December 31, 1995, none of the Partnership's properties were in the construction stage.\n- 27 -\nCapital Resources and Liquidity - Continued - -------------------------------------------\nCurrently, the Partnership's plans for renovations and other major capital expenditures include tenant improvements at the Partnership's properties as required by lease negotiations. Changes to current tenant finish improvements are a typical part of any lease negotiation. Improvements generally include a revision to the current floor plan to accommodate a tenant's needs, new carpeting and paint and\/or wallcovering. The extent and cost of the improvements are determined by the size of the space being leased and whether the improvements are for a new tenant or incurred because of a lease renewal. The tenant finish improvements will be funded by cash flow from operations, cash reserves and the escrow funds which are described on page 26.\nAs of December 31, 1995, the L\/U II Joint Venture had commitments for approximately $200,000 of tenant finish improvements and leasing costs. The commitments are the result of an 8,200 square foot new lease and a 7,100 square foot lease renewal. Both leases are for a period of five years. The Partnership's proportionate share of these commitments is approximately $24,000 or 12%. As of December 31, 1995, approximately $130,000 had been incurred toward these commitments, of which the Partnership's proportionate share is approximately $16,000 or 12%.\nAs of December 31, 1995, the L\/U II Joint Venture also had a commitment for a $200,000 special tenant finish allowance, of which approximately $92,000 will be reimbursed by the tenant over a 27-month period beginning in January 1996. This commitment is the result of lease negotiations with Full Sail Recorders, Inc. (\"Full Sail\") which currently sub-leases approximately 41,000 square feet from Philip Crosby Associates, Inc. (\"PCA\") at University Busienss Center Phase II. PCA currently leases 100% of the business center through April 1998. Full Sail's lease term with the Joint Venture is for 33 months (April 1998 to December 2000). The Partnership's proportionate share of net commitment ($200,000 less $92,000) is approximately $13,000 or 12%.\nSubsequent to December 31, 1995, a new six-year lease was signed at Lakeshore Busienss Center Phase II for approximately 7,000 square feet. As a result of the new lease, the L\/U II Joint Venture has a commitment for approximately $105,000 of tenant finish improvements of which the Partnership's proportionate share is $13,000 or 12%.\nThe Partnership had no other material commitments for renovations or capital improvements at December 31, 1995.\nThe L\/U II Joint Venture owns approximately 6 acres of land adjacent to the Lakeshore Business Center development in Ft. Lauderdale, Florida. The Partnership's proportionate interest at December 31, 1995 in the land held for development is approximately $97,000. The Joint Venture currently has a contract for the sale of .7 acres of this land for $175,000.\nHistorically, extremely weak economic conditions in Ft. Lauderdale, Florida have caused the low occupancy levels at Lakeshore Business Center Phases I and II. In the opinion of the general partner, leasing activity is improving in this part of Florida. In an effort to continue to improve the occupancy at Lakeshore Business Center Phases I and II, the Partnership has an on-site leasing agent, an employee of NTS Development Company (an affiliate of the general partner), who makes calls to potential tenants, negotiates lease renewals with current tenants and manages local advertising with the assistance of NTS Development Company's marketing staff. The leasing and renewal negotiations of University Business Center Phase II are handled by a leasing agent, an employee of NTS Development Company, located at the University Business Center development.\n- 28 -\nCapital Resources and Liquidity - Continued - -------------------------------------------\nLeases at the Partnership's properties provide for tenants to contribute toward the payment of common area expenses, insurance and real estate taxes. Leases at the Partnership's properties also provide for rent increases which are based upon increases in the consumer price index. These lease provisions should protect the Partnership's operations from the impact of inflation and changing prices.\n- 29 -\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo NTS-Properties Plus Ltd:\nWe have audited the accompanying balance sheets of NTS-Properties Plus Ltd. (a Florida 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 statements and the schedules referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NTS-Properties Plus 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 schedules included on pages 48 through 50 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 our audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nLouisville, Kentucky February 14, 1996\n- 30 -\nThe accompanying notes to financial statements are an integral part of these statements.\n- 31 -\nThe accompanying notes to financial statements are an integral part of these statements.\n- 32 -\nThe accompanying notes to financial statements are an integral part of these statements.\n- 33 -\nThe accompanying notes to financial statements are an integral part of these statements.\n- 34 -\nNTS-PROPERTIES PLUS LTD.\nNOTES TO FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. Significant Accounting Policies -------------------------------\nA) Organization ------------\nNTS-Properties Plus Ltd. (the \"Partnership\") is a limited partnership organized under the laws of the State of Florida on April 30, 1987. The general partner is NTS-Properties Plus Associates (a Kentucky limited partnership). The Partnership is in the business of developing, constructing, owning and operating commercial real estate.\nB) Properties ----------\nThe Partnership owns and operates the following properties:\n- A 39% joint venture interest in Blankenbaker Business Center 1A, a business center with approximately 50,000 net rentable ground floor square feet and approximately 50,000 net rentable mezzanine square feet located on approximately 5.2 acres of land in Louisville, Kentucky.\n- A 12% joint venture interest in the Lakeshore\/University II Joint Venture. A description of the properties owned by the Joint Venture appears below:\n- Lakeshore Business Center Phase I - a business center with approximately 103,000 net rentable square feet located in Fort Lauderdale, Florida.\n- Lakeshore Business Center Phase II - a business center with approximately 97,000 net rentable square feet located in Fort Lauderdale, Florida.\n- University Business Center Phase II - a business center with approximately 78,000 net rentable first floor (office and service) and second floor office square feet and approximately 10,000 net rentable mezzanine square feet located in Orlando, Florida.\n- Outparcel Building Sites - approximately 6.2 acres of undeveloped land adjacent to the Lakeshore Business Center development which is zoned for commercial development.\nC) Allocation of Net Income (Loss) and Cash Distributions ------------------------------------------------------\nPre-Termination Date Net Cash Receipts and Interim Net Cash Receipts, as defined in the partnership agreement and which are made available for distribution, will be distributed 99% to the limited partners and 1% to the general partner.\nNet operating income shall be allocated to the limited partners and the general partner in proportion to their respective cash distributions. Net operating income in excess of cash distributions shall be allocated as follows: (1) pro rata to all partners with a negative capital account in an amount to restore the negative capital account to zero; (2) 99% to the limited partners and 1% to the general partner until the limited partners have received cash\n- 35 -\n1. Significant Accounting Policies - Continued -------------------------------------------\nC) Allocation of Net Income (Loss) and Cash Distributions - Continued ------------------------------------------------------------------\ndistributions from all sources equal to their original capital; (3) the balance, 90% to the limited partners and 10% to the general partner. Net operating losses shall be allocated 99% to the limited partners and 1% to the general partner.\nD) Tax Status ----------\nThe Partnership has received a ruling from the Internal Revenue Service stating that the Partnership is classified as a limited partnership for federal income tax purposes. As such, the Partnership makes no provision for income taxes. The taxable income or loss is passed through to the holders of the partnership interests for inclusion on their individual income tax returns.\nA reconciliation of net loss for financial statement purposes versus that for income tax reporting is as follows:\n1995 1994 1993 ---------- ----------- -----------\nNet loss $ (386,230) $(1,803 166) $(1,754,067)\nItems handled differently for tax purposes: Write-off of unamortized tenant finish improvements (8,328) (83,565) (67,656) Allowance for doubtful accounts 2,015 (11,739) 21,832 Depreciation and amortization 174,563 963,035 1,231,928 Capitalized leasing costs 5,065 41,693 41,323 Rental income 54,108 290,001 212,888 ---------- ----------- -----------\nTaxable loss (158,807) $ (603,741) $ (313,752) ========== =========== ===========\nE) Use 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.\nF) Joint Venture Accounting ------------------------\nThe Partnership has adopted the proportionate consolidation method of accounting for joint venture properties. The Partnership's proportionate interest in the venture's assets, liabilities, revenues, expenses and cash flows are combined on a line-by-line basis with the Partnership's own assets, liabilities, revenues, expenses and cash flows. All intercompany accounts and transactions have been eliminated in consolidation.\n- 36 -\n1. Significant Accounting Policies - Continued -------------------------------------------\nG) Cash and Equivalents - Restricted ---------------------------------\nCash and equivalents - restricted represents escrow funds which are to be released as capital expenditures, leasing commissions and tenant improvements are incurred at the properties owned by the Lakeshore\/University II Joint Venture and funds which have been escrowed with mortgage companies for property taxes in accordance with the loan agreements.\nH) Basis of Property and Depreciation ----------------------------------\nLand, buildings and amenities are stated at cost to the Partnership. Costs directly associated with the acquisition, development and construction of a project are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets which are 5-30 years for land improvements, 5-30 years for building and improvements and 5 - 30 years for amenities.\nIn March 1995, the Financial Accounting Standards Board issued Statement No. 121 (the \"Statement\") on accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used. The Statement also establishes accounting standards for long-lived assets and certain identifiable intangibles to be disposed of. The Partnership is required to adopt the Statement no later than January 1, 1996, although earlier implementation is permitted. The Statement is required to be applied prospectively for assets to be held and used. The initial application of the Statement to assets held for disposal is required to be reported as the cumulative effect of a change in accounting principle.\nThe Partnership plans to adopt the Statement as of January 1, 1996. Based on a preliminary review, the Partnership does not anticipate that any material adjustments will be required.\nI) Capitalized Leasing Costs -------------------------\nThe Partnership has capitalized certain costs associated with the initial leasing of the properties. These costs are being amortized over a five year period.\nJ) Organizational and Start-up Costs ---------------------------------\nOrganizational costs are expenses incidental to the creation of the Partnership and joint ventures such as legal and accounting fees. Start-up costs are partnership administration expenses which are capitalized until the Partnership acquires its first property for development and construction. Organizational costs are amortized over a five-year period beginning when investors' funds are released from escrow. Start-up costs are amortized over a five-year period beginning when the first property is acquired.\nK) Rental Income and Deferred Leasing Commissions ----------------------------------------------\nCertain of the Partnership's lease agreements are structured to include scheduled and specified rent increases over the lease term. For financial reporting purposes, the income from these leases is being recognized on a straight-line basis over the lease term. Accrued income connected with these leases is included in accounts receivable and totalled $107,413 and $762,683 as of December 31, 1995 and 1994, respectively. All commissions paid to leasing agents are deferred and amortized on a straight-line basis over the term of the lease to which they apply.\n- 37 -\n1. Significant Accounting Policies - Continued -------------------------------------------\nL) Statements of Cash Flows ------------------------\nFor purposes of reporting cash flows, cash and equivalents include cash on hand and short-term, highly liquid investments with initial maturities of three months or less.\nM) Reclassification of 1994 and 1993 Financial Statements ------------------------------------------------------\nCertain reclassifications have been made to the December 31, 1994 and 1993 financial statements to conform with December 31, 1995 classifications. These classifications have no effect on previously reported operations.\n2. Concentration of Credit Risk ----------------------------\nNTS-Properties Plus Ltd. has a joint venture investment in commercial properties in Kentucky (Louisville) and Florida (Orlando and Ft. Lauderdale). Substantially all of the tenants are local businesses or are businesses which have operations in the location in which they lease space. The Kentucky property is occupied by one tenant.\n3. Investment in Joint Ventures ----------------------------\nA) NTS University Boulevard Joint Venture --------------------------------------\nIn January 1989, the Partnership entered into a joint venture agreement with NTS-Properties V, a Maryland limited partnership, an affiliate of the general partner of the Partnership, to develop University Business Center Phase II, an approximately 78,000 square foot business center, in Orlando, Florida. NTS-Properties V contributed land valued at $1,460,000 and the Partnership contributed development and carrying costs of approximately $8 million. During the second quarter of 1994, NTS-Properties V made an approximately $79,000 capital contribution to the Joint Venture. The capital contribution increased NTS-Properties V's ownership interest percentage from 16% to 17% and reduced the Partnership's ownership percentage from 84% to 83%. The contribution was made to fund a portion of the Joint Venture's operating costs. The net income or net loss is allocated each calendar quarter based upon the respective partnership's contribution. The Partnership's ownership share of University Business Center Phase II was 83% prior to its contribution to the Lakeshore\/University II Joint Venture. The Partnership's share of the Joint Venture's net operating income was $12,946 (1995), $143,953 (1994) and $171,391 (1993).\nOn January 23, 1995, the partners of the NTS University Boulevard Joint Venture contributed University Business Center Phase II to the newly formed Lakeshore\/University II (L\/U II) Joint Venture. For a further discussion see Note 3C to the Partnership's 1995 financial statements.\nB) Blankenbaker Business Center Joint Venture ------------------------------------------\nOn December 28, 1990 the Partnership entered into a Joint Venture agreement with NTS-Properties VII, Ltd., an affiliate of the general partner of the Partnership, to complete the development of Blankenbaker Business Center 1A. The Partnership contributed Blankenbaker Business Center 1A together with improvements and\n- 38 -\n3. Investment in Joint Ventures - Continued ----------------------------------------\nB) Blankenbaker Business Center Joint Venture - Continued ------------------------------------------------------\npersonal property (Real Property) to the capital of the Joint Venture, subject to mortgage indebtedness in the amount of $4,715,000. The agreed upon net fair market value of the Partnership's capital contribution is $1,700,000, being the appraised value of the Real Property ($6,415,000) reduced by the $4,715,000 mortgage. NTS-Properties VII, Ltd. contributed $450,000 which was used for additional tenant improvements to the Real Property and made a capital contribution to the Joint Venture of $325,000 to purchase a 2.49 acre parking lot that was being leased from an affiliate of the general partner as described in NTS- Properties Plus Ltd.'s Prospectus. NTS-Properties Plus Ltd. transferred to the Joint Venture its option to purchase the parking lot, and the Joint Venture exercised its option. The use of the parking lot is a provision of the tenant's lease agreement with the business center. By purchasing the parking lot, the Joint Venture's annual operating expenses were reduced approximately $35,000. The purchase price of the parking lot was determined by an independent appraisal.\nOn August 16, 1994, the Blankenbaker Business Center Joint Venture amended its joint venture agreement to admit NTS-Properties IV (an affiliate of the general partner of the Partnership) to the Joint Venture. In accordance with the Joint Venture Agreement, NTS- Properties IV contributed $1,100,000 and NTS-Properties VII, Ltd. contributed $500,000. Additional capital was needed by the Blankenbaker Business Center Joint Venture to fund the tenant finish and leasing costs connected with the project discussed in the following paragraph. However, the Partnership was not in a position to contribute additional capital, nor was NTS-Properties VII, Ltd. in a position to contribute all of the capital required for the project. NTS-Properties IV was willing to participate in the Joint Venture and to contribute, together with NTS-Properties VII, Ltd. the capital necessary with respect to the project. The general partner of the Partnership agreed to this admission of NTS- Properties IV to the Joint Venture, and to the capital contributions by NTS-Properties IV and NTS-Properties VII, Ltd. with the knowledge that the Partnership's joint venture interest would, as a result, decrease.\nThe need for additional capital by the Joint Venture was a result of the lease renewal and expansion which was signed April 28, 1994 between the Joint Venture and Prudential Service Bureau, Inc. (\"Prudential\"). The lease expands Prudential's leased space by approximately 15,000 square feet and extends its current lease term through July 2005. Approximately 12,000 square feet of the expansion was into new space which had to be constructed on the second level of the existing business center. With this expansion, Prudential now occupies 100% of the business center (approximately 101,000 square feet). The tenant finish and leasing costs connected with the lease renewal and expansion were approximately $1.4 million.\nIn order to calculate the revised joint venture percentage interests, the assets of the Joint Venture were revalued in connection with the admission of NTS-Properties IV as a joint venture partner and the additional capital contributions. The value of the Joint Venture's assets immediately prior to the additional capital contributions was $6,764,322 and its outstanding debt was $4,650,042, with net equity being $2,114,280. The difference\n- 39 -\n3. Investment in Joint Ventures - Continued ----------------------------------------\nB) Blankenbaker Business Center Joint Venture - Continued ------------------------------------------------------\nbetween the value of the Joint Venture's assets and the value at which they were carried on the books of the Joint Venture has been allocated to the Partnership and NTS-Properties VII, Ltd. in determining each Joint Venture partner's percentage interest.\nThe Partnership's interest in the Joint Venture decreased from 69% to 39% as a result of the capital contributions by NTS-Properties IV and NTS-Properties VII, Ltd. The respective percentage interests of NTS-Properties IV and NTS-Properties VII, Ltd. in the Joint Venture subsequent to these capital contributions are 30% and 31%.\nNet income or loss is allocated each calendar quarter based on the respective partnership's contribution. The Partnership's ownership share was 39% at December 31, 1995. The Partnership's share of the Joint Venture's net operating loss was $79,234 (1995), $302,899 (1994) and $256,432 (1993).\nC) Lakeshore\/University II Joint Venture -------------------------------------\nOn January 23, 1995, a new joint venture known as Lakeshore\/University II Joint Venture (L\/U II Joint Venture) was formed among the Partnership and NTS-Properties IV, NTS-Properties V and NTS\/Fort Lauderdale, Ltd., affiliates of the general partner of the Partnership, for purposes of owning Lakeshore Business Center Phases I and II, University Business Center Phase II and certain undeveloped tracts adjacent to the Lakeshore Business Center Development. The table below identifies which properties were contributed to the L\/U II Joint Venture and the respective owners of such properties prior to the formation of the joint venture.\nProperty (Net Asset Contributed) Owner -------------------------------- -----\nLakeshore Business Center NTS-Properties IV and NTS- Phase I ($6,249,667) Properties V\nLakeshore Business Center NTS-Properties Plus Ltd. Phase II (-$1,023,535)\nUndeveloped land adjacent to the NTS-Properties Plus Ltd. Lakeshore Business Center development (3.8 acres)(-$670,709)\nUndeveloped land adjacent to the NTS\/Fort Lauderdale, Ltd. Lakeshore Business Center development (2.4 acres) ($27,104)\nUniversity Business Center NTS-Properties V and NTS- Phase II ($953,236) Properties Plus Ltd.\nEach of the properties were contributed to the L\/U II Joint Venture subject to existing indebtedness, except for Lakeshore Business Center Phase I which was contributed to the joint venture free and clear of any mortgage liens, and all such indebtedness was assumed by the L\/U II joint venture. Mortgages have been recorded on Lakeshore Business Center Phase I in the amount of $5,500,000, and on University Business Center Phase II in the amount of $3,000,000, in favor of the banks which held the indebtedness on University Business Center Phase II, Lakeshore Business Center Phase II and the undeveloped tracts prior to the formation of the joint venture. In\n- 40 -\n3. Investment in Joint Ventures - Continued ----------------------------------------\nC) Lakeshore\/University II Joint Venture - Continued -------------------------------------------------\naddition to the above, NTS-Properties IV also contributed $750,000 to the L\/U II Joint Venture. The Partnership's ownership share was 12% at December 31, 1995. The Partnership's share of the joint ventures net operating loss was $155,457 in 1995.\n4. Land, Buildings and Amenities -----------------------------\nThe following schedule provides an analysis of the Partnership's investment in property held for lease as of December 31:\n1995 1994 ----------- -----------\nLand and improvements $ 1,847,061 $ 6,260,269 Buildings and improvements 1,690,674 14,456,717 Amenities 8,306 6,712 ---------- ----------\n3,546,041 20,723,698\nLess accumulated depreciation 2,291,213 5,821,480 ---------- ----------\n$ 1,254,828 $14,902,218 ========== ==========\n5. Land Held for Development -------------------------\nLand held for development at December 31, 1995 represents the Partnership's proportionate share of approximately 6.2 acres of land owned by the L\/U II Joint Venture which is adjacent to the Lakeshore Business Center development in Ft. Lauderdale, Florida. The Joint Venture currently has a contract for the sale of .7 acres of this land for $175,000.\nLand held for development at December 31, 1994 represents a 3.8 acre parcel of land adjacent to the Lakeshore Business Center development which the Partnership acquired on October 15, 1990. On January 23, 1995, the Partnership contributed this land held to the L\/U II Joint Venture. See Note 3C of the Partnership's 1995 financial statements for a further discussion of the L\/U II Joint Venture.\n6. Mortgage and Notes Payable --------------------------\nMortgage and notes payable as of December 31 consist of the following:\n1995 1994 ----------- ----------- Note payable to a bank bearing interest at a fixed rate of 10.6%, due January 31, 1998, secured by land and building $ 721,518 $ 5,786,000 Note payable to a bank bearing interest at a fixed rate of 10.6%, due January 31, 1998, secured by land 58,869 470,000\nNote payable to a bank bearing interest at a fixed rate of 10.6%, due January 31, 1998, secured by land and building 1,156,943 9,240,000 Note payable to a bank bearing interest at a fixed rate of 10.6%, due January 31, 1998, secured by land 155,114 1,270,000\n(continued next page)\n- 41 -\n6. Mortgage and Notes Payable - Continued --------------------------------------\n1995 1994 ----------- ----------- Note payable to a bank bearing interest at a fixed rate of 10.6%, due January 31, 1998, secured by land $ 42,738 $ --\nMortgage payable to an insurance company, bearing interest at a fixed rate of 8.5%, due November 15, 2005, secured by land and building 1,736,192 1,846,183 ---------- ---------- $ 3,871,374 $18,612,183 ========== ==========\nScheduled maturities of debt are as follows:\nFor the Years Ended December 31, Amount -------------------------------- --------- 1996 $ 170,895 1997 194,776 1998 2,151,116 1999 150,323 2000 163,610 Thereafter 1,040,654 ---------\n$ 3,871,374 =========\nBased on the borrowing rates currently available to the Partnership for loans with similar terms and average maturities, the fair value of long-term debt is approximately $4,400,000.\n7. Rental Income Under Operating Leases ------------------------------------\nThe following is a schedule of minimum future rental income on noncancellable operating leases as of December 31, 1995:\nFor the Years Ended December 31, Amount -------------------------------- --------- 1996 $ 586,541 1997 550,574 1998 436,685 1999 351,808 2000 318,684 Thereafter 1,347,332 ---------\n$ 3,591,624 ==========\n8. Related Party Transactions --------------------------\nProperty management fees of $59,849 (1995), $180,332 (1994) and $181,000 (1993) were paid to NTS Development Company, an affiliate of the general partner. The fee is equal to 6% of all revenues from commercial properties pursuant to an agreement with the Partnership. Also permitted by the partnership agreement, NTS Development Company will receive a repair and maintenance fee equal to 5.9% of costs incurred which relate to capital improvements. The Partnership has incurred $6,446 and $21,607 as a repair and maintenance fee during the years ended December 31, 1995 and 1994, respectively, and has capitalized this cost as part of land, buildings and amenities.\n- 42 -\n8. Related Party Transactions - Continued --------------------------------------\nAs permitted by the partnership agreement, the Partnership was also charged the following amounts from NTS Development Company for the years ended December 31, 1995, 1994 and 1993. These charges include items which have been expensed as operating expenses - affiliated or professional and administrative expenses - affiliated and items which have been capitalized as deferred leasing commissions, other assets or as land, buildings and amenities:\n1995 1994 1993 -------- -------- --------\nAdministrative $110,191 $125,031 $120,181 Leasing 17,194 60,213 56,158 Property manager 38,675 116,074 115,228 Other 2,482 14,624 13,391 ------- ------- -------\n$168,542 $315,942 $304,958 ======= ======= =======\nAccounts payable - operations includes approximately $113,000 and $115,000 due NTS Development Company at December 31, 1995 and 1994, respectively.\n- 43 -\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nBecause the Partnership is a limited partnership, and not a corporation, it has no directors or officers as such. Management of the Partnership is the responsibility of the general partner, NTS-Properties Plus Associates. The Partnership has entered into a management contract with NTS Development Company, an affiliate of the general partner, to provide property management services.\nThe general partners of NTS-Properties Plus Associates are as follows:\nJ. D. Nichols - -------------\nMr. Nichols (age 54) is the managing general partner of NTS-Properties Plus Associates and is Chairman of the Board of NTS Corporation (since 1985) and NTS Development Company (since 1977).\nRichard L. Good - ---------------\nMr. Good (age 56) President and Chief Operating Officer of NTS Corporation, President of NTS Development Company and Chairman of the Board of NTS Securities, Inc., joined the Manager in January 1985. From 1981 through 1984, he was Executive Vice President of Jacques-Miller, Inc., a real estate syndication, property management and financial planning firm in Nashville, Tennessee.\nNTS Capital Corporation - -----------------------\nNTS Capital Corporation (formerly NTS Corporation) is a Kentucky corporation formed in October 1979. J. D. Nichols is Chairman of the Board and the sole director of NTS Capital Corporation.\nThe Manager of the Partnership's properties is NTS Development Company, the executive officers and\/or directors of which are Messrs. J. D. Nichols, Richard L. Good and John W. Hampton:\nJohn W. Hampton - ---------------\nMr. Hampton (age 46) is Senior Vice President of NTS Corporation with responsibility for all accounting operations. Before joining NTS in March 1991, Mr. Hampton was Vice President - Finance and Chief Financial Officer of the Sturgeon-Thornton-Marrett Development Company in Louisville, Kentucky for nine years. Prior to that he was with Alexander Grant & Company CPA's. Mr. Hampton is a Certified Public Accountant and a graduate of the University of Louisville with a Bachelor of Science degree in Commerce. He is a member of the American Institute of CPA's and the Kentucky Society of CPA's.\n- 44 -\nItem 11.","section_11":"Item 11. Management Remuneration and Transactions\nThe officers and\/or directors of the corporate general partner receive no direct remuneration in such capacities. The Partnership is required to pay a property management fee based on gross rentals to NTS Development Company or an affiliate. The Partnership is also required to pay to NTS Development Company a repair and maintenance fee on costs related to specified projects. NTS Development Company provides certain other services to the Partnerships. See Note 8 to the financial statements which sets forth transactions with NTS Development Company for the years ended December 31, 1995, 1994 and 1993.\nThe general partner is entitled to receive cash distributions and allocations of profits and losses from the Partnership. See Note 1C to the financial statements which describes the methods used to determine income allocations and cash distributions.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe general partner is NTS-Properties Plus Associates, a Kentucky Limited Partnership, 10172 Linn Station Road, Louisville, Kentucky 40223. The partners of the general partner and their total respective interests in NTS-Properties Plus Associates are as follows:\nJ. D. Nichols 10172 Linn Station Road 30.10% Louisville, Kentucky 40223\nNTS Capital Corporation 10172 Linn Station Road 9.95% Louisville, Kentucky 40223\nRichard L. Good 10.00% 10172 Linn Station Road Louisville, Kentucky 40223\nThe remaining 49.95% interests are owned by various limited partners of NTS-Properties Plus Associates.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nProperty management fees of $59,849 (1995), $180,332 (1994) and $181,000 (1993) were paid to NTS Development Company, an affiliate of the general partner. The fee is equal to 6% of all revenues from commercial properties pursuant to an agreement with the Partnership. Also permitted by the partnership agreement, NTS Development Company will receive a repair and maintenance fee equal to 5.9% of costs incurred which relate to capital improvements. The Partnership has incurred $6,446 and $21,607 as a repair and maintenance fee during the year ended December 31, 1995 and 1994, respectively, and has capitalized this cost as part of land, buildings and amenities.\n- 45 -\nItem 13. Certain Relationships and Related Transactions - Continued\nAs permitted by the partnership agreement, the Partnership was also charged the following amounts from NTS Development Company for the years ended December 31, 1995, 1994 and 1993. These charges include items which have been expensed as operating expenses - affiliated or professional and administrative expenses - affiliated and items which have been capitalized as deferred leasing commissions, other assets or as land, buildings and amenities:\n1995 1994 1993 -------- -------- --------\nAdministrative $110,191 $125,031 $120,181 Leasing 17,194 60,213 56,158 Property manager 38,675 116,074 115,228 Other 2,482 14,624 13,391 ------- ------- -------\n$168,542 $315,942 $304,958 ======= ======= =======\nAccounts payable - operations includes approximately $113,000 and $115,000 due NTS Development at December 31, 1995 and 1994, respectively.\nThere are no other agreements or relationships between the Partnership, the General Partner and its affiliates than those previously described.\n- 46 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n1. Financial statements\nThe financial statements for the years ended December 31, 1995, 1994 and 1993, together with the report of Arthur Andersen LLP dated February 14, 1996 appear in Item 8. The following financial statement schedules should be read in conjunction with such financial statements.\n2. Financial statement schedules\nSchedules Page No. --------- --------\nIII - Real Estate and Accumulated Depreciation 48 - 50\nAll other schedules have been omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto.\n3. Exhibits\nExhibit No. Page No. ----------- --------\n3. Amended and Restated * Agreement and Certificate of Limited Partnership of NTS-Properties Plus Ltd., a Florida limited partnership\n10. Property Management and * Construction Agreement between NTS Development Company and NTS-Properties Plus Ltd.\n27. Financial Data Schedule Included herewith\n* Incorporated by reference to documents filed with the Securities and Exchange Commission in connection with the filing of the Registration statements on Form S-11 on July 1, 1987 (effective June 24, 1988) under Commission File No. 33-15475.\n4. Reports on Form 8-K\nThere were no reports on Form 8-K for the quarter ended December 31, 1995.\n- 47 -\n- 48 -\n- 49 -\n- 50 -\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities exchange Act of 1934, NTS-Properties Plus Ltd. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNTS-PROPERTIES PLUS LTD. . (Registrant)\nBY: NTS-Properties Plus Associates, BY: NTS Capital Corporation, General Partner\n\/s\/ John W. Hampton John W. Hampton Senior Vice President\nDate: March 28 , 1996\nPursuant to the requirements of the Securities and Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the registrant in their capacities and on the date indicated above.\nSignature Title --------- -----\n\/s\/ J. D. Nichols General Partner of NTS-Properties Plus J. D. Nichols Associates and Chairman of the Board and Sole Director of NTS Capital Corporation\n\/s\/ Richard L. Good General Partner of NTS-Properties Plus Richard L. Good Associates and President of NTS Capital Corporation\n\/s\/ John W. Hampton Senior Vice President of NTS Capital John W. Hampton Corporation\nThe Partnership is a limited partnership and no proxy material has been sent to the limited partners.\n- 51 -","section_15":""}
{"filename":"9442_1995.txt","cik":"9442","year":"1995","section_1":"Item 1. Business.\nPrincipal Products\nThe registrant and its subsidiaries (hereinafter collectively referred to as the \"Company\") mill and sell graded and finished balsa lumber in standard sizes and balsa wood strips and blocks. \"Standard sizes\" of balsa lumber are measured in boardfeet (12\" x 12\" x 1\") for the English system of measure or in cubic meters for the metric system of measure. Shipments to Europe, (except the U.K.) and Japan are made in cubic meters while shipments to the U.S. and the U.K. are in boardfeet. The Company, for production and statistical purposes, converts all metric measurements into boardfeet, thus the Company's \"standard\" is boardfeet. The Company also manufactures and sells custom-made bonded panels, blocks and beams of balsa wood, and a flexible balsa wood block mat called \"Contourkore .\"\nGlued-up balsa blocks are marketed in two ways. Part is sold directly to customers in block or panel form, the balance is shipped to the Company's factory in Northvale, N.J. for further processing into Contourkore and other products. Blocks and Contourkore are used by the Company's customers to manufacture a variety of products by laminating metal or fiberglass reinforced plastic skins to both sides of the balsa, thereby creating a sandwich structure in which balsa is the core or center. The products manufactured by the Company's customers include fiberglass boats, aircraft cargo pallets, aircraft flooring, fiberglass storage and processing tanks and fiberglass tub and shower bottoms. Balsa lumber is used mostly by the hobby industry to manufacture model airplanes.\nIn addition, the Company sells a non-balsa continuous strand fabric, imported from Holland and Japan and resold without further manufacturing. This product is marketed as \"Coremat\" and \"BaltekMat\" to the pleasure boat industry.\nIn September 1995 the Company entered into an agreement with Airex AG of Sins, Switzerland, a division of A.L. Alusuisse - Lanza Group to become the sole North American source of Airex(R) (a registered trademark of Aires AG) and Airlite(TM), structural PVC foam products. The Company does not expect sales or income to be generated from these foam products until mid to late 1996. However these additional products, together with its Balsa products, should solidify the Company's leadership as a complete supplier to the composite structural core market and result in growth opportunities for the future.\nAll the Company's balsa and shrimp are produced in Latin America, principally in Ecuador, South America. The dependence on foreign countries for raw materials represents some inherent risks. However, the Company, or its predecessors, have maintained operations in Ecuador since 1940. The Company does not consider its reliance on Ecuador to represent an undue business risk; in fact, the Company believes that operating in Ecuador is one of its strengths, where quality raw materials are produced at a reasonable cost in a politically stable atmosphere.\nThe Company is also in the aquaculture business, specifically shrimp farming in Ecuador. This operation consists of a hatchery, a farm and a packing plant. Shrimp larvae are supplied by the hatchery to the farm and after harvest, transferred to the packing plant for processing and shipment to customers in the United States and Europe.\nPrincipal Markets and Methods of Distribution\nThe Company's balsa products are sold throughout the United States, Canada, Europe, Japan, and Australia to approximately 1,600 ultimate users. The Company's salesmen are used extensively in the sale of its balsa products. Approximately 40% of its balsa product sales are made by the Company directly. The remainder of the sales are handled through regional distributors in the United States, Europe, Canada, and Japan. Sales of Contourkore to customers outside the United States are handled through a wholly-owned Foreign Sales Corporation.\nIn 1995, approximately 40% of all the shrimp production was sold to the U.S. market through food brokers; the balance was sold to the European market.\nCompetitive Conditions\nAs part of their overall business, other companies, with aggregate facilities and financial resources substantially greater than those of the Company, manufacture and sell various natural and synthetic products for nearly all the purposes for which balsa lumber and products are sold by the Company. Some of these competitive products are produced and sold at a lower cost than the Company's balsa lumber and products, and sales of these competing products are substantially greater than the Company's sales of balsa lumber and products.\nThe Company's shrimp business competes against many larger companies which produce shrimp through similar methods in addition to fishing for shrimp in the traditional method of trawling.\nMaterial Customer\nDuring the period ended December 31, 1995, the Company had sales to one customer in excess of 10% of the Company's consolidated revenues.\nBacklog\nAs of December 31, 1995, the Company had a backlog of orders believed to be firm in the total amount of $5,955,000 all of which is reasonably expected to be filled within the current fiscal year.\nAs of December 31, 1994, the Company had a backlog of orders believed to be firm in the total amount of $9,671,000.\nSources and Availability of Raw Materials\nThe Company acquires, partly from its own plantations and partly from others, substantially all of its balsa wood from western and coastal Ecuador, accessible by roads so that the balsa lumber can be transported by truck to its sawmills. The Company considers the timber presently standing in this area, combined with its planned plantation expansion program, to be ample to supply all the Company's requirements in the foreseeable future. The Company also receives small quantities of balsa from other Latin American countries. The resins, fiberglass and other materials used in the Company's manufacturing processes are available from numerous commercial sources. To date the Company has experienced no difficulty in obtaining such materials needed for its operations.\nThe Company owns and operates a shrimp farm and a shrimp hatchery in Ecuador for the production of a steady and plentiful supply of shrimp. The hatchery supplies substantially all the larvae required by the Company's ponds. The Company also owns a shrimp packing company in Ecuador, thereby achieving complete vertical integration of the shrimp business.\nPatents, Trademarks and Licenses\nThe Company features its registered trademark \"Belcobalsa(R)\" for lumber, dimension stock, and bonded panels and blocks, \"Contourkore(R)\" \"LamPrep(R)\" and \"AL-600(R)\" for the flexible wood block mat, \"Durakore(R)\", a balsa hardwood composite, \"D100(R) \" for end-grain panels and \"Decolite(R)\" a balsa composite panel used as an alternative to plywood, and low-density laminate bulkers, marketed as \"BaltekMat(R)\" and \"Firet Coremat(R)\".\nThe Company also features \"Airlite(TM)\", a cross-linked PVC foam, and \"Airex(R)\" (registered trademark of Airex AG) a linear foam.\nEstimated Research Costs\nThe Company has incurred approximately $415,000 during 1995 for research and development, compared to expenditures of $447,000 in 1994 and $535,000 in 1993. All expenditures are related to the balsa division and include customer service activities. The Company continues to actively explore possible new applications of balsa, and new manufacturing processes.\nEnvironmental Impact\nThe Company has experienced no material impact upon its capital expenditures, earnings or competitive position as a result of its compliance with federal, state or local provisions relating to the protection of the environment. Balsa is not a rainforest species, nor does it grow in the rainforest. It is usually harvested within five years. The fast growth rate makes balsa similar to short-cycle agricultural crops and an ideal tree species for forest plantations.\nEmployees\nThe Company has approximately 956 employees in Ecuador, 125 in the United States and 10 in Europe, aggregating 1091 employees.\nSeasonality\nThe Company's business is not seasonal.\nClasses of Products\nThe following table sets forth the amount and percentage of total sales and revenue represented by each of the Company's product classes in the three years ended December 31, 1995 (dollars in thousands):\nSegment Information\nThe Company is engaged in two lines of business, that of manufacturing and supplying balsa wood and balsa wood products, laminate bulkers and PVC foams, used principally as the core material in various industries, and in the aquaculture business, namely, shrimp farming in Ecuador.\nReference is made to the information set forth in Note 11 to the Notes to Consolidated Financial Statements, Part II, Item 8 hereof, with respect to assets and operating results for different business segments.\nForeign Operations\nThe Company, through its Ecuadorean subsidiaries, owns and operates five woodworking plants and approximately 15,346 acres of forest land in Ecuador. In addition, the Company owns and operates a shrimp farm on approximately 2,000 acres, a shrimp hatchery and a shrimp packing plant.\nAt the Company's woodworking plants, rough balsa lumber is received from independent loggers and then processed into finished lumber and other manufactured products.\nThe Company's shrimp ponds are stocked with larvae. After feeding, controlling the pond environment and monitoring the growth of the shrimp for a period of approximately six months, the shrimp are harvested, frozen, packed and sold for export.\nThe Company, through its European subsidiaries, operates sales offices in France, the United Kingdom and Denmark.\nReference is made to the information set forth in Note 11 to the Notes to Consolidated Financial Statements, Part II, Item 8 hereof, with respect to assets and operating results by geographic areas.\nForeign Sales\nApproximately 29% of the Company's net sales for the year ended December 31, 1995 was derived from sales to customers outside the United States.\nNo prediction can be made as to any future increase or decrease of the Company's foreign business. The Company has experienced differences in profitability between foreign and domestic sales due to the changing value of the U.S. dollar in relation to the foreign currencies of countries where its products are sold.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company owns or leases the properties indicated in the following table:\nAll of the above properties except the shrimp farming land, hatchery and packing plant are used in the balsa wood business.\nThe lease of the property at Northvale, New Jersey, continues until February 28, 2002, at an average annual rental of approximately $383,000. The lease of the Company's office space in Paris continues until March 31, 1998 at an annual rental equivalent to approximately $28,800. The lease of the Company's office in Croydon, U.K. runs until December 25, 2008 at an annual rental of approximtely $13,200.\nAll of the Company's properties, plants and equipment are considered to be presently sufficient for their respective purposes.\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 submission of matters 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.\nThe Company's common stock is traded in the over-the-counter market (NASDAQ). The following is the bid price range for the last two years.\nThe Company had approximately 216 stockholders of record as of March 1, 1996.\nNo cash dividends were paid during the past two years.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nManagement's Discussion and Analysis of Item 7.","section_7":"Item 7. Financial Condition and Results of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital ratio (current assets divided by current liabilities) decreased in 1995 to 2.50:1 from 2.97:1, after increasing in 1994 from 2.87:1.\nCash was provided and used in varying amounts during the three year period, principally as a result of changes in the elements of current assets and current liabilities and in the amount of cash provided by net income. Inventories increased in 1995 and 1993 but decreased in 1994. The increase in 1995 was due to new products and inventory buildup for anticipated increases in sales. The 1994 decrease was caused by greater sales than anticipated. The increase in 1993 was due to an inventory buildup in anticipation of the 1994 sales increase.\nCash used in investing activities for the three year period was due to increased investments in balsa plantations, replacement of old equipment, reconstruction of the shrimp ponds and purchase of new equipment required for the manufacture of the Company's new products. The Company has no material commitments for capital expenditures.\nDebt increased in 1995 and 1993 due to working capital and investment requirements. In 1994 the company repaid debt of $1,887,000 from funds generated by profits.\nThe Company had unused lines of credit of $5.0 million with a domestic bank, $1.8 million with Ecuadorean banks and $1.0 million with European banks. The Company expects that future operations and its unused lines of credit will provide sufficient resources to support its planned expansion and to maintain its favorable liquid position.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nTotal sales increased 14%, 24% and 15% in 1995, 1994 and 1993, respectively. The gains in all three years were due to increased demands from all industries using our balsa products together with substantial increases in shrimp sales.\nBalsa sales were favorably affected by the continuing recovery of the pleasure boat industry. The pleasure boat industry represented approximately 40% of the Company's 1995 balsa sales. Fluctuating interest rates make it impossible to forecast short or long range trends in the boating industry. The increases in balsa sales in all three years were due to volume increases, increased sales of value-added products and to price increases. The Company continues to explore and develop alternative applications for its balsa products.\nShrimp sales were $9,364,000, $7,297,000 and $5,084,000 in 1995, 1994 and 1993, respectively. The substantial increases in 1995 and 1994, after a decline in 1993, were the result of increased world wide market prices and increased yield at the Company's shrimp farm. The decline in 1993 was due to unfavorable weather conditions in Ecuador, where the shrimp farm is located, during the first nine months of 1993. The Company 's reconstruction program to increase yields at its shrimp farm commenced in the middle of 1993 and has proved successful. The program should be concluded in 1997.\nCost of products sold as a percentage of sales was approximately the same in 1995 and 1994 after increasing 2% in 1993. All three years were affected in varying degrees by inflationary pressures on operating expenses partially offset by currency devaluation and operating efficiencies resulting from the 1994 and earlier restructuring. Additionally, 1995 and 1994 benefited from increased absorption of overhead expenses due to increased production. The Company recorded a special charge of $323,977 in 1994 associated with a decision to reduce costs by making operational and personnel changes at the Company's factories in Ecuador. This charge was effected within the year with no related reserve balance remaining at year end.\nSelling, general and administrative expenses as a percentage of sales remained approximately the same in 1995 as in 1994 due mostly to the addition of sales personnel required to market the Company's existing and new products and to support the Company's continuing search for new markets and applications for its products. These additions were offset by increased absorption of fixed expenses. The decline in 1994 by 3% and in 1993 by 4% was due to a better absorption of fixed expenses as a result of increased sales.\nSales and expenses were slightly affected in all three years by the different exchange rates applied in translating the books of accounts of the Company's European subsidiaries.\nInterest expense increased in 1995 and 1994 due to rising interest rates and increased borrowings after declining in 1993 as a result of lower interest rates.\nTranslation losses varied greatly during the three year period. Translation losses are caused by the relationship of the U.S. dollar to the foreign currencies in the countries where the Company operates, and arise when translating foreign currency balance sheets into U.S. dollars in order to present consolidated financial statements. Management is unable to forecast the impact of translation gains or losses on future periods due to the unpredictability in the fluctuation of foreign exchange rates.\nThe effective income tax rate amounted to 21% in 1995, 39% in 1994, and 40% in 1993. Reconciliation of the effective rate with the U.S. statutory rate is detailed in footnote 8 to the financial statements.\nIn summary of the foregoing discussion, the Company realized net income of $1,962,253, $1,212,459, and $112,835 in 1995, 1994 and 1993, respectively.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements of the registrant and subsidiaries, and supplemental schedule are annexed hereto and made part hereof.\nChanges in and Disagreements With Accountants Item 9.","section_9":"Item 9. on 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 from this Report since a definitive Proxy Statement, pursuant to Regulation 14A containing the required information, will be filed with the Commission not later than 120 days after the close of registrant's fiscal year.\nItem 11.","section_11":"Item 11. Executive Compensation.\nOmitted from this Report since a definitive Proxy Statement, pursuant to Regulation 14A containing the required information, will be filed with the Commission not later than 120 days after the close of the registrant's fiscal year.\nSecurity Ownership of Certain Beneficial Item 12.","section_12":"Item 12. Owners and Management.\nOmitted from this Report since a definitive Proxy Statement, pursuant to Regulation 14A containing the required information, will be filed with the Commission not later than 120 days after the close of the registrant's fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInapplicable.\nPART IV\nExhibits, Financial Statement Item 14.","section_14":"Item 14. Schedules, and Reports on Form 8-K\n(a)(1) and (2) Consolidated Financial Statements and Financial Statement Schedule\nSee Index to Consolidated Financial Statements and Financial Statement Schedule annexed hereto and made part hereof.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by or on behalf of the registrant for the quarter ended December 31, 1995, the last quarter in the period covered by this Annual Report on Form 10-K.\n(c) List of Exhibits\nExhibit No. Item Filing - ----------- ---- ------ 3 Articles of Incorporation Pre-Filed (Bylaws)\n10 Material Contracts None\n21 Subsidiaries of Registrant Filed Herewith\n27 Financial Data Schedule Filed Herewith\nSIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALTEK CORPORATION Registrant\nBy \/s\/ Jacques Kohn --------------------------- Jacques Kohn, President\nBy \/s\/ Benson J. Zeikowitz ---------------------------- Benson J. Zeikowitz, Treasurer (Principal Financial officer and Principal accounting officer)\nDated: March 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.\nBy \/s Margot W. Kohn By \/s\/ Jacques Kohn ----------------------------- ----------------------------- Margot W. Kohn, Jacques Kohn, Director Director\nBy \/s\/ Theodore Ness By \/s\/ Benson J. Zeikowitz ----------------------------- ----------------------------- Theodore Ness, Benson J. Zeikowitz, Director Director\nDated: March 21, 1996\nBALTEK CORPORATION AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE AS OF DECEMBER 31, 1995 AND 1994 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995\nPREPARED FOR FILING AS PART OF THE ANNUAL REPORT (FORM 10-K) TO THE SECURITIES AND EXCHANGE COMMISSION FOR THE YEAR ENDED DECEMBER 31, 1995\n**********\nBALTEK CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE PREPARED FOR FILING AS PART OF THE ANNUAL REPORT (FORM 10-K) TO THE SECURITIES AND EXCHANGE COMMISSION YEAR ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 1995\nConsolidated Statements of Changes in Stockholders' Equity for Each of the Three Years in the Period Ended December 31, 1995\nConsolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 1995\nNotes to Consolidated Financial Statements for Each of the Three Years in the Period Ended December 31, 1995\nFINANCIAL STATEMENT SCHEDULE AS OF AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995:\nII - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because of the absence of the conditions under which they are required or because the required information called for is set forth in the consolidated financial statements or notes thereto.\nDeloitte & Touche LLP [GRAPHIC -- COMPANY LOGO] ____________________________________________________________ Two Hilton Court Telephone: (201) 631-7000 P.O. Box 319 Facsimile: (201) 631-7459 Parsippany, New Jersey 07054-0319\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Baltek Corporation and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of Baltek Corporation and its 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. Our audits also included the financial statement schedule listed in the accompanying index. 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. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 Baltek 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. 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\nMarch 11, 1996\nBALTEK CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1. NATURE OF OPERATIONS\nBaltek Corporation is a multinational manufacturing and marketing company. The Company's lines of business are supplying core materials (principally balsa products) to various composite industries, farming and processing shrimp, and manufacturing and selling balsa lumber and other balsa wood products. The Company reported its sales in two segments in 1995: the balsa segment including all balsa sales and other materials sold to the composite industry (80%), and the shrimp segment (20%).\nThe principal market for the Company's core materials and balsa products is in the United States, while the shrimp market is divided between the United States and Europe.\nThe balsa and shrimp products are produced in Ecuador, South America. The supply of raw materials has been without interruption for over 50 years. The balsa and shrimp identifiable assets located at various facilities in Ecuador are included in the Company's consolidated balance sheet and total approximately $23 million at December 31, 1995.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The 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 and Cash Equivalents - Cash equivalents consist of short-term highly liquid investments with maturities of three months or less when purchased. Investments are carried at cost, which approximates market.\nIn accordance with Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows,\" cash flows from Baltek's operations in foreign countries are calculated based on their reporting currencies. As a result of this, amounts related to changes in assets and liabilities reported on the consolidated statement of cash flows will not necessarily agree to changes in the corresponding balances on the consolidated balance sheets. The effect of exchange rate changes on cash balances held in foreign currencies is reported on a separate line below cash flows from financing activities.\nInventories - Inventories are valued at the lower of cost or market. Cost is determined by use of the first-in, first-out (FIFO) method.\nProperty - Property, plant and equipment is stated at cost. Depreciation is provided for depreciable assets over their estimated useful lives using various accepted depreciation methods. The assets under capital leases and leasehold improvements are amortized over their useful lives, or the life of the lease, whichever is shorter. The cost of major improvements to existing facilities is capitalized. The cost of repairs, maintenance and replacements which do not significantly improve or extend the life of the respective assets is charged to expense as incurred.\nIncome Taxes - Taxes on current income are provided by the Company and each subsidiary as prescribed by local tax laws. The Company follows the practice of comprehensive interperiod income tax allocation. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 required a change from the deferred method's income statement approach of accounting for income taxes under APB Opinion 11 to an asset and liability approach of accounting for income taxes. Under the asset and liability approach 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.\nTimber and Timberlands - Timberlands are carried at cost. Deferred cultivation costs represent the cost of preparing, clearing and seeding the Company's balsa wood plantations. Amortization of timber and timberlands is based on units of production. Timber carrying costs, which include the regular maintenance and overseeing of timberlands, are expensed as incurred.\nForeign Currency Translation - The financial statements of the Company's foreign subsidiaries are remeasured into U.S. dollars, the Company's functional currency, in accordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation.\" The majority of the foreign exchange gains and losses relate to the manufacturing process in Ecuador, and such amounts are separately stated in the accompanying consolidated statements of operations.\nResearch and Development - Research and development costs are charged to expense as incurred. Research and development expenditures, including customer service activities, charged to operations were $414,675, $447,311 and $534,781 in 1995, 1994 and 1993, respectively.\nConcentrations of Credit Risk - Baltek's principal products, balsa lumber and related end products, as well as shrimp products, are sold to a number of markets, including boating, transportation, military, hobby, and the retail food industry. Baltek's products are sold throughout the United States, Canada, Europe, Japan and Australia to approximately 1,600 ultimate users. Credit risk related to Baltek's trade receivables is limited due to the large number of customers in differing industries and geographic areas.\nIncome Per Common Share - Income per common share amounts are computed based on the weighted average number of shares outstanding during the period.\nForeign Currency Risk Management - The Company uses foreign currency forward contracts to reduce currency exchange rate risk on firm commitment purchases denominated in foreign currencies. Gains or losses resulting from these contracts are deferred and are included in the purchase price of the materials. The maximum term of these contracts is less than one year.\nUse of Estimates - In conformity with generally accepted accounting principles, the Company's financial statements include the use of estimates and assumptions which have been developed by management based on available facts and information. Actual results could differ from those estimates.\nRevenue Recognition - The Company generally recognizes revenues when goods are shipped.\nReclassifications - Certain amounts in prior year financial statements have been reclassified to conform with the current year presentation.\n3. INVENTORIES\nInventories of the balsa and shrimp segments are summarized as follows:\nIncluded in the above amounts are inventories relating to the Company's shrimp operations of $1,337,154 and $976,751 at December 31, 1995 and 1994, respectively.\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is comprised of the following:\nShrimp properties consist principally of shrimp ponds, a hatchery and a packing plant.\n5. TIMBER AND TIMBERLANDS\nTimber and timberlands are comprised of the following:\n6. NOTES PAYABLE\nNotes payable under various agreements at December 31, 1995 and 1994 consist of the following:\nThe Company has an unsecured revolving line of credit with a domestic bank for a maximum credit limit of $5,000,000 with interest at the bank's prime rate. This line of credit, which is renewable annually, expires on May 31, 1996. There were no borrowings outstanding against this line of credit at December 31, 1995. The Company was in compliance with all related loan covenants at December 31, 1995.\nThe Ecuadorian bank loans are unsecured. At December 31, 1995, unused lines of credit available under Ecuadorian borrowing arrangements amounted to approximately $1,830,000, and under European borrowing arrangements amounted to approximately $998,000.\nThe credit facilities discussed above do not require compensating balances or the payment of commitment fees. The weighted average interest rate on borrowings outstanding at December 31, 1995 and 1994 was 11.3% and 9.8%, respectively. The carrying amount of the notes payable approximates their fair value based on the short-term nature and the terms of the loans. These amounts were paid subsequent to the balance sheet date at par.\n7. COMMON STOCK AND STOCK OPTIONS\nThe weighted average number of common shares outstanding used in the calculation of income per common share amounts was 2,523,261 in 1995, 1994 and 1993.\nThe Company has a stock option plan under which options to purchase up to 100,000 shares may be granted to certain key employees. As of December 31, 1995, 2,000 options were available for grant and no options were outstanding.\n8. INCOME TAXES\nThe Company adopted SFAS 109 as of January 1, 1993. Such adoption resulted in no net effect on the Company's consolidated statement of operations.\nIncome (loss) before income taxes is comprised of:\nThe provision (benefit) for income taxes for the years ended December 31, 1995, 1994 and 1993 consists of the following:\nThe reconciliation between the Company's effective tax rate and the statutory Federal tax rate for 1995, 1994 and 1993 is as follows:\nAs a result of various incentives provided by the Ecuadorian government, the effective foreign tax rate is lower than the U.S. Federal statutory tax rate.\nSignificant components of the Company's deferred tax assets and liabilities are as follows:\nAs of December 31, 1994, the Company had a full valuation allowance recorded against the foreign tax credit carryforwards of $140,000. Management believed that it was more likely than not that the credits would expire unutilized. The Company was, however, able to utilize these credits and has included the income from the reversal of the valuation allowance in the tax provision for the year ended December 31, 1995.\nThe total current and noncurrent amounts presented above, to the extent not shown separately on the consolidated balance sheets, are included in other assets (current and noncurrent) and accrued expenses and other liabilities.\nThe Company does not accrue Federal income taxes on the equity in the undistributed earnings of its foreign subsidiaries, which amounted to approximately $5,775,000 at December 31, 1995, because such earnings are permanently reinvested. It is not practicable to estimate the tax liability that might arise if these earnings were remitted.\n9. EMPLOYEE BENEFIT PLANS\nThe Company has a profit-sharing plan under which an annual contribution may be paid from accumulated profits at the discretion of the Board of Directors for the benefit of eligible employees upon their retirement. Contributions to this plan by the Company amounted to $327,445 and $281,787 in 1995 and 1994, respectively. There were no contributions to the plan by the Company in 1993.\nThe Company has adopted an amendment to the profit sharing plan described above providing an election to all participants, pursuant to Section 401(k) of the Internal Revenue Code, to defer between 2 percent and 10 percent of salary. Amounts deferred are paid to the trustee of the plan. The amendment does not provide for matching Company contributions.\nCertain employees of the Company's Ecuadorian subsidiary companies are covered by termination and retirement plans incorporated under statutory requirements of labor laws and collective bargaining agreements. Included in the accompanying consolidated balance sheets are union employee termination benefits which approximate unpaid vested benefits under such plans. The amount of benefits to be received by an employee is established by the collective bargaining agreements and is based on length of service and compensation. Provisions of approximately $111,000, $63,000 and $106,000 were charged to income during 1995, 1994 and 1993, respectively.\n10. LEASES\nThe Company leases its office space and plant facilities in Northvale, New Jersey, under a long-term capital lease agreement which expires in 2002. The lease provides that the Company pay all real estate taxes, maintenance and insurance relating to the facilities. Accumulated amortization related to the asset under capital lease at December 31, 1995 and 1994 was $957,851 and $707,965, respectively.\nRent expense under operating leases relates principally to office buildings and amounted to $53,343, $51,210 and $51,701 in 1995, 1994 and 1993, respectively.\nFuture minimum lease payment obligations, as of December 31, 1995, for the capital lease described above, as well as operating leases, are summarized below. The operating leases are for space at the Company's offices in England and France and space in a warehouse in Norwood, New Jersey, for which lease payments begin in 1996.\n11. SEGMENT INFORMATION\nThe Company and its subsidiaries operate primarily in two segments, as a manufacturer and supplier of balsa wood products used principally as a core material in various industries, and in the shrimp farming business. Information about the Company's operations by segment for 1995, 1994 and 1993 is as follows:\nInformation pertaining to the Company's operations in different geographic areas is as follows:\nTransfers between geographic areas are at prices which permit the recovery of manufacturing costs and a reasonable operating profit. The majority of export sales from the Company's United States operations were to unaffiliated customers in Europe.\nSales to one customer from the Balsa segment amounted to approximately 13%, 13% and 20% of total revenues in 1995, 1994 and 1993, respectively.\n12. SPECIAL CHARGE\nIn 1994, the Company recorded a special charge of $323,977, associated with a decision to reduce costs by making personnel changes at the Company's mills in Ecuador. This charge was comprised primarily of severance payments for 68 employees. This action was effected within 1994 and no related reserve balance remained by year-end 1994.\n******","section_15":""}
{"filename":"711308_1995.txt","cik":"711308","year":"1995","section_1":"ITEM 1 - BUSINESS\nMay Drilling Partnership 1983-1 (the \"Drilling or General Partnership\") and May Limited Partnership 1983-1 (the \"Limited Partnership\") were organized by May Petroleum Inc. (\"May\") to explore for and develop oil and gas reserves primarily in Texas, Oklahoma and Louisiana. Funds received from the sale and production of oil and gas reserves are used to pay the obligations of the Limited Partnership. Funds not required by the Limited Partnership as working capital are distributed to the participants in the Drilling Partnership and the general partner.\nThe general partner of the Limited Partnership is EDP Operating, Ltd., which is one of the operating partnerships for Hallwood Energy Partners, L. P. (\"HEP\"). The Drilling Partnership is the sole limited partner of the Limited Partnership. The Limited Partnership does not have any subsidiaries, nor does it engage in any other kind of business. The Limited Partnership has no employees and is operated by Hallwood Petroleum, Inc. (\"HPI\"), a subsidiary of HEP. In February 1996, HPI employed 133 full-time employees.\nPursuant to the terms of the general partnership agreement and the limited partnership agreement, HEP is obligated, from time to time, to contribute certain amounts, in property, cash or unreimbursed services, to the Limited Partnership. As of December 31, 1995, all such required contributions had been made.\nPARTICIPATION IN EXPENSES AND REVENUES\nThe principal expenses and revenues of the Limited Partnership are shared by the general partner and the Drilling Partnership as set forth in the following table. The charges and credits to participants in the Drilling Partnership are shared among the participants in proportion to their ownership of units of participation.\nIn 1996, the sharing ratio will be 57.7% to the limited partner and 42.3% to the general partner.\nTo the extent that the characterization of any expense of the Limited Partnership depends on its deductibility for federal income tax purposes, the proper characterization is determined by the general partner (according to its intended characterization on the Limited Partnership's federal income tax return) in good faith at the time the expense is to be charged or credited. Such characterization will control related charges and credits to the partners regardless of any subsequent determination by the Internal Revenue Service or a court of law that the reported expenses should be otherwise characterized for tax purposes.\nCOMPETITION\nOil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy. See also \"Marketing\" for a discussion of the market structure for oil and gas sales.\nREGULATION\nProduction and sale of oil and gas is subject to federal and state governmental regulations in a variety of ways including environmental regulations, labor law, interstate sales, excise taxes and federal, state and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases.\nThe production of oil and gas is subject to regulation by the state regulatory agencies in the states in which the Limited Partnership does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas.\nFEDERAL INCOME TAX CONSIDERATIONS\nThe Limited Partnership and the GeneralPartnership are partnerships for federal income tax purposes. Consequently, they are not taxable entities; rather, all income, gains, losses, deductions and credits are passed through and taken into account by the partners on their individual federal income tax returns. In general, distributions are not subject to tax so long as such distributions do not exceed the partner's adjusted tax basis. Any distributions in excess of the partner's adjusted tax basis are taxed generally as capital gains.\nMARKETING\nThe oil and gas produced from the properties owned by the Limited Partnership has typically been marketed through normal channels for such products. Oil has generally been sold to purchasers at field prices posted by the principal purchasers of crude oil in the areas where the producing properties are located. The majority of the Limited Partnership's gas production is sold on the spot market and is transported in intrastate and interstate pipelines. Both oil and natural gas are purchased by refineries, major oil companies, public utilities and other users and processors of petroleum products.\nFactors which, if they were to occur, might adversely affect the Limited Partnership include decreases in oil and gas prices, the availability of a market for production, rising operational costs of producing oil and gas, compliance with and changes in environmental control statutes and increasing costs and difficulties of transportation.\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nENVIRONMENTAL CONSIDERATIONS\nThe exploration for, and development of, oil and gas involve the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the present general interest in environmental problems, the general partner cannot predict what effect possible future public or private action may have on the business of the Limited Partnership. The general partner is continually taking all action necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations and does not presently anticipate that the compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, earnings or the competitive position of the Limited Partnership in the oil and gas industry.\nINSURANCE COVERAGE\nThe Limited Partnership is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. The Limited Partnership maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to the Limited Partnership's, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon the Limited Partnership's earnings and financial position.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Limited Partnership's oil and gas reserves are located in prospects in south Louisiana. The Limited Partnership's reserves are predominantly natural gas, which accounts for 86% of estimated future gross revenues in the Limited Partnership's reserve report as of December 31, 1995.\nSIGNIFICANT PROSPECTS\nAt December 31, 1995, the following prospects accounted for approximately 96% of the Limited Partnership's proved oil and gas reserves. Reserve quantities were obtained from the December 31, 1995 reserve report prepared by HPI's petroleum engineers.\nBOUDREAUX PROSPECT. The Boudreaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 12,000 bbls of oil and 574,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest in this prospect ranges up to 1.2%.\nMEAUX PROSPECT. The Meaux prospect is located in Lafayette Parish, Louisiana. The Limited Partnership's interest in the prospect has remaining net proved reserves of 300 bbls of oil and 33,000 mcf of gas as of December 31, 1995, all of which are developed and producing at December 31, 1995. The Limited Partnership's working interest is 8.5%.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor a description of legal proceedings affecting the Limited Partnership, please refer to Item 8 - Note 3.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNo matter was submitted to a vote of participants 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\na) The registrant's securities consist of partnership interests which are not traded on any exchange and for which no established public trading market exists.\nb) As of December 31, 1995, there were approximately 369 holders of record of partnership interests in the Drilling Partnership.\nc) Distributions paid by the Limited Partnership were as follows (in thousands):\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\nMaterial changes in the Limited Partnership's cash position for the years ended December 31, 1995 and 1994 are summarized as follows:\nCash provided by operating activities in 1995 was used for distributions to the general partners and additions to oil and gas properties. The Limited Partnership has net working capital of $155,000. This working capital, together with future net cash flows generated from operations, may be used to fund future distributions. Future distributions depend on, among other things, continuation of current or higher oil and gas prices, markets for production and future development costs, and the outcome of the litigation described in Item 8, Note 3.\nThe Limited Partnership's ability to generate funds adequate to meet its future needs will be largely dependent upon its ability to continue to develop its existing reserves. Proved reserves and discounted future net revenues (discounted at 10% and before general and administrative expenses) from proved reserves were estimated at 12,000 bbls and 632,000 mcf valued at $1,086,000 in 1995 and 13,000 bbls and 637,000 mcf valued at $969,000 in 1994. The increase in discounted future net revenues and the fluctuation in the quantities resulted primarily from an increase in year end oil and gas prices as well as changes in the estimated rates of production on certain wells.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nRESULTS OF OPERATIONS - ---------------------\n1995 COMPARED TO 1994 - ---------------------\nOIL REVENUE\nOil revenue increased $3,000 during 1995 as compared with 1994. The increase is comprised of an increase in the average oil price from $16.03 per barrel in 1994 to $17.68 per barrel in 1995 combined with a 2% increase in production as shown in the table below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and the sale of another during the second quarter of 1994.\nGAS REVENUE\nGas revenue decreased $8,000 during 1995 as compared with 1994. The decrease is due to a decrease in the average gas price from $2.14 per mcf during 1994 to $1.83 per mcf during 1995, partially offset by a 12% increase in production as shown below. The increase in production is due to increased state allowable production limits, partially offset by normal production declines as well as the temporary abandonment of one well and the sale of another during the second quarter of 1994.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1995 and 1994.\nLEASE OPERATING\nLease operating expense decreased $10,000 during 1995 as compared with 1994 primarily due to the sale of the Warwick Richard #1 during the second quarter of 1994 and the temporary abandonment of the Duhon #1.\nPRODUCTION TAXES\nProduction taxes increased $6,000 during 1995 as compared with 1994 as a result of the settlement of a lawsuit which resulted in lower in production taxes during 1994.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $23,000 during 1995 as compared with 1994 primarily due to a decrease in the allocation of overhead from the general partner.\nDEPLETION\nDepletion expense increased $7,000 during 1995 as compared with 1994 due to a higher depletion rate caused by the 11% increase in oil and gas production during 1995.\nLITIGATION SETTLEMENT\nLitigation settlement expense during 1995 primarily represents amounts paid in connection with the settlement of a royalty dispute on the Duhon #1 well.\n1994 COMPARED TO 1993 - ---------------------\nOIL REVENUE\nOil revenue decreased $22,000 in 1994 as compared to 1993. The average oil price decreased from $17.89 per barrel in 1993 to $16.03 per barrel in 1994. Oil production decreased 38% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines.\nGAS REVENUE\nGas revenue decreased $170,000 as compared to 1993. Gas production decreased 43% as shown in the table below, primarily due to the reduction in state allowable production limits, as well as normal production declines. The average gas price decreased from $2.26 per mcf in 1993 to $2.14 per mcf in 1994.\nThe following table summarizes the Limited Partnership's share of production from the Limited Partnership's significant properties for 1994 and 1993.\nLEASE OPERATING\nLease operating expense decreased $4,000 in 1994 as compared to 1993, primarily due to the sale of the Warwick Richard #1 in the second quarter of 1994.\nPRODUCTION TAXES\nProduction taxes decreased $17,000 in 1994 as compared to 1993, primarily due to the decrease in revenue mentioned previously.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased $23,000 in 1994 as compared to 1993, due to a decrease in allocation of overhead from the general partner.\nDEPLETION\nDepletion expense decreased $24,000 in 1994 as compared to 1993, primarily due to a lower depletion rate.\nLITIGATION SETTLEMENT\nLitigation settlement expense during 1993 represents the costs of a lawsuit settlement which is discussed in Item 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report 12\nBalance Sheets at December 31, 1995 and 1994 - May Drilling Partnership 1983-1 13\nBalance Sheets at December 31, 1995 and 1994 - May Limited Partnership 1983-1 14\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-1 15\nStatements of Changes in Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-1 16\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 - May Limited Partnership 1983-1 17\nNotes to Financial Statements - May Drilling Partnership 1983-1 and May Limited Partnership 1983-1 18-21\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 22\nINDEPENDENT AUDITORS' REPORT -----------------------------\nTO THE PARTNERS OF MAY DRILLING PARTNERSHIP 1983-1 AND MAY LIMITED PARTNERSHIP 1983-1:\nWe have audited the financial statements of May Drilling Partnership 1983-1 (\"General Partnership\") and May Limited Partnership 1983-1 (\"Limited Partnership\") as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, listed in the accompanying index at Item 8. 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 the General Partnership and the Limited Partnership at December 31, 1995 and 1994, and the results of operations and cash flows of the Limited Partnership for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDenver, Colorado February 27, 1996\nMAY DRILLING PARTNERSHIP 1983-1 BALANCE SHEETS (In thousands)\nNote: The statements of operations and cash flows for May Drilling Partnership 1983-1 are not presented because such information is equal to the Limited Partners' share of such activity as presented in the May Limited Partnership 1983-1 financial statements. The May Drilling Partnership carries its investment in May Limited Partnership 1983-1 on the equity method. The May Limited Partnership 1983-1 financial statements should be read in conjunction with this balance sheet.\nMAY LIMITED PARTNERSHIP 1983-1 BALANCE SHEETS (In thousands)\nMAY LIMITED PARTNERSHIP 1983-1 STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands, except for Units)\nMAY LIMITED PARTNERSHIP 1983-1 STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nMAY LIMITED PARTNERSHIP 1983-1 STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (In thousands)\nMAY DRILLING PARTNERSHIP 1983-1 AND MAY LIMITED PARTNERSHIP 1983-1\nNOTES TO FINANCIAL STATEMENTS\n(1) ACCOUNTING POLICIES AND OTHER MATTERS\nGENERAL PARTNERSHIP\nMay Drilling Partnership 1983-1, a Texas general partnership (the \"General Partnership\"), was organized by May Petroleum Inc. (\"May\") for the purpose of oil and gas exploration through May Limited Partnership 1983-1 (the \"Limited Partnership\"). The General Partnership was formed on May 31, 1983, with investors (\"Participants\") subscribing an aggregate of $4,713,000 in assessable $1,000 units. After the expenditure of the initial contributions of the Participants, additional mandatory assessments from each Participant are provided for under the terms of the general partnership agreement in an amount up to 25% of the initial contribution of the Participant. During 1984, May assessed the Participants 13% of initial contributions. No additional assessments have been made since 1984.\nThe general partnership agreement requires that the manager, Hallwood Energy Partners, L. P. (\"HEP\"), offer to repurchase partnership interests from Participants for cash at amounts to be determined by appraisal of the Limited Partnership's net assets no later than December 31, 1988, and during the two succeeding years, if such net assets are positive. The manager has made repurchase offers in all years since 1989 and intends to make a repurchase offer in 1996.\nAs the General Partnership is the sole limited partner of the Limited Partnership, its results of operations, cash flows and changes in partners' capital are equal to the limited partner's share of the Limited Partnership's results of operations, cash flows and changes in partners' capital as set forth herein. Therefore, separate statements of operations, cash flows and changes in partners' capital are not presented for the General Partnership.\nLIMITED PARTNERSHIP\nThe Limited Partnership, a Texas limited partnership, was organized by May and the General Partnership for the purpose of oil and gas exploration and the production of crude oil, natural gas and petroleum products. The Limited Partnership's oil and gas reserves are located in prospects in south Louisiana. Among other things, the terms of the limited partnership agreement (the \"Agreement\") give the general partner the authority to borrow funds. The Agreement also requires that the general partner's total capital contributions to the Limited Partnership as of each year end, including unrecovered general partner acreage and equipment advances, must be compared to total Limited Partnership expenditures from inception to date, and if such contributions are less than 15% of such expenditures, an additional contribution in the amount of the deficiency is required. At December 31, 1995, no additional contributions were necessary to comply with this requirement.\nOn June 30, 1987, May sold to HEP all of its economic interest in the Limited Partnership and account receivable balances due from the Limited Partnership. HEP became the general partner of the Limited Partnership in 1988.\nSHARING OF COSTS AND REVENUES\nCapital costs, as defined by the Agreement, for commercially productive wells and the costs related to the organization of the Limited Partnership are borne by the general partner. Noncapital costs and direct expenses, as defined by the Agreement, are charged 1% to the general partner and 99% to the limited partner. Oil and gas sales, operating expenses and general and administrative overhead are shared so that the general partner's allocation will equal the percentage that the amount of Limited Partnership expenses, as defined, allocated to the general partner bears to the aggregate amount of Limited Partnership expenses allocated to the general partner and the limited partner, plus 15 percentage points, but in no event will the general partner's allocation exceed 50%. The sharing ratio for each of the last three years was as follows:\nSIGNIFICANT CUSTOMER\nFor the years ended December 31, 1995, 1994 and 1993, purchases by the following company exceeded 10% of the total oil and gas revenues of the Limited Partnership:\nAlthough the Limited Partnership sells the majority of its production to one purchaser, there are numerous other purchasers in the area, so the loss of its significant customer would not adversely affect the Limited Partnership's operations.\nINCOME TAXES\nNo provision for federal income taxes is included in the financial statements of the Limited Partnership or the General Partnership because, as partnerships, they are not subject to federal income tax and the tax effects of their activities accrue to the partners. The partnerships' tax returns, the qualification of the General and Limited Partnerships as partnerships for federal income tax purposes, and the amount of taxable income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes to the partnerships' taxable income or loss, the tax liability of the partners could change accordingly.\nOIL AND GAS PROPERTIES\nThe Limited Partnership follows the full cost method of accounting for oil and gas properties and, accordingly, capitalizes all costs associated with the exploration and development of oil and gas reserves.\nThe capitalized costs of evaluated properties, including the estimated future costs to develop proved reserves, are amortized on the units of production basis. Full cost amortization per dollar of gross oil and gas revenues was $.22 in 1995, $.19 in 1994 and $.16 in 1993.\nCapitalized costs are limited to an amount not to exceed the present value of estimated future net cash flows. No valuation adjustment was required in 1995, 1994 or 1993. Significant price declines in the future could cause the Limited Partnership to experience valuation adjustments and could reduce the amount of future cash flow available for distributions and operations.\nGenerally no gains or losses are recognized on the sale or disposition of oil and gas properties. Maintenance and repairs are charged against income when incurred.\nDuring 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 provides the standards for accounting for the impairment of various long- lived assets. The Limited Partnership is required to adopt SFAS 121 no later than 1996. The Limited Partnership uses the full cost method of accounting for its only long-lived assets, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 is not expected to have a material effect on the financial position or results of operations of the Limited Partnership.\nGAS BALANCING\nThe Limited Partnership uses the sales method for accounting for gas balancing. Under this method, the Limited Partnership recognizes revenue on all of its sales of production, and any over production or under production is recovered at a future date.\nAs of December 31, 1995, the net imbalance to the Limited Partnership's interest is not considered material. Current imbalances can be made up with production from existing wells or from wells which will be drilled as offsets to current producing wells.\nUSE OF ESTIMATES\nThe preparation of the financial statements for the Limited Partnership and General Partnership 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.\nRELATED PARTY TRANSACTIONS\nHallwood Petroleum, Inc. (\"HPI\"), a subsidiary of the general partner, pays all costs and expenses of operations and receives all revenues associated with the Limited Partnership's properties. At month end, HPI distributes revenues in excess of costs to the Limited Partnership.\nThe amount due from HPI as of December 31, 1995 was $8,000 and the amount due to HPI was $2,000 as of December 31, 1994. These balances represent net revenues less operating costs and expenses.\nCASH FLOWS\nAll highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior years' amounts to conform to the classifications used in the current year.\n(2) GENERAL AND ADMINISTRATIVE OVERHEAD\nHPI conducts the day to day operations of the Limited Partnership and other affiliated partnerships of HEP. The costs of operating the entities are allocated to each partnership based upon the time spent on that partnership. General and administrative overhead allocated by HPI to the Limited Partnership totaled $73,000, $99,000 and $120,000 in 1995, 1994 and 1993.\n(3) LEGAL PROCEEDINGS\nIn June 1993, 14 lawsuits were filed against the Limited Partnership in the 15th Judicial District Court, Lafayette Parish, Louisiana, Docket Nos. 93-2332-F through 93-2345-F, styled Lamson Petroleum Corporation v. Hallwood Petroleum, Inc. et al. The plaintiffs in the lawsuits claim that they have valid leases covering streets and roads in the units of the A. L. Boudreaux #1 well, G. S. Boudreaux #1 well, Mary Guilbeau #1 well and Duhon #1 well, which represent approximately 3% to 4% of the Limited Partnership's interest in these properties, and are entitled to a portion of the production from the wells dating from February 1990. The Limited Partnership has not recognized revenue attributable to the contested leases since January 1993. These revenues, totaling $20,000 at December 31, 1995, have been placed in escrow pending resolution of the lawsuits. At this time, the Limited Partnership believes that the difference between the escrowed amount and the amount of any liability that may result upon resolution of this matter will not be material.\nIn February 1994, the Limited Partnership and the other parties to the lawsuit styled SAS Exploration, Inc. v. Hall Financial Group, Inc. et al. settled the lawsuit. The plaintiffs alleged that certain leases in the A. L. Boudreaux #1 and A. M. Duhon #1 wells expired and terminated at the end of their primary terms as a result of production being from the Bol Mex 4 Sand rather than the A. B. Sand. In the settlement, the Limited Partnership and the plaintiffs cross- conveyed interests in certain leases to one another and the Limited Partnership paid the plaintiffs $102,000. The cash paid by the Limited Partnership was reflected as litigation settlement expense in the December 31, 1993 financial statements. The interest conveyance resulted in a decrease in the Limited Partnership's reserves as of December 31, 1993 totaling 66,000 mcf of gas, 1,400 barrels of oil and $124,000 in future net revenues, discounted at 10%.\nSUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited)\nThe following tables contain certain costs and reserve information related to the Limited Partnership's oil and gas activities. The Limited Partnership has no long-term supply agreements and all reserves are located within the United States.\nCOSTS INCURRED -\nOIL AND GAS RESERVES -\nCertain reserve value information is provided directly to partners pursuant to the Agreement. Accordingly, such information is not presented herein.\n(a) See Note 3 to 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 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Drilling Partnership and Limited Partnership are managed by affiliates of HEP and do not have directors or executive officers.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe partnerships pay no salaries or other direct remuneration to officers, directors or key employees of the general partner or HPI. The Limited Partnership reimburses the general partner for general and administrative costs incurred on behalf of the partnerships. See Note 2 to the Financial Statements.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo the knowledge of the general partner, no person owns of record or beneficially more than 5% of the Drilling Partnership's outstanding units, other than HEP, the address of which is 4582 S. Ulster Street Parkway, Denver, Colorado 80237, and which beneficially owns approximately 38.8% of the outstanding units. The general partner of HEP is Hallwood Energy Corporation. ITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information with respect to the Limited Partnership and its relationships and transactions with the general partner, see Part I, Item 1 and Part II, Item 7.\nPART IV ---------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na. Financial Statements and Schedules: See Index at Item 8.\nb. Reports on Form 8-K - None.\nc. Exhibits:\n3.1 The General Partnership Agreement and the Limited Partnership Agreement filed as an Exhibit to Registration Statement No. 0-11311, are incorporated herein by reference.\nSIGNATURES - ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Partnerships have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.\nMAY DRILLING PARTNERSHIP 1983-1 MAY LIMITED PARTNERSHIP 1983-1 BY: EDP OPERATING, LTD., GENERAL PARTNER\nBY: HALLWOOD G.P., INC. GENERAL PARTNER\nBy: \/s\/William L. Guzzetti ------------------------- William L. Guzzetti 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.\nSignature Title Date\n\/s\/Robert S. Pfeiffer Vice President February 29, 1996 --------------------------- (Principal ----------------- Robert S. Pfeiffer Accounting Officer)","section_15":""}
{"filename":"858912_1995.txt","cik":"858912","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nDesktop Data is the leading independent provider of customized, real-time news and information delivered to knowledge workers over their organizations' local area networks. The Company's NewsEDGE service currently delivers over 500 news and information sources in real time to users' personal computers, automatically monitors and filters the news according to pre-established personal interest profiles, and alerts users to stories matching their profiles. The NewsEDGE service is used by executives, salespeople, marketers, lawyers, accountants, consultants, bankers and financial professionals throughout customer organizations. As of December 31, 1995, NewsEDGE was installed by 335 customers, representing approximately 81,000 authorized users.\nBACKGROUND\nThe market for business information services is undergoing significant change, driven by rapid growth in the amount of available information, increasingly competitive global industry environments and increased requirements for professionals to improve the quality and timeliness of the information they receive. An industry source has estimated that businesses and organizations in the United States spent over $28 billion in 1994 on business information services. At the same time, the increasing power and declining cost of PCs, LANs and related software has fueled widespread investment in and adoption of distributed computing and communications systems utilizing client\/server architectures. According to industry sources, by the end of 1994 over 66 million PCs worldwide were connected to LANs, at an estimated annual cost for equipment, installation and support of $8,200 for each PC.\nThe decentralization of decision making and accountability in large organizations has created a need for the widespread distribution of business information to knowledge workers across a number of disciplines and at different levels within the organization. At the same time, the accelerating pace of business activity, stimulated by global competitiveness and advanced electronic communication, has created a need for business information to be more current, timely and easy to access and use.\nWhile the demand for business information has created a profusion of information sources, including on-line services and, most recently, traditional print media taking electronic initiatives such as establishing World Wide Web sites on the Internet, these sources by themselves have not addressed the need for that information to be readily available to knowledge workers on the desktop systems that they use at work every day. Traditional electronic information sources often require stand-alone proprietary hardware systems and are typically accessed by centralized, specially trained library personnel who pass the information on to the knowledge workers who request it. This approach makes access to information relatively costly and time-consuming, discourages widespread use of an organization's electronic information resources, and fails to provide immediate notice of important breaking news. Consequently, traditional approaches to accessing electronic information are not well suited to meeting knowledge workers' needs in a fast-paced and competitive global economy with decentralized decision making and accountability.\nTraditional electronic information sources also have not generally taken advantage of the large investment in LAN infrastructure. While the major investment in LAN infrastructure by large organizations has connected knowledge workers to each other and allowed them to communicate and work together through E-mail, groupware and other client\/server applications, to date it has not been used effectively to connect them to external information sources. As a result, the demand for organizations to widely distribute customized news on a timely basis to workers who need it has not been satisfied.\nTHE NEWSEDGE SOLUTION\nDesktop Data's NewsEDGE service allows knowledge workers to take advantage of the abundance of news and information available to their organizations. The Company installs its NewsEDGE software on a dedicated, customer-owned network server which is connected to the customer's LAN. Desktop Data arranges for the delivery to the server of real-time news and information from the customer's choice of over 100 newswires, aggregating news and information from over 500 sources. The news is filtered to reflect personal profiles that have been established by each user on the\nuser's desktop or laptop computer, and is delivered in real time, 24 hours a day, seven days a week. When a news story matching a user's personal profile arrives, the user is notified by a visual and audio alert, even if the user is then working in another application. When the user's computer is not on or is not connected to the LAN, stories matching that user's profile are stored by the server and delivered when the user's computer is re-activated. NewsEDGE stores approximately 90 days of news stories in a database on the NewsEDGE server, whether or not the stories have matched a profile, and enables users to quickly search the entire database at no additional charge.\nNewsEDGE is distinguished from the information offerings of individual news providers because it integrates the newswires from a number of competitive sources into a single, comprehensive service offering. It is different than on- line systems because it is implemented on customer LANs and PCs where news can be profiled and distributed to all LAN users at a fixed, predictable cost. Unlike traditional on-line services, which require users to dial out and pull information when they think of it, NewsEDGE automatically pushes news to knowledge workers on their own PCs. NewsEDGE leverages the existing LAN investment of business organizations and enables broad access to real-time news from multiple highly respected news sources. NewsEDGE alerts knowledge workers to important developments affecting their business, giving them an opportunity to gain an edge on competitors.\nTHE NEWSEDGE SERVICE\nThe Company's NewsEDGE service was designed to operate in a client\/server environment. The Company installs its NewsEDGE software on a dedicated, customer-owned network server which receives broadcast news on a 24 hour per day basis. Desktop Data arranges for the communication of news selected by the customer to the server through leased telephone lines, satellites or FM sideband transmission.\nNewsEDGE server software manages the receipt of news from multiple news sources over the communications vehicle arranged by the Company. Incoming stories are tested against the interest profiles of all NewsEDGE users on the LAN and alerts are sent to each user in accordance with the user's own profile. All stories received by the server are indexed by full text, ticker symbols, subject codes and dates and added to a news history database to support subsequent searching and retrieval. Typically, approximately 90 days of history of stories received, regardless of whether the stories have matched a profile, are maintained for user inquiry on the NewsEDGE server on the customer LAN.\nNewsEDGE client software manages the user's interface with the news. The NewsEDGE client software provides an easy-to-use graphical user interface that permits users to readily create and modify personalized profile lists of words, phrases and ticker symbols for news monitoring and alerting. When a news story matching a user's personal profile arrives, the user is notified by a visual and audio alert, even if the user is then working in another application. Users can also conduct immediate searches of news stored in the NewsEDGE server using Boolean search techniques, key words or phrases, ticker symbols and subject codes.\nNewsEDGE software also provides links to other applications. Using NewsEDGE linkage and dynamic data exchange capabilities, tabular data in news stories may be cut and pasted into spreadsheets and text may be cut and pasted into word processing or E-mail software. For example, using NewsEDGE a user may be alerted to the release of quarterly financial results by a company the user follows, retrieve financial statements just released by the company, and copy those financial statements directly into a spreadsheet, where the data may be immediately analyzed and manipulated. In addition, the Company is developing interfaces to on-line resources provided by other news and information providers. See \"Development.\"\nNewsEDGE is designed with client-server architecture to leverage customers' LAN investments. NewsEDGE operates on Windows NT and OS\/2 servers. It supports many different desktop systems including Windows, Macintosh, OS\/2, Windows NT and the most common versions of UNIX. NewsEDGE supports multiple LAN configurations, including Novell Netware, Banyan VINES and TCP\/IP, broadcast, point-to-point, session and mixed protocols. NewsEDGE also supports server to server connections to groupware, E-mail, quotation and other applications on customer LANs, including Lotus Notes, Reuters RT3 and Teknekron Marketsheet. NewsEDGE provides its own application programming interface which is available for generalized, open system connection to an application server.\nNEWS AND INFORMATION PROVIDERS\nDesktop Data has contracted with providers to make available through the NewsEDGE service over 100 newswires, aggregating news and information from over 500 news sources. News and information sources currently available on NewsEDGE include newswires from AFP\/Extel News Limited (\"AFX\"), The Associated Press, Inc. (\"The Associated Press\"), Dow Jones & Company, Inc. (\"Dow Jones\"), Knight- Ridder\/Tribune Information Services, L.P., Nihon Shimbun America, Inc. (\"Nikkei\") (English language Japanese news) and Reuters America, Inc. (\"Reuters\"), as well as the text of stories in The Financial Post (Toronto), Financial Times (London), The New York Times News Service, USA Today and The Wall Street Journal. Also available on NewsEDGE are the business sections of over 100 North American newspapers, periodicals such as Forbes, Fortune, InfoWorld, MacWeek and PC Week and newsletters such as those distributed by American Banker and Phillips Business Information Services, Inc.\nNewswires are delivered to customer LANs through one or more of three delivery vehicles: leased telephone lines; direct satellite transmission; and FM sideband transmission. Many newswire providers have established their own broadcast communications networks using one or more of these three vehicles. In these cases, Desktop Data's role is to arrange the communications between the news provider and the NewsEDGE customer's server. For newspapers, newsletters, magazines and other sources which do not have their own broadcast communications capabilities, news and information are delivered to the Company's news consolidation facility in Burlington, Massachusetts, where it is reformatted for broadcast to NewsEDGE servers and retransmitted to customers by a common carrier communications provider (currently Mainstream Data, Inc.).\nPRICING\nNewsEDGE customers are charged an annual subscription fee for the NewsEDGE service, plus a one-time installation fee. The subscription fee includes the NewsEDGE software, ongoing customer support, and the customer's choice of newswires. Pricing varies depending on the number and type of platforms in the customer's LAN, the number of authorized users and the newswires selected. Current list prices for installation within the United States range from $4,000 to $6,000 per server. There are no separate charges for creating or changing a profile or for conducting searches.\nAs a result of the low incremental cost of providing NewsEDGE to additional users, the Company offers substantial volume discounts. For example, the list price for a customer within the United States with 100 authorized users is currently $55,000 per year for NewsEDGE, including a basic package of newswires, for a cost per user per day of $1.51. The same package for 1,000 authorized users lists for $135,000, at a cost per user per day of $0.37. The NewsEDGE list price for this package decreases on a per user basis as the number of users increases.\nCertain newswires, including popular offerings from Dow Jones and Reuters, are billed separately directly by the news provider as an addition to the NewsEDGE subscription fee. Most customers purchase subscriptions for one or more of these newswires.\nSALES AND MARKETING\nNewsEDGE is sold and marketed through the Company's direct sales force and marketing staff, which as of December 31, 1995, consisted of 49 full time employees based at eleven locations throughout the United States and Canada and locations in both the United Kingdom and The Netherlands. Because the decision to purchase NewsEDGE is complex and has implications for many different groups and constituencies throughout a customer organization, the Company believes that the education, NewsEDGE demonstrations and follow-through required to make a new customer sale is best done by its own sales staff, which focuses exclusively on NewsEDGE. Desktop Data believes that the size and experience of its sales force provide the Company with a competitive advantage. The Company's new account selling is concentrated on major corporations, financial institutions and government agencies where timely news has high value, where there are numerous LAN users and where NewsEDGE cost economies of scale can provide the greatest benefit.\nNewsEDGE is generally sold pursuant to annual subscriptions that renew automatically unless notice of termination is provided prior to the end of the term. The Company sales team responsible for making the initial sale is also\nresponsible for renewals and trade-ups. Trade-ups include the purchase by the customer of additional newswires, the authorization of more users and the acquisition of additional NewsEDGE servers. The Company's experienced direct sales force and significant investments in development and customer support have resulted in annual renewal rates of at least 90% for each of the last five years.\nTo expand its service offerings and assist its sales force in selling NewsEDGE, the Company has entered into development and joint marketing relationships with various corporate partners. For example, the Company has contracted with Reuters and Teknekron to adapt NewsEDGE for use in conjunction with products sold by each of these companies to the trading floors of financial services firms, and to jointly market the resulting service. Similarly, Desktop Data has contracted with NBC Desktop to make NBC Desktop's television and video offerings available through NewsEDGE and to jointly market this service.\nUnder agreements with Lotus and Microsoft, the Company is provided with access to alpha and beta versions of new products being developed by these companies. These arrangements enable the Company to develop and launch features and services which are complementary to new Lotus or Microsoft products simultaneously with the launch by Lotus or Microsoft of those products. In addition, the Company has a marketing agreement with Lotus under which Lotus and Desktop Data sales personnel exchange information concerning sales prospects and make joint sales calls.\nNEWSEDGE CUSTOMERS\nDesktop Data customers include corporate, financial and government customers. As of December 31, 1995, NewsEDGE had been installed by 335 customers, representing approximately 81,000 authorized users. No customer has accounted for over 5% of the Company's revenues in any of the last three years.\nCUSTOMER SUPPORT\nThe Company believes that customer service and support is critical to achieving its objectives. The Company employs its own customer support staff, which provides centralized hotline telephone support, field installation, training and upgrade and maintenance support for NewsEDGE customers. The NewsEDGE support staff consists of individuals with technical knowledge and experience relating not only to NewsEDGE, but also to the various client\/server architectures and systems installed at customer sites. NewsEDGE is a highly visible application operating on customer networks. The operation of NewsEDGE is dependent on the customer's hardware, news communication to the customer's site, the operation of the customer network, other applications which the customer may be running simultaneously and the technical skills of the customer's NewsEDGE administrator. The NewsEDGE support staff diagnoses problems and suggests solutions over the telephone and, where necessary, travels to customer sites for further diagnosis and maintenance and brings in specialized expertise from the Company's emergency staff of technology experts or the NewsEDGE engineers themselves. The Company has a comprehensive call monitoring and problem tracking system to concentrate and escalate attention to customer problems.\nDEVELOPMENT\nThe Company recognizes that the continued enhancement of NewsEDGE and the extension of its news and information offerings is critical to obtaining new customers and to obtaining trade-up sales and renewals from existing customers. Since its inception, Desktop Data has made substantial investments in research and development, issuing regular new releases of its NewsEDGE software since the service's first launch in 1990. The NewsEDGE software has been developed by the Company's internal development and quality assurance staff. New versions of NewsEDGE are released periodically and made available to the client\/server systems installed at customer sites as part of the annual NewsEDGE subscription fee. The current version of NewsEDGE, release 3.00, was made available to customers beginning in February 1996.\nThe Company has developed interfaces to on-line resources provided by other news and information providers, designed to permit NewsEDGE users to be alerted to or search for these resources using NewsEDGE, and then to link directly to them. For example, through Desktop Data's LinkEDGE, a user may be alerted that a press conference announcing breaking developments for a company matching the user's profile is about to be broadcast by NBC Desktop,\nInc. LinkEDGE, which was released in December 1995, is designed to allow the user to directly access this press conference on the user's computer screen through NewsEDGE, rather than waiting for a later news story reporting on the event. Another application of this feature is designed to permit users to readily retrieve SEC filings by linking directly with Indepth Data, Inc., which distributes such filings. The SEC filings application was made available to customers in February 1996.\nOther development efforts have been focused on supporting additional desktop operating platforms and LAN configurations, increasing the number of news sources, expanding storage for news history and providing enhanced precision and functionality for user searches and profiles. The Company's development expenses were $1.7 million, $1.9 million and $2.9 million in 1993, 1994 and 1995, respectively.\nThe NewsEDGE software is entirely proprietary to the Company. The Company believes that control over its own development is critical to its speed and flexibility in meeting market and technology changes. The NewsEDGE server is developed in modules according to the primary NewsEDGE functions: a news collection and alerting module; a news database module for storing and retrieving the full text of the news stories; a network module adaptable to the network protocols installed at customer sites; and a module which allows customer administrators to configure newswire access and monitor NewsEDGE activity. An important aspect of NewsEDGE development is the continuing enhancement of the number of newswires offered by the Company. The Company's marketing personnel identify newswires to be added to the NewsEDGE offerings based on customer feedback, and negotiate contracts with news providers. The newswires are then integrated with NewsEDGE by development and support personnel. The Company is currently seeking to expand its offerings with additional industry-specific information to increase sales to customers in new vertical markets and with additional international news sources to increase the availability of global, 24 hour a day coverage by NewsEDGE.\nCOMPETITION\nThe business information services industry is intensely competitive and is characterized by rapid technological change and the entry into the field of extremely large and well-capitalized companies as well as smaller competitors. The Company competes or may compete directly or indirectly with the following categories of companies: (i) large, well-established news and information providers such as Dialog, Dow Jones, Lexis\/Nexis, Pearson, Reuters and Thomson; (ii) market data services companies such as ADP, Bloomberg, Quotron and Telerate; (iii) traditional print media companies that are increasingly searching for opportunities for on-line provision of news, including through the establishment of World Wide Web sites on the Internet; (iv) large providers of LAN-based software systems such as Lotus and Microsoft, which could, in the future, ally with competing news and information providers; and (v) to a lesser degree, consumer-oriented commercial on-line services and Internet access providers. Many of these companies and market participants not named above have substantially greater financial, technical and marketing resources than the Company.\nThe Company believes that NewsEDGE is differentiated from the news and system products offered by large news and systems providers because of the Company's ability to deliver news from many different, competing providers on an enterprise-wide basis, directly to LAN-connected personal computers, customized to meet the needs of each individual user, at a relatively low cost per user. Although they may compete with the Company in some respects, the Company attempts to establish cooperative, mutually beneficial relationships with large information or systems providers, many of whom are information providers and customers as well as current and potential joint marketing partners. In addition, several smaller companies offer directly competitive products or services that provide news to enterprises through the customer's computer network. The Company believes that NewsEDGE offers advantages over each of these competing products. For example, each of the competing services offers substantially fewer real-time news sources than does NewsEDGE. Furthermore, unlike NewsEDGE, certain competitors do not offer real-time scrolling of news stories, while others do not support Lotus Notes or other groupware applications. In addition, many competitors rely on database engines developed by third parties, and as a result the Company believes these services are not as readily adaptable to evolving customer information provider needs as is NewsEDGE. Finally, each of these smaller competitors is owned by a larger organization, which the Company believes restricts their ability to attract a large variety of news sources and makes it difficult for them to provide the same level and focus of sales, development and customer support as can be provided by Desktop Data.\nIncreased competition, on the basis of price or otherwise, may require price reductions or increased spending on marketing or software development, which could have a material adverse effect on the Company's business and results of operations.\nINTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS\nThe Company primarily relies upon a combination of copyright, trademark and trade secret laws and license agreements to establish and protect proprietary rights in its technology. The NewsEDGE software is licensed to customers on a non-exclusive basis pursuant to license agreements containing provisions prohibiting unauthorized use, copying and transfer of the licensed program. The source code for the Company's software is protected both as a trade secret and as an unpublished copyrighted work. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's software or technology without authorization or to develop similar technology independently. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. The Company does not hold any patents.\nBecause the software development industry is characterized by rapid technological change, the Company believes that factors such as the technological and creative skills of its personnel, new software developments, frequent software enhancements, name recognition and reliable maintenance are more important to establishing and maintaining a technology leadership position than the various legal protections of its technology.\nThe Company believes that its software, trademarks and other proprietary rights do not infringe the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert such infringement by the Company with respect to current or future software or services. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause software release delays or might require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company.\nEMPLOYEES\nAs of December 31, 1995, the Company had 130 full-time employees, consisting of 49 employees in sales and marketing, 35 employees in customer support, 35 employees in development and 11 employees in general administration. The Company's employees are not represented by any collective bargaining organization, and the Company has never experienced a work stoppage. The Company believes that its relationships with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe Company's corporate headquarters are located in Burlington, Massachusetts. The Company leases approximately 40,000 square feet under a lease expiring in May 2003. The Company leases additional facilities and offices for sales and customer service and support in New York, New Jersey, Washington D.C., Pennsylvania, Illinois, California, Texas, Colorado, Toronto, Canada, The Netherlands and London, England. The Company believes that its existing facilities and offices and additional alternative space available to it are adequate to meet its requirements for the foreseeable future.\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. - -------------------------------------------------------------\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 - ------------------------------------------------------------------------------\nThe Company effected its initial public offering of its Common Stock on August 11, 1995 at a price to the public of $15.00 per share. As of February 29, 1996, there were approximately 126 holders of record of the Company's Common Stock. The Company's Common Stock is listed for quotation on the Nasdaq National Market under the symbol \"DTOP.\"\nBased on the Nasdaq National Market daily closing price, the high and low stock prices for each quarter since the Company's initial public offering on August 11, 1995 are shown below. The quotations represent interdealer quotations, without adjustments for retail markups, markdowns, or commissions, and may not necessarily represent actual transactions.\nNasdaq National Market Daily Closing Price:\nThe Company has not paid any cash dividends on its Common Stock and currently intends to retain any future earnings for use in its business. Accordingly, the Company does not anticipate that any cash dividends will be declared or paid on the common stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA - ---------------------------------------------\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (In thousands, except per share data and other operating data)\n(1) Calculated on the basis described in Note 1 of Notes to Consolidated Financial Statements. (2) Number of users authorized pursuant to contracts with installed customers. (3) Calculated by dividing (i) the average of the number of authorized users at the end of the previous year and at the end of the current year, by (ii) the average of the number of installed customers at the end of the previous year and at the end of the current year. (4) Calculated by dividing (i) subscription and royalty revenues for the current year by (ii) the average of the number of installed customers at the end of the previous year and at the end of the current year. (5) Total annualized amount due under subscription agreements in effect at the end of the previous year for installed customers who renew their subscriptions during the current year, as a percentage of the total annualized amount due under all subscriptions for installed customers in effect at the end of the previous year.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - -------------\nINTRODUCTION AND OVERVIEW\nDesktop Data, through its NewsEDGE service and software, delivers a large variety of news and information sources in real time to personal computers and workstations installed on LANs, automatically monitors and filters the news, and alerts the users to stories of interest to them.\nThe Company's revenues consist primarily of NewsEDGE subscription fees and related royalties received from news providers in connection with sales of their newswires through NewsEDGE. Historically, royalties have constituted less than 10% of this amount. The Company's other revenues consist principally of NewsEDGE installation services and related computer hardware system sales, and non-recurring custom development projects related to the Company's software.\nNewsEDGE subscriptions are generally for an initial term of twelve months, payable in advance, and are automatically renewable for successive one year periods unless the customer delivers notice of termination prior to the expiration date of the then current agreement. NewsEDGE subscription revenues are recognized ratably over the subscription term, beginning on installation of the NewsEDGE service. Accordingly, a substantial portion of the Company's revenues are recorded as deferred revenues until they are recognized over the license term. The Company does not capitalize customer acquisition costs.\nCertain newswires offered by the Company through NewsEDGE are purchased by the customer directly from the news provider and payments are made directly from the NewsEDGE customer to the provider. For some of these newswires, the Company receives ongoing royalties on payments made by the customer to the news provider, and those royalties constitute part of the Company's subscription and royalty revenues. For other newswires that are resold by Desktop Data to the NewsEDGE customer, the Company includes a fee for the newswire in the NewsEDGE subscription fee paid by the customer and pays a royalty to the news provider. Such royalties are included in the Company's cost of revenues.\nThe number of installed customers increased to 335 customers at December 31, 1995, from 255 customers at December 31, 1994, an increase of 31%. The number of authorized users within customer organizations increased to 80,613 users at December 31, 1995 from 51,548 users at December 31, 1994, an increase of 56%. The average users per customer increased to 224 users at December 31, 1995 from 165 users at December 31, 1994, an increase of 36%. The Company's average revenues per customer increased to $73,706 for 1995 from $57,445 for 1994, an increase of 28%. Customers renewing their NewsEDGE subscriptions in the three years ended December 31, 1995 have accounted for 99%, 94% and 94%, respectively of the total annualized amounts due under subscription agreements in effect at the end of each of the immediately preceding years.\nRESULTS OF OPERATIONS\nThe following table sets forth certain consolidated financial data as a percentage of total revenues:\nYEAR ENDED DECEMBER 31, 1995 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1994\nRevenues. Revenues consist of (i) subscription and royalty revenues and (ii) other revenues which consist of revenues from NewsEDGE installation services and other sources. Total revenues increased 61% to $23.2 million for 1995 as compared to $14.4 million for 1994. Subscription and royalty revenues increased 68% to $21.7 million from $12.9 million for 1995 and 1994, respectively. The increase in subscription and royalty revenues was attributable to increased subscription revenues from new customers, the retention and growth of revenues from existing customers and increased royalties from the sale of third party information news.\nOther revenues, consisting of revenues from NewsEDGE installation services, computer hardware system sales and non-recurring custom development projects, remained flat at $1.4 million for 1995 and 1994. The Company currently does not solicit hardware sales, and anticipates that revenues from hardware sales will continue to decline as a percentage of total revenues.\nInternational revenues (revenues from customers outside of North America) accounted for less than 5% of revenues during the years ended December 31, 1995 and 1994. The Company established a sales and technical support operation in England during the second half of 1994. The Company expects international revenues to increase as a percentage of total revenues.\nCost of revenues. Cost of revenues consists primarily of royalties paid to third party information providers for the cost of news services licensed to customers, costs associated with transmitting news services to customer sites and the cost of computer hardware sold to customers. Cost of revenues does not include customer support expenses. Cost of revenues, as a percentage of total revenues increased slightly to 28% for the year ended December 31, 1995, as compared to 27% for the year ended December 31, 1994.\nCustomer support expenses. Customer support expenses consist primarily of costs associated with technical support of the Company's installed base of customers. Customer support expenses increased 31% to $2.5 million for 1995, as compared to $1.9 million for 1994. These increases result primarily from higher staffing levels and the continuing need for the Company to provide additional support to its growing customer base. As a percentage of total revenues, customer support expenses declined to 11% for 1995 versus 13% for 1994. The Company anticipates continuing to make significant customer support expenditures as the Company provides service to a growing customer base.\nDevelopment expenses. Development expenses consist primarily of costs associated with the design, programming, and testing of the Company's new software and services. Development expenses increased 51% to $2.9 million for 1995, as compared to $1.9 million for 1994. Development expenses increased as a result of higher staffing levels to provide for enhancements of existing features and the development of new features. Development expenses, as a percentage of total revenues, declined slightly to 12% for the year ended December 31, 1995, as compared to 13% for the year ended December 31, 1994. The Company anticipates continuing to make significant development expenditures as the Company develops new and enhanced services.\nSales and marketing expenses. Sales and marketing expenses consist primarily of compensation costs (including sales commissions and bonuses), travel expenses, trade shows and other marketing programs. Sales and marketing expenses increased 42% to $8.7 million, respectively, for 1995, as compared to $6.2 million for 1994. Sales and marketing expenses represented 38% of revenues for 1995, as compared to 43% for 1994. Sales and marketing expenses increased during these periods, primarily due to the expansion of the sales and marketing organizations. As a percentage of total revenues, however, sales and marketing expenses decreased primarily as a result of the increase in the Company's revenues, without a corresponding increase in sales and marketing expenses. As the revenues derived from subscription renewals and from the expansion of services to existing customers increases and as the productivity of the sales force increases, sales and marketing expenses are expected to increase in absolute dollar amounts but decline as a percentage of total revenues.\nGeneral and administrative expenses. General and administrative expenses consist primarily of expenses for finance, office operations, administration and general management activities, including legal, accounting and other professional fees. General and administrative expenses increased 42% to $1.3 million for 1995, from $900,000 for 1994. The increases in general and administrative expenses were due primarily to additions to staff to support the Company's growth. General and administrative expenses, as a percentage of total revenues, remained flat at 6% for both 1995 and 1994. The Company anticipates that general and administrative expenses will continue to increase in absolute dollar amounts as the Company hires additional personnel, but may vary as a percentage of revenues.\nInterest income, net. Interest income, net consists of interest earned on cash and cash equivalents, offset by interest expense on equipment financing. Interest income, net increased to $897,000 for 1995, from $97,000 for 1994, due to both the interest earned on higher cash balances generated from operations and the proceeds from the Company's initial public offering, and higher interest rates paid on invested cash balances.\nFor the year ended December 31, 1995, the provision for income taxes was $183,000. This provision is the result of state taxes due in states that do not have net operating loss carryforwards available and the alternative minimum tax due under the Internal Revenue Code. No provision for income taxes was made for the year ended December 31, 1994 because the Company experienced a net operating loss for that year.\nYEAR ENDED DECEMBER 31, 1994 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1993\nRevenues. Total revenues increased 87% to $14.4 million for 1994 as compared to $7.7 million for 1993. Total subscription and royalty revenues increased 91% to $12.9 million for 1994 from $6.8 million for 1993. Other revenues increased 60% to $1.4 million for 1994, as compared to $896,000 for 1993. The increase in subscription and royalty revenues was attributable to increased market acceptance of the Company's NewsEDGE service, expansion of NewsEDGE offerings, successful retention and growth of existing customers and growth in the Company's sales, marketing and customer service organizations. The increase in other revenues was due primarily to non-recurring custom development projects which occurred during 1994.\nCost of revenues. Cost of revenues was $3.9 million in 1994 amd $2.0 million in 1993, representing 27% and 26% of total revenues for 1994 and 1993, respectively. The increase in cost of revenues as a percentage of total revenues from 1993 to 1994 was primarily attributable to increased royalties paid to third party information providers resulting from the increase in newswires available through NewsEDGE.\nCustomer support expenses. Customer support expenses increased to $1.9 million for 1994 as compared to $719,000 for 1993. The increase resulted primarily from the hiring of additional software and technical support personnel to provide enhanced and expanded telephone and site support to the growing customer base. As a percentage of total revenues, customer support expenses increased to 13% for 1994 from 9% in 1993.\nDevelopment expenses. Development expenses increased 15% to $1.9 million for 1994, as compared to $1.7 million for 1993. Development expenses increased primarily due to the hiring of additional software and test engineers to support increased development activities. Development expenses, as a percentage of total revenues, decreased to 13% in 1994, versus 22% in 1993.\nSales and marketing expenses. Sales and marketing expenses increased 58% to $6.2 million for 1994, as compared to $3.9 million for 1993. Sales and marketing expenses represented 43% of revenues for 1994, as compared to 51% for the same period in 1993. Sales and marketing expenses increased during these periods, primarily due to the expansion of the sales and marketing organizations. As a percentage of total revenues, however, sales and marketing expenses decreased primarily as a result of the increase in the Company's revenues, without a corresponding increase in sales and marketing expenses.\nGeneral and administrative expenses. General and administrative expenses increased 33% to $900,000 for 1994 from $675,000 for 1993. The increase in general and administrative expenses were due primarily to the hiring of additional personnel to support the Company's expanding operations. General and administrative expenses, as a percentage of total revenues, decreased to 6% for 1994, versus 9% for 1993. The decrease as a percentage of total revenues is primarily due to the Company's ability to increase revenues, without a corresponding increase in general and administrative expenses.\nInterest income, net. Interest income, net increased to $97,000 in 1994, respectively, from $34,000 in 1993, due primarily to higher cash balances and higher interest rates paid on invested cash balances.\nNo provision for income taxes was made for either 1994 or 1993 because the Company experienced net operating losses for these years.\nLIQUIDITY AND CAPITAL RESOURCES\nOn August 11, 1995, the Company completed an initial public offering of its common stock, which provided the Company with net proceeds of approximately $26,711,000. Prior to the initial public offering, the Company funded its operations primarily from cash flow from operations and proceeds from the issuance of Preferred Stock.\nThe Company's cash and cash equivalents and short-term investments balance was $32.4 million at December 31, 1995, as compared to $4.1 million at December 31, 1994, an increase of $28.3 million.\nNet cash provided by operations was $5.8 million, $2.5 million and $846,000 for 1995, 1994 and 1993, respectively. Accounts receivable increased $906,000, $723,000, and $358,000 for 1995, 1994 and 1993, respectively. Deferred revenue increased $2.5 million, $2.6 million, and $2.2 million for 1995, 1994 and 1993, respectively. These increases are due to both profitable operations and the continued growth in subscription fees and increased deferred revenue resulting from advanced payments received from customers.\nNet cash used in investing activities was $14.6 million, $13.1 million for the purchase of short-term investments and $1.4 million for capital expenditures. During 1994 and 1993, the Company used $659,000 and $384,000, respectively, in investing activities, primarily for capital expenditures required to support the expansion and growth of the business.\nNet cash provided by financing activities was $24.0 million and $10,000 for 1995 and 1994, respectively. During 1993, net cash used in financing activities was $11,000. Net cash provided during 1995 consisted primarily of the net proceeds from the Company's initial public offering, offset by payments of dividends on Preferred Stock. All of the Company's Preferred Stock was either converted into Common Stock upon the closing of the public offering or redeemed by the Company during 1995. As such, there is no outstanding Preferred Stock or dividends payable.\nThe Company believes that its current cash, cash equivalents and short-term investments and funds anticipated to be generated from operations, will be sufficient to satisfy working capital and capital expenditure requirements for at least the next twelve months.\nCERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS\nThe Company operates in a rapidly changing environment that involves a number of risks, some of which are beyond the Company's control. The following discussion highlights some of the risks which may affect future operating results.\nCompetition. The business information services industry is intensely competitive and is characterized by rapid technological change and the entry into the field of extremely large and well-capitalized companies as well as smaller competitors. Increased competition, on the basis of price or otherwise, may require price reductions or increased spending on marketing or software development, which could have a material adverse effect on the Company's business and results of operations. See \"Business -- Competition.\"\nDependence on NewsEDGE Service. The Company currently derives substantially all of its revenues from NewsEDGE service subscriptions and related royalties. Although the Company intends to increase the number of news and other information sources available through NewsEDGE and to otherwise enhance NewsEDGE, the Company's strategy is to continue to focus on providing the NewsEDGE service as its sole line of business. In addition, there can be no assurance that the Company will be able to increase the number of news sources or otherwise enhance NewsEDGE. As a result, any factor adversely affecting sales of NewsEDGE would have a material adverse effect on the Company. The Company's future financial performance will depend principally on the market's acceptance of NewsEDGE and the Company's ability to sell NewsEDGE to additional customers and to increase revenue derived from existing customers by increasing the number of users within each customer, adding additional newswires or adding additional NewsEDGE servers.\nDependence on News Providers. The Company currently makes over 500 news and information sources available through NewsEDGE, pursuant to agreements between the Company and over 50 different news providers. A significant percentage of the Company's customers subscribe to services provided by one or more of Press Association Inc., a subsidiary of The Associated Press (\"The Associated Press\"), Dow Jones, The Financial Times, Reuters and Thomson. The Company's agreements with news providers are generally for a term of one year, with automatic renewal unless notice of termination is provided before the end of the term by either party. These agreements may also be terminated by the provider if Desktop Data fails to fulfill its obligations under the agreement and, under some of the agreements, upon the occurrence of a change in control of the Company. Many of these news and information providers compete with one another and, to some extent, with the Company. Termination of one or more significant news provider agreements would decrease the news and information which the Company can offer its customers and would have a material adverse effect on the Company's business and results of operations.\nDependence on News Transmission Sources. NewsEDGE news and information is transmitted using one or more of three methods: leased telephone lines, satellites or FM radio transmission. None of these methods of news transmission is within the control of the Company, and the loss or significant disruption of any of them could have a material adverse effect on the Company's business. Many newswire providers have established their own broadcast communications networks using one or more of these three vehicles. In these cases, Desktop Data's role is to arrange communications between the news provider and the NewsEDGE customer's server. For sources which do not have their own broadcast communications capability, news and information is delivered to the Company's news consolidation facility, where it is reformatted for broadcast to NewsEDGE servers and retransmitted to customers through an arrangement between the Company and Mainstream Data, Inc. (\"Mainstream\"), a common carrier communications vendor. Mainstream is also the communications provider for many newswires offered by the Company through NewsEDGE. The Company's agreement with Mainstream expires on December 31, 1996 and can be terminated earlier in the event of a material breach by the Company of the agreement. If the agreement with Mainstream were terminated on short notice, or if Mainstream were to encounter technical or financial difficulties adversely affecting its ability to continue to perform under the agreement or otherwise, the Company's business would be materially and adversely affected. Mainstream was recently acquired by WavePhore. The Company believes that if Mainstream were unable to fulfill its obligations, other sources of retransmission would be available to the Company, although the transition from Mainstream to those sources could result in delays or interruptions of service that could have a material adverse affect on the Company's business.\nRapid Technological Change. The business information services, software and communications industries are subject to rapid technological change, which may render existing products and services obsolete or require significant unanticipated investments in research and development. The Company's future success will depend, in part, upon its ability to enhance NewsEDGE and keep pace with technological developments.\nDependence on Key Personnel. The Company's success depends to a significant extent upon the continued service of its executive officers and other key management, sales and technical personnel, and on its ability to continue to attract, retain and motivate qualified personnel. The competition for such employees is intense. The Company has no long-term employment contracts with any of its employees, and, with the exception of the Company's executive officers, none of its employees is bound by a non-competition agreement. The loss of the services of one or more of the Company's executive officers, sales people, design engineers or other key personnel or the Company's inability to recruit replacements for such personnel or to otherwise attract, retain and motivate qualified personnel could have a material adverse effect on the Company's business and results of operations. The Company maintains $3 million of key-man life insurance on Donald L. McLagan, the Company's Chairman, President and Chief Executive Officer.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Desktop Data, Inc.:\nWe have audited the accompanying consolidated balance sheets of Desktop Data, Inc. (a Delaware corporation) and subsidiaries as of December 31, 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 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 Desktop Data, 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\nBoston, Massachusetts January 30, 1996\nDESKTOP DATA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDESKTOP DATA, INC. AND SUBSIDIARIES Consolidated Statements of Operations\nThe accompanying notes are an integral part of these consolidated financial statements.\nDESKTOP DATA, INC. AND SUBSIDIARIES\nConsolidated Statements of Stockholders' Equity (Deficit)\nThe accompanying notes are an integral part of these consolidated financial statements.\nDESKTOP DATA, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nThe accompanying notes are an integral part of these consolidated financial statements.\nDESKTOP DATA, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements December 31, 1995\n(1) Operations and Significant Accounting Policies\nDesktop Data, Inc. (the Company) was incorporated on July 11, 1988, and through its NewsEDGE service and software, delivers a large variety of news and information sources in real time to personal computers installed on LANs, automatically monitors and filters the news, and alerts users to stories of interest to them.\nThe accompanying consolidated financial statements reflect the application of certain significant accounting policies, as described in this note and elsewhere in the accompanying notes to consolidated financial statements.\n(a) Principles of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Desktop Data Canada, Inc. and Desktop Data Securities Corp. All material intercompany accounts and transactions have been eliminated in consolidation.\n(b) Cash and Cash Equivalents\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, effective January 1, 1994. The adoption of this statement did not have a material effect on the Company's financial position or results of operations. Under SFAS No. 115, investments that the Company has the positive intent and ability to hold to maturity are reported at amortized cost, which approximates fair market value, and are classified as held-to-maturity. These investments include all cash, cash equivalents and short-term investments. Cash equivalents have original maturities of less than three months at the time of acquistion and consist of the following:\n(c) 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 the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)\n(d) Depreciation\nThe Company provides for depreciation using the straight-line method by charges to operations in amounts that allocate the cost of assets over their estimated useful lives of five years.\n(e) Research and Development and Software Development Costs\nResearch and development costs are expensed as incurred. SFAS No. 86, Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed, requires the capitalization of certain computer software development costs incurred after technological feasibility is established. The Company has not capitalized software development costs to date, as the costs incurred after technological feasibility of a software product has been established have not been significant.\n(f) Revenue Recognition\nRevenues in the accompanying consolidated statements of operations consist of the following:\nThe Company licenses its software for a specified term under standard subscription agreements. Subscription revenues are recognized ratably over the term of the agreement, generally 12 months, beginning upon installation. The unearned portion of revenue is shown as deferred revenue in the accompanying consolidated balance sheets. Royalty revenues are recognized as they are earned under agreements with certain news providers. Other revenues are recognized at the time of shipment or when services are rendered. Cost of revenues includes royalties payable to news service and transmission providers and is expensed over the term of the subscription agreement.\n(g) Foreign Currency Translation\nRevenues and expenses are translated using exchange rates in effect during the year. Gains or losses from foreign currency translation are expensed as incurred. There were no significant gains or losses from foreign currency translations during any year presented.\n(h) Postretirement Benefits\nThe Company has no obligations for postretirement benefits.\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(1) Operations and Significant Accounting Policies (Continued)\n(i) Concentration of Credit Risk\nSFAS No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. The Company has no significant off-balance-sheet concentration of credit risk, such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company maintains the majority of cash balances with two financial institutions, and its accounts receivable balances are primarily domestic. No single customer accounted for greater than 10% of revenues or represents a significant credit risk to the Company.\n(j) Net Income (Loss) and Pro Forma Net Income (Loss) per Common and Common Equivalent Share\nFor the year ended December 31, 1995, net income per common and common equivalent share is computed by dividing net income, less the charge for the accretion of the Series B preferred stock dividends plus the discount on the redemption of the Series B preferred stock, by the weighted average common and common stock equivalents during that period. Common equivalent shares from stock options have been included in the computation using the treasury-stock method. Historical net income (loss) per share data for 1994 and 1993 has not been presented, as such information is not considered to be relevant.\nFor the year ended December 31, 1994, pro forma net loss per common and common equivalent share is computed by dividing net loss, less the charge for the accretion of the Series B preferred stock, by the pro forma weighted average number of common and dilutive common stock equivalent shares outstanding during that period, assuming conversion of all shares of Series A convertible preferred stock and all shares of Series C and D redeemable preferred stock into common stock.\nThe dollar and per share impact available to common stockholders of the redemption of the Series B preferred stock is as follows:\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(1) Operations and Significant Accounting Policies (continued)\n(k) Derivative Financial Information\nDuring October 1994, the Financial Accounting Standards Board issued SFAS No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, which requires disclosures about derivative financial instruments. SFAS No. 119 was effective for 1995. Adoption of this standard did not have a material effect on the Company's financial position or results of operations.\n(2) Income Taxes\nThe Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes, the objective of which is to recognize the amount of current and deferred income taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements as measured by enacted tax laws.\nAt December 31, 1995, the Company has net operating loss carryforwards for federal income tax purposes of approximately $4,700,000. The net operating loss carryforwards expire from 2004 through 2009 and are subject to review and possible adjustment by the Internal Revenue Service. The Tax Reform Act of 1986 contains provisions that may limit the net operating loss carryforwards available to be used in any given year in the event of significant changes in ownership interest.\nThe approximate income tax effect of each type of temporary difference and carryforward is as follows:\nDue to the uncertainty surrounding the realization of the net deferred tax asset, the Company has provided a full valuation allowance against this amount. The reduction in the valuation allowance from 1994 to 1995 is attributable to the utilization of net operating loss carryforwards.\nA reconciliation of the federal statutory rate to the Company's effective tax rate at December 31, 1995 is as follows:\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(3) Stockholders' Equity and Redeemable Preferred Stock\n(a) Redeemable Preferred Stock\nIn December 1990, the Company sold 13,500 shares of Series B redeemable referred stock (the Series B preferred stock) and 1,500 shares of Series C convertible preferred stock (the Series C preferred stock) for gross proceeds of $1,350,000 and $150,000, respectively. On October 20, 1992, the Company sold 20,000 shares of Series D convertible redeemable preferred stock (the Series D preferred stock) for gross proceeds of $2,000,000.\n(b) Stock Split\nOn June 26, 1995, the Company's stockholders approved a 1-for-2.25 reverse stock split of the Company's common stock. The reverse stock split has been retroactively reflected in the accompanying consolidated financial statements and notes for all periods presented.\n(c) Initial Public Offering\nOn August 11, 1995, the Company completed an initial public offering of 1,977,000 shares of its common stock, including 300,000 shares granted to the underwriters upon exercise of their over- allotment option. The proceeds to the Company, net of underwriting discounts, commissions and offering expenses, were approximately $26,711,000.\n(d) Conversion of Preferred Stock\nUpon the closing of the initial public offering, the Series A, Series C and Series D preferred stock was converted (at a rate of approximately 0.444, 534.90 and 33.68 shares, respectively) into an aggregate of 3,847,123 shares of common stock. In addition, the Company paid cash dividends of approximately $2,009,000 and $629,000 on the Series A and Series B preferred stock, respectively.\n(e) Series B Redeemable Preferred Stock\nIn accordance with the underlying agreement, the mandatory redemption requirement related to the Series B preferred stock was relieved upon the Company's initial public offering as the offering price exceeded $13.10 per share. In December 1995, the Company redeemed the Series B preferred stock for $10.00 per share or an aggregate of $135,000, representing a $1,232,238 discount.\n(f) Preferred Stock\nOn June 26, 1995, the Company's stockholders approved a new class of undesignated preferred stock, which became effective upon the closing of the Company's initial public offering.\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(4) Stock Option and Employee Stock Purchase Plans\n(a) 1989 Stock Option Plan\nThe Company has a stock option plan (the 1989 Plan) pursuant to which 622,222 shares of common stock are reserved for issuance. The 1989 Plan is administered by the Board of Directors and provides for the granting of incentive stock options, nonqualified stock options, stock awards and direct stock purchases. During 1995, the Board of Directors terminated the 1989 Plan, such that no further options may be granted under this plan.\nUnder the 1989 Plan, the Company has granted nonstatutory stock options to certain employees. The options generally vest over a four- year period and expire not more than five years from the date of grant.\n(b) 1995 Stock Plan\nOn June 26, 1995, the Company's stockholders approved the 1995 Stock Plan (the 1995 Plan). The 1995 Plan is administered by the Board of Directors and provides for stock awards, direct purchases and the grant of options to purchase shares of the Company's common stock. A maximum of 625,000 shares may be issued under this plan.\n(c) 1995 Non-Employee Director Stock Option Plan\nOn June 26, 1995, the Company's stockholders also approved the 1995 Non-Employee Director Stock Option Plan (the 1995 Director Plan), for which 100,000 shares of the Company's common stock have been reserved. The purpose of the 1995 Director Plan is to attract and retain qualified persons who are not also officers or employees of the Company (the Eligible Directors) to serve as directors of the Company. Under the 1995 Director Plan, any Eligible Director shall automatically be granted an option to purchase 5,000 shares of common stock on the effective date of election at an option price equal to the fair market value on the date of grant, and an option to purchase 2,500 shares of the common stock on the date of each successive annual meeting of the stockholders, if such director has attended at least 75% of the meetings of the Board during the past fiscal year. Options granted under this plan expire 10 years from the date of grant. As of December 31, 1995, the Company has not made any grants under this plan.\nDESKTOP DATA, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements December 31,1995\n(4) Stock Option and Employee Stock Purchase Plans (Continued)\nThe following schedule summarizes all stock option activity under the 1989 and 1995 plans for the three years ended December 31, 1995:\n(d) 1995 Employee Stock Purchase Plan\nOn June 26, 1995, the Company's stockholders approved the 1995 Employee Stock Purchase Plan (the 1995 Purchase Plan). This plan permits eligible employees to purchase the Company's common stock at 85% of the fair market value of the stock on the first or last date of each semiannual plan period, whichever is lower. The 1995 Purchase Plan covers substantially all employees, subject to certain limitations. An eligible employee may elect to have up to 10% of his or her total compensation, as defined, withheld and applied toward the purchase of shares in such a plan period (not to exceed $25,000 in any year). At December 31, 1995, 175,000 shares of common stock were reserved for purchases under the 1995 Purchase Plan. As of December 31, 1995, there have been no purchases to date under the 1995 Purchase Plan.\nDESKTOP DATA, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements December 31, 1995\n(5) Commitments\n(a) Operating Leases\nThe Company conducts its operations in facilities under operating leases expiring through 2003. The Company's future minimum lease payments under these leases as of December 31, 1995 are approximately as follows:\nRent expense charged to operations was approximately, $564,000, $452,000 and $319,000 for the years ended 1995, 1994 and 1993, respectively.\n(b) Capital Leases\nThe Company leases certain equipment under capital leases. Future minimum lease payments under these capital leases as of December 31, 1995 are as follows:\nDESKTOP DATA, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995\n(6) Prepaid Expenses and Deposits\nPrepaid expenses and deposits in the accompanying consolidated balance sheets consist of the following:\n(7) Accrued Expenses\nAccrued expenses in the accompanying consolidated balance sheets consist of the following:\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 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 not 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 AND OTHER INFORMATION - ------------------------------------------------------\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 SCHEDULE AND REPORTS ON FORM 8-K. - -------------------------------------------------------------------------\n(a) List of documents filed as part of this report (1) Financial Statements -------------------- Financial Statements (Listed Under Part II, Item 8 and included herein by reference).\n(2) Financial Statement Schedules -----------------------------\n(3) Exhibits --------\n* Filed herewith.\n(b) Reports on Form 8-K.\nThe Company filed no reports on Form 8-K during the last quarter of the year ended December 31, 1995.\n(c) The exhibits required by this Item are listed under Item 14(a).\n(d) The financial statement schedules required by this Item are listed under Item 14(a).\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.\nDESKTOP DATA, INC. (Registrant)\nDate: March 27, 1996 \/s\/ Donald L. McLagan ---------------------------------------- Donald L. McLagan Chairman, President and Chief Executive Officer\nSIGNATURES\nPursuant to the requirements of the Securities and 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.","section_15":""}
{"filename":"822818_1995.txt","cik":"822818","year":"1995","section_1":"ITEM 1. BUSINESS\nClean Harbors, Inc., through its subsidiaries (collectively, the \"Company\"), provides a wide range of industrial waste management services to a diversified customer base across the United States. The Company was incorporated in Massachusetts in 1980. The principal offices of the Company are located in Braintree, Massachusetts.\nThe Company is one of the largest providers of industrial waste management services in the Northeast and Mid-Atlantic regions of the United States, with a growing presence in the Central, Midwest and Southern regions. The Company seeks to be recognized by customers as the premier supplier of a broad range of value-added industrial waste management services based upon quality, responsiveness, customer service, variety of risk containment systems, and cost effectiveness.\nThe Company currently maintains a network of service centers and sales offices located in 24 states and Puerto Rico, and operates 12 waste management facilities. The service centers interface with the customers, and perform a variety of environmental remediation and hazardous waste management activities, utilizing the waste management facilities to store, treat and dispose of waste. The Company also provides analytical testing and engineering services which complement its primary services and permit it to offer complete solutions to its customers' complex environmental requirements. The Company's principal customers are chemical, petroleum, transportation, utility and industrial firms, other waste management companies and government agencies.\nIntensified levels of federal and state environmental regulation and enforcement have been a major factor in increasing the demand for the Company's services. The Company believes that its success is attributable in large part to customers' confidence in the Company's ability to comply with these regulations and to manage effectively the risks involved in providing these services. As part of its commitment to employee safety and quality customer service, the Company has an extensive compliance program and a trained environmental, health and safety staff. The Company follows a risk management program designed to reduce potential liabilities for the Company and its customers.\nBUSINESS STRATEGY\nThe Company's strategy is to develop and maintain an ongoing relationship with a diversified group of customers who have recurring needs for multiple services in managing their environmental exposure.\nIn order to maintain and enhance its leading position in the industrial waste management industry, the Company has implemented a strategy of internal growth through the increased utilization of existing facilities, the addition of new sales offices and service centers, and the development of new waste management services. In addition, the Company achieves external growth through strategic acquisitions.\nIncreased Utilization of Waste Management Facilities. The Company currently has 12 waste management facilities which represent a substantial investment in permits, plants and equipment. These facilities provide the Company with significant operating leverage. There are opportunities to expand capacity at these facilities by modifying the terms of the existing permits and by adding capital equipment and new technology. Through selected permit modifications, the Company can expand the range of treatment services which it offers to its customers without the large capital investment necessary to acquire or build new waste management facilities. The Company believes that permits for new industrial waste management facilities will become increasingly difficult to obtain, thereby placing new entrants and weaker competitors at a disadvantage.\nSales Office\/Service Center Expansion. The Company opens sales offices in attractive target markets in order to expand the Company's service areas. Sales personnel focus on selling Transportation, Treatment, Disposal and CleanPack services to the local market, with operational support from the District Logistics Office located\nclosest to the \"new\" market area. The District Logistics Office is responsible for delivering disposal and CleanPack services to the \"new\" market area by utilizing existing capacity in the transportation fleet by utilizing backhauls from existing routes. As demand at a particular sales office reaches a sufficient level for Field Services, Emergency Response or Remedial work, the sales office can be upgraded to a service center by the addition of service personnel and equipment. The Company's sales offices and service centers direct waste into the Company's waste management facilities. This allows the Company to expand its service areas with low risk capital investment and to maximize throughput with minimal incremental cost by obtaining additional wastes to be handled by the Company's service centers and waste management facilities.\nNew Waste Management Services. Industrial waste generators are demanding alternatives to traditional waste disposal methods in order to increase recycling and reclamation and to minimize the end disposal of hazardous waste into the environment. The Company utilizes its technological expertise and innovation to improve and expand the range of services which it offers to its customers. The Company has commercialized a hazardous waste treatment system, the Clean Extraction System (\"CES\"), to extract toxic compounds from industrial wastewaters by utilizing non-toxic liquid carbon dioxide at high pressures. CES offers for certain wastewater streams a recycling alternative to incineration or injection into deep underground wells.\nOccasionally, companies primarily operating in other industries or engaged in research and development have sought to join with the Company to evaluate the commercial potential of a particular technology or process for solving environmental problems. In May 1994, the Company signed a development agreement with Molten Metal Technology, Inc. of Waltham, Massachusetts (\"MMT\"), an environmental technology company developing an innovative, proprietary processing technology known as Catalytic Extraction Processing (\"CEP\"). CEP utilizes a molten metal bath as a catalyst and solvent to break down the molecular structure of various hazardous wastes into its elements. With the addition of various other elements, industrial compounds are made into products for reuse as a raw material by the feedstock generator or for sale to other industrial users. Development of the CEP system pursuant to the agreement is subject to a number of conditions, including the execution of definitive agreements, and no assurances can be given that the proposed CEP unit will be successfully developed.\nIn May 1995, the Company acquired a newly constructed hazardous waste incinerator in Kimball, Nebraska, to incinerate liquid and solid wastes which are not suitable for treatment in the CES. These actions to develop new waste management services are expected to reduce the Company's dependence on outside disposal vendors.\nIn November 1995, the Company entered into a Reciprocal Marketing and Business Development Agreement with Rochem Separation Systems, Inc. (\"Rochem\"), the California based subsidiary of Rochem, A.G., owner of the patented disc tube membrane module reverse osmosis system known as DTM (\"DTM\"). Rochem holds the exclusive U.S. rights to market and sell DTM, which is compatible with Clean Harbors' Clean Extraction System (\"CES\") Technology. Under the terms of the Agreement, Rochem and Clean Harbors will jointly market, sell, install and support or operate DTM and CES technology to customers throughout the United States. Clean Harbors also has the right to negotiate an exclusive license with Rochem for new applications of DTM technology developed during the term of the Agreement.\nCapitalization on Industry Consolidation. The Company believes that its large industrial customers will ultimately require a comprehensive range of waste treatment capabilities, field services, industrial maintenance services and emergency response services to be provided by a select number of service providers. This trend will put smaller operators at a competitive disadvantage due to their size and limited financial resources. To respond to its customers' needs, the Company has increased the range of waste management services it offers and has followed a strategy of acquiring companies in existing, contiguous and new market areas. Since its formation in 1980, the Company has completed 14 acquisitions which have significantly expanded the Company's market share. Acquisitions within the Company's existing areas of operation serve to capture incremental market share, while geographic expansion creates new market opportunities. The Company continues to investigate and discuss other potential acquisitions of permitted facilities in order to enhance\nservice to its existing customer base and expand its customer base to include new regional customers as well as waste generators with operations in several regions.\nACQUISITIONS\nThe Company has made seven acquisitions since January 1, 1989. The Company also recently expanded its Chicago waste management facility onto an adjoining site formerly occupied by Chemical Waste Management, Inc., which will allow the Company to offer new waste treatment services in the Midwest region.\nPrior to closing any acquisition, the Company attempts to investigate thoroughly the current and contingent liabilities of the company or assets to be acquired, including potential liabilities arising from noncompliance with environmental laws by prior owners for which the Company, as a successor owner, might become responsible. The Company also seeks to minimize the impact of potential liabilities by obtaining indemnities and warranties from the sellers which may be supported by deferring payment of or by escrowing a portion of the purchase price. See \"Legal Proceedings\" below for a description of the indemnities which the Company has received in connection with past acquisitions.\nSERVICES PROVIDED BY THE COMPANY\nSERVICES\nThe principal services provided by the Company fit within three categories: treatment and disposal of industrial wastes (\"Treatment and Disposal\"); field services provided at customer sites (\"Field Services\"); and specialized repackaging, treatment and disposal services for laboratory chemicals and household hazardous wastes (\"CleanPacks\"). The Company markets these services on an integrated basis and, in many instances, services in one area of the business support or lead to a project undertaken in another area.\nIn addition to these three principal services, the Company also provides technical services such as analytical testing and engineering services and personnel training. Such technical services primarily support the Company's principal services, although technical services are also offered to a limited extent on a stand-alone commercial basis.\nThe Company currently maintains a network of 12 waste management facilities, complemented by service centers, district logistic office and sales offices in 24 states and Puerto Rico. The service centers and sales offices accommodate sales personnel who develop and maintain contact with the Company's customers. Customers are generally covered by \"Agents of Business\" (Account Managers, CleanPack and Field Specialists, inside\nService Representatives) who are responsible for order taking, handling customer inquiries and other administrative tasks. Account managers utilize the expertise of product specialists in order to evaluate the scope of a potential job, quote a job and ultimately detail the work order, including personnel and equipment necessary to complete the job. The service centers and logistic offices also serve as depots for the specialized equipment and trained technical personnel which respond to customers' waste management requirements. The Company utilizes a \"hub and spoke\" organization where service centers, logistic offices and sales offices feed waste disposal business into the Company's 12 waste management facilities. Waste which cannot be treated at those facilities is sent to other final disposal sites.\nAs an integral part of the Company's services, industrial wastes are collected from customers and transported by the Company to and between its facilities for treatment or bulking for shipment to final disposal locations. Customers typically accumulate waste in containers, such as 55-gallon drums, or in bulk in storage tanks or 20-cubic yard roll-off boxes. In providing this service, the Company utilizes a variety of specially designed and constructed tank trucks and semi-trailers, as well as other third-party transporters, including railroads. Liquid waste is frequently transported in bulk, but may also be transported in drums. Heavier sludges or bulk solids are transported in sealed, roll-off boxes or bulk dump trailers.\nTREATMENT AND DISPOSAL\nThe Company transports, treats and disposes of industrial wastes for commercial and industrial customers, health care providers, educational and research organizations, other waste management companies and governmental entities. The wastes handled include substances which are classified as \"hazardous\" because of their corrosive, ignitable, infectious, reactive or toxic properties, and other substances subject to federal and state environmental regulation. Waste types processed or transferred in drums or bulk quantities include:\n.flammables, combustibles and other organics, .acids and caustics, .cyanides and sulfides, .solids and sludges, .industrial wastewaters, .items containing PCBs, such as utility transformers and electrical light ballasts, .medical waste, .other regulated wastes, and .nonhazardous industrial waste.\nThe Company receives a detailed waste profile sheet prepared by the customer to document the nature of the customer's waste. A representative sample of the delivered waste is screened to ensure that it conforms to the customer's waste profile record and to select an appropriate method of treatment and disposal. Once the wastes are characterized, compatible groups are consolidated to achieve economies in storage, handling, transportation and ultimate treatment and disposal. At the time of acceptance of a customer's waste at the Company's facility, a unique computer \"bar code\" identification character is assigned to each container of waste, enabling the Company to use sophisticated computer systems to track and document the status, location and disposition of the waste.\nWastewater Treatment. The Company's treatment operations involve processing hazardous wastes through the use of physical, chemical, thermal or other methods. The solid waste materials produced by these wastewater processing operations are then disposed of off-site at facilities owned and operated by unrelated businesses.\nThe Company treats a broad range of industrial liquid and semi-liquid wastes containing heavy metals, organics and suspended solids, including:\n.acids and caustics,\n.ammonias, sulfides, and cyanides, .heavy metals, ink wastes, and plating solutions, .landfill leachates and scrubber waters, and .oily wastes and water soluble coolants.\nWastewater treatment can be economical as well as environmentally sound, by combining different wastewaters in a \"batching\" process that reduces costs for multiple waste stream disposal. Acidic waste from one source can be neutralized with alkaline from a second source to produce a neutral solution.\nPhysical Treatment. Physical treatment methods include distillation, separation and stabilization. These methods are used to reduce the volume or toxicity of waste material or to make it suitable for further treatment, reuse, or disposal. Distillation uses either heat or vacuum to purify liquids for resale. Separation utilizes techniques such as sedimentation, filtration, flocculation and centrifugation to remove solid materials from liquids. Stabilization refers to a category of waste treatment processes designed to reduce contaminant mobility or solubility and convert waste to a more chemically stable form. Stabilization technology includes many classes of immobilization systems and applications. Examples include low-temperature processes such as adding a sand-like cement material, and high-temperature processes such as vitrification. Stabilization is a frequent treatment method for metal-bearing wastes received at several Company facilities, which treat the waste to meet specific federal land disposal restrictions. After treatment, the waste is tested to confirm that it has been rendered nonhazardous. It can then be sent to a nonhazardous waste landfill, at significantly lower cost than disposal at a hazardous waste landfill.\nThermal Treatment. Thermal treatment refers to processes that use high temperature combustion the principal means of waste destruction. In May 1995, the Company acquired a newly constructed, state-of-the-art hazardous waste incinerator in Kimball, Nebraska, which uses a fluidized bed thermal oxidation unit for maximum destruction efficiency of hazardous waste. The Company also operates an incinerator at its Braintree facility which was previously used to destroy medical waste. In late 1991, approvals were granted to allow the Braintree incinerator to destroy nonhazardous wastes which were previously sent to landfills or municipal incinerators. It also generates steam which is used in steam distillation equipment for reclaiming solvents. Other waste residues are incinerated in off-site facilities, such as the Nebraska hazardous waste incinerator, and in similar facilities owned and operated by other companies.\nResource Recovery. Resource recovery involves the treatment of wastes using various methods which will effectively remove contaminants from the original material to restore its fitness for its intended purpose, and to reduce the volume of waste requiring disposal. In conjunction with recent regulatory provisions restricting the burial of various types of hazardous wastes, the Company substantially upgraded its existing facilities for the reclamation and reuse of certain wastes, particularly solvent-based wastes generated by industrial cleaning operations, metal finishing and other manufacturing processes.\nSpent solvents that can be recycled are processed through thin film evaporators and other processing equipment and are distilled into clean, usable products. Upon recovery of these products, the Company either returns the recovered solvents to the original generator or sells them to third parties.\nOrganic liquids and solids with sufficient heat value are blended to meet strict specifications for use as supplemental fuels for cement kilns, industrial furnaces and other high-efficiency boilers. The Company has installed fuels blending equipment at its Chicago and Cincinnati plants to prepare these supplemental fuels. The Company has established relationships with a number of supplemental fuel users that are licensed to accept the blended fuel material. Although the Company pays a fee to the users who accept this product, this disposal method is substantially less costly than other disposal methods.\nClean Extraction System. The Clean Extraction System (\"CES\") is a hazardous waste treatment system commercialized by the Company which extracts organic compounds from industrial wastewater. CES uses carbon dioxide that has been compressed at high pressure into a liquid. Under these \"supercritical\" conditions,\ncarbon dioxide acts as a powerful solvent for most commonly occurring contaminants. CES uses supercritical carbon dioxide as a solvent to remove organic contaminants, such as gasoline, acetone, methylene chloride, pesticides and other chemicals, from industrial wastewater called \"lean water.\" Lean water is generated by oil companies, utilities, and manufacturers of specialty chemicals and pharmaceuticals.\nThe CES was installed at the Company's Baltimore facility, and began commercial operation in June 1992. The system includes specialized pretreatment and post-treatment systems and techniques, in addition to a central extractor unit, to maximize extraction efficiency. In the Baltimore CES, wastewater receives chemical and physical pretreatment before entering a central extractor unit. The wastewater is fed into the top of a 40-foot tall pressurized chamber, and flows down through a stack of perforated plates as a continual supply of liquefied carbon dioxide rises from the bottom of the chamber. As the wastewater and carbon dioxide mix, organic contaminants separate from the water and dissolve in the carbon dioxide. The liquid carbon dioxide flows from the top of the chamber into a decompression vessel. As the pressure decreases, the carbon dioxide vaporizes into a gas, leaving the organic contaminants at the bottom of the vessel, where they are collected. The concentrated organics can be recycled or burned as a supplemental fuel for resource recovery. The cleansed water flows from the bottom of the chamber, through a series of decompression and post-treatment tanks. After treatment, the cleansed water is discharged to the City of Baltimore sewer treatment works.\nThis process enables the Company to handle a broad range of complex, difficult to treat organic and inorganic \"lean waters\" formerly sent to other companies for disposal. CES offers the Company's industrial customers, such as chemical or pharmaceutical companies, an attractive recycling alternative to disposal of their \"lean water\" by incineration or injection into deep underground wells. Current treatment capacity is between six and ten million gallons per year, depending on the characteristics of the wastewater being treated.\nDisposal. After treatment of industrial wastes at the Company's facilities, the hazardous waste residues (such as sludges) which remain after such treatment are disposed of in facilities operated by third parties. The Company also arranges for the disposal of its customers' hazardous wastes which cannot be treated at Company-owned facilities. Wastes which cannot be disposed of in the Nebraska hazardous waste incinerator, which the Company acquired in May 1995, are sent to other incinerators, landfills, and disposal facilities operated by third parties. These arrangements are typically made before the Company accepts waste. Although the Company's transfer facilities are licensed to store waste, such storage is typically for a short period of time before the waste is sent for ultimate disposal. On occasion, a service center may also arrange to ship a customer's waste directly to another disposal company, such as a landfill or incinerator, if the size of the waste shipment or its characteristics are such that the waste does not need to pass through one of the Company's own waste management facilities. As the volume of waste handled by the Company has grown, the Company has negotiated favorable disposal arrangements with numerous companies. The Company is not dependent on any one disposal company, and the loss of any particular outlet for disposal of waste would not have a material impact on the Company.\nThe Company's wastewater treatment operations are dependent upon access to publicly owned treatment works and to hazardous or nonhazardous waste landfills for the disposal of its byproduct wastes. Generally, the Company has not experienced significant difficulty in obtaining the necessary permits from local sewer authorities.\nFIELD SERVICES\nThe Company provides a wide range of environmental field services to maintain industrial facilities and process equipment, as well as clean up or contain actual or threatened releases of hazardous materials into the environment. These services are provided primarily to large chemical, petroleum, transportation, utility, industrial and waste management companies, and to governmental agencies. The Company's strategy is to identify, evaluate, and solve its customers' environmental problems, on a planned or emergency basis, by providing a comprehensive interdisciplinary response to the specific requirements of each project.\nIndustrial Maintenance. Many of the Company's customers have a recurring need to clean equipment and facilities periodically in order to continue operations, maintain and improve operating efficiencies of their plants, and satisfy safety requirements. Industrial maintenance involves chemical cleaning, hydroblasting, vacuuming, and other methods to remove deposits from process equipment, such as paint booths and plating lines, and storage facilities for material used in the manufacturing or production process, such as feedstocks, chemicals, fuels, paints, oils, inks, metals and many other items. Service centers are equipped with specialty equipment, such as high volume pumps, pressure washers, nonsparking and chemical resistant tools, and a variety of personal protective equipment, to perform maintenance services quickly, usually during \"off periods\" to minimize downtime from production.\nProject Management. An increasingly important area of the Company's operations is the management of complex environmental remediation projects. These projects may include surface remediation, groundwater restoration, site and facility decontamination, and emergency response. An interdisciplinary team of managers, chemists, engineers, and compliance experts design and implement result-oriented remedial programs, incorporating both off-site removal and on-site treatment, as needed. The remedial projects group functions as a single source management team, relieving the customer of the administrative and operational burdens associated with environmental remediation. As a full-service environmental services company, providing waste transportation and disposal, field services, industrial maintenance and CleanPack services, the Company eliminates the need for multiple subcontractors.\nThese projects vary widely in scope, duration and revenue, and they are typically performed under service agreements between the customer and the Company. Environmental remediation projects may be undertaken in conjunction with or lead to contracts for additional remediation work or for hazardous waste management services, and typically involve the Company's analytical laboratory and engineering group.\nSurface Remediation. Surface remediation projects arise in two principal areas: the planned cleanup of hazardous waste sites and the cleanup of accidental spills and discharges of hazardous materials, such as those resulting from transportation and industrial accidents. In addition, some surface remediation projects involve the cleanup and maintenance of industrial lagoons, ponds and other surface impoundments on a recurring basis. In all of these cases, an extremely broad range of hazardous substances may be encountered.\nSurface remediation projects generally require considerable interaction among engineering, project management and analytical services. Following the selection of the preferred remedial alternative, the project team identifies the processes and equipment for cleanup. Simultaneously, the Company's health and safety staff develops a site safety plan for the project. Remedial approaches usually include physical removal, mechanical dewatering, stabilization or encapsulation.\nGroundwater Restoration. The Company's groundwater restoration services typically involve response to above-ground spills, leaking underground tanks and lines, hazardous waste landfills and leaking surface impoundments. Groundwater restoration efforts often require complex recovery systems, including recovery drains or wells, air strippers, biodegradation or carbon filtration systems, and containment barriers. These systems and technologies can be used individually or in combination to remove a full range of floating or dissolved organic compounds from groundwater. The Company internally designs and fabricates most mobile or fixed site groundwater treatment systems.\nSite and Facility Decontamination. Site and facility decontamination involves the cleanup and restoration of buildings, equipment and other sites and facilities that have been contaminated by exposure to hazardous materials during a manufacturing process, or by fires, process malfunctions, spills or other accidents. The Company's projects have included decontamination of electrical generating stations, electrical and electronics components, transformer vaults and commercial, educational, industrial, laboratory, research and manufacturing facilities.\nEmergency Response. The Company undertakes environmental remediation projects on both a planned and emergency basis. Emergency response actions may develop into planned remedial action projects when soil, groundwater, buildings, or facilities are extensively contaminated. The Company has established specially trained emergency response teams which operate on a 24- hour basis from service centers covering 24 states and Puerto Rico. Many of the Company's remediation activities result from a response to an emergency situation by one of its response teams. These incidents can result from transportation accidents involving chemical substances, fires at chemical facilities or hazardous waste sites, transformer fires or explosions involving PCBs, and other unanticipated developments when the substances involved pose an immediate threat to public health or the environment, such as possible groundwater contamination.\nEmergency response projects require trained personnel, equipped with protective gear and specialized equipment, prepared to respond promptly whenever these situations occur. To meet the staffing requirements for emergency response projects, the Company relies in part upon a network of trained personnel who are available on a contract basis for specific project assignments. The Company's health and safety specialists and other skilled personnel closely supervise these projects during and subsequent to the cleanup. The steps performed by the Company include rapid response, containment and control procedures, analytical testing and assessment, neutralization and treatment, collection, and transportation of the substances to an appropriate treatment or disposal facility.\nCLEANPACKS\nThe Company provides specialized repackaging, treatment and disposal services for laboratory chemicals and household hazardous wastes. Such chemicals and wastes are put into CleanPacks, which are packages smaller than a 55-gallon drum, generally less than five gallons or 50 pounds. The Company offers generators of CleanPack quantity waste the same economical and environmentally sound disposal services that have been offered for years to large industrial generators. The CleanPack operation services a wide variety of customers, including:\n.engineering and research and development divisions of industrial companies, .college, university and high school labs, .EPA labs and Veterans Administration facilities, .hospitals and medical care labs, .state and local municipalities, and .tens of thousands of residents through household hazardous waste collection days.\nThe Company provides a team of qualified personnel with science degrees and special training to collect, label and package waste at the customer's site. CleanPacks are then transported to one of the Company's facilities for consolidation into full-size containers, which are then sent for further treatment or disposal as part of the Company's treatment and disposal services described above. As described above, disposal options include reclamation, fuels blending, incineration, aqueous treatment, and a secure chemical landfill.\nTECHNICAL SERVICES\nTechnical services consist primarily of analytical testing, engineering services and personnel training. Many of the Company's principal services as described above involve the selection and application of various technologies. The Company's analytical testing laboratories perform a wide range of quantitative and qualitative analyses to determine the existence, nature, level, and extent of contamination in various media. The Company's engineering staff identifies, evaluates and implements the appropriate environmental solution.\nEngineering and Analytical Services. The Company provides technical support services to complement its primary service lines. For example, if the Company is engaged to perform an entire environmental remediation project, it will first perform a site or situation assessment. A site assessment begins with the determination of the existence of contamination. If present, the nature and extent of the contamination is defined by gathering\nsamples and then analyzing them in order to establish or verify the nature and extent of the contaminants. The Company's engineering staff then develops, evaluates and presents alternative solutions to remedy the particular situation. Often treatment systems are completely designed, engineered and fabricated by the Company in house. It then implements the mitigation and decontamination program mutually selected by the customer and the Company.\nThese services are also provided if a customer requires an analysis with respect to certain material, or if a customer is searching for an appropriate solution to an environmental problem or if an environmental assessment is required to allow a transfer of property.\nThe Company operates an EPA-qualified and state-certified analytical testing laboratory in Braintree, Massachusetts which tests samples provided by customers to identify and quantify toxic pollutants in virtually every component of the environment. The laboratory staff evaluates the properties of a given material, selects appropriate analytical methods, and executes a laboratory work plan that results in a comprehensive technical report. In early 1996, the Company relocated the laboratory from its headquarter offices to its waste handling facility in Braintree.\nThe Company also maintains laboratories at its waste management facilities to identify and characterize waste materials prior to acceptance for treatment and disposal, and operates mobile laboratory facilities for field use in emergency response and remedial action situations.\nPersonnel Training. The Company provides comprehensive personnel training programs for its own employees and those of its customers on a commercial basis. Such programs are designed to promote safe work practices under potential hazardous environmental conditions, whether or not toxic chemicals are present, in compliance with stringent regulations promulgated under the federal Resource Conservation and Recovery Act of 1976 (\"RCRA\") and the federal Occupational Safety and Health Act (\"OSHA\"). The Company's Technical Training Center at its Kingston, Massachusetts facility includes a 2,000 gallon tank for confined space entry, exit, and extraction, an air-system demonstration maze, respirator fit testing room, leak and spill response equipment, and a layout of a mock decontamination zone, all designed to fulfill the requirements of OSHA Hazardous Waste and Emergency Response Standard.\nCUSTOMERS\nThe Company's sales efforts are directed toward establishing and maintaining relationships with businesses which have ongoing requirements for one or more of the Company's services. The Company's customer list includes many of the largest United States industrial companies. In addition, the Company's customers include most of the major utilities in the Northeast and Mid- Atlantic regions. The Company's customers are primarily chemical, petroleum, transportation, utility and industrial firms, other waste management companies and government agencies. Management believes that the Company's diverse customer base, in terms of number, industry and geographic location, as well as its large presence in New England, provide it with a recurring stream of revenue. The Company estimates that in excess of 80% of its revenues are derived from previously served customers with recurring needs for the Company's services. The Company believes the loss of any single customer would not have a material adverse effect on the Company's financial condition or results of operations.\nThe Company's customer base is diverse, and generally not concentrated in particular industries, such as the petroleum or defense sectors, where business activity may be cyclical. In addition to serving industrial customers such as utilities, railroads, pipelines, pharmaceutical manufacturers, and chemical companies, the Company serves health care and educational institutions, federal, state and local governmental bodies, and thousands of small quantity generators who have recurring needs for multiple services in managing their environmental exposure.\nUnder applicable environmental laws and regulations, generators of hazardous wastes retain potential legal liability for the proper treatment of such wastes through and including their ultimate disposal. In response to\nthese potential liability concerns, many large generators of industrial wastes and other purchasers of waste management services (such as general contractors on major remediation projects) have increasingly sought to decrease the number of providers of such services that they utilize. Waste management companies which are selected as \"approved vendors\" by such large generators and other purchasers are firms, such as the Company, that possess comprehensive collection, recycling, treatment, transportation, disposal and waste tracking capabilities and have the expertise and financial capacity necessary to comply with applicable environmental laws and regulations. By becoming an \"approved vendor\" of a large waste generator or other purchaser, the Company becomes eligible to provide waste management services to the various plants and projects of such generator or purchaser which are located in the Company's service areas. However, in order to obtain such \"approved vendor\" status, it may be necessary for the Company to bid against other qualified competitors in terms of the services and pricing to be provided. Furthermore, large generators or other purchasers of waste management services often periodically audit the Company's facilities and operations to ensure that the Company's waste management services to such customers are being performed in compliance with applicable laws and regulations and with other criteria established by the Company and by such customers.\nCOMPLIANCE\/HEALTH & SAFETY\nThe Company regards compliance with applicable environmental regulations as a critical component of its overall operations, both from the standpoint of the health and safety of its employees and as a service to its customers. The Company strives to maintain the highest professional standards in its compliance activities; its internal operating requirements are in many instances more stringent than those imposed by regulation. The Company's compliance program has been developed for each of its operational facilities and service centers under the direction of the Company's corporate compliance and health and safety staff. The compliance staff is composed of approximately 45 full-time employees who are responsible for facilities permitting and regulatory compliance, health and safety, field safety, compliance training, transportation compliance, and related record keeping. The Company also performs periodic audits and inspections of the disposal facilities of other firms utilized by the Company.\nThe Company's treatment, storage and recovery facilities are frequently inspected and audited by regulatory agencies, as well as by customers. Although the Company's facilities have been cited on occasion for regulatory violations, the Company believes that each facility is currently in substantial compliance with applicable requirements. Major facilities and service centers have a full-time compliance or health and safety representative to oversee the implementation of the Company's compliance program at the facility or service center. These highly-trained regulatory specialists are independent from operations and report to corporate compliance and health & safety directors, who in turn report directly to the Chief Executive Officer.\nMANAGEMENT OF RISKS\nThe Company follows a program of risk management policies and practices designed to reduce potential liability, as well as to manage customers' ongoing regulatory responsibilities. This program includes installation of risk management systems at the facilities, such as fire suppression, employee training, environmental auditing, and policy decisions restricting the types of wastes handled. The Company evaluates all revenue opportunities and declines those which it believes involve unacceptable risks. The Company avoids handling high-hazard waste such as explosives, and frequently utilizes specialty subcontractors to handle any such materials when discovered at a job site.\nThe Company only disposes of its wastes at facilities owned and operated by firms which the Company has approved as prudent and financially sound. Typically, the Company applies established technologies to the treatment, storage and recovery of hazardous wastes. The Company believes its operations are conducted in a safe and prudent manner and in substantial compliance with applicable laws and regulations.\nINSURANCE\nThe Company's present insurance programs cover the potential risks associated with its multifaceted operations from two primary exposures: direct physical damage and third-party liability. The Company maintains a casualty insurance program providing coverage for vehicles, workers' compensation, employer's liability, and comprehensive general liability in the aggregate amount of $30,000,000 per year, subject to a retention of $250,000 per occurrence, except on general liability where the retention is $500,000 per occurrence. The workers' compensation limits are established by state statutes. Since the early 1980s, casualty insurance policies have typically excluded liability for pollution, which is covered under a separate pollution liability program.\nThe Company has pollution liability insurance policies covering the Company's potential risk in three areas: as a contractor performing services at customer sites; as a transporter of waste; and while it handles waste at the Company's facilities. The Company has contractor's liability insurance of $10,000,000 per occurrence and $10,000,000 in the aggregate, covering off-site remedial activities and associated liabilities. Lloyds of London provides pollution liability coverage for waste in-transit with single occurrence and aggregate liability limits of $29,000,000. This Lloyds of London policy covers liability in excess of $1,000,000 for pollution caused by sudden and accidental occurrences during transportation of waste and at the Company's facilities, from the time waste is picked up from a customer until its delivery to the final disposal site. The Company's $30,000,000 excess automobile liability insurance provides additional coverage for any in-transit pollution losses from accidents over and above the Lloyds of London coverage, so that it has a total of $59,000,000 of in-transit coverage.\nFederal and state regulations require liability insurance coverage for all facilities that treat, store, or dispose of hazardous waste. In 1989, the Company established a captive insurance company pursuant to the Federal Risk Retention Act of 1986. This company qualifies as a licensed insurance company and is authorized to write professional liability and pollution liability insurance for the Company and its operating subsidiaries. RCRA and comparable state hazardous waste regulations typically require hazardous waste handling facilities to maintain pollution liability insurance in the amount of $1,000,000 per occurrence and $2,000,000 in the aggregate per year for sudden occurrences and $3,000,000 per occurrence and $6,000,000 in the aggregate per year for non-sudden occurrences. Currently, the Company uses its captive insurance company to provide (i) the first $1,000,000 of insurance against liability from sudden occurrences at its facilities, with the excess coverage provided by Lloyds of London, and (ii) the full policy limits of insurance for non-sudden occurrences.\nOperators of hazardous waste handling facilities are also required by federal and state regulations to provide financial assurance that certain funds will be available for closure and post closure care of those facilities, should the facility cease operation. For example, closure would include the cost of removing the waste stored at a facility which ceased operating, and sending the material to another company for disposal. The Company utilizes its captive insurance company to provide such financial assurance for the waste management facilities it currently owns, with the exception of the Kimball incinerator which has closure insurance provided by a commercial insurer.\nThe Company's ability to continue conducting its industrial waste management operations could be adversely affected if the Company should become unable to obtain sufficient insurance to meet its business and regulatory requirements in the future. The availability of insurance may also be influenced by developments within the insurance industry, although other businesses in the industrial waste management industry would be similarly impacted by such developments.\nUnder the Company's insurance programs, coverage is obtained for catastrophic exposures as well as those risks required to be insured by law or contract. It is the policy of the Company to retain a significant portion of certain expected losses related primarily to workers' compensation, physical loss to property, and comprehensive general and vehicle liability. Provisions for losses expected under these programs are recorded\nbased upon the Company's estimates of the aggregate liability for claims. The Company has been successful in negotiating lower premiums recently, due in part to its favorable historical loss experience. The cancellation terms applicable to the Company are similar to those of other companies in other industries.\nCOMPETITION\nThe Company competes with numerous large and small companies, each of which is able to provide one or more of the industrial waste management services offered by the Company and some of which have access to greater financial resources. The Company believes it offers a more comprehensive range of industrial waste management services than its competitors in major portions of its service territory. The Company also believes that its ability to market and provide its services on an integrated basis constitutes a significant competitive advantage for the Company.\nThe Company's competitive position with respect to its treatment and disposal services is enhanced by the proximity of its facilities to hazardous waste generators and the barriers to market entry provided by capital and licensing requirements. However, treatment, recovery and disposal operations are conducted by a number of national and regional waste management firms. The Company believes that physical proximity of treatment and disposal facilities, comprehensiveness of services, safety, quality and efficiency of services, and pricing are the most significant factors in the market for treatment and disposal services.\nIn field services, the Company's competitors include major national and regional environmental services firms which have environmental remediation staffs. The availability of skilled technical professional personnel, quality of performance, diversity of services and, to a certain extent, price, are the key competitive factors.\nEMPLOYEES\nAs of February 1, 1996, the Company employed 1,438 people on a regular basis. None of the Company's employees is subject to a collective bargaining agreement, and the Company believes that its relationship with its employees is satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties of the Company consist primarily of its 12 waste management facilities and 17 service centers, various environmental remediation equipment, and a fleet of approximately 1,000 registered pieces of transportation equipment. Most service center locations are leased, and occasionally move to other locations as operations grow and space requirements increase. The 12 waste management facilities are described below. All of these facilities are owned by the Company, except (i) the Chicago hazardous waste management facility which is leased under a lease which (with extensions) expires September 2020, (ii) the Woburn, Massachusetts waste oil treatment and storage facility which is leased under a lease which (with extensions) expires February 2004, and (iii) the Virginia waste oil treatment and storage facility which is leased under a lease which (with extensions) expires February 2002.\nHazardous Waste Management Facilities. The Company currently maintains nine hazardous waste management facilities at which it processes, treats and temporarily stores hazardous wastes for later resale, reuse or off-site treatment or disposal. Every facility that treats, stores or disposes of hazardous wastes must obtain a license from the federal EPA or an authorized state agency and must comply with certain operating requirements. See \"Environmental Regulation-Federal Regulation of Hazardous Waste\" below for a description of licenses issued under the RCRA. All nine hazardous waste management facilities are subject to RCRA licensing. Eight of the nine facilities have been issued RCRA Part B licenses, one of which is under appeal.\nTwo of the facilities described above are waste oil treatment and storage facilities which are subject to RCRA licensing because some petroleum products, such as gasoline, are considered hazardous waste under federal law or are located in a state which regulates waste oil as a hazardous waste. In order to handle a variety\nof waste oil and petroleum products and support its field service activities in the Northeast and Mid-Atlantic regions, the Company has obtained RCRA licenses for those two facilities.\nThe Company has made substantial modifications and improvements to the physical plant and treatment and process equipment at its treatment facilities. These modifications are consistent with the Company's strategy to upgrade the quality and efficiency of treatment services, to expand the range of services provided and to ensure regulatory compliance and operating efficiencies at these facilities. Major features of this program are the addition of new treatment systems, such as the CES in Baltimore, expansion of analytical testing laboratories, drum storage and processing facilities, and equipment rearrangement and replacement to improve operating efficiency.\nBraintree, MA. The Braintree facility is located just south of Boston. The facility is primarily engaged in drummed waste processing and consolidation, solvent recovery, transformer decommissioning, PCB storage and processing, blending of waste used as supplemental fuel by industrial furnaces, pretreatment of waste to stabilize it before it is sent to landfills, and incineration of small quantities of nonhazardous waste. The facility continues to operate under a state Interim Hazardous Waste Facility License issued by the Massachusetts Department of Environmental Protection (\"DEP\") in 1981. The Company acquired the facility in 1985. In June 1992, the DEP approved the Company's application for a final Hazardous Waste Facility License, and issued a final Part B license for a five-year term. The Town of Braintree and two adjoining communities have appealed the DEP's decision to issue the final Part B license, and requested an adjudicatory hearing before the DEP, which is the normal appeal process. The appeal is an administrative proceeding before the DEP, and the facility will continue to operate normally pursuant to its state license and Interim Status authority under RCRA while the DEP considers the appeal. In the fall of 1995 the two adjoining communities withdrew their appeals. The Company is confident the review will result in confirmation of the license as granted. The authority from the federal EPA to handle PCBs is not impacted by the towns' appeal of the Part B license.\nNatick, MA. The Natick, Massachusetts facility is located just west of Boston. Its primary services are collecting CleanPacks and repackaging the small quantities of laboratory and household chemicals into 55-gallon drum quantities, consolidating wastes for shipment to other Company facilities or third parties for further treatment or disposal, and serving as a transfer station for the Northeast region. The facility has a state Hazardous Waste Facility License (the state equivalent of a Part B license), which was renewed in October 1994 for a five-year term. The facility is also authorized by the federal EPA to handle PCBs.\nChicago, IL. The Chicago, Illinois facility is located on the south side of Chicago, on Lake Calumet. It provides treatment of nonhazardous and hazardous industrial wastewaters, drummed waste processing and consolidation, and transfer and repackaging of laboratory chemicals into CleanPacks. In November 1993, the Illinois EPA issued a Part B license for a ten-year term, which significantly expanded the waste handling and storage capacity of the facility. In November 1995, the permit was modified to include the assets acquired from ChemWaste Management, Inc. (\"ChemWaste\"). The new license increased drum storage capacity and allows handling of material destined for blending of waste used as supplemental fuel by industrial furnaces, pretreatment of waste to stabilize it before it is sent to landfills, and rail shipment of hazardous and nonhazardous waste.\nAs an alternative to making the needed improvements to its own site, the Company in November 1995 acquired assets from ChemWaste on an adjoining leased site, together with the existing improvements, in exchange for sharing the costs of dismantling an existing hazardous waste incinerator and cleaning up the adjoining site. The existing improvements on the ChemWaste site, and those improvements recently constructed on the site by the Company, will allow the Company to develop new product lines not currently handled at the Company's existing facility. Under the sharing arrangement with ChemWaste, the Company could over a period of 15 years be required to contribute up to a maximum of $2,000,000 for dismantling and decontaminating the incinerator and other equipment and up to a maximum of $7,000,000 for studies and cleanup of the site. Any additional costs beyond those contemplated by the sharing arrangement during this time period would be borne by ChemWaste. In addition, the Company entered into a five year disposal services\nagreement with Chemical Waste Management in connection with the acquisition of the assets on the adjacent site. Pursuant to the terms of the disposal services agreement, the Company has agreed to use best efforts to deliver waste materials to ChemWaste facilities for disposal subject to certain customer preferences, scheduling and other considerations.\nCleveland, OH. The Cleveland, Ohio facility is located south of downtown Cleveland. It is a wastewater treatment facility that treats nonhazardous and hazardous industrial wastewaters, and serves as a transfer station for various types of containerized hazardous and nonhazardous waste. The facility is not subject to Part B licensing requirements, since its on-site wastewater treatment activities are regulated pursuant to the Clean Water Act, and therefore are exempt from RCRA.\nBaltimore, MD. The Baltimore, Maryland facility is located adjacent to Interstate 95 in central Baltimore. It provides treatment of nonhazardous and hazardous industrial aqueous wastes, drummed waste processing, pretreatment of waste to stabilize it before it is sent to landfills, and transfer of CleanPacks. It is the only commercial hazardous waste treatment facility in Maryland. The facility has a state Controlled Hazardous Substances permit (the state equivalent of a Part B license), which was issued in 1987. In 1990, the Company received a permit modification to expand the range of waste streams the facility can accept and to install the CES, which allows the facility to treat a wide range of hazardous wastewaters contaminated with gasoline, chlorinated solvents and many other organic contaminants, which were formerly sent to other companies for incineration. In 1992, the Maryland Department of the Environment issued a new Controlled Hazardous Substances permit for a three-year term, which significantly expanded the waste handling and storage capacity of the facility. The new permit also allows handling of CleanPacks and material destined for fuels-blending, pretreatment of waste to stabilize it before it is sent to landfills, and rail shipment of hazardous and nonhazardous waste. In June, 1995 the Company submitted a permit renewal application which allows operations to continue until the renewal application is approved.\nBristol, CT. In July 1992, the Company acquired Connecticut Treatment Corporation, located in Bristol, Connecticut, approximately 20 miles southwest of Hartford. It provides hazardous wastewater treatment, drummed waste processing and consolidation, and transfer of CleanPacks. This facility also offers two specialized services: equipment \"de-manufacturing,\" such as dismantling outdated computers, and treatment of special categories of hazardous wastewaters known as \"listed\" wastewaters resulting from industrial processes such as electroplating.\nThe Bristol facility has a Part B license issued by the federal EPA and the Connecticut Department of Environmental Protection. The license was issued in 1987 and expired in 1991. A new license was applied for and the facility continued to operate while the EPA and DEP reviewed the renewal application. The Company also applied for approval to expand the number of hazardous waste codes allowed to be handled, expand container storage capacity from 1,000 drums to 3,500 drums, and add eight tanks for storage of sludge and stabilization materials. In April 1995, the DEP issued a renewal of the license, with the additions requested by the Company. The term of the license is five years.\nThe Bristol facility also treats hazardous industrial wastewater, and has a permit to discharge to the publicly owned sewage treatment works an average of 50,000 gallons per day of treated water. These treatment activities are licensed by the Connecticut DEP pursuant to the Clean Water Act, and are not subject to Part B licensing requirements. In 1990 the Company's predecessor applied for renewal and modification of its Clean Water Act license, to allow construction of additional tanks for wastewater treatment and installation of new wastewater treatment technologies, such as reverse osmosis and ultrafiltration. The discharge limit would remain at 50,000 gallons average per day. In April 1995, a 5 year permit renewal was issued by DEP.\nCincinnati, OH. In February 1993, the Company acquired Spring Grove Resource Recovery, Inc. (\"Spring Grove\"), located north of downtown Cincinnati, Ohio. It provides hazardous wastewater treatment, drummed waste processing and consolidation, pretreatment of waste to stabilize it before it is sent to landfills, and transfer of CleanPacks. The facility holds a state Hazardous Waste Facility Installation and Operation permit (RCRA\nPart B) which was renewed in December 1993 for a five-year term. The facility is also authorized to handle PCBs. On March 31, 1994, the Ohio EPA approved the Company's application for a revised, comprehensive state permit that expands the range of waste that may be received and treated at the facility and allows installation of sophisticated equipment for handling and processing material to be sent to boilers and industrial furnaces and used as supplemental fuel. In May 1995, the Ohio Hazardous Waste Facility Board approved the transfer of the facility hazardous waste permit from the former owner of the facility to Clean Harbors.\nKimball, NE. In May 1995, the Company acquired a newly constructed hazardous waste incinerator in Kimball, Nebraska from Ecova Corporation, an affiliate of Amoco Oil Company. The Kimball facility includes a 45,000 ton-per-year fluidized bed thermal oxidation unit for maximum destruction efficiency of hazardous waste. It is a new, state-of-the-art facility staffed with a highly trained and motivated workforce. The construction of the incinerator and its operation have received widespread support in the local community. The incinerator has a RCRA Part B license issued by the Nebraska Department of Environmental Quality (\"NDEQ\"). In December 1994, the NDEQ approved commercial operation at 75% of capacity. The incinerator will be authorized to operate at 100% capacity upon issuance of a final Air Operating Permit which is expected to be issued by NDEQ in mid 1996.\nThe incinerator is located on a 600 acre site, which includes a landfill for disposal of incinerator ash. If the chemical composition of the ash meets the permit requirements, which is subject to verification before it is landfilled on-site, the ash will be classified as \"delisted\", meaning it will no longer be regulated as a hazardous waste under federal and state laws. No other commercial incineration facility in the United States is currently permitted to delist ash. Although the ash will be classified as nonhazardous, the landfill has been constructed to meet RCRA Subtitle C standards, which are the same stringent requirements as for landfills designed to handle hazardous waste.\nThe acquisition of this facility responds to a developing trend within the hazardous waste management industry: many generators of industrial waste prefer to treat hazardous waste, rather than bury it, because of concerns about the long-term liability associated with landfill disposal of the residue which results from incineration of the generator's hazardous waste. Conventional incinerators produce a \"slag\" which is regulated as a hazardous waste. The residue from the Kimball treatment facility, in contrast, is ash rather than slag. The ash meets the standards set by NDEQ for \"delisting\" and is therefore deemed to be non-hazardous.\nDuring September 1995, the Kimball treatment facility entered a new, expanded phase of operations as a result of two actions by Federal and State regulators. The United States Environmental Protection Agency (\"EPA\") authorized the facility to begin accepting wastes generated at sites being remediated pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA,\" also known as the \"Superfund Act\"). The EPA authorization to begin accepting wastes generated at CERCLA sites allows the Company to be directly involved in the safe treatment and disposal of wastes from Federal cleanup efforts including Superfund sites, a large portion of the incineration marketplace. Prior to obtaining CERCLA approval, the Kimball facility was limited to accepting hazardous wastes regulated by RCRA. RCRA waste materials are made up of the same constituents as CERCLA wastes, but are generated from various ongoing industrial operations rather than Federal cleanup activities at specific locations or Federal Superfund sites. In a separate action, the NDEQ approved the use of the facility's on-site landfill for disposal of ash residue as well as residues from the facility's air pollution control system. The facility now has all approvals necessary to fully use its waste disposal capacity.\nThe Company believes that the facility offers capabilities which will be very attractive to its major customers. In particular, the facility is expected to have operating costs lower than most other incinerators, given the minimal acquisition cost to the Company and its unique ability to dispose of delisted ash on-site, which will save on the cost of shipping ash to another company for landfilling. The Company expects to realize significant savings by using the Kimball facility to incinerate waste previously sent to other incinerators. Since the incinerator is a new facility, many of the Company's customers will visit the facility for a comprehensive audit of its operations before they will approve the site for disposal of their hazardous waste. As a result,\nconsiderable time is needed to complete the audit and approval process before the Company can begin shipping waste to the facility. As of December 31, 1995, over fifty large customers had audited and approved the facility, and approvals from another dozen customers were pending.\nAs part of the acquisition, the Company agreed to make royalty payments to Ecova Corporation through 2004, based on the number of tons processed at the facility.\nWaste Oil Treatment and Storage Facilities. The Company has four waste oil treatment and storage facilities: two in Massachusetts, one in Maine, and one in Virginia. The Massachusetts facilities are located in Kingston and Woburn, in the Boston area. The Kingston facility has a state recycling permit and is able to store oil collected from various activities, ranging from routine cleaning of oil storage terminals to oil spill cleanups. The facility is also used for maintenance activities and for training of employees of the Company and third-party customers. The Woburn facility is a waste oil storage and transfer facility, and received a Part B license in October 1993 for a five- year term.\nThe facility in South Portland, Maine is a petroleum reclamation facility that handles most of the waste oil received by the Company, which comes primarily from the Company's remediation activities. It has a municipal sewer user permit allowing the discharge of water separated from oil. The Company also owns another property in South Portland located on Main Street. It has a license to store virgin oil, but it also is permitted for the temporary storage and transfer of containerized hazardous waste.\nThe Virginia facility is located near Richmond, and was acquired in September 1994. The facility is able to store oil and gasoline-contaminated wastewaters collected from various activities, ranging from routine cleaning of oil storage terminals to oil spill cleanups. The facility operates under RCRA interim status pending the final submittal and review of its application for a Part B license.\nENVIRONMENTAL REGULATION\nWhile the Company's business has benefited substantially from increased governmental regulation of hazardous waste transportation, storage and disposal, the industrial waste management industry itself has become the subject of extensive and evolving regulation by federal, state and local authorities. The Company makes a continuing effort to anticipate regulatory, political and legal developments that might affect its operations, but is not always able to do so. The Company cannot predict the extent to which any environmental legislation or regulation that may be enacted or enforced in the future may affect its operations.\nOn December 21, 1995, the EPA proposed to amend its regulations in the RCRA by establishing constituent-specific exit levels for low-risk solid wastes that are designated as hazardous because they are listed, or have been mixed with, derived from, or contain listed hazardous wastes. Under the proposal, generators of listed hazardous wastes that meet the self-implementing exit levels would no longer be subject to the hazardous waste management system under Subtitle C of RCRA as listed hazardous wastes. The proposed rulemaking, referred to as the Hazardous Waste Identification Rule (\"HWIR\"), establishes a risk-based \"floor\" to hazardous waste listings that will encourage pollution prevention, waste minimization, and the development of innovative waste treatment technologies. If passed, the HWIR may impact the Company's incinerator in Kimball, since many wastes which are currently required to be managed as a hazardous waste may no longer require incineration at a RCRA incineration unit such as Kimball.\nThe Company is required to obtain federal, state and local licenses or approvals for each of its hazardous waste facilities. Such licenses are difficult to obtain and, in many instances, extensive studies, tests, and public hearings are required before the approvals can be issued. The Company has acquired or is in the process of applying for all operating licenses and approvals required for the current operation of its business and has applied for or is in the process of applying for all licenses and approvals needed in connection with planned expansion or modifications of its operations.\nFEDERAL REGULATION OF HAZARDOUS WASTE\nThe most significant federal environmental laws affecting the Company are RCRA, the Superfund Act and the Clean Water Act.\nRCRA. RCRA is the principal federal statute governing hazardous waste generation, treatment, transportation, storage and disposal. Pursuant to RCRA, the EPA has established a comprehensive, \"cradle-to-grave\" system for the management of a wide range of materials identified as hazardous waste. States, such as Massachusetts, Connecticut, Illinois, Maryland, Ohio and Nebraska, that have adopted hazardous waste management programs with standards at least as stringent as those promulgated by the EPA, have been authorized by the EPA to administer their facility permitting programs in lieu of the EPA's program.\nEvery facility that treats, stores or disposes of hazardous waste must obtain a RCRA license from the EPA or an authorized state agency and must comply with certain operating requirements. Under RCRA, hazardous waste management facilities in existence on November 19, 1980 were required to submit a preliminary license application to the EPA, the so-called Part A Application. By virtue of this filing, a facility obtained Interim Status, allowing it to operate until licensing proceedings are instituted pursuant to more comprehensive and exacting regulations (the Part B licensing process). Interim Status facilities may continue to operate pursuant to the Part A Application until their Part B licensing process is concluded. Of the Company's 12 waste management facilities, nine are subject to RCRA licensing; of the nine, only the Virginia waste oil facility operates under interim status. The other eight have been issued Part B licenses, one of which is under appeal.\nRCRA requires that Part B licenses contain provisions for required on-site study and cleanup activities, known as \"corrective action,\" including detailed compliance schedules and provisions for assurance of financial responsibility. The EPA estimates that there are approximately 4,300 facilities that treat, store or dispose of hazardous wastes, which can be compelled to take corrective action when necessary. Some facilities are very large and have extensive contamination problems which rival the largest Superfund sites. Other facilities have relatively minor environmental problems. Still others will not need remedial action at all. It is the EPA's policy to compel corrective action at the \"worst sites first.\" As a result, the EPA has developed a system for assessing the relative environmental cleanup priority of RCRA facilities, called the National Corrective Action Prioritization System, with a High, Medium or Low ranking for each facility. Although several facilities of its competitors have been assessed a High cleanup priority, none of the Company's RCRA facilities have been assessed as a High priority.\nThe Company has begun RCRA corrective action investigations at its Part B licensed facilities in Braintree, Natick, Bristol, Chicago, and Woburn. The Company is also involved in site studies at its non-RCRA facilities in Cleveland, Ohio; Kingston, Massachusetts; and on Main Street in South Portland, Maine. The Company spent approximately $790,000 on corrective action at the foregoing facilities in 1995. The Company does not expect that corrective action will be required at its Richmond, Virginia waste oil facility.\nThe Company is also involved in a RCRA corrective action investigation at a site in Chester, Pennsylvania owned by Philadelphia Electric Company (\"PECO\"). The site consists of approximately 30 acres which PECO has leased to various companies over the years. In 1989, the Company acquired by merger a public company named ChemClear Inc., which operated a hazardous waste treatment facility on approximately eight acres of the Chester site leased from PECO. The Company ceased operations at the Chester site, decontaminated the plant and equipment, engaged an independent engineer to certify closure, and obtained final approval from the Pennsylvania regulatory authorities, certifying final closure of the facility. In 1993, the EPA ordered PECO to perform a RCRA corrective action investigation at the Chester site. PECO asked the Company to participate in the site studies, and in October 1994, the Company agreed to be responsible for seventy-five percent of the cost of these studies, which is estimated to be in the range of $1,000,000 to $2,000,000, by performing field service work and analytical services required to complete the site studies and providing other environmental services to PECO at discounted rates.\nWhile the final scopes of the work to be performed at these facilities have not yet been agreed upon, the Company believes, based upon information known to date about the nature and extent of contamination at these sites, that such costs will not have a material effect on its results of operations or its competitive position, and that it will be able to finance from operating revenues any additional corrective action required at its facilities. Environmental expenditures that relate to current operations are expensed or capitalized as appropriate.\nThe Bristol, Connecticut and Cincinnati, Ohio facilities were acquired from a subsidiary of Southdown, Inc. Southdown Inc. has agreed to indemnify the Company against any costs incurred or liability arising from contamination on- site, including the cost of corrective action, or waste disposed of off-site, including any liability under the Superfund Act, at those facilities.\nThe Superfund Act. The Superfund Act provides for immediate response and removal actions coordinated by the EPA to releases of hazardous substances into the environment, and authorizes the government to respond to the release or threatened release of hazardous substances or to order persons responsible for any such release to perform any necessary cleanup. The statute assigns joint and several liability for these responses and other related costs, including the cost of damage to natural resources, to the parties involved in the generation, transportation and disposal of such hazardous substances. Under the statute, the Company may be deemed liable as a generator or transporter of a hazardous substance which is released into the environment, or as the owner or operator of a facility from which there is a release of a hazardous substance into the environment. See also \"Business--Legal Proceedings.\"\nClean Water Act. This legislation prohibits discharges to the waters of the United States without governmental authorization. The EPA has promulgated \"pretreatment\" regulations under the Clean Water Act, which establish pretreatment standards for introduction of pollutants into publicly owned treatment works. In the course of its treatment process, the Company's wastewater treatment facilities generate waste water which they discharge to publicly owned treatment works pursuant to permits issued by the appropriate governmental authority. The Clean Water Act also serves to create business opportunities for the Company in that it may prevent industrial users from discharging their untreated wastewaters to the sewer. If these industries cannot meet their discharge specifications, then they may utilize the services of an off-site pretreatment facility such as those of the Company.\nOther Federal Laws. Company operations are also subject to the Toxic Substances Control Act (\"TSCA\"), pursuant to which the EPA regulates over 60,000 commercially produced chemical substances, including the proper disposal of PCBs. TSCA has established a comprehensive regulatory program for PCBs, under the jurisdiction of the EPA, which oversees the storage, treatment and disposal of PCBs at the Company's facilities in Braintree and Natick, Massachusetts; Cincinnati, Ohio; and Bristol, Connecticut. Under the Clean Air Act, the EPA also regulates emissions into the air of potentially harmful substances. In its transportation operations, the Company is regulated by the U.S. Department of Transportation, the Federal Railroad Administration, and the U.S. Coast Guard, as well as by the regulatory agencies of each state in which it operates or through which its trucks pass. Health and safety standards under the Occupational Safety and Health Act are also applicable.\nSTATE AND LOCAL REGULATIONS\nPursuant to the EPA's authorization of their RCRA equivalent programs, Massachusetts, Connecticut, Illinois, Maryland, Ohio, and Nebraska have regulatory programs governing the operations and permitting of hazardous waste facilities. Accordingly, the hazardous waste treatment, storage and disposal activities of the Company's Braintree, Natick, Woburn, Bristol, Chicago, Baltimore, Cincinnati, and Kimball facilities are regulated by the relevant state agencies in addition to federal EPA regulation.\nSome states, such as Connecticut and Massachusetts, classify as hazardous some wastes which are not regulated under RCRA. For example, Massachusetts considers PCBs and used oil as \"hazardous wastes,\" while RCRA does not. Accordingly, the Company must comply with state requirements for handling state regulated\nwastes, and when necessary obtain state licenses for treating, storing, and disposing of such wastes at its facilities.\nThe Company believes that each of its facilities is in substantial compliance with the applicable requirements of RCRA and state laws and regulations. Ten of the Company's twelve waste management facilities have been issued final licenses; the one for the Braintree facility is under appeal. The Richmond facility operates under interim status. Final action on the South Portland waste oil storage permit is expected in the Spring of 1996. Once issued, such licenses have maximum fixed terms of a given number of years, which differ from state to state, ranging from three years to ten years. The issuing state agency may review or modify a license at any time during its term. The Company anticipates that once a license is issued with respect to a facility, the license will be renewed at the end of its term if the facility's operations are in compliance with applicable requirements. However, there can be no assurance that regulations governing future licensing will remain static, or that the Company will be able to comply with such requirements.\nThe Company's wastewater treatment facilities are also subject to state and local regulation, most significantly sewer discharge regulations adopted by the municipalities which receive treated wastewater from the treatment processes. The Company's continued ability to operate its liquid waste treatment process at each such facility is dependent upon its ability to continue these sewer discharges.\nThe Company's facilities are regulated pursuant to state statutes, including those addressing clean water and clean air. Local sewer discharge and flammable storage requirements are applicable to certain of the Company's facilities. The Company's facilities are subject to local siting, zoning and land use restrictions. Although the Company's facilities occasionally have been cited for regulatory violations, the Company believes it is in substantial compliance with all federal, state and local laws regulating its business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn April 1988, the Board of Selectmen of Braintree, Massachusetts, approved a cease and desist order with respect to the handling of flammable materials stored at the Company's Braintree facility. The Board concluded that, when the Company purchased the land on which the Braintree facility is located, a license for the storage of flammable liquids was not conveyed as an incident of ownership. The Company petitioned the Massachusetts Land Court for a declaratory judgment that either the Company possesses such a license by operation of law or that the statute requiring the license is pre-empted by the pervasive state regulation of hazardous waste facilities. In March 1994, the Land Court issued a favorable ruling, concluding that the statute is pre- empted by state hazardous waste laws and regulations and no local flammable storage license is required. The town has appealed this ruling, and has asked the Company to stipulate certain facts with respect to the other issues of the case so that a final appealable order can be issued by the Land Court. The Company has agreed to the stipulation but the Town has taken no further action.\nIn December 1991, the Company was asked to respond to an emergency cleanup after a motor vehicle struck a utility pole near the State University of New York at New Paltz, causing an electrical surge to overheat transformers which discharged toxic chemicals throughout various student dormitories and classroom buildings. The Company was hired by the State University of New York to perform technical supervisory and laboratory work for the cleanup. The actual work of cleaning the buildings was performed over approximately 15 months by other contractors hired by the State of New York. In March 1993, a group of students sued the Dormitory Authority of the State of New York (\"DASNY\") claiming that they were exposed to toxic chemicals when DASNY allowed them to reoccupy the buildings after the accident and prior to a complete removal of the toxic chemicals, causing them increased risk of future illnesses. DASNY denied the students' claims but elected to sue the Company along with 16 other third-party defendants claiming that if DASNY is liable to the students, these third-party defendants should indemnify DASNY. The Company was hired by the State University of New York to perform representative sampling for toxic chemicals but, according to its contract, was not responsible for decisions as to when students should reoccupy the buildings. Nevertheless, in June 1994, the Company and the 16 other third parties were served with a third-party complaint filed in the Ulster\nCounty Superior Court by DASNY. In January 1996, the trial judge ruled that the plaintiffs were not entitled to proceed as a class action for the medical cost claims, but were entitled to class action status for personal property losses. Since the personal property losses resulted directly from the explosions and fire, and occurred prior to the Company's involvement, the Company does not believe that it will incur any material liability as a result of this lawsuit. The Company has not received notice that the plaintiffs will appeal the trial judge's ruling.\nCertain Company subsidiaries have transported or generated waste sent to sites which have been designated state or federal Superfund sites. As a result, the Company has been named as a potentially responsible party (\"PRP\") in a number of lawsuits arising from the disposal of wastes at 20 state and federal Superfund sites.\nEleven of these sites involve two subsidiaries which the Company acquired from ChemWaste, which is a wholly-owned subsidiary of WMX Technologies, Inc. As part of the acquisition, ChemWaste agreed to indemnify the Company with respect to any liability of its Natick and Braintree subsidiaries for waste disposed of before the Company acquired them. Accordingly, ChemWaste is paying all costs of defending the Company's Natick and Braintree subsidiaries in these cases, including legal fees and settlement costs.\nThe Company's subsidiary which owns the Bristol, Connecticut facility is involved in one Superfund site. As part of the acquisition of the Bristol and Cincinnati, Ohio facilities, the seller and its parent company, Southdown, Inc., agreed to indemnify the Company with respect to any liability for waste disposed of before the Company acquired the facilities, which would include any liability arising from Superfund sites.\nWith respect to the other Superfund sites at which the Company believes it may face liability, the Company has established reserves or escrows which it believes are appropriate. Therefore, the Company believes that any future settlement costs arising from any or all of the 20 Superfund sites will not be material to the Company's operations or financial position. Management routinely reviews each Superfund site in which the Company's subsidiaries are involved, considers each subsidiary's role at each site and its relationship to the other PRPs at the site, the quantity and content of the waste it disposed of at the site, and the number and financial capabilities of the other PRPs at the site. Based on reviews of the various sites and currently available information, and management's judgment and prior experience with similar situations, expense accruals are provided by the Company for its share of future site cleanup costs, and existing accruals are revised as necessary. As of December 31, 1995, the Company had accrued environmental costs of $405,000 for cleanup of Superfund sites. Superfund legislation permits strict joint and several liability to be imposed without regard to fault, and, as a result, one PRP might be required to bear significantly more than its proportional share of the cleanup costs if other PRPs do not pay their share of such costs.\nFive of the 20 sites involve former subsidiaries of ChemClear Inc. One of the five sites is the Strasburg Landfill site in Pennsylvania. The Company and two other parties identified as PRPs received an order from the EPA in 1989 to perform certain emergency measures at the site. The Company responded by installing a leachate treatment and discharge system and repairing the landfill slope. Since early 1990, the Company has spent approximately $400,000 in complying with the EPA order. In 1992, the EPA issued its Record of Decision for the site which proposes recapping and revegetating the landfill and installing certain air emission and leachate treatment systems. In January 1993, the Company and eight other PRPs submitted to the EPA a Response to Notice Letter, which recommended additional study be performed at the site by the PRP group and that a final remedy be based on the additional data developed during the study. In July 1995, the PRP group received a reply from the EPA, which declined to accept the good faith offer submitted by the nine PRPs in January 1993. The EPA advised the PRP group that it planned to utilize Superfund monies to design and implement the remedy specified in the Record of Decision for the site, and initiate a cost recovery action for its past costs in the amount of approximately $6,000,000. The EPA indicated that the future remediation costs are estimated to be $11,000,000. In their October 1995 response to the EPA, the PRPs have indicated their willingness to accept the EPA's offer to engage in alternative dispute resolution to settle the claim for past costs. In January 1996, the Company and 16 other PRP's signed a standstill and tolling agreement with the EPA which allows for settlement discussions to take place up to July 15, 1996. In February 1996, the Company filed suit in\nthe U.S. District Court for the Eastern District of Pennsylvania against certain PRP's in order to preserve its claims for cost recovery and contribution against those parties. The Company believes its ultimate exposure in this case will not have a material impact on its financial position or results of operations.\nMr. Frank, Inc., which was acquired by the Company in July 1992, is involved in three Superfund sites, as a transporter of waste generated by others prior to the Company's purchase of Mr. Frank, Inc. The Company acquired Mr. Frank, Inc. in exchange for 233,000 shares of the Company's common stock, of which 33,222 shares were deposited into an escrow account to be held as security for the sellers' agreement to indemnify the Company against potential liabilities, including environmental liabilities arising from prior ownership and operation of Mr. Frank, Inc.\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 THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock began trading publicly in the over-the-counter market on November 24, 1987 and was added to the NASDAQ National Market System effective December 15, 1987. The Company's common stock trades on The Nasdaq Stock Market under the symbol: CLHB. The following table sets forth the high and low sales prices of the Company's common stock for the indicated periods as reported by NASDAQ.\nOn February 1, 1996 there were 920 holders of record of the Company's common stock, excluding stockholders whose shares were held in nominee name.\nThe Company has never declared nor paid any cash dividends on its common stock. In February 1993, the Board of Directors authorized the issuance of up to 156,416 shares designated as Series B Convertible Preferred Stock, with a cumulative dividend of 7% during the first year and 8% thereafter, payable either in cash or by the issuance of shares of common stock. 112,000 shares of Series B Convertible Preferred Stock (the \"Preferred Stock\") were issued on February 16, 1993 in partial payment of the purchase price for Spring Grove. Except for payment of dividends on the Preferred Stock, the Company intends to retain all earnings for use in the Company's business and therefore does not anticipate paying any cash dividends on its common stock in the foreseeable future. The Company's bank credit agreements contain financial covenants which may effectively restrict or limit the payment of dividends other than Preferred Stock dividends. See Note 9 to the Consolidated Financial Statements in Item 8 of this report.\nDividends on the Company's Preferred Stock are payable on the 15th day of January, April, July and October, at the rate of $1.00 per share, per quarter; 112,000 shares are outstanding. Under the terms of the\nPreferred Stock, the Company can elect to pay dividends in cash or in common stock with a market value equal to the amount of the dividend payable. The Company elected to pay the October 15, 1995 and the January 15, 1996 dividends in common stock. The market value of the common stock as of the October 1, 1995 and January 1, 1996 record dates of such dividends was $3.8375 and $2.6125, respectively. Accordingly, the Company has issued 72,058 shares of common stock to the holders of the Preferred Stock. The Company anticipates that the Preferred Stock dividends payable through 1996 will be paid in common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial information should be reviewed in conjunction with 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 for the periods indicated certain operating data associated with the Company's results of operations. This table and subsequent discussions should be read in conjunction with Item 6 - -Selected Financial Data and Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Clean Harbors, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedule of Clean Harbors, Inc. and its subsidiaries listed in Item 14(a) 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Clean Harbors, Inc. 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.\nCoopers & Lybrand L.L.P.\nBoston, Massachusetts January 31, 1996 (except with respect to Note 9, as to which the date is March 20, 1996)\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY (IN THOUSANDS EXCEPT FOR SHARE INFORMATION)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nFOR THE THREE YEARS ENDED DECEMBER 31, 1995 (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) OPERATIONS\nClean Harbors, Inc. and its wholly-owned subsidiaries (collectively, the \"Company\") are engaged in the business of industrial waste management services involving treatment and disposal of industrial wastes; field services provided at customer sites; and specialized handling of laboratory chemicals and household hazardous wastes. The Company provides these services to a diversified customer base across the United States, primarily in the Northeast and Mid-Atlantic Regions.\n(2) SIGNIFICANT ACCOUNTING POLICIES\nThe accompanying consolidated financial statements of the Company reflect the application of certain significant accounting policies as described below:\n(a) Principles of Consolidation\nThe accompanying consolidated statements include the accounts of Clean Harbors, Inc. and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.\n(b) Revenue Recognition\nThe Company recognizes revenues and accrues the related cost of treatment and disposal upon the receipt of waste materials, except for incineration when revenue is recognized as waste is burned. Other revenues are recognized as the related costs are incurred.\n(c) Income Taxes\nUnder the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), deferred tax assets and liabilities are determined based upon 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 or benefit 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, business combinations accounted for by the purchase method, and provisions for doubtful accounts.\n(d) Net Income Per Common and Common Equivalent Share\nNet income per common and common equivalent share is based on net income less preferred dividend requirements divided by the weighted average number of common and common equivalent shares outstanding during each of the respective years. Fully diluted net income per common share has not been presented as the amount would not differ significantly from that presented.\n(e) Cash and Cash Equivalents\nThe Company considers all highly liquid instruments purchased with original maturities of less than three months to be cash equivalents.\n(f) Restricted Investments\nThe Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115), in 1994. Under this statement, some of the Company's debt securities are classified as \"available for sale\" and are recorded at current market value with an offsetting valuation adjustment, net of tax, in stockholders' equity. The remaining securities are classified as \"held to\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) maturity\" and are recorded at amortized cost. In accordance with SFAS 115, financial statements from prior years have not been restated to reflect the change in accounting method. There was no cumulative effect as a result of adopting SFAS 115 in 1994.\n(g) Supplies Inventory\nSupplies inventory, stated at the lower of cost or market, is charged to operations on a first-in, first-out basis.\n(h) Property, Plant and Equipment\nProperty, plant and equipment are stated at cost. The Company depreciates and amortizes the cost of these assets, less the estimated salvage value, using the straight-line method as follows:\nLeaseholds are amortized over the shorter of the life of the lease or the asset. Upon retirement or other disposition, the cost and related accumulated depreciation of the assets are removed from the accounts and the resulting gain or loss is reflected in income. Site preparation and improvement costs are included in land.\n(i) Goodwill and Permits\nGoodwill and permits, as further discussed in Notes 5 and 6, are stated at cost and are being amortized using the straight-line method over 20 years for permits and periods ranging from 20 to 40 years for goodwill.\n(j) Letters of Credit\nThe Company utilizes letters of credit to provide collateral assurance to issuers of performance bonds for certain contracts; to assure regulatory authorities that certain funds will be available for corrective action activities at its hazardous waste management facilities, as described in Note 8(b) below; and to provide financial assurance to regulators of its captive insurance company. As of December 31, 1995 and 1994, the Company had outstanding letters of credit amounting to $7,535,000 and $7,492,000, respectively.\nAs of December 31, 1995, the Company had no significant concentrations of credit risk.\n(k) 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 at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.\n(3) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts of cash and cash equivalents, restricted investments, and long-term obligations approximate fair value. The Company believes similar terms for long-term obligations would be attainable. The fair value of restricted investments and senior notes is based on quoted market prices for these securities. At\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) December 31, 1995, the estimated fair values of the Company's financial instruments are as follows (in thousands):\n(4) RESTRICTED INVESTMENTS\nFederal and state regulations require liability insurance coverage for all facilities that treat, store, or dispose of hazardous waste, and financial assurance that certain funds will be available for closure of those facilities, should a facility cease operation. In 1989, the Company established a wholly-owned captive insurance company pursuant to the Federal Risk Retention Act of 1986. This company qualifies as a licensed insurance company and is authorized to write closure, professional liability, and pollution liability insurance for the Company and its operating subsidiaries. Investments are held by the captive insurance company as collateral for its insurance policies and are restricted for future payment of insurance claims. At December 31, 1995, the amortized cost of these securities was $2,451,000. A valuation allowance of $22,000 was recorded to reflect the market value of $2,429,000, and a realized gain of $4,000 was reflected in net income for the year. The amortized cost of these securities held at December 31, 1994 was $1,731,000. A valuation allowance of $220,000 was recorded to reflect the market value of $1,511,000, and a realized loss of $1,000 was reflected in net income for the year. Investments held consist of fixed maturity and mortgage- backed securities. Fixed maturity securities, other than mortgage-backed securities, have contractual maturity dates after five years through ten years from December 31, 1995. Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations without penalties.\nIn addition, the Company deposited $5,000,000 with a commercial insurance company to provide for closure costs of the incinerator (see Note 5 below). These government debt securities, which mature in ten years, are classified as held-to-maturity and are reported at amortized cost due to the intent and ability of the Company to hold these securities to maturity. At December 31, 1995 the amortized cost of these securities was $5,207,000, while the market value was $5,683,000.\n(5) BUSINESS ACQUISITIONS\nOn May 12, 1995, the Company acquired a newly constructed hazardous waste incinerator in Kimball, Nebraska from Ecova Corporation, a wholly-owned affiliate of Amoco Oil Company. The incinerator is subject to the final permit requirements under the federal Resource Conservation and Recovery Act of 1976, as amended (\"RCRA\"), and has a RCRA \"Part B\" license issued by the Nebraska Department of Environmental Quality (\"NDEQ\"). The incinerator is located on a 600 acre site, which includes a landfill for disposal of the ash from the incinerator. The Company acquired the Kimball facility for $5,160,000.\nUnder RCRA, an owner or operator of a \"Part B\" licensed facility must provide financial assurance that funds will be available for closure of the facility, should the facility cease operation. An owner or operator may satisfy the requirements for financial assurance by using one of several mechanisms allowed under RCRA: a trust fund, surety bond, letter of credit, insurance, financial test, or corporate guarantee. The mechanism chosen by the Company was insurance which has been approved by NDEQ. The Company has obtained two insurance policies: one covers closure of the incinerator, and the other covers closure of the landfill and the post-closure costs of caring for the site after the landfill is closed. Each insurance policy has a 30 year term.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The NDEQ requires that the policy premiums through the year 2025 be prepaid by the Company to eliminate the risk that the policy might be canceled for failure to pay premiums some time in the future. The Company has also deposited funds into an escrow account as collateral for the insurance policies, which is restricted for future payment of insurance claims. Funds in the escrow account remain the property of the Company and are invested in long-term, fixed-rate interest bearing securities held as restricted investments.\nAs of December 31, 1995, the Company had paid $1,805,000 for the premium on the insurance policy for the incinerator, and had deposited $5,000,000 into the escrow account. The premium on the insurance policy for the landfill is $2,000,000, payable in two installments of $1,000,000 each, and the Company was required to deposit $650,000 into the escrow account. During the fourth quarter of 1995, the Company paid the first $1,000,000 premium installment; the second installment is payable in September 1996. The Company made the $650,000 deposit into the escrow account in the first quarter of 1996. The Company is also obligated to deliver to the insurance company a letter of credit in the amount of $1,000,000, which will increase by $250,000 each quarter until the balance of the letter of credit is $3,006,000, to provide additional collateral under the two insurance policies.\nOn September 30, 1994, the Company acquired the assets of a hazardous and nonhazardous oil reclamation facility located near Richmond, Virginia from Chemical Waste Management, Inc. (\"ChemWaste\") for $200,000 in cash and $200,000 in credits for future Company services. As of December 31, 1995 all credits had been used by ChemWaste.\nOn February 16, 1993, the Company acquired all of the outstanding shares of Spring Grove Resource Recovery, Inc. (\"Spring Grove\"), a hazardous waste treatment, storage and disposal facility located in Cincinnati, Ohio, from Southdown Environmental Treatment Systems, Inc. (\"SETS\") in exchange for $1,400,000 in cash and 112,000 shares of newly issued Series B Convertible Preferred Stock with a stated value of $5,600,000.\nThe results of operations of the Kimball incinerator, Spring Grove and the Richmond facility are included in the consolidated financial statements subsequent to the dates of acquisition by the Company. Pro forma information has not been included concerning these acquisitions since the assets and operations acquired were not material to those of the Company.\n(6) INTANGIBLE ASSETS\nBelow is a summary of intangible assets at December 31, 1995 and 1994 (in thousands):\nAmortization expense approximated $1,619,000, $1,619,000, and $1,433,000 for the years 1995, 1994, and 1993, respectively. The Company continually reevaluates the propriety of the carrying amount of permits and goodwill as well as the amortization period to determine whether current events and circumstances warrant adjustments to the carrying value and estimates of useful lives. At this time, the Company believes that no significant impairment of goodwill or permits has occurred and that no reduction of the book value or estimated useful lives is warranted.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(7) OTHER ACCRUED EXPENSES\nOther accrued expenses consist of the following (in thousands):\n(8) LEGAL MATTERS AND OTHER CONTINGENCIES AND COMMITMENTS\n(a) Legal Matters\nIn April, 1988, the Board of Selectman of Braintree, Massachusetts, approved a cease and desist order with respect to the handling of flammable materials stored at the Company's Braintree facility. The Board concluded that, when the Company purchased the land on which the Braintree facility is located, a license for the storage of flammable liquids was not conveyed as an incident of ownership. The Company petitioned the Massachusetts Land Court for a declaratory judgment that either the Company possesses such a license by operation of law or that the statute requiring the license is pre-empted by the pervasive state regulation of hazardous waste facilities. In March, 1994, the Land Court issued a favorable ruling, concluding that the statute is pre- empted by state hazardous waste laws and regulations and no local flammable storage license is required. The town has appealed this ruling, and has asked the Company to stipulate certain facts with respect to the other issues of the case so that a final appealable order can be issued by the Land Court. The Company has agreed to the stipulation but the Town has taken no further action.\nIn December, 1991, the Company was asked to respond to an emergency cleanup after a motor vehicle struck a utility pole near the State University of New York at New Paltz, causing an electrical surge to overheat transformers which discharged toxic chemicals throughout various student dormitories and classroom buildings. The Company was hired by the State University of New York to perform technical supervisory and laboratory work for the cleanup. The actual work of cleaning the buildings was performed over approximately 15 months by other contractors hired by the State of New York. In March 1993, a group of students sued the Dormitory Authority of the State of New York (\"DASNY\") claiming that they were exposed to toxic chemicals when DASNY allowed them to reoccupy the buildings after the accident and prior to complete removal of the toxic chemicals, causing them increased risk of future illnesses. DASNY denied the students' claims but elected to sue the Company along with 16 other third-party defendants claiming that if DASNY is liable to the students, these third-party defendants should indemnify DASNY. The Company was hired by the State University of New York to perform representative sampling for toxic chemicals but, according to its contract, was not responsible for decisions as to when students should reoccupy the buildings. Nevertheless, in June 1994, the Company and the 16 other third parties were served with a third-party complaint filed in the Ulster County Superior Court by DASNY. In January 1996, the trial judge ruled that the plaintiffs were not entitled to proceed as a class action for the medical cost claims, but were entitled class action status for personal property losses. Since the personal property losses resulted directly from the explosions and fire, and occurred prior to the Company's involvement, the Company does not believe that it will incur any material liability as a result of this lawsuit. The Company has not received notice that the plaintiffs will appeal the trial judge's ruling.\nIn the ordinary course of conducting its business, the Company becomes involved in environmentally related lawsuits and administrative proceedings. Some of these proceedings may result in fines, penalties or judgments against the Company. The Company does not believe that these proceedings, individually or in the aggregate, are material to its business.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) As of December 31, 1995, the Company has been named in a number of lawsuits arising from the disposal of wastes by certain Company subsidiaries at 20 state and federal Superfund sites. Eleven of these cases involve two subsidiaries which the Company acquired from Chemical Waste Management, Inc. (\"ChemWaste\"). As part of the acquisition, ChemWaste agreed to indemnify the Company with respect to any liability of its Braintree and Natick subsidiaries for waste disposed of before the Company acquired them. Accordingly, ChemWaste is paying all costs of defending the Natick and Braintree subsidiaries in these 11 cases, including legal fees and settlement costs. Three cases involve Mr. Frank, Inc. and one case involves Connecticut Treatment Center (\"CTC\"). Southdown, Inc., from which the Company bought CTC, has agreed to indemnify the Company with respect to any liability for waste disposed of by CTC before the Company acquired CTC, and the sellers of Mr. Frank, Inc. agreed to a limited indemnity against certain environmental liabilities arising from prior ownership of Mr. Frank, Inc.\nThe remaining five pending cases involve subsidiaries which the Company acquired in January 1989, when it purchased all of the outstanding shares of ChemClear Inc., a publicly traded company (\"ChemClear\"). The Company is unable to predict accurately its potential liability with respect to these cases, but believes that any future settlement costs will not be material to the Company's operations or financial position.\nManagement routinely reviews each Superfund site in which the Company's subsidiaries are involved, considers each subsidiary's role at each site and its relationship to the other potentially responsible parties (\"PRPs\") at the site, the quantity and content of the waste it disposed of at the site, and the number and financial capabilities of the other PRPs at the site. Based on reviews of the various sites and currently available information, and management's judgment and prior experience with similar situations, expense accruals are provided by the Company for its share of future site cleanup costs, and existing accruals are revised as necessary. As of December 31, 1995, the Company had accrued environmental costs of $405,000 for cleanup of Superfund sites. Superfund legislation permits strict joint and several liability to be imposed without regard to fault and, as a result, one PRP might be required to bear significantly more than its proportional share of the cleanup costs if other PRPs do not pay their share of such costs.\n(b) Environmental Matters\nUnder the RCRA, every facility that treats, stores or disposes of hazardous waste must obtain a RCRA permit from EPA or an authorized state agency and must comply with certain operating requirements. Of the Company's 12 waste management facilities, nine are subject to RCRA licensing. RCRA requires that permits contain a schedule of required on-site study and cleanup activities, known as \"corrective action\", including detailed compliance schedules and provisions for assurance of financial responsibility.\nThe EPA or applicable state agency have begun RCRA corrective action investigations at the Company's RCRA licensed facilities in Bristol, Connecticut; Maryland; Chicago, Illinois; Braintree, Massachusetts; Natick, Massachusetts, and Woburn, Massachusetts. The Company is also involved in site studies at its non-RCRA facilities in Cleveland, Ohio; Kingston, Massachusetts; and South Portland, Maine. The Company spent approximately $790,000 in 1995 and $471,000 in 1994 on corrective action at the foregoing facilities. Two RCRA facilities in Bristol, Connecticut and Cincinnati, Ohio were acquired from a subsidiary of Southdown, Inc. Southdown has agreed to indemnify the Company against any costs incurred or liability arising from contamination on-site arising from prior ownership, including the cost of corrective action.\nWhile the final scope of the work to be done at these facilities has not yet been agreed upon, the Company believes, based upon information known to date about the nature and extent of contamination at these sites, that such costs will not have a material effect on its results of operations or its financial position, and that it will be able to finance from operating revenues any additional corrective action required at its facilities.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Costs incurred to obtain or renew required permits are capitalized to the related permit account as incurred and are amortized over the permit's remaining life. Costs incurred to remediate properties owned by the Company are capitalized in property, plant and equipment only if the costs extend the life, increase the capacity or improve the safety or efficiency of the property or the costs mitigate or prevent environmental contamination that has yet to occur and that otherwise may result from future operations or activities. Remediation costs incurred in excess of the fair market value of the property being remediated are expensed as incurred.\n(c) Other Contingencies\nThe Company is subject to various regulatory requirements, including the procurement of requisite licenses and permits at its facilities. These licenses and permits are subject to periodic renewal without which the Company's operations would be adversely affected. The Company anticipates that, once a license or permit is issued with respect to a facility, the license or permit will be renewed at the end of its term if the facility's operations are in compliance with the applicable regulatory requirements.\nUnder the Company's insurance programs, coverage is obtained for catastrophic exposures, as well as those risks required to be insured by law or contract. It is the policy of the Company to retain a significant portion of certain expected losses related primarily to workers' compensation, physical loss to property, and comprehensive general and vehicle liability. Provisions for losses expected under these programs are recorded based upon the Company's estimates of the aggregate liability for claims.\n(d) Other Commitments\nIn January 1995, the Company entered into a definitive agreement with ChemWaste to lease a site previously leased by ChemWaste which adjoins the Company's Chicago facility. During November 1995, the Company acquired their existing improvements in exchange for agreeing to share the costs of dismantling an existing hazardous waste incinerator and cleaning up the site. The improvements on the ChemWaste site will allow the Company to develop new product lines not currently handled at the Company's existing Chicago facility. Under the sharing arrangement with ChemWaste, the Company will manage the RCRA corrective action investigation at the site and could over a period of 15 years be required to contribute up to a maximum of $2,000,000 for dismantling and decontaminating the incinerator and other equipment and up to a maximum of $7,000,000 for studies and cleanup of the site. Any additional costs beyond those contemplated by the sharing arrangement during this time period would be borne by ChemWaste. In addition, ChemWaste is entitled to a maximum of $700,000 in credits for future Company services, the credits are to be utilized over a 5 year period.\n(9) FINANCING ARRANGEMENTS\nOn May 25, 1989, the Company issued $30,000,000 of 13.25% Senior Subordinated Notes due May 15, 1997 and warrants to purchase 100,000 shares of common stock for aggregate proceeds, before issuance costs, of $30,300,000. The notes matured at the rate of $7,500,000 per year commencing on May 15, 1994.\nOn August 4, 1994, the Company issued $50,000,000 of 12.50% Senior Notes due May 15, 2001 (the \"Senior Notes\"). The Company used the net proceeds to prepay the $22,500,000 outstanding principal amount of the 13.25% Senior Subordinated Notes, at par plus a prepayment premium of 4.417%; to prepay the $1,800,000 outstanding principal amount of a subordinated note to a financial institution; to prepay the $489,000 outstanding principal amount of two junior subordinated notes to the former owners of Mr. Frank, Inc.; and to reduce the balance under its $55,000,000 Revolving Credit Agreement with three banks (the \"Revolver\") by approximately $21,800,000.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Senior Notes are not collateralized. The Senior Note indenture does not provide for the maintenance of certain financial covenants, although it does limit, among other things, the issuance of additional debt by the Company or its subsidiaries and the payment of dividends on, and redemption of, capital stock of the Company and its subsidiaries. Interest is paid twice each year on the Senior Notes.\nIn connection with the sale of the Senior Notes, the Company amended the terms of two 8% subordinated convertible notes, in the amounts of $3,500,000 and $1,500,000, respectively. The two notes were collateralized by liens on certain Company assets, and are convertible into common stock at $15 and $10 per share, respectively. The holder of these two notes agreed to exchange such notes for new 10% Senior Convertible Notes, with less restrictive covenants than the prior notes. The new notes rank pari passu with the Senior Notes and have covenants identical to the Senior Note covenants. Principal of the two Senior Convertible Notes is payable in five equal installments of $1,000,000, which began on October 31, 1995 and end on October 31, 1999. The Company has the option to convert such notes into common stock at $25 per share.\nOn June 30, 1992, the Company acquired all of the outstanding shares of Connecticut Treatment Corporation (\"CTC\"), a hazardous waste treatment, storage and disposal facility located in Bristol, Connecticut, from SETS in exchange for $500,000 in cash and a promissory note in the amount of $1,883,000. The first principal installment on the note was $376,600, which was paid on June 30, 1993, with installments of $94,150 due at the end of each quarter thereafter, until the remaining balance is paid in full. The note bears interest at the corporate base rate announced by The First National Bank of Boston (the \"Bank\") (8.5% at December 31, 1995) plus 2%.\nAt December 31, 1994, the Company had a $35,000,000 revolving credit facility with three banks. In connection with the acquisition of the Kimball, Nebraska hazardous waste incineration facility in May 1995, the Company entered into a new $45,000,000 revolving credit and term loan agreement (the \"Loan Agreement\") with another financial institution, which replaced the bank credit facility. The Loan Agreement originally provided for a $35,000,000 revolving credit portion (the \"Revolver\") and a $10,000,000 term promissory note (the \"Term Note\"). On March 20, 1996, the Loan Agreement was amended to increase the Term Loan from its amortized balance of $8,333,000 to $15,000,000 and decrease the revolving credit portion to $30,000,000. This change in structure allows for greater availability under the Loan Agreement. The new Term Note is payable in 60 monthly installments, commencing April 1, 1996. Monthly principal payments are $250,000. The Revolver allows the Company to borrow up to $30,000,000 in cash and letters of credit. Letters of credit may not exceed $20,000,000 at any one time. The Revolver requires the Company to pay a line fee of one half of one percent on the unused portion of the line. The Revolver has a three-year term with an option to renew annually.\nAt December 31, 1995, the balance of the Term Note was $8,833,000, the Revolver balance was $12,553,000, and the letters of credit outstanding were $7,535,000.\nThe Loan Agreement allows for up to 80% of the outstanding balance of the combined Revolver and Term Note to bear interest at the Eurodollar rate plus three percent; the remaining balance bears interest at a rate equal to the \"prime\" rate plus one and one-half percent. The Loan Agreement is collateralized by substantially all of the Company's assets. The Loan Agreement provides for certain covenants including, among others, limitations on working capital and minimum adjusted net worth. The Company must also maintain borrowing availability of not less than $4,500,000 for sixty consecutive days prior to paying principal and interest on its other indebtedness and dividends in cash on its preferred stock. At December 31, 1995, the Company did not have the level of borrowing availability required in order to make principal and interest payments due within sixty days thereof, and it has obtained a waiver needed in order to make such payments.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following table is a summary of the Company's long-term debt obligations reflecting the transactions discussed above.\nBelow is a summary of minimum payments due under the Company's long-term obligations (in thousands), exclusive of obligations under capital leases discussed in Note 10:\n(10) LEASES\n(a) Capital Leases\nThe Company possesses certain equipment under capital leases. The capitalized cost of this equipment was $7,040,000 and $6,844,000 with related accumulated amortization of $6,180,186 and $5,387,000 at\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) December 31, 1995 and 1994, respectively. The obligations of the Company under such leases are collateralized by the leased equipment.\nFuture minimum lease payments under capital leases are as follows (in thousands):\n(b) Operating Leases\nThe Company leases facilities and personal property under certain operating leases in excess of one year. Some of these lease agreements contain an escalation clause for increased taxes and operating expenses and are renewable at the option of the Company. Future minimum lease payments under operating leases are as follows (in thousands):\nDuring the years 1995, 1994 and 1993 rent expense was approximately $14,120,000, $14,182,000, and $9,796,000, respectively. The Company has entered into an agreement to sublease its Bedford, Massachusetts facility. See Note 17 below.\n(11) FEDERAL AND STATE INCOME TAXES\nThe provision for income taxes consists of the following (in thousands):\nSFAS 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,\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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 sources of significant timing differences which gave rise to deferred taxes were as follows (in thousands):\nThe effective income tax rate varies from the amount computed using the statutory federal income tax rate as follows:\nThe components of the total deferred tax asset at December 31, 1995 and 1994 were as follows (in thousands):\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The components of the total deferred tax liability at December 31, 1995 and 1994 were as follows (in thousands):\nRealization of the deferred tax assets is dependent on generating sufficient taxable income to offset the assets in the foreseeable future. Although realization is not assured, management believes it is more likely than not that a majority of the deferred tax assets will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced.\nFor federal income tax purposes at December 31, 1995, as a result of the acquisition of ChemClear, the Company has regular tax net operating loss carryforwards of $3,333,000 and alternative minimum tax net operating loss carryforwards of $2,712,000, which may be used to offset future taxable income, if any, of the former ChemClear entities, subject to certain limitations. These net operating loss carryforwards expire commencing in 2002.\n(12) STOCKHOLDERS' EQUITY\n(a) Stock Option Plans\nIn 1987, the Company adopted a nonqualified stock option plan (the \"1987 Plan\"). In 1992, the Company adopted a nonqualified equity incentive plan which provides for a variety of incentive awards, including stock options (the \"1992 Plan\"). As of December 31, 1995, all awards under the 1992 Plan were in the form of nonqualified stock options. These options generally become exercisable after a period of one to five years from the date of grant, subject to certain employment requirements, and terminate ten years from the date of grant. At December 31, 1995, the Company had reserved 955,600 and 800,000 shares of common stock for issuance under the 1987 and 1992 Plans, respectively.\nUnder the terms of the 1987 and 1992 Plans, as amended, options may be granted to purchase shares of common stock at an exercise price less than the fair market value on the date of grant. The difference between the exercise price and fair market value at the date of grant is charged to operations ratably over the option vesting period. No options were granted during 1995, 1994 and 1993 with exercise prices lower than the fair market value of the common stock at the date of grant.\nOn October 10, 1994, the Board of Directors approved a plan whereby all employees (excluding senior management) who previously were awarded stock options at prices of $6.50 to $15.00 per share be given the opportunity to surrender those options in exchange for new options awarded at fair market value ($6.00 per share) with the same vesting period commencing upon the date of the award of their original option agreement.\nOn May 12, 1995, the Company's stockholders approved an Employee Stock Purchase Plan (the \"ESPP\"), which is a qualified employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986, as amended, through which employees of the Company are given the opportunity to purchase shares of common stock. According to the ESPP, a total of one million shares of common stock has been reserved for offering to\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) employees over a period of five years, in quarterly offerings of 50,000 shares each plus any shares not issued in any previous quarter, commencing on July 1, 1995 and on the first day of each quarter thereafter through April 1, 2000. Employees who elect to participate in an offering may utilize up to 10% of their payroll for the purchase of common stock at 85% of the closing price of the stock on the first day of such quarterly offering or, if lower, 85% of the closing price on the last day of the offering. As of December 31, 1995, 59,000 shares of common stock had been purchased under the ESPP.\nBelow is a summary of the stock option activity under the 1987 and 1992 Plans through December 31, 1995:\n(b) Warrants\nIn connection with the issuance of senior subordinated notes payable in May 1989, the Company issued warrants to purchase 100,000 shares of common stock at $20.75 per share in exchange for $300,000. In April 1990, the exercise price of the warrants was reduced to $9 per share. In February 1991, in connection with the refinancing of the Company's short-term debt, the exercise price was further reduced to fair market value ($5 per share). These warrants are exercisable at any time until February 1, 2001.\nIn connection with the refinancing of the Company's short-term debt in February 1991, the Company issued warrants to purchase 425,000 shares of common stock at fair market value ($5 per share) to the three banks which provided the Revolver. These warrants are exercisable at any time until February 6, 2001.\n(c) Preferred Stock\nOn February 16, 1993 the Company issued 112,000 shares of Series B Convertible Preferred Stock, $.01 par value (\"Preferred Stock\"), for the acquisition of Spring Grove. The liquidation value of each preferred share\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) is the liquidation preference of $50 plus unpaid dividends. Preferred Stock may be converted by the holder into Common Stock at a conversion rate of $18.63. The Company has the option to redeem such Preferred Stock at liquidation value plus a redemption premium of 6%, if the redemption occurs on or before August 16, 1996; thereafter, the redemption premium declines 1% each year. Each preferred share entitles its holder to receive a cumulative annual cash dividend, which was $3.50 per share from February 16, 1993 to February 16, 1994 and $4.00 per share thereafter, or at the election of the Company, a common stock dividend of equivalent value.\nDividends on the Preferred Stock are payable on the 15th day of January, April, July and October, at the rate of $1.00 per share, per quarter. The Company elected to pay the October 15, 1995 dividend in common stock with a market value equal to the amount of the dividend payable. The market value of the common stock as of the October 1, 1995 record date of such dividend was $3.8375. Accordingly, on October 12, 1995 the Company issued 29,187 shares of common stock to the holders of the Preferred Stock. The Company anticipates that the Preferred Stock dividends payable through 1996 will be paid in common stock.\n(13) EMPLOYEE BENEFIT PLAN\nThe Company has a profit-sharing plan under Section 401(k) of the Internal Revenue Code covering substantially all employees. The plan allows employees to make contributions up to a specified percentage of their compensation, a portion of which is matched by the Company. During the years 1995, 1994 and 1993, the Company's nonelective contributions aggregated approximately $834,000, $825,000, and $743,000, respectively.\n(14) RELATED PARTY TRANSACTIONS\nThe Company leases certain facilities from a partnership of which the Company's principal stockholder is a limited partner. Under the terms of the lease, the Company agreed to make aggregate lease payments of $5,633,000 from the inception of the lease through June 1, 1996. In addition, the Company has an option to renew the lease for a five-year period. Total rent expense charged to operations was $703,000 during each of the years in the three-year period ended December 31, 1995. See Note 10 for further discussion of lease commitments. The Company has subleased a portion of these facilities to an unrelated third party.\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(15) QUARTERLY DATA (UNAUDITED)\n- -------- (a) Reflects a one-time, charge of $4,247,000 in connection with the re- engineering of the Company's operations and the write-down of nonperforming assets as well as the sale of certain non-core properties. (b) Reflects a one-time, noncash charge of $1,035,000 for the write-off of leasehold improvements and machinery.\nThe above information reflects all adjustments that are necessary to fairly state the results of the interim periods presented. Any adjustments required are of a normal recurring nature.\n(16) EXTRAORDINARY ITEM\nAs described in Note 9 above, during the third quarter of 1994, the Company completed a public offering of $50,000,000 of Senior Notes, and used the net proceeds to prepay substantially all of the Company's debt. The refinancing resulted in approximately $2,043,000 of expense relating to the early retirement of outstanding debt, and an extraordinary charge of $1,220,000 ($.13 per share), net of income tax benefit, for redemption premiums paid to the holders of the prepaid debt and for the write-off of deferred financing costs.\n(17) NONRECURRING CHARGES\nDuring the fourth quarter of 1995, the Company recorded a $4,247,000 nonrecurring charge in connection with the reengineering of the Company's operations and the write-off of a non-performing asset, as well as the anticipated losses on the sale of certain non-core properties. Under the reengineering program, the Company has closed or downsized small, satellite offices; reduced employment levels; downsized and relocated the laboratory to its waste handling facility in Braintree, Massachusetts; and will be relocating its corporate headquarters to a new location in Braintree, Massachusetts in the Spring of 1996. The components of the nonrecurring charge are as follows:\nCLEAN HARBORS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)\nDuring the fourth quarter of 1994, the Company renegotiated its lease on its corporate headquarters in Quincy, Massachusetts, such that the lease would terminate on or before December 31, 1995. The Company relocated its corporate headquarters to Braintree, Massachusetts in the spring of 1995. In addition, the Company has vacated laboratory space it rents in Bedford, Massachusetts, and is subleasing the space. As a result, the Company recorded a one-time, noncash charge of $1,035,000 before taxes for the write-off of leasehold improvements at the two locations.\nSCHEDULE II\nCLEAN HARBORS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1995 (IN THOUSANDS)\n- -------- (a) Amounts deemed uncollectible, net of recoveries.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone.\nPART III\nThe information 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) Documents Filed as a Part of this Report\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.\n3. Exhibits:\nExhibits to the Form 10-K have been included only with the copies of the Form 10-K filed with the Commission. Upon request to the Company and payment of a reasonable fee, copies of the individual exhibits will be furnished. The Company undertakes to furnish to the Commission upon request copies of instruments (in addition to the exhibits listed below) relating to the Company's long-term debt.\n- -------- (1) Incorporated by reference to Exhibit 3.1 to the Company's Form S-1 Registration Statement (No. 33-17565).\n(2) Incorporated by reference to the similarly numbered exhibit to the Company's Form 10-K Annual Report for the Year 1992.\n(3) Incorporated by reference to Exhibit 3.4A to the Company's Form 10-K Annual Report for the Fiscal Year Ended February 28, 1991.\n(4) Incorporated by reference to Exhibit 4.1 to the Company's Form S-2 Registration Statement (No. 33-54191).\n(5) Incorporated by reference to the similarly numbered exhibit to the Company's Form 10-Q Quarterly Report for the Quarterly Period Ended June 30, 1995.\n(6) Incorporated by reference to the similarly numbered exhibit to the Company's Form 10-K Annual Report for the Year 1993.\n(7) Incorporated by reference to the similarly numbered exhibit to the Company's Form 10-K Annual Report for the Year 1994.\n(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, ON MARCH 28, 1996.\nCLEAN HARBORS, INC.\nBy: \/s\/ Alan S. McKim --------------------------------- ALAN S. MCKIM 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\/ Alan S. McKim Chairman of the March 28, 1996 - ------------------------------------- Board of Directors, ALAN S. MCKIM President and Chief Executive Officer\n\/s\/ Stephen H. Moynihan Vice President and March 28, 1996 - ------------------------------------- Treasurer STEPHEN H. MOYNIHAN (principal financial and accounting officer)\n* Director March 28, 1996 - ------------------------------------- CHRISTY W. BELL\n* Director March 28, 1996 - ------------------------------------- JOHN F. KASLOW\n* Director March 28, 1996 - ------------------------------------- DANIEL J. MCCARTHY\n* Director March 28, 1996 - ------------------------------------- JOHN T. PRESTON\n* Director March 28, 1996 - ------------------------------------- LORNE R. WAXLAX\n*By: \/s\/ Alan S. McKim --------------------------------- ALAN S. MCKIM ATTORNEY-IN-FACT","section_15":""}
{"filename":"763744_1995.txt","cik":"763744","year":"1995","section_1":"Item 1. BUSINESS\nIntroduction\nDrew Industries Incorporated (\"Drew\" or the \"Company\"), through its wholly-owned subsidiary, Kinro, Inc., manufactures and markets aluminum and vinyl windows for manufactured homes, and aluminum and vinyl windows and doors for recreational vehicles.\nSee \"Recent Events\" for a discussion of the Company's February 1996 acquisition of Shoals Supply, Inc. which manufactures and distributes new and refurbished axles and tires, and new chassis parts, for the manufactured housing industry.\nThe Company's principal executive and administrative offices are located at 200 Mamaroneck Avenue, White Plains, New York, 10601; telephone number (914) 428-9098.\nIn connection with the spin-off of Leslie Building Products, Inc. by the Company, which was effective on July 29, 1994, the Company and Leslie Building Products entered into a Shared Services Agreement. Pursuant to the Shared Services Agreement, for a period of two years following the spin-off, the Company and Leslie Building Products agreed to share certain administrative functions and employee services, such as management overview and planning, tax preparation, financial reporting, coordination of independent audit, stockholder relations, and regulatory matters. The Company is reimbursed by Leslie Building Products for the fair market value of such services. The Shared Services Agreement may be extended under certain circumstances.\nBUSINESS OF THE COMPANY\nKinro, acquired by the Company in October 1980, initially manufactured only aluminum primary and storm windows for the manufactured housing industry. Since 1982, Kinro acquired additional manufacturers of aluminum windows for manufactured housing and manufacturers of doors and windows for recreational vehicles, and developed its own capacity to manufacture screens for its window products. In 1993, Kinro commenced production of vinyl windows in addition to aluminum windows.\nEach of the businesses acquired by Kinro expanded Kinro's geographic market and product line, and, in certain instances, added manufacturing facilities. All manufacturing, distribution and administrative functions of the acquired businesses were integrated with those of Kinro. Although definitive information is not readily available, the Company believes that the two leading manufacturers of windows for manufactured housing within the United States are Kinro and Philips Industries, Inc., and that there are approximately 10 significant suppliers of windows and doors for the recreational vehicle industry, several of which are substantially larger than Kinro.\nIn November 1995, Kinro acquired the assets and business of Star Window (Elkhart, Indiana), a privately-owned manufacturer of windows for mini buses with pre-acquisition annual revenues of less than $1 million. The acquisition of Star Window represents a new product line for Kinro. Kinro intends to expand the operations of Star Window in a new facility currently being built in Goshen, Indiana, which will also be utilized to expand Kinro's existing operations.\nRaw materials used by Kinro, consisting of extruded aluminum, glass, vinyl and various adhesive and insulating components, are readily available from a number of sources. Kinro, through the Company, maintains an aluminum hedging program under which it purchases futures contracts on the London Metals Exchange to hedge the prices of a portion of its anticipated aluminum requirements.\nKinro's operations consist primarily of fabricating and assembling the components into the finished windows, doors and screens. Kinro's line of products is sold by eight sales personnel, working exclusively for Kinro, to major builders of manufactured housing, such as Clayton Homes, Inc., Oakwood Homes Corporation and Redman Industries, Inc., and to major manufacturers of recreational vehicles such as Fleetwood Enterprises, Inc., Thor Industries, Inc., and Skyline Corporation.\nKinro's operations are subject to certain federal, state and local regulatory requirements relating to the use, storage, discharge and disposal of hazardous chemicals used during their manufacturing processes. Kinro believes that it is currently operating in compliance with applicable regulations and does not believe that costs of compliance with these laws and regulations will have a material effect upon its capital expenditures, earnings or competitive position.\nRecent Events\nPursuant to an Asset Purchase Agreement, dated February 15, 1996 (the \"Agreement\"), the Company acquired substantially all the assets and the business, and assumed certain liabilities, of Shoals Supply, Inc., a privately-owned Alabama corporation, which manufactures and distributes new and refurbished axles and fires, and new chasis parts, for the manufactured housing industry. Simultaneously, the Company assigned all its rights and obligations pursuant to the Agreement to Shoals Acquisition Corp., a wholly-owned subsidiary of the Company, the name of which was changed to Shoals Supply, Inc. (\"Shoals\"). The transaction was consummated on February 15, 1996 (the \"Closing Date\"). For 1995, the acquired operations had revenues of approximately $57,000,000.\nThe consideration for the acquired assets and business consisted of 544,959 restricted shares of the Company's Common Stock, par value $0.01 per share, valued at $7,500,000, which are subject to certain registration rights, cash in the amount of $1,225,000, and a five-year note in the principal amount of $760,000. In addition, the Company assumed $7,449,459 of the existing bank debt of the acquired operations, which the Company discharged on the Closing Date, and certain other operating liabilities. The consideration was based upon the fair value of the net assets and business acquired.\nThe Company issued to certain key employees of Shoals options to purchase an aggregate of 72,070 shares of the Company's Common Stock, at a purchase price of $13.875 per share, exercisable 20% each year during the five-year period commencing on the Closing Date, unless terminated or accelerated upon termination of employment.\nSimultaneously with the acquisition, the Company, Shoals and Kinro, Inc., a wholly-owned subsidiary of the Company, entered into a Guaranty and Security Agreement, dated as of the Closing Date, with Chemical Bank (the \"Bank\"), pursuant to which Shoals borrowed the principal amount of $5,981,672, which, together with $3,225,000 of the Company's own funds, was utilized to consummate the acquisition and discharge the existing bank debt of the acquired operations. The loan is secured by substantially all the assets of the Company, Shoals and Kinro, and is guaranteed by the Company and Kinro. The loan matures on May 15, 1996. The Company anticipates that the loan will be refinanced at that time.\nInterest on the loan is payable to the Bank, at maturity, at the rate of, at Shoals' option, (a) the Bank's Prime Rate plus 1\/4 of 1%, or (b) a fixed rate offered from time to time by the Bank, or (c) an adjusted Eurodollar rate plus 2.25%. Shoals also paid certain additional fees and charges relating to the loan.\nOn March 8, 1995, the Board of Directors authorized the repurchase of up to 500,000 shares of the Company's Common Stock. Purchases were made from time to time in the open market or in privately negotiated transactions at market prices prevailing at the time of purchase. The Company had no commitment or obligation to purchase any minimum number of shares. The Company purchased 29,850 shares, and the repurchase program terminated on March 7, 1995.\nEmployees\nThe approximate number of persons employed full-time by the Company at December 31, 1995 was as follows:\nDrew........................ 6 Kinro....................... 1,034 ----- Total........... 1,040 =====\nNone of the Company's or Kinro's employees are represented by a union. The Company and Kinro believe that relations with its employees are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nDrew leases its principal executive offices in White Plains, New York, consisting of approximately 2,800 square feet of office space.\nKinro owns two and leases six manufacturing and warehouse facilities consisting of an aggregate of approximately 593,000 square feet, in Mansfield, Texas; Double Springs, Alabama; Liberty, North Carolina; Thomasville, Georgia; Morraine, Ohio; Syracuse and Elkhart, Indiana; Fontana, California; and Goshen, Indiana; and leases its corporate offices in Arlington, Texas consisting of approximately 8,500 square feet of office space. Kinro is currently constructing a second manufacturing and warehouse facility, consisting of 52,000 square feet, on land owned by Kinro in Goshen, Indiana.\nSee Note 9 of Notes to Consolidated Financial Statements with respect to the Company's lease obligations as of December 31, 1995.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is not a party to any legal proceedings which, in the opinion of Management, could have a material adverse effect on the Company or its consolidated financial position.\nSee Note 5 of Notes to Consolidated Financial Statements with respect to certain product liability claims pending against White Metal Rolling and Stamping Corp. (\"White Metal\"), a subsidiary of Leslie-Locke, arising in connection with the ladder manufacturing business formerly conducted by White Metal. Although the Company and Leslie-Locke were named as defendants in certain actions commenced in connection with these claims, neither the Company nor Leslie-Locke has been held responsible, and the Company and Leslie-Locke disclaim any liability for the obligations of White Metal.\nSee Note 5 of Notes to Consolidated Financial statements with respect to the filing by White Metal, on September 30, 1994, of a voluntary petition seeking liquidation under the provisions of chapter 7 of the United States Bankruptcy Code. The chapter 7 Trustee of White Metal has alleged that the Company and its affiliated entities obtained tax benefits in excess of $4.5 million solely attributable to the use of White Metal's net operating losses. The Trustee has demanded payment on behalf of White Metal in an amount equal to the value of the tax savings achieved. The Company denies any liability for the amount claimed by the Trustee and intends to vigorously defend this claim. Management believes it has substantial and meritorious defenses, however, an estimate of potential loss, if any, cannot be made at this time.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following tables set forth certain information with respect to the Directors and Executive Officers of the Company as of December 31, 1995.\nName Position ---- -------- Leigh J. Abrams President, Chief Executive Officer and Director of (Age 53) the Company since March 1984.\nEdward W. Rose, III Chairman of the Board of Directors of the Company (Age 54) since March 1984.\nDavid L. Webster Director of the Company since March 1984. (Age 60)\nJames F. Gero Director since May 1992. (Age 50)\nGene H. Bishop Director since June 1995. (Age 66)\nFredric M. Zinn Chief Financial Officer of the Company since (Age 44) January 1986.\nHarvey J. Kaplan Secretary and Treasurer of the Company since March (Age 61) 1984.\nLEIGH J. ABRAMS has also been President, Chief Executive Officer and a Director of Leslie Building Products since July 1994.\nEDWARD W. ROSE, III, for more than the past five years, has been President and principal stockholder of Cardinal Investment Company, Inc., an investment firm. Mr. Rose also serves as Co-Managing General Partner of the Texas Rangers Baseball Team and as a director of the following public companies: Osprey Holding, Inc., previously engaged in selling computer software for hospitals; ACE Cash Express, Inc. engaged in check cashing services; and as a trustee of Liberte Investors Inc., engaged in construction, development loans and investments. Since July 1994, Mr. Rose has been Chairman of the Board of Leslie Building Products.\nDAVID L. WEBSTER, since November 1980, has been President and Chief Executive Officer of Kinro, Inc., a subsidiary of the Company, and Chairman of Kinro, Inc. since November 1984. Mr. Webster has also been President and Chief Executive Officer of Shoals Supply, Inc., a subsidiary of the Company, since its acquisition on February 15, 1996.\nJAMES F. GERO, since March 1992, has been Chairman and Chief Executive Officer of Sierra Technologies, Inc., a manufacturer of defense systems technologies. From July 1987 to October 1989, Mr. Gero was Chairman and Chief Executive Officer of Varo, Inc., a manufacturer of defense electronics, and from 1985 to 1987, Mr. Gero was President and Chief Executive Officer of Varo, Inc. Mr. Gero also serves as a director of the following public companies: Recognition Equipment, Inc., a publicly-owned company engaged in providing hardware, software and services to automate work processing systems; American Medical Electronics, Inc., a publicly-owned company engaged in manufacturing and distributing orthopedic and neurosurgical medical devices; and Spar Aerospace Ltd., engaged in space robotics, communications equipment and aerospace products and services. Since July 1994, Mr. Gero has been a Director of Leslie Building Products.\nGENE H. BISHOP, from March 1975 until July 1990, was Chief Executive Officer of MCorp, a bank holding company, and from October 1990 to November 1991, was Vice Chairman and Chief Financial Officer of Lomas Financial Corporation, a financial services company. From November 1991 until his retirement in October 1994, Mr. Bishop served as Chairman and Chief Executive Officer of Life Partners Group, Inc., a life insurance holding company, of which he continues to serve as a director. Mr. Bishop also serves as a director of the following publicly-owned companies: First USA, Inc., engaged in the credit card business; Liberte Investors Inc., engaged in real estate loans and investments; Southwest Airlines Co., a regional airline; and Southwestern Public Service Company, a public utility.\nFREDRIC M. ZINN has also been Chief Financial Officer of Leslie Building Products since July 1994. Mr. Zinn is a Certified Public Accountant.\nHARVEY J. KAPLAN has also been Secretary and Treasurer of Leslie Building Products since July 1994. Mr. Kaplan is a Certified Public Accountant.\nCompliance with Section 16(a) of the Securities Exchange Act\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers and directors, and persons who beneficially own more than ten percent of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the American Stock Exchange. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased on its review of the copies of such forms received by it, the Company believes that during 1995 all such filing requirements applicable to its officers and directors (the Company not being aware of any ten percent holder during 1995 other than Edward W. Rose, III a Director) were complied with.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPer Share Market Price Information\nThe Common Stock of the Company is traded on the American Stock Exchange (symbol: DW). On March 19, 1996, there were 2,473 holders of record of the Common Stock. The Company estimates that 2,000 to 4,000 additional stockholders own shares of its Common Stock held in the name of Cede & Co. and other broker and nominee names.\nThe table below sets forth, for the periods indicated, the range of high and low closing prices per share for the Common Stock as reported by the American Stock Exchange since February 8, 1995, and by the National Association of Securities Dealers (\"NASD\") prior to February 8, 1995. The prices set forth below for the period prior to February 8, 1995 represent quotations between dealers, without adjustment for retail mark-up, mark-down or commissions, and do not necessarily represent actual transactions. Prices subsequent to July 28, 1994 reflect the Spin-off of Leslie Building Products.\nHigh Low Calendar 1994 Quarter ended March 31 ....... $11.25 $ 8.38 Quarter ended June 30 ....... $11.00 $ 9.75 Quarter ended September 30 ....... $11.00 $ 8.25 Quarter ended December 31 ....... $ 9.00 $ 8.25\nCalendar 1995 Quarter ended March 31 ....... $10.50 $ 8.38 Quarter ended June 30 ....... $13.13 $10.38 Quarter ended September 30 ....... $13.88 $11.50 Quarter ended December 31 ....... $16.38 $12.63\nThe closing price per share for the Common Stock on March 19, 1996 was $14.375.\nDividend Information\nThe Company has not paid any cash dividends on its Common Stock. Future dividend policy with respect to the Common Stock will be determined by the Board of Directors of the Company in light of prevailing financial needs and earnings of the Company and other relevant factors.\nThe Company's dividend policy is subject to restrictions contained in financing agreements relating to its secured line of credit, which provide that dividends upon the Common Stock may be payable only with the consent of the lender. See Note 7 of Notes to Consolidated Financial Statements.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA, Item 7.","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nPart III of Form 10-K is incorporated by reference to the Company's Proxy Statement with respect to its Annual Meeting of Stockholders to be held on April 18, 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\n(1) Financial Statements. The Consolidated Financial Statements of the Company and its subsidiaries are incorporated by reference to the Consolidated Financial Statements and Notes to Consolidated Financial Statements in the Company's Annual Report to Stockholders for the year ended December 31, 1995.\n(2) Schedules. Schedule II - Valuation and Qualifying Accounts.\n(3) Exhibits. See \"List of Exhibits\" at the end of this report incorporated herein by reference.\n(b) Reports on Form 8-K\nNo Current 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, Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDREW INDUSTRIES INCORPORATED\nDate: March 20, 1996 By: \/s\/ Leigh J. Abrams ------------------- Leigh J. Abrams, 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 dates indicated.\nEach person whose signature appears below hereby authorizes Leigh J. Abrams and Harvey J. Kaplan, or either of them, to file one or more amendments to the Annual Report on Form 10-K which amendments may make such changes in such Report as either of them deems appropriate, and each such person hereby appoints Leigh J. Abrams and Harvey J. Kaplan, or either of them, as attorneys-in-fact to execute in the name and on behalf of each such person individually, and in each capacity stated below, such amendments to such Report.\nDate Signature Title - ---- --------- ----- March 20, 1996 By: \/s\/ Leigh J. Abrams Director, President and Chief (Leigh J. Abrams) Executive Officer\nMarch 20, 1996 By: \/s\/ Harvey J. Kaplan Secretary and Treasurer (Harvey J. Kaplan)\nMarch 20, 1996 By: \/s\/ Fredric M. Zinn Chief Financial Officer (Fredric M. Zinn)\nMarch 20, 1996 By: \/s\/ John F. Cupak Controller (John F. Cupak)\nMarch 20, 1996 By: \/s\/ Edward W. Rose, III Director (Edward W. Rose,III)\nMarch 20, 1996 By: \/s\/ David L. Webster Director (David L. Webster)\nMarch 20, 1996 By: \/s\/ James F. Gero Director (James F. Gero)\nMarch 20, 1996 By: \/s\/ Gene H. Bishop Director (Gene H. Bishop)\nEXHIBIT INDEX\nExhibit Sequentially Number Description Numbered Page - ------- ----------- ------------- 3. Articles of Incorporation and By-laws.\n3.1 Drew Industries Incorporated Restated Certificate of Incorporation.\n3.2 Drew Industries Incorporated By-laws, as amended.\nExhibit 3.1 is incorporated by reference to Exhibit III to the Proxy Statement-Prospectus constituting Part I of the Drew National Corporation and Drew Industries Incorporated Registration Statement on Form S-14 (Registration No. 2-94693).\nExhibit 3.2 is incorporated by reference to the Exhibit bearing the same number included in the Annual Report of Drew Industries Incorporated on Form 10-K for the fiscal year ended August 31, 1985.\n10. Material Contracts.\n10.27 Lease between Kinro, Inc. and Robert A. White and Larry B. White, dated June 1, 1979, as amended.\n10.39 Leases between Robert A. White, Larry B. White and Kinro, Inc. dated July 25, 1983, as amended.\n10.47 Registration Agreement among Drew Industries Incorporated and the Leslie-Locke Shareholders dated August 28, 1985.\n10.49 Loan and Pledge Agreements between Drew Industries Incorporated and Robert S. Sandlin, Ralph C. Pepper and James S. Roach, respectively, dated August 28, 1985.\n10.56 Agreement by and between Drew Industries Incorporated and Invest, Inc., dated October 16, 1986.\n10.57 Security Agreement by and among Drew Industries Incorporated, Invest, Inc. and Carsons of Atlanta, Inc., dated October 16, 1986.\n10.58 Pledge and Security Agreement by and between Drew Industries Incorporated and Invest, Inc., dated October 16, 1986.\n10.59 Secured Promissory Note in the amount of $795,000 of Invest, Inc., dated October 16, 1986.\n10.66 Employment Agreement by and between Kinro, Inc. and David L. Webster, dated July 31, 1986, effective September 1, 1986.\n10.91 Lease between Kinro, Inc. and 1700 Industry Associates, dated April 30, 1987.\n10.100 Drew Industries Incorporated Stock Option Plan.\n10.122 Guaranty and Noncompetition Agreement given by Drew Industries Incorporated and Leslie-Locke, Inc., in favor of R.D. Werner Co., Inc., dated as of November 23, 1990.\n10.134 Letter, dated April 28, 1988, from Drew Industries Incorporated to Leigh J. Abrams confirming compensation arrangement.\n10.135 Description of split-dollar life insurance plan for certain executive officers.\n10.139 Guaranty Agreement between Drew Industries, Inc. and BBT dated June 21, 1993.\n10.140 Credit Agreement dated as of July 30, 1993 among Drew Industries Incorporated, Kinro, Inc., Leslie-Locke, Inc. and Chemical Bank.\n10.141 $15,000,000 Revolving Note of Kinro, Inc. to Chemical Bank dated July 30, 1993.\n10.142 $15,000,000 Revolving Note of Leslie-Locke, Inc. to Chemical Bank dated July 30, 1993.\n10.143 Pledge and Security Agreement dated as of July 30, 1993 between Drew Industries Incorporated and Chemical Bank.\n10.144 Patent and Trademark Security Assignment (As Collateral) dated as of July 30, 1993 between Kinro, Inc. and Chemical Bank.\n10.145 $15,000,000 Intercompany Notes from Drew Industries Incorporated to Kinro, Inc. and Leslie-Locke, Inc., and from Kinro, Inc. and Leslie-Locke, Inc. to Drew Industries Incorporated dated July 30, 1993.\n10.146 Form of Plan and Agreement of Distribution between Leslie Building Products, Inc. and Drew Industries Incorporated dated July 29, 1994.\n10.147 Form of Shared Services Agreement between Leslie Building Products, Inc. and Drew Industries Incorporated dated July 29, 1994.\n10.148 Form of Tax Matters Agreement between Leslie Building Products, Inc. and Drew Industries Incorporated dated July 29, 1994.\n10.149 Credit Agreement dated July 29, 1994 among Drew Industries Incorporated, Kinro, Inc. and Chemical Bank.\n10.150 Pledge Agreement dated as of July 29, 1994 made by Drew Industries Incorporated in favor of Chemical Bank.\n10.151 Asset Purchase Agreement, dated February 15, 1996, by and among Shoals Supply, Inc., Lecil V. Thomas, and Drew Industries Incorporated.\n10.152 Non-Negotiable Promissory Note, dated February 15, 1996, of Shoals Acquisition Corp., to the order of Shoals Supply, Inc. in the principal amount of $760,000, guaranteed by Drew Industries Incorporated.\n10.153 Bill of Sale, dated February 15, 1996 by and between Shoals Supply, Inc. and Drew Industries Incorporated.\n10.154 Registration Rights Agreement, dated February 15, 1996, by and among Drew Industries Incorporated, Shoals Supply, Inc., and Lecil V. Thomas.\n10.155 Consulting and Non-Competition Agreement, dated February 15, 1996, by and between Drew Industries Incorporated and Lecil V. Thomas.\n10.156 Leases, dated February 15, 1996, between Thomas Family Partnership, Ltd. and Shoals Acquisition Corp.\n10.157 Employment Bonus Agreements, dated February 15, 1996, by and between Shoals Supply, Inc. and the employees named therein.\n10.158 Assignment, dated February 15, 1996, by and among Shoals Supply, Inc., Lecil V. Thomas and Drew Industries Incorporated.\nExhibit 10.27 is incorporated by reference to the Exhibits bearing the same number indicated on the Registration Statement of Drew National Corporation on Form S-1 (Registration No. 2-72492).\nExhibit 10.39 is incorporated by reference to the Exhibit included in the Annual Report of Drew National Corporation on Form 10-K for the fiscal year ended August 31, 1983.\nExhibits 10.47 and 10.49 are incorporated by reference to the Exhibits included in the Company's Current Report on Form 8-K dated September 6, 1985.\nExhibits 10.56-10.59 and 10.66 are incorporated by reference to the Exhibits bearing the same numbers included in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1987.\nExhibit 10.91 is incorporated by reference to the Exhibits bearing the same numbers included in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1987.\nExhibit 10.100 is incorporated by reference to Exhibit A to the Proxy Statement of the Company dated May 10, 1995.\nExhibit 10.122 is incorporated by reference to the Exhibits included in the Company's Current Report on Form 8-K, dated November 28, 1990.\nExhibits 10.123-10.130 are incorporated by reference to the Exhibits included in the Company's Current Report on Form 8-K dated December 23, 1991.\nExhibits 10.131 and 10.132 are incorporated by reference to the Exhibits included in Amendment No. 5 on Form 8, dated October 20, 1992, to the Company's Current Report on Form 8-K dated January 9, 1987.\nExhibit 10.134 is incorporated by reference to the Exhibit bearing the same number included in the Company's Transition Report on Form 10-K for the period September 1, 1992 to December 31, 1993.\nExhibit 10.135 is incorporated by reference to the Exhibit bearing the same number included in the Company's Transition Report on Form 10-K for the period September 1, 1992 to December 31, 1993.\nExhibits 10.139-10.145 are incorporated by reference to the Exhibits bearing the same number included in the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\nExhibits 10.146-10.148 are incorporated by reference to the Exhibits bearing numbers 10.1, 10.3 and 10.4, respectively, included in Post-Effective amendment No. 1 on Form 10\/A, dated August 30, 1994, to the Registration Statement of Leslie Building Products, Inc. on Form 10 (Registration No. 0-24094).\nExhibits 10.149 and 10.150 are incorporated by reference to the Exhibits bearing the same numbers included in the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\nExhibits 10.151 - 10.158 are incorporated by reference to the Exhibits included in the Company's Current Report on Form 8-K dated February 29, 1996.\n13. 1995 Annual Report to Stockholders.\nExhibit 13 is filed herewith. ____________\n21. Subsidiaries\nExhibit 21 is filed herewith. ____________\n23. Consent of Independent Auditors.\nExhibit 23 is filed herewith. ____________\n24. Powers of Attorney.\nPowers of Attorney of persons signing this Report are included as part of this Report.\n27. Financial Data Schedule\nExhibit 27 is filed herewith and included in the EDGAR document only.\nReport of Independent Auditors\nThe Board of Directors Drew Industries Incorporated\nUnder date of February 19, 1996, we reported on the consolidated balance sheets of Drew Industries Incorporated 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 years in the three-year period ended December 31, 1995 as contained on pages 13 through 26 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 schedule as listed in Item 14. This schedule is the responsibility of the company's management. Our responsibility is to express an opinion on this schedule based on our audits.\nIn our opinion, such 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 Stamford, Connecticut February 19, 1996\n- ------------ (a) Represents accounts written-off net of recoveries. (b) Represents writeoff of uncollectible portion of notes, net of recoveries (c) Represents a $180,000 increase in valuation of loans as a result of sale of collateral and a reduction in the reserve of $163,000 as a result of a foreclosure.","section_15":""}
{"filename":"711404_1995.txt","cik":"711404","year":"1995","section_1":"ITEM 1. BUSINESS.\nINTRODUCTION\nThe Cooper Companies, Inc. ('TCC' or the 'Company'), through its subsidiaries, develops, manufactures and markets healthcare products, including a range of contact lenses and diagnostic and surgical instruments and accessories, and provides healthcare services through the ownership and operation of certain psychiatric facilities. TCC is a Delaware corporation which was organized on March 4, 1980.\nCOOPERVISION\nCooperVision, Inc. ('CooperVision' or 'CVI') develops, manufactures and markets a range of contact lenses in the United States and Canada. Approximately 75% of the lenses sold are conventional daily or flexible wear lenses and approximately 25% constitute planned replacement lenses.\nCooperVision's major brand name lenses are Hydrasoft'r', Preference'r', Vantage'r', Permaflex'r', Permalens'r' and Cooper Clear'tm'. These and other products enable CooperVision to fit the needs of a diverse group of wearers by offering lenses formulated from a variety of polymers containing varying amounts of water and different degrees of oxygen permeability, and having different design parameters, diameters, base curves and lens edges. Certain lenses offer special features such as protection against ultraviolet light, color tint, astigmatic correction or aphakic correction.\nPreference'r', which was introduced in fiscal 1992, is a planned replacement product manufactured from the Tetrafilcon A polymer. Three clinical studies, conducted at 31 investigative sites using 603 patients, have demonstrated Preference's superior performance in connection with deposit resistance, visual acuity and handling.\nIn April 1993, CooperVision acquired CoastVision, Inc. ('CoastVision'), a contact lens company which designs, manufactures and markets high quality soft toric lenses (the majority of which are custom made) designed to correct astigmatism. The acquisition has enabled CooperVision to expand into an additional niche in the contact lens market and to enlarge its customer base.\nIn October 1994, CooperVision introduced Preference Toric'tm', a toric planned replacement product. Preference Toric'tm' combines the benefits of the Tetrafilcon A polymer with the low cost 'fips' manufacturing techniques and design characteristics of the Hydrasoft'r' toric lens. This new product enables CooperVision to compete in the fast-growing toric planned replacement market segment.\nCooperVision Pharmaceuticals, now reorganized as part of CooperVision, has completed all of the clinical trials conducted during the past four years with respect to CalOptic'tm', its proprietary calcium channel blocker compound being developed for the topical treatment of glaucoma. Those clinical trials demonstrated safety and efficacy, but also indicated that considerable further research would be necessary to establish the compound's full potential and to obtain regulatory approvals to market the product. Exploratory discussions with prospective partners are continuing in an attempt to share the risks and costs of the necessary further research, as well as the potential profits that may ultimately be obtained if the product is approved for sale.\nCooperVision is continuing to explore opportunities to expand and diversify its business into additional niche markets.\nCOOPERSURGICAL\nCooperSurgical, Inc. ('CooperSurgical') was established in November 1990 to compete in niche segments of the rapidly expanding worldwide market for diagnostic and surgical instruments, accessories and disposable devices. During the past few years, increasing emphasis has been given to developing, manufacturing and distributing diagnostic and surgical instruments, disposable devices and equipment used selectively in both traditional and minimally invasive surgical procedures, especially\nthose performed by gynecologists. By the end of fiscal 1995, approximately 75% of CooperSurgical's net revenue related to women's healthcare products.\nCooperSurgical's loop electrosurgical excision procedure products, marketed under the LEEP'tm' brand name, are primarily used for the removal of cervical and vaginal pre-cancerous tissue and benign external lesions. Unlike laser ablation, which tends to destroy tissue, the electrosurgery procedure removes affected tissue with minimal charring, thereby improving the opportunity to obtain an accurate histological analysis of the patient's condition by producing a viable tissue specimen for biopsy purposes. In addition, the loop electrosurgical excision procedure is less painful to the patient than laser ablation and is easily learned by practitioners. Because this procedure enables a gynecologist to both diagnose and treat a patient in one office visit, patients incur lower costs.\nCooperSurgical's LEEP System 6000'r' branded products include an electrosurgical generator, sterile single application LEEP Electrodes'tm', the CooperSurgical Smoke Evacuation System 6080'tm', a single application LEEP RediKit'r', a series of educational video tapes and a line of autoclavable coated LEEP'tm' surgical instruments. LEEP System 1000'tm' branded products have been introduced for use abroad.\nCooperSurgical's Euro-Med mail order business offers over 400 products for use in gynecologic and general surgical procedures. Over 60% of these products are exclusive to Euro-Med, including its 'signature' instrument series, cervical biopsy punches, clear plastic instruments used for unobstructed viewing, titanium instruments used in laser surgeries, colposcopy procedure kits and instrument care and sterilization systems.\nCooperSurgical's Frigitronics'r' instruments for cryosurgery are used primarily in dermatologic procedures to treat skin cancers, in ophthalmic procedures to treat retinal detachments and remove cataracts, and in certain gynecologic, cardiovascular and general surgical procedures. The primary products bearing the Frigitronics brand name are the Model 310 Zoom Colposcope, the CCS-200 Cardiac Cryosurgical System, the Model 2000 Ophthalmic Cryosurgical System and the Cryo-Plus System for gynecologic office procedures.\nIn May 1995, CooperSurgical terminated its agreement with InnerDyne, Inc. to develop their endometrial ablation technology to control excessive uterine bleeding.\nIn June 1995, CooperSurgical acquired a proprietary line of products that facilitate the performance of gynecological procedures where uterine manipulation is required. Compared to competing products, the new CooperSurgical products offer the gynecologist substantially improved pelvic exposure, access and traction during laparoscopic surgery, and facilitate dye injection during fertility studies. Since acquiring this product line, CooperSurgical has completed development of a proprietary line extension designed to enable gynecologists to perform minimally invasive hysterectomies, which will be launched after market clearance by the FDA.\nOutside the U.S., CooperSurgical received regulatory approval during 1995 for its operating room laparoscopy products in Japan.\nHOSPITAL GROUP OF AMERICA\nIn May 1992, TCC acquired Hospital Group of America, Inc. ('HGA'), which owns and operates three psychiatric facilities: Hartgrove Hospital in Chicago, Illinois (which currently has 119 licensed beds), Hampton Hospital in Rancocas, New Jersey (which currently has 100 licensed beds) and MeadowWood Hospital in New Castle, Delaware (which currently has 50 licensed beds). Also in May 1992, a subsidiary of the Company entered into a management services agreement under which it assumed the management of three additional psychiatric facilities. The management services agreement, which provided for monthly payments to the Company of $166,667, expired by its terms in May 1995. Also in May 1995, HGA settled a purchase price adjustment and other disputes that had been pending since 1992 with the former owner of its hospitals.\nHGA's psychiatric facilities provide intensive and structured treatment for children, adolescents and adults suffering from a variety of mental illnesses and\/or chemical dependencies, including treatment for women, older adults, survivors of psychological trauma and alcohol and substance abusers. Services\ninclude comprehensive psychiatric and chemical dependency evaluations, inpatient and outpatient treatment and partial hospitalization.\nIn response to market demands for an expanded continuum of care, HGA is in the process of expanding its outpatient and partial hospitalization programs. Several of those facilities offer day-treatment to children and adolescents, others offer treatment to chronically mentally ill adults and others offer outpatient counseling. During 1995, the number of day-treatment sites was increased to eight at Hartgrove Hospital and to four at MeadowWood Hospital. Additional programs are expected to commence operations in 1996.\nThe following is a comparison of certain statistical data relating to inpatient treatment for fiscal years 1993, 1994 and 1995 for the psychiatric facilities owned by HGA:\nDuring the three-year period for which information is provided, total patient days, average length of stay, and average occupancy have declined. This trend is due, in part, to pressure from managed care groups to limit the length of hospital stays.\nEach psychiatric facility is accredited by the Joint Commission of Accreditation of Healthcare Organizations (JCAHO), a national organization which periodically undertakes a comprehensive review of a facility's staff, programs, physical plant and policies and procedures for purposes of accreditation of such healthcare facility. Accreditation generally is required for patients to receive insurance company reimbursement and for participation by the facility in government sponsored provider programs.\nUntil December 31, 1995, a medical group not affiliated with HGA was responsible for providing both clinical and clinical administrative services at Hampton Hospital. In December 1995, the Company announced the settlement of a dispute with the management of that medical group. (See Note 14.(1))\nPatient and Third Party Payments. HGA receives payment for its psychiatric services either from patients, from their health insurers or through the Medicare, Medicaid and Civilian Health and Medical Program of Uniformed Services ('CHAMPUS') governmental programs. Medicare is a federal program which entitles persons 65 and over to a lifetime benefit of up to 190 days as an inpatient in an acute psychiatric facility. Persons defined as disabled, regardless of age, also receive this benefit. Medicaid is a joint federal and state program available to persons with limited financial resources. CHAMPUS is a federal program which provides health insurance for active and retired military personnel and their dependents.\nWhile other programs may exist or be adopted in different jurisdictions, the following four categories reflect the primary methods by which HGA's facilities receive payment for services:\n(a) Standard reimbursement, consisting of payment by patients and their health insurers, is based on a facility's schedule of rates and is not subject to negotiation with insurance companies, competitive bidding or governmental limitation.\n(b) Negotiated rate reimbursement is at prices established in advance by negotiation or competitive bidding for contracts with insurers and other payors such as managed care companies, health maintenance organizations ('HMO'), preferred provider organizations ('PPO') and similar organizations which can provide a reasonable number of referrals.\n(c) Cost-based reimbursement is predicated on the allowable cost of services, plus, in certain cases, an incentive payment where costs fall below a target rate. It is used by Medicare, Medicaid\n- ------------ (1) All references to Note numbers shall constitute the incorporation by reference of the text of the specific Note contained in the Notes to Consolidated Financial Statements of the Company and its subsidiaries located in Item 8, into the Item number in which it appears.\nand certain Blue Cross insurance programs to provide reimbursement in amounts generally lower than the standard or negotiated schedule of rates in effect at an HGA facility.\n(d) CHAMPUS reimbursement is at either (1) regionally set rates, (2) a national rate adjusted upward periodically on the basis of the Medicare Market Basket Index or (3) a fixed discount rate per day at certain facilities where CHAMPUS contracts with a benefit administration group.\nThe Medicare, Medicaid and CHAMPUS programs are subject to statutory and regulatory changes and interpretations, utilization reviews and governmental funding restrictions, all of which may materially increase or decrease program payments and the cost of providing services, as well as the timing of payments to the facilities.\nLimits on Reimbursement. Changes in government reimbursement programs have resulted in limitations on increases in, and in some cases in reduced levels of reimbursement for healthcare services, and additional changes are anticipated. Such changes are likely to result in further limitations on reimbursement levels. In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures. Inpatient hospital utilization, average lengths of stay and occupancy rates continue to be negatively affected by payor-required pre-admission authorization and utilization review and by payor pressure to maximize outpatient and alternative healthcare delivery services for less acutely ill patients. In addition, efforts to impose reduced allowances, greater discounts and more stringent cost controls by government and other payors are expected to continue. Although the Company is unable to predict the effect these changes will have on its operations, as the number of patients covered by managed care payors increases, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a further adverse effect on HGA's business and earnings.\nRESEARCH AND DEVELOPMENT\nDuring the fiscal years ended October 31, 1995, 1994 and 1993, expenditures for Company-sponsored research and development were $2,914,000, $4,407,000 and $3,209,000, respectively. During fiscal 1995, approximately 43% of those expenditures was incurred by CooperVision Pharmaceuticals, primarily in connection with completing the CalOptic'tm' clinical trials, 29% was incurred by CooperVision and the balance was incurred by CooperSurgical. No customer-sponsored research and development has been conducted.\nThe Company employs 16 people in its research and development and manufacturing engineering departments. Product development and clinical research for CooperVision products are supported by outside specialists in lens design, formulation science, polymer chemistry, microbiology and biochemistry. Product research and development for CooperSurgical is conducted in-house and by outside surgical specialists, including members of both the CooperSurgical and Euro-Med surgical advisory boards.\nGOVERNMENT REGULATION\nHealthcare Products. The development, testing, production and marketing of the Company's healthcare products are subject to the authority of the U.S. Food and Drug Administration ('FDA') and other federal agencies as well as foreign ministries of health. The Federal Food, Drug and Cosmetic Act and other statutes and regulations govern the testing, manufacturing, labeling, storage, advertising and promotion of such products. Noncompliance with applicable regulations can result in fines, product recall or seizure, suspension of production and criminal prosecution.\nThe Company is currently developing and marketing medical devices, which are subject to different levels of FDA regulation depending upon the classification of the device. Class III devices, such as flexible and extended wear contact lenses, require extensive premarket testing and approval procedures, while Class I and II devices are subject to substantially lower levels of regulation.\nA multi-step procedure must be completed before a new contact lens can be sold commercially. Data must be compiled on the chemistry and toxicology of the lens, its microbiological profile and the proposed manufacturing process. All data generated must be submitted to the FDA in support of an application for an Investigational Device Exemption. Once granted, clinical trials may be initiated\nsubject to the review and approval of an Institutional Review Board and, where a lens is determined to be a significant risk device, the FDA. Upon completion of clinical trials, a Premarket Approval Application must be submitted and approved by the FDA before commercialization may begin.\nThe Company, in connection with some of its new surgical products, can submit premarket notification to the FDA under an expedited procedure known as a 510(k) application, which is available for any product that can be demonstrated to be substantially equivalent to a device marketed prior to May 28, 1976. If the new product is not substantially equivalent to a pre-existing device or if the FDA were to reject a claim of substantial equivalence, extensive preclinical and clinical testing would be required, additional costs would be incurred and a substantial delay would occur before the product could be brought to market.\nFDA and state regulations also require adherence to applicable 'good manufacturing practices' ('GMP'), which mandate detailed quality assurance and record-keeping procedures. In conjunction therewith, the Company is subject to unscheduled periodic regulatory inspections. The Company believes it is in substantial compliance with GMP regulations.\nThe Company also is subject to foreign regulatory authorities governing human clinical trials and pharmaceutical\/medical device sales that vary widely from country to country. Whether or not FDA approval has been obtained, approval of a product by comparable regulatory authorities of foreign countries must be obtained before products may be marketed in those countries. The approval process varies from country to country, and the time required may be longer or shorter than that required for FDA approval.\nThe procedures described above involve the expenditure of considerable resources and usually result in a substantial time lag between the development of a new product and its introduction into the marketplace. There can be no assurance that all necessary approvals will be obtained, or that they will be obtained in a time frame that allows the product to be introduced for commercial sale in a timely manner. Furthermore, product approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur after marketing has begun.\nHealthcare Services. The healthcare services industry is subject to substantial federal, state and local regulation. Government regulation affects the Company's business by controlling the use of its properties and controlling reimbursement for services provided. Licensing, certification and other applicable governmental regulations vary from jurisdiction to jurisdiction and are revised periodically.\nThe Company's facilities must comply with the licensing requirements of federal, state and local health agencies and with the requirements of municipal building codes, health codes and local fire department codes. In granting and renewing a facility's license, a state health agency considers, among other things, the condition of the physical buildings and equipment, the qualifications of the administrative personnel and professional staff, the quality of professional and other services and the continuing compliance of such facility with applicable laws and regulations.\nThe states in which the Company operates hospital facilities have in effect certificate of need statutes. State certificate of need statutes provide, generally, that prior to the construction of new healthcare facilities, the addition of new beds or the introduction of a new service, a state agency must determine that a need exists for those facilities, beds or services. A certificate of need is generally issued for a specific maximum amount of expenditures or number of beds or types of services to be provided, and the holder is generally required to implement the approved project within a specific time period. Certificate of need issuances for new facilities are extremely competitive, often with several applicants for a single certificate of need.\nAll of HGA's facilities are certified or approved as providers under one or more of the Medicaid or Medicare programs. In order to receive Medicare reimbursement, each facility must meet the applicable conditions promulgated by the United States Department of Health and Human Services relating to the type of facility, its equipment, its personnel and its standards of patient care.\nThe Social Security Act contains a number of provisions designed to ensure that services rendered to Medicare and Medicaid patients are medically necessary and meet professionally recognized standards. Those provisions include a requirement that admissions of Medicare and Medicaid patients to healthcare facilities must be reviewed in a timely manner to determine the medical necessity of the\nadmissions. In addition, the Peer Review Improvement Act of 1982 provides that a healthcare facility may be required by the federal government to reimburse the government for the cost of Medicare-paid services determined by a peer review organization to have been medically unnecessary.\nVarious state and federal laws regulate the relationships between providers of healthcare services and physicians. Among these laws are the Medicare and Medicaid Anti-Fraud and Abuse Amendments to the Social Security Act, which prohibit individuals or entities participating in the Medicare or Medicaid programs from knowingly and willfully offering, paying, soliciting or receiving 'remuneration' (which includes anything of value) in order to induce referrals for items or services reimbursed under those programs. Sanctions for violating the Amendments include criminal penalties and civil sanctions, including fines and possible exclusion from the Medicare and Medicaid programs. In addition, Section 1877 of the Social Security Act was amended, effective January 1, 1995, to significantly broaden the prohibitions against physicians making referrals under Medicare and Medicaid programs to providers with which the physicians have financial arrangements. Many states have adopted, or are considering, similar legislative proposals, some of which (including statutes in effect in New Jersey and Illinois) extend beyond the Medicare and Medicaid programs to all healthcare services.\nIn addition, specific laws exist that regulate certain aspects of the Company's business, such as the commitment of patients to psychiatric hospitals and disclosure of information regarding patients being treated for chemical dependency. Many states have adopted a 'patient's bill of rights' which sets forth standards for dealing with issues such as use of the least restrictive treatment, patient confidentiality, patient access to telephones, mail and legal counsel and requiring the patient to be treated with dignity.\nHealthcare Reform. In recent years, an increasing number of legislative initiatives have been introduced or proposed in Congress and in state legislatures that would effect major changes in the healthcare system, either nationally or at the state level. Among the proposals under consideration are price controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees and the creation of a government health insurance plan or plans that would cover all citizens. There continue to be efforts at the federal level to introduce various insurance market reforms, expanded fraud and abuse and anti-referral legislation and further reductions in Medicare and Medicaid reimbursement. A broad range of both similar and more comprehensive healthcare reform initiatives is likely to be considered at the state level. It is uncertain which, if any, of these or other proposals will be adopted. The Company cannot predict the effect such reforms or the prospect of their enactment may have on the business of the Company and its subsidiaries.\nRAW MATERIALS\nIn general, raw materials required by CooperVision consist of various polymers as well as packaging materials. Alternative sources of all of these materials are available. Raw materials used by CooperSurgical or its suppliers are generally available from a variety of sources. Products manufactured for CooperSurgical are generally available from more than one source. However, because some products require specialized manufacturing procedures, CooperSurgical could experience inventory shortages if an alternative manufacturer had to be secured on short notice.\nMANUFACTURING\nCooperVision manufactures products in the United States and Canada. CooperSurgical manufactures products in the United States and Europe.\nPursuant to a supply agreement entered into in May 1989 and subsequently amended between the Company and Pilkington plc, the buyer of the Company's contact lens business outside of the United States and Canada, CooperVision purchases certain of its lenses from Pilkington plc (see Note 14). These purchased lenses represented approximately 10%, 13% and 28% of the total number of lenses sold by the Company in fiscal 1995, 1994 and 1993, respectively.\nMARKETING AND DISTRIBUTION\nHealthcare Products. In the United States and Canada, CooperVision markets its products through its field sales representatives, who call on ophthalmologists, optometrists, opticians and optical chains. In the United States, field sales representatives also call on distributors.\nCooperSurgical's LEEP'tm', Frigitronics'r' and hysteroscopy products are marketed worldwide by a network of independent sales representatives and distributors. Euro-Med'r' instruments, as well as certain LEEP'tm' disposable products, are marketed in the United States through direct mail catalog programs.\nHealthcare Services. HGA's marketing concept aims to position each psychiatric facility as the provider of the highest quality mental health services in its marketplace. HGA employs a combination of general advertising, toll-free 'help lines,' community education programs and facility-based continuing education programs to underscore the facility's value as a mental health resource center. HGA's marketing emphasizes discrete programs for select illnesses or disorders because of its belief that marketing with program differentiation will be valuable to a referral source seeking treatment for specific disorders. Referral sources include psychiatrists, other physicians, psychologists, social workers, school guidance counselors, police, courts, clergy, care-provider organizations and former patients.\nPATENTS, TRADEMARKS AND LICENSING AGREEMENTS\nTCC owns or licenses a variety of domestic and foreign patents which, in the aggregate, are material to its businesses. Unexpired terms of TCC's United States patents range from less than one year to a maximum of 20 years.\nAs indicated in the references to such products in this Item 1, the names of certain of TCC's products are protected by trademark registrations in the United States Patent and Trademark Office and, in some instances, in foreign trademark offices as well. Applications are pending for additional trademark registrations. TCC considers these trademarks to be valuable because of their contribution to the market identification of its various products.\nDEPENDENCE UPON CUSTOMERS\nNo material portion of TCC's businesses is dependent upon any one customer or upon any one affiliated group of customers. However, approximately 21% and 29%, respectively, of HGA's fiscal 1995 net patient revenue was generated by Medicaid and Medicare.\nGOVERNMENT CONTRACTS\nNo material portion of TCC's businesses is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the United States government.\nCOMPETITION\nEach of TCC's businesses operates within a highly competitive environment. Competition in the healthcare industry revolves around the search for technological and therapeutic innovations in the prevention, diagnosis and treatment of illness or disease. TCC competes primarily on the basis of product quality, program differentiation, technological benefit, service and reliability, as perceived by medical professionals.\nHealthcare Products. Numerous companies are engaged in the development and manufacture of contact lenses. CooperVision competes primarily on the basis of product quality, service and reputation among medical professionals and by its participation in specialty niche markets. It has been, and continues to be, the sponsor of clinical lens studies intended to generate information leading to the improvement of CooperVision's lenses from a medical point of view. Major competitors have greater financial resources and larger research and development and sales forces than CooperVision. Furthermore, many of these competitors offer a greater range of contact lenses, plus a variety of other\neyecare products, including lens care products and ophthalmic pharmaceuticals, which may give them a competitive advantage in marketing their lenses to high volume contract accounts.\nIn the surgical segment, competitive factors are technological and scientific advances, product quality, price and effective communication of product information to physicians and hospitals. CooperSurgical believes that it benefits, in part, from the technological advantages of certain of its products and from the ongoing development of new medical procedures, which creates a market for equipment and instruments specifically tailored for use in such new procedures. CooperSurgical competes by focusing on distinct niche markets and supplying medical personnel working in those markets with equipment, instruments and disposable products that are high in quality and that, with respect to certain procedures, enable a medical practitioner to obtain from one source all of the equipment, instruments and disposable products required to perform such procedure. As CooperSurgical develops products to be used in the performance of new medical procedures, it offers training to medical professionals in the performance of such procedures. CooperSurgical competes with a number of manufacturers in each of its niche markets, including larger manufacturers that have greater financial and personnel resources and sell a substantially larger number of product lines.\nHealthcare Services. In most areas in which HGA operates, there are other psychiatric facilities that provide services comparable to those offered by HGA's facilities. Some of those facilities are owned by governmental organizations, not-for-profit organizations or investor-owned companies having substantially greater resources than HGA and, in some cases, tax-exempt status. Psychiatric facilities frequently draw patients from areas outside their immediate locale, therefore, HGA's psychiatric facilities compete with both local and distant facilities. In addition, psychiatric facilities compete with psychiatric units in acute care hospitals. HGA's strategy is to develop high quality programs designed to target specific disorders and to retain a highly qualified professional staff.\nBACKLOG\nTCC does not consider backlog to be a material factor in its businesses.\nSEASONALITY\nHGA's psychiatric facilities experience a decline in occupancy rates during the summer months when school is not in session and during the year-end holiday season. No other material portion of TCC's businesses is seasonal.\nCOMPLIANCE WITH ENVIRONMENTAL LAWS\nFederal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, do not currently have a material effect upon TCC's capital expenditures, earnings or competitive position.\nWORKING CAPITAL\nTCC's businesses have not required any material working capital arrangements in the past five years. In light of the substantial reduction in TCC's current asset base and the potential cash outflow which may occur in connection with the acquisition of new products, the Company has obtained a line of credit from a commercial lender and is pursuing a variety of other alternatives to obtain funds. See Item 7 'Management's Discussion and Analysis of Financial Condition' and 'Results of Operations -- Capital Resources and Liquidity.'\nFINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS, GEOGRAPHIC AREAS, FOREIGN OPERATIONS AND EXPORT SALES\nNote 16 sets forth financial information with respect to TCC's business segments and sales in different geographic areas.\nEMPLOYEES\nOn October 31, 1995, TCC and its subsidiaries employed approximately 1,000 persons. In addition, HGA's psychiatric facilities are staffed by licensed physicians who have been admitted to the medical staff of an individual facility. Certain of those physicians are not employees of HGA. TCC believes that its relations with its employees are good.\nEXECUTIVE OFFICERS OF THE COMPANY\nSet forth below is information regarding the current executive officers of the Company or its principal subsidiaries who are not also directors:\nGregory A. Fryling has served as Vice President, Business Development since January 1993 and has been serving as President of CooperVision Pharmaceuticals, Inc. since May 1994. He has been an officer of various subsidiaries including Vice President and Controller of The Cooper Healthcare Group from January 1990 through December 1992 and Vice President and Controller of CooperVision from October 1988 through December 1989. He also served as Vice President and Controller of Cooper Life Sciences ('CLS') (then, a manufacturer of surgical laser and ultrasonic devices) from September 1986 to September 1988.\nRobert S. Holcombe has served as Senior Vice President since October 1992 and as General Counsel since December 1989. He served as Vice President from December 1989 until October 1992. From October 1988 through June 1989 he served as Assistant General Counsel, and from June 1987 through September 1988, as General Attorney of Emhart Corporation (a manufacturer of consumer and industrial products and provider of computer based services). From September 1979 until May 1987, he served as Vice President and General Counsel of Planning Research Corporation (a professional services firm).\nMarisa F. Jacobs has served as Secretary since April 1992 and as Associate General Counsel since November 1989. From July 1987 until October 1989, she served as Senior Vice President of Prism Associates, Inc. (a business consulting firm of which she was a co-founder). From September 1981 to October 1987, she was an associate with the law firm of Reavis & McGrath (now Fulbright & Jaworski L.L.P.).\nCarol R. Kaufman has served as Vice President and Chief Administrative Officer since October 1995. From January 1989 through September 1995, she served as Vice President, Chief Administrative Officer and Secretary of Cooper Development Company ('CDC') (a healthcare and consumer products company), a former affiliate of the Company; from June 1985 through January 1989 she served as Vice President of Cooper & Company, CDC's mergers and acquisitions subsidiary. From October 1971 until June 1985 she held a variety of offices at Cooper Laboratories, Inc. (the Company's former parent).\nAudrey A. Murray has served as Vice President of Risk Management and Employee Benefits since November 1993. She served as Director of Risk Management from July 1988 until November 1993. From November 1985 until July 1988, she held the positions of Senior Risk Analyst and then Associate Director of Risk Management. From October 1984 until November 1985, she served as Employee Benefits Manager at GTE Sprint (a long distance telephone company). From June 1977 until October\n1984, she served as Risk Manager at The O'Brien Corporation (a manufacturer of paints and technical coatings).\nNicholas J. Pichotta has served as President and Chief Executive Officer of CooperSurgical since September 1992. He served as Vice President of the Company from December 1992 to May 1993 and as Vice President, Corporate Development -- Healthcare from December 1991 to December 1992 and as President of CooperVision from November 1990 to June 1991. He has served in a number of other positions since joining the Company in January 1989. From May to October 1988 he was Managing Director of Heraeus LaserSonics and from December 1986 to May 1988 he served as President of the Surgical Laser Division of CLS.\nMark R. Russell has served as the President and Chief Executive Officer of Hospital Group of America, Inc. since June 1993 and served as Executive Vice President and Chief Operating Officer from January 1987 (through the time of its acquisition by the Company in May 1992) until June 1993. From May 1986 to January 1987 he served as Senior Vice President and Chief Operating Officer of Nu-Med Psychiatric and from February 1981 to May 1986, he served as Senior Vice President and Chief Operating Officer of the Kennedy Health Care Foundation (the parent organization for a diversified healthcare services company).\nRobert S. Weiss became the Executive Vice President in October 1995. He has been the Treasurer and Chief Financial Officer of the Company since 1989. From October 1992 until October 1995, he was also as a Senior Vice President; from March 1984 to October 1992 he served as a Vice President, and from 1984 through July 1990 he served as Corporate Controller. He served as Corporate Controller of Cooper Laboratories, Inc. (the Company's former parent) from 1980 until March 1984 and as Vice President from March 1983 until March 1984.\nStephen C. Whiteford has served as Vice President and Corporate Controller since July 1992. He served as Assistant Corporate Controller from March 1988 to July 1992, as International Controller from August 1986 to February 1988 and as Vice President and Controller of CooperVision Ophthalmic Products from June 1985 to August 1986.\nThere is no family relationship between any of the above-named officers or between any such officer and any director of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following are TCC's principal facilities as of December 31, 1995:\n- ------------\n(1) On December 9, 1994, the Company entered into a sublease pursuant to which it has subleased to a third party approximately 6,000 square feet of its Fort Lee, NJ, office space at an annual base rent commencing at $113,924 in year one and increasing to $125,916 in years two through five, the last year of the sublease. The subtenant has an option to renew the sublease for an additional five years. An agreement in principal has been reached to sublease the remaining 5,000 square feet of this office to the same subtenant for four years beginning April 1, 1996, with a similar option to renew for an additional five years.\n(2) Outstanding loans, totaling $11,347,000 as of October 31, 1995, were secured by these properties.\n(3) Includes utilities, common area charges and taxes.\n------------------------\nThe Company believes its properties are suitable and adequate for its businesses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSee the discussion of legal proceedings contained in Note 14.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThe 1995 Annual Meeting of Stockholders was held on September 20, 1995.\nEach of the seven individuals nominated to serve as directors of the Company were re-elected to office. Information with respect to votes cast for or withheld from such nominee is set forth below:\nStockholders were asked to approve proposals to reduce the authorized capital stock of the Company and to effectuate a one-for-three reverse common stock split. A total of 29,108,488 and 28,569,024 shares, respectively, voted in favor of the proposals, 2,772,727 and 3,486,291 shares, respectively, voted against the two proposals, and a total of 321,720 and 147,190 shares, respectively, abstained from voting.\nStockholders were also asked to ratify the appointment of KPMG Peat Marwick LLP as independent certified public accountants for the Company for the fiscal year which ended October 31, 1995. A total of 30,510,989 shares were voted in favor of the ratification, 1,617,037 shares were voted against it and 75,809 shares abstained. The numbers contained in this section have not been adjusted to reflect the one-for-three reverse stock split which was effectuated on the day following the Annual Meeting.\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, Inc. and the Pacific Stock Exchange Incorporated. No cash dividends were paid with respect to the common stock in fiscal 1995 or 1994.\nThe Indenture, dated as of March 1, 1985, governing the Company's Debentures, as amended by the First Supplemental Indenture dated as of June 29, 1989 and the Second Supplemental Indenture dated as of January 6, 1994, and the Indenture dated as of January 6, 1994 governing the Company's 10% Senior Subordinated Secured Notes due 2003 (collectively, the 'Indentures'), prohibit the payment of cash dividends on the Company's common stock unless (i) no defaults exist or would exist under the Indentures, (ii) the Company's Cash Flow Coverage Ratio (as defined in the Indentures) for the most recently ended four full fiscal quarters has been at least 1.5 to 1, and (iii) such cash dividend, together with the aggregate of all other Restricted Payments (as defined in the Indentures), is less than the sum of 50% of the Company's cumulative net income plus the proceeds of certain sales of the Company's or its subsidiaries' capital stock subsequent to February 1, 1994. The Company does not anticipate, in the foreseeable future, paying cash dividends on its common stock.\nThe ability of the Company to declare and pay dividends is also subject to restrictions set forth in the Delaware General Corporation Law (the 'Delaware GCL'). As a general rule, a Delaware corporation may pay dividends under the Delaware GCL either out of its 'surplus,' as defined in the Delaware GCL, or, subject to certain exceptions, out of its net profits for the fiscal year in which the dividend is declared and\/or the preceding fiscal year. The Company's ability to pay cash dividends depends upon whether the Company satisfies the requirements of the Delaware GCL at the time any such proposed dividend is declared.\nOther information called for by this Item is set forth in Note 17.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES FIVE YEAR FINANCIAL HIGHLIGHTS CONSOLIDATED OPERATIONS\n- ------------\n* Prior periods have been restated to reflect the impact of the one-for-three reverse stock split effected in September 1995.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES FIVE YEAR FINANCIAL HIGHLIGHTS CONSOLIDATED FINANCIAL POSITION\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nReferences to Note numbers herein are references to the 'Notes to Consolidated Financial Statements' of the Company located in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES STATEMENT OF CONSOLIDATED OPERATIONS\nSee accompanying notes to consolidated financial statements.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET\nSee accompanying notes to consolidated financial statements.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONCLUDED)\nIn January 1994, the Company issued $22,000,000 of 10% Senior Subordinated Secured Notes due 2003 (the 'Notes') and paid approximately $4,350,000 in cash (exclusive of transaction costs) in exchange for approximately $30,000,000 of Debentures. (See Note 11.)\nDuring 1993, the Company acquired businesses and entered into certain licensing and distribution agreements. In connection with these acquisitions and agreements, the Company assumed liabilities as follows:\nSee accompanying notes to consolidated financial statements.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nThe Cooper Companies, Inc., (together with its subsidiaries, the 'Company') develops, manufactures and markets healthcare products, including a range of hard and soft daily, flexible and extended wear contact lenses, and diagnostic and surgical instruments. The Company also provides healthcare services through the ownership of psychiatric facilities, and through May 1995, the management of other such facilities.\nPRINCIPLES OF CONSOLIDATION\nIntercompany transactions and accounts are eliminated in consolidation. Certain reclassifications have been applied to prior years' financial statements to conform such statements to the current year's presentation. None of these reclassifications had any impact on results of operations, although the restatement following the September 1995 one-for-three reverse stock split (see Note 2) impacted previously reported earnings per share amounts and the average number of shares outstanding.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of the Company's operations located outside the United States (primarily Canada) are translated at prevailing year-end rates of exchange. Related income and expense accounts are translated at weighted average rates for each year. Gains and losses resulting from the translation of financial statements in foreign currencies into U. S. dollars are recorded in the equity section of the consolidated balance sheet. Gains and losses resulting from the impact of changes in exchange rates on transactions denominated in foreign currencies are included in the determination of net income or loss for each period. Foreign exchange gains (losses) included in the Company's consolidated statement of income for each of the years ended October 31, 1995, 1994 and 1993 were ($130,000), $53,000 and ($550,000), respectively.\nNET SALES OF PRODUCTS\nNet sales of products consists primarily of sales generated by the Company's CooperVision, Inc. ('CVI') and CooperSurgical, Inc. ('CSI') businesses. The Company recognizes revenue when risk of ownership has transferred to the buyer, with appropriate provisions for sales returns.\nWith respect to net sales of products, management believes trade receivables do not include any concentrated groups of credit risk.\nNET SERVICE REVENUE\nNet service revenue consists primarily of net patient service revenue, which is based on the Hospital Group of America, Inc. ('HGA') hospitals' established billing rates less allowances and discounts principally for patients covered by Medicare, Medicaid, Blue Cross, HMO's and other contractual programs. Payments under these programs are based on either predetermined rates or the cost of services. Settlements for retrospectively determined rates are estimated in the period the related services are rendered and are adjusted in future periods as final settlements are determined. Management believes that adequate provision has been made for adjustments that may result from the final determination of amounts earned under these programs. In 1995, the Company received and recognized revenue of approximately $2 million associated with prior year cost report settlements. Approximately 50%, 39% and 25%, respectively, of 1995, 1994 and 1993 net service revenue is from participation by hospitals in Medicare and Medicaid programs.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company provides care to indigent patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Company does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue. The Company maintains records to identify and monitor the level of charity care it provides. These records include the amount of charges foregone for services and supplies furnished under its charity care policy. Charges at the Company's established rates foregone for charity care provided by the Company amounted to $2,142,000, $2,498,000 and $3,220,000 for 1995, 1994 and 1993, respectively. Hampton Hospital is required by its Certificate of Need to incur not less than 5% of total patient days as free care.\nWith respect to net service revenue, receivables from government programs represent the only concentrated group of potential credit risk to the Company. Management does not believe that there are any credit risks associated with these governmental agencies. Negotiated and private receivables consist of receivables from various payors, including individuals involved in diverse activities, subject to differing economic conditions, and do not represent any concentrated credit risks to the Company. Furthermore, management continually monitors and, where indicated, adjusts the allowances associated with these receivables.\nCASH AND CASH EQUIVALENTS\nCash and cash equivalents includes commercial paper and other short-term income producing securities with a maturity date at purchase of three months or less. These investments are readily convertible to cash, and are carried at cost which approximates market.\nINVENTORIES\nInventories are stated at the lower of cost, determined on a first-in, first-out or average cost basis, or market.\nThe components of inventories are as follows:\nPROPERTY, PLANT AND EQUIPMENT AT COST\nDepreciation is computed on the straight-line method in amounts sufficient to write-off depreciable assets over their estimated useful lives. Leasehold improvements are amortized over the shorter of their estimated useful lives or the period of the related lease.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDepreciation expense amounted to $2,704,000, $2,870,000 and $2,624,000 for the years ended October 31, 1995, 1994 and 1993, respectively.\nExpenditures for maintenance and repairs are expensed; major replacements, renewals and betterments are capitalized. The cost and accumulated depreciation of depreciable assets retired or otherwise disposed of are eliminated from the asset and accumulated depreciation accounts, and any gains or losses are reflected in operations for the period.\nAMORTIZATION OF INTANGIBLES\nAmortization is provided for on all intangible assets (primarily goodwill, which represents the excess of purchase price over fair value of net assets acquired) on a straight-line basis over periods of up to thirty years. Accumulated amortization at October 31, 1995 and 1994 was $3,909,000 and $2,916,000, respectively. The Company assesses the recoverability of goodwill and other long-lived assets by determining whether the amortization of the related balance over its remaining life can be recovered through reasonably expected future cash flow.\nRESTRICTED STOCK AND COMPENSATION EXPENSE\nUnder the Company's various stock plans for employees and directors (see Note 12), certain directors, officers and key employees designated by the Board of Directors or a committee thereof have purchased, for par value, shares of the Company's common stock restricted as to resale ('Restricted Shares') unless or until certain prescribed objectives are met or certain events occur. The difference between market value and par value of the Restricted Shares on the date of grant is recorded as unamortized restricted stock award compensation, an equity account, and charged to operations as earned.\nINCOME TAXES (SEE NOTE 10)\nEffective with the beginning of fiscal 1994, the Company adopted the liability method of accounting for income taxes as prescribed by Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' ('FAS 109'). The liability method under FAS 109 measures the expected tax impact of future taxable income or deductions resulting from temporary differences in the tax and financial reporting bases of assets and liabilities reflected in the consolidated balance sheet. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the year in which these differences are expected to reverse. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that the change was enacted. In 1993 and prior years, the Company accounted for income taxes under Accounting Principles Board Opinion No. 11.\nEARNINGS PER COMMON SHARE\nNet income (loss) per common share is determined by using the weighted average number of common shares and common share equivalents (stock warrants and stock options) outstanding during each year (except where antidilutive). Fully diluted net income (loss) per common share is not materially different from primary net income (loss) per common share.\nNOTE 2. REVERSE COMMON STOCK SPLIT AND AUTHORIZED SHARE REDUCTION\nIn September 1995, at the Annual Stockholders Meeting, stockholders approved a 1-for-3 reverse split of the Company's common stock. Also, the stockholders approved an amendment to the Company's Certificate of Incorporation to decrease the number of shares of common stock authorized to be issued from 100 million to 20 million and the number of shares of preferred stock authorized to be issued from 10 million to 1 million.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nExcept where noted to the contrary, all share and per share data included in this annual report have been restated to reflect the reverse stock split.\nNOTE 3. ACQUISITIONS AND DISPOSITIONS\nACQUISITIONS\nIn June 1995, CSI acquired from Blairden Precision Instruments the exclusive worldwide rights to RUMI'tm'uterine manipulator injector and related products for $1,000,000. Payments of $800,000 have been made through October 31, 1995, and the balance of $200,000 is due at the earlier of June 15, 1996 or the date certain contractual milestones are met. No goodwill arose from the recording of this acquisition.\nOn April 1, 1993, CVI acquired via a purchase transaction the stock of CoastVision, Inc. ('CoastVision') for approximately $9,800,000 cash. CoastVision manufactured and marketed a range of contact lens products, primarily custom soft toric contact lenses, which are designed to correct astigmatism. The purchase of CoastVision expanded CooperVision's customer base for its existing product lines. CoastVision had net sales of $9,600,000 in its fiscal year ended October 31, 1992. Excess cost over net assets acquired recorded on the purchase was $7,279,000, which is being amortized over 30 years.\nDISPOSITIONS\nIn January 1994, the Company's Canadian subsidiary, CooperVision Inc. ('CooperVision Canada'), sold its EYEscrub'tm' trademark for $110,000 cash, resulting in an $80,000 gain.\nOn February 12, 1993, the Company sold its EYEscrub'tm' product line for $1,400,000 cash, which resulted in a $620,000 gain.\nNOTE 4. DISCONTINUED OPERATIONS\nIn 1993, the Company recorded a charge of $14,000,000 to increase the Company's accrual (the 'Breast Implant Accrual') for contingent liabilities associated with breast implant litigation involving the plastic and reconstructive surgical division of the Company's former Cooper Surgical business segment ('Surgical') which was sold in fiscal 1989 to Medical Engineering Corporation ('MEC'), a subsidiary of Bristol-Myers Squibb Company ('Bristol-Myers'). The Breast Implant Accrual will be charged for payments made and to be made to MEC under the agreement reached in September 1993 with MEC and Bristol-Myers, which limited the Company's liability for breast implant litigation (the 'MEC Agreement') (see Note 14 for the schedule of payments), as well as certain related charges. In October 1993 the Company made the initial payment of $3,000,000 to MEC. At October 31, 1995, the Company's balance sheet included $6,250,000 of the Breast Implant Accrual in 'other noncurrent liabilities' and $1,500,000 in accounts payable (which was paid to MEC on December 31, 1995) for future payments to MEC. The Company also recorded, in 1993, a reversal of $343,000 of accruals no longer necessary related to another discontinued business.\nNo tax benefit was applied against the above figures, as the Company was not profitable.\nNOTE 5. EXTRAORDINARY ITEMS\nThe extraordinary gain of $924,000, or $.09 per share, in 1993 represented gains on the Company's purchases of $4,846,000 principal amount of its 10 5\/8% Convertible Subordinated Reset Debentures due 2005 ('Debentures'). The purchases were privately negotiated and executed at prevailing market prices.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 6. STOCKHOLDERS RIGHTS PLAN\nOn October 29, 1987, the Board of Directors of the Company declared a dividend distribution of one right for each outstanding share of the Company's common stock, par value $.10 per share (a 'Right'). Following the effectiveness of the one-for-three reverse stock split in September 1995, the number of Rights associated with each share of the Company's common stock increased from one to three. Each Right entitles the registered holder of an outstanding share of the Company's common stock to initially purchase from the Company a unit consisting of one one-hundredth of a share of Series A Junior Participating Preferred Stock (a 'Unit'), par value $.10 per share, at a purchase price of $60.00 per Unit, subject to adjustment. The Rights are exercisable only if a person or group acquires (an 'Acquiring Person'), or generally obtains the right to acquire beneficial ownership of 20% or more of the Company's common stock, or commences a tender or exchange offer which would result in such person or group beneficially owning 30% or more of the Company's common stock.\nIf, following the acquisition of 20% or more of the Company's common stock, (i) the Company is the surviving corporation in a merger with an Acquiring Person and its common stock is not changed, (ii) a person or entity becomes the beneficial owner of more than 30% of the Company's common stock, except in certain circumstances such as through a tender or exchange offer for all the Company's common stock which the Board of Directors determines to be fair and otherwise in the best interests of the Company and its stockholders, (iii) an Acquiring Person engages in certain self-dealing transactions or (iv) an event occurs which results in such Acquiring Person's ownership interest being increased by more than 1%, each holder of a Right, other than an Acquiring Person, will thereafter have the right to receive, upon exercise, the Company's 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.\nUnder certain circumstances, if (i) the Company is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation, unless (a) the transaction occurs pursuant to a transaction which the Board of Directors determines to be fair and in the best interests of the Company and its stockholders (b) the price per share of common stock offered in the transaction is not less than the price per share of common stock paid to all holders pursuant to the tender or exchange offer, and (c) the consideration used in the transaction is the same as that paid pursuant to the offer, or (ii) 50% or more of the Company's assets or earning power is sold or transferred, each holder of a Right, other than an Acquiring Person, shall thereafter have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the Right.\nAt any time until the close of business on the tenth day following a public announcement that an Acquiring Person has acquired, or generally obtained the right to acquire, beneficial ownership of 20% or more of the Company's common stock, the Company will generally be entitled to redeem the Rights in whole, but not in part, at a price of $.05 per Right. After the redemption period has expired, the Company's right of redemption may be reinstated if an Acquiring Person reduces his beneficial ownership to 10% or less of the outstanding shares of common stock in a transaction or series of transactions not involving the Company.\nUntil a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. The Rights expire on October 29, 1997.\nIn June 1993, the Board of Directors amended the Rights Agreement dated as of October 29, 1987, between the Company and The First National Bank of Boston, as Rights Agent, so that Cooper Life Sciences, Inc. ('CLS') and its affiliates and associates as of the amendment date would not be Acquiring Persons thereunder as a result of CLS's beneficial ownership of more than 20% of the outstanding common stock of the Company by reason of its ownership of Series B Preferred Stock or common stock issued upon conversion thereof. In January 1995, the Rights Agreement was further amended to provide that any person who becomes the beneficial owner of 10% or more, but not more\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nthan 30%, of the outstanding common stock of CLS, and is, therefore, deemed to be the beneficial owner of the shares of common stock of the Company held by CLS would not be an Acquiring Person, provided that such person is not otherwise, and does not thereafter become, the beneficial owner of more than 1% of the Company's outstanding common stock. (See 'Agreements With CLS' in Note 15.)\nNOTE 7. SETTLEMENT OF DISPUTES, NET\nIn 1995, the Company recorded a charge of $5,551,000 for the settlement of a dispute with the Hampton Medical Group, P.A. The charge was partially offset by the favorable impact of settlements regarding a refund of $915,000 for directors and officers insurance premiums and disgorgement of $648,000 from a former officer of the Company. In addition, in April 1995, HGA and Progressions Health Systems, Inc. entered into the purchase price agreement which settled cross claims between the parties related to purchase price adjustments (which were credited to goodwill) and other disputes and provided for a series of payments to be made to HGA. Pursuant to this agreement, HGA received approximately $853,000 in 1995, $421,000 of which has been credited to Settlement of Disputes, Net.\nIn 1994, the Company recorded the following items related to settlement of disputes:\nA credit of $850,000 following receipt of funds by the Company to settle certain claims made by the Company associated with a real estate transaction.\nA charge of $5,800,000, which represents the Company's estimate of costs required to settle certain disputes and other litigation matters including $3,450,000 associated with the criminal conviction and related SEC enforcement action. (See Note 14.)\nThe Company and CLS entered into a settlement agreement, dated June 14, 1993, pursuant to which CLS delivered a general release of claims against the Company, subject to exceptions for specified ongoing contractual obligations, and agreed to certain restrictions on its acquisitions, voting and transfer of securities of the Company, in exchange for the Company's payment of $4,000,000 in cash and delivery of 200,000 shares of common stock of CLS owned by the Company and a general release of claims against CLS, subject to similar exceptions. See Note 15 for a discussion of the settlement terms. The cash paid and fair value of CLS shares returned to CLS were charged to the Company's statement of operations for 1993 as settlement of disputes. In addition, the Company charged another $1,500,000 for certain other disputes.\nNOTE 8. COSTS ASSOCIATED WITH RESTRUCTURING OPERATIONS\nIn 1995, the Company recorded $1,480,000 of restructuring costs to provide for costs primarily associated with the closure of facilities, with attendant reductions in personnel, in the Company's CVP, CSI and corporate operations and downsizing HGA headquarters. Approximately 85% of the $1,480,000 provision related to severance benefits accrued for 16 employees. The balance primarily reflected provisions for unproductive assets. In 1993, the Company recorded $451,000 of restructuring costs for consolidation of CSI facilities and related reorganization and relocation costs.\nNOTE 9. PREFERRED STOCK\nOn June 14, 1993, the Company acquired from CLS all of the remaining outstanding shares of the Company's Senior Exchangeable Redeemable Restricted Voting Preferred Stock ('SERPS'), having an aggregate liquidation preference of $16,060,000, together with all rights to any dividends or distributions thereon, in exchange for shares of Series B Preferred Stock having an aggregate liquidation preference of $3,450,000 and a par value of $.10 per share. The 345 shares of the Series B Preferred Stock, and any shares of the Series B Preferred Stock issued as dividends, were convertible into one share of common stock of the Company for each $3.00 of liquidation preference, subject to customary antidilution adjustments. The Company also had the right to compel conversion of the Series B Preferred Stock at any time after the market price of the common stock on its principal trading market averaged at least\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n$4.125 for 90 consecutive calendar days and closed at not less than $4.125 on at least 80% of the trading days during such period.\nOn September 26, 1994, the Company's common stock met the above requirements, and the Series B Preferred Stock was converted into 1,150,000 shares (see Note 2) of the Company's common stock.\nDuring 1994 the Company paid $89,000 or $258.90 per share in dividends on the Series B Preferred Stock.\nNOTE 10. INCOME TAXES\nThe income tax provision (benefit) in the statement of consolidated operations is related solely to current state provisions (benefits).\nA reconciliation of the provision for (benefit of) income taxes included in the Company's statement of consolidated operations and the amount computed by applying the federal income tax rate to income (loss) from continuing operations before extraordinary items and income taxes follows:\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES 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 as follows:\nThe net change in the total valuation allowance for the years ended October 31, 1995 and 1994 was an increase of $1,580,000 and $2,327,000, respectively.\nSubsequently recognized tax benefits relating to the valuation allowance for deferred tax assets as of October 31, 1995 will be allocated as follows:\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAt October 31, 1995 the Company had capital loss, net operating loss, and tax credit carryforwards for federal tax purposes expiring as follows:\nNOTE 11. LONG-TERM DEBT\nLong-term debt consists of the following:\nAggregate annual maturities, including current installments, for each of the five years subsequent to October 31, 1995 are as follows:\nIn January 1994, the Company completed an Exchange Offer and Consent Solicitation, pursuant to which the Company issued approximately $22,000,000 aggregate principal amount of Notes and paid approximately $4,350,000 in cash ($725 principal amount of Notes and $145 in cash for each $1,000 principal amount of Debentures) in exchange for approximately $30,000,000 aggregate principal amount\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nof its Debentures (out of $39,384,000 aggregate principal amount then outstanding). $9,290,000 aggregate principal amount of Debentures remains outstanding.\nIn connection with the Exchange Offer and Consent Solicitation, the Company amended the indenture governing the Debentures (the 'Indenture') to, among other things, eliminate a covenant, with which the Company was not in compliance, requiring the Company to repurchase Debentures. The amendment also reduced the conversion price at which holders may convert Debentures into shares of the Company's common stock from $82.35 to $15.00 per share, subject to adjustment under certain conditions to prevent dilution to the holders. The Company also obtained a waiver (the 'Waiver') of any and all Defaults and Events of Default (as such terms are defined in the Indenture) that occurred or may have occurred prior to the expiration of the Exchange Offer and Consent Solicitation.\nThe Exchange Offer and Consent Solicitation was accounted for in accordance with Statement of Financial Accounting Standards No. 15 'Accounting by Debtors and Creditors for Troubled Debt Restructurings.' Consequently, the difference between the carrying value of the Debentures exchanged less the face value of the Notes issued and the aggregate cash payment for the Debentures was recorded as a deferred premium aggregating approximately $4,000,000 as of the date of the Exchange. The Company is recognizing the benefit of the deferred premium as a reduction to the effective interest rate on the Notes over the life of the issue. In addition, the Company recorded a charge of $2,131,000 in the fourth quarter of fiscal 1993 and an additional charge of $340,000 in fiscal 1994 for costs related to the Exchange Offer and Consent Solicitation. The Debentures mature on March 1, 2005, with interest payments due semi-annually each March 1 and September 1.\nThe Notes mature on June 1, 2003. Interest at 10% per annum is payable quarterly on each March 1, June 1, September 1 and December 1. The Notes are redeemable solely at the option of the Company, in whole or in part, at any time, at a redemption price equal to 100% of their principal amount, together with accrued and unpaid interest thereon to the redemption date. The Company is not required to effect any mandatory redemptions or make any sinking fund payments with respect to the Notes, except in connection with certain sales or other dispositions of, or certain financings secured by, the collateral securing the Notes. Pursuant to a pledge agreement dated as of January 6, 1994, between the Company and the trustee for the holders of the Notes, the Company has pledged a first priority security interest in all of its right, title and interest in stock of its subsidiaries HGA and CSI, all additional shares of stock of, or other equity interests in HGA and CSI from time to time acquired by the Company, all intercompany indebtedness of HGA and CSI from time to time held by the Company, except as set forth in the indenture governing the Notes, and the proceeds received from the sale or disposition of any or all of the foregoing.\nThe Debentures and the Notes each contain various covenants, including limitations on incurrence and ranking of indebtedness, payment of cash dividends, acquisition of the Company's common stock and transactions with affiliates.\nHGA DEBT\nSubstantially all of the property and equipment and accounts receivable of HGA collateralize its outstanding debt. The HGA Term Loan carries interest at 4 percentage points over the prime interest rate, with a floor of 12% per annum. The rate in effect at October 31, 1995 was 12.75%. Interest and principal payments on the HGA Term Loan are due monthly through August 1997. The HGA IRB carries interest at 85% of prime, or approximately 7.44% per annum at October 31, 1995. Interest and principal payments on the HGA IRB are due monthly and holders have elected their right to accelerate all payments of outstanding principal at December 31, 1995. The HGA IRB of $1,336,000 was paid and the amount was rolled into the HGA Term Loan due August 1997. The HGA Term Loan contains and the HGA IRB contained covenants including the maintenance by HGA of certain ratios and levels of net worth (as defined), capital expenditures, interest and debt payments, as well as restrictions on payment of cash dividends.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLOAN AND SECURITY AGREEMENT\nIn September 1994, CVI entered into a Loan and Security Agreement ('Line of Credit') with a commercial lender providing for revolving advances of up to $8,000,000. On October 31, 1995 the balance outstanding on the line of credit was $1,025,000. Advances under the Line of Credit bear interest at 2 1\/2 percentage points above the highest most recently announced prime rate of the three financial institutions of national repute named in the agreement, with a floor of 8.5% per annum. The rate in effect at October 31, 1995 was 11.25% per annum. CVI agreed to the payment of various fees and minimum annual interest of $150,000. The aggregate amount of advances under the agreement is capped at the lesser of $8,000,000, or a percentage of CVI's levels of eligible receivables and inventory as defined in the agreement (approximately $5,900,000 in total line availability at October 31, 1995) and is collateralized by virtually all of the assets of CVI.\nThe Line of Credit provides that CVI (provided that no Event of Default, as defined, has occurred and is continuing) may make loans, advances, investments, capital contributions and distributions to the Company, and pay management fees to the Company, so long as the total amount of all such amounts does not exceed an amount equal to the sum of (i) 75% of CVI's Tangible Net Worth, as defined, on the closing date, plus (ii) all amounts in excess of required increases in CVI's Tangible Net Worth for each fiscal year ending after October 31, 1994. On the closing date, CVI's Tangible Net Worth was $11,480,000. At October 31, 1995, CVI had Tangible Net Worth of $9,492,000, of which $6,142,000 was unrestricted under the terms of the Loan and Security Agreement.\nThe Line of Credit contains various covenants, including the maintenance of certain ratios and levels of net worth (as defined), limitations on capital expenditures and incurrence of indebtedness as well as limitations regarding change in control and transactions with affiliates.\nIn connection with the Line of Credit, the Company guaranteed all of the obligations under the HGA Term Loan and CVI's obligations under the Line of Credit and the Company pledged all of the outstanding stock of CVI as collateral for the HGA Term Loan guaranty.\nUNAMORTIZED BOND DISCOUNT AND DEFERRED PREMIUM\nThe difference between the carrying amount and the principal amount of the Company's Debentures represents unamortized discount which is being charged to expense over the life of the issue. As of October 31, 1995, the amount of unamortized discount was approximately $75,000.\nThe carrying value of the Debentures exchanged less the face value of the Notes issued and the aggregate cash payment for the Debentures was recorded as a deferred premium. The Company is recognizing the benefit of the deferred premium as a reduction to the effective interest rate on the Notes over the life of the issue. As of October 31, 1995, the amount of the unamortized deferred premium was $2,873,000.\nNOTE 12. EMPLOYEE STOCK PLANS\n1988 LONG-TERM INCENTIVE PLAN ('LTIP')\nThe LTIP is a vehicle for the Company to attract, retain and motivate key employees and consultants to the Company and its subsidiaries and affiliates, who are directly linked to the profitability of the Company and to increasing stockholder value.\nThe LTIP authorizes a committee consisting of three or more individuals not eligible to participate in the LTIP or, if no committee is appointed, the Company's Board of Directors, to grant to eligible individuals during a period of ten years from September 15, 1988, stock options, stock appreciation rights, restricted stock, deferred stock, stock purchase rights, phantom stock units and long-term performance awards for up to 2,125,570 shares of common stock, subject to adjustment for future stock\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nsplits, stock dividends, expirations, forfeitures and similar events. As of October 31, 1995, 903,868 shares remained available under the LTIP for future grants.\nAs of August 1, 1993, there were outstanding options to purchase an aggregate of 367,500 shares of common stock granted to, and not subsequently forfeited by, optionholders at exercise prices ranging from $2.07 to $12.75. The Company offered each employee who held options granted under the LTIP an opportunity to exchange those options for a smaller number of substitute options. Each new option is exercisable at $1.68 per share. The number of shares each employee was entitled to purchase pursuant to such option was computed by an independent nationally recognized compensation consulting firm using an option exchange ratio derived under the Black-Scholes option pricing model. Each person who elected to participate in the option exchange program received an option to purchase an individually calculated percentage ranging from 21% to 70% of the shares such person was originally entitled to purchase. A percentage of the new option, equal to the percentage of the outstanding option that was already exercisable, was immediately exercisable, and the remainder became exercisable in 1994 in 25% tranches when the trading price of the Company's common stock over 30 days averaged, $3.00, $4.50, $6.00 and $7.50 per share, respectively. The option exchange program provided optionholders the opportunity to exchange options with exercise prices well in excess of the then current market price of the Company's common stock with a lesser number of options exercisable at a price that, while still above the then price, was lower than the exercise price on the surrendered options. Under the terms of the option exchange offer, each person who elected to participate waived the vesting of options that otherwise would have resulted from the Change in Control (as such term is defined in the LTIP) that occurred when stockholders approved the conversion rights of the Series B Preferred Stock on September 14, 1993. (See Note 9.)\n1990 NON-EMPLOYEE DIRECTORS RESTRICTED STOCK PLAN ('NEDRSP')\nUnder the terms of the NEDRSP, upon joining the Board of Directors, each director of the Company who is not also an employee of or a consultant to the Company or any subsidiary of the Company ('Non-Employee Director') is granted the right to purchase, for $.10 per share, 1,666 shares of the Company's common stock, subject to restrictions, which can be lifted either upon the fair market value of the Company's common stock achieving stated targets, or upon the passage of a stated period of time, typically 9 1\/2 years after the date of grant. A total of 33,333 shares of such common stock were authorized and reserved for issuance under the NEDRSP. Shares which are forfeited become available for new awards under such plan. At October 31, 1995, there were 15,000 shares of the Company's common stock available for future grants under the NEDRSP. Upon approval by the Company's stockholders of the 1996 Long Term Incentive Plan for Non-Employee Directors, which is described below, the NEDRSP will terminate.\nTransactions involving the grant of options or restricted shares of the Company's common stock in connection with the LTIP and NEDRSP during each of the years in the three year period ended October 31, 1995 are summarized below.\nOptions issued and outstanding have option prices ranging from $1.68 to $11.25 per share.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe excess of market value over $.10 per share of LTIP and NEDRSP restricted shares on respective dates of grant is initially recorded as unamortized restricted stock award compensation, a separate component of stockholders' equity and charged to operations as earned. Restricted shares and other stock compensation charged against income from operations for the years ended October 31, 1995, 1994 and 1993 was none, $55,000 and $1,084,000, respectively.\n1996 LONG-TERM INCENTIVE PLAN FOR NON-EMPLOYEE DIRECTORS\nOn December 12, 1995 the Board of Directors of the Company adopted a proposal to reduce the annual cash stipend paid to Non-Employee Directors and to award grants of restricted stock and options annually at the start of each fiscal year. Specifically, each Non-Employee Director will be awarded the right to purchase stock worth $7,500 each year (or $9,375 in the case of the Chairman of the Board who is a Non-Employee Director) and be granted an option to purchase 5,000 shares of the Company's common stock in fiscal 1996 and 3,333 shares in each subsequent fiscal year (or, in the case of a Chairman of the Board who is a Non-Employee Director, 6,250 shares in fiscal 1996 and 4,167 shares in each subsequent fiscal year) through fiscal 2000. A total of 215,000 shares of the Company's authorized but unissued common stock have been reserved for issuance under the plan. Final adoption of the plan requires stockholder approval, which will be sought at the 1996 Annual Meeting of Stockholders scheduled to be held in March 1996.\nPRIOR STOCK OPTION PLANS\nPrior to the September 15, 1988 implementation of the LTIP, the Company had two stock option plans (the 'Stock Option Plans'). With the adoption of the LTIP, all authorized but unallocated shares of stock reserved under the Stock Option Plans (options for approximately 143,500 shares of the Company's common stock) were transferred to the LTIP. No further grants are allowed from the Stock Option Plans, although previously existing grants remain in effect. On October 31, 1995, there were 7,483 outstanding shares with option prices per share ranging from $48.39 - $59.25.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13. EMPLOYEE BENEFITS\nTHE COMPANY'S RETIREMENT INCOME PLAN\nThe Company sponsors a defined benefit Retirement Income Plan which covers substantially all full-time United States employees of CVI, CVP and the Company's Corporate Headquarters. The Company's contributions are designed to fund normal cost on a current basis and to fund over thirty years the estimated prior service cost of benefit improvements (fifteen years for annual gains and losses). The unit credit actuarial cost method is used to determine the annual cost. The Company pays the entire cost of the Retirement Plan and funds such costs as they accrue. Virtually all of the assets of the Plan are comprised of participations in equity and fixed income funds.\nNet periodic pension cost of the Plan was as follows:\nThe actuarial present value of benefit obligations and funded status for the Plan was as follows:\nAssumptions used in developing the projected benefit obligation as of October 31 were:\nTHE COMPANY'S 401(K) SAVINGS PLAN\nThe Company's 401(k) Savings Plan provides for the deferral of compensation as described in the Internal Revenue Code, and is available to substantially all full-time United States employees of the Company. United States resident employees of the Company who participate in the 401(k) Plan may\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nelect to have from 2% to 10% of their pre-tax salary or wages, (but not more than $5,000 for highly compensated employees) for the calendar year ended December 31, 1995, deferred and contributed to the trust established under the 401(k) Plan. The Company's contribution to the 401(k) Plan on account of the Company's participating employees, net of forfeiture credits, was $95,000, $80,000 and $90,000 for the years ended October 31, 1995, 1994 and 1993, respectively.\nTHE COMPANY'S INCENTIVE PAYMENT PLAN\nThe Company's Incentive Payment Plan is available to officers and other key executives. Participants may, in certain years, receive bonuses based on Company and subsidiary performance. Total payments earned for the years ended October 31, 1995, 1994 and 1993, were approximately $1,504,000, $1,296,000 and $439,000, respectively.\nTHE COMPANY'S TURN-AROUND INCENTIVE PLAN\nThe Company's Turn-Around Incentive Plan ('TIP') was adopted by the Board of Directors in May 1993. The TIP was adopted, upon the recommendation of the Company's independent compensation consultants, to recognize the special efforts of certain individuals in guiding the Company through a resolution of its difficulties arising from its then current capital structure and its former ownership of companies that manufactured and distributed breast implants.\nThe TIP provided for awards in varying amounts to be made to designated participants. Before any awards could become payable, however, the Company had to significantly reduce its liabilities relating to the former breast implant business to levels approved by the Board of Directors, which condition was satisfied when the MEC Agreement became final on January 6, 1994 (see Note 4). Upon satisfaction of such condition, one-third of the award was payable when the average per share price of the Company's common stock over a period of thirty days equaled or exceeded $4.50 per share. That occurred in May 1994, and participants in the TIP were, therefore, awarded one-third of the total award for which they were eligible under the TIP. The payments were made in cash ($246,667) and by means of the issuance of 99,259 shares of restricted stock under the Company's 1988 LTIP. That stock generally will remain restricted and nontransferable until May 1996. The remaining two-thirds of the allocated TIP awards were paid August 30, 1995, the date that the 30-day average of the price of the Company's common stock equaled $9.00 per share. Payments were made in cash ($475,833) and by means of the issuance of 97,316 shares of restricted stock under the LTIP. One-half of that stock generally will remain restricted and nontransferable for a period of one year from the date of grant. The remaining shares will generally remain restricted and nontransferable for a period of two years from the date of grant.\nNOTE 14. COMMITMENTS, CONTINGENCIES AND LITIGATION\nTotal minimum annual rental obligations (net of sublease revenue of approximately $125,000 per year, through 2000) under noncancelable operating leases (substantially all real property and equipment) in force at October 31, 1995 are payable in subsequent years as follows:\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAggregate rental expense for both cancelable and noncancelable contracts amounted to $2,354,000, $2,438,000 and $2,105,000 in 1995, 1994 and 1993, respectively.\nThe remaining liability recorded for payments to be made to MEC under the MEC Agreement (see Note 4) become due as follows:\nAdditional payments to be made to MEC beginning December 31, 1999 are contingent upon the Company's earning net income before taxes in each fiscal year subsequent to the fiscal year ending October 31, 1999, and are, therefore, not recorded in the Company's financial statements. Such payments are limited to the smaller of 50% of the Company's net income before taxes in each such fiscal year on a noncumulative basis or the amounts shown below:\nUnder the terms of a supply agreement most recently modified in 1993, the Company agreed to purchase by December 31, 1997, certain contact lenses from Pilkington plc, with an aggregate cost of approximately 'L'4,063,000. Lenses with an aggregate value of approximately 'L'477,000, 'L'400,000 and 'L'213,000 were purchased under the terms of the supply agreement in fiscal years 1995, 1994 and 1993, respectively. As of December 31, 1995, there remained a commitment of approximately 'L'2,747,000.\nPayments amounting to $3,100,000 were made related to a settlement with Hampton Medical Group, P.A. ('HMG') and Dr. Pottash (see Litigation below) in December 1995. Two additional payments are scheduled to be made to HMG in May 1997 and 1998, each in the amount of $1,537,500. These amounts were charged against net income in fiscal 1995.\nWARRANTS\nIn connection with agreements to extend the due date on certain of the Company's outstanding debt in 1988, the Company issued warrants to a group of its lenders, which after a series of adjustments had an exercise price of $1.11 per share. Warrants to purchase 219,650 shares of the Company's common stock vested in December 1988 and had an expiration date of December 29, 1995. Warrants to purchase 167,227 shares of common stock were exercised by the expiration date.\nThe Company issued a warrant to Foothill Capital Corporation ('Foothill') to purchase 26,666 shares of the Company's common stock at $5.625 per share in connection with the loan and security agreement among Foothill, CVI, and CooperVision Canada. (See Note 11 'Loan and Security Agreement.') The warrant becomes exercisable on September 21, 1997 and expires on May 26, 1999. Both the number of shares under the warrant and the exercise price per share are adjustable under certain circumstances to avoid dilution.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLITIGATION\nThe Company is a defendant in a number of legal actions relating to its past or present businesses in which plaintiffs are seeking damages. In the opinion of Management, after consultation with counsel, the ultimate disposition of those actions will not materially affect the Company's financial position.\nIn January 1994, the Company was found guilty on six counts of mail fraud and one count of wire fraud based upon the conduct of a former Co-Chairman relating to a 'trading scheme' to 'frontrun' high yield bond purchases, but was acquitted of charges of conspiracy and aiding and abetting violations of the Investment Advisers Act of 1940. The Company was sentenced on July 15, 1994, at which time it was ordered to make restitution to Keystone Custodian Funds, Inc. of $1,310,166, which was paid August 15, 1994. In addition, the Company was ordered to pay a noninterest bearing fine over the next three years in the amount of $1,831,568. A total of $350,000 was paid on July 14, 1995, with the additional payments of $350,000 and $1,131,568 payable on July 15, 1996 and 1997, respectively. These amounts were charged against net income in previous fiscal years. Also the Company settled in December 1994 a related SEC action under which the Company agreed to the disgorgement of $1,621,474 and the payment of a civil penalty of $1,150,000. The Company had already disgorged $1,310,166 in connection with the sentence imposed in a related criminal action involving the 'frontrunning' arrangement; the balance of the disgorgement was paid in January 1995. The civil penalty imposed by the SEC is offset by the larger fine to which the Company was sentenced in the criminal action. In the SEC settlement, the Company also consented to being permanently enjoined from violating certain provisions of the Securities Exchange Act of 1934, from aiding and abetting violations of certain provisions of the Investment Advisers Act and from further employing certain former employees and\/or any of their relatives.\nThe Company was named as a nominal defendant in a shareholder derivative action entitled Harry Lewis and Gary Goldberg v. Gary A. Singer, Steven G. Singer, Arthur C. Bass, Joseph C. Feghali, Warren J. Keegan, Robert S. Holcombe and Robert S. Weiss, which was filed on May 27, 1992 in the Court of Chancery, State of Delaware, New Castle County. Lewis and Goldberg subsequently amended their complaint, and the Delaware Chancery Court consolidated the amended complaint with a similar complaint filed by another plaintiff as In re The Cooper Companies, Inc. Litigation, Consolidated C.A. 12584. The Lewis and Goldberg amended complaint was designated as the operative complaint (the 'Derivative Complaint').\nThe Derivative Complaint alleges that certain directors of the Company and Gary A. Singer, as Co-Chairman of the Board of Directors, caused or allowed the Company to be a party to a 'trading scheme' to 'frontrun' high yield bond purchases by the Keystone Custodian Fund, Inc., a group of mutual funds. The Derivative Complaint also alleges that the defendants violated their fiduciary duties to the Company by not vigorously investigating certain allegations of securities fraud. The Derivative Complaint requests that the Court order the defendants (other than the Company) to pay damages and expenses to the Company and certain of the defendants to disgorge their profits to the Company. The parties have been engaged in negotiations and have agreed upon the terms of a settlement, which will have no material impact on the Company. Upon completion of the settlement documentation, the proposed settlement will be submitted to the Court for approval following notice to the Company's shareholders and a hearing. Accordingly, there can be no assurance that the proposed settlement will ultimately end the litigation. The individual defendants have advised the Company that they believe they have meritorious defenses to the lawsuit and that, in the event the case proceeds to trial, they intend to defend vigorously against the allegations in the Derivative Complaint.\nThe Company was also named as a nominal defendant in a shareholder derivative action entitled Bruce D. Sturman v. Gary A. Singer, Steven G. Singer, Brad C. Singer, Dorothy Singer as the Executrix of the Estate of Martin Singer, Karen Sue Singer, Norma Singer Brandes, Normel Construction Corp., Brandes & Singer, and Romulus Holdings, Inc., which was filed on June 6, 1995 in the Court of Chancery of the State of Delaware, New Castle County. The complaint is similar to a derivative\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ncomplaint filed by Mr. Sturman in the Supreme Court of the State of New York on May 26, 1992, which was dismissed under New York Civil Practice Rule 327(a) on August 17, 1993. The dismissal of the New York case was affirmed by the Appellate Division on March 28, 1995. The allegations in the Delaware complaint relate to substantially the same facts and events at issue in In re The Cooper Companies, Inc. Litigation described above, and similar relief is sought. The parties have tentatively agreed that plaintiff's action will be consolidated into and settled with In re The Cooper Companies, Inc. Litigation (see above).\nIn two virtually identical actions, Frank H. Cobb, Inc. v. The Cooper Companies, Inc., et al., and Arthur J. Korf v. The Cooper Companies, Inc., et al., class action complaints were filed in the United States District Court for the Southern District of New York in August 1989, against the Company and certain individuals who served as officers and\/or directors of the Company after June 1987. The complaints, as amended, alleged that the defendants knew or recklessly disregarded and failed to disclose to the investing public material adverse information about the Company. The amended complaints also alleged that the defendants are liable for having violated Section 10(b) of the Securities Exchange Act and Rule 10(b)-5 thereunder and having engaged in common law fraud. The Company reached a settlement with counsel for the class plaintiffs, which had no material impact on the Company's financial condition. On May 5, 1995, the settlement was approved by the court.\nUnder an agreement dated July 11, 1985, as amended (the 'HMG Agreement'), Hampton Medical Group, P.A. ('HMG'), which is not affiliated with the Company, contracted to provide clinical and clinical administrative services at Hampton Psychiatric Institute ('Hampton Hospital'), the primary facility operated by Hospital Group of New Jersey, Inc. ('HGNJ'), a subsidiary of the Company's psychiatric hospital holding company, Hospital Group of America, Inc. ('HGA'). In late 1993 and early 1994, HGNJ delivered notices to HMG asserting that HMG had defaulted under the HMG Agreement based upon billing practices by HMG that HGNJ believed to be fraudulent. At the request of HMG, a New York state court enjoined HGNJ from terminating the HMG Agreement based upon the initial notice and ordered the parties to arbitrate whether HMG had defaulted.\nOn February 2, 1994, HMG commenced an arbitration in New York, New York (the 'Arbitration'), entitled Hampton Medical Group, P.A. and Hospital Group of New Jersey, P.A. (American Arbitration Association), in which it contested the alleged default. In addition, HMG made a claim against HGNJ for unspecified damages based on allegedly foregone fees on the contention that HMG had the right to provide services at all HGNJ-owned facilities in New Jersey, including certain outpatient clinics and the Hampton Academy, at which non-HMG physicians have been employed.\nOn December 30, 1994, Blue Cross and Blue Shield of New Jersey, Inc. commenced a lawsuit in the Superior Court of New Jersey entitled Blue Cross and Blue Shield of New Jersey, Inc. v. Hampton Medical Group, et al. against HMG and certain related entities and individuals unrelated to HGNJ or its affiliates alleging, among other things, fraudulent billing practices (the 'Blue Cross Action').\nOn or about April 12, 1995, an individual defendant in the Blue Cross Action who was formerly employed by HMG, Dr. Charles Dackis, commenced a third party claim in the Blue Cross Action against HGNJ, HGA and the Company, alleging a right under the HMG Agreement to indemnity in an unspecified amount for fees, expenses and damages that he might incur in that action. In a letter brief filed on or about April 17, 1995, HMG indicated an intention to bring a similar claim at a later date. On or about May 16, 1995, HGNJ, HGA and the Company filed an answer to the complaint, and HGNJ and HGA brought counterclaims against Dr. Dackis and cross-claims against HMG and Dr. A.L.C. Pottash, another individual defendant and the owner of HMG, in an amount to be determined, based on allegations of fraudulent and improper billing practices.\nOn October 27, 1995, the Court dismissed with prejudice all claims asserted by Dr. Dackis against HGA, HGNJ and the Company in the Blue Cross Action. On December 11, 1995, the Company announced a settlement of all disputes with HMG and Dr. Pottash. Pursuant to the settlement, (i) the parties released each other from, among other things, the claims underlying the Arbitration, (ii) HGA\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npurchased HMG's interest in the HMG Agreement on December 31, 1995, and (iii) HGNJ agreed to make certain payments to Dr. Pottash in respect of claims he had asserted. While only HMG and Dr. Pottash are parties to the settlement with HGA, HGNJ and the Company, the Company has not been notified of any claims by other third party payors or others relating to the billing or other practices at Hampton Hospital, although it continues to respond voluntarily to requests for information from the State of New Jersey Department of Insurance and other government agencies with respect to these matters. The settlement with HMG and Dr. Pottash resulted in a one-time charge with a present value of $5,551,000 to fourth quarter fiscal 1995 earnings. That charge reflects amounts paid to Dr. Pottash in December 1995 of $3,100,000 included in other current liabilities at October 31, 1995, as well as two payments scheduled to be made to HMG in May 1997 and 1998, each in the amount of $1,537,500.\nNOTE 15. RELATIONSHIPS AND TRANSACTIONS BETWEEN THE COMPANY, CLS, COOPER DEVELOPMENT COMPANY ('CDC') AND THE COOPER LABORATORIES, INC. STOCKHOLDERS' LIQUIDATING TRUST (THE 'TRUST')\nADMINISTRATIVE SERVICES\nPursuant to separate agreements between the Company and CDC, CLS and the Trust, which was formed in connection with the liquidation of the Company's former parent, Cooper Laboratories, Inc., the Company provided certain administrative services to CDC, CLS and the Trust, including the services of the Company's treasury, legal, tax, data processing, corporate development, investor relations and accounting staff. Expenses were charged on the basis of specific utilization or allocated based on personnel, space, percent of assets used or other appropriate bases. The agreements relating to the provision of administrative services to CDC and CLS terminated on September 17, 1988. The Company has not performed any services for CDC and CLS since September 17, 1988, other than historic tax services. Combined corporate administrative expenses charged to the Trust by the Company were $213,000 in 1992 and $560,000 in 1991. On July 9, 1992, the Trust filed a petition in Bankruptcy under Chapter 7 of the Bankruptcy Code; and, effective July 31, 1992, the Company ceased providing services to the Trust. The Company has asserted a claim for approximately $750,000 in the Trust's bankruptcy proceedings, primarily representing unpaid administrative service fees and expenses and legal fees advanced by the Company on behalf of the Trust. In October 1995, in connection with a final distribution of assets from the Trust, the Company received a payment of $648,000 in partial satisfaction of its outstanding claim, which was recorded as a reduction of general and administrative expenses.\nAGREEMENTS WITH CLS\nOn June 12, 1992, the Company consummated a transaction (the '1992 CLS Transaction') with CLS, which eliminated approximately 80% of the Company's then outstanding SERPS. (See Note 8.) Pursuant to an Exchange Agreement between the Company and CLS dated as of June 12, 1992 (the '1992 Exchange Agreement'), the Company acquired from CLS, among other things, 488,004 shares of the SERPS owned by CLS, and all of CLS's right to receive, by way of dividends pursuant to the terms of the SERPS, an additional 11,996 shares of SERPS (such 11,996 shares together with the 488,004 shares being referred to collectively as the SERPS) in exchange for 1,616,667 newly issued shares of the Company common stock (the 'Company Shares'). In addition, the Company entered into a settlement agreement with CLS dated as of June 12, 1992 (the '1992 Settlement Agreement'), with respect to certain litigation and administrative proceedings in which the Company and CLS were involved. Pursuant to the 1992 Settlement Agreement, the Company agreed, among other things, that, if requested by CLS, it would use its reasonable best efforts to cause the election to the Company's Board of Directors of one or two designees of CLS, reasonably acceptable to the Company (the number of designees depending, respectively, on whether CLS owns more than 333,333 but less than 800,000 shares, or more than 800,000 shares of the Company's common stock).\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn June 14, 1993, the Company acquired from CLS all of the remaining outstanding SERPS of the Company, having an aggregate liquidation preference of $16,060,000, together with all rights to any dividends or distributions thereon, in exchange for shares of Series B Preferred Stock having an aggregate liquidation preference of $3,450,000 and a par value of $.10 per share (the '1993 Exchange Agreement'). Such shares, and any shares of Series B Preferred Stock issued as dividends, were convertible into one share of common stock of the Company for each $3.00 of liquidation preference, subject to customary antidilution adjustments.\nThe Company also had the right to compel conversion of Series B Preferred Stock at any time after the market price of the common stock on its principal trading market averaged at least $4.125 for 90 consecutive calendar days and closed at not less than $4.125 on at least 80% of the trading days during such period. On September 26, 1994, the Company's common stock met the above requirements, and the Series B Preferred Stock was converted into 1,150,000 shares of the Company's common stock.\nNo dividends accrued on the Series B Preferred Stock through June 14, 1994. Subsequently, dividends accrued and were paid in cash, at the rate of 9% (of liquidation preference) per annum, through the date of conversion.\nThe Company and CLS also entered into a Registration Rights Agreement, dated June 14, 1993, providing for the registration under the Securities Act of the shares of common stock issued upon such conversion of any of the Series B Preferred Stock and any of the 1,616,667 shares of common stock currently owned by CLS which have not been sold prior thereto.\nOn June 14, 1993, the Board of Directors amended the Rights Agreement dated as of October 29, 1987, between the Company and The First National Bank of Boston, as Rights Agent, so that CLS and its affiliates and associates as of the amendment date would not be Acquiring Persons thereunder as a result of CLS's beneficial ownership of more than 20% of the outstanding common stock of the Company by reason of its ownership of Series B Preferred Stock or common stock issued upon conversion thereof. (See Note 9.)\nCLS obtained 1,616,667 shares of the Company's common stock pursuant to the 1992 Exchange Agreement described above. In Amendment No. 1 to its Schedule 13D, filed with the SEC on November 12, 1992, CLS disclosed that 'in light of the recent public disclosures relating to the Company and the recent significant decline in the public trading price of the common stock, CLS is presently considering various courses of action which it may determine to be necessary or appropriate in order to maintain and restore the value of the common stock. Included among the actions which CLS is considering pursuing are the initiation of litigation against the Company and the replacement of management and at least a majority of the members of the Board of Directors of the Company.\nOn June 14, 1993, in order to resolve all disputes with CLS, the Company and CLS entered into a Settlement Agreement (the '1993 Settlement Agreement'), pursuant to which CLS delivered a general release of claims against the Company, subject to exceptions for specified ongoing contractual obligations, and agreed to certain restrictions on its voting and transfer of securities of the Company, in exchange for the Company's payment of $4,000,000 in cash and delivery of 200,000 shares of common stock of CLS owned by the Company and a general release of claims against CLS, subject to similar exceptions.\nPursuant to the 1993 Settlement Agreement, the Company agreed to nominate, and to vote all of its shares of common stock of the Company in favor of the election of, a Board of Directors of the Company consisting of eight members, up to three of whom will, at CLS's request, be designated by CLS (such designees to be officers or more than 5% stockholders of CLS as of June 14, 1993 or otherwise be reasonably acceptable to the Company). The number of CLS designees will decline as CLS's ownership of common stock declines. A majority of the Board members (other than CLS designees) are to be individuals who are not officers or employees of the Company. Pursuant to the Settlement Agreement, CLS designated, and on August 10, 1993 the Board of Directors elected, one person to serve as a director of the Company until the 1993 Annual Meeting. CLS also designated that\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nindividual along with two other people as its three designees to the eight-member Board of Directors that was elected at the 1993 Annual Meeting. Three CLS designees were elected or reelected to the Board at the 1994 and 1995 Annual Meetings.\nCLS also agreed in the 1993 Settlement Agreement not to acquire any additional securities of the Company and to certain limitations on its transfer of securities of the Company. In addition, CLS agreed, among other things, not to seek control of the Company or the Board or otherwise take any action contrary to the 1993 CLS Settlement Agreement. CLS is free, however, to vote all voting securities owned by it as it deems appropriate on any matter before the Company's stockholders.\nThe agreements with respect to Board representation and voting, and the restrictions on CLS's acquisition and transfer of securities of the Company, were to terminate on June 14, 1995, or earlier if CLS beneficially owned less than 333,333 shares of common stock (including as owned the common stock into which shares of Series B Preferred Stock owned by CLS were converted). The agreements were to be extended if the market price of the common stock increased to specified levels prior to each of June 12, 1995, and June 12, 1996, or if the Company agreed to nominate one CLS designee, who was independent of CLS and reasonably acceptable to the Company, in addition to that number of designees to which CLS was then entitled on each such date, which would have resulted in such agreements continuing through October 31, 1996, and CLS having up to five designees on the Board (which would then have a total of ten members, or eleven members if a new chairman or chief executive officer was then serving on the Board). In January 1995, in connection with the further amendment to the Rights Agreement (see Note 6), the Company and CLS amended the 1993 Settlement Agreement to provide that the provisions relating to CLS representation on the Company's Board, CLS's obligations with respect to voting its securities of the Company and the restrictions on CLS's acquisition and transfer of securities of the Company, will now end on the earlier of (i) the first date on which CLS beneficially owns fewer than 333,333 shares of the Company's outstanding common stock or (ii) October 31, 1996, or if any person (other than two specified individuals) becomes the beneficial owner of 20% or more of the outstanding shares of common stock of CLS, April 30, 1997.\nFollowing termination of the 1993 Settlement Agreement and through June 12, 2002, CLS will continue to have the contractual right that it had pursuant to the 1992 CLS Settlement Agreement to designate two directors of the Company, so long as CLS continues to own at least 800,000 shares of common stock, or one director, so long as it continues to own at least 333,333 shares of common stock.\nOTHER\nCLS was formerly an 89.5% owned subsidiary of the Company's former parent, Cooper Laboratories, Inc.\nAs of December 31, 1995, CLS owned 2,322,533 shares (or approximately 20%) of common stock of the Company.\nTwo members of the Company's Board of Directors are also directors and\/or officers of CLS. Moses Marx is a Director of CLS. Steven Rosenberg is serving as Acting President, Vice President and Chief Financial Officer of CLS and he is also a Director of CLS. In addition to shares purchased on the open market, Mr. Marx owns 1,333 shares and Mr. Rosenberg owns 1,666 shares of the Company's common stock, obtained through the NEDRSP. (See Note 12.)\nNOTE 16. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION\nThe Company's operations are attributable to four business segments:\nHGA, which provides healthcare services for inpatient and outpatient treatment and partial hospitalization programs through the ownership and operation of certain psychiatric facilities, and through May 1995 also managed other such facilities,\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCVI, which develops, manufactures and markets a range of contact lenses,\nCVP, a development stage business, which develops proprietary ophthalmic pharmaceuticals, and\nCSI, which develops, manufactures and distributes diagnostic and surgical equipment, instruments and disposables, primarily for gynecology.\nTotal net revenue by business segment represents service and sales revenue as reported in the Company's statement of consolidated operations. Total net revenue by geographic area includes intercompany sales which are generally priced at terms that allow for a reasonable profit for the seller. Operating income (loss) is total net revenue less cost of products sold (or services provided, in the case of HGA revenue), research and development expenses, selling, general and administrative expenses, costs of restructuring and amortization of intangible assets. Corporate operating loss is principally corporate headquarters expense. Investment income, net, settlement of disputes, net, debt restructuring costs, gain on sales of assets and businesses, net, other income (expense), net, and interest expense were not allocated to individual business or geographic segments.\nIdentifiable assets are those assets used in continuing operations (exclusive of cash and cash equivalents) or which are allocated thereto when used jointly. Corporate assets include cash and cash equivalents and temporary investments.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nInformation by business segment for each of the years in the three-year period ended October 31, follows:\n- ------------\n(1) Results include Management fee revenue through May 1995.\n------------------------\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nInformation by geographic area for each of the years in the three year period ended October 31, 1995 follows:\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 17. QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------\n* The sum of income (loss) per common share for the four quarters is different from the full year net income (loss) per common share as a result of computing the quarterly and full year amounts on the weighted average number of common shares outstanding in the respective periods.\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\n- ------------\nAt December 31, 1995 and 1994 there were 3,067 and 4,495 common stockholders of record, respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nDuring fiscal years 1995 and 1994, TCC neither changed its accountants nor reported a disagreement on Form 8-K on any matter of accounting principles or practices of financial statement disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information contained under the heading 'Election of Directors' in the Company's Proxy Statement for the Annual Meeting of Stockholders scheduled to be held in March 1996 is incorporated herein by reference with respect to each of the Company's directors. For information relating to executive officers who are not also directors of the Company, see, 'Executive Officers of the Company,' located in Part I.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information contained under the sub-heading 'Executive Compensation' of the 'Election of Directors' section of the Company's Proxy Statement for the Annual Meeting of Stockholders scheduled to be held in March 1996 is incorporated herein by reference with respect to the Company's chief executive officer, the most highly compensated executive officers of the Company and the directors.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information contained under the sub-heading 'Securities Held by Management' of the 'Election of Directors' section of the Company's Proxy Statement for the Annual Meeting of Stockholders scheduled to be held in March 1996 is incorporated herein by reference with respect to certain beneficial owners, the directors and management.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information contained under the sub-heading 'Certain Relationships and Related Transactions' of the 'Election of Directors' section of the Company's Proxy Statement for the Annual Meeting of Stockholders scheduled to be held in March 1996 is incorporated herein by reference with respect to each of the Company's executive officers and directors.\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 OF THE COMPANY.\nThe Consolidated Financial Statements and the Notes thereto, the Financial Statement Schedules identified in (2) below and the Accountants' Report on the foregoing are included in Part II, Item 8 of this report.\n2. FINANCIAL STATEMENT SCHEDULES OF THE COMPANY.\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.\nAlso included herein are separate company Financial Statements and the Notes thereto, the Accountants' Report thereon and required Financial Statement Schedules of:\nHospital Group of America, Inc. and Subsidiaries and CooperSurgical, Inc.\nSCHEDULE I\nTHE COOPER COMPANIES, INC. CONDENSED STATEMENT OF OPERATIONS\nThe condensed financial statements presented in this Schedule I are the parent company only condensed financial statements of The Cooper Companies, Inc. (the 'Registrant'). The Registrant accounts for its investments in its consolidated subsidiaries, all of which are virtually wholly owned, under the equity method. Accordingly, net income (loss) applicable to common stock and shareholders' equity (deficit) reported in this Schedule I are equal to the figures reported in the consolidated financial statements of The Cooper Companies, Inc. and Subsidiaries ('Consolidated Financial Statements') located herein. See Note 14 of Notes to Consolidated Financial Statements for disclosures concerning the material contingencies and long-term obligations of the Registrant.\n- ------------\nSee Note 2 of Notes to Consolidated Financial Statements.\nSCHEDULE I (CONTINUED)\nTHE COOPER COMPANIES, INC. CONDENSED BALANCE SHEET\nSCHEDULE I (CONCLUDED)\nTHE COOPER COMPANIES, INC. CONDENSED STATEMENT OF CASH FLOWS\nFor other supplemental disclosures, all of which relate to the Cooper Companies, Inc., see 'The Cooper Companies, Inc. and Subsidiaries Consolidated Statement of Cash Flows' herein.\nSCHEDULE II\nTHE COOPER COMPANIES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED OCTOBER 31,1995\n- ------------\n(1) Represents acquired reserve of CoastVision, Inc.\n(2) Uncollectible accounts written off, recovered accounts receivable previously written off and other items.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors HOSPITAL GROUP OF AMERICA, INC.:\nWe have audited the accompanying consolidated balance sheets of Hospital Group of America, Inc. (a wholly owned subsidiary of The Cooper Companies, Inc.) and subsidiaries as of October 31, 1995 and 1994, and the related consolidated statements of operations, stockholder's equity (deficiency) and cash flows for each of the years in the three-year period ended October 31, 1995. In connection with our audits of the consolidated financial statements, we also audited financial statement Schedule II. These consolidated financial statements and financial statement schedule are the responsibility of HGA'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 Hospital Group of America, Inc. and subsidiaries at 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\nPhiladelphia, Pennsylvania December 11, 1995\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) CONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) CONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIENCY) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Accounting -- On May 29, 1992, The Cooper Companies, Inc. ('Cooper' or 'Parent') acquired all of the common stock of Hospital Group of America, Inc. (HGA) from its ultimate parent, Nu-Med, Inc. (Nu-Med). The acquisition of HGA was accounted for as a purchase and the purchase adjustments were 'pushed-down' to the separate financial statements of HGA resulting in a new basis of accounting as of May 30, 1992. The Parent's cost of the acquisition was approximately $50 million, including the assumption of approximately $22 million of third-party debt of HGA. The purchase price was allocated to assets and liabilities based on their estimated fair values as of the acquisition date. The purchase price exceeded the estimated fair value of the identifiable net assets acquired resulting in goodwill. The estimated goodwill amount of $6,155,000 was recorded as of May 30, 1992 and is being amortized over 30 years on a straight-line basis.\nBusiness -- The accompanying consolidated financial statements include the accounts of HGA and its wholly owned subsidiaries (the 'Company'). All intercompany balances and transactions have been eliminated. The Company owns and operates the following psychiatric facilities:\nEffective May 30, 1992, PSG Management, Inc. (PSG), a sister company to HGA and a wholly-owned subsidiary of Cooper, entered into a three year agreement to manage two psychiatric hospitals and the substance abuse treatment center owned by the subsidiaries of Nu-Med, Inc. HGA was not a party to this agreement and therefore the management fee earned by PSG from the subsidiaries of Nu-Med, Inc. is not recognized in the accompanying financial statements. However, in connection with this agreement, HGA performed services on behalf of PSG for which it earns a fee of 25% of certain of its corporate headquarters' cost plus a 20% mark-up. Such fees earned by HGA from PSG amounted to $269,000, $428,000 and $691,000 for 1995, 1994 and 1993, respectively. The agreement expired by its terms in May 1995.\nNet Patient Service Revenue -- Net patient service revenue is recorded at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in the period as final settlements are determined. In 1995, HGA received and recognized approximately $2,000,000 associated with prior year cost report settlements.\nCharity Care -- The Company provides care to indigent patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Company does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue. The Company maintains records to identify and monitor the level of charity care it provides. These records include the amount of charges foregone for services and supplies furnished under its charity care policy. Charges at the Company's established rates foregone for charity care provided by the Company amounted to $2,142,000, $2,498,000 and $3,220,000 for 1995, 1994 and 1993 respectively. Hampton Hospital is required by its Certificate of Need to incur not less than 5% of total patient days as free care.\nHealth Insurance Coverage -- The Company is self-insured for the health insurance coverage offered to its employees. The provision for estimated self-insured health insurance costs includes management's estimates of the ultimate costs for both reported claims and claims incurred but not reported.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSupplies -- Supplies consist principally of medical supplies and are stated at the lower of cost (first-in, first-out method) or market.\nProperty and Equipment -- Property and equipment are stated at fair value as of May 29, 1992, the date of the acquisition of HGA by Cooper. Depreciation is computed on the straight-line method over the estimated useful lives of the respective assets, which range from 20 to 40 years for buildings and improvements, and 5 to 10 years for equipment, furniture and fixtures.\nGoodwill -- Goodwill is amortized on a straight-line basis over thirty years. Goodwill is reviewed for impairment whenever events or circumstances provide evidence that suggest that the carrying amount of goodwill may not be recoverable. The Company assesses the recoverability of goodwill by determining whether the amortization of the goodwill balance over its remaining life can be recovered through reasonably expected future results.\nOther Assets -- Loan fees incurred in obtaining long-term financing are deferred and recorded as other assets. Loan fees are amortized over the terms of the related loans. The balance of unamortized loan fees amounted to $258,000, $399,000 and $540,000 respectively, for 1995, 1994 and 1993.\nIncome Taxes -- The Company is included in the consolidated income tax returns of the Parent. The consolidated federal, state and local taxes are subject to a tax sharing agreement under which the Company's liability is computed on a non-consolidated basis using a combined rate of 40%.\nEffective November 1, 1993, the Company adopted the liability method of accounting for income taxes as prescribed by Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' (FAS 109). The liability method under FAS 109 measures the expected tax impact of future taxable income or deductions resulting from temporary differences in the tax and financial reporting bases of assets and liabilities reflected in the consolidated balance sheet. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the year in which these differences are expected to reverse. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that the change was enacted. In 1993, the Company accounted for income taxes under APB Opinion II.\nCash and Cash Equivalents -- Cash and cash equivalents include investments in highly liquid debt instruments with a maturity of three months or less.\nB. NET PATIENT SERVICE REVENUE\nThe Company has agreements with third-party payors that provide for payments to the Company at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows:\nCommercial Insurance -- Most commercial insurance carriers reimburse the Company on the basis of the hospitals' charges, subject to the rates and limits specified in their policies. Patients covered by commercial insurance generally remain responsible for any differences between insurance proceeds and total charges.\nBlue Cross -- Reimbursement under Blue Cross plans varies depending on the areas in which the Company presently operates facilities. Benefits paid to the Company can be charge-based, cost-based, negotiated per diem rates or approved through a state rate setting process.\nMedicare -- Services rendered to Medicare program beneficiaries are reimbursed under a retrospectively determined reasonable cost system with final settlement determined after submission of annual cost reports by the Company and audits thereof by the Medicare fiscal intermediary.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nManaged Care -- Services rendered to subscribers of health maintenance organizations, preferred provider organizations and similar organizations are reimbursed based on prospective negotiated rates.\nMedicaid -- Services rendered to State Medicaid program beneficiaries are reimbursed based on rates established by each individual State program.\nThe Company's business activities are primarily with large insurance companies and federal and state agencies or their intermediaries. Other than adjustments arising from audits by certain of these agencies, the risk of loss arising from the failure of these entities to perform according to the terms of their respective contracts is considered remote.\nC. RELATED PARTY TRANSACTIONS\nThe current portion of Due to Parent at October 31, 1995 consists of costs of amounts due under a Demand Note (Demand Note) for costs incurred or paid by the Parent in connection with the acquisition, cash advances from the Parent, interest payable on the subordinated note in the amount of $1,920,000, and an allocation of Cooper corporate services amounting to $892,000, net of payments to the Parent.\nAll current and future borrowings under the terms of the Demand Note bear interest, payable monthly, commencing on December 1, 1993 at the rate of 15% per annum (17% in the event principal and interest is not paid when due), and all principal and all accrued and unpaid interest under the Demand Note shall be completely due and payable on demand. Prior to December 1, 1993, the Parent did not charge the Company for amounts due to it except for amounts due under the Subordinated Promissory Note. The Parent has indicated that a demand for payment will not be made prior to November 1, 1996.\nThe non-current portion of Due to Parent consists of a $16,000,000 subordinated note. The annual interest rate on the note is 12%. The principal amount of this Note shall be due and payable on May 29, 2002 unless payable sooner pursuant to the terms of the Note.\nHGA allocates interest expense to PSG primarily to reflect an estimate of the interest cost on debt incurred by HGA in connection with the May 29, 1992 acquisition which relates to the PSG management agreement with Nu-Med. Such allocations amounted to $163,000, $254,000 and $194,000 for 1995, 1994 and 1993, respectively and are recorded as reductions of interest on long-term debt and interest on due to Parent note.\nD. EMPLOYEE BENEFITS\nThe Company participates in Cooper's 401(k) plan (the 'Plan'), which covers substantially all full-time employees with more than 60 days of service. The Company matches employee contributions up to certain limits. These costs were $58,000, $61,000 and $40,000 for 1995, 1994 and 1993, respectively.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nE. LONG TERM DEBT\nLong-term debt at October 31, 1995 and 1994 consists of the following:\nAnnual maturities of long-term debt are as follows:\nThe long-term debt agreements contain several covenants, including the maintenance of certain ratios and levels of net worth (as defined), restrictions with respect to the payments of cash dividends on common stock and on the levels of capital expenditures, interest and debt payments. The Industrial Revenue Bonds ('IRB') carries interest at 85% of prime, or approximately 7.44% per annum at October 31, 1995. The holders of the IRB have exercised their right to accelerate all payments of outstanding principal to December 31, 1995.\nSubstantially all of the property and equipment and accounts receivable of the Company collateralize the debt outstanding.\nF. COMMITMENTS AND CONTINGENCIES\nIn the normal course of business, the Company is involved in various litigation cases. In the opinion of management, the disposition of such litigation will not have a material adverse effect on the Company's consolidated financial position.\nThe Company leases certain space and equipment under operating lease agreements. The following is a schedule of estimated minimum payments due under such leases with an initial term of more than one year as of October 31, 1995:\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSome of the operating leases contain provisions for renewal or increased rental (based upon increases in the Consumer Price Index), none of which are taken into account in the above table. Rental expense under all operating leases amounted to $840,000, $706,000, and $736,000 for 1995, 1994 and 1993, respectively.\nG. INCOME TAXES\nA reconciliation of the provision for (benefit of) income taxes included in the Company's statement of consolidated operations and the amount computed by applying the federal income tax rate to loss from continuing operations follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:\nThe Company's net deferred tax liability was offset against the Parent's consolidated valuation allowance. The net change in the total valuation allowance for the year ended October 31, 1995 was an increase of $3,928,000. At October 31, 1994, the net change in the offset against the Parent's consolidated valuation allowance was a decrease of $3,272,000.\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nAt October 31, 1995 the Parent had consolidated net operating loss carryforwards, of which approximately $10,000,000 related to the Company. The tax benefit of an additional $5,000,000 of the Company's net operating loss carryforwards which have been utilized in the Parent's consolidated return are available in the future should the Company have sufficient taxable income during the carryforward period. The net operating loss carryforwards expire commencing in 2001.\nH. PLEDGE AGREEMENT\nPursuant to a pledge agreement dated as of January 6, 1994, between the Parent and the Trustee for the holders of a new class of debt issued by the Parent (the 'Notes') the Parent has pledged a first priority security interest in all of its right, title and interest of its investment in the Company, all additional shares of stock of, or other equity interest in the Company from time to time acquired by the Parent, all additional intercompany indebtedness of the Company from time to time held by the Parent and except as set forth in the indenture to the Notes, the proceeds received from the sale or disposition of any or all of the foregoing.\nI. SETTLEMENTS\nUnder an agreement dated July 11, 1985, as amended (the 'HMG Agreement'), Hampton Medical Group, P.A. ('HMG'), which is not affiliated with HGA, contracted to provide clinical and clinical administrative services at Hampton Psychiatric Institute ('Hampton Hospital'), the primary facility operated by Hospital Group of New Jersey, Inc. ('HGNJ'), a subsidiary of HGA. In late 1993 and early 1994, HGNJ delivered notices to HMG asserting that HMG had defaulted under the HMG Agreement based upon billing practices by HMG that HGNJ believed to be fraudulent. At the request of HMG, a New York state court enjoined HGNJ from terminating the HMG Agreement based upon the initial notice and ordered the parties to arbitrate whether HMG had defaulted.\nOn February 2, 1994, HMG commenced an arbitration in New York, New York (the 'Arbitration'), entitled Hampton Medical Group, P.A. and Hospital Group of New Jersey, P.A. (American Arbitration Association), in which it contested the alleged default. In addition, HMG made a claim against HGNJ for unspecified damages based on allegedly foregone fees on the contention that HMG had the right to provide services at all HGNJ-owned facilities in New Jersey, including certain outpatient clinics and the Hampton Academy, at which non-HMG physicians have been employed.\nOn December 30, 1994, Blue Cross and Blue Shield of New Jersey, Inc. commenced a lawsuit in the Superior Court of New Jersey entitled Blue Cross and Blue Shield of New Jersey, Inc. v. Hampton Medical Group, et al. against HMG and certain related entities and individuals unrelated to HGNJ or its affiliates alleging, among other things, fraudulent billing practices (the 'Blue Cross Action').\nOn or about April 12, 1995, an individual defendant in the Blue Cross Action who was formerly employed by HMG, Dr. Charles Dackis, commenced a third party claim in the Blue Cross Action against HGNJ, HGA and the Parent, alleging a right under the HMG Agreement to indemnify in an unspecified amount for fees, expenses and damages that he might incur in that action. In a letter brief filed on or about April 17, 1995, HMG indicated an intention to bring a similar claim at a later date. On or about May 16, 1995, HGNJ, HGA and the Parent filed an answer to the complaint, and HGNJ and HGA brought counterclaims against Dr. Dackis and cross-claims against HMG and Dr. A.L.C. Pottash, another individual defendant and the owner of HMG, in an amount to be determined, based on allegations of fraudulent and improper billing practices.\nOn October 27, 1995, the Court dismissed with prejudice all claims asserted by Dr. Dackis against HGA, HGNJ and the Parent in the Blue Cross Action. On December 11, 1995, the Parent announced a settlement of all disputes with HMG and Dr. Pottash. Pursuant to the settlement, (i) the parties released\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES (A WHOLLY OWNED SUBSIDIARY OF THE COOPER COMPANIES, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\neach other from, among other things, the claims underlying the Arbitration, (ii) HGA purchased HMG's interest in the HMG Agreement on December 31, 1995, and (iii) HGNJ agreed to make certain payments to Dr. Pottash in respect of claims he had asserted. While only HMG and Dr. Pottash are parties to the settlement with HGA, HGNJ and the Parent, HGA has not been notified of any claims by other third party payors or others relating to the billing or other practices at Hampton Hospital, although it continues to respond voluntarily to requests for information from the State of New Jersey Department of Insurance and other government agencies with respect to these matters. The settlement with HMG and Dr. Pottash resulted in a one-time charge with a present value of $5,551,000 to fourth quarter fiscal 1995 earnings. That charge reflects amounts paid to Dr. Pottash in December 1995 of $3,100,000 included in other current liabilities at October 31, 1995 as well as two payments scheduled to be made to HMG in May 1997 and 1998, each in the amount of $1,537,500.\nHGA and Progressions Health Systems, Inc. entered into the purchase price agreement which settled cross claims between the parties related to purchase price adjustments (which were credited to goodwill) and other disputes and provided for a series of payments to be made to HGA. Pursuant to this agreement, HGA received approximately $853,000 in 1995, $421,000 of which has been credited to Settlement of Disputes, Net.\nSCHEDULE II\nHOSPITAL GROUP OF AMERICA, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS YEAR ENDED OCTOBER 31, 1995, 1994 AND 1993\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders COOPERSURGICAL, INC.:\nWe have audited the accompanying balance sheets of CooperSurgical, Inc. as of October 31, 1995 and 1994, and the related statements of operations, stockholders' equity (deficit), and cash flows for each of the years in the three-year period ended October 31, 1995. In connection with our audits of the financial statements, we also have audited financial statement schedule II. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CooperSurgical, Inc. as of October 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 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 financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nStamford, Connecticut December 4, 1995\nCOOPERSURGICAL, INC. BALANCE SHEETS\nSee accompanying notes to financial statements.\nCOOPERSURGICAL, INC. STATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nCOOPERSURGICAL, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSee accompanying notes to financial statements.\nCOOPERSURGICAL, INC. STATEMENTS OF CASH FLOWS YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSee accompanying notes to financial statements.\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGENERAL\nCooperSurgical, Inc. ('CooperSurgical'), a Delaware corporation, develops, manufactures and distributes electrosurgical, cryosurgical and general application diagnostic surgical instruments and equipment. The Cooper Companies, Inc. ('Parent'), a Delaware corporation, owns 100% of CooperSurgical's Series A convertible preferred stock. CooperSurgical's outstanding common stock is 100% owned by individuals on the CooperSurgical Advisory Board which provides counsel and management of clinical trials in the area of minimally invasive surgery. The accompanying financial statements have been prepared from the separate records of CooperSurgical and may not be indicative of conditions which would have existed or the results of its operations if CooperSurgical operated autonomously (see Note 5). Foreign exchange translation and transactions are immaterial.\nDEPENDENCE UPON PARENT\nCooperSurgical believes that the acquisition of certain patented products in fiscal 1995, the continued consolidation of administrative, selling and marketing functions to its Shelton facility, and continued inventory reductions will permit it to meet its cash obligations until its liability to its Parent matures.\nCooperSurgical's liability to Parent matures on May 1, 1997, and the Parent is committed to funding the Company's cash requirements, as necessary, until that date.\nCooperSurgical does not expect to be able to repay its liability to Parent at maturity without a significant improvement in operating results from present levels. There can be no assurance that such an improvement will be achieved or that the Parent will extend further the maturity date of CooperSurgical's liability.\nREVENUE RECOGNITION\nCooperSurgical recognizes product revenue when risk of ownership has transferred to the buyer, net of appropriate provisions for sales returns and bad debts.\nINCOME TAXES\nCooperSurgical is included in the consolidated income tax returns of the Parent. The consolidated federal, state and local taxes are subject to a tax sharing agreement under which CooperSurgical's liability is computed on a non-consolidated basis using a combined rate of 40%.\nEffective November 1, 1993, CooperSurgical adopted the liability method of accounting for income taxes as prescribed by Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' (FAS 109). The liability method under FAS 109 measures the expected tax impact of future taxable income or deductions resulting from temporary differences in the tax and financial reporting bases of assets and liabilities reflected in the consolidated balance sheet. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the year in which these differences are expected to reverse. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that the change is enacted. In 1993 and prior years, the Company accounted for income taxes under APB Opinion 11.\nPOSTEMPLOYMENT BENEFITS\nEffective November 1, 1994, CooperSurgical, Inc. adopted Statement of Financial Accounting Standards No. 112, 'Employer's Accounting for Postemployment Benefits' ('FAS 112'). FAS 112 establishes accounting standards for employers who provide benefits to former or inactive employees\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nafter employment but before retirement ('postemployment benefit'). Postemployment benefits are all types of benefits provided to former or inactive employees, their beneficiaries, and covered dependents. Those benefits include, but are not limited to, salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits (including workers' compensation), job training and counseling, and continuation of benefits such as healthcare benefits and life insurance coverage.\nThe termination benefits portion of the restructuring charge, discussed in note 2, has been accounted for in accordance with the provisions of FAS 112.\nINVENTORIES\nInventories are carried at the lower of cost, determined on an average cost basis, or market.\nADVERTISING\nCooperSurgical expenses the production costs of advertising the first time the advertising takes place, except for direct-response advertising, which is capitalized and amortized over its expected period of future benefits.\nDirect Response advertising consists primarily of catalog mailings that include order forms for CooperSurgical's products. The capitalized costs of the advertising are amortized over a three to four month period or until the next catalog mailing is made.\nAt October 31, 1995 and 1994, direct response advertising costs of $136,000 and $45,000, respectively, were included in prepaid expenses. Advertising expense was $839,000, $1,033,000 and $1,300,000 in fiscal 1995, 1994, and 1993, respectively.\nFURNITURE AND EQUIPMENT\nFurniture and equipment are carried at cost. Depreciation is computed on the straight-line method over the estimated useful lives of depreciable assets.\nAMORTIZATION OF INTANGIBLES\nAmortization is currently provided on all intangible assets on a straight-line basis over periods up to 20 years. Accumulated amortization at October 31, 1995 and 1994 was $1,454,000 and $1,136,000, respectively. The Company assesses the recoverability of goodwill and other long-lived assets by determining whether the amortization of these assets over their remaining life can be recovered through reasonably expected future cash flow.\nSTOCK BASED COMPENSATION\nIn October, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 123, 'Accounting for Stock-Based Compensation (FAS 123).' FAS 123 applies to all transactions in which an entity acquires goods or services by issuing equity instruments such as common stock, except for employee stock ownership plans. FAS 123 establishes a new method of accounting for stock-based compensation arrangements with employees which is fair value based. The statement encourages (but does not require) 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. Companies may continue to apply the accounting provisions of APB No. 25 in determining net income, however, they must apply the disclosure requirements of FAS 123. If the Company adopts the fair value based method of FAS 123, a higher compensation cost would result for fixed stock option plans and a different compensation cost will result for the Company's contingent or variable stock option plans. The recognition provisions and disclosure requirements of FAS 123 are effective for fiscal\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nyears beginning after December 15, 1995. The Company will adopt the disclosure requirements but not the recognition requirements in its 1997 fiscal year. Such adoption will have no impact on reported results.\n(2) SIGNIFICANT EVENTS\nRESTRUCTURING\nDuring fiscal 1995, CooperSurgical closed their Redmond, Washington and Belgium field offices whereby all employees at these locations and certain support personnel at CooperSurgical's Shelton, Connecticut headquarters were terminated, resulting in a $425,000 restructuring charge. The restructuring charge includes termination benefits of $314,000 which covers eight employees. As of October 31, 1995, $262,000 of these termination benefits had been paid and five employees had been officially terminated.\nPATENT ACQUISITION\nDuring fiscal 1995, CooperSurgical acquired the rights to certain patented products for $1,000,000. As of October 31, 1995, $800,000 had been paid, the final $200,000 installment (reported in accounts payable at October 31, 1995) is due at the earlier of June 15, 1996 or the date certain contractual milestones are met.\n(3) EXPORT SALES\nCooperSurgical had export sales of $2,118,000, $2,441,000, and $2,200,000 for the years ended October 31, 1995, 1994 and 1993, respectively.\n(4) ACCOUNTS PAYABLE\nCooperSurgical utilized a cash concentration account with the Parent whereby approximately $180,000 and $193,000 of checks issued and outstanding at October 31, 1995 and 1994, respectively, in excess of related bank cash balances were reclassified to accounts payable. Sufficient funds were available from the Parent to cover these checks.\n(5) RELATED PARTY TRANSACTIONS\nIncluded in CooperSurgical's selling, general and administrative expense are Parent allocations for technical service fees of $389,000, $514,000, and $1,312,000 for the years ended October 31, 1995, 1994 and 1993, respectively. Technical service fees for the year ended October 31, 1993 include $134,000 relating to redetermination of the appropriate amount for the year ended October 31, 1992. These costs are charges from the Parent for accounting, legal, tax and other services provided to CooperSurgical and are added to the balance Due to Parent.\nOn January 24, 1994, CooperSurgical's Parent converted $19,011,000 of Parent advances into 9,796,660 shares of CooperSurgical Series A convertible preferred stock and converted the remaining $3,313,000 balance of Parent advances into a Term Note, with principal and interest due January 24, 1996, bearing interest at 12%, compounded monthly (Parent advances in excess of $4,000,000 bear interest at 15%, compounded monthly). On January 10, 1995, the maturity date of this Term Note for principal plus any accrued unpaid interest was extended to May 1, 1997.\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(6) INCOME TAXES\nA reconciliation of the provision for (benefit of) income taxes included in CooperSurgical's statement of operations and the amount computed by applying the federal income tax rate to income (loss) from continuing operations before extraordinary items and income taxes follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred liabilities are as follows:\nThe valuation allowance increased $503,000 and $1,250,000 for the years ended October 31, 1995 and 1994, respectively.\nAt October 31, 1995, the Parent had consolidated net operating loss carryforwards of which approximately $11,400,000 related to CooperSurgical. The tax benefit of an additional $3,000,000 of CooperSurgical net operating loss carryforwards which have been utilized in the Parent's consolidated return are available in the future should CooperSurgical have sufficient taxable income during the carryforward period. The net operating loss carryforwards expire commencing in 2006.\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n(7) LONG-TERM DEBT\nLong-term debt consists of the following:\nDuring fiscal 1995, CooperSurgical acquired a new telephone system under the terms of a capital lease for $72,000 whereby CooperSurgical can purchase the system for $1 at the end of the 48 month lease term. As of October 31, 1995, accumulated depreciation associated with the telephone system totaled $5,000.\nAnnual maturities of long-term debt, including current installments thereof, are as follows:\n(8) COMMITMENTS AND CONTINGENCIES\nIn the normal course of its business, CooperSurgical is involved in various litigation cases. In the opinion of management, the disposition of such litigation will not have a materially adverse effect on CooperSurgical's financial condition.\nCooperSurgical leases certain property and equipment under noncancelable operating lease agreements. The following is a schedule of the estimated minimum payment due under such leases with an initial term of more than one year as of October 31, 1995:\nRental expense for all leases amounted to approximately $317,000, $311,000, and $340,000 for the years ended October 31, 1995, 1994 and 1993, respectively.\n(9) EMPLOYEE BENEFITS\nCooperSurgical employees are eligible to participate in the Parent's 401(k) Savings Plan, a defined contribution plan and the Parent's Retirement Income Plan, a defined benefit plan. As of October 31, 1995, CooperSurgical has not elected to participate in the Parent's Retirement Income Plan. Employer contributions to the Parent's 401(k) Savings Plan, as well as costs and expenses of administering the\nCOOPERSURGICAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONCLUDED)\nPlan, are allocated to CooperSurgical as appropriate. These amounts were not significant for the years ended October 31, 1995, 1994 and 1993.\n(10) SERIES A CONVERTIBLE PREFERRED STOCK\nThe Series A Convertible Preferred Stock is convertible into Common Stock on a one-to-one basis, subject to adjustment for stock splits, dividends and certain other distributions of Common Stock and has voting rights equal to the number of shares of Common Stock into which it is convertible. CooperSurgical is required to reserve for issuance, shares of Common Stock equal to the shares of Preferred Stock issued and outstanding at any given date. The Preferred Stock has a liquidation preference of $1.940625 per share and accrues cumulative dividends of $0.1940625 per share per annum. The aggregate liquidation preference of the Preferred Stock at October 31, 1995 is $20,253,000, plus cumulative dividends of $4,299,000. The Preferred Stock participates ratably with the Common Stock in any additional dividends declared beyond the cumulative dividends and in any remaining assets beyond the liquidation preference. The Series A Convertible Preferred Stock represents 99.8% of the total voting rights of all outstanding CooperSurgical stock.\nSCHEDULE II\nCOOPERSURGICAL, INC. VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED OCTOBER 31, 1995\n3. EXHIBITS.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on January 12, 1996.\nTHE COOPER COMPANIES, INC.\nBy: \/S\/ A. Thomas Bender ................................... A. THOMAS BENDER 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 indicated on the dates set forth opposite their respective names.\nSTATEMENT OF DIFFERENCES ------------------------\nThe British pound sign shall be expressed as 'L' The trademark symbol shall be expressed as 'tm' The registered trademark symbol shall be expressed as 'r'\nEXHIBIT INDEX","section_15":""}
{"filename":"782842_1995.txt","cik":"782842","year":"1995","section_1":"Item 1. Business\nFirst Albany Companies Inc. (the Company), through its wholly owned subsidiary First Albany Corporation (First Albany), conducts an investment banking business with brokerage activity centered in New York and New England. The primary business includes securities brokerage for individual and institutional customers, and market-making and trading of corporate, government, and municipal securities. In addition, First Albany underwrites and distributes municipal and corporate securities, provides securities clearance activities for other brokerage firms, and offers financial advisory services to its customers. Another of the Company's subsidiaries is First Albany Asset Management Corporation (\"Asset Management\"). Under management agreements, Asset Management serves as investment manager to individual and institutional customers. Asset Management also serves as a sub-advisor under contract to the Victory Fund for Income, a mutual fund registered under the Investment Company Act of 1940. Asset Management directs the investment of the customer and mutual fund assets by making investment decisions, placing purchase and sales orders, and providing research, statistical analysis, and continuous supervision of the portfolios.\nBrokerage services to retail and institutional customers are provided through First Albany's salesforce of Investment Executives and Institutional Salespeople. First Albany believes that Investment Executives and Institutional Salespeople are a key factor to the success of its business. Over the last five years, the number of full-time Investment Executives and Institutional Salespeople has grown from approximately 221 to 291, many of whom joined First Albany after previous associations with national brokerage firms.\nFirst Albany has organized its business to focus on and serve the needs and financial\/capital requirements of institutions, individuals, corporations, and municipalities. As investment bankers, First Albany is positioned to advise, manage, and conduct a variety of activities as requested including underwritings, initial and secondary offerings, advisory services, mergers and acquisitions, and private placements. As a brokerage firm, First Albany offers customers a full array of investment opportunities.\nFirst Albany operates a total of 29 Retail, Institutional, and Investment Banking offices in 9 states. First Albany's executive office and largest sales office are both located in Albany, New York.\nFirst Albany is a member of the New York Stock Exchange, Inc. (\"NYSE\"), the American Stock Exchange, Inc. (\"ASE\"), and the Boston Stock Exchange, Inc. (\"BSE\") and is registered as a broker-dealer with the Securities and Exchange Commission (\"SEC\"). First Albany is also a member of the National Association of Securities Dealers, Inc. (\"NASD\") and the Securities Investor Protection Corporation (\"SIPC\"), which insures customer funds and securities deposited with a broker-dealer up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. First Albany has obtained additional coverage of $24,500,000 per account from National Union, a wholly owned subsidiary of American International Group (AIG), America's largest commercial insurer. Both companies are rated A+15 (highest rating) by A.M. Best.\nSources of Revenues\nA breakdown of the amount and percentage of revenues from each principal source for the periods indicated follows:\nSecurities Commissions\nIn executing customers' orders to buy or sell listed securities and securities in which it does not make a market, First Albany generally acts as an agent and charges a commission.\nPrincipal Transactions\nFirst Albany buys and maintains inventories of municipal debt, corporate debt, and equity securities as a \"market maker\" for sale of those securities to other dealers and to customers. A staff of 46 traders, underwriters, and assistants manages First Albany's inventory of securities. First Albany Investment Executives work directly with these traders. As of September 29, 1995, First Albany made a market in 291 common stocks quoted on National Association of Securities Dealers Automated Quotation (\"NASDAQ\") and other less actively traded securities. First Albany also trades municipal bonds and taxable debt obligations, including U.S. Treasury bills, notes, and bonds, U.S. Government agency notes and bonds, bank certificates of deposit, mortgage- backed securities, and corporate obligations. Principal transactions have been a significant source of revenue and should continue to be so in the future. Continuation of these activities depends on the availability of sufficient capital and the services of highly skilled traders, Investment Executives, and Institutional Salespeople.\nThe majority of revenues derived from principal transactions are on a \"riskless\" basis. In fiscal 1995, First Albany added an institutional municipal risk trading operation in which inventory positions are hedged by highly liquid future contracts. Most of the inventory positions are carried for the purpose of generating sales by the retail and institutional salesforce.\nFirst Albany's trading activities require the commitment of capital and may place First Albany's capital at risk. Profits and losses are dependent upon the skill of traders, price movement, trading activity, and the size of inventories.\nIn executing customers' orders to buy or sell in the over-the-counter market in a security in which it makes a market, First Albany may sell to or purchase from its customers at a price which is substantially equal to the current interdealer market price, plus or minus a markup or markdown. Alternatively, First Albany may act as an agent, executing a customer's purchase or sale order with another broker-dealer, who acts as a market maker, at the best inter-dealer market price available and charging a commission.\nThe following table sets forth the highest, lowest, and average month-end inventories (including the net of securities owned and securities sold, but not yet purchased) for fiscal 1995 by securities category where First Albany acted as principal.\nHighest Lowest Average Inventory Inventory Inventory - -------------------------------------------------------------------------------- (In thousands of dollars) State and municipal bonds $ 44,314 $ 7,945 $ 26,349 Corporate obligations 12,873 1,677 4,490 Corporate stocks 3,511 (2,421) 1,903 U.S. Government and federal agencies obligations 6,119 693 3,384\nUnderwriting and Investment Banking\nFirst Albany manages, co-manages, and participates in tax-exempt and corporate securities distributions. For the periods indicated, the table below highlights the number and dollar amount of corporate and tax-exempt securities offerings managed or co-managed by First Albany and the number and amount of First Albany's underwriting participations in syndicates, including those managed or co-managed by First Albany:\nCorporate Stock and Bond Offerings ----------------------------------\nManaged or Co-Managed Syndicate Participations --------------------- ------------------------ Fiscal Number of Amount of Number of Amount of Year Issues Offering Participations Participation ------ --------- --------- -------------- ------------- (In thousands of dollars) 1995 13 $ 514,583 203 $ 227,170 1994 13 483,814 334 349,723 1993 3 158,300 344 366,314 1992 4 212,451 322 130,938 1991 1 7,650 159 51,677\nTax-Exempt Bond Offerings -------------------------\nManaged or Co-Managed Syndicate Participations Fiscal Number of Dollar Number of Dollar Year Issues Amount Participations Amount ------ --------- ------ -------------- ------ (In thousands of dollars) 1995 113 $ 12,235,469 222 $ 1,362,845 1994 123 14,744,502 332 1,598,182 1993 171 18,379,821 349 1,741,206 1992 179 14,482,448 328 1,137,423 1991 89 14,933,761 332 886,069\nParticipation in an underwriting syndicate or selling group involves both economic and regulatory risks. An underwriter or selling group member may incur losses if it is forced to resell the securities it is committed to purchase at less than the agreed-upon purchase price. In addition, under the federal securities laws, other statutes, and court decisions with respect to underwriters' liabilities and limitations on indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. Further, underwriting or selling commitments constitute a charge against net capital and First Albany's underwriting or selling commitments may be limited by the requirements that it must at all times be in compliance with the net capital rule. See \"Net Capital Requirements.\"\nInterest\nFirst Albany derives interest income primarily from the financing of customer margin loans, securities lending activities, and securities owned.\nCustomers' securities transactions are effected on either a cash or margin basis. In margin transactions, First Albany extends credit, which is collateralized by securities and cash in the customer's account, to the customer. In accordance with Federal Reserve Bank regulations, NYSE regulations, and internal policy, First Albany earns interest income as a result of charging customers at a rate of up to 2% over the brokers' call rate.\nDuring the past several years, cash balances in customers' accounts have been a source of funds to finance customers' margin account debit balances. SEC regulations restrict the use of customers' funds by broker-dealers by providing generally that free credit balances and funds derived from pledging and lending customers' securities are to be used only to finance customers' margin account debit balances, and, to the extent not so used, the funds must be deposited in a special reserve bank account for the exclusive benefit of customers. The regulations also require broker-dealers, within designated periods of time, to obtain physical possession or control of and to segregate customers' fully paid and excess margin securities.\nIn connection with both its trading and brokerage activities, First Albany borrows securities to cover short sales and to complete transactions in which customers or other brokers have failed to deliver securities by the required settlement date. First Albany also lends securities to other brokers and dealers for similar purposes. This is a common occurrence for broker-dealers.\nWhen borrowing securities, First Albany is required to deposit cash or other collateral, or to post a letter of credit with the lender and receive a rebate (based on the amount of cash deposited) calculated to yield a negotiated rate of return. When lending securities, First Albany receives cash and generally pays a rebate (based on the amount of cash received) to the other party to the transaction. Securities borrow and loan transactions are executed pursuant to written agreements with counter-parties which provide that the securities borrowed or loaned be marked to market on a daily basis and that excess collateral be refunded or that additional collateral be furnished in the event of changes in the market value of the securities. Collateral adjustments are usually made on a daily basis through the facilities of various clearinghouses.\nOperations, Clearing, and Systems\nFirst Albany's operations include: execution of orders; processing of transactions; receipt, identification, and delivery of funds and securities; custody of customers' securities; internal financial control; and compliance with regulatory and legal requirements.\nThe volume of transactions handled by the operations staff fluctuates substantially. The monthly number of purchase and sale transactions processed for the periods indicated were as follows:\nNumber of Monthly Transactions ----------------- Fiscal Year High Low Average - ----------- ---- --- ------- 1995 71,407 44,409 54,254 1994 58,245 40,537 47,257 1993 51,745 37,276 43,409 1992 43,068 30,907 36,346 1991 38,744 20,800 31,434\nFirst Albany has established internal controls and safeguards against securities theft, including use of depositories and periodic securities counts. As required by the NYSE and certain other authorities, First Albany carries fidelity bonds covering loss or theft of securities as well as embezzlement and forgery.\nFirst Albany clears its own securities transactions and posts its books and records daily. Periodic reviews of controls are conducted, and administrative and operations personnel meet frequently with management to review operating conditions. Operations personnel monitor compliance with applicable laws, rules, and regulations.\nIn addition to processing its own customer transactions, First Albany processes, for a fee, the transactions of other brokerage firms whose customer accounts are carried on a fully disclosed basis with all security positions, margin accounts receivable, and credit balances reflected on the books and records of First Albany.\nFinancial Services\nCustomized financial services are available to customers at First Albany.\nThe Financial Planning Department advises customers on a variety of interrelated financial matters, including investment portfolio review, tax management, insurance analysis, education and retirement planning, and estate analysis. For a fee, financial planners will prepare a detailed analysis with specific recommendations aimed at accumulating wealth and attaining financial goals.\nFirst Albany also offers a range of retirement plans, including IRAs, SEP Plans, profit sharing, 401K, and pension programs. Fixed and variable annuities are available as well as life, disability, and nursing home insurance programs, limited partnership interests in real estate, oil and gas drilling, and similar ventures.\nResearch\nFirst Albany maintains a professional staff of equity analysts. Research is focused on six industry sectors: technology, health care, financial services, energy, utilities, and basic industry. First Albany employs 16 analysts and 12 research assistants who support First Albany's institutional and retail brokerage and corporate finance activities.\nIn fiscal 1995, First Albany enlarged the scope ofits research in the technology sector by entering into a strategic alliance with the META Group, Inc. (META). META, an independent market assessment company, provides research and analysis of developments and trends in information technology (IT) including computer hardware, software, communications and related information technology industries to both IT users and IT vendors. The alliance with META enables First Albany to provide its investors with insights drawn from META's analysis of technology trends, user experience, and vendor pricing and negotiating tactics.\nResearch services include review and analysis of the economy; general market conditions; technology trends, industries and specific companies via both fundamental and technical analyses; recommendations of specific action with regard to industries and specific companies; review of customer portfolios; preparation of research reports which are provided to retail and institutional customers; and responses to inquiries from customers and Investment Executives. In addition, First Albany purchases outside research services including economic reports, charts, data bases, company analyses, and technical analyses.\nRetail Business\nRevenues from First Albany's retail brokerage activities are a substantial portion of First Albany's business and are generated through customer purchases and sales of stocks, bonds, mutual funds, and other investment products. For the fiscal years 1995, 1994, and 1993, these revenues accounted for approximately 53%, 54%, and 49% of net revenues, respectively.\nInstitutional Business\nRevenues generated from securities transactions with major institutions in fiscal 1995, 1994, and 1993 accounted for approximately 31%, 29%, and 30% of net revenues, respectively. Institutional revenues are derived from sales of taxexempt securities, taxable debt obligations, and equities, and are serviced by 83 Institutional Salespeople. First Albany Retail Investment Executives cover most of the regional institutions.\nMunicipal Bond Business\nFirst Albany considers its expertise in municipal bonds to be one of its major strengths. The tax-exempt department consists of 49 professionals and offers a broad range of services, including primary market underwriting, secondary market trading, institutional sales, sales liaison with branches, portfolio analysis, credit analysis, investment banking services, and financial advisory services.\nSales revenues from all secondary market tax-exempt products were $12.9 million in fiscal 1995, $8.95 million in fiscal 1994, and $7.5 million in fiscal 1993.\nEmployees\nAt September 29, 1995, the Company had 669 full-time employees, of which 193 were Retail Investment Executives, 98 were Institutional Salespeople and Institutional Traders, 129 were in branch sales support, 27 were in home office sales support, 60 were in other revenue producing positions, 60 were in operations, and 102 were in other support and administrative functions.\nNew Investment Executives are required to take examinations given by the NASD and approved by the NYSE and all principal exchanges as well as state securities authorities in order to be registered. There is intense competition among securities firms for Investment Executives with proven sales production records.\nThe Company considers its employee relations to be good and believes that its compensation and employee benefits are competitive with those offered by other securities firms. None of the Company's employees are covered by a collective bargaining agreement.\nCompetition\nFirst Albany is engaged in a highly competitive business. Its competition includes, with respect to one or more aspects of its business, all of the member organizations of the NYSE and other registered securities exchanges, all members of the NASD, members of the various commodity exchanges, and commercial banks and thrift institutions. Many of these organizations are national firms and have substantially greater financial and human resources than First Albany. Discount brokerage firms seeking to expand their share of the retail market, including firms affiliated with commercial banks and thrift institutions, are devoting substantial funds to advertising and direct solicitation of customers. In many instances, First Albany is competing directly with such organizations. In addition, there is competition for investment funds from the real estate, insurance, banking, and savings and loan industries. The Company believes that the principal factors affecting competition for the securities industry are the quality and ability of professional personnel and relative prices of services and products offered.\nRegulation\nThe securities industry in the United States is subject to extensive regulation under federal and state laws. The SEC is the federal agency charged with administration of the federal securities laws. Much of the regulation of brokerdealers, however, has been delegated to self-regulatory organizations, principally the NASD and the national securities exchanges. These self regulatory organizations adopt rules (subject to approval by the SEC) which govern the industry and conduct periodic examinations of member broker-dealers. Securities firms are also subject to regulation by state securities commissions in the states in which they are registered. First Albany is currently registered as a broker-dealer in 49 states and the District of Columbia.\nThe regulations to which broker-dealers are subject cover all aspects of the securities business, including sales methods, trade practices among broker dealers, capital structure of securities firms, recordkeeping, and conduct of directors, officers, and employees. Additional legislation, changes in rules promulgated by the SEC and by self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules often directly affect the method of operation and profitability of broker-dealers. The SEC, self regulatory organizations, and state security regulators 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 protection of creditors and stockholders of broker-dealers.\nNet Capital Requirements\nAs a broker-dealer and member of the NYSE, First Albany is subject to the Uniform Net Capital Rule promulgated by the SEC. The rule is designed to measure the general financial condition and liquidity of a broker-dealer; therefore, it imposes a minimum net capital requirement deemed necessary to meet the broker-dealer's continuing commitments to its customers.\nA broker-dealer may be required to reduce its business and to restrict withdrawal of subordinated capital if its net capital is less than 4% of aggregate debit balances; it may be prohibited from expanding its business and declaring cash dividends if its net capital is less than 5% of aggregate debit balances; and it will be subject to closer supervision by the NYSE if its net capital is less than 6% of aggregate debit balances. Compliance with the Net Capital Rule may limit those operations of a firm such as First Albany which require the use of its capital for purposes such as maintaining the inventory required for a firm trading in securities, underwriting securities, and financing customer margin account balances. Net capital and aggregate debit balances change from day to day and, at September 29, 1995, First Albany's net capital was $17,178,000 which was 18% of its aggregate debit balances (2% minimum requirement) and $15,303,000 in excess of required minimum net capital.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company has a total of 29 Retail, Institutional, and Investment Banking offices in 9 states, all of which are leased or rented. The Company's executive offices are currently located at 41 State Street, Albany, New York. The order entry, trading, investment banking, research, data processing, operations, and accounting activities are centralized in the Albany office. During 1996, these offices will be relocated to 30 South Pearl Street, Albany, New York. The offices at 30 South Pearl Street will be operated under a lease which currently expires in the year 2002. All other offices are subject to lease or rental agreements which, in the opinion of management, are sufficient to meet the needs of the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn the normal course of business, the Company has been named a defendant, or otherwise has possible exposure, in several claims. Certain of these are class actions which seek unspecified damages that could be substantial. Although there can be no assurance as to the eventual outcome of litigation in which the Company has been named as a defendant or otherwise has possible exposure, the Company has provided for those actions most likely to result in adverse dispositions. Although further losses are possible, the opinion of management, based upon the advice of its attorneys and general counsel, is that such litigation will not, in the aggregate, have a material adverse effect on the Company's liquidity or financial position, although it could have a material effect on quarterly or annual operating results in the period in which it is resolved.\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\nThe Company's common stock has traded on the Nasdaq Stock Market under the symbol \"FACT.\" As of December 14, 1995, there were approximately 875 holders of record of the Company's common stock. The following table sets forth the high and low bid quotations for the common stock as adjusted for subsequent stock dividends, along with cash dividends during each quarter for the fiscal years ended:\nSeptember 29, 1995 Quarters Ended - ------------------ -------------- Stock Price Range Dec. 31 Mar. 31 June 30 Sept. 29 - ----------------- ------- ------- ------- -------- High $7 1\/4 $7 5\/8 $8 $8 3\/4 Low $6 1\/4 $6 1\/2 $7 1\/8 $7 1\/8\nCash Dividend per Share $ .05 $ .05 $ .05 $ .05\nSeptember 30, 1994 Quarters Ended - ------------------ -------------- Stock Price Range Dec. 31 Mar. 25 June 24 Sept. 30 - ----------------- ------- ------- ------- -------- High $7 1\/2 $7 1\/2 $7 1\/2 $6 7\/8 Low $6 1\/4 $6 3\/4 $6 3\/8 $5 3\/4\nCash Dividend per Share $ .05 $ .05 $ .05 $ .05\nThe Board of Directors has from time to time authorized the Company to repurchase shares of its common stock either in the open market or otherwise. After the 5% common stock dividend declared on October 26, 1995, the total number of treasury shares was 365,739. When appropriate, the Company will consider making additional purchases.\nDuring fiscal 1995, the Company declared and paid four quarterly cash dividends totaling $.20 per share of common stock, along with declaring and issuing two 5% common stock dividends. During fiscal 1994, the Company also declared and paid four quarterly cash dividends totaling $.20 per share of common stock, along with declaring and issuing two 5% common stock dividends.\nOn October 26, 1995, subsequent to the period reflected in this report, the Board of Directors declared the regular quarterly cash dividend of $0.05 per share along with a 5% common stock dividend, both payable on November 8, 1995, to shareholders of record on November 22, 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data have been derived from the Consolidated Financial Statements of the Company.\nFirst Albany Companies Inc. FIVE YEAR FINANCIAL SUMMARY --------------------------- (In thousands of dollars except per share amounts)\nSept. 29, Sept. 30, Sept. 24, Sept. 25, Sept. 27, For the years ended 1995 1994 1993 1992 1991 - ------------------- -------- -------- -------- -------- -------- Operating Results Revenues: Commissions $ 31,889 $ 29,553 $ 28,884 $ 24,569 $ 19,445 Principal transactions 43,198 36,167 34,857 31,405 28,443 Investment banking 14,625 19,164 23,265 16,065 8,051 Fees and other 7,214 6,578 5,901 4,782 4,593 - -------------------------------------------------------------------------------- Operating revenues 96,926 91,462 92,907 76,821 60,532 Interest income 26,173 16,222 9,483 8,999 12,047 - -------------------------------------------------------------------------------- Total revenues 123,099 107,684 102,390 85,820 72,579 Interest expense 19,904 10,467 5,257 5,078 8,697 - -------------------------------------------------------------------------------- Net revenues 103,195 97,217 97,133 80,742 63,882 - --------------------------------------------------------------------------------\nExpenses Excluding Interest: Compensation and benefits 71,064 65,513 64,388 51,558 40,881 Clearing, settlement and brokerage costs 2,258 1,894 1,981 1,978 2,120 Communications and data processing 7,794 7,198 6,209 5,213 4,770 Occupancy and depreciation 6,660 5,710 5,395 5,130 5,130 Selling 4,817 4,779 4,152 3,410 2,565 Other 5,382 4,755 6,242 4,534 4,831 - -------------------------------------------------------------------------------- Total expenses excluding interest 97,975 89,849 88,367 71,823 60,297 - -------------------------------------------------------------------------------- Income before income taxes 5,220 7,368 8,766 8,919 3,585 Income tax expense 1,870 2,876 3,375 3,352 1,302 - -------------------------------------------------------------------------------- Net income $ 3,350 $ 4,492 $ 5,391 $ 5,567 $ 2,283 ================================================================================ Per Common Share: * Earnings-primary $ 0.71 $ .96 $ 1.14 $ 1.22 $ .52 Cash dividend 0.20 0.20 0.20 0.20 Book value 8.00 7.48 6.69 5.65 4.56 - --------------------------------------------------------------------------------\nFinancial Condition: Total assets $543,255 $482,749 $514,794 $203,877 $164,679 Long-term note payable 1,791 94 456 1,334 1,900 Subordinated debt 2,250 2,750 3,250 Stockholders' equity 36,192 33,230 30,088 25,272 19,989 - -------------------------------------------------------------------------------- * All per share figures have been restated for common stock dividends declared through October 26, 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nBUSINESS ENVIRONMENT\nFirst Albany Corporation (First Albany), a wholly owned subsidiary of First Albany Companies Inc. (the Company), is a full service investment banking and brokerage firm. Its primary business includes the underwriting, distribution, and trading of fixed income and equity securities. The investment banking and brokerage business earns revenues in direct correlation with the general level of trading activity in the stock and bond markets. This level of activity cannot be controlled by the Company; however, many of the Company's costs are fixed. Therefore, the Company's earnings, like those of others in the industry, reflect the activity in the markets and can fluctuate accordingly.\nThis is a highly competitive business. The competition includes not only full service national firms and discount houses, but also mutual funds that sell directly to the customer as well as banks that offer a variety of investment products.\n1995 was an unusually good year for the financial markets in general and many securities firms in particular. Long term interest rates declined sharply and the economy and profits expanded. As a result, both bond prices and stock prices rose registering returns of 17.5% and 34.8% from December 31, 1994, through November 30, 1995 for the Lehman Brothers Government\/Corporate Index and the S&P 500 Index respectively. These returns are unusual in the financial markets. The compound annual returns with all dividends and interest reinvested between 1926 and 1994 for corporate bonds was 5.5%, for government bonds 4.9%, and the return for equities 10.2%. Although First Albany remains optimistic about the outlook for equity prices in 1996, a pullback in prices could occur. If such a pullback was to occur, it would have a damaging effect on the secondary markets. Revenues from security trading, commission revenues, and underwriting fees and profits of First Albany Corporation would most likely suffer. In such an environment, it would be difficult for all securities firms to maintain growth and earnings comparable to the levels achieved in 1995.\nRESULTS OF OPERATIONS\nFiscal Year 1995 Compared with Fiscal Year 1994\nNet Income Net income for the 1995 fiscal year was $3.4 million or $0.71 per share compared to $4.5 million or $.96 per share earned in fiscal 1994. During fiscal 1995, both the Company's municipal and equity institutional businesses showed substantial growth, along with an ongoing solid contribution by the retail division. The Company continued to make investments in people and technology. These investments are critical for the firm's long-term success, but have negatively impacted short-term operating results. These investments will strengthen the Company's revenues and profitability in the future.\nCommissions\nCommission revenues increased $2.3 million or 8% in fiscal 1995, reflecting active trading in institutional equities. Revenues from listed and over-the counter stock commissions increased $4.6 or 25%, while mutual fund commission revenues decreased $2.3 million or 22%.\nPrincipal Transactions\nPrincipal transactions increased $7.0 million or 19% in fiscal 1995. This increase was comprised of an increase in equities of $2.1 million, an increase in municipal bonds of $7.8 million (primarily due to the addition in fiscal 1995 of an institutional municipal risk trading operation), a decrease in taxable fixed income securities of $2.1 million, and a decrease in investment income of $0.8 million. A primary reason for the decrease in investment income was the result of an unrealized gain of $1.4 million recorded in fiscal 1994 due to the Company's investment in a firm which completed an initial public offering in February 1994.\nInvestment Banking\nInvestment banking revenues decreased $4.5 million or 24% in fiscal 1995. Revenues from selling concessions decreased $3.4 million (equities decreased $2.4 million, while municipal bonds decreased $1.2 million and taxable fixed income increased $0.2 million), underwriting fees decreased $0.2 million, and investment banking fees decreased $0.9 million (corporate finance fees decreased $0.1 million, while municipal finance fees decreased $0.8 million). The result in investment banking revenues was largely dependent upon an industry-wide decline in underwriting activity.\nCompensation and Benefits\nCompensation and benefits increased $5.6 million or 8% in fiscal 1995. Salesrelated compensation was $0.9 million higher and salaries increased $3.8 million which impacted benefits (up $0.9 million).\nOccupancy and Depreciation\nOccupancy and depreciation expense increased $1 million or 17% in fiscal 1995 primarily as a result of our increased investment in new automated systems.\nIncome Taxes\nIncome taxes decreased $1.0 million or 35% in fiscal 1995 due to a decrease in pre-tax earnings. The Company's effective tax rate decreased to 36% from 39% as a result of an increased proportion of tax-exempt interest income to income before taxes.\nFiscal Year 1994 Compared with Fiscal Year 1993\nNet Income\nNet income for the 1994 fiscal year was $4.5 million or $.96 per share compared to $5.4 million or $1.14 per share earned in fiscal 1993. Revenues increased due to a solid contribution made by our retail brokerage business along with significant contributions by our institutional equity and corporate finance areas. However, net income decreased due to the effect of falling bond prices on fixed income sales, trading and underwritings, and because municipal bond refinancings declined significantly from last year.\nPrincipal Transactions\nPrincipal transactions increased $1.3 million or 4% in fiscal 1994. This increase was comprised of an increase in equities of $3.2 million, a decrease in taxable fixed income securities of $4.1 million, an increase in municipal bonds of $0.8 million and an unrealized gain of $1.4 million due to the Company's investment in a firm which completed an initial public offering in February 1994.\nInvestment Banking\nInvestment banking revenues decreased $4.1 million or 18% in fiscal 1994. Revenues from selling concessions decreased $0.2 million (equities increased $1.7 million, while municipal bonds decreased $1.8 million and taxable fixed income decreased $0.1 million), underwriting fees decreased $1.1 million (primarily municipal bonds), and investment banking fees decreased $2.8 million (corporate finance fees increased $1.6 million, while municipal finance fees decreased $4.4 million). The result in investment banking revenues was largely dependent upon declining municipal bond activity due to increasing interest rates and a significant decrease in municipal bond refinancings; however, these were partially offset by increasing revenues in equity corporate finance activities.\nNet Interest Income\nNet interest income increased $1.5 million or 36% in fiscal 1994 due primarily to increased revenues from customer margin balances, and increased stock borrowed and stock loaned activities.\nCompensation and Benefits\nCompensation and benefits increased $1.1 million or 2% in fiscal 1994. Salesrelated compensation decreased $1.3 million, salaries increased $1.8 million which impacted benefits (up $0.6 million).\nCommunications and Data Processing\nCommunications and data processing expense increased $1 million or 16% in fiscal 1994. Communication expense increased $0.8 million mainly as a result of the expansion of the institutional and research divisions. Data processing expense increased $0.2 million due primarily to an increased number of transactions.\nOther Expenses\nOther expenses decreased $1.5 million or 24% in fiscal 1994 due primarily to a decrease in litigation and to consulting costs.\nLIQUIDITY AND CAPITAL RESOURCES\nA substantial portion of the Company's assets, similar to other brokerage and investment banking firms, is liquid, consisting of cash and assets readily convertible into cash. These assets are financed primarily by the Company's interest-bearing and non-interest-bearing payables to customers, payables to brokers and dealers collateralized by loaned securities and bank lines-of credit. Securities borrowed and securities loaned will fluctuate due primarily to the current level of business activity in this area. Receivables from others decreased due primarily to a decrease in the adjustment to record securities owned on a trade date basis. Securities owned increased primarily due to the addition in fiscal 1995 of an institutional municipal risk trading operation. Net receivables from customers increased due to a decrease in customer free credits. Short-term bank loans increased due primarily to an increase in securities owned and an increase in net receivables from customers.\nAt fiscal year-end 1995, both First Albany Corporation and Northeast Brokerage Services Corporation, subsidiaries of First Albany Companies Inc., were in compliance with the net capital requirements of the Securities and Exchange Commission and had capital in excess of the minimum required.\nManagement believes that funds provided by operations and a variety of committed and uncommitted bank lines-of-credit_totaling $120,000,000 of which approximately $66,712,000 were unused as of September 29, 1995_will provide sufficient resources to meet present and reasonably foreseeable short-term financial needs.\nDuring fiscal 1995, the Company declared and paid four quarterly cash dividends totaling $ 0.20 per share of common stock, along with declaring and issuing two 5% common stock dividends.\nOn October 26, 1995, subsequent to the period reflected in this report, the Board of Directors declared the regular quarterly cash dividend of $ 0.05 per share along with a 5% common stock dividend, both payable on November 8, 1995, to stockholders of record on November 22, 1995.\nThe Company believes that funds provided by operations will be sufficient to fund the acquisition of office equipment and leasehold improvements, and other long-term requirements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIndex to Financial Statements and Supplementary Data\nPage REPORT OF INDEPENDENT ACCOUNTANTS 18\nFINANCIAL STATEMENTS:\nConsolidated Statements of Income, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993 19\nConsolidated Statements of Financial Condition, as of September 29, 1995, and September 30, 1994 20\nConsolidated Statements of Changes in Stockholders' Equity, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993 21\nConsolidated Statements of Cash Flows, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993 22\nNotes to Consolidated Financial Statements 23-34\nSUPPLEMENTARY DATA:\nSelected Quarterly Financial Data (Unaudited) 35\nReport of Independent Accountants\nBoard of Directors and Stockholders First Albany Companies Inc.\nWe have audited the consolidated financial statements and the financial statement schedule of First Albany Companies 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 financial position of First Albany Companies Inc. as of September 29, 1995, and September 30, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 29, 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.\nCOOPERS & LYBRAND L.L.P. Albany, New York November 10, 1995\nFirst Albany Companies Inc. CONSOLIDATED STATEMENTS OF INCOME (In thousands of dollars) ---------------------------------\nSeptember 29, September 30, September 24, For the years ended 1995 1994 1993 - ------------------- ------------- ------------- ------------- Revenues Commissions $ 31,889 $ 29,553 $ 28,884 Principal transactions 43,198 36,167 34,857 Investment banking 14,625 19,164 23,265 Interest 26,173 16,222 9,483 Fees and other 7,214 6,578 5,901 Total revenues 123,099 107,684 102,390 Interest expense 19,904 10,467 5,257 Net revenues 103,195 97,217 97,133\nExpenses excluding interest Compensation and benefits 71,064 65,513 64,388 Clearing, settlement and brokerage costs 2,258 1,894 1,981 Communications and data processing 7,794 7,198 6,209 Occupancy and depreciation 6,660 5,710 5,395 Selling 4,817 4,779 4,152 Other 5,382 4,755 6,242 Total expenses excluding interest 97,975 89,849 88,367\nIncome before income taxes 5,220 7,368 8,766 Income tax expense 1,870 2,876 3,375 Net income $ 3,350 $ 4,492 $ 5,391\nNet income per common and common equivalent share\nPrimary $ 0.71 $ .96 $ 1.14 Fully diluted $ 0.71 $ .96 $ 1.14\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.\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. Significant Accounting Policies\nOrganization and Nature of Business\nThe consolidated financial statements include the accounts of First Albany Companies Inc. and its wholly owned subsidiaries (the Company). First Albany Corporation (the Corporation) is the Company's principal subsidiary and a registered broker-dealer. All significant intercompany balances and transactions have been eliminated. The Company's year-end is the last Friday in September and, therefore, the Company's fiscal year will contain 52 or 53 week periods. The years ended September 29, 1995, September 30, 1994, and September 24, 1993, contained 52 weeks, 53 weeks, and 52 weeks, respectively.\nSecurities Transactions\nProprietary securities transactions are recorded on trade date, as if they had settled. Profit and loss arising from all securities transactions entered for the account and risk of the Company are recorded on trade date. Customers' securities transactions are reported on a settlement date basis (normally the third business day following the transaction) with related commission income and expenses reported on a trade date basis.\nAs a broker-dealer, the Corporation values marketable securities at market value and securities not readily marketable at fair value as determined by management. The resulting unrealized gains and losses are included as revenues from principal transactions. First Albany Companies Inc. also purchases securities not readily marketable for investments purposes and, as a non-broker-dealer values them at cost.\nResale and Repurchase Agreements\nTransactions involving purchases of securities under agreements to resell or sales of securities under agreements to repurchase are treated as collateralized financing transactions and are recorded at their contracted resale or repurchase amounts plus accrued interest. It is the policy of the Company to obtain possession of collateral with a market value equal to or in excess of the principal amount loaned under resale agreements. Collateral is valued daily and the Company may require counterparties to deposit additional collateral or return collateral pledged when appropriate. At September 29, 1995, and September 30, 1994, the Company had not entered into any resale or repurchase agreements with counterparties.\nSecurities-Lending Activities\nSecurities borrowed and securities loaned are recorded at the amount of cash collateral advanced or received. Securities borrowed transactions require the Company to deposit cash or other collateral with the lender. With respect to securities loaned, the Company receives collateral in the form of cash or other collateral in an amount generally in excess of the market value of securities loaned. The Company monitors the market value of securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded as necessary.\nInvestment Banking\nInvestment banking revenues include gains, losses, and fees, net of syndicate expenses, arising from securities offerings in which the Company acts as an underwriter or agent. Investment banking revenues also include fees earned from providing merger-and-acquisition and financial restructuring advisory services. Investment banking management fees are recorded on offering date, sales concessions on trade\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\ndate, and underwriting fees at the time the underwriting is completed and the income is reasonably determinable.\nIncome Taxes\nThe amount of current taxes payable is recognized as of the date of the financial statements, utilizing currently enacted tax laws and rates. Deferred income taxes are recognized for the future tax consequences attributable to differences between financial statement and tax basis of existing assets and liabilities.\nOffice Equipment and Leasehold Improvements\nOffice equipment and leasehold improvements are stated at cost less accumulated depreciation of $9,834,000 in 1995, and $7,570,000 in 1994, respectively. Depreciation is provided on a straight-line basis over the estimated useful life of the asset or the remaining life of the lease.\nStatement of Cash Flows\nFor purposes of the statement of cash flows, the Company considers amounts in demand deposit accounts at various financial institutions, other than those segregated under federal regulations, to be cash equivalents.\nEarnings per Common Share\nNet income per common and common equivalent share have been computed based upon the weighted average number of common shares and dilutive common equivalent shares (stock options) outstanding. The weighted average number of common shares and dilutive common equivalent shares were:\nFiscal Year 1995 Fiscal Year 1994 Fiscal Year 1993 ---------------- ---------------- ---------------- Primary 4,705,306 4,677,757 4,726,030 Fully diluted 4,737,101 4,677,757 4,741,455\nAll per share figures, as well as the weighted average number of common and dilutive common equivalent shares, have been restated for stock dividends declared through October 26, 1995.\nReclassifications\nCertain Amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNOTE 2. Receivables From and Payables To Brokers, Dealers, and Clearing Agencies\nAmounts receivable from and payable to brokers, dealers and clearing agencies other than correspondents, as of:\n(In thousands of dollars) September 29, September 30, 1995 1994 ------------- ------------- Securities failed to deliver $ 1,882 $ 1,511 Receivable from clearing agencies 7 Total receivables $ 1,889 $ 1,511\nSecurities failed to receive $ 3,060 $ 2,453 Payable to clearing agencies 44 2,624 Total payables $ 3,104 $ 5,077\nNOTE 3. Receivables From and Payables To Customers\nReceivables from and payables to customers include amounts due on cash and margin transactions. Securities owned by customers are held as collateral for receivables. Such collateral is not reflected in the financial statements. Total unsecured and partly secured customer receivables are $125,000 and $204,000 for the fiscal years ended 1995 and 1994, respectively. An allowance for doubtful accounts, based upon an aging of accounts receivable and specific identification, has been recorded for $125,000 and $106,000 for the fiscal years ended 1995 and 1994, respectively.\nNOTE 4. Receivables From Others\nAmounts receivable from others as of:\n(In thousands of dollars) September 29, September 30, 1995 1994 ------------- ------------- Adjustment to record securities on a trade date basis, net $ $15,040 Others 4,965 3,318 Total $ 4,965 $18,358\nFor proprietary securities transactions, amounts receivable and payable for securities transactions that have not reached their contractual settlement date are recorded net on the statement of financial condition.\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNOTE 5. Securities Owned And Sold, But Not Yet Purchased\nSecurities owned and sold, but not yet purchased consisted of the following as of:\n(In thousands of dollars) September 29, September 30, 1995 1994 ------------- ------------- Sold, but Sold, but not yet not yet Owned Purchased Owned Purchased ----- --------- ----- --------- Marketable U.S. government and federal agencies obligations $ 5,164 $ 1,045 $ 2,943 $ 1,220 State and municipal bonds 39,936 244 10,943 436 Corporate obligations 3,558 1,246 2,698 348 Corporate stocks 4,869 1,357 3,768 1,720 Options 100 Not readily marketable securities, fair value 560 636 Not readily marketable securities, cost 1,838 ------- ------- ------- ------- $56,025 $ 3,892 $20,988 $ 3,724\nSecurities not readily marketable include investment securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions, or conditions applicable to the securities or to the Company.\nNOTE 6. Bank Loans\nShort-term bank loans are made under a variety of committed and uncommitted bank lines of credit which are limited to financing securities eligible for collateralization under these arrangements. This includes Company owned securities and certain customer owned securities purchased on margin, subject to certain regulatory formulae. These loans bear interest at fluctuating rates based primarily on the Federal Funds interest rate. The weighted average interest rate on these loans were 7.54% and 5.82% at September 29, 1995, and September 30, 1994, respectively.\nShort-term bank loans and unused lines of credit were collateralized by Company owned securities of $40,391,000 and customers' margin account securities of $44,719,000 at September 29, 1995.\nA note for $1,759,912, which is collateralized by fixed assets, is payable in monthly payments of principal and interest of $65,005. Interest is at the prime rate (8.75% at September 29, 1995) plus 1.5%. The note matures April 1, 1998.\nFuture annual principal loan repayment requirements are as follows:\n(In thousands of dollars) 1996 $ 626 1997 693 1998 441 Total $1,760\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nAn unsecured note for $31,250 is payable in quarterly installments of $15,625 plus interest at the prime rate (8.75% at September 29, 1995) plus 0.5%. The note matures March 25, 1996.\nNOTE 7. Stockholders' Equity\nDuring fiscal 1995, the Company declared and paid four quarterly cash dividends totaling $0.20 per share of common stock, along with declaring and issuing two 5% common stock dividends.\nOn October 26, 1995, subsequent to the period reflected in this report, the Board of Directors declared the regular quarterly cash dividend of $0.05 per share along with a 5% common stock dividend, both payable on November 8, 1995, to shareholders of record on November 22, 1995. Stockholders' Equity and all per share figures have been adjusted to reflect the common stock dividend.\nNOTE 8. Income Taxes\nUnder the asset and liability method, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable for future years to differences between financial statement and tax basis of existing assets and liabilities. The effect of tax rate changes on deferred taxes is recognized in the income tax provision in the period that includes the enactment date.\nThe components of income taxes are:\n(In thousands of dollars) September 29, September 30, September 24, 1995 1994 1993 ------------- ------------- ------------- Federal Current $ 2,051 $ 1,463 $ 2,475 Deferred (904) 466 (165) State and local Current 1,097 755 1,146 Deferred (374) 192 (81) Total income taxes $ 1,870 $ 2,876 $ 3,375\nThe reasons for the difference between the expected income tax expense using the federal statutory rate and the income tax expense are as follows:\n(In thousands of dollars) September 29, September 30, September 24, 1995 1994 1993 ------------- ------------- ------------- Income taxes at federal statutory rate $ 1,775 $ 2,505 $ 2,984 State income taxes, net of federal income taxes 477 625 703 Tax-exempt interest income (514) (348) (357) Non-deductible expenses 132 94 45 Total income taxes $ 1,870 $ 2,876 $ 3,375\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe temporary differences that give rise to significant portions of deferred tax assets are as follows:\n(In thousands of dollars) September 29, September 30, 1995 1994 ------------- ------------- Receivables $ 80 $ 45 Securities held for investment (345) (606) Fixed assets 267 340 Deferred compensation 2,057 824 Other 145 323 Total deferred tax asset $2,204 $ 926\nThe Company has not recorded a valuation allowance for deferred tax assets as income in the carryback period is sufficient to realize the benefit of future deductions.\nNOTE 9. Employee Benefit Plans\nThe Company maintains a deferred profit sharing plan (Internal Revenue Code Section 401(k) Plan) which permits eligible employees to defer a percentage of their compensation. Company contributions to eligible participants may be made at the discretion of the Board of Directors. The Company contributed $140,000 in 1995, $56,000 in 1994, and $46,000 in 1993.\nThe Company also participates in an Employee Stock Bonus Plan (Internal Revenue Code Section 401(a)) which permits eligible employees to contribute up to 8% of their compensation on an after-tax basis. The Company makes matching contributions equal to a percentage of each employee's contributions. Company contributions vest in accordance with the Plan and are tax-deferred until withdrawal. Employee and Company contributions are invested solely in the common stock of First Albany Companies Inc. The Company contributed $408,000 in 1995, $334,000 in 1994, and $244,000 in 1993.\nNOTE 10. Incentive Plans\nIn 1982, the Company established a Stock Incentive Plan (the \"1982 Plan\") which, as amended by stockholders in 1987, authorized issuance of options to officers and key employees to purchase up to 800,000 shares of common stock. On February 27, 1989, stockholders approved adoption of the First Albany Companies Inc. 1989 Stock Incentive Plan (the \"1989 Plan\"). Coincident with the adoption of the 1989 Plan, the 1982 Plan was terminated. Options previously granted under the 1982 Plan remain valid in accordance with the terms of the grant of such options; however, the grant of new options under the 1982 Plan was ended. Both the 1982 Plan and 1989 Plan provide for incentive stock options (ISOs) which meet the requirements of Section 422A of the Internal Revenue Code of 1954, as amended, and nonqualified stock options (NSOs) which may be granted. ISOs are granted at prices not less than fair value at the date of the grant; NSOs may be issued at prices less than fair market value.\nIn addition, under the 1989 Plan, stock appreciation rights (SARs) may be granted in tandem with ISOs or NSOs. SARs may be exercised only if the related options (or portions thereof) are surrendered and at such time as the fair market value of the shares underlying the option exceeds the option price for such shares. Upon exercise of SAR and surrender of the related option, an employee will be entitled to receive an amount equal to the excess of the fair market value of one share at the time of such surrender over the option price per share specified in such option times the number of such shares called for by the option,\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nor portion thereof, which is so surrendered. Payment may be made in cash, shares of common stock, or a combination thereof. SARs may not be exercised before six months from date of grant. Both ISOs and NSOs may not have a term of more than ten years. Under certain conditions, the Company is required to purchase shares issued under this Plan at prices ranging from the original exercise or award a price to the greater of the then book or market value. If NSOs are exercised, the difference between the option price and the selling price will be recognized as an expense in the income statement.\nOption transactions for the 3-year period ended September 29, 1995 under the 1982 Plan were as follows: (all are ISOs unless otherwise noted)\nExercised Issued Or And Options Total Terminated Exercisable Issuable Authorized ---------- ----------- -------- ---------- September 25, 1992 797,000 3,000 0 800,000\nAdditional options authorized 3,950 3,950 Options expired adjustment (38,000) 38,000 Options exercised at $4.76 5,000 (5,000) September 24, 1993 764,000 39,950 0 803,950\nAdditional options authorized 3,280 3,280 Options exercised at $4.31 to $5.96 7,220 (7,220) Options forfeited (4,410) 4,410 Options terminated 4,410 (4,410) September 30, 1994 775,630 31,600 0 807,230\nAdditional options authorized 2,908 2,908 Options exercised at $4.70 to $5.00 11,605 (11,605) September 29, 1995 787,235 22,903 0 810,138\nIssued and exercisable options are outstanding at $3.91 - $5.41 per share.\nDuring fiscal year 1995, the Company declared two 5% common stock dividends. These dividends resulted in an additional 2,908 options authorized.\nIssued and exercisable options are outstanding at $4.23 - $8.23 per share\nDuring fiscal year 1995, the Company declared two 5% common stock dividends. These dividends resulted in an additional 100,057 options authorized.\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn 1992, the Company established the First Albany Companies Inc. Restricted Stock Plan which authorized the issuance of up to 331,509 shares of common stock (adjusted for all stock dividends) to certain key employees of the Company. Awards under this plan expire over a four-year period after the award date and are subject to certain restrictions including continued employment. As of September 29, 1995, 36,880 shares have been awarded under this plan. The fair market value of the awards will be amortized over the period in which the restrictions are outstanding.\nThe Company has various other incentive programs which are offered to eligible employees. These programs consist of cash incentives and deferred bonuses. Amounts awarded vest over periods ranging from three to five years. Costs are amortized over the vesting period and aggregated $1,343,000 in 1995, $1,828,000 in 1994, and $369,000 in 1993.\nNOTE 11. Commitments and Contingencies\nThe Company's main and sales offices, and certain office and communication equipment are leased under noncancellable operating leases, which expire at various times through 2003. Future minimum annual rentals payable are as follows:\n(In thousands of dollars)\n1996 $ 2,963 1997 2,379 1998 2,110 1999 1,720 2000 1,014 Thereafter 1,331 Total $11,517\nAnnual rental expense including utilities for 1995, 1994, and 1993 approximated $3,630,000, $3,955,000, and $3,932,000, respectively.\nIn the normal course of business, the Company has been named a defendant, or otherwise has possible exposure, in several claims. Certain of these are class actions which seek unspecified damages which could be substantial. Although there can be no assurance as to the eventual outcome of litigation in which the Company has been named as a defendant or otherwise has possible exposure, the Company has provided for those actions most likely to result in adverse dispositions. Although further losses are possible, the opinion of management, based upon the advice of its attorneys and general counsel, is that such litigation will not, in the aggregate, have a material adverse effect on the Company's liquidity or financial position, although it could have a material effect on quarterly or annual operating results in the period in which it is resolved.\nThe Company is contingently liable under bank stand-by letter of credit agreements, executed in connection with security clearing activities, totaling $3,710,000 at September 29, 1995.\nNOTE 12. Net Capital Requirements\nThe Corporation is subject to the SEC's Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. The Corporation has elected to use the alternative method, permitted\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nby the Rule, which requires that the Corporation maintain a minimum net capital equal to 2 percent of aggregate debit balances arising from customer transactions, as defined. At September 29, 1995, the Corporation had net capital of $17,178,000 which was 18% of aggregate debit balances and $15,303,000 in excess of required minimum net capital.\nNOTE 13. Financial Instruments with Off-Balance-Sheet Risk\nIn the normal course of business, the Company's customer and correspondent clearance activities involve the execution, settlement, and financing of various customer securities transactions. These activities may expose the Company to off-balance-sheet risk in the event the customer or other broker is unable to fulfill its contracted obligations and the Company has to purchase or sell the financial instrument underlying the contract at a loss.\nThe Company's customer securities activities are transacted on either a cash or margin basis. In margin transactions, the Company extends credit to its customers, subject to various regulatory and internal margin requirements, collateralized by cash and securities in the customers' accounts. In connection with these activities, the Company executes and clears customer transactions involving the sale of securities not yet purchased, substantially all of which are transacted on a margin basis subject to individual exchange regulations. Such transactions may expose the Company to significant off- balance-sheet risk in the event margin requirements are not sufficient to fully cover losses that customers may incur. In the event the customer fails to satisfy its obligations, the Company may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customer's obligations.\nThe Company seeks to control the risks associated with its customer activities by requiring customers to maintain margin collateral in compliance with various regulatory and internal guidelines. The Company monitors required margin levels daily and, pursuant to such guidelines, requires the customer to deposit additional collateral, or to reduce positions, when necessary.\nThe Company's customer financing and securities settlement activities require the Company to pledge customer securities as collateral in support of various secured financing sources such as bank loans and securities loaned. In the event the counterparty is unable to meet its contractual obligation to return customer securities pledged as collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations.\nThe Company controls this risk by monitoring the market value of securities pledged on a daily basis and by requiring adjustments of collateral levels in the event of excess market exposure. In addition, the Company establishes credit limits for such activities and monitors compliance on a daily basis.\nIn addition, the Company has sold securities that it does not currently own and therefore will be obligated to purchase such securities at a future date. The Company has recorded these obligations in the financial statement at the September 29, 1995 market values of the related securities and will incur a loss if the market value of the securities increases subsequent to September 29, 1995.\nThe Company acts as a manager and co-manager in underwriting security transactions. In this capacity, there is risk if the potential customer does not fulfill the obligation to purchase the securities. The Company controls this risk by dealing primarily with institutional investors. In most cases, no one institutional customer subscribes to the majority of the securities being sold, thereby spreading the risk for this type of loss among many established customers. The Company also maintains credit limits for these activities and monitors compliance with applicable limits and industry regulations on a daily basis.\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNOTE 14. Concentrations of Credit Risk\nThe Company is engaged in various trading and brokerage activities whose counterparties primarily include broker-dealers, banks, and other financial institutions. In the event counterparties do not fulfill their obligations, the Company may be exposed to risk. The risk of default depends on the credit worthiness of the counterparty or issuer of the instrument. The Company seeks to control credit risk by following an established credit approval process, monitoring credit limits, and by requiring collateral where appropriate.\nThe Company purchases debt securities and may have significant positions in its inventory subject to market and credit risk. In order to control these risks, security positions are monitored on at least a daily basis. Should the Company find it necessary to sell such a security, it may not be able to realize the full carrying value of the security due to the significance of the position sold. The Company reduces its exposure to changes in securities valuation with the use of municipal bond index futures contracts. (See Note 16.) If a single security position held in inventory represents a significant portion of net capital, referred to as \"undue concentration\" as defined by SEC Rule 15c3-1, the Company may not be able to realize the full carrying value of the security if the entire position was required to be sold. The total value of securities held in inventory at September 29, 1995, which met this criterion was $8,659,000. At September 30, 1994, the Company had no securities in inventory which met this criterion.\nNOTE 15. Market Value of Financial Instruments\nThe financial instruments of the Company are reported on the Statement of Financial Condition at market or fair value or at carrying amounts that approximate fair value with the exception of First Albany Companies Inc.'s securities not readily marketable, which are recorded at cost. In December 1995, the value of such securities, as a result of an initial public offering was $5,400,000. The fair value of other financial assets and liabilities (consisting primarily of receivable from and payable to brokers dealers, clearing agencies, customers, securities borrowed and loaned, and bank loans payable) are considered to approximate the carrying value due to the short-term nature of the financial instruments.\nThe Company also enters into transactions in financial instruments that are not recognized in the Statement of Financial Condition. The notional amounts of the open transactions at September 29, 1995, are disclosed in Note 16.\nNOTE 16. Derivative Financial Instruments\nThe Company does not engage in the proprietary trading of derivative securities with the exception of highly liquid index future contracts and options. These index future contracts and options are used to hedge securities positions in the Company's inventory. Gains and losses on these financial instruments are included as revenues from principal transactions. Trading profits and losses relating to these financial instruments were as follows:\n(In thousands of dollars)\nTrading Profits-State and Municipal Bonds $ 5,068 Index Futures Hedging Losses (1,350) Trading Profits-Corporate Stocks 1,159 Options (206) Net Trading Revenues $ 4,671\nFirst Albany Companies Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nAs of September 29, 1995, the contractual or notional amounts related to these financial instruments were as follows:\n(In thousands of dollars) Average Notional or Year End Notional or Contract Market Value Contract Market Value --------------------- --------------------- Index Futures Contracts $(5,819) $(20,773) Options 121 100\nThe contractual or notional amounts related to these financial instruments reflect the volume and activity and do not reflect the amounts at risk. The amounts at risk are generally limited to the unrealized market valuation gains on the instruments and will vary based on changes in market value. Futures contracts are executed on an exchange and cash settlement is made on a daily basis for market movements. The settlement of the aforementioned transactions is not expected to have a material adverse effect on the financial condition of the Company.\nThe market or fair value of the options are recorded in securities owned while the open equity in the future contracts are recorded as receivables from clearing organizations.\nAll per share figures have been restated for common stock dividends declared through October 1995. The sum of the quarters' earnings per share amount does not always equal the full fiscal year's amount due to the effect of averaging the number of shares of common stock and common stock equivalents throughout the year.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nThere has been no Form 8-K filed within 24 months prior to the date of the most recent consolidated financial statements reporting a change of accountants and\/or reporting disagreements on any matter of accounting principle or financial statement disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nExcept as set forth below, the information required by this item will be contained under the caption \"Election of Directors\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on or about April 2, 1996. Such information is incorporated herein by reference to the proxy statement.\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:\nEdwin T. Brondo, age 48, Senior Vice President and Chief Administrative Officer, joined First Albany Corporation in 1993 and was elected Vice President of First Albany Companies Inc. in 1994. He previously held senior management positions at Bankers Trust, Goldman Sachs, and Morgan Stanley.\nDavid J. Cunningham, age 49, Senior Vice President and Chief Financial Officer, joined First Albany Corporation in 1975 and has served as Chief Financial Officer of First Albany Corporation since 1980 and First Albany Companies Inc. since fiscal 1986.\nMichael R. Lindburg, age 46, Senior Vice President, Secretary, and General Counsel, joined First Albany Corporation in 1986 and has served as Vice President, Secretary, and General Counsel of First Albany Companies Inc. since 1986. He previously served as Vice President and General Counsel of the Boston Stock Exchange.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this item will be contained under the caption \"Compensation of Executive Officers and Directors\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on or about April 2, l996. 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 will be contained under the caption \"Stock Ownership of Principal Owners and Management\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on or about April 2, 1996. 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 will be contained under the caption \"Certain Transactions\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on or about April 2, 1996. 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) (1) The following financial statements are included in Part II, Item 8:\nReport of Independent Accountants\nFinancial Statements:\nConsolidated Statements of Income, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993.\nConsolidated Statements of Financial Condition, as of September 29, 1995, and September 30, 1994.\nConsolidated Statements of Changes in Stockholders' Equity, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993.\nConsolidated Statements of Cash Flows, For the Years Ended September 29, 1995, September 30, 1994, and September 24, 1993.\nNotes to Consolidated Financial Statements\n(2) The following financial statement schedule for the years 1995, 1994, and 1993 are submitted herewith:\nSchedule 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.\n(3) Exhibits included herein:\nExhibit Number Description 3.1 Certificate of Incorporation of First Albany Companies Inc. (filed as Exhibit No. 3.1 to Registration Statement No. 33-1353).\n3.2 By-laws of First Albany Companies Inc. (filed as Exhibit No. 3.2 to Registration Statement No.33-1353).\n3.2a By-laws of First Albany Companies Inc., as amended (as filed as Exhibit No. 3.2a to Form 10-K for the fiscal year ended September 24, 1993).\n4 Specimen Certificate of Common Stock, par value $.01 per share (filed as Exhibit No. 4 to Registration Statement No. 33-1353).\n10.2 Lease dated February 9, 1978, between MacFarland Construction Company Inc. and First Albany Corporation for office facilities at 41 State Street, Albany, New York (filed as Exhibit No. 10.2 to Registration Statement No. 33-1353).\n10.6 Deferred Profit Sharing Plan of First Albany Corporation effective October 1, 1982, as amended by shareholder vote, dated January 19, 1987 (filed as Exhibit 10.6 to Form 10-K for the fiscal year ended September 30, 1986).\n10.7 Incentive Stock Option Plan of First Albany Corporation effective October 1, 1982, as amended by shareholder vote, dated January 19, 1987 (filed as Exhibit 10.7 to Form 10-K for the fiscal year ended September 30, 1987).\n10.10 First Albany Companies Inc. Stock Bonus Plan effective July 8, 1987 (filed as Registration Statement No. 33-15220 (Form B) dated July 8, 1987).\n10.10a First Albany Companies Inc. Stock Bonus Plan, as amended, effective June 25, 1990 (filed as Registration Statement No. 33-35166 (Form S-8) dated June 25, 1990).\n10.10b First Albany Companies Inc. Stock Bonus Plan, as amended, effective February 4, 1994 (filed as Registration Statement 33-52153 (Form S-8) dated February 4, 1994).\n10.10c First Albany Companies Inc. Stock Bonus Plan, as amended, effective June 2, 1995 (filed as Registration Statement 33-59855 (Form S-8) dated June 2, 1995).\n10.12 First Albany Companies Inc. 1989 Stock Incentive Plan effective February 27, 1989, as approved by shareholder vote, dated February 27, 1989 (filed as Exhibit 10.12 to Form 10-K for the fiscal year ended September 30, 1989).\n10.15 Lease dated June 12, 1992, between First Albany Companies Inc. and Olympia and York Limited Partnership for office space at 53 State Street, Boston, Massachusetts (filed as Exhibit 10.15 to Form 10-K for the fiscal year ended September 25, 1992).\n10.16 The First Albany Companies Inc. Restricted Stock Plan as adopted by the Company on April 27, 1992 (filed as Exhibit 10.16 to Form 10-K for the fiscal year ended September 25, 1992).\n10.17 Term Loan Agreement dated March 29, 1995 between First Albany Companies Inc. and The Hudson City Savings Institution.\n(3) Exhibits included herein: (continued)\nExhibit Number Description\n10.18 Sublease dated October 13, 1995 between First Albany Companies Inc. and Keycorp for office facilities at 30 South Pearl Street, Albany, New York.\n11 Computation of per share earnings\n22 List of Subsidiaries of First Albany Companies Inc.\n24 Consent of experts\n(b) Reports on Form 8-K: No reports on Form 8-K have been filed by the Registrant during the last quarter of the period covered by this report.\n27 Financial Data Schedule BD\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 ALBANY COMPANIES INC.\nBy: \/s\/ George C. McNamee ----------------------- George C. McNamee, Chairman of the Board\nDate: December 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 in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ George C. McNamee Chairman of the Board December 19, 1995 - ------------------------- George C. McNamee\n\/s\/ Alan P. Goldberg President and Director December 19, 1995 - ------------------------- Alan P. Goldberg\n\/s\/ J. Anthony Boeckh Director December 19, 1995 - ------------------------- J. Anthony Boeckh\n\/s\/ Hon. Hugh L. Carey Director December 19, 1995 - ------------------------- Hon. Hugh L. Carey\n\/s\/ Edwin T. Brondo Vice President December 19, 1995 - ------------------------- Edwin T. Brondo\n\/s\/ David J. Cunningham Vice President and December 19, 1995 - ------------------------- Chief Financial Officer David J. Cunningham (Principal Accounting Officer)\n\/s\/ Hugh A. Johnson, Jr. Senior Vice President December 19, 1995 - ------------------------- and Director Hugh A. Johnson Jr.\n\/s\/ Michael R. Lindburg Vice President December 19, 1995 - ------------------------- General Counsel Michael R. Lindburg\n\/s\/ Daniel V. McNamee Director December 19, 1995 - ------------------------- Daniel V. McNamee\n\/s\/ Charles L. Schwager Director December 19, 1995 - ------------------------- Charles L. Schwager\nDirector December 19, 1995 - ------------------------- Benaree P. Wiley","section_15":""}
{"filename":"893958_1995.txt","cik":"893958","year":"1995","section_1":"ITEM 1. BUSINESS\nEach Capital Auto Receivables Asset Trust, (each a \"Trust\") was formed pursuant to a Trust Agreement, between Capital Auto Receivables, Inc. (the \"Seller\") and Bankers Trust (Delaware), as Owner Trustee of the related Trust. The Trusts have issued Asset-Backed Notes (the \"Notes\"). The Notes are issued and secured pursuant to Indentures, between the related Trust and The First National Bank of Chicago as Indenture Trustee. Each Trust has also issued Asset-Backed Certificates.\nCAPITAL AUTO RECEIVABLES ASSET TRUSTS ------------------------------------- CAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\n---------------------------\nPART II\nITEM 7.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEach of the Trusts was formed pursuant to a trust agreement between Capital Auto Receivables, Inc. (the \"Seller\") and Bankers Trust (Delaware), as Owner Trustee, and issued the following Asset-Backed Notes and Certificates. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for Asset-Backed Notes and Asset-Backed Certificates representing undivided interests in each of the Trusts. Each Trust's property includes a pool of retail instalment sale contracts for new and used automobiles and light trucks, certain monies due thereunder, security interests in the vehicles financed thereby and certain other property.\nRetail Finance Date of Sale Receivables and Servicing Aggregate Asset-Backed Asset-Backed Trust Agreement Amount Notes Certificates - ---------- ----------------- --------- ---------------- ------------ (millions) (millions) (millions) Capital December 17, 1992 $1,607.1 Class A-1 $ 657.7 $ 56.2 Auto Class A-2 641.6 Receivables Class A-3 251.6 Asset Trust 1992-1\nCapital February 11, 1993 $2,912.9 Class A-1 $ 322.0 $ 101.9 Auto Class A-2 225.0 Receivables Class A-3 125.0 Asset Trust Class A-4 478.0 1993-1 Class A-5 1,147.0 Class A-6 318.0 Class A-7 196.0\nCapital June 2, 1993 $2,009.3 Class A-1 $ 750.0 $ 58.6 Auto Class A-2 100.0 Receivables Class A-3 641.0 Asset Trust Class A-4 403.0 1993-2\nCapital October 21, 1993 $2,504.9 Class A-1 $ 430.0 $ 81.4 Auto Class A-2 59.0 Receivables Class A-3 63.0 Asset Trust Class A-4 210.0 1993-3 Class A-5 484.3 Class A-6 1,177.2 (Private Placement)\nGeneral Motors Acceptance Corporation (GMAC), the originator of the retail receivables, continues to service the receivables for the aforementioned Trusts and receives compensation and fees for such services. Investors receive periodic payments of principal and interest for each class of notes and certificates as the receivables are liquidated.\n--------------------\nII-1\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page - ----------- ---------------------------------------------------- ------\n-- Capital Auto Receivables Asset Trust 1992-1, Independent Auditors' Report, Financial Statements II-3 and Selected Quarterly Data for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-1, Independent Auditors' Report, Financial Statements II-9 and Selected Quarterly Data for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-2, Independent Auditors' Report, Financial Statements II-16 and Selected Quarterly Data for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-3, Independent Auditors' Report, Financial Statements II-22 and Selected Quarterly Data for the Year Ended December 31, 1995.\n27.1 Financial Data Schedule for Capital Auto Receivables Asset Trusts 1992-1, 1993-1, 1993-2 and 1993-3 (for -- SEC electronic filing purposes only).\n---------------------\nII-2\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Capital Auto Receivables Asset Trust 1992-1, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1992-1 as of December 31, 1995 and 1994, and the related Statement of Distributable Income 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 the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1992-1 at December 31, 1995 and 1994, and its distributable income and distributions for each of the three years in the period ended 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-3\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 1994 ------- ------- (in millions of dollars) ASSETS\nReceivables (Note 2) ................... $ 66.8 $ 252.5 ------- -------\nTOTAL ASSETS ........................... $ 66.8 $ 252.5 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... $ 41.4 $ 220.6\nAsset-Backed Certificates (Equity) ..... 25.4 31.9 ------- -------\nTOTAL LIABILITIES AND EQUITY............ $ 66.8 $ 252.5 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-4\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995 1994 1993 ------ ------ ------ (in millions of dollars) Distributable Income\nAllocable to Principal ............... $ 185.7 $ 506.8 $ 847.8\nAllocable to Interest ............... 9.5 27.1 53.3 ------- ------- ------- Distributable Income ................... $ 195.2 $ 533.9 $ 901.1 ======= ======= =======\nIncome Distributed ..................... $ 195.2 $ 533.9 $ 901.1 ======= ======= =======\nReference should be made to the Notes to Financial Statements.\nII-5\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1992-1 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn December 17, 1992, Capital Auto Receivables Asset Trust 1992-1 acquired retail finance receivables aggregating approximately $1,607.1 million from the Seller in exchange for three classes of Asset-Backed Notes representing indebtedness of the Trust of $657.7 million Class A-1, $641.6 million Class A-2 and $251.6 million Class A-3, and $56.2 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed. On January 16, 1996, GMAC exercised this option and repurchased the remaining receivables in GMAC 1992-1 Capital Auto Receivables Asset Trust as of February 15, 1996.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of March, June, September and December or, if any such day is not a Business Day, on the next succeeding Business Day, commencing March 15, 1993 (each, a \"Payment Date\"). Principal of the Notes will be payable on each Payment Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for each of the three Monthly Periods preceding such Payment Date, to the extent of funds available therefor. Payments of principal on the Notes are made (i) on the Class A-1 Notes until they are paid in full, (ii) then on the Class A-2 Notes until they are paid in full and (iii) then on the Class A-3 Notes until they are paid in full. The principal balance of the Class A-1 Notes was paid in full on September 15, 1993, the principal balance of the Class A-2 Notes was paid in full on December 15, 1994 and the then-unpaid principal balance of the Class A-3 Notes will be payable on February 15, 1996. The final Distribution Date for the Certificates will be February 15, 1996.\nOn each Distribution Date on and after the date on which the Class A-1 Notes have been paid in full, Certificateholders will receive, in respect of the certificate balance, an amount equal to the Certficateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor.\nII-6\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nInterest on the outstanding principal amount of the Notes accrues from December 15, 1992 (in the case of the Class A-2 Notes, December 17, 1992) or, from the most recent Payment Date on which interest has been paid to but excluding the following Payment Date. During 1993, the Class A-1 Notes received interest at the rate of 3.73 percent per annum.\nThe Class A-2 Notes received a floating rate of interest from December 17, 1992 through December 14, 1994 at a weighted average rate of 3.7394 percent.\nThe Class A-3 Notes will bear interest at the rate of 5.75 percent per annum. On each Distribution Date, the Owner Trustee will distribute pro rata to Certificateholders accrued interest at the pass through rate of 6.20 percent per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nNOTE 5. SUBSEQUENT EVENT\nEffective February 23, 1996, the Board of Directors of GMAC Auto Receivables Corporation approved the merger of and authorized the execution of an Agreement and Plan of Merger by and between Capital Auto Receivables, Inc. and GMAC Auto Receivables Corporation. The separate corporate existence of GMAC Auto Receivables Corporation shall cease and Capital Auto Receivables, Inc. shall continue as the surviving corporation.\n--------------------------\nII-7\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 68.1 $ 3.7 $ 71.8\nSecond quarter ..................... 53.3 2.7 56.0\nThird quarter ...................... 38.9 1.8 40.7\nFourth quarter ..................... 25.4 1.3 26.7 --------- -------- --------- Total ......................... $ 185.7 $ 9.5 $ 195.2 ========= ======== =========\n1994 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 160.9 $ 8.5 $ 169.4\nSecond quarter ..................... 140.9 7.5 148.4\nThird quarter ...................... 113.3 6.2 119.5\nFourth quarter ..................... 91.7 4.9 96.6 --------- -------- --------- Total ......................... $ 506.8 $ 27.1 $ 533.9 ========= ======== =========\n1993 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 225.4 $ 16.7 $ 242.1\nSecond quarter ..................... 226.9 14.3 241.2\nThird quarter ...................... 210.0 12.3 222.3\nFourth quarter ..................... 185.5 10.0 195.5 --------- -------- --------- Total ......................... $ 847.8 $ 53.3 $ 901.1 ========= ======== =========\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Capital Auto Receivables Asset Trust 1993-1, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-1 as of December 31, 1995 and 1994, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1995 and the period February 11, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-1 at December 31, 1995 and 1994, and its distributable income and distributions for each of the two years in the period ended December 31, 1995 and the period February 11, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP - ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 1994 ------- ------- (in millions of dollars) ASSETS\nReceivables (Note 2) ................... $ 233.5 $ 711.1 ------- -------\nTOTAL ASSETS ........................... $ 233.5 $ 711.1 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... $ 186.0 $ 647.9\nAsset-Backed Certificates (Equity) ..... 47.5 63.2 ------- -------\nTOTAL LIABILITIES AND EQUITY............ $ 233.5 $ 711.1 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-10\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995 1994 1993* ------ ------ ------ (in millions of dollars) Distributable Income\nAllocable to Principal ............... $ 477.6 $ 949.7 $1,252.1\nAllocable to Interest ............... 26.4 58.5 72.5 ------- -------- -------- Distributable Income ................... $ 504.0 $1,008.2 $1,324.6 ======= ======== ========\nIncome Distributed ..................... $ 504.0 $1,008.2 $1,324.6 ======= ======== ========\n* Represents the period February 11, 1993 (inception) through December 31, 1993.\nReference should be made to the Notes to Financial Statements.\nII-11 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-1 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn February 11, 1993, Capital Auto Receivables Asset Trust 1993-1 acquired retail finance receivables aggregating approximately $2,912.9 million from the Seller in exchange for seven classes of Asset-Backed Notes representing indebtedness of the Trust of $322.0 million Class A-1; $225.0 million Class A-2; $125.0 million Class A-3; $478.0 million Class A-4; $1,147.0 million Class A-5; $318.0 million Class A-6; $196.0 million Class A-7 and $101.9 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby, an interest rate cap and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed. On February 15, 1996, GMAC exercised this option and repurchased the remaining receivables in GMAC 1993-1 Capital Auto Receivables Asset Trust as of March 15, 1996.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of February, May, August and November or, if any such day is not a Business Day, on the next succeeding Business Day, commencing May 17, 1993 (each, a \"Payment Date\"). Principal of the Notes will be payable on each Payment Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for each of the three Monthly Periods preceding such Payment Date, to the extent of funds available therefor. Payments of principal on the Notes are payable by class in the priorities set forth in the Indenture (previously filed by Form 8-K).\nThe principal balance of the Class A-1 Notes was paid in full on May 17, 1993; the principal balance of the Class A-2 Notes was paid in full on August 16, 1993; the principal balances of the Class A-3 and Class A-4 Notes were paid in full on November 15, 1993; the principal balance of the Class A-5 Notes was paid in full on February 15, 1995; and the principal balance of the Class A-6 Notes was paid in full on November 15, 1995. The principal balance of the Class A-7 Notes will be payable on February 17, 1998. Payment of principal to the Certificateholders in respect of the Certificate Balance was initiated in 1993, subsequent to the full payment of the Class A-1, Class A-2, Class A-3, and Class A-4 Notes. On each Distribution Date, the Certificateholders receive an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period II-12\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\npreceding such Distribution Date, to the extent of funds available therefor. The final Distribution Date for the Certificates will be March 15, 1996.\nInterest on the outstanding principal amount of the Notes accrues from February 11, 1993 or, from the most recent Payment Date on which interest has been paid to but excluding the following Payment Date. The Class A-1 Notes received interest at the rate of 3.1875 percent per annum. The Class A-2 Notes received interest at the rate of 3.3125 percent per annum. The Class A-3 Notes received interest at the rate of 3.4375 percent per annum. The Class A-4 Notes received a floating rate of interest from February 11, 1993 through November 14, 1993 at a weighted average rate of 3.2657 percent. The Class A-5 Notes receive a floating rate of interest from February 11, 1993 through February 15, 1995 at a weighted average rate of 3.7553 percent. The Class A-6 Notes received interest at the rate of 4.90 percent per annum.\nThe Class A-7 Notes bear interest at the rate of 5.35 percent per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 5.85 percent per annum on the outstanding Certificate Balance.\nNOTE 4. DERIVATIVE FINANCIAL INSTRUMENT AND RISK MANAGEMENT\nThe Trust was a party to an interest rate cap, which matured in February 1995. The interest rate cap required payments to the Trust from the counterparty in the event the three-month London Interbank Offering Rate (LIBOR) exceeded 10%. These payments would have offset increased interest expense on the Asset-Backed Notes. No payments were received in connection with the derivative in 1995 or 1994.\nCredit Risk of the instrument was limited to payments due from the counterparty and was mitigated through the use of a financially sound counterparty. If the counterparty had defaulted, the cost, if the position was replaced at market rates in effect at December 31, 1994, would have been $5,000. Market risk of the derivative was inherently limited, since market variations offset the under- lying Asset-Backed Notes.\nThe notional amount of the interest rate cap approximated the outstanding balance in the Class A-5 Notes and was $133.8 million at December 31, 1994.\nNOTE 5. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nII-13\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nNOTES TO FINANCIAL STATEMENTS\nNOTE 6. SUBSEQUENT EVENT\nEffective February 23, 1996, the Board of Directors of GMAC Auto Receivables Corporation approved the merger of and authorized the execution of an Agreement and Plan of Merger by and between Capital Auto Receivables, Inc., and GMAC Auto Receivables Corporation. The separate corporate existence of GMAC Auto Receivables Corporation shall cease and Capital Auto Receivables, Inc. shall continue as the surviving corporation.\n_________________\nII-14\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 153.3 $ 9.4 $ 162.7\nSecond quarter ..................... 129.6 7.2 136.8\nThird quarter ...................... 109.7 5.6 115.3\nFourth quarter ..................... 85.0 4.2 89.2 --------- -------- --------- Total ......................... $ 477.6 $ 26.4 $ 504.0 ========= ======== =========\n1994 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 287.0 $ 17.7 $ 304.7\nSecond quarter ..................... 253.3 14.9 268.2\nThird quarter ...................... 217.2 14.3 231.5\nFourth quarter ..................... 192.2 11.6 203.8 --------- -------- --------- Total ......................... $ 949.7 $ 58.5 $ 1,008.2 ========= ======== =========\n1993 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 0.0 $ 1.0 $ 1.0\nSecond quarter ..................... 523.8 28.8 552.6\nThird quarter ...................... 391.3 22.9 414.2\nFourth quarter ..................... 337.0 19.8 356.8 --------- -------- --------- Total ......................... $ 1,252.1 $ 72.5 $ 1,324.6 ========= ======== =========\nII-15\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Capital Auto Receivables Asset Trust 1993-2, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-2 as of December 31, 1995 and 1994, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1995 and the period June 2, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-2 at December 31, 1995 and 1994, and its distributable income and distributions for each of the two years in the period ended December 31, 1995 and the period June 2, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP - ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-16\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 1994 ------- ------- (in millions of dollars) ASSETS\nReceivables (Note 2) ................... $ 140.8 $ 662.0 ------- -------\nTOTAL ASSETS ........................... $ 140.8 $ 662.0 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... $ 112.1 $ 617.7\nAsset-Backed Certificates (Equity) ..... 28.7 44.3 ------- -------\nTOTAL LIABILITIES AND EQUITY............ $ 140.8 $ 662.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-17\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995 1994 1993* ------ ------ ------ (in millions of dollars) Distributable Income\nAllocable to Principal ............... $ 521.2 $ 761.2 $ 529.4\nAllocable to Interest ............... 18.8 46.0 37.4 ------- -------- -------- Distributable Income ................... $ 540.0 $ 807.2 $ 566.8 ======= ======== ========\nIncome Distributed ..................... $ 540.0 $ 807.2 $ 566.8 ======= ======== ========\n* Represents the period June 2, 1993 (inception) through December 31, 1993.\nReference should be made to the Notes to Financial Statements.\nII-18\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-2 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn June 2, 1993, Capital Auto Receivables Asset Trust 1993-2 acquired retail finance receivables aggregating approximately $2,009.3 million at a discount of $56.7 million from the Seller in exchange for four classes of Asset-Backed Notes representing indebtedness of the Trust of $750.0 million Class A-1, $100.0 million Class A-2, $641.0 million Class A-3, $403.0 million Class A-4, and $58.6 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. Substantially all of the Receivables comprising the Trust property were acquired by GMAC under special incentive rate financing programs. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of each month or, if any such day is not a Business Day, on the next succeeding Business Day, commencing June 15, 1993 (each, a \"Distribution Date\"). Principal of the Notes is payable on each Distribution Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for the related Monthly Period to the extent of funds available therefor. Payments of principal on the Notes are payable by class in the priorities set forth in the Indenture (previously filed by Form 8-K). The principal balance of the Class A-1 Notes was paid in full on April 15, 1994; the principal balance of the Class A-2 Notes was paid in full on May 16, 1994; the principal balance of the Class A-3 Notes was paid in full on May 15, 1995; and the then-unpaid principal balance of the Class A-4 Notes will be payable on May 15, 1997.\nII-19\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nPayment of principal to the Certificateholders in respect of the Certificate Balance was initiated in 1994, subsequent to the full payment of the Class A-1 and Class A-2 Notes. On each Distribution Date, the Certificateholders receive an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor. The final scheduled Distribution Date for the Certificates is May 15, 1997.\nInterest on the outstanding principal amount of the Notes accrues from June 2, 1993 or, from the most recent Distribution Date on which interest has been paid to but excluding the following Distribution Date.\nThe Class A-1 Notes received interest at the rate of 3.35 percent per annum. The Class A-2 Notes received interest at the rate of 3.71 percent per annum. The Class A-3 Notes received interest at the rate of 4.20 percent per annum.\nThe Class A-4 Notes bear interest at the rate of 4.70 percent per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 4.70 percent per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a partnership, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, has agreed to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nNOTE 5. SUBSEQUENT EVENT\nEffective February 23, 1996, the Board of Directors of GMAC Auto Receivables Corporation approved the merger of and authorized the execution of an Agreement and Plan of Merger by and between Capital Auto Receivables, Inc. and GMAC Auto Receivables Corporation. The separate corporate existence of GMAC Auto Receivables Corporation shall cease and Capital Auto Receivables, Inc. shall continue as the surviving corporation.\n--------------------------\nII-20\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 147.8 $ 7.0 $ 154.8\nSecond quarter ..................... 139.3 5.4 144.7\nThird quarter ...................... 125.7 3.9 129.6\nFourth quarter ..................... 108.4 2.5 110.9 --------- -------- --------- Total ......................... $ 521.2 $ 18.8 $ 540.0 ========= ======== =========\n1994 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 213.8 $ 14.4 $ 228.2\nSecond quarter ..................... 200.5 12.5 213.0\nThird quarter ...................... 182.5 10.5 193.0\nFourth quarter ..................... 164.4 8.6 173.0 --------- -------- --------- Total ......................... $ 761.2 $ 46.0 $ 807.2 ========= ======== =========\n1993 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nSecond quarter ..................... $ 77.5 $ 2.9 $ 80.4\nThird quarter ...................... 227.0 18.3 245.3\nFourth quarter ..................... 224.9 16.2 241.1 --------- -------- --------- Total ......................... $ 529.4 $ 37.4 $ 566.8 ========= ======== =========\nII-21\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Capital Auto Receivables Asset Trust 1993-3, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-3 as of December 31, 1995 and 1994, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1995 and the period October 21, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-3 at December 31, 1995 and 1994, and its distributable income and distributions for each of the two years in the period ended December 31, 1995 and the period October 21, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP - ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-22\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 1994 ------- ------- (in millions of dollars) ASSETS\nReceivables (Note 2) ................... $ 705.2 $1,278.7 ------- --------\nTOTAL ASSETS ........................... $ 705.2 $1,278.7 ======= ========\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... $ 660.3 $1,212.4\nAsset-Backed Certificates (Equity) ..... 44.9 66.3 ------- --------\nTOTAL LIABILITIES AND EQUITY............ $ 705.2 $1,278.7 ======= ========\nReference should be made to the Notes to Financial Statements.\nII-23\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995 1994 1993* ------ ------ ------ (in millions of dollars) Distributable Income\nAllocable to Principal ............... $ 573.5 $1,160.0 $ 66.2\nAllocable to Interest ............... 49.9 78.5 5.4 ------- -------- -------- Distributable Income ................... $ 623.4 $1,238.5 $ 71.6 ======= ======== ========\nIncome Distributed ..................... $ 623.4 $1,238.5 $ 71.6 ======= ======== ========\n* Represents the period October 21, 1993 (inception) through December 31, 1993.\nReference should be made to the Notes to Financial Statements.\nII-24\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-3 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn October 21, 1993, Capital Auto Receivables Asset Trust 1993-3 acquired retail finance receivables aggregating approximately $2,504.9 million from the Seller in exchange for six classes of Asset-Backed Notes representing indebtedness of the Trust of $430.0 million Class A-1; $59.0 million Class A-2; $63.0 million Class A-3; $210.0 million Class A-4; $484.3 million Class A-5; $1,177.2 million Class A-6; and $81.4 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest on the Class A-1 Notes and the Class A-5 Notes will be made on the fifteenth day of each month or, if any such day is not a Business Day, on the next succeeding Business Day, commencing on November 15, 1993 (each a \"Distribution Date\"). Payments of interest on the Class A-2 Notes, the Class A-3 Notes, the Class A-4 Notes, and the Class A-6 Notes are made on the fifteenth day of January, April, July and October or, if any such day is not a Business Day, on the next succeeding Business Day, commencing January 18, 1994 (each, a \"Payment Date\"). Principal of the Notes will be payable by class in the priorities and in the amounts as set forth in the Indenture (previously filed by Form 8-K), equal to the sum of the Aggregate Noteholders' Principal Distributable Amounts to the extent of funds available therefor.\nThe principal balance of the Class A-1 Notes was paid in full on November 15, 1994; the principal balance of the Class A-2 Notes was paid in full on January 18, 1994; the principal balances of the Class A-3 Notes and the Class A-4 Notes were paid in full on April 15, 1994; the principal balance of the Class A-5 Notes was paid in full on January 17, 1995; and the then-unpaid principal balance of the Class A-6 Notes will be payable on October 15, 1998. On each Distribution Date on and after the date on which the Class A-2 Notes, the Class A-3 Notes and the Class A-4 Notes were paid (or provided for) in full, Certificateholders received, in respect of the\nII-25 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\ncertificate balance, an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor. The final scheduled Distribution Date for the Certificates will be October 15, 1998.\nInterest on the outstanding principal amount of the Notes accrues from October 21, 1993 or, from the most recent Distribution Date or Payment Date, as applicable, on which interest has been paid to but excluding the following Payment Date. The Class A-1 Notes received interest at the rate of 3.30 percent per annum. The Class A-2 Notes received interest at the rate of 3.25 percent per annum. The Class A-3 Notes received interest at the rate of 3.25 percent per annum. The Class A-4 Notes received interest at the rate of 3.30 percent per annum. The Class A-5 Notes received interest at the rate of 3.65 percent per annum.\nThe Class A-6 Notes bear interest at the rate of 4.60 percent per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 4.60 percent per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificate- holder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nNOTE 5. SUBSEQUENT EVENT\nEffective February 23, 1996, the Board of Directors of GMAC Auto Receivables Corporation approved the merger of and authorized the execution of an Agreement and Plan of Merger by and between Capital Auto Receivables, Inc. and GMAC Auto Receivables Corporation. The separate corporate existence of GMAC Auto Receivables Corporation shall cease and Capital Auto Receivables, Inc. shall continue as the surviving corporation.\n--------------------------\nII-26\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 65.8 $ 14.4 $ 80.2\nSecond quarter ..................... 187.0 13.9 200.9\nThird quarter ...................... 169.1 11.8 180.9\nFourth quarter ..................... 151.6 9.8 161.4 --------- -------- --------- Total ......................... $ 573.5 $ 49.9 $ 623.4 ========= ======== =========\n1994 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFirst quarter ...................... $ 303.1 $ 23.4 $ 326.5\nSecond quarter ..................... 405.1 21.3 426.4\nThird quarter ...................... 238.8 17.9 256.7\nFourth quarter ..................... 213.0 15.9 228.9 --------- -------- --------- Total ......................... $ 1,160.0 $ 78.5 $ 1,238.5 ========= ======== =========\n1993 Quarters Principal Interest Total - ------------------------------------ --------- -------- ----- (in millions of dollars)\nFourth quarter ..................... $ 66.2 $ 5.4 $ 71.6 ========= ======== =========\nII-27\nPART IV\nITEM 14.","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K\n(a) (1) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8, of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are not applicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part II of this report).\n-- Capital Auto Receivables Asset Trust 1992-1, Financial Statements for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-1 Financial Statements for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-2 Financial Statements for the Year Ended December 31, 1995.\n-- Capital Auto Receivables Asset Trust 1993-3 Financial Statements for the Year Ended December 31, 1995.\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by any of the above-mentioned Owner Trusts during the fourth quarter ended December 31, 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 Trustees have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nby: Bankers Trust (Delaware) -------------------------------------- (Owner Trustee, not in its individual capacity but solely as Owner Trustee on behalf of the Issuer.)\ns\\ Lillian Rancic --------------------------------- (Lillian Rancic, Assistant Treasurer)\nDate: March 13, 1996 --------------\nIV-2","section_15":""}
{"filename":"317781_1995.txt","cik":"317781","year":"1995","section_1":"ITEM 1. BUSINESS\nSUMMARY\nAnchor Pacific Underwriters, Inc. is a Delaware holding company that is primarily engaged in insurance brokerage and administration through its five direct and indirect wholly-owned subsidiaries listed in the chart below. Anchor Pacific Underwriters, Inc. and its subsidiaries are collectively referred to as \"Anchor\" unless the context otherwise requires.\nAnchor provides the following services to private sector small and middle market companies, groups, trusts, associations, government agencies and individual consumers: (a) insurance brokerage; (b) third-party claims administration, employee benefits consulting, underwriting and risk analysis; and (c) insurance premium financing. Anchor offers its customers, as agent, broker or administrator, a range of products and services tailored to the specific needs of such customers.\nAnchor markets the products and services of more than 50 commercial insurance companies and over a dozen managed care and preferred provider organizations. The marketing of products and services is carried out through 16 direct sales representatives and over 500 independent insurance brokers. Anchor's customer base is in the Western United States, primarily in California and Arizona. For the fiscal year ended December 31, 1995, Anchor generated $8.6 million in revenues.\nThe principal executive offices of Anchor are located approximately 30 miles east of San Francisco, California, at 1800 Sutter Street, Suite 400, Concord, California 94520.\nHISTORY\nAnchor was organized in 1986 as a California general partnership for the specific purpose of acquiring Harden & Company Insurance Services, Inc., a third-party employee benefits administrator (\"Harden\"), from Alex Brown Financial Group. Anchor was reorganized as a California corporation in March 1987. Since its inception, Anchor has expanded its insurance and financial service capabilities through internal growth as well as a series of acquisitions.\nFrom 1986 through 1990, Anchor, through Harden, focused on providing administrative services for group insurance benefit plans. In 1990, Anchor began to diversify its business by providing property, casualty and workers' compensation insurance products and services, and offering market studies and program analyses for certain non-profit associations who had endorsed Anchor's products.\nFrom 1990 through 1992, Anchor expanded its property and casualty business by: (a) acquiring certain assets, including insurance brokerage accounts, from four property and casualty brokerage firms; and (b) organizing Anchor Pacific Premium Finance Company, a California corporation (\"APPFCO\"), to complement its property and casualty business by providing premium financing to Anchor's clients. Anchor continued its expansion strategy by acquiring Benefit Resources, Inc. (\"BRI\") in August 1994, Putnam, Knudsen & Wieking, Inc. (\"PKW\") in October 1994, certain third party administration accounts from Dutcher Insurance Agency, Inc. (\"Dutcher\") in February 1995, and R. L. Ferguson Agency (\"RLF\") in March 1996. The acquisition of Dutcher and RLF accounts were not significant to Anchor. Anchor expects to continue to explore expansion opportunities.\nOn January 6, 1995, System Industries, Inc. (\"System\"), a Delaware corporation that filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in November 1993, and Anchor Pacific Underwriters, Inc. (\"Old Anchor\"), a private California corporation consummated a merger (the \"System Merger\"). Pursuant to the System Merger: (a) Old Anchor merged with and into System, with System being the surviving entity; (b) System was renamed \"Anchor Pacific Underwriters, Inc.\" (as so renamed, \"Anchor\"); (c) Old Anchor shareholders received Common Stock equal to 90% of the outstanding shares of Anchor's Common Stock; (d) former shareholders of System retained 5% of the outstanding shares of Anchor's Common Stock and certain creditors of System received the remaining 5% of such shares; (e) former shareholders and creditors of System received one warrant (the \"Warrant\") for each share of Anchor's Common Stock held by them immediately following consummation of the System Merger, which Warrant entitles the holder thereof to purchase, for a period of one year ending January 6, 1996, and subsequently extended to January 6, 1997, one share of Anchor's Common Stock at a purchase price of $3.00 per share; and (f) the directors and executive officers of Old Anchor became the directors and executive officers of Anchor. In addition, effective upon consummation of the System Merger, Anchor no longer engaged in the computer storage management business (which was System's pre-merger\/pre-bankruptcy line of business). Rather, Anchor is engaged in the insurance brokerage and administration business (which was Old Anchor's pre-Merger line of business).\nHistorical information regarding System has not been provided because: (a) following the filing of its bankruptcy petition in November 1993, System essentially ceased operations; (b) in December 1993, System sold substantially all of its assets; and (c) upon consummation of the System Merger, System changed its name to Anchor and began engaging in the pre-Merger business of Old Anchor. Consequently, historical information regarding System is not meaningful to the continued operations of Anchor.\nOPERATIONS\nINSURANCE BROKERAGE\nAnchor engages in the insurance brokerage business primarily through PKW, which offers property and casualty, health, life, disability, workers' compensation and other insurance products and services to middle market companies and individual consumers. PKW acts as an agent on behalf of insurers and other intermediaries\nin soliciting, negotiating and effecting contracts of insurance, and as a broker in procuring contracts of insurance on behalf of insureds.\nAs an insurance agent and broker, PKW derives income from the sale of insurance products and services and the receipt of commissions generated therefrom. Commissions, which generally are based on a percentage of gross premiums, and contingent commissions, which are generally based on the insurance carriers underwriting profits derived over a given period of time, can vary substantially within the insurance industry. These commissions depend on a number of factors, including the type of insurance, the amount of the premium, the insurance carrier's loss experience with respect to policies placed by Anchor, and the scope of the services that Anchor renders. Anchor derived 40%, 27% and 25% of its revenues in 1995, 1994 and 1993, respectively, from its insurance brokerage activities.\nTHIRD-PARTY CLAIMS ADMINISTRATION AND EMPLOYEE BENEFITS CONSULTING\nAnchor, primarily through Harden and BRI, engages in designing, implementing, and administering health benefit plans for employer groups of various sizes. Administration services provided by Harden and BRI include receiving and managing employer plan contributions and\/or premium payments, monitoring employee and dependent eligibility, preparing required government and tax reports, handling day-to-day administration, reviewing and analyzing claims data for coverage, and managing the claims settlement process. Anchor, through Harden and BRI, also helps develop insurance products and services tailored to the specific needs of the particular client, provides risk analysis, determines appropriate benefit and funding levels for particular insurance programs, and conducts loss control and cost studies for insurance companies and self-insured employers. As compensation for its claims administration services, Harden and BRI generally receive fees based on a percentage of premium collected, or on a per capita basis. Anchor derived 60%, 72% and 74% of its revenues in 1995, 1994 and 1993, respectively, from its third-party administration activities.\nFee revenues generated by Anchor in 1995 from third-party administration services included revenues generated by Harden and BRI. A significant portion of BRI's fee revenues related to an insurance product underwritten by one insurance carrier, which currently is an A+ (Superior) rated insurance carrier.\nHarden's third-party administration revenues related to: (a) an insurance product underwritten by two insurance carriers, which currently are A (Excellent) and A+ (Superior) rated insurance carriers; and (b) the administration of insurance programs underwritten by various insurance carriers for a number of self-insured employers. The insurance product referred to in subparagraph (a) above accounted for approximately 60.6% of Harden's revenues (or approximately 25.1% of Anchor's total revenues) in 1995, and revenues related to the administration self-insured programs accounted for 38.0% of Harden's revenues in 1995. Self-insurance is a program in which a client assumes a manageable portion of its insurance risks, usually (although not always) placing the less predictable and larger loss exposure with an excess insurance carrier.\nThe insurance company which offered the product that accounted for 65% of Harden's third-party administration revenues in 1994 had informed Harden that as a result of changes in its business strategy, it would discontinue offering such an insurance product by the end of 1995. On July 20, 1995, Harden obtained a binding commitment from an A+ (Superior) rated insurance carrier to underwrite the risk and provide a replacement product as of October 1, 1995. Although management anticipates an orderly transition to the new carrier, such a transition often causes clients to reevaluate their insurance needs, or alternatively, the client may not satisfy the new insurance carrier's underwriting requirements. Consequently there usually is a short term net loss of clients. In this regard, subsequent to December 31, 1995, one client who represented approximately 9% of Harden's 1995 revenues, has been advised by the new carrier that it does not meet its underwriting standards. The loss of this business will impact Harden's, and to a lesser extent, Anchor's 1996 revenues.\nINSURANCE PREMIUM FINANCING\nAnchor, through APPFCO, provides insurance premium financing services primarily to property and casualty clients of PKW. During 1995, Anchor derived less than 1% of its revenues from its insurance premium financing activities as compared to 1% in 1994 and 1993. This reduction in revenue was due primarily to Anchor's placing its premium financing activities through other financing facilities that were more competitively advantageous to the client.\nRECENT DEVELOPMENTS\/BUSINESS STRATEGY\nSince its inception in 1986, Anchor has grown from a single-state, single-product company, to a diversified, multi-state organization. A significant portion of such growth was achieved through the acquisition of existing third-party administrators and insurance brokerage companies and the subsequent expansion of such entities. Anchor's strategy is to strengthen its core health insurance and property and casualty (including workers' compensation) insurance businesses by: (a) continuing to develop specialized affiliated business units that target selected insurance industry market segments defined by industry type, geographic location and consumer demographics; (b) establishing new products and services; and (c) seeking to acquire and integrate compatible insurance brokerage and administration businesses in the Western United States. Effective March 1, 1996, APU acquired the R. L. Ferguson Insurance Agency (\"RLF\") located in Walnut Creek, California. RLF merged into Anchor's insurance brokerage business, PKW, located in Concord, California. Although Anchor has had preliminary discussions with a number of other potential acquisition candidates, as of March 19, 1996, it did not have any binding agreements with respect to acquisitions.\nEMPLOYEES\nAs of March 19, 1996, Anchor and its subsidiaries employed approximately 129 full-time employees. None of its employees is presently represented by a union or covered by a collective bargaining agreement. Anchor believes its employee relations are good.\nREGULATION\nThe activities of Anchor that are related to insurance brokerage, agency services and third-party administration are subject to licensing and regulation by the jurisdictions in which it conducts such activities. In addition to regulatory requirements applicable to Anchor, most jurisdictions require that individuals engaged in insurance brokerage and agency activities be personally licensed. As a result, a number of Anchor's employees are so licensed. Anchor's operations depend on the validity of and its continued good standing under the licenses and approvals pursuant to which it operates. Licensing laws and regulations vary from jurisdiction to jurisdiction. In all jurisdictions, the applicable licensing laws and regulations are subject to amendment or interpretation by regulatory authorities. Such authorities generally are vested with broad discretion as to the granting, renewing, and revoking of licenses and approvals.\nRecent legislation concerning regulations applicable to insurance carriers with which Anchor conducts business, may indirectly affect Anchor's business. One significant legislative change, the 1994 workers' compensation reform in California, has had the effect of reducing workers' compensation insurance premiums, and, consequently, reducing commissions generated by the sale of related insurance products. Anchor believes that revenues generated from anticipated future growth and continued diversification of its business will substantially offset any future loss of revenues that result from this workers' compensation reform.\nOther significant legislative change could result from current health care reform debate and various related legislation being considered by Congress. Anchor believes that its expertise in two major elements of recent health care reform proposals (managed care and managed competition), combined with its strategy of serving middle market clients, makes it well positioned to operate effectively in a managed care and managed competition environment. Anchor also believes that in light of the political changes in Congress, the United States will experience incremental, rather than comprehensive, changes in health care regulations. It is not\npossible at this time, however, to predict the effect that any health care reform legislation will have on Anchor's business condition, liquidity, capital resources or operations.\nCOMPETITION\nThe insurance brokerage and service business is highly competitive and there are many insurance brokerage and service organizations who actively compete with Anchor in every area of its business. Anchor competes directly with national insurance brokerages, insurance companies and health maintenance organizations that market their own products, through independent agencies, brokers, and third-party administrators, as well as with entities which self insure or sponsor other insurance programs. Many of these competitors are larger and have greater resources than Anchor. Anchor seeks to compete by specializing in specific market segments, developing specialty products for those markets, and maintaining relationships with consumers by providing personal service normally associated with small local businesses, together with the expertise, flexibility, and diversity of product that can only be provided by a larger broker. Anchor's claims administration operations compete with independent claims administration firms and with similar operations conducted by subsidiaries of large insurance companies and insurance brokerage companies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAnchor leases approximately 32,099 rentable square feet of office space at its executive offices at 1800 Sutter Street, Suite 400, Concord, California 94520. From November 1, 1994 through October 31, 1999, Anchor must pay rent of $1.40 per rentable square foot per month (approximately $44,939 per month), and from November 1, 1999 through October 31, 2004, Anchor must pay rent of $1.75 per rentable square foot per month (approximately $56,173 per month). Anchor also has been granted an option to lease additional office space at its executive offices in Concord.\nIn addition to Anchor's leased space, PKW leases approximately 13,128 rentable square feet of office space in Oakland, California, and BRI leases approximately 7,200 rentable square feet of office space in Scottsdale, Arizona. PKW must pay rent of between $1.75 and $2.00 per rentable square foot per month under its lease, which expires on November 30, 1999, and BRI must pay rent of between $0.92 and $1.04 per rentable square foot per month under its lease, which expires on February 28, 1997. PKW relocated its offices in December, 1994 to Anchor's office space in Concord, California and subleased its offices in Oakland.\nIn May, 1995, and December, 1995, PKW entered into subleases with respect to 82% and 10%, respectively, of PKW's prior office space in Oakland. The amounts classified as short and long-term liability with respect to the PKW leases reflect the shortfall between sublease income to be received and PKW's lease expense to be paid and are based upon the assumptions that: (a) the subtenant of the May, 1995, sublease will exercise their option to extend their lease through 1999; and (b) the remaining 8% of such office space will be subleased in 1997.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAnchor and its subsidiaries are parties from time to time to various lawsuits that have arisen in the normal course of business. Management is not aware of any lawsuits to which Anchor or its subsidiaries is currently a party or to which any property of Anchor or any of its subsidiaries is subject, which might materially adversely affect the financial condition or results of operations of Anchor, except as follows:\nPKW, together with several other entities, had been named as a defendant in a lawsuit filed in 1993 entitled Care Convalescent Ambulance, Inc., a California corporation v. Putnam, Knudsen & Wieking, Inc., a California corporation, et al. In this suit, a former client claimed that PKW acted negligently when, as agent, wrote liability insurance with an insurance carrier that was subsequently declared insolvent. On October 13, 1995, PKW, reached an agreement to settle said lawsuit. Under court approved settlement terms PKW, without admitting any liability, has paid full and final settlement payment of $50,000 in exchange for a complete release from all liability.\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 regarding certain executive officers of Anchor and\/or its subsidiaries.\nJAMES R. DUNATHAN, President, Chief Executive Officer and a Director of Anchor, has over 35 years of experience in the insurance industry, including eight years as an officer of an Ohio insurance company, 12 years as President of an independent insurance holding company in Florida, seven years as Vice President and General Manager of an insurance system software vendor and several years as a sales and marketing consultant. He joined Harden in 1985 and initiated the formation of Anchor in late 1986. Mr. Dunathan served actively for 11 years as a member of the Board of Directors of the Professional Insurance Agents Association and as President of such Association from 1975 to 1976. His past industry activities include serving as the immediate past President and Board member of the Independent Administrators Association; highest award for achievement, Dale Carnegie Institute; Florida Insurance Study Commission (development of the Florida FAIR Plan) and the Florida Reparations Reform Committee (development of the Florida \"No Fault\" Law), both appointments made by Governor Reubin Askew in 1973; and Commodore and President, Anchorage Yacht Club, St. Petersburg, Florida. Currently Mr. Dunathan serves on the Business Leaders Alliance for Contra Costa County, appointed by the Board of Supervisors. His family has been active in the insurance industry for over 100 years.\nEARL WIKLUND, Senior Vice President, Chief Financial Officer and a Director of Anchor, is also Chief Executive Officer of the Harden and BRI subsidiaries and has over 25 years of experience in operation, administrative and financial management positions. Mr. Wiklund serves on the Executive Committees for Harden and BRI. Prior to joining Harden in 1984, his career included 10 years as Controller\/Treasurer of a retail chain of 165 stores in five western states with $100 million in annual sales. In addition, he was Managing Director of a large statewide non-profit trade association, representing the interests of its members at the California State Legislature. He currently serves as Treasurer and a member of the Legislative Committee for the Independent Administrators Association as well as a member of the Board of Directors of such Association.\nLYNN A. BOYD, CLU, CHFC, President of Harden and BRI. He joined Harden in 1991 with over 25 years of experience in the group health insurance field. Mr. Boyd's career includes positions with Blue Cross, Clifton & Company, Curtis Day & Company and Sher Associates. His sales responsibilities at Harden primarily focus on the production of self-insured and large case fully insured accounts. Mr. Boyd also is responsible for general oversight and management of the Sales, Underwriting and Administration departments of Harden and BRI and serves on the Harden and BRI Executive Committees. He also currently serves on the Board of the Independent Administrators Association.\nGERARD J. LAURITA, Chief Operating Officer of PKW. An insurance professional with over 30 years on the \"carrier\" side of the business. He has performed functions and assumed responsibilities ranging from Commercial Underwriter, Sales Manager, Sales and Product Education and Division Vice President. His career has taken him through the carrier ranks with Merchant's Fire, U.S.F.&G., Safeco, Chubb, Fireman's Fund, and just prior to joining PKW, 15 years with American States. He also serves on the PKW Executive Committee.\nDONALD B. PUTNAM, CPCU, Director of Anchor, is Chairman of the Executive Committee of PKW. An insurance professional with over 38 years of experience, Mr. Putnam has been actively involved as a director or officer of many California insurance associations and served as Director of the National Association of Insurance Brokers (NAIB) and Intersure, an international affiliation of insurance brokers. He also recently served as Chairman of the NAIB- PAC. Mr. Putnam is a Business School graduate from the University of California, Berkeley.\nJAMES P. WIEKING, Director of Anchor, is the Executive Vice President of PKW. He has been active in the insurance business for 39 years. Mr. Wieking was formerly the owner of Wieking Connolly & Associates in Oakland, which merged with PKW in 1983. Mr. Wieking has been involved in various civic and professional associations and has served as a Board member of the Pacific Network Group, the Independent Insurance Agents Association and the Advisory Board of the Summit Bank in Oakland. He is a graduate of the University of California, Berkeley. He also serves on the PKW Executive Committee.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nPrior to the consummation of the System Merger, Old Anchor was a privately held California corporation with approximately 63 shareholders. There was no established trading market for Old Anchor's Common Stock. As of March 19, 1996, there were 3,674,501 shares of Anchor's Common Stock outstanding, held by approximately 878 shareholders of record. As of March 19, 1996, there also were Warrants to purchase 391,242 shares of Common Stock of Anchor (the \"Warrants\") outstanding. The Warrants which were due to expire on January 6, 1996 have been extended to January 6, 1997, all other terms and conditions remain the same.\nAnchor's shares of Common Stock and Warrants are currently publicly traded on the OTC Bulletin Board (Symbol: APUX). After a trading market is established, Anchor expects to continue to pursue the listing of its shares on The Nasdaq Small Cap Market; however, there can be no assurance as to when or whether such shares will be so listed.\nHolders of Anchor Common Stock are entitled to such dividends as may be declared from time to time by the Board of Directors out of funds legally available therefor. Anchor has not paid any cash or stock dividends to date. Anchor does not expect to pay dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain historical information for Anchor which is based on, and should be read in conjunction with, Anchor's audited financial statements that are being filed as part of this report.\nANCHOR PACIFIC UNDERWRITERS, INC. SELECTED FINANCIAL DATA - -------------------------------------------------------------------------------\n1\/ Consistent with Anchor's audited financial statements set forth elsewhere in this Annual Report, both revenues and income (Loss) before other expenses, net, include interest income.\n2\/ Earnings (Loss) per share and weighted average shares outstanding have been retroactively restated to reflect effects of the 10 for 1 stock split effected January 6, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBACKGROUND\nAnchor was organized in 1986 as a California general partnership for the specific purpose of acquiring Harden, a third-party employee benefits administrator. Anchor was reorganized as a private California corporation in March, 1987, and became a public reporting Delaware corporation on January 6, 1995 when it merged with System.\nSince its inception, Anchor has expanded its insurance and financial service capabilities through internal growth and a series of acquisitions. Anchor in August, 1994, acquired BRI, a third-party administrator located in Scottsdale, Arizona, in October, 1994, acquired PKW, a property and casualty insurance brokerage company located in Oakland, California, and in March, 1996, acquired RLF, a property and casualty insurance brokerage company located in Walnut Creek, California. The RLF acquisition is not significant to Anchor. The acquisitions of these entities were accounted for using the purchase method of accounting. Anchor expects to continue to expand its insurance brokerage and administration businesses and to explore other complementary expansion opportunities.\nHistorically, Anchor derived a majority of its revenues from third- party administration services. In light of its acquisition of PKW and the March 1, 1996 acquisition of RLF, Anchor expects to significantly increase the percentage of its revenues that are derived from property and casualty insurance brokerage activities.\nRESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nGENERAL\nAnchor derives a substantial portion of its revenues from commissions, which generally are based on a percentage of premiums produced by Anchor, contingent commissions, which generally are based on underwriting profits derived over a given period of time by the insurance carrier, and fees for claims administration (including underwriting and risk analysis) services, which generally are based on a percentage of premiums collected, or on a per capita basis. Anchor does not assume any underwriting risk in connection with its business.\nFluctuations in premiums charged by insurance companies may materially affect commission revenues. During the last seven years, the property and casualty insurance industry has experienced a \"soft market\" where the underwriting capacity of insurance companies expanded, stimulating an increase in competition and a decrease in premium rates, thereby reducing related commissions and fees. In addition, the soft market for property and casualty insurance workers' compensation reform in California has had the effect of reducing workers' compensation insurance premiums and, consequently, reducing commissions generated by the sale of related insurance products. Although some sources in the insurance industry have predicted future premium increases, the likelihood of rate increases in 1996 remains uncertain. Anchor believes that revenues generated from anticipated future growth and continued diversification of its business will offset weaknesses in the property and casualty market and any loss of revenues that may result from workers' compensation reform.\nInflation may also impact commission revenues by, among other things, increasing property replacement costs and workers' compensation and liability claims, thereby causing some clients to seek higher levels of insurance coverage and pay higher premiums. During the past several years, the United States has experienced very low rates of inflation along with business downsizing, reduced sales and lower payrolls; these events have resulted in lower levels of exposure to insure. Because the United States has recently experienced limited inflationary pressures inflation has had minimal impact on insurance prices.\nOther factors, such as client uncertainty about the effect of health care reform, could also affect Anchor's business. Anchor believes, however, that its expertise in two major elements of health care reform proposals (managed care and managed competition), combined with its strategy of serving middle market clients, makes it well positioned to operate effectively in a managed care and managed competition environment. Anchor also believes that in light of the political changes in the United States Congress, the United States will experience incremental, rather than comprehensive, changes in health care regulations. It is not possible at this time to predict the effect that any health care legislation will have on Anchor's business condition or operations.\nAnchor is unaware of any current regulatory proposals that could have a material effect on its liquidity, capital resources or operations.\nREVENUES\nTOTAL REVENUES. Total revenues for 1995 were $8,761,278, an increase of $2,670,113, or 43.8%, over 1994 revenues. The increase resulted primarily from the inclusion of the operations of PKW and BRI for the entire year in Anchor's consolidated financial statements. Anchor's revenues vary from quarter to quarter as a result of the timing of policy renewals and net new\/lost business production, whereas expenses are fairly uniform throughout the year. Total revenues for 1994 were $6,091,165, an increase of $1,323,345, or 27.7%, over 1993 revenues of $4,767,820. The increase resulted primarily from the inclusion of the operations of PKW for the period October 1, 1994 through December 31, 1994, and BRI for the period August 1, 1994 through December 31, 1994, in Anchor's consolidated financial statements.\nCommissions and fees make up substantially all of Anchor's revenues. The following table sets forth the percentages of Anchor's revenues attributable to insurance brokerage services (for which commissions are generated), and third-party administration and underwriting and risk analysis services (for which fees are generated), for the three\nyears ended December 31, 1995, 1994 and 1993. Also included is the percentage of revenues generated from premium finance activities.\nHistorically, Anchor derived a majority of its revenues from third- party administration services. In light of its acquisitions of PKW and RLF, Anchor expects to continue to experience an increase in the percentage of its revenues that are derived from insurance brokerage activities.\nCOMMISSIONS. Commissions are reported net of sub-broker commissions and generally are recognized as of the effective date of the insurance policy except for commissions on installment premiums which are recognized periodically as billed. Commissions for 1995 were $3,422,314, an increase of $1,775,125, or 107.8%, over $1,647,189 of commissions for 1994. The acquisition of PKW accounted for all of the increase. Commissions for 1993 were $1,173,643. The higher commissions generated in 1994, as compared to 1993, were attributable primarily to the PKW acquisition which accounted for approximately $541,880 of the increase.\nAnchor expects that, in 1996, commission revenues generated from sales of workers' compensation insurance, which accounted for approximately 18% of commission revenues (or 7% of Anchor's total revenues) in 1995, might decrease as a result of workers' compensation reform in California. Anchor believes, however, that revenues generated from anticipated growth and continued diversification of its business will substantially offset any loss of revenues that result from workers' compensation reform.\nFEES. Fees from Anchor's third-party administration (including underwriting and risk analysis) services for 1995 were $5,186,302, an increase of $857,064, or 19.8%, over $4,329,238 in fees for 1994. The acquisition of BRI accounted for the majority of the increase. Fee revenues for 1993 were $3,488,063. The higher fee revenues for 1994, as compared to 1993, were attributable primarily to the acquisition of BRI.\nFee revenues generated by Anchor in 1995 from third-party administration services consist of revenues generated by Harden and BRI. A significant portion of BRI's fee revenues in 1995 related to an insurance product underwritten by one insurance carrier, which currently is an A+ (Superior) rated insurance carrier.\nHarden's third-party administration revenues in 1995 related to: (a) an insurance product underwritten by two insurance carriers, which are A (Excellent) and A+ (Superior) rated insurance carriers; and (b) the administration of insurance programs underwritten by various insurance carriers for a number of self-insured employers. The insurance product referred to in subparagraph (a) above accounted for approximately 60.6% of Harden's revenues (or approximately 25.1% of Anchor's total revenues) in 1995, and revenues related to the administration self-insured programs described in sub-paragraph (b), accounted for 38.0% of Harden's revenues in 1995. Self-insurance is a program in which a client assumes a manageable portion of its insurance risks, usually (although not always) placing the less predictable and larger loss exposure with an excess insurance carrier.\nThe insurance company which offered the product that accounted for 65% of Harden's third-party administration revenues in 1994 informed Harden in early 1995, that as a result of changes in its business strategy, it would discontinue offering such an insurance product by the end of 1995. On July 20, 1995, Harden obtained a binding commitment from an A+ (Superior) rated insurance carrier to underwrite the risk and provide a replacement product as of October 1, 1995. Although management anticipates an orderly transition to the new carrier, such a transition often causes clients to reevaluate their insurance needs, or alternatively, the client may not satisfy the new insurance carrier's underwriting requirements. Consequently there usually is a short term net loss of clients. In this regard, subsequent to\nDecember 31, 1995, one client who represented approximately 9% of Harden's 1995 revenues (or 3.7% of Anchor's consolidated revenues), has been advised by the new carrier that it does not meet its underwriting standards.\nINTEREST INCOME. Interest income consists of interest earned on insurance premiums and other funds held in fiduciary accounts and interest earned on investments. Interest income was $145,156, $112,411 and $86,035 in 1995, 1994 and 1993, respectively. The increase in interest income in 1995, as compared to 1994, as well as 1994 compared to 1993, resulted primarily from a larger amount of insurance premiums and other funds held in fiduciary accounts due to the acquisitions of PKW and BRI.\nEXPENSES\nTOTAL EXPENSES. Total operating expenses for 1995 were $8,997,277, an increase of $2,969,461, or 49.3%, over 1994 operating expenses. The increase resulted primarily from the inclusion of the operating expenses of PKW, totaling approximately $1,747,949, and the operations of BRI, totaling $1,615,367, in Anchor's consolidated financial statements. For 1994, total operating expenses were $6,027,816, an increase of $1,492,670, or 32.9%, over operating expenses for 1993. The increase in operating expenses in 1994 over 1993 resulted primarily from the inclusion of the fourth quarter operating expenses of PKW, totaling $741,730, and the operations of BRI for the period August 1, through December 31, 1994, totaling $769,318, in Anchor's consolidated financial statements.\nEMPLOYEE COMPENSATION AND BENEFITS. Employee compensation and benefits for 1995 were $5,949,035, an increase of $2,027,793, or 51.7%, over 1994 employee compensation of $3,921,242. The acquisitions of PKW and BRI accounted for the majority of the increase in employee compensation and benefits. Employee compensation and benefits for 1993 were $2,847,922. The $1,073,320, or 37.6%, increase in such expenses for 1994, as compared to 1993, was principally due to acquisitions of PKW and BRI during 1994, with the remaining increase related primarily to expansion of existing operations.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were $3,048,242, $2,106,574 and $1,687,224 in 1995, 1994 and 1993, respectively. The $941,668, or 44.7%, increase in 1995, as compared to 1994, resulted primarily from the acquisitions of PKW and BRI. The $419,350, or 24.8%, increase in 1994, as compared to 1993, resulted also primarily from the acquisitions of PKW and BRI. Other operating expenses include rent, travel, insurance, postage, telephone, supplies and other miscellaneous expenses.\nINTEREST EXPENSE. Interest expense was $161,769, $35,925 and $30,492 in 1995, 1994 and 1993, respectively. The increase in interest expense in 1995, as compared to 1994, resulted primarily from an increase in outstanding borrowings on Anchor's existing line of credit. The increase in interest expense in 1994, as compared to 1993, resulted primarily from the assumption of existing debt in connection with the acquisition of PKW and an increase in outstanding borrowings on Anchor's existing line of credit. Anchor expects that its interest expense will increase in 1996, as compared to 1995, due to larger outstanding borrowings.\nAMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Goodwill represents the excess of the cost of acquisitions over the fair value of net assets acquired. Other intangibles include covenants not to compete, customer lists and other contractual rights. Amortization of goodwill and other intangibles was $409,908, $256,149 and $203,345 in 1995, 1994 and 1993, respectively. As a result of Anchor's acquisitions of PKW and BRI, amortization of goodwill and other intangibles has significantly increased. A discussion of amortization is presented in Notes 2 and 5 of the Notes to Consolidated Financial Statements.\nMERGER EXPENSES\nDuring the first quarter of 1995, Anchor incurred merger expenses of $221,220 for costs related to professional services associated with the System Merger.\nINCOME TAXES\nAnchor's expense(credit) for income taxes was $4,800 in 1995, $4,800 in 1994 and $(19,749) in 1993. An analysis of Anchor's provision for income taxes is presented in Note 9 of the Notes to Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nAnchor's business is not capital intensive and Anchor historically has had sufficient capital to meet its operating needs. Anchor reported net cash flows from operations of $178,590 for the twelve months ended December 31, 1995, compared to net cash flows (used in) operations of ($537,714) for the twelve months ended December 31, 1994. During 1996, Anchor expects to meet its operating and capital needs from cash flow derived from operations. It also anticipates borrowing under its existing credit agreements. Liquidity would be impaired if cash flow from operations were reduced or if existing credit lines were insufficient. To further supplement these funding sources Anchor is presently seeking new bank lines and, as described below, is seeking to raise up to $10 million from institutional investors.\nDuring 1995, Anchor raised $370,000 to supplement its working capital and capital expenditure requirements by selling 10% Convertible Subordinated Debentures (the \"Debentures\"). The basic terms of the Debentures are: (a) 10% interest per annum; (b) two year maturity; (c) conversion price of $1.35 in the first year and $1.65 in the second year; (d) \"piggyback\" registration rights for three years; (e) subordination provisions that subordinate the Debentures to Anchor's \"Senior Debt\" (as defined in the Debentures); and (f) provisions that permit Anchor to redeem the Debentures at par at any time. Purchasers of the Debentures included seven members of the Board of Directors of Anchor and a limited number of other sophisticated investors. The Debentures offering period terminated on December 31, 1995.\nAn additional $600,000 was raised in 1995 to supplement Anchor's working capital and capital expenditure requirements by selling a 10% Convertible Subordinated Debenture, Series A (the \"Debenture\") to Guarantee Life Insurance Company. The basic terms of the Debenture are: (a) 10% interest per annum; (b) two year maturity; (c) conversion price of $1.50; (d) \"piggyback\" registration rights for three years; (e) subordination provisions that subordinate the Debenture to Anchor's \"Senior Debt\" (as defined in the Debenture); and (f) provisions that permit Anchor to redeem the Debenture at par at any time.\nAnchor recently engaged the services of an investment banker to assist in raising approximately $10 million from institutional investors. The proceeds of this offering would be used for debt consolidation, working capital and to fund future acquisitions. At the present time, Anchor expects to offer investors preferred stock that will be convertible into shares of common stock. Anchor has had preliminary discussions with various parties, but has not yet obtained any commitments with respect to such financing. Consequently, there can be no assurance as to when or whether Anchor will raise additional capital or what the terms and conditions would be for such capital.\nCapital and certain acquisition related expenditures (not including expenditures related to the acquisition of BRI and PKW, or the System Merger) were $462,909 and $391,566 for the twelve months ended December, 1995 and 1994, respectively. The increase in such expenditures in the twelve months of 1995, as compared to 1994, related primarily to the acquisition of certain third party administration accounts from a company (Dutcher) located in Stockton, California. In addition to such expenditures, Anchor made several significant expenditures in the first quarter of 1995 related primarily to professional services associated with the System Merger and the PKW and BRI acquisitions.\nShort-term debt, current portion of long-term debt and current portion of long-term liabilities at December 31, 1995, totaling in the aggregate $1,830,159 (as compared to $1,720,010 at December 31, 1994) consisted of: (a) $975,000 outstanding under a $1,000,000 revolving line of credit maintained by Anchor with a regional San Francisco Bay Area bank; (b) $200,000 outstanding under a $500,000 unsecured line of credit maintained by Anchor with another regional San Francisco Bay Area bank; (c) approximately $228,750 of future fixed payments under a consulting agreement entered into with a company affiliated with the former shareholders of BRI; (d) $150,000 representing the current\nportion of obligations with regard to certain real property leased by PKW prior to its acquisition by Anchor and relocation to Anchor's executive offices; and (e) $276,409 for certain other current liabilities.\nOn October 25, 1995 the $1,000,000 line of credit expired. The bank has extended the line of credit to September 8, 1996. The line of credit requires Anchor to maintain shareholders' equity of at least $800,000. Anchor's shareholders' equity at December 31, 1995 was $1,563,032. The $500,000 unsecured line of credit, expires on July 30, 1996; replaces an earlier $200,000 line of credit which expired on November 5, 1995, and which was secured by the net commission portion of PKW's accounts receivable and equipment and general intangibles. The interest rate on the $1,000,000 line of credit is at the lending bank's prime rate. The $500,000 line of credit has an interest rate equal to the lending bank's prime rate plus 1-1\/4%.\nIn 1995, the bank that provided Anchor with the $1,000,000 line of credit also provided Anchor with equipment financing loans of $125,000 and $62,000 for equipment purchased with operating capital. The proceeds from the $125,000 equipment financing loan were then used to reduce the outstanding balance on said $1,000,000 line of credit.\nAt December 31, 1995, long-term liabilities, less the current portion discussed above, totaled $2,412,852 (as compared to $1,656,269 at December 31, 1994), and primarily consisted of: (a) convertible debentures, including incurred interest, of $982,583; (b) approximately $435,000 of future fixed payments under the consulting agreement mentioned above with a company affiliated with the former shareholders of BRI; (c) approximately $334,716 representing the long-term portion of obligations with regard to certain real property leased by PKW prior to its acquisition by Anchor and relocation to Anchor's executive offices; and (d) approximately $660,553 for certain other long-term liabilities. In May, 1995, PKW entered into a sublease with respect to 82% of PKW's prior office space. The sublease expires on September 30, 1997 (unless extended by the subtenant through November 30, 1999, the date on which the term of the master lease expires) and requires PKW to provide a multi-year rent subsidy. In December, 1995, PKW entered into a sublease with respect to an additional 10% of PKW's prior office space. The sublease expires on November 30, 1999 and requires PKW to provide a multi- year rent subsidy. The amounts classified as short and long-term liability with respect to the PKW leases reflect such subsidy and are based upon the assumptions that: (a) the subtenant of the May, 1995, sublease will exercise its option to extend the lease through 1999; and (b) the remaining 8% of such office space will be subleased in 1997.\nAnchor has not paid cash dividends in the past and does not expect to pay cash dividends in the foreseeable future.\nADJUSTMENT OF PKW PURCHASE PRICE\nIn connection with the acquisition of PKW in October, 1994, Anchor issued 120,077 shares of its common stock at a value determined to be $12.50 per share (which were converted into 1,200,770 shares, having a value of $1.25 per share, upon consummation of the System Merger) to the former shareholders of PKW. Two of the former shareholders of PKW are members of the Board of Directors of Anchor. Subsequent to the PKW acquisition certain contingencies regarding PKW's operations caused Anchor to negotiate and secure an adjustment to the purchase price paid for PKW. As a result, the former PKW shareholders have returned to Anchor 248,710 shares of Anchor's Common Stock that were issued in connection the PKW acquisition. The return of shares has resulted in a reduction of both shareholders' equity and goodwill by $310,890 and a reduction in the number of outstanding shares of Anchor's Common Stock by 248,710.\nSTRATEGY\nAnchor's strategy is to strengthen its core health insurance and property and casualty (including workers' compensation) insurance businesses by: (a) continuing to develop specialized affiliated business units that target selected insurance industry market segments defined by industry type, geographic location and consumer demographics; (b) establishing new products and services; and (c) seeking to acquire and integrate compatible insurance brokerage and administration businesses in the Western United States. In connection with this strategy, Anchor regularly considers acquisition opportunities. To date, acquisitions by Anchor have involved relatively small acquisitions of insurance\nbrokerage and administration accounts to larger acquisitions of insurance brokerage companies, such as PKW, and third-party administrators, such as BRI. Anchor expects to continue to pursue appropriate acquisition opportunities, and believes that its merger with System greatly enhances its ability to make acquisitions and continue its expansion strategy. Although Anchor is engaged in discussions with third parties regarding potential acquisitions, as of March 19, 1996, it did not have any binding agreements with respect to acquisitions. No assurances can be given with respect to the likelihood, or financial or business effect, of any possible future acquisition.\nRECENTLY ISSUED ACCOUNTING STATEMENTS\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, 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. Anchor adopted Statement No. 121 during the year ended 1995. The adoption had no material impact on Anchor.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements for Anchor appear on pages through of this report.\nReport of Independent Auditors\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\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information under the heading \"Independent Auditors\" from the Registrant's Proxy Statement to be mailed in connection with the Registrant's 1996 Annual Meeting of Stockholders is hereby incorporated by reference.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information under the headings \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" from the Registrant's Proxy Statement to be mailed in connection with the Registrant's 1996 Annual Meeting of Stockholders are hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information under the headings \"Executive Compensation\" and \"Employment Agreement with James R. Dunathan\" from the Registrant's Proxy Statement to be mailed in connection with the Registrant's 1996 Annual Meeting of Stockholders are hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under the headings \"Principal Stockholders\" and \"Stock Ownership Table\" from the Registrant's Proxy Statement to be mailed in connection with the Registrant's 1996 Annual Meeting of Stockholders are hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under the heading \"Certain Relationships and Related Transactions\" from the Registrant's Proxy Statement to be mailed in connection with the Registrant's 1996 Annual Meeting of Stockholders is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS.\nReport of Independent Auditors\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\n(a)(2) FINANCIAL STATEMENT SCHEDULES.\nSchedule 1 -- Condensed Financial Information of Registrant\nFull disclosure is contained in the consolidated financial statements of the Registrant and the notes thereto.\nSchedule 2 -- Valuation and Qualifying Accounts\nAmount does not satisfy the requirements for disclosure.\n(a)(3) EXHIBIT INDEX\n2.1 Amended and Restated Agreement and Plan of Merger dated as of October 24, 1994, by and between System and Old Anchor, as amended by that certain Amendment to the Amended and Restated Agreement and Plan of Merger dated as of December 29, 1994, and Agreement of Merger attached as an exhibit to the Reorganization Agreement and certified by the Delaware Secretary of State on January 6, 1995. Incorporated by reference to Exhibit 2.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n3.1 Restated Certificate of Incorporation. Incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n3.2 Bylaws. Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n4.1 Specimen Common Stock Certificate. Incorporated by reference to Exhibit 4.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n4.2 Specimen Warrant Certificate. Incorporated by reference to Exhibit 4.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n4.3 Warrant Agreement dated as of January 7, 1995, between Anchor and U.S. Stock Transfer Corporation. Incorporated by reference to Exhibit 4.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n4.3a Letter dated December 29, 1995 to all stockholders from James R. Dunathan extending warrants expiration date to January 6, 1997.\n4.4 Form of 10% Convertible Subordinated Debenture. Incorporated by reference to Exhibit 4.1 of the Company's Form 10-Q for the quarter ending March 31, 1995.\n4.5 Form of 10% Convertible Subordinated Debenture, Series A.\n10.1 1994 Stock Option Plan. Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.*\n10.2 Lease dated October 29, 1990, as amended on June 10, 1991, April 16, 1994 and September 9, 1994, between Anchor and Societe Generale (regarding 1800 Sutter Street, Concord, California). Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.3 Lease dated May 29, 1990, as amended on December 1, 1992, between PKW and Kaiser Center, Inc. (regarding 300 Lakeside Drive, Oakland, California). Incorporated by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.3a Sublease dated May 26, 1995, between PKW and Martin, Ryan & Andrada, Inc. (regarding 82% of 300 Lakeside Drive, Oakland, California). Incorporated by reference to Exhibit 10.2 of the Company's Form 10-Q for the quarter ending June 30, 1995.\n10.3b Sublease dated December 1, 1995, between PKW and Logiciel, Inc. (regarding 10% of 300 Lakeside Drive, Oakland, California).\n10.4 Lease dated July 3, 1989, as amended on February 10, 1994, between BRI and Connecticut General Life Insurance Company (regarding 10301 N. 92nd Street, Scottsdale, Arizona). Incorporated by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for year ended December 31, 1994.\n10.5 Employment Agreement dated August 16, 1994, between Anchor and James R. Dunathan. Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.*\n10.6 Amendment No. 1 to Employment Agreement dated December 19, 1994, between Anchor and James R. Dunathan. Incorporated by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.*\n10.7 Business Loan Agreement dated as of September 27, 1994, between Anchor and Concord Commercial Bank, and related documents. Incorporated by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.8 Business Loan Agreement dated as of September 7, 1994, between PKW and CivicBank of Commerce, and related documents. Incorporated by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.9 Business Loan Agreement dated as of June 17, 1992, between Harden and Concord Commercial Bank, and related documents. Incorporated by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.10 Lease of Personal Property dated April 6, 1994, between BRI and Winthrop Financial Group, Inc. (regarding computer equipment). Incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.12 Information Management Agreement dated as of May 11, 1993, between Harden and CMSI, Inc. Incorporated 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 Consulting Agreement dated as of August 1, 1994, between BRI and Hightrust, Ltd. Incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.14 Agreement for Purchase and Sale of Assets dated as of January 18, 1995, between Harden and Dutcher. Incorporated by reference to Exhibit 10.14 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.15 Amendment to Agreement for Purchase and Sale of Assets dated February 1, 1995, between Harden and Dutcher. Incorporated by reference to Exhibit 10.15 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.16 Asset Purchase Agreement dated May 17, 1995 between Putnam, Knudsen & Wieking Inc. Insurance Brokers and Crestview Leasing. Incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for the quarter ending June 30, 1995.\n10.17 Settlement Agreement and Mutual Release dated August 22, 1995 between Anchor and Donald B. Putnam, James P. Wieking, Ronald J. Marengo, Gary N. Lewis, Edward Wieking and Robert Moser. Incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for the quarter ending September 30, 1995.*\n11.1 Statement Regarding Computation of Per Share Earnings.\n21.1 Subsidiaries of Anchor. Incorporated by reference to Exhibit 21.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n27.0 Financial Data Schedule.\nAll other exhibits are omitted because they are inapplicable. *Denotes management contract or compensatory plan or arrangement.\n(b) Reports of 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.\nANCHOR PACIFIC UNDERWRITERS, INC. (Registrant)\nDate: March 19, 1996 By: \/s\/ James R. Dunathan ---------------------- James R. Dunathan President and Chief Executive Officer (Principal Executive Officer)\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.\nSignature Title Date - --------- ----- ----\n\/s\/ James R. Dunathan President, March 19, 1996 - --------------------- Chief Executive James R. Dunathan Officer and Director (Principal Executive Officer)\n\/s\/ Earl Wiklund March 19, 1996 - ---------------- Chief Financial Earl Wiklund Officer and Director (Principal Financial and Accounting Officer)\n\/s\/ Audie J. Dudum Chairman, March 19, 1996 - ------------------ Director Audie J. Dudum\n\/s\/ Steven A. Gonsalves Director March 19, 1996 - ----------------------- Steven A. Gonsalves\n\/s\/ R. William MacCullough Director March 19, 1996 - -------------------------- R. William MacCullough\n\/s\/ Donald B. Putnam Director March 19, 1996 - -------------------- Donald B. Putnam\n\/s\/ Michael R. Sanford Director March 19, 1996 - ---------------------- Michael R. Sanford\n\/s\/ Richard L. Taylor Director March 19, 1996 - --------------------- Richard L. Taylor\n\/s\/ James P. Wieking Director March 19, 1996 - -------------------- James P. Wieking\nCONSOLIDATED FINANCIAL STATEMENTS ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 WITH REPORT OF INDEPENDENT AUDITORS\nAnchor Pacific Underwriters, Inc. and Subsidiaries\nConsolidated Financial Statements\nYears ended December 31, 1995, 1994 and 1993\nCONTENTS\nReport of Independent Auditors . . . . . . . . . . . . . . . . . . . . .\nAudited Consolidated Financial Statements\nConsolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . Consolidated Statements of Shareholders' Equity . . . . . . . . . . . . . Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . .F-8\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Shareholders Anchor Pacific Underwriters, Inc. and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of Anchor Pacific Underwriters, Inc. 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. The consolidated financial statements of Anchor Pacific Underwriters, Inc. and subsidiaries for the year ended December 31, 1993, were audited by other auditors whose report dated April 1, 1994 expressed an unqualified opinion on those statements prior to restatement.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Anchor Pacific Underwriters, Inc. and subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nWe also audited the adjustments described in Note 1 that were applied to restate the 1993 financial statements. In our opinion, such adjustments are appropriate and have been properly applied.\nMarch 18, 1996\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSEE ACCOMPANYING NOTES.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSEE ACCOMPANYING NOTES.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nSEE ACCOMPANYING NOTES.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE ACCOMPANYING NOTES.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nSEE ACCOMPANYING NOTES.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n1. NATURE OF BUSINESS\nORGANIZATION\nAnchor Pacific Underwriters, Inc. (\"Anchor\") is a holding company that provides insurance administration and property and casualty brokerage services through its five direct and indirect subsidiaries. Administration services are provided to employer groups of varying size, primarily located in California and Arizona. Anchor also operates property and casualty insurance agencies which service customers located primarily in the greater San Francisco Bay Area.\nThe consolidated financial statements include the accounts of Anchor and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nRECAPITALIZATION AND RESTATEMENT\nOn January 6, 1995, Anchor merged with System Industries, Inc. (\"System\"), a previously dormant, publicly traded shell corporation. For accounting purposes, the merger has been treated as a recapitalization of Anchor with Anchor as the acquirer. Upon consummation of the merger, shareholders and certain creditors of System each received one share of Anchor common stock and one warrant to purchase one share of Anchor common stock at a price of $3.00 for every 42.3291 shares of issued and outstanding System common stock. The warrants issued allow for the purchase of 391,242 shares of common stock and expire January 6, 1997. As a result of the merger, Anchor became a publicly traded company. The historical financial statements prior to January 6, 1995 are those of Anchor and have been restated to reflect a 10 for 1 stock split effective in conjunction with the merger and the reallocation of capital between common stock and additional paid-in capital as a result of the assignment of a $0.02 par value to the previously no par value stock. All references to numbers of shares and per share amounts have been retroactively restated.\nCosts incurred in conjunction with the merger, which total $221,220 and $462,601 for the years ended 1995 and 1994, respectively, have been expensed.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe financial statements have been prepared on the going concern basis. The Company has reported net loss during the past three years. The increase in net loss in 1995 and 1994 relates to expenses in connection with acquisitions and a merger. These events are further discussed in the footnotes. The Company's business is not capital intensive and the Company historically has had sufficient capital to meet its operating needs. The Company plans to continue making acquisitions and, in order to fund these plans, is presently seeking new bank lines as well as seeking to raise up to $10 million from institutional investors.\nManagement's plan to achieve profitability includes a strategy to strengthen its core health insurance and property and casualty insurance businesses by: (a) continuing to develop specialized affiliated business units that target selected insurance market segments defined by industry type, geographic location and consumer demographics; (b) establishing new products and services; and (c) seeking to acquire and integrate compatible insurance brokerage and administration businesses in the Western United States. In conjunction with such acquisition strategies, management intends to realize efficiencies and reduce expenses through the integration and centralization of certain services with its existing infrastructure.\nUSE OF ESTIMATES\nThe preparation of financial statements 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.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nREVENUE RECOGNITION\nThe majority of revenue from third party administration services consists of fees charged for the administration of fully insured and self-insured group health plans. Fee income is recognized at the time employers remit monthly premiums and when services are rendered. Anchor derived 60%, 72%, and 74% of its revenues in 1995, 1994 and 1993, respectively, from its third-party activities.\nInsurance brokerage revenue consists principally of insurance commissions (net of split or shared commissions), fees in lieu of commissions for insurance placement services and interest income on fiduciary and corporate funds. Insurance commissions and fees in lieu of commissions for insurance placement services are recognized when coverage becomes effective, the premium due under the policy is known or can be reasonably estimated, and substantially all required services related to placing the insurance have been provided.\nBroker commission adjustments and commissions on premiums billed directly by underwriters are recognized principally when such amounts can be reasonably estimated.\nIn addition, Anchor receives annual contingency commissions from various property and casualty insurance carriers. The commissions are based upon the carrier's loss experience as well as the number of policies placed. Revenue from contingency commissions is recognized when received. Fee income for services other than placement of insurance coverages is recognized as those services are provided. Anchor derived 40%, 27%, and 25% of its revenues in 1995, 1994 and 1993, respectively, from its insurance brokerage activities.\nEXPENSE RECOGNITION\nAll costs are expensed as incurred.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nCASH AND CASH EQUIVALENTS\nAnchor considers all highly liquid investments with a maturity of three months or less at the date of acquisition to be cash equivalents.\nFIDUCIARY FUNDS AND LIABILITIES\nFunds held for self-funded employers, fully insured programs and unremitted insurance premiums are held in a fiduciary capacity.\nInterest earned on certain fiduciary funds is included in Anchor's earnings. Interest income on fiduciary funds amounted to $138,051, $64,139, and $55,907 in 1995, 1994 and 1993, respectively.\nCONCENTRATION OF CREDIT RISK\nCash and cash equivalents are on deposit in approximately 140 separate accounts with certain accounts exceeding $100,000. The FDIC insures accounts up to $100,000 each. If several accounts are maintained for the same entity at the same bank, the FDIC applies the $100,000 limit to the combined group. The accounts are maintained in well-established local commercial banks. These banks have satisfied the FDIC's more stringent capitalization requirements, qualifying them to accept broker deposits. The banks have received high ratings from bank rating services. As a result, credit risk is deemed to be minimal.\nACCOUNTS RECEIVABLE\nAnchor provides for future estimated credit losses based on an evaluation of a current aging of the accounts, current economic conditions and other factors necessary to provide for losses that can be reasonably anticipated.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying values of financial instruments such as cash and cash equivalents, fiduciary funds, and debt obligations approximate their fair market value.\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 amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.\nSHORT-TERM BORROWINGS: The carrying amounts on the lines of credits and other short-term borrowings approximate their fair value.\nLONG-TERM BORROWINGS: The fair values of Anchor's long-term borrowings are estimated using discounted cash flow analyses, based on the current incremental borrowing rates for similar types of borrowing arrangements.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years.\nSoftware costs relating to the upgrading and enhancing of existing programs are capitalized and amortized over a period of five years.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nGOODWILL AND INTANGIBLE ASSETS\nGoodwill represents the excess of the cost of acquisitions over the fair value of net assets acquired. Intangible assets relate to covenants not to compete, customer lists and other contractual rights acquired in acquisitions. Goodwill is amortized on the straight-line basis over 10 to 25 years. Covenants not to compete and customer lists are amortized on the straight-line basis over 5 to 12 years.\nINCOME TAXES\nAnchor and its subsidiaries file a consolidated federal income tax return and combined returns for state franchise tax purposes.\nLOSS PER SHARE\nLoss per share is based on the weighted average number of common shares outstanding during the period.\nRECLASSIFICATIONS\nCertain prior year balances have been reclassified to conform with the current year presentation.\nNEW ACCOUNTING PRONOUNCEMENT\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, 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 foregoing principles were used in evaluating goodwill and intangible assets at December 31, 1995, with no adjustment of carrying value being required.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n3. ACQUISITIONS\nOn August 1, 1994, Harden & Company, purchased common stock of Benefit Resources Inc. (BRI), a third-party administrator located in Scottsdale, Arizona. The purchase price consisted of $300,000 cash and certain other acquisition expenses. The preliminary purchase price has been allocated to assets and liabilities of BRI based upon their estimated respective fair values. The preliminary purchase price exceeded the fair value of BRI's net assets by approximately $212,000, which has been allocated to other intangible assets. In addition, Harden entered into a consulting contract pursuant to which it agreed to pay $940,000 over a fifty-month period to an entity affiliated with the former shareholders of BRI. At the end of the fifty-month term, a final bonus payment will be calculated, if any, that would be paid out from the fifty-first through the ninety-eighth month.\nOn October 1, 1994, Anchor acquired Putnam, Knudsen & Wieking, Inc. (PKW), a property and casualty insurance brokerage firm for an initial purchase price of $2,895,000 subject to certain future contingent payments or adjustments. The purchase price consisted of the issuance of 1,200,770 shares of newly issued Anchor stock at a value determined to be $1.25 per share plus the assumption of approximately $710,000 in relocation liabilities relating to PKW's former office facilities. The purchase price also consisted of certain other acquisition expenses. The preliminary purchase price exceeded the fair value of PKW's net assets, the excess of $2,210,000 and $685,000 has been allocated to goodwill and other intangible assets, respectively.\nDuring 1995, subsequent to the PKW acquisition certain contingencies regarding PKW's operations caused Anchor to negotiate and secure an adjustment to the purchase price paid for PKW. As a result, 248,710 shares of Anchor's common stock, that were issued in connection with the acquisition, were returned to Anchor. The returned shares resulted in a decrease of $310,890 in goodwill and shareholders' equity and a decrease in the number of outstanding shares of Anchor's common stock by 248,710. The decrease in goodwill was partially offset by a $104,540 purchase price adjustment recorded in the current year to increase the estimate of liabilities assumed in the acquisition of PKW.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. PROPERTY AND EQUIPMENT\nProperty and equipment as of December 31, 1995 and 1994 consist of the following:\n5. GOODWILL AND INTANGIBLE ASSETS\nGoodwill and intangible assets as of December 31, 1995, 1994 and 1993 consist of the following:\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. SHORT-TERM DEBT\nAnchor entered into a $1,000,000 revolving line of credit agreement with its principal bank which expires on September 8, 1996 at which time all unpaid principal and interest is due. Interest is paid monthly, at the bank's prime rate, as adjusted (8.75% at December 31, 1995). Borrowings on the line are collateralized by accounts receivable, equipment and general intangibles. The line of credit agreement contains a covenant among others, which requires Anchor to maintain a net worth greater than $800,000. The outstanding borrowings against the line of credit at December 31, 1995 and 1994 were $975,000 and $600,000, respectively. The weighted average interest rate on this loan during 1995 was 8.83%.\nOn July 30, 1995, Anchor entered into an unsecured revolving line of credit agreement with another bank which provides for a line of credit of $500,000 and expires on July 30, 1996, at which time all unpaid principal and interest is due. Amounts advanced against the line bear interest at the bank's prime rate plus 1.25% as adjusted every six months (10% at December 31, 1995). The line of credit agreement contains a covenant among others, which requires Anchor to maintain a net worth greater than $800,000. The outstanding borrowings against the line at December 31, 1995 were $200,000. The weighted average interest rate on this loan was 10%.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. OTHER LONG-TERM LIABILITIES\nOther long-term liabilities primarily consist of future contingent payments relating to contractual agreements negotiated with the previous owners of businesses acquired in 1994, deferred rent and other liabilities not due within one year. The future contingent payments are generally based upon the amount of net commission income generated from the books of business acquired. At December 31, 1995, the scheduled future payments of these liabilities are as follows:\n8. LONG-TERM DEBT\nAt December 31, 1995, long-term debt includes 10% convertible subordinated debentures totaling $970,000. The basic terms are (a) 10% interest per annum; (b) two year maturity from the date of issuance; (c) convertible to Anchor common stock at conversion prices per share ranging from $1.35 to $1.65 (d)\"piggyback\" registration rights for three years; (e) subordination provisions and (f) provisions that permit Anchor to redeem the debenture at par at any time. Based on the terms of the debenture, Anchor is prohibited from declaring, paying or setting aside any sums for a dividend or other distribution to any class of capital stock.\nAlso included in long-term debt are three loans totaling $372,275 at December 31, 1995 and other debt not due within one year totaling $80,982. Interest rates on the loans range from Prime Plus 1% to 10% with maturity dates from April, 1996 to February, 2000 and are collateralized by equipment and intangible assets.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. LONG-TERM DEBT (CONTINUED)\nMinimum future principal payments related to the long-term debt as of December 31, 1995 are as follows:\n9. INCOME TAXES\nSignificant components of the provision for income taxes are as follows:\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. INCOME TAXES (CONTINUED)\nDeferred tax liabilities and assets are comprised of the following at December 31:\nFor December 31, 1995 and 1994, deferred tax liabilities are noncurrent. For December 31, 1995 and 1994, deferred tax assets are comprised of $6,188 and $48,402 which are current and $0 and $148,000 which are noncurrent, respectively.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. INCOME TAXES (CONTINUED)\nThe change in the valuation allowance is comprised of the following items:\nAt December 31, 1995, $64,670 of the valuation allowance related to the purchase of BRI. When realized, the tax benefit will be accounted for as a reduction of goodwill.\nA reconciliation of income tax computed at the federal statutory corporate tax rate to income tax expense is:\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. INCOME TAXES (CONTINUED)\nAt December 31, 1995, the Company had federal and state net operating loss carryforwards of approximately $2,335,000 and $1,285,000, respectively. The net operating losses will begin to expire in the year ending December 31, 1998.\nAt December 31, 1995, the Company had federal general business credits of approximately $26,000. The general business credits will begin to expire in the year ending December 31, 1996. At December 31, 1995, the Company had state tax credits of approximately $16,000. The state tax credits may be carried forward indefinitely.\nAs indicated in Note 1, the Company consummated a merger with System, resulting in shares of Anchor being issued. Federal and state tax law impose limitations on the use of the net operating losses and tax credits following certain changes in ownership. If such an ownership change has occurred, the limitation could reduce the amount of the benefit of the net operating losses and general business credits that would be available to offset future taxable income starting in the year of the ownership change.\n10. RETIREMENT AND EMPLOYEE BENEFIT PLANS\nAnchor has a 401(k) profit sharing plan to which eligible employees may contribute up to 15% of their salaries, or a maximum of $9,240 as deferred compensation. The plan also provides for voluntary employer contributions whereby Anchor may match 50% of the employee contribution up to a maximum of 3% of employees' gross salary. Anchor made no contributions to the plan during the years ended 1995 and 1994.\nIn addition, Anchor offers active eligible employees certain life, health, vision and dental benefits. There are several plans which differ in amounts of coverage and deductibles. Anchor does not extend such benefits to retirees.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. STOCK OPTION PLAN\nIn conjunction with the merger with System, Anchor's employee and director stock option plans (\"Old Anchor Plan\") were terminated. On December 5, 1994, the Board of Directors of Anchor adopted a new plan, the Anchor Pacific Underwriters, Inc. 1994 Stock Option Plan (the \"1994 Plan\"). The aggregate number of shares that are available for issuance pursuant to the exercise of options granted under the 1994 Plan may not exceed 700,000 shares of Common Stock. Provisions of the 1994 Plan provide that upon the issuance of a permit from the California Department of Corporations (obtained June 1995), each nonemployee director of Anchor who held options under the Old Anchor Plans shall receive an option to purchase 35,000 shares of Anchor Common Stock and each nonemployee director who did not hold options under the Old Anchor Plans shall receive an option to purchase 15,000 shares of Anchor Common Stock and thereafter each nonemployee director who is first elected or appointed to the Board of Directors of Anchor shall receive an option to purchase 15,000 shares of Anchor Common Stock. Options granted to directors on June 20, 1995 are immediately exercise. All options have a term of 10 years.\nAnchor currently follows the provisions of Accounting Principles Board Opinion 25, \"Accounting for Stock Issued to Employees\" (APB 25), which requires compensation expense for the Company's options to be recognized only if the market price of the underlying stock exceeds the exercise price on the date of grant. Accordingly, Anchor has not recognized compensation expense for its options granted in 1995.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. STOCK OPTION PLAN (CONTINUED)\nA reconciliation of Anchor's stock option activity, and related information, for the year ended December 31, 1995 follows:\n12. LEASES\nAnchor rents its Concord, California facilities under an operating lease as renegotiated and amended in 1994, which expires in 2004. The terms of the original lease include a 12-month rent deferral and fixed rental escalation. The total rent for the lease term which reflects the 12-month deferral and the escalation is being amortized on the straight-line basis over the full term of the lease, resulting in deferred rent liability of approximately $265,000 and $233,000 at December 31, 1995 and 1994, respectively, and is included in long-term liabilities on the accompanying balance sheets.\nA subsidiary located in Scottsdale, Arizona leases offices under an operating lease which expires in 1997. In addition, in connection with the acquisition of PKW in October 1994, Anchor assumed the lease obligation of certain facilities in Oakland, California. During 1995, Anchor subleased 92% of the Oakland facility to two separate tenants. The subleases expire in 1999.\nThe consolidated statements of operations reflect rent expense of $623,563, $424,597, and $306,703 for the years ended 1995, 1994, and 1993, respectively.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n12. LEASES (CONTINUED)\nFuture minimum annual lease payments under operating leases as of December 31, 1995, exclusive of net amounts owed under the Oakland lease which are disclosed in the schedule of payments under long-term liabilities in Note 7, are as follows:\n13. COMMITMENTS\nIn 1993, Anchor entered into an agreement with a third party to provide information management services. Such services include managing and operating certain automated information systems as well as providing programming support and the development of certain software applications.\nThe agreement provides for an initial term of three years (expiring March 28, 1996) with two (2) two-year automatic renewals unless a 90-day notice of nonrenewal is given by either party. Net costs for the initial term approximate $416,000 per year. Other terms and conditions include a penalty provision should Anchor not continue the agreement through the automatic renewal periods.\nANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n14. CONTINGENCIES\nAnchor is subject to certain legal proceedings and claims arising in connection with the normal course of its business. It is management's opinion that the resolution of these claims will not have a material effect on Anchor's consolidated financial position.\nPKW, together with several other entities, had been named as a defendant in a lawsuit filed in 1993. In this suit, a former client claimed that PKW acted negligently when, as agent, wrote liability insurance with an insurance carrier that was subsequently declared insolvent. On October 13, 1995, PKW, without admitting any liability, agreed to a settlement of $50,000 in exchange for a complete release from all liability.\n15. RELATED PARTY TRANSACTIONS\nAnchor is contingently liable on certain bank loans made to three of its shareholders. The amounts outstanding on these loans total approximately $122,177 at December 31, 1995, and mature at various dates from November 20, 1996 to May 20, 1997.\n10% Convertible Subordinated Debentures, totaling $190,000 were sold to seven members of the Board of Directors and two shareholders. An additional $600,000 was raised by selling a second 10% Convertible Subordinated Debenture - Series A to Guarantee Life Insurance Company (a current shareholder). Total interest incurred and accrued under the debentures was $8,750 for the year ended December 31, 1995.","section_15":""}
{"filename":"84839_1995.txt","cik":"84839","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nSince the beginning of the calendar year, Rollins, Inc. and its subsidiaries have continued to operate and grow in the same principal services for homes and businesses.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nThe response to Item 1.(b) is incorporated by reference from the table under the caption \"Business Segment Information,\" on page 22 of the 1995 Annual Report to Stockholders.\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\n(1)(i) The Registrant is a national company with headquarters located in Atlanta, Georgia, providing services to both residential and commercial customers. The four primary services provided are termite and pest control, protective services, lawn care and plantscaping. Additionally, the revenues by business segment are incorporated by reference to the table under the caption \"Business Segment Information\" on page 22 of the 1995 Annual Report to Stockholders.\nOrkin Exterminating Company, Inc., a wholly owned subsidiary (Orkin), founded in 1901, is one of the world's largest termite and pest control companies. It provides customized services to approximately 1.6 million customers through a network of 386 branches serving customers in 49 states, the District of Columbia, the Bahamas, Canada, Mexico, and Puerto Rico. It provides customized pest control services to homes and businesses, including hotels, food service establishments, dairy farms and transportation companies. Orkin's continuous regular service provides protection against household pests, rodents and termites. Orkin's Lawn Care Division provides fertilization, weed and insect control, seeding, aeration of lawns, and tree and shrub care from 23 branches serving customers in nine states. Orkin's Plantscaping Division designs, installs and maintains green and flowering plants from ten branches and services customers in 21 states and the District of Columbia. It provides services to hotels, shopping malls, restaurants, and office buildings.\nRollins Protective Services, a division of the Registrant, was established in 1969. Services are provided from 51 branches serving customers in 41 states and the District of Columbia. A pioneer in developing customized wired and wireless electronic security systems, it provides full-service capabilities from system design and installation to maintenance and monitoring services. Full-service includes guaranteed maintenance programs, 24-hour emergency repairs, and 24-hour alarm monitoring services.\n(ii) The Registrant has made no announcement of, nor did any information become public about, a new line of business or product requiring the investment of a material amount of the Registrant's total assets.\n(iii) Sources and availability of raw materials present no particular problem to the Registrant, since its businesses are primarily in service-related industries.\n(iv) Governmental licenses, patents, trademarks and franchises are of minor importance to the Registrant's service operations. Local licenses and permits are required in order for the Registrant to conduct its termite and pest control, protective services, lawn care and plantscaping operations in certain localities. In view of the widespread operations of the Registrant's service operations, the failure of a few local governments to license a facility would not have a material adverse effect on the results of operations of the Registrant.\n(v) The business of the Registrant is affected by the seasonal nature of the Registrant's termite and pest control, lawn care and plantscaping service operations (Orkin Exterminating Company, Inc.). The metamorphosis of termites in the spring and summer (the occurrence of which is determined by the timing of the change in seasons) has historically resulted in an increase in the revenue and income of the Registrant's termite and pest control operations during such period. Lawn care services are seasonal and coincide with\nthe growing seasons of lawns. Plantscaping operations experience seasonal increases in revenues and operating income generated by the division's Exterior Color and Holiday programs offered during the spring and late fall.\n(vi) Inapplicable.\n(vii) The Registrant and its subsidiaries do not have a material part of their business that is dependent upon a single customer or a few customers, the loss of which would have a material effect on the business of the Registrant.\n(viii) The dollar amount of service contracts and backlog orders as of the end of the Registrant's 1995 and 1994 calendar years was approximately $15,508,000 and $16,063,000, respectively. Backlog services and orders are usually provided within the month following the month of receipt, except in the area of prepaid pest control and alarm monitoring where services are usually provided within twelve months of receipt.\n(ix) Inapplicable.\n(x) The Registrant believes that each of its businesses competes favorably with competitors within its respective area. Orkin Exterminating Company, Inc. is one of the world's largest termite and pest control companies. Rollins Protective Services is a pioneer and one of the leaders in residential and commercial security. Orkin Lawn Care is one of the largest lawn care companies. Orkin Plantscaping is the industry's second largest company with operations in ten major markets.\nThe principal methods of competition in the Registrant's termite and pest control business are service and guarantees, including the money-back guarantee on termite and pest control, and the termite retreatment and damage repair guarantee to qualified homeowners. Competition in the plantscaping and lawn care businesses is based on providing customized services together with guarantees, with the Registrant offering the same money-back guarantee for the services. The principal method of competition in the residential protection business of the Registrant is the provision of customized emergency protection services to meet the particular needs of each customer.\n(xi) Expenditures by the Registrant on research activities relating to the development of new products or services are not significant. Some of the new and improved service methods and products are researched, developed and produced by unaffiliated universities and companies. Also a portion of these methods and products are produced to the specifications provided by the Registrant.\n(xii) The capital expenditures, earnings and competitive position of the Registrant and its subsidiaries 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 the protection of the environment.\n(xiii) The number of persons employed by the Registrant and its subsidiaries as of the end of 1995 was 8,956.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.\nInapplicable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Registrant's administrative headquarters and central warehouse, both of which are owned by the Registrant, are located at 2170 Piedmont Road, N.E., Atlanta, Georgia 30324. The Registrant owns or leases several hundred branch offices and operating facilities used in its businesses. None of the branch offices, individually considered, represents a materially important physical property of the Registrant. The facilities are suitable and adequate to meet the current and reasonably anticipated future needs of the Registrant.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nDuring November 1995, Orkin and the Attorney General of Missouri and private plaintiffs reached an agreement in settlement of a class action regarding treatments for termites for residential customers with basement homes contracted for between January 1, 1987 and May 15, 1993. The Attorney General and the\nprivate plaintiffs raised concerns that Orkin's initial termite protection treatment for these customers was incomplete. Orkin maintains that its customers have received treatment consistent with industry practices. In order to best serve its customers and to avoid the continued expense of litigation, Orkin has agreed to reinspect the basement homes of all applicable customers and apply additional termiticide, if needed. In the event a customer covered by this agreement has suffered termite damage as a result of insufficient termiticide, Orkin has agreed to repair the customer's basement home. The presiding judge of the Circuit Court of the City of St. Louis approved the settlement on December 13, 1995. The resolution does not constitute an admission of wrongdoing by the Company and did not have a material adverse effect on the Company's financial position, results of operations, or liquidity.\nIn the normal course of business, the Company is a defendant in a number of lawsuits which allege that plaintiffs have been damaged as a result of the rendering of services by Company personnel and equipment. The Company is actively contesting these actions. It is the opinion of Management that the outcome of these actions will not have a material adverse effect 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.\nInapplicable.\nITEM 4.A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nEach of the executive officers of the Registrant was elected by the Board of Directors to serve until the Board of Directors' meeting immediately following the next annual meeting of stockholders or until his earlier removal by the Board of Directors or his resignation. The following table lists the executive officers of the Registrant and their ages, offices with the Registrant, and the dates from which they have continually served in their present offices with the Registrant.\n- ------------------------ (1) R. Randall Rollins and Gary W. Rollins are brothers.\n(2) Gene L. Smith served as the Registrant's Vice President of Finance for the period 12\/30\/85 to 1\/21\/91.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nInformation containing dividends and stock prices on page 12 and the principal markets on which common shares are traded on page 25 of the 1995 Annual Report to Stockholders are incorporated herein by reference. The number of stockholders of record on December 31, 1995 was 3,764.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected Financial Data on pages 10 and 11 of the 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.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations included on pages 13 through 15 of the 1995 Annual Report to Stockholders is incorporated herein by reference. The effects of inflation on operations were not material for the periods being reported.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe following consolidated financial statements and supplementary data of the Registrant and its consolidated subsidiaries, included in the 1995 Annual Report to Stockholders, are incorporated herein by reference.\nFinancial Statements:\nStatements of Income for each of the three years in the period ended December 31, 1995, page 17.\nStatements of Earnings Retained for each of the three years in the period ended December 31, 1995, page 17.\nStatements of Financial Position as of December 31, 1995 and 1994, page 16.\nStatements of Cash Flows for each of the three years in the period ended December 31, 1995, page 18.\nNotes to Financial Statements, pages 19 through 23.\nReport of Independent Auditors, page 24.\nSupplementary Data:\nQuarterly Information, page 12.\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 response to Item 10, applicable to the Directors of the Registrant, is incorporated herein by reference to the information set forth under the caption \"Election of Directors\" in the Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996. Additional information concerning executive officers is included in Part I, Item 4.A. of this Form 10-K.\nBased solely on its review of copies of forms received by it pursuant to Section 16(a) of the Securities Exchange Act of 1934, as amended, or written representations from certain reporting persons, Registrant believes that during the fiscal year ended December 31, 1995 all filing requirements applicable to its officers, directors, and greater than 10% stockholders were complied with.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe response to Item 11 is incorporated herein by reference to the information set forth under the caption \"Executive Compensation\" in the Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe response to Item 12 is incorporated herein by reference to the information set forth under the captions \"Capital Stock\" and \"Election of Directors\" in the Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe section entitled \"Compensation Committee Interlocks and Insider Participation\" and \"Executive Compensation\" in the Proxy Statement for the Annual Meeting of Stockholders to be held April 23, 1996, and related footnotes and information are incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nThe following are filed as part of this report:\n(a) 1. Financial Statements\nThe following financial statements are incorporated herein by reference to portions of the 1995 Annual Report to Stockholders included with this Form 10-K:\nStatements of Income for each of the three years in the period ended December 31, 1995, page 17.\nStatements of Earnings Retained for each of the three years in the period ended December 31, 1995, page 17.\nStatements of Financial Position as of December 31, 1995 and 1994, page 16.\nStatement of Cash Flows for each of the three years in the period ended December 31, 1995, page 18.\nNotes to Financial Statements, pages 19 through 23.\nReport of Independent Auditors, page 24.\n(a) 2. Financial Statement Schedule\nII Valuation and Qualifying Accounts\nSchedules not listed above have been omitted as either not applicable, immaterial or disclosed in the financial statements or notes thereto.\n(a) 3. Exhibits (3)(i) The Company's Certificate of Incorporation is incorporated herein by reference to Exhibit (3)(a) as filed with its Form 10-K for the year ended December 31, 1992.\n(ii) By-laws of Rollins, Inc. are incorporated herein by reference to Exhibit 3(b) as filed with its Form 10-K for the year ended December 31, 1993.\n(10) Rollins, Inc. 1984 Employee Incentive Stock Option Plan is incorporated herein by reference to Exhibit (10) filed with the Company's Form 10-K for the year ended December 31, 1991.\nRollins, Inc. 1994 Employee Stock Incentive Plan is incorporated herein by reference to Exhibit A of the March 18, 1994 Proxy Statement for the Annual Meeting of Stockholders held on April 26, 1994.\n(13) Portions of the Annual Report to Stockholders for the year ended December 31, 1995 which are specifically incorporated herein by reference.\n(21) Subsidiaries of Registrant.\n(23) Consent of Independent Public Accountants.\n(24) Powers of Attorney for Directors.\n(27) Financial Data Schedule.\n(b) No reports on Form 8-K were required to be filed by the Company for the quarter 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.\nROLLINS, INC.\nBy: \/s\/ R. RANDALL ROLLINS\n----------------------------------- R. Randall Rollins Chairman of the Board of Directors (Principal Executive Officer) March 27, 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.\nThe Directors of Rollins, Inc. (listed below) executed a power of attorney appointing Gary W. Rollins their attorney-in-fact, empowering him to sign this report on their behalf.\nWilton Looney, Director John W. Rollins, Director Henry B. Tippie, Director James B. Williams, Director Bill J. Dismuke, Director\n\/s\/ GARY W. ROLLINS - ---------------------------------- Gary W. Rollins, As Attorney-in-Fact & Director, President and Chief Operating Officer March 27, 1996\nROLLINS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nCONSOLIDATED FINANCIAL STATEMENTS OF ROLLINS, INC. AND SUBSIDIARIES:\nThe Registrant's 1995 Annual Report to Stockholders, portions of which are filed with this Form 10-K, contains on pages 16 through 24 the consolidated financial statements for the years ended December 31, 1995, 1994 and 1993 and the report of Arthur Andersen LLP on the financial statements for the years then ended. These financial statements and the report of Arthur Andersen LLP are incorporated herein by reference. The financial statements include the following:\nStatements of Income for each of the three years in the period ended December 31, 1995.\nStatements of Earnings Retained for each of the three years in the period ended December 31, 1995.\nStatements of Financial Position as of December 31, 1995 and 1994.\nStatements of Cash Flows for each of the three years in the period ended December 31, 1995.\nNotes to Financial Statements.\nREPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULE, Page 9. SCHEDULE\nSchedules not listed above have been omitted as either not applicable, immaterial or disclosed in the financial statements or notes thereto.\nREPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULE\nTo the Directors and the Stockholders of Rollins Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Rollins, Inc.'s annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 12, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14 of this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the 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\nAtlanta, Georgia February 12, 1996\nROLLINS, INC. AND SUBSIDIARIES SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS OF DOLLARS)\n- ------------------------ NOTE: (1) Deductions represent the write-off of uncollectible receivables, net of recoveries.\n(2) Includes a Special Charge of $12,000,000 ($7,440,000 after tax benefit or $.21 per share) relating to the write off of doubtful accounts at September 30, 1995, in the consumer finance operation, Rollins Acceptance Company.\nEXHIBITS\nEXHIBIT INDEX","section_15":""}
{"filename":"714909_1995.txt","cik":"714909","year":"1995","section_1":"ITEM 1. Business\nParker & Parsley 82-I, Ltd. (the \"Registrant\") is a limited partnership organized in 1982 under the laws of the State of Texas. The managing general partner is Parker & Parsley Development L.P. (\"PPDLP\") and its co-general partner is P&P Employees 82-I, Ltd., a Texas limited partnership (\"EMPL\"). PPDLP's general partner is Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"). The managing general partner during the year ended December 31, 1994 was Parker & Parsley Development Company (\"PPDC\"). PPDC was merged into PPDLP on January 1, 1995. See Item 12 (c).\nA Registration Statement, as amended, filed pursuant to the Securities Act of 1933, registering limited partnership interests aggregating $33,000,000 in a series of Texas limited partnerships formed under the Parker & Parsley 82 Drilling Program, was declared effective by the Securities and Exchange Commission on February 4, 1982. On June 1, 1982, the offering of limited partnership interests in the Registrant, the first partnership formed under such registration statement, was closed, with interests aggregating $9,782,000 being sold to 624 subscribers.\nThe Registrant engages primarily in oil and gas exploration, development and production and is not involved in any industry segment other than oil and gas. See \"Item 6. Selected Financial Data\" and \"Item 8. Financial Statements and Supplementary Data\" of this report for a summary of the Registrant's revenue, income and identifiable assets.\nThe principal markets during 1995 for the oil produced by the Registrant were refineries and oil transmission companies that have facilities near the Registrant's oil producing properties. The principal markets for the Registrant's gas were companies that have pipelines located near the Registrant's gas producing properties. Of the Registrant's oil and gas revenues for 1995, approximately 69% was attributable to sales made to Phibro Energy, Inc.\nBecause of the demand for oil and gas, the Registrant does not believe that the termination of the sales of its products to any one customer would have a material adverse impact on its operations. The loss of a particular customer for gas may have an effect if that particular customer has the only gas pipeline located in the areas of the Registrant's gas producing properties. The Registrant believes, however, that the effect would be temporary, until alternative arrangements could be made.\nFederal and state regulation of oil and gas operations generally includes the fixing of maximum prices for regulated categories of natural gas, the imposition of maximum allowable production rates, the taxation of income and other items, and the protection of the environment. Although the Registrant believes that its business operations do not impair environmental quality and that its costs of complying with any applicable environmental regulations are not currently significant, the Registrant cannot predict what, if any, effect these environmental regulations may have on its current or future operations.\nThe Registrant does not have any employees of its own. PPUSA employs 623 persons, many of whom dedicated a part of their time to the conduct of the Registrant's business during the period for which this report is filed. The Registrant's managing general partner, PPDLP through PPUSA, supplies all management functions.\nNo material part of the Registrant's business is seasonal and the Registrant conducts no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Registrant's properties consist primarily of leasehold interests in properties on which oil and gas wells are located. Such property interests are often subject to landowner royalties, overriding royalties and other oil and gas leasehold interests.\nFractional working interests in developmental and exploratory oil and gas prospects located in Texas and New Mexico were acquired by the Registrant, resulting in the Registrant's participation in the drilling of 34 oil and gas wells. Six were completed as dry holes from previous periods, one well was plugged and abandoned in 1993 due to unprofitable operations and one well was sold in 1995. At December 31, 1995, 26 wells were producing,\nFor information relating to the Registrant's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities for the years then ended, see Note 7 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below. Such reserves have been estimated by the engineering staff of PPUSA with a review by an independent petroleum consultant.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Registrant is a party to material litigation which is described in Note 9 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\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\nAt March 8, 1996, the Registrant had 4,891 outstanding limited partnership interests held of record by 670 subscribers. There is no established public trading market for the limited partnership interests. Under the limited partnership agreement, PPDLP has made certain commitments to purchase partnership interests at a computed value.\nRevenues which, in the sole judgement of the managing general partner, are not required to meet the Registrant's obligations are distributed to the partners at least quarterly in accordance with the limited partnership agreement. During the years ended December 31, 1995 and 1994, distributions of $200,344 and $156,143, respectively, were made to the limited partners.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe following table sets forth selected financial data for the years ended December 31: 1995 1994 1993 1992 1991 ---------- ---------- ---------- ---------- ---------- Operating results: Oil and gas sales $ 613,929 $ 636,470 $ 778,497 $ 880,424 $ 990,973 ========= ========= ========= ========= ======== Litigation settle- ment, net $ - $ - $ 458,778 $ - $ - ========= ========= ========= ========= ========= Impairment of oil and gas properties $ 20,719 $ - $ - $ - $ - ========= ========= ========= ========= ========= Net income $ 34,081 $ 102,033 $ 590,151 $ 237,784 $ 310,625 ========= ========= ========= ========= ========= Allocation of net income (loss): General partners $ 35,122 $ 45,462 $ 166,204 $ 86,448 $ 107,879 ========= ========= ========= ========= ========= Limited partners $ (1,041) $ 56,571 $ 423,947 $ 151,336 $ 202,746 ========= ========= ========= ========= ========= Limited partners' net income (loss) per limited part- nership interest $ (.21) $ 11.57 $ 86.68 $ 30.94 $ 41.45 ========= ========= ========= ========= ========= Limited partners' cash distributions per limited part- nership interest $ 40.96 $ 31.92 $ 126.59(a)$ 67.43 $ 87.44 ========= ========= ========= ========= ========= At year end: Total assets $1,585,711 $1,786,274 $1,888,277 $2,104,650 $2,306,465 - - --------------- ========= ========= ========= ========= ========= (a) Including litigation settlement per limited partnership interest of $73.44 in 1993. 4\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\nThe Registrant's 1995 oil and gas revenues decreased to $613,929 from $636,470 in 1994, a decrease of 4%. The decrease in revenues resulted from a 2% decline in the average price received per mcf of gas, offset by an 8% increase in the price received per barrel of oil, an 8% decrease in barrels of oil produced and sold and a 7% decrease in mcf of gas produced and sold. In 1995, 25,404 barrels of oil were sold compared to 27,699 in 1994, a decrease of 2,295 barrels. In 1995, 103,030 mcf of gas were sold compared to 110,979 in 1994, a decrease of 7,949 mcf. The decreases in production volumes were primarily due to the decline characteristics of the Registrant's oil and gas properties. Because of these characteristics, management expects a certain amount of decline in production to continue in the future until the Registrant's economically recoverable reserves are fully depleted.(1)\nThe average price received per barrel of oil increased $1.26 from $16.01 in 1994 to $17.27 in 1995. The average price received per mcf of gas decreased from $1.74 in 1994 to $1.70 in 1995. The market price for oil and gas has been extremely volatile in the past decade, and management expects a certain amount of volatility to continue in the foreseeable future.(1) The Registrant may therefore sell its future oil and gas production at average prices lower or higher than that received in 1995.(1)\nA gain of $1,170 from the sale of one fully depleted property was recognized during 1995, resulting from proceeds received from post closing adjustments made after the effective date of sale.\nTotal costs and expenses increased in 1995 to $587,197 as compared to $538,471 in 1994, an increase of $48,726, or 9%. The increase was primarily due to the impairment of oil and gas properties during 1995, in addition to increases in production costs and depletion, offset by a decline in general and administrative expenses (\"G&A\").\nProduction costs were $387,418 in 1995 and $380,001 in 1994, resulting in a $7,417 increase, or 2%. The increase was due to additional well repair and maintenance costs incurred in an effort to stimulate production.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 15% from $25,164 in 1994 to $21,267 in 1995. The Registrant paid the managing general partner $18,418 in 1995 and $19,094 in 1994 for G&A incurred on behalf of the Registrant. G&A is allocated, in part, to the Registrant by the managing general partner. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Registrant relative to the managing general\npartner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.(1)\nDepletion was $157,793 in 1995 compared to $133,306 in 1994. This represented an increase of $24,487, or 18%. Depletion was computed property-by-property utilizing the unit-of-production method based upon the dominant mineral produced, generally oil. Oil production decreased 2,295 barrels in 1995 from 1994, while oil reserves of barrels were revised upward by 61,976 barrels, or 21%.\nEffective for the fourth quarter of 1995 the Registrant adopted Statement of Financial Accounting Standards No. 121 - Accounting for Impairment of Long-Lived Assets (\"SFAS 121\") which requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, 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 of recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment is recognized based on the asset's fair value as determined for oil and gas properties by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result of the natural gas price environment and the Registrant's expectation of future cash flows from its oil and gas properties at the time of review, the Registrant recognized a non-cash charge of $20,719 associated with the adoption of SFAS 121.\n1994 compared to 1993\nThe Registrant's 1994 oil and gas revenues decreased to $636,470 from $778,497 in 1993, a decrease of 18%. The decrease in revenues resulted from a decrease of 7% in the average price received per barrel of oil, a 12% decline in the average price received per mcf of gas, combined with a 13% decrease in barrels of oil produced and sold and a 6% decrease in mcf of gas produced and sold. In 1994, 27,699 barrels of oil were sold compared to 31,709 in 1993, a decrease of 4,010 barrels. In 1994, 110,979 mcf of gas were sold compared to 117,576 in 1993, a decrease of 6,597 mcf. The decreases in production volumes were primarily due to the decline characteris tics of the Registrant's oil and gas properties.\nThe average price received per barrel of oil decreased $1.22 from $17.23 in 1993 to $16.01 in 1994. The average price received per mcf of gas decreased from $1.98 in 1993 to $1.74 in 1994.\nTotal costs and expenses decreased in 1994 to $538,471 as compared to $651,830 in 1993, a decrease of $113,359, or 17%. The decrease was due to a decline in production costs, abandoned property costs, G&A and depletion.\nProduction costs were $380,001 in 1994 and $413,665 in 1993, resulting in a $33,664 decrease, or 8%. The decrease was due to declines in well repair and maintenance costs, ad valorem taxes and production taxes due to the decline in oil and gas sales.\nAbandoned property costs were $50,806 in 1993 compared to no related costs in 1994. This decrease was due to the plugging of one well in 1993 and no abandonment activity in 1994.\nG&A's components are independent accounting and engineering fees, computer services, postage and managing general partner personnel costs. During this period, G&A decreased, in aggregate, 6% from $26,800 in 1993 to $25,164 in 1994. The Registrant paid the managing general partner $19,094 in 1994 and $23,355 in 1993 for G&A incurred on behalf of the Registrant.\nDepletion was $133,306 in 1994 compared to $160,559 in 1993. This represented a decrease of $27,253, or 17%. Oil production decreased 4,010 barrels in 1994 from 1993, while oil reserves of barrels were revised downward by 46,824 barrels, or 13%.\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Registrant filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ-Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Registrant and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Registrant, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest, determined the general partner's portion of the funds and calculated any inter-partnership allocations. A distribution of $91,000,000 was made to the working interest owners, including the Registrant, on July 30, 1993. The limited partners received their distribution of $359,173, or $73.44 per limited partnership interest, in September 1993.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff partnerships, including the Registrant and others, alleging his entitlement to 12% of the settlement proceeds. Price's lawsuit claim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Registrant and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court.\nOn September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Registrant, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal\nof the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Registrant is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Registrant and other joint property owners for participating in the lawsuit pursuant to the joint operating agree ment. Litigation settlement proceeds received by the Registrant, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993.\nImpact of inflation and changing prices on sales and net income\nInflation impacts the fixed overhead rate charges of the lease operating expenses for the Registrant. During 1993, the annual change in the index of average weekly earnings of crude petroleum and gas production workers issued by the U.S. Department of Labor, Bureau of Labor Statistics, decreased by 1.1%. The 1994 annual change in average weekly earnings increased by 4.8%. The 1995 index (effective April 1, 1995) increased 4.4%. The impact of inflation for other lease operating expenses is small due to the current economic condition of the oil industry.\nThe oil and gas industry experienced volatility during the past decade because of the fluctuation of the supply of most fossil fuels relative to the demand for such products and other uncertainties in the world energy markets causing significant fluctuations in oil and gas prices. Since December 31, 1993, prices for oil production have fluctuated throughout the year. The price per barrel for oil production similar to the Registrant's ranged from approximately $16.00 to $19.00. For February 1996, the average price for the Registrant's oil was approximately $18.00.\nPrices for natural gas are subject to ordinary seasonal fluctuations, and this volatility of natural gas prices may result in production being curtailed and, in some cases, wells being completely shut-in.(1)\nLiquidity and capital resources\nNet Cash Provided by Operating Activities\nNet cash provided by operating activities increased to $245,319 during the year ended December 31, 1995, a 3% increase from the year ended December 31, 1994. This increase was due to reduced production costs, offset by a decrease in oil and gas sales and G&A. Production costs decreased due to less well repair and maintenance costs. Oil and gas sales declined due to a decrease in oil and gas production and a decrease in the average price received per mcf of gas, offset by an increase in the average price received per barrel of oil. G&A decreased due to less allocated expenses by the managing general partner in 1995 compared to 1994.\nNet Cash Provided by Investing Activities\nThe Registrant's investing activities during 1995 was for expenditures related to repair and maintenance activity on various oil and gas properties.\nProceeds of $1,170 were received from the sale of one oil and gas property during 1995.\nNet Cash Used in Financing Activities\nCash was sufficient in 1995 for distributions to the partners of $263,066 of which $200,344 was distributed to the limited partners and $62,722 to the general partners. In 1994, cash was sufficient for distributions to the partners of $212,085 of which $156,143 was distributed to the limited partners and $55,942 to the general partners.\nIt is expected that future net cash provided by operations will be sufficient for any capital expenditures and any distributions.(1) As the production from the properties declines, distributions are also expected to decrease.(1)\n- - ---------------\n(1) This statement is a forward looking statement that involves risks and uncertainties. Accordingly, no assurances can be given that the actual events and results will not be materially different than the anticipated results described in the forward looking statement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Registrant's audited financial statements are included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nThe Registrant does not have any officers or directors. Under the limited partnership agreement, the Registrant's managing general partner, PPDLP, is granted the exclusive right and full authority to manage, control and administer the Registrant's business. PPUSA, the sole general partner of PPDLP, is a wholly-owned subsidiary of Parker & Parsley Petroleum Company (the \"Company\"), a publicly-traded corporation on the New York Stock Exchange.\nSet forth below are the names, ages and positions of the directors and executive officers of PPUSA. Directors of PPUSA are elected to serve until the next annual meeting of stockholders or until their successors are elected and qualified.\nAge at December 31, Name 1995 Position\nScott D. Sheffield 43 Chairman of the Board and Director\nJames D. Moring (a) 59 President, Chief Executive Officer and Director\nTimothy A. Leach 36 Executive Vice President and Director\nSteven L. Beal 36 Senior Vice President, Treasurer and Chief Financial Officer\nMark L. Withrow 48 Senior Vice President and Secretary\n- - --------------- (a) Mr. Moring retired from the Company and subsidiaries effective January 1, 1996. Mr. Sheffield assumed the positions of President and Chief Executive Officer of PPUSA effective January 1, 1996.\nScott D. Sheffield. Mr. Sheffield, a graduate of The University of Texas with a Bachelor of Science degree in Petroleum Engineering, has been the President and a Director of the Company since May 1990 and has been the Chairman of the Board and Chief Executive Officer since October 1990. Mr. Sheffield joined PPDC, the principal operating subsidiary of the Company, as a petroleum engineer in 1979. Mr. Sheffield served as Vice President - Engineering of PPDC from September 1981 until April 1985 when he was elected President and a Director of PPDC. In March 1989, Mr. Sheffield was elected Chairman of the Board and Chief Executive Officer of PPDC. On January 1, 1995, Mr. Sheffield resigned as President and Chief Executive Officer of PPUSA, but remained Chairman of the Board and a Director of PPUSA. On January 1, 1996, Mr. Sheffield reassumed the positions of President and Chief Executive Officer of PPUSA. Before joining PPDC, Mr. Sheffield was principally occupied for more than three years as a production and reservoir engineer for Amoco Production Company.\nJames D. Moring. Mr. Moring, a graduate of Texas Tech University with a Bachelor of Science degree in Petroleum Engineering has been a Director of the Company since October 1990 and was Senior Vice President - Operations of the Company from October 1990 until May 1993, when he was appointed Executive Vice President - Operations. Mr. Moring has been principally occupied since July 1982 as the supervisor of the drilling, completion, and production operations of PPDC and its affiliates and has served as an officer of PPDC since January 1983. Mr. Moring has been Senior Vice President - Operations and a Director of PPDC since June 1989 and in May 1993, Mr. Moring was appointed Executive Vice President - Operations. Mr. Moring was elected President and Director and appointed Chief Executive Officer of PPUSA on January 1, 1995. Effective January 1, 1996, Mr. Moring retired from the Company and subsidiaries. In the five years before joining PPDC, Mr. Moring was employed as a Division Operations Manager with Moran Exploration, Inc. and its predecessor.\nTimothy A. Leach. Mr. Leach, a graduate of Texas A&M University with a Bachelor of Science degree in Petroleum Engineering and the University of Texas of the Permian Basin with a Master of Business Administration degree, was elected Executive Vice President - Engineering of the Company on March 21, 1995. Mr. Leach had been serving as Senior Vice President Engineering since March 1993 and served as Vice President - Engineering of the Company from October 1990 to March 1993. Mr. Leach was elected Executive Vice President of PPUSA on December 1, 1995. He had joined PPDC as Vice President - Engineering in September 1989. Prior to joining PPDC, Mr. Leach was employed as Senior Vice President and Director of First City Texas - Midland, N.A.\nSteven L. Beal. Mr. Beal, a graduate of the University of Texas with a Bachelor of Business Administration degree in Accounting and a certified public accountant, was elected Senior Vice President - Finance of the Company in January 1995 and Chief Financial Officer of the Company on March 21, 1995. On January 1, 1995, Mr. Beal was elected Senior Vice President, Treasurer and Chief Financial Officer of PPUSA. Mr. Beal has been the Company's Chief Accounting officer since November 1992 and been the Company's Treasurer since October 1990. Mr. Beal joined PPDC as Treasurer in March 1988 and was elected Vice President - Finance in October 1991. Prior to joining PPDC, Mr. Beal was employed as an audit manager of Price Waterhouse.\nMark L. Withrow. Mr. Withrow, a graduate of Abilene Christian University with Bachelor of Science degree in Accounting and Texas Tech University with a Juris Doctorate degree, was Vice President - General Counsel of the Company from February 1991 to January 1995, when he was appointed Senior Vice President - General Counsel, and has been the Company's Secretary since August 1992. On January 1, 1995, Mr. Withrow was elected Senior Vice President and Secretary of PPUSA. Mr. Withrow joined PPDC in January 1991. Prior to joining PPDC , Mr. Withrow was the managing partner of the law firm of Turpin, Smith, Dyer, Saxe & MacDonald, Midland, Texas.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Registrant does not have any directors or officers. Management of the Registrant is vested in PPDLP, the managing general partner. Under the\nPartnership agreement, PPDLP pays 8% of the Registrant's acquisition, drilling and completion costs and 20% of its operating and general and administrative expenses. In return, PPDLP is allocated 20% of the Registrant's revenues. See Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below for information regarding fees and reimbursements paid to the managing general partner or its affiliates by the Registrant.\nEMPL is a co-general partner of the Registrant. Under this arrangement, EMPL pays 2% of the Registrant's acquisition, drilling and completion costs and 5% of its operating and general and administrative expenses. In return, EMPL is allocated 5% of the Registrant's revenues. EMPL does not receive any fees or reimbursements from the Registrant.\nThe Registrant does not directly pay any salaries of the executive officers of PPUSA, but does pay a portion of PPUSA's general and administrative expenses of which these salaries are a part. See Note 6 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Beneficial owners of more than five percent\nThe Registrant is not aware of any person who beneficially owns 5% or more of the outstanding limited partnership interests of the Registrant. PPDLP and EMPL respectively own 80% and 20% of the general partners' interests in the Registrant. PPDLP owned 497 limited partner interests at January 1, 1996.\n(b) Security ownership of management\nThe Registrant does not have any officers or directors. The managing general partner of the Registrant, PPDLP, has the exclusive right and full authority to manage, control and administer the Registrant's business. Under the limited partnership agreement, limited partners holding a majority of the outstanding limited partnership interests have the right to take certain actions, including the removal of the managing general partner or any other general partner. The Registrant is not aware of any current arrangement or activity which may lead to such removal. The Registrant is not aware of any officer or director of PPUSA who beneficially owns limited partnership interests in the Registrant.\n(c) Changes in control\nOn January 1, 1995, PPDLP, a Texas limited partnership, became the sole managing general partner of Parker & Parsley 82-I, Ltd., as a result of the merger into it of PPDC, a Delaware corporation, and an affiliate of PPDLP and the Company, which previously served as the managing general partner of the Registrant. PPDLP has, therefore, succeeded to all of the rights and obligations of PPDC and will manage and conduct the property, business and affairs of the Registrant, including the development drilling program in which the Registrant participates.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nTransactions with the managing general partner or its affiliates\nPursuant to the limited partnership agreement, the Registrant had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 -------- -------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $144,583 $146,503 $ 146,956\nReimbursement of general and administrative expenses $ 18,418 $ 19,094 $ 23,355\nPurchase of oil and gas properties and related equipment, at predecessor cost $ 249 $ - $ -\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ - $ - $ 37,363\nUnder the limited partnership agreement, the general partners, PPDLP and EMPL, together pay 10% of Registrant's acquisition, drilling and completion costs and 25% of its operating and general and administrative expenses. In return, they are allocated 25% of the Registrant's revenues. Twenty percent of the general partners' share of costs and revenues is allocated to EMPL and the remainder is allocated to PPDLP. Certain former affiliates of PPUSA are limited partners of EMPL. Also, see Notes 6 and 10 of Notes to Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" below, regarding the Registrant's participation with the managing general partner in oil and gas activities of the Registrant.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1. Financial statements\nThe following are filed as part of this annual report:\nIndependent Auditors' Report\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\n2. Financial statement schedules\nAll financial statement schedules have been omitted since the required information is in the financial statements or notes thereto, or is not applicable nor required.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits listed on the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.\nS I G N A T U R E S\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.\nPARKER & PARSLEY 82-I, LTD.\nDated: March 27, 1996 By: Parker & Parsley Development L.P., Managing General Partner\nBy: Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), General Partner\nBy: \/s\/ Scott D. Sheffield -------------------------------- Scott D. Sheffield, 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.\n\/s\/ Scott D. Sheffield President, Chairman of the Board, March 27, 1996 ------------------------ Chief Executive Officer and Scott D. Sheffield Director of PPUSA\n\/s\/ Timothy A. Leach Executive Vice President March 27, 1996 ------------------------ and Director of PPUSA Timothy A. Leach\n\/s\/ Steven L. Beal Senior Vice President, March 27, 1996 ------------------------ Treasurer and Chief Steven L. Beal Financial Officer of PPUSA\n\/s\/ Mark L. Withrow Senior Vice President and March 27, 1996 ------------------------ Secretary of PPUSA Mark L. Withrow\nINDEPENDENT AUDITORS' REPORT\nThe Partners Parker & Parsley 82-I, Ltd. (A Texas Limited Partnership):\nWe have audited the financial statements of Parker & Parsley 82-I, Ltd. as listed in the accompanying index under Item 14(a). 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 Parker & Parsley 82-I, Ltd. 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.\nAs discussed in Notes 2 and 3 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets and for long-lived assets to be disposed of in 1995 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\"\nKPMG Peat Marwick LLP\nMidland, Texas March 8, 1996\nPARKER & PARSLEY 82-I, LTD. (A Texas Limited Partnership)\nBALANCE SHEETS December 31\n1995 1994 ----------- ----------- ASSETS\nCurrent assets: Cash and cash equivalents, including interes bearing deposits of $82,469 in 1995 and $101,323 in 1994 $ 83,890 $ 101,573 Accounts receivable - oil and gas sales 62,586 67,204 ---------- ----------\nTotal current assets 146,476 168,777\nOil and gas properties - at cost, based on the successful efforts accounting method 10,409,464 10,496,709 Accumulated depletion (8,970,229) (8,879,212) ---------- ----------\nNet oil and gas properties 1,439,235 1,617,497 ---------- ----------\n$ 1,585,711 $ 1,786,274 ========== ==========\nLIABILITIES AND PARTNERS' CAPITAL\nCurrent liabilities: Accounts payable - affiliate $ 50,057 $ 21,635\nPartners' capital: Limited partners (4,891 interests) 1,277,125 1,478,510 General partners 258,529 286,129 ---------- ----------\n1,535,654 1,764,639 ---------- ----------\n$ 1,585,711 $ 1,786,274 ========== ==========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 82-I, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31\n1995 1994 1993 --------- --------- ---------- Revenues: Oil and gas sales $ 613,929 $ 636,470 $ 778,497 Interest income 6,179 3,752 4,550 Salvage income from equipment disposals - 282 156 Gain on sale of oil and gas properties 1,170 - - Litigation settlement, net - - 458,778 -------- -------- ---------\nTotal revenues 621,278 640,504 1,241,981\nCosts and expenses: Production costs 387,418 380,001 413,665 Abandoned property costs - - 50,806 General and administrative expenses 21,267 25,164 26,800 Depletion 157,793 133,306 160,559 Impairment of oil and gas propertie 20,719 - - -------- -------- ---------\nTotal costs and expenses 587,197 538,471 651,830 -------- -------- ---------\nNet income $ 34,081 $ 102,033 $ 590,151 ======== ======== =========\nAllocation of net income (loss): General partners $ 35,122 $ 45,462 $ 166,204 ======== ======== =========\nLimited partners $ (1,041) $ 56,571 $ 423,947 ======== ======== =========\nNet income (loss) per limited partnership interest $ (.21) $ 11.57 $ 86.68 ======== ======== =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 82-I, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nGeneral Limited partners partners Total ---------- ---------- ----------\nPartners' capital at January 1, 1993 $ 313,317 $1,773,283 $2,086,600\nDistributions (182,912) (619,148) (802,060)\nNet income 166,204 423,947 590,151 --------- --------- ---------\nPartners' capital at December 31, 1993 296,609 1,578,082 1,874,691\nDistributions (55,942) (156,143) (212,085)\nNet income 45,462 56,571 102,033 --------- --------- ---------\nPartners' capital at December 31, 1994 286,129 1,478,510 1,764,639\nDistributions (62,722) (200,344) (263,066)\nNet income (loss) 35,122 (1,041) 34,081 --------- --------- ---------\nPartners' capital at December 31, 1995 $ 258,529 $1,277,125 $1,535,654 ========= ========= =========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 82-I, LTD. (A Texas Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31\n1995 1994 1993 --------- --------- --------- Cash flows from operating activities: Net income $ 34,081 $ 102,033 $ 590,151 Adjustments to reconcile net income to net cash provided by operating activities: Depletion 157,793 133,306 160,559 Impairment of oil and gas properties 20,719 - - Salvage income from equipment disposals - (282) (156) Gain on sale of oil and gas properties (1,170) - - Changes in assets and liabilities: (Increase) decrease in accounts receivable 4,618 (5,345) 9,819 Increase (decrease) in accounts payable 29,278 8,049 (4,464) -------- -------- -------- Net cash provided by operating activities 245,319 237,761 755,909\nCash flows from investing activities: Additions to oil and gas properties (1,106) - (799) Proceeds from equipment salvage on abandoned property - - 35,645 Proceeds from sale of oil and gas properties 1,170 - - -------- -------- -------- Net cash provided by investing activities 64 - 34,846\nCash flows from financing activities: Cash distributions to partners (263,066) (212,085) (802,060) -------- -------- -------- Net increase (decrease) in cash and cash equivalents (17,683) 25,676 (11,305) Cash and cash equivalents at beginning of year 101,573 75,897 87,202 -------- -------- -------- Cash and cash equivalents at end of year $ 83,890 $ 101,573 $ 75,897 ======== ======== ========\nThe accompanying notes are an integral part of these statements.\nPARKER & PARSLEY 82-I, LTD. (A Texas Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNote 1. Organization and nature of operations\nParker & Parsley 82-I, Ltd. (the \"Partnership\") is a limited partnership organized in 1982 under the laws of the State of Texas.\nThe Partnership engages primarily in oil and gas exploration, development and production in Texas and New Mexico and is not involved in any industry segment other than oil and gas.\nNote 2. Summary of significant accounting policies\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\nImpairment of long-lived assets - Effective for the fourth quarter of 1995 the Partnership 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\"). Consequently, the Partnership reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows is less than the carrying amount of the assets. In this circumstance, the Partnership recognizes an impairment loss for the amount by which the carrying value of the asset exceeds the fair value of the asset.\nThe Partnership accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less costs to sell once management has committed to a plan to dispose of the assets.\nOil and gas properties - The Partnership utilizes the successful efforts method of accounting for its oil and gas properties and equipment. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized while nonproductive exploration costs are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method on a property-by-property basis based on proved oil (dominant mineral) reserves as determined by the engineering staff of Parker & Parsley Petroleum USA, Inc. (\"PPUSA\"), the sole general partner of Parker & Parsley Development L.P. (\"PPDLP\"), the Partnership's managing general partner, and reviewed by independent petroleum consultants. The carrying amounts of properties sold or otherwise disposed of and the related allowances for depletion are eliminated from the accounts and any gain or loss is included in operations.\nPrior to the adoption of SFAS 121 in the fourth quarter, the Partnership's aggregate oil and gas properties were stated at cost not in excess of total estimated future net revenues and the estimated fair value of oil and gas assets not being depleted.\nUse of estimates in the preparation of financial statements - Preparation of the accompanying 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 reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNet income (loss) per limited partnership interest - The net income (loss) per limited partnership interest is calculated by using the number of outstanding limited partnership interests.\nIncome taxes - A Federal income tax provision has not been included in the financial statements as the income of the Partnership is included in the individual Federal income tax returns of the respective partners.\nStatements of cash flows - For purposes of reporting cash flows, cash and cash equivalents include depository accounts held by banks.\nGeneral and administrative expenses - General and administrative expenses are allocated in part to the Partnership by the managing general partner or its affiliates. Such allocated expenses are determined by the managing general partner based upon its judgement of the level of activity of the Partnership relative to the managing general partner's activities and other entities it manages. The method of allocation has varied in certain years and may do so again depending on the activities of the managed entities.\nEnvironmental - The Partnership is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Partnership to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nNote 3. Impairment of long-lived assets\nThe Partnership adopted SFAS 21 effective for the fourth quarter of 1995. SFAS 121 requires that long-lived assets held and used by an entity, including oil and gas properties accounted for under the successful efforts method of accounting, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets to be disposed of are to be accounted for at the lower of carrying amount or fair value less cost to sell when management has\ncommitted to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 for fiscal years beginning after December 15, 1995.\nIn order to determine whether an impairment had occurred, the Partnership estimated the expected future cash flows of its oil and gas properties and compared such future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future cash flows, an impairment was determined to exist; therefore, the Partnership adjusted the carrying amount of those oil and gas properties to their fair value as determined by discounting their expected future cash flows at a discount rate commensurate with the risks involved in the industry. As a result, the Partnership recognized a non-cash charge of $20,719 related to its oil and gas properties during the fourth quarter of 1995.\nAs of December 31, 1995, management had not committed to sell any Partnership assets.\nNote 4. Income taxes\nThe financial statement basis of the Partnership's net assets and liabilities was $492,560 greater than the tax basis at December 31, 1995.\nThe following is a reconciliation of net income per statements of operations with the net income per Federal income tax returns for the years ended December 31: 1995 1994 1993 --------- --------- ---------\nNet income per statements of operations $ 34,081 $ 102,033 $ 590,151 Depletion and depreciation provisions for tax reporting purposes under amounts for financial reporting purposes 151,722 123,767 146,057 Impairment of oil and gas properties for financial reporting purposes 20,719 - - Abandonment costs for tax reporting purposes under amounts for financial reporting purposes - - 35,363 Other, net (86) (814) 2,272 -------- --------- -------- Net income per Federal income tax returns $ 206,436 $ 224,986 $ 773,843 ======== ========= ========\nNote 5. Oil and gas producing activities\nThe following is a summary of the costs incurred, whether capitalized or expensed, related to the Partnership's oil and gas producing activities for the years ended December 31: 1995 1994 1993 --------- --------- --------- Property acquisition costs $ - $ - $ 2,934 ======== ======== ======== Development costs $ 250 $ - $ 48,671 ======== ======== ========\nCapitalized oil and gas properties consist of the following:\n1995 1994 1993 ----------- ----------- ----------- Proved properties: Property acquisition costs $ 448,668 $ 456,246 $ 456,246 Completed wells and equipment 9,960,796 10,040,463 10,040,463 ---------- ---------- ---------- 10,409,464 10,496,709 10,496,709 Accumulated depletion (8,970,229) (8,879,212) (8,746,188) ---------- ---------- ----------\nNet capitalized costs $ 1,439,235 $ 1,617,497 $ 1,750,521 ========== ========== ==========\nDuring 1995, the Partnership recognized a non-cash charge of $20,719 associated with the adoption of SFAS 121. See Note 3.\nNote 6. Related party transactions\nPursuant to the limited partnership agreement, the Partnership had the following related party transactions with the managing general partner or its affiliates during the years ended December 31:\n1995 1994 1993 --------- --------- --------- Payment of lease operating and supervision charges in accordance with standard industry operating agreements $ 144,583 $ 146,503 $ 146,956\nReimbursement of general and administrative expenses $ 18,418 $ 19,094 $ 23,355\nPurchase of oil and gas properties and related equipment, at predecessor cost $ 249 $ - $ -\nReceipt of proceeds for the salvage value of retired oil and gas equipment $ - $ - $ 37,363\nPPDLP, P&P Employees 82-I, Ltd. (\"EMPL\") and the Partnership are parties to the Partnership agreement. EMPL is a limited partnership in which PPDLP owns 77.5% and the remaining portion is owned by former affiliates. PPDLP owned 497 limited partner interests at January 1, 1995.\nThe costs and revenues of the Partnership are allocated as follows:\nGeneral Limited partners partners -------- -------- Revenues: Proceeds from property dispositions prior to cost recovery 10% 90% All other Partnership revenues 25% 75%\nCosts and expenses: Lease acquisition costs, drilling and completion costs 10% 90% Operating costs, direct costs and general and administrative expenses 25% 75%\nNote 7. Oil and gas information (unaudited)\nThe following table presents information relating to the Partnership's estimated proved oil and gas reserves at December 31, 1995, 1994 and 1993 and changes in such quantities during the years then ended. All of the Partnership's reserves are proved and located within the United States. The Partnership's reserves are based on an evaluation prepared by the engineering staff of PPUSA and reviewed by an independent petroleum consultant, using criteria established by the Securities and Exchange Commission. Reserve value information is available to limited partners pursuant to the Partnership agreement and, therefore, is not presented.\nOil (bbls) Gas (mcf) ---------- ---------- Net proved reserves at January 1, 1993 399,375 1,600,653 Revisions of estimates of January 1, 1993 5,586 (42,877) Production (31,709) (117,576) ---------- ---------- Net proved reserves at December 31, 1993 373,252 1,440,200 Revisions of estimates of December 31, 1993 (46,824) (154,774) Production (27,699) (110,979) ---------- ---------- Net proved reserves at December 31, 1994 298,729 1,174,447 Revisions of estimates of December 31, 1994 61,976 222,702 Production (25,404) (103,030) ---------- ---------- Net proved reserves at December 31, 1995 335,301 1,294,119 ========== ==========\nThe estimated present value of future net revenues of proved reserves, calculated using December 31, 1995 prices of $19.16 per barrel of oil and $1.97 per mcf of gas, discounted at 10% was approximately $1,861,000 and undiscounted was $3,344,000 at December 31, 1995.\nThe Partnership emphasizes that reserve estimates are inherently imprecise and, accordingly, the estimates are expected to change as future information becomes available.\nNote 8. Major customers\nThe following table reflects the major customers of the Partnership's oil and gas sales during the years ended December 31:\n1995 1994 1993 ---- ---- ----\nPhibro Energy, Inc. 69% 67% 67% GPM Gas Corporation - 16% 17%\nPPDLP is party to a long-term agreement pursuant to which PPDLP and affiliates are to sell to Phibro Energy, Inc. (\"Phibro\") substantially all crude oil (including condensate) which any of such entities has the right to market from time to time. On December 29, 1995, PPDLP and Phibro entered into a Memorandum of Agreement (\"Phibro MOA\") that cancels the prior crude oil purchase agreement between the parties and provides for adjusted terms effective December 1, 1995. The price to be paid for oil purchased under the Phibro MOA is to be competitive with prices paid by other substantial purchasers in the same area who are significant competitors of Phibro. The price to be paid for oil purchased under the Phibro MOA also includes a market-related bonus that may vary from month to month based upon spot oil prices at various commodity trade points. The term of the Phibro MOA is through June 30, 1998, and it may continue thereafter subject to termination rights afforded each party. Although Phibro was required to post a $16 million letter of credit in connection with purchases under the prior agreement, it is anticipated that this security requirement will be replaced by a $25 million payment guarantee by Phibro's parent company, Salomon Inc. Accounts receivable-oil and gas sales included $36,802 due from Phibro at December 31, 1995.\nNote 9. Contingencies\nOn May 25, 1993, a final settlement agreement was negotiated, drafted and finally executed, ending litigation which had begun on September 5, 1989, when the Partnership filed suit along with other parties against Dresser Industries, Inc.; Titan Services, Inc.; BJ-Titan Services Company; BJ-Hughes Holding Company; Hughes Tool Company; Baker Hughes Production Tools, Inc.; and Baker Hughes Incorporated alleging that the defendants had intentionally failed to provide the materials and services ordered and paid for by the Partnership and other parties in connection with the fracturing and acidizing of 523 wells, and then fraudulently concealed the shorting practice from PPDLP. The May 25, 1993 settlement agreement called for a payment of $115 million in cash by the defendants, and Southmark, the Partnership, and the other plaintiffs indemnified the defendants against the claims of Jack N. Price. The managing general partner received the funds, deducted incurred legal expenses, accrued interest, determined the general partner's portion of the funds and calculated any inter-partnership allocations.\nOn May 3, 1993, Jack N. Price, the attorney who represented Gary G. \"Zeke\" Lancaster in the Federal Court lawsuit, filed suit in State Court in Beaumont against all of the plaintiff partnerships, including the Partnership and others, alleging his entitlement to 12% of the settlement proceeds. Price's lawsuit claim for approximately $13.8 million is predicated on a purported contract entered into with Southmark Corporation in August 1988 in which he allegedly binds the Partnership and the other defendants, as well as Southmark. Although PPDLP believes the lawsuit is without merit and intends to vigorously defend it, PPDLP is holding in reserve approximately 12.5% of the total settlement (the \"Reserve\") pending final resolution of the litigation by the court.\nOn September 20, 1995, the Beaumont trial judge entered a summary judgment against Southmark for the $13,790,000 contingent fee sought by Price, together with prejudgment interest, and also awarded Price an additional $5,498,525 in attorneys' fees. On January 22, 1996, the trial judge entered an interlocutory summary judgment against Dresser Industries and Baker Hughes for an amount yet to be determined. Pursuant to their indemnity obligations, the Partnership, Southmark, PPDLP and other original plaintiffs will vigorously pursue appeal when the final judgment is entered. Southmark is vigorously pursuing its appeal of the judgment, and has posted a supersedeas bond using the Reserve as collateral. Trial against the Partnership is currently scheduled for April 29, 1996.\nLegal expenses were incurred during 1989, 1990, 1991, 1992 and 1993 by the Partnership and other joint property owners for participating in the lawsuit pursuant to the joint operating agreement. Litigation settlement proceeds received by the Partnership, less legal expenses incurred in 1993, are recorded as litigation settlement, net in the accompanying statement of operations for the year ended December 31, 1993.\nA distribution of $91,000,000 was made to the working interest owners, including the Partnership, on July 30, 1993. The limited partners received their distribution of $359,173, or $73.44 per limited partnership interest, in September 1993. The allocation of the lawsuit settlement amount was based on the original verdict entered on October 26, 1990. The allocation to the working interest owners in each well (including the Partnership) was based on a ratio of the relative amount of damages due to overcharges for services and materials (\"Materials\") and damages for loss of past and future production (\"Production\"), each as determined in that initial judgment. Within the Partnership, damages for Materials were allocated between the partners based on their original sharing percentages for costs of acquiring and\/or drilling of wells. Similarly, damages related to Production were allocated to the partners in the Partnership based on their respective share of revenues from the subject wells (see Note 6).\nAs a condition of the purchase by Parker & Parsley Petroleum Company of Parker & Parsley Development Company (\"PPDC\"), which was merged into PPDLP on January 1, 1995 (see Note 10), from its former parent in May 1989, PPDC's interest in the lawsuit and subsequent settlement was retained by the former parent. Consequently, all of PPDC's share of the settlement related to its separately held interests in the wells and its partnership interests in the sponsored partnerships (except that portion allocable to interests acquired by PPDC after May 1989) was paid to the former parent.\nNote 10. Organization and operations\nThe Partnership was organized June 1, 1982 as a limited partnership under the Texas Uniform Limited Partnership Act for the purpose of acquiring and developing oil and gas properties. The following is a brief summary of the more significant provisions of the limited partnership agreement:\nGeneral partners - The general partners of the Partnership at December 31, 1994 were PPDC and EMPL. On January 1, 1995, PPDLP, a Texas limited partnership, became the managing general partner of the Partnership, by acquiring the rights and assuming the obligations of PPDC as the managing general partner of the Partnership. PPDC was merged into PPDLP on January 1, 1995. PPDLP's co-general partner is EMPL. PPDLP acquired PPDC's rights and obligations as managing general partner of the Partnership in connection with the merger of PPDC, P&P Producing, Inc. and Spraberry Development Corporation into MidPar L.P., which survived the merger with a change of name to PPDLP. PPDLP has the power and authority to manage, control and administer all Partnership affairs.\nLimited partner liability - The maximum amount of liability of any limited partner is the total contributions of such partner plus his share of any undistributed profits.\nInitial capital contributions - The limited partners entered into subscription agreements for aggregate capital contributions of $9,782,000. During 1985, the Partnership received a total of $1,372,500 from its limited partners in response to an assessment called by the general partner. Additionally, $650,000 was contributed by the managing general partner for limited partnership interests on unpaid assessments of which $500,000 was paid in 1985 and $150,000 in 1986. The general partners are required to contribute amounts equal to 10% of Partnership expenditures for lease acquisition, drilling and completion and 25% of direct, general and administrative and operating expenses, and by agreement must maintain a calculated minimum capital balance.\nPARKER & PARSLEY 82-I, LTD.\nINDEX TO EXHIBITS\nThe following documents are incorporated by reference in response to Item 14(c):\nExhibit No. Description Page\n3.1 Agreement of Limited Partnership of Parker - & Parsley 82-I, Ltd. incorporated by reference to Exhibit 4(e) of Registrant's Registration Statement on Form S-1 (Registration No. 2-75503A), as amended on February 4, 1982, the effective date thereof (hereinafter called, the Registration Statement)\n3.2 Amended and Restated Certificate of Limited - Partnership of Parker & Parsley 82-I, Ltd. incorporated by reference to Exhibit 3.2 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1983\n4.1 Form of Subscription Agreement and Power - of Attorney incorporated by reference to Exhibit 4(b) of the Registrant's Registration Statement\n4.2 Specimen Certificate of Limited Partnership - Interest incorporated by reference to Exhibit 4(d) of the Registrant's Registration Statement\n99.1 * Mutual Release and Indemnity Agreement dated May 25, 1993 -","section_15":""}
{"filename":"841692_1995.txt","cik":"841692","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nFSI International, Inc., a Minnesota corporation organized in 1973 (\"FSI\" or the \"Company\"), designs, manufactures, markets and supports microlithography, surface conditioning and chemical management equipment used in the fabrication of integrated circuits, which is the only industry segment in which the Company is presently engaged. The Company's microlithography product, the POLARIS(R) cluster, processes photoresist (light sensitive material used for patterning) on the surface of silicon wafers as part of the photolithography phase of the integrated circuit fabrication process. The Company's surface conditioning products, including the MERCURY(R) spray processing systems and the EXCALIBUR(R) vapor processing systems, remove contaminants and excess photoresist from wafers during the fabrication process and selectively remove oxide from the wafer surface. The process steps performed by the Company's microlithography and surface conditioning products, which are used repeatedly throughout the fabrication cycle, are an integral part of the manufacturing process for virtually every integrated circuit produced today. The Company's chemical management products, including its CHEMFILL(R), CHEMBLEND\/tm\/ and CHEMGEN\/tm\/ systems, perform the critical functions of blending, delivering and controlling the flow, concentration and purity of chemicals used by various types of processing equipment within a fabrication facility.\nAdvances in electronics technology in recent years have resulted in increasingly sophisticated integrated circuits which require submicron geometries and complex manufacturing processes. To meet the demand for these more complex, high performance devices, integrated circuit manufacturers require process technologies that are timely, reliable and readily integrated into high volume manufacturing environments. Competitive pressures are at the same time forcing integrated circuit manufacturers to reduce the costs of producing integrated circuits. FSI believes it responds to these demands by providing leading technology products that increase yields, integrate\nwith other suppliers' equipment and provide significant overall cost advantages. The Company's strategy is to remain focused as a technological leader in its three core markets, emphasizing close customer relationships that enhance the Company's responsiveness to the needs and cost constraints of its markets.\nThe Company markets its products directly in North America and primarily through a network of affiliated distributors in Europe, the Far East, and Japan. Through these affiliated international distributors the Company can provide timely and efficient worldwide customer service and support.\nDuring fiscal 1995, the Company completed two transactions which expanded its chemical management capabilities. In January of this year, FSI and its affiliated distributor Metron Technology B.V. (f\/k\/a Metron Semiconductors Europa B.V.) each acquired a 50% interest in FSI Metron Europe, Limited (\"FME\") located in Newhaven, England. FME manufactures, markets, and services chemical distribution systems, wet benches and portable clean rooms primarily for use by semiconductor device manufacturers.\nOn March 8, 1995, the Company acquired all of the outstanding capital stock of Applied Chemical Solutions (\"ACS\") and ACS became a wholly-owned subsidiary of the Company. Principal ACS products include chemical blending and delivery systems, point-of-use chemical generation systems and slurry mixing and delivery systems used in conjunction with chemical mechanical planarization, commonly referred to as CMP. ACS's operations are headquartered in Hollister, California.\nINDUSTRY BACKGROUND\nThe fabrication of integrated circuits is a complex process involving several distinct phases repeated numerous times during the fabrication process. Each production phase requires different processing technology and equipment, and no one semiconductor equipment supplier currently produces an entire state-of-the-art fabrication system. Rather, semiconductor device manufacturers typically construct fabrication facilities by combining manufacturing equipment produced by several different suppliers, each of which performs specific functions in the manufacturing process.\nDemand for new semiconductor production equipment is driven principally by the need for new processes and systems capable of manufacturing increasingly complex integrated circuits. Industries that utilize integrated circuits are demanding higher performance devices from semiconductor manufacturers. Over the last decade, technological advances have allowed integrated circuit manufacturers to reduce the size and substantially increase the number of transistors on each integrated circuit device. Today, 16 megabit dynamic random access memory (\"DRAM\") integrated circuits are manufactured using more than 200 process steps on six or eight inch diameter wafers and incorporating geometries of 0.5 micron. With high density logic devices and 64 megabit DRAMs that require geometries of less than 0.5 micron now under development, integrated circuit manufacturers require process technology advances that are timely, highly reliable, and readily implemented into high volume manufacturing environments.\nConcurrent with these technological advances, competitive pressures are forcing semiconductor manufacturers to reduce integrated circuit manufacturing costs. Because the capital cost of a large semiconductor fabrication facility is high, in some cases exceeding $1.0 billion, manufacturers have increased their focus on the various cost components of a semiconductor\nmanufacturing facility. This greater emphasis on total device processing cost has led manufacturers increasingly to analyze the costs associated with owning and operating each piece of process equipment in the manufacturing line (referred to as the \"cost of ownership\"), including capital cost, throughput, yield, up-time, consumables, start-up time, and other equipment related costs for each process step. In addition, the Company believes that in an effort to reduce total manufacturing costs and to reduce potential contaminant exposure as the wafer is transferred from one process step to another, manufacturers are increasingly seeking process equipment capable of being integrated with the process equipment of other suppliers to create a highly automated and integrated processing system.\nThe Company believes that semiconductor manufacturers are asking equipment suppliers to take an increasingly active role in meeting the manufacturer's technology requirements and cost constraints by developing and supporting the products and processes required to fabricate advanced semiconductor designs. Certain semiconductor manufacturers are seeking strategic relationships with equipment suppliers for specific process steps on existing and new integrated circuit designs. As a result, semiconductor equipment companies are being asked to provide advanced process expertise, superior product performance, reduced overall cost of ownership, and worldwide customer support to better meet the needs of integrated circuit manufacturers as well as meet international quality standards, such as ISO 9001 certification.\nINTEGRATED CIRCUIT FABRICATION\nThe basic component in the manufacture of integrated circuits is a thin, circular crystalline silicon wafer, typically three to eight inches in diameter. During the fabrication process, several layers of conductive or dielectric materials are sequentially grown or deposited on the wafer surface through a series of thermal and\/or chemical processes. These processes are conducted in a controlled environment, typically a \"clean room\" which is a manufacturing facility separated from the outside environment with separately controlled temperature and humidity and employing specialized filters designed to reduce the number of particulates in the air within the facility. Each layer undergoes a series of processes to etch a portion of the layer or change the electrical characteristics of the layer, leaving the desired integrated circuit pattern. The wafers are ultimately separated into individual integrated circuits or discrete components which are then packaged, assembled, and tested. The typical integrated circuit fabrication process takes between eight and twelve weeks. The primary stages of this process are discussed below.\nCleaning. The wafer surface must be cleaned and conditioned at the beginning of the fabrication process and at numerous other times throughout the process. Cleaning is generally performed by exposing the wafer to various chemicals in a liquid state, through immersion or spraying, or in a vapor state. As integrated circuit geometries become smaller and more complex, the reduction of organic, metal, and particle contamination on the wafer becomes an increasingly critical factor in improving the yields of wafer processing. In addition to contamination from particles left over from the various steps in the fabrication process, such as etching or stripping, contaminants may also be introduced from the equipment and chemicals utilized in the manufacturing process. FSI's surface conditioning products, including the MERCURY spray processors and the EXCALIBUR vapor processing systems, are designed to perform these cleaning functions throughout the integrated circuit fabrication process.\nLayering. Following cleaning and conditioning, a thin film of either conductive or dielectric material is grown or deposited on the wafer surface. Depending upon its particular electrical properties, each layer functions as an insulator, semiconductor or conductor.\nPlanarization. Recently, a new process step called chemical mechanical planarization, commonly referred to as CMP, has become important in semiconductor device manufacturing, particularly for advanced devices. The CMP process uses a chemical and mechanical polishing procedure with a slurry and pad to smooth the surface of a wafer after each layering step in the metal interconnect process. This smoothing, or planarization, is necessary to prevent extremes of topography which can reduce yield and reliability of semiconductor devices. Certain of the Company's chemical management systems are used to mix and deliver the slurry used in this process. The Company's MERCURY spray processing systems are used to remove the polishing grit from the surface of the wafer after CMP processing.\nPhotolithography. After the film layer is deposited on the wafer, the film is primed to promote the adhesion of a light sensitive material called photoresist. After the photoresist is applied, the wafer is heated in order to remove solvents from the photoresist. Integrated circuit patterns are then projected onto the photoresist by exposing it to a light source through a mask. Chemical changes occur in the portion of the photoresist exposed to the light source, resulting in a transfer of the image of the desired circuit into the photoresist on the wafer. After a circuit pattern has been imprinted, the image on the film is developed, which creates protected and unprotected areas. The developed photoresist is then baked at a high temperature to remove remaining solvents, improve adhesion to the wafer surface and harden the photoresist for subsequent processing. POLARIS clusters perform all photolithography functions except exposure.\nEtching or Doping. Upon completion of the photolithography process, the wafer is either etched or doped. During etching the unprotected areas of the patterned film are removed with chemicals to leave the desired circuit pattern. Etching can be accomplished with either a wet chemistry process using liquid chemicals, or a dry chemistry (typically plasma) process using chemical gases or vapors. With advanced devices, most pattern etching is performed using a dry process. The Company's EXCALIBUR vapor processing system is used to remove residual silicon dioxide to improve electrical performance and to remove the residue left by plasma or reactive ion etching. The Company's spray processing systems have been used to perform blanket etching in limited wet chemistry applications. During doping, specific ions are implanted on the wafer to control and change the electrical properties of the wafer surface. Doping produces the semiconductor activity on the wafer.\nStripping. After etching or doping, the wafer is stripped of photoresist through either a wet chemistry or a dry chemistry process. The Company's spray processing systems are used to perform this function with wet chemistry applications or as a final clean-up after dry chemistry applications.\nThese operations are repeated numerous times during the fabrication process depending upon the type and complexity of the semiconductor device and the overall process employed, and the precise order of the steps utilized varies by manufacturer. A finished integrated circuit consists of a number of film layers which together form thousands of extremely small electronic components that combine to perform the desired electrical functions. Each step in the fabrication process\nrequires precision and must be rigorously controlled to attain commercially acceptable yields and cost performance.\nChemical management systems enable semiconductor device manufacturers to store acids and solvents in bulk tanks outside the device fabrication clean room and to deliver programmed amounts of chemicals to various types of equipment in the clean room. The Company's chemical management products, including its CHEMFILL, CHEMBLEND and CHEMGEN systems, perform the critical functions of generating, blending, delivering and controlling the flow, concentration and purity of chemicals used by various types of processing equipment throughout the fabrication process.\nPRODUCTS\nThe mix of products sold by the Company may vary significantly from year to year. The following table sets forth, for the periods indicated, the amount of sales and approximate percentages of the Company's total sales contributed by the Company's principal products:\nMICROLITHOGRAPHY CLUSTERS. The Company's POLARIS microlithography cluster performs all of the photolithography processing steps except exposure. The POLARIS cluster consists of a clean-room qualified robot surrounded by various process modules. Each module is totally independent and requires no mechanical interface. The cluster is enclosed by transparent safety walls, creating a self-contained process environment and is configured to match the throughput capabilities of the integrated exposure equipment. The enclosure can be modified to provide a Class 1 clean room environment, providing independent control of temperature, humidity and organics from the rest of the fabrication area. Operations within the cluster are primarily controlled by a computer console and a touch screen on each cluster's console. During operation, cassettes of wafers are loaded in the cluster's input\/output module from which the robot transports wafers through the various process modules in a sequence programmed by the operator allowing the desired treatment of the wafer surface.\nThe POLARIS cluster represents a processing alternative to conventional photoresist track or linear systems, which permit processing of the wafer only according to a pre-established arrangement of the equipment. Wafer routing and throughput in a POLARIS cluster are not dependent upon module configuration. The programmable capability allows random wafer routing and continuous processing of wafers eliminating the need for the queuing of partially processed\nwafers sometimes required by traditional track systems. In addition, by controlling system variables within tight tolerance levels, the POLARIS cluster is able to better ensure the repeatability of the various process steps. As a result, the POLARIS cluster provides system flexibility and performance advantages over competing track systems. It also provides significant reliability and serviceability advantages. The highly integrated and automated cluster approach of the POLARIS cluster eliminates the need for a number of complex mechanisms which can impact system reliability, such as exposure system interface modules and wafer transport mechanisms generally associated with track systems. POLARIS process modules can be serviced from outside the cluster without disrupting other cluster process operations. In addition, should technology change in any particular process module, that individual module can be replaced with an upgrade without rendering the entire system obsolete.\nIn July 1994, the Company introduced the POLARIS 2000 cluster. This new generation POLARIS cluster system contains several process enhancements including an advanced bake\/chill plate technology and a fluid temperature control system and new robot for higher throughput of wafers. Simultaneous multiple process flow capabilities allows the system to operate in tandem with another process tool which is physically linked to the POLARIS system and to simultaneously support other process equipment which is not linked to the system. The Company began shipping the POLARIS 2000 cluster in January 1995.\nPurchasers of the POLARIS cluster include Ericsson Components AB (\"Ericsson\"); ITT Corporation; International Business Machines Corporation (\"IBM\"), LG Semicon Co., Ltd. (\"LG Semicon\"); Motorola, Inc. (\"Motorola\"); National Semiconductor, Corp. (\"NSC\"); Texas Instruments, Incorporated (\"TI\"); and Tower Semiconductor Ltd. (\"TSL\"). The Company has an installed base of approximately 120 POLARIS clusters, including approximately 45 POLARIS 2000 clusters. The price of the POLARIS cluster ranges from approximately $800,000 to $1,600,000, depending on wafer size, number of modules, and number of robots required.\nThe POLARIS cluster technology is licensed by the Company from TI. See \"Patents, Trademarks and Intellectual Property\" below.\nSURFACE CONDITIONING PRODUCTS. The Company's surface conditioning products perform cleaning and stripping functions necessary for the processing of integrated circuits.\nSpray Processing Systems. The Company's spray processing systems, which include the MERCURY system, are sophisticated wet chemistry systems used to clean and strip wafers at various stages in the integrated circuit fabrication process. These systems use centrifugal spray technology to process wafers by exposing them to a programmed, sequenced spray of fresh chemicals inside a closed, nitrogen filled chamber. Cassettes filled with wafers are loaded into a turntable in the process chamber and the processing chemicals, de-ionized water, and nitrogen are sequentially dispensed into the chamber through a spray post mounted in the chamber. As the turntable rotates, nozzles apply a chemical spray to the wafers' surface. After chemical application, de-ionized water is sprayed on the wafer surface and all surfaces of the process chamber to remove chemical residues. The wafers and chamber are then dried by centrifugal spinning combined with a flow of nitrogen into the chamber. The Company's spray processing systems also can perform certain blanket etch functions in limited wet chemistry applications. FSI's spray processing systems include a microprocessor-based controller to program, control, and monitor the operating functions of the system in order to ensure precise control and repeatability of the process.\nThe Company's spray processing systems provide an alternative to traditional immersion technology, principally wet-bench processing of wafers. A chemical wet-bench consists of an exhaust hood laboratory bench with open chemical tanks in which the wafers are either manually or automatically transferred from one chemical bath to another. The Company believes that its spray processing systems provide many cost of ownership and other benefits over wet-bench chemical processing including protection of the process operator from hazardous chemicals or fumes, improved cleaning capability, reduced chemical usage, lower space utilization in the clean room, and greater process flexibility, including the capability to easily change chemical sequences.\nSpray processing system customers include Advanced Micro Devices, Inc. (\"AMD\"); Amtel Corporation (\"Amtel\"); Cypress Semiconductor Corporation (\"Cypress\"); Digital Equipment Corporation (\"DEC\"); Fujitsu Microelectronics, Inc. (\"Fujitsu\"); IBM; International Rectifier Corporation (\"IRC\"); Motorola; NCS; Phillips Semiconductors (\"Phillips\"); SGS Thompson Microelectronics, Inc. (\"SGS Thompson\"); Siemens A.G. (\"Siemens\"); TI; TSL; and Winbond Electronics Corp. (\"Winbond\"). The Company has an installed base of over 2,170 spray processing systems. The Company offers four types of spray processing systems, which range in price from $300,000 to $600,000. The Company also markets certain equipment complementary to its spray processors, including water heaters, chemical heaters, and booster pumps.\nVapor Processing Systems. The Company's EXCALIBUR vapor processing systems use anhydrous hydrofluoric (\"HF\") gas in conjunction with water vapor to perform cleaning steps normally done with liquid chemicals. The EXCALIBUR systems are highly automated, with a microprocessor-based controller and user- friendly software for sequencing and control of the reactants. Wafers are processed on an individual basis and loaded from the wafer carrier into the process chamber by a handler that minimizes particle contamination. Single- wafer processing permits EXCALIBUR systems to be more easily integrated with equipment of other suppliers and provides greater control over process uniformity. Up to four process chambers can be operated with a single electronic controller through the utilization of multi-tasking software.\nThe advantages of vapor phase processing over wet processing include increased chemical purity (due in part to its ability to mix chemical gases with water vapor at the point of use), reduced chemical and waste disposal costs, increased processing capabilities and improved integration with cluster tools. An integrated system of this type provides the necessary environmental and surface control of the wafer between cleaning and various other process steps, resulting in reduced contamination and improved yield.\nSince introduction in 1987, EXCALIBUR systems have gone through multiple enhancements, including the development from a single gas to a multi-gas system. These continual enhancements led to the introduction of the latest version of the system, the EXCALIBUR MVP (Multi-Vapor Processor) system in July 1993. In addition to HF gas, the EXCALIBUR MVP system uses hydrochloric acid gas for improved metal removal and ozone gas for organic removal, and has the processing capability to clean the backside of the wafer along with the front. The EXCALIBUR MVP system can be used for the critical cleaning steps in the integrated circuit production process. Programs are under development to integrate the EXCALIBUR MVP system with other process equipment. The process development of the EXCALIBUR MVP system was funded in part by SEMATECH, an industry and government consortium.\nThe Company's EXCALIBUR customers include AT&T Corp. (\"AT&T\"), Fujitsu, Hyundai Electronics Industries Co., Ltd. (\"Hyundai\"), Intel Corporation (\"Intel\"), Siemens, and TI. The\nCompany has installed approximately 160 vapor processing systems, many of which contain multiple modules. Systems vary in price from approximately $150,000 to $800,000 depending on the model, wafer size, number of process chambers, and related electronic control requirements.\nIn August of 1995, the Company announced a License Agreement with IBM which will allow FSI to manufacture, market, and service products using IBM's cyrogenic aerosol cleaning technology. This IBM developed technology uses frozen ice particles formed by inert gases to dislodge contaminants or residue particles from a silicon wafer's surface. FSI anticipates having a production tool commercially available during the latter part 1996.\nOver the past several years, based in part upon funding received from the National Institute of Standards and Technology, the Company has developed the Orion\/tm\/ system, in which \"dry\" chemicals in a gaseous environment are charged by an energy source to remove contaminants from a silicon's wafer surface. The Company expects to ship a prototype to a customer for evaluation in the latter part of 1996.\nCHEMICAL MANAGEMENT SYSTEMS. The Company's chemical management systems enable semiconductor manufacturers to generate certain acids from gases, blend acids and solvents to desired concentrations, store the acids and solvents in bulk tanks outside the device fabrication clean room and to deliver programmed amounts of chemicals to various types of equipment in the clean room.\nChemical Delivery Systems. The Company offers chemical delivery systems utilizing pump, pump and pressure, and vacuum pressure designs. The Company's chemical delivery systems provide semiconductor manufacturers with enhanced chemical purity, inventory control, safety, dispensing accuracy and bulk purchasing opportunities.\nTypically, a chemical delivery system installation involves the delivery, flow and purity control of five to ten distinct chemicals. Each chemical requires its own station operated by a dedicated programmable logic controller. These dedicated controllers are in turn integrated by a host industrial computer to monitor and control the entire system. Normally, one chemical delivery module is required for each chemical; however, one module can be used to supply that chemical to multiple use points within the clean room. Each system installation requires a degree of customization based on the delivery requirements and physical layout of the customer's facility. FSI's project management expertise allows it to perform multiple installations simultaneously, which is a significant advantage during periods of growth in the number of fabrication facilities being constructed, upgraded, or expanded. In addition, upon the request of a customer, FSI will oversee and coordinate not only the installation of a chemical delivery system but also the entire chemical distribution system of the fabrication facility, including point of use interfaces and primary and secondary containment piping.\nThe Company offers four primary models of chemical delivery systems, including the CHEMFILL 500, which provides all the features of a centralized delivery system in a compact, economical unit. This model can be used as a cost-effective solution for small volume chemical users or as a local source of chemicals in large fabrication facilities. The CHEMFILL 1000 PLC (for \"programmable logic control\") offers increased automation to its users, providing enhanced control, flexibility, and functionality. The VP4500 utilizes proprietary ACS vacuum pressure technology to draw chemicals from their storage and transportation containers into the system and\npressure to transfer the chemical back to the container, in a recirculation mode, or to points of use in a dispense mode. The CHEMFILL 5000, which is also programmable logic controlled, features redundant flow systems that help increase uptime.\nChemical Blending and Mixing Systems. The Company's CHEMBLEND chemical blending and mixing systems allow semiconductor device manufacturers to reduce chemical costs by enabling them to blend a process chemical from concentrate on site to create the various chemical concentrations required at different points of use in the clean room.\nChemical Generation Systems. The CHEMGEN chemical generation systems allow semiconductor device manufacturers to reduce chemical costs by generating bulk quantities of certain chemicals by mixing gases with deionized water located at the facility. These chemicals are then delivered to the various use points in the semiconductor device manufacturing facility.\nSlurry Mixing and Delivery Systems. The Company's slurry mixing and delivery systems, which utilize proprietary vacuum pressure technology, mix and deliver slurry which is used in conjunction with CMP technology. The Company's P2000 series systems mix and deliver silicon dioxide slurry, while the P2200M mixes and delivers tungsten slurry.\nChemical management system customers include AMD, Cypress, DEC, Fujitsu, Intel, Motorola, NSC, Phillips, SGS Thompson, and Tech Semicondcutor Singapore PTE. LTD. (\"Tech Semiconductor\"). The Company has installed chemical management systems in over 75 fabrication plants worldwide. Typical installations vary in price from $250,000 to $2,500,000. However, a project involving turn-key installation with multiple chemicals and points of use can cost in excess of $6,000,000.\nSPARE PARTS AND SERVICE. The Company sells spare part kits for a number of its products and individual spare part components for its equipment, primarily spray processing and to a lesser extent chemical management systems. The Company often packages product improvements to enable customers to update previously purchased equipment.\nThe Company employs customer service and process engineers to assist and train the Company's customers in performing preventive maintenance and service on FSI equipment and developing process applications for the equipment. The Company generally provides a one to two year parts and labor warranty depending upon the product. The Company also provides in-house service and maintenance training and process application training for its customers' personnel on a fee basis. In addition, the Company offers a variety of process, service, and maintenance programs that may be purchased for a fee. A number of customers have purchased maintenance contracts whereby the Company's service employees work full-time at the customer's facility, and provide process service and maintenance support for FSI equipment.\nBACKLOG AND SEASONALITY\nThe Company's backlog at the end of fiscal 1995 and 1994 was approximately $115 million and $77 million, respectively. A substantial portion of the backlog at August 26, 1995 is scheduled to be shipped in fiscal 1996. Backlog consists of orders for which a customer purchase order has been received or a customer purchase order number has been communicated to the Company. Orders are subject to cancellation by the customer, generally with a cancellation charge. In fiscal 1995 and 1994, purchase orders aggregating approximately $1,524,000 and $708,000, constituting\n.8% and .7% of sales during fiscal 1995 and 1994, respectively, were canceled and not rescheduled. Because of the timing and relative size of certain orders received by the Company and possible changes in delivery schedules and cancellations of orders, the Company's backlog can vary from time to time and at any particular date is not necessarily indicative of actual sales for any succeeding period. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The business of the Company is not seasonal to any significant extent.\nRESEARCH AND DEVELOPMENT\nThe Company believes that its future success will depend in large part on its ability to enhance, in collaboration with its customers, its existing product lines to meet the changing needs of semiconductor device manufacturers. The Company believes that the trends in the industry, such as utilization of smaller integrated circuit geometries, increased use of eight inch and larger wafers, and manufacturers' increased desire for integral processing equipment will make highly automated and integral systems, including single wafer processing systems, more important in the manufacture of integrated circuits. To assist the Company in its development efforts, the Company maintains relationships with a number of industry professionals some of whom serve on the Company's Technical Advisory Board (\"TAB\"). This board meets periodically with FSI management to identify and review semiconductor device industry trends in advanced technology and FSI's development activities toward meeting the industry's technology needs. In addition, the industry professionals provide the Company with on-going technical consultation and support.\nThe Company's current research and development programs are primarily focused on the need for cleaner wafer surfaces due to smaller geometries, increased process control and flexibility through monitoring and software management systems, robotics automation in the clean room and integration of the Company's product offerings with the processing equipment of other suppliers. Each of these programs involves customer collaboration to ensure proper machine configuration and process development to meet the industry's requirements.\nThe Company is actively engaged in a number of development and process enhancement programs regarding the POLARIS cluster. Such programs include testing POLARIS clusters with new types of photoresist and new processes utilizing such resist. The Company also is exploring, with customer collaboration, further process refinements to its spray processing systems and conducting basic research on vacuum-based gas phase (dry) cleaning systems which may provide increased cleaning capabilities and improved process integration. The Company's dry cleaning project was funded in part by a $2.0 million research grant from the National Institute of Standards and Technology over a two-year period that ended February 28, 1995.\nThe Company maintains a demonstration and process development laboratory at its headquarters in Minnesota, occupying over 2,500 square feet, and a 2,000 square foot Class 1 microlithography demonstration and process development laboratory in Dallas, Texas. The Company's laboratory personnel work directly with customers in solving process problems, developing new processes, evaluating new pieces of equipment and designing new equipment.\nExpenditures for research and development, which are expensed as incurred, during fiscal 1995, 1994, and 1993 were approximately $24,865,000, 15,743,000 and $11,760,000, respectively, and represented 13.1%, 16.3% and 15.0% of sales, respectively. The Company attempts to supplement its research and development efforts with third party funding from industry consortiums, government sources, and customers. During fiscal 1995, 1994 and 1993, the Company\nrecognized third party funding of approximately $546,000, $1.3 million and $1.2 million, respectively, as a reduction in research and development expenses.\nMARKETING, SALES AND SUPPORT\nThe Company markets its products to integrated circuit manufacturers throughout the world. In North America, the Company markets its products through direct sales personnel located in four regional sales offices and through two independent sales representatives. The Company also has several product and technical specialists devoted to each of the Company's product lines. These product and technical specialists and the Company's process engineers work with customers to understand the customer's precise processing requirements and to configure the appropriate FSI equipment to meet such requirements. In addition, as of fiscal year end the sales effort was supported by approximately 205 employees engaged in service and marketing support.\nInternational sales, primarily in Europe, the Far East and Japan, accounted for approximately 37%, 33% and 34% of total sales for fiscal years 1995, 1994 and 1993 respectively. The Company owns a 38.2% equity interest in Metron Technology B.V. (\"Metron\"), a distributor of the Company's products which has an extensive distribution organization located in Europe, including Germany, the United Kingdom, the Netherlands, France, Sweden, Italy, and Israel, in India, and in the Far East, including, Taiwan, Korea, China, Singapore, and Hong Kong. Fluoroware, Inc., a manufacturer of plastic injection moldings for the semiconductor device industry, also owns a 38.2% equity interest in Metron. In addition to the Company's products, Metron also sells products and equipments on behalf of several other semiconductor equipment and consumables manufacturers, including Fluoroware, Inc.\nThe significant majority of the Company's international sales are made to its affiliated distributors for resale to end users of the Company's products. However, in some cases, the Company may also sell directly to an international customer, in which case the Company will pay a commission to one of its affiliated distributors in connection with the sale. When commissions are taken into account, the international sales to the Company's affiliates are on terms generally no less favorable to the Company than international sales by the Company directly to non-affiliates.\nThe Company owns a 49% equity interest in m\/.\/FSI, Ltd. (\"m\/.\/FSI\"), a Japanese joint venture company formed in August 1991 with Mitsui & Co., Ltd. and its wholly-owned subsidiary, Chlorine Engineers Corp., Ltd. (collectively, \"Mitsui\"). Mitsui owns a 51% equity interest in m\/.\/FSI. In connection with its formation, the Company and Mitsui granted m\/.\/FSI certain product and technology licenses and product distribution rights. m\/.\/FSI distributes certain FSI and Mitsui products in Japan.\nMANUFACTURING AND SUPPLIERS\nExcept with respect to ACS products and certain POLARIS cluster modules, the Company typically assembles its products and systems from components and prefabricated parts manufactured and supplied by others, such as process controllers, robots, integrated circuits, power supplies, stainless steel pressure vessels, chamber bowls, valves, and relays. Certain of the items manufactured by others are made to the Company's specifications. All final assembly and systems tests are performed within the Company's manufacturing facilities. Quality control is maintained through incoming inspection of components, in-process inspection during equipment assembly, and final inspection and operation of all manufactured equipment prior to shipment. Currently, ACS\nproducts are manufactured for the Company by contract manufacturers. The Company's manufacturing engineers routinely monitor production progress and perform source inspections prior to delivery of finished ACS products to customers. FSI has a company-wide quality program in place and received ISO 9001 certification in October 1994. Such certification, however, does not cover the operations of ACS or FME.\nIn fiscal 1995, the Company through its fifty (50%) percent interest in FME, established a manufacturing capability in Europe for its chemical management systems division. In addition, FME also provides program management, including the capability to manage the installation of large chemical generation and dispense systems throughout a semiconductor device manufacturing facility.\nCertain of the components and subassemblies included in the Company's products are obtained from a single supplier or a limited group of suppliers in order to ensure overall quality and timeliness of delivery. Although the Company seeks to reduce dependence on sole and limited source suppliers, disruption or termination of certain of these sources could have a temporary adverse effect on the Company's operations. The Company believes that alternative sources could be obtained and qualified to supply these products, if necessary. Nevertheless, a prolonged inability to obtain certain components could have an adverse effect on the Company's operating results and could result in damage to customer relationships.\nCOMPETITION\nThe semiconductor equipment industry is highly competitive. In each of the markets it serves, the Company faces intense competition from established competitors, some of which have substantially greater financial, engineering, research, development, manufacturing, marketing service and support resources, and greater name recognition than the Company, and long standing customer relationships. In order to remain competitive, the Company will be required to maintain a high level of investment in research and development, marketing, and customer service and support as well as control operating expenses. There can be no assurance that the Company will have sufficient resources to continue to make such investments or that the Company's products will continue to be viewed as competitive as a result of technological advances by competitors or changes in semiconductor processing technology. The Company's competitors also may increase their efforts to gain and retain market share through competitive pricing. Such competitive pressures may necessitate significant price reductions by the Company or result in lost orders which could adversely affect the Company's results of operations.\nSince 1992, Japanese semiconductor manufacturers substantially reduced their levels of capital spending on new fabrication facilities and equipment in Japan and elsewhere. This has resulted in reduced sales and increasing competitive pressures in the Japanese market segment (comprised of semiconductor device fabrication facilities located in Japan and those located outside of Japan which are controlled by Japanese companies). As a result, pricing pressures in both the Japanese market and elsewhere may continue into the foreseeable future due to Japanese semiconductor equipment manufacturers offering substantial discounts on their products.\nThe Company believes that the Japanese companies with which it competes have a competitive advantage because of their dominance of the Japanese market segment. Furthermore, Japanese semiconductor device manufacturers have extended their influence outside Japan by licensing products and process technologies to non-Japanese semiconductor device manufacturers.\nSuch licenses can result in a recommendation to use semiconductor device equipment manufactured by Japanese companies. Therefore, the Company may be at a competitive disadvantage with respect to the Japanese semiconductor equipment suppliers, who have been engaged for some time in collaborative efforts with Japanese semiconductor device manufacturers. Certain Japanese semiconductor equipment manufacturers have announced plans to begin manufacturing operations in the United States, which will enable them to compete more effectively in the United States market.\nThe Japanese market segment is important as it represents a substantial percentage of the world-wide semiconductor device market. To date, the Company has not yet established itself as a significant participant in the Japanese market segment with respect to its POLARIS cluster or chemical management system product lines. As part of the strategy to establish its Japanese presence, the Company formed a joint venture, m\/.\/FSI in August 1991 with Mitsui and granted m\/.\/FSI certain product and technology licenses and product distribution rights in Japan.\nA growing portion of the Company's international sales have been to semiconductor device manufacturers located in Korea. The Korean market is extremely competitive and the semiconductor device manufacturers located there have been very aggressive in seeking price concessions from suppliers. FSI does not believe that there are any existing government trade restrictions that would materially limit FSI's ability to compete in the Japanese or Korean markets.\nSignificant competitive factors in the semiconductor equipment market include quality, process repeatability, capability and flexibility, ability to integrate with other products, and overall cost of ownership, including reliability, automation, throughput, customer support, and system price. The Company has experienced significant price competition from certain of its competitors, primarily those in the microlithography and chemical management systems markets. Although the Company believes that it has certain technological and other advantages over its competitors, realizing and maintaining such advantages will require a continued high level of investment by the Company in research and development, and marketing and customer service and support as well as controlling operating expenses. There can be no assurance that the Company will continue to compete successfully in the future.\nThe Company's competitors differ across its three product lines. The Company's microlithography clusters compete with products offered by Dainippon Screen Manufacturing Co. Ltd. (\"DNS\"), Silicon Valley Group, Inc. and Tokyo Electron Ltd. (\"TEC\"),. The Company competes with DNS, TEL, Semitool, Inc., Submicron Systems, Inc. (\"Submicron\"), and Santa Clara Plastics in the area of surface conditioning products. The Company's Chemical Management System competes with products from Systems Chemistry, Inc., a subsidiary of Submicron, and a number of chemical supply companies that also offer chemical management systems.\nCUSTOMERS\nThe Company sells products from one or more of its product lines to most major integrated circuit manufacturers, including AMD, Cypress Semiconductor, DEC, International Rectifier, Ericsson, Fujitsu, Hyundai, IBM, Intel, LG Semicon, Motorola, NSC, Phillips, SGS Thompson, Siemens and TI, and has over 100 active customers worldwide.\nAlthough the composition of the Company's customers has changed from year to year, direct sales to the Company's top five customers in each of fiscal 1995, 1994 and 1993 have accounted for approximately 54%, 46% and 50%, respectively, of the Company's total sales. Direct sales to the Company's top two customers in each of fiscal 1995, 1994 and 1993 accounted for approximately 28%, 30% and 32% respectively, of the Company's total sales. In addition, approximately 38% of the Company's backlog at fiscal 1995 year-end was comprised of orders from two customers. IBM accounted for approximately 16% and 6% of the Company's sales in fiscal 1995 and 1994, respectively. Motorola accounted for approximately 12% and 8% of the Company's sales for fiscal 1995 and 1994, respectively. LG Semicon accounted for approximately 11% and 5% of the Company's sales for fiscal 1995 and 1994, respectively.\nSales to the Company's affiliated international distributors in fiscal 1995, 1994 and 1993, which may include sales of products subsequently resold to the Company's direct customers, accounted for approximately 22%, 26%, and 25%, respectively, of the Company's total sales. In addition, the earnings received from the Company's equity ownership interest in such affiliated distributors accounted for approximately 18%, 32%, and 43% of the Company's net income in fiscal 1995, 1994 and 1993, respectively. The earnings or losses of the Company's affiliated distributors can affect significantly the financial results of the Company. There can be no assurance that the affiliated distributors will continue to distribute the Company's products or do so successfully, and in such event the Company's results of operations and earnings could be adversely affected.\nThe Company has experienced and expects to continue to experience fluctuations in its customer mix. The timing of an order for the Company's equipment is primarily dependent upon the customer's expansion program, replacement needs, or requirements to improve integrated circuit fabrication productivity and yields. Consequently, a customer who places significant orders in one year will not necessarily place significant orders in subsequent years.\nCertain of the Company's present products require an export license from the United States Department of Commerce prior to their sale outside the United States, while other FSI products can be freely exported under a general export license.\nPATENTS, TRADEMARKS AND INTELLECTUAL PROPERTY\nThe POLARIS cluster is offered by the Company under a license from TI. Under the license agreement, FSI has the exclusive right to sell and the non- exclusive right to manufacture the POLARIS cluster, except that TI may manufacture and distribute the system within TI. FSI also has the non- exclusive right to manufacture and sell related TI modules. TI may modify FSI's exclusive sales rights to a non-exclusive license if FSI fails to use reasonable efforts in marketing the POLARIS cluster. The license agreement requires a royalty payment to TI on the equipment manufactured and sold by the Company pursuant to the license. The royalty to be paid is based on the \"net sales price\" of the licensed equipment, as reflected in the final invoice amount charged by the Company to the customer for such equipment, excluding amounts for packaging, insurance, freight, service, maintenance, and value- added tax.\nThe license agreement continues until terminated. It may be terminated by either party upon a breach by the other party, and the failure to cure, of certain terms of the agreement, including payment of royalties when due, refusal to sell products, and failure to meet quality standards.\nThe Company holds numerous United States patents and additional patents in Japan and several European countries, and has several United States and foreign patent applications pending. However, the Company believes that patents and trademarks are of less significance in its industry than such factors as innovative skills, technical expertise, and the ability to quickly adapt to and deliver new technology to the marketplace. The Company attempts to protect its proprietary information through non-disclosure agreements with its key employees.\nEMPLOYEES\nAs of August 26, 1995, FSI and its wholly-owned subsidiary ACS had 808 employees, of whom 259 were engaged in manufacturing, 138 were engaged in customer service, 256 were engaged in research and development, 66 were engaged in sales and marketing, and 89 held general and administrative positions. As of such date, the Company also had over 125 independent contractors working throughout the Company in various capacities, principally in the areas of manufacturing and engineering. FME employs approximately 35 employees, the majority of whom are involved in manufacturing and\/or system installation.\nThe Company is not subject to any collective bargaining agreement, has never been subject to a work stoppage and believes its relations with its employees is good.\nENVIRONMENTAL MATTERS\nThe Company believes that compliance with federal, state and local provisions which have been enacted or adopted regulating discharges of materials into the environment, or otherwise relating to the protection of the environment will not have a material effect upon the capital expenditures, earnings and competitive position of the Company. See also Item 3 - \"Legal Proceedings.\"\nINTERNATIONAL SALES\nThe Company's international sales for each of the last three fiscal years is disclosed in the financial statements incorporated by reference and referred to in Item 8 on pages 21-22 of this Report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate offices are located in Chaska, a suburb of Minneapolis, Minnesota. In fiscal 1995, the Company leased approximately 176,000 square feet, in five buildings, at a total rental cost of approximately $1.4 million. Effective December 1, 1995, the rental cost for these facilities will be reduced to approximately $790,000 as part of a new five year lease on its headquarters facility, which facility also contains a process research laboratory, and manufacturing for chemical management system products.\nIn November 1995, the Company opened a new 100,000 square foot manufacturing facility which cost approximately $11.5 million to construct. The facility contains 45,000 square feet of Class 1000 manufacturing clean room space, which can be upgraded to class 100 as required. The new facility also contains a manufacturing support operations and customer training center, and shell space for a new process research laboratory for the Surface Conditioning Division.\nThe Company also leases facilities in England and in various locations within the United States including:\n\/.\/ a 37,000 square foot process research laboratory, engineering and administrative facilities for the Microlithography Division located in Dallas, Texas.\n\/.\/ a 17,180 square foot engineering and administrative facility for the Chemical Management Division located in Hollister, California (ACS Headquarters).\n\/.\/ a 11,767 square foot engineering, manufacturing, and administrative facilities for the Chemical Management Division located in Europe (FME Headquarters).\nIn addition, in August 1995, the Company entered into a five-year lease for approximately 125,800 square feet of engineering, administrative and warehouse space near its Chaska headquarters. Approximately 45,000 square feet is being used and the remaining warehouse space is available for sublease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company generates minor amounts of liquid and solid hazardous waste and uses licensed haulers and disposal facilities to ship and dispose of such waste. The Company has received notice from state or federal enforcement agencies that it is a potentially responsible party (\"PRP\") in connection with the investigation of four hazardous waste disposal sites owned and operated by third parties. In each matter, the Company believes that it is at most a \"de minimis\" PRP. The Company recently elected to participate in a settlement offer made to all de minimis parties with respect to one such site.\nThe risk of being named a PRP is that if any of the other PRP's are unable to contribute their proportionate share of the liability, if any, associated with the site, those PRP that are able could be held financially responsible for the shortfall. While the ultimate outcome of these matters cannot presently be determined, the Company does not believe that any of these investigations, either individually or in the aggregate, will have a material adverse effect on its business, operating results, or financial condition.\nIn October, 1995, Purusar Corporation (\"Purusar\") brought suit against the Company in United States District Court, Northern District of California, seeking monetary damages and injunctive relief based upon the Company's alleged infringement of a patent held by Purusar. The lawsuit is in the very initial stages. The Company has asserted various defenses as well as noninfringement of such patent by the Company's products. While litigation is subject to inherent uncertainties and no assurance can be given that the Company will prevail in such litigation or will obtain a license under such patent on commercially reasonable terms or at all if such patent is found to be valid and it is determined the Company infringes such patent, the Company believes that the Purusar lawsuit will not have a material adverse affect on the Company's consolidated financial statements.\nThere has been substantial litigation regarding patent and other intellectual property rights in semiconductor related industries recently and further commercialization of the Company's products could provoke claims of infringement of third-parties. Except for the allegations made by Purusar, the Company is not aware of any infringement by its products of any patents or proprietary rights of others. In the future, litigation may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company or to defend the Company against claimed infringement of the rights of others and determine the scope and validity of its proprietary rights. Any such litigation could result in substantial costs and diversion of effort by the Company, which by itself could have a material adverse affect on the Company's financial condition and operating results. Further, adverse determinations in such litigation could result in the Company's loss of proprietary rights, subject the Company to significant liabilities to third parties, require the Company to seek licenses from third-parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's financial condition and results of operations.\nOther than the litigation described above or routine litigation incidental to the Company's business, there is no material litigation to which the Company is a party or of which any of its property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nThere were no matters submitted to a vote of shareholders during the fourth quarter ended August 26, 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers are elected by the board of directors, generally for a term of one year, and serve until their successor is elected and qualified. The following table and discussion contains information regarding the current executive officers of the Company.\nMr. Elftmann is a co-founder of the Company and has served as a Director of the Company since 1973 and as Chairman of the Board since August 1983. From August 1983 to August 1989, and from May 1991 until the present, Mr. Elftmann has also served as Chief Executive Officer of the Company. From 1977 to August 1983, and from May 1991 until the present, Mr. Elftmann has served as President of the Company. Prior to 1977, Mr. Elftmann was Vice President and General Manager of the Company. Mr. Elftmann is also Chairman of the Supervisory Board of Metron and is a director of m\/.\/FSI Ltd. He has been a director of Veeco Instruments, Inc. since May 1994.\nMr. Pope was elected Executive Vice President, Marketing and Account Management of the Company in January 1992. Mr. Pope served as Senior Vice President and General Manager, Process Equipment of the Company from November 1989 until January 1992. Mr. Pope served as Vice President, Sales and Service of the Company from May 1985 to November 1989. From September 1982 to May 1985, Mr. Pope served as Executive Sales Manager of the Company. Prior thereto, he was Managing Director of Metron. Mr. Pope also serves as a director of m\/.\/FSI Ltd.\nMr. Sand has served as Executive Vice President and Chief Financial Officer of the Company since January 1992. Mr. Sand served as Vice President, Finance and Chief Financial Officer of the Company from October 1990 until January 1992. He served as Vice President, Finance of the Company from October 1987 until October 1990. From August 1983 to October 1987, Mr. Sand served as Corporate Controller of the Company and from November 1982 to August 1983 as its Financial Accounting Manager. Prior thereto he was employed by the accounting firm of KMG Main Hurdman as an auditor and consultant. Mr. Sand was elected Assistant Secretary of the Company in November 1989 and Secretary in November 1990.\nDr. Sloan has served as Executive Vice President, Microlithography Division of the Company since January 1992. Prior thereto, Dr. Sloan was employed by TI in Dallas, Texas, where he served over 24 years in various research and development capacities, most recently as Vice President of TI's Semiconductor Group and Manager of the Wafer Fabrication Systems Division of TI's Process Automation Center. Dr. Sloan is Chairman of the Company's Technical Advisory Board.\nDr. Cavins has served as Senior Vice President, Chemical Management Division of the Company since March 1994. He served as Vice President, Chemical Management Division from January 1993 until March 1994. From 1988 to March 1992, Dr. Cavins served as Senior Vice President of Operations for E.F. Johnson Company. From March 1992 to July 1992, Dr. Cavins was employed by Itron Corporation in the capacity of Vice President and General Manager for Enscan Operations, the energy management division of Itron Corporation. Prior to joining E.F. Johnson Company, Dr. Cavins served in management positions in various electronics and engineering capacities at Honeywell Inc. and Control Data Corporation (now Ceridian Corporation). Dr. Cavins also serves as a Managing Director of FME.\nMr. Courtney has served as Senior Vice President, Surface Conditioning Division since March 1994. Mr. Courtney served as Vice President, Surface Conditioning Division of the Company from November 1992 until March 1994. Mr. Courtney served as Vice President, Engineering of the Company from August 1991 to November 1992. Mr. Courtney served as Director of Engineering of the Company from September 1990 to August 1991 and as manager of Engineering Software Development and Automation of the Company from September 1987 to September 1990. Prior to joining the Company, Mr. Courtney was President of D A Courtney & Associates, Dallas, Texas, specializing in the development of software for automation and real time process control systems. Mr. Courtney is a director of m\/.\/FSI Ltd.\nMr. Stewart has served as Vice President, Operations since February 1994. Prior thereto, Mr. Stewart was employed by TI in Dallas, Texas where he served over 20 years in various manufacturing and operations management positions, most recently as Corporate Computer Integrated Manufacturing Director, responsible for worldwide manufacturing and materials systems. He also was the Manufacturing Manager of TI's award winning HARM (High Speed Anti-Radar Missile) program. Mr. Stewart serves as a Managing Director of FME.\nMr. Krieg has served as Vice President, Quality and Human Resources of the Company since March 1994 and also served in that capacity from January 1992 until March 1993. Mr. Krieg was Vice President, Human Resources from March 1993 until March 1994 and also served in that same capacity from October 1987 until January 1992. From September 1979 to October 1987, he served as Human Resources Manager of the Company. Mr. Krieg was elected Assistant Secretary of the Company in November 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock, no par value, is traded on the Nasdaq National Market (\"Nasdaq-NNM\") under the symbol \"FSII.\" The information concerning the quarterly stock prices and dividends for the fiscal years ended August 26, 1995 and August 27, 1994 and the number of shareholders of record is contained in the Company's 1995 Annual Report to Shareholders (\"Annual Report\"), at page 34 under the captions \"Quarterly Data\" and \"Common Stock Prices\", which information is incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe summary of selected financial data for each of the last five fiscal years set forth in the Annual Report in the table on page 13 under the caption \"Five-Year Selected Financial Data\" is incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing in the Company's Annual Report on pages 14 to 17 is incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and supplementary data of the Company and its subsidiaries for the periods indicated and the Independent Auditors' Report listed below which are included in the Annual Report at the pages indicated, 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\nCertain information required by Part III is incorporated by reference to the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders to be held on January 24, 1996 (the \"Proxy Statement\") and which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after August 26, 1995.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information concerning the Company's directors required by this Item is included in the Proxy Statement and is incorporated by reference. For information concerning executive officers, see Item 4A of this Form 10-K Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item, which is included in the Proxy Statement, is incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item, which is included in the Proxy Statement, is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item, which is included in the Proxy Statement, is incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) The following financial statements and documents and the report of the independent auditors are included in the Annual Report (an Exhibit to this Report) and are incorporated by reference in Item 8 of this Report:\n*10.17 Management Agreement between FSI International, Inc. and Robert E. Cavins, effective as of March 28, 1994. (11) *10.18 Management Agreement between FSI International, Inc. and Dale A. Courtney, effective as of March 28, 1994. (11) *10.19 Management Agreement between FSI International, Inc. and Joel A. Elftmann, effective as of March 28, 1994. (11) *10.20 Management Agreement between FSI International, Inc. and Timothy D. Krieg, effective as of March 28, 1994. (11) *10.21 Management Agreement between FSI International, Inc. and Peter A. Pope, effective as of March 28, 1994. (11) *10.22 Management Agreement between FSI International, Inc. and Benno G. Sand, effective as of March 31, 1994. (11) *10.23 Management Agreement between FSI International, Inc. and Benjamin J. Sloan, effective as of March 28, 1994. (11) *10.24 Management Agreement between FSI International, Inc. and J. Wayne Stewart, effective as of March 28, 1994. (11) *10.25 FSI International, Inc. 1994 Omnibus Stock Plan. (12) *10.26 FSI International, Inc. 1995 Incentive Plan *10.27 FSI International, Inc. 1996 Incentive Plan 10.28 First Amendment to Lease made and entered into October 31, 1995 by and between Lake Hazeltine Properties and FSI International, Inc. 10.29 Distribution Agreement made and entered into as of July 6, 1995 by and between FSI International, Inc. and Metron Semiconductors Europa B.V. (Exhibits to Agreement omitted) 10.30 Lease dated August 9, 1995 between Skyline Builders, Inc. and FSI International, Inc. 10.31 Lease Rider dated August 9, 1995 between Skyline Builders, Inc. and FSI International, Inc. 10.32 Lease Amendment dated November 15, 1995 between Roland A. Stinski and FSI International, Inc. (Exhibits to Amendment omitted) 11.1 Computation of Per Share Earnings of FSI International, Inc. 13.0 1995 Annual Report to Shareholders 21.0 Subsidiaries of the Company 23.0 Consent of KPMG Peat Marwick LLP. 23.1 Consent of KPMG Accountants N.V. 24.0 Powers of Attorney from the Directors of FSI International, Inc. 27.0 Financial Data Schedule\n------------- (1) Filed as an Exhibit to the Company's Report on Form 8-K dated January 5, 1995, as amended, File No. 0-17276, and incorporated by reference. (2) Filed as an Exhibit to the Company's Registration Statement on Form S-3 dated January 5, 1995, SEC File No. 33-88250 and incorporated by reference. (3) Filed as an Exhibit to the Company's Report on Form 10-Q for the quarter ended\nFebruary 24, 1990, SEC File No. 0-17276, and incorporated by reference. (4) Filed as an Exhibit to the Company's Registration Statement on Form S-1, SEC File No. 33-25035, and incorporated by reference. (5) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended August 26, 1989, SEC File No. 0-17276, and incorporated by reference. (6) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended August 25, 1990, as amended by Form 8 dated December 20, 1990, and by Form 8 dated February 5, 1991, SEC File No. 0-17276, and incorporated by reference. Similar agreements between the Company and each of Robert E. Cavins, J. Wayne Stewart, Benjamin J. Sloan, Dale A. Courtney, Peter A. Pope, Benno G. Sand and Timothy D. Krieg have been omitted, but will be filed upon the request of the Commission. (7) Filed as an Exhibit to the Company's Registration Statement on Form S-1, SEC File No. 33-25035, and incorporated by reference. (8) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended August 31, 1991, as amended by Form 8 dated January 7, 1992, SEC File No. 0-17276, and incorporated by reference. (9) Filed as an Exhibit to the Company's Report on Form 10-Q for the fiscal quarter ended February 29, 1992, File No. 0-17276, and incorporated by reference. (10) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended August 27, 1993, SEC File No. 0-17276, and incorporated by reference. (11) Filed as an Exhibit to the Company's Report on Form 10-Q for the fiscal quarter ended May 28, 1994, SEC File No. 0-17276, and incorporated by reference. (12) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended August 27, 1994, SEC File No. 0-17276, and incorporated by reference.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter ending August 26, 1995.\nPROXY STATEMENT\nExcept for those portions specifically incorporated in this Report by reference to the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on January 24, 1996, no other portions of the Proxy Statement are deemed to be filed as part of this Report on Form 10-K. The Proxy Statement is furnished solely for the information of the Securities and Exchange Commission.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFSI INTERNATIONAL, INC.\nBy: \/s\/Joel A. Elftmann -------------------- Joel A. Elftmann, Chairman, President and Chief Executive Officer (Principal Executive Officer)\nDated: November 21, 1995\nBy: \/s\/Benno Sand -------------- Benno Sand, Executive Vice President and 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, constituting a majority of the Board of Directors, on behalf of the Registrant and in the capacities and on the dates indicated.\nJoel A. Elftmann, Director ) James A. Bernards, Director ) Neil R. Bonke, Director ) Terrence W. Glarner, Director ) Robert E. Lorenzini, Director ) By: \/s\/Benno Sand William M. Marcy, Director ) -------------- Charles R. Wofford, Director ) Benno Sand, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDated: November 21, 1995\nINDEPENDENT AUDITORS' REPORT ON SCHEDULE ----------------------------------------\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders FSI International, Inc.\nUnder the date of October 13, 1995, we reported on the consolidated balance sheets of FSI International, Inc. and subsidiaries as of August 26, 1995 and August 27, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended August 26, 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. 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.\nMinneapolis, Minnesota October 13, 1995\nFSI INTERNATIONAL, INC. AND SUBSIDIARIES\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS FISCAL YEARS ENDED AUGUST 26, 1995, AUGUST 27, 1994 AND AUGUST 28, 1993\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nFinancial Statements for the years ended 31 May 1995, 1994 and 1993\npage\nConsolidated Statements of Operations 2\nConsolidated Balance Sheets 3\nConsolidated Statements of Cash Flows 4\nConsolidated Statements of Shareholders' Equity 5\nNotes to the Consolidated Financial Statements 6\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nConsolidated Statements of Operations for the years ended 31 May 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nCONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended 31 May 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY for the years ended 31 May 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS for the years ended 31 May 1995, 1994 and 1993\n1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the financial statements of all subsidiaries. All significant intercompany balances and transactions have been eliminated.\nThe balance sheets of the subsidiaries are translated into Dutch Guilders (NLG) at the rates of exchange ruling at the balance sheet date, whereas the profit and loss accounts are translated at average rates. The resulting translation adjustment is charged or credited to Shareholders' Equity in the accompanying balance sheet.\nThe 50% investment in an associated company is accounted for using the equity method.\nRevenue Recognition\nRevenue is recognised on delivery of goods or the provision of services to the customers.\nInventories\nInventories consist primarily of purchased products and are stated at the lower of cost (first-in, first-out basis) or net realisable value. Suitable allowance has been made for slow moving and obsolete items.\nProperty, Plant and Equipment\nProperty, plant and equipment is stated at cost less depreciation. Depreciation is primarily determined by the straight-line method based on the estimated useful lives as follows:\nLand is not depreciated. When assets are retired or disposed of, the cost and accumulated depreciation thereon is removed from the accounts and any gains or losses included in the income statement. Repair and maintenance expenses are capitalised only if they extend the useful life of the related asset.\nIncome Taxes\nDeferred income taxes are provided to reflect the tax effect of temporary differences between financial reporting and taxable income, where applicable.\nDeferred income taxes have not been provided for undistributed earnings of subsidiaries, as it is the intention of management to finance the development of the companies through retention of earnings.\nProduct Warranty\nGenerally, the company warrants products sold to customers to be free from defects in material and workmanship for up to one year. Provision is made for the estimated cost of fulfilling these warranties at the time of sale.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nForeign Currency Transactions\nAssets and liabilities denominated in foreign currencies are translated at exchange rates ruling at the balance sheet date. Transactions in foreign currencies are translated at exchange rates approximating those at the transaction date. The resulting gains and losses are included in the profit and loss account.\nExposure to exchange movement risks is minimised by matching the maturities of foreign currency assets and liabilities, mainly accounts receivable and accounts payable. Periodically, hedging transactions are entered into by the Company or its subsidiaries to hedge differences existing between foreign currency assets and liabilities.\nNet Income Per Share\nNet income per share is computed based on the weighted average number of shares outstanding during the year. Comparative amounts have been adjusted to reflect the reduction in nominal value and the issue of new shares through the conversion of reserves. There are no dilutive share equivalents.\n2 ADDITIONAL SALES INFORMATION AND CONCENTRATION OF CREDIT RISK\nThe Company operates in the semiconductor manufacturing sector. Approximately 13% in 1994\/5, 26% in 1993\/4 and 23% in 1992\/3 of net sales for the years then ended were made to one, two and two customers, respectively, which individually represented more than 10% of net sales.\nSales by geographic area are summarised as follows:\nIt is impractical to determine net income and identifiable assets by region, as the sales are made by companies in Europe.\nA large portion of the Company's sales are made to a number of major publicly owned corporations. There is a concentration of credit risk in accounts receivable from these customers. The credit risk associated with non-payment from these customers is affected by conditions or occurrences within their industries. However, accounts receivable from these customers were substantially current at 31 May 1995. The Company believes that there is no significant credit risk with respect to these receivables.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n3. INCOME TAXES\nIncome before income taxes is as follows:\n=========================================================================== (in Dutch Guilders) 1994\/5 1993\/4 1992\/3 - --------------------------------------------------- ---------- ---------\nThe Netherlands 1,401,313 1,338,411 484,970\nForeign 11,301,127 10,288,071 5,785,852 ---------- ---------- --------- 12,702,440 11,626,482 6,270,822 ========== ========== =========\nIncome tax expense is as follows:\n=========================================================================== (in Dutch Guilders) 1994\/5 1993\/4 1992\/3 - ---------------------------------------------------------------------------\nCurrent The Netherlands 457,278 347,541 - Foreign 4,838,888 3,769,581 2,011,228 Deferred Foreign (9,803) 20,201 - --------- --------- --------- 5,286,363 4,137,323 2,011,228 ========= ========= =========\nThe expected tax rate is dependent on the amount of the profit in each of the individual companies and the rates of tax in the countries in which the companies operate. The rate will vary from year to year. The effective tax rate differs from the expected tax rate as follows:\n================================================================== 1994\/5 1993\/4 1992\/3 - ------------------------------------------------------------------\nExpected income tax rate based on 40.6 % 42.8 % 40.9 % statutory tax rates\nUse of prior year tax losses brought forward - (1.3)% (2.9)%\nTax credit arising from dividends from (0.9)% (7.2)% (9.6)% a subsidiary\nLoss benefit limitation on tax losses 0.4 % - % 1.7 % carried forward\nOther, mainly permanent differences 1.2 % 0.8 % 2.0 % ------ ------ ------ Effective income tax rate 41.3 % 35.1 % 32.1 % ====== ====== ======\nTax losses carried forward amounted to NLG 1,409,000 (31 May 1994: NLG 1,380,000), with no expiry date. A full valuation allowance has been provided against the related deferred tax asset, as there does not appear to be a chance of realisation in the near future. The deferred tax liability relates to differences between depreciation rates used for the financial statements and those for tax purposes.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n4 CASH AND BANK OVERDRAFTS\nCash and cash equivalents represents cash on hand and at banks and time deposits maturing within three months of the end of the year.\nThe Company and its subsidiaries have overdraft facilities in various currencies with a number of banks. Interest is charged at current market rates for amounts used under these facilities. The facilities are secured by charges over most of the assets of the Company and its subsidiaries. The amount of the facilities and their usage are as follows:\n======================================================== (in Dutch Guilders) 31 May 1995 31 May 1994 - ------------------------------------------- -----------\nTotal facilities available 13,337,114 10,452,070\nUsage 4,483,020 2,255,820\n5 PROPERTY, PLANT AND EQUIPMENT\nThe components of property, plant and equipment are shown as follows:\n================================================================== (in Dutch Guilders) 31 May 1995 31 May 1994 - ----------------------------------------------------- -----------\nLand 1,166,445 1,168,449\nBuildings and Leasehold Improvements 4,279,289 4,033,382\nMachinery, Equipment and Motor Vehicles 6,336,463 5,900,703 ---------- ---------- 11,782,197 11,102,534\nLess: Accumulated Depreciation 6,195,949 5,683,748 ---------- ---------- 5,586,248 5,418,786 ========== ==========\nIncluded in Machinery, Equipment and Motor Vehicles are assets under capital leases with a net book value of NLG 334,693 (1994: NLG 487,541).\n6 INVESTMENT IN ASSOCIATE\nOn 31 January, the Company acquired 50% of FSI Metron Europe Ltd. (formerly Vinylglass Ltd.), England, a manufacturer of chemical distribution systems and wet benches, to increase its presence in the European chemical distribution market. FSI International, Inc., a related party, acquired the other 50% at the same time. FSI Metron Europe Ltd. is accounted for using the equity method. Its financial year end was altered to 31 May. Its assets, liabilities and results of operations are summarised as follows:\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\nThe cost of the investment was NLG 2,084,347, including goodwill of NLG 1,204,285. The goodwill element is being written off over a period of 5 years, being the Company's assessment of the useful life of the goodwill.\nIn the period 1 February to 31 May 1995, the Group sold approximately NLG 1,087,000 of its products to its associate and purchased approximately NLG 174,000 products from its associate.\n7 LONG-TERM DEBT\nLong-term debt is summarised as follows:\nThe debt is repayable as follows: 1995\/6 NLG 348,604; 1996\/7 NLG 70,591; 1997\/8 NLG 45,259; 1998\/9 NLG 116\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n8 Related Parties\nTwo of the company's shareholders each own between 20% and 50% of the outstanding shares. The Company purchases goods from these shareholders and their subsidiaries for resale in the normal course of business. The terms and conditions of these purchases are similar to those with non-related vendors.\n9 Accrued Liabilities\nIncluded in accrued liabilities is NLG 2,690,000 (1993\/4: NLG 3,110,000) for amounts due under various profit sharing schemes.\n10 Share Capital\nDuring the year, the following changes occurred in the share capital:\ni The authorised capital of the company was increased from 1,000 shares of NLG 25.00 to 10,000,000 shares of NLG 0.10.\nii The issued share capital was changed from 1,000 shares of NLG 25.00 to 250,000 shares of NLG 0.10.\niii 1,662,500 new shares of NLG 0.10 were issued to existing shareholders through capitalising reserves.\niv 214,671 new shares plus the 12,500 shares held in treasury were issued in exchange for the minority shareholdings in two subsidiary companies.\nAlso, the company and entered into an agreement with its two minority shareholders that under certain circumstances (e.g. termination of employment, death) they or their estates may require the company to purchase their share holdings at a price to be calculated based on asset value and with restrictions as to the number of shares that can be purchased and the amount that may be paid for all such purchases in any one year.\nCircumstances which could lead to the Company being required to acquire its own shares under this agreement did not occur during the year. Subsequent to the year-end, this agreement was terminated as part of the agreement to acquire the Asian and American companies (see Note 15).\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n11 PENSION PLANS\nMost employees are covered by defined contribution plans, which are funded with insurance companies. Annual costs for such plans amounted to NLG 548,686 in 1994\/5 NLG 446,844 in 1993\/4 and NLG 300,281 in 1992\/3.\nThere are defined benefit plans for a small number of employees. The components of the cost of these plans were:\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n12 COMMITMENTS\nThe Company and its subsidiaries have commitments arising from lease and rental contracts amounting to annual expenses of:\nThe Company and its subsidiaries have given guarantees mainly to banks with a maximum commitment of NLG 1,758,688.\nRental expense for all operating leases was NLG 1,596,693 in 1994\/5, NLG 1,335,620 in 1993\/4 and NLG 1,339,891 in 1992\/3.\nThe amount of the capital lease commitment excluding the interest element and including the buy back price is NLG 251,754.\n13 CONTINGENCIES\nThe Company and its subsidiaries are involved in various disputes arising from the normal course of business. These disputes are for minor amounts and are not material to the consolidated financial statements, either individually or in total.\n14 SUPPLEMENTARY CASH FLOW INFORMATION\nThe Company paid interest in 1994\/5, 1993\/4 and 1992\/3 of NLG 418,474, NLG 684,127 and NLG 796,000, respectively. Net income taxes paid in 1994\/5 and 1993\/4 were NLG 5,112,062 and NLG 2,930,060, respectively, and net income taxes received in 1992\/3 were NLG 78,000. The non-cash investing and financing activities in 1994\/5, 1993\/4 and 1992\/3 included NLG 31,000, NLG 95,000 and NLG 375,000, respectively, for the purchase of cars under capital leases and NLG 2,057,990 in 1994\/5 for the acquisition of the minority interests in subsidiary companies.\n15 DISCLOSURE CONCERNING FINANCIAL INSTRUMENTS\nThe Company has no significant off-balance sheet financial instruments at 31 May 1995 and 1994.\nThe carrying-value of accounts receivable and accounts payable approximate fair values due to their short-term maturities. The carrying value of long-term debt does not significantly differ from its estimated fair value.\nMETRON SEMICONDUCTORS EUROPA B.V., ALMERE\n16 Subsequent Events\nFollowing a strategic review of the effects of the globalisation of the business of our customers on the Group, the Company and its major shareholders decided to position the Group as the leading world-wide distributor of products to the semiconductor manufacturing industry outside Japan. Subsequent to the year under review, the following significant transactions were completed to reach this objective:\ni In June, the Company acquired the entire share capital of three companies trading in Asia (the Metron Asia Group), excluding Japan, from its two major shareholders in exchange for 531,792 new shares in the Company.\nii In July, the Company acquired the entire share capital of Transpacific Technology Corporation, a leading American distribution and sales representation group with subsidiary companies in Europe, in exchange for 262,974 new shares in the Company, $500,000 cash and $1,300,000 promissory notes.\n17 New Accounting Standards\nIn March 1995, the US Financial Accounting Standards Board issued Statement of Financial Accounting Standards (FAS) No. 121, Accounting for the Impairment of Long-Lived Assets to be Disposed Of. This statement establishes accounting standards relating to 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 intangibles to be disposed of. The Company is first required to comply with the requirements of FAS No. 121 in its Consolidated Financial Statements for fiscal 1997. However, the company does not believe that implementation of FAS No. 121 will have a material impact on its financial statements.\n[KPMG LETTERHEAD]\nINDEPENDENT AUDITOR'S REPORT\nThe Board of Directors and Shareholders Metron Semiconductors Europa B.V. Almere, The Netherlands\nWe have audited the accompanying consolidated balance sheets of Metron Semiconductors Europa B.V. and its subsidiaries as of 31 May 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years ended 31 May 1995, 1994 and 1993 . The consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits 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 Metron Semiconductors Europa B.V. and its subsidiaries as of 31 May 1995 and 1994 and the results of their operations and their cash flows for each of the years ended 31 May 1995, 1994 and 1993 in conformity with accounting principles generally accepted in the United States of America.\nAmstelveen, The Netherlands, 20 July 1995.\n\/s\/ KPMG Accountants\nSignature for identification purposes: X ---\nRef.: drs. H.C.M. van Damme \/ C.J. Swaan\n[KPMG LETTERHEAD]\nEXHIBIT INDEX","section_15":""}
{"filename":"766041_1995.txt","cik":"766041","year":"1995","section_1":"Item 1. Business. ---------\n(a) General Development of Business --- -------------------------------\nCentral Sprinkler Corporation (the \"Company\"), through its wholly-owned subsidiaries, Central Sprinkler Company (\"Central Sprinkler\"), Spraysafe Automatic Sprinklers Limited (\"Spraysafe\"), Central Sprink Inc. (\"Sprink\"), Central Castings Corporation (\"Castings\") and Central CPVC Corporation (\"CPVC\"), is a leading manufacturer of automatic fire sprinkler heads, valves and other sprinkler system components as well as a distributor of component parts of complete automatic fire sprinkler systems that are either manufactured by the Company or purchased by the Company for resale to its customers.\nThe Company acquired Central Sprinkler in May 1984. Key executives of Central Sprinkler remained with the business and purchased a portion of the Company's common stock with the remainder purchased by an outside investor group. Prior to the acquisition, the Company did not have any significant assets or liabilities or engage in any activities other than those related to the acquisition. In May 1985, the Company went public by its sale of shares of common stock of the Company in an underwritten public offering.\nIn September 1985, the Company conducted an underwritten public offering of 8% Convertible Subordinated Debentures due 2010 (the \"Debentures\") in an aggregate principal amount of $17.3 million. During 1988, the Company called for early redemption all of its outstanding Debentures. Holders of $16.8 million face value of such Debentures elected to convert them into 1.6 million shares of newly issued common stock while $135 thousand face value of such Debentures were redeemed for cash.\nOn November 1, 1985, the Company acquired 80% of the outstanding common stock and 100% of the outstanding preferred stock of Spraysafe, a sprinkler head manufacturer and distributor in the United Kingdom. During 1989, the Company increased its ownership in Spraysafe from 80% to 100% by purchasing all of the remaining common stock from the minority shareholder. The acquisition resulted in an expansion of the Company's product lines to include Spraysafe's glass bulb sprinkler heads and provide a further means of distributing the Company's products in foreign markets.\nOn November 1, 1992, Central Sprinkler acquired certain business assets of a midwestern company engaged in the distribution of fire sprinkler equipment at a cost of approximately $1.2 million. The acquired assets consisted primarily of inventory. Central Sprinkler merged the acquired assets into its distribution network and strengthened its overall distribution network. On August 17, 1993, Central Sprinkler acquired certain business assets and assumed certain liabilities of Sprink, Inc., a company engaged in the business of manufacturing and distributing pipe couplings, fittings and other products that are used in fire sprinkler systems. The assets acquired included, among other things, inventories (excluding selected items), property and equipment, customer records, patents, warehouse and office supplies, computer software and the capital stock of Sprink International, S.A. de C.V. for a purchase price of approximately $4.1 million. The liabilities assumed were principally warranty obligations and obligations under operating leases. The acquisition was made through a newly organized company, Central Sprink Inc.\nIn July 1994, Central Sprinkler formed a new company, Central Castings Corporation (\"Castings\"). Castings acquired substantially all of the business assets of a foundry in the Southeastern United States engaged in manufacturing piping system components. The purchase price was approximately $1.8 million for assets consisting primarily of property, plant and equipment. The Company is undergoing a substantial expansion of such facility to accommodate production of several additional product lines.\nIn May 1995, Central Sprinkler formed a new company, Central CPVC Corporation (\"CPVC\"). Central Sprinkler Company contributed business assets to CPVC. CPVC is engaged in manufacturing CPVC plastic pipe and fittings.\n(b) Financial Information About Industry Segments. --- ----------------------------------------------\nThe Company operates in one industry; the manufacture and sale or purchase and sale of component parts of complete automatic fire sprinkler systems.\n(c) Narrative Description of Business. --- ----------------------------------\nGeneral - -------\nThe Company is a leading manufacturer of automatic fire sprinkler heads and valves and other components as well as a distributor of component parts of complete automatic fire sprinkler system. Approximately 56% of the Company's fiscal 1995 annual sales are derived from the manufacture and sale of the Company's primary product lines which are fire sprinkler heads and valves. The balance is derived principally from the sale of other component parts, several of which are also manufactured by the Company's subsidiaries. The Company designs, manufactures and markets a wide variety of sprinkler heads and valves for commercial, industrial, residential and institutional uses throughout the world. The Company sells its products to approximately 3 thousand customers, most of which are sprinkler installation contractors.\nProducts - ---------\nThe principal components of a sprinkler system are the sprinkler heads and the valves, both of which are manufactured and marketed by the Company and represented approximately 47% and 9%, respectively, of the Company's sales in fiscal 1995 and 49% and 10%, respectively, in both fiscal 1994 and 1993. The Company also manufactures and distributes several other components and distributes other sprinkler system component parts. Other product lines manufactured and sold under the Company's various trade names are steel and CPVC plastic pipe and fittings as well as other piping system components.\nThe sprinkler head is the mechanism that is activated by heat and discharges a water spray. The sprinkler head is composed principally of copper, brass and other non-corrosive materials. The Company presently produces and markets six basic types of sprinkler heads: the standard commercial sprinkler, the residential\/life-safety sprinkler, the Flow Control (TM) sprinkler, the extended coverage commercial sprinkler, the early suppression fast response sprinkler and specific application series sprinklers which were introduced in fiscal 1994.\nThe standard commercial sprinkler head is installed near the ceiling of a structure and consists of a fusable alloy pellet which is sealed into a bronze center strut by a stainless steel ball. When the alloy melts at its rated temperature, the ball is forced upward into the center strut, releasing two ejector springs and activating the sprinkler, which discharges water in a prescribed flow path. The Company also has standard commercial sprinklers with glass bulb activating mechanisms. Generally, standard commercial sprinklers are designed to activate at specified temperatures between 135 and 286 degrees. Standard commercial sprinkler heads are manufactured in a wide variety of models, sizes, and finishes. The Company also has several adjustable concealed standard commercial sprinklers. These models have several advantages over previous models produced by both the Company and its competitors.\nThe second type of sprinkler head produced and marketed by the Company are residential\/life-safety sprinklers. These sprinklers have quick response features and are designed to react to a fire before it has a chance to spread, which effectively minimizes the smoke, fumes and toxic by-products of the fire. These residential\/life-safety sprinklers are recognized today as the best means to protect a life in the event of a fire. In fiscal 1983, the Company introduced its first life-safety sprinkler in the form of the Omega (TM) sprinkler. This patented Omega (TM) sprinkler is equipped with unique design features which provide two principal advantages over the standard commercial sprinkler. The Omega (TM) sprinkler operates five to six times faster than a standard commercial sprinkler and features a spray pattern that has been shown to be more effective in the control or extinguishment of fire. In late 1989, the Company\nintroduced new residential\/life-safety sprinklers with glass bulb activating mechanisms. These models featured more traditional sprinkler designs along with the quick response features previously only available in the Omega (TM) model. These sprinklers are more moderately priced than the Omega (TM) model. The Company introduced several new models of its Glass Bulb residential sprinklers in fiscal 1995 and fiscal 1994. Additionally, the Company introduced a new residential series of concealed sprinklers called ROC (Residential Optima Concealed). These sprinklers offer the best flows at the greatest area of coverage on the market.\nThe third type of sprinkler head produced by the Company is the Flow Control (TM) sprinkler, which the Company has marketed since 1984. Unlike the standard commercial sprinkler head and the residential\/life-safety sprinkler head, which continue to spray water until manually turned off, the Flow Control (TM) sprinkler head has a distinct operating feature which allows it to open and close automatically as heat conditions dictate. It is, therefore, particularly well suited for areas sensitive to water damage, such as libraries, museums or computer rooms. The Flow Control (TM) sprinkler operates faster than a standard commercial sprinkler and is able to react to a fire before it has a chance to spread, thereby limiting damage to the affected area.\nThe fourth type of sprinkler head produced by the Company is the extended coverage commercial sprinkler. This sprinkler line brings about a dramatic turning point in sprinkler technology by extending ordinary spacing from 130 sq. ft. to 400 sq. ft. These sprinklers are being marketed under the trade name of Optima (TM) sprinklers. The Company introduced the Optima (TM) sprinkler in 1993 and developed new models in both fiscal 1995 and 1994. A patent has been issued on these sprinklers that provide uniform distribution of minimum densities at very low start pressures, while achieving superior fire control when compared to the standard commercial sprinkler line.\nThe fifth type of sprinkler head produced by the Company starting in fiscal 1993 is the early suppression fast response (\"ESFR\") sprinkler. This sprinkler is designed for use in special hazards situations. It is used primarily to protect storage areas where there is a need for a high density of water with a quick responding sprinkler head.\nThe sixth type of sprinkler produced and marketed by the Company is the specific application series. These sprinklers, such as the Window Sprinklers introduced in fiscal 1995 and the Attic (TM) and the ELO-231 specific application sprinklers, are designed to provide better fire protection for specific occupancies while providing overall economic savings to our installation contractor customers.\nThe Company markets a wide variety of sprinkler system valves which are used specifically in fire sprinkler installations. Several of these valves are manufactured by the Company (alarm valve, butterfly valve, check valve, deluge valve and dry pipe valve), while certain other valves are manufactured by others and marketed by the Company. In fiscal 1995, 1994 and 1993 the Company introduced several new manufactured valve models including butterfly valves and a new deluge valve. A sprinkler system valve is the mechanical device by which the water supply is controlled. When the sprinkler head is activated, the valve allows water to flow into and through the system.\nThe average cost of sprinkler heads and valves used in a complete fire sprinkler system is generally less than 5% of the total cost of a complete system.\nIn addition to its primary product lines of manufactured sprinkler heads and valve products, the Company also manufactures under a production supply contract its own line of CPVC plastic pipe and CPVC plastic pipe fittings. The Company expanded such CPVC product lines and manufacturing capacity in fiscal 1995 and fiscal 1994. The Company also manufactures its own line of steel sprinkler pipe by an investment in and production supply contract with a steel pipe manufacturer. In fiscal 1993, the Company started to manufacture its own line of glass bulb ampules for use as activating mechanisms in sprinkler heads. In addition, the 1993 acquisition of Sprink brought the Company into the manufacture of pipe couplings and fittings and a 1994 acquisition brought the Company the ability to manufacture other piping system components. The Company also distributes a wide variety of other parts used in sprinkler system installations. The majority of the other components include fittings, control valves, electric switches, hangers and a variety of other items. The Company developed and markets a computer aided design (\"CAD\") system to architects, designers, and contractors for use in the design and installation of sprinkler systems. The Company also provides other CAD related services through its SprinkCAD division.\nMarketing and Customers - -----------------------\nThe Company's products are marketed by its own sales and marketing staff. This staff consists of approximately 175 people and operates from fifteen regional sales office\/distribution centers located near Boston, Atlanta, Miami, Dallas, Chicago, Los Angeles, San Francisco, Seattle, Philadelphia, Baltimore, Salt Lake City, Greensboro, and Portland and from one distribution center in the United Kingdom. A new center was opened in the latter part of fiscal 1995 in Singapore. Unlike the majority of the industry which markets its products primarily through wholesale distributors, the Company sells most of its products directly to sprinkler installation contractors. This places the Company in direct contact with its customers and allows it to respond effectively to customer demands and suggestions.\nThe Company's sales and marketing efforts are directed primarily to these sprinkler installation contractors. Additional sales and marketing efforts are directed to the introduction and promotion of the Company's products to architects, engineers, builders, end-users, local fire authorities and insurance underwriters, for purposes of encouraging them to recommend or specify the Company's sprinklers for use in new construction and retrofit installations.\nThe Company markets its products to approximately 3 thousand customers, the majority of whom are sprinkler industry contractors, for commercial, industrial, residential and institutional use throughout the world.\nIn fiscal 1995, no single customer accounted for more than 3% of the Company's net sales.\nThe Company typically manufactures about 90% of its products for estimated shipping demands and 10% pursuant to specific customer orders. The Company does not have any significant order backlog.\nThe Company advertises its products through various media including insurance publications and trade journals. The Company also participates in trade shows and trade organizations. Approximately $662 thousand was spent on advertising the Company's products in 1995.\nThe Company's products are not marketed pursuant to long-term purchase agreements, but are sold pursuant to individual purchase orders. Often the Company's published sales terms sheet is the controlling purchase document.\nThe Company is affected by seasonal factors as well as the level of new construction activity, remodeling and retrofitting of older properties in the commercial, industrial, residential and institutional real estate markets. The Company's sales tend to increase the most when there is a high level of new construction activity in all such real estate markets and decline when there is a slowdown in new construction activity. In addition, as a result of relatively higher levels of new construction during warmer spring and summer months, the demand for sprinkler system components tends to be greater during the summer and fall than during other seasons.\nCompetition - -----------\nThe Company competes on the basis of price, service, product quality, design and performance characteristics. The Company encounters competition worldwide primarily from approximately seven domestic manufacturers of sprinkler heads and valves and a large number of manufacturers and\/or distributors of other sprinkler system component parts.\nThe Company is the world's leading manufacturer of fire sprinklers. The Company also believes its position is due in large part to its relationships with customers and the innovative technological features of its products.\nResearch and Development - ------------------------\nResearch and development has contributed significantly to the Company's success over the years and will be a major factor in the Company's ability to continue its future growth.\nThe Company maintains a staff of fourteen engineers and thirty-three support technicians who devote their time to research and development activities. During the 1995 fiscal year, the Company spent $5.1 million on research and development compared to $4.1 million in fiscal 1994 and $2.8 million in fiscal 1993. The Company's efforts in this area are primarily focused on sprinkler head and valve design and development, and are directed toward both new product development and further refinement of the quick response technology designed for residential\/life-safety purposes, extended coverage sprinklers and the specific application sprinkler series. A facility used for research and development of glass bulb sprinkler activating mechanisms was converted to production of such products early in the 1993 fiscal year leading to a reduction in the related research and development costs from year-to-year for such facility. The Company's heavy emphasis on the development of new products continued throughout the year and led to many new products in fiscal 1995 and fiscal 1994.\nPatents - -------\nThe Company holds a number of patents. The Omega (TM) sprinkler head patent, which expires January 1, 2002, protects a unique operating feature (relating to increased activating speed and extended water coverage of the spray pattern) and sets the Omega (TM) head apart from standard commercial sprinklers. The Company was issued a patent on the new extended coverage commercial sprinkler and additional related patent applications are pending on the product line. These are very important to the Company based upon the Company's substantial investment in the product line and the dramatic turning point they provide in fire sprinkler protection and technology. The Company has also filed for patent protection on a number of other products.\nTrademarks - ----------\nThe Company has a number of trademarks on various product names and selected product components. An important trademark was recently obtained on the appearance of installed Omega (TM) products and the Company hopes it will ultimately prevent others from copying this product.\nSources of Supply - -----------------\nThe Company uses a number of component parts in its manufacture of sprinkler heads and valves. The principal components of the sprinkler head include the frame, the deflector and the activating mechanism. The major component of the valve is the metal casting.\nMaterials, parts and components purchased by the Company for the production of its sprinkler heads and valves are generally available from a large number of suppliers. The vast majority of items are manufactured specifically for the Company's needs from molds, dies and patterns owned by the Company. The Company has not experienced any shortages or significant delays in delivery of these materials in the recent past, and management believes that adequate supplies will continue to be available.\nThe Company also has a non-exclusive supply contract with the B.F. Goodrich Company to supply the resin that the Company uses to produce CPVC plastic pipe and fittings. This supply contract, which expires in December 1997, is important since this resin is not generally available. Other products manufactured by the Company such as steel pipe, fittings and couplings and other piping system components use raw materials that are available from a wide variety of suppliers.\nOther component parts purchased by the Company for distribution purposes are generally available from a number of manufacturers.\nEffect of Environmental Protection Regulations - ----------------------------------------------\nThe Company is subject to compliance with various federal, state and local regulations relating to protection of the environment. The Company has not made nor does it currently expect to make any material capital expenditures for environmental protection and control equipment for its current operations. As more fully discussed in Item 7, \"Environmental Matters\", the Company has been advised by the Environmental Protection Agency of a potential contamination problem in the vicinity of the Company's primary plant.\nEmployees - ---------\nThe Company employs approximately 900 people, of whom approximately 600 are production or shipping employees, with the remainder serving in executive, administrative or sales capacities. The Company's sprinkler and valve production and shipping employees are covered by a collective bargaining agreement with the International Association of Machinists & Aerospace Workers. The agreement will expire in October 1997. All of the covered employees are located at the Company's primary manufacturing plant in Lansdale, Pennsylvania.\n(d) Financial Information about Foreign and Domestic Operations and ------------------------------------------------------------------- Export Sales. - -------------\nThe Company operates in one business segment and engages in business activity outside the United States. During fiscal 1995, 1994 and 1993, the combined export and foreign sales represented approximately 9.9%, 8.6% and 9.0%, respectively, of the Company's net sales. Included in foreign sales are the sales of the Company's United Kingdom subsidiary (Spraysafe). Spraysafe primarily manufactures sprinkler heads and distributes them and other products in Europe and other foreign countries. Significant financial information about Spraysafe's operations consists of the following in thousands of dollars:\nYear Ended October 31, ----------------------------------- 1995 1994 1993 ------- ------ ------ Sales $11,210 $8,800 $6,259 Operating Income 1,202 702 644 Net Income 699 440 279 Total Assets 7,903 5,065 3,872 Total Liabilities 4,862 2,710 2,140\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - ------- -----------\nThe Company's primary manufacturing plant and executive offices are located in Lansdale, Pennsylvania. The Lansdale facility is owned by the Company. It is comprised of several buildings which contain approximately 166 thousand square feet of floor space on a parcel of about 7 acres. This facility is pledged as security for a mortgage loan. The SprinkCAD division is in a separate leased facility in Lansdale, Pennsylvania of approximately 3 thousand square feet. The lease term is through October 1996 with annual renewals. The Company also owns a separate fire sprinkler component manufacturing facility of approximately 10 thousand square feet in Pennsylvania, a piping systems components manufacturing facility and foundry of approximately 120 thousand square feet on a 67 acre parcel in Alabama purchased in fiscal 1994 and has contract manufacturing facilities for steel and plastic pipe and fittings in Ohio and Alabama.\nThe Company's thirteen domestic sales office\/distribution centers are located in major cities across the United States listed in Item 1(c), Marketing and Customers, hereof and range in size from 9 thousand to 66 thousand square feet per building. These facilities are leased by the Company pursuant to leases which terminate from 1996 through 2002. The Company has options to extend certain of its leases for additional periods on similar terms. The Company's Sprink subsidiary occupies a sales office\/distribution facility located within the Brea, California distribution center leased space. In addition, Sprink has a number of contract manufacturing facilities located in the Far East.\nThe Company's United Kingdom subsidiary owns a manufacturing plant in the United Kingdom which contains approximately 12 thousand square feet of floor space on a parcel of about 1 acre. This facility is also pledged as security for a loan. The United Kingdom subsidiary also leases a distribution center of approximately 5 thousand square feet in the United Kingdom under a lease that expires in 2000 and leases a distribution center of approximately 3 thousand square feet in Singapore under a lease that expires in 1997.\nThe Company's manufacturing and assembly facilities operate on a two-shift per day basis. All of the manufacturing equipment used in the production process is owned by the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------------------\nThe Company is engaged in discussions with the Environmental Protection Agency concerning a claim which may develop in connection with the Company's primary manufacturing plant in Lansdale, Pennsylvania. This potential claim is more fully discussed in Item 7, \"Environmental Matters\". While there are various other claims pending and threatened against the Company pursuant to the ordinary conduct of business, these other claims are not expected to have any material adverse effect on the consolidated financial position of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ----------------------------------------------------\nNo matters were submitted to a vote of security holders of the Company, through the solicitation of proxies or otherwise, during the fourth quarter of fiscal 1995.\nItem 4(a). Executive Officers of the Registrant. -------------------------------------\nThe names and ages of the Registrant's executive officers and key employees, their positions with the Company and with Central Sprinkler, its primary operating subsidiary, and their principal occupations during the past five years are as follows:\nPosition(s) with the Company, and where indicated, with Central Name Age Sprinkler - -------------------- --- -----------------------------------------\nWinston J. Churchill 55 Chairman of the Board and Director\nWilliam J. Meyer 75 President and Director, and Chairman of the Board and Treasurer of Central Sprinkler\nGeorge G. Meyer 46 Chief Executive Officer, Secretary, Treasurer and Director, and President and Chief Executive Officer of Central Sprinkler\nStephen J. Meyer 44 Director, and Executive Vice President of Central Sprinkler\nWilliam J. Pardue 45 Executive Vice President of Central Sprinkler\nAlbert T. Sabol 43 Vice President, Finance of the Company and Central Sprinkler\nGeorge S. Polan 45 Vice President, Research and Development of Central Sprinkler\nJames R. Buchanan 46 Vice President, Sales of Central Sprinkler\nAlbert H. Schoenberger, Jr. 68 Vice President, Manufacturing of Central Sprinkler\nJames E. Golinveaux 32 Vice President, Technical Service and Engineering of Central Sprinkler\nAnthony A. DeGregorio 36 Vice President, SprinkCAD of Central Sprinkler\nMarilyn M. Thomas 36 Vice President, Distribution Operations of Central Sprinkler\nMichael J. Graham 45 Vice President, International Operations of Central Sprinkler\nWINSTON J. CHURCHILL - Mr. Churchill has been Chairman of the Board and a director of the Company and a director of Central Sprinkler since 1984. Mr. Churchill has been President of Churchill Investment Partners, Inc., a private investment firm, since 1989. He was a partner of Bradford Associates, a private investment firm, from 1984 to 1989. Mr. Churchill is also a director of IBAH, Inc., Geotek Industries, Inc. and Tescorp, Inc.\nWILLIAM J. MEYER - Mr. Meyer has been President and a director of the Company and Chairman of the Board of Central Sprinkler since 1984. He has also served Central Sprinkler as a director and Treasurer since 1975 and as President from 1975 to 1984.\nGEORGE G. MEYER - Mr. Meyer has been Chief Executive Officer since 1987 and Secretary and Treasurer of the Company since 1985, and a director of the Company and President and a director of Central Sprinkler since 1984. He was Executive Vice President of the Company from 1985 to 1987.\nSTEPHEN J. MEYER - Mr. Meyer has been a director of the Company and Executive Vice President of Central Sprinkler since 1986. He has been a director of Central Sprinkler since 1983.\nWILLIAM J. PARDUE - Mr. Pardue has been Executive Vice President of Central Sprinkler since 1980.\nALBERT T. SABOL - Mr. Sabol has been Vice President, Finance and Chief Financial Officer of the Company and Central Sprinkler since 1986.\nGEORGE S. POLAN - Mr. Polan has been Vice President, Research and Development of Central Sprinkler since 1990. He was Vice President, Engineering of Central Sprinkler from 1986 to 1989.\nJAMES R. BUCHANAN - Mr. Buchanan has been Vice President, Sales of Central Sprinkler since 1984.\nALBERT H. SCHOENBERGER, JR. - Mr. Schoenberger has been Vice President, Manufacturing of Central Sprinkler since 1977.\nJAMES E. GOLINVEAUX - Mr. Golinveaux has been Vice President, Technical Service and Engineering of Central Sprinkler since 1993 and Vice President, Technical Service of Central Sprinkler since 1992. He was Director of Technical Service from 1991 to 1992. From 1986 to 1991 he was the Design Manager for a large fire protection installation contractor.\nANTHONY A. DEGREGORIO - Mr. DeGregorio has been Vice President, SprinkCAD of Central Sprinkler since 1993 and was manager of SprinkCAD sales and service from 1990 to 1993. From 1986 to 1990 he was General Manager of a computer aided design services company.\nMARILYN M. THOMAS - Ms. Thomas has been Vice President, Distribution Operations of Central Sprinkler since 1995 and was Director of Warehouse Operations from 1984 to 1994.\nMICHAEL J. GRAHAM - Mr. Graham has been Vice President, International Operations of Central Sprinkler since 1995 and Managing Director of Spraysafe Automatic Sprinkler Limited (U.K.) since 1990.\nGeorge G., Stephen J. Meyer, and Marilyn M. Thomas are brothers and sister and are sons and daughter of William J. Meyer. William J. Pardue is William J. Meyer's son-in-law.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related ------------------------------------------------ Stockholder Matters. --------------------\nThe Company's Common Stock is traded on the NASDAQ National Market, NASDAQ symbol - CNSP. The following table sets forth, for the fiscal years indicated, the range of high and low price quotations.\nFiscal 1995: - ------------ High Low ---- --- First Quarter............... $12 $ 8 5\/8 Second Quarter.............. 21 10 3\/4 Third Quarter............... 29 1\/2 18 1\/2 Fourth Quarter.............. 37 1\/4 26 1\/2\nFiscal 1994: - ------------\nFirst Quarter............... $14 1\/4 $12 Second Quarter.............. 14 3\/4 11 1\/2 Third Quarter............... 12 1\/2 10 1\/4 Fourth Quarter.............. 11 1\/4 9\nAs of December 31, 1995, there were approximately 1 thousand holders of record of Common Stock of the Company. The closing price of such stock on the NASDAQ National Market on December 31, 1995 was $35.50.\nThe Company has not paid dividends on Common Stock since its inception in 1984. The Company intends to continue its policy of retaining earnings to finance future growth.\nItem 6.","section_6":"Item 6. Selected Financial Data. - ------ ------------------------\nThe following summary sets forth selected financial data with respect to the Company for the last five fiscal years. The selected financial data has been derived from the consolidated financial statements of the Company.\nThis data should be read in conjunction with other financial information of the Company, including the consolidated financial statements of the Company and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere herein.\nSUMMARY OF SELECTED FINANCIAL DATA (Amounts in thousands, except per share)\nThe following fiscal year information should be read in conjunction with the accompanying consolidated financial statements appearing elsewhere in this report.\nSELECTED FINANCIAL DATA FOOTNOTES\n(1) Operating income represents income before income taxes and interest expense (income), net.\n(2) After favorable cumulative effect of $238 ($.05 per share) due to accounting change for income taxes.\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, for the years indicated, the percentage relationships to net sales of the items included in the Consolidated Statements of Income and the percentage changes in the dollar amounts of such items from year-to-year.\nPercentage of Net Sales Percentage Increase Year Ended October 31, (Decrease) ----------------------- -------------------- Year 1995 Year 1994 1995 1994 1993 Over 1994 Over 1993 ----- ----- ----- --------- --------- Net sales............ 100.0% 100.0% 100.0% 36.6% 40.9% Cost of sales........ 67.5 69.7 71.6 32.3 37.1 ----- ----- ----- Gross profit......... 32.5 30.3 28.4 46.7 50.6 ----- ----- ----- Selling, general and administrative..... 20.0 21.4 21.6 27.5 40.1 Research and development........ 3.2 3.5 3.4 25.5 44.2 Other income, net.... (.3) (.1) (.1) 154.2 80.0 ----- ----- ----- 22.9 24.8 24.9 26.3 40.4 ----- ----- ----- Operating income..... 9.6 5.5 3.5 138.1 123.1 ----- ----- ----- Interest expense..... 1.5 1.1 .5 81.4 208.8 Interest income ..... (.3) (.5) (.9) (26.2) (12.8) ----- ----- ----- 1.2 .6 (.4) 180.5 N\/M ----- ----- ----- Income before income taxes....... 8.4 4.9 3.9 133.1 81.0 Income taxes......... 3.1 1.7 1.0 151.0 146.3 ----- ----- ----- Income before cumulative effect of accounting change............. 5.3 3.2 2.9 123.8 59.1\nCumulative effect of accounting change for income taxes... -- .3 -- N\/M N\/M ----- ----- -----\nNet income........... 5.3 3.5 2.9 110.5 69.1 ===== ===== =====\nN\/M indicates not meaningful.\nFiscal 1995 net sales reached a record level of $158.8 million, an increase of $42.6 million or a 36.6% increase from the net sales recorded in fiscal 1994. The significant increase in sales was led by the strong demand for fire sprinklers and related products. Growth in the new construction market and higher levels of product usage in the retrofit market have driven the strong market demand for the Company's range of products. The Company's innovation and expansion of its lines of fire sprinkler's and related products also improved sales from the prior year. The Company experienced sales gains in virtually all major product groups. The Company's major product line of fire sprinklers experienced strong sales gains particularly for its Optima (TM) and Glass Bulb models which led the Company in setting record sales levels of fire sprinklers. Significant sales gains were experienced in other product lines including plastic, steel pipe and pipe fittings. The Company's programs to develop and expand the production and marketing of pipe and fittings products continued to significantly increase sales. Sales improvements were realized in all regions throughout the United States. Foreign and export sales increased 21.2% in fiscal 1995. Late in fiscal 1995, Spraysafe opened a distribution center in Singapore. Sales prices continued to be very competitive in fiscal 1995. Overall, sales prices were slightly higher in fiscal 1995 when compared to fiscal 1994. The Company increased its list prices on most manufactured products by 7% in July 1995. This price increase contributed to the overall sales and gross margin increase for the year.\nFiscal 1994 net sales were $116.2 million, and increased by $33.8 million and was 40.9% greater than the net sales recorded in fiscal 1993. The continued growth throughout the year in sales of automatic fire sprinklers was the primary reason for the sales increase. Sales benefitted from stronger market demand along with the incremental sales from several of the Company's new lines of fire sprinkler products. Sales of the Company's new line of Optima (TM) fire sprinklers had a very significant impact on the overall increase in fire sprinklers. The Company also had greater increases in sales of its Glass Bulb line of sprinklers and its Omega (TM) line of sprinklers than other products. Improved conditions in both the new construction and retrofit markets were the primary reasons for the stronger market demand. The stronger market demand also helped the Company realize increased sales in other components used in complete automatic fire sprinkler systems. In addition, incremental sales arose from new products in the valve, CPVC plastic, steel pipe and fittings product lines. Company programs to expand the production and marketing of piping products had a significant positive impact on sales of these products. Incremental sales were also realized in fiscal 1994 from several acquisitions, the most significant of which was the late fiscal 1993 acquisition of Sprink, Inc., a manufacturer and distributor of pipe couplings, fittings and other products that are used in automatic fire sprinkler systems. Sales improvements were realized in virtually\nall regions throughout the United States. Sales gains were also experienced in foreign sales and foreign markets. Combined foreign and export sales rose 36.0% in fiscal 1994. Sales prices remained very competitive in fiscal 1994 although slightly improved when compared to fiscal 1993. The Company implemented a 7% list price increase in July 1994 on most of its manufactured products. This price increase did not have a significant impact on the overall sales increase for fiscal 1994.\nCost of sales for fiscal 1995 increased $26.2 million, or 32.3%, to $107.2 million from fiscal 1994. The increase is primarily due to the significantly higher sales volume. The Company's cost of sales decreased to 67.5% of net sales from 69.7% of net sales in fiscal 1994. This resulted in a gross margin percentage of 32.5% in fiscal 1995 compared to 30.3% in fiscal 1994. This increase in gross profit margin percentage is due primarily to a stronger sales mix of higher margin product lines. Other factors include additional contributions from new products, certain price increases that were put into effect in fiscal 1995 and lower costs of certain products. The increase in production of manufactured fire sprinkler products to meet market demand has increased utilization of the Company's production capacity. This has resulted in a lower unit product cost for certain products. The gross profit margin percentage for fiscal 1995 was somewhat lower than expected due to the costs related to the continuing expansion of the foundry and manufacturing facility for piping products acquired in late fiscal 1994. The gross profit margin was also negatively impacted by price increases to the Company from suppliers of certain materials in fiscal 1995.\nThe total dollar amount of cost of sales for fiscal 1994 increased over fiscal 1993 primarily due to the increase in the net sales between the periods. Cost of sales decreased to 69.7% of net sales for fiscal 1994 from 71.6% of net sales for fiscal 1993. This resulted in gross profit margin percentages of 30.3% and 28.4% for the 1994 and 1993 fiscal years, respectively. The continued increase in market demand for fire sprinklers and related product lines had a significant impact on the improved gross profit margin percentage for fiscal 1994. Higher numbers of production units helped to minimize cost increases and in some cases even reduced the cost of sprinkler products produced when compared to fiscal 1993. In addition, the Company's new line of Optima (TM) fire sprinklers experienced stronger margins than many of the Company's other fire sprinklers leading to an improvement in the overall sprinkler margin. In addition, the Company's increased ability to manufacture certain of its CPVC plastic piping products used in fire sprinkler systems led to certain costs lower than the costs of such items in fiscal 1993. The higher gross profit margins on manufactured sprinklers and other products were somewhat offset by lower margins on the Company's fittings product lines. The gross profit margin percentages on the fitting products and other piping system components are\ngenerally lower than the Company's other product lines and the greater sales of such products tends to reduce the Company's overall gross margin percentage. In addition, there were certain initial and continuing costs of upgrading and expanding the piping system component manufacturing facility acquired in fiscal 1994 as well as the coupling and fitting manufacturing facility acquired in 1993 that also negatively impacted the Company's gross profit for both fiscal 1994 and 1993.\nSelling, general and administrative expenses were 20.0% of net sales in fiscal 1995 compared to 21.4% of net sales in fiscal 1994. The reduced percentage of such expenses to net sales is due to sales increasing at a faster rate than the selling, general and administrative expense rate of increase. The total dollar amount of selling, general and administrative expenses increased by 27.5% or $6.9 million from fiscal 1994. The majority of the increase in expenses is due directly to the increased sales volume. The expense increases included a higher amount of sales personnel, fringe benefits, freight, travel and certain marketing costs. Distribution facility costs increased due to incremental expenses for personnel, fringe benefits, freight and other costs necessary to handle the increased sales volume. Distribution costs also increased due to the opening of three new distribution centers in late 1994 and relocations to larger facilities. In July 1995, Spraysafe opened a new distribution center in Singapore. The Company also started a project to increase efficiency of its distribution centers and to increase service to its customers. Administrative expenses increased in fiscal 1995 due in part to higher personnel and fringe benefit costs. In fiscal 1995 as compared to fiscal 1994, increased numbers of general and administrative personnel were required to provide necessary services to support the sales growth. Fringe benefit costs increased due to higher costs of the Employee Stock Ownership Plan (\"ESOP\") resulting from the significant increase in the Company's stock price as compared to fiscal 1994. ESOP expense is recorded based upon the shares allocated to the employees each month using the Company's average stock price for the period. General and administrative expenses also increased due to higher legal fees incurred in fiscal 1995 as compared to fiscal 1994 to protect patents on several new and innovative products.\nSelling, general and administrative expenses were 21.4% of net sales in fiscal 1994 compared to 21.6% of net sales in fiscal 1993. This reduced percentage of such expenses was due to the increased amount of sales in fiscal 1994. The total dollar amount of selling, general and administrative expenses increased by 40.1% or $7.1 million from fiscal 1993. Approximately 20% of this total increase is from the incremental selling, general and administrative expenses of the full fiscal 1994 year of operations of Sprink compared to only two and one-half months of such expenses in fiscal 1993. The balance of the\nincrease was a result of several other factors, the most significant of which was increased amounts of variable sales expenses related to the increased sales volume. The Company also increased the size of its warehouse distribution network in fiscal 1994 and incurred incremental expense to support the opening of two new distribution facilities - Salt Lake City, Utah and Greensboro, North Carolina to support increased sales in those regions. A third facility opened in Portland, Oregon at the end of the period. The Company also expanded several warehouse facilities and relocated to larger facilities. Additional personnel were also required to handle the increased sales volume. In addition, shipping and freight costs, travel expenses and royalties paid on certain product sales increased during the year along with inflationary increases on wages and fringe benefits. General and administrative expenses also increased during the year due to an increased number of administrative personnel along with inflationary increases in salaries, wages and fringe benefits.\nResearch and development expenses for fiscal 1995 reached $5.1 million which was an increase of $1 million or 25.5% over fiscal 1994. Research and development expenses were 3.2% of net sales in fiscal 1995 as compared to 3.5% in fiscal 1994. Such expenses increased at a high rate but somewhat lower than the growth rate in sales. The Company continues its heavy emphasis on research and development to develop new, improved and innovative products as well as improving its existing product lines. The Company considers its research and development programs to be a very important part of the Company's long-term growth plan. The higher expenses in fiscal 1995 were related to increased product development and testing, along with increases in the use of outside services and in the number of personnel. The Company continued to incur incremental research and development costs associated with the development and expansion of the piping products line.\nResearch and development expenses for fiscal 1994 increased by 44.2% over fiscal 1993 amounts. Such expenses were 3.5% of net sales compared to 3.4% of net sales for fiscal 1993. The increase in research and development expenses during fiscal 1994 was primarily related to increased costs for product development and testing, along with increases in the number of personnel and their related salaries, wages and fringe benefits. During fiscal 1994, the Company developed a number of new products for both residential and commercial applications. A variety of manufactured valves, CPVC plastic fittings and several new sprinkler models including the Attic (TM) sprinklers and Optima (TM) concealed sprinkler, were significant 1994 developments. The Company continued to focus its development efforts on its line of extended coverage sprinklers for ordinary hazards, along with a new family of dry pendent sprinklers. The Company also incurred incremental research and development costs associated with the development and expansion of the piping products line. In addition, the Company increased the number of developmental personnel which resulted in increases in salaries, wages and fringe benefits, and along with inflationary increases for existing personnel, added to the overall increase between fiscal 1994 and 1993.\nNet interest expense for fiscal 1995 of $1.9 million was 1.2% of net sales as compared to $678 thousand or .6%, in fiscal 1994. Interest expense was $2.4 million after capitalizing $333 thousand of interest incurred, as compared to $1.3 million in fiscal 1994. The increase in interest expense was primarily due to increased levels of debt. At October 31, 1995, total debt was $45.4 million as compared to $31 million at the end of fiscal 1994. In fiscal 1995, additional net short-term borrowings totaled $16.6 million and $948 thousand in additional long-term debt. The additional debt was required to repurchase treasury stock, to fund the Company's capital expenditures in primarily manufacturing and distribution expansions and to provide for increased accounts receivable and inventory. Interest income decreased to $461 thousand in fiscal 1995 from $625 thousand in fiscal 1994. The Company had lower interest income due primarily to a decline in the investment balance due to the repurchase of 1.2 million shares of the Company's common stock for the treasury in December 1994.\nNet interest expense of $678 thousand was incurred during fiscal 1994 compared to net interest income of $295 thousand for fiscal 1993. Interest expense in fiscal 1994 was $1.3 million compared to $422 thousand in fiscal 1993, while interest income was $625 thousand and $717 thousand for the fiscal years 1994 and 1993, respectively. The increase in interest expense is due primarily to a substantial increase in the Company's total debt. The Company increased its borrowings in the latter part of fiscal 1993 to provide cash for acquisitions and increased working capital needs through the issuance of a $5 million term note and $11.6 million in net short-term borrowings. In fiscal 1994, there were $13.9 million in additional net short-term borrowings and $20 million in long-term debt issued to refinance short-term borrowings. These borrowings were required to support additional working capital needs and to fund the July 1994 acquisition of a company engaged in the manufacturing of piping systems components and planned expansions of such facility. The Company had total debt outstanding at October 31, 1994 of $31 million compared to $19 million at October 31, 1993. The decrease in interest income was due solely to lower interest rates earned on invested funds in fiscal 1994. Short-term investment interest rates fell from the levels achieved in fiscal 1993 and remained at such lower levels throughout most of fiscal 1994.\nThe effective income tax rate for fiscal 1995 was 36.9% as compared to 34.3% in fiscal 1994. The increase in the effective income tax rate includes a higher effective state income tax rate due to several factors that also increased the effective U.S. Federal income tax rate. One factor is a substantial reduction in the nontaxable investment income in fiscal 1995 as compared to fiscal 1994 resulting from a lower balance in investments. The Company also had a higher level of pretax income. Income before income taxes increased by $7.7 million or 133.1%, to $13.4 million. The higher level of pretax income combined with lower amounts of nontaxable income and tax credits proportionately reduces the favorable effect on the effective tax rate in fiscal 1995.\nThe effective income tax rates for fiscal 1994 and 1993 were 34.3% and 25.2%, respectively. The increase in the effective income tax rate for fiscal 1994 was primarily due to a higher effective U.S. Federal income tax rate. The two major items which contributed to the increased rate were a significantly higher amount of income before income taxes in fiscal 1994 than fiscal 1993 and the diminished effect of income tax credits and tax-exempt income in fiscal 1994 on the effective rate. The amount of income before income taxes rose by 81% to $5.8 million in fiscal 1994 from $3.2 million in fiscal 1993. The gross amounts of both income tax credits and tax-exempt interest income declined only slightly in fiscal 1994, but this decline had a much greater impact on the overall effective U.S. Federal income tax rate due to the higher income before income taxes amount.\nThe Company's sales are affected by seasonal factors as well as the level of new construction activity, remodeling and retrofitting of older properties in the commercial, industrial, residential and institutional real estate markets. The Company's sales tend to increase the most when there is a high level of new construction activity in all such real estate markets. In addition, as a result of relatively higher levels of new construction during warmer spring and summer months, the demand for sprinkler system components tends to be greater during the summer and fall than during other seasons.\nLiquidity and Capital Resources\nThe Company's primary sources of long-term and short-term liquidity are its current financial resources, projected cash from operations and borrowing capacity. The Company believes that these sources are sufficient to fund the programs necessary for future growth and expansion.\nThe Company's combined cash, cash equivalents and short-term investments were $12.1 million, 41% or $8.4 million less than fiscal 1994. Total cash, cash equivalents and short-term investments were $20.5 million at October 31, 1994. Cash, cash equivalents and short-term investments is primarily comprised of funds on deposit and various tax-exempt securities which provide adequate liquidity to meet the Company's obligations. The decrease in total cash, cash equivalents and short-term investments was due principally to the use of $11.8 million in December 1994 for the repurchase of 1.2 million shares of the Company's common stock for the treasury.\nThe Company's net short-term borrowings obtained primarily under lines-of-credit increased by $5.6 million in fiscal 1995 as compared to a net increase of $13.9 million in fiscal 1994. At October 31, 1995, $11 million of short-term borrowings have been classified as long-term debt based upon the Company's issuance of long-term bonds on November 21, 1995. In fiscal 1995, Spraysafe obtained a $948 thousand five-year term loan. During the second quarter of fiscal 1994, $20 million of the Company's borrowings under the lines-of-credit were refinanced in noncash transactions by the issuance of long-term debt in the form of two $10 million, ten-year term loans. The increased borrowings in fiscal 1995 and 1994 were primarily a result of the need to finance the increased growth in the Company's business. The Company experienced sales growth of 36.6% and 40.9% in fiscal years 1995 and 1994, respectively. This resulted in increases in both inventories required for these sales levels as well as accounts receivable resulting from the increased sales. Accounts payable also increased with the increase in purchasing volume. Cash was provided by operating activities in fiscal 1995 of $3.9 million whereas cash was used for operating activities of $1.8 million in fiscal 1994.\nIn July 1994, the Company purchased substantially all of the business assets of a foundry in the Southeastern United States engaged in manufacturing components for piping systems for cash of $1.6 million and a $200 thousand note payable. The assets acquired were principally property, plant and equipment. The Company is in the process of substantially expanding this facility's production capacity to accommodate several additional product lines. In addition to the cash required for the purchase, substantial amounts of working capital was used for additional property, plant and equipment after the purchase. Cash used for property, plant and equipment of $16 million in fiscal 1995 was significantly higher than the $6.3 million spent in fiscal 1994. Substantially all of the amount spent in fiscal 1995 and 1994 was for buildings, building improvements and machinery and equipment to expand the manufacturing capacity for various product lines. In fiscal 1995, another use of cash was $3.1 million for the repayment of long-term debt. In fiscal 1994, the Company used $2.2 million for the repayment of long-term debt. In December 1994, the Company repurchased 1.2 million shares of its common stock that were under the control of one investment management company for the beneficial interest of various clients for which it acts as an investment adviser. The shares repurchased represented about 25% of the outstanding common stock of the Company. The repurchase price was $9.50 per share for an aggregate purchase price of approximately $11.8 million. These\nshares are being held in the treasury for possible future issuance. The treasury stock repurchase was paid for through a reduction of the Company's cash and investments and further short-term borrowings. The consummation of the repurchase reduced the Company's net worth by the $11.8 million amount of the repurchase price. The Company believes that its current cash and investments along with its future earnings and borrowing capacity will be sufficient to meet the Company's working capital requirements and anticipated capital expenditures for fiscal 1996.\nThe Company purchases property, plant and equipment from time to time as required to maintain and expand its offices, manufacturing and research facilities and distribution centers. The Company has expanded and improved its operations over the years with such purchases and the Company intends to continue this policy in the future. The Company has commitments in the ordinary course of business for such expansions of facilities and equipment and for research and other contracts. The Company intends to meet these requirements for funds from current cash and investments and cash provided by operations and by further borrowings. The Company expects that such sources of liquidity will be sufficient to fund these expenditures as they occur. In addition, the Company has made certain commitments to expand and improve the foundry and manufacturing facility for piping system components bought in July 1994. These commitments are for buildings, building improvements and various machinery and equipment. As of October 31, 1995, the open commitments relating to this facility approximate $2.4 million. It is expected that such improvements will be completed prior to February 1996.\nEnvironmental Matters\nThe Company and approximately thirty other local businesses were notified by the Environmental Protection Agency (\"EPA\") in August 1991 that they may be potentially responsible parties with respect to groundwater contamination in the vicinity of the Company's primary manufacturing plant in Lansdale, Pennsylvania. The Company has entered into an Administrative Order of Consent for Remedial Investigation\/Feasibility study (\"AOC\") effective May 19, 1995 with the EPA. Pursuant to the AOC, the Company has agreed to perform certain tests on the Company's property to determine whether any land owned by the Company or ground water beneath such land could be a source of contamination at the site. It currently estimated that the Company's portion of the overall costs related to this matter will range from $240 thousand to $2.7 million depending upon the amount of cleanup necessary. Management believes that the Company's operations did not contribute to this contamination problem. The Company has recorded a liability for the minimum amount within the range above, which does not assume any recoveries from insurance or third parties.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. --------------------------------------------\nThe financial statements of the Company for the years ended October 31, 1995, 1994, and 1993, together with the report thereon of Arthur Andersen LLP dated December 13, 1995, are set forth on pages through hereof. The supplementary financial data for the Company is set forth on page hereof.\nThe remainder of the financial information required by this report is set forth on page S-1 which follow the financial statements and supplementary financial data set forth on pages through hereof. Such information is listed in Item 14(a)(2) hereof.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. -----------------------------------------------------\nThere have been no disagreements on any matter of accounting principles or practices or financial statement disclosure between the Company and its independent public accountants within the past two fiscal years.\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 regarding the executive officers of the Registrant is incorporated herein by reference to the material under the caption \"Executive Officers of the Registrant\" in Part I - Item 4(a) hereof.\nThe remainder of the information called for by this Item is incorporated herein by reference to Registrant's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders which Registrant intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation. -----------------------\nThe information called for by this Item is incorporated herein by reference to Registrant's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders which Registrant intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. ---------------------------------------------------\nThe information called for by this Item is incorporated herein by reference to Registrant's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders which Registrant intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. -----------------------------------------------\nThe information called for by this Item is incorporated herein by reference to Registrant's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders which Registrant intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. ------------------------------------------------------\n(a) The following documents are filed as a part of this report:\n(1) The financial statements and supplemental financial data required by Item 8 of this report are filed below:\nFINANCIAL STATEMENTS:\nPage(s) ------- Report of Independent Public Accountants.................\nConsolidated Balance Sheets as of October 31, 1995 and 1994...................................................-3\nConsolidated Statements of Income for the years ended October 31, 1995, 1994 and 1993........................\nConsolidated Statements of Cash Flows for the years ended October 31, 1995, 1994 and 1993..................-6\nConsolidated Statements of Shareholders' Equity for the years ended October 31, 1995, 1994 and 1993............\nNotes to Consolidated Financial Statements...............-15\nSupplementary Financial Data (unaudited):\nPage ---- Quarterly Financial Data.................................\n(2) The financial statement schedules required by Item 8 of this report are listed below:\nPage ---- Schedule II - Valuation and Qualifying Accounts.......... 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 financial statements or notes thereto.\n(3) Index of Exhibits\nThe following is a list of the Exhibits filed as a part of this report:\nFootnote to Exhibits:-\n* Indicates this is a management contract which is a compensatory plan or arrangement which is required to be filed as an exhibit to this form pursuant to Item 14(c) of this report.\nThe following Exhibit has previously been filed with the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990 as Exhibit 3(a) and is incorporated herein by reference thereto:\n3(a) Restated Articles of Incorporation of the Registrant\nThe following Exhibit has been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1987 as Exhibit 3(b) and is incorporated herein by reference thereto:\n3(b) Restated By-Laws of the Registrant\nThe following Exhibits 10(a) through 10(b) have been previously filed with Registrant's Form S-1 Registration Statement No. 2-96850 dated April 3, 1985, to Amendment No. 1 thereto dated May 8, 1985 or to Amendment No. 2 thereto dated May 17, 1985 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(a) Deferred Compensation Plan (formerly 10(f))*\n10(b) Multiemployer Union-Sponsored Pension Plan (formerly 10(i))\nThe following Exhibit has been previously filed with Registrant's Amendment No. 1 to S-1 Registration Statement No. 33- 4828 dated April 24, 1986 as the Exhibit number indicated and is incorporated herein by reference thereto:\n10(c) Employment Agreement between Central Sprinkler and Albert H. Schoenberger, Jr. (formerly 10(t))*\nThe following Exhibits have been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1986 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(d) Form of Indemnification Agreement among Central Sprinkler Corporation, Central Sprinkler Company, CSC Finance Company and their Executive Officers and Directors dated September 15, 1986 (formerly 10(t))*\n10(e) 1986 Incentive Stock Option Plan, as amended to date (formerly 10(v))*\nThe following Exhibit has been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1988 as the Exhibit number indicated and is incorporated herein by reference thereto:\n10(f) Incentive Compensation Plan, as amended to date (formerly 10(k))*\nThe following Exhibits have been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1990 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(g) Employment Agreement with William J. Meyer dated March 19, 1990 (formerly 10(n))*\n10(h) Employment Agreement with George G. Meyer dated March 19, 1990 (formerly 10(o))*\n10(i) Employment Agreement with Stephen J. Meyer dated March 19, 1990 (formerly 10(p))*\nThe following Exhibit has been previously filed with Registrant's Quarterly Report on Form 10-Q for the quarterly period ended April 30, 1992 as the Exhibit 19 and is incorporated herein by reference thereto:\n10(j) 1988 Non-Qualified Stock Option Plan, as amended*\nThe following Exhibits have been previously filed with Registrant's Annual Report or Form 10-K for the year ended October 31, 1992 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(k) Form of Employment Agreement, Schedule of Compensation and Amendment thereto dated September 22, 1992 for certain officers (formerly 10(m))*\n10(l) Employment Agreement with George S. Polan dated October 1, 1992 (formerly 10(n))*\n10(m) Central Sprinkler Employee Stock Ownership Plan (formerly 10(o))*\n10(n) Central Sprinkler Company Term Loan Agreement dated November 20, 1992 (formerly 10(p))\nThe following Exhibit has been previously filed with Registrant's Form 8-K dated August 17, 1993 as the Exhibit number indicated and is incorporated herein by reference thereto:\n10(o) Agreement to Purchase Assets dated August 12, 1993 among Sprink Inc., James Hardie Irrigation, Inc., J.H. Industries (U.S.A.) Inc., Central Sprink Inc., Central Sprinkler Company and Central Sprinkler Corporation (formerly Exhibit 2.1)\nThe following Exhibits have been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1993 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(p) Consulting Agreement between the Company and Churchill Investment Partners, Inc. dated June 21, 1993 (formerly 10(r))\n10(q) Consulting Agreement between the Company and Bradford Ventures Ltd. dated June 21, 1993 (formerly 10(s))\n10(r) 1993 Non-Employee Director Stock Option Plan (formerly (10(t))\nThe following Exhibits have been previously filed with Registrant's Annual Report on Form 10-K for the year ended October 31, 1994 as the Exhibit numbers indicated and are incorporated herein by reference thereto:\n10(s) Central Sprinkler 401(k) Profit Sharing Plan and Trust, as amended to date (formerly 10(t))\n10(t) Term Loan Agreement between Central Sprinkler Company and First Fidelity Bank, including exhibits and amendments thereto (formerly 10(u))\n10(u) Term Loan Agreement between Central Sprinkler Company and CoreStates Bank, N.A., including exhibits and amendments thereto (formerly 10(v))\nThe following Exhibits are filed herewith:\n10(v) Amendment of Employment Agreement with William J. Meyer dated January 5, 1996) *\n10(w) Amendment of Employment Agreement with George G. Meyer dated January 5, 1996 *\n10(x) Amendment of Employment Agreement with Stephen J. Meyer dated January 5, 1996 *\n10(y) Employment Agreement with James E. Golinveaux dated November 30, 1995 *\n10(z) Amendments to Term Loan Agreement between Central Sprinkler Company and First Fidelity Bank\n10(aa) Amendments to Term Loan Agreement between Central Sprinkler Company and CoreStates Bank, N.A.\n10(ab) Loan Agreement between Alabama State Industrial Development Authority and Central Castings Corporation dated as of November 1, 1995\n10(ac) Lease Agreement between Calhoun County Economic Development Council and Central Castings Corporation dated as of November 1, 1995\n10(ad) Letter of Credit and Reimbursement Agreement by and between First Fidelity Bank, National Association and Central Castings Corporation dated as of November 1, 1995\n11 Statement of Computation of Earnings per Common Share\n21 Subsidiaries of Registrant\n23 Consent of Independent Public Accountants\n(b) No reports on Form 8-K were filed during the quarter ended October 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.\nCENTRAL SPRINKLER CORPORATION\nBy: \/s\/William J. Meyer ----------------------------------- William J. Meyer President\nDate: January 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 as of the date indicated.\nSignature Title Date - ----------------------- --------------- ----------------\n\/s\/Winston J. Churchill Chairman of the January 24, 1996 - ----------------------- Board and Director Winston J. Churchill\n\/s\/William J. Meyer President and January 24, 1996 - ----------------------- Director William J. Meyer\n\/s\/George G. Meyer Chief Executive January 24, 1996 - ----------------------- Officer, Treasurer, George G. Meyer Secretary and Director\n\/s\/Albert T. Sabol Vice President- January 24, 1996 - ------------------------ Finance(Principal Albert T. Sabol Financial and Accounting Officer)\n\/s\/Stephen J. Meyer Director January 24, 1996 - ------------------------ Stephen J. Meyer\n\/s\/Joseph L. Jackson Director January 24, 1996 - ------------------------ Joseph L. Jackson\nSignature Title Date - ----------------------- --------------- ----------------\n\/s\/Barbara M. Henagan Director January 24, 1996 - ----------------------- Barbara M. Henagan\n\/s\/Richard P. O'Leary Director January 24, 1996 - ------------------------ Richard P. O'Leary\n\/s\/Thomas J. Sharbaugh Director January 24, 1996 - ----------------------- Thomas J. Sharbaugh\n\/s\/Timothy J. Wagg Director January 24, 1996 - ----------------------- Timothy J. Wagg\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS - --------------------------------------------------------------------------------\nTo Central Sprinkler Corporation:\nWe have audited the accompanying consolidated balance sheets of CENTRAL SPRINKLER CORPORATION (a Pennsylvania corporation) AND SUBSIDIARIES as of October 31, 1995 and 1994, and the related consolidated statements of income, cash flows and shareholders' equity for the years ended October 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 Central Sprinkler Corporation and subsidiaries as of October 31, 1995 and 1994, and the results of their operations and their cash flows for the years ended October 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nAs explained in Note 2 to the consolidated financial statements, effective November 1, 1994, the Company adopted the provisions of Statement of Position No. 93-6 \"Employers' Accounting for Employee Stock Ownership Plans\". In addition, as explained in Note 1 to the consolidated financial statements, effective November 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\".\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The 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. 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\nPhiladelphia, Pa. December 13, 1995\nCentral Sprinkler Corporation and Subsidiaries Financial Statements\nCONSOLIDATED BALANCE SHEETS (Amounts in thousands)\nOctober 31, ----------------- ASSETS 1995 1994 - --------------------------------------------------------------------------- Current Assets: Cash and cash equivalents $ 2,025 $ 2,188 Short-term investments 10,079 18,334 Accounts receivable, less allowance for doubtful receivables of $3,813 in 1995 and $3,737 in 1994, respectively 31,686 24,907 Inventories 35,955 28,653 Deferred income taxes 5,038 4,686 Prepaid expenses and other assets 650 902 -------- -------\nTotal current assets 85,433 79,670 -------- -------\nProperty, Plant and Equipment:\nLand 337 289 Buildings and improvements 6,306 4,592 Machinery and equipment 35,529 21,605 Furniture and fixtures 1,421 1,060 -------- -------\n43,593 27,546\nLess - Accumulated depreciation 15,567 12,298 -------- -------\n28,026 15,248 -------- -------\nGoodwill, less accumulated amortization of $3,012 in 1995 and $2,761 in 1994, respectively 3,010 3,261 -------- -------\nOther Assets 891 882 -------- -------\n$117,360 $99,061 ======== =======\n- --------------------------------------------------------------------------- The accompanying notes are an integral part of these statements.\nOctober 31, ----------------- LIABILITIES AND SHAREHOLDERS' EQUITY 1995 1994 - -------------------------------------------------------------------------------- Current Liabilities: Short-term borrowings $ 14,062 $ 8,486 Current portion of long-term debt 3,813 3,078 Accounts payable 12,724 7,731 Accrued expenses 6,896 5,301 Accrued income taxes 646 1,906 -------- -------\nTotal current liabilities 38,141 26,502 -------- -------\nLong-Term Debt 27,516 19,391 -------- -------\nOther Noncurrent Liabilities 577 699 -------- -------\nDeferred Income Taxes 1,576 1,368 -------- -------\nCommitments and Contingent Liabilities (Note 15)\nShareholders' Equity: Common stock, $.01 par value; shares authorized - 15,000; issued - 5,472 in 1995 and 5,398 in 1994, respectively 55 54 Additional paid-in capital 29,118 27,674 Retained earnings 42,939 34,481 Cumulative translation adjustments (109) (76) Deferred cost-Employee Stock Ownership Plan (6,360) (6,679) Unrealized investment holding gains, net 10 - -------- -------\n65,653 55,454\nLess - Common stock in treasury, at cost - 1,680 shares in 1995 and 444 shares in 1994 16,103 4,353 -------- -------\n49,550 51,101 -------- -------\n$117,360 $99,061 ======== =======\n- --------------------------------------------------------------------------- The accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF INCOME (Amounts in thousands, except per share)\nYear Ended October 31, ---------------------------- 1995 1994 1993\n- ------------------------------------------------------------------------------- Net Sales $158,849 $116,249 $82,481\nCost of Sales 107,165 81,012 59,085 -------- -------- -------\nGross profit 51,684 35,237 23,396 -------- -------- -------\nOperating Expenses: Selling, general and administrative 31,795 24,934 17,797 Research and development 5,133 4,091 2,838 Other income, net (549) (216) (120) -------- -------- -------\n36,379 28,809 20,515 -------- -------- -------\nOperating income 15,305 6,428 2,881 -------- -------- -------\nInterest Expense (Income): Interest expense 2,363 1,303 422 Interest income (461) (625) (717) -------- -------- ------- 1,902 678 (295) -------- -------- -------\nIncome before income taxes 13,403 5,750 3,176\nIncome Taxes 4,945 1,970 800 -------- -------- -------\nIncome Before Cumulative Effect of Accounting Change 8,458 3,780 2,376 Cumulative Effect of Accounting Change for Income Taxes - 238 - -------- -------- -------\nNet Income $ 8,458 $ 4,018 $ 2,376 ======== ======== =======\nEarnings per Common Share: Before Cumulative Effect of Accounting Change $2.50 $.75 $.50\nCumulative Effect of Accounting Change for Income Taxes - .05 - -------- -------- -------\nEarnings Per Common Share $2.50 $.80 $.50 ======== ======== =======\n- ------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)\nYear Ended October 31, ---------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------- Cash flows from operating activities: Net Income $ 8,458 $ 4,018 $ 2,376 Noncash items included in income: Depreciation and amortization 3,520 3,083 2,059 Cumulative effect of accounting change - (238) - Deferred income taxes (144) (1,708) (573) Deferred costs 529 183 300 Decrease (increase) in - Accounts receivable, net (6,779) (4,587) (9,213) Inventories (7,302) (4,978) (5,594) Prepaid expenses and other assets 252 (233) (260) Increase (decrease) in - Accounts payable 4,993 (386) 4,435 Accrued expenses 1,595 1,381 496 Accrued income taxes (1,260) 1,690 (249) ------- ------- -------\nNet cash provided by (used for) operating activities 3,862 (1,775) (6,223) ------- ------- -------\nCash flows from investing activities: Acquisition of property, plant and equipment (16,047) (6,285) (2,660) Aquisitions of businesses - (1,571) (2,608) Proceeds from (used for) short-term investments 8,255 (1,035) (3,817) Other - net (9) 22 (199) ------- ------- -------\nNet cash used for investing activities (7,801) (8,869) (9,284) ------- ------- -------\nCash flows from financing activities: Purchase of treasury stock (11,750) - (621) Short-term borrowings, net 16,576 13,908 11,567 Proceeds from exercised stock options 745 17 - Tax benefits from exercised stock options 368 3 - Proceeds from long-term debt 948 20 5,000 Repayments of long-term debt (3,088) (2,174) (1,314) Other - net (23) 158 (122) ------- ------- -------\nNet cash provided by financing activities 3,776 11,932 14,510 ------- ------- -------\nNet (decrease) increase in cash and cash equivalents (163) 1,288 (997) Cash and cash equivalents at beginning of year 2,188 900 1,897 ------- ------- ------- Cash and cash equivalents at end of year $ 2,025 $ 2,188 $ 900 ======= ======= =======\n- ------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Amounts in thousands)\nYear Ended October 31, ---------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------- Supplemental disclosures of cash flow information:\nCash paid (received) during the year for:\nInterest expense $ 2,638 $ 1,239 $ 348 ======= ======= =======\nIncome taxes $ 6,061 $ 2,016 $ 1,622 ======= ======= =======\nInterest income $ (854) $ (928) $ (567) ======= ======= =======\nSupplemental schedule of non-cash investing and financing activities:\nRefinancing of short-term borrowings with long-term debt $11,000 $20,000 $ - ======= ======= ======= Acquisitions: Fair value of assets acquired $ - $ 1,771 $ 5,687 Liabilities assumed - - (462) Note payable issued - (200) (2,617) ------- ------- ------- Cash paid for net assets acquired $ - $ 1,571 $ 2,608 ======= ======= =======\n- ------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Amounts in thousands)\n- ------------------------------------------------------------------------------ The accompanying notes are an integral part of these statements.\nCentral Sprinkler Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except per share)\n1. Summary of Significant Accounting Policies:\nTHE COMPANY - The Company's operations are conducted in one business segment as a manufacturer and distributor of components used in automatic fire sprinkler systems. These fire sprinkler system components are used in commercial, industrial, residential and institutional properties and are sold to over 3 thousand customers, most of which are sprinkler installation contractors.\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Central Sprinkler Corporation and its subsidiaries (the \"Company\"). All significant intercompany transactions and accounts have been eliminated.\nCASH EQUIVALENTS - The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents for the purpose of determining cash flows.\nSHORT-TERM INVESTMENTS - The Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115-Accounting for Certain Investments in Debt and Equity Securities prospectively effective November 1, 1994. At October 31, 1995, the short-term investments have been categorized as available for sale and as a result are stated at fair value. Unrealized holding gains and losses are included as a separate component of shareholders' equity until realized. At October 31, 1994, the short-term investments were stated at cost plus accrued interest which approximated market value. All of the Company's investment holdings have been classified in the consolidated balance sheet as current assets.\nINVENTORIES - Inventories are stated at the lower of cost (first-in, first-out) or market.\nPROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at cost. Depreciation and amortization are being recorded on a straight-line basis over the estimated lives of the assets which range from 3 to 20 years.\nGOODWILL - Goodwill represents the excess of the purchase cost of net assets acquired over their fair market value and is amortized primarily on a straight-line basis over 25 years. The Company considers goodwill to be fully realizable through future operations.\nFOREIGN CURRENCY TRANSLATION - Assets and liabilities of a foreign subsidiary are translated into U.S. dollars at the rate of exchange prevailing at the end of the year. Income statement accounts are translated at the average exchange rate prevailing during the year. Translation adjustments resulting from this process are recorded directly in shareholders' equity.\nRESEARCH AND DEVELOPMENT COSTS - Costs of research, new product development and product redesign are expensed as incurred.\nINCOME TAXES - Effective November 1, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109-Accounting for Income Taxes. The cumulative effect of this accounting change resulted in the recognition of a one-time gain of $238 or $.05 per common share in fiscal 1994. SFAS No. 109 requires deferred tax liabilities and assets be recognized for the tax effects of differences between the financial reporting and tax bases of assets and liabilities.\nEARNINGS PER COMMON SHARE - Earnings per common share is computed using the weighted average number of shares of common stock and common stock equivalents outstanding (dilutive stock options).\nRECLASSIFICATIONS - Certain reclassification of previously reported balances have been made to conform with the current year classification of such balances.\n2. Earning Per Common Share:\nThe weighted average common shares outstanding were 3,382, 5,004, and 4,710 for the years ended October 31, 1995, 1994 and 1993, respectively.\nEffective November 1, 1994, the Company adopted Statement of Position No. 93-6, \"Employers' Accounting for Employee Stock Ownership Plans\" (\"SOP\"). The SOP requires that unallocated shares of the Company's stock in the Employee Stock Ownership Plan (\"ESOP\") should be excluded from the average number of common shares outstanding when computing earnings per common share. In accordance with this SOP, 672 unallocated ESOP shares were excluded from the average number of common shares outstanding in fiscal year 1995. In accordance with the provisions of the SOP, prior period information has not been restated.\n3. Foreign Operations:\nThe Company owns Spraysafe Automatic Sprinklers Limited (\"Spraysafe\"), a Company in the United Kingdom. Spraysafe manufactures sprinkler heads and distributes these and other products in Europe and other foreign countries.\nSignificant financial information about Spraysafe's operations consist of the following -\nYear Ended October 31, --------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------ Sales $11,210 $8,800 $6,259 Operating income $ 1,202 $ 702 $ 644 Net income $ 699 $ 440 $ 279 Total assets $ 7,903 $5,065 $3,872 Total liabilities $ 4,862 $2,710 $2,140 - ------------------------------------------------------------------------------\n4. Short-Term Investments:\nThe following is a summary of the estimated fair value of available for sale securities by balance sheet classification -\nOctober 31, -------------------- 1995 1994 - ------------------------------------------------------------------------------ Cash Equivalents: U.S. Money Market Funds $ 517 $ 1,303 ======= ======= Short-Term Investments: Tax-Exempt Securities $10,079 $18,334 ======= ======= - ------------------------------------------------------------------------------\nGross unrealized holding gains and losses for the year ended October 31, 1995 were not material. The net unrealized holding gains for the year ended October 31, 1995 have been recorded as a separate component of shareholders' equity. The gross proceeds from sales and maturities of investments were $22,069 for the year ended October 31, 1995. Gross realized gains and losses for the year ended October 31, 1995 were not material. For the purpose of determining gross realized gains and losses, the cost of securities sold is based upon specific identification.\nShort-term investments are generally comprised of variable rate securities that provide for optional or early redemption within twelve months and the contractual maturities are generally greater than twelve months.\n5. Inventories:\nInventories consist of the following -\nOctober 31, -------------------- 1995 1994 - ------------------------------------------------------------------------------ Raw materials and work in proccess $11,237 $ 9,179 Finished Goods 24,718 19,474 ------- ------- $35,955 $28,653 ======= ======= - ------------------------------------------------------------------------------\n6. Shareholders' Equity:\nREDEEMABLE PREFERRED STOCK - The Company has authorized 2,000 shares of Redeemable Preferred Stock, $.01 par value. At October 31, 1995, 1994 and 1993, there were no shares issued and outstanding.\nTREASURY STOCK - The Company repurchased 1,237 shares of its common stock on December 21, 1994 at a cost of $11,750 and repurchased 58 shares of its common stock at a cost of $621 during fiscal 1993. There were no repurchases in fiscal 1994. All shares are being held in the treasury for possible future issuance. On April 28, 1993, the Company sold, in a leveraged transaction, 750 shares of its common stock from the treasury to the ESOP for $9.70 per share in exchange for a promissory note from the ESOP. The aggregate sale amount of $7,275 resulted in a decrease in treasury stock and increase in additional paid-in-capital of $7,245 and $30 respectively, as well as a charge to deferred cost-ESOP for $7,275 on the date of the sale.\nSTOCK OPTIONS - The Company has stock option plans (\"Option Plans\") which cover a maximum of 960 shares of common stock which may be granted. The Option Plans provide for the granting of 187 incentive stock options under a plan adopted in 1986 and 713 nonqualified or incentive stock options under a plan adopted in 1988 and amended in fiscal 1991. Under a plan adopted in 1993, the Company can issue up to 60 nonqualified options under a non-employee director stock option plan. Options have been granted to officers, other key employees and non-employee directors at exercise prices not less than 100% of the fair market value of the Company's common stock on the date of the grant. The options become exercisable after the date of the grant and expire ten years from the date of grant.\nThe following table presents data related to the Option Plans-\n- ------------------------------------------------------------------------------\nIncentive Nonqualified Stock Stock Option Options Options Price --------------------------------------- October 31, 1992 126 381 $8.60-$13.80 Granted - 12 $ 9.25 ---- ----\nOctober 31, 1993 126 393 $8.60-$13.80 Granted - 12 $13.00 Exercised (2) - $ 8.60 ---- ----\nOctober 31, 1994 124 405 $8.60-$13.80 Granted - 12 $15.60 Exercised (29) (44) $8.60-$13.80 ---- ----\nOctober 31, 1995 95 373 $8.60-$15.60 ==== ==== - ------------------------------------------------------------------------------\nAt October 31, 1995, all of the outstanding options were exercisable and 24 incentive options were available for grant under the 1986 plan and 337 nonqualified or incentive stock options were available for grant under the 1988 plan.\n7. Debt:\nThe Company's long-term debt consists of the following-\nOctober 31, ---------------------- 1995 1994 - ------------------------------------------------------------------------------ Term Loan $ 8,417 $ 9,416 Term Loan 8,500 9,500 Term Note 2,000 3,000 Mortgage Loan 464 538 Short-term borrowings refinanced subsequent to year end 11,000 - Foreign Term Loan 948 - Other Loans - 15 ------- ------- 31,329 22,469 Less-Current portion 3,813 3,078 ------- ------- $27,516 $19,391 ======= ======= - ------------------------------------------------------------------------------\nThe Company obtained two $10,000 ten-year term loans from banks in fiscal 1994. These term loans are unsecured and the proceeds of such loans were used to refinance borrowings under unsecured lines of credit from such banks. The loan proceeds were used primarily for working capital purposes and the acquisition and expansion of facilities to accommodate the growth in the Company's business. One term loan is payable through 2004 in monthly principal installments of $84 and bears interest at a variable rate which was 6.69% at October 31, 1995. The other term loan is payable through 2004 in quarterly principal installments of $250 and bears interest at a variable rate which was 7.04% at October 31, 1995. The Company must maintain certain tangible net worth, certain financial ratios and other requirements under the provisions of these term loans.\nThe Company's term note is unsecured and payable through 1997 in semi-annual payments of $500. The Company must maintain certain tangible net worth, certain financial ratios and other requirements under the provisions of this term note. Interest on this note is variable and was 7.04% at October 31, 1995.\nThe mortgage loan is secured by the Company's primary manufacturing facility and is payable at $6 monthly through 2002. Interest is also payable monthly at a variable interest rate which was 7.04% at October 31, 1995.\nIn fiscal 1995, Spraysafe obtained a $948 five-year term loan. This loan is unsecured and bears interest at a variable rate which was 8.0% at October 31, 1995. The loan proceeds were used primarily for machinery and equipment and working capital purposes.\nThe Company's short-term borrowings are primarily demand loans under lines of credit. At October 31, 1995, $11,000 of short-term borrowings are classified as long-term debt based on the Company's issuance of bonds on November 21, 1995. A principal amount of $8,000 are State of Alabama Industrial Development Authority Adjustable Convertible Taxable Industrial Revenue Bonds and a principal amount of $3,000 are Calhoun County (Alabama) Economic Development Council Adjustable Convertible Taxable Industrial Revenue Bonds (\"IRB's\"). The IRB's have a 20 year term and are payable in quarterly installments of $138 and bear interest at a variable rate which was 6.05% at the date of issuance. The IRB's are collateralized by a letter of credit and are subject to early redemption under certain circumstances. After reduction for the refinancing, the Company has domestic demand loans outstanding at October 31, 1995 of $13,387 which bear interest at a variable interest rate. The weighted average interest rate on these loans is 6.46% and 5.79% at October 31, 1995 and 1994, respectively. Spraysafe has short-term borrowings in the form of a demand loan which is payable in British pounds in the amount of $675 at October 31, 1995. This loan bears interest at a variable interest rate which was 7.98% and 7.25% at October 31, 1995 and 1994, respectively.\nThe Company has lines of credit with banks at variable interest rates which are generally less than the prime lending rate. After reclassification of $11,000 of short-term borrowings as long-term, approximately $17,123 of these lines of credit were unused and available for use at October 31, 1995.\nAnnual principal payments required under long-term debt obligations are as follows -\n- ------------------------------------------------------------------------------ Fiscal Year ----------- 1996 $ 3,813 1997 3,813 1998 2,813 1999 2,813 2000 2,813 Thereafter 15,264 ------- $31,329 ======= - ------------------------------------------------------------------------------\n8. CAPITALIZED INTEREST:\nThe interest cost incurred by the Company for fiscal year 1995 amounted to $2,696. The Company capitalized $333 of interest cost in fiscal year 1995 in connection with the expansion of the foundry and manufacturing facility for piping system components. No interest was capitalized in fiscal 1994 or 1993.\n9. INCOME TAXES:\nThe following table summarizes the source of income before income taxes and information concerning the provision for income taxes-\nYear Ended October 31, -------------------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------ Income before income taxes - Domestic $12,284 $5,102 $2,749 Foreign 1,119 648 427 ------- ------ ------ Total $13,403 $5,750 $3,176 ======= ====== ====== Provision for income taxes: - Current - U.S. Federal $ 3,674 $2,774 $1,000 State 1,067 696 222 Foreign 348 208 151 ------- ------ ------ Total 5,089 3,678 1,373 ------- ------ ------ Deferred - U.S. Federal 54 (1,328) (460) State (270) (380) (113) Foreign 72 - - ------- ------ ------ Total (144) (1,708) (573) ------- ------ ------ Total tax provision $ 4,945 $1,970 $ 800 ======= ====== ====== - ------------------------------------------------------------------------------\nIncome tax expense differs from the amount currently payable because certain revenues and expenses are reported in the income statement in periods which differ from those in which they are subject to taxation. The principal differences in timing between the income statement and taxable income involve certain accrued expenses and reserves not currently deductible for tax purposes, tax regulations which limit deductions for bad debt expense, the uniform cost capitalization rules and different methods used in computing tax and book depreciation. Such differences are recorded as deferred income taxes in the accompanying balance sheets under the liability method.\nThe components of the deferred income tax assets and liabilities, measured under SFAS No. 109 at the beginning and end of the fiscal year, are listed below. There is no valuation reserve for deferred tax assets.\n10\/31\/95 10\/31\/94 - ------------------------------------------------------------------------------ Deferred Tax Assets - - --------------------- Accounts receivable $1,813 $1,691 Inventories 1,702 1,643 Pensions 230 277 Patents 466 284 Other 1,095 938 ------ ------ Deferred tax assets 5,306 4,833 ------ ------\nDeferred Tax Liabilities - - -------------------------- Depreciation (1,105) (919) Other (739) (596) ------ ------ Deferred tax liabilities (1,844) (1,515) ------ ------ Net Deferred Tax Asset $3,462 $3,318 ====== ====== - ------------------------------------------------------------------------------ The adoption of SFAS No. 109 did not result in any significant changes to the income tax provision components in 1994. The recognition of income taxes in prior years has not been restated.\nThe effective tax rate is reconciled to the statutory U.S. Federal Income tax rate as follows -\nYear Ended October 31, --------------------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------ U.S. Federal statutory rate 34.0% 34.0% 34.0% Amortization of goodwill .6 1.4 2.5 State income taxes, net of U.S. Federal benefit 3.9 2.3 2.3 Income tax credits utilized (1.6) (1.9) (9.3) Tax-exempt interest (1.0) (3.5) (7.1) Market value adjustment of ESOP shares .8 - - Other .2 2.0 2.8 ----- ----- ----- 36.9% 34.3% 25.2% ===== ===== ===== - ------------------------------------------------------------------------------ 10. RELATED-PARTY TRANSACTIONS:\nThe Company has financial consulting agreements with companies affiliated with certain of its directors\/shareholders. These agreements provide for annual fees of $175 per year plus out-of-pocket expenses. These agreements extend through October 1996 and automatically renew for an additional year unless notice of cancellation is given.\nThe Company leases an aircraft from a business in which a director and executive officer of the Company is the sole proprietor. For the years ended October 31, 1995, 1994 and 1993, the Company recorded lease expense of $322, $270, and $240, respectively.\nThe Company expensed $594, $97, and $155 in the years ended October 31, 1995, 1994 and 1993, respectively, for legal fees to a firm having a member who is also a director of the Company.\n11. LEASES:\nThe Company has operating leases for its warehousing facilities and certain transportation and office equipment. The total rental expense for the years ended October 31, 1995, 1994 and 1993 was $1,118, $975 and $735, respectively. The future minimum rental payments required under operating leases that have initial or remaining lease terms in excess of one year as of October 31, 1995 are as follows -\n- ------------------------------------------------------------------------------ Fiscal Year ----------- 1996 $1,066 1997 715 1998 536 1999 464 2000 334 Thereafter 390 - ------------------------------------------------------------------------------\n12. INCENTIVE COMPENSATION PLANS:\nThe Company has an Incentive Compensation Plan which provides awards to officers and other employees of the Company. Amounts credited to the incentive compensation fund are 8% of monthly operating income, as defined in the Plan, if monthly operating income meets specified levels. Another plan provides three executive officers with a bonus paid on annual net income in excess of the 1985 base income level at a combined rate of 2 1\/2% of the increase.\nThe total amounts charged to expense for all such plans were $1,553, $590 and $296 for the years ended October 31, 1995, 1994 and 1993, respectively. Awards from the Incentive Compensation Plan are made to officers and other employees based on both specified percentage participation in the Plan as well as special awards determined at the discretion of the Company's Chairman.\n13. EMPLOYEE BENEFIT PLANS:\nCertain of the Company's manufacturing employees are covered by a union-sponsored, collectively bargained, Multiemployer Pension Plan. The Company contributed and charged to expense $248, $210 and $122 for the years ended October 31, 1995, 1994 and 1993, respectively. These contributions are determined in accordance with the provisions of negotiated labor contracts and generally are based on the number of hours worked. At October 31, 1995, the Company had no liability for unfunded vested benefits of this plan.\nThe Company sponsors a 401(K) Profit Sharing Plan which covers certain employees not covered by collective bargaining agreements and maintains Deferred Compensation Plans which provide retirement benefits for certain officers. The expense under these plans was $189, $175 and $154 for the years ended October 31, 1995, 1994 and 1993, respectively.\nThe Company has an Employee Stock Ownership Plan (\"ESOP\") which covers certain employees not covered by collective bargaining agreements. At October 31, 1995, the ESOP holds 780 shares of the Company's common stock. On April 28, 1993, the ESOP purchased 750 shares of the Company's common stock in a leveraged transaction for $9.70 per share. The future costs of the plan will be amortized over 15 years and are reported as a deferred cost in the equity section of the accompanying balance sheets. The ESOP issued a note payable to the Company which will be repaid over 15 years with interest at a variable rate. This note will be repaid from cash contributed to the plan by the Company. The stock will be allocated to the eligible employees over 15 years i n accordance with the ESOP plan provisions. As described in Note 2, the Company adopted SOP 93-6 effective November 1, 1994. Compensation expense is recorded for shares allocated to employees based on the fair market value of those shares in the period in which they are allocated. The difference between cost and fair market value of such allocated common shares, which was $332 in 1995, is recorded in additional paid-in capital. There were 657 and 689 ESOP common shares unallocated as of October 31, 1995 and 1994, respectively. The ESOP shares are summarized as follows - October 31, 1995 - ------------------------------------------------------------------------------\nAllocated shares 123 Unreleased shares 657 ------- Total ESOP shares 780 ======= Fair value of unreleased shares at October 31, 1995 $21,681 ======= - ------------------------------------------------------------------------------\nThe ESOP expense for the years ended October 31, 1995, 1994 and 1993 was $651, $297, and $299, respectively.\n14. ACQUISITIONS:\nThe Company purchased substantially all of the business assets of a foundry in the Southeastern United States engaged in manufacturing components for piping systems for a purchase price of $1,771 effective July 15, 1994. The assets consist primarily of property, plant and equipment and were acquired for cash of $1,571 and a $200 note payable that has reduced the cash payment of the purchase price.\nOn August 17, 1993, the Company acquired certain business assets and assumed certain liabilities of Sprink, Inc., a company engaged in the business of manufacturing and distributing pipe couplings, fittings and other products that are used in fire sprinkler systems. The assets acquired included primarily inventories (excluding selected items) and property and equipment for a purchase price of $4,100. The liabilities assumed were principally warranty obligations and obligations under operating leases. A $1,500 portion of the purchase price was paid in fiscal 1993 and the balance of $2,600 was paid in fiscal 1994.\n15. COMMITMENTS AND CONTINGENT LIABILITIES: AGREEMENTS AND CONTRACTS\nThe Company is a party to patent licensing agreements to manufacture and sell certain types of sprinkler devices. Under the terms of the agreements, the Company is required to pay a royalty on net commissioned sales (as defined in the agreements) of the licensed product during the terms of the patents. The expense under these agreements was $417, $380 and $338 for the years ended October 31, 1995, 1994 and 1993, respectively.\nThe Company has employment contracts with certain officers under which their employment could not be terminated without five years prior notice. The Company also has various purchase commitments for materials, supplies, machinery and equipment incident to the ordinary conduct of business. Such commitments are not at prices in excess of current market.\nThe Company, in the normal course of business, is party to various claims and lawsuits with regard to its products and other matters. Management believes that the ultimate resolution of these matters will not have a material impact on the Company's financial position.\nThe Company has made certain commitments to expand and improve the manufacturing facility for piping system components bought in July 1994 (Note 14). These commitments are for buildings, building improvements and various machinery and equipment. As of October 31, 1995, the open commitments relating to this facility approximate $2,400. It is expected that such improvements will be completed in February 1996.\nENVIRONMENTAL MATTERS\nThe Company and approximately thirty other local businesses were notified by the Environmental Protection Agency (\"EPA\") in August 1991 that they may be a potentially responsible party with respect to a groundwater contamination problem in the vicinity of the Company's primary manufacturing plant in Lansdale, Pennsylvania. The Company has entered into an Administrative Order of Consent for Remedial Investigation\/Feasibility Study (\"AOC\") effective May 19, 1995 with the EPA. Pursuant to the AOC, the Company has agreed to perform certain tests on the Company's property to determine whether any land owned by the Company or ground water beneath such land could be a source of any of the contamination at the site. It is currently estimated that the Company's portion of the overall costs related to this matter will range from $240 to $2,700 depending upon the amount of cleanup necessary. Management believes that the Company's operations did not contribute to this contamination problem. The Company has recorded a liability for the minimum amount within the range above, which does not assume any recoveries from insurance or third parties.\nSUPPLEMENTARY FINANCIAL DATA\nQuarterly Financial Data (Unaudited)\n(Amounts in thousands, except per share amounts) ------------------------------------------------ First Second Third Fourth - ------------------------------------------------------------------------------ Net sales $33,714 $37,990 $42,758 $44,387 Gross profit 10,612 12,258 14,006 14,808 Net income 1,448 1,923 2,389 2,698 Earnings per share .39 .60 .73 .82\nNet sales $24,463 $25,766 $30,831 $35,189 Gross profit 7,438 8,339 9,049 10,411 Income before cumulative effect of accounting change 424 769 1,188 1,399 Net income 662 769 1,188 1,399 Earnings per share before cumulative effect of accounting change .08 .15 .24 .28 Earnings per share .13 .15 .24 .28\nNet sales $16,008 $18,027 $22,088 $26,358 Gross profit 4,408 5,049 6,410 7,529 Net income 136 467 817 956 Earnings per share .03 .11 .17 .19\nNote: The total of the individual quarterly earnings per common share may not equal the earnings per common share for the year due to changes in the number of shares outstanding during the year.\nSCHEDULE II\nCENTRAL SPRINKLER CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS\nRESERVE FOR DOUBTFUL RECEIVABLES\n(Amounts in thousands)\nBalance Charges Balance Beginning to End of Year Ended of Period Expense Recoveries Writeoffs Period ---------- --------- ------- ---------- --------- ------ October 31, 1995 $3,737 $ 975 $64 $963 $3,813 ====== ====== === ==== ======\nOctober 31, 1994 $2,691 $1,467 $89 $510 $3,737 ====== ====== === ==== ======\nOctober 31, 1993 $2,573 $ 941 $11 $834 $2,691 ====== ====== === ==== ======\nS-1","section_15":""}
{"filename":"32120_1995.txt","cik":"32120","year":"1995","section_1":"Item 1. Business\nElectro-Catheter Corporation (the \"Company\") is engaged in the business of developing, manufacturing and marketing products for hospitals and physicians. The majority of these products are utilized in connection with illnesses of the heart and circulatory system and make use of catheters and related devices. The Company has targeted electrophysiology as its focal area for future growth, but intends to maintain and develop products for the emergency care, cardiac surgery, invasive and non-invasive cardiology and invasive radiology markets.\nThe Company operates in one business segment, but markets its products both nationally and internationally. Export sales were approximately $1,964,000 in 1995, $1,718,000 in 1994, and $2,164,000 in 1993, representing approximately 27%, 24%, and 27% of net sales for the years 1995, 1994 and 1993, respectively.\nProducts\nThe Company produces a wide range of catheter products intended to be utilized by doctors and other trained hospital personnel for diagnostic or therapeutic purposes. Catheters are hollow tubes that can be passed through veins, arteries and other anatomical passageways. The Company considers the market within which it sells its present and proposed products as a single industry segment.\nThe selling prices for the products marketed by the Company typically range from thirty-five dollars to five hundred dollars.\nElectrophysiology Catheters\nThe field of cardiac electrophysiology is one of the most rapidly growing areas of medical technology. During approximately the past ten years, the development of transcatheter diagnosis of the heart's conduction system and transcatheter correction of certain conduction dysfunctions have increasingly attracted the attention of cardiologists. The Company believes that its lengthy experience in pacing and mapping the heart's conduction system, as well as designing and manufacturing cardiovascular catheters, place the Company in position to take advantage of this developing market.\nCardiac electrophysiology is the study of the electrical system of the heart. Cardiac electrophysiologists are concerned with electrical disorders in the heart, their etiology, diagnosis and treatment. The medical problems which cardiac electrophysiologists focus on are conduction problems of the heart, which include tachyarrhythmic episodes which can lead to sudden cardiac death.\nDiagnostic Catheters\nThe Company's line of diagnostic catheters are made of flexible radiopaque materials which are visible in use through fluoroscopy. The catheters have a variety of tips, shapes and internal configurations and can be manipulated by an experienced physician through the anatomy to the desired location. Through the use of these catheters, electrophysiological data, pressure and flow readings and blood samples may be obtained. In addition, the Company's catheters may be utilized as conduits for the injection of radiopaque materials into the bloodstream to permit fluoroscopic observation of abnormalities in the vasculature.\nDiagnostic catheters are marketed under the following names: Baltherm(R) Flow Directed Balloon Catheters, Pacewedge(R) Balloon Guided Catheters and Balwedge(R) Catheters.\nTherapeutic Catheters\nThe Company's therapeutic catheters are fabricated from a number of materials and frequently consist of an electrode-bearing tube. The tube is guided into the body and the electrode is delivered through the venous system to the heart where it is then used for pacing. This procedure involves the delivery to the heart muscle, from a source outside the body, of an electrical stimulus causing contractions like the natural heartbeat. Such pacing is necessary where there is a conduction blockage in the heart causing the heart to contract - --\"beat\"-- at a slow or irregular rate.\nOne of the therapeutic catheters manufactured by the Company is the Balectrode(R) Bipolar Pacing Probe. With this product, both the amount of manipulation of the catheter required to cause the stimulating electrode to be positioned in the proper location of the heart and the time required from the commencement of the procedure until it is completed, are substantially less than they would be if a non-balloon catheter were used as the delivery system.\nThe therapeutic products usually are sold in kits containing the catheter, a placement needle, connectors and various other devices. These kits are sold under various names, including the following: Baltherm(R), Balectrode(R) Flow-Directed Temporary Pacing Kit, Silicore(R) Semi-Floating Pacing Kit and Multipace.\nMulti-Purpose Catheters\nDiagnostic and therapeutic catheters both have features or uses which, under certain circumstances, result in the combining of purposes. Further, the Company manufactures certain electrode-bearing catheters used to make electrical measurements within the heart and provide electrical stimulation for both therapeutic and diagnostic purposes.\nTransthoracic Pacing Stylet\nThe Company has developed and patented a product for transthoracic pacing and intra-cardiac medication which it is marketing under the name PaceJector(R). The pacing electrode is delivered to the heart directly through the chest wall rather than through the veins. The technique of transthoracic pacing for emergency treatment of cardiac arrest and certain types of life-threatening heart rhythms was pioneered by the Company.\nDrainage Catheters\nAlthough the Company's principal activities have been in the cardiovascular area, it currently is manufacturing and marketing the Elecath(R) One Step(TM) Fluid Drainage System which is used for draining fluid collections from various locations in the body. This system consists of a catheter, composed of a unique formulation developed by the Company, mounted on a simple penetration apparatus. In the Company's opinion, the product is useful to many physicians, in addition to radiologists, and results in more complete and safer drainage.\nPersonnel\nAt November 17, 1995 the Company had approximately 134 employees. Of the total employees, 92 were engaged in manufacturing and quality control, 11 in general administration and executive activities, 15 in engineering and research and development, and 16 in sales and marketing. The Company is not a party to any collective bargaining agreement and considers its relations with its employees to be good.\nSales and Marketing\nAt November 17, 1995 the Company employed 10 salespersons in the field and a home office staff of marketing and sales support of 6 people. The Company also employs an International Marketing Manager based in Europe on an independent contractor basis. The Company had one significant distributor in the United States which was responsible for sales in all or part of thirteen Eastern states plus the District of Columbia. This distributor accounted for approximately 11%, 17% and 16% of net sales for the years 1995, 1994 and 1993, respectively. The Company terminated this arrangement with this distributor on May 31, 1995 and the Company now markets its products directly in this territory. Outside the U.S., the Company is represented by distributors.\nAdvertising\nAdvertising of the Company's products consists primarily of displays at medical conventions and meetings, advertisements in medical journals and direct mail. The Company also cooperates in the publication of technical papers written by medical authorities in areas relating to the Company's products.\nBacklog\nAt October 31, 1995, the Company had a backlog of orders for its products which aggregated approximately $692,000, as compared to approximately $381,000 at October 31, 1994.\nProduction\nThe Company manufactures its products in a 25,000 square foot facility it owns and another 10,000 square foot facility which it leases. The Company designs its catheters and manufactures a portion of the tubing, balloons, and many components with tooling and formulations developed by it or especially for it. The Company maintains facilities to manufacture sophisticated tubing and balloons and for the production of catheters in the unique configurations required for their use. In addition, where more convenient or when the level of sophistication warrants it, the Company uses outside suppliers for certain components.\nCompetition\nThe medical technology industry is a highly competitive field, and the Company competes with many other companies on current products and products in the development stages. Many of these competitors have significantly greater financial, marketing, sales, distribution and technical resources than the Company. Rapid technological advances by the Company's competitors could at any time require that the Company redesign a portion of its product line.\nThe Company's older products compete with those of larger companies that have greater resources and better distribution capabilities. The current principal basis of competition in these markets is price. The Company's limited resources make it less capable than larger competitors of offering aggressive pricing to meet competition. In addition, certain customers purchase their\ncatheters in blanket contracts which include products offered by the Company's larger competitors but not by the Company. For these reasons, the Company has not been able to compete as effectively as it would like during recent years in the market for non-EP products.\nThe electrophysiology market is also highly competitive and competition is expected to increase. These competitors currently include USCI, a division of C.R. Bard, Inc.; Mansfield, a division of Boston Scientific Corporation; CardioRhythm, Inc., a division of Medtronic, Inc.; EP Technologies and Webster Laboratories, a division of Cordis Corporation. The Company's electrophysiology products compete with other treatments, including prescription drugs, implantable cardiac defibrillators and open heart surgery.\nAdditionally, some of the Company's competitors have been acquired by major corporations to be able to offer a broader range of products to the cardiologist. The Company's ability to compete effectively in the future, could be dependent upon broadening its range of products and\/or an alliance with another company.\nCompetitors have developed products, specifically for use in catheter ablation, which are currently FDA approved. The Company plans to begin its clinical trials for ablation in 1996. Currently, the Company does not have an approved device for catheter ablation to allow it to compete effectively in this market. Because this is a new and developing market, the primary competitive factors are technical superiority, financial resources, the timing of regulatory approval, commercial introduction and quality. The Company's competitive position also depends on its ability to attract and retain qualified personnel, develop effective proprietary products, implement production and marketing plans and secure sufficient capital resources. The Company hopes that it can effectively compete in this market.\nThere can be no assurance that the Company will be able to compete successfully in its current markets.\nPatents and New Products\nThe Company's policy is to protect its proprietary position by, among other methods, filing United States and select foreign patent applications to protect the technology that is important to the development of the business. Although the Company holds patents or has patents pending related to several of its products, it believes that its business as a whole is not or will not be materially dependent upon patent protection. However, the Company will continue to seek such patents as it deems advisable to protect its research and development efforts and to market its products.\nThe Company develops new products as a result of its own analysis of the needs of the market which it serves and as a result of needs perceived by physicians and researchers who work with the Company on the design and the development of the devices and systems needed by them. In certain instances, the Company pays the cooperating physician or researcher a royalty based upon the revenues derived from the sales of the product to others.\nRegulation\nThe Company's products are subject to regulation by the Food and Drug Administration (\"FDA\") and, in some jurisdictions, by state and foreign governmental authorities. In particular, the Company must obtain specific clearance from the FDA before it can market new products to the public. An amendment to the Federal Food, Drug and Cosmetics Act providing for the classification of medical devices and the establishment of standards relating\nto their safety and efficacy, scientific review of certain devices, and the registration of manufacturers and others, has been in effect since 1976 and has been augmented by the new Safe Medical Devices Act of 1991. Under the new Act, a manufacturer must obtain approval from the FDA for a new medical device or a new use for an existing device or a major change to a prior approved item, before it can be marketed. The approval process requires, in the case of certain classes of medical devices, that the safety and efficacy of such devices be demonstrated by the manufacturer to the satisfaction of the FDA. The process of obtaining such pre-marketing approval can be time-consuming and expensive and there can be no assurance that all approvals sought by the Company will be granted or that the FDA review will not involve delays adversely affecting the marketing and sale of the Company's products. The Company's products are \"medical devices\" within the meaning of the amendment and new Act.\nThe Company is also required to adhere to applicable regulations setting forth current Good Manufacturing Practices (\"GMP\") requirements, which include testing, control, design and documentation requirements. During fiscal years 1994 and 1995 the Company corrected deficiencies identified by the FDA, and the Company believes it is currently in compliance with GMP.\nIn accordance with the Federal Food, Drug and Cosmetics Act, the Company has received approval from the FDA to market all of its present products, or is exempt from formal approval requirements as provided by law for those devices already in distribution before May 28, 1976.\nIn addition, certain other classes of medical devices must comply with industry-wide performance standards with respect to safety and efficacy promulgated by the FDA. The FDA has not yet developed industry-wide performance standards with respect to the safety and efficacy of those products manufactured by the Company which will be subject to such standards. When and if such standards are adopted, the Company will be required to submit data demonstrating compliance with the standards (during which period the Company may be permitted to continue to market products which have been previously approved by the FDA).\nIn recent years the FDA has pursued a more rigorous enforcement program to ensure that regulated businesses, like the Company, comply with applicable laws and regulations. The Company cannot predict the extent or impact of future federal, state or local legislation or regulation.\nVarious countries in which the Company markets its products have regulatory agencies which perform functions comparable to those of the FDA. To date, foreign regulations have not adversely affected the Company's business. The Company intends to make every effort to comply with applicable foreign regulations.\nResearch and Development\nFor the three years ended August 31, 1995, the Company incurred aggregate direct expenses of approximately $3,477,000 for research and development activities, including new product development, of which approxi mately $932,000 was attributable to fiscal 1995, $1,212,000 to fiscal 1994, and $1,333,000 to fiscal 1993. All of such activities were sponsored by the Company. The major portion of such expenses was related to salaries and other expenses of personnel employed on a regular basis in research and development efforts.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal manufacturing facilities and executive offices are located at 2100 Felver Court, Rahway, New Jersey, in premises which it purchased in fiscal 1976. The Company also leases a 10,000 square foot facility located in Avenel, New Jersey. These premises are suitable for all of the Company's current and immediately foreseeable production, development and administrative functions. The lease for the Avenel facility is on a month-to-month basis.\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\nThe Annual Meeting of Shareholders was held on May 24, 1995. The following persons were elected to serve as members of the Board of Directors until the next annual meeting of shareholders and until their successors are elected and qualify:\nPART II\nMarket for the Company's Common Stock and Related Security Holder Matters\nThe Company's common stock is traded in the NASDAQ System under the Symbol ECTH. The table below shows for the periods indicated the closing daily bid figures of the Company's stock, as reported by NASDAQ. These prices represent prices between dealers and do not include retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.\nOn November 3, 1995, the number of shareholders of record was 817.\nNo cash dividends have been paid by the Registrant during the last five fiscal years.\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\nResults of Operations\nYear Ended August 31, 1995 Compared to Year Ended August 31, 1994\nNet sales for the fiscal year ended August 31, 1995 increased $15,764 (0.2%) as compared to the fiscal year ended August 31, 1994. Total domestic sales decreased $231,256 (4.2%) and international sales increased $247,020 (14.4%) for fiscal 1995 as compared to fiscal 1994. The decline in domestic sales is attributed predominantly to a decline in the volume of business from the Company's sole domestic distributor. The Company terminated its agreement with this distributor as of May 31, 1995, pursuant to the terms of the agreement. The Company is now selling in this territory with direct sales representatives. Sales declines occurred in most of the Company's product lines, except its diagnostic steerable catheters, which increased as a result of the extension of its product line offerings. The decrease in domestic sales was partially offset by shipments to an OEM customer for a special-design catheter which will be used by this customer in its clinical trials for its own product. However, there is no assurance that sales to the OEM customer will continue in the future. The increase in international sales is attributed to an increase in sales of certain of the Company's traditional and electrophysiology products, including sales to distributors in countries where the Company had not been previously represented. The Company's plans to increase its sales include additional emphasis on its pacing and monitoring products, new product introductions and aggressive pricing strategies. However, there can be no assurance that the Company will be successful in its efforts to increase sales.\nGross profit dollars increased $281,162 (9.0%) in fiscal 1995 as compared to the prior year. This increase in gross profit is attributed primarily to the increase in operating yields and further absorption of overhead as a result of the additional personnel required to manufacture some of the new and more sophisticated products. Gross profit has been negatively affected by the Company's aggressive pricing policy. The gross profit percentage for 1995 was 46.8% as compared to 43.1% for 1994.\nSelling, general and administrative expenses increased by $41,505 for fiscal 1995 as compared to fiscal 1994. This increase is attributed primarily to an increase in marketing\/sales expenses of $264,376 (12.1%) associated with the addition of new sales representatives, the hiring of a National Sales Manager and the addition of an International Marketing Manager. The increase is offset by a decrease in corporate and administrative expenses of $222,871 (18.3%) due to lower administrative salaries as a result of reduction in personnel, legal costs, consulting fees and expenses associated with the Company's former Chief Executive Officer who retired on March 1, 1994.\nResearch and development expenditures decreased by $280,029 (23.1%) for fiscal 1995 as compared to fiscal 1994. The decrease is attributed to a reduction in personnel, decreased purchases of research and development materials and supplies and a reduction in required support from manufacturing for new product development.\nInterest expense increased in fiscal 1995 as a result of increased borrowings from the T-Partnership and higher interest rates, including the amortization of the value of warrants issued in conjunction with these borrowings.\nIn August 1994, the Company received $200,000 in settlement of its litigation with a previous supplier and such amount was included in other\nincome in fiscal 1994, thereby accounting for the reduction in other income in fiscal 1995.\nThe net loss for fiscal year 1995 was $1,135,890 or $.18 per share as compared to a loss of $1,371,915 or $.24 per share for fiscal year 1994.\nYear Ended August 31, 1994 Compared to Year Ended August 31, 1993\nNet sales decreased $907,598 or 11.1% in fiscal year 1994 as compared to fiscal year 1993. International sales decreased $445,888 or 20.6% and total domestic sales decreased $461,710 or 7.7%. International sales decreased as the result of competition, budgetary constraints in certain countries, a decline in demand for a custom-designed catheter sold to an international distributor and lower sales volumes in certain of the Company's older product lines. Domestic sales declined primarily as a result of a decline in the market for the Company's pacing products. However, this decline was partially offset by the Company's multifunction catheters which increased $481,738 or 55.2% domestically to $1,354,951 or 24.5% of total domestic sales, as a result of an increase in demand for this product.\nGross profit decreased $882,237 or 22.0% in fiscal year 1994 as compared to the prior fiscal year. The gross profit percentage was 43.1% for fiscal year 1994 as compared to 49.1% for fiscal year 1993. The decrease is primarily attributed to the decline in sales volume, lower operating yields and start-up costs associated with new products.\nSelling, general and administrative expenses decreased $65,653 or 1.9% in fiscal year 1994 as compared to the previous fiscal year. Increased selling and marketing expenses and legal costs associated with litigation against one of the Company's previous suppliers (discussed below) were more than offset by a reduction in expenses associated with the September 1993 resignation of the Company's President and the March 1, 1994 retirement of the Company's Chief Executive Officer.\nResearch and development expenditures decreased $120,770 or 9.1% for the current fiscal year as compared to the prior fiscal year. The decrease is the result of lower hiring expenses and a decrease in personnel and lower purchases of materials and supplies for research and development purposes.\nInterest income decreased as a result of lower cash balances. Interest expense increased as a result of increased borrowings from the T-Partnership and higher interest rates (including amortization of warrants issued in connection with these borrowings - see Note 7 to Notes to Financial Statements).\nIn August 1994 the Company received $200,000 in settlement of its litigation with a previous supplier and such amount was included in other income.\nThe net loss for fiscal year 1994 was $1,371,915 or $.24 per share as compared to a loss of $803,641 or $.14 per share in fiscal year 1993.\nOn April 26, 1993, the Company received a warning letter from the FDA resulting from an earlier inspection of its facilities and operations, indicating that the Company's manufacturing methods were not in conformance with Good Manufacturing Practice Regulation (GMP). In addition, the letter stated that certain products do not have the required pre-market notification approvals. The FDA completed a reinspection on August 27, 1993 which resulted in additional observations indicating non-conformance with GMP and questioned the pre-market notification approvals of other catheters currently being sold by\nthe Company. During fiscal year 1994, the Company corrected the deficiencies identified in FDA's GMP observations. In June 1994, the Company received FDA approval of export applications which the Company believes would not have been received if the Company had not corrected the GMP related matters.\nDuring the first quarter of fiscal 1995, the Company underwent an additional inspection by the FDA which resulted in two observations. The Company believes that it has satisfactorily resolved both issues and that it is now in substantial conformance with GMP.\nDuring fiscal 1994, the Company responded to the FDA's allegations that the necessary pre-market notification approval applications (510(k)s) were not filed for the products mentioned in the warning letter and the reinspection. The FDA further stated that it is the Company's responsibility to withhold distribution of such products until the FDA has acted upon the 510(k) submissions. While the Company did not agree with the determination of the FDA, the Company submitted the 510(k)s for all products in question in order to show its intent to comply with the FDA regulations and continues to distribute such products. These products in question represent approximately 31% of the Company's sales in fiscal 1994. During fiscal year 1995, the Company received final approval on all outstanding 510(k)s.\nLiquidity and Capital Resources\nWorking capital increased $143,564 to $2,505,417 from August 31, 1994. The current ratio was 3.2 to 1 at August 31, 1995 as compared to 3.3 to 1 at August 31, 1994. Net cash used in operating activities was $1,143,975 for the year ended August 31, 1995 as compared to $500,285 for the year ended August 31, 1994. During 1995, the Company continued to devote significant resources to the development of new products and sales activities. The increase in net cash used in operating activities is the result of the loss from operations and increases in accounts receivable and inventories.\nIn March 1995, the Company received from the T-Partnership approximately $500,000 for the purchase of 571,500 shares of restricted common stock, $.10 par value, in a private placement at $.875 per share. In connection with this private placement, the Company also issued to the T-Partnership a warrant to purchase 83,344 shares of the Company's common stock at an exercise price of $1.425 per share. This warrant expires on February 23, 2000. Ervin Schoenblum, the Company's Acting President and director and another member of the Company's Board of Directors are members of the T-Partnership.\nOn October 11, 1993, the Company entered into an agreement with the T-Partnership to borrow up to $1,000,000. As of August 31, 1995, the Company had drawn down all of the $1,000,000.\nOn August 31, 1995, the Company entered into an agreement with the T-Partnership to borrow an additional $500,000 and combine such loan with the original $1,000,000 for a total loan due to the T-Partnership of $1,500,000. The T-Partnership agreed to lend the Company $200,000 on the execution of this agreement and, at the Company's request, an additional sum of $300,000.\nThe rate of interest is 12% per annum and is payable monthly on any outstanding balance. Principal payments of $20,000 were scheduled to commence on September 1, 1995 for the original $1,000,000. However, the new agreement provides for repayment to begin on September 1, 1996 with installments of $25,000 each month. Any remaining balance is due on August 1, 2001. The loan is secured by the Company's property, building, accounts receivable, inventories\nand machinery and equipment. The Company must prepay the outstanding balance in the event the Company is merged into or consolidated with another corporation or the Company sells all or substantially all of its assets.\nUnder the provisions of the original agreement, the T-Partnership was granted purchase warrants which permitted the T-Partnership to purchase 166,667 shares of the Company's common stock at a price of $3.25 per share. The new agreement states that the T-Partnership will surrender its original purchase warrant to purchase 166,667 shares of common stock and be granted a new purchase warrant to purchase 500,000 shares of the Company's common stock at a price of $0.9875 per share. The warrants are immediately exercisable and expire on August 1, 2001.\nIn October 1995, the Company borrowed an additional $150,000 under this agreement and in November 1995, the remaining $150,000 was borrowed.\nThe report of the Company's independent auditors on the Company's financial statements, included elsewhere herein, includes an explanatory paragraph which states that the Company's recurring losses and limited working capital raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. During 1995, the Company was able to satisfy its cash shortfall from operating activities with the borrowings from the T-Partnership, the proceeds from the sale of stock to the T-Partnership and cash on hand. The Company's ability to continue in business is dependent upon its ability to generate sufficient cash flow from operations or to obtain additional financing. The Company continues to re-evaluate its plans and adopt certain cost reduction measures. The Company is attempting to increase sales by examining and, where appropriate, modifying its distribution network, utilizing aggressive pricing and introducing new products to market.\nThe Company does not plan to pay dividends in the near future.\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. In October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation\", which is effective for fiscal years beginning after December 15, 1995. Neither of these standards is expected to have a significant effect on either the results of operations or financial position of the Company.\nInflation\nInflation did not have a material impact on the results of the Company's operations during the last three fiscal years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nResponse to this Item is contained in Item 14.\nItem 9.","section_9":"Item 9. Changes in and 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 Company\nThe following table sets forth certain information concerning Registrant's directors and executive officers:\nName, Age and Positions and Offices Held with Business Experience During Past 5 the Company Years and Principal Occupation\nRobert I. Bernstein, Chairman of the Company. Chief Executive Sc.D., Age 68; Officer of the Company for over five years Director since 1969(1)(2) until his retirement on March 1, 1994\nMichael Bernstein, Chairman, Department of Medical M.D., M.A.C.P., Age 66; Education, Director of Internal Director since 1969 (1)(2) Medicine, Overlook Hospital, Summit, New Jersey; Clinical Professor of Medicine, Columbia University College of Physicians and Surgeons.\nGeorge M. Pavia Partner in the law firm, Pavia & Age 67; Director Harcourt for over the past five years since 1986(2)\nAbraham H. Nechemie Business Consultant. Formerly a partner Age 71; Director since in Wiss & Company, a certified public 1992(2) accounting firm. Retired from the firm in 1985.\nErvin Schoenblum Acting President since December, 1993. Age 55; Director since Management Consultant for over five 1992 years. Advisor to the Company since February 1989.\nLee W. Affonso, Age 46; Vice President of the Company since July, Vice President 1992 except for the period from September, 1993 to December, 1993 when he served as Senior Sales Specialist; Director of Marketing & Sales from 1989 to 1992.\nRobert W. Kokowitz Vice President of the Company since July Age 40; Vice President 1992. Director of Operations from 1989 to 1992.\nJoseph P. Macaluso Chief Financial Officer since May, 1987. Age 43; Treasurer and Chief Financial Officer\nArlene C. Bell Secretary since May 1987. Executive Age 50; Secretary Assistant to the Chairman since 1981, and to the Acting President since March 1, 1994.\n- ---------------------- (1)Michael Bernstein is the brother-in-law of Robert I. Bernstein. (2)Member of audit committee.\nThe Company's directors' terms will expire when their successors are elected and qualify at the annual meeting of shareholders. The Company's officers serve for a period of one year and until their successors are elected by the Board of Directors.\nOn December 6, 1993 the Board of Directors elected Mr. Ervin Schoenblum Acting President replacing Mr. Max Lee Hibbs, former President, who resigned in September, 1993.\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 ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (SEC). Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that, during the period September 1, 1994 to August 31, 1995 all filing requirements applicable to its officers and directors were complied with, except as follows:\nNumber of Transactions Relationship Number of Late Not Reported Name To Company Reports On A Timely Basis\nErvin Schoenblum Acting President 2 2\nItem 11.","section_11":"Item 11. Executive Compensation\nCOMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS\nThe following table sets forth all compensation awarded to, earned by, or paid by the Company to the following persons for services rendered in all capacities to the Company during each of the fiscal years ended August 31, 1995, 1994 and 1993: the Company's Chief Executive Officer or person acting in a similar capacity, and (2) the Company's next most highly compensated executive officer whose total compensation for the fiscal year ended August 31, 1995 exceeded $100,000.\nStock options are also granted to officers and are determined by the Board of Directors based upon the individual's contribution to the Company.\nThe following table provides information on stock option grants during fiscal year 1995.\nThe following table provides information on option exercises during the fiscal year 1995 by the named executive officers and the value of each of their unexercised options at August 31, 1995.\nThe following table provides information concerning repricing of options and Stock Appreciation Rights (\"SARs\") held by the named executive officers during the last 10 completed fiscal years.\nRemuneration of Directors\nEach non-officer director is compensated $1,000 for each meeting attended.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nA.Set forth below is information concerning persons (including any \"group\" as that term is used in Section 13(d) (3) of the Securities Exchange Act of 1934) known to the Registrant to own 5% or more of the common stock of the Company as of November 17, 1995:\nB. The following table sets forth the equity securities of the Company or any of its parents or subsidiaries beneficially owned directly or indirectly by all directors of the Company, each of the named executive officers and by the directors and executive officers of the Company as a group. The figures given are as of November 17, 1995:\nName of Beneficial Amount and Nature of Percentage of Title of Class Owner Beneficial Ownership of Class(6)\nCommon stock Robert I. Bernstein 454,367 shares 7.2% $.10 par value\nCommon stock Michael Bernstein 94,228 shares(1) 1.5% $.10 par value\nCommon stock George M. Pavia 57,366 shares(2) 0.9% $.10 par value\nCommon stock Abraham H. Nechemie 124,075 shares(3) 1.9% $.10 par value\nCommon stock Ervin Schoenblum 174,075 shares(3) 2.6% $.10 par value\nCommon stock Lee W. Affonso 28,000 shares(4) 0.4% $.10 par value\nCommon stock All executive officers $.10 par value and directors as a group 996,686 shares(5)(3) 15.3% (9 persons)\n- ---------------------- (1)Includes 28,500 shares subject to currently exercisable options.\n(2)Includes 36,000 shares subject to currently exercisable options and 16,276 shares owned by Pavia & Harcourt, a law firm of which Mr. Pavia is a member.\n(3)Messrs. Nechemie and Schoenblum each have a 5% equity interest in the T-Partnership, which owns 1,881,500 shares of the Company's common stock. Accordingly, Messrs. Nechemie and Schoenblum each reports beneficial ownership of 94,075 shares of the Company's common stock. In addition, Messrs. Nechemie and Schoenblum each reports beneficial ownership of 25,000 warrants that were issued to the T-Partnership pursuant to the August 31, 1995 Lending Agreement with the Company. Also included in the table above are currently exercisable options for 5,000 and 55,000 shares held by Messrs. Nechemie and Schoenblum, respectively.\n(4)Includes 14,600 shares subject to currently exercisable options.\n(5)Includes 173,500 shares subject to currently exercisable options held by all executive officers and directors of the Company (including those individually named in the table above).\n(6)The common stock deemed to be owned which is not outstanding but subject to currently exercisable options is deemed to be outstanding for the purpose of determining the percentage of all outstanding common stock owned.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company has no compensation committee or Board Committee performing similar functions. Ervin Schoenblum, the Company's Acting President, participated in deliberations of the Company's Board of Directors concerning executive officer compensation.\nBOARD COMPENSATION REPORT ON EXECUTIVE COMPENSATION\nThe Company has no compensation committee or other committee of the Board of Directors performing similar functions. All members of the Board of Directors review and determine executive compensation for all executive officers on an annual basis. Ervin Schoenblum, the Company's Acting President, is the only executive officer of the Company also serving on the Board. Mr. Schoenblum's compensation as Acting President was negotiated between the parties and was based in part on the amount of compensation paid to him while he was a consultant to the Company and the level of compensation historically paid by the Company for this position.\nThe Board of Directors has implemented an executive compensation philosophy that seeks to relate executive compensation to corporate performance, individual performance and creation of stockholder value. Historically, this has been achieved through compensation programs which focus on both short and long term results.\nIn accordance with the Board of Directors' executive compensation philosophy, the major component of executive compensation has been base salary. Salaries for executive officers are based on current individual and organizational performance, affordability and competitive market trends. Additional incentives are provided through issuance of incentive stock options.\nBoard of Directors: Robert I. Bernstein, Sc.D. Michael Bernstein, M.D. Abraham H. Nechemie George M. Pavia, Esq. Ervin Schoenblum\nPERFORMANCE TABLE\nThe table below shows a comparison of the five-year cumulative total return assuming $100 invested on August 31, 1990 in Elecath Common Stock, the S & P 500 Index and the S & P Medical Products and Supplies Index.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nDuring fiscal year 1993, Ervin Schoenblum, a director of the Company, and a member of the T-Partnership, was retained as a management consultant for the Company. The Company incurred fees from this individual in the amount of approximately $26,000 in fiscal year 1993. In December 1993, this individual became Acting President of the Company and still holds that position. In addition, prior to his becoming Acting President, this individual received approximately $16,000 in consulting fees in fiscal year 1994.\nOn October 11, 1993, the Company entered into an agreement with the T-Partnership to borrow up to $1,000,000. Ervin Schoenblum, the Company's Acting President and director and another member of the Company's Board of Directors are members of the T-Partnership. As of August 31, 1995, the Company had drawn down all of the $1,000,000.\nOn August 31, 1995, the Company entered into an agreement with the T-Partnership to borrow an additional $500,000 and combine such loan with the original $1,000,000 for a total loan due to the T-Partnership of $1,500,000. The T-Partnership agreed to lend the Company $200,000 on the execution of this agreement and, at the Company's request, an additional sum of $300,000.\nThe rate of interest is 12% per annum and is payable monthly on any outstanding balance. Principal payments of $20,000 were scheduled to commence on September 1, 1995 for the original $1,000,000. However, the new agreement provides for repayment to begin on September 1, 1996 with installments of $25,000 each month. Any remaining balance is due on August 1, 2001. The loan is secured by the Company's property, building, accounts receivable, inventories and machinery and equipment. The Company must prepay the outstanding balance in the event the Company is merged into or consolidated with another corporation or the Company sells all or substantially all of its assets.\nUnder the provisions of the original agreement, the T-Partnership was granted purchase warrants which permitted the T-Partnership to purchase 166,667 shares of the Company's common stock at a price of $3.25 per share. The new agreement states that the T-Partnership will surrender its original purchase warrant to purchase 166,667 shares of common stock and be granted a new purchase warrant to purchase 500,000 shares of the Company's common stock at a price of $0.9875 per share. The warrants are immediately exercisable and expire on August 1, 2001.\nIn October 1995, the Company borrowed an additional $150,000 under this agreement and in November 1995, the remaining $150,000 was borrowed.\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:\n1. Financial Statements\nSee: Index to Financial Statements\n2. Financial Statement Schedules\nSee: Index to Financial Statements\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements and the notes thereto.\n3. Exhibits\n(3)(a) Registrant's Certificate of Incorporation as amended through April 11, 1978 - filed as an Exhibit to Registrant's Report on Form 10-K for the fiscal year ended August 31, 1981, and incorporated by reference herein as an exhibit hereto.\n(3)(b) Amendment to Registrant's Certificate of Incorporation, dated March 20, 1985 - filed as an Exhibit to Registrant's Report on Form 10-Q for fiscal quarter ended May 31, 1985, and incorporated by reference herein as an exhibit hereto.\n(3)(c) Amended and Restated By-laws - filed as an Exhibit to Registrant's Report on Form 10-K for the fiscal year ended August 31, 1989, and incorporated by reference herein as an exhibit hereto.\n(10)(d) Registrant's 1984 Employee Stock Purchase Plan, filed as an Exhibit to Registrant's Report on Form 10-Q for the second quarter of fiscal year 1984 ended February 29, 1984, and incorporated by reference herein as an exhibit hereto.\n(10)(h) Registrant's 1987 Incentive Stock Option Plan filed as an Exhibit to the Registrant's Report on Form 10-K for the fiscal year ended August 31, 1987, and incorporated by refer- ence as an exhibit hereto.\n(10)(i) Registrant's 1990 Incentive Stock Option Plan filed as an Exhibit to the Registrant's Report on Form 10-K for the fiscal year ended August 31, 1990, and incorporated by refer- ence as an exhibit hereto.\n(10)(j) Registrant's 1992 Incentive Stock Option Plan filed as an Exhibit to the Registrant's Report on Form 10-K for the fiscal year ended August 31, 1992, and incorporated by refer- ence as an exhibit hereto.\n(10)(k) Agreement dated October 11, 1993 between Registrant and the T-Partnership filed as an exhibit to Registrant's Report on Form 10-K for the fiscal year ended August 31, 1993, and incorporated by reference as an exhibit hereto.\n(10)(l) Amendment dated November 21, 1994 to Agreement between Registrant and the T-Partnership filed as an exhibit to Registrant's Report on Form 10-K for the fiscal year ended August 31, 1994, and incorporated by reference as an exhibit hereto.\n(10)(m) Lending Agreement dated August 31, 1995 between Registrant and the T-Partnership filed as an exhibit hereto.\n(22) Subsidiaries - Electro-Catheter International Corp.\n(24) Consent of KPMG Peat Marwick LLP filed as an exhibit hereto.\n(27) Financial Data Schedule filed as an exhibit hereto.\n(b) Report on Form 8-K : None.\n(c) Exhibits: Reference is made to the list of exhibits contained in item 14(a) 3 above.\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.\nELECTRO-CATHETER CORPORATION (Registrant)\nBy: \/s\/Ervin Schoenblum Ervin Schoenblum Acting President\nDated: December 12, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and the capacities and on the dated indicated:\nDated: December 12, 1995 \/s\/Robert I. Bernstein Robert I. Bernstein Chairman of the Board\nDated: December 12, 1995 \/s\/Ervin Schoenblum Ervin Schoenblum, Acting President & Director\nDated: December 12, 1995 \/s\/Joseph P. Macaluso Joseph P. Macaluso Principal Accounting Officer\nDated: December 12, 1995 \/s\/Michael Bernstein Michael Bernstein, Director\nDated: December 12, 1995 \/s\/George M. Pavia George M. Pavia, Director\nDated: December 12, 1995 \/s\/Abraham H. Nechemie Abraham H. Nechemie, Director\nELECTRO-CATHETER CORPORATION\nPage\nIndependent Auditors' Report Financial Statements: Balance Sheets - August 31, 1995 and 1994 Statements of Operations - Years ended August 31, 1995, 1994 and 1993 Statements of Stockholders' Equity - Years ended August 31, 1995, 1994 and 1993 Statements of Cash Flows - Years ended August 31, 1995, 1994 and 1993 Notes to Financial Statements\nFinancial Statement Schedule:\nVIII - Valuation and Qualifying Accounts\nAll other schedules 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.\nIndependent Auditors' Report\nThe Board of Directors Electro-Catheter Corporation:\nWe have audited the financial statements of Electro-Catheter Corporation as listed in the accompanying index. In connection with our audits of the financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Electro-Catheter Corporation at August 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 August 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.\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 has suffered recurring losses from operations and has limited working capital resources which 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 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nShort Hills, New Jersey November 9, 1995\nSee accompanying notes to financial statements.\nELECTRO-CATHETER CORPORATION\nSee accompanying notes to financial statements.\nSee accompanying notes to financial statements.\n(Continued) See accompanying notes to financial statements.\nSee accompanying notes to financial statements.\nELECTRO-CATHETER CORPORATION\nNotes to Financial Statements\nAugust 31, 1995, 1994 and 1993\n(1) Summary of Significant Accounting Policies\n(a) Revenue Recognition\nRevenues are recognized at the time of shipment and provisions, when appropriate, are made where the right to return exists.\n(b) Cash and Cash Equivalents\nFor purposes of the statements of cash flows, Electro-Catheter Corporation (the \"Company\") considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost which approximates market value.\n(c) Inventory Valuation\nInventories are stated at the lower of cost (first-in, first-out method) or market.\n(d) Property, Plant and Equipment\nProperty, plant and equipment are carried at cost. Plant and equipment are depreciated using the straight-line method over the estimated useful lives of the assets.\nRepairs and maintenance costs are charged to operations as incurred.\nBetterments are capitalized. Leasehold improvements are amortized over the term of the lease or the useful life of the asset, whichever is shorter.\nWhen assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the related accounts, and any resulting gain or loss is recognized in operations for the period.\n(e) Research and Development\nResearch and development costs are charged to expense when incurred.\n(f) Income Taxes\nEffective September 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". It requires an asset and liability approach for financial accounting and reporting for deferred income taxes. Prior to the adoption of SFAS 109, deferred income taxes were provided to recognize the effect of timing differences between financial statement and income tax accounting.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(1) Summary of Significant Accounting Policies, cont.\n(g) Patents and Trademarks\nPatents and trademarks are recorded at cost and are amortized on a straight-line basis over their useful lives. Such costs, net of accumulated amortization, are included in other assets, net in the accompanying balance sheets.\n(h) Loss Per Share\nLoss per share is computed using the weighted average number of shares outstanding during each year. Shares issuable upon exercise of outstanding stock options, warrants and conversion of debentures are not included in the computation of loss per share because the result of their inclusion would be anti-dilutive.\nThe weighted average number of shares of common stock used in the computation of loss per share was approximately 6,027,000 in 1995, 5,711,000 in 1994 and 5,572,200 in 1993.\n(i) Concentration of Credit Risk\nThe Company's trade accounts receivable are disbursed principally among various hospitals and distributors of medical products. As of August 31, 1995 the Company believes it has no significant concentration of credit risk with its trade accounts receivable.\n(2) Liquidity\nThe accompanying financial statements have been prepared on a going concern basis which contemplates the continuation of operations, realization of assets and liquidation of liabilities in the ordinary course of business. The Company incurred net losses of $1,135,890, $1,371,915 and $803,641 for the years ended August 31, 1995, 1994 and 1993, respectively, and at August 31, 1995 had an accumulated deficit of $9,208,777. The net losses incurred by the Company have consumed working capital and weakened the Company's financial position. During 1995, the Company was able to satisfy its cash shortfall from operating activities with the borrowings from the T-Partnership, the proceeds from the sale of stock to the T-Partnership and cash on hand. The Company's ability to continue in business is dependent upon its success in generating sufficient cash flow from operations or obtaining additional financing. The Company continues to re-evaluate its plans and adopt certain cost reduction measures. The Company is attempting to increase sales by examining and, where appropriate, modifying its distribution network, utilizing aggressive pricing and introducing new products to market. The Company's ability to continue as a going concern is dependent upon the successful implementation of the aforementioned programs. There can be no assurances that these programs can be successfully implemented. The financial statements do not include any adjustments relating to the recoverability and classifications of reported asset amounts or the amounts of liabilities that might result from the outcome of this uncertainty.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(3) Inventories\nInventories consisted of the following:\n(4) Property, Plant and Equipment\nProperty, plant and equipment consisted of the following:\n(5) Accrued Expenses\nThe components of accrued expenses consisted of the following:\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(6) Convertible Debentures Due to T-Partnership\nIn September 1990, the Company issued two convertible subordinated debentures to the T-Partnership for $100,000 each. The debentures bore interest at the greater of 12% or one point over the prime interest rate on the first business day of each calendar quarter. Each debenture matures ten years from the date of issuance, except that the Company has the option to retire the debentures any time subsequent to three years after the issuance date.\nThe holder of the debentures had the right, at its option, to convert the debenture into common stock of the Company at the conversion price of $1.25 per share. Such debentures were converted into 160,000 shares of the Company's common stock in December 1992.\n(7) Subordinated Debentures Due to T-Partnership\nOn October 11, 1993, the Company entered into an agreement with the T-Partnership to borrow up to $1,000,000. Ervin Schoenblum, the Company's Acting President and director, and another member of the Company's Board of Directors are members of the T-Partnership. As of August 31, 1995, the Company had drawn down all of the $1,000,000.\nOn August 31, 1995, the Company entered into an agreement with the T-Partnership to borrow an additional $500,000 and combine such loan with the original $1,000,000 for a total loan due to the T-Partnership of $1,500,000. The T-Partnership agreed to lend the Company $200,000 on the execution of this agreement and, at the Company's request, an additional sum of $300,000.\nThe rate of interest is 12% per annum and is payable monthly on any outstanding balance. Principal payments of $20,000 were scheduled to commence on September 1, 1995 for the original $1,000,000. However, the new agreement provides for repayment to begin on September 1, 1996 with installments of $25,000 each month. Any remaining balance is due on August 1, 2001. The loan is secured by the Company's property, building, accounts receivable, inventories and machinery and equipment. The Company must prepay the outstanding balance in the event the Company is merged into or consolidated with another corporation or the Company sells all or substantially all of its assets.\nUnder the provisions of the original agreement, the T-Partnership was granted purchase warrants which permitted the T-Partnership to purchase 166,667 shares of the Company's common stock at a price of $3.25 per share. The new agreement states that the T-Partnership will surrender its original purchase warrant to purchase 166,667 shares of common stock and be granted a new purchase warrant to purchase 500,000 shares of the Company's common stock at a price of $0.9875 per share. The warrants are immediately exercisable and expire on August 1, 2001.\nIn October 1995, the Company borrowed an additional $150,000 under this agreement and in November 1995, the remaining $150,000 was borrowed.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(8) Other Long-Term Debt\nOther long-term debt is as follows:\nThe mortgage is payable monthly in installments of $1,684, including interest at 8.75%, and is secured by the Company's facility in Rahway, New Jersey. The mortgage was paid in full in October 1995.\nThe annual maturities for long-term debt, including subordinated debentures due to the T-Partnership for the five years subsequent to August 31, 1995 are as follows:\n1996 $ 13,055 1997 300,000 1998 300,000 1999 300,000 2000 300,000\nDuring September 1993, the Company borrowed $100,000 against the cash surrender value of the life insurance policy of the Chairman of the Company. During June 1995, the Company borrowed an additional $25,000 on this policy. Interest on the loan is 6%. The loan was recorded as a reduction in the policy's cash surrender value which is included in other assets in the accompanying balance sheets.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(9) Stock Options\nOn May 20, 1987, the Company's stockholders approved the 1987 Incentive Stock Option Plan (the \"1987 Plan\"). Under the 1987 Plan, 225,000 shares of authorized but unissued shares of Common Stock, $.10 par value, of the Company were set aside to provide an incentive for officers and other key employees to render services and make contributions to the Company. Options may be granted at not less than their fair market value at the date of grant and are exercisable at such time provided by the grants during the five-year period beginning on the date of grant.\nOn May 23, 1990, the Company's stockholders approved the 1990 Incentive Stock Option Plan (the \"1990 Plan\"). The terms of the 1990 Plan are substantially the same as the terms of the 1987 Plan. The 1990 Plan provides for the reservation of 225,000 shares of common stock for issuance thereunder.\nOn July 15, 1992, the Company's stockholders approved the 1992 Incentive Stock Option Plan (the \"1992 Plan\"). The terms of the 1992 Plan are substantially the same as the terms of the 1987 and 1990 Plans. The 1992 Plan likewise provides for the reservation of 225,000 shares of common stock for issuance thereunder.\nOn April 1, 1992, the Board of Directors adopted the 1992 Non- Qualified Stock Option Plan pursuant to which options to purchase 200,000 shares of common stock may be granted to directors, officers and key employees. Options may be granted at a price determined by the Board of Directors, but not less than 80% of the fair market value at the date of grant. Options are exercisable at such time provided by the grants, but each option granted shall terminate no longer than five years after the date of grant.\nOn July 15, 1992, the Board of Directors granted five-year options to purchase 5,000 shares at $1.50 per share, representing the fair market value at the date of grant to each of its four non-employee directors in accordance with the Company's 1992 Non-Qualified Stock Option Plan. As of August 31, 1995, all these options remain outstanding.\nOn January 24, 1994, the Company granted 25,000 stock options to the Company's Acting President. These options were issued at $2.375 per share, the fair market value price on the day of grant.\nIn July 1994, the Company extended the expiration date of certain outstanding options held by two members of its Board of Directors. The resulting compensation expense is being amortized over the extension period.\nIn October 1994, the Board of Directors voted in favor of offering all employees, officers and directors holding options at a price greater than $1.00 per share the opportunity to have those options replaced by stock options at a price of $1.00 per share, representing the fair market value at that time. Accordingly, options to purchase 384,300 shares were terminated and an equal number of new options were issued, which is reflected in the table below. In addition, the Company also granted 25,000 stock options to the Company's Acting President at $1.00 per share.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(9) Stock Options, cont.\nA summary of all stock option activity follows:\nOptions to acquire 223,060 shares of common stock were exercisable at August 31, 1995.\n(10) Employee Stock Purchase Plan\nThe Company has an Employee Stock Purchase Plan (the Plan) which provides for the issuance of a maximum of 75,000 shares of the Company's common stock which will be made available for sale under the Plan's first offering.\nAfter the first offering, subsequent offerings shall be made only upon the recommendation of the committee administering the Plan. Common stock can be purchased through employee-authorized payroll deductions at the lower of 85% of the fair market value of the common stock on either the first or last day of trading of the stock during the calendar year. It is the intention of the Company that the Plan qualify under Section 423 of the Internal Revenue Code. The Company's Board of Directors authorized extension of the Plan to January 1, 1996. During 1995, 1994 and 1993, 2,476, 7,403 and 10,455 shares, respectively, were purchased under the Plan.\n(11) Preferred Stock, Common Stock and Paid-in Capital\nThe Company is authorized to issue up to 1,000,000 shares of preferred stock. As of August 31, 1995, no preferred shares have been issued.\nIn August 1992, the Company sold 1,666,666 shares of common stock in a private placement at $1.20 per share for gross proceeds of approximately $2,000,000. The costs associated with this private placement were approximately $75,000 and have been netted against the proceeds of the private placement. As\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(11) Preferred Stock, Common Stock and Paid-in Capital, cont.\ncompensation for its services the placement agent was granted a warrant to purchase 200,000 shares of common stock of the Company at an exercise price of $1.80 per share. This warrant expires August 31, 1997. In connection with the aforementioned private placement, 833,333 shares were purchased by officers and directors of the Company or by their affiliates.\nThe Company has a lending agreement with the T-Partnership (see note 7). Under the agreement with the T-Partnership a purchase warrant was issued which permits the T-Partnership to purchase 500,000 shares of the Company's common stock at a price of $0.9875 per share. A portion of the amount borrowed has been allocated to the warrants based upon their estimated fair market value at the date of the agreement with a corresponding amount being credited to additional paid-in capital. Such amount ($50,000) is amortized as additional interest expense over the term of the indebtedness. The unamortized balance is shown in other assets in the accompanying 1995 balance sheet.\nIn March 1995, the T-Partnership purchased 571,500 shares of the Company's restricted common stock, $.10 par value, in a private placement at $.875 per share for gross proceeds of approximately $500,000. In connection with this private placement, the Company also issued to the T-Partnership a purchase warrant to purchase 83,344 shares of the Company's common stock at an exercise price of $1.425 per share. This warrant will expire five years from the date of the agreement. Ervin Schoenblum, the Company's Acting President and director, and another member of the Company's Board of Directors are members of the T-Partnership.\n(12) Income Taxes\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", as of September 1, 1993. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The effects of adopting SFAS 109 were not material to the financial statements at September 1, 1993.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(12) Income Taxes, cont.\nAt August 31, 1995 and 1994, the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows:\nA valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will be realized. The valuation allowance for deferred tax assets as of September 1, 1994 was $3,259,000. The net change in the total valuation allowance for the year ended August 31, 1994 was an increase of $319,000.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(12) Income Taxes, cont.\nAt August 31, 1995, the Company had available net operating loss carryforwards, research and development and investment tax credit carryforwards that expire as follows:\n(13) Segment Data\nThe Company operates in one business segment. Export sales were approximately $1,964,000 in 1995, $1,718,000 in 1994 and $2,164,000 in 1993. Sales to the only domestic distributor of the Company's products totalled approximately $765,000 in 1995, $1,261,000 in 1994 and $1,336,000 in 1993, representing approximately 11% of net sales in 1995, 17% in 1994 and 16% in 1993. The agreement with this distributor was terminated on May 31, 1995.\n(14) Related Party Transactions\nDuring fiscal year 1994 and 1993, a director of the Company who is associated with the T-Partnership was retained as a management consultant to the Company. The Company incurred fees from this individual in the amounts of approximately $16,000 in 1994 and $26,000 in 1993. In December 1993, this individual became the Acting President of the Company and still holds that position.\n(15) Commitments and Contingencies\n(a) The Company has agreements to lease facilities and equipment for use in the operations of the business under operating leases. The Company incurred rental expenses in connection with these leases of approximately $148,000 in 1995, $155,000 in 1994 and $152,000 in 1993.\n(Continued)\nELECTRO-CATHETER CORPORATION Notes to Financial Statements, Continued\n(15) Commitments and Contingencies, cont.\nThe following is a schedule of future minimum rental payments for operating leases which expire through 1998:\n1996 $ 26,687 1997 22,007 1998 6,877 -----\n(b) In October 1995, the Company entered into two leases that meet the requirements for capitalization. Both leases are for a duration of five years with combined annual payments of approximately $13,000.\n(c) The Company is involved in certain claims and litigation arising in the normal course of business. Management believes, based on the opinion of counsel representing the Company in such matters, that the outcome of such claims and litigation will not have a material effect on the Company's financial position and results of operations.","section_15":""}
{"filename":"726728_1995.txt","cik":"726728","year":"1995","section_1":"ITEM 1: BUSINESS - -----------------\nTHE COMPANY ===========\nRealty Income Corporation (\"Realty Income\" or the \"Company\") is a fully integrated, self-administered and self-managed Real Estate Investment Trust (\"REIT\") and the nation's largest publicly-traded owner of freestanding, single-tenant, retail properties diversified geographically and by industry and operated under triple-net lease agreements. As of February 1, 1996, the Company owned a diversified portfolio of 686 properties located in 42 states with over 4.6 million square feet of leasable space. Over 99% of the Company's properties were leased as of February 1, 1996. Unless otherwise indicated, information regarding the Company's properties is as of February 1, 1996.\nRealty Income adheres to a focused strategy of acquiring freestanding, single-tenant, retail properties leased to national and regional retail chains under long-term, triple-net lease agreements. The Company typically acquires, and then leases back, retail store locations from retail chain store operators, providing capital to the operators for continued expansion and other purposes. The Company's triple-net lease agreements generally are for initial terms of 15 to 25 years, require the tenant to pay a minimum monthly rent and all property operating expenses (taxes, insurance and maintenance), and provide for future rent increases based on increases in the consumer price index or additional rent calculated as a percentage of the tenant's gross sales above a specified level.\nSince 1970, Realty Income has acquired and leased back to national and regional retail chains over 630 properties (including approximately 20 properties that have been sold) and has collected in excess of 98% of the contractual rent obligations on those properties. Realty Income believes that the long-term ownership of an actively managed, diversified portfolio of retail properties leased under long-term, triple-net lease agreements will produce consistent, predictable income and the potential for long-term capital appreciation. Management believes that long-term leases, coupled with tenants assuming responsibility for property expenses under the triple-net lease structure, generally produce a more predictable income stream than many other types of real estate portfolios. As of February 1, 1996, the Company's single-tenant properties were leased pursuant to leases with an average remaining term (excluding extension options) of approximately 9.2 years. See \"Properties.\" The Company was formed on September 9, 1993 in the State of Delaware. Realty Income commenced operations as a REIT on August 15, 1994 through the merger of 25 public and private real estate limited partnerships with and into the Company (the \"Consolidation\"). Each of the partnerships was formed between 1970 and 1989 for the purpose of acquiring and managing long-term, triple-net leased properties. The partnerships historically made regular monthly cash distributions to investors. Realty Income pays a regular monthly distribution to its stockholders.\nThe Company is a fully integrated real estate company with in-house acquisition, leasing, legal, financial underwriting, portfolio management and capital markets expertise. The seven senior officers of the Company, who have each managed the Company's properties and operations for between five and 26 years, owned approximately 3.9% of the Company's outstanding common stock, par value $1.00 per share (the \"Common Stock\") as of March 15, 1996.\nRealty Income has 34 employees as of March 1, 1996.\nRECENT DEVELOPMENTS ===================\nSince the Consolidation, the Company has implemented its growth plan, which is intended to increase the Company's revenue and funds from operations (\"FFO\") per share. FFO is defined in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. As part of its growth plan, from the date of the Consolidation through February 1, 1996, the Company acquired 63 additional triple-net leased retail properties with an aggregate initial annual contractual base rent of approximately $7.9 million.\nINCREASE IN MONTHLY DISTRIBUTION. In August 1995, the Company increased its monthly distribution to $0.155 per share from $0.15 per share, representing an increase of 3.3%. The Company has paid distributions of $0.155 per share in August 1995 through February 1996. The February 1996 distribution was paid on January 26, 1996 and a special distribution of $0.23 per share was also paid in January 1996. The monthly distribution of $0.155 per share represents a current annualized distribution of $1.86 per share, and an annualized distribution yield of approximately 8.6% based on the last reported sale price of the Company's Common Stock on the New York Stock Exchange (\"NYSE\") on February 27, 1996. Although the Company expects to continue its policy of paying monthly distributions, there can be no assurance that the current level of distributions will be maintained by the Company or as to the actual distribution yield for any future period. See \"Distribution Policy.\"\nMERGER OF THE ADVISOR COMPANY. Prior to August 17, 1995, the day-to-day operations of the Company were managed by R.I.C. Advisor, Inc. (the \"Advisor Company\") pursuant to an advisory agreement. In order to create a fully integrated company and more closely align the interests of management with the interests of the Company's stockholders, the Advisor Company was merged with and into Realty Income on August 17, 1995 (the \"Merger\"). Pursuant to the Agreement and Plan of Merger dated April 28, 1995 (the \"Merger Agreement\"), the outstanding shares of the Advisor Company's common stock were converted into 990,704 newly issued shares of Realty Income Common Stock. As a result of the Merger, the employees of the Advisor Company became employees of the Company, and the Company became a fully integrated, self-administered and self-managed REIT.\nACQUISITION OF 63 TRIPLE-NET LEASED, RETAIL PROPERTIES. Since the Consolidation, the Company has increased the size of its portfolio through a strategic program of acquisitions. The Company has acquired 63 additional properties (the \"New Properties\"), and selectively sold five properties, increasing the number of properties in its portfolio by 9.2% from 628 properties at August 15, 1994 to 686 properties as of February 1, 1996. Of the New Properties, 61 were occupied as of February 1, 1996 and the remaining two were pre-leased and under construction pursuant to contracts under which the tenants have agreed to develop the properties (with development costs funded by the Company) and to begin paying rent when the premises open for business. The New Properties were acquired for an aggregate cost of approximately $70.7 million (including the estimated development costs of the two properties under construction), are located in 20 states, will contain approximately 655,900 leasable square feet and are 100% leased under triple-net leases, with an average initial lease term of 16.4 years. The weighted average annual unleveraged return on the cost of the New Properties (including the estimated cost of properties under construction) is estimated to be 11.3%, computed as estimated contractual net operating income (which in the case of a triple-net leased property is equal to the base rent or, in the case of properties under construction, the estimated base rent under the lease) for the first year of each lease, divided by total acquisition and estimated development costs. No assurance can be given that the actual return on the cost of the New Properties will not differ from the foregoing percentage. In addition to acquiring the New Properties, at February 1, 1996 the Company had entered into purchase agreements to acquire three additional properties for an aggregate cost of approximately $2.6 million.\nVARIABLE SENIOR NOTE REDEMPTION. On February 15, 1996, the Company announced its intent to redeem all of its outstanding variable rate senior notes due 2001 (the \"Notes\"). The Notes will be redeemed at par plus accrued interest to the date of redemption, which is scheduled for March 29, 1996.\n$130 MILLION UNSECURED ACQUISITION CREDIT FACILITY. In November 1994, the Company obtained a $100 million, three-year, revolving, unsecured acquisition credit facility (the \"Acquisition Credit Facility\") from The Bank of New York, as agent, and several major U.S. and non-U.S. commercial banks. In December 1995, the Company negotiated several modifications to the credit facility including (i) an increase in borrowing capacity to $130 million from $100 million; (ii) a reduction in the initial interest rate to London Interbank Offered Rate (\"LIBOR\") plus 1.25% from LIBOR plus 1.375%; and (iii) an extension of the credit facility from November 1997 to November 1998. The Acquisition Credit Facility has been used to fund a portion of the property acquisitions completed since the Consolidation and is anticipated to continue to be used to acquire triple-net leased, retail properties.\nLISTING OF THE COMMON STOCK ON THE NYSE. The Common Stock was authorized for listing on the NYSE under the symbol \"O\" and commenced trading on the NYSE on October 18, 1994.\nBUSINESS OBJECTIVES AND STRATEGY ================================\nGENERAL. The Company's primary business objective is to generate a consistent and predictable level of FFO per share and distributions to stockholders. Additionally, the Company generally will seek to increase FFO per share and distributions to stockholders through both internal and external growth, while also seeking to lower the ratio of distributions to stockholders as a percentage of FFO in order to allow internal cash flow to be used to fund additional acquisitions and for other corporate purposes. The Company pursues internal growth through (i) contractual rent increases on existing leases; (ii) rental increases at the termination of existing leases when market conditions permit; and (iii) the active management of the Company's property portfolio, including selective sales of properties. The Company generally pursues external growth through the acquisition of additional properties under long-term, triple-net lease agreements with initial contractual base rent which, at the time of acquisition, is in excess of the Company's estimated cost of capital.\nINVESTMENT PHILOSOPHY. Realty Income believes that the long-term ownership of an actively managed, diversified portfolio of retail properties under long-term, triple-net lease agreements should produce consistent, predictable income and the potential for long-term capital appreciation. Under a triple-net lease agreement, the tenant agrees to pay a minimum monthly rent and all property expenses (taxes, maintenance, and insurance) plus, typically, future rent increases based on increases in the consumer price index or additional rent calculated as a percentage of the tenant's gross sales above a specified level.\nThe Company believes that long-term leases, coupled with the tenants assuming responsibility for property expenses, produce a more predictable income stream than many other types of real estate portfolios, while continuing to offer the opportunity for capital appreciation.\nINVESTMENT STRATEGY. In identifying new properties for acquisition, Realty Income focuses on providing expansion capital to middle market retail chains by acquiring, then leasing back, their retail store locations. The Company classifies retail tenants into three categories: venture, middle market, and upper market. Venture companies are those which typically offer a new retail concept in one geographic region of the country and operate between five and 100 retail outlets. In general, these retail chains are thinly capitalized and are in the process of solving distribution, marketing, concept, geographic adaptation, and other problems associated with a new, growing company. Middle market retail chains are those which typically have 100 to 500 retail outlets, operations in more than one geographic region, success through one or more economic cycles, a proven, replicable concept, and an objective of further expansion. The upper market retail chains typically consist of companies with 500 or more stores which operate nationally in a mature retail concept. They generally have strong operating histories and access to several sources of capital.\nRealty Income focuses on acquiring properties leased to emerging, middle market retail chains which the Company believes are more attractive for investment because: (i) they generally have overcome many of the operational and managerial obstacles that tend to adversely affect venture retailers; (ii) they typically require capital to fund expansion but have more limited financing options compared to upper market retailers; (iii) historically, they generally have provided attractive risk-adjusted returns to the Company over time, since their financial strength has in many cases tended to improve as their businesses have matured; (iv) their relatively large size compared to venture retailers allows them to spread corporate expenses among a greater number of stores; and (v) compared to venture retailers, middle market retailers typically have the critical mass to survive if a number of locations have to be closed due to underperformance.\nACQUISITION STRATEGY. Realty Income seeks to invest in industries that are dominated by independent local operators and in which several well organized regional and national chains are capturing market share through service, quality control, economies of scale, mass media advertising, and selection of prime retail locations. The Company executes its acquisition strategy by acting as a source of capital to regional and national retail chain stores in a variety of industries by acquiring, then leasing back, their retail store locations.\nRelying on executives from its acquisitions, portfolio management, finance, accounting, operations, capital markets, and legal departments, the Company undertakes stringent research and analysis in identifying appropriate industries, tenants, and property locations for investment. In selecting real estate for potential investment, the Company generally will seek to acquire properties that have the following characteristics:\n* Freestanding, commercially zoned property with a single tenant;\n* Properties that are important retail locations for national and regional retail chains;\n* Properties that are located within attractive demographic areas relative to the business of their tenants, with high visibility and easy access to major thoroughfares;\n* Properties that can be purchased with the simultaneous execution or assumption of long-term, triple-net lease agreements, providing the opportunity for both current income and future rent increases based on increases in the consumer price index or through the payment of additional rent calculated as a percentage of the tenant's gross sales above a specified level; and\n* Properties that can be acquired at or below their appraised value at prices generally ranging from $300,000 to $10 million.\nPORTFOLIO MANAGEMENT STRATEGY. The active management of the property portfolio is an essential component of the Company's long-term strategy. The Company continually monitors its portfolio for changes that could affect the performance of the industries, tenants, and locations in which it has invested. Realty Income's executive committee meets at least monthly to review industry and tenant research, due diligence, property operations and portfolio management. This monitoring typically includes ongoing review and analysis of: (i) the performance of various tenant industries; (ii) the operation, management, business planning, and financial condition of the tenants; (iii) the health of the individual markets in which the Company owns properties, from both an economic and real estate standpoint; and (iv) the physical maintenance of the Company's individual properties. The portfolio is analyzed on an ongoing basis with a view towards optimizing performance and returns.\nWhile the Company generally intends to hold its triple-net leased properties for long-term investment, the Company believes that opportunities may exist to increase FFO through the active management of its portfolio of triple- net lease properties. The Company intends to pursue a strategy of identifying properties\nthat may be sold at attractive prices where the reinvestment of the sales proceeds is expected to generate a higher cash flow to the Company. While the Company intends to pursue such a strategy, it will only do so within the constraints of the rules regarding REIT status.\nCAPITAL STRATEGY. The Company utilizes its $130 million, unsecured Acquisition Credit Facility as a vehicle for the short-term financing of the acquisition of new properties. When outstanding borrowings under the Acquisition Credit Facility reach a certain level (generally in the range of $50 to $100 million), the Company intends to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of Common Stock, Preferred Stock or convertible Preferred Stock, debt securities or convertible debt securities. However, there can be no assurance that the Company will be able to effect any such refinancing or regarding the terms on which any such refinancing may be accomplished. The Company believes that it is best served by a conservative capital structure, with a majority of its capital consisting of equity. As of December 31, 1995, the Company's total indebtedness was approximately 4.9% of its total assets.\nCOMPETITIVE STRATEGY. The Company believes that to utilize its investment philosophy and strategy most successfully, it must seek to maintain the following competitive strategy:\n* SIZE OF INVESTMENT PROPERTIES: The Company believes that smaller ($300,000 to $10,000,000) retail triple-net leased properties represent an attractive investment opportunity in today's real estate environment. Due to the complexities of acquiring and managing a large portfolio of relatively small assets, the Company believes that these types of properties have not experienced significant institutional participation or the corresponding yield reduction experienced by larger income producing properties. The Company believes the less intensive day to day property management required by triple-net lease agreements, coupled with the active management of a large portfolio of smaller properties by the Company, is an effective investment strategy.\n* INVESTMENT IN NEW INDUSTRIES: While specializing in smaller properties, the Company will seek to further diversify its portfolio among a variety of industries. The Company believes that diversification will allow it to invest in industries that are currently growing and have characteristics the Company finds potentially profitable. These characteristics include, but are not limited to, industries dominated by local operators where national and regional chain operators can gain substantial market share and dominance through more\nefficient operations, as well as industries taking advantage of major demographic shifts in the population base. For example, in the early 1970s, Realty Income targeted the fast food industry to take advantage of the country's increasing desire to dine away from home, and in the early 1980s, it targeted the child day care industry, responding to the need for professional child care as more women entered the work force.\n* DIVERSIFICATION: Diversification of the portfolio by industry type, tenant and geographic location is key to the Company's objective of providing predictable investment results for its stockholders. As the Company expands it will seek to further diversify its portfolio.\n* MANAGEMENT SPECIALIZATION: The Company believes that its management's specialization in small properties operated under triple-net lease agreements is important to meeting its objectives. The Company plans to maintain this specialization and will seek to employ and train high quality professionals in this specialized area of real estate ownership, finance and management.\n* TECHNOLOGY: The Company intends to stay at the forefront of technology in its efforts to efficiently and economically carry out its operations. The Company maintains a sophisticated information system that allows it to analyze its portfolio's performance and actively manage its investments. In addition, the Company maintains record-keeping on an optical disc storage and retrieval system which gives it ready access to records on a cost efficient and timely basis. The Company believes that technology and information based systems will play an increasingly important role in its competitiveness as an investment manager and source of capital to a variety of industries and tenants.\nPROPERTIES ==========\nAs of February 1, 1996, the Company owned 686 properties in 42 states consisting of 135 after-market automotive retail locations, 319 child care centers, 36 convenience stores, 4 home furnishings stores, 177 restaurant facilities and 15 other properties. Of the 686 properties, 627 or 91% are leased to national or regional retail chain operators; 35 or 5% are leased to franchisees of retail chain operators; 20 or 3% are leased to other tenant types; and four or less than 1% are available for lease. Over 97% of the properties were under triple-net lease agreements. Triple-net leases typically require the tenant to be responsible for substantially all property operating costs including property taxes, insurance, maintenance and structural repairs. The Company's net-leased retail properties are primary retail locations of national and regional retail chain store operators. The properties average approximately 6,800 square feet of leasable retail space on approximately 42,400 square feet of land. Generally, buildings are single-story properties with adequate parking on site to accommodate peak retail traffic periods. The properties tend to be on major thoroughfares with relatively high traffic counts and adequate access, egress and proximity to a sufficient population base to constitute a sufficient market or trade area for the retailer's business.\nAs of February 1, 1996, Realty Income owned a diversified portfolio of 686 properties in 42 states consisting of over 4.6 million square feet of leasable space. The following table sets forth certain geographic diversification information regarding these properties:\n(1) Does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Annualized base rent is calculated by multiplying the monthly contractual base rent as of February 1, 1996 for each of the properties by 12.\nThe following table sets forth certain information regarding the Company's properties as of February 1, 1996, classified according to the business of the respective tenants:\n(1) Approximate total number of retail locations operated by each tenant (including both owned and franchised locations), based on information provided to the Company by the respective tenants.\n(2) Does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Annualized base rent is calculated by multiplying the monthly contractual base rent as of February 1, 1996 for each of the properties by 12.\nOf the 686 properties, 676 are single-tenant properties with the remaining properties being multi-tenant properties. As of\nFebruary 1, 1996, 672 or over 99% of the single-tenant properties were triple-net leased pursuant to leases with an average remaining lease term (excluding extension options) of approximately 9.2 years. The following table sets forth certain information regarding the timing of lease expirations on the Company's 672 triple-net leased, single tenant retail properties:\n(1) The table does not include ten multi-tenant properties and four vacant, unleased properties owned by the Company. The average remaining lease term for all leases on the Company's properties, excluding the multi-tenant properties, is approximately 9.2 years. The lease expirations for two properties under construction are based on the estimated date of completion of such properties.\n(2) Does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Annualized base rent is calculated by multiplying the monthly contractual base rent as of February 1, 1996 for each of the properties by 12.\nDESCRIPTION OF LEASING STRUCTURE. As of February 1, 1996, over 97% of the Company's properties were leased pursuant to triple-net leases. In most cases, the leases are for initial terms of from 15 to 20 years and the tenant has an option to extend the initial term. The leases generally provide for a minimum base rent plus future increases based on increases in the consumer price index or additional rent based upon the tenant's gross sales above a specified level (i.e., percentage rent). Where leases provide for rent increases based on increases in the consumer price index, such increases permanently become part of the base rent. Where leases provide for percentage rent, this additional rent is typically payable only if the tenant's gross sales for a given period (usually one year) exceed a specified level, and then is typically calculated as a percentage of only the amount of gross sales in excess of such level. In general, the leases require the tenant to pay all real property taxes, insurance, and expenses of maintaining the property.\nDescription of Industries - -------------------------\nThe Company's investments in properties at February 1, 1996 were concentrated in five major industries: after-market automotive parts and service stores, child care, convenience stores, home furnishings stores and restaurants. In addition, the Company owns three mixed-use light industrial business parks.\nTHE AFTER-MARKET AUTOMOTIVE PARTS AND SERVICE INDUSTRY AND TENANTS. The motor vehicle and parts after- market industry is comprised of various parts producing firms and retail outlets providing parts, service and repair to automobiles throughout the country. The Company has selectively invested in the following sectors of the after-market automotive industry: auto parts and accessories stores, lubrication services and tire stores.\nAuto Parts and Accessories. The Company believes Northern Automotive is one of the largest operators of retail after-market auto parts stores in the nation based on number of stores. The Company began investing in Northern Automotive stores in 1987 and currently owns 79 Northern Automotive properties located in 14 states. Based on information provided by Northern Automotive, the Company believes it is the largest owner of Northern Automotive properties.\nLubrication Services. Based upon industry reports, the Company believes that the quick lube market is a growing segment of the motor oil business. The Company began investing in Jiffy Lube International, Inc. (\"Jiffy Lube\") in 1985 and currently owns 24 Jiffy Lube locations in eight states.\nTire Stores. With approximately 294 outlets as of February 1, 1996, the Company believes Discount Tire Stores is one of the largest independent retail tire sales operation in the nation. The Company began investing in Discount Tire Stores in 1990 and currently owns 18 Discount Tire Stores properties located in five states.\nTHE CHILD CARE INDUSTRY AND TENANTS. According to the U.S. Bureau of Labor Statistics, the number of children under age six with mothers in the labor force grew from 6.5 million in 1980 to 9.6 million in 1993. Fueled by the increase in the number of women in the workplace, child care has grown into a national industry.\nThe Company believes that child day care remains a highly fragmented industry, with only three chains operating in excess of 500 centers. The Company's child care properties are geographically diversified, with properties leased to the three largest operators (based on number of locations) of child day care centers in the United States: La Petite Academy in 27 states, Children's World Learning Centers in 18 states, and KinderCare Learning Centers in eight states.\nTHE CONVENIENCE STORE INDUSTRY AND TENANTS. As the supermarket replaced the neighborhood grocery store, the convenience store industry emerged to provide a convenient neighborhood location for the purchase of a limited selection of high use items. The industry today is adapting to a new concept with the combination of a gas station and a traditional convenience store. The integration of the two businesses on one location gives newer convenience stores a competitive advantage over older, single-concept stores. As a result, traditional convenience store chains are beginning to sell gas at their locations while certain petroleum companies are adding convenience stores to their traditional gas stations.\nThe Company currently owns 36 convenience store properties with 18 leased to Dairy Mart Convenience Stores, Inc., 14 leased to The Pantry, three operated as 7-ELEVEN'S, and one to another tenant. The Company is actively seeking to expand its participation in the convenience store industry through additional acquisitions.\nTHE HOME FURNISHINGS INDUSTRY AND TENANT. According to the U.S. Bureau of the Census Current Business Reports, the U.S. furniture stores total estimated retail sales were approximately\n$17.7 billion for the first six months of 1995, a 6.9% increase over estimated retail sales for the last six months of 1994. The industry is segmented into a number of different niches that compete with one another. The Company believes the largest segments include conventional furniture stores, specialty stores, specialty furniture stores, manufacturers' gallery stores, vertically integrated furniture stores, department stores, general merchandise discounters, and catalog retailers. The Company believes that historically, the conventional furniture store segment was dominated by numerous local, independent retailers operating in a fragmented market. The Company believes that in recent years regional and national retail chains have been taking market share from independent operators through more efficient operations, distribution, marketing, advertising and lower prices.\nThe Company owns four home furnishing retail store properties which are leased to Levitz Furniture Corporation, one of the nation's largest home furnishings retailers.\nTHE RESTAURANT INDUSTRY AND TENANTS. According to industry estimates cited in Standard & Poor's Industry Surveys--Leisure Time Basic Analysis, spending for food prepared outside the home has grown steadily for most of the past two decades. The Company currently owns a total of 177 restaurant properties, 133 of them leased to five leading restaurant chains. All five of the Company's major restaurant tenants, Golden Corral, Taco Bell, Sizzler, Hardees and Whataburger, were ranked by NATION'S RESTAURANT NEWS among the top 100 restaurant companies for 1994 based on sales volume.\nMatters Pertaining to Certain Properties and Tenants - ----------------------------------------------------\nAs of February 1, 1996, the Company's four largest tenants were Children's World Learning Centers, La Petite Academy, Golden Corral and Northern Automotive, which accounted for approximately 25.6%, 18.0%, 12.8% and 9.1%, respectively, of the Company's rental revenue for the year ended December 31, 1995.\nFour of the Company's properties were vacant as of February 1, 1996 and available for lease. Three of the vacant properties were previously leased to restaurant operators. One of the vacant properties was formerly leased to a child care operator.\nAs of February 1, 1996, 16 of the Company's properties which were under lease, were vacant and available for sublease by the tenant. Fifteen of these properties (nine restaurants, three automotive stores, two day care and one medical building) were available for sublease and had tenants who were current with their rent and other lease obligations. The other property, a\nrestaurant, has a tenant who is delinquent with respect to rent payments.\nAs of February 1, 1996, 17 of the Company's properties had been sublet to tenants in different industries than the original tenant. At February 1, 1996, all of these tenants were current with their rent and other lease obligations.\nFor a nine month period in 1992, the Company granted temporary rent concessions to Northern Automotive with respect to certain of its leases. Northern Automotive resumed paying full rent on all of its leases in December 1992 and is currently repaying the concessions previously granted.\nDevelopment of Certain Properties - ---------------------------------\nOf the 63 New Properties acquired by the Company since the Consolidation, 53 were completed properties occupied by the tenant at the time of acquisition while the remaining 10 properties were parcels of undeveloped land acquired for development. In the case of undeveloped land, the Company typically enters into an agreement with a prospective tenant pursuant to which the tenant retains a contractor to construct the improvements on the property and the Company funds the costs of such development. The tenant is contractually obligated to complete the construction on a timely basis, generally within eight months after the Company purchases the land, to pay construction cost overruns to the extent they exceed the construction budget by more than 5% and, in some cases, to obtain a completion bond. The Company also enters into a lease with the prospective tenant at the time the Company purchases the land, which generally requires that the tenant begin paying base rent, calculated as a percentage of the Company's acquisition cost for the property, including construction costs and capitalized interest, when the premises open for business. As of February 1, 1996, eight of the Company's leased and operating New Properties had been developed through Company funding and the Company was funding the development of two additional New Properties. The total acquisition and estimated development costs for these two properties is $1.5 million, of which $1.0 million had not been funded as of February 1, 1996. The Company will continue to seek to acquire land for development under similar arrangements.\nDISTRIBUTION POLICY ===================\nDistributions are paid to the Company's stockholders on a monthly basis if, as and when declared by the Company's Board of Directors. In order to maintain its tax status as a REIT, the Company is generally required to distribute annually to its\nstockholders at least 95% of its taxable income (determined without regard to the deduction for dividends paid and by excluding any net capital gain). The Company intends to make distributions to its stockholders which are sufficient to meet this requirement.\nFuture distributions by the Company will be at the discretion of its Board of Directors and will depend on, among other things, its results of operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended (the \"Code\"), its debt service requirements and such other factors as the Board of Directors may deem relevant. In addition, the Acquisition Credit Facility contains financial covenants which could limit the amount of distributions payable by the Company in the event of a deterioration in the results of operations or financial condition of the Company, and which prohibit the payment of distributions on the Common Stock in the event that the Company fails to pay when due (subject to any applicable grace period) any principal of or interest on borrowings under the Acquisition Credit Facility.\nDistributions by the Company to the extent of its current and accumulated earnings and profits for federal income tax purposes generally will be taxable to stockholders as ordinary income. Distributions in excess of such earnings and profits generally will be treated as a non-taxable reduction in the stockholders basis in its stock to the extent of such basis, and thereafter as a gain from the sale of such stock. Approximately 4.7% of the distributions made or deemed to have been made in 1995 were classified as a return of capital for federal income tax purposes, the Company is unable to predict the portion of 1996 or future distributions which may be classified as a return of capital since such amount depends on the Company's taxable income for the entire year.\nIn connection with the Merger, the Company was treated as having acquired the accumulated earnings and profits of the Advisor Company (the \"Acquired Earnings\"). In order to maintain its status as a REIT, the Company was required to make or be deemed to have made distributions sufficient to eliminate the Acquired Earnings prior to December 31, 1995. To meet this requirement, the Company declared in December 1995 a $0.155 per share regular distribution paid on January 15, 1996, a $0.155 per share regular distribution paid on January 26, 1996 (in lieu of the regular February distribution) and a $0.23 per share special distribution paid on January 11, 1996.\nOTHER ITEMS ===========\nCOMPETITION FOR ACQUISITION OF REAL ESTATE. The Company will face competition in the acquisition, operation and sale of its properties. Such competition can be expected from other businesses, individuals, fiduciary accounts and plans and other entities engaged in real estate investment. Some of the Company's competitors are larger and have greater financial resources than the Company. This competition may result in a higher cost for properties the Company wishes to purchase. The tenants leasing the Company's properties generally face significant competition from other operators. This may result in an adverse impact on that portion, if any, of the rental stream to be paid to the Company based on a tenant's revenues and may also adversely impact the tenants' results of operations or financial condition.\nENVIRONMENTAL MATTERS. Investments in real property create a potential for environmental liability on the part of the owner of such property for contamination resulting from the presence or discharge of hazardous substances on the property. Such liability may be imposed without regard to knowledge of, or the timing, cause or person responsible for the release of such substances onto the property. The Company believes that its properties are in compliance in all material respects with all federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances or petroleum products. The Company has not been notified by any governmental authority, and is not otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances or petroleum products in connection with any of its present properties. Moreover, the tenants are required to operate in compliance with all applicable federal, state and local laws and regulations. Nevertheless, if environmental contamination should exist, the Company could be subject to strict liability by virtue of its ownership interest.\nTAXATION OF THE COMPANY. The Company has elected to be taxed as a REIT under the Code, commencing with its taxable year ended December 31, 1994. As long as the Company meets the requirements under the Code for qualification as a REIT each year, the Company will be entitled to a deduction when calculating its taxable income for dividends paid to its stockholders. For the Company to qualify as a REIT, however, certain detailed technical requirements must be met (including certain income, asset and stock ownership tests) under Code provisions for which, in many cases, there are only limited judicial or administrative interpretations. Although the Company intends to operate so that it will continue to qualify as a REIT, the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations and the possibility\nof future changes in the Company's circumstances preclude any assurance that the Company will so qualify in any year. For any taxable year that the Company fails to qualify as a REIT, it would not be entitled to a deduction for dividends paid to its stockholders in calculating its taxable income. Consequently, distributions to stockholders would be substantially reduced and could be eliminated because of the Company's increased tax liability. Should the Company's qualification as a REIT terminate, the Company may not be able to elect to be treated as a REIT for the subsequent five-year period, which would substantially reduce and could eliminate distributions to stockholders for the years involved.\nEFFECT OF DISTRIBUTION REQUIREMENTS. To maintain its status as a REIT for federal income tax purposes, the Company generally is required each year to distribute to its stockholders at least 95% of its taxable income. In addition, the Company is 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 such calendar year, 95% of its capital gain net income for the calendar year and any amount of such income that was not distributed in prior years.\nADDITIONAL CAPITAL REQUIREMENTS. The Company's future growth will depend in large part upon its ability to raise additional capital. If the Company were to raise additional capital through the issuance of equity securities, the interests of holders of Common Stock, including the shares of Common Stock offered hereby, could be diluted. Likewise, the Company's Board of Directors is authorized to cause the Company to issue preferred stock in one or more series and entitled to such dividends and voting and other rights as the Board of Directors may determine. Accordingly, the Board of Directors may authorize the issuance of preferred stock with voting, dividend and other similar rights which could be dilutive to or otherwise adversely affect the interests of holders of Common Stock.\nDEPENDENCE ON KEY PERSONNEL. The Company is dependent on the efforts of its directors and executive officers. The loss of the services of its key employees could have a material adverse effect on the Company's operations.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES - -------------------\nInformation pertaining to the properties of Realty Income can be found under Item 1.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS - --------------------------\nThe Company is subject to certain claims and lawsuits, the outcome of which are not determinable at this time. In the opinion of management, any liability that might be incurred by the Company upon the resolution of these claims and lawsuits will not, in the aggregate, have a material adverse effect on the consolidated financial condition or results of operations of the Company.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNo matters were submitted to stockholders during the fourth quarter of the fiscal year.\nPART II =======\nITEM 5:","section_5":"ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ----------------------------------------------------------\nA. Common stock of the Company is listed on the New York Stock Exchange under the symbol \"O.\" The stock initially began trading on The New York Stock Exchange on October 18, 1994. Prior to October 18, 1994, the stock was not publicly traded.\nThe following table shows the high, low and closing sales prices per share for the Common Stock as reported by the New York Stock Exchange for the periods indicated:\n(1) Distributions are currently declared monthly by the Company based on financial results for the prior months. At December 31, 1995, a special distribution of $0.23 per share and two distributions of $0.155 per share had been declared and were paid on January 11, 1996, January 15, 1996 and January 26, 1996, respectively.\nB. There were 18,557 holders of record of Realty Income's shares of common stock as of March 8, 1996, however, Realty Income believes the total number of beneficial shareholders of Realty Income to be approximately 40,000.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA - -------------------------------- (not covered by Independent Auditors' Report)\n(1) Ratio of Earnings to Fixed Charges is calculated by dividing net income after adding back interest expense, by fixed charges. Fixed charges are comprised of interest costs. Ratio of Earnings to Fixed Charges is not applicable for 1992 and 1991 because the Company did not have any fixed charges for these periods.\n(2) Due to the change in the capital structure caused by the Consolidation (see Item 8, Note 1 to the Consolidated Financial Statements), per share information would not be meaningful for 1993 through 1991 and therefore has not been included.\n(3) The 1994 amount represents distributions paid or declared, as the case may be, after the Consolidation.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ----------------------------------------------------------\nGENERAL - -------\nRealty Income Corporation (\"Realty Income\" or the \"Company\") was organized to operate as an equity real estate investment trust (\"REIT\"). The Company's primary business objective is to generate a consistent and predictable level of funds from operations (\"FFO\") per share and distributions to stockholders. Additionally, the Company generally will seek to increase FFO per share and distributions to stockholders through both internal and external growth, while also seeking to lower the ratio of distributions to stockholders as a percentage of FFO in order to allow internal cash flow to be used to fund additional acquisitions and for other corporate purposes. Realty Income pursues internal growth through (i) contractual rent increases on existing leases; (ii) rental increases at the termination of existing leases when market conditions permit; and (iii) the active management of the Company's property portfolio, including selective sales of properties. The Company generally pursues\nexternal growth through the acquisition of additional properties under long-term, triple-net lease agreements with initial contractual base rent which, at the time of acquisition, is in excess of the Company's estimated cost of capital.\nRealty Income was organized in the state of Delaware on September 9, 1993 to facilitate the merger, which was effective on August 15, 1994 (the \"Consolidation\"), of 10 private and 15 public real estate limited partnerships (the \"Partnerships\") with and into Realty Income. The Company's common stock is listed on the New York Stock Exchange (the \"NYSE\") under the symbol \"O\" and commenced trading on October 18, 1994.\nInvestors in the Partnerships who elected to invest in the equity of the Company received a total of 19,503,080 shares of common stock. Certain investors elected to receive Variable Rate Senior Notes (the \"Notes\") totaling $12.6 million. The Notes are due in 2001 and are listed on the NYSE. The Company paid $0.9 million in cash in lieu of issuing promissory notes and $0.5 million in cash in lieu of issuing fractional shares. On February 15, 1996, the Company declared its intent to redeem all of its outstanding Notes at par value, plus accrued interest to the date of redemption. The redemption date is scheduled for March 29, 1996.\nThe Consolidation was accounted for as a reorganization of affiliated entities in a manner similar to a pooling-of- interests. Under this method, the assets and liabilities of the Partnerships were carried over at their historical book values and operations have been recorded on a combined historical cost basis. The pooling-of-interests method of accounting also requires the reporting of the results of operations as though the entities had been combined as of the beginning of the earliest period presented. Accordingly, the results of operations for the year ended December 31, 1994 comprise those of the separate entities combined from the beginning of the period through August 15, 1994 (the date of the Consolidation) and those of the Company from August 16, 1994 through December 31, 1994. Financial information for 1993 has also been restated on a combined basis to provide comparative information.\nIn accordance with the Company's certificate of incorporation and bylaws, the responsibility for the management and control of the Company's operations is vested in its board of directors. Prior to August 18, 1995, the Company's day-to-day affairs were managed by R.I.C. Advisor, Inc. (the \"Advisor\") which provided advice and assistance regarding acquisitions of properties by the Company and performed the day-to-day management of the Company's properties and business. On August 17, 1995, the Advisor was merged with and into Realty Income (the \"Merger\") and the advisory agreement between Realty Income and the Advisor was terminated. Realty Income issued 990,704 shares of common\nstock as consideration for the outstanding common stock of the Advisor. The Advisor held 57,547 shares of common stock of the Company which were retired after the Merger.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nRealty Income was organized for the purpose of operating as an equity REIT which acquires and leases properties and distributes to stockholders, in the form of monthly cash distributions, a substantial portion of its net cash flow generated from lease revenue. The Company intends to retain an appropriate amount of cash as working capital reserves. At December 31, 1995, the Company had cash and cash equivalents totaling $1.65 million.\nCapital Funding\nIn November 1994, Realty Income entered into a $100 million three-year, revolving, unsecured acquisition credit facility. In December 1995, the Company negotiated several modifications to the credit facility including (i) an increase in borrowing capacity to $130 million from $100 million; (ii) a reduction in the interest rate to London Interbank Offered Rate (\"LIBOR\") plus 1.25% from LIBOR plus 1.375%; and (iii) an extension of the credit facility from November 1997 to November 1998. This credit facility has been and is expected to be used to acquire additional retail properties leased to national and regional retail chains under long term lease agreements. As of February 9, 1996, $118 million of borrowing capacity was available to the Company under the acquisition credit facility. As of February 9, 1996, the interest rate on this facility was 6.9%.\nRealty Income expects to meet its long-term capital needs for the acquisition of properties through the issuance of public or private debt or equity. In August 1995, the Company filed a universal shelf registration statement with the Securities and Exchange Commission covering up to $200 million in value of common stock, preferred stock or debt securities. In November and December 1995, the Company issued a total of 2,540,000 shares of common stock at a price of $19.625 per share. The shares were issued pursuant to the registration statement and a related prospectus supplement. The net proceeds of $46.6 million from this offering were used to repay $44.6 million of outstanding borrowings under the acquisition credit facility with the remainder invested in properties.\nThe Company is not currently involved in any negotiations and has not entered into any arrangements relating to any additional securities issuances.\nProperty Acquisitions\nDuring 1995, Realty Income purchased 58 properties in 19 states for $65.4 million. Two of the properties are currently under development. All of the above mentioned properties, including the properties under development, are leased with initial terms of ten to 20 years. The properties were purchased with $12.8 million of cash on hand, $50.6 million from the acquisition credit facility and $2.0 million from the stock offering proceeds. Additional stock offering proceeds of $44.6 million were used to repay the credit facility. The Company invested an additional $288,000 in existing properties.\n(1) The Company acquired these two properties as undeveloped land and is funding construction and other costs relating to the development of the properties by the prospective tenants. The prospective tenants have entered into leases with the Company covering these properties and are contractually obligated to complete construction on a timely basis and to pay construction cost overruns to the extent they exceed the construction budget by more than 5%. As of December 31, 1995, the total acquisition and estimated construction costs for the two development properties was $1.3 million, of which $1.0 million had not been funded.\nDistributions\nCash distributions paid for the years ended December 31, 1995, 1994 and 1993 were $36.7 million, $44.7 million and $40.8 million, respectively. The 1994 distributions were made up of twelve monthly distributions in the aggregate amount of $38.9 million and the final partnership distribution of $5.8 million. The 1994 final partnership distributions were substantially comprised of proceeds from the sales of properties sold during 1993.\nFor the year ended December 31, 1995, the Company paid monthly distributions of $0.15 per share from January through July and increased its monthly distributions to $0.155 per share in August. Monthly distributions of $0.155 per share were paid in August through December 1995. The distributions paid for 1995 totaled $1.825 per share. In December 1995, the Company declared two distributions of $0.155 per share which were paid on January 15 and January 26, 1996 and a special distribution of $0.23 per share which was paid on January 11, 1996. For tax purposes, a portion of the special distribution, in the amount of approximately $0.144 per share, is taxable as ordinary income in 1995 and represents the remaining portion of taxable earnings and profits which were assumed by the Company in the Merger with the Advisor. The remaining amount of approximately $0.086 per share of the special distribution will be included in the 1996 distributions for tax purposes.\nFrom August 15, 1994, the date of the Consolidation, through December 1994, the Company paid monthly distributions of $0.15 per share, totaling $0.60 per share. Prior to the Consolidation on August 15, 1994, the Company did not have equivalent shares outstanding so no comparative per share information is presented.\nAs a result of the Merger on August 17, 1995, the Company assumed a defined benefit pension plan (the \"Plan\") covering substantially all of its employees. The board of directors of the Advisor froze the Plan effective May 31, 1995. For each Plan participant, the accrued benefit earned under the Plan as of May 31, 1995 was frozen. In October 1995, the Company declared its intent to terminate the Plan, and the Plan was terminated on January 2, 1996. As part of the Plan's termination, the Company anticipates meeting its obligation to the Plan of approximately $1.7 million in the second half of 1996.\nManagement believes that the Company's cash provided from operating activities and borrowing capacity are sufficient to meet its liquidity needs for the foreseeable future.\nRESULTS OF OPERATIONS - ---------------------\nPrior to the Consolidation on August 15, 1994, the capital structure of the Partnerships consisted of limited partner interests with no long term debt. In the Consolidation, limited partners exchanged their partnership units for shares of common stock or Notes of the Company. The general partners did not receive any shares or Notes for their general partner interest. Due to these changes in capital structure, which were caused by the Consolidation, and additional expenses associated with the operations of a publicly traded REIT, the results of operations for the years ended December 31, 1995, 1994 and 1993 are not necessarily comparable.\nComparison of 1995 to 1994\nRental revenue was $51.2 million for 1995 versus $47.9 million for 1994. The increase in rental revenue was primarily due to the acquisition of 62 properties from December 1994 through December 1995. These properties generated revenue of $3.8 million in 1995. During 1996, the contractual lease payments (not including any percentage rents) on these properties are approximately $7.8 million.\nSubstantially all the Company's leases provide for increases in rents through base rent increases tied to a consumer price index with adjustment ceilings or overage rent based on a percentage of the tenants' gross sales. Some leases contain both types of clauses. Percentage rent, which is included in rental revenue, was $1.6 million for 1995 as compared to $2.6 million in 1994.\nVacant properties are a factor in determining gross revenue generated and property costs incurred by the Company. At December 31, 1995 and 1994, the Company had four properties that were not under lease. All of the remaining properties were under lease agreements with third party tenants.\nThe significant portion of the remaining revenue earned during 1995 and 1994 was attributable to interest earned on cash invested in two funds which hold short-term investments in United States government agency securities or direct purchases of short- term United States government agency securities. Interest revenue was $0.3 million for 1995 as compared to $0.9 million during 1994. The interest revenue decreased in 1995 due to a reduction of cash held, which was invested in properties.\nThe Company recorded a net gain on the sale of properties during 1995 of $18,000 as compared to $1.2 million for 1994. During 1995 and 1994 cash proceeds generated from these sales were $0.6 million and $3.8 million, respectively. The Company anticipates a small number of property sales will occur in the normal course of business.\nDepreciation and amortization was $14.8 million in 1995 versus $13.8 million in 1994. The increase was primarily due to the depreciation of 62 properties acquired from December 1994 through December 31, 1995 and amortization of goodwill recorded in connection with the Merger of the Advisor in 1995.\nAdvisor fees decreased by $1.7 million to $3.7 million in 1995 as compared to $5.4 million in 1994. On August 17, 1995 the Advisor was merged into the Company. The advisor fees for 1995 were calculated in accordance with the terms of the advisory agreement which became effective August 15, 1994 and was terminated on August 17, 1995. Prior to August 16, 1994, advisor\nfees were calculated in accordance with the terms of the Partnership agreements of the Partnerships.\nGeneral and administrative expenses were $4.8 million in 1995 versus $4.0 million in 1994. The $0.8 million increase in general and administrative expenses was due to a $1.3 million increase in administrative expenses reduced by a $0.5 million decrease in property expenses. The increase in administrative expenses was attributable to costs for management, accounting systems, professional and support personnel and office facilities. Prior to August 17, 1995 these costs were the responsibility of the Advisor. The decline in property expenses during 1995 as compared to 1994 was primarily due to reductions in property taxes, provision for impairment loss and other property costs. Administration expense in 1994 included approximately $0.5 million of one-time expenses primarily associated with the distribution of stock certificates, shareholder informational material and final partnership K-1's to shareholders after the Consolidation had occurred. Other administrative expenses increased in 1995 compared to 1994 due to additional expenses associated with the operation of a publicly traded REIT including, but not limited to, transfer agent fees, NYSE fees, board of directors fees and property acquisition expenses.\nThe Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. No charge was recorded for impairment loss in 1995. In 1994, a $0.1 million charge was made to general and administrative expenses to reduce the net carrying value of one property.\nInterest expense was $2.6 million for 1995 as compared to $0.4 million for 1994. Of the $2.2 million increase, $1.6 million was interest paid on the acquisition credit facility in 1995 and $0.6 million was interest paid on the Notes. During 1995, interest of $0.2 million was capitalized. No interest was capitalized in 1994.\nIn 1994, the Company expensed Consolidation costs aggregating $11.2 million which were nonrecurring costs incurred to effect the Consolidation. In a manner similar to the pooling- of-interests method of accounting, the Consolidation costs were charged to expense upon the consummation of the Consolidation. Such costs included, but were not limited to, fees paid to underwriters, attorneys, and accountants, as well as costs associated with obtaining a fairness opinion, soliciting the stockholders, and registering and listing the common stock and the Notes on the NYSE.\nFor 1995, the Company had net income of $25.6 million versus $15.2 million in 1994. The net income in 1994 was negatively impacted by one time Consolidation costs of $11.2 million. Net income for 1994, excluding the Consolidation costs, was $26.4 million.\nComparison of 1994 to 1993\nRental revenue was $47.9 million for 1994 versus $48.6 million for 1993. The decline in the 1994 rental revenue was mainly due to the sale of four retirement center properties during December 1993. The 1993 rental revenue generated from those properties was $2.4 million. Percentage rent, which is included in rental revenue, was $2.6 million for 1994 as compared to $1.0 million in 1993.\nVacant properties are a factor in determining gross revenue generated and property costs incurred by the Company. At December 31, 1994, the Company had four properties that were not under lease as compared to seven properties at December 31, 1993. All of the remaining properties were under lease agreements with third party tenants.\nThe significant portion of the remaining revenue earned during 1994 and 1993 was attributable to interest earned on cash invested in a fund which holds short-term investments in United States government agency securities or direct purchases of short- term United States government agency securities. Interest revenue was $0.9 million for 1994 as compared to $0.3 million during 1993. The interest revenue increased in 1994 due to the increase in cash from the sale of the four retirement centers as well as an increase in short-term interest rates. In the fourth quarter of 1994, portions of the proceeds from the sale of the retirement properties were distributed to the limited partners, used to pay transaction costs associated with the Consolidation and invested in properties.\nThe Company recorded a gain on the sale of properties during 1994 of $1.2 million as compared to $3.6 million for 1993. During 1994 and 1993 cash proceeds generated from these sales were $3.8 million and $26.5 million, respectively. The Company anticipates a small number of property sales will occur in the normal course of business.\nDepreciation and amortization was $13.8 million in 1994 versus $14.7 million 1993. The decrease in 1994 as compared to 1993 was primarily due to the sale of four retirement center properties during December 1993.\nAdvisor fees increased by $0.3 million to $5.4 million in 1994 as compared to $5.1 million in 1993. The increase in Advisor fees was due to the increase in expense reimbursements to\nthe Advisor primarily associated with cost of living increases in salary and general and administrative expenses. Under the terms of the advisory agreement, which became effective August 15, 1994, the fees with respect to the properties included in the Consolidation were based upon the aggregate of all fees, distributions and reimbursements paid to the general partners of the partnerships merged into the Company during the twelve months ended prior to the closing date of the Consolidation. Prior to August 15, 1994, advisor fees were calculated in accordance with the terms of the Partnership agreements of the Partnerships.\nGeneral and administrative expenses were $4.0 million in 1994 versus $3.5 million in 1993. The $0.5 million increase in general and administrative expenses was due to a $1.1 million increase in administrative expenses reduced by a $0.6 million decrease in property expenses. Of the increase in administrative expenses, approximately $0.5 million was attributable to one-time expenses primarily associated with the distribution of stock certificates, shareholder informational material and final partnership K-1's to shareholders after the Consolidation had occurred. The remainder of the increase was due to additional expenses associated with the operation of a publicly traded REIT. The decline in property expenses during 1994 as compared to 1993 was due to the reduction in the provision for impairment loss. Other property expenses increased due to increases in the cost of living.\nInterest expense was $0.4 million for 1994 as compared to $5,000 for 1993. Of the $0.4 million increase, $0.3 million was interest paid on the Notes. The remainder of the increased interest expense was attributable to short-term borrowings by certain partnerships to finance their portion of the REIT transaction costs prior to the Consolidation and amortization of deferred acquisition credit facility fees.\nIn 1994, the Company expensed Consolidation costs aggregating $11.2 million which were nonrecurring costs incurred to effect the Consolidation. In a manner similar to the pooling- of-interests method of accounting, the Consolidation costs were charged to expense upon the consummation of the Consolidation. Such costs included, but were not limited to, fees paid to underwriters, attorneys, and accountants, as well as costs associated with obtaining a fairness opinion, soliciting the stockholders, and registering and listing the common stock and the Notes on the NYSE.\nFor 1994, the Company had net income of $15.2 million versus $29.3 million in 1993. The net income in 1994 was negatively impacted by one time Consolidation costs of $11.2 million. Net income for 1994, excluding the Consolidation costs, was $26.4 million.\nFUNDS FROM OPERATIONS - ---------------------\nFunds from operations (\"FFO\") for 1995 was $40.4 million versus $39.1 million during 1994 and $40.4 million during 1993. Excluding the one-time cost to disseminate information to investors relating to the Consolidation, the 1994 FFO was approximately $39.6 million. Realty Income defines FFO as net income excluding gains or losses from sales of properties and the one-time expenses of the 1994 Consolidation, plus depreciation and amortization. In accordance with the recommendations of the National Association of Real Estate Investment Trusts (\"NAREIT\"), amortization of deferred financing costs are not added back to net income to calculate FFO. Amortization of financing costs are included in interest expense on the consolidated statements of income.\nManagement considers FFO to be an appropriate measure of the performance of an equity REIT. FFO is used by financial analysts in evaluating REITs and can be one measure of a REIT's ability to make cash distribution payments. Presentation of this information provides the reader with an additional measure to compare the performance of different REITs.\nFFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of the Company's performance or to cash flow from operating, investing, and financing activities as a measure of liquidity or ability to make cash distributions.\nBelow is reconciliation of net income to funds from operations (dollars in thousands):\nIMPACT OF INFLATION - -------------------\nTenant leases generally provide for increases in rent as a result of increases in the tenant's sales volumes or increases in the consumer price index. Management expects that inflation will cause these lease provisions to result in increases in rent over time. However, inflation and increased costs may have an adverse impact on the tenants if increases in the tenant's operating expenses exceed increases in revenues. Over 97% of the properties are leased to tenants under triple-net leases in which the tenant is responsible for substantially all property costs and expenses. These features in the leases reduce the Company's exposure to rising expenses due to inflation.\nIMPACT OF NEW ACCOUNTING PRONOUNCEMENTS - ---------------------------------------\nStatement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and of Long- Lived Assets to Be Disposed Of\" (\"Statement 121\") was issued in March 1995. Statement 121 provides guidance for recognition and measurement of impairment of long-lived assets, certain identifiable intangibles and goodwill related both to assets to be held and used and assets to be disposed of. Statement 121 is effective for financial statements issued for fiscal years beginning after December 15, 1995.\nThe Company's existing accounting policies comply with Statement 121 and therefore implementing Statement 121 is not expected to have a material effect on the Company's financial position or results of operations.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"Statement 123\") was issued in October 1995. Statement 123 established the fair value based method of accounting for stock-based compensation arrangements, under which compensation cost is determined using the fair value of the stock options at the grant date and the number of options vested, and is recognized over the periods in which the related services are rendered. Statement 123 is effective for fiscal years beginning after December 15, 1995.\nIf the Company were to retain its current intrinsic value based method, as allowed by Statement 123, it will be required to disclose the pro forma effect of adopting the fair value based method. To date, the Company has not made a decision to adopt the fair value based method.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nTable of Contents Page ================= ======\nA. Independent Auditors' Report........................... 40\nB. Consolidated Balance Sheets, December 31, 1995 and 1994........................... 41-42\nC. Consolidated Statements of Income, Years ended December 31, 1995, 1994 and 1993......... 43\nD. Consolidated Statements of Stockholders' Equity, Years ended December 31, 1995, 1994 and 1993......... 44-46\nE. Consolidated Statements of Cash Flows, Years ended December 31, 1995, 1994 and 1993......... 47-48\nF. Notes to Consolidated Financial Statements............. 49-60\nG. Consolidated Quarterly Financial Data (unaudited) for 1995 and 1994........................ 61\nH. Schedule III-Real Estate and Accumulated Depreciation.........................................62-183\nSchedules not Filed: All schedules, other than that indicated in the Table of Contents, have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders Realty Income Corporation:\nWe have audited the consolidated financial statements (Note 1) of Realty Income Corporation and subsidiaries as listed in the accompanying table of contents. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule III listed in the accompanying table of contents. 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 Realty Income 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 III, 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 Diego, California January 26, 1996, except as to Note 5B to the consolidated financial statements, which is as of February 15, 1996\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.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nFor supplemental disclosure of noncash investing and financing activities, see Note 9.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nREALTY INCOME CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements ========================================== December 31, 1995, 1994 and 1993\n1. Organization and Operation\nRealty Income Corporation (the \"Company\") was organized in the state of Delaware on September 9, 1993 to facilitate the merger, which was effected on August 15, 1994 (the \"Consolidation\"), of 10 private and 15 public real estate limited partnerships (the \"Partnerships\") with and into the Company. The Company invests in commercial real estate and has elected to be taxed as a real estate investment trust (\"REIT\").\nInvestors in the Partnerships who elected to invest in the Company received common stock of the Company totaling 19,503,080 shares. Certain investors elected to receive Variable Rate Senior Notes (the \"Notes\") totaling $12.6 million.\nThe Consolidation was accounted for as a reorganization of affiliated entities under common control in a manner similar to a pooling-of-interests. Under this method, the assets and liabilities of the Partnerships were carried over at their historical book values and their operations have been recorded on a combined historical cost basis. The pooling-of-interests method of accounting also requires the reporting of the results of operations as though the entities had been combined as of the beginning of the earliest period presented. Accordingly, the results of operations for the year ended December 31, 1994 comprise those of the separate entities combined from January 1, 1994 through August 15, 1994 and those of the Company from August 16, 1994 through December 31, 1994. Financial information for 1993 has also been restated on a combined basis to provide comparative information. Costs incurred to effect the Consolidation and integrate the continuing operations of the separate entities were expenses of the Company in the period the Consolidation was consummated. These expenses include all costs and expenses incurred in structuring and consummating the Consolidation. Such costs included, but were not limited to, fees paid to underwriters, attorneys, and accountants, as well as costs associated with obtaining a fairness opinion, soliciting the shareholders, and registering and listing the common stock and the Notes on the New York Stock Exchange. Prior to the Consolidation, the Company had no significant operations; therefore, the combined operations for the periods prior to the Consolidation represent the operations of the Partnerships. The Consolidation did not require any material adjustments to conform the accounting policies of the separate entities to that of the Company. All intercompany transactions and balances have been eliminated.\n1. Organization and Operation (continued)\nThe results of operations of the previously separate entities for the periods before the Consolidation was consummated that are included in the results of operations for the years ended December 31, 1994 and 1993 follow:\n2. Summary of Significant Accounting Policies\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and partnerships more than 50 percent owned (subsidiaries) after elimination of all material intercompany balances and transactions.\nCash and Cash Equivalents - The Company considers all short- term, highly liquid investments that are readily convertible to cash and have an original maturity of three months or less at the time of purchase to be cash equivalents.\nDepreciation and Amortization - Depreciation of buildings and improvements and amortization of goodwill are computed using the straight-line method over an estimated useful life of approximately 25 years.\nLeases - All leases are accounted for as operating leases. Under this method, lease payments are recognized as revenue over the term of the lease on a straight line basis.\nIncome Taxes - Prior to the Consolidation, the Company's operations were conducted through private and public real estate limited partnerships. In accordance with partnership taxation, each partner was responsible for reporting its share of taxable income. Accordingly, no federal income tax provision has been made in the accompanying consolidated financial statements prior to August 16, 1994.\nAfter August 15, 1994, the Company elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. Management believes the Company has qualified and continues to qualify as a REIT and therefore will be permitted to deduct distributions paid to its stockholders, eliminating the federal taxation of income represented by such distributions at the Company's level. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements for the period August 16, 1994 through December 31, 1994 and the year ended December 31, 1995.\nDistributions Paid and Payable - For the year ended December 31, 1995, cash distributions of $1.825 per share were paid. As of December 31, 1995, three distributions totaling $0.54 per share were declared and payable. In 1995, distributions of $1.876 per share are taxable as ordinary income and $0.093 per share was a return of capital. A portion of the distributions payable at December 31, 1995, in the amount of $0.144 per share, is included in the $1.876 per share taxable as ordinary income and represents the remaining portion of taxable earnings and profits which were assumed by the Company in the merger with R.I.C. Advisor, Inc. (the \"Advisor\"). For the period\n2. Summary of Significant Accounting Policies (continued)\nAugust 16, 1994 through December 31, 1994, cash distributions of $0.60 per share were paid and are taxable as ordinary income.\nProvision for Impairment Loss - The Company reviews long- lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Provision is made for impairment loss if estimated future operating cash flows (undiscounted and without interest charges) over a long-term holding period plus estimated disposition proceeds (undiscounted) are less than the current book value. There was no provision for the year ended December 31, 1995. For the years ended December 31, 1994 and 1993, a provision of $135,000 and $935,000, respectively, was charged to operations to reduce the net carrying value of three investment properties.\nNet Income Per Share - Net income per share for 1995 was calculated based upon the weighted average number of shares outstanding during the year. Net income per share for 1994 was calculated assuming 19,502,091 shares of the Company's common stock were outstanding. Prior to the Consolidation, no shares of common stock were outstanding. Due to the change in the capital structure resulting from the Consolidation, the net income per share information for the year ended December 31, 1993 would not be meaningful and has not been included.\nReclassifications - Certain of the 1994 and 1993 balances have been reclassified to conform to 1995 presentation. The reclassifications had no effect on stockholders' equity or net income.\nEstimates - Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\n3. The Merger of R.I.C. Advisor, Inc.\nOn August 17, 1995, the Company merged with the Advisor and issued 990,704 shares of the Company's common stock valued at approximately $21.2 million (the \"Merger\"). The Merger was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired based on their estimated fair values. This treatment resulted in approximately $22.9 million of goodwill. Amortization of goodwill for the year ended December 31, 1995 was $340,000.\n3. The Merger of R.I.C. Advisor, Inc. (continued)\nThe following unaudited pro forma summary presents information as if the Merger had occurred at the beginning of each period presented. The pro forma information is provided for information 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 company. The Advisor had several non-recurring expenses during 1995 and 1994 which negatively impacted net income and net income per share.\n4. Credit Facility Available for Acquisitions\nIn November 1994, the Company obtained a $100 million, three-year, revolving, unsecured acquisition credit facility from The Bank of New York, as agent, and several major U.S. and non- U.S. banks. In December 1995, the credit facility was modified to (i) increase the borrowing capacity to $130 million from $100 million; (ii) reduce the interest rate to London Interbank Offered Rate (\"LIBOR\") plus 1.25% from LIBOR plus 1.375%; and (iii) extend the credit facility from November 1997 to November 1998.\nThe credit facility is subject to various leverage and interest coverage ratio limitations, all of which the Company was in compliance with as of December 31, 1995 and 1994. As of December 31, 1995 and 1994, the outstanding balance on the credit facility was $6 million and $0, respectively. The effective interest rate at December 31, 1995 was 7.19%. A commitment fee of 0.35% or less, per annum, accrues on the average amount of the unused available credit commitment.\nInterest of $217,000 was capitalized on properties under construction in 1995. No interest was capitalized in 1994.\n5. Notes Payable\nA. In connection with the Consolidation, certain investors elected to receive Notes totaling $12.6 million. The Notes mature on June 30, 2001, and the interest rate is adjusted quarterly. Interest payments are due quarterly and principal is due at maturity. Interest incurred for the years ended December 31, 1995 and 1994 was $997,000 and $332,000, respectively. The interest rate on the Notes at December 31, 1995 and 1994, was 7.44% and 6.94%, respectively. On January 2, 1996 the interest rate adjusted to 7.13%.\nB. On February 15, 1996, the Company announced its plan to redeem all of its outstanding Notes. The Notes will be redeemed at par plus accrued interest to the date of redemption. The redemption date is scheduled for March 29, 1996.\n6. Operating Leases\nA. General\nAt December 31, 1995, the Company owned 685 properties in 42 states. Of the Company's properties, 675 are single-tenant locations and the remainder are multi-tenant. At December 31, 1995, four single-tenant properties were vacant and available for lease.\nSubstantially all leases are triple-net leases whereby the tenant 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 Company's leases are primarily for initial terms of 15 to 20 years and provide for cost of living increases and\/or increased rent based upon a percentage of the tenant's sales. Percentage rent for 1995, 1994 and 1993 was $1.6 million, $2.6 million and $1.0 million respectively.\n6. Operating Leases (continued)\nMinimum annual rents to be received on the operating leases as of December 31, 1995 are as follows (dollars in thousands):\nB. Major Tenants\nThe following schedule presents rental income, including percentage rents, from tenants representing more than 10% of the Company's total revenue for at least one of the years ended December 31, 1995, 1994 or 1993 (dollars in thousands):\n7. Net Gain on Sales of Properties\nIn 1995, the Company sold three properties for a total of $617,000 and recognized a net gain of $18,000. In 1994, the Company sold five properties and had three land easement transactions for a total of $3.8 million and recognized a net gain of $1.2 million. In 1993, the Company sold six properties, exchanged one property and had seven land easement transactions for a total of $26.5 million and recognized a net gain of $3.6 million.\n8. Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires that the Company disclose estimated fair values for its financial instruments, as well as the methods and significant assumptions used to estimate fair values. Management of the Company believes that the carrying values reflected in the balance sheets at December 31, 1995 and 1994 reasonably approximate the fair values for cash and cash equivalents, accounts receivable, due from affiliates and all liabilities. In making such assessments, the Company utilized estimates and quoted market prices.\n9. Supplemental Disclosure of Cash Flow Information\nInterest paid during 1995, 1994 and 1993 was $2,186,000, $354,000 and $5,000, respectively.\nThe following non-cash investing and financing activities are included in the accompanying financial statements:\nA. Distributions payable totaled $12.4 million and $2.9 million at December 31, 1995 and 1994, respectively.\nB. The Merger of the Advisor into the Company on August 17, 1995 resulted in the following:\nIn 1995, other assets of $95,000 were reclassified to goodwill. Common stock retired after the Merger includes par value of common stock and capital in excess of par value of $58,000 and $1,172,000, respectively.\n9. Supplemental Disclosure of Cash Flow Information (continued)\nC. In 1995, the following increases (decreases) occurred resulting from exchanges of Notes Payable for Common Stock (dollars in thousands):\nNotes Payable $ (19) Common Stock 1 Capital in Excess of Par Value 19\nD. In 1995, pursuant to the assumption of the defined benefit pension plan by the Company (Note 11), the Company recorded a due from affiliate and a liability (included in other liabilities) of $493,000. This represents the amount of the increase in the liability to the plan, of which the Company is indemnified by the former shareholders of the Advisor.\nE. In 1994, the following increases occurred resulting from exchanges of limited partnership units for Notes payable and Common Stock (dollars in thousands):\nNotes Payable $ 12,616 Common Stock 19,502 Capital in Excess of Par Value 452,996\nF. In October 1993, the Company regained possession of a property through foreclosure. The Company held a note on the property with a net balance of $1.5 million.\n10. Related Party Transactions\nA. Advisory Agreement\nIn August 1994, in connection with the Consolidation, the Company entered into an advisory agreement under which R.I.C. Advisor, Inc. advised the Company with respect to its investments and assumed day-to-day management of the Company (the \"Advisory Agreement\"). The Advisory Agreement provided for a monthly advisor fee equal to 0.1189% of the appraised value of the real estate properties as of the Consolidation date plus the current book value of the non-real estate assets of the Company. Amounts incurred under the Advisory Agreement for the period from January 1, 1995 through August 17, 1995 and August 15, 1994 through December 31, 1994 were $3.7 million and $2.2 million, respectively. Prior to the Consolidation, the general partners of the Partnerships received management fees and reimbursements from the Partnerships (Note 10B). On August 17, 1995, the Advisor was merged into the Company (Note 3). As part of the Merger, the Advisory Agreement was terminated.\n10. Related Party Transactions (continued)\nB. Related Party Transactions Prior to the Consolidation\nCash Distributions - The Advisor and William E. and Evelyn J. Clark, the former general partners of the Partnerships, collectively, received approximately 1.0% of the Partnerships' distributions. For the period from January 1, 1994 through August 15, 1994 and the year ended December 31, 1993, the general partners' distributions totaled $342,000 and $436,000, respectively.\nManagement Fees - The Advisor received management fees of approximately 1.5% of gross receipts of the Partnerships. For the period from January 1, 1994 through August 15, 1994 and the year ended December 31, 1993, management fees totaled $432,000 and $762,000, respectively.\nAdministrative Expenses - The Advisor received reimbursements for personnel and overhead costs incurred to administer the operations of the Partnerships. For the period from January 1, 1994 through August 15, 1994 and the year ended December 31, 1993, reimbursements totaled $2.8 million and $4.3 million, respectively.\nThe administrative expenses and management fees described in the preceding paragraphs are included in advisor fees in the accompanying consolidated statements of income.\n11. Employee Benefit Plan\nAs a result of the Merger on August 17, 1995, the Company assumed a defined benefit pension plan (the \"Plan\") covering substantially all of its employees. The Plan's benefit formulas generally based payments to retired employees upon their length of service and a percentage of qualifying compensation during the final years of employment. The Company's funding policy was to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding standards. The Plan did not provide for funding of prior service costs.\nThe board of directors of the Advisor froze the Plan effective May 31, 1995. No additional employees were entitled to enter the Plan after May 31, 1995. For each Plan participant, the accrued benefit earned under the Plan was frozen as of May 31, 1995. In October 1995, the Company declared its intent to terminate the Plan, and the Plan was terminated on January 2, 1996.\n11. Employee Benefit Plan (continued)\nThe following table sets forth the Plan's funded status and amounts recognized in the Company's financial statements as of December 31, 1995 (dollars in thousands):\nActuarial Present Value of Benefit Obligations: Accumulated Benefit Obligation, All Vested $(7,526) Plan Assets at Fair Value, Primarily Listed Stock and Cash and Cash Equivalents 5,319 ------- Benefit Obligation in Excess of Plan Assets (Included in Other Liabilities) $(2,207) =======\nAssumptions Used: Discount Rates 6.0% Rates of Increase in Compensation Levels N\/A Expected Long-Term Rates of Return on Assets 8.0%\nAt December 31, 1995, the benefit obligation in excess of plan assets is included in other liabilities in the accompanying balance sheet. In connection with the Merger, the Company assumed a benefit obligation of $1,714,000. The Merger agreement provides for indemnification by the former shareholders of the Advisor with respect to increases in the benefit obligation. Pursuant to the Merger agreement, an escrow was established to satisfy certain contingencies, including any potential increases in the benefit obligation. Therefore, a receivable from the Advisor's former shareholders has been recorded for $493,000, and is included as due from affiliates in the accompanying consolidated balance sheets as of December 31, 1995.\n12. Stock Incentive Plan\nOn September 9, 1993, the board of directors and the original stockholder of the Company approved a stock incentive plan (the \"Stock Plan\") designed to attract and retain directors, officers and employees of the Company by enabling such individuals to participate in the ownership of the Company. The Stock Plan provides for the award (subject to ownership limitations) of a broad variety of stock-based compensation alternatives such as nonqualified stock options, incentive stock options, restricted stock and performance awards.\nIn August 1994, options were granted to each of the three independent directors to purchase 10,000 shares of the Company's stock at an exercise price of $20 per share (the estimated value of the shares at the date of grant). These options vest during the directors' continued service periods at a rate of 2,500 shares per year. At December 31, 1995, options to acquire 7,500 shares were vested.\n13. Commitments and Contingencies\nAs of December 31, 1995, the Company had entered into agreements with unrelated parties to acquire two properties to be purchased under sale\/leaseback agreements for an estimated aggregate amount of $2.3 million and to fund two buildings under construction on land owned by the Company for an estimated aggregate amount of $1.3 million.\nIn the ordinary course of its business, the Company is a party to various legal actions which the Company believes are routine in nature and incidental to the operation of the business of the Company. The Company believes that the outcome of the proceedings will not have a material adverse effect upon its operations or financial condition.\n(1) The Consolidation costs expensed in the third quarter of 1994 represent the costs of the Consolidation of the Company and 25 private and public partnerships on August 15, 1994. The Consolidation was accounted for in a manner similar to a pooling- of-interests.\nREALTY INCOME CORPORATION AND SUBSIDIARIES SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nNote 1. Six hundred eighty two of the properties are single unit retail outlets. Trade Center, Silverton Business Center and Empire Business Center properties are multi-tenant commercial properties. All properties were acquired on an all cash basis, no encumbrances were outstanding for the periods presented.\nNote 2. The aggregate cost for federal income tax purposes is $446,365,567.\nNote 3. Reconciliation of total real estate carrying value for the three years ended December 31, 1995 are as follows:\nContinued REALTY INCOME CORPORATION AND SUBSIDIARIES SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nNote 4. Reconciliation of accumulated depreciation for the three years ended December 31, 1995 are as follows:\nNote 5. Provision is made for impairment loss if estimated undiscounted future cash flow over a long term holding period plus estimated undiscounted disposition value is less than current book value. A provision for impairment loss was made on the Stone Meadow Center in Spring, TX and the Artesian Center in Humble, TX in 1993 and on the Automall property in Mesa, AZ in 1994 and 1993.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ---------------------------------------------------------\nThe corporation has had no disagreements with its independent auditors' on accountancy or financial disclosure.\nPART III ========\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nThis item is incorporated by reference from the definitive proxy statement for the Annual Meeting of Shareholders presently scheduled to be held on May 14, 1996, to be filed pursuant to Regulation 14A.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION - --------------------------------\nThis item is incorporated by reference from the definitive proxy statement for the Annual Meeting of Shareholders presently scheduled to be held on May 14, 1996, to be filed pursuant to Regulation 14A.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------------------------------------------------------------\nThis item is incorporated by reference from the definitive proxy statement for the Annual Meeting of Shareholders presently scheduled to be held on May 14, 1996, to be filed pursuant to Regulation 14A.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nThis item is incorporated by reference from the definitive proxy statement for the Annual Meeting of Shareholders presently scheduled to be held on May 14, 1996, 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 - ----------------------------------------------------------------\nA. The following documents are filed as part of this report.\n1. Financial Statements (see Item 8)\na. Independent Auditors' Report\nb. Consolidated Balance Sheets, December 31, 1995 and 1994\nc. Consolidated Statements of Income, Years ended December 31, 1995, 1994 and 1993\nd. Consolidated Statements of Stockholders' Equity, Years ended December 31, 1995, 1994 and 1993\ne. Consolidated Statements of Cash Flows, Years ended December 31, 1995, 1994 and 1993\nf. Notes to Consolidated Financial Statements\ng. Consolidated Quarterly Financial Data (unaudited) for 1995 and 1994\n2. Financial Statement Schedule (see Item 8)\nSchedule III - Real Estate and Accumulated Depreciation\nSchedules not Filed: All schedules, other than those indicated in the Table of Contents, have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\n3. Exhibits\n2.1 Agreement and Plan of Merger between Realty Income Corporation and R.I.C. Advisor, Inc. dated as of April 28, 1995 (incorporated by reference to Appendix A to the Company's definitive Proxy Statement filed June 30, 1995)\n3.1 Amended and Restated Certificate of Incorporation of Realty Income Corporation (filed as Exhibit 3.1 to the Company's 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference)\n3.2 Amended and Restated Bylaws of Realty Income Corporation (filed as Exhibit 3.2 to the Company's 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference)\n4.1 Indenture between the Company and Chemical Trust Company as Trustee, including the Variable Rate Senior Note Due 2001 (filed as Exhibit 4.05 to the Company's Registration Statement on Form S-4 (Registration No. 33-69410) and incorporated herein by reference)\n4.2 Form of Note (attached as Exhibit A to Exhibit 4.1 above)\n4.3 Form of Stock Certificate (filed as Exhibit 4.04 to the Company's Registration Statement on S-4 (Registration Statement No. 33-69410) and incorporated herein by reference)\n4.4 Form of Indenture (filed as Exhibit 4.3 to the Company's Registration Statement on Form S-3 (Registration No. 33-95374) and incorporated herein by reference)\n4.5 Form of Debt Security (filed and included as Exhibit 4.3 to the Company's Registration Statement on Form S-3 (Registration No. 33-95374) and incorporated herein by reference)\n10.1 Revolving Credit Agreement (filed as Exhibit 99.2 to the Company's 8-K dated December 16, 1994 and incorporated herein by reference)\n10.2 Stock Incentive Plan (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (Registration No. 33-95708) and incorporated by reference)\n21.1 Subsidiaries of the Company as of January 1, 1996, filed herewith\n24.1 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule (electronically filed with the Securities and Exchange Commission only)\nB. Four reports on Form 8-K were filed by registrant during the last quarter of the period covered by this report. The reports were dated September 29, 1995; October 30, 1995; October 31, 1995 and December 19, 1995.\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.\nREALTY INCOME CORPORATION\nBy: \/s\/ William E. Clark ----------------------------------------------------------- William E. Clark Chairman and Chief Executive Officer\nDate: March 19, 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.\nBy: \/s\/ William E. Clark ----------------------------------------------------------- William E. Clark Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)\nDate: March 19, 1996\nBy: \/s\/ Thomas A. Lewis ----------------------------------------------------------- Thomas A. Lewis Vice Chairman of the Board of Directors and Vice President, Capital Markets\nDate: March 19, 1996\nSIGNATURES (continued)\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\/ Donald R. Cameron ----------------------------------------------------------- Donald R. Cameron Director\nDate: March 19, 1996\nBy: \/s\/ Roger P. Kuppinger ----------------------------------------------------------- Roger P. Kuppinger Director\nDate: March 19, 1996\nBy: \/s\/ Michael D. McKee ----------------------------------------------------------- Michael D. McKee Director\nDate: March 19, 1996\nBy: \/s\/ Gary Malino ----------------------------------------------------------- Gary Malino Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)\nDate: March 19, 1996\nBy: \/s\/ Gregory J. Fahey ----------------------------------------------------------- Gregory J. Fahey Controller\nDate: March 19, 1996","section_15":""}
{"filename":"20975_1995.txt","cik":"20975","year":"1995","section_1":"Item 1. Business (continued): - -------- ---------------------- Financing and Leverage: - -----------------------\nThe Trust believes that the use of borrowed funds in purchasing properties can help to maximize the Trust's investments. As of September 30, 1995 two of the Trust's investments were leveraged with long-term non-recourse individual mortgage financing and one property was leveraged with a $2,146,000 loan of which the first $750,000 is recourse and the balance is non-recourse. As of September 30, 1995 six of the Trust's remaining improved properties served as collateral for the Trust's bank notes payable. See Note E of the Notes to the Financial Statements presented in Part II, Item 8 of this report.\nEffective November 30, 1994 the Trust and two banks, National City Bank of Cleveland (\"NCB\") and Manufacturer's and Traders Trust Company of Buffalo (\"M & T\") signed a revolving line of credit agreement for up to $25,000,000 (but is limited by the value of the collateral provided). Of this amount a maximum of $15,000,000 is currently available and $10,000,000 will be available at the Trust's discretion upon payment of an activation fee of 3\/4 of 1% on the $10,000,000. This loan is for an initial term of three years. The banks will review the loan annually, and if satisfied, they will extend the loan for an additional year at that time. Therefore, the Trust will have an annually renewed three year loan or two years in which to replace the loan. At the Trust's option interest on any loan will be at any of the following rates (i) the prime lending rate plus 1\/4 of 1%; (ii) 250 basis points over the LIBOR rate; or (iii) NCB's fixed rate of interest in effect from time to time. It is the Trust's present intention to use this revolving line to finance the purchase of suburban office buildings and invest in real estate companies' securities.\nReal Estate Market Conditions: - ------------------------------\nInvestments in real estate equities tend to be long term investments, and accordingly, tend to limit the ability of the Trust to vary its portfolio of real estate owned promptly in response to changing economic, financial and investment conditions, such as overbuilding in certain markets and the resulting intense competition for tenants. Although the Trust requires leases from all tenants occupying space in its properties, in the event of a default by a tenant, the Trust may modify the lease terms or evict the tenant. Tenant evictions result in increased expenses and the possibility of lost rents until the space is re-leased.\nIt should be noted that the largest tenant occupying space in any of the Trust's Properties currently pays rent totaling $974,000 or 9.5% of the Trust's 1995 revenues. This tenant has a lease which matures September 30, 2005 but the lease contains six 10-year option provisions at the tenant's discretion which, if exercised, would extend the maturity date to September 30, 2065. The rent paid by this tenant is subject to an annual adjustment based on the increase or decrease in operating expenses of the property.\nThe Trust, in order to remain competitive, leases space at its properties at rates which are dictated by the market in which the property exists. The market rates, which are quoted to both new tenants and tenants who are renewing their leases, were at their highest levels in the early 1980's. These rates began to decline at most of the properties in 1984 and continued to decline through 1988. At that time, the market rates at all of the Trust's properties were at their lowest levels. Since 1989, the market rates have tended to increase. In 1995 the market rates at the majority of the properties were higher than those in 1988 but have not returned to the high rates that existed in 1983. The Trust is encouraged by the current trends in rates. Additionally, the majority of leases at the Properties include provisions for the tenant to pay additional rent if operating expenses of the property increase.\nPART I -------\nItem 1. Business (continued): - ------- --------------------- Taxation: - ---------\nThrough fiscal 1992 the Trust operated so as to qualify as a real estate investment trust (a \"REIT\") as defined by Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). Effective April 1, 1993 the Trust automatically failed to qualify as a REIT under the Code as on such date more than 50% in value of the Trust's shares (after the application of certain constructive ownership rules) were owned by five or fewer individuals.\nAlthough the Trustees had the right pursuant to Section 8.5 of the Declaration of Trust to prevent the transfer, and\/or call for the redemption of, securities of the Trust sufficient in the opinion of the Trustees to meet requirements for REIT status, the Trustees in their discretion determined that maximizing proceeds from the December 1992 rights offering (the \"1992 Rights Offering\") outweighed the benefits of REIT status. The primary impact on the Trust as a result of the failure to qualify as a REIT is that the Trust is now required to file its federal and state income tax returns as a corporation and is subject to taxation as a corporation. As a result, distributions to shareholders will be subject to double taxation to the extent of current and accumulated earnings and profits of the Trust. Additionally, the Trust will not be able to re-qualify as a REIT until fiscal year 1998. Loss of REIT status should not have a materially adverse tax effect on the shareholders because as of September 30, 1995 the Trust has net operating loss carry forwards (NOL's) of approximately $6.4 million available to offset taxable income. As the Trust has failed to qualify as a REIT as a result of five or fewer individuals acquiring 50% or more in value of the Trust's Shares, the Trust is also subject to Section 382 of the Code which limits the amount of NOL's available to the Trust on an annual basis. In future years, the Trust can use approximately $298,000 per year of NOL's plus any prior year's unused portion (limited by carryforward periods) for NOL's generated prior to December, 28, 1992. The Trust can also use NOL carryforwards generated after December 28, 1992. These carryforwards of approximately $5.4 million expire through 2009. The remaining carryforwards of $1.0 million may be recognized for a period through fiscal 1998 against gains on sales of properties, if any, to the extent that fair market values of these properties exceeded their tax bases as of December 28, 1992.\nCompetition and Limited Resources: - ----------------------------------\nThe Trust's Properties will be subject to competition from similar types of properties in the vicinities in which they are located. The areas in which the Trust intends to acquire properties have experienced a softening of their real estate markets. This is due in part to overbuilding, slower growth in certain local economics, and a decline in the energy industry which causes increased competition for tenants. Such increased competition is continuing and may adversely affect the ability of the Trust to renew existing leases as they expire or to attract new tenants for vacant space. Such competition will have an adverse effect on the levels of rents which the Trust will be able to realize on new leases and has had an adverse effect on property values in the markets being targeted by the Trust.\nThe Trust is relatively small in comparison to many of its competitors. This size limits the Trust's resources and may limit its ability to compete effectively in the geographic markets in which it focuses. Also, the Trust's relative size limits its ability to diversify its portfolio selections, which may also limit its ability to compete effectively.\nPART I -------\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 . Properties. - ------- -----------\nGeneral: - --------\nAt September 30, 1995 the Trust had a total invested assets of $41,245,000. The invested assets included $40,942,000 of investments in real estate and $303,000 of real estate mortgage loans.\nThe Trust's $40,942,000 of investments in real estate as of September 30, 1995 included the following: seven office buildings with a carrying value of $20,751,000; six commercial properties with a carrying value of $19,941,000; three single family units with a carrying value of $47,000; and one investment in land with a carrying value of $203,000. Carrying value represents amounts included in the Trust's Statement of Financial Condition as of September 30, 1995 after depreciation. Although Management will from time to time undertake a major renovation of a Property in order to keep it competitive within its market, at this time Management has no plans for a major renovation of any of its Properties. During fiscal 1994 and 1995, the Petroleum Club Building located in Tulsa, Oklahoma underwent major reconstruction and repair work as a result of a fire which occurred in January, 1994. The Trust and its insurance company agreed to a settlement for the repair of the property in July, 1994. All repairs and building improvements were paid for from the insurance proceeds.\nIn the opinion of Management, all Properties in the Trust's portfolio are adequately covered by insurance. Additionally, all properties are suitable and adequate for their intended use.\nThe amount of leverage varies among the Properties which the Trust presently owns. At September 30, 1995 two of the Trust's Properties were leveraged with long-term non-recourse individual mortgage financing and one property is leveraged with a $2,146,000 loan of which the first $750,000 is recourse and the balance is non-recourse. Additionally, as of September 30, 1995 six of the Trust's remaining investments serve as collateral for the Trust's bank notes payable.\nAt September 30, 1995 the Trust owned two real estate mortgage loans with a total balance of $303,000. Both loans are purchase money mortgages received by the Trust in connection with sales of vacant land in Akron, Ohio. The first was a $290,000 loan received in connection with the $834,000 March, 1994 sale of 70 acres. The second was a $212,000 loan received in connection with the $212,000 May, 1994 sale of 17.7697 acres.\nPART I ------\nItem 2. Properties (Continued): - ------ -----------------------\nInvestments in Real Estate: - ---------------------------\nThe following table analyzes the investments in real estate as of September 30, 1995 by type of property.\nPART I -------\nItem 2. Properties (Continued): - ------ -----------------------\nInvestments in Real Estate: (Continued): - -----------------------------------------\n(A) At September 30, 1995 the Trust had 512 tenants under lease in its office buildings, shopping centers and retail centers (excluding the mini warehouses at Triangle Square). These tenants are under leases of one year or more. Additionally, the Trust had 168 month-to-month leases for mini-warehouse spaces at Triangle Square.\n(B) The following lists individually those tenants who occupy 10,000 square feet or more, and whose original lease terms expire five years or more from September 30, 1995. Eleven (11) other tenants who occupy less than 10,000 square feet and have leases which expire five years or more from September 30, 1995 are grouped together and shown as Others on the table below:\n* Leases marked with an asterisk have additional rent provisions to be paid based on a percentage of the gross sales over a base sales figure.\nAll leases listed on the table are subject to an annual adjustment in rent based on the increase or decrease in the operating expenses of the Property.\nThe annual base rents of the tenants listed in the table equal 28% of the total 1995 rental income, and these tenants occupy 386,000 square feet (33%) of the total 1,178,000 square feet currently occupied. The remaining 792,000 square feet are occupied by 491 tenants. These tenants' leases expire during the next five years. The loss of rentals from any one of these leases, which the Trust would not be able to renew or replace, would not have a significant effect on the Trust's operations.\n(C) The following is a list of those tenants who occupy 50% or more of a Property:\nEnglewood Bank Building -- Bank One, Denver -- 108,000 sq. ft. (83%) Littleton Bank Building -- Norwest -- 35,000 sq. ft. (61%)\nPART I -------\nItem 2. Properties (Continued): - ------ -----------------------\nInvestments in Real Estate: (Continued): - -----------------------------------------\n(D) The Trust owns the improvements subject to a ground lease which expires January 31, 2024. The Trust has four, eleven year options to extend the ground lease. The current lease rent is $105,545 per year. The rent can be increased to 7 1\/2 % of the land value, not to exceed 110% of the previous year's rent. This increase is allowed every ten years. The next time an increase could be made is 2002. At the end of the lease and any extension exercised, the improvements become the property of the land owner, Bank One, Denver, which is a tenant in the building. In September, 1995 the Trust and Bank One executed an Option Purchase Agreement. The Trust has paid Bank One an Option Deposit of $40,000 which gives the Trust the option to purchase the land under lease for a purchase price of $1,260,000. The Trust currently anticipate that the closing of the purchase will take place around February 1, 1996.\n(E) The Trust owns the improvements subject to a ground lease which expires December 31, 2026. The lease rent is $10 per year through 2006, $26,000 per year for the years 2007 through 2016 and $30,000 per year for the years 2017 through 2026. At the end of the lease, the improvements become the property of the land owner, Norwest, which is a tenant in the building.\n(F) Office Alpha. Office Alpha is located in the North-Dallas LBJ-East office market of Dallas, Texas. Office Alpha contains five stories and is suitable and adequate for its use as an office building.\nSpace in the building is leased to service and professional organizations for use as general offices. The Trust's policy is to sign leases with new and renewal tenants for periods of three to five years in order to take advantage of changes in the market.\nPresently, the Trust has no plans for any significant renovations of the Property beyond normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nThere are numerous office buildings in the direct vicinity, some of higher quality, and numerous projects of similar age, style, condition and quality that directly compete with Office Alpha. Leasing proposals for both new and renewal tenants in this submarket are highly competitive. Many of the Trust's competitors in this submarket have substantially greater capital and resources than the Trust.\nOccupancy for the fiscal years ended September 30, 1991 through 1995 was as follows: 91% for 1991, 73% for 1992, 84% for 1993, 83% for 1994 and 91% for 1995. The Property's average rental rates per occupied square foot for the same period were: $9.95 in 1991, $9.61 in 1992, $8.91 in 1993, $9.00 in 1994 and $9.52 in 1995.\nAt September 30, 1995 Jewish Family Services of Dallas, Inc., a non-profit organization which performs social services primarily for the Jewish community in Dallas, was the only tenant occupying 10% or more of the space in Office Alpha. This tenant's annual rent is $96,000. Its lease expires September 30, 1996.\nPART I -------\nItem 2. Properties (Continued): - ------- -----------------------\nInvestments in Real Estate: (Continued) - ----------------------------------------\nBased upon leases in place at September 30, 1995 lease expirations for the next ten fiscal years ended September 30, 2005 are as follows:\nOffice Alpha is depreciated for tax purposes using the straight line basis with the building and improvements having a 15 year life. The depreciable tax basis was $2,261,000 at September 30, 1995. The 1994 real estate taxes for the Property were $94,960 based on a millage rate of $2.70 per $1,000 of assessed value. The 1995 real estate taxes are not yet known.\n(G) Englewood Bank Building. The Englewood Bank Building is located in Englewood, Colorado. The building contains 10 stories and is suitable and adequate for its use as a bank and office building.\nThe main tenant is Bank One, Denver which occupies 83% of the building. The balance of the building is primarily leased to small service or professional organizations for use as general offices. The Trust's policy is to sign leases of three to five years in order to take advantage of changes in the market.\nThe Trust has no plans for any significant renovations of the Property other than normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nThe Englewood Bank Building is subject to limited direct competition from comparable office projects in the general vicinity. There is only one competing high-rise office building in the area of similar size, quality, condition and location to the Englewood Bank Building. Other competing projects consist of low-rise office buildings and converted retail space generally considered to be of lesser quality.\nThe occupancy rates for the fiscal years ended September 30, 1991 through 1995 were as follows: 97% in 1991, 89% in 1992, 91% in 1993, 98% in 1994 and 97% in 1995. The Property's average rental rate per occupied square foot for the same period was $6.55 in 1991, $6.65 in 1992, $6.69 in 1993, $6.80 in 1994 and $6.63 in 1995.\nPART I -------\nItem 2. Properties (Continued): - -------- -----------------------\nInvestments in Real Estate: (Continued) - ---------------------------------------\nBank One, Denver is the only tenant occupying over 10% of the rentable space. Its annual rent is currently $974,000 but is subject to an annual adjustment based on increases or decreases in property expenses. This lease expires September 30, 2005 and has six, ten year renewal options available.\nLease expirations based upon base rents of leases in place at September 30, 1995 for the ten years ended September 30, 2005 are as follows:\nThe Englewood Bank Building is depreciated for tax purposes using the straight line method over 40 years for the building and improvements. The depreciable tax basis was $2,018,000 at September 30, 1995. The 1994 real estate taxes for the Property were $101,857 based on a millage rate of $8.1046 per $1,000 of assessed value. The 1995 real estate taxes are not yet known.\n(H) EXECUTIVE CLUB BUILDING. The Executive Club Building is located in Denver, Colorado. The building contains eleven floors and has a health club, which includes a swimming pool, located in the basement. The building is suitable and adequate for its use as an office building.\nSpace in the building is leased to service and professional organizations for use as general offices. The Trust's policy is to sign new leases with new and renewal tenants for periods of three to five years in order to take advantage of changes in the market.\nPresently, the Trust has no plans for any significant renovations of the property beyond normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nThere are numerous office buildings in the direct vicinity, some of higher quality, and numerous projects of similar age, condition and quality that directly compete with the Executive Club Building. The Trust believes that the advantage that this building has is that the building caters to small tenant users, while the majority of the properties in the area prefer larger tenants.\nPART I -------\nItem 2. Properties (Continued): - -------- ----------------------\nInvestments in Real Estate: (Continued) - ----------------------------------------\nOccupancy for the fiscal years ended September 30, 1991 through 1995 was as follows: 88% in 1991; 92% in 1992; 97% in 1993 and 1994 and 93% in 1995. The Property's average rental rates per occupied square foot for the same periods were: $9.45 in 1991; $9.69 in 1992; $9.55 in 1993; $10.15 in 1994 and $11.63 in 1995.\nThere are no tenants in this property occupying 10% or more of the space.\nBased upon leases in place as of September 30, 1995 lease expirations for the next ten fiscal years ended September 30, 2005 are as follows:\nThe Executive Club Building is depreciated for tax purposes using the straight line method with the building and improvements having a 40 year life. The depreciable tax basis was $1,827,000 at September 30, 1995. The 1994 real estate taxes for the Property were $75,396 based on a millage rate of $8.0741 per $1,000 of assessed value. The 1995 real estate taxes are not yet known.\n(I) CANNON WEST SHOPPING CENTER. The Cannon West Shopping Center is a grocery-anchored neighborhood strip center located in Austin, Texas. Cannon West's main tenants operate retail businesses. The Property is suitable and adequate for its use as a strip shopping center.\nThe Trust has no plans for significant renovations of the Property beyond normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nThe Trust owns this Property in fee simple, subject to a first mortgage loan, at a rate of 9.5%, which matures May 1, 1997. At September 30, 1995 the balance of this loan was $5,852,000. By maturity $181,000 of scheduled amortization payments are required and therefore a balance of $5,671,000 will be due at maturity. There is a prepayment penalty of 4.5% effective May 28, 1995 which decreases 1\/2 of 1% per year to a minimum of 4% until maturity.\nThe Cannon West Shopping Center is subject to a limited amount of direct competition in its immediate trade area. Although there are a number of grocery anchored shopping centers located in South Austin serving the south-side communities that are located along William Cannon Drive-- a major East-West highway serving the South Austin area -- Cannon West Shopping Center is the only retail shopping center located at the intersection of William Cannon Drive and Westgate Boulevard that serves the immediate surrounding neighborhoods.\nPART I -------\nItem 2. Properties (Continued): - -------- ----------------------\nInvestments in Real Estate: (Continued) - ----------------------------------------\nOccupancy for the fiscal years ended September 30, 1991 through 1995 was as follows: 84% in 1991; 88% in 1992; 93% in 1993; 75% in 1994; and 82% in 1995. The average rental rate, including percentage rents, per occupied square foot during the same period was $6.28 in 1991; $7.44 in 1992; $7.05 in 1993; $8.38 in 1994; and $9.01 in 1995.\nCannon West has one tenant that occupies more than 10% of the Property, H.E. Butt Grocery Store (\"HEB\"). Their annual base rent is $250,000. The lease also calls for tax, insurance and maintenance escalations and has a percentage rent clause. For 1995 the percentage rent paid was $104,000. This lease expires October 5, 2001 and has four, five year renewal options. In September, 1995 the Trust was notified by HEB that they had purchased a parcel of land approximately one mile from Cannon West. Should HEB build a store and\/or a shopping center on this parcel of land, it could effect Cannon West.\nLease expirations based on leases in place at September 30, 1995 for the ten years ended September 30, 2005 are as follows:\nThe building and improvements are depreciated for tax purposes using the straight line method over 18 years. The depreciable tax basis was $3,949,000 at September 30, 1995. The 1994 real estate taxes were $160,468 based on a millage rate of $2.51 per $1,000 of assessed value. The 1995 real estate taxes are not yet known.\n(J) SPRING VILLAGE SHOPPING CENTER. The Spring Village Shopping Center is a grocery-anchored neighborhood strip center located in Davenport, Iowa. Spring Village's main tenants operate retail businesses. The Property is suitable and adequate for its use as a strip shopping center.\nThe Trust has no plans for significant renovations of the Property beyond normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nPART I -------\nItem 2. Properties (Continued): - -------- ----------------------\nInvestments in Real Estate: (Continued) - ----------------------------------------\nThe Spring Village Shopping Center is subject to direct competition in its immediate trade area. There are several grocery anchored shopping centers located on Kimberly Road, the major retail East-West road servicing Davenport. At September 30, 1995 Spring Village was 100% occupied primarily due to the attractiveness of the center's grocery store which was recently remodeled and expanded at the cost of the Store.\nOccupancy for the fiscal years ended September 30, 1991 through 1995 was as follows: 97% in 1991; 98% in 1992; 99% in 1993; 98% in 1994; and 100% in 1995. The average rental rate, including percentage rents, per occupied square foot during the same period was $7.60 in 1991; $8.00 in 1992; $8.00 in 1993; $8.26 in 1994; and $7.89 in 1995.\nSpring Village has two tenants that occupy more than 10% of the Property. The first is Eagle Food Centers, whose annual base rent is $204,000. Their lease also calls for tax, insurance and maintenance escalations and has a percentage rent clause. There was no percentage rent due for 1995. This lease expires June 30, 2005. The second is the Walgreen Company, which operates a drug store, and pays annual base rent of $67,000. Its lease also calls for tax, insurance and maintenance escalations. This lease expires November 30, 2010.\nLease expirations based on leases in place at September 30, 1995 for the ten years ended September 30, 2005 are as follows:\nThe building and improvements are depreciated for tax purposes using the straight line method over 31-1\/2 years. The depreciable tax basis was $3,383,000 at September 30, 1995. The 1995 real estate taxes are $137,668 based on a millage rate of $3.59 per $1,000 of assessed value.\n(K) WARREN PLAZA SHOPPING CENTER. The Warren Plaza Shopping Center is a grocery-anchored neighborhood strip center located in Dubuque, Iowa. Warren Plaza's main tenants operate retail businesses. The Property is suitable and adequate for its use as a strip shopping center.\nThe Trust has no plans for significant renovations of the Property beyond normal maintenance and repairs and tenant improvements done in conjunction with the leasing of space within the Property.\nPART I -------\nItem 2. Properties (Continued): - -------- ----------------------\nInvestments in Real Estate: (Continued) - ----------------------------------------\nIn addition to the 90,000 square feet owned by the Trust, there is a 97,000 square foot Target discountstore attached to the property, which is not owned by the Trust. The Property is subject to direct competition in its immediate trade area. There are several grocery anchored shopping centers located on both Dodge Street and John F. Kennedy Blvd. (this Property is located on the corner of these two streets). Across the street from the Property is a mall, which the Trust does not consider competition. Additionally, there is both a K-Mart and Wal-mart in the area which compete with the Target store. For both 1994 and 1995 this Property has been 100% occupied. The Trust attributes this to both the grocery store and the Target Store. Both of these stores have been recently remodeled and expanded at the cost of the stores.\nOccupancy for the fiscal years ended September 30, 1991 through 1995 was as follows: 92% in 1991; 92% in 1992; 99% in 1993; 100% in 1994; and 100% in 1995. The average rental rate, including percentage rent, per occupied square foot during the same period was $8.83 in 1991; $8.86 in 1992; $8.60 in 1993; $9.67 in 1994; and $9.24 in 1995.\nWarren Plaza has one tenant that occupies more than 10% of the Property, HY-VEE Food Store. Its annual base rent is $259,000. The lease also calls for tax, insurance and maintenance escalations and has a percentage rent clause. There was no percentage rent due for 1995. The lease expires June 30, 2013.\nLease expirations based on leases in place at September 30, 1995 for the ten years ended September 30, 2005 are as follows:\nThe building and improvements are depreciated for tax purposes using the straight line method over 31-1\/2 years. The depreciable tax basis was $3,721,000 at September 30, 1995. The 1995 real estate taxes are $102,102 based on a millage rate of $3.29 per $1,000 of assessed value.\nPART I -------\nItem 2. Properties (Continued): - ------- -----------------------\nGeographic Distribution: - ------------------------\nThe Trust's properties are located in seven states. The table below demonstrates the geographic distribution of the Trust's properties at September 30, 1995:\nPART I -------\nItem 3.","section_3":"Item 3. Legal Proceedings - -------- -----------------\nThe Trust is involved in a number of legal proceedings arising in the usual course of its business activities, none of which in the opinion of the management, is expected to have a material adverse effect on the Trust.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. - ------- ----------------------------------------------------\nNo matters were submitted to a vote of the Trust's Shareholders during the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant - ------------------------------------\nThe following information regarding executive officers of the Trust is provided pursuant to Instruction 3 to Item 401(b) of Regulation S-K.\nPART II --------\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------- ----------------------------------------------------------------- Matters -------\nMarket Price Range: - -------------------\nThe shares of the Trust are traded in the Over-the-Counter market, NASDAQ National Market System, (symbol CTRIS). The table below contains the quarterly high and low closing bid prices for such Shares.\nThe bid prices for the Trust's Shares shown in the table above are interdealer prices and do not reflect retail mark ups, mark downs, or commissions and may not be representative of actual transactions. As of December 1, 1995, there were approximately 1,225 record holders of the Shares.\nDistributions to Shareholders: - ------------------------------\nAt their July 25, 1995 meeting, the Trustees declared a quarterly cash distribution of $.04 per Share of Beneficial Interest payable October 20, 1995 to shareholders of record as of October 6, 1995. At their October 24, 1995 meeting, the Trustees declared a quarterly cash distribution of $.04 per Share payable January 19, 1996 to shareholders of record as of January 5, 1996.\nFor a discussion of the tax classification of cash distributions see Management's Discussion and Analysis of Financial Condition and Results of Operations - Dividends.\nDistributions are subject to a bank convenant which require a minimum Shareholders' Equity. At September 30, 1995 the amount of required Shareholders' Equity was $20,000,000 and the amount free from this restriction was approximately $5,126,000.\nPART II -------- Item 6.","section_6":"Item 6. Selected Financial Data - ---------------------------------\nPART II ---------\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - -------- --------------------------------------------------------------- Results of Operations. ----------------------\nFinancial Condition - -------------------\nDuring the three-year period ended September 30, 1995 the Trust's total assets decreased 14% to $43,076,000. In 1994 the Trust applied the allowance for possible investment losses to three previously foreclosed properties for which it had been previously provided. This application was done in connection with the Trust's regular evaluation of its portfolio of properties. The evaluation concluded that it was unlikely that these properties would recover in value and, therefore, they were written down to their net realizable value. During this three-year period the carrying value of the Trust's invested assets after the allowance for possible investment losses decreased 13% or $6,162,000 to $41,245,000. In fiscal 1995 the Trust sold three improved properties. The first was the sale of the 197 room Quality Hotel in St. Louis, Missouri for $2,650,000 which resulted in a gain of $452,000. The second was the sale of the 124 unit Parkwood Place Apartments in Greeley, Colorado for $2,595,000 which resulted in a gain of $1,859,000. The third was the sale of the 51,000 square foot Walnut Hill West office building in Dallas, Texas for $800,000 which resulted in a gain of $97,000. In fiscal 1994 the Trust purchased a 104,000 square foot office building located in Dallas, Texas for $3,918,000. Of this amount, $2,170,000 was provided by a first mortgage loan on the property which the Trust obtained at the time of the purchase. In fiscal year 1993 the Trust sold four single-story, office-warehouse buildings containing 42,162 square feet on 2.68 acres of land within the Walnut Stemmons Office Park in Dallas, Texas for $950,000 which resulted in a gain of $337,000. Additionally, the Trust sold four vacant land parcels during this three-year period. The result of all the sales during this three year period was a decrease of approximately $4,174,000 to the carrying value of the Trust's portfolio of invested assets. Additionally, the recording of $5,967,000 of depreciation, a non-cash adjustment, reduced the carrying value during this three-year period. Also, during this three-year period, the Trust made improvements to its existing properties of $2,176,000 and received payments on real estate mortgage loan totaling $2,349,000.\nDuring the three-year period ended September 30, 1995 the Trust's mortgage notes payable decreased 51% or $9,541,000 to $9,266,000. This resulted from amortization payments of $1,280,000, the repayment of a $7,689,000 maturing loan, and additional repayments\/paydowns which reduced the mortgage notes payable $2,404,000. Of this $2,404,000, the actual cash outlay by the Trust was $2,066,000 with $338,000 representing discounts obtained by the Trust. Additionally, the Trust obtained a $2,170,000 first mortgage loan in connection with its purchase of a 104,000 square foot office building, as referenced above. The Trust's bank notes payable were reduced $9,026,000 during the three-year period ended September 30, 1995 to $6,600,000. The Trust borrowed $7,689,000 to repay the above referenced maturing mortgage loan and made principal amortization and repayments of $16,715,000.\nDuring the three-year period ended September 30, 1995 the Trust's shareholders' equity increased 83% or $11,412,000 to $25,126,000. This increase was primarily the result of the Trust receiving $4,231,000 from its 1992 rights offering, which expired December 28, 1992, $5,929,000 from its 1993 rights offering, which expired January 28, 1994, net of $1,358,000 to repurchase 253,553 of the Trust's Shares in fiscal 1995 and 103,210 of the Trust's Shares in fiscal 1994, $4,585,000 of net income and $2,002,000 of distributions to shareholders during this three-year period. As a result of the Trust's total debt being reduced approximately $18,567,000 and total shareholders' equity increasing $11,412,000, the Trust's debt to shareholders' equity ratio has decreased to .63-to-1.00 at September 30, 1995 from 2.51-to-1.00 at September 30, 1992.\nPART II ---------\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations - (Continued) ---------------------\nLiquidity and Capital Resources - -------------------------------\nFor each of the fiscal years ended September 30, 1995, 1994 and 1993, the Trust's portfolio of invested assets generated sufficient revenues to cover all operating expenses (excluding depreciation, a non-cash expense), required mortgage notes amortization payments, required bank amortization payments, capital improvements to existing properties, and distributions to shareholders. During this three-year period the year end occupancy of the Trust's portfolio has been 80% at September 30, 1993, 79% at September 30, 1994, and 81% at September 30, 1995, while the average rental rates per square foot have increased from $8.22 for the year ended September 30, 1993 to $8.47 for the year ended September 30, 1994 to $8.61 for the year ended September 30, 1995. The Trust's estimate for the fiscal year 1996 is that operating revenues should be sufficient to cover all operating expenses (excluding depreciation, a non-cash expense), required monthly mortgage amortization payments, anticipated improvements (primarily tenant improvements estimated at approximately $500,000), and distributions to shareholders.\nManagement has from time to time undertaken a major renovation of a property in order to keep it competitive within its market. During fiscal 1994 and 1995 the Petroleum Club Building located in Tulsa, Oklahoma underwent major reconstruction and repair as a result of a fire which occurred in January, 1994. The cost of the work was covered by insurance settlement proceeds. In July, 1994 the Trust and its insurance company arrived at a settlement for the repair of this property. Included in the work that was done was $253,000 for building improvements made as part of the building restoration. The Trust has capitalized these as building improvements. No other major renovation projects are currently contemplated or in process.\nThe Trust's cash flow from operating activities increased $116,000 (6%) when comparing 1995 to 1994. This increase was primarily due to the net activity of the following items:\n* In 1995 the Trust had an operating income of $596,000 compared to an operating loss of $115,000 in 1994, or an improvement of $711,000. The improvement was largely the result of income from real estate operations being $357,000 higher in 1995 than in 1994, primarily due to the Trust's purchase in August, 1994 of a 104,000 square foot office building in Dallas, Texas. Also the Trust's interest expense was $343,000 less in 1995 than 1994 primarily as a result of the Trust reducing its outstanding debt by $6,425,000 during 1995.\n* In 1995 the Trust's accrued expenses and other liabilities decreased $134,000. In 1994 the accrued expenses and other liabilities increased $351,000 due primarily to an increase in the accrual for operating payables. Therefore there was a decrease of $485,000 for 1995 compared to 1994.\n* In 1995 the Trust's depreciation expense was $126,000 less than in 1994 because of property sales in 1995.\nFor 1995 the net cash from investing activities totaled $5,522,000. As previously discussed, in 1995 the Trust sold three improved properties and a vacant land parcel. The proceeds from these sales totaled $5,545,000. Additionally, at the completion of the renovation and repair project on the Tulsa, Oklahoma Petroleum Club Building the insurance settlement proceeds exceeded the expenditures for the work by $738,000. The Trust also received $145,000 in real estate loan repayments. The only net cash outflow was\nPART II --------\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations - (Continued) ---------------------\nLiquidity and Capital Resources - (Continued) - -------------------------------\nthe $666,000 (primarily tenant improvements) spent on improvements to existing properties and the $240,000 which the Trust invested in the purchase of 14,000 shares in a real estate company. During 1994 the Trust used $3,435,000 in investing activities. As previously discussed above, in 1994 the Trust purchased a 104,000 square foot office building in Dallas, Texas for $3,918,000. This purchase plus the $853,000 (primarily tenant improvements, in addition to the previously discussed $253,000 for items capitalized in connection with the restoration work at the Petroleum Club Building in Tulsa, Oklahoma) spent on improvements to existing properties exceeded the proceeds of $879,000 from sales of properties, the net insurance proceeds of $253,000 and $204,000 of repayments on real estate mortgage loans.\nIn 1995 net cash used in financing activities totaled $7,809,000, while in 1994 net cash from financing activities was $1,263,000, a variance of $9,072,000. Mortgage notes payable amortization payments were $330,000 in 1995 and $496,000 in 1994. Principal prepayments were $1,463,000 in 1995, as the Trust repaid a $498,000 first mortgage loan and settled a $1,017,000 first mortgage loan for $965,000 (the settlement resulted in a $52,000 extraordinary income item). In 1994 the repayments were $7,689,000 as the Trust paid off a maturing first mortgage loan on September 30, 1994. Bank notes payable principal payments totaled $4,549,000 in 1995 and $5,162,000 in 1994. In 1995 the Trust paid off its $3,460,000 1986 loan and paid down the 1994 Credit (defined below) $1,089,000. In 1994 the Trust made a $666,000 principal payment on its 1986 loan. Also, in 1994 the Trust repaid the $4,496,000 balance on its 1990 Credit which was subsequently canceled December 31, 1994. In 1995 the Trust repurchased and retired 14,000 of its shares for a cost of $48,000 and through a tender offer made to all shareholders of the Trust repurchased and retired 239,553 of its shares for a cost of $1,014,000. In 1994 the Trust repurchased and retired 103,210 of its shares at a cost of $296,000. In 1994 the Trust received $5,929,000 as a result of the sale of shares in the 1993 rights offering. In 1995 the Trust cashed in a $500,000 certificate of deposit. In 1995 the Trust made four distributions of $.04 per share to shareholders of the Trust for a total of $874,000. In 1994 the Trust made four distributions (one for $.03 per share and three for $.04 per share) for a total of $735,000.\nOn November 30, 1994 the Trust and National City Bank of Cleveland, Ohio and Manufacturer's and Traders Trust Company of Buffalo, New York executed a revolving line of credit agreement for a maximum of $25,000,000 (limited by the value of the collateral provided) (\"1994 Credit\"). The 1994 Credit is for an initial term of three years. Each year the lenders will review the 1994 Credit with the option of extending the credit for one additional year. If the lenders do not extend the credit then the Trust will have two years in which to repay all borrowings outstanding under the 1994 Credit. The loans will bear interest at the Trust's option at any of the following rates: (i) 1\/4 of 1% over the prime lending rate; (ii) 250 basis points over the LIBOR rate; or (iii) NCB's fixed interest rate available from time to time. The primary reason the Trust obtained the 1994 Credit was to aid in the purchase of improved real estate, primarily suburban office buildings. The Trust now also contemplates using the 1994 Credit to purchase real estate companies' securities, although the 1994 Credit currently limits investments of this type to a maximum of $2,000,000.\nIn addition to the required monthly amortization payments under the terms of the three first mortgage loans the Trust currently has (see Note D to the financial statements), during the next five fiscal years the Trust's major debt maturities are (i) in fiscal 1998 the 1994 Credit, which currently has a balance of $6,600,000\nPART II --------\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations - (Continued) ---------------------\nLiquidity and Capital Resources - (Continued) - -------------------------------\noutstanding; (ii) on May 7, 1997 a $5,852,000 first mortgage loan; and (iii) on August 19, 2000 a $2,146,000 first mortgage loan.\nAlthough the 1994 Credit is for an initial term of three years, it is the Trust's belief that the credit will be extended for an additional year each year on its anniversary by the lenders. Therefore, at this time the Trust does not anticipate the necessity of looking for a replacement loan for the $6,600,000 of bank borrowings which currently would be due in fiscal 1998, since the 1994 Credit has not reached its first anniversary. Currently, it is Management's intention to repay the $5,852,000 first mortgage loan which matures May 7, 1997 with funds from the 1994 Credit and also to repay the $2,146,000 first mortgage loan which matures August 19, 2000 with funds from the 1994 Credit.\nResults of Operations - ---------------------\nFISCAL YEAR COMPARISON:\nIncome from real estate operations in 1995 increased $357,000 (13%) and $652,000 (27%) as compared to 1994 and 1993, respectively. The increases related primarily to higher rental income in 1995 compared to both 1994 and 1993 and lower depreciation expense in 1995 compared to both 1994 and 1993. Rental income was $495,000 (5%) higher in 1995 than 1994, and $797,000 (8%) higher in 1995 than 1993. Depreciation expense in 1995 was $126,000 (6%) and $303,000 (14%) lower than in 1994 and 1993, respectively. However, real estate operating expenses were $264,000 (5%) higher in 1995 than 1994, and $448,000 (9%) higher in 1995 than 1993. The reasons for these variances in rental income, real estate operating expenses and depreciation expense are described below.\nThe Trust considers the cyclical nature of real estate markets a normal part of portfolio risk. The performance of the various real estate markets and economies of the Southwest remains mixed. Improvement in the Trust's operations will depend partially upon further economic recovery of the Southwest and, in specific, local markets and properties, especially Dallas, Texas.\n1995 - 1994\nIncome from real estate operations increased $357,000 (13%) from 1994 to 1995. Rental income increased $495,000 (5%) from 1994 to 1995. Real estate operating expenses were $264,000 (5%) higher in 1995 compared to 1994. The increase in rental income and real estate operating expenses were primarily due to the Trust's purchase in August, 1994 of a 104,000 square foot office building located in Dallas, Texas. Additionally, depreciation expense was $126,000 (6%) lower in 1995 than 1994. The $343,000 (16%) decrease in interest expense was primarily due to lower outstanding balances. In March, 1995 the Trust repaid a $498,000 first mortgage loan on its shopping center located in Ardmore, Oklahoma. In May, 1995 the Trust settled at a discount a $1,017,000 first mortgage loan on its office building located in Englewood, Colorado. In February and March, 1995 the Trust repaid the $3,460,000 1986 loan it had with a bank. Additionally, the Trust reduced the 1994 Credit balance from $7,689,000 to $6,600,000 (a reduction of $1,089,000) during 1995.\nIn 1995 the Trust recorded gains totaling $2,499,000 as the result of four property sales. The sales and gains were as follows: (i) February, 1995 $2,650,000 sale of the 197 room Quality Hotel located in St. PART II --------\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations - (Continued) ---------------------\nResults of Operations - (Continued) - ---------------------\nLouis, Missouri, which resulted in a gain of $452,000; (ii) March, 1995 $2,595,000 sale of the 124 unit Parkwood Place Apartments located in Greeley, Colorado which resulted in a gain of $1,859,000; (iii) March, 1995 $800,000 sale of the 51,000 square foot Walnut Hill West office building located in Dallas, Texas which resulted in a gain of $97,000; and (iv) May, 1995 $212,000 sale of 17.7697 acres of vacant land located in Akron, Ohio which resulted in a gain of $91,000. In 1994 the Trust recorded gains on the sales of both a 69 acre and a 17 acre vacant land parcel located in Akron, Ohio which resulted in total gains of $445,000.\nIn 1995 the Trust settled at a discount a $1,017,000 first mortgage loan on its office building located in Englewood, Colorado. This settlement resulted in an extraordinary income item of $52,000. In January 1994 the Trust's Petroleum Club Building located in Tulsa, Oklahoma sustained a major fire. In July, 1994 the Trust and its insurance company agreed on a settlement of $6,025,000. The Trust has completed all necessary repairs and building improvements. Upon completion of the work there was $738,000 of the settlement which had not been expended. The Trust has recorded this $738,000 as an extraordinary income item in fiscal 1995. In addition $253,000 was the cost of building improvements made as part of the building restoration. This $253,000 was capitalized as building improvements and also was recorded as an extraordinary income item in fiscal 1994.\n1994 - 1993\nIncome from real estate operations increased $295,000 (12%) from 1993 to 1994. Rental income increased $302,000 (3%) from 1993 to 1994 primarily due to the average rents per occupied square foot being $.25 per square foot higher in 1994 compared to 1993. Real estate operating expenses were $184,000 (4%) higher in 1994 compared to 1993. Additionally, depreciation expense was $177,000 (8%) lower in 1994 than 1993.\nThe $187,000 (71%) decrease in interest income was primarily the result of the Trust's sale of a $2,000,000 real estate mortgage loan in July, 1993.\nThe $474,000 (52%) decrease in interest on bank notes payable for 1994 compared to 1993 was primarily due to reduced principal balances. In January and February, 1994 the Trust repaid the $4,508,000 balance of the 1990 Credit. Additionally, in March, 1994 the Trust made a $666,000 payment on its 1986 loan. Also, the Trust made $147,000 of amortization payments on its loans. The September 30, 1994 funding by National City Bank did not effect the interest expense for 1994.\nIn 1994 the Trust recorded gains on the sales of real estate of $445,000 on the sales of a 69 acre and a 17 acre vacant land parcel. In 1993, as previously discussed, the Trust recorded a $337,000 gain on the sale of four single-story office-warehouse buildings in Dallas, Texas. Also in 1993, the Trust recorded a $226,000 gain on the sale of a 46 acre vacant land parcel.\nPART II ---------\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations - (Continued) ---------------------\nResults of Operations - (Continued) - ---------------------\nAs previously discussed, in January, 1994 the Trust's Petroleum Club Building located in Tulsa, Oklahoma sustained a major fire. In July, 1994 the Trust and its insurance company agreed on a settlement of $6,025,000. In connection with the restoration $253,000 was the cost of building improvements which were capitalized and also was recorded as an extraordinary income item. In 1993 the Trust settled a second mortgage on one of its properties at a discount. Also, the Trust settled a first mortgage on the same property, at a discount. These settlements resulted in the cancellation of the mortgages and extraordinary gains totaling $286,000.\nDividends: - ----------\nFor 1993 the Trust paid distributions to its shareholders totaling $393,000 or $.12 per share. For the shareholders $.06 per share of these distributions were classified for tax purposes as dividends and $.06 per share were classified as return of capital.\nFor 1994 the Trust paid distributions to its shareholders' totaling $735,000 or $.15 per share. For the shareholders $.07 per share of these distributions were classified for tax purposes as dividends and $.08 per share were classified as return of capital.\nFor 1995 the Trust paid distributions to its shareholders of $874,000 or $.16 per share. For the shareholders preliminary analysis indicates that all of these distributions will be classified for tax purposes as dividends.\nIncome Taxes: - -------------\nCommencing with fiscal 1993 the Trust no longer qualified as a REIT. With the change in status to a taxable entity the Trust adopted the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" the effect of adoption of this statement had no cumulative effect on the Trust's operations. At September 30, 1995 the Trust had net deferred tax assets of approximately $2,567,000. As was the case at both September 30, 1993 and 1994 the Trust has established a valuation allowance equal to its net tax assets as there is doubt as to whether the net deferred tax asset will be realized.\nOther: - ------\nInflation, which has been at relatively low rates for the past three years, has had an immaterial impact on the Trust's operations during the three-year period ended September 30, 1995.\nPART II --------\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. See Item 14 of this report for information concerning financial statements and schedules filed with this report. The quarterly financial data required by this item is included as Note L of the Notes to Financial Statements filed in Part IV, Item 14 (a) (1) and (2).\nItem 9.","section_9":"Item 9. Disagreement on Accounting and Financial Disclosure. - ------- ----------------------------------------------------\nThere has not been any change in the Trust's independent auditors, nor have there been any disagreements concerning accounting principles, auditing procedures, or financial statement disclosure within the twenty four (24) months prior to the date of the most recent financial statements presented in this report.\nPART III ---------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. - --------- ---------------------------------------------------\nExcept as set forth under \"Executive Officers of the Registrant\" following Item 4 of Part I, which is incorporated by reference, all information required by this Item is incorporated by reference to the material under the caption \"Election of Trustees\" to be contained in the definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the fiscal year covered by this report.\nItem 11.","section_11":"Item 11. Executive Compensation. - --------- -----------------------\nAll information required by this Item is incorporated by reference to the material under the caption \"Executive Compensation\" to be contained in the definitive Proxy Statement to be filed with the Commission 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. - --------- ---------------------------------------------------------------\nAll information required by this Item is incorporated by reference to the material under the caption \"Beneficial Ownership of Principal Holders and Management\" of the definitive Proxy Statement to be filed with the Commission 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. - --------- -----------------------------------------------\nInformation required by this Item with respect to certain relationships and related transactions is incorporated by reference to the material under the caption \"Certain Transactions\" to be contained in the definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the fiscal year covered by this report.\nPART IV --------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - --------- ------------------------------------------------------------------\n(a) The following documents are filed as a part of this Report:\n(1) The Financial Statements listed on the List of Financial Statements and Financial Statement Schedules are filed as a separate section of this Report.\n(2) The Financial Statement Schedules listed on the List of the Financial Statements and Financial Statement Schedules are filed as a separate section of this Report.\n(3) The exhibits required by Item 601 of Regulation S-K and identified on the Exhibit Index at sequential Page 51 of this Report.\n(b) No Reports on Form 8-K were filed during the last quarter of the period covered by this Report.\n(c) The exhibits being filed with this Report are identified on the Exhibit Index at sequential Page 51 of this Report.\n(d) The Financial Statement Schedules are filed 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.\nCLEVETRUST REALTY INVESTORS Dated: December 13, 1995 By: \/s\/ Michael R. Thoms ---------------------------- Michael R. Thoms Vice President and Treasurer\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:\nANNUAL REPORT ON FORM 10-K\nPART IV, ITEM 14(a)(1) and (2) and ITEM 14(d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nYEAR ENDED SEPTEMBER 30, 1995\nCLEVETRUST REALTY INVESTORS\nWESTLAKE, OHIO Form 10-K --Part IV, Item 14(a)(1) and (2)\nCLEVETRUST REALTY INVESTORS\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFinancial Statements:\nThe following financial statements of CleveTrust Realty Investors are included in Part II, Item 8:\nStatement of Financial Condition -- September 30, 1995 and 1994\nStatement of Operations -- Years ended September 30, 1995, 1994 and 1993\nStatement of Cash Flows -- Years ended September 30, 1995, 1994 and 1993\nStatement of Changes in Shareholders' Equity -- Years ended September 30, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedules:\nThe following financial statement schedules of CleveTrust Realty Investors are included in Part IV, Item 14(d):\nSchedule XI -- Real Estate and Accumulated Depreciation.\nSchedule XII -- Mortgage Loans on Real Estate.\nAll other schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.\nLOGO ERNST & YOUNG LLP 1300 Huntington Building Phone: 216 861 5000 925 Euclid Avenue Cleveland, Ohio 44115-1405\nReport of Independent Auditors\nTrustees and Shareholders CleveTrust Realty Investors Westlake, Ohio\nWe have audited the accompanying statement of financial condition of CleveTrust Realty Investors as of September 30, 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 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 Trust's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CleveTrust Realty Investors at 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. 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 November 14, 1995\nSTATEMENT OF FINANCIAL CONDITION\nCLEVETRUST REALTY INVESTORS\nSee notes to financial statements.\nSTATEMENT OF OPERATIONS\nCLEVETRUST REALTY INVESTORS\nSee notes to financial statements.\nSTATEMENT OF CASH FLOWS\nCLEVETRUST REALTY INVESTORS\nSee notes to financial statements.\nSTATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY\nCLEVETRUST REALTY INVESTORS\nYears Ended September 30, 1995, 1994, and 1993\nNOTES TO FINANCIAL STATEMENTS\nCLEVETRUST REALTY INVESTORS\nYears Ended September 30, 1995, 1994 and 1993\nNOTE A - - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nINCOME RECOGNITION: Rental income from improved properties is generally recorded as it accrues. Interest on mortgage loans is recognized as income as it accrues during the period the loans are outstanding except where collection of interest is considered doubtful. Contingent rents and interest are recognized as income when determinable. Accrual of income is suspended on any investment when the collection of rent, principal, or interest is doubtful.\nINVESTMENTS IN REAL ESTATE: Real estate acquired by the Trust for investment purposes pursuant to normal real estate purchase transactions is recorded at cost. Real estate acquired by foreclosure, deed in lieu of foreclosure, or cancellation of land leases is recorded at estimated fair value at the date of acquisition, but not in excess of the unpaid balance of the related loan or land lease plus costs of securing title to and possession of the property.\nThe Trust has 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 No. 121 requires a review of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If, based on this review, the sum of expected future cash flows from an asset is less than the carrying amount, an impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. Based on an evaluation of the Trust's assets in accordance with SFAS No. 121, no adjustment for impairment of assets is required at September 30, 1995.\nPrior to adoption of SFAS No. 121, the Trust regularly evaluated the recoverability of each investment in the portfolio. When appropriate, an allowance for possible investment losses was provided for properties acquired through foreclosure or deed in lieu of foreclosure. In fiscal 1994 the Trust applied the allowance for possible investment losses to three previously foreclosed properties for which it had been provided. The Trust concluded that it was unlikely that the value of these properties would recover. Therefore, they were written down to their net realizable value through application of the allowance.\nDEPRECIATION: Depreciation on equity investments is computed by the straight-line method at rates based upon the expected economic lives of the assets which range from 31 to 40 years for buildings, 5 to 40 years for other property and the specific length of the tenant lease for tenant improvements. Additionally, one building and its permanent improvements are depreciated over a life of 55 years.\nREPAIRS AND CAPITAL IMPROVEMENTS: Expenditures for repairs and maintenance which do not add to the value or prolong the useful life of property owned are charged to expense as incurred; those expenditures for improvements which do add to the value or extend the useful life are capitalized.\nCASH AND CASH EQUIVALENTS : The Trust defines cash and cash equivalents as cash in bank accounts and investments in marketable securities, primarily short-term commercial paper with original maturities of three months or less.\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE A - - SUMMARY OF SIGNIFICANT ACCOUNTING POLICES - - CONTINUED\nINVESTMENTS IN SECURITIES: The Trust has adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". The Trust has classified its investments in equity securities as available for sale and as a result these are stated at fair value at September 30, 1995. The effect of the unrealized gains (losses) are included as a component of Shareholders' Equity. There was no cumulative effect adjustment as a result of adoption.\nINCOME TAXES: Commencing with fiscal 1993 the Trust no longer qualified as a REIT. Therefore, with the change in status to a taxable entity for fiscal 1993, the Trust adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\".\nNET INCOME PER SHARE: Net income per Share of Beneficial Interest has been computed using the weighted average number of Shares of Beneficial Interest outstanding each year.\nRECLASSIFICATION: Certain items in previously issued financial statements have been reclassified to conform to 1995 presentations.\nNOTE B - - INCOME TAXES\nAs of October 1, 1992 the Trust adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). The adoption of SFAS 109 had no effect on net income.\nThe Trust's deferred tax assets and liabilities under SFAS 109 at September 30, 1995 and 1994 are as follows:\nThe Trust maintains a valuation reserve equal to its net deferred tax asset as there is doubt as to whether the net deferred tax asset will be realized.\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE B - - INCOME TAXES - - CONTINUED\nThe Trust had no income tax expense for the fiscal years ended September 30, 1995 or 1994. A reconciliation between these results and the amount of income tax expense that would result from applying Federal statutory rates to pretax income is as follows:\nAt September 30, 1995 the Trust had, for federal tax purposes, a net operating loss carryforward of approximately $6.4 million. The use of net operating loss carryforwards is limited by Section 382 of the Internal Revenue Code with effect for losses associated with years prior to December 28, 1992. The Trust can use approximately $ 298,000 per year of net operating loss carryforwards, plus any prior years' unused portion (limited by carryforward periods) for losses generated prior to December 28, 1992. The Trust can also use carryforwards generated post December 28, 1992. These carryforwards of approximately $5.4 million expire through 2009. The remaining carryforwards of $1.0 million may be recognized for a period through fiscal 1998 against gains on sales of properties, if any , to the extent that fair market values of these properties exceeded their tax bases as of December 28, 1992.\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE C - - INVESTMENTS IN REAL ESTATE\nThe following is a summary of the Trust's investments in real estate and accumulated depreciation and related indebtedness at September 30, 1995:\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTES C - - INVESTMENTS IN REAL ESTATE - - CONTINUED\nFollowing is a summary of activity in investments in real estate for the three years ended September 30, 1995:\nIn September, 1995 the Trust and Bank One Colorado, N. A. executed an Option Purchase Agreement. The Trust has paid Bank One an Option Deposit of $40,000 which gives the Trust the option to purchase the land under the Trust's Englewood Bank Building located in Englewood, Colorado. The purchase price for the land is $1,260,000, towards which the $40,000 Option Deposit will be applied. The Trust anticipates that the closing of the purchase will take place around February 1, 1996. The Trust currently leases this land from Bank One under the terms of a land lease which expires January 31, 2024.\nOn January 18, 1994 the Trust's Petroleum Club Building located in Tulsa, Oklahoma sustained a major fire. In July, 1994 the Trust and its insurance company agreed on a settlement of $6,025,000. The Trust has completed all necessary repairs and building improvements for an amount less than the settlement. The Trust has recorded $738,000 as an extraordinary income item in fiscal 1995. The cost of building improvements made as part of the building restoration was $253,000 which has been capitalized and was recorded as an extraordinary income item in fiscal 1994.\nOn August 26, 1994 the Trust purchased a 104,000 square foot office building located in Dallas, Texas for $3,918,000. Of this amount $2,170,000 was provided by a first mortgage loan on the property, which the Trust obtained at the time of the purchase.\nNOTE D - - MORTGAGE NOTES PAYABLE\nAt September 30, 1995 the mortgage notes payable of the Trust are non-recourse mortgages except the first $750,000 of the $2,146,000 loan maturing August 19, 2000 which is recourse to the Trust. The following data pertains to the mortgage notes payable as of September 30, 1995.\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE D - - MORTGAGE NOTES PAYABLE - - CONTINUED\nRequired payments on the Trust's mortgage notes payable for the succeeding five years are as follows:\nOn March 16, 1995 the Trust repaid a $498,000 first mortgage loan on its shopping center located in Ardmore, Oklahoma. This loan had a maturity date of June 16, 1996. On May 1, 1995 the Trust settled at a discount, a $1,017,000 first mortgage loan on its office building located in Englewood, Colorado, which had a maturity date of February 1, 1999. This settlement resulted in an extraordinary income item of $52,000. On September 30, 1994 the Trust repaid a $7,689,000 first mortgage loan on its two shopping centers located in Iowa. This loan had a maturity date of October 1, 1994. On January 28, 1993 the Trust settled a $240,000 second mortgage on one of its properties at a discount. This settlement resulted in the cancellation of the second mortgage and an extraordinary income item of $24,000. On February 10, 1993 the Trust settled a $987,000 first mortgage on the same property at a discount. This settlement resulted in the cancellation of the first mortgage and an extraordinary income item of $262,000.\nTotal interest expense on mortgage notes payable did not differ materially from interest paid.\nNOTE E - - BANK NOTES PAYABLE\nAt September 30, 1995 the bank notes payable included $6,600,000 of borrowings under the 1994 Credit Agreement. At September 30, 1994 the bank notes payable included $7,689,000 of borrowings under a demand note and $3,491,000 of borrowings under a 1986 bank loan.\nOn September 30, 1994 the Trust borrowed $7,689,000 under the terms of a demand note from a new lender. The funds were used to repay a mortgage loan. (See Note D) This demand note, which had an interest rate of prime, was converted to a revolving line of credit (\"1994 Credit\") issued by National City\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE E - - BANK NOTES PAYABLE - - CONTINUED\nBank of Cleveland, Ohio (\"NCB\") and Manufacturer's and Traders Trust Company of Buffalo, New York (\"M&T\"), which was signed effective November 30, 1994. With the execution of the 1994 Credit the Trust canceled the 1990 Credit the Trust had with its previous lender (see below). The 1994 Credit is for up to $25,000,000 (but is limited by the value of the collateral provided). Of this amount a maximum of $15,000,000 is currently available and $10,000,000 will be available at the Trust's discretion upon payment of an activation fee of 3\/4 of 1% on the $10,000,000. The initial term of the 1994 Credit is three years. Each year the lenders will review the 1994 Credit with the right to extend it for one additional year. Interest only payments, which is at the option of the Trust, will be at either (i) 1\/4 of 1% over the prime rate; (ii) 250 basis points over the LIBOR rate; or (iii) NCB's fixed interest rate available from time to time. Additionally, a commitment fee of 3\/8 of 1% is due on any funds available but not borrowed. The 1994 Credit is secured by certain of the Trust's real estate investments and contains certain covenants including a covenant for a minimum shareholders' equity. At September 30, 1995 the amount of shareholders' equity free from such restriction was approximately $5,126,000.\nEffective January 1, 1994 the Trust and its former lender executed a third amendment to the December 31, 1990 Credit Agreement (\"1990 Credit\"). The third amendment converted the then existing five year loan to a revolving line of credit. During January and February, 1994 the Trust paid down the $4,508,000 balance of the 1990 Credit. At September 30, 1994 there were no borrowings outstanding under the 1990 Credit. This loan was canceled December 31, 1994.\nThe Trust also had a loan with another bank which was scheduled to mature December 25, 1993 but, had been extended to December 25, 1997. The interest rate was prime plus 1% with a minimum rate of 7.5%. The Trust was required to make monthly amortization payments based on a twenty-year amortization schedule. On January 5, 1993 the Trust made a principal payment of $722,000. This payment satisfied the required principal payments of $341,000 due December 1, 1993 and $381,000 due December 1, 1994. On March 8, 1994 the Trust made the third required payment of $666,000 which was due by December 1, 1995. On February 28, 1995 the Trust made a principal payment of $2,200,000 and on March 15, 1995 paid off the remaining balance of $1,260,000.\nTotal interest expense on bank notes payable did not differ materially from interest paid.\nNOTE F - - SHARES OF BENEFICIAL INTEREST\nOn August 21, 1995 the Trust mailed an Offer to purchase for cash an aggregate of 500,000 Shares of Beneficial Interest for a price of $4.00 per share to each shareholder of the Trust. The Offer ended September 22, 1995 and at its conclusion 239,553 shares were purchased and retired by the Trust. In addition to the $4.00 per share the Trust incurred costs of $56,000 in connection with the Offer.\nOn April 17, 1995 the Trust repurchased 14,000 of its Shares of Beneficial Interest for $48,000 in an open market purchase. These shares were retired by the Trust.\nOn June 26, 1994 the Trust repurchased 103,210 of its Shares of Beneficial Interest for $296,000 in an open market purchase. These shares were retired by the Trust.\nOn November 23, 1993 the Trust mailed a prospectus and certificate of rights to all shareholders of record as of November 12, 1993. The certificates entitled the shareholder to the right to purchase one Share of\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE F - - SHARES OF BENEFICIAL INTEREST - - CONTINUED\nBeneficial Interest of the Trust for every two Shares owned at a price of $3.25 per Share. Additionally, this offering also provided for an oversubscription privilege which entitled each holder of a right to subscribe for Shares not purchased by other holders of rights. Oversubscriptions were allocated prorata based on the number of Shares owned. The offering expired on January 28, 1994. All 1,857,969 Shares available were sold. The net proceeds to the Trust totaled $5,929,000.\nOn November 17, 1992 the Trust mailed a prospectus and certificate of rights to all shareholders of record as of November 12, 1992. The certificates entitled the shareholder to the right to purchase one Share of Beneficial Interest of the Trust for each Share owned at a price of $ 2.50 per Share. Additionally, the offering provided for an oversubscription privilege which entitled each holder of a right to subscribe for Shares not purchased by other holders of rights. The offering also provided that shares not purchased by shareholders could be sold to third-party investors. The offering expired on December 28, 1992. The Trust sold 1,759,165 shares of the 1,956,772 shares available in the offering. The net proceeds to the Trust totaled $4,231,000.\nOn February 21, 1992 the shareholders of the Trust approved the amended and extended 1983 Incentive Stock Option Plan, now titled the 1992 Stock Option Plan (\"1992 Plan\"). Under the 1992 Plan, an additional 200,000 Shares of Beneficial Interest of the Trust are reserved and made available for issuance of options to officers and employees of the Trust at the discretion of the Board of Trustees. The original plan had reserved 100,000 Shares. The 1992 Plan is extended to October 21, 2011. The option price is the fair market value on the date of the grant and no option shall be exercisable for less than 100% of this value. Under the 1992 Plan, the share appreciation rights granted previously will be unaffected; however, no share appreciation rights will be issued with grants of the 200,000 new Shares or the 17,500 Shares remaining from the original 100,000 Shares. Share appreciation rights entitle the holder to receive the difference between the market value on the date of exercise and the option price in Shares, cash or a combination thereof, at the discretion of the Board of Trustees.\nAs of September 30, 1995 options and share appreciation rights granted and remaining exercisable are as follows: January 20, 1986 - 21,750 Shares at $17.88 per Share granted, 13,250 Shares exercisable; January 16, 1989 - 44,250 Shares at $5.13 per Share granted, 30,400 Shares exercisable; January 1, 1993 - 125,000 Shares at $2.625 per Share granted, 125,000 Shares exercisable; January 1, 1994 - 37,500 Shares at $3.0625 per Share granted, 37,500 Shares exercisable; and January 1, 1995 - 6,000 Shares at $3.00 per Share granted, 6,000 Shares exercisable.\nNOTE G - - REAL ESTATE SALES\nThe fiscal 1995 gains on sales of real estate totaling $2,499,000 include the following: (i) $452,000 which represents the gain the Trust realized on its February, 1995 $2,650,000 sale of the 197 room Quality Hotel located at the airport in St. Louis, Missouri; (ii) $1,859,000 represents the gain the Trust realized on its March, 1995 $2,595,000 sale of the 124 unit Parkwood Place Apartments located in Greeley, Colorado; (iii) $97,000 represents the gain the Trust realized on its March, 1995 $800,000 sale of the 51,000 square foot Walnut Hill West office building located in Dallas, Texas; and (iv) $91,000 represents the gain the Trust realized on its May, 1995 $212,000 sale of 17.7697 acres of vacant land located in Akron, Ohio. The Trust received a purchase money mortgage for the total $212,000 purchase price in connection with the sale.\nThe fiscal 1994 gains on sales of real estate totaling $445,000 include the following: (i) $361,000 which represents the gain the Trust realized on its March, 1994 $834,000 sale of 70 acres of vacant land located in Akron, Ohio. The Trust received a purchase money mortgage for $290,000 of the purchase price in\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE G - - REAL ESTATE SALES - - CONTINUED\nconnection with the sale; and (ii) $84,000 which represents the gain the Trust realized on its August, 1994 $198,000 sale of 16.6 acres of vacant land located in Akron, Ohio.\nThe fiscal 1993 gains on sales of real estate totaling $563,000 include the following: (i) $337,000 which represents the gain the Trust realized on its November, 1992 $950,000 sale of four single-story office-warehouse buildings containing 42,162 square feet on 2.68 acres of land within the Walnut Stemmons Office Park, Dallas, Texas; and (ii) $226,000 which represents the gain the Trust realized on its April, 1993 $541,000 sale of 46.4 acres of vacant land located in Akron, Ohio. The Trust received a purchase money mortgage note for $150,000 of the purchase price in connection with the sale.\nNOTE H - - LITIGATION\nThe Trust is involved in a number of legal proceedings arising in the usual course of its business activities, none of which in the opinion of Management, is expected to have a material adverse effect on the financial statements.\nNOTE I - - PENSION PLAN\nThe Trust has a defined contribution pension plan covering all full-time employees of the Trust. Contributions are determined as a set percentage of each covered employee's annual cash compensation. Contributions by the Trust are accrued during the year and paid prior to the filing of the Trust's federal income tax return for said year. For fiscal 1995 the Trust accrued $24,000 for contributions to the pension plan (for fiscal 1994 - $31,000 and fiscal 1993 - $29,000).\nNOTE J - - OPERATING LEASES\nMinimum future rentals due the Trust on noncancelable leases for the succeeding five fiscal years and thereafter are as follows: 1996, $7,162,000; 1997, $5,471,000; 1998, $4,391,000; 1999, $3,340,000; 2000, $2,662,000; and $11,576,000 thereafter. Certain leases provide for contingent rentals. The Trust received $123,000 of contingent rentals for 1995 ($131,000 for 1994 and $202,000 for 1993). The Trust's carrying amount at September 30, 1995 of these real estate investments consists of land of $6,974,000 and improvements of $56,201,000, less accumulated depreciation of $22,483,000.\nNOTE K - - SUBSEQUENT EVENTS\nThe Trustees, at their July 25, 1995 meeting, declared a quarterly cash distribution of $.04 per Share of Beneficial Interest payable October 20, 1995 to shareholders of record as of October 6, 1995. At their October 24, 1995 meeting, the Trustees declared a quarterly cash distribution of $ .04 per Share payable January 19, 1996 to shareholders of record as of January 5, 1996.\nNOTES TO FINANCIAL STATEMENTS - - CONTINUED\nNOTE L - - QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for the years ended September 30, 1995 and 1994 is as follows:\nSCHEDULE XI -- REAL ESTATE AND ACCUMULATED DEPRECIATION\nCLEVETRUST REALTY INVESTORS\nAs of September 30, 1995\nSCHEDULE XI - - REAL ESTATE AND ACCUMULATED DEPRECIATION - - CONTINUED\nCLEVETRUST REALTY INVESTORS\n(3) The Trust's aggregate cost for federal income tax purposes as of September 30, 1995 was $70,268,000. The Trust's federal income tax return for the year ended September 30, 1995 has not yet been filed.\n(4) Depreciation lives exclude tenant improvements which are depreciated over the specific lease term involved.\n(5) The Trust owns the building improvements subject to a long term ground lease.\nSCHEDULE XII - - MORTGAGE LOANS ON REAL ESTATE\nCLEVETRUST REALTY INVESTORS\nSeptember 30, 1995\nSCHEDULE XII - - MORTGAGE LOANS ON REAL ESTATE - - CONTINUED\nCLEVETRUST REALTY INVESTORS\n(1) Reconciliation of carrying amount of mortgage loans:\n(2) The carrying amount at September 30, 1995 of the mortgage loans for federal income tax purposes was $303,000.\n(3) Interest only payments are due quarterly in the arrears on the 1st day of each March, June, September and December for all interest accrued to such date. Principal payments of $5,375.00 per lot are to be made from the proceeds of the sale of each lot of the vacant land securing this loan until all principal is paid or August, 1996 at which time all unpaid principal is due. Notwithstanding anything to the contrary, provided Borrower is not otherwise in default, this loan shall be interest free until September 1, 1995.\n(4) Interest only payments are due quarterly in the arrears on the 1st day of each June, September, December, and March for all interest accrued to such date. Principal payments of $16,303.00 per lot are to be made frrom the proceeds of the sale of each lot of the vacant land securing this loan until all principal is paid or May, 1997 at which time all unpaid principal is due.\nCLEVETRUST REALTY INVESTORS\nANNUAL REPORT ON FORM 10-K FOR YEAR ENDED SEPTEMBER 30, 1995\nEXHIBIT INDEX\nCLEVETRUST REALTY INVESTORS\nANNUAL REPORT ON FORM 10-K FOR YEAR ENDED SEPTEMBER 30, 1995\nEXHIBIT INDEX\n--(CONTINUED)--","section_15":""}
{"filename":"805392_1995.txt","cik":"805392","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nEnstar Income\/Growth Program Five-B, L.P., a Georgia limited partnership (the \"Partnership\"), is engaged in the ownership, operation and development, and, when appropriate, sale or other disposition, of cable television systems in small to medium-sized communities. The Partnership was formed on September 4, 1986. The general partners of the Partnership are Enstar Communications Corporation, a Georgia corporation (the \"Corporate General Partner\"), and Robert T. Graff, Jr. (the \"Individual General Partner\" and, together with the Corporate General Partner, the \"General Partners\"). On September 30, 1988, ownership of the Corporate General Partner was acquired by Falcon Cablevision, a California limited partnership that has been engaged in the ownership and operation of cable television systems since 1984 (\"Falcon Cablevision\"). Prior to March 1993, the general partner of the general partner of Falcon Cablevision was Falcon Holding Group, Inc., a California corporation (\"FHGI\"), which provided certain management services to the Partnership. On March 29, 1993 a new entity, Falcon Holding Group, L.P. (\"FHGLP\"), was organized to effect the consolidation of the ownership of various cable television businesses (including that of Falcon Cablevision) that were previously under the common management of FHGI. The management of FHGLP is substantially the same as that of FHGI. See Item 13., \"Certain Relationships and Related Transactions.\" The Corporate General Partner, FHGLP and affiliated companies are responsible for the day to day management of the Partnership and its operations. See \"Employees\" below.\nA cable television system receives television, radio and data signals at the system's \"headend\" site by means of over-the-air antennas, microwave relay systems and satellite earth stations. These signals are then modulated, amplified and distributed, primarily through coaxial and fiber optic distribution systems, to customers who pay a fee for this service. Cable television systems may also originate their own television programming and other information services for distribution through the system. Cable television systems generally are constructed and operated pursuant to non-exclusive franchises or similar licenses granted by local governmental authorities for a specified term of years.\nThe systems offer customers various levels (or \"tiers\") of cable services consisting of broadcast television signals of local network, independent and educational stations, a limited number of television signals from so-called \"super stations\" originating from distant cities (such as WTBS, WGN and WOR), various satellite-delivered, non-broadcast channels (such as Cable News Network (\"CNN\"), MTV: Music Television (\"MTV\"), the USA Network (\"USA\"), ESPN and Turner Network Television (\"TNT\"), programming originated locally by the cable television system (such as public, governmental and educational access programs) and informational displays featuring news, weather, stock market and financial reports and public service announcements. A number of the satellite services are also offered in certain packages. For an extra monthly charge, the systems also offer \"premium\" television services to their customers. These services (such as Home Box Office (\"HBO\"), Showtime, The Disney Channel and selected regional sports networks) are satellite channels that consist principally of feature films, live sporting events, concerts and other special entertainment features, usually presented without commercial interruption. See \"Legislation and Regulation.\"\nA customer generally pays an initial installation charge and fixed monthly fees for basic, expanded basic, other tiers of satellite services and premium programming services. Such monthly service fees constitute the primary source of revenues for the systems. In addition to customer revenues, the systems receive revenue from the sale of available advertising spots on advertiser-supported programming. The systems also offer to their customers home shopping services, which pay the systems a share of revenues from sales of products in the systems' service areas, in addition to paying the systems a separate fee in return for carrying their shopping service.\nAll of the Partnership's cable television business operations are conducted through its participation as a co-general partner with a 50% interest in Enstar Cable of Cumberland Valley (the \"Joint Venture\"), the other general partner of which is also a limited partnership sponsored by the General Partners of the Partnership. The Joint Venture was formed in order to enable each of its partners to participate in the acquisition and ownership of a more diverse pool of systems by combining certain of its financial resources. Because all of the Partnership's operations are conducted through its participation in the Joint Venture, much of the discussion in this report relates to the Joint Venture and its activities. References to the Partnership include the Joint Venture, where appropriate.\nThe Joint Venture began its cable television business operations in January 1988 with the acquisition of certain cable television systems located in Kentucky and expanded its operations during February 1989 with the acquisition of certain cable television systems located in Arkansas and Missouri. The Kentucky systems provide service to customers in and around the Cumberland Valley area. The Missouri systems provide service to customers in and around the municipality of Hermitage. As of December 31, 1995, the Joint Venture served approximately 17,300 homes subscribing to cable service in these areas. In February 1993, the systems serving Noel, Missouri were sold. The Joint Venture does not expect to make any additional material acquisitions during the remaining term of the Joint Venture.\nFHGLP receives a management fee and reimbursement of expenses from the Corporate General Partner for managing the Partnership's cable television operations. See Item 11., \"Executive Compensation.\"\nThe Chief Executive Officer of FHGLP is Marc B. Nathanson. Mr. Nathanson has managed FHGLP or its predecessors since 1975. Mr. Nathanson is a veteran of more than 26 years in the cable industry and, prior to forming FHGLP's predecessors, held several key executive positions with some of the nation's largest cable television companies. The principal executive offices of the Partnership, the General Partner and FHGLP are located at 10900 Wilshire Boulevard, 15th Floor, Los Angeles, California 90024, and their telephone number is (310) 824-9990. See Item 10., \"Directors and Executive Officers of the Registrant.\"\nBUSINESS STRATEGY\nHistorically, the Joint Venture has followed a systematic approach to acquiring, operating and developing cable television systems based on the primary goal of increasing operating cash flow while maintaining the quality of services offered by its cable television systems. The Joint Venture's business strategy has focused on serving small to medium-sized communities. The Joint Venture believes that its cable television systems generally involve less risk of increased competition than systems in large urban cities. In the Joint Venture's markets, consumers have access to only a limited number of over-the-air broadcast television signals. In addition, these markets typically offer fewer competing entertainment alternatives than large cities. As a result, the Joint Venture's cable television systems generally have a higher basic penetration rate (the number of homes subscribing to cable service as a percentage of homes passed by cable) with a more stable customer base than systems in large cities. Nonetheless, the Partnership believes that all cable operators will face increased competition in the future from alternative providers of multi-channel video programming services. See \"Competition.\"\nOn March 30, 1994, the Federal Communications Commission (the \"FCC\") adopted significant amendments to its rules implementing certain provisions of the 1992 Cable Act. The Joint Venture believes that compliance with these amended rules has had a negative impact on the Joint Venture's revenues and cash flow. These rules are subject to further amendment to give effect to the Telecommunications Act of 1996 (the \"1996 Telecom Act\"). The 1996 Telecom Act is expected to have a significant affect on all participants in the telecommunications industry, including the Joint Venture. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nClustering\nThe Joint Venture has sought to acquire cable television systems in communities that are proximate to other owned or affiliated systems in order to achieve the economies of scale and operating efficiencies associated with regional \"clusters\" of systems. The Joint Venture believes clustering can reduce marketing and personnel costs and can also reduce capital expenditures in cases where cable service can be delivered to a number of systems within a single region through a central headend reception facility.\nCapital Expenditures\nAs noted in \"Technological Developments,\" the Joint Venture's systems have almost no available channel capacity with which to add new channels or to provide pay-per-view offerings to customers. As a result, significant amounts of capital for future upgrades will be required in order to increase available channel capacity, improve quality of service and facilitate the marketing of additional new services such as advertising, pay-per-view, new unregulated tiers of satellite-delivered services and home shopping, so that the systems remain competitive within the industry.\nThe Joint Venture's management has selected a technical standard that mandates a 750 MHz fiber to the feeder architecture for the majority of all its systems that are to be rebuilt. A system built to a 750 MHz standard can provide approximately 95 channels of analog service. Such a system will also permit the introduction of high speed data transmission and telephony services in the future after incurring incremental capital expenditures related to these services.\nThe Joint Venture's future capital expenditure plans are, however, all subject to the availability of adequate capital on terms satisfactory to the Joint Venture, of which there can be no assurance. As discussed in prior reports, the Joint Venture postponed a number of rebuild and upgrade projects that were planned for 1993 and 1994 because of the uncertainty related to implementation of the 1992 Cable Act and the negative impact thereof on the Joint Venture's business and access to capital. As a result, the Joint Venture's systems will be significantly less technically advanced than had been expected prior to the implementation of re-regulation. The Joint Venture spent $1,975,800 on capital expenditures in 1995 primarily for line extensions and equipment upgrades, and has budgeted capital expenditures of approximately $608,800 in 1996, primarily to upgrade certain equipment. The Joint Venture believes that the delays in upgrading its systems will, under present market conditions, most likely have an adverse effect on the value of those systems compared to systems that have been rebuilt to a higher technical standard. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nDecentralized Management\nThe Corporate General Partner manages the Joint Venture's systems on a decentralized basis. The Corporate General Partner believes that its decentralized management structure, by enhancing management presence at the system level, increases its sensitivity to the needs of its customers, enhances the effectiveness of its customer service efforts, eliminates the need for maintaining a large centralized corporate staff and facilitates the maintenance of good relations with local governmental authorities.\nMarketing\nThe Joint Venture has made substantial changes in the way in which it packages and sells its services and equipment in the course of its implementation of the FCC's rate regulations promulgated under the 1992 Cable Act. Historically, the Joint Venture had offered four programming packages in its upgraded addressable systems. These packages combined services at a lower rate than the aggregate rates for such services purchased individually on an \"a la carte\" basis. The new rules require that charges for cable-related\nequipment (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. On November 10, 1994, the FCC announced the adoption of further significant amendments to its rules. One amendment allows cable operators to create new tiers of program services which the FCC has chosen to exclude from rate regulation, so long as the programming is new to the system. In addition, the FCC decided that discounted packages of non-premium \"new product tier\" services will be subject to rate regulation in the future. However, in applying this new policy to new product tier packages such as those already offered by the Joint Venture and numerous other cable operators, the FCC decided that where only a few services were moved from regulated tiers to the new product tier package, the package will be treated as if it were a tier of new program services as discussed above. Substantially all of the new product tier packages offered by the Joint Venture have received this desirable treatment. These amendments to the FCC's rules have allowed the Joint Venture to resume its core marketing strategy and reintroduce programmed service packaging. As a result, in addition to the basic service package, customers in substantially all of the Systems may purchase an expanded basic service, additional unregulated packages of satellite-delivered services and premium services on either an a la carte or a discounted packaged basis. See \"Legislation and Regulation.\"\nThe Joint Venture has employed a variety of targeted marketing techniques to attract new customers by focusing on delivering value, choice, convenience and quality. The Joint Venture employs direct mail, radio and local newspaper advertising, telemarketing and door-to-door selling utilizing demographic \"cluster codes\" to target specific messages to target audiences. In certain systems, the Joint Venture offers discounts to customers who purchase premium services on a limited trial basis in order to encourage a higher level of service subscription. The Joint Venture also has a coordinated strategy for retaining customers that includes televised retention advertising to reinforce the initial decision to subscribe and encourage customers to purchase higher service levels.\nCustomer Service and Community Relations\nThe Joint Venture places a strong emphasis on customer service and community relations and believes that success in these areas is critical to its business. FHGLP has developed and implemented a wide range of monthly internal training programs for its employees, including its regional managers, that focus on the Joint Venture's operations and employee interaction with customers. The effectiveness of FHGLP's training program as it relates to the employees' interaction with customers is monitored on an on-going basis, and a portion of the regional managers' compensation is tied to achieving customer service targets. FHGLP conducts an extensive customer survey on an annual basis and uses the information in its efforts to enhance service and better address the needs of the Joint Venture's customers. In addition, the Joint Venture is participating in the industry's recently announced Customer Service Initiative which emphasizes an on-time guarantee program for service and installation appointments. FHGLP's corporate executives and regional managers lead the Joint Venture's involvement in a number of programs benefiting the communities the Joint Venture serves, including, among others, Cable in the Classroom, Drug Awareness, Holiday Toy Drive and the Cystic Fibrosis Foundation. Cable in the Classroom is the cable television industry's public service initiative to enrich education through the use of commercial-free cable programming. In addition, a monthly publication, Cable in the Classroom magazine provides educational program listings by curriculum area, as well as feature articles on how teachers across the country use the programs.\nDESCRIPTION OF THE JOINT VENTURE'S SYSTEMS\nThe table below sets forth certain operating statistics for the Joint Venture's cable systems as of December 31, 1995.\n- --------\n(1) Homes passed refers to estimates by the Joint Venture of the approximate number of dwelling units in a particular community that can be connected to the distribution system without any further extension of principal transmission lines. Such estimates are based upon a variety of sources, including billing records, house counts, city directories and other local sources.\n(2) Homes subscribing to cable service as a percentage of homes passed by cable.\n(3) Premium service units include only single channel services offered for a monthly fee per channel and do not include tiers of channels offered as a package for a single monthly fee.\n(4) Premium service units as a percentage of homes subscribing to cable service. A customer may purchase more than one premium service, each of which is counted as a separate premium service unit. This ratio may be greater than 100% if the average customer subscribes for more than one premium service.\n(5) Average monthly revenue per home subscribing to cable service has been computed based on revenue for the year ended December 31, 1995.\n(6) The Joint Venture reports subscribers for the Systems on an equivalent subscriber basis and, unless otherwise indicated, the term \"SUBSCRIBERS\" means equivalent subscribers, calculated by dividing aggregate basic service revenues by the average lowest basic service rate within an operating entity, adjusted to reflect the impact of regulation. Basic service revenues include charges for basic programming, bulk and commercial accounts and certain specialized \"packaged programming\" services, including the appropriate components of new product tier revenue, and excluding premium television and non-subscription services. Consistent with past practices, Subscribers is an analytically derived number which is reported in order to provide a basis of comparison to previously reported data. The computation of Subscribers has been impacted by changes in service offerings made in response to the 1992 Cable Act.\nCUSTOMER RATES AND SERVICES\nThe Joint Venture's cable television systems offer customers packages of services that include the local area network, independent and educational television stations, a limited number of television signals from distant cities, numerous satellite-delivered, non-broadcast channels (such as CNN, MTV, USA, ESPN and TNT) and certain information and public access channels. For an extra monthly charge, the systems provide certain premium television services, such as HBO, Showtime, The Disney Channel and regional sports networks.\nThe Joint Venture also offers other cable television services to its customers. For additional charges, in most of its systems, the Joint Venture also rents remote control devices and VCR compatible devices (devices that make it easier for a customer to tape a program from one channel while watching a program on another).\nThe service options offered by the Joint Venture vary from system to system, depending upon a system's channel capacity and viewer interests. Rates for services also vary from market to market and according to the type of services selected.\nPrior to the adoption of the 1992 Cable Act, the systems generally were not subject to any rate regulation, i.e., they were adjudged to be subject to effective competition under then-effective FCC regulations. The 1992 Cable Act, however, substantially changed the statutory and FCC rate regulation standards. Under the new definition of effective competition, nearly all cable television systems in the United States have become subject to local rate regulation of basic service. The 1996 Telecom Act expanded this definition to include situations where a local telephone company, or anyone using its facilities, offers comparable video service by any means except direct broadcast satellite (\"DBS\"). In addition, the 1992 Cable Act eliminated the 5% annual basic rate increases previously allowed by the 1984 Cable Act without local approval; allows the FCC to review rates for nonbasic service tiers other than premium 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; and adopted regulations to establish, on the basis of actual costs, the price for installation of cable television service, remote controls, converter boxes, and additional outlets. The FCC implemented these rate regulation provisions on September 1, 1993, which affected all the Joint Venture's systems which are not deemed to be subject to effective competition under the FCC's definition. The FCC substantially amended its rate regulation rules on February 22, 1994 and again on November 10, 1994. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act. See \"Legislation and Regulation.\"\nAt December 31, 1995, the Joint Venture's monthly rates for basic cable service for residential customers, excluding special senior citizen discount rates, ranged from $16.74 to $22.20 and premium service rates ranged from $10.95 to $11.95, excluding special promotions offered periodically in conjunction with the Joint Venture's marketing programs. A one-time installation fee, which the Joint Venture may wholly or partially waive during a promotional period, is usually charged to new customers. Prior to September 1, 1993, the Joint Venture generally charged monthly fees for additional outlets, converters, program guides and descrambling and remote control tuning devices. As described above, these charges have either been eliminated or altered by the implementation of rate regulation, and as a result of such implementation under the FCC's guidelines, the rates for basic cable service for residential customers correspondingly increased in some cases. As a result, while many customers experienced a decrease in their monthly bill for all services, some customers experienced an increase. However, substantially all of the Joint Venture's customers did receive a decrease in their monthly charges in July 1994 upon implementation of the FCC's amended rules. Commercial customers, such as hotels, motels and hospitals, are charged a negotiated, non-recurring fee for installation of service and monthly fees based upon a standard discounting procedure. Most multi-unit dwellings are offered\na negotiated bulk rate in exchange for single-point billing and basic service to all units. These rates are also subject to regulation.\nEMPLOYEES\nThe Joint Venture has no employees. The various personnel required to operate the Joint Venture's business are employed by the Corporate General Partner, its subsidiary corporation or FHGLP and its affiliates. The cost of such employment is allocated and charged to the Joint Venture for reimbursement pursuant to the partnership agreement and management agreement. The amounts of these reimbursable costs to the Corporate General Partner are set forth below in Item 11, \"Executive Compensation.\"\nTECHNOLOGICAL DEVELOPMENTS\nAs part of its commitment to customer service, the Joint Venture seeks to apply technological advances in the cable television industry to its cable television systems on the basis of cost effectiveness, capital availability, enhancement of product quality and service delivery and industry wide acceptance. Currently, the Joint Venture systems have an average channel capacity of 36 and, on average, 99% of the channel capacity of the systems was utilized at December 31, 1995. The Joint Venture believes that system upgrades would enable it to provide customers with greater programming diversity, better picture quality and alternative communications delivery systems made possible by the introduction of fiber optic technology and by the possible future application of digital compression. The implementation of the Joint Venture's capital expenditure plans is, however, subject to the availability of adequate capital on terms satisfactory to the Joint Venture, of which there can be no assurance. Also, as a result of the uncertainty created by recent regulatory changes, the Joint Venture has deferred all plant rebuilds and upgrades. See \"Legislation and Regulation\" and Item 7., \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe use of fiber optic cable as an alternative to coaxial cable is playing a major role in expanding channel capacity and improving the performance of cable television systems. Fiber optic cable is capable of carrying hundreds of video, data and voice channels and, accordingly, its utilization is essential to the enhancement of a cable television system's technical capabilities. The Joint Venture's current policy to utilize fiber optic technology in substantially all rebuild projects which it undertakes is based upon the benefits that the utilization of fiber optic technology provides over traditional coaxial cable distribution plant, including lower per mile rebuild costs due to a reduction in the number of required amplifiers, the elimination of headends, lower ongoing maintenance and power costs and improved picture quality and reliability.\nDIGITAL COMPRESSION\nThe Joint Venture has been closely monitoring developments in the area of digital compression, a technology which is expected to enable cable operators to increase the channel capacity of cable television systems by permitting a significantly increased number of video signals to fit in a cable television system's existing bandwidth. The Joint Venture believes that the utilization of digital compression technology in the future could enable the systems to increase channel capacity in certain systems in a manner that could be more cost efficient than rebuilding such systems with higher capacity distribution plant. The use of digital compression in the systems also could expand the number and types of services these systems offer and enhance the development of current and future revenue sources in these systems. Equipment vendors are beginning to market products to provide this technology, but the Joint Venture's management has no plans to install it at this point based on its present understanding of the costs as compared to the benefits of the digital equipment currently available.\nPROGRAMMING\nThe Joint Venture purchases basic and premium programming for its systems from Falcon Cablevision. In turn, Falcon Cablevision charges the Joint Venture for these costs based on an estimate of what the Joint Venture could negotiate for such services for the fifteen partnerships managed by the Corporate General Partner as a group (approximately 94,600 homes subscribing to cable service at December 30, 1995), which is generally based on a fixed fee per customer or a percentage of the gross receipts for the particular service. Falcon Cablevision's programming contracts are generally for a fixed period of time and are subject to negotiated renewal. Falcon Cablevision does not have long-term programming contracts for the supply of a substantial amount of its programming. Accordingly, no assurance can be given that its, and correspondingly the Joint Venture's, programming costs will not increase substantially in the near future, or that other materially adverse terms will not be added to Falcon Cablevision's programming contracts. Management believes, however, that Falcon Cablevision's relations with its programming suppliers generally are good.\nThe Joint Venture's cable programming costs have increased in recent years and are expected to continue to increase due to additional programming being provided to basic customers, requirements to add channels under retransmission carriage agreements entered into with certain programming sources, increased costs to produce or purchase cable programming generally, inflationary increases and other factors. Under the FCC rate regulations, increases in programming costs for regulated cable services occurring after the earlier of March 1, 1994, or the date a system's basic cable service became regulated, may be passed through to customers. See \"Legislation and Regulation - Federal Regulation - Carriage of Broadcast Television Signals.\" Generally, programming costs are charged among systems on a per customer basis.\nFRANCHISES\nCable television systems are generally constructed and operated under non-exclusive franchises granted by local governmental authorities. These franchises typically contain many conditions, such as time limitations on commencement and completion of construction; conditions of service, including number of channels, types of programming and the provision of free service to schools and certain other public institutions; and the maintenance of insurance and indemnity bonds. The provisions of local franchises are subject to federal regulation under the 1984 Cable Act, the 1992 Cable Act and the 1996 Telecom Act. See \"Legislation and Regulation.\"\nAs of December 31, 1995, the Joint Venture held 19 franchises. These franchises, all of which are non-exclusive, provide for the payment of fees to the issuing authority. Annual franchise fees imposed on the Joint Venture systems range up to 5% of the gross revenues generated by a system. The 1984 Cable Act prohibits franchising authorities from imposing franchise fees in excess of 5% of gross revenues and also permits the cable system operator to seek renegotiation and modification of franchise requirements if warranted by changed circumstances.\nThe following table groups the franchises of the Joint Venture's cable television systems by date of expiration and presents the number of franchises for each group of franchises and the approximate number and percentage of homes subscribing to cable service for each group as of December 31, 1995.\nThe Joint Venture operates cable television systems which serve multiple communities and, in some circumstances, portions of such systems extend into jurisdictions for which the Joint Venture believes no franchise is necessary. In the aggregate, approximately 954 customers, comprising approximately 5.5% of the Joint Venture's customers, are served by unfranchised portions of such systems. In certain instances, however, where a single franchise comprises a large percentage of the customers in an operating region, the loss of such franchise could decrease the economies of scale achieved by the Joint Venture's clustering strategy. The Joint Venture believes that it generally has satisfactory relationships with substantially all of its franchising communities. The Joint Venture has never had a franchise revoked for any of its systems and believes that it has satisfactory relationships with substantially all of its franchising authorities.\nThe 1984 Cable Act provides, among other things, for an orderly franchise renewal process in which franchise renewal will not be unreasonably withheld or, if renewal is withheld, the franchise authority must pay the operator the \"fair market value\" for the system covered by such franchise. In addition, the 1984 Cable Act establishes comprehensive renewal procedures which require that an incumbent franchisee's renewal application be assessed on its own merit and not as part of a comparative process with competing applications. See \"Legislation and Regulation.\"\nCOMPETITION\nCable television systems compete with other communications and entertainment media, including over the 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 a 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 television system's ability to provide an even greater variety of programming than that available over the air or through competitive alternative delivery sources. In addition, certain provisions of the 1992 Cable Act and the 1996 Telecom Act are expected to increase competition significantly in the cable industry. See \"Legislation and Regulation.\"\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 for which the consumer must pay a fee. 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 Viewer Copyright Act of 1988, which became effective January 1, 1989 for an initial 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.\"\nTelevision programming is now also being delivered to individuals by high-powered direct broadcast satellites (\"DBS\") utilizing video compression technology. This technology has the capability of providing more than 100 channels of programming over a single high-powered DBS satellite with significantly higher capacity available if multiple satellites are placed in the same orbital position. Video compression technology may also be used by cable operators in the future to similarly increase their channel capacity. 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 ability of DBS operators to obtain access to programming, 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 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 license 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 statutes of several states 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\ncompatible easements within their franchise areas upon nondiscriminatory terms and conditions. Accordingly, where there are preexisting 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. Under the 1996 Telecom Act, SMATV systems can interconnect non-commonly owned buildings without having to comply with local, state and federal regulatory requirements that are imposed upon cable systems providing similar services, as long as they do not use public rights-of-way. 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 cables to interconnect separately owned and managed buildings if its lines use or cross any public right-of-way. 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. 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.\nThe 1996 Telecom Act eliminates the restriction against ownership and operation of cable systems by local telephone companies within their local exchange service areas. Telephone companies are now free to enter the retail video distribution business through any means, such as DBS, MMDS, SMATV or as traditional franchised cable system operators. Alternatively, the 1996 Telecom Act authorizes local telephone companies to operate \"open video systems\" without obtaining a local cable franchise, although telephone companies operating such systems can be required to make payments to local governmental bodies in lieu of cable franchise fees. Up to two-thirds of the channel capacity on an \"open video system\" must be available to programmers unaffiliated with the local telephone company. The open video system concept replaces the FCC's video dialtone rules. The 1996 Telecom Act also includes numerous provisions designed to make it easier for cable operators and others to compete directly with local exchange telephone carriers. With certain limited exceptions, neither a local exchange carrier nor a cable operator can acquire more than 10% of the other entity operating within its own service area.\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\nthat 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.\nLEGISLATION AND REGULATION\nThe cable television industry is regulated by the FCC, some state governments and substantially all local governments. In addition, various legislative and regulatory proposals under consideration from time to time by the Congress and various federal agencies have in the past, and may in the future materially affect the Partnership and 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.\nRECENT DEVELOPMENTS\nOn February 8, 1996, the President signed the 1996 Telecom Act, into law. This statute substantially amended the Communications Act of 1934 (the \"Communications Act\") by, among other things, removing barriers to competition in the cable television and telephone markets and reducing the regulation of cable television rates. As it pertains to cable television, the 1996 Telecom Act, among other things, (i) ends the regulation of certain nonbasic programming services in 1999; (ii) expands the definition of effective competition, the existence of which displaces rate regulation; (iii) eliminates the restriction against the ownership and operation of cable systems by telephone companies within their local exchange service areas; and (iv) liberalizes certain of the FCC's cross-ownership restrictions. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act. See \"Business - Competition\" and \"-Federal Regulation-Rate Regulation.\"\nThe Partnership believes that the regulation of its industry remains a matter of interest to Congress, the FCC and other regulatory authorities. There can be no assurance as to what, if any, future actions such legislative and regulatory authorities may take or the effect thereof on the Partnership.\nCABLE COMMUNICATIONS POLICY ACT OF 1984\nThe 1984 Cable Act became effective on December 29, 1984. This federal statute, which amended the Communications Act, creates 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\nOn October 5, 1992, Congress enacted the 1992 Cable Act. This legislation has 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 required the FCC to initiate a number of rulemaking proceedings to implement various provisions of the statute, virtually all of which have been completed. The\n1992 Cable Act allows for a greater degree of regulation of 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) customer 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 television systems by allowing municipalities to own and operate their own cable television 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.\nA constitutional challenge to the must-carry provisions of the 1992 Cable Act is still ongoing. On April 8, 1993, a three-judge district court panel granted summary judgment for the government upholding the must-carry provisions. That decision was appealed directly to the U.S. Supreme Court which remanded the case back to the district court to determine whether there was adequate evidence that the provisions were needed and whether the restrictions chosen were the least intrusive. On December 12, 1995, the district court again upheld the must-carry provisions. The Supreme Court has again agreed to review the district court's decision.\nOn September 16, 1993, a constitutional challenge to the balance of the 1992 Cable Act provisions was rejected by the U.S. District Court in the District of Columbia which upheld 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). An appeal from that decision is pending before the U.S. Court of Appeals for the District of Columbia Circuit.\nFEDERAL REGULATION\nThe FCC, the principal federal regulatory agency with jurisdiction over cable television, has heretofore promulgated regulations covering such areas as the registration of cable television systems, cross-ownership between cable television 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 television 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. The 1992 Cable Act required the FCC to adopt additional 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. The 1996 Telecom Act requires certain changes to various of these regulations. A brief summary of certain of these federal regulations as adopted to date follows.\nRATE REGULATION\nThe 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 previous 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 resulted in nearly all cable television systems becoming subject to local rate regulation of basic service. The 1996 Telecom Act expands the definition of effective competition to cover situations where a local telephone company or its affiliate, or any multichannel video provider using telephone company facilities, offers comparable video service by any means except DBS. Satisfaction of this test deregulates both basic and nonbasic tiers. Additionally, the 1992 Cable Act 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; allowed 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; prohibited cable television 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; 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 1996 Telecom Act ends FCC regulation of nonbasic tier rates on March 31, 1999.\nThe FCC adopted rules designed to implement the 1992 Cable Act's rate regulation provisions on April 1, 1993, and then significantly amended them on reconsideration on February 22, 1994. The FCC's regulations contain standards for the regulation of basic and nonbasic cable service rates (other than per-channel or per-program services). The FCC's original rules became effective on September 1, 1993. The rules have been further amended several times. The rate regulations adopt a benchmark price cap system for measuring the reasonableness of existing basic and nonbasic service rates, and a formula for calculating additional 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 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.\nLocal franchising authorities and\/or the FCC are empowered to order a reduction of existing rates which exceed the maximum permitted level for either basic and\/or nonbasic cable services and associated equipment, and refunds can be required, measured from the date of a complaint to the FCC challenging an existing nonbasic cable service rate or from September 1993, for existing basic cable service rates under the original rate regulations, and from May 15, 1994, under the February 22, 1994 amendments thereto. In general, the reduction for existing basic and nonbasic cable service rates under the original rate regulations would 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 17 percent, adjusted forward for inflation, 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 channels. Amendments adopted on November 10, 1994 incorporated an alternative method for adjusting the rate charged for a regulated nonbasic tier when new services are added. Cable operators can increase rates for such tiers by as much as $1.50 over a two year period to reflect the addition of up to six new channels of service on nonbasic tiers (an additional $0.20 for a seventh channel is permitted in the third year). In addition, new product tiers consisting of services new to the cable system\ncan be created free of rate regulation as long as certain conditions are met such as not moving services from existing tiers to the new tier. These provisions currently provide limited benefit to the Partnership's systems due to the lack of channel capacity previously discussed. There is also a streamlined cost-of-service methodology available to justify a rate increase on basic and regulated nonbasic tiers for \"significant\" system rebuilds or upgrades.\nFranchising authorities have become certified by the FCC to regulate the rates charged by the Joint Venture for basic cable service and for associated basic cable service equipment. In addition, a number of the Joint Venture's customers have filed complaints with the FCC regarding the rates charged for non-basic cable service.\nThe Joint Venture has adjusted its regulated programming 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 applicable benchmark or equipment and installation cost levels. The Joint Venture also implemented a program in substantially all of its systems under which a number of the Joint Venture's satellite-delivered and premium services are now 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.\nThe FCC, in its reconsideration of the original rate regulations, stated that it was going to take a harder look at the regulatory treatment of such a la carte packages on an ad hoc basis. Such 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 regulation. There have been no FCC rulings related to systems owned by the Joint Venture. There have been two rulings, however, on such packages offered by affiliated partnerships managed by FHGLP. In one case, the FCC's Cable Services Bureau ruled that a nine-channel a la carte package was an evasion of rate regulation and ordered this package to be treated as a regulated tier. In the other case, a six-channel package was held not to be an evasion, but rather is to be considered an unregulated new product tier under the FCC's November 10, 1994 rule amendments. The deciding factor in all of the FCC's decisions related to a la carte tiers appears to be the number of channels moved from regulated tiers, with six or fewer channels being deemed not to be an evasion. Almost all of the Joint Venture's systems moved six or fewer channels to a la carte packages. Under the November 10, 1994 amendments, any new a la carte package created after that date will be treated as a regulated tier, except for packages involving traditional premium services (e.g., HBO).\nIn December 1995, the Joint Venture, and all of its affiliated partnerships, filed petitions with the FCC seeking a determination that they are eligible for treatment as \"small cable operators\" for purposes of being able to utilize the FCC's streamlined cost-of-service rate-setting methodology. If such relief is granted, many of the Joint Venture's systems would be able to increase their basic and\/or nonbasic service tier rates.\nOn March 11, 1993, the FCC adopted regulations pursuant to the 1992 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\nThe 1992 Cable Act contains new signal carriage requirements. These new rules allowed 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 must-carry provisions for non-commercial stations became effective on December 4, 1992. Implementing must-carry rules for non-commercial and commercial stations and retransmission consent rules for commercial stations were adopted by the FCC on March 11, 1993. All commercial stations entitled to carriage were to have been carried by June 2, 1993, and any non-must-carry stations (other than superstations) for which retransmission consent had not been obtained could no longer be carried after October 5, 1993. A number of stations previously carried by the Joint Venture's cable television systems elected retransmission consent. The Joint Venture was 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 Joint Venture 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 operator, and for which it pays monthly fees to the service providers, as it does with other satellite providers. The next election between must-carry and retransmission consent for local commercial television broadcast stations will be October 1, 1996.\nNONDUPLICATION OF NETWORK PROGRAMMING\nCable television systems that have 1,000 or more customers 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\nFCC 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\nAlthough franchising authorities may impose franchise fees under the 1984 Cable Act, such payments cannot exceed 5% of a cable system's annual gross revenues. Under the 1996 Telecom Act, franchising authorities may not exact franchise fees from revenues derived from telecommunications services. 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\nThe 1984 Cable Act established renewal procedures and criteria designed to protect incumbent franchisees 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 his 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 substantially comply 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 denial of renewal based on procedural violations found to be \"harmless error.\"\nA recent federal court decision could, if upheld and if adopted by other federal courts, make the renewal of franchises more problematic in certain circumstances. The United States District Court for the Western District of Kentucky held that the statute does not authorize it to review a franchising authority's assessment of its community needs to determine if they are reasonable or supported by any evidence. This result would seemingly permit a franchising authority which desired to oust an existing operator to set cable-related needs at such a high level that the incumbent operator would have difficulty in making a renewal proposal which met those needs. This decision has been appealed. The Partnership was not a party to this litigation.\nCHANNEL SET-ASIDES\nThe 1984 Cable Act permits local franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The 1984 Cable Act further requires cable television 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.\nCOMPETING FRANCHISES\nQuestions 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 television systems and permits franchising authorities to operate their own cable television systems without franchises.\nOWNERSHIP\nThe 1984 Cable Act codified existing FCC cross-ownership regulations, which, in part, prohibit local exchange telephone companies (\"LECs\") from providing video programming directly to customers within their local exchange telephone service areas, except in rural areas or by specific waiver of FCC rules. This restriction had been ruled unconstitutional in several court cases, and was before the Supreme Court for review, when the 1996 Telecom Act was passed. That statute repealed the rule in its entirety.\nThe 1984 Cable Act and the FCC's rules 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 a television station's significant signal strength as defined by the FCC's rules) covers any portion of the community served by the cable system. The 1996 Telecom Act eliminates the statutory ban and directs the FCC to review its rule within two years. 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. The 1996 Telecom Act eliminates this prohibition. Finally, in order to encourage competition in the provision of video programming, the FCC adopted a rule prohibiting the common ownership, affiliation, control or interest in cable television systems and MDS facilities having overlapping service areas, except in very limited circumstances. The 1992 Cable Act codified this restriction and extended it to co-located SMATV systems. Permitted arrangements in effect as of October 5, 1992 are grandfathered. The 1996 Telecom Act exempts cable systems facing effective competition from this restriction. The 1992 Cable Act permits states or local franchising authorities to adopt certain additional restrictions on the ownership of cable television 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% 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\nof 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 entity which owns the cable system has an attributable interest. The limit is 40% of all activated channels.\nEEO\nThe 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\nThe 1984 Cable Act imposes a number of restrictions on the manner in which cable system operators can collect and disclose data about individual system customers. The statute also requires that the system operator periodically provide all customers with written information about its policies regarding the collection and handling of data about customers, their privacy rights under federal law and their enforcement rights. In the event that a cable operator is found to have violated the customer privacy provisions of the 1984 Cable Act, it could be required to pay damages, attorneys' 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.\nFRANCHISE TRANSFERS\nThe 1992 Cable Act precluded cable operators from selling or otherwise transferring ownership of a cable television system within 36 months after acquisition or initial construction, with certain exceptions. The 1996 Telecom Act repealed this restriction. 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\nPrior 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\nHistorically, 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\nwhich were in conflict with or more restrictive than those established by the FCC. The FCC has revised such standards and made them applicable to all classes of channels which carry downstream National Television System Committee (NTSC) video programming. 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 the technical standards and signal leakage limits is required. The 1992 Cable Act requires the FCC to periodically update its technical standards to take into account changes in technology. Under the 1996 Telecom Act, local franchising authorities may not prohibit, condition or restrict a cable system's use of any type of subscriber equipment or transmission technology.\nThe 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. The 1996 Telecom Act directs the FCC to set only minimal standards to assure compatibility between television sets, VCRs and cable systems, and to rely on the marketplace. The FCC must adopt rules to assure the competitive availability to consumers of customer premises equipment, such as converters, used to access the services offered by cable systems and other multichannel video programming distributors.\nPOLE ATTACHMENTS\nThe FCC currently regulates the rates and conditions imposed by certain public utilities for use of their poles unless state public service commissions are able to demonstrate that they regulate the rates, terms and conditions of cable television pole attachments. A number of states 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. The 1996 Telecom Act directs the FCC to adopt a new rate formula for any attaching party, including cable systems, which offer telecommunications services. This new formula will result in significantly higher attachment rates for cable systems which choose to offer such services.\nOTHER MATTERS\nFCC regulation pursuant to the Communications Act, as amended, 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; obscenity and indecency; home wiring and limitations on advertising contained in nonbroadcast children's programming.\nThe 1996 Telecom Act establishes a process for the creation and implementation of a \"voluntary\" system of ratings for video programming containing sexual, violent or other \"indecent\" material and directs the FCC to adopt rules requiring most television sets manufactured in the United States or shipped in interstate commerce to be technologically capable of blocking the display of programs with a common rating. The 1996 Telecom Act also requires video programming distributors to employ technology to restrict the reception of programming by persons not subscribing to those channels. In the case of channels primarily dedicated to sexually-oriented programming, the distributor must fully block reception of the audio and video portion of the channels; a distributor that is unable to comply with this requirement may only provide such programming during a \"safe harbor\" period when children are not likely to be in the audience, as determined by the FCC. With respect to other kinds of channels, the 1996 Telecom Act only requires that the audio and video portions of the channel be fully blocked, at no charge, upon request of the\nperson not subscribing to the channel. The specific blocking requirements applicable to sexually-oriented programming are being challenged in court on constitutional grounds.\nCOPYRIGHT\nCable 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. Requests to adjust the rates were made in January, 1996 and are pending before the Copyright Office.\nCable operators are liable for interest on underpaid and unpaid royalty fees, but are not entitled to collect interest on refunds received for overpayment of copyright fees.\nThe Copyright Office has commenced a proceeding aimed at examining its policies governing the consolidated reporting of commonly owned and contiguous cable television systems. The present policies governing the consolidated reporting of certain cable television 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 television 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 television system acquisitions.\nVarious bills have been introduced into Congress over the past several years that would eliminate or modify the cable television compulsory license. Without the compulsory license, cable operators would have to negotiate rights from the copyright owners for all of the programming on the broadcast stations carried by cable systems. Such negotiated agreements would likely 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) is 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, both ASCAP and BMI now offer \"through to the viewer\" licenses to the cable networks which cover the retransmission of the cable networks' programming by cable systems to their customers.\nCopyrighted music performed by cable systems themselves on local origination channels, in advertisements inserted locally on cable networks, et cetera, must also be licensed. A blanket license is available from BMI. Cable industry negotiations with ASCAP are still in progress.\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\nlocal 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 customer 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 television 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 television systems. Moreover, franchising authorities are immunized from monetary damage awards arising from regulation of cable television 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. The 1996 Telecom Act prohibits a franchising authority from either requiring or limiting a cable operator's provision of telecommunications services.\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.\nThe attorneys general of approximately 25 states have announced the initiation of investigations designed to determine whether cable television systems in their states have acted in compliance with the FCC's rate regulations.\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 can be predicted at this time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Joint Venture owns or leases parcels of real property for signal reception sites (antenna towers and headends), microwave facilities and business offices, and owns or leases its service vehicles. The Joint Venture believes that its properties, both owned and leased, are in good condition and are suitable and adequate for the Joint Venture's business operations.\nThe Joint Venture owns substantially all of the assets related to its cable television operations, including its program production equipment, headend (towers, antennae, electronic equipment and satellite earth stations), cable plant (distribution equipment, amplifiers, customer drops and hardware), converters, test equipment and tools and maintenance equipment.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a party to various legal proceedings. Such legal proceedings are ordinary and routine litigation proceedings that are incidental to the Partnership's business and management believes that the outcome of all pending legal proceedings will not, in the aggregate, have a material adverse effect on the financial condition of the 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 EQUITY SECURITIES AND RELATED SECURITY HOLDER MATTERS\nLIQUIDITY\nWhile the Partnership's equity securities, which consist of units of limited partnership interests, are publicly held, there is no established public trading market for the units and it is not expected that a market will develop in the future. The approximate number of equity security holders of record was 1,662 as of December 31, 1995. In addition to restrictions on the transferability of units contained in the partnership agreement, the transferability of units may be affected by restrictions on resales imposed by federal or state law.\nDISTRIBUTIONS\nThe amended Partnership Agreement generally provides that all cash distributions (as defined) be allocated 1% to the general partners and 99% to the limited partners until the limited partners have received aggregate cash distributions equal to their original capital contributions (\"Capital Payback\"). The Partnership Agreement also provides that all Partnership profits, gains, operational losses, and credits (all as defined) be allocated 1% to the general partners and 99% to the limited partners until the limited partners have been allocated net profits equal to the amount of cash flow required for Capital Payback. After the limited partners have received cash flow equal to their initial investments, the general partners will only receive a 1% allocation of cash flow from sale or liquidation of a system until the limited partners have received an annual simple interest return of at least 10% of their initial investments less any distributions from previous system sales or refinancing of systems. Thereafter, the respective allocations will be made 20% to the general partners and 80% to the limited partners. Any losses from system sales or exchanges shall be allocated first to all partners having positive capital account balances (based on their respective capital accounts) until all such accounts are reduced to zero and thereafter to the Corporate General Partner. All allocations to individual limited partners will be based on their respective limited partnership ownership interests.\nUpon the disposition of substantially all of the Partnership's assets, gains shall be allocated first to the limited partners having negative capital account balances until their capital accounts are increased to zero, next equally among the general partners until their capital accounts are increased to zero, and thereafter as outlined in the preceding paragraph. Upon dissolution of the Partnership, any negative capital account balances remaining after all allocations and distributions are made must be funded by the respective partners.\nThe policy of the Corporate General Partner (although there is no contractual obligation to do so) is to cause the Partnership to make cash distributions on a quarterly basis throughout the operational life of the Partnership, assuming the availability of sufficient cash flow from the Joint Venture operations. The amount of such distributions, if any, will vary from quarter to quarter depending upon the Joint Venture's results of operations and the Corporate General Partner's determination of whether otherwise available funds are needed for the Joint Venture's ongoing working capital and liquidity requirements. However, on February 22, 1994, the FCC announced significant amendments to its rules implementing certain provisions of the 1992 Cable Act. Compliance with these rules has had a negative impact on the Joint Venture's revenues and cash flow.\nThe Partnership began making periodic cash distributions to limited partners from operations in February 1988. The distributions were funded primarily from distributions received by the Partnership from the Joint Venture. No distributions were made during 1993, 1994 or 1995.\nThe Partnership's ability to pay distributions in the future, the actual level of any such distributions and the continuance of distributions if commenced, will depend on a number of factors, including the amount of cash flow from operations, projected capital expenditures, provision for contingent liabilities, availability of bank refinancing, regulatory or legislative developments governing the cable television industry, and growth in customers. Some of these factors are beyond the control of the Partnership, and consequently, no assurances can be given regarding the level or timing of future distributions, if any. See Item 7., Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSet forth below is selected financial data of the Partnership and of Enstar Cable of Cumberland Valley for the five years ended December 31, 1995.\nTHE PARTNERSHIP\nENSTAR CABLE OF CUMBERLAND VALLEY\n- -------- (1) Operating income before depreciation and amortization. The Joint Venture measures its financial performance by its EBITDA, among other items. Based on its experience in the cable television industry, the Joint Venture believes that EBITDA and related measures of cash flow serve as important financial analysis tools for measuring and comparing cable television companies in several areas, such as liquidity, operating performance and leverage. This is evidenced by the covenants in the primary debt instruments of the Joint Venture, in which EBITDA-derived calculations are used as a measure of financial performance. EBITDA should not be considered by the reader as an alternative to net income as an indicator of the Joint Venture's financial performance or as an alternative to cash flows as a measure of liquidity.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nCompliance with the rules adopted by the Federal Communications Commission (the \"FCC\") to implement the rate regulation provisions of the 1992 Cable Act has had a significant negative impact on the Joint Venture's revenues and cash flow. Based on certain FCC decisions that have been released, however, the Joint Venture's management presently believes that revenues for 1995 reflect the impact of the 1992 Cable Act in all material respects. Moreover, recent policy decisions by the FCC make it more likely that in the future the Joint Venture will be permitted to increase regulated service rates in response to specified cost increases, although certain costs may continue to rise at a rate in excess of that which the Joint Venture will be permitted to pass on to its customers. The FCC has recently adopted a procedure under which cable operators may file abbreviated cost of service showings for system rebuilds and upgrades, the result of which would be a permitted increase in regulated rates to allow recovery of a portion of those costs. The FCC has also proposed a new procedure for the pass-through of increases in inflation and certain external costs, such as programming costs, under which cable operators could increase rates based on actual and anticipated cost increases for the coming year. In addition to these FCC actions, on February 8, 1996, President Clinton signed into law the 1996 Telecom Act. The 1996 Telecom Act revises, among other things, certain rate regulation provisions of the 1992 Cable Act. Given events since the enactment of the 1992 Cable Act, there can also be no assurance as to what, if any, future action may be taken by the FCC, Congress or any other regulatory authority or court, or the effect thereof on the Joint Venture's business. Accordingly, the Joint Venture's historical annual financial results as described below are not necessarily indicative of future performance. See \"Legislation and Regulation\" and \"Liquidity and Capital Resources.\"\nAll of the Partnership's cable television business operations are conducted through its participation as a partner with a 50% interest in Enstar Cable of Cumberland Valley. The Partnership participates equally with its affiliated partner (Enstar Income\/Growth Program Five-A, L.P.) under the Joint Venture Agreement with respect to capital contributions, obligations and commitments, and results of operations. Accordingly, in considering the financial condition and results of operations of the Partnership, consideration must also be made of those matters as they relate to the Joint Venture. The following discussion reflects such consideration and provides a separate discussion for each entity.\nRESULTS OF OPERATIONS\nTHE PARTNERSHIP\nAll of the Partnership's cable television business operations, which began in January 1988, are conducted through its participation as a partner in the Joint Venture. The Joint Venture distributed an aggregate of $132,000, $79,100 and $9,000 to the Partnership, representing the Partnership's pro rata (i.e., 50%) share of the cash flow distributed from the Joint Venture's operations, during 1993, 1994 and 1995, respectively. The Partnership did not pay distributions to its partners during 1993, 1994 or 1995.\nTHE JOINT VENTURE\n1995 COMPARED TO 1994\nThe Joint Venture's revenues increased from $6,173,900 to $6,241,700, or by 1.1%, during 1995 compared to 1994. Of the $67,800 increase in revenues, $184,900 was due to increases in regulated service rates permitted under the 1992 Cable Act that were implemented in April 1995, $76,500 was due to greater numbers of subscriptions for cable service and $53,800 was due to increases in unregulated rates\ncharged for premium services implemented during the fourth quarter of 1994. These increases were partially offset by rate decreases implemented in 1994 to comply with the 1992 Cable Act, estimated by the Joint Venture to be approximately $238,400, and by a $9,000 decrease in other revenue producing items. As of December 31, 1995, the Joint Venture had 17,310 homes subscribing to cable service and 4,252 premium service units.\nService costs for the Joint Venture increased from $2,133,400 to $2,177,600, or by 2.1%, during 1995 compared with 1994. Service costs represent costs directly attributable to providing cable services to customers. Of the $44,200 increase, $99,200 was due to increases in property taxes and $65,300 was due to increases in programming fees charged by program suppliers (including primary satellite fees). These increases were partially offset by a $48,300 increase in the capitalization of labor and overhead expense due to increased capital expenditure activity in 1995, a decrease of $44,200 in repair and maintenance expense, a decrease of $14,000 in personnel costs and a decrease of $10,900 in pole rent expense.\nGeneral and administrative expenses decreased from $931,300 to $786,100, or by 15.6%, during 1995 compared with 1994. Of the $145,200 decrease, $77,500 was due to a decrease in bad debt expense, $26,300 was due to an increase in the capitalization of labor and overhead expense, $22,600 was due to lower marketing expenses and $11,900 was due to lower customer billing costs.\nManagement fees and reimbursed expenses decreased from $592,900 to $562,600, or by 5.1%, during 1995 compared with 1994. Of the $30,300 decrease, $33,700 was due to decreased reimbursable expenses resulting from lower allocated personnel costs and expenses related to reregulation of the cable industry during 1995. Management fees increased by $3,400 in direct relation to increased revenues as described above.\nDepreciation and amortization expense decreased from $3,158,600 to $3,104,900, or by 1.7%, during 1995 compared with 1994, due primarily to the effect of certain tangible assets becoming fully depreciated in 1994 and certain intangible assets becoming fully amortized in 1995. The decrease was partially offset by depreciation of asset additions.\nThe Joint Venture's operating loss decreased from $642,300 to $389,500, or by 39.4%, during 1995 as compared to 1994, primarily due to increased revenues, decreased general and administrative expenses and lower depreciation and amortization expense as described above.\nInterest income increased from $22,100 to $58,600 during 1995 as compared to 1994, due to higher cash balances available for investment and higher interest rates earned on invested funds.\nInterest expense increased from $664,800 to $779,300, or by 17.2%, during 1995 as compared to 1994, due to an increase in the average interest rates paid by the Joint Venture on long-term borrowings (10.3% in 1995 as compared to 8.6% in 1994).\nDue to the factors described above, the Joint Venture's net loss decreased from $1,285,000 to $1,110,200, or by 13.6%, for the year ended December 31, 1995 as compared with 1994.\nOperating income before depreciation and amortization (EBITDA) as a percentage of revenues increased from 40.8% during 1994 to 43.5% in 1995. The increase was primarily due to the increased revenues and lower general and administrative expenses discussed above. Accordingly, EBITDA increased from $2,516,300 to $2,715,400, or by 7.9%, during 1995 compared to 1994.\n1994 COMPARED TO 1993\nThe Joint Venture's revenues decreased from $6,243,400 to $6,173,900, or by 1.1%, during 1994 compared to 1993. Revenues from continuing operations decreased by $12,100 during 1994 as compared to 1993. Revenues for 1993 included $57,400 from the Noel, Missouri cable systems, which were sold in February 1993. Of the net decrease in revenues, $143,600 was estimated to be due to decreases in customer rates that were mandated by the 1992 Cable Act. The decrease was partially offset by increases of $122,800 due to greater numbers of subscriptions for service in 1994, and $8,700 due to other revenue producing items. As of December 31, 1994, the Joint Venture had 17,248 homes subscribing to cable service and 4,406 premium service units.\nService costs for the Joint Venture increased from $2,082,100 to $2,133,400, or by 2.5%, during 1994 compared with 1993. Service costs represent costs directly attributable to providing cable services to customers. Service costs decreased by $23,000 during 1994 as compared to 1993 due to the sale of the Noel systems. Service costs for continuing operations increased by $74,300 for the year ended December 31, 1994 as compared with 1993, primarily due to increases of $92,600 in programming fees charged by program suppliers (including primary satellite fees) and $17,800 in property taxes. The increase in programming expense was also due to expanded programming usage related to channel line-up restructuring and retransmission consent arrangements implemented to comply with the 1992 Cable Act. An increase of $25,900 in capitalized fixed costs related to the rebuild of plant damaged by severe winter weather in Kentucky partially offset increases in service costs during 1994. Franchise fee reductions approximating $21,200 also reduced service cost increases in 1994.\nGeneral and administrative expenses increased from $819,600 to $931,300, or by 13.6%, during 1994 compared with 1993. General and administrative expenses for continuing operations increased by $127,600 primarily due to increased bad debt expense ($91,300), personnel costs ($15,200) and marketing costs ($14,800). Increases in bad debt expense were the result of significantly larger than normal write-offs attributable to severe winter weather in Kentucky. The sale of the Noel, Missouri systems resulted in a decrease of $15,900 in general and administrative expenses during 1994 as compared with 1993.\nManagement fees and reimbursed expenses increased from $569,900 to $592,900, or by 4.0%, during 1994 compared with 1993. Management fees and reimbursed expenses for continuing operations increased $29,800 from $563,100 to $592,900, or by 5.2%, during 1994 compared to the prior year, primarily due to increases of $30,400 in reimbursable expenses payable to the Corporate General Partner. The increases were attributable to higher allocated personnel costs and costs related to compliance with the 1992 Cable Act. The sale of the Noel, Missouri systems resulted in a decrease of $6,800 during 1994 compared with 1993.\nDepreciation and amortization expense increased from $3,012,700 to $3,158,600, or by 4.8%, for the year ended December 31, 1994 compared with the prior year. The sale of the Noel, Missouri systems resulted in a $25,500 decrease during 1994 which was offset by an increase of $171,400 in depreciation and amortization for continuing operations, attributable to depreciation of asset additions and changes in the remaining lives of certain assets.\nThe Joint Venture's operating loss increased from $240,900 to $642,300, during 1994 as compared to 1993, primarily due to lower revenues and higher programming fees, bad debt expense and depreciation and amortization expense as described above.\nInterest expense increased from $439,100 to $664,800, or by 51.4%, for the year ended December 31, 1994 compared to the prior year, due to an increase in the average interest rates paid by the Joint Venture (5.5% in 1993 as compared to 8.6% in 1994).\nInterest income increased from $15,700 to $22,100, or by 40.8%, during 1994 compared with 1993, due to higher cash balances available for investment and higher interest rates earned on invested funds.\nOn February 23, 1993, the Joint Venture sold its Noel, Missouri cable systems and recognized a loss on the sale of $538,900.\nDue to the factors described above, the Joint Venture's net loss increased from $1,203,200 to $1,285,000, or by 6.8%, for the year ended December 31, 1994 as compared with the previous year.\nOperating income before depreciation and amortization (EBITDA) as a percentage of revenues decreased from 44.4% during 1993 to 40.8% in 1994. The change was primarily caused by higher programming fees and bad debt expense. EBITDA decreased from $2,771,800 to $2,516,300, or by 9.2%, during 1994 compared to 1993.\nDistributions Made By The Cumberland Valley Joint Venture\nThe Joint Venture distributed $264,000, $158,200 and $18,000 equally among its two partners during 1993, 1994 and 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nThe FCC's amended rate regulation rules were implemented during the quarter ended September 30, 1994. Compliance with these rules has had a negative impact on the Partnership's revenues and cash flow. See \"Legislation and Regulation.\"\nThe Partnership's primary objective, having invested its net offering proceeds in the Joint Venture, is to distribute to its partners distributions of cash flow received from the Joint Venture's operations and proceeds from the sale of the Joint Venture's cable systems, if any, after providing for expenses, debt service and capital requirements relating to the expansion, improvement and upgrade of such cable systems. The Joint Venture relies upon the availability of cash generated from operations and possible borrowings to fund its ongoing expenses, debt service and capital requirements. In general, these requirements involve expansion, improvement and upgrade of the Joint Venture's existing cable television systems. The Joint Venture has budgeted capital expenditures of approximately $304,400 in 1996, primarily to upgrade certain equipment.\nManagement believes that cash generated by operations of the Joint Venture, together with available cash and proceeds from borrowings, will be adequate to fund capital expenditures in 1996. As a result, the Corporate General Partner intends to use its cash for such purposes. Accordingly, management does not anticipate a resumption of distributions to unitholders during 1996.\nIn December 1993, the Joint Venture obtained a $9,000,000 reducing revolving credit facility (the \"Facility\") maturing on September 30, 1999. The Facility is secured by substantially all of the Joint Venture's assets. Interest is payable at the Base Rate plus 1.50%. \"Base Rate\" means the higher of the Lender's prime rate or the Federal Funds Effective Rate plus 1\/2%. The Facility provides for quarterly reductions of the maximum commitment beginning on September 30, 1994 which are payable at the end of each fiscal quarter. The Joint Venture is permitted to prepay amounts outstanding under the Facility at any time without penalty, and is able to reborrow throughout the term of the Facility up to the maximum commitment then available so long as no event of default exists. The Joint Venture is also required to pay a commitment fee of 1\/2% per annum on the unused portion of the Facility. The Facility contains certain financial tests and other covenants including, among others, restrictions on capital expenditures, incurrence of indebtedness, distributions and investments, sale of assets, acquisitions, and other covenants, defaults and conditions. The Joint Venture believes that it was in compliance with its loan covenants as of December 31,\n1995. The Joint Venture's maximum commitment of $8,200,000 at December 31, 1995 will decrease by $1,350,000 in 1996 to $6,850,000, which will not require any repayment since the outstanding balance under the Facility at December 31, 1995 was $6,767,200.\n1995 VS. 1994\nThe Partnership used $23,200 more cash in operating activities during 1995 as compared with 1994, primarily due to a $44,000 increase in the payment of liabilities owed to the Corporate General Partner and third party creditors, and a $4,300 increase in receivable balances. Partnership expenses used $25,100 less cash in 1995 than in 1994 after adding back non-cash equity in net loss of Joint Venture.\nCash provided by financing activities decreased by $70,100 during 1995 as compared with 1994 due to decreased distributions from the Cumberland Valley Joint Venture.\n1994 VS. 1993\nThe Partnership used $98,700 less cash in operating activities during 1994 than in 1993, primarily due to a decrease of $107,100 in the payment of liabilities owed to the Corporate General Partner and third party creditors. Partnership expenses used $8,400 more cash during 1994 than in 1993 after adding back non-cash equity in net loss of Joint Venture.\nCash provided by financing activities decreased by $52,900 during 1994 as compared with 1993 due to decreased distributions from the Cumberland Valley Joint Venture.\nRECENT ACCOUNTING PRONOUNCEMENTS\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. In such cases, impairment losses are to be recorded based on estimated fair value, which would generally approximate discounted cash flows. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Partnership 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.\nINFLATION\nCertain of the Partnership's and Joint Venture's expenses, such as those for wages and benefits, equipment repair and replacement, and billing and marketing generally increase with inflation. However, the Partnership does not believe that its financial results have been, or will be, adversely affected by inflation in a material way , provided that the Joint Venture is able to increase its service rates periodically, of which there can be no assurance. See \"Legislation and Regulation.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and related financial information required to be filed hereunder are indexed 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 General Partners of the Partnership may be considered, for certain purposes, the functional equivalents of directors and executive officers. The Corporate General Partner is Enstar Communications Corporation, and Robert T. Graff, Jr. is the Individual General Partner. As part of Falcon Cablevision's September 30, 1988 acquisition of the Corporate General Partner, Falcon Cablevision received an option to acquire Mr. Graff's interest as Individual General Partner of the Partnership and other affiliated cable limited partnerships that he previously co-sponsored with the Corporate General Partner, and Mr. Graff received the right to cause Falcon Cablevision to acquire such interests. These arrangements were modified and extended in an amendment dated September 10, 1993 pursuant to which, among other things, the Corporate General Partner obtained the option to acquire Mr. Graff's interest in lieu of the purchase right described above which was originally granted to Falcon Cablevision.\nSince its incorporation in Georgia in 1982, the Corporate General Partner has been engaged in the cable\/telecommunications business, both as a general partner of 15 limited partnerships formed to own and operate cable television systems and through a wholly-owned operating subsidiary. As of December 31, 1995, the Corporate General Partner managed cable television systems with approximately 126,200 Subscribers.\nFalcon Cablevision was formed in 1984 as a California limited partnership and has been engaged in the ownership and operation of cable television systems since that time. Falcon Cablevision is a wholly-owned subsidiary of FHGLP. FHGI is the sole general partner of FHGLP. FHGLP currently operates cable systems through a series of affiliated limited partnerships, including Falcon Cablevision, Falcon Cable Systems Company, Falcon Telecable, Falcon Cable Media, Falcon Classic Cable Income Properties, Falcon First Communications, Falcon Community Cable and Falcon Video Communications, and also controls the general partners of the 15 limited partnerships which operate under the Enstar name (including the Partnership). Although these limited partnerships are affiliated with FHGLP, their assets are owned by legal entities separate from the Partnership.\nSet forth below is certain general information about the Directors and Executive Officers of the Corporate General Partner, all of whom have served in such capacities since October 1988:\nMARC B. NATHANSON, 50, has been Chairman of the Board, Chief Executive Officer and President of FHGI and its predecessors since 1975. Prior to 1975, Mr. Nathanson was Vice President of Marketing for Teleprompter Corporation, at that time the largest multiple-system cable operator in the United States. He also held executive positions with Warner Cable and Cypress Communications Corporation. He is a former President of the California Cable Television Association and a member of Cable Pioneers. He is currently a Director of the National Cable Television Association (\"NCTA\") and serves on its Executive Committee. At the 1986 NCTA convention, Mr. Nathanson was honored by being named the recipient of the Vanguard Award for outstanding contributions to the growth and development of the cable television industry. Mr. Nathanson is a 26-year veteran of the cable television industry. He is a founder of the Cable Television Administration and Marketing Society (\"CTAM\") and the Southern California Cable Television Association. Mr. Nathanson is also a Director of TV Por Cable Nacional, S.A. de C.V. Mr. Nathanson is also\nChairman of the Board and Chief Executive Officer of Falcon International Communications, LLC (\"FIC\"). Mr. Nathanson was appointed by President Clinton and confirmed by the U.S. Senate for a three year term on the Board of Governors of International Broadcasting of the United States Information Agency.\nFRANK J. INTISO, 49, has been Executive Vice President and Chief Operating Officer of FHGI and its predecessors since 1982. Mr. Intiso has been President and Chief Operating Officer of Falcon Cable Group since its inception. Mr. Intiso is responsible for the day-to-day operations of all cable television systems under the management of FHGI. Mr. Intiso has a Master's Degree in Business Administration from the University of California, Los Angeles, and is a Certified Public Accountant. He serves as chair of the California Cable Television Association, and is on the boards of Cable Advertising Bureau, Cable In The Classroom, Community Antenna Television Association and California Cable Television Association. He is a member of the American Institute of Certified Public Accountants, the American Marketing Association, the American Management Association, and the Southern California Cable Television Association.\nSTANLEY S. ITSKOWITCH, 57, has been a Director of FHGI and its predecessors since 1975, and Senior Vice President and General Counsel from 1987 to 1990 and has been Executive Vice President and General Counsel since February 1990. He has been President and Chief Executive Officer of F.C. Funding, Inc. (formerly Fallek Chemical Company), which is a marketer of chemical products, since 1980. He is a Certified Public Accountant and a former tax partner in the New York office of Touche Ross & Co. (now Deloitte & Touche). He has a J.D. Degree and an L.L.M. Degree in Tax from New York University School of Law. Mr. Itskowitch is also Executive Vice President and General Counsel of FIC.\nMICHAEL K. MENEREY, 44, has been Chief Financial Officer and Secretary of FHGI and its predecessors since 1984 and has been Chief Financial Officer and Secretary of Falcon Cable Group since its inception. Mr. Menerey is a Certified Public Accountant and is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.\nCERTAIN KEY PERSONNEL\nThe following sets forth, as of December 31, 1995, biographical information about certain officers of FHGI and Falcon Cable Group, a division of FHGLP, who share certain responsibilities with the officers of the Corporate General Partner with respect to the operation and management of the Partnership.\nJAMES V. ASHJIAN, 51, has been Controller of FHGI and its predecessors since October 1985 and Controller of Falcon Cable Group since its inception. Mr. Ashjian is a Certified Public Accountant and was a partner in Bider & Montgomery, a Los Angeles-based CPA firm, from 1978 to 1983, and self-employed from 1983 to October 1985. He is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.\nLYNNE A. BUENING, 42, has been Vice President of Programming of Falcon Cable Group since November 1993. From 1989 to 1993, she served as Director of Programming for Viacom Cable, a division of Viacom International Inc. Prior to that, Ms. Buening held programming and marketing positions in the cable, broadcast, and newspaper industries.\nOVANDO COWLES, 42, has been Vice President of Advertising Sales and Production of Falcon Cable Group since January 1992. From 1988 to 1991, he served as a Director of Advertising Sales and Production at Cencom Cable Television in Pasadena, California. He was an Advertising Sales Account Executive at Choice Television from 1985 to 1988. From 1983 to 1985, Mr. Cowles served in various sales and advertising positions.\nHOWARD J. GAN, 49, has been Vice President of Corporate Development and Government Affairs of FHGI and its predecessors since 1988 and Vice President of Corporate Development and Government Affairs of Falcon Cable Group since its inception. He was General Counsel at Malarkey-Taylor Associates, a Washington, DC based telecommunications consulting firm, from 1986 to 1988. He was Vice President and General Counsel at the Cable Television Information Center from 1978 to 1983. In addition, he was an attorney and an acting Branch Chief of the Federal Communications Commission's Cable Television Bureau from 1975 to 1978.\nR.W. (\"SKIP\") HARRIS, 48, has been Vice President of Marketing of Falcon Cable Group since June 1991. He is a member of the CTAM Premium Television Committee. Mr. Harris was National Director of Affiliate Marketing for the Disney Channel from 1985 to 1991. He was also a sales manager, regional marketing manager and director of marketing for Cox Cable Communications from 1978 to 1985.\nJOE A. JOHNSON, 51, has been Executive Vice President - Operations of FHGI since September 1995, and between January 1992 and that date was Senior Vice President of Falcon Cable Group. He was a Divisional Vice President of FHGI between 1989 and 1992 and a Divisional Vice President of Falcon Cable Group from its inception until 1992. From 1982 to 1989, he held the positions of Vice President and Director of Operations for Sacramento Cable Television, Group W Cable of Chicago and Warner Amex. From 1975 to 1982, Mr. Johnson held Cable System and Regional Manager positions with Warner Amex and Teleprompter.\nJON W. LUNSFORD, 36, has been Vice President - Finance and Corporate Development FHGI since September 1994. From 1991 to 1994 he served as Director of Corporate Finance at Continental Cablevision, Inc. Prior to 1991, Mr. Lunsford was a Vice President with Crestar Bank.\nJOAN SCULLY, 60, has been Vice President of Human Resources of FHGI and its predecessors since May 1988 and Vice President of Human Resources of Falcon Cable Group since its inception. From 1987 to May 1988, she was self-employed as a Management Consultant to cable and transportation companies. She served as Director of Human Resources of a Los Angeles based cable company from 1985 through 1987. Prior to that time she served as a human resource executive in the entertainment and aerospace industries. Ms. Scully holds a Masters Degree in Human Resources Management from Pepperdine University.\nMICHAEL D. SINGPIEL, 48, was appointed Vice President of Operations of Falcon Cable Group in March 1996. Mr. Singpiel joined Falcon in October 1992 as Divisional Vice President of Falcon's Eastern Division. From 1990 to 1992, Mr. Singpiel was Vice President of C-Tec Cable Systems in Michigan. Mr. Singpiel held various positions with Comcast in New Jersey and Michigan from 1980 to 1990.\nRAYMOND J. TYNDALL, 48, has been Vice President of Engineering of Falcon Cable Group since October 1989. From 1975 to September 1989 he held various technical positions with Choice TV and its predecessors. From 1967 to 1975, he held various technical positions with Sammons Communications. He is a certified National Association of Radio and Television Engineering (\"NARTE\") engineer in lightwave, microwave, satellite and broadband.\nIn addition, Falcon Cable Group has six Divisional Vice Presidents who are based in the field. They are Ron L. Hall, Michael E. Kemph, Nicholas A. Nocchi, Larry L. Ott, Robert S. Smith and Victor A. Wible.\nEach director of the Corporate General Partner is elected to a one-year term at the annual shareholder meeting to serve until the next annual shareholder meeting and thereafter until his respective successor is elected and qualified. Officers are appointed by and serve at the discretion of the directors of the Corporate General Partner.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nMANAGEMENT FEE\nThe Partnership has a management agreement (the \"Management Agreement\") with Enstar Cable Corporation, a wholly owned subsidiary of the Corporate General Partner (the \"Manager\"), pursuant to which Enstar Cable Corporation manages the Joint Venture's systems and provides all operational support for the activities of the Partnership and Joint Venture. For these services, the Manager receives a management fee of 5% of gross revenues, excluding revenues from the sale of cable television systems or franchises, calculated and paid monthly. In addition, the Partnership reimburses the Manager for certain operating expenses incurred by the Manager in the day-to-day operation of the Partnership's cable systems. The Management Agreement also requires the Partnership to indemnify the Manager (including its officers, employees, agents and shareholders) against loss or expense, absent negligence or deliberate breach by the Manager of the Management Agreement. The Management Agreement is terminable by the Partnership upon sixty (60) days written notice to the Manager. The Manager has engaged FHGLP to provide certain management services for the Partnership and pays FHGLP a portion of the management fees it receives in consideration of such services and reimburses FHGLP for expenses incurred by FHGLP on its behalf. The Corporate General Partner also performs certain supervisory and administrative services for the Partnership, for which it is reimbursed.\nFor the fiscal year ended December 31, 1995, the Joint Venture paid approximately $249,700 of management fees and $250,500 of reimbursed expenses. In addition, the Joint Venture paid the Corporate General Partner approximately $62,400 in respect of its 1% special interest in the Joint Venture. Certain programming services are purchased through Falcon Cablevision. The Joint Venture paid Falcon Cablevision approximately $1,136,500 for these programming services for fiscal year 1995.\nPARTICIPATION IN DISTRIBUTIONS\nThe General Partners are entitled to share in distributions from, and profit and losses in, the Partnership. See Item 5, \"Market for Registrant's Equity Securities and Related Security Holder Matters.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of March 3, 1995, the common stock of FHGI was owned as follows: 78.5% by Falcon Cable Trust, a grantor trust of which Marc B. Nathanson is trustee and he and members of his family are beneficiaries; 20% by Greg A. Nathanson; and 1.5% by Stanley S. Itskowitch. In connection with the formation of Falcon Community Cable, on August 15, 1989, FHGI issued to Hellman & Friedman Capital Partners, A California Limited Partnership (\"H&F\"), a $1,293,357 convertible debenture due 1999 convertible under certain circumstances into 10% of the common stock of FHGI and entitling H&F to elect one director to the board of directors of FHGI. H&F elected Marc B. Nathanson pursuant to such right. In 1991 FHGI issued to Hellman & Friedman Capital Partners II, A California Limited Partnership (\"H&FII\"), additional convertible debentures due 1999 in the aggregate amount of $2,006,198 convertible under certain circumstances into approximately 6.3% of the common stock of FHGI and entitling H&FII to elect one director to the board of directors of FHGI. As of March 3, 1996, H&FII had not exercised this right. FHGLP also held 12.1% of the interests in the General Partner, and Falcon Cable Trust, Frank Intiso, H&FII and two other individuals held 58.9%, 12.1%, 16.3% and 0.6% of the General Partner, respectively. Such interests entitle the holders thereof to an allocable share of cash distributions and profits and losses of the General Partner in proportion to their ownership. Greg A. Nathanson is Marc B. Nathanson's brother.\nAs of March 3, 1996, Marc B. Nathanson and members of his family owned, directly or indirectly, outstanding partnership interests (comprising both general partner interests and limited partner interests) aggregating approximately 0.46% of Falcon Classic Cable Income Properties, L.P., 2.58% of Falcon Video Communications and 30.0% of Falcon Cable Systems Company. In accordance with the respective partnership agreements of the partnerships mentioned above, after the return of capital to and the receipt of certain preferred returns by the limited partners of such partnerships, FHGLP and certain of its officers and directors had rights to future profits greater than their ownership interests of capital in such partnerships.\nOn March 29, 1993, FHGLP was organized to effect the consolidation of certain cable television businesses, including Falcon Cablevision, Falcon Telecable, Falcon Cable Media and Falcon Community Cable, into FHGLP. At the same time FHGLP assumed the cable system management operations of FHGI. On December 28, 1995, FHGLP acquired the remaining 72.3% of outstanding shares of common stock of Falcon First, Inc., (\"First\"), that it did not previously own. First was an affiliated entity prior to December 28, 1995. The ownership interests in FHGLP are as follows: Falcon management, directors and affiliated individuals and entities: 38.2% (including 35.3% owned by Marc B. Nathanson and members of his family directly or indirectly), H&F and H&FII: 35.9%, Leeway & Co.: 10.9%, Boston Ventures Limited Partnership II and Boston Ventures II-A Investment Corporation: 6.9%, Falcon First Communications, LLC: 2.1% and other institutional investors, individuals and trusts: 6.0%.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCONFLICTS OF INTEREST\nIn March 1993, FHGLP, a new entity, assumed the management services operations of FHGI. Effective March 29, 1993, FHGLP began receiving management fees and reimbursed expenses which had previously been paid by the Partnership, as well as the other affiliated entities mentioned above, to FHGI. The management of FHGLP is substantially the same as that of FHGI.\nFHGLP also manages the operations of Falcon Cable Systems Company, Falcon Classic Cable Income Properties, L.P., Falcon Video Communications, L.P., and, through its management of the operation of Falcon Cablevision (a subsidiary of FHGLP), the partnerships of which Enstar Communications Corporation is the Corporate General Partner, including the Partnership. On September 30, 1988, Falcon Cablevision acquired all of the outstanding stock of Enstar Communications Corporation. Certain members of management of the General Partner have also been involved in the management of other cable ventures. FHGLP contemplates entering into other cable ventures, including ventures similar to the Partnership.\nConflicts of interest involving acquisitions and dispositions of cable television systems could adversely affect Unitholders. For instance, the economic interests of management in other affiliated partnerships are different from those in the Partnership and this may create conflicts relating to which acquisition opportunities are preserved for which partnerships.\nThese affiliations subject FHGLP and the General Partner and their management to certain conflicts of interest. Such conflicts of interest relate to the time and services management will devote to the Partnership's affairs and to the acquisition and disposition of cable television systems. Management or its affiliates may establish and manage other entities which could impose additional conflicts of interest.\nFHGLP and the Corporate General Partner will resolve all conflicts of interest in accordance with their fiduciary duties.\nFIDUCIARY RESPONSIBILITY AND INDEMNIFICATION OF THE GENERAL PARTNERS\nA general partner is accountable to a limited partnership as a fiduciary and consequently must exercise good faith and integrity in handling partnership affairs. Where the question has arisen, some courts have held that a limited partner may institute legal action on his own behalf and on behalf of all other similarly situated limited partners (a class action) to recover damages for a breach of fiduciary duty by a general partner, or on behalf of the partnership (a partnership derivative action) to recover damages from third parties. The Georgia Revised Uniform Limited Partnership Act also allows a partner to maintain a partnership derivative action if general partners with authority to do so have refused to bring the action or if an effort to cause those general partners to bring the action is not likely to succeed. Certain cases decided by federal courts have recognized the right of a limited partner to bring such actions under the Securities and Exchange Commission's Rule 10b-5 for recovery of damages resulting from a breach of fiduciary duty by a general partner involving fraud, deception or manipulation in connection with the limited partner's purchase or sale of partnership units.\nThe partnership agreement provides that the General Partners will be indemnified by the Partnership for acts performed within the scope of their authority under the partnership agreement if such general partner (i) acted in good faith and in a manner that it reasonably believed to be in, or not opposed to, the best interests of the Partnership and the partners, and (ii) had no reasonable grounds to believe that its conduct was negligent. In addition, the partnership agreement provides that the General Partners will not be liable to the Partnership or its limited partners for errors in judgment or other acts or omissions not amounting to negligence or misconduct. Therefore, limited partners will have a more limited right of action than they would have absent such provisions. In addition, the Partnership maintains insurance on behalf of the General Partner, and such other persons as the General Partner shall determine against any liability that may be asserted against or expense that may be incurred by such person and against which the Partnership would be entitled to indemnify such person pursuant to the Partnership Agreement. To the extent that the exculpatory provisions purport to include indemnification for liabilities arising under the Securities Act of 1933, it is the opinion of the Securities and Exchange Commission that such indemnification is contrary to public policy and therefore unenforceable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES\nAND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nReference is made to the Index to Financial Statements on page .\n(a) 2. Financial Statement Schedules\nReference is made to the Index to Financial Statements on page .\n(a) 3. Exhibits\nReference is made to the Index to Exhibits on Page E-1.\n(b) Reports on Form 8-K\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 25, 1996.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nBy: Enstar Communications Corporation, Corporate General Partner\nBy: \/s\/ Marc B. Nathanson ----------------------------------- Marc B. Nathanson President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n(*) Indicates position(s) held with Enstar Communications Corporation, the Corporate General Partner of the registrant.\nAll schedules have been omitted because they are either not required, not applicable or the information has otherwise been supplied.\nREPORT OF INDEPENDENT AUDITORS\nPartners Enstar Income\/Growth Program Five-B, L.P. (A Georgia Limited Partnership)\nWe have audited the balance sheets of Enstar Income Program Five-B, L.P. (A Georgia Limited Partnership) as of December 31, 1994 and 1995, and the related statements of operations, partnership capital (deficit), and cash flows for the years then ended. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. The statements of operations, partnership capital (deficit), and cash flows of Enstar Income\/Growth Program Five-B, L.P. for the year ended December 31, 1993 were audited by other auditors whose report dated February 23, 1994, expressed an unqualified opinion on those 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 Enstar Income Program Five-B, L.P. at December 31, 1994 and 1995, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP\nLos Angeles, California February 20, 1996\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nBALANCE SHEETS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nSTATEMENTS OF OPERATIONS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nSTATEMENTS OF PARTNERSHIP CAPITAL (DEFICIT)\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nSTATEMENTS OF CASH FLOWS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nSUMMARY OF ACCOUNTING POLICIES\n==============================\nFORM OF PRESENTATION\nEnstar Income\/Growth Program Five-B, L.P., a Georgia limited partnership (the \"Partnership\"), pays no income taxes as an entity. All of the income, gains, losses, deductions and credits of the Partnership are passed through to the general partners and the limited partners. Nominal taxes are assessed by certain state jurisdictions. The basis in the Partnership's assets and liabilities differs for financial and tax reporting purposes. At December 31, 1995, the book basis of the Partnership's net assets exceeds its tax basis by $1,342,400.\nThe financial statements do not give effect to any assets that the partners may have outside of their interest in the Partnership, nor to any obligations, including income taxes, of the partners.\nINVESTMENT IN JOINT VENTURE\nThe Partnership's investment and share of the income or loss in the Joint Venture is accounted for on the equity method of accounting.\nEARNINGS PER UNIT OF LIMITED PARTNERSHIP INTEREST\nEarnings and losses are allocated 99% to the limited partners and 1% to the general partners. Earnings and losses per unit of limited partnership interest are based on the weighted average number of units 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nNOTES TO FINANCIAL STATEMENTS\n==============================\nNOTE 1 - PARTNERSHIP MATTERS\nThe Partnership was formed on September 4, 1986 to acquire, construct or improve, develop, and operate cable television systems in various locations in the United States. The partnership agreement provides for Enstar Communications Corporation (the \"Corporate General Partner\") and Robert T. Graff, Jr. to be the general partners and for the admission of limited partners through the sale of interests in the Partnership.\nOn September 30, 1988, Falcon Cablevision, a California limited partnership, purchased all of the outstanding capital stock of the Corporate General Partner.\nThe Partnership was formed with an initial capital contribution of $1,100 comprised of $1,000 from the Corporate General Partner and $100 from the initial limited partner. Sale of interests in the Partnership began in January 1987, and the initial closing took place in March 1987. The Partnership continued to raise capital until $15,000,000 (the maximum) was sold in July 1987.\nThe amended partnership agreement generally provides that all cash distributions (as defined) be allocated 1% to the general partners and 99% to the limited partners until the limited partners have received aggregate cash distributions equal to their original capital contributions (\"Capital Payback\"). The partnership agreement also provides that all partnership profits, gains, operational losses, and credits (all as defined) be allocated 1% to the general partners and 99% to the limited partners until the limited partners have been allocated net profits equal to the amount of cash flow required for Capital Payback. After the limited partners have received cash flow equal to their initial investments, the general partners will only receive a 1% allocation of cash flow from sale or liquidation of a system until the limited partners have received an annual simple interest return of at least 10% of their initial investments less any distributions from previous system sales or refinancing of systems. Thereafter, the respective allocations will be made 20% to the general partners and 80% to the limited partners. Any losses from system sales or exchanges shall be allocated first to all partners having positive capital account balances (based on their respective capital accounts) until all such accounts are reduced to zero and thereafter to the Corporate General Partner. All allocations to individual limited partners will be based on their respective limited partnership ownership interests.\nUpon the disposition of substantially all of the Partnership's assets, gains shall be allocated first to the limited partners having negative capital account balances until their capital accounts are increased to zero, next equally among the general partners until their capital accounts are increased to zero, and thereafter as outlined in the preceding paragraph. Upon dissolution of the Partnership, any negative capital account balances remaining after all allocations and distributions are made must be funded by the respective partners.\nThe Partnership's operating expenses and distributions to partners are funded primarily from distributions received from the Joint Venture.\nENSTAR INCOME\/GROWTH PROGRAM FIVE-B, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONCLUDED)\n==============================\nNOTE 2 - EQUITY IN NET ASSETS OF JOINT VENTURE\nThe Partnership and an affiliate partnership (Enstar Income\/Growth Program Five-A, L.P.) each own 50% of Enstar Cable of Cumberland Valley, a Georgia general partnership (the \"Joint Venture\"). The Joint Venture was initially funded through capital contributions made by each venturer during 1988 totaling $11,821,000 in cash and $750,000 in capitalized system acquisition and related costs. Each partnership shares equally in the profits and losses of the Joint Venture. The Joint Venture incurred losses of $1,203,200, $1,285,000 and $1,110,200 in 1993, 1994 and 1995 of which $601,600, $642,500 and $555,100 were allocated to the Partnership. The operations of the Joint Venture are significant to the Partnership and should be reviewed in conjunction with these financial statements. Reference is made to the accompanying financial statements of the Joint Venture on pages to of this Form 10-K, which should be read in connection with these financial statements.\nNOTE 3 - TRANSACTIONS WITH THE GENERAL PARTNERS AND AFFILIATES\nThe Partnership has a management and service agreement (the \"Agreement\") with a wholly owned subsidiary of the Corporate General Partner (the \"Manager\") for a monthly management fee of 5% of gross receipts, as defined, from the operations of the Partnership. The Partnership did not own or operate any cable television operations in 1993, 1994 or 1995 other than through its investment in the Joint Venture. No management fees were paid by the Partnership during 1993, 1994 and 1995.\nThe Agreement also provides that the Partnership will reimburse the Manager for direct expenses incurred on behalf of the Partnership and for the Partnership's allocable share of operational costs associated with services provided by the Manager. Reimbursed expenses totaled approximately $24,500 and $26,100 in 1993 and 1994. No reimbursed expenses were incurred on behalf of the Partnership during 1995.\nNOTE 4 - COMMITMENTS\nThe Partnership, together with Enstar 5-A, L.P., pledged its Joint Venture interest as collateral against the debt of the Joint Venture.\nREPORT OF INDEPENDENT AUDITORS\nTo the Venturers of Enstar Cable of Cumberland Valley\nWe have audited the balance sheets of Enstar Cable of Cumberland Valley as of December 31, 1994 and 1995, and the related statements of operations, venturers' capital, and cash flows for the years then ended. 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. The statements of operations, venturers' capital, and cash flows of Enstar Cable of Cumberland Valley for the year ended December 31, 1993 were audited by other auditors whose report thereon dated February 16, 1994, expressed an unqualified opinion on those 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 Enstar Cable of Cumberland Valley at December 31, 1994 and 1995, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP\nLos Angeles, California February 20, 1996\nENSTAR CABLE OF CUMBERLAND VALLEY\nBALANCE SHEETS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR CABLE OF CUMBERLAND VALLEY\nSTATEMENTS OF OPERATIONS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR CABLE OF CUMBERLAND VALLEY\nSTATEMENTS OF VENTURERS' CAPITAL\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR CABLE OF CUMBERLAND VALLEY\nSTATEMENTS OF CASH FLOWS\n==============================\nSee accompanying summary of accounting policies and notes to financial statements.\nENSTAR CABLE OF CUMBERLAND VALLEY\nSUMMARY OF ACCOUNTING POLICIES\n=================================\nFORM OF PRESENTATION\nEnstar Cable of Cumberland Valley, a Georgia general partnership (the \"Joint Venture\") operates cable systems in rural areas of Kentucky, Arkansas and Missouri. As a Partnership, the Joint Venture pays no income taxes. All of the income, gains, losses, deductions and credits of the Joint Venture are passed through to the Joint Venturers. Nominal taxes are assessed by certain state jurisdictions. The basis in the Joint Venture's assets and liabilities differ for financial and tax reporting purposes. At December 31, 1995, the book basis of the Joint Venture's net assets exceeds its tax basis by $2,684,800.\nThe financial statements do not give effect to any assets that the Joint Venturers may have outside of their interest in the Joint Venture, nor to any obligations, including income taxes, of the Joint Venturers.\nCASH EQUIVALENTS\nFor purposes of the statements of cash flows, the Joint Venture considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents.\nCABLE MATERIALS, EQUIPMENT AND SUPPLIES\nCable materials, equipment and supplies are stated at cost using the first-in first-out method. These items are capitalized until they are used for system upgrades, subscriber installations or repairs to existing systems. At such time, they are either transferred to property, plant and equipment or expensed as appropriate.\nPROPERTY, PLANT, EQUIPMENT AND DEPRECIATION AND AMORTIZATION\nProperty, plant and equipment are stated at cost. Direct costs associated with installations in homes not previously served by cable are capitalized as part of the distribution system, and reconnects are expensed as incurred. For financial reporting, depreciation and amortization is computed using the straight-line method over the following estimated useful lives:\nCable television systems 5-15 years\nVehicles 3 years\nFurniture and equipment 5-7 years\nLeasehold improvement Life of lease\nFRANCHISE COST\nThe excess of cost over the fair values of tangible assets and customer lists of cable television systems acquired represents the cost of franchises. In addition, franchise cost includes capitalized costs incurred in obtaining new, undeveloped franchises. These costs (primarily legal fees) are direct and\nENSTAR CABLE OF CUMBERLAND VALLEY\nSUMMARY OF ACCOUNTING POLICIES (CONCLUDED)\n=================================\nFRANCHISE COST (Continued)\nincremental to the acquisition of the franchise and are amortized using the straight-line method over the lives of the franchises, ranging up to 15 years. The Joint Venture periodically evaluates the amortization periods of these intangible assets to determine whether events or circumstances warrant revised estimates of useful lives. Costs relating to unsuccessful franchise applications are charged to expense when it is determined that the efforts to obtain the franchise will not be successful.\nDEFERRED LOAN COSTS AND OTHER DEFERRED CHARGES\nCosts related to obtaining new loan agreements are capitalized and amortized to interest expense over the life of the related loan. Other deferred charges are amortized using the straight-line method over two to five years.\nRECOVERABILITY OF ASSETS\nThe Joint Venture assesses on an on-going basis the recoverability of intangible assets and capitalized plant assets based on estimates of future undiscounted cash flows compared to net book value. If the future undiscounted cash flow estimate were less than net book value, net book value would then be reduced to the undiscounted cash flow estimate. The Joint Venture also evaluates the amortization periods of assets to determine whether events or circumstances warrant revised estimates of useful lives.\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. In such cases, impairment losses are to be recorded based on estimated fair value, which would generally approximate discounted cash flows. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Joint Venture 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.\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.\nREVENUE RECOGNITION\nRevenues from cable services are recognized as the services are provided.\nRECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform to the 1995 presentation.\nENSTAR CABLE OF CUMBERLAND VALLEY\nNOTES TO FINANCIAL STATEMENTS\n=================================\nNOTE 1 - JOINT VENTURE MATTERS\nThe Joint Venture was formed under the terms of a general partnership agreement (the \"Partnership Agreement\") effective January 11, 1988 between Enstar Income\/Growth Program Five-A, L.P. and Enstar Income\/Growth Program Five-B, L.P. (collectively, the \"Venturers\"), which are two limited partnerships sponsored by Enstar Communications Corporation (the \"Corporate General Partner\"). The Joint Venture was formed to pool the resources of the two limited partnerships to acquire, own, operate and dispose of certain cable television systems.\nOn September 30, 1988, Falcon Cablevision, a California limited partnership, purchased all of the outstanding capital stock of the Corporate General Partner.\nUnder the terms of the Partnership Agreement, the Venturers share equally in profits, losses, allocations and assets. Capital contributions, as required, are also made equally.\nNOTE 2 - INSURANCE CLAIM RECEIVABLE\nInsurance claim receivable consists of an uncollected insurance claim arising from storm related system damage incurred in 1994. The Joint Venture is currently in negotiations with the insurance company to settle the outstanding claim and believes it is fully collectible.\nNOTE 3- PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of:\nNOTE 4 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and Cash Equivalents\nThe carrying amount approximates fair value due to the short maturity of these instruments.\nENSTAR CABLE OF CUMBERLAND VALLEY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n=================================\nNOTE 4 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)\nNote Payable\nThe carrying amount approximates fair value due to the variable rate nature of the note payable.\nNOTE 5 - NOTE PAYABLE\nDuring 1993, the Joint Venture entered into a $9,000,000 reducing revolving line of credit agreement (the \"Credit Agreement\") with a final maturity of September 30, 1999. The Credit Agreement provides for quarterly reductions of the maximum commitment which commenced September 30, 1994, permanently reducing the maximum available borrowings under the Credit Agreement. The commitment reduces in quarterly installments of $250,000 through June 30, 1996, $425,000 through June 30, 1997, $500,000 through June 30, 1998, $550,000 through June 30, 1999 and a final payment of $1,800,000 on September 30, 1999. Repayment of principal is required to the extent the loan balance then outstanding exceeds the reduced maximum commitment.\nThe Joint Venture will be permitted to prepay amounts outstanding under the Credit Agreement at any time without penalty, and will be able to reborrow throughout the term of the Credit Agreement up to the maximum commitment then available so long as no event of default exists.\nBorrowings bear interest at the lender's base rate (8.5% at December 31, 1995), as defined, plus 1.5%, payable quarterly. The Joint Venture is also required to pay a commitment fee of .5% per annum on the unused portion of the revolver. Borrowings under the Credit Agreement are collateralized by substantially all assets of the Joint Venture and by a pledge of the Venturers' interests in the Joint Venture. The Joint Venture has substantially utilized its borrowing capacity under the note payable.\nThe Credit Agreement contains various requirements and restrictions including maintenance of minimum operating results, required financial reporting, restrictions on sales of assets and limitations on investments, loans and advances. According to the Credit Agreement, the lender may also require that at least 50% of borrowings under the Credit Agreement be subject to a fixed rate of interest for a period of at least two years. Management believes that the Venture was in compliance with all covenants at December 31, 1995.\nPrincipal maturities of the note payable as of December 31, 1995 are as follows:\nENSTAR CABLE OF CUMBERLAND VALLEY\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n=================================\nNOTE 6 - COMMITMENTS AND CONTINGENCIES\nThe Joint Venture leases buildings and tower sites associated with the systems under operating leases expiring in various years through 2002.\nFuture minimum rental payments under non-cancelable leases that have remaining terms in excess of one year as of December 31, 1995 are as follows:\nRentals, other than pole rentals, charged to operations approximated $48,100, $49,200 and $48,400 in 1993, 1994 and 1995, respectively, while pole rental expense approximated $112,800, $106,700 and $95,800 in 1993, 1994 and 1995, respectively.\nThe Joint Venture is subject to regulation by various federal, state and local government entities. The Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") provides for, among other things, federal and local regulation of rates charged for basic cable service, cable programming services and equipment and installation services. Regulations issued in 1993 and significantly amended in 1994 by the Federal Communications Commission (the \"FCC\") have resulted in changes in the rates charged for the Joint Venture's cable services. The Joint Venture believes that compliance with the 1992 Cable Act has had a significant negative impact on its operations and cash flow. It also believes that any potential future liabilities for refund claims or other related actions would not be material. The Telecommunications Act of 1996 (the \"1996 Telecom Act\") was signed into law on February 8, 1996. This statute contains a significant overhaul of the federal regulatory structure. As it pertains to cable television, the 1996 Telecom Act, among other things, (i) ends the regulation of certain nonbasic programming services in 1999; (ii) expands the definition of effective competition, the existence of which displaces rate regulation; (iii) eliminates the restriction against the ownership and operation of cable systems by telephone companies within their local exchange service areas; and (iv) liberalizes certain of the FCC's cross-ownership restrictions. The FCC will have to conduct a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Telecom Act.\nENSTAR CABLE OF CUMBERLAND VALLEY\nNOTES TO FINANCIAL STATEMENTS (CONCLUDED)\n=================================\nNOTE 6 - COMMITMENTS AND CONTINGENCIES (Continued)\nThe attorneys general of approximately 25 states have announced the initiation of investigations designed to determine whether cable television systems in their states have acted in compliance with the FCC's rate regulations.\nA recent federal court decision could if upheld and if adopted by other federal courts, make the renewal of franchises more problematic in certain circumstances. The United States District Court for the Western District of Kentucky held that the statute does not authorize it to review a franchising authority's assessment of its community needs to determine if they are reasonable or supported by any evidence. This result would seemingly permit a franchising authority which desired to oust an existing operator to set cable-related needs at such a high level that the incumbent operator would have difficulty in making a renewal proposal which met those needs. This decision has been appealed. The Joint Venture was not a party to this litigation.\nNOTE 7 - TRANSACTIONS WITH THE GENERAL PARTNERS AND AFFILIATES\nThe Joint Venture has a management and service agreement (the \"Agreement\") with a wholly owned subsidiary of the Corporate General Partner (the \"Manager\") for a monthly management fee of 4% of gross receipts, as defined, from the operations of the Joint Venture. Management fees approximated $249,800, $247,000 and $249,700 in 1993, 1994 and 1995, respectively. In addition, the Joint Venture is required to distribute 1% of its gross revenues to the Corporate General Partner in respect to its interest as the Corporate General Partner. This fee approximated $62,400, $61,700 and $62,400 in 1993, 1994 and 1995, respectively.\nThe Joint Venture also reimburses the Manager for direct expenses incurred on behalf of the Joint Venture and for the Venture's allocable share of operational costs associated with services provided by the Manager. All cable television properties managed by the Corporate General Partner and its subsidiaries are charged a proportionate share of these expenses. Corporate office allocations and district office expenses are charged to the properties served based primarily on the respective percentage of basic customers or homes passed (dwelling units within a system) within the designated service areas. The total amounts charged to the Joint Venture for these services approximated $257,700, $284,200 and $250,500 during 1993, 1994 and 1995, respectively.\nCertain programming services have been purchased through Falcon Cablevision. In turn, Falcon Cablevision charges the Joint Venture for these costs based on an estimate of what the Joint Venture could negotiate for such programming services on a stand-alone basis. The Joint Venture recorded programming fee expense of $989,500, $1,071,200 and $1,136,500 in 1993, 1994 and 1995, respectively.\nNOTE 8 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nCash paid for interest amounted to $447,000, $662,500 and $777,400 in 1993, 1994 and 1995, respectively.\nEXHIBIT INDEX\nE-1 EXHIBIT INDEX\nFOOTNOTE REFERENCES\n(1) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1987.\n(2) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1988.\n(3) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1989.\n(4) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1990.\n(5) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1991.\n(6) Incorporated by reference to the exhibits to the Registrant's Quarterly Report on Form 10-Q, File No. 0-16789 for the quarter ended March 31, 1993.\n(7) Incorporated by reference to the exhibit to the Registrant's Current Report on Form 8-K, File No. 0-16789 dated October 17, 1994.\n(8) Incorporated by reference to the exhibits to the Registrant's Annual Report on Form 10-K, File No. 0-16789 for the fiscal year ended December 31, 1993.\nE-2","section_15":""}
{"filename":"7610_1995.txt","cik":"7610","year":"1995","section_1":"ITEM 1. BUSINESS.\nOVERVIEW\nThe Company is engaged primarily in the mail-order sales and marketing of a broad range of personalized products such as personalized bank checks, address labels, personalized stationery and gift items.\nThe Company markets its personalized products through advertising in mass circulation print media, such as Sunday newspaper free standing inserts (\"FSI's\") purchased from Valassis Communications, Inc. (\"Valassis\") and NewsAmerica Publications, cooperative insert mailings (\"Co-op Mailings\"), package insert program advertising (\"PI Programs\") and through its mail order catalog PERSONAL TOUCH. The Company has also initiated an advertising and sales campaign over the Internet and is actively testing other media.\nA substantial majority of the Company's orders are received through the mail, with the remainder being received by the Company's telemarketing department. All orders are shipped through the U.S. mail and via private courier services.\nGENERAL DESCRIPTION OF BUSINESS\nThe Company traces its roots to 1925. It was incorporated as Artistic Greetings in the State of New York in 1965 and reincorporated in the State of Delaware in 1987. Since 1980, the Company has evolved from being a manufacturer and marketer of private label greeting cards and a provider of limited order fulfillment services into primarily a manufacturer and direct- mail marketer of personalized products. Sales of its personalized products accounted for a substantial portion of the Company's revenues during the last three years. Other revenue has been realized through the rental of the Company's proprietary list of customer names (\"List Rentals\") and through its PI Programs, in which it sells space in its outgoing packages to third-party advertisers.\nThrough the expansion and diversification of its product lines, the Company is less subject to seasonal swings in its business than it formerly was. However, since a large number of the Company's catalog items are purchased as gifts, the fourth quarter remains the strongest sales quarter of the Company's fiscal year, due to Christmas season sales. Additionally, sales in the first quarter tend to be higher than the second and third quarters. Management believes that this is partially a result of an increase in the payment of bills with personalized checks and an increase in mailings during the Christmas season which causes a depletion in its customers' supply of checks and labels, and the concomitant need for replenishment. Additionally, FSI advertising is generally more limited during Christmas and New Years which, management believes, creates pent-up demand.\nPERSONALIZED CHECKS\nThe Company began advertising Artistic Checks{}, its own personalized bank checks, in August 1993. After its initial advertising campaign, Artistic Checks{} sales grew to more than $2.2 million by the end of 1993, $17.7 million by the end of 1994 and to $37 million by the end of 1995.\nOn May 30, 1995 (the \"Closing Date\"), the Company purchased various assets (the \"Valcheck Acquisition\") from Valcheck Company (\"Valcheck\"), a subsidiary of Valassis, related to Valcheck's manufacture, direct-mail marketing and sale of checks. Under the terms of the Purchase Agreement among the Company, Valassis and Valcheck, the Company purchased Valcheck's customer lists, machinery and equipment, inventory and artwork related to Valcheck's mail- order check business and assumed the obligation to fulfill Valcheck's then- current check orders, as well as any check orders received from Valcheck customers after the Closing Date. In consideration of the assets purchased, the Company: (i) issued to Valcheck 500,000 shares of the Company's Common Stock (the \"Valcheck Stock\"), pursuant to the terms of a related Investment Agreement between the Company and Valcheck (the \"Investment Agreement\"); and (ii) agreed to pay Valcheck 20% of the revenues it would receive within one year following the Closing Date, less certain adjustments for both the existing check orders the Company assumed the obligation to fulfill and for first-time check orders during this period that the Company would receive as a result of prior Valcheck solicitations.\nUnder the terms of the Investment Agreement, the Company granted Valcheck a put option exercisable on the second anniversary of the Closing Date, which requires the Company to purchase up to all of the Valcheck Stock at a price of $5.00 per share. The closing price of the Company's Common Stock on the Closing Date was $3.75 per share. The Investment Agreement also provides that, so long as Valcheck controls at least 300,000 of the shares, Valcheck may designate one representative as a member of the Company's Board of Directors (the \"Board\"), and that so long as Valcheck controls any of the shares, it will vote all such shares in accordance with the recommendations made by the Board with respect to any matters put before the Company's stockholders for action. The shares of Valcheck Stock are \"restricted securities\" within the meaning of Rule 144 under the Securities Act of 1933, as amended (the \"Act\") and can only be disposed of in an offering registered under that Act or in a transaction exempt from registration thereunder. Valcheck has no registration rights in respect of the Valcheck Stock.\nIn connection with the Valcheck Acquisition, the Company more than doubled its production capacity of personalized checks. Concurrent with the Valcheck Acquisition, the Company began a consolidation of its check production and other operations into a new 130,000 square foot facility. This facility is in the process of being completed and is further described below under \"- Manufacturing\" and \"Properties.\" In addition to the capacity increase, the Valcheck Acquisition added well over 900,000 names to the existing Artistic Checks{} customer name list. These names provide the Company with a potential low cost revenue stream resulting from reorders which have minimal advertising expense. The sale of personalized checks accounted for approximately 39.0% of the Company's total sales in 1995 as compared to 19.4% in 1994.\nArtistic Checks{ }offered 57 designs at the close of 1995 and is in the process of reducing that number by the end of the first quarter of 1996. This strategy is intended to assist the Company in managing its inventory levels and base stock procurement processes, as well as to improve its press run efficiencies.\nAlthough management believes that the check business has matured to a stable growth level, the portion of that market represented by the sale of checks directly to consumers within the check business as a whole, is growing rapidly. The Company plans to grow its direct mail check business in 1996 by managing profitably the ratio between first-time orders and reorders, however, there can be no assurance that such strategy will necessarily result in profitable growth. This strategy was implemented with vigor in the third quarter of 1995 when the Company began to withdraw from certain unprofitable portions of media distribution.\nIn September of 1995, Joseph Calabro, an experienced check-printing professional with thirty years in the business joined the Company as a consultant to oversee and manage the check production. Mr. Calabro became Senior Vice President of Manufacturing in January of 1996.\nPERSONALIZED NAME AND ADDRESS PRODUCTS\nThe Company shipped millions of personalized name and address labels, Mini-Printers and re-inkable stampers from its mechanized production line in 1995 to help grow its general merchandise customer lists to over 9 million names. This segment of the Company's business has been a staple for many years and management believes that the Company's proprietary processes for the production of these items have matured to provide a low-cost means to support high volume production while maintaining the high quality standards its customers have come to expect. The cost structure and efficiencies of the label operation in 1995 were somewhat less favorable than the Company has experienced in the past, primarily as a result of the temporary transfer of highly skilled employees from the name and address product manufacturing operation to assist in the production of personalized checks following the Valcheck Acquisition. The sale of personalized name and address products accounted for approximately 45.5% of the Company's total sales in 1995 as compared to 58.0% in 1994.\nPERSONALIZED GENERAL MERCHANDISE\nMore than ten years ago, the Company began a catalog solicitation program as a tool to market the Company's personalized products and broaden the number of products sold, as well as to attract a more upscale market with higher margin products and to increase its mail-order customer base. The Company distributes its catalog through mailings to its own customers, to customers whose names are rented from mailing lists and by inclusion of its catalog in each of the millions of boxes shipped in the Company's PI Programs each year, as well as in orders shipped by other catalog and merchandise mailers. The Company currently distributes one catalog called PERSONAL TOUCH. The sales from catalog operations accounted for approximately 10.1% of the Company's total sales in 1995 compared to 16.0% in 1994.\nIn 1995, the Company distributed approximately 12 million catalogs in the U.S., compared with 26 million in 1994 and 31 million in 1993. The share of the Company's total revenues contributed by its catalog sales has declined year-to-year over the past several years for several reasons. First, during this time, the Company has been intensively reviewing its catalog product offerings and its catalog customer base to determine whether its catalogs are offering the product selections desired by its catalog customers, while at the same time working toward maximizing the margins on the products offered. As a result of such reviews, at the beginning of 1995, the Company terminated its \"Initials\" catalog and sold its accompanying rights and name list to a third party. At the same time, the Company also terminated its AMY ALLISON catalog. Secondly, all efforts were concentrated on downsizing and returning to profitability the remaining catalog, PERSONAL TOUCH. This included in-depth analysis of product mix to meet customer demand and maintain lower cost of goods, product designs, trends in the marketplace and segmentation of both in- house and rented customer lists. Top-selling products were then included in the PERSONAL TOUCH catalog if they matched the product mix and cost factors. Upon completion of the analysis, the PERSONAL TOUCH catalog was restructured as a more paper-goods-oriented catalog, targeting a lower cost of goods and an increased page count.\nDIRECT MAIL ADVERTISING\nThe Company's direct mail-order advertising efforts are focused primarily on FSI and Co-op Mailings.\nFor many years, the Company has advertised its products through FSI advertising in Sunday newspapers nationwide in the United States and to a lesser extent in Canada. Since 1993, the Company has also advertised its personalized checks through its FSI and other direct mail programs. The Company has obtained the right of first refusal to purchase from Valassis extensive FSI circulation in newspapers throughout the United States each week. The Company believes that such access to its customers is crucial to manage its sales volumes profitably and targets its advertising to potential customers in regions which have historically produced the best response rates.\nSince 1988, the Company has been participating in nationwide Co-op Mailing programs to further its market penetration. Under these programs, printed inserts advertising the Company's products are distributed nationally along with the inserts of other participating advertisers on a regular basis through the mail. Additionally, the Company has been advertising in Co-op Mailing programs in Canada since 1993. Partially as a result of the Company's increased access to the FSI market, it has determined to reduce its participation in the less profitable Co-op Mailing programs to a minimum in 1996.\nINTERNET AND OTHER MEDIA TESTS\nThe Company began experimenting with advertising its personalized checks on the World Wide Web in August 1994, long before today's intense level of awareness of this medium. The Web pages have the advantage of showing all available designs (therefore, not being as limited as an ad showing only a few designs), as well as all other information and options regarding the checks. The site can be reached at http:\/\/www.spectra.net\/mall\/artistic.\nThe Company is also accessible by e-mail on the Internet at artistic@spectra.net.\nSERVICES\nThe Company generates a small amount (approximately 2.5%) of its annual revenues through order fulfillment services, its PI Programs and List Rentals to other concerns for their use of the Company's customer names in mass mailings and solicitations. \"Order fulfillment\" services consist of the Company's filling orders placed as a result of advertising promotions by various third parties. In the PI Programs, the Company inserts its customers' promotional materials in the Company's own mail order solicitations and product shipments.\nDATA ENTRY\/ORDER PROCESSING\nOver 8 million incoming orders were handled in the Company's Order Processing department in 1995. Approximately 80% of the Company's orders are received through the mail, with the remainder being accepted via the telephones. The orders received through the mail are opened, processed and batched for data entry usually within four hours of receipt from the post office.\nFour data entry sites, located in three New York State communities, key and verify tens of thousands of orders every day. Networked computers, utilizing post-relational database technology, along with fully integrated scanning devices, assist data entry clerks in the process of individually personalizing every product on every order. The speed and accuracy consistently exhibited by this department contributes to a high level of customer satisfaction, as well as the continued growth of repeat customers.\nTELEMARKETING\nAn increasing percentage of the Company's revenue is being generated through its call center. In 1995, over 2 million telephone calls were answered as compared to 1.2 million calls in 1994. With over 9 million customers and their orders on-line, along with a direct link to the manufacturing floor, the customer service\/telemarketing representatives are able to recall detailed order history instantly, facilitating customer inquiries, reorders or problem resolution. The use of cross-selling and up-selling techniques results in the average order being 20-30% higher when an order is placed over the telephone versus being received through the mail.\nMANUFACTURING\nThe Company personalizes the majority of the paper products that it sells, while a few such items and certain non-paper products are manufactured by outside vendors. The Company has renovated a 130,000 square foot facility, which provides the necessary space for all present manufacturing operations of the Company. Management believes that housing all manufacturing under one roof will decrease the cost of material movement and increase productivity through more efficient utilization of its personnel.\nManufacturing operations utilize some of the newest technology available for production of the Company's products. Activities are monitored to provide up-to-the-minute order tracking. Training programs assure a qualified group of employees. Quality assurance is maintained to provide the Company's customers with the highest degree of accuracy of product received.\nThe Company must maintain a wide variety of paper inventory to meet the demand for its customers' orders. Based in part on past success rates with mail solicitations, mass advertising and on the somewhat cyclical nature of its business, the Company has traditionally been able to plan for its inventory needs without the necessity of committing large amounts of working capital to inventory for substantial periods of time. In spite of that fact, inventories increased substantially during 1995, largely as the result of a decision to focus on preventing out-of-stock conditions in the check operation and the nearly doubling of the number of the Company's check designs as a result of the Valcheck Acquisition, the former customers of which the Company now services. Management has discontinued many of these designs and is actively managing the reduction of inventory levels through various programs. The Company fulfills the majority of the orders it receives from its facilities in Elmira, New York. The orders not fulfilled in Elmira consist primarily of personalization of certain check designs which is subcontracted to a third party check printer.\nThe Company's backlog of orders is generally small in relation to total sales and is not material to an understanding of the Company's business. Additionally, rapid order fulfillment is one means by which the Company can distinguish itself from its competition. Once a product is available for shipment, the mode of transportation can be U.S. bulk mail, priority mail or Federal Express. Because the Company is so heavily involved in direct mail solicitations and shipping of orders, increases in U.S. Postal Service rates affect its cost of doing business to a degree. Each time the U.S. Postal Service raises postage rates, the Company evaluates the classes of postage affected, the rates of increase and the potential impact on Company profits before it passes those increases on to its customers. The Company ships 3.5% of its products through private shipping providers such as Federal Express pursuant to contractual arrangements. The cost of such shipping is, generally, passed on to the customer and the Company is therefore not detrimentally affected by these changes in price structure.\nRAW MATERIALS\nThe raw materials necessary for its business are principally paper, paper products and printing supplies. While increases in the prices of these commodities affect the Company's cost of goods sold, such increases likewise affect the Company's competition; thus, it is not uniquely vulnerable to such changes. However, the Company's cash flow was detrimentally affected in 1995 as a result of substantial increases in the price of paper early in the year. Management believes that the availability of paper products in 1996 will expand with a concomitant stabilization in prices, although there can be no assurance of such stabilization. The Company historically has found the necessary materials readily available in sufficient quantities.\nEMPLOYEES\nDue primarily to the rapid expansion of check-printing operations following the Valcheck Acquisition, the Company's full-time employment levels in 1995 fluctuated between a minimum of 554 persons to a high of 1,146 persons. All of the Company's employees are located at its facilities in Elmira, Binghamton and Penn Yan, New York. The central New York area provides an adequate supply of labor to meet the Company's present and foreseeable needs. Of its total number of employees, nine are executive management personnel and the remainder are employed in the areas of order entry, processing, production and shipping, sales and administration. The Company considers its employee relations to be good. The Company has never experienced a work stoppage and its employees are not represented by a labor union.\nCOMPETITION\nThe Company believes that it competes primarily with all those who sell personalized products through the mails. Because the substantial majority of the Company's products are personalized, the Company does not believe that it encounters much, if any, retail competition. The Company does, however, face significant competition from as many as ten other direct-mail marketers of personalized checks, personalized name and address products and purveyors of personalized catalog general merchandise, as well as large check printing houses such as Deluxe Corporation (\"Deluxe\"), John H. Harland Company (\"Harland\") and Clarke American Checks, Inc. (\"Clarke American\"), which distribute personalized checks through banks and financial institutions across the country, each as further described below.\nIn connection with the Company's three main product lines: personalized checks, personalized name and address products and personalized general merchandise (sold primarily through the Company's catalog, PERSONAL TOUCH), the Company believes specific and identifiable competitive factors exist for each.\nIn the personalized check-printing segment, the Company believes that gross sales of personalized checks in the United States are in excess of $1.8 billion per year, the substantial majority of which consists of sales of checks through banks, directly to their accountholders. The three principal purveyors of those checks are Deluxe, Harland and Clarke American. Although the Company currently services certain credit unions, it has yet to enter the bank check market, which the Company believes has significant barriers to entry as a result of long-term arrangements between banks and their current suppliers. The Company, therefore, offers its personalized checks through direct-mail solicitations and FSI's in tens of millions of Sunday newspapers throughout the country, and to its existing customers and their friends and families, through reorder forms contained in the customers' checkbooks. A number of other companies offer personalized checks through direct-mail solicitation and FSI's. However, the Company believes that it can compete effectively with those companies because of the selling and processing economies resulting from its substantial customer name lists; the previously mentioned access to targeted FSI advertising through Valassis; the accuracy, quality and speed of its production techniques; the variety of its design selections; and the efficacy of its customer-service department. Although the Company faces significant competitive price pressure, the Company believes that its price points and value-added services provide an attractive option to its customers. The Company also, unlike most of its competitors, benefits from its policy of not charging more for reorders, thereby maintaining loyalty from its established customer-base. Additionally, the Company guarantees the quality of all of its products, maintains a liberal exchange and refund policy in respect of unsatisfied customers, and maintains high standards of order turnaround times to ensure its customers are provided with their checks quickly.\nIn the personalized name and address product segment, the Company directly competes with numerous direct mail purveyors of personalized labels whose product is sold at substantially the same price as the Company's personalized labels. The Company, therefore, has broadened its personalized name and address product line with new designs and offers its labels through unique advertising presentations to distinguish Artistic Labels from its competition. In addition, the Company believes it has a substantial share of this market, with resulting processing and production economies to be a low-cost producer of these items.\nIn the personalized product segment sold through the PERSONAL TOUCH catalog, the Company competes with many other catalog purveyors of personalized general merchandise, the number of which has grown over the years. The Company believes that its competition does not lie directly with all catalog marketers because of the value-added perception of potential customers to having their name on the products which the Company offers. The Company attempts to distinguish itself from other direct-mail manufacturers of personalized merchandise by providing an interesting variety of high-quality goods in a quick period of time. The Company has also focused its catalog offerings on personalized-paper products and it believes that such focus has, and will continue to, set it apart from other marketers of personalized general merchandise. Additionally, through the Company's telemarketing department, its employees utilize upselling techniques as well as encourage its customers to join the Company's buyers' club, entitling them to discounts and encouraging their loyalty to the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's operations are conducted in Elmira, Binghamton and Penn Yan, New York. Presently, the Elmira facilities consist of the Company's new 130,000 production facility on Lake Street in which check and catalog manufacturing, and warehousing is located (\"Artistic Plaza\"); two adjacent locations on William Street; two adjacent buildings in downtown Elmira; and warehouse space in the Elmira area. The Company owns the entire premises at 401-409 William Street, which contains approximately 35,000 square feet of manufacturing (collation and insertion for mailings) and warehouse space. The Company also owns approximately 28,000 square feet at 308 William Street, where labels and other products are personalized, and leases approximately 3,400 square feet at 406 Academy Place pursuant to a lease with Stuart Komer, the Company's Chairman, Chief Executive Officer and President, which expires upon notice solely at the discretion of the Company. These facilities are used for production and warehouse space. The Company also owns the adjacent buildings at One Komer Center and 112 North Main Street in Elmira, which contain approximately 49,000 and 21,000 square feet, respectively. The building at One Komer Center is used for telemarketing, order entry and administrative office space, while the building at 112 North Main Street is used for a retail store, product display, training and data entry. The Company also leases approximately 14,000 square feet in Elmira, which it uses as a warehouse, as well as 3,000 square feet in Penn Yan and 5,600 square feet in Binghamton, both of which facilities are used primarily for data entry. The Company believes that these areas are well maintained and suitable for its present needs. Under its leases, the Company paid an aggregate of approximately $340,000 in annual rents in 1995, which it believes is comparable to the market rate for similar space in the Elmira, New York and surrounding areas.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere were no material legal proceedings involving the Company pending at December 31, 1995.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS.\nNo matter was submitted to a vote of the Company's stockholders during the fourth quarter of the Company's fiscal year ended December 31, 1995.\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 of the Company's 1995 Annual Report to Stockholders (\"1995 Annual Report\") entitled \"MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThis information is incorporated by reference to the section of the 1995 Annual Report entitled \"SELECTED FINANCIAL DATA - FINANCIAL HIGHLIGHTS.\"\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 of the 1995 Annual Report entitled \"MANAGEMENT'S DISCUSSION AND ANALYSIS.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThis information is incorporated by reference to the sections of the 1995 Annual Report entitled \"BALANCE SHEETS,\" \"STATEMENTS OF OPERATIONS,\" \"STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY,\" \"STATEMENTS OF CASH FLOW,\" \"NOTES TO FINANCIAL STATEMENTS,\" \"SELECTED FINANCIAL DATA - SELECTED QUARTERLY FINANCIAL INFORMATION,\" and \"REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.\"\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.\nThis information is incorporated by reference to the section of the Company's definitive Proxy Statement filed with respect to its 1996 Annual Meeting of Stockholders (the \"1996 Proxy Statement\") entitled \"PROPOSAL 1 \"-ELECTION OF DIRECTORS\" AND \"-EXECUTIVE OFFICERS.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThis information is incorporated by reference to the section of the 1996 Proxy Statement entitled \"PROPOSAL 1 - COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThis information is incorporated by reference to the section of the 1996 Proxy Statement entitled \"PROPOSAL 1 - SECURITY OWNERSHIP OF CERTAIN PERSONS.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThis information is incorporated by reference to the Company's 1996 Proxy Statement entitled \"PROPOSAL 1 - CERTAIN TRANSACTIONS.\"\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. The following financial statements of the Company and the accountant's report thereon are included in the 1995 Annual Report and are incorporated herein by reference:\nReport of Independent Public Accountants.\nBalance Sheets, December 31, 1995 and 1994.\nStatements of Operations for the three years ended December 31, 1995.\nStatements of Changes in Stockholders' 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.\n(2) FINANCIAL STATEMENT SCHEDULES. Not applicable.\n(3) EXHIBITS. The following constitutes the list of exhibits required to be filed as a part of this Report pursuant to Item 601 of Regulation S-K:\n___________________________\n* Indicates a 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(b) REPORTS ON FORM 8-K. On October 3, 1995, the Company filed a report on Form 8-K to report, under the heading of Item 5, Other Events, on the resignation of David C. Lee as its President and Chief Operating Officer, effective September 15, 1995.\n(c) EXHIBITS. See Exhibit Index.\n(d) FINANCIAL STATEMENT SCHEDULES. 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 on its behalf by the undersigned, thereunto duly authorized. ARTISTIC GREETINGS INCORPORATED\nDated: March 29, 1995 By: \/S\/ROBERT E. JOHNSON Name: Robert E. Johnson Title: Senior Vice President Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons, on behalf of the Company, in the capacity and as of the dates indicated.\nBy: \/S\/NORMAN S. EDELCUP Date: March 29, 1996 Name: Norman S. Edelcup Title: Director\nBy: \/S\/LYNDON E. GOODRIDGE Date: March 29, 1996 Name: Lyndon E. Goodridge Title: Director\nBy: \/S\/STUART KOMER Date: March 29, 1996 Name: Stuart Komer Title: Chairman, Chief Executive Officer and President\nBy: \/S\/ALAN F. SCHULTZ Date: March 29, 1996 Name: Alan F. Schultz Title: Director\nBy: \/S\/IRVING I. STONE Date: March 29, 1996 Name: Irving I. Stone Title: Director\nBy: \/S\/MORRY WEISS Date: March 29, 1996 Name: Morry Weiss Title: Director","section_15":""}
{"filename":"850033_1995.txt","cik":"850033","year":"1995","section_1":"ITEM 1. BUSINESS\nDESCRIPTION OF THE TRUST\nBP Prudhoe Bay Royalty Trust (the \"Trust\"), a grantor trust, was created as a Delaware business trust. The Trust has been established by The Standard Oil Company (\"Standard Oil\") and is administered by The Bank of New York, as trustee (collectively with the co-trustee located in Delaware, the \"Trustee\"), pursuant to the BP Prudhoe Bay Royalty Trust Agreement dated February 28, 1989 by and among Standard Oil, BP Exploration (Alaska) Inc. (the \"Company\") and the Trustee (the \"Trust Agreement\"). The Company and Standard Oil are indirect, wholly owned subsidiaries of The British Petroleum Company p.1.c. (\"BP\"). The Trustee's offices are located at 101 Barclay Street, New York, New York 10286 and its telephone number is (212) 815-5092.\nUpon creation of the Trust, the Trust acquired an overriding royalty interest (the \"Royalty Interest\"), which entitles the Trust to a Per Barrel Royalty, as defined herein, on 16.4246% of the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter (the \"Royalty Production\") from the Company's working interest in the Prudhoe Bay Unit (the \"PBU\"). The Royalty Interest was conveyed to Standard Oil pursuant to the terms of an Overriding Royalty Conveyance dated February 27, 1989 (the \"Overriding Conveyance\") and from Standard Oil to the Trust by a Trust Conveyance dated February 28, 1989 (the \"Trust Conveyance\"). The Overriding Conveyance and the Trust Conveyance are herein collectively referred to as the \"Conveyance\". The Royalty Interest is free of any exploration and development expenditures. The Trust is a passive entity, and the Trustee has been given only such powers as are necessary for the collection and distribution of revenues from the Royalty Interest and the payment of Trust liabilities and expenses. The Trust has been formed under the Delaware Trust Act, which entitles holders of the Units of Beneficial Interest (the \"Trust Units\") to the same limitation of personal liability as stockholders of a corporation are afforded under Delaware law. The Trust Units evidence undivided interests in the Trust and are listed on the New York Stock Exchange under the ticker symbol \"BPT\".\nThe Trust Units are not an interest in or obligation of the Company, Standard Oil or BP. The ultimate value of the Royalty Interest will be dependent on the Royalty Production and the Per Barrel Royalty for each day. The \"Per Barrel Royalty\" for any day will equal the per barrel price of West Texas Intermediate crude oil, less scheduled chargeable costs, as adjusted, and production taxes. See \"Description of the Royalty Interest.\" In certain circumstances, the Royalty Interest provided for a minimum royalty payment of $8.92 per barrel of Royalty Production, if any, from the PBU for each quarter through September 30, 1991; for all quarters thereafter there is no minimum royalty payment. Pursuant to a Support Agreement among BP, the Company, Standard Oil and the Trust, BP has guaranteed the performance by the Company of its payment obligations with respect to the Royalty Interest.\nThe only assets of the Trust are (i) the Royalty Interest assigned to the Trust and, (ii) from time to time, cash reserves and cash equivalents being held by the Trustee for distribution. Subject to compliance with certain conditions, additional royalty interests may be assigned to the Trust. See \"Description of the Trust Units and the Trust Agreement -- Additional Conveyances.\"\nThe value of the Trust Units is substantially dependent upon estimates of proved reserves, production and the value of oil. Estimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. See \"Report of Miller and Lents, Ltd.\", independent petroleum consultants, included herein.\nThe Company shares control of the operation of the PBU with the other working interest owners, and has no obligation to continue production from the PBU or to maintain production at any level and may interrupt or discontinue production at any time. In addition, the operation of the PBU is subject to normal operating hazards incident to the production and transportation of oil in Alaska. In the event of damage to the PBU which is covered by insurance, the Company has no obligation to use insurance proceeds to repair such damage and may elect to retain such proceeds and close damaged areas to production.\nThe financial statements of the Trust contained in this Annual Report on Form 10-K include information regarding amounts distributed to Trust Unit holders with respect to 1995, 1994, and 1993. This Annual Report also includes information with respect to 1995 production and production in past periods. Amounts distributed with respect to 1995, 1994, and 1993, production in 1995 and in the past, and the most recent estimates of proved reserves attributable to the Trust are not indicative of amounts to be distributed in the future.\nThe following information is subject to the detailed provisions of the Trust Agreement, the Overriding Conveyance, and the Trust Conveyance.\nThe provisions governing the Trust are complex and extensive, and no attempt has been made below to describe all of such provisions. The following is a general description of the basic framework of the Trust and reference is made to the Trust Agreement for detailed provisions concerning the Trust.\nDESCRIPTION OF THE TRUST UNITS AND THE TRUST AGREEMENT\nCREATION AND ORGANIZATION OF THE TRUST\nThe Trust holds the Royalty Interest pursuant to the terms of the Trust Agreement and the Conveyance, subject to the laws of the States of Alaska and Delaware. The beneficial interest in the Trust created by the Trust Agreement is divided into equal undivided portions called Trust Units. See the discussion below under \"Trust Units\".\nThe Bank of New York (Delaware) has been appointed co-trustee in order to satisfy certain requirements of the Delaware Trust Act, but The Bank of New York alone is able to exercise the rights and powers granted to the Trustee in the Trust Agreement.\nASSETS OF THE TRUST\nThe Royalty Interest is the only asset of the Trust, other than cash being held for the payment of expenses and liabilities and for distribution to the holders of Trust Units. See \"Duties and Limited Powers of Trustee\".\nLIABILITY OF THE TRUST\nBecause of the passive nature of the Trust's assets and the restrictions on the power of the Trustee to incur obligations, it is anticipated that the only liabilities the Trust will incur will be those for routine administrative expenses, such as Trustee's fees, and accounting, legal and other professional fees. However, if a court were to hold that the Trust is an association taxable as a corporation, as more fully discussed in \"Certain Tax Considerations -- Federal Income Tax -- Classification of the Trust\", the Trust would incur substantial income tax liabilities in addition to its other expenses. In addition, if the Trust were required to make allocations of income and deductions other than on a quarterly basis, the administrative expenses of the Trust might increase. See \"Certain Tax Considerations -- Federal Income Tax -- Taxation of Trust Unit Holders\". The administrative fees and expenses of the Trust for the years ended December 31, 1995, 1994, 1993, 1992, 1991, 1990 and 1989 were approximately $690,000, $660,000, $555,000, $415,000, $415,000, $460,000 and $170,000, respectively, including fees paid by the Trust to accountants, petroleum consultants and counsel. Future administrative fees and expenses will depend, among other things, on the number of Trust Unit holders and the fees of accountants, petroleum consultants, counsel and other experts, if any, engaged by the Trust.\nDUTIES AND LIMITED POWERS OF TRUSTEE\nThe duties of the Trustee are as specified in the Trust Agreement and by the laws of the State of Delaware. The basic function of the Trustee is to collect income from the Royalty Interest, to pay out of the Trust's income and assets all expenses, charges and obligations and to pay available cash to holders of Trust Units.\nThe Trustee may establish a cash reserve for the payment of material liabilities of the Trust which may become due, if the Trustee has determined that it is not practical to pay such liabilities on subsequent Quarterly Record Dates (as defined below) out of funds anticipated to be available on such dates and that, in the absence of such reserve, the trust estate is subject to the risk of loss or diminution in value or The Bank of New York is subject to the risk of personal liability for such liabilities, provided that, except in certain limited circumstances, it has received an opinion of counsel to the effect that the establishment and maintenance of such reserve will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes. The Trustee is obligated, subject to certain conditions, to borrow funds required to pay liabilities of the Trust, if they become due, and pledge or otherwise encumber the Trust's assets, if it determines that the cash on hand is insufficient to pay such liabilities and that it is not practical to pay such liabilities on subsequent Quarterly Record Dates out of funds anticipated to be available on such dates, provided that, except in certain limited circumstances, it has received an opinion of counsel to the effect described above. Borrowings must be repaid in full before any further distributions are made to holders of Trust Units.\nAll distributable cash of the Trust will be distributed on a quarterly basis. To date, and until certain requirements of the Trust Agreement are met concerning the status of the assets of the Trust for purposes of certain Department of Labor regulations, all distributions to Trust Unit holders must be made as soon as practicable and the Trustee must hold cash received uninvested pending such distribution. The Trustee is required to invest any cash being held by it for distribution on the next distribution date or being held by it as a reserve for liabilities in U.S. Obligations or, if U.S. Obligations having a maturity date on the next distribution date are not available, repurchase agreements with banks, including The Bank of New York, secured by U.S. Obligations and meeting certain specified requirements. Any U.S. Obligation or any such repurchase agreement must mature on the next distribution date or on the due date of the liability with respect to which the reserve is established, if known, and subject to certain exceptions, will be held to maturity. The Trustee is required, in certain circumstances, to invest the cash being held by it in an overnight time deposit with a bank, including The Bank of New York. Amounts being held by the Trustee after the date fixed for distribution of assets upon termination of the Trust, however, must be held uninvested.\nThe Trust Agreement grants the Trustee only such rights and powers as are necessary to achieve the purposes of the Trust. The Trust Agreement prohibits the Trust from engaging in any business, commercial or, with certain exceptions, investment activity of any kind and from using any portion of the assets of the Trust to acquire any oil and gas lease, royalty or other mineral interest. The Trustee may sell Trust properties only as authorized by a vote of the holders of Trust Units, or when necessary, to provide for the payment of specific liabilities of the Trust then due (if, among other things, the Trustee determines that it is not practicable to submit such sale to a vote of the holders of Trust Units, and it receives an opinion of counsel to the effect that such sale will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes), or upon termination of the Trust. Pledges or other encumbrances to secure borrowings are permitted without a vote of holders of Trust Units if the Trustee determines such action is advisable. Any sale of Trust properties must be for cash unless otherwise authorized by the holders of Trust Units, and the Trustee is obligated to distribute the available net proceeds of any such sale to the holders of Trust Units after establishing reserves for liabilities of the Trust.\nLIABILITIES OF TRUSTEE\nExcept in the circumstances described below, in which the Company will indemnify the Trustee and The Bank of New York in its individual capacity, the Trustee and The Bank of New York in its individual capacity will be indemnified out of the assets of the Trust for any liability, expense, claim, damage or other loss incurred by it in the performance of its duties unless such loss results from its negligence, bad faith, or fraud or from its expenses in carrying out such duties exceeding the compensation and reimbursement it is entitled to under the Trust Agreement. The Trustee and The Bank of New York in its individual capacity will be indemnified by the Company for liabilities to the extent described above (a) whenever the assets of the Trust are insufficient or not permitted by applicable law to provide such indemnity and (b) after the termination of\nthe Trust, to the extent that the Trustee did not have knowledge or should not have reasonably known of a potential claim against the Trustee for which a reserve could have been established and used to satisfy such claim prior to the final distribution of assets of the Trust upon its termination. In no event will the Trustee be deemed to have acted negligently, fraudulently or in bad faith if it takes or suffers action in good faith in reliance upon and in accordance with the written advice of counsel or other experts.\nThe Trustee is not entitled to indemnification from the holders of Trust Units except in certain limited circumstances related to the replacement of mutilated, destroyed, lost or stolen certificates. In addition, the Company has agreed to indemnify and hold the Trustee and the Trust harmless from certain liabilities under the federal securities laws.\nRESIGNATION OR REMOVAL OF TRUSTEE\nThe Trustee may resign at any time or be removed with or without cause by the holders of a majority of the outstanding Trust Units. Its successor must be a corporation organized and doing business under the laws of the United States, any state thereof or the District of Columbia authorized under such laws to exercise trust powers, or a national banking association domiciled in the United States, in either case having a combined capital, surplus and undivided profits of at least $50,000,000 and subject to supervision or examination by federal or state authorities. Unless the Trust already has a trustee that is a resident of or has a principal office in the State of Delaware, then any successor trustee will be such a resident or have such a principal office. No resignation or removal of the Trustee shall become effective until a successor trustee shall have accepted such appointment.\nDURATION OF TRUST\nThe Trust is irrevocable and the Company has no power to terminate the Trust or, except with respect to certain corrective amendments agreed to by the Trustee, to alter or amend the terms of the Trust Agreement. The Trust will terminate upon the first to occur of the following events or times: (a) upon a vote of holders of not less than 70% of the outstanding Trust Units, on or prior to December 31, 2010, in accordance with the procedures described under \"Voting Rights of Holders of Trust Units\" below, or (b) after December 31, 2010 either (i) at such time as the net revenues from the Royalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year, unless the net revenues during such period have been materially and adversely affected by an event constituting force majeure, or (ii) upon a vote of holders of not less than 60% of the outstanding Trust Units. Upon the dissolution of the Trust, the Trustee will continue to act in such capacity until completion of the winding up of the affairs of the Trust. Upon termination of the Trust, the Trustee will sell Trust properties in one or more sales for cash, unless holders representing 70% of the Trust Units outstanding (60% if the decision to terminate the Trust is made after December 31, 2010) authorize the sale for a specified non-cash consideration in which event the Trustee may, but is not obligated to, consummate such non-cash sale, but only if the Trustee shall have received a ruling from the Internal Revenue Service (the \"IRS\") or an opinion of counsel to the effect that such non-cash sale will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes. Prior to such sale the Trustee will obtain an opinion of an investment banking firm or other entity qualified to give such opinion as to the fair market value of the assets of the Trust on the day of termination of the Trust. The Trustee will effect any such sale pursuant to procedures or material terms and conditions approved by the vote of holders of 70% of the outstanding Trust Units (60% if the sale is made after December 31, 2010) in accordance with the procedures described under \"Voting Rights of Holders of Trust Units\" below, unless the Trustee determines that it is not practicable to submit such procedures or terms to a vote of the holders of Trust Units, and the sale is effected at a price which is at least equal to the fair market value of the trust estate as set forth in the opinion mentioned above and pursuant to terms and conditions deemed commercially reasonable by the investment banking firm or other entity rendering such opinion. Upon dissolution of the Trust, the Company will have an option to purchase the Royalty Interest at a price equal to the greater of (i) the fair market value of the trust estate as set forth in the opinion mentioned above, or (ii) the number of then outstanding Trust Units multiplied by (a) the closing price of Trust Units on the day of termination of the\nTrust on the stock exchange on which the Trust Units are listed, or (b) if the Trust Units are not listed on any stock exchange but are traded in the over-the-counter market, the closing bid price on the day of termination of the Trust as quoted on the National Market System of the National Association of Securities Dealers Automated Quotation System. If the Trust Units are neither listed nor traded in the over-the-counter market, the price will be the fair market value of the trust estate as set forth in the opinion mentioned above. After satisfying all existing liabilities and establishing adequate reserves for the payment of contingent liabilities, the Trustee will distribute all available proceeds to the holders of Trust Units on the date specified in a notice given by the Trustee, which date will be no later than 10 days after delivery of such notice.\nThe Trustee cannot predict what amount it will be able to receive for the Trust's assets if the Trust terminates or the expenses which the Trust may incur in attempting to sell the assets.\nVOTING RIGHTS OF HOLDERS OF TRUST UNITS\nAlthough holders of Trust Units possess certain voting rights, their voting rights are not comparable to those of shareholders of a corporation. For example, there is no requirement for annual meetings of holders of Trust Units or annual or other periodic reelection of the Trustee.\nMeetings of holders of Trust Units may be called by the Trustee at any time at its discretion and must be called by the Trustee at the written request of holders of not less than 25% of the then outstanding Trust Units or at the request of the Company or as may be required by law or applicable regulation. The presence of a majority of the outstanding Trust Units is necessary to constitute a quorum, and holders may vote in person or by proxy.\nNotice of any meeting of holders of Trust Units must be given not more than 60 nor fewer than 10 days prior to the date of such meeting. The notice must state the purpose or purposes of the meeting and no other matter may be presented or acted upon at the meeting.\nThe Trust Agreement may be amended without a vote of the holders of Trust Units to cure an ambiguity, to correct or supplement any provision of the Trust Agreement that may be inconsistent with any other such provision or to make any other provision with respect to matters arising under the Trust Agreement that do not adversely affect the holders of Trust Units. The Trust Agreement may also be amended with the approval of a majority of the outstanding Trust Units at any duly called meeting of holders of Trust Units. However, no such amendment may alter the relative rights of Trust Unit holders unless approved by the affirmative vote of 100% of the holders of Trust Units and by the Trustee or reduce or delay the distributions to the holders of Trust Units or effect certain other changes unless approved by the affirmative vote of 80% of the holders of Trust Units and by the Trustee. No amendment will be effective until the Trustee has received a ruling from the IRS or an opinion of counsel to the effect that such modification will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes.\nRemoval of the Trustee will require the affirmative vote of the holders of a majority of the Trust Units represented at a duly called meeting of the holders of Trust Units. A successor trustee may be appointed by the holders of Trust Units at such meeting. If the Trustee has given notice of its intention to resign, a successor trustee will be appointed by the Company.\nThe sale of all or any part of the Royalty Interest must be authorized by the affirmative vote of the holders of 70% of the outstanding Trust Units (60% if such sale is to be effected after December 31, 2010), provided that if such sale is effected in order to provide for the payment of specific liabilities of the Trust then due and involves a part, but not all or substantially all, of the assets of the Trust, such sale may be approved by the affirmative vote of holders of a majority of the outstanding Trust Units. However, subject to certain conditions, the Trustee may, without a vote of the holders of Trust Units, sell all or any part of the Trust assets if necessary to provide for the payment of specific liabilities of the Trust then due or upon termination of the Trust. The Trust can be terminated by the holders of Trust Units only if the termination is approved by the holders of 70% of the Trust Units (on or prior to December 31, 2010) or of 60% of the Trust Units (after December 31, 2010). The Trust may also be terminated after December 31, 2010 if the net revenues from the\nRoyalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year, unless the net revenues have been materially and adversely affected by an event constituting force majeure.\nThe Company and Standard Oil will vote or cause to be voted any Trust Units held of record or beneficially by the Company, Standard Oil or any affiliate of either of them in the same proportion as the Trust Units voted by other holders of Trust Units at such meeting.\nTRUST UNITS\nEach Trust Unit represents an equal undivided share of beneficial interest in the Trust. Trust Units are evidenced by transferable certificates issued by the Trustee. If at any time there is assigned to the Trust an Additional Royalty Interest, the beneficial interest in the Trust will thereafter be considered to be divided into a number of Trust Units equal to the sum of the number of Trust Units existing prior to such assignment and the number of Trust Units created upon such assignment. The Trust Units will not represent an interest in or obligation of the Company, Standard Oil or any of their respective affiliates. Except in the limited circumstances described under \"Additional Conveyances\" each Trust Unit will entitle its holder to the same rights as the holder of any other Trust Unit, and the Trust will have no other authorized or outstanding class of equity securities. There are 21,400,000 Trust Units outstanding.\nDISTRIBUTIONS OF INCOME\nThe Company will pay the Trust amounts due pursuant to the Royalty Interest on a quarterly basis on the fifteenth day after the end of each calendar quarter (or, if such day is not a business day, on the next succeeding business day) unless due to applicable law or stock exchange rules a different payment day is required. Distributions of Trust income are currently made as soon as practicable after receipt of such amounts by the Trustee. After certain requirements of the Trust Agreement concerning the status of the assets of the Trust under certain Department of Labor regulations are met, distributions of Trust income will be made on the fifth day (or if such day is not a business day, on the next succeeding business day) after the Trustee's receipt in same day finally collected funds of amounts to be received on a Quarterly Record Date for each Quarter (defined below) in each year during the term of the Trust. Such distribution will be made to the person in whose name the Trust Unit (or any predecessor Trust Unit) is registered at the close of business on the immediately preceding January 15, April 15, July 15, or October 15 (or, if such day is not a business day, on the next succeeding business day), as the case may be, unless the Trustee determines that a different date is required to comply with applicable law or stock exchange rules (each a \"Quarterly Record Date\"). A \"Quarter\", for purposes of the Trust Agreement, is a period of approximately three months beginning on the day after a Quarterly Record Date and continuing through and including the next succeeding Quarterly Record Date. The aggregate quarterly distribution of income (the \"Quarterly Income Amount\") will be the excess of (i) revenues from the Royalty Interest plus any decrease in cash reserves previously established for estimated liabilities and any other cash receipts of the Trust over (ii) the expenses and payments of liabilities of the Trust plus any net increase in cash reserves for estimated liabilities. If prior to the end of a Quarter the Trustee makes a determination of the Quarterly Income Amount which it anticipates will be distributed to holders of Trust Units on the Quarterly Record Date for such Quarter, based on notice provided to the Trustee by the Company, and the Quarterly Income Amount is not equal to the amount so determined due to late payment, the Trustee will treat such amounts when received as if they were received on such Quarterly Record Date. Payment of the respective pro rata portion of the aggregate quarterly distribution of income to each holder of Trust Units will be made by check mailed to each such holder, provided that holders of Trust Units may arrange for payments of $100,000 or more to be made by wire transfer in immediately available funds.\nTRANSFERS\nThe Trustee acts as registrar and transfer agent for the Trust Units. Subject to the limitations set forth below and to the limitation described under \"Additional Conveyances\" below, Trust Units may be transferred by surrender of the certificates duly endorsed, or accompanied by a written instrument of transfer, in form satisfactory to the Trustee, duly executed by the holder of the Trust Unit or his attorney duly authorized in\nwriting. No service charge will be made for any registration of transfer of Trust Units, but the Trustee may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer. Until a transfer is made in accordance with the regulations prescribed by the Trustee, the Trustee may conclusively treat as the owner of any Trust Unit, for all purposes, the holder shown by its records (except in the event of a purchase by the Company or a designee thereof of Trust Units subject to the Trustee's right of redemption, as described under \"Possible Divestiture of Trust Units\" below). Any transfer of a Trust Unit will vest in the transferee all rights of the transferor at the date of transfer, except that the transfer of a Trust Unit after the Quarterly Record Date for distribution will not transfer the right of the transferor to such distribution. The Trustee is specifically authorized to rely upon the application of Article 8 of the Uniform Commercial Code, the Uniform Act for Simplification of Fiduciary Security Transfers and other statutes and rules with respect to the transfer of securities, each as adopted and then in force in the State of Delaware, as to all matters affecting title, ownership, warranty or transfer of certificates and the Trust Units represented thereby.\nMUTILATED, DESTROYED, LOST OR STOLEN CERTIFICATES\nIf a mutilated certificate is surrendered to the Trustee, the Trustee will execute and deliver in exchange therefor a new certificate. If there shall be delivered to the Trustee evidence of the destruction, loss or theft of a certificate and such security or indemnity as may be required to hold the Trust and the Trustee harmless, then, in the absence of notice to the Trustee that such certificate has been acquired by a bona fide purchaser, the Trustee will execute and deliver, in lieu of any such lost, stolen or destroyed certificate, a new certificate. In connection with the issuance of any new certificates, the Trustee may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses (including fees and expenses of the Trustee) in connection therewith.\nREPORTS TO HOLDERS OF TRUST UNITS\nAs promptly as practicable following the end of each calendar year, but no later than 90 days thereafter, the Trustee will mail to each person who was a holder of record at any time during such calendar year a report containing sufficient information to enable holders of Trust Units to make all calculations necessary for federal and Alaska income tax purposes, including the calculation of any depletion or other deduction which may be available to them for such calendar year. As promptly as practicable following the end of each Quarter, but no later than 60 days following the end of such Quarter, during the term of the Trust, the Trustee will mail a report for such Quarter showing in reasonable detail on a cash basis the assets and liabilities, receipts and disbursements and income and expenses of the Trust and the Royalty Production for such Quarter to holders of Trust Units of record on the last Quarterly Record Date immediately preceding the mailing thereof. Within 90 days following the end of each calendar year, the Trustee will mail an annual report containing (a) audited financial statements of the Trust, (b) a statement as to whether or not all fees and expenses of the Trustee were calculated and paid in accordance with the Trust Agreement, (c) such information as the Trustee deems appropriate from a letter of the independent public accountants engaged by the Trustee as to compliance with certain terms of the Conveyance and any Additional Conveyances and computation of the amounts payable to the Trust in respect of the Royalty Interest, (d) a letter of the independent petroleum engineers engaged by the Trust setting forth a summary of such firm's determinations regarding the Company's methods, procedures and estimates referred to in the Conveyance concerning proved reserves and other related matters, and (e) a copy of the latest annual report with respect to the Trust Units filed with the Securities and Exchange Commission (the \"Commission\") or information furnished to the Trustee pursuant to the Conveyance, to holders of Trust Units of record on the last Quarterly Record Date immediately preceding the mailing thereof.\nThe Trustee will mail to holders of Trust Units any other reports or statements required to be provided to Trust Unit holders by applicable law or governmental regulations or by the requirements of any stock exchange on which the Trust Units may be listed.\nIn the Trust Agreement, holders of Trust Units have waived the right to seek or secure any portion or distribution of the Royalty Interest or any other asset of the Trust or any accounting during the term of the Trust or during any period of liquidation and winding up.\nLIABILITY OF HOLDERS OF TRUST UNITS\nThe Trust Agreement provides that the holders of Trust Units will, to the full extent permitted by Delaware law, be entitled to the same limitation of personal liability extended to stockholders of private corporations for profit under Delaware law.\nPOSSIBLE DIVESTITURE OF TRUST UNITS\nThe Trust Agreement imposes no restrictions on nationality or other status of the persons or other entities which are eligible to hold Trust Units. However, the Trust Agreement provides that if at any time the Trust or the Trustee is named a party in any judicial or administrative proceeding seeking the cancellation or forfeiture of any property in which the Trust has an interest because of the nationality, or any other status, of any one or more holders the following procedures will be applicable:\n(i) The Trustee will give written notice of the existence of such proceedings to each holder whose nationality or other status is an issue in the proceeding. The notice will contain a reasonable summary of such proceeding and will constitute a demand to each such holder that he dispose of his Trust Units within 30 days to a party not of the nationality or other status at issue in the proceeding described in the notice.\n(ii) If any holder fails to dispose of his Trust Units in accordance with such notice, the Trustee shall have the right to redeem and shall redeem at any time during the 90-day period following the termination of the 30-day period specified in the notice, any Trust Unit not so transferred for a cash price per unit equal to the closing price of the Trust Units on the stock exchange on which the Trust Units are then listed or, in the absence of any such listing, the closing bid price on the National Market System of the National Association of Securities Dealers Automatic Quotation System if the Trust Units are so quoted or, if not, the mean between the closing bid and asked prices for the Trust Units in the over-the-counter market, in either case as of the last business day prior to the expiration of the 30-day period stated in the notice. If the Trust Units are neither listed nor traded in the over-the-counter market, the price will be the fair market value of the Trust Units as determined by a recognized firm of investment bankers or other competent advisor or expert.\n(iii) The Trustee will cancel any Trust Unit redeemed by the Trustee in accordance with the foregoing procedures.\n(iv) The Trustee may, in its sole discretion, cause the Trust to borrow any amount required to redeem the Trust Units.\nIf the purchase of Trust Units from an ineligible holder by the Trustee would result in a non-exempt \"prohibited transaction\" under the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"), or under the Internal Revenue Code of 1986, as amended (the \"Code\"), the Trust Units subject to the Trustee's right of redemption will be purchased by the Company or a designee thereof, at the above-described purchase price.\nADDITIONAL CONVEYANCES\nAdditional royalty interests (\"Additional Royalty Interests\") identical in all respects to the initial Royalty Interest except for the identity of the parties (other than the Trust) (provided that the entity which will make payments to the Trust under any Additional Royalty Interest is the same entity making payments to the Trust under the initial Conveyance), the effective date (which must be on the first day of a calendar quarter and must be the date of delivery thereof to the Trustee) and the percentage set forth in the definition of Royalty Production in the related additional conveyance, may be assigned by the Company or an affiliate thereof to the Trust from time to time, through the execution of additional conveyances (each an \"Additional Conveyance\"). In consideration of the grant of an Additional Royalty Interest, the Trustee will issue to the order of the Company or such affiliate, a number of Trust Units, not to exceed a total of 18,600,000 additional Trust Units, equal to (i) the product of (a) the percentage set forth in the definition of \"Royalty Production\" in the related Additional Conveyance and (b) 21,400,000, (ii) divided by 16.4246%. In connection with such issuance, the recipients of such Trust Units and their transferees will not be treated as holders of Trust Units of record entitled to distributions with respect to the Quarterly Income Amount for the Quarterly Record Date\nwhich occurs during the month in which such Additional Conveyance is effective and will not be entitled to transfer such Trust Units (other than to the Company or one of its affiliates) on or prior to such Quarterly Record Date, and the certificates representing such Trust Units will prominently so state.\nThe acceptance by the Trustee of any such assignment will be subject to the conditions that the Trustee shall have received a ruling from the IRS to the effect that neither the existence nor the exercise of the right to assign the Additional Royalty Interest or the power to accept such assignment will adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes, and rulings from the IRS or an opinion of counsel to the effect that such assignment will not cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes, or the holders of Trust Units to recognize income, gain or loss attributable to the Royalty Interest as a result of such assignment, except to the extent of any gain or loss attributable to any cash received by the Trust in connection with such assignment.\nIn addition, the Trustee will require that the Company or its affiliate contribute a cash reserve computed by reference to the value of the cash reserve for future liabilities existing on the date the Additional Conveyance is effective. The Trustee will invest any cash so contributed as described under \"Duties and Limited Powers of Trustee\" above, and will distribute the cash so contributed and any interest earned thereon to holders of Trust Units of record on the Quarterly Record Date which occurs during the month in which the related Additional Conveyance becomes effective, except to holders of Trust Units issued upon the assignment of the Additional Conveyance.\nAny Additional Royalty Interest assigned to the Trust will constitute a part of the trust estate and, to the extent permitted by law, will be treated by the Trustee, together with the initial Royalty Interest and all other Additional Royalty Interests previously assigned to the Trust, as constituting one Royalty Interest held for the benefit of all holders of Trust Units.\nDESCRIPTION OF THE ROYALTY INTEREST\nThe Trust property consists of a Royalty Interest entitling the Trust to a Per Barrel Royalty on 16.4246% of the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter (the \"Royalty Production\") from the Company's working interest in the PBU. There are 21,400,000 Trust Units outstanding. If additional Trust Units are issued, the Royalty Interest percentage will be increased proportionately. The net production referred to herein pertains only to the Ivishak and PESS formations collectively known as the Prudhoe Bay (Permo-Triassic) Reservoir, and does not pertain to the Lisburne and Endicott formations. The Company's average daily net production from its working interest in the PBU during 1995 was approximately 316,000 barrels of oil and condensate.\nAs is true of net profits royalty interests generally, the Royalty Interest is a property right under applicable principles of Alaska law which burdens production, but there is no other security interest in the reserves or production revenues to which the Royalty Interest is entitled.\nThe royalty payable to the Trust under the Royalty Interest is the product of the Royalty Production and the Per Barrel Royalty for each day.\nPER BARREL ROYALTY\nThe Per Barrel Royalty in effect for any day will equal the WTI Price for such day less the sum of (i) the product of the Chargeable Costs and the Cost Adjustment Factor and (ii) Production Taxes.\nWTI PRICE\nThe \"WTI Price\" for any trading day means (i) the latest price (expressed in dollars per barrel) for West Texas Intermediate crude oil of standard quality having a specific gravity of 40 degrees API for delivery at Cushing, Oklahoma (\"West Texas Crude\"), quoted for such trading day by the Dow Jones International Petroleum Report (which is published in The Wall Street Journal) or if the Dow Jones International Petroleum Report does not publish such quotes, then such price as quoted by Reuters, or if Reuters does not\npublish such quotes, then such price as quoted in Platt's Oilgram Price Report, or (ii) if for any reason such publications do not publish such price, then the WTI Price will mean, until (i) is again applicable, the simple average of the daily mean prices (expressed in dollars per barrel) quoted for West Texas Crude by one major oil company, one petroleum broker and petroleum trading company, in each case unaffiliated with BP. Such major oil company, petroleum broker and petroleum trading company must have substantial U.S. operations and will be designated by the Company from time to time in an officer's certificate delivered to the Trustee. In the event that prices for West Texas Crude are not quoted so as to permit the calculation of the WTI Price, \"West Texas Crude,\" for the purposes of calculating the WTI Price first for (i) and then (ii) above, will mean such other light sweet domestic crude oil of standard quality as is designated by the Company in an officer's certificate delivered to the Trustee and approved by the Trustee in the exercise of its reasonable judgment, with appropriate allowance for transportation costs to the Gulf Coast (or other appropriate location) to equilibrate such price to the WTI Price. The WTI Price for any day which is not a trading day will be the WTI Price for the next preceding day which is a trading day.\nCHARGEABLE COSTS\nThe \"Chargeable Costs\" per barrel of Royalty Production were $4.50 per barrel through December 31, 1991, $6.00 per barrel from January 1, 1992 through December 31, 1992, $6.75 per barrel from January 1, 1993 through December 31, 1993, $8.00 per barrel from January 1, 1994 through December 31, 1994, $8.25 per barrel from January 1, 1995 through December 31, 1995 and will be the amount set forth in the following table opposite the calendar year stated:\nChargeable Costs are multiplied by the Cost Adjustment Factor as defined below.\nChargeable Costs will be reduced up to a maximum of $1.20 per barrel in any given year subsequent to 2000 based on the following tests of the Company's additions of Proved Reserves to Current Reserves. Current Reserves are defined as the Company's Proved Reserves of crude oil and condensate as of December 31, 1987 (2035.6 million stock tank barrels (\"STB\")) and before taking into account any production therefrom and before any reduction that may result from the creation of the Trust.\n(a) As of December 31, 1995 approximately 773,500,000 STB of Proved Reserves have been added to Current Reserves. If, by December 31, 1995, 100,000,000 or more STB of Proved Reserves had not been added to Current Reserves, then for each year 1996 through 2000, inclusive, Chargeable Costs as set forth in the table above would have been reduced, as of January 1 in each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which would have been the\ndifference between 100,000,000 STB of Proved Reserves and the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 1995 and the denominator of which would have been 100,000,000 STB of Proved Reserves. The Company added approximately 42,000,000 STB to Proved Reserves during 1988, approximately 45,500,000 STB during 1989, approximately 24,000,000 STB during 1990, approximately 116,000,000 STB during 1991, approximately 144,000,000 STB during 1992, approximately 206,000,000 STB during 1993, approximately 90,000,000 STB during 1994 and approximately 106,000,000 STB during 1995.\n(b) If between January 1, 1996 and December 31, 2000 an additional 200,000,000 STB of Proved Reserves (that is, 200,000,000 STB of Proved Reserves in addition to the 100,000,000 STB of Proved Reserves that are referred to in (a)) have not been added to Current Reserves, then for each year from 2001 through 2005, inclusive, Chargeable Costs as set forth in the table above shall be reduced, as of January 1 in each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between (1) 200,000,000 STB of Proved Reserves and (2) the sum of (i) the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 1996 through December 31, 2000 plus (ii) the excess, if any, of the number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 1995 over 100,000,000 STB of Proved Reserves (provided that the sum of (i) and (ii) shall not exceed 200,000,000 STB of Proved Reserves) and the denominator of which shall be 200,000,000 STB of Proved Reserves.\n(c) The tests set forth in (i) and (ii) below will be utilized to calculate the reduction, if any, in Chargeable Costs for the year 2006 and each year thereafter. If the calculation under one of such tests produces a reduction in Chargeable Costs but the calculation under the other test does not, the calculation that produces the reduction shall apply. In applying the tests below, it is the intention of the Company that test (i) allow as a credit toward the 400,000,000 STB of Proved Reserves that must be added to Current Reserves during the period set forth in such test an amount equal to the excess, if any, of the number of STB of Proved Reserves added to Current Reserves prior to December 31, 2000 over 300,000,000 STB of Proved Reserves while test (ii) sets a level of only 100,000,000 STB of Proved Reserves that must be added to Current Reserves during the period set forth in such test, but does not allow a credit for additions of STB of Proved Reserves accrued prior to December 31, 2000.\n(i) If, between January 1, 2001 and December 31, 2005, an additional 400,000,000 STB of Proved Reserves (that is, 400,000,000 STB of Proved Reserves in addition to the 100,000,000 STB of Proved Reserves that are referred to in (a) and the 200,000,000 STB of Proved Reserves that are referred to in (b)) have not been added to Current Reserves, then for the year 2006 and each year thereafter Chargeable Costs as set forth in the table above shall be reduced, as of January 1 of each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between (1) 400,000,000 STB of Proved Reserves and (2) the sum of (x) the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 2001 through December 31, 2010 plus (y) the excess, if any, of the number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 2000 over 300,000,000 STB of Proved Reserves (provided that the sum of (x) and (y) shall not exceed 400,000,000 STB of Proved Reserves) and the denominator of which shall be 400,000,000 STB of Proved Reserves.\n(ii) If, between January 1, 2001 and December 31, 2005, an additional 100,000,000 STB of Proved Reserves (that is, 100,000,000 STB of Proved Reserves in addition to any and all STB of Proved Reserves that are added to Current Reserves prior to January 1, 2001) have not been added to Current Reserves, then for the year 2006 and each year thereafter, Chargeable Costs as set forth in the table above shall be reduced, as of January 1 of each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between 100,000,000 STB of Proved Reserves and the number of STB of Proved Reserves added to Current Reserves from January 1, 2001 through December 31, 2005 and the denominator of which shall be 100,000,000 STB of Proved Reserves.\nCOST ADJUSTMENT FACTOR\nThe \"Cost Adjustment Factor\" is the ratio of (1) the Consumer Price Index (\"CPI\") published for the most recently past February, May, August or November, as the case may be, to (2)121.1 (the Consumer Price Index for January 1989); provided, however, that (a) if for any calendar quarter the average WTI Price is $18.00 or less, then in such event the Cost Adjustment Factor for such quarter shall be the Cost Adjustment Factor for the immediately preceding quarter, and (b) the Cost Adjustment Factor for any calendar quarter in which the average WTI Price exceeds $18.00, after a calendar quarter during which the average WTI Price is equal to or less than $18.00, and for each following calendar quarter in which the average WTI Price is greater than $18.00, shall be the product of (x) the Cost Adjustment Factor for the most recently past calendar quarter in which the average WTI Price is equal to or less than $18.00 and (y) a fraction, the numerator of which shall be the Consumer Price Index published for the most recently past February, May, August or November, as the case may be, and the denominator of which shall be the Consumer Price Index published for the most recently past February, May, August or November during a quarter in which the average WTI Price is equal to or less than $18.00. The \"Consumer Price Index\" is the U.S. Consumer Price Index, all items and all urban consumers, U.S. city average, 1982-84 equals 100, as first published, without seasonal adjustment, by the Bureau of Labor Statistics, Department of Labor, without regard to subsequent revisions or corrections by such Bureau.\nPRODUCTION TAXES\n\"Production Taxes\" are the sum of any severance taxes, excise taxes (including windfall profit tax, if any), sales taxes, value added taxes or other similar or direct taxes imposed upon the reserves or production, delivery or sale of Royalty Production. For this purpose, such taxes will be computed at defined statutory rates. In the case of taxes based upon wellhead or field value, the Overriding Conveyance provides that the WTI Price less the product of $4.50 and the Cost Adjustment factor will be deemed to be the wellhead or field value. At the present time, the Production Taxes payable with respect to the Royalty Production are the Alaska Oil and Gas Properties Production Tax (\"Alaska Production Tax\") and the Alaska Oil and Gas Conservation Tax (\"Alaska Conservation Tax\"). For the purposes of the Royalty Interest, the Alaska Production Tax will be computed without regard to the \"economic limit factor\", if any, as the greater of the \"percentage of value amount\" (based on the statutory rate and the wellhead value as defined above) and the \"cents per barrel amount\" as such terms are used with respect to such tax. As of the date of this report, the statutory rate for the purpose of calculating the \"percentage of value amount\" is 15%, and the Alaska Conservation Tax is a tax of $0.004 per barrel of net production. A surcharge to the Alaska Production Tax increased Production Taxes by $0.05 per barrel of net production effective July 1, 1989. Due to the spill response fund reaching $50 million in 1995, $0.02 per barrel of the surcharge has been indefinitely suspended. In the event the balance of that fund falls below $50 million, the $0.02 per barrel will be reinstated until the fund balance again reaches $50 million. The remaining $0.03 per barrel is not effected by the fund's balance and will continue to be imposed at all times.\nROYALTY PRODUCTION\nThe Royalty Production for each day in a calendar quarter will be 16.4246% of the first 90,000 barrels of the average of the Company's actual daily net production of oil and condensate for such quarter as produced from the company's oil rim and gas cap participation as of February 28, 1989 or as modified thereafter by any redetermination provided under the terms of the Prudhoe Bay Unit Operating Agreement and the Prudhoe Bay Unit Agreement. The Royalty Production will be based upon oil produced from the oil rim and condensate produced from the gas cap, but not upon gas production or natural gas liquids production. The Company's actual average daily net production of oil and condensate for any calendar quarter will be the total production of oil and condensate for such quarter, net of the State of Alaska royalty, divided by the number of days in such quarter.\nCALCULATION OF ROYALTY AMOUNT\nThe Royalty Interest for each calendar quarter is the sum of the product of each day in such quarter of (i) the Royalty Production and (ii) the Per Barrel Royalty; provided that the payment under the Royalty Interest for any calendar quarter will not be (1) less than zero or (2) more than the aggregate value of the total production of oil and condensate from the Company's current working interest in the PBU for such calendar quarter, net of the State of Alaska royalty and less the value of any applicable payments made to affiliates of the Company.\nMINIMUM ROYALTY\nThe Royalty Interest provided for a Minimum Per Barrel Royalty for the period from February 28, 1989 to September 30, 1991 of $8.92 per barrel (the \"Minimum Per Barrel Royalty\"); for all periods thereafter there is no Minimum Per Barrel Royalty.\nDuring 1989, 1990, and 1991 through and including October 15, 1991, the Trust's distributions were based on the Average Per Barrel Royalty and not on the Minimum Per Barrel Royalty.\nPOTENTIAL CONFLICTS OF INTEREST BETWEEN THE COMPANY AND TRUST\nThe interests of the Company and the Trust with respect to the PBU could at times be different. In particular, because the Per Barrel Royalty will be based on the WTI Price and Chargeable Costs rather than the Company's actual price realized and actual costs, the actual per barrel profit received by the Company on the Royalty Production could differ from the Per Barrel Royalty to be paid to the Trust. It is possible, for example, that the relationship between the Company's actual per barrel revenues and costs could be such that the Company may determine to interrupt or discontinue production in whole or in part even though a Per Barrel Royalty may otherwise have been payable to the Trust pursuant to the Royalty Interest. This potential conflict of interest could affect the royalties paid to Trust Unit holders, although the Company will be subject to the terms of the Prudhoe Bay Unit Operating Agreement.\nHolders of Trust Units will have certain voting rights with respect to the administration of the Trust, but will have no voting rights with respect to, and no control over, any operating matters related to the PBU. The Company will retain the sole right to control all matters relating to its working interest in the PBU, subject to the terms of the Prudhoe Bay Unit Operating Agreement.\nDESCRIPTION OF THE BP SUPPORT AGREEMENT\nBP has agreed pursuant to the terms of a Support Agreement, dated February 28, 1989, among BP, the Company, Standard Oil and the Trust (the \"Support Agreement\"), to provide financial support to the Company in meeting its payment obligations under the Royalty Interest.\nWithin 30 days of notice to BP pursuant to Article XI of the Trust Agreement, BP will ensure that the Company is in a position to perform its payment obligations under the Royalty Interest and to satisfy its payment obligations to the Trust under the Trust Agreement (including, without limitation, the obligation to make payments as indemnification), including, without limitation, contributing to the Company such funds as are necessary to make such payments. BP's obligations under the Support Agreement are unconditional and directly enforceable by Trust Unit holders.\nExcept as described below, no assignment, sale, transfer, conveyance, mortgage or pledge or other disposition of the Royalty Interest will relieve BP of its obligations under the Support Agreement.\nNeither BP nor the Company may transfer or assign its rights or obligations under the Support Agreement without the prior written consent of the Trust, except that BP can arrange for its obligations under the Support Agreement to be performed by any affiliate of BP, provided that BP remains responsible for ensuring that such obligations are performed in a timely manner.\nThe Company may sell or transfer all or part of its working interest in the PBU, although such a transfer will not relieve BP of its responsibility to ensure that the Company's payment obligations with respect to the Royalty Interest and under the Trust Agreement and the Conveyance are performed.\nBP will be released from its obligation under the Support Agreement upon the sale or transfer of all or substantially all of the Company's working interest in the PBU if the transferee is of Equivalent Financial Standing and unconditionally agrees to assume and be bound by BP's obligation under the Support Agreement in a writing in form and substance reasonably satisfactory to the Trustee. A transferee of \"Equivalent Financial Standing\" is defined in the Support Agreement as an entity having a rating assigned to outstanding unsecured, unsupported long term debt from Moody's Investors Service of at least A3 or from Standard & Poor's Corporation of at least A- or an equivalent rating from at least one nationally-recognized statistical rating organization (after giving effect to the sale or transfer to such entity of all or substantially all of the Company's working interest in the PBU and the assumption by such entity of all of the Company's obligations under the Conveyance and of all BP's obligations under the Support Agreement).\nDESCRIPTION OF THE PROPERTY\nBACKGROUND\nThe Prudhoe Bay field (the \"Field\") is located on the North Slope of Alaska, 250 miles north of the Arctic Circle and 650 miles north of Anchorage. The Field extends approximately 12 miles by 27 miles and contains nearly 150,000 productive acres. The Field, which was discovered in 1968 by BP and others, has been in production since 1977 and during 1989, 1990, 1991, 1992, 1993, 1994 and 1995 produced on average 1.4 million, 1.3 million, 1.3 million, 1.2 million, 1.1 million, 1 million, and 900 thousand barrels of oil and condensate per day, respectively. The Field is the largest producing field in North America. As of January 1, 1996, approximately 8.96 billion STB of oil and condensate had been produced from the Field. The Company estimates that production will decline at an average rate of approximately 10% per year. Field development is well advanced with approximately $16.7 billion gross capital spent and a total of about 1,259 wells drilled. Other large fields located in the same area include the Kuparuk, Endicott, and Lisburne fields. Production from those fields is not included in the Royalty Interest.\nSince several oil companies hold acreage within the Field, the PBU was established to optimize Field development. The Prudhoe Bay Unit Operating Agreement specifies the allocation of production and costs to PBU owners. The Company and a subsidiary of the Atlantic Richfield Company (\"Arco\") are the two Field operators. Other Field owners include affiliates of Exxon Corporation (\"Exxon\"), Mobil Corporation (\"Mobil\"), Phillips Petroleum Company (\"Phillips\") and Chevron Corporation (\"Chevron\").\nGEOLOGY\nThe principal hydrocarbon accumulations at Prudhoe Bay are in the Ivishak sandstone of the Sadlerochit Group at a depth of approximately 8,700 feet below sea level. The Ivishak is overlain by four minor reservoirs of varying extent which are designated the Put River, Eileen, Sag River and Shublik (collectively, \"PESS\") formations. Underlying the Sadlerochit Group are the oil-bearing Lisburne and Endicott formations. The net production referred to herein pertains only to the Ivishak and PESS formations, collectively known as the Prudhoe Bay (Permo-Triassic) Reservoir, and does not pertain to the Lisburne and Endicott formations.\nThe Ivishak sandstone was deposited some 250 million years ago during the Permian and Triassic geologic ages. The sediments in the Ivishak are composed of sandstones, conglomerate and shales which were deposited by a massive braided river\/delta system that flowed from an ancient mountain system to the north. Oil was trapped in the Ivishak by a combination of structural and stratigraphic trapping mechanisms.\nGross reservoir thickness is 550 feet, with a maximum oil column thickness of 425 feet. The original oil column is bounded on the top by a gas-oil contact, originally at 8,575 feet below sea level across the main field, and on the bottom by an oil-water contact at approximately 9,000 feet below sea level. A layer of heavy oil\/tar overlays the oil-water contact in the main field and has an average thickness of around 40 feet.\nOIL CHARACTERISTICS\nThe produced oil from the reservoir is a medium grade, low sulfur crude with an average specific gravity of 27 degrees API.\nThe gas cap composition is such that, upon surfacing, a liquid hydrocarbon phase, known as condensate, is formed.\nThe interests of the Trust Unit holders are based upon oil produced from the oil rim and condensate produced from the gas cap, but not upon gas production (which is currently uneconomic) or natural gas liquids production stripped from gas produced.\nPRUDHOE BAY UNIT OPERATION AND OWNERSHIP\nSince several companies hold acreage within the Field's limits, a unit was established to ensure optimum development of the Field. The Prudhoe Bay Unit, which became effective on April 1, 1977, divided the Field into two operating areas. The Company is the operator of the Western Operating Area (\"WOA\") and Arco Alaska Inc. is the operator of the Eastern Operating Area (\"EOA\"). Oil and condensate production comes from both the WOA and EOA.\nThe Prudhoe Bay Unit Operating Agreement specifies the allocation of production and costs to the working interest owners. The Prudhoe Bay Unit Operating Agreement also defines operator responsibilities and voting requirements and is unusual in its establishment of separate participating areas for the gas cap and oil rim. Effective December 31, 1995, the Company acquired the interest of Amerada Hess Corporation of 0.537991% on the oil rim participating area.\nThe Prudhoe Bay Unit ownership by participating area is summarized in the following table:\nPRUDHOE BAY UNIT OWNERSHIP BY PARTICIPATING AREA (AS OF JANUARY 1, 1996)\nOIL RIM REDETERMINATION\nThe Prudhoe Bay Unit Operating Agreement, which was entered into in 1977, required a final redetermination of participating interests in the oil rim, based upon improved technical knowledge of the reservoir as a result of Field operations. In 1982, the Company, Arco and Exxon (the three major interest owners holding a total of approximately 94% of the oil rim) reached an agreement regarding final redetermination of participating interests in the Field.\nIn October 1982, Exxon initiated arbitration proceedings regarding final redetermination of participating interests in the oil rim. As a result of the arbitration proceedings, which were concluded in 1985, the Company's participating interest in the oil reservoir was 50.68%. At the then current maximum allowable production rate, this resulted in the Company's interest becoming 655,200 net barrels of oil per day (\"BOPD\"). Also to adjust its share of cumulative total production since the inception of commercial production, the Company overlifted about 13,500 net BOPD for a two-year period ending in August, 1987. After the arbitration award, MPC challenged the award through litigation. Mobil, Phillips and Chevron agreed in principle in October 1990 to end their challenge to the 1985 arbitration on their participating area interest in exchange for a cash settlement from BP, ARCO and Exxon. This settlement became effective on completion\nof a definitive binding agreement between all PBU owners, known as the Issues Resolution Agreement (\"IRA\").\nThe Company has advised the Trustee that the IRA addresses, among other things, final determination of the Original Condensate Reserve (\"OCR\"), agreement on allocation of the OCR over time, agreement on an additional gas handling expansion project (GHX-2), extension of an existing Enhanced Oil Recovery (\"EOR\") project to the end of field life and the establishment of a plan of additional development.\nThe IRA is an agreement among the owners of the Prudhoe Bay Unit which is designed to promote cooperation, reduce conflicts, increase efficiency of operations, and resolve a number of issues that were previously subject to negotiation, arbitration, or litigation among the Unit owners. The Company has advised that final approval of the IRA has now been obtained from all Unit owners.\nThe Company has further advised that the OCR was finally determined to be 1,175 million stock tank barrels (\"STB\") for the Prudhoe Bay Unit, and that this OCR determination resulted in a reallocation of approximately 500 million STB of crude oil reserves to condensate reserves, for the Prudhoe Bay Unit. The Company has also advised that because BP owns 51.22% of the crude oil and 13.84% of the condensate, this OCR settlement alone results in a BP net reserve reduction. The Company has advised the Trustee, however, that the establishment of the OCR at this level when combined with the other elements of the agreement described above should result in no significant change to BP's net reserves, and that the changes agreed to by the Prudhoe Bay Unit owners, including the attendant increased production, are expected to have limited impact on the point at which the company's net production of oil and condensate would fall below 90,000 barrels per day.\nPRODUCTION AND RESERVES\nProduction began on June 19, 1977, with the completion of the Trans Alaska Pipeline System (\"TAPS\"). Initially 750,000 BOPD was the TAPS limit, but after start-up, pipeline capacity was increased and in November 1979 a production rate of 1.5 million BOPD was achieved.\nAs of January 1, 1996, there were about 1,019 producing oil wells, 36 gas reinjection wells, 51 water injection wells and 128 water and miscible gas injection wells in the Field. In terms of individual well performance, oil production rates range from 100 to 6,500 BOPD. Currently, the average well production rate is about 843 BOPD.\nThe Company's share of the hydrocarbon liquids production from the Field includes oil, condensate and natural gas liquids. Using the production allocation procedures from the Prudhoe Bay Unit Operating Agreement, the Field's production and the Company's 1995 share of oil and condensate (net of State of Alaska royalty) was as follows:\nPRUDHOE BAY UNIT 1995 PRODUCTION (BARRELS PER DAY)\nThe Company's net proved remaining reserves of oil and condensate in the PBU as of December 31, 1995 were 1,385,000,000 STB. This current estimate of reserves is based upon various assumptions, including a reasonable estimate of the allocation of hydrocarbon liquids between oil and condensate pursuant to the procedures of the Prudhoe Bay Unit Operating Agreement. The Company anticipates that its net production from its current proved reserves will exceed 90,000 barrels per day until the year 2012. The Company also\nprojects continued economic production thereafter, at a declining rate, until the year 2030; however, for the economic conditions and reserve estimates as of December 31, 1995 the Per Barrel Royalty will be zero following the year 2010. For years subsequent to 2000, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year if additions of Proved Reserves to Current Reserves (as defined in CHARGEABLE COSTS) do not meet certain specific levels (see CHARGEABLE COSTS). The Company has added and anticipates adding to its proved reserves. Even if expected reservoir performance does not change, the estimated reserves, economic life, and future revenues attributable to the BP Prudhoe Bay Royalty Trust may change significantly in the future. This may result from changes in the West Texas Intermediate Price or from changes in other prescribed variables utilized in calculations defined by the Overriding Royalty Conveyance. See Report of Miller and Lents, Ltd., Independent Petroleum Consultants, below.\nMILLER AND LENTS, LTD. MARTIN G. MILLER (1948-1980) MAX R. LENTS MILLER AND LENTS, LTD. KENNETH B. FORD OIL AND GAS CONSULTANTS WALTER CROW TWENTY-SEVENTH FLOOR P. G. VON TUNGELN 1100 LOUISIANA JAMES C. PEARSON HOUSTON, TEXAS 77002-5216 S. J. STIEBER Telephone 713 651-9455 T. LESLIE REEVES Telefax 713 654-9914 LARRY M. GRING K. R. CHEATHAM J. L. POWELL WILLIAM P. KOZA ROBERT W. RASOR CHARLES G. GUFFEY JAMES A. COLE WILLIAM K. KIBLER KELLY V. SIMMONS KAREN F. LOVING CHRISTOPHER A. BUTTA GREGORY W. ARMES GARY B. KNAPP\nFebruary 12, 1996\nThe Bank of New York Trustee, BP Prudhoe Bay Royalty Trust 101 Barclay Street 21 W New York, New York 10286\nRe: Estimates of Proved Reserves, Future Production Rates, and Future Net Revenues for the BP Prudhoe Bay Royalty Trust As of December 31,\nGentlemen:\nThis letter report is a summary of investigations performed in accordance with our engagement by you as described in Section 4.8(d) of the Overriding Royalty Conveyance dated February 27, 1989, between BP Exploration (Alaska) Inc., and The Standard Oil Company. The investigations included reviews of the estimates of Proved Reserves and production rate forecasts of oil and condensate made by BP Exploration (Alaska) Inc. attributable to the BP Prudhoe Bay Royalty Trust as of December 31, 1995. Additionally, we reviewed calculations of the resulting Estimated Future Net Revenues and Present Value of Estimated Future Net Revenues attributable to the BP Prudhoe Bay Royalty Trust.\nThe estimates and calculations reviewed are summarized in the report prepared by BP Exploration (Alaska) Inc. and transmitted with a cover letter dated February 5, 1996, addressed to Ms. Marie Trimboli of The Bank of New York and signed by Mr. David K. Woodward. Reviews were also performed by Miller and Lents, Ltd. during this year or in previous years of (1) the procedures for estimating and documenting Proved Reserves, (2) the estimates of in-place reservoir volumes, (3) the estimates of recovery factors and production profiles for the various areas, pay zones, projects, and recovery processes that are included in the estimate of Proved Reserves, (4) the production strategy and procedures for implementing that strategy, (5) the sufficiency of the data available for making estimates of Proved Reserves and production profiles, and (6) pertinent provisions of the Prudhoe Bay Unit Operating Agreement, the Issues Resolution Agreement, the Overriding Royalty Conveyance, the Trust Conveyance, the BP Prudhoe Bay Royalty Trust Agreement, and other related documents referenced in the Form Registration Statement filed with the Securities and Exchange Commission on August 7, 1989, by BP Exploration (Alaska) Inc.\nProved Reserves were estimated by BP Exploration (Alaska) Inc. in accordance with the definitions contained in Securities and Exchange Commission Regulation S-X, Rule 4-10(a). Estimated Future Net Revenues and Present Value of Estimated Future Net Revenues are not intended and should not be interpreted to represent fair market values for the estimated reserves.\nMILLER AND LENTS, LTD. ----------------------\nThe Prudhoe Bay (Permo-Triassic) Reservoir is defined in the Prudhoe Bay Unit Operating Agreement. The Prudhoe Bay Unit is an oil and gas unit situated on the North Slope of Alaska. The BP Prudhoe Bay Royalty Trust is entitled to a royalty payment on 16.4246 percent of the first 90,000 barrels of the actual average daily net production of oil and condensate for each calendar quarter from the BP Exploration (Alaska) Inc. working interest in the Prudhoe Bay Unit. The payment amount depends upon the Per Barrel Royalty which in turn depends upon the West Texas Intermediate Price, the Chargeable Costs, the Cost Adjustment Factor, and Production Taxes, all of which are defined in the Overriding Royalty Conveyance. \"Barrel\" as used herein means Stock Tank Barrel as defined in the Overriding Royalty Conveyance.\nOur reviews do not constitute independent estimates of the reserves and annual production rate forecasts for the areas, pay zones, projects, and recovery processes examined. We relied upon the accuracy and completeness of information provided by BP Exploration (Alaska) Inc. with respect to pertinent ownership interests and various other historical, accounting, engineering, and geological data.\nAs a result of our cumulative reviews, based on the foregoing, we conclude that:\n1. A large body of basic data and detailed analyses are available and were used in making the estimates. In our judgment, the quantity and quality of currently available data on reservoir boundaries, original fluid contacts, and reservoir rock and fluid properties are sufficient to indicate that any future revisions to the estimates of total original in-place volumes should be minor. Furthermore, the data and analyses on recovery factors and future production rates are sufficient to support the Proved Reserves estimates.\n2. The methods and procedures employed to accumulate and evaluate the necessary information and to estimate, document, and reconcile reserves, annual production rate forecasts, and future net revenues are effective and are in accordance with generally accepted geological and engineering practice in the petroleum industry.\n3. Based on our limited independent tests of the computations of reserves, production flowstreams, and future net revenues, such computations were performed in accordance with the methods and procedures described to us.\n4. The estimated net remaining Proved Reserves attributable to the BP Prudhoe Bay Royalty Trust as of December 31, 1995, of 81.0 million barrels of oil and condensate are, in the aggregate, reasonable. Of the 81.0 million barrels of total Proved Reserves, 80.2 million barrels are Proved Developed Reserves, and 0. 8 million barrels are Proved Undeveloped Reserves.\n5. Utilizing the specified procedures outlined in Financial Accounting Standards Board Statement of Financial Accounting Standards No. 69, BP Exploration (Alaska) Inc. calculated that as of December 31, 1995, production of the Proved Reserves will result in Estimated Future Net Revenues of $331 million and Present Value of Estimated Future Net Revenues of $203 million to the BP Prudhoe Bay Royalty Trust. These estimates are reasonable.\n6. BP Exploration (Alaska) Inc. estimated that, as of December 31, 1995, 773.8 million barrels of Proved Reserves have been added to Current Reserves. This estimate is reasonable. Current Reserves are defined in the Overriding Royalty Conveyance as net Proved Reserves of 2,035.6 million barrels as of December 31, 1987. Net additions to Proved Reserves after December 31, 1987 affect the Chargeable Costs that are used to calculate the Per Barrel Royalty paid to the BP Prudhoe Bay Royalty Trust.\n7. The BP Exploration (Alaska) Inc. projection that its net production of oil and condensate from Proved Reserves will continue at an average rate exceeding 90,000 barrels per day until the year 2012 is reasonable. As long as the Per Barrel Royalty has a positive value, average daily production attributable to the BP Prudhoe Bay Royalty Trust will remain constant until the net production falls below 90,000 barrels per day; thereafter, production attributable to the BP Prudhoe Bay Royalty Trust will decline with the BP Exploration (Alaska) Inc. production. However, the Per Barrel Royalty will\nMILLER AND LENTS, LTD. ----------------------\nnot have a positive value if the West Texas Intermediate Price is less than the sum of the per barrel Chargeable Costs and per barrel Production Taxes, appropriately adjusted in accordance with the Overriding Royalty Conveyance. Under such circumstances, average daily production attributable to the BP Prudhoe Bay Royalty Trust will have no value and therefore will not contribute to the reserves regardless of BP Exploration (Alaska) Inc.'s net production level.\n8. Based on the West Texas Intermediate Price of $19.58 per barrel on December 31, 1995, current Production Taxes, and the Chargeable Costs adjusted as prescribed by the Overriding Royalty Conveyance, the projection that royalty payments will continue through the year 2010 is reasonable. BP Exploration (Alaska) Inc. expects continued economic production at a declining rate through the year 2030; however, for the economic conditions and production forecast as of December 31, 1995, the Per Barrel Royalty will be zero following the year 2010. Therefore, no reserves are currently attributed to the BP Prudhoe Bay Royalty Trust after that date.\n9. Even if expected reservoir performance does not change, the estimated reserves, economic life, and future revenues attributable to the BP Prudhoe Bay Royalty Trust may change significantly in the future. This may result from changes in the West Texas Intermediate Price or from changes in other prescribed variables utilized in calculations defined by the Overriding Royalty Conveyance.\nEstimates of ultimate and remaining reserves and production scheduling depend upon assumptions regarding expansion or implementation of alternative projects or development programs and upon strategies for production optimization. BP Exploration (Alaska) Inc. has continual reservoir management, surveillance, and planning efforts dedicated to (1) gathering new information, (2) improving the accuracy of its reserves and production capacity estimates, (3) recognizing and exploiting new opportunities, (4) anticipating potential problems and taking corrective actions, and (5) identifying, selecting, and implementing optimum recovery program and cost reduction alternatives. Given this significant effort and ever-changing economic conditions, estimates of reserves and production profiles will change periodically.\nThe current estimate of Proved Reserves includes only those projects or development programs that are deemed reasonably certain to be implemented, given current economic and regulatory conditions. Future projects, development programs, or operating strategies different from those assumed in the current estimates may change future estimates and affect recoveries. However, because several complementary and alternative projects are being considered for recovery of the remaining oil in the reservoir, a decision not to implement a currently planned project may allow scope expansion or implementation of another project, thereby increasing the overall likelihood of recovering the reserves.\nFuture production rates will be controlled by facilities limitations and upsets, well downtime, and the effectiveness of programs to optimize production and costs. BP Exploration (Alaska) Inc. currently expects continued economic production from the reservoir at a declining rate through the year 2030. Additional drilling, workovers, facilities modifications, new recovery projects, and programs for production enhancement and optimization are expected to mitigate but not eliminate the anticipated future decline in gross oil and condensate production capacity.\nIn making its future production rate forecasts, BP Exploration (Alaska) Inc. provided for normal downtime and planned facilities upsets. Although allowances for unplanned upsets are also considered in the estimates, the studies do not provide for any impediments to crude oil production as a consequence of major disruptions.\nUnder current economic conditions, gas from the Alaskan North Slope, except for minor volumes, cannot be marketed commercially. Oil and condensate recoveries are expected to be greater as a result of continued reinjection of produced gas than the recoveries would be if major volumes of produced gas were being sold. No major gas sale is assumed in the current estimates. If major gas sales are determined to be economically viable in the future, BP Exploration (Alaska) Inc. estimates that such sales would not actually commence until eight\nMILLER AND LENTS, LTD. ----------------------\nto ten years after such a determination. In the event that major gas sales are initiated, ultimate oil and condensate recoveries may be reduced from the current estimates unless recovery projects other than those included in the current estimates are implemented.\nLarge volumes of natural gas liquids are likely to be produced and marketed in the future whether or not major gas sales become viable. Natural gas liquids reserves are not included in the estimates cited herein. The BP Prudhoe Bay Royalty Trust is not entitled to royalty payments from production or sales of natural gas or natural gas liquids.\nThe evaluations presented in this report, with the exceptions of those parameters specified by others, reflect our informed judgments based on accepted standards of professional investigation but are subject to those generally recognized uncertainties associated with interpretation of geological, geophysical, and engineering information. Government policies and market conditions different from those reflected in this study or disruption of existing transportation routes or facilities may cause the total quantity of oil or condensate to be recovered, actual production rates, prices received, or operating and capital costs to vary from those reviewed in this report.\nMiller and Lents, Ltd., is an independent oil and gas consulting firm. None of the principals of this firm have any direct financial interests in BP Exploration (Alaska) Inc. or its parent or any related companies or in the BP Prudhoe Bay Royalty Trust. Our fee is not contingent upon the results of our work or report, and we have not performed other services for BP Exploration (Alaska) Inc. or the BP Prudhoe Bay Royalty Trust that would affect our objectivity.\nVery truly yours,\nMILLER AND LENTS, LTD.\nBy \/s\/ William P. Koza ------------------------ William P. Koza Vice President\nEstimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. Information regarding estimates of proved reserves attributable to the combined interests of the Company and the Trust were based on Company prepared reserve estimates.\nThe reserves attributable to the Trust are only a part of the overall above stated reserves. There is no precise method of allocating estimates of physical quantities of reserve volumes between the Company and the Trust, since the Royalty Interest is not a working interest and the Trust does not own and is not entitled to receive any specific volume of reserves from the Field. Reserve volumes attributable to the Trust were estimated by allocating to the Trust its share of estimated future production from the Field, based on the WTI Prices on December 31, 1995 ($19.58 per barrel), December 31, 1994 ($17.75 per barrel), December 31, 1993 ($14.15 per barrel), December 31, 1992 ($19.50 per barrel), December 31, 1991 ($19.10 per barrel), and December 31, 1990 ($28.45 per barrel). Because the reserve volumes attributable to the Trust are estimated using an allocation of reserve volumes based on estimated future production, the current WTI Price, no future movement in the CPI, and no future additions by the Company of Proved Reserves to Current Reserves, a change in the timing of estimated production, a change in the WTI Price, future movement in the CPI, or future additions by the Company of Proved Reserves to Current Reserves will result in a change in the Trust's estimated reserve volumes. Therefore, the estimated reserve volumes attributable to the Trust will vary if different production estimates and prices are used. See \"Financial Statements\" and Note 5 thereto.\nEstimated net proved reserves allocable to the Trust as of December 31, 1995, December 31, 1994 and December 31, 1993 were 80,991,000 barrels, 80,991,000 barrels and 43,193,000 barrels, respectively. See \"Financial Statements\" and Note 5 thereto. The increase from December 31, 1993 to December 31, 1994 reflects the increase in the WTI Price from $14.15 per barrel on December 31, 1993 to $17.75 per barrel on December 31, 1994. Proved developed reserves allocable to the Trust as of December 31, 1995, December 31, 1994 and December 31, 1993 were 80,203,000 barrels, 80,991,000 barrels, and 43,193,000 barrels, respectively.\nThe Company is under no obligation to make investments in development projects which would add additional non-proved resources to proved reserves and cannot make such investments without the concurrence of the PBU working interest owners. However, several such investments which would augment Prudhoe Bay projects are already in process. These include additional drilling, waterflood expansions and miscible injection continuation\/expansion projects. Other possible investments could include expanded gas cycling, miscible\/waterflood infill drilling, miscible injection supply increases to peripheral areas, heavy oil tar recovery and development of the smaller reservoirs. While there is no assurance that the PBU working interest owners will make any such investments, they do regularly assess the technical and economic attractiveness of implementing further projects to increase PBU proved reserves.\nAs noted above, the Company's reserve estimates and production assumptions and projections are predicated upon a reasonable estimate of hydrocarbon allocation between oil and condensate. The Company's share of Prudhoe Bay production is the sum of 51.22% of the gross oil production and 13.84% of the gross condensate production from the Field. Oil and condensate are physically produced in a commingled stream of hydrocarbon liquids. The allocation of hydrocarbon liquids between the oil and condensate from the Field is a theoretical calculation performed in accordance with procedures specified in the Prudhoe Bay Unit Operating Agreement. Due to the differences in percentages between oil and condensate, the Company's overall share of oil and condensate production will vary over time according to the proportions of hydrocarbon liquid being allocated as condensate or as oil under the Prudhoe Bay Unit Operating Agreement allocation procedures. Under the terms of the IRA effective October 4, 1990 the present allocation procedures have been adjusted to generally allocate condensate in a manner which approximates the anticipated decline in the production of oil until the agreed condensate reserve of 1.175 billion STB has been allocated to the Working Interest Owners. The Company believes this is a reasonable estimate of hydrocarbon allocation between oil and condensate.\nThe occurrence of major gas sales could accelerate the time at which the Company's net production would fall below 90,000 barrels per day, due to the consequent decline in reservoir pressure.\nIn the event of changes in the Company's current assumptions, oil and condensate recoveries may be reduced from the current estimates, unless recovery projects other than those included in the current estimates are implemented.\nRESERVOIR MANAGEMENT\nThe Prudhoe Bay Field is a complex, combination-drive reservoir, with widely varying reservoir properties. Reservoir management involves directing Field activities and projects to maximize the economic value of Field reserves.\nSeveral different oil recovery mechanisms are currently active in the Field, including pressure depletion, gravity drainage\/gas cap expansion, waterflooding and miscible gas flooding. Separate yet integrated reservoir management strategies have been developed for the areas impacted by each of these recovery processes.\nTRANSPORTATION OF PRUDHOE BAY OIL\nProduction from the Field is carried to Pump Station 1, which is the starting point for TAPS, through two 34-inch diameter transit lines, one from each half of the Field. At Pump Station 1, Alyeska Pipeline Service Company, the pipeline operator, meters the oil and pumps it south to Valdez where it is either loaded onto marine tankers or stored temporarily. It takes the oil about six days to make the trip in the 48-inch diameter pipeline.\nVarious protests of the TAPS tariffs have been filed by, among others, the State of Alaska over a period of several years. Proceedings to resolve these protests are ongoing in the Federal Energy Regulatory Commission, the Alaska Public Utilities Commission and a Court of Appeal.\nHISTORICAL PRODUCTION OF OIL AND CONDENSATE\nThe following table sets forth information concerning the production of oil and condensate for the periods indicated. The amounts listed are the Company's share of production, net of royalties to the State of Alaska.\nHISTORICAL PRODUCTION\nINDUSTRY CONDITIONS\nThe production of oil and gas in Alaska is affected by many state and federal regulations with respect to allowable rates of production, marketing, environmental matters and pricing. Future regulations could change allowable rates of production or the manner in which oil and gas operations may be lawfully conducted.\nIn general, the Company's oil and gas activities are subject to laws and regulations relating to environmental quality and pollution control. The Company believes that the equipment and facilities currently being used in its operations generally comply with the applicable legislation and regulations. During the past few years, numerous environmental laws and regulations have taken effect at the federal, state and local levels. Oil and gas operations are subject to extensive federal and state regulation and to interruption or termination by governmental authorities due to ecological and other considerations. Although the existence of legislation and regulation has had no material adverse effect on the Company's current method of operations, existing and future legislation and regulations could result in the Company experiencing delays and uncertainties in commencing projects. The ultimate impact of such legislation and regulations cannot generally be predicted.\nOil prices are subject to international supply and demand. Political developments (especially in the Middle East) and the outcome of meetings of OPEC can particularly affect world oil supply and oil prices.\nCERTAIN TAX CONSIDERATIONS\nThe following is a summary of the principal tax consequences to the Trust Unit holders resulting from the ownership and disposition of Trust Units. The laws or regulations affecting these matters are subject to change by future legislation or regulations or new interpretations by the IRS, state taxing authorities or the courts, which could adversely affect Trust Unit holders. In addition, there may be differences of opinion as to the applicability or interpretation of present tax laws or regulations. BP and the Trust have not requested from the IRS any rulings on the tax treatment described below, and no assurance can be given that such tax treatment will be available.\nTaxpayers are urged to consult their tax advisors on the application of the following discussion to their specific circumstances.\nEMPLOYEES\nThe Trust has no employees. Administrative functions of the Trust are performed by the Trustee.\nFEDERAL INCOME TAX\nCLASSIFICATION OF THE TRUST\nThe Trust files its federal tax return as a \"grantor trust\" rather than as \"an association taxable as a corporation.\" If the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trust's tax liability as an association. The following discussion is based on the legal conclusion that the Trust will be classified as a grantor trust under current law.\nTAXATION OF THE TRUST\nA grantor trust is not subject to tax, and its beneficiaries (the Trust Unit holders in the case of the Trust) are considered for tax purposes to own its income and corpus. A grantor trust files an information return reporting all items of income or deduction. The Trust, therefore, will pay no federal income tax, but will file an information return.\nTAXATION OF TRUST UNIT HOLDERS\nThe income of the Trust will be deemed to have been received or accrued by the Trust Unit holders at the time such income is received or accrued by the Trust and not when distributed by the Trust. Income will be recognized by a Trust Unit holder consistent with its method of accounting and without regard to the accounting period or method employed by the Trust.\nThe Trust will make quarterly distributions to Trust Unit holders of record on each Quarterly Record Date. See \"Description of the Trust Units and the Trust Agreement -- Distributions of Income.\" The terms of the Trust Agreement as described above, seek to assure to the extent practicable that taxable income attributable to such distributions will be reported by the Trust Unit holder who receives such distributions, assuming that such holder is the owner of record on the Quarterly Record Date. In certain circumstances, however, a Trust Unit holder may be required to report taxable income attributable to its Trust Units, but the Trust Unit holder will not receive the distribution attributable to such income. For example, if the Trustee establishes a reserve or borrows money to satisfy debts and liabilities of the Trust income used to establish such reserve or to repay such loan must be reported by the Trust Unit holder, even though such income is not distributed to the Trust Unit holder.\nThe Trust intends to allocate income and deductions to Trust Unit holders based on record ownership at Quarterly Record Dates. It is unknown whether the IRS will accept such allocation or will require income and deductions of the Trust to be determined and allocated daily or require some method of daily proration, which could result in an increase in the administrative expenses of the Trust.\nIt is anticipated that each Trust Unit holder will be entitled to a deduction for cost depletion and certain other deductions for state and local taxes imposed upon the Trust or a Trust Unit holder and administrative expenses of the Trust. A Trust Unit holder's deduction for cost depletion in any year will be calculated by multiplying the holder's adjusted tax basis in the Trust Units (generally its cost less prior depletion deductions) by Royalty Production during the year and dividing that product by the sum of Royalty Production during the year and estimated remaining Royalty Production as of the end of the year. Trust Unit holders acquiring units on or after October 12, 1990 are possibly permitted to utilize percentage depletion with respect to such Units. Percentage depletion is based on the Trust Unit holders gross income from the Trust rather than on his adjusted basis in his Units. Any deduction for cost depletion or percentage depletion allowable to a Trust Unit holder will reduce its adjusted basis in its Trust Units for purposes of computing subsequent depletion or gain or loss on any subsequent disposition of Trust Units.\nEach Trust Unit holder must maintain records of its adjusted basis in the Trust Units, make adjustments for depletion deductions to such basis, and use such basis for the computation of gain or loss on the disposition of the Trust Units.\nTAXATION OF NONRESIDENT ALIEN INDIVIDUALS, PARTNERSHIPS AND FOREIGN CORPORATIONS\nGenerally, nonresident alien individuals, partnerships and foreign corporations (i.e., Foreign persons) are subject to a tax of 30 percent on gross income from sources within the U.S. that are not from a U.S. trade or business. Income from the Trust is considered income which is not effectively connected with a U.S. trade or business. As a result, Foreign persons would be subject to a 30 percent tax on their gross income from the Trust, without deductions. Usually such tax is to be withheld at the source of payment by the withholding agent. However, if there is a treaty in effect between the U.S. and the country of residence of the foreign person, such treaty may reduce the rate of withholding.\nA holder of Trust Units who is a Foreign person may make an election pursuant to Internal Revenue Code Section 871 (d) or 882(d), or pursuant to any similar provisions of applicable treaties, to treat the income (which constitutes income from real property) from the Trust as income which is effectively connected with a U.S. trade or business. If this election is made such a holder of Trust Units will not be subject of withholding but will, however, be taxed on such income in the same manner as a U.S. person (i.e. U.S. individual, partnership or corporation). As a result, such holder of Trust Units will be taxed on his net income as opposed to his gross income from the Trust. Also, under such an election, any gain or loss upon the\ndisposition of a Trust Unit will be deemed to be connected with a U.S. trade or business and taxed in the manner described above. If a Foreign person owns a greater than 5 percent interest in the Trust, that interest is a U.S. real property interest as provided under Internal Revenue Code Section 897. Gain on disposition of that interest will be taxed as if the holder of Trust Units were a U.S. person. In addition, Foreign persons subject to Internal Revenue Code Section 897 who are nonresident alien individuals will be subject to a minimum tax of 26 percent or 28 percent (depending on filing status and taxable income) on the lesser of:\n1. the individual's alternative minimum taxable income for the taxable year, or\n2. the individual's net United States real property gain for the taxable year.\nGain or loss on the disposition is determined by subtracting the adjusted basis of the Trust Units from the proceeds received. If the Foreign person is a corporation which made an election under Internal Revenue Code Section 882(d), the corporation would also be subject to a 30 percent tax under Internal Revenue Code Section 884. This tax is imposed on U.S. branch profits of a foreign corporation that are not reinvested in the U.S. trade or business. This tax is in addition to the tax on effectively connected income. The branch profits tax may be either reduced or eliminated by treaty.\nSALE OF TRUST UNITS\nGenerally, a Trust Unit holder will realize gain or loss on the sale or exchange of his Trust Units measured by the difference between the amount realized on the sale or exchange and his adjusted basis for such Trust Units. Gain on the sale of Trust Units by a holder that is not a dealer with respect to such Trust Units will generally be treated as capital gain. However, pursuant to Internal Revenue Code Section 1254, certain depletion deductions claimed with respect to the Trust Units must be recaptured as ordinary income upon sale or disposition of such interest.\nBACKUP WITHHOLDING\nA payor must withhold 31 percent of any reportable payment if the payee fails to furnish his taxpayer identification number (\"TIN\") to the payor in the required manner or if the Secretary of the Treasury notifies the payor that the TIN furnished by the payee is incorrect. A Unit holder will avoid backup withholding by furnishing his correct TIN to the Trustee in the form required by law.\nREPORTS\nThe Trustee will furnish the Trust Unit holders of record quarterly and annual reports described above under \"Description of the Trust Units and the Trust Agreement -- Reports to Holders of Trust Units\" in order to permit computation of tax liability by the Trust Unit holders.\nSTATE INCOME TAXES\nUnit holders may be required to report their share of income from the Trust to their state of residence or commercial domicile. However, only corporate Unit holders will need to report their share of income to the State of Alaska. Alaska does not impose an income tax on individuals or estates and trusts. Corporate Unit holders should be advised that all Trust income is Alaska source income and should be reported accordingly.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nReference is made to \"Item I. -- Business\" for the information required by this item.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNIT HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR TRUST UNITS\nThe Trust Units are listed on the New York Stock Exchange (\"NYSE\"). The following table represents the high and low per unit sales prices for the Trust Units as reported on the consolidated tape for 1994 and 1995 and the distributions paid by the Trust for the periods presented.\nAs of March 26, 1996, there were 1,373 registered holders of Trust Units.\nFuture payments of cash distributions are dependent on such factors as the prevailing WTI Price, the relationship of the rate of change in the WTI Price to the rate of change in the Consumer Price Index, the Chargeable Costs, the rates of Production Taxes prevailing from time to time, and the actual production from the PBU.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to \"Item 1. -- Report of Miller and Lents, Ltd., Independent Petroleum Consultants\" of this Annual Report on Form 10-K.\nThe following table presents in summary form selected financial information regarding the Trust.\nBP PRUDHOE BAY ROYALTY TRUST\nStatements of Cash Earnings and Distributions For each of the years in the five-year period ended December 31, 1995, 1994, 1993, 1992 and 1991 (In thousands, except unit data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION\nThe Trust is a passive entity with the Trustee having only such powers as are necessary for the collection and distribution of revenues from the Royalty Interest, the payment of Trust liabilities and expenses and the protection of the Royalty Interest. All royalty payments received by the Trustee are distributed, net of Trust expenses, to Trust Unit holders. Accordingly, a discussion of liquidity or capital resources is not applicable.\nRESULTS OF OPERATIONS\nPayments to the Trust with respect to the Royalty Interest are generally payable on the fifteenth day after the end of the calendar quarter (or the next succeeding business day if such fifteenth day is not a business day) in an amount equal to the per barrel WTI Price for each day during the calendar quarter less the sum of (i) the product of the per barrel Chargeable Costs and the Cost Adjustment Factor (such product hereinafter referred to as \"Adjusted Chargeable Costs\") and (ii) the per barrel Production Taxes, multiplied by the Royalty Production.\nACTUAL RESULTS\nDuring 1995 the Trust received payments with respect to the Royalty Interest in the aggregate amount of $34,886,000 and made distributions to Unit holders in the aggregate amount of $34,198,000. The payment with respect to the Royalty Interest for the calendar quarter ended December 31, 1995, which was paid to the Trust on January 16, 1996, was $8,411,028. The following table sets forth with respect to each calendar quarter the average WTI price, the per barrel Chargeable Costs, the Cost Adjustment Factor, the per barrel Adjusted Chargeable Costs, the per barrel Production Taxes, and the Per Barrel Royalty.\nCALENDAR YEARS 1995, 1994 AND 1993\n(All Figures after rounding)\nAs discussed above in Part I \"Industry Conditions\" the production of oil and gas in Alaska is affected by many state and federal regulations. Existing and future legislation and regulations could result in the Company's experiencing delays and uncertainties, although the ultimate impact cannot generally be predicted. Per barrel royalty payments will also remain subject to oil prices, to the WTI Price, to Chargeable Costs, which increase in accordance with the schedule contained above under \"Description of the Royalty Interest -- Chargeable Costs\", to the Cost Adjustment Factor, which is based on CPI, and to Production Taxes.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nBP PRUDHOE BAY ROYALTY TRUST\nINDEPENDENT AUDITORS' REPORT\nTrustee and Holders of Trust Units of BP Prudhoe Bay Royalty Trust:\nWe have audited the accompanying statements of assets, liabilities and Trust Corpus of BP Prudhoe Bay Royalty Trust as of December 31, 1995 and 1994, and the related statements of cash earnings and distributions and changes in Trust Corpus for each of the years in the three-year period ended December 31, 1995. These financial statements are the responsibility of the Trustee. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Trustee, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in note 2 to the financial statements, these financial statements have been prepared on a modified basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities and Trust Corpus of BP Prudhoe Bay Royalty Trust as of December 31, 1995 and 1994, and its cash earnings and distributions and its changes in Trust Corpus for each of the years in the three-year period ended December 31, 1995, on the basis of accounting described in note 2.\nKPMG Peat Marwick LLP\nNew York, New York March 22, 1996\nBP PRUDHOE BAY ROYALTY TRUST\nSTATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS\nDECEMBER 31, 1995 AND 1994 (IN THOUSANDS, EXCEPT UNIT DATA)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nSTATEMENTS OF CASH EARNINGS AND DISTRIBUTIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT UNIT DATA)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nSTATEMENTS OF CHANGES IN TRUST CORPUS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(1) FORMATION OF THE TRUST AND ORGANIZATION\nBP Prudhoe Bay Royalty Trust (the \"Trust\") was formed pursuant to a Trust Agreement dated February 28, 1989 among The Standard Oil Company (\"Standard Oil\"), BP Exploration (Alaska) Inc. (the \"Company\"), The Bank of New York and a co-trustee (The Bank of New York (Delaware)) (collectively, the \"Trustee\"). Standard Oil and the Company are indirect wholly owned subsidiaries of the British Petroleum Company p.1.c. (\"BP\").\nOn February 28, 1989, Standard Oil conveyed an overriding royalty interest (the \"Royalty Interest\") to the Trust. The Trust was formed for the sole purpose of owning and administering the Royalty Interest. The Royalty Interest represents the right to receive, effective February 28, 1989, a per barrel royalty (the \"Per Barrel Royalty\") of 16.4246% of the lesser of (a) the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter or (b) the average actual daily net production of oil and condensate per quarter from the Company's working interest in the Prudhoe Bay Field (the \"Field\") located on the North Slope of Alaska. Trust Unit holders will remain subject at all times to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any quarter. BP has guaranteed the performance by the Company of its payment obligations with respect to the Royalty Interest.\nThe co-trustees of the Trust are The Bank of New York, a New York corporation authorized to do a banking business, and The Bank of New York (Delaware), a Delaware banking corporation. The Bank of New York (Delaware) serves as co-trustee in order to satisfy certain requirements of the Delaware Trust Act. The Bank of New York alone is able to exercise the rights and powers granted to the Trustee in the Trust Agreement.\nThe Per Barrel Royalty in effect for any day is equal to the price of West Texas Intermediate crude oil (the \"WTI Price\") for that day less scheduled Chargeable Costs (adjusted in certain situations for inflation) and Production Taxes (based on statutory rates then in existence). The Chargeable Costs per Barrel of Royalty Production was $8.25 during the year ended December 31, 1995, as set forth in section 4.4 of the Overriding Royalty Conveyance. During the period from February 28, 1989 (date of formation) to September 30, 1991, the Royalty Interest provided for a minimum royalty in certain situations. For the years 2001 through 2005, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year if additions to the Field's proved reserved from January 1, 1996 through December 31, 2000 do not meet certain specific levels.\nThe Trust is passive, with the Trustee having only such powers as are necessary for the collection and distribution of revenues, the payment of Trust liabilities and the protection of the Royalty Interest. The Trustee, subject to certain conditions, is obligated to establish cash reserves and borrow funds to pay liabilities of the Trust when they become due. The Trustee may sell Trust properties only (a) as authorized by a vote of the Trust Unit holders, (b) when necessary to provide for the payment of specific liabilities of the Trust then due (subject to certain conditions) or (c) upon termination of the Trust. Each Trust Unit issued and outstanding represents an equal undivided share of beneficial interest in the Trust. Royalty payments are received by the Trust and distributed to Trust Unit holders, net of Trust expenses, in the month succeeding the end of each calendar quarter. The Trust will terminate upon the first to occur of the following events:\n(a) On or prior to December 31, 2010: upon a vote of Trust Unit holders of not less than 70% of the outstanding Trust Units.\n(b) After December 31, 2010: (i) upon a vote of Trust Unit holders of not less than 60% of the outstanding Trust Units, or (ii) at such time the net revenues from the Royalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year (unless the net revenues during such period are materially and adversely affected by certain events).\nBP PRUDHOE BAY ROYALTY TRUST\nNOTES TO FINANCIAL STATEMENTS\n(2) BASIS OF ACCOUNTING\nThe financial statements of the Trust are prepared on a modified cash basis and reflect the Trust's assets, liabilities and Trust Corpus and the earnings and distributions as follows:\n(a) Revenues are recorded when received (generally within 15 days of the end of the preceding quarter) and distributions to Trust Unit holders are recorded when paid.\n(b) Trust expenses (which include accounting, engineering, legal, and other professional fees, trustees' fees and out-of-pocket expenses) are recorded when incurred.\n(c) Amortization of the Royalty Interest is calculated based on the units of production attributable to the Trust over the production of estimated proved reserves attributable to the Trust at the beginning of the fiscal year (approximately 80,991,000, 43,193,000 and 94,306,000 barrels were used to calculate the amortization of the Royalty Interest for the years ended December 31, 1995, 1994 and 1993, respectively). Such amortization is charged directly to the Trust Corpus, and does not affect cash earnings. The rate for amortization per net equivalent barrel of oil was $6.61, $12.39 and $5.67 for the years ended December 31, 1995, 1994 and 1993, respectively. The remaining unamortized balance of the net overriding Royalty Interest at December 31, 1995 is not necessarily indicative of the fair market value of the interest held by the Trust.\nWhile these statements differ from financial statements prepared in accordance with generally accepted accounting principles, the cash basis of reporting revenues and distributions is considered to be the most meaningful because quarterly distributions to the Unit holders are based on net cash receipts.\nThe conveyance of the Royalty Interest by Standard Oil to the Trust was accounted for as a purchase transaction. On February 28, 1989, Standard Oil sold 13,360,000 Trust Units to a group of institutional investors for $334 million in a private placement. For financial reporting purposes, the Trust's management valued the remaining Trust Units owned by Standard Oil (8,040,000 units) at a per unit value equivalent to the amount paid by the investors in the private placement.\nThe 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 periods. Actual results could differ from those estimates.\n(3) INCOME TAXES\nThe Trust files its federal tax return as a grantor trust subject to the provisions of subpart E of Part I of Subchapter J of the Internal Revenue Code of 1986, as amended, rather than as an association taxable as a corporation. The Unit holders are treated as the owners of Trust income and Corpus, and the entire taxable income of the Trust will be reported by the Unit holders on their respective tax returns.\nIf the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trust's tax liability as an association.\nBP PRUDHOE BAY ROYALTY TRUST\nNOTES TO FINANCIAL STATEMENTS\n(4) SUMMARY OF QUARTERLY RESULTS (UNAUDITED)\nA summary of selected quarterly financial information for the years ended December 31, 1995 and 1994 is as follows (in thousands, except unit data):\n(5) SUPPLEMENTAL RESERVE INFORMATION AND STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOW RELATING TO PROVED RESERVES (UNAUDITED)\nPursuant to Statement of Financial Accounting Standards No. 69 - \"Disclosures About Oil and Gas Producing Activities\" (\"FASB 69\"), the Trust is required to include in its financial statements supplementary information regarding estimates of quantities of proved reserves attributable to the Trust and future net cash flows.\nEstimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. Information regarding estimates of proved reserves attributable to the combined interests of the Company and the Trust were based on Company-prepared reserve estimates. The Company's reserve estimates are believed to be reasonable and consistent with presently known physical data concerning the size and character of the Field.\nThere is no precise method of allocating estimates of physical quantities of reserve volumes between the Company and the Trust, since the Royalty Interest is not a working interest and the Trust does not own and is not entitled to receive any specific volume of reserves from the Field. Reserve volumes attributable to the Trust were estimated by allocating to the Trust its share of estimated future production from the Field, based on the WTI Price on December 31, 1995 ($19.58 per barrel), December 31, 1994 ($17.75 per barrel) and December 31, 1993 ($14.15 per barrel). Because the reserve volumes attributable to the Trust are estimated using an allocation of reserve volumes based on estimated future production and on the current WTI Price, a change in the timing of estimated production or a change in the WTI price will result in a change in the Trust's estimated reserve volumes. Therefore, the estimated reserve volumes attributable to the Trust will vary if different production estimates and prices are used.\nIn addition to production estimates and prices, reserve volumes attributable to the Trust are affected by the amount of Chargeable Costs that will be deducted in determining the Per Barrel Royalty. The Royalty Interest includes a provision under which, in years subsequent to 1996, if additions to the Field's proved reserves from January 1, 1988 do not meet certain specified levels, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year. Under the provisions of FASB 69, no consideration can be given to reserves not considered proved at the present time. Accordingly, in estimating the reserve volumes\nBP PRUDHOE BAY ROYALTY TRUST\nNOTES TO FINANCIAL STATEMENTS\nattributable to the Trust, Chargeable Costs were reduced by the maximum amount in years subsequent to 1996, after considering the amount of reserves that have been added to the Field's proved reserves from January 1, 1988.\nNet proved reserves of oil and condensate attributable to the Trust as of December 31, 1995, 1994 and 1993 based on the Company's latest reserve estimate at such time, the WTI Prices on December 31, 1995, 1994 and 1993 and a reduction in Chargeable Costs in years subsequent to 1996, were estimated to be 81, 81 and 43 million barrels, respectively (of which 80, 81 and 43 million barrels, respectively, are proved developed).\nThe standardized measure of discounted future net cash flow relating to proved reserves disclosure required by FASB 69 assigns monetary amounts to proved reserves based on current prices. This discounted future net cash flow should not be construed as the current market value of the Royalty Interest. A market valuation determination would include, among other things, anticipated price increases and the value of additional reserves not considered proved at the present time or reserves that may be produced after the currently anticipated end of field life. At December 31, 1995, 1994 and 1993 the standardized measure of discounted future net cash flow relating to proved reserves attributable to the Trust (estimated in accordance with the provisions of FASB 69), based on the WTI Prices on those dates of $19.58, $17.75 and $14.15, respectively, were as follows (in thousands):\n(a) The standardized measure of discounted future net cash flow relating to proved reserves, estimated without reducing Chargeable Costs in years subsequent to 1995, would be $202,602, $154,200 and $65,174 at December 31, 1995, 1994 and 1993, respectively.\nThe following are the principal sources of the change in the standardized measure of discounted future net cash flows (in thousands):\n(b) Royalty income received for 1995, 1994 and 1993 includes the royalty applicable to the period October 1, 1995 through December 31, 1995 ($8,411), October 1, 1994 through December 31, 1994 ($8,478) and October 1, 1993 through December 31, 1993 ($9,172) which was received by the Trust in January 1996, 1995 and 1994, respectively.\nBP PRUDHOE BAY ROYALTY TRUST\nNOTES TO FINANCIAL STATEMENTS\nThe changes in quantities of proved oil and condensate were as follows (thousands of barrels):\nAs of December 31, 1995, the 80,991 barrels of proved reserves were comprised of 80,203 barrels of proved developed reserves and 788 barrels of proved undeveloped reserves.\nITEM 9.","section_9":"ITEM 9. CHANGES IN ACCOUNTANTS\nThe Trust dismissed Ernst & Whinney as its independent accountants on June 15, 1989 and, as of the same date, engaged KPMG Peat Marwick (now KPMG Peat Marwick LLP) as independent accountants.\nA Form Registration Statement (Registration No. 33-27923) filed by BP, the Company, and Standard Oil contained a single financial statement of the Trust audited by Ernst & Whinney, namely, a Statement of Assets and Trust corpus as of February 28,1989. The report of Ernst & Whinney on the Statement of Assets and Trust corpus contained in Registration Statement No. 33-27923 did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. During the period from February 28, 1989 through June 15, 1989 there were no disagreements with Ernst & Whinney on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of Ernst & Whinney would have caused them to make reference thereto in their report on the Statement of Assets and Trust corpus as of February 28, 1989. During the period from February 28, 1989 through June 15, 1989, there were no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)) with Ernst & Whinney. Ernst & Whinney has furnished the Trust with a copy of a letter addressed to the Securities and Exchange Commission stating that it agreed with the above statements.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe Trust has no directors or executive officers. The Trustee has only such rights and powers as are necessary to achieve the purposes of the Trust.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNot applicable.\nITEM 12.","section_12":"ITEM 12. UNIT OWNERSHIP\n(a) Unit Ownership of Certain Beneficial Owners.\nAs of March 1, 1996 the Trustee does not know of any person beneficially owning 5% or more of the Trust Units except based on filings with the Securities and Exchange Commission dated as of or prior to December 31, 1995, which filings set forth the following:\n(1) Amount known to be Units with respect to which beneficial owner has the right to acquire beneficial ownership: None.\n(b) Unit Ownerships of Management\nNeither the Company, Standard Oil, nor BP owns any Units. Neither The Bank of New York, as Trustee, or in its individual capacity, nor The Bank of New York (Delaware), as co-trustee, or in its individual capacity, owns any Units.\n(c) Change in Control\nThe Trustee knows of no arrangement, including the pledge of Units, the operation of which may at a subsequent date result in a change in control of the Trust.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot Applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) FINANCIAL STATEMENTS\nThe following financial statements of the Trust are included in Part II, Item 8:\n(b) FINANCIAL STATEMENT SCHEDULES\nAll financial statement schedules have been omitted because they are either not applicable, not required or the information is set forth in the financial statements or notes thereto.\n(c) EXHIBITS\nALL OTHER EXHIBITS HAVE BEEN OMITTED BECAUSE THEY ARE EITHER NOT APPLICABLE OR NOT REQUIRED.\n(d) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed with the Securities and Exchange Commission by the Trust during the quarter ending in December 31, 1995.\nSIGNATURE\nPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBP PRUDHOE BAY ROYALTY TRUST\nTHE BANK OF NEW YORK, as Trustee\nBy: \/s\/ Marie Trimboli ----------------------------- Marie Trimboli Assistant Treasurer\nMarch 29, 1996\nThe Registrant, BP Prudhoe Bay Royalty Trust, has no principal executive officer, principal financial officer, board of directors or persons performing similar functions. Accordingly, no additional signatures are available and none have been provided.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"351139_1995.txt","cik":"351139","year":"1995","section_1":"ITEM 1. BUSINESS\nApertus Technologies Incorporated (\"Apertus\" or the \"Company\") provides computer communications products that enable customers to successfully integrate traditional large scale systems (referred to as \"legacy systems\") with open systems computing environments. Open systems are typically characterized by powerful processors running the UNIX operating system and industry-standard communications topologies such as TCP\/IP. Specifically, the Company provides network gateways that facilitate interoperability between local area networks (\"LANs\") and legacy systems, server-based tools that integrate legacy system data and applications into client\/server applications, and system management applications for the centralized management of distributed networks and applications.\nIn December 1993, the Company acquired all of the stock of Systems Strategies, Inc. (\"SSI\"), a wholly-owned subsidiary of AGS Computers, Inc., a NYNEX company. SSI provides communications software products for linking UNIX, IBM mainframe, AS\/400, and DEC systems, as well as multi-vendor messaging\/ queuing solutions. The purchase price for SSI was $14 million, with $10 million paid in cash at closing and $4 million in the form of promissory notes payable over a three-year period. During fiscal 1995 Apertus and NYNEX reached a settlement whereby the purchase price of SSI was reduced by $1.68 million. The settlement, along with a cash payment of $2.06 million made in the fourth quarter, relieved the Company of any future obligations to NYNEX.\nSince the acquisition, the Company markets three broad categories of products for enterprise-strength communications. Its Network Integration products provide solutions for linking the new, open networks with IBM's SNA, legacy computing environments. Its Data Integration products enable legacy data to be integrated and\/or migrated from mainframe centric environments to open systems computing. Its Management Integration products provide management applications for the centralized management of distributed networks.\nThe Company, a Minnesota corporation, was incorporated in March 1979.\nMARKET\nMARKET FOCUS: The computer industry has undergone dramatic changes over the past decade, and this revolution has centered largely on bringing more computing power to the desktop. The problem with desktop systems, however, was that while they were designed to provide open (non-proprietary) computing, they were generally isolated from information on other systems. This resulted in a costly and inefficient computing enterprise. Over the past few years, connectivity between desktop, server, midrange, and mainframe systems has become a priority for most large organizations. Today's desktop systems and applications are often called upon to share information and resources with departmental, branch and corporate data, which may be across the office or across the world.\nAs organizations reengineer their information systems' infrastructure from traditional mainframe-oriented environments, where older, legacy applications are housed, to a new distributed style of computing characterized by client\/server configurations, they need solutions to facilitate this integration. Apertus provides products and services that address the emerging requirements for bridging legacy and open systems environments.\nTARGET MARKET: The Apertus product lines are horizontal in nature. As a result, products provide solutions for the entire spectrum of industries, including, but not limited to, telecommunications, retail, manufacturing, finance\/banking and healthcare. Apertus' target customer base is Fortune 1000 corporations in the commercial marketplace, major telephone and interchange companies, original equipment manufacturers (OEMs), value added resellers (VARs), and systems integrators. Its products are sold in the United States and internationally.\nTelecommunications Industry: Historically, the Company has been successful in marketing its products to the Regional Bell Operating Companies (\"RBOCs\"), which require significant communications capabilities for sharing data across large, complex databases contained in multiple mainframes. Such customers include Ameritech and Bell Atlantic. Recently, the Company also has\nbeen successful selling to large independent telephone companies. Over the last fiscal year, companies within the telecommunications industry have made significant purchases of the Company's products, with GTE, MCI and Bell South each buying products from the Company with an aggregate purchase price in excess of $1 million.\nWorldwide, Commercial Marketplace: Apertus recently broadened its market reach to include commercial customers outside the telecommunications industry. Through its own domestic sales force, the Company has sold products to customers such as Chicago Board of Trade, Northwestern Mutual Life, Hughs Aircraft, Norwest Financial, State Of Maryland, and American Presidents Lines. With the acquisition of SSI, the Company has moved more broadly into the Fortune 1000 market, is expanding into the European market with major strategic wins this year at the German and Italian Finance Ministries, and now has a significant base of prominent international OEMs reselling the Company's products, including Bull, ICL, and Motorolla.\nPRODUCT OFFERINGS: NETWORK INTEGRATION PRODUCTS\nIBM computing environments continue to dominate most large corporations. In recent years, many of these organizations have begun migrating from IBM's proprietary computing environments and investing in more open computing solutions. The challenge for the information systems manager is to find a way to integrate the IBM legacy environment with new, open networks and systems.\nApertus addresses this need for integration with its Datastar product line, which is sold directly to end user organizations, and its EXPRESS product line, which is marketed primarily to OEMs, systems integrators and VARs.\nTHE DATASTAR PRODUCT LINE: The Datastar product line, consisting of a number of gateway products, provides high-performance communications links between diverse network environments and IBM mainframe and midrange host computers.\nNetwork Gateways: The Datastar Data Center Hub is a high-performance, channel-attached gateway system that assists major corporations in solving a variety of challenges related to the integration of IBM proprietary technology with more open, multi-protocol LANs. Available in three sizes to meet a range of network needs, the product features a modular architecture and switch-based backplane. These features permit end users to customize the Datastar to meet their unique networking requirements.\nDatastar gateway configurations include: Offload TCP\/IP Gateway, which allows users on TCP\/IP networks to transparently access IBM SNA and BiSync hosts; TCP\/IP Interconnect Controller, providing a high performance connection between TCP\/IP networks and IBM hosts running TCP\/IP. NetWare for SAA Gateway, which allows Novell's NetWare users to access channel- attached IBM host resources; SNA DSPU Gateway, which allows users on Ethernet and Token-Ring SNA-based LANs to access IBM host resources; the Universal Access Gateway, which provides a \"virtual\" gateway complex across multiple Datastars and guarantees access through its innovative load balancing and fault tolerant features. A new higher-capacity Datastar is planned for release in fiscal year 1996.\n3270 Terminal Servers: The Company's terminal server products allow corporations to connect their large installed base of 3270 terminals to bridge\/router internetworks. These terminal server products are marketed under the name Datastar\/3270 Access Hub. By providing access to both IBM SNA resources and UNIX resources across LAN environments (Ethernet and Token Ring), the 3270 Access Hub allows users to continue to use their investment in 3270 terminals and participate in open computing environments.\nPeripheral Products: The Company supplements its Datastar line with a series of complementary products marketed under third-party agreements. These products principally include networking software and terminal emulation software.\nEXPRESS ADVANCED SNA PRODUCT LINE: The Company markets Apertus EXPRESS products: a broad range of software products for connecting systems on TCP\/IP networks with mainframes and AS\/400s operating in an IBM SNA environments. EXPRESS software provides enterprise-wide connectivity between multivendor UNIX systems and IBM mainframes and AS\/400s. With Apertus EXPRESS, users are provided with advanced SNA capabilities, built on the latest technology standards, resulting in a high speed, flexible network integration solution. EXPRESS provides: terminal emulation (3270 and TN3270, 5250 and TN5250), file transfer (SNA\/RJE and LU6.2), and a Telnet-to-SNA gateway solution. It also provides programmers with the tools they need to develop application programs for UNIX systems so they can communicate with applications on IBM mainframes and AS\/400s. This enables the development of EHLLAPI, CPI-C\/APPC, LUA and network management applications. EXPRESS also offers an X.25 solution for linking UNIX systems across a packet-switched data network.\nAs an extension of the EXPRESS product, the Company also markets its Data Transfer Services product line. Data Transfer Services provides a series of applications for data exchange, including file transfer and printer sharing between UNIX, VAX, IBM mainframe AS\/400 utilizing IBM's LU6.2 programming interface.\nPRODUCT OFFERINGS: DATA INTEGRATION PRODUCTS\nIncreasingly, new applications are being written in a distributed computing environment, where systems are spread throughout corporate locations. Typically, a database resides on a high-performance server, with user interaction driven by a graphical user interface. These new applications often need to access and update information contained in legacy computing environments. Apertus addresses this need with Enterprise\/Access\/TM\/ and Enterprise\/Integrator\/TM\/.\nENTERPRISE\/ACCESS product is a development toolkit that allows users to transparently access data residing in legacy applications. It is being sold in the commercial market as an enterprise-strength solution for integrating new applications with mainframe-based legacy systems and providing a smooth migration to open systems environments. Enterprise\/Access product was selected as a finalist in the \"Best of Show\" Applications Development Tool category at Networld + Interop, one of the industry's largest trade shows.\nENTERPRISE\/INTEGRATOR technology is the fundamental technology in the Company's strategic alliance with GTE. This contract with GTE is valued at $10 million. The Enterprise\/Integrator product permits data to be integrated from multiple source databases to a single target database. During the integration process, the Enterprise\/Integrator product performs a data cleansing and consistency function that ensures a high level of accuracy for the newly created databases. Enterprise\/Integrator is used by major telecommunication companies to synchronize and integrate heterogeneous databases. In fiscal 1996, the Company will begin marketing a new version of Enterprise\/Integrator to the commercial market.\nPRODUCT OFFERINGS: MANAGEMENT INTEGRATION PRODUCTS\nApertus is engaged in a strategic relationship with IBM relating to the development of MQSeries software. MQSeries software provides a standard way of sending messages in real-time between distributed applications, while assuring that no messages are lost, duplicated or delivered out of order. It enables applications to communicate with applications distributed across other multi- platform environments. Apertus is focusing its current development efforts on systems management products that complement MQSeries software. The first systems management product, MQView, is expected to be generally available in fiscal 1996 and will provide a centralized management application for the configuration, monitoring and\nmanagement of MQ networks. The Company intends to expand its effort in fiscal 1996 through the addition of other system management products.\nMARKETING AND CUSTOMERS\nDomestically, Apertus uses a direct sales force, located throughout the United States, to market to its end user customers. For small orders, the Company uses an in-house telesales group that completes sales without involvement from the direct sales force. The Company is organized around four business units, each of which is responsible for implementing its own strategy which is based on the Company's mission. The primary marketing communications vehicles used to generate leads include advertising, direct mail, press relations, vendor relations, seminars, and trade shows.\nThe Company's European operations, based in an office in a suburb of London, England, and in Stuttgart, Germany, which opened in April 1995, markets and distributes all of the Company's products. It sells directly to end users and indirectly through OEMs, distributors and VARs. The Company is also expanding outside of Europe with strategic distribution partners. In fiscal 1995 the Company added Samsung in Korea and CPM in Brazil as key new partners. In addition, the Company uses manufacturers' representatives and distributors on a selective basis.\nBACKLOG\nThe Company attempts to ship orders to end-user customers within 30 days. Because of this short delivery cycle, the Company does not believe backlog is a meaningful indicator of future revenues.\nCUSTOMER SERVICE\nThe Company works directly with customers on a direct service basis out of Minneapolis, New York and London to provide prompt and reliable support for products installed at end-user facilities. Company employees provide software product maintenance worldwide. Generally, hardware maintenance is provided through third-party vendors providing first-line service. Customers may chose either self-maintenance programs where the customers' personnel provide first- line repair, or direct service programs where the Company or third-party vendors provide first-line repair. In either case, more advanced technical support is provided by the Company's field specialists and technical support groups located in Minneapolis, New York and London.\nPRODUCT DEVELOPMENT\nBecause of rapidly changing technology in the communications software market, the Company is committed to ongoing research and development. The Company spent approximately $6.0 million (10.9 percent of revenues), $4.2 million (16.0 percent of revenues) and $2.9 million (10.5 percent of revenues) during fiscal years 1995, 1994 and 1993, respectively, on research and development, all of which was sponsored by the Company. Due to the expanding range of products and features available in the communications software marketplace, management recognizes that the capability to interface the Company's products with other available or installed products has increasing significance.\nDuring the 1995 fiscal year, the Company continued to develop enhancements to the Datastar architecture. Also, the Company became involved with the development of the EXPRESS product line, including UNIX-to-IBM connectivity software and extension of the EXPRESS Data Transfer Services software product to the mainframe environment. Software research and development for Enterprise\/Access and Enterprise\/Integrator product include enhancements to existing products as well as new product development.\nThe Company believes that copyright protection is important to its business. Accordingly, the Company copyrights software source code modules. The Company also relies on trade secrets, proprietary know-how and continuing product innovation to maintain its competitive position.\nCOMPETITION\nApertus' product lines each have their own distinct significant competitors:\nNETWORK INTEGRATION SOLUTIONS\nThe Datastar products primarily compete with mainframe-dependant products manufactured by IBM, Cicso and Interlink, and off-load products manufactured by OpenConnect, Novell, Microsoft, CNT\/Brixton.\nThe EXPRESS products' primary competition comes from OEMs, including Sun, Hewlett Packard and IBM. While most of these manufacturers offer an IBM communications solution, they typically are platform-specific (as opposed to multi-platform). EXPRESS products also compete with products manufactured by companies such as Cleo, OpenConnect and Brixton.\nDATA INTEGRATION SOLUTIONS\nThe Enterprise\/Access and Enterprise\/Integrator products compete in an emerging segment of the information systems marketplace providing enabling technologies for development of client\/server applications. Both products compete with internal development initiatives. The Enterprise\/Access product also competes with desktop tools (as opposed to server based tools) from Wall Data, Attachmate, DCA, and Easel Corp. and is complementary to database gateway products from companies such as Sybase, Oracle and Information Builders. The Enterprise\/Integrator competes with an MVS mainframe-based data integrity tool manufactured by Vality Corporation and market data extraction tools manufactured by Prism and Evolutionary Technologies, Inc.\nMANAGEMENT INTEGRATION\nThe MQSeries product line's competition comes primarily from development efforts launched within organizations. In addition, companies that have products that compete with the MQSeries include Covia, DEC and Momentum.\nSERVICE AND MAINTENANCE\nThe Company's service and maintenance programs compete with comparable programs offered by AT&T, Memorex-Telex, IBM, and other competitors that have substantially more locations and personnel than the Company. The Company's products support industry network management standards (SNMP, NetView) and have extensive remote diagnostic capabilities. As hardware has become more reliable, the Company has relied on third-party vendors for hardware support and its own regional service organization for software support.\nMANUFACTURING AND SUPPLY\nFor its communications software products, the Company has a central production facility (at its headquarters in Minneapolis) that adheres to uniform manufacturing policies and procedures. For the Datastar communications product, the Company performs final assembly and final test, with the majority of components (including the printed circuit boards) purchased from suppliers.\nEmphasis is placed on ensuring a quality product through such means as Statistical Process Control (SPC), Cellular Management, Just In Time (JIT) concepts and a suppliers' certification program. A computerized system is used to manage purchasing, production scheduling, order entry, and inventory management functions.\nMost of the components used in the Company's products are available from a number of suppliers. However, a number of parts, including certain integrated circuits and monitors, are generally available only from single sources of supply. In some cases, if the Company were to be deprived of these single- source items, the Company would be required to obtain an alternative supplier, manufacture the items itself or redesign certain products, all of which could cause delays in product shipments. The Company has never experienced significant production delays because of the failure of a supplier to provide component parts.\nEMPLOYEES\nAs of June 7, 1995, the Company employed 297 persons, including 126 in product development, 41 in manufacturing, 74 in marketing, 29 in customer service, and 27 in finance and administration. None of the employees are covered by collective bargaining agreements, and the Company believes its employee relations are good.\n- ---------------------- ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn July 1990 the Company moved its principle office and manufacturing facility to 60,000 square feet of leased space in a building located in Eden Prairie, Minnesota. The lease has a six-year term and requires total lease payments of $3.3 million over the term of the lease.\nAdditionally, SSI's corporate headquarters is located in New York, New York. SSI has a 10-year lease which began on November 1, 1991, on this 11,729 square foot facility. Annual rent for fiscal year 1994 was approximately $300,000. SSI subleased approximately one-half of the space commencing February 6, 1995.\nThe Company sold its previous headquarters facility to a major retail electronics company located in Minneapolis, Minnesota. The facility is a 262,000 square foot office and manufacturing building located on a 28-acre site in Eden Prairie, Minnesota. It was purchased in June 1986 for $12,890,000. Under the terms of the transaction, the Company will carry a contract for deed for three years. In return, the purchaser will make interest payments for three years, with a final balloon payment in June 1996 for $8.7 million. The Company has assumed liability for the purchaser's former headquarters through April 1995.\n- ---------------------- ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has no pending legal proceedings which the Company believes are material.\n- ---------------------- ITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following sets forth certain information regarding the executive officers of the Company:\nRobert D. Gordon has been Chairman of the Board and Chief Executive Officer of the Company since April 1990 and President of the Company since December 1988. He was first employed by the Company as Senior Vice President in July 1987, and subsequently he served as Chief Financial Officer from August 1987 to May 1988, Secretary from January 1988 to September 1988, and Group Vice President, Sales and Marketing from April 1988 to December 1988. From April 1984 to July 1987, Mr. Gordon was Executive Vice President of First Bank System, Inc. He has been a director of the Company since August 1987.\nJulie Cummins Brady has held the position of Secretary and General Counsel since April 1990. Prior to joining the Company, Ms. Brady held legal positions with various divisions of Control Data Corporation, most recently as Corporate Counsel for Imprimus Technology Incorporated.\nSue A. Hogue has held the position of Chief Financial Officer of the Company since August 1993. Prior to her current position, she served as Corporate Controller of the Company for three years. Ms. Hogue has been employed by the Company since August 1989.\nMartin G. Hahn has been General Manager, Network Integration Group of the Company, since January 1994. Prior to his current position, he served as Vice President of Marketing for the Internetworking Solutions Group for three years. Mr. Hahn has been employed by the Company since July 1987.\nWilliam Fell has served as General Manager of the Company's United Kingdom operations since March 1994. Prior to joining the Company, Mr. Fell was employed by McData Corporation in the United Kingdom as Director of European Operations.\nLeslie Yeamans has served as General Manager, Management Integration Group of the Company, since January 1994. Prior to joining SSI in 1985, Mr. Yeamans held positions with Andersen Consulting in Boston and later at Powerbase Systems.\nNorman Friedman has served as General Manager, Express Group of the Company, since January 1994. Mr. Friedman has over 14 years of experience with SSI and is responsible for the Core Technology Group which manufactures the EXPRESS product line. Prior to joining SSI, he was employed by Warner Computer Systems in New York City.\nLizabeth Converse Wilson has served as General Manager, Data Integration Group of the Company, since May 1993. Ms. Wilson has been employed by the Company for 11 years. Prior to her current position, she served as Director of Sales and Marketing for the Enterprise Systems Group and previously as a Regional Account Manager.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------\nThe information contained under the heading \"Dividend Policy and Price Range of Common Stock\" on page 13 of the portions of Annual Report to Shareholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nThe information contained under the heading \"Selected Financial Data\" on page 12 of the portions of Annual Report to Shareholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - -------------\nThe information contained under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 1 and 2 of the portions of Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe independent auditors' report, consolidated financial statements, and notes to consolidated financial statements on pages 3 through 10 of the portions of 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.\n\/ Part III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nThe information contained under the heading \"Election of Directors\" on pages 2 and 3 of the Proxy Statement is incorporated herein by reference. The information contained under the heading \"Executive Officers of the Registrant\" in Part I hereof is also incorporated into this Item 10 by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nThe information contained under the heading \"Executive Compensation\" on pages 4 through 11 of the Proxy Statement is incorporated herein by reference, except that the information set forth under the captions \"Report of Compensation Committee on Annual Compensation\" and the \"Comparative Stock Performance\" chart are not incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------------------------------------------------------------------------\nThe information contained under the heading \"Security Ownership of Certain Beneficial Owners and Management\" on pages 12 and 13 of the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nNone.\nPart IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe report on the Company's previous indepedent auditors with respect to the above financial statements appears on page 17 of this Annual Report.\nThe financial statements listed above are included in Exhibit 13 and are hereby incorporated by reference.\nAll other schedules are omitted since the required information is not represented or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes thereto.\n3. Exhibits --------\n(b)Distribution Agreement, dated March 30, 1990, between the Company, as Manufacturer, and IIS Inc., as Distributor.\/1\/\n(c)Software Support Agreement, dated March 30, 1990, between the Company and IIS Inc.\/1\/\n(d)Manufacturing Agreement, dated March 30, 1990, between the Company and IIS Inc.\/1\/\n(e)Amendment to the Software Support Agreement, dated as of March 30, 1990 between the Company and IIS Inc.\/3\/\n10.6(a) *1994 Management Bonus Plan description.\/5\/\n10.6(b) *1995 Management Bonus Plan description.\/6\/\n10.6(c) *1996 Management Bonus Plan description.\n10.7 Stock Purchase Agreement dated December 31, 1993 between Apertus Technologies Incorporated and NYNEX Worldwide Services Group, Inc.\/8\/\n10.8(a) *Stock Acquisition Loan Assistance Program.\/5\/\n10.8(b) *1993 Stock Acquisition Loan Assistance Program.\/9\/\n10.9 Office Lease Agreement, dated June 1991, between Mid City Associated and Systems Strategies, Inc.\/6\/\n13 Portions of Annual Report to Shareholders for the fiscal year ended April 2, 1995.\n21 Subsidiaries of the registrant.\n23.1 Consent of Ernst & Young LLP.\n23.2 Consent of Deloitte & Touche LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule. - -------------------\n*Denotes management contracts and compensatory plans, contracts, and arrangements.\n\/1\/Incorporated by reference to the Company's Report on Form 8K filed April 16, 1990.\n\/2\/Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended April 1, 1990.\n\/3\/Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1991.\n\/4\/Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended March 29, 1992.\n\/5\/Incorporated by reference to the Company's Annual Report on Form 10-K for fiscal year ended March 28, 1993.\n\/6\/Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended April 3, 1994.\n\/7\/Incorporated by reference to the Company's Report on Form 8-K filed November 5, 1993.\n\/8\/Incorporated by reference to the Company's Report on Form 8-K\/A filed March 15, 1994.\n\/9\/Incorporated by reference to the Company's Registration Statement on Form S- 8 filed March 31, 1994.\n\/10\/Incorporated by reference to the Company's Registration Statement on Form S- 8 filed January 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.\nDate: June 23, 1995 APERTUS TECHNOLOGIES INCORPORATED\nBy: \/s\/ Robert D. Gordon ----------------------------------- Robert D. Gordon 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 date indicated.\n____________\n*Executed on behalf of the indicated persons by Robert D. Gordon pursuant to the Power of Attorney included as Exhibit 24 to this annual report.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders of Apertus Technologies Incorporated:\nWe have audited the accompanying consolidated statements of operations, changes in shareholders' equity, and cash flows of Apertus Technologies Incorporated for the year ended March 28, 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 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 audit provides a reasonable basis for our opinion.\nIn our opinion, such 1993 consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Company for the year ended March 28, 1993 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nMinneapolis, Minnesota May 11, 1993\nAPERTUS TECHNOLOGIES INCORPORATED SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED APRIL 2, 1995, APRIL 3, 1994 AND MARCH 28, 1993 (DOLLARS IN THOUSANDS)\nALLOWANCE FOR DOUBTFUL ACCOUNTS:\/(A)\/\n__________________________\n\/(A)\/ The allowance has been netted against accounts receivable as of the respective balance sheet dates.\n\/(B)\/ Write-offs net of recoveries.\n\/(C)\/ Includes $511 of allowance for doubtful accounts acquired in the Systems Strategies, Inc. acquisition.\n\/(D)\/ Includes approximately $1.1 million of NYNEX settlement. This settlement released NYNEX of any liability connected with the collection of outstanding receivables guaranteed by NYNEX under the original contract.\n\/(E)\/ Includes approximately $1.3 million of receivables written off against the NYNEX settlement discussed in footnote (D) as well as the $511 noted in footnote (C).\nAPERTUS TECHNOLOGIES INCORPORATED\nINDEX OF EXHIBITS\nANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED APRIL 2, 1995\nEXHIBIT PAGE NUMBER DESCRIPTION NUMBER - -----------------------------------------------------------------------------\n10.6(d) 1996 Management Bonus Plan Description 19\n13 Portions of Annual Report to Shareholders for the fiscal year ended April 2, 1995 20\n21 Subsidiaries of the registrant 33\n23.1 Consent of Ernst & Young LLP 34\n23.2 Consent of Deloitte & Touche LLP 35\n24 Powers of Attorney 36\n27 Financial Data Schedule 37","section_15":""}
{"filename":"728586_1995.txt","cik":"728586","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nAs used herein, \"LBI\" or the \"Registrant\" means Lehman Brothers Inc., a Delaware corporation, incorporated on January 21, 1965. LBI and its subsidiaries are collectively referred to as the \"Company\" or \"Lehman Brothers\". LBI is a wholly owned subsidiary of Lehman Brothers Holdings Inc., a Delaware corporation, which (together with its subsidiaries, where appropriate) is referred to herein as \"Holdings\".\nThe Company is one of the leading global investment banks serving institutional, corporate, government and high-net-worth individual clients and customers. Its executive offices are located at 3 World Financial Center, New York, New York 10285 and its telephone number is (212) 526-7000.\nLEHMAN BROTHERS\nLehman Brothers is one of the leading global investment banks serving institutional, corporate, government and high-net-worth individual clients and customers. The Company's worldwide headquarters in New York are complemented by offices in additional locations in the United States, Europe, the Middle East, Latin and South America and the Asia Pacific region. Lehman Brothers also operates a commodities trading and sales operation in London. Holdings provides investment banking and capital markets services in Europe and Asia. The Company is engaged primarily in providing financial services. Other businesses in which the Company is engaged represent less than 10 percent of consolidated assets, revenues or pre-tax income.\nThe Company's business includes capital raising for clients through securities underwriting and direct placements; corporate finance and strategic advisory services; merchant banking; securities sales and trading; asset management; research; and the trading of foreign exchange, derivative products and certain commodities. The Company acts as a market-maker in all major equity and fixed income products in both the domestic and certain international markets. Lehman Brothers is a member of all principal securities and commodities exchanges in the United States, as well as the National Association of Securities Dealers, Inc. (\"NASD\"). Holdings holds memberships or associate memberships on several principal international securities and commodities exchanges, including the London, Tokyo, Hong Kong, Frankfurt and Milan stock exchanges.\nSince 1990, Lehman Brothers has focused on a \"client\/customer-driven\" strategy. Under this strategy, Lehman Brothers concentrates on serving the needs of major issuing and advisory clients and investing customers worldwide to build an increasing \"flow\" of business that leverages the Company's research, underwriting and distribution capabilities. Customer flow continues to be the primary source of the Company's net revenues. Developing lead relationships with issuing clients and investing customers is a central premise of the Company's client\/customer-driven strategy. Based on management's belief that each client and customer directs a majority of its financial transactions to a limited number of investment banks, Lehman Brothers' investment banking and institutional and private client sales professionals focus on a targeted group of clients and customers worldwide to identify and develop lead relationships. The Company believes that such relationships position Lehman Brothers to receive a substantial portion of its clients' and customers' financial business and lessen the volatility of revenues generally associated with the financial services industry.\nLEHMAN BUSINESSES INVESTMENT BANKING\nLehman Brothers is a leading underwriter of equity and fixed income securities in the public and private markets. The Company is also a prominent advisor for corporations and governments around the world.\nInvestment Banking professionals are responsible for developing and maintaining relationships with issuing clients, gaining a thorough understanding of their specific needs and bringing together the full resources of Lehman Brothers and Holdings to accomplish their financial objectives. Investment Banking is organized into industry, product and geographic coverage groups, enabling individual bankers to develop specific expertise in particular industries and markets. Industry coverage groups include Consumer Products, Financial Services, Financial Sponsors, Health Care, Industrials, Merchandising, Natural Resources, Real Estate and Mortgage Finance, Technology, Media and Telecommunications, Transportation and Utilities. Where appropriate, specialized groups such as Equity Capital Markets, Debt Capital Markets, Mergers and Acquisitions, Private Placements, Leveraged Finance, Derivatives, Liability Management and Project Finance are integrated into the client coverage teams.\nLehman Brothers has a long history of providing strategic advisory services to corporate, institutional and government clients around the world on a wide range of financial matters, including mergers and acquisitions, divestitures, leveraged transactions, takeover defenses, spin-offs, corporate reorganizations and recapitalizations, tender and exchange offers, privatizations, opinion letters and valuations. The Company's Mergers and Acquisitions group works closely with product, industry and geographic coverage bankers around the world.\nMerchant Banking. Through its Merchant Banking group, the Company and its affiliates make equity and certain other investments in merger, acquisition, restructuring and leveraged capital transactions, including leveraged buyouts, either independently or in partnership with the Company's clients. Current merchant banking investments held by the Company include both publicly traded and privately held companies diversified on a geographic and industry basis.\nSince 1989, the Company and its affiliates' principal method of making merchant banking investments has been through a series of partnerships (the \"1989 Partnerships\"), for which the Company and its affiliates act as general partner, and in some cases as a limited partner. During the remaining life of the 1989 Partnerships, the Company's merchant banking activities, with respect to investments made by the 1989 Partnerships, will be directed toward selling or otherwise monetizing such investments.\nFIXED INCOME\nLehman Brothers actively participates in all key fixed income product areas. The Company combines professionals from the sales, trading, financing, derivatives and research areas of Fixed Income, together with investment bankers, into teams to serve the financial needs of the Company's clients and customers. The Company is a leading underwriter of new issues, and also makes markets in these and other fixed income securities. The Company's global presence facilitates client and customer transactions and provides liquidity in marketable fixed and floating rate debt securities.\nFixed Income products consist of government, sovereign and supranational agency obligations; money market products; corporate debt securities; mortgage and asset-backed securities; emerging market securities; municipal and tax-exempt securities; derivative products and research. In addition, the Company's financing unit provides global access to cost efficient debt financing sources, including repurchase agreements, for the Company and its clients and customers.\nGovernment and Agency Obligations. Lehman Brothers is one of the leaders among the 37 primary dealers in U.S. Government securities, as designated by the Federal Reserve Bank of New\nYork, participating in the underwriting and market-making of U.S. Treasury bills, notes and bonds, and securities of federal agencies.\nMoney Market Products. Lehman Brothers holds dominant market positions in the origination and distribution of medium-term notes and commercial paper. The Company and its affiliates have received global medium-term note mandates for 1,125 programs with a borrowing capacity of $1.6 trillion. The Company and its affiliates are appointed dealers for approximately 750 commercial paper programs on behalf of companies and government agencies worldwide. The Company is also a major participant in the preferred stock market.\nCorporate Debt Securities. Lehman Brothers engages in the underwriting and market making of fixed and floating rate investment grade debt. The Company also underwrites and makes markets in non-investment grade debt securities and bank loans.\nHigh Yield Securities and Bank Loans. In 1995, the Company expanded its high yield debt business from both a strategic and an operational perspective. The Company now provides a \"one-stop\" leveraged finance solution for corporate and financial acquirers and high yield issuers.\nMortgage and Asset-Backed Securities. The Company is a leading underwriter of and market maker in mortgage and asset-backed securities.\nEmerging Market Securities. The Company is active in the trading, structuring and underwriting of Latin American, Eastern European, and Asian dollar and local currency instruments.\nMunicipal and Tax-Exempt Securities. Lehman Brothers is a major dealer in municipal and tax-exempt securities, including general obligation and revenue bonds, notes issued by states, counties, cities, and state and local governmental agencies, municipal leases, tax-exempt commercial paper and put bonds. Lehman Brothers is also a leader in the structuring, underwriting and sale of tax-exempt and taxable securities and derivative products for city, state, not-for-profit and other public sector clients.\nDerivative Products. The Company offers a broad range of derivative product services. Derivatives professionals are integrated into all of the Company's major fixed income product areas to develop optimal issuance structures and investment products for the Company's clients.\nLehman Brothers Financial Products Inc. (\"LBFP\"), the Company's triple-A rated derivatives subsidiary, commenced trading with counterparties in July 1994. It exceeded expectations in 1995 in terms of notional volumes and number of counterparties. This entity also received rating agency approval to double the amount of products eligible for inclusion in the subsidiary.\nFinancing. The Company's Financing unit engages in three primary functions: managing the Company's matched book activities, supplying secured financing to customers, and providing funding for the Company's inventory positions. Matched book funding involves lending cash on a short-term basis to institutional customers collateralized by marketable securities, typically government or government agency securities. The Company enters into these agreements in various currencies and seeks to generate profits from the difference between interest earned and interest paid. The Financing unit works with the Company's institutional sales force to identify customers that have cash to invest and\/or securities to pledge to meet the financing and investment objectives of the Company and its customers. Financing also coordinates with the Company's treasury area to provide collateralized financing for a large portion of the Company's securities and other financial instruments owned.\nFixed Income Research. Fixed Income research at Lehman Brothers encompasses the full range of research disciplines: quantitative, economic, strategic, credit, portfolio and market-specific analysis. Fixed Income research is integrated with and supports the Company's investment banking, sales and trading activities. An important objective of Fixed Income research is to have in place high quality research analysts covering industry, geographic and economic sectors that support the activities of the Company's clients and customers. The Company and its affiliates' 200 specialists are based in New York, Toronto, London, Tokyo and Hong Kong. Their expertise includes U.S., European and Asian\ngovernment and agency securities, derivatives, sovereign issues, corporate securities, high yield, asset-and mortgage-backed securities, commercial real estate, emerging market debt and municipal securities.\nForeign Exchange. Through its foreign exchange operations, Lehman Brothers seeks to provide its clients and customers with superior trading execution, price protection and hedging strategies to manage volatility. The Company and its affiliates, through operations in New York, London, Hong Kong, Singapore, and Tokyo engage in trading activities in all major currencies and maintain a 24-hour foreign exchange market-making capability for clients and customers worldwide. In addition to the Company's traditional client\/customer-driven foreign exchange activities, Lehman Brothers also trades foreign exchange for its own account.\nCommodities and Futures. Lehman Brothers engages in commodities and futures trading through its market-making activities in metals as well as its activities in exchange futures execution for its institutional and private clients. The Company and its affiliates provide their clients with global market-making and execution through its commodities and futures operations in New York, London, Frankfurt, Singapore, Hong Kong and Tokyo.\nEQUITIES\nLehman Brothers combines professionals from the sales, trading, financing, derivatives and research areas of Equities, together with investment bankers, into teams to serve the financial needs of the Company's equity clients and customers. The Company's equity expertise and the integrated nature of the Company's global operations enable Lehman Brothers to structure and execute global equity transactions for clients worldwide. The Company is a leading underwriter of initial public and secondary offerings of equity and equity-related securities. Lehman Brothers also makes markets in these and other securities, and executes block trades on behalf of clients and customers. The Company also actively participates in assisting governments around the world in raising equity capital as part of their privatization programs.\nThe Equities product group is responsible for the Company's equity operations and all dollar and non-dollar equity and equity-related products worldwide. These products include listed and over-the-counter (\"OTC\") securities, American Depositary Receipts, convertibles, options, warrants and derivatives.\nDerivative Products. Lehman Brothers, in conjunction with affiliates, offers equity derivative capabilities across a wide spectrum of products and currencies, including domestic and international program trading, listed options and futures, structured derivatives and convertible products.\nEquity Research. The Equity Research department is integrated with and supports the Company's investment banking, sales and trading activities. An important objective of Equities research is to have in place high quality research analysts covering industry and geographic sectors that support the activities of the Company's clients and customers. The Equity Research department is comprised of 250 professionals covering 26 industry sectors and over 1,100 companies worldwide from locations in New York, London, Hong Kong and Tokyo.\nEquity Finance. Lehman Brothers operates a comprehensive Equity Financing and Prime Broker business to provide liquidity to its clients and customers. Margin lending for the purchase of equities and equity derivatives, securities lending and short sale facilitation are among the main functions of the Equity Financing group. The Prime Broker business engages in full operations, clearing and processing services for that unit's customers.\nASSET MANAGEMENT\nThe Company's asset management activities provide investment management services to institutional investors, individuals and small to mid-sized institutions. At November 30, 1995, the Company\nand its affiliates had over $10 billion in assets under management. The Company and its affiliates plan to focus on sponsoring and distributing more sophisticated strategic funds attractive to high-net-worth individuals and institutions. The Asset Management division also has developed individually customized investment services through the Company's Private Client Services group.\nINSTITUTIONAL SALES\nInstitutional Sales serves the investing and liquidity needs of major institutional investors worldwide and provides the distribution mechanism for new issues and secondary market securities. Lehman Brothers maintains a network of over 500 sales professionals in major locations around the world. Institutional Sales focuses on the large institutional investors that constitute the major share of global buying power in the financial markets. Lehman Brothers' goal is to be considered one of the top three investment banks by such institutional investors. By serving the needs of these customers, the Company also gains insight into investor sentiment worldwide regarding new issues and secondary products and markets, which in turn benefits the Company's issuing clients.\nInstitutional Sales is organized into four distinct sales forces, specialized by the following product types: Equities, Fixed Income, Foreign Exchange\/Commodities and Asset Management. Institutional Sales professionals work together to coordinate coverage of major institutional investors through customer teams. Depending on the size and investment objectives of the institutional investor, a customer team can be comprised of from two to five sales professionals, each specializing in a specific product. This approach positions Lehman Brothers to understand and to deliver the full resources of the Company to its customer base.\nPRIVATE CLIENT SERVICES\nThe Company's Private Client Services Group serves the investment needs of private investors with substantial assets as well as small and mid-sized institutions. The group has a global presence with investment representatives located in seven offices in North America and additional offices in major financial centers in South America, Europe, the Middle East and Asia. The Company's investment representatives provide investing customers with direct access to Lehman Brothers' equity and fixed income product and research, including capabilities in new issue and secondary product, foreign exchange and derivatives. The Private Client Services group also enables the Company's issuing clients to access a diverse, high-net-worth investor base throughout the world. The group employs portfolio strategists within their organization to optimize asset allocation requirements and to manage the specific asset classes of their private clients.\nOTHER BUSINESS ACTIVITIES\nWhile Lehman Brothers concentrates on its client\/customer-driven strategy, the Company also participates in business opportunities such as arbitrage and proprietary trading that leverage the Company's expertise, infrastructure and resources. These businesses may generate substantial revenues but generally entail a higher degree of risk as the Company trades for its own account.\nArbitrage. Lehman Brothers engages in a variety of arbitrage activities. In traditional or \"riskless\" arbitrage, the Company seeks to benefit from temporary price discrepancies that occur when a security is traded in two or more markets, or when a convertible or derivative security is trading at a price disparate from its underlying security. The Company's \"risk\" arbitrage activities involve the purchase of securities at discounts from the expected values that would be realized if certain proposed or anticipated corporate transactions (such as mergers, acquisitions, recapitalizations, exchange offers, reorganizations, bankruptcies, liquidations or spin-offs) were to occur. To the extent that these anticipated transactions do not materialize in a manner consistent with the Company's expectations, the Company is subject to the risk that the value of these investments will decline. Lehman Brothers' arbitrage activities benefit from the Company's presence in the global capital markets, access to\nadvanced information technology, in-depth market research, proprietary risk management tools and general experience in assessing rapidly changing market conditions.\nProprietary Trading. Lehman Brothers engages in the trading of various securities, derivatives, currencies and commodities for its own account. The Company's proprietary trading activities bring together various research and trading disciplines allowing it to take market positions, which at times may be significant, consistent with the Company's expectations of future events (such as movements in the level of interest rates, changes in the shape of yield curves and changes in the value of currencies). The Company is subject to the risk that actual market events will be different from the Company's expectations, which may result in significant losses associated with such proprietary positions. The Company's proprietary trading activities are generally carried out in consultation with personnel from the relevant major product area (e.g., mortgages, derivatives and foreign exchange).\nTRADING SERVICES AND CORPORATE\nThe Company's Trading Services and Corporate divisions provide support to its businesses through the processing of certain securities and commodities transactions; receipt, identification and delivery of funds and securities; safeguarding of customers' securities; and compliance with regulatory and legal requirements. In addition, this staff is responsible for technology infrastructure and systems development, treasury operations, financial control and analysis, tax planning and compliance, internal audit, expense management, career development and recruiting and other support functions.\nIn 1995, the Company made broad enhancements to its technology environment, including the implementation of improved funding, credit, market risk and sales support systems. The Company also made significant investments in its employees through management training and career development initiatives and an expanded recruitment program for analysts and associates.\nOn October 12, 1994, the Company and Bear Stearns Securities Corp. (\"BSSC\") entered into an agreement pursuant to which BSSC agreed to process the transactions previously cleared by Smith Barney (the \"BSSC Agreement\"). As a result, the Company is now self-clearing, and the accounts previously carried by Smith Barney are carried on the Company's books. The BSSC Agreement took effect on February 17, 1995 and will run for a term of five years.\nONGOING COST REDUCTION EFFORT\nThroughout 1995, Holdings and the Company took actions to reduce costs based on Holdings' cost reduction efforts announced at year-end 1994. Throughout 1995, Holdings achieved its cost reduction goals in personnel costs, non-personnel costs and interest and tax expense. As a result of these efforts, the Company's expense base has been permanently lowered. With respect to personnel costs, the Company's total number of employees was reduced from approximately 6,950 at fiscal year-end 1994 to approximately 6,200 at fiscal year-end 1995. Non-personnel cost reductions were achieved as a result of a systematic and comprehensive global review of all major expense categories.\nRISK MANAGEMENT\nAs a leading global investment company, risk is an inherent part of all of Lehman Brothers' businesses and activities. The extent to which Lehman Brothers properly and effectively identifies, assesses, monitors and manages each of the various types of risks involved in its trading, brokerage and investment banking activities is critical to the success and profitability of the Company. The principal types of risk involved in Lehman Brothers' activities are market risks, credit or counterparty risks and transaction risks. Lehman Brothers has developed a control infrastructure to monitor and manage each type of risk on a global basis throughout the Company.\nIn its trading, market-making and underwriting activities, Lehman Brothers is subject to risks relating to fluctuations in market prices and liquidity of specific securities, instruments and derivative\nproducts, as well as volatility in market conditions in general. The markets for these securities and products are affected by many factors, including the financial performance and prospects of specific companies and industries, domestic and international economic conditions (including inflation, interest and currency exchange rates and volatility), the availability of capital and credit, political events (including proposed and enacted legislation) and the perceptions of participants in these markets.\nLehman Brothers' exposure to credit risks in its trading activities arise from the possibility that a counterparty to a transaction could fail to perform under its contractual commitment, resulting in Lehman Brothers incurring losses in liquidating or covering its position in the open market.\nIn connection with its investment banking and product origination activities, Lehman Brothers is exposed to risks relating to the merits of proposed transactions. These risks involve not only the market and credit risks associated with underwriting securities and developing derivative products, but also potential liabilities under applicable securities and other laws which may result from Lehman Brothers' role in the transaction.\nThe Company aims to reduce risk through the diversification of its products, counterparties and activities in geographic regions. The Company accomplishes this objective through allocating the usage of capital to each of its businesses, establishing trading limits for individual products and traders, and the approval of credit limits for individual counterparties including regional concentrations. In addition, the Company is committed to employing qualified personnel with expertise in each of its various businesses who are responsible for the establishment of risk management policies and the continued review and evaluation of these policies in light of changes in market conditions, counterparty credit status, and the long- and short-term goals of the Company. Senior management plays a critical role in the ongoing evaluation of risks, including credit, market, operational and liquidity risks and makes necessary changes in risk management policies in light of these factors.\nThe Company's risk management strategy is based on a multi-tier approach to risk which includes many independent groups (i.e., risk management, finance, legal, front office senior management, credit) being included in the risk monitoring process. The Company's risk management department independently reviews the Company's trading portfolios on a daily basis from a market risk perspective which includes value at risk and other quantitative and qualitative risk measurements and analyses. The risk management department has full time professionals dedicated to each of the trading and geographic areas. The Company's trade analysis department performs independent verification of the prices of trading positions, regularly monitors the aging of inventory, and performs daily review and analysis of the Company's profitability, by business unit. The corporate credit department has the responsibility for establishing and monitoring counterparty limits, structuring and approving specific transactions, and establishing collateral requirements or other credit enhancement features (such as financial covenants, guarantees or letters of credit), when deemed necessary, to secure the Company's position. The Company's Commitment Committee has the responsibility for reviewing and approving proposed transactions involving the underwriting or placement of securities by Lehman Brothers, while the Investment Committee performs a similar function in reviewing and approving proposed transactions related to investments of capital in connection with the Company's investment banking and merchant banking activities. Additionally, the Company employs an internal audit department that reports directly to the Company's Audit Committee and the Board of Directors. This group performs periodic reviews to evaluate compliance with established control processes. These reviews include performing tests on the accuracy of inventory prices, compliance with established credit and trading limits, and compliance with securities and other laws. The Company's control structure and various control mechanisms are also subject to periodic reviews as a result of examinations by the Company's external auditors as well as various regulatory authorities.\nThe Company seeks to ensure that it achieves adequate returns from each of its business units commensurate with the risks assumed. To achieve this objective, the Company periodically re-allocates capital to each of its businesses based upon their ability to obtain returns consistent with established guidelines as well as perceived opportunities in the marketplace and the Company's long-term strategy.\nNON-CORE ASSETS\nPrior to 1990, the Company participated in a number of activities that are not central to its current business as an institutional investment banking firm. As a result of these activities, the Company carries on its balance sheet a number of relatively illiquid assets (the \"Non-Core Assets\"), including a number of individual real estate assets, limited partnership interests and a number of smaller investments. Subsequent to their purchase, the values of certain of these Non-Core Assets declined below the recorded values on the Company's balance sheet, which necessitated the write-down of the carrying values of these assets and corresponding charges to the Company's income statement. Certain of these activities have resulted in various legal proceedings.\nSince 1990, management has devoted substantial resources to reducing the Company's Non-Core Assets. Between December 31, 1990 and November 30, 1995, the Company's Non-Core Assets decreased from $1.1 billion in 1990 to approximately $60 million in 1995. The value of the Company's Non-Core Assets includes carrying value plus contingent exposures net of reserves. Management's intention with regard to these Non-Core Assets is the prudent liquidation of these investments as and when possible.\nCOMPETITION\nAll aspects of the Company's business are highly competitive. The Company competes in domestic and international markets directly with numerous other brokers and dealers in securities and commodities, investment banking firms, investment advisors and certain commercial banks and, indirectly for investment funds, with insurance companies and others.\nThe financial services industry has become considerably more concentrated as numerous securities firms have either ceased operations or have been acquired by or merged into other firms. In addition, several small and specialized securities firms have been successful in raising significant amounts of capital for their merger and acquisition activities and merchant banking investment vehicles and for their own accounts. These developments have increased competition from firms, many of whom have significantly greater equity capital than the Company.\nREGULATION\nThe securities industry in the United States is subject to extensive regulation under both federal and state laws. LBI and certain other subsidiaries of Holdings are registered as broker-dealers and investment advisers with the Commission and as such are subject to regulation by the Commission and by self-regulatory organizations, principally the NASD and national securities exchanges such as the NYSE, which has been designated by the Commission as LBI's primary regulator, and the Municipal Securities Rulemaking Board. Securities firms are also subject to regulation by state securities administrators in those states in which they conduct business. LBI is a registered broker-dealer in all 50 states, the District of Columbia and the Commonwealth of Puerto Rico. The Commission, self-regulatory organizations and state securities commissions may conduct administrative proceedings, which may result in censure, fine, the issuance of cease-and-desist orders or suspension or expulsion of a broker-dealer or an investment adviser, its officers or employees.\nLBI is registered with the CFTC as a futures commission merchant and is subject to regulation as such by the CFTC and various domestic boards of trade and other commodity exchanges. The Company's U.S. commodity futures and options business is also regulated by the National Futures Association, a not-for-profit membership corporation which has been designated as a registered futures association by the CFTC.\nHoldings and the Company do business in the international fixed income, equity and commodity markets and undertakes investment banking activities through Holdings' subsidiaries. The U.K. Financial Services Act of 1986 (the \"Financial Services Act\") governs all aspects of the United Kingdom investment business, including regulatory capital, sales and trading practices, use and safekeeping of customer funds and securities, record keeping, margin practices and procedures, registration standards for individuals, periodic reporting and settlement procedures. Pursuant to the Financial Services Act, Holdings and the Company are subject to regulations administered by The Securities and Futures Authority Limited, a self regulatory organization of financial services companies (which regulates their equity, fixed income, commodities and investment banking activities) and the Bank of England (which regulates their wholesale money market, bullion and foreign exchange businesses).\nThe Company believes that it is in material compliance with regulations described herein.\nThe Company anticipates regulation of the securities and commodities industries to increase at all levels and for compliance therewith to become more difficult. Monetary penalties and restrictions on business activities by regulators resulting from compliance deficiencies are also expected to become more severe.\nCAPITAL REQUIREMENTS\nAs a registered broker-dealer, LBI is subject to the Commission's Rule 15c3-1 (the \"Net Capital Rule\") promulgated under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). The Net Capital Rule requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined.\nCompliance with the Net Capital Rule could limit those operations of LBI that require the intensive use of capital, such as underwriting and trading activities and the financing of customer account balances, and also could restrict the ability of Holdings to withdraw capital from LBI, which in turn could limit the ability of Holdings to pay dividends, repay debt and redeem or purchase shares of its outstanding capital stock. See Footnote 8 of Notes to Consolidated Financial Statements.\nEMPLOYEES\nAs of November 30, 1995 the Company employed approximately 6,200 persons. The Company considers its relationship with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters occupy approximately 1,147,000 square feet of space at 3 World Financial Center in New York, New York, which is owned by the Company as tenants-in-common with American Express and various other American Express subsidiaries.\nHoldings entered into a lease for approximately 392,000 square feet for offices located at 101 Hudson Street in Jersey City, New Jersey (the \"Operations Center\"). The Operations Center is used by\nsystems, operations, and certain administrative personnel and contains certain back-up trading systems. The lease term is approximately 16 years and commenced in August 1994.\nMost of the Company's other offices are located in leased premises, the leases for which expire at various dates through the year 2007. During 1995, the Company conducted a global review of its real estate requirements, and took an occupancy-related real estate charge. See Note 17 to Consolidated Financial Statements. The Company intends to sublet certain of these leased premises. Facilities owned or occupied by the Company and its subsidiaries are believed to be adequate for the purposes for which they are currently used and are well maintained.\nITEM 3","section_3":"ITEM 3 - -LEGAL PROCEEDINGS\nThe Company is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its business. Such proceedings include actions brought against the Company and others with respect to transactions in which the Company acted as an underwriter or financial advisor, actions arising out of the Company's activities as a broker or dealer in securities and commodities and actions brought on behalf of various classes of claimants against many securities and commodities firms of which the Company is one.\nAlthough there can be no assurance as to the ultimate outcome, the Company has denied, or believes it has a meritorious defense and will deny, liability in all significant cases pending against it including the matters described below, and intends to defend vigorously each such case. Although there can be no assurance as to the ultimate outcome, based on information currently available and established reserves, the Company believes that the eventual outcome of the actions against it, including the matters described below, will not, in the aggregate, have a material adverse effect on the consolidated financial condition of the Company.\nBamaodah v. E.F. Hutton & Company Inc.\nIn April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F. Hutton & Company Inc., (\"EFH\") to recover all losses the Bamaodahs had incurred since May 1981 in the trading of commodity futures contracts in a nondiscretionary EFH trading account. The Dubai Civil Court ruled that the trading of commodity futures contracts constituted illegal gambling under Islamic law and that therefore the brokerage contract was void. In January 1987, a judgment was rendered against EFH in the amount of $48,656,000. On January 5, 1991, the Dubai Court of Appeals affirmed the judgment. On March 22, 1992, the Court of Cassation, Dubai's highest court, revoked and quashed the decision of the Court of Appeals and ordered that the case be remanded to the Court of Appeals for a further review. On April 26, 1994, the Dubai Court of Appeals again affirmed the judgment of the Dubai Civil Court. The Company appealed the judgment to the Court of Cassation, which reversed the Court of Appeals on November 27, 1994 and ordered that a new expert be appointed to review the case. A new expert has been appointed, with instructions to report back to the Court of Cassation.\nActions Relating To First Capital Holdings Inc.\nDerivative Actions. On or about March 29, 1991, two identical purported shareholder derivative actions were filed, entitled Mentch v. Weingarten, et al. and Isaacs v. Weingarten, et al. The complaints in these two actions, pending in the Superior Court of the State of California, County of Los Angeles, are filed allegedly on behalf of and naming as a nominal defendant First Capital Holdings Inc. (\"FCH\"). Other defendants include Holdings, two former officers and directors of FCH, Robert Weingarten and Gerry Ginsberg, the four outside directors of FCH, Peter Cohen, Richard DeScherer, William L. Mack and Jerome H. Miller (collectively, the \"Outside Directors\"), and Michael Milken. The complaints alleged generally breaches of fiduciary duty, gross corporate mismanagement and waste\nof assets in connection with FCH's purchase of non-rated bonds underwritten by Drexel Burnham Lambert Inc. and sought damages for losses suffered by FCH, punitive damages and attorneys' fees. On January 30, 1996, these two actions were dismissed.\nConcurrent with the bankruptcy filing of FCH and the conservatorship and receivership of its two life insurance subsidiaries, First Capital Life Insurance Company (\"First Capital Life\") and Fidelity Bankers Life Insurance Company (\"Fidelity Bankers Life\") (First Capital Life and Fidelity Bankers Life collectively, the \"Insurance Subsidiaries\"), a number of additional actions were instituted, naming one or more of Holdings, Lehman Brothers and American Express as defendants (individually or collectively, as the case may be, the \"American Express Defendants\").\nUnder the terms of an agreement between American Express and Holdings, Holdings has agreed to indemnify American Express for liabilities which it may incur in connection with any action (including any derivative action) relating to FCH. In connection therewith, Holdings' indemnification obligation extends to the below described actions.\nFCH Shareholder and Agent Actions. Three actions were commenced in the United States District Courts for the Southern District of New York and the Central District of California allegedly as class actions on behalf of the purchasers of FCH securities during certain specified periods, commencing no earlier than May 4, 1988 and ending no later than May 31, 1991 (the \"Shareholder Class\"). The complaints are captioned Larkin, et al. v. First Capital Holdings Corp., et al., amended on May 15, 1991 to add American Express as a defendant, Zachary v. American Express Company, et al., filed on May 20, 1991, and Morse v. Weingarten, et al., filed on June 13, 1991 (the \"Shareholder Class Actions\"). The complaints raised claims under the federal securities laws and alleged that the defendants concealed adverse material information regarding the finances, financial condition and future prospects of FCH and made material misstatements regarding these matters.\nOn July 1, 1991 an action was filed in the United States District Court for the Southern District of Ohio entitled Benndorf v. American Express Company, et al. The action was brought purportedly on behalf of three classes. The first class is similar to the Shareholder Class; the second consisted of managing general agents and general agents who marketed various First Capital Life products from April 2, 1990 to the present and to whom it is alleged misrepresentations were made concerning FCH (the \"Agent Class\"); and the third class consists of Agents who purchased common stock of FCH through the First Capital Life Non Qualified Stock Purchase Plan (\"FSPP\") and who have an interest in the Stock Purchase Account under the FSPP (the \"FSPP Class\"). The complaint raised claims similar to those asserted in the other Shareholder Class Actions, along with additional claims relating to the FSPP Class and the Agent Class alleging damages in marketing the products. In addition, on August 15, 1991, Kruthoffer v. American Express Company, et al. was filed in the United States District Court for the Eastern District of Kentucky, whose complaint was nearly identical to the Benndorf complaint (collectively the \"Agent Class Actions\").\nOn November 14, 1991, the Judicial Panel on Multidistrict Litigation issued an order transferring and coordinating for all pretrial purposes all related actions concerning the sale of FCH securities, including the Shareholder Class Action and Agent Class Actions, and any future filed \"tag-along\" actions, to Judge John G. Davies of the United States District Court for the Central District of California (the \"California District Court\"). The cases are captioned In Re: First Capital Holdings Corporation Financial Products Securities Litigation. MDL Docket No.-901 (the \"MDL Action\").\nOn January 18, 1993, an amended consolidated complaint (the \"Third Complaint\") was filed on behalf of the Shareholder Class and the Agent Class. The Third Complaint names as defendants American Express, Holdings, Lehman Brothers, Weingarten and his wife, Palomba Weingarten, Ginsberg, Philip A. Fitzpatrick (FCH's Chief Financial Officer), the Outside Directors and former FCH outside directors Jeffrey B. Lane and Robert Druskin (the \"Former Outside Directors\"), Fred\nBuck (President of First Capital Life) and Peat Marwick. The complaint raises claims under the federal securities law and the common law of fraud and negligence. On March 10, 1993, the American Express defendants answered the Third Amended Complaint, denying its material allegations.\nOn March 11, 1993, the California District Court entered an order granting class certification to the Shareholder Class. The class consists of all persons, except defendants, who purchased FCH common stock, preferred stock and debentures during the period May 4, 1988 to and including May 10, 1991. It also issued an order denying class certification to the Agent Class. The FSPP Class action had been previously dropped by the plaintiffs.\nThe American Express Shareholder Action. On or about May 20, 1991, a purported class action was filed on behalf of all shareholders of American Express who purchased American Express common shares during the period beginning August 16, 1990 to and including May 10, 1991. The case is captioned Steiner v. American Express Company, et al. and was commenced in the United States District Court for the Eastern District of New York. The defendants are Holdings, American Express, James D. Robinson, III, Howard L. Clark, Jr., Harvey Golub and Aldo Papone. The complaint alleges generally that the defendants failed to disclose material information in their possession with respect to FCH which artificially inflated the price of the common shares of American Express from August 16, 1990 to and including May 10, 1991 and that such nondisclosure allegedly caused damages to the purported shareholder class. The action has been transferred to California and is now part of the MDL Action. The defendants have answered the complaint, denying its material allegations.\nAmerican Express Derivative Action. On June 6, 1991, a purported shareholder derivative action was filed in the United States District Court for the Eastern District of New York, entitled Rosenberg v. Robinson, et al., against all of the then-current directors of American Express. In January 1992, this action was transferred by stipulation to be part of the MDL action. The complaint alleged that the Board of Directors of American Express should have required Holdings to divest its investment in FCH and to write down such investment sooner. In addition, the complaint alleged that the failure to act constituted a waste of corporate assets and caused damage to American Express' reputation. The complaint sought a judgment declaring that the directors named as defendants breached their fiduciary duties and duties of loyalty and requiring the defendants to pay money damages to American Express, and remit their compensation for the period in which the duties were breached, to pay attorneys' fees and costs and other relief. The parties to the American Express Shareholder Action and the American Express Derivative Action have entered into a settlement agreement, subject to approval by the Court.\nThe Virginia Commissioner of Insurance Action. On December 9. 1992, a complaint was filed in federal court in the Eastern District of Virginia by Steven Foster, the Virginia Commissioner of Insurance as Deputy Receiver of Fidelity Bankers Life. The Complaint names Holdings and Weingarten, Ginsberg and Leonard Gubar, a former director of FCH and Fidelity Bankers Life, as defendants. The action was subsequently transferred to California to be part of the MDL Action. The Complaint alleges that Holdings acquiesced in and approved the continued mismanagement of Fidelity Bankers Life and that it participated in directing the investment of Fidelity Bankers Life assets. The complaint asserts claims under the federal securities laws and asserts common law claims including fraud, negligence and breach of fiduciary duty and alleges violations of the Virginia Securities laws by Holdings. It allegedly seeks no less than $220 million in damages to Fidelity Bankers Life and its present and former policyholders and creditors and punitive damages. Holdings has answered the complaint, denying its material allegations.\nEaston & Co. v. Mutual Benefit Life Insurance Co., et al.; Easton & Co. v. Lehman Brothers Inc.\nLehman Brothers has been named as a defendant in two consolidated class action complaints pending in the United States District Court for the District of New Jersey (the \"N.J. District Court\").\nEaston & Co. v. Mutual Benefit Life Insurance Co., et al. (\"Easton I\"), and Easton & Co. v. Lehman Brothers Inc. (\"Easton II\"). The plaintiff in both of these actions is Easton & Co., which is a broker-dealer located in Fort Lee, New Jersey. Both of these actions allege federal securities law claims and pendent common law claims in connection with the sale of certain municipal bonds as to which Mutual Benefit Life Insurance Company (\"MBLI\") has guaranteed the payment of principal and interest. MBLI is an insurance company which was placed in rehabilitation proceedings under the supervision of the New Jersey Insurance Department on or about July 16, 1991. In the Matter of the Rehabilitation of Mutual Benefit Life Insurance Company, (Sup. Ct. N.J. Mercer County.)\nEaston I was commenced on or about September 17, 1991. In addition to Lehman Brothers, the defendants named in this complaint are MBLI, Henry E. Kates (MBLI's former Chief Executive Officer) and Ernst & Young (MBLI's accountants). The litigation is purportedly brought on behalf of a class consisting of all persons and entities who purchased DeKalb, Georgia Housing Authority Multi- Family Housing Revenue Refunding Bonds (North Hill Ltd. Project), Series 1991, due November 30, 1994 (the \"DeKalb Bonds\") during the period from May 3, 1991 (when the DeKalb bonds were issued) through July 16, 1991. Lehman Brothers acted as underwriter for this bond issue, which was in the aggregate principal amount of $18.7 million. The complaint alleges that Lehman Brothers violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and seeks damages in an unspecified amount or rescission. The complaint also alleges a common law negligent misrepresentation claim against Lehman Brothers and the other defendants.\nEaston II was commenced on or about May 18, 1992, and names Lehman Brothers as the only defendant. Plaintiff purports to bring this second lawsuit on behalf of a class composed of all persons who purchased \"MBLI-backed Bonds\" from Lehman Brothers during the period April 19, 1991 through July 16, 1991. The complaint alleges that Lehman Brothers violated Section 10(b) and Rule 10b-5, and seeks monetary damages in an unspecified amount, or rescission pursuant to Section 29(b) of the Exchange Act. The complaint also contains a common law claim of alleged breach of duty and negligence.\nOn or about February 9, 1993, the N.J. District Court granted plaintiffs' motion for class certification in Easton I. The parties have agreed to certification of a class in Easton II for purchases of certain fixed-rate MBLI-backed bonds during the class period.\nMaxwell Related Litigation\nCertain of the Company's subsidiaries are defendants in several lawsuits arising out of transactions entered into with the late Robert Maxwell or entities controlled by Maxwell interests. These actions are described below.\nBerlitz International Inc. v. Macmillan Inc. et al. This interpleader action was commenced in Supreme Court, New York County (the \"Court\") on or about January 2, 1992, by Berlitz International Inc. (\"Berlitz\") against Macmillan Inc. (\"Macmillan\"), Lehman Brothers Holdings PLC (\"PLC\"), Lehman Brothers International Limited (now known as Lehman Brothers International (Europe), (\"LBIE\") and seven other named defendants. The interpleader complaint seeks a declaration of the rightful ownership of approximately 10.6 million shares of Berlitz common stock, including 1.9 million shares then registered in PLC's name, alleging that Macmillan claimed to be the beneficial owner of all 10.6 million shares, while the defendants did or might claim ownership to some or all of the shares. As a result of its bankruptcy filing, MacMillan sought to remove this case to the Bankruptcy Court for the Southern District of New York. On the motion of LBIE and PLC, the case was remanded back to the Court. Following the remand, the parties entered into a stipulation pursuant to which all proceedings have been stayed pending the outcome of the appeal in Macmillan v. Bishopsgate Investment Trust et al., referred to below.\nMacmillan, Inc. v. Bishopsgate Investment Trust, Shearson Lehman Brothers Holdings PLC et al. This action was commenced by issuance of a writ in the High Court of Justice in London, England on or about December 9, 1991. In this action, Macmillan sought relief virtually identical to that sought in the Berlitz action, described above. Specifically, Macmillan sought a declaration that it is the legal and beneficial owner of the disputed 10.6 million shares of Berlitz common stock, including the 1.9 million shares then held by PLC. After a trial, on December 10, 1993, the High Court of Justice handed down a judgment finding for the Company on all aspect of its defense and dismissing MacMillan's claims. On November 2, 1995, the Court of Appeal issued a preliminary judgment dismissing MacMillan s appeal. MacMillan has sought leave to appeal to the House of Lords.\nMCC Proceeds Inc. v. Lehman Brothers International (Europe) This action was commenced by issuance of a writ in the High Court of Justice in London, England on July 14, 1995. In this action, MCC Proceeds Inc., as successor to Macmillan, Inc., seeks relief identical to that sought in the Berlitz action described above, but based on a legal theory which was initially pleaded but ultimately abandoned by the plaintiff in Berlitz. The High Court granted LBIE's has issued an application to dismiss the proceeding and assessed costs against MCC Proceeds.\nLehman Brothers Commercial Corporation and Lehman Brothers Special Financing Inc. v. China International United Petroleum and Chemical Co., Ltd.\nOn November 15, 1994, two Lehman Brothers subsidiaries, Lehman Brothers Commercial Corporation (\"LBCC\") and Lehman Brothers Special Financing Inc. (\"LBSF\"), commenced an action against China International United Petroleum and Chemicals Company (\"Unipec\") in the United States District Court for the Southern District of New York alleging breach of contract. The litigation arose from the refusal by Unipec to honor its obligations with respect to certain foreign exchange and swap transactions. LBCC and LBSF seek to recover approximately $44 million from Unipec. Unipec asserted fifteen counterclaims against Lehman entities based on violations of federal securities and commodities laws and rules and theories of fraud, breach of fiduciary duty, conversion and business torts. Unipec seeks $8 million in compensatory damages, as well as punitive damages. The Court granted the motion of the Lehman counterclaim defendants in part, and dismissed the counterclaims based on business tort theories. Discovery is progressing.\nLehman Brothers Commercial Corporation and Lehman Brothers Special Financing Inc. v. Minmetals International Non-Ferrous Metals Trading Company\nOn November 15, 1994, LBCC and LBSF commenced an action against Minmetals International Non-Ferrous Metals Trading Company (\"Minmetals\") and China National Metals and Minerals Import and Export Company (\"CNM\") in the United States District Court for the Southern District of New York alleging breach of contract against Minmetals and breach of guarantee against CNM. The litigation arose from the refusal by Minmetals and CNM to honor their obligations with respect to certain foreign exchange and swap transactions. LBCC and LBSF seek to recover approximately $53.5 million from Minmetals and\/or CNM. On June 26, 1995, the court granted CNM's motion to dismiss the claims against it, but also granted LBCC and LBSF leave to replead. Minmetals filed fourteen counterclaims against Lehman entities based on violations of federal securities and commodities laws and rules, and theories of fraud, breach of fiduciary duty and conversion. The court denied a motion by the Lehman counterclaim defendants to dismiss the six fraud-based counterclaims. On February 7, 1996, LBCC and LBSF sought leave to file an amended complaint naming CNM as an additional defendant. Discovery is progressing.\nSinochem(USA) Inc. v. Lehman Brothers Inc. et al.\nOn January 4, 1996, a complaint was filed in the United States District Court for the Southern District of New York by Sinochem (USA) Inc. (\"Sinochem\") against Lehman Brothers Inc., Lehman Special Financing and Sheng Yan, a former Lehman salesperson. The complaint alleges that Sinochem has been exposed to losses of approximately $20 million by entering into unsuitable investments, namely interest rate swaps and repurchase transactions, with the defendants. The complaint, which includes claims based on fraud, breach of fiduciary duty, breach of contract and alleged violations of federal securities and commodities laws and rules, seeks return of the capital Sinochem invested, a declaration that the transactions are void, and punitive damages. The defendants intend to file an answer denying the material allegations of the complaint and to assert counterclaims against Sinochem and its parent corporation, China National Chemicals Import & Export Corporation (\"Sinochem Beijing\"), to recover all amounts due and owing from Sinochem and Sinochem Beijing.\nActions Relating to National Association of Securities Dealers Automated Quotations System (\"NASDAQ\") Market Maker Antitrust and Securities Litigation.\nBeginning in May, 1994, several class actions were filed in various state and federal courts against various broker-dealers making markets in NASDAQ securities. With respect to a number of those actions LBI was either specifically named as a defendant or was not specifically named as a defendant but could be deemed to be a member of the defendant class as defined in the complaints. Plaintiffs in these cases have alleged violations of the antitrust laws, securities laws and have pled a variety of other statutory and common law claims. All of these actions are based on the theory that because odd-eighth quotes occur less often than quarter quotes, NASDAQ market makers must be colluding wrongfully to maintain a wider spread.\nBy Order filed October 14, 1994, the Judicial Panel on Multidistrict Litigation consolidated these actions in the Southern District of New York and ordered that all related actions be transferred and coordinated for all pretrial purposes. The case is captioned In Re NASDAQ Market-Makers Antitrust Litigation, MDL No. 1023.\nOn December 16, 1994, plaintiffs served a consolidated Amended Complaint naming 33 defendants including LBI. Plaintiffs claim violations of the federal antitrust laws including Section 1 of the Sherman Antitrust Act. Plaintiffs seek unspecified compensatory damages trebled in accordance with the antitrust laws, costs including attorneys' fees as well as injunctive relief. The court dismissed the action with leave to replead, stating that the complaint failed to identify the securities involved with sufficient specificity. The plaintiffs replied and the defendants answered the amended complaint on November 17, 1995. Discovery has commenced.\nLeetate Smith, et al. v. Merrill Lynch, et al.\nOn February 28, 1995 a First Amended Consolidated Class Action Complaint for Violations of the Federal Securities Laws and the California Corporations Code (the \"Complaint\") was filed in the United States District Court for the Central District of California amending a previously filed complaint and adding, among other defendants, LBI. The Complaint is purportedly brought on behalf of purchasers of bonds, notes and other securities during the period July 1, 1992 through December 6, 1994 (the \"Class Period\") that were issued by Orange County or by other public entities which had funds invested in Orange County's Investment Pool (collectively the \"County\"). Also named as defendants are eight other broker-dealers who are, like LBI, alleged to have acted as underwriters of the County's debt securities and the five financial advisors who allegedly advised the County during the Class Period. The Complaint alleges violations of Section 10b of the Exchange Act of 1934 and various sections of the California Corporations Code based on alleged misstatements and omissions in the\nOfficial Statements of the debt offerings by the County primarily relating to the County's creditworthiness and ability to repay the debts. The Complaint seeks (i) to certify the action as a class action; (ii) unspecified damages plus interest; and (iii) attorneys fees.\nSonnenfeld v. The City and County of Denver, Colorado, et al.\nOn August 4, 1995, a Consolidated Amended Class Action Complaint (the \"Complaint\") was filed in the United States District Court for the District of Colorado, consolidating and amending previously filed complaints and adding, among other defendants, LBI. The Complaint is purportedly brought on behalf of all persons, other than defendants, who purchased Denver Airport System Revenue Bonds during the period February 27, 1992 through May 3, 1994 that were issued by the City and County of Denver (the \"Bonds\") and who were damaged by their investments. Also named as defendants are seven other broker-dealers who acted as underwriters or financial advisors in connection with the issuances of the Bonds and the City and County of Denver. The Complaint alleges violations of Section 10b of the Exchange Act of 1934 and the Colorado Securities Act and common law fraud based on alleged misstatements and omissions in the Official Statements for the Bonds primarily relating to status of the design and construction of the new Denver International Airport (the \"Airport\"), the amount of revenues it would likely generate and the risks posed to the timely opening of the Airport by the installation of an automated baggage system. The Complaint seeks (i) to certify the action as a class action; (ii) unspecified damages; and (iii) costs and attorneys fees.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nPursuant to General Instruction J of Form 10-K, the information required by Item 4 is omitted.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the outstanding common stock of the Company is owned by Holdings.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPursuant to General Instruction J of Form 10-K, the information required by Item 6 is omitted.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSet forth on the following pages is Management's Discussion and Analysis of Financial Condition and Results of Operations for the twelve months ended November 30, 1995, the eleven months ended November 30, 1994 and the twelve months ended December 31, 1993.\nBUSINESS ENVIRONMENT\nThe principal business activities of Lehman Brothers Inc., a registered broker-dealer (\"LBI\") and subsidiaries (collectively, the \"Company\" or \"Lehman Brothers\") are investment banking and securities trading and sales, which by their nature are subject to volatility, primarily due to changes in interest and foreign exchange rates, global economic and political trends and industry competition. As a result, revenues and earnings may vary significantly from quarter to quarter and from year to year. LBI is a wholly owned subsidiary of Holdings.\nThe adverse market conditions that prevailed during the last three quarters of 1994, characterized by rising interest rates and depressed underwriting volumes, continued throughout most of the first quarter of 1995.\nIn the second quarter of 1995, market conditions showed signs of improvement as expectations for lower U.S. interest rates prompted strong rallies in the stock and bond markets. Although customer volumes increased in both the debt and equity markets, market conditions continued to be volatile during this period. In general, investors remained conservative and defensive due to uncertainties surrounding the direction of U.S. interest rates and the value of the dollar. Over the same period, derivative transaction volumes showed improvement as customers and clients were looking for protection in a declining interest rate and volatile currency environment.\nThe positive momentum established during the second quarter of 1995 continued into the third quarter of 1995. In early July 1995, the U.S. Federal Reserve Bank reduced the federal funds rate by one-quarter of a percentage point. Investors reacted favorably to this long-awaited rate cut, leading to a rally in the bond market. However, by the middle of July 1995, positive economic data caused renewed investor concerns regarding inflation, the growth rate of the economy and the future direction of interest rates. Towards the end of the third quarter, the market tone turned decidedly more positive as investors concluded that interest rate increases would be unnecessary. In addition, the dollar continued to strengthen against key currencies such as the yen and the Deutsche mark, providing further support for a more stable interest rate environment.\nThe fixed income and equity markets rallied as a result of these factors. Improved market conditions allowed for a continuing increase in debt and equity origination activity. Driving the robust equity markets were strong individual company and industry fundamentals, near record levels of merger and acquisition activity and substantial cash inflows into mutual funds.\nThe market rally, which began in September, accelerated through the months of October and November. The more favorable view on interest rates provided strong support for the U.S. equity market as the major equity indices hit all-time highs. Business fundamentals have remained reasonably positive in the U.S. bond market, as lower levels of inflation and the possibility of a deficit reduction agreement by the U.S. Government have raised the potential for further interest rate reductions by the U.S. Federal Reserve Bank. These conditions have been positive for debt and equity origination activity and secondary trading volumes for the industry as a whole. Internationally, lower growth rates in the major European countries have prompted interest rate reductions from a number of central banks and strong rallies in their respective bond and stock markets. Higher relative returns in the U.S. markets vis-a-vis foreign markets have bolstered international interest in U.S. securities and provided support for the U.S. dollar. This positive market environment has continued into 1996.\nHOLDINGS' SPIN-OFF FROM AMERICAN EXPRESS\nOn May 31, 1994, American Express effected a special dividend to its common shareholders of record on May 20, 1994, of approximately 98.2 million shares of Holdings' common stock. (See Note 6 to the Consolidated Financial Statements.) As part of the spin-off, Holdings' equity capital was increased and restructured, with Holdings receiving a net increase of $1.25 billion of equity, primarily from American Express. As a result of the Distribution, Holdings became a widely held public corporation with its common stock traded on the New York Stock Exchange.\nCHANGE IN YEAR-END\nEffective with the Distribution, the Company and Holdings changed their year-end from December 31 to November 30, in order to shift certain year-end administrative activities to a time period that conflicts less with the business needs of the Company's institutional customers. As a result of the change in the Company's year-end, it reported its 1994 financial statements on the basis of an eleven month transition period ended November 30, 1994. Due to the eleven month reporting period for 1994, the Company's 1994 results of operations are not directly comparable with the Company's results for 1995 or 1993.\nBUSINESSES SOLD\nThe Company completed the sale of three businesses during 1993: The Boston Company, Shearson, and SLHMC which were completed on May 21, July 31, and August 31, 1993, respectively. (See Note 18 to the Consolidated Financial Statements.) The Company's operating results reflect The Boston Company as a discontinued operation, while the operating results of Shearson and SLHMC are included in the Company's results from continuing operations for all periods prior to their sale in 1993. Because of the significant sale transactions completed during 1993, the Company's historical financial statements are not fully comparable for all periods presented.\nRESULTS OF OPERATIONS\nSUMMARY. The Company reported net income of $69 million for 1995, including a $26 million ($43 million pretax) charge for occupancy-related real estate expenses and severance. Excluding the restructuring charge, net income was $95 million for 1995. The Company's 1995 results reflect improved performance in corporate finance advisory activity and in fixed income and equity origination as well as higher levels of customer activity in a number of businesses. The Company benefited from the continuing increase in merger and acquisition activity throughout the year and from a stronger market climate beginning in the second quarter of 1995. Realization of benefits from the continued investments in selective investment banking, research and sales resources, combined with reductions in the Company's non-interest expenses (excluding special charges), also had a positive effect on 1995 results. For 1994, the Company reported a net loss of $29 million, including a $13 million ($23 million pretax) charge for the cumulative effect of a change in accounting for postemployment benefits, a $15 million ($27 million pretax) severance charge recorded in the first quarter of 1994 related to the Company's ongoing review of its personnel needs (\"Severance Charge\") and $50 million preferred dividend of subsidiary. Excluding these charges, net income from continuing operations before preferred dividend of subsidiary was $49 million in 1994. The 1994 results reflect the difficult market environment for many of the Company's principal businesses. The Company reported a net loss of $259 million for 1993 which included a loss of $646 million for businesses sold, net income of $198 million for the Company's continuing businesses and a net gain of $189 million from discontinued operations. A detailed breakout of the 1993 results into these three categories is included on page 25. The primary discussion and comparison of operating results for 1993 includes only the continuing Lehman Businesses, with a separate section for Businesses Sold\/Discontinued Operations listed subsequently on pages 25-26.\nNET REVENUES. Net revenues were $2,078 million for 1995, $1,969 million for 1994 and $2,674 million for 1993. Revenues in 1995 were positively affected by increased underwriting volumes and customer flow activity due to strong rallies in the stock and bond markets during the last three quarters of the year. The Company's revenues increased during each quarter of 1995. Although 1994 revenues on an annualized basis were comparable to 1995 levels, the Company's 1994 revenues declined from a first quarter peak as increasing interest rates and volatile equity markets served to depress underwriting volumes and to reduce customer flow activity. Revenues in 1993 were affected by the positive economic environment, which resulted in a record year for the U.S. securities industry, as historically low interest rates, higher volumes of new stock and bond issues and the continued restructuring of corporate balance sheets produced strong results.\nSince 1990, Lehman Brothers has focused on a \"client\/customer-driven\" strategy. Under this strategy, Lehman Brothers concentrates on serving the needs of major issuing and advisory clients and investing customers worldwide to build an increasing \"flow\" of business that leverages the Company's research, underwriting and distribution capabilities. Customer flow continues to be the primary source of the Company's net revenues. In addition to its customer flow activities, the Company also takes proprietary positions based upon expected movements in interest rate, foreign exchange, equity and commodity markets in both the short- and long-term. The Company's success in this area is dependent upon its ability to anticipate economic and market trends and to develop trading strategies that\ncapitalize on these anticipated changes. Consistent with the Company's client\/customer-driven strategy, the Company estimates that proprietary trading activities accounted for approximately 9% of net revenues in 1995. Proprietary trading is not anticipated to grow significantly.\nAs part of its market-making activities, the Company maintains inventory positions of varying amounts across a broad range of financial instruments which are marked-to-market on a daily basis and along with the Company's proprietary trading positions, give rise to principal transactions revenues. The Company utilizes various hedging strategies to minimize its exposure to significant movements in interest and foreign exchange rates and the equity markets. Net revenues from the Company's market making and trading activities in fixed income and equity products are recognized as either principal transactions or net interest revenues depending upon the method of financing and\/or hedging related to specific inventory positions. The Company evaluates its trading strategies on an overall profitability basis which includes both principal transaction revenues and net interest. Therefore, changes in net interest should not be viewed in isolation but should be viewed in conjunction with revenues from principal transactions. Net interest and dividend revenues in 1995 decreased over the prior year due to decreased net interest spreads in certain of the Company's fixed income and equity financing portfolios. Additionally, net interest and dividend revenues in 1995 were adversely affected by increased financing costs due to the net reduction in the Company's equity capital base, primarily as a result of dividends and capital distributions to Holdings. The Company's net interest and dividend revenues in 1994 were adversely affected by reduced spreads on fixed income products and increased funding costs to the Company as compared to the prior year as a result of the higher interest rate environment in 1994.\nThe following table of net revenues by business unit and the accompanying discussion have been prepared in order to present the Company's net revenues in a format which reflects the manner in which the Company manages its businesses. For internal management purposes, the Company has been segregated into five major business units: Fixed Income, Equity, Corporate Finance Advisory, Merchant Banking and Asset Management. Each business unit represents a grouping of financial activities and products with similar characteristics. These business activities result in revenues that are recognized in multiple revenue categories contained in the Company's Consolidated Statement of Operations. Net revenues by business unit contain certain internal allocations, including funding costs, which are centrally managed.\nTWELVE MONTHS ENDED NOVEMBER 30, 1995\nELEVEN MONTHS ENDED NOVEMBER 30, 1994\nTWELVE MONTHS ENDED DECEMBER 31, 1993\nFor 1995, net revenues were positively impacted by significantly improved underwriting levels in fixed income and equity products, and strengthened customer activity throughout the year. Net revenues by business unit for 1994 were down in each major category except corporate finance advisory and merchant banking in comparison to the business unit revenues recorded in 1993, reflecting the particularly robust conditions in the capital markets for the entire 1993 year. In 1995, fixed income revenues of $1,224 million reflected a higher contribution from investment banking, as the mix and after-market performance of the Company's underwriting improved from 1994 levels. Equity revenues of $584 million in 1995 also reflected the stronger underwriting market environment. Corporate finance advisory revenues of $186 million in 1995 reflected the Company's increased participation in strategic mergers and acquisitions and advisory activities throughout the year. Merchant banking revenues of $50 million in 1995 reflected the merger of certain subsidiaries of Holdings with merchant banking activities into the Company in the fourth quarter of 1994.\nThe following discussion provides an analysis of the Company's net revenues based upon the various business units which generated these revenues.\nFIXED INCOME\nThe Company's fixed income revenues reflect customer flow activities (both institutional and high net-worth retail), secondary trading, debt underwriting, syndicate and financing activities related to fixed income products. Fixed income products include government securities, mortgage- and asset-backed securities, money market products, dollar and non-dollar corporate debt securities, emerging market securities, municipal securities, financing (global access to debt financing sources including repurchase and reverse repurchase agreements), foreign exchange, commodities and fixed income derivative products. Lehman Brothers is one of the leading 37 primary dealers in U.S. government securities. The Company is also a dominant market-maker for a broad range of other fixed income products.\nFixed income revenues were $1,224 million for 1995, $1,151 million for 1994 and $1,514 million for 1993. Reduced interest rates and a strengthening U.S. dollar contributed to a favorable market environment in 1995, particularly during the second half of the Company's year. The improved market environment contributed to a stronger debt syndicate calendar and increased customer flow activities for many of the Company's fixed income products, including high grade corporates, municipals and foreign exchange. The most significant component of the increases in fixed income revenues was investment banking due to a strengthening in origination volumes and an improved mix of underwriting revenues compared to the depressed 1994 levels. Holdings and its subsidiaries ranked #2 in lead-managed fixed income offerings worldwide in 1995 with underwritings of $77 billion, based on Securities Data Company information. Commission revenues which primarily relate to the Company's foreign exchange and commodities trading in listed products decreased in 1995 from 1994 levels. Fixed income derivative revenues were down in 1995 compared to 1994 due to a decrease in new customer activity early in the year. Toward the end of 1995, derivative activities increased with related revenues in the fourth quarter up substantially compared to the same quarter in 1994; much of the increase was attributable to a broadening of the Company's international customer and client business. This reflects the results of a concerted effort to continue to globalize the Company's efforts in these areas. Financing revenues were down in 1995 compared to 1994 due to decreased net interest spreads in certain of the matched book portfolios.\nRising interest rates and inflationary concerns in 1994 had a negative effect on customer activity resulting in reduced profitability for most of the fixed income businesses as compared to 1993.\nEQUITY\nThe Company's equity revenues reflect customer flow activities (both institutional and high-net-worth retail), secondary trading, equity underwriting, equity finance and arbitrage activities.\nEquity revenues were $584 million for 1995, $620 million for 1994 and $986 million for 1993. The favorable syndicate calendar in 1995 contributed to increased customer flow in the Company's secondary trading activities. Commission revenues were up as trading volumes on domestic exchanges increased. These increases were more than offset by reduced trading revenues in certain products in 1995. Holdings and its subsidiaries ranked third in total NYSE listed trading volume throughout all of 1995.\nThe decrease in equity revenues in 1994 from 1993 reflected the difficult business environment in 1994. The 1994 decline was broad based across most equity-related products.\nCORPORATE FINANCE ADVISORY\nCorporate finance advisory net revenues, classified in the Consolidated Statement of Operations as a component of investment banking revenues, result primarily from fees earned by the Company in its role as strategic advisor to its clients. This role primarily consists of advising clients on mergers and acquisitions, divestitures, leveraged buyouts, financial restructurings, and a variety of cross border transactions. The net revenues for corporate finance advisory increased in 1995 to $186 million from $153 million and $101 million in 1994 and 1993, respectively. The increased revenues reflected a strong mergers and acquisitions environment throughout 1995 as companies concentrated on cost cutting and creating greater economies of scale via acquisitions, asset sales, and corporate restructurings on a global basis. During 1995, Holdings and its subsidiaries acted as advisor for 141 completed transactions valued at approximately $67 billion, based on Securities Data Company information. Corporate finance advisory exhibited renewed strength in 1994 versus 1993 as both the fees earned by the Company and the number of completed transactions increased from 1993 levels.\nMERCHANT BANKING\nMerchant banking net revenues primarily represent the net realized gains and net unrealized changes resulting from the Company's participation in certain investment partnerships, such amounts are classified in the Consolidated Statement of Operations as a component of investment banking revenues. Merchant banking net revenues also reflect the related net interest expense used to finance capital contributions to the partnerships. Merchant banking revenues were $50 million, $4 million and $3 million for 1995, 1994 and 1993, respectively.\nThe Company, through a subsidiary, is the general partner for four merchant banking partnerships, including three institutional funds and one employee investment vehicle. Current merchant banking investments held by the partnerships include both publicly traded and privately held companies diversified on a geographic and industry basis. For 1995, merchant banking revenues resulting from the participation in these partnerships increased to $77 million from $12 million for 1994, reflecting the merger of certain subsidiaries of Holdings with merchant banking activities into the Company in the fourth quarter of 1994. For 1994, merchant banking revenues decreased slightly to $12 million from $15 million for 1993. Net revenues of the merchant banking business include an allocation of net interest expense related to the Company's investment in the partnerships. The method used to allocate interest expense was revised in 1995 from prior periods to better reflect the costs of capital utilized.\nASSET MANAGEMENT\nRevenues from asset management activities were $34 million for 1995, $41 million for 1994 and $70 million for 1993. These revenues primarily consist of fees from the management of various funds, commissions from the sale of funds to customers and fees from the management of certain accounts for institutions and high-net-worth individuals. The decline in revenues from 1994 to 1995 resulted from the realignment of product offerings to be consistent with the change in the Company's focus towards high-net-worth and institutional clients. The decrease in revenues from 1993 to 1994 relates to the loss of certain commissions and other revenues related to funds and customers transferred to Smith Barney in conjunction with the sale of the retail division.\nNON-INTEREST EXPENSES. Non-interest expenses were $2,000 million for 1995, $1,968 million for 1994 and $2,282 million for 1993. Compensation and benefits expense was $1,055 million for 1995, $1,004 million for 1994 and $1,400 million for 1993. Compensation and benefits expense does not include any portion of management fees, which are separately categorized on the Company's Consolidated Statement of Operations, related to employee services provided by Holdings. Non-interest expenses in 1995 included a restructuring charge of $43 million. Non-interest expenses in 1994 included a $27 million severance charge. Included within non-interest expenses in 1993 was a charge of $21\nmillion related to certain non-core partnership syndication activities in which the Company is no longer actively engaged.\nThe restructuring charge in 1995 included a $26 million occupancy related real estate charge and a $17 million severance charge. The real estate component of the charge resulted from a complete review of the Company's real estate requirements at current headcount levels and the elimination of excess real estate, primarily in New York, London and Tokyo. This charge includes costs to write-down the carrying value of leasehold improvements, as well as projected shortfalls of sublease rentals versus expected operating costs related to the Company's excess capacity. The excess real estate capacity resulted from headcount reductions associated with the Company's cost reduction efforts. The severance component of the charge relates to payments made to terminated personnel arising from a formalized fourth quarter business unit productivity review. The Company expects to realize approximately $11 million of reduced occupancy and depreciation expenses on an annualized basis as a result of these actions.\nExcluding these special charges, non-interest expenses were $1,957 million for 1995, $1,941 million for 1994 and $2,261 million for 1993.\nCOST REDUCTION EFFORT. At year-end 1994, Holdings announced a cost reduction program to reduce expenses by $300 million on an annualized basis (pretax) compared to Holdings' third quarter 1994 expense run rate. The Company's expense base was permanently lowered as a result of Holdings' cost reduction efforts. However, the Company's cost structure differs from Holdings in that nonpersonnel related expenses are not readily determinable from the Company's consolidated statement of operations, since a portion of the Company's management fee expense is comprised of charges related to employee services provided by Holdings and its subsidiaries. In addition, the Company's management fees are subject to fluctuation due to changes in the nature and levels of intercompany services provided. Listed below is a summary of Holdings' cost reduction efforts which were targeted into three areas: personnel cost savings of $100 million, nonpersonnel cost savings of $150 million and interest and tax expense savings of $50 million.\nThrough November 1995, Holdings achieved its cost reduction goals in all the identified cost categories. In fact, through the fourth quarter of 1995, Holdings reduced total expenses by approximately $326 million on an annualized basis compared to the third quarter of 1994. These costs savings achieved do not include the $11 million of future cost savings attributable to the Company's real estate related restructuring charge previously discussed.\nWith respect to Holdings' personnel related cost reduction goals, Holdings reduced headcount to 7,771 at November 30, 1995 from 8,512 at November 30, 1994 and 17% from a peak of 9,400 in early 1994. As a result of these reductions, Holdings reduced its operating compensation and benefits ratio to 50.7% in the fourth quarter of 1995 from the third quarter 1994 benchmark of 53.9%, translating into annualized cost savings of approximately $100 million.\nNonpersonnel cost reductions were achieved as a result of a systematic and comprehensive global review of all major expense categories. As a result, Holdings' nonpersonnel expenses decreased to $254 million in the fourth quarter of 1995 from the third quarter 1994 benchmark of $298 million, resulting in reduced quarterly expenses of $44 million or annualized savings of approximately $177 million.\nHoldings achieved its $50 million cost reduction goal related to interest and taxes through equal reductions in each category. The interest expense savings were accomplished as a result of Holdings' efforts to improve its collateral utilization and long-term debt hedging strategies. Holdings achieved tax savings of approximately $25 million as a result of the implementation of additional tax planning strategies.\nAs a result of these efforts, Holdings' expense base has been permanently lowered. Holdings plans to continue its focus on nonpersonnel costs, with the goal of achieving further cost savings in excess of $50 million by the end of 1996.\nINCOME TAXES\nThrough affirmative actions the Company continues to aggressively pursue maintaining a low effective tax rate. The actions taken in 1995 include the restructuring of certain legal entities and a general review of overall operations to assure the Company is operating in the most tax efficient manner. The Company anticipates ongoing benefits related to the actions taken.\nThe Company had an income tax provision of $9 million for 1995 compared to an income tax benefit of $33 million for 1994, and an income tax provision of $126 million for 1993. The 1995 provision reflects the Company's continued focus on generating income subject to preferential tax treatment as well as creating organizational structures that optimize tax results. The 1994 benefit reflects an increase in benefits attributable to income subject to preferential tax treatment as compared to that of 1993. The 1993 income tax provision consisted of a provision of $133 million for continuing businesses and a tax benefit of $7 million related to non-core business reserves. During the third quarter of 1993, the statutory U.S. federal income tax rate was increased to 35% from 34%, effective January 1, 1993. The Company's 1993 tax provision includes a one-time benefit of approximately $8 million from the impact of the federal rate change on the Company's net deferred tax assets.\nThe Company's net deferred tax assets increased $25 million to $39 million at November 30, 1995 from $14 million at November 30, 1994. The net increase is primarily attributable to the reversal of certain temporary differences. It is anticipated that the deferred tax assets will be realized through future earnings. The Company had a net deferred tax asset of $14 million at November 30, 1994 as compared to a net deferred tax liability of $36 million at December 31, 1993. The increase in net deferred tax assets is primarily attributable to the reversal of certain temporary differences.\nAs of November 30, 1995, the Company had approximately $25 million of tax net operating losses available to offset future taxable income.\n1993 RESULTS\nBecause of the significant sale transactions completed during 1993, the Company's 1993 financial statements are not fully comparable with 1995 and 1994. In order to facilitate an understanding of the Company's 1993 results, the following table segregates the Company's results between the results of the Lehman Businesses (the results of the businesses that now comprise Lehman Brothers), Businesses Sold (the results of Shearson and SLHMC through their respective sale dates; the loss on the sale of Shearson; and the reserves for non-core businesses) and Discontinued Operations (the results of The Boston Company accounted for as a discontinued operation).\nThe discussion of the 1993 results for the Lehman Businesses has been included in the previous sections discussing revenues, non-interest expenses and taxes. The following section includes a discussion of the Businesses Sold\/Discontinued Operations.\nBUSINESSES SOLD\/DISCONTINUED OPERATIONS\nThis discussion is provided to analyze the results of the Businesses Sold. All 1993 amounts for the Businesses Sold include results through their dates of sale.\nThe Businesses Sold recorded a net loss of $646 million for 1993. The 1993 results include a loss on the sale of Shearson of $630 million and a $79 million charge recorded in the first quarter as a reserve for non-core businesses in anticipation of the sale of SLHMC. The loss on the sale of Shearson included a reduction in goodwill of $750 million and transaction-related costs such as relocation, systems and operations modifications and severance. Excluding the $630 million aftertax loss on the sale, Shearson's net income was $63 million in 1993. Excluding the $79 million aftertax charge discussed above, SLHMC operations were break-even in 1993.\nNet revenues related to the Businesses Sold were $1,751 million for 1993. Excluding the loss on the sale of Shearson and the reserve for non-core businesses related to SLHMC, non-interest expenses of\nthe Businesses Sold were $1,634 million for 1993. Compensation and benefits expense were $1,164 million for 1993.\nThe 1993 tax provision of $108 million for the Businesses Sold included (i) expenses of $54 million related to the operating results of Shearson: (ii) an expense of $95 million from the sale of Shearson and (iii) a tax benefit of $41 million related to the $120 million reserve for non-core businesses recorded in anticipation of the sale of SLHMC. The provision related to the sale of Shearson primarily resulted from the write-off of $750 million of goodwill which was not deductible for tax purposes.\nThe Company reported net income of $189 million from discontinued operations of The Boston Company, including an aftertax gain of $165 million on the sale and aftertax earnings of $24 million. (See Note 18 for further discussion of the Businesses Sold and the Discontinued Operations.)\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's total assets increased to $82.6 billion at November 30, 1995 from $79.1 billion at November 30, 1994. The increase in total assets is primarily the result of the change in the Company's clearing arrangements, partially offset by decreases in other areas. At the close of business on February 17, 1995, the Company became self-clearing for equities, municipal securities and corporate debt instruments. As a result of this arrangement, assets increased at that time by approximately $11 billion which were predominantly funded with offsetting liabilities. The Company's Consolidated Statement of Financial Condition now includes accounts previously cleared, settled and carried by Smith Barney Inc. Principal areas impacted include the Company's stock borrow and lending activities and high-net-worth customer business. The Company has entered into an agreement for a term of five years with the Bear Stearns Securities Corp (\"BSSC\") pursuant to which BSSC has agreed to process the transactions previously cleared by Smith Barney Inc.\nThe Company's balance sheet is highly liquid and consists primarily of cash and cash equivalents, securities and other financial instruments owned which are marked-to-market daily and collateralized short-term financing agreements which arise primarily from the Company's customer flow securities transactions. As the Company's primary activities are based on customer flow, the assets experience a rapid turnover rate. In addition, the highly liquid nature of these assets provides the Company with flexibility in financing and managing its business. At November 30, 1995, short-term assets, those which can be converted to cash in less than one year, represented approximately 99% of the Company's total balance sheet.\nFUNDING AND CAPITAL POLICIES\nHoldings' Global Asset and Liability Committee (\"ALCO\"), which includes senior officers from key areas of the Company, are responsible for establishing and managing the funding and liquidity policies of the Company. This includes recomendations for balance sheet size as well as the allocation of balance sheet to product areas as determined by internal profitability models and return on equity targets.\nThe primary goal of the Company's funding principles as set by ALCO are to provide sufficient liquidity and availability of funding sources throughout all market environments. These funding principles are:\n(i) To maintain an appropriate overall capital structure to support the business activities in which the Company is engaged.\nThe Company manages Total Capital, defined as long-term debt, both senior notes and subordinated indebtedness, plus stockholder's equity, on a business and product level. The determination of the amount of capital assigned to each business and product is a function of asset quality,\nrisk, liquidity and regulatory capital requirements. Periodically, the Company reallocates capital to its businesses based upon their ability to obtain targeted returns, perceived opportunities in the marketplace and the Company's long-term strategy.\n(ii) To maximize the portion of the Company's balance sheet that is funded through collateralized borrowing sources and conversely minimize the use of commercial paper and short-term debt.\nCollateralized borrowing sources include securities and other financial instruments sold but not yet purchased, as well as collateralized short-term financings, defined as securities sold under agreements to repurchase (\"repos\") and securities loaned.\nBecause of their secured nature, repos and other types of collateralized borrowing sources are less credit-sensitive and have historically been a more stable financing source under adverse market conditions. Also, collateralized borrowing sources generally provide the Company with access to lower cost funding. The Company has been able to exceed its goal of maintaining repo funding lines significantly in excess of actual utilization.\n(iii) To minimize refunding risk by funding the Company's assets with liabilities which have maturities similar to the anticipated holding period of the assets.\nThe Company continually reviews its mix of long- and short-term borrowings as it relates to maturity matching and the availability of secured and unsecured financing. In general, long-term assets are financed with fixed rate long-term debt and stockholder's equity and inventories and all other short-term assets are financed with a combination of short-term funding and floating rate long-term debt and stockholder's equity.\n(iv) To diversify and expand the Company's borrowing sources to maximize liquidity and reduce concentration risk. The Company seeks financing from a global investor base with the goal of broadening the availability of its funding sources and maintaining funding availability well in excess of actual utilization. The Company also utilizes a broad range of debt instruments, which it issues in varying maturities and currencies.\nThe Company accesses both commercial paper and other short-term debt instruments, including master notes and bank borrowings under uncommitted lines of credit. To reduce liquidity risk, the Company carefully manages its maturities to avoid large refinancings on any one given day. In addition, the Company limits its exposure to any single investor to avoid concentration risk.\n(v) To maintain sufficient liquidity in a period of financial stress. Financial stress is defined as any event which severely constrains the Company's access to unsecured funding sources.\nThe Company's liquidity contingency plans are continually reviewed and updated as the Company's asset\/liability mix and liquidity requirements change. The Company's liquidity contingency plan is based on an estimate of its ability to meet its funding requirements through a combination of collateralized short-term financings and short-term secured debt, as well as Total Capital.\nTo achieve this objective, the Company's liquidity policies include maintaining sufficient excess unencumbered securities to use as collateral, if necessary, to obtain secured financing to meet maturities of short-term unsecured liabilities as well as current maturities of long-term debt. Also, the Company maintains a sufficient amount of Total Capital to enable the Company to fund those assets which are less liquid. Lastly, the Company periodically tests its secured and unsecured credit facilities to insure availability and operational readiness. The Company believes that these policies position the Company to meet its liquidity requirements in all periods including those of financial stress.\nSHORT-TERM FUNDING\nTo implement the policies as noted above, each business is required to fund its products primarily through global collateralized financings. There are two principal business areas which are responsible for these efforts, Lehman Brothers' Fixed Income Financing (\"Financing\") and Equity Finance. Financing works in conjunction with the institutional fixed income sales and trading professionals to provide financing to customers and the firm through the repurchase markets. Equity Finance provides a similar function in the equity markets typically through securities loaned\/securities borrowed transactions. An ability to leverage their global market expertise and the Company's distribution capabilities are a key to successful financing efforts. The amount of the Company's collateralized borrowing activities will vary reflecting changes in the mix and overall levels of securities and other financial instruments owned and global market conditions. However, at all times, the majority of the Company's assets are funded with collateralized borrowing sources. The Company's Treasury area works closely with Financing and Equity Finance to develop funding plans to support the business areas, as well as to execute daily funding activities. On a daily basis, Treasury is responsible for meeting any funding needs not met through Financing and Equity Finance. Funding through treasury is managed globally with regional centers which have access to the capital markets though the issuance of commercial paper as well as bank lines of credit and other short- and long-term debt instruments.\nAt November 30, 1995 and 1994, $56 billion and $54 billion respectively, of the Company's total balance sheet was financed using collateralized borrowing sources. The remainder of the financing for the balance sheet is comprised of short-term debt, payables and Total Capital.\nIn conjunction with the increase in collateralized short-term financings, as well as the increase in the Company's Total Capital, as discussed below, the Company's use of short-term debt decreased to $1.0 billion at November 30, 1995 from $2.3 billion at November 30, 1994. On November 30, 1995 and 1994, there was no commercial paper outstanding.\nThe Company's uncommitted lines of credit provide an additional source of secured and unsecured short-term financings. At November 30, 1995, the Company had $5.1 billion of uncommitted lines of credit compared to $5.3 billion at November 30, 1994. Uncommitted lines consist of facilities that the Company has been advised are available but for which no contractual lending obligations exists.\nTOTAL CAPITAL\nLong-term assets are financed with Total Capital. The Company maintains Total Capital in excess of its long-term assets to provide additional liquidity, which the Company uses to meet its short-term funding requirements and to reduce its reliance on commercial paper and short-term debt.\nAt November 30, 1995 the Company had $5.5 billion of Total Capital compared to $6.0 billion at November 30, 1994. During 1995, the Company issued $250 million in long-term debt, compared to $1.6 billion for 1994. At November 30, 1995 the Company had long-term debt outstanding of $3.5 billion with an average life of 3.1 years, compared with $3.4 billion with an average life of 3.5 years at November 30, 1994. For debt with a maturity of greater than one year, the average life was 3.5 years at November 30, 1995 compared to 3.7 years at November 30, 1994.\nAt November 30, 1995 the Company had approximately $1.0 billion of debt securities available for issuance under various shelf registrations.\nThe Company's stockholder's equity decreased to $2.0 billion at November 30, 1995 from $2.6 billion at November 30, 1994 primarily due to the payment of $635 million to Holdings by the Company, $559 million as a return of capital and $76 million as dividends, partially offset by net income of $69 million. These distributions were made to Holdings in order to more efficiently utilize the capital of the consolidated group and did not decrease the level of LBI's net capital compared to 1994, as\ndefined by the Net Capital Rules used by its regulators. As a regulated company, LBI is required to maintain a sufficient amount of capital as dictated by the Net Capital Rules. These rules require specific amounts of capital to be maintained by LBI depending on the composition of its assets and the related risk factors.\nAt November 30, 1995 LBI's net capital, as defined by regulatory authorities, aggregated $1,402 million and was $1,301 million in excess of the minimum regulatory requirements. This is a slight increase from the net capital of $1,338 million at November 30, 1994, which was $1,281 million in excess of the minimum regulatory requirements.\nThe Company is subject to certain rules and regulations which limit the amount of capital which can be withdrawn from regulated entities. As of November 30, 1995, the Company is in compliance with all such regulatory capital requirements.\nIn 1996, the Company expects to maintain Total Capital at levels consistent with the amount outstanding at November 30, 1995.\nDEPENDENCE ON CREDIT RATINGS\nThe Company, like other companies in the securities industry, relies on external sources to finance a significant portion of its day-to-day operations. Access to global capital markets for short-term financing, such as commercial paper and short-term debt, senior notes and subordinated indebtedness are dependent on the Company's short- and long-term debt ratings. The current short- and long-term senior and subordinated ratings of the Company are as follows:\n- ------------\n* Provisional ratings on shelf registration\n** Senior\/subordinated\n*** Long-term ratings outlook revised to negative on September 21, 1994\nOn March 21, 1995 Moody's Investors Service Inc. (\"Moody's\") lowered the short-term and long-term subordinated ratings of the Company. However, the long-term senior ratings remained unchanged.\nEND USER ACTIVITIES\nTo achieve certain asset and liability management objectives as set forth by ALCO, the Company utilizes a variety of derivative products as an end user to modify the interest rate characteristics of its long-term debt portfolio and to reduce borrowing costs (see Note 5 to the Consolidated Financial Statements).\nIn addition, the Company also enters into interest rate swap agreements as an end user to modify its interest rate exposure associated with its secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase and securities loaned (see Note 13 to the Consolidated Financial Statements).\nCASH FLOWS. Cash and cash equivalents decreased $74 million in 1995 to $287 million, as the net cash used in financing and investing activities exceeded the net cash provided by operating activities. Net cash provided by operating activities of $2,037 million included income from continuing operations adjusted for non-cash items of approximately $219 million for 1995. Net cash used in financing and investing activities was $2,090 million and $21 million, respectively.\nCash and cash equivalents increased $45 million in 1994 to $361 million, as the net cash provided by financing activities exceeded the net cash used in operating and investing activities. Net cash used in operating activities of $2,422 million included income from continuing operations adjusted for non-cash items of approximately $159 million for 1994. Net cash provided by financing activities was $2,518 million and net cash used in investing activities was $51 million.\nCash and cash equivalents increased $21 million in 1993 to $316 million, as the net cash provided by operating and investing activities exceeded the net cash used in financing activities. In addition, cash and cash equivalents for discontinued operations increased $42 million in 1993. Net cash provided by operating activities of $1,312 million included the loss from continuing operations adjusted for non-cash items of approximately $464 million for 1993. Net cash used in financing activities was $3,784 million in 1993. Net cash provided by investing activities of $2,535 million in 1993 included cash proceeds from the sales of The Boston Company, Shearson and SLHMC of $2,570 million.\nINCENTIVE PLANS. In 1994, to broaden and increase the level of employee ownership in Holdings, the Compensation and Benefits Committee (the \"Compensation Committee\") approved the 1994 Management Ownership Plan (the \"1994 Plan\") pursuant to which it has awarded in 1995 and 1994 approximately 8.0 million and 5.2 million Restricted Stock Units (\"RSUs\"), respectively, to employees as a portion of total compensation in lieu of cash, subject to vesting and transfer restrictions. Included in the 1995 awards are Performance Stock Units (\"PSUs\") granted by the Compensation Committee to members of the Corporate Management Committee as part of a three year long-term incentive award. The number of PSUs which may be earned, if any, is dependent upon the achievement of certain performance levels within a two-year period. At the end of the performance period, any PSUs earned will convert one-for-one to RSUs which then vest at the end of the third year. Holdings will meet the share requirements for the 1994 Plan and other common stock based compensation and benefit plans by either repurchasing shares in the open market or issuing additional common stock or a combination of both.\nOFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES\nOVERVIEW\nDerivatives are financial instruments, which include swaps, options, futures and forwards whose value is based upon an underlying asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A derivative contract may be traded on an exchange or negotiated in the over-the-counter markets. Exchange-traded derivatives are standardized and include futures and certain option contracts listed on an exchange. Over-the-counter (\"OTC\") derivative contracts are individually negotiated between contracting parties and include forwards, swaps and certain options, including caps,\ncollars and floors. The use of derivative financial instruments has expanded significantly over the past decade. One reason for this expansion is that derivatives provide a cost effective alternative for managing market risk. In this regard, derivative contracts provide a reduced funding alternative for managing market risk since derivatives are based upon notional values, which are generally not exchanged, but rather are used merely as a basis for exchanging cash flows during the duration of the contract. Derivatives are also utilized extensively as highly effective tools that enable users to adjust risk profiles, such as interest rate, currency, or other market risks, or to take proprietary trading positions, since OTC derivative instruments can be tailored to meet individual client needs. Additionally, derivatives provide users with access to market risk management tools which are often times unavailable in traditional cash instruments.\nDerivatives are subject to various risks similar to non-derivative financial instruments including market, credit and operational risk. The risks of derivatives should not be viewed in isolation but rather should be considered on an aggregate basis along with the Company's other trading-related activities. A brief description of these risks is included below.\nMARKET RISK. Market risk is the potential for a financial loss due to changes in the value of derivative financial instruments due to market changes. Market risk includes interest rate risk, foreign exchange risk, equity price risk and commodity price risk. Market risk is affected by both the absolute levels and volatility of interest and foreign exchange rates and equity and commodity prices. Market risk is also directly impacted by the size, diversification and duration of positions held, and the liquidity in the markets in which the related underlying assets are traded.\nCREDIT RISK. Credit risk is the possibility that a loss may occur from the failure of a counterparty to perform according to the terms of a contract. Credit risk is a significant factor in the evaluation of OTC derivatives. Credit risk considerations for OTC derivative instruments include assessing the credit quality of the counterparty, length of time to the maturity of the derivative contract, collateral arrangements and the existence of a master netting agreement. At any point in time, the credit risk for OTC derivative contracts is limited to the net unrealized gain for each counterparty for which a master netting agreement exists, net of collateral received. Exchange clearing houses require margin to be posted on exchange-traded contracts on the origination of the contract and for any changes in the market value of open contracts on a daily basis (certain foreign exchanges extend settlement to three days). Due to the daily settlement of variation margin, credit risk related to exchange-traded contracts is limited to unsettled variation and original margin outstanding.\nOPERATIONAL RISK. Operational risk is the possibility of a deficiency in systems for executing derivative transactions. Such risks include the potential for liabilities resulting from one's role in the execution of a derivative transaction in which there was a breakdown in information transfer or settlement systems.\nIn addition to these risks, counterparties to derivative financial instruments may also be exposed to legal risks related to its derivative activities including the possibility that a transaction may be unenforceable under applicable law. The Company may be exposed to the risk that a derivative transaction may not be enforceable against the counterparty. The Company mitigates this risk through a process of carefully reviewing derivative transactions with the counterparties to ensure that they fully understand the economic and legal consequences of entering into a derivative products transaction. In addition, the Company performs its own legal due diligence to ensure that the counterparty has the legal capacity to enter into the derivative product transaction and that the transaction is appropriately documented.\nAs derivative products have continued to expand in volume, so has market participation and competition. As a result, additional liquidity has been added into the markets for conventional derivative products, such as interest rate swaps. Competition has also contributed to the development of more complex products structured for specific clients. It is this rapid growth and complexity of certain derivative products which has led to the perception, by some, that derivative products are unduly risky\nto users and the financial markets. In order to remove the public perception that derivatives may be unduly risky and to ensure ongoing liquidity of derivatives in the marketplace, the Company supports the efforts of the regulators in striving for enhanced risk management disclosures which consider the effects of both derivative products and cash instruments. In addition, the Company supports the activities of regulators which are designed to ensure that users of derivatives are fully aware of the nature of risks inherent within derivative transactions. As evidence of this support, the Company, through its participation as a member of the Derivatives Policy Group, provided leadership in the development of a framework for voluntary industry self regulation of derivatives. The Company has also been actively involved with the various regulatory and accounting authorities in the development of additional enhanced reporting requirements related to derivatives. The Company strongly believes that derivatives provide significant value to the financial markets and is committed to providing its clients with innovative products to meet their financial needs.\nLEHMAN BROTHERS' USE OF DERIVATIVE INSTRUMENTS\nIn the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end user. As an end user, the Company utilizes derivative products to adjust the interest rate nature of its funding sources from fixed to floating interest rates and vice versa, and to change the index upon which floating interest rates are based (i.e., Prime to LIBOR) (collectively, \"End User Derivative Activities\"). For a further discussion of the Company's End User Derivative Activities, see Note 13 to the Consolidated Financial Statements.\nThe Company utilizes derivative products in a trading capacity both as a dealer to satisfy the financial needs of its clients and in each of its trading businesses (collectively, \"Trading Related Derivative Activities\"). The Company's use of derivative products in its trading businesses is combined with cash instruments to fully execute various trading strategies.\nAs a dealer, the Company conducts its activities in fixed income derivative products through its special purpose subsidiary, Lehman Brothers Special Financing Inc., and a separately capitalized triple-A rated subsidiary, Lehman Brothers Financial Products Inc. As a dealer of interest rate swap products, the Company enters into derivative transactions to satisfy the financial needs of its clients who wish to modify the nature of their interest rate risk based upon existing positions or speculate on the direction or volatility of interest rates. These fixed income derivative products include swaps (interest and currency), interest rate option contracts (caps, collars and floors), swap options and similar instruments. In addition, the Company also takes proprietary positions to profit from market movements based upon the Company's expectations regarding the level and volatility of interest rates. The counterparties to the Company's fixed income derivative products business are primarily other swap dealers, commercial banks, insurance companies, corporations and other financial institutions.\nIn addition to these businesses, the Company also enters into derivative transactions in its role as a global investment bank. The Company is a market-maker in a number of foreign currencies. As a market-maker, the Company actively trades currencies in the OTC spot, forward and futures markets and also takes positions in the currency markets in which the Company seeks to profit from pricing inconsistencies in the spot, forward and futures currency markets. The Company also makes a market in foreign currency options and offers clients currency swaps as a means to hedge or speculate in the currency markets on a longer-term basis. The significant majority of the Company's foreign exchange transactions are conducted in major foreign currencies, including: Canadian dollar, Deutsche mark, French franc, British pound sterling, Swiss franc and the Japanese yen. The Company also transacts in a broad range of other foreign currencies, including the currencies of emerging market countries. The counterparties to the Company's OTC foreign exchange transactions primarily include central banks, commercial banks, other investment banks, brokers and dealers and other corporations.\nAs a global investment bank the Company also actively trades in the global commodity markets. The Company is a market-maker in physical metals (base and precious) and is active in trading a\nvariety of derivatives related to these commodities, such as futures, forwards and exchange and OTC options. The counterparties to the Company's commodity derivative transactions primarily include precious metal producers, consumers and refiners, central banks and shipping companies.\nThe Company manages the risks associated with derivatives on an aggregate basis along with the risks associated with its proprietary trading and market-making activities in cash instruments as part of its firmwide risk management policies. For a further discussion of the Company's risk management policies, refer to Management's Discussion and Analysis page 36.\nThe Company's Trading-Related Derivative Activities have increased during the current year to a notional value of $1,139 billion at November 30, 1995 from $1,028 billion at November 30, 1994, primarily as a result of growth in the Company's activities as a dealer in fixed income derivative products. Notional values are not recorded on the balance sheet and are not indicative of potential risk, but rather they provide a measure of the Company's involvement with such instruments.\nAs a result of the Company's Trading-Related Derivative activities, the Company is subject to credit risk. With respect to OTC derivative contracts, the Company's credit exposure is directly with its counterparties and extends through the duration of the derivative contracts. The Company views its net credit exposure to be $3,030 million at November 30, 1995, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral. Collateral held related to OTC contracts generally includes cash and U.S. government and federal agency securities. At November 30, 1995 approximately 87% of the Company's net credit risk exposure related to OTC contracts was with counterparties rated single-A or better.\nAdditionally, the Company is exposed to credit risk related to its exchange-traded derivative contracts. Exchange-traded derivative contracts include futures contracts and certain options. Futures contracts and options on futures are transacted on the respective exchange. The exchange clearing house is a counterparty to the futures contracts and options. As a clearing member firm, the Company is required by the exchange clearing house to deposit cash or other securities as collateral for its obligation upon the origination of the contract and for any daily changes in the market value of open futures contracts. Unlike OTC derivatives which involve numerous counterparties, the number of counterparties from exchange-traded derivatives include only those exchange clearing houses of which the Company is a clearing member firm or utilizes other member firms as agents. Substantially all of the Company's exchange-traded derivatives are transacted on exchanges of which the Company and\/or its affiliates are clearing member firms. To protect against the potential for a default, all exchange clearing houses impose net capital requirements for their membership. Therefore, the potential for losses from exchange-traded products is limited. As of November 30, 1995 the Company had approximately $144 million on deposit with futures exchanges consisting of cash and securities (customer and proprietary), and had posted approximately $242 million of letters of credit. Included within this amount was $94 million and $50 million of cash and securities related to domestic and foreign futures exchanges, respectively, and $152 million and $90 million of letters of credit with domestic exchanges and the London Clearing House, respectively. In addition, the Company had approximately $665 million of cash and securities (customer and proprietary) on deposit with affiliates, acting as the Company's clearing broker related to futures contracts. These deposits primarily relate to futures contracts on foreign exchanges.\nSee Note 13 to the Consolidated Financial Statements for a further discussion of the Company's Trading-Related Derivative Activities.\nSPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS\nThe following sections include information on specific business activities of the Company which affect overall liquidity and capital resources:\nHIGH YIELD SECURITIES. The Company underwrites, trades, invests and makes markets in high yield corporate debt securities. The Company also syndicates, trades and invests in loans to below investment grade companies. For purposes of this discussion, high yield debt securities are defined as securities or loans to companies rated as BB+ or lower, or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans which, in the opinion of management, are non-investment grade. Non-investment grade securities generally involve greater risks than investment grade securities due to the issuer's creditworthiness and the liquidity of the market for such securities. In addition, these issuers have higher levels of indebtedness, resulting in an increased sensitivity to adverse economic conditions. The Company recognizes these risks and aims to reduce market and credit risk through the diversification of its products and counterparties. High yield debt securities are carried at market value and unrealized gains or losses for these securities are reflected in the Company's consolidated statement of operations. The Company's portfolio of such securities at November 30, 1995 and 1994 included long positions with an aggregate market value of approximately $940 million and $624 million, respectively, and short positions with an aggregate market value of approximately $72 million and $71 million, respectively. The portfolio may, from time to time, contain concentrated holdings of selected issues. The Company's largest high yield position was $47 million at November 30, 1995 and $89 million at November 30, 1994.\nWESTINGHOUSE. In May 1993, the Company and Westinghouse Electric Corporation (\"Westinghouse\") entered into a partnership to facilitate the disposition of Westinghouse's commercial real estate portfolio, valued at approximately $1.1 billion, to be accomplished substantially through securitizations, asset sales and mortgage remittances. The Company's original investment in the partnership was approximately $136 million. The Company also advanced approximately $750 million of financing to the partnership in 1993, which has subsequently been repaid in its entirety from proceeds related to the disposition of the real estate assets. In August 1995, the Company agreed to purchase the partnership interests owned by Westinghouse. The Company also entered into an agreement to sell a portion of its partnership interest to an affiliate of Lennar Inc., a third party mortgage servicer, so that the Company and Lennar Inc. would own 75% and 25%, respectively, of the partnership. The Company's net investment in the partnership at November 30, 1995 is $142 million. As a result of its increased ownership percentage, the Company's consolidated financial statements at November 30, 1995 include the accounts of the partnership. The Partnership expects to substantially liquidate the remaining real estate assets by the end of 1996.\nMERCHANT BANKING PARTNERSHIPS. At November 30, 1995 the Company's investment in merchant banking partnerships, for which the Company acts as a general partner, was $80 million. At November 30, 1995 the Company had no remaining commitments to make investments through these partnerships. The Company's policy is to carry its interests in merchant banking partnerships at fair value based upon the Company's assessment of the underlying investments. The Company's merchant banking investments, made primarily through a series of partnerships are consistent with the terms of those partnerships and are expected to be sold or otherwise monetized during the remaining term of the partnerships.\nNON-CORE ACTIVITIES AND INVESTMENTS. In March 1990, the Company discontinued the origination of partnerships (the assets of which are primarily real estate) and investments in real estate. Currently, Holdings and the Company act as general partner for approximately $4 billion of partnership investment capital and manage the remaining real estate investment portfolio. At November 30, 1995 the Company had $32 million of investments in these real estate activities, as well as $28 million of commitments and contingent liabilities under guarantees and credit enhancements, both net of applicable reserves. In certain circumstances, the Company provides financial and other support and assistance to such investments to maintain investment values. There is no contractual requirement that the Company continue to provide this support.\nNon-core activities and investments have declined 42% since November 30, 1994. Management's intention with regard to non-core assets is the prudent liquidation of these investments as and when possible.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"). SFAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. The financial accounting standards of SFAS No. 123 permit companies to either continue accounting for stock-based compensation under existing rules or adopt SFAS No. 123 and begin reflecting the fair value of stock options and other forms of stock-based compensation in the results of operations as additional expense. The disclosure requirements of SFAS No. 123 require companies which elect not to record the fair value in the statement of operations to provide pro forma disclosures of net income and earnings per share in the notes to the consolidated financial statements as if the fair value of stock-based compensation had been recorded. The disclosure requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning after December 15, 1995. Holdings will provide the pro forma disclosures beginning with its 1996 Annual Report and will continue accounting for such plans under the existing accounting rules.\nDuring the first quarter of 1994, the Company adopted Financial Accounting Standards Board Interpretation No. 39, \"Offsetting of Amounts Related to Certain Contracts\" (\"FIN No. 39\"). FIN No. 39 restricts the historical industry practice of offsetting certain receivables and payables. In January 1995, the Financial Accounting Standards Board issued Interpretation No. 41, \"Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements\" (\"FIN No. 41\"). FIN No. 41 is a modification to FIN No. 39, to permit certain limited exceptions to the criteria established under FIN No. 39 for offsetting certain repurchase and reverse repurchase agreements with the same counterparty. The Company has adopted this modification, effective January 1995, which partially mitigates the increase in the Company's gross assets and liabilities resulting from the implementation of FIN No. 39.\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 requires the accrual of obligations associated with services rendered to date for employee benefits accumulated or vested for which payment is probable and can be reasonably estimated. These benefits principally include the continuation of salary, health care and life insurance costs for employees on service disability leaves. The Company previously expensed the cost of these benefits as they were incurred. The cumulative effect of adopting SFAS No. 112 reduced net income for the first quarter of 1994 by $13 million aftertax ($23 million pretax). Excluding the cumulative effect of this accounting change, the effect of this change on the 1994 results of operations was not material.\nEFFECTS OF INFLATION\nBecause the Company's assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects the Company's expenses, such as employee compensation, office space leasing costs and communications charges, which may not be readily recoverable in the price of services offered by the Company. To the extent inflation results in rising interest rates and has other adverse effects upon the securities markets, it may adversely affect the Company's financial position and results of operations in certain businesses.\nRISK MANAGEMENT\nRisk management is an integral part of the Company's business. The Company has established extensive policies and procedures to identify, monitor, assess and manage risk effectively. For a discussion of these policies and procedures, see \"Business--Risk Management.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary financial information required by this Item and included in this Report are listed in the Index to Financial Statements and Schedules appearing on page 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\nPursuant to General Instruction J of Form 10-K, the information required by Item 10 is omitted.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nPursuant to General Instruction J of Form 10-K, the information required by Item 11 is omitted.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPursuant to General Instruction J of Form 10-K, the information required by Item 12 is omitted.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction J of Form 10-K, the information required by Item 13 is omitted.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements:\nSee Index to Financial Statements and Schedules appearing on page.\n2. Financial Statement Schedules:\nSchedules are omitted since they are not required or are not applicable.\n3. Exhibits\n- ------------\n* Filed herewith.\nSIGNATURES\nPursuant to the Requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLEHMAN BROTHERS INC.\n(Registrant)\nFebruary 28, 1996\nBy: \/s\/ Karen M. Muller ..................................\nTitle: Managing 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.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholder of Lehman Brothers Inc.\nWe have audited the accompanying consolidated statement of financial condition of Lehman Brothers Inc. and Subsidiaries (the \"Company\") as of November 30, 1995 and 1994, and the related consolidated statements of operations, changes in stockholder's equity, and cash flows for the year ended November 30, 1995, for the eleven month period ended November 30, 1994 and 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 audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Lehman Brothers Inc. and Subsidiaries at November 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for the year ended November 30, 1995, for the eleven month period ended November 30, 1994 and for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 9 to the consolidated financial statements, in 1994 the Company changed its method of accounting for postemployment benefits.\nERNST & YOUNG LLP\nNew York, New York January 10, 1996\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION\nSee Notes to Consolidated Financial Statements.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION--(CONTINUED)\nSee Notes to Consolidated Financial Statements.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY\nSee Notes to Consolidated Financial Statements.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nLEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS--(CONTINUED)\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) (INCLUDING THE BOSTON COMPANY)\nInterest paid totaled $9,985 in 1995, $5,818 in 1994 and $4,796 in 1993. Income taxes paid totaled $194 in 1995, $33 in 1994 and $265 in 1993.\nSUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITY\nDuring 1993, the Company completed the sale of The Boston Company, Shearson and SLHMC. The cash proceeds related to these sales have been separately reported in the above statement. Excluded from the statement are the individual Statement of Financial Condition changes related to the net assets sold as well as the non-cash proceeds received related to these sales. See Note 18.\nSee Notes to Consolidated Financial Statements.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Lehman Brothers Inc., a registered broker-dealer (\"LBI\") and subsidiaries (LBI together with its subsidiaries, the \"Company\"). LBI is a wholly owned subsidiary of Lehman Brothers Holdings Inc. (\"Holdings\"). LBI is one of the leading global investment banks serving institutional, corporate, government and high-net-worth individual clients and customers. The Company's worldwide headquarters in New York are complemented by offices in additional locations in North America, Europe, the Middle East, Latin and South America and the Asia Pacific region. Holdings provides investment banking and capital markets services in Europe and Asia. The Company is engaged primarily in providing financial services. The Company also operates a commodities trading and sales operation in London. All material intercompany accounts and transactions have been eliminated in consolidation. Prior to May 31, 1994, the American Express Company (\"American Express\") owned 100% of Holdings' common stock (the \"Common Stock\"), which represented approximately 93% of Holdings' voting stock. Effective May 31, 1994, Holdings became a widely held public company with its Common Stock traded on the New York Stock Exchange. (See Note 6.)\nThe Consolidated Statement of Operations includes the results of operations of Shearson and SLHMC which were sold on July 31, 1993 and August 31, 1993, respectively. (See Note 18 for definitions and additional information concerning these sales.)\nThe Company uses the trade date basis of accounting for recording principal transactions.\nCertain prior period amounts reflect reclassifications to conform to the current period's presentation.\nDISCONTINUED OPERATIONS\nAs described in Note 18, the Company completed the sale of The Boston Company, Inc. (\"The Boston Company\"), on May 21, 1993. The accompanying consolidated financial statements and notes to consolidated financial statements reflect The Boston Company as a discontinued operation.\nTRANSLATION OF FOREIGN CURRENCIES\nAssets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at exchange rates at the statement of financial condition date. Revenues and expenses are translated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars, net of hedging gains or losses and related tax effects, are included in a separate component of stockholder's equity, the foreign currency translation adjustment. Gains or losses resulting from foreign currency transactions are included in the Consolidated Statement of Operations.\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. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates.\nSECURITIES AND OTHER FINANCIAL INSTRUMENTS\nSecurities and other financial instruments owned and securities and other financial instruments sold but not yet purchased are valued at market or fair value, as appropriate, with unrealized gains and\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) losses reflected in principal transactions in the Consolidated Statement of Operations. Market value is generally based on listed market prices. If listed market prices are not available, fair value is determined based on other relevant factors, including broker or dealer price quotations, and valuation pricing models which take into account time value and volatility factors underlying the financial instruments.\nDERIVATIVE FINANCIAL INSTRUMENTS\nDerivatives include futures, forwards, swaps and options and other similar instruments. Derivative transactions entered into for market-making or proprietary position taking or used as hedges of other trading instruments are recorded at market or fair value with realized and unrealized gains and losses reflected in principal transactions in the Consolidated Statement of Operations.\nThe market or fair value associated with derivatives utilized for trading purposes is recorded on a net by counterparty basis where a legal right of set-off exists in the Consolidated Statement of Financial Condition. Unrealized gains and losses related to swaps and option contracts are recorded as securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased, as applicable. Unrealized gains and losses related to securities and foreign exchange forwards and commodity contracts are recorded as receivables and payables with brokers, dealers and clearing organizations and customers, as applicable.\nIn addition to trading and market-making activities, the Company enters into various derivative products as an end user to modify the interest rate exposure of certain assets and liabilities. In this regard, the Company utilizes interest rate swaps, caps, collars and floors to manage the interest rate exposure associated with its long-term debt obligations and secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase and securities loaned. In addition to modifying the interest rate exposure of existing assets and liabilities, the Company utilizes derivative instruments as an end user to modify the interest rate characteristics of certain anticipated transactions related to its secured financing activities, where there is a high degree of certainty that the Company will enter into such contracts. Derivatives which have been designated and are effective in modifying the interest rate characteristics of existing assets and liabilities or anticipated transactions are accounted for on an accrual basis.\nThe Company monitors the effectiveness of its end user hedging activities by periodically comparing the change in the value of the hedge instrument to the underlying item being hedged and re-assessing the likelihood of the occurrence of anticipated transactions. In the event that the Company determines that a hedge is no longer effective, such as upon extinguishment of the underlying asset or liability or a change in circumstances whereby there is not a high degree of certainty that the anticipated transaction will occur, the derivative transaction is accounted for at fair value, with changes in the fair value of the derivative contract being recognized in the Consolidated Statement of Operations. In the event that a derivative designated as a hedge is terminated early, any realized gain or loss on termination would be deferred and amortized over the original period of the hedge.\nREPURCHASE AND RESALE AGREEMENTS\nSecurities purchased under agreements to resell and securities sold under agreements to repurchase, which are treated as financing transactions for financial reporting purposes, are collateralized primarily by government and government agency securities and are carried net by counterparty, when permitted, at the amounts at which the securities will be subsequently resold or repurchased plus accrued interest. It is the policy of the Company to take possession of securities purchased under agreements to resell. The Company monitors the market value of the underlying positions on a daily basis as compared to the related receivable or payable balances, including accrued interest. The Company requires counterparties to deposit additional collateral or return collateral pledged as necessary, to ensure that the market value of the underlying collateral remains sufficient. Securities and\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) other financial instruments owned which are sold under repurchase agreements are carried at market value with changes in market value reflected in the Consolidated Statement of Operations.\nSecurities purchased under agreements to resell and Securities sold under agreements to repurchase for which the resale\/repurchase date corresponds to the maturity date of the underlying securities are accounted for as purchases and sales, respectively. At November 30, 1995, such resale and repurchase agreements which have not yet matured aggregated $6.7 billion and $3.1 billion, respectively.\nSECURITIES BORROWED AND LOANED\nSecurities borrowed and securities loaned are carried at the amount of cash collateral advanced or received plus accrued interest. It is the Company's policy to value the securities borrowed and loaned on a daily basis and to obtain additional cash as necessary to ensure such transactions are adequately collateralized.\nINCOME TAXES\nThe Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" The Company recognizes the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws. In this regard, deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for tax loss carryforwards, if in the opinion of management, it is more likely than not that the deferred tax asset will be realized. SFAS 109 requires companies to set up a valuation allowance for that component of net deferred tax assets which does not meet the \"more likely than not\" criterion for realization.\nFIXED ASSETS AND INTANGIBLES\nProperty, equipment, and leasehold improvements are recorded at historical cost, net of accumulated depreciation and amortization. Depreciation is recognized on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the lesser of their economic useful lives or the terms of the underlying leases. The Company capitalizes interest costs during construction and amortizes the interest costs based on the useful lives of the assets.\nExcess of cost over fair value of net assets acquired (goodwill) is amortized using the straight-line method over a period of 35 years. Goodwill is also reduced upon the recognition of certain acquired net operating loss carryforward benefits.\nSTATEMENT OF CASH FLOWS\nThe Company defines cash equivalents as highly liquid investments with original maturities of three months or less, other than those held for sale in the ordinary course of business.\nNOTE 2. CHANGE OF YEAR-END\nDuring 1994, the Company changed its year-end from December 31 to November 30. Such a change to a non-calendar cycle shifts certain year-end administrative activities to a time period that conflicts less with the business needs of the Company's institutional customers.\nNOTE 2. CHANGE OF YEAR-END--(CONTINUED) The following is selected financial data for the eleven month transition period ending November 30, 1994 and the comparable prior year period.\nThe selected financial data for 1993 includes the results of operations of Shearson and SLHMC, which were sold on July 31, 1993 and August 31, 1993, respectively. The Company completed the sale of The Boston Company on May 21, 1993. The above selected financial data for 1993 reflects The Boston Company as a discontinued operation. (See Note 18 for definitions and additional information concerning these sales.)\nNOTE 3. CASH AND SECURITIES SEGREGATED AND ON DEPOSIT FOR REGULATORY AND OTHER PURPOSES\nIn addition to amounts presented in the accompanying Consolidated Statement of Financial Condition as cash and securities segregated and on deposit for regulatory and other purposes, securities with a market value of approximately $320 million and $941 million at November 30, 1995 and 1994, respectively, primarily collateralizing securities purchased under agreements to resell, have been segregated in a special reserve bank account for the exclusive benefit of customers pursuant to the Reserve Formula requirements of the Securities and Exchange Commission (\"SEC\") Rule 15c3-3.\nNOTE 4. SHORT-TERM FINANCINGS\nThe Company obtains short-term financing on both a secured and unsecured basis. The secured financing is obtained through the use of repurchase agreements and securities loaned agreements, which are primarily collateralized by government, agency and equity securities. The unsecured financing is generally obtained through short-term debt and the issuance of commercial paper.\nNOTE 4. SHORT-TERM FINANCINGS--(CONTINUED) The Company's short-term debt is comprised of the following:\nThe Company's weighted average interest rates were as follows:\nNOTE 5. LONG-TERM DEBT\nOf the Company's subordinated debt outstanding as of November 30, 1995, $200 million is repayable prior to maturity at the option of the holder, at par value. These obligations are reflected in the above table as maturing at their put date, of fiscal 1997, rather than at their contractual maturity of fiscal 2003.\nNOTE 5. LONG-TERM DEBT--(CONTINUED) The Company's interest in 3 World Financial Center is financed with U.S. dollar fixed rate senior notes totaling $308 million as of November 30, 1995. These notes are unconditionally guaranteed by American Express with a portion of these notes being collateralized by certain mortgage obligations.\nAs of November 30, 1995, the Company had $1.0 billion available for the issuance of debt securities under various shelf registrations.\nOf the fixed rate senior notes maturing in fiscal 1996, $102 million are an obligation of a subsidiary of LBI and are guaranteed by Holdings.\nEND USER DERIVATIVE ACTIVITIES\nThe Company utilizes interest rate swaps as an end user to modify the interest rate characteristics of its long-term debt portfolio. The Company actively manages the interest rate exposure on its long-term debt portfolio to more closely match the terms of its debt to the assets being funded and to minimize interest rate risk. In certain instances, two or more derivative contracts may be utilized by the Company to manage the interest rate nature of an individual long-term debt issuance. In these cases, the notional value of the derivative contracts may exceed the carrying value of the related long-term debt issuance.\nAt November 30, 1995, the notional values of the Company's interest rate swaps related to its long-term debt obligations were approximately $2.7 billion. In terms of notional amounts outstanding, these derivative products mature as follows:\nDuring 1995, the Company terminated certain swaps which were utilized to modify the interest rate characteristics of the Company's long-term debt issuances. At November 30, 1995, the Company had deferred gains of approximately $7 million related to such terminated contracts which will be amortized to reduce interest expense through fiscal 1997.\nOn an overall basis, the Company's long-term debt related end user derivative activities resulted in reduced interest expense of approximately $29 million, $40 million and $54 million in 1995, 1994 and 1993, respectively. In addition, the Company's end user derivative activities resulted in the following\nNOTE 5. LONG-TERM DEBT--(CONTINUED) changes to the Company's mix of fixed and floating rate debt and effective weighted average rates of interest.\nNOTE 6. HOLDINGS--EQUITY INVESTMENTS AND DISTRIBUTION OF COMMON STOCK\nOn May 31, 1994 all of the shares of common stock of Holdings were distributed (the \"Distribution\") to American Express common shareholders of record on May 20, 1994, as a result of a special dividend declared on April 29, 1994 by the Board of Directors of American Express. Prior to the Distribution, an additional equity investment of approximately $1.25 billion was made in Holdings, most significantly by American Express.\nNOTE 7. INCENTIVE PLANS\n1994 REPLACEMENT PLAN\nThe Lehman Brothers Holdings Inc. 1994 Management Replacement Plan (the \"Replacement Plan\") allowed the Compensation and Benefits Committee (the \"Compensation Committee\") to grant stock options and restricted stock awards to eligible employees. The primary purpose of the Replacement Plan was to provide awards similar to the American Express common shares granted to Company employees which were canceled as of the date of the Distribution. No further awards will be granted under this plan.\nEMPLOYEE STOCK PURCHASE PLAN\nThe Employee Stock Purchase Plan (the \"ESPP\") allows employees to purchase Common Stock at a 15% discount from market value, with a maximum of $15,000 ($25,000 effective on January 1, 1996) in annual aggregate purchases by any one individual. The number of shares of Common Stock authorized for purchase by eligible employees is 6,000,000. As of November 30, 1995 and 1994,\nNOTE 7. INCENTIVE PLANS--(CONTINUED) 663,349 shares and 130,827 shares, respectively, of Common Stock were purchased by eligible employees through the ESPP. The shares were purchased in the open market and thus did not increase Holdings' total shares outstanding.\n1994 MANAGEMENT OWNERSHIP PLAN\nThe Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (the \"1994 Plan\") provides for the Compensation Committee to grant stock options, stock appreciation rights (\"SARs\"), restricted stock units (\"RSUs\"), restricted stock, performance shares and performance stock units (\"PSUs\") for a period of up to ten years to eligible employees. A total of 16,650,000 shares of Common Stock may be subject to awards under the 1994 Plan, including 150,000 shares available as RSUs which may be issued to non-employee Directors. In addition, the 1994 Plan provides that non-employee Directors of Holdings will receive on an annual basis RSUs representing $30,000 of Common Stock, which vest ratably over a three-year period. Vesting provisions for stock options and SARs are at the discretion of the Compensation Committee, but in no case may the term of the award exceed ten years. No individual may receive options or SARs over the life of the 1994 Plan, attributable to more than 1,650,000 shares of Common Stock. Stock options may be awarded as either incentive stock options or non-qualified stock options. The exercise price for any stock option shall not be less than the market price of Common Stock on the day of grant.\nUnder the 1994 Plan, eligible employees received RSUs in 1995 and 1994 as a portion of their total compensation in lieu of cash. There was no further cost to employees and senior officers associated with the RSU awards. In addition, the Compensation Committee may, from time to time, award RSUs to certain senior officers of Holdings and its subsidiaries (the \"Firm\"). The Firm records compensation expense for RSUs based on the market value of Common Stock and the applicable vesting provisions. All of the RSUs awarded to employees vest 80% one year from the date of the grant with the remaining 20% vesting five years from the date of grant. Each RSU outstanding on the respective dates for which 100% vesting occurs will be exchanged for a share of Common Stock. Holdings pays a dividend equivalent on each RSU outstanding based on dividends paid on the Common Stock.\nOn October 25, 1995, Holdings granted 1,125,000 options to members of the Corporate Management Committee (\"CMC\") at the market price of the Common Stock on that date ($20.875) (the \"1995 Options\"). The 1995 Options become exercisable in four and one half years; exercisability is accelerated ratably in one-third increments at such time as the closing price of Holdings' Common Stock meets, or exceeds, $26.00, $28.00 and $30.00 for 30 consecutive trading days. If a minimum target price is not reached and maintained for the specified period on or before April 24, 2000, the award recipients may then exercise all of their options beginning April 25, 2000. Other than the 1995 Options, all options awarded under the 1994 Plan become exercisable in one-third increments ratably in the three years following grant date. No compensation expense has been recognized for Holdings' stock options as all have been issued at the market price of the Common Stock on the date of the respective grant.\nThe Compensation Committee also awarded PSUs to members of the CMC during 1995 as part of a three-year long term incentive award. The number of PSUs which may be earned, if any, is dependent upon achievement of certain performance levels within a two-year period. At the end of the performance period, any PSUs earned will convert one-for-one to RSUs which then vest at the end of the third year. The compensation cost for the estimated number of RSUs that may eventually become payable in satisfaction of PSUs is accrued over the three-year performance and vesting period and added to common stock issuable.\nNOTE 7. INCENTIVE PLANS--(CONTINUED) EMPLOYEE INCENTIVE PLAN\nDuring 1995, the Board of Directors of Holdings adopted the Employee Incentive Plan (\"EIP\"), which has provisions similar to the 1994 Plan, and under which up to 5 million shares may be awarded to eligible employees. During 1995, approximately 2 million RSUs were awarded to new hires as part of the Company's recruitment efforts. In addition, Holdings granted PSUs and 1.4 million options to certain senior officers which have provisions similar to the PSUs and 1995 Options granted under the 1994 Plan. Holdings will fund these awards over time with purchases of Common Stock in the open market and thus will not increase total shares outstanding.\nThe following is a summary of stock awards issued and outstanding under Holdings' stock based compensation plans:\nRESTRICTED STOCK\nRESTRICTED STOCK UNITS\nOf the RSUs issued and outstanding at November 30, 1995, approximately 4.2 million RSUs vested on July 1, 1995, approximately 5.6 million RSUs will vest on July 1, 1996, and the remaining will vest July 1, 1997 to July 1, 2000.\nNOTE 7. INCENTIVE PLANS--(CONTINUED) STOCK OPTIONS\nAt November 30, 1995, approximately 2.1 million options are currently exercisable at a price of $18.00.\nAs of December 31, 1995, the Compensation Committee awarded RSUs to members of the CMC under the 1994 Plan based on performance goals satisfied for the period from January 1, 1995 through December 31, 1995. An annual RSU award also was made to employees in the Company's high-net-worth sales force. Approximately 500,000 RSUs, not included in the preceding RSU summary, were added to common stock issuable at November 30, 1995 for these awards.\nNOTE 8. CAPITAL REQUIREMENTS\nAs a registered broker-dealer, LBI is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At November 30, 1995, LBI's regulatory net capital, as defined, of $1,402 million exceeded the minimum requirement by $1,301 million. On August 31, 1995, Lehman Government Securities Inc., a wholly owned subsidiary of LBI and a registered broker-dealer, was merged into LBI.\nRepayment of subordinated indebtedness and certain advances and dividend payments by LBI are restricted by the regulations of the SEC and other regulatory agencies. In addition, certain instruments governing the indebtedness of LBI contractually limit its ability to pay dividends. At November 30, 1995, $1,414 million of net assets of the Company were restricted as to the payment of dividends.\nNOTE 9. CHANGES IN ACCOUNTING PRINCIPLES\nACCOUNTING FOR POSTEMPLOYMENT BENEFITS\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 requires the accrual of obligations associated with services rendered to date for employee benefits accumulated or vested for which payment is probable and can be reasonably estimated. These benefits principally include the continuation of salary, health care and life insurance costs for employees on service disability leaves. The Company previously expensed the cost of these benefits as they were incurred.\nThe cumulative effect of adopting SFAS No. 112 reduced net income for the first quarter of 1994 by $13 million aftertax ($23 million pretax). The effect of this accounting change on the 1994 results of operations was not material, excluding the cumulative effect.\nOFFSETTING OF CERTAIN RECEIVABLES AND PAYABLES\nDuring the first quarter of 1994, the Company adopted the Financial Accounting Standards Board Interpretation No. 39, \"Offsetting of Amounts Related to Certain Contracts\" (\"FIN No. 39\"). FIN No. 39 restricts the historical industry practice of offsetting certain receivables and payables. In January 1995, the Financial Accounting Standards Board issued Interpretation No. 41, \"Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements\" (\"FIN No. 41\"). FIN No. 41 is a modification to FIN No. 39 to permit certain limited exceptions to the criteria established under FIN No. 39 for offsetting certain repurchase and reverse repurchase agreements with the same counterparty. The Company has adopted this modification, effective January 1995, which partially mitigates the increase in the Company's gross assets and liabilities resulting from the implementation of FIN No. 39.\nNOTE 10. PENSION PLANS\nThe Company participates in several noncontributory defined benefit pension plans sponsored by Holdings. The cost of pension benefits for eligible employees, measured by length of service, compensation and other factors, is currently being funded through trusts established under the plans. Funding of retirement costs for the applicable plans complies with the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974, as amended.\nNOTE 10. PENSION PLANS--(CONTINUED) Total (income) expense related to pension benefits for 1995, 1994 and 1993 consisted of the following components:\nPlan assets within the trusts consist principally of equities and bonds. The actual returns on plan assets for 1995 and 1993 reflect a favorable market environment in those years. In addition, Company contributions increased assets under investment in 1995. Adverse market conditions in 1994 were the principal reason for the lower return earned in that year.\nThe following table sets forth the funded status of Holdings' domestic defined benefit plans:\nThe weighted average assumed discount rate used in determining the actuarial present value of the projected benefit obligation for the plans was 7.25% and 8.5% in 1995 and 1994, respectively. The weighted average rate of increase in future compensation levels used was 5.0% and 5.5% in 1995 and 1994, respectively. The weighted average expected long-term rate of return on assets was 9.75% in 1995, 1994 and 1993.\nDuring 1993, the Company incurred a settlement and curtailment with respect to its domestic pension plan in relation to the Primerica Transaction. The net gain of approximately $26 million pretax was included in the loss on the sale of Shearson. (See Note 18 for definitions and additional information concerning this sale.)\nNOTE 11. POSTRETIREMENT BENEFITS\nThe Company participates in several defined benefit health care plans sponsored by Holdings that provide health care, life insurance and other postretirement benefits to substantially all eligible retired employees. The health care plans include participant contributions, deductibles, co-insurance provisions\nNOTE 11. POSTRETIREMENT BENEFITS--(CONTINUED) and service-related eligibility requirements. The Company funds the cost of these benefits as they are incurred.\nNet periodic postretirement benefits cost for 1995, 1994, and 1993 consisted of the following components:\nDuring 1993, the Company incurred a curtailment with respect to its postretirement plan, in relation to the Primerica Transaction. The net gain of approximately $56 million pretax was included in the loss on the sale of Shearson. (See Note 18 for definitions and additional information concerning this sale.)\nThe following table sets forth the amount recognized in the Consolidated Statement of Financial Condition for the Company's postretirement benefit obligation (other than pension plans):\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7.25% and 8.5% in 1995 and 1994, respectively.\nThe annual assumed health care cost trend rate is 11% for the year ended November 30, 1996 and is assumed to decrease at the rate of 1% per year to 6% in the year ended November 30, 2001 and remain at that level thereafter. An increase in the assumed health care cost trend rate by one percentage point in each period would increase the accumulated postretirement benefit obligation as of November 30, 1995 by approximately $1 million.\nNOTE 12. INCOME TAXES\nFor tax filings subsequent to the spin-off from American Express, commencing with the period June 1, 1994 to December 31, 1994, the Company will file a consolidated U.S. federal income tax return with Holdings reflecting the income of Holdings and its subsidiaries. For the period prior to the spin-off, the income of Holdings was included in the American Express consolidated U.S. federal income tax return, as it had been since August of 1990. The income tax provision for the Company is computed in accordance with the income tax allocation agreement among Holdings and its subsidiaries.\nNOTE 12. INCOME TAXES--(CONTINUED) With respect to the period in which the Company was included in the American Express consolidated U.S. federal income tax return, intercompany taxes are remitted to, or from, American Express when they are otherwise due to or from the relevant taxing authority. The balances due to Holdings at November 30, 1995 and November 30, 1994 were $9 million and $226 million, respectively.\nThe provision for (benefit from) income taxes from continuing operations consists of the following:\nDuring the third quarter of 1993, the statutory U.S. federal income tax rate was increased to 35% from 34%, effective January 1, 1993. The Company's 1993 tax provision includes a one-time benefit of approximately $8 million from the impact of the rate change on the Company's net deferred tax assets as of January 1, 1993.\nIncome from continuing operations before taxes included $24 million, $79 million and $41 million that is subject to income taxes of foreign jurisdictions for 1995, 1994 and 1993, respectively.\nThe income tax provision (benefit) differs from that computed by using the statutory federal income tax rate for the reasons shown below:\nDeferred income tax assets and liabilities result from the recognition of temporary differences. Temporary differences are differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements that will result in differences between income for tax purposes and income for consolidated financial statement purposes in future years.\nNOTE 12. INCOME TAXES--(CONTINUED) At November 30, 1995 and 1994, the Company's net deferred tax assets from continuing operations consisted of the following:\nThe net deferred tax assets increased by $25 million to $39 million at November 30, 1995. The net increase is primarily attributable to the reversal of certain temporary differences. At November 30, 1995 and 1994 the deferred tax assets and liabilities consist primarily of reserves not yet deducted for tax purposes of $30 million and $99 million, respectively, and unrealized gains related to trading and investment activities of $33 million and $11 million, respectively. In addition, in accordance with the tax sharing agreement with Holdings, the Company was reimbursed for $238 million and $345 million of net deferred tax assets as of November 30, 1995 and November 30, 1994, respectively.\nThe net deferred tax assets are included in deferred expenses and other assets in the accompanying Consolidated Statement of Financial Condition. At November 30, 1995, the valuation allowance recorded against deferred tax assets from continuing operations was $26 million as compared to $97 million at November 30, 1994, of which approximately $2 million and $59 million, respectively, will reduce goodwill if future circumstances permit recognition. The decrease in the valuation allowance primarily relates to the write-off of certain net operating losses (\"NOLs\") that no longer meet the asset recognition criteria under SFAS 109. The decrease had no impact on the Company's profit and loss since it was associated with a corresponding decrease in gross assets.\nFor tax return purposes, the Company has approximately $25 million of NOL carryforwards, substantially all of which are attributable to the 1988 acquisition of E.F. Hutton Group Inc. (now known as LB I Group Inc.) Substantially, all of the NOLs are scheduled to expire in the years 1999 through 2009.\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS\nDerivatives are financial instruments whose value is based upon an underlying asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). Over-the-counter (\"OTC\") derivative products are privately negotiated contractual agreements that can be tailored to meet individual client needs and include forwards, swaps and certain options including caps, collars and floors. Exchange-traded derivative products are standardized contracts transacted through regulated exchanges and include futures and certain option contracts listed on an exchange.\nIn the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end user. Acting in a trading capacity, the Company enters into derivative transactions to satisfy the needs of its clients and to manage the Company's own exposure to market and credit risks resulting from its trading activities in cash instruments (collectively, \"Trading-Related Derivative Activities\"). As an end user, the Company primarily enters into interest rate swap and option contracts to adjust the interest rate nature of its funding sources from fixed to floating rates and vice versa, and to change the index upon which floating interest rates are based (i.e., Prime to LIBOR) (collectively, \"End User Derivative Activities\").\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED) There is an extensive volume of derivative products available in the marketplace which can vary from a simple forward foreign exchange contract to a complex derivative instrument with multiple risk characteristics involving the aggregation of the risk characteristics of a number of derivative product types including swap products, options, futures and forwards. Listed below are examples of various derivative products types along with a brief discussion of the performance mechanics of certain specific derivative instruments.\nSWAP PRODUCTS\nInterest rate swap products include interest rate and currency swaps, leveraged swaps, swap options, and other interest rate option products including caps, collars, and floors. An interest rate swap is a negotiated OTC contract in which two parties agree to exchange periodic interest payments for a defined period, calculated based upon a predetermined notional amount. Interest payments are usually exchanged on a net basis throughout the duration of the swap contract. A currency swap is an OTC agreement to exchange a fixed amount of one currency for a specified amount of a second currency at the outset and completion of the swap term. Leveraged swaps involve the multiplication of the interest rate factor upon which the interest payment streams are based (i.e., Party A pays 3 times six month LIBOR). Caps are contractual commitments that require the writer to pay the purchaser the amount by which an interest reference rate exceeds a defined contractual rate, if any, at specified times during the contract. Conversely, a floor is a contractual commitment that requires the writer to pay the amount by which a defined contractual rate exceeds an interest reference rate at specified times over the life of the contract, if any.\nEquity swaps are contractual agreements whereby one party agrees to receive the appreciation (or depreciation) value over a strike price on an equity investment in return for paying another rate, which is usually based upon equity index movements or interest rates. Commodity swaps are contractual commitments to exchange the fixed price of a commodity for a floating price (which is usually the prevailing spot price) throughout the swap term.\nOPTIONS\nOption contracts provide the option purchaser (holder) with the right but not the obligation to buy or sell a financial instrument, commodity or currency at a predetermined exercise price (strike price) during a defined period (American Option) or at a specified date (European Option). The option purchaser pays a premium to the option seller (writer) for the right to exercise the option. The option seller is obligated to buy (call) or sell (put) the item underlying the contract at a set price, if the option purchaser chooses to exercise. Option contracts also exist for various indices and are similar to options on a security or other instrument except that, rather than settling physical with delivery of the underlying instrument, they are cash settled. As a purchaser of an option contract, the Company is subject to credit risk but is not subject to market risk, since the counterparty is obligated to make payments under the terms of the option contract if the Company exercises the option. As the writer of an option contract, the Company is not subject to credit risk but is subject to market risk, since the Company is obligated to make payments under the terms of the option contract if exercised.\nOption contracts may be exchange-traded or OTC. Exchange-traded options are the obligations of the exchange and generally have standardized terms and performance mechanics. In contrast, all of the terms of an OTC option including the method of settlement, term, strike price, premium, and security are determined by negotiation of the parties.\nFUTURES AND FORWARDS\nFutures contracts are exchange-traded contractual commitments to either receive (purchase) or deliver (sell) a standard amount or value of a financial instrument or commodity at a specified future\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED) date and price. Maintaining a futures contract requires the Company to deposit with the exchange, as security for its obligation (original margin), an amount of cash or other specified asset. Additionally, futures exchanges generally require the daily cash settlement of unrealized gains\/losses on open contracts with the futures exchange. Therefore, futures contracts provide a reduced funding alternative to purchasing the underlying cash position in the marketplace. Futures contracts may be settled by physical delivery of the underlying asset or cash settlement (for index futures) on the settlement date or by entering into an offsetting futures contract with the futures exchange prior to the settlement date.\nForwards are OTC contractual commitments to purchase or sell a specified amount of a financial instrument, foreign currency or commodity at a future date at a predetermined price. TBA's are forward contracts which give the purchaser\/seller an obligation to obtain\/deliver mortgage securities in the future. Therefore, TBA's subject the holder to both interest rate risk and principal prepayment risk.\nTRADING-RELATED DERIVATIVE ACTIVITIES\nDerivatives are subject to various risks similar to other financial instruments including market, credit and operational risk. In addition, the Company may also be exposed to legal risks related to its derivative activities including the possibility that a transaction may be unenforceable under applicable law. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with the Company's other trading-related activities. The Company manages the risks associated with derivatives on an aggregate basis along with the risks associated with its proprietary trading and market-making activities in cash instruments as part of its firmwide risk management policies.\nDerivatives are generally based upon notional values. Notional values are not recorded on-balance-sheet, but rather are utilized solely as a basis for determining future cash flows to be exchanged. Therefore, notional amounts provide a measure of the Company's involvement with such instruments, but are not indicative of potential risk.\nThe following table reflects the notional\/contract value of the Company's Trading-Related Derivative Activities.\nTRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED) Approximately $326 billion and $269 billion of these contracts relate to foreign exchange transactions at November 30, 1995 and 1994, respectively. Approximately $636 billion of the notional\/contract value of the Company's Trading-Related Derivative Activities mature within the year ended November 30, 1996, of which approximately 43% have maturities of less than one month.\nThe Company records its Trading-Related Derivative Activities on a mark-to-market basis with realized and unrealized gains (losses) recognized currently in principal transactions. The Company currently records unrealized gains and losses on derivative contracts on a net basis in the Consolidated Statement of Financial Condition for those transactions with counterparties executed under a legally enforceable master netting agreement. While the Company may utilize derivative products in all its businesses, the Company views its derivative product revenues as the revenues earned from the Company's fixed income derivative product business, foreign exchange derivatives and metals. Principal transactions revenues related to the fixed income derivative product business were $219 million for 1995, $354 million for 1994 and $230 million for 1993. Principal transactions revenues related to foreign exchange derivatives and metals were $42 million for 1995, $54 million for 1994 and $88 million for 1993.\nListed in the following table is the fair value of the Company's Trading-Related Derivative Activities as of November 30, 1995 and 1994 as well as the average fair value of these instruments. Average fair values of these instruments were calculated based upon month-end statement of financial condition values,which the Company believes does not vary significantly from the average fair value calculated on a more frequent basis. Variances between average fair values and period-end values are due to changes in the volume of activities in these instruments and changes in the valuation of these instruments due to changes in market and credit conditions.\nFAIR VALUE OF TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS\n- ------------\n(1) Fair values of futures contracts represent the unsettled net receivable or payable amount due to\/from various future exchanges on open futures contracts.\nAssets included in the table above represent the Company's unrealized gains, net of unrealized losses for situations in which the Company has a master netting agreement. Similarly, liabilities represent net amounts owed to counterparties. Therefore, the fair value of assets related to derivative contracts at November 30, 1995 represents the Company's net receivable for derivative financial instruments before consideration of collateral. Included within this amount was $3,794 million and $79 million, respectively, related to OTC and exchange-traded contracts.\nThe primary difference in risks related to OTC and exchange-traded contracts is credit risk. OTC contracts contain credit risk for unrealized gains from various counterparties, net of collateral. Exchange-traded contracts are transacted directly on the respective exchanges. The exchange clearing house requires its counterparties to post margin upon the origination of the contract and for any changes in the market value of the contract on a daily basis (certain foreign exchanges extend settlement to three days).\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)\nWith respect to OTC instruments, the Company views its net credit exposure to be $3,030 million at November 30, 1995, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral of $764 million.\nCounterparties to the Company's OTC derivative products are primarily financial intermediaries (U.S. and foreign banks), securities firms, corporations, governments and their agencies, finance companies, insurance companies, investment companies, pension funds and consumers and producers of metals products. Collateral held related to OTC contracts generally includes cash and U.S. government and federal agency securities. Presented below is an analysis of the Company's net credit exposure for OTC contracts based upon internal designations of counterparty credit quality.\nThese designations are based on actual ratings made by external rating agencies or by equivalent ratings established and utilized by the Company's Corporate Credit Department.\nWith respect to exchange-traded derivative instruments, the fair value of assets reflects the unsettled variation margin due from futures exchanges as well as the fair value of exchange-listed purchased options. Foreign futures exchanges, consistent with their domestic counterparts, require cash or other securities to be deposited with the exchange as collateral for open contracts.\nEND USER DERIVATIVE ACTIVITIES\nThe Company utilizes interest rate swaps as an end user to modify the interest rate characteristics of its long-term debt portfolio. The Company actively manages the interest rate exposure on its long-term debt portfolio to more closely match the terms of its debt portfolio to the assets being funded and to minimize interest rate risk. At November 30, 1995 and November 30, 1994 the notional value of the Company's interest rate swaps related to its long-term debt obligations were approximately $2.7 billion and $3.8 billion, respectively. (For a further discussion of the Company's long-term debt related end user activities see Note 5.)\nThe Company also enters into interest rate swap agreements as an end user to modify its interest rate exposure associated with its secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase and securities loaned. At November 30, 1995 and 1994, the Company had $87 billion and $83 billion, respectively, of such secured financing activities. As with the Company's long-term debt, its secured financing activities expose the Company to interest rate risk. The Company, as an end user, manages the interest rate risk related to these activities by entering into derivative financial instruments, including interest rate swaps and purchased options. The Company designates certain specific derivative transactions against specific assets and liabilities with matching maturities. In addition, the Company manages the interest rate risk of anticipated secured financing transactions with derivative products. These derivative products are designated against the existing secured financing transactions for their applicable maturity. The remaining term of these transactions are designated against the anticipated secured financing transactions which will replace the existing secured financing transactions at their maturity. The Company continuously monitors the level of secured financing transactions to ensure that there is a high degree of\nNOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED) certainty that the Company will enter into the anticipated secured financing transactions at a level in excess of the designated derivative product transactions. At November 30, 1995 and November 30, 1994, the Company, as an end user, utilized derivative financial instruments with an aggregate notional amount of $21.5 billion and $32.3 billion, respectively, to modify the interest rate characteristics of its secured financing activities. The total notional value of these agreements had a weighted average maturity of 1.1 years and 1.2 years as of November 30, 1995 and November 30, 1994, respectively.\nDuring 1995, the Company terminated certain swaps designated as hedges of the Company's secured financing activities. At November 30, 1995, a loss of approximately $16 million from these terminated contracts was deferred and will be amortized to interest expense in 1996. On an overall basis, the Company's secured financing end user activities increased net interest income by approximately $39 million and $6 million for 1995 and 1994, respectively.\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS No. 107 \"Disclosures about Fair Value of Financial Instruments\" requires the disclosure of the fair value of on- and off-balance sheet financial instruments, both assets and liabilities, for which it is practicable to estimate fair value. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. The fair values of financial instruments are estimates based upon market conditions and perceived risks as of the statement of financial condition date and require varying degrees of management judgment. Quoted market prices, when available, are used as the measure of fair value. In cases where quoted market prices are not available, fair values are based on quotations of similarly traded instruments and pricing models. Pricing models which consider time value, volatility factors, the current market and contractual prices of the underlying financial instrument are used to value derivatives and other contractual agreements. The disclosure requirements of SFAS No. 107 exclude certain financial instruments such as employee benefit obligations and all non-financial instruments such as fixed assets and goodwill.\nAll of the Company's financial instruments are carried at fair value or contractual values which approximate fair value, with the exception of long-term debt, certain secured financing activities and the related financial instruments utilized by the Company as an end user to manage the interest rate risk of these portfolios. Assets and liabilities which are carried at fair value include securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased. Assets and liabilities, which are recorded at contractual amounts that approximate market or fair value, include cash and cash equivalents, cash and securities segregated and on deposit for regulatory and other purposes, receivables, certain other assets and deferred expenses, commercial paper and short-term debt, and payables.\nThe Company's long-term debt is recorded at contractual or historical amounts that do not necessarily approximate market or fair value. For fair value purposes, the carrying value of variable rate long-term debt that reprices within one year and fixed rate long-term debt which matures in less than six months is considered to approximate fair value. For the remaining long-term debt portfolio, fair value is estimated using either quoted market prices or discounted cash flow analyses based on the Company's current borrowing rates for similar types of borrowing arrangements. The Company utilizes derivative financial instruments as an end user to convert the interest rate basis for its long-term debt from fixed or floating to another basis. The unrecognized net gains\/(losses) related to these end user activities reflect the estimated amounts the Company would receive\/pay if the agreements were\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS--(CONTINUED) terminated based on market rates at November 30, 1995 and 1994, respectively. The following is a summary of the fair value of the Company's long-term debt and related end user activities:\nThe Company carries its secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase and securities loaned, at their original contract amount plus accrued interest, which for the majority of such financing activities is an approximation of fair value. At November 30, 1995 and 1994, the Company had $87 billion and $83 billion, respectively, of such secured financing activities. As with the Company's long-term debt, its secured financing activities expose the Company to interest rate risk.\nAt November 30, 1995 and 1994, the Company, as an end user, utilized derivative financial instruments with an aggregate notional amount of $21.5 billion and $32.3 billion, respectively, to modify the interest rate characteristics of its secured financing activities. The unrecognized net losses related to these derivative financial instruments of $36 million and $110 million at November 30, 1995 and 1994, respectively, were offset by unrecognized net gains arising from the Company's secured financing activities.\nNOTE 15. OTHER COMMITMENTS AND CONTINGENCIES\nAs of November 30, 1995 and 1994, the Company was contingently liable for $721 million and $675 million, respectively, of letters of credit, primarily used to provide collateral for securities and commodities borrowed and to satisfy margin deposits at option and commodity exchanges, and other guarantees.\nThe Company has commitments under certain secured lending arrangements of approximately $1.6 billion at November 30, 1995. These commitments require borrowers to provide acceptable collateral, as defined in the agreements, when amounts are drawn under the lending facilities. Advances under the above lending arrangements are typically at variable interest rates and generally provide for over-collateralization based upon the borrowers' creditworthiness.\nAs of November 30, 1995 and 1994, the Company had pledged or otherwise transferred securities, primarily fixed income, having a market value of $23.2 billion and $15.2 billion, respectively, as collateral for securities borrowed or otherwise received having a market value of $23.1 billion and $15.1 billion, respectively.\nSecurities and other financial instruments sold but not yet purchased represent obligations of the Company to purchase the securities at prevailing market prices. Therefore, the future satisfaction of such obligations may be for an amount greater or less than the amount recorded. The ultimate gain or loss is dependent upon the price at which the underlying financial instrument is purchased to settle its obligation under the sale commitment.\nIn addition, the Company's customer activities may expose it to off-balance-sheet credit and market risk. These risks may arise in the normal course of business as a result of executing, financing and settling various customer security and commodity transactions. Off-balance-sheet risk arises from the potential that customers or counterparties fail to satisfy their obligations and that the collateral\nNOTE 15. OTHER COMMITMENTS AND CONTINGENCIES--(CONTINUED) obtained is insufficient. In such instances, the Company may be required to purchase or sell financial instruments at unfavorable market prices. The Company seeks to control these risks by obtaining margin balances and other collateral in accordance with regulatory and internal guidelines.\nSubsidiaries of the Company, as general partner, are contingently liable for the obligations of certain public and private limited partnerships organized as pooled investment funds or engaged primarily in real estate activities. In the opinion of the Company, contingent liabilities, if any, for the obligations of such partnerships will not in the aggregate have a material adverse effect on the Company's consolidated financial position or results of operations.\nIn the normal course of its business, the Company has been named a defendant in a number of lawsuits and other legal proceedings. After considering all relevant facts, available insurance coverage and the advice of outside counsel, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company's consolidated financial position or results of operations.\nCONCENTRATIONS OF CREDIT RISK\nAs a major international securities firm, the Company is actively involved in securities underwriting, brokerage, distribution and trading. These and other related services are provided on a worldwide basis to a large and diversified group of clients and customers, including multinational corporations, governments, emerging growth companies, financial institutions and individual investors.\nA substantial portion of the Company's securities and commodities transactions is collateralized and is executed with, and on behalf of, commercial banks and other institutional investors, including other brokers and dealers. The Company's exposure to credit risk associated with the non-performance of these customers and counterparties in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile or illiquid trading markets, which may impair the ability of customers and counterparties to satisfy their obligations to the Company.\nSecurities and other financial instruments owned by the Company include U.S. government and agency securities, and securities issued by non-U.S. governments which, in the aggregate, represented 17% of the Company's total assets at November 30, 1995. In addition, substantially all of the collateral held by the Company for resale agreements or securities borrowed, which together represented 52% of total assets at November 30, 1995, consisted of securities issued by the U.S. government, federal agencies or non-U.S. governments. In addition to these specific exposures, the Company's most significant concentration is financial institutions, which include other brokers and dealers, commercial banks and institutional clients. This concentration arises in the normal course of the Company's business.\nLEASE COMMITMENTS\nThe Company leases office space and equipment throughout the world and has entered into a ground lease with the Battery Park City Authority covering its headquarters at 3 World Financial Center which extends through 2069. Total rent expense for 1995, 1994 and 1993 was $31 million, $34 million and $85 million, respectively. Certain leases on office space contain escalation clauses providing for additional rentals based upon maintenance, utility and tax increases.\nNOTE 15. OTHER COMMITMENTS AND CONTINGENCIES--(CONTINUED) Minimum future rental commitments under noncancellable operating leases (net of subleases of $589 million) are as follows:\nThe minimum future rental commitments shown above include lease obligations related to facilities which the Company intends to vacate and sublease in future periods, before consideration of the Company's fourth quarter restructuring charge. (See Note 17.)\nNOTE 16. RELATED PARTY TRANSACTIONS\nIn the normal course of business, the Company engages in various securities trading, investment banking and financing activities with Holdings and many of its subsidiaries (the \"Related Parties\"). Various charges, such as compensation, occupancy, administration and computer processing are allocated between the Related Parties, based upon specific identification and allocation methods.\nIn addition, Holdings and subsidiaries of Holdings raise money through short- and long-term funding in the capital markets, which is used to fund the operations of certain of the Company's wholly owned subsidiaries. Advances from Holdings and other affiliates were $8,418 million and $8,807 million at November 30, 1995 and 1994, respectively.\nIn connection therewith, advances from Holdings aggregating approximately $7.4 billion and $7.1 billion at November 30, 1995 and 1994, respectively, are generally payable on demand. The average interest rate charged on these advances is primarily based on Holdings' average daily cost of funds, which was 6.5% for the twelve months ended November 30, 1995 and 4.8% for the eleven months ended November 30, 1994. In addition, the Company had borrowings from subsidiaries of Holdings comprised of approximately $821 million in subordinated indebtedness. Interest charges incurred during the twelve months ended November 30, 1995, the eleven months ended November 30, 1994 and the twelve months ended December 31, 1993 from Holdings, including interest charges on subordinated and senior debt issued to Holdings, amounted to $483 million, $277 million and $227 million, respectively. In addition, the Company has advances from other subsidiaries of Holdings aggregating approximately $1.0 billion and $1.7 billion, at November 30, 1995 and 1994, respectively, with various repayment terms. The Company had notes and other receivables due from Holdings and subsidiaries of Holdings aggregating approximately $2.1 billion and $3.4 billion at November 30, 1995 and 1994, respectively, with various repayment terms.\nDuring the third quarter of 1994, Holdings acquired additional space in the World Financial Center and also began occupying its leased facility at 101 Hudson Street in Jersey City, New Jersey. In addition, certain employees of the Company who perform administrative and corporate functions were transferred to Holdings. Accordingly, Holdings has allocated the cost of these new facilities and services provided by employees transferred to its appropriate subsidiaries. These charges, which are classified in the Consolidated Statement of Operations as Management fees, are primarily comprised of compensation, occupancy and computer processing. The result of these allocations was to reduce expenses incurred directly by the Company in previous periods with an offsetting increase in Management fees.\nNOTE 16. RELATED PARTY TRANSACTIONS--(CONTINUED) The Company believes that amounts arising through related party transactions, including those allocated expenses referred to above, are reasonable and approximate the amounts that would have been recorded if the Company operated as an unaffiliated entity.\nLBI Group (\"Group\"), a wholly owned subsidiary of the Company had outstanding 1,000 shares of its 9% Cumulative Preferred Stock, Series A (the \"Preferred Stock\"), which it issued for an aggregate purchase price of $750,000,000 to LB Funding Corp. (\"Funding\"), a wholly owned subsidiary of Holdings for $1,000 in cash and a promissory note of $749,999,000 bearing interest at a rate equal to the holder's cost of funds (the \"Note\"). In the fourth quarter of 1994, the Preferred Stock and Note were canceled. Interest income for the eleven months ended November 30, 1994 and the twelve months ended December 31, 1993 includes $25 million and $28 million, respectively, from the Note. The dividend requirement on the Preferred Stock, as reflected on the Company's Consolidated Statement of Operations was $50 million for the eleven months ended November 30, 1994 and $68 million for the twelve months ended December 31, 1993.\nEffective June 10, 1994, Lehman Special Securities Inc., a wholly owned subsidiary of Holdings, was merged into a subsidiary of the Company resulting in an increase in stockholder's equity of approximately $149 million. In addition, in the fourth quarter of 1994, Funding and certain other wholly owned subsidiaries of Holdings were merged into the Company. As a result, Stockholder's equity increased by $318 million. The effect of these mergers on the results of operations to this and prior periods was not material.\nDuring 1995, the Company paid $635 million to Holdings, $559 million as a return of capital and $76 million as dividends. During 1994, the Company paid $536 million to Holdings, $300 million as a return of capital and $236 million as dividends.\nIn 1993, the Company issued three shares of its common stock to Holdings for $430 million.\nNOTE 17. OTHER CHARGES\nRESTRUCTURING CHARGE\nDuring the fourth quarter of 1995, the Company recorded a charge of $43 million pretax ($26 million aftertax) for occupancy-related real estate and severance expenses. The occupancy-related real estate expense component of the charge, $26 million pretax ($16 million aftertax), resulted from a complete global review of the Company's real estate requirements at current headcount levels and the elimination of excess real estate, primarily in its New York, London and Tokyo locations. The charge includes the cost to write-down the carrying value of leasehold improvements as well as the difference between expected operating costs and projected sublease recoveries. In addition, the restructuring charge includes a $17 million pretax ($10 million aftertax) component related to severance payments made during the fourth quarter. The severance component of the charge relates to payments made to terminated personnel arising from a fourth quarter formalized business unit productivity review.\nREDUCTION IN PERSONNEL\nDuring the first quarter of 1994, the Company conducted a review of personnel needs, which resulted in the termination of certain personnel. The Company recorded a severance charge of $27 million pretax ($15 million aftertax) in the first quarter of 1994.\nRESERVES FOR NON-CORE BUSINESSES\nDuring the first quarter of 1993, the Company provided $141 million pretax ($93 million aftertax) of non-core business reserves. Of this amount, $21 million pretax ($14 million aftertax) related to\nNOTE 17. OTHER CHARGES--(CONTINUED) certain non-core partnership syndication activities in which the Company is no longer actively engaged. The remaining $120 million pretax ($79 million aftertax) related to reserves recorded in anticipation of the sale of SLHMC. Such sale was completed during the third quarter of 1993.\nNOTE 18. SALE OF BUSINESS UNITS\nSHEARSON\nOn July 31, 1993, pursuant to an asset purchase agreement (the \"Primerica Agreement\"), the Company completed the sale (the \"Primerica Transaction\") of LBI's domestic retail brokerage business (except for such business conducted under the Lehman Brothers' name) and substantially all of its asset management business (collectively, \"Shearson\") to Primerica Corporation (now known as The Travelers Inc., \"Travelers\") and its subsidiary, Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Also included in the Primerica Transaction were the operations and data processing functions that supported these businesses, as well as certain of the assets and liabilities related to these operations.\nLBI received approximately $1.2 billion in cash and a $586 million interest-bearing note from Smith Barney which was repaid in January 1994 (the \"Smith Barney Note\"). As further consideration for the sale of Shearson, LBI received 2,500,000 shares of 5.50% Convertible Preferred Stock, Series B, of Travelers and a warrant to purchase 3,749,466 shares of common stock of Travelers at an exercise price of $39 per share. In August 1993, American Express purchased such preferred stock and warrant from LBI for aggregate consideration of $150 million.\nThe Company recognized a 1993 first quarter loss related to the Primerica Transaction of approximately $630 million aftertax ($535 million pretax), which included a reduction in goodwill of $750 million and transaction-related costs such as relocation, systems and operations modifications and severance.\nPresented below is the results of operations and the loss on the sale of Shearson:\nShearson operating results reflect allocated interest expense of $72 million for the year ended December 31, 1993.\nTHE BOSTON COMPANY\nOn May 21, 1993, pursuant to a stock purchase agreement (the \"Mellon Agreement\") between LBI and Mellon Bank Corporation (\"Mellon Bank\"), LBI sold to Mellon Bank (the \"Mellon Transaction\") The Boston Company. Under the terms of the Mellon Agreement, LBI received approximately $1.3 billion in cash, 2,500,000 shares of Mellon Bank common stock and ten-year warrants to purchase an additional 3,000,000 shares of Mellon Bank's common stock at an exercise price of $50 per share. In June 1993, such shares and warrants were sold by LBI to American Express for an aggregate purchase\nNOTE 18. SALE OF BUSINESS UNITS--(CONTINUED) price of $169 million. After accounting for transaction costs and certain adjustments, the Company recognized a 1993 first quarter aftertax gain of $165 million for the Mellon Transaction.\nAs a result of the Mellon Transaction, the Company treated The Boston Company as a discontinued operation. Accordingly, the Company's financial statements segregate the operating results of The Boston Company.\nPresented below is the results of operations and the gain on disposal of The Boston Company included in income from discontinued operations:\nSHEARSON LEHMAN HUTTON MORTGAGE CORPORATION\nLBI completed the sale of its wholly owned subsidiary, Shearson Lehman Hutton Mortgage Corporation (\"SLHMC\") to GE Capital Corporation on August 31, 1993. The sales price, net of proceeds used to retire debt of SLHMC, was approximately $70 million. During the first quarter of 1993, the Company provided $120 million of pretax reserves in anticipation of the sale of SLHMC, which reserves are included in the $141 million of pretax reserves for non-core businesses on the Consolidated Statement of Operations. After accounting for these reserves, the sale did not have a material effect on the Company's results of operations.\nNOTE 19. QUARTERLY INFORMATION (UNAUDITED)\nThe following information represents the Company's unaudited quarterly results of operations for 1995 and 1994. Certain amounts reflect reclassifications to conform to the current period's presentation.\nNOTE 19. QUARTERLY INFORMATION (UNAUDITED)--(CONTINUED) These quarterly results reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results. Revenues and earnings of the Company can vary significantly from quarter to quarter due to the nature of the Company's business activities.\nIn conjunction with the decision to change its year-end, the Company reported its third quarter 1994 results on the basis of its new fiscal year for the three months ended August 31, 1994. As such, the results for the month of June 1994 have been reflected in both the second and third quarters of 1994. Thus, the four quarters of 1994 are not additive.\nNet income for the first quarter of 1994 includes a $13 million aftertax charge for the cumulative effect of a change in accounting for postemployment benefits as a result of the adoption of SFAS No. 112.","section_15":""}
{"filename":"814077_1995.txt","cik":"814077","year":"1995","section_1":"ITEM 1. BUSINESS\nAssociated Planners Realty Growth Fund (the \"Partnership\"), was organized in March 1987, under the California Revised Limited Partnership Act. West Coast Realty Advisors, Inc. (\"WCRA\"), a California corporation, and W. Thomas Maudlin Jr., an individual, are general partners (collectively referred to herein as the \"General Partner\").\nThe Partnership was organized for the purpose of investing in, holding, and managing improved, leveraged income-producing property, such as residential property, office buildings, commercial buildings, industrial properties, mini- warehouse facilities, and shopping centers (\"Properties\"), which are believed to have potential for cash flow and capital appreciation. The Partnership intends to own and operate such Properties for investment over an anticipated holding period of approximately five to ten years. At December 31, 1995, the Partnership had no employees.\nThe Partnership's principal investment objectives are to invest the net proceeds in real properties which will:\n1. Preserve and protect the Partnership's invested capital; 2. Provide for cash distributions from operations; 3. Provide gains through potential appreciation; and 4. Generate federal income tax deductions so that a portion of cash distributions may be treated as a return of capital for tax purposes and, therefore, may not represent taxable income to the Limited Partners.\nOn November 17, 1989, the Partnership acquired a 100% interest in a office building located in Santa Ana, California which was financed with $1,553,102 in cash and $1,675,000 in long-term debt. On January 9, 1990, the Partnership, together with Associated Planners Realty Income Fund (an affiliate), purchased a one-story building located in San Marcos, California. The acquisition was paid for entirely in cash totaling $3,118,783 of which $311,878 was provided by the Partnership and $2,806,905 by the affiliate. The Partnership owns a 10% undivided interest in the property.\nThe ownership and operation of any leveraged, income-producing real estate is subject to those risks inherent in all real estate investments. These include national and local economic conditions, the supply of and demand for similar types of real property, competitive marketing conditions, zoning changes, possible casualty losses, and increases in real estate taxes, assessments, and operating expenses, as well as others. In addition, the real estate market at this date is in a general state of uncertainty, and there is no assurance as to how long it might continue or its possible effect on the Partnership.\nThis uncertainty is evidenced by the following conditions:\n1. Downtrends in the real estate market in various areas of the country as evidenced by high vacancy rates in the commercial sector, and a large unsold inventory of new homes, particularly in California.\n2. Economic recession, as evidenced by higher unemployment, slow consumer spending, and low increases in gross national product figures.\n3. The effect of current or proposed tax reform legislation which has slowed the level of sale and development of real estate and the formation of real estate partnerships, in many areas of the country.\n4. Availability and cost of financing to allow for the purchase and sale of properties and to maintain overall real estate values.\nThere is a potential for these factors to have a material effect on the Partnership's operations over the long-term.\nThe Partnership is subject to competitive conditions that exist in the local markets where it operates rental real estate. These conditions are discussed in ITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - - \"PROPERTIES\".\nThe Partnership is operated by the General Partner, subject to the terms of the Amended and Restated Agreement of Limited Partnership. The Partnership has no employees, and all administrative services are provided by West Coast Realty Advisors Inc.(\" WCRA\") the co-General Partner.\nOn August 29, 1988, the Partnership attained its minimum funding requirement with the initial release of escrow funds totaling $1,205,650 and terminated its offering on September 5, 1989. As of December 31, 1989, gross proceeds from sales of Partnership units totaled $2,061,000 and $1,823,953 net of syndication costs and sales commissions.\nITEM 2. PROPERTIES\nPARKCENTER OFFICE BUILDING\nOn November 17, 1989, the Partnership purchased the Parkcenter Office Building, located in Santa Ana, California.\nThe office building, constructed in 1978, provides 24,090 rentable square feet located on a 1.32 acre parcel of land. As of December 31, 1995, the building was 66% leased to seven tenants. Roselinsky, Gerrick, et al. accounted for 26% of the occupied space in the building as of December 31, 1995. The tenants rent space on a full-service gross lease basis, including utilities and janitorial.\nThe building and improvements are depreciated over 31.5 to 40 years using a straight-line method for both financial and income tax reporting purposes. The financial and income tax basis for the property are the same. In the opinion of the General Partner, the property is adequately insured. The property is managed by West Coast Realty Management, Inc. (\"WCRM\"), an affiliate of the corporate General Partner.\nThe center is dependent upon the vitality of the consumer market in the general area. A drop in occupancy levels among buildings located in the general area of the office building has required the Partnership's management to lower rental rates that it has been charging to tenants in order to maintain an acceptable occupancy level at the property. This has resulted in a significant drop in operating cash flow that has been generated by the building. See further discussion under Item 7 - \"Management Discussion And Analysis of Financial Condition and Results of Operations.\"\nTenants occupying 10% or more of rentable square footage:\nRoselinsky, Gerrick, et al (a law firm): 26% of rentable square footage; $99,185 rent per year; lease expires 1\/31\/97. Renewal options: No renewal option.\nNote: The tenants of this building consist are primarily service oriented companies such as mortgage lenders, real estate agents, lawyers, and escrow companies.\nSAN MARCOS INDUSTRIAL BUILDING\nOn January 9, 1990, the Partnership, together with Associated Planners Realty Income Fund (a 10%\/90% interest, respectively), purchased an Industrial Building, located in San Marcos, California.\nThe building, constructed in 1986, consists of 40,720 rentable square feet, including 6,000 square feet of office area, plus 1,300 square feet of mezzanine storage above the office area. It is located on a 2.66 acre parcel of land. The building was 100% occupied by Professional Care Products, Inc. through January 8, 1995, on a triple net lease. The lease required the tenant to pay insurance, taxes, maintenance and all other operating costs.\nOn February 13, 1995, a new lease was executed with No Fear, Inc., which runs through June 30, 1998. This is also a triple net lease, and the beginning monthly revenue is approximately 70% of the Professional Care Products lease's ending monthly revenue.\nThe building and improvements are depreciated over 31.5 to 40 years using a straight-line method for both financial and income tax reporting purposes. The financial and income tax basis for the property are the same. In the opinion of the General Partner, the property is adequately insured. The property is managed by WCRM.\nThe building is located in North San Diego County, in an area of increasing population and desirability for San Diego area professional and skilled workers and significant employers. It is expected the building will benefit from projected growth of the North San Diego County area.\nTenants occupying 10% or more of rentable square footage:\nPROCARE (Professional Care Products, Inc.): 100% of rentable square footage; $30,024 rental per year (10% of total rent). Lease expired 1\/8\/95. Renewal options: None (tenant vacated building prior to lease expiration).\nNo Fear, Inc.: 100% of rentable square footage; Rent is $21,989 per year (10% of total rent). Lease expires on June 30, 1998. Tenant began occupying the building on February 13, 1995. Renewal option: $21,598 per year in the first year, increasing 104% per year thereafter for a maximum of five years.\nNote: PROCARE was involved in the assembly of medical instruments. No Fear, Inc. (the current tenant) is involved in the manufacture and sale of clothing.\nSUMMARY\nAs of December 31, 1995, the combined occupancy rate of all the Partnership's properties was 71%. In the opinion of the General Partner, all properties are adequately covered by insurance. Although the Partnership's 10% interest in the San Marcos Building is generating positive cash flow, this amount is not sufficient to offset the negative cashflow resulting from the Partnership's interest in the Santa Ana Office Building.\nThe total acquisition cost to the Partnership of each property and the dates of acquisition are as follows:\nDESCRIPTION ACQUISITION ACQUISITION COST DATES\nPARKCENTER OFFICE BUILDING $3,228,102 11\/17\/89\nSAN MARCOS INDUSTRIAL BUILDING (10% $311,878 01\/09\/90 INTEREST)\nNoted below are some key data pertaining to the operations of improved property that is operated by the Partnership:\nAverage annual occupancy rate as a percentage of square feet:\nSanta Ana Building:\n1991: 84% 1992: 87 1993: 85 1994: 73 1995: 66\nSan Marcos Building (10% interest by the Partnership):\n1991: 100% 1992: 100 1993: 100 1994: 100 1995: 88\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\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 THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt December 31, 1995, there were 2,061 limited partnership units outstanding and 180 unit holders of record. The units sold are not freely transferable and no public market for the sold units presently exists or is likely to develop. There are no unissued units available for sale as of December 31, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data should be read in conjunction with the financial statements and related notes and ITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership began offering for sale limited partnership units in October 1987. On August 29, 1988, the Partnership reached its minimum offering level of $1,200,000 and funds were released from escrow, to the Partnership. The Partnership sold units throughout the remainder of 1988, and had raised $1,362,000 in gross proceeds or $1,219,262 net of syndication costs and sales commissions as of December 31, 1988. As of December 31, 1989, gross proceeds from sales of partnership units totaled $2,061,000 or $1,823,953 net of syndication costs and sales commissions.\nIn reading the discussion of operations, the reader should understand that the Partnership has a 100% interest in an office building in Santa Ana, California, and a 10% interest in a commercial building in San Marcos, California. The results of the Partnership's operations have been dominated by the results of operations for the Santa Ana building; thus, the discussion of the Partnership's results of operations will emphasize the operations of that building.\nDue to the recurring losses from operations and a net capital deficiency of $800,058 at December 31, 1995, the Partnership's independent certified public accountants have included an explanatory paragraph in their report stating that these factors raise substantial doubt as to Partnership ability to continue as a going concern.\nFrom 1992 to 1994, the overall operations of the Partnership gradually improved; however, the Partnership continued to generate unacceptable net losses and negative cash flows. (These negative cash flows first started appearing in calendar 1991). For example, the net loss for 1993 of $123,357 was $17,737 (13%) less than the $141,094 net loss for 1992, while the negative cash flow (net loss excluding depreciation and amortization) dropped from $70,738 to $54,276--a $16,462 (23%) decrease. Progress continued in 1994, with the net loss of $115,143 that year being $8,214 (7%) less than that for 1993, and the negative cash flow dropping to $47,779--a $6,497 (12%) decrease from 1993's level. Despite these improvements, the fact remained that the Partnership's operations were still insufficient to support the Company without cooperation from the General Partner in deferring collection of various management fees, interest expense, and overhead cost allocations.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\n1995 was a turning point in terms of the viability of the Partnership. Although the general economy in which the Santa Ana building is located was generally poor from 1990 to 1994, the operations of the Partnership's building were still somewhat stable (if not overly profitable) as explained above. However, in December of 1994, the County of Orange (in which the Santa Ana Building is located) declared bankruptcy due to large losses in connection with unauthorized derivative and bond investment activity. The County's problems had a trickle down effect on the entire area as a large number of small businesses dependent upon County purchases went out of business or moved away. This put further pressure on all commercial property owners to further lower rents to attract or retain tenants. The Partnership saw the negative cash flow situation on the Santa Ana building worsen as a result of these problems. On July 31, 1995, at the Partnership's request, the holder of the first deed of trust on the Santa Ana property agreed to provide relief to the Partnership by deferring collection of debt payments due on the loan for September 1995 to January 1996. The General Partner used this opportunity to improve the liquidity of the Partnership, and to allow for the implementation of necessary capital improvements to the Property. However, the relief offered by the lender in the latter part of 1995 was not sufficient to improve the operating results for the Partnership. Largely as a result of the economic problems in Orange County, the net loss from operations for the Partnership increased to $189,168-- a $74,025 (64%) increase in loss. Cash basis loss (net loss from operations less depreciation expense) increased from $47,779 to $122,772--a $74,993 (157%) increase. In addition, during the fourth quarter, despite the Partnership's best efforts to enhance the value of the property with tenant improvements and greater occupancy, it was determined that the surrounding economic conditions of the area dictated a thorough review of the carrying value of the property. Using recent comparative building sales data for the general area in which the building is located, it was determined that a $1,912,727 impairment loss in the value of the building should be recorded on the Partnership's Statement of Loss for 1995. This loss is unrealized, and thus does not flow through to the partners for tax purposes, and may not flow through until the ParkCenter Office Building is sold or otherwise disposed of. This allowance, in itself, does not directly affect the liquidity of the Partnership, which as previously set forth, is extremely poor. This impairment in value means that the equity of the Partnership is now a deficit, and the sale of the Santa Ana property would probably result in less proceeds than what is currently outstanding on the first deed of trust attached to the building.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nIn February 1996, the Partnership failed to make the first payment due following the debt relief period granted by the holder of the first deed of trust. The Partnership again approached the holder of the first deed of trust to attempt to obtain additional debt relief. The holder of the note declined to provide additional relief, and demanded immediate payment of the installment due to prevent immediate foreclosure of the property. The Partnership met this demand and default provisions were not instituted. The Partnership projects that additional cash advances will be necessary from the General Partner, or one of its affiliates, in order to prevent an additional liquidity crisis in April 1996 when property taxes become due on the property. The General Partner has made no commitment at this time concerning the availability of future cash advances to the Partnership. The Partnership will continue to seek relief from the debt holder, while at the same time seeking to enhance the value of the property by increasing occupancy and contracting long term leases. Failure to obtain additional funding from the General Partner, relief from the lender, or significantly improved operations could result in the eventual loss of the building through foreclosure proceedings.\nDuring the year ended December 31, 1995, the Partnership did not make distributions to limited partners or pay General Partner management fees, in an attempt to rebuild cash reserves. Distributions are determined by management based on cash flow and the liquidity position of the Partnership.\nManagement uses cash as its primary measure of a partnership's liquidity. The amount of cash that represents adequate liquidity for a real estate limited partnership depends on several factors. Among them are:\n1. Relative risk of the partnership; 2. Condition of the partnership's properties; 3. Time in the partnership's life cycle (e.g., money-raising, acquisition, operating or disposition phase); and 4. Partner distributions.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nDue to the large amount of vacancies, general economic problems in the area, and an increase in maintenance and repair expenses at the Santa Ana Property, the 3% reserve remained depleted during 1995. In addition, the General Partner has made loans to the Partnership and deferred collection of miscellaneous amounts owed to it by the Partnership. For this reason, there were no distributions made to the limited partners during the year. It is the Partnership's intention to eliminate partner distributions until such time as the reserves are built back up to acceptable levels and various deferred liabilities due to the Advisor and its affiliates are paid. It is uncertain at this point how long it will take the Partnership to rebuild cash reserves and operate profitably on a cash basis; however, the possibility of partners receiving future cash distributions or a significant portion of their original investment back is considered remote. The Partnership's ability to meet cash requirements in the short-run is dependent upon the willingness of the General Partner and its affiliates to defer collection of amounts due for property management fees and overhead allocations, advance cash as needed for ongoing operating expenses, and the stabilization of the tenant base and rental rates at the Santa Ana property. The ability of the General Partner to make advances to the Partnership is dependent upon the liquidity of the Parent company of the General Partner. The General Partner is a wholly owned subsidiary of Associated Financial Group (the \"Parent\"), which consolidated, as of December 31, 1995, had $6.2 million in assets, $2.1 million in cash and cash equivalents, and $3.3 million in equity, and had net income of $.2 million for the year ended December 31, 1995. In addition, the General Partner must be willing to make advances, and as of December 31, 1995, the General Partner has no future commitments to do so.\nIn the long run, the Partnership's cash requirements will be further affected by the need to pay off the Deed of Trust that secures the Santa Ana property. This note is due on January 1, 2000, and is projected to have a balance of approximately $1,550,000 at that time. A sale or refinance of the property will be necessary prior to that date.\nThe San Marcos property has no debt financing and their are currently no plans by the Partnership or Associated Planners Realty Income Fund to seek financing on that jointly owned property. In the short-term, the fact that this property has a quality tenant and operates under a triple net lease, allows the Partnership to collect a nominal amount of cash from the operations of this Property. In the long-run, the Partnership expects to benefit from the sale of this property when it is sold. The General Partner anticipates that the San Marcos property will be sold prior to the year 2000.\nThe condition of the properties is relatively good, therefore there are no unusually large capital improvements or repair costs that would severely deplete the cash reserves.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nAs previously discussed, the Partnership has a 10% interest in a building in San Marcos, California. Subsequent to year-end, the building was leased to a tenant at a rate 70% of the previous rental rate. Because the Partnership has such a small percentage interest in this property, the decrease in rent results in only a $750 per month decrease in cash flow. This particular decrease is not expected to have a material impact on operations.\nThe Tax Reform Acts of 1986 and 1987 and the Revenue Reconciliation Acts of 1990 and 1993 did not have a material impact on the Partnership's operations.\nDuring the years of the Partnership's existence, inflationary pressures in the U.S. economy have been minimal, and this has been consistent with the experience of the Partnership in operating rental real estate in California. The Partnership has several clauses in its leases with some of its properties' tenants that will help alleviate some of the negative impact of inflation. However, the lack of inflation is hurting the Partnership due to the stagnation of office rental rates.\nThere are currently no plans for any material renovation, improvement or further development of the properties.\nRESULTS OF OPERATIONS - 1995 VS. 1994\nOperations for the years ended December 31, 1995 and 1994 reflect full years of rental activities for the Partnership's properties. For the year ended December 31, 1995, the return on funds invested in property was (1.8%) vs. (.2%) in calendar 1994.\nAs previously discussed, poor economic conditions resulted in a $27,729 (10.2%) decrease in rental revenue. As a result of the debt relief received, interest expense increased $19,312 (11.4%). However, the provisions of the debt relief did not require an increase in the use of cash as a result of this. Operating expenses increased $24,027 (25.4%) due to increased maintenance expenses incurred in order to improve the appearance of the Santa Ana Building.\nThe cash basis loss for 1995 was $122,772 vs. $47,779 in 1994. This $74,993 (157%) increase pushed the Partnership close to default on its ability to meet its current loan and property tax obligations. As previously discussed, continual support from the lender and\/or the General Partner and its affiliates will be necessary to avoid foreclosure of the Partnership's primary real estate asset.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nDuring the year ended December 31, 1995, $4,468 in cash was provided by operating activities. This resulted from an increase in accounts payable of $70,899 (primarily resulting from an increase in the deferral of payment of amounts due to the General Partner and affiliates) plus the $71,954 increase in accrued interest on notes payable (resulting from the relief the Partnership received in making payments on the debt from September 1995 through January 1996), offset by the net cash basis loss of $122,772 from operations (net loss plus depreciation expense and impairment loss), and the $16,409 net increase in receivables and other assets (primarily work in progress pertaining to certain capital improvements to the Santa Ana Building). There were no investing activities during the year by the Partnership; in recent years, some cash had been used for capital improvements to the properties. Financing activities resulted in a use of cash of $10,125 in connection with the Partnership's debt on the Santa Ana Building. Cash decreased a net $5,657 as a result of the net cash used by operating activities and financing activities. As a result, the net cash at the end of the year was zero.\nThe number of limited partnership units outstanding remained at 2,061.\nRESULTS OF OPERATIONS - 1994 VS. 1993\nOperations for the years ended December 31, 1994 and 1993 reflect full years of rental activities for the Partnership's properties. For the year ended December 31, 1994, the return on funds invested in property was (.2%) vs. (.1%) in calendar 1993. As has been the case for several years, the Partnership realized an overall cash basis net loss due to the administrative costs of operating the Partnership (cash basis is net income plus an addback of depreciation expense). Rental income fell $17,298 (6%) due to continuing rental rate and occupancy problems at the Santa Ana Building. Of the $17,298 decrease in rental revenue from 1993, we would estimate that $12,000 was due to increased vacancy at the Santa Ana property, with the balance due to lower overall rental rates in the area.\nOperating expense decreased $22,400 (19%) as a result of less maintenance and ongoing operating costs due to lower vacancy at the Santa Ana property and lower property taxes due to some relief granted by the County of Orange in 1994.\nThe cash basis loss decreased from $54,276 in 1993 to $47,779 in 1994. Although this did represent a $6,497 (12.0%) decrease, the viability of the Partnership was dependent upon the General Partner and affiliates waiving collection of certain fees and reimbursements that it was entitled to. Coupled with prior year (1991-1993) losses, the cash loss for 1994 continued to put the Partnership in a mode of extremely low liquidity.\nITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONT.)\nDuring the year ended December 31, 1994, $9,443 in cash was used in operating activities. This resulted from a net cash basis loss of $47,779 (net loss plus depreciation expense), plus the $11,486 decrease in security deposits and prepaid rents (primarily resulting decrease in occupancy from 85% in 1993 to 73% in 1994), offset by a increase in accounts payable of $46,235 (primarily resulting from an increase in the deferral of payment of amounts due to the General Partner and affiliates), and the $3,887 net increase in receivables and other assets (primarily work in progress pertaining to certain capital improvements to the Santa Ana Building). There were no investing activities during the year by the Partnership; in recent years, some cash had been used for capital improvements to the properties. Financing activities resulted in a use of cash of $14,464 in connection with the Partnership's debt on the Santa Ana Building. Cash decreased a net $23,907 as a result of the net cash used by operating activities and financing activities. As a result, the net cash at the end of the year was $5,657.\nThe number of limited partnership units outstanding remained at 2,061.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE\nReport of Independent Certified Public Accountants................ 16\nBalance Sheets -- December 31, 1995 and 1994 ..................... 17\nStatements of Loss for the years ended December 31, 1995, 1994, and 1993 .......................... 18\nStatements of Partners' Equity (Deficit) for the years ended December 31, 1995, 1994, and 1993 .......................... 19\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 ........................... 20\nSummary of Accounting Policies .................................. 21-22\nNotes to Financial Statements ................................... 23-28\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nAssociated Planners Realty Growth Fund (a California limited partnership) Los Angeles, California\nWe have audited the accompanying balance sheets of Associated Planners Realty Growth Fund (a California limited partnership) as of December 31, 1995 and 1994 and the related statements of loss, 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 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 presentation. We believe that our 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 Associated Planners Realty Growth Fund (a California 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.\nAlso, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 8 to the financial statements, the Partnership changed its method of accounting for the impairment of long-lived assets in 1995. The accompanying financial statements and schedules have been prepared assuming that the Partnership will continue as a going concern. As discussed in the summary of accounting policies, the Partnership 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 the summary of accounting policies. The financial statements and schedules do not include any adjustments that might result from the outcome of this uncertainty.\nBDO SEIDMAN, LLP\nLos Angeles, California February 12, 1996\n[FN] See accompanying summary of accounting policies and notes to financial statements.\n[FN] See accompanying summary of accounting policies and notes to financial statements.\n[FN]\nSee accompanying summary of accounting policies and notes to financial statements.\n[FN] See accompanying summary of accounting policies and notes to financial statements.\nASSOCIATED PLANNERS REALTY GROWTH FUND SUMMARY OF ACCOUNTING POLICIES\nBUSINESS Associated Planners Realty Growth Fund (the \"Partnership\"), a California limited partnership, was formed on March 9, 1987 under the Revised Limited Partnership Act of the State of California. The Partnership met its minimum funding of $1,200,000 on August 29, 1988 and terminated its offering on September 5, 1989. The Partnership was formed to acquire income- producing real property throughout the United States with emphasis on properties located in California and southwestern states. The Partnership intends to purchase such properties by borrowing up to an aggregate of fifty percent of the purchase price of such properties and intends to own and operate such properties for investment over an anticipated holding period of approximately five to ten years.\nBASIS OF The financial statements do not give effect to any assets PRESENTATION that the partners may have outside of their interest in the partnership, nor to any personal obligations, including income taxes, of the partners.\nThe Partnership'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 Partnership has suffered recurring losses from operations and has a net capital deficiency of $800,058 at December 31, 1995. The deficiency is attributable to a $1,912,727 impairment loss recognized on the difference between the carrying amount of rental real estate and the fair value less cost to sell. The Partnership plans to seek relief from the debt holder, while at the same time seeking to enhance the value of the property by increasing occupancy and contracting long-term leases. Failure to obtain additional funding from the General Partner, relief from the lender, or significantly improved operations could result in the eventual loss of the building through foreclosure proceedings.\nASSOCIATED PLANNERS REALTY GROWTH FUND SUMMARY OF ACCOUNTING POLICIES\nRENTAL REAL Assets are stated at cost. Depreciation is computed ESTATE AND using the straight-line method over estimated useful DEPRECIATION lives ranging from 31.5 to 40 years for financial reporting and income tax reporting purposes.\nIn the event that facts and circumstances indicate that the cost of an asset may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the carrying amount to determine if a write-down to market value is required.\nLOAN ORIGINATION Loan origination fees are capitalized and amortized over FEES the life of the loan.\nLEASE COMMISSIONS Lease commissions which are paid to real estate brokers for locating tenants are capitalized and amortized over the life of the lease.\nRENTAL REVENUE Rental revenue is recognized on a straight-line basis to the extent that rental revenue is deemed collectible.\nSTATEMENTS OF For purposes of the statements of cash flows, the CASH FLOWS Partnership considers cash in the bank and all highly liquid investments purchased with original maturities of three months or less to be cash and 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 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.\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n1. NATURE OF The Partnership began accepting subscriptions in October PARTNERSHIP 1987 and closed the offering on September 5, 1989. The Partnership began operations in September 1988.\nUnder the terms of the partnership agreement, the General Partners (West Coast Realty Advisors, Inc., and W. Thomas Maudlin, Jr.) are entitled to cash distributions from 10% to 15%. The General Partners are also entitled to net income (loss) allocations varying from 1% to 15% in accordance with the partnership agreement. Further, the General Partners will receive acquisition fees for locat- ing and negotiating the purchase of rental real estate, management fees for operating the Partnership and a commission on the sale of the partnership properties.\n2. RENTAL REAL The Partnership owns the following two rental real estate ESTATE properties, one wholly-owned and the second, a 10% undivided interest:\nAcquisition Location (Property Name) Date Purchased Cost\nSanta Ana, California November 17, 1989 $3,228,102\nSan Marcos, California January 9, 1990 311,878\nThe major categories of rental real estate are:\nDecember 31, 1995 1994\nLand $519,777 $1,349,900 Buildings and improvements 806,468 2,241,600\n1,326,245 3,591,500 Less accumulated depreciation 40,800 336,449\nRental real estate, net $1,285,445 $3,255,051\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n2. RENTAL REAL A significant portion of the Partnership's rental revenue ESTATE was earned from tenants whose individual rents represent (CONTINUED) more than 10% of total rental revenue. Specifically:\nTwo tenants accounted for 14% and 41% in 1995; Two tenants accounted for 11% and 43% in 1994; Two tenants accounted for 11% and 43% in 1993.\nDuring 1995, the property tax assessment on the Santa Ana, California office building was significantly reduced. It is the intention of the General Partner to sell the Santa Ana property when it is reasonably feasible. The Partnership determined that the total expected future cash flows from operations and disposition of the property are less than the carrying value of the property. Therefore the property was deemed to be impaired. As a result, an impairment loss of $1,912,727 was recorded, measured as the amount by which the carrying amount of the asset exceeded its fair value less cost to sell. Fair value was determined based on comparable sales. The Partnership intends to continue to annually assess the carrying values of its long-lived assets.\n3. FUTURE As of December 31, 1995, future minimum rental income MINIMUM under existing leases, excluding month to month rental RENTAL INCOME agreements, that have remaining noncancelable terms in excess of one year are as follows:\nAmount\n1996 $179,124 1997 48,930 1998 10,383\n$238,437\nFuture minimum rental income does not include lease renewals or new leases that may result after a noncancelable lease expires.\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n4. RELATED PARTY (a) In accordance with the partnership agreement, TRANSACTIONS compensation earned by or services reimbursed to the corporate General Partner consisted of the following:\nYears ended December 31, 1995 1994 1993\nAdministrative services: Data processing $5,645 $5,680 $5,669 Postage 710 640 662 Investor processing 2,258 2,272 2,268 Duplication 1,129 1,136 1,134 Investor communications 1,693 1,704 1,701 Miscellaneous 565 568 566\n$12,000 $12,000 $12,000\n(b) The Partnership owns a 10% undivided interest in the property located in San Marcos, California. The 90% interest is owned by Associated Planners Realty Income Fund, an affiliate.\n(c) Property management fees incurred in accordance with the partnership agreement with West Coast Realty Management, Inc., totaled $10,393, $12,045 and $12,422 for the years ended December 31, 1995, 1994 and 1993.\n(d) The Partnership has a note payable of $150,000 at December 31, 1995 and December 31, 1994 which is payable on demand to the corporate General Partner and bears interest of 7.5%.\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n(e) Related party accounts payables are as follows:\nDecember 31, 1995 1994\nAssociated Planners Realty Income Fund $ - $ 2,173 West Coast Realty Advisors 108,408 73,158 West Coast Realty Management 81,056 70,663 Associated Financial Group, Inc. 50,631 41,813\n$ 240,095 $187,807\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n5. NOTE PAYABLE The Partnership has a 9.75% promissory note payable secured by a Deed of Trust. This note is due January 1, 2000, and provides significant prepayment penalties. Payments are made in monthly installments of $15,088 including principal and interest. The outstanding balance is $1,676,385 and $1,614,884 at December 31, 1995 and 1994.\nThe carrying amount is a reasonable estimate of fair value of notes payable because the interest rates approximate the borrowing rates currently available for mortgage loans with similar terms and average maturities.\nThe aggregate annual future maturities at December 31, 1995 are as follows:\nAmount\n1996 $16,811 1997 20,129 1998 22,182 1999 24,443 2000 1,592,820\nTotal $1,676,385\n6. NET LOSS The Net Loss per Limited Partnership Unit was computed in AND CASH accordance with the partnership agreement using the DISTRIBUTIONS weighted average number of outstanding Limited PER LIMITED Partnership Units of 2,061 for 1995, 1994 and 1993. PARTNERSHIP UNIT No distributions were made in 1995, 1994 or 1993.\n7. FOURTH In the fourth quarter of 1995 the Partnership recorded an QUARTER adjustment to the carrying value of rental real estate to ADJUSTMENT recognize an impairment loss of $1,912,727 as discussed in Note 2.\nASSOCIATED PLANNERS REALTY GROWTH FUND NOTES TO FINANCIAL STATEMENTS\n8. SUPPLEMENTAL Cash paid during the years ended December 31, 1995, 1994 DISCLOSURES and 1993 for interest was $117,044, $168,731 and OF CASH FLOW $159,565. INFORMATION Noncash investing and financing activities:\nNotes payable was increased by $71,954 of accrued interest relating to a deferral of loan payments during 1995.\n9. NEW Statement of Financial Accounting Standards No. 121, ACCOUNTING \"Accounting for the Impairment of Long-Lived Assets and PRONOUNCE- for Long-Lived Assets to Be Disposed of\" (SFAS No. 121) MENTS 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 new 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 Partnership has elected the early adoption of SFAS No. 121. An impairment loss of $1,912,727 was recorded in the statement of loss for the year ended December 31, 1995.\nA reconciliation of mortgage loans payable for the year ended December 31, 1993, 1994, 1995 follows:\nBalance at December 31, 1992 $1,642,473 .................................. 1993 Additions - 1993 Paydowns (13,125) .................................. ............................... Balance at December 31, 1993 1,629,348 .................................. ...... 1994 Additions - 1994 Paydowns (14,464) .................................. ............................... Balance at December 31, 1994 1,614,884 .................................. ...... 1995 Additions 71,954 1995 Paydowns (10,453) .................................. ............................... Balance at December 31, 1995 $1,676,385 .................................. ......\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership is managed by the General Partner and the Limited Partners have no right to participate in the management of the Partnership or its business.\nResumes of the General Partners' principal officers and directors and a description of the General Partner are set forth in the following paragraphs.\nWEST COAST REALTY ADVISORS, INC.\nWest Coast Realty Advisors, Inc. (\"WCRA\") is a California corporation formed on May 10, 1983 for the purpose of structuring real estate programs and to act as general partner of such programs. It is a subsidiary of Associated Financial Group, Inc.\nPHILIP N. GAINSBOROUGH (Born 1938) is Chairman and a Director of West Coast Realty Advisors, Inc. He is also currently the President of Associated Financial Group, Inc., Associated Securities Corp., Associated Planners Insurance Services, Inc., and Associated Planners Investment Advisory, Inc. In addition, from January 1981 to the present, he has served as President of Gainsborough Financial Consultants, Inc., a financial planning firm located in Los Angeles, California. From January 1981 to December 1982, Mr. Gainsborough served as a Registered Principal of Private Ledger Financial Services, Inc. From January 1977 to December 1980, he was employed by E.F.Hutton & Co. as a Registered Representative.\nW. THOMAS MAUDLIN JR. (Born 1936) is a Director and President of West Coast Realty Advisors, Inc. (\"WCRA\"). He is also co-General Partner (with WCRA) of the Partnership. Mr. Maudlin has been active in the real estate area for over 30 years, serving as co-developer of high-rise office buildings and condominiums. He has structured transactions for syndicators in apartment housing, including sale leasebacks, all-inclusive trust deeds, buying and restructuring transactions to suit a particular buyer, and as a buyer acting as a principal. Mr. Maudlin was co-developer of the Gateway Los Angeles office building, a 165,000 square foot, fourteen-story office building located in West Los Angeles. Form 1980 to 1985, in partnership with the Muller Company, he developed eleven acres in San Bernardino which included a 42,000-square foot office building, a six-plex movie theater and two restaurants. From 1980 to 1985, Mr. Maudlin was involved in building in San Bernardino, California, a 134- unit condominium development, a shopping center, and a restaurant in Ventura. He is a graduate of the University of Southern California.\nWILLIAM T. HAAS (Born 1946 ) is a Director and Executive Vice President\/Secretary of West Coast Realty Advisors, Inc., Associated Planners Insurance Services, Associated Securities Corp., and Associated Planners Investment Advisory, Inc. He is also Executive Vice President\/Secretary and Director of Associated Financial Group, Inc. Mr. Haas has been affiliated with various Associated companies since 1982. From December 1977 to December 1982, Mr. Haas was employed by the National Association of Securities Dealers, Inc. in various capacities, including that of Supervisor of Examiners. From 1968 to 1977, he was associated with Merrill Lynch as a branch office operations manager, and in the home office Operations Liaison department.\nMICHAEL G. CLARK (Born 1956) is Senior Vice President\/Treasurer of West Coast Realty Advisors, Inc., Associated Financial Group, Inc., and Associated Securities Corp. Prior to joining AFG in 1986, he served as Controller for Quest Resources, a Los Angeles-based syndicator and operator of alternative energy projects, from October 1984 to March 1986, and Assistant Controller for Valley Cable T.V., from March 1982 through September 1984. In addition, Mr. Clark served as an auditor for Arthur Young & Co. in Los Angeles, from July 1978 to March 1982. He is a graduate of the University of California, Santa Barbara (BA) and California State University, Northridge (MS).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDuring its last calendar year, the Registrant paid no direct or indirect compensation to directors, officers, or employees of the General Partner.\nThe Registrant has no annuity, pension or retirement plans, or existing plan or arrangement pursuant to which compensatory payments are proposed to be made in the future to directors or officers.\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 Registrant has no outstanding securities possessing general voting rights. No person owns of record, or is known by the Registrant to own beneficially, five percent or more of its units of limited partnership interest.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Registrant was organized in March 1987 as a California Limited Partnership. Its General Partners (collectively referred to herein as the \"General Partner\") are West Coast Realty Advisors, Inc., and W. Thomas Maudlin Jr., an individual. The Registrant has no executive officers or directors. Philip N. Gainsborough, an officer of the General Partner, made an original limited partnership contribution to the Partnership in March 1987, which was subsequently paid back to him in September 1988 when the Partnership met its minimum funding requirement. The General Partner and its affiliates will receive compensation from the Partnership for the following services rendered:\n1. For Partnership management services rendered to the Partnership, the General Partner is entitled to receive up to 10% of all distributions of cash from operations. For the year ended December 31, 1995, no distributions were made to the General Partner. In addition, the General Partner is entitled to reimbursement for the cost of certain personnel employed in the organization of the Partnership, and certain administrative services performed by the General Partner. During the year ended December 31, 1995, the Partnership incurred $12,000 for these services, payable to the General Partner.\n2. For property management services, the General Partner engaged West Coast Realty Management, Inc. (\"WCRM\"), an affiliate of the General Partner. During the year ended December 31, 1995, the Partnership incurred property management fees of $10,393 payable to WCRM.\n3. The General Partner received a 1% allocation of net loss. For the year ended December 31, 1995, this resulted in a $21,018 allocation of net loss.\n4. At December 31, 1995 the Partnership had a note payable to the General Partner of $150,000, bearing an interest rate of 7\/ % and payable upon demand. On December 31, 1995, the Partnership was indebted to the General Partner for $258,408.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS The following financial statements of Associated Planners Realty Growth Fund, a California Limited Partnership, are included in PART II, ITEM 8:\nPAGE\nReport of Independent Certified Public Accountants................... 16\nBalance Sheets -- December 31, 1995 and 1994 ........................ 17\nStatements of Loss for the years ended December 31, 1995, 1994, and 1993 .............................. 18\nStatements of Partners' Equity (Deficit) for the years ended December 31, 1995, 1994, and 1993 .............................. 19\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 ............................... 20\nSummary of Accounting Policies ...................................... 21-22\nNotes to Financial Statements ....................................... 23-28\n2. FINANCIAL STATEMENT SCHEDULES\nSchedule III --Real Estate and Accumulated Depreciation ............. 29\nSchedule IV --Mortgage Loans on Real Estate ......................... 30\nAll other schedules have been omitted because they are either not required, not applicable or the information has been otherwise supplied.\n(b) REPORTS ON FORM 8-K\nNONE\n(c) EXHIBITS NONE\nSIGNATURES\nPursuant to the requirements of the 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nASSOCIATED PLANNERS REALTY GROWTH FUND A California Limited Partnership (Registrant)\nW. THOMAS MAUDLIN JR. (A General Partner)\nBy: WEST COAST REALTY ADVISORS, INC. (A General Partner)\nWILLIAM T. HAAS (Director and Executive Vice President\/Secretary)\nMICHAEL G. CLARK (Vice President\/Treasurer)\nApril 1, 1996","section_15":""}
{"filename":"909298_1995.txt","cik":"909298","year":"1995","section_1":"ITEM 1\nBUSINESS\nMid-Atlantic Realty Trust was incorporated June 29, 1993 and commenced operations effective with the completion of its initial public share offering on September 11, 1993. Mid-Atlantic Realty Trust is the successor to the operations of BTR Realty, Inc. (the predecessor to Mid-Atlantic Realty Trust), and qualifies as a real estate investment trust, \"REIT\", for Federal income tax purposes. As used herein, the term \"MART\" refers to Mid-Atlantic Realty Trust, the term \"Company\" refers to MART and its subsidiaries, the successor company, and \"BTR\" refers to BTR Realty, Inc. and its subsidiaries.\nThe Company is a fully integrated, self managed real estate investment trust which owns, leases, develops, redevelops and manages its retail shopping center facilities and commercial properties. The Company's primary objective is to manage the properties for long-term cash flow growth. The Company's principal strategies are to grow the portfolio through the selective acquisition of additional properties in the Mid-Atlantic region, redeveloping or developing retail properties on a selective basis, and, when appropriate, divesting through sale or exchange of non-strategic properties.\nThe Company's financial strategy is to continue to refocus the portfolio through the selective acquisition of retail properties utilizing (1) proceeds from divestitures, (2) issuance of equity or debt securities, when appropriate, and (3) arranging bank or other borrowings for short term needs. The Company intends to maintain the conservative ratio of secured debt to total estimated property value below 50%.\nThe Company has an equity interest in twenty-three operating shopping centers, seventeen of which are wholly-owned by the Company, and six others in which the Company has an interest ranging from 50% to 80%, as well as other commercial properties. The operating properties have a gross leasable area of approximately 3,237,000 square feet, of which approximately 93% was leased at December 31, 1995. Total gross leasable area includes 3,001,000 square feet of established operating properties, of which approximately 96% was leased at December 31, 1995 and approximately 236,000 square feet of a shopping center acquired in October, 1993, currently under redevelopment, of which 64% was leased at December 31, 1995. Of these properties, approximately 89% of the gross leasable area is in the states of Maryland, Virginia, New York and Delaware, 9% in Arizona and 2% in other states. The Company also owns 8 undeveloped parcels of commercial and residential zoned land totaling approximately 166 acres and varying in size from 3 to 56 acres.\nThe business of the Company is not materially affected by seasonal factors. Although construction may be affected to some extent by inclement weather conditions, usually during winter months, property sales and revenue from income producing properties held for investment are usually not so affected.\nThe commercial real estate development and investment industry is subject to widespread competition for desirable sites, tenants and favorable financing. The industry is extremely fragmented and there are no principal methods of competition. However, the ability to compete is dependent in part upon the ability to find and complete appropriate real estate investments in a timely manner. While many competitors have fewer assets and financial resources than the Company, there are many competitors with greater financial resources competing for similar business activities. Accordingly, it is not possible to estimate the Company's position in the industry. In addition, certain of the Company's real estate projects are near unimproved sites that could be developed commercially and would provide further competition to the Company. The management of the Company believes, however, that the Company competes favorably in the industry due to the quality of its developments, its ability to take advantage of opportunities as they arise, its access to capital, and its reputation in the industry.\nThe Company has 52 full time employees and believes that its relationship with its employees is good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2\nPROPERTIES\nThe following schedule describes the Company's commercial and residential properties as of December 31, 1995:\nI. SHOPPING CENTERS A. In Operation (1) Type Percent- of Leas- age of land Area able Percent- Lease Name and owner- owner- in square age Principal expir- Location ship ship acres feet leased tenants ations MARYLAND PROPERTIES: Harford Mall 100% Fee(2) 38.0 584,000(3) 98% Hecht's, 1996-2010 U.S. Route 1 Montgomery Ward, Bel Air Woolworth, Best Buy\nPatriots Plaza 50% Long-term 6.1 39,000 97% Denny's, 1996-2005 Ritchie Highway of lease(4) Dunkin Donuts Anne Arundel Partnership County\nRolling Road 100% Fee 6.5 63,000 100% Fair Lanes,1996-2009 Plaza Firestone Rolling Road Baltimore County\nRosedale Plaza 100% Fee 9.2 73,000 84% Valu Food, 1996-2002 Chesaco and Weyburn Avenue Rite Aid Baltimore County\nShoppes at Easton 100% Fee 13.9 113,000 97% Giant Food,1997-2024 Route 50 Fashion Bug Easton\nNew Town Village(5) 100% Fee 11.0 118,000 95% Giant Food,1998-2020 Lakeside Drive Blockbuster Video Owings Mills Starbucks, Hair Cuttery\nWilkens Beltway 75% Fee 7.1 77,000 100% Giant Food,1996-2014 Plaza of Provident Bank, Wilkens Avenue Partnership Radio Shack, Baltimore County Carrollton Bank\nYork Road Plaza 100% Fee 7.5 90,000 98% Giant Food,1997-2005 York Road Firestone, Starbucks Baltimore County Sears Optical, GNC Boston Market, Great Clips\nVIRGINIA PROPERTIES: Burke Town Plaza 100% Long-term 12.6 114,000 91% Safeway, 1996-2005 Old Keene Mill Road lease(6) CVS Drugs Burke\nSkyline Village(7) 100% Fee 14.6 127,000 98% Toys \"R\" 1996-2010 US Route 33 Us, Richfood Harrisonburg\nSmoketown Plaza 60% Fee 27.0 176,000 93% Hub 1996-2011 Davis Ford and of Furniture, Smoketown Roads Partnership Frank's Nursery Prince William County & Crafts\nSpotsylvania 80% Fee 11.2 142,000 100% K-Mart, 1996-2007 Crossing of CVS Drugs Route 3 & Bragg Partnership Road Fredericksburg\nITEM 2. Properties (continued)\nI. SHOPPING CENTERS (continued) A. In Operation (continued)\nType Percent- of Leas- age of land Area able Percent- Lease Name and owner- owner- in square age Principal expir- Location ship ship acres feet leased tenants ations VIRGINIA PROPERTIES (continued): Sudley Towne 100% Fee 9.6 108,000 100% Burlington 1996-2009 Plaza Coat Factory, Route 234 & Sudley Manor Dr. CVS Drug Store Manassas\nARIZONA PROPERTIES: Dobson-Guadalupe(8) 100% Fee 3.2 22,000 94% Nevada 1996-2001 Shopping Center Bob's Dobson & Guadalupe Roads Mesa\nFair Lanes Chandler 50% Fee 1.1 10,000 100% No 1996 Plaza of principal Arizona & Partnership tenants Warner Roads selected Chandler\nFair Lanes Union 50% Fee 5.9 17,000 88% No 1996-2000 Hills Plaza of principal Union Hills Drive Partnership tenants Phoenix selected\nGateway Park 100% Fee 10.5 82,000 89% Bashas', 1996-2011 Page Corral West\nPark Sedona (9) 100% Fee 11.4 99,000 98% Safeway, 1996-2011 Highway 89 A Payless Drug Sedona Store\nPlaza Del Rio (10) 100% Fee 11.8 60,000 98% Payless 1996-2009 16th Street and Avenue B Drug Store Yuma\nDELAWARE PROPERTIES: Brandywine Commons 100% Long-term 25.9 164,000 100% Shoprite, 2008-2014 Concord Pike lease (11) Computer City, Wilmington Ground Round, Sports Authority, Service Merchandise\nNEW YORK PROPERTIES: Colonie Plaza (12) 100% Fee 18.7 140,000 98% Price 1996-2010 Central Avenue Chopper, RX Place, Colonie Paper Cutter\nColumbia Plaza 100% Fee 16.0 117,000 99% Price 1996-2008 Columbia Turnpike Chopper, East Greenbush Ben Franklin\nB. Under Development MARYLAND PROPERTIES: Timonium Mall 100% Long-term 12.9 236,000 64% Caldor, 2001-2011 York & Ridgely Rds. lease (13) Circuit City Timonium\n(1) Shopping centers in operation are subject to mortgage financing aggregating $60,485,066 at December 31, 1995. (2) Subject to the following long-term ground leases: (i) 150,000 square feet on 10 acres for Montgomery Ward's department store, (ii) 10,200 square feet on one acre for Montgomery Ward's auto accessory store. The Harford Mall property is subject to a mortgage principal balance at December 31, 1995 of $19,686,335. The Harford Mall mortgage has an interest rate of 9.78%, a 30 year amortization, with a 10 year balloon payment of $18,148,848 due at the maturity date of July, 2003. The mortgage's prepayment provision prohibits prepayment until June, 1997, after which the penalty is the greater of 1% of the outstanding principal balance or yield maintenance. (3) Includes 302,000 square feet occupied by department stores. (4) Remaining term of 12 years plus two 10 year options. (5) A $13,000,000 mortgage secured by Owings Mills New Town Shopping Center is expected to close in March, 1996. This loan will bear interest at 8.05%, will be repaid on a thirty year amortization and will mature 10 years from closing. Proceeds will be used to repay the construction loan secured by this project, ($10,099,510) at December 31, 1995), as well as pay down MART's revolving line of credit. (6) Remaining term of 36 years plus three 15 year renewal options. (7) On February 26, 1996, MART closed a permanent fixed rate mortgage secured by the Skyline Village Shopping Center $5,900,000. The loan bears interest at 7.55% and will be repaid on a 15 year amortization schedule. (8) A purchase option agreement was signed on February 7, 1996 to sell this property for $850,000, which should generate a gain on the sale of approximately $195,000. (9) Park Sedona was sold on January 5, 1996 for $9,000,000, generating a gain on the sale of approximately $138,000. (10) A purchase option agreement was signed on February 22, 1996 to sell this property for $4,150,000, which should generate a loss on the sale of approximately $900,000. The Company signed this agreement at a value lower than it had considered to be market value in an effort to accelerate the divestiture of properties in Arizona. (11) Remaining term of 57 years plus two 10 year options. (12) On March 1, 1996, the mortgage loan secured by Colonie Plaza was repaid ($5,442,755 at December 31, 1995). (13) Remaining term of 21 years plus five 10 year options.\nITEM 2. Properties (Continued)\nII. OFFICE BUILDINGS A. In Operation (14) Type Percent- of Leas- age of land Area able Percent- Lease Name and owner- owner- in square age Principal expir- Location ship ship acres feet leased tenants ations MARYLAND PROPERTIES: Gateway 100% Fee 7.0 84,000 86% Browning 1997-2003 International I Ferris, Daughters Elkridge Landing & of Charity Health Winterson Roads System, Anne Arundel County US Healthcare, Tandem Computers\nGateway 100% Fee 15.5 119,000 95% AT&T, 1996-2004 International II MART, Price Elkridge Landing & Waterhouse, American Winterson Roads Express, TNT Anne Arundel County Logistics\nPatriots Plaza 50% Long-term 0.5 28,000 24% No 1996-2004 Office Building of lease (15) principal Ritchie Highway Partnership tenants Anne Arundel County selected\nWilkens Beltway 75% Fee 3.9 53,000 94% Freestate,1996-2003 Plaza Office Park of Health, Prudential Buildings I, Partnership Health System II & III Wilkens Avenue & Maiden Choice Lane Baltimore County\nIII. OTHER DEVELOPED PROPERTIES A. In Operation Type Percent- of Leas- Per- age of land Area Im- able cent- Princi- Lease Name and owner- owner- in prove- square age pal expir- Location ship ship acres ments feet leased tenants ations MARYLAND PROPERTIES: The Business Center 100% Fee 5.4 One-story 27,000 100% No 1996-2001 at Harford Mall Warehouse principal Harford County tenants selected\nClinton Property 100% Long-term2.9 Bowling 29,000 100% Fair 1996-2003 Prince George's lease (16) Center and Lanes, County Bank Suburban Bank\nSouthwest Property 100% Fee 3.2 One-story 25,000 86% Shell1998-1999 Anne Arundel Office Building, One-story Oil, Carrier\/ County Warehouse and Gas Station Otis, Potomac Air Gas\nWaldorf Property 100% Fee 3.6 Bowling 30,000 100% Fair 1997-1998 Waldorf Center and Lanes, Tire Center Firestone\nILLINOIS PROPERTIES: Illinois Properties: (17) 100% 2 par- 5.0 2 Bowling 71,000 100% Fair 1998 Chicago cels in Centers Lanes fee\n(14) Office buildings in operation are subject to mortgage financing aggregating $1,926,038 as of December 31, 1995. (15) Remaining term of 12 years plus two 10 year options. (16) Remaining term of 31 years plus a 45 year renewal option. (17) 1 of 2 Bowling Centers, Dolton Bowl, was sold on January 4, 1996 for $720,000 generating a gain on the sale of approximately $360,000.\nITEM 2. Properties (Continued) IV. UNDEVELOPED PROPERTIES\nPercentage of Type of land Area in Name and Location ownership ownership acres Zoning MARYLAND PROPERTIES: Dorsey Property 100% Fee 19.4 Commercial Anne Arundel County\nGateway International III 100% Fee 6.5 Commercial Anne Arundel County\nHarford Property 100% Fee 3.0 Light (Adjacent to Harford Mall) Industrial Harford County\nNorth East Property 100% Fee 56.0 Commercial\/ North East Residential\nNorthwood Industrial Park 67% Fee 24.5 Industrial Salisbury of Partnership\nPulaski Property 100% Fee 3.0 Industrial Baltimore County\nNORTH CAROLINA PROPERTIES: Burlington Commerce Park 100% Fee 45.5 Commercial Burlington\nHillsborough Crossing 100% Fee 8.0 Commercial Hillsborough\nManagement believes the Company's properties are adequately covered by insurance.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nIn the ordinary course of business, the Company is involved in legal proceedings. However, there are no material legal proceedings presently pending against the Company.\nITEM 4","section_4":"ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNONE\nPART II\nITEM 5","section_5":"ITEM 5 Market for the Registrant's Common Stock And Related Stockholder Matters\nMART's common shares of beneficial interest, par value $.01 per share, (\"shares\"), are listed on the American Stock Exchange (symbol: MRR), which reports high, low and last sales prices. The table below lists high and low sales prices for MART for the periods indicated.\n1995 High Low First Quarter 8 1\/2 7 3\/4 Second Quarter 9 1\/2 7 1\/2 Third Quarter 9 1\/4 8 Fourth Quarter 9 8 1\/8\n1994 High Low First Quarter 10 3\/8 8 1\/2 Second Quarter 9 3\/4 8 7\/8 Third Quarter 9 1\/4 8 1\/2 Fourth Quarter 9 1\/4 7 3\/8\n1993 High Low September 11 (Inception) - September 30 10 3\/4 10 1\/4 Fourth Quarter 11 9\nCash dividends paid to holders of MART's shares during the periods indicated are as follows:\nCash Dividend Paid 1995 1994 1993 First Quarter $0.22 $0.21 Second Quarter $0.22 $0.21 Third Quarter $0.22 $0.21 Fourth Quarter $0.23 $0.22 $0.05 ------- ------- ------- Totals $0.89 $0.85 $0.05\nFor record shareholders of MART during the entire year, for each respective year, it was determined that the per share dividends for each year indicated are taxable as follows:\nPer Share 1995 1994 1993 Ordinary Dividends - taxable as ordinary income $0.48 $0.55 $0.05 Capital Gain Distribution - taxable as capital gain - $0.06 - Non-taxable Distribution - return of capital or taxable gain - (depending on a shareholder's basis in MART shares) $0.41 $0.24 - ------- ------- ------- Total Annual Gross Dividends Per Share $0.89 $0.85 $0.05\nOn February 12, 1996, MART declared a quarterly cash dividend of $.23 per share payable March 15, 1996 to shareholders of record February 29, 1996.\nThe number of holders of record of the MART shares as of February 15, 1996 was 1,275.\nITEM 6","section_6":"ITEM 6\nSELECTED FINANCIAL DATA\nThe following table sets forth the consolidated financial data for the Company and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. The table consists of Selected Financial Data of Mid-Atlantic Realty Trust as of December 31, 1995, December 31, 1994 and December 31, 1993, and for the years ended December 31, 1995, and December 31, 1994 and for the period September 11, 1993 (commencement of operations) through December 31, 1993, and also includes Selected Financial Data of BTR Realty, Inc. as of December 31, 1992, and 1991 and for the periods January 1, 1993 through September 10, 1993, and for the years ended December 31, 1992, and 1991. Mid-Atlantic Realty Trust, a Real Estate Investment Trust, was merged with BTR Realty, Inc. on September 11, 1993. The consolidated financial data of BTR, the predecessor company, are presented for comparative purposes.\nMid-Atlantic Realty Trust || ------------------------------------------------|| September 11, || 1993 to || Year ended December 31, December 31, || 1995 1994 1993 || Revenues $24,918,971 22,848,881 6,576,684 || ============== ============= ============ || Net Earnings (Loss) || Before Cumulative || Effect of Change In || Accounting Principle and || Extraordinary Item $3,165,082 2,916,286 467,474 || Cumulative Effect of Change || In Accounting Principle 612,383 - - || -------------- ------------- ------------ || Net Earnings (Loss) Before || Extraordinary Item 3,777,465 2,916,286 467,474 || Extraordinary Item - - - || -------------- ------------- ------------ || Net Earnings (Loss) $3,777,465 2,916,286 467,474 || ============== ============= ============ || || Net Earnings (Loss) Per || Share Before Cumulative || Effect of Change In || Accounting Principle || and Extraordinary Item $0.51 0.46 0.07 || Cumulative Effect of Change || In Accounting Principle $0.10 - - || ------------- ------------- ------------ || Net Earnings (Loss) Per || Share Before || Extraordinary Item $0.61 0.46 0.07 || Extraordinary Item - - - || ------------- ------------- ------------ || Net Earnings (Loss) || Per Share $0.61 0.46 0.07 || ============= ============= ============ || || Weighted Average Shares || Outstanding, || Including Common || Share Equivalents (1) 6,176,991 6,291,407 6,291,407 || ============= ============= ============ || || Total Assets $182,521,299 162,842,567 148,563,052 || ============= ============= ============ || || Indebtedness: || Total mortgages, convertible || debentures, construction || loans and notes payable $154,020,757 133,390,553 116,494,372 || ============= ============= ============ || || Net cash provided by || (used in) operating || activities $11,193,068 7,766,044 3,479,346 || ============= ============= ============ || || Cash Dividends || Paid Per Share $0.89 0.85 0.05 || ============= ============= ============ ||\nBTR Realty, Inc. --------------------------------------------- January 1, 1993 to September 10, Years ended December 31, 1993 1992 1991\nRevenues 15,912,211 22,655,133 22,779,812\nNet Earnings (Loss) Before Cumulative Effect of Change In Accounting Principle and Extraordinary Item (2,057,106) (1,118,957) (4,688,646) Cumulative Effect of Change In Accounting Principle - 1,286,000 - -------------- ------------ ------------ Net Earnings (Loss) Before Extraordinary Item (2,057,106) 167,043 (4,688,646) Extraordinary Item (548,323) - - -------------- ------------ ------------ Net Earnings (Loss) (2,605,429) 167,043 (4,688,646) ============== ============ ============\nNet Earnings (Loss) Per Share Before Cumulative Effect of Change In Accounting Principle and Extraordinary Item (0.24) (0.13) (0.55) Cumulative Effect of Change In Accounting Principle - 0.15 - -------------- ------------ ------------ Net Earnings (Loss) Per Share Before Extraordinary Item (0.24) 0.02 (0.55) Extraordinary Item (0.06) - - -------------- ------------ ------------ Net Earnings (Loss) Per Share (0.30) 0.02 (0.55) ============== ============ ============\nWeighted Average Shares Outstanding, Including Common Share Equivalents (1) 8,512,718 8,503,916 8,527,036 ============== ============ ============\nTotal Assets 147,869,512 153,212,133 159,879,954 ============== ============ ============\nIndebtedness: Total mortgages, convertible debentures, construction loans and notes payable 150,666,971 149,168,632 153,024,838 ============== ============ ============\nNet cash provided by (used in) operating activities 4,129,635 1,249,138 (961,065) ============== ============ ============ Cash Dividends Paid Per Share 0.58 - - ============== ============ ============\n(1) In September, 1993, MART issued 3,450,000 shares in its initial public offering, and as part of the merger, exchanged for every 3 shares of BTR, 1 share of MART totaling approximately 8,526,000 shares of BTR for approximately 2,842,000 shares of MART.\nContinued\nITEM 6 - SELECTED FINANCIAL DATA - CONTINUED\nSummary Financial Data The following sets forth summary financial data on an actual and pro forma basis. Management believes the following data should be used as a supplement to the historical statements of operations. The data should be read in conjunction with the historical financial statements and the Notes thereto for MART included in Item 8. The pro forma financial data is unaudited and is not necessarily indicative of the results which actually would have occurred if the transactions had been consummated at January 1, 1992, nor does it purport to represent the financial position and results of operations for future periods. The following assumes the MART public offering took place on January 1, 1992.\nSummary Financial Data In thousands, except per share data\nYears ended December 31, 1995 1994 1993 1992 ACTUAL ACTUAL PROFORMA\nRevenues $24,919 22,849 20,777 20,051\nEarnings $3,777 2,916 1,217 494 Earnings per share $0.61 0.46 0.19 0.08\nFunds from operations (FFO) (1): Primary $8,008 6,797 6,034 5,398 Fully diluted $12,582 11,400 10,609 9,973\nNet Cash Flow Provided by operating activities $11,193 7,766 N\/A (2) N\/A (2) Used in investing activities $23,584 19,630 N\/A (2) N\/A (2) Provided by financing activities $12,561 11,521 N\/A (2) N\/A (2)\nWeighted average number of shares outstanding: Primary 6,177 6,291 6,291 6,291 Fully diluted 11,889 12,005 12,005 12,005\n(1) Funds from operations as defined by the National Association of Real Estate Investment Trusts, Inc. (NAREIT) - funds from operations means net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO does not represent cash flows from operations as defined by generally accepted accounting principles (GAAP). FFO is not indicative that cash flows are adequate to fund all cash needs and is not to be considered as an alternative to net income as defined by GAAP. The presentation of FFO is not normally included in financial statements prepared in accordance with GAAP. (2) Net Cash Flow activities cannot be reasonably estimated on a pro forma basis for 1993 and 1992.\nQuarterly Results of Operations (Unaudited)\nThe unaudited quarterly results of operations for MART for 1995 are summarized as follows:\nQuarter ended 1995 March 31, June 30, September 30, December 31,\nRevenues $6,260,154 6,012,769 6,044,535 6,601,513\nEarnings before Cummulative Effect of Change in Accounting Principle $1,352,427 570,058 531,636 710,961 Cummulative Effect of Change In Accounting Principle $612,383 - - - ----------- ----------- ----------- ---------- Net Earnings $1,964,810 570,058 531,636 710,961 =========== =========== =========== ========== Net Earnings per share $0.31 0.09 0.09 0.12 =========== =========== =========== ==========\nThe unaudited quarterly results of operations for MART for 1994 are summarized as follows:\nQuarter ended 1994 March 31, June 30, September 30, December 31,\nRevenues $5,556,016 5,868,272 5,444,666 5,979,927\nNet earnings $700,334 750,505 317,461 1,147,986 =========== =========== =========== =========\nNet earnings per share $0.11 0.12 0.05 0.18 =========== =========== =========== =========\nQuarterly results are influenced by a number of factors including timing of settlements of property sales, completion of operating projects, and write-offs of unrecoverable development costs.\nITEM 7","section_7":"ITEM 7\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion compares the Company's operations for the year ended December 31, 1995, with the year ended December 31, 1994. The discussion also compares the Company's operations for the year ended December 31, 1994 with the year ended December 31, 1993, which includes the summation of the Company's and BTR's results of operations.\nComparison of 1995 to 1994\nRental revenues increased by $2,023,000, or 9%, to $23,914,000 for the year ended December 31, 1995 from $21,891,000 for the year ended December 31, 1994. Two acquisitions, Easton Shoppes in September, 1994 and Brandywine Commons in November, 1995, contributed to rental increases of $943,000 and $222,000, respectively. Also, new redevelopment and development projects contributed $527,000 to rental revenue increases. Additionally, net increases, primarily in occupancy and rental rates, resulted in rental increases of $763,000. The rental increases were offset by a $357,000 decrease in rental revenues attributable to the sale in February, 1995 of the Regal Row warehouse project and the sale in December, 1994 of the Oakton Bowling center. In addition, $75,000 in net rental decreases were primarily related to vacancies.\nLoss (gain) on sales of properties held for sale decreased by $103,000 to a loss of $22,000 in 1995 from a gain of $81,000 in 1994. The decrease was attributable to a $25,000 net loss on the sales of lots in North Carolina as well as a $3,000 gain on the sale of an Arizona outparcel in 1995. In 1994, there was a $31,000 net gain on the sales of lots in North Carolina, as well as a $50,000 gain on the sale of a lot in Fallston, Maryland.\nOther income increased by $150,000 to $1,027,000 in 1995 from $877,000 in 1994 primarily from an increase due to fire insurance proceeds for lost rent at Rolling Road which was damaged by a fire in December, 1992, interest income increases and from other income increases at Patriots Plaza and Wilkens Office II.\nAs a result of the above changes, total revenues increased by $2,070,000 to $24,919,000 in 1995 from $22,849,000 in 1994.\nInterest expense increased by $1,005,000 to $11,348,000 in 1995 from $10,343,000 in 1994 primarily due to the two new acquisitions, Easton Shoppes and Brandywine Commons, which contributed to interest expense increases of $692,000, and $97,000, respectively. Also, new redevelopment and development projects contributed $268,000 to interest expense increases. The interest expense increases were offset by $59,000 in interest expense decreases related to interest rate reductions, and $25,000 in interest expense decreases from principal reductions.\nDepreciation and amortization increased by $481,000 to $5,564,000 from $5,083,000 primarily due to the redevelopment at Harford Mall and York Road, the Easton Shoppes acquisition, and to tenant improvements at the Gateway I & II Offices. The increases were offset by depreciation decreases primarily from the aforementioned sale of the Regal Row warehouse property.\nOperating expenses decreased by $249,000 to $3,088,000 from $3,337,000 primarily due to $156,000 in lower legal fees related to a tenant suit, settled in 1995, at the Smoketown Plaza project. Operating expenses also decreased by $144,000 due to the sales of the aforementioned Regal Row warehouse project and the Oakton bowl project sold in December, 1994. Other net operating expense decreases of $70,000 were primarily related to higher tenant occupancy resulting in lower landlord operating expenses. The operating expense decreases were offset primarily by $70,000 in operating expense increases related to McRay Plaza, sold in December, 1995 and Park Sedona Plaza, sold in January, 1996 and $51,000 in operating expense increases related to the new acquisition, Brandywine Commons.\nGeneral and administrative expenses increased by $29,000 to $1,780,000 from $1,751,000 due primarily to a $92,000 increase in net payroll expense, $52,000 in other net expense increases offset by a $82,000 decrease in insurance expense and a $33,000 decrease in legal fees.\nMinority interest expense increased by $177,000 to $718,000 from $541,000 generally due to higher earnings in minority interest ventures in 1995.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nComparison of 1995 to 1994 - Continued\nEarnings from operations increased by $627,000 to $2,421,000 from $1,794,000. Certain non-operating items occurred for both periods. For the year ended December 31, 1995, MART recognized a loss on the sale of the Regal Row warehouse operating property of $377,000, a gain on the sale of the McRay Shopping Center in Arizona of $119,000, a cumulative effect of a change in accounting for percentage rents of $612,000 and a gain on life insurance proceeds of $1,002,000, which, when combined with earnings from operations resulted in net earnings of $3,777,000 for the period. For the year ended December 31, 1994, MART recorded a gain on sales of operating properties of $1,122,000, and, when combined with the earnings from operations for the period, resulted in net earnings of $2,916,000.\nComparison of 1994 to 1993\nRental revenues increased by $1,209,000, or 6%, to $21,891,000 for the year ended December 31, 1994 from $20,682,000 for the year ended December 31, 1993. Net increases in occupancy and CPI rental rates resulted in rental increases of approximately $1,125,000. Additionally, two acquisitions, Timonium Mall in October, 1993 and Easton Shoppes in September, 1994, contributed to rental increases of $600,000 and $374,000, respectively. The rental increases were offset by a $732,000 loss of rental attributable to operating properties sold or discontinued in 1993, a $74,000 loss of rental attributable to the redevelopment of York Road Plaza in 1994, and $84,000 in other net rental decreases.\nSales of residential property decreased by $1,032,000 due to the discontinuation and final sellout of BTR's residential assets in July, 1993.\nGains on sales of properties held for sale increased by $50,000 to $81,000 in 1994 from $31,000 in 1993 due to higher profit margins on properties sold in 1994.\nOther income increased by $133,000 to $877,000 in 1994 from $744,000 in 1993 primarily as a result of $424,000 in interest income increases from partners' notes receivables added in September, 1993, and increases due to a $166,000 loss included in BTR's other income in September, 1993 related to a provision for losses on notes receivable. The increases were offset by decreases due to a $210,000 decrease in income from a lease termination payment recorded as other income in December, 1993 and $247,000 in net decreases primarily related to higher tenant lease cancellation charges and fees in 1993.\nAs a result of the above changes, total revenues increased by $360,000 to $22,849,000 in 1994 from $22,489,000 in 1993.\nInterest expense decreased by $2,011,000 to $10,343,000 in 1994 from $12,354,000 in 1993 primarily due to the payoff in September, 1993 of higher fixed rate mortgage debt which was replaced by the sale of lower interest convertible subordinated debentures and the sale of common shares. Approximately $1,839,000 in interest expense decreases can be attributable to the payoff of mortgage debt and replacement with debentures and common shares. A decrease in interest expense of $409,000 can be attributable to the discontinuation of operations in September, 1993 of a residential operating property sold in February, 1994. Other net decreases of $100,000 in interest expense are generally related to projects terminated in 1993 and principal paydowns. Additionally, the interest expense decreases were offset by increases from the two new acquisitions, Timonium Mall in October, 1993 and Easton Shoppes in September, 1994, which contributed to interest increases of $106,000 and $231,000, respectively.\nDepreciation and amortization increased by $347,000 to $5,083,000 in 1994 from $4,736,000 in 1993, primarily due to the following increases: amortization of debentures sold in September, 1993, $204,000, new acquisitions - Timonium, $99,000, and Easton, $57,000, new tenant improvements Gateway I & II, $64,000, and new redevelopment, Rolling Road Plaza, $28,000. The increases were offset by a $111,000 decrease in depreciation expense due to the discontinuation of operations in September, 1993 of a residential property sold in February, 1994.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nComparison of 1994 to 1993 - Continued\nOperating expenses decreased by $417,000 to $3,337,000 in 1994 from $3,754,000 in 1993, primarily due to the discontinuation in September, 1993 of the residential operating property sold in February, 1994 which decreased operating expenses by $321,000. In addition, operating expense decreased by $117,000 as a result of the sale of certain projects, Harbour Island and Plantation Bowl,which were sold in July, 1993 and January, 1994, respectively. Some operating expense decreases were due to projects with additional occupancy in 1994, which included Columbia Plaza, $68,000, Sedona, $57,000, & McRay, $49,000. Other projects had operating decreases due to various gross expense decreases, such as Burke Town, $43,000 (primarily legal fees decreased) and York Road Plaza, $28,000 (primarily real estate taxes decreased). These major decreases in operating expenses were offset by increases in operating expenses primarily related to the new acquisition of Timonium of $173,000 and additional legal fees related to the Smoketown Plaza project of $101,000.\nCost of residential property sold decreased by $1,008,000 due to the discontinuation of the residential sales in July, 1993.\nGeneral and administrative expenses increased by $397,000 to $1,751,000 in 1994 from $1,354,000 in 1993 due to an increase of $120,000 in payroll expenses which was due to the adoption, in 1994, of an incentive based compensation plan. In addition, payroll expenses increased by $158,000 primarily due to fewer payroll costs capitalized in 1994. Other increases in general and administrative expenses were related to additional shareholder related costs of $52,000, an increase in 401K Plan expense of $45,000 due to a one time downward expense adjustment in December, 1993, and various other net increases totaling $104,000. The increases were offset by decreases in general and administrative expenses related to lower outside professional fees of $33,000 and a decrease of $49,000 in stock compensation expense.\nUnrecoverable development costs decreased by $1,279,000 due to write-downs in 1993 to net realizable value of two residential properties under contract of sale pursuant to a divestiture plan and the write-down in 1993 to net realizable value of a property held for sale.\nMinority interest expense increased by $539,000 to $541,000 in 1994 from $2,000 in 1993 generally due to higher earnings in minority interest ventures.\nEarnings from operations increased by $3,792,000 to $1,794,000 in 1994 from a loss from operations of $1,998,000 in 1993. At September 10, 1993, BTR recorded an extraordinary loss of $548,000 due to an early extinguishment of debt. A net income tax benefit of $408,000 was recognized by BTR for the period January 1 to September 10, 1993. The 1993 extraordinary item and income tax benefit for the combined year ended December 31, 1993, offset the loss from operations for the period resulting in a $2,138,000 net loss for the combined year ended 1993 for BTR and the Company. For the year ended December 31, 1994, the Company recorded a gain on the sales of operating properties of $1,122,000, and, when combined with the earnings from operations for the period, resulted in net earnings of $2,916,000 for the year ended December 31, 1994.\nCash Flow comparison\nThe following discussion compares the statements of cash flows of the Company for the year ended December 31, 1995 with the statements of cash flows for the year ended December 31, 1994. The discussion also compares the statments of cash flows of the Company for the year ended December 31, 1994 with the statements of cash flows for the year ended December 31, 1993, which includes the summation of the Company's and BTR's cash flows.\nCash Flow comparison of 1995 to 1994\nNet cash flow provided by operating activities increased by $3,427,000, to $11,193,000 for the year ended December 31, 1995 from $7,766,000 for the year ended December 31, 1994. Net cash flow increased generally due to the following: an increase in net earnings of $861,000 (described above), an increase of $658,000 due to increases in depreciation and minority interest expense adjustments, a $1,379,000 increase related to the gain on the sales of operating properties in 1994 offset by a net loss on the sales of operating properties in 1995, and a $1,933,000 increase in operating liabilities. The cash flow increases were offset by a decrease in operating assets of $1,404,000.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nCash Flow comparison of 1995 to 1994 - Continued\nNet cash flow used in investing activities increased by $3,954,000, to $23,584,000 from $19,630,000. The increase was primarily a result of the following: acquistions and additions to properties which resulted in an increase of $7,325,000 (primarily the acquistion of Brandywine Commons, the Owings Mills development project and the redevelopment projects in 1995 exceeding the Easton Shoppes acquisition in 1994), a decrease in cash flow used in investing activities related to an increase in proceeds from sales of properties of $1,652,000, and an increase of $1,719,000 related to an increase in receipts from minority partners in 1995.\nNet cash flow provided by financing activities increased by $1,040,000, to $12,561,000 from $11,521,000. The increase was primarily from two major net cash increases: (1) a $10,100,000 cash increase due to the addition to construction loan payable for the new Owings Mills New Town shopping center under development, and (2) $9,603,000 in cash increases due to additions to mortgages payable primarily related to the closing of mortgages in 1995 for the Shoppes at Easton and York Road redevelopment. The increases were offset by decrease in cash flow provided by financing activities primarily from two major cash decreases: (1) a decrease of $15,949,000 in cash flows due to a net increase in payments on notes payable, and (2) a $2,235,000 decrease in cash flow due to the purchase of common shares in 1995, (3) a decrease in cash due to an increase of $347,000 in deferred finance costs, and (4) a decrease in cash flow due to an increase in dividends paid in 1995 of $132,000.\nCash Flow comparison of 1994 to 1993\nNet cash flow provided by operating activities increased by $157,000, to $7,766,000 for the year ended December 31, 1994 from $7,609,000 for the year ended December 31, 1993. Net cash flow increased generally due to the following: An increase in net earnings of $5,054,000 (described above), an increase of $886,000 due to increases in depreciation and minority interest expense adjustments, an increase of $611,000 due to increased lease cancellation fees deferred in 1994, an increase of $461,000 due to deferred income tax liability for 1993 (See Note K of notes to the consolidated financial statements), and the balance of the increases, $31,000, was an increase in operating assets. The increases were offset by decreases of $4,138,000 related to reductions in operating liabilities. Other major decreases in net cash flow were due to $1,279,000 in unrecoverable development cost decreases, a $1,122,000 decrease related to the gain on the sales of operating properties in 1994, and other decreases totaling $347,000 primarily related to the extraordinary loss on early extinguishment of debt in 1993.\nNet cash flow used in investing activities increased by $13,680,000, to $19,360,000 from $5,950,000. The increase was primarily a result of the following: acquisitions and additions to properties which resulted in an increase of $14,644,000 (primarily the Shoppes at Easton acquisition in September, 1994), a decrease in cash flow used in investing activities related to an increase in proceeds from sales of properties of $1,617,000 (primarily due to sales of land held for sale and operating properties in 1994), and an increase of $653,000 related to an increase in payments to minority partners in 1994.\nNet cash flow provided by or used in financing activities increased by $12,591,000, to net cash provided by financing activities of $11,521,000 from net cash used in financing activities of $1,070,000. The increase was primarily from three major net cash increases: (1) $18,369,000 in cash increases due to net additions to notes payable primarily in 1994 for tha acquisition of the Shoppes at Easton in September, 1994 and the land for the new Owings Mills New Town shopping center under development purchased in December, 1994, (2) net reductions in 1993 in construction loans payable, and mortgages payable of $84,560,000, (3) 1993 additions to deferred debenture costs of $3,063,000. The increases were offset by a decrease in cash flow provided by financing activities resulting from the net cash flow provided by the net proceeds in 1993 from the sale of debentures and common shares of $93,453,000. Other net increases for the period totaled $52,000.\nLiquidity and Capital Resources\nMART improved its liquidity in September, 1993 with the conversion from BTR. The initial public share and debenture offering on September 10, 1993 replaced higher fixed rate mortgage debt with lower interest convertible subordinated debentures and the sale of common shares.\nIn order to qualify as a REIT for Federal income tax purposes, MART is required to pay dividends to its shareholders of at least 95% of its REIT taxable income. MART intends to pay these dividends from operating cash flows which have increased due to the reduction in debt service resulting from the repayment of indebtedness with the proceeds of the offering, and from future growth in rental revenues and other sources, such as the leasing of currently vacant space and development of undeveloped parcels. While MART intends to distribute to its shareholders a substantial portion of its cash flows from operating activities, MART also intends to retain or reserve such amounts as it considers necessary from time to time for the acquisition or development of new properties as suitable opportunities arise and for the expansion and renovation of its shopping centers. Also, MART currently has and will continue to maintain a line of credit of at least $40,000,000 from a commercial bank (See Note I of notes to the consolidated financial statements).\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nLiquidity and Capital Resources - Continued\nThe Company anticipates material committments for capital expenditures to include, in the next two years, the redevelopment or development of four Maryland projects with an additional four redevelopment projects in the planning stage at an estimated cost between $14 and $25 million. The Company expects to fund the development projects and other capital expenditures with (i) available net cash flows from operating activities, (ii) if necessary, construction loan financing, (iii) if necessary, long term mortgage financing on unencumbered operating properties, and (iv) if necessary, the use of its $40,000,000 line of credit from a commercial bank (See Note I of notes to the consolidated financial statements).\nIt is management's intention that MART continually have access to the capital resources necessary to expand and develop its business. Management cannot practically quantify MART's 1996 cash requirements, but, expects to meet its short-term liquidity requirements generally through available net cash flow provided by operations and short-term borrowings. To meet its long-term liquidity requirements, MART intends to obtain funds through additional equity offerings or long-term debt financing in a manner consistent with its intention to operate with a conservative debt capitalization policy. MART anticipates that the cash flow available from operations, together with cash from borrowings, will be sufficient to meet the capital and liquidity needs of MART in both the short and long term.\nNew Accounting Standards\nEffective January 1, 1995 the Company changed its accounting treatment for percentage rent. Percentage rent revenues are based on store sales for certain periods and are charged according to a percentage over a breakpoint amount of sales for the period according to the lease agreement. During the year ended December 31, 1994 and previously, percentage rent was recognized as rental revenues in the period when the actual percentage rent was billed and received. The new method will recognize percentage rent as rental revenues in the period when the actual percentage rent is earned. On January 1, 1995, the Company began estimating the percentage rent earned from major tenants and recorded the amounts monthly as receivable. The cumulative effect of this change on January 1, 1995 was $612,383. The Company believes that this change is preferable since it provides better matching of revenues and expenses.\nEffective April 1, 1994 the Company adopted a new accounting treatment regarding lease cancellation fees received from tenants who want to discontinue their remaining lease term obligations. Prior to April 1, 1994, the lease termination payments for major tenants were recognized as other income in the period when the termination agreement was executed. Under the new treatment, the entire amount of the cancellation or termination fee on the date of the lease termination is deferred and then amortized into income on a straight-line basis over the remaining original lease term as minimum rent. The Company believes that this change is preferable since it provides a better matching of revenues and expenses. During 1994, approximately $687,000 of termination fees were deferred, and $56,000 were amortized. During 1995, approximately $772,000 of termination fees were deferred, and $266,000 were amortized.\nDeferred Financing Costs\nEffective January 1, 1996 the Company changed its reporting of amortization of deferred finance costs. During the year ended December 31, 1995 and previously, the annual amortization of deferred finance costs was reported in the depreciation and amortization of property and improvements expense line on the consolidated statements of operations. Effective January 1, 1996, the Company will be reporting the annual amortization of deferred finance costs in the interest expense line on the consolidated statement of operations. The Company will restate all comparative prior year interest and depreciation and amortization expense line items. The change will have no effect on the presentation of net earnings, but will only reclassify interest expense and depreciation and amortization expense line items.\nInflation\nThe majority of all of the leases at the shopping center properties contain provisions which may entitle MART to receive percentage rents based on the tenants' gross sales. Such percentage rents ameliorate the risk to MART of the adverse effects of inflation. Percentage rent received by MART remained stable in the year ended December 31, 1995 compared to the year ended December 31, 1994. If a recession were to begin and continue for a prolonged time, funds from operations could decline as some tenants may have trouble meeting their lease obligations. Most of the leases at the properties require the tenants to pay a substantial share of operating expenses, such as real estate taxes, insurance and common area maintenance costs, and thereby reduce MART's exposure to increased costs. In addition, many of the leases at the properties are for terms of less than 10 years, which may enable MART to seek increased rents upon renewal of existing leases if rents are below the then-existing market value.\nStock Repurchase Plan\nOn February 14, 1995 the MART Board of Trustees approved a stock repurchase plan. Under this plan, MART may, from time to time, repurchase shares of its common stock either in the open market or in privately negotiated transactions upon such prices and other terms as the Company deems appropriate. The aggregate number of shares authorized on February 14, 1995 for repurchase could not exceed 5% of the number of shares currently outstanding, or approximately 310,000. On February 12, 1996 the MART Board of Trustees increased by 100,000 the authorized number of shares that may be repurchased up to 410,000.\nITEM 8","section_7A":"","section_8":"ITEM 8\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES, & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) Financial Statements: Independent auditors' report ......................24\nConsolidated Balance Sheets - as of December 31, 1995 and 1994 ................25\nConsolidated Statements of Operations - For the Years ended December 31, 1995 and 1994 and the Periods ended December 31, 1993 and September 10, 1993 ..............................26\nConsolidated Statements of Shareholders' Equity - For the Years ended December 31, 1995 and 1994 and the Periods ended December 31, 1993 and September 10, 1993 ..............................27\nConsolidated Statements of Cash Flows - For the Years ended December 31, 1995 and 1994 and the Periods ended December 31, 1993 and September 10, 1993 ..............................28\nNotes to Consolidated Financial Statements ........30\nExhibits, Financial Statement Schedule, and Reports on Form 8-K are included in Part IV - Item 14.\nSchedule:\nSchedule III - Real Estate and Accumulated Depreciation ..................................40\nINDEPENDENT AUDITORS' REPORT\nBoard of Trustees and Shareholders Mid-Atlantic Realty Trust :\nWe have audited the accompanying consolidated balance sheets of Mid-Atlantic Realty Trust and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 1995, and 1994 and the period ended December 31, 1993 and the consolidated statements of operations, shareholders' equity and cash flows of BTR Realty, Inc. and subsidiaries for the period ended September 10, 1993. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mid-Atlantic Realty Trust and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years ended December 31, 1995 and 1994, and the period ended December 31, 1993, and the results of BTR Realty, Inc. and subsidiaries' operations and their cash flows for the period ended September 10, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in note A to the consolidated financial statements, the Company changed its method of accounting for percentage rents on January 1, 1995. Also, as discussed in note A, the Company changed its method of accounting for lease termination payments in 1994.\nKPMG PEAT MARWICK LLP\nBaltimore, Maryland February 15, 1996\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES\nConsolidated Balance Sheets\nAs of December 31, 1995 1994\nASSETS Properties: Operating properties (Notes C and D)............$ 204,132,134 176,511,730 Less accumulated depreciation and amortization .......... 39,430,308 36,448,969 ------------- ------------- 164,701,826 140,062,761 Development operations (Note E)................... 1,510,544 6,354,947 Property held for development or sale ....... 8,179,378 8,630,465 ------------- ------------- 174,391,748 155,048,173\nCash and cash equivalents .... 514,386 344,522 Notes and accounts receivable - tenants and other (Note F).......... 2,350,578 1,688,194 Due from joint venture partners ................... 1,599,581 1,937,019 Prepaid expenses and deposits. 449,850 402,283 Deferred financing costs (Note G) ................... 3,215,156 3,422,376 ------------- ------------- $ 182,521,299 162,842,567 ============= =============\nLIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accounts payable and accrued expenses (Note H).......... $ 4,604,848 3,534,277 Notes payable (Note I)....... 21,530,143 20,139,413 Construction loan payable (Note D)................... 10,099,510 - Mortgages payable (Note D) .. 62,411,104 53,251,140 Convertible subordinated debentures (Note J)........ 59,980,000 60,000,000 Deferred income ............. 1,222,673 730,466 Minority interest in consolidated joint ventures 1,734,799 330,893 ------------- ------------- 161,583,077 137,986,189\nShareholders' Equity (Note L): Preferred shares of beneficial interest, $.01 par value, authorized 2,000,000 shares, issued and outstanding, none .......... - - Common shares of beneficial interest, $.01 par value, authorized 100,000,000, issued and outstanding, 6,016,111, and 6,291,407, respectively...... 60,161 62,914 Additional paid-in capital .. 40,389,783 42,602,505 Distributions in excess of accumulated earnings ........ (19,511,722) (17,809,041) ------------- ------------- 20,938,222 24,856,378 Commitments (Note M) ------------- ------------- $ 182,521,299 162,842,567 ============= =============\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) Consolidated Statements of Operations\nMid-Atlantic Realty Trust ||BTR Realty, Inc. September 11 || to || January 1 to Years Ended December 31, December 31,|| September 10, 1995 1994 1993 || 1993 || REVENUES: || Rentals .......... $23,914,267 21,890,446 6,061,175 || 14,620,418 (Loss) gain on sales of properties held || for sale, net ..... (22,631) 81,313 - || 31,501 Sales of residential || property .......... - - - || 1,032,000 Other (Note O) ...... 1,027,335 877,122 515,509 || 228,292 ------------ ----------- ---------- || ----------- 24,918,971 22,848,881 6,576,684 || 15,912,211 ------------ ----------- ---------- || ----------- COSTS AND EXPENSES: || Interest ............11,347,541 10,342,725 3,076,060 || 9,278,198 Depreciation and || amortization of property || and improvements .. 5,564,395 5,083,384 1,502,449 || 3,233,530 Operating............ 3,087,593 3,336,415 1,104,193 || 2,649,341 General and || administrative .... 1,780,397 1,751,101 300,625 || 1,053,295 Cost of residential || property sold...... - - - || 1,008,475 Unrecoverable || development costs.. - - - || 1,278,817 ------------ ----------- ---------- || ----------- 21,779,926 20,513,625 5,983,327 || 18,501,656 ------------ ----------- ---------- || ----------- EARNINGS (LOSS) FROM || OPERATIONS BEFORE || MINORITY INTEREST .. 3,139,045 2,335,256 593,357 || (2,589,445) Minority interest || (expense) benefit .. (718,019) (540,744) (125,883) || 124,129 ------------ ----------- ---------- || ----------- EARNINGS (LOSS) FROM || OPERATIONS ......... 2,421,026 1,794,512 467,474 || (2,465,316) Gain on life insurance || proceeds (Note P)... 1,001,787 - - || - (Loss) gain on sales of || operating properties (257,731) 1,121,774 - || - ------------ ----------- ---------- || ----------- || EARNINGS (LOSS) BEFORE INCOME || TAXES, CUMULATIVE EFFECT OF || CHANGE IN ACCOUNTING PRINCIPLE || AND EXTRAORDINARY || ITEM 3,165,082 2,916,286 467,474 || (2,465,316) Income tax benefit, || net (Note K) ...... - - - || 408,210 ------------ ----------- ---------- || ----------- EARNINGS (LOSS) BEFORE || CUMULATIVE EFFECT OF || CHANGE IN ACCOUNTING || PRINCIPLE AND || EXTRAORDINARY ITEM . 3,165,082 2,916,286 467,474 || (2,057,106) Cumulative effect of || change in accounting || for percentage || rents .............. 612,383 - - || - ------------ ----------- ---------- || ----------- EARNINGS (LOSS) BEFORE || EXTRAORDINARY ITEM . 3,777,465 2,916,286 467,474 || (2,057,106) Extraordinary item - || Loss on early || extinguishment || of debt ............ - - - || (548,323) ------------ ----------- ---------- || ----------- NET EARNINGS || (LOSS) ............$ 3,777,465 2,916,286 467,474 || (2,605,429) ============ =========== ========== || =========== || Earnings (loss) per share || before cumulative effect || of change in accounting || principle and extraordinary || item ............. $ 0.51 0.46 0.07 || (0.24) Cumulative effect of change || in accounting principle 0.10 - - || - ------------ ----------- ---------- || ----------- Earnings (loss) per || share before extraordinary || item .............. 0.61 0.46 0.07 || (0.24) Extraordinary item - || early extinguishment || of debt ........... - - - || (0.06) ------------ ----------- ---------- || ----------- NET EARNINGS (LOSS) || PER SHARE .........$ 0.61 0.46 0.07 || (0.30) ============ =========== ========== || ===========\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) Consolidated Statements of Shareholders' Equity Years Ended December 31, 1995, 1994 and 1993\nDistributions Additional in Excess of Net Common Par Paid-in Accumulated Shareholders' Shares Value Capital Earnings Equity\nBTR REALTY, INC. BALANCE, January 1, 1993 8,503,916 $85,039 9,078,718 (7,980,227) 1,183,530\nStock issued through the exercise of options pursuant to the BTR stock compensation plan 78,286 783 224,475 - 225,258 Stock canceled for repayment of a note receivable from a former employee (56,554) (566) (176,485) - (177,051) Dividend paid - $.58 per share - - - (4,944,879) (4,944,879) Net loss - - - (2,605,429) (2,605,429) ---------- ------- ---------- ------------ ----------- BALANCE, September 10, 1993 8,525,648 85,256 9,126,708 (15,530,535) (6,318,571) ==========================================\nMID-ATLANTIC REALTY TRUST\nConversion of 3 shares of BTR for 1 share of MART (5,683,765)(56,837) 56,837 - - Acquisition of fractional Shares (476) (5) (5,024) - (5,029) Initial sale of common shares of beneficial interest 3,450,000 34,500 33,423,984 - 33,458,484 Dividend paid - $.05 per share - - - (314,570) (314,570) Net Earnings - - - 467,474 467,474 ---------- ------- ----------- ------------- ------------ BALANCE, December 31, 1993 6,291,407 62,914 42,602,505 (15,377,631) 27,287,788 ========== ======= =========== ============= ============\nDividends paid - $.85 per share - - - (5,347,696) (5,347,696) Net Earnings - - - 2,916,286 2,916,286 ---------- ------- ----------- ------------- ------------ BALANCE, December 31, 1994 6,291,407 62,914 42,602,505 (17,809,041) 24,856,378 ========== ======= =========== ============= ============\nConversion of convertible subordinated debentures 1,904 19 19,122 - 19,141\nShare purchase plan (277,200) (2,772) (2,231,844) - (2,234,616)\nDividends paid - $.89 per share - - - (5,480,146) (5,480,146) Net earnings - - - 3,777,465 3,777,465 ---------- ------- ----------- ------------- ------------ BALANCE, December 31, 1995 6,016,111 $60,161 40,389,783 (19,511,722) 20,938,222 ========== ======= =========== ============= ============\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR)\nConsolidated Statements of Cash Flows\nMid-Atlantic Realty Trust ||BTR Realty, Inc. September 11 || to || January 1 to Year Ended December 31, December 31,|| September 10, 1995 1994 1993 || 1993 || Cash flows from || operating activities: || Net earnings (loss) $3,777,465 2,916,286 467,474 || (2,605,429) Adjustments to reconcile || net earnings (loss) || to net cash provided || by operating activities: || Depreciation and || amortization .... 5,564,395 5,083,384 1,502,449 || 3,233,530 Minority interest || in earnings (loss), || net ............. 718,019 540,744 125,883 || (124,129) Loss (gain) on sales || of operating || properties ...... 257,731 (1,121,774) - || - Loss (gain) on sales of || residential properties || and properties held || for sale, net ... 22,631 (81,313) - || (7,976) Unrecoverable || development costs - - - || 1,278,817 Loss on early || extinguishment || of debt - || capitalized ..... - - - || 273,308 Deferred income || taxes benefit ... - - - || (460,570) Changes in operating || assets and liabilities: || (Increase) decrease || in operating || assets ......... (709,951) 694,434 108,480 || 555,067 Increase (decrease) || in deferred rental || income .......... 505,887 610,678 (974,173) || 974,173 Increase (decrease) || in operating || liabilities .... 1,056,891 (876,395) 2,249,233 || 1,012,844 ----------- ---------- ---------- || ----------- Total || adjustments... 7,415,603 4,849,758 3,011,872 || 6,735,064 ----------- ---------- ---------- || ----------- NET CASH PROVIDED BY || OPERATING || ACTIVITIES 11,193,068 7,766,044 3,479,346 || 4,129,635 ----------- ---------- ---------- || ----------- || Cash flows from || investing activities: || Additions to || properties .... (29,522,542)(22,197,577) (6,173,532) || (1,379,710) Proceeds from sales || of properties.. 4,914,988 3,263,444 - || 1,646,748 Payments to minority || partners ..... (779,675) (792,394) (256,009) || (117,382) Receipts from minority || partners ..... 1,803,000 96,800 42,253 || 287,606 ----------- ---------- ---------- || ----------- NET CASH (USED IN) || PROVIDED BY || INVESTING || ACTIVITIES $(23,584,229)(19,629,727) (6,387,288) || 437,262 ----------- ----------- ---------- || -----------\n(CONTINUED)\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR)\nConsolidated Statements of Cash Flows (Continued)\nMid-Atlantic Realty Trust ||BTR Realty, Inc. September 11 || to || January 1 to Year Ended December 31, December 31,|| September 10, 1995 1994 1993 || 1993 || Cash flows from || financing activities: || Proceeds from || notes payable ..$ 80,400,000 39,456,366 3,100,000 || 90,832,649 Principal payments || on notes payable (79,009,270)(22,116,953) (87,486,651)|| (7,475,452) Proceeds from || mortgages payable 16,400,000 - - || 2,682,600 Principal payments || on mortgages || payable ....... (7,240,036) (443,232) (3,143,953)|| (46,709,513) Proceeds from || construction || loans payable .. 10,099,510 - - || - Payments on || construction || loans payable .. - - - || (37,831,945) Additions to deferred || finance costs - || other........... (374,417) (27,388) (171,954)|| (45,149) Proceeds from sale || of convertible || debentures ..... - - 60,000,000 || - Additions to deferred || finance costs - || debentures...... - - (3,063,274)|| - Net proceeds from || sale of common || shares ......... - - 33,453,455 || - Stock issued - || options exercised || in compensation || plan .......... - - - || 225,258 Stock canceled - || employee note || payment ....... - - - || (177,051) Shares purchased (2,234,616) - - || - Dividends paid .. (5,480,146) (5,347,696) (314,570)|| (4,944,879) ----------- ----------- -----------|| ----------- NET CASH PROVIDED || BY (USED IN) || FINANCING || ACTIVITIES ... 12,561,025 11,521,097 2,373,053 || (3,443,482) ----------- ----------- -----------|| ----------- NET INCREASE (DECREASE) || IN CASH AND CASH || EQUIVALENTS 169,864 (342,586) (534,889)|| 1,123,415 || CASH AND CASH || EQUIVALENTS, || beginning of period 344,522 687,108 1,221,997 || 98,582 ----------- ----------- -----------|| ----------- || CASH AND CASH || EQUIVALENTS, || end of period .....$ 514,386 344,522 687,108 || 1,221,997 =========== =========== ===========|| =========== || Supplemental disclosures of || cash flow information: || Cash paid for: || Interest ...........$11,760,934 10,404,859 1,659,428 || 9,218,811 Income taxes ....... - - 20,560 || 16,813 =========== =========== ===========|| ===========\nSupplemental information of noncash investing and financing activities:\nIn April, 1995 $20,000 in convertible debentures were converted to 1,904 common shares of beneficial interest decreasing convertible subordinated debentures by $20,000, decreasing net deferred financing costs by $859 and increasing shareholders' equity by $19,141.\nDuring 1995 and 1994, respectively, $19,838,543 and $2,832,641 in assets were transferred from Development Operations to Operating Properties.\nAt December 31, 1993, MART recorded an asset on the balance sheet, net assets of properties to be sold of $449,219. The reclassification of the assets and liabilities consisted of the following: a decrease in operating properties of $6,505,807, a decrease in operating assets of $304,377, a decrease in deferred financing costs of $323,449, a decrease in operating liabilities of $42,419, and a decrease in mortgages payable of $6,641,995. Proceeds from sales of properties for the year ended December 31, 1994 included net proceeds of $504,820 from the sale, in February, 1994, of net assets of properties to be sold which included proceeds of $7,146,815 reduced by the payoff of the mortgage payable of $6,641,995.\nOn September 10, 1993, BTR reported a loss on an early extinguishment of debt of $548,323. The loss included prepayment penalties and loan fee expenses amounting to $275,015, and a reduction of net amortized financing costs capitalized as costs of the related operating properties of $273,308.\nIn August, 1993, a former Officer of BTR surrendered 56,544 shares of BTR stock as full repayment of his note receivable.\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYears Ended December 31, 1995, 1994, 1993\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nMid-Atlantic Realty Trust, \"the Company\", was incorporated on June 29, 1993 and commenced operations effective with the completion of its initial public share offering on September 11, 1993. The Company is the successor to the operations of BTR Realty, Inc., \"BTR\". The Consolidated Financial Statements for the period January 1, 1993 through September 10, 1993 of BTR Realty, Inc. are presented for comparative purposes.\nDescription of Business\nThe Company is a fully integrated, self managed real estate investment trust which owns, leases, develops, redevelops and manages its retail shopping center facilities and commercial properties. The Company's primary objective is to manage the properties for long-term cash flow growth. The Company's principal strategies are to grow the portfolio through the selective acquisition of additional properties in the Mid-Atlantic region, redeveloping or developing retail properties on a selective basis, and, when appropriate, divesting through sale or exchange of non-strategic properties.\nThe commercial real estate development and investment industry is subject to widespread competition for desirable sites, tenants and favorable financing. The industry is extremely fragmented and there are no principal methods of competition. However, the ability to compete is dependent in part upon the ability to find and complete appropriate real estate investments in a timely manner. While many competitors have fewer assets and financial resources than the Company, there are many competitors with greater financial resources competing for similar business activities. Accordingly, it is not possible to estimate the Company's position in the industry. In addition, certain of the Company's real estate projects are near unimproved sites that could be developed commercially and would provide further competition to the Company. The management of the Company believes, however, that the Company competes favorably in the industry due to the quality of its developments, its ability to take advantage of opportunities as they arise, its access to capital, and its reputation in the industry.\nBasis of Presentation\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and judgements that affect the reported amounts of assets and liabilities and disclosures of contigencies at the date of the financial statements and revenues and expenses recognized during the reporting period. Actual results could differ from those estimates.\nPrinciples of Consolidation\nThe consolidated financial statements include all wholly-owned subsidiaries and majority-owned partnerships. Investments in unconsolidated joint ventures are carried on the equity method. All significant intercompany balances and transactions have been eliminated.\nThe Company owns 100% majority interests in corporate subsidiaries which are general managing partners as well as limited partners of several partnerships which have outside partners with 50% interests. Based upon the structure of the respective partnership management agreements the Company has control (as defined by the Statement of Financial Accounting Standards No. 94, \"Consolidation of All Majority-Owned Subsidiaries\", which describes the full consolidation method as preferable to the equity method where there is a 50% or less financial interest but control) over the 50% owned partnerships. The Company uses the full consolidation method to record the 50% owned partnerships.\nIn September, 1993, MART loaned to outside partners funds to cover their respective partner share of partnership mortgage paydowns using their respective equity interests in the partnerships as collateral for the notes receivable. The company eliminates the partner notes receivable against what is due from joint venture partners. The interest on the partner notes is recognized as interest income.\nRecognition of Revenue From Rentals\nThe Company earns rental income under operating leases with tenants. Minimum rental payments are recognized as rental revenues in the period when they are earned according to the applicable lease term. Effective January 1, 1995 the Company changed its accounting treatment for percentage rent. Percentage rent revenues are based on store sales for certain periods and are charged according to a percentage over a breakpoint amount of sales for the period according to the lease agreement. During the year ended December 31, 1994 and previously, percentage rent was recognized as rental revenues in the period when the actual percentage rent was billed and received. The new method will recognize percentage rent as rental revenues in the period when the actual percentage rent is earned. On January 1, 1995, the Company began estimating the percentage rent earned from major tenants and recorded the amounts monthly as receivable. The cumulative effect of this change on January 1, 1995 was $612,383. The Company believes that this change is preferable since it provides a better matching of revenues and expenses.\nContinued\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nRecognition of Revenue from Rentals - Continued\nEffective April 1, 1994 the Company adopted a new accounting treatment regarding lease cancellation fees received from tenants who want to discontinue their remaining lease term obligations. Prior to April 1, 1994, the lease termination payments for major tenants were recognized as other income in the period when the termination agreement was executed. Under the new treatment, the entire amount of the cancellation or termination fee on the date of the lease termination is deferred and then amortized into income on a straight-line basis over the remaining original lease term as minimum rent. The Company believes that this change is preferable since it provides a better matching of revenues and expenses. During 1994, approximately $687,000 of termination fees were deferred, and $56,000 were amortized. During 1995, approximately $772,000 of termination fees were deferred, and $266,000 were amortized.\nRecognition Of Revenue From Property Sales\nThe sale of residential property and any resulting gain or loss on properties held for sale are recorded upon settlement. Properties held for sale are primarily outparcels of operating properties or undeveloped commercial land.\nNet Earnings (Loss) Per Share\nEarnings (loss) per share are computed by dividing net earnings (loss) by the weighted average number of common shares and common share equivalent shares outstanding during each year. The effect on earnings per share assuming conversion of the convertible subordinated debentures would be anti-dilutive.\nCapitalization Policy and Net Realizable Value\nAcquisition costs, interest and other carrying costs, as well as construction and start-up costs of commercial property are capitalized and charged to related undeveloped land, construction in progress or deferred costs. In addition, costs incurred in the financing and leasing of shopping centers and other commercial properties are deferred until the project is completed and are then amortized over the term of the related mortgage or lease. Management ceases to capitalize or defer these costs when the carrying value equals the net realizable value of the property or costs are unlikely to be recoverable. Net realizable value is determined primarily by the application of the principles of valuation of operating properties. The basis for determining the value of operating properties is the lower of historical cost or the net realizable value. The net realizable value of operating properties is based on the present value of each property's anticipated net cash flow, before debt service payments, calculated using prevailing industry discount and capitalization rates. Anticipated net cash flow is based upon an analysis of the history and future of the property, existing and prospective tenant leases, occupancy rates, and estimated operating expenses. The discount factor, capitalization rates or reversion rates used to arrive at the net realizable value of each property are based on the risk associated with the property as well as the prevailing rates at the end of the reporting period. Risk variations reflect differences in quality, age, location and market conditions of each property.\nProperties\nOperating properties and property held for development or sale are carried at the lower of historical cost or, where appropriate, an amount not to exceed estimated net realizable value. The amount the Company will ultimately realize could differ from the estimated net realizable value. Depreciation of buildings and leaseholds is provided using the straight-line method over the estimated useful lives or lease terms of the properties. Improvements for tenants are amortized on a straight-line basis over the terms of the related tenant leases. Expenditures for normal maintenance and repairs are charged against income as incurred.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued\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). The statement established accounting standards for the impairment of long-lived assets and certain identifiables to be disposed of. This statement requires a write down to fair value when long-lived assets to be held and used are impaired. The statement also requires long-lived assets to be disposed of (e.g. real estate held for sale) to be carried at the lower of cost or fair value less cost to sell and does not allow such assets to be depreciated. The adoption of this statement effective January 1, 1996 will not have a material effect on results of operations, financial condition or liquidity.\nIn October 1995, the Financial Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", which is effective for fiscal years beginning after December 15, 1995 and for transactions occurring after December 15, 1995. The Statement defines a fair value based method of accounting for an employee stock option or similar equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. The Statement encourages all entities to adopt the fair value method of accounting for an employee stock option or similar equity instrument; however, it allows an entity to continue to measure compensation costs for stock options or similar equity instruments using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Under the intrinsic value based method, compensation costs are the excess, if any, of the quoted market price of the stock at the grant date or other measurement date over the amount an employee must pay to acquire the stock. Entities electing to remain with the accounting in Opinion 25 must make proforma disclosure of net income and earnings per share as if the fair value method of accounting had been applied. The Company has elected to continue to measure compensation costs for stock options or similar equity instruments using the intrinsic value based method of accounting prescibed by APB Opinion No. 25 with proforma disclosure of net income and earnings per share as if the fair value based method f accounting had been applied.\nIncome Taxes\nThe Company has elected to qualify, and intends to continue to qualify as a real estate investment trust, \"REIT\", pursuant to the Internal Revenue Code Sections 856 through 860, as amended. In general, under such Code provisions a trust which, in any taxable year, meets certain requirements and distributes to its shareholders at least 95% of its REIT taxable income will not be subject to Federal income tax to the extent of the income which it distributes.\nCash and Cash Equivalents\nAll highly liquid unrestricted investments with original maturities of three months or less are considered cash equivalents for purposes of the statements of cash flows.\nDeferred Financing Costs\nCosts associated with the issuance of debt are capitalized and recorded as deferred finance costs and amortized on a straight-line basis, which is not materially different from the interest method, over the term of the related debt.\nEffective January 1, 1996 the Company changed its reporting of amortization of deferred finance costs. During the year ended December 31, 1995 and previously, the annual amortization of deferred finance costs was reported in the depreciation and amortization of property and improvements expense line on the consolidated statements of operations. Effective January 1, 1996, the Company will be reporting the annual amortization of deferred finance costs in the interest expense line on the consolidated statement of operations. The Company will restate all comparative prior year interest and depreciation and amortization expense line items. The change will have no effect on the presentation of net earnings, but will only reclassify interest expense and depreciation and amortization expense line items.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nB. PUBLIC OFFERINGS\nOn September 11, 1993, the Company completed a public offering of 3,450,000 common shares of beneficial interest at $10.50 per share and $60,000,000 in convertible subordinated debentures at 7.625%. Net proceeds from these offerings totaled approximately $90,390,000.\nC. OPERATING PROPERTIES\nOperating properties consist of the following: December 31, 1995 1994 Land $22,137,380 17,993,243 Land improvements 28,370,084 21,123,172 Buildings 115,270,325 107,030,436 Improvements for tenants 6,136,228 6,013,294 Development costs on completed projects 16,597,684 16,577,892 Furniture, fixtures and equipment 2,377,401 2,181,109 Deferred lease costs 13,243,032 5,592,584 ------------ ----------- 204,132,134 176,511,730 Less accumulated depreciation and amortization 39,430,308 36,448,969 ------------ ----------- $164,701,826 140,062,761 ============ ===========\nD. PROPERTIES AND RELATED ACCUMULATED DEPRECIATION AND AMORTIZATION AND MORTGAGES AND CONSTRUCTION LOAN PAYABLE\nA summary of all of the Company's properties and related mortgages payable at December 31, 1995 follows:\nAccumulated Cost of Depreciation Classi- Mortgages Initial Subsequent Total and fication Payable Cost Improvements Cost Amortization Net Cost\nShopping centers $60,485,066 140,991,245 26,571,938 167,563,183 31,140,277136,422,906 Bowling centers - 2,866,998 69,293 2,936,291 1,387,535 1,548,756 Office buildings 1,926,038 26,415,163 3,652,043 30,067,206 5,718,653 24,348,553 Other rental properties - 2,173,695 706,200 2,879,895 740,250 2,139,645 Other property - 685,559 - 685,559 443,593 241,966 -------------------------------------------------------------------- Operating proper- ties 62,411,104 173,132,660 30,999,474 204,132,134 39,430,308164,701,826 Development operations - 1,510,544 - 1,510,544 - 1,510,544 Property held for development or sale - 8,179,378 - 8,179,378 - 8,179,378 -------------------------------------------------------------------- $62,411,104 182,822,582 30,999,474 213,822,056 39,430,308174,391,748\n=================================================================\nMortgages payable aggregating $62,411,104 at December 31, 1995 bear interest at 7.87% to 10.375% and mature in installments through 2006. Aggregate annual principal payments applicable to mortgages payable for the five years subsequent to December 31, 1995 are:\n1996 $ 5,972,885 1997 5,388,446 1998 14,204,762 1999 425,901 2000 466,820 Thereafter 35,952,290\nA construction loan payable of $10,099,510 at December 31, 1995 bears interest at the lesser of 2.5% over the 30 day LIBOR rate or the prime rate (at December 31, 1995 the interest rate was 8.469%) and matures on October 31, 1996.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. DEVELOPMENT OPERATIONS\nDevelopment operations consist of the following:\nDecember 31, 1995 1994 Land $ - 5,072,696 Construction in progress 1,225,844 953,456 Pre-construction costs 284,700 328,795 ---------- --------- $1,510,544 6,354,947 ========== =========\nDevelopment operations are transferred to operating property costs when a project is completed, at which time depreciation and amortization commences. Consruction period interest cost capitalized during 1995 was approximately $570,000.\nF. NOTES AND ACCOUNTS RECEIVABLE\nIncluded in notes and accounts receivable at December 31, 1995 are significant concentrations of amounts due from tenants in two primary geographical areas: the mid-Atlantic region of the United States and Arizona. The Company performs in depth credit evaluations of prospective new tenants and requires security deposits in most circumstances. Tenants compliance with the terms of the leases is monitored closely and the allowance for doubtful accounts is established based on an analysis of the risk of loss on specific tenants, historical trends, and other relevant information. The Company's accounts receivable at December 31, 1995 included $1,207,000 and $336,000 due from tenants in the mid-Atlantic region and Arizona, respectively. Management believes adequate provision has been made for the Company's credit risk for all receivables.\nG. DEFERRED FINANCING COSTS December 31, Deferred financing costs consist of the following: 1995 1994 Deferred costs related to the debentures $3,062,253 3,063,274 Deferred costs of line of credit 263,409 198,972 Deferred financing costs capitalized related to operating properties 1,852,598 1,720,827 --------- --------- 5,178,260 4,983,073 Less accumulated amortization (1,963,104)(1,560,697) --------- --------- Deferred financing costs $3,215,156 3,422,376 ========= =========\nH. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses consist of the following: December 31, 1995 1994 Trade accounts payable $1,600,118 1,195,143 Retainage on construction in progress 635,558 61,117 Accrued debenture interest expense 1,333,994 1,334,375 Accrued expenses 1,035,178 943,642 --------- --------- $4,604,848 3,534,277 ========= =========\nI. NOTES PAYABLE Notes payable consist of the following: December 31, 1995 1994 Line of credit $21,500,000 20,100,000 Note payable, bearing interest at 8.71% 30,143 39,413 ---------- ---------- $21,530,143 20,139,413 ========== ==========\nAt December 31, 1995, the Company has amended the existing agreement with its primary bank to provide for an additional $5,000,000 to its $35,000,000 secured line of credit. The agreement also provides that as long as the Company is in compliance with all loan covenants, the loan maturity date, which at December 31, 1995 was December 31, 1998, will be extended one year automatically each year. Under the agreement, the Bank must give the Company two years notice should it decide to terminate the loan. Availability under the agreement is determined by the amount of collateral provided. At December 31, 1995, $33,000,000 was fully collateralized with $40,000,000 fully collateralized on March 1, 1996. The line bears interest at the prime rate. However, the Company has the option to fix the rate at LIBOR plus 1.125% for fixed periods from three to nine months. A stand-by fee is required by the bank for any unused portion of the line. The agreement contains covenants which provide for the maintenance of specified debt service ratios and minimum levels of net worth, and other requirements, among which is the requirement that the Company maintain its status as a REIT, and other normal conditions consistent with bank lines of credit.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nI. NOTES PAYABLE - Continued\nAt December 31, 1995, the unused line of credit available to the Company, subject to compliance with all terms and conditions of the agreement and net of outstanding letters of credit of $232,805, was $11,267,000. The maximum level of borrowings under the line of credit was $32,000,000, $20,100,000 and $4,633,130 in 1995, 1994 and 1993, respectively. The average amounts of borrowings were approximately $17,534,000, $6,131,000, and $1,888,000, with weighted average interest approximating 7.8%, 6.5%, and 5.6%, in 1995, 1994 and 1993, respectively. The weighted average interest rate at December 31 was 7.8%, 8.1%, and 6.0% in 1995, 1994, and 1993, respectively.\nAggregate annual principal maturities of notes payable subsequent to December 31, 1995 are as follows: 1996 $ 9,270 1997 9,270 1998 21,509,270 1999 2,333 ==========\nJ. CONVERTIBLE SUBORDINATED DEBENTURES\nEffective September 11, 1993 the Company issued $60,000,000 of convertible subordinated debentures at 7.625% scheduled to mature in September, 2003. Interest on the debentures is paid semi-annually on March 15 and September 15. The debentures are convertible, unless previously redeemed, at any time prior to maturity into common shares of beneficial interest of the Company at $10.50 per share, subject to certain adjustments. In April, 1995, $20,000 in debentures were converted to 1,904 common shares of beneficial interest. The balance of the debentures, at December 31, 1995, of $59,980,000, convertible at $10.50 per share, if fully converted, would produce an additional 5,712,381 shares. Costs associated with the issuance of the debentures were approximately $3,062,000 at December 31, 1995 and are being amortized through 2003. The debentures are redeemable by the Company at any time on or after September 15, 1996, or at any time for certain reasons intended to protect the Company's REIT status, at 100% of the principal amount thereof, together with accrued interest. The debentures are subordinate to all mortgages payable. On January 29, 1996, $57,000 in debentures were converted to 5,428 common shares of beneficial interest reducing the balance of debentures to $59,923,000.\nK. INCOME TAXES\nAs discussed in Note A, the Company plans to maintain its status as a REIT, and be taxed under Sections 856-860 of the Internal Revenue Code of 1986, as amended. In general terms, under such Code provisions a trust or corporation which, in any taxable year, meets certain requirements and distributes to its shareholders at least 95% of its taxable income will not be subject to Federal income tax to the extent of the income which it distributes.\nA REIT will generally not be subject to federal income taxation for the portion of its income that qualifies as REIT taxable income to the extent that it distributes at least 95 percent of its taxable income to its shareholders and complies with certain other requirements. Accordingly, no provision has been made for federal income taxes for the Company and certain of its subsidiaries in the accompanying consolidated financial statements. At December 31, 1995, the income tax basis of the Company's assets was approximately $165,000,000 and liablities was approximately $ 160,000,000.\nThe income taxes benefit, net, in BTR, for the period January 1, 1993 through September 10, 1993 included a currently payable income tax expense of $52,360, offset by a deferred income tax benefit of $460,570, including the balance of deferred income taxes payable of $466,570 in BTR which was recognized as an income tax benefit. It was determined by BTR that it was more likely than not that there would be no payment in the future of any deferred tax temporary differences due to the expected merger with the Company. This was in accordance with the Statement 109 adopted by BTR as of January 1, 1992.\nThe net benefit for income taxes consists of the following:\nJan. 1, 1993 thru September 10, 1993\nCurrent taxes: Federal $ - State 52,360 ---------- 52,360 ---------- Deferred: Federal 118,430 State (579,000) ---------- (460,570) ---------- $(408,210) ==========\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nL. SHAREHOLDERS' EQUITY AND STOCK COMPENSATION PLAN\nPreferred Shares At its inception on September 11, 1993, Mid-Atlantic Realty Trust authorized 2,000,000 preferred shares of beneficial interest at a par value of $.01 per share. At December 31, 1995, none of these shares were issued and outstanding.\nBTR Stock Compensation Plan Under the BTR Executive Stock Compensation Plan, certain officers had been awarded shares of BTR's stock to be issued at a rate of 20% of the shares awarded for each year of continued employment. A charge was made to general and administrative expense at the time of such awards. In 1993, the 78,286 remaining shares in the plan were exercised and issued prior to the merger on September 11, 1993. For the period January 1, 1993 through September 10, 1993, BTR recorded general and administrative expenses of approximately $49,000 representing the increase in recorded value of the awarded share of BTR stock.\nMART Incentive Stock Option Plans MART has an Omnibus Share Plan, \"Plan\", under which Trustees, officers and employees may be granted awards of stock options, stock appreciation rights, performance shares and restricted stock. The purpose of the Plan is to provide equity-based incentive compensation based on long-term appreciation in value of MART's shares and to promote the interests of MART and its shareholders by encouraging greater management ownership of MART's shares. Pursuant to the Plan, the Company authorized on February 1, 1994 the availability of 300,000 shares for the Plan. Upon inception at February 1, 1994 trustees, officers and key employees were granted 256,000 stock options. During 1995 additional grants and cancellations of stock options totaled 1,332 and 3,000, respectively. The outstanding stock options at December 31, 1995, totaling 254,332, allow holders to purchase one share of MART for $10.50 per share. Of outstanding stock options, 170,332 were vested and exercisable at December 31, 1995 and an additional 84,000 vested on January 1, 1996. The closing price of MART shares at December 31, 1995 was $8.625 per share. No options were exercised during the year ended December 31, 1995 and based on the market value of MART shares, the options, if converted, would be anti-dilutive producing fewer weighted average shares for the year ended December 31, 1995.\nOn September 14, 1995, the Company authorized the availability of 180,000 shares for a \"New Plan\", the 1995 Stock Option Plan, subject to the approval of shareholders. The New Plan granted a number of shares equal to approximately 56% of the number under the current Plan, or 141,300, which shares will vest 1\/3, or 47,100 on September 30, 1995, exercisable at $8 15\/16 per share. The balance of the shares will vest on the first and second anniversary thereof, to be priced at the market price on the close of business each date of vesting. No options were exercised during the period September 30, 1995 through December 31, 1995 and based on the market value of MART shares, the options, if converted, would be anti-dilutive.\nAcquisition of Outstanding Shares On February 14, 1995, the MART Board of Trustees approved a stock repurchase plan which authorizes the repurchase of up to approximately 310,000 shares. The Company purchased 277,200 shares during the year ended December 31, 1995 for $2,234,616, at an average cost of $8.06 per share. On February 12, 1996 the MART Board of Trustees increased by 100,000 the authorized number of shares that may be repurchased up to 410,000\nIn 1993, BTR retired 56,544 shares of BTR stock held as collateral for a note receivable from a former officer of the Company.\nM. COMMITMENTS\nLease Commitments Minimum rental commitments for operating land leases as of December 31, 1995 are as follows: 1996 $566,000 1997 566,000 1998 566,000 1999 566,000 2000 566,000 Thereafter 22,337,000\nCertain of the leases contain renewal or purchase options. All of the leases require the Company to pay real estate taxes. Total annual minimum lease payments amounted to $262,000 in 1995, $219,000 in 1994, and $176,000 in 1993.\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nN. LEASES\nThe Company owns shopping centers and other commercial property which are leased, generally on a long-term basis. All leases are classified as operating leases. Future minimum lease payments receivable under noncancelable operating leases are as follows:\n1996 $23,461,821 1997 21,724,487 1998 19,208,084 1999 16,975,654 2000 15,105,709 Thereafter 117,694,206 ===========\nThe minimum future lease payments do not include contingent rentals which may be paid under certain leases on the basis of a percentage of sales in excess of stipulated amounts. Contingent rentals amounted to $1,246,000 in 1995, $1,206,000 in 1994, and $1,259,000 in 1993. On a prospective basis, no more than 3% of rental income is derived from any one tenant, except Giant Food of Maryland, which is approximately 11% of Rental income. Giant Food minimum lease payments represent approximately 12% for the years 1996 through 2000 and 34% thereafter of the total minimum lease payments above. The 34% percentage of total minimum lease payments is high due to the fact that Giant Food leases contain long lease terms compared with other major tenants who use renewal option terms. Renewal option minimum lease payments are not included in the totals above.\nO. OTHER INCOME\nOther income consists of the following: MART BTR Realty, Inc. Sept. 11 Jan. 1, thru thru Years Ended December 31, Dec. 31, Sept. 10, 1995 1994 1993 1993\nInterest and dividends $757,905 727,249 266,141 93,312 Miscellaneous 269,430 149,873 249,368 134,980 ------------------------------------------------- $1,027,335 877,122 515,509 228,292 =================================================\nP. GAIN ON LIFE INSURANCE PROCEEDS\nIn January, 1995, the Company received $1,002,000 in life insurance proceeds as a result of the death of a former BTR general partner and officer.\nQ. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (Statement 107) requires the Company to disclose estimated fair values for certain on- and off-balance sheet financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments as of December 31, 1995 and 1994.\nCash and Cash Equivalents The carrying amount for cash and cash equivalents approximates fair value due to the short maturity of these instruments.\nNotes and Accounts Receivable The carrying amount for notes and accounts receivable approximates fair value due to the short maturity of these instruments.\nNotes Payable The carrying amount for the line of credit approximates fair value due to its adjustable interest rate.\nMortgages Payable The fair value of mortgages payable was based on the discounted value of contractual cash flows. The discount rate for mortgages payable was estimated using the rate currently offered for borrowings of similar remaining maturities. The carrying amount and estimated fair value of mortgages payable at December 31, 1995 was $62,411,104 and $67,179,000 respectively, and at December 31, 1994 was $53,251,140 and $53,641,000, respectively.\nConvertible Subordinated Debentures The fair value of convertible subordinated debentures was based on the discounted value of contractual cash flows. The discount rate for convertible subordinated debentures was estimated using the rate currently offered for borrowings of similar remaining maturities. The carrying amount and estimated fair value of convertible subordinated debentures at December 31, 1995 was $59,980,000 and $60,982,000, respectively, and at December 31, 1994 was $60,000,000 and $52,119,000, respectively.\nITEM 9","section_9":"ITEM 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 Directors and Executive Officers of the Registrant\nThe information with respect to the identity and business experience of the directors of MART and their remuneration, in the definitive proxy statement (to be filed pursuant to Regulation 14A) with respect to the election of directors at the 1996 annual meeting of stockholders, is incorporated herein by reference.\nThe Executive Officers of MART are as follows: Position and Name Age Business Experience\nLeRoy E. Hoffberger 70 Chairman of the Board of MART since September, 1993.Director of BTR from 1963 to September 1993.President of CPC, Inc., President and Director of Keystone Realty Co., Vice President and Director of MP Commercial Inc., Director of the following public mutual funds - Davis New York Venture Fund and eight other public mutual funds also advised by Davis Selected Advisers, L.P., President and Director of the Hoffberger Foundation, Vice President and Director of Hoffberger Family Fund.\nF. Patrick Hughes 48 President, Principal Executive Officer, and CEO of MART since September, 1993. President of BTR from November, 1990 to September, 1993. Senior Vice President BTR from May, 1989 to November, 1990. Vice President, Controller and Secretary of BTR for more than five years.\nPaul F. Robinson 42 Vice President of MART since September, 1993. Vice President of BTR from May, 1992 to September, 1993. Secretary and General Counsel of MART since September, 1993. Secretary and General Counsel of BTR from May 1989 to September, 1993; General Counsel since August, 1985.\nEugene T. Grady 47 Treasurer of MART since September, 1993. Treasurer of BTR since May, 1989.\nPaul G. Bollinger 36 Controller and Principal Financial Officer of MART since September, 1993. Controller of BTR since June, 1992. Assistant Treasurer & Assistant Secretary since May, 1992 Principal Financial Officer of Financial Associates of Maryland, (BTR Related Residential development partnership), for more than five years.\nEach executive officer is elected for a term expiring at the next regular annual meeting of the Board of Directors of the Company or until his successor is duly elected and qualified.\nITEM 11","section_11":"ITEM 11 Executive Compensation\nThe information required by this item is incorporated by reference from the Registrant's Proxy Statement filed with respect to the 1996 annual meeting of stockholders.\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 Registrant's Proxy Statement filed with respect to the 1996 annual meeting of stockholders.\nITEM 13","section_13":"ITEM 13 Certain Relationships and Related Transactions\nThe information required by this item is incorporated by reference from the Registrant's Proxy Statement filed with respect to 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. Financial Statements The following financial statements of Mid-Atlantic Realty Trust and Subsidiaries and BTR Realty, Inc. and Subsidiaries (Predecessor) are included in Part II Item 8: Independent auditors' report Consolidated balance sheets at December 31, 1995 and 1994 Consolidated statements of operations for the years ended December 31, 1995 and 1994 and for the periods ended December 31, 1993 and September 10, 1993 Consolidated statements of shareholders' equity for the years ended December 31, 1995 and 1994 and for the periods ended December 31, 1993 and September 10, 1993 Consolidated statements of cash flows for the years ended December 31, 1995 and 1994 and for the periods ended December 31, 1993 and September 10, 1993 Notes to consolidated financial statements (a) 2. Financial Statement Schedule Schedule III - Real estate and accumulated depreciation and amortization All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto. (a) 3. Exhibits Exhibit No. 3. Articles of Incorporation and by-laws. None. 4. Instrument Defining the Right of Shareholders. None. 9. Voting Trust Agreement. None. 11. Computations of net earnings per common share. See Summary of Significant Accounting Policies under Notes to Financial Statements appearing on page 31 of this report. 12. Statement re: computation of ratios. Not applicable. 13. Annual Report to Shareholders. Not applicable. 18. Letter regarding change in accounting principles. See Summary of Significant Accounting Policies under Notes to Financial Statements appearing on pages 30, 31 and 32 of this report and letter from KPMG Peat Marwick LLP. 19. Previously unfiled documents. Not applicable. 21. List of subsidiaries of registrant. Filed herewith. 22. Published report regarding matters submitted to vote of security holders. Not applicable. 23. Consents of experts and counsel. Filed thru EDGAR. 24. Power of Attorney. Not applicable. 27. Financial Data Schedule Filed thru EDGAR. 28. Additional exhibits. Not applicable.\n(b) Reports on Form 8-K. None.\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nCost capitalized subsequent Year ended Initial cost to Company to acquisition December 31, 1995 Mortgages Buildings and Description Payable Land Improvements Improvements Shopping Centers Harford Mall $19,686,335 599,031 8,457,331 15,649,900 Owings Mills - 4,381,666 8,619,103 - The Shoppes at Easton 7,657,932 2,600,000 10,379,069 10,486 Brandywine Commons - - 12,244,289 - Smoketown Plaza - 516,312 10,095,077 638,297 Park Sedona - 2,251,624 8,397,274 242,766 Colonie Plaza 5,442,755 1,137,567 7,755,095 599,795 Columbia Plaza 4,921,594 999,739 6,887,711 1,466,142 Spotsylvania Crossing - 1,544,314 6,600,616 268,739 Skyline Village - 555,295 6,240,003 1,035,922 Page Plaza - 496,404 5,777,369 120,740 York Road Plaza 8,700,000 1,562,382 2,102,575 2,344,121 Plaza Del Rio - 1,291,325 3,938,734 409,334 Sudley Towne Plaza - 789,881 3,736,837 449,124 Burke Town Plaza 7,198,894 - 2,936,134 1,716,707 Rosedale Plaza 1,869,857 1,024,712 3,217,926 305,002 Wilkens Beltway Plaza 5,007,699 - 3,601,891 337,505 Timonium Shopping Ctr - - 4,031,809 246,212 Rolling Road Plaza - 338,791 1,632,268 2,000,980 Patriots Plaza - - 1,709,846 521,846 Union Hills Plaza - 274,920 679,863 150,417 Dobson-Guadalupe - 69,146 791,347 94,211 Chandler Plaza - 160,671 565,298 64,833 ---------------------------------------------------- 60,485,066 20,593,780 120,397,465 28,673,079 Office Buildings Gateway II - 364,982 12,376,977 1,579,472 Gateway I - 82,396 8,271,751 1,380,776 Patriots Plaza - - 1,522,943 243,394 Wilkens Office II 1,926,038 - 1,644,370 141,706 Wilkens Office I - - 1,383,102 264,969 Wilkens Office III - - 768,642 41,726 ----------------------------------------------------- 1,926,038 447,378 25,967,785 3,652,043 Bowling Centers Freestate - 307,656 1,279,278 2,719 Waldorf - 243,139 579,161 5,690 Clinton - - 457,764 60,884 ------------------------------------------------------ - 550,795 2,316,203 69,293\n(Continued)\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nCost capitalized subsequent Amount at which carried Year ended to acquisition at close of period December 31, 1995 Carrying Costs Land Buildings and Total Description Land Improvements Improvements Shopping Centers Harford Mall 599,031 24,107,231 24,706,262 Owings Mills 4,381,666 8,619,103 13,000,769 The Shoppes at Easton 2,600,000 10,389,555 12,989,555 Brandywine Commons - 12,244,289 12,244,289 Smoketown Plaza 516,312 10,733,374 11,249,686 Park Sedona (293,550) (1,095,141) 1,958,074 7,544,899 9,502,973 Colonie Plaza 1,137,567 8,354,890 9,492,457 Columbia Plaza 999,739 8,353,853 9,353,592 Spotsylvania Crossing 1,544,314 6,869,355 8,413,669 Skyline Village 555,295 7,275,925 7,831,220 Page Plaza 496,404 5,898,109 6,394,513 York Road Plaza 1,562,382 4,446,696 6,009,078 Plaza Del Rio 1,291,325 4,348,068 5,639,393 Sudley Towne Plaza 789,881 4,185,961 4,975,842 Burke Town Plaza - 4,652,841 4,652,841 Rosedale Plaza 1,024,712 3,522,928 4,547,640 Wilkens Avenue 475,481 475,481 3,939,396 4,414,877 Timonium Shopping Ctr - 4,278,021 4,278,021 Rolling Road Plaza (837,931) 338,791 2,795,317 3,134,108 Patriots Plaza - 2,231,692 2,231,692 Union Hills Plaza 274,920 830,280 1,105,200 Dobson-Guadalupe 69,146 885,558 954,704 Chandler Plaza (86,450) (263,550) 74,221 366,581 440,802 ---------------------------------------------------------- 95,481 (2,196,622)20,689,261 146,873,922 167,563,183\nOffice Buildings Gateway II 364,982 13,956,449 14,321,431 Gateway I 82,396 9,652,527 9,734,923 Patriots Plaza - 1,766,337 1,766,337 Wilkens Office II - 1,786,076 1,786,076 Wilkens Office I - 1,648,071 1,648,071 Wilkens Office III - 810,368 810,368 ---------------------------------------------------------- - - 447,378 29,619,828 30,067,206 Bowling Centers Freestate 307,656 1,281,997 1,589,653 Waldorf 243,139 584,851 827,990 Clinton - 518,648 518,648 ----------------------------------------------------------- - - 550,795 2,385,496 2,936,291\n(Continued)\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nLife on which Year ended depreciation on December 31, 1995 latest income Accumulated Date of Date statement is Description Depreciation Construction Acquired computed Shopping Centers Harford Mall 9,569,980 12\/73 5-50 yrs. Owings Mills 15,692 12\/95 5-50 yrs. The Shoppes at Easton 289,368 9\/94 5-50 yrs. Brandywine Commons 34,823 11\/95 5-50 yrs. Smoketown Plaza 2,618,269 4\/87 5-50 yrs. Park Sedona 1,007,351 11\/90 5-50 yrs. Colonie Plaza 1,980,527 12\/87 5-50 yrs. Columbia Plaza 1,848,496 6\/88 5-50 yrs. Spotsylvania Crossing 1,768,599 5\/87 5-50 yrs. Skyline Village 1,626,264 5\/88 5-50 yrs. Page Plaza 740,648 8\/91 5-50 yrs. York Road Plaza 922,675 11\/85 5-50 yrs. Plaza Del Rio 696,779 2\/89 5-50 yrs. Sudley Towne Plaza 1,252,424 7\/84 5-50 yrs. Burke Town Plaza 1,801,538 7\/79-7\/82 5-50 yrs. Rosedale Plaza 540,639 10\/89 5-50 yrs. Wilkens Avenue 1,394,775 5\/81 5-50 yrs. Timonium Shopping Ctr 260,285 10\/93 5-50 yrs. Rolling Road Plaza 1,051,738 6\/73 5-50 yrs. Patriots Plaza (A) 879,381 6\/84 5-50 yrs. Union Hills Plaza 323,571 11\/83 5-50 yrs. Dobson-Guadalupe 325,387 9\/85 5-50 yrs. Chandler Plaza 191,068 3\/84 5-50 yrs. -------------- 31,140,277 Office Buildings Gateway II 1,913,709 7\/89 5-50 yrs. Gateway I 2,245,984 4\/87 5-50 yrs. Patriots Plaza 519,941 8\/85 5-50 yrs. Wilkens Office II 403,326 1\/87 5-50 yrs. Wilkens Office I 516,507 1\/85 5-50 yrs. Wilkens Office III 119,186 1\/91 5-50 yrs. ----------------- 5,718,653 Bowling Centers Freestate 917,453 3\/78 5-50 yrs. Waldorf 218,707 3\/79 5-50 yrs. Clinton 251,375 8\/71 5-50 yrs. ------------------ 1,387,535\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nCost capitalized subsequent Year ended Initial cost to Company to acquisition December 31, 1995 Mortgages Buildings and Description Payable Land Improvements Improvements (Continued)\nOther Rental Properties Business Center - 395,536 1,190,692 59,403 Southwest - - 283,039 596,738 Waldorf Firestone - 9,261 161,543 4,910 Ocean City - - 133,624 - --------------------------------------------------------- - 404,797 1,768,898 661,051\nDevelopment Operations - - 1,510,544 -\nProperty Held - 8,179,378 - -\nOther Property - - 685,559 - -------------------------------------------------------- $62,411,104 30,176,128 152,646,454 33,055,466 ============================================\n(Continued)\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nCost capitalized subsequent Amount at which carried Year ended to acquisition at close of period December 31, 1995 Carrying Costs Land Buildings and Total Description Land Improvements Improvements (Continued)\nOther Rental Properties Business Center 395,536 1,250,095 1,645,631 Southwest 45,149 45,149 879,777 924,926 Waldorf Firestone 9,261 166,453 175,714 Ocean City - 133,624 133,624 --------------------------------------------------------- 45,149 - 449,946 2,429,949 2,879,895\nDevelopment Operations - - - 1,510,544 1,510,544\nProperty Held - - 8,179,378 - 8,179,378\nOther Property - - - 685,559 685,559 --------------------------------------------------------- 140,630(2,196,622) 30,316,758 183,505,298 213,822,056 ============================================\n(Continued)\nMID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Schedule III - Real Estate and Accumulated Depreciation\nLife on which Year ended depreciation on December 31, 1995 latest income Accumulated Date of Date statement is Description Depreciation Construction Acquired computed (Continued)\nOther Rental Properties Business Center 177,138 4\/90 5-50 yrs. Southwest 443,206 4\/68 5-50 yrs. Waldorf Firestone 60,889 9\/78 5-50 yrs. Ocean City 59,017 12\/87 5-50 yrs. ------------- 740,250\nDevelopment Operations - 91-95\nProperty Held - 7\/73-12\/95\nOther Property 443,593 9\/82-12\/95 3-10 yrs. ------------- 39,430,308 =============\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR) SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued\n(1) The changes in total cost of properties for the three years ended December 31, 1995 are as follows: Years ended December 31, 1995 1994 1993 Balance beginning of year $191,497,142 171,661,868 174,593,579 Additions during year: Acquisitions 12,244,289 18,051,765 4,076,958 Improvements 2,356,780 2,159,354 5,308,235 Development operations 15,685,170 1,986,458 1,448,303 ------------------------------------------ 30,286,239 22,197,577 10,833,496 Deductions during year: Write-downs to net realizable value (2)(a) - - (1,318,314) Cost of real estate sold (6,292,793) (2,304,214) (1,637,772) Transfers (4) - - (9,416,190) Retirements and disposals (1,668,532) (58,089) (1,392,931) ------------------------------------------ (7,961,325) (2,362,303) (13,765,207) ------------------------------------------ Balance end of year $213,822,056 191,497,142 171,661,868 ========================================== (2) Write-downs to net realizable value are reported in the statement of operations as follows:\nBTR Realty, Inc. January 1 thru Sep. 10, 1993\nUnrecoverable development costs $ 1,278,817 -------------- $ 1,278,817 ==============\n(a) In the period 1\/1\/93 thru 9\/10\/93 BTR reduced total cost of properties by $1,318,314 and reduced related accumulated depreciation by $39,497 resulting in a net write-down of $1,278,817.\n(3) The changes in accumulated depreciation for the three years ended December 31, 1995 are as follows:\nYears ended December 31, 1995 1994 1993 Balance beginning of year ($36,448,969) (32,650,352) (29,168,658) Depreciation and amortization (4,983,617) (4,549,782) (4,735,979) Transfers (4) - - 96,041 Retirements and disposals 2,002,278 751,165 1,158,244 -------------------------------------------- Balance end of year ($39,430,308) (36,448,969) (32,650,352) ============================================\n(4) Transfers include assets originally in operating properties reclassified on the balance sheet to the following:\nYear ended December 31, Total Cost Net assets of properties to be sold ($7,030,232) Deferred financing costs (2,385,958) ------------- (9,416,190) Accumulated Depreciation Net assets of properties to be sold 524,425 Deferred financing costs: - Reclassification of asset (765,192) - Reclassification of amortization 336,808 ------------- 96,041 ------------- Net transfers ($9,320,149) =============\n(5) The aggregate basis of properties for Federal income tax purposes is approximately $157,000,000 at December 31, 1995. (6) See Item 2 for geographic location of properties. (7) Freestate includes 2 bowling centers in Illinois.\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT\nThe subsidiaries of MART are listed below. All are engaged in the ownership and\/or development of commercial or residential real estate in the United States. All are included in the consolidated financial statements filed as part of this Annual Report.\nState of Incorporation Name or Formation Interest CORPORATIONS:\nBTR Arkor, Inc. Maryland 100% BTR Atlanta Daycare, Inc. Maryland 100% BTR Business Center, Inc. Maryland 100% BTR Chandler, Inc. Maryland 100% BTR Delmar, Inc. Maryland 100% BTR East Greenbush, Inc. Maryland 100% BTR Fallston, Inc. Maryland 100% BTR Fallston Corner, Inc. Maryland 100% BTR Fallston Management, Inc. Maryland 100% BTR Financial, Inc. Maryland 100% BTR Free State Bowls, Inc. Maryland 100% BTR Gateway, Inc. Maryland 100% BTR Hillside, Inc. Maryland 100% BTR Holdings, Inc. (Formerly Diamond Alley, Inc.) Maryland 100% BTR Manassas, Inc. Maryland 100% BTR Marigot, Inc. Maryland 100% BTR Marina, Inc. Maryland 100% BTR McClintock, Inc. Maryland 100% BTR New Ridge, Inc. Maryland 100% BTR Northwood Properties, Inc. Maryland 100% BTR Odenton Properties, Inc. Maryland 100% BTR Ray Road, Inc. Maryland 100% BTR Real Estate Enterprises, Inc. Maryland 100% BTR Rockburn, Inc. Maryland 100% BTR Salisbury, Inc. Maryland 100% BTR Southdale, Inc. Maryland 100% BTR Union Hills, Inc. Maryland 100% BTR Waldorf Development Corporation Maryland 100% BTR Waldorf Tire, Inc. Maryland 100% BTR Yuma, Inc. Maryland 100%\n(Continued)\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT - (Continued)\nState of Name Incorporation CORPORATIONS: or Formation Interest\nBurke Town Plaza, Inc. Maryland 100% Burlington Commerce Park, Inc. Maryland 100% Brandywine Commons, Inc. Maryland 100% Christiansburg Plaza, Inc. Maryland 100% Clinton Development Company, Inc. Maryland 100% Cobleskill Plaza, Inc. Maryland 100% Colonie Plaza, Inc. Maryland 100% Columbia Plaza, Inc. Maryland 100% Commonwealth Plaza, Inc. Maryland 100% Concourse Realty Management, Inc. Maryland 100% Cypress Square, Inc. Maryland 100% Davis Ford Properties, Inc. Maryland 100% Essanwy, Inc. Maryland 100% Easton Shoppes, Inc. Maryland 100% Fredericksburg Plaza, Inc. Maryland 100% Greenbush Residential, Inc. Maryland 100% Greencastle Plaza, Inc. Maryland 100% Harrisonburg Plaza, Inc. Maryland 100% Kingsbrook Funding, Inc. Maryland 100% Kingston Crossing, Inc. Maryland 100% MART Acquisitions, Inc. Maryland 100% New Town Village, Inc. Maryland 100% North East Station, Inc. Maryland 100% Orchard Landing Apartments, Inc. Maryland 100% Orchard Landing Limited, Inc. Maryland 100% Page Plaza Associates, Inc. Maryland 100% Park Sedona, Inc. Maryland 100% Parkway Pond, Inc. Maryland 100% Ridgewood Funding, Inc. Maryland 100% Rolling Road Plaza, Inc. Maryland 100% Rosedale Partners, Inc. Maryland 100% Rosedale Plaza, Inc. Maryland 100% Route 642 Properties, Inc. Maryland 100% Scotia Crossing, Inc. Maryland 100% Sedona Sewer, Inc. Maryland 100% Senate Properties, Inc. Maryland 100% Southdale Mortgage Inc. Maryland 100% Southwest Development Properties, Inc. Maryland 100% Timonium Shopping Center, Inc. Maryland 100% Tempe Auto Center, Inc. Maryland 100% Wake Plaza, Inc. Maryland 100% Wyaness, Inc. Maryland 100%\n(Continued)\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT - (Continued)\nThe following are partnerships in which Mid-Atlantic Realty Trust, BTR Realty, Inc. or Financial Associates of Maryland have partnership interests:\nState of Incorporation Name or Formation Interest Arizona & Warner Limited Partnership Maryland 50% BBG Joint Venture Maryland 60% BBG Properties Limited Partnership Maryland 60% Cypress Square Limited Partnership Maryland 55% Fredericksburg Plaza Limited Partnership Maryland 80% Gateway International Limited Partnership Maryland 100% Harbour Island Associates Maryland 100% Hillside at Seminary Joint Venture Maryland 100% Kensington Associates Maryland 75% North Greenbrier Limited Partnership Maryland 100% Northwood Limited Partnership Maryland 67% Ridgewood Associates Maryland 100% Rockburn Associates Maryland 100% Rosedale Plaza Limited Partnership Maryland 100% Route 642 Limited Partnership Maryland 60% Scotia Associates Limited Partnership Maryland 50% Southdale Limited Partnership Maryland 50% Union Hills Limited Partnership Maryland 50% Wyaness Associates Maryland 100%\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMID-ATLANTIC REALTY TRUST\nDate 3\/26\/96 \/s\/s F. Patrick Hughes F. Patrick Hughes, President\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:\nDate: 3\/27\/96 \/s\/s LeRoy E. Hoffberger LeRoy E. Hoffberger, Chairman\nDate: 3\/26\/96 \/s\/s F. Patrick Hughes F. Patrick Hughes, Trustee, Principal Executive Officer\nDate: 3\/26\/96 \/s\/s Paul G. Bollinger Paul G. Bollinger, Controller, Principal Financial Officer\nDate: 3\/26\/96 \/s\/s Eugene T. Grady Eugene T. Grady, Treasurer\nDate: 3\/26\/96 \/s\/s Robert A. Frank Robert A. Frank, Trustee\nDate: 3\/26\/96 \/s\/s Marc P. Blum Marc P. Blum, Trustee\nDate: M. Ronald Lipman, Trustee\nDate: 3\/23\/96 \/s\/s Stanley J. Moss, Esquire Stanley J. Moss, Esquire, Trustee\nDate: 3\/26\/96 \/s\/s Daniel S. Stone Daniel S. Stone, Trustee\nDate: 3\/25\/96 \/s\/s David F. Benson David F. Benson, Trustee","section_15":""}
{"filename":"748827_1995.txt","cik":"748827","year":"1995","section_1":"ITEM 1. BUSINESS\nI.R.E. PENSION INVESTORS, LTD., a limited partnership organized under the laws of the State of Florida as of January 17, 1985, is primarily engaged in the business of operating and holding for investment an income producing real property. The Partnership commenced a public offering of its units of limited partnership interest in February 1985, broke escrow in April 1985 and closed the offering in October 1985, having raised $15,960,250 in capital and issued 63,837 units of limited partnership interest at $250 per unit. The Partnership initially acquired two properties, Independence Tower in Charlotte, North Carolina and One West Nine Mile in Hazel Park, Michigan for cash. The One West Nine Mile Holiday Inn was sold in December 1991. The Partnership currently holds one property, Independence Tower which is currently being marketed for sale. The property is 98% leased and is generating a positive cash flow\nUninvested cash of the Registrant is deposited in demand accounts with commercial banks and may be invested temporarily in U.S. Treasury Bills, certificates of deposit or other interest bearing accounts or investments.\nAlan B. Levan and I.R.E. Pension Advisors, Corp. are the general partners of the Registrant. I.R.E. Pension Advisors, Corp., as Managing General Partner, manages and controls the Registrant's affairs and has general responsibility and the ultimate authority in all matters affecting the Registrant's business.\nAffiliates of the general partners of the Registrant also own and operate their own improved real estate and may have investment objectives and policies similar to those of the Registrant. Registrant may be in competition with other limited partnerships served by affiliates of the Managing General Partner or by other companies wherein the individual general partner is a controlling stockholder.\nOn December 31, 1995, Registrant had 2 employees. The balance of information required in Item 1 is either inapplicable or not material to an understanding of the Registrant's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe property listed below is not utilized by Registrant but is held for investment. This property is zoned for its current use.\nIndependence Tower 107,236 square feet owned Charlotte, NC leasable office space\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nKugler et. al, (formerly Martha Hess, et. al.), on behalf of themselves and all others similarly situated, v. Gordon, Boula, Financial Concepts, Ltd., KFB Securities, Inc., et al. In the Circuit Court of Cook County, Illinois. On or about May 20, 1988, an individual investor filed the above referenced action against two individual defendants, who allegedly sold securities without being registered as securities brokers, two corporations organized and controlled by such individuals, and against approximately sixteen publicly offered limited partnerships, including Registrant, interests in which were sold by the individual and corporate defendants.\nPlaintiff alleged that the sale of limited partnership interests in Registrant (among other affiliated and unaffiliated partnerships) by persons and corporations not registered as securities brokers under the Illinois Securities Act constituted a violation of such Act, and that the Plaintiff, and all others who purchased securities through the individual or corporate defendants, should be permitted to rescind their purchases and recover their principal plus 10% interest per year, less any amounts received. The Partnership's securities were properly registered in Illinois and the basis of the action relates solely to the alleged failure of the Broker Dealer to be properly registered.\nIn November 1988, Plaintiff's class action claims were dismissed by the Court. Amended complaints, including additional named plaintiffs, were filed subsequent to the dismissal of the class action claims. Motions to dismiss were filed on behalf of the Partnership and the other co-defendants. In December 1989, the Court ordered that the Partnership and the other co-defendants rescind sales of any plaintiff that brought suit within three years of the date of sale. Under the Court's order of December 1989, the Partnership would not be required to rescind any sales. Plaintiffs appealed, among other items, the Court's order with respect to plaintiffs that brought suit after three years of the date of sale. While there has been no formal dismissal of the claims against the Partnership, it has been determined that none of the sales made to investors of the Partnership occurred during the time periods which are still being considered in this case and therefore, there is no longer any ongoing claims against the Partnership in this matter.\nKnight Communications, Inc. v. I.R.E. Pension Investors, Ltd., In the North Carolina Superior Court Division 95-CVS-7381. I.R.E. Pension Investors, Ltd. v. Knight Communications, Inc. North Carolina District Court Division - 95-CVD-9645. I.R.E. Pension Investors, Ltd. v. Randall Knight in the North Carolina Superior Court Division 96-CVS-1383. In May 1995, the lease of a tenant occupying approximately 5,000 square feet at Independence Tower expired. Prior to expiration, the Partnership attempted to negotiate a renewal with the tenant, however, the parties were never able to reach agreement. The tenant contends that a lease extension was agreed to by the parties. The tenant brought an action against the Partnership seeking specific performance under the lease the tenant claims exists, or in the alternative, damages that would be sustained by tenant if it was forced to move, an injunction to keep the Partnership from seeking an order for eviction, damages caused by the Partnership's unfair and deceptive trade practices and for attorneys' fees. Subsequently, the Partnership brought an action for possession of the premises. The tenant also had a note due to the Partnership for prior delinquent rent and when a default occurred under the terms of the note, the Partnership filed suit against the tenant and the co-maker under the note. A trial is scheduled in June 1996 regarding the possession portion of the above.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNERSHIP INTEREST AND RELATED SECURITY HOLDER MATTERS\n(a) There is no established public trading market for Registrant's units of limited partnership interest.\n(b) There are approximately 2,740 holders of units of limited partnership interest as of December 31, 1995.\n(c) See Item 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFor the five years ended December 31, 1995.\n1991 1992 1993 1994 1995 ---- ---- ---- ---- ----\nRevenues $ 1,440,418 1,109,557 1,146,293 1,266,818 1,527,208 ========== ========== ========== ========== ========== Net income (loss) $ (1,796,743) 61,421 (24,174) 42,284 (438,316) ========== ========== ========== ========== ========== Net income (loss) per weighted average limited partnership unit outstanding (27.89) .95 (.38) .66 (6.80)\n========== ========== ========== ========== ========== Total assets $ 9,620,472 7,739,318 7,826,907 7,268,449 6,810,550 ========== ========== ========== ========== ========== Partners' capital $ 9,490,863 7,552,523 7,528,349 7,070,371 6,632,055 ========== ========== ========== ========== ========== Distributions per weighted average limited partnership unit outstanding $ - - 31.36 7.84 - ========== ========== ========== ========== ==========\nTEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF I.R.E. PENSION INVESTORS, LTD.\nA description of the Partnership's original investment properties follows:\n* Independence Tower - A 107,000 square foot office building located in Charlotte, North Carolina.\n* One West Nine Mile Holiday Inn Hotel (\"Holiday Inn\") - A 211 room hotel located in Hazel Park, Michigan through a joint venture in which the Partnership had 91.3% interest. This property was sold in December 1991.\nThe Partnership was organized on January 17, 1985, to engage in acquiring, improving, operating and holding for investment, income producing real properties. The Partnership's objectives were to invest in properties which would: 1) Preserve and protect the Partnership's original capital; 2) Provide long-term appreciation in the value of the Partnership's properties; and 3) Provide cash distributions to the Limited Partners.\nOn April 1, 1985, sufficient capital had been raised to allow funds to be released from escrow to the Partnership. The Partnership closed the offering in October 1985, having raised $15,960,250 in capital and issued 63,837 units of limited partnership interest at $250 per unit.\nDuring August 1985, the Partnership acquired an office building in Charlotte, North Carolina. In December 1986, the Partnership acquired a majority interest in a joint venture with an affiliate. This joint venture acquired a hotel in Hazel Park, Michigan. The hotel building was net leased to Holiday Inn. During 1991, the hotel was sold and the joint venture was liquidated.\nRental income increased for the year ended December 31, 1995 as compared with prior years primarily due to additional rents received as a consequence of an increase in occupancy at Independence Tower. Occupancy at Independence Tower increased from 88% in December 1994 to 95% in December 1995.\nInterest income increased for the year ended December 31, 1995 as compared to the comparable period in 1994 primarily due to increases in funds available for investment and yield on those investments. Interest income increased for the year ended December 31, 1994 as compared to the comparable period in 1993 primarily due to an increase in yields on the investment of funds.\nOther income increased for the year ended December 31, 1995 as compared with the same period in 1994 as a result of late fees charged to delinquent tenants at Independence Tower. Other income decreased for the year ended December 31, 1994 as compared to the comparable period in 1993 due principally to decreased fees resulting from investor transfers of partnership units.\nDepreciation expense increased for the year ended December 31, 1995 as compared to the comparable periods in 1994 and 1993 due to additional property improvements at Independence Tower.\nDuring the fourth quarter of 1995, the carrying value of Independence Tower was reduced approximately $665,000 to its estimated fair value. This was based upon an agreement to sell the property to an unaffiliated third party for a sales price of approximately $4.0 million. (See note 6 (c)). This $665,000 reduced net income for the 1995 fiscal year.\nInsurance increased for the year ended December 31, 1995 as compared to the comparable periods in 1994 and 1993 primarily due to an increase in Independence Tower property insurance premium.\nUtilities expense increased for the year ended December 31, 1995 as compared to the comparable periods in 1994 and 1993 primarily due to an increase in electrical consumption at Independence Tower.\nThe net increase in rental income in 1995 was the causal factor for the increase in property management fees to affiliate for the year ended December 31, 1995 as compared to the comparable periods in 1994 and 1993.\nRepairs and maintenance increased for the year ended December 31, 1995 as compared to the comparable periods in 1994 and 1993 primarily due to increases in HVAC cost, janitorial cost, windows maintenance and general repair and maintenance cost at Independence Tower.\nOther property expenses increased for the year ended December 31, 1995 as compared to the same period in 1994 primarily due to an increase in legal fees as a result of a litigation with a tenant at Independence Tower.\nOther general and administrative expenses decreased for the year ended December 31, 1995 as compared to the prior year comparable period in 1994 primarily due to the elimination of interest accruals, during the third quarter of 1995, relating to the Hess litigation. During the quarter ended September 30, 1995, the interest that had been accrued through June 30, 1995 of approximately $69,000 related to the Hess litigation was reversed based upon determination that the Partnership had no ongoing claims against it.\nGeneral and administrative expense to affiliates decreased for the year ended December 31, 1995 as compared to the 1994 and 1993 comparable periods as a result of decreased costs associated with administrative and accounting service reimbursements. These cost reimbursements are associated with filing requirements to regulatory agencies, tax return preparation, general accounting services and monitoring of pending litigation.\nA summary of the Partnership's cash flows is as follows:\n1993 1994 1995 ---- ---- ---- Net cash provided (used) by: Operating activities $ 541,869 413,945 693,434 Investing activities (274,819) (2,553,170) (371,656) Financing activities - (500,262) - --------- ---------- -------- $ 267,050 (2,639,487) 321,778 ========= =========== ========\nThe changes in operating activities were impacted by the changes in net income (loss) described above, a provision in 1995 to state real estate at fair value for Independence Tower and the changes in operating assets and liabilities between the periods. Investing activities include an increase and a decrease in securities available for sale related to the redemption and purchase of treasury bills and property improvements related to Independence Tower in 1995, 1994 and 1993. Such improvements normally are incurred in connection with the obtaining or renewal of tenant leases. Although there are no other significant improvements contemplated for the property, improvement costs will be incurred in connection with the obtaining or renewal of tenant leases. Any costs related to the asbestos removal and replacement issue discussed below would be considered property improvements subject to an impairment test for the property. Present costs of implementing an operations and maintenance program for the asbestos issue are considered a cost of operations. Financing activities for 1994 reflect a cash distribution to limited partners.\nBecause of a decline in revenue from the hotel property and growth being less than originally anticipated for Independence Tower, distributions paid to limited partners were reduced in 1988 to 3.5% of original capital from the 7% level paid in prior years and no distributions were paid in 1989, 1990, 1991, 1993 or 1995. Future distributions, if any, are anticipated to be paid on an annual basis and will be commensurate with actual prior year operations, cash reserves and anticipated operating requirements. During March 1992, a distribution of approximately $2,000,000 ($31.36 per limited partnership unit) was made to all limited partners. In September 1994, a distribution of approximately $500,000 ($7.84 per limited partnership unit) was paid to all limited partners.\nAt December 31, 1995, the Partnership had cash and cash equivalents of approximately $624,850 and approximately $2.5 million in Treasury Bills included in securities available for sale. Management is of the opinion that the Partnership's liquidity, based on its current activities is adequate to meet anticipated, normal operating requirements during the near term. The costs of asbestos removal at Independence Tower is estimated at from $1.6 million to $2.2 million and the Partnership has retained funds for such removal if it becomes necessary. Should the cost of removal exceed the above estimates, it may need to be funded through financing of this property. Implementation of an operations and maintenance program has been initiated; however, in the future it may be necessary for the Partnership to remove any asbestos in order to sell or refinance the property.\nIn addition to the items discussed above, the Partnership's long term prospects will be primarily effected by future occupancy levels and rental rates achieved at Independence Tower. Due to the uncertain economic climate in general and the real estate market in particular, management cannot reasonably determine the Partnership's long term liquidity position.\nOn November 6, 1995, the Partnership entered into an agreement to sell Independence Tower to an unaffiliated third party for a sales price of $4,000,000 with a closing scheduled to take place during the first half of 1996. Consummation of this sale pursuant to its contract is subject to a number of conditions and there is no assurance that the conditions will be met or that the property will be sold pursuant to the agreement. Upon sale of the property and resolution of outstanding issues, the Board of Directors of the Managing General Partner will consider the possible liquidation of the Partnership.\nITEM 8.","section_7":"","section_7A":"","section_8":"ITEM 8. INDEX TO FINANCIAL STATEMENTS\nIndependent Auditors' Report\nFinancial Statements:\nBalance Sheets - December 31, 1994 and 1995\nStatements of Operations - For each of the Years in the Three Year Period ended December 31, 1995\nStatements of Partners' Capital - For each of the Years in the Three Year Period ended December 31, 1995\nStatements of Cash Flows - For each of the Years in the Three Year Period ended December 31, 1995\nNotes to Financial Statements\nITEM 14. FINANCIAL STATEMENT SCHEDULE\nIII. Properties and Accumulated Depreciation - December 31, 1995.\nAll other schedules are omitted as the required information is either not applicable or is presented in the financial statements and related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners I.R.E. Pension Investors, Ltd.:\nWe have audited the financial statements of I.R.E. Pension Investors, Ltd. (a Florida Limited Partnership), as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of I.R.E. Pension Investors, Ltd.'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 I.R.E. Pension Investors, 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. 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\nFort Lauderdale, Florida March 26, 1996\nI.R.E. PENSION INVESTORS, LTD. (A Florida Limited Partnership)\nBalance Sheets December 31, 1994 and 1995\nAssets\n1994 1995 -------- ------\nCash and cash equivalents $ 303,072 624,850\nSecurities available for sale 2,361,081 2,517,404\nInvestment in real estate: Office building 7,562,066 7,129,075 Less accumulated depreciation (2,999,846) (3,529,452) ----------- ----------- Net investment in real estate 4,562,220 3,599,623\nOther assets, net 42,076 68,673 ---------- ----------\n$ 7,268,449 6,810,550 ========== ==========\nLiabilities and Partners' Capital\nAccrued expenses 72,640 1,987 Accounts payable and other liabilities 114,639 164,293 Due to affiliates 10,799 12,215 ---------- ---------- Total liabilities 198,078 178,495\nPartners' capital: 63,776 limited partnership units issued and outstanding 7,070,371 6,632,055 ---------- ----------\n$ 7,268,449 6,810,550 ========== ==========\nSee accompanying notes to financial statements.\nI.R.E. PENSION INVESTORS, LTD. (A Florida Limited Partnership)\nStatements of Operations For each of the Years in the Three Year Period ended December 31, 1995\n1993 1994 1995 ---- ---- ----\nRevenues: Rental income $ 1,068,273 1,159,262 1,357,241 Tenant reimbursements 1,226 - - Interest income 70,711 103,995 161,775 Other income 6,083 3,561 8,192 ---------- --------- --------- Total revenues 1,146,293 1,266,818 1,527,208 ---------- --------- ---------\nCosts and expenses: Depreciation 430,330 490,817 529,606 Provision to state real estate at fair value - - 665,000 Property operations: Taxes 71,445 68,692 68,686 Insurance 17,424 35,383 44,404 Utilities 195,997 184,917 201,415 Property management fees to affiliate 64,170 69,769 81,934 Repairs and maintenance 199,131 196,349 255,770 Other 83,285 84,363 108,707 General and administrative: To affiliates 63,987 51,582 41,424 Other 44,698 42,662 37,998 Reversal of interest accrued related to the Hess litigation - - (69,420) --------- --------- --------- Total costs and expenses 1,170,467 1,224,534 1,965,524 --------- --------- ---------\nNet income (loss) $ (24,174) 42,284 (438,316) ======== ========= =========\nNet income (loss) per weighted average limited partnership unit outstanding $ (.38) .66 (6.80) ========== ========= =========\nSee accompanying notes to financial statements.\nI.R.E. PENSION INVESTORS, LTD. (A Florida Limited Partnership)\nStatements of Partners' Capital For each of the Years in the Three Year Period ended December 31, 1995\nLimited General Partners Partners Total -------- -------- --------- Balance at December 31, 1992 $ 7,566,570 (14,047) 7,552,523\nNet (Loss) (23,932) (242) (24,174) --------- ------- ---------\nBalance at December 31, 1993 7,542,638 (14,289) 7,528,349\nLimited partner distribution (500,262) - (500,262)\nNet income 41,861 423 42,284 --------- ------- ---------\nBalance at December 31, 1994 7,084,237 (13,866) 7,070,371\nNet loss (433,932) (4,384) (438,316) --------- ------- ---------\nBalance at December 31, 1995 $ 6,650,305 (18,250) 6,632,055 ========= ======== =========\nSee accompanying notes to financial statements.\nI.R.E. PENSION INVESTORS, LTD. (A Florida Limited Partnership)\nStatements of Cash Flows For each of the Years in the Three Year Period ended December 31, 1995\n1993 1994 1995 --------- ---------- -------- Operating Activities: Net income (loss) $ (24,174) 42,284 (438,316) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 430,330 490,817 529,606 Non-cash portion of rental income 715 1,574 2,480 Provision to state real estate at fair value - - 665,000 Changes in operating assets and liabilities: Increase (decrease) in accrued expenses, accounts payable, other liabilities, and due to affiliates 111,763 (100,480) (19,583)\n(Increase) decrease in other assets, net 23,235 (20,250) (45,753) ---------- ---------- ----------\nNet cash provided by operating activities 541,869 413,945 693,434 ---------- ---------- ----------\nInvesting Activities: Purchase of securities available for sale - (2,361,081) (4,930,459)\nMaturities and redemptions of securities available for sale - - 4,790,812 Property improvements (274,819) (192,089) (232,009) ---------- ---------- ----------\nNet cash (used) in investing activities (274,819) (2,553,170) (371,656) ---------- ---------- ----------\nFinancing Activities: Limited partner distribution - (500,262) - ---------- ---------- ---------- Net cash (used) in financing activities - (500,262) - ---------- ---------- ---------- Increase (decrease)in cash and cash equivalents 267,050 (2,639,487) 321,778\nCash and cash equivalents at beginning of year 2,675,509 2,942,559 303,072 ---------- ---------- ----------\nCash and cash equivalents at end of year $ 2,942,559 303,072 624,850 ========== ========== ==========\nSee accompanying notes to financial statements.\nI.R.E. PENSION INVESTORS, LTD. (A Florida Limited Partnership)\nNotes to Financial Statements\n(1) Summary of Significant Accounting Policies\nGeneral\nI.R.E. Pension Investors, Ltd. (the \"Partnership\") was organized on January 17, 1985 in accordance with the provisions of the Florida Uniform Limited Partnership Act to invest in, hold and manage income producing real estate. A sufficient amount of capital was raised to allow funds to be released from escrow to the Partnership on April 1, 1985. The Partnership closed its offering of limited partnership units in October 1985 after having raised $15,960,250.\nThe Managing General Partner has complete authority in the management and control of the Partnership. I.R.E. Pension Advisors, Corp. is the Managing General Partner and Alan B. Levan is the individual General Partner of the Partnership. The General Partners may serve in the same capacity for other entities having similar investment objectives. Should any conflicts of interest arise among these entities, the management of the managing general partners will, at their sole discretion, resolve such conflicts.\nBasis of Financial Statement Presentation - The financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\"). 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 statements of financial condition and income and expenses for the periods presented. Actual results could differ significantly from those estimates. A material estimate that is susceptible to significant change in the next year relates to the determination of the allowance to state real estate at fair value.\nCompensation to General Partners and Affiliates\nThe General Partners and\/or their affiliates are entitled to receive compensation only as specified by the Partnership Agreement. The determination of amount and timing of payment is subject to certain limitations and to cash distribution preferences of limited partners. Following is a brief description of such compensation and the services to be rendered:\nUnderwriting Commissions:\nDue upon the sale of Partnership units of interest.\nNon-recurring Acquisition Fees:\nPrincipally for evaluating and selecting real property for potential purchase by the Partnership.\nProperty Management Fee:\nDue for services in connection with the continuing professional property management of the Partnership properties.\nPartnership Management Fee:\nDue for services rendered in evaluating and selecting properties for the Partnership, reviewing cash requirements, including the determination of the amount and timing of distributions, if any, making decisions as to the nature and terms of the acquisition and disposition of such properties, selecting, retaining and supervising consultants, contractors, architects, engineers, lenders, borrowers, agents and others and otherwise generally managing the day-to-day operations of the Partnership.\nMortgage Servicing Fees:\nDue for mortgage servicing on notes held by the Partnership.\nSubordinated Real Estate Commissions:\nRelated to sales of Partnership properties.\nInterest in Cash from Sales or Financing:\nDue also for services as listed under \"Partnership Management Fee\".\nInterest in Net Income and Net Loss as Determined for Federal Income TaxPurposes:\n1% of net losses and the greater of (a) 1% of net income or (b) an amount of such net income which is in proportion to the percentage of cash distributed to the General Partners as a Partnership Management Fee or for their Interest in Cash From Sales or Financing.\nCash and cash equivalents\nCash equivalents include liquid investments with a maturity of three months or less.\nSecurities Available for Sale\nThe Partnership's securities are available for sale. In accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (\"FAS 115\") issued in May 1993 by the Financial Accounting Standards Board (\"FASB\"), these securities are carried at fair value, with any related unrealized appreciation or and depreciation reported as a separate component of partners capital. At December 31, 1994, the Partnership owned one treasury bill that matured in May 1995 for which cost approximated fair value. At December 31, 1995 the Partnership owned one treasury bill that matures in February 1996 for which cost approximated fair value.\nProperties\nProperties are stated at the lower of cost or fair value in the accompanying statements of financial condition. The office building is depreciated using the straight-line method over an estimated useful life of 20 years. Tenant improvements are capitalized and depreciated using the straight-line method over an estimated useful life of five years.\nIncome Taxes\nThe payment of income taxes is the obligation of the individual partners; therefore, there is no provision for income taxes in the accompanying financial statements. The Partnership's tax returns have not been examined by Federal or state taxing authorities.\nNet income or loss reported for income tax purposes involves, among other things, various determinations relating to properties purchased. Although management of the Partnership believes that such determinations are appropriate, there can be no assurance that the Internal Revenue Service will not contest the Partnership's tax treatment of various items or, if contested, such treatment will be sustained by the Courts. Further, there is a possibility that the Treasury will amend existing regulations or promulgate new regulations, and such action may be retroactive. Accordingly, the tax status of the Partnership and the availability of prior and future income tax benefits to limited partners may be adversely affected.\nFinancial Reporting\nThe Partnership maintains its accounting records on a modified cash basis. The accompanying financial statements are presented on an accrual basis\nReclassifications\nFor comparative purposes, certain prior year balances have been reclassified to conform with the 1995 financial statement presentation.\nRental Income\nRental income is recognized under the operating method whereby aggregate rentals are reported as income over the life of the lease and the costs and expenses are charged against such revenue. Leasing commissions, when significant, are capitalized and amortized over the term of the lease. Rental income, from leases with periods of rent abatement and\/or graduated payments, is recognized ratably over the term of the lease when the credit worthiness of the tenant can be verified to assure collectibility. When this policy is followed a receivable is created in the early years of the lease.\nNew Accounting Standards\nIn 1995, the FASB 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.\" (\"FAS 121\"). FAS 121 requires that long-lived assets, assets held for sale 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 performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. FAS 121 is effective for financial statements for fiscal years beginning after December 15, 1995. Earlier application is encouraged. Management is of the opinion that adoption of FAS 121 did not have a material effect on financial position or results of operations, upon adoption on January 1, 1996.\n(2) Properties\nFollowing is a brief description of the property investments made by the Partnership.\nIndependence Tower\nOn August 19, 1985, the Partnership purchased a twelve story office building containing 103,512 square feet of net leasable area in Charlotte, North Carolina. See note 6(a)and (c).\nOne West Nine Mile Holiday Inn Hotel\nOn December 18, 1986, the Partnership acquired a 91.3% interest in a Joint Venture with an affiliate. This joint venture purchased a 211-room hotel in Hazel Park, Michigan. In December 1991, One West Nine Mile Holiday Inn Hotel was sold and the joint venture was liquidated.\nLeases\nThe aggregate sum of the minimum lease rental payments to be received for Independence Tower over the five succeeding years is approximately as follows:\nYear ending December 31, ----------------------------------- 1996 1997 1998 1999 2000 --------- -------- ------- ------- -----\n$1,180,000 1,015,000 514,000 259,000 187,000 ========= ========= ======= ======= =======\nThe above table does not consider exercise of renewal options by existing tenants, leasing premises that were not leased as of December 31, 1995 or renewal of leases expiring during the above periods.\n(3) Compensation To General Partners And Affiliates\nDuring the year ending December 31, 1993, 1994 and 1995 compensation and reimbursements to general partners and affiliates were as follows:\n1993 1994 1995 ---- ---- ---- Reimbursements for administrative and accounting services $ 63,987 51,582 41,424 Property management fees 64,170 69,769 81,934 ------- ------- -------\nTotal $ 128,157 121,351 123,358 ======= ======= =======\n(4) Reconciliation of Net Income (Loss) and Partners' Capital\nThe following reconciliation provides details of the nature and amount of differences between net income (loss) and partners' capital per the accompanying financial statements and the Partnership's tax return.\n1993 1994 1995 -------- -------- ------ Net income (loss): Amount reported for financial statement purposes $ (24,174) 42,284 (438,316) Difference in financial statement\/tax depreciation expense 241,740 294,467 328,430 Adjustment to the carrying value of real estate for financial statement purposes - - 665,000 Difference between accrual basis of accounting used for financial statements and the method used for income tax purposes (9,834) 8,100 (62,736) -------- -------- -------- Amount reported for income tax purposes $ 207,732 344,851 492,378 ======== ======== ========\n1993 1994 1995 -------- -------- ------ Partners' capital: Amount reported for financial statement purposes $ 7,528,349 7,070,371 6,632,055\nDifference in financial statement\/tax depreciation expense 1,125,261 1,419,728 1,748,158 Difference due to fair value considerations in the carrying value of real estate for financial statement purposes - - 665,000\nDifference between accrual basis of accounting used for financial statements and the method used for income tax purposes 56,115 64,214 1,478 Cost of raising capital, deducted from partners' capital for financial statements and included in other assets for income tax purposes, net 1,751,049 1,751,049 1,751,049 ---------- ---------- ---------- Amount reported for income tax purposes $10,460,774 10,305,362 10,797,740 ========== ========== ==========\n(5) Litigation\nDuring May 1988, an individual investor filed an action against two individual defendants who allegedly sold securities without being registered as securities brokers, two corporations organized and controlled by such individuals, and against approximately sixteen publicly offered limited partnerships, including the Partnership, interests in which were sold by the individual and corporate defendants.\nPlaintiff alleged that the sale of limited partnership interests in the Partnership (among other affiliated and unaffiliated partnerships) by persons and corporations not registered as securities brokers under the Illinois Securities Act constituted a violation of such Act, and that the Plaintiff, and all others who purchased securities through the individual or corporate defendants, should be permitted to rescind their purchases and recover their principal plus 10% interest per year, less any amounts received. The Partnership's securities were properly registered in Illinois and the basis of the action relates solely to the alleged failure of the Broker Dealer to be properly registered.\nIn November 1988, Plaintiff's class action claims were dismissed by the Court. Amended complaints, including additional named plaintiffs, were filed subsequent to the dismissal of the class action claims. Motions to dismiss were filed on behalf of the Partnership and the other co-defendants. In December 1989, the Court ordered that the Partnership and the other co-defendants rescind sales of any plaintiff that brought suit within three years of the date of sale. Under the Court's order of December 1989, the Partnership was not required to rescind any sales. Plaintiffs appealed, among other items, the Court's order with respect to plaintiffs that brought suit after three years of the date of sale. While there has been no formal dismissal of the claims against the Partnership, it has been determined that none of the sales made to investors of the Partnership occurred during the time periods which are still being considered in this case and therefore, there is no longer any ongoing claims against the Partnership in this matter.\nThrough June 20, 1995, an accrual of $69,000 for interest on amounts that would be due upon rescission had been made. Based upon the determination that the Partnership had no ongoing claims against it, the accrual was reversed during the quarter ended September 30, 1995.\nIn May 1995, the lease of a tenant occupying approximately 5,000 square feet at Independence Tower expired. Prior to expiration, the Partnership attempted to negotiate a renewal with the tenant, however, the parties were never able to reach agreement. The tenant contends that a lease extension was agreed to by the parties. The tenant brought an action against the Partnership seeking specific performance under the lease the tenant claims exists, or in the alternative, damages that would be sustained by tenant if it was forced to move, an injunction to keep the Partnership from seeking an order for eviction, damages caused by the Partnership's unfair and deceptive trade practices and for attorneys' fees. Subsequently, the Partnership brought an action for possession of the premises. The tenant also had a note due to the Partnership for prior delinquent rent and when a default occurred under the terms of the note, the Partnership filed suit against the tenant and the co-maker under the note. A trial is scheduled in June 1996 regarding the possession portion of the above.\n(6) Other Matters\n(a) A preliminary environmental site assessment and asbestos survey of Independence Tower has revealed the presence of asbestos containing materials. The estimated cost to remove and replace the asbestos items is approximately a range of $1.6 to $2.2 million. Implementation of an operations and maintenance program has been initiated, however, in the future, it may be necessary for the Partnership to remove any asbestos in order to sell or refinance this property.\n(b) An affiliate earned a real estate brokerage commission of approximately $97,000 in connection with the sale of One West Nine Mile Holiday Inn. However, in accordance with the terms of the Partnership Agreement, payment of such commission is subordinated to the limited partners receipt of their original capital plus a specified return thereon. The Partnership has not reflected its portion of this commission in its financial statements, because payment of such commission is remote.\n(c) On November 6, 1995, the Partnership entered into an agreement to sell Independence Tower to an unaffiliated third party for a sales price of $4,000,000 with a closing scheduled to take place during the first half of 1996. Consummation of this sale pursuant to its contract is subject to a number of conditions and there is no assurance that the conditions will be met or that the property will be sold pursuant to the agreement. Upon sale of the property and resolution of outstanding issues, the Board of Directors of the Managing General Partner will consider the possible liquidation of the Partnership. Based upon the estimated sales price, an allowance of $665,000 was established during the fourth quarter to state the carrying value of Independence Tower at fair value.\nSCHEDULE III\nProperties and Accumulated Depreciation December 31, 1995\nIndependence Tower Office Building Charlotte North Carolina -------------- Acquisition Date 8\/85\nEncumbrances $ - =====\nInitial Costs: Land 823,161 Building and Improvements 4,628,240 --------- 5,451,401 ---------\nImprovements: Costs capitalized subsequent to acquisition: Land - Building and Improvements 2,342,674 --------- 2,342,674 ---------\nAllowance to state real estate at fair value (665,000) -------- (665,000) --------\nGross Amount: Land 823,161 Building and Improvements 6,305,914 --------- Total $ 7,129,075 =========\nAccumulated Depreciation $ 3,529,452 =========\nLife on which depreciation is computed 20 years ========\nReconciliation of Cost and Accumulated Depreciation For each of the Years in the Three Year Period ended December 31, 1995\n1993 1994 1995 ---- ---- ----\nCost:\nBalance at beginning of period $ 7,095,158 7,369,977 7,562,066 Allowance to state real estate at fair value - - (665,000) Additions: Improvements 274,819 192,089 232,009 --------- --------- ---------\nBalance at end of period $ 7,369,977 7,562,066 7,129,075 ========= ========= =========\nAccumulated Depreciation:\nBalance at beginning of period $ 2,078,699 2,509,029 2,999,846 Addition: Depreciation 430,330 490,817 529,606 --------- --------- ---------\nBalance at end of period $ 2,509,029 2,999,846 3,529,452 ========= ========= =========\nThe aggregate basis (not reduced by accumulated depreciation) for Federal income tax purposes of the above property was approximately $7,794,000 at 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\nRegistrant has no directors or officers.\na) Directors.\nListed below are the directors of I.R.E. Pension Advisors Corp., Managing General Partner of Registrant, all of whom are to serve until the election and qualification of their respective successors unless sooner removed from office: NAME AGE POSITIONS HELD -------------- --- ------------------- Alan B. Levan 51 Director since 1985\nEarl Pertnoy 69 Director since 1985\nCarl E. B. McKenry, Jr. 67 Director since 1985\nb) Executive Officers.\nListed below are the executive officers of I.R.E . Pension Advisors Corp., all of whom are to serve until they resign or are replaced by the Board of Directors: NAME AGE POSITIONS HELD -------------- --- ------------------- Alan B. Levan 51 President since 1985\nGlen R. Gilbert 51 Senior Vice President since 1985; Chief Financial Officer since 1987; Secretary since c) Certain Significant Employees.\nNot applicable.\nd) Family Relationships.\nNot applicable.\ne) Business Experience.\nALAN B. LEVAN formed the I.R.E. Group in 1972. Since 1978, he has been the Chairman of the Board, President, and Chief Executive Officer of BFC Financial Corporation (or its predecessor companies), a financial services and savings bank holding company. He is also Chairman of the Board and President of I.R.E. Realty Advisors, Inc., I.R.E. Properties, Inc., I.R.E. Realty Advisory Group, Inc., U.S. Capital Securities, Inc., and Florida Partners Corporation. Mr. Levan is also Chairman of the Board and Chief Executive Officer of BankAtlantic, Bancorp, Inc. Mr. Levan is also an individual general partner and an officer and a director of the corporate general partners of various public limited partnerships (including the Registrant), all of which are affiliated with BFC Financial Corporation.\nGLEN R. GILBERT has been Senior Vice President of BFC Financial Corporation since 1984, Chief Financial Officer since 1987 and Secretary since 1988. Mr. Gilbert has been a certified public accountant since 1970. Mr. Gilbert serves as an officer of Florida Partners Corporation and of the corporate general partners of various public limited partnerships (including the Registrant), all of which are affiliated with BFC Financial Corporation.\nEARL PERTNOY has been for more than the past five years a real estate investor and developer. He has been a director of BFC Financial Corporation and its predecessor companies since 1978. He is a director of the corporate general partners of various public limited partnerships (including the Registrant), all of which are affiliated with BFC Financial Corporation.\nCARL E. B. McKENRY, JR. is the Director of the Small Business Institute at the University of Miami in Coral Gables, Florida. He has been associated in various capacities with the University since 1955. He has been a director of BFC Financial Corporation since 1981 and is a director of the corporate general partners of various public limited partnerships (including the Registrant), all of which are affiliated with BFC Financial Corporation.\nf) Certain Legal Proceedings.\nNone.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\na) Cash Compensation.\nThe Registrant has no officers or directors.\nThe Registrant did not pay salaries or expenses of the officers and directors of the general partner of the Registrant in 1995, except for travel and other expenses directly related to activities of the Registrant.\nb) Compensation Pursuant to Plans.\nRegistrant has no annuity, pension or retirement plan for any director, officer or employee.\nc) Other Compensation.\nNot applicable.\nd) Compensation of Directors.\nRegistrant has no directors.\ne) Termination of Employment and Change of Control Arrangement.\nNot applicable.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\na) No person owns 5% or more of Registrant's voting securities.\nb) Registrant has no officers or directors. The following information is provided with respect to units owned by directors and officers of the managing general partner.\n(3) AMOUNT AND (2) NATURE OF (4) (1) NAME AND ADDRESS OF BENEFICIAL PERCENT TITLE OF CLASS BENEFICIAL OWNER OWNERSHIP OF CLASS ---------------- --------------------- ----------- ----------- (i) Units of Limited Alan B. Levan 28 Direct .0% (approx.) Partnership 1750 E. Sunrise Blvd. (ii) Interest Fort Lauderdale, FL 33304\nAll other directors and officers of the Managing General Partner as a group 0 Direct .0% - -- TOTAL 28 Direct .0% (approx.) ======== ===\n(i) Alan B. Levan is a general partner of Registrant and is President and Director of the Managing General Partner.\n(ii) Includes 8 units held by spouse.\nc) Registrant knows of no contract or other arrangement that could result in a change in control of registrant.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\na) & b) During the year ending December 31, 1995, the following entities received the fees and payments indicated for services rendered with respect to the Registrant:\nNAME AND RELATIONSHIP TO REGISTRANT TRANSACTION AMOUNT -------------------------- ------------------- -------- BFC Financial Corporation Reimbursement for and subsidiaries, administrative and Affiliates of the General accounting services $41,424 Partners Property management fees $81,934\nc) Indebtedness of Management.\nNone.\nd) Transactions with Promoters.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nA-1. See Item 8. Financial Statements and Supplementary Data.\nA-2. See Item 8. Financial Statements and Supplementary Data.\nA-3. Exhibits:\n(3) Articles of incorporation and by-laws. Limited Partnership Agreement set forth as Exhibit A to the Prospectus of the Partnership dated February 13, 1985, as filed with the Commission pursuant to Rule 424(c), is hereby incorporated herein by reference.\n(4) Instruments defining the rights of security holders, including indentures - Not applicable.\n(9) Voting trust agreement - Not applicable.\n(10) Material contracts - Not applicable.\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, Form 10-Q or quarterly report to security holders - Not applicable.\n(18) Letter re change in accounting principles - Not applicable.\n(19) Previously unfiled documents - Not applicable.\n(22) Subsidiaries of the Registrant - Not applicable.\n(23) Published report regarding matters submitted to a vote of security holders - Not applicable.\n(24) Consents of experts and counsel - Not applicable.\n(25) Power of attorney - Not applicable.\n(27) Financial Data schedule - Included as Exhibit 27.\n(28) Additional exhibits - None.\n(29) Information from reports furnished to state insurance regulatory authorities - Not applicable.\nB. 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.\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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nI.R.E. PENSION INVESTORS, LTD. Registrant By:I.R.E. Pension Advisors Corp., Managing General Partner\nBy:\/S\/ Alan B. Levan ---------------------------- Alan B. Levan, 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 Managing General Partner on behalf of the Registrant and in the capacities and on the dates indicated.\n\/S\/ Alan B. Levan March 26 1996 - ------------------------------------------------------- Alan B. Levan, Director and Principal Executive Officer\n\/S\/ Earl Pertnoy March 26, 1996 - ------------------------------------------------------- Earl Pertnoy, Director\n\/S\/ Carl E.B. McKenry, Jr. March 26, 1996 - ------------------------------------------------------- Carl E. B. McKenry Jr., Director","section_15":""}
{"filename":"46738_1995.txt","cik":"46738","year":"1995","section_1":"ITEM 1. BUSINESS\nHeller Financial, Inc. (the \"Company\") was incorporated in 1919 under the laws of the State of Delaware and is engaged in various aspects of the commercial finance business. The Company and its consolidated subsidiaries employ approximately 1,500 people. The executive offices are located at 500 West Monroe Street, Chicago, Illinois 60661 (telephone: (312) 441-7000). Unless the context indicates otherwise, references to the Company include Heller Financial, Inc. and its consolidated subsidiaries.\nThe Company operates in the middle market segment of the commercial finance industry, which generally includes entities in the manufacturing and service sectors with annual sales in the range of $15 million to $200 million and in the real estate sector with property values generally in the range of $5 million to $40 million. The Company currently provides services in five product categories: (1) corporate finance, (2) asset based finance, (3) real estate finance, (4) international factoring and asset based finance and (5) specialized finance and investments. The asset based finance product category consists of financing for working capital and receivable management, vendor finance program loans and leases, secured working capital finance, equipment loans and leases to end users, small business lending, and indirect consumer finance.\nThe Company is continuing the program begun in 1990 to diversify its portfolio and earnings sources, strengthen earnings, improve asset quality and maintain its capital strength. The Company is diversifying its portfolio and earnings sources by growing the asset based businesses, reducing reliance on the corporate finance and real estate finance businesses, and continuing to grow its equity investments and international businesses. Earnings quality is being strengthened by growing the asset based businesses which provide more consistent earning streams and reduce the level and volatility of credit quality costs. Asset quality is improving by emphasizing lower risk asset based business through conservative underwriting practices and the resolution of pre-1990 problem accounts. The Company is pursuing these goals in the framework of continued moderate leverage, appropriate reserves and conservative liquidity.\nCORPORATE FINANCE\nThe Corporate Finance Group offers a broad spectrum of services based on the cash flows underlying a client's business. These services are often provided through coordination with private equity sponsors and include the financing of corporate recapitalizations, refinancings, expansions, acquisitions and buy- outs of publicly and privately held entities in a wide variety of industries. Loans are provided on both a term and revolving basis for periods of up to ten years and are typically collateralized by senior liens on the borrower's stock or assets or both. Corporate Finance transactions may also include some unsecured or subordinated financings or non-voting equity infusions.\nASSET BASED FINANCE\nAsset based financing is offered by the Current Asset Management Group, Vendor Finance Division, Heller Business Credit (\"Business Credit\"), Commercial Equipment Finance Division, Heller First Capital (\"First Capital\") and Sales Finance Group.\nThe Current Asset Management Group provides working capital financing, receivable management, and credit protection to companies in a broad range of industries. The group offers factoring services to approximately 650 clients and over 100,000 customers primarily in the apparel, textile, houseware, transportation, and home furnishings industries. In return for a commission, the group purchases the client's accounts receivable and provides collection and management information services. Working capital is provided by advancing on a formula basis a percentage of the client's factored accounts receivable. The group also provides advances against inventory on a formula basis.\nVendor Finance Division provides leasing and financing of capital equipment through approximately 75 manufacturer and vendor programs, financing of independent leasing companies and direct relationships with end\nusers. These transactions generally have partial or full recourse to the vendor. This division finances the machining, graphic arts, information technology, energy management, healthcare, communication, and food processing markets.\nBusiness Credit provides working capital and term financing to middle market companies for refinancings, recapitalizations and acquisitions. The group provides financing to manufacturers, retailers, wholesalers, distributors, exporters, and service firms. The group also serves as co-lender or participates in transactions agented by other asset based lenders. The revolving credit facilities and term loans are generally cross-collateralized.\nThe Commercial Equipment Finance Division provides financing to a diverse group of middle market companies for equipment acquisition (expansion, replacement and modernization) or refinancing of existing equipment obligations. The equipment is typically essential to the operations of the borrower and the amount financed is generally not a substantial part of the capital structure for an individual borrower. The markets served include transportation (rail, air and shipping), supermarket, manufacturing, restaurant and food processing.\nFirst Capital is a provider of long-term financing to independent small businesses and franchises under U.S. Small Business Administration loan guarantee programs. The types of loans include real estate acquisition, refinancing or construction financing, equipment or business acquisition, permanent working capital for expansion efforts, and debt consolidation. The guaranteed portions of these loans are sometimes sold in the secondary market, with servicing rights retained by First Capital.\nThe Sales Finance group, recently formed as a stand-alone business unit, provides financing to under-served market niches in consumer finance by providing financing lines to consumer receivables originators. The group provides receivable funding and project finance for vacation ownership, home improvement, and non-prime auto finance companies.\nREAL ESTATE FINANCE\nThe Real Estate Financial Services group provides interim financing to real estate owners, investors and developers primarily for the acquisition, refinancing and renovation of commercial income producing properties in a wide range of property types and geographic areas. The group also offers financing for discounted loan portfolio acquisitions, participating junior debt and equity financing to developers of single and multi-family housing, credit sale-leaseback financing for single tenant properties, as well as standby commitments. The group also originates loans secured by manufactured housing communities, self storage facilities, and multi-tenant industrial property types to be sold through the capital markets via commercial mortgage securitization.\nINTERNATIONAL FACTORING AND ASSET BASED FINANCE\nThe International Group provides factoring, asset based finance, acquisition finance, leasing, vendor finance and\/or trade finance programs primarily to small and mid-sized businesses outside the United States through investments in commercial finance companies located in 19 countries in Europe, Asia, Australia and Latin America. These companies may be wholly or majority-owned or joint ventures. During 1995, the International Group continued to pursue new international opportunities and has expanded support of the international needs of existing domestic customers.\nSPECIALIZED FINANCE AND INVESTMENTS\nSpecialized financing and investments are generally originated in three areas: project investment, aircraft finance, and middle market equity investing. The Project Investment and Advisory Division offers financing to independent power producers and industrial projects in the form of senior and junior secured loans, equity investments and development loans. Aircraft Finance offers financing for commercial aircraft and aircraft engines through operating leases or junior secured loans to an operating lessor, with terms ranging from 4 to 10 years and direct investing in new aircraft through strategic alliances. Equity Finance provides financing to or invests in middle market companies and provides capital to companies requiring an operational or financial turnaround.\nSYNDICATION ACTIVITIES\nHeller's strategy continues to focus on managing exposure to individual credits and industry concentrations. A key part of this strategy has been to sell participations to control the concentration of credit risk. The Company has established syndication programs in most of its businesses syndicating $532 million of receivables during 1995.\nOWNERSHIP\nAll of the outstanding Common Stock of the Company is owned by Heller International Corporation (the \"Parent\"), a wholly-owned subsidiary of The Fuji Bank Limited (\"Fuji Bank\"), headquartered in Tokyo, Japan. Fuji Bank also directly owns 21% of the outstanding shares of Heller International Group, Inc., a consolidated subsidiary of the Company engaged in international factoring and asset based financing activities. Fuji Bank is one of the largest banks in the world, with total deposits of approximately $378 billion at September 30, 1995. For a discussion of the \"Keep Well Agreement\" between Fuji Bank and the Company, see \"Certain Relationships and Related Transactions--Keep Well Agreement with Fuji Bank.\"\nSUMMARY OF TOTAL REVENUES, LENDING ASSETS AND INVESTMENTS\nA summary of total revenues, lending assets and investments by product category is included in the \"Portfolio Composition\" section of \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on page 10. This summary closely corresponds to a classification by operating unit. For information about international operations, see Notes 3 and 15 to the Consolidated Financial Statements.\nRATES CHARGED; COMPETITION; REGULATION\nRates charged by the Company vary depending on the risk and maturity of the loan, competition, current cost of borrowing to the Company, state usury laws and other governmental regulations. The Company's portfolio of receivables primarily earns interest at variable rates. These variable rates float in accordance with various agreed upon reference rates, including the London Inter-bank Offered Rate, the Prime Rate or corporate based lending rates. Competition varies by operating group. In general, the Company is subject to competition from a variety of financial institutions, including commercial finance companies, banks and leasing companies.\nAs a subsidiary of Fuji Bank, the Company is subject to the limitations imposed by the Bank Holding Company Act of 1956, as amended, and related regulations adopted by the Board of Governors of the Federal Reserve System. Those regulations restrict the Company to activities that have been defined as being so closely related to banking as to be incidental thereto and also restrict certain lending activities. Certain of the Company's equity investment and small business lending activities are subject to the supervision and regulation of the Small Business Administration. To date, such regulations have not had a material adverse effect on the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases executive offices located at 500 West Monroe Street, Chicago, Illinois 60661 and maintains various offices throughout the United States, Europe, Asia, Australia and Latin America, all of which are leased premises. For information concerning the Company's lease obligations, see Note 7 to the Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is party to a number of legal proceedings as plaintiff and defendant, all arising in the ordinary course of its business. The Company believes that the amounts, if any, which may ultimately be funded or paid with respect to these matters, will not have a material adverse effect on the financial condition or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were acted upon in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe outstanding Common Stock of the Company is owned entirely by the Parent, which is wholly-owned by Fuji Bank. There is no public trading market for the Company's Common Stock. The Company is prohibited from paying cash dividends on Common Stock unless full cumulative dividends on all outstanding shares of Perpetual Preferred, Convertible Preferred and NW Preferred Stock have been paid. All Preferred Stock dividends have been paid and in 1995 the Company declared and paid $52 million in cash dividends on Common Stock to its Parent. The Company anticipates paying future dividends on Common Stock while maintaining its conservative capital structure.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents information from the Company's Consolidated Financial Statements for the five years ended December 31, 1995, which have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report included herein. 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 Supplementary Data.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nDuring 1995, the Company remained committed to its four strategies, which are to strengthen earnings, diversify assets, strengthen asset quality and maintain a conservative capital structure. Earnings quality improved as operating revenues continued to show increased diversity among the Company's various business lines. The Company continued to balance the portfolio by growing the asset based businesses and reducing the level of corporate finance and real estate finance lending assets. Asset quality also improved due to the excellent credit performance in the newer asset based businesses, the favorable credit experience of the post-1990 financings in the corporate finance and real estate businesses and the continued resolution of pre-1990 corporate finance and real estate problem accounts. The Company's capital structure remained conservative as evidenced by a debt to equity ratio (net of short-term investments) of 5 to 1 and a reduction to 30% of commercial paper and short term borrowings as a percentage of total debt.\nRESULTS OF OPERATIONS\nThe following table summarizes the Company's operating results for the years ended December 31, 1995, 1994, and 1993.\n1995 vs. 1994\nFor the third straight year the Company achieved record net income. Net income for 1995 increased by $7 million or 6% due to increased net interest income, higher revenues from fees and other income and increased income of international joint ventures. These increases were partially offset by continued spending for developing businesses and a higher provision for losses related to resolution of pre-1990 accounts.\nNet interest income increased 6% from the prior year period due to growth in earning funds and a moderate increase in net interest margin which exceeded the costs of carrying higher average levels of equity investments. Average earning funds grew by 8% during 1995. Rates charged on 81% of average earning funds for 1995 were based on floating indices such as the average three month London Inter-bank Offered Rate, which increased to 6.0% in 1995 from 4.7% in 1994 and contributed to the increase in interest income for the year. Interest expense increased during 1995 partly due to the rise in the average borrowing rate to 6.9% from 5.5% in 1994 and the higher level of debt used to finance portfolio growth.\nFees and other income increased $28 million or 16% for 1995 due to increased net gains from sales of investments and increased revenues from real estate transactions. Net gains on sales of investments increased 51% during 1995 primarily due to the sale of several equity investments at substantial gains. Realized gains from sales of investments during 1995 were $133 million, which were partially offset by writedowns and realized losses of $59 million. Due to the timing and recognition of investment activity, the Company expects net investment gains to vary from year to year.\nIncome of international joint ventures increased by $14 million during 1995 primarily due to growth in earnings from European joint ventures in the Netherlands and France, and benefits from changes in foreign exchange rates relative to the U.S. dollar.\nOperating expenses were higher principally due to increased spending to support growth of the asset based businesses. This trend is expected to continue in 1996.\nThe provision for losses increased by $35 million or 19% over prior year levels as the Company continued to aggressively resolve pre-1990 real estate and corporate finance problem accounts through paydown, sale, restructure or writedown of these accounts. Net writedowns of receivables and repossessed assets increased by $52 million compared to the prior year due to this aggressive account management. The Company's newer business portfolios continued to exhibit strong credit quality resulting in a very low level of writeoffs for this portfolio during 1995.\nThe Company's effective tax rate decreased to 27% and was below statutory rates primarily due to the favorable resolution of certain state tax issues in 1995.\n1994 vs. 1993\nThe Company achieved record pre-tax income of $174 million, an increase of $41 million or 31%. This increase reflects higher fees and other income from several product categories and a lower provision for losses as portfolio quality improved. These factors offset increased spending on developing businesses and a higher provision for income taxes, as net income slightly exceeded 1993's record level.\nNet interest income increased as growth in the level of average earning funds and a reduction in the cost to carry nonearning assets was partially offset by modest spread compression. Average earning funds grew 2% and the portfolio mix shifted towards lower risk, lower priced assets, resulting in some spread compression. Interest income increased due to higher market interest rate levels. Rates charged on 81% of average earning funds employed were based on floating indices such as the three month London Inter-bank Offered Rate, which increased to 4.7% for 1994 from 3.3%. Interest expense increased as a result of the rise in the average borrowing rate to 5.5% from 4.4% and the higher level of debt used to finance portfolio growth.\nFees and other income increased $32 million or 23% reflecting revenues from several sources including higher revenues from certain real estate activities, higher gains from equity interests and investments and higher revenues from asset based businesses.\nThe income of international joint ventures was somewhat lower, while the income from overall international operations increased primarily due to the improved performance of wholly-owned subsidiaries. This improvement resulted from subsidiaries in the Asia\/Pacific region as well as gains on Brazilian investments.\nOperating expenses were higher principally due to the increased spending on developing businesses in the asset based product category.\nThe provision for losses declined in 1994 as the level of problem assets continued to recede and the performance of new financings over the past four years remained strong. The allowance for losses was 3.0% of receivables, which equaled 81% of nonearning receivables at December 31, 1994. These amounts were restated to reflect the adoption of Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" in order to conform with the 1995 presentation.\nThe Company's effective tax rate increased to 30% from 8% for the prior year, in which higher deferred tax benefits were recognized. The Company's provision for income taxes is lower than the statutory rate due to the favorable resolution of a tax issue and the recognition of additional deferred tax benefits during the second quarter.\nPORTFOLIO COMPOSITION\nLending assets and investments increased $596 million or 7% during 1995 as the Company continued to build a more balanced portfolio by diversifying its asset base and sources of income. The growth experienced was primarily from the domestic asset based businesses. The Company achieved this level of growth despite a $486 million reduction of the pre-1990 corporate finance and real estate portfolio. In line with the Company's diversification efforts, lending assets and investments for both corporate finance and real estate finance have been reduced as a percentage of total lending assets and investments. The following tables present lending assets and investments and total revenues by product category. The asset based finance category includes factoring, vendor finance program loans and leases, secured working capital finance, equipment loans and leases to end-users, small business activities, and indirect consumer finance.\nLending Assets and Investments. During the last several years, the Company has developed a more balanced, lower risk portfolio, while maintaining its market position in business value and real estate finance. During 1995, asset based lending assets and investments increased $900 million to 33% of total lending assets and investments and became the second largest product category of the Company. Corporate finance and real estate lending assets and investments have decreased to 34% and 22% of the portfolio, respectively, reflecting the Company's desire to reduce concentration in these businesses and establish a balanced portfolio. Total lending assets increased $478 million while the ratio of nonearning assets to total lending assets decreased to 3.6% from 4.0% at the prior year end. Total investments increased $118 million during 1995 due to an increase in real estate transactions and investments in and undistributed earnings of International joint ventures.\nConcentrations of lending assets of 5% or more at December 31, 1995 and 1994, based on the standard industrial classification of the borrower, are as follows:\nThe majority of lending assets in the textiles and apparel manufacturing and department and general merchandise retail stores categories is comprised of factored accounts receivable which represent short-term trade receivables from a large number of customers. The general industrial machines classification is distributed among machinery used for many different industrial applications.\nTotal Revenues. Total revenues include interest income, net gains from the sales of investments, fees and other income from domestic and consolidated international operations, and the Company's share of the net income of its international joint ventures.\nThe growth in total revenues of $191 million or 21% in 1995 is primarily attributable to growth in interest income from higher variable interest rates and average earning fund levels, an increase in the net gains on sales of investments, and growth in income of international joint ventures. Consistent with the shift in lending assets, corporate finance and real estate revenues decreased as a percentage of total revenues, while asset based revenues and revenues from specialized finance and investments increased. Earnings quality improved for the year as the Company achieved greater diversification of revenues among all of its product lines.\nPRODUCT CATEGORIES\nCorporate finance. The Corporate Finance Group provides senior and subordinated financing for corporate recapitalizations, refinancings, expansions, acquisitions and buy-outs of publicly and privately held companies. Strong credit disciplines were maintained by financing transactions with smaller retained balances and utilizing syndication capabilities to reduce customer concentrations as evidenced by an average hold size of $16 million in 1995 versus $18 million in the prior year. While the number of new transactions during 1995 has increased over the prior year, corporate finance lending assets and investments decreased $217 million to 34% of the total portfolio, due to run off or resolution of pre-1990 accounts and a relatively high level of payoffs in the newer portfolio. Repayments and syndications totaled $1,457 million and $1,341 million for 1995 and 1994, respectively. The Corporate Finance Group originated $1,412 million of financings during 1995 compared to $1,153 million in the prior year.\nInterest income increased as higher variable interest rates more than offset the effect of a decline in the level of average corporate finance funds employed. Fees and other income decreased during 1995 as realized gains from sales of equity investments were offset by $37 million of writedowns and realized losses on several equity investments related primarily to troubled pre-1990 accounts.\nNet writedowns of corporate finance lending assets increased by $36 million primarily due to net writedowns on pre-1990 assets which comprised 85% of total corporate finance net writedowns for the year. Nonearning assets decreased to 3% of total corporate finance lending assets due to the continued strong credit quality of the receivables originated since 1990 and the resolution of several pre-1990 problem credits. Approximately 80% of the group's nonearning assets were originated prior to 1990.\nAt December 31, 1995, the Corporate Finance Group was contractually committed to finance an additional $627 million to new and existing borrowers, generally contingent upon the maintenance of specific credit standards. Since many of the commitments are expected to remain unused, the total commitment amounts do not necessarily represent future cash requirements. No significant commitments exist to provide additional financing related to nonearning assets.\nCorporate financings are generally considered by certain regulatory agencies as highly leveraged transactions.\nAsset based finance. The asset based lending portfolio is comprised of factored accounts receivable, vendor finance program loans and leases, secured working capital finance, equipment loans and leases to end users, small business finance activities, and indirect consumer finance. Asset based lending assets and investments increased by 43% over the prior year as the group funded $1,696 million and $1,009 million during 1995 and 1994, respectively. This was offset by repayments and syndications totaling $803 million and $410 million during 1995 and 1994, respectively. Revenues increased by 38% as a result of the continued growth of these businesses.\nCurrent Asset Management Group provides factoring services that are short- term trade receivables primarily from department and general merchandise retailers. These accounts are highly liquid with an average turnover of approximately 50 days, and are managed continuously by evaluating the consolidated exposure from all clients to a particular customer. Credit files are maintained for customers in order to control this credit exposure. In 1995, the group was one of the largest factors in the highly competitive United States factoring industry with volume in excess of $6 billion.\nThe Vendor Finance Division provides customized finance and lease programs to a variety of equipment manufacturing and distribution clients, as well as independent leasing companies. Loans to purchasers of equipment are generally made with partial recourse to the vendor. Individual transactions generally range from $50,000 to approximately $2.5 million with an average transaction size of approximately $100,000. New business volume this year increased over 1994, while asset quality continued to be strong.\nBusiness Credit provides senior secured revolving and term facilities based on accounts receivable, inventory, and to a lesser extent, machinery and equipment. Business Credit provides financing both as agent and on a participation basis with other traditional asset-based lenders in senior secured transactions with an average commitment and loan size of $17 million and $8 million, respectively, as of December 31, 1995. These loans are usually for periods of 3 to 5 years and consist of revolving credit facilities secured by accounts receivable and inventory and to a much lesser extent, term loans secured by property, plant and equipment. New business volume increased significantly during 1995 while the group also maintained excellent asset quality.\nThe Commercial Equipment Finance Division offers general equipment financing direct to customers in multiple industries for equipment acquisition (expansion, replacement and modernization), or refinancing of existing equipment obligations. Transactions financed generally range from $1 million to $15 million with terms ranging from 3 to 10 years. New business growth for 1995 exceeded 1994 while asset quality continues to be excellent.\nFirst Capital is the third largest lender of Small Business Administration loans providing loans to a broad range of individual small businesses and franchises. Types of loans include real estate acquisition, refinancing or construction financing and equipment or business acquisition. These loans are guaranteed up to 75% by the U.S. Small Business Administration. These loans are generally for amounts up to $2 million and have an average transaction size of $350,000. First Capital has historically sold, and may from time to time in the future sell, the guaranteed portion of these loans.\nSales Finance, established as a separate division at the end of 1995, provides senior and subordinate consumer financing on an indirect basis or through strategic alliances with originator and servicer companies. Financing is provided primarily for vacation ownership, home improvement, and non-prime auto finance companies. Transaction sizes generally range from $3 million to $25 million with terms ranging from three to seven years.\nThe asset based portfolio and revenues are presented below:\nThe lending assets in each of the asset based categories grew significantly as a result of increased emphasis on the development of each of these lines of business. Disciplined underwriting standards combined with strong collateral coverage have been key elements resulting in the low level of nonearning assets as of December 31, 1995. The increase in asset based nonearning assets is primarily due to two portfolios of workers compensation claims financed by the healthcare unit of the Current Asset Management Group.\nThe revenues generated by asset based businesses increased by $82 million or 38% primarily as the result of an increase in average funds employed and the effects of higher variable interest rates. These products continued to demonstrate very favorable credit experience as evidenced by the low levels of nonearning assets and writedowns during the year. Net writedowns in the asset based portfolios were concentrated in the Current Asset Management Group and primarily resulted from several bankruptcies of discount retailers due to intense competition in this market segment. Business Credit, Commercial Equipment Finance Division and Sales Finance did not experience any writedowns during the year.\nAt December 31, 1995, the asset based groups were contractually committed to finance an additional $729 million to new and existing borrowers, generally contingent upon the maintenance of specific credit standards. Since many of the commitments are expected to remain unused, the total commitment amounts do not necessarily represent future cash requirements. No significant commitments exist to provide additional financing related to nonearning assets.\nReal estate finance. During 1995, the Real Estate Finance Group continued to diversify its assets through a number of lending programs, while maintaining its credit disciplines and the relative size of its portfolio. Real estate lending assets and investments decreased, as financings of $746 million were offset primarily by\nrepayments and loan sales of $857 million. The majority of the 1995 fundings in real estate lending assets is attributable to the financing of hotels, discounted loan portfolio acquisitions, manufactured housing and self storage facilities. These loans generally range from $1 million to $15 million, have terms ranging from one to five years and are principally collateralized by first mortgages. The average retained size of real estate financings was approximately $5 million at December 31, 1995, which is lower than prior periods due to the impact of increased investment activity and holding smaller positions in lending transactions.\nThe group originates loans to manufactured housing communities, self storage facilities, and multi-tenant industrial property types to be sold through the capital markets via commercial mortgage securitization. The group securitized $220 million of assets in 1995 of which $44 million was retained resulting in an increase in investments. The remaining increase in investments is due to growth in acquisition, development and construction transactions.\nThe level of nonearning assets decreased as a result of the Real Estate Finance Group's continued efforts to resolve its pre-1990 problem accounts combined with strong credit performance in the newer real estate portfolios. General purpose office building loans originated prior to 1990 accounted for 51% of real estate nonearning assets. The Company's ongoing real estate lending and investment philosophy includes financing smaller individual transactions and increasing the diversification of the portfolio in terms of geographic location and property type. The effectiveness of this strategy is evidenced by extremely low levels of writedowns and nonearning assets on transactions originated in the last five years.\nInterest income increased due to higher variable interest rates and growth in interest income from securitized assets. Fees and other income increased primarily due to income from participating interests received in connection with development loans.\nThe continued high level of real estate writedowns reflects management's efforts to resolve pre-1990 problem real estate accounts through sales, restructures and independent appraisals of accounts in this portfolio. All of the Real Estate Finance Group's writedowns of lending assets during 1995 related to pre-1990 accounts with the majority of the writedowns being concentrated in general purpose office buildings.\nDuring 1995, the group continued its efforts to diversify the portfolio. At December 31, 1995 and 1994, real estate lending assets and investments were distributed as follows:\nThe real estate portfolio is geographically dispersed throughout the United States and, as of December 31, 1995, 89% of real estate loans were collateralized by first mortgages. In an effort to reduce its exposure to general purpose office buildings, the Company has limited fundings in this sector since 1990. General purpose office building loans have decreased by $116 million or 26% during 1995. Loan portfolios are financings of borrowers engaged in the acquisition of discounted residential, commercial and industrial loans. Other includes several product types that are individually less than 5% of the portfolio.\nAt December 31, 1995, the Real Estate Finance Group was contractually committed to finance an additional $232 million to new and existing borrowers, generally contingent upon the maintenance of specific credit standards. Since many of the commitments are expected to remain unused, the total commitment amounts do not necessarily represent future cash requirements. No significant commitments exist to provide additional financing related to nonearning assets.\nInternational factoring and asset based finance. The financial information presented includes majority and wholly-owned subsidiaries and joint ventures in commercial finance companies in 19 countries. Most of the assets of consolidated subsidiaries are located in Australia, Singapore and Mexico, while joint ventures consist of investments in 50% or less owned companies in 16 countries in Europe, Asia and Latin America. Several of these companies hold leading positions in their served markets.\nConsistent with the presentation in the Consolidated Financial Statements, the investments in and income of international joint ventures set forth below represents the Company's ownership share of the net assets and income of the international joint ventures.\nThe increase in receivables and investments of consolidated subsidiaries reflects the effect of the Company increasing its ownership position in the Mexican joint venture in December 1995, and growth of asset based and factoring receivables in Singapore and Australia. The higher level of investments in international joint ventures\nis the result of undistributed 1995 joint venture income, the benefit from currency exchange rate movements and additional investments in existing joint ventures. Other investments are comprised of trading securities in Brazil.\nTotal international revenues grew $18 million in 1995 compared to the prior year due to growth in income from European joint ventures and increased interest income from the Australian and Singapore subsidiaries. Income grew $11 million due to the strong performance of several European companies. The international income amounts shown above are before costs of financing the Company's investments and central administration expenses.\nAt December 31, 1995, the International Group's consolidated subsidiaries were contractually committed to finance an additional $22 million to new and existing borrowers, generally contingent upon the maintenance of specific credit standards. Since many of the commitments are expected to remain unused, the total commitment amounts do not necessarily represent future cash requirements.\nSpecialized finance and investments. Specialized finance and investments are originated through financing of power producers and industrial projects, aircraft investment loans and leases, and through middle market equity investing. Project Investment and Advisory Division offers financing to independent power producers and industrial projects through senior and junior secured loans, equity investments and development loans. Aircraft Finance offers financing of commercial aircraft and equipment through leases or junior secured loans to operating lessors and invests in new aircraft through strategic alliances. Substantially all of these assets were under lease at December 31, 1995. Equity Finance is generally composed of subordinated debt and investments which are originated either on a direct basis or through private equity sponsors in established middle market companies or in companies requiring an operational or financial turnaround. These transactions are originated either on a direct basis or through private equity sponsors and generally range from $1 to $9 million.\nTotal lending assets and investments decreased $33 million primarily due to the sale of an aircraft by Aircraft Finance and the sale of several investments in Equity Finance. This decrease was partially offset by growth in funds in the Project Investment and Advisory Division.\nInterest income increased slightly due to modest growth in average fund levels and higher variable rates of interest. Fees and other income increased primarily from realized gains from the sale of several investments totaling $56 million, offset by equity writedowns or losses of $20 million from Equity Finance, and exit fees generated from Project Investment and Advisory Division transactions.\nAt December 31, 1995, the Specialized Finance and Investments Groups were contractually committed to finance an additional $162 million to new and existing borrowers, generally contingent upon the maintenance of specific credit standards. Since many of the commitments are expected to remain unused, the total commitment amounts do not necessarily represent future cash requirements. No significant commitments exist to provide additional financing related to nonearning assets.\nCREDIT MANAGEMENT\nThe Company manages credit risk through its underwriting procedures, centralized approval of individual transactions and active portfolio and account management. Underwriting procedures have been developed for each product category which enable the Company to assess a prospective borrower's ability to perform in accordance with established loan terms. These procedures may include analyzing business or property cash flows and collateral values, performing financial sensitivity analyses and assessing potential exit strategies. Financing and restructuring transactions over a certain amount are reviewed by an independent corporate credit function and require approval by a centralized credit committee.\nThe Company manages the portfolio by monitoring transaction size and diversification by industry, geographic area and property type. Through these methods, management identifies and limits exposure to unfavorable risks, and seeks favorable financing opportunities. Loan grading systems are used to monitor the performance of loans by product category and an overall risk classification system is used to monitor the risk characteristics of the total portfolio. These systems generally consider debt service coverage, the relationship of loan to underlying business or collateral value, industry characteristics, principal and interest risk and credit enhancements such as guarantees, irrevocable letters of credit and recourse provisions. When problem accounts are identified, professionals that specialize in various industries formulate strategies to optimize and accelerate the resolution process. A centralized department, independent of operations, periodically reviews the ongoing credit management of the individual portfolios and reports its findings to senior management and the Audit Committee of the Board of Directors.\nPORTFOLIO QUALITY\nThe overall credit quality of the portfolio continued to improve as portfolio growth was concentrated in the Company's lower risk asset based product areas. These portfolios and those in corporate finance and real estate\nfinance funded under the Company's revised lending strategies continued to exhibit strong credit quality. In addition, the Company has continued to be aggressive in resolving the pre-1990 corporate finance and real estate portfolios as evidenced by a 24% reduction in these assets in 1995 and considerable writedowns taken on these portfolios.\nPre-1990 Portfolio. The Company continued its efforts to reduce the pre-1990 corporate finance and real estate portfolios. These pre-1990 portfolios are diminishing in size and in the level of nonearning assets. The following table provides a breakdown of the pre-1990 portfolio.\nThe Company reduced the level of the pre-1990 portfolio by $486 million during 1995. The decrease was primarily attributable to the run-off of accounts and the significant amount of writedowns taken on troubled pre-1990 accounts.\nNonearning Assets. Receivables are classified as nonearning when there is significant doubt as to the ability of the debtor to meet current contractual terms as evidenced by loan delinquency, reduction of cash flows, deterioration in the loan to value relationship or other considerations. Nonearning assets decreased $14 million, from 4.0% to 3.6% of total lending assets at December 31, 1995. This decrease reflects the Company's continued efforts to resolve its pre-1990 corporate finance and real estate troubled accounts combined with the strong credit performance in its newer portfolios. The table below presents nonearning assets by product category.\nCorporate finance and real estate nonearning assets decreased $43 million from December 31, 1994 to December 31, 1995 due to the sale or restructure of several large pre-1990 credits during the year combined with considerable writedowns taken on these portfolios. Corporate finance and real estate nonearning assets are principally comprised of accounts which were underwritten prior to 1990. The increase in asset based nonearning assets is primarily due to two portfolios of workers compensation claims financed by the healthcare unit of the Current Asset Management Group.\nThe level of nonearning assets in the developing asset based businesses has remained very low. Commercial Equipment Finance Division, Business Credit and Sales Finance had no nonearning assets at December 31, 1995. Vendor Finance Division and First Capital had $5 million of combined nonearning assets at December 31, 1995.\nThe increase in nonearning assets in international factoring and asset based finance is related to the consolidation of the Mexican subsidiary.\nAllowances for Losses. The allowance for losses of receivables is a general reserve available to absorb losses in the entire portfolio. This allowance is established through direct charges to income, and losses are charged to\nthe allowance when all or a portion of a receivable is deemed uncollectible. The allowance is reviewed periodically and adjusted when necessary given the size and loss experience of the overall portfolio, the effect of current economic conditions and the collectibility and workout potential of identified risk accounts. For repossessed assets, if the fair value declines after the time of repossession, a writedown is recorded or a valuation allowance is established to reflect this reduction in value.\nThe allowance for losses of receivables totals $229 million or 2.8% of receivables at December 31, 1995 versus $231 million or 3.0% of receivables at December 31, 1994. The decrease as a percentage of receivables reflects the strong credit profile of the post-1990 portfolios and the continued decrease in the pre-1990 portfolio.\nDelinquent Earning Accounts and Loan Modifications. The level of delinquent earning accounts changes between periods based on the timing of payments and the effects of changes in general economic conditions on the Company's borrowers. Troubled debt restructurings have decreased to $14 million at December 31, 1995 from $54 million at December 31, 1994 primarily due to the sale of one large pre-1990 corporate finance credit and the transfer of another credit to nonearning status.\nThe Company had $151 million of receivables at December 31, 1995 that were restructured at market rates of interest, written down from the original loan balance and returned to earning status. The recorded investment of these receivables is expected to be fully recoverable.\nWritedowns. Total net writedowns increased during 1995 reflecting the significant amount of resolutions and reductions of exposures on pre-1990 corporate finance and real estate troubled accounts during the year. Approximately 80% of net writedowns during the year were attributable to pre- 1990 strategy accounts.\nDue to the aggressive management and considerable writedowns recorded on the pre-1990 corporate finance and real estate portfolio, the Company expects writedowns on this portfolio to decline in future periods. In addition, the mix of writedowns should shift to post-1990 assets as credit performance on those portfolios approaches normalized levels. The combined effect of these items is expected to result in a lower level of writedowns than in the Company's past experience.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995, lending assets and investments increased by $596 million, levels of commercial paper and short-term borrowings were reduced by $228 million, notes and debentures totaling $459 million were retired, and dividends of $64 million were paid to common and preferred stockholders. To meet these funding requirements, the Company supplemented its cash flow from operations by issuing $1,674 million of senior notes and debentures. The Company has continued to demonstrate the liquidity of the loan portfolio through the syndication of $532 million in assets and the securitization of $220 million of mobile home park, self storage facilities and limited service hotel receivables during 1995.\nLeverage and the level of commercial paper and short-term borrowings are within the ranges targeted by the Company to maintain a strong financial position. Consistent with the Company's desire to maintain a\nconservative liquidity posture, the Company increased its level of short term investments by $392 million at December 31, 1995. The ratio of commercial paper and short-term borrowings to total debt decreased to 30% at December 31, 1995, compared with 38% and 33% at December 31, 1994 and 1993, respectively, reflecting the Company's decision to reduce the level of short-term funding during 1995. The ratio of debt (net of short-term investments) to total stockholders' equity at December 31, 1995, remains conservative at 5.0x, compared with 4.7x at December 31, 1994 and 1993.\nThe Company plans to continue to be active in issuing senior debt during 1996 to support the replacement of $1,192 million of maturing term debt as well as the combined growth of the asset based and other portfolios. In 1995, the Company renewed its medium-term note program by filing a new shelf registration for the sale of $2.5 billion in debt to be issued from time to time. The Company had issued $175 million under this new registration as of December 31, 1995.\nThe Company revised its bank credit facilities during 1995 to provide $2.2 billion in liquidity support. These arrangements include a $1,105 million one- year credit facility, a $1,105 million five-year credit facility as well as a $25 million foreign currency revolving credit agreement entered into during 1995. The one-year credit facility includes a term loan option which expires one year after the option exercise date. The terms of the revised bank credit facilities, which require the Company to maintain stockholders' equity of $900 million, also include reduced pricing and the elimination of any funding covenant based on material adverse change in the financial condition of the Company.\nThe bank credit facilities together with $494 million available under a factored accounts receivable sale program, of which $394 million are provided from unaffiliated entities, provide the Company with an aggregate amount of $2.6 billion of committed credit and sale facilities representing 118% of outstanding commercial paper and short-term borrowings at December 31, 1995 from unaffiliated entities.\nThe consolidated international subsidiaries are funded primarily through committed and uncommitted foreign bank credit facilities in local currencies totaling $88 million and $200 million (U.S. dollar equivalent), respectively, at December 31, 1995.\nOn May 3, 1995 the Company and Fuji Bank agreed to extend the \"Keep Well Agreement,\" which provides $500 million of additional liquidity support, for an additional two years from December 31, 2000 to December 31, 2002.\nRISK MANAGEMENT\nThe Company uses derivatives as an integral part of its asset\/liability management program to reduce its overall level of financial risk arising from normal business operations. These derivatives, particularly interest rate swap agreements, are used to lower funding costs, diversify sources of funding or alter interest rate exposure arising from mismatches between assets and liabilities. All of the Company's derivative instruments are related to accomplishing these risk management objectives. The Company is not an interest rate swap dealer nor is it a trader in derivative securities, and it has not used speculative derivative products for the purpose of generating earnings from changes in market conditions.\nBefore entering into a derivative agreement, management determines that an inverse correlation exists between the value of a hedged item and the value of the derivative. At the inception of each agreement, management designates the derivative to specific assets, pools of assets or liabilities. The risk that a derivative will become an ineffective hedge is generally limited to the possibility that an asset being hedged will prepay before the related derivative expires. Accordingly, after inception of a hedge, asset\/liability managers monitor its effectiveness through an ongoing review of the amounts and maturities of asset, liability and swap positions. This information is reported to the Financial Risk Management Committee (\"FRMC\"), which determines the direction the Company will take with respect to its asset\/liability position. This position and the related activities of the FRMC are reported regularly to the Executive Committee of the Board of Directors and to the Board of Directors.\nThe Company has numerous swap agreements with commercial banks and investment banking firms with notional amounts aggregating approximately $5.1 billion at December 31, 1995. This includes $1 billion of basis swaps entered into during 1995, effective January 2, 1996, which have the effect of changing the index on an equivalent amount of debt from the three month London Inter- bank Offered Rate (\"LIBOR\") to a rate based on Prime. Before the effect of these swap agreements, the Company's variable rate assets exceeded variable rate liabilities by $1.7 billion. After the effect of these interest rate swap agreements, variable rate liabilities exceeded variable rate assets by approximately $234 million. The average interest rates paid by the Company on outstanding indebtedness, before and after the effect of swap agreements, during the three years ended December 31, 1995 are summarized below. These swap agreements increased interest expense by $14 million during 1995. If no management actions were taken to alter the gap position existing at December 31, 1995, a one percent parallel shift in the yield curve would have a $1 million annual effect on interest income.\nIn order to minimize the effect of movements in exchange rates on its financial results, the Company periodically enters into forward contracts and purchases options. The Company held $243 million of forward contracts and $20 million of purchased options at December 31, 1995. These financial instruments serve as hedges of its foreign investment in international subsidiaries and joint ventures or effectively hedge the translation of the related foreign currency income. The Company invests in and operates commercial finance companies throughout the world. Over the course of time, reported results from the operations and investments in foreign countries may fluctuate in response to exchange rate movements in relation to the U.S. dollar. While the Western European operations and investments are the largest areas of the Company's activities, reported results will be influenced to a lesser extent by the exchange rate movements in the currencies of other countries in which our subsidiaries and investments are located.\nACCOUNTING DEVELOPMENTS\nThe Financial Accounting Standards Board has released 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 financial statements for fiscal years beginning after December 15, 1995. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment. Whenever events indicate that the carrying amount of an asset may not be recoverable, an impairment loss should be recorded based on the fair value of the asset. 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.\nThe Financial Accounting Standards Board has released Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights,\" effective for financial statements for fiscal years beginning after December 15, 1995. This statement requires that a separate asset be recognized for rights to service mortgage loans for others, however those servicing rights are acquired. The total cost of the mortgage loan should be allocated between the servicing rights and the loans (without the servicing rights) based on their relative fair values.\nThe Company does not expect the adoption of these pronouncements to have a material effect on its results of operations or financial position.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Heller Financial, Inc. and its subsidiaries has the responsibility for preparing the accompanying consolidated financial statements and is responsible for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles and are not misstated due to material fraud or error. The consolidated financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the December 31, 1995 annual report filed on Form 10-K and is responsible for its accuracy and consistency with the consolidated financial statements.\nThe Company's consolidated financial statements have been audited by Arthur Andersen LLP, independent public accountants selected by the holder of the common stock. Management has made available to Arthur Andersen LLP all the Company's financial records and related data, as well as the minutes of the stockholders' and directors' meetings. Furthermore, management believes that all representations made to Arthur Andersen LLP during its audit were valid and appropriate.\nManagement of the Company has established and maintains a system of internal control that provides 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 system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management monitors the system of internal control for compliance. The Company maintains an internal auditing program that independently assesses the effectiveness of internal controls and recommends possible improvements. The Company's independent public accountants have developed an overall understanding of our accounting and financial controls and have conducted other tests they consider necessary to support their opinion on the consolidated financial statements. Management has considered the internal auditors' and Arthur Andersen LLP's recommendations concerning the Company's system of internal control and has taken actions that it believes are cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that, as of December 31, 1995, the Company's system of internal control is adequate to accomplish the objectives discussed above.\nManagement also recognizes its responsibility for fostering a strong ethical climate so that the Company's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Company's code of ethical business practices, which is publicized throughout the Company. The code of ethical business practices addresses, among other things, the necessity of ensuring open communication within the Company, potential conflicts of interest, compliance with all domestic and foreign laws, including those relating to financial disclosure, and the confidentiality of proprietary information.\nRichard J. Almeida Chairman and Chief Executive Officer\nLawrence G. Hund Senior Vice President, Controller and Chief Accounting Officer\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Heller Financial, Inc.:\nWe have audited the accompanying consolidated balance sheets of HELLER FINANCIAL, INC. (a Delaware 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 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 Heller Financial 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.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets as of December 31, 1993, 1992 and 1991, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the two years in the period ended December 31, 1992 (none of which are presented herein), and we have expressed an unqualified opinion 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 ending December 31, 1995, appearing on page 7 is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived.\nARTHUR ANDERSEN LLP\nChicago, Illinois, January 25, 1996\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT FOR INFORMATION ON SHARES)\nASSETS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (IN MILLIONS)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (IN MILLIONS)\n- -------- The retained earnings balance included $5 of unrealized losses and $5 of unrealized gains on securities available for sale at December 31, 1995 and 1994, respectively. Retained earnings also included deferred foreign currency translation adjustments of $(14), $(17), $(12), and $(7) at December 31, 1995, 1994, 1993 and 1992, respectively. The accompanying Notes to Consolidated Financial Statements\nare an integral part of these statements.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF ACCOUNTING POLICIES\nDescription of the Reporting Entity and Basis of Presentation--\nHeller Financial, Inc. and its subsidiaries (\"The Company\") are engaged principally in furnishing commercial finance services to businesses in the United States and investing in and operating commercial finance companies throughout the world. The Company operates in the middle market segment of the commercial finance industry, which generally includes entities in the manufacturing and service sectors with annual sales in the range of $15 to $200 million and in the real estate sector with property values generally in the range of $5 to $40 million. The Company currently provides services in five product categories: 1) corporate finance, 2) asset based finance, 3) real estate finance, 4) international factoring and asset based finance and 5) specialized finance and investments.\nAll of the common stock of the Company is owned by Heller International Corporation (the \"Parent\"), which is a wholly-owned subsidiary of The Fuji Bank, Limited (\"Fuji Bank\") of Tokyo, Japan. Fuji Bank also directly owns 21% of the outstanding shares of Heller International Group, Inc. (\"International Group\"), a consolidated subsidiary, through which the Company holds its international operations. The remaining 79% of the outstanding shares of International Group are owned by the Company. The accompanying consolidated financial statements include the accounts of the Company and its majority- owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliated companies owned 50% or less are accounted for by the equity method. Certain temporary interests are included in investments and carried at cost.\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.\nCash and Cash equivalents--\nCash and cash equivalents consist of cash deposits maintained in banks and short-term debt securities with original maturities of less than 60 days. The fair value of cash equivalents approximates their carrying value.\nReceivables--\nReceivables are presented net of unearned income which generally includes deferred loan origination and commitment fees, direct loan origination costs and other amounts attributed to the fair value of equity interests and other investments received in connection with certain financings. These amounts are amortized to interest income using the effective interest method over the life of the related loan or commitment period. From time to time, the Company finances certain loans which it may elect to sell if the aggregate amount of these loans reaches a sufficient size and market conditions are favorable. These receivables are also presented net of unearned income. In the event the Company sells a portion of a loan that it had originated, any deferred fees or discounts relating to the portion of the loan sold are recognized in interest income. For loan sales that qualify as syndications, fees received are generally recognized in income, subject to certain yield tests, when the syndication is complete.\nAs a commercial finance company, income recognition is reviewed on an account by account basis. Collateral is evaluated regularly primarily by assessing the related current and future cash flow streams. Loans are classified as nonearning and all interest and unearned income amortization is suspended when there is significant doubt as to the ability of the debtor to meet current contractual terms. Numerous factors including loan covenant defaults, deteriorating loan-to-value relationships, delinquencies greater than 90 days, the sale of\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) major income generating assets or other major operational or organizational changes may lead to income suspension. An account taken nonearning may be restored to earning status either when all delinquent principal and interest have been paid under the original contractual terms or the account has been restructured and has demonstrated both the capacity to service the amended terms of the debt and adequate loan to value coverage.\nAllowance for Losses--\nThe allowance for losses of receivables is established through direct charges to income. Losses are charged to the allowance when all or a portion of a receivable is deemed impaired and uncollectible as determined by account management procedures. These procedures include assessing how the borrower is affected by economic and market conditions, evaluating operating performance and reviewing loan-to-value relationships.\nManagement evaluates the allowance for losses on a quarterly basis. Nonearning assets and all loans with certain loan grading characteristics are reviewed to determine if there is a potential risk of loss under varying scenarios of performance. The estimates of potential loss for these individual loans are aggregated and added to a general allowance requirement, which is based on the total of all other loans in the portfolio. This total allowance requirement is then compared to the existing allowance for losses and adjustments are made, if necessary.\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 SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures,\" an amendment to SFAS No. 114. These pronouncements require that impaired receivables be measured based on the present value of expected future cash flows discounted at the receivable's effective interest rate, at the observable market price of the receivable, or at the fair value of the collateral if the receivable is collateral dependent. When the recorded balance of an impaired receivable exceeds the relevant measure of value, impairment is recorded through an increase in the provision for losses. The Company had previously measured receivable impairment using methods consistent with those prescribed in SFAS No. 114. Accordingly, upon adoption of these statements, there was no effect to total nonearning assets nor to the total allowance for losses as previously reported at December 31, 1994.\nSecuritized receivables--\nFrom time to time certain receivables are securitized and sold to investors with limited recourse. Upon sale of the loans, a gain is recognized for the difference between the net carrying value of the receivables and the fair value of the securities sold. The gain on the sale is reduced by a reserve established for estimated future losses. The gain recognized is recorded in fees and other income. Income from the acceleration of discounts and deferred fees attributed to the loans sold is recorded as interest income. The Company may choose to retain a portion of the securitized receivables. Under these circumstances, the amount of the gain related to the retained portion is deferred and amortized over the life of the securities. The retained securities are recorded as debt securities available for sale. To date, the servicing rights to securitized receivables have been retained by the Company.\nInvestments in Joint Ventures--\nInvestments in unconsolidated joint ventures represent investments in companies in 16 foreign countries. The Company accounts for its investments in joint ventures under the equity method of accounting. Under this method, the Company recognizes its share of the earnings or losses of the joint venture in the period in which they are earned by the joint venture. Dividends received from joint ventures reduce the carrying amount of the investment.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nInvestments--\nEquity interests and investments--Investments in warrants, certain common and preferred stocks and other equity investments, which are not subject to the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" are carried at cost. The valuation of these investments is periodically reviewed and the investment balance is written down to reflect declines in value determined to be other than temporary. Gains or losses recognized upon sale or write-down of these investments are recorded as a component of fees and other income.\nEquipment on lease--Aircraft and related equipment under lease are recorded at cost and depreciated over their estimated useful lives principally using the straight line method for financial reporting purposes and accelerated methods for tax purposes. Rental revenue is reported over the lease term as it becomes receivable according to the provisions of the lease.\nAvailable for sale, trading, and held to maturity securities--Investments designated as available for sale securities are carried at fair value using the specific identification method with unrealized gains or losses included in stockholders' equity, net of related taxes. Trading securities are carried at fair value with the related unrealized gains or losses included currently in fees and other income. Securities that are held to maturity are recorded at amortized cost, but are written down to fair value to reflect declines in value determined to be other than temporary.\nReal Estate Investments--The Company provides financing through certain real estate loan arrangements that are recorded as investments by the Company. Income is generally recognized only to the extent that cash received exceeds the investment carrying amount.\nOther Assets--\nRepossessed Assets--Assets which have been legally acquired in satisfaction of receivables are carried at fair value less selling costs and are included in other assets, net of the related valuation allowance. After repossession, operating costs are expensed and cash receipts are applied to reduce the asset balance. In connection with the adoption of SFAS No. 114 in 1995, an in- substance repossessed receivable is presented as an impaired receivable until the related collateral is physically possessed or legally foreclosed by the Company, at which time it will be accounted for as a repossessed asset.\nIncome Taxes--\nThe Company and its wholly-owned domestic subsidiaries are included in the consolidated United States federal income tax return of the Parent. The International Group files a separate United States federal income tax return. The Company reports income tax expense as if it were a separate taxpayer and records future tax benefits as soon as it is more likely than not that such benefits will be realized.\nDerivative Financial Instruments--\nThe Company is a party to interest rate swaps and cross currency and basis swap agreements which have been designated by the Company to hedge its exposure to interest rate risk on specific assets, pools of assets or liabilities. The swap agreements are generally held to maturity and the differential paid or received under these agreements is recognized over the life of the related agreement.\nThe Company periodically enters into forward currency exchange contracts which are designated as hedges of its exposure to foreign currency fluctuations from the translation of its foreign currency denominated\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) investments in certain European and Asian joint ventures and subsidiaries. Through these contracts, the Company primarily sells the local currency and buys U.S. dollars. Gains and losses resulting from translation of foreign currency financial statements and the related effects of the hedges of net investments in joint ventures and subsidiaries outside the United States are accumulated in stockholders' equity, net of related taxes, until the international investment is sold or substantially liquidated.\nThe Company also periodically enters into forward contracts or purchases options. These financial instruments serve as hedges of its foreign investment in international subsidiaries and joint ventures or effectively hedge the translation of the related foreign currency income. These contracts are carried at fair value, with gains or losses included in the determination of net income.\nReclassifications--\nCertain prior year amounts have been reclassified in order to conform to the current year's presentation.\n2. LENDING ASSETS\nLending assets include receivables and repossessed assets.\nDiversification of Credit Risk--\nConcentrations of lending assets of 5% or more at December 31, 1995 and 1994, based on the standard industrial classification of the borrower, are as follows:\nThe majority of lending assets in the textiles and apparel manufacturing category and the department and general merchandise retail stores category is comprised of factored accounts receivable which represent short-term trade receivables from numerous customers. The general industrial machines classification is distributed among machinery used for many different industrial applications.\nContractual Maturity of Loan Receivables--\nThe contractual maturities of the Company's receivables at December 31, 1995, which are presented in the table below, should not be regarded as a forecast of cash flows (in millions):\nCommercial loans consist principally of corporate finance and asset based receivables. Corporate finance receivables are predominantly collateralized by senior loans on the borrower's stock, or assets, or both. Asset\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) based receivables are collateralized by inventory, receivables and property, plant and equipment of the borrowers. Real estate loans are principally collateralized by first mortgages on commercial and residential real estate. Equipment loans and leases are secured by the underlying equipment and the Company often has partial recourse to the equipment vendor. Factored accounts receivable are purchased from clients in return for a commission.\nImpaired Receivables, Repossessed Assets, and Troubled Debt Restructurings--\nThe Company does not recognize interest and fee income on impaired receivables classified as nonearning and on repossessed assets, which are set forth in the following table:\nNonearning assets have decreased $14 million to 3.6% from 4.0% of total lending assets during 1995 due to the favorable performance of loans originated since 1990 in all businesses and the resolution and writedown of problem accounts in the pre-1990 corporate finance and real estate portfolios. Nonearning assets are principally comprised of $142 million from real estate and $89 million from corporate finance which are primarily attributed to accounts underwritten prior to 1990.\nSFAS No. 114 requires changes in the presentation and disclosure of certain impaired receivables. Receivables that were considered in-substance repossessions of collateral are now presented as impaired receivables until the underlying collateral is physically possessed or legally foreclosed. Upon adoption, this requirement was retroactively applied resulting in the reclassification of $31 million of in-substance repossessed assets to impaired receivables and $4 million of related valuation allowance to the allowance for losses of receivables at December 31, 1994.\nThe average investment in impaired receivables was $344 million for the year ended December 31, 1995.\nThe Company had $14 million and $54 million of loans that are considered troubled debt restructures at December 31, 1995 and 1994, respectively. The following table indicates the effect on income if interest on nonearning impaired receivables and troubled debt restructurings outstanding at year-end had been recognized at original contractual rates during the year.\nLoan Modifications--\nThe Company had $151 million of receivables at December 31, 1995 that were restructured at a market rate of interest and written down from the original loan balance. The recorded investment of these receivables is expected to be fully recoverable. Interest income of approximately $5 million has been recorded on these\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) receivables under the modified terms, along with cash interest collections of the same amount. At December 31, 1995, the Company was not committed to lend significant additional funds under the restructured agreements.\nAllowance for Losses--\nThe changes in the allowance for losses of receivables and in the valuation allowance for repossessed assets were as follows:\nWritedowns occurring at the time of repossession are considered writedowns of receivables.\nImpaired receivables with identified reserve requirements were $234 million and $195 million at December 31, 1995 and 1994, respectively.\nThe valuation allowance for repossessed assets of $2 million and $6 million at December 31, 1995 and 1994 is included in other assets on the balance sheet.\nThe Company maintains an allowance for losses of receivables based upon management's best estimate of future possible losses in the portfolio of receivables. Management's estimate is based upon current economic conditions, previous loss history, and knowledge of clients' financial position. Changes in these estimates could result in an increase or decrease in the reserve maintained.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n3. INVESTMENTS AND OTHER ASSETS\nInvestments in International Joint Ventures--\nThe international joint ventures, which are independently financed, on a combined basis had total receivables of $5.2 billion at December 31, 1995, factoring volume and net income of $27.2 billion and $74 million, respectively, for the year ended December 31, 1995. The Company owns interests from 40% to 50% of these joint ventures. The comparable amounts for 1994 for receivables, factoring volume and net income were $4.0 billion, $20.7 billion and $55 million, respectively. The Company's two largest investments in international joint ventures are Factofrance Heller, S.A. and NMB-Heller Holding N.V., which account for 66% of the total investments in and 86% of income from unconsolidated joint ventures.\nOther Investments and Assets--\nThe following table sets forth a summary of the major components of investments and other assets (in millions):\nEquity interests and investments principally include common and preferred stocks received in connection with certain financings, investments in limited partnerships and warrants.\nReal estate investments are acquisition, development and construction investment transactions. At December 31, 1995, the Company held investments in 91 projects with balances ranging from $1 million to $5 million.\nEquipment on lease is comprised of aircraft and related equipment. Noncancellable future minimum rental receipts under the leases are $18 million, $12 million, $8 million, $4 million and $3 million for 1996 through 2000. Substantially all equipment was under lease as of December 31, 1995.\nThe available for sale debt securities principally consist of subordinated securities retained in connection with the securitization of certain receivables on mobile home parks, self storage facilities, and limited service\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) hotels. These securities mature on dates ranging to 2005 based on the related stated maturity dates of the underlying receivables. The Company has established a reserve of $2 million for possible losses related to these securities, which is included in other payables and accruals on the balance sheet. Net unrealized holding losses on these securities amounted to $7 million and $9 million at December 31, 1995 and 1994, respectively, and are recorded in stockholder's equity on a net of tax basis. Available for sale debt securities also includes $55 million of short-term debt securities at December 31, 1995 which are included in cash equivalents.\nThe available for sale equity securities are principally comprised of common stocks. Net unrealized holding losses on these securities were $2 million and net unrealized holding gains were $16 million at December 31, 1995 and 1994, respectively. These amounts are recorded in stockholders' equity on a net of tax basis.\nThe Company had realized gains from sales of equity investments of $133 million and $64 million during the year ended December 31, 1995 and 1994, respectively, and had realized losses and writedowns totaling $59 million and $15 million for 1995 and 1994, respectively. Sales proceeds on equity investments may be subject to normal post-closing adjustments, the impact of which is estimated at the time of closing.\nSecurities that are held to maturity consist of $409 million and $72 million of short-term debt securities which are included in cash and cash equivalents at December 31, 1995 and 1994, respectively.\nThe Company holds certain foreign investments which are classified as trading securities. Net gains of $4 million and $7 million related to these investments were recorded in income for the years ended December 31, 1995 and 1994, respectively.\nNoncash investing activities which occurred during the period ended December 31, 1995 include $62 million of receivables which were classified as repossessed assets and $31 million of insubstance repossessed assets which were classified as impaired receivables in accordance with SFAS No. 114. Receivables of $34 million were exchanged for investments of the same amount, and a $12 million gain was realized on an exchange of available for sale equity securities. During the comparable 1994 period, $117 million of positions in two repossessed companies were converted to equity investments. In addition, $59 million of receivables were classified as repossessed assets and $51 million of repossessed assets were resolved and returned to receivables. The comparable amounts for 1993 were $87 million and $25 million, respectively.\n4. SENIOR DEBT\nCommercial Paper and Short-Term Borrowings--The table below sets forth information concerning commercial paper. The average amounts are computed based on the average daily balances outstanding during the year. The Company issues commercial paper with maturities ranging up to 270 days.\nCommercial paper borrowings have been reduced at December 31, 1995 to more conservative levels, reflecting the Company's decision to temporarily reduce its level of short-term funding. In addition to\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) commercial paper, the consolidated international subsidiaries had short-term borrowings of $156 million, $113 million and $69 million at December 31, 1995, 1994 and 1993, respectively, which are used to finance international operations.\nAvailable credit and asset sale facilities--At December 31, 1995, the Company had committed credit and asset sale facilities from unaffiliated entities which totaled $2,629 million. This total includes $2,235 million in bank facilities and $394 million of additional liquidity available under a receivables purchase agreement. The receivables purchase agreement, which expires March 24, 1999, provides that the Company may sell to Freedom Asset Funding Corporation (\"Freedom\"), with limited recourse, an undivided interest of up to $500 million in a designated pool of its factored accounts receivable. The amount of liquidity provided by Fuji Bank to Freedom is $100 million. The Company had sold $6 million of receivables for cash as of December 31, 1995.\nIn April of 1995, the Company replaced its existing bank credit facilities with a new agreement at more favorable terms to the Company. The terms of these facilities primarily include reduced pricing, an increase in the term for $1.1 billion of the facilities to five years, required stockholders' equity of $900 million, and the elimination of any funding covenant based on material adverse change in the financial condition of the Company. Under the terms of the debt covenants of these agreements, the Company could have borrowed an additional $6 billion of debt at December 31, 1995.\nThe Company and Fuji Bank are parties to a \"Keep Well Agreement\" which cannot be terminated by either party prior to December 31, 2002. The Agreement provides that Fuji Bank will maintain the Company's net worth in an amount equal to $500 million. The Agreement further provides that if the Company should lack sufficient cash, other liquid assets or credit facilities to meet its payment obligations on its commercial paper, then Fuji Bank will lend the Company up to $500 million which the Company may use only for the purpose of meeting such payment obligations. No loans have been made by Fuji Bank under this agreement.\nNotes and debentures--The scheduled maturities of debt outstanding at December 31, 1995, other than commercial paper and short-term borrowings and excluding unamortized discount, are as follows:\nThe Company had fixed rate debt of $2,699 million and $2,510 million at December 31, 1995 and 1994 respectively. At December 31, 1995, total fixed rate debt included $452 million of debt denominated in Japanese yen for which the Company pays a combined weighted average contractual rate of interest of 3.4%. The Company has fixed the exchange rate of Japanese yen to U.S. dollars on the yen denominated debt using cross currency interest rate swap agreements resulting in an effective rate of interest of 6.46% at December 31, 1995.\nThe contractual interest rates for remaining U.S. dollar denominated fixed rate debt range between 5.63% and 9.63% at December 31, 1995 and 5.63% and 9.70% at December 31, 1994. Excluding swaps, the weighted\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) average interest rate on this debt is 8.03% and 8.06% at December 31, 1995 and 1994, respectively. The weighted average interest rates of the U.S. dollar denominated fixed rate debt at December 31, 1995 and 1994 are 7.0% and 7.12%, after the effect of related swap agreements, which converted certain of the Company's fixed rate debt to floating rate debt. The combined U.S. dollar and yen denominated fixed rate debt had an effective interest rate of 6.91% at December 31, 1995 after the effects of the cross currency interest rate swap agreements.\nThe Company had floating rate debt of $2,449 million and $1,423 million at December 31, 1995 and 1994, respectively. At December 31, 1995, total floating rate debt included $330 million of debt denominated in primarily Japanese yen which has a weighted average contractual rate of 2.5%. The Company had fixed the exchange rate of yen denominated debt to U.S. dollars using cross currency interest rate swap agreements resulting in an effective interest rate on this debt of 8.06% at December 31, 1995.\nThe contractual rates on the remaining U.S. dollar denominated floating rate debt are based primarily on indices such as the Constant Maturity Treasury Index less a range of .12% to .40%, the Federal Funds rate plus .18% to .38%, the three month Treasury bill rate plus .46%, the London Inter-bank Offered Rate plus .05% to .95%, or the Prime rate less 2.56% to 2.75%. Excluding the effect of swaps, the weighted average rate on U.S. dollar denominated floating rate debt is 6.07% and 6.46% at December 31, 1995 and 1994. The weighted average interest rates on this debt at December 31, 1995 and 1994 including the effect of basis swap agreements, were 6.10% and 6.39%, respectively. The combined variable rate debt had an effective interest rate of 6.36% at December 31, 1995 due to cross currency interest rate swap agreements.\nNotes redeemable solely at the option of the Company prior to the final maturity date are reflected in the table above as maturing on the final maturity date.\n5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK\nThe Company is a party to several agreements involving financial instruments with off-balance sheet risk. These instruments are used to meet the financing needs of borrowers and to manage the Company's own exposure to interest rate and currency exchange rate fluctuations. These instruments principally include interest rate swap agreements, forward currency exchange contracts, purchased options, loan commitments, letters of credit, and guarantees.\nDerivative financial instruments used for risk management purposes--The Company utilizes derivatives as an integral part of its asset\/liability management program to reduce its overall level of financial risk. These derivatives, particularly interest rate swap agreements, are used to lower funding costs, diversify sources of funding or alter interest rate exposure arising from mismatches between assets and liabilities. All of the Company's derivative instruments are entirely related to accomplishing these risk management objectives which arise from normal business operations. The Company is not an interest rate swap dealer nor is it a trader in derivative securities, and it has not used speculative derivative products for the purpose of generating earnings from changes in market conditions.\nBefore entering into a derivative agreement, management determines that an inverse correlation exists between the value of the hedged item and the value of the derivative. At the inception of each agreement, management designates the derivative to specific assets, pools of assets or liabilities. The risk that a derivative will become an ineffective hedge is generally limited to the possibility that an asset or liability being hedged will prepay before the related derivative expires. Accordingly, after inception of a hedge, asset\/liability managers monitor its effectiveness through an ongoing review of the amounts and maturities of assets, liabilities and swap positions. This information is reported to the Financial Risk Management Committee (FRMC) which determines the direction the Company will take with respect to its asset\/liability position. The asset\/liability position of the\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Company and the related activities of the FRMC are reported regularly to the Executive Committee of the Board of Directors and to the Board of Directors.\nThe following table summarizes the notional amounts of the Company's interest rate swap agreements, foreign exchange contracts, purchased options and interest rate cap agreements. The credit risk associated with these instruments is limited to amounts earned but not collected and to any additional amounts which may be incurred to replace the instrument under then current market conditions. These amounts are substantially less than the notional amounts of these agreements. The Company manages this risk by establishing minimum credit ratings for each counterparty and by limiting the exposure to individual counterparties as measured by the total notional amount and the current replacement cost of existing agreements. The Company has not experienced nonperformance by any counterparty related to its derivative financial instruments.\nInterest rate swaps are primarily used to convert fixed rate financings to variable rate debt. Less frequently, when the issuance of debt denominated in a foreign currency is deemed more cost effective, cross currency interest rate swaps are employed to convert foreign currency denominated debt to U.S. dollar denominated debt and U.S. based indices. The Company also uses swap agreements to alter the characteristics of specific asset pools to more closely match the interest terms of the underlying financing. These agreements enhance the correlation of the interest rate and currency characteristics of the Company's assets and liabilities and thereby mitigate its exposure to interest rate volatility. Basis swap agreements involve the exchange of two different floating rate interest payment obligations and are used to manage the basis risk between different floating rate indices. The Company has also entered into $1 billion of basis swaps effective January 2, 1996, which have the effect of changing the index on an equivalent amount of debt from the three month London Inter-bank Offered Rate (\"LIBOR\") to a rate based on Prime. The amount of these basis swaps is included in the table above.\nForwards are contracts for the delivery of an item in which the buyer agrees to take delivery of an instrument or currency at a specified price and future date. To minimize the effect of exchange rate movements in the currencies of foreign countries, in which certain of our subsidiaries and investments are located, the Company will periodically enter into forward currency exchange contracts and purchase options. These financial instruments serve as hedges of its foreign investment in international subsidiaries and joint ventures or effectively hedge the translation of the related foreign currency income. The Company also periodically enters into forward contracts to hedge receivables denominated in foreign currencies or may purchase foreign currencies in the spot market in order to settle a foreign currency denominated liability.\nCommitments, letters of credit and guarantees--The Company generally enters into various commitments, letters of credit and guarantees in response to the financing needs of its customers. As many of the agreements are expected to expire unused, the total commitment amount does not necessarily represent future cash\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) requirements. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to borrowers and the credit quality and collateral policies are similar to those involved in the Company's normal lending transactions. The contractual amount of the Company's commitments, letters of credit and guarantees are shown below:\nCommitments to fund new and existing borrowers generally have fixed expiration dates and termination clauses and typically require payment of a fee. Letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a borrower or an affiliate to a third party. At December 31, 1995, the contractual amount of guarantees includes $32 million related to affiliates. For factoring credit guarantees, the Company receives a fee for guaranteeing the collectibility of certain factoring clients' accounts receivable. Under this arrangement, clients generally retain the responsibility for collection and bookkeeping. Losses related to these services have historically not been significant.\nOther financial instruments with off-balance sheet risk--As of December 31, 1995 and 1994 the Company had sold $6 million of factored receivables for cash, under a receivables purchase agreement with limited recourse. As the average maturity of factored accounts receivable is approximately 50 days and the historical loss experience is substantially less than 1%, the Company's recourse exposure is considered minimal.\n6. LEGAL PROCEEDINGS\nThe Company is party to a number of legal proceedings as plaintiff and defendant, all arising in the ordinary course of its business. The Company believes that the amounts, if any, which may ultimately be funded or paid with respect to these matters will not have a material adverse effect on the financial condition or results of operations of the Company.\n7. RENTAL COMMITMENTS\nThe Company and its consolidated subsidiaries have minimum rental commitments under noncancellable operating leases at December 31, 1995, as follows (in millions):\nThe total rent expense, net of rental income from subleases, was $18 million, $17 million and $15 million for the year ended December 31, 1995, 1994 and 1993, respectively.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n8. PREFERRED STOCK\nPerpetual Preferred Stock--The Company's Cumulative Perpetual Senior Preferred Stock, Series A, (\"Perpetual Preferred Stock\") is not redeemable prior to September 22, 2000. On or after that date, the Perpetual Preferred Stock will be redeemable at the option of the Company, in whole or in part at a redemption price of $25 per share, plus accrued and unpaid dividends. The Perpetual Preferred Stock has an annual dividend rate of 8.125%. Dividends are cumulative and payable quarterly. The Perpetual Preferred Stock ranks senior with respect to payment of dividends and liquidation to other outstanding or authorized preferred stock of the Company.\nConvertible Preferred Stock--The Company's Cumulative Convertible Preferred Stock, Series D (no par value) (\"Convertible Preferred Stock\") is held by the Parent. The Convertible Preferred Stock has a dividend yield established quarterly at a rate of 1\/2% less than the announced prime commercial lending rate of Morgan Guaranty Trust Company of New York, payable quarterly. Under the terms of the Convertible Preferred Stock, the Company is prohibited from paying cash dividends on Common Stock unless full cumulative dividends on all outstanding shares of Convertible Preferred Stock for all past dividend periods have been paid. The Convertible Preferred Stock is convertible into Common Stock of the Company at the conversion price of one share of Common Stock for each 200 shares of Convertible Preferred Stock. Subject to certain conditions, the Convertible Preferred Stock is redeemable at any time at the option of the Company at a redemption price equal to the price paid for such stock plus accumulated dividends.\nRedeemable Preferred Stock--The Company has authorized the issuance of 100,000 shares of a series of preferred stock designated NW Preferred Stock, Class B (No Par Value) (\"NW Preferred Stock\"), pursuant to the \"Keep Well Agreement\" between the Company and Fuji Bank wherein, among other things, Fuji Bank has agreed to purchase NW Preferred Stock in an amount required to maintain the Company's net worth at $500 million. The Company's net worth was $1,384 million at December 31, 1995. If and when issued, dividends will be paid quarterly on NW Preferred Stock at a rate per annum equal to 1% over the three-month London Inter-bank Offered Rate. Subject to certain conditions, NW Preferred Stock will be redeemable at the option of the holder within a specified period of time after the end of a calendar quarter in an aggregate amount not greater than the excess of the net worth of the Company as of the end of such calendar quarter over $500 million and at a redemption price equal to the price paid for such stock plus accumulated dividends. No purchases of NW Preferred Stock have been made by Fuji Bank under this agreement.\n9. DIVIDEND RESTRICTIONS AND PAYMENTS\nDividends may legally be paid only out of the Company's surplus, as determined under the provisions of the Delaware General Corporation Law, or net profits for either the current or preceding fiscal year, or both. In addition, the Company is prohibited from paying cash dividends on Common Stock or any other preferred stock that ranks, with respect to payment of dividends, equal or junior to the Perpetual Preferred Stock, unless full cumulative dividends on the Perpetual Preferred Stock have been paid.\nThe Company declared and paid dividends on the Perpetual Preferred Stock of $10 million in 1995, 1994 and 1993. Dividends declared and paid on the Company's Convertible Preferred Stock amounted to $2 million each year during 1995, 1994 and 1993. The Company also declared and paid cash dividends of $52 and $20 million on Common Stock in 1995 and 1994, respectively.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n10. OPERATING EXPENSES\nThe following table sets forth a summary of the major components of operating expenses:\nThe Parent performs services for the Company and charges the Company for the related costs incurred. These charges are reflected in certain of the above captions.\n11. BENEFIT PLANS AND OTHER POST RETIREMENT BENEFITS\nThe Company has various incentive compensation plans and a savings and profit-sharing plan which provide for annual contributions to eligible employees based on the Company's achievement of certain financial objectives and employee achievement of certain objectives.\nIn addition, the Company has noncontributory defined benefit pension plans covering substantially all of its domestic employees. Certain foreign employees are covered by contributory or noncontributory defined contribution plans. The Company's policy is to fund, at a minimum, pension contributions as required by the Employee Retirement Income Security Act of 1974. Benefits are based on an employee's years of service and average earnings for the five highest consecutive years of compensation occurring during the last ten years before retirement.\nThe following table summarizes the funded status of the defined benefit pension plans at December 31, 1995 and 1994:\nIn accordance with the provisions of SFAS No. 87 \"Employers' Accounting for Pensions\" and SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" the Company adjusts the discount, salary and health care cost trend rates, as well as the rates of return on assets, to reflect market conditions at the measurement date. Changes in these assumptions will impact the amount of the pension and net periodic postretirement benefit expense in future years. At December 31, 1995, the Company decreased the discount rate used to calculate the projected pension benefit obligation to 7.25%, reflecting the change in the interest rate environment. The decrease in the discount rate had no effect on 1995 pension expense, which was\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) $1 million compared to $2 million in 1994 and $1 million in 1993. The discount rate change is expected to increase 1996 pension expense by approximately $1 million. Due to market conditions, the Company had increased the discount rate at December 31, 1994 to 8.5%, which decreased 1995 pension expense by approximately $1 million. The Company maintained the salary rate assumption at 6% at December 31, 1995, based on the Company's experience. The Company had reduced the salary assumption from 7% to 6% at December 31, 1993. This rate reduction had no effect on 1993 pension expense but reduced 1994 pension expense by less than $1 million.\nThe Company also provides health care benefits for eligible retired employees and their eligible dependents. At December 31, 1995 and 1994, $6 million of the transition obligation remains unamortized. The accumulated postretirement benefit obligation, under the terms of the amended healthcare plan, was calculated using relevant actuarial assumptions and health care cost trend rates projected at annual rates ranging from 10% in 1995 to 5.5% in 2004 and thereafter. The effect of a 1.0% annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by less than $1 million, while annual service and interest cost components in the aggregate would not be materially affected. Consistent with the changes in the pension plan discount rate at December 31, 1995 and 1994, the discount rate used to calculate the accumulated postretirement benefit obligation was decreased to 7.25% at December 31, 1995 from 8.5% at December 31, 1994. The decrease in the discount rate at December 31, 1995 had no effect on the 1995 expense and it is expected to increase 1996 expense by less than $1 million. The increase in the discount rate at December 31, 1994 to 8.5% from 7.5% at December 31, 1993 decreased 1995 expense by less than $1 million. The net postretirement benefit liability was $2 million at December 31, 1995 and $1 million at December 31, 1994 and 1993. The net periodic postretirement benefit cost was $1 million for the years ended December 31, 1995, 1994 and 1993.\nThe Parent has established the Executive Deferred Compensation Plan (the \"Plan\"), a nonqualified deferred compensation plan, in which certain employees of the Parent and the Company may elect to defer a portion of their annual compensation on a pre-tax basis. The amount deferred remains an asset of the Company and may be invested in any of certain mutual funds at the participant's direction. Payment of amounts deferred are made in a lump sum or in annual installments over a five, ten or fifteen year period as determined by the participant. Plan assets were approximately $10 million and $3 million at December 31, 1995 and 1994, respectively.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n12. INCOME TAXES\nAlthough the Company files a consolidated U.S. tax return with its Parent, the Company reports income tax expense as if it were a separate taxpayer and records deferred tax benefits for deductible temporary differences if it is more likely than not that these benefits will be realized. Included in income tax expense are amounts relating to the International Group, which files a separate United States federal income tax return. United States federal income taxes paid by the International Group amounted to $1 million in both 1995 and 1994.\nThe provision for income taxes is summarized in the following table:\nIn accordance with the provisions of the current tax allocation agreement, net payments of $70 million were made to the Parent in 1995 and $25 million were made in January 1996 for the Company's estimated current federal and state income tax liability. In 1994 and 1993, income taxes paid amounted to $1 million and $56 million, respectively.\nThe reconciliation between the statutory federal income tax provision and the actual effective tax provision for each of the three years ended December 31 is as follows:\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The significant components of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are shown below:\nThe tax benefits of deductible temporary differences are shown net of a valuation allowance of $15 million and $11 million, as of December 31, 1995 and 1994, respectively. The valuation allowance was reduced in 1994 as a result of management's increased confidence in the recognition of the benefit of deductible temporary differences.\nProvision has not been made for United States or additional foreign taxes on $94 million of undistributed earnings of subsidiaries outside the United States, as those earnings are intended to be reinvested. Such earnings would become taxable upon the sale or liquidation of these international operations or upon the remittance of dividends. Given the availability of foreign tax credits and various tax planning strategies, management believes any tax liability which may ultimately be paid on these earnings would be substantially less than that computed at the statutory federal income tax rate. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against the Company's U.S. tax liability, if any. The amount of withholding tax that would be payable upon remittance of the entire amount of undistributed earnings would be approximately $11 million.\nDuring 1994, the Company utilized alternative minimum tax credit and investment tax credit carryforwards of $5 million. The Company had unused foreign tax credit carryforwards of $13 million and $8 million at December 31, 1995 and 1994, respectively. Due to substantial restrictions on the utilization of foreign tax credits imposed by the Tax Reform Act of 1986, the Company may not be able to utilize a significant portion of foreign tax credit carryforwards prior to expiration. Accordingly, the Company has recognized a valuation allowance for the amount of foreign tax credits recorded at December 31, 1995 and 1994.\nThe Company has recorded a net deferred tax asset of $121 million as of December 31, 1995. Although realization is not assured, management believes it is more likely than not that the deferred tax assets will be\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) realized. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.\n13. RELATED PARTIES\nSeveral financial, administrative or other service arrangements exist between the Company and Fuji Bank, the Parent or related affiliates. In management's opinion, the terms of these arrangements are similar to those the Company would have been able to obtain in like agreements with unaffiliated entities in an arms-length transaction.\nServices Provided by Fuji Bank and the Parent for the Company. Certain employees of Fuji Bank and the Parent perform managerial and administrative and other related functions for the Company. The amounts paid to Fuji Bank and the Parent for these services were $2 million and $53 million, respectively for 1995, and $2 million and $47 million for 1994. Additionally, certain subsidiaries of Fuji Bank periodically serve as managers for various offerings of the Company's debt securities and the Fuji Bank and Trust Company may act as registrar and paying agent for certain debt issuances by the Company.\nServices Provided by the Company for Fuji and the Parent. The Company performs services for its affiliates and charges them for the cost of the work performed. The Company may also guarantee the obligations of its clients or the clients of certain joint ventures, under letters of credit issued by financial institutions, some of which are affiliates of the Company. Additionally, the Company guarantees payment under a deferred compensation arrangement between the Parent and certain of its employees. The Company has agreements with the Parent and certain other subsidiaries of the Parent which provide for the Company to receive an annual negotiated fee for servicing assets which have been sold by the Company to the Parent and these affiliates. The Company continues to service these assets and all other direct costs and expenses, including any additional advances made after the date of the agreement, are borne by the subsidiaries of the Parent. The amount of fees for servicing these assets in 1995, 1994 and 1993, was approximately $1 million, $2 million and $4 million, respectively. These amounts are recorded as a reduction of operating expenses in the consolidated statements of income.\nIntercompany Receivables, Payables, Transactions and Financial Instruments. At December 31, 1995 and 1994, other assets included net amounts due from affiliates of $25 million and $29 million, respectively. The amounts are comprised principally of interest bearing demand notes representing amounts due to the Company arising from the interest rate swap agreement with the Parent, advances, administrative fees and costs charged to other subsidiaries of the Parent. The notes bear interest at rates which approximate the average rates on the Company's commercial paper obligations or short-term bank borrowing rates outstanding during the period.\nIn the ordinary course of its business, the Company participates in joint financings with Fuji Bank or certain affiliates. During 1995, the Company sold to Fuji Bank its $25 million interest in a joint financing with Fuji Bank. During 1994, the Company paid $17 million to repurchase loan participations which it had previously sold to Fuji Bank.\nThe Company is a party to a $200 million interest rate swap agreement with the Parent, which expires December 15, 2000, and was a party with the Parent for a $250 million interest rate swap agreement which expired on July 31, 1995. The purpose of these agreements is to manage the Company's exposure to interest rate fluctuations. Under these agreements, the Company pays interest to the Parent at a variable rate based on the commercial paper rate published by the Board of Governors of the Federal Reserve System and the Parent pays interest to the Company at fixed rates of 5.57% and 5.0%, respectively. These agreements had the effect of increasing the Company's interest expense by $3 million in 1995, and reducing the Company's interest expense by $3 million in 1994 and $5 million in 1993.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDuring 1995, the Company terminated two cross-currency basis swap agreements with a subsidiary of Fuji Bank. Fuji Bank paid to the Company net amounts approximately $1 million and received approximately $7 million under these agreements during the years ended December 31, 1995 and 1994, respectively.\nThe Company and Fuji Bank are parties to a \"Keep Well Agreement,\" which provides that if the Company should lack sufficient cash or credit facilities to meet its commercial paper obligations, Fuji Bank will lend the Company up to $500 million. That loan would be payable on demand and the proceeds from the loan could only be used by the Company to meet its commercial paper obligations. The Keep Well Agreement further provides that Fuji Bank will maintain the Company's net worth in an amount equal to $500 million. Accordingly, if the Company should determine, at the close of any month, that its net worth is less than $500 million, then Fuji Bank will purchase, or cause one of its subsidiaries to purchase, shares of the Company's NW Preferred Stock in an amount necessary to increase the Company's net worth to $500 million. Commitment fees paid by the Company to Fuji Bank under the Keep Well Agreement amounted to less than $1 million in 1995, 1994 and 1993. Interest on any loans will be charged at the prime rate of Morgan Guaranty Trust Company of New York plus .25% per annum. No loans or purchases of NW Preferred Stock have been made by Fuji Bank under this agreement.\nThe Keep Well Agreement cannot be terminated by either party prior to December 31, 2002. After December 31, 2002, either Fuji Bank or the Company may terminate the agreement upon 30 business days prior written notice. As long as the Perpetual Preferred Stock is outstanding and held by third parties other than Fuji Bank, the agreement may not be terminated by either party unless the Company has received written certifications from Moody's Investors Services, Inc. and Standard and Poor's Corporation that, upon such termination, the Perpetual Preferred Stock will be rated no lower than \"a3\" and \"A-\", respectively.\nOn March 30, 1994, the Company entered into a receivables purchase agreement with Freedom Asset Funding Corporation (\"Freedom\"). Under this agreement, which expires March 24, 1999, the Company may sell to Freedom with limited recourse an undivided interest of up to $500 million in a designated pool of its factored accounts receivable. As of December 31, 1995, the Company had sold a $6 million interest to Freedom for cash. Freedom has entered into a revolving liquidity facility and an operating agreement with Fuji Bank and one of its affiliates. The amount of liquidity provided by Fuji Bank under this facility is $100 million at December 31, 1995.\nFuji Bank and one of its subsidiaries provided uncommitted lines of credit to consolidated international subsidiaries totaling $14 million and $15 million at December 31, 1995 and 1994, respectively. Borrowings under these facilities totaled $10 million and $5 million at both December 31, 1995 and 1994, respectively. In addition, Fuji Bank provides uncommitted lines of credit to certain international joint ventures.\n14. FAIR VALUE DISCLOSURES\nSFAS No. 107 \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information for certain financial instruments, for which it is practicable to estimate that value. These values must be estimated as there is no well established market for many of the Company's assets and financial instruments. Fair values are based on estimates using present value, property yield, historical rate of return and other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. These assumptions are inherently judgmental and changes in such assumptions could significantly affect fair value calculations. The derived fair value estimates may not be substantiated by comparison to independent markets and may not be realized in immediate liquidation of the instrument.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe book values and estimated fair market values of the Company's financial instruments at December 31, 1995 and 1994, are as follows:\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. Carrying values approximate fair values for all financial instruments which are not specifically addressed.\nFor variable rate receivables that reprice frequently and have no significant credit risk, fair values were assumed to equal carrying values. All other receivables were pooled by loan type and risk rating. The fair value for these receivables was estimated by discounted cash flow analyses, using interest rates equal to the London Inter-bank Offered Rate or the Prime Rate offered as of December 31, 1995 and 1994, plus an adjustment for normal spread, credit quality and the remaining terms of the loans.\nBook and fair values of the trading securities and securities available for sale are based on quoted market prices. The fair values of equity interests and other investments are calculated by first using the Company's business valuation model to determine the estimated value of these investments as of the anticipated exercise date. The business valuation model analyzes the cash flows of the related company and considers values for similar equity investments. The determined value is then discounted back to December 31, 1995 and 1994, using a rate appropriate for returns on equity investments. Although the investments in international joint ventures accounted for by the equity method are not considered financial instruments and as such are not included in the above table, management believes that the fair values of these investments significantly exceed the carrying value of these investments.\nThe fair values of the debt and swap agreements were estimated using discounted cash flow analyses, based on current incremental borrowing and swap rates for arrangements with similar terms and remaining maturities, as quoted by independent financial institutions as of December 31, 1995 and 1994. As market interest rates are lower at December 31, 1995 compared to the prior year end, the fair value of debt increased relative to book value. Accordingly, the fair value of the interest rate swap agreements moved toward a net mark to market gain of $127 million at December 31, 1995 as compared to a net mark to market loss of $2 million at December 31, 1994. The fair values of loan commitments, letters of credit and guarantees are negligible.\nHELLER FINANCIAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n15. FINANCIAL DATA BY REGION\nThe following table shows certain financial information by geographic region for the years ended December 31, 1995, 1994 and 1993.\n16. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following financial information for the calendar quarters of 1995, 1994 and 1993, is unaudited. In the opinion of management, all adjustments necessary to present fairly the results of operations for such periods have been included.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe names and ages of all directors and all persons nominated or chosen to become directors and executive officers of the Company as of December 31, 1995, and a biographical summary for each such person appear in the following pages. No family relationship exists among the persons named below.\nDIRECTORS\nEach of the officers and directors of the Company are elected at the annual meeting for a term of one year or until their successors are duly elected and qualified.\nDuring 1995, an Initial Statement of Beneficial Ownership of Securities on Form 3 was filed by: (i) Hajime Maeda (elected January 9, 1995 as Director) on January 13, 1995; (ii) Lawrence P. Chapman (elected January 1, 1995 as Senior Vice President) on February 1, 1995; (iii) Debra H. Snider (elected April 25, 1995 as Executive Vice President, Acting General Counsel and Secretary) on May 1, 1995; (iv) Lawrence G. Hund (elected May 8, 1995 as Senior Vice President and Controller) on May 17, 1995; (v) Hidehiko Ide (elected May 25, 1995 as Director) on August 21, 1995; (vi) Robert J. Szambelan (elected May 15, 1995 as Senior Vice President and Chief Information and Technology Officer) on August 25, 1995; (vii) Jay S. Holmes (elected December 1, 1995 as Group President) on December 6, 1995; (viii) David J. Kantes (elected December 1, 1995 as Group President) on December 6, 1995; and (ix) Masahiro Sawada (elected December 18, 1995 as Director) on December 20, 1995. No Forms 4 or Forms 5 were filed during the year. In all filings, there were no reported holdings of the Registrant's equity securities.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following information is furnished as to all plan and non-plan compensation awarded to, earned by, or paid to each Chief Executive Officer of the Company and the four next most highly compensated executive officers of the Company (as determined at December 31, 1995) for services rendered in all capacities to the Company and its subsidiaries during the years ended December 31, 1995, 1994 and 1993.\nSUMMARY COMPENSATION TABLE (1)(2)\n- -------- (1) All numbers are rounded to the nearest whole dollar. (2) Certain executive officers of the Company whose compensation is included above are employed and paid by the Parent. Pursuant to a management agreement between the Company and the Parent, the Company reimburses the Parent for their services. (3) The cash bonus under the management incentive plan for services rendered to the Company and its subsidiaries during the year ended December 31, 1995 was not calculable as of the date of this report. Such amounts will be disclosed in the Company's annual report for the subsequent fiscal year in the appropriate column for the year in which earned. Annual bonus amounts are earned and accrued for the year shown and paid subsequent to the end of such year. (4) Accruals under the Company's Long Term Incentive Plans (\"LTIPs\") are earned and recorded annually during the plan period based upon the Company's performance during each applicable year. Once determined, accruals are not affected by the Company's performance in subsequent years. As a result, the Company reports annual accruals under its LTIPs as other annual compensation as defined by the SEC. During 1995, the Company had an LTIP that commenced on January 1, 1994 and will terminate on December 31, 1996 (\"1994-96 LTIP\"). Accruals under the 1994-96 LTIP for calendar year 1995 are reflected in the Summary Compensation Table. Under the terms of the 1994-96 LTIP, payouts of all accruals will be made after the termination of the 1994-96 LTIP to officers who are active employees of the Company and participants in the 1994-96 LTIP through\nits termination date (subject to exceptions in the case of disability, death or retirement). Due to Mr. Blum's death in October, 1995, his 1994 and 1995 accruals under the 1994-96 LTIP will be distributed in early 1996. In March, 1995, payouts were made to the named executive officers of previously reported accruals under an LTIP that commenced January 1, 1992 and terminated December 31, 1994.\nPerquisites and other personal benefit amounts for each of the named executive officers fall below the minimum level for disclosure and therefore have been excluded.\n(5) Mr. Vernick received the following special payments, attributable to the performance of specific business units and investments in 1995, 1994 and 1993, respectively: $22,500, $103,156 and $67,494.\n(6) Amounts reported reflect the Company's contribution made in the form of a match on amounts deferred by the officer in the Company's Savings and Profit Sharing Plan, that is qualified under Section 501(a) of the Internal Revenue Code. This Plan is available to all employees who work at least 900 hours per year. The Company makes matching contributions equal to 50% of the employee's contribution provided, however, that the Company's contribution will not exceed 2.5% of the employee's base salary.\nRETIREMENT AND OTHER DEFINED BENEFIT PLANS\nThe Company has a defined benefit retirement income plan (the \"Retirement Plan\") for the benefit of its employees that is a qualified plan under Section 401 of the Internal Revenue Code. Substantially all domestic employees of the Company who have one year of service, including executive officers and directors of the Company, and also certain executive officers and directors of International, participate in the Retirement Plan. Non-employee directors are not eligible for retirement benefits. Under a defined benefit plan, such as the Company's, contributions are not specifically allocated to individual participants.\nThe Company adopted a Supplemental Executive Retirement Plan (\"SERP\"), effective October 28, 1987, which provides to all officers at the level of Senior Vice President and above who participate in the Company's LTIP and the Retirement Plan, benefits which are in excess of the limitations imposed by Sections 401(a)(17) and 415 of the Internal Revenue Code, as amended from time to time.\nThe table below shows estimated annual retirement benefits for executives in specified remuneration and service classifications.\nESTIMATED ANNUAL RETIREMENT BENEFITS\nIn general, remuneration covered by the Retirement Plan consists of the annual base salary determined before any salary reduction contributions to the Company's Savings and Profit Sharing Plan. The figures shown in the table above include benefits payable under the Retirement Plan and SERP as described above. However, the figures shown are prior to offsets for Social Security and Company match benefits (under its Savings and Profit Sharing Plan). The estimates assume that benefits commence at age 65 under a straight life annuity form.\nThe number of years of credited service as of December 31, 1995, and the actual average remuneration for their respective years of credited service with the Company for those individuals listed on the Summary Compensation Table are as follows: Richard J. Almeida, 8 years 5 months, $276,475; Michael S. Blum, 9 years 4.5 months, $623,550; Mitchell F. Vernick, 9 years 4.5 months, $228,353; Lauralee E. Martin, 9 years 4.5 months, $222,240; Dennis P. Lockhart, 8 years, $233,417; and Michael J. Litwin, 24 years 2 months, $219,303.\nCOMPENSATION OF DIRECTORS\nDirectors of the Company are not compensated for provision of services as directors.\nEMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS\nRichard J. Almeida has an employment contract with the Parent which became effective as of November 13, 1995, the date on which he was elected Chairman, and expires on December 31, 1997. The contract provides that if Mr. Almeida's employment is terminated by the Parent without cause (as defined in the contract), or if he resigns with cause (as specified in the contract), he will be entitled to receive full salary through the later of December 31, 1997 or the date fifteen months from the date of termination. In the event of a termination under either of the situations described above, Mr. Almeida is also entitled to receive a pro rata portion of his incentive plan payments and will continue to be covered under certain benefit plans through the later of December 31, 1997 or the date fifteen months from the date of termination. Additionally, if Mr. Almeida and the Parent do not reach an agreement regarding the terms of an extension or renewal of his contract, Mr. Almeida is entitled to full salary until the later of December 31, 1997 or the date fifteen months from the date the Parent informs him that it does not intend to extend his employment. Under this circumstance, Mr. Almeida would also receive incentive compensation until December 31, 1997 and coverage under certain benefit plans during the period he receives salary continuation.\nMitchell Vernick participates in special incentive arrangements with the Company pursuant to which he is eligible to receive payments based upon the performance of specific business units and investments.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nKenji Miyamoto served as a member of the Compensation Committee of the Board of Directors of the Company throughout calendar year 1995. Hajime Maeda served as a member of the Compensation Committee of the Company from January 9, 1995 through December 31, 1995. Messrs. Miyamoto and Maeda also served concurrently as members of the Compensation Committees of the Parent, International and Holdings. Richard J. Almeida served on the Compensation Committee of the Company from November 13, 1995 through December 31, 1995. Michael S. Blum served on the Compensation Committee of the Company from January 1, 1995 until his death on October 29, 1995.\nUntil his death, Mr. Blum also served as Chairman and Chief Executive Officer of the Company and its subsidiaries, International and Holdings. In addition, Mr. Blum served as the Chairman of the Board, Chief Executive Officer and President of the Parent and as a member of the Compensation Committees of the Parent, International, and Holdings. Mr. Almeida succeeded Mr. Blum as Chairman and Chief Executive Officer and a member of the Compensation Committees of the named companies as of November 13, 1995. Messrs. Miyamoto and Maeda each also served as executive officers of the Parent during their tenure as members of the Compensation Committees.\nAs identified below, several directors of the Company also served as executive officers of one or more of the other companies for whom Mr. Blum, and subsequently Mr. Almeida, served as a member of the Compensation Committee of the Board of Directors: Mr. Lockhart, Parent, International and Holdings; and Mr. Vernick, International and Holdings.\nNo other relationships exist between the members of the Compensation Committee of the Company, the Parent, International or Holdings and the directors and executive officers of those companies.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nVOTING SECURITIES\nThe following table sets forth the ownership of all of the outstanding common stock of the Company, as of February 1, 1996:\nEQUITY SECURITIES\nAll of the outstanding common stock of the Parent is owned by Fuji Bank. As of December 31, 1995, certain directors and executive officers of the Company owned beneficially certain amounts of Fuji Bank's common stock, all as indicated below.\nIn addition, Messrs. Ide, Itosaka, Kobayashi, Miyamoto, Ogura, Sawada, and Watanabe participate in a Fuji Bank employee stock purchase plan and, as of December 31, 1995, beneficially held, in aggregate, approximately 24,000 shares.\nThe aggregate number of shares of Fuji Bank common stock that are beneficially owned by the Company's directors and officers, considered as a group, including those shares held in the Fuji Bank employee stock purchase plan, does not exceed 1% of the outstanding shares of such stock.\nThe following table sets forth the ownership by all directors, nominees and executive officers, of all outstanding equity securities of the Company, and its subsidiaries, as of February 1, 1996:\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nKEEP WELL AGREEMENT WITH FUJI BANK\nThe Company entered into a Keep Well Agreement (the \"Agreement\") with Fuji Bank on April 23, 1983 in order to assist the Company in maintaining its credit rating. The Agreement was amended and supplemented on January 26, 1984, in connection with the consummation of the purchase of the Company by Fuji Bank and has been amended since that date from time to time. Most recently, on May 3, 1995, the Company and Fuji Bank agreed to extend the term of the Keep Well Agreement for an additional two years from December 31, 2000 to December 31, 2002.\nThe Agreement provides that Fuji Bank will maintain the Company's net worth in an amount equal to $500 million. Accordingly, if the Company should determine, at the close of any month, that its net worth is less than $500 million, then Fuji Bank will purchase, or cause one of its subsidiaries to purchase, shares of the Company's NW Preferred Stock, Class B (No Par Value) (\"NW Preferred Stock\") in an amount necessary to increase the Company's net worth to $500 million. If and when issued, dividends will be paid quarterly on the NW Preferred Stock at a rate per annum equal to 1% over the three-month London Inter-bank Offered Rate. Such dividends will not be paid during a default in the payment of principal or interest on any of the outstanding indebtedness for money borrowed by the Company. Subject to certain conditions, the NW Preferred Stock will be redeemable at the option of the holder within a specified period of time after the end of a calendar quarter, in an aggregate amount not greater than the excess of the net worth of the Company as of the end of such calendar quarter over $500 million.\nThe Agreement further provides that if the Company should lack sufficient cash, other liquid assets or credit facilities to meet its payment obligations on its commercial paper, then Fuji Bank will lend the Company up to $500 million (the \"Liquidity Commitment\"), payable on demand, which the Company may use only for the\npurpose of meeting such payment obligations. Any such loan by Fuji Bank to the Company (a \"Liquidity Advance\") will bear interest at a fluctuating interest rate per annum equal to the announced prime commercial lending rate of Morgan Guaranty Trust Company of New York plus .25% per annum. Each Liquidity Advance will be repayable on demand at any time after the business day following the 29th day after such Liquidity Advance was made. No repayment of the Liquidity Advance will be made during a period of default in the payment of the Company's senior indebtedness for borrowed money.\nNo Liquidity Advances or purchases of NW Preferred Stock have been made by Fuji Bank under the Agreement; other infusions of capital in the Company have been made by Parent.\nUnder the Agreement, the Company has covenanted to maintain, and Fuji Bank has undertaken to assure that the Company will maintain, unused short-term lines of credit and committed credit facilities in an amount approximately equal to 75% of the amount of its commercial paper obligations from time to time outstanding. In addition, under the Agreement, neither Fuji Bank nor any of its subsidiaries can sell, pledge or otherwise dispose of any shares of the Company's Common Stock or permit the Company to issue shares of its Common Stock except to Fuji Bank or a Fuji Bank affiliate.\nNeither Fuji Bank nor the Company may terminate the Agreement for any reason prior to December 31, 2002. After December 31, 2002 either Fuji Bank or the Company may terminate the Agreement upon 30 business days prior written notice. So long as the Perpetual Preferred Stock is outstanding and held by third parties other than Fuji Bank, the Agreement may not be terminated by either party unless the Company has received written certifications from Moody's Investors Services, Inc. and Standard & Poor's Corporation that upon termination the Perpetual Preferred Stock will be rated by them no lower than a3 and A-, respectively. For these purposes the Perpetual Preferred Stock will no longer be deemed outstanding at such time as an effective notice of redemption of all of the Perpetual Preferred Stock shall have been given by the Company and funds sufficient to effectuate such redemption shall have been deposited with the party designated for such purpose in the notice. In addition, any termination of the Keep Well Agreement by the Company must be consented to by Fuji Bank. Any such termination will not relieve the Company of its obligations in respect of any NW Preferred Stock outstanding on the date of termination or the dividends thereon, any amounts owed in respect of Liquidity Advances on the date of termination or the unpaid principal or interest on those Liquidity Advances or Fuji Bank's fee relating to the Liquidity Commitment. Any such termination will not adversely affect the Company's commercial paper obligations outstanding on the date of termination. The Agreement can be modified or amended by a written agreement of Fuji Bank and the Company. However, no such modification or amendment may change the prohibition against termination before December 31, 2002 or adversely affect the Company's then-outstanding commercial paper obligations.\nUnder the Agreement, the Company's commercial paper obligations and any other debt instruments are solely the obligations of the Company. The Agreement is not a guarantee by Fuji Bank of the payment of the Company's commercial paper obligations, indebtedness, liabilities or obligations of any kind.\nTAX ALLOCATION AGREEMENTS\nUnder the terms of the tax allocation agreement between the Parent and the Company, as amended, each company covered by the agreement calculates its current and deferred income taxes based on its separate company taxable income or loss, utilizing separate company net operating losses, tax credits, capital losses and deferred tax assets or liabilities. Under the terms of other tax allocation agreements with certain of the Company's subsidiaries, the Company and the Parent, in calculating their current income taxes, can utilize the taxable income or loss of the subsidiaries.\nCERTAIN TRANSACTIONS WITH FUJI BANK AND WITH THE PARENT AND ITS SUBSIDIARIES\nSeveral financial, administrative or other service arrangements exist between the Company and Fuji Bank, the Parent or related affiliates. In management's opinion, the terms of these arrangements are similar to those the\nCompany would have been able to obtain in like agreements with unaffiliated entities in an arms-length transaction.\nServices Provided by Fuji Bank and the Parent for the Company. Certain employees of Fuji Bank and the Parent perform managerial, administrative and other related functions for the Company. The Company compensates Fuji Bank and the Parent for the use of such individuals' services at a rate which reflects current costs to Fuji Bank and the Parent. The amounts paid to Fuji Bank and the Parent for these services in 1995 were $2 million and $53 million, respectively. Additionally, certain subsidiaries of Fuji Bank periodically serve as managers for various offerings of the Company's debt securities and the Fuji Bank and Trust Company may act as registrar and paying agent for certain debt issuances by the Company.\nServices Provided by the Company for Affiliates. The Company performs services for its affiliates and charges them for the cost of the work performed. The Company may also guarantee the obligations of its clients or the clients of certain joint ventures under letters of credit issued by financial institutions, some of which are affiliates of the Company. Additionally, the Company guarantees payment under a deferred compensation arrangement between the Parent and certain of its employees. The Company has agreements with the Parent and certain other subsidiaries of the Parent which provide for the Company to receive an annual negotiated fee for servicing assets which have been sold by the Company to the Parent and these affiliates. The Company continues to service these assets and all other direct costs and expenses, including any additional advances made after the date of the agreement, are borne by the subsidiaries of the Parent. The amount of fees for servicing these assets in 1995 was approximately $1 million.\nHeller Capital Markets Group, Inc. (\"CMG\"), a wholly-owned subsidiary of the Company, acts as placement agent for the sale of commercial paper issued by the Parent. CMG receives compensation, based upon the face amount of the commercial paper notes sold. For the year ending December 31, 1995, the Parent paid $.2 million to CMG as compensation pursuant to this arrangement.\nIntercompany Receivables, Payables, Transactions and Financial Instruments. At December 31, 1995, the net amount due from affiliates was $25 million. The amounts are comprised principally of interest bearing demand notes representing amounts due to the Company arising from the interest rate swap agreement with the Parent, advances, administrative fees and costs charged to other subsidiaries of the Parent. The notes bear interest at rates which approximate the average rates on the Company's commercial paper obligations or short-term bank borrowing rates outstanding during the period.\nIn the ordinary course of its business, the Company participates in joint financings with certain affiliates. During 1995, the Company sold to Fuji Bank its $25 million interest in a joint financing with Fuji Bank.\nFuji Bank and one of its subsidiaries provided uncommitted lines of credit to consolidated international subsidiaries totaling approximately $14 million at December 31, 1995. Borrowings under these facilities totaled $10 million at December 31, 1995. In addition, Fuji Bank provides uncommitted lines of credit to certain international joint ventures.\nThe Company is a party to a $200 million interest rate swap agreement with the Parent, which expires December 15, 2000, and was a party with the Parent for a $250 million interest rate swap agreement which expired on July 31, 1995. The purpose of these agreements is to manage the Company's exposure to interest rate fluctuations. Under these agreements, the Company pays interest to the Parent at a variable rate based on the commercial paper rate published by the Board of Governors of the Federal Reserve System and the Parent pays interest to the Company at fixed rates of 5.57% and 5.0%, respectively. These agreements had the effect of increasing the Company's interest expense by $3 million in 1995.\nDuring 1995, the Company terminated two cross-currency basis swap agreements with a subsidiary of Fuji Bank. Net amounts received from Fuji Bank under these agreements during 1995 were approximately $1 million.\nOn February 15, 1985, the Company issued to the Parent 1,000 shares of previously subscribed Cumulative Convertible Preferred Stock, Series D (No Par Value) (\"Convertible Preferred Stock\"), which has a dividend yield established quarterly at the rate of 1\/2% under the announced prime commercial lending rate of Morgan Guaranty Trust Company of New York, cumulative from March 30, 1984 and payable quarterly commencing on March 31, 1989. During 1995, the Company declared and paid $2 million of dividends on the Convertible Preferred Stock. The Convertible Preferred Stock is convertible into Common Stock of the Company at the conversion price of one share of Common Stock for each 200 shares of Convertible Preferred Stock. Subject to certain conditions, the Convertible Preferred Stock is redeemable, in whole or in part, at any time at the option of the Company at a redemption price equal to the price paid for such stock plus accumulated dividends. Upon voluntary or involuntary liquidation, the holder of the Convertible Preferred Stock is entitled to be paid an amount equal to the price paid for each share plus accumulated dividends.\nCERTAIN OTHER RELATIONSHIPS\nMr. Kessel, a director of the Company and Parent, is a partner of the law firm of Shearman & Sterling, which from time to time acts as counsel in certain matters for Fuji Bank, the Company and the Parent.\nOn March 30, 1994, the Company entered into a receivables purchase agreement with Freedom Asset Funding Corporation (\"Freedom\"). Under this agreement, which expires March 24, 1999, the Company may sell to Freedom with limited recourse an undivided interest of up to $500 million in a designated pool of its factored accounts receivable. As of December 31, 1995, the Company had sold a $6 million interest to Freedom for cash. Freedom has entered into a revolving liquidity facility and an operating agreement with Fuji Bank and one of its affiliates. The amount of liquidity provided by Fuji Bank under this facility is $100 million at December 31, 1995.\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:\nHeller Financial, Inc. and Subsidiaries--\nReport of Independent Public Accountants--Arthur Andersen LLP\nConsolidated Balance Sheets--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 Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules:\nSchedules are omitted because they are not applicable or because the required information appears in the financial statements or the notes thereto.\n3. Exhibits:\n- -------- *Filed herewith.\nInstruments defining the rights of holders of certain issues of long- term debt of the Company have not been filed as exhibits to this Report because the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Company. In accordance with paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company hereby agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument that defines the rights of holders of the Company's long-term debt.\n(b) Current Reports on Form 8-K:\nDuring the fourth quarter of 1995, the Company filed Current Reports on Form 8-K dated October 17, 1995, October 24, 1995, October 30, 1995 and November 14, 1995.\nOn January 29, 1996, the Company filed with the U.S. Securities and Exchange Commission a Current Report on Form 8-K, dated January 26, 1996, to announce the Company's earnings for 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.\nHeller Financial, Inc.\nR. J. Almeida By: _________________________________ Richard J. Almeida (Chairman and Chief Executive Officer)\nFebruary 14, 1996 Dated: ______________________________\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT 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.\nR. J. Almeida * By: _________________________________ By: _________________________________ Richard J. Almeida Michael J. Litwin (Director and Principal Financial (Director) Officer)\n* * By: _________________________________ By: _________________________________ Dennis P. Lockhart Hajime Maeda (Director) (Director)\n* * By: _________________________________ By: _________________________________ Lauralee E. Martin Mitchell F. Vernick (Director) (Director)\n* Lawrence G. Hund By: _________________________________ By: _________________________________ Kenji Miyamoto Lawrence G. Hund (Director) Senior Vice President, Controller and( Chief Accounting Officer)\n* * By: _________________________________ By: _________________________________ Hidehiko Ide Osamu Ogura (Director) (Director)\n* * By: _________________________________ By: _________________________________ Minoru Itosaka Masahiro Sawada (Director) (Director)\n* * By: _________________________________ By: _________________________________ Mark Kessel Atsushi Takano (Director) (Director)\n* * By: _________________________________ By: _________________________________ Tomonori Kobayashi Kenji Watanabe (Director) (Director)\nD. H. Snider *By: ________________________________ Debra H. Snider Attorney-in-Fact Dated: February 14, 1996\nINDEX TO EXHIBITS\n- -------- *Filed herewith.","section_15":""}
{"filename":"14957_1995.txt","cik":"14957","year":"1995","section_1":"ITEM 1. BUSINESS\nBrush Wellman Inc. (\"Company\") manufactures and sells engineered materials for use by manufacturers and others who perform further operations for eventual incorporation into capital, aerospace\/defense or consumer products. These materials typically comprise a small portion of the final product's cost. They are generally premium priced and are often developed or customized for the customer's specific process or product requirements. The Company's product lines are supported by research and development activities, modern processing facilities and a global distribution network.\nCustomers include manufacturers of electrical\/electronic connectors, communication equipment, computers, automobiles, lasers, appliances, spacecraft, aircraft, oil field instruments and equipment, sporting goods, and defense contractors and suppliers to all of the foregoing industries.\nThe Company operates in a single business segment with product lines comprised of beryllium-containing materials and other specialty materials.\nThe Company is a fully integrated producer of beryllium, beryllium alloys (primarily copper beryllium), and beryllia ceramic, each of which exhibits its own unique set of properties. The Company holds extensive mineral rights and mines the beryllium bearing ore, bertrandite, in central Utah. Beryllium is extracted from both bertrandite and imported beryl ore. In 1995, 73% of the Company's sales were of products containing the element beryllium (70% in 1994 and 74% in 1993). Beryllium-containing products are sold in competitive markets throughout the world through a direct sales organization and through owned and independent distribution centers. NGK Metals Corporation of Reading, Pennsylvania and NGK Insulators, Ltd. of Nagoya, Japan compete with the Company in the beryllium alloys field. Beryllium alloys also compete with other generally less expensive materials, including phosphor bronze, stainless steel and other specialty copper and nickel alloys. General Ceramics Inc. is a domestic competitor in beryllia ceramic. Other competitive materials include alumina, aluminum nitride and composites. While the Company is the only domestic producer of the metal beryllium, it competes with other fabricators as well as with designs utilizing other materials.\nSales of other specialty materials, principally metal systems and precious metal products, were 27% of total sales in 1995 (30% in 1994 and 26% in 1993). Precious metal products are produced by Williams Advanced Materials Inc. (hereinafter referred to as \"WAM\"), a subsidiary of the Company comprised of businesses acquired in 1986, 1989 and 1994. WAM's major product lines include sealing lid assemblies, vapor deposition materials, contact ribbon products for various segments of the semiconductor markets, clad and precious metal preforms, ultra fine wire and restorative dental products. WAM also specializes in precious metal refining and recovery.\n- ----------- As used in this report, except as the context otherwise requires, the term \"Company\" means Brush Wellman Inc. and its consolidated subsidiaries, all of which are wholly owned. WAM's principal competitors are Semi-Alloys and Johnson Matthey in the sealing lid assembly business and Materials Research Corporation in the vapor deposition materials product line. The products are sold directly from WAM's facilities in Buffalo, New York and Singapore as well as through sales representatives.\nTechnical Materials, Inc. (hereinafter referred to as \"TMI\"), a subsidiary of the Company, produces specialty metal systems, consisting principally of narrow metal strip, such as copper alloys, nickel alloys and stainless steels into which strips of precious metal are inlaid. TMI also offers a number of other narrow metal strip material systems, including electron beam welded dual metal, contour milling and skiving, thick and thin selective solder coatings, selective electroplated products and bonded aluminum strips on nickel-iron alloys for semiconductor leadframes. Divisions of Cookson, Texas Instruments and Metallon are competitors for the sale of inlaid strip. Strip with selective electroplating is a competitive alternative as are other design approaches. The products are sold directly and through sales representatives.\nSales and Backlog\nThe backlog of unshipped orders as of December 31, 1995, 1994 and 1993 was $95,718,000, $95,354,000, and $86,531,000, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. The Company expects that, based on recent experience, substantially all of its backlog of orders at December 31, 1995 will be filled during 1996.\nSales are made to approximately 6,515 customers. Government sales, principally subcontracts, accounted for about 1.3% of consolidated sales in 1995 as compared to 3.2% in 1994 and 6.1% in 1993. Sales outside the United States, principally to Western Europe, Canada and Japan, accounted for approximately 34% of sales in 1995, 33% in 1994 and 29% in 1993. Financial information as to sales, identifiable assets and profitability by geographic area set forth on page 15 in Note L to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 1995 is incorporated herein by reference.\nResearch & Development\nActive research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development amounted to $7,814,000 in 1995, $8,754,000 in 1994 and $7,121,000 in 1993. A staff of 48 scientists, engineers and technicians was employed in this effort during 1995. Some research and development projects were externally sponsored and expenditures related to those projects (approximately $36,000 in 1995, $102,000 in 1994 and $80,446 in 1993) are excluded from the above totals.\nAvailability of Raw Materials\nThe more important raw materials used by the Company are beryllium (extracted from both imported beryl ore and bertrandite mined from the Company's Utah properties), copper, gold, silver, nickel and palladium. The availability of these raw materials, as well as other materials used by the Company, is adequate and generally not dependent on any one\nsupplier. Certain items are supplied by a preferred single source, but alternatives are believed readily available.\nPatents and Licenses\nThe Company owns patents, patent applications and licenses relating to certain of its products and processes. While the Company's rights under the patents and licenses are of some importance to its operations, the Company's businesses are not materially dependent on any one patent or license or on the patents and licenses as a group.\nEnvironmental Matters\nThe inhalation of excessive amounts of airborne beryllium particulate may present a health hazard to certain individuals. For decades the Company has operated its beryllium facilities under stringent standards of inplant and outplant discharge. These standards, which were first established by the Atomic Energy Commission over forty years ago, were, in general, subsequently adopted by the United States Environmental Protection Agency and the Occupational Safety and Health Administration. The Company's experience in sampling, measurement, personnel training and other aspects of environmental control gained over the years, and its investment in environmental control equipment, are believed to be of material importance to the conduct of its business.\nEmployees\nAs of December 31, 1995 the Company had 1,856 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe material properties of the Company, all of which are owned in fee except as otherwise indicated, are as follows:\nCleveland, Ohio - A structure containing 110,000 square feet on an 18 acre site housing corporate and administrative offices, data processing and research and development facilities.\nElmore, Ohio - A complex containing approximately 676,000 square feet of building space on a 385 acre plant site. This facility employs diverse chemical, metallurgical and metalworking processes in the production of beryllium, beryllium oxide, beryllium alloys and related products. Beryllium ore concentrate from the Delta, Utah plant is used in all beryllium-containing products.\nShoemakersville (Reading), Pennsylvania - A 123,000 square foot plant on a ten acre site that produces thin precision strips of beryllium copper and other alloys and beryllium copper rod and wire.\nNewburyport, Massachusetts - A 30,000 square foot manufacturing facility on a four acre site that produces alumina, beryllia ceramic and direct bond copper products.\nTucson, Arizona - A 45,000 square foot plant on a ten acre site for the manufacture of beryllia ceramic parts from beryllium oxide powder supplied by the Elmore, Ohio facility.\nDelta, Utah - An ore extraction plant consisting of 86,000 square feet of buildings and large outdoor facilities situated on a two square mile site. This plant extracts beryllium from bertrandite ore from the Company's mines as well as from imported beryl ore.\nJuab County, Utah - The Company holds extensive mineral rights in Juab County, Utah from which the beryllium bearing ore, bertrandite, is mined by the open pit method. A substantial portion of these rights is held under lease. Ore reserve data set forth on page 18 of this Form 10-K annual report for the year ended December 31, 1995 are incorporated herein by reference.\nFremont, California - A 16,800 square foot leased facility for the fabrication of precision electron beam welded, brazed and diffusion bonded beryllium structures.\nTheale (Reading), England - A 19,700 square foot leased facility principally for distribution of beryllium alloys.\nStuttgart, West Germany - A 24,750 square foot leased facility principally for distribution of beryllium alloys.\nFukaya, Japan - A 35,500 square foot facility on 1.8 acres of land in Saitama Prefecture principally for distribution of beryllium alloys.\nLincoln, Rhode Island - A manufacturing facility consisting of 124,000 square feet located on seven and one-half acres. This facility produces metal strip inlaid with precious metals and related metal systems products.\nBuffalo, New York - A complex of approximately 97,000 square feet on a 3.8 acre site providing facilities for manufacturing, refining and laboratory services relating to high purity precious metals.\nSingapore, Singapore - A 4,500 square foot leased facility for the assembly and sale of precious metal hermetic sealing lids.\nProduction capacity is believed to be adequate to fill the Company's backlog of orders and to meet the current level of demand. However, the Company is currently reevaluating production capacity in light of anticipated sales increases from development of new applications for the Company's products and expanding international presence.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(a) Environmental Proceedings.\nIn April 1993, the Company learned that the Ohio Environmental Protection Agency (the \"Ohio EPA\") had referred it to the Ohio Attorney General's Office (the \"OAG\") for consideration of initiation of enforcement proceedings against the Company with respect to alleged violations of various environmental laws at its facility in Elmore, Ohio. On October 19, 1994, the Court of Common Pleas for Ottawa County, Ohio entered a consent decree resolving alleged violations relating to air emission standards. Negotiations between the OAG and the Company regarding alleged hazardous waste and solid waste violations, including matters discovered during the course of such negotiations, have resulted in a preliminary agreement pursuant to which a consent decree would be entered providing that the Company would pay a total of $227,000 and undertake a specific pollution prevention project in lieu of paying additional penalties. Finalization of the consent decree is awaiting administrative review and approval of an application for a permit modification which is to be part of the consent decree.\nOn or about September 25, 1992, the Company was served with a third-party complaint alleging that the Company, along with 159 other third-party defendants, is jointly and severally liable under the Comprehensive, Environmental, Response Compensation and Liability Act (\"CERCLA\"), 42 U.S.C. Sections 9607(a) and 9613(b), for response costs incurred in connection with the clean-up of hazardous substances in soil and groundwater at the Douglassville Site (the \"Site\") located in Berks County, Pennsylvania. United States of America v. Berks Associates Inc. et al. v. Aamco Transmissions et al., United States District Court for the Eastern District of Pennsylvania, Case No. 91-4868. Prior to the commencement of litigation, the Company responded to a request for information from the United States Environmental Protection Agency (the \"United States EPA\") by denying that it arranged to send any substances to the Site. Although the Company has no documents in its own files relating to the shipment of any waste to the Site, documents maintained by third-party plaintiffs suggest that 8,344 gallons of waste oil from the Company may have been taken there. According to a consultant retained by third-party plaintiffs, approximately 153 million gallons of waste were sent to the Site. The Company denies liability. The Company has been participating in court-ordered settlement proceedings, which have resulted in a de minimis settlement offer by the United States. The Company has accepted the offer and is awaiting notice from the government showing the final settlement calculation.\nOn July 26, 1994, the Company received a complaint, service of which was waived on September 29, 1994, in Glidden Company et al. v. American Color and Chemical et al., No. 94-C-3970, filed in the United States District Court for the Eastern District of Pennsylvania. The plaintiffs are five companies which, pursuant to orders issued by the United States EPA under CERCLA, have been spending funds to secure, maintain and conduct an investigation of the Berks Landfill in Sinking Springs, Pennsylvania. The plaintiffs are alleged to have disposed of wastes at the landfill, which operated from the 1950 through October 1, 1986. The 18 defendants consist of former owners or operators of the site and alleged transporters and\/or generators of waste disposed of at the site. It is believed that hundreds of other entities disposed of waste at the site during its long period of operation. The plaintiffs seek to recover their past and future costs pursuant to rights of contribution under CERCLA and the Pennsylvania Hazardous Sites Cleanup Act. Plaintiffs allege that, as of\nSeptember 1994, they had spent $355,000 to secure and maintain the site and that they expected to spend $1.7 million for a remedial investigation\/feasibility study and a risk assessment. The remedial investigation and risk assessment have been submitted to EPA for its approval. The feasibility study has not yet commenced. Discovery is proceeding pursuant to a case management order entered on June 22, 1995.\nIn 1989, the Company was identified by the United States EPA as a potentially responsible party (\"PRP\") under CERCLA at the Spectron Site in Elkton, Maryland. To date, the United States EPA has identified approximately 2,000 PRPs with respect to the Spectron Site. The Company resolved a portion of its liability with respect to this Site by entering into Administrative Orders by Consent dated August 21, 1989 and October 1, 1991. Compliance with the terms of these Orders cost approximately $8,480,000, of which the Company's proportionate share was $20,461. On September 29, 1995, the United States EPA sent a \"Special Notice for Negotiations for Remedial Investigation\/Feasibility Study\" to approximately 700 PRPs including the Company. The United States EPA estimates that the final remedy for the Site will cost approximately $45 million. In October 1995, the terms of several proposed de minimis settlement\/buyout options designed to resolve all remaining liability with respect to this Site were circulated among a group of PRPs including the Company. The Company indicated its willingness to pursue a complete resolution of its liability with respect to this Site through a de minimis settlement\/buyout. No litigation has been initiated by the United States EPA with respect to this matter.\n(b) Beryllium Exposure Claims.\nThe inhalation of excessive amounts of airborne beryllium particulate may present a health hazard to certain individuals. For decades the Company has operated its beryllium facilities under stringent standards of inplant and outplant discharge. These standards, which were first developed by the Atomic Energy Commission over forty years ago, were, in general, substantially adopted by the United States EPA and the Occupational Safety and Health Administration.\nPending Claims. The Company is currently a defendant in the following product liability actions in which the plaintiffs allege injury resulting from exposure to beryllium and beryllium-containing materials and are claiming recovery based on various legal theories. The Company believes that resolution of these cases will not have a material adverse effect on the Company.\nDefense for each of the cases identified above is being conducted by counsel selected by the Company and retained, with certain reservations of rights, by the Company's insurance carriers.\nThe Company and certain of its employees are defendants in separate suits filed by nine Company employees and their spouses against the Company and certain Company employees in the Superior Court of Pima County, Arizona. Six of such suits were instituted on June 10, 1994; one was instituted on December 13, 1994; and two were instituted on February 28, 1995. The plaintiffs claim that, during their employment with the Company, they contracted chronic beryllium disease as a result of exposure to beryllium and beryllium-containing products. The plaintiffs seek compensatory and punitive damages of an unspecified amount based on allegations that the Company intentionally misrepresented the potential danger of exposure to beryllium and breached an agreement to pay certain benefits in the event the plaintiffs contracted chronic beryllium disease. Defense of this case is being conducted by counsel retained by the Company. The Company believes that resolution of these cases will not have a material effect on the Company.\nThe State Compensation Fund filed suit against the Company and each of the plaintiff employees discussed above in the Superior Court of Pima County, Arizona, for which service of process on the Company occurred on August 21, 1995. In August 1993, the Company first notified the State Compensation Fund, a workers' compensation fund, of the filing of employee suits. The Company requested that the State Compensation Fund defend such suits pursuant to the Company's State Compensation Fund policies. The State Compensation Fund has denied coverage and defense of such suits, but after discussion, indicated that it would defend some of the employee lawsuits under a reservation of rights. In view of the dispute with respect to defense and indemnity, the State Compensation Fund filed a declaratory judgment action. The State Compensation Fund's complaint seeks a determination that it is not required to defend or indemnify the Company with respect to the employee claims. The Company has filed an answer and counterclaim. Defense of this case is being conducted by counsel retained by the Company.\nThe Company is also a defendant in two cases, filed August 1, 1995 and November 1, 1995, respectively, in the Court of Common Pleas for Cuyahoga County, Ohio. Both cases were brought by current employees of the Company who allege that they contracted chronic beryllium disease as a result of exposure to beryllium or beryllium dust. The complaints include claims by the employees for employer intentional tort, fraud and misrepresentation and claims by family members for loss of consortium. The plaintiffs seek compensatory damages in excess of $25,000 and punitive damages in excess of $25,000. Defense of this case is being conducted by counsel selected by the Company, and retained by the Company in one case and by the Company's insurance carriers, with certain reservation of rights, in the other. A motion to dismiss one of the cases was granted in part and denied in part on January 18, 1996. Plaintiffs then filed an amended complaint, which the Company moved to dismiss. Motions to dismiss the complaints in both cases remain pending. The Company believes that resolution of these cases will not have a material effect on the Company.\nRecent Developments Relating to Pending Claims. On March 18, 1996 the United States Magistrate Judge appointed by the District Court in the HOUK and VANCE cases described in the table above issued a report recommending that the Company's answer in these cases be stricken, that a default judgment be entered against the Company, and that certain facts be taken as established for purposes of these cases. These recommendations resulted from the plaintiffs' motion for sanctions against the Company for alleged failure to fulfill discovery requests and failure to comply with certain Court orders despite the Magistrate Judge's finding that the prior local counsel retained by the Company's insurer had not reported the existence of these orders to the Company. The report also recommended that the Court determine whether disciplinary proceedings should be commenced against such counsel. The Company intends to contest the default recommendation vigorously.\nClaims Concluded Since the End of Third Quarter 1995. Esmeralda Mendoza, on her own behalf and on behalf of the estate of her husband Phillip Mendoza, filed suit against the Company in the Court of Common Pleas of Ottawa County, Ohio on September 5, 1995. The complaint alleged that, while he was an employee of the Company, Mr. Mendoza contracted chronic beryllium disease as a result of exposure to beryllium dust. The estate of Mr. Mendoza sought $500,000 in compensatory damages and $500,000 in punitive damages. Mrs. Mendoza sought damages for loss of consortium in the amount of $250,000. On October 6, 1995, the Company's motion for summary judgment was granted. The time for appeal has expired.\nErnest Needham filed suit against the Company in the Superior Court of Passaic County, New Jersey, for which service of process occurred on December 10, 1992. The complaint alleged that, while he was an employee of a customer of the Company, Mr. Needham contracted chronic beryllium disease as a result of exposure to beryllium-containing products. Mr. Needham sought compensatory damages of an unspecified amount. This case has been settled, and it is expected that the case will be dismissed with prejudice by the court pending final settlement papers.\nFrances Lutz filed suit against the Company in the Superior Court of Passaic County, New Jersey, on February 24, 1994, for which service of process occurred on March 3, 1994. The complaint alleged that, while she was an employee of a customer of the Company, Ms. Lutz contracted chronic beryllium disease as a result of exposure to beryllium-containing products. Ms. Lutz sought compensatory damages of an unspecified amount. This case has been settled, and it is expected that the case will be dismissed with prejudice by the court pending final settlement papers.\n(c) Asbestos Exposure Claims.\nA subsidiary of the Company (the \"Subsidiary\") is a co-defendant in twenty-eight cases making claims for asbestos-induced illness allegedly relating to the former operations of the Subsidiary, then known as The S. K. Wellman Corp. twenty-four of these cases have been reported in prior filings with the S.E.C. In all but a small portion of these cases, the Subsidiary is one of a large number of defendants in each case. The plaintiffs seek compensatory and punitive damages, in most cases of unspecified sums. Each case has been referred to a liability insurance carrier for defense. With respect to those referrals on which a carrier has acted to date, a carrier has accepted the defense of the actions, without admitting or denying liability. Two hundred twenty-five similar cases previously reported have been dismissed or disposed of by pre-trial judgment, one by jury verdict of no liability and ten others by settlement for nominal sums. The Company believes that resolution of the pending cases referred to above will not have a material effect upon the Company.\nThe Subsidiary has entered into an agreement with the predecessor owner of its operating assets, Pneumo Abex Corporation (formerly Abex Corporation), and five insurers, regarding the handling of these cases. Under the agreement, the insurers share expenses of defense, and the Subsidiary, Pneumo Abex Corporation and the insurers share payment of settlements and\/or judgments. In eleven of the pending cases, both expenses of defense and payment of settlements and\/or judgments are subject to a limited, separate reimbursement agreement with MLX Corp., the parent of the company that purchased the Subsidiary's operating assets in 1986.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nExecutive Officers of the Registrant\nThe following table provides information as to the executive officers of the Company.\nMr. Harnett was elected Chairman of the Board, President, Chief Executive Officer and Director of the Company effective January 22, 1991. He had served as a Senior Vice President of The B. F. Goodrich Company from November, 1988.\nMr. Anderson was elected Vice President Beryllium Products effective March 5, 1996. He was promoted to executive officer status effective December 5, 1995. He had served as Director Sales and Marketing-Beryllium Products since November, 1994, Director of Marketing-Ceramics since February, 1994 and Director of Marketing since April, 1989.\nMr. Cramer was elected Vice President - Finance and Chief Financial Officer in December 1994. Prior to that, he served as President of U.S. Operations and Director for the Americas and Australasia for the Swedish multinational, Esselte Meto.\nMr. Freeman was elected Vice President Alloy Products effective February 7, 1995. He had served as Vice President Sales and Marketing since August 3, 1993. He had\nserved as Vice President Sales and Marketing-Alloy Products since July, 1992. Prior to that, he had served as Management Consultant for Adastra, Inc.\nMr. Harlan was elected Vice President International-Europe effective June 7, 1994. He had served as Vice President Business Development since August, 1993. He had served as Senior Vice President, Sales and Marketing since October, 1991. He had served as Vice President\/General Manager, Alloy Division since January 1, 1987.\nMr. Lubrano was promoted to executive officer status of Brush Wellman Inc. effective December 5, 1995. He was elected President - Technical Materials, Inc. effective Apirl, 1995 and Vice President and General Manager effective March, 1992. Prior to that, he served as Vice President and Business Director of Engelhard Corporation from 1987.\nMr. Moyer was promoted to executive officer status effective December 5, 1995. He was elected Director Ceramic Operations effective June, 1990.\nMr. Paschall was promoted to executive officer status of Brush Wellman Inc. effective December 5, 1995. He was elected President - Williams Advanced Materials Inc. effective November, 1991. He had served as Vice President Operations - Williams Advanced Materials Inc. since April, 1989.\nMr. Rozek was elected Senior Vice President International effective March 5, 1996. He had served as Senior Vice President International and Beryllium Products since March 7, 1995. Prior to that, he has served as Vice President International effective October 1991 and Vice President Corporate Development effective February 27, 1990.\nMr. Sandor was elected Vice President Alloy Technology effective March 5, 1996. He had served as Vice President Operations since October 1991. He had served as Senior Vice President since September 1989.\nMr. Skoch was elected Vice President Administration and Human Resources effective March 5, 1996. He had served as Vice President Human Resources since July, 1991. Prior to that he was Corporate Director - Personnel.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange. As of March 11, 1996, there were 2,308 shareholders of record. Information as to stock price and dividends declared set forth on page 16 in Note M to the consolidated financial statements in the annual report to shareholders for the year ended December 31, 1995 is incorporated herein by reference. The Company's ability to pay dividends is generally unrestricted, except that it is obligated to maintain a specified level of tangible net worth pursuant to an existing credit facility.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data on pages 22 and 23 of the 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\nRESULTS OF OPERATIONS\n1995 to 1994 Comparison\nWorldwide sales in 1995 were a record $370 million compared to $346 million in 1994. All product lines, except precious metals, increased over the prior year with beryllium alloys and specialty metal systems increasing significantly.\nSales of beryllium alloy products increased in both the domestic and international markets. The focused marketing efforts -- teams dedicated towards particular markets and\/or end use applications -- helped support the domestic growth. Successful examples of these efforts include the continued penetration into the automotive electronics market and a significant increase in shipments of products used in aircraft bearings and bushings. Telecommunications and computers also remain important markets for beryllium alloys as do appliances, especially in Europe. Favorable economic conditions in portions of western Europe, particularly in the first half of the year, helped fuel an addition in sales there. Sales in Asia grew as a result of increased market share and development of new applications. The sales trend in general for beryllium alloy strip products is for customers to move toward the lower price alloys such as the Company's Alloy 174. The sales increase in 1995 over 1994 was also due, in part, to favorable foreign currency exchange rates and the pass-through effect of higher commodity costs, particularly copper.\nBeryllium sales increased slightly in 1995 over 1994, but were still somewhat lower than in the recent years prior to 1994. A large portion of beryllium sales continues to be for defense\/aerospace applications and 1995 sales were enhanced by shipments for defense programs in Europe and growth in new domestic defense applications in avionics. The two targets for\ngrowth are new defense\/aerospace systems, particularly upgrades of current defense systems, and commercial applications. Research and development, marketing and manufacturing efforts have now been re-deployed to concentrate on specific applications in these and related markets.\nThe Company filed a petition before the U.S. Department of Commerce, International Trade Administration and the U.S. International Trade Commission on March 14, 1996 requesting the imposition of antidumping duties on imports of beryllium metal from Kazakhstan. The Company believes that beryllium from Kazakhstan was dumped in the United States, and that, as a consequence, the Company has lost substantial domestic sales to the principal Kazakhstan manufacturer of beryllium metal, the Ulba Metallurgical Complex (also known as the Ulbinsky Metal factory) in Ust Kamenogorsk, Kazakhstan which directly competes with the Company in beryllium sales.\nCeramic sales grew in 1995 as compared to 1994. The increase is primarily a result of the continued development of products utilizing the direct bond copper technology. These sales were not profitable due to new process development and other start-up costs. Equipment designed to increase efficiencies was installed late in the year.\nSales of specialty metal systems increased in 1995 over 1994. Most products experienced gains in 1995 with CERDIP sales increasing significantly. Sales improved as a result of developing new product applications, increasing market share and continued expansion into the international markets. Major applications for these products continue to be automotive electronics and telecommunications.\nPrecious metal sales declined significantly in 1995 as compared to 1994. Frame lid assembly sales were reduced due to a customer's re-design of a major microprocessor application. The re-design had been anticipated by management and resources have been directed towards developing alternative products and markets. Sales of vapor deposition targets, which service the CD-ROM, specialty coatings, telecommunications and semiconductor fabrication markets, continue to increase. A small acquisition in late 1994 gave the Company access to the ultra-fine wire market. These sales were minor in 1995, but are anticipated to grow.\nInternational operations consist of distribution centers in Germany, England and Japan, primarily for alloy products, a marketing office in Singapore and a small precious metal finishing facility in Singapore. Sales by these operations totaled $91 million in 1995 compared to $84 million in 1994. As previously noted, sales of beryllium alloy increased while sales of frame lid assemblies from Singapore declined. Sales by the international operations are predominantly in their respective local currencies with the balance in U.S. dollars. Direct export sales to unaffiliated customers totaled $36 million in 1995 and $31 million in 1994. The majority of these sales are to Canada and western Europe. U.S. exports are all denominated in dollars.\nAs outlined in Note F to the Consolidated Financial Statements, the Company has a foreign currency hedge program to protect against adverse currency movements. Should the dollar strengthen significantly, the decrease in value of foreign currency transactions will be partially offset by gains on the hedge contracts. As of December 31, 1995, outstanding hedge contracts totaled $24.8 million compared to $18.2 million at December 31, 1994.\nGross margin was 27.3% in 1995 as compared to 26.6% in 1994. The increase in international sales, which generally carry higher margins, contributed to this improvement as did the favorable exchange rates. The direct bond copper start-up costs and a shift in the remaining frame lid assembly business to smaller and costlier pieces offset a portion of this increase. Certain manufacturing expenses, including maintenance at the Elmore, Ohio facility, were higher in 1995 than 1994. Commercial applications of beryllium, particularly those products containing AlBeMet(R), also have lower margins than traditional defense applications, although restructuring efforts have reduced certain overhead costs. The pass-through effect of higher commodity costs in beryllium alloy sales reduced the margin percent while having no bearing on the actual margin measured in dollars.\nSelling, administrative and general expenses were $62.7 million (17.0% of sales) in 1995 compared to $55.5 million (16.0% of sales) in 1994. Most expense categories were higher. Causes of the increases include the alloy products re-design effort and start-up costs associated with the Singapore subsidiary established to provide marketing support in South Asia. Portions of these expenses should be lower in future periods. Distribution and other sales-related expenses grew due to higher volumes of beryllium alloy products. The exchange rate effect on the international operations' expenses was also unfavorable.\nResearch and development (R&D) expenses were $7.8 million in 1995 compared to $8.8 million in 1994. The decrease was due to focusing beryllium products' research efforts on selected key applications. R&D expenses supporting all other products either increased or were flat with the prior year. The R&D efforts for new process and product development are coordinated with the Company's overall marketing strategies and growth plans.\nOther-net expense was $1.3 million in 1995 and $2.6 million in 1994. This category included such expenses as amortization of intangible assets and other non-operating items. The decrease in net expense was due, in part, to an increase in foreign currency exchange gains in 1995.\nInterest expense fell to $1.7 million in 1995 from $2.1 million in 1994 due to a lower average level of debt outstanding and an increase in capitalized interest associated with active capital expenditure projects.\nIncome before income taxes rose to $27.4 million in 1995 from $23.0 million in 1994. Higher sales and the resulting gross margin, along with a favorable foreign currency effect, combined to improve earnings. This improvement was partially offset by the increase in selling, general and administrative expenses.\nIn 1995, an effective tax rate of 24.6% of pre-tax earnings was employed compared to 19.4% of pre-tax earnings in 1994. Higher domestic and foreign pre-tax earnings account for the increase. The 1995 effective rate is still well below the statutory rate as detailed in Note H to the Consolidated Financial Statements.\nComparative earnings per share were $1.26 in 1995 and $1.14 in 1994.\n1994 to 1993 Comparison\nWorldwide sales in 1994 were $346 million compared to $295 million in 1993. The product lines of beryllium alloys, specialty metal systems and precious metal products achieved\nsignificant sales increases in 1994. Sales also increased in the ceramics product line while beryllium product line sales had a significant reduction in 1994 as compared to 1993.\nThe significant sales growth in beryllium alloys was achieved in both domestic and international markets. The principal markets driving the increase were automotive electronics, computers, telecommunications and appliances. Most beryllium alloy products experienced gains in 1994 as compared to 1993. Beryllium alloys were supported by a strong U.S. economy, continued economic growth in Asia and improving conditions in Europe. While the favorable economic background was a plus, the key to the added volume was a focused marketing effort. This effort was a combination of the marketing, sales, technical, quality and operating groups working as a team to provide quality, cost-competitive products on a timely basis. This was best seen in the expanding use of the Company's Alloy 174 strip in automotive electronics on a growing list of car platforms and global demand for the Company's products in undersea cable components. Also, in the steel industry, Phase 3HP Mold Plate underwent field trials at two slab casters during 1994 with performance results exceeding expectations in all respects.\nBeryllium sales were lower due to completion of the Defense Logistics Agency (DLA) supply contract and reduced AlBeMet(R) sales due to the end of an application at a computer disk drive manufacturer. Although overall defense spending is at a reduced level, this is still the base business to support the beryllium product line in the near term.\nCeramic sales increased in 1994 as compared to 1993. The increase was principally in the U.S. automotive and worldwide telecommunications industries, which have more than offset declining defense applications.\nSpecialty metal systems saw major gains in 1994 as compared to 1993. During 1994, this product line was able to maintain the momentum of programs initiated in prior years. The additional sales resulted primarily from a combination of successfully executing marketing strategies, enlarging market share and new product applications. The improved economy also contributed to growth.\nSales of precious metal products also increased significantly in 1994 over 1993. Continued high demand and increased market share for frame lid assemblies from semiconductor manufacturers, along with increasing vapor deposition target sales, accounted for most of the improved volume. A substantial portion of the increase came from frame lid assembly sales in Asia through the Singapore facility. To further enhance this product line, the Company purchased the assets of Hydrostatics Inc., a small manufacturer of precious metal ultra-fine wire produced using an innovative technology in October 1994. This product fills an identified need to support markets in the semiconductor and hybrid microelectronics industries.\nTotal international sales were $115 million in 1994 and $86 million in 1993. Sales from foreign operations were $84 million in 1994 compared to $51 million in 1993, while direct exports totaled $31 million in 1994 and $35 million in 1993. The 1994 increase was primarily from beryllium alloys and the previously mentioned frame lid assemblies fabricated in Singapore. This increase occurred even though delivery of disk drive components ceased in 1994. Although much of the beryllium alloy sales increase was in Europe and Asia, growth was also seen in other parts of the world.\nGross margin (sales less cost of sales) was 26.6% in 1994 and 22.9% in 1993. In 1994, a provision of $2 million was reserved for downsizing the Fremont, California facility and a provision of $0.6 million was made to transfer direct bond copper production from the Syracuse, New York facility to the Newburyport, Massachusetts plant. Without these charges, gross margin would have been 27.2%. Higher sales and production volumes of beryllium alloys account for much of the improvement. The beryllium alloy product line experienced lower unit costs from the higher throughput and benefited from manufacturing improvements, especially in strip products. In the beryllium product line, margins recovered in 1994 from 1993. However, the major reason for improvement in the beryllium product line was that 1994 did not experience the negative impact of manufacturing problems with the AlBeMet(R) disk drive component that occurred in 1993.\nSelling, administrative and general expenses in 1994 were $55.5 million (16.0% of sales) compared to $47.8 million (16.2% of sales) in 1993. The increase was across all expense categories and includes an increased accrual for incentive compensation. A portion of the increase in administrative costs relate to an alloy business process redesign effort. A group of employees and consultants have been charged with reviewing and analyzing specific activities in the Company to find opportunities for improvement.\nResearch and development (R&D) expenses of $8.8 million in 1994 exceeded the $7.1 million spent in 1993 by more than 20%. The addition was primarily in the beryllium and ceramic product lines where efforts centered on new product development. The beryllium alloy product line also saw an increase as efforts were directed at both product development and process technology enhancements.\nInterest expense was $2.1 million in 1994 and $3.0 million in 1993. All amounts are net of interest capitalized on active construction and mine development projects. Lower average debt reduced interest costs in 1994.\nOther-net expense was $2.6 million in 1994 and $2.2 million in 1993. Included in both years were the postretirement benefit costs pursuant to Statement of Financial Accounting Standard (FAS) 106 for a divested operation. In 1993, the Company made an adjustment to the FAS 106 demographic assumptions for the divested operation, which resulted in a reduction of the liability and increased income by $1.3 million. Concurrently, the carrying value of a building from the divested operation was reduced by $0.9 million.\nIncome before income taxes in 1994 of $23.0 million was significantly higher than the 1993 pre-tax income of $7.7 million. Higher sales volume and related gross margin improvements account for the increase. The increased selling, general and administrative expense offsets some of the gains in gross margin.\nThe effective tax rate employed for 1994 was 19.4% of pre-tax income as compared to 16.2% of pre-tax income in 1993. The increase in pre-tax income accounts for the higher rate. The effective rate was significantly below statutory rates due to relatively fixed tax credits and allowances as shown in Note H to the Consolidated Financial Statements.\nComparative earnings per share were $1.14 in 1994 and $0.40 in 1993.\nFINANCIAL POSITION CAPITAL RESOURCES AND LIQUIDITY\nCash flow from operating activities totaled $39.6 million in 1995. Cash balances increased $9.1 million and total debt increased $0.6 million. Accounts receivable were essentially unchanged from year-end 1994. FIFO inventories increased $3.4 million, primarily due to higher copper and nickel costs and an increase in international inventories corresponding to higher sales. The LIFO reserve, however, increased $4.3 million resulting in a net decrease of $0.9 million in the LIFO inventory value.\nCapital expenditures for property, plant and equipment amounted to $24.2 million in 1995. Major expenditures included a new rod mill for the Elmore, Ohio facility that is scheduled to be completed in mid-1996 and a plating line and a stretch bend leveler for the Lincoln, Rhode Island facility. There were also several environmental remediation projects that were capitalized at the Elmore, Ohio and Delta, Utah plant sites. Management is currently studying plans for modernizing portions of the alloy strip manufacturing process in order to reduce costs, improve quality and add capacity in selected areas. Capital expenditures are anticipated to increase in 1996.\nDuring the fourth quarter 1995, the Company initiated a program to re-purchase up to one million shares of its Common Stock. Approximately 165,000 shares at a cost of $2.8 million were re-purchased under this program as of December 31, 1995, with the balance anticipated to be re-purchased during 1996. The average number of shares outstanding increased in 1995 over 1994 due to an increase in the number of previously issued stock options included in the diluted outstanding share calculation as a result of a higher share price. Dividends paid on outstanding shares totaled $5.5 million.\nShort-term debt at December 31, 1995 was $22.8 million, including $1.5 million of the current portion of long-term debt. The $21.3 million balance is denominated principally in gold and foreign currencies to provide hedges against current assets so denominated. Credit lines amounting to $71.5 million are available for additional borrowing. The domestic and foreign lines are uncommitted, unsecured and renewed annually. The precious metal facility is committed, secured and renewed annually.\nLong-term debt was $17.0 or 8% of total capital at December 31, 1995. Long-term financial resources available to the Company include $60 million of medium-term notes and $50 million under a revolving credit agreement.\nFunds being generated from operations plus the available borrowing capacity are believed adequate to support operating requirements, capital expenditures, remediation projects, dividends and small acquisitions. Excess cash, if any, is invested in money market instruments and other high quality investments.\nCash flow from operating activities in 1994 was $35.2 million. During 1994, cash balances increased $12.7 million while total debt decreased $1.1 million. Capital expenditures totaled $17.2 million and dividends paid were $3.7 million. Long-term debt of $18.5 million was 9% of total capital at December 31, 1994.\nORE RESERVES\nThe Company's reserves of beryllium-bearing bertrandite ore are located in Juab County, Utah. An ongoing drilling program has generally added to proven reserves. Proven reserves are the measured quantities of ore commercially recoverable through the open pit method. Probable reserves are the estimated quantities of ore known to exist, principally at greater depths, but prospects for commercial recovery are indeterminable. Ore dilution that occurs during mining approximates 7%. About 87% of beryllium in ore is recovered in the extraction process. The Company augments its proven reserves of bertrandite ore through the purchase of imported beryl ore (approximately 4% beryllium) which is also processed at the Utah extraction plant.\nINFLATION AND CHANGING PRICES\nThe prices of major raw materials, such as copper, nickel and gold, purchased by the Company increased during 1995. Such changes in costs are generally reflected in selling price adjustments. The prices of labor and other factors of production generally increase with inflation. Additions to capacity, while more expensive over time, usually result in greater productivity or improved yields. However, market factors, alternative materials and competitive pricing have affected the Company's ability to offset wage and benefit increases. The Company employs the last-in, first-out (LIFO) inventory valuation method domestically to more closely match current costs with revenues.\nENVIRONMENTAL MATTERS\nAs indicated in Note K to the Consolidated Financial Statements, the Company maintains an active program of environmental compliance. For projects involving remediation, estimates of the probable costs are made and the Company has set aside a reserve of $3.3 million at December 31, 1995 ($3.8 million at December 31, 1994). This reserve covers existing and currently foreseen projects.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe report of independent auditors and the following consolidated financial statements of the Company included in the annual report to shareholders for the year ended December 31, 1995 are incorporated herein by reference:\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.\nReport of Independent Auditors.\nQuarterly Data on page 16 of the annual report to shareholders for the years ended December 31, 1995 and December 31, 1994 is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information under Election of Directors on pages 2 through 5 of the Proxy Statement dated March 18, 1996 is incorporated herein by reference. Information with respect to Executive Officers of the Company is set forth earlier on pages 10 and 11 of this Form 10-K annual report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information under Executive Officer Compensation on pages 8 through 13 of the Proxy Statement dated March 18, 1996 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under Common Stock Ownership of Certain Beneficial Owners, Directors and Management on pages 6 and 7 of the Proxy Statement dated March 18, 1996 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under Related Party Transactions on page 17 of the Proxy Statement dated March 18, 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 and Supplemental Information\nIncluded in Part II of this Form 10-K annual report by reference to the annual report to shareholders for the year ended December 31, 1995 are the following consolidated financial statements:\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.\nReport of Independent Auditors.\n(a) 2. Financial Statement Schedules\nThe following consolidated financial information for the years 1995, 1994 and 1993 is submitted herewith:\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(a) 3. Exhibits\n(3a) Articles of Incorporation of the Company as amended February 28, 1989 (filed as Exhibit 3a to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(3b) Regulations of the Company as amended April 27, 1993 (filed as Exhibit 3b to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(4a) Credit Agreement dated as of December 13, 1994 between the Company and National City Bank acting for itself and as agent for three other banking institutions (filed as Exhibit 4a to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(4b) Rights Agreement between the Company and Society National Bank (formerly Ameritrust Company National Association) as amended February 28, 1989 (filed as Exhibit 4b to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(4c) Issuing and Paying Agency Agreement dated as of February 1, 1990, including a specimen form of a medium term note issued thereunder, between the Company and First Trust N.A. (formerly with Morgan Guaranty Trust Company of New York) (filed as Exhibit 4c to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(4d) Pursuant to Regulation S-K, Item 601 (b)(4), the Company agrees to furnish to the Commission, upon its request, a copy of the instruments defining the rights of holders of long-term debt of the Company that are not being filed with this report.\n(10a)* Employment Agreement entered into by the Company and Mr. Gordon D. Harnett on March 20, 1991.\n(10b)* Form of Employment Agreement entered into by the Company and Messrs. Brophy, Hanes, Harlan, Rozek and Sandor on February 20, 1989 (filed as Exhibit 10b to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n* Reflects management contract or other compensatory arrangement required to be filed as an Exhibit pursuant to Item 14(c) of this Report.\n(10c)* Form of Amendment to the Employment Agreement (dated February 20, 1989) entered into by the Company and Messrs. Brophy, Hanes, Harlan, Rozek and Sandor dated February 28, 1991.\n(10d)* Form of Employment Agreement entered into by the Company and Mr. Daniel A. Skoch on January 28, 1992, Mr. Stephen Freeman dated August 3, 1993, and Mr. Carl Cramer dated December 6, 1994 (filed as Exhibit 10d to the Company's Form 10-K Annual Report for the year ended December 31, 1991), incorporated herein by reference.\n(10e)* Form of Trust Agreement between the Company and Key Trust Company of Ohio, N.A. (formerly Ameritrust Company National Association) on behalf of Messrs. Brophy, Hanes, Harlan, Rozek and Sandor dated February 20, 1989, Mr. Harnett dated March 20, 1991 and Mr. Skoch dated January 28, 1992, Mr. Freeman dated August 3, 1993, and Mr. Cramer dated December 6, 1994 (filed as Exhibit 10e to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(10f) Form of Indemnification Agreement entered into by the Company and Mr. G. D. Harnett on March 20, 1991 (filed as Exhibit 10f to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(10g) Form of Indemnification Agreement entered into by the Company and Messrs. J. H. Brophy, A. J. Sandor, C. B. Harlan, H. D. Hanes, and R. H. Rozek on June 27, 1989, Mr. D. A. Skoch on January 28, 1992, Mr. S. Freeman dated August 3, 1993, Mr. C. Cramer on December 6, 1994 and Messrs. M. D. Anderson, A. T. Lubrano, S. A. Moyer and J. J. Paschall on January 19, 1996 (filed as Exhibit 10g to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(10h) Form of Indemnification Agreement entered into by the Company and Messrs. C. F. Brush III, F. B. Carr, W. P. Madar, G. C. McDonough, R. M. McInnes, H. G.Piper and J. Sherwin Jr. on June 27, 1989, Mr. A. C. Bersticker on April 27, 1993 and Mr. D. L. Burner on May 2, 1995 (filed as Exhibit 10h to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated here by reference.\n* Reflects management contract or other compensatory arrangement required to be filed as an Exhibit pursuant to Item 14(c) of this Report.\n(10i)* Directors' Retirement Plan as amended January 26, 1993 (filed as Exhibit 10i to the Company's Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.\n(10j)* Deferred Compensation Plan for Nonemployee Directors effective January 1, 1992 (filed as Exhibit I to the Company's Proxy Statement dated March 6, 1992, Commission File No. 1-7006), incorporated herein by reference.\n(10k)* Form of Trust Agreement between the Company and National City Bank dated January 1, 1992 on behalf of Nonemployee Directors of the Company (filed as Exhibit 10k to the Company's Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.\n(10l)* Incentive Compensation Plan adopted December 16, 1991, effective January 1, 1992 (filed as Exhibit 10l to the Company's Form 10-K Annual Report for the year ended December 31, 1991), incorporated herein by reference.\n(10m)* Supplemental Retirement Plan as amended and restated December 1, 1992 (filed as Exhibit 10n to the Company's Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.\n(10n)* Amendment Number 3, adopted February 8, 1995, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992 (filed as Exhibit 10o to the Company's Form 10-K Annual Report for the year ended December 31, 1994), incorporated herein by reference.\n(10o)* Amendment Number 2, adopted January 1, 1996, to Supplemental Retirement Benefit Plan as amended and restated December 1, 1992.\n(10p)* Form of Trust Agreement between the Company and Key Trust Company of Ohio, N.A. (formerly Society National Bank) dated January 8, 1993 pursuant to the December 1, 1992 amended Supplemental Retirement Benefit Plan (filed as Exhibit 10p to the Company's Form 10-K Annual Report for the year ended December 31, 1992), incorporated herein by reference.\n* Reflects management contract or other compensatory arrangement required to be filed as an Exhibit pursuant to Item 14(c) of this Report.\n(10q)* 1979 Stock Option Plan, as amended pursuant to approval of shareholders on April 21, 1982 (filed as Exhibit 15A to Post-Effective Amendment No. 3 to Registration Statement No. 2-64080), incorporated herein by reference.\n(10r)* 1984 Stock Option Plan as amended by the Board of Directors on April 18, 1984 and February 24, 1987 (filed as Exhibit 4.4 to Registration Statement No. 33-28605), incorporated herein by reference.\n(10s)* 1989 Stock Option Plan (filed as Exhibit 4.5 to Registration Statement No. 33-28605), incorporated herein by reference.\n(10t)* 1990 Stock Option Plan for Nonemployee Directors (filed as Exhibit 4.6 to Registration Statement No. 33-35979), incorporated herein by reference.\n(10u)* 1995 Stock Incentive Plan (filed as Exhibit A to the Company's Proxy Statement dated March 13, 1995, Commission File No. 1-7006), incorporated herein by reference.\n(11) Statement re: calculation of per share earnings for the years ended December 31, 1995, 1994 and 1993.\n(13) Portions of the Annual Report to shareholders for the year ended December 31, 1995.\n(21) Subsidiaries of the registrant.\n(23) Consent of Ernst & Young LLP.\n(24) Power of Attorney.\n(27) Financial Data Schedule.\n(99) Form 11-K Annual Report for the Brush Wellman Inc. Savings and Investment Plan for the year ended December 31, 1995.\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed during the fourth quarter of the year ended December 31, 1995.\n* Reflects management contract or other compensatory arrangement required to be filed as an Exhibit pursuant to Item 14(c) of this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. March 21, 1996\nBRUSH WELLMAN INC.\nBy: \/s\/ Gordon D. Harnett By: \/s\/ Carl Cramer -------------------- ----------------- Gordon D. Harnett Carl Cramer Chairman of the Board, Vice President and President and Chief Executive Officer 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*The undersigned, by signing his name hereto, does sign and execute this report on behalf of each of the above-named officers and directors of Brush Wellman Inc., pursuant to Powers of Attorney executed by each such officer and director filed with the Securities and Exchange Commission.\nBy: \/s\/ Carl Cramer -------------- Carl Cramer Attorney-in-Fact March 21, 1996\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nBRUSH WELLMAN INC. AND SUBSIDIARIES\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNote A - Bad debts written off.\nNote B - The Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. Under Statement 109, a deferred tax assets of $1,540,000 was recorded for net operating loss carryforwards. Since it was unknown as to whether the deferred tax assets would be utilized, a valuation allowance was recorded to offset the asset.\nNote C - Inventory written off.\nNote D - Net operating loss carryforwards utilized or expired.","section_15":""}
{"filename":"50957_1995.txt","cik":"50957","year":"1995","section_1":"Item 1. Business - ---------------- BUSINESS\nGENERAL\nINTERCO INCORPORATED, which is to be renamed Furniture Brands International, Inc., is the largest manufacturer of residential furniture in the United States. The Company markets its products through its three operating subsidiaries, Broyhill Furniture Industries, Inc., The Lane Company Incorporated and Thomasville Furniture Industries, Inc. As used herein, unless the context indicates otherwise, (i) the \"Company\" refers to INTERCO INCORPORATED and its subsidiaries, (ii) \"Broyhill\" refers to Broyhill Furniture Industries, Inc., (iii) \"Lane\" refers to The Lane Company Incorporated and its subsidiaries, (iv) \"Thomasville\" refers to Thomasville Furniture Industries, Inc. and (v) \"Action Industries\" refers to Action Industries, Inc., a subsidiary of Lane.\nOn December 29, 1995, the Company completed the acquisition of Thomasville from Armstrong World Industries, Inc. for approximately $339 million, consisting of $331 million in cash and $8 million in assumed indebtedness. The cash portion of the acquisition of Thomasville was financed through funds obtained under a secured credit agreement (the \"Secured Credit Agreement\") and an amended receivables securitization facility (the \"Receivables Securitization Facility\").\nPRODUCTS\nThe Company manufactures and distributes (i) case goods, consisting of bedroom, dining room and living room furniture, (ii) occasional furniture, consisting of wood tables and accent items and freestanding home entertainment centers and (iii) upholstered products, consisting of sofas, loveseats, sectionals, chairs and (iv) recliners, motion furniture and sleep sofas. The Company's brand name positioning by price and product category are shown below.\n- -------- (1) Promotional and RTA furniture is currently sold by Thomasville under the Armstrong name. See \"Thomasville Furniture Industries\" below.\nBROYHILL FURNITURE INDUSTRIES\nBroyhill produces collections of medium price bedroom, dining room, upholstered and occasional furniture aimed at middle-income consumers. Broyhill's wood furniture offerings consist primarily of bedroom, dining room and living room furniture, occasional tables, accent items and free standing home entertainment centers. Upholstered products include sofas, sleep sofas, loveseats, sectionals and chairs, all offered in a variety of fabrics and leathers. Broyhill's residential furniture divisions produce a wide range of furnishings in colonial, country, traditional and contemporary styles.\nThe widely recognized Broyhill trademarks include Broyhill, Broyhill Premier and Highland House. The flagship Broyhill product line concentrates on bedroom, dining room, upholstered and occasional furniture designed for the \"good\" and \"better\" price categories. The Broyhill Premier product line enjoys an excellent reputation for classically styled, complete furniture collections in the \"better\" price category. Highland House also manufactures upholstered products in the \"better\" price category.\nTHE LANE COMPANY\nLane manufactures and markets a broad range of high quality furniture targeting the \"better,\" \"best\" and \"premium\" price categories. Lane targets niche markets with its seven operating divisions, which participate in such segments of the residential furniture market as 19th century reproductions, motion furniture, wicker and rattan, cedar chests and finely tailored upholstered furniture. Using its recently installed, state-of-the-art finishing system, Lane produces quality high sheen and enhanced grain finishes at attractive prices.\nThe Lane Division of Lane manufactures and sells cedar chests, occasional living room tables, bedroom and dining room furniture, wall systems, desks, console tables and mirrors and other occasional wood pieces. The Lane Division has teamed up with widely recognized designers such as Dakota Jackson, as well as design institutions such as the American Museum of Folk Art in New York, to design and market furniture collections. The Lane Division furniture is sold in the \"better\" and \"best\" price categories.\nAction Industries, a subsidiary of Lane, manufactures and markets reclining chairs and motion furniture in the \"good,\" \"better\" and \"best\" price categories under the Action by Lane brand name. Motion furniture consists of sofas and loveseats with recliner-style moving parts and comfort features, wall saver recliners, pad-over chaise recliners, and motion sectionals. Lane's Royal Development Company designs and manufactures the mechanisms used in Action Industries' reclining furniture products.\nThe Hickory Chair division manufactures and markets traditional styles of upholstered furniture, dining room chairs and occasional tables in the \"best\" and \"premium\" price categories. The Hickory Chair division has been crafting fine reproductions of 18th century furniture for over 80 years. For example, Hickory Chair offers the James River collection which features reproductions of fine furnishings from Virginia plantations, and more recently the new Mount Vernon collection, which features reproductions from George Washington's home.\nThe Pearson division has been manufacturing and selling contemporary and traditional styles of finely tailored upholstered furniture including sofas, love seats, chairs and ottomans for over 50 years. Pearson manufactures the Viceroy collection, which features fine furnishings from the award winning designer Victoria Moreland. Pearson furniture sells in the \"premium\" price category and is distributed to high end furniture stores and interior designers.\nThe Lane Upholstery division includes two product lines, one of which is composed of contemporary and modern upholstered furniture and metal and glass occasional and dining tables, and the other of which is composed of traditional and contemporary upholstered furniture, primarily sofas, love seats, chairs and ottomans.\nThe Venture Furniture division manufactures and markets moderately priced wicker, rattan and bamboo upholstered furniture, tables, occasional wood pieces and other home furnishings accessories. The division manufactures a line of outdoor and patio furniture featuring fast drying upholstered cushions under the name WeatherMaster, which has developed significant consumer acceptance.\nHickory Business Furniture manufactures and sells a line of office furniture, including chairs, tables, conference tables, desks and credenzas, in the upper- medium price range.\nTHOMASVILLE FURNITURE INDUSTRIES\nThomasville manufactures and markets wood furniture, upholstered products and RTA\/promotional furniture. Thomasville markets its products primarily under the Thomasville brand name. Thomasville offers an assortment of upholstery under the Thomasville brand name that targets the \"best\" and \"premium\" price categories. Upholstery is primarily marketed in three major styles: Traditional, American Traditional\/Country and Casual Contemporary. Upholstery style is determined by both frame style and fabric or leather selection. Thomasville's frame assortment allows the consumer to select from over 90 different styles within the general style categories, and as much as 45% of the Thomasville fabric offering changes in a 12 month period, insuring that the latest styles are available.\nThomasville's RTA\/Promotional division offers assembled bedroom sets, bookcases and home entertainment centers as well as RTA furniture consisting of home entertainment centers, audio cabinets, television\/VCR carts, room dividers, bookcases, bedroom and kitchen\/utility furniture, microwave carts, computer desks and storage armoires. These products are primarily constructed from fibreboard or particleboard and are printed or covered with laminated paper in a variety of finishes and colors.\nThomasville's RTA\/Promotional division markets products under the Armstrong brand name to a variety of retailers for sale to consumer end-users and certain contract customers. The Company has the right to continue to use the Armstrong name for 18 months after the closing of the Thomasville acquisition. Management does not believe that the loss of the Armstrong name will have a material adverse effect on the Company's sales of RTA and promotional furniture.\nDISTRIBUTION\nThe Company's strategy of targeting diverse distribution channels such as furniture centers, independent dealers, national and local chain stores, department stores, specialty stores and decorator showrooms is supported by dedicated sales forces covering each of these distribution channels. The Company is also exploring opportunities to expand international sales and to distribute through non-traditional channels such as electronic retailers, wholesale clubs, catalog retailers and television home shopping.\nThe Company's breadth of product and national scope of distribution enable it to service effectively national retailers such as J.C. Penney, Sears and Levitz and key regional retailers such as Haverty's and Heilig-Meyers. These large retailers are commanding an increasing presence in the consolidating furniture retailing industry and management believes that the Company is better positioned than its competitors to meet their needs. Additionally, the consolidation of the retail furniture industry has made access to distribution channels an important competitive advantage for manufacturers. The Company has developed dedicated distribution channels by expanding its gallery program and the network of independently-owned dedicated retail locations, such as Thomasville Home Furnishings stores. The Company distributes its products through a diverse network of independently-owned retail locations, which includes approximately 80 free-standing stores, more than 680 galleries and more than 410 furniture centers.\nBroyhill, Lane and Thomasville have all developed gallery programs with dedicated dealers displaying furniture in complete room ensembles. These retailers employ a consistent showcase gallery concept wherein products are displayed in complete and fully accessorized room settings instead of as individual pieces. This presentation format encourages consumers to purchase an entire room of furniture instead of individual pieces from different manufacturers. As a result, galleries tend to have higher sales per square foot as well as faster inventory turns than non-gallery locations. The Company recognizes the importance of the gallery network to its long-term success, and has developed and maintains close relationships with its dealers. The Company offers substantial services to retailers to support their marketing efforts, including coordinated national advertising, merchandising and display programs and extensive dealer training.\nThe Thomasville Home Furnishings stores are free-standing retail locations that exclusively feature Thomasville furniture. The Company believes distributing its products through dedicated free-standing stores strengthens brand awareness, provides well-informed and focused sales personnel and encourages the purchase of multiple items per visit. Management is currently evaluating similar opportunities to market Lane and Broyhill products.\nShowrooms for the national furniture market are located in High Point, North Carolina and for regional markets in Dallas, Texas, Atlanta, Georgia, Chicago, Illinois, and San Francisco, California.\nBROYHILL FURNITURE INDUSTRIES\nBroyhill distributes its products through an extensive distribution network of more than 6,200 independently-owned retail locations. One of Broyhill's principal distribution channels is the Broyhill Showcase Gallery Program. This program, developed over the past twelve years, involves more than 330 participating dealer locations. Each dealer in the Broyhill Showcase Gallery Program owns the gallery and the Broyhill furniture inventory. The program incorporates a core merchandise program, advertising material support, in-store merchandising events and educational opportunities for the retail store sales and management personnel. The average Broyhill Showcase Gallery consists of 7,500 square feet of display space within a 30,000 square foot store. Furniture is displayed in complete and fully accessorized room settings instead of as individual pieces.\nFor the retailer that is currently not a participant in the gallery program, Broyhill offers the Independent Dealer Program. This concept, initiated in 1987, is designed to strengthen Broyhill's relationship with these retailers by assisting them in overcoming some of the significant difficulties in running an independent furniture business. The Company seeks to develop these relationships so that these retailers may become participants in the Broyhill Showcase Gallery Program. Participating retailers in the Independent Dealer Program commit to a minimum pre-selected lineup of Broyhill merchandise and, in return, receive a detailed, step-by-step, year-round advertising and merchandising plan. The program includes four major sales events per year, monthly promotional themes and professionally prepared advertising and promotional materials at nominal cost in order to help increase consumer recognition on the local level. As part of the Independent Dealer Program, Broyhill offers the Broyhill Furniture Center Program for retailers that have committed at least 2,000 square feet exclusively to Broyhill products. This program includes all of the benefits of the Independent Dealer Program, plus additional marketing, designing and advertising assistance.\nThe Company is currently exploring opportunities to expand its distribution channels for Broyhill through free-standing retail stores similar to the Thomasville Home Furnishings stores. A retailer in Memphis, Tennessee recently opened an independently-owned Broyhill store.\nTHE LANE COMPANY\nLane distributes its products nationally through a well established network of approximately 16,000 retail locations. A diverse distribution network is utilized in keeping with Lane's strategy of supplying customers highly specialized products in selected niche markets. This distribution network primarily consists of independent furniture stores, regional chains such as Haverty's and Art Van, and department store companies such as J.C. Penney, Sears, May Department Stores, Federated Department Stores and Dillard Department Stores. Lane has an established specialty gallery program with more than 200 participating dealers.\nTHOMASVILLE FURNITURE INDUSTRIES\nThomasville products are offered at more than 680 independently-owned retail locations, including more than 410 Thomasville Galleries, approximately 80 Thomasville Home Furnishings stores and more than 180 selected furniture chains and retailers. The Thomasville Gallery concept was initiated in 1983. Each Thomasville Gallery has an average 7,500 square feet of retail space specifically dedicated to the display, promotion and sale of Thomasville products. Management believes that the gallery concept results in increased sales of Thomasville products by encouraging the consumer to purchase a complete collection as opposed to individual pieces from different manufacturers. The first Thomasville Home Furnishings store opened in 1988. The typical Thomasville Home Furnishings store is a 15,000 square foot independently-owned store offering a broad range of Thomasville products, presented in a home-like setting by specially trained salespersons. Thomasville's management believes that the gallery and dedicated store programs have helped create one of the most efficient distribution systems in the industry.\nThomasville's RTA\/Promotional division sells promotional and RTA furniture to a variety of retailers for sale to consumer end-users and certain contract customers. Promotional furniture is sold to retail chains such as Wal-Mart and Levitz, as well as independent furniture stores. Promotional furniture is also sold in the hospitality and health care markets of Thomasville's contract business. RTA customers include national chains such as Wal-Mart and Ames, catalog showrooms, discount mass merchandisers, warehouse clubs and home furnishings retailers.\nMARKETING AND ADVERTISING\nThe Company continues to strengthen its valuable brand names through ongoing investment in innovative consumer advertising. The Company is one of the largest advertisers in the residential furniture industry.\nAdvertising is used to increase consumer awareness of its brand names and is targeted to specific customer segments through leading shelter magazines. Each operating company uses focused advertising in major markets to create buying urgency around specific sale and location information, enabling retailers to be listed jointly in advertisements for maximum advertising efficiency and shared costs. The Company seeks to increase consumer buying and strengthen relationships with retailers through cooperative advertising and selective promotional programs. The Company focuses its marketing efforts on prime potential customers utilizing information from databases and from callers to each operating company's toll-free telephone number. Each of the operating companies also advertises selectively on television in conjunction with dealers, and Action and Thomasville also use television advertising independently.\nBROYHILL FURNITURE INDUSTRIES\nBroyhill's advertising programs focus on translating its strong consumer awareness into increased sales.\nBroyhill's current marketing strategy features a national print advertising program in addition to traditional promotional programs such as furniture \"giveaways\" on television gameshows and dealer-based promotions such as product mailings and brochures. The national print advertising program, which consists of multi-page lay-outs, is designed to appeal to the consumer's desire for decorating assistance and increased confidence in making the decision to purchase a big ticket product such as furniture. These advertisements are run in publications such as Good Housekeeping and Country Living which appeal to Broyhill's customer base. Game show promotions, a long-standing Broyhill tradition, include popular programs such as Wheel of Fortune and The Price is Right.\nTHE LANE COMPANY\nLane became a well-known brand name through Lane's initial use in the 1920s of creative advertising to promote its cedar chests. Since then, Lane has continued to use advertising programs to generate consumer awareness of the Lane brand name. Through Lane's in-house advertising agency, recent programs have been developed for print campaigns in national publications such as Country Home, Country Living, House Beautiful and Architectural Digest. Action Industries is engaged in selective national and regional television advertising.\nThe Lane Keepsake program has made the Lane cedar chest one of the best-known furniture products in the industry and contributes to the high level of consumer recognition. The program enables the 1,100 participating dealers to establish early personal contact with a large number of women who are about to enter the bridal market as potential buyers of home furnishings. Information regarding a graduation gift of a miniature Lane cedar chest, available at the local participating furniture store, is sent to the parents of graduating high school women. This Keepsake program is believed to be instrumental in building consumer recognition and promoting the Lane brand name.\nLane markets its products through the use of well-known designers and affiliation with institutions. For example, Lane has teamed up with widely recognized designers such as Mark Hampton and Dakota Jackson, as well as design institutions such as the American Museum of Folk Art in New York, to design and market furniture collections.\nTHOMASVILLE FURNITURE INDUSTRIES\nThomasville's current advertising campaign, featured in household magazines and periodic television commercials, emphasizes single dramatic, high quality wood and upholstery pieces to support the emphasis on higher quality. Thomasville invests in image advertising by placing advertisements in up-front positions in national household magazines, such as Better Homes and Gardens, Good Housekeeping and House Beautiful. Thomasville also utilizes focused advertising in major markets to create buying urgency around specific sale and location information, enabling retailers to be listed jointly in advertisements for maximum advertising efficiency and shared costs.\nTo reach additional customers, Thomasville uses promotional discounts and dealer cooperative advertising support. Thomasville has two major retailer promotions, the Winter and Summer Thomasville Sales, which coincide with traditional industry sale periods and are supported by eight page color circulars and full page advertisements in USA Today. Typically, six to eight million circulars are mailed by retailers during these periods to draw customers to Thomasville Galleries and Thomasville Home Furnishings stores.\nMANUFACTURING\nBroyhill operates 16 finished case goods and upholstery production and warehouse facilities totalling over 4.9 million square feet of manufacturing and warehouse space. All finished goods plants are located in North Carolina. Broyhill pioneered the use of mass production techniques in the furniture industry and continues to be a leader in this area by utilizing longer production runs to achieve economies of scale. Short set-up times and long production runs have allowed for a reduction of both manufacturing cost and overhead over the last five years. Broyhill recently completed construction of a state-of-the-art particleboard manufacturing facility that provides a captive, cost-effective source of high quality particleboard, a primary material used in the Company's products.\nLane operates 15 finished case goods and upholstery production and warehouse facilities in Virginia, North Carolina and Mississippi. Since the late 1980s, significant capital expenditures have been made to acquire technologically advanced manufacturing equipment which has increased factory productivity. In 1993, Lane completed a new 396,000 square foot plant, located in Mississippi, which manufactures motion furniture as well as a new sleep sofa product line. This facility added approximately $100 million of annual production capacity. Lane recently installed a state-of-the-art flat-line finishing system that produces quality high sheen and enhanced grain finishes at attractive prices.\nThomasville manufactures or assembles its products at 16 finished case goods and upholstery production and warehouse facilities located in North Carolina, Virginia, Tennessee and Mississippi, close to sources of raw materials and skilled craftsmen. Each plant is specialized, manufacturing limited product categories, allowing longer, more efficient production runs and economies of scale. During recent years, Thomasville has focused on reducing manufacturing costs by closing less efficient plants, reducing labor costs and establishing process improvement programs.\nThe manufacturing process for Thomasville's RTA\/promotional product line is highly automated. Large fiberboard and particleboard sheets are machine- finished in long production runs, then stored and held for assembly using highly automated assembly lines. Completed goods are stored in an automated warehouse to provide quicker delivery to customers. All plant operations use automated manufacturing processes and inventory management systems. Ninety percent of Thomasville's RTA\/promotional products are shipped within 14 days of production.\nRAW MATERIALS AND SUPPLIERS\nThe raw materials used by the Company in manufacturing its products are lumber, veneers, plywood, fiberboard, particleboard, paper, hardware, adhesives, finishing materials, glass, mirrored glass, fabrics, leathers and upholstered filling material (such as synthetic fibers, foam padding and polyurethane cushioning). The various types of wood used in the Company's products include cherry, oak, maple, pine and pecan, which are purchased domestically, and mahogany, which is purchased abroad. Fabrics, leathers and other raw materials are purchased both domestically and abroad. Management believes that its supply sources for those materials are adequate.\nThe Company has no long-term supply contracts and has experienced no significant problems in supplying its operations. Although the Company has strategically selected suppliers of raw materials, the Company believes that there are a number of other sources available, contributing to its ability to obtain competitive pricing for raw materials. Raw materials prices fluctuate over time depending upon factors such as supply, demand and weather. Increases in prices may have a short-term impact on the Company's margins for its products.\nThe majority of supplies for RTA and promotional products is purchased domestically, although paper and certain hardware is purchased abroad. Management believes, however, that its proximity to and relationships with suppliers are advantageous for the sourcing of such materials. In addition, by combining the purchase of various raw materials (such as foam, cartons, springs and fabric) and services, Lane and Broyhill have been able to realize cost savings. Management believes that the Company's position as the largest residential furniture manufacturer will create opportunities for additional cost savings.\nENVIRONMENTAL MATTERS\nThe Company is subject to a wide-range of federal, state and local laws and regulations relating to protection of the environment, worker health and safety and the emission, discharge, storage, treatment and disposal of hazardous materials. These laws include the Clean Air Act of 1970, as amended, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act and the Comprehensive Environmental, Response, Compensation and Liability Act (\"Superfund\"). Certain of the Company's operations use glues and coating materials that contain chemicals that are considered hazardous under various environmental laws. Accordingly, management closely monitors the Company's environmental performance at all of its facilities. Management believes that the Company is in substantial compliance with all environmental laws.\nUnder the provisions of the Clean Air Act Amendments of 1990 (the \"CAA\"), in December 1995, the Environmental Protection Agency (the \"EPA\") promulgated air emission standards for the wood furniture industry. These regulations, known as National Emission Standards for Hazardous Air Pollutants (\"NESHAPs\"), govern the levels of emission of certain designated chemicals into the air and will require that the Company reduce emissions of certain volatile organic compounds (\"VOCs\") by November 1997. Management is investigating and evaluating techniques to meet these standards at all facilities to which the NESHAPs standards will apply. While the Company may be required to make capital investments at some of its facilities to ensure compliance, the Company believes that it will meet all applicable requirements in a timely fashion and that the amount of money required to meet the NESHAP requirements will not materially affect its financial condition or its results of operations.\nThe Company has been identified as a potentially responsible party (\"PRP\") at a number of superfund sites. The Company believes that its liability with respect to most of the sites is de minimis, and the Company is entitled to indemnification by others with respect to liability at certain sites. The Company also accrued a reserve for such environmental liabilities in connection with the acquisition of Thomasville. Management believes that any liability as a PRP with regard to the superfund sites will not have a material adverse effect on the financial condition or results of operations of the Company.\nCOMPETITION\nThe furniture manufacturing industry is highly competitive. The Company's products compete with products made by a number of furniture manufacturers, including Masco Corporation, La-Z-Boy Chair Company, Ladd Furniture, Inc., Bassett Furniture Industries, Inc., and Ethan Allen Interiors, Inc., as well as approximately 600 smaller producers. The elements of competition include pricing, styling, quality and marketing.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 20,700 people. None of the Company's employees is represented by a union.\nBACKLOG\nThe combined backlog of the Company's operating companies as of December 31, 1995 aggregated approximately $194 million, compared to approximately $209 million as of December 31, 1994. The backlog calculations for each year have been adjusted to include the backlog for Thomasville. Substantially all of the decrease in backlog is attributable to a change in the Company's method of calculating backlog with regard to certain operations. Management believes that if it had reported its backlog on a consistent basis, the year end backlog would have been substantially the same for each of the years ended December 31, 1994 and 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - -------------------\nThe Company owns or leases the following principal plants, offices and warehouses:\n- ------------------\nSubstantially all of the owned properties listed above are encumbered by a first priority lien and mortgage pursuant to the Secured Credit Agreement. In addition, the Tupelo, Mississippi facility is encumbered by a mortgage and first lien securing industrial revenue bonds.\nThe Company believes its properties are generally well maintained, suitable for its present operations and adequate for current production requirements. Productive capacity and extent of utilization of the Company's facilities are difficult to quantify with certainty because in any one facility maximum capacity and utilization varies periodically depending upon the product that is being manufactured, the degree of automation and the utilization of the labor force in the facility. In this context, the Company estimates that overall its production facilities were effectively utilized during calendar 1995 at moderate to high levels of productive capacity and believes that in general its facilities have the capacity, if necessary, to expand production to meet anticipated product requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\nThe Company is or may become a defendant in a number of pending or threatened legal proceedings in the ordinary course of business. In the opinion of management, the ultimate liability, if any, of the Company from all such proceedings will not have a material adverse effect upon the consolidated financial position or results of operations of the Company and its subsidiaries.\nThe Company is also subject to regulation regarding environmental matters, and is a party to certain actions related thereto. For information regarding environmental matters, see \"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 The Registrant's Common Equity and Related Stockholder - -------------------------------------------------------------------------- Matters - -------\nAs of December 31, 1995, there were approximately 3,000 holders of record of Common Stock.\nShares of the Company's Common Stock are traded on the New York Stock Exchange. The reported high and low sale prices for the Company's Common Stock on the New York Stock Exchange is included in Note 16 to the consolidated financial statements of the Company.\nThe Company has not paid cash dividends on its Common Stock during the two years ended December 31, 1994 and December 31, 1995.\nA discussion of restrictions on the Company's ability to pay cash dividends is included in Note 10 to the consolidated financial statements of the Company.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\n(1) Effective December 31, 1992, the Company changed its fiscal year to end on December 31. The Company's adoption of fresh-start reporting required reporting calendar 1992 results in two 22 week periods.\n(2) In connection with the adoption of fresh-start reporting, property, plant and equipment was adjusted to fair value resulting in an increase of approximately $77,500 as of August 2, 1992.\n(3) Long-term debt (including debt pertaining to discontinued operations) totaling $1,055,132 was reclassified to liabilities subject to compromise as of February 29, 1992.\n(4) Net earnings from continuing operations before gain on insurance settlement, net of income tax expense, and net earnings per common share from continuing operations before gain on insurance settlement, net of income tax expense, were $29,463 and $0.56, respectively.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results - -------------------------------------------------------------------------------- of Operstions - -------------\nMANAGEMENT'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 consolidated financial statements and related notes included elsewhere in this document. In addition management believes that the following four factors have had a significant effect on its recent financial statements.\nAcquisition of Thomasville. During the year ended December 31, 1995, the Company had two primary operating subsidiaries, Broyhill and Lane. On December 29, 1995, the Company acquired Thomasville. The transaction was accounted for as a purchase and, since the acquisition occurred as of the last business day of 1995, has been reflected in the Company's consolidated balance sheet. The Company's results of operations for 1995 do not include any of the operations of Thomasville. The cash portion of the acquisition of Thomasville was financed through funds obtained under the Secured Credit Agreement and the Receivables Securitization Facility.\nRecent Industry Conditions. During 1995, residential furniture manufacturers' results were adversely affected by industry-wide price discounting and promotional activity in response to weaker consumer demand for durable goods. The Company believes that it minimized the impact of these factors on its operations by introducing new products and continued support of its brand names.\n1994 Spin-Off Transactions. In order to focus on its core furniture operations, the Company completed a spin-off of its footwear subsidiaries in 1994. On November 17, 1994, the Company simultaneously refinanced the majority of its outstanding indebtedness and distributed to its stockholders all the stock of its former footwear subsidiaries, Converse Inc. and The Florsheim Shoe Company. Upon completion of this restructuring, the Company retained no ownership interest in or management control of the footwear businesses. Accordingly, the financial results of the footwear businesses have been reflected as discontinued operations for all applicable periods.\n1992 Asset Revaluation (Fresh-Start Reporting). Included in the Company's statement of operations are depreciation and amortization charges related to adjustments of assets and liabilities to fair value made in 1992. These adjustments are a result of the Company's 1992 reorganization and the adoption of AICPA SOP 90-7, \"Financial Reporting by Entities in Reorganization under the Bankruptcy Code\" (commonly referred to as \"fresh-start\" reporting) and are not the result of historical capital expenditures.\nRESULTS OF OPERATIONS\nAs an aid to understanding the Company's results of operations on a comparative basis, the following table has been prepared to set forth certain statements of operations and other data for fiscal 1993, 1994 and 1995. The results for these periods do not include any of the operations of Thomasville.\n- --------\n(1) The Company believes that gross profit provides useful information regarding a company's financial performance. Gross profit should not be considered in isolation or as an alternative to net earnings, an indicator of the Company's operating performance, or an alternative to the Company's cash flow from operating activities as a measure of liquidity. Gross profit has been calculated by subtracting cost of operations and the portion of depreciation associated with cost of goods sold from net sales.\n(2) Net earnings from continuing operations before gain on insurance settlement, net of income tax expense was $29.5 million.\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994\nNet sales for 1995 were $1.07 billion, approximately unchanged from 1994. The Company was able to maintain comparable net sales despite soft industry conditions and weaker consumer demand for durable goods through new product introductions at both Broyhill and Lane and continued support of its brand names.\nCost of operations for 1995 was $760.4 million, compared to $752.5 million for 1994, an increase of 1.0%. The increase in cost of operations as a percentage of net sales from 70.2% in 1994 to 70.8% in 1995, was primarily the result of unfavorable overhead absorption rates reflecting the Company's effort to maintain manufacturing utilization rates at levels necessary to balance inventory with incoming orders.\nSelling, general and administrative expenses decreased to $198.3 million in 1995 from $199.3 million in 1994, a reduction of 0.5%. In 1995, such expenses included $2.7 million non-cash expense related to stock options. As a percentage of net sales, selling, general and administrative expenses were 18.5% in 1995 compared to 18.6% in 1994, reflecting the Company's successful implementation of its ongoing cost reduction programs.\nDepreciation and amortization for 1995 was $36.1 million, compared to $35.8 million in 1994, an increase of 0.9%. The amount of depreciation and amortization attributable to the \"fresh-start\" reporting was $15.9 million and $16.9 million, in 1995 and 1994, respectively.\nInterest expense for 1995 totaled $33.9 million and reflects twelve months of interest expense on the Company's debt structure, which was substantially refinanced as of December 29, 1995. Interest expense for 1995 was not comparable to interest expense for 1994 as a result of the previous refinancing of substantially all of the Company's debt in November 1994.\nOther income, net for 1995 totaled $11.8 million, compared to $1.6 million in 1994. For 1995, other income, consisted of a gain on insurance settlement of $7.9 million pertaining to the November 1994 destruction of a particleboard plant, interest income on short-term investments of $2.4 million and other miscellaneous income and (expense) items totaling $1.5 million.\nFor 1995, the Company provided for income taxes totaling $22.8 million on earnings before income tax expense, discontinued operations and extraordinary item, producing an effective tax rate of 40.0%, compared to an effective tax rate for 1994 of 42.8%. The effective tax rates for such years were adversely impacted by certain nondeductible expenses incurred and provisions for state and local income taxes. The effective income tax rate for 1995 was favorably impacted by special state income tax incentives granted in connection with the issuance of certain industrial revenue bonds on behalf of one of the Company's subsidiaries.\nNet earnings per common share for continuing operations on a fully diluted basis were $0.65 and $0.54 for 1995 and 1994, respectively. Net earnings per common share for continuing operations before gain on insurance settlement net of income tax expense on a fully diluted basis was $0.56 and $0.54 for 1995 and 1994, respectively.\nWeighted average shares used in the calculation of primary and fully diluted net earnings per common share for 1995 were 50,639,000 and 52,317,000, respectively.\nGross profit for 1995 was $291.2 million, compared to $298.7 million for 1994, a decrease of 2.5%. Gross profit as a percentage of net sales declined from 27.8% in 1994 to 27.1% in 1995, and was primarily a result of lower factory utilization rates at certain of the Company's manufacturing facilities to balance inventories with incoming orders.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nNet sales for 1994 were $1.07 billion, representing an increase of 9.4% over net sales of $980.5 million in 1993. The net sales increase for 1994 reflected an improving U.S. economy and favorable industry conditions as well as new product offerings and marketing programs that were well received by customers.\nCost of operations for 1994 was $752.5 million, compared to $685.7 million for 1993, an increase of 9.7%. The increase in cost of operations as a percentage of net sales from 69.9% in 1993 to 70.2% in 1994, was primarily the result of start-up costs at a new motion upholstery manufacturing facility, the testing of a new state-of-the-art finishing facility and the impact of an explosion and fire that destroyed a particleboard plant in November 1994, partially offset by favorable factory utilization rates.\nSelling, general and administrative expenses for 1994 was $199.3 million, representing an increase of 7.0% over selling, general and administrative expenses for 1993 of $186.2 million. Selling, general and administrative expenses as a percentage of net sales, decreased to 18.6% from 19.0%. The reduction in selling, general and administrative expenses as a percentage of net sales was attributable to the Company's emphasis on control and reduction of operating expenses, as well as a nonrecurring $2.6 million charge included in 1993 related to the Company's 1992 reorganization.\nDepreciation and amortization for 1994 was $35.8 million, compared to $34.5 million in 1993, an increase of 3.8%. The amount of depreciation and amortization attributed to the \"fresh-start\" reporting was $16.9 million and $16.5 million, in 1994 and 1993, respectively.\nInterest expense for 1994 totaled $37.9 million compared to $38.6 million in 1993. The reduction in interest expense was primarily due to refinancing the Company's long-term debt in conjunction with the November 17, 1994 spin-off distribution to shareholders of the Company's footwear segment.\nOther income, net for 1994 and 1993 totaled $1.6 million and $1.8 million, respectively.\nThe Company's effective tax rate for 1994 and 1993 was 42.8% and 42.7%, respectively. The effective tax rates for such years were adversely impacted by certain nondeductible expenses incurred and provisions for state and local income taxes.\nNet earnings per common share from continuing operations on a fully diluted basis were $0.54 and $0.41 for 1994 and 1993, respectively.\nGross profit for 1994 was $298.7 million, representing an increase of 8.5% over gross profit for 1993 of $275.3 million. The increase resulted from an increase in net sales, partially offset by a reduction in gross profit margin. The reduction in gross profit margin, to 27.8% in 1994 from 28.1% for 1993, was primarily a result of start-up costs at a new motion upholstery manufacturing facility, the testing of a state-of-the-art finishing facility and the impact of an explosion and fire that destroyed a particleboard plant in November 1994, partially offset by favorable factory utilization rates.\nFINANCIAL CONDITION AND LIQUIDITY\nCash and cash equivalents at December 31, 1995 totaled $26.4 million, compared to $32.1 million at December 31, 1994. For 1995, net cash provided by operating activities totaled $92.0 million. Net cash used by investing activities totaled $370.5 million, including $335.4 million related to the acquisition of Thomasville and $35.6 million of capital expenditures incurred to add, upgrade or replace property, plant and equipment. Net cash provided by financing activities during 1995 totaled $272.8 million.\nWorking capital was $455.0 million at December 31, 1995, compared to $308.3 million at December 31, 1994. The current ratio was 4.4 to 1 at December 31, 1995, compared to 4.2 to 1 at December 31, 1994. The increase in working capital between years is primarily the result of the acquisition of Thomasville.\nAt December 31, 1995, long-term debt, including current maturities, totaled $723.7 million, compared to $426.3 million at December 31, 1994. The increase in long-term debt resulted from entering into the Secured Credit Agreement and the Receivables Securitization Facility in conjunction with the December 29, 1995 Thomasville acquisition. The Company's debt-to-capitalization ratio was 70.6% at December 31, 1995, compared to 60.8% at December 31, 1994.\nTo meet short-term working capital and other financial requirements, the Company maintains a $180 million revolving credit facility as part of its Secured Credit Agreement with a group of financial institutions. The revolving credit facility allows for both issuance of letters of credit and cash borrowings. Letter of credit outstandings are limited to no more than $60.0 million. Cash borrowings are limited only by the facility's maximum availability less letters of credit outstanding. See Note 8 of the notes to consolidated financial statements for additional information. At December 31, 1995, there was $71.0 million of cash borrowings outstanding under the revolving credit facility and $28.3 million in letters of credit outstanding, leaving an excess of $80.7 million available under the revolving credit facility.\nIn addition to the revolving credit facility, the Company also had $20.5 million of excess availability under its Receivables Securitization Facility as of December 31, 1995.\nThe Company believes its revolving credit facility, together with cash generated from operations, will be adequate to meet liquidity requirements for the foreseeable future.\nThe Company maintains a significant capital expenditure program focusing on increasing manufacturing efficiency and expanding capacity as required. The Company's total capital expenditures were $35.6 million, $21.1 million and $30.2 million for the years ended December 31, 1995, 1994 and 1993, respectively. These figures do not include the capital expenditures of Thomasville. Significant new projects during the past three years included a new upholstery manufacturing facility at Action Industries to meet the increased demand for the Company's recliners, motion furniture and sleep sofas and a state-of-the-art flat line finishing system at Lane. The capital expenditures for 1995 include $18.2 million to construct a new state-of-the-art particleboard manufacturing facility at Broyhill, which was funded by proceeds from an insurance settlement, to replace the Company's facility that was destroyed by fire in November 1994. The Company believes that as a result of the availability of excess capacity in the Lane and Thomasville manufacturing facilities, the Company will be able to pursue its growth strategy over the next several years without the necessity of making significant additional capital expenditures to expand capacity.\nACCOUNTING STANDARDS NOT YET IMPLEMENTED\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"). Under SFAS No. 123, companies can either measure the compensation cost of equity instruments issued under employee compensation plans using a fair value based method, or can continue to recognize compensation cost under the provisions of Accounting Principles Board Opinion No. 25 (\"Opinion No. 25\"). However, if the provisions of Opinion No. 25 are continued, pro forma disclosures of net income and earnings per share must be presented in the financial statements as if the fair value method had been applied. The Company intends to continue to recognize compensation costs under the provisions of Opinion No. 25, and upon adoption of SFAS No. 123 as of January 1, 1996, will disclose the effects of SFAS No. 123 on net earnings and earnings per share for 1995 and 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\"). SFAS No. 121 requires that long-lived assets, certain identifiable intangibles and goodwill to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. SFAS No. 121 is effective for the Company in 1996. The Company believes the adoption of this accounting standard will not have a material impact on its operating results or financial condition.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\n1. THE COMPANY\nINTERCO INCORPORATED (the \"Company\") is a major manufacturer of residential furniture. During the year ended December 31, 1995, the Company had two primary operating subsidiaries, Broyhill Furniture Industries, Inc. and The Lane Company, Incorporated. On December 29, 1995, the Company acquired Thomasville Furniture Industries, Inc. (\"Thomasville\"). In conjunction with the acquisition, the Company refinanced its Secured Credit Agreement and amended its Receivables Securitization Facility.\nSubstantially all of the Company's sales are made to unaffiliated furniture retailers. The Company has a diversified customer base with no one customer accounting for 10% or more of consolidated sales and no particular concentration of credit risk in one economic section. Foreign operations and sales are not material.\nOn November 17, 1994, the Company simultaneously refinanced the majority of its outstanding indebtedness and distributed to holders of its common stock the common stock of The Florsheim Shoe Company and the common stock of Converse Inc. (which, in aggregate, represented the Company's footwear segment). Upon completion of this restructuring, the Company retained no ownership interest or management control of the footwear businesses. Accordingly, the financial results of the footwear businesses have been reflected as discontinued operations for all applicable periods.\n2. ACQUISITION OF BUSINESS\nOn December 29, 1995, the Company acquired all of the outstanding stock of Thomasville Furniture Industries, Inc. The purchase price totaled $331,200 plus the assumption of $8,000 of long-term debt. The purchase price, including capitalized expenses which approximated $4,200, was paid in cash. The transaction was accounted for as a purchase and, since the acquisition occurred as of the last business day of 1995, has been reflected in the Company's consolidated balance sheet. The Company's results of operations for 1995 do not include any of the operations of Thomasville. The total acquisition cost exceeded the estimated fair value of the net assets acquired by $105,764 with such amount being recorded as an intangible asset.\nThe following unaudited summary, prepared on a pro forma basis, combines the consolidated results of operations of the Company for 1994 and 1995 with those of Thomasville as if the transaction occurred at the beginning of each year presented.\nThe pro forma data has been adjusted, net of income taxes, to reflect interest expense and the amortization of the excess of cost over net assets acquired. Such pro forma amounts are not necessarily indicative of what the actual consolidated results of operations might have been if the acquisition had been effective at the beginning of each year presented.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n3. SIGNIFICANT ACCOUNTING POLICIES\nThe significant accounting policies of the Company are set forth below.\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. Actual results could differ from those estimates.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and all its subsidiaries, the majority of which are wholly owned. All material intercompany transactions are eliminated in consolidation. The Company's fiscal year ends on December 31. The operating companies included in the consolidated financial statements report their results of operations as of the Saturday closest to December 31. Accordingly, the results of operations will periodically include a 53 week fiscal year. 1993, 1994 and 1995 all represent 52 week fiscal years.\nCash and Cash Equivalents\nThe Company considers all short-term investments with an original maturity of three months or less to be cash equivalents. Short-term investments are recorded at amortized cost, which approximates market.\nInventories\nInventories are stated at the lower of cost (first-in, first-out) or market.\nProperty, Plant and Equipment\nProperty, plant and equipment are recorded at cost when acquired. Expenditures for improvements are capitalized while normal repairs and maintenance are expensed as incurred. When properties are disposed of, the related cost and accumulated depreciation or amortization are removed from the accounts, and gains or losses on the dispositions are reflected in results of operations. For financial reporting purposes, the Company utilizes both accelerated and straight-line methods of computing depreciation and amortization. Such expense is computed based on the estimated useful lives of the respective assets, which generally range from 3 to 45 years for buildings and improvements and from 3 to 12 years for machinery and equipment.\nIntangible Assets\nThe Company emerged from Chapter 11 reorganization effective with the beginning of business on August 3, 1992. In accordance with generally accepted accounting principles, the Company was required to adopt \"fresh-start\" reporting which included adjusting all assets and liabilities to their fair values as of the effective date. The ongoing impact of the adoption of fresh- start reporting is reflected in the financial statements for all years presented.\nAs a result of adopting fresh-start reporting, the Company recorded reorganization value in excess of amounts allocable to identifiable assets of approximately $146,000. This intangible asset is being amortized on a straight-line basis over a 20 year period.\nAlso in connection with the adoption of fresh-start reporting, the Company recorded approximately $156,800 in fair value of trademarks and trade names based upon an independent appraisal. Such trademarks and trade names are being amortized on a straight-line basis over a 40 year period.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe excess of cost over net assets acquired in connection with the acquisition of Thomasville totaled approximately $105,764. This intangible asset is being amortized on a straight-line basis over a 40 year period.\nIncome Tax Expense\nIncome tax expense is based on results of operations before discontinued operations and extraordinary items. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. 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.\nExtraordinary Item\nIn conjunction with the December 29, 1995 acquisition of Thomasville, the Company refinanced its Secured Credit Agreement and amended its Receivables Securitization Facility. As a result thereof, the Company charged to results of operations, as an extraordinary item, the deferred financing fees and expenses pertaining to such credit facilities.\nNet Earnings Per Common Share\nNet earnings per common share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the year. The stock options and warrants outstanding (Note 10) are considered common stock equivalents. Weighted average shares used in the calculation of primary and fully diluted net earnings per common share for 1995 were 50,639,000 and 52,317,000, respectively.\nReclassification\nCertain 1993 and 1994 amounts have been reclassified to conform to the 1995 presentation.\n4. DISCONTINUED OPERATIONS\nOn November 17, 1994, the Company distributed the common stock of each of The Florsheim Shoe Company and Converse Inc. (which, in aggregate, represented the Company's footwear segment) to its shareholders. In accordance with generally accepted accounting principles, the financial results for the footwear segment are reported as \"Discontinued Operations\" and the Company's financial results of prior periods were restated. Condensed results of the discontinued operations were as follows:\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe loss on distribution reflects expenses related to: the distribution of the common stock of The Florsheim Shoe Company and Converse Inc. to the Company's shareholders, including certain expenses associated with establishing the capital structure of each company; compensation expense accrued as a result of adjustments required to be made to exercisable employee stock options; interest expense on certain long-term debt defeased, net of estimated interest income to be received from the trustees; and applicable income taxes.\nPrior to the distribution of the common stock of The Florsheim Shoe Company to its shareholders, the Company had guaranteed certain of Florsheim's retail store operating leases. At December 31, 1995, the Company had guarantees outstanding on 101 retail store leases with a contingent liability totaling approximately $37,400. The Florsheim Shoe Company has agreed to indemnify the Company against any losses incurred as a result of the lease guarantees.\n5. EXTRAORDINARY ITEM--EARLY EXTINGUISHMENT OF DEBT\nIn conjunction with the December 29, 1995 acquisition of Thomasville, the Company refinanced its Secured Credit Agreement and amended its Receivables Securitization Facility. As a result thereof, the Company charged to results of operations $5,815, net of taxes of $3,478, representing the deferred financing fees and expenses pertaining to such credit facilities. The charge was recorded as an extraordinary item.\n6. INVENTORIES\nInventories are summarized as follows:\n7. INTANGIBLE ASSETS\nIntangible assets include the following:\n8. SHORT-TERM FINANCING\nIn conjunction with the December 29, 1995 acquisition of Thomasville and related refinancing of certain long-term debt, the Company entered into a $630,000 Secured Credit Agreement which includes a $180,000\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nrevolving credit facility. The revolving credit facility allows for issuance of letters of credit and cash borrowings. Letter of credit outstandings are limited to no more than $60,000, with cash borrowings limited only by the facility's maximum availability less letters of credit outstanding. On December 29, 1995, $71,000 in cash borrowings were outstanding under the revolving credit facility as a result of the acquisition of Thomasville. Cash borrowings from the revolving credit facility have no fixed amortization and, since the facility does not mature until December 2001, are classified as long-term debt.\nAs part of the Secured Credit Agreement, the revolving credit facility is secured by a first priority lien on and security interest in substantially all of the Company's assets except for trade receivables. See Note 9--Long-Term Debt for further information regarding the Secured Credit Agreement.\nThe outstanding cash borrowings under the revolving credit facility bear interest at a base rate plus 1.125% or at an adjusted Eurodollar rate plus 2.125%, depending upon the type of loan the Company executes. The \"spread\" or margin over the base rate and Eurodollar rate is subject to a \"step-down\" or reduction when the Company achieves certain financial performance ratios. At December 31, 1995, there was $71,000 of cash borrowings outstanding under the revolving credit facility, all of which are classified as long-term debt.\nUnder the letter of credit facility, a fee of 2.125% per annum (subject to the same \"step-down\" as noted earlier) is assessed for the account of the lenders ratably. A further fee of 0.25% is assessed on stand-by letters of credit representing a facing fee. A customary administrative charge for processing letters of credit is also payable to the relevant issuing bank. Letter of credit fees are payable quarterly in arrears. At December 31, 1995, there were $28,300 in letters of credit outstanding under the revolving credit facility.\n9. LONG-TERM DEBT\nLong-term debt consisted of the following:\nOn December 29, 1995, in conjunction with the acquisition of Thomasville, the Company refinanced its Secured Credit Agreement by entering into a new $630,000 facility with a group of financial institutions. The Company also amended its Receivables Securitization Facility to increase its maximum availability to $225,000. Proceeds from these loan facilities were used to repay the existing secured credit facility and to acquire Thomasville.\nThe following discussion summarizes certain provisions of the long-term debt.\nSecured Credit Agreement\nThe common stock of the Company's principal subsidiaries, substantially all of the Company's cash, working capital (other than trade receivables) and property, plant and equipment, have been pledged or mortgaged as security for the Secured Credit Agreement. The Secured Credit Agreement contains a number of restrictive covenants and events of default, including covenants limiting capital expenditures and incurrence of debt, and requires the Company to achieve certain financial ratios, some of which become more restrictive over time.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Secured Credit Agreement consists of the revolving credit facility discussed in Note 8 and three term loan facilities with the following terms:\nSimilar to the revolving credit facility, the \"spread\" or margin over the base rate and Eurodollar rate is subject to a \"step-down\" or reduction when the Company achieves certain financial performance ratios. Interest is payable based upon the type (base rate or Eurodollar rate) of the loan the Company executes; however, interest is payable quarterly at a minimum. At December 31, 1995, all loans outstanding under the Secured Credit Agreement were based on the Eurodollar rate.\nMandatory principal payments of the term loan \"A\" facility are semi-annual (last business day of June and December). Mandatory principal payments of the term loan \"B\" facility are semi-annual through 2001 and convert to quarterly payments beginning in March 2002. Mandatory principal payments of the term loan \"C\" facility are semi-annual through 2002 and convert to quarterly payments beginning in June 2003. Annual mandatory principal payments are as follows:\nIn addition to mandatory principal payments, the term loan facilities require principal payments from excess cash flow (as defined in the Secured Credit Agreement), and a portion of the net proceeds realized from (i) the sale, conveyance or other disposition of collateral securing the debt or (ii) the sale by the Company for its own account of additional subordinated debt and\/or shares of its preferred and\/or common stock. The revolving credit facility has no mandatory principal payments prior to its maturity date.\nReceivables Securitization Facility\nThe amended Receivables Securitization Facility is an obligation of the Company which matures on December 29, 2000 and is secured by substantially all of the Company's trade receivables. The facility operates through use of a special purpose subsidiary (Interco Receivables Corp.) which \"buys\" trade receivables from the operating companies and \"sells\" interests in same to a third party financial institution, which uses the interests as collateral for borrowings in the commercial paper market to fund the purchases. The Company accounts for this facility as long-term debt.\nThe Company pays a commercial paper index rate on all funds received (outstanding) on the facility. In addition, a program fee of 0.75% per annum on the entire $225,000 facility is payable on a monthly basis. The balance outstanding\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nat December 31, 1995 was $185,000. The Company may increase or decrease its use of the facility on a monthly basis subject to the availability of sufficient trade receivables and the facility's maximum amount ($225,000). As of December 31, 1995, the Company had $20,474 in excess availability under the facility.\nOther\nOther long-term debt consists of various industrial revenue bonds and other debt instruments with interest rates ranging from approximately 4.0% to 9.0%. Annual mandatory principal payments are required through 2004.\nOther Information\nMaturities of long-term debt are $18,639, $23,709, $28,531, $52,800 and $252,800 for years 1996 through 2000, respectively.\n10. COMMON STOCK\nThe Company's restated certificate of incorporation includes authorization to issue up to 100.0 million shares of common stock with a $1.00 per share stated value. As of December 31, 1995, 50,120,079 shares of common stock were issued and outstanding. It is not presently anticipated that dividends will be paid on common stock in the foreseeable future and certain of the debt instruments to which the Company is a party restrict the payment of dividends.\nShares of common stock were reserved for the following purposes at December 31, 1995:\nUnder the Company's 1992 Stock Option Plan, certain key employees may be granted nonqualified options, incentive options or combinations thereof. Nonqualified and incentive options may be granted to expire up to ten years after the date of grant. Options granted become exercisable at varying dates depending upon the achievement of certain performance targets and\/or the passage of certain time periods.\nThe 1992 Stock Option Plan authorizes grants of options to purchase common shares at less than fair market value on the date of grant. During 1993, an option grant of 250 thousand common shares was made by the Company at less than market value resulting in a credit to paid-in capital and a charge to compensation expense of approximately $1.0 million.\nChanges in options granted and outstanding are summarized as follows:\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAs a result of the November 17, 1994 distribution of the common stock of The Florsheim Shoe Company and Converse Inc. to the Company's shareholders, options granted to the employees of those operating companies were cancelled. In addition, the exercise prices of the remaining options were adjusted to reflect the distribution in accordance with the antidilution provisions of the 1992 Stock Option Plan.\nAs of December 31, 1995, the Company had outstanding approximately 6.9 million warrants to purchase common stock. Each warrant entitles the holder thereof to purchase one share of common stock at $7.13 per share (as adjusted for the November 17, 1994 distribution to shareholders of the Company's former footwear segment). The warrants, which expire on August 3, 1999, were issued in two series; Series 1 warrants include a five year call protection, whereas Series 2 warrants do not include such a feature. All other terms and conditions of the two series of warrants are identical. The warrants trade on the over-the-counter market.\n11. INCOME TAXES\nIncome tax expense was comprised of the following:\nThe following table reconciles the differences between the Federal corporate statutory rate and the Company's effective income tax rate:\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe sources of the tax effects for temporary differences that give rise to the deferred tax assets and liabilities were as follows:\nThe net deferred tax liabilities are included in the consolidated balance sheets as follows:\nThe Federal income tax returns of the Company and its major subsidiaries have been examined by the Internal Revenue Service (\"IRS\") through February 23, 1991.\n12. EMPLOYEE BENEFITS\nThe Company sponsors or contributes to retirement plans covering substantially all employees. The total cost of all plans for 1993, 1994 and 1995 was $5,716, $6,303 and $7,070, respectively.\nCompany-Sponsored Defined Benefit Plans\nAnnual cost for defined benefit plans is determined using the projected unit credit actuarial method. Prior service cost is amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits.\nIt is the Company's practice to fund pension costs to the extent that such costs are tax deductible and in accordance with ERISA. The assets of the various plans include corporate equities, government securities,\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\ncorporate debt securities and insurance contracts. The table below summarizes the funded status of the Company-sponsored defined benefit plans.\nNet periodic pension cost for 1993, 1994 and 1995 includes the following components:\nEmployees are covered primarily by noncontributory plans, funded by Company contributions to trust funds, which are held for the sole benefit of employees. Monthly retirement benefits are based upon service and pay with employees becoming vested upon completion of five years of service.\nThe expected long-term rate of return on plan assets was 8.0%-9.5% in 1993 and 1994 and 8.5% in 1995. Measurement of the projected benefit obligation was based upon a weighted average discount rate of 7.25%, 8.0% and 7.25% and a long-term rate of compensation increase of 4.5%, 4.5% and 4.5% for 1993, 1994 and 1995, respectively.\nOther Retirement Plans and Benefits\nIn addition to defined benefit plans, the Company makes contributions to a defined contribution plan and sponsors employee savings plans. The cost of these plans is included in the total cost for all plans reflected above.\nIn addition to pension and other supplemental benefits, certain employees and retirees are currently provided with specified health care and life insurance benefits. Eligibility requirements generally state that benefits are available to employees who retire after a certain age with specified years of service if they agree to contribute a portion of the cost. The Company has reserved the right to modify or terminate these benefits. Health care and life insurance benefits are provided to both retired and active employees through medical benefit trusts, third-party administrators and insurance companies.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following table sets forth the financial status of postretirement benefits other than pensions as of December 31, 1995. Until the acquisition of Thomasville as of December 29, 1995, postretirement benefits other than pensions were considered immaterial and not previously reported.\nFor measurement purposes, a 11.0% annual rate of increase in the cost of health care benefits for pre-age 65 retirees and 11.0% for post-age 65 retirees was assumed for 1995. For 1995, the rates are assumed to decrease gradually to 6.0% in the year 2000 and remain at those levels thereafter. Increasing the assumed health care cost trend rates by one point in each year would have resulted in an increase in the accumulated postretirement benefit obligation as of December 31, 1995 of approximately $3,098 and the net periodic cost by $6 for the year.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% for 1995.\n13. LEASE COMMITMENTS\nCertain of the Company's real properties and equipment are operated under lease agreements expiring at various dates through the year 2005. Leases covering equipment generally require, in addition to stated minimums, contingent rentals based on usage. Generally, the leases provide for renewal for various periods at stipulated rates.\nRental expense under operating leases was as follows:\nFuture minimum lease payments under operating leases, reduced by minimum rentals from subleases of $616 at December 31, 1995, aggregate $36,023. Annual minimum payments under operating leases are $10,715, $7,840, $6,470, $5,005 and $2,852 for 1996 through 2000, respectively.\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company considers the carrying amounts of cash and cash equivalents, receivables and accounts payable to approximate fair value because of the short maturity of these financial instruments.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAmounts outstanding under the Secured Credit Agreement and Receivables Securitization Facility are also considered to be carried on the financial statements at their estimated fair values because they were entered into recently and both accrue interest at rates which generally fluctuate with interest rate trends.\nAmounts outstanding under the other long-term debt is considered special purpose financing as an incentive to acquire specific real estate and for settlement of certain claims. Accordingly, the Company believes the carrying amounts approximate fair value given the circumstances under which such financings were acquired.\n15. GAIN ON INSURANCE SETTLEMENT\nOn November 20, 1994, an explosion and fire destroyed a particleboard plant owned and operated by the Company. During 1995, the Company rebuilt the plant with proceeds received from the insurance settlement. As a result thereof, a gain on insurance settlement, totaling $7,882, was recorded during the fourth quarter of 1995. The gain includes all costs associated with the claim with no further expenses or liability anticipated.\n16. LITIGATION\nThe Company is or may become a defendant in a number of pending or threatened legal proceedings in the ordinary course of business. In the opinion of management, the ultimate liability, if any, of the Company from all such proceedings will not have a material adverse effect upon the consolidated financial position or results of operations of the Company and its subsidiaries.\nINTERCO INCORPORATED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFollowing is a summary of unaudited quarterly information:\nThe 1994 fourth quarter common stock price range reflects the impact of the November 17, 1994 distribution of the discontinued operations to the Company's shareholders.\nThe Company has not paid cash dividends on its common stock during the two years ended December 31, 1995. The closing market price of the Company's common stock on December 31, 1995 was $9.00 per share.\nPART III\nItem 10.","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------\nThe section entitled \"Nominees and Continuing Directors\" of the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders on April 23, 1996 is incorporated herein by reference.\nExecutive Officers of the Registrant\nCurrent Appointed Name Age Position Positions or Elected ---- --- -------- --------- ----------\n*Richard B. Loynd 68 Chairman of the Board of the Former Subsidiary - Converse Inc. 1982 Vice President 1987 Director X 1987 President X 1989 Chief Operating Officer 1989 Chief Executive Officer X 1989 Chairman of the Board X 1990\nBrent B. Kincaid 64 President and Chief Exec- utive Officer of the Sub- sidiary - Broyhill Furni- ture Industries, Inc. X 1992\nFrederick B. Starr 63 President and Chief Exec- utive Officer of the Sub- sidiary - Thomasville Furniture Industries, Inc. X 1982\nK. Scott Tyler, Jr. 56 President of the Subsidiary - The Lane Company, In- corporated X 1989 Chief Executive Officer of the Subsidiary - The Lane Company, Incorporated X 1991\nDavid P. Howard 45 Controller 1990 Vice-President X 1991 Chief Financial Officer X 1994\nLynn Chipperfield 44 General Counsel X 1993 Vice-President and Secretary X 1996\nSteven W. Alstadt 41 Controller X 1994\nThe following officer retired on January 30, 1996 Duane A. Patterson 63 Secretary 1973 Director 1991 Vice-President 1992\n_________________________ * Member of the Executive Committee\nThere are no family relationships between any of the executive officers of the Registrant.\nThe executive officers are elected at the organizational meeting of the Board of Directors which follows the annual meeting of stockholders and serve for one year and until their successors are elected and qualified.\nEach of the executive officers has held the same position or other positions with the same employer during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nThe sections entitled \"Executive Compensation\", \"Executive Compensation and Stock Option Committee Report on Executive Compensation\", \"Compensation Committee Interlocks and Insider Participation\", \"Stock Options\", \"Retirement Plans\", \"Employment and Incentive Agreements\" and \"Performance Graph\" of the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders on April 23, 1996, are incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nThe section entitled \"Security Ownership\" of the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders on April 23, 1996, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nThe section entitled \"Certain Business Relationships\" of the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders on April 23, 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) List of documents filed as part of this report:\n1. Financial Statements:\nConsolidated balance sheets, December 31, 1994 and 1995.\nConsolidated statements of operations for each of the years in the three-year period ended December 31, 1995.\nConsolidated statement of cash flows for each of the years in the three-year period ended December 31, 1995.\nConsolidated statement of shareholders' equity for each of the years in the three-year period ended December 31, 1995.\nNotes to consolidated financial statements.\nIndependent Auditors' Report\n2. Financial Statement Schedules:\nValuation and qualifying accounts (Schedule II).\nAll other schedules are omitted as the required information is presented in the consolidated financial statements or related notes or are not applicable.\n3. Exhibits:\n3(a) Restated Certificate of Incorporation of the Company, as amended (Incorporated by reference to Exhibit 4(a) to INTERCO INCORPORATED's Quarterly Report on Form 10-Q for the quarter ended on March 31, 1993.)\n3(b) By-Laws of the Company revised and amended to May 5, 1993. (Incorporated by reference to Exhibit 4(b) to INTERCO INCORPORATED's Quarterly Report on Form 10-Q for the quarter ended on March 31, 1993.)\n4(a) Credit Agreement, dated as of November 17, 1994, as amended and restated as of December 29, 1995, among the Company, Broyhill Furniture Industries, Inc., The Lane Company, Incorporated, Thomasville Furniture Industries, Inc., Various Banks, Credit Lyonnais New York Branch, as Documentation Agent, Nationsbank, N.A., as Syndication Agent and Bankers Trust Company, as Administration Agent. (Incorporated by reference to Exhibit 99(a) to INTERCO INCORPORATED's Current Report on Form 8-K, dated January 12, 1996.)\n4(b) Purchase and Contribution Agreement, dated as of November 15, 1994, as amended and restated as of December 29, 1995 among The Lane Company, Incorporated, Action Industries, Inc., Broyhill Furniture Industries, Inc. and Thomasville Furniture Industries as Sellers and Interco Receivables Corp. as Purchaser.\n4(c) Receivables Purchase Agreement, dated as of November 15, 1994, as amended and restated as of December 29, 1995, among Interco Receivables Corp. as the Seller and Atlantic Asset Securitization Corp. as an Investor and Credit Lyonnais New York Branch as the Agent. (Incorporated by reference to Exhibit 99(b) to INTERCO INCORPORATED's Current Report on Form 8-K, dated January 12, 1996.)\n4(d) Warrant Agreement, dated as of August 3, 1992, between the Company and Society National Bank, as Warrant Agent. (Incorporated by reference to Exhibit 4.5 to INTERCO INCORPORATED's Current Report on Form 8-K, dated August 18, 1992.)\n4(e) Agreement to furnish upon request of the Commission copies of other instruments defining the rights of holders of long-term debt of the Company and its subsidiaries which debt does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis. (Incorporated by reference to Exhibit 4(c) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended February 28, 1981.)\n10(a) INTERCO INCORPORATED's 1992 Stock Option Plan. (Incorporated by reference to Exhibit 10(b) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended December 31, 1992.)\n10(b) Form of Indemnification Agreement between the Company and Richard B. Loynd, Donald E. Lasater and Lee M. Liberman. (Incorporated by reference to Exhibit 10(h) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended February 29, 1988.)\n10(c) Consulting Agreement, dated as of September 23, 1992, between the Company and Apollo Advisors, L.P. as amended on February 20, 1995.\n10(d) Registration Rights Agreement, dated as of August 3, 1992, between the Company and Apollo Interco Partners, L.P. (Incorporated by reference to Exhibit 10(g) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended December 31, 1992.)\n10(e) Written description of bonus plan for management personnel of the Lane Company, Incorporated.\n10(f) Retirement Plan for directors. (Incorporated by reference to Exhibit 10(g) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(g) INTERCO Corporate Executive Incentive Plan. (Incorporated by reference to Exhibit 10(h) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(h) Broyhill Furniture Industries, Inc. Executive Incentive Plan. (Incorporated by reference to Exhibit 10(i) to INTERCO INCORPORATED's Annual Report on Form 10-K for the year ended December 31, 1994.)\n11 Statement regarding computation of per share earnings.\n21 List of Subsidiaries of the Company.\n23 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule\n99(a) Distribution and Services Agreement, dated November 17, 1994, between the Company and Converse Inc. (Incorporated by reference to Exhibit 99(a) to INTERCO INCORPORATED's Annual Report on Form 8-K, dated December 2, 1994.)\n99(b) Tax Sharing Agreement, dated November 17, 1994, between the Company and Converse Inc. (Incorporated by reference to Exhibit 99(b) to INTERCO INCORPORATED's Annual Report on Form 8-K, dated December 2, 1994.\n99(c) Distribution and Services Agreement, dated November 17, 1994, among the Company, The Florsheim Shoe Company and certain of its subsidiaries. (Incorporated by reference to Exhibit 99(c) to INTERCO INCORPORATED's Annual Report on Form 8-K, dated December 2, 1994.\n99(d) INTERCO\/Florsheim Tax Sharing Agreement, dated November 17, 1994, among the Company, The Florsheim Shoe Company and certain of its subsidiaries. (Incorporated by reference to Exhibit 99(d) to INTERCO INCORPORATED's Annual Report on Form 8-K, dated December 2, 1994.)\n(b) Reports on Form 8-K.\nA Form 8-K was filed on November 27, 1995, reporting the signing of an agreement to acquire Thomasville Furniture Industries, Inc., a Form 8-K was filed on January 12, 1996, as amended by Form 8-K\/A-1 filed on January 16, 1996 and Form 8-K\/A-2 filed on February 1, 1996, reporting the acquisition of Thomasville Furniture Industries, Inc., summarizing the Company's amended credit agreements and filing the agreements as exhibits thereto and a Form 8-K was filed on January 31, 1996 reporting information in the Company's press releases dated January 30, 1996.\nSHAREHOLDERS REQUESTING COPIES OF EXHIBITS TO FORM 10-K WILL BE SUPPLIED ANY OR ALL SUCH EXHIBITS AT A CHARGE OF TEN CENTS PER PAGE.\nINTERCO INCORPORATED AND SUBSIDIARIES\nIndex to Consolidated Financial Statements and Schedule\nINTERCO INCORPORATED AND SUBSIDIARIES Valuation and Qualifying Accounts\n(a) Uncollectible accounts written off, net of recoveries. (b) Cash discounts taken by customers.\nSee accompanying independent auditors' report.\nIndependent Auditors' Report\nThe Board of Directors and Shareholders INTERCO INCORPORATED:\nWe have audited the consolidated financial statements of INTERCO INCORPORATED 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 INTERCO INCORPORATED 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. 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\nSt. Louis, Missouri January 30, 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.\nINTERCO INCORPORATED ------------------------- (Registrant)\nBy Richard B. Loynd ---------------------- Richard B. Loynd Chairman of the Board\nDate: February 1, 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 indicated on February 1, 1996.\nSignature Title --------- -----\nRichard B. Loynd Chairman of the Board, - ----------------------------- President and Director (Richard B. Loynd) (Principal Executive Officer)\nDonald E. Lasater Director - ----------------------------- (Donald E. Lasater)\nLee M. Liberman Director - ----------------------------- (Lee M. Liberman)\nLeon D. Black Director - ----------------------------- (Leon D. Black)\nJoshua J. Harris Director - ----------------------------- (Joshua J. Harris)\nMichael S. Gross Director - ----------------------------- (Michael S. Gross)\nJohn J. Hannan Director - ----------------------------- (John J. Hannan)\nBruce A. Karsh Director - ----------------------------- (Bruce A. Karsh)\nJohn H. Kissick Director - ----------------------------- (John H. Kissick)\nJohn J. Ryan III Director - ----------------------------- (John J. Ryan III)\nMichael D. Weiner Director - ----------------------------- (Michael D. Weiner)\nDavid P. Howard Vice President - ----------------------------- (Principal Financial Officer) (David P. Howard)\nSteven W. Alstadt Controller - ----------------------------- (Principal Accounting Officer) (Steven W. Alstadt)","section_15":""}
{"filename":"705959_1995.txt","cik":"705959","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors-83 (the \"Registrant\") is a limited partnership formed in 1981 under the laws of the State of Illinois. The Registrant raised $75,005,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of real properties, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire eleven real property investments and a minority joint venture interest in an additional property. The Registrant has since disposed of five of these properties, including the property in which the Registrant held a minority joint venture interest. As of December 31, 1995, the Registrant owns the seven 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 Registrant'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 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 entered into a letter of intent to sell one of its seven properties, and, if the market remains favorable, intends to begin actively marketing more of the 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 7.70% of the total interests outstanding in the Registrant and assigned the interests to its affiliate, WIG 83 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 is an affiliate of Insignia Financial Group, Inc., which provides property management services to all of the Registrant's properties. Metropolitan has 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 the impact of this tender offer or any future tender offers will have on the operations or management of the Registrant.\nThe Registrant completed the refinancings of two mortgage notes payable in 1995. See \"Item 7. Liquidity and Capital Resources,\" for additional information.\nDuring 1995, the Registrant sold the North Cove apartment complex. See \"Item 7. Liquidity and Capital Resources,\" for additional information.\nThe Registrant, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor Partners-XIII, 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 seven properties described below:\nLocation Description of Property - -------- -----------------------\nSan Antonio, Texas * Deer Oaks Apartments: a 244-unit apartment complex located on approximately 10 acres.\nPhoenix, Arizona Desert Sands Apartments: a 412-unit apartment complex located on approximately 20 acres.\nIrving, Texas * Eagle Crest Apartments - Phase I: a 296-unit apartment complex located on approximately 12 acres.\nPasadena, Texas Sandridge Apartments - Phase II: a 196-unit apartment complex located on approximately 8 acres.\nLas Vegas, Nevada Springs Pointe Village Apartments: a 484-unit apartment complex located on approximately 27 acres.\nCorpus Christi, Texas Walnut Ridge Apartments - Phase I: a 380-unit apartment complex located on approximately 11 acres.\nCorpus Christi, Texas Walnut Ridge Apartments - Phase II: a 324-unit apartment complex located on approximately 9 acres.\n*Owned by the Registrant through a joint venture with the seller.\nSee Note 6 of Notes to Financial Statements for additional information.\nEach of the 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 Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\nDeer Oaks Apartments - ---------------------\nIn 1983, a joint venture consisting of the Registrant as general partner and the seller as limited partner (the \"Joint Venture\") acquired the Deer Oaks Apartments. In 1981, 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 $195,654 and the Affiliate $205,860, 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 $208,250 and $216,750, respectively.\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. Liquidity and Capital Resources.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 7,310.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ------------------------------------------------------------ 1995 1994 1993 1992 1991 ----------- ----------- ----------- ------------ -----------\nTotal income $15,442,492 $16,120,215 $16,565,748 $16,433,299 $15,820,488 Income (loss) before gain on sale of property and extraordinary items 734,890 (291,500) (774,247) (1,179,837) (1,541,314) Net income (loss) 3,387,955 1,108,900 2,994,111 (1,179,837) 1,355,068 Net income (loss) per Limited Part- nership Interest 42.91 14.05 37.92 (14.94) 17.16 Total assets 42,023,971 55,306,162 58,987,183 60,133,453 61,884,993 Mortgage notes payable 46,407,211 56,248,201 58,567,203 62,635,603 62,801,950 Distributions per Limited Partner- ship Interest(A) 85.00 18.00 None None None\n(A) These amounts included a distribution of original capital of $67.00 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 - ---------------------\nBalcor Realty Investors-83 (the \"Partnership\") recognized gains on the sales of the North Cove Apartments during 1995 and the Sunset Place Apartments during 1993. In addition, in connection with the 1994 refinancing of the North Cove Apartments mortgage loan, the lender forgave deferred interest and a portion of the principal due on the loan resulting in the recognition of an extraordinary gain on forgiveness of debt. These gains are the primary reasons the Partnership generated net income during 1995, 1994 and 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nThe sale of North Cove Apartments in June 1995 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. Certain of these decreases were also affected by the events described below. In connection with this sale, the Partnership recognized a gain of $2,711,565 during 1995.\nHigher rental rates at most of the Partnership's remaining properties during 1995 were offset by the above-mentioned sale. As a result, rental and service income and, correspondingly, property management fees decreased during 1995 as compared to 1994.\nDue to higher interest rates, interest income on short-term investments increased during 1995 as compared to 1994.\nAmortization expense decreased during 1995 as compared to 1994 as a result of lower deferred expenses relating to the Eagle Crest - Phase I new mortgage loan.\nThe Partnership incurred higher 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.\nDuring 1995, the Partnership recognized an extraordinary gain on forgiveness of debt in connection with the settlement reached with the seller of the Springs Pointe and Desert Sands apartment complexes. In February 1994, the first mortgage loan collateralized by North Cove Apartments was refinanced, and the lender forgave deferred interest and a portion of the principal. In connection with this transaction, the Partnership recognized an extraordinary gain on forgiveness of debt.\nIn June 1995, the first mortgage loan collateralized by Deer Oaks Apartments was refinanced, and a prepayment penalty of $43,153 was incurred. Also in June 1995, the North Cove Apartments was sold and the remaining unamortized deferred expenses in the amount of $56,000 were recognized. These two amounts have been recognized as extraordinary items and classified as debt extinguishment expenses.\n1994 Compared to 1993 - ---------------------\nThe sale of Sunset Place Apartments in August 1993 resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, amortization of deferred expenses, property operating expenses, real estate taxes and property management fees during 1994 as compared to 1993.\nThese decreases were affected by the events described below. In connection with the sale, the Partnership recognized a gain of $3,768,358 during 1993.\nHigher rental rates at most of the Partnership's remaining properties during 1994 resulted in increases in rental and service income, and correspondingly property management fees, which partially offset the decrease from the Sunset Place Apartments sale.\nDue to higher interest rates and larger average cash balances available for investment during 1994 as a result of the net proceeds from the 1993 property sale and refinancings, interest income on short-term investments increased in 1994 as compared to 1993.\nInterest expense decreased for 1994 as compared to 1993 as a result of the sale of Sunset Place Apartments, lower interest rates on the Desert Sands and Springs Pointe mortgage loans effective in 1993 when the interest rates were adjusted downward based on a market index in accordance with the loan agreements, lower interest expense relating to the North Cove mortgage loan refinancing in February 1994, and a prepayment penalty (which was classified as interest expense) in connection with the July 1993 refinancing of the Walnut Ridge - Phase II Apartment's mortgage loan. These decreases were partially offset by higher interest expense due to an increase in debt resulting from the 1993 refinancings on Walnut Ridge Phases - I and II apartment complexes.\nPrimarily due to higher insurance costs at each of the Partnership's properties, higher roof repair expenditures at the Deer Oaks, Desert Sands, and Sandridge-Phase II apartment complexes, higher exterior painting expenditures at the Desert Sands and Springs Pointe apartment complexes and higher carpet replacement costs at the Eagle Crest - Phase I apartment complex, property operating expenses increased during 1994 as compared to 1993. These expenditures fully offset the decrease from the property sale and a decrease resulting from lower painting costs at the Walnut Ridge - Phase I and II apartment complexes.\nAs a result of higher accounting and data processing fees combined with legal expenses incurred related to the North Cove bankruptcy proceedings, administrative expenses increased 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 primarily due to a special distribution to Limited Partners in October 1995 of $5,025,335 from Net Cash Proceeds. The Partnership's operating activities consisted primarily of cash flow generated from the operation of the properties and interest income on short-term investments, which were partially offset by the payment of administrative expenses. Investing activities consisted of the release of the cash collateral related to Desert Sands Apartments and proceeds from the sale of North Cove Apartments. Financing activities consisted of distributions to Limited Partners, principal payments on mortgage notes payable and activity associated with the refinancings of the Eagle Crest-Phase I and Deer Oaks Apartments mortgage loans.\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 of the Partnership's seven remaining properties generated positive cash flow. The North Cove Apartments, which was sold in June 1995, generated a marginal cash flow deficit during 1994 and 1995 prior to its sale. As of December 31, 1995, the occupancy rates of the Partnership's properties ranged from 93% to 97%.\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 the refinancing of mortgage loans, 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 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 reentry of REITs into the acquisition market. Since November 1995, the Partnership has entered into a letter of intent to sell one of its seven properties, and, if the market remains favorable, intends to begin actively marketing more of the 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.\nAlthough an affiliate of the General Partner has, in certain circumstances, provided loans for certain properties of the Partnership, there can be no assurance that loans of these types will be available from either an affiliate or the General Partner in the future. During 1997, approximately $734,000 of loan financing on the Walnut Ridge - Phase II Apartments with an affiliate of the General Partner matures.\nDuring January and June 1995, the Eagle Crest - Phase I and Deer Oaks apartment complexes' first mortgage loans, respectively, were refinanced. See Note 4 of Notes to Financial Statements 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. 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. As a result of the General Partner's efforts to obtain loan modifications as well as refinancings of many existing loans, the Partnership has no third party financing which matures prior to 1998.\nA restricted deposit in the amount of $700,000 was pledged as additional collateral related to the mortgage loan on the Desert Sands Apartments. The amount pledged as collateral was invested in short-term instruments pursuant to the terms of the pledge agreement with the lending institution and interest earned on this amount accumulated to the benefit of the Partnership. In March 1995, this restricted deposit was released and the accumulated interest was paid to the Partnership.\nDuring June 1995, the Partnership sold the North Cove Apartments for a sale price of $10,750,000, subject to the underlying mortgage loan, and received net proceeds of $785,831. See Note 9 of Notes to Financial Statements for additional information.\nIn January 1996, the Partnership paid $337,523 ($4.50 per Interest) to Limited Partners representing the quarterly distribution for the fourth quarter of 1995. The General Partner made four distributions totaling $85.00 and $18.00 per Interest during 1995 and 1994, respectively. Distributions were comprised of $18.00 of Net Cash Receipts during each of 1995 and 1994 and $67.00 of Net Cash Proceeds during 1995. To date, investors have received distributions of Net Cash Receipts of $75.50 and Net Cash Proceeds of $167.00, totaling $242.50 per $1,000 Interest, as well as certain tax benefits. The General Partner expects to continue quarterly distributions to Limited Partners based on the current performance of the Partnership's properties. However, the level of future distributions will depend on cash flow from the Partnership's remaining properties, 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 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 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. The timing of the long-term effects of inflation on real estate may be dictated by general or local economic conditions.\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 $42,023,971 $27,201,280 $55,306,162 $36,658,363 Partners' capital (deficit): General Partner (3,478,957) (4,314,868) (3,648,355) (5,449,072) Limited Partners (2,269,466) (14,860,814) 887,404 (14,646,823) Net income: General Partner 169,398 1,134,204 55,445 362,811 Limited Partners 3,218,557 6,161,448 1,053,455 54,555 Per Limited Part- nership Interest 42.91 82.15 14.05 .73\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-XIII, 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.\nParker 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-XIII, 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 then 5% of the outstanding Limited Partnership Interests of the Registrant:\nName and Amount and Address of Nature of Beneficial Beneficial Titled of Class Owner Ownership Percent of Class --------------- ----------- ----------- ----------------- Limited WIG 83 5,778.08 7.70% Partnership Partners Limited Interests Chicago, Partnership Illinois Interests\n(b) Balcor Partners-XIII and its officers and partners own as a group the following Limited Partnership Interests in the Registrant:\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nLimited Partnership 99 Interests Less than 1% Interests\nRelatives and affiliates of the officers and partners of the General Partner own 18 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 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 set forth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated December 10, 1982 (Registration No. 2-79043) is incorporated herein by reference.\n(4) Amended and Restated 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 10, 1982 (Registration No. 2-79043) 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. 0-11805) are incorporated herein by reference.\n(10) Agreement of sale relating to the sale of North Cove Apartments previously filed as Exhibit (2) to Registrant's Current Report on Form 8-K dated April 24, 1995 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 were 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 Schedules: See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR REALTY INVESTORS-83\nBy: \/s\/Brian D. Parker ------------------------------ Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XIII, 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-XIII, \/s\/Thomas E. Meador the General Partner March 28, 1996 - -------------------- -------------- Thomas E. Meador Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XIII, 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' Capital (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-83:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors-83 (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-83 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 REALTY INVESTORS-83 (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------ ------------ Cash and cash equivalents $ 2,734,729 $ 5,950,452 Restricted investment 700,000 Escrow deposits 1,694,777 1,560,542 Accounts and accrued interest receivable 64,523 97,846 Prepaid expenses 184,700 36,266 Deferred expenses, net of accumulated amortization of $702,304 in 1995 and $631,300 in 1994 648,778 597,642 ------------ ------------ 5,327,507 8,942,748 ------------ ------------ Investment in real estate: Land 8,885,606 10,560,405 Buildings and improvements 54,739,601 66,665,695 ------------ ------------ 63,625,207 77,226,100 Less accumulated depreciation 26,928,743 30,862,686 ------------ ------------ Investment in real estate, net of accumulated depreciation 36,696,464 46,363,414 ------------ ------------ $42,023,971 $ 55,306,162 ============ ============\nLIABILITIES AND PARTNERS' DEFICIT\nAccounts payable $ 141,244 $ 214,310 Due to affiliates 24,811 74,058 Accrued liabilities, principally real estate taxes 938,309 1,241,718 Security deposits 260,819 288,826 Mortgage note payable - affiliate 734,154 772,896 Mortgage notes payable 45,673,057 55,475,305 ------------ ------------ Total liabilities 47,772,394 58,067,113 ------------ ------------ Limited Partners' (deficit) capital (75,005 Interests issued and outstanding (2,269,466) 887,404 General Partner's deficit (3,478,957) (3,648,355) ------------ ------------ Total partners' deficit (5,748,423) (2,760,951) ------------ ------------ $ 42,023,971 $ 55,306,162 ============ ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1995, 1994 and 1993\nPartners' Capital (Deficit) Accounts ------------------------------------------ General Limited Total Partner Partners -------------- -------------- ------------\nBalance at December 31, 1992 $ (5,513,870) $ (3,853,506) $(1,660,364)\nNet income for the year ended December 31, 1993 2,994,111 149,706 2,844,405 -------------- -------------- ------------ Balance at December 31, 1993 (2,519,759) (3,703,800) 1,184,041\nCash distributions to Limited Partners (A) (1,350,092) (1,350,092) Net income for the year ended December 31, 1994 1,108,900 55,445 1,053,455 -------------- -------------- ------------ Balance at December 31, 1994 (2,760,951) (3,648,355) 887,404\nCash distributions to Limited Partners (A) (6,375,427) (6,375,427) Net income for the year ended December 31, 1995 3,387,955 169,398 3,218,557 -------------- -------------- ------------ Balance at December 31, 1995 $ (5,748,423) $ (3,478,957) $ (2,269,466) ============== ============== ============\n(A) Summary of cash distributions paid per Interest:\n1995 1994 1993 ------------- ------------- ------------- First Quarter $ 4.50 $ 4.50 None Second Quarter 4.50 4.50 None Third Quarter 4.50 4.50 None Fourth Quarter 71.50 4.50 None\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (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 $ 15,054,742 $ 15,796,390 $ 16,422,721 Interest on short-term investments 387,750 323,825 143,027 ------------- ------------- ------------- Total income 15,442,492 16,120,215 16,565,748 ------------- ------------- ------------- Expenses: Interest on mortgage notes payable 4,037,357 4,477,599 5,843,874 Depreciation 1,797,112 1,988,938 2,144,183 Amortization of deferred expenses 169,149 192,062 214,176 Property operating 5,970,865 6,935,788 6,287,619 Real estate taxes 1,300,427 1,446,103 1,582,090 Property management fees 753,664 789,447 824,080 Administrative 679,028 581,778 443,973 ------------- ------------- ------------- Total expenses 14,707,602 16,411,715 17,339,995 ------------- ------------- ------------- Income (loss) before gain on sale of property and extraordinary items 734,890 (291,500) (774,247) Gain on sale of property 2,711,565 3,768,358 ------------- ------------- ------------- Income (loss) before extraordinary items 3,446,455 (291,500) 2,994,111 ------------- ------------- ------------- Extraordinary items: Gain on forgiveness of debt 40,653 1,400,400 Debt extinguishment expenses (99,153) ------------- ------------- Total extraordinary items (58,500) 1,400,400 ------------- ------------- ------------- Net income $ 3,387,955 $ 1,108,900 $ 2,994,111 ============= ============= ============= Income (loss) before extra- ordinary items allocated to General Partner $ 172,323 $ (14,575) $ 149,706 ============= ============= ============= Income (loss) before extra- ordinary items allocated to Limited Partners $ 3,274,132 $ (276,925) $ 2,844,405 ============= ============= ============= Income (loss) before extra- ordinary items per Limited Partnership Interest (75,005 issued and outstanding) $ 43.65 $ (3.69) $ 37.92 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 ------------- ------------- ------------- Extraordinary items allocated to General Partner $ (2,925)$ 70,020 None ============= ============= ============= Extraordinary items allocated to Limited Partners $ (55,575)$ 1,330,380 None ============= ============= ============= Extraordinary items per Limited Partnership Interest (75,005 issued and outstanding) $ (0.74)$ 17.74 None ============= ============= ============= Net income allocated to General Partner $ 169,398 $ 55,445 $ 149,706 ============= ============= ============= Net income allocated to Limited Partners $ 3,218,557 $ 1,053,455 $ 2,844,405 ============= ============= ============= Net income per Limited Partnership Interest (75,005 issued and outstanding) $ 42.91 $ 14.05 $ 37.92 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (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 $ 3,387,955 $ 1,108,900 $ 2,994,111 Adjustments to reconcile net income to net cash provided by operating activities: Gain on forgiveness of debt (40,653) (1,400,400) Debt extinguishment expenses 99,153 Gain on sale of property (2,711,565) (3,768,358) Depreciation of properties 1,797,112 1,988,938 2,144,183 Amortization of deferred expenses 169,149 192,062 214,176 Deferred interest expense 323,214 Payments of deferred interest expense (377,109) Net change in: Escrow deposits (134,235) (367,273) (387,049) Accounts and accrued interest receivable 33,323 (87,622) 173,344 Prepaid expenses (148,434) 73,987 (75,022) Accounts payable (73,066) (53,813) (88,499) Due to affiliates (49,247) (37,417) 29,818 Accrued liabilities (303,409) (82,335) 48,926 Security deposits (28,007) (13,788) (8,331) ------------- ------------- ------------- Net cash provided by operating activities 1,998,076 1,321,239 1,223,404 ------------- ------------- ------------- Investing activities: Redemption of restricted investment 700,000 Improvements to properties (110,424) (93,545) Proceeds from sale of real estate 954,428 10,600,000 Payment of selling costs (168,597) (26,200) ------------- ------------- ------------- Net cash provided by or used in investing activities 1,485,831 (110,424) 10,480,255 ------------- ------------- ------------- Financing activities: Distributions to Limited Partners (6,375,427) (1,350,092) Proceeds from issuance of mortgage notes payable 11,980,000 3,000,000 11,043,750 Repayment of mortgage notes payable (11,254,363) (3,123,000) (10,916,567) Repayment of mortgage note payable - affiliate (38,742) (121,443) (3,837,920) Principal payments on mortgage notes payable (691,660) (1,607,633) (357,663) Payment of deferred expenses (276,285) (209,719) (275,200) Payment of prepayment premium (43,153) ------------- ------------- ------------- Net cash used in financing activities (6,699,630) (3,411,887) (4,343,600) ------------- ------------- -------------\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 ------------- ------------- ------------- Net change in cash and cash equivalents (3,215,723) (2,201,072) 7,360,059 Cash and cash equivalents at beginning of year 5,950,452 8,151,524 791,465 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 2,734,729 $ 5,950,452 $ 8,151,524 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-83 (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Realty Investors-83 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 reported 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\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.\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 modification and 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) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(g) Cash and cash equivalents include all highly liquid investments with an original maturity of three months or less when purchased. Cash and cash equivalents are held or invested primarily in one issuer of commercial paper.\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) 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 or 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized in December 1981; however, operations did not commence until February 1983. The Partnership Agreement provides for Balcor Partners-XIII to be the General Partner and for the admission of Limited Partners through the sale of up to 75,005 Limited Partnership Interests at $1,000 per Interest, all of which were sold as of March 28, 1983, the termination date of the offering.\nThe Partnership Agreement provides that the General Partner will be allocated 5% of the operating profits and losses and 1% of capital losses and the greater of 1% of capital profits or an amount equal to Net Cash Proceeds distributed to the General Partner. The Partnership has allocated 5% of capital profits (which are mainly a result of prior depreciation deductions) to the General Partner. This method more evenly matches deductions and the gain resulting from those deductions. 100% 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 5.26% of the total Net Cash Receipts being distributed, which will be paid only out of available Net Cash Proceeds.\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 the Limited Partners until such time as the Limited Partners have received an amount equal to their Original Capital plus any\ndeficiency in the Cumulative Distribution of 6% per annum on Adjusted Original Capital. Only after such returns are made to the Limited Partners would the General Partner receive 18% of further distributed Net Cash Proceeds including its accrued share of Net Cash Receipts, subject to certain limitations as specified in the Partnership Agreement.\n4. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 consisted of the following: Carrying 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 - Nonaffiliates:\nApartment Complexes:\nDeer Oaks (A) $4,777,636 $4,332,577 7.350% 2002 $33,071 $4,404,000 Desert Sands 9,034,548 9,272,229 6.498% 1998 66,166 8,472,000 Eagle Crest - Phase I (B) 7,140,577 6,939,000 9.621% 2002 61,008 6,776,000 North Cove (C) 9,831,545 (C) (C) (C) (C) Sandridge - Phase II (D) 2,971,144 2,991,895 9.125% 2001 24,409 2,816,000 Springs Pointe Village 10,902,316 11,174,573 6.498% 1998 79,845 10,209,000 Walnut Ridge - Phase I 5,764,108 5,810,155 8.940% 2000 46,968 5,498,000 Walnut Ridge - Phase II 5,082,728 5,123,331 8.940% 2000 41,416 4,848,000 ----------- -----------\nSubtotal 45,673,057 55,475,305 ----------- -----------\nMortgage Notes Payable - Affiliate: Apartment Complex:\nWalnut Ridge - 734,154 772,896 10.50% 1997 (E) 734,000 Phase II (E) ----------- -----------\nTotal $46,407,211 $56,248,201 =========== ===========\n(A) In June 1995, this loan was refinanced. The interest rate decreased from 10.00% to 7.35%, the maturity date was extended from October 1995 to July 2002 and the monthly payments decreased from $39,491 to $33,071. A portion of the proceeds from the new $4,800,000 first mortgage loan were used to repay the existing first mortgage loan of $4,315,363. In connection with the refinancing, a prepayment penalty of $43,153 was incurred and classified as debt extinguishment expense.\n(B) In January 1995, this loan was refinanced. The interest rate increased from 9.025% to 9.621%, the maturity date was extended from November 1994 to February 2002 and the monthly payments increased from $52,187 to $61,008. A portion of the proceeds from the new $7,180,000 first mortgage loan were used to repay the existing first mortgage loan of $6,939,000.\n(C) This property was sold to an unaffiliated party during June 1995. See Note 9 of Notes to Financial Statements for additional information. Prior to the sale, this loan had originally matured in June 1993 and the Partnership remitted the property's monthly cash flow as interest expense until the loan was refinanced in February 1994. Pursuant to the terms of the refinancing, the Partnership was required to remit $1,000,000 to the lender representing a principal reduction, and the lender forgave $466,926 of the principal balance and deferred interest of $933,474, reducing the principal balance from $11,366,926 to $9,900,000. This resulted in a $1,400,400 extraordinary gain on forgiveness of debt in 1994.\n(D) In July 1994, this loan was refinanced. The interest rate increased from 9.025% to 9.125%, the maturity date was extended from December 1994 to August 2001 and the monthly payments increased from $23,489 to $24,409. The proceeds from the new $3,000,000 first mortgage loan and cash reserves were used to repay the existing first mortgage loan of $3,123,000.\n(E) Represents an unsecured loan from The Balcor Company (\"TBC\"), an affiliate of the General Partner, as successor to Balcor Real Estate Holdings, Inc. The pay rate is equal to the net cash flow from the property and payments are applied first to interest and then to principal. The loan matured in December 1994, and TBC extended the loan for an additional three years.\nReal estate with an aggregate carrying value of $36,696,464 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, unless otherwise noted.\nFive-year maturities of the mortgage notes payable are approximately as follows:\n1996 $ 682,000 1997 1,467,000 1998 19,217,000 1999 275,000 2000 10,577,000\nDuring 1995, 1994 and 1993, the Partnership incurred interest expense on mortgage notes payable to non-affiliates of $3,962,845, $4,382,118 and $5,519,514, respectively. The Partnership paid interest expense to non-affiliates of $3,962,845 in 1995, $4,382,118 in 1994 and $5,312,292 in 1993.\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. Sellers' Participation in Joint Ventures:\nThe Deer Oaks and Eagle Crest - Phase I apartment complexes are owned by joint ventures between the Partnership and the respective sellers. Consequently, the sellers retain an interest in each property through their interest in each joint venture. All assets, liabilities, income and expenses of the joint ventures are included in the financial statements of the Partnership with the appropriate adjustment to income or loss, if any, for the sellers' participation in the joint ventures.\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. For 1995, the net effect of these accounting differences is that the net income in the financial statements is $3,907,697 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 ---------------- ---------------- ----------------\nPaid Payable Paid Payable Paid Payable -------- ------- -------- ------- -------- -------\nProperty management fees None None $721,999 None $806,815 $86,121 Reimbursement of expenses to General Partner, at cost: Accounting $58,817 $ 2,504 86,414 $30,902 59,807 4,984 Data processing 32,721 2,404 54,173 10,892 31,161 5,706 Investor communica- tions 7,620 None 20,528 5,964 18,471 1,539 Legal 30,838 2,549 13,567 8,702 13,841 1,153 Portfolio management 98,173 11,332 54,667 14,929 54,668 10,974 Property sales administration 12,043 5,932 None None None None Other 3,279 90 9,785 2,669 11,986 998\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, 1995, the Partnership has a $734,154 unsecured third loan outstanding to TBC. The Partnership incurred interest expense on the affiliate loans of $74,512, $95,481 and $324,360 and paid interest expense of $81,500, $164,371 and $381,585 during 1995, 1994 and 1993, respectively.\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 $97,533, $161,478 and $106,145 in 1995, 1994 and 1993, respectively.\n9. Property Sale:\nIn June 1995, the North Cove Apartments was sold for $10,750,000. In connection with the sale, the purchaser assumed the $9,795,572 third party first mortgage loan. The basis of the property was $7,869,838, which is net of accumulated depreciation of $5,731,055. For financial statement purposes, the Partnership recognized a gain of $2,711,565 from the sale of the property. In connection with the sale, the remaining unamortized deferred expenses in the amount of $56,000 were recognized as an extraordinary item and classified as debt extinguishment expense.\n10. Restricted Investments:\nA restricted deposit in the amount of $700,000 was pledged as additional collateral to the mortgage loan on the Desert Sands Apartments. The amount pledged as collateral was invested in short-term instruments pursuant to the terms of the pledge agreement with the lending institution and interest earned on this amount accumulated to the benefit of the Partnership. In March 1995, this restricted deposit was released and the accumulated interest was paid to the Partnership.\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.\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 approximates the carrying value.\n12. Extraordinary Items:\n(a) During 1995, the Partnership recognized an extraordinary gain on forgiveness of debt of $40,653 in connection with the settlement reached with the seller of the Springs Pointe and Desert Sands apartment complexes.\n(b) During 1995, the Partnership refinanced the Deer Oaks Apartments first mortgage loan. In connection with the refinancing, a prepayment penalty of $43,153 was incurred and classified as debt extinguishment expense.\n(c) During 1995, the Partnership sold the North Cove Apartments. In connection with the sale, the remaining unamortized deferred expenses in the amount of $56,000 were recognized as an extraordinary item and classified as debt extinguishment expense.\n13. Subsequent Events:\n(a) In January 1996, the Partnership made a distribution of $337,523 ($4.50 per Interest) to the holders of Limited Partnership Interests for the fourth quarter of 1995.\n(b) The Partnership reached a settlement with the seller of the Deer Oaks Apartments in February 1996. In connection with this settlement, the Partnership received $208,250 representing amounts due from the seller under the management and guarantee agreement, as well as construction defects at the property.\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 REALTY INVESTORS-83 (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS-83 (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 and real estate taxes.\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) The aggregate cost of land for Federal income tax purposes is $8,862,383 and the aggregate cost of buildings and improvements for Federal income tax purposes is $50,554,229. The total of these is $59,416,612.\nReconciliation of Real Estate (e) ----------------------------- 1995 1994 1993 ----------- ----------- ----------- Balance at beginning of year: $77,226,100 $77,115,676 $87,572,161\nAdditions during year: Improvements None 110,424 93,545 Deductions during year: Cost of real estate sold (13,600,893) None (10,550,030) ----------- ----------- ----------- Balance at close of year $63,625,207 $77,226,100 $77,115,676 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------- 1995 1994 1993 ----------- ----------- -----------\nBalance at beginning of year $30,862,686 $28,873,748 $30,474,153\nDepreciation expense for the year 1,797,112 1,988,938 2,144,183 Accumulated depreciation of real estate sold (5,731,055) None (3,744,588) ----------- ----------- ----------- Balance at close of year $26,928,743 $30,862,686 $28,873,748 =========== =========== ===========\n(f) Depreciation expense is computed based upon the following estimated useful lives:\nYears ----- Buildings and improvements 20 to 30 Furniture and fixtures 5","section_15":""}
{"filename":"64674_1995.txt","cik":"64674","year":"1995","section_1":"Item 1.\tBusiness\nCement Industry Overview\nPortland cement is the essential binding material used in making concrete, which is widely used in residential and non-residential construction and in public works and infrastructure projects. Cement is sold primarily in bulk form to producers of ready-mix concrete and manufacturers of concrete products.\nCement is made in a multi-stage process that begins with the crushing, grinding and mixing of calcium (usually in the form of quarried limestone), sand, alumina, iron oxide and other materials. This raw materials mixture is then reacted in rotary kilns at extremely high temperatures. The resulting marble-size pellet material (called \"clinker\") is cooled and ground with a small amount of gypsum to produce cement having the consistency of fine powder.\nThere are two basic methods of clinker production. The older \"wet\" process involves mixing the raw materials with water to form a slurry that is reacted in the kiln. This process involves the use of a large amount of fuel, but enables the raw materials to be handled and mixed easily. In the more fuel-efficient \"dry\" process, the slurrying step is eliminated and clinker is produced by reacting only the dry raw materials. Even more fuel-efficient processes involve preheater and preheater\/precalciner techniques that recycle excess heat from the kiln to either preheat or to enhance chemical reaction of the raw materials prior to their introduction into the kiln. The company estimates that, in general, the energy consumed to produce cement from a dry process preheater\/precalciner kiln is approximately 40% less than a wet process kiln. All the company's kilns use the dry process.\nAccording to the United States Bureau of Mines' current report, the average price of a ton of portland cement in 1994, F.O.B. the point of sale, was $55.40. Cement markets tend to be regional because of the low price of cement relative to its weight, making cost of transportation an important factor in the industry. The company estimates that the approximate distance that one ton of cement can be transported for the same relative cost is 500 miles by vessel, 60 miles by rail and 20 miles by truck. As a result, cement plants whose products can be transported only by truck or rail tend to serve relatively small geographic markets (typically not in excess of a 200 mile radius of the plant), while plants with access to water transportation are able to efficiently serve considerably larger geographic markets. The market served by a cement plant may be extended through the use of distribution terminals to which cement is transferred in bulk and inventoried for sale to customers in surrounding areas.\nPART I\nItem l. Business (continued)\nDemand\nDemand for cement is correlated to cyclical construction activity, which, in turn, is influenced largely by national and regional economic conditions, including (particularly in the case of residential construction) prevailing interest rates. In addition, levels of government spending on infrastructure improvement affect cement consumption. Demand for cement is also seasonal, particularly in northern markets where inclement weather affects construction activity. According to the Portland Cement Association (\"PCA\"), total annual cement consumption (i.e.: the total demand for both portland and masonry cements) in the United States over the past 20 years has ranged from a low of 65.5 million tons in 1982 to a high of 95.0 million tons in 1995, generally corresponding to the prevailing economic conditions and construction activity. Portland cement consumption in the United States in 1995 was estimated at 91.7 million tons, of which approximately 21% was used in residential construction, 24% in non-residential construction, and the remainder in public construction, such as infrastructure.\nThe company believes increased government spending on infrastructure improvement should have a favorable impact on future cement demand. Enactment of the Intermodal Surface Transportation Efficiency Act of 1991, which authorized the appropriation of federal funds primarily for construction and improvement of highways, bridges and mass transit systems, reflected Congressional recognition of the need for national infrastructure repair and replacement. Future demand for cement for infrastructure improvement will depend on the level of funding made available for such purpose by federal, state and local governments.\nSupply\nAccording to current statistics published by the PCA, United States clinker production capacity decreased from 91.1 million tons to 83.1 million tons, or by approximately 9%, from 1975 to 1994. Statistics published by the United States Bureau of Mines and the PCA indicate that from 1975 to 1994 the number of cement companies operating in the United States has dropped from 57 to 47, and in 1994 the 10 largest of such companies accounted for approximately 59% of total United States production capacity for clinker. The company believes that domestic production will remain inadequate to meet demand going into the next century. With an approximate 7.7 million ton shortfall between supply and demand, imports will continue to be needed to supplement domestic demand. That shortfall, the company believes, is due principally to the unfair dumping of imports into the United States during the 1980's, when the domestic industry was forced to divest itself of a significant portion of its capacity. Presently, with the dumping duties imposed PART I\nItem l. Business (continued)\nagainst offenders by the International Trade Commission in 1990 and 1991, the United States industry is becoming healthier and is beginning to be able to afford to reinvest in itself. However, because of the extent of capital investment required and the long lead times associated with establishing new or re-opening closed facilities, the company does not expect that significant additional domestic cement production capacity will be added unless cement prices increase significantly on a sustained basis over current levels.\nImports of cement and clinker, which have had the most impact on markets along coastal and southern border areas of the United States, with ripple effects elsewhere, have varied from a high of 19% of total United States consumption in 1987 to a low of 8% in 1992, to an estimated 16% in 1995, according to the latest Bureau of Mining figures. Factors influencing imports have included the effect of anti-dumping actions brought against several foreign importers, which resulted in the imposition of substantial duties on cement and clinker imports from various countries beginning in 1990, changes in domestic and foreign demand, rising ocean shipping rates, and the decline in the value of the United States dollar relative to other currencies. Increased ownership of import facilities by domestic producers has also contributed to a more orderly flow of imports into the United States.\nCement production is capital-intensive and involves high fixed costs. As a result, plant capacity utilization levels are an important measure of a plant's profitability, since incremental sales volumes tend to generate increasing profit margins. The PCA has estimated that total United States cement plant capacity utilization was 90.0% for 1995.\nPrice Trends\nDue to the lack of product differentiation, competition in the cement industry is based largely on price. Service and location of plants and terminals are also competitive factors. Notwithstanding favorable construction activity during the 1980's, cement prices remained relatively low due to the impact of lower-priced imported cement. Until 1993, United States portland cement prices remained flat due to the downturn in general economic conditions and consequent declines in construction activity. However, gradual improvement in the United States economy, coupled with reduced domestic production capacity and lower levels of imported cement, have led to supply and demand relationships more favorable to cement producers, resulting in increased cement prices. In 1995, due to heavy demand coupled with limited domestic supply, the company was able to increase prices by 12% over 1994 levels, with price increases of up to $5.00 per ton in most of our markets on April 1, 1994, increases up to $5.00 per ton on August 1, 1994 in our Southeastern markets and another increase of $5.00 to $8.00 per ton on April 1, 1995, in most of our markets. The company expects PART I\nItem l. Business (continued)\nthese favorable market conditions to continue in 1996 and have announced cement price increases of up to $5.00 per ton, effective April 1, 1996, in most of its markets.\nGeneral\nThe company produces and sells gray portland cement and masonry cement; and, through various wholly-owned subsidiaries, mines, processes and sells coarse aggregates (crushed stone), fine aggregates (aglime) and high calcium limestone products. The company also provides construction services for highway safety. The company's operations are conducted principally in the eastern half of the United States. During the past five years, cement, aggregates and limestone, and highway safety operations accounted for approximately 69% to 80%, 14% to 20%, and generally less than 10%, respectively, of the company's consolidated net sales. From 1991 through 1995, Medusa's quarterly sales as a percentage of annual sales have ranged from 12% to 16% during the first quarter and from 32% to 34% during the third quarter.\nConstruction activity increased modestly in 1995, in spite of concern over high interest rates, which led to a slowdown in the housing sector. As indicated, tight supply conditions along with record demand resulted in upward pricing and record profits. The company expects the construction cycle to continue its upward trend in 1996, highlighted by a modest housing recovery and slight increases in infrastructure and commercial activity. Infrastructure construction and, to a lesser extent, commercial building, appears to be less sensitive to interest rates than housing. The housing sector provides about one quarter of the company's sales volume.\nIn an effort to satisfy the strong product demand, our four cement plants achieved a 95.0% capacity utilization. The company's focused business strategy, the principal elements of which are: a concentration on its core business, a constant drive to lower operating costs, centralization of pricing decisions and the maintenance of a lean management organization, enable the company to position itself to capitalize upon favorable market conditions. In furtherance of that strategy, the company expects to realize more of the benefits from the completion in 1996 of about half of the several projects designed to incrementally increase cement capacity by 6-8%.\nCement Operations\nThe company ranks eighth in capacity among all United States cement companies and fourth in capacity among those domestically owned. The company's cement operations serve markets in portions of the Great\nPart I\nItem l. Business (continued)\nLakes, the Southeast and the Western Pennsylvania\/Northeastern Ohio portions of the United States.\nRegional Markets\nGreat Lakes. The Great Lakes regional market, consisting of portions of Michigan, Wisconsin, Ohio, Illinois, Indiana and Ontario, is served by the company's Charlevoix plant and its distribution network of ten terminals, eight of which are water based. Demand in the Great Lakes region has been steady, with very little new production capacity added in recent years.\nManagement believes that the Charlevoix plant is among the lowest cost cement production facilities in the Great Lakes region. This is due to its use of a single modern preheater\/precalciner kiln which provides significant energy savings over other dry and wet process kilns. In 1995, Charlevoix implemented an artificial intelligence kiln control system and an automated process control instrumentation system to enhance productivity and reduce operating costs. The layout of the plant also results in an efficient utilization of manpower. Charlevoix's deep-water shipping location and water-based terminals enable 95% of cement produced to be shipped by water, the lowest cost method of long-distance distribution, via the Medusa Conquest or the Medusa Challenger. These company owned vessels have a combined capacity of 20,000 tons. The company has made substantial distribution improvements that include the conversion of the company's cement barge, the Medusa Conquest, in 1987, and its subsequent modification to a more efficient tug\/barge system in 1992. This subsequent modification increased the utilization of the barge by enabling it to operate in inclement weather. The company has also expanded its distribution system with the construction of the Toledo, Ohio terminal in 1985, the Owen Sound, Ontario terminal in 1991, and the doubling of the capacity of the Cleveland, Ohio terminal in 1992.\nSoutheast. The company has two plants and nine terminals (excluding the Orlando, Florida facility closed in February, 1995) in the Southeast regional market: the Clinchfield, Georgia plant, acquired from Penn Dixie Corporation and extensively rebuilt in 1972, and the Demopolis, Alabama plant, built in 1977 and acquired from Lafarge Corporation in February 1993. The Demopolis plant serves water-based terminals in Chattanooga, Tennessee and Decatur, Alabama with up to six river barges. Together, the two plants also serve seven rail\/truck terminals in Alabama, Florida and Georgia. The two plants should benefit from the completion in mid-1996 of a new cement terminal in Atlanta, Georgia. This new facility will replace the current terminal and will have increased storage capacity and more efficient rail unloading capabilities that will lower handling costs. Since the plants are\nPART I\nItem l. Business (continued)\nlocated 240 miles apart, a number of marketing and manufacturing synergies exist, including the ability to alternatively ship to seven terminals, to specialize in certain cement products and packaging, and to rationalize distribution in what are the two plants' overlapping markets.\nLargely because both the Demopolis and Clinchfield plants operate energy-efficient preheater kilns, management believes that they are among the lowest cost production facilities in the region. In 1995, the Demopolis plant burned waste derived liquid fuel (WDLF) for 27% of its current fuel needs. The Clinchfield plant burns waste whole tires as an alternative kiln fuel and has been able to reduce its coal usage by 10%.\nWestern Pennsylvania\/Northeastern Ohio. The company's Wampum plant is located between Pittsburgh, Pennsylvania and Youngstown, Ohio, serving markets as far east in Pennsylvania as State College, as far south as Wheeling, West Virginia, and as far west in Ohio as Columbus. While demand in this region continues to grow slowly, supply has remained relatively constant, with no new plants or major capacity expansions having occurred in the last five years or expected by management in the foreseeable future.\nManagement believes that the Wampum plant's three dry kilns give it an operating cost advantage over its wet process competitors in the region. The Wampum plant also had the advantage in 1995 of obtaining about 21% of its coal needs from its nearby limestone quarry which contains coal reserves. Since 1985, the Wampum plant has burned WDLF, supplying 31% of its fuel needs in 1995. The company erected at the Wampum limestone quarry a large (40-cubic yard) dragline, replacing two smaller less efficient units. This $7.0 million capital improvement was placed in operation in April 1994.\nEnergy\nCement manufacturing is an energy intensive process, using fuel to fire kilns and electricity to grind raw materials into kiln fuel and clinker into finished cement. The company has been an innovator in burning alternative fuels, such as WDLF and whole tires at its plants as a coal replacement. The company has burned whole tires at its Clinchfield plant since 1990. The company has entered into arrangements with independent contractors (which, in turn, contract with suppliers of alternative fuel) which allow the company to reduce its energy costs by receiving WDLF either at a profit through tipping fees or at a nominal charge. In 1985, at its Wampum cement plant, the company became one of the first such facilities to burn WDLF. The company also burns WDLF at its Demopolis plant. The favorable economics of burning WDLF are significantly influenced by the tipping fees, which have been declining,\nPART I\nItem l. Business (continued)\nthe cost of environmental regulation, which has been increasing and a small reduction in maximum clinker output when burning WDLF. The company is constantly evaluating the potential for and use of alternative fuels in its ongoing effort to help conserve scarce natural resources, utilize waste in a productive capacity and reduce materials that might otherwise take up valuable space in landfills. The company will use alternative fuels where it is environmentally and economically prudent and provided it continues to permit the company to maintain the safe and profitable operation of its facilities. The company also seeks to minimize its energy costs by running its grinding mills, whenever possible, during off-peak demand periods.\nCustomers and Marketing\nThe company's cement operations have over 1,350 customers which are primarily ready-mix concrete dealers. No single customer accounts for more than 6% of total consolidated sales. The company's marketing efforts are focused on maximizing profitability, rather than market share. This sales strategy is facilitated by the company's policy that pricing decisions (including the decision whether to meet lower competitive prices) are made only in the company's Cleveland headquarters. Further, decisions whether to extend credit are made centrally by financial management. Sales personnel are critical in developing and maintaining relationships with, and providing technical assistance to, customers. They also facilitate production planning by meeting with customers regularly to discuss future requirements.\nConstruction Aggregates\nThrough a wholly-owned subsidiary, Medusa Aggregates Company, the company operates nine crushed stone plants in Bardstown, Butler, Bowling Green (two plants) and Hartford, Kentucky; Columbia, Missouri; Lenoir, North Carolina; and West Pittsburg, Pennsylvania. These operations mine, crush, screen and sell various sizes of aggregates to the construction industry, primarily to road builders for use in asphalt and concrete paving, road and base material, drainage blankets, erosion control and assorted small-volume applications. The company is a major supplier of these products in all of the markets in which it operates. Management believes the company to be among the low-cost producers in its primary markets and that it has achieved this result through constant review of its competitive position and the installation of cost improving plant modifications. The total capacity of the company's aggregate plants is approximately 3,400 tons per hour, or in excess of 5 million tons annually. Approximately 15% of the company's total construction aggregate capacity is covered by mineral reserves of over\nPart I\nItem l. Business (continued)\n50 years, 32% is covered by reserves of from 25 to 50 years, 27% is covered by reserves from 10 to 25 years and 26% is covered by reserves under 10 years. Most aggregates are generally sold within a radius of 25 miles of the plant and are shipped to customers primarily by truck.\nIn 1995, the company closed its sand and gravel plant at Edinburg, Pennsylvania, which was experiencing continued operating losses.\nIndustrial Materials\nThrough a wholly-owned subsidiary, Thomasville Stone and Lime Company (\"Thomasville\"), the company mines and processes high calcium limestone from an underground deposit possessing chemical purity and whiteness at Thomasville, Pennsylvania. Chemical grade limestone is used by customers to manufacture white cement, supply calcium for livestock and poultry feeds, and neutralize soil for more efficient crop production. White stone is pulverized to a fine powder and used in joint compound, caulk, carpet padding, floor tile and paper. Chemical stone is packaged for lawn application and white stone is processed and packaged for use as a decorative mulch by homeowners and landscaped contractors. Limestone which does not meet chemical and color specifications is reduced to powder and used as a filler by manufacturers of asphalt shingles. Industrial minerals are marketed primarily in the mid- Atlantic states. Thomasville now has 14 products serving over 30 specialized agricultural, white cement, home improvement, consumer products and environmental markets.\nHighway Safety Construction\nThe James H. Drew Corporation (\"Drew\"), a wholly-owned subsidiary of the company, operates generally in the mid-western states installing highway safety systems such as guardrail, traffic signals, signs, highway lighting and raised pavement markers. Although Drew functions primarily as a subcontractor to paving and bridge contractors, approximately 30% of its work is bid directly to state highway departments and municipalities.\nCompetition\nGenerally, market conditions in the cement and construction aggregate industry are cyclical and highly price-competitive. Because there is generally no product differentiation, these products are marketed as commodities, with price the principal method of competition. To some extent, factors other than price, such as service, delivery time and proximity to the customer are competitively important. The number and\nPART I\nItem l. Business (continued)\nsize of the company's competitors differ from market area to market area. The company estimates that it competes with 28 cement manufacturers in its overall market areas and between 5 and 10 producers within each sales region. Competitors include domestic and foreign producers and importers. Because cement has a low value-to-weight ratio, cement companies with access to water-based transportation have a significant advantage in shipping over land-locked plants and terminals.\nShort-Term Borrowings\nDuring 1995 and 1994, the company had no short-term borrowings. In 1993, short-term borrowings' weighted average interest rate was 5.08%.\nCapital Expenditures\nIn 1995, Medusa's capital expenditures were approximately $21.2 million in its cement operations and $3.9 million in its aggregates operations. For 1994, Medusa's capital expenditures were approximately $12.0 million in its cement operations and $2.1 million in its aggregates operations.\nBacklog\nBacklog for Medusa and its subsidiaries totaled approximately $12.2 million as of December 31, 1995, compared with $10.5 million as of December 31, 1994. Management does not believe that backlog is material to an understanding of Medusa's business, because long-term contracts generally comprise only a small portion of total sales.\nRaw Materials\nThe principal raw materials used by the company in the manufacture of cement are limestone or other calcareous materials, clay or shale, sand, iron ore, and gypsum. Owned reserves of limestone and clay or shale are available at or near all of the company's cement plants, while other raw materials are readily available for local purchase by the company at all of its plant locations.\nEmployees\nAs of December 31, 1995, the company had about 1,100 employees. The company's business is seasonal and employment therefore declines from August 31 to December 31 of each year. Most of the company's hourly employees in its cement operations are represented by labor unions. During 1994, the company entered into new four-year labor agreements with the local union of the United Cement, Lime, Gypsum and Allied Workers Division (International Brotherhood of Boilermakers, Iron Ship\nPART I\nItem l. Business (continued)\nBuilders, Blacksmiths, Forgers and Helpers, AFL-CIO) covering the hourly workers at the Clinchfield and Charlevoix plants, expiring April 30, 1998. Contracts with the locals of the same national union covering the hourly employees at the Wampum and Demopolis plants expire on April 30, 1996. The contract with the United Steel Workers of America Local #13051-7 covering Thomasville hourly employees expires on March 31, 1996.\nEnvironmental Matters\nCharlevoix Plant\nFuel Release. On June 21, 1991, the Company discovered and immediately filed a report with the Michigan Department of Natural Resources (\"MDNR\") relating to a release of #2 fuel oil which occurred on the property of the Charlevoix plant. The matter was investigated both by the MDNR and the U.S. Environmental Protection Agency, Region 5 (\"EPA\"), and such investigations have been completed. Under MDNR supervision, the Company immediately began to undertake preventive measures to preclude migration of the oil off the plant property or to surface water. Available data indicate that these measures are working to preclude such migration. The MDNR has requested that the Company make a proposal for long-term remediation of the oil release. The company has retained environmental remediation consultants to conduct a study for review by the MDNR. In December 1993, the company established on its books a contingent liability for $1.4 million, or $.06 per common share, for environmental remediation of the release of #2 fuel oil. This charge represents the company's current estimate of such remediation costs. As additional information becomes available, changes in the estimate of that liability may be required. The company is continuing to examine remediation alternatives at the site, none of which at this time are expected to have any material effect on the company's financial condition, results of operations, or liquidity.\nPrevention of Significant Deterioration. On September 8, 1994, the company received a Notice of Violation (\"NOV\") from the EPA. The NOV alleged the company's Charlevoix, Michigan cement plant to be in violation of the Michigan State Implementation Plan and Part C of the federal Clean Air Act with respect to Prevention of Significant Deterioration (\"PSD\"), concerning sulphur dioxide (\"SO2\") emissions. The company modified the Charlevoix plant in 1978 without filing for PSD review in reliance upon a consultant's advice that SO2 emissions would not increase. Recent emissions tests, disclosed to the Michigan Department of Natural Resources (\"MDNR\") and the EPA, indicate that SO2 emissions did increase. A study by an independent consultant\nPart I Item l. Business (continued)\ndemonstrates that the current SO2 emissions from the Charlevoix plant do not violate either the PSD increment or the National Ambient Air Quality Standard. Therefore, neither the health, safety and welfare of the community nor the environment are impaired. The company has filed for a revised air emissions permit and is cooperating with MDNR and EPA investigations.\nCement Kiln Dust. On February 1, 1995, the EPA announced its decision to regulate Cement Kiln Dust (\"CKD\") as a hazardous waste under Subtitle C of the Resource Conservation and Recovery Act (\"RCRA\"), using tailored regulations site-specific to each U.S. cement plant. CKD is a product of cement kilns which is collected in air emissions control devices (baghouses and electrostatic precipitators). Previously, CKD had been exempt from regulation as a hazardous waste under an 1980 amendment to RCRA (the so-called \"Bevill Amendment\") as a high volume\/low toxicity solid waste. The cement industry, including the company, have offered a contract to EPA (on an individual company and cement plant site basis) which would be used in lieu of EPA-promulgated regulation to enforce certain voluntary CKD landfill disposal guidelines previously developed by the cement industry. Until either the contract or the regulation becomes enforceable, CKD remains exempt from regulation as a hazardous waste under the Bevill Amendment. While the disposal standards contained in the regulation\/contract and the effective date of the regulation\/contract remain uncertain, the company nonetheless made a preliminary review to determine whether or not the regulation\/contract is likely to have a material effect on the company's results of operations, financial condition or liquidity. The company has preliminarily concluded that the CKD regulation\/contract is unlikely to have a material effect on the operations of the company's Demopolis, Alabama, Clinchfield, Georgia and Wampum, Pennsylvania cement plants. However, based upon the significant volume of CKD currently generated at the company's Charlevoix, Michigan cement plant and the characteristics of the local geology, the company cannot now conclude, based upon its preliminary evaluation, whether or not the CKD regulation\/contract is likely to have a material effect on Charlevoix plant operations. Moreover, due to the size and importance of the Charlevoix plant to the company's overall operations, the company is currently unable to determine whether or not the CKD regulation\/contract is likely to have a material effect on the company's results of operations, financial condition or liquidity. The company has begun the process of evaluating raw material replacements at the Charlevoix plant which could reduce the generation of CKD. The company is also cooperating with other members of the cement industry to seek a reversal of the EPA's February 1, 1995, action via judicial or legislative means.\nOpacity Notification. On January 2, 1996, the company received a notification from the Pennsylvania Department of Environmental\nPART I\nItem l. Business (continued)\nProtection (\"PaDEP\"), advising the company that it should expect substantial civil penalties for opacity violations at the Wampum Plant during calendar 1995. Although fourth quarter 1995 penalties are not yet available, calendar 1995 penalties are estimated to be between $100,000 and $200,000. \"Opacity\" is a somewhat subjective assessment of air emissions, generally used by regulatory officials as an indicator of particulate (dust) emissions. Officials of the company have conferred with officials of PaDEP. The company is closely monitoring its manufacturing procedures and conducting a higher level of preventive equipment maintenance. Currently, it is premature to conclude whether any material capital improvements will be necessary to attain compliance with PaDEP's opacity requirements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nMedusa's principal physical properties are utilized by its cement manufacturing operations.\nThese operations consist of four cement plants and a total of 20 distribution terminals (excluding Orlando, Florida terminal closed February 1995). All four of the company's plants are fully integrated, from limestone mining through bulk cement production, and all possess at least 50 years of limestone reserves. The annual rated cement and clinker capacities of Medusa as of February 28, 1996, are shown in the following table:\nRegional\t\t\tCapacity in Tons Market \tPlant Location\t Clinker \t Cement \tKiln Type Great Lakes\tCharlevoix, Michigan\t 1,395,000\t1,465,000\t\tPreheater\/precalciner Southeast\tDemopolis, Alabama\t 814,000\t858,000\t\tPreheater Southeast\tClinchfield, Georgia\t603,000 \t809,000\t\tPreheater W. PA\/N.E. OH\tWampum, Pennsylvania\t 722,000\t 750,000\t\tLong-Dry \t\t \t\t3,534,000\t3,882,000\n\"Annual rated capacity\" is defined as the annual output of cement or clinker theoretically to be achieved from full operation of a facility after giving consideration to such factors as down-time for regular maintenance, location and climatic conditions bearing upon the number of days per year during which the particular plant may be expected to operate, and actual historical performance. Cement plant capacities are evaluated periodically taking into account actual experience in producing cement, plant modifications and innovations, and other factors.\nDuring 1996, the company plans to continue demolishing its wet process kiln at Clinchfield. This kiln has not been operated in over 10 years.\nThe company's cement plants, as a group, operated at 95.0% of annual rated clinker capacity in 1995 (91.2% in 1994). Part I\nProperties (continued)\nThe Wampum and Clinchfield cement manufacturing plants are equipped to ship products by either rail or truck. The Charlevoix plant can ship products by water or truck. The Demopolis plant can ship products by water, rail or truck, The plants are well maintained and in good operating condition. There have been no physical changes in quarrying techniques over the past several years, nor is it anticipated that there will be any changes which would materially affect the cost of production. All plants operate their own quarries, located adjacent to each of the plants.\nDuring 1995, The company operated at 37 locations in 13 states and Canada. Property, including those described above, is as follows:\nNumber of buildings 284 Square feet of buildings 1,291,543 Total acreage 14,993\nOf the total acreage above, approximately 786 acres are leased.\nItem 3.","section_3":"Item 3. Legal Proceedings\nSee also \"Environmental Matters\" section under Item 1. Business, above.\nAntitrust Investigation\nOn March 3, 1994, the company received a Civil Investigative Demand (\"CID\") from the Atlanta, Georgia office of the U.S. Department of Justice, Antitrust Division (\"USDOJ\"). The CID was apparently part of a nationwide investigation of what is believed to be virtually the entire domestic U.S. cement industry. On November 9, 1995, the company received notice from the USDOJ of the termination of its investigation.\nPART I\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.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the registrant are as follows:\nRobert S. Evans\t Chairman and Chief Chairman & Chief Executive\t 52 \t Executive Officer Officer, Medusa Corporation: \t\t Chairman and Chief Executive \t\t Officer, Crane Co. (Diversified \t\t Manufacturer of Engineered \t\t Products).\nGeorge E. Uding,\t President and Chief\t President and Chief Operating\t64 Jr.\t Operating Officer\t Officer of the company; \t\t formerly Senior Vice President, \t\t Essroc Corporation. \t\t Robert J. Kane \tSenior Vice\t Senior Vice President of the 46 \t President\t Company and President of Medusa \t\t Cement Group; previously Vice \t\t President of the company and \t\t President of Medusa Aggregates \t\t Group; Vice-President and \t\t Controller of Medusa Aggregates \t\t Company, a subsidiary.\nJohn P. Siegfried\t Vice President\t Vice President, Secretary\t\t57 \t Secretary and\t and General Counsel of the \t General Counsel\t company; previously Corporate \t\t Attorney and Assistant Secretary \t\t of the company.\nDennis R. Knight\t Vice President\t Vice President of the company;\t50 \t\t and President of Medusa \t\t Aggregates group; formerly \t\t Regional Vice President - \t\t General Manager Vulcan Materials \t\t (Wisconsin, Indiana, Central \t\t Illinois and Iowa).\nPART I\nItem 4. Submission of Matters to a Vote of Security Holders \t\t(continued)\nR. Breck Denny\t Vice President\t Vice President-Finance and\t\t47 \t Finance and\t Treasurer, (Chief Financial \t Treasurer\t Officer) of the company; previously Director of \t\t Strategic Planning, Medusa Corporation; formerly Vice President - Advisory, Mergers and Acquisitions, J.P. Morgan\nAlan E. Redeker \tVice President \tVice President of the company\t52 \t\t and Vice President \t\t Manufacturing, Medusa Cement \t\t Company, a division; formerly \t\t General Manager of Northern \t\t California operations of \t\t Associated Concrete Products \t\t and held various positions at \t\t Kaiser Cement Corporation.\nRichard A. Brown\t Vice President\t Vice President - Human\t\t48 \t\t Resources of the company; \t\t previously Director of \t\t Human Resources\nAll executive officers serve at the pleasure of the Board of Directors with no fixed term of office.\n\tPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Shares and Related Stockholder Matters\nMarket prices and dividends paid for the company's common shares are hereby incorporated by reference to page 20 of the 1995 Annual Report to Shareholders. The number of shareholders is 5,638 as of January 31, 1996. On February 26, 1996, the Board of Directors increased the company's quarterly dividend 20% to $.15 per common share. Prior to this action the dividend was $.125 per common share since February 26, 1994 and since the third quarter of 1991 the company had paid regular quarterly dividends of $.067 per share. There were no cash dividends prior to the third quarter 1991 since the spin-off in October 1988.\nItems 6 through 8. Selected Financial Data; Management's Discussion and Analysis of Results of Operations and Financial Condition; Financial Statements and Supplementary Data\nIn addition to the discussion below, the information required by Items 6 through 8 is hereby incorporated by reference to pages 9 through 20 of the 1995 Annual Report to Shareholders.\nThe company has assessed that a work stoppage could occur at any one or all of the three locations currently involved in labor negotiations as indicated under Part 1, Item 1. Business, \"Employees,\" pages 9 and 10 of this report. Collectively, the three operations accounted for approximately 40% and 43% of consolidated 1995 net sales and operating profit, respectively. The company in not now able to quantify whether a work stoppage at any facility would have a material effect on the company's future financial results. Clearly, if all three facilities are affected, the effect would be the greatest. The company has developed contingency plans to continue operations at each of the three locations in the event of a work stoppage at any one of them.\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\n\tNone\n\tPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. (a)Directors of Registrant\nThe information required by Item 10(a) has been omitted from this report as the company will file with the Commission a definitive proxy statement pursuant to Regulation 14A.\n(b)Executive Officers of the Registrant\nIncluded pursuant to Instruction 3 to paragraph (b) of Item 401 to Regulation S-K under Part I above.\n\tPART III Item 11.","section_11":"Item 11. Executive Compensation\nThe information required by Item 11 has been omitted from this report as the company will file with the Commission a definitive proxy statement pursuant to Regulation 14A.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 has been omitted from this report as the company will file with the Commission a definitive proxy statement pursuant to Regulation 14A.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by Item 13 has been omitted from this report as the company will file with the Commission a definitive proxy statement pursuant to Regulation 14A.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nPage a)Financial Statements and Schedules\nThe consolidated balance sheets of Medusa Corporation and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, shareholders' equity and of cash flows for each of the three years in the period ended December 31, 1995 and the Independent Auditors' Report relating thereto, appearing on Pages 9 through 17 of Medusa Corporation's 1995 Annual Report to Shareholders are incorporated herein by reference.\nIndependent Auditors' Report on Financial Statement Schedule...\t19\nSchedule VIII Valuation and Qualifying Accounts................\t20\nAll other statements and schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because they are not required under related instructions or are inapplicable, or the information is shown in the consolidated financial statements and related financial review.\n(b) No Reports on Form 8-K were filed during last quarter of 1995:\n(c) Exhibits to Form 10-K: Exhibit 11 - Statement Re Computation of Per Share Earnings PART IV\nExhibit 13 - Annual Report to Shareholders for the Year Ended December 31, 1995 Exhibit 21 - Subsidiaries of the Registrant\nPART IV\n(d) Financial Statements Required by Regulation S-X which are excluded from the Annual Report to Shareholders by Rule 14a-3(b):\nNot applicable.\nSIGNATURES\n\tPursuant 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.\nMEDUSA CORPORATION (Registrant)\nRobert S. Evans Robert S. Evans Chairman, Chief Executive Officer and a Director\nDate March 25, 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.\n- -Officers-\nR. Breck Denny George E. Uding, Jr. Edward A. Doles R. Breck Denny George E. Uding, Jr. Edward A. Doles Vice President-Finance President, and Chief Corporate Controller and Treasurer Operating Officer and a Director\nDate March 25, 1996 Date March 25,1996 Date March 25, 1996\n- -DIRECTORS-\nMone Anathan, III E. Thayer Bigelow, Jr. Richard S. Forte' Mone Anathan, III E. Thayer Bigelow, Jr. Richard S. Forte'\nDate March 25, 1996 Date March 25, 1996 Date March 25, 1996\nDorsey R. Gardner Jean Gaulin Dwight C. Minton Dorsey R. Gardner Jean Gaulin Dwight C. Minton\nDate March 25, 1996 Date March 25, 1996 Date March 25, 1996\nCharles J. Queenan, Jr. Boris Yavitz Charles J. Queenan, Jr. Boris Yavitz\nDate March 20 ,1996 Date\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Board of Directors of Medusa Corporation:\nWe have audited the consolidated financial statements of Medusa 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 January 22, 1996, which report includes an explanatory paragraph related to a change in accounting for income taxes in 1993; 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 consolidated financial statement schedule of Medusa Corporation and subsidiaries, listed in Item 14(a). This financial statement schedule is the responsibility of the company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDeloitte & Touche LLP\nCleveland, Ohio January 22, 1996\n\tMEDUSA CORPORATION AND SUBSIDIARIES \tSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\n\tYEARS ENDED DECEMBER 31,\n\tMEDUSA CORPORATION AND SUBSIDIARIES \tExhibit 11 to Form 10-K\n\tCOMPUTATION OF EARNINGS PER COMMON SHARE\n\t(in thousands, except per share amounts)\n* Amounts not restated, not dilutive under 3% test.\n\tMEDUSA CORPORATION AND SUBSIDIARIES \tExhibit 21 to Form 10-K \tSubsidiaries of the Registrant \tDecember 31, 1995\nThe following is a list of active subsidiaries of the Registrant and their jurisdiction of incorporation. All of these subsidiaries are wholly- owned, directly or indirectly, and are included in the consolidated financial statements.\n\tCement Transit Company\tDelaware\n\tJames H. Drew Corporation\tIndiana\n\tMedusa Aggregates Company\tIowa\n\tThe Thomasville Stone and Lime Company\tMaryland\n\tCanadian Medusa Cement Limited\tOntario, Canada\n\tMedusa-Citadel, Inc.\t\tAlabama\n\tMedusa-Crescent, Inc.\t\tOhio","section_15":""}
{"filename":"816249_1995.txt","cik":"816249","year":"1995","section_1":"Item 1. Business\nDESCRIPTION OF BUSINESS\nGeneral\nCoachman Incorporated (the \"Corporation\") was formed on February 5, 1985 as a Delaware Corporation. The Corporation sold shares to the public on August 13, 1987. The Corporation has 7 subsidiaries: Olympic Mills Corporation; Lutania Mills, Inc.; Back Bay Outfitters, Inc.; Caribbean Outfitters, Inc.; Resorts of the Americas Inc.; Innkeepers, Inc. and Coachman Inns of America, Inc. Back Bay Outfitters, Inc.; Caribbean Outfitters, Inc. and Resorts of the America, Inc. are now inactive as their operations were discontinued in 1995 and early 1996. The Corporation's subsidiaries, Coachman Inns of America, Inc. and Innkeepers, Inc. will continue to operate as in the past.\nAcquisition of Olympic Mills Corporation and Lutania Mills, Inc.\nOn December 21, 1995 the Corporation purchased all of the stock of Olympic Mills Corporation (\"OMC\") and Lutania Mills, Inc. (\"LMI\") (together \"Olympic Mills\"). The business of Olympic Mills will become the primary business of the Corporation.\nOMC, a Delaware Corporation, is a 46 year old vertical textile and apparel manufacturer located in Puerto Rico and LMI is a Puerto Rican Corporation which is an affiliate. Olympic Mills is Puerto Rico's leading producer of knitted underwear, T-shirts and polo shirts. Trade names owned by OMC are Grana (registered) underwear, America Project underwear and sportswear and Olympic Mills. In addition, Olympic Mills produces underwear for the U.S. Department of Defense. Currently, Olympic Mills produces 3,000 dozen T-shirts and 2,000 dozen briefs, polo shirts and other products daily. OMC operates one vertical mill in Guaynabo, Puerto Rico and LMI operates a second vertical mill in Humacao, Puerto Rico that will be in full operation later this year. A subsidiary of OMC, Yabucoa Industries, Inc. (\"YII\"), also operates a cutting and sewing operation in Yabucoa, Puerto Rico. These facilities are sufficient to supply the current sales and future expansion.\nAudited results of OMC for 1995 were sales of $31,184,281 and net earnings of $1,179,632. Audited results for 1994 were sales of $28,930,919 with net income of $1,669,082. During 1995, OMC recorded invento- ry adjustments of approximately $600,000 and expensed approximately $244,100 of transaction fees associated with the acquisition by the Corporation.\nLMI, a Puerto Rico corporation is a development stage company which is completing the construction and begin- ning operation of a vertical mill in Humacao, Puerto Rico. Early in 1996 the mill will begin production will full operations commencing by mid 1996. LMI had losses of $624,407 and limited operations for 1995.\nOlympic Mills\nOMC, a wholly owned subsidiary of the Corporation, is a vertically integrated textile and apparel manufacturer in Puerto Rico. OMC is Puerto Rico's leading manufactur- er of underwear, T-shirts and polo shirts. OMC is classified as a \"936 Company\" under the U.S. Internal Revenue Code which generally provides that qualified income earned in Puerto Rico is not subject to U.S. taxation, subject to certain limitations. OMC is ranked 82nd in Caribbean Business' \"Top 200 Puerto Rican Companies.\" OMC operates one vertical mill and its subsidiary YII operates a cut and sew operation and its affiliate, LMI operates another vertical mill all in Puerto Rico. OMC and LMI operate as subsidiaries of the Corporation and YII operates as a subsidiary of OMC.\nProducts. Olympic Mills has four basic product lines. All cotton knitted men's underwear, cotton and cotton blend knitted T-shirts, cotton and cotton blend polo shirts and non-knitted sewn products such as pajamas and shorts. Trade names used by Olympic Mills include Grana (registered) underwear, America Project (registered) underwear and sportswear and Olympic Mills. Olympic Mills knits, bleaches and dies most of the knitted fabric used by it and purchases non-knitted fabric from outside sources.\nIn 1995, the product mix of Olympic Mills business was underwear 47%, T-shirts 32%, polo shirts 14%, panties 1% and other products 6%. Currently, Olympic Mills produces 3,000 dozen T-shirts and 2,000 dozen briefs, polo shirts and other products daily. Olympic Mills operates a vertical mill in Guaynabo, Puerto Rico, a vertical mill in Humacao, Puerto Rico and a cutting and sewing opera- tion in Yabucoa, Puerto Rico.\nCustomers. With the exception of underwear sold to the U.S. Department of Defense and a private label \"big and tall\" program, all of Olympic Mill's products are now sold in Puerto Rico. Grana (registered) underwear is sold to the general public through leading department stores, retailers and such as WalMart (registered) and K-Mart (registered). America Project (registered) t-shirts are sold to screen printers who distribute printed shirts to retailers. America Project polo shirts are used primarily as school uniform shirts and are sold through retailers and also directly to schools in Puerto Rico.\nAll of the sales to third parties by Olympic Mills are through OMC. The three largest customers in 1995 were the U.S. Department of Defense, E. Mendoza & Co., and Estampados Deportivos. These three customers accounted for 34.4%, 15.7% and 7.4% of OMC's net sales in fiscal 1995, respectively. No other single customer accounted for more than 5% of OMC's net sales in fiscal 1995. The loss of the sales to any of the key customers would have a material adverse effect on OMC's results of operations. OMC has no long-term purchase contracts or commitments with any customer other than the U.S. Department of Defense.\nOMC recently completed a military contract to supply underwear to all branches of the U.S. military and, in June 1995, the U.S. Department of Defense entered into a new two year contract which may result in a significant increase in sales to the U.S. Department of Defense. The contract business with the U.S. military is relatively new to OMC. Sales from the military contract are becoming a significant portion of OMC's net sales. During 1995, OMC produced underwear for all branches of the military with quality and service meeting or exceed- ing military standards. The Department of Defense contract provides that OMC must sell goods meeting certain specifications at contracted prices if ordered by the Department of Defense. In addition, the contract has no minimum purchase requirements and can be terminat- ed by the Department of Defense at any time. The U.S. military now requires contractors to electronically receive purchase orders and transmit invoices, and OMC has made the necessary changes to meet this requirement.\nSupplying products to retail stores outside of Puerto Rico could represent a major growth area for OMC. Shirts imprinted at the Humacao plant will be exported through- out the Caribbean Basin. Customers would be retail stores, hotel shops, and cruise ships. A fast growing segment of the T-shirt business is licensing. This area could be pursued by OMC.\nIn the past OMC operated a sales office in the United States. The office was closed in 1987 due to a change in the ownership of OMC and the owner's desire to concen- trate on business in Puerto Rico. Re-entering the U.S. market directly or through strategic alliances present a significant opportunity for growth. Approximately 2.8 million Puerto Ricans live in the United States, and they constitute approximately 20% of the Latin community in the United States. With the high name recognition of Grana in the Puerto Rican community, both Grana underwear and America Project T-shirt, offer potential opportunities for penetrating the U.S. market.\nMarketing. At the present time, OMC is marketing its consumer products only in Puerto Rico through two channels of distribution. One is through an in-house sales staff of 6 which handles direct sales, and the other is through its distributors.\nIn the past, OMC has used limited advertising in promoting brand awareness. The existing core business is supplying quality underwear and T-shirts to the Puerto Rican market. By expanding the product line, increasing marketing and advertising and expanding the customer base, management believes that future growth in this core business is attainable.\nFuture Expansion. In the future, OMC expects to open a sales and marketing operation in the United States. Such operation would handle sales and distribution of all of OMC's products in the United States. OMC believes that both the Grana (registered) underwear and America Project (registered) T-shirts lines could be very competitive in the U.S. market. The Grana (registered) brand is familiar to a large number of Puerto Ricans living in the United States, and OMC intends to market its products to other hispanics. OMC will also pursue licensing and private label manufactur- ing in the U.S.\nCompetition. There are several competitors for OMC consumer products. The two largest are Fruit of the Loom (registered) and Hanes (registered). In Puerto Rico, OMC is very competi- tive due to brand recognition, loyalty, delivery time and service. However; as OMC expands outside Puerto Rico, it will be at a disadvantage due to the size and financial strength of its competitors.\nRaw Materials. The principal raw materials used by Olympic Mills are 100% cotton yarn and a blend of pre- spun 50% cotton and 50% synthetic yarn. Many factors including crop conditions, agricultural policies, market conditions and demand can significantly affect the cost and availability of these yarns, but to date, Olympic Mills has experienced no difficulty obtaining adequate supplies. Olympic Mills currently purchases yarn from three suppliers; however, these are commodity purchases and are available from a wide range of suppliers. It currently maintains a 60 day inventory of raw materials. All woven and some knitted cloth is purchased from outside suppliers.\nInventory and Backlog. OMC's backlog consists of confirmed purchase orders. At December 31, 1995, OMC had approximately $14,000,000 of unfilled customer orders for goods (of which approximately $11,000,000 was to the Department of Defense) compared to $4,000,000 on December 31, 1994. OMC has not experienced any difficulty in filling orders on a timely basis or material returns of its products. OMC maintains a 60 day supply of raw materials and also maintains an inventory of finished goods to level out the effects of seasonality of sales.\nSeasonality. The products sold to the U.S. Department of Defense are not seasonal. Commercial sales are seasonal in nature with Christmas, back to school and Fathers Day being the peak seasons.\nPatents, Copyrights and Trademarks. OMC is the holder of a number of copyrights and registered trademarks. Those actively used now are Grana (registered) and America Project (registered). OMC has used the trade names \"Olympic Mills Corporation\" and \"Olympic Mills\" for 46 years in Puerto Rico and has used it in the United States while operating a sales office in the United States; however, it has not been registered.\nEmployees. OMC employs 1,035 full and part-time employees. OMC does not have a collective bargaining agreement covering any of its employees, nor has it ever experienced any material labor disruption, and is not aware of any efforts or plans to organize its employees. OMC contributes part of the cost of medical and life insurance coverage for eligible employees. OMC considers relations with its employees to be excellent. OMC does not have a retirement or pension program.\nDiscontinued Operations\nDuring 1995, the Corporation elected to close all of its retail operations. These included all of the remaining Caribbean Outfitters stores and Back Bay Outfitters store. These operations had not been profitable and had contributed significant losses to the Corporation. Caribbean Outfitters, Inc. and Back Bay Outfitters, Inc. (together \"Outfitters\"), the corpora- tions which owned these stores, have considerable debt and virtually no assets. No determination has been made as to the future of Outfitters. The Corporation contin- ues to own the right and title to the names and regis- tered trademarks.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Facilities\nThe Corporation currently leases approximately 5,700 square feet of office space at 301 N.W. 63rd Street, Suite 500, Oklahoma City, Oklahoma, as its corporate headquarters. The current rate is $9.25 per square feet on a lease which expires March 31, 1997.\nThe Corporation's subsidiary, Coachman Inns of America, Inc., is co-general partner of a partnership which owns one Coachman Inn property at Military Drive and Interstate 37 in San Antonio, Texas and has an interest in a hotel property in Anaheim, California, located on Katella Avenue at Harbour Drive adjacent to Disneyland.\nOMC leases from a related party a 170,000 square foot manufacturing facility, which contains the executive offices, in Guaynabo, Puerto Rico which lease expires December 31, 1996 and is renewable annually. OMC believes that the current terms are greater than the market rate and that any renewal would be on terms that are no more favorable than could be negotiated with an independent third party. OMC intends to explore relocat- ing to another facility if more favorable terms can be obtained. LMI, also leases and occupies a 140,000 square foot manufacturing facility in Humacao which lease expires May 31, 2002 and YII occupies a 28,000 square foot cut and sew facility in Yabucoa, Puerto Rico which lease expires July 1, 2000.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere were no material legal proceedings pending against the Corporation, Olympic Mills Corporation; Lutania Mills, Inc.; Innkeepers, Inc. or Coachman Inns of America, Inc.; at December 31, 1995. The Corporation's subsidiaries, Caribbean Outfitters, Inc. and Back Bay Outfitters, Inc., have total liabilities of approximately $2,202,000, some of which are pending claims and litiga- tion filed against those companies. One claim which was made against the Corporation for a guarantee of $40,000 on a lease at a store which was closed has been settled. Landlord for the closed store in Sarasota, Florida has named the Corporation in a suit for back and future rent, the Corporation feels it is not liable for these amounts and will vigorously defend itself against any claim arising out of the acquisition of Caribbean Outfitters, Inc.\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\nPRICE RANGE OF COMMON STOCK\nThe Corporation's Common Stock is listed for trading on the OTC Bulletin Board under the trading symbol \"CINC\". The following table reflects the range of high and low bid prices, as reported by the National Quotation Bureau, for each quarterly period during 1995. The prices represent inter-dealer prices, without mark-up, mark-down or commission and may not represent actual transactions. Trading in the Corporation's common stock is very thin and may not be an indication of the value of the Common Stock.\nQuarterly Period Ended High Low High Low Bid Bid Ask Ask\nMarch 31, 1995 $.21875 .125 .40625 .2 June 30, 1995 $.5 .125 .6875 .1875 September 30, 1995 $.3125 .25 .5625 .4375 December 31, 1995 $.53125 .25 .75 .4375\nOn March 31, 1996, the bid and asked price for the Common Stock, as reported on the OTC Bulletin Board, was $.1875 and $.28125 per share, respectively. As of December 31, 1995, the Corporation had approximately 675 holders of its common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nOperating Data\nYear Ended Year Ended Year Ended Year Ended Year Ended Dec 31, Dec 31, Dec 31, Dec 31, Dec 31, 1995 1994 1993 1992 1991\nRevenues $67,590 $119,856 $124,686 $134,528 $98,826 Income (loss) from continuing operations (302,492) (1,808,805) (24,127) 277,408 (9,204) Net income (loss) (1,296,320) (2,522,692) (73,273) 420,315 (9,204) Income (loss) per common share from continuing operations (.04) (.28) (.01) .07 -- Dividends declared per common share -- -- -- -- --\nBalance Sheet Data:\nDec 31, Dec 31, Dec 31, Dec 31, Dec 31, 1995 1994 1993 1992 1991\nWorking capital (deficiency) $(6,883,573) $(1,160,886) $(387,889) $(58,903) $(18,623) Total assets 9,587,921 1,578,095 3,092,343 1,142,393 825,996 Long-term debt 32,975 339,196 816,155 36,156 30,000 Total liabilities (1) 7,266,449 1,996,025 1,841,091 149,119 141,085 Stockholders' equity (deficit) 2,321,472 (417,930) 1,251,252 993,274 684,911\n(1) $2,202,000 of the total liabilities at December 31, 1995 are liabilities related to discontinued opera- tions. $5,108,826 of total liabilities relate to the acquisition of Olympic Mills. See the Consoli- dated Financial Statements and notes thereto.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nDuring the past three years, the Corporation has made significant changes in its business, which have, and will, affect its financial condition and results of operations. On December 21, 1995, the Corporation purchased all of the common stock of OMC and LMI (to- gether \"Olympic Mills\"). The operation and develop- ment of Olympic Mills will become the major focus of the Corporation for the foreseeable future. During 1991, the Corporation was primarily in the hotel man- agement business. During 1992 and 1993, most of the properties managed by the Corporation were sold and, at the end of 1993, the Corporation purchased Caribbean Outfitters, Inc., which operated specialty retail stores. During 1994 the Corporation purchased Back Bay Outfitters, Inc. a retail store specializing in adven- ture travel gear, clothing and equipment. The Corpora- tion also purchased the West Indies Resort Company and the West Indies Club Limited, thus entering the time share vacation sales business. During 1995, the Corpo- ration closed the operations of Outfitters and dis- continued the retail operations thereof. No decision has been made as to the future of Outfitters. The Corporation also elected not to exercise the option to purchase the Hotel on the Cay held by West Indies Club Limited. These changes in operations from past to present to future make the analysis of the Corporation's Consolidated Financial Statements diffi- cult. The purpose of this discussion will be to clari- fy these significant changes and supply forward looking information about the Corporation's planned activity (although there can be no assurance that these activi- ties will meet expectations).\nLiquidity The Corporation closed the acquisition of all of the issued and outstanding stock of OMC and its affili- ate LMI pursuant to a Stock Purchase Agreement dated December 21, 1995 (the \"Agreement\") for $2,002,000 in cash, $4,448,826 in notes due the Sellers and 6,000,000 shares of the Common Stock of the Corporation. The 6,000,000 shares have a guaranteed public trading price of $2.50 per share after 2 years from issuance, with additional shares being issued if the price is lower. The Sellers were Corporacion Inmobiliaria Textil (\"Cintex\"), a Puerto Rico corporation; Fideicomiso Hispamer (\"Hispamer\"), a Puerto Rico trust; OM Acquisi- tion Corp. (\"OM\"), a Delaware corporation; Olympic Holding Corp. (\"Holding\"), a Puerto Rico corporation and Estampados Deportivos (\"ED\"), a Puerto Rico corpo- ration (collectively \"the Sellers\"). Under the Agree- ment the Corporation purchased all of the common stock of OMC from ED and provided the necessary capital in the form of cash, notes and stock for OMC to repay all sums due to the Sellers by OMC totalling $3,570,400 and to redeem all of the preferred stock and accumulated dividends of OMC owned by and owed to the Sellers. All of the Common Stock of LMI was purchased from Holdings for a cash payment of $1,000. The sources of the funds used to close the acquisition were loans of $2,000,000 and $852,000 from Congress Credit Corporation to OMC, deferred payment notes from the Corporation and OMC to the Sellers, $1,500,000 from the sale of 3,747,650 shares of common stock of the Corporation in a private placement, $250,000 from the sale of 2,500 shares of preferred stock of the Corporation in a private place- ment and $250,974 in funds of the Corporation.\nIn order to complete the acquisition the Corpora- tion arranged loans from Congress Credit Corporation (\"Congress\") to OMC and LMI totaling up to $15,000,000 in the form of a $13,000,000 revolving credit line and $2,000,000 three year term loan. The availability of the revolving credit line is based on 50% of qualified inventory and 80% of qualified receivables of OMC. At December 31, 1995, the availability, based on collater- al, of the revolving credit line was $8,411,304 and the balance drawn was $5,787,091; leaving an excess avail- ability of $2,624,213.\nThe terms of various notes used to close the Acquisition were as follows: 1. Note from the Corpora- tion of $4,448,826, due July 15, 1996 at a rate of 8%; to be repaid by the Corporation. 2. Note from OMC of $1,785,200, due July 15, 1996 at a rate of 12%; which will be repaid out of available credit of OMC or through OMC's operations. 3. Note from OMC of $603,589 to be repaid out of sums owed to OMC by the government of Puerto Rico. 4. Note from OMC of $370,000 at a rate of .11% per day; which has been repaid in full out of available funds of OMC.\nThe $4,448,826 note from the Corporation and the $1,785,200 note from OMC are secured by a pledge of the common stock of OMC. The Corporation is planning to repay the notes through the sale of common or pre- ferred stock of the Corporation, through the sale of preferred stock of OMC or through borrowings. The other loans should be self liquidating from the opera- tions, receivables and credit facilities of Olympic Mills.\nIn addition to the above, OMC issued notes to the sellers of $1,000,000 and $465,000 due in December 21, 2000 at a rate of 7%. OMC has agreed to issue another note to the sellers of up to $1,000,000 on similar terms; if the sellers arrange a grant from the govern- ment of Puerto Rico.\nDuring 1995, the Corporation elected to close all of its retail operations. The subsidiaries which own the operations accounted for $2,202,000 of the accounts payable, accrued liabilities, notes payable and long term debt of the Corporation. Management feels that these are not liabilities of the Corporation as the parent company, but only of the respective subsidiary, although this has not been decided by court action.\nWith the exception of the liabilities associated with discontinued operations, management believes that the Corporation will be able to meet its commitments. Of the working capital deficiency at December 31, 1995, of $6,883,573; $2,202,000 related to discontinued operations of Outfitters and $4,448,826 resulted from the Acquisition. Management believes that the amount resulting from discontinued operations can be settled at significantly less than face amount and that if Outfitters were liquidated, none of these liabilities would accrue to the Corporation. If the $4,448,826 note to the Sellers of OMC is not reduced, the Corpora- tion would own at least 29% of the common stock of OMC. If the note is reduced by $1,386,666 the Corporation would own at least 51% of the common stock of OMC. In either case the Corporation would be entitled to a portion of the profits of OMC.\nCapital Resources\nDuring 1996, the Corporation or OMC have commit- ments to repay $7,207,655 to the sellers of OMC. The Corporation anticipates repaying $605,514 of the amount from funds due to OMC from the government of Puerto Rico, another $5,280,000 from the sale of convertible preferred stock of OMC which would be convertible into the Common Stock of the Corporation. The balance of $1,324,066 would be repaid out of funds available to OMC through its credit line or from profits.\nOutfitters have current liabilities of $2,200,000. The Corporation has discontinued the operations of Outfitters which now have no operations and limited assets. During the past year, Outfitters have been successful in settling some of their liabilities. During 1996, Outfitters will continue to try to work out satisfactory arrangements to settle the remaining liabilities. If this cannot be successfully done, these corporations will seek bankruptcy protection and liquidation.\nManagement believes that the current commitments of the Corporation, other than described above can be met out of current operations.\nResults of Operations\nRevenues from continuing operations decreased by $52,266, during 1995 compared to 1994. Management fee income was relatively stable, decreasing by $1,779. Management fee income should be comparable in 1996. Time-share commissions decreased by $50,487 and Time- share commission expenses decreased by $49,468; during 1995 compared to 1994. After the expiration of the option on the time-share hotel these operations ceased. There will be no Time-share commissions or commission expense in the future. General and administrative expenses were decreased by $49,809. This was caused by closing the office in Florida in September and other cost savings instituted during the year. During 1996, management believes that it can further decrease these expenses. During 1994, Impairment of goodwill and other assets totaled $1,483,870; as the Corporation wrote off goodwill and other assets associated with Outfitters. Because these assets were totally written off in 1994 there was no Impairment of goodwill and other assets in 1995.\nOn December 21, 1995 the Corporation purchased all of the common stock of Olympic Mills. The transaction is being accounted for as an acquisition in progress due to the fact that the Sellers have control over contracts and commitments over $100,000 and Mr. Fran- cisco Carvajal, beneficial owner of the Seller, must serve as Chairman of the Board of OMC until certain amounts are paid. Also, the common stock of OMC owned by the Corporation is pledged as collateral on certain notes issued to close the transaction. After the completion of the transaction, the financial statements of OMC, LMI and the Corporation will be consolidated. Revenues for OMC were $31,184,281; $28,187,898 and $23,613,611 for 1995, 1994 and 1993 respectively. Net earnings for OMC were $1,179,632; $1,964,342 and $1,572,504 for the same periods.\nLMI was a development stage company in 1995. During early 1996, LMI began operations. By the end of the second quarter of 1996 it should be in full opera- tions. LMI will produce goods on contract to OMC. LMI incurred a net loss of $624,407 for 1995. The additional capacity provided by LMI should increase the revenues of OMC. Projected revenues for 1996, for OMC are approximately $50,000,000.\nDuring 1995, the Corporation elected to close all of its retail operations and discontinued them. Retail sales were approximately $517,000, $1,843,000 and $54,000 in 1995, 1994 and 1993 respectively. The loss from retail operations was $601,027; $713,887 and $30,615 in 1995, 1994 and 1993 respectively. The Corporation does not expect the loss from discontinued operations to be significant in 1996. During 1996, the Corporation will attempt to settle the liabilities of Outfitters. If the liabilities cannot be settled, management will seek to liquidate Outfitters. In addition to reducing the loss from the retail opera- tions, discontinuing retail operations will decrease general and administrative expenses.\nDuring 1995, the Corporation also closed its time share sales operation which earned revenues of $2,293 and $52,780 in 1995 and 1994 respectively.\nThe reports of independent auditors on the Corporation's consolidated financial statements for 1995 and 1994 contain an explanatory paragraph discuss- ing conditions that raise doubt about the Corporation's ability to continue as a going concern. These condi- tions relate to recurring losses, working capital deficiencies at December 31, 1995 and 1994, insuffi- cient operating cash flows in 1995 and 1994, default on notes and bonds by a subsidiary, and certain future commitments relating to the Corporation's acquisition of Olympic Mills. Management believes that it has begun the process of alleviating these situations.\nThe continuing losses were caused by the unprofitability of the Corporation's retail operations. These operations have been closed. As was stated in Liquidity and Capital Resources, $2,200,000 of the working capital deficiency is from debts of Outfitters. The Corporation will try to settle these debts, howev- er; if they cannot be successfully settled, Outfitters will seek the protection from its debtors through a bankruptcy court filing.\nManagement believes that the funding necessary to complete the acquisition of Olympic Mills can be ar- ranged prior to the due date of the acquisition notes of July 15, 1996. During the first two quarters of 1996, OMC will offer for sale convertible preferred stock. The proceeds of the sale of this stock along with other financing now available should be sufficient to repay the notes and complete the acquisition. However, no assurance can be given that the Corporation or OMC will be successful in its convertible preferred stock offering.\nUpon the completion of the acquisition of Olympic Mills, management believes that the situations leading to the going concern explanatory paragraph in the reports of the Corporation's independent auditors will be mitigated.\nImpact of Inflation\nThe Corporation's hotel operations have not been adversely affected by inflation. Revenues have kept up with the increase in costs.\nOlympic Mills operations are affected primarily by changes in the cost of cotton. During 1994, the costs of cotton increased more rapidly than the company could increase prices due to contractual agreements. During 1995, major contracts were negotiated with escalation clauses for increases in cotton prices. The proposed increase in the minimum wage could cause an adverse affect on the cost of the products of Olympic Mills.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial Statements as of December 31, 1995 and 1994 and for the three year period ended December 31, 1995 are contained at pages through 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\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nManagement\nThe names, ages and current positions with the Corporation of the directors and executive officers of the Corporation are set forth below:\nName Age Positions Dennis D. Bradford 50 Chairman of the Board, President and Chief Executive Officer Catherine A. Myers 34 Secretary Robert E. Swain 49 Director Jay T. Edwards 63 Director Alejandro G. Asmar 46 Director Nominee\nThe following is a brief description of the busi- ness experience during the past five years of each of the above-named persons:\nDennis D. Bradford, age 50, has been the Chairman, President, Chief Executive Officer and Director (except from December 1993 until January 1995 when he did not serve as President) of the Corporation since its incep- tion on February 5, 1985. From 1973 to 1985, he was a partner in various partnerships which constructed, owned and operated real estate properties including Coachman Inns until the sale of his interests in those partnerships to the Corporation. From 1983 until 1984, he served as Vice President of Corporate Development for PetroSouthern, Inc., a publicly held oil and gas exploration company. PetroSouthern became Craft World International, Inc. (\"Craft World\") in 1986 and changed its basic business to a distributor of craft and lei- sure products. In 1986, Mr. Bradford was elected to the Board of Directors of Craft World. Mr. Bradford has been Vice Chairman of the National Advisory Council to the U.S. Small Business Administration and a dele- gate to the 1986 White House Conference on Small Busi- ness. He is a graduate of the University of Tulsa with a BSBA degree in Economics.\nCatherine A. Myers, age 34, has been an employee of the Company since 1988, serving as an administrative assistant. She was elected Secretary of the Company in 1995 and has served in that capacity since that date. Ms. Myers received a B.S. Degree from Oklahoma State University in 1984.\nRobert E. Swain, age 49, has been a Director of the Company since December 14, 1993 and was President from December, 1993 until December 31, 1994. Mr. Swain is president of American Landmark Homes, Inc. Mr. Swain founded Caribbean Outfitters, Inc. and has been its President, Chief Executive Officer and Director since its inception in 1989. Prior to founding Carib- bean Outfitters, Inc. Mr. Swain was the Chairman, President and Chief Executive Officer of Craft World. Mr. Swain also has developed and marketed a time share resort and shopping mall in Aruba from 1983 through 1990 and managed sales at a resort in the Dominican Republic during 1990 and 1991. Mr. Swain is a graduate of Bowdoin College.\nJay T. Edwards, age 63, has been a Director of the Company since it inception on February 5, 1985. He is a management consultant and General Administrator of the Oklahoma Corporation Commission. He was the Presi- dent, Chief Operating Officer and Director of CMI Corporation, a publicly held American Stock Exchange company from 1985 until 1991. From 1982 to 1985, General Edwards was the Executive Director of the University of Oklahoma Energy Center. From 1954 to 1982, General Edwards served in the United States Air Force, retiring in 1982 after having achieved the rank of Major General. General Edwards is a Director of the State Fair of Oklahoma, a Director of Oklahoma Airspace Museum and Chairman of the Natural Resource Education Foundation. General Edwards is a graduate of the United States Military Academy, West Point, New York, and received a B.S. Degree in Mechanical Engineering in 1954. General Edwards received a Master of Science Degree in Aeronautical Engineering from Texas A & M University in 1962, and a Master of Science Degree in Management from George Washington University in 1971.\nDr. Alejandro G. Asmar, age 46, Director nominee. Dr. Asmar is President of the merchant banking firm AGA Associates, Inc. (formerly AGA & Associates). From 1984 to 1988, Dr. Asmar was with Drexel Burnham Lam- bert, Inc.'s Puerto Rico Branch and was its First Vice President and Chief Operating Officer from 1987 to 1988. From 1983 to 1984, he served as Vice President, Finance and Administration Puerto Rican American Insur- ance Co. and from 1977 to 1982 was Senior Vice Presi- dent, Finance of First Federal Savings & Loan Associa- tion of Puerto Rico. Dr. Asmar served as an Indepen- dent Consultant, Assistant Professor, Director, Depart- ment of Administration and Director, Business Research Center with the University of Puerto Rico from 1972 to 1977. Dr. Asmar is a graduate of the University of Pennsylvania, The Wharton School, receiving a Ph.D. in Business and Applied Economics in 1976 and a MA in Finance in 1972; and received a BA in Social Sciences in 1969 from University of Puerto Rico.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following sets forth the annual and long-term compensation paid to the Chief Executive Officer of the Corporation during the last three fiscal years.\nSummary Compensation Table\nLong-Term Compensation Securities Name and Annual Compensation Underlying All Other Principal Position Year Salary $ Bonus $ Option Compensation$\nDennis D. Bradford 1995 120,000.00 -0- -0- -0- Chairman of the Board 1994 81,666.70 -0- -0- -0- Chief Executive Officer 1993 90,000.00 -0- -0- -0- 1992 90,000.00 -0- -0- -0-\nAll officers and directors serve at the pleasure of the Board of Directors, except that Dennis D. Brad- ford entered into a three year Management Agreement, dated December 14, 1993, with the Corporation. Mr. Bradford's current salary with the Company under the terms of his employment agreement is $120,000 per year; however, Mr. Bradford was only paid approximately $82,000 to preserve cash for the Corporation. No other officer received a salary in excess of $100,000 during the past three years. All the executive officers as a group (2) received $136,000 in 1995.\nThe following table indicates the total number and value of exercisable and unexercisable non-qualified stock options held by the executive officer named in the Summary Compensation Table above as of December 31, 1995. No options to purchase stock were exercised by him in the fiscal year ended December 31, 1995.\nNumber of Securities Value of Unexercised Underlying Unexercised In-The Money Options Options at FY-End(1995) at FY-End(1995) Exercisable\/ Exercisable\/ Name Unexercisable(2) Unexercisable(1)(2)\nDennis D. Bradford 13,100\/403,000 $6,550\/$201,500 __________________\n(1) Based on an asked price of $.50 per share of the Corporation's Common Stock as quoted by the OTC Electronic Bulletin Board on December 31, 1995.\n(2) Due to the discontinuation of operations of Outfitters, these options will never become exercisable and will expire December 31, 1996.\nThe employment contract also provides for addi- tional bonus compensation based on the annual net income of the Corporation. Mr. Bradford is to receive an amount equal to 4% of the Corporation's net pre-tax income as determined by the Corporation's annual audit up to $1,000,000 of net pre-tax income and 6% thereaf- ter. The compensation committee of the Board of Direc- tors is empowered to increase base salaries for 1996 based upon performance of the executives.\nIncentive Stock Option Plan\nThe Corporation has an incentive stock option plan (the \"Plan\"). Under the terms of the Plan, shares of Common Stock are reserved for issuance to key employees and directors of the Corporation. The Plan provides for administration by the Corporation's Board of Direc- tors or by a committee consisting of not less than two persons. Any option granted under the Plan must be for a term not to exceed ten years. The purchase price for shares subject to options, and the manner in which the options may be exercised, are determined by the Board of Directors on a case by case basis. However, the purchase price to be paid for the shares underlying the options may not be less than the fair market value of the Common Stock on the date of the grant.\nExcept for the Plan described above, the Corpora- tion does not have any pension plan, profit sharing plan, incentive bonus plan or similar plans for the benefit of its officers, directors or employees. However, the Corporation reserves the right to estab- lish any such plans in the future in its sole discre- tion.\nItems 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table and notes thereto sets forth, as of the date of this Memorandum, certain information regarding ownership of Common Stock by (i) each person known to the Corporation to beneficially own more than 5% of its Common Stock, (ii) each director and nominee for director of the Corporation and (iii) all present officers and directors of the Corporation as a group.\nUnder the rules and regulations of the Commission, a person is deemed to own beneficially all securities of which that person owns or shares voting or invest- ment power as well as all securities which may be acquired through the exercise of currently available conversion, warrant or option rights. Unless otherwise indicated, each such person possesses sole voting and investment power with respect to the shares owned by him.\nName and Address Amount and Nature of Percent of Beneficial of Beneficial Owner Beneficial Ownership Ownership After Offering\nFrancisco Carvajal 6,000,000(a) 29.6% Box 1669 Guaynabo, PR 00970\nDennis D. Bradford 1,522,638 (b)(c) 7.5% 301 NW 63rd, Suite 500 Oklahoma City, OK 73116\nRobert E. and Linda D. Swain 1,721,170 8.5% 1055 Bay Esplanade Tampa, FL 34630\nJay T. Edwards 6,150 (d) * 301 NW 63rd, Suite 500 Oklahoma City, OK 73116\nCatherine Myers 20 * 301 NW 63rd, Suite 500 Oklahoma City, OK 73116\nAll officers and directors as a group (4 persons) 3,249,978 (e) 16%\n*Less than 1% of the common stock outstanding at June 30, 1995. __________________\n(a) Francisco Carvajal is beneficial owner of 500,000 shares held by Corporation Inmobiliaria Textil; and 5,500,000 shares held by Fundacion Carvajal as Trustee of Fideicomiso Hispamer.\n(b) Includes 13,100 shares of Common Stock that may be acquired upon exercise of employee stock options previously granted under the Corporation's 1987 Stock Option Plan.\n(c) Includes 403,000 shares of Common Stock which may be acquired upon exercise of non-qualified incentive stock options granted December 14, 1993, however; due to the discontinuation of operations of Outfitters, these options will never be exercisable.\n(d) Includes 4,700 shares of Common Stock that may be acquired upon exercise of employee stock options previously granted under the Corporation's 1987 Stock Option Plan.\n(e) Includes 417,800 shares of Common Stock that may be acquired by such persons upon exercise of employee stock options previously granted under the Corporation's 1987 Stock Option Plan and on December 14, 1993.\nCompensation of Directors\nNon-employee directors of the Corporation are entitled to a fee of $2,000 per year plus $500 for attendance at each meeting of the Board of Directors. Non-employee directors receive a fee of $250 for each committee meeting attended.\nItem 13.","section_12":"","section_13":"Item 13. Certain Relationships and Related Transactions\nHospitality Realty, Inc. (\"Hospitality\"), in which Mr. Bradford holds approximately 35% of the outstanding shares of common stock, was indebted to the Corporation in the amount of $804,669 as of December 31, 1988, which was subsequently written off by the Corporation. During 1993, Hospitality repaid $225,000 of the amount owed to the Corporation.\nDuring 1991 and 1993, the Corporation loaned $109,958 to Dennis D. Bradford and received as collat- eral 1,109,513 shares of the Corporation's Common Stock owned by Mr. Bradford. Mr. Bradford in turn loaned a portion of the funds to Hospitality.\nOn December 16, 1993, the Corporation acquired all of the stock of Caribbean Outfitters, Inc. in exchange for 2,000,000 shares of Common Stock of the Corpora- tion. In addition to the 2,000,000 shares of Common Stock issued, the Corporation also granted a contingent stock earn-out to the stockholders of Caribbean Outfit- ters, Inc. for up to an additional 2,000,000 shares to be issued based upon the following earnings and expan- sion contingencies: (i) an additional 100,000 shares of Common Stock for each new store location opened up to 1,000,000 shares; and (ii) an additional 100,000 shares of Common Stock for each $1,000,000 in cumulative gross revenues from Caribbean Outfitters' operations over $2,000,000 in annual revenues up to an additional 1,000,000 shares. The contingent stock earn-out runs through December 31, 1996. Mr. Swain and his wife received 1,721,170 shares of Common Stock issued in the acquisition. Due to the fact that the Corporation has discontinued the operations of Outfitters, it is antic- ipated that no stock will be issued under the earnout.\nDuring July 1994, the Corporation purchased all of the stock of the West Indies Resort Company and all of the limited partnership interests in the West Indies Club Limited which together owned the option to pur- chase the Hotel on the Cay in St. Croix and a marketing agreement to sell time share units in that hotel. As a result of this transaction, 125,962 shares of Common Stock were issued to Robert E. Swain as a part owner of those companies.\nDr. Alejandro G. Asmar, a director of the Corpora- tion is the president and principal in AGA Associates, Inc. which acted as a financial advisor to the Corpora- tion in the acquisition of Olympic Mills. AGA will receive a fee of $440,000 in stock and cash for provid- ing financial advisory services with respect to the Acquisition. AGA also received a fee of $112,500 from OMC for arranging a loan with respect to the Acquisi- tion. AGA also receives an on going fee of $8,000 per month for providing advisory services to OMC.\nDirector Liability\nBecause of increasing concern about director liability and the growing unavailability of insurance, the Corporation may find it necessary to provides incentives to induce outside individuals to join its Board. For the same reasons, the Corporation has adopted the provisions of the Delaware Corporation Law permitting the Corporation to limit the liability of the Corporation's directors to the Corporation and its stockholders for monetary damages for breach of fidu- ciary duty as a director. Such limitation on a director's liability is subject to the following statu- tory exceptions: (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders; (ii) for acts of omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) in respect of certain unlawful dividend payments or stock redemptions or repurchases, or (iv) for any transaction from which the director derived an improper personal benefit.\nThe Corporation has also adopted the provisions of the Delaware Corporation Law permitting indemnification of directors, officers, employees or agents of the Corporation against expenses, including attorneys' fees, incurred in connection with the defense of any action, suit or proceeding in which such a person is a party by reason of his being or having been a director, officer, employee or agent of the Corporation, or of any corporation, partnership, joint venture, trust or other enterprise in which he served as such at the request of the Corporation, provided that he acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the Corpora- tion, and with respect to any criminal action or pro- ceeding, had no reasonable cause to believe his conduct was unlawful, and provided further (if the threatened, pending or completed action or suit is by or in the right of the Corporation) that he shall not have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation (unless the court determines that indemnity would nevertheless be proper under the circumstances).\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following are filed as part of this report:\n1. Consolidated Financial Statements:\nReference is made to the Index to Consolidated Financial Statements appearing on page of this report.\n2. Financial Statement Schedules All Financial Statement Schedules are omitted as they are inapplicable or the required information is immaterial.\n3. Exhibits:\n3.1 Amended and Restated Certificate of Incorporation (1)\n3.2 Amended and Restated By-Laws (1)\n4.1 Form of Common Stock Certificate (1)\n10.1 Stock Purchase and Redemption Agreement - Olympic Mills Corporation (2)\n10.2 Form of Management Contract (1)\n10.3 Coachman Incorporated 1987 Stock Option Plan, with Stock Option Agreement (1)\n10.4 Coachman Incorporated Employee Stock Ownership Plan with Trust Indenture (1)\n16.1 Letter regarding Changes in Certifying Accountants (3)\n21.1 Subsidiaries of the Registrant\nThe Corporation has wholly owned subsidiaries, Innkeepers, Inc.; Coachman Inns of America, Inc.; Caribbean Outfitters, Inc.; COVI, Inc.; Caribbean Outfitters, N.V.; Caribbean Outfitters, N.V. Aruba; Back Bay Outfitters, Inc.; Olympic Mills Corporation and Lutania Mills, Inc.\n27.1 Financial Data Schedule\n(b)(1) Previously filed as Exhibit to Registration Statement #33-15082. (2) Previously filed as Exhibit to Form 8-K\/A dated December 21, 1995. (3) Previously filed as Exhibit to Form 8-K\/A dated March 25, 1996.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Consolidated Financial Statements\nPage\nIndependent Auditors' Report\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 (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\nAll financial statement schedules are omitted, as the required information is inapplicable, immaterial, or the information is presented in the consolidated financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Coachman Incorporated and Subsidiaries:\nWe have audited the consolidated balance sheet of Coachman Incorporated and subsidiaries (Coachman) as of December 31, 1995, and the related statements of operations, stockholders' equity (deficit) and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the 1995 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Coachman Incorporated and 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.\nThe accompanying consolidated financial statements have been prepared assuming that Coachman will continue as a going concern. As shown in the accompanying consolidated financial statements, Coachman and its subsidiaries have suffered recurring losses from operations, have a working capital deficiency of approximately $6.5 million at December 31, 1995, and have not generated cash from operations sufficient to pay their obligations when due. As discussed in note 7, a subsidiary of Coachman is in default on several notes and bonds and management of Coachman is seeking to renegotiate the terms of certain debt or settle the debt for less than its face amount. Also, as discussed in note 2, Coachman has future commitments related to an acquisition in progress. These conditions raise substantial doubt about Coachman s ability to continue as a going concern. Management's plans in regard to these matters are described in note 13. The consolidated 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 Coachman be unable to continue as a going concern.\nKPMG Peat Marwick LLP\nOklahoma City, Oklahoma April 5, 1996\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Coachman Incorporated and Subsidiaries Oklahoma City, Oklahoma\nWe have audited the accompanying consolidated balance sheet of Coachman Incorporated and Subsidiaries as of December 31, 1994, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the two years ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Coachman Incorporated and Subsidiaries as of December 31, 1994, and the consolidated results of their operations and their cash flows for each of the two years ended December 31, 1994 in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the accompanying consolidated financial statements, the Company has suffered recurring losses from operations, has a working capital deficiency and has not generated cash from operations sufficient to pay their obligations when due. As discussed in note 7, Caribbean Outfitters is in default on several notes and bonds. These conditions raise substantial doubt about Coachman's ability to continue as a going concern. Management's plans in regard to these matters are described in note 13. The consolidated 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.\nSartein Fischbein & Co.\nJune 8, 1995\nCOACHMAN INCORPORATED\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\nAssets 1995 1994\nCurrent assets: Cash and cash equivalents $ 99,846 32,777 Accounts receivable: Trade 922 25,317 Related parties 99,636 2,658 Notes receivable from affiliates 35,702 35,702 Inventory -- 228,855 Marketable equity securities 108,000 168,750 Other current assets 5,795 1,884 ----------- ---------- Total current assets 349,901 495,943 ----------- ----------\nProperty and equipment, net of accumulated depreciation of $244,626 in 1995 and $320,145 in 1994 2,252 309,105\nNotes receivable: Officer 127,609 120,386 Affiliates 402,633 436,656\nAcquisition in progress 8,629,488 --\nInvestments in affiliated entities and other assets 76,038 90,638\nDeferred costs, net of accumulated amortization of $19,936 in 1994 -- 23,367\nDeposits -- 67,345\nOther assets -- 34,655 ----------- ----------\nTotal assets $ 9,587,921 1,578,095 =========== ==========\nSee accompanying notes to consolidated financial statements.\nLiabilities and Stockholders' Equity (Deficit) 1995 1994\nCurrent liabilities: Accounts payable: Trade $ 822,994 657,127 Related parties 1,822 1,771 Accrued liabilities: Rent 138,870 48,400 Interest 301,491 195,128 Other 535,859 114,279 Notes payable: Related parties 4,710,526 211,150 Other 125,000 139,189 Current maturities of long-term debt 596,912 289,785 ------------ ---------- Total current liabilities 7,233,474 1,656,829 ------------ ----------\nLong-term debt 32,975 339,196\nStockholders' equity (deficit): Preferred stock, $.01 par value; authorized 200,000 shares; issued and outstanding 7,250 in 1995 and 4,750 in 1994 73 48 Common stock, $.01 par value; authorized 25,000,000 shares; issued and outstanding 20,265,100 in 1995 and 7,421,000 in 1994 202,651 74,210 Additional paid-in capital 11,411,589 7,819,458 Common stock subscribed, unissued 391,500 -- Common stock subscriptions receivable (100,000) -- Accumulated deficit (9,607,966) (8,311,646) Net unrealized gain on marketable equity securities 23,625 -- ---------- ---------- Total stockholders' equity (deficit) 2,321,472 (417,930)\nCommitments and contingencies (notes 2, 11, 12, and 13) ---------- ----------\nTotal liabilities and stockholders' equity (deficit) $ 9,587,921 1,578,095 ============ ==========\nCOACHMAN INCORPORATED\nConsolidated Statements of Operations\nYears ended December 31, 1995, 1994, and 1993\n1995 1994 1993\nRevenues: Management fees from affiliates $ 65,297 67,076 124,686 Time-share commissions 2,293 52,780 -- ------------ ----------- ----------- 67,590 119,856 124,686 ------------ ----------- ----------- Expenses: Time-share commission expenses 6,372 55,840 -- General and administrative 444,316 494,125 237,554 Depreciation and amortization 1,435 4,499 7,417 Impairment of goodwill and other assets -- 1,483,870 -- ----------- ----------- ----------- 452,123 2,038,334 244,971 ----------- ----------- -----------\nOperating loss (384,533) (1,918,478) (120,285)\nOther income (expenses): Interest income 51,675 52,384 84,888 Interest expense (10,558) (5,354) (7,380) Other income 8,260 62,643 18,650 Gain on sale of marketable equity securities 32,664 -- -- ----------- ------------ ----------- 82,041 109,673 96,158 ----------- ------------ -----------\nLoss from continuing operations (302,492) (1,808,805) (24,127)\nDiscontinued operations: Loss from operation of discontinued retail activities (601,027) (713,887) (49,146) Loss from discontinuing retail activities (392,801) -- -- ----------- ------------ -----------\nNet loss on discontinued operations (993,828) (713,887) (49,146) ----------- ------------ -----------\nNet loss $(1,296,320) (2,522,692) (73,273) =========== ============ ===========\nNet loss applicable to common shares $(1,367,722) (2,584,976) (73,273)\nAverage outstanding common shares 9,334,313 6,616,750 3,895,833 =========== =========== ===========\nNet loss per average outstanding common share from continuing operations $ (.04) (.28) (.01)\nNet loss per average outstanding common share from discontinued operations $ (.11) (.11) (.01)\nNet loss per average outstanding common share $ (.15) (.39) (.02)\nSee accompanying notes to consolidated financial statements.\nCOACHMAN INCORPORATED\nConsolidated Statements of Cash Flows\nYears ended December 31, 1995, 1994, and 1993\n1995 1994 1993\nCash flows from operating activities: Net loss $(1,296,320) (2,522,692) (73,273) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinuing retail activities 392,801 -- -- Gain on sale of marketable equity securities (32,664) -- -- Impairment of goodwill and other assets -- 1,483,870 -- Depreciation and amortization 1,435 121,536 11,717 Write-off of deferred revenue -- (25,626) -- Impairment of accounts receivable-related parties -- 1,449 -- Increase in accounts receivable (72,583) (10,263) (40,103) Decrease (increase) in inventory 228,855 106,336 (43,367) (Increase) decrease in other current assets (3,911) 27,758 2,844 Increase in accrued interest on notes receivable-officer (7,223) -- -- Increase (decrease) in accounts payable and accrued liabilities 344,331 374,352 (51,362) Addition of interest, legal, and other costs related to renegotiated long-term debt 7,319 -- -- ----------- ---------- -------- Net cash used in operating activities (437,960) (443,280) (193,544) ----------- ---------- --------\nCash flows from investing activities: Payments related to acquisition in progress (2,113,658) -- -- Proceeds from sales of marketable equity securities 117,039 -- -- Dividends received from investments in affiliated entities 14,600 -- -- Proceeds from collection of note receivable 34,023 54,705 402,920 Purchases of property and equipment -- (43,631) (3,413) Loan made to officer -- -- (85,000) Proceeds from officer loan repayments -- 17,308 -- Increase in other assets -- (36,479) -- ---------- ---------- -------- Net cash (used in) provided by investing activities (1,947,996) (8,097) 314,507 ---------- ---------- --------\nCash flows from financing activities: Proceeds from issuance of preferred and common stock, net of issuance costs 2,093,593 260,000 -- Payment received for subscribed, unissued stock 291,500 -- -- Capital contributions received -- -- 50,000 Proceeds of loan from related party 50,550 68,771 -- Proceeds of loan from third party 50,000 -- -- Principal payments on note payable and long-term debt (32,618) (19,586) -- ---------- ---------- -------- Net cash provided by financing activities 2,453,025 309,185 50,000 ---------- ---------- -------- Net increase (decrease) in cash and cash equivalents 67,069 (142,192) 170,963\nCash and cash equivalents, beginning of year 32,777 174,969 4,006\nCash and cash equivalents, end of year $ 99,846 32,777 174,969 ============ ========== ========\n(Continued)\nCOACHMAN INCORPORATED\nConsolidated Statements of Cash Flows, Continued\nYears ended December 31, 1995, 1994, and 1993\n1995 1994 1993 Supplemental disclosure of noncash investing and financing activities:\nNet unrealized gain on marketable equity securities $ 23,625 (60,938) 131,251 ========== ======= ========= Accrued liability related to acquisition in progress $ 440,000 -- -- ========== ======= ========= Issuance of note payable related to acquisition in progress $4,448,826 -- -- ========== ======= ========= Issuance of common stock related to acquisition in progress $1,627,004 -- -- ========== ======= ========= Common stock subscription receivable $ 100,000 -- -- ========== ======= ========= Purchase of Caribbean Outfitters, Inc. common stock through the issuance of common stock $ -- -- 1,943,334 ========== ======= ========= Conversion of long-term debt and accrued interest into preferred stock $ -- 425,040 -- ========== ======= ========= Purchase of St. Thomas retail store through increase in notes payable $ -- 75,000 -- ========== ======= ========= Purchase of Florida retail store through assumption of liabilities $ -- 113,427 -- ========== ======= =========\nCash payments for interest $ -- 3,223 4,125 ========== ======= =========\nSee accompanying notes to consolidated financial statements.\nCOACHMAN INCORPORATED\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994, and 1993\n(1) Organization and Summary of Significant Accounting Policies\nOrganization\nCoachman Incorporated (Coachman) was incorporated on February 5, 1985. During 1995 and 1994, Coachman's primary business segment was retail sales of leisure wear which resulted from an acquisition in late 1993 (see note 2). As discussed in note 3, Coachman discontinued its retail operations in 1995. Coachman has also managed lodging properties in the United States since its inception and received commissions from the sale of time-share units in the Virgin Islands in 1995 and 1994 as a result of an acquisition in 1994 (see note 2).\nBasis of Presentation and Principles of Consolidation\nThe accompanying financial statements include the accounts of Coachman and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCash and Cash Equivalents\nFor purposes of the consolidated statements of cash flows, Coachman considers all highly liquid investments with original maturities of three months or less to be cash equivalents.\nInventory\nInventory is stated at the lower of cost or market. Cost is determined using the first in, first out method.\nInvestments\nCoachman adopted the provisions of Statement of Financial Accounting Standards (Statement) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" as of January 1, 1993. Under Statement 115, all of Coachman's equity securities are classified as available-for-sale.\nAvailable-for-sale securities are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders' equity (deficit) until realized. A decline in the fair value of any available-for-sale security below cost that is deemed other than temporary is charged to operations resulting in the establishment of a new cost basis for the security. Dividend income is recognized when earned. Realized gains and losses for securities classified as available-for-sale are included in earnings as of the trade date. The cost of securities sold is determined by the specific identification method.\nAs a result of adopting Statement 115, Coachman adjusted its investment in marketable equity securities to fair value at December 31, 1992, with recognition of the adjustment reflected as a separate component of stockholders' equity (deficit).\nInvestments in affiliated entities are accounted for by use of the equity method, and investments in other assets are carried at cost.\nProperty and Equipment\nProperty and equipment are stated at cost and consist principally of office equipment at December 31, 1995, and retail store equipment at December 31, 1994. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets which range from 3 to 7 years. Repairs and maintenance are expensed as incurred; however, major improvements are capitalized.\nIncome Taxes\nEffective January 1, 1993, Coachman adopted Statement No. 109, \"Accounting for Income Taxes.\" The cumulative effect of the change in accounting principle was not material and was included in determining the net loss for 1993.\nUnder Statement 109, income 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 statements of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nManagement Fees\nCoachman recognizes management fees from the management of an affiliated hotel in San Antonio, Texas. Management fees are based on a percentage of hotel gross revenue.\nGoodwill\nGoodwill represents the excess of purchase price over the fair value of net assets acquired and is amortized on a straight-line basis over the expected periods to be benefited, generally 25 years. Amortization expense charged to operations in 1994 and 1993 was approximately $43,000 and $4,000, respectively. In 1994, the remaining balance of approximately $1,330,000 was charged to operations based on management's evaluation of future operations and the uncertainty of future revenues.\nDeferred Costs\nDeferred costs relate to the issuance of bonds and are amortized using the straight-line method over five years. Amortization expense charged to operations for 1994 and 1993 was approximately $15,900 and $700, respectively. Coachman charged to operations the remaining deferred costs in 1995, as the related retail operations were discontinued in December 1995 (see note 3).\nLoss Per Common Share\nLoss per common share amounts are computed by dividing net loss amounts increased for redeemable preferred stock dividends by the weighted average outstanding number of common shares. The computations exclude consideration of certain stock options considered common stock equivalents as their effect is antidilutive. Coachman's Series A, Series_B, and Series C cumulative convertible redeemable preferred stock were not common stock equivalents at issuance. The computation of fully diluted earnings per share, which would assume the conversion of the preferred stock, is not presented as the effect of the conversion of the preferred stock is antidilutive. Undeclared preferred stock dividends of $71,408 and $62,284 were considered in determining net loss applicable to common shares in 1995 and 1994, respectively.\nReclassifications\nCertain reclassifications have been made to the 1994 and 1993 amounts to conform to the 1995 presentation.\nFair Value of Financial Instruments\nCoachman's financial instruments consist of cash and cash equivalents, accounts receivable, notes receivable, accounts payable, accrued liabilities, notes payable, and long-term debt. The carrying values of cash and cash equivalents and accounts receivable approximate fair value due to the short-term nature of these instruments. The carrying value of notes receivable and notes payable approximates fair value due to the interest rates approximating the prevailing market rates at December 31, 1995.\nIt is not practicable to determine the fair value of accounts payable, accrued liabilities, and long-term debt. The majority of these liabilities relate to the discontinued operations of Coachman (see note 3). Coachman is past due on payment of a large portion of accounts payable and accrued liabilities and is in default on portions of the long-term debt. Management currently intends to settle these obligations for amounts less than the face amounts.\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 amounts could differ from those estimates.\n(2) Acquisitions\nOlympic Mills Corporation and Lutania Mills\nOn December 21, 1995, Coachman acquired all of the outstanding common stock of Olympic Mills Corporation (Olympic) and Lutania Mills (Lutania), an affiliate of Olympic in development stage (collectively called the Olympic Group) (the Olympic Acquisition) for $2,000 in cash. The Olympic Group operates a textile manufacturing plant in Puerto Rico which produces underwear and pajamas. Concurrent with and as an integral part of the Olympic Acquisition, Coachman contributed to the capital of Olympic the following:\n-- $2,000,000 in cash;\n-- 6,000,000 shares of Coachman common stock; and\n-- A promissory note for $4,448,826 due on July 15, 1996. The note bears no interest for the first 30 days after issuance; however, any principal payments made after 30 days will bear interest at a rate of 8% per annum. While there is any balance\noutstanding on the note, Coachman will apply the net proceeds from the issuance of any shares of its stock to the payment of principal and interest under the note and the previous ultimate owner of Olympic and Lutania will remain chairman of the board of directors of Olympic and will have veto power over all transactions over $100,000.\nAs part of the Olympic Acquisition, certain amounts due from Olympic to the former owner amounting to $3,570,000 plus accrued interest, and 96,405 preferred shares of Olympic, each with a par value of $100, owned by entities related to the former Olympic shareholder, were paid or acquired by Olympic for $5,458,460 in cash, deferred payment notes amounting to $4,225,714, the assignment of the 6,000,000 shares of Coachman contributed by Coachman to Olympic, the assignment of accounts receivable from an affiliate of Olympic amounting to $1,716,392, and the assignment of the $4,448,826 promissory note contributed by Coachman to Olympic. One of the deferred payment notes is collateralized by a pledge of the shares of Olympic by Coachman. Furthermore, contingent consideration based on the 1995 net earnings of the Olympic Group is to be paid to an entity related to the former owner, as well as a future payment of up to $1,000,000 conditioned upon the obtainment of certain grants requested by the Olympic Group, which amount would be due five years after the conditional payment becomes fixed and the corresponding notes are issued. Additionally, Coachman is committed to issue additional shares of its common stock as of the second anniversary date of the Olympic Acquisition sufficient for the entities currently owning the 6,000,000 shares of common stock issued as part of the Olympic Acquisition to own shares of Coachman having a value of $15 million at such anniversary date.\nThis transaction has been determined to be an acquisition in progress and has been accounted for under the equity method of accounting. It is considered an acquisition in progress because the current operating control of the Olympic Group remains with the former owner, and a promissory note issued in connection with the acquisition in the amount of $1,785,200, which is due July 15, 1996, is secured by the stock of Olympic. Operations of the Olympic Group from December 21, 1995, through December 31, 1995, were insignificant and are, therefore, excluded from the 1995 consolidated statement of operations of Coachman. Following are pro forma (unaudited) 1995 results assuming the Olympic Acquisition had been consummated on January 1, 1995:\nPro Forma Coachman Effect of Coachman Historical Olympic Group Pro Forma ---------- ------------- --------- Revenues $ 67,590 -- 67,590 Expenses 452,123 -- 452,123 ---------- --------- -------- Operating loss (384,533) -- (384,533) ---------- --------- --------\nOther income (expenses) 82,041 (335,172) (253,131)\nEquity in earnings of the Olympic Group -- 555,225 555,225 ---------- --------- -------- Net earnings (loss) from continuing operations $ (302,492) 220,053 (82,439) ========== ========= ======== Net earnings (loss) per share from continuing operations $ (.04) .03 (.01)\nSummarized financial information of the Olympic Group as of and for the year ended December 31, 1995, are as follows:\nTotal assets $ 28,970,482 Total liabilities 15,786,867 Stockholders' equity 13,183,615 Net sales 31,184,281 Net income 555,225\nThe purchase price has not been allocated to the assets of Olympic as the transaction is an acquisition in progress and has been accounted for under the equity method of accounting.\nWest Indies Resort Company and West Indies Club Limited\nEffective July 1, 1994, Coachman issued 300,000 shares of its common stock for all of the outstanding common stock of West Indies Resort Company (WIRC). WIRC entered into a sales and marketing agreement with Legend Resorts L.P. (Legend), a limited partnership and one of Coachman's common stockholders, whereby WIRC marketed and sold time-share units on behalf of Legend for the Hotel On the Cay, a resort property located in St. Croix, Virgin Islands. WIRC earned commissions equal to 45% of the sales price of each time-share unit sold. For the year ended December 31, 1995, and six months ended December 31, 1994, respectively, WIRC recognized approximately $2,300 and $52,800 in commissions, which has been included in time-share commissions in the accompanying statements of operations. The sales and marketing agreement expired October 1, 1995.\nEffective July 1, 1994, Coachman issued 260,000 shares of its common stock and paid cash of $260,000 for all of the limited partnership interests of West Indies Club Limited (WICL). WICL had entered into an asset purchase option agreement with Legend to purchase the assets of the Hotel On the Cay for $2,000,000, subject to reductions based on time-share sales activity in accordance with the agreement. The asset purchase option agreement expired unexercised October 1, 1995.\nThe acquisitions of WIRC and WICL were considered to be tax-free mergers under Internal Revenue Code section 368(a)(2)(D). The transactions were accounted for as purchases and, accordingly, the consolidated financial statements include the results of operations of WIRC and WICL since the acquisition date. The purchase price of $265,600 consisted of cash of $260,000 and $5,600 of Coachman common stock. The purchase price of the acquisition was allocated to the assets acquired based on their fair value and resulted in the recognition of goodwill of approximately $260,000, which was charged to operations in 1994.\nCaribbean Outfitters, Inc.\nEffective December 16, 1993, Coachman acquired Caribbean Outfitters, Inc. (Caribbean) and its wholly owned subsidiaries in a tax-free merger with Coachman's wholly owned subsidiary, COI Acquisition, Inc. Caribbean operated a chain of four retail clothing stores specializing in men's and women's sports apparel located in Aruba (2), Bonaire, and St. Croix. Coachman issued 2,000,000 shares of its common stock with a fair market value of $200,000 and assumed all of Caribbean's liabilities for all of the outstanding common stock of Caribbean.\nAs part of the merger agreement, the former Caribbean stockholders had the right to receive as a contingent stock earn-out additional shares of Coachman common stock based on increased store locations and cumulative revenues from operations of Caribbean. No contingent shares were issued in 1994. The Coachman retail operations, including Caribbean, were discontinued in 1995 (see note 3), and as such no contingent shares were issued in 1995 and none are expected to be issued in future periods.\nThe acquisition was considered a tax-free merger under Internal Revenue Code section 368(a)(2)(D). This transaction was accounted for as a purchase and, accordingly, the consolidated financial statements include the results of operations of Caribbean since the acquisition date. The purchase price of $1,943,334 consisted of $200,000 of Coachman common stock plus Caribbean liabilities of $1,743,334. The purchase price of the acquisition was allocated to the assets acquired based on their fair value and resulted in the recognition of goodwill of approximately $1,020,000, which was charged to operations in 1994.\nFlorida Stores\nDuring April 1994, Back Bay Outfitters, Inc., a wholly owned subsidiary of Coachman, acquired the assets and assumed the liabilities of a retail store located in Florida. In addition, a wholly owned subsidiary of Caribbean acquired the assets of a retail store in St. Thomas in May 1994. The transactions were accounted for as purchases and, accordingly, the consolidated financial statements include the results of operations of the stores since the acquisition dates. The purchase price of the acquisitions was allocated to the assets acquired based on their fair value and resulted in goodwill of approximately $95,000, which was charged to operations in 1994.\n(3) Discontinued Operations\nThe results of the retail sales segment have been reported as discontinued operations in the accompanying consolidated statements of operations. Prior year financial statements have been reclassified to present the retail sales segment as discontinued operations. All of the retail stores were closed prior to December 31, 1995, except one, which was closed in March 1996.\nRevenues applicable to the discontinued operations were approximately $517,000, $1,843,000, and $54,000 in 1995, 1994, and 1993, respectively. As of December 31, 1995, the assets of the retail sales segment were insignificant. The liabilities of the retail sales segment as of December 31, 1995, include approximately $823,000, $442,000, $337,000, and $600,000 included in accounts payable, accrued liabilities, notes payable, and current maturities of long-term debt, respectively.\nThe 1995 consolidated statement of operations includes a loss from operations of discontinued retail operations of $601,027 and a loss from discontinuing retail activities of $392,801. The loss from discontinuing retail activities primarily consists of the impairment of assets related to the retail sales segment. Coachman intends to settle the liabilities related to the retail sales segment for amounts less than the face amounts.\n(4) Notes Receivable-Officer\nNotes receivable-officer is a $110,000 note due December 2003 plus accrued interest. The note bears an interest rate of 6% with interest and principal of approximately $15,000\npayable annually and is collateralized by 1,109,498 restricted shares of Coachman common stock. No payments on the note have been received since the inception of the note in 1993.\n(5) Notes Receivable-Affiliates\nNotes receivable-affiliates consist of the following at December 31:\n1995 1994\nCoachman Inns Income Limited Partnership (CIILP) $ 436,658 472,358 Other 1,677 -- --------- ------- 438,335 472,358 Less current maturities 35,702 35,702 --------- ------- $ 402,633 436,656 ========= =======\nCoachman is co-general partner in CIILP and advanced $700,000 to CIILP under a note agreement which bears interest at 9.0%, payable in monthly installments of $6,397 and maturing in January 2004. The loan is collateralized by a second mortgage on real estate owned by CIILP. In the event that the first mortgage lender were to foreclose on the real estate, management believes proceeds from the eventual sale of the property would be sufficient to cover the lender's first mortgage and Coachman's second mortgage. Coachman recognized interest income on this note of approximately $41,000, $44,000, and $58,000 in 1995, 1994, and 1993, respectively.\n(6) Marketable Equity Securities\nThe aggregate fair value of the marketable equity securities amounted to $108,000, $168,750, and $229,688, including gross unrealized holding gains of approximately $24,000, $-0 , and $60,938 at December 31, 1995, 1994, and 1993, respectively. In 1995, the Company sold half of the securities available-for-sale for approximately $117,000 and realized a gain of approximately $33,000.\n(7) Notes Payable and Long-Term Debt\nNotes payable consist of the following at December 31:\n1995 1994 8% note payable to Olympic Mills Corporation, due in July 1996 (1). $ 4,448,826 --\nSummary judgment awarded by court with interest at 12%, due on demand (2). -- 64,189\n6% unsecured note payable to a company, due in monthly installments of approximately $6,500, including interest, with the final installment due in June 1995 (3). 75,000 75,000\nUnsecured note payable to a stockholder director, due on demand. Interest accrued at New York prime rate plus 2%. 154,150 154,150\n1995 1994\n6% unsecured notes payable to various affiliates, due on demand. $ 107,550 57,000\n9% unsecured note payable to unrelated party, due in April 1996. 50,000 -- ----------- ------- $ 4,835,526 350,339\n(1) The Olympic Mills Corporation note was contributed to the capital of the Olympic Mills Corporation in connection with the acquisition in progress discussed in note 2.\n(2) The summary judgment includes amounts awarded by court decree to an individual for outstanding amounts advanced and other costs incurred. The debt was settled during 1995.\n(3) Required payments under the unsecured note have not been made by Coachman through December 1995. The holder of the note and Coachman are currently renegotiating the terms of the note.\nLong-term debt consists of the following at December 31:\n1995 1994\n12% note payable to Aruba Bank, Ltd. from Caribbean Outfitters, N.V. (CONV), a wholly owned subsidiary of Caribbean. The note was secured by certain equipment, furniture, and fixtures of Caribbean (4). $ 86,680 86,680\n11.5% note payable to a bank from Caribbean, due in monthly installments, including interest, with the final installment due in January 1997. The note is unsecured and is guaranteed by a stockholder board member (5). 37,207 29,888\n14% CONV bearer bonds, with interest payable annually on April 1 (6). 260,000 260,000\n12% CONV bearer bonds, with interest payable semiannually on March 31 and September 30 (6). 188,000 188,000\n12% CONV bearer bonds, with interest payable semiannually on March 31 and September 30 (6). 28,000 28,000\n13% unsecured note payable to an unrelated party with interest and principal due January 1997. The note contains provisions permitting settlement through the issuance of Coachman common stock assuming a conversion rate of approximately $.15 per share. 30,000 30,000\nOther secured note -- 6,413 -------- ------- 629,887 628,981 Less current maturities 596,912 289,785 -------- ------- $ 32,975 339,196 ========= =======\n(4) No principal or interest payments were made on the 12% note to Aruba Bank, Ltd. in 1995 or 1994. The note is past due. Coachman continues to accrue interest on the outstanding principal balance.\n(5) The note payable to a bank was in default at December 31, 1994. The bank had first priority on a retail store's inventory and property and equipment. In 1995, the bank received the assets of the store. The bank and Coachman also renegotiated the terms of the note in 1995 which extended the note to January 1997 and increased the interest rate to 11.5%. The new note is unsecured.\n(6) The 14% and 12% CONV bearer bonds have varying maturity dates. A number of the bonds matured in 1994 and 1995, and have not been paid by CONV, Caribbean, or Coachman. In addition, neither Coachman, CONV, nor Caribbean have met the required interest payment obligations related to the bonds. However, interest has been accrued on the outstanding principal balance. The bonds were originally secured by certain inventory, furniture, fixtures, equipment, and accounts receivable of Caribbean, which were disposed of during 1995. These bonds are included in current maturities of long-term debt. Coachman intends to settle these obligations in future periods for amounts less than the face amounts.\n(8) Income Taxes\nAs discussed in note 1, Coachman adopted Statement 109 as of January 1, 1993. The cumulative effect of the change in accounting for income taxes was not material and is included in determining the net loss for 1993.\nThe net deferred tax assets at December 31 are as follows:\n1995 1994\nDeferred tax assets $ 1,301,000 989,000\nDeferred tax asset valuation allowance (1,301,000) (989,000) ------------ -------- Net deferred tax asset $ -- -- ============ ========\nThe deferred tax asset is comprised primarily of income tax net operating loss carryforwards. Based on the results of Coachman's operations, management does not believe that it is more likely than not that it will be able to realize the benefit of the net operating loss carryforwards and other deductions before they begin to expire. Therefore, Coachman has fully allowed for the deferred tax assets through a valuation allowance.\nThere is no income tax benefit as a result of Coachman allowing for 100% of the deferred tax assets. The valuation allowance was increased by $312,000, $499,000, and $490,000 in 1995, 1994, and 1993, respectively.\nAt December 31, 1995, Coachman has net operating loss carryforwards of approximately $3,200,000 which, if unused, will expire between the years 2003 and 2010.\n(9) Common and Preferred Stock\nDuring 1995, Coachman issued 12,844,100 shares of its common stock for approximately $3,500,000 and 2,500 shares of its preferred stock for approximately $218,000 through\nprivate placements to raise capital needed for the acquisition in progress discussed in note2 and other corporate purposes. A portion of the shares issued were accompanied by warrants, all of which were exercised by December 31, 1995.\nAt December 31, 1995, 1,125,000 shares of Coachman's common stock were subscribed but unissued. Coachman received $391,500 in 1995 related to the subscribed, unissued shares, and has recorded a subscription receivable of $100,000 for the remaining amount to be received for the shares.\nDuring 1994, Coachman issued 1,608,500 shares of its common stock for approximately $460,000 and 4,800 shares of its preferred stock for approximately $455,000 through private placements to raise capital for the retail sales operations.\nAt December 31, 1995, preferred stock includes 3,000 shares of Coachman's 6% Cumulative Convertible Redeemable Series A preferred stock (Series A), 979 shares of Coachman's 14% Cumulative Convertible Redeemable Series B preferred stock (Series B), and 3,271 shares of Coachman's 12% Cumulative Convertible Redeemable Series C preferred stock (Series C). Stated values are $100, $115, and $115 for Series A, Series B, and Series C, respectively, and all three series have a liquidation preference of $100 plus accrued but unpaid dividends per share.\nDividends, when, as, and if declared by the board of directors, will be at the annual rate of $6.00, $16.10, and $13.80 per share for the Series A, Series B, and Series C preferred stock, respectively, payable in semiannual installments on June 30 and December 31 of each year, commencing on December 31, 1994, for the Series A preferred stock and commencing on June 30, 1994, for the Series B and Series C preferred stock.\nAny or all three of the series are redeemable, in whole or in part, at the option of Coachman on at least 30 days' notice, at any time and at the redemption price of $110, $115, and $115 per share for the Series A, Series B, and Series C preferred stock, respectively, plus accrued and unpaid dividends to the redemption date.\nThe Series A, Series B, and Series C preferred stocks are convertible at any time prior to December 31, 1996, at the option of the holder, into 200, 115, and 115 shares of Coachman common stock for each share of Series A, Series B, or Series C preferred stock, respectively, subject to adjustment in certain events.\nThe Series A, Series B, and Series C preferred stock will not have voting rights (except as required by law) unless unpaid dividends accumulate in an amount equal to or exceeding three six-month dividend periods, at which time the holders of Series A, Series B, or Series_C preferred stock will be entitled to elect 20% of the members of Coachman's board of directors. The voting rights (one vote per share) will continue until all dividends on the Series A, Series B, or Series C preferred stock are paid current. The sale and transfer of all three series of preferred stock are restricted. The right to elect 20% of the members of Coachman's board of directors will become effective in 1996 as no dividends have been paid since issuance of the preferred stock in 1994.\nThe Series A preferred stock is senior to the Series B and Series C preferred stock issues. All preferred stock is senior to Coachman's common stock with respect to dividends and on liquidation or dissolution.\nAt December 31, 1995, cumulative unpaid dividends on Series A, Series B, and Series C preferred stock totaled approximately $134,000. There were no Series A, Series B, or Series C redemptions during 1995, 1994, or 1993.\n(10) Employees Incentive Stock Option Plans\nOn March 30, 1987, Coachman adopted an Employees Incentive Stock Option Plan (the Plan). The Plan provides for the granting of options to purchase shares of Coachman's common stock by certain officers, directors, and employees of Coachman upon terms and conditions (including price, exercise date, number of shares, and vesting period) determined by the Compensation Committee (the Committee) appointed by the board of directors which administers the plan. The exercise price specified by the Committee may not be less than 100% of the fair market value, as defined, of Coachman's common stock as of the date of the grant. At December 31, 1995 and 1994, 33,550 options were exercisable with an average exercise price of $.26. No options were exercised during 1995, 1994, or 1993.\nNo accounting is made with respect to these incentive stock options until such time as they are exercised, at which time the proceeds in excess of the par value of the shares issued will be added to additional paid-in capital.\nIn December 1993, Coachman granted to three Coachman officers nonqualified options to purchase a total of 1,000,000 shares of Coachman common stock exercisable at an exercise price of 120% of the closing asked price on December 15, 1993 (closing price of $.10 per share). The options may be exercised at any time during the succeeding five-year period from the option grant date subject to Coachman's ability to raise $1,500,000, the opening of ten new Caribbean stores, and two years of continuous employment by the officers from the option grant date. During 1995, two of the officers resigned from the Company. As a result, stock options granted to the two officers during 1993 to purchase a total of 600,000 shares have been canceled. In addition, as discussed in note 3, Coachman discontinued its retail sales segment in 1995, including Caribbean. As a result, the remaining stock options granted in 1993 to purchase a total of 400,000 shares are not exercisable and will be canceled by December 31, 1996.\n(11) Related Party Transactions\nIn addition to the management fees which Coachman receives, Coachman is also reimbursed for direct administrative services that it provides to affiliates. General and administrative expenses from continuing operations in the accompanying statements of operations are net of allocated direct charges. Reimbursement of these expenses were approximately $313,000, $314,000, and $564,000 for the year ended December 31, 1995, 1994, and 1993, respectively.\nCoachman, one of its subsidiaries, and an officer are guarantors on certain debt of CIILP which is collateralized by real estate. The outstanding balance of the debt amounted to approximately $2,200,000 at December 31, 1995. Coachman also holds a second mortgage on the real estate (see note 5).\nDuring 1995 a consulting company whose president and principal is a director of Coachman provided financial advisory services to Coachman in conjunction with the Olympic Acquisition. The consulting company will receive a fee of $440,000 in\nCoachman common stock and cash, payable in 1996. The fee is included in other accrued liabilities at December 31, 1995. During 1994 Coachman paid approximately $30,000 to a consulting company whose owner is related to one of Coachman's stockholders.\n(12) Commitments and Contingencies\nMinimum future rental payments under noncancellable operating leases for office space and equipment at December 31, 1995, are as follows: $74,000 in 1996 and $14,000 in 1997.\nRental expense was approximately $413,000, $536,000, and $44,000 in 1995, 1994, and 1993, respectively.\nDuring 1995 and 1994, Coachman leased retail facilities under operating leases with varying expiration dates. As discussed in note 3, Coachman discontinued its retail sales segment in 1995. All of the retail stores were closed in 1994 and 1995, except one, which was closed in March 1996. Some of the lease expiration dates were subsequent to the dates of the store closings. As such, Coachman or its subsidiaries may be liable for future accelerated rent. Coachman has accrued approximately $139,000 for current and past due rent at December 31, 1995. No amounts have been recorded for future accelerated rent.\nCoachman is a defendant in a lawsuit filed by the landlord of a closed store for nonpayment of rents. The suit asks for past due rent of approximately $56,000 and accelerated rents of approximately $351,000, plus attorney fees and costs. Coachman believes the claim is without merit and intends to vigorously defend its position. Coachman has accrued approximately $34,000 related to this claim.\nAs discussed in note 3, at December 31, 1995, Coachman has liabilities recorded related to the discontinued retail sales segment. These liabilities include accounts payable, accrued liabilities, notes payable, and long-term debt. Some of these liabilities are in various stages of dispute and\/or litigation, as well as default. Coachman intends to settle these obligations in future periods for amounts less than the face amounts.\nCoachman's wholly owned subsidiary, Coachman Inns of America, Inc., serves as a general partner in a partnership owning one lodging property which another Coachman subsidiary manages. As a general partner, Coachman's subsidiary may be exposed to liability with respect to claims asserted against the partnership.\nCoachman has an employment agreement with an officer that commits Coachman to employ the officer through December 31, 1996. Should the officer be terminated, under certain conditions, the officer is entitled to severance pay in the amount of the salary to be paid during the following 24-month period after the officer is terminated or the number of months remaining in the employment period, whichever is less. The agreement stipulates that bonus compensation shall be paid to the officer in an amount of 4% of Coachman's pretax net income up to the first $1,000,000 of such net income and 6% thereafter.\n(13) Going Concern\nAs shown in the accompanying financial statements, Coachman has incurred losses of $1,296,320, $2,522,692, and $73,273 in 1995, 1994, and 1993, respectively. At December 31, 1995, Coachman's current liabilities exceeded its current assets by\n$6,483,573, and a subsidiary of Coachman was in default on several notes, bonds, and interest payments. These factors create an uncertainty about Coachman's ability to continue as a going concern.\nDuring 1995, Coachman initiated the acquisition discussed in note 2. Coachman intends to complete the acquisition of the Olympic Group in 1996 by raising additional cash equity through issuance of its common and preferred stock. Amounts payable to the former owner of the Olympic Group aggregate $9.2 million of which $4.5 million is due in 1996.\nIf necessary, management could sell its marketable equity securities and receive cash of approximately $100,000 from the sale based on the value of the securities at December 31, 1995. Due to the fact that a substantial portion of accounts payable, accrued liabilities, notes payable, and long- term debt are owed by Caribbean, which has no operations and limited assets, that subsidiary could seek bankruptcy court protection from its creditors while negotiating for the settlement of its liabilities.\nThe ability of Coachman to continue as a going concern is dependent on the settlement of certain of its liabilities for less than face amounts and the payment of liabilities incurred in connection with the acquisition of the Olympic Group. The consolidated financial statements do not include any adjustments that might be necessary if Coachman is unable to continue as a going concern.\nOLYMPIC MILLS CORPORATION, SUBSIDIARY AND AFFILIATE\nCombined Financial Statements\nDecember 31, 1995, 1994 and 1993\nWith Independent Auditors' Report Thereon\nIndependent Auditors' Report\nThe Board of Directors Olympic Mills Corporation:\nWe have audited the accompanying combined balance sheets of Olympic Mills Corporation, subsidiary and affiliate as of December 31, 1995 and 1994, and the related combined statements of operations and retained earnings, and cash flows for each of the three years 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of Olympic Mills Corporation its subsidiary and affiliate as of December 31, 1995 and 1994, and the results of their combined operations and their combined 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\nMarch 14, 1996\nStamp No. 1308576 of the Puerto Rico Society of Certified Public Accountants was affixed to the record copy of this report.\nOLYMPIC MILLS CORPORATION, SUBSIDIARY AND AFFILIATE\nCombined Balance Sheets\nDecember 31, 1995 and 1994\nAssets 1995 1994\nCurrent assets: Cash (note 4) $ 500 800 Accounts receivable: Trade, net of allowance for doubtful accounts of $340,111 in 1995 and $319,574 in 1994 (notes 4 and 11) 5,087,883 4,577,559 Other 1,161,811 531,390 ----------- ---------- 6,249,694 5,108,949\nDue from affiliates (note 8) -- 55,976 Inventories (notes 2 and 4) 9,759,353 8,358,664 Prepaid expenses 198,512 299,814 Prepaid income taxes (note 6) 17,094 3,025 ----------- ---------- Total current assets 16,225,153 13,827,228\nEquipment and improvements, net (notes 3, 4, 5 and 8) 4,599,815 4,941,904\nIntangibles (note 5): Leasehold rights, net of accumulated amortization of $548,766 in 1995 and $488,351 in 1994 55,378 115,793 Tradenames, net of accumulated amortization of $1,414,070 in 1995 and $1,265,920 in 1994 1,548,930 1,697,080 Goodwill, net of accumulated amortization of $3,784,907 in 1995 and $3,413,322 in 1994 5,504,706 5,876,291 Debt issue costs 255,900 -- Other assets, including advances to affiliated company of $914,329 in 1994 (note 8) 48,815 937,300 Deferred tax assets, net (note 6) 731,785 450,534 ----------- ----------\n$ 28,970,482 27,846,130 ============ ==========\nLiabilities and Stockholder s Equity\nCurrent liabilities: Notes payable (note 4) 8,545,880 2,605,388 Accounts payable (including bank overdraft of $391,834 in 1995) 2,656,991 1,651,743 Accrued expenses 1,017,798 1,921,346 Income tax payable (note 6) 101,198 103,697 ------------ ---------- Total current liabilities 12,321,867 6,282,174\nDue to preferred and common shareholders (note 5) -- 3,570,400 Class A redeemable preferred stock, $100 par value. Authorized, issued and outstanding 96,405 shares (notes 7 and 8) -- 9,640,500 Long-term notes payable (note 4) 3,465,000 -- ----------- ---------- 15,786,867 19,493,074 ----------- ----------\nStockholder's equity (notes 7 and 10): Common stock, $10 par value. Authorized, issued and outstanding 100 shares (note 4) 1,000 1,000 Additional paid-in capital 9,502,384 1,426,554 Retained earnings 3,680,231 6,925,502 ----------- ---------- Total stockholder's equity 13,183,615 8,353,056\nCommitments (notes 8 and 9) ------------ ---------- $ 28,970,482 27,846,130 ============ ==========\nSee accompanying notes to combined financial statements.\nOLYMPIC MILLS CORPORATION, SUBSIDIARY AND AFFILIATE\nCombined Statements of Operations and Retained Earnings\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nNet sales (note 11): Trade $ 31,184,281 25,839,901 20,853,870 Affiliated company (note 8) -- 3,091,018 2,759,741 ------------ ---------- ---------- Total net sales 31,184,281 28,930,919 23,613,611\nCost of goods sold 26,224,992 23,209,536 17,265,011 ------------ ---------- ---------- Gross profit 4,959,289 5,721,383 6,348,600\nSelling, general and administrative expenses 4,924,779 4,582,790 4,405,301 ------------ ---------- ---------- Operating income 34,510 1,138,593 1,943,299 ------------ ---------- ---------- Other income\/(expense) (note 8): Interest expense net, including interest income of $46,249 in 1995 and $62,112 in 1994 from affiliated company (871,983) (614,464) (694,052) Reversal of loss contingency reserve 1,125,948 1,125,948 -- ------------ ---------- ---------- Other income\/(expense), net 253,965 511,484 (694,052) ------------ ---------- ---------- Earnings before income taxes 288,475 1,650,077 1,249,247\nIncome tax benefit (notes 1 and 6) 266,750 19,005 38,148 ------------ ---------- ---------- Net earnings 555,225 1,669,082 1,287,395\nRetained earnings at beginning of year 6,925,502 5,256,420 3,969,025\nDividends on preferred stock (3,800,496) -- -- ------------ ---------- ----------\nRetained earnings at end of year $ 3,680,231 6,925,502 5,256,420 ============= ========== ==========\nSee accompanying notes to combined financial statements.\nOLYMPIC MILLS CORPORATION, SUBSIDIARY AND AFFILIATE\nCombined Statements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nCash flows from operating activities: Net earnings $ 555,225 1,669,082 1,287,395 Adjustments to reconcile net earnings to net cash provided by\/(used in) operating activities: Depreciation and amortization 1,132,339 1,015,364 1,008,002 Deferred income taxes (281,251) (102,744) (100,790) Reversal of loss contingency reserve (1,125,948) (1,125,948) -- Changes in assets and liabilities: Accounts receivable (1,140,745) (2,080,303) 561,435 Due from affiliates 55,976 354,913 186,185 Inventories (1,400,689) 385,104 (1,486,357) Prepaid expenses 101,302 (121,180) (7,791) Prepaid income taxes (14,069) (3,025) -- Other assets (827,907) 6,499 -- Accounts payable 1,005,248 1,127,589 (502,935) Accrued expenses 687,400 292,010 (881,632) Income tax payable (2,499) (29,740) (260,448) ---------- ---------- ---------- Total adjustments (1,810,843) (281,461) (1,484,331) ---------- ---------- ---------- Net cash provided by\/(used in) operating activities (1,255,618) 1,387,621 (196,936) ---------- ---------- ----------\nCash flows used in investing activities - capital expenditures (210,100) (859,553) (273,329) ---------- ---------- ----------\nCash flows from financing activities: Net borrowings under line-of-credit agreement 5,181,703 (528,068) 467,382 Capital contribution by Coachman Incorporated 2,000,000 -- -- Acquisition and redemption of preferred shares of stock (3,673,260) -- -- Payment in partial liquidation of notes payable to affiliates (1,785,200) -- -- Deferred debt issuance costs (255,900) -- -- Other payments (1,925) -- -- ---------- ---------- ---------- Net cash provided by\/(used in) financing activities 1,465,418 (528,068) 467,382 ---------- ---------- ----------\nNet change in cash (300) -- (2,883) ---------- ---------- ---------- Cash at beginning of year 800 800 3,683 ---------- ---------- ----------\nCash at end of year $ 500 800 800 =========== ========== ==========\nSupplemental disclosure of cash flow information: Interest paid $ 209,159 133,417 254,115 =========== ========== ==========\nIncome taxes paid $ 19,070 116,504 286,000 =========== ========== ==========\nNoncash Transactions\nAs part of the acquisition of the Company s common stock by Coachman Incorporated and the concurrent payment or refinancing of certain notes due to certain affiliates, and the reaquisition and redemption of the $100 preferred shares of stock, certain noncash transactions were entered into as follows:\nAssignment of an account receivable from an affiliate $ 1,716,392 =========== Assignment of 6,000,000 shares of Coachman Incorporated received by the Company as a capital contribution $ 1,627,004 =========== Assignment of a promissory note received from Coachman Incorporated as a capital contribution $ 4,448,826 =========== Deferred payment notes issued in partial or total payment of the preferred shares of stock and related dividends $ 1,975,514 =========== Deferred payment note issued for an equal amount note $ 1,785,200 =========== Deferred payment note issued for accrued, but unpaid interest $ 465,000 ===========\nSee accompanying notes to combined financial statements.\nOLYMPIC MILLS CORPORATION, SUBSIDIARY AND AFFILIATE\nNotes to Combined Financial Statements\nDecember 31, 1995, 1994 and 1993\n(1) Organization and Significant Accounting Policies\nOrganization\nThe accompanying combined financial statements include the accounts of Olympic Mills Corporation, its wholly-owned subsidiary, Yabucoa Industries, Inc. and Lutania Mills, Inc. (an affiliate)\nOlympic Mills Corporation (the Company) was organized under the laws of the State of Delaware on October 19, 1984 to operate a textile manufacturing plant. On April 20, 1990, Corporaci n Inmobiliaria Textil (Cintex), then owner of 51% of the Company's common stock, acquired 100% control over the Company through the acquisition of the stock of the other shareholder, Bruce Acquisition Corp. (BAC). Bruce Acquisition Corp. had 100% control over OM Acquisition Corp. and ED Acquisition Corp. OM Acquisition Corp. possessed the remaining outstanding common stock of Olympic Mills Corporation until December 21, 1995. On that date, BAC, ED Acquisition Corp. and OM Acquisition Corp. were merged into Estampados Deportivos, Inc. (an affiliate). Simultaneously, Cintex acquired a $3,000,000 promissory note payable jointly and severally by the Company, and its affiliate, Estampados Deportivos, Inc. (Estampados) (the Companies), 39,276 shares of the Company's preferred stock, and 4,724 shares of Estampados' preferred stock. Yabucoa Industries, Inc. (Yabucoa), the Company s wholly-owned subsidiary, operates a cut and saw manufacturing plant which produces underwear, polo shirts and pajamas that are sold exclusively to the Company. Lutania Mills, Inc. (Lutania) is a company in development stage which will operate a textile manufacturing plant. These companies are referred to hereafter as the Olympic group.\nOn December 21, 1995, all of the outstanding stock of the Company and Lutania was acquired by Coachman Incorporated (Coachman) from Estampados and Olympic Holding Corporation. Concurrent with and as an integral part of the acquisition by Coachman, Coachman contributed to the capital of the Company the following:\n-- $2,000,000 cash\n-- 6,000,000 shares of Coachman Incorporated's common stock, and\n-- A promissory note for $4,448,826 due on July 15, 1996. This note bears no interest for the first 30 days after issuance, however, any principal payments made after 30 days of issuance will bear interest at the rate of 8% per annum. While there is any balance outstanding on this note, Coachman will apply the net proceeds from the issuance of any shares of its stock to the payment of principal and interest due under the note. Additionally, as long as there are any amounts due under the promissory note, the previous ultimate owner of the Company, Mr. Francisco Carvajal, will remain Chairman of the Board of Directors of the Company and will have veto power over all transactions over $100,000.\nAs part of the Company's acquisition, certain amounts due by the Company to Cintex and Fideicomiso Hispamer (an affiliate) amounting to $3,570,000 plus accrued interest, and 96,405 preferred shares of the Company, each with a par value of $100, owned by Cintex and Hispamer, were acquired by the Company for $5,458,460 in cash, deferred payment notes amounting to $4,225,714, the assignment of the 6,000,000 shares of Coachman contributed by Coachman to the Company, the assignment of an account receivable from an affiliate of the Company amounting to $1,716,392, and the assignment of the $4,448,826 promissory note referred to above. One of the deferred payment notes is collateralized by the pledge of the shares of the Olympic group. Furthermore, a payment based on the 1995 combined earnings of the Olympic group, was to be made (no such payment is estimated to be due), as well as a future payment of up to $1,000,000 conditioned upon the obtention of certain grants requested by the Olympic group, which amount would be due five years after the conditional payment becomes fixed and the corresponding notes are issued.\nAdditionally, Coachman is committed to issue additional shares of its common stock as of the second anniversary date of the acquisition sufficient for the entities related to Mr. Francisco Carvajal owning the 6,000,000 shares of common stock issued as part of the acquisition to own shares of Coachman having a value of $15 million at such anniversary date.\nThe payment of the note payable to Cintex and the acquisition of the preferred shares owned by it were funded with the proceeds of the $2,000,000 capital contribution by Coachman, net borrowings of $2,852,000 and the collection of amounts due from Lutania of $608,385. Additionally, an account receivable from an affiliate amounting to $1,716,392 was assigned to Cintex, notes aggregating to $1,975,514 were issued and 500,000 of the 6,000,000 shares of Coachman received as a capital contribution, with a recorded book value of $135,584, were assigned to Cintex. The amount paid by the Company in excess of the face value of the $1,785,200 note due to Cintex and the par value of the 39,276 shares of $100 preferred shares of stock ($3,574,392) was accounted for as a dividend on the preferred shares of stock.\nThe transaction with Hispamer did not involve an immediate cash payment but, rather, the issuance of a deferred payment note, the assignment of the $4,448,826 note referred to above and the assignment of the remaining 5,500,000 shares of Coachman received by the Company as a capital contribution, which had a recorded book value of $1,491,420. The excess of the face and recorded values of these instruments over the par value of the 57,129 shares of $100 preferred shares of stock was recorded as a dividend on said preferred stock.\nThe shares of stock of Coachman received by the Company as a contribution to its capital were accounted for at their estimated market value diluted by the issuance of said additional shares of stock.\nSignificant Accounting Policies:\n(a) Investment in Yabucoa Industries, Inc.\nThe combined financial statements include the accounts of the Olympic group. All significant intercompany balances and transactions have been eliminated in the combination, including intercompany profit on assets remaining within the group.\n(b) Inventories\nInventories are stated at the lower of cost (first-in, first-out method) or market.\n(c) Equipment and Improvements\nEquipment and improvements are stated at cost. Depreciation is computed by the straight-line method over the estimated useful life of the assets. The estimated useful lives (in years) of the Company's equipment and improvements are as follows:\nUseful Life\nMachinery and equipment 2.5 to 15 Leasehold improvements 8\nThe cost of maintenance and repairs is charged to expense as incurred. The cost of significant renewals and improvements is added to the carrying amounts and accumulated depreciation for assets sold or retired are eliminated from the respective accounts and gains or losses on disposition are reflected in the combined statement of operations and retained earnings.\n(d) Intangibles\nGoodwill represents the excess of the purchase price over the net identifiable fair value of assets acquired. Goodwill is being amortized by the straight-line method over 25 years. Tradenames and leasehold rights represent the portion of the purchase price attributable to these intangible assets at the acquisition date based on fair values determined by an independent appraisal. Tradenames and leasehold rights are being amortized by the straight-line method over 20 years and 10 years, respectively. Deferred debt issuance costs represent expenses incurred in the restructuring of the Congress Credit Corporation financing agreement and will be amortized over a period of three years.\nAmortization expense for the Company for each of the years ended December 31, 1995, 1994 and 1993 is summarized as follows:\n1995 $ 580,150 1994 580,148 1993 580,149\n(e) Income Taxes\nUnder the asset and liability method 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 bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date.\n(f) Fair Value of Financial Instruments\nThe fair value information of financial instruments in the accompanying financial statements was determined as follows:\nCash\nThe carrying amount approximates fair value because of the short-term nature of this instrument.\nReceivables, Due from Affiliates, Inventories, Prepayments, Other Assets, Accounts Payable, Accrued Expenses and Income Tax Payable\nThe carrying amount approximates fair value because these financial instruments mature and should be collected or paid within six months after December 31.\nNotes Payable\nThe fair value of the notes payable is estimated based on the discounted cash flows for the same or similar issues under current rates offered to the Company for debt of the same remaining maturity. The fair value of the long-term debt at December 31, 1995 approximates its book value because of the proximity of the issuance date and December 31, 1995.\n(g) Reclassifications\nCertain amounts in the 1994 financial statements have been reclassified to conform them to the 1995 presentation.\n(h) 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 financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\n(2) Inventories\nInventories as of December 31 were comprised of the following:\n1995 1994\nFinished goods $ 4,419,314 4,754,195 Work-in-process 424,025 462,406 Raw materials 4,671,914 3,142,063 ----------- --------- $ 9,515,253 8,358,664 =========== =========\n(3) Equipment and Improvements\nEquipment and improvements as of December 31 consist of the following:\n1995 1994\nMachinery and equipment $ 7,749,644 7,572,155 Leasehold improvements 196,903 164,292 ----------- --------- 7,946,547 7,736,447 Less accumulated depreciation and amortization 3,346,732 2,794,543 ----------- --------- Equipment and improvements, net $ 4,599,815 4,941,904 =========== =========\n(4) Borrowings\nThe following debts were outstanding at December 31, 1995 and 1994:\n1995 1994\nNotes payables: Note payable to Corporacion Inmobiliaria Textil (Cintex), due and payable upon receipt of sums due to the Company by a governmental instrumentality under a Special Incentives for Infrastructure Contract. The note is interest free if repaid within thirty days after issuance, otherwise, interest accrues at 8% $ 603,589 --\nNote payable to Corporacion Inmobiliaria Textil (Cintex), due and payable ninety days from the date of issue, bearing interest at the rate of eleven hundredths of one percent per day 370,000 --\nNote payable to Fideicomiso Hispamer, due on July 15, 1996, bearing interest at the rate of 12% if paid at maturity (at 8% if paid prior to the maturity date), collateralized by the pledge of the common shares of stock of the Company 1,785,200 --\nRevolving loans due to Congress Credit Corporation pursuant to a loan and security agreement. 5,787,091 2,605,388 ---------- --------- $8,545,880 2,605,388 ========== =========\nLong-Term Debt: Term loans due to Congress Credit Corporation (Congress), collateralized by a chattel mortgage over the Companies' property 2,000,000 --\nPromissory note due to Corporacion Inmobiliaria Textil (Cintex) due and payable on December 21, 2000, bearing interest at 7%, due quarterly 1,000,000 --\nPromissory note to Fideicomiso Hispamer due on December 21, 2000, interest at 7% due quarterly 465,000 -- ---------- --------- $3,465,000 --\nOn December 21, 1995, the Olympic group entered into a loan and security agreement with Congress Credit Corporation (Congress) providing a maximum credit of $15,000,000. The agreement provides the following financing arrangements and financial accommodations.\nCongress will provide revolving loans subject to certain limitations up to a maximum amount of $13,000,000, letter of credit accommodations up to a maximum amount of $1,000,000 and a $2,000,000 term loan. The Olympic group shall pay Congress a letter of credit fee at an annual 4% rate over the daily outstanding balance of the letter of credit accommodations and an annual facility fee of $75,000 while the agreement is in effect. An unused line fee will be charged to the Olympic group at a rate of .50% over the excess of $13,000,000 over the average principal balance of the outstanding revolving loans and letter of credit accommodations. The agreement provides for a first chattel mortgage on all the equipment owned by the Olympic group and a lien upon its intangible assets, cash and investments, inventory and eligible receivables.\nInterest is payable on the outstanding principal amount at a 4% annual interest rate over Congress's cost of borrowing 936 fund in the commercial paper market or 2% over prime rate, whichever is less. At December 31, 1995, the Company was being charged at 2% over prime rate pending the filing of certain documentation on 936 funds.\nThe agreement contains various financial and nonfinancial covenants for which the Company has complied except certain convenants for which a waiver was obtained.\n(5) Due to Preferred and Common Shareholders\nDue to preferred and common shareholders at December 31, 1994 consisted of the following:\n-- 12% promissory note payable to the Hispamer Trust on October 1, 2000 $ 1,785,200\n-- 12% promissory note payable to Cintex on October 1, 2000 1,785,200 ----------- Total $ 3,570,400 ===========\nPromissory notes payable were secured by a first mortgage on the equipment and improvements of the Companies. The note payable to Cintex was paid in cash on December 21, 1995. The note payable to Hispamer was refinanced on December 21, 1995 and is presently due on July 15, 1996 at 12% (see note 5).\n(6) Income Taxes\nThe provision for income taxes is calculated separately for the each of the companies since the tax laws of Puerto Rico require the filing of separate income tax returns for each company. Corporate income earned in Puerto Rico is taxed at graduated statutory rates of 22% to 45%.\nUnder the provisions of the Puerto Rico Industrial Incentives Act of 1978, as amended, the Company has been granted partial tax exemption from the payment of Puerto Rico income, property and municipal taxes for a period of 10 years ending in March 1995 at the following rates:\nFirst 5 years 80% Second 5 years 70%\nThe Company has applied for a new tax exemption grant under the provisions of the Puerto Rico Tax Incentives Act of 1987 at 90% exemption for income and property and 60% for municipal taxes. The new tax grant is expected to be retroactively effective on January 1, 1993; accordingly, the provision for income taxes reflected in the accompanying financial statements has been calculated assuming the 90% exemption will be granted.\nYabucoa has been granted, under the provisions of the Puerto Rico Tax Incentives Act of January 24, 1987, as amended, partial tax exemption from the payment of Puerto Rico income, property and municipal taxes for a period of 20 years ending in August 2010, January 2010 and June 2011, respectively, at the following rates:\nIncome and property 90% Municipal 60%\nAs discussed in note 1, the Olympic group adopted Statement of Financial Accounting Standard No. 109 as of January 1, 1993. The income tax benefit for the years ended December 31, 1995, 1994 and 1993, which is from Puerto Rico, consists of the following:\n1995 1994 1993\nCurrent income tax expense $ 14,501 83,739 62,642 Deferred income tax benefit (281,251) (102,744) (100,790) ---------- -------- -------- Income tax benefit, net $ (266,750) (19,005) (38,148) ========== ======== ========\nThe income tax effect of the temporary difference comprising the deferred income tax benefit for the years ended December 31, 1995, 1994 and 1993 relates to net operating loss carryforwards of Lutania and the undistributed earnings of Yabucoa, the latter at a tax rate of ten percent which is the applicable statutory tax rate for exempt subsidiaries.\nCombined income tax expense for the years ended December 31, 1995, 1994 and 1993 differed from the amounts computed by applying the statutory rates applicable in Puerto Rico as a result of the following:\n1995 1994 1993\nComputed \"expected\" tax expense $ 129,814 742,535 562,161 Tax reduction resulting from Industrial Incentives Tax Grant (116,832) (668,282) (505,945) Other permanent and other differences 1,519 9,486 6,426 --------- -------- -------- $ 14,501 83,739 62,642 ========== ======== ========\nThe Company is incorporated in the United States and, accordingly, is subject to U.S. income taxes; however, it has elected the benefits of Section 936 of the U.S. Internal Revenue Code. In 1993 and 1992, Section 936 allowed a credit equal to the tax on earnings derived from Puerto Rico. In taxable years after December 31, 1993, the credit under Section 936 is subject to certain limitations. Section 936 allows an income tax credit limited to the sum of 60% of total employees compensation subject to certain limitations, certain percentages of the depreciation allowance and qualified state income taxes. Based on this formula called \"Economic Activity Limitation\", no federal tax liability results for the years ended December_31, 1995 and 1994.\nAt December 31, 1995, Lutania has the following net operating loss carryforwards available to offset taxable income, if any:\nYear\n1998 $ 144,777 1999 489,915 2000 467,109 2001 484,260 2002 399,938 ------------ $ 1,985,999 ============\n(7) Redeemable Preferred Stock\nThe holders of the Class A Redeemable Preferred Stock (the Preferred Stock) are entitled to receive, when and as declared by the Board of Directors, preferred cumulative cash dividends at the rate of $12.00 per share per annum. The Preferred Stock is redeemable in certain instances. In the event of a voluntary or involuntary liquidation of the Company, the holders of the Preferred Stock are entitled to receive out of the assets of the Company up to the sum of $100 per share, plus an amount equal to any unpaid dividends at the distribution date, prior to any payments to the holders of the common stock. The holders of the Preferred Stock are not entitled to voting rights. The preferred shares of stock were acquired by the Company on December 21, 1995 and redeemed (see note 1).\n(8) Transactions with Related Parties\nDuring the years ended December 31, 1995, 1994 and 1993, sales to Estampados amounted to approximately $2,300,000, $3,091,000 and $2,760,000, respectively.\nHispamer Trust, a beneficiary trust (the \"Trust\") created by Francisco Carvajal Narvaez and his family under the laws of the Commonwealth of Puerto Rico and under the administration of Central Hispano Puerto Rico held 57,129 shares of the Company's Preferred Stock and 6,871 shares of Estampados Class A Preferred Stock. The Trust also held a $2,000,000 promissory note issued by the Company and Yabucoa, secured by the Company s and Yabucoa s equipment and improvements. The preferred shares of stock were acquired by the Company on December 21, 1995 and redeemed (see note 1).\nThe Company advanced $701,999 and $513,561 during 1995 and 1994, respectively, to an affiliate in development stage and charged interest of $46,249 in 1995 and $62,112 in 1994.\nThe Company allocated insurance expense of approximately $96,761 in 1995, $167,239 in 1994 and $114,636 in 1993 to affiliated companies.\nThe Company leases its office and manufacturing facilities from Cintex under a yearly renewable lease agreement. Total rent expense under all leases amounted to approximately $742,000 in 1995, $682,000 in 1994 and $676,000 in 1993.\nThe Company, together with Estampados and other affiliates, guaranteed the repayment of a $1,000,000 loan granted by a commercial bank to America Mills C. por A., an affiliate. This loan contained certain covenants which were not met as of December 31, 1995 and 1994. Mr. Francisco Carvajal has agreed with the Company to satisfy all future payments, if any, to be made by the Company in the event of default by America Mills C. por A.\n(9) Commitments and Contingencies\nOn September 23, 1993, the U.S. Environmental Protection Agency issued a complaint and notice of opportunity for hearing against the Company for alleged violation of Section 313 of the Emergency Planning and Community Right to Know Act (\"ECPRA\"). This complaint alleged eleven different violations and proposed a total penalty of $187,000. The parties have agreed to settle the claims for $70,000, which payment shall be made in two installments, the first of which shall be satisfied 45 days after executing the settlement. The Company has accrued the $70,000 at December 31, 1995 and it is included in accrued expenses in the accompanying balance sheet.\nYabucoa and Lutania leases office and operating facilities under operating leases.\nRent expense under all noncancellable operating leases for the Company and its subsidiary for the years ended December 31, 1995, 1994 and 1993 is summarized as follows:\n1995 $ 801,474 1994 735,526 1993 723,590\nFollowing is a summary of future minimum lease payments by Yabucoa under its noncancellable operating lease at December 31, 1995:\n1996 $ 59,474 1997 59,474 1998 59,474 1999 59,474 2000 29,737 ---------- Total minimum lease payments $ 267,633 ==========\nLutania has entered into a lease agreement covering its manufacturing facilities. The conditions of this agreement stipulate annual rents varying from $1.50 to $2.75 per square feet (135.500 square feet in total) upon the satisfactory construction of a waste water treatment plant acceptable to the Puerto Rico Aqueduct and Sewer Authority or upon the occupation of more than 50% of the available manufacturing space whichever occurs first. The agreement is for a 10 year period commencing on June 1, 1994. Since none of the conditions previously mentioned have been fulfilled, Lutania has not and is not presently paying nor accruing any rent.\nThe Company and Cintex have been assessed approximately $822,000 by the Puerto Rico Aqueduct and Sewer Authority for excess waste discharges dating back to January 1989 up to November 1995. Management intends to object the reasonableness of this assessment; however, the Company is presently not in a position to estimate the amount, if any, by which such assessment may be overstated. In the event that the Company is required to pay any part of the aforementioned assessment, Hispamer Trust, as previous principal co-owner and principal beneficiary in the sale of the Company agrees to hold the Company harmless for any such payment, subject to a deductible of $50,000.\n(10) Changes in Capital Structure\nThe Company is contemplating a private placement offering of 240,000 shares of Series A 10% cumulative convertible preferred stock with a minimum limit of 180,000 shares. The preferred stock will be offered at $25 per share with quarterly dividends payable at a fixed annual rate of $2.50 per share beginning June 30, 1996. The preferred stock will have liquidation preference of $25 per share plus accrued and unpaid interest. The preferred stock will be convertible at the option of the holder at any time after the first year, unless, earlier redeemed, into shares of common stock of Coachman Incorporated, the parent of the Company (\"Coachman\") at a conversion ratio of 40 shares of Coachman common stock for each share of preferred stock. The preferred stock may be redeemed by the Company after two years at $26.25 per share, after three years at $26 per share, after four years at $25.50 per share and after five years at $25 per share, plus accrued and unpaid dividends. After five years, a preferred stock holder has the right to require the redemption of his preferred stock by the Company at $25.00 per share plus accrued and unpaid dividends.\nContingent upon the successful sale of the preferred stock being offered, the Certificate of Incorporation will be amended, to increase the aggregate number of authorized shares of common and preferred stock to 4,500,000 and 500,000, respectively. The amended Certificate of Incorporation will provide for the exchange of $100 par value common and preferred stock for new shares of $.01 common and preferred stock, respectively. It is anticipated that a final decision as to these matters may be taken by the latter part of April 1996 or during the month of May 1996.\n(11) Major Customers\nSales to three customers accounted for $17,923,840, $14,181,657 and $8,646,529 during the years ended December 31, 1995, 1994 and 1993, respectively. Accounts receivable from those customers were $2,839,029 and $2,329,228 at December 31, 1995 and 1994, 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 Oklahoma City, on May 13, 1996.\nCOACHMAN INCORPORATED\nBy: \/s\/ Dennis D. Bradford Dennis D. Bradford, Chairman of the Board, Chief Executive Officer 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 Registrant.\nSignature Title Date\n\/s\/ Dennis D. Bradford Chairman, Chief Executive May 13, 1996 Dennis D. Bradford Officer, Chief Financial Officer and Director\n\/s\/ Alejandro G. Asmar Director May 13, 1996 Alejandro G. Asmar\n\/s\/ Jay T. Edwards Director May 13, 1996 Jay T. Edwards\n\/s\/ Robert E. Swain Director May 13, 1996 Robert E. Swain","section_15":""}
{"filename":"32017_1995.txt","cik":"32017","year":"1995","section_1":"Item 1. Business.\nElcor Corporation (Registrant), incorporated in 1965 as a Delaware corporation, is a publicly held corporation headquartered in Dallas, Texas. Shares of the Registrant's common stock are traded on the New York Stock Exchange with the ticker symbol -- ELK.\nLines of Business.\nRoofing Products\nThe Registrant, through Elk Corporation of Dallas and its subsidiaries (Elk), is engaged in the manufacture and sale of premium laminated fiberglass asphalt residential roofing products. Elk also manufactures and sells nonwoven fiberglass mats for use as a substrate material in manufacturing asphalt roofing products, and nonwoven mats for use in other industrial applications. Elk is spending about $80 million over a three-year period to significantly increase its manufacturing capacity for premium laminated fiberglass asphalt shingles and nonwoven fiberglass mats. As of June 30, 1995, cumulative capital expenditures for this expansion program have been approximately $54 million.\nElk's premium laminated fiberglass asphalt shingle manufacturing plants are located in Tuscaloosa, Alabama, Ennis, Texas and a new plant in Shafter, California was in start-up operations at the end of fiscal 1995. Capital expenditures for the new plant are expected to be about $45 million. The new plant has the potential to increase Elk's present capacity for manufacturing premium laminated fiberglass asphalt shingles by more than 65%.\nThe major products manufactured at Elk's roofing plants are premium laminated fiberglass asphalt shingles sold under its brand names: Prestique(R) Plus, Prestique(R) I, Prestique(R) II and Capstone(R). Late in the first quarter of fiscal 1995, Elk introduced Prestique premium laminated fiberglass asphalt shingle product lines with the patented new enhanced High Definition(R) and Raised Profile(TM) look. In addition, Elk also manufactures premium fiberglass asphalt hip and ridge products: Seal-a-Ridge(R) and Z(R) ridge brands.\nElk's roofing products are sold by employee sales personnel primarily to non-owned distributors, delivery being made by common carrier or by customer vehicles from the manufacturing plants. Elk's products are distributed in about 40 states with Texas, California and Florida representing the largest market areas. The Roofing Products segment accounted for approximately 87% of consolidated sales of the Registrant's in fiscal 1995. One customer, ABC Supply Co. Inc., accounted for 11% of consolidated sales in fiscal 1995.\nElk is constructing a major new fiberglass mat manufacturing facility, which will be installed in parallel to its existing fiberglass mat manufacturing facility at its Ennis, Texas plant. It will manufacture nonwoven fiberglass mats for use as a roofing substrate material and for industrial facer products. The new plant will have the potential to more than triple present manufacturing capacity for nonwoven fiberglass mats. Capital expenditures for the new plant addition are estimated to be about $35 million. The new plant is scheduled to begin operations in the spring of 1996.\nElk's nonwoven fiberglass mats are used in the production of its premium roofing products and are sold by employee sales personnel to other asphalt roofing products manufacturers, manufacturers of construction and industrial products which use such mats in their products, and to distributors of industrial filtration products. Elk's nonwoven mats are shipped by common carrier to its other roofing plants and to its customers' locations.\nIndustrial Products\nThe Registrant, through Chromium Corporation (Chromium), is engaged in the remanufacture of diesel engine cylinder liners and tin plating of pistons, including hard chrome plating of cylinder bores, primarily for the railroad, marine, and stationary power industries; and hard chrome plating of original equipment cylinder liners and tin plating of pistons for major domestic locomotive manufacturers and stationary power equipment manufacturers. Chromium is also engaged in electroless shielding of telecommunications, medical electronic and other electronic equipment which is designed to control the level of electromagnetic and radio frequency interference (EMI\/RFI) emissions generated by electronic components. Sales are generated by employee sales personnel, with delivery made primarily by common carrier. Chromium's sales accounted for 11% of consolidated sales of the Registrant in fiscal 1995.\nAnother unit of the Registrant, OEL, LTD., d\/b\/a Ortloff Engineers, Ltd. (Ortloff), is engaged in providing patent licensing and engineering support services and providing consulting engineering services to the oil and gas production, gas processing and sulfur recovery industries. Ortloff licenses patents owned by the Registrant for use in new or redesigned natural gas and refinery gas processing facilities and utilizes technology licenses from others and its own expertise in the performance of consulting engineering assignments. Ortloff continues to develop and patent improved processes for natural gas processing. Three new patent applications were filed in fiscal 1995 and work is continuing on additional applications to be filed in fiscal 1996. These efforts reflect Ortloff's commitment to continually update and advance its technological position.\nPatent license fees are calculated by standard formulas that take into account both specific project criteria and market conditions, adjusted for special conditions that exist in a project. Consulting engineering assignments are performed under consulting services agreements at negotiated rates.\nCompetitive Conditions.\nRoofing Products\nEven though the asphalt roofing products manufacturing business is highly competitive, the Registrant believes that Elk is a leading manufacturer of premium laminated fiberglass asphalt shingles. Elk has been able to compete successfully with its competitors, some of which are larger in size and have greater financial resources.\nThere are a number of major national and regional manufacturers marketing their products in a portion or all of the market areas served by the Registrant's plants. The Registrant competes primarily on the basis of product quality, design, service and price.\nIndustrial Products\nThe Registrant believes that Chromium is the leading remanufacturer of diesel engine cylinder liners and pistons for the railroad and marine transportation industries and is the primary supplier of hard chrome plated finishes for original equipment diesel engine cylinder liners to all of the major domestic locomotive manufacturers. The Registrant believes it has smaller competitors in the locomotive diesel engine cylinder liner remanufacturing market. The Registrant also believes that Chromium is one of the leading hard chrome platers of recycled and original equipment large bore cylinder liners for stationary power applications. Chromium has achieved a leading position in these markets through competition on the basis of product performance, quality, service and price. The Registrant, through the Conductive Coatings Division of Chromium, is engaged in electroless shielding of plastic enclosures for telecommunications, medical electronic and other electronic equipment. The Registrant believes the success of Chromium's Conductive Coatings Division in becoming a qualified supplier for and obtaining orders from major telecommunications, medical electronic and other electronic equipment manufacturers will enable it to successfully compete in this market niche with the potential of becoming a leader in the future.\nThe Registrant believes that it holds significant state-of-the-art patents covering some of the most competitive processes for the separation of ethane and heavier hydrocarbon liquids from refinery and natural gas streams. The Registrant believes it has widely recognized expertise in the design and operation of facilities for natural gas liquids recovery, sulfur recovery and field processing of sour crude oil and natural gas production.\nBacklog.\nBacklog was not significant, nor is it material, in the Registrant's operations.\nRaw Materials.\nRoofing Products\nIn the asphalt roofing products manufacturing business, the significant raw materials are ceramic coated granules, asphalt, glass fibers, resins and mineral filler. All of these materials are presently available from several sources and are in adequate supply. Historically, the Registrant has been able to pass some of the higher raw material and transportation costs through to the customer. Costs of asphalt and glass fibers increased during the latter half of fiscal 1995 resulting in reduced margins. The Company implemented three modest price increases during the March through July 1995 period to offset the impact of higher raw material costs.\nIndustrial Products\nIn the Registrant's business of hard chrome plating and remanufacturing diesel engine cylinder liners and large bore cylinder liners, chromic acid is a significant raw material which is presently available from a number of domestic suppliers. The Registrant believes these domestic suppliers obtain the ore for manufacturing chromic acid principally from sources outside the United States, some of which are subject to political uncertainty. The Registrant has been advised by its suppliers that they maintain substantial inventories of chromic acid in order to minimize the potential effects of foreign interruption in ore supply.\nNo raw materials are utilized in the Registrant's consulting engineering and technology licensing business.\nPatents, Licenses, Franchises and Concessions.\nThe Registrant holds certain patents, particularly in its consulting engineering and licensing business, which are significant to its operations. However, the Registrant does not believe that the loss of any one of these patents or of any license, franchise or concession would have a material adverse effect on the Registrant's overall business operations. The Registrant, through its subsidiary, Elk Corporation of Dallas, is involved in litigation against GAF Building Materials Corporation concerning design and utility patents covering aspects of Elk's High Definition shingles. Refer to Item 3 \"Legal Proceedings\" for a more detailed discussion of this matter.\nEnvironmental Matters.\nThe Registrant and its subsidiaries are subject to federal, state and local requirements regulating the discharge of materials into the environment, the handling and disposal of solid and hazardous wastes, and protection of the public health and the environment generally (collectively,\nEnvironmental Laws). Governmental authorities have the power to require compliance with these Environmental Laws, and violators may be subject to civil or criminal penalties, injunctions or both. Third parties may also have the right to sue to enforce compliance and to require remediation of contamination.\nThe Registrant and its subsidiaries are also subject to Environmental Laws that impose liability for the costs of cleaning up contamination resulting from past spills, disposal, and other releases of hazardous substances. In particular, an entity 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 violations -- for the generation, transportation or disposal of hazardous substances that have caused, or may cause, environmental contamination. In addition, an entity could be liable for cleanup of property it owns or operates even if it did not contribute to the contamination of such property. From time to time, the Registrant or its subsidiaries may incur such remediation and related costs at the company owned plants and at certain offsite locations.\nThe Registrant anticipates that its subsidiaries will incur costs to comply with Environmental Laws, including correcting existing non-compliance with such laws and achieving compliance with anticipated future standards for air emissions and reduction of waste streams. Such subsidiaries expend funds to minimize the discharge of materials into the environment and to comply with governmental regulations relating to the protection of the environment. Neither these expenditures nor other activities initiated in compliance with Environmental Laws is expected to have a material impact on the consolidated financial position, net earnings or liquidity of the Company.\nPersons Employed.\nAt June 30, 1995, the Registrant and its subsidiaries had 704 employees.\nExtended Payment Terms.\nIn some years, the Registrant's roofing products business grants extended payment terms to certain customers for some product shipments during the late winter and early spring months, with payment due during the summer months. As of June 30, 1995, $884,000 in receivables relating to such shipments were outstanding, with payments due primarily in July 1995.\nSeasonal Business.\nThe Registrant's industrial products businesses are substantially nonseasonal. However, the Registrant's roofing products manufacturing business is seasonal to the extent that cold, wet or icy weather conditions during the late fall and winter months in its marketing area typically cause sales to decrease during such periods. Working capital requirements and related borrowings fluctuate during the year because of seasonality. Generally, working capital requirements and borrowings are higher in the spring and summer months, and lower in the fall and winter months.\nInformation as to Lines of Business and Industry Segments.\nFor Lines of Business Information and Financial Information by Company Segments, see the tables under such captions on pages 13 and 24, respectively, in the Registrant's 1995 Annual Report to Shareholders. The information in such tables is incorporated herein by reference.\nExecutive Officers of the Registrant.\nCertain information concerning the Registrant's executive officers is set forth below:\nAll of the executive officers except Mr. Dow and Mr. Sisler have been employed by the Registrant or its subsidiaries in responsible management positions for more than the past five years. In October 1993, Mr. Rosebery and Mr. Work were elected as Executive Vice Presidents of the Registrant. Previously Mr. Rosebery was Vice President, Treasurer and Chief Financial Officer. Mr. Work was Vice President. Also in October 1993, Mr. Harral and Mr. Waibel were elected as Vice Presidents. Previously Mr. Harral was Chief Accounting Officer and Mr. Waibel was Assistant Vice President Administration.\nMr. Dow was previously employed by Kaneb Services, Inc. as Counsel and Assistant Secretary. He served in that capacity from 1990 until he joined the Registrant on February 1, 1992. Mr. Dow resigned from all positions effective July 16, 1995.\nOn August 14, 1995, Mr. Sisler was appointed by the Board of Directors as Vice President, General Counsel and Secretary of the Registrant. Mr. Sisler was employed by Central and South West Corporation as a Senior Attorney from 1993 to 1995 and as an Attorney from 1991 to 1993. From 1989 to 1991, Mr. Sisler was employed by Johnson & Gibbs, a private law firm. Mr. Sisler's responsibilities included corporate, securities and other business legal matters in several industries.\nOfficers are elected annually by the Board of Directors.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAll significant facilities are owned and unencumbered except as discussed herein and under the caption \"Notes to Consolidated Financial Statements\" under the heading \"Long-Term Debt\" on page 22 of the Registrant's 1995 Annual Report to Shareholders.\nRoofing Products\nAsphalt roofing products are manufactured at plants located at Tuscaloosa, Alabama and Ennis, Texas with a new plant at Shafter, California in start-up operations. Fiberglass mat, industrial nonwoven and reinforcement products are manufactured at a plant located at Ennis, Texas. A new plant at the Ennis, Texas facility to manufacture nonwoven fiberglass substrate materials and\nindustrial facer products for the construction industry is under construction. This plant is scheduled to begin operations in the spring of 1996.\nAdministrative offices for the asphalt roofing products operations are located in the same leased facility as the Registrant's corporate offices in Dallas, Texas.\nIndustrial Products\nPlants for the hard chrome plating of original equipment and remanufactured diesel engine cylinder liners and related equipment are located in Cleveland, Ohio and Lufkin, Texas. The Conductive Coatings Division's EMI\/RFI shielding facility is located at the Lufkin, Texas plant. Administrative offices are located in the same leased facility as the Registrant's corporate offices in Dallas, Texas.\nThe engineering and licensing group is located in leased offices in Midland, Texas.\nCorporate Offices\nThe Registrant's corporate headquarters are located in leased offices in Dallas, Texas.\nIn addition, the Registrant or its subsidiaries owns the following properties which are being held for sale or lease:\n(a) Former concrete roof tile plants in North Miami, Boca Raton and Pompano Beach, Florida. The Boca Raton and Pompano Beach plants have been leased for a term of 50 years with an option to purchase through July 10, 1996. The North Miami facility is being held for sale.\n(b) Land and buildings in Waco, Texas, formerly used in the solid waste baler manufacturing business.\n(c) Land in Tulsa, Oklahoma, purchased for use by the former engineering and construction business.\n(d) Land and buildings in Midland, Texas, formerly used in the engineering and construction business.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nGAF Patent Litigation\nIn February 1994, Elk Corporation of Dallas (Elk of Dallas) was granted a design patent covering the ornamental aspects of its High Definition(R) and Raised Profile(TM) shingles. In December 1994, Elk of Dallas was granted a utility patent on the functional aspects of the High Definition and Raised Profile shingles. Elk of Dallas filed lawsuits in federal court in Dallas, Texas, against GAF Building Materials Corporation and related entities (collectively, GAF) for infringement of these patents. Elk of Dallas contends that the GAF Timberline(R) Natural Shadow(TM) and Timberline Ultra(R) Natural Shadow(TM) shingles infringe the patents. In the design patent case, Elk of Dallas seeks to recover as damages the total profit that GAF has made from the infringing shingles. In the utility patent case, Elk of Dallas seeks to recover as damages a reasonable royalty on GAF's sales of infringing shingles and certain lost profits. Elk of Dallas in its actions has also sought to enjoin GAF from making or selling infringing shingles. In the design patent case, GAF filed a motion to bifurcate the issue of liability from that of damages. On August 21, 1995, the court denied GAF's motion.\nGAF seeks a declaratory judgement that the Elk patents are not infringed and are either invalid or unenforceable. GAF has also asserted claims for alleged unfair competition, Lanham Act violations based on alleged false advertising, and common law fraud, generally praying for damages of not less than $25 million, including actual and punitive damages, plus interest, costs, and reasonable attorneys' fees. Elk of Dallas disputes GAF's claims, and management intends vigorously to defend them.\nThe parties are engaged in discovery and pretrial motion practice. The design patent case is set for trial on May 6, 1996. The utility patent case is set for trial on September 16, 1996. Management believes Elk's position is meritorious and intends vigorously to enforce its intellectual property rights. No assurances regarding the outcome of these cases may be given, but their outcome is not expected to have a material adverse effect on the Registrant's results of operations, financial position, or liquidity.\nFrontier Chemical Site\nCertain facilities of the Registrant's subsidiaries ship waste products to various waste disposal facilities for disposal. In May 1993, Chromium received a Notification Letter from the United States Environmental Protection Agency (USEPA) informing Chromium that USEPA had reason to believe that Chromium was a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at the Frontier Chemical Royal Avenue Site (Site), a state-permitted waste processing and management facility located on 9.7 acres in Niagara Falls, New York. After receiving shipments from PRP's, the facility was closed by state regulators leaving all products shipped there on-site. USEPA identified 438 generators, including Chromium,\nas being responsible for Phase I of the response action. Phase I involved primarily the removal of 4,086 drums from the Site. Chromium is alleged to have sent 96 drums of waste to the Site.\nIn September 1993, Chromium entered into an Administrative Order on Consent with USEPA without admitting any liability or USEPA findings or determinations. Chromium agreed along with the other parties to the order to perform Phase I response activities at the Site and to reimburse USEPA for response costs incurred by USEPA at the Site. All of the PRP drums were removed from the Frontier Chemical Royal Avenue Site. The work was concluded in May 1994 and the PRP group of which Chromium was a part filed its final report on May 30, 1995. Chromium was assessed a total of $109,250 under the final assessment dated July 7, 1995, an additional amount of approximately $21,000 above what it had already paid. The assessment was based on an estimated total cost of approximately $4 million. Chromium's total obligation cannot be calculated until its PRP group can determine what portion of its assessments are uncollectible.\nPhase II of the response action involves the removal of waste from process tanks at the Site. USEPA has issued Notice Letters to additional PRPs for Phase II. To date, the Company has not been named as a PRP in Phase II. Estimated costs have been provided for Phase II but have not been provided for any additional phases of cleanup.\nManagement of the Company believes that the final disposition of this matter will not have a material adverse effect on the consolidated results of operations, financial position, or liquidity of the Registrant.\nChromium\/TWC Settlement\nIn October 1991, the Texas Water Commission (\"TWC\") sent Chromium a Notice of Executive Director's Preliminary Report and Petition for a TWC Order Assessing administrative Penalties and Requiring Certain Actions of Chromium (the \"Petition\"). This Petition alleged several violations of TWC rules and recommended that Chromium be assessed $134,800 in penalties and ordered to perform technical, procedural, assessment and remedial activities at Chromium's Lufkin, Texas facility only (\"Technical Recommendations\"). Chromium timely answered this notice and negotiated an Agreed Order in settlement of this case, which the Commission executed on May 19, 1993. Under the Agreed Order, $74,800 of Chromium's penalties will be deferred and forgiven contingent on completion of the Technical Recommendations. The remaining $60,000 penalty is being paid in installments over a three year period. Chromium already has complied with many of the Technical Recommendations, and, working with the Texas Natural Resource Conservation Commission (\"TNRCC\"), TWC's successor, will implement the remainder on a schedule set forth in the Agreed Order.\nManagement believes that this settlement will not have a material adverse effect on the consolidated results of operations, financial position, or liquidity of the Registrant.\nOther\nThere are various other lawsuits and claims pending against the Registrant and its subsidiaries arising in the ordinary course of their business. In the opinion of the Registrant's management based in part on advice of counsel, none of these actions should have a material adverse effect on the Registrant's consolidated results of operations, financial position, or liquidity.\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 Stock and Related Stockholder Matters.\nThe principal market on which the Registrant's Common Stock is traded is the New York Stock Exchange. The Boston, Midwest, Philadelphia and Toronto Stock Exchanges have granted unlisted trading privileges for the Registrant's Common Stock. There were 1,204 holders of record of the Registrant's Common Stock at September 5, 1995.\nThe remaining information required by this item is incorporated by reference to the information under the caption \"Stock Prices\" on page 1 of the Registrant's 1995 Annual Report to Shareholders. No cash dividends were paid in fiscal 1995 or 1994. The limitations affecting the future payment of dividends by Registrant, imposed as a part of the Registrant's revolving credit agreement, are discussed under the caption \"Notes to Consolidated Financial Statements\" under the heading \"Long-Term Debt\" on page 22 of the Registrant's 1995 Annual Report to Shareholders.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information required by this item is incorporated herein by reference to the information under the caption \"Five-Year Summary of Selected Financial Data\" on page 16 of the Registrant's 1995 Annual Report to Shareholders.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe information required by this item is incorporated herein by reference to the information under the caption \"Management's Discussion and Analysis of the Results of Operations and Financial Condition\" on pages 14 and 15 of the Registrant's 1995 Annual Report to Shareholders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe information required by this item is incorporated herein by reference to the information under the caption \"Quarterly Summary of Operations\" and the financial statements and notes thereto on page 13 and pages 18 through 24, respectively, of Registrant's 1995 Annual Report to Shareholders.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure.\nThe Registrant has retained its independent public accountants for over 25 years. There have been no disagreements with the independent public accountants on accounting or financial disclosure matters.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation concerning the Directors of the Registrant required by this item is incorporated herein by reference to the material under the caption \"Election of Directors\" on page 4 of the Registrant's Proxy Statement dated September 19, 1995. Information concerning the Executive Officers of the Registrant is contained 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 is incorporated herein by reference to the information under the caption \"Executive Compensation\" on pages 6 through 13 of the Registrant's Proxy Statement dated September 19, 1995.\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 under the caption \"Stock Ownership\" on pages 2 and 3 of the Registrant's Proxy Statement dated September 19, 1995. The referenced information was provided as of September 5, 1995. Registrant is aware of no material change since such date in the beneficial ownership of any officer, director or beneficial owner of five percent of any class of its voting stock.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThere are no reportable transactions, business relationships or indebtedness between the Registrant and any covered party.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a)1. Financial Statements\nThe financial statements and notes thereto, together with the report of independent public accountants dated August 14, 1995, appearing on pages 17 through 24 of the Registrant's 1995 Annual Report to Shareholders, are incorporated herein by reference. With the exception of such information and other information incorporated herein by reference, 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 report. Such financial statements include:\n-- Report of Independent Public Accountants; -- Consolidated Statement of Operations, years ended June 30, 1995, 1994, and 1993; -- Consolidated Balance Sheet, years ended June 30, 1995 and 1994; -- Consolidated Statement of Cash Flows, years ended June 30, 1995, 1994, and 1993; -- Consolidated Statement of Shareholders' Equity, years ended June 30, 1995, 1994, and 1993; -- Summary of Significant Accounting Policies; and -- Notes to Consolidated Financial Statements.\n2. Financial Statement Schedule for the Years Ended June 30, 1995, 1994, and\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(b) Reports on Form 8-K\nThere were no Form 8-K's filed by the Registrant during the fourth quarter of the fiscal year ended June 30, 1995.\n(c) Exhibits\n- ---------------\n* Filed herewith.\n** Incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 1O-K for the year ended June 30, 1994.\n*** Incorporated by reference to Exhibit 3 to the Registrant's Annual Report on Form 1O-K for the year ended June 30, 1981 and to Exhibit 3.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1988 originally filed with the Securities and Exchange Commission on February 11, 1989.\n**** Incorporated by reference to the Registrant's Quarterly Report on Form 1O-Q for the quarter ended September 30, 1993.\n***** Incorporated by reference to the Registrant's Quarterly Report on Form 1O-Q for the quarter ended September 30, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nELCOR CORPORATION\nBy \/s\/ Richard J. Rosebery Richard J. Rosebery Executive Vice President, Treasurer, Chief Administrative and Financial Officer\nBy \/s\/ Leonard R. Harral Leonard R. Harral Vice President and Chief Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below in multiple counterparts by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANT ON SUPPLEMENTAL SCHEDULE\nTo the Shareholders and Board of Directors of Elcor Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Elcor Corporation's annual report to shareholders incorporated by reference in this Form 10-K and have issued our report thereon dated August 14, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The Supplemental 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 Arthur Andersen LLP\nDallas, Texas August 14, 1995\nSCHEDULE II (in thousands)\nELCOR CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JUNE 30, 1995, 1994, AND 1993\nIndex to Exhibits\n- ---------------\n* Filed herewith.\n** Incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 1O-K for the year ended June 30, 1994.\n*** Incorporated by reference to Exhibit 3 to the Registrant's Annual Report on Form 1O-K for the year ended June 30, 1981 and to Exhibit 3.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1988 originally filed with the Securities and Exchange Commission on February 11, 1989.\n**** Incorporated by reference to the Registrant's Quarterly Report on Form 1O-Q for the quarter ended September 30, 1993.\n***** Incorporated by reference to the Registrant's Quarterly Report on Form 1O-Q for the quarter ended September 30, 1994.","section_15":""}
{"filename":"1004024_1995.txt","cik":"1004024","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2.\t\tProperties\n\tThe Issuer has no physical properties. The EquiVantage Home Equity Loan Trust 1995-2 securities represent in the aggregate the entire beneficial ownership interest in a trust consisting fixed rate, closed-end mortgage loans secured by first or junior mortgages or deeds of trust on one-to-four family 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 the series.\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 EquiVantage Home Equity Loan Trust 1995-2 will be subsequently 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 subsequently on \t\t\t\t\t\t\t\t\t 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":"277923_1995.txt","cik":"277923","year":"1995","section_1":"Item 1. Business\nGeneral Development of Business\nPiccadilly Cafeterias, Inc. was incorporated under the laws of Louisiana in 1965 and is the successor to various predecessor corporations and partnerships which operated \"Piccadilly\" cafeterias beginning with the acquisition of the first unit in 1944. Except where the context otherwise indicates, the terms \"Company\", \"Piccadilly\", and \"Registrant\" as used herein refer to Piccadilly Cafeterias, Inc.\nAt June 30, 1995, the Company operated 132 cafeterias in 17 states. Of these, 60 were in suburban malls, 22 were in suburban strip centers, and 50 were free-standing suburban locations. One new cafeteria is expected to be opened during the year ending June 30, 1996. The following table sets forth certain information regarding development of the Company's cafeteria chain during the five years ended June 30, 1995:\n_______________________________________________________________________________ Year Ended June 30 1995 1994 1993 1992 1991 _______________________________________________________________________________ Net sales per unit (in thousands)(A) $1,990 $1,916 $1,868 $1,880 $1,903\nUnits opened 5 3 1 3 2\nUnits closed 3 4 11 5 0\nUnits open at year-end 132 130 131 141 143\nTotal customer volume (in thousands) 48,274 48,098 50,564 54,298 56,441 __________________\n(A) Excludes cafeterias opened or closed during period. ___________________________________\nAt June 30, 1995 the Company operated eight \"Ralph and Kacoo's\" seafood restaurants in Louisiana, Alabama, Mississippi, and Texas. No additional Ralph & Kacoo's seafood restaurants are expected to be opened in the year ending June 30, 1996. The following table sets forth certain information regarding the Company's \"Ralph and Kacoo's\" seafood restaurant chain during the five years ended June 30, 1995:\n_______________________________________________________________________________ Year Ended June 30 1995 1994 1993 1992 1991 _______________________________________________________________________________ Net sales per unit (in thousands)(A) $3,394 $3,343 $3,362 $3,151 $3,995\nUnits opened 1 0 0 1 3\nUnits closed 0 0 2 1 0\nUnits open at year-end 8 7 7 9 9 _________________\n(A) Excludes restaurants opened or closed during period. ___________________________________\nAlthough the Company's operations are primarily in the southern, southwestern, and western regions of the United States, the Company does not consider its growth to be limited to such areas. During the year ended June 30, 1995, the Company opened its first cafeterias in Louisville, Kentucky and Chicago, Illinois. Although, as disclosed above, the Company has no immediate plans for additional expansion in 1996, Piccadilly continues to evaluate numerous potential expansion locations, focusing on demographic data such as population densities, population profiles, income levels, traffic counts, as well as the extent of competition.\nCafeteria and Restaurant Operations\nThe Company's cafeterias seat from 250 to 450 customers each. Each cafeteria unit offers a wide variety of food, at reasonable prices, and with the convenience of cafeteria service, to a diverse luncheon and dinner clientele. Cafeteria personnel cook and prepare from scratch substantially all food served. All items are prepared from standardized recipes. Menus are varied at the discretion of unit management in response to local and seasonal food preferences.\nLike most industry participants, the Company purchases foodstuffs in small quantities from local and regional suppliers in order to better assure freshness. As a result, inventory is kept relatively low; average per-cafeteria-inventory at June 30, 1995 was $16,100. Foodstuffs are typically purchased on 30-day credit terms and sold for cash within such 30-day period, thereby favorably affecting cash flow.\nRalph & Kacoo's restaurants seat from 250 to 600 customers each. These restaurants are full-service menu facilities. All of the food served is cooked and prepared by the restaurant staff from standardized recipes. Substantially all of the food, supplies, and other materials required for the preparation of meals are supplied by the Company-owned commissary.\nThe commissary, located in Baton Rouge, Louisiana, contains approximately 26,500 square feet of restaurant food and supplies storage. Seafood accounts for approximately 50% of inventory at the commissary. In order to provide consistent quality, selection, and price throughout the year, the commissary purchases in-season seafood in quantities sufficient to supply the restaurants during periods when such products would otherwise not be available at reasonable prices in the marketplace. On the average, seafood inventory turns approximately once every four months. Inventory maintained at the commissary at June 30, 1995, was approximately $2,656,000 while the average \"Ralph and Kacoo's\" restaurant inventory level at year-end was approximately $48,000. The commissary is not dependent upon a single supplier nor a small group of suppliers.\nEach cafeteria and restaurant is operated as a separate unit under the control of a manager and associate manager who have responsibility for virtually all aspects of the unit's business, including purchasing, food preparation, and employee matters. Thirteen district managers, under the supervision of one general manager, and the chief executive officer oversee and regularly inspect cafeteria operations. Two district managers, under the supervision of a region manager and the chief executive officer, oversee restaurant operations. The Company employed approximately 7,600 persons at June 30, 1995, of whom all but 69 corporate headquarters employees worked at Piccadilly's 140 cafeteria and restaurant locations and its commissary.\nThe food service industry is highly competitive. Competitive factors include food quality and variety, price, customer service, location, the number and proximity of competitors, decor, and public reputation. The Company considers its principal competitors to be other cafeterias, casual dining venues, and fast-food operations. Like other food service operations, the Company is attuned to changes in both consumer preferences for food and habits in patronizing eating establishments.\nCustomer volume at established cafeterias and sales volume at established restaurants are generally higher in the Company's second fiscal quarter and lower in the third quarter. These patterns reflect the general seasonal fluctuations of the retail industry.\nCost of sales is affected by statutory minimum wage rates. The Company's operations are subject to federal, state, and local laws and regulations relating to environmental protection, including regulation of discharges into the air and water, and relating to safety and labor, including the Federal Occupational Safety and Health Act and wage and hour laws. Additionally, the Company's operations are regulated pursuant to state and local sanitation and public health laws. Operating units utilize electricity and natural gas, which are subject to various federal and state regulations concerning the allocation of energy. The Company's operating costs have been and will continue to be affected by increases in the cost of energy. Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAll but 24 of the cafeterias and restaurants operated by the Company at June 30, 1995, were operated on premises held under long- term leases with differing provisions and expiration dates. The 24 cafeterias and restaurants not operated on premises held under long- term leases are owned. Leases provide for monthly rentals, typically computed on the basis of a fixed amount plus a percentage of sales. Most leases contain provisions permitting the Company to renew for one or more specified terms. These leases are scheduled to expire, exclusive of renewal provisions, as follows:\n__________________________________________ Five-year periods Units Units ending June 30 Operating Closed __________________________________________ 2000 37 2\n2005 37 2\n2010 34 11\n2015 8 2 =========================================== Total 116 17 ___________________________________________\nReference is made to Note C of the Notes to Consolidated Financial Statements for certain additional information regarding the Company's leases.\nAll cafeterias and restaurants have been constructed or remodeled since 1984 and all cafeteria equipment is maintained and modernized as necessary to maintain appearance and utility. For a discussion of the Company's current remodeling program see Management's Discussion and Analysis of Financial Condition and Results of Operations on pages four and five of the Annual Shareholders Report for the year ended June 30, 1995. The list below provides a general geographic review of the locations of the Company's cafeterias and restaurants at June 30, 1995:\n________________________________________ State Cafeterias Restaurants ________________________________________ Alabama 6 1\nArizona 4\nCalifornia 1\nFlorida 22\nGeorgia 18\nIllinois 1\nKansas 1\nKentucky 1\nLouisiana 26 5\nMississippi 3 1\nMissouri 3\nNorth Carolina 5\nOklahoma 4\nSouth Carolina 2\nTennessee 11\nTexas 17 1\nVirginia 7 __________________________\nThe Company utilizes generally standardized building configurations for its new cafeterias and restaurants in terms of seating, food display, preparation areas, and other factors and attempts to build out floor space to maximize efficient use of available space.\nThe Company continues to pursue strategies to increase the capacity and utilization of its cafeterias. Although most of the Company's cafeterias are single-line, 33 of the Company's cafeterias are double-line which provide increased capacity at peak hours. The Company does not currently intend to convert any of its single-line cafeterias to double-line.\nPiccadilly's corporate headquarters occupy approximately two- thirds of a Company-owned 45,000 square foot office building completed in 1974 and located on a Company-owned tract comprising approximately five acres in Baton Rouge, Louisiana. The remainder of the building is leased to commercial tenants.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is not a party to and does not have any property that is the subject of any legal proceedings pending or, to the knowledge of management, threatened, other than ordinary routine litigation incidental to its business and proceedings which are not material or as to which management believes the Company has adequate insurance.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nItem 4(a). Executive Officers of the Registrant\nExecutive officers are elected annually by the Board of Directors and hold office until a successor is duly elected. The names and positions of executive officers of the Registrant, together with a brief description of the business experience of each such person during the past five years, is set forth below.\nW. Scott Bozzell, Vice President and Assistant Controller, age 32, has held such positions since May 1992. He joined the Company in December 1988 as Assistant Controller.\nFrederick E. Fuchs Jr., Executive Vice President and Director of Real Estate, age 48, has held such positions since June 1986.\nJere W. Goldsmith Jr., Executive Vice President and Director of Training, age 49, has held such positions since July 1995. Mr. Goldsmith previously served in this capacity from May 1987 to February 1992. From February 1992 to July 1995 he was Executive Vice President and Region Manager.\nRonald A. LaBorde, age 39, President and Chief Executive Officer, has held such positions since June 1995. From January 1992 to May 1995 he was Executive Vice President, Treasurer and Chief Financial Officer. Prior to that he was Executive Vice President, Secretary, and Controller.\nD. Thomas Landry, Executive Vice President and Director of Maintenance, Construction and Design, age 43, has held such positions since May 1992. From July 1990 to May 1992 he was Vice President and Director of Maintenance.\nRobert P. Listen, Executive Vice President and Director of Technical Services, age 47, has held such positions since December 1992. From July 1987 to November 1992 he was Executive Vice President and District Manager.\nMark L. Mestayer, Executive Vice President, Secretary, and Controller, age 37, has held such positions since May 1992. From January 1992 to May 1992, he was Vice President and Controller. Prior to that, he was Vice President and Controller, Ralph & Kacoo's.\nJoseph S. Polito, Executive Vice President and General Manager, age 53, has held such positions since July 1995. From October 1992 to July 1995, he was Executive Vice President and Director of Training. From 1987 to October 1992 he was Executive Vice President and District Manager.\nPatrick R. Prudhomme, Executive Vice President and Region Manager, age 45, has held such positions since February 1992. From January 1989 to February 1992 he was Vice President and District Manager, Ralph & Kacoo's.\nC. Warriner Siddle, Executive Vice President and Director of Development, age 44, has held such positions since July 1995. From February 1992 to July 1995 he was Executive Vice President and Region Manager. From October 1984 to February 1992 he was Executive Vice President and District Manager.\nDonovan B. Touchet, Executive Vice President and Director of Data Processing, age 46, has held such positions since June 1988.\nBrian G. Von Gruben, Executive Vice President and Director of Administrative Services, age 47, has held such positions since May 1987. PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters\nInformation regarding Common Stock market prices and dividends, on page one of the Annual Shareholders Report for the year ended June 30, 1995, is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\n\"Selected Financial Data\", on page one of the Annual Shareholders Report for the year ended June 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 four and five of the Annual Shareholders Report for the year ended June 30, 1995, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements and supplementary data, included on pages six through 14 of the Annual Shareholders Report for the year ended June 30, 1995, are incorporated herein by reference:\nConsolidated balance sheets as of June 30, 1995 and 1994 Consolidated statements of income for the fiscal years ended June 30, 1995, 1994 and 1993 Consolidated statements of changes in shareholders' equity for the fiscal years ended June 30, 1995, 1994 and 1993 Consolidated statements of cash flows for the fiscal years ended June 30, 1995, 1994 and 1993 Notes to consolidated financial statements for the fiscal years ended June 30, 1995, 1994 and 1993\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 (3) to Form 10-K, Items 10, 11, 12, and 13 have been omitted since the Company will file with the Commission a definitive proxy statement complying with Regulation 14A relating to its 1995 annual meeting and involving the election of directors not later than 120 days after the close of its fiscal year. The Company incorporates by reference the information in response to such items set forth in its 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 (a) (1) Financial Statements--The following are incorporated herein by reference in this Annual Report on Form 10-K from the indicated pages of the Registrant's Annual Shareholders Report for the year ended June 30, 1995:\nAnnual Shareholders Description Report Page ___________ ___________ Consolidated balance sheets as of June 30, 1995 and 1994 6\nConsolidated statements of income for the fiscal years ended June 30, 1995, 1994 and 1993 7\nConsolidated statements of changes in shareholders' equity for the fiscal years ended June 30, 1995, 1994 and 1993 7\nConsolidated statements of cash flows for the fiscal years ended June 30, 1995, 1994 and 1993 8\nNotes to consolidated financial statements for the fiscal years ended June 30, 1995, 1994 and 1993 9 - 13\nReport of independent auditors 14\n(2) Schedules--The following consolidated schedules and information are included in this annual report on Form 10-K on the pages indicated. 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.\nAnnual Report on Form 10-K Description Page ___________ ____ Schedule VIII--Valuation and qualifying accounts 10\n(3) Listing of Exhibits -- See sub-section (c) below.\n(b) No reports on Form 8-K were filed during the last quarter of the year covered by this report.\nEXHIBITS\n(3) (a) Articles of Incorporation of the Company , as amended on September 14, 1987 as amended on September 27, 1988 , and as amended on September 28, 1989 .\n(b) By-laws of the Company, as amended through June 19, 1995.\n(4) (a) Piccadilly Cafeterias, Inc. Stockholder Rights Agreement .\n(b) Note Agreement, dated as of January 31, 1989, relating to $30 million principal amount of 10.15% Senior Notes due January 31, 1999 .\n(10) (a) Piccadilly Cafeteria, Inc. Pension Plan, as amended, dated May 3, 1993 .\n(b) Piccadilly Cafeterias, Inc. Employee Stock Purchase Plan , as amended on September 27, 1991 .\n(c) Piccadilly Cafeterias, Inc. 1988 Stock Option Plan , as amended on August 2, 1993.\n(d) Agreement between Piccadilly Cafeterias, Inc. and James W. Bennett, effective September 28, 1994 .\n(e) Form of Management Continuity Agreement, effective March 27, 1995, between Piccadilly Cafeterias, Inc. and each of Messrs. LaBorde, Bozzell, Fuchs, Goldsmith, Landry, Listen, Mestayer, Polito, Prudhomme, Siddle, Touchet, von Dameck and Von Gruben.\n(f) Form of Director Indemnity Agreement, effective April 27, 1995, between Piccadilly Cafeterias, Inc. and each of Messrs. LaBorde, Durham, Murrill, Quick, Ross, Simmons, Smith and Stein and Ms. Hamilton.\n(g) Agreement between Piccadilly Cafeterias, Inc. and Ronald A. LaBorde, effective June 26, 1995.\n(h) Form of Agreement, effective August 1, 1995, between Piccadilly Cafeterias, Inc. and each of Malcolm T. Stein, Jr. and James E. Durham, Jr.\n(13) The Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995.\n(21) List of Subsidiaries of the Registrant\n(23) Consent of Independent Auditors\n(27) Financial Data Schedule\nIncorporated by reference from the Registrant's Registration Statement on Form S-1 (Registration No. 2-63249) filed with the Commission on December 19, 1978.\nIncorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1987.\nIncorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.\nIncorporated by reference from the Registrant's Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 1989.\nIncorporated by reference from the Company's Current Report on Form 8-K filed with the Commission on August 22, 1988.\nIncorporated by reference from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 1988.\nIncorporated by reference from the Company's Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 1993.\nIncorporated by reference from the Registrant's Registration Statement on Form S-8 (Registration No. 33-17737) filed with the Commission on October 7, 1989.\nIncorporated by reference from the Registrant's Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 1991.\nIncorporated by reference from the Registrant's Registration Statement on Form S-8 (Registration No. 33-27793) filed with the Commission on March 29, 1989.\nIncorporated by reference from the Registrant's Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPiccadilly Cafeterias, Inc. _____________________________________ (Registrant)\nBy:\/s\/ Ronald A. LaBorde _____________________________________ Ronald A. LaBorde President & CEO\nDate: 9\/25\/95 ______________________\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\/s\/ James E. Durham, Jr. 9\/25\/95 \/s\/ Dale E. Redman 9\/25\/95 __________________________ _______ ________________________ _______ James E. Durham, Jr., Date Dale E. Redman, Director Date\n\/s\/ Norman D. Francis 9\/25\/95 \/s\/ William D. Ross, Jr. 9\/25\/95 ___________________________ _______ ________________________ _______ Norman D. Francis, Director Date William D. Ross, Jr., Date Director\n\/s\/ Julia H. R. Hamilton 9\/25\/95 \/s\/ Edward M. Simmons, Sr. 9\/25\/95 ___________________________ _______ ________________________ _______ Julia H. R. Hamilton, Date Edward M. Simmons, Sr., Date Director Director\n\/s\/ Ronald A. LaBorde 9\/25\/95 \/s\/ C. Ray Smith 9\/25\/95 ___________________________ _______ ________________________ _______ Ronald A. LaBorde, President, Date C. Ray Smith, Director Date Chief Executive Officer and Director (Principal Financial Officer)\n\/s\/ Paul W. Murrill 9\/25\/95 \/s\/ Malcolm T. Stein, Jr. 9\/25\/95 ___________________________ _______ ________________________ _______ Paul W. Murrill, Chairman of Date Malcolm T. Stein, Jr., Date the Board Director\n\/s\/ O.Q. Quick, Director 9\/25\/95 \/s\/ Mark L. Mestayer 9\/25\/95 ___________________________ _______ ________________________ _______ O.Q. Quick, Director Date Mark L. Mestayer, Secretary Date and Controller (Principal Accounting Officer)\n(A) Deductions are for the write-off of certain property, plant and equipment relating to units closed and for the payment of other obligations (primarily rent) for those units closed and for those units for which a provision for unit closing was recorded during the year ended June 30, 1992 but were operating during the year ended June 30, 1993.","section_15":""}
{"filename":"743532_1995.txt","cik":"743532","year":"1995","section_1":"Item 1. Business. --------\n(a) General Development of Business. Alfa Corporation is a holding ------------------------------- company for Alfa Life Insurance Corporation (Life), Alfa Insurance Corporation (AIC), Alfa General Insurance Corporation (AGI), Alfa Financial Corporation (AFC), Alfa Investment Corporation, Alfa Realty, Inc. (ARI), and Alfa Agency Mississippi, Inc. The Registrant's property and casualty insurance subsidiaries are rated \"A++ Superior\" and its life subsidiary is rated \"A+ Superior\" by A. M. Best Company, the leading rating organization in the insurance industry. The Registrant's commercial paper ratings are A-1+ by Standard & Poors and P-1 by Moody's Investors Service. The commercial paper is guaranteed by an affiliate, Alfa Mutual Insurance Company.\nUntil August 1, 1987, Registrant's life insurance subsidiary was its principal source of revenue. Effective that date Registrant's property and casualty subsidiaries entered into a pooling agreement with Alfa Mutual Insurance Company (Mutual), Alfa Mutual Fire Insurance Company (Fire) and Alfa Mutual General Insurance Company (General) (collectively referred to as Mutual Group) pursuant to which premiums, losses, loss adjustment expenses and other underwriting expenses attributable to the direct property and casualty insurance business of each party are pooled and reallocated among the parties. Under the pooling agreement, sixty five percent of the pooled business is allocated to Registrant's subsidiaries, Alfa Insurance Corporation and Alfa General Insurance Corporation.\nThe majority of the Company's Property Casualty Premiums are derived from the Company's participation in the Pooling Agreement.\n(b) Information as to Industry Segments. Prior to August 1, 1987, ----------------------------------- Registrant considered it operated in one main reportable segment, that being the life insurance industry which is operated through its subsidiary, Life. Effective August 1, 1987, Registrant entered into a property and casualty Pooling Agreement. Because of the Pooling Agreement, Registrant substantially increased its property and casualty insurance business. As a result Registrant is now engaged in two major industry segments, the life and property and casualty insurance industries. The Information as to Industry Segments contained in Note 13 to Financial Statements on page 37 of Registrant's Annual Report is incorporated herein by reference.\n(c) Narrative Description of Business. Registrant is a holding company --------------------------------- organized and existing under the laws of the State of Delaware. Until August 1, 1987, Registrant's life insurance business was its principal source of revenue. Life directly writes individual life insurance policies consisting primarily of ordinary whole life, term life, interest sensitive whole life and universal life products. Life maintains an agency force in Alabama, Georgia and Mississippi.\n(i) Life offers several different types of whole life and term insurance products. As of December 31, 1995, Life had in excess of $8.6 billion of life insurance in force. As of December 31, for each year indicated the Company had insurance in force as follows:\n1995 1994 1993 ---------- ---------- ---------- (in thousands) [S] [C] [C] [C] Ordinary Life $8,313,698 $7,553,056 $6,782,539 Credit Life $ 14,382 $ 19,499 $ 9,326 Group Life $ 314,826 $ 295,254 $ 272,470\nI-1\nThe following table shows Life's premiums and policy charges by type of policy and life insurance operating income for the years ended December 31, 1995, 1994, and 1993:\nYears Ended December 31, ------------------------- 1995 1994 1993 ------- ------- ------- (in thousands) Premiums and Policy Charges Universal life $ 8,789 $ 7,876 $ 6,354 Interest sensitive life 7,991 7,705 7,361 Traditional life 18,320 17,224 17,141 ------------------------- Total $35,100 $32,805 $30,856 ========================= Operating income $13,205 $12,039 $14,520 =========================\nLife generally reinsures all life insurance risks in excess of $200,000 on any one life. The purpose of this is to limit the liability of Life with respect to any one risk and afford it a greater diversification of its exposure. When Life reinsures a portion of its risk it must cede the premium income to the company who reinsures the risk, thereby decreasing the income of Registrant.\nLife performs various underwriting procedures and blood testing for AIDS and other diseases before issuance of insurance.\nIn addition to the income from premiums of life insurance contracts, Life's income is directly affected by its investment income or loss from its investment portfolio. The capital and reserves of the Registrant are invested in assets comprising its investment portfolio. The insurance laws prescribe the nature and quality of investments that may be made, and included in its investment portfolio are qualified state, municipal and federal obligations, high quality corporate bonds and stocks, mortgage backed securities, mortgages and certain other assets.\nProperty and Casualty Insurance. Registrant's two property and -------------------------------- casualty subsidiaries, Alfa Insurance Corporation and Alfa General Insurance Corporation, are direct writers of preferred and standard risk property and casualty insurance in Georgia and Mississippi. Registrant's business is predominantly in personal, rather than commercial lines, including automobile, homeowner and fire insurance and similar policies. These companies also write limited commercial lines (church and business owner's insurance). Registrant also assumes property and liability insurance written in Alabama through the pooling agreement.\nI-2\nThe following table sets forth the components of property and casualty insurance earned premiums, net underwriting income, underwriting margin and operating income for the years ended December 31, 1995, 1994 and 1993 including the business written through the property and casualty pooling agreement:\nYears Ended December 31, ------------------------------- 1995 1994 1993 -------- ------- ------- (in thousands) Earned Premiums Personal lines $270,109 $208,358 $181,686 Commercial lines 10,606 8,524 8,920 Pools, associations and fees 3,709 2,920 2,541 Reinsurance ceded (11,435) (5,476) (4,090) ------------------------------- Total $272,989 $214,326 $189,057 =============================== Net Underwriting Income (Loss) $(10,598) $ 10,793 $ 17,217 =============================== Underwriting Margin (3.9%) 5.0% 9.1% =============================== Operating Income $ 8,182 $ 20,179 $ 24,144 ===============================\nPooling Agreement. Effective August 1, 1987, the Registrant's ----------------- property and casualty insurance subsidiaries entered into the Pooling Agreement with Mutual, Fire, and General. Under the terms of the Pooling Agreement, the Registrant ceded to Mutual all of its property and casualty insurance business in force and written on or after August 1, 1987, net of reinsurance ceded to others. All of the Mutual Group's direct property and casualty insurance business, net of such reinsurance, in force or written on or after such date, is also included in the pool. Mutual retrocedes 65% of the pooled premiums, losses, loss adjustment expenses and other underwriting expenses to Registrant. The Pooling Agreement enabled Registrant, in effect, to expand its property and casualty insurance revenues and to spread and stabilize the underwriting risks borne by each party through the creation of a larger and more diversified risk pool.\nThe Boards of Directors of Mutual, Fire and General and of the Registrant's property and casualty insurance subsidiaries have established the pool participation percentages and must approve any changes in such participation. The Alabama Insurance Department reviewed the Pooling Agreement and determined that its implementation did not require its approval.\nA committee consisting of two members of the Boards of Directors of the Mutual Group, two members of the Board of Directors of the Registrant and Goodwin Myrick, as chairman of each such Board, has been established to review and approve any changes in the Pooling Agreement. The committee is responsible for matters involving actual or potential conflicts of interest between the Registrant and the Mutual Group and for attempting to ensure that, in operation, the Pooling Agreement is equitable to all parties. Conflicts in geographic markets are currently minimal because the Mutual Group writes property and casualty insurance only in Alabama and at present all of such insurance written by the Registrant is outside of Alabama. The Pooling Agreement is intended to reduce conflicts which could arise in the selection of risks to be insured by the participants by making the results of each participant's operations dependent on the results of all of the Pooled Business. Accordingly, the participants should have substantially identical direct underwriting ratios for the Pooled Business as long as the Pooling Agreement remains in effect.\nI-3\nThe participation of Registrant in the Pooling Agreement may be changed or terminated without the consent or approval of the shareholders, and the Pooling Agreement may be terminated by any party thereto upon 90 days notice. Any such termination, or a change in Registrant's allocated share of the Pooled Business, inclusion of riskier business or certain types of reinsurance assumed in the pool, or other changes to the Pooling Agreement, could have a material adverse impact on Registrant's earnings. Participants' respective abilities to share in the Pooled Business are subject to regulatory capital requirements.\nRelationship with Mutual Group. The Registrant's business and ------------------------------ operations are substantially integrated with and dependent upon the management, personnel and facilities of Mutual. Under a Management and Operating Agreement with Mutual all management personnel are provided by Mutual and Registrant reimburses Mutual for field office expenses and operations services rendered by Mutual in the areas of advertising, sales administration, underwriting, legal, sales, claims, management, accounting, securities and investment, and other services rendered by Mutual to Registrant.\nMutual periodically conducts time usage and related expense allocation studies. Mutual charges Registrant for its allocable and directly attributable salaries and other expenses, including office facilities in Montgomery, Alabama.\nThe Board of Directors of Registrant consisted at year end of eleven members, six of whom serve on the Executive Committee of the Boards of Mutual, Fire and General and two of whom are Executive Officers of Registrant.\nMutual owns 16,201,538 shares, or 39.72%, and Fire owns 4,515,286 shares, or 11.07%, of Registrant's Outstanding Common Stock.\nOther Business - --------------\nRegistrant operates five other subsidiaries which are not considered to be significant by SEC Regulations. These subsidiaries are Alfa Financial Corporation (AFC), a lending institution, Alfa Investment Corporation, a real estate investment business and its wholly owned subsidiary, Alfa Builders, Inc., a construction company, Alfa Realty, Inc., a real estate sales agency, and Alfa Agency Mississippi, Inc.\nAFC is a lending institution engaged principally in making consumer loans. These loans are available through substantially all agency offices of Registrant.\nAlfa Investment Corporation is a Florida corporation engaged in the real estate investment business. Alfa Builders, Inc. is engaged in the construction business in Alabama and is also engaged in real estate investments.\nAlfa Realty, Inc., is engaged in the business of listing and selling real estate in the Montgomery and Autauga County, Alabama, areas.\nAlfa Agency Mississippi Inc. places substandard insurance risks with third party insurers for a commission.\n(ii) - (ix). Not applicable.\nI-4\n(x) Both the life and property and casualty insurance businesses are highly competitive. There are numerous insurance companies in Registrant's area of operation and throughout the United States. Many of the companies which are in direct competition with the Registrant have been in business for a much longer period of time, have a larger volume of business, offer a more diversified line of insurance coverage, and have greater financial resources than Registrant. In its life and property and casualty insurance businesses, Registrant competes with other insurers in the sale of insurance products to consumers and the recruitment and retention of qualified agents. Registrant believes that the main competitive factors in its business are price, name recognition and service. Registrant believes that it competes effectively in these areas in Alabama. In Georgia and Mississippi, however, the Registrant's name is not as well recognized.\nRegistrant's insurance subsidiaries are subject to licensing and supervision by the governmental agencies in the jurisdictions in which they do business. The nature and extent of such regulation varies, but generally has its source in State Statutes which delegate regulatory, supervisory and administrative powers to State Insurance Commissioners. Such regulation, supervision and administration relate, among other things, to standards of solvency which must be met and maintained, licensing of the companies and the benefit of policyholders, periodic examination of the affairs and financial condition of the Registrant, annual and other reports required to be filed on the financial condition and operation of the Registrant. Life insurance rates are generally not subject to prior regulatory approval. Rates of property and casualty insurance are subject to regulation and approval of regulatory authorities.\nThe Mutual Group and Registrant's insurance subsidiaries are subject to the Alabama Insurance Holding Company Systems Regulatory Act and are subject to reporting to the Alabama Insurance Department and to periodic examination of their transactions and regulation under the Act with Mutual being considered the controlling party.\n(xi-xii) Not applicable.\n(xiii) The Registrant has no management or operational employees. Registrant and its subsidiaries have a Management and Operating Agreement with Mutual whereby Registrant and its subsidiaries reimburse Mutual for salaries and expenses of employees provided to Registrant under the Agreement. Involved are employees in the areas of Life Underwriting, Life Processing, Accounting, Sales, Administration, Legal, Files, Data Processing, Programming, Research, Policy Issuing, Claims, Investments, and Management. At December 31, 1995, Registrant was represented by 469 agents in Alabama who are employees of Mutual. Registrant's property and casualty subsidiaries had 116 independent exclusive agents in Georgia and Mississippi at December 31, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ----------\n(a) Physical Properties of Registrant and Its Subsidiaries. The ------------------------------------------------------- Registrant leases it home office facilities in Montgomery, Alabama,from Mutual.\nRegistrant and its subsidiaries own several investment properties, none of which are material to Registrant's business.\n(b) Oil and Gas Operations. Not applicable. ----------------------\nI-5\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nVarious legal proceedings arising during the normal course of business with policyholders and agents are in process at December 31, 1995. Based upon information presently available, applicable law and the defenses available to Alfa Corporation and its subsidiaries, management does not consider that contingent liabilities which might arise from pending litigation are material in relation to the financial position, results of operations or cash flows of the Company. Management's opinion is based upon the Company's experience in dealing with such claims and the historical results of such claims against the Company. However, it should be noted that in Alabama, where Alfa Corporation has substantial business, the frequency of large punitive damage awards, bearing little or no relation to actual damages awarded by juries, continues to increase.\nItem 4.","section_4":"Item 4. Submission of Matters to Vote of Security Holders. -------------------------------------------------\nNot applicable.\nExecutive Officers of the Registrant: - ------------------------------------\nPursuant to General Instruction G(3) of Form 10-K, the following 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 stockholders to be held April 18, 1996.\nThe following is a list of name and ages of all of the executive officers of the Registrant indicating all positions and offices with the Registrant held by such person and each such person's principal occupation or employment during the past five years. No person other than those listed below has been chosen to become an executive officer of the Registrant.\nI-6\nI-7\nPart II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Security Holder ---------------------------------------------------------------- Matters. --------\nThe \"Stockholder Information\" section on the Inside Back Cover of Registrant's annual report to security holders for the fiscal year ended December 31, 1995, is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data. ------------------------\nThe \"Selected Financial Data\" section on pages 6 and 7 of the Registrant's annual report to security holders 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. ----------------------\nThe \"Management's Discussion and Analysis\" section on pages 14 through 20 of the Registrant's annual report to security holders for the fiscal year ended December 31, 1995, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. --------------------------------------------\nThe Financial Statements on pages 21 through 40 of the Registrant's annual report to security holders for the fiscal year ended December 31, 1995, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. ----------------------------------------------------\nNone.\nII-1\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 Page 2 of the Proxy statement for the annual meeting of stockholders to be held April 18, 1996, which is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nThe information set forth under the caption \"Executive Compensation\" on Page 6 of the Proxy Statement for the annual meeting of stockholders to be held April 18, 1996, except for the report of the Compensation Committee and Performance Graph, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------\nThe information appearing on Pages 1 through 3 of the Proxy Statement for the annual meeting of stockholders to be held April 18, 1996, relating to the security ownership of certain beneficial owners and management is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ----------------------------------------------\nThe information set forth under the caption \"Executive Compensation\" on Page 6 of the Proxy Statement for the annual meeting of stockholders to be held April 18, 1996, is incorporated herein by reference.\nIII-1\nPart IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, Reports on Form 8-K. ------------------------------------------------------------\n(a) The following documents are filed as part of this report:\n1. Financial Statements. --------------------\nReport of Independent Certified Public Accountants for 1995, 1994, and 1993.\nConsolidated Balance Sheets as of December 31, 1995 and 1994.\nConsolidated Statements of Income for the three years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity for the three years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nSelected Quarterly Financial Data.\n2. Financial Statement Schedules. -----------------------------\nIncluded in Part IV of this report:\nPage ---- Reports on Financial Statements and Financial Statement Schedules of Independent Certified Public Accountants for 1995, 1994 and 1993. IV-3\nSchedule I - Summary of Investments Other Than Investments in Related Parties for the year ended December 31, 1995 IV-4\nSchedule II - Condensed Financial Information IV-5-7\nSchedule III - Supplementary Insurance Information IV-8\nSchedule IV - Reinsurance for the years ended December 31, 1995, 1994 and 1993 IV-9\nSchedule V - Valuation and Qualifying Accounts IV-10\nIV-1\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 required or applicable.\n3. Exhibits. --------\nExhibit (3) - Articles of Incorporation and By-Laws of the Registrant are incorporated by reference from Registrant's 10-K for the year ended December 31, 1987.\nExhibit (10(a)) - Amendment No. 2 to Management and Operating Agreement effective January 1, 1992 is incorporated by reference from Registrant's 10-K for the year ended December 31, 1992.\n(10(b)) - Insurance Pooling Agreement is incorporated by reference from registrant's 10-K for the year ended December 31, 1987.\nExhibit (13) - Registrant's Annual Report to Security Holders for the fiscal year ended December 31, 1995. Such report, except for the portions incorporated herein by reference, is furnished to the Commission for information only and is not deemed filed as part of this report.\nExhibit (19) - Employee Stock Purchase Plan and 1993 Stock Incentive Plan are incorporated by reference from registrant's 10-K for the year ended December 31, 1993.\nExhibit (24) - Consents of Independent Accountants\n(b) Reports on Form 8-K. -------------------\nAn 8-K report was filed on May 22, 1995 reporting a change in certifying accountants from Coopers & Lybrand L.L.P. to KPMG Peat Marwick LLP .\nIV-2\nINDEPENDENT AUDITOR'S REPORT\nThe Stockholders and Board of Directors Alfa Corporation Montgomery, Alabama:\nWe have audited the accompanying consolidated balance sheet of Alfa Corporation and subsidiaries (the Company) as of December 31, 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the 1995 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alfa Corporation and subsidiaries as of December 31, 1995, and the results of their operations and their cash flows for the year ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audit for the year ended December 31, 1995, was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplementary information included in Schedules I through V for the year ended December 31, 1995, 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 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 for the year ended December 31, 1995.\nKPMG Peat Marwick LLP\nBirmingham, Alabama January 31, 1996\nIV-3(a)\nReport of Independent Accountants\nTo the Stockholders and Board of Directors Alfa Corporation Montgomery, Alabama\nWe have audited the consolidated financial statements and the financial statement schedules of Alfa Corporation and subsidiaries (the Company) as of December 31, 1994 and for each of the years ended December 31, 1994 and 1993 as listed in the index on page IV-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 and financial statement schedules referred to above present fairly, in all material respects, the financial position of Alfa Corporation and its subsidiaries 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.\nAs discussed in Note 1 to the Consolidated Financial Statements, the Company changed its method of accounting for certain investments in debt and equity securities in 1994 and in 1993 the Company changed its methods of accounting for income taxes, postretirement benefits other than pensions, and for certain reinsurance contracts to comply with new Financial Accounting Standards Board pronouncements.\nCoopers & Lybrand L.L.P.\nBirmingham, Alabama February 2, 1995\nIV-3(b)\nALFA CORPORATION AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES FOR THE YEAR ENDED DECEMBER 31, 1995\n------------\nIV-4\nALFA CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS DECEMBER 31, 1995 AND 1994\n------------\nLIABILITIES AND STOCKHOLDERS' EQUITY\nIV-5\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n-------------\nIV-6\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nIV-7\nALFA CORPORATION SCHEDULE III - SUPPLEMENTAL INSURANCE INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nIV-8\nALFA CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE FOR YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n- -------------- *These amounts are subject to the pooling agreement.\nIV-9\nALFA CORPORATION AND SUBSIDIARIES SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994\nIV-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.\nALFA CORPORATION\nBy \/s\/ Goodwin L. Myrick -------------------------------------- Goodwin L. Myrick President\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.\nChairman of the Board \/s\/ Goodwin L. Myrick Director and Principal - -------------------------- Executive Officer --------- (Goodwin L. Myrick) (Date)\nSenior Vice President, \/s\/ Donald Price Finance, (Principal - -------------------------- Financial Officer) --------- (Donald Price) (Date)\n\/s\/ John D. Holley Vice President and - -------------------------- Controller -------- (John D. Holley) (Date)\n\/s\/ Jerry A. Newby - -------------------------- Director -------- (Jerry A. Newby) (Date)\n\/s\/ James E. Mobley - -------------------------- Director -------- (James E. Mobley) (Date)\n\/s\/ James A. Tolar, Jr. - -------------------------- Director -------- (James A. Tolar, Jr.) (Date)\n\/s\/ John W. Morris - -------------------------- Director -------- (John W. Morris) (Date)\n\/s\/ Milborn N. Chesser - -------------------------- Director -------- (Milborn N. Chesser) (Date)\n\/s\/ James I. Harrison, Jr. - -------------------------- Director -------- (James I. Harrison, Jr.) (Date)\n\/s\/ Young J. Boozer - -------------------------- Director -------- (Young J. Boozer) (Date)\n\/s\/ John R. Thomas - -------------------------- Director -------- (John R. Thomas) (Date)\n\/s\/ B. Phil Richardson - -------------------------- Director -------- (B. Phil Richardson) (Date)\n\/s\/ Boyd E. Christenberry - -------------------------- Director -------- (Boyd E. Christenberry) (Date)\n\/s\/ Thomas H. Miller - -------------------------- Director -------- (Thomas H. Miller) (Date)","section_15":""}
{"filename":"355573_1995.txt","cik":"355573","year":"1995","section_1":"ITEM 1. BUSINESS:\nReal Estate Associates Limited IV (\"REAL IV\" or the \"Partnership\") is a limited partnership which was formed under the laws of the State of California on August 24, 1981. On March 12, 1982, REAL IV offered 3,000 units consisting of 6,000 Limited Partnership Interests and Warrants to purchase a maximum of 6,000 Additional Limited Partnership Interests through a public offering managed by Lehman Brothers, Inc.\nThe general partners of Real IV 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 Charles H. Boxenbaum as limited partner. The business of REAL IV is conducted primarily by its general partners as REAL IV 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 IV holds limited partnership interests in twenty-two local limited partnerships as of December 31, 1995 and a general partner interest in Real Estate Associates II (\"REA II\") which in turn holds limited partnership interests in an additional seven limited partnerships. Therefore, REAL IV holds directly or indirectly through REA II investments in twenty-nine local limited partnerships. The general partners of REA II are REAL IV and NAPICO. Each of the local partnerships 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 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 remains, however, significant risks. The long-term nature of investments in government assisted housing limits the ability of REAL IV to vary its portfolio in response to changing economic, financial and investment conditions. These 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 partnerships in which REAL IV 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 IV became the principal limited partner in these local limited partnerships pursuant to arm's-length negotiations with these developers, or others, who act as general partners. As a limited partner, REAL IV'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 IV has the right to replace the general partner of the local limited partnerships.\nAlthough each of the partnerships in which REAL IV has invested generally owns 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.\nDuring 1995, the projects in which REAL IV had invested were substantially rented. The following is a schedule of the status as of December 31, 1995, of the projects owned by local limited partnerships in which REAL IV, either directly or indirectly, has invested.\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV HAS AN INVESTMENT DECEMBER 31, 1995\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV HAS AN INVESTMENT DECEMBER 31, 1995 (CONTINUED)\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV HAS AN INVESTMENT DECEMBER 31, 1995 (CONTINUED)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThrough its investment in local limited partnerships, REAL IV 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 Corporate General Partner was a plaintiff or defendant in several lawsuits. None of these suits were related to REAL IV.\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 interest. Limited partnership interests may be transferred only if certain requirements are satisfied. At December 31, 1995, there were 2,703 registered holders of units in REAL IV. No distributions have 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.\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\nThe Partnership's primary sources of funds include interest income on money market funds and certificates of deposit and distributions from local partnerships in which the Partnership has invested. It is not expected that any of the local limited 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.\nCAPITAL RESOURCES\nREAL IV received $16,500,000 in subscriptions for units of limited partnership interests (at $5,000 per unit) during the period March 12, l982 to July 15, 1982, pursuant to a registration statement on Form S-11. As of March 31, 1983, REAL IV received an additional $16,500,000 in subscriptions pursuant to the exercise of warrants and the sale of additional limited partnership interests.\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 limited partnerships in which REAL IV has invested could produce tax losses for as long as 20 years. The Partnership will seek to defer 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 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 will decrease as mortgage principal is amortized, and as the Tax Reform Act of 1986 limits the deductions available. The 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.\nThe Partnership accounts for its investments in the local limited partnerships on the equity method, thereby adjusting its investment balance by its prportionate 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 partnerships owning government assisted projects. Available cash not invested in Limited Partnerships is invested in these funds earning interest income as reflected in the statements of operations. These money market funds and certificates of deposit 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 limited partnership.\nOperating expenses, exclusive of management fees and interest,consist substantially of professional fees for services rendered to the Partnership.\nThe Partnership, as a limited partner in the local limited partnerships in which it has invested, is subject to the risks incident to the 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:\nNot applicable.\nREAL ESTATE ASSOCIATES LIMITED IV (A California limited partnership)\nFINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND INDEPENDENT PUBLIC ACCOUNTANTS' REPORT DECEMBER 31, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Real Estate Associates Limited IV (A California limited partnership)\nWe have audited the accompanying balance sheets of Real Estate Associates Limited IV (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (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 22 percent and 30 percent of total assets as of December 31, 1995 and 1994, respectively, and the equity in income of these limited partnerships represents 27 percent, 20 percent and 33 percent of the total net income 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 IV 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\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIENCY) FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nREAL ESTATE ASSOCIATES LIMITED IV (a California 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 financial statements.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nReal Estate Associates Limited IV (the Partnership) was formed under the California Limited Partnership Act on August 24, 1981. The Partnership was formed to invest either directly or indirectly in other limited partnerships which own and operate primarily federal, state and local government-assisted housing projects. The general partners are National Partnership Investments Corp. (NAPICO), the corporate general partner, and Coast Housing Investments Associates (CHIA), a limited partnership. Casden Investment Corp. owns 100 percent of NAPICO's stock. The limited partner of CHIA is an officer of NAPICO.\nThe Partnership issued 13,200 limited partner interests through a public offering. 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 52 complete calendar years (December 31, 2033) from the date of formation of the Partnership or the occurrence of various other events as specified in the terms of 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 item 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) sold and shall receive from the sale of the project(s) an amount sufficient to pay state and federal income taxes, if any, calculated at the maximum rate then in effect. The general partners' 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\nThese financial statements include the accounts of the Partnership and Real Estate Associates II (REA II), a California general partnership in which the Partnership holds a 99.9 percent general partner interest. Losses in excess of the minority interest is equity that would otherwise be attributed to the minority interest are being allocated to the Partnership.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\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.\nNet Income Per Limited Partnership Interest\nNet income per limited partnership interest was computed by dividing the limited partners' share of net income by the number of limited partnership interests outstanding during the year. The number of limited partnership interests was 13,202 for all years presented.\nCash and Cash Equivalents\nCash and cash equivalents consist of cash and bank certificates of deposit with an original maturity date 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 twenty-two limited partnerships. In addition, the Partnership holds a general partner interest in REA II. NAPICO is also a general partner in REA II. REA II, in turn, holds limited partner interests in seven additional limited partnerships. In total, therefore, the Partnership holds interests, either directly or indirectly through REA II, in twenty-nine partnerships which own residential low income rental projects consisting of 2,783 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 80 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 II. REA II is entitled to a 99 percent interest in each of the limited partnerships in which it has invested.\nEquity in loss of the limited partnerships is recognized until the investment balance is reduced to zero. 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 certain limited partnerships was approximately $9,713,000 and $9,316,000 as of December 31, 1995 and 1994, respectively.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\nDistributions from the limited partnerships are accounted for as a return of capital until the investment balance is reduced to zero or to a negative amount equal to further capital contributions required. Subsequent distributions received are recognized as income.\nThe following is a summary of the investments in limited partnerships and reconciliation to the limited partnership accounts:\nThe difference between the investment per the accompanying balance sheets at December 31, 1995 and 1993, and the deficiency per the limited partnerships' combined financial statements is due primarily to cumulative unrecognized equity in losses of certain limited partnerships, additional basis 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\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\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 investee 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 two of the limited partnerships included above, and another affiliate receives property management fees of 5 percent of their revenue. The affiliate received property management fees of $120,060, $119,980 and $117,316 in 1995, 1994 and 1993, respectively. The following sets forth the significant data for these partnerships, reflected in the accompanying financial statements using the equity method of accounting:\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n3. NOTES PAYABLE\nCertain of the Partnership's investments involved purchases of partnership interests from partners who subsequently withdrew from the operating partnership. The Partnership is obligated on non-recourse notes payable of $1,230,743 bearing interest at 10 percent, to the sellers of the partnership interests. The notes and the related interest are payable by the Partnership through REA II, and have principal maturity dates ranging from 2015 to 2022 or upon sale or refinancing of the underlying partnership properties. The notes are collateralized by REA II's investment in the respective limited partnerships and are payable only out of cash distributions from the investee partnerships as defined in the notes. Unpaid interest is due at maturity of the notes.\nMaturity dates on the notes payable are as follows:\n4. FEES AND EXPENSES DUE GENERAL PARTNER\nUnder the terms of the Restated Certificate and Agreement of Limited Partners, the Partnership is obligated to NAPICO for an annual management fee equal to .4 percent of the original invested assets of the limited partnerships. Invested assets is defined as the costs of acquiring project interests, including the proportionate amount of the mortgage loans related to the Partnerships interest in the capital accounts of the respective partnerships.\nThe Partnership reimburses NAPICO for certain expenses. The reimbursement to NAPICO was $32,004, $30,841 and $30,665 in 1995, 1994 and 1993, respectively, and is included in operating expenses.\n5. 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 the opinion of management and the corporate general partner, the claims will not result in any material liability to the Partnership.\nREAL ESTATE ASSOCIATES LIMITED IV (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n6. 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.\nThe 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. 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.\n7. 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 notes payable are collateralized by the Partnership's investments in the investee limited partnerships and are payable only out of cash distributions from the investee partnerships. The operations generated by the investee limited partnerships are subject to various government rules, regulations and restrictions which make it impracticable to estimate the fair value of the 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.\n8. FOURTH-QUARTER ADJUSTMENT\nThe Partnership's policy is to record its equity in the income (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 financial statements is based primarily upon audited financial statements of the investee limited partnerships. The increase, approximately $91,000, between the estimated nine-month equity in income and the actual 1995 income has been recorded in the fourth quarter.\nSCHEDULE\nREAL ESTATE ASSOCIATES LIMITED IV INVESTMENT IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED IV INVESTMENT IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED) REAL ESTATE ASSOCIATES LIMITED IV INVESTMENT IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (Continued)\nREAL ESTATE ASSOCIATES LIMITED IV INVESTMENT IN LIMITED PARTNERSHIPS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTES: 1. Equity in income (losses) of the limited partnerships represents the Partnership's allocable share of the net income (loss) from the limited partnerships for the year. Equity in income (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 on 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.\nSCHEDULE III REAL ESTATE ASSOCIATES LIMITED IV REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV HAS INVESTMENTS DECEMBER 31, 1995\n(A) This project was complete when REAL IV entered the Partnership.\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED IV REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV HAS INVESTMENTS DECEMBER 31, 1995\nNOTES: 1. Each local limited partnership has developed, owns and operates the housing project. Substantially all project costs, including construction period interest expense, are being capitalized by the limited partnerships.\n2. Depreciation is, or will be, 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:\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED IV REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL IV 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 IV (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.\nMr. 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, 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.\nPATRICIA 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.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT RENUMERATION AND TRANSACTIONS:\nReal Estate Associates Limited IV 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 .4% 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 limited partnership. In addition, the Partnership reimburses the Corporate General Partner for certain expenses.\nAn affiliate of the General Partner is responsible for the on-site property management 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 IV; no person is known to own beneficially in excess of 5% of the outstanding limited partnership interests.\n(b) At December 31, 1995, security ownership of management is as listed:\n* Cumulative limited partnership interests owned by corporate officers or the General Partner is less than 1% interest of total outstanding Limited Partnership interests.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe Partnership has no officers, directors or employees of it's 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.\nITEM 14.","section_14":"ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORT ON FORM 8-K:\nFINANCIAL STATEMENTS\nReport of Independent Public Accountants.\nBalance Sheets as of December 31, 1995 and December 31, 1994.\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993.\nStatements of Partners' Equity (Deficiency) 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 December 31, 1995.\nFINANCIAL STATEMENT SCHEDULES APPLICABLE TO REAL ESTATE ASSOCIATES LIMITED IV, REAL ESTATE ASSOCIATES II AND TO THE LIMITED PARTNERSHIPS IN WHICH REAL ESTATE ASSOCIATES IV AND REAL ESTATE ASSOCIATES II HAVE INVESTMENTS:\nSchedule - Investment 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\n(3) Articles of incorporation and bylaws: The registrant is not incorporated. The Partnership Agreement was filed with Form S-11, File #274063 which is hereby incorporated by reference.\n(10) Material contracts: The registrant is not party to any material contracts, other than the Restated Certificate and Agreement of Limited Partnership dated August 24, 1981, and the twenty-nine contracts representing the Partnership investment directly or indirectly in local limited partnerships as previously filed at the Securities Exchange Commission, File #274063 which is hereby incorporated by reference.\n(13) Annual report to security holders: Pages ____ to ____.\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the year ended December 31, 1995.","section_15":""}
{"filename":"32776_1995.txt","cik":"32776","year":"1995","section_1":"Item 1 hereof for a description of the terms of the Lease and Sublease.\nItem 3. Legal Proceedings.\nThe Property of Registrant is the subject of the following pending litigation:\n(1) On October 21, 1991, the holder of a $20,000 original participation in Registrant brought suit in New York Supreme Court, New York County against the Registrant, the Partners; the Sublessee; Harry B. Helmsley, a partner in Sublessee; and Counsel. Registrant is a nominal defendant. The suit claims that the defendants have engaged in breaches of fiduciary duty and acts of self-dealing in relation to the Partners' solicitation of consents and authorizations of the participants in Registrant in September 1991 and in relation to other unrelated acts of the Partners and Sublessee. The suit\nis styled as a class action, but the Court has ruled that class certification shall not be granted. The suit seeks relief including an injunction and an accounting. On January 10, 1992, all defendants answered the complaint and denied all material allegations of liability and damage. The complaint does not seek any relief against Registrant, and accordingly, Registrant's counsel is of the opinion that no loss or other unfavorable outcome of the action against Registrant is anticipated. The action has been dismissed against Sublessee and Mr. Helmsley.\n(2) In December 1994, Registrant received a notice of default from Trump Empire State Partners (\"Trump\"). The Trump default notice to Registrant claims that Registrant is in violation of its master lease because of extensive work which Sublessee has undertaken as part of an improvement program that commenced before Trump reportedly acquired its interest in the property in 1994. Trump's notice also complains that the Building is in need of repairs.\nOn February 14, 1995, Registrant and Sublessee filed an action in New York State Supreme Court against Trump for a declaratory judgment that none of the matters set forth in the notice of default constitutes a violation of the master lease or sublease, and that the notice of default is entirely without merit. Registrant's and Sublessee's suit also seeks an injunction to prevent Trump from implementing the notice of default.\nOn February 15, 1995, Trump filed an action against Registrant, Sublessee, Counsel, Harry B. Helmsley, Helmsley-Spear, Inc. (the management company of Empire State Building), and the Partners in New York State Supreme Court, alleging that the notice of default is valid and seeking damages and related relief based thereon. The defendants intend to defend against Trump's action and seek its dismissal. Counsel believes that Registrant and Sublessee should prevail in their actions against Trump, and that Trump's action should be dismissed.\nOn March 24, 1995, the New York State Supreme Court granted Registrant a preliminary injunction against Trump. The injunction prohibits Trump from acting on its notice of default to Registrant, at any time, pending the prosecution of claims by Registrant and Sublessee for a final judgment granting a permanent injunction and other relief against the Trump defendants.\nIn May 1995, Registrant and Sublessee filed a separate legal action against Trump and various affiliated persons for breach of the master lease and sublease, and disparagement of the property in violation of Registrant's and Sublessee's leasehold rights. This action seeks money damages and related relief.\nItem 4. Submission of Matters to a Vote of Participants.\nDuring the fourth quarter of the fiscal year ended December 31, 1995, Registrant did not submit any matter to a vote by the Participants through the solicitation of proxies or otherwise.\nPART II\nItem 5. Market for Registrant's Common Equity and Related Security Holder Matters.\nRegistrant is a partnership organized pursuant to a partnership agreement dated as of July 11, 1961.\nRegistrant has not issued any common stock. The securi- ties registered by it under the Securities Exchange Act of 1934, as amended, consist of participations in the partnership interests of the Partners in Registrant (the \"Participations\") and are not shares of common stock nor their equivalent. The Participations represent each Participant's fractional share in a Partner's undivided interest in Registrant and are divided approximately equally among the Partners. A full unit of the Participations was offered originally at a purchase price of $10,000; fractional units were also offered at proportionate purchase prices. Regis- trant has not repurchased Participations in the past and is not likely to change that policy in the future.\n(a) The Participations neither are traded on an established securities market nor are readily tradable on a secondary market or the substantial equivalent thereof. Based on Registrant's transfer records, Participations are sold by the holders thereof from time to time in privately negotiated transac- tions and, in many instances, Registrant is not aware of the prices at which such transactions occur. During the past year there were 207 transfers. In 39 instances, the indicated purchase price was equal to two times the face amount of the Participation transferred, i.e., $20,000 for a $10,000 participation. In all other cases, no consideration was indicated.\n(b) As of December 31, 1995, there were 2,641 holders of Participations of record.\n(c) Registrant does not pay dividends. During the year ended December 31, 1995, Registrant made regular monthly distributions of $98.21 for each $10,000 Participation. On February 28, 1995, Registrant made an additional distribution for each $10,000 Participation of $1,036.15. Such distribution represented primarily Overage Rent payable by Sublessee for the prior year. There was no Overage Rent payable for the year ended December 31, 1995. See Item 1 hereof. There are no restrictions on Registrant's present or future ability to make distributions; however, the amount of such distributions, particularly distributions of Overage Rent, depends solely on Sublessee's ability to make payments of Basic Rent and Overage Rent to Registrant. See Item 1 hereof. Registrant expects to make distributions in the future so long as it receives the payments provided for under the Sublease. See Item 7 hereof.\nItem 6. EMPIRE STATE BUILDING ASSOCIATES\nSELECTED FINANCIAL DATA\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nRegistrant was organized solely for the purposes of owning the Property described in Item 2","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements, together with the accompanying report by, and the consent to the use thereof by Jacobs Evall & Blumenfeld LLP, immediately following, are being filed in response to this item.\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 Registrant.\nRegistrant has no directors or officers or any other centralization of management. There is no specific term of office for any Partner. The table below sets forth as to each Partner as of December 31, 1995 the following: name, age, nature of any family relationship with any other Partner, business experience during the past five years and principal occupation and employment during such period, including the name and principal business of any corporation or any organization in which such occupation and employment was carried on and the date such individual became a Partner:\nPrincipal Date Nature of Occupation Individual Family Business and became Name Age Relationship Experience Employment Partner\nDonald A. Bettex 64 None Attorney-at-Law Senior Partner 1988 Wien, Malkin & Bettex, Counsellors- at-Law\nPeter L. Malkin 62 None Attorney-at-Law Senior Partner 1961 Wien, Malkin & Bettex, Counsellors- at-Law\nC. Michael Spero 59 None Attorney-at-Law Senior Partner 1995 Wien, Malkin & Bettex, Counsellors- at-Law\nAs stated above, the Partners are members of Counsel. See Items 1, 11, 12 and 13 hereof for a description of the services rendered by, and the compensation paid to, Counsel and for a discussion of certain relationships which may pose actual or potential conflicts of interest among Registrant, Sublessee and certain of their respective affiliates.\nThe names of entities which have a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 or are subject to the requirements of Section 15(d) of that Act, and in which the Partners are either a director, joint venturer or general partner are as follows:\nC. Michael Spero is a joint venturer in 250 West 57th St. Associates; and a general partner in Navarre - 500 Building Associates and 60 East 42nd St. Associates.\nPeter L. Malkin is a joint venturer in 250 West 57th St. Associates and Navarre-500 Building Associates and a general partner in Garment Capitol Associates, Navarre-500 Building Associates and 60 East 42nd St. Associates.\nDonald A. Bettex is a general partner in Garment Capitol Associates and 60 East 42nd St. Associates.\nItem 11.","section_11":"Item 11. Executive Compensation.\nAs stated in Item 10 hereof, Registrant has no directors or officers or any other centralization of management.\nNo remuneration was paid during the current fiscal year ended December 31, 1995 by Registrant to any of the Partners as such. Registrant pays Counsel, for supervisory services and dis- bursements, fees of $100,000 per annum plus 6% of all sums distributed to the Participants in excess of 9% per annum on their original cash investment. Pursuant to such arrangements described herein, Registrant incurred fees to Counsel of $159,417 for supervisory services rendered during the fiscal year ended December 31, 1995. The supervisory services include, among other items, the preparation of reports and related documentation required by the Securities and Exchange Commission, the monitoring of all areas of federal and local security law compliance, the preparation of certain financial reports, as well as the supervision of accounting and other documentation related to the administration of Registrant's business. See Item 7 hereof. Out of its fees, Counsel paid all disbursements and costs of regular accounting services. As noted in Items 1 and 10 of this report, the Partners are also members of Counsel.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) Registrant has no voting securities. See Item 5 hereof. At December 31, 1995, no person owned of record or was known by Registrant to own beneficially more than 5% of the outstanding Participations.\n(b) At December 31, 1995, the Partners (see Item 10 hereof) beneficially owned, directly or indirectly, the following Participations:\nName & Address Amount of of Beneficial Beneficial Percent Title of Class Owners Ownership of Class\nParticipations Donald A. Bettex $20,000 .0606% in Partnership 700 Park Avenue Interests New York, NY 10021\nC. Michael Spero $35,000 .1061% 1165 Park Avenue New York, NY 10128\nPeter L. Malkin $63,750 .1932% 21 Bobolink Lane Greenwich, CT 06830\nAt such date, certain of the Partners (or their respective spouses) held additional Participations as follows:\nBarbara N. Bettex, the wife of Donald A. Bettex, owned of record and beneficially, $12,500 of Participations. Mr. Bettex disclaims any beneficial ownership of such Participations.\nPeter L. Malkin owned of record as trustee or co-trustee but not beneficially, $170,000 of Participations. Mr. Malkin disclaims any beneficial ownership of such Participations.\nPeter L. Malkin owned of record as co-trustee of two separate trusts a total of $40,000 of Participa- tions. Mr. Malkin has a remainder interest in each of such trusts.\nIsabel W. Malkin, the wife of Peter L. Malkin, owned of record and beneficially, $100,000 of Participa- tions. Mr. Malkin disclaims any beneficial ownership of such Participations.\n(c) Not applicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\n(a) As stated in Item 1 hereof, Mr. Donald A. Bettex, Mr. Peter L. Malkin and Mr. C. Michael Spero are the three Partners of Registrant and also act as agents for the Participants in their respective partnership interests. Mr. Malkin is also a partner in Sublessee. As a consequence of one of the three Partners being a partner in Sublessee and all three Partners being members of Counsel (which represents Registrant and Sublessee),\ncertain actual and potential conflicts of interest may arise with respect to the management and administration of the business of Registrant. However, under the respective participating agreements pursuant to which the Partners act as agents for the Participants, certain transactions require the prior consent of a specified number of the Participants in order for the agents to act on their behalf. Such transactions include modifications and extensions of the Sublease, or a sale or other disposition of the Property or substantially all of Registrant's other assets.\nReference is made to Items 1 and 2 hereof for a description of the terms of the Sublease between Registrant and Sublessee. The respective interests of the Partners in Registrant and in the Sublease arise solely from ownership of their respec- tive participations in Registrant and, in the case of Mr. Malkin, his ownership of a partnership interest in Sublessee. The Partners receive no extra or special benefit not shared on a pro rata basis with all other security holders of Registrant or partners in Sublessee. However, each of the Partners, by reason of his respective interest in Counsel, is entitled to receive his pro rata share of any legal fees or other remuneration paid to Counsel for professional services rendered to Registrant and Sublessee.\nReference is also made to Items 1 and 10 hereof for a description of the relationship between Registrant and Counsel, of which the Partners are among its members. The interest of each Partner in any remuneration paid or given by Registrant to Counsel arise solely from the ownership of such Partner's interest in Counsel. See Item 11 hereof for a description of the remuneration arrangements between Registrant and Counsel.\n(b) Reference is made to Paragraph (a) above.\n(c) Not applicable.\n(d) Not applicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a)(1) Financial Statements:\nConsent of Jacobs Evall & Blumenfeld LLP, Certified Public Accountants, dated March 18, 1996.\nAccountant's Report of Jacobs Evall & Blumenfeld LLP, Certified Public Accountants, dated February 27, 1996.\nBalance Sheets at December 31, 1995 and at December 31, 1994 (Exhibit A).\nStatements of Income for the fiscal years ended December 31, 1995, 1994 and 1993 (Exhibit B).\nStatement of Partners' Capital for the fiscal year ended December 31, 1995 (Exhibit C-1).\nStatement of Partners' Capital for the fiscal year ended December 31, 1994 (Exhibit C-2).\nStatement of Partners' Capital for the fiscal year ended December 31, 1993 (Exhibit C-3).\nStatements of Cash Flows for the fiscal years ended December 31, 1995, 1994 and 1993 (Exhibit D).\nNotes to Financial Statements for the fiscal years ended December 31, 1995, 1994 and 1993.\n(2) Financial Statement Schedules:\nList of Omitted Schedules.\nReal Estate and Accumulated Depreciation - December 31, 1995 (Schedule III).\n(3) Exhibits: See Exhibit Index.\n(b) No Form 8-K was filed by Registrant for the final quarter of 1995.\n[LETTERHEAD OF JACOBS EVALL & BLUMENFELD LLP CERTIFIED PUBLIC ACCOUNTANTS]\nMarch 18, 1996\nEmpire State Building Associates New York, N. Y.\nWe consent to the use of our independent accountants' report dated February 27, 1996 covering our audits of the accompanying financial statements of Empire State Building Associates in connection with and as part of your December 31, 1995 annual report (Form 10-K) to the Securities and Exchange Commission.\nJacobs Evall & Blumenfeld LLP\nCertified Public Accountants\nINDEPENDENT ACCOUNTANTS' REPORT\nTo the participants in Empire State Building Associates (a Partnership) New York, N. Y.\nWe have audited the accompanying balance sheets of Empire State Building Associates (\"Associates\") 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, and the supporting financial statement schedule as contained in Item 14(a)(2) of this Form 10-K. These financial statements and schedule are the responsibility of Associates' 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 Empire State Building Associates 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, and the related financial statement schedule, when considered in relation to the basic financial statements, presents fairly, in all material respects, the information set forth therein.\nAs discussed in Note 9 to the financial statements, Associates has been included as a defendant in actions with other related parties, including the Agents for Associates and Empire State Building Company, the sublessee.\nJacobs Evall & Blumenfeld LLP\nCertified Public Accountants New York, N. Y. February 27, 1996\nEXHIBIT A\nEMPIRE STATE BUILDING ASSOCIATES\nBALANCE SHEETS\nA S S E T S\nSee accompanying notes to financial statements.\nEXHIBIT B\nEMPIRE STATE BUILDING ASSOCIATES\nSTATEMENTS OF INCOME\nSee accompanying notes to financial statements.\nEXHIBIT C-1\nEMPIRE STATE BUILDING ASSOCIATES\nSTATEMENT OF PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 1995\nSee accompanying notes to financial statements.\nEXHIBIT C-2\nEMPIRE STATE BUILDING ASSOCIATES\nSTATEMENT OF PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 1994\nSee accompanying notes to financial statements.\nEXHIBIT C-3 EMPIRE STATE BUILDING ASSOCIATES\nSTATEMENT OF PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 1993\nSee accompanying notes to financial statements.\nEXHIBIT D\nEMPIRE STATE BUILDING ASSOCIATES\nSTATEMENTS OF CASH FLOWS\nSee accompanying notes to financial statements.\nEMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS\n1. Business Activity\nEmpire State Building Associates (\"Associates\") is a general partnership which holds the tenant's position in the master leasehold of the Empire State Building, located at 350 Fifth Avenue, New York City. Associates subleases the property to Empire State Building Company (\"Company\").\n2. Summary of Significant Accounting Policies\na. Cash and Cash Equivalents:\nCash and cash equivalents include investments in money market funds and all highly liquid debt instruments purchased with a maturity of three months or less.\nb. Real Estate and Amortization of Leasehold:\nReal estate, consisting of a leasehold, is stated at cost. In 1988, Associates determined that it would exercise its first renewal option under the lease, and did so in January 1989. Amortization of the leasehold is being computed by the straight-line method over the estimated useful life of 25 years, from January 1, 1988 to January 5, 2013 (see Note 4).\nc. Use of Estimates:\nIn preparing financial statements in conformity with generally accepted accounting principles, management often 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.\n3. Related Party Transactions - Rent Income\nRent income for the years ended December 31, 1995, 1994 and 1993, totalling $6,018,750, $9,616,637 and $13,731,568, respectively, consists of the minimum annual rent plus overage rent under an operating sublease dated December 27, 1961, as modified February 15, 1965, with Company (the \"sublessee\"), as follows:\nYear ended December 31,\n1995 1994 1993\nMinimum net basic rent...... $6,018,750 $6,018,750 $ 6,018,750 Overage rent earned......... - 3,597,887 7,712,818\n$6,018,750 $9,616,637 $13,731,568\nEMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS (Continued)\n3. Related Party Transactions - Rent Income (continued)\nThe sublease provides for the same initial term and renewal options as the leasehold (see Note 4), less one day. The initial term of the sublease expired on January 4, 1992 and the annual minimum net basic rent during such term was $6,780,560. In January 1989, the sublessee exercised its option to renew the sublease for the first renewal period from January 4, 1992 to January 4, 2013. The annual minimum net basic rent during the first renewal term was reduced to $6,018,750, and is to be further reduced to $5,895,625 during each of the remaining three renewal terms.\nOverage rent earned is equal to fifty percent of the sublessee's annual net income (as defined in the sublease) in excess of $1,000,000.\nA partner in Associates is also a partner in the sublessee.\n4. Leasehold Rent\nLeasehold rent represents the net basic rent of $3,470,560 per annum under an operating lease dated December 27, 1961, as modified February 15, 1965, with The Prudential Insurance Company of America (\"Prudential\"), over the initial term of the lease, 30 years and 9 days, from December 27, 1961 to January 5, 1992.\nIn January 1989, Associates exercised its option to renew the lease for the first renewal period from January 5, 1992 to January 5, 2013. The lease contains options for Associates to renew the leasehold for an additional 3 successive periods of 21 years each. The basic rent was reduced to $1,970,000 per annum during the first renewal term, and is to be further reduced to $1,723,750 per annum during each of the remaining three renewal terms.\nOn November 27, 1991, Prudential sold the property to E.G. Holding Co., Inc. which, through merger and conveyance, reportedly transferred its interest as lessor to Trump Empire State Partners (\"Trump\") (see Note 9). Associates' rights under the master leasehold remain unchanged.\n5. Related Party Transactions - Supervisory Services\nSupervisory services (including disbursements and cost of regular accounting services) during the years ended December 31, 1995, 1994 and 1993, totalling $159,417, $377,670 and $625,826, respectively, represent fees paid to the firm of Wien, Malkin & Bettex. Some partners in that firm are also partners in Associates.\nFees for supervisory services are paid pursuant to an agreement, which amount is based on a rate of return of investment achieved by the participants in Associates each year.\nEMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS (Continued)\n6. Number of Participants\nThere were approximately 2,620 participants in the participating groups at December 31, 1995, 1994 and 1993.\n7. Determination of Distributions to Participants\nDistributions to participants in 1995, 1994 and 1993 of $7,308,634, $11,196,399 and $16,223,486, respectively, represented the following:\nEMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS (Continued)\n8. Distributions and Amount of Income per $10,000 Participation Unit\nDistributions per $10,000 participation unit during the years 1995, 1994 and 1993 based on 3,300 participation units outstanding during each year, consisted of the following:\nYear ended December 31,\n1995 1994 1993\nIncome........................ $1,126 $2,152 $3,330\nReturn of capital............. 1,089 1,241 1,586\nTOTAL DISTRIBUTIONS......... $2,215 $3,393 $4,916\nNet income is computed without regard to income tax expense since Associates does not itself pay a tax on its income; instead, any such taxes are paid by the participants in their individual capacities.\n9. Litigation\na. On October 21, 1991, the holder of a $20,000 original participation in Associates brought suit in New York Supreme Court, New York County against the Agents for Associates (Peter L. Malkin, Donald A. Bettex and Alvin Silverman); Company; Harry B. Helmsley (\"Helmsley\"), a partner in Company; and Wien, Malkin & Bettex, counsel to Associates. Associates is a nominal defendant. The suit claims that the defendants have engaged in breaches of fiduciary duty and acts of self-dealing in relation to the Agents' solicitation of consents and authorizations of the participants in Associates in September 1991 and in relation to other unrelated acts of the Agents and the sublessee. The suit is styled as a class action, but the Court has ruled that class certification shall not be granted. The suit seeks relief including an injunction and an accounting. On January 10, 1992, all defendants answered the complaint and denied all material allegations of liability and damage. The complaint does not seek any relief against Associates, and accordingly, Associates' counsel is of the opinion that no loss or other unfavorable outcome of the action against Associates is anticipated. The action has been dismissed against Company and Helmsley.\nb. In December 1994, Associates received a notice of default from Trump. The Trump default notice to Associates claims that Associates is in violation of its master lease because of extensive work which the sublessee, Company, has undertaken as part of an improvement program that commenced before Trump reportedly acquired its interest in the property in 1994. Trump's notice also complains that the building is in need of repairs.\nEMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS (Continued)\n9. Litigation (continued)\nOn February 14, 1995, Associates and Company filed an action in New York State Supreme Court against Trump for a declaratory judgment that none of the matters set forth in the notice of default constitutes a violation of the master lease or sublease, and that the notice of default is entirely without merit. Associates' and Company's suit also seeks an injunction to prevent Trump from implementing the notice of default.\nOn February 15, 1995, Trump filed an action against Associates, Company, Wien, Malkin & Bettex, Helmsley, Helmsley-Spear, Inc. (the management company of the Empire State Building), and the Agents for Associates in New York State Supreme Court, alleging that the notice of default is valid and seeking damages and related relief based thereon. The defendants intend to defend against Trump's action and seek its dismissal. Counsel believes that Associates and Company should prevail in their actions against Trump, and that Trump's action should be dismissed.\nOn March 24, 1995, the New York State Supreme Court granted Associates a preliminary injunction against Trump. The injunction prohibits Trump from acting on its notice of default to Associates, at any time, pending the prosecution of claims by Associates and Company for a final judgement granting a permanent injunction and other relief against the Trump defendants.\nIn May, 1995, Associates and Company filed a separate legal action against Trump and various affiliated persons for breach of the master lease and sublease, and disparagement of the property in violation of Associates' and Company's leasehold rights. This action seeks money damages and related relief.\n10. Contingent Liability of Sublessee\nThe State of New York has asserted a utility tax deficiency of $1,528,816, plus accrued interest, against the sublessee through December 31, 1992 in connection with electricity, water and steam charges to tenants. The Supreme Court, New York County granted summary judgement in favor of the State, which ruling was affirmed by the Appellate Division, First Department, holding that the State utility tax applies to such rent inclusion charges. The sublessee is seeking permission to appeal the Appellate Division decision before the Court of Appeals and the final outcome of the appeal cannot presently be determined. The City of New York has also asserted a utility tax deficiency of $277,125, plus accrued interest, against the sublessee through December 31, 1994 in connection with electricity, water and steam charges to tenants. An appeal before the New York City taxing authority is pending and the final outcome of the appeal cannot presently be determined. EMPIRE STATE BUILDING ASSOCIATES\nNOTES TO FINANCIAL STATEMENTS (Continued)\n10. Contingent Liability of Sublessee (continued)\nIf it is finally determined that the State's and City's positions are correct, the sublessee would also be liable for additional utility taxes for quarterly periods ending after December 31, 1992 for New York State utility tax and for periods after December 31, 1994 for New York City utility tax. Any amounts for which the sublessee might be ultimately liable would reduce the sublessee's net income in the year it becomes determinable, and may therefore impact additional rent payable to Associates.\n11. Concentration of Credit Risk\nAssociates maintains cash balances in a bank, money market fund (Fidelity U.S. Treasury Income Portfolio), and a distribution account held by Wien, Malkin & Bettex. The bank balance is insured by the Federal Deposit Insurance Corporation up to $100,000, and at December 31, 1995 was completely insured. The cash in the money market fund and the distribution account held by Wien, Malkin & Bettex is not insured. The funds held in the distribution account were paid to the participants on January 1, 1996.\nEMPIRE STATE BUILDING ASSOCIATES\nOMITTED SCHEDULES\nThe following schedules have been omitted as not applicable in the present instance:\nSCHEDULE I - Condensed financial information of registrant.\nSCHEDULE II - Valuation and qualifying accounts.\nSCHEDULE IV - Mortgage loans on real estate.\nSCHEDULE III EMPIRE STATE BUILDING ASSOCIATES\nReal Estate and Accumulated Depreciation December 31, 1995\n(a) There have been no changes in the carrying values of real estate for the years ended December 31, 1995, December 31, 1994 and December 31, 1993. The costs for federal income tax purposes are the same as for financial statement purposes.\n(b) Accumulated amortization Balance at January 1, 1993 $34,830,613 Amortization: F\/Y\/E 12\/31\/93 $208,469 12\/31\/94 208,469 12\/31\/95 208,469 625,407\nBalance at December 31, 1995 $35,456,020\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.\nThe individual signing this report on behalf of Registrant is Attorney-in-Fact for Registrant and each of the Partners in Registrant, pursuant to a Power of Attorney, dated March 29, 1996 (the \"Power\").\nEMPIRE STATE BUILDING REGISTRANT (Registrant)\nBy \/s\/Stanley Katzman Stanley Katzman, Attorney-in-Fact*\nDate: March 29, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person as Attorney-in-Fact for each of the Partners in Registrant, pursuant to the Power, on behalf of Registrant and as a Partner in Registrant on the date indicated.\nBy \/s\/Stanley Katzman Stanley Katzman, Attorney-in-Fact*\nDate: March 29, 1996\n______________________ * Mr. Katzman supervises accounting functions for Registrant.\nEXHIBIT INDEX\nNumber Document Page*\n3(a) Registrant's Partnership Agreement dated July 11, 1961, filed as Exhibit No. 1 to Registrant's Registration Statement on Form S-1 as amended (the \"Registration Statement\") by letter dated August 8, 1962 and assigned File No. 2-18741, is incorporated by reference as an exhibit hereto.\n3(b) Amended Business Certificate of Registrant filed with the Clerk of New York County on October 25, 1995 reflecting a change in the Partners of Registrant.\n4 Registrant's form of Participating Agreement, filed as Exhibit No. 6 to the Registration Statement by letter dated August 8, 1962 and assigned File No. 2-18741, is incorporated by reference as an exhibit hereto.\n10(a) Mortgage dated December 21, 1951 from Imperium Corporation to Prudential Insurance Company of America (\"Prudential\"), filed by letter dated March 31, 1981 (Commission File No. 0-827) as Exhibit 10(a) to Registrant's Form 10-K for the fiscal year ended December 31, 1980, is incorporated by reference as an exhibit hereto.\n10(b) Modification of Indenture of Lease dated December 27, 1961 between Prudential and Registrant filed by letter dated March 31, 1981 (Commission File No. 0-827) as Exhibit 10(b) to Registrant's Form 10-K for the fiscal year ended December 31, 1980, is incorporated by reference as an exhibit hereto.\n______________________ * Page references are based on sequential numbering system.\n10(c) Sublease dated December 27, 1961 between Registrant and Sublessee, filed by letter dated March 31, 1981 (Commission File No. 0-827) as Exhibit 10(d) to Registrant's Form 10-K for the fiscal year ended December 31, 1980, is incorporated by reference as an exhibit hereto.\n10(e) Modification and Extension Agreement, dated October 26, 1964 between The Bowery Savings Bank and Celeritas Realty Corp., filed by letter dated March 31, 1981 (Commission File No. 0-827) as Exhibit 10(e) to Registrant's Form 10-K for the fiscal year ended December 31, 1980, is incorporated by reference as an exhibit hereto.\n13 Letter to Participants, dated March 6, 1996 with financial reports for the fiscal year ended December 31, 1995. The foregoing material shall not be deemed to be \"filed\" with the Commission or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\n24 Power of Attorney dated March 29, 1996, between Peter L. Malkin, C. Michael Spero and Donald A. Bettex, the partners of Registrant and Richard A. Shapiro and Stanley Katzman.\n27 Financial Data Schedule of Registrant for the fiscal year ended December 31, 1995\nExhibit 3(b)\nAMENDED BUSINESS CERTIFICATE\nThe undersigned hereby certify that a certificate of business under the assumed name\nEMPIRE STATE BUILDING ASSOCIATES\nfor the conduct of business at 60 East 42nd Street, New York, New York, was filed in the office of the County Clerk New York County, State of New York, on the 23rd day of August, 1961, under index number 6543\/61; that the last amended certificate was filed on the 17th day of January 1989, in the office of said County Clerk under index number 6543\/61.\nIt is hereby further certified that this amended certificate is made for the purposes of more accurately setting forth the facts recited in the original certificate or the last amended certificate and to set forth the following changes in such facts.\nALVIN SILVERMAN, residing at 110 Redwood Drive, Roslyn, New York 11576, has been succeeded as a partner by C. MICHAEL SPERO, residing at 1165 Park Avenue, New York, New York 10128.\nThe members of EMPIRE STATE BUILDING ASSOCIATES now consist of: Donald A. Bettex, Peter L. Malkin and C. Michael Spero.\nIN WITNESS WHEREOF, the undersigned have as of the 2nd day of July, 1995 made and signed this certificate.\n\/s\/ Alvin Silverman \/s\/ Donald A. Bettex ALVIN SILVERMAN DONALD A. BETTEX\n\/s\/ C. Michael Spero C. MICHAEL SPERO\nState of New York, County of New York ss.:\nOn this 2nd day of July, 1995, before me personally appeared ALVIN SILVERMAN, C. MICHAEL SPERO and DONALD A. BETTEX, to me known and known to me to be the individuals described in and who executed the foregoing certificate, and they thereupon duly acknowledged to me that they executed the same.\n\/s\/ Estelle Beeber Notary Public State of New York No. 5241708 Qualified in New York County Commission Expires 9\/30\/96\nSTATE OF NEW YORK ) : ss.: COUNTY OF NEW YORK )\nOn the __ day of March, 1996 before me personally came\nPETER L. MALKIN, DONALD A BETTEX and C. MICHAEL SPERO, to me known\nto be the individuals described in and who executed the foregoing\ninstrument, and acknowledged that they executed the same.\n\/s\/___________________________ NOTARY PUBLIC","section_15":""}
{"filename":"710389_1995.txt","cik":"710389","year":"1995","section_1":"ITEM 1. BUSINESS\nKrupp Realty Limited Partnership-IV (\"KRLP-IV\") was formed on December 1, 1982 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Krupp Corporation, a Massachusetts corporation, and The Krupp Company Limited Partnership-II, a Massachusetts limited partnership, are the General Partners of KRLP-IV. KRLP-IV has also issued all of the Original Limited Partner Interests to The Krupp Company Limited Partnership-II. On January 18, 1983, KRLP-IV commenced the offering of up to 30,000 Units of Investor Limited Partner Interests (the \"Units\"). As of March 31, 1983, KRLP-IV had received subscriptions for all 30,000 Units at $1,000 per Unit and therefore, the public offering was successfully completed on that date. For details, see Note A to Consolidated Financial Statements included in Item 8 (Appendix A) of this report.\nThe primary business of KRLP-IV is to acquire, operate and ultimately dispose of real estate. KRLP-IV initially acquired six multi-family apartment complexes (Copper Creek, Walden Pond (formerly Westbridge), Indian Run, Fenland Field, Pavillion and Tilbury Woods Apartments), a retail center (Lakeview Plaza) and invested in a joint venture in Lakeview Towers with an affiliated limited partnership (the \"Joint Venture\"). KRLP-IV considers itself to be engaged only in the industry segment of investment in real estate.\nKRLP-IV has sold Lakeview Plaza and Tilbury Woods Apartments. Additionally, KRLP-IV received a terminating capital distribution from the Joint Venture with proceeds from the sale of Lakeview Towers. In 1990, the General Partners formed three limited partnerships: Pavillion Partners, Ltd., Copper Creek Partners, Ltd. and Westbridge Partners, Ltd. At the same time, the General Partners transferred ownership of Pavillion Apartments to Pavillion Partners, Ltd., Copper Creek Apartments to Copper Creek Partners, Ltd., and Walden Pond Apartments to Westbridge Partners, Ltd. in exchange for a 99% limited partner interest in the new entities. Westcop Corporation, an affiliate of KRLP-IV, contributed a total of $11,216 in cash in exchange for a 1% General Partner interest. KRLP-IV, Pavillion Partners, Ltd., Copper Creek Partners, Ltd. and Westbridge Partners, Ltd., are collectively known as Krupp Realty Limited Partnership-IV and Subsidiaries (collectively referred to herein as the \"Partnership\"). The Partnership endeavored to renegotiate the debt on these properties, the negotiations were unsuccessful and these partnerships subsequently petitioned for relief under federal bankruptcy laws.\nPavillion emerged from its bankruptcy proceedings with a restructuring of its indebtedness during 1991. In 1992, the bankruptcy court approved the plans of reorganization for Copper Creek Partners, Ltd. and Westbridge Partners, Ltd. Under their respective plans of reorganization, the Court allowed the lender to foreclose on Copper Creek Apartments and the Partnership received a restructuring of Walden Pond Apartments indebtedness (see Note D to Consolidated Financial Statements included in Item 8 (Appendix A)).\nThe Partnership's real estate investments are subject to some seasonal fluctuations resulting from changes in utility consumption and seasonal maintenance expenditures. However, the future performance of the Partnership will depend upon factors which cannot be predicted. Such factors include general economic and real estate market conditions, both on a national basis and in those areas where the Partnership's real estate investments are located, the availability and cost of borrowed funds, real estate tax rates, operating expenses, energy costs, government regulations and federal and state income tax laws. The requirements for compliance with federal, state and local regulations to date have not had an adverse effect on the Partnership's operations, and no adverse effect therefrom is anticipated in the future.\nThe Partnership's investments in real estate are also subject to such risks as (i) competition from existing and future projects held by other owners in the locations of the Partnership's properties, (ii) possible reduction in rental income due to an inability to maintain high occupancy levels, (iii) possible adverse changes in mortgage interest rates, (iv) possible adverse changes in general economic and local conditions, such as competitive over-building, increases in unemployment, or adverse changes in real estate zoning laws, (v) the possible future adoption of rent control legislation which would not permit the full amount of increased costs to be passed on to tenants in the form of rent increases, and (vi) other circumstances over which the Partnership may have little or no control.\nAs of December 31, 1995, there were 38 full and part-time on-site personnel employed by the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Partnership had an aggregate of 1,256 apartment units.\nA summary of the Partnership's multi-family real estate investments is presented below.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe transfer of Units of Limited Partner Interest is subject to certain limitations contained in the Partnership Agreement. There is no public market for the Units and it is not anticipated that any such public market will develop.\nThe number of Investor Limited Partners as of December 31, 1995 was approximately 2,000.\nThe Partnership made the following distributions to its Partners during the years ended December 31, 1995 and 1994:\nThe Partnership issued special distributions to the General Partners and Investor Limited Partners during the fourth quarter of 1992 with a portion of the funds received from the sale of the Lakeview Joint Venture. The Partnership made no distributions during the years ended December 31, 1991 and 1993. Due to improvements in the operations of the properties and the availability of sufficient cash flow, the General Partners reinstated distributions in August, 1994. These distributions are expected to continue in 1996.\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 Supplementary Data, which are included in Items 7 and 8 of this report, respectively.\nITEM 6. SELECTED FINANCIAL DATA, Continued\nOperating results for the years 1991 through 1992 are not comparable to 1993, 1994 and 1995 because:\n1. Lakeview Towers was sold on August 28, 1992, Copper Creek was foreclosed on March 3, 1992 and Walden Pond's debt was restructured effective February 28, 1992.\n2. Tilbury Woods was sold on August 19, 1991.\nThe years 1993 through 1995 are not necessarily indicative of the Partnership's future operations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe Partnership refinanced Pavillion and Indian Run at lower interest rates during 1994. As a result of the lower rates, the reduced mortgage payments have provided additional liquidity to the Partnership. This additional liquidity assisted the Partnership in funding $427,000 in capital improvements to the properties in 1995, and anticipated capital improvements of $550,000 for 1996. These improvements consist of continued interior enhancements which include the replacement of appliances, carpeting and vinyl flooring.\nDue to improvements in the operations of the properties and reduced debt service, the Partnership had sufficient cash flow in 1994 to reinstate distributions at a rate of $4.67 per Unit. In 1995, the distribution rate increased to $28.00 per Unit. In 1996, the distribution rate is scheduled to increase at a rate of $37.33 per Unit.\nThe Partnership's ability to generate cash adequate to meet its needs is dependent primarily upon the operations of its remaining real estate investments. Such ability would also be impacted by the future availability of bank borrowings, and upon the future refinancing and sale of the Partne\nrship's real estate investments and the collection of any mortgage receivables which may result from such sales. These sources of liquidity will be used by the Partnership for payment of expenses related to real estate operations, capital improvements, refinancings and expenses. Cash Flow, if any, as calculated under Section 8.2(a) of the Partnership Agreement, will then be available for distribution to the partners.\nCash Flow\nShown below is a calculation of Cash Flow as defined by Section 8.2(a) of the Partnership Agreement for the year ended 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, Cash Flow should not be considered by the reader as a substitute to net income (loss), as an indicator of the Partnership's operating performance or to cash flows as a measure of liquidity.\n1995 versus 1994\nCash flow, as defined by Section 8.2(a) of the Partnership Agreement, increased due to a 4% increase in rental revenues and a decrease in interest expense of $168,000, due to the 1994 refinancings of Pavillion and Indian Run. The refinancings of Pavillion and Indian Run have provided additional liquidity to the Partnership which has assisted the funding of additional capital improvements in 1995 and allowed the Partnership to command higher rental rates in the properties' prospective markets.\nOther income increased due to an increase in interest income on cash and cash equivalents as a result of higher average cash balances.\nThe Partnership recognized a reduction in operating expense due to management's efforts to reduce reimbursable costs. Real estate tax expense increased due to an increase in the assessed value of Walden Pond.\n1994 versus 1993\nCash flow, as defined by Section 8.2(a) of the Partnership Agreement, increased significantly. Rental revenue increased by 10% primarily due to increased occupancy rates at Fenland, Pavillion and Walden Pond and rental rate increases at all the Partnership's properties. The completion of renovations in 1993 allowed the Partnership to command higher rental rates and improve occupancy in the properties' prospective markets.\nAs a result of the extensive rehabilitation programs at Walden Pond and Pavillion completed in 1993, the Partnership experienced a 42% reduction in maintenance costs in 1994. The completion of the rehabilitation programs also resulted in an increase in depreciation expense for 1994.\nIn 1994, the Partnership successfully completed the refinancings of Pavillion and Indian Run. Both were refinanced at lower interest rates. The reduced debt service payments will provide additional liquidity in future years.\nGeneral\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate assets.\nThe investments in properties are carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down investments in properties to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are significantly impaired.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A to this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership has no directors or executive officers. Information as to the directors and executive officers of The Krupp Corporation, which is a General Partner of both KRLP-IV and The Krupp Company Limited Partnership- II, the other General Partner of KRLP-IV, is as follows:\nPosition with Name and Age The Krupp Corporation\nDouglas Krupp (49) Co-Chairman of the Board\nGeorge Krupp (51) Co-Chairman of the Board\nLaurence Gerber (39) President\nRobert A. Barrows (38) Senior Vice President and Corporate Controller\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, healthcare facility ownership and the management of the Company. 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 $4 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 is Chairman of the Board and a Director of Berkshire Realty Company, Inc. (NYSE-BRI). George Krupp is Douglas Krupp's brother.\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 $4 billion under management for institutional and individual clients. Mr. Krupp attended the University of Pennsylvania and Harvard University. Mr. Krupp also serves as Chairman of the Board and Trustee of Krupp Government Income Trust and as Chairman of the Board and Trustee of 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 Director of Berkshire Realty Company, Inc. (NYSE-BRI) and President and Trustee of Krupp Government Income Trust and President and Trustee of Krupp Government Income Trust II.\nRobert A. Barrows is the 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 of record owned or was known by the General Partners to own beneficially more than 5% of KRLP-IV's 30,000 outstanding Units. On that date, the General Partners or their affiliates owned 100 units (.3% of the total outstanding) of KRLP-IV, in addition to the General Partner and Original Limited Partner Interests.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership does not have any directors, executive officers or nominees for election as director. Additionally, as of December 31, 1995, no person of record owned or was known by the General Partners to own beneficially more than 5% of the Partnership's outstanding Units.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Consolidated Financial Statements - see Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule included under Item 8, Appendix A, on page to this report.\n2. Consolidated Financial Statement Schedule - see Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule included under Item 8, Appendix A, on page to this report. All other schedules are omitted as they are not applicable or not required or the information is provided in the Consolidated Financial Statements or the Notes thereto.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable Exhibits required under Item 601 of Regulation S-K:\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended Agreement of Limited Partnership dated as of January 12, 1983 [Exhibit A to Prospectus\nincluded in Registrant's Registration Statement on Form S-11 (File 2-80650)].*\n(4.2) Amended Certificate of Limited Partnership filed with the Massachusetts Secretary of State on March 31, 1983 [Exhibit 4.2 to Registrant's Annual Report on Form 10-K dated December 31, 1983 (File No. 2-80650)].*\n(10) Material Contracts\nFenland Field Apartments\n(10.1) Management Agreement dated December 19, 1986 between Krupp Realty Limited Partnership-IV, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent. [Exhibit 10.3 to Registrant's Annual Report on Form 10-K dated December 31, 1986 (File No. 0-11987)].*\n(10.2) Modification and Restatement of Promissory Note dated April 28, 1993 between Krupp Realty Limited Partnership-IV and John Hancock Mutual Life Insurance Company [Exhibit 10.2 to Registrant's Annual Report on Form 10-K dated December 31, 1993 (File No. 0-11987)].*\n(10.3) Modification and Restatement of Indemnity Deed of Trust and Security Agreement dated April 28, 1993 between Krupp Realty Limited Partnership- IV and John Hancock Mutual Life Insurance Company [Exhibit 10.3 to Registrant's Annual Report on Form 10-K dated December 31, 1993 (File No. 0-11987)].*\nIndian Run Apartments\n(10.4) Management Agreement dated June 2, 1983 between Krupp Realty Limited Partnership-IV, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent [Exhibit 10.16 to Registrant's Annual Report on Form 10-K dated December 31, 1983 (File No. 2-80650)].*\n(10.5) Multifamily Note, dated October 25, 1994 between Bank United of Texas FSB and Krupp Realty Limited Partnership-IV, a Massachusetts limited partnership. (File No. 0-11987).*\n(10.6) Multifamily Deed of Trust, dated October 25, 1994 by Krupp Realty Limited Partnership-IV, a Massachusetts limited partnership and Randolph C. Henson, as Trustee, and Bank United of Texas FSB. (File No. 0-11987).*\nWalden Pond Apartments\n(10.7) Management Agreement dated June 2, 1983 between Krupp Realty Limited Partnership-IV, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent [Exhibit 10.19 to Registrant's Annual Report on Form 10-K dated December 31, 1983 (File No. 2-80650)].*\n(10.8) Certificate of Limited Partnership of Westbridge Partners, Ltd., executed March 1, 1990. [Exhibit 19.9 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0- 11987)].*\n(10.9) Westbridge Partners, Ltd. Agreement of Limited Partnership executed March 1, 1990. [Exhibit 20.1 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.10) Bill of Sale Agreement between Krupp Realty Limited Partnership-IV and Westbridge Partners, Ltd., executed March 1, 1990. [Exhibit 20.2 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.11) Westbridge Partners, Ltd. First Amendment to Agreement of Limited Partnership, executed April 9, 1990. [Exhibit 20.3 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.12) Order Granting Motion of First Boston Mortgage Capital Corp. for Relief from the Automatic Stay dated January 28, 1992. [Exhibit C to Registrant's Report on Form 8-K dated March 3, 1992 (File No. 0-11987)].*\n(10.13) Modification Agreement dated February 28, 1992 between Westbridge Partners, Ltd. and University Mortgage Acquisition Corp. [Exhibit 10.14 to Registrant's Annual Report on Form 10- K dated December 31, 1993 (File No. 0-11987)].*\n(10.14) Renewal Multifamily Note dated February 28, 1992 between Westbridge Partners, Ltd. and University Mortgage Acquisition Corp. [Exhibit 10.15 to Registrant's Annual Report on Form 10- K dated December 31, 1993 (File No. 0-11987)].*\n(10.15) Renewal Multifamily Deed of Trust, Assignment of Rents and Security Agreement dated February 28, 1992 by Westbridge Partners, Ltd. and John M. Walker, Jr., as Trustee, and University Mortgage Acquisition Corp. [Exhibit 10.16 to Registrant's Annual Report on Form 10-K dated December 31, 1993 (File No. 0-11987)].*\nPavillion Apartments\n(10.16) Management Agreement dated June 2, 1983 between Krupp Realty Limited Partnership-IV, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\"), as Agent [Exhibit 10.25 to Registrant's Annual Report on Form 10-K dated December 31, 1983 (File No. 2-80650)].*\n(10.17)Certificate of Limited Partnership of Pavillion Partners, Ltd., executed March 1, 1990. [Exhibit 19.1 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.18) Pavillion Partners, Ltd. Agreement of Limited Partnership executed March 1, 1990. [Exhibit 19.2 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.19) Bill of Sale Agreement between Krupp Realty Limited Partnership-IV and Pavillion Partners, Ltd., executed March 1, 1990. [Exhibit 19.3 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.20) Pavillion Partners, Ltd. First Amendment to Agreement of Limited Partnership, executed April 9, 1990. [Exhibit 19.4 to Registrant's Report on Form 10-Q dated June 30, 1990 (File No. 0-11987)].*\n(10.21) Pavillion Partners, Ltd. Chapter 11 Voluntary Petition executed June 4, 1990 in The United States Bankruptcy Court for the Northern District of Texas, Dallas Division. [Exhibit 10.51 to Registrant's Annual Report on Form 10- K for the year ended December 31, 1990 (File No. 0-11987)].*\n(10.22) Pavillion Partners, Ltd., Debtor's First Amended Plan of Reorganization executed January 16, 1991 in The United States Bankruptcy Court for the Northern District of Texas, Dallas Division. [Exhibit 10.52 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 0-11987)].*\n(10.23) Promissory Note dated April 13, 1994 by and between Pavillion Partners, Ltd. and Sunlife Insurance Company of America. [Exhibit 10.1 to Registrant's Report on Form 10-Q dated June 30, 1994 (File No. 0-11987)].*\n(10.24) Promissory Note dated April 13, 1994 between Pavillion Partners, Ltd. and Sunlife Insurance Company of America. [Exhibit 10.2 to Registrant's Report on Form 10-Q dated June 30, 1994 (File No. 0-11987)].*\n* Incorporated by reference.\n(c) Reports on Form 8-K During 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 21st day of March, 1996.\nKRUPP REALTY LIMITED PARTNERSHIP-IV\nBy: The Krupp Corporation a General Partner\nBy: \/s\/ Douglas Krupp Douglas Krupp, Co-Chairman (Principal Executive Officer) and Director of The Krupp Corporation\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the 21st day of March, 1996.\nSignatures Titles\n\/s\/ Douglas Krupp Co-Chairman (Principal Executive Douglas Krupp Officer) and Director of The Krupp Corporation, a General Partner.\n\/s\/ George Krupp Co-Chairman (Principal Executive George Krupp Officer) and Director of The Krupp Corporation, a General Partner.\n\/s\/ Laurence Gerber President of The Krupp Corporation, Laurence Gerber a General Partner.\n\/s\/Robert A. Barrows Senior Vice President and Corporate Robert A. Barrows Controller of The Krupp Corporation, a General Partner.\nAPPENDIX A\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL 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 REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nReport of Independent Accountants\nConsolidated Balance Sheets at December 31, 1995 and December 31, 1994\nConsolidated Statements of Operations For the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Partners' Equity (Deficit) For the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows For the Years Ended\nDecember 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements -\nSchedule III - Real Estate and Accumulated Depreciation -\nAll other schedules are omitted as they are not applicable, not required, or the information is provided in the consolidated financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Krupp Realty Limited Partnership-IV and Subsidiaries:\nWe have audited the consolidated financial statements and the financial statement schedule of Krupp Realty Limited Partnership-IV and Subsidiaries (the \"Partnership\") listed in the index on page of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of\nmaterial misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Krupp Realty Limited Partnership-IV 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.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. January 31, 1996\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nASSETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY (DEFICIT) For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Organization\nKrupp Realty Limited Partnership-IV (\"KRLP-IV\") was formed on December 1, 1982 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. KRLP-IV terminates on December 31, 2020, unless earlier terminated upon the sale of the last of KRLP-IV and Subsidiaries' properties or the occurrence of certain other events as set forth in the Partnership Agreement.\nKRLP-IV issued all of the General Partner Interests to The Krupp Corporation, a Massachusetts corporation, and The Krupp Company Limited Partnership-II, a Massachusetts limited partnership, in exchange for capital contributions aggregating $1,000. Except under certain limited circumstances upon termination of KRLP-IV, the General Partners are not required to make any additional capital contributions. KRLP-IV has also issued all of the Original Limited Partner Interests to The Krupp Company Limited Partnership-II in exchange for a capital contribution of $4,000. The Original Limited Partner is not required to make any additional capital contributions to KRLP-IV. The purchasers of 30,000 units of Investor Limited Partner Interests (the \"Units\"), at a price of $1,000 per Unit, are the Investor Limited Partners.\nIn 1990, the General Partners on behalf of KRLP-IV formed three limited partnerships: Pavillion Partners, Ltd., Copper Creek Partners, Ltd. and Westbridge Partners, Ltd. At the same time, the General Partners transferred ownership of Pavillion Apartments to Pavillion Partners, Ltd., Copper Creek Apartments to Copper Creek Partners, Ltd., and Walden Pond Apartments to Westbridge Partners, Ltd. in exchange for KRLP-IV's 99% limited partner interest in the new entities. Westcop Corporation contributed a total of $11,216 in cash to the entities and is the General Partner in each with a 1% interest. On March 3, 1992, Copper Creek was foreclosed upon by the holder of the first and second mortgage notes pursuant to an agreement approved by the Bankruptcy Court.\nKRLP-IV, Pavillion Partners, Ltd., and Westbridge Partners, Ltd. are collectively known as Krupp Realty Limited Partnership-IV and Subsidiaries (collectively the \"Partnership\").\nAs of December 31, 1995, the Partnership owns four multi-family apartment complexes.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (see Note G).\nBasis of Presentation\nThe consolidated financial statements present the consolidated assets, liabilities and operations of Pavillion Partners, Ltd., Westbridge Partners, Ltd. and KRLP-IV (see Note A). All intercompany balances and\ntransactions have been eliminated. At December 31, 1995 and 1994, a minority interest of $28,793 and $30,037, respectively, is included in other liabilities.\nRisks and Uncertainties\nThe Partnership invests its cash primarily in deposits and money market funds with commercial banks. The Partnership has not experienced any losses to date on its invested cash.\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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\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 cash investments are recorded at cost, which approximates current market values.\nRental Revenues\nLeases require the payment of base rent monthly in advance. Rental revenues are recorded on the accrual basis.\nImpairment of Long-Lived Assets\nIn accordance with Financial Accounting Standards 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, the Partnership has implemented policies and practices for assessing impairment of its real estate assets.\nThe investments in properties are carried at cost less accumulated depreciation unless the General Partners believe there is a significant impairment in value, in which case a provision to write down investments in properties to fair value will be charged against income. At this time, the General Partners do not believe that any assets of the Partnership are significantly impaired.\nDepreciation\nDepreciation is provided for by the use of the straight-line method over estimated useful lives of the related asset, as follows:\nBuildings and improvements 3-25 years Appliances, carpeting and equipment 3-5 years\nDeferred Expenses\nThe Partnership amortizes the costs incurred in connection with the\norganization of its subsidiaries over a 5-year period using the straight- line method.\nThe Partnership amortizes the costs incurred to obtain the financing of Partnership's properties over the term of the related mortgage note using the straight-line method.\nIncome Taxes\nThe Partnership is not liable for federal or state income taxes as Partnership's income or loss is allocated to the partners for income tax purposes. In the event that the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and the examination results in a change in Partnership taxable income or loss, such change will be reported to the partners.\nReclassifications\nCertain prior year balances have been reclassified to conform with current year financial statement presentation.\nC. Cash and Cash Equivalents\nCash and cash equivalents consist of the following:\nDecember 31, December 31, 1995 1994\nCash and money market accounts $ 818,058 $ 416,066 Commercial paper 1,984,636 2,084,008 $2,802,694 $ 2,500,074\nAt December 31, 1995, commercial paper represents investments which mature between January 10 and February 9, 1996 having effective yields ranging from 5.81% to 5.91% per annum.\nD. Mortgage Notes Payable\nSubstantially all of the property owned by the Partnership is pledged as collateral for the non-recourse mortgage notes payable outstanding at December 31, 1995 and 1994. Mortgage notes payable consist of the following:\nFenland Field Apartments\nThe non-recourse mortgage note payable collateralized by the property is payable, based on a 20-year amortization, in equal monthly installments of principal and interest of $42,167. At maturity, all unpaid principal ($3,824,206) and any accrued and unpaid interest is due. The note may not be prepaid prior to June 1, 1998 and thereafter, may be prepaid subject to certain prepayment premiums.\nBased on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities, the fair value of long-term debt is approximately $4,600,000.\nIndian Run Apartments\nEffective October 26, 1994, the Partnership refinanced Indian Run's first mortgage note in the amount of $2,747,000. The new mortgage note is payable, based on a 25-year amortization, in equal monthly installments of principal and interest of $24,021. At maturity, all unpaid principal ($2,298,949) and any accrued and unpaid interest is due. The note may be prepaid at any time, subject to certain prepayment premiums.\nBased on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities, the fair value of long-term debt is approximately $3,300,000.\nWalden Pond Apartments\nOn February 28, 1992, the prior wrap-around mortgage note was modified in bankruptcy court. The modified principal balance of $5,500,000 is being amortized over a 30-year period and requires monthly principal payments of $46,247. For financial reporting purposes, generally accepted accounting principles required the Partnership to increase the outstanding principal balance of the mortgage to the sum of the future cash flow payments required under the new terms of the mortgage. All cash payments made subsequent to the restructure are recorded as a reduction of the principal balance and no interest expense is recognized by the Partnership.\nBased on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities, the fair value of long-term debt is approximately $5,700,000.\nPavillion Apartments\nEffective April 13, 1994, the Partnership refinanced Pavillion's first mortgage note in the amount of $7,000,000. The Partnership paid a $76,188 prepayment penalty to the previous mortgage holder. The new mortgage note is payable, based on a 30-year amortization, in equal monthly installments of principal and interest of $57,587. At maturity, all unpaid principal ($6,580,326) and any accrued and unpaid interest is due. The Partnership cannot prepay the note until October 13, 1997. Thereafter, the note may be prepaid subject to certain prepayment premiums.\nBased on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities, the fair value of long-term debt is approximately $7,300,000.\nThe aggregate principal amounts of borrowings due in the five years 1996 through 2000 are $744,553, $762,942, $783,115, $5,521,757 and $4,007,863, respectively.\nThe Partnership paid interest of $1,311,140, $1,376,867 and $1,496,429 during the years ended December 31, 1995, 1994 and 1993, respectively.\nE. Partners' Equity (Deficit)\nUnder the terms of the Partnership Agreement, profits and losses from operations are allocated 95% to the Investor Limited Partners, 4% to the Original Limited Partner and 1% to the General Partners until such time that the Investor Limited Partners have received a return of their total invested capital plus a 9% per annum cumulative return thereon. There- after, profits and losses will be allocated 65% to the Investor Limited Partners, 28% to the Original Limited Partner and 7% to the General Partners.\nUnder the Agreement, cash distributions are generally made on the same basis as the allocations of profits and losses described above. Distributions from a sale, exchange, or other disposition of a property or upon the termination of the Partnership are to be allocated differently than that described.\nAs of December 31, 1995, the following cumulative partner contributions and allocations have been made since inception of KRLP-IV:\nF. Related Party Transactions\nCommencing with the date of acquisition of the Partnership's properties, the Partnership entered into agreements under which property management fees are paid to an affiliate of the General Partners for services as management agent. Such agreements provide for management fees payable monthly at a rate of 5% of the gross receipts from residential properties under management. The Partnership also reimburses affiliates of the General Partners for certain expenses incurred in the operation of the Partnership and its properties including accounting, computer, insurance, travel, legal, payroll, and the preparation and mailing of reports and other communications to the Limited Partners.\nAmounts paid to the General Partners or their affiliates for the years ended December 31, 1995, 1994 and 1993 were as follows:\nIn addition to the amounts above, the following amounts relating to refinancing and disposition activities were paid to the General Partners or their affiliates:\n1995 1994 1993\nCost reimbursements $ 1,942 $ 22,050 $ 18,544\nG. Federal Income Taxes\nThe reconciliation of the net loss for each year reported in the accompanying Consolidated Statement of Operations with the net loss reported in the Partnership's 1995, 1994 and 1993 federal income tax returns follows:\n1995 1994 1993\nNet loss per Consolidated Statement of Operations $ (21,628) $(488,936) $(1,468,566)\nAdd: Difference in book to tax depreciation for Fenland Field and Indian Run 90,581 73,092 42,694\nPartnership's share of Pavillion Partners net loss not recognized for tax purposes 37,923 35,153 609,179\nPartnership's share of Westbridge Partners net loss (income) not recognized for tax purposes (448,394) (448,610) 148,765\nNet loss for federal income tax purposes $(341,518) $(829,301) $ (667,928)\nThe allocation of the net loss for federal income tax purposes for 1995 is as follows:\nPortfolio Passive Income Loss Total\nInvestor Limited Partners $158,810 $(483,253) $(324,443)\nOriginal Limited Partner 6,687 (20,347) (13,660)\nGeneral Partners 1,672 (5,087) (3,415) $167,169 $(508,687) $(341,518)\nDuring the years ended December 31, 1995, 1994 and 1993 the per Unit net loss to the Investor Limited Partners for federal income tax purposes was $11, $26 and $21, respectively.\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nGross Amounts Carried at End of Year\n(a) The mortgage note payable balance per the Consolidated Balance Sheets include all interest payable through maturity (see Note D).\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-IV AND SUBSIDIARIES\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION, Continued December 31, 1995\nReconciliation of Real Estate and Accumulated Depreciation for each of the three years in the period ended December 31, 1995:\nNote: The aggregate cost of the Partnership's real estate for federal income tax purposes at December 31, 1995 is $39,782,928 and the aggregate accumulated depreciation for federal income tax purposes is $31,000,047.","section_15":""}
{"filename":"216810_1995.txt","cik":"216810","year":"1995","section_1":"Item 1. BUSINESS Introduction - The New Paraho Corporation and its subsidiaries (the \"Company\" or \"New Paraho\") hold patents and proprietary rights applicable to the retorting of oil from shale by use of an aboveground, vertical shaft retort. The Company also has rights to use certain intellectual properties to test and to commercially develop the use of shale oil in the production of asphalt. In addition, the Company owns interests in oil shale lands and holds a note receivable from the sale of certain property and mineral rights. History - On July 23, 1986 Paraho Development Corporation merged with New Paraho, which was a wholly-owned subsidiary of Energy Resources Technology Land, Inc. (\"ERTL\"), pursuant to a plan of reorganization under Chapter 11 of the Bankruptcy Code. Following the merger, shareholders of Paraho Development Corporation received 5% of the outstanding common stock of New Paraho. Former creditors of Paraho Development Corporation received 15% of the common stock of New Paraho and income certificates (the \"Income Certificates\") representing rights in oil shale mineral properties located in Rio Blanco County, Colorado which were previously owned by ERTL (all of ERTL's interest in such properties before it transferred 50% of such interest to the Company is hereinafter defined as the \"Rio Blanco Properties\"). After the merger, ERTL owned 80% of the outstanding common stock of New Paraho. New Paraho was incorporated in December 1985 as a wholly- owned subsidiary of ERTL. ERTL capitalized New Paraho with $1,000 and contributed 50% of its interest in the Rio Blanco Properties. ERTL accounted for the acquisition of Paraho Development Corporation as a purchase. Based upon the current control by ERTL of New Paraho, the Company is included for Federal income tax purposes as part of the ERTL consolidated group of corporations and the results of its operations are reported in the consolidated Federal income tax returns filed by ERTL from the date of the confirmation of reorganization, July 23, 1986, forward. Accordingly, and as long as such controlling interest is maintained, losses and\/or tax credits, if any, for Federal income tax purposes generated by New Paraho may be applied against the income and\/or income tax for Federal income tax purposes of members of the ERTL group. The group has established a tax allocation policy which requires the Federal income tax liability to be computed on a separate return basis. Any losses or other credits directly attributable to the Company which result in a reduction of the consolidated tax liability will be reimbursed by the parent. Likewise, the Company will be charged for its share of the consolidated tax liability. Asphalt Feasibility Program - The activities of the Company are devoted to developing, testing and test marketing shale oil-derived asphalt paving materials. There is no established market for these materials, and they are not produced in commercial quantities, although the Company has sold small quantities of these materials to customers on an isolated basis. The Company's current activities and sales are not sufficient to sustain the Company on an ongoing basis without either substantial additional outside funding or the financing and development of a commercial plant. The Company's recent activities have been designed to establish the feasibility of constructing and operating such a plant. Even if the feasibility of such a plant can be established, a number of events or circumstances could prevent the Company from establishing commercial production of shale oil-derived asphalt paving materials. These include changes in technology, changes in government regulations, and the inability to obtain financing for a commercial facility. In June 1987, the Company began a commercial feasibility program in order to evaluate the economic viability of producing and marketing commercial quantities of shale oil- derived asphalt paving materials. ERTL has acquired certain rights in patents, patent applications and other intellectual properties from Western Research Institute (\"WRI\") regarding the use of shale oil-derived asphalt material (the \"WRI Technology\"). ERTL has granted the Company the right to use the WRI Technology for the Asphalt Feasibility Program. Researchers at WRI discovered that certain species present in shale oil significantly reduce moisture damage and potentially reduce binder embrittlement when added to asphalt. This is particularly true for shale oil produced by direct-heated retorting process such as the oil shale retorting technology owned by the Company (the \"Paraho Process\"). Accordingly, a significant and cost effective extension to the durability and life of asphalt paving materials could be realized if the WRI Technology were combined with the use of shale oil produced by the Paraho Process. On the basis of the initial WRI laboratory tests and the Company's field tests performed to date, it appears that shale oil-based asphalt paving material will last significantly longer than conventional asphalt. Paraho has revised its original economic estimates, and has developed a staged development option in anticipation that initial investors would elect to finance a smaller production facility due to capital and\/or market considerations. Under this scenario, and based on initial estimates by Paraho, a plant sized to retort 850 tons per day of oil shale and to then further process the crude shale oil into asphalt modifiers using the proprietary SOMAT (Shale Oil Modified Asphalt Technology) process developed by the Company, represents the minimum production capacity required to achieve a satisfactory return on equity. The Company believes that the assumptions it employed in making these estimates are reasonable. There can be no assurance, however, that the assumptions will prove to be true or that the Asphalt Feasibility Program will be successful. To establish the commercial economics of producing shale oil-derived asphalt, the Company initiated the Asphalt Feasibility Program which includes the construction and evaluation of field test strips and a more thorough evaluation of the economic viability of producing and marketing commercial quantities of shale oil-derived asphalt paving materials. Working in cooperation with state, county and municipal highway officials in Colorado, Utah, Wyoming, Texas, and Michigan a total of twelve test strips were constructed during the 1989 to 1991 time frame. During fiscal year 1991, Marathon Oil Company (\"Marathon\") began evaluating Paraho's plans for the construction and operation of a facility to commercially produce SOMAT. Marathon continues to fund the expanded field evaluation program designed to assess the technical performance characteristics of SOMAT over a broader range of climatic and road use conditions. This expanded program has resulted in the construction of three of the aforementioned test strips, two of which are located in Texas, and one in Michigan. Seven of the twelve test strips, including the three funded by Marathon, were selected for a five year technical monitoring program which is designed to provide detailed data on the performance characteristics of the SOMAT and control asphalts used in the construction of each of the test strips. The seven test strips were selected primarily on the basis of geographical, or climatic, diversity. The results from the five annual evaluations of four of these seven test strips, and the first three annual evaluations of the additional three have been obtained. Results from the fifth and third annual evaluations, respectively, continue to show that with respect to stripping, aging and rejuvenation of recycled asphalt, SOMAT demonstrated superior performance compared to conventional and polymer modified asphalts. In terms of rutting, thermal cracking, and fatigue cracking, SOMAT appeared superior compared to conventional asphalts and comparable to polymer modified asphalts. In addition, SOMAT enjoys a distinct advantage over polymer modified asphalts and is comparable to conventional asphalts with regard to materials and construction handling characteristics. In January, 1993, Paraho initiated the test market phase of the Asphalt Feasibility Program. This phase was intended to determine the actual marketability of the product in the paving industry. The first sale of the material in the open marketplace occurred in June 1993, with four more projects completed during the remainder of 1993. In addition, paving projects utilizing SOMAT in the states of Colorado, Wyoming and, California were completed in the late summer of 1994. These projects utilized a total of approximately 1,400 barrels of shale oil modifier, which comprises approximately half of the shale oil modifier produced during fiscal year 1994. The Company plans to market the remaining modifier for paving projects in the summer of 1996, and terminate the test market phase, with no further plans to produce additional material. The Company expended approximately $324,000 in 1992, $1,068,000 in 1993, $880,000 in 1994, and $743,000 in 1995 on direct research and development of this shale oil-derived asphalt product. The Company does not have funding for any additional research and development or commercial production efforts. Although the Company is seeking additional financing to fund these efforts, it currently appears unlikely that the Company will succeed in doing so. Based on the results of the test strip evaluations, the Asphalt Feasibility Program has determined that this product is technically feasible. Since 1989, the Company has been attempting to finance, design, and construct a retorting and SOMAT production facility suitable for asphalt operations. This has included efforts to seek funding to construct and operate a commercial-scale production facility with an initial capacity of 275 BPSD of shale oil (Phase I) and subsequent expansion by an additional 275 BPSD (Phase II). A preliminary estimate for the construction of Phase I of the project, modernization and expansion of the mine, pilot and start-up operating losses, working capital and financing costs is $42.5 million. The estimated cost for Phase II is $15.8 million, with expected positive cash flow from operations reducing costs by $4.1 million in the fourth year of the project. Total estimated net costs for Phase I and II are $54.2 million. Although the Company has been aggressively seeking financial commitments for the construction of a commercial retorting facility since 1989, to date the Company has not received any commitments or serious indications of interest from any potential financial partner. Although the Company is continuing to seek financial commitments, it appears unlikely it will succeed in doing so. Asphalt Feasibility Program Financing - On June 1, 1995, the Tell Ertl Family Trust (the \"Trust\") approved an extension of the due date of the Company's line of credit to July 1, 1996 in order to continue to finance the test market program. Under the terms of the note securing this line of credit, the Trust, through its trustees, reserves the right to approve the Company's activities and budgets during the term of the note. Although the Company believes the existing sources of financing will be sufficient to continue the Asphalt Feasibility Program through June 30, 1996, there is no assurance that the Company will have the funding to continue the program beyond that date. When the note becomes due on such date, the Company will have to either extend the term of the note or find other financing to pay off the note and continue operations. There can be no assurance that an extension will be granted or that other financing could be found. If the Trust does not extend the maturity of its note due July 1, 1996 and the Company cannot obtain other financing, the Company will be required to sell assets to repay the note, and may be required to terminate all activities and liquidate. The Company also has funds available resulting from the exercise by Tosco Corporation's wholly-owned subsidiary, The Oil Shale Corporation, of its option to purchase the Rio Blanco Properties (the \"Purchase Option\"). The total purchase price was $12,711,700, of which the Company received half. On closing, the Company received $575,000 and a 50% interest in a note receivable in the amount of $11,561,700, payable in fifteen equal annual installments of $770,780 commencing December 17, 1990 with interest at 5% payable quarterly. Paraho Technology - The Company, directly and through its subsidiaries, owns the Paraho Process which consists of patents and proprietary rights applicable to the retorting of oil from shale by use of an above ground, vertical shaft retort. In connection with the Asphalt Feasibility Program, the Company has continued its research and development activities on the Paraho Process. The Company has already successfully demonstrated the Paraho Process on a semi-works scale. Paraho Development Corporation, predecessor to the Company, produced approximately 110,000 barrels of shale oil. Of these, approximately 98,000 barrels were refined into gasoline, jet fuel, heavy fuel oil and other products. These products were tested by several government agencies and private companies under the direction of the U.S. Navy, and met specifications set by the U.S. Navy. There can be no assurance, however, that any commercial oil shale facility will be constructed or that, if such a facility is constructed, it will use the Paraho Process. The Company will not be able to generate revenues from the Paraho Process unless it succeeds in financing the construction of a commercial facility, or is able to license the technology to third parties for construction of such a facility. Due to the Company's inability to obtain financing to date, and the lack of any interest by third parties in licensing the technology, the Company does not expect it will realize any revenues from the Paraho Process in the foreseeable future. Even if it succeeds in financing a facility or licensing the technology to third parties, due to the lengthy lead time necessary to engineer and construct a commercial oil shale facility, as well as the constraints imposed by governmental regulations, at best, it will be a number of years before any royalties may be earned by New Paraho under any licenses it may grant for the use of the Paraho Process. The Paraho Process includes an entire system for the processing of oil shale, including mining, crushing, retorting and disposing of the shale. Protection of the Paraho Process is based upon several patents covering equipment, process conditions and methods of operating a retort, many of which have expired. The Company expended resources in prior years to apply for new patents as a result of the Department of Energy sponsored PON Commercial design project initiated by Paraho Development Corporation. As a result of these efforts, on August 14, 1990, the U.S. Patent Office issued this patent as #4,948,468. Management believes that the interrelation of the remaining patents, in addition to this new patent should provide adequate protection of the Paraho Process through the year 2007. Along with the patent protection, New Paraho has developed proprietary know-how and technical data and experience regarding the design, construction and operation of retorts and related facilities. Such technology and know-how are protected by confidentiality and patent assignment agreements. The agreements generally require the maintenance of the confidentiality of all Paraho Process technology and trade secrets and require assignment to the Company of all patents relating to its business or products. New Paraho also has rights received from ERTL to use the WRI Technology for the Asphalt Feasibility Program. SOMAT Technology - While proceeding with the Asphalt Feasibility Program, the Company developed the SOMAT (Shale Oil Modified Asphalt Technology) process to further process crude shale oil into shale oil asphalt modifiers. This process is proprietary information and the Company seeks to protect it under patent and trade secrets law. Governmental Regulation - Environment - Federal, state and local laws and regulations have a substantial impact on the development of an oil shale industry. Environmental concerns include air quality, water usage and pollution, dust problems, spent shale disposal and land reclamation. Numerous governmental permits are required in connection with the construction and operation of one or more commercial-size retorts and related facilities (including the mine from which oil shale is extracted). Mining of the oil shale, which is accomplished using conventional room and pillar or surface mining methods, presents the usual difficulties associated with mining methods, including safety considerations. The Company believes that it and its subsidiaries have received all permits necessary for them to mine oil shale and to process it at the Pilot Plant Lease site in support of the Asphalt Feasibility Program. Employees - The Company currently has four paid employees. The Company has no plans to add employees, and will be required to lay off some or all employees in the future unless financing for a commercial facility is obtained. Competition - New Paraho is only one of many companies that has attempted to develop a workable, economical process for recovering oil from shale. The adverse conditions which now exist for the commercial development of oil shale, when coupled with the absence of federal government incentives, have caused many of these companies to abandon or to defer further research and development of their competing technologies as well as development of their oil shale mineral resource holdings. Nonetheless, many of the Company's future competitors may have far greater resources than the Company. If any one of these companies is successful, its success may significantly reduce the value of the Paraho Process. Further, it is possible that new technologies, which could require lower capital costs or present other advantages, could reduce the value of the Paraho Process. New Paraho is unable, at this time, to assess accurately the status of the development or economics of competing processes, and no assurance can be given that the Paraho Process will be able to compete effectively with other processes. At present, management believes that the Company is the only producer of a shale oil-derived asphalt material for testing purposes. The Company's exclusive right to use the WRI Technology provides protection against competitors using that technology to produce the material without first obtaining a license from New Paraho. In addition, the Company believes that shale oil produced by the Paraho Process used in connection with the SOMAT Process produces a higher quality and a higher yield of asphalt modifier than shale oil produced by other processes. With respect to competing asphalt modifiers, a Federal program focused on the development of improved asphalt testing systems and on the development of improved asphalt binders, has led to a greater demand for improved asphalt quality. Among the products used to improve the asphalt binder, lime, liquid anti- strip additives, and polymer modified asphalts are the most popular and widely used. Based on the results of the laboratory and actual road tests to date, Paraho believes that SOMAT will be able to compete effectively with these products. In the case of lime and liquid anti-strips, SOMAT's competitive advantage will come through a technically superior product that is priced comparable to the best performing anti-strip products, and in the case of the polymer modified products, SOMAT's advantage will come through comparable, if not superior, technical performance at a lower price. However, there is no assurance that competitors will not develop products with performance characteristics superior to SOMAT.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES Rio Blanco Properties - On December 17, 1987, The Oil Shale Corporation, a wholly-owned subsidiary of Tosco Corporation exercised the Purchase Option on the Rio Blanco Properties. Details of the transaction are as described in the discussion of the Asphalt Feasibility Program. Pilot Plant Lease - On October 15, 1982, Paraho Development leased 200 acres of private land near Rifle, Colorado from an individual for an initial term of ten years with provisions for extensions. The leased land provides a location for the Company to operate its pilot oil shale retort facility, and management considers the land to be adequate space to enable New Paraho to carry out research operations. As renegotiated on October 8, 1992, the lease calls for an annual minimum rent of $6,000 and an operational rate of $28,296 per year. The new lease expires in October, 2002. The rent for the land at the operational rate for the twelve months ended June 30, 1995 will be prorated on a daily basis. Utah Oil Shale Lands - New Paraho has acquired rights to approximately 10,432 acres of oil shale lands in Uintah County, Utah. Of the total, New Paraho owns an undivided 80% interest in 160 acres in fee. The remaining 10,272 acres are controlled by New Paraho under State of Utah Leases for oil shale or under agreements with third parties.\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.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK HOLDER MATTERS The Company's common stock is traded over-the-counter. The reported high and low bid prices for each quarterly period since July 1, 1993 are as follows:\nFROM THE NATIONAL DAILY QUOTATION SERVICE\nThe high and low prices specified above represent prices between broker-dealers. They do not include retail mark-ups and mark-downs or any commissions to the broker-dealer and may not reflect prices in actual transactions. As of July 14, 1992, the Company's stock was deleted from the NASDAQ Small-Cap Market, because the Company failed to meet the new bid price requirement. The stock has been only thinly and sporadically traded, and is now listed on an electronic bulletin board system. As of September 1, 1995, the approximate number of shareholders of record of The New Paraho common stock was 1,100. New Paraho has never paid dividends on its common stock and there is no prospect that dividends will be paid in the foreseeable future. The Company intends to follow its policy of retaining any earnings to provide funds to offset current obligations, for additional research and development and for expansion.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity - Due to the inability to obtain financing for a commercial project, the exhaustion of the Company's existing financial resources, and the fact that the Company's line of credit will mature on July 1, 1996, the Company expects that it will not have the funds to continue operations, and may be required to sell assets or liquidate to meet its obligations. The Company realized an increase in working capital of $84,825 in the fiscal year ended June 30, 1995. Funds were primarily obtained from sales of asphalt paving material, borrowing on the promissory note to the Tell Ertl Family Trust, and from interest and principal payments on the promissory note from The Oil Shale Corporation. Funds were used primarily for operating expenses, and research and development related to the Asphalt Feasibility Program. On May 1, 1994, the Company was granted an increase in its line of credit to $5,500,000 by the Trust. Borrowings under this note are at the discretion of the trustees of the Trust. The note is due on July 1, 1996. The Company had borrowed $5,497,119 and owes an additional $1,294,959 in accrued interest on this note as of June 30, 1995. The Company does not expect to be able to pay the note when it becomes due. The Trust has notified the Company that it does not intend to increase the line of credit, and it is uncertain whether the Trust will agree to extend the maturity date. Accordingly, the Company will not have any funds to continue operations unless it succeeds in obtaining additional financing. Since 1989, the Company has been seeking to obtain financial commitments to design, construct, and operate a commercial facility to produce asphalt. To date, the Company has not received significant indications of interest, and it currently appears unlikely that it will succeed in obtaining such financial commitments. Possible future sources of cash include sales of oil shale- derived asphalt paving materials and payments on The Oil Shale Corporation's Promissory Note. Additional future sources of cash may include revenues from the performance of further research services or from the use of the Company's pilot plant retort facility. Management presently does not expect that significant revenues from these sources will be obtained. Management believes that the Company's share of payments on The Oil Shale Corporation's Promissory Note and sale of the remaining asphalt paving material will be sufficient to cover projected operating costs for the Asphalt Feasibility Program for the year ending June 30, 1996, other than debt service on the note payable to the Trust. The Company does not believe it will have sufficient revenues to pay operating costs or debt service on the note payable to the Trust in later years. Further, if the Trust does not agree to extend the maturity date of its note beyond July 1, 1996, unless the Company obtains additional financing (which currently appears unlikely), the Company will be required to sell assets to repay the note, and may be required to terminate operations and liquidate. Capital Resources - New Paraho's current long-term objectives include research and development related to the Asphalt Feasibility Program and the Paraho Process, licensing of the Paraho Process and commercialization of shale oil and shale oil-derived products. In pursuit of these objectives, New Paraho incurred costs and expenses of $993,004 in fiscal 1995. The Company expects to spend approximately $500,000 during fiscal 1996 to finalize the test market program. This need for funds will be met by payments received on the TOSCO note, and sales of SOMAT. At the present time, New Paraho believes that the most viable option for the continued pursuit of these aforementioned objectives is the successful completion of the Asphalt Feasibility Program and subsequent commercialization efforts. Management has estimated that such a commercial project would require capital of $54 million. While the Company has been attempting to seek commitments for such financing, it has been unable to do so to date, and it currently appears unlikely that it will succeed in doing so.\nResults of Operations 1995 - Revenues in fiscal 1995 consisted primarily of sales of SOMAT and interest payments on the promissory note from The Oil Shale Corporation. Costs and expenses related to research and development of the Asphalt Feasibility Program. Furthering the test market phase of the Asphalt Feasibility Program, as well as attempting to finance a commercial project are expected to be the main operations of the Company in the near future.\n1994 - Revenues in fiscal 1994 consisted mainly of interest payments on the promissory note from The Oil Shale Corporation and sales of SOMAT. Costs and expenses related primarily to research and development of the Asphalt Feasibility Program. 1993 - Revenues in fiscal 1993 consisted mainly of interest payments on the promissory note from The Oil Shale Corporation and sales of SOMAT. Costs and expenses related primarily to research and development of the Asphalt Feasibility Program.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Financial Statements Page\nReport of Independent Auditors 26\nConsolidated Balance Sheets at June 30, 27 1995 and June 30, 1994\nConsolidated Statements of Operations for 29 the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of 30 Stockholders' Equity (Deficit) for the years ended June 30, 1995, 1994, 1993 and 1992\nConsolidated Statements of Cash flows for 31 the years ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements 32\nConsolidated Financial Statements\nTHE NEW PARAHO CORPORATION\nYears ended June 30, 1995, 1994 and 1993 with Report of Independent Auditors\nReport of Independent Auditors\nThe Board of Directors The New Paraho Corporation\nWe have audited the accompanying consolidated balance sheets of The New Paraho 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of The New Paraho Corporation 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 2 to the financial statements, the Company's recurring losses from operations, net capital deficiency and inability to obtain financing to construct a commercially feasible oil shale retort facility raise substantial doubt about its ability to continue as a going concern. Management's plan as to these matters are also described in Note 2. The accompanying financial statements do not include any adjustments that might result from the out come of this uncertainty.\nAugust 23, 1995\nERNST & YOUNG LLP\nTHE NEW PARAHO CORPORATION\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes\nLIABILITIES AND STOCKHOLDERS' EQUITY (deficit)\nSee accompanying notes\nTHE NEW PARAHO CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATION\nSee accompanying notes.\nTHE NEW PARAHO CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)\nSee accompanying notes.\nTHE NEW PARAHO CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nThe New Paraho Corporation Notes to Consolidated Financial Statements June 30, 1995\n1. Description of Business and Summary of Accounting Policies\nDescription of Business\nThe New Paraho Corporation (the \"Company\") was incorporated in December 1985 as a wholly-owned subsidiary of Energy Resources Technology Land, Inc. (\"ERTL\"). ERTL capitalized The New Paraho Corporation with $1,000 and contributed 50% of its interest in oil shale mineral properties located in Rio Blanco County, Colorado. Operations of the Company commenced on July 23, 1986.\nOn July 23, 1986, the Company merged with Paraho Development Corporation pursuant to Paraho Development Corporation's Plan of Reorganization (\"Plan of Reorganization\") under Chapter 11 of the United States Bankruptcy Code. Shareholders of Paraho Development Corporation received 5% of the outstanding common stock of the Company and former creditors of Paraho Development Corporation received 15% of the common stock of the Company and income certificates representing a right to a specified percentage of certain income received by the Company from oil shale mineral properties located in Rio Blanco County, Colorado (see Note 6).\nFollowing the merger, ERTL holds 80% of the outstanding common stock of the Company and, accordingly, the Company accounted for the acquisition of Paraho Development Corporation as a purchase.\nThe Company, directly and through its subsidiaries, holds patents and proprietary rights applicable to the retorting of oil from shale by use of an above-ground, vertical shaft retort. The Company also has rights to use certain intellectual properties to test the suitability of shale oil in the production of asphalt. In addition, the Company owns interests in oil shale lands.\nPrinciples of Consolidation\nThe consolidated financial statements of the Company include the accounts of wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. The New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n1. Description of Business and Summary of Accounting Policies (continued)\nPlant, Furniture and Equipment, Oil Shale Mineral Properties, and Patent\nDepreciation is provided on a straight-line basis over the estimated useful lives of the assets, which range from three to ten years. Amortization is provided on a straight-line basis over seventeen years, the estimated useful life of the patent.\nInventory\nInventory consists of shale oil asphaltic cement and is stated at the lower of cost or estimated net realizable value.\nNet Loss Per Share\nLoss per share is computed based on the weighted average number of common shares outstanding during the period.\nIncome Taxes\nThe Company has elected to file a consolidated federal income tax return with its parent, ERTL. The consolidating companies have implemented a tax allocation policy. Under this policy, the federal income tax provision is computed on a separate return basis and the companies receive reimbursement to the extent their losses and other credits result in a reduction of the consolidated tax liability, or are charged for their share of the consolidated tax liability.\nEffective July 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes\" (\"FAS No. 109\"). This change in accounting method has no material effect on the Company's accounting for income taxes.\nStatement of Cash Flows\nFor purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents. The New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n1. Description of Business and Summary of Accounting Policies (continued)\nConcentration of Credit Risk\nThe Company's note receivable is the result of a sale of certain property and mineral rights in fiscal year 1988 (Note 4). The note is secured by the assets sold.\n2. Ability to Continue as a Going Concern\nAs of June 30, 1995, the Company has an accumulated deficit of $2,514,142 and a net capital deficiency of $2,374,950. Ultimately, the Company's ability to continue as a going concern is dependent on obtaining sufficient financing to construct a commercially feasible oil shale retort facility. Management will continue to seek sources for this financing. Management believes proceeds from the note receivable (see Note 4) and the sale of inventory will be sufficient to fund operations through June 30, 1996.\nThese financial statements do not include any adjustments to reflect the possible effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.\n3. Plant, Furniture and Equipment and Oil Shale Mineral Properties\nPlant, furniture and equipment at June 30, 1995 and 1994 consist of:\nOil shale mineral properties at June 30, 1995 and 1994 consist of:\nThe New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n3. Plant, Furniture and Equipment and Oil Shale Mineral Properties (continued)\nOil shale mineral properties consist of approximately 10,272 acres of Utah state leases and an 80% undivided interest in 160 acres of Utah fee land. Annual renewal rental payments of $10,272 are required on the Utah state leases.\n4. Note Receivable and Sale of Property and Mineral Rights\nOn December 17, 1987, Tosco Corporation's wholly-owned subsidiary, The Oil Shale Company, exercised its option, granted in 1963 by the Company's parent, to acquire from the Company its 50% ownership interest in certain property and mineral rights for $6,355,850. The Company received $575,000 cash and a note receivable in the amount of $5,780,850 on closing. The note is receivable in fifteen equal annual installments of $385,390 which commenced December 17, 1990. The principal balance bears interest at 5% receivable quarterly.\n5. Certificates of Deposit\nOn June 23, 1994, the Company obtained a $20,000 one-year certificate of deposit to secure a letter of credit. On June 23, 1995, the certificate of deposit was reinvested in another one-year certificate of deposit which bears interest at 5.1%.\nThe Company also has $27,000 in certificates of deposit which are restricted under terms of a reclamation performance bond and will be released following completion of mining activities and restoration of mining sites.\n6. Payable to Income Certificate Holders\nPursuant to the merger and Plan of Reorganization (see Note 2), certain creditors of Paraho Development Corporation were issued income certificates with face values equal to 50% or, in specified court approved circumstances, a varying percentage of the debt owed. These certificates were unsecured, noninterest-bearing obligations of the Company which were to expire December 31, 1995, and were payable from 30% of any future proceeds received by the Company from the Rio Blanco County oil shale mineral properties (see Note 4). Amounts payable resulting from the obligation under the income certificates were recognized when the related revenue was recognized. These certificates were paid off during 1994.\nThe New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n7. Income Taxes\nThe Company accounts for income taxes in conformity with FAS No. 109. Under the provisions of FAS No. 109, a deferred tax liability or asset (net of a valuation allowance) is provided in the financial statements by applying the provisions of applicable tax laws to measure the deferred tax consequences of temporary differences which result in net taxable or deductible amounts in future years as a result of events recognized in the financial statements in the current or preceding years.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows:\nThe Company has operating loss carryforwards for income tax purposes of approximately $10,023,000, which expire in varying amounts from 2000 to 2010. In addition, the Company has general business credit carryovers for income tax purposes of approximately $150,000, which expire in varying amounts from 1995 to 2004.\nThe Company is included, for federal income tax purposes, in the consolidated income tax return filed by ERTL. Income tax operating loss carryforwards and general business credit carryovers of approximately $677,000 and $106,000, respectively, are a result of the pre-acquisition operations of Paraho Development Corporation and may only be applied against future taxable income of the Company. The New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n8. Related Party Transactions\nIn June 1987, the Company obtained a $2,500,000 unsecured line of credit from the Tell Ertl Family Trust, which holds 47% of the outstanding common stock of ERTL. This line was increased to $5,500,000 in May 1994 and amended in June 1995 to reflect a maturity date of July 1, 1996. The note bears interest at 2% over prime (effective rate of 11% at June 30, 1995) and provides that the Trust reserves the right to approve activities and budgets of the Company during the term of the promissory note.\nFor the year ended June 30, 1995, the Company paid professional fees totalling $36,000 to an affiliate of a director.\n9. Operating Lease\nThe lease for land upon which the pilot plant is located was renegotiated and extended to October 1, 2002. Future minimum lease payments for this land are as follows:\nThe lease provides for fixed payments of $28,296 per year prorated on a daily basis for periods when the pilot plant is in operation. The pilot plant commenced operations on November 10, 1992. Total lease payments relating to this lease were $6,000, $26,521, and $17,635 for 1995, 1994 and 1993, respectively.\n10. Stock Option\nOn January 1, 1991, the Company granted an officer of the Company an option to purchase up to 1,150,000 shares of Common Stock for $.05 per share. Of the 1,150,000 shares included in the grant, 150,000 shares became exercisable on July 1, 1991. The remaining 1,000,000 shares are exercisable in increments of 250,000 shares to 500,000 shares upon the occurrence of specified events. The option expires ten years from the date of grant. The New Paraho Corporation Notes to Consolidated Financial Statements (continued)\n10. Stock Option (continued)\nThe Company recorded $6,600 of compensation expense in 1991 related to the 150,000 shares that became exercisable on July 1, 1991. The remaining options to purchase 1,000,000 shares will be accounted for as a variable plan and compensation, if any, will be determined based on the market value of the Company's stock at the dates the specified events occur and thus the number of shares subject to the option is known.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable.\nPART III ITEMS 10 THROUGH 13\nItems 10 through 13 are incorporated by reference from the sections entitled \"Election of Directors and Officers\", \"Amount and Nature of Beneficial Ownership\", and \"Remuneration and Other Transactions with Management and Others\" in the Registrant's definitive proxy statement for its annual meeting to be held in December, 1995 which proxy statement shall be filed no later than 120 days after the end of the Company's most recent fiscal year.\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 The Index to Financial Statements is at Page 24. No financial statements or financial statement schedules are incorporated by reference. All schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements and notes thereto. There were no reports on Form 8-K during the last quarter of the period covered by this Annual Report.\nExhibit Index Exhibit No. Description (3) Articles of Incorporation and By-Laws. Reference is made to Exhibits 4 and 5 to Registrant's Form 8-K filed on July 23, 1986 (file number 0-8536) that is incorporated herein by reference.\n(10) (a) William Clough Lease, dated October 15, 1982 for land near Rifle, Colorado. Reference is made to Exhibit 10(e) to Registrant's Annual Report on form 10-K for the Fiscal Year Ended August 31, 1982 that is incorporated herein by reference.\n(10)(a)(i) Amendment to William Clough Lease effective October 1, 1986. Reference is made to exhibit (10)(a)(i) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1987 that is incorporated herein by reference.\n(10)(a)(ii) Amendment to William Clough Lease effective October 8, 1992.\n(10) (b) State of Utah Mineral Lease No. 35894 assigned to Paraho, with assignment. Reference is made of Exhibit 13(c) to Registrant's Registration Statement dated June 17, 1980 on Form S-1 (file number 2-67272) that is incorporated herein by reference.\n(10) (c) State of Utah Mineral Lease No. 35891 assigned to Paraho, with assignment. Reference is made to Exhibit 10(d) for the Fiscal Year Ended August 31, 1981 that is incorporated herein by reference.\n(10) (e) Commitment to lease or otherwise convey from Gulf. Reference is made to Exhibit 10(h) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended August 31, 1981 that is incorporated herein by reference.\n(10) (f) Debtors Joint Plan of Reorganization (Case No. 86 B1593G) dated February 25, 1986. Reference is made to Exhibit 1 to Registrant's 8-K dated July 23, 1986 that is incorporated herein by reference.\n(10) (g) Debtors Disclosure Statement dated June 3, 1986. Reference is made to Exhibit 2 to Registrant's 8-K dated July 23, 1986 that is incorporated herein by reference.\n(10) (h) Plan and Agreement of Merger between and among ERTL, Paraho Development Corporation, a Colorado corporation and Paraho Development Corporation, a Delaware corporation dated December 30, 1985, with amendments dated February 18, 1986 and July 23, 1986. Reference is made of Exhibit 3 to Registrant's 8-K dated July 23, 1986 that is incorporated herein by reference.\n(10) (j) Employment Agreement with Larry A. Lukens, dated January 1, 1991. Reference is made of Exhibit 10(j) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1991 that is incorporated herein by reference.\n(10)(j)(i) Stock Option Agreement with Larry A. Lukens, dated January 1, 1991. Reference is made of Exhibit 10(j)(i) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1991 that is incorporated herein by reference.\n(10) (k) Promissory Note from The Oil Shale Corporation in the principal sum of $11,561,699.50, dated December 17, 1987. Reference is made of Exhibit 10(k) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1988 that is incorporated herein by reference.\n(10) (l) Promissory Note to the Tell Ertl Family Trust in the principal sum of $3,000,000 dated August 29, 1989. Reference is made of Exhibit 10(l) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1989 that is incorporated herein by reference.\n(10)(l)(i) Amendment to the Promissory Note to the Tell Ertl Family Trust, dated September 19, 1990. Reference is made of Exhibit 10(l)(i) to Registrant's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1991 that is incorporated herein by reference.\n(10)(l)(ii) Amendment to the Promissory Note to the Tell Ertl Family Trust, dated August 26, 1992. Reference is made of Exhibit (10)(l)(ii) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1992, that is incorporated herein by reference.\n(10)(l)(iii) Amendment to the Promissory Note to the Tell Ertl Family Trust, dated August 20, 1993. Reference is made of Exhibit (10)(l)(iii) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1993, that is incorporated herein by reference.\n(10)(l)(iv) Amendment to the Promissory Note to the Tell Ertl Family Trust, dated May 1, 1994. Reference is made of Exhibit (10)(l)(iv) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1994, that is incorporated herein by reference.\n(10)(l)(v) Amendment to the Promissory Note to Tell Ertl Family Trust, dated June 1, 1995.\n(10) (m) State of Utah Mineral Lease No. 42360 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(m) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (n) State of Utah Mineral Lease No. 42362 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(n) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (o) State of Utah Mineral Lease No. 42363 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(o) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (p) State of Utah Mineral Lease No. 42477 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(p) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (q) State of Utah Mineral Lease No. 42478 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(q) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (s) State of Utah Mineral Lease No. 42838 assigned to New Paraho, with assignment. Reference is made of Exhibit 10(s) to Registrant's Annual Report on Form 10-K for the Fiscal Year ended June 30, 1990 that is incorporated herein by reference.\n(10) (t) State of Utah Mineral Lease No. 46377 granted to New Paraho.\n(10) (u) State of Utah Mineral Lease No. 46378 granted to New Paraho.\nThe Company will furnish to shareholders a copy of any exhibit upon request and the payment of five cents per page for copying costs.\nPursuant to the requirements of Section 13 or 15(d) of the 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 NEW PARAHO CORPORATION (Registrant)\nBy:\/s\/ Joseph L. Fox Joseph L. Fox President\nDate: September 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\/s\/Joseph L. Fox Principal Executive 9\/28\/95 Joseph L. Fox Officer and Director\n\/s\/Theo Ertl Chairman of the 9\/28\/95 Theo Ertl Board of Directors\n\/s\/Jann Ertl Director 9\/28\/95 Jann Ertl\n\/s\/Jill Ertl Director 9\/28\/95 Jill Ertl\n\/s\/Buff Ertl Palm Director 9\/28\/95 Buff Ertl Palm\n\/s\/Twig Ertl Director 9\/28\/95 Twig Ertl\n\/s\/Larry A. Lukens Director 9\/28\/95 Larry A. Lukens\n\/s\/William Murray, Jr. Director 9\/28\/95 William Murray, Jr.\n\/s\/Adam A. Reeves Director 9\/28\/95 Adam A. Reeves\n\/s\/Peter L. Richard Director 9\/28\/95 Peter L. Richard\n\/s\/Anne M. Smith Controller 9\/28\/95 Anne M. Smith\nEXHIBIT (10)(l)(v)\nJune 1, 1995\nWE, THE UNDERSIGNED, agree that the Promissory Note, between The New Paraho Corporation and the Tell Ertl Family Trust, dated August 29, 1989, and attached hereto, has been amended to state a due date of July 1, 1996, and a total principal amount of $5,500,000.\nTELL ERTL FAMILY TRUST THE NEW PARAHO CORPORATION\nBY \/s\/ Theo Ertl BY \/s\/ Joseph L. Fox Theo Ertl Joseph L. Fox Co-Trustee President","section_15":""}
{"filename":"846876_1995.txt","cik":"846876","year":"1995","section_1":"Item 1. Business.\nGeneral\nPresstek, Inc. (the \"Company\"), which was incorporated in the State of Delaware in September 1987, continues to further develop and market its proprietary, digital imaging technologies and system architectures (the \"Direct Imaging\" technologies), and non-photographic consumables primarily to the graphic arts and related imaging industries. The Company's current Direct Imaging technologies, referred to as PEARL(R) permit the direct digital imaging of printing plates and films which eliminates the need for photosensitive materials and the hazardous waste by-products usually associated with these processes. The Company's system accepts digital PostScript(R)* compatible files from digitally based electronic prepress systems and images the color separated pages directly on to the Company's proprietary non-photographic based consumables.\nPEARL, is a high resolution, high powered semiconductor laser diode imaging technology and is the result of significant past development efforts by the Company. The Company believes that PEARL represents a technological breakthrough for the worldwide printing and publishing industry and has several applications for it and its consumables in the graphic arts industry: a printing press (the \"Direct Imaging Printing Press\") and a stand-alone computer-to-plate imaging device (the \"PEARLsetterTM\"), both of which incorporate the Company's PEARL Direct Imaging technology. PEARL uses its precision, high powered semiconductor laser diode to ablate, or remove the materials from the surface of the Company's plates to produce precisely positioned and formed laser dots at resolutions up to 2540 dots per inch. When these laser dots are combined by the Company's proprietary system (software, firmware and hardware) they form printers' dots from which high quality, lithographic color print images are printed. The graphic arts industry recognizes that the automation and simplification of the color printing process resulting from the use of these types of computer direct-to-plate and direct-to-press devices, will provide significant reductions in the time and cost of multi-color lithographic printing. Therefore, the Company believes the graphic arts industry will move with ever increasing speed towards computer-to-plate imaging devices and computer-to-press printing systems. The Company also believes that its PEARL laser ablation imaging technology's ability to produce high quality\n- ----------\n* PostScript is a registered trademark of Adobe Systems, Inc.\nprinted materials, with freedom from environmental concerns, represents a breakthrough in the expanding market for computer-to-plate\/press products. As a result, the Company believes its past investments in its proprietary PEARL Direct Imaging technology and its years of experience in developing digital imaging systems (software, firmware and hardware) places the Company in a significant position in the markets it has chosen to serve.\nStrategic Alliances\/Proposed New Products\nThe Company continues to pursue a strategy based on alliances and relationships with major corporations in the graphic arts and other industries encompassing licensing, product development and commercialization, manufacturing, marketing, distribution, sales and services. The Company and Heidelberger Druckmaschinen AG (\"Heidelberg\"), the world's largest manufacturer of printing presses and printing equipment, based in Germany, have jointly developed the first Heidelberg Direct Imaging Printing Press (the \"GTO-DI\"). The Company and Heidelberg experienced a wider range of market applications, and greater market acceptance due to the improved image quality of a PEARL equipped GTO-DI press. As a result, the Company's relationship with Heidelberg has been expanded to include a new, four color, fully automated lithographic press, the Quickmaster DI 46-4 (\"Quickmaster DI\") which was jointly designed by the Company and Heidelberg to take full advantage of the Company's improved implementation of its Direct Imaging Technology. The press, which was introduced by Heidelberg in May 1995, has a smaller \"footprint\" than existing four color presses and employs the Company's recently developed automatic plate changing cylinder which eliminates the need for manually changing plates between jobs. This press also employs many other innovations which will result in reduced costs per printed page and contains or employs nine of the Company's patented technologies, some of which have been licensed to Heidelberg. The Company believes that the Quickmaster-DI will be able to compete on jobs requiring as few as 200 sheets per job, while also being able to produce runs in excess of 20,000 sheets at a cost that cannot be equalled by any existing \"on demand\" four color printing system. Both Heidelberg and the Company believe the Quickmaster-DI will greatly expand the use of the Company's Direct Imaging technology and allow a much broader cross section of the graphic arts market to experience the productivity and lower cost benefits of direct-to-press digital, high quality lithographic printing. The Company also has an agreement with the Adast-Adamov Company, a manufacturer of offset lithographic presses. This agreement will result in the use of Company's direct imaging technologies on a larger format (19\" x 26\") multicolor press. This new, large format direct imaging press is being publicly displayed for the first time at the Graphic Communications Tradeshow in Philadelphia on March 28-30, 1996. The Company believes the availability of a\nlarger format direct imaging press will provide a greater number of market applications and will strengthen the Company's position in the direct-to-press market. Currently, the Company is engaged in discussions relating to additional strategic relationships and\/or arrangements focused principally on the PEARLsetter, other Direct Imaging Printing Presses and the manufacture and distribution of the Company's consumables, for these and other applications.\nBackground\nThe Company believes that thermally based computer-to-press imaging devices and computer-to-plate printing systems, free of environmental concerns, will eventually replace photo chemically based imaging systems as the preferred method for providing printing plates in the graphic arts industry. The most current and widely used method for producing color printing plates for the full-color printing process employs desktop computers, which outputs PostScript compatible digital data to a film imaging device, known as a film recorder, or imagesetter. The film recorder is used to expose four pieces of film, each representing a corresponding color separation for yellow, cyan, magenta and black, the subtractive primary colors used in combination to produce process color printing. Each of these unprocessed films must then be developed utilizing photographic chemical developing systems which generate waste effluents that are difficult to dispose of in an environmentally sound manner. The four processed films are then delivered to the printer for imposition, platemaking, and printing. Imposition is a costly, time and labor intensive process preceding platemaking, in which all of the image elements required to maximize the available imaging area of the plate are manually assembled to make the most efficient use of the plate material. Once the components of the press sheet are imposed for each of the four separations, each is then exposed onto separate plates, typically using ultra-violet light sources and vacuum frames to hold the imposed image tightly against the plate material during its exposure cycle. To produce the final printing plates, the exposed plates must then go through a chemical development process similar to that which is used to develop the separation films. This process also produces chemical wastes which must be disposed of in an environmentally sound manner at an ever increasing cost to the printer. The printer then brings the plates to the press, mounts the plates on the press, registers or precisely aligns all four plates one to another, adjusts the ink density and settings, and then, begins the actual printing process on the press. The complex nature of color printing utilizing a conventional press is such that the quality of the printed materials are very dependent on the press operators performing these highly skilled functions.\nIn response to perceived market opportunities for more time and cost-effective color printing; (an opportunity that would encompass taking\nbetter advantage of the growing use of PostScript based digital prepress systems; one that would be less reliant on operator skills and that would be free from chemical processes and environmental concerns,) the Company undertook development of its proprietary Direct Imaging technologies.\nThe original implementation of the Company's Direct Imaging technology employed a complex system of software and hardware. This first generation process imaged or etched the Company's proprietary printing plates by means of discharging an electrical spark (the \"spark discharge\" technology). The spark discharge technology, while lacking in some aspects, was viable enough to allow the Company to develop a business relationship with Heidelberg and apply the spark discharge technology on an initial product offering introduced in September 1991, the Heidelberg GTO-DI. The GTO-DI was initially introduced by Heidelberg at Print '91. In 1992, the Company began shipping to Heidelberg spark discharge based DI Kits for integration into GTO presses. The resultant GTO-DI's were used by Heidelberg distributors for customer sales as well as for shows and demonstrations worldwide.\nThe Company realized that the use of a laser based imaging concept as a replacement for its spark discharge technology held the promise of significantly improved image quality. In response to the market's demand for higher quality printed materials, even in the short-run markets, the Company developed its high resolution semiconductor laser diode based imaging technology, PEARL. In 1993, the Company introduced its PEARL Direct Imaging Technology. This second generation technology is based on the same concept as the spark discharge technology which, under computer control, burns away the surface of the plate material except that it employs the use of an infrared semiconductor laser in place of the spark discharge. This second generation PEARL technology completely replaced the Company's prior spark discharge technology.\nThe GTO-DI was reintroduced by Heidelberg with PEARL in September 1993. The Company began shipping initial kits necessary to install the PEARL Imaging System on the GTO-DI to Heidelberg in September 1993, with full production commencing in February 1994. The Company believes that its PEARL Direct Imaging technologies as implemented on the GTO-DI has been well accepted by the market, which includes commercial printers, color service bureaus, digital on-demand print shops and corporate in-house plants.\nThe Company believes the radically different press design of the Quickmaster-DI, in concert with the Company's third generation of Direct Imaging technology targeted towards the growing short run process color print market has been well received by the print industry. The product won the 1995 Intertech New Technology award and in February 1996 two Seybold Editors' Awards at Seybolds\n16th Annual Boston Seminars Conference oriented towards the printing and publishing market. One award was made to the Company for it PEARL Direct Imaging Technology and one to Heidelberg for the Quickmaster DI. The Company also received the National Association of Printers and Lithographers Award for the contribution its Direct Imaging Technology has made to the printing industry.\nThe Company's PEARL Direct Imaging Technology System and Consumables\nThe Company's PEARL Direct Imaging technology is part of the PEARL imaging system for producing imaged color printing plates and nonphotosensitive films in a simple one-step process (the \"PEARL Imaging System\"). The primary elements of the PEARL Imaging System are:\n(i) DI Server Computer - which accepts, stores and allows for viewing the bitmapped files of the digital page and then transmits that data to implement the imaging function. The DI Server consists of either a Pentium(R)* or a DEC Alpha(R)** based computer, image capture software, viewing software and memory.\n(ii) The Imaging Computer - communicates with the DI Server to receive, store and implement the imaging function.\n(iii) Imaging heads - consist of the semi-conductor laser diodes and drivers, lens assembly, precision carriage assembly and chiller systems.\n(iv) Consumables - consist of wet and dry aluminum based printing plates and wet and dry polyester based printing plates.\nThe Direct Imaging Press\nThe Direct Imaging Printing Press automates or eliminates most of the intermediate processes and steps necessary for full color printing, including many of the highly skilled functions required to prepare the press. The plates are imaged in register directly on the press. After the plates are wiped either automatically or manually, an operator can begin the printing process. The use of dry offset plates in the printing process eliminates the need for the chemical dampening solution and its required balancing. Proper ink density is automatically pre-set by the computer. The Company and its licensees typically jointly develop and\/or work together on the development of the press. The Company, as more fully described below, supplies hardware components and subassemblies and software necessary for\n- ---------- * Pentium is a registered trademark of Intel Corp.\n** Alpha is a registered trademark of Digital Equipment Corporation.\ninstallation of PEARL Imaging Systems (the \"PEARL Kits\") into two, four and five color presses. The advantages and features of the direct imaging presses include:\no the ability to accept and buffer the bitmapped image data of fully composed pages, particularly those utilizing postscript interpreters;\no imaging on-press of all two, four or five plates simultaneously;\no imaging of the plates directly on the plate cylinders, in register (i.e., the fitting of two or more printing images in precise alignment with each other);\no elimination of the need for plate development processes, by-products of which cause environmental concerns;\no the imaged plates are waterless, therefore eliminating the need of the chemical dampening solution and its required balancing; and\no automatic pre-setting of the ink keys from the bitmap already resident in the computer.\nAs a result, process color offset lithographic printing can be produced with fewer complex steps and at a lower cost than in the case of other conventional color printing methods. The time savings in producing four color work would permit a printer to perform a greater number of printing jobs per day more cost effectively with less waste.\nFurther, by accepting the digital data directly from a prepress page layout system, the user of a press equipped with the Company's direct imaging benefits from the efficiency and cost advantages of electronic page make up and, by extending the use of digital data to the printing process, permits a closure of the digital loop in the production of color printing.\nThe Company believes that its PEARL based direct imaging computer-to-press technology with PEARL has been well received by the industry. By the end of 1995 the Company had shipped 211 of its PEARL Imaging Kits.\nPresstek Consumables\nThe Company has and continues to develop its proprietary, thermally based consumables that are imaged by its PEARL semiconductor laser diode imaging technology. As part of the PEARL laser diode development process the Company has\nincreased the number, types and functional characteristics of its consumable products. These consumables currently include a polyester based dry printing plate, a polyester based wet printing plate, an aluminum based dry printing plate and an aluminum based wet printing plate. There are additional consumable products in various stages of development including a non-photosensitive film which may, in the future, provide new sources of consumable revenues.\nThe Company has developed and is currently having manufactured by Rexham Industries Corp (\"Rexham\"), a custom maker of precision films based in North Carolina, both the polyester- and aluminum-based dry and wet offset printing plates. The Company believes that wet offset plates imaged by its PEARL Direct Imaging technology have applications for use on the large installed base of existing printing presses. This population of printing presses operates with a dampening system which requires wet offset printing plates. The Company has also developed a prototype non-photosensitive film that it believes has market applications imaged by its PEARL Direct Imaging technology. Although the Company believes that it can complete the development and commercialization of the polyester and aluminum based wet offset printing plates and its non-photosensitive film and other consumable products, there can be no assurances that it can do so.\nThe Company, realizing that sources for the Company's requirements for current and new PEARL consumables, plates and films, would have to be found, in February 1996 acquired 90% of the outstanding common stock (the \"Purchased Shares\") of Catalina Coatings, Inc. (\"Catalina\"), an Arizona corporation engaged in the development, manufacture and sale of vacuum deposition coating equipment and the licensing and sublicensing of patent rights with respect to a vapor deposition process to coat moving webs of materials at high speeds. The aggregate consideration paid by the Company pursuant to the Stock Purchase Agreement was $8,400,000, of which $8,200,000 represented the purchase price of the Purchased Shares and $200,000 represented consideration for the non-competition and confidentiality covenants of two of the principal shareholders of Catalina who sold their shares to the Company. During the fiscal year ended December 31, 1995, Catalina, a Subchapter S corporation, achieved net income of approximately $1,542,000 on revenues of approximately $5,400,000.\nThe Company intends that Catalina, which operates as a subsidiary of the Company, will develop the equipment the Company needs to manufacture its PEARL thermal printing plates and films in a more cost effective manner than using currently available conventional technology. Even if Catalina commences manufacturing of PEARL thermal printing plates and films the Company may still need to enter into manufacturing arrangements with third parties. The Company is currently engaged in discussions with certain other parties relating to entering\ninto strategic alliances, arrangements or relationships with respect to the manufacture and\/or the distribution of the Company's PEARL consumables. There can be no assurance that the Company will be able to enter into any arrangements for the manufacturing of its consumables, or that such arrangements will result in successful commercial products. Additionally, there can be no assurance that the Company through Catalina will be able to successfully complete the development and undertake the manufacture of the PEARL consumables.\nDirect Imaging Printing Press\nIn January 1991, the Company entered into a master agreement (the \"Master Agreement\"), a technology license agreement (the \"Technology License\") and a supply agreement (the \"Supply Agreement\") (the foregoing agreements being sometimes collectively referred to herein as the \"Heidelberg Agreements\")with Heidelberg. Pursuant to this series of related agreements, the Company and Heidelberg agreed to certain terms relating to the integration of the Direct Imaging technology into various presses manufactured by Heidelberg and certain of its related parties (the \"Heidelberg Presses\") and the manufacture of components for and the commercialization of such presses. The Master Agreement supersedes certain prior agreements between the Company and Heidelberg.\nPursuant to the Heidelberg Agreements, the Company granted Heidelberg certain exclusive rights, relating to the Company's spark discharge technology subject to the satisfaction of certain conditions, for use of the Direct Imaging Technology in Heidelberg Presses. In consideration for such rights, Heidelberg agreed to pay to the Company royalties on the net sales prices of various specified types of Heidelberg Presses. Heidelberg's exclusive rights with respect to the different categories of Heidelberg Presses are conditioned upon Heidelberg undertaking specified development efforts on a timely basis, paying certain minimum royalties during specified initial periods and satisfying continuing product sale conditions. These original agreements have been modified by the parties from time to time.\nThe Heidelberg Agreements further provided for the Company to supply D.I. Kits to Heidelberg at specified rates. The terms of the Heidelberg agreements are for periods ending in December 2011 in the case of each of the Master Agreement and Technology License and December 1995 in the case of the Supply Agreement. The Supply Agreement related primarily to the GTO-DI which is no longer manufactured. The Heidelberg Agreements also contain, among other things, certain early termination provisions and extension provisions.\nOn September 3, 1992, the Company and Heidelberg signed a contract modification agreement that details arrangements with\nrespect to the development of additional products planned to be introduced in the future.\nOn April 27, 1993, the Company and Heidelberg signed a contract modification agreement that details the arrangements with respect to Heidelberg's licensing of the Company's PEARL Direct Imaging technology, which was not otherwise encompassed within the prior arrangements.\nThe Company has also subsequently granted Heidelberg a forty-five month exclusive license for the manufacture and sale of the Quickmaster -DI which uses PEARL technology. Certain other modifications have been made to the exclusive arrangements under the previous agreements between Heidelberg and the Company which provide for a non-exclusive license for the balance of the term of the original agreement.\nOn February 4, 1994, the Company announced an agreement with Heidelberg that provided for the Company to receive $4,180,000 during 1994 for engineering services performed by the Company for joint development projects during 1994. This agreement was subsequently modified and resulted in increasing the engineering services performed by the Company. This change resulted in Heidelberg agreeing to pay an additional $1,499,400 through June 1995 for these incremental services related to these joint development projects. PEARL Imaging Systems manufactured by the Company for Heidelberg, for the GTO-DI and the Quickmaster DI, represent additional revenue to the Company. Additionally, the Company receives a royalty payment for certain presses shipped by Heidelberg which contains Presstek's PEARL imaging technology.\nIn November 1995 the Company and Heidleberg agreed to certain other arrangements whereby the Company was provided with incremental engineering revenue, certain price increases, and modifications of the Quickmaster DI royalty billing and payment terms by Heidelberg. These arrangements were made as a result of a schedule change requested by Heidelberg for the PEARL imaging systems manufactured by the Company for Heidelberg. The Company also provided Heidelberg with a fixed royalty rate on the Quickmaster DI.\nThe PEARL Platesetter\nThe PEARL Platesetter, now referred to as the PEARLsetterTM is an additional application of the Company's PEARL Direct Imaging technology and consumables. The PEARLsetter is a computer-to-plate imaging device that will be able to image both the Company's wet and dry offset plates. The Company also anticipates that the PEARLsetter will have applications in the larger format\nsize markets as well and provides the product in both an A3 (2-up) and A2 (4-up) format size.\nThe PEARLsetter directly accepts the digital page layout data from a prepress system and utilizing its high powered semiconductor laser diodes, produces a precisely shaped and located laser dot. The imaged plates require no further processing, other than wiping the ablated debris from the imaging process off the plates, and accordingly, do not create chemical waste which must be disposed of. The plates can then be immediately mounted and registered on the press.\nThe Company has entered into distribution agreements with the Pitman Company in the United States, KNP-BT in certain European countries and Heidelberg Australia in Australia and New Zealand. Those agreements provide for the exclusive distribution of the Company's PEARLsetter product line and its PEARL based consumables. The Company has also entered into OEM relationships with Sakurai Machinery Company and Heath Custom Press for the resale of its PEARLsetter product under private label by these companies. The Company is also currently engaged in additional discussions with certain other parties relating to entering into strategic alliances and OEM arrangements or relationships with respect to the PEARLsetter product line and its PEARL based consumables. To maximize the anticipated beneficial effects to it, the Company has continued independent development and commercialization of one or more PEARLsetter products. There can be no assurance that the Company will be able to enter into any additional arrangements with respect to, or that any such arrangements will result in, the successful commercialization of additional PEARLsetter products. Additionally, there can be no assurance that the Company will have the resources or otherwise be able to successfully complete development and undertake the manufacture of, or successfully commercialize, additional PEARLsetter products.\nManufacturing, Marketing Component Procurement\nThe Company engages in certain manufacturing, as described below, and also is engaged in the distribution and sales of PEARL based offset printing plates, which are manufactured exclusively for the Company by third parties. In addition, the Company engages in certain marketing activities which include informing the industry of the Company's products and capabilities; contacting potential strategic partners; establishing relationships with potential resellers including both OEM partners and dealers; establishing liaisons with companies which manufacture and\/or market products which may incorporate the Company's PEARL Direct Imaging Technology, or jointly develop new applications of the Company's vast intellectual property portfolio. The Company also provides Heidelberg and its other licensees and distribution partners with worldwide marketing and sales support.\nThe Company's agreements provide, among other things, for it to supply its PEARL Imaging Systems for integration into certain printing presses. In November 1994, the Company announced the start of operations in a new 36,000 square foot manufacturing facility located adjacent to its existing headquarters and engineering offices. These increased facilities, which have now been completed, were required based on both existing and projected manufacturing requirements for PEARL Imaging Systems or other similar items which are or may be manufactured by the Company in the future. Given sufficient time, the Company believes that it has the available resources and personnel with the knowledge and experience to further increase its manufacturing capacity to satisfy any future product demand.\nThe Company obtains certain components and supplies used in production of PEARL Imaging Systems from a number of suppliers. Although the Company believes that there are available various sources for necessary components, parts and disposable items (including printing plates and inks) for both the Company's manufacturing activities and to support the market for products incorporating the Company's PEARL Direct Imaging technology, sources for certain of such items are limited and there can be no assurance that procurement or supply arrangements will be available on satisfactory terms; any inability to establish satisfactory manufacturing or procurement or supply arrangements or significant delays in establishing such arrangements could have an adverse effect on the Company and\/or cause delays in the Company's ability to deliver products incorporating its PEARL Imaging Technology.\nThe PEARL laser diode system includes semiconductor laser diodes. Although the Company currently uses only one source for the laser diode devices, it believes that there will be several sources available to manufacture the laser diodes to the Company's specification, if required, in the future. Additionally, the Company has \"in-house\", limited laser diode manufacturing capabilities. The Company would still require the submounted \"diode chips,\" a component of the laser diode, to be supplied by a third party. The Company believes that several sources are available to supply this component, if required. The Company's laser diode manufacturing capabilities currently function principally for research and development, quality assurance and manufacturing engineering. However, the Company believes that, if required, it could expand these facilities in the future as a primary or secondary source.\nThe Company has developed and continues to develop proprietary consumables that are imaged or ablated by its PEARL semiconductor laser diode imaging technology as well as other thermally based direct-to plate systems. As part of the PEARL laser diode development process the Company has increased the number, types and functional characteristics of the consumable products it has under\ndevelopment or which are currently being manufactured. These consumables currently include a polyester based dry printing plate, a polyester based wet printing plate, an aluminum based dry printing plate, an aluminum based wet printing plate and a non-photosensitive film. There are additional consumable products in various stages of development which may, in the future, provide new sources of consumable revenues. The Company's PEARL offset printing plates, both aluminum and polyester based are being supplied by Rexham. The Company, realizing that sources for the Company's requirements for current and new PEARL consumables, plates and films, would have to be found, in February 1996 acquired Catalina. The Company anticipates that Catalina, which operates as a subsidiary of the Company, will develop the equipment the Company needs to manufacture its PEARL thermal printing plates and films [which are currently manufactured by third parties] in a more cost effective manner than using currently available conventional technology. However, even if Catalina commences manufacture of PEARL thermal printing plates and consummables, additional sources to satisfy all of the Company's requirements for current and new consumables, printing plates and films, may have to be found. Therefore, the Company is actively pursuing these additional sources at this time. However, there can be no assurance that the Company will be able to enter into any arrangements for the volume manufacturing of its consumables, or that any such arrangement will result in successful commercial products.\nThe Company currently anticipates that the PEARLsetter will continue to be marketed through traditional graphic arts distribution sales channels and will be positioned as an alternative to existing imagesetter or platesetter products.\nMarket acceptance for any products incorporating the Company's technology will require substantial marketing efforts and expenditure of significant sums, either by the Company, its strategic partners or both. There can be no assurance that any existing products will continue to achieve market acceptance or that any new product that may be introduce will achieve market acceptance or be commercially viable.\nDevelopment Program\nDuring the years ended December 31, 1993, 1994, and December 30, 1995, the Company expended $5,647,000, $5,123,000 and $6,155,000 respectively, on engineering and product development. The Company is currently concentrating its development efforts on refining and improving the performance of its current and future technologies, and proprietary printing plates and anticipates that it will continue to do so, both independently and in conjunction with strategic partners. The Company is also engaged in continuing development efforts with respect to its PEARLsetter product line. There can be no assurance that the\nCompany, in conjunction with a strategic partner or independently, will successfully complete development of any additional marketable products, or that technical or other problems will not occur in connection with the Company's development program, products or technology.\nPatents and Proprietary Rights\nAs of March 1, 1996, the Company has been issued forty-three (43) U.S. patents, five (5) Canadian patents and one (1) European patent and has received notice of allowance for three (3) European patents. The Company has applied for twenty-two (22) additional U.S. patents and seventy-three (73) foreign patents and anticipates that it will apply for additional patents and for copyrights, as deemed appropriate. There can be no assurance as to the issuance of any such patents or the breadth or degree of protection which the Company's patents or copyrights may afford the Company. There is rapid technological development in the computer and image reproduction industries, resulting in extensive patent filings and a rapid rate of issuance of new patents. Although the Company believes that its technology has been independently developed and that the products it markets and proposes to market will not infringe the patents or violate other proprietary rights of others, it is possible that such infringement of existing or future patents or violation of proprietary rights may occur. In such event the Company may be required to modify its design or obtain a license. No assurance can be given that the Company will be able to do so in a timely manner, upon acceptable terms and conditions, or at all. The failure to do any of the foregoing could have a material adverse effect on the Company. Furthermore, there can be no assurance that the Company will have the financial or other resources necessary to successfully defend a patent infringement or proprietary rights violation action. Moreover, the Company may be unable, for financial or other reasons, to enforce its rights under any of its patents.\nThe Company also intends to rely on proprietary know-how and to employ various methods to protect the source codes, concepts, ideas and documentation of its proprietary software, which methods may include copyrights. However, such methods may not afford complete protection and there can be no assurance that others will not independently develop such know-how or obtain access to the Company's know-how or software codes, concepts, ideas and documentation. Furthermore, although the Company has and expects to have confidentiality agreements with its employees and appropriate vendors, there can be no assurance that such arrangements will adequately protect the Company's trade secrets.\nCompetition\nThe Company believes that its developed and proprietary technologies, its alliance with Heidelberg, the world's largest printing press manufacturer; and\nother press manufacturing companies and graphic arts distribution organizations and its established presence in the direct imaging market provide the Company with a competitive advantage.\nThe Company is aware of several companies employing electrophotography as their imaging technology. Electrophotography, sometimes referred to as xerography, is a technology which historically has been used primarily in black and white copiers. Canon was the first company to successfully employ electrophotography in a full color copier product, the CLC 500.\nIndigo N.V., a company with research and development, and manufacturing operations in Israel, introduced their digital, sheet-fed offset color press, the E-Print 1000 in September 1993. The E-Print 1000 utilizes an electrophotographic imaging technology, with a liquid toner, and prints at 800 dots per inch. The E-Print 1000 sells for approximately $450,000. Xeikon, N.V. of Belgium also introduced their digital, web-(roll)fed color printing product, the Xeikon DCP-1 in September, 1993. The Xeikon DCP-1, a version of which is also being marketed by Agfa Gevaert as the Chromopress, also utilizes an electrophotographic imaging technology with a dry toner and prints a variable dot density of 600 dots per inch. The Chromopress is reported to sell for between $350,000 and $400,000.\nCanon and Xerox Corp. are two major corporations which have also developed and introduced color electrophotographic copier products that could impact the very short-run digital color printing markets. Canon has at least two color copier products which it claims provide improved print quality even at their resolution limitation of 400 dots per inch. They also claim faster speeds. Xerox also has a color copier which it is currently marketing. Additionally, the Company is aware of two companies, XMX Corporation and Delphax that have publicly announced their intentions of developing their own proprietary technological solutions for digital color printing. Scitex Corp. has also introduced its Spontane xerographic based color imaging system which uses a xerographic color copier engine supplied by Fuji Xerox.\nThe Company is also aware that there is a direction in the graphic arts industry to create stand-alone computer-to-plate imaging devices for single and multi-color applications. The Company anticipates that most of the major corporations in the graphic arts industry have or are considering a computer-to-plate imaging device. To date, these devices, for the most part, utilize printing plates that require a post imaging photochemical developing step, and in some cases, also require a heating process. This is, nonetheless, an important step in the printing industry, as it eliminates the use of films. Potential competitors in this area would include, among others, Creo Products, Gerber Scientific Inc., Misomex, Optronics, a Division of Intergraph Corporation, Komori, Krause, Scitex Corporation\nLtd., Linotype-Hell, Kodak, Dai Nippon Screen, Crossfield, a Division of Dupont, Agfa-Gevaert, Polaroid Corp. and Sony Corp. The Company's stand-alone computer-to-plate imagesetter is, in the Company's opinion, a further technological advancement. The Company's computer-to-plate imagesetter eliminates not only the films, but also the post-imaging photochemical developing steps. The Company believes that other graphic arts companies, such as those stated above, are likely to be working on similar plate imaging processes that would also eliminate the production of the hazardous materials associated with the photochemical developing process.\nThe Company also anticipates competition from printing plate manufacturing companies that either manufacture, or have the potential to manufacture digital plates. Such companies include Agfa-Gevaert, Polychrome Corp., a Division of Dai Nippon Ink & Chemicals, Inc., Toray, Howsen, a Division of Dupont, Horsell\/Anitec, a Division of International Paper, Kodak, Polaroid Corp., Mitsubishi, Fuji Photo Film Co., Ltd. and Minnesota Mining & Mfg. Co.\nProducts incorporating Direct Imaging technology can also be expected to face competition from conventional presses and products utilizing existing platemaking technology, as well as presses and other products utilizing new technologies. Leading press manufacturers include Heidelberg, Komori Printing Machinery Co., Ltd., Mitsubishi, and MAN Roland, and, in the single color and two color press market, Ryobi Limited, Hamada and AB Dick. Companies marketing conventional imagesetter equipment include Agfa, Linotype-Hell, ECRM, Optronics, Crossfield and Scitex Corporation Ltd. Other companies, which may include such major corporations as International Business Machines Corporation, Xerox Corporation, Polaroid Corp., Canon and Kodak, are considered by the Company to have the type of electronic and image reproduction expertise which could encourage them to attempt to develop and market competitive products.\nMost of the companies marketing competitive products or with the potential to do so are well established, have substantially greater financial and other resources than the Company and have established records in the development, sale and service of products. There can be no assurance that the Company, any Company product or any products incorporating the Company's technology will be able to compete successfully in the future.\nBacklog\nAs of February 29, 1996 the Company had a backlog of products under contract aggregating approximately $16,822,000 (including royalties payable to\nthe Company) compared to a backlog of $2,800,000 as of February 28, 1995 (including royalties payable to the Company).\nEmployees\nAs of February 29, 1996, the Company had one hundred and five (105) employees, fifty four (54) of whom, including Richard A. Williams and Robert E. Verrando, the Company's Chief Executive Officer and President, respectively, are engaged primarily in engineering, service and marketing; forty (40) of whom are engaged primarily in manufacturing, manufacturing engineering and quality control; and eleven (11) of whom are engaged primarily in corporate management, administration and finance. The Company considers its relationship with its employees to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company leases approximately 24,000 square feet of space at 8 Commercial Street, Hudson, New Hampshire. The lease of these premises, which expires in March 1996, subject to three one-year renewal options, provides for rent at the rate of $8,693 per month plus a pro rata share of real estate taxes, utilities and certain other expenses. During May 1994, the Company entered into a three year lease agreement (which was amended in December 1994, effective January 1, 1995) for approximately 36,000 square feet to accommodate its manufacturing facilities. The lease, as amended, specifies a fixed base monthly rent of $11,250, plus a pro rata share of real estate taxes, utilities, and certain other expenses. The lease contains an option to renew for an additional three years and a right of first refusal to purchase the property.\nThe Company believes that its existing facilities are adequate for its existing operations. To the extent that the Company is required to increase its manufacturing capacity, the Company believes that additional space is readily available in the vicinity of its existing facilities.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn April 1995 the Company commenced an action against Agfa-Gevaert, N.V. (\"Agfa\") in the U.S. District Court for the District of New Hampshire alleging that Agfa violated provisions of a confidentiality agreement and a manufacturing agreement (the \"Manufacturing Agreement\") between the parties and misappropriated certain trade secrets of the Company. In June 1995, Agfa commenced an arbitration proceeding against the Company in the International Chamber of Commerce in which it seeks arbitration of the disputes between the parties arising from the Manufacturing Agreement and also seeks to have the\ntrade secret issues determined in arbitration. In its request for arbitration Agfa has, among other things, charged Presstek with breaches of the Manufacturing Agreement, good faith and fair dealing, and is seeking damages in an amount alleged to be $2,000,000. The action commenced by the Company in District Court has been stayed to allow the arbitrators to determine the issues in dispute between the parties.\nThe Company has vigorously pursued its claims against Agfa and intends to vigorously contest Agfa's assertions of breach of the Manufacturing Agreement and other claims. Although the Company and its counsel believes that an unfavorable outcome of the litigation and arbitration is unlikely, there can be no assurance as to the outcome of the proceedings.\nThe Company has been advised that the Securities and Exchange Commission (the \"Commission\") has entered a formal order of private investigation with respect to certain activities by certain unnamed persons and entities in connection with the securities of the Company. In that connection, the Company has received subpoenas duces tecum requesting it to produce certain documents and has complied with the requests. The Company has not been advised by the Staff of the Commission that the Staff intends to recommend to the Commission that it initiate a proceeding against the Company in connection with the foregoing investigation.\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 has traded in the over-the-counter market on the NASDAQ National Market System under the symbol PRST since July 18, 1990 and, prior thereto, from May 11, 1990 to July 17, 1990, traded on the NASDAQ System. Prior thereto, from the Company's initial public offering until May 11, 1990, the principal redemption date of the Warrants, the Company's Units, Common Stock and Warrants were traded on the NASDAQ System. The following table sets forth, for the periods indicated, the high and low sales prices of the Company's Common Stock as reported by NASDAQ and retroactively adjusted for the Company's five for four stock split effected in the form a 25% stock dividend paid in September 1994 and the Company's two for one stock split effected in the form of a 100% stock divided paid in May 1995.\nYear Ended High Low December 31, 1994 ---- --- - -----------------\nFirst Quarter $14 5\/8 $10 5\/8\nSecond Quarter 13 7 3\/8\nThird Quarter 25 12 3\/4\nFourth Quarter 25 7\/8 16\nYear Ended December 31, 1995 - -----------------\nFirst Quarter $37 1\/8 $21 1\/2\nSecond Quarter 62 1\/2 23 1\/2\nThird Quarter 63 49 1\/2\nFourth Quarter 100 38 1\/2\nAs of March 13, 1996, there were approximately 1,200 holders of record of the Company's Common Stock. The Company believes that, in addition, there are in excess of 500 beneficial owners of its Common Stock whose shares are held in \"street name.\"\nDividend Policy\nTo date, the Company has not paid any cash dividends on its Common Stock. The payment of cash dividends, if any, in the future is within the discretion of the Company's 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 cash dividends in the foreseeable future, but instead intends to retain all earnings, if any, 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 has been derived from the financial statements of the Company appearing elsewhere herein (except for the statement of operations data for the years ended December 31, 1991 and 1992 and the balance sheet data at December 31, 1991, 1992 and 1993 which is not included in such financial statements). All references to average number of shares outstanding and per share data have been restated retroactively to reflect the five-for-four and two-for-one stock splits effected in the form of stock dividends.\nBalance Sheet Data:\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nThe Company was organized as a Delaware corporation on September 3, 1987 and was a development stage company through 1991. In September 1991, Heidelberger Druckmaschinen A.G. (\"Heidelberg\"), the world's largest printing press manufacturer introduced the Company's initial spark discharge based imaging technology, in a jointly developed product, the Heidelberg GTO-DI. In 1993, after investing substantial effort and resources, the Company completed the development of PEARL, a patented, proprietary, nonphotographic, toxic-free, digital imaging and printing plate technology for the printing and graphic arts industries. PEARL's laser diode technology is capable of imaging various types of Presstek printing plates either off-press or on-press which may then be used to produce high-quality, full-color lithographic printed materials at what the Company believes is a lower cost than competitive processes. PEARL has completely replaced the Company's spark discharge technology. The GTO-DI was re-introduced in September 1993, utilizing PEARL as its Direct Imaging technology and the Company is now building an installed base of customers which utilizes its proprietary consumable printing plates on PEARL equipped Heidelberg presses. The Company's relationship with Heidelberg has been expanded to include the development and manufacture of Direct Imaging Kits to be utilized in Heidelberg's new four color, fully automated lithographic press, the Quickmaster DI 46-4. This press was introduced in May of 1995 at DRUPA '95, the industry's largest trade show, and was well received. Shipments of production kits to Heidelberg for use in the Quickmaster commenced in the second quarter of 1995. This new press incorporates certain improvements to the Company's PEARL Direct Imaging technologies and employs the Company's recently developed automatic plate changing cylinder which eliminates the need for manually changing plates between jobs. The Company is also engaged in the development of additional products and applications that incorporate the use of its proprietary technologies and consumables, including both computer-to-plate and computer-to-press applications. Some of these additional activities have resulted in an agreement with the Adast Adamov Company, another manufacturer of sheet fed offset presses. This new agreement will result in the availability of the Company's PEARL Direct Imaging Technology on a larger format Omni-Adast (19\" x 26\") multicolor press, the first showing of which will occur at an industry trade show to be held on March 28, 1996.\nOn June 19, 1995, the Company's Board of Directors determined to change its fiscal year from a calendar year ending December 31 to a fiscal year ending on the Saturday closest to\nDecember 31; accordingly, the 1995 fiscal year ended on December 30. Fiscal 1993, 1994, and 1995 each reflect 52 week periods.\nOn August 2, 1994, the Company's Board of Directors authorized a five-for-four stock split, effected in the form of a 25% stock dividend, during the third quarter of 1994. The split resulted in the issuance of 1,410,235 new shares of common stock.\nOn April 19, 1995, the Company's Board of Directors authorized a two-for-one stock split, effected in the form of a 100% stock dividend, during the second quarter of 1995. The split resulted in the issuance of 7,275,972 new shares of common stock.\nRevenues\nRevenues for the years ended December 30, 1995, and December 31, 1994 and 1993 of approximately $27,611,000, $16,518,000 and $11,682,000, respectively, consisted primarily of product sales, royalties, fees and other reimbursements earned under the Company's agreements with Heidelberg. Revenues increased $11,093,000 (67%) comparing 1995 with 1994. Product sales increased $10,567,000 over 1994, principally as a result of increased sales of the Company's PEARL on-press direct imaging technology, used in Heidelberg's GTO-DI and Quickmaster DI 46-4, and consumable printing plates. Revenues from royalty and fees for the year ended December 30, 1995 increased $527,000 compared to 1994 as a result of an increase of $3,595,000 in royalties earned on product sales and a decrease of $3,068,000 in engineering fees and other revenues. Revenues from royalties and fees for the year ended December 31, 1994 decreased $3,499,000 compared to 1993, as a result of modifications to the Company's agreements with Heidelberg and in part because the majority of the early shipments of PEARL systems were to retrofit existing spark discharge technology GTO-DI machines which did not result in additional royalties to the Company. At this time, the Company relies on Heidelberg to generate substantially all of its revenues.\nCosts of Products Sold\nCosts of products sold for the years ended December 30, 1995, December 31, 1994 and 1993 of approximately $14,924,000, $6,944,000, $755,000, respectively, consisted of the material, labor, and overhead costs associated with product sales, as well as anticipated future warranty costs.\nEngineering and Product Development\nEngineering and product development expenses were $6,155,000 for the year ended December 30, 1995, as compared to\n$5,123,000 for the year ended December 31, 1994. The increase in such expenses of $1,032,000 (20%) resulted principally from increased expenditures for parts, supplies and labor related to the Company's PEARL technology as well as other product development efforts and matters relating to the Company's technologies.\nEngineering and product development expenses totaled $5,123,000 for the year ended December 31, 1994, compared to $5,648,000 for 1993. This decrease in such expenses of $525,000 (9%) resulted principally from the reassignment of personnel from engineering and development functions to manufacturing functions in response to the commencement of shipments of the PEARL laser imaging systems.\nMarketing\nMarketing expenses were $1,727,000 for the year ended December 30, 1995, as compared to $1,226,000 for the year ended December 31, 1994, an increase of $501,000 (41%). The increase related principally to increased expenditures for additional personnel and related costs as well as various promotional activities which included one time DRUPA '95 trade show expenses incurred principally during the second quarter of 1995.\nMarketing expenses of $1,226,000 for 1994 increased by 7% when compared with 1993 primarily due to increased travel and related expenses of marketing personnel.\nGeneral and Administrative\nFor the year ended December 30, 1995, general and administrative expenses were $2,050,000, an increase of 28% over 1994. For the year ended December 31, 1994, general and administrative expenses increased by 5% over 1993 to $1,604,000. The increased expenses in 1995 and 1994 related principally to increased expenditures for salaries and other costs required to conduct various general and administrative functions for the Company.\nNonrecurring Charge\nThe 1993 results include a $1,949,000 nonrecurring charge associated with the Company's fundamental change from spark discharge technology to its newly developed PEARL technology. The termination of shipments of units incorporating the spark discharge technology dictated that certain assets associated with the earlier imaging process be written off, and that reserves be established for the transition to PEARL technology. The individual elements making up the charge consisted of write offs of property and equipment, inventory, and\npatent application costs of $613,000, $546,000, and $294,000, respectively, and a reserve of $496,000 for certain estimated costs required to retrofit existing customer equipment. The reserve was fully utilized as of December 30, 1995.\nNet Income\nAs a result of the foregoing, the Company had net income of $2,860,000 for the year ended December 30, 1995 compared to net income of $1,842,000 and $960,000 for the years ended December 31, 1994 and 1993, respectively.\nLiquidity and Capital Resources\nAt December 30, 1995, the Company had working capital of $16,837,000, an increase of $9,161,000 as compared to working capital of $7,676,000 at December 31, 1994. This increase was primarily attributable to net income from operations of $2,860,000; noncash items of depreciation and amortization of $998,000, and the state tax benefit of disposition of stock options of $176,000; sales, maturities and reclassifications of noncurrent marketable securities of $5,004,000 and proceeds from issuances of common stock and sales of equipment of $3,022,000 and $76,000, respectively, offset by additions to property and equipment and other assets of $2,387,000 and $561,000, respectively. In February 1996 the Company raised $20,200,000 through the sale of approximately 283,000 shares of common stock, of which approximately $8,200,000 was used to acquire the Catalina Shares, $200,000 was used to pay for the non-compete and confidentiality covenants of two of Catalina's selling stockholders.\nNet cash used for operating activities of $234,000 for the year ended December 30, 1995, resulted principally from increases in accounts receivable and inventory of $3,759,000 and $3,165,000, respectively, offset by net income from operations of $2,860,000 plus noncash items of depreciation and amortization, the provision for warranty costs and the tax benefit of disposition of stock options of $998,000, $916,000, and $176,000, respectively, a decrease in other current assets of $407,000 and increases in accounts payable and accrued expenses totaling $1,333,000.\nNet cash used for investing activities of $693,000 for the year ended December 30, 1995, resulted principally from the additions to property and equipment used in the Company's business of $2,387,000 and increases in other assets of $561,000, offset by proceeds from the sales and maturities of marketable securities of $2,180,000 and the proceeds from the sale of equipment of $76,000.\nNet cash provided by financing activities during the year ended December 30, 1995, consisted of $3,022,000 received from the sale of common stock incident to the exercise of various stock options and warrants.\nThe Company's agreements with Heidelberg provide that during 1996 the Company will receive certain royalty payments and be reimbursed for certain engineering and development work provided to Heidelberg.\nThe Company estimates that existing funds and the funds generated under its agreements with Heidelberg will be sufficient to satisfy its anticipated cash requirements for the foreseeable future.\nEffect of Inflation\nInflation has not had, and is not expected to have, a material impact upon the Company's operations.\nRecently Issued Accounting Standards\nThe Financial Accounting Standards Accounting Board (\"FASB\") has issued Statement of Financial Accounting Standards No. 121: \"Accounting for the Impairment of Long-Lived Assets to be Disposed Of\" (\"SFAS 121\") which is effective for fiscal years beginning after December 15, 1995. No write down of assets have been necessary through the fiscal year ended December 30, 1995 as a result of the Company's adoption of SFAS 121. See Note 2 of Notes to the Financial Statements.\nThe FASB has also issued Financial Accounting Standards No. 123 (\"\"SFAS 123\"): \"Accounting for Stock-Based Compensation\" which is effective for transactions entered into in fiscal years beginning after December 15, 1995. The Company currently does not intend to adopt the fair value method of accounting for stock compensation plans as permitted by SFAS 123.\nNet Operating Loss Carryforwards\nAs of December 30, 1995, the Company had net operating loss carryforwards totaling approximately $16,500,000 resulting from compensation deductions relative to stock option plans. To the extent net operating losses resulting from stock option plan compensation deductions become realizable, the benefit will be credited directly to additional paid in capital. The amount of the net operating loss carryforwards which may be utilized in any future period may be subject to certain limitations, based upon changes in the ownership of the Company's common stock.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSELECTED QUARTERLY FINANCIAL DATA (unaudited) (in thousands except share and per share data)\nQUARTER ENDED 1994 MARCH 31 JUNE 30 SEPT. 30 DECEMBER 31 ---------- ---------- ---------- -----------\nTotal revenues $ 3,007 $ 3,887 $ 4,440 $ 5,184 Total costs & expenses 2,784 3,707 3,976 4,430 Net income 320 265 511 746 Net income per share $ 0.02 $ 0.02 $ 0.03 $ 0.05 Weighted average number of common and common equivalent shares 14,670,986 14,370,622 15,217,694 15,377,404\nQUARTER ENDED 1995 MARCH 31 JULY 1 SEPT. 30 DECEMBER 30 ---------- ---------- ---------- -----------\nTotal revenues $ 5,084 $ 5,503 $ 7,629 $ 9,395 Total costs & expenses 4,972 5,435 6,740 7,709 Net income 160 177 872 1,650 Net income per share $ .01 $ .01 $ .05 $ .10 Weighted average number of common and common equivalent shares 15,532,688 15,933,563 16,066,947 16,121,561\nThe per share data has been restated retroactively to reflect five-for-four and two-for-one stock splits effected in the form of stock dividends.\nThe audited financial statements appear in a separate section of this report following Part IV.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nAs previously reported by the Company on Forms 8-K, in January 1996 the Company engaged BDO Seidman LLP as its principal independent accountants to audit and report on the financial statements of the Company for the fiscal year ended December 30, 1995, replacing Deloitte & Touche LLP, the Company's former independent accountants whose services were terminated on December 28, 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe current directors and executive officers of the Company and their ages and positions are as follows:\nName Age Position ---- --- --------\nRobert Howard 72 Chairman of the Board and Director\nDr. Lawrence Howard 43 Director\nRichard A. Williams 61 Chief Executive Officer, Secretary, Vice Chairman of the Board and Director\nRobert E. Verrando 62 President, Chief Operating Officer and Director\nFrank G. Pensavecchia 61 Senior Vice President - Engineering\nGlenn J. DiBenedetto 46 Chief Financial Officer\nHarold N. Sparks(1) 74 Director\nBert DePamphilis(1) 63 Director\nJohn W. Dreyer 58 Director\n- ---------- (1) Member of the Company's Audit Committee and 1991 and 1994 Stock Option Plan Committees.\nRobert Howard, a founder of the Company, has been Chairman since June 1988 and a director since September 1987. Mr. Howard served as President and Treasurer of the Company from October 1987 until June 1988. Mr. Howard was the founder of Howtek, Inc. (\"Howtek\"), a publicly-held company engaged in the manufacture of electronic prepress equipment, and has served as Chairman of the Board of Howtek since August 1984. Mr Howard served as the President of Howtek from August 1984 through November 1987 and as its Chief Executive Officer from August 1994 to December 1993. Mr. Howard, the inventor of the first impact dot matrix printer, was the founder of Centronics Data Computer Corporation (\"Centronics\"), a manufacturer of printers. From 1969 to April 1980, he served as President and Chairman of the Board of Directors of Centronics, and he resigned from Centronics' Board of Directors in 1983. From April 1980 until 1983, Mr. Howard was principally engaged in the management of his personal investments. Mr. Howard devotes only a limited portion of his\nbusiness time to consulting with management concerning the Company's affairs. In February 1994, Mr. Howard entered into a settlement agreement in the form of a consent decree with the Securities and Exchange Commission (the \"Commission\") in connection with the Commission's investigation covering trading in the common stock of Howtek by an acquaintance of Mr. Howard and a business associate of such acquaintance. Mr. Howard, without admitting or denying the Commission's allegations of securities laws violations, agreed to pay a fine and to the entry of a permanent injunction against future violations of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.\nDr. Lawrence Howard, a founder of the Company, has been a director of the Company since November 1987 and served as Vice Chairman of the Company from November 1992 to February 1996. He served as Chief Executive Officer and Treasurer of the Company from June 1988 to June 1993; served as President from June 1988 to November 1992; and was Vice President from October 1987 to June 1988. From July 1995 to the present Dr. Howard has been President of Howard Capital Partners, Inc., an investment and merchant banking firm. From July 1994 to July 1995 Dr. Howard was Senior Managing Director of Whale Securities Co. L.P., an NASD registered broker-dealer. From October 1992 through June 1994 Dr. Howard was President and Chief Executive Officer of LH Resources, Inc., a management and financial consulting firm. From July 1986 until June 1988, Dr. Howard was primarily engaged in the management of his personal investments. Dr. Howard was the Assistant Medical Director of the Pride of Judea mental health clinic in New York City from July 1985 to July 1986. Dr. Howard is a director of Resurgence Properties, Inc., a public company engaged in investments in and management of real estate and Cellular Technical Services Company, Inc. a public company engaged in the design, development marketing, installation and support of integrated billing and data processing for the cellular telephone industry. Dr. Howard is the son of Robert Howard.\nRichard A. Williams has been Chief Executive Officer and Vice Chairman of the Board of the Company since February 1996. He has been Secretary of the Company since June 1988 and a director of the Company since November 1987. From June 1988 to February 1996 Mr. Williams served as Executive Vice President and Chief Operating Officer of the Company. From November 1987 to June 1988, Mr. Williams served as Vice President of the Company. From June 1985 to February 1987, Mr. Williams served as Vice President of Engineering for Centronics, where he was responsible for line matrix, and laser printer development and introduction.\nRobert E. Verrando has been President and Chief Operating Officer of the Company since February 1996 and a director of the Company since November 1994. From October 1994 to February 1996 he served as Executive Vice President of the Company. From July 1993 to October 1994 Mr. Verrando was employed as a consultant to the graphic arts industry. From October 1986 through July 1993 he was employed in a variety of executive positions with Compugraphic Corporation\/Agfa Compugraphic\/Agfa Division, Miles, Inc; most recently as Vice President, General Manager Business Imaging Systems Group. From April 1981 through September 1986 he was employed as Vice President-Business Development of A.B. Dick Company.\nFrank G. Pensavecchia has served as Senior Vice President Engineering since October 1991 and was the Company's Vice President - Engineering from August 1988 to October 1991. From September 1987 to August 1988, he served as the Company's Director of Engineering. From October 1983 to September 1987, Mr. Pensavecchia served as Director of Laser Printer Engineering for Centronics.\nGlenn J. DiBenedetto has served as Chief Financial Officer since November 1990. Mr. DiBenedetto has been a principal with the firm of DiBenedetto & Company, P.A., certified public accountants, since July 1989. From 1984 to July 1989, Mr. DiBenedetto was a principal with the firm of Newton & DiBenedetto, P.A., certified public accountants. Under his arrangement with the Company, Mr. DiBenedetto engages in other activities and is not required to devote his full business time to the affairs of the Company.\nHarold N. Sparks has been a director since February 1989. From 1971 to September 1995, Mr. Sparks was the President and Chief Executive Officer of Fashion Neckwear Co., Inc., a manufacturer of men's neckties. Mr. Sparks has served as a consultant to Fashion Neckwear Co., Inc. since September 1995.\nBert DePamphilis has been a director since June 1990. Mr. DePamphilis has been an independent consultant to the graphic arts industry since May 1995. From September 1994 through April 1995 he was a consultant to Applied Graphics Technology (\"AGT\"), the world's largest prepress service. Mr. DePamphilis was the founder, and from 1976 through August 1994, a principal of PDR Royal, Inc., a color prepress service for advertising agencies\nand Fortune 100 companies that ceased independent operations when it became a division of AGT in September 1994.\nJohn Dreyer has been a director since February 1996. Mr. Dreyer has been employed by Pitman Corporation (\"Pitman\"), the largest graphic arts and image supplier in the United States, since 1965. He has served as Pitman's President since 1977 and has also served as its Chief Executive Officer since 1978.\nDirectors are elected annually by the stockholders. Officers are elected annually by the Board of Directors and serve at the discretion of the Board.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe following table discloses the compensation for the person who served as the Company's principal executive officer during the fiscal year ended December 30, 1995 and for the only other executive officers of the Company whose salaries exceeded $100,000 for the Company's fiscal year ended December 30, 1995. The number of securities underlying options has been adjusted to give retroactive effect to the Company's five-for-four common stock split in the form of a 25% stock dividend effected in September 1994 and a two-for-one split in the form of a 100% split dividend effected in May 1995.\nSummary Compensation Table\nLong-Term Annual Compensation Compensation Awards Securities Name and Principal Salary Underlying Position Year ($) Options (#) - ------------------ ---- ------ -----------\nRichard A. Williams 1995 134,000 -- Chief Executive Officer 1994 125,000 40,000 1993 115,000 50,000\nRobert E. Verrando 1995 179,000 -- President and 1994 28,000 100,000 Chief Operating Officer\nFrank G. Pensavecchia 1995 114,000 -- Senior Vice President- 1994 105,000 40,000 Engineering 1993 95,000 37,500\nNo stock options were granted during fiscal 1995 to any of the named executive officers indicated in the Summary Compensation Table.\nThe following table sets forth information concerning the value of unexercised stock options held by the named executive officers as of December 30, 1995 and the options exercised during the fiscal year ended December 30, 1995.\nCompensation of Directors\nDirectors received no cash compensation for serving on the Board during the year ended December 30, 1995. However, during such year, the Company paid Mr. Robert Howard, the Chairman of the Board, $110,000 for consulting services rendered to the Company.\nEffective December 1993 the Company adopted its Non-Employee Director Stock Option Plan (the \"Director Plan\"). Only non-employee directors of the Company (other than Robert Howard or Dr. Lawrence Howard) are eligible to receive grants under the Director Plan. The Director Plan provides that eligible directors automatically receive a grant of options to purchase 5,000 shares of Common Stock at fair market value upon first becoming a director and, thereafter, an annual grant, in January of each year, of 2,500 options at fair market value.\nUnder each of the Company's 1988 Stock Option Plan (\"1988 Plan\"), 1991 Stock Option (\"1991 Plan\") and 1994 Stock Option Plan (\"1994 Plan\"), directors who are not employees of the Company (other than directors who are members of the Stock Option Committee of the particular plan) are eligible to be granted nonqualified options under such plan. The Board of Directors or the Stock Option Committee (the \"Committee\") of each plan, as the case may be, has discretion to determine the number of shares subject to each nonqualified option (subject to the number of shares available for grant under the particular plan), the exercise price thereof (provided such price is not less than the par value of the underlying shares of Common Stock), the term thereof (but not in excess of 10 years from the date of grant,\nsubject to earlier termination in certain circumstances), and the manner in which the option becomes exercisable (amounts, intervals and other conditions). Directors who are employees of the Company (but not members of the Committee of the particular plan) are eligible to be granted incentive stock options or nonqualified options under such plans. The Board or Committee of each plan, as the case may be, also has discretion to determine the number of shares subject to each incentive stock option (\"ISO\"), the exercise price and other terms and conditions thereof, but their discretion as to the exercise price, the term of each ISO and the number of ISOs that may vest may be in any year is limited by the Internal Revenue Code of 1986, as amended. As of February 29, 1996, there were 4,382 shares of Common Stock available for grant under the 1988 Plan, 6,016 shares of Common Stock available for grant under the 1991 Plan, 438,126 shares available for grant under the 1994 Plan and 92,500 shares of Common Stock available for grant under the Director Plan.\nEmployment Arrangements\nThe Company has an employment agreement dated August 23, 1988 with Mr. Richard A. Williams, which provides for an annual salary which is subject to periodic review by the Company's Board of Directors. The employment agreement expires on March 31, 1997 and contains certain non-disclosure provisions. In February 1996, the Board increased Mr. Williams' annual salary to $155,000.\nCompensation Committee Interlocks and Insider Participation in Compensation Decisions\nThe Company does not have a Compensation Committee of its Board of Directors. Decisions as to compensation are made by the Company's Board of Directors. Mr. Richard A. Williams, and Mr. Robert E. Verrando, in their capacity as a director, participated in the Board's deliberations concerning compensation of executive officers for the Company's fiscal year ended December 30, 1995. During the fiscal year ended December 30, 1995, none of the executive officers of the Company has served on the board of directors or the compensation committee of any other entity, any of whose officers has served on the Board of Directors of the Company.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth information at February 29, 1996, based on information obtained from the persons named below, with respect to the beneficial ownership of shares of Common Stock by (i) each person known by the Company to be the owner of more than 5% of the outstanding shares of Common Stock, (ii) each director, (iii) each of the persons named in response to Item 11 (Executive Compensation) that are currently employed by the\nCompany, and (iv) all executive officers and directors of the Company as a group.\nAmount and Nature Percentage Name of of Beneficial of Outstanding Beneficial Owner (1) Ownership (2) Shares Owned - -------------------- ----------------- -------------\nRobert Howard (3) 1,469,224 9.5 Dr. Lawrence Howard (4) 1,397,736 9.2 Richard A. Williams (5) 321,250 2.1 Robert E. Verrando (6) 20,000 (7) Harold N. Sparks (8) 48,500 (7) Bert DePamphilis (9) 15,550 (7) John W. Dreyer -- -- John T. Oxley (10) 1,070,000 7.1\nAll executive officers and directors as a group (nine persons) (11) 3,371,010 21.2\n- ----------\n(1) The address of Dr. Lawrence Howard is 120 East End Avenue, New York, New York 10028. The address of Robert Howard is 303 East 57th Street, New York, New York 10022.\n(2) The Company believes that except as set forth herein, all persons referred to in the table have sole voting and investment power with respect to all shares of Common Stock reflected as beneficially owned by them.\n(3) Includes options to purchase 352,500 shares of Common Stock held by Mr. Howard which are currently exercisable. Also includes 12,000 shares owned by Mr. Howard's wife. Does not include shares owned by the son of Mr. Howard's wife, with respect to which Mr. Howard disclaims any beneficial interest.\n(4) Includes options to purchase 175,000 shares of Common Stock held by Dr. Howard which are currently exercisable. Also includes 17,500 shares owned by Dr. Howard's wife, 26,892 shares owned by Dr. Howard's wife as custodian for Dr. Howard's children and 22,500 shares owned by Dr. Howard as custodian for his children.\n(5) Includes options to purchase 165,000 shares of Common Stock held by Mr. Williams which are currently exercisable.\n(6) Represents options held by Mr. Verrando which are currently exercisable.\n(7) Less than 1%.\n(8) Includes options to purchase 11,250 shares of Common Stock held by Mr. Sparks which are currently exercisable.\n(9) Includes options to purchase 11,250 shares of Common Stock held by Mr. DePamphilis which are currently exercisable.\n(10) The address of Mr. Oxley is One West 3rd Street, William Center Tower, Suite 1305, Tulsa, Oklahoma 74103. Includes 181,000 shares of Common Stock owned by the Oxley Foundation for which Mr. Oxley is Co-Trustee. The information with respect to Mr. Oxley's share ownership were based upon information contained in Amendment No. 3 to Mr. Oxley's Schedule 13D.\n(11) Includes options to purchase 352,500, 175,000, 146,250, 88,750, 11,250, 11,250, and 10,000 shares held by Robert Howard, Dr. Lawrence Howard, Richard Williams, Frank Pensavecchia, Bert DePamphilis, Harold Sparks and Glenn J. DiBenedetto, respectively, which are currently exercisable. Does not include options to purchase 18,750, 80,000, 18,750, 2,500, 2,500 and 10,000 shares of Common Stock held by Richard Williams, Robert E. Verrando, Frank Pensavecchia, Harold Sparks, Bert Depamphilis and John W. Dreyer, respectively, none of which are exercisable within 60 days from the date hereof.\nDr. Lawrence Howard and Robert Howard may be deemed \"parents\" and \"promoters\" of the Company, as such terms are defined under the federal securities laws.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe Company paid Mr. Howard $110,000 during 1995 for consulting services rendered to the Company.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)(1) Financial Statements\nPage\nReport of Independent Certified Public\nAccountants\nIndependent Auditors' Report\nBalance Sheets as of December 31, 1994 and December 30, 1995\nStatements of Operations for the Years Ended December 31, 1993 and 1994 and December 30, 1995\nStatement of Changes in Stockholders' Equity for the three years ended December 30, 1995 -7\nStatements of Cash Flows for the Years Ended December 31, 1993 and 1994 and December 30, 1995\nNotes to Financial Statements\n(a)(2) Financial Statement Schedules\nSchedule II-Valuation and Qualifying Accounts and Reserves.\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(a)(3) Exhibits\nExhibit Number Description - ------ -----------\n2(a) Stock Purchase Agreement dated and effective as of January 1, 1996, among the Company and David G. Shaw, Marc G. Langlois and David G. Shaw and Lynn R. Shaw, as Trustees of the David and Lynn Shaw Charitable Remainder Unitrust, dated February 12, 1996 and John E. Madocks and Catalina. **\n2(b) Put and Call Option Agreement by and among the Company, David G. Shaw, Marc G. Langlois and John E. Madocks. **\n2(c) Confidentiality and Non-Competition Agreement by and among the Company, David G. Shaw and Catalina. **\n2(d) Confidentiality and Non-Competition Agreement by and among the Company, Marc G. Langlois and Catalina. **\n2(e) Confidentiality and Non-Competition Agreement by and among the Company, John E. Madocks and Catalina. **\n2(f) Special Option Agreement, among the Company, Catalina, David G. Shaw, Marc G. Langlois and John E. Madocks. **\n3(a)(1) Amended and Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3(a)(1) of Registration Statement 33-27112, effective March 28, 1989.\n3(a)(2) Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3(a)(2) of Registration Statement 33-27112, effective March 28, 1989.\n3(a)(3) Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company filed June 3, 1994.+\n3(b) By-laws of the Company.\n10(a) Employment Agreement dated August 23, 1988, by and between the Company and Richard Williams, incorpo- rated by reference to Exhibit 10(b) of Registra- tion Statement 33-27112, effective March 28, 1989.\n10(b) 1988 Stock Option Plan, incorporated by reference to Exhibit 10(c) of Registration Statement 33- 27112, effective March 28, 1989.\n10(c) 1988 Restricted Stock Purchase Plan, incorporated by reference to Exhibit 10(d) of Registration Statement 33-27112, effective March 28, 1989.\n10(d) Confidentiality Agreement between the Company and Heidelberger Druckmaschinen A.G., effective December 7, 1989 as amended, incorporated by reference to Exhibit 10(i) of the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(e) Development and Supply Agreement dated July 23, 1991, by and between the Company and Inx\nIncorporated, incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1991.\n10(f) Master Agreement effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(g) Technology License effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(h) Supply Agreement effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(i) Memorandum of Performance No. 3 dated April 27, 1993 to the Master Agreement, Technology License, and Supply Agreement between the Company and Heidelberger Druckmaschinen Aktiengesellschaft, incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1993.\n10(j) Modification to Memorandum of Performance No. 3 dated April 27, 1993 to the Master Agreement, Technology License, and Supply Agreement between the Company and Heidelberger Druckmaschinen Aktiengesellschaft.+\n10(k) Memorandum of Performance No. 4 dated November 9, 1995 to the Master Agreement and Technology License and Supply Agreement between the Comapany and Heidelberger Druckmaschinen Aktiengesellschaft.\n10(l) Lease dated as of September 10, 1987, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(e) of Registration Statement 33- 27112, effective March 28, 1989.\n10(m) Amendment to Lease relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(k) of the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(n) Third Amendment to Lease, dated September 15, 1990, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(o) of the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10(o) Fourth Amendment to Lease, dated as of March 16, 1993, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, Incorporated by reference to Exhibit 10(m) of the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10(p) Development and Supply Agreement dated November 13, 1991 by and between the Company and Gans Ink & Supply Co., Inc.*\n10(q) Amendment to Employment Agreement between the Company and Richard Williams.*\n10(r) 1991 Stock Option Plan.*\n10(s) 1994 Stock Option Plan.+\n10(t) Non Employee Director Stock Option Plan.+\n10(u) Lease dated as of May 9, 1994, as amended, relating to facilities located at 9 Commercial Street, Hudson, New Hampshire.+\n23(a) Consent of BDO Seidman LLP.\n23(b) Consent of Deloitte & Touche LLP.\n27 Financial Data Schedule\n(b) During the quarter ended December 30, 1995 no reports on Form 8-K were filed. However, during January 1996 the Company filed a Form 8-K with respect to the termination of its former independent accountants on December 28, 1995.\n(c) See Item 14(a)(3) above.\n(d) See Item 14(a)(2) above.\n- --------------------\n* Incorporated by reference to the Company's Annual report on Form 10-K for the year ended December 31, 1991.\n** Incorporated by reference to the exhibit filed with the Company's Form 8-K for the event dated February 15, 1996.\n+ Incorporated by reference to the exhibit of the corresponding number continued under Company's Annual report on Form 10-K for the year ended December 31, 1994\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPRESSTEK, INC.\nDated: March 26 , 1996 By: \/s\/ Richard A. Williams ----------------------- Richard A. Williams 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\/ Richard A. Williams Chief Executive Officer, March 26, 1996 - ----------------------- Secretary and Director, Richard A. Williams (Principal Executive Officer)\n\/s\/ Robert E. Verrando President, Chief Operating March 26, 1996 - ----------------------- Officer and Director Robert E. Verrando\n\/s\/ Robert Howard Chairman of the Board and March 26, 1996 - ----------------------- Director Robert Howard\n\/s\/ Lawrence Howard Director March 26, 1996 - ----------------------- Dr. Lawrence Howard\n\/s\/ Howard N. Sparks Director March 26, 1996 - ----------------------- Harold N. Sparks\n\/s\/ Bert DePamphilis Director March 26, 1996 - ----------------------- Bert DePamphilis\n- ----------------------- Director March 26, 1996 John Dreyer\n\/s\/ Glenn J. DiBenedetto Chief Financial Officer March 26, 1996 - ------------------------ (Principal Financial and Glenn J. DiBenedetto Accounting Officer)\nPage ----\nReport of Independent Certified Public Accountants\nIndependent Auditors' Report\nBalance Sheets as of December 31, 1994 and December 30, 1995\nStatements of Operations for the Years Ended December 31, 1993 and 1994, and December 30, 1995\nStatements of Changes in Stockholders' Equity for the Three Years Ended December 30, 1995 -7\nStatements of Cash Flows for the Years Ended December 31, 1993 and 1994, and December 30, 1995\nNotes to Financial Statements\nFinancial Statement Schedule:\nSchedule II - Valuation and qualifying accounts and reserves FS-1\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors Presstek, Inc. Hudson, New Hampshire\nWe have audited the accompanying balance sheet of PRESSTEK, INC. as of December 30, 1995 and the related statements of operations, changes in stockholders' equity, and cash flows for the year then ended. We have also audited the financial statement 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 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 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 presentation of the financial statements and schedule. 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 Presstek, Inc. at December 30, 1995 and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\nBDO SEIDMAN, LLP\nNew York, New York February 16, 1996\nINDEPENDENT AUDITORS' REPORT\nPRESSTEK, INC.:\nWe have audited the accompanying balance sheet of Presstek, Inc. as of December 31, 1994, and the related statements of operations, changes in stockholders' 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 and to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 statement present fairly, in all material respects the financial position of Presstek, Inc. 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.\nAs discussed in Note 3 to the financial statements, the Company changed its method of accounting for certain investments in debt and equity securities, effective January 1, 1994, to conform with Statement of Financial Accounting Standards No. 115.\nDELOITTE & TOUCHE LLP\nBedford, New Hampshire March 15, 1995\nPART I - FINANCIAL INFORMATION\nItem 1. Financial Statements\nSee notes to financial statements\nSee notes to financial statements\nSee notes to financial statements\n-7\nSee notes to financial statements\nPRESSTEK, INC.\nNOTES TO FINANCIAL STATEMENTS\n1. NATURE OF BUSINESS\nBusiness - Presstek, Inc. (\"the Company\" or \"Presstek\") was organized as a Delaware corporation on September 3, 1987 and was a development stage company through 1991. In September, 1991, Heidelberger Druckmaschinen A.G. (\"Heidelberg\") the world's largest printing press manufacturer introduced the Company's initial spark discharge based imaging technology, in a jointly developed product, the Heidelberg GTO-DI. In 1993, after investing substantial effort and resources, the Company completed the development of PEARL(R), a patented proprietary, nonphotographic, toxic-free, digital imaging and printing plate technology for the printing and graphic arts industries. PEARL's laser diode technology is capable of imaging various types of Presstek printing plates either off-press or on-press which may then be used to produce high quality, full-color lithographic printed materials. PEARL has completely replaced the Company's spark discharge technology. The GTO-DI was re-introduced in September 1993, utilizing PEARL as its direct imaging technology. The Company is now building an installed base of customers which utilizes its proprietary consumable printing plates on PEARL equipped Heidelberg presses. During the second quarter of 1995, the Company commenced shipments of kits to be utilized on Heidelberg's recently introduced Quickmaster DI 46-4. Presstek is also engaged in the development of additional products and applications that incorporate its proprietary PEARL technologies and consumables, including both computer-to-plate and other direct-to-press applications. At this time, the Company relies on Heidelberg to generate substantially all of its revenues.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFiscal Year - On January 19, 1995, the Company's Board of Directors determined to change its fiscal year from a calendar year ending December 31 to a fiscal year ending on the Saturday closest to December 31; accordingly, the 1995 fiscal year ended December 30. Fiscal 1993, 1994, and 1995 each reflect 52 week periods.\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 these estimates. Many of the Company's estimates and assumptions used in the financial statements relate to the Company's products, which are subject to rapid technological change. It is reasonably possible that changes may occur in the near term that would affect management's estimates with respect to inventories, equipment and software development costs.\nRevenue Recognition - The Company records revenues on product sales and related royalties at the time of shipment. Certain fees and other reimbursements are recognized as revenue when the related services have been performed or the revenue otherwise earned.\nProduct Warranties - The Company warrants its products against defects in material and workmanship for a period of one year. Anticipated future\nwarranty costs are accrued by a charge to expense as products are shipped and the related revenue recognized. At December 31, 1994 and December 30, 1995, accrued expenses included accrued warranty costs of $199,000 and $601,000 and product replacement reserves of $28,000 and $291,000, respectively.\nProperty and Equipment - Property and equipment are stated at cost and are depreciated using a straight-line method for both financial reporting and for tax purposes over their estimated useful lives (ranging from 3 to 7 years). Leasehold improvements are amortized over the life of the lease for financial reporting purposes and a required longer period for tax purposes.\nSoftware Development Costs - Software development costs for products and certain product enhancements are capitalized subsequent to the establishment of their technological feasibility (as defined in Statement of Financial Accounting Standards No. 86) based upon the existence of working models of the products which are ready for initial customer testing. Costs incurred prior to such technological feasibility or subsequent to a product's general release to customers are expenses as incurred. Prior to 1994, the Company did not incur material costs subject to capitalization. During 1994 and 1995, the Company incurred and capitalized $530,350 and $154,129, respectively, of costs subject to capitalization. Amortization of these costs commenced during 1995 using the straight-line method. Amortization expense for the year ended December 30, 1995 was $98,500.\nInventory - Inventory is valued at the lower of cost or market, with cost determined on the first-in, first-out method. At December 31, 1994, and December 30, 1995, inventory consisted of the following:\n1994 1995 ---- ----\nRaw materials $ 1,269,607 $ 3,476,713 Work in process 952,704 1,959,382 Finished goods 573,854 425,648 ----------- -----------\nTotal $ 2,796,165 $ 5,861,743 =========== ===========\nPatent Application Costs - Patent application costs represent the expense of preparing and filing applications to patent the Company's proprietary technologies. Such costs are amortized against income over a period of five years, beginning on the date the patents are issued. As of December 30, 1995, the Company had been issued 49 patents. Amortization expense for the years ended December 31, 1993 and 1994, and December 30, 1995 was $53,904, $55,639, and $72,530, respectively. (Also see Note 10.)\nResearch and Development Costs - Research and development costs are expenses as incurred for financial reporting purposes.\nCash Flow Information - For purposes of reporting cash flows, the Company considers all savings deposits, certificates of deposit, and money market funds and deposits purchased with a maturity of three months or less to be cash equivalents. At December 31, 1994 and December 30, 1995, cash and cash equivalents consisted of cash balances on deposit and money market funds.\nReclassification - Various accounts in the prior years' balance sheet and statement of operations have been reclassified for comparative purposes to conform with the presentation in the current-year financial statements.\nEffect of New Accounting Pronouncements\nLong-Lived Assets - Long-lived assets, such as property and equipment, are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. This policy is in accordance with Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets to be Disposed Of,\" which is effective for fiscal years beginning after December 15, 1995. No write downs have been necessary through December 30, 1995.\nStock-Based Compensation - The Company does not presently intend to adopt the fair value based method for accounting for stock compensation plans, as permitted by Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" which is effective for transactions entered into in fiscal years that begin after December 15, 1995.\n3. MARKETABLE SECURITIES\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Marketable Securities are classified as available for sale and consist of United States Treasury Bills and Notes having maturity dates of more than three months, and are stated at fair value.\nMarketable securities are classified based on expected realization which, as of December 31, 1994, was consistent with security maturity date. Accordingly, at that date such securities were classified as current where maturity dates were one year or less, or noncurrent where maturity dates exceed one year from the balance sheet date. 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. Aggregate net unrealized holding losses of $199,334 and $3,176 at December 31, 1994 and December 30, 1995, respectively, have been included as a separate component of stockholders' equity in the accompanying balance sheet. Certain information with respect to the Company's marketable securities as of December 31, 1994 and December 30, 1995 is presented below:\n1994 1995 -----------------------------------------------------\nCurrent Noncurrent Total Total ------- ---------- ----- -----\nAmortized Cost $254,154 $ 5,007,382 $ 5,261,536 $ 3,054,001 Gross Unrealized Holding Gains 227 - 227 7,810 Gross Unrealized Holding Losses ( 199,561) ( 199,561) ( 10,986) ------- --------- --------- ---------\nFair Value $254,381 $ 4,807,821 $ 5,062,202 $ 3,050,825 ======= ========= ========= =========\nFor the years ended December 31, 1994 and December 30, 1995, the Company received proceeds from the sale or maturity of available for sale securities of $5,157,394 and $2,179,510 and recorded net realized losses of $28,174 and $28,024. In computing such realized losses, cost was determined using the specific cost method. The change in net unrealized holding gain or loss on\navailable for sale securities that has been included in the separate component of stockholders' equity for the years ended December 31, 1994 and December 30, 1995 was $199,334 and $3,176, respectively.\n4. NET INCOME PER COMMON SHARE\nNet income per common share is computed by dividing net income by the weighted average number of Common Stock and Common Stock equivalent shares outstanding. Common Stock equivalents represent the dilutive effect of the assumed exercise of outstanding stock options and warrants. On August 2, 1994, the Company's Board of Directors authorized a five-for-four stock split, effected in the form of a 25% stock dividend, during the third quarter of 1994. The split resulted in the issuance of 1,410,235 shares of common stock. On April 19, 1995, the Company's Board of Directors declared a two-for-one stock split, effected in the form of a 100% stock dividend, during the second quarter of 1995. The split resulted in the issuance of 7,275,972 shares of common stock. All references to average number of shares outstanding and prices per share have been restated retroactively to reflect the splits. A summary of the calculations for the years ended December 31, 1993 and 1994, and December 30, 1995 follows:\n5. INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" as of January 1, 1993. SFAS 109 requires that the Company utilize an asset and liability approach for financial accounting and reporting for income taxes. The primary objectives of accounting for taxes under SFAS 109 are to (a) recognize the amount of tax payable for the current year and (b) recognize the amount of deferred tax liability or asset for the future tax consequences of events that have been reflected in the Company's financial statements or tax returns.\nThe components of the provision for income taxes for the years ended December 31, 1993 and 1994 and December 30, 1995 were as follows:\n1993 1994 1995 ---- ---- ----\nCurrent tax expense $ 70,000 $ 46,600 $ 44,000\nState tax benefit of disposition 80,000 140,000 176,000 of stock options\nChange in deferred tax asset - net (50,000) - - -------- -------- --------\nTotal provision $100,000 $186,600 $220,000 ======== ======== ========\nDeferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. These temporary differences are determined in accordance with SFAS 109. Deferred tax assets and liabilities consisted of the following at December 31, 1994 and December 30, 1995:\n1994 1995 ---- ---- Deferred tax assets: NOL carryforwards $ 2,856,000 $5,600,000 Tax credits 300,000 350,000 Warranty provision and other accruals 258,000 640,000 --------- --------- Gross deferred tax assets 3,414,000 6,590,000 --------- ---------\nDeferred tax liabilities: Patent application costs 274,000 368,000 Accumulated depreciation 162,000 187,000 --------- --------- Gross deferred tax liabilities 436,000 555,000 --------- ---------\n2,978,000 6,035,000\nLess valuation allowance (2,928,000) (5,985,000) --------- ---------\nDeferred tax asset - net $ 50,000 $ 50,000 ========= =========\nThe $50,000 deferred tax asset was included in other current assets at December 31, 1994 and December 30, 1995. The valuation allowance increased $403,000, $195,000, and $3,057,000 in 1993, 1994, and 1995, respectively.\nThe difference between income taxes at the United States federal income tax rate and the effective income tax rate was as follows for the years ended December 31, 1993 and 1994, and December 30, 1995:\n1993 1994 1995 ---- ---- ----\nComputed at federal statutory rate 34% 34% 34% Increase (decrease) resulting from: Expenses producing no current tax benefit 17% 2% 11% State tax, net of federal benefit 7% 7% 7% Alternative minimum tax 2% 2% - Net operating loss carryforwards 19% 10% 98% Compensation relative to stock option plans -58% -38% -140% Deductions for tax purposes previously expenses for financial statement purposes - 7% - 7% - Patent perfection costs and other - 5% - 1% - 3% -- -- --- Effective rate, net 9% 9% 7% == == ===\nAs of December 30, 1995, the Company had net operating loss carryforwards totaling approximately $16,500,000 resulting from compensation deductions relative to stock option plans. To the extent net operating losses resulting from stock option plan compensation deductions become realizable, the benefit will be credited directly to additional paid in capital. The amount of the net operating loss carryforwards which may be utilized in any future period may be subject to certain limitations, based upon changes in the ownership of the Company's common stock. The following is a breakdown of the net operating losses and their expiration dates:\nExpiration date Amount of remaining NOL\n2005 $2,230,000 2006 $5,020,000 2007 $ 550,000 2008 $ 600,000 2009 $8,100,000\nIn addition, the Company has available tax credit carryforwards (adjusted to reflect provisions of the Tax Reform Act of 1986) of approximately $350,000, which are available to offset future taxable income and income tax liabilities, when earned or incurred.\n6. RELATED PARTIES\nDuring the years ended December 31, 1993 and 1994 and December 30, 1995, the Company made various sales to Howtek totaling approximately $38,800, $114,500, and $23,250, respectively. Mr. Robert Howard, Chairman and a principal stockholder of the Company, is the Chairman of the Board of Directors and a principal stockholder of Howtek and the father of Dr. Lawrence Howard, who was the President and Chief Executive Officer of the Company through November 30, 1992, when he resigned as President and was appointed, by the Board of\nDirectors, Vice Chairman of the Board. Dr. Lawrence Howard was a director of Howtek until May 30, 1989.\nThe Company subleases certain of its office facilities from Mr. Robert Howard, Chairman, as a tenant-at-will. Payments totaled $33,352, $35,379, and $35,400, respectively, for the years ended December 31, 1993 and 1994 and December 30, 1995. Mr. Howard was paid $100,000 during each of 1993 and 1994 as a bonus for consulting services rendered. The Company paid Mr. Howard $110,000 for consulting services provided to the Company during 1995.\n7. STOCKHOLDERS' EQUITY\nReferences herein to shares, options, warrants and the prices per share have been restated to the 1994 and 1995 stock splits, effected in the form of stock dividends, referred to in Note 4.\nPreferred Stock - The Company's certificate of incorporation empowers the Board of Directors, without stockholder approval, to issue up to 1,000,000 shares of $.01 par value preferred stock, with dividend, liquidation, conversion, and voting or other rights to be determined upon issuance by the Board of Directors.\nRestricted Stock Purchase Plan - On August 22, 1988, the Company adopted a Restricted Stock Purchase Plan (\"the Purchase Plan\") authorizing the sale of up to 125,000 shares of common stock to its employees at a price to be determined by the Board of Directors, but in no event to be less than $.01 per share or greater than 10% of the then fair market value. At December 30, 1995, after adjustment for the 1994 and 1995 splits 40,000 shares remained available for sale.\nStock Option Plans - On August 22, 1988, the Company adopted the 1988 Stock Option Plan (the \"1988 Plan\"), and effective August 19, 1991, the Company adopted the 1991 Stock Option Plan (the \"1991 Plan\"), and effective April 8, 1994, the Company adopted the 1994 Stock Option Plan (the \"1994 Plan\"). Each plan originally provided for the aware, to key employees and other persons, options to purchase up to 500,000 shares of the Company's common stock. As a result of the 1994 and 1995 stock splits, the number of shares of common stock issuable upon exercise of outstanding options granted under the above plans and upon exercise of options available for future grants increased by 25% and 100%, respectively. Options granted under the plans may be either Incentive Stock Options (\"ISOs\") or Nonqualified Options. Generally, ISOs may only be granted to employees of the\nCompany, at an exercise price of not less than fair market value of the stock at the date of grant. Nonqualified Options may be granted to any person, at any exercise price. Nonqualified Options may be granted to any person, at any exercise price not less than par value, within the discretion of the Board of Directors or a committee appointed by the Board of Directors (\"Committee\"). Any options granted will generally become exercisable in increments over a period not to exceed ten years from the date of grant, to be determined by the Board of Directors or Committee, and generally will expire not more than ten years from the date of grant.\nInformation concerning incentive stock option activity under the 1988, 1991, and 1994 plans for the years ended December 31, 1993 and 1994, and December 30, 1995 is summarized as follows:\nOption Option price Options Shares per share Exercisable ------ --------- -----------\nOutstanding at December 31, 1992 193,800 $ 1.20 - $ 1.50 118,799 =======\nGranted 186,808 $10.00 - $25.00 Exercised (91,000) $ 1.50 Cancelled\/Expired - -------\nOutstanding at December 31, 1993 289,608 $ 1.20 - $25.00 289,608 =======\nGranted 509,000 $15.55 - $19.50 Exercised (116,861) $ 1.20 - $20.00 Cancelled\/Expired (14,844) $20.00 - $25.00 -------\nOutstanding at December 31, 1994 666,903 $10.00 - $19.50 12,591 =======\nGranted 34,500 $41.275 - $52.75 Exercised (112,877) $15.55 - $20.00 Cancelled\/Expired - -------\nOutstanding at December 30, 1995 588,526 $10.00 - $52.75 76,279 ======= ======\nThe proceeds to the Company from incentive stock options exercised during the years ended December 31, 1993 and 1994 and December 30, 1995 totaled $136,500, $416,670, and $1,629,371, respectively.\nInformation concerning nonqualified stock option activity under the 1988, 1991, and 1994 Plans for the years ended December 31, 1993 and 1994 and December 30, 1995 is summarized as follows:\nOption Option price Options Shares per share Exercisable ------ --------- -----------\nOutstanding at December 31, 1992 819,719 $ 2.00 - $16.75 487,219 =======\nGranted 268,624 $ 7.10 - $21.00 Exercised (34,300) $ 5.00 - $14.75 Cancelled\/Expired (64,250) $10.38 - $21.00 -------\nOutstanding at December 31, 1993 989,793 $ 2.00 - $19.40 865,543 =======\nGranted 421,687 $ 9.70 - $29.20 Exercised (74,856) $ 5.00 - $16.75 Cancelled\/Expired (2,878) $11.80 - $29.20 -------\nOutstanding at December 31, 1994 1,333,746 $ 2.00 - $25.00 878,802 =======\nGranted 52,750 $22.313 - $62.00 Exercised (191,381)* $ 4.00 - $15.55 Cancelled\/Expired (245) $12.20 - $18.40 ---------\nOutstanding at December 30, 1995 1,194,870 $ 4.00 - $62.00 802,800 ========= =======\n* Includes 31,450 additional options arising from the 1995 stock split.\nThe incentive and nonqualified stock options summarized in the tables above were granted under various vesting schedules ranging from immediate to five years, with termination dates ranging from five to six years from dates of grant and may be subject to earlier termination as provided in the Plans.\nThe proceeds to the Company from nonqualified stock options exercised during the years ended December 31, 1993 and 1994 and December 30, 1995 totaled $320,670, $613,711, and $1,284,359, respectively.\nDirector Stock Option Plan - Effective December 1993, the Company adopted its Nonemployee Director Stock Option Plan (the \"Director Plan\"). Only nonemployee directors of the Company (other than Robert Howard or Dr. Lawrence Howard) are eligible to receive grants under the Director Plan. The Director Plan provides that eligible directors automatically receive a grant of options to purchase 5,000 shares of Common Stock at fair market value upon first becoming a director and, thereafter, an annual grant, in January of each year, options to purchase 2,500 shares at fair market value. Pursuant to the terms of the Director Plan, options to purchase 3,125 shares, after adjustment for the five-for-four stock split, were automatically granted to each of two of the directors in January, 1994, and options to purchase\n5,000 shares, after adjustment for the two-for-one stock split, were automatically granted to each of two of the directors in January, 1995.\nUnderwriter's Warrants - In connection with an initial public offering during 1989, the Company issued the underwriter warrants to purchase 260,000 shares of common stock.\nThrough December 30, 1995, 138,034 shares of common stock at $5.75 per share and 138,034 shares of common stock at $6.25 ($4.60 and $5.00 for exercises after the four-for-five stock split) were issued to certain designees of the underwriter pursuant to their exercise of warrants and unit warrants. The proceeds to the Company from these transactions totaled $1,559,993.\nAt December 30, 1995, there were no remaining warrants outstanding.\nOther - On January 20, 1992, in consideration of the payment by Union Bank of Switzerland (the \"Bank\") to the Company of $25,000, the Company issued to the Bank a warrant which, entitled the Bank or its assigns to purchase from the Company 25,000 shares of common stock at $26.00 per share, which was subsequently amended to $14.25 per share. The Warrant was exercised during March, 1994, generating proceeds to the Company of $356,250.\nOn February 11, 1994, the Company issued 25,000 shares of common stock, at $12.50 per share, to a consultant, in consideration of payment of $312,000 pursuant to the exercise of a warrant granted on August 12, 1992.\n8. LEASES\nEffective March 16, 1993, the Company entered into an agreement to amend and extend the basic lease for its operating facilities for an additional period of three years ending March 15, 1996 with three one-year renewal options. The amended lease specifies a fixed base monthly rent of $8,693, plus a pro rata share of real estate taxes and certain other expenses. The Company paid approximately $132,000 in 1993, $130,000 in 1994, and $131,000 in 1995 under the lease agreement and amendments. During May, 1994, the Company entered into an additional three year lease agreement (which was amended in December 1994) for approximately 36,000 square feet to accommodate its manufacturing facilities. The lease, as amended, specifies a fixed base monthly rent of $11,250, plus real estate taxes, utilities, and certain other expenses. The lease contains an option to renew for an additional three years and a right of first refusal to\npurchase the property. The Company paid approximately $71,500 in 1994 and $165,000 in 1995 under this lease agreement. As of December 30, 1995, future minimum lease payments under these agreements were as follows:\n1996 $ 152,386 1997 45,000 --------- Total $ 197,386 =========\n9. HEIDELBERG AGREEMENTS\nIn January 1991, the Company entered into a master agreement (the \"Master Agreement\"), a technology license agreement (the \"Technology License\"), and a supply agreement (the \"Supply Agreement\"), (the foregoing agreements being sometimes collectively referred to herein as the \"Heidelberg Agreements\") with Heidelberg. Pursuant to this series of related agreements, as amended, the Company and Heidelberg agreed to certain terms relating to the integration of the Company's proprietary Direct Imaging Technology into various presses manufactured by Heidelberg and certain of its related parties (the \"Heidelberg Presses\") and the manufacture of components for and the commercialization of such presses.\nPursuant to the Heidelberg Agreements, the Company granted Heidelberg certain exclusive rights, subject to the satisfaction of certain conditions, for the use of the Direct Imaging Technology in Heidelberg Presses. In consideration of such rights, Heidelberg agreed to pay to the Company royalties on the net sales prices of various specified types of Heidelberg Presses.\nThe Heidelberg Agreements also provide for the Company to furnish, among other things, engineering and development work based upon work projects and budgets agreed to by the Company and Heidelberg. The terms of the Heidelberg Agreements are for periods ending in December 2011 in the case of each of the Master Agreement and Technology License and December 1995 in the case of the Supply Agreement. The Heidelberg Agreements also contain, among other things, certain early termination provisions and extension provisions.\n10. NONRECURRING CHARGE\nDuring the second quarter of 1993 the Company recorded a $1,949,000 nonrecurring charge associated with the Company's change from spark discharge technology to its PEARL technology. The termination of shipments of units incorporating the spark discharge technology dictated that certain assets associated with the earlier imaging process, including certain property and\nequipment, unamortized patent costs and inventory, be written off, and that reserves be established for the transition to PEARL technology. The individual elements making up the charge consisted of write-offs of property and equipment, inventory, and patent application costs of $613,000, $546,000, and $294,000, respectively, and a reserve of $496,000 for certain estimated costs required to retrofit existing customer equipment. The reserve was fully utilized during 1993, 1994, and 1995.\n11. OTHER INFORMATION\nIn April 1995 the Company commenced an action against Agfa-Gevaert, N.V. (\"Agfa\") in the U.S. District Court for the District of New Hampshire alleging that Agfa violated provisions of a confidentiality agreement and a manufacturing agreement (the \"Manufacturing Agreement\") between the parties and misappropriated certain trade secrets of the Company. In June 1995, Agfa commenced an arbitration proceeding against the Company in the International Chamber of Commerce in which it seeks arbitration of the disputes between the parties arising from the Manufacturing Agreement and also seeks to have the trade secret issues determined in arbitration. In its request for arbitration Agfa has, among other things, charged Presstek with breaches of the Manufacturing Agreement, good faith and fair dealing, and is seeking damages in an amount alleged to be $2,000,000. The action commenced by the Company in District Court has been stayed to allow the arbitrators to determine the issues in dispute between the parties.\nThe Company has vigorously pursued its claims against Agfa and intends to vigorously contest Agfa's assertions of breach of the Manufacturing Agreement and other claims. Although the Company and its counsel believes that an unfavorable outcome of the litigation and arbitration is unlikely, there can be no assurance as to the outcome of the proceedings.\nThe Company has been advised that the Securities and Exchange Commission (the \"Commission\") has entered a formal order of private investigation with respect to certain activities by certain unnamed persons and entities in connection with the securities of the Company. In that connection, the Company has received subpoenas duces tecum requesting it to produce certain documents and has complied with the requests. The Company has not been advised by the Staff of the Commission that the Staff intends to recommend to the Commission that it initiate a proceeding against the Company in connection with the foregoing investigation.\n12. SUBSEQUENT EVENTS\nDuring February, 1996, the Company completed private placements of an aggregate of 282,846 shares of its common stock for net proceeds of $20,208,758 to a limited number of domestic individual and institutional investors.\nA portion of the funds raised from the private placements were utilized to complete the acquisition referred to below, with the balance to be utilized for general working capital purposes.\nOn February 15, 1996, the Company acquired 90% of the outstanding common stock (the \"Purchased Shares\") of Catalina Coatings, Inc., an Arizona corporation (\"Catalina\"). Catalina is engaged in the development, manufacture and sale of vacuum deposition coating equipment and the licensing and sublicensing of patent rights with respect to vapor deposition process to coat moving webs of material at high rates. The Company intends to continue the business of Catalina which will operate as a subsidiary of the Company. The Purchased Shares were acquired from the selling shareholders pursuant to a Stock Purchase Agreement (the \"Stock Purchase Agreement\") dated and effective as of January 1, 1996. The aggregate consideration paid by the Company pursuant to the Stock Purchase Agreement was $8,400,000, of which $8,200,000 represented the purchase price of the Purchased Shares and $200,000 represented consideration for the non-competition and confidentiality covenants of the selling shareholders.\nSimultaneous with the closing of the acquisition, the Company entered into a Put and Call Option Agreement (the \"Option Agreement\") which provides the Company with the right, at any time after February 15, 2000, to acquire the remaining 10% of the outstanding common stock of Catalina for aggregate consideration of $2,000,000. The Option Agreement also provides the selling shareholders and another employee of Catalina with the right, at any time after August 15, 2000, to cause the Company to purchase the remaining shares for aggregate consideration of $1,000,000. The Option Agreement will terminate if Catalina consummates an initial public offering of its securities prior to February 15, 2000.\nThe Company granted the Selling Shareholders and the other employee of Catalina five-year non-qualified options to purchase an aggregate 100,000 of the Company's common stock at an exercise price of $89.50 per share and Catalina granted to the same individuals an option to purchase an aggregate 5% of the issued and outstanding common stock of Catalina in the event that a registration statement relating to an initial public offering of Catalina common stock is declared effective by February 15, 2000.\nPRESSTEK, INC.\n- ---------- (1) Warranty expenditures\n(2) Equipment replacement expenditures\nFS-1\nEXHIBIT INDEX\nExhibit No. Description Page No.\n2(a) Stock Purchase Agreement dated and effective as of January 1, 1996, among the Company and David G. Shaw, Marc G. Langlois and David G. Shaw and Lynn R. Shaw, as Trustees of the David and Lynn Shaw Charitable Remainder Unitrust, dated February 12, 1996 and John E. Madocks and Catalina. **\n2(b) Put and Call Option Agreement by and among the Company, David G. Shaw, Marc G. Langlois and John E. Madocks. **\n2(c) Confidentiality and Non-Competition Agreement by and among the Company, David G. Shaw and Catalina. **\n2(d) Confidentiality and Non-Competition Agreement by and among the Company, Marc G. Langlois and Catalina. **\n2(e) Confidentiality and Non-Competition Agreement by and among the Company, John E. Madocks and Catalina. **\n2(f) Special Option Agreement, among the Company, Catalina, David G. Shaw, Marc G. Langlois and John E. Madocks. **\n3(a)(1) Amended and Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3(a)(1) of Registration Statement 33-27112, effective March 28, 1989.\n3(a)(2) Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3(a)(2) of Registration Statement 33-27112, effective March 28, 1989.\n3(a)(3) Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company filed June 3, 1994.+\n3(b) By-laws of the Company.\n10(a) Employment Agreement dated August 23, 1988, by and between the Company and Richard Williams, incorpo- rated by reference to Exhibit 10(b) of Registra- tion Statement 33-27112, effective March 28, 1989.\n10(b) 1988 Stock Option Plan, incorporated by reference to Exhibit 10(c) of Registration Statement 33- 27112, effective March 28, 1989.\nExhibit No. Description Page No.\n10(c) 1988 Restricted Stock Purchase Plan, incorporated by reference to Exhibit 10(d) of Registration Statement 33-27112, effective March 28, 1989.\n10(d) Confidentiality Agreement between the Company and Heidelberger Druckmaschinen A.G., effective December 7, 1989 as amended, incorporated by reference to Exhibit 10(i) of the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(e) Development and Supply Agreement dated July 23, 1991, by and between the Company and Inx Incorporated, incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1991.\n10(f) Master Agreement effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(g) Technology License effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(h) Supply Agreement effective January 1, 1991 by and between Heidelberger Druckmaschinen Aktiengesellschaft and the Company, incorporated by reference to the Company's Form 8-K, dated January 1, 1991.\n10(i) Memorandum of Performance No. 3 dated April 27, 1993 to the Master Agreement, Technology License, and Supply Agreement between the Company and Heidelberger Druckmaschinen Aktiengesellschaft, incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1993.\n10(j) Modification to Memorandum of Performance No. 3 dated April 27, 1993 to the Master Agreement, Technology License, and Supply Agreement between the Company and Heidelberger Druckmaschinen Aktiengesellschaft.+\nExhibit No. Description Page No.\n10(k) Memorandum of Performance No. 4 dated November 9, 1995 to the Master Agreement and Technology License and Supply Agreement between the Comapany and Heidelberger Druckmaschinen Aktiengesellschaft.\n10(l) Lease dated as of September 10, 1987, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(e) of Registration Statement 33- 27112, effective March 28, 1989.\n10(m) Amendment to Lease relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(k) of the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(n) Third Amendment to Lease, dated September 15, 1990, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, incorporated by reference to Exhibit 10(o) of the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10(o) Fourth Amendment to Lease, dated as of March 16, 1993, relating to real property located at 8 Commercial Street, Hudson, New Hampshire, Incorporated by reference to Exhibit 10(m) of the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10(p) Development and Supply Agreement dated November 13, 1991 by and between the Company and Gans Ink & Supply Co., Inc.*\n10(q) Amendment to Employment Agreement between the Company and Richard Williams.*\n10(r) 1991 Stock Option Plan.*\n10(s) 1994 Stock Option Plan.+\n10(t) Non Employee Director Stock Option Plan.+\n10(u) Lease dated as of May 9, 1994, as amended, relating to facilities located at 9 Commercial Street, Hudson, New Hampshire.+\n23(a) Consent of BDO Seidman LLP.\n23(b) Consent of Deloitte & Touche LLP.\n27 Financial Data Schedule\n- ------------- * Incorporated by reference to the Company's Annual report on Form 10-K for the year ended December 31, 1991.\n** Incorporated by reference to the exhibit filed with the Company's Form 8-K for the event dated February 15, 1996.\n+ Incorporated by reference to the exhibit of the corresponding number continued under Company's Annual report on Form 10-K for the year ended December 31, 1994","section_15":""}
{"filename":"792334_1995.txt","cik":"792334","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Growth Fund A Real Estate Investment for Capital Appreciation (the \"Registrant\") is a limited partnership formed in August 1985 under the laws of the State of Illinois. The Registrant raised $7,084,000 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 joint venture interests in the two real property investments described under Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owns joint venture interests in the two properties described below:\nLocation Description of Property - -------- -----------------------\nCobb County, Georgia * Post Lake Apartments: a 484-unit apartment complex located on approximately 60 acres.\nRedwood City, California ** Redwood Shores Apartments: a 304-unit apartment complex located on approximately 15 acres.\n* Owned by the Registrant through a joint venture with affiliates. ** Owned by the Registrant through a joint venture with the seller and an affiliate.\nSee Note 4 of Notes to Financial Statements for additional information.\nEach of the above properties is held subject to various mortgages and other forms of financing.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for the properties in which it has joint venture interests.\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 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. As anticipated, the Registrant has not made distributions to date to investors. For additional information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 690.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ----------- ---------- ---------- ---------- ---------- Net loss $(224,813) $(479,754) $(436,167) $(481,508) $(770,618) Net loss per Limited Part- nership Interest (31.42) (67.05) (60.95) (67.29) (107.70)\nTotal assets 1,171,976 1,009,834 1,453,169 1,919,258 2,459,673\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nThe operations of Balcor Growth Fund A Real Estate Investment for Capital Appreciation (the \"Partnership\") are primarily comprised of the Partnership's participation in the operations of the Post Lake and Redwood Shores apartment complexes. Improved property operations at Post Lake and decreased interest expense at Redwood Shores resulted in a decrease in the net loss during 1995 as compared to 1994, while higher administrative expenses during 1994 resulted in\nan increase in the net loss during 1994 as compared to 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nPost Lake Apartments generated net income during 1995 as compared to a net loss during 1994 primarily as a result of higher rental income due to higher rental rates and occupancy. This higher rental income resulted in an increase in property management fees for 1995 as compared to 1994. The net improvement in operations resulted in affiliate's participation in income from joint venture during 1995 as compared to a participation in loss during 1994.\nThe net loss from Redwood Shores Apartments decreased during 1995 as compared to 1994 as a result of higher rental income due to increased rental rates and occupancy and lower interest expense on the mortgage note payable as a result of the re-marketing of the bonds secured by the property. The decrease in the net loss was partially offset by a decrease in interest income due to lower interest rates earned on investments and an increase in administrative expense due to costs incurred in connection with the re-marketing of the bonds.\nThe seller's 30% participation in the operations of Redwood Shores is limited to the extent the seller contributes capital to the joint venture. Generally accepted accounting principles require that the seller's participation in any losses exceeding such contributions be suspended to subsequent years when sufficient contributions are made. The seller's share of the joint venture's losses exceeded the capital contributed in both 1993 and 1994. However, due to higher capital contributions in 1995 related to the bond re-marketing, a portion of the seller's losses suspended from previous years was recognized in 1995.\nAs a result of higher outstanding balances and interest rates during 1995, interest expense on the Partnership's short-term loan with an affiliate increased during 1995 as compared to 1994.\nPrimarily as a result of lower data processing costs, administrative expenses decreased during 1995 as compared to the same period in 1994.\n1994 Compared to 1993 - ---------------------\nThe net loss from Post Lake Apartments decreased during 1994 as compared to 1993 primarily due to higher rental rates in 1994. This decrease in net loss was partially offset by increased maintenance and repairs expenses due to the exterior painting of the buildings during 1994.\nThe net loss from Redwood Shores Apartments increased slightly during 1994 as compared to 1993 primarily due to an increase in administrative expenses, which was the result of increased legal fees.\nAs a result of higher interest rates and outstanding affiliate loan balances in 1994, interest expense on the Partnership's short-term loan with an affiliate increased during 1994 as compared to 1993.\nPrimarily as a result of increased accounting and data processing fees, administrative expenses increased during 1994 as compared to 1993.\nLiquidity and Capital Resources - ------------------------------- The cash position of the Partnership increased as of December 31, 1995 as compared to December 31, 1994. The Partnership's operating activities consisted of the payment of Partnership administrative expenses; investing activities consisted of the Partnership's share of the distributions from the Atlanta Lakes Joint Venture and contributions to Redwood Partners; and financing activities consisted of distributions to the affiliated partner on the Atlanta Lakes Joint Venture and borrowings from the General Partner.\nThe Partnership classifies the cash flow performance of the properties as either positive, a marginal deficit or a significant deficit, each after consideration of debt service payments. 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 the properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1995 and 1994, Post Lake Apartments generated positive cash flow. During 1995, Redwood Shores Apartments generated positive cash flow, while in 1994, the property generated a marginal cash flow deficit. The improvement in cash flow at Redwood Shores was due to higher rental income resulting from increased rental rates and occupancy and lower interest on the mortgage note payable as a result of the re-marketing of the bonds. During 1995 and 1994, the mortgage financing on the Redwood Shores Apartments required principal payments of $387,500 and $352,500, respectively. The joint venture partners of Redwood Shores (Redwood Partners and the seller) were required to fund their share of any cash flow deficit the property generated.\nWhile the cash flow of the properties in which the Partnership holds joint venture interests has improved, the General Partner continues to pursue a number of actions aimed at improving the cash flow of these properties including improving property operating performance, and seeking rent increases where market conditions allow.\nRedwood Shores Apartments is located in the Redwood Shores Planned Unit Development of Redwood City, California, along the western shores of San Francisco Bay approximately halfway between San Francisco and San Jose. This is an upscale community and surrounding area. There are approximately 400 competing apartment units within the Redwood Shores sub-market plus various townhomes and condominiums, some of which also rent. The market rent of this higher-end product ranges between $1,200 and $1,500 per month for one and two bedroom units, respectively. However, Redwood Shores Apartments, with smaller square footage within its units and fewer amenities, competes more directly with approximately 2,000 units of comparably priced product within the nearby communities of San Mateo and Foster City. Current occupancy at Redwood Shores is 98%. Occupancy in the surrounding market for comparable apartment complexes is comparable.\nPost Lake Apartments is located in the northwest metropolitan area of Atlanta in the submarket of Cobb County. Cobb County has a diverse apartment market, catering to a wide range of apartment dwellers. Post Lake Apartments competes with the higher-end product of this submarket and has comparable rental rates. Current occupancy at Post Lake Apartments is 95% while occupancy in the surrounding market for comparable apartment complexes is 94%. The overall Atlanta market population continues to grow and thus, new rental units are under construction in this submarket. Atlanta is the most active metropolitan area in the country relative to multi-family housing permits. Approximately\n20,000 new units will be added to inventory in the two year period which began in January 1995. While the Atlanta market is still considered strong, an oversupply situation could occur. This would have a negative impact on rental and occupancy rates.\nEach of the 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. In October 1995, the Redwood Shores joint venture completed the re-marketing of the $25,630,000 bonds collateralized by the Redwood Shores Apartments. The principal and bond reserve were unchanged and the interest rate was reduced from 8.75% to 5.20%. The principal will initially be amortized by $200,000 semi-annually. The semi-annual amortization will subsequently increase by $10,000 or $15,000 for each six-month period thereafter through the next tender\/re-marketing date, October 2000. The maturity date of the bonds is September 2008. The joint venture paid refinancing fees of $320,000 and Redwood Partners paid legal fees of $39,213 in connection with the re-marketing. The Post Lake Apartments mortgage note payable matures in May 1997.\nAs of December 31, 1995, $1,118,145 was owed to the General Partner. The additional borrowings in 1995 were primarily used to fund the Partnership's share of the costs of the re-marketing of the Redwood Shores bonds. The General Partner may continue to provide additional short-term loans to the Partnership for working capital or liquidity purposes, although there is no assurance that such loans will be available. Should such short-term loans not be available, the General Partner will seek alternative third party sources of financing working capital. Should additional borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of one or both of its joint venture interests to satisfy these obligations. It is not expected that the Partnership will generate substantial Net Cash Receipts, and any cash flow that is generated is expected to be used to finance the Partnership's share of improvements that are intended to enhance the value of the properties and to repay General Partner advances.\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 properties.\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's joint ventures as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership's joint ventures.\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 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 $1,171,976 $(1,533,354) $1,009,834 $(1,431,185) Partners' capital accounts (deficit): General Partner (65,055) (803,831) (62,807) (711,681) Limited Partners (419,078) (1,978,446) (196,513) (1,603,327) Net loss: General Partner (2,248) (92,150) (4,798) (157,218) Limited Partners (222,565) (375,119) (474,956) (521,433) Per Limited Partnership Interest (31.42) (52.95) (67.05) (73.61)\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-XX, 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 ----- -------- 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 Balcor Partners-XX, the General Partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant.\n(b) Neither Balcor Partners-XX nor its officers and partners own as a group or individually any Limited Partnership Interests of the Registrant.\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 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 the Indexes to the Financial Statements and Financial Statement Schedules in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement and Certificate of Limited Partnership of Balcor Growth Fund A Real Estate Investment for Capital Appreciation, previously filed as Exhibit 3 to Amendment No. 3 dated October 1, 1986 to the Registrant's Registration Statement on Form S-11 (Registration No. 33-4963), is incorporated herein by reference.\n(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 3 dated October 1, 1986 to the Registrant's Registration Statement on Form S-11 (Registration No. 33-4963) 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. 0-15646) 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 the Indexes to the Financial Statements and Financial Statement Schedules 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 GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION\nBy: \/s\/Brian D. Parker --------------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XX, the General Partner\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.\nSignature Title Date - --------------------- ------------------------------- ------------\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XX, \/s\/Thomas E. Meador the General Partner March 25, 1996 - ---------------------- -------------- Thomas E. Meador Senior Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XX, \/s\/Brian D. Parker the General Partner March 25, 1996 - ---------------------- -------------- Brian D. Parker\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' (Deficit) 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 Growth Fund A Real Estate Investment for Capital Appreciation:\nWe have audited the financial statements of Balcor Growth Fund A Real Estate Investment for Capital Appreciation (An Illinois Limited Partnership) as listed in the index 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 Balcor Growth Fund A Real Estate Investment for Capital Appreciation 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.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 20, 1996\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION (AN ILLINOIS LIMITED PARTNERSHIP)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ----------- ----------- Cash and cash equivalents $ 139,880 $ 37,514 Accounts receivable 39,213 Investment in joint ventures with affiliates 992,883 972,320 ----------- ----------- $ 1,171,976 $ 1,009,834 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nLoan payable - affiliate $ 1,118,145 $ 731,645 Accounts payable 4,480 14,556 Due to affiliates 185,138 139,292 ----------- ----------- Total liabilities 1,307,763 885,493 ----------- -----------\nAffiliate's participation in joint venture 348,346 383,661 ----------- ----------- Limited Partners' deficit (7,084 Interests issued and outstanding) (419,078) (196,513) General Partner's deficit (65,055) (62,807) ----------- ----------- Total Partners' deficit (484,133) (259,320) ----------- ----------- $ 1,171,976 $ 1,009,834 =========== ===========\nThe accompanying notes are an integral part of the financial statements.\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' (DEFICIT) for the years ended December 31, 1995, 1994 and 1993\nPartners' Capital (Deficit) Accounts ---------------------------------------- General Limited Total Partner Partners ------------ ------------ ------------\nBalance at December 31, 1992 $ 656,601 $ (53,647)$ 710,248\nNet loss for the year ended December 31, 1993 (436,167) (4,362) (431,805) ------------ ------------ ------------ Balance at December 31, 1993 220,434 (58,009) 278,443\nNet loss for the year ended December 31, 1994 (479,754) (4,798) (474,956) ------------ ------------ ------------ Balance at December 31, 1994 (259,320) (62,807) (196,513)\nNet loss for the year ended December 31, 1995 (224,813) (2,248) (222,565) ------------ ------------ ------------ Balance at December 31, 1995 $ (484,133)$ (65,055)$ (419,078) ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Expenses: Interest on short-term loan from an affiliate $ 65,502 $ 40,003 $ 27,912 Administrative 138,987 155,844 110,285 Participation in losses of joint ventures with affiliates 10,437 299,782 319,766 ------------ ------------ ------------ Total expenses 214,926 495,629 457,963 ------------ ------------ ------------ Loss before affiliate's participation in (income) loss from joint venture (214,926) (495,629) (457,963)\nAffiliate's participation in (income) loss from joint venture (9,887) 15,875 21,796 ------------ ------------ ------------ Net loss $ (224,813)$ (479,754)$ (436,167) ============ ============ ============ Net loss allocated to General Partner $ (2,248)$ (4,798)$ (4,362) ============ ============ ============ Net loss allocated to Limited Partners $ (222,565)$ (474,956)$ (431,805) ============ ============ ============ Net loss per Limited Partnership Interest (7,084 issued and outstanding) $ (31.42)$ (67.05)$ (60.95) ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION (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 $ (224,813)$ (479,754)$ (436,167) Adjustments to reconcile net loss to net cash used in operating activities: Affiliate's participation in income (loss) from joint venture 9,887 (15,875) (21,796) Participation in losses of joint ventures with affiliates 10,437 299,782 319,766 Net change in: Accounts receivable (39,213) Accounts payable (10,076) 2,013 Due to affiliates 45,846 61,496 28,605 ------------ ------------ ------------ Net cash used in operating activities (207,932) (134,351) (107,579) ------------ ------------ ------------ Investing activities: Capital contributions to joint venture with an affiliate (206,000) (37,000) (35,000) Distributions from joint ventures with affiliates 175,000 175,000 150,000 ------------ ------------ ------------ Net cash (used in) or provided by investing activities (31,000) 138,000 115,000 ------------ ------------ ------------ Financing activities: Proceeds from loan payable - affiliate 386,500 36,000 Distributions to joint venture partner - affiliate (45,202) (45,202) (38,744) ------------ ------------ ------------ Net cash provided by or (used in) financing activities 341,298 (9,202) (38,744) ------------ ------------ ------------ Net change in cash and cash equivalents 102,366 (5,553) (31,323) Cash and cash equivalents at beginning of year 37,514 43,067 74,390 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 139,880 $ 37,514 $ 43,067 ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR GROWTH FUND A REAL ESTATE INVESTMENT FOR CAPITAL APPRECIATION (An Illinois Limited Partnership) NOTES TO FINANCIAL STATEMENTS\n1. Balcor Growth Fund A Real Estate Investment For Capital Appreciation is engaged principally in the investment in joint ventures owning residential real estate located in Atlanta, Georgia and San Francisco\/San Jose, California.\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) Investment in joint ventures with affiliates represents the recording of the Partnership's interests, under the equity method of accounting, in two joint ventures with affiliated entities. Under the equity method of accounting, the Partnership records its initial interests at cost and adjusts its investment accounts for additional capital contributions, distributions and its share of joint venture income or loss. Supplemental financial information for the respective joint ventures is provided in the attached joint venture financial statements.\n(c) 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 and investment in joint ventures from its disclosure requirements.\n(d) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less.\n(e) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income and loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n3. Partnership Agreement:\nThe Partnership was organized in August 1985. The Partnership Agreement provides for Balcor Partners-XX 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, 7,084 of which were sold through October 2, 1987, the termination date of the offering.\nThe Partnership Agreement provides that profits and losses are allocated 99% to the Limited Partners and 1% to the General Partner. 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. There shall, however, be accrued for the benefit of the General Partner as its distributive share from operations, an amount\nequivalent to approximately 1% of the total Net Cash Receipts being distributed, which will be paid only as a part of the General Partner's share of distributed Net Cash Proceeds. This accrued distributive share along with the General Partner's share of Net Cash Proceeds is subordinated to the receipt by Limited Partners of certain levels of returns as defined in the Partnership Agreement.\n4. Investment in Joint Ventures with Affiliates:\n(a) The Partnership, through Atlanta Lakes Investors (a partnership which initially was wholly-owned by the Partnership), acquired a 50% joint venture interest in Atlanta Lakes Joint Venture which owns Post Lake Apartments. The remaining 50% joint venture interest is owned by Atlanta Lakes, Inc., an entity managed by an affiliate of the General Partner. The Partnership did not raise sufficient capital to enable it to retain its original ownership percentage of Atlanta Lakes Investors without incurring additional mortgage financing. The Partnership transferred 25.83% of its interest in Atlanta Lakes Investors to another affiliate of the General Partner for 25.83% of the amount of the Partnership's cash payments made in connection with the acquisition of the property. During 1995, 1994 and 1993, Atlanta Lakes Investors received $175,000, $175,000 and $150,000, respectively, representing its portion of distributions from the joint venture.\n(b) The Partnership, through its ownership of Redwood Associates, owns a 50% joint venture interest in Redwood Partners (the \"Joint Venture\"), a joint venture between Redwood Associates and Sequoia Shores, Inc. (an entity managed by an affiliate of the General Partner). The Joint Venture acquired a 70% general partnership interest in an existing limited partnership which owns Redwood Shores Apartments. During 1995, 1994, and 1993 Redwood Associates contributed $206,000, $37,000 and $35,000, respectively, to the Joint Venture.\n5. Affiliate's Participation in Joint Venture:\nAtlanta Lakes Investors is a joint venture between the Partnership and an affiliated partnership. Profits and losses are allocated 74.17% to the Partnership and 25.83% to the affiliate. All assets, liabilities, income and expenses of the joint venture (which owns a 50% equity investment in Atlanta Lakes Joint Venture) are included in the financial statements of the Partnership with the appropriate adjustment of profit or loss for the affiliate's participation in the joint venture. Distributions of $45,202, $45,202, and $38,744 were made to the joint venture partner during 1995, 1994 and 1993, respectively, as its share of distributions received from Atlanta Lakes Joint Venture.\n6. Tax Accounting:\nThe Partnership keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder, and existing interpretations thereof. The accompanying financial statements, which are prepared in accordance with generally accepted accounting principles, will differ from the tax returns due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net loss for 1995 in the financial statements is $242,456 less than the tax loss of the Partnership for the same period.\n7. Transactions with Affiliates:\nExpenses 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 ------ ------- ------ ------- ------ ------- Reimbursement of expenses to the General Partner, at cost: Accounting $29,145 $1,702 $36,741 $14,602 $27,597 $2,300 Data processing 8,899 479 17,018 3,322 5,158 368 Investor communica- tions 2,822 None 11,974 2,708 9,434 786 Legal 4,796 548 2,512 528 487 41 Portfolio management 25,912 3,018 4,322 4,261 7,674 639 Other 2,503 343 3,408 325 1,770 119\nAs of December 31, 1995, $1,118,145 is owed to the General Partner, $386,500 of which was borrowed during 1995. The Partnership incurred interest expense of $65,502, $40,003, and $27,912 in 1995, 1994 and 1993, respectively. The Partnership paid no interest expense during these years. As of December 31, 1995, interest expense of $179,048 is payable. Interest expense was 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 6.31%.\nThe General Partner may continue to make arrangements with an affiliate to provide additional short-term loans to the Partnership to fund future working capital needs or operating deficits, although there is no assurance that such loans will be available. Should such short-term loans from affiliates not be available, the General Partner will seek alternative third party sources of financing working capital. Should additional borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of one or both of its joint venture interests to satisfy these obligations.\n8. 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 receivable, and accounts payable approximates fair value.\nATLANTA LAKES JOINT VENTURE INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Income and Expenses and 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\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 Atlanta Lakes Joint Venture\nWe have audited the financial statements and the financial statement schedule of Atlanta Lakes Joint Venture (An Illinois General 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 Atlanta Lakes Joint Venture 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\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ----------- ----------- Cash and cash equivalents $ 229,555 $ 47,918 Escrow deposits 80,257 92,357 Accounts receivable 218,300 207,180 Deferred expenses, net of accumulated amortization of $190,493 in 1995 and $168,513 in 1994 29,306 51,286 ----------- ----------- 557,418 398,741 ----------- ----------- Investment in real estate: Land 3,794,165 3,794,165 Buildings and improvements 21,297,917 21,297,917 ----------- ----------- 25,092,082 25,092,082 Less accumulated depreciation 7,623,429 6,970,136 ----------- ----------- Investment in real estate, net of accumulated depreciation 17,468,653 18,121,946 ----------- ----------- $ 18,026,071 $ 18,520,687 =========== ===========\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 902 $ 3,112 Security deposits 109,891 108,009 Mortgage note payable 15,195,030 15,415,878 ----------- ----------- Total liabilities 15,305,823 15,526,999\nPartners' capital 2,720,248 2,993,688 ----------- ----------- $ 18,026,071 $ 18,520,687 =========== ===========\nThe accompanying notes are an integral part of the financial statements.\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nSTATEMENTS OF INCOME AND EXPENSES AND PARTNERS' CAPITAL for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Income: Rental and service $ 4,077,724 $ 3,812,914 $ 3,634,210 Interest on short-term investments 11,003 6,393 7,037 ------------ ------------ ------------ Total income 4,088,727 3,819,307 3,641,247 ------------ ------------ ------------ Expenses: Interest on mortgage note payable 1,416,761 1,436,202 1,453,932 Depreciation 653,293 653,293 650,296 Amortization of deferred expenses 21,980 21,980 21,980 Property operating 1,474,839 1,431,346 1,288,293 Real estate taxes 246,286 227,583 232,857 Property management fees 188,804 160,401 154,262 Administrative 10,204 11,423 8,395 ------------ ------------ ------------ Total expenses 4,012,167 3,942,228 3,810,015 ------------ ------------ ------------ Net income (loss) 76,560 (122,921) (168,768)\nPartners' capital at beginning of year 2,993,688 3,466,609 3,935,377\nDistributions to joint venture partners (350,000) (350,000) (300,000) ------------ ------------ ------------ Partners' capital at end of year $ 2,720,248 $ 2,993,688 $ 3,466,609 ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Operating activities: Net income (loss) $ 76,560 $ (122,921)$ (168,768) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation of property 653,293 653,293 650,296 Amortization of deferred expenses 21,980 21,980 21,980 Net change in: Escrow deposits 12,100 (3,141) (4,835) Accounts receivable (11,120) (12,966) (10,268) Accounts payable (2,210) 112 Security deposits 1,882 13,164 3,460 ------------ ------------ ------------ Net cash provided by operating activities 752,485 549,409 491,977 ------------ ------------ ------------ Investing activity: Improvements to property (89,891) Net cash used in investing ------------ activity (89,891) ------------ Financing activities: Distributions to joint venture partners (350,000) (350,000) (300,000) Principal payments on mortgage notes payable (220,848) (201,408) (183,679) ------------ ------------ ------------ Net cash used in financing activities (570,848) (551,408) (483,679) ------------ ------------ ------------ Net change in cash and cash equivalents 181,637 (1,999) (81,593)\nCash and cash equivalents at beginning of year 47,918 49,917 131,510 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 229,555 $ 47,918 $ 49,917 ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Atlanta Lakes Joint Venture (the \"Joint Venture\") is engaged solely in the operation of residential real estate located in Atlanta, Georgia.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the Joint Venture 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.\n(c) Effective January 1, 1995 the Joint Venture 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 Joint Venture records its investment 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 the property. The Joint Venture estimates the fair value of the property 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 Joint Venture 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 Joint Venture considers the method referred to above to result in a reasonable measurement of the 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 agreement.\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\nby 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) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(g) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less.\n(h) The Joint Venture is not liable for Federal income taxes and each partner recognizes its proportionate share of the Joint Venture loss or income in its tax return; therefore, no provision for income taxes is made in the financial statements of the Joint Venture.\n(i) A reclassification has been made to the previously reported 1994 and 1993 financial statements to conform with the classifications used in 1995. This reclassification has not changed the 1994 or 1993 results.\n3. Joint Venture Agreement:\nThe Joint Venture was organized in December 1986 and provides for Atlanta Lakes Investors, an Illinois limited partnership, and Atlanta Lakes, Inc., an Illinois corporation, to be joint venturers (together, the \"Partners\"). Atlanta Lakes Investors is owned by Balcor Growth Fund A Real Estate Investment for Capital Appreciation (\"BGF\") and Balcor Employee Investment Partners-87. An affiliate of the General Partner of BGF manages the business activities of Atlanta Lakes, Inc.\nThe Joint Venture Agreement provides that each Partner will have a participation percentage of 50% in the Joint Venture. Each item of income, gain, loss, deduction or credit for each year will be allocated to the Partners in accordance with their respective participation percentages. The Partners may set aside as a reserve for contingencies and\/or working capital, any portion of Net Cash Receipts and\/or Net Capital Proceeds which they reasonably deem necessary or appropriate for the business of the Joint Venture. Net Cash Receipts of the Joint Venture shall be distributed from time to time as the Partners shall determine, in accordance with the Partners' respective participation percentages. Net Capital Proceeds shall be distributed first, to the repayment in full of any loans or advances made to the Joint Venture by any Partner; and thereafter, to the Partners in accordance with their respective participation percentages.\nDuring 1995, 1994 and 1993, the Joint Venture distributed $350,000, $350,000 and $300,000, respectively, to its Partners.\n4. Mortgage Note Payable:\nThe Joint Venture obtained first mortgage financing in the amount of $16,575,000 collateralized by Post Lake Apartments, which has a carrying value of $17,468,653 at December 31, 1995. The mortgage note bears interest at the rate of 9.25% and is payable in monthly installments of principal and interest of $136,468 through May 1997, the maturity date of the loan. At maturity, the Joint Venture will be required to make a balloon payment of approximately $14,867,000, which will require the sale or refinancing of the property.\nFuture annual maturities of the above mortgage note payable during each of the next two years are approximately as follows:\n1996 $ 242,000 1997 14,953,000\nDuring 1995, 1994, and 1993 the Joint Venture incurred and paid interest expense on the mortgage note payable of $1,416,761, $1,436,202 and $1,453,932, respectively.\n5. Management Agreement:\nPost Lake Apartments is managed by an affiliate of the seller for a management fee of 4.25% of gross receipts. In addition, the manager is entitled to receive 20% of operating income in excess of the budgeted operating income for each year up to an amount which, when added to the base monthly fee, equals 5.5% of the gross receipts for Post Lake for such calendar year. The manager earned $15,240 and $3,683 of additional management fees for 1995 and 1993. The operating income did not exceed the budgeted operating income in 1994. The term of the agreement continues until terminated by either party.\n6. Tax Accounting:\nThe Joint Venture 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 $169,210 more than the tax loss of the Joint Venture for the same period.\n7. 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.\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.\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nATLANTA LAKES JOINT VENTURE (An Illinois General Partnership)\nNOTES TO SCHEDULE III\n(a) See description of the mortgage note payable in Note 4 of Notes to Financial Statements.\n(b) Consists of acquisition and investigatory fees, legal fees, appraisal fees, title costs and other related professional fees.\n(c) Guaranteed income earned under the terms of the management agreement was recorded by the Joint Venture as a reduction of the basis of the property.\n(d) The aggregate cost of land, buildings, and improvements is the same for Federal income tax purposes.\n(e)Reconciliation of Real Estate ----------------------------- 1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $25,092,082 $25,092,082 $25,002,191\nAdditions during the year: Improvements 89,891 ----------- ----------- ------------\nBalance at end of year $25,092,082 $25,092,082 $25,092,082 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $6,970,136 $6,316,843 $5,666,547\nDepreciation expense for the year 653,293 653,293 650,296 ---------- ---------- ---------- Balance at end of year $7,623,429 $6,970,136 $6,316,843 ========== ========== ==========\n(f) Depreciation expense is computed based upon the following estimated useful lives: Years -----\nBuilding and improvements 30 Furniture and fixtures 5\nREDWOOD PARTNERS INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Income and Expenses and 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\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 Redwood Partners\nWe have audited the financial statements and the financial statement schedule of Redwood Partners (An Illinois General 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 Redwood Partners 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\nREDWOOD PARTNERS (An Illinois General Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ----------- ----------- Cash and cash equivalents $ 7,025 $ 9,887 Bond reserve 2,478,000 2,478,000 Accounts and accrued interest receivable 587,529 204,228 Deferred expenses, net of accumulated amortization of $17,961 in 1995 341,252 ----------- ----------- 3,413,806 2,692,115 ----------- ----------- Investment in real estate: Land 6,043,941 6,043,941 Buildings and improvements 22,942,335 22,942,335 ----------- ----------- 28,986,276 28,986,276 Less accumulated depreciation 7,329,420 6,598,769 ----------- ----------- Investment in real estate, net of accumulated depreciation 21,656,856 22,387,507 ----------- ----------- $ 25,070,662 $ 25,079,622 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nAccounts payable $ 70,217 $ 3,890 Security deposits 113,213 115,565 Mortgage note payable 25,530,000 25,917,500 ----------- ----------- Total liabilities 25,713,430 26,036,955\nPartners' deficit (642,768) (957,333) ----------- ----------- $ 25,070,662 $ 25,079,622 =========== ===========\nThe accompanying notes are an integral part of the financial statements.\nREDWOOD PARTNERS (An Illinois General Partnership)\nSTATEMENTS OF INCOME AND EXPENSES AND PARTNERS' DEFICIT for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Income: Rental and service $ 3,604,060 $ 3,450,870 $ 3,437,041 Interest on short-term investments 271,092 303,404 302,390 ------------ ------------ ------------ Total income 3,875,152 3,754,274 3,739,431 ------------ ------------ ------------\nExpenses: Interest on mortgage note payable 2,047,003 2,290,644 2,318,298 Depreciation 730,651 730,652 730,651 Amortization of deferred expenses 17,961 Property operating 857,163 797,404 773,747 Real estate taxes 296,936 286,438 282,440 Property management fees 139,319 138,142 137,530 Administrative 64,760 31,422 16,124 ------------ ------------ ------------ Total expenses 4,153,793 4,274,702 4,258,790 ------------ ------------ ------------ Loss before seller's participation in loss of joint venture (278,641) (520,428) (519,359) Seller's participation in loss of joint venture 181,206 43,784 48,593 ------------ ------------ ------------ Net loss (97,435) (476,644) (470,766)\nPartners' deficit at beginning of year (957,333) (554,689) (153,923)\nContributions from joint venture partners 412,000 74,000 70,000 ------------ ------------ ------------ Partners' deficit at end of year$ (642,768)$ (957,333)$ (554,689) ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nREDWOOD PARTNERS (An Illinois General Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------ ------------ ------------ Operating activities: Net loss $ (97,435)$ (476,644)$ (470,766) Adjustments to reconcile net loss to net cash provided by operating activities: Seller's participation in loss from joint venture (181,206) (43,784) (48,593) Depreciation of property 730,651 730,652 730,651 Amortization of deferred expenses 17,961 Net change in: Accounts receivable (243,301) 19,022 (20,772) Accounts payable 66,327 140 Due to affiliates (506) Security deposits (2,352) (4,245) (6,140) ------------ ------------ ------------ Net cash provided by operating activities 290,645 225,001 184,014 ------------ ------------ ------------ Financing activities: Capital contributions by joint venture partners 412,000 74,000 70,000 Capital contributions by joint venture partner - seller 181,206 43,784 48,593 Principal payments on mortgage note payable (387,500) (352,500) (322,500) Payment of deferred expenses (359,213) Funding of reserve for replacements (140,000) ------------ ------------ ------------ Net cash used in financing activities (293,507) (234,716) (203,907) ------------ ------------ ------------ Net change in cash and cash equivalents (2,862) (9,715) (19,893)\nCash and cash equivalents at beginning of year 9,887 19,602 39,495 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 7,025 $ 9,887 $ 19,602 ============ ============ ============\nThe accompanying notes are an integral part of the financial statements.\nREDWOOD PARTNERS (An Illinois General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Redwood Partners (the \"Joint Venture\") is engaged solely in the operation of residential real estate located in the San Francisco\/San Jose, California market.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the Joint Venture 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 financial statements include the accounts of Redwood Partners and its 70% general partnership interest in Redwood Shores Apartments Associates (\"RSAA\") on a consolidated basis. The seller owns a 30% limited partnership interest in RSAA. The seller's 30% participation in the operations of the property is limited to the extent of the seller's capital contributions. The seller's participation in any losses exceeding such contributions is suspended until sufficient contributions are made.\n(c) 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.\n(d) Effective January 1, 1995 the Joint Venture 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 Joint Venture records its investment 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 the property. The Joint Venture estimates the fair value of the property 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 Joint Venture 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 Joint Venture considers the method referred to above to result in a reasonable measurement of the property's fair value, unless other factors affecting the property's value indicate otherwise.\n(e) Deferred expenses consist of financing fees which are amortized over the term of the re-marketing period of the bonds secured by the property.\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.\n(i) The Joint Venture is not liable for Federal income taxes and each partner recognizes its proportionate share of the Joint Venture loss or income in its tax return; therefore, no provision for income taxes is made in the financial statements of the Joint Venture.\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 or 1993 results.\n3. Joint Venture Agreement:\nThe Joint Venture was organized in April 1987 and provides for Redwood Associates, an Illinois limited partnership, and Sequoia Shores, Inc., an Illinois corporation, to be joint venturers (together, the \"Partners\"). In June 1987, the Joint Venture acquired a 70% general partnership interest in RSAA, an existing California limited partnership which owns the Redwood Shores Apartments in Redwood City, California. Redwood Associates is owned by Balcor Growth Fund A Real Estate Investment for Capital Appreciation (\"BGF\"). An affiliate of the General Partner of BGF manages the business activities of Sequoia Shores, Inc.\nThe Joint Venture Agreement provides that each Partner will have a participation percentage of 50% in the Joint Venture. Each item of income, gain, loss, deduction or credit for each year will be allocated to the Partners in accordance with their respective participation percentages. Joint Venture distributions from all sources will also be made to the Partners in accordance with their respective participation percentages.\n4. Mortgage Note Payable:\nRSAA assumed a $28,000,000 loan (the \"Bond Loan\") funded from the proceeds of the sale of Multi-Family Housing Revenue Bonds, Series 1985B, issued by the City of Redwood City, California, consisting of $2,370,000 in serial bonds and $25,630,000 in term bonds. The Bond Loan is collateralized by a mortgage on the Redwood Shores apartment complex, which has a carrying value of $21,656,856 at December 31, 1995. A bond reserve of $2,478,000 was established with proceeds\nfrom the Bond Loan. Pursuant to the loan agreement, these amounts are invested in short-term investments and interest earned thereon accumulates to the benefit of RSAA and is applied against the debt service payments on the Bond Loan.\nIn October 1995, RSAA completed the re-marketing of the $25,630,000 term bonds. The principal and bond reserve were unchanged and the interest rate was reduced from 8.75% to 5.20%. The principal will initially be amortized by $200,000 semi-annually. The semi-annual amortization will subsequently increase by $10,000 or $15,000 for each six-month period thereafter through the next tender\/re-marketing date in October 2000. RSAA paid refinancing fees of $320,000 and Redwood Partners paid legal fees of $39,213 in connection with the re-marketing.\nThe remaining serial bonds were fully repaid during 1995. Principal and interest payments due on the term bonds reflect payments due to the bondholders and are payable monthly in an amount equal to one-sixth of the principal and interest due on the bonds semi-annually. The term bonds are subject to various redemption options and tender provisions pursuant to the terms of the bond indenture. RSAA is obligated to make principal payments on the mortgage note to the extent the bonds are redeemed or mature under these provisions. Unless there is a prior redemption of all or a part of the bonds, principal of approximately $16,820,000 will be due in September 2008, which will require the sale or refinancing of the property.\nFuture annual maturities of the above mortgage note payable during each of the next five years are approximately as follows:\n1996 $ 410,000 1997 450,000 1998 490,000 1999 530,000 2000 580,000\nRSAA incurred and paid interest expense in 1995, 1994 and 1993 on the Bond Loan of $2,047,003, $2,290,644 and $2,318,298, respectively.\n5. Management and Guarantee Agreement:\nAn affiliate of the seller, the limited partner of RSAA, is managing the property for a fee of 4% of gross rental receipts. The management agreement extends through the sale date of the property unless terminated earlier by mutual consent of the seller and the Joint Venture. In addition, Redwood Partners receives a management fee of 1% of gross rental income plus $10,000 from RSAA.\n6. Tax Accounting:\nThe Joint Venture keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder, and existing interpretations thereof. The accompanying financial statements, which are prepared in accordance with generally accepted accounting principles, will differ from the tax returns due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net loss for 1995 in the financial statements is $359,410 less than the tax loss of the Joint Venture for the same period.\n7. 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 and accounts payable approximates fair value.\nMortgage note payable: The fair value for the Joint Venture's mortgage note payable is $22,754,218. The fair value of the mortgage note payable was estimated using discounted cash flow analysis based on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities.\nREDWOOD PARTNERS (An Illinois General Partnership)\nREDWOOD PARTNERS (An Illinois General Partnership)\nNOTES TO SCHEDULE III\n(a) See description of Mortgage Note Payable in Note 3 of Notes to Financial Statements.\n(b) Guaranteed income earned under the terms of the management and guarantee agreement was recorded by the Joint Venture as a reduction of the basis of the property.\n(c) The aggregate cost of land for Federal income tax purposes is $6,607,981 and the aggregate cost of buildings and improvements for Federal income tax purposes is $16,007,658. The total of the above-mentioned is $22,615,639.\n(d)Reconciliation of Real Estate ----------------------------- 1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $28,986,276 $28,986,276 $28,986,276 ----------- ----------- -----------\nBalance at end of year $28,986,276 $28,986,276 $28,986,276 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------ 1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $6,598,769 $5,868,117 $5,137,466\nDepreciation expense for the year 730,651 730,652 730,651 ---------- ---------- ---------- Balance at end of year $7,329,420 $6,598,769 $5,868,117 ========== ========== ==========\n(e) Depreciation expense is computed based upon the following estimated useful lives: Years -----\nBuildings and improvements 30 Furniture and fixtures 5","section_15":""}
{"filename":"48174_1995.txt","cik":"48174","year":"1995","section_1":"ITEM 1. Business\nHOME BENEFICIAL CORPORATION\nHome Beneficial Corporation (\"the Corporation\") was incorporated in Virginia on March 5, 1970, for the purpose of becoming a holding company for Home Beneficial Life Insurance Company (\"the Life Company\"), which originated in 1899. On December 31, 1970, pursuant to a Plan of Reorganization proposed by the Board of Directors and approved by the stockholders of the Life Company, the Corporation acquired all of the issued and outstanding capital stock of the Life Company by merger of the Life Company into a wholly-owned subsidiary of the Corporation, the name of which was immediately changed to Home Beneficial Life Insurance Company. At the present time, the Life Company, which is engaged in the life and accident and health insurance business, is the major subsidiary of the Corporation.\nThere was no material change in the nature of business done by the Corporation during 1995.\nBUSINESS OF THE LIFE COMPANY\nThe Life Company sells group life insurance and substantially all of the forms of ordinary insurance, including universal life, whole life, term, and annuities, together with accidental death and disability riders. The Life Company's business is concentrated in six Mid-Atlantic states and the District of Columbia, and its products are marketed through its own sales force of approximately 1,150 full-time personnel assigned to some 47 district offices located in principal cities and towns. In addition to the agency force, there were some 235 supervisory, administrative, clerical and other personnel employed in the home office.\nThe following table sets forth the geographic distribution of direct business premiums received during 1995:\nPremiums Jurisdiction (In 000's)\nDelaware $ 2,596 District of Columbia 2,802 Maryland 15,210 North Carolina 10,058 Tennessee 22,084 Virginia 40,012 West Virginia 1,194\nThe maximum amount of ordinary individual insurance presently retained by the Life Company without reinsurance is $200,000 plus an additional $75,000 coverage for accidental death. The total amount of life insurance in force at December 31, 1995 reinsured by the Life Company\nwith other companies aggregated $85 million representing less than 1% of the Life Company's life insurance in force on that date. A contingent liability exists on insurance ceded to the reinsurer since the Life Company would be liable in the event that the reinsurer is unable to meet obligations assumed by it under the reinsurance agreement. The Life Company participates in several group life insurance programs as a reinsurer and also assumes reinsurance on a facultative (individual risk) basis from two other life insurance companies. Life insurance assumed relates principally to group life and represented approximately 17% of premium income and 56% of life insurance in force for 1995. Claims incurred under these group life insurance programs approximate the related premium income, and no significant assets or liabilities are required in the balance sheet.\nAccident and health insurance premiums accounted for less than 8% of premium income for 1995. A significant proportion of the accident and health premium is attributable to medical benefit coverage provided for the Life Company's employees and their dependents under its Protection and Retirement Plan. The Life Company offers no health insurance coverage other than to its own employees. The Life Company writes individual accident policies with death and dismemberment benefits. These policies accounted for approximately 30% of total accident and health premiums for 1995.\nThe Life Company, as a legal reserve company, is required by the various laws of the states in which it is licensed to transact business to carry as liabilities aggregate policy reserves which are considered adequate to meet its obligations on insurance policies in force. Such required reserves are considered statutory reserves because the methods and assumptions used in their calculation are explicitly prescribed by the laws of the various states. The liabilities shown herein for all policies issued since 1948 are based on guidelines prescribed by the American Institute of Certified Public Accountants and have been calculated in accordance with generally accepted accounting principles. Such liabilities are calculated by the use of assumptions as to mortality rates, interest rates, withdrawal rates and expense rates in effect at the time the gross premiums were calculated. Liabilities on paid-up policies include a liability for future maintenance expenses which the Life Company expects to incur. See Revenues, Benefits, Claims and Expenses, Note 1 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference from pages 11 and 12 of the 1995 Annual Report to Stockholders, for additional information relating to the Life Company's reserves.\nThe investment of the Life Company's funds and assets is determined by an Investment Committee. Generally, investments made must meet requirements established by the applicable investment statutes of the Commonwealth of Virginia governing the nature and quality of investments which may be made by life insurance companies.\nThe following table shows investments of the Life Company at December 31, 1995. Fixed maturities (bonds, notes and redeemable preferred stocks) and equity securities (nonredeemable preferred and common stocks) are stated at fair value; mortgage loans on real estate are stated at cost\nadjusted where appropriate for amortization of premium or discount;\nshort-term investments are at cost; and policy loans are stated at unpaid balances.\nThere were no principal and interest payments past due on fixed maturities at December 31, 1995.\nThe Life Company's mortgage portfolio consists of approximately 2,400 conventional first mortgages on a wide range of residential and commercial properties located primarily in those Mid-Atlantic states in which the Life Company conducts its insurance business. At December 31, 1995 the aggregate carrying value of mortgage loans was $339,773,729, broken down by category as follows:\nResidential $167,751,726 Commercial 172,022,003\nCommercial loans include loans on apartments, shopping centers, office buildings and warehouses. Generally, commercial loans range from $250,000 to $4,500,000 in principal amount. The Life Company also makes some mortgage loans to churches. Every property is inspected by a staff underwriter prior to the issuance of a loan commitment. On commercial loans of more than $250,000, the property is inspected every two years after the loan is closed as long as the balance exceeds $250,000.\nThe Life Company's mortgage lending business is heavily concentrated in the states of Virginia and North Carolina. At December 31, 1995, approximately 77% of the Life Company's mortgages, constituting approxi- mately 75% of the total book value of the Life Company's mortgage port- folio, were on residential or commercial properties located in the State of Virginia. Additionally, at the same date approximately 14% of the\nLife Company's mortgages, constituting approximately 12% of the total book value of the Life Company's mortgage portfolio, were on properties in North Carolina. The relatively high percentage of mortgage loans made in these two states reflects the geographical concentration of the Life\nCompany's insurance business activities in the same two states. Although the Life Company's mortgage loan portfolio is heavily concentrated in Virginia and North Carolina, the economies of those states are diversified, and the Life Company does not believe its mortgage loan portfolio reflects undue risk from the large percentage of its loans originated in those two states.\nAlthough the economic downturn during 1990 and 1991 was characterized by troubled real estate loans in the portfolios of many financial institutions operating in the Life Company's market, the Life Company's mortgage loan portfolio has not reflected the widely-publicized experience of other financial institutions. The Life Company presently holds one real estate parcel acquired through foreclosure with a carrying value in the financial statements of $670,000. Mortgage loans whose terms have been restructured over the past five years are immaterial, and no mortgage loans were in foreclosure proceedings at December 31, 1995. Except as indicated below, there were no mortgage loans otherwise not performing in accordance with the contractual terms.\nAt December 31, 1995, the aging schedule for delinquent mortgage loans in terms of past due days was as follows:\nPast due days 30-60 60-90 Over 90 Total\n130-60 days past due includes a substantial amount of loan payments that have been received by the Life Company's brokers after their December, 1995 cut-off reporting date to the Life Company. These amounts will be included in their next remittance report.\nThe Life Company believes the quality of its loan portfolio is attributable to its relatively stringent underwriting standards which have been in force for many years. At the present time, and for a number of years, the Life Company's lending policies have restricted mortgage loans to a maximum loan to value ratio of 75%, based on the lower of cost or appraisal, except for purchase money mortgages and insured or guaranteed mortgages. The Life Company's policy is to place mortgage loans on non-accrual status where any mortgage payment is 90 days or more past due.\nDuring the period 1986-1995, the Life Company experienced only six foreclosures on real estate loans, one in each of the years 1986, 1989, 1990 and 1995, two in 1992, none in 1993 and 1994. The total of the unpaid principal balances of loans in these six foreclosures was approxi-\nmately $1.7 million. The Life Company disposed of five properties acquired in pre-1994 foreclosure proceedings without a net loss. The Corporation does not provide a provision for loan losses in its financial statements. Based upon the de minimis loss experience of the mortgage loan portfolio over many years and the continuing satisfactory performance of its portfolio, the Corporation's management does not feel that a provision is required.\nSee Investment Operations, Note 2 of Notes to Consolidated Financial Statements, which is incorporated herein by reference from pages 12, 13, 14 and 15 of the 1995 Annual Report to Stockholders, and Schedule I included in Part IV elsewhere herein, for additional information concerning the Corporation's consolidated investment portfolio.\nThe Life Company, in common with other insurance companies, is subject to regulation and supervision in each of the states in which it does business. Such regulation is primarily for the benefit of the policy- holders of the Life Company rather than the stockholders. Although the extent of such regulation varies from state to state, in general, the insurance laws of the respective states delegate broad administrative powers to supervisory agencies. These powers relate to the granting and revocation of licenses to transact business, the licensing of agents, the approval of the forms of policies used, reserve requirements, and the type and concentration of investments permitted. In addition, the supervisory agencies have power over the form and content of required financial statements and reports, including requirements regarding accounting practices to be employed in the presentation of such statements and reports. Certain of the required accounting practices vary from generally accepted accounting principles. See Notes 1 and 7 of the Notes to Consolidated Financial Statements, which Notes are incorporated herein by reference from pages 11, 12 and 18 of the 1995 Annual Report to Stockholders.\nSeveral jurisdictions in which the Life Company does business including its domiciliary state of Virginia, have enacted legislation providing for specific regulation of the relationship between licensed insurers and their holding companies and among affiliated members of a holding company group. These statutes vary in substance from state to state, but generally speaking, vest administrative control in the insurance regulatory authority. Among the provisions found in these statutes are provisions for the filing of registration statements by insurers which are members of a holding company group, provisions that the holding company will be subject to reporting requirements and to visitation by the insurance regulatory authorities, standards as to transactions between insurers and their holding companies or between members of a holding company group, and control over the payment of extraordinary dividends. See Stockholders' Equity and Restrictions, Note 7 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference from page 18 of the 1995 Annual Report to Stockholders for additional information concerning transactions between the Life Company and its affiliates.\nThe life insurance business is intensely competitive and the Life Company competes with many other companies in the states in which it is licensed. The American Council of Life Insurance in its \"1995 Fact Book\", estimates that there were 1,770 life insurance companies doing business in the United States at the beginning of 1995.\nAccording to figures reported in the October 1995 issue of Best's Review, Life\/Health Edition, calculated on a statutory accounting basis, the Life Company ranks in the top 12% of all life insurance companies in the United States based on total admitted assets as of December 31, 1994.\nNo material portion of the business of the Life Company is dependent upon a single customer or a very few customers. The group life insurance sold by the Life Company consists largely of reinsurance participations described on page 4.\nThe Corporation's only industry segment is the business of the Life Company, and its operations have contributed over 98% of the total consolidated revenues and income before income taxes for each of the past three years.\nNeither the Corporation nor any of its subsidiaries engage in material operations outside of the United States, or derives material business from customers outside the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe principal office of the Corporation is located at 3901 West Broad Street, Richmond, Virginia 23230, which also serves as the home office premises of the Life Company. The home office building, which contains approximately 110,000 square feet of office space, was originally completed in 1950 with a 30,000 square foot addition completed in 1990. The building is used solely for company purposes.\nThe Life Company presently leases space for 61 district and detached offices in Delaware, Maryland, the District of Columbia, West Virginia, Virginia, Tennessee and North Carolina. The termination dates on these leases range from 1996 to 2005; all of the longer term leases being for district office purposes. The maximum annual rent paid under any lease is $28,776. The annualized rent under all leases in effect on December 31, 1995 was approximately $750,000.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nAs of the date of this report, neither the Corporation nor any of its subsidiaries was a party to any material pending legal proceedings.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of the Corporation's security holders during the fourth quarter of its fiscal year ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nIncorporated herein by reference from the 1995 Annual Report to Stockholders, page 22.\nITEM 6.","section_6":"ITEM 6. Selected Consolidated Financial Data\nIncorporated herein by reference from the 1995 Annual Report to Stockholders, page 23.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nIncorporated herein by reference from the 1995 Annual Report to Stockholders, pages 20 and 21.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nConsolidated financial statements of the Corporation at December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 and the independent auditor's report thereon and the Corporation's unaudited quarterly financial data for the two year period ended December 31, 1995 are incorporated herein by reference from the 1995 Annual Report to Stockholders, pages 6 through 19 and 22.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\n(a) and (b) The following table gives the name and age of each of the directors (all of whom, except L. W. Richardson and Dianne N. Collins are executive officers of the Corporation and the Life Company) and their positions and offices with the Corporation and the Life Company and the dates first elected to those positions with the Corporation.\nPosition and Offices with the Corporation and the Life Company and Date Elected to Name Age Corporation Officer Position\nDianne N. Collins 50 Director of the Corporation and the Life Company and Community Volunteer\nH. D. Garnett 53 Vice President (since 1979), Controller (since 1974) and a director of the Corporation and the Life Company\nW. G. Hancock 45 Counsel (since 1984) and a director of the Corporation and the Life Company\nG. T. Richardson 43 Vice President (since 1983) and a director of the Corporation and the Life Company\nL. W. Richardson 76 Retired Vice President and a director of the Corporation and the Life Company\nJ. M. Wiltshire, Jr. 70 Secretary (since 1994) and a director of the Corporation and the Life Company\nR. W. Wiltshire 74 Chairman of the Board (since 1983) and a director of the Corporation and the Life Company\nR. W. Wiltshire, Jr. 50 President (since 1988) and Chief Executive Officer (since 1992) and a director of the Corporation and the Life Company\nW. B. Wiltshire 47 Vice President (since 1983) and a director of the Corporation and the Life Company\nMrs. Collins was first elected to the Board of Directors of the Corporation on February 15, 1994, Messrs. Garnett, Hancock, G. T. Richardson, and W. B. Wiltshire were first elected to the Board in 1983, and Messrs. R. W. Wiltshire, Jr. and J. M. Wiltshire, Jr. were first elected to the Board in 1976 and 1971, respectively, all to fill then existing vacancies on the Board. Messrs. R. W. Wiltshire and L. W. Richardson have served as directors of the Corporation since its organization in 1970.\nAll of the above persons serve one year terms as both executive officers and directors, or in the case of L. W. Richardson and Mrs. Collins, as directors only, which expire April 2, 1996. There are no executive officers of the Corporation who are not directors.\n(c) Not applicable.\n(d) L. W. Richardson is the father of G. T. Richardson and the first cousin of R. W. Wiltshire. R. W. Wiltshire is the father of R. W. Wiltshire, Jr. and W. B. Wiltshire and the first cousin of J. M. Wiltshire, Jr.\n(e)(1) Except as set forth below, each of the persons named in (a) and (b) above has been principally employed by the Corporation and the Life Company in the present position for more than the past five years. Dianne N. Collins has been a Trustee of the 1984 Voting Trust described in Item 12 below since January 4, 1994 and a volunteer in the Richmond, Virginia community for more than the past five years. W. G. Hancock has been a partner of the law firm of Mays & Valentine since 1981 specializing in real estate and mortgage lending, insurance company regulation and general business matters. He was designated as Counsel to the Corporation and the Life Company effective June 13, 1984. L. W. Richardson retired on December 31, 1987, having served in the office shown for more than five years immediately prior to his retirement. J. M. Wiltshire, Jr. retired as an employee and salaried officer of the Corporation and the Life Company on December 31, 1995, having served as Vice President and Counsel for more than five years immediately prior to his retirement. He was elected Secretary of the Corporation and Life Company effective January 18, 1994 and continues to serve in that capacity. Effective April 7, 1992, R. W. Wiltshire, Jr. was elected Chief Executive Officer of the Corporation and the Life Company to succeed R. W. Wiltshire who had served in that office for more than five years immediately prior thereto. Prior to his election as Chief Executive Officer, R. W. Wiltshire, Jr. was responsible for the general management of the operations of the Corporation and the Life Company. R. W. Wiltshire retired as an employee and salaried officer of the Corporation and the Life Company effective September 6, 1993.\n(e)(2) Not applicable.\n(f) Not applicable.\n(g) Not applicable.\n(h) The Corporation's directors and executive officers are required to file reports with the Securities and Exchange Commission (the \"Commission\") concerning their initial ownership of shares of the Corporation's Class A and Class B Common Stock and any subsequent changes in that ownership, and the Corporation traditionally has assisted its directors and executive officers in the filing of these reports. In making these reports, the Corporation has relied on written representations of its directors and executive officers and copies of the reports that they have filed with the Commission. The Corporation believes that these filing requirements were satisfied in 1995.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\n(a) and (b) Summary Compensation Table\nThe following Summary Compensation Table sets forth certain information concerning cash compensation paid to or contributed for the benefit of the five individuals named below for services rendered to the Corporation and its subsidiaries as executive officers during each of the three years in the period ended December 31, 1995.\nSUMMARY COMPENSATION TABLE\n(1) Offices shown are of both the Corporation and the Life Company. (2) The amounts shown include employee contributions to the Thrift Plan. (3) All of the amounts shown reflect matching contributions by the Corporation and the Life Company to the Thrift Plan. The Thrift Plan is a defined contribution plan available to substantially all salaried employees. Participants may make thrift contributions to the plan in any whole percentage of 2-14% of their compensation, and the Corporation and the Life Company will make a matching contribution to the plan in an amount equal to three-fourths of the first 4% of each eligible employee's compensation so contributed for the year. All matching amounts shown for each executive officer are fully vested. Benefits under the Thrift Plan are payable at death, retirement or other termination of employment (or at January of the calendar year of age 70 1\/2, if earlier). (4) Effective December 31, 1995, J. M. Wiltshire, Jr. retired from active service as an employee and salaried officer of the Corporation and the Life Company (c) Not applicable\n(d) Not applicable\n(e) Not applicable\n(f) Pension and Postretirement Medical Benefits Plans\nThe Corporation's Retirement Plan, a defined benefit pension plan, covers substantially all employees of the Corporation and the Life Company with two months of service. The Plan provides a retirement annuity, payable by the Life Company as the insurer under the Plan, to each employee who is credited with five years of service, who attains his normal retirement age (which is age 65 or, if the employee becomes a participant at or after age 60, his fifth anniversary of becoming a participant) while employed by the Corporation or the Life Company, or who is totally and permanently disabled while an employee. The retirement annuity is earned in the form of a single life annuity for the life of the employee, commencing at the employee's normal retirement age, and is equal to the sum of retirement annuity credits earned by the employee for each calendar year he is credited with a year of service. Retirement annuity benefits under the plan can be paid as early as age 55 if the employee retires with at least ten years of service (or at disability retirement, if earlier) and must be paid starting in January of the calendar year the employee reaches age 70 1\/2, even though he has not then retired. The annuity is payable monthly and is subject to actuarial reduction in the event the employee commences to receive his retirement annuity prior to his normal retirement age (other than as a result of disability retirement) or receives his retirement annuity in a joint and survivor rather than a single life annuity form of payment. A survivor annuity benefit is provided to the employee's spouse in certain cases if the employee dies before his retirement annuity payments begin.\nThe annual annuity credit for years after 1988 is equal to 2% of the first $10,000 of the employee's compensation for the year, plus 2.5% of the employee's compensation for the year in excess of $10,000. Once an employee is credited with 35 years of service, whether before or after 1989, the annual annuity credit after 1988 becomes 2.5% of the employee's compensation for the year. Prior to 1989, several different benefit formulas were applied, and employees who were participants before 1989 will retain their annuity credits as determined through December 31, 1988 based on those earlier formulas. Covered compensation for purposes of the Plan is aggregate cash compensation up to $150,000 per year for years after 1993 ($200,000 for the year 1993), as adjusted from time to time under the Internal Revenue Code of 1986, as amended, which in the case of each executive officer is identical to the amount shown as salary in the Summary Compensation Table appearing in Item 11(a) and (b).\nThe estimated annual benefits payable under the Plan for each of the individuals listed in the Summary Compensation Table, other than J. M. Wiltshire, Jr. are as follows: R. W. Wiltshire, Jr. - $94,110, W. B. Wiltshire - $89,542, G. T. Richardson - $98,658, and H. D. Garnett - $73,672. The benefits as shown are estimated on the basis that the per- sons named will continue to receive, until the end of the calendar year in which they reach age 65, salaries at the same rates in effect during 1995 and will then retire and elect a single life rather than a joint and survivor annuity form of payment. J. M. Wiltshire, Jr. retired as an employee and salaried officer of the Corporation and the Life Company effective December 31, 1995 and receives an annual benefit of $33,936\nunder the Plan based upon his election of a joint and survivor annuity.\nAmounts payable under the Plan are not subject to deduction for social security benefits under the Federal Social Security Act.\nIn addition to the Corporation's defined benefit pension plan, the Corporation has a postretirement medical benefits plan consisting of defined benefit medical coverage for pre-1993 retirees and defined contribution medical coverage for post-1992 retirees who were active employees on December 31, 1992. The pre-1993 retiree program covers all employees who had retired under the Corporation's pension plan as of December 31, 1992. The post-1992 retiree program covers all full time active employees as of December 31, 1992 who retire under the Corporation's pension plan thereafter. Employees who joined the Corporation after December 31, 1992 are not eligible for participation in either program under the postretirement medical benefits plan.\nThe pre-1993 retiree program reimburses its participants for actual covered costs subject to specified deductibles and coinsurance. The pre- 1993 retiree program is contributory and participant contribution requirements may be increased from time to time and benefits may be modified or terminated by the Corporation. The post-1992 retiree program is noncontributory and reimburses its participants for the cost of health insurance and other health care coverage premiums up to a maximum benefit amount (stated in terms of health care spending credits) determined in accordance with the plan based on years of service as of December 31, 1992. The unused maximum benefit amount, initially determined as of December 31, 1992, is increased thereafter only for interest from January 1, 1993 until it is fully expended.\nAll current salaried executive officers of the Corporation, upon their retirement, will be covered under the post-1992 retiree program. The spending account credit balances determined as of December 31, 1995 (without interest to be credited thereafter) for each of them are as follows: R. W. Wiltshire, Jr. - $29,823, W. B. Wiltshire - $30,551, G. T. Richardson - $27,641, and H. D. Garnett - $27,641. J. M. Wiltshire, Jr. retired as of December 31, 1995 with a spending account credit balance of $32,733.\nThe Corporation is self insured with respect to benefits under the postretirement medical benefits plan.\n(g) Compensation of Directors\nAll directors of the Corporation (other than Messrs. L. W. Richardson, R. W. Wiltshire, J. M. Wiltshire, Jr., and Hancock and Mrs. Collins) are salaried executive officers. Messrs. L. W. Richardson, R. W. Wiltshire and J. M. Wiltshire, Jr. have retired as salaried executive officers of the Corporation and the Life Company on December 31, 1987, September 6, 1993, and December 31, 1995, respectively. In consideration of their past services to the Corporation and the Life Company, the Corporation agreed to pay L. W. Richardson (more than 42 years of continuous service) $30,000 per year, R. W. Wiltshire (more than 47 years of continuous service) $90,000 per year and J. M. Wiltshire, Jr. (more than 27 years of continuous service) $25,000 per year, in addition to their respective\nannual benefits of $34,109, $55,002 and $33,936 under the Corporation's pension plan. The Corporation's agreements with each of them provide that they will not compete with the Corporation or its subsidiaries, directly or indirectly, on a full time or a part time or on a consulting or advisory basis. L. W. Richardson also is a participant in the pre- 1993 retiree program under the Corporation's postretirement medical benefits plan. R. W. Wiltshire is a participant in the post-1992 retiree program under the plan and has a spending account credit balance as of December 31, 1995, after payment of premiums subsequent to his retirement, of $40,264. (See \"Pension and Postretirement Medical Benefits Plan\" in Item 11(f)). Mr. Hancock is a partner in the law firm of Mays & Valentine. The amount of legal fees paid to that firm by the Corporation and its subsidiaries and affiliates in 1995, including amounts for legal services provided by Mr. Hancock, did not exceed 5% of the firm's gross revenues for its last fiscal year. C. M. Glenn, Jr. a director of the Corporation and the Life Company until his death on April 9, 1995, served as a Consultant to the Corporation and its subsidiaries after his retirement for which he received $10,000 during 1995 in addition to his normal retirement benefits under the Corporation's pension and postretirement medical benefits plan. Under the terms of the contract, Mr. Glenn agreed to perform such services of a consulting and advisory nature as were requested of him from time to time by the Chairman of the Board of the Corporation. No director of the Corporation receives any additional compensation in the form of directors' fees or otherwise for attendance at meetings of the Board or committees thereof, or other services performed solely in his or her capacity as a director.\n(h) Employment Contracts and Termination of Employment and Change-in- Control Arrangements\n(1) Not applicable\n(2) Not applicable\n(i) Not applicable\n(j) Board of Director Interlocks and Insider Participation\nThe Corporation has no formal compensation committee, and all final decisions as to executive officer compensation are made by the entire Board of Directors. All members of the Board of Directors, except Mrs. Collins, are present or retired officers of the Corporation. Messrs. R. W. Wiltshire, Jr., W. B. Wiltshire, G. T. Richardson and Garnett are salaried executive officers of the Corporation. Messrs. R. W. Wiltshire and J. M. Wiltshire, Jr. have retired as employees of the Corporation and now serve as unsalaried executive officers in the capacities of Chairman of the Board and Secretary, respectively. L. W. Richardson is a retired executive officer of the Corporation. Mr. Hancock is an unsalaried executive officer of the Corporation and a partner in the law firm of Mays & Valentine which is general counsel to the Corporation.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) and (b) As of March 8, 1996, 5,267,275 shares of Class A Common Stock of the Corporation, constituting 63.3% of the 8,317,827 shares then outstanding, were held by trustees under a voting trust agreement dated as of May 1, 1984, which, by virtue of a voting trust extension agreement dated as of May 1, 1987, continues in force until May 11, 1997 (1984 Voting Trust). The Voting Trustees, each of whom is a director of the Corporation and the Life Company are R. W. Wiltshire, L. W. Richardson, R. W. Wiltshire, Jr., G. T. Richardson, and Dianne N. Collins (together, the Trustees). Their mailing address is 3901 West Broad Street, Richmond, Virginia 23230. The Trustees are given exclusive voting power of the Class A Common Stock subject to the 1984 Voting Trust, but must vote or execute consents in accordance with the instructions of the holders of voting trust certificates with respect to any action submitted to a vote of the holders of Class A Common Stock as to which a majority of the Trustees then in office favor an affirmative vote, where such action, if approved by the holders of Class A Common Stock in accordance with and to the extent required by law and the Corporation's Articles of Incorporation, would result in: (a) the increase or decrease of the authorized number of shares of Class A Common Stock; (b) an exchange, reclassification, or cancellation of all or part of the shares of Class A Common Stock; (c) an exchange, or right of exchange, of all or any part of the shares of another class into the shares of Class A Common Stock; (d) any change that may be adverse to the designations, preferences, limitations, voting rights or relative to other rights of any nature of the shares of Class A Common Stock; (e) any change of the shares of Class A Common Stock into a different number of shares of the same class or into the same or a different number of shares, either with or without par value, of other classes of stock; (f) the creation of a new class of stock, or change of a class with subordinate and inferior rights into a class having rights and preferences prior and superior to shares of Class A Common Stock, or any increase of the rights and preferences of any class having rights and preferences prior or superior to shares of Class A Common Stock; (g) any limitation or denial of preemptive rights of shares of Class A Common Stock; (h) the sale, lease, exchange, mortgage, pledge or other disposition of all, or substantially all, the property and assets of the Corporation; (i) the merger or consolidation of the Corporation with or into any other corporation, or of any other corporation with or into the Corporation; or (j) the dissolution of the Corporation. If a majority of the Trustees shall oppose any such matter, the Trustees need not solicit, obtain or follow directions from the holders of the voting trust certificates, and such majority of Trustees opposing any such proposal are authorized and empowered to vote all the shares of Class A Common Stock held by the Trustees under the 1984 Voting Trust against such proposal. A majority vote of the Trustees controls actions to be taken by them; they may vote in person or by proxy to another Trustee with or without direction how to vote. They may vote for themselves as directors and officers of the Corporation and fix their compensation provided it be commensurate with the duties and responsibilities of the office or position held. They may name successor trustees in event of death, resignation, removal from the Commonwealth of Virginia or incapacity of any Trustee. They receive no compensation for their services as Trustees. In the event that by virtue of a stock dividend, stock split, reclassification of stock or subscription, the Trustees receive further Class A Common Stock, it is to be held by them\nsubject to all of the provisions of the 1984 Voting Trust. In the event that as a result of any merger, consolidation, sale of assets or property, exchange or other cause, the shares of Class A Common Stock of the Corporation held by the Trustees should be converted into and become shares of another corporation, the 1984 Voting Trust shall be terminated automatically unless the amount of voting stock in such other corporation received as a result of the conversion would thereafter represent more than one-third of the issued and outstanding voting stock of such other corporation if it has no class of stock registered under the Securities Exchange Act of 1934, or more than one-twentieth of the issued and outstanding voting stock of such other corporation if it has a class of stock so registered, in either of which cases the 1984 Voting Trust shall continue in force according to its terms.\nClass B Common Stock, which has no vote on most matters, is publicly traded in the over-the-counter market and is not subject to the 1984 Voting Trust.\nDue to the substantial number of shares of Class A Common Stock held subject to the 1984 Voting Trust, the Trustees individually and collectively may be deemed to be \"control persons\" of the Corporation under rules and regulations of the Securities and Exchange Commission.\nAs of March 8, 1996, the Trustees under the 1984 Voting Trust beneficially owned, directly or indirectly, voting trust certificates evidencing an aggregate of 1,288,270 shares of Class A Common Stock subject thereto, as well as another 465,753 shares of Class A Common Stock that are not subject to the 1984 Voting Trust.\nThe following table shows as of March 8, 1996, the beneficial owner- ship of all Class A and Class B Common Stock by each director of the Corporation, and the beneficial ownership of the Corporation's Class A Common Stock by any other person or entity known to the Corporation to own more than 5% of the outstanding shares of such class. The Corporation has no executive officers who are not directors. The amounts shown for Class A Common Stock include beneficial ownership evidenced by voting trust certificates of the 1984 Voting Trust, but exclude Class A shares held by the Trustees thereunder.\nDirectors\n5% Class A Stockholders (Other Than Directors and Trustees)\n(1) Beneficial ownership has been determined in accordance with Rule 13d- 3 under the Securities Exchange Act of 1934. (2) Where an asterisk is shown, the percentage is less than 1%. (3) 5,267,275 shares of Class A Common Stock constituting 63.3% of the 8,317,827 shares outstanding are held by R. W. Wiltshire, L. W. Richardson, R. W. Wiltshire, Jr., G. T. Richardson and Dianne N. Collins, as Trustees under the 1984 Voting Trust. (4) All of the voting trust certificates for Class A shares and the Class B shares are held of record by Dixie Company and may be acquired by Mrs. Collins pursuant to her power to revoke an inter vivos trust. Such voting trust certificates are also included in the table for Dixie Company. (5) Some portion or all of the Class A shares shown for each of the indicated directors or stockholders are subject to the 1984 Voting Trust, and their beneficial ownership as to those shares is evidenced\nby voting trust certificates that have been issued to them thereunder. The number of Class A shares deposited in the 1984 Voting Trust by each of them is as follows: Dianne N. Collins - 13,536; G. T. Richardson - 427,110; L. W. Richardson - 250,708; R. W. Wiltshire - 586,276; R. W. Wiltshire, Jr. - 10,640; W. B. Wiltshire - 10,492; Dixie Company - 2,423,800; Estate of Mary Morton Parsons - 1,174,427; and Estate of George L. Richardson - 404,600. (6) All of the Class B shares shown for Mr. Garnett are owned jointly with his wife. (7) Includes an aggregate of 6,240 shares of Class A (of which 2,696 shares are evidenced by voting trust certificates of the 1984 Voting Trust) and 12,710 shares of Class B Common Stock held by directors as trustees or custodians for the benefit of children (that are not described in other footnotes to this table), or by their wives, and with respect to which beneficial ownership is or will be disclaimed by individual directors in ownership reports filed with the Securities and Exchange Commission. (8) The ownership shown for Mr. Hancock excludes 188,800 shares of Class A Common Stock held in trust for the benefit of his mother, with remainder to her issue, in which Mr. Hancock has a vested one-third beneficial interest subject to partial divestment upon any further children of his mother. (9) Includes 2,400 shares of Class A Common Stock held by Mr. Hancock and his brother and sister as trustees under inter vivos trusts created by their mother for the benefit of her six grandchildren, three of whom are children of Mr. Hancock. (10) 195,080 shares of Class A Common Stock and voting trust certificates for 404,600 shares of Class A Common Stock are held by the Estate of George L. Richardson and an inter-vivos trust created by George L. Richardson prior to his death. The co-executors of the estate and co-trustees of the trust are his grandsons, G. T. Richardson and Miles Corbett Wright, III who share voting and investment power over all of the foregoing shares. L. W. Richardson and his sister, who are the children of George L. Richardson, have a vested two-thirds present interest and a vested one-third remainder interest in the assets of the estate and trust. The ownership shown includes all such shares for G. T. Richardson and excludes all such shares for L. W. Richardson. Such shares are also included in the table for the Estate of George L. Richardson. (11) Includes 25,538 shares of Class A Common Stock evidenced by voting trust certificates of the 1984 Voting Trust and 36,912 shares of Class B Common Stock held by Mr. Richardson, as trustee with sole voting and shared investment power, for the benefit of a member of his immediate family. (12) 141,804 shares of Class A Common Stock, voting trust certificates for 94,976 shares of Class A Common Stock subject to the 1984 Voting Trust and 660 shares of Class B Common Stock are held by the Estate of Essie Lee Wiltshire for the life of R. W. Wiltshire with a vested remainder interest in the children of R. W. Wiltshire. R. W. Wiltshire is the sole executor of the Estate of Essie Lee Wiltshire. During the life of R. W. Wiltshire the income from the foregoing shares is paid to his children. In addition, R. W. Wiltshire has a life estate in voting trust certificates evidencing 450,524 shares of Class A Common Stock subject to the 1984 Voting Trust, with remainder to his children. R. W. Wiltshire, Jr. and W. B. Wiltshire have vested one-fourth beneficial interests in all of the foregoing\nshares, subject to partial divestment upon any further children of R. W. Wiltshire. The ownership shown includes such shares for R. W. Wiltshire and excludes all such shares for R. W. Wiltshire, Jr. and W. B. Wiltshire. Both R. W. Wiltshire, Jr. and W. B. Wiltshire also have the same vested one-fourth remainder interests subject to partial divestment in voting trust certificates for 17,528 Class A shares and 123,308 shares of Class B Common Stock in which various children and grandchildren of R. W. Wiltshire residing in other households have an interest for his life. The ownership shown for R. W. Wiltshire, R. W. Wiltshire, Jr. and W. B. Wiltshire does not reflect any of such shares, except in the case of R. W. Wiltshire, Jr. for voting trust certificates evidencing 8,764 Class A shares held by him for his own benefit and 26,445 Class B shares held by him as custodian for his minor children and, in the case of W. B. Wiltshire, for voting trust certificates evidencing 8,764 Class A shares held by him for his own benefit and 17,630 Class B shares held by him as custodian for his minor children. (13) Dixie Company is the nominee of Jefferson National Bank which holds 137,536 Class A shares and voting trust certificates for another 2,423,800 Class A shares in a number of fiduciary accounts that it administers (including voting trust certificates for 13,536 Class A shares previously reported in the table for Mrs. Collins). (14) Clinton Webb and NationsBank, N.A. are the co-executors of the Estate of Mary Morton Parsons.\nAs of March 8, 1996, executive officers and directors of the Corporation as a group beneficially owned 1,880,533 shares or 22.61% of the Class A (including beneficial ownership evidenced by voting trust certificates of, but exclusive of shares held by the Trustees under, the 1984 Voting Trust) and 170,446 shares or 1.9% of the Class B Common Stock of the Corporation, respectively.\n(c) The Corporation has no knowledge of any contractual arrangement which may at a subsequent date result in a change of control of the Corporation, except that the 1984 Voting Trust is scheduled to expire on May 11, 1997. Upon its expiration, the shares of Class A Common Stock of the Corporation now held by the Trustees under the 1984 Voting Trust will be held by persons presently holding voting trust certificates representing those shares.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\n(a) Not applicable.\n(b) W. G. Hancock is a partner in the law firm of Mays & Valentine which provided legal services as general counsel to the Corporation and its subsidiaries and affiliates during 1995, and is expected to serve in the same capacity in 1996. The amount of legal fees paid to that firm by the Corporation and its subsidiaries and affiliates for 1995 did not exceed 5% of the firm's gross revenues for its last full fiscal year.\n(c) Not applicable.\n(d) Not applicable.\nPart IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. and 2. Financial Statements and Financial Statement Schedules\nThe financial statements and financial statement schedules listed in the accompanying Index to Financial Statements and Financial Statement Schedules on page 22 are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed in the accompanying Index to Exhibits are filed as part of this annual report.\n(b) Reports on Form 8-K\nNone\nHOME BENEFICIAL CORPORATION and Financial Statement Schedules (Item 14(a))\nAll other schedules are omitted since the required information is not present, or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes thereto.\nThe consolidated financial statements and supplementary information listed in the above index, which are included in the Annual Report to Stockholders for Home Beneficial Corporation for the year ended December 31, 1995, are incorporated herein by reference.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report(Form 10-K) of Home Beneficial Corporation of our report dated February 9, 1996, included in the 1995 Annual Report to Stockholders of Home Beneficial Corporation.\nOur audits also included the financial statement schedules of Home Beneficial Corporation listed in Item 14(a). These schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nRichmond, Virginia February 9, 1996\nSchedule I HOME BENEFICIAL CORPORATION\n(CONSOLIDATED)\nSUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES\nAt December 31, 1995\nSchedule II\nHOME BENEFICIAL CORPORATION\n(PARENT COMPANY)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEET December 31, 1995 and 1994\n1995 1994\n(*) See Notes 6 and 7 to Consolidated Financial Statements\nSchedule II\nHOME BENEFICIAL CORPORATION\n(PARENT COMPANY)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF INCOME Years Ended December 31, 1995, 1994 and 1993\nSchedule II\nHOME BENEFICIAL CORPORATION\n(PARENT COMPANY)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (*)\n(*) Short-term investments, which consist of investments with maturities of 30 days or less, are considered cash equivalents\nSchedule IV HOME BENEFICIAL CORPORATION (CONSOLIDATED) REINSURANCE Years Ended December 31, 1995, 1994 and 1993\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHOME BENEFICIAL CORPORATION Registrant\nBy: H. D. Garnett Vice President and Controller, 3\/19\/96\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nR. W. Wiltshire Chairman of the Board and Director, 3\/19\/96\nL. W. Richardson Retired Vice President and Director, 3\/19\/96\nR. W. Wiltshire, Jr. President, Chief Executive Officer and Director, 3\/19\/96\nJ. M. Wiltshire, Jr. Secretary and Director, 3\/19\/96\nW. B. Wiltshire Vice President and Director, 3\/19\/96\nH. D. Garnett Vice President, Controller and Director, 3\/19\/96\nG. T. Richardson Vice President and Director, 3\/19\/96\nW. G. Hancock Counsel and Director, 3\/19\/96\nDianne N. Collins Director, 3\/19\/96\nHOME BENEFICIAL CORPORATION Index to Exhibits (Items 14(c)) Sequential Page Number\nExhibit 22\nHOME BENEFICIAL CORPORATION\nSUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 1995\nJurisdiction Percentage of Under Which Voting Securities Name of Subsidiaries* Organized Owned\nHome Beneficial Life Insurance Company Virginia 100%\nHBC Development Corporation Virginia 100%\n*Business name of the subsidiaries is the same.","section_15":""}
{"filename":"790966_1995.txt","cik":"790966","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nPlasti-Line, Inc. which was incorporated in Tennessee in 1984, is a leading producer of indoor and outdoor signs for corporate identification programs. These signs are used primarily at retail outlets of large national or regional companies such as automobile dealerships, gasoline stations, banks and fast food restaurants. Plasti-Line, Inc. designs, engineers and manufactures substantially all its products in Knoxville, Tennessee, Florence, Kentucky, and Ontario, California. Plasti-Line, Inc. markets its products throughout the United States and, to a limited extent, in Canada. As used herein, the \"Company\" refers to Plasti-Line, Inc. and its subsidiary unless the context requires otherwise.\nThe Company concentrates on providing a complete range of products and services to high-volume users in the automotive, fast food, petroleum, banking and other retail markets. The Company's manufacturing facilities in Knoxville, Tennessee and Ontario, California serve this aspect of the business. The Company's subsidiary, American Sign and Marketing Services, Inc. (\"American Sign\"), in Florence, Kentucky, concentrates on production and marketing of small outdoor signs, indoor signs and menuboards.\nPRODUCTS\nThe Company's basic sign product is composed of two rigid plastic faces that are molded and decorated to reflect the customer's name and logo. These faces are mounted in a steel or aluminum frame and generally placed on a steel column to permit visibility. Typically, the signs are internally illuminated to make them visible at night. The sign faces range in size from two square feet to 245 square feet.\nThe Company's products are used by its customers primarily for brand identification of their retail outlets. For high-volume customers in the automotive and fast food markets, and to a lesser extent for petroleum customers, the Company produces a full package of signs used to identify a particular retail location with the corporate image known to consumers. A package may consist of many sign elements, including (i) road signs decorated with the customer's logo and colors and often built in a distinctive shape; (ii) high rise signs typically used for locations adjacent to interstate highways or in high traffic areas; (iii) menuboards with changeable copy areas and price mechanisms to enable fast food customers to identify and change their menus and prices; (iv) signs typically used by petroleum customers to provide on-site advertising of the prices of various products; (v) specialty lighting products that provide accent or decorative lighting, typically at fast food restaurants and gasoline stations; and (vi) illuminated fascia signage that is mounted on buildings for decoration and identification.\nThe Company concentrates on high-volume, standardized products, but also produces customized signage as an accommodation to its regular customers. Custom signs typically require special fabrication techniques and tend to generate low-volume production runs with longer lead times.\nThe Company provides at least a one-year limited warranty on all signs for defects in materials and workmanship, with the Company being obligated to repair or replace any defective product.\nIn addition to production, the Company offers a complete spectrum of sign services, including design, site analysis, graphic analysis, installation and maintenance. Working with the customer or a design consultant retained by the customer, the Company assists in developing designs that meet the customer's goals. Upon customer request, the Company coordinates the sign package with local ordinances and regulatory requirements, assists in determining where to place the signs for maximum visibility and assists in obtaining necessary permits and variances. In cases where the Company has a contract for the installation of a sign, the Company utilizes the services of a subcontractor in the area in which the sign is to be installed. Maintenance service, regular cleaning, inspection and replacement of lights and other parts when needed or on a predetermined schedule are also provided through local subcontractors.\nCUSTOMERS\nThe Company for internal purposes separates its business by customers into automotive, banks, fast food, petroleum and other industry groupings. For its automotive, bank, and fast food customers, the Company typically provides a full range of products and services, including most or all of those described above. For the petroleum industry, the Company typically manufactures signs to the customer's specifications and ships them for installation by the customer's own subcontractors. Customer commitments vary by market segment and specific account. Commitments range from multi-year contracts with firm prices for all products and services, to specific orders for specific quantities at firm prices. From time to time, the Company is awarded large, one-time contracts by customers who are changing their name or image. These programs can create concentrated surges in volume.\nPRINCIPAL CUSTOMERS Since 1969, the Company's principal customers have been subsidiaries of General Motors Corporation (\"General Motors\"). General Motors accounted for approximately 21% of the Company's net sales in fiscal 1994. The loss of General Motors as a customer would have a material adverse effect on the Company if it were unable to compensate promptly for that loss by generating new business.\nThe Company's original contract for the supply of internally illuminated outdoor signs for the General Motors dealership sign program extended through December 31, 1990 with two automatic two year extensions if the Company maintained established performance levels. Both extensions were granted to the Company. Recently, another one year extension through December 31, 1995 was executed. The Company furnishes all services associated with the manufacture and installation of signs and replacement parts ordered by General Motors for approximately 9,000 participating dealerships. The contract is terminable on 30 days' notice by either party and is non-exclusive; however, the Company believes that it is currently the sole supplier for the General Motors dealership sign program. Signs are supplied for new dealerships, as replacements of signs at existing dealerships and in connection with moves to new locations. The Company provides General Motors with a 10-year limited warranty for defects in materials and workmanship, with the Company being obligated to repair or replace any defective product.\nMARKETING\nProducts and services are marketed on a direct basis and through sales representatives throughout the United States and, to a limited extent, in Canada. The Company's principal marketing focus is on companies with many retail outlets requiring substantial numbers of signs. This type of business enables the Company to maintain economic production runs, and increases the opportunity to provide a full range of services.\nMarketing opportunities are generated by the construction of new facilities, acquisition of existing locations requiring re-identification, addition of signage at existing locations, design of a new image requiring re-identification of all facilities and replacement of parts damaged by storms, vandalism and accidents.\nPRODUCTION AND RAW MATERIALS\nProduction of the Company's products is a labor intensive process. The typical sign consists of large acrylic or polycarbonate faces mounted in a metal frame and internally illuminated. The shapes of the faces are formed using vacuum or press forming after the face material has been heated. Letters or logos that are not molded into the faces are either glued or silk-screened on the faces. During the production process, signs move through the plants on an overhead monorail system. After the signs are manufactured, they are crated and shipped from the Company's facilities principally by commercial trucking companies.\nThe practice of the Company is to start producing finished goods only after receipt of a firm order from a customer, although for customers with long-term programs, the Company produces finished goods in anticipation of customer needs. Credit terms are generally net 30 days from the date of sale. Occasionally the Company engages the services of subcontractors for special manufacturing work to assist during peak production periods.\nThe Company designs and engineers its products to customer specifications. The Company's manufacturing operations include machining, welding, plastic molding and fabrication, painting, assembly and packaging. The principal raw materials and purchased components used in the Company's manufacturing process are steel shapes and sheet, aluminum shapes and sheet, electrical components (wire, sockets, ballasts and lamps) and acrylic and polycarbonate sheets. The Company does not hold any material patents or trademarks.\nTo date, the Company has experienced no difficulty in satisfying its requirements for raw materials and subcontractor assistance. It considers its sources of supply to be adequate.\nCOMPETITION\nThe Company defines its principal market as the volume production sign industry. Competition varies depending on the market segment and the size of the project. Larger projects require a more comprehensive service capability which limits the number of competitors. Smaller, less complex projects attract a larger number of competitors.\nAlthough no authoritative ranking of the Company's industry is published, the Company believes that in 1994 it was the leading supplier of volume production signs and related services in the United States. Most of the Company's competition is from other suppliers, rather than from other products.\nCompetition for national accounts, the principal source of the Company's business, is intense. The Company believes it has adequate financial resources with which to compete. In general, the Company believes that its products, contract conditions, terms, and warranty provisions are consistent with those prevailing in the industry. The Company believes that its principal advantage is its ability to provide a complete range of products and services to customers on a competitive basis.\nEMPLOYEES\nThe Company had a total of 843 full-time employees as of January 1, 1995 of which approximately sixty percent were employed under union contract.\nPRODUCT BACKLOG\nAt January 1, 1995, booked orders believed to be firm amounted to approximately $32.1 million as compared with approximately $27.1 million at January 2, 1994. Products are shipped by the Company against customer delivery schedules, which generally call for delivery two to four months after the order is placed. The Company believes that substantially all of its product backlog at January 1, 1995 will be shipped before the end of its current fiscal year. In addition to firm product backlog, the Company has open commitments from a number of customers to supply products as required to meet their construction schedules. At the time such a customer gives the Company a release to ship signs to a particular location, the Company includes the products covered by the release in backlog and commences production or ships the items from inventory.\nSEASONALITY\nThe Company's sales in fiscal 1994 exhibited some limited seasonality, with sales in the first quarter being the lowest and those in the fourth quarter the highest. First quarter sales tend to be relatively lower because of weather constraints which slow down customers' construction schedules and their pattern of sign purchases. Sales normally accelerate in the second, third and fourth quarters corresponding with accelerating construction schedules.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth the names, ages, present positions and business experience of all Executive Officers of the Company. Officers are appointed to serve at the pleasure of the Board.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns its corporate headquarters and manufacturing space in Knoxville which are housed in two buildings on 45 acres of land. One building contains approximately 23,000 square feet of office space. The other building contains approximately 325,000 square feet of manufacturing space. The facilities and equipment in Knoxville were financed in part with the proceeds of industrial revenue bonds issued on behalf of the Company and are collateralized by mortgages or liens. American Sign owns an approximately 230,000 square foot manufacturing and office facility in Florence, Kentucky. The Company owns an approximately 170,000 square foot manufacturing and office facility in Centerville, Tennessee, at which operations ceased during 1992. The Company also rents approximately 20,000 square feet of manufacturing and office facility in Ontario, California. The Company's equipment consists primarily of molds, vacuum forming equipment, computers and general office equipment. The Company believes its existing facilities and equipment are adequate for present and anticipated business. The Company does not hold any material patents or trademarks.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn December 5, 1994, the Company and its subsidiary, American Sign, filed a complaint (the \"Complaint\") against Teledyne Industries, Inc. (\"Teledyne\") in Knoxville, Tennessee, in the United States District Court for the Eastern District of Tennessee, Northern Division. This litigation arose in connection with an agreement with Teledyne whereby Teledyne was designing and developing on behalf of the Company and American Sign a drive-through order verification product for fast food restaurants (\"Horizon\"). Pursuant to the Complaint, the Company and American Sign are seeking approximately $650,000 plus interest from Teledyne plus additional amounts to be proven at trial in connection with their contract with Teledyne relating to Horizon design flaws. The Company and American Sign are also seeking a declaratory judgment against Teledyne stating that the Company and American Sign are not obligated to purchase any Horizon units.\nIn connection with the Complaint, on January 20, 1995 Teledyne filed a counterclaim against the Company and American Sign in the United States District Court for the Eastern District of Tennessee, Northern Division seeking approximately $2,355,754 plus interest and additional amounts to be proven at trial. This counterclaim is based on the Horizon contract and related fraud and tortious interference claims. The Company and American Sign dispute the allegations in Teledyne's counterclaim and intend to vigorously defend themselves in such litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nNo matters were submitted to a vote of stockholders, through a solicitation of proxies or otherwise, during the fourth quarter of the 1994 fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThis information is incorporated by reference from the inside back cover of the Company's 1994 Annual Report to Stockholders, which is attached hereto as Exhibit 13.0.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThis information is incorporated by reference from the inside cover of the Company's 1994 Annual Report to Stockholders, which is attached hereto as Exhibit 13.0.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis information is incorporated by reference from pages 15-16 of the Company's 1994 Annual Report to Stockholders, which is attached hereto as Exhibit 13.0.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThis information is incorporated by reference from pages 5-15 of the Company's 1994 Annual Report to Stockholders, which is attached hereto as Exhibit 13.0.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nInformation required under this Item with respect to Directors is incorporated by reference from pages 2-8 of the Company's Proxy Statement dated March 21, 1995. Information about Executive Officers of the Company is included in Item 1 of 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 \"Executive Compensation\" appearing on pages 6 through 8 of the Company's Proxy Statement dated March 21, 1995. Such information is incorporated herein by reference. In no event shall the information contained in the section 5 captioned \"Compensation Committee Report\" on pages 8 through 11 of the Company's Proxy Statement dated March 21, 1995, and \"Performance Graph\" on page 11 of the Company's Proxy Statement dated March 21, 1995 be incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is incorporated by reference from pages 13-14 of the Company's Proxy Statement dated March 21, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information is incorporated by reference from page 12 of the Company's Proxy Statement dated March 21, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements: See Index to Financial Statements and Financial Statement Schedules, pages 9 and 10.\n2. Financial Statement Schedules: See Index to Financial Statements and Financial Statement Schedules, pages 9 and 10.\n3. Exhibits: See Index to Exhibits, page 13.\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.\nDATED: April 3, 1995\nPLASTI-LINE, INC.\nJames R. Martin -------------------------------- James R. Martin (Principal Executive Officer)\nEach person whose signature appears below hereby authorizes James R. Martin and Mark J. Deuschle, and each of them, as attorneys-in-fact and agents, with full powers of substitution, to sign on his or her behalf, amendments to this Annual Report on Form 10-K with the Securities and Exchange Commission, granting to said attorney-in-fact and agents 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 Company in the capacities and on the dates indicated.\nPLASTI-LINE, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPLASTI-LINE, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (CONTINUED)\nPLASTI-LINE, INC. AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II\nYears ended January 1, 1995 (1994), January 2, 1994 (1993) and January 3, 1993 (1992) (In thousands)\n- ------------------------------- (a) Write-offs, net of recoveries, of uncollectible accounts.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors Plasti-Line, Inc.\nOur report on the consolidated financial statements of Plasti-Line, Inc. and Subsidiary has been incorporated by reference in this Form 10-K from page 15 of the 1994 Annual Report to Stockholders of Plasti-Line, Inc. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 11 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\nKnoxville, Tennessee February 17, 1995\nPLASTI-LINE, INC. AND SUBSIDIARIES EXHIBIT INDEX\nExhibits marked with an asterisk are filed herewith. The remainder of the exhibits have heretofore been filed with the Commission and are incorporated herein by reference.\n- -------------------------- (1) Plans and arrangements where executives receive compensation.","section_15":""}
{"filename":"814676_1995.txt","cik":"814676","year":"1995","section_1":"ITEM 1. BUSINESS.\nCeramics Process Systems Corporation (the \"Company\" or \"CPS\") develops, manufactures, and markets advanced metal-matrix composite and ceramic components used to house and interconnect microelectronic devices. These components are typically in the form of housings, packages, lids, substrates, thermal planes, or heat sinks. The Company's products are used in applications where thermal management is important such as power amplifiers for wireless communications, power modules for motor controllers, and transmit and receive modules for radar and electronic warfare.\nThe Company's products are manufactured by proprietary processes the Company has developed such as the Quickset(TM) Injection Molding Process (\"Quickset Process\") and the QuickCast(TM) Pressure Infiltration Process (\"QuickCast Process\").\nAlthough the Company's focus is the microelectronics market, the Company participates in other markets through licensing its technology to corporations who manufacture and sell products in these other markets.\nIn fiscal 1995, more than 99% of the Company's total revenue was derived from manufactured products, and less than 1% from licensing fees, versus fiscal 1994 and fiscal 1993 in which 97%, 3%, and less than 1%, and 72%, 12%, and 16%, respectively, of total revenues was derived from manufactured products, research contracts, and licensing fees, respectively.\nThe Company was incorporated in Massachusetts in 1984. The Company reincorporated in Delaware in April 1987, through merger into its wholly-owned Delaware subsidiary organized for purposes of the reincorporation. In July 1987, the Company completed its initial public offering of 1.5 million shares of its Common Stock.\nMarkets and Products - --------------------\nThe manufacture of microelectronic systems is comprised of three key steps: (1) the integration of transistors into integrated circuits (\"ICs\"), (2) the integration of ICs on boards or modules, and (3) the integration of boards and modules into systems. The Company produces products for the second and third steps described above - products used to integrate ICs on boards, and used to integrate boards and modules into systems.\nThe Company believes that as the complexity, speed, and density of electronic devices continues to increase, the market will grow for advanced packaging and interconnecting products which have a thermal coefficient of expansion match to ICs, and which provide for the efficient removal of heat from the system while providing the necessary mechanical and electrical properties.\nThe metal-matrix composite aluminum silicon carbide (\"Al-SiC\"), manufactured using the Company's proprietary processes, is a material system which meets all these requirements and which is finding acceptance in the marketplace as a replacement for copper, copper-tungsten, copper-moly, and graphite. The Company's aluminum nitride (\"AlN\") ceramic components, and high-purity aluminum oxide (\"Al2O3\") ceramic components are used in applications where high thermal conductivity and high circuit density are required, respectively.\nIn fiscal 1995, Motorola Corporation, Texas Instruments, and Hughes Corporation accounted for 27%, 21%, and 11% of total revenues, respectively. In fiscal 1994 and fiscal 1993, these same companies accounted for 1%, 23%, and 19%, and less than 1%, 2%, and 11% respectively, of total revenue. In fiscal 1995, 54% of the Company's total revenue resulted from defense-related business and 46% was from commercial or non-defense related business.\nStrategic Partnerships In Other Market Areas - --------------------------------------------\nIn addition to its primary focus in the microelectronics market, the Company participates in other markets through licensing its technology to corporations who manufacture and sell products in these other markets.\nCompanies who are licensees of CPS technology include Carpenter Technology Corporation (\"CarTech\"), Aluminum Corporation of America (\"Alcoa\"), and Vesuvius International (\"Vesuvius\"). In fiscal 1995, CPS recognized no income from license agreements with these companies.\nIn 1991, CPS and Sopretac, a subsidiary of Vallourec of Boulogne, France, established a joint venture, Metals Process Systems (\"MPS\"), to market on a worldwide basis, licenses to use the Quickset Process for metal injection molding. At December 30, 1995 the Company owned 40% of the voting stock in MPS (see Patents and Trade Secrets), and Sopretac owned 60%. The Company accounted for its investment in MPS under the equity method and did not recognize any income or dividends from the joint venture in 1995. In 1996, the Company's ownership interest in MPS was reduced to less than 1%, based on additional investment in MPS by Sopretac.\nResearch and Development - ------------------------\nAll of the research, development and engineering costs incurred for the years 1993 through 1995 pertained to partially externally funded research and development contracts. In fiscal 1995, the Company did not incur any costs for research and development. In fiscal 1994 and 1993, the Company incurred research, development and engineering costs in the amounts of $0.04 million, and $0.3 million, respectively.\nAvailability of Raw Materials - -----------------------------\nThe Company uses a variety of raw materials from numerous domestic and foreign suppliers. These materials are primarily ceramic and metal powders and chemicals. Other than certain precious metals, of which little is used by the Company, the raw materials used by the Company are available from domestic and foreign sources and none is believed to be scarce or restricted for national security reasons.\nPatents and Trade Secrets - -------------------------\nAs of December 30, 1995 the Company had 17 United States patents. The Company also had several international patent applications pending. The Company's licensees have rights to use certain patents as defined in their respective license agreements. The Company has granted co-ownership of five of its patents and licensing rights to MPS in exchange for its equity ownership in MPS. Under terms of the agreement, MPS has the exclusive right to use such patents in the area of metal powders and the Company has the exclusive right to use such patents in all other areas, provided, however, that MPS has granted to the Company a non-exclusive license to use the patents in the area of metal powders.\nThe Company intends to continue to apply for domestic and foreign patent protection in appropriate cases. In other cases, the Company believes it may be\nbetter served by reliance on trade secret protection. In all cases, the Company intends to seek protection for its technological developments to preserve its competitive position.\nBacklog and Contracts - ---------------------\nAs of December 30, 1995, the Company had a product backlog of $0.9 million, compared with a product backlog of $1.1 million at December 31, 1994. The Company shipped 54% of the year-end 1995 product backlog in 1996.\nCompetition - -----------\nThe Company has developed and expects to continue to develop products for a number of different markets and will encounter competition from different producers of ceramic and non-ceramic products. PCC Composites, Lanxide Electronic Products, and Alcoa are the Company's primary competitors in the metal matrix composite business. Kyocera Corporation and Toshiba Corporation of Japan are the primary competitors in the aluminum nitride component business. Kyocera Corporation and ACX Corporation are the primary competitors in the aluminum oxide component business.\nThe Company believes that the principal competitive factors in its markets include technical competence, product performance, quality, reliability, price, corporate reputation, and strength of sales and marketing resources. The Company believes its proprietary processes, reputation, and the price at which it can offer products for sale will enable it to compete successfully in the advanced microelectronics markets. However, many of the American and foreign companies now producing or developing products for the advanced ceramic market have far greater financial and sales and marketing resources than the Company, which may enable them to develop and market products which would compete against those developed by the Company.\nGovernment Regulation - ---------------------\nThe Company produces non-nuclear, non-medical hazardous waste in its development and manufacturing operations. The disposal of such waste is governed by state and federal regulations.\nVarious customers, vendors, and collaborative development agreement partners of the Company may reside abroad, thereby possibly involving export and import of raw materials, intermediate products, and finished products, as well as potential technology transfer abroad under the respective collaborative development agreements. These types of activities are regulated by the Bureau of Export Administration of the United States Department of Commerce.\nThe Company performs and solicits various contracts from the United States government agencies and also sells to other government contractors.\nEmployees - ---------\nAs of year-end 1995, the Company and its wholly-owned subsidiary, CPS Superconductor Corporation (\"CPSS\"), had 18 full-time employees, of whom 14 were engaged in manufacturing and engineering, and 4 in administration. The Company also employs temporary employees as needed to support production and program requirements.\nNone of the Company's employees is covered by a collective bargaining agreement. The Company considers its relations with its employees to be excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nIn February, 1994, the Company relocated its corporate headquarters, manufacturing operations, engineering activities, and research and development laboratories to a leased facility in Chartley, Massachusetts. The Company is operating at the Chartley facility as a tenant at will. Prior to its relocation to Chartley, the Company was headquartered in a leased facility in Milford, Massachusetts.\nDuring 1993, the Company also entered into a five year lease for a facility in Hopkinton, Massachusetts. In 1994, the Company used the Hopkinton facility for storage and warehousing. In 1995, the Company reached an agreement with the lessor to terminate the lease effective January 31, 1995.\nThe Company's rental expenses for operating leases was $68 thousand, $147 thousand and $217 thousand in 1995, 1994 and 1993, respectively.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a party to any litigation which could have a material adverse effect on the Company or its business and is not aware of any pending or threatened material litigation against the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the fourth quarter of the year ended December 30, 1995.\nPART II\n- -------------------------------------------------------------------------------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company has never paid cash dividends on its Common Stock. The Company currently plans to reinvest its earnings, if any, for use in the business and does not intend to pay cash dividends in the foreseeable future. Future dividend policy will depend, among other factors, upon the Company's earnings and financial condition.\nThe Company's Common Stock is traded on the Over-the-Counter Bulletin Board under the symbol CPSX.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis Annual Report on Form 10-K contains forward-looking statements that involve a number of risks and uncertainties. There are a number of factors that could cause the Company's actual results to differ materially from those forecasted or projected in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to publicly release the results of any\nrevisions to these forward-looking statements which may be made to reflect events or changed circumstances after the date hereof or to reflect the occurrence of unanticipated events.\nResponsibility For Financial Statements - ---------------------------------------\nManagement has prepared and is responsible for the consolidated financial statements and information included in this report. These financial statements were prepared in accordance with generally accepted accounting principles which are consistently applied. The Company maintains accounting and control systems to assure its records accurately and appropriately reflect the operations of the Company, based on management's best available information and judgment.\nThe Company's independent accountants, Coopers & Lybrand L.L.P. (\"Coopers & Lybrand\"), provide an independent, objective assessment of the degree to which management fulfills it responsibility for fairness in financial reporting. They evaluate the Company's financial accounting for operations and apply such tests and procedures as they deem necessary to reach and express an opinion on the financial statements. The report of Coopers & Lybrand, which includes an explanatory paragraph, is included in this report.\nRisks and Uncertainties - -----------------------\nThe Company manufactures its products to customer specifications and currently sells it products to a limited number of customers and in limited industries. Generally such customers have not been recurring in recent years. A significant portion of the Company's revenues has historically been generated from fewer than three customers and from customers in the defense industry. As discussed in Notes 2, 7 and 8 to the Company's Consolidated Financial Statements, the Company has incurred cumulative losses since its inception. In addition, the Company in 1995 and 1996 defaulted on interest and principal repayments of certain notes payable that have matured. Although the Company seeks to modify the original terms of these notes, it is unable to repay the matured balances at this time and there is no assurance that the notes will be modified on terms acceptable to the Company.\nThe Company financed its 1996 recurring working capital requirements in large part to (1) payments received from a license agreement entered into in 1996 by the Company and a customer; (2) sales to a single customer which accounted for a substantial portion of the Company's increased product revenues in 1996; and (3) $0.1 million of capital lease financing obtained by the Company and used to acquire essential production equipment. However, there is no assurance that the Company will continue to be able to meet its operating cash requirements in 1997.\nResults of Operations - ---------------------\nRevenue\nTotal revenue of $1.4 million in 1995 reflects an increase of $0.2 million, or 16%, from 1994 total revenue of $1.2 million. Over 97% of total revenue in both 1995 and 1994 consisted of sales of manufactured products; combined revenue earned under collaborative development and license agreements in 1995 amounted to $2 thousand.\nThe increase in product sales in 1995 versus the prior year was attributable to the Company being fully operational in 1995, whereas the Company was in the process of relocating to Chartley, Massachusetts, over the first nine months of 1994. The\nrelocation resulted in a series of operational inefficiencies and disruptions which had an adverse effect on product sales and related gross margins in 1994.\nTotal revenue of $1.2 million in 1994 reflected a decrease of 71% from 1993 total revenue of $4.2 million. The decline in total revenue in 1994 included a $1.8 million decline in product sales, from $3.0 mission in 1993 to $1.2 million in 1994; a $0.5 million decline in collaborative development revenue, from $0.5 million in 1993 to $0.03 million in 1994; and a $0.6 million decline in license revenue, from $0.7 million in 1993 to less than $0.01 million in 1994.\nIn addition to the Company's relocation in 1994, the decrease in product sales in 1994 versus 1993 was attributable to the completion of, or reductions in, orders from four major customers in 1993 or the first quarter of 1994, which were not replaced by significant orders from these or other customers. Product sales to these four customers amounted to $2.2 million in 1993; product sales to the same customers amounted to $0.4 million in 1994. The decrease in collaborative development and license revenue in 1994 versus 1993 is attributable to the completion of a development program with CarTech in the first quarter of 1994. Virtually all of the 1993 collaborative development and license revenues were derived from sales to CarTech.\nOperating Costs\nTotal operating costs were $2.2 million, $3.1 million, and $4.1 million for the fiscal years 1995, 1994, and 1993, respectively. Other operating expenses of $0.4 million, incurred in the fit-up of a building in connection with the Company's relocation to Chartley, Massachusetts in February, 1994, were included with total operating costs in 1994.\nCost of sales for the years 1995, 1994, and 1993 amounted to $1.6 million, $1.8 million, and $3.0 million, respectively. Research, development and engineering costs pertaining to collaborative development revenue amounted to no costs, $.04 million, and $.3 million for the years 1995, 1994, and 1993, respectively, and selling, general and administrative costs amounted to $0.6 million, $0.8 million, and $0.7 million for these same years respectively.\nThe $0.2 million reduction in cost of sales in 1995 versus 1994 is primarily attributable to the Company being fully operational in 1995 as opposed to 1994, during which time the physical relocation of the Company resulted in a series of operational inefficiencies and disruptions which had an adverse impact on the Company's costs.\nThe decrease in research, development and engineering expenses of $0.04 million from 1994 to 1995, and $0.3 million from 1993 to 1994 reflected reduced activity under collaborative development agreements over these respective years.\nThe decrease in selling, general and administrative expenses of $0.2 million from 1994 to 1995 was primarily attributable to a $0.1 million reduction in accounting and legal costs in 1995 versus 1994. Selling, general and administrative expenses increased $0.1 million in 1994 compared to 1993, primarily due to increases in marketing activities and patent costs.\nNet Other Expense\nThe Company had net other expense of less than $1 thousand, $38 thousand, and $274 thousand for the fiscal years 1993, 1994, and 1995, respectively. The increase in net other expense over this three year period was primarily due to an increase in\ninterest expense accrued on a larger average principal balance of interest bearing debt agreements over these years.\nIncome Taxes - ------------\nThe Company neither paid nor accrued income taxes in 1995, 1994, or 1993 due to its tax losses in those years. The Company's net operating loss carryforward was approximately $34 million at December 30, 1995.\nCertain provisions of the Internal Revenue Code limit the annual utilization of net operating loss carryforwards if, over a three-year period, a greater than 50% change in ownership occurs.\nLiquidity and Cash Reserves - ---------------------------\nCash on hand at December 30, 1995 totaled $32 thousand, a decrease of $220 thousand from the 1994 year end balance of $253 thousand.\nIn 1994 and 1995, the Company issued notes and convertible notes in the amount of $2.4 million to finance its working capital obligations and building fit-up costs (See Notes 7, 8, and 14 to the Notes to Consolidated Financial Statements). Certain of these notes and convertible notes matured in 1995 and 1996. The Company defaulted on principal and interest repayments of these obligations, and is currently unable to repay this debt. Although the Company seeks to modify the original terms of the notes and convertible notes, there is no assurance that these obligations can be modified on terms acceptable to CPS.\nAlthough the Company was able to finance its operating cash requirements in 1996, there is no assurance that the Company will be able to continue to meet its operating cash requirements in 1997.\nIn November 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 123 \"Accounting for Stock-Based Compensation\". The Company intends to adopt the disclosure requirements of SFAS No. 123 for the year ending December 28, 1996; therefore the adoption will have no impact on the Company's financial position or results of operation.\nInflation - ---------\nInflation had no material effect on the results of operations or financial condition during 1995, 1994, or 1993. There can be no assurance, however, that inflation will not affect the Company's operations or business in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index to the Company's Financial Statements and the accompanying financial statements and notes which are filed as part of this Annual Report on Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\n- -------------------------------------------------------------------------------- ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDirectors of the Company are elected annually and hold office until the next annual meeting of stockholders and until their respective successors are duly elected and qualified. The executive officers of the Company are appointed by the Board of Directors and hold office until their respective successors are duly elected and qualified.\nMr. Grant C. Bennett has held the positions of President, Chief Executive Officer and Director of the Company since September, 1992. Prior to that time, he served as Vice President-Marketing and Sales of the Company from November, 1985 to September, 1992. Before joining CPS, Mr. Bennett was a consultant at Bain & Company, a Boston-based management consulting firm.\nMr. Peter F. Valentine has held the position of Treasurer since August, 1992, and has served as Controller of the Company since June, 1989. Prior to joining the Company, Mr. Valentine served as Controller of Martindale Associates, a distributor of industrial computer systems.\nDr. H. Kent Bowen has served as a Professor at Harvard Business School since July, 1992. Prior to that time, he held the position of Ford Professor of Engineering at the Massachusetts Institute of Technology (\"MIT\") from 1981 to 1992. Dr. Bowen served as Co-Director of the Leaders for Manufacturing Program at MIT from 1991 through July, 1992. Dr. Bowen has been a Director of the Company since 1984 and served as Chairman of the Board of Directors of the Company from 1984 to August, 1988.\nMr. Francis J. Hughes, Jr. has served as President of American Research and Development Corporation (\"ARD\"), a venture capital firm, since 1992. Mr. Hughes joined ARD's predecessor organization in 1982, and became Chief Operating Officer in 1990. Mr. Hughes served as General Partner (or general partner of the general partner) of the following venture capital funds: ARD I, L.P., ARD II, L.P. (since July, 1985), ARD III, L.P. (since April, 1988) and Hospitality Technology Fund, L.P. (since June, 1991). Mr. Hughes has served as a Director of the Company since 1993. Mr. Hughes is also a director of RF Monolithics, Inc. and Sequoia Systems, Inc.\nThere are no family relationships between or among any executive officers or Directors of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDirectors' Fees - ---------------\nUnder the terms of the Company's 1992 Director Option Plan (the \"Director Plan\"), Directors who are neither officers nor employees of the Company (the \"Outside Directors\") are entitled to receive stock options as compensation for their services as Directors. A non-statutory stock option (the \"initial option\") to purchase up to 4,000 shares of Common Stock was granted on May 1, 1992 to each eligible Director who was then serving as a Director, and shall be granted to each other eligible Director upon his or her initial election as a Director. Also, each eligible Director is entitled to receive a non-statutory stock option (the \"reelection option\") to purchase up to 2,000 shares of Common Stock on each subsequent date that he or she is reelected as a Director of the Company. In addition, under the terms of the Plan, the Director serving as Chairman of the Board and each Director serving on a standing committee of the Board is entitled to receive an option to an additional 500 shares as part of his initial option and each reelection option. Options vest in 12 equal monthly installments beginning one month from the date of grant, provided that 2,000 shares of each initial option vest immediately. No options were granted to Directors under the Director Plan in 1994. At December 30, 1995, options to purchase 35,500 shares of Common Stock were outstanding under the Director Plan.\nOutside Directors may receive expense reimbursements for attending Board and Committee Meetings. Directors who are officers or employees of the Company do not receive any additional compensation for their services as Directors.\nSeverance Benefit Program - -------------------------\nEffective June 1, 1989, the Board of Directors adopted the Company's Severance Benefit Program (the \"Severance Program\") for certain employees and officers selected from time to time by the Compensation Committee. The Severance Program, which extends through May, 1998, provides that upon \"Involuntary Termination\" of a participating employee (a \"Participant\"), such Participant will (i) continue to receive 50% of his then current annual base salary for a period of six months from the termination date, (ii) receive a lump sum payment at the time of termination equal to the Participant's unused vacation pay, and (iii) for a period not to exceed six months, continue to receive benefits in all group benefit plans of the Company in which such Participant participated immediately prior to termination, at a cost to the Participant no greater than the cost at the time of termination. \"Involuntary Termination\" is defined in the Severance Program as the (a) involuntary termination of employment, other than for \"cause\" or due to disability or death, or (b) voluntary termination of employment as a result of reduction in the Participant's salary, other than a reduction which is related primarily to the economic performance or prospects of the Company, and which is not applied to an individual Participant. \"Cause\" is defined in the Severance Program as willful engaging of a Participant in conduct that is materially injurious to the Company.\nIn order to receive benefits under the Severance Program, the Participant may not (i) become employed by, render any services for, act on behalf of, or have any interest, direct or indirect, in any business which competes, directly or indirectly, with the Company, or (ii) recruit or solicit any employee of the Company to terminate his or her employment or relationship with the Company.\nMr. Bennett is currently participating in the Severance Program. No amounts were paid under the Severance Program in 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\ninterest thereon), convertible within 60 days after January 23, 1997 (See \"Certain Transactions\"). Includes options to purchase 4,800 shares of Common Stock exercisable within 60 days after January 23, 1997.\n(5) Excludes 821,469 shares of Common Stock owned by ARD III, an entity under common control with ARD I. Excludes an option to purchase 4,500 shares of Common Stock, exercisable within 60 days after January 23, 1997, held by Mr. Hughes, a Director of the Company and former General Partner of a partnership which controls ARD I. Includes an aggregate of 302,302 shares of Common Stock issuable upon conversion of the Convertible Notes held by ARD I (including principal and interest thereon), convertible within 60 days after January 23, 1997 (See \"Certain Transactions\"). Includes options to purchase 4,200 shares of Common Stock exercisable within 60 days after January 23, 1997.\n(6) Includes an aggregate of 251,726 shares of Common Stock issuable upon conversion of the Convertible Notes held by Techno Venture Management Corp. (\"TVM\")(including principal and interest thereon), convertible within 60 days after January 23, 1997 (See \"Certain Transactions\").\n(7) Includes 688,500 shares of Common Stock owned by ARD I and 821,469 shares of Common Stock owned by ARD III, as to which shares Mr. Hughes disclaims beneficial ownership. Mr. Hughes, a Director of the Company, is a General Partner of partnerships which control ARD I and ARD III. Includes an aggregate of 662,732 shares of Common Stock issuable upon conversion of the Convertible Notes held by ARD I and ARD III (including principal and interest thereon), convertible within 60 days after January 23, 1997 (See \"Certain Transactions\"); Mr. Hughes disclaims beneficial ownership of these shares. Includes options to purchase 4,500 shares of Common Stock held by Mr. Hughes which are exercisable within 60 days after January 23, 1997. Includes options to purchase an aggregate of 9,000 shares of Common Stock, exercisable within 60 days after January 23, 1997, held by ARD I and ARD III.\n(8) Includes (a) an aggregate of 1,509,969 shares of Common Stock owned by affiliates of Directors, as to which shares they disclaim beneficial ownership, (b) includes an aggregate of 662,732 shares of Common Stock issuable upon conversion of the Convertible Notes held by affiliates of Directors (including principal and interest thereon), convertible within 60 days January 23, 1997 (See \"Certain Transactions\"), as to which shares the Directors disclaim beneficial ownership, and (c) an aggregate of 6,317 shares of Common Stock which officers and Directors have the right to acquire under outstanding stock options exercisable within 60 days after January 23, 1997, and (d) an aggregate of 9,000 shares of Common Stock which a Director has the right to acquire under outstanding stock options exercisable within 60 days after January 23, 1997, as to which shares the Director disclaims beneficial ownership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn February, 1991, the Company transferred to Metals Process Systems (\"MPS\"), a French societe anonyme, certain licensing rights and a co-ownership interest in certain of the Company's patents, for 49% of the voting stock of MPS. Under the terms of the transfer agreement, MPS shall have the exclusive right to use such patents in the area of metal powders and the Company shall have the exclusive right to use such patents in all other areas, provided, however that MPS has granted to the Company a non-exclusive license to use the patents in the area of metal powders. In 1993, this equity position was adjusted to 40%, based on additional capital contributions to MPS by the Company and Sopretac, the co-owner of the joint venture. The Company's investment was recorded under the equity method. To date the Company's\ninvestments in MPS have been written down to zero as the Company's share of MPS' losses have exceeded its investment. In 1995 the Company contributed approximately $60,000 to MPS, which, based on CPS'share of MPS' losses, was also charged to operations in 1995. In 1996, CPS' equity interest was reduced to 1% based upon additional investment by Vallourec in MPS.\nPART IV\n- -------------------------------------------------------------------------------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of this Form 10-K.\n1. Financial Statements -------------------- The financial statements filed as part of this Form 10-K are listed on the Index to Consolidated Financial Statements on page 22 of this Form 10-K.\n2.a. Exhibits --------\nThe exhibits to this Form 10-K are listed on the Exhibit Index on pages 18-20 of this Form 10-K.\n2.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.\nCERAMICS PROCESS SYSTEMS CORPORATION\nBy: \/s\/ Grant C. Bennett --------------------------- Grant C. Bennett President Date: March 7, 1997\nPursuant to the Requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ Grant C. Bennett President and Director } - -------------------------- (Principal Executive Officer) } Grant C. Bennett } } } \/s\/ Peter F. Valentine Controller and Treasurer } - -------------------------- (Principal Financial and } Accounting Officer) } } } March 7, 1997 } \/s\/ H. Kent Bowen Director } - -------------------------- } H. Kent Bowen } } } \/s\/ Francis J. Hughes, Jr. Director } - -------------------------- } Francis J. Hughes, Jr. } }\nCERAMICS PROCESS SYSTEMS CORPORATION\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF CERAMICS PROCESS SYSTEMS CORPORATION\nPage ----\nReport of Independent Accountants 22\nConsolidated Balance Sheets as of December 30, 1995 and December 31, 1994 23-24\nConsolidated Statements of Operations for the years ended December 30, 1995, December 31, 1994, and January 1, 1994 25\nConsolidated Statements of Stockholders' Deficit for the years ended December 30, 1995, December 31, 1994, and January 1, 1994 26\nConsolidated Statements of Cash Flows for the years ended December 30, 1995, December 31, 1994, and January 1, 1994 27\nNotes to Consolidated Financial Statements 28-37\nAll schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS - --------------------------------------------------------------------------------\nThe Board of Directors and Stockholders Ceramics Process Systems Corporation\nWe have audited the consolidated financial statements of Ceramics Process Systems listed in the index on page 22 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. 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 Ceramics Process Systems Corporation as of December 30, 1995 and December 31, 1994, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 30, 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 in Note 2 to the consolidated financial statements, the Company's need for additional capital and its cumulative losses from operations 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 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nCOOPERS & LYBRAND L.L.P.\nBoston, Massachusetts January 17, 1997\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(1) Nature of Business ------------------\nCeramics Process Systems Corporation develops, manufactures, and markets advanced metal-matrix composite and ceramic components used to house and interconnect microelectronic devices.\n(2) Summary of Significant Accounting Policies ------------------------------------------\n(a) Principles of Consolidation --------------------------- The consolidated financial statements include the accounts of Ceramics Process Systems Corporation and its wholly-owned subsidiary, CPS Superconductor Corporation (\"CPSS\"). All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts in the fiscal 1993 financial statements have been reclassified to conform to the 1995 and 1994 presentation.\n(b) Basis of Presentation --------------------- The accompanying financial statements have been presented on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Although operating income was positive in 1993, the Company has experienced cumulative losses from operations since its inception.\nThe Company has continued to incur losses from operations. In addition, as discussed in Notes 7 and 8, certain of the Company's notes and convertible notes payable obligations have matured, and in 1995 and 1996, the Company defaulted on the related principal repayments and interest obligations.\nIn 1996, the Company entered into a license agreement which provides for the use of certain of its patented technology and the sale of its products. Also, sales to a single customer contributed to a significant portion of product revenue in 1996. Amounts received from this customer, payments received under the license agreement, and capital lease financing obtained by the Company funded working capital requirements in 1996. Additionally, the Company continues to aggressively market the products it manufactures, and seeks to modify the original terms of its notes and convertible notes payable.\nThere is no assurance that revenues from the license agreement or sales to the significant customer noted above will continue. Also, there is no assurance that the notes and convertible notes payable can be modified on terms acceptable to the Company.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(2) Summary of Significant Accounting Policies (continued)\n(d) Property and Equipment ---------------------- Property and equipment are stated at cost. Depreciation of equipment is calculated on a straight-line basis over an estimated useful life, generally five years. Amortization under capital leases is calculated on a straight-line basis over the life of the lease. Depreciation of leasehold improvements is calculated using the straight-line method over the lease term or the estimated useful lives, whichever is shorter. Upon retirement, the cost and related accumulated depreciation or amortization are removed from their respective accounts. Any gains or losses are included in the results of operations in the period in which they occur.\n(e) Revenue Recognition ------------------- The Company recognizes product revenue generally upon shipment. Revenue related to research and development contracts is recognized on the percentage-of-completion basis, which is generally based on the relationship of incurred costs to total estimated costs on each contract. Revenue related to license agreements is recognized upon receipt of the license payment or over the license period, if the Company has continuing obligations under the agreement. Advance payments in excess of revenue recognized are recorded as deferred revenue.\n(f) Research and Development Costs ------------------------------ Research and development costs are charged to expense as incurred.\n(g) Income Taxes ------------ The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 proscribes the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between tax and financial statement basis of assets and liabilities, measured using enacted tax rates expected to be in effect in the period which the temporary differences reverse.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(2) Summary of Significant Accounting Policies (continued) ------------------------------------------------------\n(h) Net Income (Loss) Per Share --------------------------- Net loss per share is calculated based on the weighted average number of common shares outstanding during the year. Stock options and stock purchase warrants are not considered in the calculations of net loss per share since their effect would be antidilutive. Net income per share is calculated based on the weighted average number of common and common share equivalents outstanding during the year, using the treasury stock method. Primary and fully diluted earnings per share were not separately stated for 1993, as they were the same.\n(i) 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 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.\n(j) Risks and Uncertainties ----------------------- The Company manufactures its products to customer specifications and currently sells its products to a limited number of customers in a limited number of industries. Generally such customers have not been recurring in recent years. A significant portion of the Company's revenues has historically been generated from fewer than three customers and from customers in the defense industry. Financial instruments which potentially subject the Company to concentrations of credit risk consist of trade accounts receivable. The Company has not incurred significant losses on its accounts receivable in the past.\n(k) Financial Instruments --------------------- A substantial portion of the Company's borrowings have been financed by significant stockholders of the Company, some of which have reduced their ownership interest subsequent to December 30, 1995. In addition, the Company is in default of a significant portion of its notes payable and convertible notes payable. As a result of the Company's defaults and the uncertainties surrounding the Company's ability to continue as a going concern, it is not practicable to estimate the fair value of the Company's notes payable and convertible notes payable.\n(l) Fiscal Year-End --------------- The Company's fiscal year end is the last Saturday in December or the first Saturday in January, which results in a 52- or 53-week year. Fiscal years 1995, 1994, and 1993 consisted of 52 weeks.\n(m) Dividend Policy --------------- Dividends are declared at the discretion of the Company's Board of Directors. To date, no cash dividends have been declared. Any earnings are reinvested in the Company.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(3) Supplemental Cash Flow Information ----------------------------------\nThe Company acquired no equipment through capital lease obligations in 1995, 1994, and 1993. Additionally, the Company paid interest amounting to $3,901, $10,687 and $5,005 in 1995, 1994, and 1993, respectively. In 1995, the Company settled $71,918 of interest cost owed to a noteholder through issuance of 169,980 shares of common stock. In 1993, the Company received 6,250 shares of common stock with a fair market value of $10,938 in exchange for the issuance of common stock under a stock option plan. The Company paid state income taxes of $951, $1,049 and $1,254 in 1995, 1994 and 1993, respectively.\n(4) Leases ------\nAt December 30, 1995 the Company had no property under capital leases. At December 31, 1994, the Company had production equipment with a cost of $82,927 and accumulated amortization of $71,409 under capital leases.\nIn 1989, the Company entered into a ten-year lease for a facility in Milford, Massachusetts. In 1993, the Company reached an agreement with the lessor to terminate its lease effective January 31, 1994. In February, 1994, the Company relocated its operations to Chartley, Massachusetts (See Note 14). The Company is currently operating at the Chartley facility as a tenant at will.\nDuring 1993, the Company entered into an operating lease agreement for an office, manufacturing, and research facility in Hopkinton, Massachusetts. The Company did not relocate to this facility, but in 1994 used it for purposes of storage and warehousing. In 1995, the Company reached an agreement with the lessor to terminate the lease effective January 31, 1995.\nTotal rental expense for operating leases was $67,500, $146,789, and $216,923 in 1995, 1994, and 1993.\n(5) Stock Options -------------\nIn 1995, the Company maintained two stock option plans affording employees and other persons affiliated with the Company, excluding non-employee Directors, the opportunity to purchase shares of its common stock. In August, 1994, one of the stock option plans expired and no new grants are currently available under it. Under the remaining plan, the Board of Directors may grant incentive stock options to officers and other key employees of the Company. Additionally, the remaining plan permits the Board of Directors to issue non-qualified stock options to officers and other key employees and consultants of the Company. All incentive stock options are granted at the fair market value of the stock or in the case of certain optionees, at 110% of such fair market value at the time of the grant. Such options are exercisable in installments following a minimum period of employment and expire within ten years from the date granted. All non-qualified stock options are granted a price not less than 50% of the fair market value at the time of the grant. The difference between the option price and such fair market value is accounted for as compensation expense and amortized over the vesting period of the stock, which is determined by the Board of Directors.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(5) Stock Options (Continued) -------------------------\nIn addition, during 1992 the Company adopted the 1992 Director Option Plan (the \"Director Plan\") to compensate outside directors for their services. Under the Director Plan, eligible directors are initially granted options to purchase up to 4,000 shares of the Company's common stock, and are granted options to purchase up to 2,000 shares of the Company's common stock upon re-election as a director. Additionally, directors serving on standing committees of the Board are granted options to purchase up to 500 shares of the Company's common stock. No options to purchase shares of the Company's common stock under the Director Plan were granted in 1995 or 1994. In 1993, options to purchase 12,500 shares of the Company's common stock were granted to outside directors under the Director Plan at a price of $0.75 per share. At December 30, 1995, options to purchase 35,500 shares of Common Stock were outstanding under the Director Plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(5) Stock Options (Continued) -------------------------\nIn June 1995, the Company granted 400,390 options at the current fair market value of $0.44 with similar terms and conditions to existing option holders in exchange for the previously issued options.\nIn November 1995, the financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 123 \"Accounting for Stock-Based Compensation\". The Company intends to adopt the disclosure requirements of SFAS No. 123 for the year ending December 28, 1996; therefore the adoption will have no impact on the Company's financial position or results of operations.\n(6) Research and Development Agreements -----------------------------------\nIn 1995, the Company recognized no revenue or related costs from research and development agreements. In 1994 and 1993 the Company maintained research and development agreements with several parties. For fiscal years 1994 and 1993, the Company recognized revenue from these agreements in the amounts of $32,143 and $493,716, respectively, and incurred research and development costs relating to this revenue in the amounts of $36,065 and $337,480, respectively. Substantially all of the revenue and costs associated with research and development agreements in 1994 and 1993 were the result of collaborative development agreements with The Office of Naval Research (\"ONR\") and Carpenter Technology Corporation (\"CarTech\").\n(7) Notes Payable -------------\nNotes payable consist of the following at December 30, 1995:\nIn 1995, the Company obtained financing under three agreements with separate parties, the terms and conditions of which are summarized as follows:\nNote Payable 1 -------------- Note payable dated March 31, 1995 due March 30, 1996, with interest payable at a rate of 10% per year. The Company is in default of this note effective March 30, 1996 and is accruing interest from that date at the default rate of 15% per year. The note is collateralized by accounts receivable, inventory, property and equipment. $250,000\nNote Payable 2 -------------- Note payable dated July 19, 1995, as amended July 31, 1996, with interest payable at a rate of 10% per year due in installments on September 27, 1996, December 27, 1996, March 28, 1997 and July 31, 1997. 200,000\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(7) Notes Payable (continued) -------------------------\nNote Payable 3 -------------- Note payable dated November 30, 1995 due in installments commencing December 30, 1995 through June 30, 1996 with interest at a rate of 12% per year due June 30, 1996. The note is secured by accounts receivable, inventory and property and equipment. $ 50,000 -------- $500,000 ========\n(8) Convertible Notes Payable -------------------------\nConvertible notes payable consist of the following at December 30, 1995 and December 31, 1994:\nNote Payable 1 -------------- Unsecured notes payable dated February 16, 1994 with five parties, due June 30, 1995 plus interest at 10% per annum $250,000\nNote Payable 2 -------------- Unsecured note payable dated April 21, 1994, due April 21, 2001; interest at 10% per annum is due semi-annually on September 30 and March 31. 500,000\nNote Payable 3 -------------- Unsecured note payable dated July 20, 1994, due January 31, 1996 plus interest at 10% per annum 120,000\nNote Payable 4 -------------- Unsecured notes payable dated October 26, 1994 with six parties, due April 24, 1996 plus interest at 10% per annum. $1,000,000 ---------- $1,870,000 ==========\nAt December 30, 1995, the Company was in default of Note Payable 1 and Note Payable 2 and on January 31, 1996 and April 24, 1996, the Company defaulted on Notes Payable 3 and 4, respectively. $920,000 of the principal balance of the convertible notes payable represent amounts due to holders of greater than 10% of the Company's common stock for which the related accrued interest and interest expense as of and for the years ended December 30, 1995 and December 31, 1994 amounted to $120,489 and $28,741, and $92,000 and $28,741, respectively.\nConversion privileges provided in the notes payable allow for the conversion of any unpaid principal throughout the term of each note, at the option of the note holders, for one share of the Company's common stock for each $0.50 of unpaid principal. The convertible notes are subordinated to all other indebtedness of the Company.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(8) Convertible Notes Payable (continued) -------------------------------------\nConversion privileges provided in Note Payable 1, Note Payable 3, and Note Payable 4 allow for the conversion of any unpaid interest throughout the note terms, at the option of the note holders, for one share of the Company's common stock for each $0.50 of unpaid principal. At the option of the Company, interest due under Note Payable 2 may be paid in shares of the Company's common stock at a conversion price of the lesser of $0.50 per share or 90% of the average closing bid price of the Company's common stock during the twenty consecutive trading days ending five business days immediately preceding the date on which any interest payment is due (See Note 3). 4,127,761 shares of common stock at December 30, 1995 are reserved for the conversion of convertible notes and related interest.\nIn connection with the issuance of convertible notes payable, the Company issued warrants for the purchase of shares of the Company's common stock at a price of $0.50 per common share. Warrants for the purchase of 410,628 shares of common stock were outstanding at December 30, 1995 of which 315,560 expired on December 31, 1995 and 95,068 were exercisable from January 31, 1996 through July 30, 1996.\n(9) Accrued Expenses ----------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(10) Income Taxes ------------\nDue to the uncertainty related to the realization of the net deferred tax asset, a full valuation allowance has been provided. At December 30, 1995, the Company had net operating loss carryforwards of approximately $34,000,000 available to offset future income for U.S. Federal income tax purposes, and $8,000,000 for state income tax purposes. These operating loss carryforwards expire at various dates from the years 2000 through 2011 for federal income tax purposes and the years 1997 through 2001 for state income tax purposes.\nThe Tax Reform Act of 1986 limits the amount of operating loss and tax credit carryforwards that companies may utilize in any one year in the event of cumulative changes in ownership in excess of 50% over a three year period.\n(11) Retirement Savings Plan -----------------------\nEffective September 1, 1987, the Company established The Retirement Savings Plan (the \"Plan\") under the provisions of Section 401 of the Internal Revenue Code. Employees, as defined in the Plan, are eligible to participate in the Plan after 180 days of employment. Under the terms of the Plan, the Company may match employee contributions under such method as described in the Plan and as determined each year by the Board of Directors. Through December 30, 1995, no employer matching contributions had been made to the Plan.\n(12) Joint Venture -------------\nIn February 1991, the Company formed a joint venture company, Metals Process Systems (\"MPS\"), headquartered in Boulogne, France, with Sopretac, a Vallourec Group Company, to market and license jointly-held technology for use with powdered metals to third parties. The Company contributed certain proprietary technology to the venture in exchange for a 49% equity position. The Company's investment was recorded under the equity method. To date the Company's investments in MPS have been written down to zero as the Company's share of MPS' losses have exceeded its investment. In 1995 the Company contributed approximately $60,000 to MPS, which, based on CPS'share of MPS' losses, was also charged to operations in 1995. In 1996, CPS' equity interest was reduced to 1% based upon additional investment by Vallourec in MPS.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CERAMICS PROCESS SYSTEMS CORPORATION - --------------------------------------------------------------------------------\n(13) Significant Customers and Export Sales --------------------------------------\nExport sales were 2%, 4%, and less than 1% of total revenue in 1995, 1994, 1993, respectively, and represented sales to Europe and Japan.\n(14) Other Operating Expenses ------------------------\nIn connection with the Company's relocation to Chartley, Massachusetts in February, 1994 (See Note 4), costs totaling $432,850 were incurred in the fitup of the Chartley building. These previously capitalized costs were expensed in their entirety in the fourth quarter of 1994.","section_15":""}
{"filename":"73864_1995.txt","cik":"73864","year":"1995","section_1":"ITEM 1 - BUSINESS\nGeneral Development of Business\nOEA, Inc. (\"Registrant\" or the \"Company\") was organized as a Delaware business corporation on October 1, 1969. Its predecessor, Ordnance Engineering Associates, Inc., an Illinois corporation, was organized on July 13, 1957, and was merged into the Registrant on December 3, 1969. OEA, Inc. consists of the OEA Automotive Safety Products Divisions, OEA Aerospace, Inc., Pyrospace S.A. (45% ownership) and Pyroindustrie S.A. (80% direct ownership, 9% indirect ownership). OEA Automotive Safety Products consists of the Automotive Initiator Division - Denver, Automotive Initiator Division - Utah, Hybrid Gas Generator Division, and Hybrid Inflator Division.\nExplosive Technology, Inc. was acquired as a wholly owned subsidiary of the Registrant on March 30, 1971. It was organized as a California business corporation on June 21, 1961. Effective December 11, 1989, the subsidiary's name was changed to ET, Inc. On October 1, 1994, the name was again changed to OEA Aerospace, Inc. The Aerospace Systems Group from the Parent Company (Denver Operations) was merged into the subsidiary effective October 1, 1994.\nAerotest Operations, Inc., a California corporation, was acquired as a wholly owned subsidiary of OEA Aerospace, Inc. (described above) on April 1, 1974.\nPyrospace S.A. was organized on July 29, 1987, in France as a joint venture (45% OEA, Inc. ownership) with two French firms, Aerospatiale and SNPE. Its facility is located in Les Mureaux, 25 miles northwest of Paris.\nPyroindustrie S.A. was incorporated on June 21, 1994, in France as a joint venture (80% OEA, Inc., 20% Pyrospace S.A.) with Pyrospace. Its facility is collocated with Pyrospace in Les Mureaux, 25 miles northwest of Paris.\nThere has been no material change in the mode of business conducted by the Registrant or its above-named subsidiaries and divisions during fiscal year 1995, except as mentioned above.\nFinancial Information about Industry Segments\nNarrative Description of Business\nAutomotive Safety Products\nThe Company established the Automotive Safety Products division in 1989 as a separate division to support the rapid growth in automotive air bags and related technologies. Prior to 1989, automotive-related work was performed in the aerospace division. The Company designs, tests, develops, and manufactures propellant and other pyrotechnic devices for use in automotive safety products. Major products currently in production include electric initiators, hybrid gas generators and linear cord, all for use in inflators. These products are sold to automotive inflator manufacturers for assembly into air bag modules for delivery to the auto companies.\nThe Company is currently completing the prototype phase for smokeless hybrid inflators for passenger, driver and side-impact inflators. These products are environmentally friendly and produce no toxic materials. In addition, these inflators are smaller, lighter, and less expensive than current designs in production. High-volume production of the new smokeless hybrid inflators is scheduled to begin in April 1996. The inflators are sold to module manufacturers for delivery to the auto companies.\nThe Company's principal officers and engineers represent its sales force. A significant investment in plant and equipment will be required by the Company to provide the previously announced projected sales of inflators of more than 2.5 million units for model year 1997. While the Company has ordered equipment from companies experienced in the manufacture of automated high-rate production equipment, no assurance can be given that the equipment will perform as designed and at the capacity required until the equipment has been operated for a period of time in our plant.\nThe automotive segment accounted for approximately 70%, 62%, and 49% of the Company's net sales for fiscal years 1995, 1994, and 1993, respectively.\nInitiators are produced in three plants owned by the Company with highly automated equipment: Denver, Colorado; Tremonton, Utah; and Les Mureaux, France. Hybrid gas generators are produced in Denver with highly automated equipment. The initial production of hybrid inflators will be performed in Denver.\nRaw materials used by the Company include stamped and machined parts, elastomer seals, and commercially available pyrotechnic materials. The Company is not dependent upon any one source for purchased materials because alternate sources of supply are generally available in the marketplace.\nThe initiator business is not dependent upon patented items, trademarks, franchises, concessions, or licenses thereunder. The Company does not pay any substantial royalties or similar payments in connection with any patents or license agreements. The gas generator and smokeless hybrid inflator business is covered by several patents. Some of the patents have been issued and others are pending.\nThe Company's business is not seasonal in nature.\nProducts are manufactured to order; accordingly, significant amounts of inventory are not required to be maintained. Most customers operate in a just-in-time inventory environment. Customer payments are reasonably prompt and extended terms are not required.\nThe Company's customer providing more than 10% of consolidated sales for the fiscal year ended July 31, 1995, was Morton International, 57%. The loss of OEA's primary automotive safety products customer, Morton International, would have a materially adverse effect on the Company. As the Company's sales of inflators to module manufacturers grow, its sales to Morton International may decrease both as a percentage of total sales and in amount.\nThere is no particular relationship between the Company and its customers other than that of supplier\/customer, except for the following:\n1. An agreement with Daicel Chemical Industries, Ltd., Tokyo, Japan, for the transfer of technology and manufacture of OEA's automotive air bag initiators, and\n2. An agreement with Daicel Chemical Industries, Ltd., Tokyo, Japan, for the transfer of technology and manufacture of OEA's smokeless hybrid inflators for passenger, driver and side-impact automotive air bags for manufacture in Asia for the Asian market. The initial payment for this fifteen year agreement was received in 1995.\nAuto manufacturers generally change designs every three to five years. The Company receives annual blanket purchase orders, but deliveries are specified by customers on weekly releases for deliveries over the next 10 to 12 weeks. Because this is the accepted practice in the automotive industry, the amount of backlog at any given time is not representative of annual sales.\nThe Company currently has orders from Takata Corporation, Daicel Chemical Industries and Delphi Interior & Lighting, a division of General Motors, to supply in excess of 2.5 million passenger side inflators for model year 1997.\nThe Company believes that OEA is the only independent inflator manufacturer in the world that is not affiliated with, or owned by, a module manufacturer. This independence gives us wide latitude to sell to all module manufacturers. By fiscal year 2000, OEA's Inflator Division could be the largest customer of the OEA Initiator Division.\nCurrently, there are three major air bag initiator manufacturers in the United States: Imperial Chemical Industries, Inc., Special Devices, Inc., and the Company. Additionally, there are four major air bag initiator manufacturers in Europe: Davey Bickford Smith, Nouvelle Cartoucherie de Survilliers, Patvag and Pyroindustrie (89% owned directly\/indirectly by OEA, Inc.). The Company is currently the world's leading producer of initiators for automotive air bags.\nDaicel Chemical Industries is expected to begin manufacturing automotive air bag initiators under the previously mentioned technology transfer and manufacturing agreement in 1997. Other companies may enter the automotive initiator market; however, substantial financial resources, development, and qualification time would be required to achieve design and product verification. Contracts are generally awarded based upon competitive price, product reliability and production capacity. The Registrant believes it is in a good competitive position.\nCurrently, the Company is aware of two major hybrid gas generator manufacturers in the world, a joint venture between Atlantic Research Corporation and Allied Signal, and the Company. The Company is currently the world's second leading producer of hybrid gas generators for automotive air bags.\nThe estimated amount spent by the automotive segment during each of the last three fiscal years for customer-sponsored and company-sponsored research and development activities was:\nCompliance with federal, state, and local provisions regulating the discharge of materials into the environment is not expected to materially affect capital expenditures, earnings, or competitive position of the Registrant or its subsidiaries.\nThe Registrant, together with its consolidated subsidiaries and divisions, employs approximately 700 people in its automotive segment.\nNonautomotive Products\nThe nonautomotive segment of the business is primarily aerospace (Defense and Commercial). OEA Aerospace, Inc. designs, develops, and manufactures propellant and explosive-actuated devices used in (1) personnel escape systems in high-speed aircraft, (2) separation and release devices for space vehicles and aircraft, (3) control, separation, ejection, and jettison of missiles, and (4) flexible linear-shaped charges and mild detonating cord systems. The principal customers for such products are the United States Government and major aircraft and aerospace companies. Other products and services include hot gas and explosive initiated valves, fluid control systems, inflatable systems, and the largest neutron radiography inspection operation of its kind.\nSales are made directly to the customer. The Company's principal officers and engineers represent its sales force. The nonautomotive segment accounted for approximately 30%, 38% and 51% of the Company's net sales for fiscal years 1995, 1994, and 1993, respectively.\nThe nonautomotive products are produced principally in Fairfield, California. A smaller test facility is located in San Ramon, California.\nThe Registrant's customers are primarily in the defense and space field under prime government contracts. The major portion of the Registrant's business comes from subcontracts which are generally awarded on a fixed-price basis. Each new contract involves either the design and manufacture of a new product to meet a specific requirement, or a follow-on order for additional items previously manufactured under other contracts. Inasmuch as the Registrant's aerospace business involves constant development and engineering of products required by its customers, it would be inappropriate to announce each new item as a new product.\nRaw materials used by the Registrant include aluminum, inconel, monel, molybdenum, rubbers, copper, alloy and stainless steel, ceramics, silver, titanium alloys, certain commercially available and special-order propellants and explosives, elastomer seals to government specifications, and epoxy sealing materials. The Registrant is not dependent upon any one source for purchased materials because alternate sources of supply are generally available in the marketplace.\nThe Registrant's business is not dependent upon patented items, trademarks, franchises, concessions, or licenses thereunder. The Registrant does not pay any substantial royalties or similar payments in connection with any patents or license agreements.\nThe Registrant's business is not seasonal in nature.\nProducts are manufactured to order; accordingly, significant amounts of inventory are not required to be maintained.\nDeliveries are made according to contract usually in a just-in-time environment. Customer payments are reasonably prompt and extended terms are not required.\nThe Company did not have a customer providing more than 10% of consolidated sales for the fiscal year ended July 31, 1995. Transactions with the United States Government are with several procurement agencies and\/or prime contractors. Although the loss of all government contracts would have an adverse effect, the loss of any one agency or prime contract would not have a materially adverse effect on the Registrant.\nThere is no particular relationship between the Company and its customers other than that of supplier\/customer.\nThe Company's nonautomotive funded backlog of orders as of July 31, 1995, was $40,000,000. The Company estimates that $7,000,000 of its current backlog will not be recorded as a sale within its fiscal year ending July 31, 1996.\nThe majority of the business of the Registrant with the United States Government is subject to termination of contracts for the convenience of the United States Government. Such termination, however, is not a frequent occurrence. In addition, a significant portion of the Registrant's sales for the current and prior years is subject to audit by the Defense Contract Audit Agency. Such audits may occur at any time up to three years after contract completion.\nThe Registrant competes for new contracts with a number of larger corporations with substantially greater resources. Other companies, both larger and smaller than the Registrant, also have capabilities and resources to design and develop similar items.\nThere is no official information available concerning total annual purchases from all manufacturers of the types of products which the Registrant produces for the nonautomotive segment. The Registrant believes it has at least seven competitors in its principal field of propellant and explosive devices. No individual competitor dominates the field. The Registrant believes it is in a good competitive position.\nOn new development and qualification programs, contract awards are based upon technical and competitive price proposals. Subsequent production awards are both negotiated with the customer and subject to competitive bid.\nThe estimated amount spent by the nonautomotive segment during each of the last three fiscal years for customer-sponsored and company-sponsored research and development activities was:\nCompliance with federal, state, and local provisions regulating the discharge of materials into the environment is not expected to materially affect capital expenditures, earnings, or competitive position of the Registrant or its subsidiaries.\nThe Registrant, together with its subsidiaries and divisions, employs approximately 375 people in its nonautomotive segment.\nFinancial Information about Foreign and Domestic Operations and Export Sales\nNotes:\n(1) Sales amounts differ from those previously reported for 1993 as a result of reclassifications of domestic and foreign sales.\n(2) There were no sales or transfers between the geographic areas reported above.\n(3) It is not possible, under the existing accounting systems, to isolate profits and identifiable assets by geographic areas.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Registrant's properties are located in Arapahoe County, Colorado (near Denver); Fairfield, California; San Ramon, California; Tremonton\/Garland, Utah; and Les Mureaux, France.\nThe Arapahoe County facilities are located on 640 acres of land which the Registrant owns. In fiscal year 1995, automotive and nonautomotive operations were conducted in various one-story brick and steel buildings containing 213,000 square feet of floor space in the aggregate. Effective October 1, 1994, only automotive operations are conducted in these facilities. The facilities vacated by the aerospace division's transfer to Fairfield, California, will be used for smokeless hybrid inflators.\nThe Fairfield, California, facilities are occupied by OEA Aerospace, Inc., a wholly owned subsidiary of the Registrant. Its nonautomotive and automotive operations are conducted in twenty buildings containing 162,700 square feet of floor space in the aggregate, located on 515 acres of land which the Company owns. All parts of the various buildings are occupied and used in the operations of the Company's business.\nThe San Ramon, California, property consists of a 10,000 square foot steel building situated on approximately one acre of land which the Company owns. It is occupied by Aerotest Operations, Inc., a wholly owned subsidiary of OEA Aerospace, Inc., which conducts neutron radiography therein. Also contained in this building, as a part of the premises, is a 250-kilowatt nuclear reactor used in the process.\nThe property in Tremonton\/Garland, Utah, consists of a 66,000 square-foot manufacturing facility located on 160 acres which the Registrant owns. This facility will accommodate the growing demand for air bag initiators and other automotive safety products.\nThe property in Les Mureaux, France, consists of a 34,600 square foot manufacturing facility located on 6 acres which the Company owns. It is occupied by Pyroindustrie, S.A., a joint venture (80% OEA, Inc., 20% Pyrospace S.A.) with Pyrospace. This facility will accommodate the growing demand for air bag initiators and other automotive safety products for the European market.\nThe above-described properties are considered suitable and adequate for the Registrant's operations.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS None\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n(a) (1) (i) Registrant has only common capital stock, $0.10 par value, issued. Its principal United States market is made on the New York Stock Exchange, New York, New York, where such shares have been listed.\n(ii) The high and low sales prices for the Registrant's shares traded, as reported in the consolidated transaction reporting system over the last two fiscal years on a quarterly basis, are as follows:\n(iii) Not applicable\n(iv) Not applicable\n(v) Not applicable\n(b) The approximate number of holders of record of Registrant's issued and outstanding shares at October 16, 1995, was 1330.\n(c) It is anticipated that the Company will pay a dividend during fiscal year 1996.\nThe Board of Directors has declared dividends during the last three fiscal years as follows:\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nConsolidated Summary of Operations\nBalance Sheet Data at July 31,\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\nNet sales and operating profits for the fiscal year ended July 31, 1995, were a record $129,210,800 and $34,926,700, respectively, compared to prior-year net sales of $109,892,700 and operating profits of $30,071,500. Net earnings and earnings per share for fiscal year 1995 were $21,276,200 and $1.04, respectively, compared to prior-year net earnings of $17,952,500 and earnings per share of $0.88. In the first half of fiscal year 1995, the Company reached a final settlement in its environmental matters in the net amount of $2,250,000 or $0.11 per share. Eliminating the effect of the above settlement, current-year net earnings from operations would have been $23,526,200 and earnings per share would have been $1.15.\nThe Automotive Safety Products division was again the primary contributor to the sales and operating profit increases over the prior year. Automotive sales and operating profit both increased 33% due primarily to the increased volume. Nonautomotive sales decreased 8% with an operating profit decrease of 23%. Total operating profit as a percentage of sales for fiscal year 1995 was 27%, consistent with the prior year. This performance was accomplished in spite of an increased expenditure of funds for Company funded research and development ($3,507,300 in 1995 vs. $1,814,800 in 1994) primarily for smokeless hybrid inflators for automotive air bags.\nAutomotive segment sales for fiscal year 1996 are expected to increase significantly due to the increased demand for driver and passenger side air bags, including initial production deliveries of hybrid inflators in the fourth quarter.\nPotential effects of changes in defense spending are not expected to have a material impact upon the operations of the nonautomotive segment. While it is impossible to accurately predict what the defense procurement budget will be, the Registrant anticipates that nonautomotive segment sales during fiscal year 1996 will increase due to deliveries on a number of programs currently in the backlog and programs expected to book soon.\nThe Registrant's contract pricing methods have offset the effect of inflation.\nFiscal Year 1994 vs. 1993\nNet sales and operating profits for the fiscal year ended July 31, 1994, were $109,892,700 and $30,071,500, respectively, compared to fiscal year 1993 net sales of $94,184,200 and operating profits of $23,632,800. Net earnings and earnings per share for fiscal year 1994 were $17,952,500 and $0.88, respectively, compared to fiscal year 1993 net earnings of $14,571,100 and earnings per share of $0.72. Fiscal year 1994 net earnings include $148,900 and $0.01 per share related to a technology transfer agreement for the Japanese FSX aircraft program. Fiscal year 1993 net earnings included $397,800, or $0.02 per share, related to that same technology transfer agreement. Eliminating the effect of the above agreement, fiscal year 1993 net earnings from operations would have been $14,173,300 and earnings per share would have been $0.70, and fiscal year 1994 net earnings from operations would have been $17,803,600 and earnings per share would have been $0.87.\nThe Automotive Safety Products division was the primary contributor to the sales and operating profit increases over fiscal year 1993. Automotive sales increased 46% and the operating profit increased 64% due primarily to the increased volume and a significant reduction in research and development cost. Nonautomotive sales decreased 12% with an operating profit decrease of 16%. Total operating profit as a percentage of sales increased to 27% in 1994 as compared to 25% for 1993. This increase was achieved primarily because of a reduced expenditure of funds for Company funded research and development ($1,814,800 in 1994 vs. $3,729,600 in 1993).\nLiquidity and Capital Resources\nThe Company's working capital at July 31, 1995, increased to $62,711,100, from the $53,506,800 at July 31, 1994, due to increased earnings from operations resulting in increased cash and cash equivalents of $14,495,300, offset by reductions in accounts receivable and inventories.\nDuring fiscal year 1995, the Company made capital expenditures totaling $19,912,300 as compared to $16,823,900 and $19,593,100 in fiscal years 1994 and 1993, respectively. These capital expenditures were funded principally from operations. Currently the Company has capital expenditure commitments totaling approximately $20,000,000 for fiscal year 1996.\nIn January 1995 the Company renewed an $8,000,000 Revolving Credit Agreement with its principal bank and at July 31, 1995, had no outstanding balance against this line of credit. Anticipated working capital requirements, capital expenditures, and facility expansions are expected to be met through\ninternally generated funds and, when necessary, borrowings from the agreement mentioned above, which can be increased when required.\nForeign Currency Translation\nAssets and liabilities of the Company's foreign subsidiary are translated to U.S. dollars at period-end exchange rates. Income and expense items are translated at average exchange rates prevailing during the period. The local currency is used as the functional currency for the subsidiary. A translation adjustment results from translating the foreign subsidiary's accounts from functional currencies to U.S. dollars. Exchange gains (losses) resulting from foreign currency transactions are included in the consolidated statements of earnings.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and financial statement schedules of the Company filed as part of this report on Form 10-K are listed in Item 14.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item will appear in, and is incorporated by reference from, the Registrant's definitive proxy statement for its 1996 annual shareholders meeting to be filed with the Securities and Exchange Commission prior to November 29, 1995.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information required by this item will appear in, and is incorporated by reference from, the Registrant's definitive proxy statement for its 1996 annual shareholders meeting to be filed with the Securities and Exchange Commission prior to November 29, 1995.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item will appear in, and is incorporated by reference from, the Registrant's definitive proxy statement for its 1996 annual shareholders meeting to be filed with the Securities and Exchange Commission prior to November 29, 1995.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item, if any, will appear in, and is incorporated by reference from, the Registrant's definitive proxy statement for its 1996 annual shareholders meeting to be filed with the Securities and Exchange Commission prior to November 29, 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:\n(1) Financial Statements:\nReport of Independent Auditors\nConsolidated Balance Sheets - July 31, 1995 and\nConsolidated Statements of Earnings Years ended July 31, 1995, 1994, and 1993\nConsolidated Statements of Stockholders' 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\n(2) Financial Statement Schedules required to be filed by Item 8 of Form 10-K and by paragraph (d) of this Item 14:\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 inapplicable, and therefore, have been omitted.\n(3) Exhibits required to be filed by Item 601 of Regulation S-K and paragraph (c) of this Item 14:\nExhibit 3 - Articles of Incorporation, as amended, (incorporated by reference) and By- laws, as amended (incorporated by reference).\nExhibit 10 - Material contracts between the Registrant and its Chairman\/CEO and President\/COO include retirement agreements dated May 5, 1989, and May 15, 1990, respectively, (incorporated by reference).\nExhibit 22 - During fiscal year 1995, the Registrant was the parent company of each of the following described companies:\nPercent of Outstanding Corporation Stock Owned by Parent\nOEA Aerospace, Inc. 100% a California corporation, which owns 100% of Aerotest Operations, Inc., a California Corporation\nForeign Corporate Percentage of Joint Venture Ownership ----------------- ------------- Pyrospace S.A. 45% a corporation in France\nPyroindustrie S.A. 80% a corporation in France\nThe above entities are included in the consolidated financial statements of the Registrant being submitted herewith.\n(b) Reports on Form 8-K during the quarter ended July 31, 1995.\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nDate: October 23, 1995\nOEA, INC. Registrant\nBy_________________________ Ahmed D. Kafadar, Chairman and Chief Executive Officer DIRECTORS AND OFFICERS\nAhmed D. Kafadar,Chairman of the Charles B. Kafadar, President, Board and Principal Executive Principal Operating Officer, and Officer Director\nJohn E. Banko, Director George S. Ansell, Director\nJ. Robert Burnett, Director Philip E. Johnson, Director\nPaul J. Martin, Vice President\/ John E. Banko IV, Controller Treasurer and Principal Financial Officer\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) and (2)\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nYear Ended July 31, 1995\nOEA, Inc. and Subsidiaries\nDenver, Colorado\n21A\nReport of Independent Auditors\nThe Board of Directors and Stockholders OEA, Inc.\nWe have audited the accompanying consolidated balance sheets of OEA, Inc. and subsidiaries as of July 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 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of OEA, Inc. and subsidiaries at July 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 July 31, 1995, in conformity with generally accepted accounting principles.\nSeptember 29, 1995\nOEA, Inc. and Subsidiaries Consolidated Balance Sheets\nOEA, Inc. and Subsidiaries Consolidated Statements of Earnings\nOEA, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity\nOEA, Inc. and Subsidiaries Consolidated Statements of Cash Flows\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements July 31, 1995\n1. Accounting Policies\nPrinciples of Consolidation The consolidated financial statements include the accounts and transactions of OEA, Inc. (the \"Company\"), its wholly owned subsidiary, OEA Aerospace, Inc., and a foreign joint venture in which the Company has more than 50% equity ownership. All significant intercompany balances and transactions have been eliminated.\nThe investment in a foreign joint venture in which the Company does not have control, but has the ability to exercise significant influence over operating and financial policies (greater than 20% ownership), is accounted for using the equity method, under which the Company's share of earnings of the joint venture is reflected in income as earned and distributions will be credited against the investment when received.\nRevenue Recognition Sales of products within the government contracting segment are recognized as deliveries are made or when the products are completed and held on the Company's premises to meet specified contract delivery dates. Sales of undelivered products are included in unbilled costs and accrued earnings and are anticipated to be delivered and billed within 12 months of the balance sheet date. Costs are based on the estimated average cost per unit based on units to be produced under the contract.\nInventories Inventories of raw materials and component parts are stated at the lower of cost (principally first-in, first-out) or market. Inventoried costs of work in process and finished goods are stated at average production costs consisting of materials, direct labor, and manufacturing overhead, reduced by costs identified with recorded sales. General and administrative expenses, initial tooling, and other nonrecurring costs are not included in inventoried costs.\nProperty, Plant, and Equipment Property, plant, and equipment are recorded at cost. Expenditures for maintenance and repairs are charged to earnings as incurred and major renewals and betterments are capitalized. Upon sale or retirement, the cost of the assets and related allowances for depreciation are removed from the accounts, and the resulting gains or losses are reflected in operations.\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n1. Accounting Policies (continued)\nDepreciation is computed on the straight-line, double-declining balance, and units-of-production methods at rates calculated to amortize the cost of the depreciable assets over the related useful lives.\nDepreciation charged to costs and expenses was $7,454,851, $5,485,673 and $4,651,073 in 1995, 1994, and 1993, respectively. Repairs and maintenance charged to costs and expenses was $5,027,645, $4,090,642 and $2,950,358 in 1995, 1994, and 1993, respectively.\nEarnings per Share\nEarnings per share of common stock is computed on the basis of the weighted average number of shares outstanding during the year.\nThe effect on reported earnings per share from the assumed exercise of stock options outstanding during the years ended July 31, 1995, 1994, and 1993 would be insignificant.\nCash Equivalents\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nResearch and Development\nExpenses for new products or improvements of existing products, net of amounts reimbursed from others, are charged against operations in the year incurred.\nForeign Currency Translation\nAssets and liabilities of the Company's foreign subsidiary (Pyroindustrie S.A.) are translated to U.S. dollars at period-end exchange rates. Income and expense items are translated at average exchange rates prevailing during the period. The local currency is used as the functional currency for the subsidiary. A translation adjustment, which is recorded as a separate component of stockholders' equity, results from translating the foreign subsidiary's accounts from functional currencies to U.S. dollars. Exchange gains (losses) resulting from foreign currency transactions are included in the consolidated statements of earnings.\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n2. Stock Options On January 13, 1995, the shareholders approved an Employees' Stock Option Plan (the \"Employees' Plan\") and Nonemployee Directors' Stock Option Plan (the \"Directors' Plan\"). These plans provide for stock options to be granted for a maximum of 600,000 shares of common stock under the Employees' Plan and a maximum of 50,000 shares of common stock under the Directors' Plan. Options may be granted to employees and nonemployee directors at prices not less than fair market value of the Company's common stock on the date of grant. Options granted under the Employees' Plan may be exercised at any time after the grant date and options issued under the Directors' Plan may be exercised after the first six months following the grant date. Shares may be granted from either authorized but unissued common stock or issued shares reacquired and held as treasury stock. As of July 31, 1995, no options have been granted under either plan.\nPrior to July 28, 1994, the Company had a qualified incentive stock option plan for key employees of the Company whereby a total of 666,000 shares of common stock were reserved for issuance. Options were granted to key employees at prices not less than the fair market value of the Company's common stock on the date of grant, and were exercisable after one year of continuous employment following the date of grant. Under this plan, options for 624,153 shares, net of forfeitures, were granted at an average option price of $7.50, and options for 175,695 shares remain outstanding as of July 31, 1995. During 1995, options for 10,336 shares were forfeited. During 1995 and 1994, options for 21,083 and 63,832 shares, respectively, were exercised at an average price of $7.59 and $7.77, respectively.\n3. Line of Credit At July 31, 1995, the Company has an $8,000,000 unsecured revolving credit line with a financial institution with an interest rate at the lower of the institution's prime interest rate or 1% per annum above the federal funds rate. In addition, at the request of the borrower, the Bank, in its sole discretion, may make loans to the borrower at an interest rate equal to \"LIBOR\" plus 1%. The Company is required to pay an annual commitment fee equal to .1875 of 1% on the total amount of the commitment. The facility will expire on December 31, 1995. The Company has no debt outstanding relating to the line of credit as of July 31, 1995.\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n4. Inventories Inventories are summarized as follows:\n5. Investment in Foreign Joint Ventures On October 5, 1986, a joint venture agreement was signed between the Company and two French companies for the establishment of a company (Pyrospace S.A.) in France. Pyrospace is engaged in the design, development, and manufacture of propellant and explosive devices for European space programs, as well as aircraft and missiles. The Company is a 45% owner of Pyrospace.\nDuring October 1993, a joint venture agreement was signed between the Company and Pyrospace for the establishment of a company (Pyroindustrie S.A.) in France. Pyroindustrie is engaged in the manufacture of initiators for the European air bag market. The Company is an 80% owner of Pyroindustrie.\n6. Profit Sharing and Pension Plans The Company has noncontributory profit sharing and defined contribution pension plans covering all full-time employees. Combined contributions to these plans for the years ended July 31, 1995, 1994, and 1993 were $1,501,958, $1,430,984 and $1,232,671, respectively.\nThe Company is committed to contribute to the pension plans 5% of participants' eligible annual compensation as defined in the plan documents. Employer contributions to the profit sharing plans are discretionary, but are not to exceed 10% of eligible annual compensation.\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n7. Income Taxes\nDeferred income taxes reflect the net 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 July 31, 1995 and 1994 are as follows:\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n7. Income Taxes (continued) Components of income tax expense (benefit) are as follows:\nActual tax expense for 1995, 1994, and 1993 differs from \"expected\" tax expense for those years (computed by applying the U.S. federal corporate tax rate of 35% for 1995, 35% for 1994 and 34.5% for 1993 to earnings before income taxes) as follows:\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n8. Segment Information and Major Customers The Company operates primarily in two industry segments, automotive and nonautomotive. Financial information for each segment and major customers is summarized as follows:\nThe automotive segment includes the manufacturing and sales of automotive safety products for both domestic and foreign automobile manufacturers. The nonautomotive segment primarily includes the manufacture and sale of propellant and explosive-actuated devices for the U.S. government and prime contractors of the U.S. government and\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n8. Segment Information and Major Customers (continued) foreign governments, and also includes the manufacture and sale of similar explosiveactuated devices for commercial aircraft. Customer payments of accounts receivable are reasonably prompt and collateral is not required.\nCustomers representing 10% or more of consolidated net sales in each of the years 1995, 1994, and 1993 are as follows:\nAccounts receivable are summarized as follows:\n9. Commitments and Contingencies Contract disputes and other claims may arise in connection with government contracts and subcontracts. A substantial portion of the Company's nonautomotive sales for the current and prior years is subject to audit by the Defense Contract Audit Agency. Such audits may occur at any time up to three years after contract completion. In the opinion of the Company's management, a provision for government claims is not necessary.\nDuring December 1994, the Company effected a complete settlement of the previously reported Colorado Department of Health (\"CDH\") civil action and U.S. Environmental Protection Agency federal criminal investigation. Under the terms of the settlement agreements, the Company agreed to pay fines in the amount of $2,250,000. The Company has paid $2,070,000 and has accrued $180,000, respectively, as of July 31, 1995.\nOEA, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued)\n9. Commitments and Contingencies (continued) The Company has employment agreements with the Chairman of the Board and the President providing for their full-time active service with specified retirement benefits after employment termination. The estimated discounted present value of these retirement benefits has been accrued as of July 31, 1995 and 1994.\nThe Company has commitments to purchase approximately $20,000,000 of property, plant, and equipment.\n10. Quarterly Results of Operations for 1995 and 1994 (Unaudited)","section_15":""}
{"filename":"844893_1995.txt","cik":"844893","year":"1995","section_1":"ITEM 1. THE BUSINESS\nGENERAL\nThe Registrant was incorporated under the laws of the State of Delaware on November 20, 1988, and issued 500,000 shares of its $.0001 par value Common Stock (the \"Common Stock\") to TRIM-A-LAWN on January 23, 1989, for $1,000 cash. The Company was organized with a view toward (a) the distribution of the 500,000 shares of the Company's Common Stock to the shareholders of TRIM-A-LAWN and (b) the subsequent search for, location of and combination of the Company with a privately-held business enterprise. The Company has no current business operations, except for the activities of its officers in searching for a potential combination partner. The Company has limited assets and no operating income. Since inception, the costs associated with the company's search for a mergercandidate have been and will be paid by the company, first, and Capital Investment Managers, Inc., on a discretionary basis. The Company's offices are located at at 3900 Paradise Road, Suite 263, Las Vegas, Nevada 89109, and its telephone number is (702) 734-8721.\nThe Company proposes to combine with an existing, privately-held company which is profitable and, in Management's view has growth potential (irrespective of the industry in which it is engaged). A Combination may be structured as a merger, consolidation, exchange of the Company's Common Stock for stock or assets or any other form which will result in the combined enterprise's being a publicly-held corporation. The Company will pursue a combination with a company that satisfies its combination suitability standards by advertising in one or more newspapers or magazines to establish contact with, or by otherwise contacting, selected privately-held companies which are profitable and are believed to have growth potential. There are no assurances that Management of the Company will be able to locate a suitable combination partner or that a combination can be structured on terms acceptable to the Company.\nPending negotiation and consummation of a combination, the Company anticipates that it will have limited business activities, will have no significant sources of revenue and will incur no significant expenses or liabilities not required to be advanced on behalf of the Company by S. Gregory Smith pursuant to his 1989-Employment Agreement. Nevertheless, should necessary funds be available, the Company will engage attorneys, accountants and\/or other consultants to evaluate and assist in completing a potential combination.\nCAPITAL EXPENDITURES\nThe Registrant plans no significant expenditures.\nEMPLOYEES\nAt December 31, 1995 the Registrant had no full time employees other than the executive officers listed below.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAt December 31, 1995 the Registrant did not own property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant is not a party to any material legal proceedings, nor to the Registrant's knowledge, are there any other material legal proceedings contemplated against it.\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 or the past fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThere is no established public trading market for the Registrant's Common Stock. As of December 31, 1995, there were 1,325,000 shares of the Registrant's Common Stock outstanding and approximately 423 shareholders of record.\nThe Registrant has never declared or paid any cash dividend on its shares of Common Stock., and does not anticipate paying dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee the Financial Statements of the Registrant in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Registrant is in the development stage with a view towards combining with an existing, privately-held Registrant which is profitable and, in management's opinion, has growth potential. The Registrant has no significant assets, revenues or expenses; and the Registrant is not expected to have significant operations until a business combination is effected.\nLIQUIDITY AND CAPITAL RESOURCES\nThere have been no material changes in the financial condition of the Registrant since its inception, nor is a material change anticipated until the Registrant is able to identify and consummate a business combination.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENTS SCHEDULES ARE ALL SET FORTH AS EXHIBIT \"A\" ATTACHED HERETO.\nAll other schedules are not submitted because they are not applicable or not required or because the information is included in the financial statements or notes thereto.\nREPORT OF MANAGEMENT\nThe financial statements have been prepared by management and have been audited by McBride & Company, the Registrant's independent auditors, whose report follows. The management of the Registrant is responsible for the financial information and representations contained in the financial statements and other sections of the annual report. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances to reflect, in all material respects, the substance of events and transactions that should be included. In preparing the financial statements, it is necessary that management make informed estimates and judgments based upon currently available information of the effects of certain events and transactions.\nIn meeting its responsibility for the reliability of the financial statements, management depends on the Registrant's system of internal accounting control. This system is designed to provide reasonable assurance that assets are safeguarded and transactions are executed in accordance with management's authorization and properly recorded. In designing control procedures, management recognizes that errors or irregularities may nevertheless occur. Also, estimates and judgments are required to assess and balance the relative cost and expected benefits of the controls. Management believes that the Registrant's accounting controls provide reasonable assurance that errors or irregularities that could be material to the financial statements are prevented or would be detected within a timely period by employees in the normal course of performing their assigned functions.\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 following table lists all of the Directors and Executive Officers of the Registrant, and provides certain information concerning each such person, including the number of shares of Common Stock of the Registrant beneficially owned directly or indirectly by such person at the close of business as of December 31, 1995. As of December 31, 1995 there were 1,325,000 shares of the Registrant's Common Stock, $.0001 par value, outstanding.\n- --------------- NOTES: 1. Thomas R. Brooksbank is the principal and owner of Brooksbank & Associates, the registered owner of 200,000 shares of the Registrant's common stock as set forth above.\n(1) Principal Occupation\nThomas A. Hantges - Elected as a Director on March 7, 1995. Appointed as the President and Treasurer of the Registrant on March 7, 1995 following the resignation by S. Gregory Smith. Mr. Hantges is the President of USA Partners, Inc., which is the General Partner of USA Partners Limited, a Nevada limited partnership which acts as the General Partner of the USA Capital Land Fund Limited Partnership. He is currently the President, Director and 100% owner of USA Commercial Real Estate Group, USA Mortgage Company, Inc., and USA Development, Inc., all Nevada corporations. Mr. Hantges was the President and Treasurer of USA Financial Services of Nevada, Inc. until August 25, 1995. Mr. Hantges, a 29 year resident of Las Vegas, received his B.S. degree in Hotel Administration in 1973 and his Masters Degree in Business Administration in 1979 both from the University of Nevada at Las Vegas. Mr. Hantges has been in the securities industry since 1980. Prior to entering the Securities industry, Mr. Hantges held positions as an assistant hotel manager for the Riviera and Stardust hotels in Las Vegas, Nevada. Mr. Hantges has served as Vice President for Rauscher Pierce Refsnes, Inc., Smith Barney, Prudential Bache Securities all New York Stock Exchange member firms. Mr. Hantges holds both Series 7 and Series 24 licenses issued by the NASD, is licensed with the Insurance Division for the State of Nevada as a broker and a salesman, and is licensed as a corporate broker by the Nevada Real Estate Division. He is also licensed through the Financial\nInstitutions Division of the State of Nevada Department of Business and Industry as the \"qualified employee\" for USA Mortgage Company, Inc.\nThomas R. Brooksbank - Elected as a Director on March 7, 1995. Appointed as Secretary of the Registrant on March 7, 1995 following the resignation by S. Gregory Smith. Mr. Brooksbank is the principal of Brooksbank & Associates, Attorneys at Law, a commercial and financial institution collection law firm; Mr. Brooksbank was admitted to the State Bar of Nevada in 1987 and the State of Bar of Arizona in 1995. Mr. Brooksbank received a Bachelor of Science degree in 1975 from the University of Maryland, DDS in 1981 and his Juris Doctor degree from California Western School of Law in 1986 graduating magna cum laude.\nE. C. Kaufer - Elected as a Director on September 1, 1995 following the resignation of David M. Berkowitz. Mr. Kaufer is a Certified Fraud Examiner and President of Crisis Management Inc., a fraud detection and financial recovery firm. Mr. Kaufer's concentration has been in the institutional creditor area. Mr. Kaufer received a degree in Finance and Marketing from the Northern Arizona University in 1969 and an MBA from Northern Arizona University in 1973.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION OF OFFICERS\nNo executive officer of the Registrant received any compensation during the fiscal year ended December 31, 1995.\nEMPLOYMENT CONTRACTS\/STOCK INCENTIVE PLANS\nNo employment contracts or stock incentive plans were adopted or granted by the Registrant during the fiscal year ended December 31, 1995.\nCOMPENSATION OF DIRECTORS\nThere were no regular meetings of the Board of Directors and no director of the Registrant received any compensation during the fiscal year ended December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information, to the extent known by the Registrant, as to the persons and companies who owned beneficially more than five percent (5%) of the outstanding shares of the Common Stock of the Registrant at the close of business on December 31, 1995, and the beneficial ownership of the Registrant, as a group, as of such date. The number of shares held by each Director is set forth in Item 10 hereinabove.\nAmount and Nature of\n- --------------- NOTES: 1. Capital Investment Managers, Inc., is controlled by S. Gregory Smith, the President and Director of the Registrant as of December 31, 1994.\n2. The Hantges Children's Education Trust is the beneficial owner of 12,806 shares of the common stock of the Registrant. These shares are separate and distinct from those owned by Thomas A Hantges. The Hantges Education Trusts is an Irrevocable Trust with an independent third party Trustee, Helen Miller. Thomas A. Hantges does not have direct or indirect control over the 12,806 shares beneficially owned by the Trust.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as a part of this report:\n(1) Financial Statements and Supplementary Data:\nThe financial statements filed as a part of this report are attached hereto as Exhibit 1, and are listed in the \"Index to Financial Statements\" at Item 8.\n(2) Financial Statements Schedules:\nThe financial statements schedules filed as a part of this report are attached as Exhibit 1 and are listed in the \"Index to Financial Statements\" at Item 8.\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.\nCAPITAL ADVISORS ACQUISITION CORP. (REGISTRANT)\nDate: July 1, 1996 \\s\\ Thomas Hantges ------------------------------------ By: Thomas Hantges President\nDate: July 1, 1996 \\s\\ Thomas R. Brooksbank ------------------------------------ By: Thomas R. Brooksbank Chief Financial Officer\nCAPITAL ADVISORS ACQUISITION CORP. FINANCIAL STATEMENTS DECEMBER 31, 1995, AND 1994 (WITH AUDITORS' REPORT THEREON) REPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors Capital Advisors Acquisition Corp. Fort Worth, Texas\nWe have audited the accompanying balance sheets of Capital Advisors Acquisition Corp. (a Delaware corporation in the development stage), as of December 31, 1995 and 1994, and the related statements of operations, stockholders' equity, and cash flows as of 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. The statements of operations, stockholders' equity and cash flows of Capital Advisors Acquisition Corp. as of December 31, 1991 and from November 22, 1988 (inception), were audited by other auditors whose report dated February 29, 1992, expressed an unqualified opinion on those 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 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 Capital Advisors Acquisition Corp. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles.\nMCBRIDE & REEVES CPA'S\nApril 13, 1996 Las Vegas, Nevada CAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of the financial statements.\nCAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993 AND FOR THE PERIOD FROM NOVEMBER 22, 1988 (INCEPTION), TO DECEMBER 31, 1995\nThe accompanying notes are an integral part of the financial statements.\nCAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993 AND FOR THE PERIOD FROM NOVEMBER 22, 1988 (INCEPTION), TO DECEMBER 31, 1995\nThe accompanying notes are an integral part of the financial statements.\nCAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993, AND FOR THE PERIOD FROM NOVEMBER 22, 1988 (INCEPTION), TO DECEMBER 31, 1995\nThe accompanying notes are an integral part of the financial statements.\nCAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) NOTE TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\n(1) Summary of Organization and Significant Accounting Policies\n(a) Organization\nThe Company was organized as a Delaware corporation on November 22, 1988.\nOn January 30, 1989, the Company was registered (Form S-1) with the Securities and Exchange Commission, file number 033-26344.\nFrom the date of inception, through the registration with the Securities and Exchange Commission, through December 31, 1995 the Company has had minimal business operations.\n(b) Capital Stock\nThe authorized, issued and outstanding shares of capital stock at December 31, 1995, were as follows:\nPreferred stock; $1.00 par value; 1,000,000 shares authorized, none issued and outstanding.\nCommon Stock; $.0001 par value; authorized 50,000,000 shares; 1,325,000 shares issued and outstanding.\n(c) Earnings Per Share\nEarnings per share of common stock was computed by dividing net income (loss) by the weighted average number of common shares outstanding for the year (1,325,000 shares).\n(d) Dividends Per Share\nNo dividends have been paid as of December 31, 1995.\n(2) Convertible Debentures\nOn December 31, 1988, the Company issued to Capital Investment Managers, Inc., an affiliate of each of the officers of the Company by common ownership, 8% convertible debentures totaling $3,750. The debentures were exercised March 7, 1989 and were converted to common stock of the Company at a conversion rate of $.015 in common stock value per each $1.00 in debenture. The conversion resulted in the issuance of an additional 250,000 shares of common stock of the Company.\nCAPITAL ADVISORS ACQUISITION CORP. (A DEVELOPMENT STAGE COMPANY) NOTE TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\n(3) Stock Bonus Plan\nThe Company has established a Stock Bonus Plan for the benefit of its employees. The plan allows for the award of a maximum of 750,000 common shares of the Company in any one year. On December 25, 1988, the Company provided 250,000 shares of common stock to officers of the Company. No other stock bonus awards have occurred through December 31, 1994.\n(4) Related Party Transactions\nThere are certain operating costs incurred by the Company that were paid directly by stockholders for the Company. These costs are de minimis and the parties paying the costs do not intend to be repaid or reimbursed by the Company. The expenses paid by related parties for 1994 amounted to $4,272 and is recorded as additional paid in capital.\nIn addition, their were certain operating costs incurred by the Company that were paid for with the issuance of common stock. 100,000 shares of common stock were issued in exchange for legal services in the amount of $5,000.\nDuring 1995, The Company issued 225,000 shares of common stock for directors' fees. The transaction was recorded at The Companys' market value of the shares of zero.\n(5) Liquidation of Subsidiary\nDuring the year ended December 31, 1991, the Company liquidated its investment in Continental Commerce Corporation, another development stage company. The transaction resulted in a loss on the investment of $2,500 and cash received of $1,500. The cash proceeds were distributed to shareholders for reimbursement of various professional fees paid on behalf of the Company.\n(6) Income Taxes\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standard 109, \"Accounting for Income Taxes\" which requires the use of the \"liability method\" of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which 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.","section_15":""}
{"filename":"799119_1995.txt","cik":"799119","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAmerican International Petroleum Corporation (\"AIPC\" or the \"Company\"), was organized on April 1, 1929 under the laws of the State of Nevada under the name Pioneer Mines Operating Company. The Company's name was changed to its current name pursuant to an agreement and plan of reorganization and merger in April 1982. The Company and its wholly-owned subsidiaries, American International Petroleum Corporation of Colombia (\"AIPC-Colombia\") and Pan American International Petroleum Corporation (\"PAIPC\") is engaged in petroleum exploration, drilling, production and marketing operations in Colombia and Peru, South America and in Indonesia. The Company's wholly-owned subsidiary, American International Refinery, Inc. (\"AIRI\") is the owner of a refinery in Lake Charles, Louisiana, which is currently leased through March 31, 1998 to Gold Line Refining, Ltd. (\"Gold Line\"), an independent refiner. The term the \"Company\" or \"AIPC\" includes AIPC, AIPC-Colombia, PAIPC, and AIRI unless the context otherwise requires.\nThe Company's principal oil and gas properties consist of (i) between 40% and 80% of the working interest in all oil and\/or gas wells drilled on approximately 36,000 acres in the Puli Anticline and the Toqui-Toqui Field,located in the Middle Magdalena Region of Colombia, South America, which are part of the Puli Association Contract and (ii) 65% of the working interest in approximately 77,000 acres of exploratory and development contract rights in the Talara Basin in Peru. In December 1995, the Company entered into a Farmout Agreement in Indonesia, whereby the company would to earn a 49% working interest in a Technical Assistance Contract (\"TAC\") with the Indonesian government oil company (\"Pertamina\") for the Pamanukan Selatan area of West Java Province, Indonesia. The TAC is subject to government approval.\nINTERNATIONAL EXPLORATION AND PRODUCTION\nCOLOMBIA, SOUTH AMERICA\nIn 1987, the Company acquired the rights to 45% of the Puli Association Contract Area in the Middle Magdalena Region, from the previous operator. In December 1991, it purchased an additional 35% interest, bringing its total working interest to 80%. Petroleros Del Norte, a Colombian company (\"Petroleros\"), owns the remaining 20% of the working interest. The Company acts as operator of its Association Contract in Colombia, which is subject to a 20% royalty payable to the Colombian government national oil company (\"Ecopetrol\") and to certain Colombian taxes.\nPULI AREA\nThe Puli Association Contract originally covered approximately 92,000 gross acres in the Middle Magdalena Valley. In 1991, the acreage was reduced to approximately 33,000 gross acres under the terms of the Association Contract. Twenty-one productive wells have been drilled on a prospect of approximately 1,900 acres in the Puli Area, all of which were completed as of December 31, 1995. These wells produced an average of 868 gross barrels of oil per day during March 1996. All of the producing wells are located in the Toqui-Toqui Field.\nIn April 1992, Ecopetrol declared the Toqui-Toqui field commercial. As a consequence of declaring the field commercial, Ecopetrol will participate in 50% of the costs of developing the field and must reimburse the Company for 50% of its previous successful drilling costs to date. Production from the field is subject to a 20% royalty payable to the Colombian government.\nIn December 1995, the Company completed the drilling of its TT-34 well in the Toqui-Toqui Field. The TT-34 well was drilled to a total depth of 4,069 feet and encountered 120 feet of net pay, or productive region, in the Doima Sands which is the normal productive sand in the Toqui-Toqui Field. In addition, the well encountered 161 feet of net pay in a newly-discovered zone in the Chicoral Formation (the \"Chicoral\"). The Company and its independent petroleum engineers (\"Huddleston & Co., Inc.\") believe the well should have been drilled deeper, and the net pay could have been more than 161 feet. However, further drilling was constrained by the rig's capacity. Huddleston & Co. estimates the potential oil in place in the Chicoral to be approximately 133 million barrels, of which approximately 13%, or 17.1 million barrels, is recoverable. Some of these reserves are included in the Company's proved reserve base at December 31, 1995. Huddleston further estimates that the Chicoral extends over an area of 1,673 acres with an oil reservoir of an average thickness of 113 feet. The drilling of additional wells will be required to adequately define the commercial extension of the Chicoral. The TT-34 well was drilled on a \"sole risk\" basis, which allows the Company to recover 200% of its costs before its partner, Petroleros, may convert its 20% working interest. The other partner, Ecopetrol, may choose to participate in 50% of the future net profits generated by this discovery by reimbursing the Company 50% of past costs and participating in 50% of future costs associated with this discovery. Presently, the Company maintains a 100% working interest until each of the other parties decide whether or not to participate. If both Petroleros and Ecopetrol decides, to participate, the new discovery will then be owned as follows: 40% AIPC, 50% Ecopetrol and 10% Petroleros.\nFour wells have been drilled in a separate area of the Puli Association Contract known as the Puli Anticline. The first well was drilled by a third party operator and was not productive. The second well was drilled by the Company to 5,400 feet and completed as a gas discovery. The third well was completed in 1992 as an oil well and is currently shut-in. In August 1993, the Company drilled a fourth well to a target depth of approximately 7,600 feet. This well was not commercially productive. The Company re-entered the second well in mid-1994 and deepened the well without encountering further productive intervals. Further evaluation of the Puli Area's potential is still in progress.\nLAGUNILLAS\nIn December 1991, the Company signed an Association Contract with Ecopetrol to explore approximately 190,000 acres in the Lagunillas area of the Middle Magdalena Valley. In October 1994, the Company farmed-out a 50% working interest in Lagunillas to a non-affiliated company. In September 1995, the Company entered into a farmout agreement with a separate non-affiliated oil and gas company (the \"Farmee\"), whereby the Company will transfer all of its remaining interest and obligations at Lagunillas. The Company will remain as operator and 50% working interest owner of this block until the Farmee has been qualified as a petroleum company by the Colombian Ministry of Mines, which is expected in mid-1996.\nRELINQUISHED BLOCKS\nDuring 1995, after completing its technical evaluations of the Viani, Tabacales and Aguablanca Blocks in Colombia (where the Company had previously signed Association Contracts with Ecopetrol), the Company relinquished all of its rights in these Blocks to Ecopetrol. As compensation for the early relinquishment and cancellation of all its obligations in these blocks, the Company paid Ecopetrol approximately $500,000, which was substantially less than the $3.1 million the Company was previously required to invest under the related contractual work programs.\nAlso during 1995, the Company relinquished all of its rights and obligations in the Rio Planas Area of Colombia to a non-affiliated company.\nPERU, SOUTH AMERICA\nIn October 1993, PAIPC entered into a joint venture agreement with Rio Bravo, a Peruvian corporation (\"Rio Bravo\"), to participate in the exploration and development of a 77,000 acre block in the Talara Basin under which PAIPC receives a 65% interest in production from exploration and development after recovery of 150% of all drilling costs invested by PAIPC on behalf of Rio Bravo. The agreement also provides PAIPC with an option to participate in the rehabilitation and further development of a producing oil field on the block on a 50\/50 basis.\nIn late 1994 and early 1995, PAIPC drilled one exploratory well and two new step-out development wells. However, full evaluation of the potential of those oil reservoirs has been delayed, primarily due to a dispute with Rio Bravo (See \"Item 3 - Legal Proceedings\"), so the timing or amount, if any, of oil reserves that the Company may add to its reserve base as a result of its drilling in Peru is not presently determinable. In spite of these problems, during 1995, the minimum work program required under the license contract in Peru was completed and certified as complete by the government.\nRio Bravo has continuously refused to cooperate in the development program in the block and to honor PAIPC's right to oil production from the Block. Consequently, PAIPC has not received its share of revenues since the unilateral lockout by Rio Bravo in October 1995 (See \"Item 3 - Legal Proceedings\"). As all relations with the government are joint with PAIPC and its partner, the government cannot act unilaterally to resolve a dispute between the parties. However, the Company continues its efforts to negotiate an amicable settlement to this situation.\nMANAGEMENT PLANS\nThe Company recently performed an analysis to determine the viability of operating its 16,500 barrel per day Vacuum Distillation Unit to produce vacuum gas oil and asphalt in addition to, but separate from, the operations currently being performed by Gold Line. Preliminary studies utilizing actual pricing scenarios from 1994 and 1995 indicate that such a project could provide the Company with significant amounts of revenues and profits, if appropriate feedstock and end-product contracts, and adequate financing, could be secured. The Company plans to pursue a program of this nature in order to maximize the capability of its Refinery assets, however, the timing for the implementation of such an operation, if any, is indeterminable at this time.\nThe Company has received an offer from an oil company and inquiries from various others regarding a possible farmout of its new Chicoral discovery and its other Colombian properties in return for cash and drilling obligations in the Company's Toqui-Toqui field. Such a transaction could provide the Company with the necessary capital to repay a portion of its recently-issued 10% Debenture, while establishing a plan for the full exploitation of its Chicoral discovery with little or no cost to the Company. Although a farmout would result in a lower overall Company ownership interest of its Colombian reserves, the net result to the Company could be an increase in its oil and gas reserve base, a stronger balance sheet and greater potential for earnings and cash-flow growth.\nThe Company is also engaged in negotiations with Far Eastern Hydrocarbons Ltd., a Hong Kong Corporation (\"FEH\"), to exchange shares of the Company's common stock in return for 100% of the outstanding common stock of a wholly-owned subsidiary of FEH (See \"Indonesian Agreements\" below). FEH has indicated a desire to provide the necessary financing, or guarantees for same, to enable the Company to actively participate in the international energy community. In addition, the oil fields owned by FEH are producing significant amounts of cash\nflow, which could also be utilized to fund the Company's operations, if necessary. However, the Company is not able, as of this writing, to determine if the current negotiations will be successful and, consequently, there can be no assurance when, or if, the share exchange agreement will be consummated.\nINDONESIAN AGREEMENTS\nUSTRAINDO\nIn January 1995, the Company signed an agreement with P.T. Ustraindo Petrogas (\"Ustraindo\"), a private Indonesian energy company, whereby the Company agreed to assist Ustraindo in operating all of the concession areas now held by Ustraindo in Indonesia, namely 22 oil and gas fields, including 2,000 wells.\nIn return for providing its technical assistance to Ustraindo, the Company was to receive a reimbursement of all of its related costs, plus a 3% net profits interest in the 22 fields. In addition, the Company received a one-year option to purchase a minimum of 25% working interest in the concessions for $17 million in cash.\nDuring the fourth quarter of 1995, the closing of the Ustraindo agreement was suspended due to certain issues of controversy between Ustraindo and Pertamina, which issues are primarily related to Ustraindo's alleged non-performance under their TACs with Pertamina. The Company elected to wait for a resolution of these issues before taking any further action regarding its agreement with Ustraindo. However, at this point, it is very unlikely that any agreement between the Company and Ustraindo will be consummated in the form to which the parties originally agreed.\nMALACCA STRAIT\nIn November 1995, the Company reached a preliminary agreement with FEH to purchase a portion of the issued and outstanding common stock of Resource Holdings, Inc. (\"RHI\"), a private Delaware corporation and a wholly-owned subsidiary of FEH, in exchange for common stock of the Company. The Company was also to receive a six-month option to acquire the remainder of RHI's common stock payable with shares of the Company's common stock.\nIn January 1996, the Company and FEH modified the structure of the proposed transaction. Under the new structure, 100% of RHI's shares would be exchanged for an as yet unspecified number of the Company's shares, subject to the signing of a definitive agreement. Because of the large number of shares of common stock required, the transaction is also subject to approval by the Company's shareholders. As of April 5, 1996, the parties were continuing their due diligence processes and, as stated above, no assurance can be given as to when, or if, an agreement will be consummated.\nRHI's assets consist of its wholly-owned Panamanian corporation, Kondur Petroleum S.A. (\"Kondur\"), which owns 34.46% of the Malacca Strait PSC Contract (\"Malacca\") in Sumatra, Indonesia. Kondur is the largest Indonesian-owned domestic operator in Indonesia. The remaining interests in Malacca are owned by China National Offshore Oil Corporation and Novus Petroleum Ltd. Malacca covers an area of 2.7 million acres and contains 16 oil fields operated by Kondur, which are currently producing an aggregate of approximately 20,000 barrels of oil per day. Malacca has an estimated 58 million barrels of proven recoverable oil reserves and 47 billion cubic feet of proven recoverable gas reserves. It also includes an additional 133 million barrels of probable oil reserves. Kondur intends to increase the daily average production rates of Malacca through future development and exploration, which is scheduled to commence during the third quarter of 1996.\nPAMANUKAN SELATAN\nIn December 1995, the Company entered into a Farmout Agreement with P.T. Pelangi Niaga Mitra Internasional, an Indonesian company (\"PNMI\"), whereby the Company is expected to earn a 49% working interest in a Technical Assistance Contract (\"TAC\") with Pertamina for the Pamanukan Selatan area of West Java Province, Indonesia by providing 100% of the funding for the exploration, development and operation of the TAC. Full exploration and development of the TAC is expected to cost between $2 and $3 million over the next three years, of which approximately $700,000 will be required during 1996. As a portion of its obligations under the Farmout Agreement, the Company issued, pursuant to Regulation S of the Securities Act of 1933, 100,000 shares of its common stock to PNMI. The Company will be the operator of the joint operations and the TAC and is to be reimbursed for 175% of all expenditures, pursuant to the cost recovery provisions in the TAC, before any distribution of profits to PNMI can occur. The Company will also be entitled to recoup Indirect Overhead charges up to five percent of total expenditures, which amount will be part of the cost recovery.\nAll monetary obligations the Company may have under the Farmout Agreement are subject to PNMI receiving governmental certification and Pertamina's approval to conduct operations under this TAC, which PNMI expects to occur in May of 1996. In the event the negotiations with FEH, discussed above, are not successful, the Company may reconsider its participation with PNMI.\nPamanukan Selatan includes an estimated 16 billion cubic feet of gas reserves. The field's initial well tested at 5.7 million cubic feet of gas per day and is temporarily shut-in pending construction of a 1.3 mile delivery pipeline.\nIn October 1995, the Company signed a Memorandum of Understanding with PNMI, which entitles the Company to a two-year right of first refusal to farm-in to a 49% working interest in any future contracts obtained by PNMI from Pertamina. The Company will have three months to exercise its rights, after receipt of each notification from PNMI, at a cost to be negotiated on a deal-by-deal basis.\nDOMESTIC OPERATIONS - REFINERY\nGENERAL\nIn July 1988, AIRI acquired an inactive oil refinery located on a site bordering the Calcasieu River near Lake Charles, Louisiana (the \"Refinery\"). The Refinery is situated on 30 acres of land. The Company also owns 22 acres of vacant waterfront property adjacent to the Refinery and another 45 acres of vacant land across the highway from the Refinery. The river connects with the Port of Lake Charles, the Lake Charles Ship Channel and the Intracoastal Waterway. Most of the Refinery's feedstock and products are handled through the Refinery's barge dock at the river.\nAfter the Company acquired the Refinery, it was recommissioned and then extensively tested during operations between February and July 1989. During that time it processed over a million barrels of Louisiana, North African and West African crude oils and operated at rates of up to 24,000 barrels per day. Numerous modifications were designed to bring the Refinery into compliance with new and existing environmental regulations and to facilitate production of higher value products. Construction commenced during the fourth quarter of 1989, resulting in completion of most environmental compliance projects and a military specification jet fuel (\"JP-4\") upgrade project in 1990. The Company has continuously leased the Refinery to Gold Line Refining, Ltd. (\"Gold Line\") since October 1990. (See \"Refinery Lease\" below).\nDESCRIPTION OF REFINERY\nThe main unit of the Refinery is a 30,000 barrels per day crude distillation tower suitable for adaption to process sour crude oil. The fractionator is capable of producing light naphtha overhead, and the following side cuts: heavy naphtha, kerosene (for jet fuel), #2 diesel, atmospheric gas oil, and reduced crude oil sold as special #5 fuel oil.\nIn 1989, the Company purchased a 16,500 barrel per day vacuum distillation unit (\"VDU\") which was dismantled and moved to Lake Charles. Construction of the VDU on the Refinery site was completed in 1993 and, for various economic reasons, the VDU has been idle since then. However, the Company is currently in the process of studying the viability of utilizing the VDU to produce asphalt and vacuum gas oil which can be sold to other refineries as a feedstock to manufacture high octane gasoline. The main portion of the plant has the capacity to process 30,000 barrels per day of crude oil. (See \"Management Plans\" below).\nTotal petroleum storage capacity is 645,000 barrels. Storage tanks on the Refinery's land include 220,000 barrels of crude storage, 345,000 barrels of storage for finished products sales and 80,000 barrels of product rundown storage. The Refinery also has 20,000 barrels of waste water storage.\nREFINERY LEASE\nUnder its lease, Gold Line is responsible for substantially all costs associated with operating the Refinery. One-half of all lease rental payments to the Company under this or any other lease of the Refinery are to be paid to MG Trade Finance (\"MGTF\") to retire principal and interest on Refinery debt. (See \"Business - Refinery Financing Activities\" below. Prior to such lease becoming effective April 1, 1991, the Company arranged certain financing, referred to below, and completed construction of substantially all of certain environmental compliance projects and jet fuel upgrade projects required to produce military jet fuel. As consideration for concessions made in the agreement, Gold Line released the VDU from the property subject to the lease. The VDU has the capacity to utilize the residue fractions remaining after completion of refining operations in the main refinery, or utilize similar product obtained elsewhere, to produce asphalt and vacuum gas oil.\nAll amounts owed to AIRI by Gold Line on October 1, 1992 were restructured and evidenced by a promissory note in the principal amount of $1,244,192 and bearing interest at prime plus 2%, due on September 30, 1995. The note was to be retired in monthly installments equal to 10% of Gold Line's monthly operating cash flow, if such operating cash flow was positive. From December 31, 1992 until March 22, 1995, the note remained unpaid. During 1994 AIRI established a $1,244,192 reserve for potentially uncollectible receivables from Gold Line. In 1994, the lease expired and was not renewed. However, by mutual consent, Gold Line continued to operate the Refinery through mid-December 1994, when Gold Line shut down its operations pending receipt of new financing from its banks.\nOn March 22, 1995 Gold Line obtained a line of credit with NationsBank to finance its obligations at the Refinery, and the Company entered into an amended Lease Agreement with Gold Line, extending the lease term through March 31, 1998. The rental fees, payable monthly, were $.40 for each barrel of feedstock processed through the Refinery by Gold Line through December 31, 1995, and increased to $.50 per barrel from January 1, 1996 through the end of the lease. Also on March 22, 1995, the Company again restructured all past due amounts owed to AIRI by Gold Line and executed a promissory note (to replace the old note) in the principal amount of $1,801,464 (the \"Note\"), which is subject to a Subordination and Standby Agreement between the Company, Gold Line and NationsBank (the \"Subordination Agreement\"). Gold Line agreed to amortize the Note by making quarterly payments to AIRI during the term of the lease of approximately $144,000, plus accrued interest at a rate of prime plus 1%. The remainder is to be paid by (i) a series of additional payments during the last 6 months of the lease or (ii) Gold Line will fund and construct a vacuum recovery unit on the Refinery, at which time the Company will reduce the balance due on Gold Line's note by $650,000. Gold Line may not make payments on the Note to\nAIRI unless it is in compliance with certain covenants included in the Subordination Agreement. Because of the problems mentioned below, and pursuant to the Subordination Agreement, to date, Gold Line has not been permitted to make any payments of principal and interest on the Note to AIRI.\nDuring 1995, Gold Line encountered problems in obtaining the financing necessary for it to secure sufficient levels of feedstock to keep the Refinery operating at full capacity. As a result, the lease fees the Company received during 1995 of $1,185,000 were substantially lower than expected. In addition, these problems put Gold Line in a difficult position in obtaining new fuel supply contracts with the United States Defense Fuel Supply Center (\"DFSC\").\nWith the objective of assisting Gold Line in securing the necessary financing to ensure renewal of its supply contracts, in February 1996, the Company agreed to reduce the amount of the Note from $1,801,464 to $900,732. All other terms of the Note remain unchanged. In March 1996, Gold Line was successful in obtaining the necessary financing to secure a $45 million fuel supply contract with the DFSC. As a result, Gold Line expects to process higher volumes of feedstock, which should permit it to make payments to AIRI as called for in the Note.\nREFINERY FINANCING ACTIVITIES\nSubsequent to the purchase of the Refinery, the Company entered into a series of transactions with MGTF to finance the upgrade and operations of the Refinery.\nIn 1990, AIRI entered into a loan and security agreement (the \"Loan Agreement\") with MGTF whereby MGTF loaned AIRI $9,855,000 to (i) repay all of AIRI's obligations under a 1988 supply agreement of $6,505,000; (ii) repay AIRI's prior loan obligation with MGTF; (iii) fund certain improvements related to environmental regulations and production of J-4 jet fuel; and (iv) provide working capital.\nIn order to secure AIRI's obligations under the Loan Agreement, AIRI granted MGTF a first priority security interest in the Refinery and in substantially all of the remainder of AIRI's assets. The Company also guaranteed AIRI's obligations under the Loan Agreement and pledged to MGTF all of the capital stock of AIRI. AIRI may not, during the term of the Loan Agreement, make a dividend distribution to the Company or repay amounts advanced to it by the Company, and AIRI is limited in the amount of indebtedness it can incur.\nIn the Loan Agreement, the Company granted MGTF warrants to purchase 516,667 shares (as adjusted) of the Company's common stock at an exercise price of $7.50 per share, exercisable at any time prior to June 30, 1994 (the \"MGTF Warrants\"). The expiration dates of 246,667 of the MGTF Warrants were extended to June 30, 1997 and the exercise price was adjusted to $15.63 per share of common stock. In addition, MGTF's parent company, MG Corp., is entitled to one seat on the Company's Board of Directors without the consent of the Company and a second seat upon the consent of the Company's Board, which consent is not to be unreasonably withheld. One of such Directors is also eligible to be appointed to the Executive Committee, also upon consent of the Company's Board, which consent is not to be unreasonably withheld. MGTF has not nominated any directors to the Board.\nIn April 1993, the Company negotiated an amendment to the Loan Agreement whereby MGTF reduced the balance of the loan by $750,000 through the exercise of 100,000 warrants to purchase common stock of the Company. In addition, MGTF retained the right to lease the Refinery in the event the existing lease with Gold Line is terminated prior to its expiration. Also, in consideration for rescheduling the loan, MGTF received a fee of $100,000 and a warrant to acquire 100,000 shares of the Company's common stock at $16.88 per share. Such warrant was exercisable at any time prior to June 30, 1997. In July 1995 MGTF released\nall of its then-existing warrants for cancellation and received new warrants to purchase 150,000 shares of the Company's common stock at $2.00 per share. The expiration date of June 30, 1997 remained unchanged.\nIn March 1995, the Company further amended the Loan Agreement whereby MGTF extended the unpaid balance due by the Company of $2,845,000 to March 31, 1998. Fifty percent of the monthly lease fee proceeds from Gold Line are to be applied to amortize the MGTF loan. To the extent the portion of such lease rental payments is not sufficient to meet accrued interest due on the loan, the Company must advance funds to AIRI to satisfy such obligation. The related interest rate was also reduced to the prime rate plus 1%.\nOTHER FINANCINGS\nIn January 1993, the Company issued $5.6 million of 12% Secured Debentures, due December 31, 1997, which are secured by all of the issued and outstanding capital stock of its wholly-owned subsidiary AIPC-Colombia. The Company used the proceeds to fund its Colombian drilling, production and marketing operations and to repay certain debt. The Company has $3.6 million of principal payments remaining on its 12% Secured Debentures. (See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\".)\nIn March 1994, the Company completed an offering of rights to its shareholders. Each right was exercised for $3.00, and the holder received two shares of common stock and one redeemable warrant to acquire an additional share of common stock at any time prior to March 1, 1996 at an exercise price of $4.00 per share. In March 1996, the expiration date of these warrants was extended to March 1, 1997, however the exercise price remains at $4.00 per share. The rights offering resulted in the exercise of 5,957,390 rights for gross proceeds of $17,872,170.\nGross proceeds consisted of the surrender of $950,000 of the Company's 12% Secured Debentures, receipt of $16,521,000 cash and issuance of a $400,000 note receivable bearing interest at 10% per annum to an officer of the Company. The Company paid commissions of $1,181,757 from gross proceeds to various placement agents. Additionally, the Company incurred approximately $484,000 of expenses related to the offering.\nProceeds from the offering were utilized for general corporate purposes including exploration and development of the Company's prospects in Colombia and Peru, repayment of debt and for working capital.\nDuring 1995 and the first quarter of 1996, the Company issued an aggregate of 7,668,318 shares of its common stock in exchange for cash and services rendered to the Company valued at an aggregate of approximately $4,714,000 through various private placements and agreements, most of which were placed in accordance with the safe harbor provided by Regulation S as promulgated by the Securities and Exchange Commission (the \"SEC\").\nIn March 1996, the Company received net proceeds of $1,350,000 from the sale of 10% Convertible Subordinated Redeemable Debentures (the \"10% Debentures\") in a private placement to various foreign buyers under Regulation S. At its option, the Company may redeem any or all of the 10% Debentures prior to conversion by paying to the holder in cash 135% of the then outstanding principal balance of the 10% Debenture plus accrued interest to date. Such payment may also be made by the Company within 15 days of receipt of a conversion notice by the Company from the holder(s). In addition, the Company, at its sole option, may force conversion at any time on and after 120 days from the date of issuance of the 10% Debentures if the average closing bid price for the Company's common stock for five consecutive trading days shall be in excess of $1.50. The holders of the 10% Debentures may convert all or any amount over $25,000 of the original principal amount, commencing May 11, 1996, into shares of the Company's common stock at a conversion price per share equal to the lower of (i) 65% of the average closing bid price of the Common Stock for the five business days immediately preceding the date of receipt by the Company of notice of conversion or (ii) 65% of the average of the closing bid price of the Common Stock for the five business days immediate preceding the date of Subscription by the holders.\nThe Company is utilizing the proceeds from the 10% Debenture to repay debts and for working capital purposes.\nCOMPETITION\nThe oil and gas industry, including oil refining, is highly competitive. In South America and Indonesia, the Company is in competition with numerous major oil and gas companies and large independent companies for prospects, skilled labor, drilling contracts and equipment. Many of the companies operating in South America and Indonesia have greater resources than the Company's. The Company believes, however that despite this intense competition, it will be able to sell all of its production at prevailing market rates.\nDue to highly volatile crude oil prices and environmental regulation, many oil refineries have ceased or curtailed production. The Company believes, although no assurance can be given, that the high costs of constructing new refineries, as well as the cost of updating and modifying inactive existing refineries will discourage competition in the refining business. However, since the Company has leased a portion of the Refinery to Gold Line and, unless it implements its contemplated VDU operations (See \"Business - Management Plans\", below) it does not stand to benefit or suffer directly from competitive factors in the refinery business (provided such competitive factors do not result in a default by Gold Line under the lease) so long as the Refinery remains under lease. There is no assurance that the Refinery will remain under lease, or that after the termination of the lease, the Company will be able to compete successfully in the refining business should it operate the Refinery itself.\nRISKS ASSOCIATED WITH THE COMPANY'S FOREIGN OPERATIONS\nThe following are some of the risks that the Company encounters in its foreign operations:\nPolitical Risks in Colombia, Peru and Indonesia. The Company's operations could be adversely affected by the occurrence of political instability and civil unrest in Colombia, Peru and Indonesia. Political instability could also change the current operating environment for the Company in these countries through the imposition of restrictions on foreign ownership, repatriation of funds, adverse environmental laws and regulations, adverse labor laws, and the like. Any such changes could significantly affect the ability of the Company to conduct business in these countries, which could (particularly in Colombia) have a material adverse effect on the Company.\nRisk of Capital Losses Due to Speculative Nature of Oil and Gas Industry. Oil and gas exploration is extremely speculative, involving a high degree of risk. Even if reserves are found as a result of drilling, profitable production from reserves cannot be assured.\nEnergy Market Subject to Fluctuation. Revenues generated by the Company's oil and gas operations and the carrying value of its oil and gas properties are highly dependent on the prices for oil and natural gas. The price which the Company receives for its oil is dependent upon numerous factors beyond the control of the Company's management, the exact effect of which cannot be predicted. These factors include, but are not limited to, (i) the quantity and quality of the oil or gas produced, (ii) the overall supply of domestic and foreign oil or gas from currently producing and subsequently discovered fields, (iii) the extent of importation of foreign oil or gas, (iv) the marketing and competitive position of other fuels, including alternative fuels, as well as other sources of energy, (v) the proximity, capacity and cost of oil or gas pipelines and other facilities for the transportation of oil or gas, (vi) the regulation of allowable production by governmental authorities, (vii) the regulations of the Federal Energy Regulatory Commission governing the transportation and marketing of oil and gas, and (viii) international political developments, including nationalization of oil wells and political unrest or upheaval in South America, Iraq, Kuwait, Iran and other areas. All of the aforementioned factors, coupled with the Company's ability or inability to engage\nin effective marketing strategies, may affect the supply or demand for the Company's oil or gas and, thus, the price attainable therefore.\nFINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe table below sets forth, for each of the last three fiscal years, the amounts of revenue, operating profit or loss and assets attributable to each of the Company's geographical areas, and the amount of its export sales.\nINSURANCE; ENVIRONMENTAL REGULATIONS\nThe Company's operations are subject to all risks normally incident to (i) oil and gas exploratory and drilling activities, including, but not limited to, blowouts, extreme weather conditions, pollution and fires; and (ii) the refining of petroleum products. Any of these occurrences could result in damage to or destruction of oil and gas wells, related equipment, production facilities, and may otherwise inflict damage to persons and property. The Company maintains comprehensive and general liability coverage, as is customary in the oil and gas industry and coverage against most risks, although no assurance can be given that such coverage will be sufficient to cover all risks, be adequate in amount, or that any damages suffered will not be governed by exclusionary clauses, thereby rendering such coverage incomplete or non-existent to protect the Company's interest in specific property. The Company is not fully covered for damages incurred as a consequence of environmental mishaps. The Company believes it is presently in compliance with government regulations and follows safety procedures which meet or exceed industry standards. Because the Company's oil and gas operations are carried out in countries where the cost of environmental compliance is relatively low, such compliance is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company.\nMARKETING\nDuring 1993 and for the four months ended April 30, 1994, the Company sold all of its oil production from its Colombian properties to Ecopetrol. Effective May 1, 1994, the Company entered into an agreement with Carbopetrol S.A. to sell all of its crude oil currently produced in Colombia. This contract is a 6-month renewable fixed-price sales contract for all crude oil produced by the Company from the Toqui-Toqui field. Payments are made in Colombian Pesos adjusted for expected exchange fluctuation. Prices are based on the price of local fuel oil\nand, effective March 1996, are equivalent to a net price to the Company of approximately $8.40 per barrel of oil. (See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Exploration and Production Activity.\") In Peru, a contract with PetroPeru provides for a flexible royalty rate based on the amount of production and world basket price for this contract area providing a net sales price to the operator of approximately 65% of the world basket price for the field, which, based on a gross price of $16.53 per barrel in January 1996, provided a net price to the Company of approximately $10.75 per barrel of oil.\nSales of the Company's crude oil to Carbopetrol S.A. in Colombia accounted for 39% and 18% of the Company's 1995 and 1994 revenues, respectively. Sales to Ecopetrol accounted for approximately 10% and 47% of the Company's 1994 and 1993 revenues, respectively. Lease fees from Gold Line accounted for approximately 42%, 59% and 43% of the Company's 1995, 1994 and 1993 revenues, respectively. There is no assurance that Gold Line will be able to meet its obligations under the lease, however, if Gold Line could not complete its obligations under the Refinery lease, the Company believes it could obtain another lessee on substantially the same terms as Gold Line's lease or operate the Refinery itself. (See \"Management Plans\"above.)\nManagement does not believe that the loss of Carbopetrol S.A. or PetroPeru as customers would materially adversely effect the Company's operations. In the past, the Company has been approached by other purchasers of oil willing to purchase the Company's production on terms similar to those in effect with its current purchasers. While no assurance can be given, Management believes that it would be able to sell its oil and gas to other persons on terms similar to that being offered from time to time by the Company's present purchasers.\nIn addition, continuing market for the Company's oil and gas will depend upon numerous factors, many beyond the control of the Company, and most of which are not predictable. These factors include regulation of oil production, price controls on petroleum and petroleum products, the amount of oil and gas available for sale, the availability of adequate pipeline and other transportation facilities, the marketing of competitive fuels, and other matters affecting the availability of a ready market, such as fluctuating supply and demand.\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nThe Company purchases all raw materials needed for its operations from major suppliers and manufacturers located throughout the United States, Colombia and Peru. The Company believes that these materials are in good supply and are available from multiple sources.\nEMPLOYEES\nAs of April 6, 1996, the Company employed 33 persons on a full-time basis: 13 persons who are engaged in management, accounting and administrative functions in the United States, 19 in management, technical and administrative functions in the Company's offices in Bogota, Colombia, and 1 technical person in Lima, Peru. The Company frequently engages the services of consultants that are experts in various phases of the oil and gas industry, such as petroleum engineers, refinery engineers, geologists and geophysicists. The Company believes that relations with its employees are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOFFICE FACILITIES\nThe Company leases approximately 2,900 square feet of office space at 444 Madison Avenue, New York, N.Y. 10022. This space comprises the Company's principal executive office. The space was leased effective November 1, 1994 for a period of four years at a monthly rental rate of $6,546. In addition, the\nCompany leases approximately 3,400 square feet of office space in Houston, Texas. The lease expires in November 1997 and provides for a monthly rental of $3,570.\nThe Company leases approximately 15,000 square feet of office space in Bogota, Colombia under an annually renewable lease. The Company renewed the lease for one year on March 1, 1996; however it now occupies approximately 3,400 square feet, for which it pays $3,000 per month in rent. The remainder is being sublet at approximately the same rate as the Company's obligation.\nThe Company also owns 87 acres of land in Lake Charles, Louisiana where its oil Refinery is located. In addition to the structure and equipment comprising the Refinery facility, the Refinery assets include an approximately 4,000 square foot office building and three metal building structures serving as work shops, maintenance and storage facilities with an aggregate square footage of approximately 3,800 square feet.\nOIL AND GAS ACREAGE AND WELLS\nGross acreage presented below represents the total acreage in which the Company owns a working interest and net acreage represents the sum of the fractional working interests owned by the Company in such acreage.\nThe table below indicates the Company's developed and undeveloped acreage as of December 31, 1995.\nThe table below indicates the Company's gross and net oil and gas wells as of December 31, 1995. Gross wells represents the total wells in which the Company owns a working interest and net wells represents the sum of the fractional working interests owned by the Company in such wells.\n*Still under evaluation\nOIL AND GAS PRODUCTION\nThe table below indicates the Company's net oil and gas production, by country, for each of the five years in the period ended December 31, 1995, 1994, 1993, 1992, and 1991, along with the average sales prices for such production during these periods.\nAverage foreign lifting costs in 1995, 1994, 1993, 1992 and 1991 were approximately $2.75, $4.64, $9.02, $9.11, and $4.84 per equivalent barrel of oil, respectively. The Company's average domestic lifting costs for 1992 and 1991 were approximately $10.26 and $8.35 per equivalent barrel of oil, respectively.\nRESERVES\nHuddleston & Co., Inc., petroleum and geological engineers, performed an evaluation to estimate proved reserves and future net revenues from oil and gas interests owned by the Company as of January 1, 1996. As of January 1, 1996, all of the Company's proved reserves were located in Colombia. The report, dated March 22, 1996, is summarized below. Future net revenues were calculated after deducting applicable taxes and after deducting capital costs, transportation costs and operating expenses, but before consideration of Federal income tax. Future net revenues were discounted at a rate of ten percent to determine the \"present worth\". The present worth was shown to indicate the effect of time on the value of money and should not be construed as being the fair market value for the Company's properties. Estimates of future revenues did not include any salvage value for lease and well equipment or the cost of abandoning any properties.\nHuddleston & Co., Inc. used the net market price, exclusive of transportation cost, of $8.72 per average barrel of oil and $1.00 per MCF of gas in their report. The oil prices utilized were the prices received by the Company as of December 31, 1995 for oil produced from the Company's leaseholds. The gas prices utilized were based on the Ecopetrol spot price at December 31, 1995. The prices were held constant throughout the report except for where contracts provide for increases.\nOperating costs for the Company's leaseholds include direct leasehold expenses only. Capital expenditures were included as required for new development wells, developed non-producing wells and current wells requiring restoration to operational status on the basis of prices supplied by the Company.\nThe report indicates that the reserves were estimates only and should not be construed as being exact quantities. These reserves may or may not be actually recovered, and, if recovered, the revenues therefrom and the actual costs related thereto could be more or less than the estimated amounts. Because of governmental policies and uncertainties of supply and demand, the actual sales rates and prices actually received for the reserves along with the cost incurred in recovering such reserves, may vary from those assumptions included in the report. The report further states that estimates of reserves may increase or decrease as a result of future operations.\nIn evaluating the information at their disposal concerning the report, Huddleston & Co. excluded from consideration all matters as to which legal or accounting interpretation may be controlling. As in all aspects of oil and gas evaluation, there are uncertainties inherent in the interpretation of engineering data and such conclusions necessarily represent only informed professional judgments.\nThe data used in the Huddleston & Co. estimates were obtained from the Company and were assumed to be accurate by Huddleston & Co. Basic geologic, engineering and field performance data are maintained on file by the Company.\nDRILLING\nThe following table sets forth the gross and net exploratory and development wells which were completed, capped or abandoned in which the Company participated during the years indicated.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nExcept as described below, there is no litigation pending to which the Company is a party or to which any of its properties is subject. Further, except as described below, there are no proceedings known to be contemplated by United States or foreign governmental authorities relating to either the Company or its properties.\nIn May 1992, AIRI was advised by the Internal Revenue Service (\"IRS\") that the IRS was considering an assessment of excise taxes, penalties and interest of approximately $3,500,000 related to the sale of fuel products during 1989. The IRS claims that AIRI failed to comply with an administrative procedure that required sellers and buyers in tax-free transactions to obtain certification from the IRS. The Company believes that AIRI complied with the substance of the existing requirements and such sales were either tax-free or such excise taxes were paid by the end-users of such products. AIRI has offered to negotiate a settlement of this matter with IRS Appeals since early 1993. Such negotiations included face-to-face meetings, numerous phone calls and written transmittals and several offers of settlement by both the Company and the IRS. During these negotiations, the IRS Appeals officers offered to waive all of the penalties and 75% of the amount of the proposed tax liability. However, AIRI rejected this offer and requested the IRS' National Office to provide technical advice to its Appeals officers. After numerous conferences and discussions with the National Office in 1995, the National Office issued an adverse Technical Advice Memorandum (\"TAM\") to its Appeals Office in Dallas, Texas, to the effect that AIRI should be liable for the tax on the sale of diesel fuel for the first three quarters of 1989. However, even in light of the findings of the TAM, the IRS Appeals officer has indicated to AIRI that the IRS still wants to negotiate a settlement. As a result, AIRI has scheduled a meeting for April 30, 1996 with the IRS Appeals Office to discuss the situation. Depending upon the results of this meeting, the Company will decide whether to litigate or settle this situation. Regardless of whether the Company decides to litigate or settle, it believes it will incur some form of liability, either in legal expenses or payments to the IRS, or some combination of both. Consequently, it has provided an allowance during 1995 of $250,000 for this potential incurrence of expenditures, although at this time, the Company is unable to determine exactly what liability may arise from this assessment.\nOn January 25, 1994, a lawsuit captioned Paul R. Thibodeaux, et al. v. Gold Line Refinery Ltd. (a limited partnership), Earl Thomas, individually and d\/b\/a Gold Line Refinery Ltd., American International Petroleum Corporation, American International Refinery, Inc., Joseph Chamberlain individually (Docket No. 94-396), was filed in the 14th Judicial District Court for the Parish of Calcasieu, State of Louisiana. Subsequently, several parties were joined as plaintiffs or defendants in the lawsuit. Responsive pleadings have been filed by AIRI to this action and to the three amendments which added plaintiffs, defendants and restructured the plaintiff's claims (deleting some claims and adding new claims). The lawsuit alleges, among other things, that the defendants, including AIRI, caused or permitted the discharge of hazardous and toxic substances from the Lake Charles Refinery into the Calcasieu River. The plaintiffs seek an unspecified amount of damages, including special and exemplary damages. AIRI continues to vigorously defend such action. In March 1996, the Company and AIRI filed an Exception of Prescription which is expected to eliminate most of the plaintiffs claims. At this time, the Company is unable to determine what, if any, liability may arise from this action.\nIn October 1995, Rio Bravo S.A., the operator of the Company's Lot IV Block in Peru, locked-out PAIPC personnel from access thereto and filed a legal action in Peru against PAIPC claiming damages of $11,695,000 and alleging that PAIPC's License Contract with the government to explore Block IV (the \"License Contract\") was cancelled by the government due to the fact PAIPC did not complete the minimum work program required under the License Contract. However, because the\nminimum work program was completed and was certified as complete by the government (the performance bond placed by PAIPC to assure its compliance with the minimum work program has, in fact, been released by the government) and, since the License Contract with the government is still in effect and has not been cancelled, the Company expects the legal action by Rio Bravo will be decided in PAIPC's favor. PAIPC has also filed counter-claims and is in the process of filing liens against Rio Bravo to defend its interests in the Block and License Contract and continues to participate in meetings with the government related to the activities in the Block and in all matters of administration and execution of the obligations in the License Contract. At this time, the Company is unable to determine what, if any, liability or benefits may arise from this action.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock and its Class A Warrants are traded on NASDAQ\/NMS under the symbols \"AIPN\" and \"AIPNW\", respectively. The following table sets forth, for the periods indicated, the range of closing high and low bid prices of the Common Stock and the Class A Warrants as reported by NASDAQ. These quotations represent prices between dealers, do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions.\nAt April 1, 1996, the Company had approximately 1,280 shareholders of record of its Common Stock and 79 holders of record of its Class A Warrants. The Company estimates that an additional 10,000 shareholders hold Common Stock in street name.\nDIVIDEND POLICY\nCertain covenants set forth in the indentures governing certain outstanding Debentures of the Company prohibit payment of cash dividends. The present policy of the Board of Directors is to retain earnings to finance the operations and development of the Company's business. Accordingly, the Company has never paid cash dividends on its Common Stock, and no cash dividends are contemplated to be paid in the foreseeable future. (See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\".)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL INFORMATION\nThe following selected financial data for each of the five years in the period ended December 31, 1995 have been derived from the audited consolidated financial statements for those respective years. (See \"Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the last three years, the Company has had difficulty generating sufficient cash flow to fund its operations, capital expenditures and required principal payments. As a result, the Company has from time to time operated with limited liquidity or negative working capital. In order to continue operations under such circumstances, the Company has historically relied on outside sources of capital.\nAt December 31, 1995 the Company had an unrestricted cash balance of $162,218 compared to $943,000 at December 31, 1994. During the year ended December 31, 1995, the Company utilized approximately $274,000 for operations. Net loss for the period totalled $4,338,000, including non-cash provisions for depreciation, depletion and amortization of $1,502,000, non-cash provisions for bad debts and a contingent excise tax liability (or for legal expenses related thereto, or both) of $711,000 and $250,000, respectively, and a non-cash charge of $56,000 related to initial employment signing bonuses, and for forgiveness of amounts receivable from an employee stock purchase. Approximately $189,000 was used during the period to increase current assets other than cash, and approximately $1,985,000 was provided by an increase in accounts payable and accrued liabilities. Cash for operations during 1995 was provided, in part, by the issuance of Common Stock in an aggregate amount of approximately $3,723,000.\nDuring the years ended December 31, 1994 and December 31, 1993, the Company generated net losses of $10,967,000 and $14,140,000 respectively. There were non-cash charges in 1994 and 1993 of $6,904,000 and $9,975,000, respectively, for reductions in the carrying costs of oil and gas properties due primarily to prior-period reductions in the estimated volume of proven oil and gas reserves for these periods. There was also a non-cash provision of $211,000 in 1994 for an adjustment to the exercise price of certain outstanding warrants. Cash flow provided from operations in 1994 and 1993 totalled $5,110,000 and $3,648,000, respectively. Cash flow from operations was adjusted for depreciation, depletion and amortization of $1,699,000 and $1,136,000 in 1994 and 1993, respectively.\nAdditionally, $277,000 and $228,000 in 1994 and 1993, respectively, were invested in current assets other than cash. Accounts payable increased by $3,234,000 and $847,000 in 1994 and 1993 respectively. Additional uses of funds during the periods included investments in oil and gas properties during 1994 and 1993 of $5,557,000 and $5,680,000, respectively, net of certain recoverable costs, and investment in the Refinery of $289,000 in 1993. Total cash used in operations and investment activity during the years ended December 31, 1994 and 1993 was $10,341,000 and $8,610,000, respectively.\nCash was provided primarily from outside sources, including $14,978,000 and $2,646,000 from the issuance of common stock during 1994 and 1993, respectively; $770,000 from the exercise of common stock warrants and options in 1993, and $60,000 and $5,237,000 in 1994 and 1993, respectively, in proceeds from the issuance of long term debt.\nThe Company's 12% Secured Debentures (the \"Debentures\") require certain principal payments and contain certain restrictive covenants and conditions with which the Company must comply. During the next twelve months approximately $1,229,000 and $421,000 in principal and interest, respectively, are due for payment, of which all of the principal is payable in December 1996 and one-half of the interest is payable in each of June and December 1996. The Company is currently having discussions with the principal holder of the Debentures regarding the possibility of prepaying them at a discount from face value. In the event the Company is not successful in accomplishing a prepayment to MGTF, it believes it will be capable of fulfilling its normal payment obligations under the respective Debenture and Note agreements with MGTF. However, in the event the Company is unable to meet its obligations pursuant to the Debentures in a timely manner, the Company's oil and gas reserves and its operations may be adversely affected.\nAs of March 22, 1995, the Company amended certain terms of its Loan Agreement with MG Trade Finance Corp. (\"MGTF\"), extending the due date for the unpaid balance from May 31, 1995 to March 31, 1998. In addition, payments on the loan have been reduced from 100% to 50% of the monthly lease fee proceeds the Company receives from Gold Line (See \"Item 1 - Business - Refinery Financing Activities\"). If lease fees are not sufficient to satisfy all accrued interest and principal when due, the Company is obligated to satisfy any shortfall. The Company may be required to fund future working capital requirements that arise from Refinery operations, including any liability that may arise from any claims or settlements related to the Refinery. (See \"Item 3 - - Legal Proceedings\"). The Loan Agreement contains certain restrictive covenants and requirements. The Company and MGTF have from time to time amended the Loan Agreement or waived certain events of technical default.\nDuring 1995, Gold Line incurred various financial and purchasing problems which resulted in diminished throughput volumes and lower lease fees to the Company and also prevented Gold Line from making its note payments to the Company as scheduled in September and December 1995 (See \"Item 1 - Business - Refinery Lease\"). These problems resulted in lower cash flow to the Company of up to $1.4 million, which required it to utilize other methods to acquire funds necessary to satisfy its monetary and contractual obligations, including the issuance of equity, as described above. During the first quarter of 1996, the Company issued shares of its common stock in exchange for cash and services rendered to the Company totalling an aggregate of approximately $991,000 placed in accordance with the safe harbor provided by Regulation S as promulgated by the SEC.\nIn March 1996, Gold Line was successful in solving its financial and purchasing problems, and secured a new one-year $45 million fuel supply contract with the DFSC. As a result, Gold Line expects to process higher volumes of feedstock through the Refinery, which should enable it to make its scheduled quarterly principal and interest note payments to the Company beginning in June 1996. In addition, Gold Line's lease fees increased to $.50 per barrel of\nfeedstock in 1996 from $.40 per barrel in 1995. During March 1996, Gold Line processed a high of approximately 18,000 daily barrels of feedstock and was processing an average of 15,500 barrels of feedstock per day. It expects to average 16,000 barrels per day during the remainder of the lease, a level it needs to maintain in order to meet its obligations under its two DFSC contracts. The combination of Gold Line's note payments and increased lease fees could provide the Company with approximately $1.8 million more cash flow during the next twelve months than during the last.\nAlso in March 1996, the Company received net proceeds of $1,350,000 from the sale of 10% Convertible Subordinated Redeemable Debentures (the \"10% Debentures\") in a private placement to various foreign buyers under Regulation S. At its option, the Company may redeem any or all of the 10% Debentures after issue and prior to conversion by paying to the holder in cash 135% of the then outstanding principal balance of the 10% Debentures plus accrued interest to date. Such payment may also be made at the Company's option within 15 days of receipt of a conversion notice by the Company from the holder(s). In addition, the Company, at its sole option, may force conversion at any time on and after 120 days from the date of issuance of the 10% Debentures if the average closing bid price for the Company's common stock for five consecutive trading days shall be in excess of $1.50. The holders of the 10% Debentures may convert all or any amount over $25,000 of the original principal amount commencing May 11, 1996 into shares of the Company's common stock at a conversion price per share equal to the lower of (i) 65% of the average closing bid price of the Common Stock for the five business days immediately preceding the date of receipt by the Company of notice of conversion or (ii) 65% of the average of the closing bid price of the Common Stock for the five business days immediately preceding the date of Subscription by the holders. The Company is utilizing the proceeds from the 10% Debenture to repay debts and for working capital purposes.\nThe Company has received an offer from an oil company and inquiries from various others regarding a possible farmout of its new Chicoral discovery and its other Colombian properties in return for cash and drilling obligations in the Company's Toqui-Toqui field. Such a transaction could provide the Company with capital to repay a major portion of its recently-issued 10% Debenture, while ensuring that its Chicoral discovery would be fully exploited in the shortest time practicable with little or no cost to the Company. Although a farmout would result in a lower overall Company ownership interest of its Colombian reserves, the net result to the Company could be an increase in its oil and gas reserve base, a stronger balance sheet and greater potential for earnings and cash-flow growth.\nThe Company has no remaining drilling or work obligations in Colombia or Peru. Depending upon available funds, or whether the Company is successful with its farmout plans, the Company estimates it could utilize up to $4,000,000 for exploration and development of its properties and prospects in South America during the next twelve months.\nIn December 1995, the Company entered into a Farmout Agreement with P.T. Pelangi Niaga Mitra Internasional, an Indonesian company (\"PNMI\"), whereby the Company is expected to earn a 49% working interest in a Technical Assistance Contract (\"TAC\") with Pertamina for the Pamanukan Selatan area of West Java Province, Indonesia by providing 100% of the funding for the exploration, development and operation of the TAC. Full exploration and development of the TAC is expected to cost between $2 and $3 million over the next three years, of which approximately $700,000 will be required during 1996. As a portion of its obligations under the Farmout Agreement ($100,000), the Company issued, pursuant to Regulation S of the Securities Act of 1933, 100,000 shares of its common stock to PNMI. The Company will be the operator of the joint operations and the TAC and is to be reimbursed for 175% of all expenditures, pursuant to the cost recovery provisions in the TAC, before any distribution of profits to PNMI can occur. The Company will also be entitled to recoup Indirect Overhead charges up\nto five percent of total expenditures, which amount will be part of the cost recovery. All monetary obligations the Company may have under the Farmout Agreement are subject to PNMI receiving governmental certification and Pertamina's approval to conduct operations under this TAC, which PNMI expects to occur in May of 1996. Under certain circumstances however, the Company could decide not to proceed with the project.\nThe Company intends to meet its capital and operating funds requirements in the near term from revenues generated from operations, and from additional financing as necessary. However, there is no assurance of success of any farmout or financing efforts the Company may pursue or the timing or success of the exploitation of its discoveries in Colombia and Peru, its potential projects in Indonesia, and\/or its VDU project. In the event the Company is not able to fund its exploration and development projects on its own in a timely manner, Management believes it will be able to obtain partners for certain projects.\nThe Company does not engage in hedging transactions to reduce the risk of foreign currency exchange rate fluctuations and has not experienced significant gains or losses related to such events. The Company receives proceeds from sales of oil and gas in Colombia and Peru in local currency and utilizes these receipts for local operations. Periodically funds are transferred from U.S. accounts to Colombia and Peru and converted into pesos and soles, respectively, when the local currency is insufficient to meet obligations payable in local currency.\nIMPACT OF CHANGING PRICES\nThe Company's revenues, its ability to repay indebtedness and the carrying value of its oil and gas properties are affected by changes in oil and gas prices. Oil and natural gas prices are subject to substantial seasonal, political and other fluctuations that are beyond the ability of the Company to control. Since crude oil prices are an important determining factor in the carrying value of oil and gas assets, significant reductions in the price of crude oil could require non-cash write-downs of the carrying value of those assets. This occurred in 1993, when the prices the Company received for its crude oil declined significantly. As a consequence, a reduction in the carrying value of the Company's oil and gas properties of $9,975,000 was recorded during the fourth quarter 1993. In 1994 however, prices increased, thereby reducing the impact of a reduction of previous estimates of proven reserve quantities by the Company's independent reservoir engineers, whose estimate for that period resulted in a further reduction of the carrying value of the Company's oil and gas assets of $6,904,000 during the fourth quarter of 1994.\nNo reduction in the carrying value of the Company's oil and gas assets was necessary at December 31, 1995.\nRESULTS OF OPERATIONS\nThe following table highlights the results of operations for the years ended December 31, 1995, 1994 and 1993.\n(1) DD&A does not include provision for reduction of oil and gas properties of $6,904,000 and $9,975,000 in 1994 and 1993, respectively. Also excludes Peruvian activity since all related properties are currently considered \"unevaluated\".\nPRODUCTION ACTIVITY\nFor the Year ended December 31, 1995 compared to the Year ended December 1994.\nOil production in 1995 increased to 155,615 barrels, a 12% increase over 1994. Average oil prices declined however, by 6% or $.50 per barrel, to $8.16 in 1995 as compared to $8.66 in 1994. The net effect of these occurrences resulted in a $65,000 (5%) increase in the Company's oil revenues in 1995 compared to 1994.\nProduction cost declined by $184,000 (30%) in 1995 compared to 1994, primarily due to transportation costs incurred during the first four months of 1994, which were not incurred after that time. Effective May 1, 1994 the Company sells all of its crude oil directly to an end-user at the well head, eliminating transportation costs.\nFor the Year ended December 31, 1994 compared to the Year ended December 31, 1993.\nOil and gas revenues decreased by $791,000, or 42%, in 1994 compared to 1993. Approximately 60% of the decrease resulted from the Company's new crude oil sales contract, which became effective May 1, 1994. Under the terms of the new contract, the Company sells its crude oil directly to an end user at the well\n- 23 -\nhead. Therefore, the transportation cost, which was included in the selling price during 1993, was excluded from the price under the new agreement. Approximately 30% of the decline was related to a 20% decrease in the average price of the Company's crude oil in 1994 as compared to 1993, reflecting the overall weakness in the world oil market during much of 1994. The remaining portion of the decline was due to an 8% decrease in the total oil produced in 1994 as compared to the previous year.\nProduction costs decreased by $593,000, or 54%, in 1994 as compared to 1993. Approximately half of the decline was due to the elimination of transportation costs, mentioned above. The remainder was due to decreased workover and well maintenance activity in 1994 as compared to 1993.\nREFINERY OPERATIONS\nFor the Year Ended December 31, 1995 compared to the Year Ended December 31, 1994\nThe Company leases its refinery to Gold Line Refinery Ltd. As lessee, Gold Line is responsible for all operating costs of the refinery. The Company charges Gold Line a fee for each barrel of feedstock processed at the refinery. The fee during 1995 was $.40 per barrel of throughput, which increased to $.50 per barrel on January 1, 1996. This rate continues until the Lease expires on March 31, 1998.\nRefinery lease fees declined by approximately 43% in 1995 to $1,185,000 as compared to 1994. The decline relates primarily to financing and purchasing problems encountered by Gold Line during 1995 (See \"Item 1 - Business - Refinery Lease\"). As a result, Gold Line experienced a 44% decline in its annual throughput in 1995 compared to 1994. However, Gold Line, as previously discussed, has apparently resolved these problems and in March 1996 secured a one-year $45 million fuel supply contract with the DFSC which, when combined with its other contract with the DFSC, is expected to result in Gold Line processing 16,000 barrels of feedstock per day. This increased activity should provide the Company with minimum annual lease fees of approximately $2.9 million. Gold Line has also indicated to the Company that it is attempting to obtain supplemental fuel supply contracts, which would call for an additional 4,000 barrels per day of throughput volume to be processed in the Refinery. There can be no assurance at this time, however, that Gold Line will continue to process an average of 16,000 barrels of feedstock per day or be successful in securing supplemental contracts.\nFor the Year Ended December 31, 1994 compared to the Year Ended December 31, 1993.\nRefinery lease fees increased approximately 19% to $2,065,000 in 1994 as compared to 1993. The increase was due primarily to a 15% increase in the per-barrel throughput fees charged to Gold Line in the last half of 1994 and a 5% increase in the average daily throughput compared to the previous year.\nOTHER INCOME\nOther income increased by $118,000 (50%) during 1995 to $356,000 as compared to 1994. A 60% increase in interest income in 1995 related to the Gold Line note was partially offset by a 10% decrease in 1995 compared to 1994 of foreign exchange gains, primarily due to narrower fluctuations in the currency exchange rates between the United States and Colombia.\nOther income declined by 38% during the year ended December 31, 1994 as compared to the same period in 1993, primarily due to narrower fluctuations in the currency exchange rates between the United States and Colombia during 1994 as compared to 1993.\nGENERAL AND ADMINISTRATIVE\nTotal General and Administrative Expenses (\"G&A\") during 1995 decreased by $564,000, or 14%, compared to 1994. Payroll expenses declined by $255,000 (6%) during 1995 compared to 1994. Decreases also occurred in the following categories during 1995 versus 1994: professional fees, $73,000; travel, $69,000; office rents, $60,000; public relations, $60,000; insurance, $33,000; and office operating expenses, $54,000. Further declines are expected during 1996 as the Company continues its efforts to reduce overhead costs.\nTotal G&A declined by only 1% in the year ended December 31, 1994 as compared to 1993. However, excluding capitalized G&A and G&A reimbursements related to exploration and development projects, which decreased by approximately $420,000, or 46%, in 1994 as compared to 1993, and other non-cash items, the Company's overall G&A declined by approximately $541,000, or 11%, in 1994 as compared to the same period in the previous year. A 21% decrease in payroll of $467,000 and a 30% decrease in investor relations of $120,000 were partially offset by a 76% increase in legal expenses of $130,000, related primarily to an environmental lawsuit and excise tax dispute with the Internal Revenue Service. The reductions in the capitalization and reimbursements of G&A during 1994 as compared to 1993 resulted primarily from reduced exploration and development during 1994 as compared to 1993.\nINTEREST\nInterest expense decreased 20% by $262,000 during the year ended December 31, 1995 as compared to 1994. Excluding a decrease in non-cash amortized bond costs of $95,000, which are included in the interest expense category, interest expense decreased by $167,000 during 1995 versus 1994, primarily due to reduced debt balances.\nInterest expense decreased by $224,000, or 15%, during the year ended December 31, 1994 as compared to 1993, primarily due to reduced debt balances in 1994.\nADOPTION OF ACCOUNTING STANDARD\nOn March 31, 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\". SFAS No. 121 addresses the accounting for the impairment of long-lived assets, identified intangibles and goodwill related to those assets and requires that the carrying amount of impaired assets be reduced to fair value. SFAS No. 121 has been adopted by the Company and had no effect on its financial statements for the year ended December 31, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial information required by Item 8 follows Item 14 of this Report and is hereby incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth information concerning the Company's executive officers and directors.\nBIOGRAPHICAL INFORMATION\nDr. George N. Faris has been Chairman of the Board of Directors and Chief Executive Officer of the Company since 1981. Dr. Faris was the founder of ICAT, an international engineering and construction company, and served as its President from ICAT's inception in 1972 until October 1985. Prior to 1972, Dr. Faris was the President and Chairman of the Board of Directors of Donbar Development Corporation, a company engaged in the patent development of rotary heat exchangers, devices which exchange heat from medium to medium and on which Dr. Faris has received a number of patents. Dr. Faris received a Ph.D. in Mechanical Engineering from Purdue University in 1968.\nMr. Denis J. Fitzpatrick joined the Company in August 1994 as Vice President, Secretary and Chief Financial Officer. During the previous five years, Mr. Fitzpatrick was the Chief Financial Officer of Nahama & Weagant Energy Company, a publicly traded independent exploration and production company. Mr. Fitzpatrick received a B.S. degree in Accounting from the University of Southern California in 1974.\nMr. William L. Tracy has been employed by the Company since February 1992 and was named Treasurer and Controller of the Company in August 1993. From May 1989 until February 1992, Mr. Tracy was self-employed as an energy consultant with the Commonwealth of Kentucky. From June 1985 until May 1989, Mr. Tracy served as President of City Gas and Transmission Corp., a public oil and gas production and refining company. He received his BBA from Bellarmine College in Louisville, Kentucky in 1974.\nDr. Daniel Y. Kim has served as a member of the Company's Board of Directors since July 1987. Dr. Kim is a Registered Professional Geophysicist in California and Colorado. From 1981 until 1984, Dr. Kim was President and Chief Executive Officer of Kim Tech, Inc., a research and development company. In 1984, Kim Tech, Inc. was merged into Bolt Industries, a public company engaged in the manufacture of air guns and auxiliary equipment used to generate shock waves in seismic exploration for oil, gas and minerals. Dr. Kim has been a director of Bolt Industries since 1984. Dr. Kim received a B.S. degree in Geophysics and a Ph.D. degree in Geophysics from the University of Utah in 1951 and 1955, respectively.\nMr. Donald G. Rynne was elected to the Company's Board of Directors in September 1992. Mr. Rynne has been Chairman of the Board of Directors of Donald G. Rynne & Co., Inc., a privately owned company engaged in international consulting and trading, since founding that company in 1956. Mr. Rynne is also Chairman of the Board of Directors of Dynamax Maritime & Resources Ltd., a company engaged in the trading and shipping business, and has served in such capacity since August 1984, and Chairman of the Board of Directors of Centurion Maritime Ltd., a company engaged in the shipping business, and has served in such capacity since August 1984. Mr. Rynne is involved in international maritime trading and consulting, dealing primarily in the Middle East in hydrocarbon products and capital equipment. Mr. Rynne received a B.A. degree from Columbia University in 1949.\nMr. William R. Smart has served as a member of the Company's Board of Directors since June 1987. Mr. Smart is currently a director of Executone Information Systems, Inc., an electronics manufacturer, and has served in such capacity since September 1992. Mr. Smart was Chairman of the Board of Directors of Electronic Associates, Inc., a manufacturer of electronic equipment, from May 1984 until May 1992. Since November 1, 1983, Mr. Smart has been Senior Vice President of Cambridge Strategic Management Group, a management consulting firm. Mr. Smart is also a director of National Datacomputer Company and Hollingsworth and Voss Company. Mr. Smart received a B.S. degree in Electrical Engineering from Princeton University in 1941.\nThe Company's directors and executive officers are elected annually to serve until their respective successors are duly elected and qualified.\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 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. Such reporting persons are required by regulation to furnish the Company with copies of all Section 16(a) reports that they file.\nBased solely on its review of the copies of such reports received by it, or written representations from certain reporting persons that no Form 5 was required for those persons, the Company believes that, during the period from January 1, 1995 through December 31, 1995, all filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied with, except that one report covering one transaction was filed late by Mr. Kenneth Durham, a former director of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table discloses compensation for services rendered by the Company's Chief Executive Officer and all other executive officers of the Company whose compensation exceeded $100,000 in 1995.\n(1) $35,503 of this amount constituted forgiveness of interest on a note owed to the Company, the principle of which was repaid to the Company, and $9,600 was paid as a vehicle allowance for Dr. Faris pursuant to his contract.\n(2) Options issued in substitution for outstanding options. The exercise price was reduced to $1.00 per share.\n(3) On October 13, 1995, the Company and Dr. Faris executed an amendment to Dr. Faris' employment agreement, pursuant to which Dr. Faris relinquished certain rights in exchange for 900,000 shares of Common Stock. (See \"Employment Contract\" below). The amendment to the employment agreement is subject to shareholder ratification. If the shareholders do not ratify the amendment at the next annual meeting of shareholders, the Company and Dr. Faris have agreed that the amendment will not be effective.\n(4) Includes split dollar life insurance premiums of $16,250 in 1994 and $22,960 in 1993 and term life insurance premiums of $4,544 in 1993 paid by the Company on behalf of Dr. Faris.\n(5) Mr. Durham resigned from employment with the Company effective on November 3, 1995.\n(6) Mr. Durham joined the Company in November 1993 at an annual salary level of $190,000.\n(7) Options awarded upon hiring. All such options expired 90 days after Mr. Durham's resignation.\n(8) Mr. Fitzpatrick was awarded 5,000 restricted shares of Common Stock as a signing bonus, which shares were issued in 1995.\n(9) Cost of living allowance payable while Mr. Fitzpatrick is based in New York is $15,000 annually.\n(10) Mr. Fitzpatrick joined the Company on August 15, 1994 at an annual salary level of $105,000.\n(11) Options awarded upon hiring, 50% of which are exercisable one-year after issuance, the remainder of which are exercisable after two years.\nSTOCK OPTION PLANS\nThe Company has established three employee stock option plans. The three plans provide for the grant of options to qualified employees (including officers and directors) of the Company, independent contractors, consultants and other persons to purchase an aggregate of 3,650,000 shares of Common Stock. The exercise price of the options granted under each plan cannot be less than the fair market value of the shares of Common Stock on the date the option is granted. If an option granted under any of the plans terminates or expires\nwithout having been exercised in full, the unexercised shares subject to that option will be available for a further grant of options under such plan. Options may not be transferred other than by will or the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by the optionee.\nThe 1988 Incentive Stock Option Plan (the \"Incentive Stock Option Plan\") is to be administered by the Board of Directors of the Company or a Committee designated by them. Under the Incentive Stock Option Plan, only full-time employees, including officers and managerial or supervising personnel, are eligible to receive Incentive Stock Options, as defined in Section 422(b) of the Internal Revenue Code of 1986, as amended (\"ISO's\"). ISO's may not be granted under the Incentive Stock Option Plan after July 1998. ISO's granted to Shareholders owning 10% or more of the outstanding voting power of the Company must be exercised at a price equal to 110% of the fair market value of the shares of Common Stock on the date of grant. The maximum number of shares of Common Stock reserved for issuance pursuant to the Incentive Stock Option Plan is 100,000. As of April 10, 1996, no options were outstanding pursuant to this plan.\nThe 1988 Non-Qualified Stock Option Plan (the \"Non Qualified Stock Option Plan\") provides for the grant from time to time to key employees of the Company (including officers and directors of the Company) of options to purchase Common Stock at an exercise price determined by disinterested members of the Company's Board of Directors or by a Stock Option Committee which may be appointed. Options are granted for a five-year period and become exercisable on a pro-rata basis over three years at the end of each month subsequent to the date of grant, provided the optionee is employed by the Company at the end of such month. The maximum number of shares of Common Stock reserved for issuance pursuant to the Non-Qualified Stock Option Plan is 50,000. As of April 10, 1996, no options were outstanding pursuant to this plan.\nThe Company's 1995 Stock Option Plan (the \"1995 Plan\") was approved by the Board of Directors on November 8, 1995, and it is subject to shareholder approval. If the shareholders do not approve the 1995 Plan, all options issued under the 1995 Plan will be non-qualified stock options. The 1995 Plan is to be administered by the Board of Directors of the Company or a Committee designated by them. Under the 1995 Plan employees, including officers and managerial or supervising personnel, are eligible to receive ISO's or ISO's in tandem with stock appreciation rights (\"SAR's\"), and employees, directors, contractors and consultants are eligible to receive non-qualified stock options (\"NQSO's\") or NQSO's in tandem with SAR's.\nOptions may not be granted under the 1995 Plan after November 7, 2005. ISO's granted to Shareholders owning 10% or more of the outstanding voting power of the Company must be exercised at a price equal to 110% of the fair market value of the shares of Common Stock on the date of grant. The aggregate fair market value of Common Stock, as determined at the time of the grant with respect to which ISO's are exercisable for the first time by any employee during any calendar year, shall not exceed $100,000. Any additional Common Stock as to which options become exercisable for the first time during any such year are treated as NQSO's. The maximum number of shares of Common Stock reserved for issuance pursuant to the 1995 Plan is 3,500,000. The total number of options granted under the 1995 Plan, as of April 10, 1996 was 302,500, which were merely repriced options granted in substitution for options previously held.\nOPTION GRANTS IN LAST FISCAL YEAR\nThe table below includes the number of stock options granted to certain executive officers during the year ended December 31, 1995, exercise information and potential realizable value. All of the options granted in 1995 were repriced options granted in substitution for options previously held by such officers.\nAGGREGATE OPTION EXERCISES IN 1995 AND OPTION VALUES AT DECEMBER 31, 1995\nThe table below includes the number of shares covered by both exercisable and unvested stock options owned by certain executive officers as of December 31, 1995. Also reported are the values for \"in-the-money\" options which represent the positive spread between exercise price of any such stock options and the year-end price.\n- -------------------------------\n(1) The closing price of the Common Stock on the last day of the year ended December 31, 1995 was $.63.\n(2) Mr. Durham left the Company on November 3, 1995, and his options expired on February 1, 1996.\nEMPLOYMENT CONTRACT\nEffective May 1, 1989, the Company entered into a five-year employment agreement with George N. Faris at an annual salary of $200,000, which agreement was extended, in November 1990, for an additional two years. In November 1991, Dr. Faris' salary was increased to $250,000 effective retroactively to January 1, 1990. Additionally, in February 1992, the Board increased Dr. Faris' salary to $300,000 per year effective January 1, 1992. In April 1994, Dr. Faris voluntarily reduced his salary to $240,000 per year. In February 1996, Dr. Faris' salary was reinstated to $300,000 per year effective February 1, 1996.\nPursuant to the employment agreement, In the event that there is a change in control of the Company which Dr. Faris and a majority of the Company's Board of Directors approve, Dr. Faris will be entitled, upon such change of control, to terminate his employment and receive 2.9 times his fixed compensation as defined in the employment agreement. However, if Dr. Faris opposes a change in control, but the majority of the Board of Directors votes in favor of such change, then Dr. Faris may terminate his employment and receive 2.5 times his fixed compensation. In the event Dr. Faris' employment is terminated prior to the expiration of his contract for reasons other than cause or death, or if such employment agreement is not renewed at termination, the Company must pay\nseverance to Dr. Faris in an amount equal to the product of his number of years of service, beginning with the calendar year 1981, multiplied by $50,000. Such payments are to be made in annual installments of $250,000 beginning on the tenth day after termination or non-renewal.\nOn September 7, 1995, the Board of Directors approved an amendment to Dr. Faris' employment agreement, which was signed by Dr. Faris and the Company on October 13, 1995, and which is subject to shareholder ratification. If the shareholders ratify the amendment, the rights of Dr. Faris described in the previous paragraph would terminate, and Dr. Faris would receive, in exchange, 900,000 shares of restricted stock of the Company. Otherwise, the amendment will not be effective.\nSALARY REINSTATEMENTS\nIn April 1994, officers of the Company voluntarily reduced their salaries (the Chief Executive Officer by 20% and other officers by 15%) until, in February 1996, the Compensation Committee recommended, and the Board of Directors approved, a reinstatement of these officers' salaries to their previous levels, effective February 1, 1996. The reinstatement was made to provide the necessary incentives to management to continue their efforts under very difficult circumstances and to ensure that the Company maintains a competititive position in the industry regarding the contuity of the employment of its officers. During the past two fiscal years, Management has significantly reduced general and administrative and operating costs (See \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations\"). In addition, in 1995, the volume and discounted value of the Company's equivalent oil reserves increased by 44% and 23%, respectively.\nCOMPENSATION OF DIRECTORS\nDuring 1995, the Company reimbursed directors for their actual Company-related expenses, including the costs of attending directors' meetings. The Company accrued, for each outside director, $500 per month for serving in such capacity; $500 per each Committee meeting, if such director served on a Standing Committee of the Board of Directors; and $500 for each Board meeting attended in person. A former director, Robert Stobaugh, received 19,000 shares of restricted stock of the Company in payment of director fees accrued but not paid to him.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nNo member of the Compensation Committee was an officer or employee of the Company or of any of its subsidiaries during the prior year or was formerly an officer of the Company or any of its subsidiaries. During the last fiscal year, none of the executive officers of the Company has served on the Board or Compensation Committee of any other entity whose officers served either on the Board of Directors of the Company or on the Compensation Committee of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information, as of April 10, 1996, regarding (i) each person known by the Company to be the owner of more than 5% of the outstanding Common Stock, (ii) each director, (iii) each executive officer named in the Summary Compensation Table above, and (iv) all directors and executive officers as a group. The number of shares beneficially owned by each director or executive officer is determined by the rules of the Securities and Exchange Commission, and the information is not necessarily indicative of beneficial ownership for any other purpose.\n- ----------------------------- * Less than 1% of class\n(1) Includes 29,800 shares of Common Stock owned by Mrs. Claudette Faris, Dr. Faris' wife, and 488,169 shares of Common Stock issuable upon exercise of stock options and warrants held by Dr. Faris. Also includes 7,600 shares of Common Stock issuable upon exercise of warrants held by Mrs. Faris.\n(2) Dr. Faris has agreed to accept 900,000 shares of Common Stock, subject to shareholder ratification, in exchange for certain rights under his employment agreement. (See \"Item 11 - -Executive Compensation--Employment Contract.\") If shareholders ratify the amendment to Dr. Faris' employment agreement, Dr. Faris would be deemed to beneficially own 7.0% of the Common Stock.\n(3) Includes 5,500 shares of Common Stock issuable upon exercise of a like number of options owned by Dr. Kim.\n(4) Includes 99,260 shares of Common Stock issuable upon exercise of a like number of options and warrants owned by Mr. Rynne.\n(5) Includes 61,986 shares of Common Stock issuable upon exercise of a like number of options and warrants owned by Mr. Smart.\n(6) Includes 20,000 shares of Common Stock issuable upon exercise of options owned by Mr. Fitzpatrick.\n(7) Includes all of the shares of Common Stock issuable upon exercise of options and warrants described in Notes (1) through (6) above, plus 1,000 shares of Common Stock issuable upon exercise of options owned by another officer of the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Item 11 - Executive Compensation - Employment Contract\".\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A)DOCUMENTS FILED AS PART OF THE REPORT\n(2) FINANCIAL STATEMENT SCHEDULES.\nNone.\n(3) EXHIBITS.\n3.1 Certificate of Incorporation of the Registrant, as amended. (1)\n3.2 Certificate of Amendment to Articles of Incorporation, dated June 29, 1988.(2)\n3.3 Certificate of Amendment to Articles of Incorporation, dated August 10, 1988. (2)\n3.4 Certificate of Amendment to Articles of Incorporation, dated November 18, 1993. (7)\n3.5 By-Laws of the Registrant, as amended.\n4.1 Indenture dated January 20, 1993, governing the Registrant's 12% Secured Debentures Due 1997.(6)\n4.2 Form of Class A Warrant. (8)\n4.3 1995 Stock Option Plan and Form of Option Agreements of the Registrant.\n4.4 Form of Debenture and Subscription Agreements dated March 21, 1996 between the Company and purchasers listed on Schedule A attached thereto.\n10.1 Employment Agreement, dated May 1, 1989 by and between George N. Faris and the Registrant.(3)\n10.2 Loan and Security Agreement (\"Loan Agreement\") dated December 4, 1990 by and between MG Trade Finance Corp. (\"MGTF\") and AIRI. (4)\n10.3 Schedule of construction and Other Loan Uses attached to the Loan Agreement. (4)\n10.4 Schedule of JP-4 Construction Permitted After December 15, 1990 attached to the Loan Agreement.(4)\n10.5 Corporate Continuing Guarantee of the Registrant to MGTF, dated December 4, 1990. (4)\n10.6 Pledge Agreement, dated as of the 4th day of December 1990, by and among the Registrant, AIRI and MGTF. (4)\n10.7 Shareholder Distribution Agreement dated as of the 4th day of December 1990, by and between the Registrant, AIRI and MGTF. (4)\n10.8 Form of Sale of Indebtedness and Assignment of Collateral Mortgage Notes and Security Documents. (4)\n10.9 Form of Collateral Mortgage Note drawn by AIRI. (4)\n10.10 Form of Amended and Restated Collateral Pledge Agreement drawn by AIRI (Inventory). (4)\n10.11 Form of Amended and Restated Collateral Pledge Agreement drawn by AIRI (Fixed Assets). (4)\n10.12 Environment Indemnity Agreement dated December 4, 1990 by and between AIRI, the Registrant and MG. (4)\n10.13 Amendment to Loan and Security Agreement, dated as of September 26, 1991. (5)\n10.14 Pledge and Security Agreement, dated January 20, 1993, by and between American International Petroleum Corporation and Society National Bank as Trustee. (6)\n10.15 Letter Agreement, dated January 4, 1995, by and between American International Petroleum Corporation and P.T. Ustraindo Petrogas.(9)\n10.16 Promissory Note, dated March 15, 1995 from Gold Line Refining, Ltd. to American International Petroleum Corporation.(9)\n10.17 Amended and Restated Lease Agreement between Gold Line and AIRI dated March 22, 1995.(9)\n10.18 Letter Agreement dated March 22, 1995 amending Loan and Security Agreement(9)\n10.19 Subordination and Standby Agreement dated March 22, 1995 between NationsBank, Gold Line Refining, Ltd., Citizens Bank and AIRI.\n10.20 Intercreditor Letter Agreements dated March 22, 1995 between MGTF, Citizens Bank and AIRI.\n10.21 Amendment #1 to Employment Agreement, dated October 13, 1995, between George N. Faris and the Registrant(10).\n10.22 Letter dated February 9, 1996 amending Promissory Note between AIRI and Gold Line Refining Ltd.\n21.1 Subsidiaries of the Registrant.(9)\n27.1 Financial Data Schedule.\n- ------------------------- (1) Incorporated herein by reference to the Registration Statement on Form S-1, declared effective on February 16, 1988 (File No. 33-17543).\n(2) Incorporated herein by reference to the Registration Statement on Form S-1 File No. 33-23584 declared effective on January 27, 1989.\n(3) Incorporated herein by reference to the Registration Statement on Form S-1 declared effective on February 13, 1990.\n(4) Incorporated herein by reference to the Registrant's Current Report on Form 8-K, dated December 4, 1990.\n(5) Incorporated herein by reference to the Registration Statement on ForM S-1, declared effective November 9, 1992.\n(6) Incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(7) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n(8) Incorporated herein by reference to the Registration Statement on Form S-2, declared effective January 13, 1994.\n(9) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n(10) Incorporated herein by reference to Amendment #19 to Schedule 13D of George N. Faris for October 13, 1995.\n(B) REPORTS ON FORM 8-K\nNone.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of American International Petroleum Corporation\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) on page 33 present fairly, in all material respects, the financial position of American International Petroleum 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 did not audit the financial statements for the year ended December 31, 1995 of American International Petroleum Corporation of Colombia (AIPC-Colombia), a wholly-owned subsidiary, which statements reflect total assets of $14,136,257 at December 31, 1995 and total revenues of $1,214,213 for the year ended December 31, 1995. 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 AIPC-Colombia, 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 2 and 11 to the financial statements, the Company has suffered recurring losses from operations, has a working capital deficiency and is in the process of trying to resolve certain contingencies, all of which 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 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nPRICE WATERHOUSE LLP\nHouston, Texas April 9, 1996\nTRANSLATION OF AUDITOR'S REPORT\nBogota, March 15, 1996\nTo the Members of the Board of Directors American International Petroleum Corporation of Colombia\nI have audited the balance sheet of the Colombian Branch of American International Petroleum Corporation of Colombia as of December 31, 1995 and the corresponding statements of income, changes in the net worth of the Branch, changes in the financial position and cash flows for the year 1995. The presentation of those financial statements and their corresponding notes is the responsibility of the Branch's administration and they reflect its performance. It is among my functions to audit them and to render an opinion about them. The financial statements of the Company for the year 1994 were audited by a different Auditor, who expressed his opinion in his Report.\nI obtained the necessary information to comply with my functions as Auditor and conducted my work in accordance with generally accepted auditing standards which require that the audit be planned and carried out to make sure that the financial statements reasonably reflect the financial condition of the Company and the results of its operations. An audit of financial statements implies, among other things, to conduct an examination based on selective tests of the evidence that support the figures and disclosures of the financial statements, as well as to evaluate the accounting principles used, the accounting estimates made by the administration and the presentation of the financial reports as a whole. I consider that my audit provides a reasonable basis for the opinion regarding the financial reports as expressed below.\nIn its accounting and in the presentation of the financial statements, the Branch follows accounting principles generally accepted for oil companies, established by the Superintendency of Companies and the Colombian law. In my opinion, the financial statements previously mentioned, which were faithfully taken from the books, present fairly the financial position of the Colombian Branch of American International Petroleum Corporation of Colombia at December 31, 1995, the results of its operations, changes in its financial position and its cash flows for the year then ended, in accordance with and based on accounting principles generally accepted in Colombia.\nFurthermore, it is also my opinion that the Branch's accounting for the year ended on December 31, 1995 was kept in compliance with the legal norms and accounting practices; the operations registered in the books and the administrator's actions\nBogota, March 15, 1996 To the Members of the Board of Directors\ncomplied with the statutes and the decisions of the Board of Directors of its Home Office; the correspondence and vouchers of the accounts were duly carried out and kept; and adequate measures of internal control and maintenance and custody of the Branch's and third parties' assets in its possession were observed.\nBERNARDO VILLEGAS PEREZ Auditor Professional Card No. 4962-A\nINFORME DEL REVISOR FISCAL\nSantafe de Bogota, D.C. Marzo 15 de 1996\nA los senores Miembros de la Junta Directiva de American International Petroleum Corporation Colombia\nHe auditado el balance general de la Sucursal en Colombia de American International Petroleum Corporation of Colombia al 31 de Diciembre de 1995 y los correspondientes Estados de Resultados, de cambios en el patrimonio, de cambios en la situacion financiera y del flujo de efectivo del ano 1995. La presentacion de dichos estados financieros y sus correspondientes notas son responsabilidad de la administracion y estos reflejan su gestion. Entre mis funciones se encuentra la de auditarlos y expresar una opinion funciones se encuentra la de auditarlos y expresar una opinion sobre ellos. Los estados financieros de la Compania correspondientes al ano 1994 fueron auditados por otro Revisor Fiscal, quien en su informe expreso su opinion.\nObtuva la informacion necesaria para cumplir mi funcion de Revisor Fiscal y lleve a cabo mi trabajo de acuerdo con normas de auditoria generalmente aceptadas en Colombia; las cuales requieren que la auditoria sea planeada y efectuada para cerciorarse de que los estados financieros reflejan razonablemente la situacion financiera y las operaciones del ejercicio. Una auditoria de estados financieros implica, entre otras cosas, hacer un examen con base en pruebas selectivas de la evidencia que respaldan las cifras y las revelaciones en los estados financieros; ademas evaluar los principios de contabilidad utilizados, las estimaciones contables hechas por la administracion y la presentacion de los estados financieros en conjunto. Considero que mi auditoria provee una base razonable para la opinion que sobre los estados financieros expreso mas adelante.\nEn su contabilidad y en la presentacion de los estados financieros la sucursal observa normas contables de general aceptacion para Companias Petroleras establecidas por la Superintendencia de Sociedades y las leyes colombianas. En mi opinion los estados financieros antes mencionados, que fueron tomados fielment ede los libros, presentan razonablemente la situacion financiera de American International Petroleum Corporation of Colombia al 31 de Diciembre de 1995, los resultados de sus operaciones, los cambios en el patrimonio, en su situacion financiera y en los flujos efectivos del ano terminados en esa fecha de conformidad y con base en los principios de contabilidad generalmente aceptados en Colombia.\nSantafe de Bogota, D.C. Marzo 15 de 1996 A los se#ores Miembros de la Junta Directiva Pagina 2\nAdemas conceptuo que durante el ano terminado en 31 de Diciembre de 1995 la contabilidad de American International Petroleum Corporation of Colombia se llevo de conformidad con las normas legales y la tecnica contable; las operaciones en los libros y los actos de los administradores se ajustaron a los estatutos y a las decisiones de la Junta Directiva de su Casa Matriz; la correspondencia, los comprobantes de las cuentas se llevaron y conservan debidamente; se observaron medidas adecuadas de control interno y conservacion y custodia de los bienes de American Internatioal Petroleum Corporation of Colombia y de terceros en su poder.\nBERNARDO VILLEGAS PERES Revisor Fiscal Tarjeta Profesional 4962-A\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS\n* Reflects the one-for-ten reverse stock split as described in Note 1.\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)\nReflects the one-for-ten reverse stock split as described in Note 1.\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)\nReflects the one-for-ten reverse stock split as described in Note 1.\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY\nReflects the one-for-ten reverse stock split as described in Note 1.\nThe accompanying notes are an integral part of this statement.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:\nAmerican International Petroleum Corporation (the \"Company\") is incorporated in the State of Nevada and, through its wholly-owned subsidiaries, is engaged in petroleum exploration, drilling, production and marketing operations in Colombia, Peru and Indonesia, and is the owner of a refinery in Lake Charles, Louisiana.\nPrinciples of consolidation\nThe consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries, American International Refinery, Inc. (\"AIRI\"), American International Petroleum Corporation of Colombia and Pan American International Petroleum Corporation (\"PAIPC\").\nIntercompany balances and transactions are eliminated in consolidation.\nCash and cash equivalents\nAll liquid short-term instruments purchased with original maturity dates of three months or less are considered cash equivalents. Restricted cash represents cash utilized as collateral for the Company's drilling commitments in Peru. Subsequent to December 31, 1995, the Company fulfilled its drilling requirements and the cash was released.\nInventory\nInventory consists of oil and gas equipment and is stated at the lower of average cost or market.\nProperty, plant and equipment\nOil and gas properties\nThe Company follows the full cost method of accounting for exploration and development of oil and gas reserves, whereby all costs incurred in acquiring, exploring and developing properties are capitalized including estimates of abandonment costs net of estimated equipment salvage costs. Individual countries are designated as separate cost centers. All capitalized costs plus the undiscounted future development costs of proved reserves are depleted using the unit-of-production method based on total proved reserves applicable to each country. Under the full cost method of accounting, unevaluated\nproperty costs are not amortized. A gain or loss is recognized on sales of oil and gas properties only when the sale involves significant reserves. Costs related to acquisition, holding and initial exploration of concessions in countries with no proved reserves are initially capitalized and periodically evaluated for impairment.\nCertain geological and general administrative costs are capitalized into the cost pools of the country cost centers. Such costs include certain salaries and benefits, office facilities, equipment and insurance. Capitalized general and administrative costs are directly related to the Company's exploration and development activity in Colombia and Peru and totaled $472,606, $383,004 and $485,494 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe net capitalized costs of oil and gas properties for each cost center, less related deferred income taxes, are expensed to the extent they exceed the sum of (i) the estimated future net revenues from the properties, discounted at 10%, (ii) unevaluated costs not being amortized; and (iii) the lower of cost or estimated fair value of unproved properties being amortized; less (iv) income tax effects related to differences between the financial statement basis and tax basis of oil and gas properties. As a result of applying this policy, the Company charged $6,904,016 and $9,975,000 to expense in 1994 and 1993, respectively, for the reduction of carrying costs of oil and gas assets. No such charge was required in 1995.\nOn March 31, 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\". SFAS No. 121 addresses the accounting for the impairment of long-lived assets, identified intangibles and goodwill related to those assets and requires that the carrying amount of impaired assets be reduced to fair value. The Company adopted SFAS No. 121 in the fourth quarter of 1995 and determined that it has no effect on the financial statements for the year ended December 31, 1995.\nProperty and equipment - other than oil and gas properties\nProperty and equipment are carried at cost. Depreciation and amortization are calculated under the straight-line method over the anticipated useful lives of the assets which range from 5 to 25 years. Major additions are capitalized. Expenditures for repairs and maintenance are charged against earnings.\nEarnings per share\nEarnings per share of common stock are based on the weighted-average number of shares outstanding. Fully diluted earnings per share amounts are not presented because they are anti-dilutive.\nOn October 6, 1993, the Company's Board of Directors approved a one-for-ten reverse split of its common stock. Accordingly, the financial statements and related footnotes have been restated to reflect this reverse stock split where applicable.\nForeign currency\nThe U.S. dollar is the functional currency of the Company. Foreign currency transaction gains and losses are included in the consolidated statement of operations. The Company does not engage in hedging transactions to reduce the risk of foreign currency exchange rate fluctuations and has not experienced significant gains or losses related to such events. The Company collects sales of oil and gas in Colombia and Peru in local currency and utilizes receipts for local operations. Periodically, funds are transferred from U.S. accounts to Colombia or Peru and converted into pesos or soles, respectively, when local currency is insufficient to meet obligations payable in local currency. Foreign exchange gains were $12,544, $34,300 and $230,156 in 1995, 1994 and 1993, respectively.\nDeferred charges\nThe Company capitalizes certain costs associated with the offering and sale of debentures. Such costs are amortized as interest expense over the life of the related debt instrument.\nStock-based compensation\nSFAS No. 123, \"Accounting for Stock-Based Compensation\" defines a fair value based method of accounting for an employee stock option or similar equity instrument or plan. However, SFAS No. 123 allows an entity to continue to measure compensation costs for these plans using the current method of accounting. AIPC has elected to continue to use the current method of accounting for employee stock compensation plans and, beginning in 1996, will disclose the fair value as defined in SFAS No. 123, which may be materially different from the recorded amount.\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 certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the related reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that the estimates are reasonable.\nReclassifications\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nNOTE 2 - MANAGEMENT'S PLANS:\nThe Company has incurred losses of $4,338,322, $10,966,914 and $14,139,737 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company also had negative working capital of $3,403,000 at December 31, 1995, which included approximately $2,122,000 of principal and interest due on its 12% Secured Debentures. During 1995, the lessee of the Company's refinery (Gold Line Refining Inc. (\"Gold Line\") incurred various financial and purchasing problems which resulted\nin diminished throughput volumes and lower lease fees to the Company. These events prevented Gold Line from making its scheduled note payments to the Company. This situation, coupled with other operating losses and the negative working capital required the Company to find other sources with which to fund its operations and meet its financial obligations. As a result, the Company issued 5,606,870 shares of its common stock for cash and services rendered to the Company of approximately $3,723,000 during 1995.\nDuring the first quarter of 1996, the Company received cash and settled certain liabilities totaling approximately $991,000 from the sales and issuance of its common stock (Note 18). Further, in March 1996, the Company received $1,350,000 in net proceeds from the private placement of 10% Convertible Debentures to certain foreign buyers. Funds from these transactions enabled the Company to make payments of principal and interest on its 12% Secured Debentures and settle certain other obligations outstanding at December 31, 1995 totaling approximately $1,800,000.\nIn March 1996, Gold Line secured the necessary financing to enable it to be awarded a one-year fuel supply contract from the Defense Fuel Supply Center (\"DFSC\"), valued at approximately $45 million. This contract, when coupled with its other DFSC contract, brings the total of Gold Line's annual contracts to approximately $69 million. These contracts are expected to require Gold Line to process a minimum of 16,000 barrels of feedstock per day through the refinery, which would result in monthly lease fees to the Company of approximately $245,000 and could enable Gold Line to repay its debt to the Company as originally scheduled, approximately $160,000 of principal and interest per quarter.\nThe Company has received one offer and inquiries from various companies regarding a farmout of its new Chicoral discovery and its other Colombian properties in return for cash and drilling on the Company's behalf in the Toqui-Toqui Field. Such a transaction could provide the Company with the necessary capital to repay the recently-issued 10% Debenture, while establishing a plan for full exploitation of the Chicoral discovery over an aggressive timeline with little or no cost to the Company.\nThe Company is currently having discussions with the principal holder of its 12% Secured Debentures, MG Trade Finance Corporation (\"MGTF\"), regarding the possibility of prepaying the total balance of MGTF's Debentures and Note, which together total approximately $5.5 million as of April 9, 1996. MGTF has been in the process over the past few months of closing its business affairs in the United States and has indicated a desire to negotiate a prepayment of the Company's debts to MGTF at a discount from face value. Concurrent with these discussions, the Company has been meeting with various financial institutions and industry participants who may provide the Company with the capital necessary to allow it to prepay its debts to MGTF and develop its oilfields in South America.\nThe Company is also engaged in negotiations with Far Eastern Hydrocarbons Ltd. (\"FEH\"), a Hong Kong corporation, to exchange shares of the Company's common stock in return for 100% of the outstanding common stock of a wholly-owned subsidiary of FEH. FEH has indicated a desire to provide the necessary financing, or guarantees for same, to enable the Company to actively participate in the international energy community. In addition, the oil fields owned by FEH are producing significant amounts of cash flow, which could also be utilized to fund the Company's operations, if necessary.\nManagement believes the proceeds generated from its internal operations should be significantly enhanced by the increased operations at its refinery resulting from Gold Line's new contract. This increase in cash flow, combined with the development of its new discovery in Colombia and net borrowings from external sources, should provide the Company with the funds necessary to meet its working capital obligations and operating commitments during the ensuing fiscal year.\nThe Company is also currently having discussions with various banking institutions in the United States and abroad regarding financing for the contemplated operation of the vacuum distillation unit at its refinery to produce asphalt and vacuum gas oil. In addition, the Company has alternative methods of obtaining funds, including private or public equity and debenture or mezzanine financing, some of which it has utilized successfully in the past.\nIn the event the Company is unable to raise sufficient proceeds from debt financing, the exercise of outstanding options and warrants, farmout proceeds, or from the consummation of additional equity financing, of which there is no assurance, the Company may be required to postpone and\/or curtail its planned development activities at the refinery and in Colombia, Peru and\/or Indonesia (Note 11).\nNOTE 3 - STOCKHOLDER RIGHTS OFFERING:\nIn March 1994, the Company completed an offering of rights to its stockholders. Each right was exercisable for $3.00 and entitled the holder to two shares of common stock and one redeemable warrant to acquire an additional share of common stock at any time prior to March 1, 1997 at an exercise price of $4.00. The Rights Offering resulted in the exercise of 5,957,390 rights for gross proceeds of $17,872,170.\nGross proceeds consisted of the surrender of $950,000 of the Company's 12% secured debentures, receipt of $16,521,000 cash and issuance of a $400,000 note receivable bearing interest at 10% per annum to an officer of the Company, $367,064 of which was repaid in 1994. The Company paid commissions of $1,181,757 from gross proceeds to various placement agents. Additionally, the Company incurred approximately $484,000 of expenses related to the offering.\nProceeds from the offering were utilized for general corporate purposes including exploration and development of the Company's prospects in Colombia and Peru, repayment of debt and for working capital.\nNOTE 4 - ACCOUNTS AND SHORT-TERM NOTES RECEIVABLE:\nAccounts receivable are shown below:\nNOTE 5 - OTHER LONG-TERM ASSETS:\nOther long-term assets consist of the following:\nNOTE 6 - ACCOUNTS PAYABLE:\nAccounts payable at December 31, 1995 and 1994 included $500,000 payable to an individual subcontractor for oil and gas operational services which was paid subsequent to December 31, 1995.\nNOTE 7 - ACCRUED LIABILITIES:\nAccrued liabilities consist of the following:\nNOTE 8 - LONG-TERM DEBT:\nLong-term debt consists of the following:\nLong-term debt of $1,870,000, $2,587,500 and $2,845,171 matures during 1996, 1997 and 1998, respectively.\nNote payable to MG Trade Finance Corporation\nOn December 4, 1990, AIRI entered into a loan and security agreement (the \"Loan Agreement\") with MGTF. Pursuant to the Loan Agreement, MGTF loaned AIRI $9,855,392. As collateral for the borrowings, substantially all of the assets of AIRI were pledged, payment was guaranteed by the\nCompany and the Company pledged 100% of the common stock of AIRI. In the event of a default, whereby AIRI common stock may be sold, MGTF will retain, after satisfying all indebtedness due MGTF, an amount equal to 50% of the amount due MGTF on the date of the default.\nIn order to induce MGTF to enter into the Loan Agreement, the Company granted MGTF warrants to purchase 516,667 shares of the Company's $0.08 par value common stock at $7.50 per share exercisable at any time prior to June 30, 1994. Such warrants outstanding at December 31, 1993 were adjusted to an exercise price of $1.25 based on an anti-dilutive provision in the warrant agreements. In addition, MGTF's parent company, MG Corp., is entitled to one seat on the Company's Board of Directors without the consent of the Company and a second seat upon the consent of the Company's Board, which consent is not to be unreasonably withheld. One of these seats would then be eligible to be appointed to the Executive Committee, also upon consent of the Company's Board, which consent is not to be unreasonably withheld. MGTF has not made such a request. As long as the Company has any obligations to MGTF, the Company has agreed not to undertake any financial commitments, or acquire or dispose of assets in excess of $250,000 without the unanimous consent of the Executive Committee. MGTF has not nominated any persons to be on the Board.\nIn November 1992, MGTF agreed to modify the Loan Agreement and extend the maturity of a portion of the principal due on May 31, 1993. Under the modified agreement, principal payments of $3,374,520 were made during 1994 and the remaining principal of $2,845,171 was due May 31, 1995. In consideration for the extension, the Company agreed to extend the expiration date of all warrants held by MGTF and its affiliate, Metallegesllschaft, that remain outstanding on December 31, 1993 or June 30, 1994, to June 30, 1997. The exercise price of any warrants subject to the extension was increased to $15.63 per share of common stock. All warrants previously held by MGTF were returned to the Company and canceled and 150,000 new warrants were issued at an exercise price of $2.00 per share of common stock.\nIn March 1995, MGTF agreed to further modify the Loan Agreement and extend the maturity of the $2,845,171 principal originally due from the Company on May 31, 1995. Under the modified agreement, the balance of principal is now due on March 31, 1998. Previously, all monthly lease fees received pursuant to the terms of any lease of the refinery were required to be remitted to MGTF in repayment of the loan principal and interest. Under the modified Loan Agreement, one-half of the monthly lease fees are required to be remitted to MGTF and the related interest rate was reduced from prime plus 2.0% to prime plus 1.0%. Pursuant to the Loan Agreement, AIRI granted MGTF an option to lease the refinery for a period of 13 months commencing after the expiration of the current lease (Note 9). Any such lease will call for a rental, net of all operating expenses, of $.45 per barrel for a minimum throughput of 18,000 bbls per day, and $.48 per barrel for any amounts in excess of 18,000 bbls per day.\nThe Loan Agreement with MGTF contains various events of default including, but not limited to, failure to make principal or interest payments in a timely manner, transfers of funds by dividend or other means from AIRI to the Company, age of accounts payable amounts and refurbishment and maintaining adequate insurance coverage. An event of default, if declared and not cured within the allowed time,\nwould permit MGTF to accelerate the loan and demand immediate payment. At various times during 1995, 1994 and 1993, the Company has been in technical default with respect to certain monetary covenants. The Company believes it will continue to be successful in negotiating the resolution of such compliance issues with MGTF.\nNOTE 9 - REFINERY LEASE:\nIn October 1990, the Company leased its refinery to Gold Line. All amounts owed to AIRI by Gold Line on October 1, 1992 were restructured to a note totaling $1,244,192, due on September 30, 1995 bearing interest at prime plus 2%. The note was to be retired in monthly instalments equal to 10% of Gold Line's monthly operating cash flow, if such operating cash flow was positive. No amounts were collected pursuant to this provision and the note was fully reserved for during 1992. No interest was accrued with respect to this note.\nOn March 22, 1995, the term of the lease was extended through March 31, 1998. In consideration for extending the lease, Gold Line executed a $1,801,464 promissory note (which amount includes the $1,244,192 note referred to above and certain trade receivables owed the Company by Gold Line of $506,332 at December 31, 1994) payable in instalments of principal and interest through June 15, 1997. The promissory note bears interest at prime plus 1%. The Company established a reserve for doubtful accounts of $2,039,041 and $1,327,919 at December 31, 1995 and 1994, respectively.\nIn the event Gold Line funds and constructs a vapor recovery unit (the \"VRU\") at the Refinery, the Company will reduce the principal by $650,000. If Gold Line does not build the VRU, it will pay the Company additional monthly payments of $108,333 during the final six months of the lease term. Lease fees are based on refinery throughput. Terms of the lease called for rental fees of $.40 per barrel of throughput during 1995 and $.50 per barrel from January 1, 1996 through March 31, 1998. The lease also calls for a monthly minimum throughput of 10,000 barrels per day.\nFifty percent of the payments to the Company under this lease of the refinery are to be paid to MGTF to retire principal and interest on the note payable to MGTF (Note 8). In the event Gold Line defaults under the lease agreement, such default would adversely affect the Company's ability to satisfy its obligations to MGTF. This situation could then result in a default by the Company thereunder if the Company is unable to pay interest on the MGTF note.\nNOTE 10 - STOCK OPTIONS AND WARRANTS:\nOutstanding warrants and options\nAt December 31, 1995, 1994 and 1993, the following warrants and options for the purchase of common stock of the Company were outstanding, which are exercisable upon demand any time prior to the expiration date. All amounts have been restated to reflect the one-for-ten reverse stock split as described in Note 1.\n(1) The exercise price for the 336,940 warrants was adjusted to $1.25 per share based on an anti-dilutive provision in the respective warrant agreements.\n(2) Represents options held by employees and directors of the Company. The exercise price and expiration date of such options reflect the adjustments approved by the Company's Board of Directors.\nOptions and warrants to purchase 8, 35 and 238,385 shares were exercised in 1995, 1994 and 1993, respectively, at prices of $4.00, $4.00 and ranging from $6.00 to $25.00, respectively.\nStock option plans\n1995 Plan\nUnder the Company's 1995 Stock Option Plan (the \"1995 Plan\"), the Company's employees, Directors, independent contractors, and consultants are eligible to receive options to purchase shares of the Company's common stock. The Plan allows the Company to grant incentive stock options (\"ISOs\"), nonqualified stock options (\"NQSOs\"), and ISOs and NQSOs in tandem with stock appreciation rights (\"SARs\"; collectively \"Options\"). A maximum of 3,500,000 shares may be issued and no Options may be granted after ten years from the date the 1995 Plan is adopted, or the date the Plan is approved by the stockholders of the Company, whichever is earlier. The exercise price of the Options cannot be less than the fair market value of the shares of common stock on the date the Option is granted. Options granted to individuals owning 10% or more of the outstanding voting power of the Company must be exercisable at a price equal to 110% of the fair market value on the date of the grant.\nAt December 31, 1995, 302,500 Options were granted or outstanding under the 1995 Plan. The 1995 Plan will be submitted for approval to the Company's stockholders at its annual meeting in 1996. If the Plan is not approved, the 302,500 options will be treated as NQSOs.\n1988 Plans\nUnder the Company's 1988 Incentive Stock Option Plan, only full-time employees, including officers, are eligible to receive options. A maximum of 100,000 shares may be issued and no options may be granted after July 1998. The exercise price of the options cannot be less than the fair market value of the shares of common stock on the date the option is granted. Options granted to stockholders owning 10% or more of the outstanding voting power of the Company must be exercisable at a price equal to 110% of the fair market value on the date of the grant. There were no options granted under the Incentive Stock Option Plan as of December 31, 1995. No options have been exercised under this plan.\nThe Company's Nonqualified Stock Option Plan provides for the granting to key employees of options to purchase the Company's common stock at a price determined by the Board of Directors. Options are granted for a five-year period. The maximum number of shares reserved for issuance pursuant to the plan is 50,000. There were no options granted under the Nonqualified Option Plan as of December 31, 1995. No options have been exercised under this plan.\nNOTE 11 - COMMITMENTS AND CONTINGENT LIABILITIES:\nDrilling commitments\nThe Company has completed all its contractual work commitments in Colombia and Peru.\nIndonesian agreements\nPamanukan Selatan -\nIn December 1995, the Company entered into a Farmout Agreement with P.T. Pelangi Niaga Mitra Internasional (\"PNMI\"), an Indonesian privately-held limited liability company, whereby the Company is expected to earn a 49% working interest in a Technical Assistance Contract (\"TAC\") with Pertamina for the Pamanukan Selatan area of West Java Province, Indonesia by providing 100% of the funding for the exploration, development and operation of the TAC. Full exploration and development of the TAC is expected to cost between $2 and $3 million over the next three years, of which approximately $700,000 will be required during 1996. As a portion of its obligations under the farmout agreement, the Company issued, pursuant to Regulation S of the Securities Act of 1933, 100,000 shares of its common stock to PNMI. The Company will be the operator of the joint operations and the TAC and is to be reimbursed for 175% of all expenditures, pursuant to the cost recovery provisions in the TAC, before any distribution of profits to PNMI can occur. The Company will also be entitled to recoup indirect overhead charges up to five percent of total expenditures, which amount will be part of the cost recovery.\nAll monetary obligations the Company may have under the farmout agreement are subject to PNMI receiving governmental certification and Pertamina's approval to conduct operations under this TAC, which are expected to occur by May of 1996.\nPamanukan Selatan includes an estimated 16 billion cubic feet of gas reserves. The field's initial well tested at 5.7 million cubic feet of gas per day and is temporarily shut-in pending construction of a 1.3 mile delivery pipeline (unaudited).\nIn October 1995, the Company signed a memorandum of understanding with PNMI, which entitles the Company to a two-year right of first refusal to farm-in to a 49% working interest in any future contracts obtained by PNMI from Pertamina. The Company will have three months to exercise its rights, after receipt of each notification from PNMI, at a cost to be negotiated on a case-by-case basis.\nMalacca Strait -\nIn November 1995, the Company reached a preliminary agreement with FEH to purchase a portion of the issued and outstanding common stock of Resource Holdings, Inc. (\"RHI\"), a private Delaware corporation and a wholly-owned subsidiary of FEH, in exchange for shares of the Company's common stock. This agreement also gave the Company a six-month option to acquire the remainder of RHI's common stock, payable with shares of the Company's common stock. In January 1996, the Company and FEH modified the structure of the proposed transaction. Under the new structure, 100% of RHI's shares would be exchanged for an as yet unspecified number of the Company's shares, subject to the signing of a definitive agreement and approval by the Company's shareholders. As of April 9, 1996, the parties were continuing their due diligence processes.\nRHI's assets consist of its wholly-owned Panamanian corporation, Kondur Petroleum S.A. (\"Kondur\"), which owns 34.46% of the Malacca Strait PSC Contract (\"Malacca\") in Sumatra, Indonesia. Kondur is the largest Indonesian-owned domestic operator in Indonesia. The remaining interests in Malacca are owned by China National Offshore Oil Corporation and Novus Petroleum Ltd. Malacca covers an area of 2.7 million acres and contains 16 oil fields operated by Kondur, which are currently producing an aggregate of approximately 20,000 barrels of oil per day. Malacca has an estimated 58 million barrels of proven recoverable oil reserves and 47 billion cubic feet of proven recoverable gas reserves. Kondur intends to increase the daily average production rates of Malacca through development and exploration, which is scheduled to commence during the third quarter of 1996 (unaudited).\nIRS Excise Tax Claim\nIn May 1992, AIRI was notified by the Internal Revenue Service (\"IRS\") that the IRS was considering an assessment of excise taxes, penalties and interest of approximately $3,500,000 related to the sale of fuel products during 1989. The IRS claims that AIRI failed to comply with an administrative procedure that required sellers, and buyers in tax-free transactions, to obtain certification from the IRS. The Company believes that AIRI complied with the substance of the existing requirements and such sales were either tax-free or such excise taxes were paid by the end-users of such products.\nAIRI has offered to negotiate a settlement of this matter with IRS Appeals since early 1993. Such negotiations included face-to-face meetings, numerous phone calls and written transmittals and several offers of settlement by both the Company and the IRS. During these negotiations, the IRS Appeals officers offered to waive all of the penalties and 75% of the amount of the proposed tax liability. However, AIRI rejected this offer and requested the IRS' National Office provide technical advice to its Appeals officers. After numerous conferences and discussions with the National Office in 1995, the National Office issued an adverse Technical Advice Memorandum (\"TAM\") to the effect that AIRI should be liable for the tax on the sale of diesel fuel for the first three quarters of 1989. Subsequent to the issuance of the TAM the IRS Appeals officer indicated to AIRI that the IRS still wants to negotiate a settlement. As a result, AIRI has scheduled a meeting with the IRS Appeals Office on April 30, 1996 to discuss the situation. Depending upon the results of this meeting, the Company will decide whether to litigate or settle this matter.\nThe Company accrues an estimated loss from a loss contingency when a liability has been incurred and the amount of such loss can be reasonably estimated. Such accruals are based on developments to date and the Company's estimate of the liability. In this instance, the Company has provided an allowance during 1995 of $250,000 for estimated costs, either in the form of legal expenses or payments to the IRS, or some combination of both. As the liability becomes better defined there will be changes in the estimated costs which could have a material effect on the Company's future results of operations and financial condition or liquidity.\nEnvironmental lawsuit\nOn January 25, 1994, a lawsuit captioned Paul R. Thibodeaux, et al. v. Gold Line Refinery Ltd. (a limited partnership), Earl Thomas, individually and d\/b\/a\/ Gold Line Refinery Ltd., American International Petroleum Corporation, American International Refinery, Inc., Joseph Chamberlain individually (Docket No. 94-396) was filed in the 14th Judicial District Court for the Parish of Calcasieu, State of Louisiana. Subsequently, several parties were joined as plaintiffs or defendants in the lawsuit. Responsive pleadings have been filed by AIRI to this action and to the three amendments which added plaintiffs, defendants and restructured the plaintiff's claims (deleting some claims and adding new claims). The lawsuit alleges, among other things, that the defendants, including the Company's wholly-owned subsidiary, AIRI, caused or permitted the discharge of hazardous and toxic substances from the Lake Charles refinery into the Calcasieu River. The plaintiffs seek an unspecified amount of damages, including special and exemplary damages. AIRI continues to vigorously defend such action. In March 1996, the Company and AIRI filed an Exception of Prescription which is expected to eliminate most of the plaintiffs' claims. At this time, the Company is unable to determine what, if any, liability may arise from this action.\nContract claims\nIn October 1995, Rio Bravo S.A., the operator of the Company's Lot IV Block in Peru, locked out PAIPC personnel from access thereto and filed a legal action in Peru against PAIPC claiming damages of $11,695,000 and alleging that PAIPC's License Contract with the government to explore Block IV (the \"License Contract\") was canceled by the government due to the fact PAIPC did not complete the minimum work program required under the License Contract. However, because the minimum work program was completed and was certified as complete by the government (the performance bond placed by PAIPC to assure its compliance with the minimum work program has, in fact, been released by the government) and, since the License Contract with the government is still in effect and has not been canceled, the Company expects the legal action by Rio Bravo will be decided in PAIPC's favor. PAIPC has also filed counter-claims and is in the process of filing liens against Rio Bravo to defend its interests in the Block and License Contract and continues to participate in meetings with the government related to the activities in the Block and in all matters of administration and execution of the obligations in the License Contract. At this time, the Company is unable to determine what, if any, liability or benefits may arise from this action.\nEmployment agreements\nThe Company has entered into an employment agreement with its chief executive officer. Total salaries payable under this contract for 1996 are $300,000.\nIn September 1995, the Company's Board of Directors authorized the issuance, subject to shareholder approval, of 900,000 restricted shares (the \"Shares\") of the Company's common stock to its Chairman and Chief Executive Officer, Dr. George Faris. The Shares were granted to Dr. Faris in consideration for Dr. Faris waiving certain rights under his employment contract, thereby relieving the Company of its obligation to make cash payments to Dr. Faris upon a change of control or involuntary termination. If shareholder approval is obtained, the Company will record the issuance of the shares and the related expense at that time.\nLease commitments\nThe Company leases office space under various operating leases expiring in 1997 and 1998. Additional office space is rented on a month-to-month basis. Future minimum payments under operating leases with remaining terms of one year or more consisted of the following at December 31, 1995:\nMinimum lease payments have not been reduced by minimum sublease rentals due in the future under noncancelable subleases. The composition of total rental expense for all operating leases was as follows:\nContingencies\nIn addition to certain matters described above, the Company and its subsidiaries are party to various legal proceedings, including environmental matters. Although the ultimate disposition of these proceedings is not presently determinable, in the opinion of the Company, any liability that might ensue would not be material in relation to the consolidated financial position or results of operations of the Company.\nNOTE 12 - INCOME TAXES:\nIncome taxes\nThe Company uses the asset and liability approach for financial accounting and reporting 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. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.\nThe Company reported a loss from operations during 1995 and has a net operating loss carryforward from prior years' operations. Accordingly, no income tax provision has been provided in the accompanying statement of operations. As a result of previous years' operations, the Company has available unused tax carryforwards of approximately $15,000,000 which expire in years 1996 through 2009. The Company's utilizable tax operating loss carryforwards to offset future income have been restricted in accordance with Section 382 of the Internal Revenue Code. These restrictions will limit the Company's future use of its loss carryforwards due to stock ownership changes that have occurred.\nThe Company's operations in Colombia are subject to taxes on net income levied by the Government of Colombia which may not be offset by net operating losses incurred in other countries. The Company has not generated taxable income in Colombia since it began operations in that country. The net operating loss carryforward from prior years is approximately $641,000.\nThe components of deferred tax assets and liabilities are as follows:\nThe valuation allowance relates to the uncertainty as to the future utilization of net operating loss carryforwards.\nNOTE 13 - CONCENTRATIONS OF CREDIT RISK:\nFinancial instruments which potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company's production of oil and gas in Colombia is sold to one customer. Related trade accounts receivable were $291,043 at December 31, 1995. Although the Company is directly affected by the well-being of the oil and gas industry and the stability of the business environment in Colombia, management believes that a ready market exists for its oil and gas production in the event its current customer does not perform under the existing agreement. Refinery processing fees are earned through lease of the Company's refinery to Gold Line. Trade accounts receivable and notes receivable from Gold Line aggregated $2,537,858 at December 31, 1995, net of\nreserves for uncollectible amounts of $2,033,554. The Company's ability to collect outstanding amounts from Gold Line and restrictions thereon are subject to agreements between MGTF, Gold Line, NationsBank (a Gold Line creditor), and the Company (Notes 2, 8 and 9).\nNOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe estimated fair value of the Company's financial instruments is as follows:\nFor investments, fair value equals quoted market price. Fair value of fixed-rate long-term debt is determined by reference to rates currently available for debt with similar terms and remaining maturities. The reported amounts of financial instruments such as cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short-term maturities.\nNOTE 15 - GEOGRAPHICAL SEGMENT INFORMATION:\nThe Company's operations involve a single industry segment, the exploration, development, production, transportation, refining and marketing of oil and natural gas. Its principal oil and gas properties are located in South America. Operating in foreign countries subjects the Company to inherent risks such as a loss of revenues, property and equipment from such hazards as exploration, nationalization, war and other political risks, risks of increases of taxes and governmental royalties, renegotiation of contracts with government entities and changes in laws and policies governing operations of foreign-based companies.\nThe Company's oil and gas business is subject to operating risks associated with the exploration, production and refining of oil and gas, including blowouts, pollution and acts of nature that could result in damage to oil and gas wells, production facilities or formations. In addition, oil and gas prices have fluctuated substantially in recent years as a result of events which were outside of the Company's control.\nFinancial information, summarized by geographic area, is as follows:\n* Excludes provisions for write-down of oil and gas properties.\nTransactions with the Company's major customers (greater than 10% of revenue) accounted for 49% and 39% in 1995, 63%, 23% and 13% in 1994 and 43% and 47% of revenue in 1993.\nNOTE 16 - SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES AND DISCLOSURES OF CASH FLOW INFORMATION:\nThe Company has issued shares of common stock in the acquisitions and conversions of the following noncash transactions:\nCash paid for interest, net of amounts capitalized, was $963,609, $647,439 and $1,135,187 during 1995, 1994 and 1993, respectively. Cash paid for corporate franchise taxes was $52,050, $36,001 and $67,677 during 1995, 1994 and 1993, respectively.\nNOTE 17 - RELATED PARTY TRANSACTIONS:\nSee disclosure regarding transactions with directors of the Company in Notes 3 and 11.\nNOTE 18 - SUBSEQUENT EVENTS:\nRegulation S offering\nDuring the first quarter of 1996, the Company received cash and settled certain liabilities totaling approximately $991,000 from the sales and issuance of shares of its common stock in accordance with the safe harbor provided by Regulation S as promulgated by the Securities and Exchange Commission. The proceeds were used for working capital purposes.\nNote receivable\nIn order to enhance the business strength of the lessee of its Refinery and to assist it in securing a new government contract, in February 1996, the Company agreed to reduce the fully reserved principal balance of its note receivable from the lessee to $900,732 from $1,801,464. The lessee was awarded a new one-year contract to provide fuels to the DFSC effective April 1, 1996.\nSale of debentures\nOn March 21, 1996, the Company received net proceeds of $1,350,000 from the sale of 10% Convertible Redeemable Subordinated Debentures, issued in accordance with Regulation S. The proceeds are being utilized to repay debt and for working capital purposes.\nIndonesian agreements\nIn January and February 1996, respectively, the Company and FEH announced their intent to combine into one phase the two phases originally specified in their Memorandum of Understanding dated November 1, 1995, and extended the closing date of the previously-announced share exchange agreement between the Company and FEH to an unspecified future date to allow both companies more time to complete their due diligence procedures. Such procedures were still in progress as of the date of filing of the Company's Form 10-K for the fiscal year ended December 31, 1995.\nAMERICAN INTERNATIONAL PETROLEUM AND SUBSIDIARIES\nSUPPLEMENTARY OIL AND GAS INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (UNAUDITED)\nThe accompanying unaudited oil and gas disclosures are presented as supplementary information in accordance with Statement No. 69 of the Financial Accounting Standards Board.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION AND SUBSIDIARIES\nSUPPLEMENTARY OIL AND GAS INFORMATION (UNAUDITED)\nCapitalized costs relating to oil and gas activities and costs incurred in oil and gas property acquisition, exploration and development activities for each year are shown below:\nCapitalized costs\nCOSTS NOT SUBJECT TO AMORTIZATION:\nThe following table summarizes the categories of cost which comprise the amount of unproved properties not subject to amortization.\nAcquisition costs of unproved properties not subject to amortization at December 31, 1995, 1994 and 1993, respectively, consists mainly of lease acquisition costs related to unproved areas. The Company will continue to evaluate these properties over the lease terms; however, the timing of the ultimate evaluation and disposition of a significant portion of the properties has not been determined. Exploration costs on unproved properties at December 31, 1995, consist mainly of exploration costs of the Peru properties. The Company anticipates completing its evaluation of these properties during 1996. Approximately 32%, 46% and 0% of the balance in unproved properties at December 31, 1995, related to additions made in 1995, 1994 and 1993, respectively.\nOIL AND GAS RESERVES:\nOil and gas proved reserves cannot be measured exactly. Reserve estimates are based on many factors related to reservoir performance which require evaluation by the engineers interpreting the available data, as well as price and other economic factors. The reliability of these estimates at any point in time depends on both the quality and quantity of the technical and economic data, the production performance of the reservoirs as well as extensive engineering judgment. Consequently, reserve estimates are subject to revision as additional data become available during the producing life of a reservoir. When a commercial reservoir is discovered, proved reserves are initially determined based on limited data from the first well or wells. Subsequent data may better define the extent of the reservoir and additional production performance, well tests and engineering studies will likely improve the reliability of the reserve estimate. The evolution of technology may also result in the application of improved recovery techniques such as supplemental or enhanced recovery projects, or both, which have the potential to increase reserves beyond those envisioned during the early years of a reservoir's producing life.\nThe following table represents the Company's net interest in estimated quantities of proved developed and undeveloped reserves of crude oil, condensate, natural gas liquids and natural gas and changes in such quantities at December 31, 1995, 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.\nRevisions to crude oil reserves in 1995 reflect the increased working interest participation of the Company in the proved undeveloped reserves due to nonparticipation of the other joint venture partners.\nRevisions to crude oil and gas reserves in 1994 reflect the elimination of the Puli No. 3 K4 formation reserves, which were found to be incapable of production due to formation damage. Recoverable reserves could be included in future estimates in the event this problem can be solved or a new well can be drilled. These revisions were partially offset by an increase in the Toqui reserves due to the lower decline rate demonstrated during 1994 as compared to the 1993 estimate.\nRevisions to crude oil reserves in 1993 reflect a decrease in proved reserves resulting from unanticipated production declines experienced during 1993 and from the abandonment in 1993 of the eastern most producing oil well in the Toqui field due to water encroaching in that area of the field.\nGas reserves were revised upward as a result of the development of a viable gas market for associated gas currently being flared in the Toqui-Toqui field and new seismic data acquired in the Puli Anticline in 1993 that expanded the boundaries of the gas producing reservoir.\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE 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 No. 69. Accordingly, future cash inflows were determined by applying year-end oil and gas prices to the Company's estimated share of future production from proved oil and gas reserves. Future production and development costs were computed by applying year-end costs to future years. 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 cash flows in 1995 increased as a result of the upward revision in estimated future recoverable equivalent barrels of oil by approximately 1,166,258 BOE and also to the addition of recoverable equivalent barrels of oil of 813,000 BOE from newly discovered oil reserves and commercial gas in 1995.\nEstimated future income taxes were eliminated in 1993, 1994 and 1995 because estimated future tax deductions related to oil and gas properties exceeded estimated future net revenues based on oil and gas prices and related costs at December 31, 1993, 1994 and 1995.\nCHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS:\nThe aggregate change in the standardized measure of discounted future net cash flows was an increase of $2,288,243 in 1995 and a decrease of $3,532,119 and $13,624,693 in 1994 and 1993. The principal sources of change were 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.\nAMERICAN INTERNATIONAL PETROLEUM CORPORATION\nDated: April 12, 1996 By: \/s\/ Denis J. Fitzpatrick --------------------------- Denis J. Fitzpatrick 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:\nBy: \/s\/ George N. Faris Date: April 12, 1996 --------------------------------------- George N. Faris, Chairman of the Board of Directors and Chief Executive Officer\nBy: \/s\/ Denis J. Fitzpatrick Date: April 12, 1996 --------------------------------------- Denis J. Fitzpatrick Vice President, Secretary, Principal Financial and Accounting Officer\nBy: \/s\/ Donald G. Rynne Date: April 12, 1996 --------------------------------------- Donald G. Rynne, Director\nBy: \/s\/ Daniel Y. Kim Date: April 12, 1996 --------------------------------------- Daniel Y. Kim, Director\nBy: \/s\/ William R. Smart Date: April 12, 1996 --------------------------------------- William R. Smart, Director\nEXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.1 Certificate of Incorporation of the Registrant, as amended. (1)\n3.2 Certificate of Amendment to Articles of Incorporation, dated June 29, 1988. (2)\n3.3 Certificate of Amendment to Articles of Incorporation, dated August 10, 1988. (2)\n3.4 Certificate of Amendment to Articles of Incorporation, dated November 18, 1993. (7)\n3.5 By-Laws of the Registrant, as amended.\n4.1 Indenture dated January 20, 1993, governing the Registrant's 12% Secured Debentures Due 1997.(6)\n4.2 Form of Class A Warrant. (8)\n4.3 1995 Stock Option Plan and Form of Option Agreements of the Registrant.\n4.4 Form of Debenture and Subscription Agreements dated March 21, 1996 between the Company and purchasers listed on Schedule A attached thereto.\n10.1 Employment Agreement, dated May 1, 1989 by and between George N. Faris and the Registrant.(3)\n10.2 Loan and Security Agreement (\"Loan Agreement\") dated December 4, 1990 by and between MG Trade Finance Corp. (\"MGTF\") and AIRI. (4)\n10.3 Schedule of construction and Other Loan Uses attached to the Loan Agreement. (4)\n10.4 Schedule of JP-4 Construction Permitted After December 15, 1990 attached to the Loan Agreement.(4)\n10.5 Corporate Continuing Guarantee of the Registrant to MGTF, dated December 4, 1990. (4)\n10.6 Pledge Agreement, dated as of the 4th day of December 1990, by and among the Registrant, AIRI and MGTF. (4)\n10.7 Shareholder Distribution Agreement dated as of the 4th day of December 1990, by and between the Registrant, AIRI and MGTF. (4)\n10.8 Form of Sale of Indebtedness and Assignment of Collateral Mortgage Notes and Security Documents. (4)\n10.9 Form of Collateral Mortgage Note drawn by AIRI. (4)\n10.10 Form of Amended and Restated Collateral Pledge Agreement drawn by AIRI (Inventory). (4)\n10.11 Form of Amended and Restated Collateral Pledge Agreement drawn by AIRI (Fixed Assets). (4)\n10.12 Environment Indemnity Agreement dated December 4, 1990 by and between AIRI, the Registrant and MG. (4)\nEXHIBIT NUMBER DESCRIPTION - ------- ----------- 10.13 Amendment to Loan and Security Agreement, dated as of September 26, 1991. (5)\n10.14 Pledge and Security Agreement, dated January 20, 1993, by and between American International Petroleum Corporation and Society National Bank as Trustee. (6)\n10.15 Letter Agreement, dated January 4, 1995, by and between American International Petroleum Corporation and P.T. Ustraindo Petrogas.(9)\n10.16 Promissory Note, dated March 15, 1995 from Gold Line Refining, Ltd. to American International Petroleum Corporation.(9)\n10.17 Amended and Restated Lease Agreement between Gold Line and AIRI dated March 22, 1995.(9)\n10.18 Letter Agreement dated March 22, 1995 amending Loan and Security Agreement.(9)\n10.19 Subordination and Standby Agreement dated March 22, 1995 between NationsBank, Gold Line Refining Ltd., Citizens Bank and AIRI.\n10.20 Intercreditor Letter Agreements dated March 22, 1995 between MGTF, Citizens Bank and AIRI.\n10.21 Amendment #1 to Employment Agreement, dated October 13, 1995, between George N. Faris and the Registrant(10).\n10.22 Letter dated February 9, 1996 amending Promissory Note between AIRI and Gold Line Refining Ltd.\n21.1 Subsidiaries of the Registrant.(9)\n27.1 Financial Data Schedule.\n- ----------------\n(1) Incorporated herein by reference to the Registration Statement on Form S-1, declared effective on February 16, 1988 (File No. 33-17543).\n(2) Incorporated herein by reference to the Registration Statement on Form S-1 File No. 33-23584 declared effective on January 27, 1989.\n(3) Incorporated herein by reference to the Registration Statement on Form S-1 declared effective on February 13, 1990.\n(4) Incorporated herein by reference to the Registrant's Current Report on Form 8-K, dated December 4, 1990.\n(5) Incorporated herein by reference to the Registration Statement on ForM S-1, declared effective November 9, 1992.\n(6) Incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(7) Incorporated herein by reference to the Registration Statement on Form S-2, declared effective January 13, 1994.\n(8) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n(9) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n(10) Incorporated herein by reference to Amendment #19 to Schedule 13D of George N. Faris for October 13,1995.","section_15":""}
{"filename":"764843_1995.txt","cik":"764843","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nFounded in 1972, and located in suburban Philadelphia, SCAN-GRAPHICS(R), Inc. is an international provider of GIS database management software products, large document scanners, backfile conversion services, and imaging technology, software and systems.\nDue to the Company's established areas of expertise and the continued emergence and growth of imaging and document management technologies, SCAN-GRAPHICS has taken aggressive steps to reposition itself in the Electronic Document Management (EDM) market during 1995.\nThe Company is now divided into the following three divisions:\noThe Scanner Division oSedona TM GeoServices, Inc. oTechnology Resource Center, Inc. (TRC)\nThe Scanner Division is a provider of monochrome, greyscale, and color large document scanners and imaging subsystems. It is an innovator in the development of new scanning and raster-to-vector conversion technology. The color scanners and related subsystem software are manufactured and distributed by Tangent Engineering, Inc., of Englewood, CO. Tangent was acquired by the Company during December 1995.\nSedona GeoServices, Inc., was acquired by SCAN-GRAPHICS in July 1995. It immediately became a wholly owned subsidiary of the Company, and, through this acquisition, acquired the right to package and commercially distribute Lockheed Martin geospatial software products, which will be launched during the third to fourth quarter 1996. Sedona is the only authorized distributor of these products in the commercial marketplace.\nThe formation of the Technology Resource Center, Inc. (TRC) was announced in November 1995. Due to be incorporated and functional in the fourth quarter of 1996, this new subsidiary will provide document conversion services, computer system services and training services focused on imaging and document management technologies. A key objective of TRC is to address the existing shortage of qualified imaging and document management personnel through the training and certification of many individuals, including, but not limited to unemployed and under-employed people.\nFinancial Information (In Thousands)\nTotal revenues for the years ended December 31, 1995, 1994 and 1993 were $4,987 $5,067, and $3,839, respectively. The percentages of total revenue for scanners and related services for years ended 1995, 1994 and 1993 were 93%, 91%, and 85% respectively. The percentages of total revenue for software and related services for years ended 1995, 1994 and 1993 were 5%, 2%, and 2% respectively. The percentages of total revenue for license and royalty fees for years ended 1995, 1994 and 1993 were 2%, 7%, and 13%, respectively.\nFinancial Information Relating to Domestic and International Sales: (In Thousands)\n1995 1994 1993 ---- ---- ---- Sales to unaffiliated customers: United States $3,825 $4,105 $3,030 Export 1,162 962 809\nGross Profit: United States $1,048 $2,130 $1,001 Export 692 747 456\nExports were sold into the following regions: Western Europe, Eastern Europe, Asia and Middle East.\nITEM 1. BUSINESS (Continued)\nIt should be noted that to-date, the Company has financed the start-up of Sedona GeoServices, Inc. from its Scanner Division's cash flow and partially from the proceeds of a $1.25 million private placement of the Company's convertible preferred stock completed in September, 1995.\nDescription of Business and Principal Products\nSCAN-GRAPHICS is a provider of GIS database management software products and is a pioneer and leader in scanning and image processing technology, large document scanners, backfile conversion services, and imaging software and systems. SCAN-GRAPHICS markets its products internationally through systems integrators and distributors. The Company is divided into the following three divisions:\noThe Scanner Division oSedona GeoServices, Inc. oTechnology Resource Center, Inc. (TRC)\nScanner Division\nSCAN-GRAPHICS Scanner Division offers a variety of monochrome and greyscale imaging software for multiple platforms and applications. Specifically, the Company offers scanner operating systems software, image viewing, software, and raster-to-vector conversion, editing, and OCR software.\nTangent Engineering, Inc., a part of the Company's Scanner Division, was acquired in December 1995, and markets its products under the Tradename of Tangent Color Systems. Tangent offers three styles of color large document scanners and associated imaging software which are packaged into complete color scanning systems and sold under the brand name INTREPID.\nSedona GeoServices, Inc.\nSedona GeoServices, Inc., is the only Master Value Added Reseller authorized to commercially package and distribute Lockheed Martin geospatial software products to the commercial marketplace. These leading edge products are based upon the first open architecture, object-oriented database management system for processing geospatially oriented information. These products will allow data types such as maps, images, text and relational database information to be organized and manipulated within a single, user intuitive Geographic Information Systems (GIS).\nSedona GeoServices will offer the following commercial off-the-shelf (COTS) products:\n1) Sedona GeoCATALOG TM will enable developers and resellers of geospatial information products, such as maps, aerial photography, and satellite imagery to create and distribute soft copy and on-line products catalogs.\n2) Sedona GeoVIEW TM will be a full-function, high-speed software subsystem that will enable a user to browse through, view, clean, annotate, manipulate and print large, complex digital images.\n3) The Sedona VPFKit TM will consist of a set of class libraries which will permit a software developer easy access to any database which uses the Vector Product Format(VPF). The Sedona VPFKit will provide a layer between the \"raw\" data in the database and the user's highest level (graphical or non-graphical)interface.\nITEM 1. BUSINESS (Continued)\n4) Sedona DMTool TM will consist of an integrated set of sophisticated computer software organized into a toolbox which will manipulate geospatial data and transform it into pertinent geographic information. The toolbox will contain open, object oriented data management tools which will organize and manipulate world objects, such as maps, images and text information within a single, user intuitive Geographic Information System (GIS).\nTechnology Resource Center, Inc. (TRC)\nThe TRC will provide a wide range of services in support of computer technologies that have been proven to improve office work productivity. The center will be a document conversion and training center. The center will concentrate on services that support imaging and document management technologies and the integration of these applications with other office processes such as accounting, information databases, and project controls.\nLicense and Royalty Fees\nThe Company benefits from its technology expertise by the licensing of its patented hardware technology and software.\nResearch & Development (In Thousands)\nThe Company's engineering group is engaged in a continuing research and development program of its software and scanner products. Research and development expenses were $582, $783, and $770 for the years ended December 31, 1995, 1994, and 1993, respectively.\nPatents and Copyrights\nThe Company is the sole owner of two patents entitled \"High Speed, High Resolution Image Processing System,\" Patent Number 4,631,598 issued December 23, 1986 and Patent Number 4,972,273, issued November 20, 1990. Patents are effective for seventeen years from date of issuance.\nDuring fiscal year 1995, 1994 and 1993 the Company capitalized costs related to the issuance of trademarks on its software products and patent costs related to the continuance, application and amendment of its High Speed, High Resolution Image Processing System.\nThese patents relate to the Company's scanner products. The Company believes that the technology contained in these patents is very important to electronic document scanner and\/or digital copier products and to the Company's competitive position. The Company's developed software programs are covered and registered by copyrights.\nMarketing\nEach of the Company's three separate and distinct, yet synergistic business units sells its products and services through independent, yet complimentary distribution systems.\nThe Scanner Division sells its monochrome and greyscale scanners and related software through an expanding network of distributors, value added resellers, and system integrators. There are over 25 resellers in North America and 22 others throughout Europe, Asia, South America and the Pacific Rim. Tangent Engineering, Inc. sells its scanners and software products internationally through distributors, manufacturers representatives, and direct sales people.\nITEM 1. BUSINESS (Continued)\nSedona GeoServices, Inc. is developing a distribution system which consists of value added resellers, systems integrators, and strategic partners which will resell shrink-wrapped and customized commercial off-the-shelf (COTS) products and\/or license technology for use in the products of resellers, integrators, and partners.\nThe TRC will sell its services through resellers, manufacturers representatives, and direct sales people. Marketing programs will focus on specific industries, such as engineering and manufacturing, where the Company has established expertise. Subsequently, the TRC expects to sell into other industries that have a high demand for imaging and document management services.\nMajor Customers\nThe Company's revenues for the 1995 fiscal year were derived from a number of customers. One customer accounted for more than 10% of the Company's net revenue for this period. (See Note 10 to the Financial Statements)\nCompetition\nThe Company's competition must be categorized according to the markets in which the three divisions operate.\nThe Scanner Division's monochrome and greyscale hardware products compete with four other hardware manufacturers. These five companies control approximately 75% of the worldwide marketplace. The Company's Tangent Color Systems products compete with primarily other makers of large format color reprographic products such as Canon and Xerox. In the area of front end image processing, the Company competes with numerous competitors located throughout the world. In all cases, the Company's market niche remains large document scanning and digital file manipulation.\nSedona GeoServices, Inc. competes against two types of organizations, GIS software developers and GIS-related systems integrators\/consultants. Recent industry surveys show that 10 competitive software developers control over 80% of the GIS software market.\nThere are a number of organizations that offer services similar to those offered by the TRC. These organizations include scanning service providers, hardware and software product developers, consulting organizations, computer resellers and VARs, systems integrators, and electronic document management training and certification companies.\nSuppliers\nThe Company is not dependent on any single supplier for components and subassemblies in the manufacture of its products.\nManufacturing\nThe Company manufactures its large format scanners, MK35 Aperture Card Library Management System, scanner interfaces, scan servers, and software products at its Broomall, PA and Englewood, CO facilities.\nManagement believes that the facilities are adequate to fulfill its current and near term needs given the current and projected level of sales.\nEmployees\nAs of December 31, 1995, the Company had fifty-five full-time employees. None of these employees are represented by a labor union. The Company believes that its relationships with its employees are satisfactory.\nITEM 1. BUSINESS (Continued)\nDependence Upon Key Personnel\nThe Company is dependent upon certain key members of its management for the successful operation and development of its business. The loss of the services of one or more of its management personnel could materially and adversely affect the operation of the Company. In addition, in order to continue its operations, the Company must attract and retain additional technically qualified personnel with backgrounds in engineering, production and marketing. There is keen competition for such highly qualified personnel and consequently there can be no assurance that the Company will be successful in recruiting or retaining personnel of the requisite caliber or in the numbers necessary to enable the Company to continue to conduct its business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nThe Company leases its principal offices and one of its manufacturing facilities at 700 Abbott Drive, Broomall PA 19008. The current lease was renewed on September 1, 1994 and continues through August 31, 1997 with an option to renew for two additional years. An additional manufacturing facility is located at 14 Inverness Drive East, Suite A-100, Englewood, CO 80112. The current lease has a term of five years beginning on June 1, 1994 and ending on May 31, 1999. Management believes that the facilities adequately fulfill its office and manufacturing space requirements. (See Notes 12 and 14 to the Financial Statements)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS (In Thousands)\nOn September 15 1992, SCAN-GRAPHICS, Inc. and Scorpion Technologies, Inc. reached an initial settlement agreement regarding a jury verdict in favor of SCAN-GRAPHICS, Inc. in August 1992. The agreement provided that Scorpion Technologies, Inc. was to pay SCAN-GRAPHICS, Inc. $2,000. As a result of the settlement, Scorpion paid the Company $1,430 through December 31, 1993, but defaulted in May 1993 on its obligation. As a result of Scorpion's default, in November 1993, the Company received the software product source codes and capitalized such for $695 which represented the remaining balance due from Scorpion. The value of the software was verified by an independent appraiser and was valued at $1,243. In March 1994, Scorpion turned over and the Company took possession of all Scorpion SGS8000 scanner technology which included all tangible and intangible assets\nOn November 20, 1995, an action was commenced against the Company seeking damages in excess of $117, for alleged fraud and breach of contract. On February 8, 1996, the Company answered the complaint, denying entitlement to recovery of any monies and counter-claiming for breach of contract and fraud. (See Note 11 to the Financial Statements)\nDuring 1995, an action was filed against the Company through the International Arbitration Tribunal in Paris, France, claiming amounts due and damages for the Company's alleged failure to perform its obligations under a March 30, 1990 agreement. The Company has filed an answer to the complaint on February 30, 1996, asserting loss of profits from failure by the Plaintiff to forward sales orders for parts, maintenance and software. (See Note 11 to the 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 COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe common stock is traded in the over-the-counter market and is authorized to be quoted on the National Association of Securities Dealers, Inc. Automated Quotation (\"NASDAQ\") System under the symbol \"SCNG\".\nThe following Table sets forth the high and low bid prices of the Company's common stock as reflected on NASDAQ for the periods indicated. The bid prices represent quotations in the over-the-counter market between dealers in securities and do not include retail markups, markdowns, or commissions and do not necessarily represent actual transactions.\nAs of February 29, 1996 there were approximately 2,000 Shareholders of record. On February 29, 1996, the last reported sale price of the Company's common stock as reported on the NASDAQ System was $3.53125.\nThe Company has never declared or paid cash dividends on its common stock and does not anticipate payment of cash dividends on its common stock in the foreseeable future. It is the current intent of the Company to continue to retain any earnings to finance the development and expansion of its business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (In Thousands)\nThe following table sets forth selected financial information regarding the Company for the year ended December 31, 1995 and for the four previous years.\nITEM 6. SELECTED FINANCIAL DATA (In Thousands) (Continued)\nThis information should be read in conjunction with the financial statements and notes thereto included in Item 8 of this Form 10-K.\nYEAR ENDED DECEMBER 31,\n- --------------------------- 1 Restated due to acquisition of Tangent Engineering, Inc.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources (In Thousands)\nAt December 31, 1995, cash and cash equivalents decreased to $189, a $37 decrease compared to the December 31, 1994 amount of $226. At December 31, 1994, cash and cash equivalents increased to $226, a $84 increase compared to the December 31, 1993 amount of $142. The above changes in cash and cash equivalents are explained as follows in the cash flow from operating, investing and financing activities.\nAs of December 31, 1995, the cash flows from operating activities resulted in a net use of cash of $1,234 compared to the December 31, 1994 and December 31, 1993's use of cash of $138 and $375, respectively. The increase in the use of cash as of December 31, 1995, as compared to 1994 is primarily due to higher losses incurred, the increase in inventory and the payment of accrued bonuses. The decrease in the use of cash as of December 31, 1994 as compared to 1993 is primarily due to lower losses incurred, the increase in both accounts payable\/accrued expenses and accrued bonuses.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nAs of December 31, 1995, the cash flows from investing activities resulted in a net use of cash of $139 compared to the December 31, 1994 and 1993's use of cash of $29 and $224, respectively. The increase in the use of cash as of December 31, 1995, is due to no proceeds from the sale of property and equipment compared to the December 31, 1994, amount of $104. The decrease in the use of cash as of December 31, 1994, is due to the decrease in the purchase of property and equipment and the proceeds from the sale of property and equipment of $104 compared to $3 at December 31, 1993.\nAs of December 31, 1995, the cash flows from financing activities resulted in net cash provided by financing activities of $1,336 compared to the December 31, 1994 and 1993's cash provided of $251 and $257, respectively. The increase in cash provided is primarily due to the proceeds from the issuance of preferred stock of $1,050 and the proceeds from the exercise of common stock warrants\/options of $444. There was a minimal decrease in the cash provided at December 31, 1994 as compared to December 31, 1993. In 1994, cash provided was primarily due to the proceeds from loans payable, officers and the issuance of long term debt as compared to 1993's proceeds from the issuance of stock and loans payable officers.\nIn 1995, the Company acquired the rights to develop and distribute a geospatial software product and acquired Tangent Engineering, Inc., a manufacturer of color document scanners. The Company is planning on raising additional capital through the private placement of its securities and\/or the issuance of convertible notes. The use of these funds will be used for the further development of the geospatial software and the start-up of the Company's Technology Resource Center (TRC) which will be a document conversion and technology training center.\nIn connection with a $3,100,000 private placement of its securities in March 1996, the Company offered for sale 62 units, each of which consisted of a $50,000, 8% convertible note due March 28, 1997, 19,355 \"A\" warrants and 19,355 \"B\" warrants. The notes and any accrued interest are convertible within one year at a price per share equal to the lesser of $3.00 or 65% of the average closing bid price for the five days preceding conversion.\nThe warrants are exercisable immediately and expire in March 1999. The \"A\" warrants are exercisable at $3.00 per share or, if less, the lowest price per share at which any conversion shall have occurred under any of the convertible notes. The \"B\" warrants are exercisable at $4.00 per share. As of March 30, 1996, the Company has received proceeds amounting to $1,995,000. The proceeds will be used for working capital purposes and to fund the requirements of its subsidiary, Sedona GeoServices, Inc.\nThe Company believes that the proceeds from the private placement and funds generated from operations will be sufficient to meet the Company's working capital requirements for 1996.\nResults of Operations (In Thousands)\nNet Revenue in 1995 decreased to $4,987, a 1.6% decrease in revenue compared to the 1994 revenue of $5,067. This was a result of an decrease in license fees. Net revenue in 1994 increased to $5,067, a 32.0% increase in revenue compared to the 1993 revenue of $3,839. This increase occurred due to hardware sales.\nThe acquisitions during 1995 has significantly enhanced the product offering of the Company. The addition of color document scanners and geospatial software increase the Company's presence in the imaging market.\nThe percentage of total revenue for scanners and related services for years ended 1995, 1994 and 1993 was 93%, 91% and 85%, respectively. The percentage of total revenue for software and related services for years ended 1995, 1994 and 1993 was 5%, 2% and 2%, respectively. The percentage of total revenue for license fees for years ended 1995, 1994 and 1993 was 2%, 7% and 13%, respectively.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nThe gross margin decrease in 1995 was a result of the increase in manufacturing costs of its monochrome document scanners due to lack of working capital. This resulted in the Company paying a premium for its cost of material and labor. The Company believes that this was a one-time event and costs of manufacturing will return to its appropriate level. The Company's gross margin percentages were 35%, 57% and 38% for years ended 1995, 1994 and 1993, respectively. The gross margin increase in 1994 compared to 1993 was a result of a decrease in sales of third party products which had a lower gross margin than the Company's manufactured products.\nResearch and Development Expenses: In the years ended December 31, 1995, 1994 and 1993, the Company had research and development expenses of $582, $783, and $770, respectively. Research and development expenses as a percentage of revenue in 1995, 1994 and 1993 were 11.7%, 15.5%, and 20.1%, respectively. The Company's engineering and software group is engaged in continuous research and development of its software and scanner products. The decrease in research and development expenses was due primarily to the reduction in software engineering expenses as a result of completing the development of certain products. While continuing its research and development, the Company due to its limited resources, will focus those resources on products which can be brought to market in a short time frame.\nSales and Marketing Expenses: Sales and Marketing expenses for years ended December 31, 1995, 1994 and 1993 totaled $1,388 $1,360, and $1,340, respectively. Sales and marketing expenses as a percentage of Revenue in 1995, 1994 and 1993 were 27.8%, 26.8% and 34.9%, respectively. The Company is continuing its efforts to market its products through increasing its advertising and promotion and developing distributor relationships.\nOperating, General and Administrative Expenses: General and Administrative expenses for the years ended December 31, 1995, 1994 and 1993 totaled $985, $1,641, and $1,142, respectively. General and Administrative expenses decreased in 1995 compared to 1994 as a result of a reversal of an Accounts Receivable Reserve of $229 set-up in 1994 and 1993 for a potentially uncollectible account. An agreement with the customer was reached for the full amount in March 1995 to pay the receivable. General and Administrative as a percentage of revenue in 1995, 1994 and 1993 were 19.8%, 32.4% and 29.7%, respectively.\nOther Income\/Expense: Litigation Legal Fees for the year ended December 31, 1995, 1994 and 1993 were $-0-, $42, and $39, respectively. These expenses are a result of the Company pursuing license fees owed to the Company per contractual obligations, patent infringement and a failed acquisition attempt.\nInterest expense for years ended December 31, 1995, 1994 and 1993 were $44, $35, and $10, respectively. Interest expense increased in 1995, 1994 and 1993 due to the increase of the Company's Long Term Debt. As a result of the Company's losses in fiscal years 1995 and 1994 and prior years, the Company has borrowed money and has incurred varying amounts of interest expense.\nInterest Income for years ended December 31, 1995, 1994 and 1993 was $2, $5, and $5, respectively. During 1995 and prior years interest income was earned on cash investments and sales type lease receivables.\nOther Income for years ended December 31, 1995, 1994 and 1993 was $47, $120, and $7, respectively. The increase in other income in 1994 was due to the sale of equipment.\nOther Expenses for years ended December 31, 1995, 1994 and 1993 were $27, $30, and $24, respectively. These expenses in 1995, 1994 and 1993 were primarily due to late payment charges.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nStock-Based Compensation\nIn 1996, the Company will adopt SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This standard establishes a fair value method for accounting for stock-based compensation plans either through recognition or disclosure. The Company intends to adopt this standard by disclosing the pro forma net income and earnings per share amounts assuming the fair value method was adopted on January 1, 1995. The adoption of this standard will not impact the Company's results of operations, financial position or cash flows.\nRecoverability of Intangibles\nThe Company evaluates the recoverability of all intangibles annually, or more frequently whenever events and circumstances warrant revised estimates, and considers whether the intangibles should be completely or partially written off if the amortization period should be accelerated. In accordance 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,\" the Company assesses the recoverability of the intangibles based on undiscounted estimated future operating cash flows. As of December 31, 1995, the carrying value of the intangibles has been determined not to be impaired.\nInflation\nAlthough inflation has resulted in an increase in certain operating costs during the past three years, management believes it has not had a material effect on the Company's results of operations or financial condition.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index on.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENT 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\nThe following table sets forth certain information regarding the directors and executive officers of the Company.\nName Age Position - ---- --- --------- Andrew E. Trolio 66 President, Chief Executive Officer and Chairman of the Board Joseph N. Battista 41 Vice President of Finance Robert Garber 46 Director Michael A. Mulshine 56 Secretary and Director Anthony M. Trolio (*) 39 Executive Vice President Howard L. Morgan 50 Director James C. Sargent 78 Director David S. Hirsch 60 Director\nAll Directors hold office until the next annual meeting of the Shareholders of the Company and until their successors are elected and qualified.\nAll officers serve at the discretion of the Board of Directors subject to the terms of their employment agreements.\n(*) Anthony M. Trolio is the son of Andrew E. Trolio.\nThe business experience, principal occupation and employment of the directors and executive officers have been as follows:\nAndrew E. Trolio, is Chairman of the Board, President and Chief Executive Officer of the Company. He founded the Company in 1972. From 1961 to 1971 he was President, Director and Founder of KDI Adtrol, Inc., a company which manufactured photo-optical recording and reading devices for motion picture cameras. He is also credited with several patents as inventor or co-inventor. Mr. Trolio is a Trustee of Cabrini College and has served as Chairman of the Finance and Audit Committee of SPIE and is currently a Fellow of the International Society of Optical Engineers.\nJoseph N. Battista, Jr., the Company's Vice President of Finance, has been a Officer of the Company since October 1990. From 1987 to 1990, he was Vice President and Chief Financial Officer of Wefa, Inc. (Formerly Chase Econometrics and Wharton Econometrics), an economic consulting, economic data provider and software company. He received a BS degree in Accounting and an MBA degree from St. Joseph's University (Philadelphia) in 1976 and 1981, respectively. He is also a Certified Public Accountant in the State of Pennsylvania and is a member of the AICPA and PICPA.\nRobert A. Garber, has served as Vice President and Chief Financial Officer of Tangent Engineering, Inc., since August of 1993. He now serves as Tangent's Chief Operating Officer. Mr. Garber has specialized in the domestic and international corporate finance, assets based lending investment banking, where he held various senior management positions, including positions with Chase Manhattan Bank, United States Leasing Corporation and Litton Industries. Mr. Garber was one of the founders of ICON Group, Inc., a New York based investment banking and securities organization. Robert A. Garber, is a graduate of New York's Bernard Baruch College, having earned as BS in Business Administration and Finance.\nMichael A. Mulshine, has been a Director and Secretary of the Company since May 1985 and has been associated with the Company on a management consulting basis since 1979. He has been the President of Osprey Partners, a management consulting firm, since 1977. He is also Chairman of Dynex Sport Optics, Inc., an exclusive licensee of the Wilson Sporting Goods Company, and a director of Vasco Corp., an OTC traded company.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (Continued)\nAnthony M. Trolio, the Company's Executive Vice President has been with the Company since 1978. He is responsible for direction and planning related to software and hardware engineering. He received a BS degree from Villanova University in 1978.\nHoward L. Morgan, Ph.D. has been a Director of the Company since September 1989. He is President of the ARCA Group, Inc., a consulting and investment management firm. Dr. Morgan was Professor of Decision Sciences at the Wharton School of the University of Pennsylvania from 1972 to 1986 and has headed Renaissance Technologies Corporation's venture capital activities since 1986. He serves on the board of directors of a number of emerging technology companies including Franklin Computer Corporation, Quarterdeck Office Systems, Integrated Circuit Systems, Inc., Cylink Corporation and Kentek Information Systems.\nJames C. Sargent, a Director of the Company since January 1992, is of Counsel to the law firm of Whitman & Ransom. He has been a partner at Whitman & Ransom for the past five years. He was Regional Administrator from 1955 to 1956, and Commissioner from 1956 to 1960, of the New York Regional Office of the Securities and Exchange Commission.\nDavid S. Hirsch, a Director of the Company since January 1992, retired in 1991 from Wertheim Schroder & Co. Incorporated and its predecessor firms where he was a principal for over the last five years. Mr. Hirsch is also a director of Postal Buddy Corporation, Myers, Holdings & F.W. Myers and Reprise Capital Corp. He received an AB degree from Cornell University in 1957 and an MBA degree from Harvard University in 1959.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated herein by reference to the information under the caption \"Compensation of Executive Officers and Directors\" in the Company's definitive proxy statement for the 1996 annual meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 is incorporated by reference to the information under the caption \"Security Ownership of Management and Certain Beneficial Owners\" in the Company's proxy statement for the 1996 annual meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated by reference to the information under the caption \"Certain Relationships and Related Transactions\" in the Company's proxy statement for the 1996 annual meeting of Shareholders.\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 and Schedules\" on.\n(b) Reports on Form 8-K\nNone filed in the last quarter of the period covered by this report.\n(c) Exhibits\nThe following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parenthesis.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n3.1 Articles of incorporation (2) (Exhibit 3.1).\n3.2 Bylaws (2) (Exhibit 3.2).\n*3.3 Amendment to Articles of Incorporation\n4.1 Specimen copy of stock certificate for shares of Common Stock of the Registrant. (5)\n4.2 Specimen copy of stock certificate for shares of Class A Convertible Preferred Stock Series A (1) (Exhibit 4.2).\n4.3 Specimen copy of stock certificate for shares of Class B Preferred Stock (1) (Exhibit 4.3).\n4.4 Restricted Common Stock Registration Rights (1) (Exhibit 4.1).\n4.5 Form of Common Stock Warrant (1) (Exhibit 4.4).\n4.6 Form of Redeemable Common Stock Purchase Warrant and Subscription Agreement (1) (Exhibit 4.5).\n4.7 Letter agreement between Cameron Associates, Inc. and SCAN-GRAPHICS, Inc. (1) (Exhibit 4.6).\n*4.8 Specimen copy of stock certificate for shares of Class A Convertible Preferred Stock Series C.\n**10.1 Employment Contract - Andrew E. Trolio (1) (Exhibit 10.1).\n**10.2 Employment Contract - Anthony M. Trolio (1) (Exhibit 10.4).\n**10.3 Employment Contract - Joseph N. Battista (1) (Exhibit 10.5).\n**10.4 Form of Common Stock Option (1) (Exhibit 10.6).\n**10.5 SCAN-GRAPHICS, Inc. 1992 Long Term Incentive Plan (3) (Exhibit 2.1 - Annex E).\n10.6 Facility Lease, 700 Abbott Drive, Broomall, PA (6)\n10.7 Form of Selling Shareholder Agreement (4) (Exhibit 10.2).\n10.8 Agreement between SCAN-GRAPHICS, Inc. and Howard L. Morgan and the ARCA Group, Inc. (5) (Exhibit 10.9)\n10.9 Agreement between SCAN-GRAPHICS, Inc. and Michael A. Mulshine and Osprey Partners. (6)\n*24.1 Consent of BDO Seidman with respect to the registration statement on Form S-3 (33-47127).\n25.1 Power of attorney (included on the signature page to this Form 10-K).\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n* Filed herewith. ** Executive Compensation Plans and Arrangements.\n(1) Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal year ended December 31, 1991, as amended by Amendment No. 1 on Form 8 dated June 12, 1992 and Amendment No. 2 on Form 8 dated July 27, 1992.\n(2) Filed as an Exhibit to the Company's Current report on Form 8-K dated June 15, 1992.\n(3) Filed as an Exhibit to the Registration Statement on Form 8-K, filed under the Securities Exchange Act of 1934, dated June 19, 1992.\n(4) Filed as an Exhibit to Pre-Effective Amendment No. 1 to the Registration Statement on Form S-3 (Registration No. 33-47127) filed on July 2, 1992.\n(5) Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as amended by Amendment No. 1 on Form 8 dated April 21, 1993.\n(6) Filed as an Exhibit to the Annual Report on Form 10-K for the fiscal ended December 31, 1994.\nSIGNATURES\nursuant to the requirements of Sections 13 or 15(d) of the Securities xchange Act of 1934, the registrant has duly caused this report to the e signed on its behalf by the undersigned, thereunto duly authorized.\nSCAN-GRAPHICS, INC.\nMarch 29, 1996 \/s\/ ANDREW E. TROLIO DATE ----------------------------- ANDREW E. TROLIO 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.\nEach person in so signing also makes, constitutes and appoints Andrew E. Trolio, Chairman of the Board of Directors, President and Chief Executive Officer, his true and lawful attorney-in-fact, in his name, place and stead, to execute and cause to be filed with the Securities and Exchange Commission, any or all amendments to this report.\nSignatures\nBY: \/S\/ ANDREW TROLIO Date March 29, 1996 - -------------------------------------------- Andrew E. Trolio Chairman of the Board of Directors, President and Chief Executive Officer\nBY: \/S\/ JOSEPH N. BATTISTA Date March 29, 1996 - -------------------------------------------- Joseph N. Battista Vice President Finance (Principal Financial and Accounting Officer)\nBY: \/S\/ MICHAEL A. MULSHINE Date March 29, 1996 - -------------------------------------------- Michael A. Mulshine Director and Secretary\nBY: \/S\/ HOWARD L. MORGAN Date March 29, 1996 - -------------------------------------------- Howard L. Morgan Director\nBY: \/S\/ DAVID S. HIRSCH Date March 29, 1996 - -------------------------------------------- David S. Hirsch Director\nBY: \/S\/ JAMES C. SARGENT Date March 29, 1996 - -------------------------------------------- James C. Sargent Director\nBY: \/S\/ ROBERT GARBER Date March 29, 1996 - -------------------------------------------- Robert Garber Director\nScan-Graphics, Inc. and Subsidiaries\n------------------------------------------- Report on Consolidated Financial Statements Years Ended December 31, 1995, 1994 and 1993\nScan-Graphics, Inc. and Subsidiaries\n- -------------------------------------------------------------------- All other schedules have been omitted because they are inapplicable, not required, or the required information is included elsewhere in the financial statements and notes thereto.\nReport of Independent Certified Public Accountants\nScan-Graphics, Inc. and Subsidiaries Broomall, Pennsylvania\nWe have audited the accompanying consolidated balance sheets of Scan-Graphics, 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 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 audit. We did not audit the financial statements of Tangent Engineering, Inc., a wholly-owned subsidiary, which statements reflect total assets of $1,657,000 and $1,748,000 as of December 31, 1995 and 1994, and total revenues of $3,023,000, $2,631,000 and $1,632,000 for the years ended 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 the amounts included for Tangent Engineering, Inc., is based solely on the report of the other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and 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 presentation of the financial statements and schedule. 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 referred to above present fairly, in all material respects, the financial position of Scan-Graphics, Inc. and subsidiaries 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.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\nBDO Seidman, LLP\nMarch 8, 1996, except for Note 18, as to which the date is March 30, 1996\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Balance Sheets (In Thousands, Except Share and Per Share Data)\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\n- -------------------------------------------------------------------------------- Scan-Graphics, Inc. and Subsidiaries\nConsolidated Statements of Operations (In Thousands, Except Share and Per Share Data)\n- -------------------------------------------------------------------------------- Scan-Graphics, Inc.\nConsolidated Statements of Operations (continued) (In Thousands, Except Share and Per Share Data)\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Statements of Stockholders' Equity (In Thousands, Except Share Data)\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Statements of Cash Flows (continued) (In Thousands)\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Statements of Cash Flows (continued) (In Thousands)\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nScan-Graphics, Inc. and Subsidiaries\nSummary of Significant Accounting Policies (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nSummary of Significant Accounting Policies (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nSummary of Significant Accounting Policies (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nYears ended December 31, 1995 1994 1993 ---------------------------------------------------------------------\nNet Sales Scan-Graphics, Inc. $ 1,964 $ 2,436 $ 2,207 Tangent 3,023 2,631 1,632 ---------------------------------------------------------------------\nCombined $ 4,987 $ 5,067 $ 3,839 ---------------------------------------------------------------------\nNet Income (Loss) Scan-Graphics, Inc. $ (1,360) $ (917) $ (1,884) Tangent 123 28 28 ---------------------------------------------------------------------\nCombined $ 1,237 $ (889) $ (1,856) ---------------------------------------------------------------------\nNet Income (Loss) Per Common Share Scan-Graphics, Inc. $ (.15) $ (.11) $ (.22) Tangent .01 .01 .01 ---------------------------------------------------------------------\nCombined $ (.14) $ (.10) $ (.21) ---------------------------------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - -------------------------------------------------------------------------------- 2. Inventories Inventories are summarized as follows:\n4. Other Assets Product Acquisition Costs\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nIn 1991, the Company purchased for $400 the rights and title to a product line which is now being manufactured by Scan-Graphics, Inc. Amortization expense was $100, $100 and $80 for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn 1993, the Company received software product source codes and capitalized $695 (see Note 11). Amortization expense was $139 for the year ended December 31, 1995, when the product was released for general sale to customer. The Company had no amortization expense for the years ended December 31, 1994 and 1993.\n5. Loans Payable, The Company has a line of credit agreement, expiring on May Officer and 31, 1996, with the chief executive officer and a related Related party owned by the chief executive officer. The terms are to Company lend up to $150 in the form of loans and deferred rent payments. The interest rate is a bank's prime rate, plus 1% or the interest charged to the chief executive officer to secure borrowings (8.50% bank's prime rate at December 31, 1995). As of December 31, 1995, the Company had loans payable of $55 and interest payable of $4. As of December 31, 1994, the Company had loans payable of $132, interest payable of $5 and other accrued expenses of $5. On December 30, 1994, the chief financial officer advanced to the Company $30. This advance was repaid in January 1995.\n6. Notes Payable, Notes payable to officers accrue interest at 5% per annum, Officers are due on demand and are without collateral. At December 31, 1995 and 1994, the balance was $259 and $78, respectively, and interest paid on the notes during the years ended December 31, 1995 and 1994 totalled $13 and $4, respectively.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n7. Long-Term Long-term debt consists of the following: Debt\nAs of December 31, 1995, long-term debt matures as follows:\n1996 $ 69 1997 74 1998 69 1999 39\n8. Capital Lease At December 3, 1995 and 1994, equipment with a net book Obligation value of $112 and $219, respectively, (net of accumulated amortization of $157 and $50, respectively) has been leased under capital leases.\nFuture minimum annual lease payments are as follows:\nYear ending December 31, ------------------------------------------ 1996 $ 93 1997 49 ------------------------------------------ Total minimum lease payments 142 Less amount representing interest (12) ------------------------------------------\nLess current maturities (87) ------------------------------------------ $ 43 ------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n9. Stockholders' Class B Preferred Stock Equity Each share of the Company's Class B preferred stock is convertible at the holder's option into ten shares of common stock. The holders of Class B preferred stock are entitled to share in any dividends declared by the Board of Directors on a pro-rata basis, without preference, with the holders of common stock. Dividends are not cumulative. In liquidation, the only preference is for the par value of the preferred shares.\nClass A Preferred Stock\nSeries A and C\nClass A preferred stock is issuable in various series and is convertible in accordance to the issued series. The Board of Directors has the authority to fix by resolution all other rights.\nThe Class A Series A preferred shares pay quarterly dividends at the rate of twelve percent (12%) per annum, have cumulative rights and have a liquidation preference for the par value of the preferred shares. Each holder has the same right to vote each share on all corporate matters as the holder of one share of common stock.\nThe Class A Series C preferred shares pay quarterly dividends at the rate of eight percent (8%) per annum, have cumulative rights and have a liquidation preference for the par value of the preferred shares. Each share is convertible at the election of the holder after twenty-four months from date of issue into shares of common stock at a 50% discount from \"Market Price\" (closing bid price for the day) average for the twenty trading days preceding notice of conversion, but not less than $.50 per share or more than $2.50 per share of common stock. The Company has the right to force conversion to common stock upon thirty days written notice after thirty-six months from date of issue. Each share of Class A, Series C represents twenty (20) shares of common stock in voting power in matters brought before the shareholders.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nCommon Stock\nOn December 29, 1995, the Company issued 1,000,000 shares for all the shares outstanding of Tangent Engineering, Inc. in a pooling of interests business combination (see Note 1).\nIn November 1993, the Company issued 600,000 shares at $.50 a share, or a value of $300 in a private placement under Regulation S (overseas issuances).\nDividends Declared\nDuring 1995, the Board of Directors declared preferred dividends on the Company's Class A Series A and Series C preferred stock payable on a quarterly basis as due. Dividends for 1995 totalled $158 of which none were paid as of December 31, 1995.\nDuring 1994, the Board of Directors declared preferred dividends on the Company's Class A preferred stock payable on a quarterly basis as due. Dividends for 1994 totalled $120 of which all were paid during 1995.\nOn February 12, 1993, the Board of Directors declared preferred dividends on the Company's Class A Preferred Stock payable on a quarterly basis as due. Dividends for 1993 totalled $120 of which $40 was paid during 1993 and $80 was paid during 1995.\nOptions and Warrants\nLong-Term Incentive Plan\nOn June 12, 1992, at the Company's Annual Meeting, the stockholders of the Company approved a Long-Term Incentive Plan for the issuance of options for the purchase of up to 1,000,000 restricted common stock shares in the aggregate, or such other number of shares as are subsequently approved by the Company's stockholders.\nThe Long-Term Incentive Plan provides for the granting of both incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, and non-qualified stock options which do not so qualify. Unless the Plan is terminated earlier by the Board of Directors, the Plan will terminate in March 2002. As of December 31, 1995, the Company has 291,112 of options still permitted to be granted under the Plan.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - -------------------------------------------------------------------------------- Options outstanding under the Long-Term Incentive Plan have been granted to officers, directors and employees to purchase common stock at prices ranging from $.46875 to $2.50 per share and expiring between December 31, 1996 and September 25, 2000. All options were granted at market prices. A summary of the option transactions follows:\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nNonqualified Stock Option Plan\nAs indicated in the previous pages, a Long-Term Incentive Plan was approved on June 12, 1992. Prior to the inception of the Plan, there were options to purchase 450,000 common shares outstanding. Options under the Nonqualified Stock Option Plan have been granted to officers of the Company to purchase common stock at prices ranging from $.78125 to $1.34 and expire on December 31, 1996.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts)\nWarrants outstanding have been granted to officers, directors, stockholders and others to purchase common stock at prices ranging from $.375 to $3.00 per share and expiring between December 3, 1996 and December 31, 2000. All warrants were granted at market prices. A summary of the warrant transactions follows:\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nExercise Price Shares Per Share Aggregate - --------------------------------------------------------------------------------\nWarrants granted 125,000 $.375 $ 47 - --------------------------------------------------------------------------------\nWarrants outstanding at December 31, 1994 1,650,892 $.375 2,308 to $2.10\nWarrants granted 2,546,500 $.4375 4,289 to $3.00\nWarrants exercised (285,000) $.4375 (297) to $2.10 - -------------------------------------------------------------------------------\nWarrants outstanding at December 31, 1995 3,912,392 $.375 6,300 to $3.00 - --------------------------------------------------------------------------------\nThe Company is obligated to purchase 605,000 options and 1,090,000 warrants from three (3) officers and five (5) employees of the Company in the event of change of control of the Company or termination of employment at a cash purchase price equal to the amount of the aggregate fair market value of the shares, less the aggregate option\/warrant price of such shares. As of December 31, 1995, the market value exceeded the aggregate option\/warrant price by approximately $514.\n10. Revenues During the years ended December 31, 1995, 1994, and 1993, from Major customers which accounted for 10% or more of the Company's Customers total sales revenue was one in 1995 at 14.6%, none in 1994 and one in 1993 at 10.4%.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nA summary of domestic and export sales and gross profits for the years ended December 31, 1995 and 1994 are as follows:\n- --------------------------------------------------------------------------------\nTotal Domestic Export - --------------------------------------------------------------------------------\nRevenues $ 4,987 $ 3,825 $ 1,162\nCost of sales 3,247 2,777 470 - --------------------------------------------------------------------------------\nGross profit $ 1,740 $ 1,048 $ 692 - --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nTotal Domestic Export - --------------------------------------------------------------------------------\nRevenues $ 5,067 $ 4,105 $ 962\nCost of sales 2,190 1,975 215 - --------------------------------------------------------------------------------\nGross profit $ 2,877 $ 2,130 $ 747 - --------------------------------------------------------------------------------\nExports were sold into western and eastern Europe, Asia and middle east regions.\n11. Litigation On September 15, 1992, Scan-Graphics, Inc. and Scorpion Settlements Technologies, Inc. reached an initial settlement agreement regarding a jury verdict in favor of Scan-Graphics, Inc. in August 1992. The agreement provided that Scorpion Technologies, Inc. was to pay Scan-Graphics, Inc. $2,000. As a result of the settlement, Scorpion paid the Company $1,430 through December 31, 1993, but defaulted in May 1993 on its obligation. As a result of Scorpion's default, in November 1993, the Company received the software product source codes and capitalized such for $695 which represented the remaining balance due from Scorpion. The value of the software was verified by an independent appraiser and was valued at $1,243. In March 1994, Scorpion turned over and the Company took possession of all Scorpion SGS8000 scanner technology which included all tangible and intangible assets.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nOn November 20, 1995, an action was commenced against the Company seeking damages in excess of $117, for alleged fraud and breach of contract. On February 8, 1996, the Company answered the complaint, denying entitlement to recovery of any monies and counter-claiming for breach of contract and fraud. No provision has been made in the accompanying financial statements related to this uncertainty.\nDuring 1995, an action was filed against the Company through the International Arbitration Tribunal in Paris, France, claiming amounts due and damages for the Company's alleged failure to perform its obligations under a March 30, 1990 agreement. The Company has filed an answer to the complaint on February 30, 1996, asserting loss of profits from failure by the Plaintiff to forward sales orders for parts, maintenance and software. No provision has been made in the accompanying financial statements related to this uncertainty.\n12. Related Party The Company leases its principal office and one of its Transactions manufacturing facilities from a corporation which is owned by the chief executive officer of the Company. This operating lease, which continues through August 31, 1997 with an option to renew for an additional two years, provides for the payment of an annual base rental of $96 and excess real estate taxes. Rent expense charged to operations was $96 for each of the years ended December 31, 1995, 1994 and 1993.\nThe Company incurred consulting and commission fees, and out-of-pocket expenses of $73, $390 and $6 for the years ended December 31, 1995, 1994 and 1993, respectively, to a company owned by a director of the Company. Commissions, plus out-of-pocket expenses, were incurred for investment banking type services and other agreed-upon duties provided to the Company.\nThe Company issued 20,000 shares of common stock at $1.5625 per share to a director of the Company in 1992 for services to be rendered over a 24 month period ending August 31, 1994. Consulting expense incurred was $10 and $16 in 1994 and 1993, respectively.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n13. Profit-Sharing A subsidiary of the Company has a qualified profit Plan sharing\/401(k) plan (the Plan) for those employees who meet certain eligibility requirements set forth in the Plan. Employees become eligible to participate in the Plan after one year of service. The Plan does permit voluntary contributions by participants. Contributions to the 401(k) portion of the Plan are matched by the Company equal to 100% of voluntary contributions by individual participants, limited to 3% of the individual participant's annual pay. Annual profit sharing contributions to the Plan are at the discretion of the Board of Directors. Vested benefits are distributed upon death, disability or termination of employment according to the following vested schedule:\nYears of Service Percentage Less than 2 0% 2 20% 3 40% 4 60% 5 80% 6 or more 100%\nThe total amount charged to operations under the plan was $83, $92, and $49 for the years ended December 31, 1995, 1994, and 1993, respectively.\n14. Commitments The Company has employment agreements with certain key and employees which expire at various dates through December Contingencies 1998. The agreements provide for minimum salary levels, plus any additional compensation as directed by the Board of Directors. The commitment for future salaries at December 31, 1995 is $585 for 1996, $525 for 1997 and $285 for 1998.\nIn addition, the Company will be obligated to pay one to two years of annual salary to certain officers of the Company if the Company is acquired or merged and the acquirer chooses to terminate their services. The aggregate potential severance pay at December 31, 1995 was $690.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\nThe Company has entered into a facility lease agreement other than its principal office and equipment leases through May 31, 1999. Rent expense for the years ended December 31, 1995, 1994 and 1993 totalled $75, $62 and $36, respectively. Future minimum lease payments are as follows:\nYear Ending December 31, ------------------------------------------------------------\n1996 $ 60 1997 58 1998 59 1999 24 ------------------------------------------------------------\n$ 201 ------------------------------------------------------------\n15. Leased The Company's leasing operations consist principally of the Equipment leasing of scanning and copying equipment and maintenance agreements. The leases are classified as operating leases. Lease terms range from one to five years. At December 31, 1995 and 1994, machinery and equipment included $301 and $180 of leased equipment, respectively, and accumulated depreciation of $57 and $18, respectively.\nThe following is a schedule of the minimum future rentals on noncancelable operating leases as of December 31, 1995:\nYear ending December 31, ------------------------------------------------------------\n1996 $ 179 1997 125 1998 115 1999 40 ------------------------------------------------------------\n$ 459 ------------------------------------------------------------\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n16. Income Taxes At December 31, 1995, the Company has accumulated, for federal and state income tax purposes, net operating loss carryforwards and federal tax credit carryforwards. These carryforwards are generally available for use by the Company through the indicated expiration dates.\nApproximate Expiration Description Amount Dates (In Thousands) - --------------------------------------------------------------------------------\nNet operating loss carryforwards $ 7,993 1998-2010 Investment tax credit carryforwards 35 1996-2000 Foreign tax credit carryforwards 120 2000 Research credit carryforwards 253 2000-2010\nApproximately $3.7 million of deferred tax assets arising primarily from net operating loss and tax credit carryovers have been offset by a $3.7 million valuation allowance, as there is little likelihood that the asset will result in future tax savings.\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n17. Supplemental Year ended December 31, 1995 1994 1993 Disclosures ------------------------------------------------------------ of Cash Flow Cash paid during the year Information for interest $ 45 $ 32 $ 8\nCash paid during the year for income taxes 10 10 7 Noncash investing and financing activities are as follows: Software capitalized in lieu of payment of notes receivable 695 Declaration of preferred stock cash dividend 158 120 80 Capitalized lease obligations incurred to lease new equipment 17 Net effect of terminated lease obligation by the return of equipment and cancellation of prepaid maintenance contracts 17 Preferred stock Series C issued in lieu of payment of preferred dividends 200 Transfer of inventory to equip- ment in fixed assets 137 180 Transfer of equipment in fixed assets to inventory upon termination of lease 50 Purchase of a vehicle through a note payable 33 Exchange of scanning and copying equipment for software rights 90\nScan-Graphics, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (In Thousands, Except Share and Per Share Amounts) - --------------------------------------------------------------------------------\n18. Subsequent In connection with a $3,100,000 private placement of its Events securities in March 1996, the Company offered for sale 62 units, each of which consisted of a $50,000, 8% convertible note due March 28, 1997, 19,355 \"A\" warrants and 19,355 \"B\" warrants. The notes and any accrued interest are convertible within one year at a price per share equal to the lesser of $3.00 or 65% of the average closing bid price for the five days preceding conversion.\nThe warrants are exercisable immediately and expire in March 1999. The \"A\" warrants are exercisable at $3.00 per share or, if less, the lowest price per share at which any conversion shall have occurred under any of the convertible notes. The \"B\" warrants are exercisable at $4.00 per share. As of March 30, 1996, the Company has received proceeds amounting to $1,995,000. The proceeds will be used for working capital purposes and to fund the requirements of its subsidiary, Sedona GeoServices, Inc.\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Schedule II - Valuation and Qualifying Accounts and Reserves (In Thousands) - --------------------------------------------------------------------------------\n(A) Accounts receivable written-off.\nScan-Graphics, Inc. and Subsidiaries\nConsolidated Schedule II - Valuation and Qualifying Accounts and Reserves (In Thousands) - --------------------------------------------------------------------------------\n(A) Accounts receivable written-off.","section_15":""}
{"filename":"812906_1995.txt","cik":"812906","year":"1995","section_1":"ITEM 1: BUSINESS\nHancock Fabrics, Inc., a Delaware corporation (\"Hancock\"), was incorporated in 1987 and succeeded to the retail and wholesale fabric business of Hancock Textile Co., Inc., a Mississippi corporation and a wholly owned subsidiary of Lucky Stores, Inc., a Delaware corporation (\"Lucky\").\nFounded in 1957, Hancock operated as a private Company until 1972 when it was acquired by Lucky. Hancock became a publicly owned company as a result of the distribution of the shares of its common stock to the shareholders of Lucky on May 4, 1987.\nHancock and its subsidiary are engaged in the retail and wholesale fabric business, selling fabrics, crafts and related accessories to the home sewing and home decorating market and at wholesale to independent retailers. Hancock is one of the largest fabric retailers in the United States. At January 29, 1995, Hancock operated 500 fabric stores in 33 states under the names \"Hancock Fabrics,\" \"Minnesota Fabrics,\" \"Fabric Warehouse\" and \"Fabric Market.\" As a wholesaler of fabrics and related items, Hancock sells to independent retail fabric stores through its wholesale distribution facility in Tupelo, Mississippi.\nOPERATIONS\nHancock offers a wide selection of apparel fabrics, notions (which include sewing aids and accessories such as zippers, buttons, threads and ornamentation), patterns, quilting materials and supplies, home decorating products (which include drapery and upholstery fabrics), craft items and related supplies. Each of Hancock's retail stores maintains an inventory that includes cotton, woolen and synthetic staple fabrics such as broadcloth, poplin, gaberdine, unbleached muslin and corduroy, as well as seasonal and current fashion fabrics.\nHancock's stores are primarily located in neighborhood shopping centers. Hancock opened 23 and 18 net stores in 1992 and 1993, respectively. Hancock did not have an increase in the total number of stores during 1994 and no change in the net number of units is planned for 1995.\nAs a wholesaler, Hancock sells to almost 200 independent retailers in locations in which Hancock has elected not to open its own stores. These wholesale customers accounted for less than 5% of Hancock's total sales for the fiscal year ended January 29, 1995.\nMARKETING\nHancock principally serves the home sewing and home decorating markets, which largely consists of value conscious women who make clothing for their families and decorations for their homes or who\nhire professional home seamstresses to sew for them. Quilters, crafters and hobbyists also comprise a growing base of customers, as do consumers of bridal, party, prom and special occasion merchandise.\nHancock offers its customers a wide selection of products at prices that it believes are generally lower than the prices charged by its competitors. In addition to staple fabrics and notions for clothing and home decoration, Hancock provides a variety of seasonal and current fashion apparel merchandise.\nHancock uses aggressive promotional advertising, primarily through newspapers, direct mail and television, to reach its target customers. Hancock mails eight to ten direct mail promotions each year to approximately two million households, including the \"Directions\" magazine which contains discount coupons, sewing instructions and fashion ideas as well as product advertisements.\nDuring 1994, Hancock entered into an agreement with the Home and Garden Television Network to sponsor a weekly sewing show called \"Sew Perfect(TM).\" The program, which will reach almost 10 million U.S. households, is designed for the beginning and intermediate skilled seamstress.\nDISTRIBUTION AND SUPPLY\nHancock's retail stores and its wholesale customers are served by Hancock's 525,000 square foot warehouse, distribution and office facility in Tupelo, Mississippi. Hancock believes this facility is adequate for the near term and has no expansion plans for 1995.\nContract trucking firms, common carriers and parcel delivery are used to deliver merchandise to Hancock's retail stores and to its wholesale customers. A substantial portion of the deliveries to Hancock's stores and wholesale customers are made directly by vendors.\nBulk quantities of fabric are purchased from mills, fabric jobbers and importers. Hancock has no long-term contracts for the purchase of merchandise and did not purchase more than 5% of its merchandise from any one supplier during the fiscal year ended January 29, 1995. Hancock has experienced no difficulty in maintaining satisfactory sources of supply.\nCOMPETITION\nHancock is among the largest fabric retailers in the United States. The retail fabric business has become increasingly competitive due to excess capacity in many geographical markets resulting from the entry and expansion of other major fabric retailers. Hancock principally competes with other national and regional fabric store chains on the basis of price, selection, quality, service and location.\nHancock's competition has changed significantly with two major competitors in bankruptcy and two large competitors consolidating with other fabric chains. In the past year, over 300 full size stores have closed and liquidated.\nSEASONALITY\nHancock's business is slightly seasonal. Peak sales periods occur during the fall and pre-Easter weeks, while the lowest sales periods occur during pre-Christmas and mid-summer.\nEMPLOYEES\nAt January 29, 1995, Hancock employed approximately 7,100 people on a full-time and part-time basis, approximately 6,750 of whom work in the Company's retail stores. The remainder work in the Tupelo warehouse, distribution and office facility. Currently, thirty-six (36) of Hancock's employees are covered by a collective bargaining agreement.\nGOVERNMENT REGULATION\nHancock is subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime and other working conditions. A significant number of Hancock's employees are paid at rates related to federal and state minimum wages and, accordingly, increases in minimum wages affect Hancock's labor cost.\nLegislation under the Americans With Disabilities Act requiring, among other things, that \"reasonable accommodation\" to the Company's facilities be afforded to employees and to the general public has resulted in additional costs to Hancock under the revised guidelines. Additionally, legislation providing for family leave to employees has resulted in higher costs to the Company in labor, unemployment and health insurance, and reduced productivity due to replacement hiring constraints while employees are on family leave.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nHancock's 500 retail stores are located principally in neighborhood shopping centers. Most of Hancock's retail stores range in size from 9,000 to 12,000 square feet. Hancock's sixty-three (63) \"Fabric Warehouse\" stores range in size from 10,300 to 30,000 square feet. Hancock's six (6) \"Fabric Market\" stores average 12,600 square feet.\nWith the exception of five (5) locations, Hancock's retail stores are leased. The original lease terms generally range from 10 to 20 years and most leases contain one or more renewal options, usually of five years in length. At January 29, 1995, the remaining terms of the leases for stores in operation, including renewal options, averaged approximately 13 years. During 1995, 39 store leases will\nexpire. Hancock is currently negotiating renewals on certain of these leases.\nHancock's 525,000 square foot warehouse, distribution and office facility in Tupelo, Mississippi is owned by Hancock and is not subject to any mortgage or similar encumbrance. Hancock also owns approximately 40 acres of land adjacent to its Tupelo facility, providing room for future expansion.\nReference is made to the information contained in Note 5 to the Consolidated Financial Statements included in the accompanying Hancock Fabrics, Inc. 1994 Annual Report to Shareholders (Exhibit 13 hereto) for information concerning Hancock's long-term obligations under leases.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nHancock is not a party to, nor is any of its properties the subject of, any material pending legal proceedings, other than ordinary and routine litigation incidental to its business.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nExecutive Officers of Registrant\nThe term of each of the officers expires June 8, 1995.\nThere are no family relationships among the executive officers.\nThere are no arrangements or understandings pursuant to which any person was selected as an officer.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nHancock's common stock and the associated common stock purchase rights are listed on the New York Stock Exchange and trade under the symbol HKF. The following table sets forth the high and low sales price for Hancock's common stock as reported in \"New York Stock Exchange - Composite Transactions\" and the dividends paid per share for Hancock's common stock:\nAs of April 13, 1995, there were 12,283 holders of record of Hancock's common stock. Holders of shares of common stock are entitled to dividends when, as and if declared by the Board of Directors out of funds legally available therefor (subject to the prior payment of cumulative dividends on any outstanding shares of preferred stock, of which none are outstanding).\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nThe selected financial data for the five years ended January 29, 1995, which appears on page 9, of the Hancock Fabrics, Inc. 1994 Annual Report to Shareholders, is incorporated by reference in this Annual Report on Form 10-K.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe management's discussion and analysis of financial condition and results of operations appearing on pages 10 to 11 of the Hancock Fabrics, Inc. 1994 Annual Report to Shareholders is incorporated by reference in this Annual Report on Form 10-K.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements, together with the report thereon of Price Waterhouse LLP dated March 3, 1995, appearing on pages 12 to 21 of the Hancock Fabrics, Inc. 1994 Annual Report to Shareholders are incorporated by reference 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\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nExcept as noted below, for information with respect to Items 10, 11, 12 and 13, see the Proxy Statement for the Annual Meeting of Shareholders to be held June 8, 1995, to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year, which is incorporated herein by reference.\nThe information concerning \"Executive Officers of the Registrant\" is included in Part I of this Form 10-K in accordance with Instruction 3 of paragraph (b) of Item 401 of Regulation S-K.\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n# Incorporated by reference from the indicated pages of the Hancock Fabrics, Inc. 1994 Annual Report to Shareholders.\n(3) Those exhibits required to be filed as Exhibits to this Annual Report on Form 10-K pursuant to Item 601 of Regulation S-K are as follows:\nExhibit No. 3.1**** Certificate of Incorporation of Registrant. 3.2*** By-laws of Registrant. 4.1**** Certificate of Incorporation of Registrant. 4.2*** By-laws of Registrant. 4.3*** Rights Agreement between Registrant and C & S\/Sovran Trust Company (Georgia), N.A., as amended March 14, 1991 and restated as of April 2, 1991.\n4.4****** Amendment to Rights Agreement between Registrant and NationsBank of Georgia, N.A. (formerly C & S\/Sovran Trust Company (Georgia), N.A.) dated June 25, 1992. 4.5****** Agreement between Registrant and Continental Stock Transfer & Trust Company (as Rights Agent) dated as of July 16, 1992. 4.6**** Note Purchase Agreement between Registrant and Nationwide Life Insurance Company, West Coast Life Insurance Company, Financial Horizons Insurance Company, Farmland Life Insurance Company and Wisconsin Health Care Liability Insurance Plan (\"Note Purchase Agreement\") dated as of January 15, 1992. 4.7****** Amendment to Note Purchase Agreement dated as of November 4, 1992. 4.8******* Credit Agreement among Registrant and NationsBank of Georgia, National Association, as Agent and Lenders as Signatories Hereto (\"Credit Agreement\") dated as of September 20, 1993. 10.1**** Swap Transaction between Registrant and Continental Bank N.A. dated November 1, 1991. 10.2**** Note Purchase Agreement dated as of January 15, 1992. 10.3****** Amendment to Note Purchase Agreement dated as of November 4, 1992. 10.4******* Credit Agreement dated as of September 20, 1993. 10.5****** +Form of Indemnification Agreements dated March 23, 1987 between Registrant and each of Don L. Fruge, Morris O. Jarvis, Ivan Owen and Donna L. Weaver. 10.6 +Indemnification Agreement between Registrant and R. Randolph Devening dated as of March 9, 1995. 10.7****** +Form of Indemnification Agreements dated March 23, 1987 between Registrant and each of Dean W. Abraham, Jack W. Busby, Jr., David H. Jensen, Larry G. Kirk, Billy M. Morgan, William D. Smothers, Charles R. Warren and Carl W. Zander. 10.8** Indemnification Agreement between Registrant and James A. Gilmore dated as of March 2, 1989. 10.9**** Indemnification Agreement between Registrant and James A. Nolting dated as of December 12, 1991. 10.10****** Indemnification Agreement between Registrant and David A. Lancaster dated as of March 10, 1993.\n10.11******* Indemnification Agreement between Registrant and Bradley A. Berg dated as of March 10, 1994. 10.12 Indemnification Agreement between Registrant and Larry D. Fair dated as of June 9, 1994. 10.13****** +Agreement between Registrant and Morris O. Jarvis dated as of May 3, 1987. 10.14* +Amendment to Severance Agreement and to Deferred Compensation Agreement between Registrant and Morris O. Jarvis dated as of June 9, 1988. 10.15* +Agreement to Secure Certain Contingent Payments between Registrant and Morris O. Jarvis dated as of June 9, 1988. 10.16** +Amendment and Renewal of Severance Agreement and Amendment of Other Related Agreements between Registrant and Morris O. Jarvis dated as of March 8, 1990. 10.17*** +Agreement between Registrant and Jack W. Busby, Jr. dated as of June 9, 1988. 10.18*** +Agreement to Secure Certain Contingent Payments between Registrant and Jack W. Busby, Jr. dated as of June 9, 1988. 10.19** +Agreement between Registrant and Larry G. Kirk dated as of June 9, 1988. 10.20** +Agreement to Secure Certain Contingent Payments between Registrant and Larry G. Kirk dated as of June 9, 1988. 10.21*** +Form of Amendments and Renewals of Severance Agreement and Amendments of Other Related Agreements between Registrant and each of Jack W. Busby, Jr. and Larry G. Kirk dated as of March 8, 1990. 10.22****** +Amendment, Extension and Restatement of Severance Agreement between Registrant and Morris O. Jarvis dated as of March 10, 1993. 10.23****** +Form of Amendment, Extension and Restatement of Severance Agreements dated as of March 10, 1993 between Registrant and each of Jack W. Busby, Jr. and Larry G. Kirk. 10.24 +Supplemental Retirement Plan, as amended. 10.25***** +1987 Stock Option Plan, as amended. 10.26**** +Extra Compensation Plan. 10.27** +1989 Restricted Stock Plan. 10.28***** +1991 Stock Compensation Plan for Nonemployee Directors. 11 Computation of Earnings Per Share. 13 Portions of the Hancock Fabrics, Inc. 1994 Annual Report to Shareholders (for the fiscal year ended January 29, 1995) incorporated by reference in this filing. 21 Subsidiaries of the Registrant. 23 Consent of Price Waterhouse LLP.\n_____________________\n* Incorporated by reference from Registrant's Form 10-K dated April 26, 1989 as filed with the Securities and Exchange Commission.\n** Incorporated by reference from Registrant's Form 10-K dated April 26, 1990 as filed with the Securities and Exchange Commission.\n*** Incorporated by reference from Registrant's Form 10-K dated April 26, 1991 as filed with the Securities and Exchange Commission.\n**** Incorporated by reference from Registrant's Form 10-K dated April 27, 1992 as filed with the Securities and Exchange Commission.\n***** Incorporated by reference from Registrant's Form 10-Q dated June 12, 1992 as filed with the Securities and Exchange Commission.\n****** Incorporated by reference from Registrant's Form 10-K dated April 26, 1993 as filed with the Securities and Exchange Commission.\n******* Incorporated by reference from Registrant's Form 10-K dated April 27, 1994 as filed with the Securities and Exchange Commission.\n+ Denotes management contract or compensatory plan or arrangement.\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.\nShareholders may obtain copies of any of these exhibits by writing to the Secretary at the executive offices of the Company. Please include payment in the amount of $1.00 for each document, plus $.25 for each page ordered, to cover copying, handling and mailing charges.\nUNDERTAKING IN CONNECTION WITH REGISTRATION STATEMENTS ON FORM S-8\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 \"Act\"), the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 33-17215 (filed September 15, 1987) and 33-29138 (filed June 12, 1989).\nInsofar as indemnification for liabilities arising under the Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 512(h) of Regulation S-K, 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, ON THIS 24TH DAY OF APRIL, 1995.\nHANCOCK FABRICS, INC.\nBY \/s\/ Morris O. Jarvis ------------------------------- Morris O. Jarvis Chairman of the Board and Chief Executive Officer\nBY \/s\/ Larry G. Kirk ------------------------------- Larry G. Kirk President and Chief Financial Officer (Principal Financial and Accounting Officer)\nPURSUANT TO THE REQUIREMENT 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 THIS 24TH DAY OF APRIL, 1995.","section_15":""}
{"filename":"803509_1995.txt","cik":"803509","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF BUSINESS AND ORGANIZATIONAL STRUCTURE\nMarkel Corporation (\"the Company\") evolved from a small mutual insurance company founded in the 1920's. The Company was incorporated in Virginia in 1930, reorganized as a holding company in 1980 and had its initial public offering in December 1986.\nThe Company is primarily an underwriter of specialty insurance products and programs. The Company focuses on specialty products and programs which serve particular market niches. This focus allows the Company to develop expertise which brings added value to its customers. In this way, the Company enhances its market recognition and is able to compete in its chosen markets on a basis other than price.\nThe Company is organized into four primary business units -- professional and products liability, excess and surplus lines, specialty programs and specialty personal and commercial lines. These products are offered through the Company's four insurance subsidiaries. Evanston Insurance Company (\"EIC\") offers professional and products liability coverages. Essex Insurance Company (\"Essex\") offers excess and surplus lines property and casualty coverages. Markel Insurance Company (\"MIC\") offers specialty program and specialty personal lines coverages. Markel American Insurance Company (\"MAIC\") offers specialty personal and commercial lines coverages.\nOn May 30, 1995 the Company acquired all of the issued and outstanding stock of Lincoln Insurance Company (\"LIC\") and certain other assets for total consideration of approximately $24.3 million. Some of LIC's business has been renewed in Essex and LIC is being reorganized. LIC is not currently writing new or renewal business.\nThe Company's underwriting management and brokerage operations include Shand Morahan and Co., Inc. (\"SMCO\"), Underwriting Management, Inc., (\"UMI\"), American Underwriting Managers Agency, Inc. (\"AUM\") and Markel Service, Inc. (\"MSI\"). SMCO, UMI, AUM, and MSI develop and market insurance products primarily for the four business units described above. MSI maintains retail and wholesale brokerage operations which produce business for the Company and provide assistance and expertise in marketing and new product development.\nEssex and EIC offer coverages in the excess and surplus lines market. The surplus lines market is for hard to place risks and risks that admitted insurers specifically refuse to write. Premium levels are typically higher for excess and surplus lines coverages than for standard coverages because of the lack of availability of coverage through admitted companies. State insurance authorities allow excess and surplus lines companies greater rate and policy form\nflexibility than admitted companies. As a result, the Company is generally free to set policy premiums and coverage terms by applying its own judgement after consideration of the risks involved. Surplus lines companies are required to be admitted in at least one state, usually their state of domicile. Essex is admitted in Delaware and is eligible to write excess and surplus lines insurance in 49 states and the District of Columbia. EIC is admitted in Illinois and is eligible to write excess and surplus lines insurance in 48 states and the District of Columbia.\nMAIC and MIC operate as admitted carriers and consequently the Company has been able to expand its insurance underwriting operations by insuring certain risks which Essex and EIC, as non-admitted companies, are unable to insure. An admitted or licensed insurer is required to follow a state insurance department's rule, rate and form filing requirements, to pay premium taxes, and to join various state associations, such as guaranty funds. MAIC is licensed to write property and casualty risks in 38 states (including the domicile state of Virginia) and the District of Columbia and is in the process of applying for licenses in other states. MAIC is eligible to write excess and surplus lines insurance in Illinois. MIC is licensed to write insurance in 50 states (including the domicile state of Illinois) and the District of Columbia.\nIn a \"hard\" market characterized by constrained capacity, rising rates and stricter underwriting criteria and policy terms, excess and surplus lines insurers may benefit from their ability to increase their rates more quickly than admitted insurers. In a \"soft\" market, excess and surplus lines companies may be unable to underwrite certain products due to increased competition from admitted insurers, which may result in lower rates and less stringent underwriting criteria. The Company believes its focus on specialty products and programs mitigates, to some extent, the impact of effects of the cycle of \"soft\" and \"hard\" insurance markets.\nInsurance coverages for which losses can be determined and settled in relatively short periods of time are referred to as \"short-tail\" lines of business, while insurance coverages which require extended periods of time between the occurrence of a loss and the final disposition of a claim are referred to as \"long-tail\" lines of business. Exposure to external variables, such as inflationary trends or adverse trends in the average cost of settlements, may be greater for \"long- tail\" lines than for \"short-tail\" lines because loss reserves are held open for a longer period of time. The Company's property and casualty, specialty program insurance and specialty personal and commercial lines tend to be \"short-tail\", while its professional and products liability lines tend to be \"long-tail\". The Company considers the higher variability associated with the professional and products liability business relative to its other lines of business in its estimation of reserves for losses and loss adjustment expenses.\nSPECIALTY INSURANCE PRODUCTS\nThe Company's specialty insurance products offer coverages designed to meet the needs of policyholders in various market niches. The Company's products and programs are unique because they are generally designed to meet the needs of insureds in niche or emerging markets or they are designed for insureds with specialized exposures or risks that are not adequately served by the standard markets.\nIn order to avoid the risks of this business as perceived by the standard markets, the Company must have extensive knowledge and expertise in the specialty areas being marketed and underwritten, which range from medical malpractice and specified medical professions liability insurance to property and liability insurance for campgrounds, exercise clubs or vacant properties. Each risk is considered on an individual basis, and limit restrictions, large deductibles, exclusions and\/or surcharges are employed in order to respond to distinctive risk characteristics. The Company may also arrange the insurance for specialized businesses, such as campgrounds or exercise clubs, on a \"program\" basis, which addresses all or most of the property and liability coverage requirements of the insureds.\nIn most of its lines of business, the Company acts as an underwriter, retaining both the risk and related insurance premiums. Specialization allows the Company to bring value to the customer in the form of the particular knowledge and experience of its professional personnel. This specialization also provides a basis for competition other than price and is the manner in which the Company seeks to attain market leadership and achieve superior profitability. The Company evaluates market leadership separately for each of its insurance products and measures market leadership based on external considerations. A product line exhibiting characteristics of market leadership might include underwriting profitability consistently better than the industry average, the fulfillment of a specific need for an identifiable and accessible group of customers, or the delivery of excellent customer service. Management emphasizes quality service in all phases of its operations and believes that this approach has enabled it to maintain strong relationships with its producers.\nThe Company underwrites professional liability, errors and omissions, directors and officers and products liability insurance, primarily through EIC. Target markets for the Company's professional liability products include architects and engineers, insurance companies, insurance agents and brokers, lawyers, physicians, surgeons, dentists and other medical professionals. The Company also underwrites products liability insurance for manufacturers and distributors on a selected basis and other specialty property and casualty coverages, including mutual fund management and other specified professions errors and omissions. In 1995 professional and products liability gross premiums written totalled $127.2 million.\nIn 1995 the Company underwrote approximately $104.8 million in excess and surplus property\/casualty gross premiums through Essex. Property coverages consist principally of fire and allied lines and to a lesser degree, burglary and theft on small commercial buildings such as restaurants, bowling alleys and vacant buildings. Essex also underwrites specialized property coverages, including earthquake, primarily to multi-location, multi-state commercial accounts. Liability coverages encompass premises and business activities for which standard insurance is not available, such as bars and taverns (excluding liquor liability coverages), restaurants, vacant properties and special events. Inland marine coverages are provided primarily for collision and motor truck cargo.\nThrough MIC, the Company underwrites specialty program insurance which seeks to meet all of the needs of clients in unique or specialized businesses or with difficult risks. Coverages offered relate primarily to agribusiness, youth and recreation, and health and fitness organizations. MIC also provides accident and health insurance to colleges.\nThe agribusiness program provides complete property and casualty coverages, including animal mortality, for any size private farm and for commercial equine operations such as stables and race tracks. The Company markets coverages to horse and farm owners directly and through retail and wholesale insurance agents across the country.\nThe youth and recreation program includes camp coverages designed to meet the requirements of the particular facility and may include general liability, property, workers' compensation, umbrella, auto and inland marine insurance. The Company's staff has knowledge of and experience with unique camp exposures such as horseback riding, water sports and other camping activities. The product line also includes package programs for white water rafting operations. Gross premiums written on these coverages have historically been seasonal, peaking during the summer months.\nThe Company markets insurance products to health clubs, martial arts schools, gymnastic schools, dance and fitness studios and similar operations. Coverages include property, liability and auto.\nIn 1995 gross premium volume from specialty program insurance totalled $102.3 million.\nMAIC underwrites specialty personal and commercial lines insurance. Products offered include property and liability coverages for watercraft, motorcycles, automobiles, mobile homes, dwellings, and commercial freight operations. In 1995 gross premium volume from specialty personal and commercial lines was $44.5 million.\nThe Company's brokerage and underwriting management operations, MSI, SMCO, AUM and UMI, develop insurance products, evaluate insurance applications, establish applicable premiums and terms of coverage, collect premiums, place reinsurance and process claims for the Company's insurance company subsidiaries. These operations also broker a small amount of business for unaffiliated companies.\nDepending on the insurance product offered and the market involved, the Company may market its products through its own sales representatives, other wholesale and retail brokers, or direct to its customers. These producers provide specialized knowledge of particular products, markets and customers and enable the Company to capitalize on underwriting opportunities. The Company seeks to be a substantial underwriter for its producers in order to enhance the likelihood of receiving the most desirable underwriting opportunities. The Company pays brokers and agents commissions based on the amount of premiums and types of business underwritten. The Company accepts business from insurance brokers and general agents nationwide.\nIn 1995 the Company's total gross premium volume was approximately $402.1 million. The Company's largest program accounted for less than 12% of this total. The risk of geographic concentration is generally higher for property exposures than for liability exposures. In 1995, 40% of the Company's earned premiums (32% of gross premiums) were from professional and products liability business. The Company believes its exposure to the risk of geographic concentration is not material because the diversity of its coverages and product lines effectively disperse this risk. In addition, where geographic concentration occurs (for example, earthquake coverage), management seeks to reduce exposure to any one event by use of effective reinsurance programs and through use of exposure analyses generated with catastrophe modeling software.\nFor additional information about premium volume and underwriting results, refer to Management's Discussion and Analysis of Financial Condition and Result of Operations on pages 41 through 52 of the Company's 1995 Annual Report to Shareholders filed as an exhibit to this report on Form 10-K. This information is incorporated by reference into this report on Form 10- K.\nCLAIMS AND RESERVES\nThe table on page 46 of the 1995 Annual Report to Shareholders shows the development of balance sheet reserves for the Company for a ten year period. Note 8 to the Consolidated Financial Statements of Markel Corporation (the \"Consolidated Financial Statements\") on page 32 of the Company's 1995 Annual Report to Shareholders sets forth a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the Company for 1995, 1994 and 1993. This information is incorporated by reference into this report on Form 10-K.\nREINSURANCE CEDED\nThe Company enters into reinsurance agreements in order to reduce its liability on individual risks and enable it to underwrite policies with higher limits. In a reinsurance transaction, an insurance company transfers, or \"cedes\", all or part of its exposure in return for a portion of the premium. The ceding of insurance does not legally discharge the ceding company from its primary liability for the full amount of the policies, and the ceding company is required to pay losses if the reinsurer fails to meet its obligations under the reinsurance agreement.\nThe Company's treaties are generally subject to cancellation by the reinsurers or the Company on the anniversary date upon 90 days prior written notice and are subject to renegotiation annually. The reinsurer remains responsible for all business produced prior to termination. The treaties also typically contain provisions concerning ceding commissions, required reports to the reinsurers, responsibility for taxes, arbitration in the event of a dispute, and provisions allowing the Company to demand that a reinsurer post letters of credit or assets as security if a reinsurer is or becomes an \"unauthorized\" or \"unapproved\" reinsurer under applicable state laws and regulations.\nBecause the Company retains a substantial portion of gross premiums produced by its subsidiaries, the continued availability of reinsurance is not considered material to the Company's consolidated operations. The Company's use of several reinsurers further limits its reliance on any individual reinsurer.\nAt December 31, 1995, only one reinsurer, TIG Reinsurance Company, had paid and unpaid claim recoverables which exceeded 10% of the Company's consolidated shareholders' equity at that date. The recoverable from TIG at December 31, 1995 was $24.7 million. TIG has received claims paying ability ratings from A.M. Best Co., Inc. (see \"Ratings\" below) and S&P of \"A\" and \"AA-\" respectively.\nAt December 31, 1995, the Company's total paid and unpaid reinsurance recoverable balance was $179.5 million. For additional information about reinsurance see Note 12 to the Consolidated Financial Statements included on page 36 of the Company's 1995 Annual Report to Shareholders. This information is incorporated by reference into this report on Form 10-K.\nStandard & Poor's (\"S&P\") claims paying ability ratings are assigned at the request of insurers, and are based on extensive quantitative and qualitative analysis. Ratings from AAA to BBB- are within S&P's secure range. Within the secure range, AAA category ratings indicate superior financial security, AA category ratings indicate excellent financial security and A category ratings indicate good financial security. Plus (+) or minus (-) signs show relative standing within a category.\nIn recent years, the Company has pursued the settlement of older claims in as aggressive a manner as reasonably possible. These actions may from time to time prompt some reinsurers to dispute claim payment requests or provisions in the reinsurance contract. The Company believes that these types of disputes are without merit, and expects to continue its claims closing efforts in order to reduce both reserve and reinsurance risks. Further, the Company plans to continue to commute paid and unpaid reinsurance recoverables when possible in order to reduce collection risks.\nRATINGS\nA.M. Best Company (\"Best\") publishes Best's Insurance Reports, Property-Casualty, and assigns ratings to property and casualty insurance companies based on quantitative criteria, such as profitability, leverage and liquidity as well as qualitative assessments, such as the spread of risk, the adequacy and soundness of reinsurance, the quality and estimated market value of assets, the adequacy of loss reserves and surplus and the competence, experience and integrity of management. Best's letter ratings range from A++ (Superior) to F (In Liquidation).\nBest has currently assigned an A (Excellent) rating to Essex. EIC has been assigned an A (Excellent) rating and MAIC, based on its participation in an intercompany pooling arrangement with EIC, is also rated A (Excellent). MIC is rated A- (Excellent).\nDuff & Phelps' Credit Rating Co. (\"Duff & Phelps\") and S&P's Insurance Rating Services each provide purchasers of insurance policies and contracts with analytical and statistical information on the solvency and liquidity of major U.S. licensed insurance companies. They also rate companies based on their ability to meet policyholder obligations. The claims paying ability (CPA) ratings are based on the same scale as the Duff & Phelps and S&P bond and preferred stock ratings. However, reflecting the difference between an insurance company's ability to meet its claim obligations and an obligation to service debt, the insurance company CPA rating scale utilizes different definitions of safety. The Duff & Phelps CPA rating categories range from AAA (risk factors are negligible) to DD (under order of liquidation). The S&P CPA ratings range from AAA (superior financial security) to R (Regulatory action). Both the S&P and Duff & Phelps CPA ratings concern only the likelihood of timely payment of policyholder obligations and are not intended to refer to the ability of either the rated company, or its parent, affiliate or subsidiary to pay nonpolicy obligations such as debt or commercial paper.\nDuff & Phelps has currently assigned a rating of A+ (High Claims Paying Ability) to EIC, Essex, MIC and MAIC.\nS&P has currently assigned a rating of A (Good Financial Security) to EIC, Essex, MIC and MAIC.\nRatings from Best, Duff & Phelps and S&P are based upon factors of concern to policyholders, agents and brokers and are not directed toward the protection of investors. These ratings are subject to change or withdrawal at the discretion of the rating agencies.\nINVESTMENTS\nThe Company and its subsidiaries invest their funds in equity and debt securities with the objectives of preserving capital, maintaining liquidity and generating income. Approximately 29% of the Company's cash and investments at December 31, 1995 were managed by Hamblin Watsa Investment Counsel Ltd., a Canadian investment management firm which is controlled by V. Prem Watsa, a director of the Company. Approximately 4% is managed by other independent portfolio managers. The balance of the portfolio is managed by officers of the Company, with the approval of the boards of directors of the insurance companies. The investments of the Company's insurance company subsidiaries are regulated by the insurance laws of their respective states of domicile. These laws limit the nature of permitted investments and the amount which may be invested in a particular category of investment or in a single issue or issuer.\nThe Company has established an Investment Committee composed of key members of management to monitor investment performance, make basic asset allocation decisions, evaluate and direct the activities of outside investment advisors and review compliance with regulatory requirements. The Company's Board of Directors provides oversight of the Investment Committee, however, the Board of Directors of each of the Company's insurance company subsidiaries reviews and approves all investment transactions on a quarterly basis.\nThe Company's investment philosophy generally provides that policyholder funds are invested predominately in high quality corporate, government and municipal bonds. Shareholder funds and retained earnings are primarily invested in growth securities such as common stocks. The Company's fixed maturity portfolio has an average rating of AA, with over 90% rated A or better by at least one nationally recognized rating organization. The following table shows the make-up of the Company's fixed maturity portfolio, at estimated fair value, by rating category at December 31, 1995 (in thousands).\nEst. Fair Value Rating December 31, 1995 ------ ----------------- AAA\/AA $ 392,808 A 242,907 BBB 61,223 BB\/B 4,387 C\/D\/UNRATED 4,730 --------- Total $ 706,055 =========\nS&P and Moody's Investors Service provide corporate and municipal debt ratings based on assessments of the credit worthiness of an obligor with respect to a specific obligation. These debt ratings range from \"AAA\" (capacity to pay interest and repay principal is extremely strong) to D (debt is in payment default). Securities with ratings of \"BBB\" or higher are referred to as \"investment grade\" securities. Debt rated \"BB\" and below is regarded by the rating agencies as having predominately speculative characteristics with respect to capacity to pay interest and repay principal. It is the Company's general policy to minimize its investments in fixed maturity securities that are unrated or rated below investment grade.\nFor further information regarding the Company's investment portfolio, see Note 2 to the Consolidated Financial Statements included on pages 26 and 27 of the Company's 1995 Annual Report to Shareholders. This information is incorporated by reference into this report on Form 10-K.\nCOMPETITION\nThe Company's underwriting operations compete with numerous other insurance companies, many of which are much larger and have significantly greater resources than the Company. Among other things, competition may take the form of lower prices, broader coverages, greater product flexibility, higher quality services or the insurer's rating by independent rating agencies. The Company competes by developing specialty products to satisfy well-defined market needs and by maintaining relationships with brokers and insureds who rely upon the Company's expertise in the market\nsegments it serves. In the excess and surplus lines markets, the Company competes principally on the basis of its expertise in offering and underwriting products that are not readily available. Few barriers exist to prevent property and casualty insurers from entering into the Company's segments of the property and casualty industry, but many of the larger property and casualty insurance companies generally have been unwilling to write specialty coverages. The Company also competes with risk retention groups, insurance buying groups and alternative self-insurance mechanisms. In the highly competitive admitted markets, the Company competes with innovative products, appropriate pricing, expense control and quality service to policyholders and agents.\nREGULATION\nThe Company's insurance company subsidiaries are subject to regulation and supervision by the insurance regulatory authorities of the various jurisdictions in which they conduct business. Such regulation is intended primarily for the benefit of policyholders rather than shareholders. The insurance regulatory authorities have broad regulatory, supervisory and administrative powers. These powers relate primarily to the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the approval of forms and policies used; the nature of, and limitations on, insurers' investments; the issuance of securities by insurers; periodic examinations of the affairs of insurers; the form and content of annual statements and other reports required to be filed on the financial condition of such insurers or for other purposes; and the establishment of reserves required to be maintained for unearned premiums, losses or other purposes.\nThe Company is also subject to state laws regulating insurance holding companies. Under these laws, the respective insurance departments may, at any time, examine the Company, require disclosure of material transactions by the holding company, require prior approval of certain \"extraordinary\" transactions, such as extraordinary dividends from the insurance subsidiary to the holding company, or require approval of changes in control of an insurer or an insurance holding company such as the Company.\nThe Company's subsidiaries which act as admitted insurers are also subject to additional regulation to which the non-admitted insurers are not subject outside their states of domicile. Such regulation of admitted insurers includes restrictions on changes to premium rates charged to insureds and, in certain jurisdictions, may prohibit withdrawing from a line of business and\/or rate increases for certain lines of business at a time when loss experience or other factors would otherwise mandate such changes. In addition, most jurisdictions in the United States require all admitted insurance companies to participate in their respective guaranty funds. Insurers admitted to transact business in such jurisdictions are required to cover losses of insolvent insurers and are generally subject to annual assessments from 1% to 2% of direct premiums written in that jurisdiction to pay the claims of insolvent insurers. Certain jurisdictions also require admitted companies to participate in assigned risk plans for automobile insurance and other specialized liability coverage (for example, natural disasters) for insureds who, for various reasons, cannot otherwise obtain insurance in the open market. The portion of a particular type of coverage that is assigned to a particular insurer is based on the relative amount of that type of coverage that is written by the insurer on a voluntary basis. Each participating insurer assumes the premiums and losses only for the insureds assigned to it. Losses for insurance written under assigned risk plans generally are significantly greater than losses for insurance written in the voluntary market. Thus, participation in mandatory funds and assigned risk plans is likely to be unprofitable.\nIn addition, the Company may be subject to additional regulation by certain jurisdictions in the future, including possible limitations on the ability of the Company's brokerage operations to place business with insurance companies affiliated with the Company.\nThe activities of the Company related to insurance brokerage and agency services are subject to licensing and regulation by the jurisdictions in which it conducts such activities. In addition to regulatory requirements applicable to the Company and its subsidiaries, most jurisdictions require that certain individuals engaging in brokerage and agency activities be personally licensed. As a result, a number of the Company's employees are so licensed. The Company's operations depend on the validity and continuation of its good standing under the licenses and approvals pursuant to which it operates.\nThe laws of the domicile states of the Company's insurance company subsidiaries restrict the amount of dividends which may be paid by such subsidiaries to the Company without prior regulatory approval. Generally, statutes in Delaware, Illinois and Virginia (the domicile states of the Company's insurance company subsidiaries) require prior approval for payment of \"extraordinary\" as opposed to \"ordinary\" dividends. Delaware and Illinois define \"ordinary dividends\" for any twelve month period as the greater of 10% of the prior year's surplus or the prior year's net income. Delaware excludes realized gains in the calculation of prior year's net income. Virginia defines \"ordinary dividends\" for any twelve month period as the lesser of 10% of prior year's surplus or prior year's net income reduced for realized gains. In Virginia, a company may add to net income for purposes of calculating the dividend restriction, the net income less realized gains for the second and third preceding years less dividends paid in those preceding years.\nIn addition to ordinary dividends described above, a company domiciled in Delaware, Illinois and Virginia may make an extraordinary dividend if the respective State Insurance Department approves the dividend within 30 days of the request.\nDifficulties with insurance availability and affordability have increased legislative activity at both the federal and state levels. Some state legislatures and regulatory agencies have enacted measures to limit mid-term cancellations, require advance notice of renewal intentions and limit rates\nwhich may be charged. Congress is investigating possible avenues for federal regulation of the insurance industry. Any of these activities could adversely affect the Company's operations.\nIn addition, the National Association of Insurance Commissioners (NAIC) and insurance regulators are re-examining existing laws and regulations and their application to insurance companies. In particular, this re-examination has focused on insurance company investment and solvency issues and, in some instances, has resulted in new interpretations of existing law, the development of new laws and the implementation of non-statutory guidelines. In connection with its accreditation of states and as part of its program to monitor the solvency of insurance companies, the NAIC requires states to adopt model NAIC laws and regulations on specific topics, such as holding company regulations and the definition of extraordinary dividends and risk-based capital requirements. For additional information about risk-based capital requirements, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations on page 51 of the Company's 1995 Annual Report to Shareholders. This information is incorporated by reference into this report on Form 10-K.\nEMPLOYEES\nAt December 31, 1995, the Company and its consolidated subsidiaries employed 767 persons, of whom four were executive officers. The Company believes that, as a service organization, its continued growth is dependent to a large measure upon its personnel.\nITEM 1A.","section_1A":"ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company and their ages as of January 31, 1996, are as follows:\nName Age Position With the Company ---- --- ------------------------- Alan I. Kirshner 60 Chairman and Chief Executive Officer\nAnthony F. Markel (1) 53 President and Chief Operating Officer\nSteven A. Markel (1) 47 Vice Chairman\nDarrell D. Martin 47 Executive Vice President and Chief Financial Officer - ----------------------------------\n(1) Anthony and Steven Markel are first cousins.\nAlan I. Kirshner has been Chairman of the Board and Chief Executive Officer since 1986. He also served as President from 1979 until March of 1992 and has been a director of the Company since 1978.\nAnthony F. Markel has been President and Chief Operating Officer since March 1992. He served as Executive Vice President from 1979 until March of 1992 and has been a director of the Company since 1978.\nSteven A. Markel has been Vice Chairman since March of 1992. He served as Treasurer from 1986 to August 1993, and Executive Vice President from 1986 to March of 1992. He has been a director of the Company since 1978.\nDarrell D. Martin, a certified public accountant, has been Executive Vice President and Chief Financial Officer of the Company since March 1992. He served as Chief Financial Officer from 1988 to March of 1992 and has been a director of the Company since January 1991.\nITEM 2.","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has entered into long term operating leases with respect to three office buildings in a suburban office park in Richmond, Virginia. The Company leases approximately 216,000 square feet in these buildings of which approximately 156,000 square feet is used by the Company and its subsidiaries. See Note 5 to the Consolidated Financial Statements on page 29 of the 1995 Annual Report to Shareholders for additional information regarding these leases. This information is incorporated by reference into this report on Form 10-K.\nShand\/Evanston currently occupies approximately 65,000 square feet of a 160,000 square foot office building in Evanston, Illinois. This building is owned by Shand\/Evanston.\nAUM also leases and occupies approximately 19,000 square feet in an office building in Pewaukee, Wisconsin.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company's subsidiaries routinely are party to litigation incidental to their business. In the opinion of the Company's management, no individual item of litigation or group of similar items of litigation, taken net of claims reserves established therefore and giving effect to reinsurance, errors and omissions insurance and indemnity agreements, is likely to result in judgments for amounts material to the consolidated financial condition of the Company and its subsidiaries.\nFor additional information required by this item, see the information in Exhibit 13.1 -- Annual Report to Shareholders, under the caption \"Notes to Consolidated Financial Statements-Note 13, \"Contingencies\" on page 37 thereof, which information is incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe aggregate market value of the shares of the registrant's Common Stock held by non-affiliates as of January 31, 1996, shown on the cover page of this report, was calculated by multiplying (i) the closing price of the registrant's Common Stock as reported on the National Association of Securities Dealers Automated Quotation National Market System on January 31, 1996 ($75.88), by (ii) the number of shares of the registrant's Common Stock not held by the directors or officers of the registrant or any person known to the registrant to own more than five percent of the outstanding Common Stock of registrant. Such calculation does not constitute an admission or determination that any such officer, director or holder of more than five percent of the outstanding shares of Common Stock of the registrant is, in fact, an affiliate of the registrant.\nFor additional information required by this item, see the information in Exhibit 13.1 -- Annual Report to Shareholders, under the captions \"Quarterly Information\" and \"Market and Dividend Information\" on pages 40 and 54, respectively, which information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFor the information required by this item, see the information in Exhibit 13.1 -- Annual Report to Shareholders, under the caption \"Selected Financial Data\" and Notes 1 and 16 to the Consolidated Financial Statements on pages 18, 19, 24, 25 and 38, respectively, 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\nFor the information required by this item, see the information in Exhibit 13.1 -- Annual Report to Shareholders, under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 41 through 52 thereof, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements of the registrant and its subsidiaries required to be included in this item are set forth in item 14 of this report and are either incorporated herein by reference to the specified information in Exhibit 13.1 -- Annual Report to Shareholders or set forth herein, in each case as indicated in item 14 of this report.\nFor the supplementary financial information on quarterly results of operations required by item 302 of Regulation S-K, see the information under the caption \"Quarterly Information\" set forth in Exhibit 13.1 -- Annual Report to Shareholders on page 40 thereof, which 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\nFor information required by this item, other than information required by Item 401(b) of Regulation S-K, see the information under \"Election of Directors\" in the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 7, 1996, which information is incorporated herein by reference.\nInformation required by Item 401(b) of Regulation S-K is set forth in Item 1A of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nFor information required by this item, see the information under the caption \"Executive Compensation\" in the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 7, 1996, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nFor information required by this item, see the information under the caption \"Principal Shareholders\" in the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 7, 1996, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information required by this item, see the information under the caption \"Executive Compensation -- Certain Transactions\" and \"Executive Compensation - Compensation Committee Interlocks and Insider Participation\" in the registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 7, 1996, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) DOCUMENTS FILED AS PART OF THE REPORT\n1. FINANCIAL STATEMENTS\nThe following financial statements of Markel Corporation and Subsidiaries are incorporated herein by reference to pages 20 through 39 of Exhibit 13.1 -- 1995 Annual Report to Shareholders:\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Income - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Shareholders' Equity - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\n2. FINANCIAL STATEMENT SCHEDULES\nIncluded herein are the financial statement schedules listed under \"Index to Financial Statement Schedules\" on page 19 of this Report.\n3. EXHIBITS\nIncluded herein or incorporated herein by reference are the exhibits listed under \"Index to Exhibits\" on pages 30 through 32 of this report. Management Contracts and Compensatory Plans or Arrangements required to be filed are listed in Items 10.1 - 10.7 in the \"Index to Exhibits\" on pages 30 through 31 of this report.\n(B) REPORTS ON FORM 8-K\nNo reports on form 8-K were filed during the fourth quarter of 1995.\n(C) See Index to Exhibits and Item 14(a)(3) of this Report.\n(D) See \"Index to Financial Statements and Schedules\" and Item 14(a)(1) of this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMARKEL CORPORATION\nBy: \/s\/ STEVEN A. MARKEL ----------------------- Steven A. Markel Vice Chairman 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.\nSignature Capacity Date\n\/s\/ ALAN I. KIRSHNER Chief Executive Officer and March 22, 1996 - --------------------- Chairman of the Board of Directors Alan I. Kirshner\n\/s\/ ANTHONY F. MARKEL President, Chief Operating Officer March 22, 1996 - --------------------- and Director Anthony F. Markel\n\/s\/ STEVEN A. MARKEL Vice Chairman and Director March 22, 1996 - --------------------- Steven A. Markel\n\/s\/ DARRELL D. MARTIN Executive Vice President, March 22, 1996 - --------------------- Chief Financial Officer and Director Darrell D. Martin (Principal Accounting Officer)\n\/s\/ LESLIE A. GRANDIS Director March 22, 1996 - --------------------- Leslie A. Grandis\n\/s\/ STEWART M. KASEN Director March 22, 1996 - --------------------- Stewart M. Kasen\n\/s\/ GARY L. MARKEL Director March 22, 1996 - --------------------- Gary L. Markel\n\/s\/ V. PREM WATSA Director March 22, 1996 - --------------------- V. Prem Watsa\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPage No.\nIndependent Auditors' Report 20\nSchedule I -- Summary of Investments Other Than Investments in Related Parties 21\nSchedule II -- Condensed Financial Information of Registrant 22\nSchedule III -- Supplementary Insurance Information 25\nSchedule IV -- Reinsurance 26\nSchedule V -- Valuation and Qualifying Accounts 27\nSchedule VI -- Supplemental Information Property -Casualty Insurance 28\nSchedules other than those listed above have been omitted since they either are not required or are not applicable, or the information called for is shown in the Consolidated Financial Statements or in the Notes thereto.\nIndependent Auditors' Report\nThe Board of Directors and Shareholders Markel Corporation:\nUnder date of February 7, 1996, we reported on the consolidated balance sheets of Markel Corporation and subsidiaries (the \"Company\") 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, as contained in the Company's 1995 Annual Report to Shareholders. These consolidated financial statements and our independent auditors' report thereon are incorporated by reference in the Company's 1995 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the Company's 1995 annual report on Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nEffective December 31, 1993, the Company changed its method of accounting for investments to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities.\nKPMG Peat Marwick LLP\nRichmond, Virginia February 7, 1996\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES\nDecember 31, 1995 (dollars in thousands)\nMARKEL CORPORATION (PARENT COMPANY)\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nCONDENSED BALANCE SHEET INFORMATION\nDECEMBER 31, 1995 1994 --------- --------- (dollars in thousands) ASSETS Investments in consolidated subsidiaries $ 282,732 $ 192,459 Short-term investments at estimated fair value (estimated fair value approximates cost) 13,740 15,302 Cash and cash equivalents 812 692 Notes receivable due from subsidiary 45,224 41,219 Other assets 12,097 8,854 --------- ---------\nTotal assets $ 354,605 $ 258,526 ========= =========\nLIABILITIES AND SHAREHOLDERS' EQUITY Income taxes: Currently payable $ 173 $ 775 Deferred 8,280 7,548 Long-term debt 106,589 100,536 Other liabilities 26,121 11,166 --------- ---------\nTotal liabilities 141,163 120,025\nShareholders' equity 213,442 138,501 --------- ---------\nTotal liabilities and shareholders' equity $ 354,605 $ 258,526 ========= =========\nMARKEL CORPORATION (PARENT COMPANY)\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nCONDENSED STATEMENT OF INCOME INFORMATION\nMARKEL CORPORATION (PARENT COMPANY)\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nCONDENSED STATEMENT OF CASH FLOWS INFORMATION\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE IV - REINSURANCE\nYears ended December 31, 1995, 1994 and 1993 (dollars in thousands)\n(*) The Company acts as an underwriting manager for its own insurance companies as well as non-affiliated companies. In 1995, 1994 and 1993, substantially all of the premiums assumed from other companies were underwritten by the Company's management subsidiaries.\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - SUPPLEMENTAL INFORMATION PROPERTY-CASUALTY INSURANCE\nMARKEL CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - SUPPLEMENTAL INFORMATION PROPERTY-CASUALTY INSURANCE\n- ------------------------------\n* Incorporated by reference from the exhibit shown in parenthesis filed with the Commission in the Registrant's 1990 Form 10-K Annual Report\n** Incorporated by reference from the exhibit shown in the parenthesis filed with the Commission on May 25, 1989 in the Registrant's Registration Statement on Form S-8 (Registration No. 33-28921)\n*** Incorporated by reference from the exhibit shown in parenthesis filed with the Commission in the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on May 15, 1989, as filed with the Commission\n**** Incorporated by reference from the exhibit shown in the parentheses filed with the Commission in the Registrant's 1991 Form 10-K Annual Report\no Incorporated by reference from the exhibit shown in parenthesis filed with the Commission on January 13, 1988 in the Registrant's current report on Form 8-K dated December 29, 1987\no o Incorporated by reference from the exhibit shown in the parenthesis filed with the Commission in the Registrant's 1988 Form 10-K Annual Report\na Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1992 Form 10-K Annual Report\nb Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1993 Form 10-K Annual Report\nc Incorporated by reference from the exhibit shown in parentheses filed with the Commission in the Registrant's 1994 Form 10-K Annual Report\nd Incorporated by reference from the exhibit shown in parentheses filed with the Commission under cover of Form SE dated March 21, 1996","section_15":""}
{"filename":"792979_1995.txt","cik":"792979","year":"1995","section_1":"Item 1. Business\na. General Development of Business\nDiversified Historic Investors III (\"Registrant\") is a limited partnership formed in 1986 under the Pennsylvania Uniform Limited Partnership Act. As of December 31, 1995, Registrant had outstanding 13,981.5 units of limited partnership interest (the \"Units\").\nRegistrant is presently in its operating stage. It originally owned five properties or interests therein. One property has been lost through foreclosure. See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of the date hereof, Registrant owned four properties, or interests therein. A summary description of each property held at December 31, 1995 is given below.\na. Lincoln Court - consists of 58 apartment units in three buildings located at 5351 Overbrook Avenue in Philadelphia, Pennsylvania. In March 1987, the Registrant acquired the buildings and is the 100% equity owner of this property. Registrant acquired and rehabilitated the Property for $3,417,640 ($64 per sf) (such amount is exclusive of $158,985 of capitalized fees incurred, which were funded by Registrant's equity contributions), including mortgage financing of $1,730,000, (total balance due of $2,172,415 at December 31, 1995 including $143,518 of accrued interest) and a note payable of $10,000 (total balance due of $10,000 at December 31, 1995). The first mortgage loan bears interest at prime plus 1.25% with a minimum of 9.5% and a maximum of 14.5%, therefore 9.75% at December 31, 1995 and 1994. The other mortgage loan bears interest at prime plus 1%, therefore 9.5% at December 31, 1995 and 1994. Such mortgage is payable interest only in monthly installments, and was due in 1994. The note payable bears interest at 10% payable interest only on a quarterly basis, principal was due in 1994. In 1988, a $95,000 second mortgage loan (total balance due of $110,538 at December 31, 1995 including $10,260 of accrued interest) was obtained which bears interest at prime plus 1.25%, therefore 9.75% at December 31, 1995 and 1994, and was due in 1994. In 1991, an $100,000 third mortgage loan (total balance due of $119,885 at December 31, 1995 including $12,765 of accrued interest) was made which bears interest at 11%, principal and interest payable monthly, and was due in 1994. Due to decreased cash flow, the Registrant stopped making scheduled debt service payments to the holder of the first, second and third mortgages. Notice of default was received from the lender on November 29, 1993. The Registrant pursued settlement discussions with the lender; however, in December 1994 the mortgage notes were sold. The Registrant entered into an agreement with the new holder of the mortgages whereby the maturities of the notes were extended to 1999 and monthly payments of interest are to be made to the new note holder in an amount equal to net operating income, with a minimum of $7,000 per month, increasing to $9,000 per month in January 1996 and to $11,000 per month in January 1997. The property is managed by BCMI. As of December 31, 1995, 53 of 58 residential units were under lease (91%) at monthly rents ranging from $425 to $1,768.\nAll leases are renewable, one-year leases. The occupancy for the previous four years was 58% for 1994, 63% for 1993, 79% for 1992 and 84% for 1991. The monthly rental range has been approximately the same since 1991. For tax purposes, this property has a federal tax basis of $3,618,113 and is depreciated using the straight-line method with a useful life of 27.5 years. The\nannual real estate taxes are $30,226 which is based on assessed value of $365,760 taxed at a rate of $8.264 per $100. No one tenant occupies ten percent or more of the building. It is the opinion of the management of the Registrant that the property is adequately covered by insurance.\nb. The Green Street Apartments - consists of 18 apartment units in three adjoining buildings located at 1826-1828-1830 Green Street in Philadelphia, Pennsylvania. In July 1987, Registrant acquired its interest in this property by purchasing a 99% general partnership interest in 18th & Green Associates General Partnership (\"18th & Green\"), a Pennsylvania general partnership, for $800,000. 18th & Green contracted to acquire and rehabilitate the Property for $1,600,000 ($100 per sf). Additionally, $100,000 of cash\/marketing reserves were provided. The total cost of the project was funded by Registrant's equity contribution and mortgage financing of $900,000 (total balance due of $1,427,998 at December 31, 1995 including $118,196 of accrued interest) which has been added to principal) which bears interest at 12%. During 1990, Registrant defaulted on its mortgage loan and the lender obtained a confession of judgment pursuant to the loan documents. Registrant petitioned the court to open the judgment and negotiated a settlement with the lender. The settlement required the Registrant to make payments toward delinquent interest in December 1990 and April 1991. Registrant did not make the April 1991 payment, however, no notice of default was received from the lender. In 1992, the Resolution Trust Corporation (\"RTC\") took over control of the lender. The Registrant received notice in 1993 that the RTC had sold the loan. The purchaser of the note contacted the Registrant who attempted to negotiate a loan modification. In September 1994, the mortgage note was sold again. The Registrant entered into an agreement with the new holder of the mortgage whereby the note maturity is extended to 1999 and monthly payments of interest are to be made in an amount equal to net operating income, with a minimum of $5,750 per month. The property is managed by BCMI. As of December 31, 1994, 16 apartments were under lease (89%) at monthly rents ranging from $495 to $795.\nAll leases are renewable, one-year leases. The occupancy for the previous four years was 99% for 1994, 98% for 1993, 91% for 1992 and 94% for 1991. The monthly rental range has been approximately the same since 1991. For tax purposes, this property has a federal tax basis of $1,480,897 and is depreciated using the straight-line method with a useful life of 27.5 years. The annual real estate taxes are $15,470 which is based on assessed value of $187,200 taxed at a rate of $8.264 per $100. No one tenant occupies ten percent or more of the building. It is the opinion of the management of the Registrant that the property is adequately covered by insurance.\nc. The Loewy Building - consists of two adjoining buildings located at 505 West Fourth Street in Winston-Salem, North Carolina. The buildings consist of 63,300 sf of commercial space. In November 1986, the Registrant acquired its interest in this Property by purchasing a 99% interest in Triad Properties General Partnership (\"Triad\"), a Pennsylvania general partnership, for a cash contribution of $2,250,000. Triad contracted to acquire and rehabilitate the Property for $5,690,000 ($88 per sf). Additionally, $560,000 of\nworking capital\/marketing reserves were provided. The total cost of the project was funded by Registrant's equity contribution, mortgage financing of $3,560,000 (total balance due of $4,190,591 at December 31, 1995 including $405,691 of accrued interest) and a $500,000 note payable to the Developer (Cwood Properties, Inc., Thomas L. Kummer and Gail R. Citron; all of whom are general partners of Triad). The first mortgage bears interest at 11.5%. Triad obtained $200,000 (total balance due of $265,160 at December 31, 1995 including $65,160 of accrued interest) and interest at prime with a minimum of 6% and a maximum of 8% adjusting annually on January 2, therefore 8% and 6% at December 31, 1995 and 1994, respectively) of additional financing in 1987 to fund cost overruns resulting from delays and changes in rehabilitation and construction plans, and the Registrant advanced an additional $1,098,000. The property is managed by BCMI. As of December 31, 1995, 59,845 sf were rented (95%) at annual rates ranging from $6.00 sf to $12.93 sf.\nThe occupancy for the previous four years has been 93% for 1994, 93% for 1993, 79% for 1992 and 80% for 1991. The range for annual rents has been $6.95 to $14.08 per sf for 1994, $6.95 to $13.41 per sf for 1993, $7.08 to $13.08 per sf for 1992 and $7.08 to $13.44 per sf for 1991. There are three tenants who each occupy ten percent or more of the rentable square footage. They operate principally as a bank, a law firm and a retail store.\nThe following is a table showing commercial lease expirations at Loewy Building for the next five years.\nTotal annual % of gross Number of Total sf of rental covered annual rental Years leases expiring expiring leases by expiring leases from property\n1996 2 21,047 $270,752 37% 1997 2 10,495 127,757 17% 1998 1 1,457 13,113 2% 1999 2 8,100 98,999 13% 2000 1 3,200 45,312 6%\nOne commercial tenant at the building which occupies 15,546 sf has a lease which expired in October 1995. This lease has not been renewed but the tenant is still occupying the space under the terms of the expired lease. The total annual rental covered by this lease is $110,426 which represents 7% of the total gross annual rental. The Registrant is in the process of negotiating a new lease with the tenant which would increase the annual rental rate by 30% and extend the lease for at least three years. There are two commercial leases which expire in 1996. The first lease is for 200 sf and although no negotiations have taken place, the Registrant expects the tenant to renew. The other lease, which expires in December 1996, is for 20,847 sf and no negotiations regarding renewal have taken place. For tax purposes of depreciation, this property has federal tax basis of $6,116,065 and is depreciated using the straight-line method with a useful life of 27.5 years. The annual real estate taxes are $21,967 which is based on an assessed value of $1,657,900 taxed at a rate of $1.325 per $100. It\nis of the opinion of the management of the Registrant that the property is adequately covered by insurance.\nd. Magazine Place - is a four story building consisting of 57 apartment units located at 730 Magazine Street in New Orleans, Louisiana. In October 1986, the Registrant was admitted with a 60% general partnership interest in Magazine Place Limited Partnership (\"MPP\"), a Louisiana partnership, for a cash contribution of $600,000. Registrant believes that its acquisition of a majority general partnership interest in MPP, though technically non-compliant with the provisions of Registrant's partnership agreement disapproving of investments in limited partnerships, will have no adverse impact on Registrant's limited partners. Registrant subsequently made an additional equity contribution of $142,393 to fund certain fees incurred by MPP. MPP acquired and rehabilitated the property for $4,091,393 ($51 per sf), including mortgage financing of $3,050,000 (principal balance of $2,912,697 at December 31, 1995) and cash contributions by limited partners of $344,000. The mortgage note bears interest at 10%, is payable in monthly installments of principal and interest of $26,766, and is due in 1999. The excess proceeds from equity investments and mortgage financing over the acquisition and rehabilitation costs were utilized to provide working capital reserves. In 1987, Registrant made an equity contribution of $7,000 (MPP's other partners contributed cash in the amount of $28,000 in 1987) to fund operating deficits incurred during the lease-up period. According to the Amended and Restated Partnership Agreement, the Registrant's interest in MPP will be reduced from 60% to 40% as of the First Conversion Date. The First Conversion Date is the date on which the Registrant will have received a return of its initial capital contribution. For purposes of determining the First Conversion Date, the Registrant will be deemed to have received a return of its initial capital contribution when the sum of the following amounts equals $600,000: (i) cash distributions from MPP; (ii) investment tax credit allocable to the Registrant; and (iii) 50% of the aggregate of MPP's net losses and deductions allocable to the Registrant. As of December 31, 1994, the Registrant had received a return of its initial capital and the Registrant's interest in the MPP was reduced to 40%. Since that date, the Registrant has accounted for its investment in MPP on the equity basis. The property is managed by an independent property management firm. As of December 31, 1995, 52 residential units were under lease (91%) at monthly rents ranging from $610 to $1,240.\nAll leases are renewable, one-year leases. The occupancy for the previous four years was 89% for 1994, 97% for 1993, 90% for 1992 and 95% for 1991. The monthly rental range has been approximately the same since 1991. For tax purposes, this property has a federal tax basis of $2,586,532 and is depreciated using the straight-line method with a useful life of 27.5 years. The annual real estate taxes are $14,077 which is based on assessed value of $79,000 taxed at a rate of $17.819 per $100. No one tenant occupies ten percent or more of the building. It is the opinion of the management of the Registrant that the property is adequately covered by insurance.\nItem 3.","section_3":"Item 3. Legal Proceedings\na. For a description of legal proceedings involving Registrant's properties, see Part II, Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations -- Cathedral Court.\nb. No such proceeding was terminated during the fourth quarter of the fiscal year covered by this report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted during the fiscal years covered by this report to a vote of security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\na. There is no established public trading market for the Units. Registrant does not anticipate any such market will develop. Trading in the Units occurs solely through private transactions. The Registrant is not aware of the prices at which trades occur. Registrant's records indicate that 92 Units of record were sold or exchanged in 1995.\nb. As of December 31, 1995, there were 1,577 record holders of Units.\nc. Registrant has not declared any cash dividends in 1995 or 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data are for the five years ended December 31, 1995. The data should be read in conjunction with the consolidated financial statements included elsewhere herein. This data is not covered by the independent auditors' report.\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nRental income $1,658,031 $2,016,023 $1,971,274 $1,991,600 $1,895,520 Interest income 840 1,005 3,365 6,131 1,419 Net loss (533,933) (1,756,104) (1,719,611) (1,221,214) (1,680,415) Net loss per Unit (37.80) (124.35) (121.76) (86.54) (118.99) Total assets(net 8,887,472 18,771,092 19,662,834 20,848,362 21,919,371 of depreciation and amortization) Debt obligations 7,776,693 15,216,724 14,642,621 14,337,159 14,501,479\nNote: See Part II. Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations\n(1) Liquidity\nAt December 31, 1995, Registrant had cash of approximately $10,685. Such funds are expected to be used to pay liabilities and general and administrative expenses of Registrant and to fund cash deficits of the properties. Cash generated from operations is used primarily to fund operating expenses and debt service. If cash flow proves to be insufficient, the Registrant will attempt to negotiate with the various lenders in order to remain current on all obligations. The Registrant is not aware of any additional sources of liquidity.\nAs of December 31, 1995, Registrant had restricted cash of $108,288 consisting primarily of funds held as security deposits, replacement reserves and escrows for taxes. As a consequence of these restrictions as to use, Registrant does not deem these funds to be a source of liquidity.\nIn recent years the Registrant has realized significant losses, including the foreclosure of one property, due to the properties' inability to generate sufficient cash flow to pay their operating expenses and debt service. At the present time, with the exception of the Magazine Place, where the Registrant does not receive any of the distributable cash (see page 7), the Registrant has feasible loan modifications in place. However, in all three cases, the mortgages are basically \"cash-flow\" mortgages, requiring all available cash after payment of operating expenses to be paid to the first mortgage holder. Therefore, it is unlikely that any cash will be available to the Registrant to pay its general and administrative expenses.\nIt is the Registrant's intention to continue to hold the properties until they can no longer meet the debt service requirements and the properties are foreclosed, or the market value of the properties increases to a point where they can be sold at a price which is sufficient to repay the underlying indebtedness (principal plus accrued interest).\nSince the lenders have agreed to forebear from taking any foreclosure action as long as cash flow payments are made, the Registrant believes it is appropriate to continue presenting the financial statements on a going concern basis.\n(2) Capital Resources\nDue to the relatively recent rehabilitations of the properties, any capital expenditures needed are generally replacement items and are funded out of cash from operations or replacement reserves, if any. The Registrant is not aware of any factors which would cause historical capital expenditures levels not to be indicative of capital requirements in the future and accordingly does not believe that it will have to commit material resources to capital investment in the foreseeable future. If the need for capital expenditures does arise, the first mortgage holder for Lincoln Court and 18th and Green has agreed to fund capital expenditures at terms similar to the first\nmortgage. The mortgagee funded $169,445 during 1995 at Lincoln Court.\nResults of Operations\nDuring 1995, Registrant incurred a net loss of $533,993 ($37.80 per limited partnership unit), compared to a net loss of $1,756,104 ($124.35 per limited partnership unit) in 1994 and a net loss of $1,719,611 ($121.76 per limited partnership unit), in 1993. Included in the 1995 loss was an extraordinary gain of $1,316,188 due to the foreclosure of Cathedral Court.\nRental income increased from $1,971,274 in 1993 to $2,016,023 in 1994 and decreased to $1,658,031 in 1995. The decrease from 1994 to 1995 is due to a decrease in rental income recognized by the Registrant at Magazine Place, due to the reduction in the Registrant's ownership interest in MPP (See Item 2.d. Magazine Place) partially offset by increases in rental income at Lincoln Court and Loewy Building due to higher average occupancy rates. The increase from 1993 to 1994 is due mainly to an increase in rental income at Loewy Building which resulted from the billing of prior years' common area charges.\nOther income increased from $0 in 1993 to $81,870 and decreased to $0 in 1995. The increase from 1993 to 1994 and the decrease from 1994 to 1995 was the result of insurance proceeds resulting from a claim for water damage to several units in 1994 at Cathedral Court.\nAs a result of a decrease in the average amount of cash held by the Registrant, interest income declined from $3,365 in 1993 to $1,005 in 1994 to $840 in 1995.\nRental operations expenses increased from $1,173,645 in 1993 to $1,335,727 in 1994 and decreased to $1,088,752 in 1995. The decrease from 1994 to 1995 is due to change in accounting method as a result of the change in ownership at one of the properties (Magazine Place) partially offset by the overall increase in operating expenses such as utilities, maintenance, management fees, commissions and advertising, at Lincoln Court and Loewy Building, due to the higher occupancy. The overall increase from 1993 to 1994 results from the increase of several operating expenses items at the various properties such as utilities, commissions, legal, maintenance, insurance, and wages and salaries, partially offset by a decrease in real estate taxes at one of the properties.\nInterest expense increased from $1,376,400 in 1993 to $1,478,380 in 1994 to $1,447,420 in 1995. The decrease from 1994 to 1995 is the result an increase in interest expense at Lincoln Court and Cathedral Court partially offset by a decrease at 18th and Green and the change in accounting method as a result of the change in ownership at one of the properties (Magazine Place). Interest expense increased at Lincoln Court due to an increase in the principal balance upon which interest is accrued along with an increase in the interest rate. Cathedral Court interest expense increased due to an increase in\nthe interest rate from 6% to 12% due to the expiration of a loan modification. Interest expense decreased at 18th and Green due to the accrual of interest in 1994 on amounts owed to an affiliate of the Registrant upon which interest had not been accrued in prior years. The increase in interest expense from 1993 to 1994 is due to the additional accrual of interest on the notes which were restructured pursuant to the agreements reached with the new note holders (See Part I. Item 2. Properties - Lincoln Court and Green Street Apartments) combined with the accrual of additional interest in 1994 of interest that should have been accrued in prior years.\nDepreciation and amortization decreased $1,007,481 in 1993 to $927,774 in 1994 to $829,265 in 1995. The decrease from 1994 to 1995 is due to the change in the accounting method as a result of the change in ownership at one of the properties (Magazine Place). The overall decrease from 1993 to 1994 is the result of an adjustment made in 1993 to correct a previous year's error which increased depreciation to a higher-than-usual level in 1993 at Loewy Building. Depreciation expense for 1994 is at the usual level.\nIn 1995, income of $150,230 was recognized at the Registrant's five properties compared to losses of $1,590,000 in 1994 and $1,533,000 in 1993. A discussion of property operations\/activities follows:\nIn 1995, Registrant sustained a loss of $300,000 at Lincoln Court including $174,000 of depreciation expense compared to a loss of $285,000 including $174,000 of depreciation expense in 1994 and a loss of $236,000 including $174,000 of depreciation expense in 1993. The increase in the loss from 1994 to 1995 is the result of an increase in operating expenses such as management fees, commissions and advertising and an increase in interest expense partially offset by an increase in rental income. Operating expenses and rental income increased due to an increase in average occupancy (58% to 91%) and a corresponding increase in operating expenses. Interest expense increased due to an increase in the principal balance upon which interest is accrued along with an increase in the interest rate. The increase in the loss from 1993 to 1994 is due to an increase in certain operating expenses such as utilities, maintenance, advertising, and commissions and an increase in legal fees (incurred in connection with the loan default and subsequent loan modification which occurred in 1994. See Part I. Item 2.b). Utilities and maintenance charged to the property increased as occupancy decreased from 63% to 58% and maintenance work was done in order to attract new tenants. Advertising and commissions increased as the marketing campaign was enhanced to attract new tenants.\nOn June 30, 1992 DHP, Inc. assigned to D, LTD a note receivable from the Registrant in the amount of $432,103 which bears interest at 10% with the entire principal and accrued interest due on June 30, 1997. Interest accrued during 1995 was $45,703. Payments on the note are to be made from available cash flow and before any distribution can be made to the Registrant's limited partners. The balance of the note at December 31, 1995 was $533,200.\nIn 1995, the Green Street Apartments sustained a loss of $153,000 including $59,000 of depreciation expense compared to a loss of $281,000 in 1994 including $59,000 of depreciation expense and a loss of $89,000 in 1993 including $66,000 of depreciation expense. The decrease from 1994 to 1995 and the increase from 1993 to 1994 is due primarily to the additional accrual of interest on the modified loan (See Part I. Item 2.c.) combined with the accrual of additional interest in 1994 of interest that should have been accrued in prior years.\nOn June 30, 1992 DHP, Inc. assigned to D, LTD a note receivable, from 18th and Green to the Registrant, that had been assigned to it, in the amount of $63,493 which bears interest at 10% with the entire principal and accrued interest due on June 30, 1997. On December 6, 1993 D, LTD obtained a judgment in the amount of $78,171 on this note in Common Pleas Court for Philadelphia County. The judgment accrues interest at 15%. Interest accrued during 1995 was $8,001. Payments on the judgment are to be made from available cash flow from 18th and Green. The balance of the note at December 31, 1995 was $40,015.\nIn 1995, Cathedral Court recognized income of $636,000 including $337,000 of depreciation expense compared to a loss of $576,000 including $334,000 of depreciation expense in 1994 and a loss of $691,000 including $338,000 of depreciation expense in 1993. The 1995 loss without the effect of the foreclosure would have been $850,000. The increase in the loss from 1994 to 1995 is the result of an increase in interest expense due to an increase in the interest rate from 6% to 12% due to the expiration of a loan modification partially offset by a decrease in other income. Other income decreased due to the receipt of insurance proceeds in 1994 due to a claim for water damage in several units. . Included in operations from 1995 is an extraordinary gain of $1,316,188 representing the difference between the fair market value of the assets relinquished and the liabilities satisfied. The decreased loss from 1993 to 1994 was primarily due to the receipt of insurance proceeds of $81,000 in 1994, which resulted from a claim for water damage to several units, combined with a decrease of $23,000 in legal fees, due to legal fees paid in 1993 associated with the settlement agreement and dismissal of the bankruptcy. The remainder of the decrease is due to a decrease in other operating expenses such as insurance and real estate taxes.\nIn 1995, the Loewy Building sustained a loss of $332,000 including $260,000 of depreciation expense compared to a loss of $379,000 including $260,000 of depreciation expense, in 1994 and a loss of $490,000 including $301,000 of depreciation expense in 1993. The decrease in the loss from 1994 to 1995 is the result of an increase in rental income partially offset by an increase in operating expenses. Rental income increased due to an increase in average occupancy from 93% to 95% along with higher rental rates. Operating expenses such as utilities, maintenance and management fees increased due to the increase in occupancy and (with respect to management fees) the higher average rental rates. The decreased loss from 1993 to 1994 is the combination of an increase in rental income and a decrease in depreciation partially offset by an increase in other operating expenses such as utilities, management fees and real estate taxes. The increase in rental income is primarily the result of the\nbilling to tenants of prior years' common area charges. Depreciation decreased in 1994 due to an adjustment made in 1993 which increased depreciation to a higher-than-usual level in 1993. Depreciation expense for 1994 is at the usual level.\nSummary of Minority Interests\nIn 1995, the Registrant incurred a net loss of $19,121 at Magazine Place compared to a loss of $69,000 including $102,000 of depreciation expense in 1994 and a loss of $27,000 including $127,000 of depreciation expense in 1993. Prior to 1995, Magazine Place was treated as a consolidated subsidiary. Pursuant to the First Conversion Date as discussed in Item 2. Properties, the Registrant's ownership interest was reduced to 40%. From January 1, 1995 forward, the investment is accounted for by the equity method. The increase in the loss from 1993 to 1994 is due to an increase in certain operating expenses such as maintenance, repairs, insurance, and wages and salaries partially offset by an increase in rental income.\nEffective January 1, 1995, the Registrant adopted the provisions 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.\" There was no cumulative effect of the adoption of SFAS No. 121.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nRegistrant is not required to furnish the supplementary financial information referred to in Item 302 of Regulations S-K.\nIndependent Auditor's Report\nTo the Partners of Diversified Historic Investors III\nWe have audited the accompanying consolidated balance sheets of Diversified Historic Investors III (a Pennsylvania Limited Partnership) and its subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, changes in partners' equity and cash flows for the years ended December 31, 1995, 1994 and 1993. These consolidated 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 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to in the first paragraph presents fairly, in all material respects, the financial position of Diversified Historic Investors III and subsidiaries as of December 31, 1995 and 1994, and the 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.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedule of Real Estate and Accumulated Depreciation on page 30 is presented for the purposes of additional analysis and is not a required part 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.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. In recent years, the Partnership has incurred significant losses from operations, which raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nGross, Kreger & Passio Philadelphia, Pennsylvania February 9, 1996\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\nAND FINANCIAL STATEMENT SCHEDULES ---------------------------------\nConsolidated financial statements: Page ----\nConsolidated Balance Sheets at December 31, 1995 and 1994 16\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994, and 1993 17\nConsolidated Statements of Changes in Partners' Equity for the Years Ended December 31, 1995, 1994, and 1993 18\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 19\nNotes to consolidated financial statements 20-28 Financial statement schedules:\nSchedule XI - Real Estate and Accumulated Depreciation 30\nNotes to Schedule XI 31\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nCONSOLIDATED BALANCE SHEETS --------------------------- December 31, 1995 and 1994\nAssets ------\n1995 1994 ---------- -------- Rental properties at cost: Land $ 465,454 $ 2,029,818 Buildings and improvements 11,857,302 23,324,996 Furniture and fixtures 86,351 215,794 ------------ ------------\n12,409,107 25,570,608 Less - accumulated depreciation (3,991,148) (7,035,889) ------------ ------------ 8,417,959 18,534,719\nCash and cash equivalents 10,685 31,437 Restricted cash 108,288 108,674 Accounts receivable 7,385 17,063 Investment in affiliate 276,180 0 Other assets (net of accumulated amortization of $69,775 and $109,081) 66,975 79,199 ------------ ------------\nTotal $ 8,887,472 $ 18,771,092 ============ ============\nLiabilities and Partners' Equity --------------------------------\nLiabilities: Debt obligations $ 7,776,693 $ 15,216,724 Accounts payable: Trade 579,664 454,438 Related parties 533,200 599,721 Taxes 155,907 465,705 Interest payable 755,866 2,319,544 Tenant security deposits 54,919 143,216 Other liabilities 15,399 13,457 ------------ ------------ Total liabilities 9,871,648 19,212,805 ------------ ------------\nMinority Interests 0 8,530 ------------ ------------\nPartners' equity (984,176) (450,243) ------------ ------------ Total $ 8,887,472 $ 18,771,092 ============ ============\nThe accompanying notes are an integral part of these financial statements.\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nFor the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---------- ---------- ----------\nRevenues: Rental income $ 1,658,031 $ 2,016,023 $ 1,971,274 Other income 0 81,870 0 Interest income 840 1,005 3,365 ----------- ----------- ----------- Total revenues 1,658,871 2,098,898 1,974,639 ----------- ----------- -----------\nCosts and expenses: Rental operations 1,088,752 1,335,727 1,173,645 General and administrative 140,800 141,181 142,090 Interest 1,447,420 1,478,380 1,376,400 Depreciation and amortization 829,265 927,774 1,007,481 ----------- ----------- ----------- Total costs and expenses 3,506,237 3,883,062 3,699,616 ----------- ----------- -----------\nLoss before minority interests and (1,847,366) (1,784,164) (1,724,977) equity in affiliate Minority interests' portion of loss 16,365 28,060 5,366 Equity in net loss of affiliate (19,120) 0 0 ----------- ----------- ----------- Loss before extraordinary item (1,850,121) 1,756,104 1,719,611 Extraordinary gain 1,316,188 0 0 ----------- ----------- -----------\nNet loss ($ 533,993) ($1,756,104) ($1,719,611) =========== =========== ===========\nNet loss per limited partnership unit: Loss before minority interests and equity in affiliate (130.80) (126.33) (122.14) Minority interests' portion of loss 1.15 1.99 .38 Equity in net loss of affiliate (1.35) 0 0 ----------- ----------- -----------\nLoss before extraordinary item (131.00) (124.35) (121.76) Extraordinary gain 93.20 0 0 ----------- ----------- ----------- ($ 37.80) ($ 124.35) ($ 121.76) =========== =========== ===========\nThe accompanying notes are an integral part of these financial statements.\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY ------------------------------------------------------\nFor the Years Ended December 31, 1995, 1994 and 1993\nDover Historic Limited Advisors II(1) Partners(2) Total -------------- ----------- -----\nPercentage participation in profit or loss 1% 99% 100% == === ====\nBalance at December 31, 1992 (82,785) 3,108,257 3,025,472 Net loss (17,196) (1,702,415) (1,719,611) ----------- ----------- -----------\nBalance at December 31, 1993 (99,981) 1,405,842 1,305,861 Net loss (17,561) (1,738,543) (1,756,104) ----------- ----------- -----------\nBalance at December 31, 1994 (117,542) (332,701) (450,243) Net loss (5,510) (545,483) (550,993) ----------- ----------- -----------\nBalance at December 31, 1995 ($ 123,052) ($ 878,184) ($1,001,236) =========== =========== ===========\n(1) General Partner.\n(2) 13,981.5 limited partnership units outstanding at December 31, 1995, 1994, and 1993.\nThe accompanying notes are an integral part of these financial statements.\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\nFor the Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---------- ---------- ---------\nCash flows from operating activities: Net loss ($ 533,993) ($1,756,104) ($1,719,611) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 829,265 927,774 1,007,481 Extraordinary gain (1,316,188) 0 0 Minority interests (16,365) (28,060) (5,366) Equity in loss of affiliate 19,120 0 0 Changes in assets and liabilities: Increase in restricted cash (45,897) (7,552) (4,949) Decrease (increase) in accounts 7,450 (1,754) 12,186 receivable Decrease in other assets 1,604 380 0 Increase (decrease) in accounts 204,853 331,553 (281,094) payable - trade Increase (decrease) in accounts 33,479 (206,364) 177,688 payable - related parties Increase in accounts payable-taxes 59,277 41,342 295,315 Increase in interest payable 903,426 125,380 485,979 (Decrease) increase in tenant security (31,928) 18,070 (25,014) deposits Increase in other liabilities 1,942 8,338 5,119 ----------- ----------- ----------- Net cash provided by (used in) operating activities: 116,105 (546,997) (52,266) ----------- ----------- ----------- Cash flows from investing activities: Capital expenditures (302,989) (18,609) (17,690) ----------- ----------- ----------- Net cash used in investing activities: (302,989) (18,609) (17,690) ----------- ----------- ----------- Cash flows from financing activities: Proceeds from debt obligations 196,445 635,956 5,000 Payments of principal under debt (30,313) (61,853) (123,544) obligations ----------- ----------- -----------\nNet cash provided by (used in) financing activities: 166,132 574,103 (118,544) ----------- ----------- ----------- (Decrease) increase in cash and cash (20,752) 8,497 (188,500) equivalents Cash and cash equivalents at beginning of 31,437 22,940 211,440 year ----------- ----------- ----------- Cash and cash equivalents at end of year $ 10,685 $ 31,437 $ 22,940 =========== =========== ===========\nSupplemental Disclosure of Cash Flow Information: Cash paid during the year for interest $ 491,008 $ 299,696 $ 846,232\nThe accompanying notes are an integral part of these financial statements.\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\nNOTE A - ORGANIZATION\nDiversified Historic Investors III (the \"Partnership\") was formed in February 1986 under the laws of the Commonwealth of Pennsylvania. The Partnership was formed to acquire, rehabilitate, and manage real properties which were certified historic structures as defined in the Internal Revenue Code of 1986 (the \"Code\"), or which were eligible for designation as such, utilizing mortgage financing and the net proceeds from the sale of limited partnership units. Any rehabilitations undertaken by the Partnership are done with a view to obtaining certification of expenditures therefore as \"qualified rehabilitations expenditures\" as defined in the Code.\nThe General Partner of the Partnership is Dover Historic Advisors II (a general partnership), whose partners are Mr. Gerald Katzoff and DHP, Inc.\nNOTE B - SIGNIFICANT ACCOUNTING POLICIES\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:\n1. Principles of Consolidation\nThe accompanying financial statements of the Partnership include the accounts of three subsidiary partnerships (the \"Ventures\"), in which the Partnership has a controlling interest with appropriate elimination of inter-partnership transactions and balances. In addition, the Partnership owns a minority interest of 40% in one partnership which it accounts for on the equity method. These financial statements reflect all adjustments (consisting only of normal recurring adjustments) which, in the opinion of the Partnership's General Partner, are necessary for a fair statement of the results for those years.\n2. Depreciation\nDepreciation is computed using the straight-line method over the estimated useful lives of the assets. Buildings and improvements are depreciated over 25 years and furniture and fixtures over five years.\n3. Costs of Issuance\nCosts incurred in connection with the offering and sale of limited partnership units were charged against partners' equity as incurred.\n4. Cash and Cash Equivalents\nThe Partnership considers all highly liquid instruments purchased with a maturity of less than three months to be cash equivalents.\n5. Interest Payable\nInterest payable includes all accrued and unpaid interest on the debt obligations, as well as interest in arrears.\n6. Net Loss Per Limited Partnership Unit\nThe net loss per limited partnership unit is based on the weighted average number of limited partnership units outstanding during the period (13,891.5 in 1995, 1994, and 1993).\n7. Income Taxes\nFederal and state income taxes are payable by the individual partners; accordingly, no provision or liability for income taxes is reflected in the annual financial statements.\n8. Restricted Cash\nRestricted cash includes amounts held for tenant security deposits and real estate tax reserves.\n9. Revenue Recognition\nRevenues are recognized when rental payments are due on a straight-line basis. Rental payments received in advance are deferred until earned.\n10. Other income\nOther income consists of insurance proceeds received at one of the properties resulting from a claim for water damage to several of the units.\n11. Rental Properties\nRental properties are stated at cost. A provision for impairment of value is recorded when a decline in value of property is determined to be other than temporary as a result of one or more of the following: (1) a property is offered for sale at a price below its current carrying value, (2) a property has significant balloon payments due within the foreseeable future for which the Partnership does not have the resources to meet, and anticipates it will be unable to obtain replacement financing or debt modification sufficient to allow a continued hold of the property over a reasonable period of time, (3) a property has been, and is expected to continue, generating significant operating deficits and the Partnership is unable or unwilling to sustain such deficit results of operations, and has been unable to, or anticipates it will be unable\nto, obtain debt modification, financing or refinancing sufficient to allow a continued hold of the property for a reasonable period of time or, (4) a property's value has declined based on management's expectations with respect to projected future operational cash flows and prevailing economic conditions. An impairment loss is indicated when the undiscounted sum of estimated future cash flows from an asset, including estimated sales proceeds, and assuming a reasonable period of ownership up to 5 years, is less than the carrying amount of the asset. The impairment loss is measured as the difference between the estimated fair value and the carrying amount of the asset. In the absence of the above circumstances, properties and improvements are stated at cost. An analysis is done on an annual basis at December 31 of each year.\n12. New Accounting Pronouncement\nEffective January 1, 1995, the Partnership adopted the provisions 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.\" There was no cumulative effect of the adoption of SFAS No. 121.\nNOTE C - GOING CONCERN\nIn recent years the Partnership has realized significant losses, including the foreclosure of one property, due to the properties' inability to generate sufficient cash flow to pay their operating expenses and debt service. At the present time, with the exception of the Magazine Place, where at the present time the Partnership does not receive any of the distributable cash (see page 7), the Partnership has feasible loan modifications in place. However, in all three cases, the mortgages are basically \"cash-flow\" mortgages, requiring all available cash after payment of operating expenses to be paid to the first mortgage holder. Therefore, it is unlikely that any cash will be available to the Partnership to pay its general and administrative expenses.\nIt is the Partnership's intention to continue to hold the properties until they can no longer meet the debt service requirements and the properties are foreclosed, or the market value of the properties increases to a point where they can be sold at a price which is sufficient to repay the underlying indebtedness (principal plus accrued interest).\nSince the lenders have agreed to forebear from taking any foreclosure action as long as cash flow payments are made, the Partnership believes it is appropriate to continue presenting the financial statements on a going concern basis.\nNOTE D - PARTNERSHIP AGREEMENT\nThe significant terms of the Agreement of Limited Partnership (the \"Agreement\"), as they relate to the financial statements, follow:\nAll distributable cash from operations (as defined in the Agreement of Limited Partnership) will be distributed 90% to the limited partners and 10% to the General Partner.\nAll distributable cash from sales or dispositions (as defined) will be distributed to the limited partners up to their adjusted invested capital (as defined) plus an amount equal to the sum of the greater of a 6% cumulative, noncompounded annual return on the average after-credit invested capital, less amounts previously distributed (as defined); thereafter, after receipt by the General Partner or its affiliates of any accrued but unpaid real estate brokerage commissions, the balance will be distributed 15% to the General Partner and 85% to the limited partners.\nNet income or loss from operations of the Partnership is allocated 1% to the General Partner and 99% to the limited partners.\nNOTE E - ACQUISITIONS\nThe Partnership acquired five controlling or limited partnership interests in Ventures during the period October 1986 to July 1987, as discussed below.\nIn October 1986, the Partnership was admitted, with a 60% general partnership interest, to a Louisiana limited partnership which owns a building located in Louisiana consisting of 57 residential units, for a cash capital contribution of $600,000. Pursuant to the Amended and Restated Partnership Agreement, the Partnership's interest was reduced to 40% effective January 1, 1995.\nIn November 1986, the Partnership was admitted, with a 99% general partnership interest, to a Pennsylvania general partnership which owns a building located in North Carolina consisting of 64,000 square feet of commercial space, for a cash contribution of $2,450,000.\nIn December 1986, the Partnership was admitted, with a 99% general partnership interest, to a Maryland general partnership which owns a property located in Maryland consisting of 55 residential units and 14,800 square feet of commercial space, for a cash contribution of $3,508,700. The lender on the property foreclosed in January 1996.\nIn March 1987, the Partnership purchased a property consisting of three buildings (58 residential units) located in Pennsylvania for a cash capital contribution of $500,000.\nIn July 1987, the Partnership was admitted, with a 99% general partnership interest, to a Pennsylvania general partnership which owns a building located in Pennsylvania consisting of 18 residential units, for a cash capital contribution of $800,000.\nNOTE F- DEBT OBLIGATIONS\nDebt obligations are as follows: December 31, ------------ 1995 1994 ---- ----\nMortgage loan, interest at 11 1\/2%, principal and $ 3,784,900 $ 3,784,900 interest payable monthly in installments with a minimum of $25,000, plus 70% of the gross revenues from the rental of 10,330 square feet on the first and second floors; due November 1997; collateralized by the related rental property; accrued interest of $405,691 relating to this loan is included in interest payable on the balance sheet\nNote payable, interest payable monthly at prime, 200,000 200,000 with a minimum of 6% and a maximum of 8%, adjusting annually on January 2 (8% and 6% at December 31, 1995 and 1994, respectively); due in 1997; collateralized by the related rental property; accrued interest of $65,160 relating to this loan is included in interest payable on the balance sheet\nAllowed unsecured claims in the amount of $268,042 199,058 213,357 are to be repaid, without interest, in the following manner: 15% at substantial consummation of the Plan of Reorganization and 17% in each of the five successive years\nPriority tax claims in the amount of $80,705 36,638 52,652 payable commencing February 1993 in equal quarterly installments of $5,055.52. The note bears interest at 9% and is due in November 1997\nMortgage loan, interest only payable monthly at 0 4,524,000 the greater of prime plus 2% or 12% fixed, therefore 12% at December 31, 1995 and 1994; collateralized by the related rental property (A)\nPriority tax claims in the amount of $157,114 are 0 141,104 payable commencing January 1992 in equal quarterly installments of $3,365.81. The note bears interest at 20% and is due in May 1999 (A)\nNote payable, interest only at 10% payable 10,000 10,000 quarterly; principal due in 1994; (B)\nMortgage loan, interest only at prime plus 1% 80,000 80,000 (9.5% at December 31, 1995 and 1994); payable annually; principal and accrued interest due in 1994;collateralized by the related rental property; accrued interest of $66,862 relating to this loan is included in interest payable on the balance sheet(B)\nMortgage loan, interest at prime plus 1 1\/4% with 1,948,897 1,754,452 a minimum of 9.5% and a maximum of 14.5%; therefore, 9.75% at December 31, 1995 and 1994; principal due in 1999; collateralized by the related rental property; accrued interest of $76,656 relating to this loan is included in interest payable on the balance sheet (C)\nMortgage loan, interest at 11% per annum; 107,120 107,120 principal due in 1999; collateralized by the related rental property; accrued interest of $12,765 relating to this loan is included in interest payable on the balance sheet (C)\nNote payable, interest at prime plus 1 1\/4% (9.75% 100,278 100,278 at December 31, 1995 and 1994); principal due in 1999; collateralized by the related rental property; accrued interest of $10,260 relating to this loan is included in interest payable on the balance sheet (C)\nMortgage loan, principal and interest of 0 2,941,059 $26,765.93 payable monthly; interest at 10%; due in 1999; collateralized by the related rental property (D)\nMortgage loan, interest at 12%; interest only payable to the extent of net operating income with a minimum of $5,750; principal due in 1999; collateralized by the related rental property; accrued interest of $118,196 relating to this loan is included in interest payable on the balance sheet (E) 1,309,802 1,307,802 ---------- -----------\n$ 7,776,693 $15,216,724 ========== ==========\n(A) The Partnership which owns the property that collaterizes this loan had been in bankruptcy since January 1990. Although a Plan of Reorganization was filed, it was not approved. However, pursuant to a settlement agreement reached with the first mortgage holder on July 31, 1993, the bankruptcy was dismissed. It was expected that, subsequent to the bankruptcy's dismissal, the first mortgage holder would sell the loan, however the Partnership would be given the right of first refusal. In September 1994, a receiver was appointed to take possession of the\nproperty. The lender on the property foreclosed in January 1996.\n(B) Although these obligations have matured, the lenders have not made any demand for payment.\n(C) Monthly payments of interest are to be made, on all three loans combined, in an amount equal to net operating income, with a minimum of $7,000 per month, increasing to $9,000 per month in January 1996 and to $11,000 per month in January 1997.\nOn December 2, 1994, the terms of this loan were modified to those described above. In accordance with Statement of Financial Accounting Standards No. 15, \"Accounting for Debtors and Creditors for Troubled Debt Restructurings\" the effects of the modification have been and will continue to be accounted for prospectively from the date of the restructuring with no gain recognized at that time.\n(D) According to the Amended and Restated Partnership Agreement, the Partnership's interest in the property was reduced from 60% to 40% as of December 31, 1994. Since that date, the Registrant has accounted for its investment in MPP on the equity basis. See Note G - COMMITMENTS AND CONTINGENCIES.\n(E) On September 2, 1994, the terms of this loan were modified to those described above. In accordance with Statement of Financial Accounting Standards No. 15, \"Accounting for Debtors and Creditors for Troubled Debt Restructurings\" the effects of the modification have been and will continue to be accounted for prospectively from the date of the restructuring with no gain recognized at that time.\nApproximate maturities of the mortgage loan obligations at December 31, 1995, for each of the succeeding five years are as follows:\n1996 $ 152,221 1997 4,048,751 1998 44,717 1999 3,531,004 ----------- $ 7,776,693 ===========\nNOTE G - COMMITMENTS AND CONTINGENCIES\nPursuant to certain agreements, the developers of the properties and limited partners in the Ventures are entitled to share in the following:\na. 15% to 50% of net cash flow from operations above certain specified amounts (three properties)\nb. 30% of the net proceeds, as defined, from the sale or refinancing of one property. The Partnership is entitled to a priority distribution of such proceeds prior to any payment to the developer.\nThe sellers of two of the properties (who have maintained minority interests in the ventures) have agreed to reimburse the Partnership for cash flow deficits, as defined, of the properties for a five-year period (one property) and an eight-year period (one property). No reimbursements were made by the sellers pursuant to these agreements.\nAccording to the Amended and Restated Partnership Agreement, the Partnership's interest in Magazine Place Limited Partnership (\"MPP\") was reduced from 60% to 40% as of the First Conversion Date. The First Conversion Date is the date on which the Registrant will have received a return of its initial capital contribution. For purposes of determining the First Conversion Date, the Registrant will be deemed to have received a return of its initial capital contribution when the sum of the following amounts equals $600,000: (i) cash distributions from MPP; (ii) investment tax credit allocable to the Registrant; and (iii) 50% of the aggregate of MPP's net losses and deductions allocable to the Registrant. As of December 31, 1994, the Registrant had received a return of its initial capital and the Registrant's interest in the MPP was reduced to 40%. Since that date, the Registrant has accounted for its investment in MPP on the equity basis.\nNOTE H - EXTRAORDINARY GAINS\nDue to insufficient cash flow at Cathedral Court General Partnership (\"CCGP\") from the property owned by it, the property ceased making debt service payments in 1989. In January 1990, CCGP filed a reorganization petition pursuant to Chapter 11 of the U.S. Bankruptcy Code. Although a plan of reorganization was filed, it was not approved. Pursuant to a settlement agreement reached with the first mortgage holder on July 31, 1993 the bankruptcy was dismissed. The terms of the settlement agreement called for payment to the first mortgage holder by CCGP of certain monies held, and for CCGP to continue to control the property. CCGP anticipated that, subsequent to the bankruptcy's dismissal, the first mortgage holder would attempt to sell the loan, but that the Partnership would be given a right of first refusal. In September 1994, due to the inability of the first mortgage holder and CCGP to reach an agreement regarding CCGP's purchase of the loan, the first mortgage holder petitioned the Circuit Court for the City of Baltimore in the matter of Harrington v. Cathedral Court General Partnership, Case No. 89340045\/CE 106281, to have a receiver appointed, and such petition was granted. Pursuant to the appointment of the receiver, CCGP was directed to deliver immediate possession of any and all property connected with and used in the current operation of the property to the receiver and on January 22, 1996 the lender foreclosed on the property. The Partnership wrote off the property as of December 31, 1995. The Partnership has recognized an extraordinary gain of $1,316,188 for the difference between the book value of the property (which approximates fair value) and the extinguished debt.\nNOTE I - TRANSACTIONS WITH RELATED PARTIES\nIncluded in debt obligations for 1995, 1994 and 1993 is $140,000 owed to an affiliate of the General Partner, by one of the Partnership's Ventures, for additional amounts advanced for working capital needs.\nOn June 30, 1992 DHP, Inc. assigned to D, LTD a note receivable from the Registrant in the amount of $432,103 which bears interest at 10% with the entire principal and accrued interest due on June 30, 1997. Interest accrued during 1995 was $45,703. Payments on the note are to be made from available cash flow and before any distribution can be made to the Registrant's limited partners. The balance of the note at December 31, 1995 was $533,200.\nOn June 30, 1992 DHP, Inc. assigned to D, LTD a note receivable, from 18th and Green to the Registrant, that had been assigned to it, in the amount of $63,493 which bears interest at 10% with the entire principal and accrued interest due on June 30, 1997. On December 6, 1993 D, LTD confessed judgment in the amount of $78,171 against 18th and Green in Common Pleas Court for Philadelphia County. The judgment accrues interest at 15%. Interest accrued during 1995 was $8,001. Payments on the judgment are to be made from available cash flow from 18th and Green. The balance of the note at December 31, 1995 was $40,015.\nNOTE J - INCOME TAX BASIS RECONCILIATION\nCertain items enter into the determination of the results of operations in different time periods for financial reporting (\"book\") purposes and for income tax (\"tax\") purposes. Reconciliations of net loss and partners' equity follow:\nFor the Years Ended December 31, -------------------------------- 1995 1994 1993 ---- ---- ---- Net loss - book ($ 550,993) ($1,739,044) ($1,719,611) Excess of tax over book depreciation 166,823 115,217 98,885 Interest 793,672 461,176 289,292 Gain on foreclosure 216,411 0 0 Other timing differences (2,746) (8,695) 0 Minority interest (19,675) 22,087 18,305 ----------- ----------- ----------- Net loss - tax $ 603,492 ($1,149,259) ($1,313,129) =========== =========== ===========\nPartners' equity - book ($ 995,617) ($ 441,878) $ 1,305,861 1987 distribution of interest on (39,576) (39,576) (39,576) escrow deposits to limited partners Costs of issuance 1,697,342 1,697,342 1,697,342 Cumulative tax over (under) book loss 170,377 (986,854) (1,585,334) ----------- ----------- ----------- Partners' equity - tax $ 832,526 $ 229,034 $ 1,378,293 =========== =========== ===========\nSUPPLEMENTAL INFORMATION\nDIVERSIFIED HISTORIC INVESTORS III ---------------------------------- (a limited partnership)\nSCHEDULE XI - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nCosts Capitalized Subsequent to Initial Cost to Partnership(b) Acquisition ------------------------------ -----------\nBuildings and Description (a) Encumbrances(f) Land Improvements Improvements - - --------------- --------------- ---- ------------ ------------\n64,000 square feet of commercial space in Winston-Salem, 4,220,596 308,624 6,290,125 476,976 NC\n58 apartment units in Philadelphia, PA 2,246,295 86,187 3,490,437 --\n18 apartment units in Philadelphia, PA 1,309,802 70,643 1,559,017 -- ----------- ----------- ----------- ----------- $ 7,776,693 $ 465,454 $11,339,579 $ 476,976 =========== =========== =========== ===========\nGross Amount at which Carried at December 31, 1995 -----------------\nBuildings and Accumulated Date of Date Land Improvements Total(c)(d) Depr.(d)(e) Constr.(a) Acquired ---- ------------ ----------- ----------- ---------- --------\n308,624 6,767,111 7,075,735 2,180,266 1986-1988 11\/14\/86\n86,187 3,617,525 3,703,712 1,279,237 1986-1987 9\/9\/86\n70,643 1,559,017 1,629,660 531,645 1987 - - ------------- -------------- ------------- -------------- $465,454 $11,943,653 $12,409,107 $3,991,148 ============= ============== ============= ==============\nDIVERSIFIED HISTORIC INVESTORS III ----------------------------------\n(a limited partnership)\nNOTES TO SCHEDULE XI --------------------\nDecember 31, 1995\n(A) All properties are certified historic structures as defined in the Internal Revenue Code. The \"date of construction\" refers to the period in which such properties are rehabilitated.\n(B) Includes development\/rehabilitation costs incurred pursuant to turnkey development agreements entered into when the properties are acquired.\n(C) The aggregate cost of real estate owned at December 31, 1995, for Federal income tax purposes is approximately $11,215,075. However, the depreciable basis of buildings and improvements is reduced for Federal income tax purposes by the investment tax credit and the historic rehabilitation credit obtained.\n(D) Reconciliation of real estate:\n1995 1994 1993 ------------ ------------ ------------ Balance at beginning of year: $ 25,570,608 $ 25,551,999 $ 25,534,309 Additions during the year: Improvements 297,731 18,609 17,690 ------------ ------------ ------------\nDeductions during the year: Retirements (9,253,739) 0 0 Deconsolidated subsidiary (4,205,493) 0 0 ------------ ------------ ------------\nBalance at end of year $ 12,409,107 $ 25,570,608 $ 25,551,999 ============ ============ ============\nReconciliation of accumulated depreciation: 1995 1994 1993 ------------ ------------ ------------ Balance at beginning of year $ 7,035,889 $ 6,108,115 $ 5,102,596 Depreciation expense for the year 829,265 927,774 1,005,519 Retirements (2,830,686) 0 0 Deconsolidated subsidiary (1,040,320) 0 0 ------------ ------------ ------------ Balance at end of year $ 3,991,148 $ 7,035,889 $ 6,108,115 ============ ============ ============\n(E) See Note B to the financial statements for depreciation method and lives.\n(F) See Note E to the financial statements for further 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 Registrant\na. Identification of Directors - Registrant has no directors.\nb. Identification of Executive Officers\nThe General Partner of the Registrant is Dover Historic Advisors II (DoHA-II), a Pennsylvania general partnership. The partners of DoHA-II are as follows:\nName Age Position Term of Office Period Served - - ---- --- -------- -------------- -------------\nGerald Katzoff 48 Partner in No fixed term Since February DoHA-II 1986\nDHP, Inc. -- Partner in No fixed term Since February (\"Formerly Dover DoHA-II 1986 Historic Properties, Inc.\")\nFor further description of DHP, Inc., see paragraph e. of this Item. There is no arrangement or understanding between either person named above and any other person pursuant to which any person was or is to be selected as an officer.\nc. Identification of Certain Significant Employees. Registrant has no employees. Its administrative and operational functions are carried out by a property management and partnership administration firm engaged by the Registrant.\nd. Family Relationships. There is no family relationship between or among the executive officers and\/or any person nominated or chosen by Registrant to become an executive officer.\ne. Business Experience. DoHA-II is a general partnership formed in February 1986. The partners of DoHA-II are DHP, Inc. and Gerald Katzoff. The General Partner is responsible for the management and control of the Registrant's affairs and has general responsibility and authority in conducting its operations.\nGerald Katzoff (age 48) has been involved in various aspects of the real estate industry since 1974. Mr. Katzoff is the owner of Katzoff Resorts, which controls various hotel and spa resorts in the United States. Mr. Katzoff is a principal in an entity which is the owner of a property in Avalon, New Jersey which has filed a petition pursuant to Chapter 11 of the U.S. Bankruptcy\nCode. Mr. Katzoff is a former President and director of D, LTD., (formerly The Dover Group, Ltd., the corporate parent of DHP, Inc.).\nDover Historic Properties, Inc. was incorporated in Pennsylvania in December 1984 for the purpose of sponsoring investments in, rehabilitating, developing and managing historic (and other) properties. In February 1992, Dover Historic Properties, Inc.'s name was changed to DHP, Inc. DHP, Inc. is a subsidiary of The Dover Group, Ltd., an entity formed in 1985 to act as the holding company for DHP, Inc. and certain other companies involved in the development and operation of both historic properties and conventional real estate as well as in financial (non-banking) services. In February 1992, Dover Group's name was changed to D, LTD.\nThe executive officers, directors, and key employees of DHP, Inc. are described below.\nMichael J. Tuszka (age 49) was appointed Chairman and Director of both D, LTD and DHP, Inc. on January 27, 1993. Mr. Tuszka has been associated with D, LTD and its affiliates since 1984.\nDonna M. Zanghi (age 39) was appointed Secretary\/Treasurer of DHP, Inc. on June 15,1993. She is also a Director and Secretary\/Treasurer of D, LTD. She has been associated with D, LTD, and its affiliates since 1984, except for the period from December 1986 to June 1989 and the period from November 1, 1992 to June 14, 1993.\nMichele F. Rudoi (age 31) was appointed on January 27, 1993 as Assistant Secretary and Director of both D. LTD and DHP, Inc.\nItem 11.","section_11":"Item 11. Executive Compensation\na. Cash Compensation - During 1995, Registrant has paid no cash compensation to DoHA-II, any partner therein or any person named in paragraph c. of Item 10. Certain fees have been paid to DHP, Inc. by Registrant.\nb. Compensation Pursuant to Plans - Registrant has no plan pursuant to which compensation was paid or distributed during 1995, or is proposed to be paid or distributed in the future, to DoHA-II, any partner therein, or any person named in paragraph c. of Item 10 of this report.\nc. Other Compensation - No compensation not referred to in paragraph a. or paragraph b. of this Item was paid or distributed during 1995 to DoHA-II, any partner therein, or any person named in paragraph c. of Item 10.\nd. Compensation of Directors - Registrant has no directors.\ne. Termination of Employment and Change of Control Arrangement - Registrant has no compensatory plan or arrangement, with respect to any individual, which results or will result from the resignation or retirement of\nany individual, or any termination of such individual's employment with Registrant or from a change in control of Registrant or a change in such individual's responsibilities following such a change in control.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\na. Security Ownership of Certain Beneficial Owners - No person is known to Registrant to be the beneficial owner of more than five percent of the issued and outstanding Units.\nb. Security Ownership of Management - No equity security of Registrant are beneficially owned by any person named in paragraph c. of Item 10.\nc. Changes in Control - Registrant does not know of any arrangement, the operation of which may at a subsequent date result in a change in control of Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to Registrant's Amended and Restated Agreement of Limited Partnership, DoHA-II is entitled to 10% of Registrant's distributable cash from operations in each year. There was no such share allocable to DoHA-II for fiscal years 1993 through 1995.\na. Certain Business Relationships - Registrant has no directors.\nb. Indebtedness of Management - No executive officer or significant employee of Registrant, Registrant's general partner (or any employee thereof), or any affiliate of any such person, is or has at any time been indebted to Registrant.\nPART IV\nItem 14.","section_14":"Item 14. (A) Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n1. Financial Statements:\na. Consolidated Balance Sheets at December 31, 1995 and 1994.\nb. Consolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993.\nc. Consolidated Statements of Changes in Partners' Equity for the Years Ended December 31, 1995, 1994 and 1993.\nd. Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993.\ne. Notes to consolidated financial statements.\n2. Financial statement schedules:\na. Schedule XI- Real Estate and Accumulated Depreciation.\nb. Notes to Schedule XI.\n3. Exhibits:\n(a) Exhibit Number Document\n3 Registrant's Amended and Restated Certificate of Limited Partnership and Agreement of Limited Partnership, previously filed as part of Amendment No. 2 of Registrant's Registration Statement on Form S-11, are incorporated herein by reference.\n21 Subsidiaries of the Registrant are listed in Item 2. Properties of this Form 10-K.\n(b) Reports on Form 8-K:\nNo reports were filed on Form 8-K during the quarter ended December 31, 1995.\n(c) Exhibits:\nSee Item 14(A)(3) above.\nSIGNATURES\nPursuant to the requirement 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.\nDIVERSIFIED HISTORIC INVESTORS III\nDate: May 24, 1996 By: Dover Historic Advisors II, General Partner ------------\nBy: DHP, Inc., Partner\nBy: \/s\/ Donna M. Zanghi --------------------------- DONNA M. ZANGHI, Secretary and Treasurer\nBy: \/s\/ Michele F. Rudoi --------------------------- MICHELE F. RUDOI, 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 Registrant and in the capacities and on the dates indicated.\nSignature Capacity Date --------- -------- ----\nDOVER HISTORIC ADVISORS II General Partner\nBy: DHP, Inc., Partner\nBy: \/s\/ Donna M. Zanghi May 24, 1996 ---------------------------- ------------ DONNA M. ZANGHI, Secretary and Treasurer\nBy: \/s\/ Michele F. Rudoi May 24, 1996 ---------------------------- ------------ MICHELE F. RUDOI, Assistant Secretary","section_15":""}
{"filename":"789851_1995.txt","cik":"789851","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nThe Registrant is primarily engaged in the development, manufacture, and marketing of precision measuring instrumentation and accompanying computer hardware and software technology. The Registrant sells its measurement instruments to private industry and governmental agencies for both industrial and military applications. The Registrant also owns its ANOMS Software which is used in airport noise and operations monitoring systems. Subsequent to the year ended June 30, 1995, the Registrant reached an agreement with Harris Miller Miller & Hanson, Inc. (\"HMMH\"), to license the Registrant's ANOMS Software and to transfer the management and implementation of essentially all of the Registrant's airport noise monitoring contracts to HMMH. (See discussion below under \"Recent Events.\")\nThe Registrant is comprised of two active wholly-owned subsidiaries: Larson Davis Laboratories (\"LDL\"), which conducts the design, manufacturing, and sales operations of the Registrant, and Larson Davis, Ltd. (\"LTD\"), the Registrant's distribution subsidiary located in the United Kingdom. Unless the context otherwise requires, when used herein, the term \"Registrant\" refers to Larson Davis Incorporated and its operating subsidiaries.\nRECENT EVENTS\nAirport Noise Monitoring\nEffective August 15, 1995, the Registrant entered into an agreement with HMMH to exclusively license its ANOMS Software for use in the airport noise and operations monitoring industry to HMMH and to transfer the management and implementation of its existing airport noise monitoring contracts and pending bid proposals to HMMH. HMMH is a consulting firm established in 1981 by experienced acoustical engineers that has focused its business on consulting in the noise and vibration market in the transportation industry, including interpreting airport noise regulations and establishing specifications for the hardware and software airports need to monitor sound levels and other environmental occurrences at airports and in surrounding communities. HMMH established the specifications for a number of airports at which the Registrant's systems are being installed and provides consulting work to the Federal Aviation Administration (the \"FAA\"). The Registrant\nbelieves that HMMH has a strong marketing advantage in the airport industry because of its established reputation, experience, and long association with airport administrators. Under the terms of the transaction, the Registrant will receive a guaranteed annual royalty, a percentage of the gross annual revenues of HMMH from the airport noise monitoring business, and a commitment from HMMH to use its best efforts to install the Registrant's instrumentation at all new airport installations. The Registrant will be prohibited from competing with HMMH and, consequently, has accounted for the transaction as a discontinued operation. (See \"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\")\nThe Registrant acquired the ANOMS Software from Technology Integration Incorporated (\"TII\") during the year ended June 30, 1994. Certain former key employees of TII that became employees of the Registrant in connection with this earlier transaction have become employees of HMMH.\nAgreement in Principle\nIn September 1995, the Registrant entered into an Agreement in Principle to acquire technology held by Sensar Corporation, a privately-held Utah corporation (\"Sensar\"), in exchange for the issuance of restricted Common Stock, the payment of cash to redeem certain shares of Sensar, and the assumption or payment of the liabilities of Sensar.\nSensar holds rights to patented proprietary technology with respect to a time-of-flight mass spectrometer designed to detect smaller quantities of impurities in gas vapors than is possible with competing instruments with a much quicker analysis time. Sensar has a great deal of expertise in mass spectrometry, which is used for chemical analysis, chemical separation, isotope identification, and impurity detection. Sensar has sold a limited number of its newly-developed analyzers and does not have significant ongoing revenues. Sensar's instrumentation is currently being used by Micron and Atmel in connection with the fabrication of semiconductors, and it is anticipated that future sales of this product will also be in the semiconductor industry. Sensar also has conducted research and development with respect to instrumentation with applications outside the semiconductor industry, although these technologies have not yet been reduced to marketable products.\nThe technology was developed by Dr. Milton Lee at Brigham Young University (\"BYU\"). BYU holds the patent on the mass spectrometry technology exclusively licensed to Sensar as well as several related technologies. The transaction with Sensar is conditioned on the Registrant obtaining license rights to certain related technologies from BYU.\nThe closing of the transaction is subject to the completion of a due diligence review of Sensar, the negotiation and execution of definitive agreements, and the negotiation of licensing agreements from BYU with respect to related technology. There can be no assurance at this time that the transaction contemplated by the Agreement in Principle will be consummated.\nMEASUREMENT INSTRUMENTATION BUSINESS\nThe hardware products of the Registrant are focused on precision measuring instruments for use in the acoustics and vibration industry. Subdivisions of this market in which the Registrant's instrumentation is currently being utilized are:\nEnvironmental Monitoring provides data used to monitor, control, or avoid noise (unwanted and\/or irritable sound which has a detrimental effect on living organisms). It includes such applications as community noise ordinance compliance surveys, airport noise monitoring, vehicle passby surveys, industrial complex perimeter monitoring, environmental impact studies, OSHA (noise in the work place) mandated surveys, military aircraft sonic boom monitoring, and others.\nProduct Design and Improvement encompasses the use by manufacturers to optimize utilization and minimize acoustic output. For example, the auto and aircraft industries determine noise dampening properties of materials used in insulation; a yacht manufacturer studied acoustic spectrums as an aid in selecting efficient hull designs; and other manufacturers of items such as lawn mowers, computer printers, office equipment, and kitchen appliances employ instruments to alter encasement designs to minimize sound emission.\nStructural Dynamics is the study of the motion of materials to determine characteristics such as fatigue, resonance, material density, and bonding strengths. A consultant used the Registrant's instrumentation to determine the resonant frequency of the vibrations in the Statue of Liberty's arm holding the torch. Braces were designed and installed which resulted in doubling the torch bulb life.\nMedical Applications include hardware and software used in automatic calibration systems for medical equipment. The analysis and treatment of both hearing and speech problems can be improved utilizing the Registrant's instrumentation.\nPredictive Maintenance is an emerging industry in which characteristics of rotating or moving machinery are analyzed to predict failure points. Based on information obtained, planned service can be performed. Currently, the Registrant's instrumentation is being used by helicopter manufacturers, power plant turbine operators, paper producers, and others.\nProfessional Sound includes both manufacturers and consultants. The Registrant provides equipment used to certify sound products' (such as amplifiers, mixers, equalizers, speakers, and microphones) compliance with published specifications. Field engineers rely on portable instrumentation to evaluate the acoustic characteristics of a room or building.\nDefense and Government applications range from ship\/vehicle identification based on spectrum analysis to artillery blast noise studies.\nENVIRONMENTAL NOISE MONITORING BUSINESS\nThe Registrant utilizes its hardware products and its internally developed proprietary software ENOMS in the design, bid, installation, and maintenance of integrated environmental noise monitoring systems. These systems have been used by manufacturing plants as parameter monitors, governmental test labs for blast noise monitoring and analysis, and other environmental and community noise applications. It is also anticipated that the ENOMS software will be applied to the data retrieval and management requirements of the time-of-flight mass spectrometry technology in the event the transactions with Sensar is completed.\nThe Registrant has recently granted an exclusive license to its ANOMS Software to HMMH for use in the airport noise monitoring systems industry, although the Registrant will continue to supply hardware to this industry. (See discussion under \"Recent Events.\")\nMANUFACTURING AND ASSEMBLY\nThe Registrant is involved in the manufacture of both its hardware and software products. It utilizes the service of certain subcontractors to manufacture component parts for its products to minimize the amount of its capital investment and increase its flexibility in dealing with changes in the manufacturing processes. Approximately 30% of manufacturing is performed by subcontractors. However, all final assembly is done by the Registrant's employees as part of its quality control program. Manufacturing activities occupy approximately 12,000 square feet of the Registrant's facilities.\nPRODUCT COMPONENTS\nThe Registrant utilizes a large number of individual electronic components in connection with the manufacture of its precision instrumentation. The Registrant has developed and sells its own line of high quality transducers so that it is no longer dependent on suppliers for these component parts. Most of the other electronic components utilized by the Registrant are available from a number of manufacturers and the Registrant's decisions with respect to suppliers are based on availability of the necessary component, the reliability of the supplier in meeting its commitments, and pricing.\nThe Registrant purchases certain supplies from third-parties for installation in environmental noise monitoring systems. Generally, these supplies consist of \"brand name\" computers, printers, and other peripherals, and are readily available from a variety of manufacturers or suppliers.\nMARKETING AND DISTRIBUTION\nInstrumentation\nThe Registrant markets and distributes its hardware products primarily through independent manufacturer's representatives. The efforts of these contracted representatives are supported by an in-house staff of marketing and technical personnel.\nThe Registrant invests in both image building and direct product advertising. This exposure takes many forms, including participation on industry standards boards, exhibitions at trade shows, company sponsored training classes, direct technical demonstrations, and industry publication ads. The Registrant has budgeted resources to support its belief that effective and continued exposure is required to establish greater name recognition and overall positive market perception.\nThe total market size of the acoustics and vibration industry decreased in the past few years, although it has begun to increase again since June 30, 1994. Management believes this was due in part to general global economic conditions. The timing of the purchase of acoustical noise monitoring equipment is often discretionary and both private industry and governments made alternative applications of their limited funds. Since June 30, 1994, the Registrant has seen signs of a change in these conditions. Revenues from continuing operations are up over last year, product backlog has increased, and inquiries about instrumentation have strengthened significantly. As resources allow, the Registrant plans to increase its marketing efforts as a stimulus to sales efforts. The Registrant has no current plans to change its basic approach to distribution.\nEnvironmental Monitoring\nEnvironmental monitoring contracts are normally awarded after a competitive bid process. Such bids are typically awarded based on the price, specifications of the proposed system, reputation of the contractor, and recommendations from current users.\nCURRENT ORDERS\nAs of October 6, 1995, the Registrant had an order backlog believed to be firm of approximately $1,200,000 which is not reflected in the financial statement included elsewhere herein. The Registrant anticipates filling this backlog within 60 days. This compares to a backlog in October of 1994 of $850,000, which took approximately 45 days to fill. This increase is primarily due to a growth in unit orders for the Registrant's instrumentation.\nRESEARCH AND DEVELOPMENT\nGeneral\nThe Registrant is engaged in a highly technical industry where constant research and development is required to maintain competitive products in its sophisticated market. The Registrant has since its inception committed a significant portion of operating capital to perform needed development. As compared to net sales from continuing operations the expenditure for research and development for the fiscal years ended June 30, 1995 and 1994, has been 11% and 16%, respectively. During the fiscal year ended June 30, 1995, research and development spending was $708,679. It is anticipated that in future years this commitment level to research and development will continue to be a material portion of the Registrant's spending.\nCrossCheck Technology\nIn March 1994, the Registrant acquired the exclusive license to a technology known as \"CrossCheck,\" a proprietary hardware and process used to determine, in real time, the in situ characteristics of polymer substances. The technology was developed at Brigham Young University, and the Registrant gained its rights through an exclusive licensing agreement with the University's Technology Transfer Office. Brigham Young University has recently been granted a United States patent with respect to this technology.\nOriginally developed and tested as a means to quantify the cure and shelf life characteristics of resins used in pre-impregnated composites (graphite, fiberglass, and boron fibers), CrossCheck has broad potential application. Polymers are a large category of chemicals that form \"giant\" molecules from individual molecules of the same substance, and include such materials as oils, resins, plastics, concretes, paints, and adhesives. Under traditional methods for testing the characteristics of such materials, a sample portion is used in destructive testing. The CrossCheck technology monitors the cross-linking chemical qualities of polymers. A real time, in situ method to determine material quality will potentially save a great deal of time and money in those industries in which the chemical composition of polymers is important. In testing, CrossCheck has been shown to detect changes in polymers with sensitivity greatly in excess of that of existing testing equipment costing in excess of $50,000. It is expected the CrossCheck technology will be able to provide such information economically.\nThe Registrant has investigated the potential application of CrossCheck in a number of industries. Set forth below is a short summary of certain of these applications.\nComposites Industry. Many \"space age\" composite materials are cured polymers that provide superior weight to strength ratios. It is anticipated that CrossCheck will be able to monitor the chemical reactivity of the polymers from the instant of application through full cure, providing assurances that the desired characteristics are achieved.\nLubrication Industry. The Registrant anticipates that CrossCheck can be used to monitor the lubrication properties of engine, transmission, and hydraulic oils. Existing technology is impractical for reasons of cost, size, inability to withstand high temperatures, or other factors. It is anticipated that the technology would first be focused on applications in which chemical changes in the oil can lead to critical failures, but will be followed by efforts in the automobile industry.\nEnvironmental Monitoring. The CrossCheck technology can potentially be used to test ground water, lakes, streams, or storage facilities for potential contaminants.\nManufacturing Industry. Delivering consistent, high-quality chemical products can be a challenging task. The CrossCheck technology may allow chemists and engineers involved in the manufacture of paints, adhesives, foods, medicines, fuels, oils, and similar products to monitor the chemical properties of the product during the mixing cycles.\nChemical Inventory Control. The CrossCheck technology could be used to monitor the quality of stored chemicals to assure quality at the time of usage.\nElectrical Utilities. The CrossCheck technology could be used to monitor the oil in transformers to minimize or prevent the unpredicted failure of such transformers due to changes in the oil composition.\nConcrete Industry. CrossCheck technology could be used to monitor the \"curing\" of concrete to assure quality, strength, and hardness. The only current method of obtaining this information is destructive testing.\nThe foregoing applications are currently being explored by the Registrant. The Registrant anticipates that it will be required to enter into agreements with established industry partners and to obtain substantial research and development funding before it will be able to reduce the CrossCheck technology to marketable products and exploit one or more of the potential market applications.\nMass Spectrometer Technology\nIf the acquisition of Sensar technology and the related technology from BYU is completed, the Registrant will acquire a nest of related technologies that will require significant research and development expenditures.\nThe Registrant will enter into employment agreements with Dr. Milton Lee and Dr. Edgar Lee in connection with the closing. In addition, the Registrant will make employment offers to two additional employees of Sensar.\nDr. Milton L. Lee is a founder and chairman of the board of Sensar. He is the H. Tracy Hall Professor of Chemistry at Brigham Young University, where he has taught since 1976. Dr. Lee founded and is the editor of the Journal of MicroColumn Separations and serves on the editorial advisory boards of Chromatographia, Journal of Supercritical Fluids, and Polycyclic Aromatic Compounds. Dr. Lee is the co-author of two books and over 330 scientific publications. Dr. Lee has received numerous awards for his contributions in chemical analysis and is listed as the inventor on nine patents.\nDr. Lee is a member of the American Chemical Society, Sigma Xi, and the Scientific Organizing Committee of the International Symposia on Capillary Chromatography. He received his B.A. in Chemistry from the University of Utah in 1971, and his Ph.D. in Analytical Chemistry from Indiana University in 1975.\nDr. Edgar D. Lee is a founder and vice-president of research of Sensar and serves as an adjunct researcher at Brigham Young University. Dr. Lee has extensive experience in a number of areas of mass spectrometry and has co-authored 21 published articles and 45 technical papers in this field. Dr. Lee is also the co-holder of three patents in his areas of expertise. Prior to founding Sensar in 1990, Dr. Lee was employed at Midwest Research Institute from December 1988 through August 1990, first as a mass spectrometrist and later as a senior mass spectrometrist. While at Midwest Research Institute, Dr. Lee was responsible for research, development, and implementation of state-of-the-art mass spectrometric techniques at its Center for Advanced Instrumentation.\nDr. Lee is a member of the American Chemical Society and the American Society for Mass Spectrometry. He pursued undergraduate chemistry studies at Utah State University and was awarded a B.A. in Chemistry in 1984 from Brigham Young University. Dr. Lee received a Ph.D. in Analytical Toxicology, with emphasis in Analytical Chemistry and Instrumentation Engineering in 1988 from Cornell University.\nPATENTS AND TRADEMARKS\nThe technology owned by the Registrant is proprietary in nature. In connection with the design and construction of its precision measurement instrumentation and its proprietary software, the Registrant primarily relies on confidentiality and nondisclosure agreements with its employees, appropriate security measures, copyrights, and the encoding of its software in order to protect the proprietary nature of its technology rather than patents which are difficult to obtain in the computer software area, require public disclosure, and can often be successfully avoided by sophisticated computer programmers. The CrossCheck technology held by the Registrant is the subject of a recent United States patent and several continuations-in-part and international patent applications. The Registrant has also registered \"NOISEBADGE\" to use as a trademark in the marketing of noise level meters with the United States Office of Patents and Trademarks.\nCOMPETITION\nInstrumentation\nThe hardware products are positioned in a niche market which caters to a technically sophisticated user base. For a number of years this market was dominated by a single competitor, Bruel & Kjaer (\"B&K\"). B&K has traditionally been the largest supplier of acoustics and vibration instrumentation in the world. B&K was purchased by a German company which had no previous ties to the acoustics and vibration industry in 1992, and currently has a much reduced presence in the market.\nIn addition to B&K, there are several smaller companies in direct competition with the Registrant. None of these other competitors has available the full line of products offered by the Registrant. There are also a small number of large companies which produce, in most cases, a single product which can be adapted to certain applications in the acoustics industry.\nWhile many of the companies which compete with the Registrant have greater financial and managerial resources, management believes the Registrant can compete effectively based on its ability to: (1) adapt rapidly to technology changes, (2) technically market to specialized users, and (3) offer a complete line of solutions to users' needs.\nEnvironmental Monitoring\nThe environmental noise monitoring market has several smaller consulting or value-added companies which compete indirectly with the Registrant's ENOMS systems. There are no completed noise monitoring systems which compare with all the features and capabilities of the software provided by the Registrant.\nB&K manufactures instrumentation used in noise monitoring systems. Many of the competitors to the Registrant use B&K's equipment in systems. For a time, B&K entertained the idea of permanently linking their hardware to one of the smaller competitor's software. Eventually, B&K announced they would supply hardware only, and not get directly involved with software elements.\nMAJOR CUSTOMERS AND FOREIGN SALES\nThere were no customers which represented more than 10% of the total revenues for the Registrant during the years ended June 30, 1995, or 1994. In fiscal years ended June 30, 1995 and 1994, government sales were not significant with sales volumes less than 5% of continuing operations for each of the years.\nExport sales of the Registrant for the years ended June 30, 1995 and 1994, are 54% and 45% of revenues from continuing activities, respectively. The Registrant exported its products into a number of geographical markets that are more specifically identified in the notes to the financial statements of the Registrant. (See \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\")\nPERSONNEL\nThe Registrant currently has 81 employees, 20 of which are involved in professional or technical development of products, 36 in manufacturing, 13 in marketing and sales, and 12 in administrative and clerical. None of the employees of the Registrant are represented by a union or subject to a collective bargaining agreement, and the Registrant considers its relations with its employees to be favorable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nThe Registrant owns its own administrative and manufacturing facilities in Provo, Utah, subject to a security lien granted to a commercial financial institution to secure a purchase money loan. The facilities include approximately 12,000 square feet of administrative, engineering, and research and development space and approximately 12,000 square feet of manufacturing, storage, and shipping space. Management considers the existing manufacturing facilities sufficient to accommodate the anticipated growth of the Registrant over the next three to five years. (See \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\")\nIn connection with the operation of its Airports Business, the Registrant opened an office in Boston, Massachusetts. The lease covers approximately 4,200 square feet of space with a monthly rental payment of approximately $4,100. This space is currently sublet on a month-to-month basis for the amount of the monthly rental payment plus operating expenses.\nIn addition, approximately 1,200 square feet of space is being rented on a month-to-month basis in England for the offices of LTD. The monthly rental is approximately $425.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant is not a party to any material pending legal proceedings and, to the best of its knowledge, no such proceedings by or against the Registrant have been threatened. To the knowledge of management, there are no material proceedings pending or threatened against any director or executive officer of the Registrant, whose position in any such proceeding would be adverse to that of the Registrant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the Registrant's fiscal quarter ended June 30, 1995, the Registrant did not hold an annual meeting and no matters were submitted to a vote of the security holders of the Registrant, through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of the Registrant is listed on the National Association of Securities Dealers, Inc., Automated Quotation system (\"NASDAQ\"), under the symbol \"LDII.\"\nThe following table sets forth the approximate range of high and low bids for the common stock of the Registrant during the periods indicated. The quotations presented reflect interdealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions in the common stock.\nQuarter Ended High Bid Low Bid\nSeptember 30, 1993 $4.75 $2.375 December 31, 1993 $4.50 $3.625 March 31, 1994 $7.50 $3.875 June 30, 1994 $5.875 $3.375 September 30, 1994 $4.875 $2.625 December 31, 1994 $3.38 $2.00 March 31, 1995 $3.00 $2.00 June 30, 1995 $4.1666 $2.25\nOn October 6, 1995, the closing quotation for the common stock on NASDAQ was $6.0625. As reflected by the high and low bids on the foregoing table, the trading volume of the common stock of the Registrant is limited, creating significant changes in the trading price of the common stock as a result of relatively minor changes in the supply and demand. Consequently, potential investors should be aware that the price of the common stock in the trading market can change dramatically over short periods as a result of factors unrelated to the earnings and business activities of the Registrant.\nAs of October 6, 1995, there were 7,586,726 shares of common stock issued and outstanding, held by approximately 1,300 beneficial holders.\nThe Registrant has not paid dividends with respect to its common stock. The Registrant has 1,000,000 shares of its 1995 preferred stock issued and outstanding which prohibit the payment of dividends on the common stock if the annual dividend of $0.225 per share of preferred stock is in arrears. Other than the foregoing, there are no restrictions on the declaration or payment of dividends set forth in the articles of incorporation of the Registrant or any other agreement with its shareholders. Management anticipates retaining any potential earnings for working capital and investment in growth and expansion of the business of the Registrant and does not anticipate paying dividends on the common stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCERTAIN FINANCIAL DATA\nThe following financial data of the Registrant is not covered by an opinion of independent certified public accountants and should be read in conjunction with the financial statements and related notes of the Registrant for the periods indicated included elsewhere herein.\nDISCONTINUED OPERATIONS\nIn conformity to Management's plan to focus its available monetary and human resources, the Registrant has restructured its business. During the fiscal year ended June 30, 1993, the Registrant made a decision to discontinue the development of wholesale and retail software products not related to its instrumentation business, and pursued a sale of the technology and related assets. During the fiscal year ended June 30, 1994, the Registrant elected to write-down the carrying value of the related net assets to zero and is no longer actively seeking to sell the related assets.\nDuring the fourth quarter of the fiscal year ended June 30, 1995, the Registrant made a decision to transfer its technology, marketing rights, and interests in airport noise monitoring installation contracts (the \"Airports Business\") as a method to maximize financial return from assets purchased from TII and later enhanced by development. (See \"ITEM 1. BUSINESS: Recent Developments.\")\nSubsequent to June 30, 1995, the Registrant entered into an agreement to transfer the Airports Business to HMMH. (See Notes to Financial Statements, Note 17 - DISCONTINUED OPERATIONS.) Because of the exclusive marketing rights transferred to HMMH, \"Airports Business\" was determined to include contracts assigned to HMMH and essentially completed contracts retained by the Registrant. Consequently, the Registrant in the fourth quarter of the fiscal year ended June 30, 1995, reassessed revenues and expenses associated with the Airports Business, which contributed to a greater loss from operations of the discontinued business segment than earlier anticipated. The Registrant determined in the fourth quarter that estimated costs to complete existing airport contracts had increased each interim period. The assets and results of operations from the Airports Business has been reflected on the financial statements as a discontinued business segment.\nBecause a portion of the payment is based on a royalty from gross sales by HMMH, the Registrant has elected to use the \"Cost Recovery\" method to recognize revenues and costs. This means that a dollar for dollar matching of monies received and costs expensed will be performed until all costs are expensed, and only after this will the Registrant realize any gain from the HMMH agreement. As part of the HMMH agreement, HMMH must use its best efforts to install the Registrant's instrumentation with all new airport noise monitoring contracts it obtains. The Registrant will realize its normal, export level, gross profit on these sales, due to the 25% discount from list price offered to HMMH.\nNet sales from continuing operations represents sales from the Registrant's instrumentation business. The Registrant in past years has pursued a strategy of diversification as a way to enhance sales and increase profits. After a period of disappointing results, the Registrant has refocused efforts to develop its instrumentation business.\nDue to the required netting of revenues, costs, and expenses associated with discontinued operations, the following tables identify the nature of discontinued operations:\nSIGNIFICANT FINANCIAL CHANGES - STATEMENTS OF INCOME\nTotal Revenue\nNet sales from continuing operations for the fiscal years ended June 30, 1995 and 1994, is $6,515,830 and $5,137,638, respectively. The Registrant experienced a decline in sales of its sound and vibration instrumentation in 1994. This was related in part to a general global recession. The Registrant was able to maintain its established market share in a then shrinking market. In the fiscal year ended June 30, 1995, instrumentation sales increased by 27% from $5,137,638 in 1994 as compared to $6,515,830 in 1995. Management expects the strengthening of its instrumentation market to continue.\nForeign sales have been an important part of the Registrant's business plan for many years. For the fiscal years ended June 30, 1995 and 1994, foreign sales as a portion of continuing operations account for 54% and 45%, respectively. The increase in 1995 is partially due to the Registrant's operations in the United Kingdom through its subsidiary, LTD.\nIn the fiscal years ended June 30, 1995 and 1994, government sales were not significant and represented less than 5% of sales from continuing operation in each year.\nCost of Sales and Operating Expenses\nThe Registrant's cost of sales and operating expenses as a percentage of sales from continuing operations for the years ended June 30, 1995 and 1994, are 40% and 42%, respectively. The Registrant believes its efforts to better track costs and control inventories has contributed to the decrease in cost of sales and operating expenses between the fiscal years ended June 30, 1995, and 1994.\nResearch and Development\nSince its inception, the Registrant has dedicated significant operating funds to research and development. For the years ended June 30, 1995 and 1994, this commitment represents 11% and 16%, respectively, of the Registrant's net sales from continuing operations. The Registrant introduced a number of new products over the past 12 months which caused the increased spending reflected in 1994 (the time period when costs were expensed before sales began), and will continue to offer new instruments to enhance its product line.\nThe Registrant is involved in a high-tech industry which demands constant improvements and development of its instrumentation to remain technically viable. It is anticipated this aggressive approach to research and development will continue and the Registrant will dedicate significant levels of available resources to this activity.\nSIGNIFICANT FINANCIAL CHANGES - BALANCE SHEETS\nTrade Accounts Receivable\nThe Registrant's accounts receivable increased by 32% from June 30, 1994 to 1995, and two factors have contributed to this increase. First, sales from continuing operations grew 27% for the same period. Secondly, foreign sales are a larger portion of net sales from continuing operations (traditionally, foreign billings take longer to collect). On June 30, 1995, the balance of $2,130,835 represents a receivable aging of 123 days.\nInventories\nInventories have remained virtually identical to 1995 from 1994 at $2,152,768 and $2,155,232, respectively. The Registrant has been able to increase net sales from continuing operations by 27% and maintain the inventory level unchanged.\nCost and Estimated Earnings in Excess of Related Billings\nThe Registrant recognizes income on long-term contracts on a percentage-of-completion method while billings to customers are made on milestones specified in agreements. With the introduction of the discontinued operations classification of the balance sheet, a reclassification of assets related to the Airports Business occurred. Portions of the costs and estimated earnings in excess of related billings were reclassed to net assets held for sales. The $200,318 balance of this account represents actual invoices which the Registrant will bill in the normal course of its business. The remainder of this category was transferred to HMMH. (See Report on Form 8-K dated June 30, 1995.)\nNet Assets Held For Sale\nNotes to Financial Statements - Note 17 - \"Discontinued Operations\" details the effect of the disposal of the Airports Business on the balance sheet as of June 30, 1995. Net assets held for sale are reflected at $3,135,776 and will be expensed against revenues received from HMMH.\nOther Assets - Product technology, licenses rights and software development costs\nNotes to Financial Statements - Note 6 - \"Product Technology, License Rights and Software Development Costs\" details the effect of the disposal of the Airports Business on the balance sheet as of June 30, 1995. The balance at year end is $1,975,699.\nCurrent Liabilities\nCurrent liabilities decreased $991,165 from June 30, 1994, to June 30, 1995. This decrease is primarily due to reductions in short-term notes payable of $562,862 and in accounts payable of $402,977. Other current liability accounts varied as a result of normal operations. The Registrant utilized proceeds from the issuance of common stock to reduce liabilities and restructure debts.\nCAPITAL AND LIQUIDITY\nAt June 30, 1995, the Registrant had total current assets of $4,702,603 and total current liabilities of $3,954,816, resulting in a working capital ratio of 1.2:1. Included in total current liabilities is approximately $1,920,000 representing the Registrant's revolving line of credit. The limit on this line of credit is currently $2,400,000 and is adjusted from time to time based on ratios of inventories and accounts receivable levels. The line of credit is also secured by common stock owned by two of the directors of the Registrant along with personal guarantees from these same directors. The line of credit is reviewed annually and the Registrant anticipates it will continue to remain available.\nIn an agreement effective August 15, 1995, the Registrant transferred the rights to certain assets to HMMH in return for guaranteed and variable payments. The Registrant was paid a one-time fee of $125,000, will receive $150,000 in guaranteed annual royalties of the lessor of a ten-year period or the term of the agreement, and will be a varying royalty of 2.5% to 4% on the gross revenues of HMMH from the sale, installation, upgrade, and maintenance of airport noise and operations monitoring systems. HMMH will use its best efforts to include the Registrant's hardware in its future proposals for airport noise monitoring systems and the Registrant will provide such equipment at a 25% discount from its regular pricing structure. HMMH has the right to purchase all of the Registrant's rights to the ANOMS software at a predetermined price of $3,000,000, $2,200,000, $1,700,000, and $875,000, respectively, on the three, five, seven, and ten year anniversaries of the agreement. HMMH has the right to terminate the agreement after an initial three- year period and, at the end of the ten year term, can elect to extend the agreement for an additional five years during which it would be obligated to pay a royalty of 3% on its gross revenues from the airport systems.\nThe Registrant has eliminated out-of-pocket expenses in connection with its Airports Business which will benefit overall cash flow. The funds anticipated from HMMH will be applied to liabilities associated with the acquisition of assets from TII. The Registrant's net cash condition should be significantly improved by this arrangement.\nSubsequent to the fiscal year end of June 30, 1995, the Registrant has received proceeds from the sale of common stock of approximately $1,100,000 net. The Registrant has relied on capital infusion for the past two years to sustain its losses in discontinued operations and anticipates further sales of common stock during the upcoming year.\nThrough its acquisition of Sensar, if completed, the Registrant would benefit from various state and federal government grant and development contract funds which have been awarded to Sensar for development of its technologies. Sensar has made application for and received in the past funds made available through governmental agencies such as EPA, the State of Utah, and SBIR research grants. The Registrant intends to continue the practice of seeking this type of development funding.\nITEM 7.","section_7":"ITEM 7. FINANCIAL STATEMENTS\nThe financial statements and supplementary data are included beginning at page ___. See page ___ for the index to the financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Registrant and its auditors have not disagreed on any items of accounting treatment or financial 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\nSet forth below is the name and age of each executive officer and director of the Registrant, together with all positions and offices of the Registrant held by each and the term of office and the period during which each has served:\nDirector and\/or Position and Executive Officer Name Age Office Held Since\nBrian G. Larson 52 President and Chairman of the Board September 30, 1987\nLarry J. Davis 44 Vice-President and Director September 30, 1987\nDan J. Johnson 44 Vice-President, Secretary, Treasurer, and Director September 30, 1987\nNathan H. West 36 Principal Accounting Officer, LDL August 10, 1994\nRick Clayton 45 Principal Accounting Officer, LTD. January 1, 1991\nA director's regular term is for a period of three years or until his successor is duly elected and qualified. The terms of the board are staggered so that one-third of the board is subject to election at each annual shareholders' meeting. The current term of Brian G. Larson expires at the 1996 annual meeting, the current term of Larry J. Davis expires at the 1997 annual meeting, and the current term of Dan J. Johnson expires at the 1995 annual meeting.\nThere is no family relationship among the current directors and executive officers. The following sets forth brief biographical information for each director and executive officer of the Registrant.\nBrian G. Larson, was a founder and has been an executive officer, director, and principal shareholder of the Registrant since its inception in 1981. Mr. Larson earned his masters of business administration from Brigham Young University in 1972 and a bachelor's degree in electrical engineering from the same institution in 1971. During the time he was attending Brigham Young University, Mr. Larson worked as a design engineer in the medical research laboratory of Brigham Young University.\nLarry J. Davis, was a founder and has been an officer, director, and principal shareholder of the Registrant since its inception in 1981. Mr. Davis earned his electrical engineering degree from Brigham Young University in 1974, where he graduated Magna Cum Laude.\nDan J. Johnson, has served as the vice-president in charge of administration and financial strategy, asset control, and fiscal operations of the Registrant since 1984. Prior to that time, he was a director of finance for Fiber Technology Corporation. Mr. Johnson has also been previously employed with a public accounting firm.\nNathan H. West, has served as the principal accounting officer of Larson Davis Laboratories since August 1994. Immediately prior to his employment by the Registrant, he was assistant controller for Savage Industries, Inc., a privately-held company, from 1987 through 1994. Mr. West received a bachelor of science degree in accounting from the University of Utah in 1985.\nRick Clayton, has been an employee of the Registrant since February 1988 and the principal accounting officer of LD Info., Inc., since January 1991. Prior to his employment by the Registrant, Mr. Clayton was an assistant controller for Zions Mortgage Company. Mr. Clayton received a bachelor of science in accounting from Brigham Young University in 1976.\nSection 16 Reporting\nLaura Huberfeld and Naomi Bodner, principal shareholders of the Registrant, each filed a report on form 3 in an untimely fashion. Reports with respect to the foregoing transactions have been filed.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. EXECUTIVE COMPENSATION\nThe following table sets forth the cash compensation paid by the Registrant and its subsidiaries for the fiscal years ended June 30, 1995, 1994, and 1993 to the chief executive officer of the Registrant and the other officers of the Registrant who received compensation in excess of $100,000.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nOptions to acquire 17,570 shares of stock were exercised during the year ended June 30, 1995.\nITEM 11.","section_11":"ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of October 6, 1995, the number of shares of the Registrant's common stock, par value $0.001, held of record or beneficially by each person who held of record or was known by the Registrant to own beneficially, more than 5% of the Registrant's common stock, and the name and shareholdings of each officer and director and of all officers and directors as a group.\n[FN] (1)Except as otherwise indicated, to the best knowledge of the Registrant, all stock is owned beneficially and of record, and each shareholder has sole voting and investment power.\n(2)These options have been issued to the executive officers and directors pursuant to the 1987 Stock Option Plan and the Director Stock Option Plan. Options to acquire 130,000 shares each issued to Messrs. Larson and Davis have an exercise price of $2.0625 per share; options to acquire 30,000 shares each have an exercise price of $2.54375 per share; options to acquire 30,000 shares have an exercise price of $3.30 per share; options to acquire 30,000 shares have an exercise price of $3.85 per share, and options to acquire 30,000 shares have an exercise price of $3.64375 per share. The options held by Mr. Johnson to acquire 159,430 shares have an exercise price of $2.0625 per share; options to acquire 30,000 shares have an exercise price of $2.3125 per share; options to acquire 30,000 shares have an exercise price of $3.00 per share; and options to acquire 30,000 shares have an exercise price of $3.50, and options to acquire 30,000 shares have an exercise price of $3.64375 per share The exercise price is equal to the fair market value, in the case of Mr. Johnson, and 110% of fair market value, in the case of Messrs. Larson and Davis, of the common stock of the Registrant as of the date of grant as determined by the board of directors based on the trading price of the common stock of the Registrant in the over-the-counter market. The options are exercisable for a period of five years from the date of grant. Each of the directors is restricted from first exercising options with respect to more than $100,000 worth of stock during the initial years of the term of the options.\n(3)The percentages shown are based on 7,586,726 shares of common stock of the Registrant issued and outstanding as of October 6, 1995.\n(4)The percentage ownership for the options held by the indicated individuals is based on an adjusted total of issued and outstanding shares giving effect only to the exercise of each individual's options.\n(5)The number of shares indicated for Mr. Larson includes 793,619 shares owned jointly with his wife over which he exercises joint investment and voting control, and 47,400 shares which are held of record by Mr. Larson for the benefit of his minor children and in which he disclaims direct economic interest.\n(6)The number of shares owned by Mr. Davis includes 745,498 shares held jointly with his wife over which he exercises joint investment and voting control and 75,000 shares which are held of record by Mr. Davis for the benefit of his minor children and in which he disclaims direct economic interest.\n(7)The Registrant entered into an agreement with the holders of its $3.50 and $4.50 A Warrants, including Ms. Huberfeld and Ms. Bodner, pursuant to which it agreed to issue additional warrants to purchase shares of common stock at $4.50 (the $4.50 B Warrants\") and $5.75 (the \"$5.75 Warrants\") if the holders exercised their $3.50 Warrants by October 1, 1995 (which has occurred) and their $4.50 Warrants by November 1, 1995, or, if later, 30 days after the effectiveness of a registration statement with respect to the resale by the warrant holders of the common stock underlying the $4.50 A Warrants. In the event Ms. Huberfeld and Ms. Bodner timely exercise their $4.50 A Warrants as set forth above, they will each receive a $4.50 B Warrant to acquire 200,104 shares of common stock and a $5.75 Warrant to acquire 400,208 shares of common stock. The $4.50 B and $5.75 Warrants which might be issued are not reflected on the foregoing table.\nITEM 12.","section_12":"ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nGUARANTEES FROM PRINCIPALS\nThe two founders and principal shareholders of the Registrant have guaranteed the obligation of the Registrant on its revolving line of credit that had an outstanding balance of approximately $1,920,000 at June 30, 1995, and on a short-term obligation in the principal amount of $301,500. In addition, these principals have guaranteed the performance of the Registrant with respect to certain equipment leases and other financial commitments of the Registrant in the amount of approximately $389,000.\nPART IV\nITEM 13.","section_13":"ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND SCHEDULES\nThe following financial statements and schedules are included immediately following the signatures to this report. Page\nReport of Peterson, Siler & Stevenson, independent public accountants ___\nConsolidated Balance Sheets as of June 30, 1995 ___\nConsolidated Statements of Operations for the years ended June 30, 1995 and 1994 ___\nConsolidated Statement of Stockholders' Equity for the years ended June 30, 1995 and 1994 ___\nStatements of Cash Flows for the years ended June 30, 1995 and 1994 ___\nNotes to Financial Statements ___\nFinancial Statement Schedules are omitted because they are not applicable or because the required information is contained in the Financial Statements or the Notes thereto.\nEXHIBITS SEC Exhibit Reference No. No. Title of Document Location 1 (3) Articles of Incorporation, Exhibit to report as amended on form 10-K for November 3, 1987 the year ended June 30, 1988*\n2 (3) Certificate of Amendment Exhibit to report Articles of Incorporation on form 10-K for the year ended June 30, 1989*\n3 (3) Designation of Rights, Registration Privileges, and Preferences Statement filed of 1995 Series Preferred on form SB-2, Stock Exhibit 3, SEC File No. 33-59963*\n4 (3) Bylaws Registration Statement filed on form S-18, Exhibit 5, SEC File No. 33-3365-D*\n5 (4) Form of $2.50 Warrant Registration Agreement Statement filed on form SB-2, Exhibit 5, SEC File No. 33-59963*\n6 (4) Form of $3.50 Warrant Registration Agreement Statement filed on form SB-2, Exhibit 6, SEC File No. 33-59963*\n7 (4) Form of $4.50 A Warrant This Filing Agreement\n8 (4) Agreement between Larson This Filing Davis Incorporation and Warrant Holders\nAgreements relating to research and development work performed by the Company in 1983 for two unrelated funding entities\n9 (10) (a) Purchase Option Exhibit to report Agreement between on form 10-K for Larson Davis, the year ended Laboratories and LDL June 30, 1988* Research and Development, dated August 31, 1983\n10 (10) (b) License Option Exhibit to report Agreement between on form 10-K for Larson Davis the year ended Laboratories and LDL June 30, 1988* Research and Development, Ltd., dated August 31,\n11 (10) (c) Cross License Option Exhibit to report between Larson Davis on form 10-K for Laboratories and LDL the year ended Research and June 30, 1988* Development II, Ltd., dated November 21, 1983\n12 (10) (d) Purchase Option between Exhibit to report Larson-Davis on form 10-K for Laboratories and LDL the year ended Research and Development June 30, 1988* II, Ltd., dated November 21, 1983\n13 (10) 1987 Stock Option Plan Exhibit to report of Larson Davis on form 10-K for the year ended June 30, 1988*\n14 (10) 1991 Employee Stock Exhibit to report Award Plan of Larson on form 10-K for Davis Incorporated the year ended June 30, 1992*\n15 (10) 1991 Director Stock Exhibit to report Option and Stock on form 10-K for Award Plan of Larson the year ended Davis Incorporated June 30, 1992*\n16 (10) Acquisition Agreement Incorporated by by and between Larson Reference from Davis Laboratories and report on form Technology Integration 8-K dated Incorporated, dated March 18, 1994* March 18, 1994\n17 (10) First Amendment to Incorporated by Acquisition Agreement Reference from dated March 28, 1994 report on form 8-K dated June 30, 1994*\n18 (10) Second Amendment to Incorporated by Acquisition Agreement Reference from dated June 16, 1994 report on form 8-K dated June 30, 1994*\n19 (10) Agreement between Registration Larson Davis Statement Filed Laboratories and Summit on Form SB-2, Enterprises, Inc., Exhibit 20, SEC of Virginia dated File No. May 24, 1995 33-59963*\n20 (10) Technology License, Incorporated by Assumption, and Reference from Maintenance Agreement report on form between Larson Davis 8-K\/A dated Incorporated and Harris June 30, 1995 Miller Miller & Hanson, Inc., dated August 15,\n21 (21) Subsidiaries of Larson Incorporated by Davis Incorporated Reference from report on form 10-KSB dated June 30, 1994*\n22 (23) Consent of Peterson, This Filing Siler & Stevenson\n_____________________ *Incorporated by reference\nREPORTS ON FORM 8-K\nThe Registrant filed a form 8-K dated June 30, 1995, as amended, with respect to the transaction with Harris Miller Miller & Hanson, Inc.\nSIGNATURES\nPursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.\nLARSON DAVIS INCORPORATED\nDated: October 12, 1995 By \/s\/ Brian G. Larson Brian G. Larson, President (Principal Executive Officer)\nDated: October 12, 1995 By \/s\/ Dan J. Johnson Dan J. Johnson, Secretary\/Treasurer (Principal Financial and Accounting 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:\nDated: October 12, 1995 By \/s\/ Brian G. Larson Brian G. Larson, Director\nDated: October 12, 1995 By \/s\/ Larry J. Davis Larry J. Davis, Director\nDated: October 12, 1995 By \/s\/ Dan J. Johnson Dan J. Johnson, Director\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nFINANCIAL STATEMENTS\nJUNE 30, 1995\nPETERSON, SILER & STEVENSON, P.C. CERTIFIED PUBLIC ACCOUNTANTS\nPETERSON, SILER & STEVENSON, P.C. Certified Public Accountants 430 East 400 South Salt Lake City, Utah 84111 (801) 328-2727\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors LARSON-DAVIS INCORPORATED AND SUBSIDIARIES Provo, Utah\nWe have audited the accompanying consolidated balance sheet of Larson- Davis Incorporated and Subsidiaries at June 30, 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended June 30, 1995 and 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Larson-Davis, Ltd., a wholly owned subsidiary, which statements constitute approximately 4% of total assets and 14% of total revenues of the related consolidated totals. 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 Larson-Davis, Ltd., 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Larson-Davis Incorporated and Subsidiaries as of June 30, 1995 and the results of their operations and their cash flows for the years ended June 30, 1995 and 1994 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 18 to the consolidated financial statements, the Company has suffered a significant loss from operations and is currently discontinuing certain of its operations. Management's plans in regard to these matters is also contained in Note 18.\n\/s\/ PETERSON, SILER & STEVENSON, P.C. August 4, 1995\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nASSETS June 30, CURRENT ASSETS: Cash and cash equivalents $ 83,334 Trade accounts receivable, net of allowance for doubtful accounts of $15,825 2,130,835 Inventories 2,152,768 Other current assets 135,348 Costs and estimated earnings in excess of related billings 200,318 Total Current Assets 4,702,603\nPROPERTY, PLANT, AND EQUIPMENT, net of accumulated depreciation of $1,672,979 1,337,574\nASSETS UNDER CAPITAL LEASE OBLIGATIONS, net of accumulated depreciation of $322,267 303,522\nNET ASSETS OF DISCONTINUED OPERATIONS 3,135,776\nOTHER ASSETS:\nProduct technology, license rights and software development costs net of amortization of $419,626 1,975,699\nGoodwill 124,493 Total Other Assets 6,877,064 $11,579,667\nThe accompanying notes are an integral part of these financial statements.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nLIABILITIES AND STOCKHOLDERS' EQUITY\nJune 30, CURRENT LIABILITIES: Bank overdraft $ 40,039 Short-term notes payable 2,219,187 Accounts payable 886,489 Accrued liabilities: Salaries and commissions 295,243 Payroll taxes 51,308 Other 122,452 Current maturities of long-term debt 206,409 Current maturities of capital lease obligations 133,719 Total Current Liabilities 3,954,846\nLONG - TERM DEBT, less current maturities 958,251\nCAPITAL LEASE OBLIGATIONS, less current maturities 255,080 Total Liabilities 5,168,177\nSTOCKHOLDERS' EQUITY: Preferred stock; $.001 par value: 10,000,000 shares authorized, 200,000 shares issued and outstanding 200\nCommon stock; $.001 par value, 290,000,000 shares authorized, 6,559,479 shares issued and outstanding 6,559 Additional paid-in capital 7,406,114 Retained earnings (deficit) (997,362) Equity adjustment from translation of foreign currency (4,021) Total Stockholders' Equity 6,411,490 $11,579,667\nThe accompanying notes are an integral part of these financial statements.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS For the years Ended June 30, 1995 1994 NET SALES $ 6,515,830 $ 5,137,638\nCOST AND OPERATING EXPENSES: Costs of sales and operating expenses 2,598,586 2,139,814 Research and development 708,679 834,520 Selling, general and administrative 2,449,765 2,442,029 Total costs and operating expenses 5,757,030 5,416,363\nINCOME (LOSS) FROM CONTINUING OPERATIONS 758,800 (278,725)\nOTHER INCOME (EXPENSE): Interest income 7,302 5,625 Interest expense (301,402) (270,383) Other (6,189) 102,247 Total Other Income (Expense) (300,289) (162,511)\nINCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND DISCONTINUED OPERATIONS 458,511 (441,236)\nCURRENT TAX EXPENSE - - DEFERRED TAX EXPENSE - -\nINCOME FROM CONTINUING OPERATIONS BEFORE DISCONTINUED OPERATIONS 458,511 (441,236)\nDISCONTINUED OPERATIONS: Income (loss) from operations of discontinued airport installations division (net of income tax) (770,128) 643,280\nEstimated income (loss) on disposal of airport installations division - -\nLoss from discontinued operations of Larson- Davis Info., Inc. and Advantage Software, Inc. (net of income taxes) - (400,200)\n\tLoss on disposal of the operations of Larson- \t Davis Info., Inc. and Advantage Software, \t Inc. (net of income taxes) -\t (2,156,987)\nINCOME (LOSS) FROM DISCONTINUED OPERATIONS (770,128) (1,913,907)\nCHANGE IN ACCOUNTING PRINCIPLE - Cumulative effect on years prior to June 30, 1994, of application of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes -\t 486,992\nNET INCOME (LOSS) $ (311,617) \t$(1,868,151)\nPRIMARY EARNINGS (LOSS) PER COMMON SHARE: Income (loss) from continuing operations $ .07\t $ (.08) Income (Loss) from discontinued operations of airports installation division (.12) .11 Loss from discontinued operations of Larson- Davis Info., Inc. and Advantage Software, Inc. - (.07) Loss on disposal of Larson-Davis Info., Inc. and Advantage Software Inc. - (.37) Cumulative effect of change in accounting principle - .08\nPRIMARY EARNINGS (LOSS) PER COMMON SHARE $ (.05)\t $ (.33)\nThe accompanying notes are an integral part of these financial statements.\nSupplemental Disclosures of Non-Cash Investing and Financing Activities: For the year ended June 30, 1995: The Company issued 43,405 shares of common stock to employees in lieu of compensation with a computed value of $108,513. The Company in connection with the discontinuance of their operations in the Airport Noise and Operations Monitoring Systems Industry reclassified the associated assets and liabilities to net assets of discontinued operations [See Note 17]. The Company issued 200,000 shares of preferred stock in payment of $500,000 of short term obligations. The Company converted $300,000 of short-term debt to a long-term note payable. The Company issued 30,500 shares of restricted common stock for $26,250 of patent costs and $11,875 of research and development costs expended on the Company's behalf on acquired technologies. The Company issued 25,000 shares of common stock valued at $62,500 to a consultant for services rendered. The Company issued 5,125 shares of common stock valued at $10,575 to an officer of the Company for the cancellation of 8,245 stock options. For the year ended June 30, 1994: The Company acquired certain software and technology by issuing and assuming various liabilities, valued at $2,029,047 [See Note 19].\nThe accompanying notes are an integral part of this financial statement.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation - The accompanying consolidated financial statements of Larson-Davis Incorporated include the accounts of the Company and its wholly-owned subsidiaries, Larson-Davis Laboratories, Advantage Software, Inc., LD Info., Inc. and Larson Davis Limited (a Foreign Corporation). All significant intercompany transactions and accounts have been eliminated in consolidation.\nInventories - Inventories are valued at the lower of cost (using average cost method) or market.\nPlant and Equipment - Equipment is carried at cost less related accumulated depreciation. Depreciation, including amortization of capitalized leases, is computed using the straight-line method over useful lives ranging from 3 to 7 years. Real property and improvements are being depreciated over a useful life of 25 years using the straight-line method.\nEarnings Per Share - The computation of earnings per share of common stock is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period. The weighted average number of shares outstanding for primary earnings (loss) per share are 6,227,707 and 5,824,345 for the years ending 1995 and 1994, respectively. Fully diluted earnings per share are not presented as their effect is anti- dilutive.\nRevenue Recognition - The Company recognizes revenue on product sales and services at the time of product delivery or rendering services. However, with respect to long-term contracts, the Company's earning process extends over a much longer time period. The Company has adopted a percentage-of-completion method for accruing revenues and expenses related to long term contracts. Revenues are accrued and a current, non-trade receivable is created based on progress toward completion of the particular contract. Progress is determined by comparing actual time incurred and materials used with expected estimates of total contract costs. In short, revenues are accrued as they are earned by the Company. Billings to the customer are made according to payment terms of the contract. When a billing is created, the amount of the billing is transferred into the regular trade receivable account to await receipt of payment [See Note 3]. Losses on long-term contracts are recognized when they become apparent.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [Continued]\nCash and Cash 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.\nProduct Technology and License Rights - The Company capitalizes costs incurred to acquire product technology and license rights. These costs are being amortized over estimated useful lives ranging from 10 to 17 years by the straight line method.\nSoftware Development Costs - The Company conducts multiple software development efforts simultaneously. Each individual program is reviewed and evaluated on a product-by-product basis. Pursuant to FASB No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, the Company capitalizes costs incurred to develop software after technological feasibility has been established. Where required by FASB Statement No. 86, amortization of these development costs is computed either based on the number of contracts initiated during the current year relative to the anticipated total number of contracts for that period, or the straight line method over the expected useful life of 10 years, whichever is greater.\nIncome Taxes - Effective for the year ended June 30, 1994, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. There was a cumulative benefit from the change in accounting principle of $486,992 [See Note 7]. The Company previously calculated its tax provision according to FASB Statement No. 96.\nForeign Currency Translation \/ Re-measurement - For foreign subsidiaries whose functional currency is the local foreign currency, balance sheet accounts are translated at exchange rates in effect at the end of the year and income statement accounts are translated at average exchange rates for the year. Translation gains and losses are included as a separate component of stockholders' equity. Exchange gains (losses) are included as a component of general and administrative expense.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 2 - INVENTORIES\nThe composition of inventories at June 30, 1995, consists of the following:\nNOTE 3 - CONTRACTS IN PROGRESS\nThe Company has accrued and recognized revenues on long-term contracts based on a percentage-of completion method [See Note 1], which attempts to recognize the income as it is being earned. The unbilled contract receivable represents amounts of contract revenues accrued and recognized that have not yet been billed to the customer. Billings on the contracts are being made according to payment term stipulations which do not necessarily coincide with the \"earning\" process. At June 30, 1995, the Massport contract accounted for $98,750 of cost and estimated earning in excess of related billings.\nCosts to date, estimated earnings, and the related progress billings to date on other airport contracts in progress are as follows:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nSubsequent to the year ended June 30, 1995, the Company discontinued their business operations in the Airport Noise and Operations Monitoring Systems Industry. The Company has licensed its proprietary Airport Noise and Operations Monitoring Software (ANOMS), with the intent to sell, and transferred management, implementation and future billings of substantially all of its airport noise monitoring contracts [See Note 20].\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 4 - PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at June 30, 1995 consists of the following:\nTotal depreciation expense related to property and equipment was $217,790 and $222,020 for the years ended June 30, 1995 and 1994, respectively.\nNOTE 5 - ASSETS UNDER CAPITAL LEASE OBLIGATIONS\nThe Company leases certain equipment on 36 to 60 month capital leases. The leases contain provisions for the Company to acquire the equipment at the end of the lease term through either payment of a nominal amount or in other cases the greater of fair market value or 10% of the original equipment cost.\nEquipment under capital lease obligations at June 30, 1995 is as follows:\nTotal depreciation on equipment under capital lease obligation was $111,496 and $68,755 for the years ended June 30, 1995 and 1994, respectively.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 5 - ASSETS UNDER CAPITAL LEASE OBLIGATIONS [Continued]\nTotal future minimum lease payments, executor costs and current portion of capital lease obligations is as follows:\nFuture minimum lease payments for the years ended June 30,\nThe Company leases certain office space and equipment under operating leases expiring in 1997. Minimum future rental payments under these non-cancelable operating leases as of June 30, 1995 are as follows:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 6 - PRODUCT TECHNOLOGY, LICENSE RIGHTS AND SOFTWARE DEVELOPMENT COSTS\nThe intangible asset balances at June 30, 1995 of $1,975,699 consist of product technology, license rights, patents and software development costs. These intangible assets are being amortized using the straight line method over useful lives ranging from 5 to 17 years. Total amortization expense on intangible assets was $406,452 and $464,951, for the years ended June 30, 1995 and 1994.\nThe long term value of these assets is connected to the application of these technologies and software costs to viable products which can be successfully marketed by the Company. Management believes current and projected sales levels of its current and planned products will support the carrying costs of the related software and technologies.\nThe following is a summary of product technology, license rights and software development costs at June 30, 1995:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTE 6 - PRODUCT TECHNOLOGY, LICENSE RIGHTS AND SOFTWARE DEVELOPMENT COSTS [Continued]\nSome of the technology was purchased from the founders of the Company, but the largest portion of these rights and technologies were purchased from unrelated third party entities and by entering into royalty contracts. The Company paid royalty expenses included in the statement of income for the years ended June 30, 1995 and 1994 of $73,937 and $69,536, respectively.\nSubsequent to the year ended June 30, 1995, the Company discontinued their operation in the Airport Noise and Operations Monitoring Systems Industry. The Company has licensed its rights to proprietary Airport Noise and Operations Monitoring Software (ANOMS) and has reclassified the net capitalized software costs of $2,533,879 to \"Net Assets of Discontinued Operations.\"\nNOTE 7 - INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes [FASB 109] during Fiscal 1994. FASB 109 requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carryforwards. The financial statements for years prior to 1994 have not been restated and there was a cumulative benefit from the change in accounting principle of $486,992. At June 30, 1995, the total of all deferred tax assets are $953,677 and the total of the deferred tax liabilities are $494,570. The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined. Because of the uncertainty surrounding the realization of the deferred tax assets, the Company has established a valuation allowance of $459,107 as of June 30, 1995, which has been offset against the deferred tax assets. The net change in the valuation allowance during the years ended June 30, 1995, was $177,799.\nThe Company has available at June 30, 1995, unused operating loss carryforwards of approximately $1,500,000, which may be applied against future taxable income and which expire in various years through 2010.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTE 7 - INCOME TAXES [Continued]\nThe components of income tax expense from continuing operations for the years ended June 30, 1995 and 1994 consist of the following:\nDeferred income tax expense results primarily from the reversal of temporary timing differences between tax and financial statement income.\nA reconciliation of income tax expense at the federal statutory rate to income tax expense at the Company's effective rate is as follows:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 7 - INCOME TAXES [Continued]\nThe temporary differences gave rise to the following deferred tax asset (liability) at June 30, 1995:\nThe deferred taxes are reflected in the consolidated balance sheet at June 30, 1995 as follows:\nNOTE 8 - 401(K) PROFIT SHARING PLAN\nDuring February 1995, the Company adopted a 401(K) profit sharing plan under which eligible employees may choose to save up to 10% of salary income on a pre-tax basis, subject to IRS limits. All employees who have completed 6 months of service are eligible to enroll in the plan. The Company matches 50% of the employee's contribution to the plan up to a maximum of 1.5% of the employees annual salary. For the year ended June 30, 1995, the Company contributed $15,282 to the plan.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 9 - LONG-TERM NOTES PAYABLE\nAggregate maturities of long-term debt for the succeeding five years are as follows:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS\nNOTE 10 - PREFERRED STOCK\nDuring the fiscal year ended June 30, 1995 the Company issued 200,000 shares of preferred stock in return for the extinguishment of $500,000 of short-term debt payable in connection with the acquisition of ANOMS [See Note 19]. The Company's preferred stock pays cumulative dividends at a rate of $.225 per share per annum, payable monthly. As of June 30, 1995, dividends payable amounted to approximately $5,000. The preferred stock is convertible into common stock at the option of the holder at a conversion price of $2.50 per share. The preferred stock holders are not entitled to voting privileges.\nNOTE 11 - SHORT-TERM NOTES PAYABLE\nAt June 30, 1995, the Company is indebted for the following short-term notes payable:\nAs of June 30, 1995, in addition to the above $1,920,215, the Company had two letters of credit against the line of credit in the amounts of $400,000 and $7,040. At June 30, 1995 the maximum allowed based on eligible accounts receivable and inventory was exceed by draws against the revolving line by $140,902. However, the overdraft is temporarily approved by the bank based on a pledge of 200,000 shares of the Company's stock and the granting in favor of the bank of a 2nd trust deed on the Company's real estate holdings. Assuming the existence of eligible accounts receivable and inventory as collateral, the available line at June 30, 1995 would be $172,745.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTE 11 - SHORT-TERM NOTES PAYABLE [Continued]\nThe following table presents the average borrowing, the maximum amount outstanding, and the weighted average interest rate on short term borrowings:\nNOTE 12 - COMMON STOCK\nDuring the year ended June 30, 1995 and 1994, the Company issued 14,200 and 33,000 shares of common stock to certain officers, directors, shareholders and an employee upon exercise of common stock options at prices ranging from $1.50 to $2.56 per share. During 1995, the Company also issued 5,125 shares of common stock valued at $10,575 to an officer of the Company for the cancellation of 8,245 stock options\nThe Company issued during the year ended June 30, 1995 and 1994, 614,000 and 381,122 shares of common stock in various private placements at prices ranging from $1.63 to $3.32 per share. In one of the private placements, warrants to purchase 500,000 additional shares of common stock at $2.50 and to purchase 500,000 shares of common stock at $3.50 per share were also issued.\nThe Company also issued 65,500 shares of common stock valued at prices ranging from $1.25 to $2.5 per share for services rendered and in reimbursement of legal fees and research and development cost.\nDuring the year ended June 30, 1995, pursuant to a discretionary stock award plan, the Company issued 43,405 shares of previously unissued common stock to its employees, valued at $2.50 per share, the market price on the date the Board of Directors passed the resolution. This transaction resulted in taxable compensation to the employees and a corresponding deduction to the Company in the amount of $108,513.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 13 - RELATED PARTY TRANSACTIONS\nDuring 1995 and 1994, officers, directors and shareholders exercised certain options to acquire shares of common stock [See Note 12].\nDuring December 1987, the Company loaned an aggregate of $55,000 to three of its officers and directors. In the fiscal year ended June 30, 1993, one of the loans was eliminated by a compensation charge of $7,763 to the related individual for the amount of principal and interest then outstanding. During the fiscal year ended June 30, 1994 the two remaining notes were reduced through a $19,308 charge to compensation to the related individuals. One of the notes was eliminated through the transfer of 6,000 shares, of the Company's stock held by the individual, in payment of $33,750 of the Company's obligations. The remaining note was eliminated through the transfer of 7,100 shares of the Company's Stock held by the officer in payment of $28,400 of the Company's obligations and a cash payment of $1,417. Interest accrued on the loans amounted to $0 and $5,250 at June 30, 1995 and 1994, respectively. The unpaid balance at June 30, 1995 and 1994 was $0 and $29,817\nNOTE 14 - STOCK OPTIONS \/ WARRANTS\nIn July 1991, the board of directors adopted the Employee Stock Award Plan, which was later approved by shareholders at the annual meeting in June 1993. Under the provisions of the plan, the board can award up to 225,000 shares of common stock over the three year life of the plan to employees of the Larson-Davis who are not also directors of the Company. A total of 9,705 shares have been awarded to officers who are not also directors of the Company.\nIn July 1991, the board of directors also adopted the Director Stock Option Plan which was approved by the shareholders in June 1992. Under the terms of the plan, options are automatically awarded on June 30 of each year during the term of the plan, to the three individuals who are currently directors of the Company. The options have an exercise price equal to the closing bid price as reported by NASDAQ for the common stock on June 30, or an exercise price equal to 110% of that price, if the director is also a 10% shareholder of the Company. Awards under the plan are automatic as long as the individual is a director of the Company as of each June 30 during the term of the plan, which expires July 1, 1996. A maximum of 450,000 shares can be optioned under this plan. Effective June 30, 1992, two directors each receive\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS\nNOTE 14 - STOCK OPTIONS \/ WARRANTS [Continued]\noptions to acquire 30,000 shares at an exercise price of $2.54 per share. The other director received an option to acquire 30,000 shares with an exercise price of $2.31 per share. Effective June 30, 1993, two directors each received options to acquire 30,000 shares at an exercise price of $3.30 per share and the remaining director received an option to acquire 30,000 shares with an exercise price of $3.00 per share. Effective June 30, 1994 two directors received options to acquire 30,000 shares each at an exercise price of $3.85 per share. The other director received an option to acquire 30,000 shares with an exercise price of $3.50 per share. Effective June 30, 1995 two directors each received options to acquire 30,000 shares at $3.64 per share. The other director received an option to acquire 30,000 shares at $3.31 per share. None of the foregoing options have been exercised by the directors and the options expire five years from the date the options were granted.\nIn November 1987, and later revised in December of 1994, the board of directors of the Company authorized a stock option plan pursuant to which options to acquire common stock of the Company can be issued to employees of the Company. The issued options are intended to qualify as incentive stock options under the provisions of the Internal Revenue Code. Two directors hold options at June 30, 1995 which expire in December 1999, under this plan to acquire 130,000 shares each at $2.27 per share. As of June 30, 1995 none of the options had been exercised. The third director holds options at June 30, 1995, which expire in December 1999, to acquire 177,000 shares at $2.06 per share. During the year ended June 30, 1995 and 1994 options for 20,570 and 3,000 were exercised at prices ranging from $1.60 to $2.06 per share.\nDuring December 1994, employees of the Company who were not directors were granted options, expiring in December, 1999, to purchase 50,000 shares of stock at $2.06 per share. As of June 30, 1995 none of the options had been exercised.\nDuring March, 1995, employees of the Company who were not directors were granted options, expiring in March 2000, to acquire 30,000 shares of stock at $2.56 per share. As of June 30, 1995, 10,000 options had been exercised by an employee.\nEffective June 1989, a former employee was granted options outside of the plan. 20,000 options were granted, bearing exercise prices of $2.75 for 15,000 options and $5.00 per share for 5,000 options. During the year ended June 30, 1994 these options were extended for an additional five years and options for an additional 6,000 shares at $2.00 per share were granted to the individual. As of June 30, 1995 none of these options were exercised.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 14 - STOCK OPTIONS \/ WARRANTS [Continued]\nDuring the year ended June 30, 1994, 30,000 options were granted and exercised by an non-related party at $1.66 per share.\nDuring April 1995, in connection with a private placement of common stock, the Company issued warrants to purchase 500,000 shares of common stock at $2.50 per share expiring in April 1996 and warrants to purchase 500,000 shares of common stock at $3.50 per share expiring in April 1997.\nNOTE 15 - LEGAL MATTERS\nThe Company is from time to time involved in litigation as a normal part of its ongoing operations. At June 30, 1995, there were no litigation's which in management's estimate would have any material impact on the financial condition of the Company.\nNOTE 16 - MAJOR CUSTOMER AND EXPORT SALES\nFor the fiscal year ended June 30, 1995 and 1994, the Company has no customer whose sales exceed 10% of the continuing sales of the Company.\nExport sales for the fiscal years ending June 30, 1995 and 1994 are broken down as follows:\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS\nNOTE 17 - DISCONTINUED OPERATIONS\nThe accompanying financial statements as of June 30, 1995 and 1994 have been reclassified to reflect management's decision to discontinue the Company's operations in the Airports Noise and Operation Monitoring Industry [See Note 20]. The net assets related to the Airport Industry are included on the Company's June 30, 1995 balance sheet as \"net assets of discontinued operations\". The Company's operations in the Airport Industry for the years ended June 30, 1995 and 1994 are included as Discontinued Operations in the financial statements of the Company. As of June 30, 1995, management estimates the proceeds from the subsequent license\/sales of the \"Net assets of discontinued operations\" will equal or exceed the carrying value of these assets. Therefore, no loss on disposal has been recognized.\nDuring the year ended June 30, 1994, with the return of the minority interest shares in Larson-Davis Info, Inc. (\"Info\"), the Board of Directors decided, pursuant to a plan effective June 30, 1993, to discontinue the operations and pursue the sale or licensing of the software technologies then owned by Info and Advantage Software, Inc.. In as much as the Company was unable to locate a buyer for the technologies, management elected to reduce the carrying value of the related assets to zero as of June 30, 1994, resulting in a loss of $2,256,987. As a result, the balance sheets and statements of operations presented in these financial statements reflect a separation of the net assets of these subsidiaries as of June 30, 1994 and operating results for the fiscal year then ended.\nAssets to be disposed of consisted of the following at June 30, 1995:\nAssets are shown at their net book values.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS\nNOTE 17 - DISCONTINUED OPERATIONS [Continued]\nThe following is a condensed, proforma statement of operations that reflects what the presentation would have been without the reclassifications required by \"discontinued operations\" accounting principles:\nNOTE 18 - CONTINUING OPERATIONS\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplates continuation of the Company as a going concern. However, the Company had net losses of $(311,617) and $(1,868,151) for the years ended June 30, 1995 and 1994. The overall net loss for fiscal 1995 is a result of operating revenues and expenses related to discontinued operations. Further the company has significant intangible assets (including those held for resale from its discontinued operations) the realization of which is not assured. The financial statements do not include any adjustments relating to the recoverability and classification of recorded assets that might be necessary in the event the Company cannot continue in its present form.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 18 - CONTINUING OPERATIONS [Continued]\nAs highlighted in the statements of operations, the discontinued operations produced losses of $(770,128) and $(1,913,907) for years 1995 and 1994, respectively. The effect of the discontinued operation and subsequent transfer of rights and assets eliminates substantial amortization expense (a non-cash expense). This in addition to management's plan and subsequent actions to reduce labor expenditures should favorably affect future reporting years. The Company has also subsequently received proceeds from the sale of common stock which greatly improves its ability to meet current and future obligations [See Note 20].\nThe Company, as of June 30, 1995, had a current ratio of 1.2:1 indicating sufficient current assets to operate; The Company had significant order backlog for the Company's instrumentation subsequent to the financial statement date (approximately $916,000). Management believes the discontinued operations will not hinder their ability to generate working capital for their on-going operations. In view of these factors, Management believes the Company's operating and financial requirements provide the opportunity for the Company to maintain current operations.\nNOTE 19 - BUSINESS ACQUISITIONS\nDuring the quarter ended March 31, 1994, the Company purchased all of the outstanding common shares of Industrial & Marine Acoustics, Ltd. [IMA], a corporation chartered in England, for a cash payment of 6,000 British pounds (approximately $9,300). IMA was formerly an independent sales representative of the Company for Great Britain. As of the date of acquisition, IMA had negative net assets of approximately $(133,000), giving rise to the \"goodwill\" recorded on the company's balance sheet at that time. This \"goodwill\" is being amortized over 10 years. The balance sheet as of March 31, 1994 for this subsidiary has been consolidated with the rest of the Company, and operations for the months subsequent to March 1994 have been reflected in the consolidated statements of operations. Subsequently, management renamed the British subsidiary Larson-Davis, Ltd. and plans to develop an expanded service and repair center to serve the European Community.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 19 - BUSINESS ACQUISITIONS [Continued]\nOn June 30, 1994, the Company completed the acquisition of substantially all of the intangible assets of Technology Integration Incorporated, a privately-held Massachusetts Corporation [\"TII\"] as a purchase. The Company acquired TII's rights and obligations to approximately 25 contracts for the installation, maintenance, and support of airport noise monitoring systems. In addition, the Company acquired all rights to the ANOMS Software developed by TII for use in airport noise monitoring systems, a principal competitor of the Company's own proprietary software. The Company also hired 10 former employees of TII who were an integral part of TII's airport noise monitoring business. The Company intended to complete existing contracts with ANOMS and then combine ANOMS and its own proprietary software to produce an enhanced product. However, subsequent to June 30, 1995, the Company discontinued their selling, installation and maintenance of airport noise and operations monitoring systems [See Note 20].\nUnder the terms of the Acquisition Agreement with TII, as amended, the cost of the acquired assets were $2,508,541. The Company paid $100,000 to reduce TII's obligation to its principal bank, delivered $267,380 in cash to TII at closing, and assumed the obligation of TII with respect to a promissory note (the \"Note\") in the principal amount of $950,000. Principal payments and the issuance of preferred stock reduced this liability to $300,000 as of June 30, 1995. The Note bears interest at 9% per annum, requires monthly principal and interest payments of $15,845 and is due and payable on or before March, 1997. The note was acquired by the majority shareholder of TII from TII's principal bank and represents the remainder of the obligation of TII to such bank. The company paid this shareholder $20,000 to cover his expenses in connection with the acquisition of the Note and granted the shareholder a warrant to purchase, at a purchase price of $0.001 per share, shares of common stock of the Company having a fair market value equal to 1% of the unpaid principal balance of the Note for each month the Note remained outstanding subsequent to September 30, 1994 (warrants to acquire a total of 16,483 shares were issued and remain outstanding at June 30, 1995). In addition, the Company assumed $471,675 of TII's accounts payable, $28,771 of other payables, $22,424 of accrued liabilities of TII, forgave receivables from TII of $306,177 and issued a note payable of $250,000 to TII bearing interest of 8% that was payable over an 18 month period. This $250,000 liability was eliminated prior to June 30, 1995.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 19 - BUSINESS ACQUISITIONS [Continued]\nThe following are the [Unaudited] Condensed Combined Proforma Statements of Operations that reflect what the presentation would have been if the purchase of the acquired assets of TII and the purchase of IMA had occurred at the beginning of the respective periods and if the operations acquired from TII had not been subsequently discontinued.\nNOTE 20 - SUBSEQUENT EVENTS\nThe Company entered into a definitive agreement effective August 15, 1995 with Harris Miller Miller & Hanson, Inc. (\"HMMH\"), an established consulting firm. Under the terms of the agreement, the company has licensed its proprietary Airport Noise and Operations Monitoring Software (\"ANOMS\") and transferred management and implementation of substantially all of its airport noise monitoring contracts to HMMH (Airports Business). The Company has also agreed to discontinue its operations in this area and not to compete with HMMH in the airport noise and operations monitoring systems industry.\nLARSON-DAVIS INCORPORATED AND SUBSIDIARIES\nNOTE 20 - SUBSEQUENT EVENTS [Continued]\nThe Company was paid a one-time fee of $125,000, will receive $150,000 in guaranteed annual royalties for the lessor of a ten-year period or the term of the agreement, and will receive a varying royalty of 2.5% to 4% on the gross revenues of HMMH from the sale, installation, upgrade, and maintenance of airport noise and operations monitoring systems. HMMH also assumed $99,500 of the Company's liabilities related to the A HMMH will use its best efforts to include the Company's hardware in its future proposals for airport noise monitoring systems and the Company will provide such equipment at a 25% discount from its regular pricing structure. HMMH has the right to purchase all of the Company's rights to the ANOMS software at a predetermined price of $3,000,000, $2,200,000, $1,700,000 and $875,000, respectively, on the three, five, seven and ten year anniversaries of the agreement. HMMH has the right to terminate the agreement after an initial three-year period and, at the end of the ten year term, can elect to extend the agreement for an additional five years during which it would be obligated to pay a royalty of 3% on its gross revenues from the airport systems.\nSubsequent to June 30, 1995 the Company issued 129,275 shares of common stock upon exercise of common stock purchase options and warrants. Total proceeds amounted to $283,371. The Company also received $1,000,520 proceeds for the sale of 400,208 shares of common stock in a private placement. The Company also issued 27,679 share of common stock for non-cash consideration.\nSubsequent to June 30, 1995, the Company entered into an Agreement in Principle wherein it would acquire technology held by Sensar Corporation, a privately-held Utah corporation (\"Sensar\"), in exchange for the issuance of restricted Common Stock, the payment of cash to redeem certain shares of Sensar, and the assumption or payment of the liabilities of Sensar. Sensar holds rights to patented proprietary technology with respect to a time-of-flight mass spectrometer designed to detect smaller quantities of impurities in gas vapors than is possible with competing instruments with a much quicker analysis time. The acquisition is subject to the completion of a due diligence review of Sensar, the negotiation and execution of definitive agreements and other provisions. There can be no assurance that the transaction contemplated by the Agreement in Principle will be consummated.","section_14":"","section_15":""}
{"filename":"795252_1995.txt","cik":"795252","year":"1995","section_1":"Item 1. Business.\nFormation.\nML Delphi Premier Partners, L.P. (the \"Partnership\") is a\nDelaware limited partnership formed with the principal business\nobjective of achieving cash returns through the production,\nownership, acquisition of interests in and exploitation of\nfeature length motion pictures. The Partnership has acquired\n(a) Preferred Film (\"PF\") Interests in 22 films, with payments\nbased on the gross receipts of those films, and (b) Single Film\n(\"SF\") Interests in 20 films with payments based on the net\nproceeds of those films or, if it would result in a greater\namount, payments based on gross receipts. The PF Interests and\nmost of the SF Interests have been acquired through a joint\nventure between the Partnership and TriStar Pictures, Inc.\n(\"TriStar\"). The remaining SF Interests are in films\ndistributed by Columbia Pictures (\"Columbia Pictures\"), a\ndivision of Columbia Pictures Industries, Inc. (\"Columbia\").\nA public offering (the \"Offering\") of limited partnership\ninterests in the Partnership, at $5,000 per unit, was completed\nin December l986 with the sale of 12,610 units. Net proceeds to\nthe Partnership after selling commissions, organizational\nexpenses and other expenses of the Offering were approximately\n$55,500,000. The general partner of the Partnership, ML Delphi\nPartners, L.P. (the \"General Partner\"), contributed\napproximately $637,000 as its capital contribution to the\nPartnership.\nPreferred Film Interests.\nApproximately 40% ($22,445,000) of the net proceeds of\nthe Offering, including the General Partner's capital\ncontribution, was available for contribution to a joint venture\nbetween the Partnership and TriStar (the \"Tri-Star Joint\nVenture\") for the acquisition, at the rate of $l,000,000 per\nfilm, of PF Interests (the \"PF Proceeds\"). PF Interests have\nbeen acquired in 22 TriStar and Columbia feature length motion\npictures having direct production costs (excluding overhead) of\nat least $5,000,000. In June 1989, it was agreed that Columbia\nfilms, meeting the same criteria as set forth for Tri-Star PF\nInterest films (the \"Tri-Star PF Interest Films\"), would be\ntreated as if they were Tri-Star PF Interest Films and would be\naccounted for, through the Tri-Star Joint Venture, in the same\nmanner as Tri-Star PF Interest Films (hereinafter referred to as\nthe \"Columbia PF Interest Films\"). Of the $22,000,000 that was\ncontributed by the Partnership toward the acquisition of PF\nInterests, $19,000,000 was contributed toward Tri-Star PF\nInterest Films and $3,000,000 was contributed toward the\nacquisition of Columbia PF Interest Films. Films in which PF\nInterests have been acquired are hereinafter collectively\nreferred to as the \"PF Films.\"\nPayments made to the Partnership in respect of the PF\nFilms consist of two components, one of which is determined on a\nfilm-by-film basis and the other of which is determined on an\naggregate basis (as described below). Both components are based\non the gross receipts of the film or films to which they relate.\nThe Partnership receives an amount equal to the following\npercentages of gross receipts of each PF Film:\n5.0% of the first $5,000,000 7.5% of the next $5,000,000 10.0% of the next $5,000,000 Accordingly, the maximum payment based on gross receipts\nfor any PF Film based on the individual film component will be\n$l,l25,000.\nThe Partnership is also entitled to receive an amount\nequal to the following percentages of the aggregate gross\nreceipts of all the PF Films (computed after deducting U.S. and\nCanadian (domestic) theatrical gross receipts of the films):\n12.5% of the first $74,800,000 ll.5% of the next $74,800,000 ll.0% of the next $202,400,000 1.0% of the excess over $352,000,000 The distribution agreement between TriStar and the Tri-\nStar Joint Venture provides, in general, that gross receipts\nconsist of all sums received by TriStar, as distributor, from\nthe exploitation of a film throughout the world, including its\nreceipts from theatrical showings (i.e., the amounts received by\nthe distributor from exhibitors, which generally are based on a\npercentage of \"box office\" receipts), pay cable television\nexhibition, its receipts from free television showings, and\nspecified royalties (less certain expenses) from video cassette\nand video disc sales, soundtrack revenue, music publishing and\nmerchandising licenses. Gross receipts generally include all\nadvances and guaranteed payments received and not refunded by\nTriStar, as distributor, for theatrical exhibition, free\ntelevision, soundtrack, music publishing and merchandising.\nThe Partnership received its first payment in respect of PF\nFilms in December 1987. Payments in respect of PF Films are made\non an annual basis in December of each year through 1996.\nTriStar agreed to advance to the Partnership, through the TriStar\nJoint Venture, an amount sufficient to enable the Partnership to\nreceive a payment in December 1987 equal to l4% of the PF\nProceeds (the \"14% Return\"). Approximately $3,142,000 was paid\nto the Partnership, through the Tri-Star Joint Venture, by\nTriStar in December 1987, of which approximately $458,000 was\nattributable to the performance of one PF Film which was released\nin 1987. The balance of $2,684,000 represented an advance (the\n\"Advance\") which TriStar will be entitled to recoup, without\ninterest, in December 1996 from revenues earned by the\ndistribution of the Partnership's PF Films. In addition, in\nDecember of each year 1988 through 1995 TriStar, through the Tri-\nStar Joint Venture, made a payment to the Partnership of\n$3,142,000 representing the 14% Return. To the extent the annual\ncash return to the Partnership from the PF Interests causes the\nPartnership's cumulative non-compounded return to exceed the l4%\nReturn in any of the years 1988 through 1995, the excess amount\nwill be carried forward and, to the extent not applied in later\nyears to generate the 14% Return, will be payable without\ninterest in December 1996 less the Acceleration Payment\nrecoupments and related interest described below. At that time,\nTriStar will make a final payment taking into account gross\nreceipts to the date of payment, as well as the gross receipts\nestimated to be received by TriStar during the next seven years\nfrom the distribution of all PF Films (subject to discount under\ncertain circumstances). Following the final payment, the\nPartnership's PF Interests will cease. As of December 31, 1995,\n$21,471,000, net of the Acceleration Payments and related\ninterest described below and the Advance, is carried forward and\nis included in the receivable from the Tri-Star Joint Venture in\nthe accompanying financial statements.\nIf in any calendar year the Partnership recognizes income\nfor federal tax purposes with respect to PF Interest Films in\nexcess of the December payment for that year (the \"Excess\"),\nTriStar is required to make an acceleration payment to the\nPartnership with respect to the Excess. The amount of the\nacceleration payment is equal to the Excess multiplied by the\nmaximum individual federal income tax rate in effect for the\nyear of the Excess (the \"Acceleration Payment\"). During March\n1993 and 1992, the Partnership received $360,000 and $7,548,000\nwith respect to the Acceleration Payment for 1992 and 1991,\nrespectively.\nThese Acceleration Payments were distributed to partners\nin April 1993 and 1992, respectively. These Acceleration\nPayments are recoupable, with interest, by TriStar, with certain\nexceptions, from the payment to be received by the Partnership\nwith respect to its PF Interests in December 1996 and are\nreflected as a reduction to the receivable from the Tri-Star\nJoint Venture in the accompanying financial statements.\nAll of the films in which the Partnership has a PF\nInterest have been released both domestically and in foreign\nmarkets. See \"PF Interest Films.\"\nSingle Film Interests.\nThe Tri-Star Joint Venture has acquired interests in\ncertain films produced or co-produced by earlier joint ventures\nbetween TriStar and one or more of the Delphi Partnerships (as\nthat term is defined under \"Distribution of Films\" below) and\nhas produced certain films for which TriStar commenced\nproduction after the expiration of TriStar's similar commitment\nto an earlier joint venture between TriStar and Delphi Film\nAssociates V.\nThe Partnership has an SF Interest in 20 films, 17\nthrough the Tri-Star Joint Venture (the \"Tri-Star SF Interest\nfilms\") and three which are participation interests owned\ndirectly in films being distributed by Columbia Pictures (the\n\"Columbia SF Interest films\"). Those films in which the\nPartnership has an SF Interest are sometimes collectively\nreferred to as the \"SF Interest films\" and individually referred\nto as an \"SF Interest film.\" See \"Columbia SF Interest Films\"\nand \"Tri-Star SF Interest Films.\" See also \"Tri-Star SF\nInterest Extra Film Profit Participations\" regarding the\nPartnership's interest in the films \"Avalon,\" \"Another You,\" and\n\"Fisher King.\"\nThe Partnership has an interest ranging from 5% to 25% in\neach of the SF Interest films. The maximum contribution that\nthe Partnership was required to make for any Tri-Star SF\nInterest film was $3,600,000; however, the Partnership had the\nright to elect to contribute up to 25% of the total production\ncost of any Tri-Star SF Interest film. The Partnership agreed\nto contribute amounts in excess of $3,600,000 toward the\nproduction of four motion pictures (\"Nadine,\" \"The Squeeze,\"\n\"Gardens of Stone\" and \"Suspect\").\nIn 1987, it was agreed that to the extent the Partnership\ncontributed amounts to the Tri-Star Joint Venture in excess of\n$3,600,000 toward the production of these four films, the\nPartnership, through the Tri-Star Joint Venture, would have the\nright to reduce its interest in a mutually agreed upon film and\nto apply that amount toward an interest in three additional SF\nInterest films produced by the Tri-Star Joint Venture. In\nDecember 1987, the Partnership, through the Tri-Star Joint\nVenture, elected to reduce its interest in the motion picture\n\"Blind Date\" to 5% and contribute the funds thereby made\navailable toward the production of the motion pictures \"Sunset,\"\n\"For Keeps,\" and \"The Seventh Sign.\" The Partnership has a 5%\ninterest in each of these films.\nThe Partnership's ownership interest with respect to each\nSF Interest film is generally equal to the percentage the\nPartnership's cash contribution for production or acquisition of\na film bears to the total cash contributions for production or\nacquisition of that film. The Partnership (directly, or through\nthe Tri-Star Joint Venture) is entitled to payments based on the\nnet proceeds of SF Interest films or, if it would result in a\ngreater amount, payments based on gross receipts. Each\nDistributor (as hereinafter defined) is also required to make\nspecial recoupment payments which may enable the Partnership to\nrecover up to the otherwise unrecouped amount of its\ncontributions for SF Interest films distributed by that\nDistributor. These special recoupment payments are to be made\nin December 1996.\nAll 20 films in which the Partnership has an SF Interest\nhave been released both domestically and in foreign markets.\nThe Partnership's contributions (including interest) for the\nproduction and acquisition of SF Interest films aggregated\napproximately $42,213,000. Of this amount, approximately\n$37,768,000 was contributed to the Tri-Star Joint Venture and\napproximately $4,445,000 to Columbia.\nDistribution of Films.\nThe films in which the Partnership owns an interest are\ndistributed pursuant to distribution agreements (the\n\"Distribution Agreements\") between TriStar and the Tri-Star\nJoint Venture and between Columbia Pictures and the Partnership.\nTriStar and Columbia Pictures, as distributors, are sometimes\nreferred to collectively as the \"Distributors\" and individually\nas a \"Distributor.\" The Distributor has the ultimate authority\nfor all decisions with respect to the distribution of the films.\nFor each SF Interest film, the Partnership is generally entitled\nto receive an amount equal to the product of its percentage\ninterest in a film multiplied by the greater of (a) an amount\nequal to 100% of the net proceeds from the distribution of the\nfilm and (b) an amount equal to 32% of the gross receipts from\nthe distribution of the film. As previously discussed, the\npayments to which the Partnership is entitled in respect of PF\nInterest films are based solely on gross receipts without regard\nto net proceeds. The Distribution Agreements provide, in\ngeneral, that gross receipts consist of all sums received by the\nDistributor from the worldwide exploitation of a film. Net\nproceeds with respect to each film generally are determined by\ndeducting from gross receipts:\n(a) a distribution fee equal to 17-1\/2% of substantially\nall of the gross receipts of the film. The Distributor's\nentitlement to this distribution fee is deferred until the Tri-\nStar Joint Venture or the Partnership (in the case of Columbia's\nSF Interest films) has received from the distribution of that\nfilm an amount equal to the amount contributed (other than\ninterest) to produce or acquire an interest in the film;\n(b) expenses incurred in the distribution, promotion and\nmarketing of the film, including expenditures for prints and\nadvertising except that deductions for the cost of domestic\ntheatrical distribution of Tri-Star SF Interest films may not be\ndeducted beyond the sum of $6,000,000 plus 20% of the gross\nreceipts from the domestic theatrical release of a film; and\n(c) payments to third party participants who have a\ncontingent participation in the film. The extent to which\npayments to third party participants may be deducted from the\ngross receipts of a film in determining net proceeds is limited\nby the Distribution Agreements.\nEach Distributor reports to the Partnership or the Tri-\nStar Joint Venture, as the case may be, on a quarterly basis\nwith respect to gross receipts and net proceeds for each film.\nThe Distributors make payments with respect to the SF Interest\nfilms based on those quarterly reports when the reports are\ndelivered. Under the terms of each Distribution Agreement,\npayments based on gross receipts did not take into account\namounts accrued through December 31, 1986. In addition to\ndistributing motion pictures produced or acquired by the Joint\nVenture and the Partnership (in the case of the Columbia SF\nInterest films), each Distributor distributes films in which\njoint ventures between each of Columbia and TriStar and certain\nother limited partnerships (the \"Delphi Partnerships\") own an\ninterest, as well as films in which neither the Partnership nor\nany of the Delphi Partnerships own an interest.\nSpecial Recoupment Payment for SF Interest Films.\nUnder the terms of the Distribution Agreements, the\nPartnership will be entitled to a payment (a \"Special Recoupment\nPayment\") from the Distributors in late 1996 for each SF\nInterest film (an \"Unrecouped Film\") for which the Tri-Star\nJoint Venture or the Partnership (in the case of the Columbia SF\nInterest films) has not received from the distribution of that\nfilm (or its sale) an amount equal to the total contributions to\nproduce or acquire an interest in the film, other than amounts\nspent for payments in the nature of interest (\"Cost Return\").\nInitially, the Special Recoupment Payment would be\npayable only to the extent of the distribution fees received by\nthe Distributor from the distribution of all of its SF Interest\nfilms. The Special Recoupment Payments to the Tri-Star Joint\nVenture based on distribution fees would be allocated by the Tri-\nStar Joint Venture first to the Partnership to the extent\nnecessary for the Partnership to recoup (without interest) the\namount of its contributions to the Tri-Star Joint Venture for\nthe production or acquisition of the Unrecouped Films (other\nthan contributions for payments in the nature of interest); any\nexcess would then be allocated to TriStar. If these\ndistribution fees are insufficient to enable a Distributor to\nmake the Special Recoupment Payments with respect to all of its\nUnrecouped Films, gross receipts and net proceeds of each\nremaining Unrecouped Film distributed by that Distributor would\nbe recalculated to include as gross receipts in respect of that\nUnrecouped Film (i) the excess, if any, of the minimum payments\nunder its license agreement with Home Box Office, Inc. (\"HBO\"),\nin the case of Columbia, or the minimums determined under the\nagreement between TriStar and HBO based on the formula for films\nthat commence principal photography in 1986, in the case of\nTriStar, and (ii) certain minimum amounts in respect of video\ncassette and video disc exploitation in excess of the amounts\npreviously included in the gross receipts of that Unrecouped\nFilm. Each Distributor would then make a Special Recoupment\nPayment to the Partnership with respect to each Unrecouped Film\nto the extent of the Partnership's share of additional gross\nreceipts or net proceeds payable as a result of the\nrecalculation but only up to the amount of the unrecouped\ncontributions (other than contributions for payments in the\nnature of interest) in respect of that Unrecouped Film. Each\nSpecial Recoupment Payment made on the basis of such\nrecalculation would be allocated between the Partnership and\nTriStar in proportion to their respective interests in the\napplicable Unrecouped Film.\nEach Distributor will be entitled to recoup the Special\nRecoupment Payments made to the Partnership in respect of each\nUnrecouped Film, with interest calculated at 110% of the prime\nrate from time to time, from the Partnership's share of\nsubsequent gross receipts or net proceeds of that Unrecouped\nFilm and from the proceeds of any sale of the Partnership's\ninterest in that Unrecouped Film. In calculating the amount of\ndistribution fees available for the Special Recoupment Payments,\nno distribution fee will be deemed received by a Distributor\n(and therefore no distribution fee will be deemed available for\nthe Special Recoupment Payment) from a film with respect to\nwhich the most recent payment by that Distributor was based on\ngross receipts or from a film that did not reach Cost Return.\nBased on the anticipated performance of the three\nColumbia SF Interest Films and the 17 Tri-Star SF Interest\nFilms, as of December 31, 1995, approximately $2,576,000 and\n$15,642,000 (amounts present valued at Columbia and the Tri-Star\nJoint Venture's respective discount rate from December 1996),\nrespectively, had been accrued on the financial statements of\nthe Partnership as Special Recoupment Payments allocable to the\nPartnership. To the extent available, the Special Recoupment\nPayments from the Distributors are expected to enable the\nPartnership to achieve Cost Return for the Unrecouped Films and\nare not intended to enable the Partnership to recoup any amounts\npaid by the Partnership for management fees or other expenses of\nthe Partnership.\nTri-Star SF Interest Bonus Film Profit Payments.\nThe Partnership is entitled to receive certain bonus\nprofit payments with respect to the three films \"Like Father,\nLike Son,\" \"Blind Date\" and \"Peggy Sue Got Married\" (the \"Bonus\nFilms\") for which it paid no consideration (the \"Bonus Film\nProfit Payments\"). All three SF Interest films have generated\ncash payments to the Partnership. The Film Profit Bonus\nPayments are equal to 30% of the first $9,000,000 of profits to\nthe Partnership from its SF Interest in each of these films.\nBonus Film Profit Payments in the amounts of $9,000, $81,000\nand $9,000 were received by the Partnership in 1995, 1994 and\n1993, respectively.\nAdditional Bonus Film Profits Payments will be paid in\ninstallments, without interest, and will continue on a quarterly\nbasis, on the basis of each Bonus Film's performance, subject to\nreaching a stipulated maximum amount.\nTri-Star SF Interest Extra Film Profit Participations.\nPursuant to the Distribution Agreement between Tri-Star\nand the Tri-Star Joint Venture, the Partnership, through the Tri-\nStar Joint Venture, has a net profit participation in three\nextra SF Interest films (the \"Extra Films\"). The Partnership's\nExtra Films are \"Avalon\", \"Another You\" and \"Fisher King\" each\nof which has been released.\nThe Partnership was not required to make a capital\ncontribution with respect to the Extra Films. The Partnership's\nprofit participation (through the Tri-Star Joint Venture) with\nrespect to the Extra Films is equal to 10% of the net proceeds\nof the Extra Film after 100% of the net proceeds of the Extra\nFilm exceeds 112 1\/2% of its production cost. The interest in\nthese Extra Films will cease should the Partnership's overall\nCash Return (as defined below) with respect to Tri-Star SF\nInterest Amount. For these purposes, \"Cash Return\" is an amount\nequal to (a) the estimated cash payments ultimately to be\nreceived by the Partnership from the Tri-Star SF Interest films\nless (b) the Partnership's contributions for those films in\nexcess of the Allocated Amount and interest on such excess.\nBased on the performance of the Extra Films through December 31,\n1995, no receivable has been reflected in the accompanying\nfinancial statements.\nTriStar and Columbia License Arrangements.\nCertain of the Partnership's SF Interest films have been\nlicensed to HBO for exhibition on its pay television services.\nThe Distribution Agreements provide that the gross receipts of a\nfilm will initially be credited with respect to pay television\nexhibition by HBO in an amount equal to specified percentages of\nthe first year's domestic theatrical gross receipts of that\nfilm, regardless of the actual license fee payable to Columbia\nor TriStar under its license agreement with HBO. The amount\ninitially included in gross receipts may be less, and in some\ninstances substantially less, than the amount actually received\nby Columbia or TriStar under its agreement with HBO. See the\n\"Special Recoupment Payments\" provision described above for\ninformation concerning additional amounts that gross receipts\nmay be credited with in connection with pay television\nexhibition by HBO.\nColumbia Pictures entered into an arrangement with CBS\nInc. (\"CBS\") for CBS to license for exhibition on the CBS\ntelevision network, a specified number of motion pictures from\namong a specified number of groups of Columbia's motion\npictures. The arrangement provides for CBS to pay a specified\naverage license fee for the motion pictures in each group\nlicensed by CBS. The Partnership and Columbia Pictures have\nagreed that, subject to adjustment in certain circumstances,\ngross receipts for films licensed to CBS under this arrangement\nwould include an amount equal to the higher of the license fees\npaid by CBS and the comparable fair market value for the license\nrights involved for the relevant license period. The Columbia\nSF Interest films may be licensed for network television\nexhibition under this arrangement. Certain of the Tri-Star SF\nInterest Films have been licensed for network television\nexhibition on CBS or on other television networks on a film-by-\nfilm basis.\nThe films in which the Partnership owns an interest are\nsubject to agreements between each Distributor and Columbia\nTriStar Home Video (formerly known as RCA\/Columbia Pictures Home\nVideo) and Columbia TriStar Home Video (International) Inc.\n(formerly known as RCA\/Columbia Pictures International Video).\nThe Distribution Agreements provide for a specified royalty for\nvideo cassettes and video discs regardless of the amounts\npayable to TriStar or Columbia under their respective\narrangements with such joint ventures (which may exceed the\namounts includable in gross receipts).\nMany films in which the Partnership has an interest have\nbeen licensed by their respective Distributors for exhibition on\nother cable television services, independent television stations\nin the United States and on foreign television stations.\nGenerally, these films have been made available for foreign\ntelevision exhibition and domestic independent television\nexhibition approximately three and five years, respectively,\nafter a film's domestic theatrical release.\nTri-Star SF Interest Films.\nAll 17 films in which the Tri-Star Joint Venture has an\nSF Interest have been released. Certain information concerning\nthese films is set forth below:\nPartnership's Approximate Initial Percentage Title Release Date Interest\nLet's Get Harry October 1986 5% Peggy Sue Got Married October 1986 5% Every Time We Say Goodbye November 1986 5% The Boss' Wife November 1986 5% No Mercy December 1986 18% Blind Date March 1987 5% Amazing Grace and Chuck April 1987 25% Gardens of Stone May 1987 25% The Squeeze July 1987 25% Nadine August 1987 25% The Principal September 1987 25% Like Father Like Son September 1987 25% Suspect October 1987 25% For Keeps January 1988 5% Sunset April 1988 5% The Seventh Sign April 1988 5% Sweet Hearts Dance September 1988 23% In addition, the Partnership holds a l0% net profit\nparticipation interest in the films \"Avalon,\" \"Another You\" and\n\"Fisher King\" each of which are Extra Films. See \"Tri-Star SF\nInterest Extra Film Profit Participations.\"\nColumbia SF Interest Films.\nAll three of the Columbia SF Interest films have been\nreleased. Certain information concerning these films is set\nforth below:\nPartnership's Initial Percentage Title Release Date Interest Armed and Dangerous August 1986 5% That's Life September 1986 5% Ishtar May 1987 7.5%\nPF Interest Films.\nAll 22 Films in which the Partnership has an interest have\nbeen released. Certain information concerning these films is\nset forth below:\nInitial Title Release Date The Principal September 1987 Short Circuit 2 July 1988 Tap February 1989 Who's Harry Crumb? February 1989 Chances Are March 1989 Slaves of New York March 1989 Sing March 1989 See No Evil, Hear No Evil May 1989 Loverboy April 1989 Casualties of War August 1989 Look Who's Talking October 1989 Immediate Family October 1989 Steel Magnolias November 1989 Glory December 1989 Family Business December 1989 Loose Cannons February 1990 Blind Fury June 1989 (Foreign) March 1990 (Domestic) Side Out March 1990 I Love You To Death April 1990 The Freshman July 1990 Postcards From The Edge September 1990 Avalon October 1990\nWith the exception of \"Casualties of War,\" \"Immediate\nFamily\" and \"Postcards From The Edge,\" which are each Columbia\nPF Interest Films, the films set forth above are Tri-Star PF\nInterest Films.\nAll of the Partnership's SF Interest films and PF Films\nhave been theatrically released both domestically and in foreign\nmarkets. In addition, substantially all of the Partnership's SF\nInterest films have been made available on video cassettes and\nhave been exhibited on pay television. Certain of the\nPartnership's SF Interest films and PF Films have been exhibited\non network television and certain of these films are currently\nunder license for domestic syndicated television exhibition and\nforeign television exhibition. See \"Distribution of Films.\"\nCompetition.\nCompetition in the motion picture industry is intense,\nboth in theatrical distribution as well as in the ancillary\nmarkets where most of the Partnership's films are now being\ndistributed. All of the \"major\" studios and independent\ndistribution companies are distributing films that compete for\nthe attention of purchasers of product for these ancillary\nmarkets which include pay cable television, home video, network\ntelevision exhibition, and syndicated television exhibition both\nforeign and domestic. The Partnership's films compete in many\nof these markets not only with films that were released\ncontemporaneously, but also with many films that were released\nin prior and subsequent years. The level of theatrical success\nthat a film enjoyed is often an important factor with respect to\nresults achieved in these ancillary markets.\nEmployees.\nThe Partnership has no employees. The General Partner,\nhowever, retains the services of Magera Management Corporation\n(\"Magera\") to provide operational and financial services to it.\nSee Item l0 \"Directors and Executive Officers of the Partnership-\nOperational and Financial Services.\" Magera has eight employees\nwho perform services for the General Partner and for the general\npartners of other private and public limited partnerships,\nincluding the other Delphi Partnerships.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe executive offices of the Partnership and the General\nPartner are located at 666 Third Avenue, New York, New York\n10017. The Partnership pays no rent.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of\nSecurity Holders.\nNone.\nPART II. Item 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Security Holder Matters.\nThe Partnership is a limited partnership; there is no\nestablished public market for limited partnership units of the\nPartnership.\nEffective November 9, 1992, the Partnership was advised\nthat Merrill Lynch, Pierce, Fenner & Smith Incorporated\n(\"Merrill Lynch\") introduced a new limited partnership secondary\nservice available to its clients through Merrill Lynch's Limited\nPartnership Secondary Transaction Department.\nBeginning with the December 1994 client account\nstatements, Merrill Lynch implemented new guidelines for\nproviding estimated values of limited partnerships and other\ndirect investments reported on client account statements. As a\nresult, Merrill Lynch no longer reports general partner\nestimates of limited partnership net asset value on its client\naccount statements. Pursuant to the guidelines, estimated\nvalues for limited partnership interests originally sold by\nMerrill Lynch (such as the Partnership's Units) will be provided\ntwo times per year to Merrill Lynch by independent valuation\nservices. The estimated values will be based on financial and\nother information available to the independent services on the\nprior August l5th for reporting on December year-end client\naccount statements, and on information available to the services\non March 31st for reporting on June month-end Merrill Lynch\nclient account statements. Merrill Lynch clients may contact\ntheir Merrill Lynch Financial Consultants or telephone the\nnumber provided to them on their account statements to obtain a\ngeneral description of the methodology used by the independent\nvaluation services to determine their estimates of value. The\nestimated values provided by the independent services are not\nmarket values and Unit holders may not be able to sell Units or\nrealize the amount upon a sale. In addition, Unit holders may\nnot realize the independent estimated value upon the liquidation\nof the Partnership over its remaining life.\nAs of March 15, 1996, there were approximately 5,100\nholders of record of limited partnership units of the\nPartnership.\nCash Distributions.\nCash distributions attributable to revenue received by\nthe Partnership from PF Films commenced in December of 1987.\nCash distributions attributable to revenue received by the\nPartnership from SF Interests commenced in September 1989.\nThe following chart sets forth the cash distributions\nmade by the Partnership through March 15, 1996:\nYear Amount Per Unit 1987 $ 245 1988 245 1989 270 1990 270 1991 330 1992 840 1993 275 1994 245 1995 245 1996 (through March 15) 0 Total $2,965\nAccordingly, as of March 15, 1996, the partners have\nreceived cash distributions aggregating 59.3% of their original\ninvestment in the Partnership.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 1. Liquidity and Capital Resources.\nThe Partnership has satisfied its commitment to\ncontribute funds to the Tri-Star Joint Venture and to Columbia\nfor the production of, and acquisition of SF Interests in films.\nIn addition, the Partnership has satisfied its commitment to\ncontribute funds to the Tri-Star Joint Venture for PF Interests\nin films. As of December 31, 1995, the Partnership held cash of\napproximately $714,000 and short-term investments of\napproximately $588,000. Short-term investments consist solely\nof U.S. government securities.\nIn March 1993 and 1992, the Partnership received $360,000\nand $7,548,000 with respect to the Acceleration Payment for 1992\nand 1991, respectively. These Acceleration Payments are\nrecoupable, with interest, by TriStar, with certain exceptions,\nfrom the payment to be received by the Partnership with respect\nto its PF Interests in December 1996.\nSince the Partnership's obligations to make contributions\nto the Joint Venture for the production of, and acquisition of\ninterests in, films have been satisfied, all revenues received\nby the Partnership are used to pay operating expenses of the\nPartnership and to make cash distributions to partners.\n2. Results of Operations.\nThe Partnership's operating results are primarily\ndependent upon the operating results of the Tri-Star Joint\nVenture's films and films owned directly and are significantly\nimpacted by the Tri-Star Joint Venture's and Columbia's\npolicies.\nThe performance of each film where net proceeds\ndetermines the amount of revenue recognized is based upon the\namount expended for production and other costs associated with a\nfilm and the gross receipts generated by a film. The amount and\ntiming of gross receipts generated by each film is dependent\nupon the degree of acceptance by the consumer public and the\nparticular ancillary market in which the film is then being\nexhibited.\nAmounts contributed toward each film are compared\nperiodically to the expected total revenue to be generated for\nthat film, and write-downs may occur to the extent the amounts\ninvested exceed the expected total revenue for that film.\nAdditionally, the Tri-Star Joint Venture and the\nPartnership may record income with respect to Special Recoupment\nPayments, to the extent available, which may allow it to recover\nits investment in SF Interest films.\nFor the year ended December 31, 1995, the Tri-Star Joint\nVenture had a net profit of which the Partnership's share was\napproximately $1,156,000 and the Partnership had an overall net\nprofit of approximately $788,000. The variance between the\nPartnership's share of the Tri-Star Joint Venture's net profit\nand the Partnership's net profit for the year ended December 31,\n1995 was attributable to the Partnership's operating expenses\n(including amortization of the Partnership's direct interest in\nmotion pictures), partially offset by the accrual of the Special\nRecoupment Payments, revenues generated by films in which the\nPartnership holds an interest directly and interest income. The\nPartnership's share of the net profit reported by the Tri-Star\nJoint Venture was due primarily to interest income related to\nthe accrual of the Special Recoupment Payments and the\nprofitable results of certain films offset, in part, by interest\nexpense related to the Acceleration Payments and the recapture\nof the Special Recoupment Payments.\nFor the year ended December 31, 1994, the Tri-Star Joint\nVenture had a net profit of which the Partnership's share was\napproximately $609,000 and the Partnership had an overall net\nprofit of approximately $208,000. The variance between the\nPartnership's share of the Tri-Star Joint Venture's net profit\nand the Partnership's net profit for the year ended December 31,\n1994 was attributable to the Partnership's operating expenses\n(including amortization of the Partnership's direct interest in\nmotion pictures), partially offset by the accrual of the Special\nRecoupment Payments, interest income and revenues generated by\nfilms in which the Partnership holds an interest directly. The\nPartnership's share of the net profit reported by the Tri-Star\nJoint Venture was due primarily to interest income related to\nthe accrual of Special Recoupment Payments and the profitable\nresults of certain PF Interest films offset, in part, by\nexpenses related to foreign exchange losses and by interest\nexpense related to the Acceleration Payments and the recapture\nof the Special Recoupment Payments.\nFor the year ended December 31, 1993, the Tri-Star Joint\nVenture had a net profit of which the Partnership's share was\napproximately $1,420,000 and the Partnership had an overall net\nprofit of approximately $905,000. The variance between the\nPartnership's share of the Tri-Star Joint Venture's net profit\nand the Partnership's net profit for the year ended December 31,\n1994 was attributable to the Partnership's operating expenses\n(including amortization of the Partnership's direct interest in\nmotion pictures), partially offset by the accrual of the Special\nRecoupment Payments, interest income and revenues generated by\nfilms in which the Partnership holds an interest directly. The\nPartnership's share of the net profit reported by the Tri-Star\nJoint Venture was due primarily to interest income related to\nthe accrual of Special Recoupment Payments and the profitable\nresults of certain PF Interest films offset, in part, by\nexpenses related to foreign exchange losses and by interest\nexpense related to the Acceleration Payments and the recapture\nof the Special Recoupment Payments.\nThe increase in the Special Recoupment Payments accrued\nfor the years ended December 31, 1995 and 1994 as compared with\nthe prior years is primarily due to the shortening of the\ndiscount period in 1994 and 1993.\nThe Partnership reports net revenues from motion picture\nexploitation for the three films in which it owns interests\ndirectly. The increase in net revenues for the year ended\nDecember 31, 1995 as compared with the prior year is due\nprimarily to an increase in the accrual of syndicated television\nrevenues in 1995. The decrease in net revenues for the year\nended December 31, 1994 as compared with the prior year is due\nprimarily to lower syndicated television revenues accrued in\n1994. The amortization of the Partnership's direct interest in\nmotion pictures for the year ended December 31, 1995 as compared\nwith the prior year is unchanged. The decrease in amortization\nof the Partnership's direct interest in motion pictures for the\nyear ended December 31, 1994 as compared with the prior year is\ndue primarily to a decrease in net revenues from motion picture\nexploitation.\nThe increase in interest income for the years ended\nDecember 31, 1995 and 1994 as compared with the corresponding\nperiods in 1994 and 1993 was due primarily to more funds being\navailable for short-term investments as well as higher interest\nrates earned on short-term investments during 1995 and 1994.\nThe increase in total expenses for the year ended\nDecember 31, 1995 as compared with the prior year (exclusive of\namortization of the Partnership's direct interest in motion\npictures) is due primarily to an increase in Other Expenses.\nThe increase in Other Expenses is primarily attributable to an\nincrease in professional fees related to the performance of a\ngreater number of distribution audits in 1995. The decrease in\ntotal expenses for the year ended December 31, 1994 as compared\nwith the prior year (exclusive of amortization of th\nPartnership's direct interest in motion pictures) is due\nprimarily to a decrease in Other Expenses. The decrease in\nOther Expenses is primarily attributable to a decrease in\nprofessional fees related to the performance of fewer film\naudits in 1994.\nThe Partnership does not believe that the impact of\ninflation on the results of its operations has been material.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee the financial statements set forth in Item 14 of this\nannual 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 Partnership.\nThe General Partner of the Partnership is ML Delphi\nPartners, L.P., a Delaware limited partnership formed in January\n1987 between ML Film Entertainment Inc. (\"ML Film\"), a Delaware\ncorporation, and a wholly-owned subsidiary of ML Leasing\nEquipment Corp. (which is an indirect wholly-owned subsidiary of\nMerrill Lynch & Co., Inc., and the successor in interest to\nMerrill Lynch Leasing Inc. and Merlease Leasing Corp.) and an\naffiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated\n(\"Merrill Lynch\"), its general partner, and Delphi Film\nServices, its sole limited partner. ML Delphi Partners, L.P. is\nthe successor to ML Delphi Partners, a New York general\npartnership between ML Film and Delphi Film Services, which was\nthe general partner of the Partnership from June 1986 through\nDecember 1986. Since the Partnership's inception, ML Film has\nbeen the managing partner of the Partnership's General Partner.\nSet forth below is certain information regarding the current\nmanagement of the General Partner.\nML Film.\nThe executive officers and directors of ML Film are:\nKevin K. Albert . . . . . President, Director Robert F. Aufenanger. Executive Vice President, Director Steven N. Baumgarten. Vice President, Director Michael E. Lurie. . . . . Vice President, Director Diane T. Herte . . . . . Treasurer\nKevin K. Albert, 43, a Managing Director of Merrill\nLynch Investment Banking Group (\"ML Investment Banking\"),\njoined Merrill Lynch in 1981. Mr. Albert works in the\nEquity Private Placement Group and is involved in\nstructuring and placing a diversified array of private\nequity financings including common stock, preferred stock,\nlimited partnership interests and other equity related\nsecurities. Mr. Albert is also a director of ML Media\nManagement Inc. (\"ML Media\"), an affiliate of ML Film and a\njoint venturer of Media Management Partners, the general\npartner of ML Media Partners, L.P.; a director of ML\nOpportunity Management Inc. (\"ML Opportunity\"), an affiliate\nof ML Film and a joint venturer in Media Opportunity\nManagement Partners, the general partner of ML Media\nOpportunity Partners, L.P.; a director of ML Mezzanine II\nInc. (\"ML Mezzanine II\"), an affiliate of ML Film and the\ngeneral partner of the managing general partner of ML Lee\nAcquisition Fund II, L.P. and ML Lee Acquisition Fund\n(Retirement Accounts) II, L.P.; a director of ML Mezzanine\nInc. (\"ML Mezzanine\"), an affiliate of ML Film and the\ngeneral partner of the managing partner of ML Lee\nAcquisition Fund, L.P.; a director of Merrill Lynch Venture\nCapital Inc. (\"ML Venture\"), an affiliate of ML Film and the\ngeneral partner of the Managing General Partner of ML\nVenture Partners I, L.P. (\"Venture I\"), ML Venture Partners\nII,L.P. (\"Venture II\"), and ML Oklahoma Venture Partners\nLimited Partnership (\"Oklahoma\"); and a director of Merrill\nLynch R&D Management Inc. (\"ML R&D\"), an affiliate of ML\nFilm and the general partner of the Managing General Partner\nof ML Technology Ventures, L.P. Mr. Albert also serves as\nan independent general partner of Venture I and Venture II.\nRobert F. Aufenanger, 42, a Vice President of Merrill\nLynch & Co. Corporate Credit and a Director of the\nPartnership Management Department, joined Merrill Lynch in\n1980. Mr. Aufenanger is responsible for the ongoing\nmanagement of the operations of the equipment and project\nrelated limited partnerships for which affiliates of ML Film\nserve as general partners. Mr. Aufenanger is also a\ndirector of ML Media, ML Opportunity, ML Venture, ML R&D, ML\nMezzanine and ML Mezzanine II.\nSteven N. Baumgarten, 40, a Vice President of Merrill\nLynch & Co. Corporate Credit, joined Merrill Lynch in 1986.\nMr. Baumgarten shares responsibility for the ongoing\nmanagement of the operations of the equipment and project\nrelated limited partnerships for which subsidiaries of ML\nLeasing Equipment Corp., an affiliate of Merrill Lynch, are\ngeneral partners.\nMichael E. Lurie, 52, a First Vice President of\nMerrill Lynch & Co. Corporate Credit and the Director of the\nAsset Recovery Management Department, joined Merrill Lynch\nin 1970. Prior to his present position, Mr. Lurie was the\nDirector of Debt and Equity Markets Credit responsible for\nthe global allocation of credit limits and the approval and\nstructuring of specific transactions relating to debt and\nequity products. He also served as Chairman of the Merrill\nLynch International Bank Credit Committee. Mr. Lurie is\nalso a director of ML Media, ML Opportunity, ML Venture and\nML R&D.\nDiane T. Herte, 35, an Assistant Vice President of\nMerrill Lynch & Co., Corporate Credit since 1992, joined\nMerrill Lynch in 1984. Ms. Herte's responsibilities include\ncontrollership and financial management functions for\ncertain partnerships for which subsidiaries of ML Leasing\nEquipment Corp., an affiliate of Merrill Lynch, are general\npartners.\nMr. Aufenanger is an executive officer of Mid-Miami\nDiagnostics Inc. (\"Mid-Miami Inc.\"). On October 28, 1994\nboth Mid-Miami Inc. and Mid-Miami Diagnostics, L.P. filed\nvoluntary petitions for protection from creditors under\nChapter 7 of the United States bankruptcy Code in the United\nStates Bankruptcy Court for the Southern District of New\nYork.\nMerrill Lynch was a co-managing underwriter of the\ninitial public offering of Sony Pictures Entertainment Inc.\n(\"SPE\") (then known as \"Tri-Star Pictures, Inc.\") securities\nand of several subsequent public offerings of additional SPE\nsecurities. In addition, an affiliate of the Managing\nPartner serves as a manager for certain film financing\ntransaction conducted on behalf of SPE in Japan. Therefore,\nML Film and its affiliates could have interests that may\nconflict with those of the Partnership.\nMerrill Lynch, or an affiliate, has served as a\nselling agent for the public offerings of units in each of\nthe Delphi Partnerships.\nOperational and Financial Services.\nTo assist it in the performance of its duties, the\nGeneral Partner has engaged Magera, subject to the direction\nand supervision of the General Partner, to provide\noperational and financial services which are provided at no\nadditional cost to the Partnership for each year for which\nthere is a management fee. Magera is owned by Richard M.\nMason and Aaron German. Mr. Mason, the sole shareholder of\nGoshen Services, Inc. (which is a partner of Delphi Film\nServices, the sole limited partner of the General Partner)\nand the President of Magera, and Mr. German, the Executive\nVice President of Magera, also previously acted as\nconsultants to SPE. Magera also provides operational and\nfinancial services to the general partners of other private\nand public limited partnerships, including the other Delphi\nPartnerships, and serves as a consultant to others engaged\nin the entertainment industry.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe General Partner was paid a management fee of\napproximately $569,000 for 1995 and is entitled to an annual\nmanagement fee in the same amount through 1996. The General\nPartner is responsible for payments to all personnel\nemployed by it, office and travel expenses and other matters\nrelating to the administration of the Partnership. The\nGeneral Partner does not, however, bear the expense of\nprofessional fees rendered on behalf of the Partnership,\nsuch as legal fees and fees to certified public accountants\nwhich are paid directly by the Partnership. In addition,\nthe General Partner is being reimbursed for out-of-pocket\nexpenses with respect to administering the Partnership and\nreporting to partners. For years subsequent to 1996 there\nwill be no fixed management fee. In that regard, the\nGeneral Partner, on behalf of the Partnership, has retained\nMagera to provide those services to the Partnership for\nyears after 1996.\nUntil limited partners have received total cash\ndistributions equal to their capital contributions (the\n\"Capital Return\"), they will receive 99% of, and the General\nPartner will receive 1% of, all cash distributions.\nFollowing Capital Return, until limited partners have\nreceived total cash distributions equal to 150% of Capital\nReturn, the General Partner, in addition to receiving\ndistributions in respect of 1% interest for which it has\npaid, will be entitled to receive distributions in amounts\nequal to 10% of all further cash distributions made. After\nthe limited partners have received total cash distributions\nequal to 150% of Capital Return, the General Partner, in\naddition to receiving distributions in respect of the 1%\ninterest for which it has paid, will be entitled to receive\ndistributions in amounts equal to 15% of all further cash\ndistributions made.\nPrior to reaching Capital Return, income will be\nallocated 99% to the limited partners and 1% to the General\nPartner. After Capital Return is reached, allocations of\nincome will be based on the aggregate prior allocations of\nincome and losses, the aggregate prior cash distributions\nand cash available for distribution.\nThe foregoing describes the provisions of the\npartnership agreement concerning the General Partner's right\nto share in cash distributions, and is not intended to\nsuggest that any particular level of cash distributions will\nbe reached.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nTo the best of the knowledge of the Partnership, no\nperson beneficially owns in excess of 5% of the limited\npartnership units of the Partnership.\nTo the best of the knowledge of the Managing Partner, as\nof March 1, 1996, no person is the beneficial owner of 5% or\nmore of the outstanding common stock of Merrill Lynch.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe Partnership's operations relating to the ownership\nand exploitation of films involve Columbia or TriStar. See Item\n1 \"Business.\"\nThe General Partner is entitled to management fees and to\na portion of cash distributions to partners. The General\nPartner of the Partnership is affiliated with the general\npartners of other Delphi Partnerships all of which are limited\npartnerships similar to the Partnership.\nPART IV.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)(1) Financial Statements:\nML Delphi Premier Partners, L.P.\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 Cash Flows 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\nNotes to Financial Statements\nTri-Star-ML Delphi Premier Productions\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 Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Venturers' Capital for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\n(a)(2) Financial Statement Schedules:\nNo financial statement schedules have been filed as part of\nthis report as none are required.\n(1) Incorporated by reference to the Partnership's registration statement No. 33-6489, as amended, on file with the Securities and Exchange Commission.\n(2) Incorporated by reference to the Partnership's Form 10-K for the year ended December 31, 1987 on file with the Securities and Exchange Commission.\n(3) Incorporated by reference to the Partnership's Form 10-K for the year ended December 31, 1988 on file with the Securities and Exchange Commission.\n(4) Incorporated by reference to the Partnership's Form 10-K for the year ended December 31, 1989 on file with the Securities and Exchange Commission.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter\nof the Partnership's fiscal year ended December 31, 1995.\n(c) Exhibits.\nThe Exhibits required by Item 601 of Regulation S-K are\nsubmitted as a separate section following the Partnership's\nfinancial statements.\n(d) Financial Statement Schedule.\nNo financial statement schedules have been filed as part\nof this report as none are required.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 28, 1996 ML DELPHI PREMIER PARTNERS, L.P. By: ML DELPHI PARTNERS, L.P. General Partner By: ML Film Entertainment Inc., General Partner\n\/s\/ Kevin K. Albert (Kevin K. Albert) President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Kevin K. Albert Director and President of March 28, 1996 (Kevin K. Albert) the general partner of the General Partner (principal executive officer of the Registrant)\n\/s\/ Robert F. Aufenanger Director and Executive Vice March 28, 1996 (Robert F. Aufenanger) President of the general partner of the General Partner\n\/s\/ Steven N. Baumgarten Director and Vice President March 28, 1996 (Steven N. Baumgarten) of the Managing Partner of the General Partner\nDirector and Vice President March 28, 1996 (Michael E. Lurie) of the Managing Partner of the General Partner\n\/s\/ Diane T. Herte Treasurer of the general March 28, 1996 (Diane T. Herte) partner of the General Partner (principal financial officer and principal accounting officer of the Registrant) EXHIBIT INDEX\nPage Reference\nin Sequentially\nNumbered Copy\n4.1 Amended and Restated Agreement of Limited Partnership*\n4.2(a) Production Credit Agreement dated as of January 18, 1988*\n4.2(b) Amendment No. 1 to the Production Credit Agreement dated as of March 1, 1988*\nl0.l Tri-Star Joint Venture Agreement*\nl0.2 Product Origination Agreements*\nl0.4 Distribution Agreements*\n10.5 Agreement dated June 13, 1989 between ML Delphi Premier Partners, L.P. and Columbia Pictures Entertainment, Inc.*\n27 Financial Data Schedule\nINDEPENDENT AUDITORS' REPORT\nThe Partners ML Delphi Premier Partners, L.P.:\nWe have audited the accompanying balance sheets of ML Delphi Premier Partners, L.P. (a Delaware Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, cash flows and changes in partners' capital 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 ML Delphi Premier Partners, L.P. (a Delaware Limited Partnership) 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.\nKPMG PEAT MARWICK LLP\nNew York, New York March 25, 1996\nML DELPHI PREMIER PARTNERS, L.P. (A Delaware Limited Partnership)\nBALANCE SHEETS (000's Omitted)\nML DELPHI PREMIER PARTNERS, L.P. (A Delaware Limited Partnership)\nSTATEMENTS OF OPERATIONS (000's Omitted, except net profit per unit)\nML DELPHI PREMIER PARTNERS, L.P. (A Delaware Limited Partnership) STATEMENTS OF CASH FLOWS (000's Omitted)\nML DELPHI PREMIER PARTNERS, L.P. (A Delaware Limited Partnership)\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 3l, 1995, 1994 AND 1993 (000's Omitted, except distributions per unit)\nML DELPHI PREMIER PARTNERS, L.P. (A Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. General\nML Delphi Premier Partners, L.P. (the \"Partnership\") is a\nlimited partnership which was formed to participate in the\nproduction, ownership, acquisition of interests in and\nexploitation of feature length motion pictures. The Partnership\nwas organized under the laws of the State of Delaware on\nJune 12, 1986. ML Delphi Partners, L.P., a Delaware limited\npartnership (the \"General Partner\"), is the general partner of\nthe Partnership. The General Partner, which has the full\nresponsibility for the management of the Partnership's business,\nreceived a fee for its management services of $569,000 in l995,\nl994 and 1993. A public offering (the \"Offering\") of limited\npartnership interests in the Partnership was completed on\nDecember 23, 1986. A total of 12,610 units at $5,000 per unit\nwere sold.\nA substantial portion of the business of the Partnership is\nthe production, ownership, acquisition of interests in and\nexploitation of motion pictures through its participation in the\nJoint Venture (as hereinafter defined.) Accordingly, the\nPartnership's operating results are in large part dependent upon\nthe operating results of the Joint Venture, and are\nsignificantly impacted by the Joint Venture's policies (see Note\n4).\nThe General Partner contributed $637,000, an amount equal to\nl% of the total capital contributions, to the Partnership.\nProfits and losses are currently being allocated l% to the\nGeneral Partner and 99% to the limited partners (See Note 9).\nThe Partnership (a) has acquired Preferred Film (\"PF\")\nInterests in films through Tri-Star-ML Delphi Premier\nProductions (the \"Joint Venture\"), a joint venture with TriStar\nPictures, Inc. (formerly Tri-Star Pictures, Inc.) (\"TriStar\"),\nwith returns based on gross receipts of those films and (b) has\nacquired Single Film (\"SF\") Interests in films through the Joint\nVenture with returns generally based on the net proceeds of\nthose films or upon certain gross receipts if it would result in\na greater amount. In addition, SF Interests have been acquired\nin three films released by Columbia Pictures, a division of\nColumbia Pictures Industries, Inc. (the \"Columbia Distributor\").\n2. Summary of Significant Accounting Policies\n(a) Short-Term Investments\nShort-Term Investments consist solely of U.S. government\nsecurities which are stated at cost plus accrued interest, which\napproximate market value.\n(b) Accounting for Participation in Tri-Star-ML Delphi Premier Productions The Partnership records its investment in the Joint Venture\nunder the equity method of accounting.\n(c) Interests in Motion Pictures Released and Amortization\nInterests in Motion Pictures Released include the\nPartnership's share of the direct costs of production of certain\nfilms plus an overhead charge equivalent to 12.5% of the direct\nproduction costs. In addition, advertising expenditures which\nbenefit future periods were capitalized as incurred by the\nPartnership and are included in Interests in Motion Pictures\nReleased.\nThe Partnership's interests in motion pictures are amortized\nbased on net revenues recognized in proportion to the\nPartnership's estimate of ultimate net revenues to be received.\nUnamortized amounts are compared with net realizable value on a\nfilm by film basis, and losses are recognized to the extent of\nany excess of costs over net realizable value with respect to\neach film.\nHowever, should losses be indicated for films, the Special\nRecoupment Payments described in Note 5, to the extent\navailable, are accrued as Motion Picture Costs Recoverable from\nSpecial Recoupment Payments.\nColumbia agreed to compensate the Partnership for the\nunavailability to it of an investment tax credit with respect to\none of the films in which the Partnership has a direct ownership\ninterest by making a payment to the Partnership in l987 of\n$85,000. This amount is equal to approximately one and one-half\ntimes the investment tax credit applicable to the Partnership's\ninterest in that film. This payment results in a reduction in\nthe account, Interests in Motion Pictures Released, in the\naccompanying financial statements.\n(d) Recognition of Revenue for Motion Pictures Released\nNet revenues from the Columbia Distributor with respect to SF\nInterest motion pictures released in which the Partnership has\nan interest are recognized on an accrual basis. Net revenues\nconsist of: (a) the portion of net proceeds (gross receipts less\na distribution fee, unless deferred, and other distribution and\nreleasing costs) or, if greater, a percentage of gross receipts\naccrued payable to the Partnership under the distribution\nagreement, plus, (b) the portion of gross receipts accrued (not\nin excess of the advertising expenditures for the films, subject\nto certain limitations, plus an amount intended to approximate\nthe cost of funds incurred by the Partnership in connection with\nits advertising obligation). However, certain advances received\nby the Columbia Distributor which are includable in gross\nreceipts under the distribution agreement are not reflected in\nthe calculation of net revenues until those advances are earned.\n(e) Receivable from Columbia Pictures (Distributor)\nThis asset represents the amounts receivable by the\nPartnership from Columbia. The total receivable from Columbia\nconsists of amounts accrued with respect to film exploitation of\n$110,000 in 1995 and $113,000 in l994.\n(f) Distribution Fee\nThe Columbia Distributor is entitled to receive a 17.5%\ndistribution fee on substantially all gross receipts in\ncalculating the net proceeds to which the Partnership is\nentitled from the distribution of a film; however, the Columbia\nDistributor's entitlement to this distribution fee is deferred\nuntil the Partnership has received from the distribution of a\nfilm an amount equal to the amount spent by the Partnership to\nproduce or acquire an interest in that film, other than amounts\nspent for payments in the nature of interest (\"Cost Return\").\nAfter Cost Return for a film, the deferred distribution fee will\nbe recouped by the Distributor from a portion (based on the\nPartnership's interest in the film) of the amount otherwise\npayable to the Partnership. After Cost Return, the Distributor\nwould be entitled to receive a distribution fee equal to 17.5%\nof substantially all gross receipts, including gross receipts\nprior to Cost Return.\n(g) Accounting for Income Taxes\nNo provision for income taxes has been made as ML Delphi\nPremier Partners, L.P. is treated as a partnership for income\ntax purposes, with all income tax consequences flowing directly\nto its partners.\nEffective January l, l993, the Partnership adopted Statement\nof Financial Accounting Standards No. 109, \"Accounting for\nIncome Taxes.\" As of December 31, 1995 and 1994, the reported\namounts of the Partnership's assets less liabilities exceeded\nthe tax bases by approximately $13,492,000 and $11,138,000,\nrespectively. The adoption of the Statement had no impact on\nthe Partnership's financial statements.\n3. Supplemental Disclosure of Cash Flow Information\nNo amounts for interest were paid in 1995, l994 and l993.\n4. Transactions with Joint Venture\n(a) PF Interests in Motion Pictures\nThe Partnership, through the Joint Venture, acquired PF\ninterests in twenty-two films for a cost of $l,000,000 per film.\nOf these twenty-two films, nineteen were produced by TriStar and\nthree were produced by Columbia. The Partnership is receiving\nan amount for each film based on certain percentages of gross\nreceipts of that film from all sources, with a maximum payment\nof $l,l25,000 per film. In addition, the Partnership will also\nbe entitled to receive an amount based on certain percentages of\nthe aggregate gross receipts of all PF Interest films excluding\nU.S. and Canadian domestic theatrical gross receipts. In any of\nthe years l988 through l995 in which the annual cash return to\nthe Partnership from the PF Interest films would cause the\nPartnership's cumulative non-compounded return on the amount of\nthe Partnership's total funds to be contributed for PF Interest\nfilms to exceed l4% per year, the balance of the amount due is\ncarried forward and, to the extent not applied in later years to\ngenerate a l4% return to the Partnership, will be payable,\nwithout interest, to the Partnership on December 23, l996 less\nthe Acceleration Payment recoupments described below. As of\nDecember 31, 1995, $21,471,000, net of Acceleration Payments and\nrelated interest and the Advance described below, is carried\nforward and is included in the receivable from the Tri-Star\nJoint Venture in the accompanying financial statements.\nAs of December 31, 1995, the Partnership had an interest in\ntwenty-two Joint Venture PF Interest films all of which had been\nreleased. In each December of 1988 through 1995, TriStar,\nthrough the Joint Venture, made a payment to the Partnership of\n$3,l42,000 representing revenue for the PF Interest Films. In\nDecember l987, $3,l42,000 was also paid to the Partnership,\nthrough the Joint Venture, by TriStar. Approximately $2,684,000\nof the l987 amount represented an advance (the \"Advance\") which\nTriStar will be entitled to recoup, without interest, in\nDecember l996 from revenues earned by the distribution of the\nPartnership's PF Interest Films. Such amount has been netted\nagainst the receivable from the Tri-Star Joint Venture (see Note\n4(e)).\nIf in any calendar year the Partnership recognizes income for\nfederal tax purposes with respect to PF Interest films in excess\nof the December payment for that year (the \"Excess\"), TriStar is\nrequired to make an acceleration payment to the Partnership with\nrespect to the Excess. The amount of the acceleration payment\nis equal to the Excess multiplied by the maximum individual\nfederal income tax rate in effect for the year of the Excess\n(the \"Acceleration Payment\"). The Acceleration Payment is\nrecoupable, with interest, by TriStar, with certain exceptions,\nfrom the payment to be received by the Partnership in December\n1996. The Partnership received approximately $360,000 and\n$7,548,000 in March l993 and l992 with respect to the\nAcceleration Payment for l992 and 1991, respectively. As of\nDecember 31, 1995 and 1994, Acceleration Payments of\napproximately $8,702,000 have been netted against the receivable\nfrom Tri-Star Joint Venture. Cumulative interest accrued on the\nAcceleration Payments as of December 31, 1995 and l994 of\napproximately $2,870,000 and $l,836,000, respectively, has been\nnetted against the receivable from Tri-Star Joint Venture (see\nNote 4(e)).\n(b) SF Interests in Motion Pictures\nThe Partnership, through the Joint Venture, has interests\nranging from 5% to 25% in (and has borne a corresponding\npercentage of the cost of) seventeen motion pictures produced by\nthe Joint Venture (\"Joint Venture Films\"). The Partnership has\nsatisfied its commitment to contribute (including interest) a\nmaximum of approximately $37,768,000 to the Joint Venture for\nthe production or acquisition of SF Interest films. The Joint\nVenture Films are distributed pursuant to a distribution\nagreement between TriStar Pictures, Inc. (a \"Distributor\") and\nthe Joint Venture (see Note 5). The Distributor is entitled to\nreceive a fee of l7.5% of substantially all gross receipts from\neach film, except that the Distributor's entitlement to this\ndistribution fee is deferred until the Joint Venture has\nreceived from the distribution of that film an amount equal to\nthat spent by the Joint Venture to produce or acquire an\ninterest in the film, other than amounts spent for payments in\nthe nature of interest. In light of the results of Joint\nVenture Films, net revenues have been computed as of December\n31, l995, l994 and l993 without the Distributor deducting a\ndistribution fee, with the exception of five films in 1995 and\nfour films in 1994 and 1993 for which a portion of the fees were\ndeducted.\n(c) Joint Venture Revenue Recognition\nThe Joint Venture recognizes net revenues for SF Interest\nfilms from the Distributor on an accrual basis. Net revenues\nconsist of: a) the portion of net proceeds (gross receipts less\na distribution fee, unless deferred, and other distribution and\nreleasing costs) or, if greater, gross receipts payable to the\nJoint Venture under the distribution agreement, plus b) gross\nreceipts accrued (not in excess of the amount of the advertising\nand promotion charge paid by the Joint Venture plus an amount\nintended to approximate the cost of funds incurred by the\nPartnership in connection with the payment of that charge). The\nJoint Venture recognizes revenues for a PF Interest film based\non certain percentages of gross receipts for that film up to a\nmaximum amount of $l,l25,000 per film. In addition, the Joint\nVenture also recognizes revenue based on certain percentages of\nthe aggregate gross receipts of all PF Interest films, excluding\nU.S. and Canadian theatrical gross receipts. However, certain\nadvances received by the Distributor which are includable in\ngross receipts under the distribution agreement are not\nreflected in the calculation of net revenues until those\nadvances are earned.\n(d) Joint Venture Amortization Policies\nAdvertising expenditures which benefit future periods were\ncapitalized as incurred by the Joint Venture. Advertising\nexpenditures and unamortized production costs are amortized by\nthe Joint Venture under the individual film forecast method\nbased upon net revenues recognized in proportion to the Joint\nVenture's estimate of ultimate net revenues to be received\nwithout regard to any Special Recoupment Payments (see Note 5).\nUnamortized production costs are compared with net realizable\nvalue on a film by film basis, and losses are recognized to the\nextent of any excess of costs over net realizable value.\nUnamortized advertising expenditures are compared with the total\nestimated gross receipts from all films in the aggregate and\nlosses are recognized to the extent of any excess of\nexpenditures over gross receipts.\n(e) Receivable from Tri-Star-ML Delphi Premier Productions,\nnet\nThis asset represents the excess of the amounts receivable by\nthe Partnership from the Joint Venture over amounts payable by\nthe Partnership to the Joint Venture. The total receivable of\n$37,301,000 in 1995 consists of $15,642,000 accrued as special\nrecoupment payments, $27,025,000 accrued with respect to gross\nreceipts payments from PF Interest films (net of Acceleration\nPayments of $8,702,000) and $188,000 accrued with respect to net\nproceeds and gross receipts payments from SF Interest films\npartially offset by a $2,684,000 advance to the Partnership\nrelated to its PF Interest films and $2,870,000 of interest\nexpense related to the Acceleration Payments. The total\nreceivable of $39,600,000 in l994 consisted of $l3,925,000\naccrued as special recoupment payments and $29,873,000 accrued\nwith respect to gross receipts payments from PF Interest films\n(net of Acceleration Payments of $8,702,000) and $322,000\naccrued with respect to net proceeds and gross receipts payments\nfrom SF Interest films partially offset by a $2,684,000 advance\nto the Partnership related to its PF Interest films and\n$l,836,000 of interest expense related to the Acceleration\nPayments.\n(f) Transactions with Tri-Star\nThe films in which the Joint Venture has an interest are\ndistributed pursuant to a distribution agreement between TriStar\nand the Joint Venture with terms similar to those with the\nColumbia Distributor (see Note 2(f)).\n5. Special Recoupment Payments\nUnder the terms of the distribution agreement between the\nJoint Venture and its Distributor and the distribution agreement\nbetween the Partnership and the Columbia Distributor, the\nPartnership will be entitled to a payment (a \"Special Recoupment\nPayment\") from the Distributors in l996 for each SF Interest\nfilm (an \"Unrecouped Film\") for which the Partnership has not\nreceived from the distribution of that film or a sale of the\nPartnership's interest in that film an amount (\"Cost Return\")\nequal to the amount spent by the Partnership to produce or\nacquire an interest in the film, other than amounts spent for\npayments in the nature of interest. Each Special Recoupment\nPayment would be in the amount necessary for the Partnership to\nbe repaid (without interest) the amounts contributed by it (from\nall sources) with respect to the production or acquisition of an\nUnrecouped Film (other than contributions for payments in the\nnature of interest), but not more than the amount specified\nbelow. Initially, the Special Recoupment Payment would be\npayable only to the extent of the distribution fees received by\neach Distributor from the distribution of all SF Interest films\ndistributed by it, reduced to the extent of the Special\nRecoupment Payments made with respect to other Unrecouped Films\ndistributed by it. The Special Recoupment Payments to the Tri-\nStar Joint Venture based on distribution fees would be allocated\nby the Tri-Star Joint Venture first to the Partnership to the\nextent necessary for the Partnership to recoup (without\ninterest) the amount of its contributions to the Tri-Star Joint\nVenture for the production or acquisition of the Unrecouped\nFilms (other than contributions for payments in the nature of\ninterest); any excess would then be allocated to TriStar. If\nthose distribution fees are insufficient to enable each\nDistributor to make the Special Recoupment Payments with respect\nto all Unrecouped Films distributed by it, gross receipts and\nnet proceeds of each remaining Unrecouped Film distributed by\nthat Distributor would be recalculated by including as gross\nreceipts in respect of each such Unrecouped Film the excess, if\nany, of the minimum payments under its license agreement with\nHome Box Office, Inc. (\"HBO\"), in the case of Columbia, or the\nminimums determined under the agreement between TriStar and HBO\nbased on the formula for films that commenced principal\nphotography in l986, in the case of TriStar, and certain minimum\namounts in respect of video cassette and video disc exploitation\nin excess of the amounts previously included in the gross\nreceipts of that Unrecouped Film in respect of those\narrangements. The Distributor would then make a Special\nRecoupment Payment for the account of the Partnership to the\nextent of the additional gross receipts or net proceeds payable\nfor the account of the Partnership as a result of the\nrecalculation (and, in the case of a Columbia SF Interest film,\nto the extent of the amount equal to any additional payments\nthat the Partnership would have received in respect of that film\nhad the limit on the deduction of distribution expenses\napplicable to Tri-Star SF Interest films been applicable to that\nColumbia SF Interest film), but only up to the amount of the\nunrecouped contribution (other than contributions for payments\nin the nature of interest) in respect of that Unrecouped Film.\nEach Special Recoupment Payment made on the basis of such\nrecalculation would be allocated between the Partnership and\nTriStar in proportion to their respective interests in the\napplicable Unrecouped Film. The Distributor will be entitled to\nrecoup the Special Recoupment Payments in respect of each\nUnrecouped Film, with an amount in the nature of interest\ncalculated at ll0% of the prime rate from time to time, from the\nPartnership's share of all subsequent gross receipts or net\nproceeds of that Unrecouped Film and from the proceeds of any\nsale of the Partnership's interest in that Unrecouped Film. In\ncalculating the amount of distribution fees available for the\nSpecial Recoupment Payments, no distribution fee will be deemed\nreceived by a Distributor (and therefore no distribution fee\nwill be deemed available for the Special Recoupment Payment)\nfrom a film with respect to which the most recent payment by\nthat Distributor was based on gross receipts or from a film that\ndid not reach Cost Return.\nBased on the anticipated performance of the three films\nreleased by Columbia as of December 31, 1995 and 1994 $2,576,000\nand $2,373,000, respectively (amounts present valued at\nColumbia's discount rate from December 1996), have been accrued\nby the Columbia Distributor as Special Recoupment Payments\npayable to the Partnership. Based on the anticipated\nperformance of the seventeen SF films released by the Joint\nVenture as of December 31, 1995 and 1994, $15,642,000 and\n$l3,925,000, respectively (amounts present valued at the Joint\nVenture's discount rate from December 1996), have been accrued\nby the Joint Venture as Special Recoupment Payments allocable to\nthe Partnership. To the extent available, the Special\nRecoupment Payments from the Distributors are expected to enable\nthe Partnership to achieve Cost Return for the Unrecouped Films.\n6. Bonus Film Profit Payments\nThe Partnership is entitled to certain additional payments\n(\"Bonus Profit Payments\") with respect to the three Tri-Star SF\nInterest films that generate the greatest payments to the\nPartnership (\"Bonus Films\"). All three SF Interest Films have\ngenerated cash payments to the Partnership. The Bonus Profit\nPayments will be equal to 30% of the first $9,000,000 received\nby the Joint Venture in excess of the Partnership's\ncontributions with respect to that Bonus Film. Bonus Profit\nPayments were made in 1995, 1994 and 1993 in the amounts of\n$9,000, $81,000 and $9,000, respectively. Additional Bonus\nProfit Payments will be made to the extent earned, in\ninstallments, without interest, and continue on a quarterly\nbasis to the extent subsequently earned until reaching the\nmaximum profit payments.\n7. Extra Film Profit Participations\nThe Partnership will be entitled to receive, without any\nadditional cost or payment to it, a profit participation in\nthree additional Tri-Star SF Interest films (\"Extra Films\")\nsince, in December l990, the aggregate Cash Return (as defined\nbelow) to the Partnership from the Tri-Star SF Interest films\nwas estimated to be less than l25% of the portion of the net\nproceeds of the Offering (and of the General Partner's capital\ncontribution) allocated to such Tri-Star SF Interest films (the\n\"Allocated Amount\"). The profit participation will equal l0% of\nthe net proceeds of each Extra Film after l00% of the net\nproceeds of that Extra Film exceeds 112 1\/2% of its production\ncost. The profit participation in these Extra Films will cease\nshould the Partnership's overall Cash Return with respect to Tri-\nStar SF Interest films plus any profit participation payments\nwith respect to the Extra Films equal 200% of the Allocated\nAmount. The Cash Return is an amount equal to (a) the cash\npayments then estimated ultimately to be received by the\nPartnership from the Tri-Star SF Interest films less (b) the\nPartnership's contributions for those films in excess of the\nAllocated Amount and an amount in the nature of interest on such\nexcess. Insofar as the selection of these Extra Films is\nconcerned, the Partnership chose one Extra Film, TriStar chose\none Extra Film, and the third Extra Film was jointly chosen. As\nof December 31, 1995, all three Extra Films have been selected\nand released. Based on the performance of the Extra Films\nthrough December 31, 1995, no receivable has been reflected in\nthe accompanying financial statements.\n8. Current Operations\nAs of December 31, 1995, the Partnership had an interest in\ntwenty SF Interest films (seventeen of which are owned through\nthe Joint Venture), all of which had been released.\nAdditionally, the Partnership had an interest in twenty-two PF\nInterest films which had been released. Based on the\nperformance of the released films during the year ended\nDecember 31, 1995 and after deducting the net operating expenses\nof the Partnership, the Partnership is reporting a net profit of\n$788,000 for the year ended December 31, 1995.\n9. Distribution to Partners\nUntil limited partners have received total cash\ndistributions equal to their capital contributions (the\n\"Capital Return\"), they will receive 99% of, and the General\nPartner will receive 1% of, all cash distributions.\nFollowing Capital Return, until limited partners have\nreceived total cash distributions equal to 150% of Capital\nReturn, the General Partner, in addition to receiving\ndistributions in respect of 1% interest for which it has\npaid, will be entitled to receive distributions in amounts\nequal to 10% of all further cash distributions made. After\nthe limited partners have received total cash distributions\nequal to 150% of Capital Return, the General Partner, in\naddition to receiving distributions in respect of the 1%\ninterest for which it has paid, will be entitled to receive\ndistributions in amounts equal to 15% of all further cash\ndistributions made.\nPrior to reaching Capital Return, income will be\nallocated 99% to the limited partners and 1% to the General\nPartner. After Capital Return is reached, allocations of\nincome will be based on the aggregate prior allocations of\nincome and losses, the aggregate prior cash distributions\nand cash available for distribution. As of December 31,\n1995, the limited partners have not reached Capital Return\nand, as such, income and losses have been allocated 99% to\nthe limited partners and 1% to the General Partner.\nREPORT OF INDEPENDENT ACCOUNTANTS\nVenturers TriStar - ML Delphi Premier Productions\nIn our opinion, the accompanying balance sheets and the related statements of operations, of cash flows and of venturers' capital present fairly, in all material respects, the financial position of TriStar - ML Delphi Premier Productions 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 Venture'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.\nCentury City, California March 22, l996\nTRI-STAR-ML DELPHI PREMIER PRODUCTIONS (A Joint Venture)\nBALANCE SHEETS (000's Omitted)\nTRI-STAR-ML DELPHI PREMIER PRODUCTIONS (A Joint Venture)\nSTATEMENTS OF OPERATIONS (000's Omitted)\nTRI-STAR - ML DELPHI PREMIER PRODUCTIONS (A Joint Venture)\nSTATEMENTS OF CASH FLOWS (000's Omitted)\nTRI-STAR-ML DELPHI PREMIER PRODUCTIONS (A Joint Venture)\nSTATEMENTS OF VENTURERS' CAPITAL FOR THE YEARS ENDED DECEMBER 3l, 1995, 1994 AND 1993 (000's Omitted)\nTRI-STAR-ML DELPHI PREMIER PRODUCTIONS (A Joint Venture)\nNOTES TO FINANCIAL STATEMENTS\n1. General\nTri-Star-ML Delphi Premier Productions (the \"Joint Venture\")\nis a joint venture between TriStar Pictures, Inc. (formerly Tri-\nStar Pictures, Inc.) (\"TriStar\") (\"TSPI\") and ML Delphi Premier\nPartners, L.P., a Delaware limited partnership (the\n\"Partnership\") formed in June 1986 to engage in the business of\nproducing, owning, acquiring interests in and exploiting feature\nlength motion pictures. Substantial operation of the Joint\nVenture began in December l986. The Joint Venture has acquired\nPreferred Film (\"PF\") Interests in twenty-two films with returns\nbased on gross receipts of those films. Of these twenty-two\nfilms, nineteen were produced by TSPI and three were produced by\nColumbia Pictures Industries, Inc. (\"Columbia\"). The\nPartnership has and will continue to receive all amounts paid to\nthe Joint Venture based on the gross receipts of those films.\nThe Joint Venture has also acquired seventeen Single Film (\"SF\")\nInterests in films with returns generally based on the net\nproceeds of those films. Generally, through the Joint Venture,\nTSPI has either a 75% or a 95% interest and the Partnership has\neither a 25% or a 5% interest in, and each was responsible for\nthose respective percentages of the production cost of, SF\nInterest films in which the Joint Venture has a 100% interest\nand which were produced by the Joint Venture (\"Joint Venture\nFilms\").\nThree of the Joint Venture Films were co-produced with Tri-\nStar Delphi IV Productions, a joint venture between TSPI and\nDelphi Film Associates IV (\"DFA IV\"), a New York limited\npartnership, and with Tri-Star-Delphi V Productions, a joint\nventure between TSPI and Delphi Film Associates V (\"DFA V\"), a\nNew York limited partnership. The Joint Venture has an interest\nranging from l0-36% in these three films. In addition, three of\nthe Joint Venture Films were co-produced only with Tri-Star-\nDelphi V Productions. The Joint Venture has an interest of l0%\nin two and 50% in one of these three films. With respect to one\nJoint Venture Film in which the Joint Venture has a l00%\ninterest, Tri-Star-Delphi IV Productions has acquired a l0%\nparticipation interest which was derived from TSPI's interest in\nthat film through the Joint Venture. All seventeen Joint\nVenture Films and all twenty-two PF Interest Films had been\nreleased as of December 31, 1995.\nAll of the Joint Venture's films are to be distributed\npursuant to a distribution agreement with TSPI (the\n\"Distributor\"). The general partner of the Partnership is\naffiliated with the general partner of DFA IV and DFA V.\nThe Partnership has acquired an SF Interest in three films\nreleased by Columbia, which are similar to the Joint Venture's\nSF Interests.\nSony Pictures Entertainment Inc., the parent company of\nColumbia and TriStar, is an indirect wholly-owned subsidiary of\nSony Corporation.\n2. Summary of Significant Accounting Policies\nRecognition of Revenue\nThe Joint Venture recognizes net revenues for SF Interest\nfilms from the Distributor on an accrual basis. Net revenues\nconsist of: a) the portion of net proceeds (gross receipts less\na distribution fee, unless deferred, and other distribution and\nreleasing costs) or, if greater, gross receipts payable to the\nJoint Venture under the distribution agreement, plus b) gross\nreceipts accrued (not in excess of the amount of the advertising\nand promotion charge paid by the Joint Venture plus an amount\nintended to approximate the cost of funds incurred by the\nPartnership in connection with the payment of that charge). The\nJoint Venture recognizes revenues for a PF Interest film based\non certain percentages of gross receipts for that film up to a\nmaximum amount of $l,l25,000 per film. In addition, the Joint\nVenture also recognizes revenue based on certain percentages of\nthe aggregate gross receipts of all PF Interest films, excluding\nU.S. and Canadian theatrical gross receipts. However, certain\nadvances received by the Distributor which are includable in\ngross receipts under the distribution agreement are not\nreflected in the calculation of net revenues until those\nadvances are earned.\nDistribution Fee\nThe Distributor is entitled to receive a distribution fee\nequal to 17.5% of the gross receipts of an SF Interest film;\nhowever, TSPI's entitlement to this distribution fee is deferred\nuntil the Joint Venture has received from the distribution of a\nparticular SF Interest film an amount equal to the amount spent\nby the Joint Venture to produce or acquire an interest in that\nfilm, other than amounts spent for payments in the nature of\ninterest (\"Cost Return\"). After Cost Return for a film, in\ncalculating subsequent payments to the Joint Venture based on\nnet proceeds, the Distributor will be entitled to receive a\ndistribution fee equal to 17.5% of substantially all gross\nreceipts of the film prior to Cost Return and l7.5% of\nsubstantially all gross receipts after Cost Return.\nNet revenues accrued at December 31, 1995, 1994 and 1993 were\ncomputed without deducting a distribution fee to the Distributor\nin light of the results of the films released through those\nrespective dates, with the exception of five films in 1995 and\nfour films in 1994 and 1993 for which a portion of the\ndistribution fees were deducted.\nMotion Picture Production and Advertising Costs\nMotion picture production costs include the direct cost of\nproduction plus an overhead charge equivalent to 12.5% of the\ndirect production costs; these costs were capitalized as\nincurred by the Joint Venture. Payments by the Joint Venture in\nrespect of the advertising and promotion charge payable to the\nDistributor were capitalized as incurred to the extent those\npayments benefit future periods. These costs are amortized\nunder the individual film forecast method based upon net revenue\nrecognized in proportion to the Joint Venture's estimate of\nultimate net revenues to be received. Unamortized production\ncosts are compared with net realizable value on a film by film\nbasis and unamortized advertising costs are compared with net\nrealizable value in the aggregate; losses are recognized to the\nextent of any excess of costs over net realizable value. If\nlosses are indicated for films, the Special Recoupment Payments\ndescribed in Note 3, to the extent available, are accrued as\nMotion Picture Costs Recoverable from Special Recoupment\nPayments in the accompanying financial statements.\n3. Special Recoupment Payments (See Note 7)\nThe Joint Venture will be entitled to a payment (a \"Special\nRecoupment Payment\") from the Distributor in l996 with respect\nto each film (an \"Unrecouped Film\") for which the Joint Venture\nhas not received from the film's distribution (or its sale) an\namount equal to the amount spent by the Joint Venture to produce\nor acquire an interest in the film (other than amounts spent for\npayments in the nature of interest). Each Special Recoupment\nPayment would be in the amount necessary for the Joint Venture\nto be repaid (without interest) the amounts spent by it with\nrespect to the production or acquisition of an Unrecouped Film\n(other than contributions for payments in the nature of\ninterest), but not more than the amount specified below.\nInitially, the Special Recoupment Payment would be payable only\nto the extent of the distribution fees received by the\nDistributor from the distribution of all of the Joint Venture's\nfilms (reduced to the extent of the Special Recoupment Payments\nmade with respect to other Unrecouped Films). The Special\nRecoupment Payments to the Joint Venture based on distribution\nfees would be allocated by the Joint Venture first to the\nPartnership to the extent necessary for the Partnership to\nrecoup (without interest) the amount of its contributions to the\nJoint Venture for the production or acquisition of the\nUnrecouped Films (other than contributions for payments in the\nnature of interest); any excess would then be allocated to TSPI.\nIf those distribution fees are insufficient to enable the\nDistributor to make the Special Recoupment Payments with respect\nto all Unrecouped Films, gross receipts and net proceeds of each\nremaining Unrecouped Film would be recalculated by including as\ngross receipts in respect of that Unrecouped Film the excess, if\nany, of the minimum payments under the Distributor's agreement\nwith Home Box Office, Inc., and certain minimum amounts in\nrespect of video cassette and video disc exploitation over the\namounts previously included in the gross receipts of that\nUnrecouped Film in respect of those arrangements. The\nDistributor would then make Special Recoupment Payments to the\nJoint Venture to the extent of the additional gross receipts or\nnet proceeds payable to the Joint Venture as a result of the\nrecalculation, but only up to the amount of the unrecouped\ncontributions (other than contributions for payments in the\nnature of interest) for the production or acquisition of that\nUnrecouped Film; each Special Recoupment Payment made on the\nbasis of such recalculation would be allocated between the\nPartnership and TSPI in proportion to their respective interests\nin the applicable Unrecouped Film. The Distributor will be\nentitled to recoup the Special Recoupment Payments made on\neither basis in respect of each Unrecouped Film, with an amount\nin the nature of interest, from the Joint Venture's share of\nsubsequent gross receipts or net proceeds of that Unrecouped\nFilm and from the proceeds of any sale of the Partnership's\ninterest in that Unrecouped Film or amounts allocable to that\nUnrecouped Film upon a sale of the Partnership's interest in the\nJoint Venture. In calculating the amount of distribution fees\navailable for the Special Recoupment Payments, no distribution\nfee will be deemed received by the Distributor (and therefore no\ndistribution fee will be deemed available for the Special\nRecoupment Payment) from a film with respect to which the most\nrecent payment to the Joint Venture was based on gross receipts\nor from a film that did not reach Cost Return.\n4. Bonus Film Profit Payments\nThe Joint Venture will be entitled to certain additional\npayments (\"Bonus Profit Payments\") with respect to the three\nTSPI SF Interest films that generate the greatest profits to the\nPartnership (\"Bonus Films\"). All three SF Interest Films have\ngenerated cash profits to the Partnership. The Bonus Profit\nPayments will be equal to 30% of the first $9,000,000 of cash\nprofits received by the Partnership. Bonus Profit Payments were\nmade in 1995, l994 and l993 in the amounts of $9,000, $81,000\nand $9,000, respectively. Additional Bonus Profit Payments will\nbe made to the extent earned, in installments without interest,\nand continue on a quarterly basis to the extent subsequently\nearned.\n5. Extra Film Profit Participations\nThe Joint Venture is entitled to receive, without any\nadditional cost or payment by the Joint Venture, a profit\nparticipation in three additional TSPI SF Interest films (\"Extra\nFilms\") not otherwise included in the SF Interest program since,\nin December l989, the aggregate Cash Return (as defined below)\nto the Partnership from the TSPI SF Interest films was estimated\nto be less than l25% of the portion of the net proceeds of the\nPartnership's offering (and of the General Partner's capital\ncontribution) allocated to such TSPI SF Interest films (the\n\"Allocated Amount\"). The profit participation will equal l0% of\nthe net proceeds of each Extra Film after l00% of the net\nproceeds of that Extra Film exceeds 112 1\/2% of its production\ncost. The profit participation in these Extra Films will cease\nshould the Partnership's overall Cash Return with respect to\nTSPI SF Interest films plus any profit participation payments\nwith respect to the Extra Films equal 200% of the Allocated\nAmount. The Cash Return is an amount equal to (a) the cash\npayments then estimated ultimately to be received by the\nPartnership from the TSPI SF Interest films less (b) the\nPartnership's contributions for those films in excess of the\nAllocated Amount and an amount in the nature of interest on such\nexcess. As of December 31, 1995, all three Extra Films had been\nselected and released by TriStar. Due to the results of their\nrelease to date, the Joint Venture is not expected to receive\nany profit participation from those films.\n6. Income Taxes\nNo provision for income taxes is made in the Joint Venture's\nfinancial statements since the venturers treat the Joint Venture\nas a partnership for income tax purposes, with all income tax\nconsequences flowing directly to the venturers.\nEffective January l, l993, the Partnership adopted\nStatement of Financial Accounting Standards No. 109, \"Accounting\nfor Income Taxes.\" As of October 31, 1995 and 1994 (the Joint\nVenture's tax year end is October 31), the tax bases of the\nJoint Venture's assets less liabilities exceeded amounts\nreported in the financial statements at December 31, 1995 and\nl994 by approximately $35,499,000 and $40,992,000, respectively.\nManagement estimates that the tax bases of the Joint Venture's\nassets and liabilities did not differ significantly between\nOctober 31 and December 31 in l995 and l994. The adoption of\nthe Statement had no impact on the Joint Venture's financial\nstatements.\n7. Current Operations\nAs of December 31, 1995, the Distributor had released\nseventeen SF Interest films in which the Joint Venture has an\ninterest. The Joint Venture is not expected to recoup its\ninvestment in twelve of these SF Interest films out of the\nproceeds from their distribution. However, due to the Special\nRecoupment Payment referred to below, the Partnership is\nexpected to recoup its investment in these films. In addition,\none of these SF Interest films has also been designated as a PF\nInterest film and the Distributor had released another twenty-\none PF films (see Note l). For the years ended December 31,\n1995, 1994 and 1993, motion picture production and advertising\ncosts have been reduced by amortization of $145,000, $188,000\nand $648,000, respectively.\nBased upon the anticipated performance of the films in\nrelease, it is expected that the Distributor will be required to\nmake Special Recoupment Payments to the Joint Venture with\nrespect to its SF Interest films (see Note 3). Accordingly,\napproximately $62,590,000 and $53,072,000 (discounted at 13%\nfrom December l996) have been accrued as Motion Picture Costs\nRecoverable from Special Recoupment Payments at December 31,\n1995 and 1994, respectively, in the accompanying financial\nstatements. The current year increase in Motion Picture Costs\nRecoverable from Special Recoupment Payments of approximately\n$9,518,000 consists of an increase in the principal amount of\napproximately $2,152,000 (discounted) and an increase of\napproximately $7,336,000 due to the reduction in the discount\nperiod.\n8. Receivables and Payables\nAnalysis of the Joint Venture's receivables and payables is as follows:\nAT DECEMBER 31, 1995\nReceivable Payable Payable from to to Distributor TriStar Partnership (000's omitted)\nNet Proceeds and Gross Receipts $ 24,082 $ 2,423 $21,659\nAccrued Special Recoupment Payments 62,590 46,948 15,642\nTotal $ 86,672 $49,371 $37,301\nAT DECEMBER 31, 1994\nReceivable Payable Payable from to to Distributor TriStar Partnership (000's omitted)\nNet Proceeds and Gross Receipts $28,210 $2,535 $25,675\nAccrued Special Recoupment Payments 53,072 39,147 13,925\nTotal $81,282 $41,682 $39,600\n9. PF Interest Payments\nPayments in respect of PF Interest films began December 8,\nl987 and will be made annually by the Distributor. In any of\nthe years l988 through l995 in which the annual cash return to\nthe Partnership from the PF Interest films would cause the\nPartnership's cumulative non-compounded return on the amount of\nthe Partnership's total contributions for PF Interest films to\nexceed l4% per year, the balance of the amount due will be\ncarried forward and, to the extent not applied in later years to\ngenerate a l4% return to the Partnership, will be payable\nwithout interest to the Partnership on December 23, l996. On\nthat date, the Distributor will make a final payment based on\nthe gross receipts through the date of the payment in l996, and\nalso on the additional gross receipts estimated to be received\nby the Distributor from the distribution of all PF Interest\nfilms (subject to discount under certain circumstances) during\nthe next seven years. Following the final payment, the\nPartnership's PF Interests in films will cease. As of December\n31, 1995, $24,155,000, (net of the Acceleration Payments and\nrelated interest described below) is carried forward and\nincluded in the receivable from the Distributor and payable to\nthe Partnership in the accompanying financial statements.\nThe Distributor made payments equating a l4% return each\nyear, through the Joint Venture, to the Partnership of\n$3,l42,000 in 1995, 1994 and 1993 based upon revenue for the PF\nInterest Films released.\nl0. Deferred Revenue\nOn December 8, l987, the Distributor was contractually\nobligated to make a payment to the Partnership of $3,l42,000\nrepresenting a return to the Partnership equal to l4% of the\namount of the Partnership's total funds to be contributed for PF\nInterests in films. Because net proceeds generated from TSPI\nwith respect to the PF Interest film were not sufficient to\nprovide a l4% return to the Partnership, $2,684,000 was advanced\nto the Partnership. This advance will be recouped by the\nDistributor from the December 23, l996 PF Payment. There will be\nno further payments of $3,142,000 after December 31, 1995. The\ndeferred revenue amount has been reflected as a reduction to the\nreceivable from the Distributor due in December l996.\n11. Acceleration Payment\nWith respect to PF Interest films, if in any calendar year\nthe Partnership recognizes income for federal income tax\npurposes in excess of the payment received in December for that\nyear (the \"Excess\"), TriStar is required to make an acceleration\npayment to the Partnership, through the Joint Venture, with\nrespect to the Excess. The amount of the acceleration payment\nis equal to the Excess multiplied by the maximum federal income\ntax rate in effect for the year of the Excess (the \"Acceleration\nPayment\"). The Acceleration Payment is recoupable with\ninterest, by TriStar, with certain exceptions, from the payment\nto be received by the Partnership with respect to the PF\nInterest films in December 1996. The Partnership received,\nthrough the Joint Venture, approximately $360,000 and $7,548,000\nin March 1993 and l992 with respect to the Acceleration Payment\nfor 1992 and l991, respectively. For the years ended December\n31, 1995, 1994 and 1993, approximately $1,034,000, $721,000 and\n$586,000 of interest expense has been recognized on the 1993,\n1992 and l991 Acceleration Payments and has been offset against\nInterest Income in the accompanying financial statements.\n12. Foreign Exchange Gains and Losses\nThe distribution agreement between the Joint Venture and the\nDistributor provides that revenues earned in foreign currencies be\nvalued as of the date that monies are remitted or are \"freely\nremittable\" to the United States. Other Expense for the year ended\nDecember 31, l994 of $2,363,000 represents the cumulative difference\nbetween the monies remitted in U.S. dollars and the value previously\nrecorded based on the exchange rate at the time of revenue\nrecognition in the applicable international territory. No such\nrevenue adjustment was necessary in 1995.","section_15":""}
{"filename":"767405_1995.txt","cik":"767405","year":"1995","section_1":"Item 1. Business.\nGeneral\nRurban Financial Corp., an Ohio corporation (the \"Corporation\"), is a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). The executive officers of the Corporation are located at 401 Clinton Street, Defiance, Ohio 43512.\nThrough its subsidiaries, The State Bank and Trust Company, Defiance, Ohio (\"State Bank\"), The Peoples Banking Company, Findlay, Ohio (\"Peoples Bank\"), The First National Bank of Ottawa (\"First National Bank\") and The Citizens Savings Bank Company, Pemberville, Ohio (\"Citizens Bank\"), the Corporation is engaged in the business of commercial banking. The Corporation's subsidiary, Rurbanc Data Services, Inc. (\"Rurbanc\"), is engaged in the related business of providing data processing services, principally to banks. The Corporation's subsidiary, Rurban Life Insurance Company (\"Rurban Life\"), is engaged in the related business of accepting life and disability reinsurance ceded in part by USLIFE Credit Life Insurance Company (\"USLIFE\") from the credit life and disability insurance purchased by customers of State Bank, Peoples Bank, First National Bank and Citizens Bank from USLIFE in connection with revolving credit loans secured by mortgages and with certain installment loans made to such customers by State Bank, Peoples Bank, First National Bank and Citizens Bank.\nGeneral Description of Holding Company Group\nState Bank\nState Bank is an Ohio state-chartered bank. State Bank presently operates seven branch offices in Defiance County, Ohio (six in the city of Defiance and one in Ney), one branch office in adjacent Paulding County, Ohio and three branch offices in Fulton County, Ohio (one in each of Delta, Lyons and Wauseon). At December 31, 1995, State Bank had 119 full-time equivalent employees.\nState Bank offers a full range of commercial banking services, including checking and NOW accounts; passbook savings and money market accounts; automatic teller machines; commercial, installment, agricultural and residential mortgage loans (including \"Home Value Equity\" line of credit loans); personal and corporate trust services; commercial leasing; bank credit card services; safe deposit rentals; and other personalized banking services. In addition, State Bank serves as a correspondent (federal funds investing and check clearing purposes) for five financial institutions in the region (including Peoples Bank and First National Bank).\nPeoples Bank\nPeoples Bank is an Ohio state-chartered bank. The main office of Peoples Bank is located in Findlay, Ohio. Peoples Bank provides checking and NOW accounts; passbook savings and money market accounts; time certificates of deposit; commercial loans, student loans and real estate mortgage loans; trust services; and safe deposit rental facilities. Peoples Bank also operates full-service branches in Findlay and McComb, Ohio. At December 31, 1995, Peoples Bank had 24 full-time equivalent employees.\nFirst National Bank\nFirst National Bank is a national banking association. The executive offices of First National Bank are located at 405 East Main Street, Ottawa, Ohio. At its present location on Main Street, First National Bank operates four drive-in teller lanes and an automatic teller machine with a traditional banking lobby on the first floor. First National Bank presently operates no branch offices. At December 31, 1995, First National Bank had 15 full-time equivalent employees.\nFirst National Bank offers a full range of commercial banking services, including checking and NOW accounts; passbook savings and money market accounts; automatic teller machines; commercial, installment, agricultural and residential mortgage loans; personal and corporate trust services; commercial leasing; bank credit card services; safe deposit rentals; and other personalized banking services.\nCitizens Bank\nCitizens Bank is an Ohio state-chartered bank. The main office of Citizens Bank is located in Pemberville, Ohio. Citizens Bank provides checking and NOW accounts; passbook savings and money market accounts; time certificates of deposit; commercial, installment, agricultural and residential loans; personal and corporate trust services; commercial leasing; bank credit card services; safe deposit rentals; and other personalized banking services. Citizens Bank also operates a full-service branch in Gibsonburg, Ohio. At December 31, 1995, Citizens Bank had 28 full-time equivalent employees.\nRurbanc\nSubstantially all of Rurbanc's business is comprised of providing data processing services to 32 financial institutions primarily in the northwest area of Ohio (including State Bank, Peoples Bank, First National Bank and Citizens Bank), including information processing for financial institution customer services, deposit account information and data analysis. Rurbanc also provides payroll services for customers which are not financial institutions. At December 31, 1995, Rurbanc had 18 full-time equivalent employees.\nRurban Life\nRurban Life commenced its business of transacting insurance as an Arizona life and disability reinsurer in January, 1988. Rurban Life may accept life and disability reinsurance ceded to Rurban Life by an insurance company authorized to write life and disability insurance, provided that the amount accepted does not exceed certain limitations imposed under Arizona law. Rurban Life is not currently authorized to write life and disability insurance on a direct basis. Rurban Life accepts reinsurance ceded in part by USLIFE from the credit life and disability insurance purchased by customers of State Bank, Peoples Bank, First National Bank and Citizens Bank from USLIFE in connection with revolving credit loans secured by mortgages and with certain installment loans made to such customers by State Bank, Peoples Bank, First National Bank and Citizens Bank. The operations of Rurban Life do not materially impact the consolidated results of operations of the Corporation. As of December 31, 1995, Rurban Life has not accepted any other reinsurance. Rurban Life does not currently intend to accept any other reinsurance in the immediate future. At December 31, 1995, Rurban Life had no employees.\nCompetition\nState Bank, Peoples Bank, First National Bank and Citizens Bank experience significant competition in attracting depositors and borrowers. Competition in lending activities comes principally from other commercial banks in the lending areas of State Bank, Peoples Bank, First National Bank and Citizens Bank, and, to a lesser extent, from savings associations, insurance companies, governmental agencies, credit unions, securities brokerage firms and pension funds. The primary factors in competing for loans are interest rates charged and overall banking services.\nCompetition for deposits comes from other commercial banks, savings associations, money market funds and credit unions as well as from insurance companies and securities brokerage firms. The primary factors in competing for deposits are interest rates paid on deposits, account liquidity and convenience of office location.\nRurbanc also operates in a highly competitive field. Rurbanc competes primarily on the basis of the value and quality of its data processing services, and service and convenience to its customers.\nRurban Life operates in the highly competitive industry of credit life and disability insurance. A large number of stock and mutual insurance companies also operating in this industry have been in existence for longer periods of time and have substantially greater financial resources than does Rurban Life. The principal methods of competition in the credit life and disability insurance industry are the availability of coverages, premium rates and quality of service. The Corporation believes that Rurban Life has a competitive advantage due to the fact that the business of Rurban Life is limited to the accepting of life and disability reinsurance ceded in part by USLIFE from the credit life and disability insurance purchased by loan customers of State Bank, Peoples Bank, First National Bank and Citizens Bank.\nSupervision and Regulation\nThe following is a summary of certain statutes and regulations affecting the Corporation and its subsidiaries. The summary is qualified in its entirety by reference to such statutes and regulations.\nThe Corporation 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 shares 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 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 or 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 or extensions of credit 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. A bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with extensions of credit and\/or the provision of other property or services to a customer by the bank holding company or its subsidiaries.\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 Board. In addition, acquisitions across state lines are limited to acquiring banks in those states specifically authorizing such interstate acquisitions. However, since September 1995, federal law has permitted interstate acquisitions of banks, if the bank acquired retains its separate charter.\nAs a national bank, First National Bank is supervised and regulated by the Comptroller of the Currency. As Ohio state-chartered banks, State Bank, Peoples Bank and Citizens Bank are supervised and regulated by the Ohio Division of Banks and the Federal Deposit Insurance Corporation (\"FDIC\"). The deposits of State Bank, Peoples Bank, First National Bank and Citizens Bank are insured by the FDIC and those entities are subject to the applicable provisions of the Federal Deposit Insurance Act. A subsidiary of a bank holding company can be liable to reimburse the FDIC if the FDIC incurs or anticipates a loss because of a default of another FDIC-insured subsidiary of the bank holding company or in connection with FDIC assistance provided to such subsidiary in danger of default. In addition, the holding company of any insured financial institution that submits a capital plan under the federal banking agencies' regulations on prompt corrective action guarantees a portion of the institution's capital shortfall, as discussed below.\nVarious requirements and restrictions under the laws of the United States and the State of Ohio affect the operations of State Bank, Peoples Bank, First National Bank and Citizens Bank including requirements to maintain reserves against deposits, restrictions on the nature and amount of loans which may be made and the interest that may be charged thereon, restrictions relating to investments\nand 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. Pursuant to recent federal legislation, First National Bank may branch across state lines, if permitted by the law of the other state. In addition, effective June 1997, such interstate branching by First National 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 and for state member banks, such as State Bank and Citizens Bank. The risk-based capital guidelines include both a definition of capital and a framework for calculating weighted risk assets by assigning assets and off-balance sheet items to broad risk categories. The minimum ratio of total capital to weighted risk assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least 4.0 percentage points is to be comprised of common stockholders' equity (including retained earnings but excluding treasury stock), noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (\"Tier 1 capital\"). The remainder (\"Tier 2 capital\") may consist, among other things, of 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 also imposes a minimum leverage ratio (Tier 1 capital to total assets) of 4% for bank holding companies and state member banks that meet certain specified conditions, including no operational, financial or supervisory deficiencies, and including having the highest regulatory rating. The minimum leverage ratio is 1.0-2.0% higher for other bank holding companies and state member banks based on their particular circumstances and risk profiles and those experiencing or anticipating significant growth. National bank subsidiaries, such as First National Bank, are subject to similar capital requirements adopted by the Comptroller of the Currency, and state non-member bank subsidiaries, such as Peoples Bank, are subject to similar capital requirements adopted by the FDIC. Under an outstanding proposal of the Comptroller and the FDIC to establish an interest rate risk component, First National Bank, State Bank, Peoples Bank and Citizens Bank may be required to have additional capital if their interest rate risk exposure exceeds acceptable levels provided for in the regulation when adopted.\nThe Corporation and its subsidiaries currently satisfy all capital requirements. Failure to meet applicable capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal and state regulatory authorities, including the termination of deposit insurance by the FDIC.\nThe federal banking regulators have established regulations governing prompt corrective action to resolve capital deficient banks. Under these regulations, institutions which become undercapitalized become subject to mandatory regulatory scrutiny and limitations, which increase as capital continues to decrease. Such institutions 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 institution at the time it becomes undercapitalized.\nThe ability of a bank holding company 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 its subsidiary banks and other subsidiaries. However, the Federal Reserve Board expects the Corporation to serve as a source of strength to its subsidiary banks, which may require it to retain capital for further investment in the subsidiaries, rather than for dividends for shareholders of the Corporation. State Bank, Peoples Bank, First National Bank and Citizens Bank may not pay dividends to the Corporation if, after paying such dividends, they would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. State Bank, Peoples Bank, First National Bank and Citizens Bank must have the approval of their respective regulatory authorities if a dividend in any year would cause the total dividends for that year to exceed the sum of the current year's net profits and the retained net profits for the preceding two years, less required transfers to surplus. Payment of dividends by the bank subsidiaries 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. These provisions could have the effect of limiting the Corporation's ability to pay dividends on its outstanding common shares.\nRurban Life is chartered by the State of Arizona and is subject to regulation, supervision, and examination by the Arizona Department of Insurance. The powers of regulation and supervision of the Arizona Department of Insurance relate generally to such matters as minimum capitalization, the grant and revocation of certificates of authority to transact business, the nature of and limitations on investments, the maintenance of reserves, the form and content of required financial statements, reporting requirements and other matters pertaining to life and disability insurance companies.\nMonetary Policy and Economic Conditions\nThe commercial banking business is affected not only by general economic conditions, but also by the policies of various governmental regulatory authorities, including the Federal Reserve Board. The Federal Reserve Board 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, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. These policies and regulations significantly affect the overall growth and distribution of bank loans, investments and deposits, and the interest rates charged on loans as well as the interest rates paid on deposits and accounts.\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 have significant effects in the future. In view of the changing conditions in the economy and the money market and the activities of monetary and fiscal authorities, no definitive predictions can be made as to future changes in interest rates, credit availability or deposit levels.\nStatistical Financial Information Regarding the Corporation\nThe following schedules and tables analyze certain elements of the consolidated balance sheets and statements of income of the Corporation and its subsidiaries, as required under Exchange Act Industry Guide 3 promulgated by the Securities and Exchange Commission, and should be read in conjunction with the narrative analysis presented in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation and the Consolidated Financial Statements of the Corporation and its subsidiaries included at pages 46 through 73 of this Annual Report on Form 10-K.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL\nA. The following are the average balance sheets for the years ending December 31:\n1995 1994 1993 ---- ---- ---- ASSETS Interest-earning assets Securities available-for-sale(1) Taxable $64,643,230 $51,347,311 $ - Non-taxable 25,869 - - Securities held-to-maturity Taxable 1,485,961 370,644 - Non-taxable 9,416,228 7,584,860 - Investment securities Taxable - - 55,916,157 Non-taxable - - 8,518,053 Federal funds sold 10,145,738 5,162,152 3,047,975 Loans, net of unearned income and deferred loan fees(2) 282,864,867 249,993,210 225,013,808 ----------- ----------- ----------- Total interest-earning assets 368,581,893 314,458,177 292,495,993 Allowance for loan losses (4,606,629) (4,089,404) (3,461,056) ----------- ----------- ----------- 363,975,264 310,368,773 289,034,937 Noninterest-earning assets Cash and due from banks 17,670,513 11,613,379 13,090,931 Premises and equipment, net 8,857,350 7,766,744 7,031,156 Accrued interest receivable and other assets 8,056,940 5,368,618 5,072,715 ----------- ----------- -----------\n$398,560,067 $335,117,514 $314,229,739\nLIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities Deposits Savings and interest-bearing demand deposits $83,243,571 $70,551,648 $63,445,763 Time deposits 231,640,466 191,533,849 183,162,012 Federal funds purchased and securities sold under agree- ments to repurchase 684,484 2,488,229 1,567,400 ----------- ----------- ----------- Total interest-bearing liabilities 315,568,521 264,573,726 248,175,175\nNoninterest-bearing liabilities Demand deposits 41,427,007 37,778,969 33,874,124 Accrued interest payable and other liabilities 3,687,999 2,150,694 2,214,232 ----------- ----------- ----------- 360,683,527 304,503,389 284,263,531\nShareholders' equity(3)(4) 37,876,540 30,614,125 29,966,208 ----------- ----------- -----------\n$398,560,067 $335,117,514 $314,229,739\n__________________________\n(1) Securities available-for-sale are carried at fair value. The average balance includes quarterly average balances of the market value adjustments and daily average balances for the amortized cost of securities. (2) Loan balances include principal balances of nonaccrual loans. (3) Shown net of average net unrealized appreciation (depreciation) on securities available-for-sale, net of tax. (4) Includes common stock subject to repurchase obligation in ESOP.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)\nB. The following tables set forth, for the years indicated, the condensed average balances of interest-earning assets and interest-bearing liabilities, the interest earned or paid on such amounts, and the average interest rates earned or paid thereon.\nAverage Average Balance Interest Rate ------- -------- ------- INTEREST-EARNING ASSETS Securities(1) Taxable $66,675,224 $3,756,764 5.63% Non-taxable 9,442,097 645,724(2) 6.84(2) Federal funds sold 10,145,738 707,596 6.97 Loans, net of unearned income and deferred loan fees 282,864,867(3) 26,539,689(4) 9.38 ----------- ---------- --------\nTotal interest-earning assets $369,127,926 31,649,773(2) 8.57%(2) ============\nINTEREST-BEARING LIABILITIES Deposits Savings and interest-bearing demand deposits $83,243,571 2,088,899 2.51 Time deposits 231,640,466 12,109,099 5.23 Federal funds purchased and securities sold under agree- ments to repurchase 684,484 40,050 5.85 ----------- ----------\nTotal interest-bearing liabilities $ 315,568,521 14,238,048 4.51% ============= -------------\nNet interest income $17,411,725(2) ==============\nNet interest income as a percent of average interest-earning assets 4.72%(2) ======== _________________________\n(1) Securities balances represent daily average balances for the amortized cost of securities. (2) Computed on tax equivalent basis for non-taxable securities (34% statutory tax rate in 1995). (3) Loan balances include principal balances of nonaccrual loans. (4) Includes fees on loans of $967,504 in 1995.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)\nAverage Average Balance Interest Rate INTEREST-EARNING ASSETS Securities(1) Taxable $52,307,884 $2,485,695 4.75% Non-taxable 7,584,860 524,977(2) 6.92(2) Federal funds sold 5,162,152 220,244 4.27 Loans, net of unearned income and deferred loan fees 249,993,210(3) 20,421,474(4) 8.17 ----------- ----------\nTotal interest-earning assets $315,048,106 23,652,390(2) 7.51%(2) ============\nINTEREST-BEARING LIABILITIES Deposits Savings and interest-bearing demand deposits $70,551,648 1,900,683 2.69 Time deposits 191,533,849 7,586,023 3.96 Federal funds purchased and securities sold under agree- ments to repurchase 2,488,229 125,647 5.05 ----------- ----------\nTotal interest-bearing liabilities $ 264,573,726 9,612,353 3.63% ============= ------------\nNet interest income $14,040,037(2) =========== Net interest income as a percent of average interest-earning assets 4.46%(2) =====\n_________________________\n(1) Securities balances represent daily average balances for the amortized cost of securities. (2) Computed on tax equivalent basis for non-taxable securities (34% statutory tax rate in 1994). (3) Loan balances include principal balances of nonaccrual loans. (4) Includes fees on loans of $797,957 in 1994.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)\nAverage Average Balance Interest Rate INTEREST-EARNING ASSETS Securities(1) Taxable $55,916,157 $2,989,616 5.35% Non-taxable 8,518,053 675,121(2) 7.93(2) Federal funds sold 3,047,975 94,625 3.10 Loans, net of unearned income and deferred loan fees 225,013,808(3) 17,948,466(4) 7.98 ----------- ----------\nTotal interest-earning assets $292,495,993 21,707,828(2) 7.42%(2) ============\nINTEREST-BEARING LIABILITIES Deposits Savings and interest-bearing demand deposits $63,445,763 1,778,120 2.80% Time deposits 183,162,012 7,078,584 3.86 Federal funds purchased and securities sold under agree- ments to repurchase 1,567,400 52,406 3.34 ----------- ----------\nTotal interest-bearing liabilities $ 248,175,175 8,909,110 3.59% ============= -----------\nNet interest income $12,798,718 (2) ===========\nNet interest income as a percent of average interest-earning assets 4.38%(2) ===== _________________________\n(1) Securities balances represent daily average balances for the amortized cost of securities. (2) Computed on tax equivalent basis for non-taxable securities (34% statutory tax rate in 1993). (3) Loan balances include principal balances of nonaccrual loans. (4) Includes fees on loans of $705,978 in 1993.\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)\nC. The following tables set forth the effect of volume and rate changes on interest income and expense for the periods indicated. For purposes of these tables, changes in interest due to volume and rate were determined as follows: Volume Variance - change in volume multiplied by the previous year's rate. Rate Variance - change in rate multiplied by the previous year's volume. Rate\/Volume Variance - change in volume multiplied by the change in rate. This variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each. Interest on non-taxable securities has been adjusted to a fully tax equivalent basis using a statutory tax rate of 34% in 1995, 1994 and 1993.\nTotal Variance Variance Attributable To 1995\/1994 Volume Rate --------- ------ ------- Interest income Securities Taxable $1,271,069 $ 758,382 $ 512,687 Non-taxable 120,747 127,084 (6,337) Federal funds sold 487,352 294,045 193,307 Loans, net of unearned income and deferred loan fees 6,118,215 2,872,531 3,245,684 ---------- ---------- ---------- 7,997,383 4,052,042 3,945,341\nInterest expense Deposits Savings and interest-bearing demand deposits 188,216 324,954 (136,738) Time deposits 4,523,076 1,789,516 2,733,560 Federal funds purchased and securities sold under agreements to repurchase (85,597) (102,943) 17,346 ---------- ---------- ---------- 4,625,695 2,011,527 2,614,168 ---------- ---------- ----------\nNet interest income $3,371,688 $2,040,515 $1,331,173 ========== ========== ==========\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)\nTotal Variance Variance Attributable To 1994\/1993 Volume Rate --------- ------ ------ Interest income Securities Taxable $ (503,921) $ (185,042) $ (318,879) Non-taxable (150,144) (69,617) (80,527) Federal funds sold 125,619 81,591 44,028 Loans, net of unearned income and deferred loan fees 2,473,008 2,031,958 441,050 ---------- ---------- ---------- 1,944,562 1,858,890 85,672\nInterest expense Deposits Savings and interest-bearing demand deposits 122,563 193,417 (70,854) Time deposits 507,439 328,750 178,689 Federal funds purchased and securities sold under agreements to repurchase 73,241 39,196 34,045 ---------- ---------- ---------- 703,243 561,363 141,880 ---------- ---------- ----------\nNet interest income $1,241,319 $1,297,527 $ (56,208) ========== ========== ==========\nII. INVESTMENT PORTFOLIO\nA. The book value of securities available-for-sale as of December 31 are summarized as follows: 1995 1994 1993 ---- ---- ---- U.S. Treasury and U.S. Government agency securities $74,251,501 $50,533,082 $ - Obligations of states and political subdivisions 9,543,395 - - Mortgage-backed securities 5,345,748 8,402,970 - Marketable equity securities 1,189,222 875,803 - ---------- ----------- ----------\n$90,329,866 $59,811,855 $ - =========== =========== ==========\nThe book value of securities held-to-maturity as of December 31 are summarized as follows:\n1995 1994 1993 ---- ---- ---- U.S. Treasury and U.S. Government agency securities $ - $ 1,482,576 $ - Obligations of states and political subdivisions - 8,888,336 - ---------- ----------- ----------\n$ - $10,370,912 $ - ========== =========== ==========\nThe book value of investment securities as of December 31 are summarized as follows:\n1995 1994 1993 ---- ---- ---- U.S. Treasury and U.S. Government agency securities $ - $ - $32,059,109 Obligations of states and political subdivisions - - 6,527,912 Federal Reserve Bank stock - - 240,000 ---------- ----------- ----------\n$ - $ - $38,827,021 ========== =========== ===========\nThe book value of securities held for sale as of December 31 are summarized as follows:\n1995 1994 1993 ---- ---- ---- U.S. Treasury and U.S. Government agency securities $ - $ - $16,424,157 Mortgage-backed securities - - 3,340,691 Marketable equity securities - - 322,292 ---------- ----------- ----------\n$ - $ - $20,087,140 ========== =========== ===========\nII. INVESTMENT PORTFOLIO (Continued) - ------------------------------------------------------------------------------\nB. The maturity distribution and weighted average interest rates of securities available-for-sale at December 31, 1995 are as follows:\n------------------Maturing----------------- After One Year Within But Within One Year Five Years -------- -------------- Amount Rate Amount Rate ------ ------ ------ ------ U.S. Treasury and U.S. Government agency securities $25,523,007 5.43% $48,682,150 6.37% Mortgage-backed securities(1) - - 5,345,748 6.61 Obligations of state and political subdivisions(2) 3,958,600 6.13 3,207,024 7.81 ---------- ----------- $29,481,607 5.52% $57,234,922 6.47% =========== ====== =========== ======\n------------------Maturing----------------- After Five Years But Within After Ten Years Ten Years ---------------- --------- Amount Rate Amount Rate U.S. Treasury and U.S. Government agency securities $ 10,067 7.05% $ 36,277 6.04% Obligations of state and political subdivisions(2) 2,377,771 8.24 - - Marketable Equity Securities - - 1,189,222 6.00 ---------- ----------- $2,387,838 8.23% $ 1,225,499 6.00% ========== ==== =========== ======\n(1) Maturity based upon estimated weighted-average life. (2) Yields are presented on a tax-equivalent basis (34% statutory rate).\nThe weighted average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount.\nC. Excluding those holdings of the investment portfolio in U.S. Treasury securities and other agencies of the U.S. Government, there were no securities of any one issuer which exceeded 10% of the shareholders' equity of the Corporation at December 31, 1995.\nIII. LOAN PORTFOLIO\nB. Maturities and Sensitivities of Loans to Changes in Interest Rates - The following table shows the amounts of commercial, financial and agricultural loans outstanding as of December 31, 1995 which, based on remaining scheduled repayments of principal, are due in the periods indicated. Also, the amounts have been classified according to sensitivity to changes in interest rates for loans due after one year. (Variable-rate loans are those loans with floating or adjustable interest rates.)\nCommercial, Financial and Maturing Agricultural ---------------- -------------\nWithin one year $38,324,128 After one year but within five years 17,123,093 After five years 7,996,815 ----------- $63,444,036\nCommercial, Financial and Agricultural\nInterest Sensitivity -------------------- Fixed Variable Rate Rate Total ----- -------- ------- Due after one year but within five years $6,281,947 $10,841,146 $17,123,093 Due after five years 1,853,492 6,143,323 7,996,815 ---------- ---------- ----------\n$8,135,439 $16,984,469 $25,119,908 ========== =========== ===========\nIII. LOAN PORTFOLIO (Continued)\nC. Risk Elements\n1. Nonaccrual, Past Due and Restructured Loans - The following schedule summarizes nonaccrual, past due and restructured loans at December 31.\n(1) Includes loans defined as \"impaired\" under SFAS No. 114.\nManagement believes the allowance for loan losses balance at December 31, 1995 is adequate to absorb any losses on nonperforming loans, as the allowance balance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values, and other factors and estimates which are subject to change over time.\n(In thousands)\nGross interest income that would have been recorded in 1995 on nonaccrual loans outstanding at December 31, 1995 if the loans had been current, in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period ................................................... $ 332\nInterest income actually recorded on nonaccrual loans and included in net income for the period ........................................... (41) ------- Interest income not recognized during the period ...................................................... $ 291 =======\nIII. LOAN PORTFOLIO (Continued)\n1. Discussion of the Nonaccrual Policy\nThe accrual of interest income is discontinued when the collection of a loan or interest, in whole or in part, is doubtful. When interest accruals are discontinued, interest income accrued in the current period is reversed. While loans which are past due 90 days or more as to interest or principal payments are considered for nonaccrual status, management may elect to continue the accrual of interest when the estimated net realizable value of collateral, in management's judgment, is sufficient to cover the principal balance and accrued interest.\n2. Potential Problem Loans\nAs of December 31, 1995, there are approximately $3,815,000 in outstanding loans where known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans pursuant to Item III. C.1. Consideration was given to loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed in Section 1 above. To the extent that these loans are not included in the $3,815,000 potential problem loans described above, management believes that these loans do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or management believes that these loans do not represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.\n3. Foreign Outstandings\nNone\n4. Loan Concentrations\nAt December 31, 1995, loans outstanding related to agricultural operations or collateralized by agricultural real estate aggregated approximately $39,695,000. At December 31, 1995, there were no agriculture loans which were accounted for on a nonaccrual basis; and there are approximately $190,000 of accruing agriculture loans which are contractually past due ninety days or more as to interest or principal payments.\nD. Other Interest-Bearing Assets\nOther than approximately $320,000 held as other real estate owned, there are no other interest-bearing assets as of December 31, 1995 which 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 schedule presents an analysis of the allowance for loan losses, average loan data and related ratios for the years ended December 31:\n(1) Net of unearned income and deferred loan fees\nThe allowance for loan losses balance and the provision charged to expense are judgmentally determined by management based upon periodic reviews of the loan portfolio. In addition, management considered the level of charge-offs on loans as well as the fluctuations of charge-offs and recoveries on loans including the factors which caused these changes. Estimating the risk of loss and the amount of loss is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values and other factors and estimates which are subject to change over time. The increase in loans charged off in 1995 as compared to 1994 is due largely to the charge off of certain credits which were previously reported on a nonaccrual basis.\nIV. SUMMARY OF LOAN LOSS EXPERIENCE (Continued)\nB. The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and related ratios.\nAllocation of the Allowance for Loan Losses ------------------------------------------- Percentage Percentage of Loans of Loans In Each In Each Category to Category To Allowance Total Allowance Total Amount Loans Amount Loans --------- ----------- --------- --------- December 31, 1995 December 31, 1994 Commercial, financial and agricultural $1,665,000 22.9% $1,764,900 22.4% Real estate mortgage 512,000 54.9 572,400 54.2 Installment loans 1,452,000 22.2 1,621,800 23.4 Lease financing - - - - Unallocated 641,000 N\/A 810,900 N\/A ---------- --- ---------- ---\n$4,270,000 100.0% $4,770,000 100.0% ========== ===== ========== =====\nDecember 31, 1993 December 31, 1992 Commercial, financial and agricultural $1,220,400 22.4% $1,072,000 20.4% Real estate mortgage 372,900 53.7 343,000 54.3 Installment loans 1,084,800 23.9 1,020,443 25.2 Lease financing - - 1,000 .1 Unallocated 711,900 N\/A 650,000 N\/A ---------- --- ---------- ---\n$3,390,000 100.0% $3,086,443 100.0% ========== ===== ========== =====\nDecember 31, 1991 ------------------- Commercial, financial and agricultural $ 835,000 21.2% Real estate mortgage 300,000 54.6 Installment loans 951,835 24.1 Lease financing 15,000 .1 Unallocated 600,000 N\/A ---------- ---\n$2,701,835 100.0% ========== ======\nWhile management's periodic analysis of the adequacy of the allowance for loan losses 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\nThe average amount of deposits and average rates paid are summarized as follows for the years ended December 31:\nMaturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 1995 are summarized as follows:\nAmount -------- Three months or less ......................................... $14,772,940 Over three months and through six months ..................... 7,529,668 Over six months and through twelve months .................... 6,500,836 Over twelve months ........................................... 4,622,089 ---------- $33,425,533 ===========\nVI. RETURN ON EQUITY AND ASSETS\nThe ratio of net income to average shareholders' equity and average total assets and certain other ratios are as follows:\n1995 1994 1993 ---- ---- ----\nAverage total assets $398,560,067 $335,117,514 $314,229,739 ============ ============ ============\nAverage shareholders' equity (1) (2) $ 37,876,540 $ 30,614,125 $ 29,966,208 ============ ============ ============\nAverage shareholders' equity (1) (3) $ 29,792,748 $ 24,588,737 $ 25,412,300 ============ ============ ============\nNet income $ 4,094,813 $ 3,910,374 $ 3,874,981 ============ ============ ============\nCash dividends declared $ 1,310,627 $ 1,264,128 $ 1,221,980 ============ ============ ============\nReturn on average total assets 1.03% 1.17% 1.23% ==== ==== ====\nReturn on average share- holders' equity (2) 10.81% 12.77% 12.93% ===== ===== =====\nReturn on average share- holders' equity (3) 13.74% 15.90% 15.25% ===== ===== =====\nDividend payout percentage (4) 32.01% 32.33% 31.54% ===== ===== =====\nAverage shareholders' equity (2) to average total assets 9.50% 9.14% 9.54% ==== ==== ====\nAverage shareholders' equity (3) to average total assets 7.48% 7.34% 8.09% ==== ==== ====\n(1) Net of average unrealized appreciation or depreciation on securities available-for-sale. (2) Includes common stock subject to repurchase obligation in ESOP. (3) Excludes common stock subject to repurchase obligation in ESOP. (4) Dividends declared divided by net income.\nVII. SHORT-TERM BORROWINGS\nThe Corporation did not have any category of short-term borrowings for which the average balance outstanding during the reported periods was 30 percent or more of shareholders' equity at the end of the reported periods.\nEffect of Environmental Regulation\nCompliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect upon the capital expenditures, earnings or competitive position of the Corporation and its subsidiaries. The Corporation believes that the nature of the operations of its subsidiaries has little, if any, environmental impact. The Corporation, therefore, anticipates no material capital expenditures for environmental control facilities for its current fiscal year or for the foreseeable future. The Corporation's subsidiaries may be required to make capital expenditures for environmental control facilities related to properties which they may acquire through foreclosure proceedings in the future; however, the amount of such capital expenditures, if any, is not currently determinable.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following is a listing and brief description of the properties owned or leased by State Bank and used in its business:\n1. Its main office is a two-story brick building located at 401 Clinton Street, Defiance, Ohio, which was built in 1971. Including a basement addition built in 1991, it contains 33,400 square feet of floor space. Approximately 1,100 square feet on the second floor and 1,900 on the lower level presently are leased to Rurbanc.\n2. A branch office located in downtown Defiance, Ohio containing 3,600 square feet of floor space was built in 1961. It contains a three-bay drive-in, two inside teller locations and a night deposit unit.\n3. A full service branch office located on Main Street in Ney, Ohio containing 1,536 square feet of floor space was opened in 1968.\n4. A full service branch office located at 1796 North Clinton Street, Defiance, Ohio containing 2,120 square feet of floor space was opened in 1968. It is a free standing structure located in front of a shopping center.\n5. A full service branch office located at 1856 East Second Street, Defiance, Ohio containing 2,160 square feet of floor space was opened in 1972. It is a free standing structure located in front of a shopping center.\n6. A full service branch office located at 2010 South Jefferson, Defiance, Ohio containing 2,160 square feet of floor space was opened in 1979. It is located in a primarily residential area.\n7. A full service branch office located at 220 North Main Street, Paulding, Ohio containing 6,200 square feet of floor space was opened in 1980.\n8. A full service branch office located at 312 Main Street, Delta, Ohio containing 3,470 square feet of floor space was acquired from Society Bank & Trust (\"Society\") in 1992.\n9. A full service branch office located at 133 E. Morenci Street, Lyons, Ohio containing 2,578 square feet of floor space was acquired from Society in 1992.\n10. A full service branch office located at 515 Parkview, Wauseon, Ohio containing 3,850 square feet of floor space was acquired from Society in 1992.\n11. A full service branch located in the Chief Market Square supermarket at 705 Deatrick Street, Defiance, Ohio and containing 425 square feet was opened in 1993. State Bank leases the space in which this branch is located pursuant to a 15-year lease.\nThe following is a listing and brief description of the properties owned by Peoples Bank and used in its business:\n1. The full service main office located at 301 South Main Street, Findlay, Ohio was opened in 1990. It contains approximately 30,000 square feet of floor space, of which 12,000 is used by an unrelated law firm.\n2. A full service branch office located at 124 East Main Street, McComb, Ohio was opened in 1990. It contains approximately 3,600 square feet of floor space.\n3. A full service branch office located at 1330 North Main Street, Findlay, Ohio, was opened in 1979. It contains approximately 1,500 square feet of floor space.\nThe only real property owned by First National Bank is the location of the Bank at 405 East Main Street, Ottawa, Ohio. First National Bank's facility is a two-story brick and steel building containing approximately 7,100 square feet of space. The first floor is a traditional banking lobby and the second floor contains proof\/bookkeeping and office space.\nThe following is a listing and brief description of the properties owned by Citizens Bank and used in its business:\n1. The full service main office is located at 132 East Front Street, Pemberville, Ohio and contains 6,389 square feet. It was built near the turn of the century and was completely remodeled and added on to in 1992.\n2. A full service branch office located at 230 West Madison Street, Gibsonburg, Ohio occupies 2,520 square feet and was built in 1988.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no pending legal proceedings to which the Corporation or any of its subsidiaries is a party or to which any of their property is subject, except routine legal proceedings to which the Corporation or any of its subsidiaries is a party incidental to its banking business. None of such proceedings are considered by the Corporation to be material.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Registrant.\nThe following table lists the names and ages of the executive officers of the Corporation as of the date of this Annual Report on Form 10-K, the positions presently held by each such executive officer and the business experience of each such executive officer during the past five years. Unless otherwise indicated, each person has held his principal occupation(s) for more than five years. All executive officers serve at the pleasure of the Board of Directors of the Corporation.\nPosition(s) Held with the Corporation and its Subsidiaries Name Age and Principal Occupation(s) ------ ----- -----------------------------------\nThomas C. Williams 47 President and Chief Executive Officer of the Corporation and of State Bank since June 1995; President of FirstMerit Bank, FSB, Clearwater, Florida, from 1994 to June, 1995; Senior Vice President and Managing Officer of the Northern Region of The First National Bank of Ohio, Cleveland, Ohio, from 1990 to 1994; Director of the Corporation, State Bank and Rurbanc.\nDavid E. Manz 46 Executive Vice President, Secretary and Treasurer since 1992, Chief Financial Officer since 1990, and Vice President from 1990 to 1992, of the Corporation; President and Chief Executive Officer of Rurbanc since 1988; Executive Vice President since 1992, Senior Vice Presi- dent from 1991 to 1992, and Vice President from 1983 to 1991, of State Bank; Director of the Corporation and Rurbanc.\nEdward L. Yoder 50 Vice President of the Corporation since 1992; Executive Vice President since 1992, Senior Vice President from 1991 to 1992, and Vice President from 1981 to 1991, of State Bank; President and Chief Executive Officer of Rurban Life since 1992; Director of Rurban Life.\nRobert W. Constien 43 Vice President of the Corporation since 1994; Executive Vice President since 1994, Senior Vice President from 1991 to 1993, Vice President from 1987 to 1991, and a Trust Officer since 1987, of State Bank.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe common shares of the Corporation are traded on a limited basis in the over-the-counter market. The table below sets forth the high and low bid quotations for, and the cash dividends declared with respect to, the common shares of the Corporation, for the indicated periods. The bid quotations were obtained from one of the securities dealers who makes a market in the Corporation's common shares (the Corporation is aware of three securities dealers who make a market in its common shares). The bid quotations reflect the prices at which purchases and sales of the Corporation's common shares could be made during each period and not inter-dealer prices. The bid quotations reflect retail mark-ups, but not commissions or retail mark-downs. The bid quotations represent actual transactions in the Corporation's common shares. The per share amounts have been restated for the two-for-one stock split in January 1994.\nPer Share Per Share Bid Prices Dividends 1994 High Low Declared ---- ---- --- --------\nFirst Quarter $ 21.00 $ 18.25 $ .15 Second Quarter 23.00 20.00 .15 Third Quarter 24.00 22.00 .15 Fourth Quarter 25.50 24.00 .15\nFirst Quarter $ 25.50 $ 23.75 $ .15 Second Quarter 27.75 25.13 .15 Third Quarter 30.50 27.75 .15 Fourth Quarter 32.38 29.38 .15\nThere can be no assurance as to the amount of dividends which will be declared with respect to the common shares of the Corporation in the future, since such dividends are subject to the discretion of the Corporation's Board of Directors, cash needs, general business conditions, dividends from the subsidiaries and applicable governmental regulations and policies. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources and Note 1 of Notes to Consolidated Financial Statements.\nThe approximate number of holders of outstanding common shares of the Corporation, based upon the number of record holders as of December 31, 1995, is 1,056.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n- --------------------------------------------------------------------------------\n(1) Per share data restated for 1994 two-for-one stock split and 1992 15% stock dividend. (2) Includes common shares subject to repurchase obligation in ESOP.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nEarnings Summary\nConsolidated net income for the Corporation for 1995 was $4,095,000, up from $3,910,000 in 1994 and $3,875,000 in 1993. Net income per share was $1.87 in 1995, a decrease of 1% from $1.89 in 1994. The 1994 net income per share results represented a 1% decrease from $1.91 in 1993. Cash dividends declared per share amounted to $.60 in 1995, 1994 and 1993. Per share data has been adjusted to reflect the two-for-one stock split paid in January of 1994.\nResults Of Operations\n1995 Compared With 1994\nNet interest income for 1995 was $17,192,000, an increase of $3,331,000 (24%) over 1994. The increase is primarily due to the additional net interest income resulting from a 13% increase in the average balance of total loans, net of unearned income and deferred loan fees. Net interest income was significantly impacted by the acquisition of Citizens Bank in October of 1994. For the year ended December 31, 1994, approximately three months of net interest income was recorded for Citizens Bank in the Corporation's consolidated net interest income as compared to a full year of net interest income for December 31, 1995. Net interest income was also favorably impacted by a 121 basis point increase in the average yield on loans due to higher average rates charged on loans resulting from an upward movement of interest rates during 1995. This contributed to a 26 basis point increase in average tax equivalent net interest margin from 4.46% in 1994 to 4.72% in 1995. The tax equivalent yield on average balances of interest-earning assets increased from 7.51% for 1994 to 8.57% in 1995 due to the upward movement of interest rates during 1995.\nThe average rate on interest-bearing liabilities for 1995 was 4.51%, an increase of 88 basis points from 3.63% for 1994. This increase was primarily the result of an increase in interest rates paid on time deposits when the interest rates were rising during the early part of 1995.\nAt December 31, 1995, net loans amounted to $273,095,000, a decrease of 1% over net loans of $275,647,000 at December 31, 1994. This decrease is primarily due to the lower demand for consumer loans in 1995 compared to 1994. With the recent decrease in interest rates, management expects increased refinancing activity may lead to net mortgage loan growth if the Corporation is able to refinance loans currently held by other financial institutions. Lower rates are expected to boost the growth of small businesses by lowering borrowing costs. Management expects this to lead to increased demand for commercial, financial and agricultural loans.\nAt December 31, 1995, approximately $2.9 million of real estate mortgage loans were held for sale in the secondary market. During 1995, approximately $10.4 million of real estate mortgage loans were originated for sale and approximately $12.2 million were sold in the secondary market. This represents a decrease of $325,000 (3%) in loans sold in 1995 as compared to 1994. Mortgage loans originated for sale decreased $2.1 million in 1995, as compared to 1994, primarily due to increasing interest rates in the early part of 1995 which slowed the demand for mortgage loan refinancings. Net gains on loan sales for 1995 totaled $84,000, a decrease of $28,000 (25%) as compared to 1994. The Corporation continues to retain the servicing of these loans as a fee generating service. Primarily, loans originated for sale are fixed rate mortgage loans. Management anticipates an increase in the volume of loans originated for sale in 1996 as compared to 1995 based on the lowering of interest rates in the first quarter of 1996.\nSecurities totaled $90,330,000 at December 31, 1995 which represented an increase of $20,147,000 (29%) from total securities of $70,183,000 at December 31, 1994. The increase in securities is primarily due to a growing deposit base, outpacing loan demand, as customers take advantage of the deposit services being offered by the Corporation. In November 1995, the Financial Accounting Standards Board (\"FASB\") issued its Special Report, A Guide to Implementation of SFAS No. 115 on Accounting for Certain Investments in Debt and Equity Securities (\"Guide\"). As permitted by the Guide, on December 31, 1995, the Corporation made a one-time reassessment and transferred securities from the held-to-maturity portfolio to the available-for-sale portfolio. At the date of transfer, these securities had an amortized cost of $10,854,000 and the transfer increased the unrealized gain on securities available-for-sale by $211,000 and shareholders' equity by $139,000, net of tax of $72,000. As of December 31, 1995, all securities of the Corporation consisted of available-for-sale securities. The available-for-sale securities represent those securities the Corporation may decide to sell if needed for liquidity, asset\/liability management or other reasons. These securities are reported at fair value with unrealized gains and losses included as a separate component of shareholders' equity, net of tax. This resulted in a net addition to shareholders' equity of approximately $449,000 at December 31, 1995.\nTotal deposits at December 31, 1995 amounted to $367,797,000, an increase of $13,151,000 (4%) over total deposits of $354,646,000 at December 31, 1994. The increase of deposits is believed to have occurred as a result of increased deposit services and flexibility of products offered. Management believes that customers continue to place a value on federal insurance on deposit accounts and that, to the extent the Corporation continues to pay competitive rates on deposits and continues to provide flexibility of deposit products, the Corporation will be able to maintain its deposit levels.\nThe provision for loan losses which was charged to operations was based on the amount of net losses incurred and management's estimation of future losses based on an evaluation of portfolio risk and economic factors. The provision for loan losses was $1,452,000 in 1995 compared to $701,000 in 1994. The increased provision and decrease in the allowance in 1995 as compared to 1994 is due largely to the charge off of certain credits which were previously reported on a nonaccrual basis. The amount of allowance acquired through the acquisition of Citizens Bank in 1994 was $1.1 million. The allowance at December 31, 1995 was $4,270,000 or 1.54% of total loans, net of deferred loan fees, compared to $4,770,000 or 1.70% of total loans, net of deferred loan fees, at December 31, 1994.\nManagement adopted Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, effective January 1, 1995, which requires recognition of loan impairment. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. Under this guidance, 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. A portion of the allowance for loan losses is allocated to impaired loans. The effect of adopting these standards in 1995 was not material.\nSmaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, and automobile, home equity and second mortgage loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower's business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Commercial loans are rated on a scale of 1 to 5, with 1 being satisfactory, 2 watch, 3 substandard, 4 doubtful, and 5 as loss which are then charged off. Loans graded a 4 or worse are considered for impairment. Loans are generally moved to nonaccrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. This typically occurs when the loan is 120 days or more past due. At December 31, 1995, the Corporation classified four loan relationships as impaired, totaling $1,835,000. Management allocated $643,000 of the allowance for loan losses to impaired loans at December 31, 1995.\nManagement allocated approximately 39% of the allowance for loan losses to commercial, financial and agricultural loans; 34% to installment loans; and 12% to real estate mortgage loans at December 31, 1995, leaving a balance of 15% unallocated. Nonperforming loans decreased to $3,114,000 at December 31, 1995 from $4,736,000 at December 31, 1994. The decrease in nonperforming loans relates primarily to the charge off of certain nonperforming loans in 1995. Management believes the allowance for loan losses balance at December 31, 1995 is adequate to absorb losses on these and other loans, as the allowance balance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values, and other factors and estimates which are subject to change over time.\nTotal noninterest income increased $440,000 (8%) to $5,753,000 in 1995 from $5,313,000 in 1994, primarily due to increases in three areas. The Corporation's service charges on deposits increased $163,000 (16%) to $1,185,000 in 1995 compared to $1,022,000 in 1994, trust department income increased $161,000 (9%) to $1,946,000 in 1995 from $1,785,000 in 1994 and data processing fees increased $107,000 (6%) to $2,039,000 in 1995 compared to $1,932,000 in 1994. A significant factor in the increase in noninterest income was the addition of Citizens Bank in the fourth quarter of 1994, resulting in a full year of noninterest income for Citizens Bank in 1995 as compared to approximately three months of noninterest income in 1994.\nTotal noninterest expense increased $2,608,000 (21%) to $15,272,000 in 1995, from $12,664,000 in 1994, primarily due to the following factors. Salaries and employee benefits increased $1,173,000 (20%) to $6,909,000 in 1995 compared to $5,736,000 in 1994. This increase is due to normal annual salary increases and the inclusion of Citizen Bank's salary and employee benefits for the entire year for 1995 compared to approximately three months in 1994. Equipment rentals, depreciation and maintenance expenses increased $638,000 (51%) to $1,890,000 in 1995 compared to $1,252,000 in 1994. This increase is largely due to depreciation on the new data processing equipment at Rurbanc, which was placed in service in the last quarter of 1994, resulting in a full year of depreciation in 1995. Other expenses increased $716,000 (15%) primarily due to increases in professional fees of $244,000, increases in the amortization of intangible assets of $417,000 and a general increase in all operating expenses, partially offset by a decrease in FDIC insurance expense. Another significant factor in the increase in other expenses was the addition of Citizens Bank in the fourth quarter of 1994, resulting in a full year of other expenses for Citizens Bank in 1995 as compared to approximately three months of other expenses in 1994.\nIncome tax expense for the year ended December 31, 1995 was $2,127,000, an increase of $228,000 (12%) from 1994. This increase was primarily attributable to an increase in income before income tax expense.\nSeveral new accounting standards have been issued by the FASB that will apply in 1996. SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed Of\", requires a review of long-term assets for impairment of recorded value and resulting write-downs if the value is impaired. SFAS No. 122, \"Accounting for Mortgage Servicing Rights\", requires recognition of an asset when servicing rights are retained on in-house originated loans that are sold. These statements are not expected to have a material effect on the Corporation's consolidated financial position or results of operations.\n1994 Compared With 1993\nNet interest income for 1994 was $13,862,000, an increase of $1,292,000 (10%) over 1993. The increase was primarily due to the additional net interest income resulting from an 11% increase in the average balance of total loans, net of unearned income and deferred loan fees. Approximately one-third of this increase was attributable to the acquisition of Citizens Bank, located in Pemberville, Ohio, in October of 1994. Net interest income was also favorably impacted by a 19 basis point increase in the average yield on loans. This contributed to an 8 basis point increase in average tax equivalent net interest margin from 4.38% in 1993 to 4.46% in 1994. The tax equivalent yield on average balances of interest-earning assets increased from 7.42% for 1993 to 7.51% in 1994 due to increasing interest rates during most of 1994.\nThe average rate on interest-bearing liabilities for 1994 was 3.63%, an increase of 4 basis points from 3.59% for 1993. This increase was primarily the result of an increase in interest rates paid on time deposits.\nAt December 31, 1994, net loans amounted to $275,647,000, an increase of 23% over net loans of $224,258,000 at December 31, 1993. The increase in loans was primarily funded by an increase of 25% in total deposits from 1993 to 1994. Of the $51,389,000 increase in net loans, approximately $35 million was attributable to the acquisition of Citizens Bank.\nAt December 31, 1993, approximately $4.7 million of real estate mortgage loans were held for sale. During 1994, approximately $12.5 million of real estate mortgage loans were originated for sale and approximately $12.5 million were sold in the secondary market. This represented a decrease of $28.9 million (70%) in loans sold in 1994 as compared to 1993. Net gains realized on loan sales for 1994 totaled $112,000, a decrease of $318,000 (74%) as compared to 1993. The Corporation continued to retain the servicing of these loans as a fee generating service. As of December 31, 1994, loans held for sale in the secondary market totaled approximately $4.7 million. Mortgage loans originated for sale decreased $32.1 million in 1994, as compared to 1993, primarily due to increasing interest rates and the resulting decrease in customer refinancings throughout most of 1994. Primarily, loans originated for sale were fixed rate mortgage loans.\nSecurities totaled $70,183,000 at December 31, 1994 which represented an increase of $11,269,000 (19%) from total securities of $58,914,000 at December 31, 1993. The increase in securities was primarily due to securities acquired in the acquisition of Citizens Bank. On January 1, 1994, the Corporation adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". As a result, the Corporation classified $59,812,000 of securities as available-for-sale and $10,371,000 of securities as held-to-maturity at December 31, 1994. The available-for-sale securities represent those securities the Corporation may decide to sell if needed for liquidity, asset liability management or other reasons. These securities are reported at fair value with unrealized gains and losses included as a separate component of shareholders' equity, net of tax. This resulted in a net reduction to shareholders' equity of $1,170,000 at December 31, 1994. The held-to-maturity securities represent those securities which the Corporation has the positive intent and ability to hold to maturity, and are reported at amortized cost.\nTotal deposits at December 31, 1994 amounted to $354,646,000, an increase of $71,043,000 (25%) over total deposits of $283,603,000 at December 31, 1993. The acquisition of Citizens Bank brought in approximately $56 million in deposits. The additional increase of deposits was believed to have occurred as a result of increased deposit services and flexibility of products offered.\nThe provision for loan losses which was charged to operations was based on the growth of the loan portfolio, the amount of net losses incurred and management's estimation of future losses based on an evaluation of portfolio risk and economic factors. The provision for loan losses was $701,000 in 1994 compared to $795,000 in 1993. The amount of allowance for loan losses acquired through the acquisition of Citizens Bank was $1.1 million. The allowance at December 31, 1994 was $4,770,000 or 1.70% of total loans, net of deferred loan fees, compared to $3,390,000 or 1.49% of total loans, net of deferred loan fees, at December 31, 1993.\nManagement allocated approximately 37% of the allowance for loan losses to commercial, financial and agricultural loans; 34% to installment loans; and 12% to real estate mortgage loans at December 31, 1994, leaving a balance of 17% unallocated. Nonperforming loans increased to $4,736,000 at December 31, 1994 from $3,821,000 at December 31, 1993. The increase in nonperforming loans was primarily due to one large commercial borrower totaling approximately $832,000 at December 31, 1994 being 90 days or more past due.\nTotal noninterest income decreased $121,000 (2%) to $5,313,000 in 1994 primarily due to decreases in two areas. Data processing fees decreased $51,000 (3%) to $1,932,000 in 1994 compared to $1,983,000 in 1993. Also, as discussed above, the Corporation did not sell as many loans in the secondary market in 1994 resulting in a decline in net gains on loan sales of $318,000 (74%) from $430,000 in 1993 to $112,000 in 1994. These decreases were partially offset by increases in service charges on deposits, trust department income and other noninterest income.\nTotal noninterest expense increased $1,154,000 (10%) to $12,664,000 in 1994, primarily due to the following factors. Salaries and employee benefits increased $461,000 (9%) due in part to the acquisition of Citizens Bank as well as normal annual salary increases. Equipment rentals, depreciation and maintenance increased $190,000 (18%) of which $54,000 was due to the acquisition of Citizens Bank. Other expenses increased $534,000 (12%) primarily due to increases in professional fees of $121,000 (17%), advertising expense of $72,000 (45%), state, local and other taxes of $82,000 (16%) and other operating expenses of $225,000 (25%). The most significant factor in the increase in other expenses of $534,000 was the addition of Citizens Bank.\nIncome tax expense for the year ended December 31, 1994 was $1,899,000, an increase of $76,000 (4%) from 1994. This increase was primarily attributable to an increase in income before income tax expense and a reduction in the level of tax-exempt income in 1994 as compared to 1993.\nLiquidity\nLiquidity relates primarily to the Corporation's ability to fund loan demand, meet deposit customers' withdrawal requirements and provide for operating expenses. Assets used to satisfy these needs consist of cash, deposits in other financial institutions, federal funds sold, securities and loans held for sale. These assets are commonly referred to as liquid assets. Liquid assets were $121,839,000 at December 31, 1995 compared to $100,397,000 at December 31, 1994 and $82,100,000 at December 31, 1993. Liquidity levels increased $21,442,000 from 1994 to 1995 primarily due to the increase in cash and cash equivalents and securities available-for-sale. Management recognizes that securities may need to be sold in the future to help fund loan demand and, accordingly, as of December 31, 1995, $90,330,000 of securities were classified as available-for-sale. Management believes its current liquidity level is sufficient to meet anticipated future growth.\nThe cash flow statements for the periods presented provide an indication of the Corporation's sources and uses of cash as well as an indication of the ability of the Corporation to maintain an adequate level of liquidity. A discussion of the cash flow statements for 1995, 1994 and 1993 follows.\nFor all periods presented, the Corporation experienced a net increase in cash from operating activities. Net cash from operating activities was $8,033,000, $6,856,000 and $2,681,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The increase in net cash from operating activities of $1,177,000 for 1995 as compared to 1994 was primarily due to an increase in interest received on interest-earning assets which outpaced an increase in interest paid on interest-bearing liabilities. Net cash from operating activities increased $4,175,000 in 1994 as compared to 1993 primarily due to changes in activity related to loans originated for sale and an increase in interest received on interest-earning assets outpacing the increase in interest paid on interest-bearing liabilities due to the acquisition of Citizens Bank in October of 1994 and rising interest rates.\nNet cash flow from investing activities was $(16,672,000), $(13,086,000) and $(9,212,000) for the years ended December 31, 1995, 1994 and 1993, respectively. The changes in net cash from investing activities include the result of normal maturities and reinvestments of securities as well as financing loan growth and premises and equipment expenditures. In 1995, the Corporation received $2,263,000 from sales of securities available-for-sale and $25,509,000 from principal repayments, maturities and calls of securities, and had a cash outflow of $45,462,000 for the purchase of securities. In 1994, the Corporation received $3,266,000 in net cash as a result of the acquisition of Citizens Bank.\nNet cash flow from financing activities was $11,840,000, $13,071,000 and $3,685,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The net cash increase was primarily attributable to growth in total deposits of $13,151,000, $15,335,000 and $3,907,000 in 1995, 1994 and 1993, respectively.\nManagement of interest sensitivity is accomplished by matching the maturities of interest-earning assets and interest-bearing liabilities. The following table illustrates the asset (liability) funding gaps for selected maturity periods as of December 31, 1995.\nINTEREST SENSITIVITY GAP ANALYSIS\n------------Repricable or Maturing Within------------- 0-6 6-12 Total 1 Over 1 Total Months Months yr. yr. (000) (000) (000) (000) (000) ----- ----- ----- ----- ----- ASSETS Interest-earning deposits in other financial institutions $ 20 $ 100 $ 120 $ 60 $ 180 Federal funds sold 7,313 - 7,313 - 7,313 Securities 15,414 17,695 33,109 57,221 90,330 Loans\/loans held for sale 141,051 66,598 207,649 72,665 280,314 --------- -------- -------- --------- --------\nTotal interest-earning $163,798 $ 84,393 $248,191 $129,946 $378,137 assets ======== ======== ======== ======== ========\nLIABILITIES Interest-bearing deposits $232,458 $ 42,155 $274,613 $ 44,463 $319,076 ======== ======== ======== ======== ========\nAssets (liability) GAP $(68,660) $ 42,238 $(26,422) $ 85,483 $ 59,061 GAP ratio (assets\/ 70% 200% 90% 292% 119% liabilities)\nCapital Resources\nTotal shareholders' equity was $40,078,000 (which includes $9,333,000 of common shares subject to repurchase obligation in ESOP) as of December 31, 1995, an increase of $4,403,000 over total shareholders' equity of $35,675,000 as of December 31, 1994. The increase in total shareholders' equity was primarily due to 1995 net income of $4,095,000 and $1,619,000 net change in unrealized appreciation on securities available-for-sale, net of tax, partially offset by dividends of $1,311,000. Under risk-based capital guidelines issued by the Federal Reserve Board, the Corporation and its subsidiary banks are required to maintain a minimum risk-based capital ratio of 8% and a minimum leverage ratio of 4% as of December 31, 1995. While risk-based capital guidelines consider on-balance-sheet and off-balance-sheet risk, the minimum leverage ratio measures capital in relation to total on-balance-sheet assets.\nThe components of risk-based capital are tier 1 capital and tier 2 capital. The definition of capital, used in the leverage ratio, is identical to tier 1 capital under risk-based capital guidelines. Tier 1 capital is total shareholders' equity less intangible assets and tier 2 capital includes total allowance for loan losses in the calculation of total capital for risk-based capital purposes. The allowance for loan losses is includable in tier 2 capital up to a maximum of 1.25% of risk-weighted assets. The net unrealized appreciation\/depreciation on securities available-for-sale, net of tax, under SFAS No. 115 is not considered for meeting regulatory capital requirements. The following table provides the minimum regulatory capital requirements and the Corporation's capital ratios at December 31, 1995:\nTYPE OF CAPITAL RATIO Minimum Regulatory Capital Corporation's Requirements Capital 12\/31\/95 Ratio ----------- -------------\nRatio of tier 1 capital to weighted-risk assets 4.00% 14.51% Ratio of total capital to weighted-risk assets 8.00% 15.76% Leverage Ratio 4.00% 9.26% Ratio of total shareholders' equity to total assets N\/A 9.75%\nThe Corporation's subsidiaries meet the applicable minimum regulatory capital requirements at December 31, 1995. The Corporation remains comfortably above the minimum regulatory capital requirements. The banking regulators may alter minimum capital requirements as a result of revising their internal policies and their ratings of the Corporation's subsidiary banks.\nRestrictions exist regarding the ability of the subsidiary banks to transfer funds to the Corporation in the form of cash dividends, loans or advances. (See Note 1 to Consolidated Financial Statements.) These restrictions have had no major impact on the Corporation's dividend policy or operations and it is not anticipated that they will have any major impact in the future.\nAs of December 31, 1995, management is not aware of any current recommendations by banking regulatory authorities which, if they were to be implemented, would have, or are reasonably likely to have, a material adverse effect on the Corporation's liquidity, capital resources or operations.\nImpact Of Inflation And Changing Prices\nThe majority of assets and liabilities of the Corporation are monetary in nature and therefore the Corporation differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation significantly affects noninterest expense, which tends to rise during periods of general inflation.\nManagement believes the most significant impact on financial results is the Corporation's ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities and actively manages the amount of securities available-for-sale in order to protect against the effects of wide interest rate fluctuations on net income and shareholders' equity.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Consolidated Balance Sheets of the Corporation and its subsidiaries as of December 31, 1995 and December 31, 1994, 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, the related Notes to Consolidated Financial Statements and the Report of Independent Auditors, appear on pages 46 through 73 of this Annual Report on Form 10-K. The Corporation is not required to furnish the supplementary financial information specified by Item 302 of Regulation S-K.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nIn accordance with General Instruction G(3), the information called for in this Item 10 is incorporated herein by reference to the Corporation's definitive Proxy Statement, filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Corporation's Annual Meeting of Shareholders to be held on April 22, 1996, under the captions \"ELECTION OF DIRECTORS\" and \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\" In addition, certain information concerning the executive officers of the Corporation called for in this Item 10 is set forth in the portion of Part I of this Annual Report on Form 10-K entitled \"Executive Officers of the Registrant\" in accordance with General Instruction G(3).\nItem 11.","section_11":"Item 11. Executive Compensation.\nIn accordance with General Instruction G(3), the information called for in this Item 11 is incorporated herein by reference to the Corporation's definitive Proxy Statement, filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Corporation's Annual Meeting of Shareholders to be held on April 22, 1996, under the captions \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\" and \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.\" Neither the \"REPORT ON EXECUTIVE COMPENSATION\" nor the \"PERFORMANCE GRAPH\" included in the Corporation's definitive Proxy Statement relating to the Corporation's Annual Meeting of Shareholders to be held on April 22, 1996, shall be deemed to be incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nIn accordance with General Instruction G(3), the information called for in this Item 12 is incorporated herein by reference to the Corporation's definitive Proxy Statement, filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Corporation's Annual Meeting of Shareholders to be held on April 22, 1996, under the caption \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nIn accordance with General Instruction G(3), the information called for in this Item 13 is incorporated herein by reference to the Corporation's definitive Proxy Statement, filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Corporation's Annual Meeting of Shareholders to be held on April 22, 1996, under the caption \"TRANSACTIONS INVOLVING MANAGEMENT.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) (1) Financial Statements.\nFor a list of all financial statements included in this Annual Report on Form 10-K, see \"Index to Financial Statements\" at page 45.\n(a) (2) 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.\n(a) (3) Exhibits.\nExhibits filed with this Annual Report on Form 10-K are attached hereto. For a list of such exhibits, see \"Index to Exhibits\" at page 74. The following table provides certain information concerning executive compensation plans and arrangements required to be filed as exhibits to this Annual Report on Form 10-K.\nExecutive Compensation Plans and Arrangements\nExhibit No. Description Location\n10(a) Employees' Stock Ownership Incorporated herein by Plan of Rurban Financial Corp. reference to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 0-13507) [Exhibit 10(a)].\n10(b) First Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to the Financial Corp., dated June Corporation's Annual 14, 1993 and made to be Report on Form 10-K for effective as of January 1, 1993 the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(b)].\n10(c) Second Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to the Financial Corp., dated March Corporation's Annual 14, 1994 and made to be Report on Form 10-K for effective as of January 1, 1993 the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(c)].\n10(d) Third Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to the Financial Corp., dated March Corporation's Annual 13, 1995 Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 10(d)].\n10(e) Fourth Amendment to Employees' Pages 79 through 81 of Stock Ownership Plan of Rurban this Annual Report on Form Financial Corp., dated 10-K. June 10, 1995 and made to be effective as of January 1, 1995\n10(f) The Rurban Financial Corp. Incorporated herein by Savings Plan and Trust reference to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 0-13507) [Exhibit 10(d)].\n10(g) First Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to the and Trust, dated December 10, Corporation's Annual 1990 and effective January 1, Report on Form 10-K for 1990 the fiscal year ended December 31, 1990 (File No. 0-13507) [Exhibit 10(g)].\n10(h) Second Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to the and Trust, dated March 11, Corporation's Annual 1991, effective February 1, Report on Form 10-K for 1991 the fiscal year ended December 31, 1992 (File No. 0-13507) [Exhibit 10(d)].\n10(i) Third Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to the and Trust, dated June 11, 1991 Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (File No. 0-13507) [Exhibit 10(e)].\n10(j) Fourth Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to the and Trust, dated July 14, Corporation's Annual 1992, effective May 1, 1992 Report on Form 10-K for the fiscal year ended December 31, 1992 (File No. 0-13507) [Exhibit 10(f)].\n10(k) Fifth Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to the and Trust, dated March 14, 1994 Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(i)].\n10(l) Sixth Amendment to The Rurban Pages 82 through 84 of Financial Corp. Savings Plan this Annual Report on Form and Trust dated May 1, 1995 10-K.\n10(m) Summary of Incentive Incorporated herein by Compensation Plan of State Bank reference to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(j)].\n10(n) Summary of Bonus Program Incorporated herein by adopted by the Trust reference to the Department of State Bank for Corporation's Annual the benefit of Robert W. Report on Form 10-K for Constien in his capacity as the fiscal year ended Manager of the Trust Department December 31, 1991 (File No. 0-13507) [Exhibit 10(e)].\n10(o) Summary of Bonus Program for Incorporated herein by the Trust Department of State reference to the Bank Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (File No. 0-13507) [Exhibit 10(i)].\n10(p) Summary of Sales Bonus Program Incorporated herein by of State Bank reference to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 10(n)].\n10(q) Summary of Rurban Financial Incorporated herein by Corp. Bonus Plan reference to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(q)].\n10(r) Executive Salary Continuation Incorporated herein by Agreement, dated December 15, reference to the 1994, between Rurban Financial Corporation's Annual Corp. and Richard C. Burrows Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 10(p)].\n10(s) Executive Salary Continuation Pages 85 through 93 of Agreement, dated October 11, this Annual Report on Form 1995, between Rurban Financial 10-K. Corp. and Thomas C. Williams; and Schedule A to Exhibit 10(s) identifying other identical Executive Salary Continuation Agreements between executive officers of Rurban Financial Corp. and Rurban Financial Corp. 10(t) Description of Split-Dollar Page 94 of this Annual Insurance Policies Maintained Report on Form 10-K. for Certain Executive Officers of Rurban Financial Corp.\n(b) Reports on Form 8-K.\nThere were no Current Reports on Form 8-K filed during the fiscal quarter ended December 31, 1995.\n(c) Exhibits.\nExhibits filed with this Annual Report on Form 10-K are attached hereto. For a list of such exhibits, see \"Index to Exhibits\" at page 74.\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.\nRURBAN FINANCIAL CORP.\nDate: March 26, 1996 By: Thomas C. Williams, 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 Date Capacity ------ ------ ----------\n*Thomas C. Williams * President, Chief Executive Officer, Principal Executive Officer and Director\n*David E. Manz * Executive Vice President, Secretary, Treasurer, Chief Financial Officer, Principal Financial and Accounting Officer and Director\n*Richard C. Burrows * Director\n*John R. Compo * Director\n*Robert A. Fawcett, Jr. * Director\n*Richard Z. Graham * Director\n*John H. Moore * Director\n*Merlin W. Mygrant * Director\n*Steven D. VanDemark * Director\n*J. Michael Walz, D.D.S. * Director\n*By: Thomas C. Williams (Attorney-in-Fact) Date: March 26, 1996\nRURBAN FINANCIAL CORP.\nANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1995\nPages in this Annual Report on Description Form 10-K\nReport of Independent Auditors.................................... 46\nConsolidated Balance Sheets at December 31, 1995 and 1994........................................................ 47-48\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.......................... 49\nConsolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 1995............................................................ 50\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993............................................................ 51-52\nNotes to Consolidated Financial Statements........................ 53-73\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Shareholders Rurban Financial Corp. Defiance, Ohio\nWe have audited the accompanying consolidated balance sheets of Rurban Financial Corp. as of December 31, 1995 and 1994 and the related consolidated 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 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 Rurban Financial Corp. 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 discussed in Note 1, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", as of January 1, 1994.\nCrowe, Chizek and Company LLP\nSouth Bend, Indiana January 19, 1996\nRURBAN FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ---- ---- ASSETS Cash and due from banks (Note 10) ............ $ 21,067,131 $ 20,606,577 Federal funds sold ........................... 7,312,525 4,571,594 ------------- ------------- Total cash and cash equivalents ........... 28,379,656 25,178,171 ------------- ------------- Interest-earning deposits in other financial institutions ............................... 180,000 346,324 Securities available-for-sale (Note 2) ....... 90,329,866 59,811,855 Securities held-to-maturity (Note 2) (Fair value: 1994 - $ 10,346,000) .......... -- 10,370,912 Loans Commercial, financial and agricultural .... 63,444,036 62,866,040 Real estate mortgage ...................... 152,555,540 152,136,086 Installment ............................... 61,600,664 65,676,876 ------------- ------------- Total loans ............................ 277,600,240 280,679,002 Deferred loan fees, net ................... (235,396) (262,204) Allowance for loan losses (Note 3) ........ (4,270,000) (4,770,000) ------------- ------------- Net loans .............................. 273,094,844 275,646,798 ------------- ------------- Loans held for sale .......................... 2,949,293 4,689,611 Premises and equipment, net (Note 4) ......... 8,383,717 9,264,085 Accrued interest receivable .................. 3,240,154 2,694,374 Other assets ................................. 4,668,235 5,545,354 ------------- -------------\nTotal assets ........................... $ 411,225,765 $ 393,547,484 ============= =============\nSee accompanying notes to consolidated financial statements.\nRURBAN FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ---- ---- LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Noninterest-bearing ...................... $ 48,721,000 $ 50,381,190 Interest-bearing (Note 5) ................ 319,075,538 304,264,446 ------------ ------------- Total deposits ........................ 367,796,538 354,645,636 ------------ ------------- Accrued interest payable .................... 1,035,048 908,248 Other liabilities ........................... 2,315,688 2,319,013 ------------ -------------\nTotal liabilities ..................... 371,147,274 357,872,897\nCommitments, off-balance-sheet risk and contingencies (Note 10)\nCommon stock subject to repurchase obligation in ESOP (Note 6) (1995 - 297,467 shares out- standing; 1994 - 271,428 shares outstanding) . 9,333,027 6,834,557 Common stock: stated value $2.50 per share; 5,000,000 shares authorized; 1995 - 1,886,911 shares outstanding; 1994 - 1,912,950 shares outstanding .................................. 4,717,277 4,782,375 Additional paid-in capital ..................... 5,798,813 8,232,185 Retained earnings .............................. 19,779,897 16,995,711 Net unrealized appreciation (depreciation) on securities available-for-sale, net of tax of $231,549 in 1995 and $602,851 in 1994 ........ 449,477 (1,170,241) ------------ -------------\nTotal liabilities and shareholders' equity .. $411,225,765 $ 393,547,484 ============ =============\nSee accompanying notes to consolidated financial statements.\nRURBAN FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Interest income Interest and fees on loans $26,539,689 $20,421,474 $17,948,466 Interest and dividends on securities Taxable 3,756,764 2,485,695 2,989,616 Non-taxable 426,178 346,485 445,580 Other interest income 707,596 220,244 94,625 ---------- ----------- ---------- Total interest income 31,430,227 23,473,898 21,478,287\nInterest expense Interest on deposits (Note 5) 14,197,998 9,486,706 8,856,704 Interest on short-term borrowings 40,050 125,647 52,406 ---------- ----------- ---------- Total interest expense 14,238,048 9,612,353 8,909,110 ---------- ----------- ----------\nNet interest income 17,192,179 13,861,545 12,569,177\nProvision for loan losses (Note 3) 1,451,898 701,490 795,486 ---------- ----------- ----------\nNet interest income after provision for loan losses 15,740,281 13,160,055 11,773,691\nNoninterest income Service charges on deposits 1,184,787 1,021,685 1,004,321 Trust department income 1,946,013 1,784,626 1,616,930 Data processing fees 2,038,948 1,932,045 1,982,739 Net securities gains (losses) (Notes 2 and 8) 3,113 (8,556) (6,399) Net gains on loan sales 83,919 112,156 430,321 Other income 496,419 470,727 405,917 ---------- ----------- ---------- Total noninterest income 5,753,199 5,312,683 5,433,829\nNoninterest expense Salaries and employee benefits (Note 6) 6,909,268 5,736,434 5,275,815 Net occupancy expense of premises 869,678 788,377 818,739 Equipment rentals, depreciation and maintenance 1,889,540 1,251,898 1,061,832 Other expenses (Note 7) 5,603,077 4,886,990 4,353,348 ---------- ----------- ---------- Total noninterest expense 15,271,563 12,663,699 11,509,734 ---------- ----------- ----------\nIncome before income tax expense 6,221,917 5,809,039 5,697,786\nIncome tax expense (Note 8) 2,127,104 1,898,665 1,822,805 ---------- ----------- ----------\nNet income $4,094,813 $ 3,910,374 $3,874,981 ========== =========== ==========\nEarnings per common share (Note 1) $ 1.87 $ 1.89 $ 1.91 =========== ============ ===========\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nRURBAN FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994 and 1993\nSee also Note 14\nSee accompanying notes to consolidated financial statements.\nRURBAN FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995, 1994, and 1993\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNature of Operations and Industry Segment Information: Rurban Financial Corp. is a bank holding company, organized under Ohio law, that owns all the outstanding stock of The State Bank and Trust Company (\"State Bank\"), The Peoples Banking Company (\"Peoples Bank\"), The First National Bank of Ottawa (\"First National Bank\"), The Citizens Savings Bank Company (\"Citizens Savings Bank\"), Rurbanc Data Services, Inc. (\"RDSI\") and Rurban Life Insurance Company (\"Rurban Life\") (together referred to as \"the Corporation\"). The Corporation's subsidiary banks grant credit and accept deposits from their customers in the normal course of business primarily in the northwestern Ohio region. Rurbanc's business is comprised of providing data processing services primarily to financial institutions located in the northwest area of Ohio. Rurban Life accepts reinsurance ceded in part by USLIFE from the credit life and disability insurance purchased by customers of the Corporation's subsidiary banks. The Corporation operates primarily in the banking industry which accounts for more than 90% of its revenues, operating income and assets.\nBasis of Reporting: The accompanying consolidated financial statements in- clude the accounts of Rurban Financial Corp. and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.\nOn October 3, 1994, the Corporation acquired 100% of the common stock of Citizens Savings Bank located in Pemberville, Ohio with approximately $60 million in assets. The transaction was accounted for as a purchase. Citizens Savings Bank's results of operations are included in the income statement of the Corporation beginning as of the purchase date. Each share of Citizens Savings Bank's common stock was exchanged for $73.39 in cash or 3.91 common shares of the Corporation's common stock. The Corporation paid a total of $2,378,046 and issued 155,000 common shares in the acquisition.\nPresented below are the consolidated proforma results of operations of the Corporation for the years ended December 31, 1994 and 1993, assuming this acquisition had occurred as of January 1, of each year.\n1994 1993 ---- ----\nNet interest income ............................ $15,569,000 $14,965,000 Net income ..................................... 3,687,000 3,382,000 Earnings per share ............................. 1.69 1.55\nUse of Estimates In Preparing Financial Statements: 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, 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.\n- -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - --------------------------------------------------------------------------------\nCertain Significant Estimates: Areas involving the use of management's estimates and assumptions include the allowance for loan losses, the realization of deferred tax assets, fair values of securities and other financial instruments, the determination and carrying value of impaired loans, the carrying value of loans held for sale, the carrying value of other real estate, the determination of other-than-temporary reductions in the fair value of securities, recognition and measurement of loss contingencies, depreciation of premises and equipment and the carrying value and amortization of intangibles. Estimates that are more susceptible to change in the near term include the allowance for loan losses, securities valuations, the carrying value of loans held for sale, the carrying value of intangibles and the realization of deferred tax assets.\nCertain Vulnerability Due to Certain Concentrations: Management is of the opinion that no concentrations exist that make the Corporation vulnerable to the risk of near-term severe impact.\nSecurities: On 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\". The Corporation classifies securities into held-to-maturity, available-for-sale and trading categories. Held-to-maturity securities are those which the Corporation has the positive intent and ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those the Corporation may decide to sell if needed for liquidity, asset-liability management or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains and losses included as a separate component of shareholders' equity, net of tax. Trading securities are bought principally for sale in the near term, and are reported at fair value with unrealized gains and losses included in earnings. Adoption of SFAS No. 115 on January 1, 1994 increased shareholders' equity by $198,496, net of $102,256 tax effect.\nIn November 1995, the Financial Accounting Standards Board (\"FASB\") issued its Special Report, A Guide to Implementation of SFAS No. 115 on Accounting for Certain Investments in Debt and Equity Securities (\"Guide\"). As permitted by the Guide, on December 31, 1995, the Corporation made a one-time reassessment and transferred securities from the held-to-maturity portfolio to the available-for-sale portfolio. At the date of transfer, these securities had an amortized cost of $10,854,066 and the transfer increased the unrealized gain on securities available-for-sale by $210,566 and shareholders' equity by $138,974, net of tax of $71,592.\nRealized gains and losses resulting from the sale of securities are computed by the specific identification method. Interest and dividend income, adjusted by amortization of purchase premium or discount, is included in earnings. Premiums and discounts on securities are recognized using the level yield method over the estimated life of the security.\n- -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - --------------------------------------------------------------------------------\nPrior to January 1, 1994, securities were reported at amortized cost, except for securities held for sale, which were reported at the lower of cost or market value in the aggregate. Net unrealized losses were recognized in a valuation allowance by charges to income.\nLoans Held for Sale: Loans intended for sale are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized in a valuation allowance by charges to income.\nInterest Income on Loans: Interest on loans is accrued over the term of the loans based upon the principal outstanding. Management reviews loans delinquent 90 days or more to determine if the interest accrual should be discontinued. When serious doubt exists as to the collectibility of a loan, the accrual of interest is discontinued. Effective January 1, 1995, under SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\", 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 and other cash payments are reported as reductions in carrying value. Increases or decreases in carrying value due to changes in estimates of future payments or the passage of time are reported as a component of the provision for loan losses.\nLoan Fees and Costs: Loan fees, net of direct origination costs, are deferred. The net amount deferred is reported in the consolidated balance sheets as part of loans and is recognized into interest income over the term of the loan using the level yield method.\nAllowance For Loan Losses: An allowance for loan losses is established and maintained because some loans may not be repaid in full. Increases to the allowance are recorded by a provision for loan losses charged to expense. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values, and other factors and estimates which are subject to change over time. While management may periodically allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge-offs that may occur. A loan is charged off by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur.\n- -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - --------------------------------------------------------------------------------\nSFAS No. 114 and SFAS No. 118 were adopted effective January 1, 1995 and require recognition of loan impairment. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans. If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses. The effect of adopting these standards in 1995 was not material.\nSmaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, and automobile, home equity and second mortgage loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower's business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 30 days or more. Commercial loans are rated on a scale of 1 to 5, with 1 being satisfactory, 2 watch, 3 substandard, 4 doubtful, and 5 as loss which are then charged off. Loans graded a 4 or worse are considered for impairment. Loans are generally moved to nonaccrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. This typically occurs when the loan is 120 days or more past due. The nature of disclosures for impaired loans is considered generally comparable to prior nonaccrual and renegotiated loans and non-performing and past-due asset disclosures.\nPremises and Equipment: Buildings and improvements are depreciated using primarily the straight-line method with useful lives ranging from 10 to 50 years. Furniture and equipment are depreciated using the straight-line and declining-balance methods with useful lives ranging predominantly from 5 to 20 years. Maintenance and repairs are expensed and major improvements are capitalized.\nIntangible Assets: Goodwill arising from the acquisition of subsidiary banks is amortized over 5 to 25 years using the straight-line method. Core deposit intangibles are amortized on an accelerated basis over 10 years, the estimated life of the deposits acquired. As of December 31, 1995, unamortized goodwill totaled approximately $784,000 and unamortized core deposit intangibles totaled approximately $521,000.\nOther Real Estate Owned: Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value at the date of acquisition. Any reduction to fair value from the carrying value of the related loan at the time of acquisition is accounted for as a loan loss and charged against the allowance for loan losses. After acquisition, a valuation allowance is recorded through a charge to income for the amount of estimated selling costs. Valuations are periodically performed by management, and valuation allowances are adjusted through a charge to income for changes in fair value or estimated selling costs. Other real estate owned amounted to approximately $320,000 and $400,000 at December 31, 1995 and 1994, respectively, and is included in other assets in the consolidated balance sheets.\n- -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - --------------------------------------------------------------------------------\nIncome Taxes: The Corporation files an annual consolidated federal income tax return. Income tax is based upon the asset and liability method. The asset and liability method requires the Corporation to record income tax expense based on the amount of taxes due on its consolidated tax 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 enacted tax rates.\nEmployee Benefits (See Note 6): The Corporation sponsors an employee stock ownership plan (ESOP) and 401(k) profit sharing plan for which contributions are made and expensed annually. The Corporation provides split-dollar life insurance plans for certain executive officers of the Corporation. Also, the Corporation sponsors a supplemental retirement plan for certain executive officers of the Corporation.\nPostretirement Health Care Benefits: The Corporation sponsors a postretirement health care plan that covers both salaried and nonsalaried employees. Effective January 1, 1993, the Corporation adopted the provisions of SFAS No. 106, \"Employers' Accounting For Postretirement Benefits Other Than Pensions\". SFAS No. 106 requires the accrual, during the years that employees render the necessary service, of the expected cost of providing postretirement health care benefits to employees and their beneficiaries and covered dependents. The Corporation's postretirement health care plan provides that retired employees may remain on the Corporation's health care plan with each retiree's out-of-pocket contribution to the Corporation equal to their premium expense determined exclusively on the loss experience of the retirees in the plan. The impact of adopting the guidance was not material.\nEarnings Per Common Share: Earnings and dividends per common share have been computed based on the weighted average number of shares outstanding during the periods presented, restated for all stock dividends and stock splits. In 1994, a two-for-one split was declared and paid. The number of shares used in the computation of earnings per common share was 2,184,378 for 1995, 2,067,597 for 1994 and 2,029,378 for 1993.\nDividend Restriction: Certain restrictions exist regarding the ability of the subsidiaries to transfer funds to Rurban Financial Corp. in the form of cash dividends, loans or advances. As of December 31, 1995, approximately $3,665,000 of undistributed earnings of the subsidiaries, included in consolidated retained earnings, was available for distribution to Rurban Financial Corp. as dividends without prior regulatory approval.\n- -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - --------------------------------------------------------------------------------\nConcentrations of Credit Risk: The Corporation grants commercial, real estate and installment loans to customers mainly in northwest Ohio. Commercial loans include loans collateralized by business assets and agricultural loans collateralized by crops and farm equipment. Commercial loans make up approximately 23% of the loan portfolio and the loans are expected to be repaid from cash flow from operations of businesses. Real estate loans make up approximately 55% of the loan portfolio and are collateralized by both commercial and residential real estate. Installment loans make up approximately 22% of the loan portfolio and are primarily collateralized by consumer assets.\nFinancial Instruments With Off-Balance-Sheet Risk: The Corporation, in the normal course of business, makes commitments to extend credit which are not reflected in the consolidated financial statements. A summary of these com- mitments is disclosed in Note 10.\nStatements of Cash Flows: For purposes of reporting cash flows, cash and cash equivalents is defined to include cash on hand, demand deposits in other financial institutions and federal funds sold with maturities of 90 days or less. The Corporation reports net cash flows for customer loan transactions, deposit transactions, short-term borrowings with maturities of 90 days or less and interest-earning deposits in other financial institutions.\nReclassifications: Certain amounts appearing in the financial statements and notes thereto for the years ended December 31, 1994 and 1993 have been reclassified to conform with the December 31, 1995 presentation.\nNOTE 2 - SECURITIES\nInformation related to the amortized cost and fair value of securities at December 31, 1995 and 1994 is provided below:\nGross Gross Securities Available-for-Sale Amortized Unrealized Unrealized 1995 Cost Gains Losses Fair Value ----------------------------- --------- ---------- ---------- ---------- U.S. Treasury and U.S. Government agency securities $73,799,068 $574,819 $(122,386) $74,251,501 Obligations of states and political subdivisions 9,365,076 191,846 (13,527) 9,543,395 Mortgage-backed securities 5,295,474 62,183 (11,909) 5,345,748 ----------- -------- --------- ---------- Total debt securities available-for-sale 88,459,618 828,848 (147,822) 89,140,644 Marketable equity securities 1,189,222 - - 1,189,222 ----------- -------- --------- ----------\nTotal securities available- for-sale $89,648,840 $828,848 $(147,822) $90,329,866 =========== ======== ========= ===========\n- -------------------------------------------------------------------------------- NOTE 2 - SECURITIES (Continued) - --------------------------------------------------------------------------------\nGross Gross Securities Available-for-Sale Amortized Unrealized Unrealized 1994 Cost Gains Losses Fair Value ----------------------------- --------- ---------- ---------- ---------- U.S. Treasury and U.S. Government agency securities $51,925,952 $ 712 $(1,393,582) $50,533,082 Mortgage-backed securities 8,783,192 19,356 (399,578) 8,402,970 ----------- -------- --------- ---------- Total debt securities available-for-sale 60,709,144 20,068 (1,793,160) 58,936,052 Marketable equity securities 875,803 - - 875,803 ----------- -------- --------- ----------\nTotal securities available- for-sale $61,584,947 $ 20,068 $(1,793,160) $59,811,855 =========== ======== =========== ===========\nGross Gross Securities Held-to-Maturity Amortized Unrealized Unrealized 1994 Cost Gains Losses Fair Value --------------------------- --------- ---------- ---------- ---------- U.S. Treasury and U.S. Government agency securities $ 1,482,576 $ 1,811 $ (3,387) $1,481,000 Obligations of states and political subdivisions 8,888,336 74,229 (97,565) 8,865,000 ----------- -------- --------- ----------\nTotal securities held- to-maturity $10,370,912 $ 76,040 $(100,952) $10,346,000 =========== ======== ========= ===========\nThe amortized cost and fair values of debt securities 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.\nAvailable-for-Sale -------------------- Amortized Cost Fair Value ---------- ---------- Due in one year or less $29,399,818 $29,481,607 Due after one year through five years 51,421,608 51,889,174 Due after five years through ten years 2,302,918 2,387,838 Due after ten years 39,800 36,277 ---------- ----------- 83,164,144 83,794,896 Mortgage-backed securities 5,295,474 5,345,748 ---------- -----------\nTotal debt securities $88,459,618 $89,140,644 =========== ===========\n- -------------------------------------------------------------------------------- NOTE 2 - SECURITIES (Continued) - --------------------------------------------------------------------------------\nProceeds, gross gains and gross losses realized from sales of securities for the years ended December 31, 1995, 1994 and 1993 are as follows:\n1995 1994 1993 ---- ---- ----\nProceeds from sales of debt securities available-for-sale $2,263,104 $ - $ - Proceeds from sales of marketable equity securities held for sale - - 1,025,941 --------- ----------- -----------\nTotal proceeds from sales of securities $2,263,104 $ - $ 1,025,941 ========== ============ ===========\nGross gains from sales of debt securities available-for-sale $ 11,975 $ - $ - Gross losses from sales of debt securities available-for-sale (8,672) - - Net losses on calls of securities available-for-sale (190) - - Net losses on calls of securities held-to-maturity - (8,556) - Net losses from sales of marketable equity securities held for sale and calls of debt investment securities - - (6,399) --------- ----------- ---------\nNet securities gains (losses) $ 3,113 $ (8,556) $ (6,399) ========== ========== ===========\nAt December 31, 1995 there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies and corporations, in an amount greater than 10% of shareholders' equity.\nSecurities with an amortized cost of approximately $47,893,000 and $40,753,000 as of December 31, 1995 and 1994, respectively, were pledged to secure public and trust deposits.\n- -------------------------------------------------------------------------------- NOTE 3 - ALLOWANCE FOR LOAN LOSSES - --------------------------------------------------------------------------------\nThe following is a summary of the activity in the allowance for loan losses account for the years ended December 31, 1995, 1994 and 1993:\n1995 1994 1993 ---- ---- ----\nBalance at beginning of year $4,770,000 $3,390,000 $3,086,443 Allowance of acquired bank - 1,100,000 - Provision for loan losses 1,451,898 701,490 795,486 Recoveries credited to the allowance 698,928 329,463 441,811 Losses charged to the allowance (2,650,826) (750,953) (933,740) ---------- ---------- ---------\nBalance at end of year $4,270,000 $4,770,000 $3,390,000 ========== ========== ==========\nAt December 31, 1995 and 1994, loans past due more than 90 days and still accruing interest approximated $711,000 and $1,198,000, respectively.\nInformation regarding impaired loans is as follows for the year ending December 31, 1995:\nAverage investment in impaired loans $2,542,000 Interest income recognized on impaired loans including interest income recognized on cash basis 32,000 Interest income recognized on impaired loans on cash basis 32,000\nInformation regarding impaired loans at December 31, 1995 is as follows:\nBalance of impaired loans $1,835,000 Less portion for which no allowance for loan losses is allocated (302,000)\nPortion of impaired loan balance for which an allowance for loan losses is allocated $1,533,000 ==========\nPortion of allowance for loan losses allocated to impaired loan balance $ 643,000 ==========\nLoans on which the recognition of interest has been discontinued or reduced totaled approximately $3,538,000 at December 31, 1994. Interest income not recognized on these loans totaled approximately $289,000 and $189,000 during 1994 and 1993, respectively.\n- -------------------------------------------------------------------------------- NOTE 4 - PREMISES AND EQUIPMENT, NET - --------------------------------------------------------------------------------\nPremises and equipment are stated at cost, less accumulated depreciation, and consist of the following at December 31, 1995 and 1994:\n1995 1994\nLand $ 966,579 $ 976,579 Buildings and improvements 6,927,945 7,002,690 Furniture and equipment 5,980,928 5,647,452 ---------- ---------- Total cost 13,875,452 13,626,721 Accumulated depreciation (5,491,735) (4,362,636) ---------- ----------\nPremises and equipment, net $8,383,717 $9,264,085 ========== ==========\nNOTE 5 - INTEREST-BEARING DEPOSITS\nIncluded in interest-bearing deposits are time deposits in denominations of $100,000 or more of approximately $33,426,000 and $32,642,000 as of December 31, 1995 and 1994, respectively.\nInterest expense on time deposits in denominations of $100,000 or more was approximately $1,090,000, $1,205,000 and $1,012,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 6 - EMPLOYEE BENEFITS\nEmployee Stock Ownership Plan: The Corporation has a noncontributory employee stock ownership plan (ESOP) covering substantially all employees of the Corporation's subsidiaries. Each eligible employee is vested based upon years of service, including prior years of service. Contributions and related expense attributable to the plan included in salaries and employee benefits were approximately $374,000, $274,000 and $273,000 in 1995, 1994 and 1993, respectively.\nFor corporations not listed on NASDAQ, ERISA rules require employers with an ESOP to agree to repurchase shares from participants for a certain time period following the distribution of shares to the participants. The Corporation's common stock subject to repurchase obligation in ESOP had an estimated value of $9,333,027 and $6,834,557 at December 31, 1995 and 1994, respectively.\n- -------------------------------------------------------------------------------- NOTE 6 - EMPLOYEE BENEFITS (Continued) - --------------------------------------------------------------------------------\n401(k) Profit Sharing Plan: The Corporation has 401(k) profit sharing plans. The annual expense of the plans is based on 50% matching of voluntary employee contributions of up to 6% of individual compensation. Employee contributions are vested immediately and the Corporation's matching contributions are fully vested after six years. The plans cover substantially all employees of the Corporation. Contributions and related expense attributable to the plans, included in salaries and employee benefits, were approximately $101,000, $88,000 and $93,000 in 1995, 1994 and 1993, respectively.\nLife Insurance Plans: Life insurance plans are provided for certain executive officers on a split-dollar basis and the Corporation is the owner of the split-dollar policies. The officers are entitled to a sum equal to two times either the employee's annual salary at death, if actively employed, or final annual salary, if retired, less $50,000. The Corporation is entitled to the remainder of the death proceeds less any loans on the policy and unpaid interest or cash withdrawals previously incurred by the Corporation. The employees have the right to designate a beneficiary(s) to receive their share of the proceeds payable upon death. The cash surrender value of these life insurance policies was approximately $596,000 and $556,000 at December 31, 1995 and 1994, respectively, and is included in other assets in the consolidated balance sheets.\nSupplemental Retirement Plan: During 1994, the Corporation established a supplemental retirement plan for selected officers. The Corporation has purchased insurance contracts on the lives of the participants in the supplemental retirement plan and has named the Corporation as beneficiary. While no direct contract exists between the supplemental retirement plan and the life insurance contracts, it is management's current intent that the proceeds from the insurance contracts will be used to help offset earlier payments made under the supplemental retirement plan. The Corporation is recording an expense equal to the projected present value of the payment due at retirement based on the projected remaining years of service using the projected unit credit method. The expense attributable to the plan, included in salaries and employee benefits, was approximately $133,000 and $33,000 in 1995 and 1994, respectively. The cash surrender value of the life insurance was approximately $1,439,000 and $1,383,000 at December 31, 1995 and 1994, respectively, and is included in other assets in the consolidated balance sheets.\nNOTE 7 - OTHER EXPENSES\nThe following is an analysis of other expenses for the years ended December 31, 1995, 1994 and 1993: 1995 1994 1993\nAmortization of intangible assets $ 634,000 $ 217,000 $ 203,000 Advertising expense 259,938 233,548 161,511 Professional fees 1,097,162 853,241 732,151 Insurance expense 525,189 702,172 694,002 Data processing fees 436,983 323,942 333,079 Printing, stationery and supplies 604,340 587,995 594,609 Postage and delivery expense 304,362 241,441 214,213 State, local and other taxes 630,829 586,899 504,698 Other operating expenses 1,110,274 1,140,752 916,085 --------- ---------- ----------\nTotal other expenses $5,603,077 $4,886,990 $4,353,348 ========== ========== ==========\n- -------------------------------------------------------------------------------- NOTE 8 - INCOME TAX EXPENSE - --------------------------------------------------------------------------------\nIncome tax expense consists of the following for the years ended December 31, 1995, 1994 and 1993: 1995 1994 1993\nCurrent expense $2,915,522 $1,668,675 $1,801,099 Deferred expense (benefit) (788,418) 229,990 21,706 --------- ---------- ----------\nTotal income tax expense $2,127,104 $1,898,665 $1,822,805 ========== ========== ==========\nTax expense (benefit) on net securities gains (losses) were $1,058, $(2,909) and $(2,176) in 1995, 1994 and 1993, respectively.\nThe difference between the financial statement income tax expense and amounts computed by applying the statutory federal income tax rate to income before income tax expense is as follows for the years ended December 31, 1995, 1994 and 1993:\n1995 1994 1993 ---- ---- ----\nStatutory tax rate 34% 34% 34% Income taxes computed at the statutory federal income tax rate $2,115,452 $1,975,073 $1,937,247 Add (subtract) tax effect of: Tax-exempt income (184,312) (149,706) (178,144) Non-deductible expenses and other 195,964 73,298 63,702 --------- ---------- ----------\nTotal income tax expense $2,127,104 $1,898,665 $1,822,805 ========== ========== ==========\nThe components of the net deferred tax asset recorded in the consolidated balance sheets as of December 31, 1995 and 1994 are as follows:\n1995 1994 ---- ---- Deferred tax assets Provision for loan losses $1,061,264 $1,201,000 Market to market adjustment 162,050 - Net deferred loan fees 65,309 89,149 Net unrealized depreciation on securities available-for-sale - 602,851 Accrued compensation and benefits 185,003 147,428 AMT credit carryforward - 157,539 Other 118,250 111,338 ---------- ---------- Total deferred tax assets $1,591,876 $2,309,305 ========== ==========\n- -------------------------------------------------------------------------------- NOTE 8 - INCOME TAX EXPENSE (Continued) - -------------------------------------------------------------------------------- 1995 1994 Deferred tax liabilities ------ ------ Net unrealized appreciation on securities available-for-sale $(231,549) $ - Depreciation (139,185) (44,544) Purchase accounting adjustments (259,324) (397,136) Market-to-market adjustment - (815,304) Other (4,566) (49,087) ---------- ---------- Total deferred tax liabilities (634,624) (1,306,071)\nValuation allowance - - --------- ----------\nNet deferred tax asset $ 957,252 $1,003,234 ========= ==========\nNOTE 9 - RELATED PARTY TRANSACTIONS\nCertain directors, executive officers and principal shareholders of the Corporation, including associates of such persons, were loan customers during 1995. A summary of the related party loan activity, for loans aggregating $60,000 or more to any one related party, follows:\nBalance, January 1, 1995 ...................... $5,164,000 New loans .................................. 7,601,000 Repayments ................................. (9,111,000) Other changes .............................. (142,000) ----------\nBalance, December 31, 1995 .................... $3,512,000 ==========\nOther changes include adjustments for loans applicable to one reporting period that are excludable from the other reporting period.\nNOTE 10 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES\nThe Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to make loans, unused lines of credit and standby letters of credit. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to make loans, unused lines of credit and standby letters of credit is represented by the contractual amount of those instruments. The Corporation follows the same credit policy to make such commitments as it uses for on-balance-sheet items.\n- -------------------------------------------------------------------------------- NOTE 10 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES - -------------------------------------------------------------------------------- (Continued)\nThe Corporation has the following commitments outstanding at December 31:\n1995 1994 ---- ---- Fixed rate loan commitments and unused lines of credit $4,491,000 $ 4,733,000 Variable rate loan commitments and unused lines of credit 47,552,000 51,699,000 Standby letters of credit 2,945,000 2,674,000 ---------- -----------\n$54,988,000 $59,106,000 =========== ===========\nFixed rate loan commitments and unused lines of credit, at December 31, 1995, are at current rates, ranging primarily from 5.20% to 17.90% and are primarily for terms of up to two years.\nVariable rate loan commitments and unused lines of credit, at December 31, 1995, are at current rates, ranging primarily from 7.75% to 16.25% and are primarily for terms of up to two years. The primary index used for adjustments is the prime rate.\nSince many commitments to make loans expire without being used, the amount does not necessarily represent future cash commitments. In addition, commitments to extend credit are arrangements to lend to customers as long as there is no violation of any condition established in the contract. No losses are anticipated as a result of these transactions. Collateral obtained upon exercise of the commitment is determined using management's credit evaluation of the borrower and may include real estate, business assets, consumer assets, deposits and other items.\nThe Corporation was required to have approximately $3,475,000 and $3,438,000 of cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve requirements at December 31, 1995 and 1994, respectively. These balances do not earn interest.\n- -------------------------------------------------------------------------------- NOTE 11 - PARENT COMPANY FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nPresented below are condensed financial statements for the parent company, Rurban Financial Corp.:\nCONDENSED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ====== ====== ASSETS Cash and cash equivalents $ 844,790 $ 515,691 Securities available-for-sale 306,097 - Investment in and advances to subsidiaries Banking subsidiaries 36,520,419 33,541,947 Non-banking subsidiaries 2,238,418 2,014,227 ----------- ---------- Total investment in subsidiaries 38,758,837 35,556,174 Other assets 834,052 50,843 ----------- ----------\nTotal assets $40,743,776 $36,122,708 =========== ===========\nLIABILITIES Other liabilities $ 665,285 $ 448,121 ----------- ---------- Total liabilities 665,285 448,121\nCOMMON STOCK SUBJECT TO REPURCHASE OBLIGATION IN ESOP 9,333,027 6,834,557\nOTHER SHAREHOLDERS' EQUITY 30,745,464 28,840,030 ----------- ----------\nTotal liabilities and shareholders' equity $40,743,776 $36,122,708 =========== ===========\n- -------------------------------------------------------------------------------- NOTE 11 - PARENT COMPANY FINANCIAL STATEMENTS (Continued) - --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF INCOME Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Income Interest on securities-non-taxable $ 5,347 $ - $ - Dividends from subsidiaries Banking subsidiaries 3,015,000 3,900,000 1,125,000 Non-banking subsidiaries 75,000 300,000 325,000 ---------- ---------- --------- Total 3,090,000 4,200,000 1,450,000 Noninterest income 11,509 - - ---------- ---------- --------- Total income 3,106,856 4,200,000 1,450,000\nNoninterest expense 896,999 685,952 469,051 ---------- ---------- ---------\nIncome before income tax benefit and equity in undistributed net income of subsidiaries 2,209,857 3,514,048 980,949\nIncome tax benefit 302,011 233,224 159,478 ---------- ---------- ---------\nIncome before equity in undistributed net income 2,511,868 3,747,272 1,140,427\nEquity in undistributed net income Banking subsidiaries 1,358,754 80,153 2,598,967 Non-banking subsidiaries 224,191 82,949 135,587 ---------- ---------- --------- Total 1,582,945 163,102 2,734,554 ---------- ---------- ---------\nNet income $4,094,813 $3,910,374 $3,874,981 ========== ========== ==========\n- -------------------------------------------------------------------------------- NOTE 11 - PARENT COMPANY FINANCIAL STATEMENTS (Continued) - --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Cash flows from operating activities Dividends received from subsidiaries Banking subsidiaries $3,015,000 $3,900,000 $1,125,000 Non-banking subsidiaries 75,000 300,000 325,000 ---------- ---------- --------- Total 3,090,000 4,200,000 1,450,000 Cash paid to suppliers and employees (681,050) (744,321) (262,616) Income tax refunds 253,486 269,455 95,540 ---------- ---------- --------- Net cash from operating activities 2,662,436 3,725,134 1,282,924\nCash flows from investing activities Investment in banking subsidiary - (2,378,046) - Purchase of securities available- for-sale (306,097) - - Cash paid for life insurance premiums (716,613) - - ---------- ---------- --------- Net cash from investing activities (1,022,710) (2,378,046) -\nCash flows from financing activities Cash dividends paid (1,310,627) (1,264,128) (1,221,980) ---------- ---------- ---------- Net cash from financing activities (1,310,627) (1,264,128) (1,221,980) ---------- ---------- ----------\nNet change in cash and cash equivalents 329,099 82,960 60,944\nCash and cash equivalents at beginning of year 515,691 432,731 371,787 ---------- ---------- ------------\nCash and cash equivalents at end of year $ 844,790 $ 515,691 $ 432,731 ========== ========== ==========\n- -------------------------------------------------------------------------------- NOTE 11 - PARENT COMPANY FINANCIAL STATEMENTS (Continued) - --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF CASH FLOWS (CONTINUED) Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Reconciliation of net income to net cash from operating activities Net income $4,094,813 $3,910,374 $3,874,981 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed net income of subsidiaries Banking subsidiaries (1,358,754) (80,153) (2,598,967) Non-banking subsidiaries (224,191) (82,949) (135,587) Change in income taxes receivable (48,525) 36,231 (63,938) Change in other assets (18,071) - - Change in other liabilities 217,164 (58,369) (206,435) ---------- ---------- ---------- Net cash from operating activities $2,662,436 $3,725,134 $1,282,924 ========== ========== ==========\nSupplemental disclosures of cash flow information\nNon-cash increases related to Citizens Bank acquisition (Note 1): Common stock $ - $ 387,500 $ - Additional paid-in capital - 2,518,373 $ -\n- -------------------------------------------------------------------------------- NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS - --------------------------------------------------------------------------------\nThe following table shows the estimated fair values and the related carrying values of the Corporation's financial instruments at December 31, 1995 and 1994. Items which are not financial instruments are not included.\nFor purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 1995 and 1994. The estimated fair value for cash and cash equivalents is considered to approximate cost. The estimated fair value for interest-earning deposits in other financial institutions, securities available-for-sale and securities held-to-maturity is based on quoted market values for the individual securities or for equivalent securities. The estimated fair value for loans is based on estimates of the difference in interest rates the Corporation would charge the borrowers for similar such loans with similar maturities made at December 31, 1995 and 1994, applied for an estimated time period until the loan is assumed to reprice or be paid. The estimated fair value for demand and savings deposits is based on their carrying value. The estimated fair value for time deposits is based on estimates of the rate the Corporation would pay on such deposits at December 31, 1995 and 1994, applied for the time period until maturity. The estimated fair value for other financial instruments and off-balance-sheet loan commitments approximate cost at December 31, 1995 and 1994 and are not considered significant to this presentation.\nWhile these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Corporation to have disposed of such items at December 31, 1995 and 1994, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 1995 and 1994 should not necessarily be considered to apply at subsequent dates.\n- -------------------------------------------------------------------------------- NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued) - --------------------------------------------------------------------------------\nIn addition, other assets and liabilities of the Corporation that are not defined as financial instruments are not included in the above disclosures, such as premises and equipment. Also, non-financial instruments typically not recognized in the financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the earnings potential of State Bank's and Peoples Bank's trust departments, the trained work force, customer goodwill and similar items.\nNOTE 13 - IMPACT OF NEW ACCOUNTING STANDARDS\nSeveral new accounting standards have been issued by the FASB that will apply in 1996. SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of\", requires a review of long-term assets for impairment of recorded value and resulting write-downs if the value is impaired. SFAS No. 122, \"Accounting for Mortgage Servicing Rights\", requires recognition of an asset when servicing rights are retained on in-house originated loans that are sold. These statements are not expected to have a material effect on the Corporation's consolidated financial position or results of operations.\nNOTE 14 - SUPPLEMENTAL CASH FLOW DISCLOSURES\nOn October 3, 1994, Rurban Financial Corp. purchased all of the common stock of Citizens Bank for $2,378,046 in cash and issued 155,000 common shares at a market value of $18.75 per share. In conjunction with the acquisition, liabilities were assumed as follows:\nFair value of assets acquired ............................. $58,707,000 Cash paid ................................................. (2,378,046) Common stock issued ....................................... (2,905,873) -----------\nLiabilities assumed .................................... $53,423,081\nNOTE 14 - SUPPLEMENTAL CASH FLOW DISCLOSURES (Continued)\nAdditionally, transfers of securities were as follows:\n1995 Transfer from securities held-to-maturity to securities available-for-sale ........................... $10,854,066 1994 Transfer from investment securities and securities held for sale to: Securities available-for-sale ......................... 52,386,249 Securities held-to-maturity ........................... 6,527,912 1993 Transfer from investment securities to securities held for sale ........................................... 1,533,028\nRURBAN FINANCIAL CORP.\nANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1995\nINDEX TO EXHIBITS\nExhibit No. Description Page No. - ----------- ------------------------- -------------- 3(a) Amended Articles of Incorporated herein by Registrant, as amended reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-13507) [Exhibit 3(a)(i)].\n3(b) Certificate of Amendment to Incorporated herein by the Amended Articles of reference to Registrant's Rurban Financial Corp. Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 3(b)].\n3(c) Regulations of Registrant, as Incorporated herein by amended reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (File No. 0-13507) [Exhibit 3(b)].\n10(a) Employees' Stock Ownership Incorporated herein by Plan of Rurban Financial Corp. reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(b)].\n10(b) First Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to Registrant's Financial Corp., dated June 14, Annual Report on Form 10-K 1993 and made to be effective for the fiscal year ended as of January 1, 1993 December 31, 1993 (File No. 0-13507) [Exhibit 10(b)].\n10(c) Second Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to Registrant's Financial Corp., dated Annual Report on Form 10-K March 14, 1994 and made to be for the fiscal year ended effective as of January 1, 1993 December 31, 1993 (File No. 0-13507) [Exhibit 10(c)].\n10(d) Third Amendment to Employees' Incorporated herein by Stock Ownership Plan of Rurban reference to Registrant's Financial Corp., dated Annual Report on Form 10-K March 13, 1995 for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 10(d)].\n10(e) Fourth Amendment to Pages 79 through 81. Employees' Stock Ownership Plan of Rurban Financial Corp., dated June 10, 1995 and made to be effective as of January 1, 1995\n10(f) The Rurban Financial Corp. Incorporated herein by Savings Plan and Trust reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 0-13507) [Exhibit 10(g)].\n10(g) First Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to Registrant's and Trust, dated December 10, Annual Report on 1990 and effective January 1, Form 10-K for the fiscal 1990 year ended December 31, 1990 (File No. 0-13507) [Exhibit 10(g)].\n10(h) Second Amendment to The Incorporated herein by Rurban Financial Corp. reference to Registrant's Savings Plan and Trust, dated Annual Report on Form March 11, 1991, effective 10-K for the fiscal year February 1, 1991 ended December 31, 1992 (File No. 0-13507) [Exhibit 10(d)].\n10(i) Third Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to Registrant's and Trust, dated June 11, 1991 Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (File No. 0-13507) [Exhibit 10(e)].\n10(j) Fourth Amendment to The Incorporated herein by Rurban Financial Corp. reference to Registrant's Savings Plan and Trust, dated Annual Report on Form July 14, 1992, effective 10-K for the fiscal year May 1, 1992 ended December 31, 1992 (File No. 0-13507) [Exhibit 10(f)].\n10(k) Fifth Amendment to The Rurban Incorporated herein by Financial Corp. Savings Plan reference to Registrant's and Trust, dated March 14, Annual Report on Form 1994 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(i)].\n10(l) Sixth Amendment to The Rurban Pages 82 through 84. Financial Corp. Savings Plan and Trust dated May 1, 1995\n10(m) Summary of Incentive Incorporated herein by Compensation Plan of State reference to Registrant's Bank Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(j)].\n10(n) Summary of Bonus Program Incorporated herein by adopted by the Trust reference to Registrant's Department of State Bank for Annual Report on Form the benefit of Robert W. 10-K for the fiscal year Constien in his capacity as ended December 31, 1991 Manager of the Trust (File No. 0-13507) Department [Exhibit 10(e)].\n10(o) Summary of Bonus Program for Incorporated herein by the Trust Department of State reference to Registrant's Bank Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (File No. 0-13507\n[Exhibit 10(i)]. 10(p) Summary of Sales Bonus Incorporated herein by Program of State Bank reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 10(n)].\n10(q) Summary of Rurban Financial Incorporated herein by Corp. Bonus Plan reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-13507) [Exhibit 10(q)].\n10(r) Executive Salary Continuation Incorporated herein by Agreement, dated December 15, reference to Registrant's 1994, between Rurban Annual Report on Form Financial Corp. and Richard 10-K for the fiscal year C. Burrows ended December 31, 1994 (File No. 0-13507) [Exhibit 10(p)].\n10(s) Executive Salary Continuation Pages 85 through 93. Agreement, dated October 11, 1995, between Rurban Financial Corp. and Thomas C. Williams; and Schedule A to Exhibit 10(s) identifying other identical Executive Salary Continuation Agreements between executive officers of Rurban Financial Corp. and Rurban Financial Corp.\n10(t) Description of Split-Dollar Page 94 Insurance Policies Maintained for Certain Executive Officers of Rurban Financial Corp.\n11 Statement re Computation of Page 57 [included in Per Share Earnings Note 1 of the Notes to the Consolidated Financial Statements of Registrant in the financial statements portion of this Annual Report on Form 10-K].\n21 Subsidiaries of Registrant Incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (File No. 0-13507) [Exhibit 21].\n24 Powers of Attorney Pages 95 through 105.\n27 Financial Data Schedule Pages 106 through 108.","section_15":""}
{"filename":"108703_1995.txt","cik":"108703","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nWyman-Gordon Company, founded in 1883, is a leading manufacturer of highly engineered, technically advanced components for both the commercial and defense aerospace market and the commercial power generation market. The Company uses die forging, extrusion and investment casting processes to produce metal components to exacting customer specifications for technically demanding applications such as jet turbine engines, airframes and land-based gas turbine engines. The Company also extrudes seamless heavy-wall steel pipe for use primarily in commercial power generation plants, and designs and produces prototype aircraft using composite technologies. The Company produces components for most of the major commercial and U.S. defense aerospace programs. Metallurgical skills, a unique asset base and a broad offering of capabilities allow the Company to serve competing customers effectively and to lead the development and use of new metal technologies for its customers' uses.\nWyman-Gordon Company's acquisition of Cameron Forged Products Company from Cooper Industries, Inc. in May 1994 united two of the country's largest and most technically advanced forgings companies and had a pervasive impact on Wyman-Gordon Company. As a result of the acquisition, the Company has broadened its revenue base and expanded into new markets. The Company is also realizing substantial operating and processing efficiencies through the consolidation of systems and facilities and the reduction of personnel performing duplicate functions.\nMARKETS AND PRODUCTS\nThe principal markets served by the Company are aerospace and power generation. Revenue by market for the respective periods were as follows (000's omitted):\n[FN] (1) Revenues for the year ended May 28, 1994 are being presented for comparative purposes only.\nAEROSPACE\nThe Company produces products utilized in general aviation, defense and business jet aircraft. The Company manufactures numerous forged and cast components for jet engines produced by all of the major manufacturers, including General Electric, Pratt & Whitney, and Rolls-Royce. The Company's forged engine parts include fan discs, compressor discs, turbine discs, seals, spacers, shafts, hubs and cases. Cast engine parts include thrust reversers, valves and fuel system parts such as combustion chamber swirl guides. Jet engines may produce in excess of 100,000 pounds of thrust and may subject parts produced by the Company to temperatures reaching 1,350 degrees Fahrenheit. Components for such extreme conditions require precision manufacturing and expertise with high-purity titanium and nickel-based superalloys. Rotating parts such as fan, compressor and turbine discs must be manufactured to precise quality specifications.\nThe Company manufactures forged and cast structural parts for fixed-wing aircraft and helicopters. These products include wing spars, engine mounts, struts, landing gear beams, landing gear, wing hinges, wing and tail flaps, housings, and bulkheads. These parts may be made of titanium, steel, aluminum and other alloys, as well as composite materials. The Company also produces dynamic rotor forgings for helicopters. Forging is particularly well- suited for airframe parts because of its ability to impart greater proportional strength to metal than other manufacturing processes. Investment casting can produce complex shapes to precise, repeatable dimensions.\nThe Company has been a major supplier for many years of the beams that support the main landing gear assemblies on the Boeing 747 and has begun shipment of main landing gear beams for the new Boeing 777 widebody. The Company forges landing gear and other airframe structural components for the Boeing 747, 757, 767 and 777, the McDonnell Douglas MD-11 and the Airbus A330 and A340. The Company produces structural forgings for the, and fighter aircraft and the Sikorsky Black Hawk helicopter. The Company also produces large, one-piece bulkheads for Lockheed and Boeing for the next generation air superiority fighter aircraft.\nPOWER GENERATION\nThe Company is a major supplier of extruded seamless heavy wall pipe for the critical piping systems in commercial power plants worldwide, both fossil fuel and nuclear as well as offshore petrochemical applications. The Company believes it is the leading U.S. supplier, and also a leading U.K. supplier, of large diameter, seamless heavy wall pipe. The Company produces steam turbine generator, gas turbine generator and forged valve components for land-based power generation applications. The Company also manufactures shafts, cases, compressor and turbine discs for marine gas turbines.\nOTHER PRODUCTS\nThe Company supplies products to builders of military missiles. Examples of these products include breech block and breech rings for large cannon and forged steel casings for bombs, rockets and expendable launch vehicles. The Company participates in a variety of U.S. Government programs including the Standard, Harm, Patriot and Aegis programs. For naval defense applications, the Company supplies components for propulsion systems for nuclear submarine and aircraft carriers as well as pump, valve, structural and non nuclear propulsion forgings.\nThe Company also manufactures extruded missile, rocket and bomb cases and supplies extruded products for nuclear submarines and aircraft carriers including heavy wall piping for nuclear propulsion systems, torpedo tubes and catapult launch tubes.\nThe Company's investment castings operations produce products for commercial applications such as: components for golf clubs, pistol frames, bicycles, food processing equipment, diesel turbo- chargers, land-based military equipment such as tanks, and various other applications.\nThe Company also supplies extruded powders for other superalloy powder manufacturers. The Company is actively seeking to identify alternative applications for its capabilities, such as in the automotive and other commercial markets.\nCUSTOMERS\nThe Company has approximately 150 active customers that purchase forgings, approximately 550 active customers that purchase investment castings and approximately 20 active customers that purchase composite structures. The Company's principal customers are similar across all of these production processes. Five customers accounted for 50% of the Company's revenues for the year ended June 3, 1995, 51% for the five months ended May 28, 1994, 56% and 53% for the two years ended December 31, 1993 and 1992, respectively. General Electric Company (\"GE\") and United Technologies Corporation (\"UT\") (Pratt & Whitney and Sikorsky Divisions) each accounted for more than 10% of revenues for the year ended June 3, 1995, the five months ended May 28, 1994 and the two years ended December 31, 1993 and 1992, respectively, as follows:\nBoeing Company, McDonnell Douglas Corporation and Rolls Royce PLC are also significant customers of the Company.\nThe Company has organized its operations into product groups which focus on specific customers or groups of customers with similar needs. The Company has become actively involved with its aerospace customers through joint development relationships and cooperative research and development, engineering, quality control, just-in-time inventory control and computerized design programs. This involvement begins with the design of the tooling and processes to manufacture the customer's components to its precise specifications.\nMARKETING AND SALES\nThe Company markets its products principally through its own sales engineers and makes only limited use of manufacturers' representatives. Substantially all sales are made directly to original equipment manufacturers.\nThe Company's sales are not subject to significant seasonal fluctuations.\nA substantial portion of the Company's revenues are derived from long-term, fixed price contracts with major engine and aircraft manufacturers. These contracts are typically \"requirements\" contracts under which the purchaser commits to purchase a given portion of its requirements of a particular component from the Company. Actual purchase quantities are typically not determined until shortly before the year in which products are to be delivered.\nBACKLOG\nThe backlog of unfilled orders from customers in the various markets served by the Company has been as follows (000's omitted):\nAt June 3, 1995 approximately $365.0 million of total backlog was scheduled to be shipped within one year and the remainder in subsequent years, although there can be no assurances that products ordered will not be subject to schedule changes.\nMANUFACTURING PROCESSES\nThe Company employs three manufacturing processes: forging, investment casting and composites production.\nFORGING\nForging is the process by which desired shapes, metallurgical characteristics, and mechanical properties are imparted to metal by heating and shaping it through pressing or extrusion. The Company forges alloys of titanium, aluminum and steel as well as high temperature nickel-based superalloys.\nThe Company manufactures most of its forgings at its facilities in Grafton and Worcester, Massachusetts, near Houston, Texas and Livingston, Scotland. The Company also operates a superalloy powder metal facility in Brighton, Michigan and vacuum arc remelting facilities in Houston, Texas and Millbury, Massachusetts which produce steel, nickel and titanium ingots, and a plasma arc melting facility for the production of high quality titanium ingots and nickel powder in Millbury, Massachusetts. The Company has six large closed die hydraulic forging presses rated as follows: 18,000 ton, 35,000 ton and 50,000 ton in Grafton Massachusetts; 29,000 ton and 35,000 ton in Houston, Texas and 30,000 ton in Livingston, Scotland. The 35,000 ton vertical extrusion press in Houston can be modified to a 55,000 ton hydraulic forging press. The Company also operates an open die cogging press rated at 2,000 tons at its Grafton, Massachusetts location and a hydraulic isothermal forging press rated at 8,000 tons at its Worcester, Massachusetts location. The Company operated forging hammers rated at 35,000 pounds at its Worcester, Massachusetts location. Such hammers will be idled during September 1995. The majority of this facility's production has been transferred to other Company facilities in Massachusetts and Texas.\nThe Company employs all major forging processes, including the following:\nOPEN-DIE FORGING. In this process, the metal is forged between dies that never completely surround the metal, thus allowing the metal to be observed during the process. Typically, open-die forging is used to create relatively simple, preliminary shapes to be further processed by closed die forging.\nCLOSED-DIE FORGING. Closed-die forging involves pressing heated metal into the required shapes and size determined by machined impressions in specially prepared dies which exert three dimensional control on the metal. In hot-die forging, a type of closed-die process, the dies are heated to a temperature approaching the transformation temperature of the materials being forged so as to allow the metal to flow more easily within the die\ncavity which produces forgings with superior surface conditions, metallurgical structures, tighter tolerances, enhanced repeatability of the part shapes and greater metallurgical control. Both titanium and nickel-based superalloys are forged using this process, in which the dies are heated to a temperature of approximately 1,300 degrees Fahrenheit.\nCONVENTIONAL\/MULTI-RAM. The closed-die, multiple-ram process featured on the Company's 30,000 ton press enables the Company to produce extremely complex forgings with multiple cavities in a single heating and pressing cycle. Dies may be split either on a vertical or a horizontal plane and shaped punches may be operated by side rams, piercing rams, or both. Multi-ram forging enables the Company to produce a wide variety of shapes, sizes, and configurations utilizing less input weight. The process also optimizes grain flow and uniformity of deformation, reduces machining requirements, and minimizes overall costs.\nISOTHERMAL FORGING. Isothermal forging is a closed-die process in which the dies are heated to the same temperature as the metal being forged, typically in excess of 1,900 degrees Fahrenheit. The forged material typically consists of nickel-based superalloy powders. Because of the extreme temperatures necessary for forming these alloys, the dies must be made of refractory metal (such as molybdenum) so that the die retains its strength and shape during the forging process. Because the dies may oxidize at these elevated temperatures, the forging process is carried on in a vacuum or inert gas atmosphere. The Company's isothermal press also allows it to produce near-net shape components (requiring less machining by the customer) made from titanium alloys, which can be an important competitive advantage in times of high titanium prices. The Company carries on this process in its 8,000-ton isothermal press.\nEXTRUSION. The Company's 35,000 ton vertical extrusion press is one of the largest and most advanced presses in the world. Extrusions are produced for applications in the oil and gas industry, including tension leg platforms, riser systems and production manifolds. It is supported by manipulators capable of handling work pieces weighing up to 20 tons, rotary hearth furnaces and a 14,000 ton blocking press. It is capable of producing heavy wall seamless pipe with outside diameters up to 48 inches and wall thicknesses from 1\/2 inch up to 7 inches or more. Solid extrusions can be manufactured from 6 to 32 inches in diameter. Typical lengths vary from 10 to 45 feet. Powder materials can also be compacted and extruded into forging billets utilizing this press. The 30,000 ton press has similar extrusion capabilities in addition to its multi-ram forging capabilities.\nTITANIUM AND SUPERALLOY PRODUCTION. The Company utilizes vacuum arc remelting technology to produce titanium alloy suitable for structural and turbine aerospace applications. Titanium produced in this manner is utilized in both the Company's forging and castings operations.\nThe Company's Brighton, Michigan powder metal facility has the capability to atomize, process, and consolidate (by hot isostatic pressing) superalloy metal powders for use in aerospace, medical implant, petrochemical, hostile environment oil and gas drilling and production, and other high technology applications. This facility has an annual production capacity of up to 500,000 pounds of superalloy powder. In addition, the Company has the capacity to consolidate powdered metals by extrusion using its 30,000 ton and 35,000 ton presses. Extruded billets are further processed and either sold to other forge shops or forged into critical jet engine components on the Company's 8,000 ton isothermal press.\nThe Company's Plasma Arc Melting facility (PAM) in Millbury, Massachusetts is capable of producing high quality titanium ingot and nickel-based superalloy powder. The Company is currently pursuing certifications by certain customers for use of this technology in high performance jet engines.\nThe Company believes that its vacuum arc remelt (\"VAR\") shop in Houston, Texas is one of the finest facilities of its kind in the world. This facility, with its five computer-controlled VAR furnaces, accepts electrodes up to 42 inches in diameter and weighing up to 40,000 pounds. The Houston VAR furnaces are used to remelt purchased electrodes into high purity alloys for internal use in severe applications. In addition, the VAR furnaces are used for toll melting. These vacuum metallurgy techniques provide consistently high levels of purity, low gas content, and precise control over the solidification process. This minimizes segregation in complex alloys and results in improved mechanical properties, as well as hot and cold workability.\nThe Company has entered into a joint venture with Pratt & Whitney and certain Australian investors to produce nickel-based superalloy ingots in Perth, Australia. These ingots will be utilized as raw materials for the Company's forging and casting products.\nSUPPORT OPERATIONS. The Company manufactures its own forging dies out of high-strength steel and molybdenum. These dies can weigh in excess of 100 tons and can be up to 25 feet in length. In manufacturing its dies, the Company takes its customers' drawings and engineers the dies using CAD\/CAM equipment and sophisticated metal flow computer models that simulate metal flow during the forging process. This activity improves die design and process control and permits the Company to enhance the metallurgical characteristics of the forging.\nThe Company also has machine shops at its three major forging locations with computer aided profiling equipment, vertical turret lathes and other equipment that it employs to rough machine products to a shape allowing inspection of the products. The Company also operates rotary and car-bottom heat treating furnaces that enhance the performance characteristics of the forgings. These furnaces have sufficient capacity to handle all the Company's forged products. The Company subjects its products to extensive quality inspection and contract qualification procedures involving zyglo, chemical etching, ultrasonic, red dye, and electrical conductivity testing facilities.\nTESTING. Because the Company's products are for high performance end uses rigorous testing is necessary and is performed internally by Company engineers. Throughout the manufacturing process, numerous tests and inspections are performed to insure the final quality of each product; statistical process control (\"SPC\") techniques are also applied throughout the entire manufacturing process.\nINVESTMENT CASTINGS\nThe Company's investment castings operations use modern, automated, high volume production equipment and both air-melt and vacuum-melt furnaces to produce a wide variety of complex investment castings. Castings are made of a range of metal alloys including aluminum, magnesium, steel, titanium and nickel-based superalloys.\nThe Company's castings operations are conducted in facilities located in Connecticut, New Hampshire, Nevada and California. These plants house air and vacuum-melt furnaces, wax injection machines and investment dipping tanks. Because of the growth in demand for the Company's high quality titanium castings, the Company is in the process of restarting its Franklin, New Hampshire facility which it mothballed in 1993. The Company has ordered a new state-of-the-art titanium melting furnace for installation in the Franklin plant. Additionally, the Company has expanded its Groton, Connecticut facility for the production of high quality titanium castings.\nInvestment castings are produced in four major stages. First, molten wax is injected into an aluminum mold, known as a \"tool,\" in the shape of the ultimate component to be produced. These tools are produced to the specifications of the customer and are primarily purchased from outside die makers, although the Company maintains internal tool-making capabilities. In the second stage, the wax patterns are mechanically coated with a sand and silicate- bonded slurry in a process known as investment. This forms a ceramic shell which is subsequently air-dried under controlled environmental conditions. The wax inside this shell is then melted and removed in a high temperature steam autoclave and the molten wax is recycled. In the third, or foundry stage, metal is melted in an electric furnace in either an air or vacuum environment and poured into the ceramic shell. After cooling, the ceramic shells are removed by vibration. The metal parts are then cleaned in a high temperature caustic bath, followed by water rinsing. In the fourth, or finishing stage, the castings are finished to remove excess metal. The final product then undergoes a lengthy series of testing (radiography, fluorescent penetrant, magnetic particle and dimensional) to ensure quality and consistency.\nCOMPOSITES\nThe Company's composites operation, Scaled Composites, Inc., plans, designs, fabricates and tests composite airframe structures for the aerospace market. Customers include Lawrence Livermore Laboratories and Orbital Sciences Corp.\nFACILITIES\nThe following table sets forth certain information with respect to the Company's major facilities at June 3, 1995. The Company believes that its facilities are well-maintained, are suitable to support the Company's business and are adequate for the Company's present and anticipated needs. At June 3, 1995, the Company's forging, investment castings and composites facilities were operating at approximately 60%, 70% and 90% of their total productive capacity, respectively.\nRAW MATERIALS\nRaw materials used by the Company in its forgings and castings include alloys of titanium, nickel, steel, aluminum, magnesium and other high-temperature alloys. The composites operation uses high strength fibers such as fiberglass or graphite, as well as materials such as foam and epoxy, to fabricate composite structures. The major portion of metal requirements for forged and cast products are purchased from major non-ferrous metal suppliers producing forging and casting quality material as needed to fill customer orders. The Company has two or more sources of supply for all significant raw materials. The Company satisfies some of its nickel and titanium requirements internally by producing titanium alloy from titanium scrap and \"sponge\". The Company's powder metal\nfacility and PAM units produce nickel-based superalloy powder and high quality titanium ingot as demand for the Company's products grew during its 1995 fiscal year and prices of raw materials rose. The Company has experienced delays in the delivery of its raw materials.\nThe titanium and nickel-based superalloys utilized by the Company have a relatively high dollar value. Accordingly, the Company attempts to recover and recycle scrap materials such as machine turnings, forging flash, scrapped forgings, test pieces and casting sprues, risers and gates.\nIn the event of customer cancellation, the Company may, under certain circumstances, obtain reimbursement from the customer if the material cannot be diverted to other uses. Costs of material already on hand, along with any conversion costs incurred, have generally been billed to the customer unless transferable to another order. As demand for the Company's products grew during its 1995 fiscal year, and prices of raw materials rose, the Company experienced certain raw material shortages and production delays. Although this situation improved during the second half of fiscal 1995, it had a negative impact on overall revenues.\nENERGY USAGE\nThe Company is a large consumer of energy. Energy is required primarily for heating metals to be forged and melting metals to be cast, melting of ingots, heat-treating materials after forging and casting, operating forging presses, melting furnaces, die-sinking, mechanical manipulation and pollution control equipment and space heating. The Company uses natural gas, oil and electricity in varying amounts at its manufacturing facilities. Supplies of natural gas, oil and electricity have been sufficient and there is no anticipated shortage for the future.\nEMPLOYEES\nAs of June 3, 1995, the Company had approximately 3,100 employees of whom 850 were executive, administrative, engineering, research, sales and clerical and 2,250 production and craft. Approximately 61% of the production and craft employees, consisting of employees in the forging business, are represented by unions. The Company has entered into collective bargaining agreements with these union employees as follows:\nThe Company believes it has good relations with its employees although it experienced a one week strike in August 1995 in connection with the negotiation of its current collective bargaining agreement with the union representing most of its factory workforce in Houston, Texas.\nRESEARCH AND PATENTS\nThe Company maintains research and development departments at both Millbury, Massachusetts and Houston, Texas which are engaged in applied research and development work primarily relating to the Company's forging operations. The Company works closely with customers, universities and government technical agencies in developing advanced forging and casting materials and processes. The Company's composites operation conducts research and development related to aerospace composite structures at the Mojave, California facility. The Company spent approximately $2.2 million, $0.7 million, $2.8 million, and $3.0 million on applied research and development work during the year ended June 3, 1995, the five months ended May 28, 1994, and the years ended December 31, 1993 and 1992. Although the Company owns patents covering certain of its processes, the Company does not consider that these patents are of material importance to the Company's business as a whole. Most of the Company's products are manufactured to customer specifications and, consequently, the Company has few proprietary products.\nCOMPETITION\nMost of the Company's production capabilities are possessed in varying degrees by other companies in the industry, including both domestic and foreign manufacturers. Competition is intense among the companies currently involved in the industry. Competitive advantages are afforded to those with high quality products, low cost manufacturing, excellent customer service and delivery and engineering and production expertise. The Company considers that it is in a leading position in these areas.\nENVIRONMENTAL REGULATIONS\nThe Company is subject to extensive, stringent and changing federal, state and local environmental laws and regulations, including those regulating the use, handling, storage, discharge and disposal of hazardous substances and the remediation of alleged environmental contamination. Accordingly, the Company is involved from time to time in administrative and judicial inquiries and proceedings regarding environmental matters. Nevertheless, the Company believes that compliance with these laws and regulations will not have a material adverse effect on the Company's operations as a whole. The Company continues to design and implement a system of programs and facilities for the management of its raw materials, production processes and industrial waste to promote compliance with environmental requirements. In the fourth quarter of 1991, the Company recorded a pre-tax charge of $7.0 million with respect to environmental investigation and remediation costs at the Grafton facility and a pre-tax charge of $5.0 million against potential environmental remediation costs upon the eventual sale of the Worcester facility. Pursuant to an agreement entered into with the U.S. Air Force upon the acquisition of the Grafton facility from the\nfederal government in 1982, the Company has agreed to make additional expenditures for environmental management and remediation projects at that site during the period 1982 through 1999, approximately $6,100,000 of which remain as of June 3, 1995. The Company, together with numerous other parties, has been alleged to be a potentially responsible party (\"PRP\") at the following four federal or state superfund sites: Operating Industries, Monterey Park, California; Cedartown Municipal Landfill, Cedartown, Georgia; PSC Resources, Palmer, Massachusetts; and the Gemme site, Leicester, Massachusetts. The Company believes that any liability it may incur with respect to these sites will not be material.\nAt the Gemme site a proposed agreement would allocate 33% of the clean-up costs to the Company. An insurance company is defending the Company's interests and the Company believes that any recovery against the Company would be covered by insurance. A consulting firm retained by the PRP group has recently made a preliminary remediation cost estimate of $0.3 million to $9.9 million.\nThe Company's Grafton, Massachusetts plant location is included in the U.S. Nuclear Regulatory Commission's (\"NRC\") May 1992 Site Decommissioning Management Plan for low-level radioactive waste. The NRC conducted a long-range dose assessment in 1992 and determining that the site should be remediated. However, the Company believes that the NRC's draft assessment was flawed and has challenged that draft assessment. The Company has provided $1.5 million for the estimated cost of the remediation. The Company believes that it may have meritorious claims for reimbursement from the U.S. Air Force in respect of any liabilities it may have for such remediation.\nPRODUCT LIABILITY EXPOSURE\nThe Company produces many critical engine and structural parts for commercial and military aircraft. As a result, the Company faces an inherent business risk of exposure to product liability claims. The Company maintains insurance against product liability claims, but there can be no assurance that such coverage will continue to be available on terms acceptable to the Company or that such coverage will be adequate for liabilities actually incurred. The Company has not experienced any material loss from product liability claims and believes that its insurance coverage is adequate to protect it against any claims to which it may be subject.\nLEGAL PROCEEDINGS\nAt June 3, 1995, the Company was involved in certain legal proceedings arising in the normal course of its business. The Company believes the outcome of these matters will not have a material adverse effect on the Company.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table set forth certain biographical information with respect to executive officers of the Company.\nJohn M. Nelson was elected Chairman of the Company in May 1994 having previously served as the Company's Chairman of the Board and Chief Executive Officer since May 1991. Prior to joining the Company, he served for many years in a series of executive positions with Norton Company, a manufacturer of abrasives and ceramics based in Worcester, Massachusetts, and was Norton's Chairman and Chief Executive Officer from 1988 to 1990 and its President and Chief Operating Officer from 1986 to 1988. Mr. Nelson is also Chairman of the Board of Directors of the TJX Companies, Inc., a Director of Brown & Sharpe Manufacturing Company, Cambridge Biotechnology, Inc., Commerce Holdings, Inc. and Stocker & Yale, Inc. He is also Chairman of the Board of Trustees of Worcester Polytechnic Institute and Vice President of the Worcester Art Museum.\nDavid P. Gruber was elected President and Chief Executive Officer of the Company in May 1994 having served as President and Chief Operating Officer since October 1991. Prior to joining the Company, Mr. Gruber served as Vice President, Advanced Ceramics, of Compagnie de Saint Gobain (which acquired Norton Company in 1990), a position he held with Norton Company since 1987. Mr. Gruber previously held various executive and technical positions with Norton Company since 1978. He is a Trustee of the Manufacturers' Alliance for Productivity and Innovation, and is a member of the Mechanical Engineering Advisory Committee of Worcester Polytechnic Institute.\nAndrew C. Genor joined the Company as Vice President, Chief Financial Officer and Treasurer in January 1995. Prior to joining the Company, Mr. Genor was Chief Financial and Operating Officer of HNSX Supercomputers, Inc., a Company he co-founded in 1987 to provide support to supercomputer users and vendors. Prior to that time, he spent 20 years at Honeywell, Inc., including service as Vice President and Corporate Treasurer and Vice President, Finance, Administration and Business Development for Honeywell Europe.\nSanjay N. Shah was elected Vice President, Corporate Strategy Planning and Business Development in May 1994 having previously served as Vice President and Assistant General Manager of the Company's Aerospace Forgings Division. He has held a number of executive, research, engineering and manufacturing positions at the Company since joining the Company in 1975.\nJ. Douglas Whelan joined the Company in March 1994 and was elected President, Forgings Division in May 1994. Prior to joining the Company he had served for a short time as the President of Ladish Co., Inc., a forging Company in Cudahy, Wisconsin, and prior thereto had been Vice President, Operations of the Cameron Forged Products Division of Cooper Industries, Inc. with which company and its predecessors he had been employed since 1965 in various executive and managerial capacities.\nWallace F. Whitney, Jr. joined the Company in 1991. Prior to that time, he had been Vice President, General Counsel and Secretary of Norton Company since 1988, where he had been employed in various legal capacities since 1973.\nFrank J. Zugel joined the Company in June 1993. He was elected President Investment Castings Division in May 1994. Prior to joining the Company, he had served as President of Stainless Steel Products, Inc., a metal fabricator for aerospace applications, since 1992 and before then as Vice President of Pacific Scientific Company, a supplier of components to the aerospace industry, since 1988.\nNone of the executive officers has any family relationship with any other executive officer. All officers are elected annually.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe response to ITEM 2. PROPERTIES incorporates by reference the paragraphs captioned \"Facilities\" included in ITEM 1. BUSINESS.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe response to ITEM 3. LEGAL PROCEEDINGS incorporates by reference the paragraphs captioned \"Environmental Regulations\" and \"Legal Proceedings\" included in ITEM 1. BUSINESS.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of fiscal 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe response to ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS incorporates by reference the \"Market and Dividend Information\" section of the Company's Annual Report to Stockholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe response to ITEM 6. SELECTED FINANCIAL DATA incorporates by reference the \"Consolidated Financial Review\" section of the Company's 1995 Annual Report to Stockholders. Also incorporated by reference is the \"Accounting and Tax Matters\" section of the Company's 1995 Annual Report to Stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe response to ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS incorporates by reference the \"Management's Discussion\" section of the Company's 1995 Annual Report to Stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA incorporates by reference the following sections of the Company's 1995 Annual Report:\nConsolidated Statements of Operations\nConsolidated Balance Sheets\nConsolidated Statements of Cash Flows\nConsolidated Statement of Stockholder Equity\nNotes to Consolidated Financial Statements\nReport of Independent Auditors\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information regarding executive officers is incorporated by reference to PART I, ITEM 1. BUSINESS, under the caption \"Executive Officers of the Registrant.\" Other information required by Items 401 and 405 of Regulation S-K is incorporated by reference to the following sections of the Company's \"Proxy Statement for Annual Meeting of Stockholders\" on October 18, 1995.\nElection of Directors\nNominees for Three-Year Term\nContinuing Directors\nSecurities and Exchange Commission Reports\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe response to ITEM 11. EXECUTIVE COMPENSATION incorporates by reference the following sections of the Company's \"Proxy Statement for Annual Meeting of Stockholders\" on October 18, 1995.\nElection of Directors\nNominees for a Three-Year Term\nContinuing Directors\nCommittees of the Board\nMeetings of the Board\nCompensation Committee Report\nExecutive Compensation\nPension Benefits\nAgreements with Management\nProposal for Approval of Long-Term Incentive Plan\nProposal for Approval of Employee Stock Purchase Plan\nProposal for Approval of the Wyman-Gordon Company Non-Employee Director Stock Option Plan\nProposal for the Approval of the Performance Share Agreement\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe response to ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT incorporates by reference the information of the following sections of the \"Proxy Statement for Annual Meeting of Stockholders\" on October 18, 1995.\nElection of Directors\nNominees of a Three-Year Term\nContinuing Directors\nShares of Company Stock Beneficially Owned by Certain Owners and by Management\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe response to ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS incorporates by reference the following sections of the Company's \"Proxy Statement for Annual Meeting of Stockholders\" on October 18, 1995.\nNominees for Three-Year Term\nContinuing Directors\nCompensation Committee Report\nExecutive Compensation\nAgreements with Management\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nEXHIBITS\nThe exhibit listing required by Item 601 of Regulation S-K is included on page E-1.\nFINANCIAL STATEMENTS\nThe following financial statements, together with the report thereon of Ernst & Young dated June 26, 1995 appearing in the Company's Fiscal 1995 Annual Report to Stockholders are incorporated by reference in this Form 10-K:\nConsolidated Statements of Operations and Retained Earnings\nConsolidated Balance Sheets\nConsolidated Statements of Cash Flows\nConsolidated Statements of Stockholders Equity\nNotes to Consolidated Financial Statements\nSCHEDULES\nThe following additional financial data should be read in conjunction with the consolidated financial statements in the Company's Fiscal 1995 Annual Report to Stockholders. Other schedules have been omitted because they are inapplicable or are not required.\nPAGE\nII - Valuation and Qualifying Accounts S-1\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed with the Commission during the fourth quarter of fiscal 1995.\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Wyman-Gordon Company and Subsidiaries of our report dated June 26, 1995, included in the Fiscal 1995 Annual Report to Stockholders of Wyman-Gordon Company and subsidiaries.\nOur audits also included the financial statement schedule of Wyman-Gordon Company listed in Item 14. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nWe also consent to the incorporation by reference in the Registration Statements (Form S-8, File Numbers 2-56547, 2-75980, 33-26980 and 33-48068) pertaining to the Wyman-Gordon Company Executive Long-Term Incentive Program (1975) - Amendment No. 6, the Wyman-Gordon Company Stock Purchase Plan, the Wyman-Gordon Company Savings\/Investment Plan and the Wyman-Gordon Company Long-Term Incentive Plan and in the related Prospectuses of our report dated June 26, 1995, with respect to the consolidated financial statements of Wyman-Gordon Company and Subsidiaries incorporated by reference in the Annual Report (Form 10-K) for the year ended June 3, 1995.\nBoston, Massachusetts ERNST & YOUNG LLP August 29, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWyman-Gordon Company (REGISTRANT)\nBy \/S\/ ANDREW C. GENOR September 1, 1995 Andrew C. Genor Date 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.\nS-1\nE-1\nE-2\nE-3\nNOTE: Exhibits not physically located in this Form 10-K can be obtained from the Company upon written request to the Clerk at the address on the cover of this Form 10-K at a cost of $.25 per page.\nE-4","section_15":""}
{"filename":"72945_1995.txt","cik":"72945","year":"1995","section_1":"Item 1. Business\nNorthrop Corporation was incorporated in Delaware in 1985. Effective May 18, 1994, Northrop Corporation was renamed Northrop Grumman Corporation. Northrop Grumman is an advanced technology company operating in the aerospace industry. The company designs, develops and manufactures aircraft, aircraft subassemblies and electronic systems for military and commercial use and designs and develops, operates and supports computer systems for scientific and management information. Additional information required by this Item is contained in Part II Item 7 of this Annual Report on Form 10-K.\nNORTHROP GRUMMAN CORPORATION Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe major locations, general status of the company's interest in the property and identity of the industry segments which use the property described, are indicated in the following table.\nLocation Property Interest Arlington, Virginia (1) (5) (a) Leased Benton, Pennsylvania (2) (b) Leased *Bethpage, New York (1) (2) (3) (5) (a) (b) (c) (d) Owned, Leased Bohemia, New York (3) (a) Owned, Leased Bridgeport, West Virginia (2) (a) (b) Owned, Leased Calverton, New York (2) (a) (b) (c) (d) (e) Owned Chandler, Arizona (1) (a) (b) Owned Compton, California (1) (b) (c) Owned, Leased El Segundo, California (1) (4) (a) (b) (c) (d) Owned, Leased Fairborn, Ohio (3) (a) (c) Leased Fort Tejon, California (1) (d) Owned, Leased Gardena, California (1) (c) Owned Glen Arm, Maryland (2) (b) Owned Grand Prairie, Texas (1) (a) (b) (c) (d) Owned, Leased Great River, New York (2) (a) (b) Owned Hawthorne, California (1) (2) (4) (5) (a) (b) (c) (d) Owned, Leased *Hicksville, New York (2) (a) (d) (e) Owned Hondo, Texas (3) (e) Leased Houston, Texas (3) (a) Leased Irvine, California (2) (d) Leased Kent, Washington (1) (c) Leased Lake Charles, Louisiana (1) (a) (b) (c) Leased Lawton, Oklahoma (3) (a) (c) Owned, Leased Lexington, South Carolina (1) (a) (c) Owned, Leased Los Angeles, California (1) (2) (5) (a) Leased Mayfield, Pennsylvania (1) (b) Owned Melbourne, Florida (2) (a) (b) (c) (e) Owned, Leased Milledgeville, Georgia (1) (b) (c) (e) Owned, Leased Mojave, California (1) (e) Owned, Leased Montebello, California (1) (c) Leased Montgomery, Pennsylvania (1) (b) Owned\nNORTHROP GRUMMAN CORPORATION\nNew Town, North Dakota (2) (b) (c) Owned, Leased Newbury Park, California (5) (a) (b) (c) (d) Owned Norwood, Massachusetts (5) (b) (c) (e) Owned, Leased Palatine, Illinois (2) (c) Leased Palmdale, California (1) (a) (b) (c) (d) (e) Owned, Leased Perry, Georgia (1) (4) (a) (b ) (c) Owned Pico Rivera, California (1) (a) (b) (c) (d) Owned, Leased Portsmouth, Rhode Island (1) (b) (e) Owned, Leased Rolling Meadows, Illinois (2) (a) Owned, Leased Sherman, Texas (1) (b) Owned St. Augustine, Florida (1) (a) (b) (c) (e) Owned, Leased Stuart, Florida (1) (b) (c) Leased Sturgis, Michigan (1) (a) (b) (c) Owned, Leased Torrance, California (1) (b) (c) Owned, Leased Tulare, California (1) (b) Owned Warner Robins, Georgia (2) (3) (a) Owned, Leased Warren, Michigan (1) (b) Leased\n__________\n* Certain portions of the properties at each of these locations are leased or subleased to others. The company believes that in the aggregate the property covered by such leases or subleased to others is not material compared to the property actually utilized by the company in its business.\nNORTHROP GRUMMAN CORPORATION\nFollowing each described property are numbers indicating the industry segments utilizing the property:\n(1) Military and Commercial Aircraft (2) Electronics and Systems Integration (3) Data Systems and Other Services (4) Missiles and Unmanned Vehicle Systems (5) General Corporate Asset\nFollowing each described property are letters indicating the types of facilities located at each location:\n(a) office (b) manufacturing (c) warehouse (d) research and testing (e) other\nGovernment-owned facilities used or administered by the company consist of 10.2 million square feet at various locations across the United States. The company believes its properties are well-maintained and in good operating condition. Under present business conditions and the company's volume of business, productive capacity is currently in excess of requirements.\nNORTHROP GRUMMAN CORPORATION\nItem 3.","section_3":"Item 3. Legal Proceedings\nFalse Claims Act Litigation\nOn June 9, 1987, a Complaint, entitled U.S. ex rel, David Peterson and Jeff Kroll v. Northrop Corporation, was filed in the U.S. District Court for the Central District of California alleging violations by the Company of the False Claims Act in connection with the operation of petty cash funds, inspection, testing, and pricing for the MX Peacekeeper Missile program. On September 1, 1989, the government intervened and reduced the scope of the lawsuit by filing an amended complaint. The amended complaint does not completely specify the total amount being sought but, rather, seeks damages in excess of $1.2 million. On May 7, 1990, the Court ruled that the original plaintiffs may proceed with portions of the lawsuit that the government declined to include in the amended complaint. In 1994, the court granted summary judgment for the Company on the government's fraud allegations related to petty cash, integrated test stations, extended work week and experimental change orders. Trial on the remaining allegations is scheduled for March 1996. In addition, the Company is a party to a number of civil actions brought by private parties alleging violation of the False Claims Act in which the government has declined to intervene. These actions, which have been previously reported, relate to the MX Peacekeeper Missile, the Air Launched Cruise Missile and the Advanced Technology Bomber (B-2) programs. In a number of these actions, plaintiffs also allege employment related claims including claims of wrongful termination. Damages sought include claims for compensatory and punitive damages. A number of these civil actions were initially reported when it was unclear what position, if any, the government would take in the litigation. In light of the government's decision not to intervene or otherwise pursue the litigation, as well as the amounts involved, the cases will not be individually reported. Further, the Company learns from time to time that it has been named as a defendant in lawsuits which are filed under seal pursuant to the False Claims Act. Since these matters remain under seal, the Company does not possess sufficient information to accurately report on the particular allegations.\nWalsh, et al. v. Northrop Grumman Corporation\nIn November 1994, a class action complaint was filed against Northrop Grumman Corporation, Grumman Corporation, Renso Caporali, Howard J. Dunn, Jr., Robert Denien and Robert E. Foster in the U.S. District Court for the Eastern District of New York, Case No. CV 94-5105 (Platt C.J.). A first amended complaint was filed on November 29, 1994 alleging that Grumman Corporation's March 8 and April 4, 1994 Form 14D-9 filings with the Securities and Exchange Commission incorporated a statement concerning the Grumman Severance Plan which violated Sections 10(b) and 14(e) of the Securities and Exchange Act of 1934 (the \"Act\") and Rule 10b-5 of the Rules and Regulations under the Act. The complaint also contains a cause of action for equitable estoppel based upon the same statement and plaintiffs' alleged reliance thereon. The complaint also alleges that the trustees of Grumman's Investment Plan violated their fiduciary obligations by voting the Plan's shares in favor of the merger without consulting the class members. The complaint seeks an order enjoining the defendants from amending or discontinuing the Severance Plan for a period of thirty (30) months from the date of the merger and an order mandating that defendants permit class members who have accepted voluntary termination with severance pay to rescind their elections. On December 8, 1994 the court denied plaintiffs' application for a preliminary injunction but declined to dismiss the action. On April 7, 1995 the court granted plaintiffs' motion to amend their complaint to add a claim for damages based on post-acquisition changes to Grumman benefit plans. In July 1995, the court certified a class of plaintiffs consisting of all employees who, at the time of the tender offer, were Grumman employees, owned Grumman stock either directly or beneficially through the Employee Investment Plan, and were injured as a result of defendants conduct. Absent dispositive motions, this matter will proceed to trial in late 1996 or early 1997. The defendants intend to vigorously defend this litigation and the Company does not expect this matter to have a material adverse effect on its financial condition.\nU.S. Government Investigation\nThe Company, as a government contractor, is from time to time subject to U.S. Government investigations relating to its operations. Government contractors that are found to have violated the False Claims Act, or are indicted or convicted for violations of other Federal laws, or are considered not to be responsible contractors may be suspended or debarred from, government contracting for some period of time. Such convictions could also result in fines. Given the Company's dependence on government contracting, suspension or debarment could have a material adverse effect on the Company. On May 3, 1995 federal agents executed search warrants at the Military Aircraft Division facilities in Hawthorne and El Segundo, California. Since that time, the Company has learned that the United States Attorney for the Central District of California is conducting a Grand Jury investigation of the F\/A-18 and Targets Programs at the Military Aircraft Division. Although the Government has declined to inform the Company of the details of the investigation, it has confirmed that there are no issues regarding flight safety.\nNORTHROP GRUMMAN CORPORATION\nExecutive Officers of the Registrant\nNORTHROP GRUMMAN CORPORATION\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders No information is required in response to this Item.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information required by this Item is contained in Part II, Item 8 of this Annual Report on Form 10-K.\nItem 6.","section_6":"Item 6. Selected Financial Data The information required by this Item is contained in Part II, Item 7","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nBusiness Conditions Northrop Grumman's industry segments - military and commercial aircraft, electronics and systems integration, data systems and other services, and missiles and unmanned vehicle systems (MUVS) - are each a factor in the broadly defined aerospace industry. While Northrop Grumman is subject to the usual vagaries of the marketplace, it is also affected by the unique characteristics of the aerospace industry and by certain elements peculiar to its own business mix. In the second quarter of 1994 the company purchased the outstanding common stock of Grumman Corporation (Grumman) for $2.1 billion. Northrop Corporation was renamed Northrop Grumman Corporation effective May 18, 1994. In August 1994 the company purchased the remaining 51 percent interest in Vought Aircraft Company (Vought) for $130 million. The company had purchased a 49 percent interest in Vought in 1992. As a result of these acquisitions the company reorganized, effective January 1, 1995, into five operating divisions - B-2 Division, Military Aircraft Division, Commercial Aircraft Division(CAD), Electronics and Systems Integration Division(ESID) and the Data Systems and Services Division(DSSD). To further strengthen and streamline operations, the B-2 and Military Aircraft Divisions were combined, effective January 1, 1996. The combined division has been designated the Military Aircraft Systems Division (MASD). Northrop Grumman is one of the major companies that compete for the relatively small number of large, long-term programs that characterize both the defense and commercial segments of the aerospace business. It is common in the aerospace industry for work on major programs to be shared between a number of companies. A company competing to be a prime contractor can turn out to be a subcontractor. It is not uncommon to compete with customers, and to simultaneously be both a supplier to and customer of a given competitor. Boeing, Lockheed Martin and McDonnell Douglas are the largest companies in the aerospace industry at this time. Northrop Grumman also competes against many other companies for a number of large and smaller programs, notably in the electronics and systems integration areas. Competition is intense, yet the nature of major aerospace programs, conducted under binding contracts, allows companies that perform well to benefit from a level of program continuity unknown in many industries. Thus, intense competition and long operating cycles are both characteristic of the industry's - and Northrop Grumman's - business. The B-2 bomber, for which the company is the prime contractor, is Northrop Grumman's largest program. The MASD headquartered in El Segundo, California is responsible for final assembly of the B-2's airframe and systems integration (in Palmdale, California), and the manufacture of the fuselage and parts of the B-2's navigation and electronic warfare\/situation awareness system. Major subcontractors include Boeing, which makes the aft center section, outboard wing sections, landing gear and fuel system, and GM Hughes, which produces the radar systems. The Air Force currently plans to operate two B-2 bomber squadrons of eight aircraft each with an additional four aircraft available to fill in for those in depot for periodic maintenance.\nNORTHROP GRUMMAN CORPORATION\nThe MASD is also the principal subcontractor on the McDonnell Douglas F\/A-18 program. The F\/A-18 is a fighter\/ground-attack aircraft that can carry either one or two crew members. It is principally deployed by the U.S. Navy on aircraft carriers, but several other nations have purchased the aircraft and use it as a land-based combat aircraft. The company builds approximately 40 percent of the aircraft including the center and aft fuselage sections and vertical tails. Of the versions of the F\/A-18 currently in production, the C is a single-seat combat aircraft that was first delivered to the Navy in 1987 and the D is a two-seat version principally used for training. The F\/A-18E\/F is an enhanced version currently under development for the U.S. Navy as its next generation multi- mission aircraft. MASD also produces aerial targets, principally the BQM-74\/Chukar. The BQM-74 series has been in production since the 1960s. It is used by the Navy for air defense training, gunnery practice and weapon system evaluation. The company builds the airframe and the electronics that are used to guide the drone with the drone's engine being produced by Williams International. The CAD manufactures portions of the Boeing 747, 757, 767 and 777 jetliners, the Gulfstream IV and V business jets, and the McDonnell Douglas C-17. Northrop Grumman has been a principal airframe subcontractor for the Boeing 747 jetliner since the program began in 1966. The company produces the fuselage and aft body section for the 747 as well as cargo and passenger doors, the vertical and horizontal body stabilizers, floor beams and smaller structural components. The majority of the Boeing jetliner work is performed at CAD's primary production sites in Hawthorne, California; Grand Prairie, Texas; and Stuart, Florida. CAD manufactures engine nacelles for the Gulfstream IV and other business jets and recently initiated production of the wings for Gulfstream's newest business jet, the Gulfstream V. CAD also produces the empennage, engine nacelles and control surfaces for the McDonnell Douglas C-17 program, the U.S. Air Force's most advanced airlifter, at various locations. The work performed on the C-17, Gulfstream IV and V, 757, 767, 777 and some of the components of the 747 were added as a result of the Grumman and Vought acquisitions. The Northrop Grumman designed and built all-weather E-2C Hawkeye Airborne Early Warning Command and Control aircraft has been in active service with the U.S. Navy since 1973 and is also employed by the air forces of five other nations. The E-2C is produced by the company's ESID. ECM denotes electronic countermeasures equipment manufactured by the ESID. The largest program in this business area is the AN\/ALQ-135, which is an internally mounted radar jammer deployed on fighter aircraft as part of that aircraft's Tactical Electronic Warfare System. The AN\/ALQ-162 Shadowbox is a jammer built specifically to counter continuous wave radars. The AN\/ALQ-162 has been installed on the AV-8B and certain foreign F\/A-18 aircraft. It is also being deployed on U.S. Army helicopters and special mission aircraft and it has been sold to the air forces of three other nations. ESID also produces the E-8 Joint Surveillance Target Attack Radar System (Joint STARS). Joint STARS detects, locates, classifies, tracks and targets potentially hostile ground movement in all weather. It is designed to operate around the clock, in constant communication through secure data links with air force command posts, army mobile ground stations or centers of military analysis far from the point of conflict. The Joint STARS platform is a remanufactured Boeing 707-300 airframe. The 707 is remanufactured at Northrop Grumman's Lake Charles, Louisiana site. Final installation of electronics and testing are performed at the ESID integration and test facility in Melbourne, Florida.\nNORTHROP GRUMMAN CORPORATION\nThe ESID, as the prime contractor to the U.S. Army, is developing a \"brilliant\" anti-armor submunition, designated as BAT, with production scheduled to commence in 1998. BAT is a three foot long, 44 pound, wide- area-attack submunition that will be used to disable and destroy armored vehicles and trucks. BATs are meant to be carried and dispensed by a larger missile. BATs are designed to be ejected over an armored vehicle column or attacking formation. Each BAT has an infrared sensor that can home in on the heat generated by a vehicle's engine, and an acoustic sensor that can home in on the noise created by the tank or truck's engine. Northrop Grumman's DSSD designs, develops, operates and supports computer systems for scientific and management information. Services provided include systems integration, systems service, information conversion and training for federal, state and local governments and private industry. DSSD also provides military base support functions and aircraft maintenance at a number of U.S. Government facilities. Tables of contract acquisitions, sales and funded order backlog by major program, follow and complement industry segment data. B-2, F\/A-18, Boeing Jetliners (the 747, 757, 767 and 777) and C-17 are currently the major programs of the military and commercial aircraft industry segment. E- 2C Hawkeye, ECM, E-8 Joint STARS and BAT are included in the electronics and systems integration industry segment. The Tri-Service Standoff Attack Missile (TSSAM), the segment's principal program in 1994 and prior years, and aerial targets are included in the company's MUVS industry segment. The \"all other\" category includes the data systems and other services as well as the balance of the company's numerous other contracts, classified and unclassified. Individual companies prosper in the competitive aerospace\/defense environment according to their ability to develop and market innovative products. They must also have the ability to provide the people, facilities, equipment and financial capacity needed to deliver those products with maximum efficiency. It is necessary to maintain, as the company has, sources for raw materials, fabricated parts, electronic components and major subassemblies. In this manufacturing and systems integration environment, effective oversight of subcontractors and suppliers is as vital to success as managing internal operations. Northrop Grumman's operating policies are designed to enhance these capabilities. The company also believes that it maintains good relations with its employees, a relatively small number of whom are covered by collective bargaining agreements. U.S. Government programs in which Northrop Grumman either participates, or strives to participate, must compete with other programs for consideration during our nation's budget formulation and appropriation processes. As a consequence of the end of the Cold War and pressure to reduce the federal budget deficit, the U.S. defense budget is not expected to increase substantially in the near term. Budget decisions made in this environment will have long-term consequences for the size and structure of Northrop Grumman and the entire defense industry. An important factor in determining Northrop Grumman's ability to successfully compete for future contracts will be its cost structure vis-a-vis other bidders.\nNORTHROP GRUMMAN CORPORATION\nAlthough the ultimate size of future defense budgets remains uncertain, the defense needs of the nation are expected to provide substantial research and development (R&D) and other business for the company to pursue well into the future. Northrop Grumman has historically concentrated its efforts in such high technology areas as stealth, airborne surveillance, battle management, precision weapons and systems integration. Even though a high priority has been assigned by the Department of Defense to the company's major programs, there remains the possibility that one or more of them may be reduced, stretched or terminated. In the commercial aircraft market, many airlines have recently deferred deliveries and purchases of new aircraft. This has caused The Boeing Company to reduce scheduled production of various jetliners, including the 747. As a result, Northrop Grumman's subcontract workload for the 747, the company's largest commercial program, was stretched out beginning in late 1993, with deliveries declining 43 percent in 1994, with a further 23 percent decline in 1995. Business conditions in the commercial aircraft industry appear to be on the upswing. The three major producers of jetliners recorded more than twice the number of new aircraft orders in 1995 than in 1994. This positive trend is expected to continue in 1996, potentially signifying a new commercial airplane buying cycle. Northrop Grumman, with its involvement on various Boeing jetliners, remains optimistic about the long-term prospects for its commercial structures business. Northrop Grumman pursues new business opportunities when justified by acceptable financial returns and technological risks. The company examines opportunities to acquire or invest in new businesses and technologies to strengthen its traditional business areas. Northrop Grumman continues to capitalize on its technologies and skills by entering into joint ventures, partnerships or associations with other companies.\nNORTHROP GRUMMAN CORPORATION\nNORTHROP GRUMMAN CORPORATION\nNORTHROP GRUMMAN CORPORATION\nNorthrop Grumman, as well as many other companies in the defense industry, suffered the effects of the Department of Defense's practice in the 1980s of structuring new, high-risk research and development contracts, such as TSSAM, as fixed-price or capped cost-reimbursement type contracts. Although Northrop Grumman has stopped accepting these types of contracts, it has experienced financial losses on TSSAM and other similar programs acquired under them in the past. The company received a termination for convenience notice on the TSSAM program in February 1995. In the event of termination for convenience, contractors are normally protected by provisions covering reimbursement for all costs incurred subsequent to termination. The company does not expect that the TSSAM termination will have a material financial effect on the company's financial position. Prime contracts with various agencies of the U.S. Government and subcontracts with other prime contractors are subject to a profusion of procurement regulations, with noncompliance found by any one agency possibly resulting in fines, penalties, debarment or suspension from receiving additional contracts with all agencies. Given the company's dependence on U. S. Government business, suspension or debarment could have a material adverse affect on the company's future. Moreover, these contracts may be terminated at the Government's convenience as was done with the TSSAM program. While Northrop Grumman conducts most of its business with the U.S. Government, principally the Department of Defense, commercial sales still represent a significant portion of total revenue. Federal, state and local laws relating to the protection of the environment affect the company's manufacturing operations. The company has provided for the estimated cost to complete remediation where it is probable that the company will incur such costs in the future, including those for which it has been named a Potentially Responsible Party (PRP) by the Environmental Protection Agency or similarly designated by other environmental agencies. The company has been designated a PRP under federal Superfund laws at 11 hazardous waste sites and under state Superfund laws at seven sites. It is difficult to estimate the timing and ultimate amount of environmental cleanup costs to be incurred in the future due to the uncertainties, regarding the extent of the required cleanup and the status of the law, regulations and their interpretations. Nonetheless, to assess the potential impact on the company's financial statements, management estimates the total reasonably possible remediation costs that could be incurred by the company. Such estimates take into consideration the professional judgment of the company's environmental engineers and, when necessary, consultation with outside environmental specialists. In most instances, only a range of reasonably possible costs can be estimated. However, in the determination of accruals the most probable amount is used when determinable and the minimum is used when no single amount is more probable. The company records accruals for environmental cleanup costs in the accounting period in which the company's responsibility is established and the costs can be reasonably estimated. Management estimates that at December 31, 1995, the reasonable range of future costs for environmental remediation, including Superfund sites, is $39 million to $63 million, of which $41 million has been accrued. The amount accrued has not been offset by potential recoveries from insurance carriers or other PRPs. Should other PRPs not pay their allocable share of remediation costs the company may have to incur costs in addition to those already estimated and accrued. The company is making the necessary investments to comply with environmental laws; the amounts, while not insignificant, are not considered material to the company's financial position or results of its operations.\nNORTHROP GRUMMAN CORPORATION\nMeasures of Volume\nContract acquisitions tend to fluctuate and are determined by the size and timing of new and add-on orders. The effects of multi-year orders and\/or funding can be seen in the highs and lows shown in the following table. The funded order backlog of Grumman and Vought on the date the companies were acquired are reflected as acquisitions in 1994. The 757, 767, 777 (included in Boeing Jetliners category), E-2, E-8 Joint STARS, and C-17 programs were acquired as part of Grumman and Vought. B-2 acquisitions in 1995 include incremental funding for ongoing development work, spares and other customer support for the 20 operational aircraft program. In 1994 $2.4 billion of funding to complete the last five B-2 production aircraft was received as well as incremental funding for ongoing development work, spares and other customer support. The company still stands to gain future new post-production business, such as airframe depot maintenance, repair of components, operational software changes and product improvement modifications. The debate over the future of the B-2, which is built in the nation's only active bomber producing facility, is now taking place. Without future production orders the nation's multi-billion dollar investment in this capability will be disassembled and become retrievable only at a large additional cost.\nContract Acquisitions\n$ in millions 1995 1994 1993 1992 1991 B-2 $ 475 $ 3,646 $ 2,632 $ 2,235 $ 4,794 E-8 Joint STARS 608 1,151 Boeing Jetliners 464 1,177 242 76 870 E-2 475 1,136 F\/A-18C\/D 650 211 89 576 564 F\/A-18E\/F 238 249 743 131 10 ECM 590 323 445 361 431 C-17 208 434 BAT 87 88 90 147 82 TSSAM (153) 157 248 349 369 All other 950 3,393 318 289 432 $ 4,592 $11,965 $ 4,807 $ 4,164 $ 7,552\nOrders for 128 F\/A-18C\/D shipsets were finalized in 1995. Acquisitions in 1994 and 1993 included long-lead funding received from the McDonnell Douglas Corporation for new F\/A-18C\/D shipsets. Advance funding for the next phase of the 747 jetliner programs was received from the Boeing Company in 1995. In 1993, additional contract value was received for, among other things, extending the delivery schedule of the current phase of the 747 into 1996. ECM acquisitions for 1995 included an award of $279 million from the United Kingdom Ministry of Defence to develop and produce directed infrared countermeasures systems.\nNORTHROP GRUMMAN CORPORATION\nThe balance of Grumman and Vought funded order backlog at the dates of acquisition, for those programs not listed in the table, is included in the \"all other\" category and accounts for the major increase in 1994 over 1993. Year-to-year sales vary less than contract acquisitions and reflect performance under new and ongoing contracts. The 1994 results of operations include Grumman and Vought since the acquisitions in April and August 1994, respectively. Comparative results for 1993 and prior do not include Grumman and Vought data. Sales for 1995 were the highest in the company's history and were 2 percent higher than in 1994. Without the Grumman and Vought acquisitions, sales for 1994 would have declined 10 percent from the 1993 level.\nNet Sales $ in millions 1995 1994 1993 1992 1991 B-2 $1,914 $2,392 $2,881 $3,212 $3,100 E-8 Joint STARS 613 345 Boeing Jetliners 569 483 531 549 540 E-2 566 409 F\/A-18C\/D 418 309 362 492 562 F\/A-18E\/F 404 508 279 118 10 ECM 351 357 372 378 415 C-17 244 121 BAT 90 88 100 135 71 TSSAM 81 276 179 265 390 All other 1,568 1,423 359 401 606 $6,818 $6,711 $5,063 $5,550 $5,694\nThe decreasing trend in the B-2 revenues from both EMD and production work continued in 1995. The level of EMD effort, included in amounts reported as contract R&D, constituted 30 percent of the total B-2 revenue, up from 26 percent in 1994 and 28 percent in 1993. Current planning data indicate that the level of overall B-2 revenue will decline roughly 20 percent per year for the remainder of the decade. Sales increased in 1995 for the C\/D version of the F\/A-18 program with an increase of deliveries to 56, as compared to 42 shipsets delivered in 1994 and the 52 delivered in 1993. In 1996 and 1997, the company currently plans to deliver 68 and 36 F\/A-18C\/D shipsets respectively. A total of seven shipsets were delivered under the F\/A-18E\/F EMD contract in 1995. F\/A-18E\/F revenue is expected to drop below $300 million in 1996 with the final three shipsets for the EMD phase of the program scheduled for delivery. The Low Rate Initial Production phase of the F\/A-18E\/F program is expected to begin in 1996. Deliveries of 747 center fuselages were 24 in 1995, 31 in 1994 and 54 in 1993. Twenty-eight fuselages are expected to be delivered in 1996. The electronics and systems integration segment revenues increased 40 percent in 1995 as a result of higher revenues on the E-2 Hawkeye and E-8 Joint STARS programs. The increase in 1994 was due to the acquisition of Grumman which more than offset the decrease from lower BAT development revenue and lower ECM sales. Reduced electronics segment revenues in 1993 stemmed from lower BAT development revenue, lower MX Peacekeeper sales and lower sales in the sensor product area.\nNORTHROP GRUMMAN CORPORATION\nThe year-end funded order backlog is the sum of the previous year-end backlog plus the year's contract acquisitions minus the year's sales. Backlog is converted into the following years' sales as costs are incurred or deliveries are made. It is expected that approximately 50 percent of the 1995 year-end backlog will be converted into sales in 1996.\nFunded Order Backlog $ in millions 1995 1994 1993 1992 1991 B-2 $ 3,736 $ 5,175 $ 3,921 $ 4,170 $ 5,147 E-8 Joint STARS 801 806 Boeing Jetliners 1,312 1,417 723 1,012 1,485 E-2 637 727 F\/A-18C\/D 577 345 443 716 632 F\/A-18E\/F 54 220 477 13 ECM 747 506 540 467 484 C-17 277 313 BAT 17 20 20 30 18 TSSAM 14 248 367 298 214 All other 1,775 2,396 428 469 581 $ 9,947 $12,173 $ 6,919 $ 7,175 $ 8,561\nTotal U.S. Government orders, including those made on behalf of foreign governments (FMS), comprised 77 percent of the backlog at the end of 1995 compared with 80 percent at the end of 1994 and 89 percent at the end of 1993. Total foreign customer orders, including FMS, accounted for 10 percent of the backlog at the end of 1995 compared with nine percent in 1994 and three percent in 1993. Domestic commercial business in backlog at the end of 1995 was 16 percent, 14 percent at the end of 1994 and 11 percent at the end of 1993.\nMeasures of Performance\nThe company's operating profit for 1995 was a record high and has improved in its electronics and systems integration segment for the last two years. These improvements stem from both increased revenue and improved operating margin rates in that segment. Company-wide efforts to reduce costs, install tighter business controls, improve cash management, dispose of excess assets and more effectively utilize productive assets, are all goals aimed at contributing to the future success of Northrop Grumman. This financial report demonstrates the degree to which the accomplishment of these goals is being achieved. Operating profit in the military and commercial aircraft segment decreased in 1995 primarily as a result of lower overall sales volume and $31 million in expenditures for company sponsored research and development for commercial aerostructures. The rate and amount of operating margin on the F\/A-18E\/F increased in 1995 due to an increase in the rate of operating margin being recorded on the EMD contract, which was made during the third quarter. This resulted from the continuing evaluation of the overall operating margin to be earned on this phase of the program. The increase on the F\/A-18E\/F more than offset reduced operating margin earned, on higher sales volume, for the F\/A-18C\/D.\nNORTHROP GRUMMAN CORPORATION\nThe military and commercial aircraft industry segment operating profit increased to its highest level ever in 1994, exceeding the previous high reached in 1993, as margin rates improved on the B-2 and F\/A-18 programs. The rate and amount of operating margin recorded on the F\/A-18E\/F increased in 1994 due to an approximately one and one half percent increase in the rate of operating margin being recorded on the EMD contract. The F\/A-18 program operating margin improved in 1994 and 1993 despite reduced F\/A- 18C\/D shipset deliveries in each of these years versus the previous year. The rate and amount of operating margin recorded on the B-2 production contract increased in 1995 as a result of negotiated contract adjustments and a revised estimate of the overall operating margin expected to be earned. This increase was offset by lower operating margin recorded on decreased revenue on the other phases of the B-2 program. B-2 operating margin improved in 1994 as the amount of margin recorded on the delivery of four aircraft more than offset reduced operating margin from lower production and EMD sales. Following the award of the last increment of production funding for the B-2, the company began recording future operating margin increases on all production aircraft as these units are delivered and accepted by the customer. At the time each unit is delivered an assessment is made of the status of the production contract so as to estimate the amount of any probable additional margin available beyond that previously recognized. That unit's proportionate share of any such unrecognized remaining balance will then be recorded. In this fashion it is believed that margin improvements will be recognized on a more demonstrable basis. The current 15 production units are scheduled for their initial delivery over a five year period, which began in December 1993. All but two units (four equivalent units for this purpose) will be returned for scheduled retrofitting with final deliveries beginning in 1997 and ending in 2000. It is anticipated that the total of 30 equivalent units will be delivered at a rate of from three to five per year. Fewer deliveries and cost increases related to a stretch-out of the current production contract for the Boeing 747 jetliner resulted in a lower rate and amount of operating margin in 1995. The current phase of the program is now expected to be completed in the fall of 1996. A reduction in the rate of operating margin due to increased costs allocated, as a result of establishing a separate commercial aircraft operating element and fewer deliveries than in 1993, caused decreased operating profit on the 747 program in 1994. Operating profit in the electronics and systems integration segment reached a record level in 1995. This was a result of an increased rate of operating margin and higher sales volume on the E-2 Hawkeye and increased sales volume on the E-8 Joint STARS program. The electronics and systems integration segment operating profit increased in 1994 due primarily to the addition of the E-2 Hawkeye, E-8 Joint STARS and various other military electronics programs associated with the Grumman acquisition and an increased rate of margin recorded in the company's electronic countermeasures business, which more than offset the $8 million in provisions recorded by the ESID-Norwood operation for unrecoverable costs incurred. The 13 percent sales decline in the electronics and systems integration segment for 1993 from the level achieved in 1992 was accompanied by an 11 percent decline in operating profit. Lower margins in the sensor product area and on the BAT program more than offset the increase in ECM operating margin. A loss provision of $20 million was made during 1994 on the TSSAM development contract and followed a similar provision of $201 million in 1993. The recording of the expected loss from the performance of this long-term fixed-price R&D contract caused major losses in the MUVS segment during three of the last five years. Production delays caused increased amounts of sustaining labor to be absorbed by the development phase of the program in which the company has invested over $600 million. The ultimate loss on this contract will depend on the resolution of pending claims against the U.S. Government. The company is unable to predict whether it will realize some or all of its claims against the U.S. Government from the TSSAM contract. The company does not expect the termination of the program to have a material adverse financial impact on the company.\nNORTHROP GRUMMAN CORPORATION\nOperating margin in 1995 included $23 million of pension income compared with $36 million in 1994, and $71 million in 1993. Also contributing to the change from net retiree benefit income in 1993 to a net retiree benefit cost in 1994 and 1995 was the increase in the cost of providing retiree health care and life insurance benefits - $87 million in 1995 versus $69 million in 1994 and $32 million in 1993. A major contributor to the net retiree benefit cost was the addition of the Grumman and Vought retiree plans in 1994. Operating margin in 1994 was reduced by $282 million to record the effect of an early retirement incentive program. The Financial Accounting Standards Board's (FASB) accounting standard No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions - was adopted by the company in 1991. The liability representing previously unrecognized costs of $145 million for all years prior to 1991 was recorded as of January 1, 1991, with an after-tax effect on earnings of $88 million or $1.86 per share. In 1994 the company recorded a $42 million pretax charge for the planned disposal of excess real estate and other assets. This was a result of the company's continuing efforts to reduce operating costs and dispose of assets which have become excess due to changes in the company's business strategy. This charge is reported in Other Deductions in the Consolidated Statements of Income. Interest expense increased $28 million in 1995, following a $71 million increase in 1994 after declining $9 million in 1993. The increases in 1995 and 1994 came primarily from the issuance of debt to finance the acquisition of Grumman. Total debt at December 31, 1995 stood at $1.4 billion compared to $1.9 billion at the end of 1994 and $160 million at the end of 1993. In 1991 the company adopted FASB standard No. 109 - Accounting for Income Taxes - and recorded, as of January 1, 1991, a benefit of $21 million, or 43 cents per share. As described in the accounting policy footnote to the financial statements, any future change in the tax rate would result in the immediate recognition in current earnings of the cumulative effect on deferred tax assets and liabilities. The company's effective federal income tax rate was 38.4 percent in 1995, 46.2 percent in 1994 and 43.5 percent in 1993. The decrease in the 1995 rate was due to a reduction in the ratio of expenses not deductible for income taxes to the tax provision at the statutory rate of 35 percent. The change in the 1994 rate was caused by an increase in the amount of expenses not deductible for income taxes, primarily the amortization of goodwill. The rate for 1993 would have been 31.8 percent but for the effects of the retroactive application of The Revenue Reconciliation Act of 1993. The one percentage point increase in the federal statutory income tax rate, now 35 percent, required the redetermination of the December 31, 1992 deferred tax asset and liability balances. This redetermination added $18 million to 1993's tax provision thereby reducing earnings per share by 38 cents. During 1989, final regulations were issued concerning the research tax credit. The company had taken a conservative approach in calculating its tax provisions since 1981 pursuant to uncertain proposed regulations. An exhaustive study was undertaken throughout the company to redetermine qualifying expenditures in compliance with the final regulations so as to recalculate prior years' tax credits and amend its tax returns as appropriate. The benefit resulting from the conclusion of that study was the $90 million in additional research credits recognized in the determination of the 1991 effective tax rate of 3.2 percent.\nNORTHROP GRUMMAN CORPORATION\nMeasures of Liquidity and Capital Resources The improvement of the company's financial condition and liquidity continued in 1995. Over the last three years operating cash flows have averaged over $500 million annually. The $744 million of cash flow from operations in 1995 was an increase of $303 million over 1994 which was an increase of $61 million over 1993 which in turn was a $96 million increase over that of 1992. The trend and relationship of sales volume with accounts receivable and inventoried cost balances, before and after the benefit of progress payments, is a useful measure in assessing liquidity. In 1993 the company's net investment in these balances represented 27 percent of sales. It rose to 33 percent at the end of 1994 with the acquisition of Grumman and Vought before decreasing to 29 percent at year-end 1995. The following table is a condensed summary of the detailed cash flow information contained in the Consolidated Statements of Cash Flows.\nYear ended December 31 1995 1994 1993 1992 1991 Cash came from Customers 96% 71% 99% 98% 100% Lenders 2% 29% 1% 2% Buyers of assets\/other 2% 100% 100% 100% 100% 100% Cash went to Employees and suppliers of services and materials 83% 65% 89% 93% 88% Sellers of assets 2% 18% 1% Lenders 12% 15% 8% 3% 9% Suppliers of facilities\/other 2% 1% 2% 2% 2% Shareholders 1% 1% 1% 1% 1% 100% 100% 100% 100% 100%\nThe increased cash received from lenders in 1994 resulted from the acquisition of Grumman, which was financed mainly through new borrowings. Other important indicators of short-term liquidity are the trend in working capital, the current ratio, and the ratio of long-term debt to shareholders' equity. This information is reported in the table captioned Selected Financial Data. In connection with the financing of the Grumman acquisition the company, in April 1994, replaced the $400 million credit agreement with a new $2.8 billion Credit Agreement. The new facility provided for $600 million, available on a revolving credit basis through March 1999 and a $2.2 billion term loan payable through March 1999. The Credit Agreement was amended in May 1994 to increase the revolving credit line to $800 million and reduce the term loan to $2 billion. In October 1994, the company issued $350 million of notes due in 2004 and $250 million of debentures due in 2024 pursuant to a public offering. The net proceeds from the offering, along with other available funds, were used to prepay $900 million in addition to paying the $100 million September quarterly installment due under the term loan facility. In December 1994, the company amended the Credit Agreement to provide for the repayment of the remaining $1 billion balance of the term loan in 14 quarterly installments of $62.5 million plus interest beginning in September 1995, with a final installment of $125 million due in March 1999. Cash flow from operations during 1994 enabled the company to prepay the $160 million of notes payable to institutional investors due in 1995 and acquire, in the open market, $58 million of notes due in 1999, while paying a net premium of $5 million for the early payments of these notes. The charge for the premium is included in Other Deductions in the Consolidated Statements of Income. Cash flow from operations in 1995 was sufficient to allow the company to make the $125 million required term loan payment as well as $312 million in voluntary payments for amounts which were due through March 1997. During 1995 the company entered into an agreement with a financial institution to sell designated pools of its commercial accounts receivable, in amounts up to $75 million. The company acts as an agent for the purchaser by performing record keeping and collections functions. At December 31, 1995, $34 million of accounts receivable had been sold. On January 3, 1996 the company entered into a definitive agreement to acquire the defense and electronics systems business of Westinghouse Electric Corporation for $3 billion in cash. The company has obtained bank commitments totaling $4.8 billion to finance the transaction and replace its current credit agreement. The sale, which is expected to close in March 1996, is subject to normal governmental and regulatory reviews. Any future near-term borrowing needs will be met through the use of short-term credit lines and the company's revolving credit agreement. To provide for long-term liquidity the company believes it can obtain additional capital from such sources as: the public or private capital markets, the further sale of assets, sale and leaseback of operating assets, and leasing rather than purchasing new assets. The cash improvement program underway throughout the company has produced favorable results, with the expectation that further efforts will result in minimizing, the need to incur additional borrowings during 1996. Cash generated from operations is expected to be sufficient in 1996 to service debt, finance capital expansion projects and continue paying dividends to the shareholders. Capital expenditure commitments at December 31, 1995, were approximately $110 million including $2 million for environmental control and compliance purposes. The company will continue to provide the productive capacity to perform its existing contracts, dispose of assets no longer needed to fulfill operating requirements, prepare for future contracts and conduct R&D in the pursuit of developing opportunities. While these expenditures tend to limit short-term liquidity, they are made with the intention of improving the long-term growth and profitability of the company.\nNew Accounting Standards During 1995 the company adopted the new FASB No. 121 - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The adoption thereof had no material effect on the company's financial position or operating results. In October 1995, the Financial Accounting Standards Board issued FASB No. 123 - Accounting for Stock-Based Compensation. This standard changes the manner in which compensation for employee stock options is measured and reported. The company's management is presently evaluating the impact of this standard on the company's financial statements to determine if it will adopt this standard. The company must decide whether or not to adopt this new standard by the end of the first quarter of 1996.\nNORTHROP GRUMMAN CORPORATION\nNORTHROP GRUMMAN CORPORATION Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nNORTHROP GRUMMAN CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements.\nNORTHROP GRUMMAN CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements\nNORTHROP GRUMMAN CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements.\nNORTHROP GRUMMAN CORPORATION\nNORTHROP GRUMMAN CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements\nNORTHROP GRUMMAN CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation The consolidated financial statements include the accounts of the corporation and its subsidiaries. All material intercompany accounts, transactions and profits are eliminated in consolidation. The company's financial statements are in conformity with generally accepted accounting principles. The preparation thereof requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ from those estimates.\nNature of Operations Northrop Grumman is a major producer of military and commercial aircraft sub-assemblies and defense electronics and is the prime contractor on the U.S. Air Force B-2 Stealth Bomber. The company operates in the military and commercial aircraft, electronics and systems integration, data systems and other services, and missiles and unmanned vehicle systems industry segments within the broadly defined aerospace industry. The majority of the company's products and services are sold to the U.S. Government and the company is therefore affected by the federal budget process and the competition in the aerospace and defense environment. Sales to the U.S. Government (including foreign military sales) are reported within each industry segment and in total in the Selected Financial Data. The company does not conduct a significant volume of activity through foreign operations or in foreign currencies. Descriptions of the company's principal products and services along with industry segment data, which is considered to be an integral part of these financial statements, can be found in the Management's Discussion and Analysis section of this report. Intersegment sales are transacted at cost incurred with no profit added. Operating profit is defined to include the Other Income earned by each industry segment, but to exclude costs allocated to segments for General Corporate Expenses and State and Local Income Taxes. For segment reporting, the amount of the costs of retiree benefit plans (pension and nonpension) allocable to contracts as determined by government cost accounting standards captioned Retiree Benefit Cost Included in Contract Costs and the income(cost) of retiree benefit plans (pension and nonpension) as calculated in conformity with financial accounting standards captioned Retiree Benefit Income(Cost) are shown separately from general corporate expenses so as not to distort operating profit as reported by industry segment. General corporate assets include cash and cash equivalents, corporate office furnishings and equipment, other unallocable property, investments in affiliates, prepaid pension cost, intangible pension asset, benefit trust fund assets and certain assets held for sale.\nNORTHROP GRUMMAN CORPORATION\nSales Sales under cost-reimbursement, service, research and development, and construction-type contracts are recorded as costs are incurred and include estimated earned fees or profits calculated on the basis of the relationship between costs incurred and total estimated costs (cost-to-cost type of percentage-of-completion method of accounting). Construction-type contracts embrace those fixed-price type contracts that provide for the delivery at a low volume per year or a small number of units after a lengthy period of time over which a significant amount of costs have been incurred. Sales under other types of contracts are recorded as deliveries are made and are computed on the basis of the estimated final average unit cost plus profit (units-of-delivery type of percentage-of-completion method of accounting). Certain contracts contain provisions for price redetermination or for cost and\/or performance incentives. Such redetermined amounts or incentives are included in sales when the amounts can reasonably be determined. In the case of the B-2 bomber production contract, future changes in operating margin will be recognized on a units-of-delivery basis and recorded as each equivalent production unit is delivered. Amounts representing contract change orders, claims or limitations in funding are included in sales only when they can be reliably estimated and realization is probable. In the period in which it is determined that a loss will result from the performance of a contract, the entire amount of the estimated ultimate loss is charged against income. Loss provisions are first offset against costs that are included in assets, with any remaining amount reflected in Other Current Liabilities. Other changes in estimates of sales, costs, and profits are recognized using the cumulative catch-up method of accounting. This method recognizes in the current period the cumulative effect of the changes on current and prior periods. Hence, the effect of the changes on future periods of contract performance is recognized as if the revised estimates had been the original estimates.\nContract Research and Development Customer-sponsored research and development costs (direct and indirect costs incurred pursuant to contractual arrangements) are accounted for like other contracts.\nNoncontract Research and Development This category includes independent research and development costs and company-sponsored research and development costs (direct and indirect costs not recoverable under contractual arrangements). Independent research and development (IR&D) costs are included in administrative and general expenses (indirect costs allocable to U.S. Government contracts) while company-sponsored research and development costs are charged against income as incurred.\nNORTHROP GRUMMAN CORPORATION\nEnvironmental Costs Environmental liabilities are accrued when the company determines its responsibility for cleanup costs and such amounts are reasonably estimable. When only a range of amounts is established and no amount within the range is better than another, the minimum amount in the range is recorded. The company does not anticipate and record insurance recoveries before collection is probable.\nInterest Rate Swap Agreements The company may enter into interest rate swap agreements to offset the variable rate characteristic of certain variable rate term loans outstanding under the company's Credit Agreement. Interest on these interest rate swap agreements is recognized as an adjustment to interest expense in the period incurred.\nIncome Taxes Provisions for federal, state and local income taxes are calculated on reported financial statement pretax income based on current tax law and also include, in the current period, the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. The company accounts for certain contracts in process using different methods of accounting for financial statements and tax reporting and thus provides deferred taxes on the difference between the financial and taxable income reported during the performance of such contracts. State and local income and franchise tax provisions are included in administrative and general expenses.\nEarnings per Share Earnings per share are based on the weighted average number of shares of common stock outstanding during each period, after giving recognition to stock splits and stock dividends. The dilutive effect of common stock equivalents, shares under stock options, was insignificant.\nCash and Cash Equivalents Cash and cash equivalents include interest-earning debt instruments that mature in three months or less from the date purchased.\nAccounts Receivable Accounts receivable include amounts billed and currently due from customers under all types of contracts; amounts currently due but unbilled (primarily related to contracts accounted for under the cost-to-cost type of percentage-of-completion method of accounting), certain estimated contract changes, claims in negotiation and amounts retained by the customer pending contract completion.\nNORTHROP GRUMMAN CORPORATION\nInventoried Costs Inventoried costs primarily relate to work in process under fixed-price type contracts (excluding those included in unbilled accounts receivable as previously described). They represent accumulated contract costs less the portion of such costs allocated to delivered items. Accumulated contract costs include direct production costs, factory and engineering overhead, production tooling costs, and allowable administrative and general expenses (except for general corporate expenses and IR&D allocable to commercial contracts, which are charged against income as incurred). In accordance with industry practice, inventoried costs are classified as a current asset and include amounts related to contracts having production cycles longer than one year.\nDepreciable Properties Property, plant and equipment owned by the company are depreciated over the estimated useful lives of individual assets. Capital leases providing for the transfer of ownership upon their expiration or containing bargain purchase options are amortized over the estimated useful lives of individual assets. Most of these assets are depreciated using declining-balance methods, with the remainder using the straight-line method, with the following lives:\nYears Land improvements 4-25 Buildings 4-45 Machinery and other equipment 2-20 Leasehold improvements Length of lease\nGoodwill and Other Purchased Intangible Assets Goodwill and other purchased intangible assets are amortized on a straight- line basis over periods of 40 years and a weighted average 23 years, respectively. Goodwill and other purchased intangibles balances are included in the identifiable assets of the industry segment to which they have been assigned and amortization is charged against the respective industry segment operating profit. The future profitability and cash flow of the operations to which they relate are evaluated annually. These factors, along with management's plans with respect to the operations are considered in assessing the recoverability of goodwill and other purchased intangibles.\nNORTHROP GRUMMAN CORPORATION\nAcquisitions In April 1994, the company purchased the outstanding stock of Grumman Corporation (Grumman) at a cost of $2.1 billion and financed the transaction mainly with new borrowings. The operations of Grumman since acquisition are included in the industry segments to which products are associated. In August 1994 the company purchased the remaining 51 percent interest in Vought Aircraft Company (Vought) for $130 million cash. The company had previously purchased a 49 percent interest in Vought for $45 million in September 1992. The operations of Vought since August 1994 are included in the military and commercial aircraft industry segment. The purchase method of accounting was used to record both acquisitions with estimated fair values being assigned to assets and liabilities. The excess of the purchase price over the net tangible assets acquired was assigned to identifiable intangible assets and the balance to goodwill. The following unaudited proforma financial information combines Northrop's, Grumman's and Vought's results of operations as if the acquisitions had taken place on January 1, 1993, and is not necessarily indicative of future operating results for Northrop Grumman.\n$ in millions, except per share 1994 1993 Sales $7,770 $8,653 Net income 57 112 Earnings per share 1.16 2.33\nACCOUNTS RECEIVABLE Unbilled amounts represent sales for which billings have not been presented to customers at year end, including differences between actual and estimated overhead and margin rates. These amounts are usually billed and collected within one year, progress payments are however received on a number of fixed-price contracts accounted for using the cost-to-cost type percentage-of-completion method. Amounts due upon contract completion are retained by customers until work is completed and customer acceptance is obtained. The company entered into an agreement in 1995 with a financial institution to sell designated pools of its commercial accounts receivables, with limited recourse, in amounts up to $75 million. Under the agreement, new receivables are sold as previously sold amounts are collected. The accounts receivable are sold at a loss which is included in cost of sales in the period incurred. The company acts as an agent for the purchaser by performing record keeping and collection function. At December 31, 1995, $34 million of accounts receivable had been sold. Accounts receivable at December 31, 1995, are expected to be collected in 1996 except for approximately $93 million due in 1997 and $29 million due in 1998 and later. These amounts principally relate to long-term contracts with the U.S. Government. Allowances for doubtful amounts represent mainly estimates of overhead type costs which may not be successfully negotiated and collected.\nNORTHROP GRUMMAN CORPORATION\nInventoried costs relate to long-term contracts in process and include expenditures for raw materials and work in process beyond what is required for recorded orders. These expenditures are incurred to help maintain stable and efficient production schedules. However, no material amount representing claims, learning curve, unamortized tooling or other deferred costs is included in inventoried costs. The ratio of inventoried administrative and general expenses to total inventoried costs is assumed to be the same as the ratio of total administrative and general expenses to total contract costs. According to the provisions of U.S. Government contracts, the customer has title to, or a security interest in, substantially all inventories related to such contracts.\nNORTHROP GRUMMAN CORPORATION\nINCOME TAXES Income tax expense, both federal and foreign (which arises primarily from work performed abroad by domestic operations), was comprised of the following:\nIncome tax expense differs from the amount computed by multiplying the statutory federal income tax rate times the income before income taxes due to the following:\nThe research and experimentation tax credit shown for 1991 was the result of an internal company study that determined the amount earned over the years 1981 through 1990 in excess of the amount previously recognized for those years pending final government regulations which were not issued until 1989. Deferred income taxes arise because of differences in the treatment of income and expense items for financial reporting and income tax purposes. The principal type of temporary difference stems from the recognition of income on contracts being reported under different methods for tax purposes than for financial reporting. Effective January, 1991, the company adopted FASB Statement No. 109 - Accounting for Income Taxes. The tax effects of significant temporary differences and carryforwards that gave rise to year-end deferred federal and state tax balances, as categorized in the Consolidated Statements of Financial Position, were as follows:\nNORTHROP GRUMMAN CORPORATION\nThe tax carryforward benefits are expected to be used in the periods that net deferred tax liabilities mature. The expiration dates for these tax credit carryforwards are in various amounts over the years 1996 through 2007. The alternative minimum tax credit can be carried forward indefinitely.\nNORTHROP GRUMMAN CORPORATION\nNOTES PAYABLE TO BANKS AND LONG-TERM DEBT The company has available short-term credit lines in the form of money market facilities with several banks. The amount and conditions for borrowing under these credit lines depend on the availability and terms prevailing in the marketplace. No fees or compensating balances are required for these credit facilities. At December 31, 1995, $65 million was outstanding at a weighted average interest rate of 6.15 percent. At December 31, 1994, $171 million was outstanding at a weighted average interest rate of 7 percent. Additionally, the company has a credit agreement with a group of domestic and foreign banks. The Credit Agreement provides for two credit facilities: $800 million available on a revolving credit basis through March 1999 and a floating interest rate term loan payable quarterly through March 1999. In December 1994 the company amended the Credit Agreement to provide for repayment of the $1 billion balance of the term loan in 14 quarterly installments of $62.5 million plus interest beginning in September 1995, with a final installment of $125 million due in March 1999. During 1995 the company made the $125 million required term loan payments as well as $312 in voluntary prepayments for amounts which were due through March 1997. The borrowings under the term loans bear interest at various rates generally equal to the London Interbank Offered Rate (LIBOR) plus .43 percent. At December 31, 1995, $563 million was outstanding at a weighted average interest rate of 6.31 percent. Principal payments permanently reduce the amount available under this agreement as well as the debt outstanding. In 1995 there were no borrowings under the company's revolving credit facility. The company paid an average facility fee in 1995 of .18 percent per annum on the total amount of the revolving credit facility. Under these agreements, in the event of a \"change in control,\" the banks are relieved of their commitments. Compensating balances are not required under these agreements. The company's credit agreements contain restrictions relating to the payment of dividends, acquisition of the company's stock, aggregate indebtedness for borrowed money and the maintenance of shareholders' equity. At December 31, 1995, $413 million of retained earnings were unrestricted as to the payment of dividends. Total indebtedness for all types of borrowed money is limited under the company's credit agreement covenants. At December 31, 1995, indebtedness was limited to $3.1 billion.\nNORTHROP GRUMMAN CORPORATION\nIn November 1995 the notes due in 1999 were called for redemption at face value, on January 2, 1996. The December 31, 1995 balance of $143 million was classified as current. The debentures due in 2024 are callable after October 15, 2004 at a premium of 4 percent declining to par after 2013. The principal amount of long-term debt outstanding at December 31, 1995, is due in: 1997 - $188 million, 1998 - $250 million, 1999 - $125 million and after five years $600 million.\nNORTHROP GRUMMAN CORPORATION\nFAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the company in estimating its fair value disclosures for financial instruments:\nThe carrying amount reported in the consolidated Statements of Financial Position for Cash and Cash Equivalents, Accounts Receivable and amounts borrowed under the company's short-term credit lines approximate their fair value.\nThe fair value of the long-term debt was calculated based on interest rates available for debt with terms and due dates similar to the company's existing debt arrangements.\nThe company has limited involvement with financial instruments and does not use them for trading purposes. To mitigate the variable rate characteristic of the term loans, the company entered into interest rate swap agreements through May 1997 with several banks resulting in a fixed interest rate of 6.47 percent on a notional amount of $300 million at December 31, 1995 and $200 million at December 31, 1994. Unrealized gain(loss) on interest rate swap agreements are calculated based upon the amounts at which they could be settled at current interest rates. The unrealized market gain(loss) on interest rate swaps was $(7) million and $7 million at December 31, 1995 and 1994 respectively. The institutions have options to extend $200 million of the swaps through May 1998. The company anticipates that the banks will fully satisfy their obligations under the arrangements. Carrying amounts and the related estimated fair values of the company's financial instruments at December 31 of each year are as follows:\n$ in millions 1995 1994 1993 1992 Cash and Cash Equivalents Carrying amount $ 18 $ 17 $ 100 $ 230 Fair value 18 17 100 230\nAccounts Receivable Carrying amount 1,197 1,202 820 791 Fair value 1,197 1,202 820 791 Notes payable Carrying amount 65 171 100 Fair value 65 171 100\nLong-term debt Carrying amount 1,307 1,763 160 410 Fair value 1,405 1,758 160 443\nInterest rate swap agreements Notional amount 300 200 Unrealized gains(losses) (7) 7\nNORTHROP GRUMMAN CORPORATION\nRETIREMENT BENEFITS The company sponsors several defined-benefit pension plans covering substantially all employees. Pension benefits for most employees are based on the employee's years of service and compensation during the last ten years before retirement. It is the policy of the company to fund at least the minimum amount required for all qualified plans, using actuarial cost methods and assumptions acceptable under U.S. Government regulations, by making payments into a trust separate from the company. Four of the company's seven qualified plans which cover over 80 percent of all employees, were in a legally defined full-funding limitation status at December 31, 1995. To protect the assets in the master trust from a \"change in control\" the trust agreement and the Northrop Grumman Pension Plan were appropriately amended during 1991. The company and subsidiaries also sponsor defined-contribution plans in which most employees are eligible to participate. Company contributions, up to 4 percent of compensation, are based on a matching of employee contributions. In addition, the company and its subsidiaries provide certain health care and life insurance benefits for retired employees. Employees achieve eligibility to participate in these contributory plans upon retirement from active service and if they meet specified age and years of service requirements. Election to participate must be made at the date of retirement. Qualifying dependents are also eligible for medical coverage. Approximately 85 percent of the company's current retirees participate in the medical plans. The cost and funded status for the medical and life benefits are combined in the tables that follow because (1) life benefits constitute an insignificant amount of the combined cost, and (2) for those plans with assets, the assets in trust for each plan can be used to pay benefits under either plan. Plan documents reserve the company's right to amend or terminate the plans at any time. Premiums charged retirees for medical coverage are based on years of service and are adjusted annually for changes in the cost of the plans as determined by an independent actuary. In addition to this medical inflation cost-sharing feature, the plans also have provisions for deductibles, copayments, coinsurance percentages, out-of-pocket limits, schedule of reasonable fees, managed care providers, maintenance of benefits with other plans, Medicare carve-out and a maximum lifetime benefit of from $250,000 to $1,000,000 per covered individual. It is the policy of the company to fund the maximum amount deductible for income taxes into the VEBA trust established for the Northrop Retiree Health Care Plan for Retired Employees for payment of benefits. The company elected to implement the accounting standard, FASB Statement No. 106 - Employer's Accounting for Postretirement Benefits Other Than Pensions, for 1991 by immediately recognizing the January 1, 1991, accumulated postretirement benefit obligation of $437 million. This amount was offset by $292 million, the fair value of plan assets held in trust outside the company, in recording a net obligation and pretax charge to operations of $145 million.\nNORTHROP GRUMMAN CORPORATION\nThe cost to the company of these plans in each of the last five years is shown in the following table.\nIn addition to the net periodic pension income and postretirement benefit cost, in 1994 the company recognized the effect of an early retirement incentive program of $250 million for pension and $32 million for postretirement benefits. The total $282 million effect on the company's 1994 operating margin is shown in the Consolidated Statements of Income under the caption Special Termination Benefits.\nNORTHROP GRUMMAN CORPORATION\nMajor assumptions as of each year-end used in the accounting for the defined-benefit plans are shown in the following table. Pension cost is determined using all three factors as of the end of the preceeding year, whereas the funded status of the plans, shown later, uses only the first two factors, as of the end of each year.\n1995 1994 1993 1992 1991 Discount rate for obligations 7.00% 8.25% 7.00% 8.00% 8.00% Rate of increase for compensation 5.00 5.25 5.50 5.50 5.50 Expected long term rate of return on plan assets 9.00 8.75 8.25 8.25 8.25\nThese assumptions were also used in retiree health care and life insurance benefit calculations with one modification. Since, unlike the pension trust, the earnings of the VEBA trust are taxable, the above 9 percent expected rate of return on plan assets was reduced accordingly to 5.25 percent after taxes. A significant factor used in estimating future per capita cost, for the company and its retirees, of covered health care benefits is the health care cost trend rate assumption. The rate used was 8 percent for 1995 and is assumed to decrease gradually to 6 percent for 2006 and remain at that level thereafter. An additional one-percentage-point of increase each year in that rate would result in an $11 million annual increase in the aggregate of the service and interest cost components of net periodic postretirement benefit cost, and a $113 million increase in the accumulated postretirement benefit obligation at December 31, 1995. The following tables set forth the funded status and amounts recognized in the Consolidated Statements of Financial Position at each year-end for the company's defined-benefit pension and retiree health care and life insurance benefit plans. The summary showing pension plans whose accumulated benefits are in excess of assets at December 31, 1995, is comprised of two qualified plans along with thirteen unfunded nonqualified plans for benefits provided to directors, officers and employees either beyond those provided by, or payable under, the company's main plans. The company changed the discount rate for obligations and rate of increase for compensation assumptions in calculating the funded status of the plans at December 31, 1995. The changes resulted in a $922 million increase in the projected benefit obligation for pension plans and a $167 million increase in the accumulated postretirement benefit obligation.\nNORTHROP GRUMMAN CORPORATION\nNORTHROP GRUMMAN CORPORATION\nPension plan assets at December 31, 1995, were comprised of 50 percent domestic equity type investments in listed companies (including four percent in Northrop Grumman common stock), 13 percent equity investments listed on international exchanges, eight percent in cash and venture capital real estate and 29 percent in fixed income type investments, principally U.S. Government securities. The investment in Northrop Grumman represents 5,974,826 shares, or 12 percent of the company's total shares outstanding. Effective January 1, 1995, the company adopted amendments to two of the company's retirement plans to cap the maximum years of service credit that an employee can earn and adjusted the amount of service credit earned each year. The effect of these changes was to increase the projected benefit obligation at December 31, 1994 by $210 million.\nRetiree health care and life insurance plan assets at December 31, 1995, were almost entirely comprised of equity type investments in listed companies.\nCONTINGENCIES The corporation and its subsidiaries have been named as defendants in various legal actions. Based upon available information, it is the company's expectation that those actions are either without merit or will have no material adverse effect on the company's results of operations or financial position. Minimum rental commitments under long-term noncancellable operating leases total $158 million which is payable as follows; 1996 - $47 million, 1997 - $35 million, 1998 - $24 million, 1999 - $19 million, and 2000 - $11 million, and 2001 and thereafter - $22 million.\nNORTHROP GRUMMAN CORPORATION\nSTOCK RIGHTS\nOn September 21, 1988, the company adopted a Common Stock Purchase Rights plan. One right for each outstanding share of common stock was issued to shareholders of record on October 5, 1988. The rights will become exercisable on the tenth business day after a person or group has acquired 15 percent or more of the general voting power of the company, or announces an intention to make a tender offer for 30 percent or more of such voting power, without the prior consent of the Board of Directors. If the rights become exercisable, a holder will be entitled to purchase one share of common stock from the company at an initial exercise price of $105. If a person acquires more than 15 percent of the then outstanding voting power of the company or if the company is combined with an acquiror, each right will entitle its holder to receive, upon exercise, shares of the company's or the acquiror's (depending upon which is the surviving company) common stock having a value equal to two times the exercise price of the right. The company will be entitled to redeem the rights at $.02 per right at any time prior to the earlier of the date that a person has acquired or obtained the right to acquire 15 percent of the general voting power of the company or the expiration of the rights in October 1998. The rights are not exercisable until after the date on which the company's prerogative to redeem the rights has expired. The rights do not have voting or dividend privilege and cannot be traded independently from the company's common stock until such time as they become exercisable.\nLONG-TERM INCENTIVE STOCK PLAN\nThe company's 1993 Long-Term Incentive Stock Plan(LTISP) provides for stock options, stock appreciation rights (SARs) and stock awards to key employees. This plan added 2,300,000 shares, of which up to one-half may be in the form of stock awards, to the pool available for future grants. The 1993 LTISP was amended in 1995, adding 1,800,000 shares, along with 300,000 shares added from the adoption of a stock option plan for non-employee directors, to the pool available for grants. The number of shares reserved for future grants shown in the following table reflects both stock options and stock awards. Stock awards, in the form of restricted performance stock rights, are granted to key employees without payment to the company. Recipients of the rights earn shares of stock based on a total shareholder return measure of performance over a five year period with interim distributions beginning three years after grant. If at the end of the five year period the performance objectives have not been met, 70 percent of the original grant will be forfeited. Compensation expense is estimated and accrued over the vesting period. Each grant of a stock option is made at the closing market price on the date of the grant. When stock options are exercised, the amount of the cash proceeds to the company is added to paid-in capital. Under current accounting standards there are no additions to or deductions from income in connection with these options. Termination of employment can result in forfeiture of some or all of the benefits extended under the plans.\nNORTHROP GRUMMAN CORPORATION\nStock option activity for the last five years is summarized below:\nNORTHROP GRUMMAN CORPORATION\nSUBSEQUENT EVENT On January 3, 1996 the company entered into a definitive agreement to acquire the defense and electronics systems business of Westinghouse Electric Corporation for $3 billion in cash. The company has obtained bank commitments totaling $4.8 billion to finance the transaction and replace its current credit agreement. The transaction is subject to normal governmental and regulation reviews and is expected to close in March 1996.\nUNAUDITED SELECTED QUARTERLY DATA Quarterly financial results, previously reported are set forth in the following tables together with dividend and common stock price data.\n1995 Quarters, $ in millions, except per share 4 3 2 1 Net sales $1,812 $1,630 $1,759 $1,617 Operating margin 121 131 167 117 Net income 58 61 79 54 Earnings per share 1.17 1.25 1.59 1.10 Dividend per share .40 .40 .40 .40 Stock price: High 64 1\/4 62 5\/8 54 49 3\/4 Low 56 51 7\/8 47 39 3\/4\nThe operating margin in the second quarter of 1995 benefited from a net $34 million in cumulative operating margin adjustments. Positive adjustments on the B-2 stealth bomber and C-17 military transport programs were partially offset by a downward adjustment on the Boeing 747 jetliner program. The 747 adjustment reflected cost increases related to the stretch-out of the current production contract, which is now scheduled to conclude in the fall of 1996. The B-2 adjustment was made as a result of negotiated contract adjustments and a revised estimate of the overall operating margin expected to be earned on the B-2 production contract. The positive adjustment on the C-17 reflected improved operating performance on this program.\n1994 Quarters, $ in millions, except per share 4 3 2 1 Net sales $1,880 $1,927 $1,686 $1,218 Operating margin(loss) (107) 99 126 81 Net income(loss) (121) 39 65 52 Earnings(loss) per share (2.45) .79 1.33 1.05 Dividend per share .40 .40 .40 .40 Stock price: High 47 3\/8 45 3\/8 39 3\/4 45 7\/8 Low 40 1\/4 35 3\/4 34 1\/2 36 7\/8\nOperating margin(loss) for the first three quarters of 1994 has been restated to reflect the reclassification of losses on disposals of machinery and other equipment previously included in the \"Other, net\" classification in the Consolidated Statements of Income. The operating loss in the fourth quarter of 1994 resulted from a $282 million charge for a voluntary early retirement incentive program offered in 1994 and a $42 million provision for the planned disposal of real estate and other assets. The corporation's common stock is traded on the New York and Pacific Stock Exchanges (trading symbol NOC). The approximate number of holders of record of the corporation's common stock at January 31, 1996, was 10,858.\nNORTHROP GRUMMAN CORPORATION\nINDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Northrop Grumman Corporation Los Angeles, California\nWe have audited the accompanying consolidated statements of financial position of Northrop Grumman Corporation and Subsidiaries as of December 31 for each of the years 1991 through 1995, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the years then ended. 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. 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 Northrop Grumman Corporation and Subsidiaries at December 31 for each of the years 1991 through 1995, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in the footnotes to the consolidated financial statements, in 1991 the company changed its method of computing income taxes by adopting Financial Accounting Standards Board Statement No. 109 - Accounting for Income Taxes and its accounting for nonpension benefit plans by adopting Financial Accounting Standards Board Statement No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions.\nDeloitte & Touche LLP Los Angeles, California February 7, 1996 NORTHROP GRUMMAN CORPORATION\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure No 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 The information as to Directors will be incorporated herein by reference to the Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed within 120 days after the end of the company's fiscal year.\nThe information as to Executive Officers is contained in Part I of this report as permitted by General Instruction G(3).\nItem 11.","section_11":"Item 11. Executive Compensation The information required by this Item will be incorporated herein by reference to the Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed 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 The information required by this Item will be incorporated herein by reference to the Proxy Statement for the 1996 Annual Meeting of Stockholders to 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 The information required by this Item will be incorporated herein by reference to the Proxy Statement for the 1996 Annual Meeting of Stockholders to 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 (a) 1. Financial Statements Consolidated Statements of Financial Position Consolidated Statements of Income Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Independent Auditors' Report\n2. Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted either because they are not applicable or not required or because the required information is included in the financial statements or notes thereto. Separate financial statements of the parent company are omitted since it is primarily an operating company and minority equity interests in and\/or nonguaranteed long-term debt of subsidiaries held by others than the company are in amounts which together do not exceed 5 percent of the total consolidated assets at December 31, 1995.\nNORTHROP GRUMMAN CORPORATION\nExhibits:\n3(a) Certificate of Incorporation, as amended (incorporated by reference to Form S-3 Registration Statement, filed August 18, 1994)\n3(b) Northrop Grumman Corporation Bylaws, amended as of May 18, 1994 (incorporated by reference to Form S-3 Registration Statement, filed August 18, 1994) and amended as of August 17, 1994\n4(a) Common Stock Purchase Rights Agreement (incorporated by reference to Form 8-A filed September 22, 1988, amended on August 2, 1991 (incorporated by reference to Form 8 filed August 2, 1991) and amended on September 28, 1994 (incorporated by reference to Form 8\/A- A filed October 7, 1994)\n4(b) Indenture Agreement dated as of October 15, 1994 (incorporated by reference to Form 8-K filed October 25, 1994)\n10(a) Northrop Grumman Corporation Amended and Restated Credit Agreement dated as of April 15, 1994, as amended and restated as of April 18, 1994 (incorporated by reference to Report on Form 10-Q filed May 9, 1994), amended as of May 11, 1994, and amended as of December 9, 1994 (incorporated by reference to Form 10-K filed March 21, 1995)\n10(b) Uncommitted Credit Facility dated October 10, 1994, between Northrop Grumman Corporation and Wachovia Bank of Georgia, N.A., which is substantially identical to facilities between Northrop Grumman Corporation and certain banks some of which are parties to the Credit Agreement filed as Exhibit 10(a) hereto\n*10(c) 1973 Incentive Compensation Plan (incorporated by reference to Form 8-B filed June 21, 1985)\n*10(d) 1973 Performance Achievement Plan (incorporated by reference to Form 8-B filed June 21, 1985)\n*10(e) Northrop Supplemental Plan 2\n*10(f) Northrop Grumman Corporation ERISA Supplemental Plan 1 (incorporated by reference to Form 10-K filed February 28, 1994).\n*10(g) Retirement Plan for Independent Outside Directors (incorporated by reference to Form SE filed March 29, 1991), amended September 21, 1994 (incorporated by reference to Form 10-K filed March 21, 1995)\n*10(h) 1987 Long-Term Incentive Plan, as amended (incorporated by reference to Form SE filed March 30, 1989)\n*10(i) Executive Life Insurance Policy\n*10(j) Executive Accidental Death, Dismemberment and Plegia Insurance Policy\n*10(k) Executive Long-Term Disability Insurance Policy\n*10(l) Key Executive Medical Plan Benefit Matrix\nNORTHROP GRUMMAN CORPORATION\n*10(m) Executive Dental Insurance Policy Group Numbers 5134 and 5135\n*10(n) Group Excess Liability Policy\n*10(o) Northrop Grumman 1993 Long-Term Incentive Stock Plan, as amended (incorporated by reference to Northrop Grumman Corporation Proxy Statement filed March 30, 1995)\n*10(p) Northrop Corporation 1993 Stock Plan for Non-Employee Directors (incorporated by reference to Northrop Corporation 1993 Proxy Statement filed March 30, 1993), amended as of September 21, 1994 (incorporated by reference to Form 10-K filed March 21, 1995)\n*10(q) Northrop Grumman Corporation 1995 Stock Option Plan for Non-Employee Directors (incorporated by reference to 1995 Proxy Statement filed March 30, 1995)\n*10(r) Northrop Corporation Special Severance Pay Agreement (incorporated by reference to Northrop Corporation Report on Form 10-K filed February 28, 1994), amended and restated as of July 13, 1995\n*10(s) Employment Agreement effective January 1, 1996 between Northrop Grumman Corporation and Gordon L. Williams\n*10(t) Executive Deferred Compensation Plan (effective December 29,1994)\n*10(u) Northrop Grumman Transition Project Incentive Plan (incorporated by reference to Form 10-K filed March 21, 1995)\n10(v) Agreement and Plan of Merger dated April 3, 1994 (incorporated by reference to Form 8-K filed May 2, 1994)\n11 Statement Re Computation of Per Share Earnings\n21 Significant subsidiaries of registrant\n23 Independent Auditors' Consent\n24 Power of Attorney\n27 Financial Data Schedule\n________________ * Listed as Exhibits pursuant to Item 601(b)(10) of Regulation S-K\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this report.\nNORTHROP GRUMMAN 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 the 23rd day of February 1996.\nNorthrop Grumman Corporation\nBy: Nelson F. Gibbs Nelson F. Gibbs Corporate Vice President and Controller (Principal Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on behalf of the registrant this 23rd day of February 1996, by the following persons and in the capacities indicated.\nSignature Title Kent Kresa* Chairman of the Board, President and Chief Executive Officer and Director (Principal Executive Officer)\nJack R. Borsting* Director John T. Chain, Jr.* Director Jack Edwards* Director Aulana L. Peters* Director John E. Robson* Director Richard R. Rosenberg* Director Brent Scowcroft* Director John Brooks Slaughter* Director Wallace C. Solberg* Director Richard J. Stegemeier* Director Richard B. Waugh, Jr.* Corporate Vice President and Chief Financial Officer\n*By James C. Johnson James C. Johnson, Attorney-in-Fact pursuant to a power of attorney\nNORTHROP GRUMMAN CORPORATION\n____________ (1) Uncollectible amounts written off, net of recoveries. (2) Additions include $15,625 of allowance for bad debts from acquired company.\nNORTHROP GRUMMAN CORPORATION\n(1) This calculation was made in compliance with Item 601 of Regulation S-K. Earnings per share presented elsewhere in this report exclude from their calculation shares issuable under employee stock options, since their dilutive effect is less than 3%.\nNORTHROP GRUMMAN CORPORATION\nEXHIBIT 23\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statements Nos. 2-73293, 2-98614, 33-15764, 33-49667, 33-55141, 33-55146, 33-59815 and 33-59853 of Northrop Grumman Corporation on Form S-8 of our report dated February 7,1996, appearing in this Annual Report on Form 10-K of Northrop Grumman Corporation for the year ended December 31, 1995.\nDELOITTE & TOUCHE LLP\nLos Angeles, California February 22, 1996","section_15":""}
{"filename":"102420_1995.txt","cik":"102420","year":"1995","section_1":"Item 1.\nItem 3.","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings.\nAs previously reported, in November 1981, the Company filed a third amended complaint against Louis Wilcox and other former officers of USLIFE Savings and Loan Association, a former subsidiary of the Company, for indemnification, injunctive relief and accounting (USLIFE Savings and Loan Association v. Louis Wilcox, et al., Superior Court of the State of California for the County of Riverside). In April 1984, defendant Louis M. Wilcox filed a cross complaint against the Company seeking general damages of $1 million, punitive damages of $10 million and special damages. In 1986, Wilcox's causes of action for malicious prosecution and abuse of process were dismissed. On appeal, the dismissal of the cause of action for malicious prosecution was reversed while the dismissal of the abuse of process claim was upheld. Pursuant to the Company's request, the case was bifurcated for trial. In July, 1993, the trial court, after hearing evidence on the issue, without a jury, decided that the Company had probable cause to sue Wilcox in 1981. That ruling was dispositive of the claim for malicious prosecution and, thus, the Court dismissed Wilcox's only remaining claim against the Company. A judgment in the Company's favor was entered in late 1993. Wilcox has appealed and the appeal is still pending. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated, nor is it probable in the opinion of management that the ultimate outcome of this litigation will result in a liability to the Company or any of its subsidiaries.\nAs previously reported in the Company's Report on Form 10-Q for the quarter ended September 30, 1995, on November 17, 1994, a purported class action (Smith, et al. v. USLIFE Credit Life Insurance Company, et al.) was filed against three subsidiaries of the Company in the United States District Court for the Northern District of Illinois. The Complaint alleges that in connection with purchases by plaintiffs of single premium term life insurance from mortgage lenders in connection with second mortgage loans, defendants misrepresented the type of insurance offered as credit life insurance and sold the term life insurance at premiums in excess of those permitted for credit life insurance. The Complaint further alleges that upon prepayment of mortgage loans plaintiffs did not receive refunds of unearned premiums, which they would have been entitled to receive had they purchased credit life insurance. On July 27, 1995, the parties filed a Stipulation of Dismissal of plaintiffs' claims against USLIFE Credit Life Insurance Company and Security of America Life Insurance Company, leaving the matter pending against only All American Life Insurance Company. The parties have agreed to a settlement of all claims asserted and the settlement was given tentative approval by the Court on December 20, 1995. Under the terms of the Settlement Agreement, class members will be notified of their right to file claims for partial premium refunds. The settlement would resolve all claims against the Company's subsidiaries in this lawsuit as well as the claims asserted by plaintiffs in two cases previously reported in the Company's Report on Form 10-Q for the quarter ended September 30, 1995, which have been terminated without prejudice (Hoban v. USLIFE Credit Life Insurance Company, All American Life Insurance Company and Security of America Life Insurance Company, and Grant, et al. v. USLIFE Credit Life Insurance Company and Security of America Life Insurance Company). A list of potential class members is being compiled and a status hearing is scheduled. In the opinion of management, the ultimate resolution of this action in accordance with the terms of the Settlement Agreement will not result in a material additional liability on the part of the Company.\nAs previously reported, on August 28, 1995, a purported class action (John G. Robinson & Company, et al. v. The Old Line Life Insurance Company of America) was filed in the District Court of Tarrant County, Texas. On September 29, 1995, the case was removed to the United States District Court for the Northern District of Texas. The Complaint alleges that defendant, a subsidiary of the Company, violated the federal Telephone Consumer Protection Act (\"TCPA\") by sending unsolicited facsimiles of advertisements. Plaintiff also asserts claims for negligence, gross negligence, trespass to chattels and invasion of privacy. The Complaint contains claims for damages in the amount of $500 for each such unsolicited facsimile (allowed under the TCPA) or alternatively, plaintiffs'\nactual monetary loss; plaintiffs have also sued for treble damages or alternatively, punitive damages. Defendant has filed a Motion to Dismiss based on application of the McCarran-Ferguson Act, a Motion to Dismiss plaintiff's class action allegations based on procedural defects and a Motion for Partial Judgment on the Pleadings. These Motions are currently pending before the Court. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated.\nAs previously reported, on March 16, 1995, a purported class action (Dana Galloway v. USLIFE Credit Life Insurance Company) was filed in the Circuit Court of Fayette County, Alabama. The complaint alleges that defendant, a subsidiary of the Company, issued insurance contracts in an amount sufficient to cover the gross amount of indebtedness, rather than the net amount of indebtedness, contrary to Alabama law. The complaint contains claims of fraud and breach of contract based on allegations that defendant misrepresented the amount of insurance needed (based on a recent ruling in a similar case by the Alabama Supreme Court in McCullar v. Universal Underwriters ). Plaintiffs seek compensatory and punitive damages. Defendant contends that its sale of insurance covering the gross amount of indebtedness was done in reliance on regulations promulgated by the Insurance Department of the State of Alabama and is aggressively defending the case. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated.\nIn addition to the aforementioned legal proceedings, the Company and its subsidiaries are parties to various routine legal proceedings incidental to the conduct of their business. Based on currently available information, in the opinion of management, it is not probable that the ultimate resolution of these suits will result in a material liability on the part of the Company.\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.\nUSLIFE's Common Stock is traded on the New York, Chicago, Pacific and London Stock Exchanges. Dividends for the years ended December 31, 1995 and 1994 have been declared and paid to Common Stockholders at the annual rates of $.91 and $.84 respectively (paid quarterly in 1995 and 1994). As of February 22, 1996 there were approximately 8,500 record holders of the Common Stock. The following table sets forth the high and low sales prices for the Common Stock as reported in the consolidated transaction system for each quarterly period during the years indicated.\nMARKET PRICE RANGES (low to high)\n1995 1994 ____ ____\nFirst quarter...... 22.58 - 25.58 25.00 - 27.58 Second quarter..... 24.67 - 27.67 23.25 - 26.42 Third quarter...... 26.17 - 31.58 22.08 - 25.17 Fourth quarter..... 26.88 - 32.00 20.58 - 23.92\nSee Note 18 of Notes to Financial Statements and Management's Discussion and Analysis of \"Liquidity\" herein, for information concerning regulatory restrictions upon payment of dividends by the Life Insurance Subsidiaries to the Company.\nItem 8.","section_6":"","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee separate Index to Financial Statements and Financial Statement Schedules on page 45. See Note 21 of Notes to Financial Statements as to condensed quarterly results of operations.\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.\nExecutive Officers of the Registrant\nThe executive officers of USLIFE are listed below. The executive officers, after their initial election, are elected at USLIFE's annual Board of Directors meeting to serve, unless removed, until the next such annual meeting, scheduled for May 1996.\n(1) Mr. Crosby has served as Chairman of USLIFE Corporation since March 21, 1967 and as Chief Executive Officer from June 6, 1971 to December 31, 1994. Mr. Crosby served as President of USLIFE Corporation from November 1966 to June 1971; from October 1974 to March 1976; from January 1984 to November 1987; from December 1988 to May 1993; and from April 1994 to December 1994.\nAll of USLIFE's executive officers devote their full time to the business of USLIFE or its subsidiaries.\nMessrs. Bushey, Forte, Chouinard, Faulkner and Griffin have served in their present positions for more than five years.\nMr. Henderson was elected Vice Chairman and Chief Executive Officer in February 1996. He previously served as Vice Chairman and Chief Financial Officer since 1983.\nMr. Ruisi was elected President and Chief Operating Officer in February 1996. He previously served as Vice Chairman and Chief Administrative Officer from May 1993 until that date and has been a Director since November 1992. Prior to May 1993, he served as Senior Executive Vice President - Administration since 1990 and as Executive Vice President - Administration from 1987 to 1990.\nMr. Simpson was elected President - Life Insurance Division in February 1996. He previously served as President and Chief Executive Officer of USLIFE Corporation from January 1995 until that date and has served as a Director since March 1990. He served as President and Chief Executive Officer of All American Life from April 1990 to October 1994 and as President - Chief Operating Officer of the life insurance division of USLIFE Corporation from April 1994 to December 1994. Prior to his employment with USLIFE, Mr. Simpson served as President and Chief Operating Officer, and a member of the board of directors of Transamerica Occidental Life Insurance Company since 1986.\nMr. Dicke has served as Executive Vice President - Product Actuary since April 1992. He previously served as Vice President and Actuary for The Equitable Life Assurance Society since April 1991, and as Consultant and Actuary with Tillinghast, a Towers Perrin Company, from 1988 to 1991.\nMr. Gavrity has served as Executive Vice President-Financial Actuary since October 1991 and previously served as Executive Vice President - Chief Actuary since 1984.\nMr. LeFante was elected Executive Vice President - Administration in February 1996. He previously served as Senior Vice President - Audit and Control since September 1991. Prior to that date, he served as Vice President - Audit and Control since 1990.\nMr. Schlomann was elected Executive Vice President - Finance in February 1996. He previously served as Executive Vice President - Financial Operations since joining USLIFE Corporation in October 1993. Prior to that date, he served as Senior Vice President and Controller with Frank B. Hall & Co., Inc. since 1986.\nMr. Hohn has served as Senior Vice President - Investor Relations, Secretary and Counsel since October 1994. He previously served as Senior Vice President - Corporate Secretary and Counsel since May 1993, and as Vice President - Corporate Secretary since April 1991. Prior to that date, he served as consultant to the Life Insurance Council of New York, Inc., a trade association of New York life insurance companies, since 1990.\nMr. Auriemmo has served as Senior Vice President and Treasurer since May 1995. He previously served as Vice President and Treasurer since 1984.\nMr. Stern has served as Senior Vice President - Controller since January 1996. He previously served as Senior Vice President - Accounting since May 1993 and as Vice President - Accounting since 1984.\nMr. Bickler has served as President and Chief Executive Officer of All American Life since May 1995. He previously served as President - Chief Operating Officer of All American Life since October 1994. Prior to that date, he served as Executive Vice President - Marketing with that subsidiary since 1990.\nMr. Cargiulo has served as President and Chief Executive Officer of United States Life since May 1993. He previously served as President- Chief Operating Officer of United States Life since October 1991. Prior to that date, he served as Executive Vice President for individual underwriting and insurance services of that subsidiary since 1990.\nMr. Hendricks has served as President and Chief Executive Officer of USLIFE Systems Corporation since 1988 and as President and Chief Executive Officer of USLIFE Insurance Services Corporation since April 1991.\nMr. Keeler has served as President and Chief Executive Officer of USLIFE Credit Life since May 1995. He previously served as Senior Executive Vice President - Marketing of that subsidiary since May 1994. Prior to joining USLIFE Credit Life at that time, he served as President - Chief Operating Officer for Consolidated Insurance Group of America, Inc. from August 1992. He previously served as executive vice president - chief operating officer of domestic insurance operations and a member of the board of directors of AVCO Financial Services from 1989 to 1992.\nInformation regarding directors of the Registrant is incorporated by reference to USLIFE Corporation's definitive proxy statement to be filed within 120 days after the end of USLIFE's fiscal year ended December 31, 1995 for use in connection with the Annual Meeting of Shareholders to be held on May 21, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation regarding executive compensation is incorporated by reference to USLIFE Corporation's definitive proxy statement to be filed within 120 days after the end of USLIFE's fiscal year ended December 31, 1995 for use in connection with 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 regarding beneficial ownership of USLIFE's voting securities by directors, officers, and persons who, to the best knowledge of USLIFE, are known to be the beneficial owners of more than 5% of any class of USLIFE's voting securities as of March 29, 1996, is incorporated by reference to USLIFE Corporation's definitive proxy statement to be filed within 120 days after the end of USLIFE's fiscal year ended December 31, 1995 for use in connection with 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 by reference to USLIFE Corporation's definitive proxy statement to be filed within 120 days after the end of USLIFE's fiscal year ended December 31, 1995 for use in connection with the Annual Meeting of Shareholders to be held on May 21, 1996.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1 and 2. Financial Statements and Financial Statement Schedules of USLIFE and Subsidiaries.\nSee separate Index to Financial Statements and Financial Statement Schedules on page 45.\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 the Registrant's Registration Statements on Form S-8 Nos. 33-40793 (filed June 23, 1991), 33-13999 (filed May 11, 1987) and 2- 77278 (filed April 30, 1982):\nInsofar as indemnification for liabilities 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(a) 3. Exhibits.\n3 (i) - Restated Certificate of Incorporation, as amended, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, SEC File No. 1-5683.\n3 (ii) - By-laws, as amended and restated, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1994, SEC File No. 1-5683.\n4 (i) - See Exhibit 3(i).\n(ii) - Indenture dated as of October 1, 1982 (9.15% Notes due June 15, 1999, 6.75% Notes due January 15, 1998, and 6.375% Notes due June 15, 2000) incorporated herein by reference to USLIFE's Registration Statement No. 2-79559 on Form S-3.\nAgreements or instruments with respect to long-term debt which are not filed as exhibits hereto do not in total exceed 10% of USLIFE's consolidated total assets and USLIFE agrees to furnish a copy thereof to the Commission upon request.\n(iii) - Amended and Restated Rights Agreement, dated as of September 27, 1994, between USLIFE Corporation and Chemical Bank (successor by merger to Manufacturers Hanover Trust Company), as Rights Agent, relating to Common Stock Purchase Rights issued by USLIFE on July 10, 1986, incorporated herein by reference to USLIFE's Report on Form 8-K dated October 12, 1994, SEC File No. 1-5683.\n10 * (i) - Employment contract dated as of April 1, 1989 between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989, SEC File No. 1-5683.\n* (ii) - First Amendment dated as of May 1, 1989 to employment contract dated as of April 1, 1989 between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, SEC File No. 1-5683.\n* (iii) - Second Amendment dated as of May 1, 1990 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990, SEC File No. 1-5683.\n* (iv) - Third Amendment dated as of May 1, 1991 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, SEC File No. 1-5683.\n* (v) - Fourth Amendment dated as of May 1, 1992 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, SEC File No. 1-5683.\n* (vi) - Fifth Amendment dated as of February 1, 1993 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1992, SEC File No. 1-5683.\n* (vii) - Sixth Amendment dated as of May 1, 1993 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 1-5683.\n* (viii) - Seventh Amendment dated as of May 1, 1994 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, SEC File No. 1-5683.\n* (ix) - Eighth Amendment dated as of May 1, 1995 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Gordon E. Crosby, Jr., incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1-5683.\n* (x) - Employment contract dated as of April 1, 1989 between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989, SEC File No. 1-5683.\n* (xi) - First Amendment dated as of May 1, 1989 to employment contract dated as of April 1, 1989, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, SEC File No. 1-5683.\n* (xii) - Second Amendment dated as of May 1, 1990 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990, SEC File No. 1-5683.\n* (xiii) - Third Amendment dated as of May 1, 1991 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, SEC File No. 1-5683.\n* (xiv) - Fourth Amendment dated as of May 1, 1992 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, SEC File No. 1-5683.\n* (xv) - Fifth Amendment dated as of May 1, 1993 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 1-5683.\n* (xvi) - Sixth Amendment dated as of May 1, 1994 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, SEC File No. 1-5683.\n* (xvii) - Seventh Amendment dated as of May 1, 1995 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Greer F. Henderson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1-5683.\n* (xviii) - Employment contract dated as of April 1, 1989 between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989, SEC File No. 1-5683.\n* (xix) - First Amendment dated as of May 1, 1989 to employment contract dated as of April 1, 1989 between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, SEC File No. 1-5683.\n* (xx) - Second Amendment dated as of May 1, 1990 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990, SEC File No. 1-5683.\n* (xxi) - Third Amendment dated as of May 1, 1991 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, SEC File No. 1-5683.\n* (xxii) - Fourth Amendment dated as of May 1, 1992 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, SEC File No. 1-5683.\n* (xxiii) - Fifth Amendment dated as of May 1, 1993 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 1-5683.\n* (xxiv) - Sixth Amendment dated as of May 1, 1994 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, SEC File No. 1-5683.\n* (xxv) - Seventh Amendment dated as of May 1, 1995 to employment contract dated as of April 1, 1989, as amended, between USLIFE Corporation and Christopher S. Ruisi, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1-5683.\n* (xxvi) - Employment contract dated as of April 16, 1990 between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990, SEC File No. 1-5683.\n* (xxvii) - First Amendment dated as of May 1, 1991 to employment contract dated as of April 16, 1990 between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, SEC File No. 1-5683.\n* (xxviii) - Second Amendment dated as of May 1, 1992 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, SEC File No. 1-5683.\n* (xxix) - Third Amendment dated as of October 1, 1992 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992, SEC File No. 1-5683.\n* (xxx) - Third Amendment dated as of May 1, 1993 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 1-5683.\n* (xxxi) - Fourth Amendment dated as of May 1, 1994 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, SEC File No. 1-5683.\n* (xxxii) - Fifth Amendment dated as of January 1, 1995 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1-5683.\n* (xxxiii) - Sixth Amendment dated as of May 1, 1995 to employment contract dated as of April 16, 1990, as amended, between USLIFE Corporation and William A. Simpson, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1-5683.\n* (xxxiv) - Form of Key Executive Employment Protection Agreement dated November 14, 1995, between USLIFE Corporation and Gordon E. Crosby, Jr., Greer F. Henderson, Christopher S. Ruisi, and William A. Simpson.\n* (xxxv) - Form of Employment and Key Executive Employment Protection Agreement dated November 14, 1995, between USLIFE Corporation and Wesley E. Forte, A. Scott Bushey, Arnold A. Dicke, James M. Schlomann and John D. Gavrity.\n* (xxxvi) - Form of Key Executive Employment Protection Agreement dated November 14, 1995, between USLIFE Corporation and Frank J. Auriemmo, Jr., Richard J. Chouinard, Richard G. Hohn, Michael LeFante and Neal M. Stern.\n* (xxxvii) - Form of Key Executive Employment Protection Agreement dated November 27, 1995, between All American Life Insurance Company and James A. Bickler, USLIFE Real Estate Services Corporation and Philip G. Faulkner, The Old Line Life Insurance Company and James A. Griffin, USLIFE Insurance Services Corporation and Thomas L. Hendricks, USLIFE Credit Life Insurance Company and William M. Keeler, and dated January 24, 1996, between The United States Life Insurance Company In the City of New York and Ralph J. Cargiulo.\n(xxxviii) - Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1986, SEC File No. 1-5683.\n(xxxix) - Amendment to Lease dated August 31, 1988 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1988, SEC File No. 1- 5683.\n(xl) - Second Amendment to Lease dated November 16, 1988 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1988, SEC File No. 1-5683.\n(xli) - Third Amendment to Lease dated May 10, 1989 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1- 5683.\n(xlii) - Fourth Amendment to Lease dated April 14, 1995 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, SEC File No. 1- 5683.\n(xliii) - Fifth Amendment to Lease dated as of December 26, 1995 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York.\n(xliv) - Sixth Amendment to Lease dated as of December 26, 1995 to Lease dated as of December 30, 1986 between The United States Life Insurance Company In the City of New York and RREEF USA Fund-III for the lease of a portion of 125 Maiden Lane, New York, New York.\n(xlv) - Lease dated May 21, 1987 between The United States Life Insurance Company In the City of New York and Commercial Realty & Resources Corp. for the lease of premises at the Jumping Brook Corporate Office Park in Neptune, New Jersey, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1988, SEC File No. 1-5683.\n(xlvi) - February 9, 1989 Amendment to Lease dated May 21, 1987 between The United States Life Insurance Company In the City of New York and Commercial Realty & Resources Corp. for the lease of premises at the Jumping Brook Corporate Office Park in Neptune, New Jersey, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1988, SEC File No. 1-5683.\n* (xlvii) - 1978 Stock Option Plan, as amended, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, SEC File No. 1-5683.\n* (xlviii) - 1981 Stock Option Plan, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, SEC File No. 1-5683.\n* (il) - USLIFE Corporation Non-Employee Directors' Deferred Compensation Plan, as amended January 23, 1996.\n* (l) - USLIFE Corporation Book Unit Plan, as amended effective September 1, 1995, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, SEC File No. 1-5683.\n* (li) - USLIFE Corporation Retirement Plan for Outside Directors (as amended January 23, 1996).\n* (lii) - USLIFE Corporation Restricted Stock Plan, as amended effective September 1, 1995, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, SEC File No. 1-5683.\n* (liii) - USLIFE Corporation 1991 Stock Option Plan, as amended effective September 1, 1995, incorporated herein by reference to USLIFE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, SEC File No. 1-5683.\n* (liv) - USLIFE Corporation Non-Employee Directors' Stock Option Plan, incorporated herein by reference to Exhibit 4(a) to USLIFE's Registration Statement No. 33-53265 on Form S-8 dated April 25, 1994.\n* (lv) - Annual Incentive Plan, as amended October 25, 1994, for Selected Key Officers of USLIFE Corporation and its Subsidiaries, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1994, SEC File No. 1- 5683.\n* (lvi) - USLIFE Corporation Executive Officer Deferred Compensation Plan (as amended January 23, 1996).\n* (lvii) - USLIFE Corporation 1993 Long-Term Incentive Award Guidelines, as amended, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1994, SEC File No. 1-5683.\n* (lviii) - USLIFE Corporation Supplemental Employee Savings and Investment Plan (as amended January 23, 1996).\n* (lix) - USLIFE Corporation Supplemental Retirement Plan (as amended January 23, 1996).\n* (lx) - Trust Agreement made as of March 1, 1994, as amended, effective January 23, 1996, among USLIFE Corporation, Chemical Bank, and KPMG Peat Marwick LLP (as independent contractor) establishing a trust to fund certain employment contracts and the USLIFE Corporation Executive Officer Deferred Compensation Plan.\n* (lxi) - Trust Agreement made as of March 1, 1994, as amended, effective January 23, 1996, among USLIFE Corporation, Chemical Bank and KPMG Peat Marwick LLP (as independent contractor) establishing a trust to fund the USLIFE Corporation Supplemental Retirement Plan and the Supplemental Employee Savings and Investment Plan.\n* (lxii) - Trust Agreement made as of March 1, 1994, as amended, effective January 23, 1996, among USLIFE Corporation, Chemical Bank and KPMG Peat Marwick LLP (as independent contractor) establishing a trust to fund the USLIFE Corporation Retirement Plan for Outside Directors and the USLIFE Corporation Deferred Compensation Plan for outside directors.\n12 - Computations of ratios of earnings to fixed charges.\n21 - List of Subsidiaries.\n23 - Consent of Independent Certified Public Accountants (see page 42).\n27 - Financial Data Schedule.\n99 (i) - Annual Report on Form 11-K of USLIFE Corporation Employee Savings and Investment Plan for the plan year ended December 31, 1995 (to be filed within 120 days of fiscal year end of Plan).\n99 (ii) - Trust Agreement made as of December 6, 1990 among USLIFE Corporation, Manufacturers Hanover Trust Company (predecessor to Chemical Bank), and KPMG Peat Marwick LLP (as independent contractor) establishing a trust to fund the USLIFE Corporation Retirement Plan, incorporated herein by reference to USLIFE's Annual Report on Form 10-K for the year ended December 31, 1990, SEC File No. 1-5683.\n99 (iii) - Amendment, effective January 23, 1996, to the Trust Agreement made as of December 6,1990 among USLIFE Corporation, Manufacturers Hanover Trust Company (predecessor to Chemical Bank), and KPMG Peat Marwick LLP (as independent contractor) establishing a trust to fund the USLIFE Corporation Retirement Plan.\n* Indicates a management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K.\nNo Current Report on Form 8-K has been filed for the last quarter of the fiscal year ended December 31, 1995.\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Board of Directors and Shareholders USLIFE Corporation:\nWe consent to the incorporation by reference in Registration Statements Nos. 33-18287, 33-8489, 33-58944, 33-29934, 33-17126, 33-67344 and 33-9159 on Form S-3 relative to Debt Securities, and common stock, respectively; the post effective amendment to Registration Statement No. 33-29934 on Form S-3 relative to Debt Securities; the post effective amendment to Registration Statement No. 33-9159 on Form S-3 relative to common stock; the post effective amendments to Registration Statement Nos. 2-93655 and 33-11019 on Form S-3 relative to the General Agents Incentive Compensation Plan; Registration Statement No. 33-45377 on Form S-3 relative to the United States Life Insurance Company Retirement Plan for General Agents and Producers; the post effective amendments to Registration Statement No. 33-17126 relative to Debt Securities; Registration Statement No. 33-40793 on Form S-3 relative to the 1991 Stock Option Plan; Registration Statement No. 33-53265 on Form S-8 relative to the USLIFE Corporation Non- Employee Directors' Stock Option Plan; and the post effective amendment to Registration Statement Nos. 2-63159, 2-32606 and 2-77278 on Form S-8 relative to the Stock Option Plans and Registration Statement Nos. 2-75011 and 33-13999 on Form S-8 relative to the Employee Savings and Investment Plan of USLIFE Corporation of our report dated February 27, 1996, relating to the consolidated balance sheets of USLIFE Corporation and subsidiaries as of December 31, 1995 and 1994 and the related statements of consolidated income, equity capital, and cash flows for each of the years in the three-year period ended December 31, 1995 which report appears in this December 31, 1995 Annual Report on Form 10-K of USLIFE Corporation. Our report refers to a change in accounting to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\".\n\/s\/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP\nMarch 26, 1996 345 Park Avenue New York, New York\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUSLIFE Corporation (Registrant)\nDated: March 26, 1996\nBy:\/s\/ Gordon E. Crosby, Jr. ___________________________ (Gordon E. Crosby, Jr., Chairman of the Board)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders USLIFE Corporation:\nWe have audited the accompanying consolidated balance sheets of USLIFE Corporation and subsidiaries as of December 31, 1995 and 1994, and the related statements of consolidated income, equity capital, 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 USLIFE 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.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for debt and equity securities in 1994 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\n\/s\/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP\nFebruary 27, 1996 345 Park Avenue New York, New York\nSee accompanying notes to financial statements.\nUSLIFE CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNote 1. Significant Accounting Policies\nBasis of Presentation\nThe consolidated financial statements have been prepared in accordance with generally accepted accounting principles (\"GAAP\") and include the accounts of USLIFE and all of its subsidiaries (the \"Company\"). GAAP differs from the statutory accounting practices used by the Company's operating subsidiaries to report to insurance regulatory authorities (see Note 18). All subsidiaries are wholly owned. All material intercompany accounts and transactions have been eliminated.\nUse of Estimates\nThe preparation of financial statements in accordance 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.\nChanges in Accounting Principles\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 (\"SFAS 114\"), entitled \"Accounting by Creditors for Impairment of a Loan,\" as modified by SFAS 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" These Statements require a writedown, as defined by SFAS 114, for certain mortgage loans and similar investments where impairment results in a change in repayment terms. The adoption of these Statements did not have a material impact on the Company's reported financial position or results of operations.\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), entitled \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS 115 requires that debt securities which may be sold as part of the Company's asset\/liability management strategy be classified as \"available for sale\" and carried at fair value in the Consolidated Balance Sheets, commencing with the date of adoption of the Statement. The Company's portfolio of debt securities had been similarly classified as \"available for sale\" prior to the adoption of SFAS 115, but was carried at lower of aggregate adjusted cost or fair value pursuant to previous accounting standards. Since the aggregate fair value of these securities exceeded their adjusted cost at December 31, 1993, this classification had no impact on Equity Capital at that date. The Company's equity securities portfolio had been carried at fair value in accordance with previous accounting standards prior to the adoption of SFAS 115 and continues to be carried at fair value as required by the Statement.\nAs required by SFAS 115, the net impact of the initial adjustment to fair value of these securities, less corresponding adjustments to deferred policy acquisition costs (required where fair value differs from cost for certain securities), certain policyholder liabilities, and deferred income taxes, was recorded through a direct credit to \"Net unrealized gains (losses) on securities\" included in Equity Capital as follows:\n(Amounts in Thousands)\nImpact of adoption of SFAS 115:\nUnrealized gain on debt securities at January 1, 1994......... $380,343 Less: Adjustment of deferred policy acquisition costs............. 99,889 Increase in certain policyholder liabilities................ 16,706\n________\nAdjustment to Equity Capital before federal income tax........ 263,748 Adjustment of deferred federal income tax liability........... (92,312) ________\nNet adjustment to Equity Capital at January 1, 1994........... $171,436 ========\nSFAS 115 requires that unrealized gains and losses on available-for-sale securities, other than those relating to a reduction in value determined to be other than temporary, be recorded as direct charges and credits to \"Net unrealized gains (losses) on securities\" included in Equity Capital. Consequently, the recognition of these unrealized gains and losses (including the required adjustments of deferred policy acquisition costs, certain policyholder liabilities, and deferred income taxes) has no impact on net income.\nUnder both SFAS 115 and previous accounting standards, valuation reserves (established through income statement charges) are maintained as an adjustment to cost for investments, including \"available for sale\" securities, with a reduction in value determined to be other than temporary. The cost and fair value of the Company's investments in securities are presented in Note 3.\nAlso in 1994, the Company adopted Statement of Financial Accounting Standards No. 112, (\"SFAS 112\") entitled \"Employers' Accounting for Postemployment Benefits.\" SFAS 112 requires advance recognition of non- retirement benefits such as severance pay and health insurance continuation when certain conditions are met. The adoption of SFAS 112 did not have a material impact on the Company's reported financial position or results of operations. Financial statements of previous years were not restated as a result of the adoption of SFAS 112.\nSplit of Common Stock\nIn July 1995, the Board of Directors of USLIFE Corporation approved a 3- for-2 split of its common stock, $1.00 par value. As a result of this action, one additional share of USLIFE common stock was distributed on September 22, 1995 for each two shares held by shareholders of record on September 1, 1995. The par value of the common stock was not changed, and the aggregate par value of $19.2 million for the additional shares issued was transferred from Paid-in Surplus to Common Stock as of the effective date of the transaction. All references in the financial statements herein to number of common shares and related prices, per-share amounts, and stock plan data have been restated as appropriate to reflect the 3-for-2 split of the Company's common stock.\nFuture Accounting Changes\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") 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.\" The Statement requires that long-lived assets such as property and equipment, and certain intangible assets, be reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. When recoverability standards specified in the Statement are not met, a writedown of the covered assets may be required. The Statement does not apply to various classes of assets including the Company's investment securities and deferred policy acquisition costs, which will continue to be evaluated based on previously established accounting standards. The adoption of this Statement, in the first quarter of 1996, will not have a material impact on the Company's financial position or results of operations.\nIn October 1995, FASB issued Statement of Financial Accounting Standards No. 123, entitled \"Accounting for Stock-Based Compensation.\" This Statement, which must be adopted no later than 1996, establishes financial accounting and reporting standards for stock option plans and other stock-based forms of compensation. Under previously established accounting standards, stock options such as those granted by the Company (with option price set equal to market price at date of grant) do not require income statement charges, although the outstanding options are considered in earnings per share calculations. FASB 123 introduces standards for computing \"fair value\" of these stock options using a mathematical model, as well as expense charges over the related service period based on this calculated value. However, companies can elect to report the pro- forma impact of these computed charges on net income and earnings per share in a footnote rather than actually recording the computed income statement charges. USLIFE Corporation will adopt Statement No. 123 in 1996 and intends to provide footnote disclosure of the pro-forma impact of the calculated stock option expense charges, commencing with its year end 1996 financial statements (indicating comparative data for 1995), rather than record these charges in its income statement.\nInvestments\nThe Company's investment management policies include continual monitoring and evaluation of securities market conditions and circumstances relating to its investment holdings which may result in the selection of investments for sale prior to maturity. Securities may also be sold as part of the Company's asset\/liability management strategy in response to changes in interest rates, resultant prepayment risk, and similar factors. Accordingly, the Company's entire fixed maturity portfolio (bonds and redeemable preferred stocks) is classified as \"available for sale\" and is carried in the accompanying consolidated balance sheets at fair value. The Company's investments in non- redeemable preferred stocks and common stocks (\"equity securities\") are carried at fair value in the accompanying consolidated balance sheets. Fair values for fixed maturities and equity securities are based on quoted market prices or dealer quotes.\nMortgage loans are carried at the aggregate of unpaid principal balances, net of unamortized discount and applicable reserves and writedowns. Mortgage loans are considered impaired when it is determined to be probable that the Company will not collect all amounts due under the contractual terms of the loan agreement, and are evaluated based on present value of estimated future cash flows discounted at the contractual rate of the loan. Mortgage loans that are more than 60 days delinquent or in foreclosure are carried at the lower of amortized cost or estimated net realizable value of the underlying collateral.\nReal estate is carried at the lower of depreciated cost or estimated net realizable value. Depreciation is calculated on a straight line basis with useful lives varying based on the type of building.\nPolicy loans are stated at the aggregate of unpaid principal balances. Other long term investments are stated at the lower of cost or their estimated net realizable value. Short term investments are carried at cost, which approximates fair value.\nRealized gains and losses are included in net income based on specific identification of investments disposed.\nValuation reserves (established through income statement charges which are included in realized gains and losses) are maintained as an adjustment to cost for investments, including \"available for sale\" securities, with a reduction in value determined to be other than temporary.\nUnrealized gains and losses on available-for-sale securities, other than those relating to a reduction in value determined to be other than temporary, are recorded through direct charges and credits to Equity Capital.\nLife Insurance\nTraditional Individual Contracts; Group and Credit Insurance\nThe Company's traditional individual life insurance products, including term insurance, whole life insurance, and immediate annuities, generally provide fixed premiums and guaranteed benefits. Premiums on these policies, as well as group and credit life and health insurance contracts, are recognized when due. Appropriate provisions are made for future policy benefits or unearned premiums. Policy claims are charged to expense when incurred.\nLiabilities for future policy benefits relating to traditional life insurance policies have been computed by the net level premium method based on estimated future investment yield, mortality and termination experience. Interest rate assumptions for most non-interest sensitive life insurance have ranged from 2-1\/2 to 3-1\/2 percent on issues of 1959 and prior, to 5-1\/2 to 6- 3\/4 percent on issues of 1967 and subsequent years. (On certain products, the rate ranges as high as 8-3\/4 percent.) Mortality has been calculated principally on an experience multiple applied to select and ultimate tables in common usage in the industry. Estimated terminations have been determined principally based on industry tables.\nUniversal Life-Type and Investment Contracts\nUniversal life insurance policies permit the policyholder to vary the timing and amount of premium payments, within contractual limits. Revenues for universal life insurance, other interest-sensitive life insurance, and investment contracts include policy charges for administration and cost of insurance, and surrender charges assessed against policyholder account balances during the period. These charges are subject to periodic adjustment by the Company. Premiums received on these products are treated as policyholder deposits rather than revenues. The liability for policyholder account balances represents the accumulated amounts which accrue to the benefit of policyholders, and reflects interest credited at rates which are subject to periodic adjustment. Charges to expense relating to these policies and contracts include such interest credited as well as benefits during the period in excess of related policy account balances.\nDeferred Policy Acquisition Costs\nThe costs of acquiring new business (principally commissions) and certain costs of issuing policies (such as medical examinations and inspection reports) and certain agency and marketing expenses, all of which vary with and are primarily related to the production of new business, have been deferred.\nFor most policies other than universal life-type contracts, these costs are being amortized over the premium-paying periods of the related policies in proportion to the ratio of the annual premium revenue to the total anticipated premium revenue. Anticipated premium revenue was estimated using the same assumptions which were used for computing liabilities for future policy benefits.\nFor universal life-type contracts, these costs are being amortized over the lives of the policies in relation to the incidence of gross profits arising principally from investment, mortality and expense margins. Additionally, as required by SFAS 115, the carrying amount of these costs is adjusted at each balance sheet date as if the unrealized gains or losses on securities associated with these contracts had been realized and included in the gross profits used to determine required amortization.\nDeferred policy acquisition costs are reviewed at least annually to determine that the unamortized portion of such costs does not exceed recoverable amounts, after considering anticipated investment income.\nParticipating Policies\nParticipating policies subject to profit limitations approximate 4.9 percent of the individual life insurance in force at December 31, 1995 and 9.5 percent of individual life insurance premium income in 1995. The portion of earnings therefrom that inures to the benefit of the participating policyholders is not available to shareholders. Undistributed earnings payable to participating policyholders are included as a liability in the Consolidated Balance Sheets.\nAll participating policies approximate 5.0 percent of the total individual life insurance in force at December 31, 1995 and 9.7 percent of individual life insurance premium income in 1995. The provisions for dividends to policyholders in the statements of consolidated income include dividends paid or payable on participating policies.\nLiability for Unpaid Claims\nThe liability for unpaid claims and claim adjustment expenses is based on the estimated amount payable on claims reported prior to the balance sheet date which have not yet been settled, claims reported subsequent to the balance sheet date which have been incurred during the period then ended, and an estimate (based on prior experience) of incurred but unreported claims relating to such period.\nLiability for Guaranty Fund Assessments\nThe Company's life insurance subsidiaries may be required, under the solvency or guaranty laws of the various states in which they are licensed, to pay assessments up to prescribed limits to fund policyholder losses or liabilities of insolvent insurance companies. Certain states permit these assessments, or a portion thereof, to be recovered as an offset to future premium taxes. Assessments are recognized based on notification of liability by regulatory authorities, including provision for certain future amounts payable, and, when subject to credit against future premium taxes and judged to be recoverable, may be capitalized and amortized on a basis consistent with the credits to be realized under applicable state law.\nReinsurance\nAmounts paid for or recoverable under reinsurance contracts are included in total assets as reinsurance receivable or recoverable amounts. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.\nOther Assets\nIncluded in other assets is the unamortized portion of goodwill, representing the excess of cost over the value of net assets acquired in subsidiary acquisitions accounted for by the purchase method. Such amounts are being amortized by straight-line basis charges to income over forty year periods which began at the respective dates of acquisition of the acquired subsidiaries. Amortization of goodwill amounted to approximately $2 million for each of the three years ended December 31, 1995.\nIncome Taxes\nDeferred income taxes arise as a result of applying enacted statutory tax rates to the temporary differences between the financial statement carrying value and the tax basis of assets and liabilities. Such differences result primarily from amounts capitalized for policy acquisition costs and calculated for future policy benefit liabilities.\nThe Company and its subsidiaries file a consolidated Federal income tax return and have elected to include the life insurance and non-life insurance subsidiaries in the consolidated tax return. Taxes on income for life insurance and non-life insurance subsidiaries are recorded in the individual income accounts of the subsidiaries and are remitted to the Company on a separate return basis. The provision for taxes in the Statements of Consolidated Income represents the tax for all companies on a consolidated return basis.\nIncome Per Share\nIncome per share was computed by dividing the income applicable to common and common equivalent shares by the weighted average number of common and common equivalent shares outstanding during each year. The weighted average number of common and common equivalent shares was determined by using the average number of common shares outstanding during each year, net of reacquired (treasury) shares from the date of acquisition; by converting the shares of the Series A and Series B Preferred Stock to their equivalent common shares, and by calculating the number of shares issuable on exercise of those common stock options with exercise prices lower than the market price of the common stock, reduced by the number of shares assumed to have been purchased with the proceeds from the exercise of the options. Fully diluted income per share is the same as income per share data indicated.\nStandby and Permanent Financing Commitments\nIn the ordinary course of investment operations, the life insurance subsidiaries may, in return for commitment fees, extend standby commitments which represent contingent obligations to replace certain borrowings in the event of default by unaffiliated borrowers. The life insurance subsidiaries historically have not provided permanent financing on the major portion of such commitments. The life insurance subsidiaries also may extend permanent financing commitments for investments in mortgage loans, with specified closing dates typically within 90 to 120 days after approval and interest rates and other terms (based on the credit policies utilized for investments in mortgage loans) determined at the commitment date. There were no outstanding standby commitments or material permanent financing commitments at December 31, 1995.\nNote 2. Nature of Operations and Segment Information\nUSLIFE Corporation is a life insurance-based holding company whose principal subsidiaries engage in the life insurance business. USLIFE operates nationwide through four life insurance companies and offers a broad portfolio of individual life insurance and annuity policies as well as group and credit insurance. The individual life and annuity product line, which includes universal life, term life, whole life, and deferred annuity products as well as income attributed to capital and surplus, accounts for the major portion of USLIFE's pre-tax income and total revenues. These individual products are sold primarily through independent general agencies who are compensated on a commission basis and usually sell products of other companies in addition to those of USLIFE. Other product lines include group life and health insurance, sold principally through employers and associations, and credit life and disability products which are sold primarily to customers of financial institutions through USLIFE's credit insurance group.\nThe only reportable industry segment of the Company is \"Life Insurance\" and the related information is presented below:\nSupplementary information for product groups included in the Life Insurance industry segment is presented below:\nNote 3. Investments\nThe investments of the Company at December 31, 1995 are summarized as follows:\nBased on balance sheet carrying value, assets categorized as \"non-income producing\" for the 12 months ended December 31, 1995 included in fixed maturities, mortgage loans, real estate investment properties, and real estate acquired in satisfaction of debt amounted to $7.0 million, $4.5 million, $6.1 million and $.9 million, respectively.\nAt December 31, 1995, consolidated invested assets included approximately $244 million (based on adjusted cost) of less than investment grade corporate securities, based on ratings assigned by recognized rating agencies and insurance regulatory authorities. Such investments had an aggregate fair value of approximately $246 million at December 31, 1995 and, based on fair value, represent approximately 3% of consolidated total assets at that date. Approximately $7 million (at fair value) of these investments (adjusted cost, $6 million) represented securities in default at December 31, 1995. Also at December 31, 1995, the book value of mortgage loans included in consolidated total assets which were 60 days or more delinquent or in foreclosure was approximately $5 million, and the book value of property acquired through foreclosure of mortgage loans was approximately $18 million.\nThe adjusted cost and fair value of the Company's consolidated investments in equity securities and debt securities at December 31, 1995 and 1994 are as follows:\nEquity Capital at December 31, 1995 and 1994 includes net unrealized gains and losses on available-for-sale securities as follows:\nChanges in net unrealized gains and losses on available-for-sale securities were as follows:\nThe classification of the Company's fixed maturity portfolio as \"available for sale\" had no impact on Equity Capital at December 31, 1993, when these securities were carried at the lower of aggregate adjusted cost or market value, since the aggregate market value of these securities exceeded their adjusted cost at that date.\nRealized gains and losses on the Company's consolidated investments in fixed maturities and equity securities for the three years ended December 31, 1995 are summarized as follows:\nPre-tax realized gains and losses shown above reflect provisions for valuation of certain investments with decline in value determined to be other than temporary.\nPre-tax realized gains and losses on fixed maturities and equity securities are reconciled to consolidated realized gains and losses on investments as follows:\n1995 1994 1993 __________ __________ __________\n(Amounts in Thousands) Realized gains (losses):\nFixed maturities.............. $ 3,629 $ (630) $ 46,891 Equity securities............. 262 (923) 897 __________ __________ __________\n3,891 (1,553) 47,788\nReal estate, mortgage loans, and other investments (a)... 2,497 173 (39,272)\n__________ __________ __________\nTotal......................... $ 6,388 $ (1,380) $ 8,516 ========== ========== ==========\n(a) Reflects provisions for valuation to estimated net realizable value for certain investments.\nThe adjusted cost and fair value of debt securities at December 31, 1995 and 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.\nProceeds from disposals of investments in debt securities (excluding short term investments) during 1995, 1994 and 1993 were $437.7 million, $1.072 billion, and $1.209 billion, respectively. During 1995, gross gains of $12.5 million and gross losses of $8.9 million were realized on such disposals. During 1994, gross gains of $31.3 million and gross losses of $31.9 million were realized on such disposals. During 1993, gross gains of $57.9 million and gross losses of $11.0 million were realized on such disposals.\nThe details of consolidated net investment income for the three years ended December 31, 1995 follow:\nNote 4. Deferred Policy Acquisition Costs\nDetails with respect to consolidated deferred policy acquisition costs for the three years ended December 31, 1995 are as follows:\nThe balance of deferred policy acquisition costs is allocated to product lines as follows:\nThe balance of deferred policy acquisition costs for employer\/association group health insurance includes amounts deferred with respect to the Company's traditional indemnity major medical coverages. As a result of a shift in market emphasis toward managed care products and consequent decline in revenues from indemnity products, the Company initiated strategies to increase the proportion of group business from non-major medical lines, and introduced new managed care products in several states (using provider networks made available through unrelated companies).\nAlthough a significant portion of the Company's 1995 major medical sales came from managed care products, historically the majority of its group insurance premium revenues were derived from indemnity major medical coverages. As a result, about 60% of current employer\/association group health and disability premium in force relates to traditional indemnity products. These policies were often sold together with employer\/association group life insurance. Recoverability of deferred policy acquisition costs for the employer \/ association lines has been evaluated based on estimates of future persistency and claims experience by aggregating related product groups.\nIn January 1996, the Company announced that it would discontinue offering its traditional indemnity major medical products, and that it would restrict its new sales of managed care major medical products to eight states where it has significant market presence and an appropriate managed care network in place. The Company will, however, continue to provide full support and service to all existing indemnity customers regardless of location and will seek to convert cases from indemnity coverage to managed care in order to conserve the business. The Company will continue to monitor this business in order to determine whether future financial statement adjustments are necessary.\nNote 5. Notes Payable\nNotes payable at December 31, 1995 includes $150 million borrowings under a revolving credit agreement between the Company and The Bank of New York (as agent) which expires in April 1996, at which time all borrowings thereunder must mature. The credit agreement provides for term borrowings in segments of up to six months with interest indexed to the LIBOR borrowing rate or based on certain alternative interest rates at the option of the Company. USLIFE has the option to prepay amounts borrowed under the credit agreement, in whole or in part, and to reborrow loans thereunder provided the total amount of outstanding borrowings does not exceed $150 million.\nAlso included in this item are short term borrowings against bank lines of credit or pursuant to certain bank revolving credit agreements, and other short term bank borrowings. The Company has lines of credit of $60.0 million with 7 banks and a revolving short term bank credit agreement which provide term loan borrowing facilities up to a maximum of $100 million. The lines of credit provide for annual review and renewal at the option of each bank. The interest rates and terms of loans under the lines of credit and the revolving credit agreements are determined bilaterally on the date of borrowing. Although there are no formal requirements to maintain compensating balances, the Company has carried balances which generally approximate 5 to 10 percent of the lines.\nThe following table sets forth summary information with respect to short term borrowings of the Company for the three years ended December 31, 1995.\n(a) The average amounts of short term borrowings were computed by determining the arithmetic average of months' end short term borrowings.\n(b) The weighted average interest rates were determined by dividing interest expense related to short term borrowings by the average amounts of such borrowings.\nNote 6. Long Term Debt\nAt December 31, 1995 and 1994, consolidated long term debt consists of the following:\nThe contractual maturities of the Company's long term debt are as follows:\nParent Company and Consolidated _______________________________\nDecember 31, December 31, 1995 1994 ____________ ____________\n(Amounts in Thousands)\n1998....................... $149,861 $149,798 1999....................... 50,000 50,000 2000....................... 149,632 149,562 ________ ________\nTotal............... $349,493 $349,360 ======== ========\nNone of the Company's debt issues are or have been in default.\nNote 7. Federal Income Taxes\nFederal income tax expense relating to operations of the Company for 1995, 1994 and 1993 is comprised of the following components:\nThe Omnibus Budget Reconciliation Act of 1993, enacted in August 1993, increased the Federal corporate income tax rate from 34% to 35% retroactively to January 1, 1993. This rate increase resulted in additional tax expense for the first half of 1993 amounting to $666 thousand, and the effect of the tax rate change upon net deferred tax liabilities as required by Statement of Financial Accounting Standards No. 109 (\"SFAS 109\") was $1.322 million. In accordance with SFAS 109, the $1.988 million aggregate catch-up impact of the rate change was included in Federal income tax expense for 1993.\nThe significant components of deferred income tax expense for the years ended December 31, 1995, 1994 and 1993 are as follows:\nTotal tax expense differs from the amount computed by applying the Federal income tax rate of 35 percent in 1995, 1994 and 1993, to income before tax for the following reasons:\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 presented below:\nDecember 31 ______________________\n1995 1994 ____ ____\n(Amounts in Thousands)\nDeferred Tax Assets:\nFuture policy benefits.......................... $ 152,158 $ 136,884 Net unrealized loss on securities............... -- 84,134 Tax net operating loss carryforward............. 26,161 26,752 Capital gains and losses........................ 40,211 39,845 Capitalization of policy acquisition costs, net of amortization, for tax return purposes.. 66,859 56,313 Sale and leaseback transactions................. 873 1,745 Allowance for uncollectible receivables......... 2,496 2,496 Resisted claim liability........................ 2,840 2,043 Employee retirement benefits.................... 29,740 27,930 Unearned interest............................... 1,451 1,560 Accrual of interest payable..................... 353 1,053 Differences between tax and accounting for reinsurance............................... 926 5,333 Other........................................... 2,510 2,346 _________ _________\nTotal gross deferred tax assets................. 326,578 388,434\nTotal valuation allowance....................... (16,368) (16,368) _________ _________\nNet deferred tax assets......................... 310,210 372,066 _________ _________\nDeferred Tax Liabilities: _________________________\nDeferral of policy acquisition costs, net of amortization, for accounting purposes......... (299,028) (275,501) Net unrealized gain on securities............... (105,244) -- Basis differences between tax and accounting for joint ventures............................ (4,499) (6,427) Basis differences between tax and accounting for securities................................ (4,920) (5,145) Depreciation.................................... (5,387) (5,502) Prepaid expenses................................ (3,055) (1,642) Other........................................... (10,853) (6,184) _________ _________\nTotal gross deferred tax liabilities............ (432,986) (300,401)\n_________ _________\nNet deferred tax asset (liability).............. $(122,776) $ 71,665 ========= =========\nFederal income tax returns have been examined and settled for all years through 1988. The Company believes that its recorded income tax liabilities are adequate for all open years.\nUnder the provisions of prior tax law applicable to life insurance companies, one half of the excess of the gain from operations of a life insurance company over its taxable investment income was not taxed but was set aside in a special \"Policyholders' Surplus Account\". Under provisions of the Tax Reform Act of 1984, this account is \"frozen\" as of December 31, 1983 and is subject to tax under conditions set forth pursuant to prior tax law. Policyholder Surplus may be taxable at the time of its distribution to the company's shareholders or under certain other specified conditions. The Company does not believe that any significant portion of the amount in this account will be taxed in the foreseeable future. However, should the balance at December 31, 1995 become taxable, the tax computed at present rates would be approximately $47.8 million.\nAt December 31, 1995, the Company has nonlife net operating loss carryforwards for Federal income tax purposes of approximately $74.7 million which are available to offset future Federal taxable income, if any, through 2010.\nNote 8. Liability for Unpaid Claims\nActivity in the liability for unpaid claims and claim adjustment expenses for the Company's health and disability coverages is summarized as follows:\n1995 1994 1993 ________ ________ ________ (Amounts in Thousands)\nBalance at January 1................. $ 73,627 $ 81,638 $104,222 Less: reinsurance recoverables....... 4,115 4,021 13,831 ________ ________ ________ Net balance at January 1............. 69,512 77,617 90,391 ________ ________ ________\nAmount incurred (a).................. 301,344 334,699 370,409\nAmount paid, related to: Prior years (b).................. 102,099 94,083 121,470 Current year..................... 196,024 248,721 261,713 ________ ________ ________ Total...................... 298,123 342,804 383,183 ________ ________ ________\nNet balance at December 31........... 72,733 69,512 77,617 Plus: reinsurance recoverables....... 5,107 4,115 4,021 ________ ________ ________ Balance at December 31............... $ 77,840 $ 73,627 $ 81,638 ======== ======== ========\n(a) Substantially all of the Company's incurred claims and claim adjustment expenses relate to the respective current year.\n(b) Includes current year incurred amount on certain claims originating prior to respective current year.\nNote 9. Retirement Plans\nThe Company and its subsidiaries have a qualified noncontributory defined benefit pension plan covering substantially all employees. Benefits are generally based on years of service, the employee's compensation during the last three years of employment, and an average of Social Security covered wage bases. It is the Company's policy to fund pension costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Based on such standards, contributions amounting to $4.2 million, $4.5 million and $4.5 million were made for the years ended December 31, 1995, 1994 and 1993, respectively. Substantially all of the Plan assets are invested in the general investment account of a life insurance subsidiary of the Company through a deposit administration insurance contract. As a result of compensation and benefit limitations under Federal tax law applicable to the Company's qualified defined benefit pension plan, the \"excess\" portion of the pension benefits for certain employees is provided under an unfunded Supplemental Retirement Plan for which eligibility requirements and certain other provisions were modified during 1993. Additionally, the Company has an unfunded Retirement Plan for Outside Directors which provides pension benefits to non-employee Directors of USLIFE Corporation subject to specified eligibility requirements. Benefits are based on years of service and the annual retainer at time of retirement.\nPension expense for all of the above pension plans amounted to $7.724 million, $7.848 million and $5.212 million in 1995, 1994 and 1993, respectively. The net periodic pension cost for these plans in 1995, 1994 and 1993 included the following components:\nThe funded status is reconciled to accrued pension cost included in the Company's consolidated balance sheets as of December 31, 1995 and 1994 as follows:\nThe unrecognized net asset relating to the qualified pension plan is being recognized over a 14 year period which began January 1, 1987. Under Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" an additional minimum pension liability is required for the Company's non- qualified plans to reflect the excess of the accumulated benefit obligations over the liability already recognized as unfunded accrued pension cost. Statement No. 87 also permits offsetting of this liability with an intangible asset, based on provisions of the Statement. The unrecognized net loss and unrecognized prior service cost relating to the Company's pension plans are subject to amortization on a straight-line basis over the estimated average future service period of active employees expected to receive benefits under the plan. Assumptions used in the actuarial computations for the Company's pension plans were as follows:\nIn addition to providing pension benefits, the Company and its subsidiaries provide certain health care and life insurance benefits to retired employees under a defined benefit plan. Employees may become eligible for these benefits if they have accumulated ten years of service and reach normal or early retirement age while working for the Company. The plan provides benefits supplemental to Medicare after retirees are eligible for Medicare benefits. The\npostretirement benefit plan contains cost-sharing features such as deductibles and coinsurance, and contributions of certain retirees are subject to annual adjustment. It is the Company's current policy to fund these benefits, which are provided through an insurance contract with a life insurance subsidiary of the Company, on a \"pay as you go\" basis.\nDuring 1993, the Company's non-pension postretirement benefit program was modified in several respects, including the establishment of a maximum dollar cap on amounts to be paid by the Company for future increases in the cost of retiree health benefits. These plan amendments resulted in an unrecognized reduction in prior service cost, which is being amortized over the remaining average service period to full eligibility for benefits of the active participants. Excess gains or losses are being amortized over the average remaining service period to full eligibility for benefits of the active participants.\nThe funded status of the non-pension postretirement benefit program as of December 31, 1995 and 1994 is reconciled to accrued postretirement benefit cost as follows:\nNet periodic postretirement benefit cost for 1995, 1994 and 1993 included the following components:\nFor measurement purposes, a 10 percent annual rate of increase in the per- capita cost of covered health benefits (ie., health care cost trend rate) was assumed for 1995; the rate was assumed to decrease gradually to 6 percent by the year 1997 and remain at that level thereafter. A 9 percent annual rate of increase in claims reimbursed by Medicare for retirees over age 65 was assumed for 1995; the rate was assumed to decrease gradually to 6 percent by the year 1997 and remain at that level thereafter. The assumed health care cost trend rate does not have a significant effect on the amounts reported in accordance with Statement of Financial Accounting Standards No. 106 (\"Employers' Accounting for Postretirement Benefits Other Than Pensions\") due to the maximum dollar cap adopted. 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 approximately $185 thousand and the aggregate of the service and interest cost components of 1995 net periodic postretirement benefit cost by $12 thousand. The discount rate used in determining the accumulated postretirement benefit obligation was 7.0% at December 31, 1995, 8.25% at December 31, 1994 and 7.5% at December 31, 1993.\nNote 10. Capital Stock\nNon-Redeemable Preferred Stocks\nThe $4.50 Series A Convertible Preferred Stock ($1.00 par value; authorized and issued as of December 31, 1995, 4,480 shares; December 31, 1994, 4,653 shares; December 31, 1993, 4,815 shares) is carried at involuntary liquidating value of $100 per share in the financial statements; is entitled to cumulative annual dividends of $4.50 per share; may be redeemed in whole or in part at the option of the Company at $100 per share; and is convertible at any time into Common Stock at a conversion price which at December 31, 1995 was $8.33 per share (each share of Series A Stock valued at $100), subject to adjustment under a formula intended to protect against dilution in certain events. Holders are entitled to vote together with the Common Stock and Series B Convertible Preferred Stock as one class on the basis of one vote per share and to vote as a class upon the election of two directors during any period in which four quarterly dividends (whether or not consecutive) are in default.\nThe $5.00 Series B Convertible Preferred Stock ($1.00 par value; authorized and issued as of December 31, 1995, 1,852 shares; December 31, 1994, 2,003 shares; December 31, 1993, 2,050 shares) is carried at involuntary liquidating value of $50 per share in the financial statements; is entitled to cumulative annual dividends of $5.00 per share; may be redeemed in whole or in part at the option of the Company at $100 per share; and is convertible at any time into Common Stock at a conversion price which at December 31, 1995 was $8.34 per share (each share of Series B Stock valued at $100), subject to adjustment under a formula intended to protect against dilution in certain events. Voting rights are the same as those of holders of Series A Stock.\nThe Preferred Stock, undesignated ($1.00 par value; authorized as of December 31, 1995, 10,793,668 shares, issued none), may be issued by authorization of the Board of Directors without further approval of shareholders. The Board has broad powers to fix the terms of such issues subject to the limit that the aggregate of all amounts which may be paid to holders of all of the series of Preferred Stock upon the involuntary liquidation, dissolution or winding up of the Company cannot exceed $100 times the number of such shares plus accrued unpaid dividends.\nCommon Stock\nThe outstanding shares of Common Stock (par value $1.00 per share; authorized, as of December 31, 1995, 1994 and 1993: 60,000,000 shares; issued, including treasury shares, as of December 31, 1995, 57,468,882 shares; December 31, 1994, 57,465,735 shares; December 31, 1993, 57,463,235 shares) entitle each holder to one vote per share in the election of directors and on all other matters submitted to a vote of shareholders and to such dividends and distributions as may be declared by the Board of Directors out of funds legally available. At December 31, 1995, 75,965 shares of Common Stock were reserved for issuance upon conversion of Preferred Stock. The Company sponsors, through certain of its life insurance subsidiaries, savings plans for selected general agents and producers (the \"Agents Plans\") providing for distribution of Common shares to participants if specified qualification and vesting requirements are satisfied. As of December 31, 1995, participant interests relating to 34,713 Common shares had vested under the Agents Plans. On July 10, 1986 the Company issued, to shareholders of record on that date, one Common Stock Purchase Right (a \"Right\") for each share of Common Stock owned on that date. Until the Rights become exercisable they will be represented by the stock certificates for all outstanding Common Stock including newly issued shares. Upon the occurrence of certain events specified in a Rights Agreement dated as of June 24, 1986 and amended and restated as of September 27, 1994 between the Company and Chemical Bank (successor by merger to Manufacturers Hanover Trust Company) as Rights Agent, the Rights will become exercisable, separate certificates representing the Rights will be issued, and each Right will entitle the holder to purchase one half of a share of the Common Stock for $107. Under certain circumstances specified in the Rights Agreement each Right will entitle the holder to purchase, for one half of its then market value, publicly traded common stock of any corporation which acquires the Company; each Right will also entitle the holder, with certain exceptions specified in the Rights Agreement, to purchase $150 worth of the Common Stock for $75. As of December 31, 1995, the Rights had not become exercisable.\nThe Company also sponsors a Dividend Reinvestment and Stock Purchase Plan which enables holders of the Company's Common Stock to invest cash dividends and optional cash payments in additional shares of the Common Stock. In 1995, 1994 and 1993, respectively, 37,208, 39,861 and 38,534 shares of the Common Stock had been sold pursuant to the Dividend Reinvestment and Stock Purchase Plan.\nTreasury Stock\nAt December 31, 1995, there were 22,997,693 shares of Common Stock held in treasury. During 1995, 207,589 Common shares were acquired (including 128,700 shares purchased under a repurchase program and 78,889 shares relating to benefit plans), at an aggregate cost of $5.3 million, and 449,618 Common shares, with an aggregate cost of $5.6 million, were utilized for certain employee, director, and agent benefit plans and for the Dividend Reinvestment and Stock Purchase Plan of USLIFE Corporation. At December 31, 1994, treasury stock consisted of 23,239,722 Common shares. Common shares outstanding, net of treasury shares, as of December 31, 1995 and 1994 are as follows:\nDecember 31 ________________________\n1995 1994 ____ ____\nCommon shares issued.............. 57,468,882 57,465,735 Treasury shares................... 22,997,693 23,239,722 __________ __________\nNet outstanding common shares..... 34,471,189 34,226,013 ========== ==========\nNote 11. Stock Options and Long-Term Incentive Plans\nIn May, 1991, the Company adopted a stock option plan (the \"1991 Stock Option Plan\") for key employees to replace the previous stock option plan under which options could no longer be granted. Under the 1991 Stock Option Plan, a maximum of 1,575,000 shares of the Company's common stock may be issued upon the exercise of stock options which may be granted pursuant to the Plan. The 1991 Stock Option Plan also provides for \"Reload\" options, which are automatically granted to a participant upon the exercise of an option if the participant uses previously owned shares to pay for the option shares. Reload options will be for the number of previously-owned shares delivered upon the employee's exercise of an option. Under the 1991 Stock Option Plan, the purchase price of shares subject to each option will be not less than 100% of their fair market value at the time of the grant of the option. The Plan limits the number of options that may be granted to any one individual during any one-year period to 112,500. No options may be granted under the 1991 Stock Option Plan after May 20, 2001.\nIn May 1994, the Company adopted a stock option plan (the \"Non-Employee Director Stock Option Plan\") for directors of USLIFE who are not employees of the Company or its subsidiaries or affiliates. The Plan provides that on the date of each Annual Meeting of Shareholders, each eligible director will automatically be granted options to purchase 3,000 shares of USLIFE common stock. A maximum of 375,000 shares of the Company's common stock may be issued upon the exercise of stock options which may be granted under the Non-Employee Director Stock Option Plan. No options may be granted under this Plan after May 17, 2004.\nNo option granted under the Company's stock option plans is exercisable in whole or in part in less than six months from the date of grant. Each option may be exercisable in one or more installments as provided therein. To the extent such options are not exercised, installments accumulate to the total granted and are exercisable in whole or in part at any time during the term of the option. This term is set forth in the option but in no event is an option\nexercisable, in whole or in part, after the expiration of ten years from the date of grant. The 1991 Stock Option Plan provides that in the event of a Change in Control (as defined in the Plan), all outstanding options granted under that Plan which have been held for at least six months from the date of grant shall become immediately exercisable.\nAs of December 31, 1995, the Company had outstanding options to its employees (including officers) and non-employee directors for purchase of shares of its Common Stock as follows:\nA summary of activity under all stock option plans for the three years ended December 31, 1995 is presented below:\nAs of December 31, 1995, options for 904,525 common shares were exercisable under all stock option plans at $15.61 to $29.08 per share. At December 31, 1995, up to 2,408,636 common shares could be issued under the Company's stock option plans. Common shares may be issued under the Company's stock option plans from shares in treasury or authorized but unissued shares.\nThe Company has a Book Unit Plan for certain key employees. Under the terms of the Plan, the Board of Directors may award, at its sole discretion, one or more units to employees it has selected to become participants in the Plan. No more than 900,000 units shall be outstanding under the Plan at any time. The value of units granted prior to 1994 shall be the amount by which the book value per share, as of the award date, has been increased or decreased by (a) the sum of the increases or decreases in the book value per share of the Company's common stock, excluding the impact of \"mark-to-market\" adjustments required by FASB Statement No. 115 to recognize unrealized gains and losses on debt and equity securities, plus (b) dividend equivalents for subsequent years up to and including the valuation date. In May 1994, the Plan was amended to limit the number of book units that may be granted to any one individual during a one-year period to no more than 112,500 and further, to eliminate the inclusion of cumulative dividends paid to shareholders in calculating the value of book units awarded in 1994 and thereafter. Accordingly, approximately $1.3 million, $1.7 million, and $2.1 million were charged to expense in 1995, 1994 and 1993, respectively.\nA summary of units outstanding under the Book Unit Plan follows:\nThe Company also has a Restricted Stock Plan for selected key employees. Under the terms of the Plan, a committee of the Board of Directors may award restricted shares of common stock of the Company, up to an aggregate maximum of 1,575,000 shares, to designated Participants. The shares, when awarded, are initially non-transferable and subject to forfeiture in the event that the Participant ceases to be an employee of USLIFE or any of its subsidiaries other than by reason of death, permanent disability, retirement, or certain other specified circumstances. These restrictions generally terminate with respect to 20% of the number of shares awarded on March 1 of each of the five calendar years following the year of award, at which time the appropriate number of unrestricted shares are distributed to the Participant. For certain awards, restrictions terminate with respect to one-third of the number of shares awarded on the first, second, and third anniversaries of the award date, with similar distribution. In the event of a Change in Control, as defined in the Plan, restrictions would terminate as to previously awarded but unvested shares. The Plan limits the number of shares that may be granted to any one individual during any one-year period to 112,500, and provides for forfeiture of awards to certain key officers under the Plan in the event that performance goals based on the Company's \"Earnings Per Share from Continuing Operations,\" as defined in the Plan, are not satisfied. Upon award of shares under the Plan, deferred compensation equivalent to the market value of the shares on the award date is charged to Equity Capital. Such deferred compensation is subsequently amortized by means of charges to expense over the period during which the restrictions lapse. During 1995, a total of 126,699 shares were awarded under the Plan. During 1994, a total of 306,411 shares were awarded under the Plan, and 7,998 previously awarded shares were forfeited pursuant to the terms of the Plan. As of December 31, 1995, there were 375,429 previously awarded shares outstanding under the Plan as to which the restrictions had not yet lapsed. Expense charges recognized in 1995, 1994 and 1993 relating to these awards amounted to approximately $2.6 million, $2.0 million and $2.1 million, respectively.\nIn May 1994, the Company adopted an Annual Incentive Plan (the \"Incentive Plan\") for certain key executive officers. Under the Incentive Plan, annual bonuses for participating key officers will depend on the attainment of performance goals based on levels of income from the Company's core life insurance businesses, as defined in the Plan. The Incentive Plan is administered by the Executive Compensation and Nominating Committee, which may authorize awards of up to 75% of a Participant's base salary based on attainment of performance goals established by the Committee. These awards are payable in cash no later than April 30 after each plan year, following certification by the Committee that the performance goals have been met. The Incentive Plan provides that in the event of a Change in Control (as defined in the Plan), the amount of awards will be calculated as if all performance targets have been met to produce the maximum award and payment of the awards will be accelerated to the date on which the Change in Control occurs.\nNote 12. Leases\nA subsidiary of the Company leases a portion of a building located at 125 Maiden Lane, New York, New York, which houses the subsidiary's principal executive offices as well as the headquarters of the Company and several other subsidiaries. The lease expires in 2006 and provides a renewal option based on fair rental value at time of renewal. Additionally, several subsidiaries lease office space at other locations generally for periods ranging from five to fifteen years, and certain subsidiaries utilize leased furniture and office equipment. Certain of the operating leases for office premises provide for renewal options for periods ranging from five to twenty years based on fair rental value at time of renewal, and further options relating to rental of additional office space. The minimum rental commitments for all such non- cancelable operating leases as of December 31, 1995 approximate $12.0 million in 1996, $10.2 million in 1997, $9.5 million in 1998, $8.6 million in 1999, $8.0 million in 2000, a total of $25.4 million from 2001 to 2005, and a total of $4.1 million from 2006 to 2007. Total rental expense amounted to approximately $12.5 million, $13.1 million and $13.5 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote 13. Contingent Liabilities and Commitments\nThe Company has outstanding Standby Letters of Credit with two banks representing contingent obligations to fund various trusts established in connection with certain employment contracts of management employees, as well as certain employee and Director benefit plans, in the event of a Change in Control (as defined in the trust agreements), totalling $93 million. The Company has also entered into Key Executive Employment Protection Agreements with selected key employees, which provide for certain contingent severance benefits, based on compensation, in the event of a Change in Control (as defined in the agreements). Additionally, in connection with the application by a life insurance subsidiary for an additional state license to transact business, USLIFE Corporation has agreed to guarantee that subsidiary's maintenance of the state's minimum capital and surplus requirements (amounting to $4.4 million at December 31, 1995) for a ten year period commencing at the effective date of such license. The Company has also agreed to guarantee the payment and performance of two real estate leases which expire December 31, 2006 and June 30, 2007, respectively, for two of its subsidiaries, which represent gross minimum rents for the remaining term of the leases totalling, as of December 31, 1995, $19.4 million and $14.9 million, respectively, plus additional rents representing any increase in operating expenses and real estate taxes over the base year (defined in the leases as calendar year 1995 and 1997, respectively).\nThe Company and certain of its subsidiaries are involved in litigation, which originated in 1981, with a former officer of a former subsidiary of the Company. Allegations in the former officer's lawsuit include breach of the covenant of good faith and fair dealing, breach of fiduciary duty, infliction of emotional distress and malicious prosecution. Judgment was rendered in favor of the Company. That judgment is being appealed. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated, nor is it probable in the opinion of management that the ultimate outcome of this litigation will result in a liability to the Company or any of its subsidiaries.\nIn November, 1994, a purported class action was filed against three of the Company's subsidiaries alleging that in connection with purchases by plaintiffs of single premium term life insurance from mortgage lenders, defendants misrepresented the type of insurance offered as credit life insurance and sold the term life insurance at premiums in excess of those permitted for credit life insurance. The parties have agreed to a settlement of all claims asserted and the settlement was given tentative approval by the Court in December, 1995. Under the terms of the Settlement Agreement, class members will be notified of their right to file claims for partial premium refunds. In the opinion of management, the ultimate resolution of this action in accordance with the terms of the Settlement Agreement will not result in a material additional liability on the part of the Company.\nIn August, 1995, a purported class action was filed alleging that a subsidiary of the Company violated the federal Telephone Consumer Protection Act by sending unsolicited facsimiles of advertisements. The Complaint contains claims for damages in the amount of $500 for each such unsolicited facsimile or\nalternatively, plaintiffs' actual monetary loss; plaintiffs have also sued for treble damages or alternatively, punitive damages. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated.\nIn March, 1995, a purported class action was filed alleging that a subsidiary of the Company issued insurance contracts in an amount sufficient to cover the gross amount of indebtedness, rather than the net amount of indebtedness, contrary to Alabama law. The complaint contains claims of fraud and breach of contract based on allegations that defendant misrepresented the amount of insurance needed (based on a recent ruling in a similar case by the Alabama Supreme Court). Plaintiffs seek compensatory and punitive damages. No contingent loss has been accrued for this litigation because the amount of loss, if any, cannot be reasonably estimated.\nIn addition to the aforementioned legal proceedings, the Company and its subsidiaries are parties to various routine legal proceedings incidental to the conduct of their business. Based on currently available information, in the opinion of management it is not probable that the ultimate resolution of these suits will result in a material liability on the part of the Company.\nNote 14. Financial Instruments and Concentrations of Credit Risk\nThe following methods and assumptions were used to estimate the fair value of the indicated classes of financial instruments:\nCash and Short-term Investments\nThe carrying amounts of these assets approximate their fair value.\nFixed Maturities and Equity Securities\nFair values are based on quoted market prices or dealer quotes.\nMortgage Loans\nThe fair value of mortgage loans, other than those which are more than 60 days delinquent or in foreclosure, is estimated by discounting the expected future cash flows. The rates used for this purpose are the estimated current rates that would be applied to the loans in a purchase or sale transaction, on an aggregate or bulk basis grouped by maturity range, considering the creditworthiness of the borrowers and the general characteristics of the collateral. For purposes of this calculation, the fair value of loans with stated interest rates greater than the estimated applicable market rate was adjusted to reflect the impact of prepayment options or other contractual terms upon market value. For mortgage loans which are classified as delinquent or are in foreclosure, fair value is based on estimated net realizable value of the underlying collateral.\nPolicyholder Account Balances Relating to Investment Contracts\nThe fair value of the Company's liabilities under investment contracts, primarily deferred annuities, is estimated using discounted cash flow calculations based on interest rates being offered by the Company for similar contracts at the balance sheet date.\nLong-term Debt\nThe fair value of the Company's long-term debt is estimated based on rates believed to be currently available to the Company for borrowings with terms similar to the remaining maturities of the outstanding debt. For outstanding debt securities with fixed interest rates in excess of current market rates, repayment on call dates prior to stated maturity was assumed for purposes of fair value estimation.\nThe carrying amounts and estimated fair values of the Company's financial instruments are as follows:\nIn accordance with the requirements of Statement No. 107 of the Financial Accounting Standards Board, the financial instruments presented above exclude accounts relating to the Company's insurance contracts and certain other classes of assets and liabilities. The Company has not utilized derivative financial instruments such as futures, forward, swap, or option contracts as defined in Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" for periods presented herein.\nThe estimated fair values of the Company's policy loan assets at December 31, 1995 and 1994 are not materially different from the respective carrying values at those dates. It should be noted that fair value estimates based on assumed discount rates and assumptions and estimates of the timing and amount of future cash flows are significantly affected by the assumptions used.\nConcentrations of Credit Risk\nThe Company's investments in fixed maturities and equity securities are comprised of a diverse portfolio represented by approximately 650 issuers, with no issuer accounting for more than 2% of the Company's total investment in these securities, based on fair value, at December 31, 1995.\nThe geographical distribution of the collateral for the Company's mortgage loans at December 31, 1995, by United States region and based on book value, is as follows:\nNew England.......................... 6% Middle Atlantic states............... 17 North-central states................. 21 South Atlantic states................ 17 South-central states................. 12 Mountain states...................... 13 Pacific states....................... 14 _____\n100% =====\nThe distribution of the Company's mortgage loans at December 31, 1995 by type of collateral, based on book value, is as follows:\nOffice buildings..................... 36% Industrial \/ warehouse properties.... 24 Retail............................... 29 Apartments........................... 1 One to four family residential....... 2 Hotel \/ motel, medical, and other.... 8 _____\n100% =====\nThe Company's reinsurance receivables and other recoverable amounts at December 31, 1995 relate to approximately 150 reinsurers. Two major United States insurance companies, rated \"A+\" (superior) and \"A\" (excellent) respectively by A. M. Best Company, a recognized insurance rating agency, account for approximately 15% and 9%, respectively, of the total reinsurance receivable and recoverable amount at that date. Other than these companies, no single reinsurer accounts for more than 6% of the total reinsurance receivable and recoverable amount at December 31, 1995. The Company monitors the financial condition of its reinsurers in order to minimize its exposure to loss from reinsurer insolvencies.\nNote 15. Reinsurance\nThe life insurance subsidiaries reinsure with other companies portions of the risks they underwrite and assume portions of risks on policies underwritten by other companies. The life insurance subsidiaries generally reinsure risks over $1.5 million as well as selected risks of lesser amounts. In this connection, $9.3 billion, representing 6 percent of total life insurance in force as of December 31, 1995, was ceded to other carriers. Reinsurance contracts do not relieve the Company from its obligations to policyholders, and the Company is contingently liable with respect to insurance ceded in the event any reinsurer is unable to meet the obligations which have been assumed.\nThe effect of reinsurance on premiums, other considerations, and benefits to policyholders and beneficiaries, is as follows:\nA summary of reinsurance activity for the three years ended December 31, 1995 is presented below:\nThe estimated amounts of reinsurance recoverable on paid and unpaid claims included in the Consolidated Balance Sheets as of December 31, 1995 and 1994 are as follows:\nThe amount included in the consolidated balance sheets at December 31, 1995 and 1994 for \"Other reinsurance recoverable\" includes the estimated amounts recoverable on unpaid claims as indicated above as well as prepaid reinsurance premiums.\nNote 16. Income Per Share\nThe following table sets forth the computations of income per share for the three years ended December 31, 1995:\nNote 17. Statement of Cash Flows Information\nFor the years ended December 31, 1995, 1994 and 1993, respectively, interest paid amounted to $38.2 million, $34.8 million, and $32.6 million, and Federal income taxes paid amounted to $55.7 million, $60.5 million and $60.7 million. The major portion of the disposals of fixed maturity investments relate to securities sold or redeemed prior to their maturity dates. The $438 million disposals of fixed maturity investments by the Company for the year ended December 31, 1995 included approximately $115 million (adjusted cost) of securities which were called for redemption by the respective issuers prior to maturity. On a similar basis, redemptions of fixed maturities included in total disposals amounted to $209 million and $928 million in 1994 and 1993, respectively.\nNote 18. Statutory Financial Information; Dividend Paying Capability of Life Insurance Subsidiaries\nNet income and equity capital of the life insurance subsidiaries, as reported on a regulatory basis and as included in USLIFE's consolidated financial statements in accordance with GAAP, are as follows:\n(a) Statutory accounting practices require acquisition costs on new business (including commissions and underwriting and issue costs) to be charged to expense when incurred. Regulatory net income includes income (loss) attributed to participating policyholders of approximately $(21) million, $200 thousand, and $2 million in 1995, 1994, and 1993, respectively, with the 1995 loss primarily a result of increased sales of participating term insurance products. Regulatory equity capital includes capital attributed to participating policyholders of approximately $20 million, $30 million, and $39 million at December 31, 1995, 1994 and 1993, respectively. Capital attributed to participating policyholders is not available for payment of dividends to shareholders.\n(b) Regulatory net income includes after-tax capital losses of $8 million, $10 million, and $2 million in 1995, 1994, and 1993, respectively. GAAP net income includes after-tax capital gains (losses) of $4 million, $(1) million and $7 million in those years, respectively.\nThe dividend paying capability of the life insurance subsidiaries is generally limited by after-tax income and equity capital as reported on a regulatory basis. As a result of the appropriate adjustments, including deferral and amortization of policy acquisition costs and fair value accounting for fixed maturities under GAAP, equity capital of the life insurance subsidiaries prepared in accordance with GAAP exceeds regulatory equity capital as indicated above. Notice to or approval by regulatory authorities is frequently required for dividends paid by insurance companies. Loans to or advances from the life insurance subsidiaries to the parent company may also be subject to regulatory approval requirements or limitations. At December 31, 1995, the portion of the aggregate $1.786 billion GAAP equity capital of the life insurance subsidiaries which was not available for transfer to the parent company by dividend, loan, or advance or available for such transfer only with regulatory approval (\"Restricted Net Assets\"), as a result of insurance laws and regulations, amounted to $1.732 billion. Cash dividends paid by all consolidated subsidiaries to the parent company totalled $42 million (including $6.5 million remitted by an inactive life insurance subsidiary and then contributed to another life subsidiary in connection with the earlier combination of the two companies' operations), $46 million and $61 million in 1995, 1994 and 1993, respectively. Additionally, during 1993, securities with market value of $22 million were transferred from a life insurance subsidiary to the parent company and subsequently contributed to another life insurance subsidiary in connection with the combination of the two subsidiaries' operations.\nNote 19. Supplementary Insurance Information\nSupplementary data relating to the life insurance industry segment of the Company for the three years ended December 31, 1995 is presented below.\nNote 21. Condensed Quarterly Results of Operations (Unaudited)\nThe quarterly results of consolidated operations for the two years ended December 31, 1995 are presented below (in thousands of dollars except per share amounts):","section_15":""}
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{"filename":"80255_1995.txt","cik":"80255","year":"1995","section_1":"ITEM 1. BUSINESS.\nT. Rowe Price Associates, Inc. and its subsidiaries (the Company) serve as investment adviser to the T. Rowe Price Mutual Funds (the Price Funds), other sponsored investment products, and private accounts of other institutional and individual investors, including defined benefit and defined contribution retirement plans, endowments, foundations, trusts, and other mutual funds. Total assets under management at December 31, 1995 were $75.4 billion, up $17.6 billion since December 31, 1994. The Company also provides various administrative services to the Price Funds and other clients, including mutual fund transfer agent, accounting and shareholder services; participant recordkeeping and transfer agent services for defined contribution retirement plans; discount brokerage; and trust services. The Company was incorporated in Maryland in January 1947 as successor to the investment counseling business formed by the late Mr. T. Rowe Price in 1937.\nThe Company offers its Price Funds' shareholders and private accounts a broad range of investment products designed to attract and retain investors with varying investment objectives. Shareholders are allowed to exchange funds among mutual fund products as economic and market conditions and investor needs change. The Company frequently introduces new mutual funds designed to complement and expand its investment product offerings, respond to competitive developments in the financial marketplace, and meet the changing needs of its funds' shareholders. New mutual funds and other investment products are introduced when the Company has personnel with sufficient investment expertise to manage the product successfully for a substantial group of investors over a long period of time. The Company's base of assets under management consists of a broad range of domestic and international stock, bond and money market mutual funds and other investment products which meet the varied needs and objectives of its individual and institutional investors. In recent years, there have been significant net cash inflows to the stock mutual funds, particularly the international funds in 1993 and 1994 and the domestic funds in 1995. Company revenues are largely dependent on the total value and composition of assets under management; accordingly, fluctuations in financial markets and in the composition of assets under management impact revenues and results of operations. Investment advisory fees earned on assets under management and related expenses incurred to generate such fees are generally higher for stock and international investment products which have become a substantially larger portion of the Company's assets under management than in the past.\nThe investment strategies employed by the Company accommodate a variety of private account client investment objectives encompassing both domestic and international securities. Management of investments in stocks include active approaches emphasizing established growth, mid-cap growth, New America growth (companies that participate in the growth of the service sector of the U.S. economy), small cap, equity income, capital appreciation, and natural resources as well as systematic and balanced portfolio strategies. Approaches for investing in fixed income securities portfolios include active and systematic (index) management strategies and management of high yield securities and cash reserves. The Company has also developed several specialized investment management services including private company investing, investing in debt securities and creditor claims of financially-troubled companies, the efficient disposition of equity distributions from venture capital investments, and stable value investment contract management.\nAverage assets under management (in millions) during the past five years and total assets under management at December 31, 1995 are:\n1991 1992 1993 1994 1995 12\/31\/95 ________ ________ ________ ________ ________ ________ Price Funds Stock $ 7,599 $ 10,280 $ 14,713 $ 21,495 $ 27,211 $ 32,311 Taxable bond 3,304 5,150 6,025 5,412 5,392 5,763 Tax-free bond 2,530 3,187 4,169 4,225 4,211 4,487 Money market 6,177 5,428 4,903 5,333 5,865 6,008 ________ ________ ________ ________ ________ ________ Total 19,610 24,045 29,810 36,465 42,679 48,569 Other sponsored in- vestment products and private accounts 13,066 14,510 17,136 19,490 23,866 26,868 ________ ________ ________ ________ ________ ________ Total assets under management $ 32,676 $ 38,555 $ 46,946 $ 55,955 $ 65,545 $ 75,437 ________ ________ ________ ________ ________ ________ ________ ________ ________ ________ ________ ________\nThe Company's revenues (in thousands) from investment advisory and administrative services provided under agreements with the Price Funds and other clients during the past five years are:\n1991 1992 1993 1994 1995 ________ ________ ________ ________ ________ Investment advisory fees Price Funds Stock $ 47,712 $ 65,202 $ 96,136 $145,020 $180,574 Taxable bond 17,730 25,149 31,869 28,561 28,404 Tax-free bond 12,960 15,869 19,873 19,744 20,018 Money market 25,416 21,780 19,137 20,132 22,113 ________ ________ ________ ________ ________ Total 103,818 128,000 167,015 213,457 251,109 Other sponsored investment products and private accounts 41,576 46,590 57,794 76,614 80,978 ________ ________ ________ ________ ________ Total 145,394 174,590 224,809 290,071 332,087 ________ ________ ________ ________ ________ Administrative fees Price Funds 37,623 45,153 54,184 61,057 67,166 Price Funds' shareholders and others 13,197 18,405 23,024 24,615 27,211 ________ ________ ________ ________ ________ Total 50,820 63,558 77,208 85,672 94,377 ________ ________ ________ ________ ________ Total investment advisory and administrative fees $196,214 $238,148 $302,017 $375,743 $426,464 ________ ________ ________ ________ ________ ________ ________ ________ ________ ________\nMUTUAL FUND MANAGEMENT.\nOVERVIEW. Each of the Price Funds has a distinct investment objective that has been developed as part of the Company's strategy to provide a broad and balanced selection of investment products. All Funds are sold exclusively by the Company on a no-load basis (without a sales commission). No-load mutual funds offer investors a low-cost and relatively easy method of investing in a variety of stock and bond products. The Company's marketing effort is focused on advertising in the print media and direct mail communications. During 1996, the Company will expand its promotional activities to the television market including cable channels. In addition, considerable direct marketing efforts are targeted at large participant-directed defined contribution plans that invest, in whole or in part, in mutual funds. The Company believes that its distribution methods and fund shareholder and administrative services promote stability of assets in the Price Funds through market cycles in addition to reducing costs to fund shareholders.\nAt December 31, 1995, assets under management in the Price Funds aggregated $48.6 billion, an increase of $11.3 billion during 1995. The following information includes the net assets (in millions) at December 31, 1995 of each fund available to the investing public, the year the fund was added to the Price family of funds, and the fund's primary investment objective.\nSTOCK FUNDS:\n$ 2,762 GROWTH STOCK (1950) - Long-term growth of capital and, secondarily, increasing dividend income by investing primarily in common stocks of well-established growth companies.\n$ 2,855 NEW HORIZONS (1960) - Long-term growth of capital by investing primarily in common stocks of small, rapidly growing companies.\n$ 1,090 NEW ERA (1969) - Long-term capital appreciation by investing primarily in common stocks of companies that own or develop natural resources and other basic commodities, and selected nonresource growth companies.\n$ 6,703 INTERNATIONAL STOCK (1980) - Long-term growth of capital through investments primarily in common stocks of established, non-U.S. companies.\n$ 1,748 GROWTH & INCOME (1982) - Long-term capital growth, a reasonable level of current income, and increasing future income through investments primarily in dividend-paying stocks.\n$ 1,028 NEW AMERICA GROWTH (1985) - Long-term growth of capital by investing primarily in common stocks of U.S. growth companies operating in service industries.\n$ 5,215 EQUITY INCOME (1985) - Substantial dividend income as well as long- term capital appreciation through investments in common stocks of established companies.\n$ 864 CAPITAL APPRECIATION (1986) - Maximum capital appreciation by investing primarily in common stocks.\n$ 2,285 SCIENCE & TECHNOLOGY (1987) - Long-term growth of capital by investing primarily in common stocks of companies expected to benefit from the development, advancement, and use of science and technology.\n$ 936 SMALL-CAP VALUE (1988) - Long-term capital growth by investing primarily in common stocks of small companies that are believed to be undervalued.\n$ 303 INTERNATIONAL DISCOVERY (1988) - Long-term growth of capital through investments primarily in common stocks of rapidly growing, small- to medium-sized non-U.S. companies.\n$ 532 EUROPEAN STOCK (1990) - Long-term growth of capital through investments primarily in common stocks of both large and small European companies.\n$ 457 EQUITY INDEX (1990) - To match the total return performance of the U.S. equity market as represented by the Standard & Poor's 500 Composite Stock Index by investing in the stocks that compose the S&P 500 Index.\n$ 1,358 SPECTRUM GROWTH (1990) - Long-term growth of capital and growth of income by investing primarily in a diversified group of T. Rowe Price mutual funds which, in turn, invest principally in equity securities.\n$ 1,880 NEW ASIA (1990) - Long-term growth of capital through investments in large and small companies domiciled or with primary operations in Asia, excluding Japan, and in Pacific Rim countries such as Australia and New Zealand.\n$ 608 BALANCED (1991) - Capital appreciation, current income, and preservation of capital through investments in a diversified portfolio consisting of approximately 60% in common stocks and the balance in fixed-income securities.\n$ 208 JAPAN (1991) - Long-term growth of capital through investments in common stocks of large and small companies domiciled or with primary operations in Japan.\n$ 264 MID-CAP GROWTH (1992) - Long-term capital appreciation by investing primarily in common stocks of medium-sized (mid-cap) companies offering the potential for above-average earnings growth.\n$ 279 OTC (1992) - Long-term growth of capital by investing in securities traded in the U.S. over-the-counter (OTC) market, primarily the stocks of small- to medium-sized companies.\n$ 84 DIVIDEND GROWTH (1992) - Increasing dividend income over time, long-term capital appreciation, and reasonable current income through investments primarily in dividend-paying stocks.\n$ 146 BLUE CHIP GROWTH (1993) - Long-term growth of capital by investing in common stocks of large- and medium-sized blue chip companies.\n$ 150 LATIN AMERICA (1993) - Long-term growth of capital through investments primarily in common stocks of companies domiciled, or with primary operations, in Latin America.\n$ 19 PERSONAL STRATEGY - BALANCED (1994) - Highest total return over time consistent with an emphasis on both capital appreciation and income by investing in a diversified portfolio consisting of 50-70% stocks and the balance in bonds and money market securities.\n$ 16 PERSONAL STRATEGY - GROWTH (1994) - Highest total return over time consistent with a primary emphasis on capital appreciation by investing in a diversified portfolio consisting of 70-90% stocks and the balance in bonds and money market securities.\n$ 26 PERSONAL STRATEGY - INCOME (1994) - Highest total return over time consistent with a primary emphasis on income and secondary emphasis on capital appreciation by investing in a diversified portfolio consisting of 30-50% stocks and the balance in bonds and money market securities.\n$ 47 VALUE FUND (1994) - Long-term capital appreciation by investing primarily in common stocks believed to be undervalued.\n$ 62 CAPITAL OPPORTUNITY (1994) - Superior capital appreciation over time by investing primarily in U.S. common stocks of small, medium and large companies.\n$ 17 EMERGING MARKETS STOCK (1995) - Long-term growth of capital through investments primarily in common stocks of large and small companies domiciled, or with primary operations, in emerging markets in Latin America, Asia, Europe, Africa and the Middle East.\n$ 2 GLOBAL STOCK (1995) - Long-term growth of capital through investments primarily in common stocks of established companies throughout the world, including the U.S.\n$ 2 HEALTH SCIENCES (1995) - Long-term growth of capital by investing primarily in common stocks of companies engaged in the research, development, production, or distribution of products or services related to health care, medicine, or the life sciences. TAXABLE BOND FUNDS:\n$ 1,668 NEW INCOME (1973) - Highest level of income consistent with preservation of capital over time through investment primarily in marketable debt securities.\n$ 1,227 HIGH YIELD (1984) - High current income and, secondarily, capital appreciation by investing in a widely diversified portfolio of lower-quality, long-term corporate bonds, often called high yield or junk bonds.\n$ 464 SHORT-TERM BOND (1984) - High level of liquidity and income consistent with minimum fluctuation in principal value by investing in a diversified portfolio of short- and intermediate-term corporate, government, and debt securities.\n$ 896 GNMA (1985) - High level of current income consistent with maximum credit protection and moderate price fluctuation by investing exclusively in securities backed by the full faith and credit of the U.S. Government, primarily mortgage-backed securities issued by the Government National Mortgage Association (GNMA), and instruments involving these securities.\n$ 1,016 INTERNATIONAL BOND (1986) - High current income and capital appreciation by investing in high-quality, nondollar-denominated government and corporate bonds outside the U.S.\n$ 183 U.S. TREASURY INTERMEDIATE (1989) - High level of income consistent with maximum credit protection and moderate fluctuation in principal value by investing primarily in U.S. Treasury securities and repurchase agreements.\n$ 71 U.S. TREASURY LONG-TERM (1989) - Highest level of current income consistent with maximum credit protection by investing primarily in U.S. Treasury securities and repurchase agreements.\n$ 987 SPECTRUM INCOME (1990) - High level of current income consistent with moderate price fluctuation by investing primarily in a diversified group of T. Rowe Price Mutual Funds which, in turn, invest principally in fixed-income securities.\n$ 28 GLOBAL GOVERNMENT BOND (1990) - High current income and, secondarily, capital appreciation and protection of principal by investing primarily in high-quality foreign and U.S. government bonds.\n$ 105 SHORT-TERM U.S. GOVERNMENT (1991) - Highest level of current income consistent with minimal share price fluctuation by investing in a diversified portfolio of short-term U.S. government-backed securities.\n$ 40 SHORT-TERM GLOBAL INCOME (1992) - High level of current income consistent with modest share price fluctuation by investing primarily in high-quality fixed-income securities.\n$ 24 SUMMIT GNMA (1993) - High level of income and maximum credit protection by investing in mortgage-backed certificates issued by GNMA.\n$ 28 SUMMIT LIMITED-TERM BOND (1993) - High level of income consistent with moderate fluctuation in principal value by investing in short- and intermediate-term, investment-grade bonds.\n$ 10 EMERGING MARKETS BOND (1994) - High income and capital appreciation by investing in the government and corporate debt securities of emerging nations.\n$ 3 CORPORATE INCOME (1995) - High income and some capital appreciation by investing in investment-grade corporate debt securities.\nTAX-FREE BOND FUNDS:\n$ 1,397 TAX-FREE INCOME (1976) - High level of income exempt from federal income taxes by investing primarily in long-term, investment-grade municipal securities.\n$ 451 TAX-FREE SHORT-INTERMEDIATE (1983) - High level of income exempt from federal income taxes consistent with modest price fluctuation by investing primarily in municipal securities in the four highest credit categories.\n$ 983 TAX-FREE HIGH YIELD (1985) - High level of income exempt from federal income taxes by investing primarily in long-term, low- to upper-medium quality municipal securities.\n$ 135 NEW YORK TAX-FREE BOND (1986) - Highest level of income exempt from federal, New York state and city income taxes by investing primarily in investment-grade New York municipal bonds.\n$ 147 CALIFORNIA TAX-FREE BOND (1986) - Highest level of income exempt from federal and California state income taxes by investing primarily in investment-grade California municipal bonds.\n$ 800 MARYLAND TAX-FREE BOND (1987) - Highest level of income exempt from federal and Maryland state and local income taxes by investing primarily in investment-grade Maryland municipal bonds.\n$ 70 NEW JERSEY TAX-FREE BOND (1991) - Highest level of income exempt from federal and New Jersey state income taxes by investing primarily in investment-grade New Jersey municipal bonds.\n$ 178 VIRGINIA TAX-FREE BOND (1991) - Highest level of income exempt from federal and Virginia state income taxes by investing primarily in investment-grade Virginia municipal bonds.\n$ 91 TAX-FREE INSURED INTERMEDIATE BOND (1992) - High level of income exempt from federal income taxes and moderate price fluctuation while minimizing credit risk by investing primarily in insured municipal securities.\n$ 84 MARYLAND SHORT-TERM TAX-FREE BOND (1993) - Highest level of income exempt from federal and Maryland state and local income taxes consistent with modest fluctuation in principal value by investing primarily in investment-grade Maryland municipal bonds.\n$ 72 FLORIDA INSURED INTERMEDIATE TAX-FREE BOND (1993) - High level of income exempt from federal income taxes while minimizing credit risk by investing primarily in insured Florida municipal bonds.\n$ 32 GEORGIA TAX-FREE BOND (1993) - Highest level of income exempt from federal and Georgia state income taxes by investing primarily in investment-grade Georgia municipal bonds.\n$ 12 SUMMIT MUNICIPAL INCOME (1993) - High level of income exempt from federal income taxes by investing primarily in long-term, investment-grade municipal bonds.\n$ 23 SUMMIT MUNICIPAL INTERMEDIATE (1993) - Highest possible income exempt from federal income taxes consistent with moderate price fluctuation by investing primarily in investment-grade municipal bonds.\n$ 12 VIRGINIA SHORT-TERM TAX-FREE BOND (1994) - Highest level of income exempt from federal and Virginia state income taxes consistent with modest fluctuation in principal value by investing primarily in investment-grade Virginia municipal bonds.\nMONEY MARKET FUNDS:\n$ 3,988 PRIME RESERVE (1976) - Preservation of capital, liquidity and, consistent with these, the highest possible current income through investments primarily in high-quality, money market securities.\n$ 660 TAX-EXEMPT MONEY (1981) - Preservation of capital, liquidity and, consistent with these, the highest current income exempt from federal income taxes by investing in high-quality, short-term municipal securities.\n$ 717 U.S. TREASURY MONEY (1982) - Maximum safety of capital, liquidity and, consistent with these, the highest possible current income by investing primarily in a portfolio of U.S. Treasury securities.\n$ 70 NEW YORK TAX-FREE MONEY (1986) - Highest possible current income exempt from federal, New York state and city income taxes consistent with preservation of principal and liquidity by investing in municipal securities.\n$ 73 CALIFORNIA TAX-FREE MONEY (1986) - Highest possible current income exempt from federal and California state income taxes consistent with preservation of principal and liquidity by investing in municipal securities.\n$ 427 SUMMIT CASH RESERVES (1993) - Preservation of capital, liquidity and, consistent with these, the highest possible current income by investing in a diversified portfolio of U.S. dollar-denominated money market securities.\n$ 73 SUMMIT MUNICIPAL MONEY MARKET (1993) - Preservation of capital, liquidity and, consistent with these, the highest possible current income exempt from federal income taxes by investing in high- quality municipal securities.\nThe Company also sponsors the Foreign Equity Fund, an international stock fund begun in 1989 for institutional investors, which seeks to provide long- term growth of capital through investments primarily in common stocks of established, non-U.S. companies. Assets under management in this fund were $1,723 million at December 31, 1995.\nAGREEMENTS WITH PRICE FUNDS. The Company provides investment advisory, distribution and administrative services to the Price Funds under investment management, underwriting, transfer agency and service agreements. Pursuant to investment management agreements with each of the Price Funds, the Company provides investment advisory services to each fund, subject to the authority of each fund's board of directors and to each fund's fundamental investment objective. The investment management agreements with the Price Funds are approved annually by the directors of the respective funds, including a majority of the directors who are not \"interested persons\" of the funds or the Company as defined under the Investment Company Act of 1940, as amended (the Investment Company Act). Amendments to such agreements must be approved by the Price Funds' shareholders. Each agreement automatically terminates in the event of its assignment (as defined in the Investment Company Act) and either party may terminate the agreement without penalty after notice (generally 60 days). Each fund has the right to use the \"T. Rowe Price\" name for so long as its investment management agreement with the Company remains in effect.\nThe Company is paid an investment advisory fee based upon the average daily net assets of the funds and separate administrative fees for the support services rendered by the Company. Management of the Company and the independent directors of the Price Funds regularly review the fund fee structures in light of fund performance, the level and range of services provided, industry conditions, and other factors. The current advisory fee paid by each of the Price Funds (excluding the Price Spectrum and Summit\nFunds, the Price Equity Index Fund and the Foreign Equity Fund) is computed by multiplying the individual fund's average daily net assets by a composite fee determined by adding a group fee based on the combined net assets of the Price Funds and an individual fund fee applicable to each fund.\nEach fund (excluding the Price Summit Funds) bears all expenses associated with the operation of the fund and the issuance and redemption of its securities. In particular, each fund pays investment advisory fees; shareholder servicing fees and expenses; fund accounting fees and expenses; transfer agent fees; custodian fees and expenses; legal and auditing fees; expenses of preparing, printing and mailing prospectuses and shareholder reports to existing shareholders; registration fees and expenses; proxy and annual meeting expenses; and independent directors' fees and expenses. All advertising, promotion and selling expenses are borne by the Company.\nThe Company does, however, absorb expenses of funds that are in excess of limitations established under state securities laws. The Company does not expect that state expense limits, at current fee and expense levels, will have any significant effect on the results of its operations. The Company generally guarantees that a newly-organized fund's expenses will not exceed a specified ratio during its initial operations. Allowances made for reduced advisory fees and other mutual fund expenses in excess of limitations may be recovered in future periods if and when fund performance and related expense limitation provisions permit.\nPursuant to underwriting agreements with each fund, T. Rowe Price Investment Services, Inc. (TRP Investment Services) is the exclusive distributor of the Price Funds. The agreements provide that TRP Investment Services shall always offer the funds' shares at a public offering price equal to the net asset value per share and shall use its best efforts to obtain investors for the funds. The underwriting agreements with the Price Funds are approved annually by the directors of the respective funds, including a majority of the directors who are not \"interested persons\" of the funds or the Company as defined under the Investment Company Act. Each agreement automatically terminates in the event of its assignment (as defined in the Investment Company Act), and either party may terminate the agreement without penalty after notice (generally 60 days). TRP Investment Services does not receive a separate fee for its services to the Price Funds. The Company expends substantial resources in advertising and direct mail communications to existing and potential Price Funds' shareholders and in providing the staff and communications capabilities to respond to inquiries. The level of advertising and promotion expenditures varies over time as market conditions and cash inflows to the Price Funds warrant.\nADMINISTRATIVE SERVICES. T. Rowe Price Services, Inc. (TRP Services) provides transfer agent and shareholder services under contracts with the Price Funds. Shareholder servicing activities include maintenance of staff and equipment to respond to all telephone inquiries from existing Fund shareholders and to provide the mutual fund transfer agent function. In addition, the Company provides mutual fund accounting services including maintenance of financial records, preparation of financial statements and\nreports, daily valuation of portfolio securities and computation of daily net asset values per share.\nT. Rowe Price Retirement Plan Services, Inc. (TRP Retirement Plan Services) provides participant accounting, plan administration and transfer agent services for defined contribution retirement plans that invest, at least in part, in the Price Funds. Plan sponsors compensate TRP Retirement Plan Services for certain administrative services while the Price Funds compensate it for maintaining and administering the individual participant accounts for those plans that invest in the Price Funds.\nThe Company provides certain trust services through its Maryland-chartered limited service trust company, T. Rowe Price Trust Company, Inc. (TRP Trust Company). TRP Trust Company serves as custodian or trustee for the Price Funds' prototype retirement plans, IRAs, and certain other retirement plans. TRP Trust Company also sponsors common trust funds principally for investment by qualified employee retirement plans. Under its charter, TRP Trust Company may not be in the business of accepting deposits and cannot make personal or commercial loans.\nThe Company also provides discount brokerage services through TRP Investment Services. Such services are provided primarily to shareholders of the Price Funds and are intended to complement the other investment services offered to them. All discount brokerage transactions are cleared through and accounts maintained by BHC Securities, Inc., an independent clearing broker.\nOTHER SPONSORED PRODUCTS AND PRIVATE ACCOUNT MANAGEMENT.\nThe Company serves as investment adviser to pension, profit sharing and other employee benefit plans, endowments, foundations, trusts, individuals, corporations, other mutual funds and other investors who are principally domiciled in the United States. No private account client accounted for more than 5% of the Company's 1995 private account investment advisory revenues. Investment management services are provided to client accounts on an individual basis and through sponsored investment partnerships and trusts. Sponsored investment products have generally been issued through private placements.\nFees for separately managed private account clients are generally computed based on the value of assets under management. The standard form of investment advisory agreement with private account clients provides that the agreement may be terminated at any time and that any unearned fees paid in advance will be refunded. The minimum account size is generally $20 million for institutional private account services, although the minimum account size for certain specialized investment services may be higher. Fees for sponsored product management are based on individual product advisory agreements, which result from consideration of, among other things, the type of investments to be made and the unique investment management services to be provided.\nMany specialized investment advisory services are provided to private\naccounts by subsidiaries of the Company. International equity and fixed income securities management is provided by Rowe Price-Fleming International, Inc. (RPFI). Management of stable value investment contracts, aggregating $5.3 billion at December 31, 1995, is provided by T. Rowe Price Stable Asset Management, Inc. (TRP Stable Asset Management).\nINVESTMENT RESEARCH.\nIn the performance of its investment advisory functions, the Company uses fundamental, technical and cyclical security analysis methods. The Company maintains a substantial internal equity and fixed income investment research effort, undertaken by analysts, economists, statisticians and support personnel, which includes original industry and company research, utilizing such sources as inspection of corporate activities, management interviews, company-prepared information, financial information published by companies and\/or filed with the SEC, financial newspapers and magazines, corporate rating services, and field checks with participants in the industry such as suppliers or competitors. In addition, the Company utilizes research provided by brokerage firms in a supportive capacity; information is received from private economists, political observers, foreign commentators, government experts, and market and security analysts. In certain instances, computerized data is the basis of the stock selection process rather than security analysis.\nROWE PRICE-FLEMING INTERNATIONAL, INC.\nTRP Finance, Inc., an investment holding company subsidiary, owns 50% of the common stock of RPFI which, by virtue of the Company's controlling interest, is consolidated into the Company's financial statements. The balance of the common stock of RPFI is owned equally by Copthall Overseas Limited (United Kingdom), a subsidiary of the London-based merchant banking group Robert Fleming Holdings Limited, and Jardine Fleming International Holdings Limited (Cayman Islands), a subsidiary of the Jardine Fleming Group Limited, an investment bank in the Asia-Pacific Region. RPFI serves as investment adviser to the Price International Funds and to other mutual funds, sponsored investment products and private accounts of institutional investors. During 1995, international assets under management by RPFI increased $3.9 billion to $22.2 billion at year end, including $12.6 billion in the T. Rowe Price International Funds. RPFI's financial information and assets under management are included in the Company's consolidated financial data and statistical information presented elsewhere in this Form 10-K.\nInternational investment research is provided to RPFI by affiliates of its minority stockholders. Fees are paid for these services based on RPFI's assets under management.\nREGULATION.\nThe Company, RPFI, TRP Stable Asset Management, and T. Rowe Price (Canada), Inc. (TRP Canada) are registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940 and all applicable state securities agencies. Each of the Price Funds is registered with the Securities and Exchange Commission under the Investment Company Act and, except for the specific state tax-free funds, is qualified for sale throughout the United States and Puerto Rico. TRP Investment Services is registered as a broker- dealer under the Securities Exchange Act of 1934 (Exchange Act) and all applicable state securities laws and is a member of the National Association of Securities Dealers, Inc. and the Securities Investor Protection Corporation. TRP Services is registered under the Exchange Act as a transfer agent, and TRP Trust Company is regulated by the State of Maryland Bank Commissioner. TRP Canada is also registered as an investment adviser with the Ontario Securities Commission.\nAll aspects of the Company's business are subject to extensive federal and state laws and regulations. These laws and regulations are primarily intended to benefit or protect the Company's clients and the Price Funds' shareholders and generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict the Company from carrying on its business in the event that it fails to comply with such laws and regulations. In such event, the possible sanctions that may be imposed include the suspension of individual employees, limitations on engaging in certain lines of business for specified periods of time, revocation of the investment adviser and other registrations, censures and fines.\nThe Company and certain of its subsidiaries are subject to net capital requirements including those of various federal and state regulatory agencies. The Company's net capital, as defined, has consistently met or exceeded all minimum requirements.\nCOMPETITION.\nAs a member of the financial services industry, the Company is subject to substantial competition in all aspects of its business. A significant number of mutual funds are sold to the public by investment management firms, broker-dealers and insurance companies. In addition to other investment advisory and mutual fund management companies, the Company competes with brokerage and investment banking firms, insurance companies, banks, and other financial institutions in all aspects of its business. Many of these financial institutions have substantially greater resources than the Company. The Company competes with other providers of investment products and services primarily on the basis of the range of investment products offered, the investment performance of such products, the manner in which such products are distributed, and the scope and quality of the services provided.\nThe Company believes that competition among the mutual funds industry will increase as a result of consolidation and acquisition activity within the industry. In order to maintain and enhance its competitive position as an independent, no-load, direct marketer of mutual funds, the Company frequently reviews acquisition prospects and may, from time to time, engage in discussions or negotiations that could lead to acquisitions by the Company. Currently, the Company is not party to any agreements or understandings\nregarding any acquisitions; however, as a result of the Company's process of reviewing possible acquisition prospects, negotiations may occur from time to time if appropriate opportunities arise.\nEMPLOYEES.\nAt December 31, 1995, the Company and its subsidiaries had 1,910 active, full-time employees. The Company employs additional temporary and part-time personnel to meet seasonal and other periodic demands for mutual fund shareholder and investor services.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's primary corporate offices consist of approximately 270,000 square feet of space located at 100 East Pratt Street in Baltimore, Maryland. The Company also leases facilities in Los Angeles and San Francisco, California; Owings Mills, Maryland; Glen Allen, Virginia; Washington, D.C.; and Tampa, Florida. Future minimum rental payments under noncancelable operating leases at December 31, 1995 are set forth in Note 9 to the consolidated financial statements included in Item 8. of this Form 10-K.\nTRP Suburban, Inc. owns a $19.8 million financial operations center in Owings Mills, Maryland consisting of approximately 110,000 square feet of operating space. The facility houses a portion of the Company's administrative services operations. The land has been leased until 2089.\nTRP Suburban Second, Inc. acquired 32.5 acres of land in Owings Mills, Maryland in December 1995 and has begun development of two buildings with a combined 219,000 square feet of space in early 1996. Construction is expected to be completed in the second half of 1997. The acreage will accommodate additional development of approximately 300,000 square feet of space. TRP Suburban Second also has an option to acquire an adjacent 37.4 acres to meet further development needs.\nInformation concerning anticipated 1996 capital expenditures is set forth in the last paragraph of Item 7. of this Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFrom time to time, the Company is a party to various claims arising in the ordinary course of business. The Company is not currently the subject of any claim that, if adversely determined, is likely 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.\nNo matters were submitted to a vote of the Company's stockholders during the fourth quarter of 1995.\nITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following information includes the names, ages, and positions of the executive officers and certain significant employees of the Company. There are no arrangements or understandings pursuant to which any person serves the Company. The first seven individuals listed are presently members of the Board of Directors; however, Messrs. Broadus and Hoffman will retire from the Board in April 1996.\nGeorge J. Collins (55), President and Chief Executive Officer (1984) and Managing Director (1989) George A. Roche (54), Managing Director (1989) and Chief Financial Officer (1984) Thomas H. Broadus, Jr. (58), Managing Director (1989) Carter O. Hoffman (68), Managing Director (1989) Henry H. Hopkins (53), Managing Director (1989) James S. Riepe (52), Managing Director (1989) M. David Testa (51), Managing Director (1989) Edward C. Bernard (40), Managing Director (1995) and Vice President (1989-1995) Stephen W. Boesel (51), Managing Director (1993) and Vice President (1977-1993) James A.C. Kennedy (42), Managing Director (1990) John H. LaPorte (50), Managing Director (1989) Mary J. Miller (40), Managing Director (1993) and Vice President (1986-1993) Charles A. Morris (33), Managing Director (1995) and Vice President (1990-1995) Mark E. Rayford (44), Managing Director (1993) and Vice President (1984-1993) William T. Reynolds (47), Managing Director (1990) Brian C. Rogers (40), Managing Director (1991) Charles P. Smith (52), Managing Director (1990) Peter Van Dyke (57), Managing Director (1990) Charles E. Vieth (39), Managing Director (1993) and Vice President (1985-1993) Richard T. Whitney, (37), Managing Director (1995) and Vice President (1988-1995) Alvin M. Younger, Jr. (46), Managing Director (1990), Treasurer (1985) and Secretary (1987)\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) trades on The Nasdaq Stock Market under the symbol \"TROW\". The high and low trade price information and dividends per share during the past two years were:\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter ________ ________ ________ ________\n1994 - High price $ 38.25 $ 31.75 $ 34.75 $ 34.50 Low price $ 26.25 $ 26.25 $ 24.625 $ 27.75 Cash dividends declared $ .13 $ .13 $ .13 $ .16\n1995 - High price $ 37.25 $ 41.00 $ 51.75 $ 56.75 Low price $ 27.00 $ 35.25 $ 33.75 $ 45.00 Cash dividends declared $ .16 $ .16 $ .16 $ .21\nAt February 12, 1996, there were approximately 2,400 holders of record of the Company's outstanding common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nYear ended December 31, ___________________________________________________ 1991 1992 1993 1994 1995 ________ ________ ________ ________ ________ (in thousands, except per-share amounts)\nRevenues $205,206 $245,112 $310,041 $382,378 $439,299 Net income $ 30,437 $ 35,784 $ 48,539 (1) $ 61,151 $ 75,409 (3) Earnings per share (2) $ 1.02 $ 1.19 $ 1.59 (1) $ 2.00 $ 2.47 (3) Cash dividends declared per share (2) $ .33 $ .375 $ .445 $ .55 $ .69 Weighted average shares outstanding (2) 29,823 30,158 30,615 30,571 30,525\n(1) Net income and earnings per share before the cumulative effects of changes in accounting principles were $48,869 and $1.60, respectively. (2) Retroactively adjusted to give effect to the 2-for-1 stock split in November 1993. (3) Net income and earnings per share before an extraordinary charge were $76,458 and $2.50, respectively.\nDecember 31, ________________________________________________ 1991 1992 1993 1994 1995 ________ ________ ________ ________ ________ (in thousands, except as noted) Balance sheet data Total assets $179,571 $206,072 $263,400 $297,282 $365,343 Debt $ 15,969 $ 13,190 $ 12,915 $ 12,613 $ -- Stockholders' equity $132,525 $154,198 $195,953 $216,239 $274,232 Assets under manage- ment (in millions) $ 35,623 $ 41,415 $ 54,396 $ 57,835 $ 75,437\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGENERAL.\nT. Rowe Price Associates, Inc. (the Company) derives its revenue primarily from investment advisory and administrative services provided to the Price Mutual Funds (the Funds), other sponsored investment products, and private accounts of other institutional and individual investors. Investment advisory fees are generally based on the net assets of the portfolios managed. The majority of administrative revenues are derived from services provided to the Funds.\nThe Company's base of assets under management consists of a broad range of domestic and international stock, bond and money market mutual funds and other investment products which meet the varied needs and objectives of its individual and institutional investors. In recent years, there have been significant net cash inflows to the stock mutual funds, particularly the international funds in 1993 and 1994 and the domestic funds in 1995. Company revenues are largely dependent on the total value and composition of assets under management; accordingly, fluctuations in financial markets and in the composition of assets under management impact revenues and results of operations.\nRESULTS OF OPERATIONS.\n1995 versus 1994. Net income increased almost $14.3 million or 23% to $75.4 million. Earnings per share grew more than 23%, or $.47 per share, to an annual record of $2.47. The 1995 results include an extraordinary charge of $1.0 million or $.03 per share from the early extinguishment of the Company's 9.77% fixed rate, $12.4 million promissory note due in 2001. The Company's common stock repurchases during 1994 and 1995 resulted in a decrease in weighted average shares outstanding and account for $.03 of the increase in earnings per share. Total revenues increased 15% from $382.4 million to an annual record of $439.3 million, led by an increase of $42.0 million in investment advisory revenues.\nInvestment advisory revenues from the Funds increased more than $37.6 million as average assets under management rose $6.2 billion to $42.7 billion. Fund assets totaled $48.6 billion at December 31, 1995, up $11.3 billion from December 31, 1994, with stock funds accounting for $9.5 billion of the increase. Net cash inflows to the Funds during 1995 of $3.8 billion, including $3.6 billion to the stock funds, surpassed the 1994 total of $3.4 billion and nearly equaled the record of $3.9 billion in 1993. Private accounts and other sponsored products contributed the balance of the investment advisory revenue gains as these assets under management rose $6.3 billion to more than $26.8 billion at December 31, 1995. Total assets under management at year end increased to $75.4 billion from $57.8 billion.\nAdministrative fees from services to the Funds and their shareholders rose 10% during 1995 to $94.4 million, primarily as a result of growth in the\nactivities of the Company's mutual fund transfer agent and defined contribution retirement plan recordkeeping services; however, increases in related operating expenses more than offset these revenue gains.\nInvestment and other income rose $6.2 million primarily due to greater earnings on the Company's larger mutual fund holdings and capital gains realized on stock mutual fund investments.\nOperating expenses increased 13% or $34.4 million to $295.6 million from $261.2 million. Greater compensation and related costs, which were up $14.0 million, were attributable to increases in overall compensation rates, including higher bonuses, and an 8% increase in the average number of employees primarily to support the Company's growing administrative operations. Advertising and promotion expenditures increased 12% to $34.8 million as fourth quarter 1995 spending was boosted significantly in response to investor demand for stock mutual funds. Early 1996 cash inflows to the mutual funds have been strong. Advertising and promotion expenditures in 1996 are expected to remain high relative to 1995 expenditures as long as market conditions and cash inflows warrant. Depreciation, amortization, and operating rentals of property and equipment increased $5.2 million as a result of the Company's recent investments in computer and communications equipment and office facilities. International investment research fees increased $4.3 million as international assets under management rose to $22.2 billion at December 31, 1995, including $12.6 billion in the mutual funds. Administrative and general expenses increased $7.2 million due to greater costs associated with the Company's growing operations and data processing capabilities.\nThe provision for income taxes decreased as a percentage of income before income taxes and minority interests primarily due to the recognition of federal research expenditure credits. Tax laws allowing such credits expired June 30, 1995.\nLower net income reported on a separate company basis by the Company's 50%- owned subsidiary, Rowe Price-Fleming International, Inc. (RPFI), was the primary reason for the decrease in income attributable to the minority interests in the Company's consolidated subsidiaries.\n1994 versus 1993. Net income increased $12.6 million or 26% from $48.5 million and $1.59 per share to $61.2 million and $2.00 per share. Revenues increased 23% to $382.4 million from $310.0 million. Results for 1993 included a net charge of $.3 million or $.01 per share reflecting the cumulative effects of changes in accounting principles.\nInvestment advisory revenues from the Funds increased $46.4 million as average assets under management rose $6.7 billion to $36.5 billion. Assets in the Funds closed 1994 at $37.3 billion, up $2.6 billion during the year, with stock funds accounting for $22.8 billion of the year-end total. Net cash inflows to the Funds during 1994 totaled nearly $3.4 billion as net subscriptions of $4.1 billion into the stock funds and $.8 billion into the money market funds were partially offset by net redemptions of $1.5 billion\nfrom the bond funds. Private accounts and other sponsored products primarily in the international asset area and performance management fees earned from sponsored partnerships contributed $18.8 million of the revenue gains. Private account assets under management rose to $20.5 billion at December 31, 1994, up $.8 billion during the year. Total assets under management at year end increased to $57.8 billion from $54.4 billion.\nAdministrative fees from services to the Price Funds and their shareholders rose 11% during 1994 to $85.7 million as a result of growth in the activities of the Company's mutual fund transfer agent and defined contribution plan recordkeeping services; however, increases in related operating expenses more than offset these revenue gains. Investment and other income decreased $1.4 million from 1993 due to losses from dispositions and write-downs of the Company's bond fund holdings in the higher interest rate environment that existed throughout 1994.\nOperating expenses increased 19% or $42.1 million to $261.2 million from $219.1 million. Greater compensation and related costs, which were up $19.7 million, were attributable to increases in overall compensation rates, including higher bonuses, and a 6% increase in the average number of employees, primarily to support the growing administrative services operations. The Company increased spending on advertising and promotion by $1.8 million primarily to attract additional investments into the international funds during early 1994. Such expenditures vary over time as market conditions and cash inflows to the Funds warrant. Depreciation, amortization, and operating rentals of property and equipment increased $3.5 million as a result of the Company's recent investments in computer and communications equipment, office facilities and furnishings. International investment research fees, which are based on international assets under management, increased $9.2 million. Administrative and general expenses increased $7.9 million as a result of greater operating costs associated with the Company's growing operations, including those related to data processing and communications.\nIncreased earnings by RPFI was the primary reason for the increase in income attributable to the minority interests in consolidated subsidiaries. The Company's international assets, which are managed by RPFI, increased $2.9 billion to $18.3 billion at December 31, 1994, including $10.8 billion in the Price Funds.\nCAPITAL RESOURCES AND LIQUIDITY.\nDuring the three years ended December 31, 1995, stockholders' equity increased 78% or $120.0 million to $274.2 million. Stockholders' equity at December 31, 1995 includes $12.7 million of net unrealized security holding gains on the Company's investments in sponsored mutual funds and $43.2 million which is restricted as to use under various regulations and agreements to which the Company and its subsidiaries are subject in the ordinary course of business.\nOperating activities provided net cash inflows of $101.8 million in 1995 when net income increased $14.3 million. Comparatively, 1994 provided net operating cash inflows of $111.9 million, including $27.3 million from the\nliquidation of sponsored mutual fund investments which had been held as trading securities. Net cash expended in investing activities during 1995 aggregated $35.5 million, down from the $53.4 million expended in 1994 when the proceeds of the liquidation of the trading securities portfolio were reinvested in the Company's longer-term investment portfolios. Property and equipment expenditures reached $23.9 million in 1995, including $7.8 million for the acquisition of 32.5 acres of land in suburban Owings Mills, Maryland on which the Company will develop additional office facilities for its expanding operations. Financing activities consumed $44.9 million in 1995, including common stock repurchases, dividends and distributions to minority interests as well as $13.6 million for the early extinguishment of the Company's long-term debt. The Company realized a substantial savings by retiring the debt at market rates versus the terms of the original borrowing.\nAt December 31, 1995, the Company held net liquid assets of more than $170 million, including $81.4 million of cash and cash equivalents, to meet business demands and opportunities. In addition, a maximum of $20 million is available to the Company under unused bank lines of credit.\nThe Company anticipates 1996 property and equipment acquisitions of approximately $50 million, including $20 million for development of two office buildings on the land acquired in 1995. Additional construction and furnishing costs of approximately $30 million for these new facilities are expected in 1997 before occupancy occurs in the latter half of the year. These capital expenditures are expected to be funded from liquid assets currently available and from operating cash inflows. The future need for additional facilities can be met on the substantial acreage remaining undeveloped and on an adjacent 37.4 acres presently under purchase option. Commitments for additional investments in partnerships and other ventures aggregate $7.5 million at December 31, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Financial Statements: Report of Independent Accountants 22 Consolidated Balance Sheets at December 31, 1994 and 1995 23 Consolidated Statements of Income for each of the three years in the period ended December 31, 1995 24 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995 25 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1995 26 Summary of Significant Accounting Policies 28 Notes to Consolidated Financial Statements 30\nSupplementary Data - Selected Quarterly Data. 37\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of T. Rowe Price Associates, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of T. Rowe Price Associates, 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.\nDuring 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and income taxes by adopting new standards of the Financial Accounting Standards Board. These changes are more fully described in Notes 8 and 4 accompanying the consolidated financial statements.\n\/s\/ PRICE WATERHOUSE LLP\nBaltimore, Maryland January 25, 1996\nT. ROWE PRICE ASSOCIATES, INC. CONSOLIDATED BALANCE SHEETS\nDecember 31, __________________ 1994 1995 ________ ________ (in thousands) ASSETS Cash and cash equivalents (Note 1) $ 60,016 $ 81,431 Accounts receivable (Note 1) 46,722 55,841 Investments in sponsored mutual funds held as available-for-sale securities (Note 1) 93,010 121,606 Partnership and other investments (Note 9) 28,657 28,049 Property and equipment (Note 2) 49,341 60,222 Goodwill and other assets (Notes 3 and 4) 19,536 18,194 ________ ________ $297,282 $365,343 ________ ________ ________ ________\nLIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Accounts payable and accrued expenses (Note 6) $ 18,538 $ 27,287 Accrued compensation and retirement costs (Note 8) 27,413 28,803 Income taxes payable (Note 4) 1,573 7,376 Dividends payable 4,575 6,036 Debt (Note 5) 12,613 -- Minority interests in consolidated subsidiaries 16,331 21,609 ________ ________ Total liabilities 81,043 91,111 ________ ________\nCommitments and contingent liabilities (Note 9)\nStockholders' equity (Notes 6 and 9) Preferred stock, undesignated, $.20 par value - authorized and unissued 20,000,000 shares in 1995 -- -- Common stock, $.20 par value - authorized 48,000,000 shares in 1994 and 100,000,000 shares in 1995; issued 28,569,419 shares in 1994 and 28,665,472 shares in 1995 5,714 5,733 Capital in excess of par value 1,935 2,912 Retained earnings 206,036 252,934 Unrealized security holding gains (Note 1) 2,554 12,653 ________ ________ Total stockholders' equity 216,239 274,232 ________ ________ $297,282 $365,343 ________ ________ ________ ________\nThe accompanying notes are an integral part of the consolidated financial statements.\nT. ROWE PRICE ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF INCOME\nYear ended December 31, __________________________ 1993 1994 1995 ________ ________ ________ (in thousands, except per-share amounts) Revenues Investment advisory fees (Note 1) $224,809 $290,071 $332,087 Administrative fees (Note 1) 77,208 85,672 94,377 Investment and other income (Notes 1 and 7) 8,024 6,635 12,835 ________ ________ ________ 310,041 382,378 439,299 ________ ________ ________\nExpenses Compensation and related costs (Notes 6 and 8) 109,637 129,373 143,369 Advertising and promotion 29,448 31,201 34,843 Depreciation, amortization and operating rentals of property and equipment (Note 9) 21,528 24,993 30,247 International investment research fees 16,469 25,719 30,023 Administrative and general (Note 5) 41,975 49,899 57,124 ________ ________ ________ 219,057 261,185 295,606 ________ ________ ________\nIncome before income taxes and minority interests 90,984 121,193 143,693 Provision for income taxes (Note 4) 35,320 46,587 54,335 ________ ________ ________ Income from consolidated companies 55,664 74,606 89,358 Minority interests in consolidated subsidiaries 6,795 13,455 12,900 ________ ________ ________ Income before extraordinary charge and cumulative effects of changes in accounting principles 48,869 61,151 76,458 Extraordinary charge from early extinguishment of debt, net of income tax benefit (Note 5) -- -- (1,049 ) Cumulative effects of changes in accounting principles for Postretirement benefits other than pensions (Note 8) (621) -- -- Income taxes (Note 4) 291 -- -- ________ ________ ________ Net income $ 48,539 $ 61,151 $ 75,409 ________ ________ ________ ________ ________ ________\nEarnings per share, including a net charge of $.01 per share in 1993 for the cumulative effects of changes in accounting principles and an extraordinary charge of $.03 per share in 1995 $ 1.59 $ 2.00 $ 2.47 ________ ________ ________ ________ ________ ________\nThe accompanying notes are an integral part of the consolidated financial statements.\nT. ROWE PRICE ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nYear ended December 31, ____________________________ 1993 1994 1995 ________ ________ ________ (in thousands) Cash flows from operating activities Net income $ 48,539 $ 61,151 $ 75,409 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization of property and equipment 7,974 10,134 13,278 Amortization of goodwill and deferred expenses 1,845 1,761 1,281 Deferred income taxes (tax benefits) 3,139 (2,232) 711 Minority interests in consolidated subsidiaries 6,795 13,455 12,900 Increase in accounts receivable (13,036) (3,620) (9,119) Liquidation of (investment in) sponsored mutual funds held as trading securities (27,657) 27,292 -- Increase in accounts payable and accrued liabilities 8,648 6,505 6,055 Other changes in assets and liabilities 2,591 (2,587) 1,237 ________ ________ ________ Net cash provided by operating activities 38,838 111,859 101,752 ________ ________ ________ Cash flows from investing activities Investments in sponsored mutual funds (30,710) (33,962) (19,101) Proceeds from dispositions of sponsored mutual funds 1,034 5,192 6,846 Proceeds from disposition of MRT holdings 34,636 -- -- Partnership and other investments (3,214) (8,812) (1,387) Return of partnership investments 905 1,563 2,076 Additions to property and equipment (12,240) (17,431) (23,906) ________ ________ ________ Net cash used in investing activities (9,589) (53,450) (35,472) ________ ________ ________ Cash flows from financing activities Purchases of stock (2,251) (26,401) (9,679) Receipts relating to stock issuances 2,457 3,497 4,455 Dividends paid to stockholders (12,138) (15,085) (18,259) Distributions to minority interests (4,775) (6,320) (7,720) Debt payments (275) (302) (12,613) Extraordinary charge from early extinguishment of debt -- -- (1,049) ________ ________ ________ Net cash used in financing activities (16,982) (44,611) (44,865) ________ ________ ________ Cash and cash equivalents Net increase during year 12,267 13,798 21,415 At beginning of year 33,951 46,218 60,016 ________ ________ ________ At end of year $ 46,218 $ 60,016 $ 81,431 ________ ________ ________ ________ ________ ________\nThe accompanying notes are an integral part of the consolidated financial statements. T. ROWE PRICE ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands)\nCapital Unreal- Common in ized Total Common stock excess security stock- stock - par of par Retained holding holders' - shares value value earnings gains equity __________ ______ _______ ________ ________ ________ Balance at December 31, 1992 14,429,315 $2,886 $ 1,171 $150,141 $154,198 Common stock issued under stock-based compensation plans 254,629 51 2,963 3,014 2-for-1 stock split 14,491,095 2,898 (1,997) (901) -- Purchases of common stock (80,000) (16) (940) (1,295) (2,251) Net income 48,539 48,539 Dividends declared (12,892) (12,892) Unrealized security holding gains $5,345 5,345 __________ ______ _______ ________ ______ ________ Balance at December 31, 1993 29,095,039 5,819 1,197 183,592 5,345 195,953 Common stock issued under stock-based compensation plans 366,880 74 4,277 4,351 Purchases of common stock (892,500) (179) (3,539) (22,831) (26,549) Net income 61,151 61,151 Dividends declared (15,876) (15,876) Decrease in unrealized security holding gains (2,791) (2,791) __________ ______ _______ ________ ______ ________ Balance at December 31, 1994 28,569,419 5,714 1,935 206,036 2,554 216,239\nContinued on next page.\nT. ROWE PRICE ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands)\nCapital Unreal- Common in ized Total Common stock excess security stock- stock - par of par Retained holding holders' - shares value value earnings gains equity __________ ______ _______ ________ ________ ________\nContinued from prior page.\nCommon stock issued under stock-based compensation plans 465,553 93 5,555 (2) 5,646 Purchases of common stock (369,500) (74) (4,578) (8,789) (13,441) Net income 75,409 75,409 Dividends declared (19,720) (19,720) Increase in unrealized security holding gains 10,099 10,099 __________ ______ _______ ________ _______ ________ Balance at December 31, 1995 28,665,472 $5,733 $ 2,912 $252,934 $12,653 $274,232 __________ ______ _______ ________ _______ ________ __________ ______ _______ ________ _______ ________\nThe accompanying notes are an integral part of the consolidated financial statements. T. ROWE PRICE ASSOCIATES, INC. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nT. Rowe Price Associates, Inc. and its consolidated subsidiaries (the Company) derives its revenue primarily from investment advisory and administrative services provided to sponsored mutual funds and investment products and to private accounts of other institutional and individual investors. Company revenues are largely dependent on the total value and composition of assets under management, which include domestic and international equity and debt securities; accordingly, fluctuations in financial markets and in the composition of assets under management impact revenues and results of operations.\nBASIS OF PREPARATION. The consolidated financial statements are prepared in accordance with generally accepted accounting principles which requires the use of estimates made by the Company's management. Certain 1993 and 1994 amounts have been reclassified to conform to the 1995 presentation.\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of all majority owned subsidiaries and, by virtue of the Company's controlling interest, its 50%-owned subsidiary, Rowe Price-Fleming International, Inc. (RPFI). All material intercompany accounts and transactions are eliminated in consolidation.\nInternational investment research is provided by affiliates of the minority stockholders of RPFI. Fees paid for these services are based on international assets under management by RPFI.\nCASH EQUIVALENTS. For purposes of financial statement disclosure, cash equivalents consist of all short-term, highly liquid investments including certain money market mutual funds and all overnight commercial paper investments. The cost of these investments is equivalent to fair value.\nINVESTMENTS IN SPONSORED MUTUAL FUNDS. On December 31, 1993, the Company began accounting for its investments in sponsored stock and bond mutual funds at fair value and, accordingly, classifies these holdings as either trading securities (held for only a short period of time) or available-for-sale securities. Unrealized holding gains on securities classified as available-for-sale are reported, net of income taxes, as a separate component of stockholders' equity.\nCONCENTRATION OF CREDIT RISK. Financial instruments which potentially expose the Company to concentrations of credit risk as defined by Statement of Financial Accounting Standards (SFAS) No. 105 consist primarily of investments in sponsored money market and bond mutual funds and accounts receivable. Credit risk is believed to be minimal in that counterparties to these financial instruments have\nsubstantial assets, including the diversified investment portfolios under management by the Company which aggregate $75.4 billion at December 31, 1995.\nPARTNERSHIP AND OTHER INVESTMENTS. The Company invests in various partnerships and ventures, including those sponsored by the Company. These entities, which hold equity securities, venture capital investments and debt securities, are generally accounted for using the equity method which adjusts the Company's cost for its share of subsequent earnings or losses. These investments do not have a readily determinable fair value. Minor limited partnership investments are accounted for using the cost method.\nPROPERTY AND EQUIPMENT. Property and equipment is stated at cost net of accumulated depreciation and amortization computed using the straight-line method. Provisions for depreciation and amortization are based on the following estimated useful lives: computer and communications equipment, furniture and other equipment, 2 to 7 years; building, 40 years; leasehold improvements, the shorter of their estimated useful lives or the remainder of the lease term; and leased land, the term of the lease.\nREVENUE RECOGNITION. Investment advisory and administrative services fees are recognized during the period in which such services are performed, except when advisory fees from mutual funds are adjusted in accordance with the expense limitation provisions of the investment advisory agreements between the Company and the funds. Allowances made for reduced advisory fees and other mutual fund expenses in excess of limitations may be recovered in future periods if and when fund performance and related expense limitation provisions permit.\nADVERTISING. Costs of advertising are expensed the first time that the advertising takes place.\nEARNINGS PER SHARE. Earnings per share is computed based on the weighted average number of common shares outstanding, including share equivalents arising from unexercised stock options. The aggregate weighted average shares outstanding used in computing earnings per share were 30,615,114 in 1993, 30,571,496 in 1994, and 30,524,853 in 1995.\nT. ROWE PRICE ASSOCIATES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - INVESTMENTS IN AND TRANSACTIONS WITH SPONSORED MUTUAL FUNDS.\nInvestments in sponsored money market mutual funds, which are classified as cash equivalents in the accompanying consolidated financial statements, aggregate $59,355,000 at December 31, 1994 and $78,947,000 at December 31, 1995.\nThe Company's investments in sponsored mutual funds held as available-for- sale at December 31 include:\nGross unrealized Aggregate Aggregate holding gains fair cost (losses) value _________ ______________ _________ (in thousands) ___________ Stock funds $ 58,540 $ 4,346 $ 62,886 Bond funds 30,460 (336) 30,124 ________ _______ ________ Total $ 89,000 $ 4,010 $ 93,010 ________ _______ ________ ________ _______ ________\n___________ Stock funds $ 70,872 $17,345 $ 88,217 Bond funds 30,856 2,533 33,389 ________ _______ ________ Total $101,728 $19,878 $121,606 ________ _______ ________ ________ _______ ________\nDividends earned on the Company's investments in sponsored mutual funds aggregated $4,439,000 in 1993, $5,644,000 in 1994, and $9,845,000 in 1995. The Company recognized net losses of $34,000 and $1,306,000 in 1993 and 1994, respectively, and a net gain of $473,000 in 1995 from dispositions and write- downs of fund investments.\nThe Company provides investment advisory and administrative services to the T. Rowe Price family of mutual funds which had aggregate net assets under management at December 31, 1995 of $48.6 billion. All services rendered by the Company are provided under contracts that set forth the services to be provided and the fees to be charged. These contracts are subject to periodic review and approval by each of the funds' boards of directors and, with respect to investment advisory contracts, also by the funds' shareholders. Revenues derived from services rendered to the sponsored mutual funds were $221,199,000 in 1993, $274,618,000 in 1994, and $318,276,000 in 1995.\nAccounts receivable from the sponsored mutual funds aggregate $23,666,000 and $30,029,000 at December 31, 1994 and 1995, respectively.\nNOTE 2 - PROPERTY AND EQUIPMENT.\nProperty and equipment at December 31 consists of:\n1994 1995 ________ ________ (in thousands)\nComputer and communications equipment $ 42,316 $ 52,265 Building and leasehold improvements 23,991 25,277 Furniture and other equipment 17,053 18,207 Land owned and leased 2,736 10,518 ________ ________ 86,096 106,267 Accumulated depreciation and amortization (36,755) (46,045) ________ ________ $ 49,341 $ 60,222 ________ ________ ________ ________\nNOTE 3 - GOODWILL.\nGoodwill of $7,937,000 arising from the 1992 acquisition of an investment management subsidiary of USF&G Corporation and the combination of six USF&G mutual funds into the T. Rowe Price family of funds is being amortized over 11 years using the straight-line method. Accumulated amortization at December 31, 1994 and 1995 aggregates $1,738,000 and $2,483,000, respectively.\nGoodwill of $1,980,000 arising from an earlier corporate acquisition is being amortized over 40 years using the straight-line method. Accumulated amortization was $1,089,000 at December 31, 1994 and $1,138,000 at December 31, 1995.\nNOTE 4 - INCOME TAXES.\nThe provision for income taxes consists of:\n1993 1994 1995 ________ ________ ________ (in thousands) Current income taxes Federal and foreign $ 27,254 $ 42,635 $ 46,350 State and local 4,927 6,184 7,274 Deferred income taxes (tax benefits) 3,139 (2,232) 711 ________ ________ ________ $ 35,320 $ 46,587 $ 54,335 ________ ________ ________ ________ ________ ________\nDeferred income taxes arise from temporary differences between taxable income for financial statement and income tax return purposes. Significant temporary differences resulted in deferred income taxes of $2,713,000 in 1993 related to income from the MRT holdings and $944,000 in 1995 related to accrued compensation and retirement costs. Deferred tax benefits arising from significant temporary differences include $1,712,000 related to accrued compensation and $704,000 related to net unrealized investment income in 1994.\nOn January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income\nTaxes,\" which requires the use of the liability method for computing deferred income taxes instead of the deferred method previously used in the Company's financial statements. The cumulative effect of adopting the new accounting principle was a credit to earnings of $291,000 or $.01 per share.\nThe net deferred tax asset of $1,125,000 included in other assets at December 31, 1994 consists of total deferred tax liabilities of $3,660,000 and total deferred tax assets of $4,785,000. Deferred tax liabilities include $1,100,000 arising from RPFI's undistributed earnings, $1,901,000 arising from net unrealized investment income, and $659,000 from depreciation expense. Deferred tax assets include $3,646,000 arising from deferred compensation and retirement costs and $1,139,000 from other accrued expenses.\nThe net deferred tax liability of $5,189,000 included in income taxes payable at December 31, 1995 consists of total deferred tax liabilities of $8,991,000 and total deferred tax assets of $3,802,000. Deferred tax liabilities include $1,475,000 arising from RPFI's undistributed earnings, $7,037,000 arising from net unrealized investment income, and $479,000 from depreciation expense. Deferred tax assets include $2,702,000 arising from deferred compensation and retirement costs and $1,100,000 from other accrued expenses.\nCash outflows from operating activities include income taxes paid of $31,355,000 in 1993, $49,686,000 in 1994, and $52,956,000 in 1995.\nThe following table reconciles the statutory federal income tax rate to the Company's effective income tax rate.\n1993 1994 1995 ______ ______ ______ Statutory federal income tax rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefits 3.6 3.1 3.3 Other items .2 .3 (.5) ______ ______ ______ Effective income tax rate 38.8% 38.4% 37.8% ______ ______ ______ ______ ______ ______\nNOTE 5 - DEBT.\nIn September 1995, the Company extinguished the $12,375,000 balance of its 9.77% promissory note due in 2001 and recognized an extraordinary charge equal to the $1,500,000 prepayment premium and the unamortized debt issuance cost of $235,000, net of an income tax benefit of $686,000. The estimated fair value of this note at December 31, 1994 exceeded the outstanding principal balance at that time by $1,392,000.\nA maximum of $20,000,000 is available to the Company under unused bank lines of credit at December 31, 1995.\nCash outflows from operating activities include interest paid of $1,481,000 in 1993, $1,643,000 in 1994, and $1,000,000 in 1995. Interest expense was $1,754,000 in 1993, $1,330,000 in 1994, and $1,023,000 in 1995.\nNOTE 6 - COMMON STOCK AND STOCK-BASED COMPENSATION PLANS.\nSHARES AUTHORIZED AND ISSUED.\nA 2-for-1 split of the Company's common stock was effected on November 30, 1993. Earnings per-share data in the accompanying consolidated financial statements and all per-share and share data in these notes have been adjusted to give retroactive effect to the stock split.\nAt December 31, 1995, the Company had reserved 7,318,402 shares of its unissued common stock for issuance upon the exercise of stock options and 420,000 shares for issuance under a plan whereby substantially all employees may acquire shares of Company stock through payroll deductions at prevailing market prices.\nThe Company's board of directors has authorized the future repurchase of up to 1,670,000 common shares at December 31, 1995. Accounts payable and accrued expenses includes $148,000 at December 31, 1994 and $3,910,000 at December 31, 1995 for pending settlements of common stock repurchases.\nSubsequent to year end, the Company's board of directors adopted resolutions to effect a two-for-one split of common shares and a proportional increase in authorized common shares from 100,000,000 to 200,000,000. These changes require amendment of the Company's charter and have been recommended by the board to the Company's stockholders for approval at their annual meeting on April 12, 1996.\nDIVIDENDS.\nThe Company declared cash dividends per share of $.445 in 1993, $.55 in 1994 and $.69 in 1995.\nFIXED STOCK OPTION PLANS.\nAt December 31, 1995, the Company has four stock-based compensation plans (the 1986, 1990 and 1993 Stock Incentive Plans and the 1995 Director Stock Option Plan) under which it has granted fixed stock options with a maximum term of 10 years to its employees and directors. Vesting of employee options is based solely on the individual continuing to render service to the Company and generally occurs over a 5-year graded schedule. The exercise price of each option granted is equivalent to the market price of the Company's stock at the date of grant. The Company applies the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" in accounting for its stock option awards. Accordingly, the Company has not recognized any related compensation expense. Beginning with financial statements for 1996, the Company will be required to make certain additional disclosures as if the fair value based method of accounting defined in SFAS No. 123, \"Accounting for Stock-Based Compensation,\" had been applied to the Company's stock option grants made subsequent to 1994.\nThe following table summarizes the status of and changes in the Company's stock option plans during the past three years. Weighted- Weighted- average average exercise Options exercise Options price exercisable price _________ __________ ___________ _________ Outstanding at beginning of 1993 3,772,640 $12.95 Granted 1,154,000 28.13 Exercised (343,525) 8.95 Forfeited (58,800) 15.31 _________ ______ Outstanding at end of 1993 4,524,315 17.09 1,461,927 $11.63 _________ ______ _________ ______ Granted 1,231,500 32.25 Exercised (387,392) 10.16 Forfeited (173,000) 18.24 _________ ______ Outstanding at end of 1994 5,195,423 21.16 1,989,913 $14.49 _________ ______ _________ ______ Granted 1,241,500 52.05 Exercised (515,521) 12.02 Forfeited (96,110) 25.52 _________ ______ Outstanding at end of 1995 5,825,292 $28.48 2,462,192 $17.07 _________ ______ _________ ______ _________ ______ _________ ______\nAdditional information regarding stock options outstanding at December 31, 1995 follows.\nWeighted- average Weighted- remaining Weighted- average contractual average Range of exercise life (in exercise exercise prices Outstanding price years) Exercisable price ________________ ___________ __________ ___________ ___________ _________ $5.375 to 7.9375 474,720 $ 7.37 4.0 474,720 $ 7.37 8.50 to 11.375 514,645 10.74 3.2 514,645 10.74 17.00 to 18.75 1,352,910 17.98 6.3 889,310 17.85 28.125 to 38.375 2,257,517 30.37 8.4 583,517 29.35 45.75 to 52.25 1,225,500 52.23 9.8 0 -- _________ ______ ____ _________ ______ $5.375 to 52.25 5,825,292 $28.48 7.4 2,462,192 $17.07 _________ ______ ____ _________ ______ _________ ______ ____ _________ ______\nNOTE 7 - OTHER INCOME.\nIn 1993, the Company received interest income of $2,046,000 and recognized a capital loss of $112,000 on its holdings of the defaulted indebtedness of Mortgage and Realty Trust (MRT).\nNOTE 8 - EMPLOYEE RETIREMENT PLANS.\nThe Company sponsors two defined contribution retirement plans: a profit sharing plan based on participant compensation and a 401(k) plan. Costs recognized for these plans were $7,601,000 in 1993, $7,881,000 in 1994, and $8,676,000 in 1995.\nThe Company also has a defined benefit plan covering those employees whose annual base salaries do not exceed a plan-specified salary limit. Participant benefits are based on the final month's base pay and years of service subsequent to January 1, 1987. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. The following table sets forth the plan's funded status and the amounts recognized in the Company's consolidated balance sheets.\n1994 1995 ________ ________ (in thousands) Actuarial present value of Accumulated benefit obligation for service rendered Vested $ 1,430 $ 3,207 Non-vested 343 890 ________ ________ Total 1,773 4,097 Obligation attributable to estimated future compensation increases 685 1,725 ________ ________ Projected benefit obligation 2,458 5,822 Plan assets held in sponsored mutual funds, at fair value 2,747 3,956 ________ ________ Projected benefit obligation in excess of (less than) plan assets (289) 1,866 Unrecognized net gain from changes in discount rate and past experience different from that assumed 2,501 24 ________ ________ Accrued retirement costs $ 2,212 $ 1,890 ________ ________ ________ ________\nDiscount rate used in determining actuarial present values 8.25% 6.10% ________ ________ ________ ________\nNet periodic retirement plan expense includes:\n1993 1994 1995 ______ ______ ______ (in thousands) Service cost for benefits earned during the year $1,077 $867 $531 Interest cost on projected benefit obligation 252 230 202 Actual return on plan assets (94) (5 (754) Net amortization and deferral 489 (271 330) ______ _____ _____ $1,724 $821 $309 ______ _____ _____ ______ _____ _____\nOn January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which changed the Company's practice of accounting for postretirement health and life insurance benefits from the cash basis to the accrual basis. The effect of adopting the new accounting principle was an aftertax charge to earnings of $621,000 or $.02 per share. Postretirement benefits plan participants include only those retirees and their dependents who were receiving benefits on January 1, 1993.\nNOTE 9 - COMMITMENTS AND CONTINGENT LIABILITIES.\nThe Company leases office facilities and equipment under noncancelable operating leases. Related rent expense was $13,554,000 in 1993, $14,859,000\nin 1994, and $16,969,000 in 1995. Future minimum rental payments under these leases aggregate $9,516,000 in 1996, $7,062,000 in 1997, $5,937,000 in 1998, $5,203,000 in 1999, $5,203,000 in 2000, and $31,094,000 in later years.\nAt December 31, 1995, the Company had outstanding commitments to invest an additional $7,472,000 in various investment partnerships and ventures.\nThe Company has contingent obligations at December 31, 1995 under a $500,000 direct pay letter of credit expiring not later than 1999 and a $780,000 standby letter of credit which is renewable annually.\nConsolidated stockholders' equity at December 31, 1995 includes $43,195,000 which is restricted as to use under various regulations and agreements to which the Company and its subsidiaries are subject in the ordinary course of business.\nFrom time to time, the Company is a party to various claims arising in the ordinary course of business. In the opinion of management, after consultation with counsel, it is unlikely that any adverse determination in one or more pending claims would have a material adverse effect on the Company's financial position or results of operations.\nSupplementary Data - Selected Quarterly Financial Data:\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter ________ ________ ________ ________ (in thousands, except per-share amounts)\nRevenues $ 91,927 $ 92,468 $ 96,943 $101,040 Net income $ 13,753 $ 15,049 $ 16,262 $ 16,087 Earnings per share (1) $ .44 $ .49 $ .53 $ .53\nRevenues $ 97,846 $104,789 $113,226 $123,438 Net income $ 14,991 $ 18,222 $ 20,502 (2) $ 21,694 Earnings per share $ .50 $ .60 $ .67 (2) $ .70\n(1) The sum of the 1994 quarterly earnings per share does not equal the full-year amount because the quarterly computations are done independently based on average shares outstanding during each quarter.\n(2) Net income and earnings per share before an extraordinary charge were $21,551 and $.70, respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation required by this item as to the identification of the Company's executive officers and other significant employees is contained as a separate item at the end of Part I of this Form 10-K Annual Report. The balance of the information required by this item as to the Company's directors and executive officers appears in the definitive proxy statement for the Company's 1996 Annual Meeting of Stockholders and is incorporated by reference in this Form 10-K.\nITEM 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.\nInformation required by Items 11. through 13. appears in the definitive proxy statement for the Company's 1996 Annual Meeting of Stockholders and is incorporated by reference in this Form 10-K.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this report. 1. Financial Statements: See index at Item 8 of Part II. 2. Financial Statement Schedules: Not applicable. 3. The following exhibits required by Item 601 of Regulation S-K are filed as part of this Form 10-K. Exhibits 10.09 through 10.13 are compensatory plan arrangements.\n3.(i) Composite Restated Charter of T. Rowe Price Associates, Inc. as of April 6, 1995. (Incorporated by reference from Form 8- A12G\/A: Accession No. 933259-95-16; CIK 80255)\n3.(ii) Amended and Restated By-Laws of T. Rowe Price Associates, Inc. as of April 7, 1993. (Incorporated by reference from Form 10-Q Report for the quarterly period ended September 30, 1995; Accession No. 80255-95-83)\n10.01 Form of Investment Management Agreement with each of the T. Rowe Price Funds. (Incorporated by reference from Form N-1A; Accession No. 313212-96-5)\n10.02 Transfer Agency and Service Agreement dated as of January 1, 1996 between each of the T. Rowe Price Funds and T. Rowe Price Services, Inc. (Incorporated by reference from Form N- 1A; Accession No. 313212-96-5)\n10.03 Agreement dated January 1, 1996 between T. Rowe Price Retirement Plan Services, Inc. and each of the T. Rowe Price Taxable Funds. (Incorporated by reference from Form N-1A; Accession No. 313212-96-5)\n10.04 Form of Underwriting Agreement between each of the T. Rowe Price Funds and T. Rowe Price Investment Services, Inc. (Incorporated by reference from Form N-1A; Accession No. 313212-96-5)\n10.05 Contract of Sale and Option dated September 29, 1995 between McDonogh School, Incorporated and TRP Suburban Second, Inc.\n10.06 Office Lease dated as of July 27, 1989 between 100 East Pratt Street Limited Partnership and T. Rowe Price Associates, Inc. (Incorporated by reference from the 1989 Annual Report on Form 10-K [File No. 0-14282])\n10.07 Lease agreement dated April 17, 1990 between McDonogh School, Incorporated and TRP Suburban, Inc. (Incorporated by reference from the 1990 Annual Report on Form 10-K [File No. 0-14282])\n10.08 Amendment dated December 22, 1995 to Lease Agreement between McDonogh School, Incorporated and TRP Suburban, Inc.\n10.09 1986 Employee Stock Purchase Plan of T. Rowe Price Associates, Inc. as Amended to April 5, 1990. (Incorporated by reference from Exhibit A to the Definitive Proxy Statement for the 1990 Annual Meeting of Stockholders which is included in the 1989 Annual Report on Form 10-K [File No. 0-14282])\n10.10 T. Rowe Price Associates, Inc. 1986 Stock Incentive Plan. (Incorporated by reference from Form S-1 Registration Statement [File No. 33-3398])\n10.11 T. Rowe Price Associates, Inc. 1990 Stock Incentive Plan. (Incorporated by reference from Form S-8 Registration Statement [File No. 33-37573])\n10.12 T. Rowe Price Associates, Inc. 1993 Stock Incentive Plan. (Incorporated by reference from Form S-8 Registration Statement [File No. 33-72568])\n10.13 T. Rowe Price Associates, Inc. 1995 Director Stock Option Plan. (Incorporated by reference from Form DEF 14A; Accession No. 933259-95-9; CIK 80255)\n21 Subsidiaries of T. Rowe Price Associates, Inc.\n23 Consent of Independent Accountants, Price Waterhouse LLP.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K.\nNone were 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, on March 22, 1996.\nT. Rowe Price Associates, Inc.\nBy: \/s\/ George J. Collins, 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 22, 1996.\n\/s\/ George J. Collins, Chief Executive Officer and Director\n\/s\/ George A. Roche, Chief Financial Officer and Director\n\/s\/ Thomas H. Broadus, Jr., Director\n\/s\/ James E. Halbkat, Jr., Director\n\/s\/ Carter O. Hoffman, Director\n\/s\/ Henry H. Hopkins, Director\n\/s\/ Richard L. Menschel, Director\n\/s\/ James S. Riepe, Director\n\/s\/ John W. Rosenblum, Director\n\/s\/ Robert L. Strickland, Director\n\/s\/ M. David Testa, Director\n\/s\/ Philip C. Walsh, Director\n\/s\/ Anne Marie Whittemore, Director\n\/s\/ Alvin M. Younger, Jr., Principal Accounting Officer","section_15":""}
{"filename":"819546_1995.txt","cik":"819546","year":"1995","section_1":"ITEM 1 - BUSINESS\nGENERAL\nUltrafit Centers, Inc., (formerly D.S.S., Inc.), a Colorado corporation was formed May, 1987 (the \"Company\" or \"Ultrafit\") to primarily engage in the sale and distribution of dental, medical, pharmaceutical and related supplies and equipment. Prior to October 27, 1995 nor in any of its previous fiscal years, the Company did not have meaningful business operations. On October 27, 1995, the Company exchanged 6,600,000 shares of its Common Shares for 100% of Ultrafit Centers, Inc., a Texas Corporation; thereafter, the Company's name was changed from D.S.S., Inc. to Ultrafit Centers, Inc.\nUltrafit is a management company that manages and develops the Ultrafit Preventive Medicine Centers concept through the operation of individual Ultrafit Preventive Medicine Centers (the \"Ultrafit Center(s)\") and Nutritional Biosciences, Inc. (\"Nutritional Biosciences\"), the Company's sole provider of certain dietary supplements. An Ultrafit Center represents an alternative model for health care which takes a preventive approach versus repair approach to medicine through combining a physician-staffed medical clinic with a state-of-the-art fitness and nutrition center. The Ultrafit program is designed to recognize most patients have never exercised before and a majority have one or more pre-existing illnesses such as high blood pressure, coronary artery disease, diabetes, degenerative arthritis, rheumatoid arthritis and osteoporosis. Therefore, at the outset, a customized patient program is developed with appropriate exercise and diet regimen suited to the particular patient's abilities. Each customized patient program is developed based on a medical evaluation performed by an on-site physician. The Company has developed a proprietary specific step-by-step enrollment process.\nThe Company currently operates six (6) Ultrafit Centers in the State of Texas. As of March 1, 1996, these six (6) Centers had a combined membership of approximately 10,000 patients. On December 1, 1995, the Company entered into an agreement to commence operations in an Ultrafit Preventive Medicine Center in Phoenix, Arizona.\nITEM 1 - BUSINESS (CONT'D.)\nIn June 1995, the Company opened a new Ultrafit Center pursuant to a joint venture agreement with Davlin Corporation. Pursuant to the terms of the Agreement, the Company retains a 49% ownership interest in the center. The Company is also entitled to franchise royalties of 7% of gross revenues.\nThe Company also operates Nutritional Biosciences, Ultrafit's sole provider of certain dietary supplements. Nutritional Biosciences was formed on January 30, 1986, primarily as a wholesaler of vitamins and dietary supplements. For the twelve-month period ending December 31, 1995, Nutritional Biosciences derived approximately sixty-six percent (66%) of its revenues from supplying Ultrafit Centers with certain dietary supplements.\nTHE DEVELOPMENT OF THE ULTRAFIT STATE\nThe Ultrafit concept and system of preventive medicine was developed by Dr. Joseph E. Davis, founder, Chairman of the Board of Directors and Chief Medical Officer of the Company. During his tenure at the Heart and Lung Institute at Bethesda, Maryland, Dr. Davis developed a keen interest in nutritional biochemistry. The goal of Dr. Davis' work was to develop a dietary and exercise program designed to form a preventive versus repair approach to health care. Dr. Davis coined the term \"Ultrafit State\" to characterize his approach to preventive healthcare.\nIn 1978, Dr. Davis opened a private practice in Nacogdoches, Texas and began to apply his concepts in his work of rehabilitating cardiac and orthopedic patients. In 1990, Dr. Davis published a book entitled \"ULTRAFIT\" describing his program. Subsequently, Dr. Davis relocated to Edinburgh, Texas and with John Russell, an executive of a health club group, established the first Ultrafit Center.\nAN ULTRAFIT PREVENTIVE MEDICINE FACILITY\nThe Company delivers its products and services to consumers through the management operation of Ultrafit Centers. Members of each Ultrafit Center pay an initial fee and small monthly charge to have created a customized program incorporating matters relating to physical health, exercise and diet under the direction of a staff physician and a team of exercise and nutrition personnel. Each center houses facilities for patient use of various exercise equipment including stationary bikes, weights, treadmills and other exercise equipment necessary for the Ultrafit program.\nThe non-discounted initial charge to become a patient of an Ultrafit Center is $498.00. The fee covers an initial medical evaluation which includes a cardiac stress test, blood profile, resting electrocardiogram, urinalysis, complete chemistry analysis and physical. Thereafter, each patient is charged a $60.00 monthly fee for use of the Center's facilities, equipment and services. The monthly fee is collected on a pre-authorized bank draft of the patients bank account or credit card. A patient may cancel membership by providing 60 days notice or may move a membership to another Center by providing 30 days notice. Patients have reciprocity at all Ultrafit Centers.\nITEM 1 - BUSINESS (CONT'D.)\nPATIENT ENROLLMENT\nUpon acceptance and prior to the first appointment, each new patient is provided with a copy of the book entitled \"Ultrafit\", a health review form and the rules of the Ultrafit Center. Patients are instructed to read the book, complete the health review and refrain from foods for 12 hours before the first appointment because of the physical exam. Patients are also encouraged to wear clothing appropriate for exercise and, if desired, a change of clothes.\nDuring this evaluation portion of the Company's enrollment process, the patient provides a blood and urine sample followed by a medical exam performed by the on-site physician. This exam typically takes approximately one-hour and includes treadmill evaluation. The first visit concludes with arrangements for the second visit.\nThe second visit is a review of the lab results and doctors physical examination and stress test evaluation. Using these results, the doctor can structure the patients dietary and exercise program and scrutinize same in light of any medical considerations. In some cases, the doctor may prescribe dietary supplements or regimens. The second visit concludes with arranging for the third visit.\nDuring this phase of the enrollment process, a customized training program is developed for the patient taking into account the factors of age, physical limitation, weight and medical exam results and medical history. Within these parameters, the exercise physiologist can develop a program based on goals to lower body fat, lose inches or to develop body tone.\nPatients are provided a program card and a complete demonstration of the exercise equipment by a personal trainer employed by the Ultrafit Center. The personal trainer will work with the patient for at least the next ten visits to ensure a smooth and consistent transition into the Ultrafit program. During this time, patients are taught to monitor their heart rate and technique on how to control heart rate.\nThirty to sixty days after the initial visit, each patient is measured and weighed. In some cases, the exercise program is graduated or decreased to keep pace with the patient.\nDIETARY PROGRAMS\nIn certain cases, an individual patient program includes a dietary regimen in conjunction with a consistent exercise program. The Ultrafit program recommends one of three diets depending upon the needs and medical condition of each patient. Basically, the Ultrafit Diet plans allow different people to eat the same foods, but at different calorie levels.\nTHE ULTRAFIT AMINO ACID DIET provides predigested amino acid tablets and vitamin\/mineral supplements for people with serious weight problems who need help with hunger control. Predigested means that the protein has been broken down to its most basic building blocks.\nITEM 1 - BUSINESS (CONT'D.)\nTHE ULTRAFIT REDUCING DIET helps people lose weight more gradually. Just as does the Ultrafit Amino Acid Diet, the Ultrafit Reducing Diet protects the patient's muscle and reduces the fat in the patient's diet and on the patient's body. This diet does not use amino acid tablets. It does require that the patient takes vitamin\/mineral supplements.\nTHE ULTRAFIT MAINTENANCE DIET helps people of normal weight who have health problems achieve that Ultrafit State. It protects the patient's muscle as the patient reduces the fat in his\/her diet and on the patient's body. This diet includes a weekly \"pig-out meal.\"\nTHE BODY WARRANTY\nThe Company provides qualified members free limited outpatient care including:\n(1) Routine Outpatient care for illness that can be appropriately treated by a general practitioner or internist during posted office hours.\n(2) All lab work completed at cost plus a nominal drawing and handling fee.\n(3) All medical fees will be posted.\nConditions of eligibility for the Company's free limited outpatient care state: \"This Body Warranty remains in effect as long as the terms heretofore mentioned are honored and the member is in good standing; members must exercise a minimum of ten (10) times per month; members must be 14 years in age or older; and, must be current on premiums.\"\nThe Company previously obtained its supply of Amino Acid tablets offered by the Company to certain of its patients from Nutritional Biosciences. The Company acquired the assets of Nutritional Biosciences on April 3, 1995, thereby relieving dependence on an outside party for supplies of Amino Acid tablets.\nCOMPETITION\nManagement believes its competition arises primarily from health clubs and diet centers. Although the Company believes its approach to preventive medicine through providing a physician-staffed medical clinic with a state-of-the-art fitness and nutrition center allows it a competitive advantage, the majority of health clubs and diet centers have substantially greater financial and marketing resources than the Company. Moreover, there can be no assurance that competitors that more closely parallel the Company's method of operation might not enter markets in which the Company has a presence at some time in the future.\nITEM 1 - BUSINESS (CONT'D.)\nINDUSTRY - PREVENTIVE MEDICINE\nAlthough the Company shares the characteristics of a fitness center or gym as well as the characteristics of a diet center, management considers its industry segment is better defined as \"preventive medicine.\"\nThe Company's founder developed the Ultrafit series of programs in the course of providing services as a practicing physician. As such, while an Ultrafit Center offers all the amenities standard to other fitness centers such as exercise equipment, weight machines, etc., the Company's use of an on-site physician, exercise physiologist and nutrition expert substantially differentiate it from either health clubs or diet centers. The Company defines preventive medicine in the same manner as the Centers for Disease Control, i.e. \"preventive\" medicine are programs able to \"reduce the incidence, prevalence and burden of disease and injury and enhance health by improving physical social and mental well-being.\"\nManagement believes there is a general growing trend of acceptance for a preventive approach to medicine versus a repair approach. According to a survey by the U.S. Department of Health and Human Services, approximately 81 percent of private work-sites with at least 50 employees offered some type of health promotion activities in 1992, compared with 66 percent in 1985. An October 1993 William M. Mercer Inc. survey showed the main motivation for establishing such programs was to reduce health care costs (83 percent). Others cited employee interest (36 percent) and absenteeism\/productivity issues (17 percent). Fourteen percent mentioned other reasons, the most common being a concern for employee welfare.\nAmong the published studies which management believes demonstrate growth in the popularity of a preventive approach to medicine include Johnson & Johnson's Live For Life program showed cost savings of about $180 a year for each employee. Stanford University School of Medicine's Healthtrac program showed a reduction of $300 in medical claims for each $30 spent on guiding individuals into healthier lifestyles. Stratus Computer Inc. of Marlborough, Mass., is saving about $50,000 a year on medication and diabetic treatment for its employees who completed the HealthMatters program during 1992 and 1993.\nMARKETING\nThe Company intends to market and develop its locations through franchising and jointly-owned Ultrafit Centers. The rationale for franchising the Ultrafit is based, in part, upon management's belief that new Centers can best be developed if owned by physicians practicing preventive medicine. Additionally, Company-owned locations require significant capital and management estimates that expansion would be restricted to the availability of capital.\nITEM 1 - BUSINESS (CONT'D.)\nThe Company has not conducted any marketing studies which would indicate a demand or lack of demand for its approach to preventive medicine or its approach to marketing through offering for sale jointly-owned or franchised Ultrafit Centers. Accordingly, the Company is relying solely on the opinion of management that a need exists in the marketplace for preventive medicine in general and for the Ultrafit approach to preventive medicine in particular. As such, there can be no assurance that any market exists or, if a market exists, that it would be receptive to preventive medicine as delivered according to the Ultrafit approach.\nFRANCHISING AND JOINTLY-OWNED ULTRAFIT CENTERS.\nThe Company intends to develop the Ultrafit concept, in part, through obtaining qualified franchisees, which franchisees may include, as equity participants, physicians practicing preventive medicine. The Company is also seeking to extend and develop its Ultrafit concept through joint venture or joint development agreements.\nUnder the jointly-owned approach, the Company licenses its system for center operation, together with its name and other materials. The Company retains 40% to 50% ownership of each center and the purchaser provides funding to establish a particular center. The Company envisions it will market the jointly-owned approach exclusively to physicians who practice a preventive form of medicine and agree to act as or provide for a full-time, on-site physician.\nDEVELOPMENT OF JOINTLY-OWNED ULTRAFIT CENTERS\nThe Company intends to market the jointly-owned approach exclusively to physicians who practice a preventive form of medicine and agree to act as or provide for a full-time, on-site physician.\nSALES OF FRANCHISE ULTRAFIT CENTERS\nOn September 21, 1994, the Company entered its first franchise agreement with Princeton Medical Group (\"PMG\") for the San Antonio, Texas, area. Said area contains two existing Ultrafit Centers which PMG continues to operate. The Company intends to offer franchises to qualified individuals, primarily physicians. Franchises will be awarded for an initial fee of $50,000 and a monthly royalty of between seven percent (7%) and nine percent (9%) of gross sales.\nDuring the term of a franchise agreement, a franchisee must pay the Company a continuing monthly royalty fee between seven and nine percent (7-9%) of the gross sales of the Ultrafit Center. The Company, in its sole discretion, may modify the royalty fee for a specific franchise under certain limited circumstances. Such circumstances include an evaluation of market conditions, including the degree of market penetration of the Ultrafit Centers in the area to be developed and the demographics of the area; the number of Ultrafit Centers to be developed; the time period for such development and the location of the Ultrafit Center; the financial strength and experience of the franchisee and related factors.\nITEM 1 - BUSINESS (CONT'D.)\nREGULATORY COMPLIANCE\nIn connection with its franchise operations and with respect to the provisioning of medical services through the physician employees of the particular Centers, the Company is subject to state, federal and professional medical practice requirements.\nTRADEMARKS AND COPYRIGHTS\nAlthough the Company does not have any registered trademarks or copyrights, the Company believes that it has proprietary rights with respect to certain of its trademarks and copyrights.\nEMPLOYEES\nNone of the Company's employees are subject to collective bargaining agreements. The Company's employees have never been on strike while in the employ of the Company. As of December 31, 1995, The Company employed individuals in the following capacities: The following table sets forth the Company's employees by category as of December 31, 1995:\nCURRENT CATEGORY EMPLOYEES -------- ---------\nCorporate\/Administration 2 Sales and Marketing Office\/Customer Service 1\nTotal 3\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company leases its facilities under various operating leases. Reference is made to Note 12 of the Company's Notes to Consolidated Financial Statements with respect to current and future lease obligations.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThe Company's property is subject to a pending legal proceeding filed in 1994 in the U.S. Banruptcy Court for the Western District of Texas. Such action is an outcome of the Chapter 7 bankruptcy case filed by John and Patty Russell. In such proceeding, the Bankruptcy Trustee is seeking recovery from Dr. Davis \"the true value of the stock in DPJ\" [Inc.], which company was acquired by Dr. Davis from John Russell in 1992. The Trustee in such action is alleging, among other matters, that the Company has liability, as a subsequent transferee of Dr. Davis, due to the fact that, as alleged by the Trustee, DPJ was purchased by Ultrafit for a price below its market value. The Company was named as a party in this litigation in December 1995.\nReference is made to Note 13 to the Company's Notes to Consolidated Financial Statements for the year ended December 31, 1995.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn the final quarter of the year, no matters were submitted to a vote of security holders.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANTS' COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMarket Information\nCommencing October 27, 1995, the Company's Common Stock is traded on the electronic bulletin board. The high and low bid price during such period was, as follows:\nHIGH LOW ---- ---\n3-1\/4 2\nThere are currently 300,000 outstanding Warrants for the purchase of Common Shares, in prices ranging from $1.00 to $1.50. The Warrants are effective for a period of two years from date of issuance and would, if unexercised, expire at midnight on December 19, 1997. There are no other options, warrants or securities convertible into common equity of the Registrant. None of the Registrant's securities may be sold pursuant to Rule 144. However, the Company has undertaken to register approximately three million (3,000,000) of its Common Shares for certain unaffiliated Shareholders of Record. The Company currently plans to register such Common shares in the Summer of 1996.\nSince inception the Company has never paid dividends on any class of its equity. The Company does not intend to pay dividends in the future.\nAs of December 31, 1995, there were 288 Shareholders of Record.\nITEM 6","section_6":"ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company believes that it has effectively limited the amount of debt incurred in opening new Centers by utilizing internal financial and off the balance sheet financing. With these factors in mind, the Company has improved its ratio of total assets to total liabilities from 1.88 to 1 as of December 31, 1995, and 5.7 to 1 as of March 31, 1996.\nCapital is derived from the operation of the Ultrafit Centers and from the sale of franchises and subsequent franchise royalties. As of March 1, 1996, the Company had six (6) Centers in operation. The fee to acquire a franchise is $50,000 with franchise royalties ranging between 7-9% of gross sales. Additionally, capital is derived from the sale of certain dietary and vitamin supplements through Nutritional Biosciences. Distribution is currently through sales at the Centers and also through advertisements in a state-wide publication.\nCAPITAL REQUIREMENTS AND SOURCE OF FUNDS\nEach new center requires approximately $500,000 of capital for hard assets and an additional $100,000 of short term working capital.\n1. Ultrafit has a $1,000,000 line of credit with Mission State Bank of Mission, Texas, (currently not utilized).\n2. Ultrafit has an on-going loan\/debt relationship with NationsBank. Ultrafit has a $340,000 loan outstanding to NationsBank that is collateralized by shares of Ultrafit's stock.\n3. Ultrafit's Board of Directors has authorized Warrants for a total of 700,000 shares of Ultrafit's stock for a total value of $1,400,000.\nEFFECT OF INFLATION\nUltrafit is affected by inflation or deflation in the areas of labor cost (which makes up in excess of 50% of operation cost, supply cost and cost of construction). As a result, Ultrafit uses the C.P.I. guide for project increases in costs on an annual basis.\nRESULTS OF OPERATIONS\nTypically, during the first 12 months of operation, all short term working capital is repaid. Centers are projected to be posting cash flow. At the 18-month marker, Centers are projected to be profitable.\nMature Centers (those Centers with 1,500 or more patients) produce approximately $20,000 in excess cash, and approximately $12,000 in profit each month.\nNutritional Biosciences has a 100% gross profit margin in all of its products. Currently 2\/3 of these products sold by Nutritional Biosciences are sold to Ultrafit Centers. One-third of Nutritional Biosciences sales are sold directly to the consumer via the telephone and Internet sales. By January 1, 1997, Ultrafit projects that 50% of Nutritional Biosciences sales will be via the Internet and telephone sales.\nFINANCIAL CONDITION\nFor the year ended December 31, 1995, Ultrafit reflected a loss in operations. However, management is optimistic about future financial results, due to the following factors:\no Limited use of debt and the utilization of off-the-balance-sheet financing, when possible, in opening new Centers.\no Continued strong performance by the McAllen centers.\no Change in ownership of a San Antonio franchise.\no Opening of Victoria center - expected break-even by June 1997, profit margin of $5,000 in July 1997 with continued growth of approximately 5% per month.\no Change in management of Harlingen center - expected break-even by June 1996, profit margin of $5,000 in July 1996 with continued growth of approximately 5% per month.\no Opening of the first out-of-state franchise in the Phoenix, Arizona, area. Expected opening in June 1996, with six (6) Centers expected to follow.\no Addition of two (2) corporate-owned centers and four (4) franchised centers.\no Entrance of Nutritional Biosciences into the national distribution market via the Internet. Increase in the number of Centers operating will lead to greatly increased sales ratios, while increases in retail sales will lead to a greater profit margin.\nManagement believes all of the above factors will have a positive impact on the financial condition of the Company.\nITEM 7","section_7":"ITEM 7 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the Financial Statements attached hereto, commencing on page.\nITEM 8","section_7A":"","section_8":"ITEM 8 - CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no disagreements between the Company and its accountants and auditors with respect to accounting and financial disclosure.\nPART III\nITEM 9","section_9":"ITEM 9 - DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nThe following table sets forth certain information with the respect to the Company's Officers, Directors and Key Personnel:\nNAME AGE POSITIONS WITH THE COMPANY - - ---- --- --------------------------\nJoseph Davis 50 Chairman of the Board of Directors, Chief Medical Officer\nWendell Porth 42 President, Chief Executive Officer, Director\nJohn Russell 50 Consultant, Director\nDaniel Boone 42 Director\nAll Directors hold office until the next annual meeting of Shareholders of the Company or until their successors are elected and qualified. Officers hold office until their successors are chosen or qualified, subject to earlier removal by the Board of Directors. The Company does not have an Executive, Nominating, Compensation or Audit Committee.\nSet forth below is a biographical description of each Officer listed above and of each Director:\nJoseph E. Davis, M.D., is the Chairman of the Board of Directors and the founder of the Ultrafit concept. Dr. Davis obtained his Doctor of Medicine at the University of Texas, Southwestern Medical School in 1972, graduating Magna Cum Laude. Dr. Davis completed his internship and medical residency in Massachusetts General Hospital, Boston Massachusetts. Dr. Davis established his initial practice in Nacogdoches, Texas, specializing in internal medicine and continued that practice until July 1989. Dr. Davis then concentrated his efforts on the Ultrafit Preventive Medicine concept. The New American Library published Dr. Davis' book entitled \"Ultrafit\" in 1992. Dr. Davis has been the recipient of numerous awards, including the Phi Kappa Phi National Scholastic Honorary Society, the Alpha Omega Alpha National Medical Honor Society. Dr. Davis has also received numerous body building awards including the Texas Timberland Championship, South Central U. S. A. Middleweight and Mr. Mid-America Novice, North Texas Body Building Championship.\nWendell A. Porth has served as a member of the Board of Directors and as the Chief Executive Officer of the Company since October 27, 1995. Mr. Porth is responsible for the formulation of corporate strategy and for corporate development. Mr. Porth has been employed in various executive level positions within the health care industry for the past twelve years. Mr. Porth's prior executive level positions include associations with Humana Women's and Children's Hospital, San Antonio, St. Luke's Lutheran Hospital, San Antonio and Memorial Hospital, El Campo, Texas. Mr. Porth holds an MBA and BS in Finance.\nJohn Russell has been a director of the Company since March 1992. Since March 1992, Mr. Russell has been self-employed as a consultant in the health and fitness industry. Mr. Russell has been a consultant to Ultrafit since March 1992. His background includes one time part- owner of International Fitness Centers. In May 1994, Mr. Russell filed Chapter 7 petition under the bankruptcy code.\nDaniel Boone, M.D., was admitted to practice in Texas. From 1991 to 1993, Dr. Boone managed and operated a private medical practice. From 1993 to 1995, Dr. Boone has been employed by the Company, and has provided medical services for the Ultrafit Center in Kerrville, Texas.\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - EXECUTIVE COMPENSATION\nThe following summary compensation table sets forth the aggregate cash compensation paid, accrued or deferred to the Chief Executive Officer of the Company and to each officer of the Company who earned in excess of $100,000 for services rendered in all capacities to the Company during the fiscal year ended December 31, 1995:\nSUMMARY COMPENSATION TABLE\nNAME AND ANNUAL ANNUAL OTHER ANNUAL ALL OTHER PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION COMPENSATION - - ------------------ ---- ------ ------ ------------ ------------\nJoseph Davis 1995 $120,000 $0 $0 $45,000(1) Wendell Porth 1995 $ 65,625 $0 $0 $45,000(1) John Russell* 1995 $120,000 $0 $0 $45,000(1)\n* John Russell was paid as a consultant to the corporation, not as an employee. (See Item 12 below).\n(1) Paid in 50,000 Shares of restricted common stock at a per share price of $1.50 per share, discounted 40% due to two-year resale restriction.\nThe Company's Directors do not receive compensation for acting in their respective capacities as such.\nITEM 11","section_11":"ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the holdings of Common Stock by each person who, as of December 31, 1995, held of record or was known by the Company to own beneficially more than five percent of the outstanding Common Stock of the Company, by each Director and Officer of the Company and by all Directors and Officers of the Company as a group.\nNo. of Shares and Name and Address of Nature of Beneficial Percentage of Common Beneficial Owner Ownership Shares Outstanding\nHartvale Holdings Ltd. 444,000 5.4% 14A Eddelston Street London, England\nLomax Co. Limited 695,000 8.55% P. O. Box 1792 Grand Cayman Office Georgetown, Grand Cayman\nOTC Capital Corp. 647,000 8% P. O. Box 669 Palm Beach, Florida 33480\nJoseph Davis 2,939,646 36% 500 Thompson Dr. Kerrville, TX 78028\nDaniel Boone 495,530 6% 236 Wesley Kerrville, Texas 78028\nWendell Porth 50,000 .50% 105 Painted Post San Antonio, Texas 78231\nJohn Russell 50,000 .50% 13750 U.S. 281 North, Suite 610 San Antonio, Texas 78232\nAll Directors and Officers as a group (4 persons) 3,535,176 43%\nITEM 12","section_12":"ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTION\nDaniel Boone purchased 100,000 shares of additional stock in February 1996 for $100,000.00.\nFrom March 1992 through the present, John Russell, a director of the Company, has served as a consultant to the Company. For the fiscal year ended December 31, 1995, Mr. Russell received consulting fees of $120,000. In the Company's opinion, the terms of Mr. Russell's consulting agreement with the Company are on terms no less favorable than could have been obtained from unaffiliated third parties.\nPART IV\nITEM 13","section_13":"ITEM 13 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following financial statements are included in Part II, Item 8:\nPAGE ----\nIndependent Auditor's Report\nBalance Sheet as of December 31, 1995 and 1994\nState of Operations for the years ended December 31, 1995, 1994, 1993\nStatement of Shareholders' Equity 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\n(b) Reports of 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.\nUltrafit Centers, Inc. a Colorado corporation\nBy: ------------------------------ Wendell A. Porth, President\nDated: __________________ , 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.\n------------------------------ Joseph Davis, M.D., Chairman of the Board of Directors\nDate: July 15, 1996 ---------------------------\n---------------------------------, Wendell A. Porth, Director\nDate: July 15, 1996 ----------------------------\n---------------------------------- John Russell, Director\nDate: July 15, 1996 -----------------------------\n---------------------------------- Daniel Boone, M.D., Director\nDate: July 15, 1996\nANGEL E. LANA, P.A. CERTIFIED PUBLIC ACCOUNTANT [LETTERHEAD]\nBoard of Directors Ultrafit Centers, Inc. and Subsidiaries\nINDEPENDENT AUDITOR'S REPORT\nI have audited the accompanying balance sheets of Ultrafit Centers, Inc. (formerly D.S.S., Inc.) and subsidiaries as of December 31, 1995 and 1994, and the related statements of operations, 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. My responsibility is to express an opinion on these financial statements based on my audit. I did not audit the 1994 financial information contained in Note 2 relating to the financial position and results of operations of acquired subsidiaries. The 1994 financial statements of the acquired subsidiaries were audited by other auditors whose reports have been furnished to me, and my opinion, insofar as it relates to the 1994 financial information included in Note 2, is based solely on the report of the other auditors.\nI conducted my audits in accordance with generally accepted auditing standards. Those standards require that I plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. 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 and the report of other auditors provide a reasonable basis for my opinion.\nIn my opinion, based on my audits and the report of other auditors, the financial statements referred to above present fairly, in all materials respect, the financial position of Ultrafit Centers, Inc. (formerly D.S.S., Inc.) and subsidiaries as of December 31 1995 and 1994, and the results of its operations, changes in its shareholders' equity and its cash flows for the years ended December 31, 1995, 1994 and 1993 in conformity with generally accepted accounting principles.\n\/s\/ ANGEL E. LANA, P.A. ------------------------------ Angel E. Lana, P.A. CERTIFIED PUBLIC ACCOUNTANT\nApril 18, 1996 Fort Lauderdale, Florida\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nASSETS ------\n1995 1994 -------- ------ Current Assets: Cash $ 48,776 $ -0- Accounts Receivable-Trade 24,729 -0- Accounts Receivable-Other 13,181 -0- Note Receivable-current portion 100,000 -0- Prepaid Expense 21,000 -0- Inventory 37,496 -0- -------- -------\nTotal Current Assets 245,182 -0- -------- ------- Property and Equipment, net of depreciation 215,875 -0- -------- ------- Other Assets: Note Receivable, net 115,000 -0- Security Deposits 16,506 -0- Development Costs, net of amortization 242,083 -0- Joint Venture Investment-at equity 20,927 -0- Pre-opening Costs-new center 73,597 -0- Goodwill, net of amortization 271,614 -0- -------- ------- Total Other Assets 739,727 -0- -------- ------- Total Assets $1,200,784 $ -0- ========== =======\nLIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------\nCurrent Liabilities: Accrued Expenses $ 30,283 $ -0- Note Payable-Bank 43,364 -0- Notes Payable-Other 500,000 -0- -------- -------\nTotal Current Liabilities 573,647 -0-\nOther Liabilities: Deferred Revenue 66,642 -0- -------- ------- Total Liabilities 640,289 -0- -------- ------- Commitments and Contingencies\nShareholders' Equity: Preferred Stock, $.50 par value; 3,000,000 shares authorized, none issued -0- -0- Class A, Non-Voting Common Stock, $.001 par value; 2,000,000 shares authorized, none issued -0- -0- Common Stock, $.001 par value; 20,000,000 shares authorized, issued and outstanding shares- 8,100,000 in 1995; 650,000 in 1994 8,100 650 Additional Paid-In Capital 1,030,238 49,289 Accumulated Deficit (477,843) (49,939) ----------- --------- Total Shareholders' Equity 560,495 -0- ----------- --------- Total Liabilities and Shareholders' Equity $1,200,784 $ -0- =========== =========\nThe accompanying notes are an integral part of these financial statements.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1995 1994 1993 ----------- -------- ---------- Net Revenues $ 267,010 $ -0- $ -0- Cost of goods sold 16,299 -0- -0- ----------- -------- ---------- Gross Profit 250,711 -0- -0- ----------- -------- ---------- Operating Expenses: Personnel 138,530 -0- -0- Marketing 16,378 -0- -0- General and administrative 188,244 -0- 31,768 Physician services 46,500 -0- -0- Depreciation and amortization 17,466 -0- -0- Loss-equity investment, net of royalties of $3,681 10,887 -0- -0- Loss-note receivable write-down 260,000 -0- -0- ----------- -------- ---------- Total Operating Expenses 678,005 -0- 31,768 ----------- -------- ---------- Other income (expense): Interest income 284 -0- -0- Interest expense (894) -0- -0- ----------- -------- ---------- Total Other Income (Expense) (610) -0- -0- ----------- -------- ---------- Net Loss $ (427,904) $ -0- $ (31,768) =========== ======== ========== Loss Per Common Share $ (0.20) $ -0- $ (0.05) =========== ======== ========== Weighted average number of shares outstanding 2,092,466 650,000 650,000 =========== ======== ==========\nThe accompanying notes are an integral part of these financial statements.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS ACTIVITY\nUltrafit Centers, Inc. (the Company), formerly D.S.S., Inc., was organized under the laws of the State of Colorado on May 27, 1987 to engage in the business of the sale and distribution of dental, medical, pharmaceutical and other related supplies and equipment. The Company was a development stage entity until October 27, 1995, at which time it acquired the assets and assumed the liabilities of Ultrafit Centers, Inc. (UCI), a Texas corporation. The assets of UCI included two wholly-owned subsidiaries. Prior to the acquisition of UCI, the Company had no assets and no significant operating activities other than transactions related to its formation and organization.\nThe acquired corporation, Ultrafit Centers, Inc. (UCI), is a management company. It was formed on February 3, 1993, to operate and expand the Ultrafit Preventive Medicine Centers concept which represents an alternative model for health care. It utilizes a preventive approach to medicine by combining a physician-staffed medical clinic providing customized patient exercise and diet programs with a state-of-the-art fitness and nutrition center. UCI plans to franchise Ultrafit Centers throughout the United States. UCI has two wholly-owned subsidiaries, Ultrafit Fitness Centers, Inc. (UFCI) and Nutritional Biosciences, Inc. (NBI). Both subsidiaries were acquired by UCI on April 3, 1995. As more fully explained in Note 14, subsequent to December 31, 1995 UFCI ceased being a subsidiary of the Company.\nThe Company issued 6,600,000 shares of common stock upon its acquisition of UCI. The shares were valued at $903,399, representing the net book value of UCI. Accordingly, no goodwill was recorded as a result of the acquisition.The goodwill reflected in these financial statements represents excess of cost over net assets acquired resulting from the acquisition by UCI of one of its subsidiaries on April 3, 1995. The acquisition of UCI by the Company was accounted for by the purchase method of accounting. The results of operations of UCI and its subsidiaries is included in the accompanying financial statements only from the date of acquisition (October 27, 1995) through December 31, 1995. Pro forma financial information on the Company, UCI and subsidiaries is presented in Note 2.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated. Operations for the subsidiaries acquired during the year ended December 31, 1995 (described above and in Note 2) are included in the consolidated results of operations since the date of acquisition.\nPER SHARE DATA - Per share data have been computed by dividing net loss by the weighted average number of common and common equivalent shares outstanding during the period.\nREVENUE AND EXPENSE RECOGNITION - Revenue is recognized when products and services are delivered, irrespective of when payments are received. Expenses are recorded as liabilities are incurred, regardless of when they are paid.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nPROVISION FOR ESTIMATED UNCOLLECTIBLE ACCOUNTS - The Company records a provision for estimated uncollectible accounts for the portion of recognized revenues which it estimates may not be ultimately collected. The provision and related allowance are adjusted periodically, based upon the Company's evaluation of historical collection experience. As of the balance sheet date no allowance for bad debts on trade accounts receivable was deemed necessary.\nINVENTORY - Inventory consists of books, vitamins and dietary supplements. It is stated at the lower of cost or market and is determined using the first-in, first-out method.\nDEVELOPMENT COSTS - Development costs are being amortized using the straight-line method over the estimated benefit periods, ranging from 3 to 7 years. They primarily consist of direct franchise development costs. Other costs include software and video development costs.\nGOODWILL - Goodwill represents the excess of the purchase price over the fair value of net assets acquired by UCI, Inc., prior to its acquisition by the Company on October 27, 1995. Goodwill is being amortized on a straight-line basis over the expected benefit period, 15 years. For the year ended December 31, 1995, the Company recorded amortization expense of $14,295, $3,176 of which occurred after October 27, 1995 and is included in the statement of operations.\nPRE-OPENING COSTS - Pre-opening costs represent direct costs incurred in the process of readying the Company's Ultrafit Centers for operations. The costs remain capitalized and not subject to amortization until the Center opens for business. Once the Center commences operations the costs are amortized over the expected useful life.\nINCOME TAXES - The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes\". SFAS 109 requires an asset and liability approach to financial accounting and reporting for income taxes.\nPROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation is computed using straight-line and accelerated methods over their estimated useful lives ranging from 3 to 7 years.\nProperty and equipment are summarized as follows:\nFurniture and fixtures $ 35,322 Medical and exercise equipment 267,430 --------- 302,752 Less accumulated depreciation 86,877 --------- $215,875\nFor the year ended December 31, 1995, the Company recorded depreciation expense of $68,262, $14,290 of which occurred after October 27, 1995 and is included in the statement of operations.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2 - BUSINESS ACQUISITION AND PRO FORMA INFORMATION As more fully discussed in Note 1, the Company acquired Ultrafit Centers, Inc.(UCI) on October 27, 1995, a business combination accounted for as a purchase.Pro forma financial position and results of operations of the Company for the periods presented below assume the Company acquired UCI as of January 1, 1994.\nThe adjustments for 1995 reflects additional amortization of goodwill of $23,826 as if the acquired company, UCI, had acquired its two subsidiaries as of the beginning of the period. The adjustments also reflect additional amortization of $19,061 from 1994. The 1994 adjustments include net goodwill, amortization and debt incurred by UCI in the acquisition. A subsidiary included above ceased being part of the Company after December 31, 1995 (see Note 14).\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3 - NOTE RECEIVABLE\nEffective October 1, 1994, UCI sold, as the franchisor, two Ultrafit Centers located in San Antonio, Texas for $475,000. The franchisee was required to pay the $475,000 from available profits derived from the centers. As of December 31, 1995, the Company had not received any payments from the franchisee. Subsequent to December 31, 1995, the Company took possession of the centers. One center was sold for $100,000, the other was closed. The net book value of the equipment the Company has repossessed is approximately $73,000. The Company was liable as lessee of the two facilities sublet to the franchisee. To release itself from any obligations relating thereto, the Company paid the landlord $20,000.\nThe statement of operations for the year ended December 31, 1995, includes a charge to operations of $260,000 reflecting the write-down deemed necessary to reflect the net realizable value of the note receivable. The note receivable is shown on the Company's 1995 balance sheet as follows:\nNote Receivable $ 475,000 Less: Allowance for uncollectibility (260,000) ---------- 215,000 Less: Current portion $(100,000) ---------- 115,000 =========\nNOTE 4 - DEVELOPMENT COSTS Development costs, net of amortization, are summarized as follows:\nAmortization AMOUNT PERIOD (YEARS) ------ -------------- Franchise development $220,200 7 Software development 7,190 5 Video development 14,693 3 -------- $242,083 ========\nNOTE 5 - JOINT VENTURE INVESTMENT UCI opened a new Ultrafit Center in June 1995 pursuant to a joint venture arrangement with Davlin Corporation (Davlin). As a 49% owner, the Company is accounting for the investment under the equity method. Accordingly, the investment is adjusted for dividends and 49% of earnings or losses. As of December 31, 1995, the net investment amount is $20,927. The Company is entitled to franchise royalties of 7% of gross revenues. The royalties totalled $19,738 as of December 31, 1995, of which $3,681 was earned after October 27, 1995 and is reflected in the statement of operations. The Company's share of the joint venture loss as of December 31, 1995 was $39,960, of which $14,568 occurred after October 27, 1995 and is reflected in the statement of operations.\nAt December 31, 1995, the investment in Davlin exceeded the Company's share of the underlying net assets by $36,575. The excess relates to property and equipment and will be amortized against the Company's share of Davlin's net income or loss on the straight-line method over the estimated useful lives of the property and equipment beginning in 1996. Amortization is not charged to operations in 1995 due to immateriality.\nNOTE 6 - GOODWILL On April 3, 1995, UCI acquired 100% of UFCI as follows: ACQUISITION NET ASSETS PRICE ACQUIRED GOODWILL ----------- ---------- -------- UFCI Acquisition $440,732 $154,823 $285,909 Less accumulated amortization 14,295 -------- $271,614\nUFCI ceased being part of the Company after December 31, 1995, as more fully discussed in Note 14.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7 - NOTE PAYABLE-BANK\nNote payable to bank represents a loan made to UCI in the original amount of $110,756. Principal is payable on demand. Monthly payments of principal and interest in the amount of $3,000 is required. The loan has a stated interest rate of 11% annually and matured on April 4,1996. The loan is collateralized primarily by the equipment located at two of UCI's Ultrafit Centers. As of December 31, 1995 the outstanding principal balance is $43,364.\nThe note was not paid in full at maturity, a balance of approximately $36,000 remained. The note was refinanced by way of a personal assumption of $25,000 by the Company's principal shareholder (see Note 14). The remaining balance will be paid by the Company over a period of six months from the original date of maturity.\nNOTE 8 - NOTES PAYABLE-OTHER\nNotes payable-other consists of the following:\nA. Upon the acquisition of UFCI by UCI, see Note 6, UFCI was issued a $440,732 note payable. The note has no stated interest rate and was scheduled to be paid in full upon its maturity date of April 3, 1996. The note is collateralized by all the common stock of UCI, which shares are held in escrow until the note is paid. The note is payable to related parties (see Note 10A). The note obligation was settled subsequent to December 31, 1995 as more fully discussed in Note 14. $440,732\nB. On April 3, 1995, UCI acquired the assets of an Ultrafit Center for a total consideration price of $59,268 in the form of a note payable. The note has no stated interest rate or collateralization and was scheduled to be paid in full on April 3, 1996. The note obligation was settled subsequent to December 31, 1995 as more fully discussed in Note 14.\n59,268 -------- $500,000 ========\nNOTE 9 - INCOME TAXES\nAt December 31, 1995, the Company and its subsidiaries had net operating loss carryforwards (subject to certain tax code limitations) of approximately $575,000 available to offset future taxable income, if any, expiring in the years 2008 through 2010. The effect of the future tax benefit, if any, has not been recognized because of the Company's limited operating history.\nNOTE 10 - RELATED PARTY TRANSACTIONS\nRelated party transactions are summarized as follows:\nA. A principal officer and a director of the Company were the owners of UFCI, acquired by UCI on April 3, 1995. Goodwill in the amount of $285,909 related to the acquisition has been recorded. A note payable in the amount of $440,732, referred to in Note 8A, is payable to the aforementioned officer and the director.\nB. A principal officer of the Company was the owner of NBI, acquired by UCI on April 3, 1995 for $98,802. No goodwill related to the acquisition has been recorded.\nULTRAFIT CENTERS, INC. (FORMERLY D.D.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIUDATED FINANCIAL STATEMENTS\nNOTE 10 - RELATED PARTYB TRANSACTIONS (Continued)\nC. Effective April 3, 1995, UCI entered into two service agreements, one with its principal shareholder and one with a director of the Company. Each will receive an annual compensation of $120,000 in exchange for management services. The agreements terminated on April 3, 1996, at which time only one was renewed for a period of two years at the same compensation rate. The Company's president was also under contract to manage operations through March, 1995. Total management fees paid by the Company for year ended December 31, 1995 totaled $175,000, $40,000 of which occurred after October 27, 1995 and is included in the statement of operations.\nD. On April 17, 1995, in an effort to stimulate franchise growth and demonstrate a long-term commitment to the Company and the Ultrafit concept, the Board of Directors approved a proposal entitling four Board members to be eligible to each own single franchise center at a location of their choice. The center would have to be operated within the guidelines of the Franchise Agreement but no francise fees or royalties would be paid to the Company. This option is a one-time opportunity only, expiring on April 30, 2005.\nNOTE 11 - SHAREHOLDERS' EQUITY The Company is authorized to issue 3,000,000 shares of $.50 par value Preferred Stock in one or more series. The Board of Directors can fix or alter the rights, preferences, privileges and restrictions relating to dividends, conversion, voting, redemption and liquidation without any further vote or action by the shareholders. None has been issued to date.\nThe Company is also authorized to issue 2,000,000 shares of Class A, $.001 par value, non-voting common stock having no voting, preemptive or conversion rights. No such shares have been issued.\nThe Company is authorized to issue 20,000,000 shares of common stock, with a per share par value of $.001. Holders of common stock do not have any rights of redemption or conversion or preemptive rights to subscribe to additional shares if issued by the Company. In the event of liquidation of the company, the common shareholders are to share ratably in any distribution of the Company's assets after payment of all liabilities, subject to the rights of the holders of preferred stock.\nDuring the Company's third quarter, a reverse stock split of 1 share for each 10 outstanding was effectuated. Total capitalization was unchanged.\nOn September 1, 1995, the Company entered into four consulting agreements whereby in exchange for services to be rendered the consultants were issued 500,000 shares of common stock. The shares were registered on October 31, 1995 pursuant to a Form S-8 filing.\nOn October 26, 1995, the Company issued 350,000 shares of common stock in exchange for services rendered.\nThe value of the services to be rendered for the 850,000 shares referred to above is $85,000, said amount is reflected in the Statements of Sharenholders' Equity. Services rendered through the year end was $64,000.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES The Company leases its facilities under various operating leases. The monthly lease obligations total $16,824. One of the leases requiring monthly payments of $5,440 became effective after December 31, 1995. For the year ended December 31, 1995, the Company recorded rent expense of $116,396, $22,071 of which occurred after October 27, 1995 and is included in the statement of operations.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12 - COMMITMENTS AND CONTINGENCIES (Continued)\nAt December 31, 1995 the aggregate future minimum lease payments are as follows:\n1996 $ 163,811 1997 201,891 1998 140,955 1999 75,160 2000 65,280 Thereafter 413,440 ----------- $1,060,537 ===========\nOn August 8, 1995, the Company entered into a consulting agreement for the purpose of establishing a franchise financing program to include Company and franchisee locations. The agreement also includes a product support package whereby the consultant will supervise construction, attend tradeshows and develop vendor relations. The consultant was paid a $5,000 consulting fee and shall receive a fee of 3% of funds obtained for the Company. The Company has the option of paying a flat fee of $10,000 in lieu of the 3% fee. The consultant shall be paid $500 per day, plus expenses, for work performed under the product support package.\nOn December 4, 1995, the Company entered into three Executive Search Contracts. The contracts obligate the Company to pay a recruiting fee of $25,000 for each of three physicians which the Company hires through the efforts of the employment agency. The contract term is for ninety days.\nOn December 20, 1995, the Company entered into a nine month agreement with an organization that was to provide a broad range of services pertaining to investor relations at a cost of $4,000 per month. The Company paid for one month of service after which the agreement was terminated by the company for lack of performance.\nOn December 26, 1995, the Company entered into a six month agreement whereby in exchange for management consulting services the Company granted the consultant warrants to purchase 700,000 shares of common stock. The warrants may be exercised during a period of two years from the date of the agreementas follows\n# OF COMMON SHARES UNDERLYING WARRANTS PRICE PER SHARE ------------------- --------------- 200,000 $ 1.00 100,000 1.50 100,000 2.00 100,000 2.50 200,000 3.00 --------- 700,000 =========\nSubsequent to December 31, 1995, 300,000 shares were issued to the consultant to have available for the exercise of the warrants of which 85,000 were exercised.\nThe Company adopted a bonus plan for its officers and directors, 10% of net profits, if any, will be distributed annually. The Board of Directors will determine individual bonuses payable equally between cash and common stock.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13 - LEGAL PROCEEDING\nThe Company was named as a defendant in a lawsuit in December 1995. The claim alleges that in April 1995, a subsidiary of the Company (UCI) acquired the assets and assumed certain liabilities of DPJ, Inc. (the entity referred to in Note 8B) for a price far below its market value. The Company denies the allegations and intends to vigorously defend its position. The Company believes a judgment against it is highly doubtful and that it will prevail in the litigation.\nNOTE 14 - SUBSEQUENT EVENTS\nSubsequent to December 31, 1995, the Company repossessed the assets collateralizing a note receivable in the amount of $475,000. See Note 3.\nSubsequent to December 31, 1995, the Company issued 300,000 shares of common stock to the consulting group referred to in Note 12.\nOn January 25, 1996, the Company filed a Form S-8 Registration Statement registering 705,000 shares of common stock which included the 700,000 shares referred to in Note 12 and 5,000 shares issued subsequent to December 31, 1995 in exchange for legal services rendered.\nOn February 1, 1996, the Company entered into a consulting agreement for a period of six months. In exchange for financial public relations services the Company agreed to pay the consultant as follows:\n$ WORTH OF FREE - $ AMOUNT TRADING COMMON STOCK -------- --------------------\nUpon signing of contract $10,000 $ -0- Within two weeks of contract date -0- 15,000 (7000 shares) 1st day of month two 10,000 15,000 1st day of month three 10,000 15,000 1st day of month four 10,000 10,000 1st day of month five 10,000 5,000 1st day of month six 10,000 5,000 -------- -------- $60,000 $65,000\nThe number of shares to be issued is determined by the average bid price for five days prior to the beginning of the new contract month.\nThe agreement may be terminated by either party by providing written notice at least five business days prior to the expiration of the current contract month.\nOn March 28, 1996, the Company issued 18,500 shares of common stock pursuant to the consulting agreement.\nOn February 21, 1996, the Board of Directors approved a Directors Stock Option Plan granting directors the option to acquire 110,000 shares of restricted common stock, in the aggregate, at $1 per share. The plan is to remain in effect for a period of two years.\nOn February 29, 1996, the Company issued 100,000 shares of restricted common stock to a company Director in exchange for $100,000.\nULTRAFIT CENTERS, INC. (FORMERLY D.S.S., INC.) AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 14 SUBSEQUENT EVENTS (Continued)\nOn March 1, 1996, the Company entered into an equipment leasing contract which requires sixty monthly payments of $706 each and contains a purchase option.\nOn March 4, 1996, 625,000 shares of common stock were issued to the company's President. The shares were pledged as collateral on a $340,000 bank loan dated March 5, 1996. The principal portion of the proceeds were used to make operational a new fitness center located in Victoria, Texas. The loan is payable in sixty monthly installments of $6,983 each through March 19, 2001 at an annual interest rate of 8.25%.\nOn February 20, 1996, an agreement was reached between the Company and its principal shareholder and one of its directors'. The agreement stipulates that the Company exchange UFCI, which operates a fitness center located in Kerrville, Texas (See Note 6), for the forgiveness of the two notes payable in the amount of $500,000 referred to in Note 8. The principal shareholder,who will retain the 639,724 shares of restricted common stock issued to him as a result of the Company's acquisition of UFCI, also agrees to assume $25,000 of the bank note payable referred to in Note 7. Financial data relating to UFCI, the Kerrville Center, (without the recognition of goodwill)as of December 31, 1995 and for the year then ended is as follows:\nAFTER DATE OF ACQUISITION (10\/27\/95) AS OF YEAR ENDED THROUGH 12\/31\/95 12\/31\/95 12\/31\/95 ---------- ---------- ---------------------- Balance Sheet: Assets $177,923\nLiabilities $ 31,969 Shareholders' Equity $145,954 -------- $177,923 ========\nStatement of Operations: Net Revenue $640,839 $132,611 Cost of Revenue 33,541 6,959 --------- --------- Gross Profit 607,298 125,652 Total Operating Expenses 616,166 164,413 --------- --------- Net Loss from operations $(8,868) $(38,761) ========= ========= Net Loss per common share NIL $ (0.02) Weighted average number of ========= ========= shares outstanding 2,092,466 2,092,466 ========= =========","section_14":"","section_15":""}
{"filename":"785932_1995.txt","cik":"785932","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nExcel Properties, Ltd., a California limited partnership (the \"Partnership\"), was organized to purchase commercial real estate properties for cash and to hold these assets for long-term investment.\nThe general partners of the Partnership are Excel Realty Trust, Inc., a Maryland corporation, and Gary B. Sabin, an individual. The Partnership was formed on September 19, 1985, and will continue in existence until December 31, 2015, unless dissolved earlier under certain circumstances.\nProperties that have been acquired by the Partnership are subject to long-term triple-net leases. Such leases require the lessee to pay the prescribed minimum rental plus all costs and expenses associated with the operations and maintenance of the property. These expenses include real property taxes, property insurance, repairs and maintenance and similar expenses, the net effect being that, under normal circumstances, no expenses will offset the rental payment. Most of the leases also provide some form of inflation hedge which calls for the minimum rent to be increased, based upon adjustments in the consumer price index, fixed rent escalation, or by receipt of a percentage of the gross sales of the tenant.\nProperties have been acquired free and clear of liens and encumbrances. The Partnership may seek to finance one or more of the properties and distribute the financing proceeds to the partners, but only if the financing proceeds equal or exceed 100% of the Partnership's capital invested in the property or properties (including a prorata amount of the Partnership's public offering unit selling commissions and organization expenses). To date, no properties owned by the Partnership have been the subject of any mortgage financing, therefore, at the present time, all properties remain free and clear from any mortgage loan, lien or encumbrance.\nThe principal investment objectives of the Partnership are to provide to its limited partners: (1) preservation, protection and eventual return of the investment, (2) distributions of cash from operations, some of which may be a return of capital for tax purposes rather than taxable income, (3) distributions of cash from financing the properties, and (4) realization of long-term appreciation in value of properties.\nThe general partners have selected properties they believe meet certain minimum investment standards and that are most likely to accomplish the investment objectives of the Partnership. Properties were acquired through arms-length negotiations with third parties.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership presently owns twenty properties. These properties are briefly described on the following pages:\nKINDER-CARE LEARNING CENTERS\nThe Partnership owns seven properties on lease to Kinder-Care, Inc., the nation's largest provider of day care centers.\nKINDER-CARE LEARNING CENTER - GAHANNA, OHIO\nDate of purchase: May 28, 1987\nPurchase price: $216,822\nProperty description: This property is located approximately fifteen miles northeast of Columbus, Ohio in the suburb of Gahanna. The building is located on .551 acres and contains 4,528 square feet.\nThe current lease expires June 30, 1998 with gross rents of $21,000 per year.\nKINDER-CARE LEARNING CENTER - GROVE CITY, OHIO\nDate of purchase: May 28, 1987\nPurchase price: $222,340\nProperty description: This property is located in Grove City, Ohio, seven miles south of Columbus, Ohio. The building is located on .8939 acres and contains 4,528 square feet.\nThe current lease expires November 30, 1998 with gross rents of $21,000 per year.\nKINDER-CARE LEARNING CENTER - WEST CARROLLTON, OHIO\nDate of purchase: May 28, 1987\nPurchase price: $190,337\nProperty description: This property is located approximately eight miles southwest of Dayton, Ohio in the suburb of West Carrollton. The building contains 4,560 square feet and is situated on .55 acres of land.\nThe current lease expires December 31, 2001. The annual rent over the remainder of the lease is as follows:\nJanuary 1, 1996 to December 31, 1998 $ 33,202 January 1, 1999 to December 31, 2001 $ 35,526\nKINDER-CARE LEARNING CENTER - COLUMBUS, OHIO\nDate of purchase: May 28, 1987\nPurchase price: $190,337\nProperty description: This property is located in Columbus, Ohio. The building is situated on .538 acres and contains 4,650 square feet. The property has been sublet by Kinder-Care to Children Today, another child-care provider.\nThe property is on lease until December 31, 2001. The annual rent over the remainder of the lease is as follows:\nJanuary 1, 1996 to December 31, 1998 $ 33,202 January 1, 1999 to December 31, 2001 $ 35,526\nKINDER-CARE LEARNING CENTER - DAYTON, OHIO\nDate of purchase: May 28, 1987\nPurchase price: $190,337\nProperty description: This property is located approximately thirty miles northeast of Dayton, Ohio in the Mud River Township. The building is situated on .645 acres and contains 4,650 square feet.\nThe current lease expires December 31, 2001. The annual base rent over the remaining term of the lease is as follows:\nJanuary 1, 1996 to December 31, 1998 $ 33,202 January 1, 1999 to December 31, 2001 $ 35,526\nKINDER-CARE LEARNING CENTER - INDIANAPOLIS, INDIANA\nDate of purchase: May 2, 1989\nPurchase price: $201,079\nProperty description: This property is located at 1034 N. Whitcomb Ave. in Indianapolis, Indiana. The building contains 4,487 square feet and is situated on .598 acres.\nThe current lease expires December 31, 2000 with gross rents of $49,694 per year.\nKINDER-CARE LEARNING CENTER - INDIANAPOLIS, INDIANA\nDate of purchase: May 2, 1989\nPurchase price: $201,079\nProperty description: This property is located at 29 N. Coronado in Indianapolis, Indiana. The building contains 4,487 square feet and is situated on 1.106 acres. The gross rents are $18,000 per year and the lease expires December 31, 2000.\nPARAGON RESTAURANT GROUP, INC.\nThe Partnership owns two properties operated as Mountain Jack's Restaurants, on lease to Paragon Steakhouse Restaurants, Inc. The company, headquartered in San Diego, California, is one of the nation's premier specialty restaurant chain operators. Their trade names include Mountain Jacks's and Hungry Hunter.\nMOUNTAIN JACK'S RESTAURANT - MIDDLEBURG HEIGHTS, OHIO\nDate of purchase: July 21, 1987\nPurchase price: $1,046,222\nProperty description: The property, situated on 1.72 acres and containing 6,331 square feet, is an upscale steak and seafood restaurant located in Middleburg Heights, Ohio, a suburb of Cleveland. It has seating for approximately 163 persons and parking for approximately 115 cars.\nThe annual lease payment is the greater of $104,500 or 5% of the gross sales. The lease expires on July 20, 2005.\nMOUNTAIN JACK'S RESTAURANT - LAFAYETTE, INDIANA\nDate of purchase: September 29, 1987\nPurchase price: $1,080,097\nProperty description: This property is located at 2411 State Road 26 East, Lafayette, Indiana. Lafayette is strategically located between Chicago, Illinois to the north and Indianapolis, Indiana to the south. It is the home of Purdue University. The property is situated on 1.72 acres, contains 8,112 gross square feet, and has seating for approximately 294 persons. The site is ideally located along a main commercial artery and is surrounded by seven hotels.\nThe annual lease payment is the greater of $107,800 or 5% of the gross sales. The lease expires on September 28, 2005.\nKENTUCKY FRIED CHICKEN - BLAINE, MINNESOTA\nDate of purchase: May 6, 1988\nPurchase price: $424,762\nProperty description: This property is located at 8770 University Avenue N.E., Blaine, Minnesota. It contains 3,090 square feet, and has seating for 92 persons. The surrounding area is predominantly commercial and includes such major retail stores as K-Mart and Club Food stores, in addition to the Northtown Shopping Center.\nThe lease in guaranteed by Kentucky Fried Chicken. The annual lease payment is the greater of $48,240 or 5% of the gross sales. The lease expires on February 29, 2000.\nWENDY'S - BLAINE, MINNESOTA\nDate of Purchase: May 6, 1988\nPurchase price: $398,478\nProperty description: The property is located at 8780 University Avenue N.E., Blaine, Minnesota. Blaine is located eight miles north of Minneapolis. The property is across the street from a major regional shopping mall. The building contains 2,474 square feet and has seating for 92 persons.\nThe lease is guaranteed by Wendy's International, Inc., the parent corporation. The annual lease payment is the greater of $45,360 or 5% of the gross sales. The lease expires on February 29, 2000.\nNORTHERN AUTOMOTIVE CORPORATION\nThe Partnership owns two auto parts stores leased to Northern Automotive Corporation, the nation's largest auto parts chain. Northern Automotive markets its specialty automotive parts and accessories through its retail outlets located throughout the country under the trade names of Checker, Kragen, and Schuck's Autoworks stores. Northern Automotive operates over 475 retail outlets. The company caters to the do-it-yourself market and maintains a broad product line of both private label and national brand names.\nAUTOWORKS - BELLEVUE, NEBRASKA\nDate of purchase: July 5, 1988\nPurchase price: $688,579\nProperty description: The property is located at a major shopping center at 915 Fort Crook Road, Bellevue, Nebraska, a suburb of Omaha, Nebraska. Bellevue is the home of the Strategic Air Command (SAC) which contributes largely to the area economy. The improvements consist of a free standing concrete block and glass building containing 4,870 square feet.\nThe base minimum annual rent is $80,484 per year with scheduled rental increases occurring every third year of the lease based on increases in the Consumer Price Index not to exceed a 10% increase. The lease expires on July 5, 2008.\nAUTOWORKS - LITTLETON, COLORADO\nDate of purchase: July 5, 1988\nPurchase price: $715,925\nProperty description: This property is located at 8219 South Holly in Littleton, Colorado and is surrounded by new commercial complexes and extensive single and multi-family developments. The property is situated on approximately .75 acres and contains 4,960 square feet.\nThe base minimum annual rent is $83,720 per year with scheduled rental increases occurring every third year of the lease based on increases in the Consumer Price Index not to exceed a 10% increase. The lease expires on July 6, 2008.\nDENNY'S RESTAURANT - LAKEWOOD, COLORADO\nDate of purchase: July 27, 1988\nPurchase price: $603,992\nProperty description: The property is located at 565 Union Blvd., Lakewood, Colorado. The area is extensively developed in commercial, retail and office uses. The property, located on approximately .75 acres, contains improvements of 4,489 square feet.\nThe lease is guaranteed by Denny's Inc. and calls for minimum rent of $47,420 to be paid annually or 6% of the tenant's gross sales, whichever is greater. The Partnership received $36,994 in percentage rent from this property in 1995. The lease expires on July 23, 1996 and calls for a full CPI increase from the inception of the lease upon exercise of a 10-year lease option.\nPONDEROSA RESTAURANT - ANN ARBOR, MICHIGAN\nDate of purchase: January 20, 1989\nPurchase price: $759,619\nProperty description: The property, containing 5,033 square feet, is situated on approximately one acre located at 3354 East Washtenaw Street, Ann Arbor, Michigan. The property is surrounded by numerous commercial enterprises including the Arbor Land enclosed shopping mall.\nThe lease calls for a minimum rent of $77,400 plus 6.5% of the annual gross sales in excess of the average annual sales for the years 1989 and 1990. The lease expires September 22, 2003.\nPONDEROSA RESTAURANT - ALTON, ILLINOIS\nDate of purchase: January 31, 1989\nPurchase price: $924,379\nDescription of property: The building, containing 5,587 square feet, is situated on approximately one acre at 3354 Homer-Adams Parkway along Highway 111, which is the major east\/west road system through the city. Alton, Illinois is situated across the Mississippi River from St. Louis, Missouri. The property is in the center of one of the city's prime commercial areas.\nThe lease calls for a minimum annual rent of $94,070 plus 6.5% of the gross sales generated by the property in excess of the average annual sales for the year 1989 and 1990. The lease expires September 22, 2003. The tenant has vacated the premises but continues to pay the monthly base rent.\nPAYLESS SHOE STORE - PLANT CITY, FLORIDA\nDate of purchase: December 1, 1989\nPurchase price: $648,123\nProperty description: The property is located at 1801 Jim Redman Parkway, Plant City, Florida. Plant City is located approximately 18 miles northeast of the central business district of Tampa, Florida. The property is situated on .89 acres and contains 2,989 square feet.\nThe lease is guaranteed by the May Department Store Co. which has a net worth in excess of $3 billion. The property is on lease until November 30, 1999 with four additional 5-year options. The minimum rent is $70,785 per year. The rent would be $82,682, $94,578, $106,495 and $118,372 for each option period should the options be exercised by the tenant.\nTIMBER LODGE STEAKHOUSE - BURNSVILLE, MINNESOTA\nDate of purchase: February 12, 1990\nPurchase price: $722,040\nProperty description: This family restaurant is located at 13050 Aldrich Avenue South. Burnsville is a suburb approximately 11 miles south of Minneapolis. The property contains 6,916 square feet and is situated on 1.43 acres. The current rent is $60,000 per year and the lease expires on July 14, 2001.\nTODDLE HOUSE RESTAURANT - KENNER, LOUISIANA\nDate of purchase: November 26, 1991\nPurchase price: $218,738\nProperty description: Toddle House Restaurants is a national restaurant chain. It features 24-hour service with a cook-to-order menu. Toddle House Restaurants, Inc. is a wholly owned subsidiary of Diversified Hospitality Group, Inc. (DHG) which also operates the Steak 'N' Eggs Kitchen restaurants. The property is located at 2841 Loyola, Kenner, Louisiana and contains 2,175 square feet. The land on which the restaurant is located is 16,800 square feet.\nThe current annual rent is $34,998 and the lease expires on November 25, 2011. Toddle House is currently in Chapter 11 Bankruptcy and did not pay any rent in 1995. The Partnership has been in negotiations with the company to begin collecting rent again. The Partnership collected $3,168 in rent in February 1996.\nLAND - LAS VEGAS, NEVADA\nDate of purchase: March 9, 1995\nPurchase price: $195,152\nProperty description: A 39% undivided interest in two parcels of land located on Sahara Avenue in Las Vegas, Nevada. The land is not currently generating any rental income. The parcels are being held for sale which is expected to happen in 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S LIMITED PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nA) A public market for the Partnership's units does not exist and is not likely to develop.\nB) As of December 31, 1995, there were 1,633 investors holding 135,299 units.\nC) The Partnership made its first cash flow distribution from operations in May 1987. Since that date, consistent cash distributions have been made at the end of each calendar quarter through December 31, 1995. The Partnership expects to continue to make cash distributions on a quarterly basis in the future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following information has been selected from the financial statements of the Partnership.\nINCOME STATEMENT DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the financial statements and the notes thereto as noted in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Partnership is filing as part of this report, its financial statements which contain the following:\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Partnership had no disagreements with its independent public accountants over accounting or financial disclosure.\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 Excel Realty Trust, Inc., a Maryland corporation, and Gary B. Sabin.\nNeither Gary B. Sabin, nor the executive officers of Excel Realty Trust, Inc. receive compensation from the Partnership. The General Partner and the officers and employees of Excel Realty Trust, Inc. spend such time in the administration of Partnership affairs to the extent deemed necessary.\nThe names, ages and positions of responsibility held by the executive officers and directors of Excel Realty Trust, Inc. are as follows:\nFAMILY RELATIONSHIPS\nGary B. Sabin and Ronald H. Sabin are brothers.\nBUSINESS EXPERIENCE\nThe following is a brief background of the directors and executive officers of Excel Realty Trust, Inc.\nGARY B. SABIN has served as Chief Executive Officer, President and Chairman of the Board of Directors since January 1989. He is a graduate of Brigham Young University and Stanford University's Graduate School of Business where he received a master's degree as a Sloan Fellow. Mr. Sabin has extensive experience in the financial services industry with emphasis in the areas of commercial real estate and marketable securities.\nRICHARD B. MUIR has served as Executive Vice President, Secretary and Director of the Company since January 1989. Mr. Muir has worked extensively in the field of commercial real estate, developing expertise in real estate acquisition, property management, leasing and project financing. He has also been actively involved in the securities brokerage industry. He is a general and financial and operations principal with the National Association of Securities Dealers.\nDAVID A. LUND, CPA has served as Chief Financial Officer of the Company since June 1994. He previously served from 1989 to 1994 in various capacities with the Company, including Vice President and Vice President of Finance. From 1983 to 1989 he worked for various affiliated companies. Prior to 1983, Mr. Lund was a partner in a CPA firm.\nRONALD H. SABIN has served as Senior Vice President of the Company in charge of property management since January 1989. Mr. Sabin has also served in various similar capacities with other affiliated companies since 1979.\nGRAHAM R. BULLICK, Ph.D. has served as Senior Vice President of the Company since January 1991. Prior to joining the company, Mr. Bullick served for four years as an account manager of a company specializing in organizational development and service\/quality systems.\nMARK T. BURTON has served as Vice President of the Company since January 1989 and was recently promoted to Senior Vice President. Mr. Burton's duties for the Company primarily consist of the evaluation and selection of property acquisitions and dispositions. Mr. Burton has served in various capacities with other affiliated companies since 1984.\nS. ERIC OTTESEN has served as General Counsel of the Company since January 1995. Prior to 1995, Mr. Ottesen worked as a partner in a law firm based in San Diego, California.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no executive officers and has not paid nor proposes to pay any compensation or retirement benefits to the directors or executive officers of Excel Realty Trust, Inc. See ITEM 13 for compensation to the general partner.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND\nMANAGEMENT\nNo person is known by the Partnership to be the beneficial owner of more than 5% of the limited partner units.\nThe following information sets forth the number of units owned directly or indirectly by each general partner.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe table below reflects compensation paid to the general partner or their affiliates during the year ended December 31, 1995:\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) Documents filed as part of this report:\n(1) (2) Financial statements under Item 8 in Part II hereof.\n(3) Exhibits:\nNone\n(B) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the past year.\nSIGNATURES\nPursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 22, 1996 Excel Properties, Ltd. (Registrant)\nExcel Realty Trust, Inc. (General Partner)\nBy: \/s\/ Gary B. Sabin --------------------------- Gary B. Sabin President\nBy: \/s\/ David A. Lund --------------------------- David A. Lund Principal Financial Officer\nEXCEL PROPERTIES, LTD.\n----------\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners Excel Properties, Ltd.\nWe have audited the accompanying balance sheets of Excel Properties, Ltd., 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 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 Excel Properties, Ltd., as of December 31, 1995 and 1994, and the results of operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principals.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Financial statement Schedules II and III are presented for the purpose of additional analysis and are not a required part of the basic financial statements. Such 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.\nSQUIRE & CO.\nFebruary 9, 1996 Poway, California\nEXCEL PROPERTIES, LTD.\nBALANCE SHEETS DECEMBER 31, 1995 AND 1994\n----------\nThe accompanying notes are an integral part of the financial statements.\nEXCEL PROPERTIES, LTD.\nSTATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n----------\nThe accompanying notes are an integral part of the financial statements.\nEXCEL PROPERTIES, LTD.\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n----------\nThe accompanying notes are an integral part of the financial statements.\nEXCEL PROPERTIES, LTD.\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n----------\nThe accompanying notes are an integral part of the financial statements.\nEXCEL PROPERTIES, LTD.\nNOTES TO FINANCIAL STATEMENTS\n----------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nORGANIZATION\nExcel Properties, Ltd. was formed in the State of California on September 19, 1985, for the purpose of, but not limited to, acquiring real property and syndicating such property.\nREAL ESTATE\nLand and buildings are recorded at cost. Buildings are depreciated using the straight-line method over the tax life of 31.5 years. The tax life does not differ materially from the economic useful life. Expenditures for maintenance and repairs are charged to expense as incurred. Significant renovations are capitalized. The cost and related accumulated depreciation of real estate are removed from the accounts upon disposition. Gains and losses arising from the dispositions are reported as income or expense.\nCASH DEPOSITS\nAt December 31, 1995, the carrying amount of the Partnership's cash deposits total $1,817,201. The bank balances are $1,855,566 of which $200,000 is covered by federal depository insurance.\nSTATEMENT OF CASH FLOWS - SUPPLEMENTAL DISCLOSURE\nThere was no interest or taxes paid for the years ended December 31, 1995, 1994 or 1993. The Partnership had no noncash investing or financing transactions in 1995 or 1994. The Partnership received notes receivable of $877,500 in 1993 from the sale of two buildings.\nINCOME TAXES\nThe Partnership is not liable for payment of any income taxes because as a partnership, it is not subject to income taxes. The tax effects of its activities accrue directly to the partners.\nACCOUNTS RECEIVABLE\nAll net accounts receivable are deemed to be collectible within the next 12 months.\nFINANCIAL STATEMENT 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.\nContinued EXCEL PROPERTIES, LTD.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n----------\n2. FINANCIAL STATEMENT AND TAX RETURN DIFFERENCES\nThe Partnership had the following differences between the financial statements and the Partnership tax return.\n3. FEES PAID TO GENERAL PARTNER:\nThe Partnership has paid the General Partner or its affiliates the following fees:\nContinued EXCEL PROPERTIES, LTD.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n----------\n4. NOTES RECEIVABLE:\nThe Company had the following notes receivable at December 31, 1995 and 1994:\n5. MINIMUM FUTURE RENTALS:\nThe Company leases single-tenant buildings to tenants under noncancelable operating leases requiring the greater of fixed or percentage rents. The leases are either: (1) triple-net, requiring the tenant to pay all expenses of operating the property such as insurance, property taxes, repairs and utilities, or (2) requiring the tenant to reimburse the Company for substantially all of the tenant's share of real estate taxes and other common area maintenance expenses.\nMinimum future rental revenue for the next five years for the commercial real estate currently owned and subject to noncancelable operating leases is as follows:\nContinued EXCEL PROPERTIES, LTD.\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n----------\n6. PURCHASE OF PROPERTY:\nIn March 1995, the Partnership purchased a 39% undivided interest in a parcel of ground in Las Vegas, Nevada for $1,410,233. The ground was leased with the Partnership's share of rent equaling $169,228 per year. The ground was subdivided into three building lots and the lessee constructed a building on one of the three lots. The building was sold in November 1995 as described in Note 7 below. The Partnership still has a 39% undivided interest in the remaining two parcels of land.\n7. SALES OF PROPERTIES:\nIn November 1995, the Partnership sold part of the ground that had been purchased in February 1995. The sales price was $1,566,234 which included an equity participation with the builder\/lessee. The Partnership recognized a $351,152 gain on the sale.\nIn February 1995, the Partnership sold a building in Phoenix, Arizona that was on lease to Childrens World. The sales price was $1,135,000 less $28,729 in selling expenses. The Partnership recognized a gain of $99,141.\nIn November 1993, the Partnership sold a building in Tucson, Arizona, that was on lease to Fuddruckers. The sales price was $937,500 less $39,267 in selling expenses. The Partnership recognized a gain of $358,155 on the sale. As part of the sale, the Partnership received a note receivable of $757,500 from the purchaser as mentioned in Note 4.\nIn November 1993, the Partnership sold a building in Eagan, Minnesota, that was on lease to Rax Restaurant. The sales price was $150,000 less $16,539 in selling expenses. The Partnership recognized a loss of $84,903 on the sale. As part of the sale, the Partnership received a note receivable of $120,000 from the purchaser as mentioned in Note 4.\nEXCEL PROPERTIES, LTD. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nEXCEL PROPERTIES, LTD. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nEXCEL PROPERTIES, LTD. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 (Continued)\n(a) Also represents cost for federal income tax purposes. (b) Reconciliation of total real estate carrying value for the three years ended December 31, 1995 is as follows:\n(c) Reconciliation of accumulated depreciation for the three years ended December 31, 1995 is as follows:","section_15":""}
{"filename":"793375_1995.txt","cik":"793375","year":"1995","section_1":"Item 1. Business\n\t (a) General Development of Business.\n\t Registrant is a holding company organized under the laws of \t Pennsylvania. Registrant has conducted virtually no business operations \t in the past four years, other than its efforts to seek merger partners. \t Subsequent to year end the Registrant entered into an agreement to \t exchange approximately 83.5% of its no par value common stock for \t approximately 60% of the common stock of Communications\/USA, Inc. \t (Comm\/USA).\n\tComm\/USA owns and operates interactive voice messaging franchises in \tthe Voice-Tel system. Voice -Tel is the largest interactive voice \tmessaging company in the United States, operating a digital \ttelecommunications network through independently owned franchises. \tThe system operates on proprietary software which was created by \tCentigram Communications Corporation. Comm\/USA operates in the \tfollowing sales territories: (i)the cities of Tampa, St. \tPetersburg, Clearwater, Largo, Bradenton, and Sarasota; and \t(ii) the Metropolitan Statistical Areas of Lakeland-Winter Haven, \tMelbourne-Titusville-Palm Bay, Fort Pierce, Fort Myers-Cape Coral, \tand Naples.\n\tAfter the merger, the Registrant expects to change its name to \tNET LNNX, Inc., to more closely identify with the high technology \tnature of its future business. Besides the above mentioned \tinteractive voice messaging, the Registrant expects to form and \toperate an Internet Service Provider, and Comm\/USA expects to \tprovide additional services including ,long distance debit or \tprepaid cards, long distance re-selling, as well as purchasing \tits own paging company.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe executive and business office of the Registrant consist of office space located at 2240 Woolbright Rd. Suite 336, Boynton Beach, FL 33426.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere were no material legal proceedings pending or known to be threatened or contemplated to which registrant is a party.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\n\tNo matter was submitted to a vote of holders of Registrant's Common \tStock during 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholders Matters.\nRegistrant's Common Stock has been traded on the over-the-counter market since May 1989. The following table sets forth the range of high and low bid quotations for each quarterly period in the fiscal year ended\nDecember 31, 1995 as reported by brokers making a market in the Company's stock. The quotations shown do not include commissions and therefore do not reflect actual transactions.\nAs of March 29, 1996, there were approximately 2,300 holders of record of Common Stock. No cash dividends were paid in the last 4 years.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n\tNone\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results \tof Operations.\nLIQUIDITY AND CAPITAL RESOURCES\nRegistrant has projected that it will incur only minor operating costs during 1996. After the merger with Comm\/USA, some working capital will flow from the subsidiary to the Registrant in the form of management fees. The company expects these fees to be in the vicinity of $10,000 per month which more than adequately cover any expected expenses that may occur. The Registrant ended the year with $2,164 of cash, which was used to pay for expenses of the merger.\nRESULTS OF OPERATIONS\nThere was a loss of $186 for the year which is a result of stock transfer fee income and associated miscellaneous operating expenses. The company expects that its revenues will approximate $1,000,000 from its interactive voice messaging services. The company's subsidiary Comm\/USA expects to have a net income of 10%-12% of revenues for the 1996 year.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial Statements of Registrant and Financial Statement schedules are attached as Appendix A (following Exhibits) and included as part of this Form 10-K Report. A list of said Financial Statements and Financial Statement Schedules is provided in response to Item 14 (a).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on \tAccounting 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\t (A) Identification of Directors\n\t\t\t Age Director Since\nRobert C. Hackney 45 December 1995\nEach director is elected until the next Annual Meeting of shareholders and until his successor is qualified.\n\t (B) Identification of Executive Officers\nName Office Age When Elected\nRobert C. Hackney President 45 December 1995\nEach officer is elected until the next Annual Meeting of Directors is held and until his successor is qualified\n\t (C) Not required as Registrant was subject to Section 13(a) of \t\tSecurities Act of 1934\n\t (D) Business experience\nRobert C. Hackney: Has been a Director of the Company since December 1995. He will be in charge of implementing the Company's acquisition strategy. For nearly two decades his corporate and securities law practice has included public and private securities offerings, mergers and acquisitions, tender offers, and complex corporate structures. From 1988 until 1995, Mr. Hackney was a partner in the law firm of DeSantis, Gaskill & Hunston P.A., in North Palm Beach, Florida. He is a former securities fraud prosecutor and state securities regulator. He also serves on the Board of Directors of Micro Typing Systems, Inc., a company in the medical products industry. Mr. Hackney is a member of the Florida Bar, the United States District Court, Middle District of Florida, the United States Court of Appeals for the Eleventh Circuit. He has lectured and authored several books in the area of corporate securities law, including \"The Complete Guide to Mergers and Acquisitions\", (1989), \" An Insiders Guide to Non-Bank Business Financing\" (1990), and \"Firesale! Advice on Buying Financially Distressed Companies\" (1991). Mr. Hackney is a member of United States Senator Connie Mack's Senate Roundtable and is listed in the Who' Who Registry.\nItem 11.","section_11":"Item 11. Executive Compensation.\n\tNo officer or Director received any cash compensation during the fiscal \tyear ended December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n\tThe following table identifies the only persons known by the Company \twho owned beneficially as of March 28, 1995, more than five percent of \tany class of the Company's voting securities, after giving effect to a 1 \tfor 20 reverse split which was anounced by the Company on January 3, \t1996.\nTitle Name and Address Amount & Nature of Percent of Class of Beneficial Owner Beneficial Ownership of Class _______ _________________ ____________________ ________ \t\t\t Common Robert C. Hackney No par value Palm Beach Gardens, Fl 835,000 83.5%\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNo related transactions have taken place during 1995\n\t\t\t\t PART 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 Registrant are filed as part of this Form 10-K Report:\n\t1. Audited Balance Sheet as of December 31, 1995 and Unaudited \t\tBalance Sheet as December 31, 1994.\n\t2. Audited Statement of Operation for the Year ended December 31, \t\t1995 and Unaudited Statements of Operations for the years ended \t\tDecember 31, 1994 and 1993. \t3. Audited Statement of Cash Flows for the year ended December 31, \t\t 1995 and Unaudited Statements of Cash Flows for the Years ended \t\tDecember 31, 1994 and 1993. \t4. Notes to Financial Statements\nAll schedules are omitted because they are not required, are not applicable or the required information is given in the financial statements or notes thereto.\n(a) (3) Exhibits\n(3) (A) Articles of Incorporation (incorporated by reference to Registrant's \tForm 10-K Report for the year ended December 31, 1983, Exhibit (3) (A), \tFile No. 0-6553)\n(3) (B) By-Laws(incorporated by reference to Registrant's Form 10-K report for \tthe year ended Decenber 31, 1983, Exhibit (3) (B) , File No. 0-6503)\n(11) Earnings per share\n(b) Reports on Form 8-K\n\t During the year ended December 31, 1995 no reports on Form 8-K were \t filed by Registrant.\nSIGNATURES\nPursuant to the requirements of Secetion 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:\nCHESTER COUNTY SECURITY FUND, INC.\nBy:\/S\/ Robert C. Hackney Robert C. Hackney, President and Director\nDate: March 29,1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following on behalf of the Registrant and in the capacities and on the dates indicated.\nBy: \/S\/Robert C. Hackney Robert C. Hackney, President and Director\nDate: March 29,1996","section_15":""}
{"filename":"12570_1995.txt","cik":"12570","year":"1995","section_1":"ITEM 1. BUSINESS\nLexington Precision Corporation (\"LPC\") is a Delaware corporation which was incorporated in 1966. Unless the context otherwise requires, all references herein to the \"Company\" are to LPC and its wholly-owned subsidiary, Lexington Components, Inc. (\"LCI\"). Through its two business segments, the Rubber Group and the Metals Group, the Company manufactures, to customer specifications, rubber and metal component parts used primarily by manufacturers of automobiles, automotive replacement parts, industrial equipment, computers, office equipment, medical devices and home appliances. The Company's business is conducted primarily in the continental United States.\nRUBBER GROUP\nThe Company's Rubber Group manufactures silicone and organic rubber components. The Rubber Group currently conducts its business through three divisions of LCI, the Precision Seals Division, the Electrical Insulator Division and Lexington Medical, and through a division of LPC, Lexington Manufacturing.\nPRECISION SEALS DIVISION. The Precision Seals Division manufactures molded rubber seals used in primary wire-harnesses for automobiles and trucks. Primary wire-harnesses distribute electrical power to interior and exterior lighting fixtures, electrically powered accessories and other electrical equipment. The seals are designed to assure the integrity of the many connections which are required throughout the harnesses. The seals are generic in nature. A particular seal may be used in a number of connectors within a harness and in a variety of car models produced by several different car manufacturers. The Precision Seals Division's largest customer is Delphi Packard Electric Systems, a division of General Motors Corporation (\"Delphi Packard Electric\").\nELECTRICAL INSULATOR DIVISION. The Electrical Insulator Division manufactures molded rubber insulators used in ignition-wire-harnesses for automobiles and trucks. Insulators are used to shield the electrical connections made by the ignition-wire at the distributor and at the spark plug. Approximately 33% of the insulators manufactured by the Electrical Insulator Division are used in harnesses for new vehicles, primarily those manufactured by Ford Motor Company and Chrysler Corporation, and approximately 67% are used in replacement harnesses.\nLEXINGTON MEDICAL. Lexington Medical manufactures molded rubber components which are used in a variety of medical devices, such as intravenous feeding systems, syringes, laparoscopic instruments and catheters.\nLEXINGTON MANUFACTURING. Lexington Manufacturing manufactures rubber molds which are sold to customers of the other divisions of the Rubber Group and are used by the other divisions to produce components. Lexington Manufacturing also provides engineering support to the other divisions of the Rubber Group.\nDuring 1995, the Company sold the Rubber Group's Extruded and Lathe-Cut Products Division. The former Division manufactured extruded rubber components used primarily by manufacturers of industrial equipment, lighting products and home appliances.\nMETALS GROUP\nThe Company's Metals Group manufactures metal components. The Metals Group conducts its business through Falconer Die Casting Company (\"Falconer\") and Ness Precision Products (\"Ness\"), both of which are divisions of LPC.\nFALCONER DIE CASTING COMPANY. Falconer manufactures aluminum, magnesium and zinc die castings used primarily by manufacturers of computers, office equipment, recreational equipment, communications equipment, industrial equipment and automobiles. Many of the die castings produced by Falconer are also machined by Falconer using computer-controlled machining centers and other secondary machining equipment.\nNESS PRECISION PRODUCTS. Ness produces machined aluminum, brass and steel components used primarily by manufacturers of automobiles, home appliances, office equipment, communications equipment and industrial equipment. In 1995, approximately 38% of the revenues of Ness were generated by sales of components for automotive air bag inflators.\nPRINCIPAL END USES FOR THE COMPANY'S PRODUCTS\nThe following table summarizes net sales of the Company during 1995, 1994 and 1993 by the type of product in which the Company's components were utilized (dollar amounts in thousands):\nThe following table summarizes net sales of the Rubber Group and the Metals Group during 1995, 1994 and 1993 by the type of product in which the Company's components were utilized (dollar amounts in thousands):\n(For additional information concerning the Rubber Group and the Metals Group, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Part II, Item 7, and Note 11 to the consolidated financial statements in Part II, Item 8.)\nMARKETING AND SALES\nThe marketing and sales effort within the Rubber Group is carried out by management personnel and internal sales personnel. The marketing and sales effort within the Metals Group is carried out by management personnel, internal sales personnel and independent sales representatives.\nRAW MATERIALS\nEach of the principal raw materials used by the Company is available at competitive prices from several major manufacturers. All raw materials have been readily available and the Company does not foresee any significant shortages.\nSEASONAL VARIATIONS\nThe Company's business generally is not subject to significant seasonal variations.\nMAJOR CUSTOMERS\nDuring 1995, 1994 and 1993, net sales to the largest customer of the Rubber Group, Delphi Packard Electric, accounted for 22.5%, 20.6% and 22.3%, respectively, of the Company's total net sales. Net sales to the second largest customer of the Rubber Group accounted for 6.8%, 6.1% and 5.1%, respectively, of the\nCompany's total net sales. Net sales to the largest customer of the Metals Group, TRW Vehicle Safety Systems, Inc. (\"TRW VSSI\"), accounted for 8.1%, 13.0% and 11.8%, respectively, of the Company's total net sales. Loss of a significant amount of business from the Company's three largest customers, as a group, would have a material adverse effect on the business of the Company if such business were not replaced by additional business from existing or new customers. (See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Dependence on Large Customers\" in Part II, Item 7.)\nBACKLOG\nThe Company's backlog of customer orders includes orders which have scheduled shipping dates and orders which do not have scheduled shipping dates but which, based upon historical experience, the Company anticipates will be produced and shipped within one year. Orders included in such backlog may be subject to cancellation or postponement by customers; however, based upon past experience, the Company expects to ship during 1996 substantially all of the orders which were included in the backlog at December 31, 1995. The Company believes that its order backlog is not necessarily indicative of future net sales levels. The following table sets forth the backlog of orders for the Rubber Group and the Metals Group at December 31, 1995 and 1994 (dollar amounts in thousands):\nCOMPETITION\nThe Company competes for business primarily on the basis of quality, service, technical and engineering capabilities and price. The Rubber Group and the Metals Group encounter substantial competition from a large number of manufacturing companies. Competitors range from small and medium-sized specialized firms to large diversified companies, many of which have resources substantially greater than those of the Company. Additionally, some of the Company's customers have captive manufacturing operations which compete with the Company.\nPRODUCT LIABILITY RISKS\nThe Company is subject to potential product liability risks which are inherent in the manufacture and sale of component parts. Although there have been no claims made to date against the Company which the Company believes will have a material adverse effect upon its financial position, there can be no assurance that any existing claims or any claims made in the future will not have a material adverse effect upon the financial position of the Company. Although the Company maintains insurance coverage for product liability, there can be no assurance that, in the event of a claim, such insurance coverage would automatically apply or that, in the event of an award arising out of a claim, the amount of such insurance coverage would be sufficient to satisfy the award.\nENVIRONMENTAL COMPLIANCE\nThe Company's operations are subject to numerous federal, state and local laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the\nenvironment. Although the Company continues to make expenditures for the protection of the environment, compliance with federal, state and local environmental regulations has not had a significant impact on the capital spending requirements, earnings or competitive position of the Company. There can be no assurance that changes in environmental laws and regulations, or the interpretation or enforcement thereof, will not require material expenditures by the Company in the future. (See also \"Legal Proceedings\" in Part I, Item 3.)\nEMPLOYEES\nThe following table shows the number of employees at the Rubber Group, the Metals Group and the Corporate Office at December 31, 1995:\nAt December 31, 1995, thirty-four hourly workers at one plant location within the Rubber Group were subject to a collective bargaining agreement. The Company believes that its employee relations are generally good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAt December 31, 1995, the Company conducted its operations at eight manufacturing plants. In 1995, the Company acquired real estate in North Canton, Ohio, and commenced construction of an additional manufacturing facility. Production is expected to commence at the new facility during the second quarter of 1996. In addition, in 1995, the Company sold a manufacturing facility in Blue Ridge, Georgia. The following table shows the location and square footage of each of the properties of the Rubber Group, the Metals Group and the Corporate Office at December 31, 1995:\n[FN]\n(1) Encumbered by mortgage. (2) Includes a 26,000 square foot addition, which was under construction at December 31, 1995. The addition was completed in the first quarter of 1996. (3) Under construction at December 31, 1995. The Company expects this facility to be completed during the second quarter of 1996. (4) Includes a 30,000 square foot addition, which was under construction at December 31, 1995. The Company expects the addition to be completed during the second quarter of 1996. This facility is leased from an industrial development authority pursuant to a lease which expires in 2006 and provides the Company with an option to purchase the facility for nominal consideration. (5) Leased from an industrial development authority pursuant to a lease which expires in 2000 and provides the Company with an option to purchase the facility for nominal consideration. (6) Provided to the Company by an affiliate pursuant to arrangements under which the Company reimburses the affiliate for a portion of the cost relating to the space. (7) Leased.\nAll of the plants are well maintained, general manufacturing facilities which are suitable for the Company's operations. The Company believes that, except for Ness, which generally is operating near capacity, all of the operating companies have facilities which are adequate to meet significant increases in the demand for their products.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to certain legal actions arising in the ordinary course of its business, including actions naming the Company as a potentially responsible party or as a third-party defendant in cost recovery actions initiated pursuant to environmental laws. Based upon the information presently available to the Company, the Company believes that the ultimate outcome of these actions will not have a material adverse effect upon its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\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 Company's common stock, held by approximately 1,100 holders of record as of February 29, 1996, is traded in the over-the-counter market. Trading of shares of the Company's common stock is limited. No reliable trading data for the Company's common stock was publicly available for the period January 1, 1993 through April 7, 1994. Since April 8, 1994, trading information has been available from the OTC Bulletin Board provided by the National Association of Securities Dealers (NASD). The following table sets forth selling prices of the Company's common stock as reported by the OTC Bulletin Board:\nThe Company is not able to determine whether or not retail mark-ups, mark-downs or commissions were included in the above prices. The Company believes that five brokerage firms currently make a market in the Company's common stock, although both bid and asked quotations may at times be limited.\nNo dividends have been paid on the Company's common stock since 1979. The future payment of dividends is dependent upon, among other things, the earnings and capital requirements of the Company. The agreements pursuant to which certain of the Company's indebtedness is outstanding, and the terms of the Company's preferred stock, contain provisions limiting the Company's ability to make dividend payments on its common stock. The most restrictive of such provisions would have permitted the Company to pay $3,495,000 of dividends on its common stock at December 31, 1995. (See also Notes 6 and 7 to the consolidated financial statements in Part II, Item 8.)\nThe Board of Directors intends, for the foreseeable future, to follow a policy of retaining the Company's earnings in order to reduce the indebtedness of the Company and finance the development and expansion of its business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)\n[FN] (1) In 1992, income from continuing operations included charges of $1,113,000 for the amortization of and $2,132,000 for the write-off of covenants not to compete. In 1991, income from continuing operations included a charge of $1,113,000 for the amortization of covenants not to compete.\n(2) In 1991, the extraordinary item represented the gain on the repurchase of $1,500,000 principal amount of the Company's 12-3\/4% Subordinated Notes, due February 1, 1997.\n(3) In 1995, 1994 and 1993, fully diluted income per common share was reduced by $.02, $.02 and $.07, respectively, to reflect the effect of dividends paid or accrued on the Company's preferred stock and the amount by which payments made to effect the redemption of the preferred stock exceeded the par value of such shares.\n(4) At December 31, 1992 and 1991, $29,046,000 and $30,429,000, respectively, of debt obligations with scheduled maturities of one year or more were classified as current liabilities because of certain defaults. In January 1993, the Company completed a restructuring of substantially all of its indebtedness which eliminated all defaults on its outstanding debt.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995\nVarious statements in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and elsewhere in this report are based upon projections and estimates, as distinct from past or historical facts and events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to be materially different. Such risks and uncertainties include changes in future economic conditions, changes in the competitive environment, changes in the capital markets, unanticipated operating results and a number of other factors.\nThe results of operations for any particular fiscal period of the Company are not necessarily indicative of the results to be expected for any one or more succeeding fiscal periods. In addition, because the Company's business is materially affected by the level of activity in the automotive industry, any material reduction in the level of activity in that industry may have a material adverse effect on the Company's results of operations.\nRESULTS OF OPERATIONS\n1995 VERSUS 1994\nNET SALES\nA summary of the net sales of the Rubber Group and the Metals Group for 1995 and 1994 follows (dollar amounts in thousands):\nApproximately 89% of the $15,434,000 increase in net sales of the Rubber Group came from increased sales of seals for primary wire-harnesses and insulators for ignition-wire-harnesses. Increased sales of tooling and medical components were responsible for the balance of the increase. If net sales of the Extruded and Lathe-Cut Products Division, which was sold on June 30, 1995, were excluded from the above table, net sales of the Rubber Group would have increased from $44,306,000 to $60,981,000, an increase of 37.6%.\nIn 1995, net sales of the Metals Group were adversely affected by a decline of $3,978,000 in sales of a single component to TRW VSSI. The decline in sales of the component resulted from the planned phase-out of the inflator system of which the component is a part. (See also \"Liquidity and Capital Resources - Dependence on Large Customers\" in this Item 7.)\nCOST OF SALES\nA summary of cost of sales and cost of sales as a percentage of net sales for the Rubber Group and the Metals Group for 1995 and 1994 follows (dollar amounts in thousands):\nThe decrease in cost of sales of the Rubber Group as a percentage of net sales from 83.9% in 1994 to 81.3% in 1995, resulted from reduced direct labor expense as a percentage of net sales, primarily because of the purchase of new equipment and the introduction of improved manufacturing processes, and reduced factory overhead expense as a percentage of net sales, primarily because factory overhead expense grew at a slower rate than sales at the Precision Seals Division and the Electrical Insulator Division. Reductions in factory overhead expense as a percentage of net sales at the Precision Seals Division and the Electrical Insulator Division were offset in part by costs associated with the development and startup of new products at Lexington Medical. The reduction in factory overhead expense as a percentage of net sales at the Precision Seals Division would have been greater but for the impact of startup expenses and production inefficiencies at the Division's new facility in LaGrange, Georgia.\nCost of sales of the Metals Group as a percentage of net sales increased from 77.6% in 1994 to 81.3% in 1995, primarily because of increased factory overhead expense as a percentage of net sales and, to a lesser extent, increased direct labor expense as a percentage of net sales at Ness. Increased factory overhead expense and direct labor expense as a percentage of net sales at Ness were offset in part by lower material costs as a percentage of net sales and decreased factory overhead expense and direct labor expense as a percentage of net sales at Falconer. Factory overhead and direct labor expense as a percentage of net sales increased at Ness because of the installation of new equipment and the start-up of new products. In addition, factory overhead expense as a percentage of net sales increased because of reduced absorption of fixed factory overhead expense due to a decrease in net sales at Ness.\nSELLING AND ADMINISTRATIVE EXPENSES\nA summary of selling and administrative expenses and selling and administrative expenses as a percentage of net sales for the Rubber Group, the Metals Group and the Corporate Office follows (dollar amounts in thousands):\nAt the Rubber Group, selling and administrative expenses as a percentage of net sales decreased to 6.7% during 1995, primarily because most selling and administrative expenses grew at a slower rate than net sales and because of reduced legal expenses.\nAt the Metals Group, selling and administrative expenses as a percentage of net sales increased to 8.8% during 1995, primarily because of increased legal expenses.\nIn 1995, administrative expenses at the Corporate Office increased, primarily because of increased wage expenses and increased accruals for incentive compensation, offset in part by reduced legal expenses.\nINTEREST EXPENSE\nInterest expense totaled $7,585,000 during 1995, an increase of $1,313,000, compared to 1994. This increase was caused primarily by an increase in average borrowings outstanding.\nOTHER INCOME\nOn June 30, 1995, the Company sold the Extruded and Lathe-Cut Products Division of LCI for cash and the assumption by the purchaser of certain liabilities, which resulted in a pre-tax gain of $578,000. In addition, during 1995, the Company realized a pre-tax gain in the amount of $63,000 on the sale of several other pieces of equipment. During 1994, other income consisted of a gain of $336,000 on the sale of marketable securities and a gain of $200,000 from the sale of real estate in connection with the settlement of litigation.\nPROVISION FOR INCOME TAXES\nThe income tax provisions otherwise recognizable during 1995 and 1994 were reduced by the utilization of portions of the Company's tax loss carryforwards and tax credit carryforwards. In 1995, the income tax provision was also reduced by $265,000 because the Company's valuation allowance was reduced by the recognition of federal operating loss carryforwards which the Company expects to utilize during 1996. The Company's valuation allowance decreased $703,000 in 1995.\nAt December 31, 1994, the Company's valuation allowance equaled 100% of its net deferred tax assets. (For additional information concerning income tax expense and the utilization of tax loss carryforwards and tax credit carryforwards, see Note 10 to the consolidated financial statements in Part II, Item 8.","section_7A":"","section_8":"Item 8.)\n1994 VERSUS 1993\nNET SALES\nA summary of the net sales of the Rubber Group and the Metals Group for 1994 and 1993 follows (dollar amounts in thousands):\nApproximately 77% of the $6,480,000 increase in net sales of the Rubber Group came from increased sales of seals for primary wire-harnesses and insulators for ignition-wire-harnesses. Increased net sales of medical components were primarily responsible for the balance of the increase.\nNet sales of the Metals Group increased by $7,076,000 in 1994, primarily due to a $2,762,000 increase in net sales to TRW VSSI and a $2,690,000 increase in net sales of die cast components.\nCOST OF SALES\nA summary of cost of sales and cost of sales as a percentage of net sales for the Rubber Group and the Metals Group for 1994 and 1993 follows (dollar amounts in thousands):\nCost of sales of the Rubber Group as a percentage of net sales increased from 82.4% in 1993 to 83.9% in 1994, primarily as a result of increased factory overhead expense as a percentage of net sales. During 1994, increased factory overhead expense included increased indirect labor expense, increased workers' compensation expense and increased depreciation and amortization expense. Increased factory overhead expense as a percentage of net sales was offset in part by lower direct labor expense as a percentage of net sales resulting from the installation of new and refurbished equipment and the introduction of improved manufacturing processes.\nCost of sales of the Metals Group as a percentage of net sales decreased from 79.3% in 1993 to 77.6% in 1994. During 1994, material costs and direct labor expense as percentages of net sales were essentially unchanged, while factory overhead expense as a percentage of net sales decreased, primarily because sales increased while certain components of factory overhead expense remained relatively unchanged.\nSELLING AND ADMINISTRATIVE EXPENSES\nA summary of selling and administrative expenses and selling and administrative expenses as a percentage of net sales for the Rubber Group, the Metals Group and the Corporate Office follows (dollar amounts in thousands):\nAt the Rubber Group, selling and administrative expenses as a percentage of net sales increased to 7.9% in 1994 compared to 7.8% in 1993, primarily as a result of the addition of sales and administrative personnel.\nAt the Metals Group, selling and administrative expenses as a percentage of net sales decreased to 7.9% in 1994, compared to 8.4% in 1993. Increased sales of products subject to sales commissions and increased advertising costs were more than offset by efficiencies related to increased volume.\nIn 1994, administrative expenses at the Corporate Office decreased by $58,000, or 3.1%, primarily as a result of reduced legal fees. In 1993, administrative expenses at the Corporate Office included $730,000 of expenses recorded in connection with the Company's restructuring of its 12-3\/4% Subordinated Notes, due February 1, 1997 (the \"12-3\/4% Notes\"), and 14% Junior Subordinated Convertible Notes, due May 1, 2000, which were partially offset by a credit of $215,000 resulting from the settlement of litigation.\nINTEREST EXPENSE\nInterest expense totaled $6,272,000 during 1994, an increase of $776,000, compared to 1993. This increase was caused primarily by an increase in average borrowings outstanding and increases in the Prime Rate.\nOTHER INCOME\nDuring 1994, other income consisted of a gain of $336,000 on the sale of marketable securities and a gain of $200,000 from the sale of real estate in connection with the settlement of litigation.\nPROVISION FOR INCOME TAXES\nThe income tax provisions otherwise recognizable during 1994 and 1993 were reduced by the utilization of portions of the Company's tax loss carryforwards and tax credit carryforwards. (For additional information concerning income tax expense and the utilization of tax loss carryforwards and tax credit carryforwards, see Note 10 to the consolidated financial statements in Part II, Item 8.)\nIMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD ADOPTED DURING 1994\nFINANCIAL ACCOUNTING STANDARD NO. 112\nEffective January 1, 1994, the Company changed its method of accounting for postemployment benefits, such as Company funded disability benefits, from the cash basis (recognizing expense as benefits are paid) to the accrual method (recognizing the estimated cost of providing such benefits as an expense while the employee renders service) as required by \"Financial Accounting Standard No. 112, Employers' Accounting for Postemployment Benefits\" (\"FAS 112\"). The adoption of FAS 112 did not materially affect the financial position or results of operations of the Company because benefits of this type currently provided by the Company are de minimis in amount.\nIMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS TO BE ADOPTED DURING 1996\nFINANCIAL ACCOUNTING STANDARD NO. 121 - IMPAIRMENT OF LONG-LIVED ASSETS\nIn March 1995, the Financial Accounting Standards Board issued \"Financial Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" (\"FAS 121\"), which requires losses to be recorded on long-lived assets used in operations where indicators of\nimpairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of such assets. FAS 121 also addresses the accounting for long-lived assets to be disposed of. The Company plans to adopt FAS 121 during the first quarter of 1996 and believes that, at the time of adoption, FAS 121 will not affect the financial position or results of operations of the Company.\nFINANCIAL ACCOUNTING STANDARD NO. 123 - STOCK-BASED COMPENSATION\nThe Company has a Restricted Stock Award Plan and an Incentive Stock Option Plan pursuant to which it may award to officers and key employees restricted shares of the Company's common stock and options to purchase shares of the Company's common stock. Awards under both plans are accounted for in accordance with the provisions of \"Accounting Principles Board Opinion Number 25, Accounting for Stock Issued to Employees\" (\"APB 25\"). With respect to restricted shares, the Company recognizes compensation expense on the date of grant equal to the then market value of the Company's common stock. With respect to options to purchase shares of common stock or shares of common stock issued at the time options are exercised, the Company does not recognize compensation expense.\nDuring 1995, the Financial Accounting Standards Board issued \"Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation\" (\"FAS 123\"), which establishes new standards for the measurement and recognition of stock-based compensation, but allows entities to continue using APB 25 to account for the issuance of stock-based compensation if they disclose the pro forma effect of stock-based compensation on net income and earnings per share as if FAS 123 had been adopted. FAS 123 is effective for 1996. The Company intends to continue using the provisions of APB 25 to account for stock-based compensation.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS RELATING TO OPERATING ACTIVITIES\nDuring 1995, net cash provided by the operating activities of the Company totaled $7,860,000.\nDuring 1995, $481,000 of cash was used to fund increased levels of accounts receivable, resulting primarily from increased levels of sales and orders during the fourth quarter of 1995, compared to the fourth quarter of 1994.\nAt December 31, 1995, the Company's trade accounts payable included approximately $2,876,000 relating to the purchase of new property, equipment and customer-owned tooling, compared to $4,325,000 at December 31, 1994. Excluding accounts payable balances related to purchases of new property, equipment and customer-owned tooling, trade accounts payable increased by $1,588,000, from $6,164,000 at December 31, 1994 to $7,752,000 at December 31, 1995. The increase resulted from higher levels of production during the fourth quarter of 1995, compared to the fourth quarter of 1994, and, to a lesser extent, a temporary slowing of payments to suppliers.\nCompared to December 31, 1994, accrued expenses at December 31, 1995 included increased accruals for employee compensation and related taxes and benefits and increased accruals for alternative minimum taxes.\nNet working capital declined during 1995 by $3,197,000, primarily because capital expenditures were financed with increased short-term borrowings under the Company's revolving line of credit (the \"Revolving Line of Credit\") provided to the Company by Congress Financial Corporation (\"Congress\"). (For additional information concerning the Revolving Line of Credit, see \"Cash Flows Relating to Financing Activities\" in this Item 7 and Notes 5 and 6 to the consolidated financial statements in Part II, Item 8.)\nCASH FLOWS RELATING TO INVESTING ACTIVITIES\nDuring 1995, the investing activities of the Company used $17,997,000 of cash, primarily for capital expenditures.\nThe following table sets forth capital expenditures for the Rubber Group, the Metals Group and the Corporate Office during 1995 and 1994 (dollar amounts in thousands):\nAs a result of growing market share in certain market niches and increased volume because of a healthy economy and, in particular, a strong automotive industry, the Company commenced a major expansion plan in 1994. Net sales increased from $74,976,000 in 1993, to $88,532,000 in 1994 and then to $104,298,000 in 1995. Net sales for 1996 are currently projected to range between $110,000,000 and $120,000,000. The Company estimates that approximately $4,000,000 of capital expenditures are required annually to maintain or replace existing equipment or to effect cost reductions and that the balance of capital expenditures are for the expansion of facilities and the purchase of production equipment to meet increased demand for product.\nDuring 1995, $958,000 of funds were used to finance deferred tooling expense. Also, during 1995, $998,000 of funds were provided by the sale of the Extruded and Lathe-Cut Products Division of LCI.\nThe Company presently estimates that capital expenditures will total approximately $13,000,000 during 1996. At December 31, 1995, the Company had commitments outstanding for capital expenditures totaling approximately $6,700,000. The Company anticipates that the funds needed for capital expenditures in 1996 will be provided by cash flows from operations and from borrowings. (See also \"Liquidity\" in this Item 7.)\nCASH FLOWS RELATING TO FINANCING ACTIVITIES\nDuring 1995, the financing activities of the Company provided $10,176,000 of cash, primarily from increased borrowings.\nThe Company finances its day-to-day operations through the Revolving Line of Credit. The Company also uses the Revolving Line of Credit to fund capital expenditures with the intention of later refinancing such borrowings with term loans. The Company borrows and repays loans outstanding under the Revolving Line of Credit daily, depending on cash receipts and disbursements. The ability of the Company to borrow under the Revolving Line of Credit is based on certain availability formulas, agreed upon by the Company and Congress, which are based on the levels of accounts receivable and inventories of the Company.\nIn addition to borrowings under the Revolving Line of Credit, in 1995, the Company borrowed an aggregate of $15,067,000 in term loans from Congress. Proceeds from the term loans were used to refinance loans outstanding under the Revolving Line of Credit. Congress provides the Company with a line of credit which can be used to finance a portion of qualifying new equipment purchases through term loans (the \"Equipment Line of Credit\"). Generally, the amount of financing available to fund new equipment purchases is equal to 85% of the appraised orderly liquidation value of the equipment being purchased. At December 31, 1995, the Equipment Line of Credit totaled $5,466,000.\nIn the first quarter of 1996, the Company obtained from Congress, The CIT Group\/Equipment Financing, Inc. and Bank One, Akron, NA (\"Bank One\") term loans in the aggregate amount of $10,302,000. Proceeds from the term loans were used to refinance $4,035,000 of term loans outstanding with Congress and $6,267,000 of loans outstanding under the Revolving Line of Credit.\nAs a result of the borrowings under long-term agreements during the first quarter of 1996, $3,730,000 of loans outstanding under the Revolving Line of Credit were classified as long-term debt at December 31, 1995.\nAlso, in the first quarter of 1996, the Company borrowed $1,000,000 from Bank One on a demand basis. The $1,000,000 loan is scheduled to be refinanced as part of a $2,500,000 term loan to be advanced during the second quarter of 1996 (the \"Bank One Commitment\").\nThe Company's financing arrangements, which are secured by substantially all of the Company's assets and the stock of LCI, require the Company to maintain certain financial ratios and limit the payment of dividends.\nLIQUIDITY\nThe Company operates with high financial leverage and limited liquidity. During 1995, aggregate indebtedness of the Company, excluding accounts payable, increased by $10,808,000 to $68,086,000 at December 31, 1995. As a result of increased borrowings during the first quarter of 1996, the aggregate indebtedness of the Company, excluding accounts payable, totaled $75,390,000 as of March 26, 1996.\nCash interest and principal payments totaled $7,299,000 and $3,228,000, respectively, in 1995. During 1996, cash interest and principal payments are projected to total approximately $7,986,000 and $5,163,000, respectively.\nAvailability under the Revolving Line of Credit totaled $2,340,000 at March 26, 1996. Availability under the Revolving Line of Credit is calculated without deducting outstanding checks issued by the Company. Typically, outstanding checks average approximately $1,500,000.\nDuring 1996, the Company anticipates that, in addition to its projected cash flows from operations, borrowings in the amount of approximately $10,400,000 will be required to meet the Company's working capital, capital expenditure and debt service requirements. Peak borrowing requirements during 1996 of approximately $78,000,000 are projected to occur on August 1, 1996, the scheduled payment date for $2,022,000 of interest then due on the 12-3\/4% Notes. Although no assurances can be given, based on its present business plan, the Company currently believes that cash flows from operations and availability under the Revolving Line of Credit, the Equipment Line of Credit, and the Bank One Commitment should be adequate to meet its anticipated working capital, capital expenditure and debt service requirements for 1996. If cash flows from operations or availability under the Revolving Line of Credit, the Equipment Line of Credit, and the Bank One Commitment fall below expectations, the Company intends to reduce or delay its capital expenditure program and\/or to extend accounts payable balances with suppliers beyond terms which the Company believes are customary in the industries in which it operates.\nDEPENDENCE ON LARGE CUSTOMERS\nDuring 1995, 1994 and 1993, net sales to TRW VSSI, the Company's second largest customer, accounted for 8.1%, 13.0% and 11.8%, respectively, of the Company's total net sales and consisted primarily of sales of a single component. During 1995, net sales of the single component declined by $3,978,000. The decline in sales, which occurred because of the planned phase-out of the inflator system of which the component is a part, had an adverse affect on the operating profit of Ness and the Company. Currently, management of the Company believes that the component will only be in production through June 30, 1996. The Company believes that, during 1996, orders for new parts from TRW VSSI and other companies which supply TRW VSSI will not offset the decrease in sales of the single component and that the decrease will result in a significant reduction of operating profit at Ness in 1996. The Company currently believes that the reduction in operating profit at Ness will not have a material adverse effect on the financial position or operating profit of the Company.\nACQUISITIONS\nThe Company is seeking to acquire assets and businesses related to its current operations with the intention of expanding its existing operations. Depending on, among other things, the size and terms of such acquisitions, the Company may be required to obtain additional financing and, in some cases, the approval of Congress and the holders of other debt of the Company. The Company's ability to effect acquisitions may be dependent upon its ability to obtain such financing and, to the extent applicable, consents.\nINFLATION\nMany customers of the Company will not accept price increases from the Company to compensate for increases in labor and overhead expenses that result from inflation. To the extent practical, fluctuations in material costs are passed through to customers. Although the Company may, in certain cases, commit to a fixed material cost for a specified time period, generally, a similar offsetting commitment is made to the Company by its material supplier. To offset inflationary costs which the Company cannot pass through to its customers and to maintain or improve its operating margins, the Company has continually worked to improve its production efficiencies and manufacturing processes. Although the Company believes that during the three-year period ended December 31, 1995 inflationary increases in labor and overhead expenses have been substantially offset as a result of its efforts, there can be no assurance that the Company will continue to be able offset inflationary cost increases through such measures.\nENVIRONMENTAL MATTERS\nThe Company has been named from time to time as one of numerous potentially responsible parties under applicable environmental laws for restoration costs at waste disposal sites, as a third-party defendant in cost recovery actions pursuant to applicable environmental laws and as a defendant or potential defendant in various other environmental law matters. It is the Company's policy to record accruals for such matters when a loss is deemed probable and the amount of such loss can be reasonably estimated. The various actions to which the Company is or may be a party in the future are at various stages of completion and, although there can be no assurance as to the outcome of existing or potential environmental litigation, in the event such litigation were commenced, based upon the information currently available to the Company, the Company believes that the outcome of such actions would not have a material adverse effect upon its financial position.\nTHIS PAGE INTENTIONALLY LEFT BLANK\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Lexington Precision Corporation and Subsidiary\nWe have audited the accompanying consolidated balance sheets of Lexington Precision Corporation and subsidiary at December 31, 1995 and 1994, and the related consolidated statements of income, 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 table of contents in Part IV, Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lexington Precision Corporation and subsidiary at December 31, 1995 and 1994, and the consolidated 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 financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nERNST & YOUNG LLP\nCleveland, Ohio March 22, 1996\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED BALANCE SHEETS (CONTINUED) (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF INCOME (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Lexington Precision Corporation (\"LPC\") and its wholly-owned subsidiary, Lexington Components, Inc. (\"LCI\"). Unless the context otherwise requires all references herein to the \"Company\" are to LPC and LCI. All significant intercompany accounts and transactions have been 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 reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCONCENTRATION OF CREDIT RISK\nAt December 31, 1995 and 1994, trade accounts receivable outstanding from automotive customers totaled $8,357,000 and $7,904,000, respectively. The Company provides for credit losses based upon historical experience and ongoing credit evaluations of its customers' financial condition but does not generally require collateral from its customers to support the extension of trade credit. At December 31, 1995 and 1994, the Company had reserves for credit losses of $175,000 and $174,000, respectively.\nINVENTORIES\nInventories are valued at the lower of cost (first-in, first-out method) or market. Inventory levels by principal classification are set forth below (dollar amounts in thousands):\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are carried at cost less accumulated depreciation. Depreciation is calculated principally on the straight-line method over the estimated useful life of the various assets (15 to 32 years for buildings and 3 to 10 years for equipment). Maintenance and repair expenses were $3,162,000, $2,484,000 and $2,189,000 for 1995, 1994 and 1993, respectively. Maintenance and repair expenses are charged against income as incurred, while major improvements are capitalized. When property is retired or otherwise disposed of, the related cost and accumulated depreciation are eliminated.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED\nExcess of cost over the net assets of businesses acquired (goodwill) is amortized on the straight-line method, principally over 40 years. At December 31, 1995 and 1994, accumulated amortization of goodwill was $2,264,000 and $1,948,000, respectively. Amortization of goodwill is classified as part of selling and administrative expenses. During each of 1995, 1994 and 1993, amortization of goodwill totaled $316,000. The carrying value of goodwill is assessed for impairment quarterly. Based upon such assessment, the Company believes that no impairment of goodwill existed at December 31, 1995.\nINCOME PER SHARE\nPrimary net income per common share and fully diluted net income per common share are computed using the weighted average number of common shares and dilutive common equivalent shares outstanding. For purposes of the income per share calculations, income for each period is reduced by preferred stock dividends and by the amount by which payments made to redeem shares of the Company's $8 Cumulative Convertible Redeemable Preferred Stock, Series B (the \"Redeemable Preferred Stock\"), exceed the par value of such shares. Common equivalent shares are those shares issuable upon the assumed exercise of outstanding dilutive stock options and conversion of Redeemable Preferred Stock, calculated using the treasury stock method. Fully diluted income per share assumes conversion of the 14% Junior Subordinated Convertible Notes, due May 1, 2000 (the \"14% Convertible Notes\").\nREPORTING OF CASH FLOWS\nThe Company considers all highly liquid investments with maturities at the time of purchase of less than three months to be cash equivalents.\nFINANCIAL ACCOUNTING STANDARD NO. 121 - IMPAIRMENT OF LONG-LIVED ASSETS\nIn March 1995, the Financial Accounting Standards Board issued \"Financial Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" (\"FAS 121\"), which requires losses to be recorded on long-lived assets used in operations where indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of such assets. FAS 121 also addresses the accounting for long-lived assets to be disposed of. The Company plans to adopt FAS 121 during the first quarter of 1996 and believes that, at the time of adoption, FAS 121 will not affect the financial position or results of operations of the Company.\nFINANCIAL ACCOUNTING STANDARD NO. 123 - STOCK-BASED COMPENSATION\nThe Company has a Restricted Stock Award Plan and an Incentive Stock Option Plan pursuant to which it may award to officers and key employees restricted shares of the Company's common stock and options to purchase shares of the Company's common stock. Awards under both plans are accounted for in accordance with the provisions of \"Accounting Principles Board Opinion Number 25, Accounting for Stock Issued to Employees\" (\"APB 25\"). With respect to restricted shares, the Company recognizes compensation expense on the date of grant equal to the then market value of the Company's common stock. With respect to options to purchase shares of common stock or shares of common stock issued at the time options are exercised, the Company does not recognize compensation expense.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDuring 1995, the Financial Accounting Standards Board issued \"Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation\" (\"FAS 123\"), which establishes new standards for the measurement and recognition of stock-based compensation, but allows entities to continue using APB 25 to account for the issuance of stock-based compensation if they disclose the pro forma effect of stock-based compensation on net income and earnings per share as if FAS 123 had been adopted. FAS 123 is effective for 1996. The Company intends to continue using the provisions of APB 25 to account for stock-based compensation.\nRECLASSIFICATIONS\nCertain amounts in the consolidated financial statements have been reclassified to conform to the 1995 presentation.\nNOTE 2 -- PREPAID EXPENSES AND OTHER ASSETS\nAt December 31, 1995 and 1994, other current assets included $1,790,000 and $1,242,000, respectively, of tooling acquired by the Company for certain customers. Upon customer approval of the components produced from such tooling, which normally takes less than 90 days, the customer is required to purchase the tooling from the Company.\nNOTE 3 -- OTHER NONCURRENT ASSETS\nAt December 31, 1995 and 1994, other noncurrent assets included $1,481,000 and $990,000, respectively, which represented amounts paid by the Company for tooling owned by the Company's customers in excess of the amounts paid by the customers for such tooling. Such excess amounts are amortized over periods not exceeding three years. During 1995 and 1994, amortization expense related to tooling owned by customers but funded by the Company was $626,000 and $272,000, respectively.\nNOTE 4 -- ACCRUED EXPENSES\nAccrued expenses at December 31, 1995 and 1994 are summarized below (dollar amounts in thousands):\nNOTE 5 -- SHORT-TERM DEBT\nAt December 31, 1995 and 1994, short-term debt consisted of loans outstanding under the revolving line of credit (the \"Revolving Line of Credit\") provided to the Company by Congress Financial Corporation (\"Congress\"). The Revolving Line of Credit has an expiration date of January 2, 1998. Except for certain loans\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nwhich were refinanced under long-term agreements before the consolidated financial statements were issued, the loans outstanding under the Revolving Line of Credit have been classified as short-term debt at December 31, 1995 and 1994 because the Company's cash receipts are automatically used to reduce the loans outstanding under the Revolving Line of Credit on a daily basis, by means of a lock-box sweep arrangement, and Congress has the ability to modify certain terms of the Revolving Line of Credit without the prior approval of the Company. (See also Note 6, \"Long-Term Debt.\")\nAt December 31, 1995, 1994 and 1993, the interest rates on borrowings under the Revolving Line of Credit were 9.1%, 10.0% and 7.5%, respectively.\nNOTE 6 -- LONG-TERM DEBT\nLong-term debt at December 31, 1995 and 1994 is summarized below (dollar amounts in thousands):\nLOANS OUTSTANDING UNDER THE REVOLVING LINE OF CREDIT CLASSIFIED AS LONG-TERM DEBT\nAt December 31, 1995 and 1994, there were loans of $3,730,000 and $7,267,000, respectively, outstanding under the Revolving Line of Credit which were classified as long-term debt because the loans were refinanced under long-term agreements before the consolidated financial statements for the respective years were issued.\nDuring the first quarter of 1996, the Company obtained term loans in the aggregate amount of $10,302,000, payable in installments ranging from 48 to 84 months. Of that amount, $4,035,000 was used to refinance term loans and $6,267,000 was used to refinance loans outstanding under the Revolving Line of Credit. Of the latter amount, $3,730,000 was used to refinance loans that were outstanding under the Revolving Line of Credit at December 31, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe term loans obtained during the first quarter of 1996 are payable in monthly installments with final maturities in 2000, 2001, 2002 or 2003. Interest on the loans is due monthly at the London Interbank Offered Rate (\"LIBOR\") plus 3% or 3-1\/4%, Prime Rate plus 3\/4% or 1%, or a fixed rate of 8.37%. The loans are secured, in the aggregate, by all receivables, inventories and equipment, and by certain real property and other personal property.\nCONGRESS TERM LOANS\nAt December 31, 1995 and 1994, term loans in the aggregate amounts of $20,488,000 and $8,029,000, respectively, were outstanding with Congress. The loans are payable in monthly installments with final maturities in 2002 or 2003, subject to earlier maturity in the event the Revolving Line of Credit terminates or expires. Interest on the loans is due monthly at LIBOR plus 3-1\/4% or Prime Rate plus 1%. The loans are secured by all receivables and inventories and by certain equipment, real property and other personal property.\n12% NOTE\nThe 12% Note, due April 30, 2000 (the \"12% Note\"), is payable by LCI, is secured by a mortgage on LCI's Rock Hill, South Carolina, facility and is guaranteed by LPC. Level payments of principal and interest in the amount of $66,000 are due monthly until the 12% Note is paid in full.\n12-3\/4% NOTES\nThe 12-3\/4% Senior Subordinated Notes, due February 1, 2000 (the \"12-3\/4% Notes\"), are unsecured obligations of the Company, redeemable at the option of the Company, in whole or in part, at a declining premium over the principal amount thereof. Interest on the 12-3\/4% Notes is due semi-annually on February 1 and August 1.\n14% NOTES\nThe 14% Junior Subordinated Convertible Notes, due May 1, 2000, and 14% Junior Subordinated Nonconvertible Notes, due May 1, 2000 (collectively, the \"14% Notes\"), are unsecured obligations of the Company and are redeemable at the option of the Company, in whole or in part, at a declining premium over the principal amount thereof. Interest on the 14% Notes is due quarterly on February 1, May 1, August 1 and November 1. The 14% Convertible Notes are convertible into 440,000 shares of the Company's common stock.\nRESTRICTIVE COVENANTS\nCertain of the Company's loan agreements contain covenants restricting the Company's business and operations, including restrictions on the issuance or assumption of additional debt, the sale of all or substantially all of the Company's assets, the purchase of common stock, the redemption of preferred stock and the payment of cash dividends.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company believes that, at December 31, 1995, the fair value of the Congress term loans and the loans outstanding under the Revolving Line of Credit approximately equaled the outstanding principal balances of such loans because the interest rates on these loans floated at a spread over LIBOR or Prime Rate and because the Company obtained commitments for similar loans from lending institutions other than Congress during 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe 12% Note is secured by a mortgage on the Company's manufacturing facility located in Rock Hill, South Carolina. The Company believes that the fair value of the 12% Note is probably between 85% and 115% of its principal amount because, although the interest rate on the loans is probably in excess of market rates for industrial mortgage loans, the market value of the facility may be less than the outstanding balance of the 12% Note so that a portion of the 12% Note may be unsecured. Depending on how unsecured the loan is perceived to be, the rate on the note may actually be lower than market rates and, as a result, the fair value for the loan may be less than the outstanding principal balance.\nThere is a limited market for the 12-3\/4% Notes. The Company believes that, based on informal discussions with securities brokers that have traded the 12-3\/4% Notes and with buyers and sellers of the 12-3\/4% Notes, that the 12-3\/4% Notes traded at discounts of between 15% and 30% during 1995.\nThe Company believes that the 14% Nonconvertible Notes would hypothetically trade at a discount equal to or in excess of the discount assumed for the 12-3\/4% Notes and that the 14% Convertible Notes would hypothetically trade at around par or in excess of par because, at December 31, 1995, they were convertible at a price per common share of $2.2727, which was 9% below the last reported trade of the Company's common stock in 1995.\nFair value estimates of the Company's securities are subjective in nature and involve uncertainties and matters of judgement and therefore cannot be determined definitively. Any change in the market for similar securities, the financial performance of the Company or interest rates could materially affect the fair value of all of the Company's securities.\nSCHEDULED MATURITIES OF LONG-TERM DEBT\nMaturities of long-term debt for the five-year period ending December 31, 2000 and for the years thereafter are listed below (dollar amounts in thousands):\nNOTE 7 -- PREFERRED STOCK\nREDEEMABLE PREFERRED STOCK\nEach share of $8 Cumulative Convertible Redeemable Preferred Stock, Series B, is (1) entitled to one vote, (2) redeemable for $200 plus accumulated and unpaid dividends, (3) convertible into 14.8148 shares of common stock (subject to adjustment) and (4) entitled, upon voluntary or involuntary liquidation and after payment of the debts and other liabilities of the Company, to a liquidation preference of $200 plus accumulated and unpaid dividends. On November 30, 1995, 450 shares of Redeemable Preferred Stock were redeemed for $90,000. Further redemptions of $90,000 are scheduled on November 30 of each year in order to retire annually\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n450 shares of Redeemable Preferred Stock. Scheduled redemptions for the years 1996 through 2000 total $450,000. For accounting purposes, when such stock is redeemed, the redeemable preferred stock account is reduced by the $100 par value of each share redeemed and paid-in-capital is charged for the $100 excess of redemption value over par value of each share redeemed. Under the terms of the Redeemable Preferred Stock, the Company may not declare any cash dividends on its common stock if there exists a dividend arrearage on the Redeemable Preferred Stock. During 1995, the Company paid the holders of the Redeemable Preferred Stock regular dividends aggregating $8.00 per share.\nOTHER AUTHORIZED PREFERRED STOCK\nThe Company's Restated Certificate of Incorporation provides that the Company is authorized to issue 2,500 shares of 6% Cumulative Convertible Preferred Stock, Series A, $100 par value (\"Series A Preferred Stock\"). At December 31, 1995 and 1994, no shares of the Series A Preferred Stock were issued or outstanding.\nThe Company's Restated Certificate of Incorporation also provides that the Company is authorized to issue 2,500,000 shares of preferred stock having a par value of $1 per share. At December 31, 1995 and 1994, no shares of the preferred stock, $1 par value, were issued or outstanding.\nNOTE 8 -- COMMON STOCK\nCOMMON STOCK, $.25 PAR VALUE\nAt December 31, 1995 and 1994, there were 4,228,036 and 4,203,036 shares, respectively, of the Company's common stock outstanding and 385,000 and 410,000 shares, respectively, reserved for issuance under the Company's Restricted Stock Award Plan and Incentive Stock Option Plan.\nRESTRICTED STOCK AWARD PLAN\nThe Company has a Restricted Stock Award Plan pursuant to which the Company may award restricted shares of common stock to officers and key employees. Plan participants are entitled to receive cash dividends (if any) and to vote their respective shares. The restricted shares vest at a rate set by the Compensation Committee of the Company's Board of Directors, which has generally set the rate at 25% per year on each of the four anniversary dates subsequent to the award date. Unless otherwise amended, the Restricted Stock Award Plan expires on December 31, 2001.\nDuring 1995, 1994 and 1993, no shares of restricted common stock were awarded. At December 31, 1995 and 1994, 350,000 shares of common stock were available for grant under the terms of the Restricted Stock Award Plan.\nINCENTIVE STOCK OPTION PLAN\nThe Company has an Incentive Stock Option Plan that provides for grants to officers and key employees of options to purchase shares of the Company's common stock. The exercise price of an option is established by the Compensation Committee of the Company's Board of Directors at the date of grant at a price not less than the then market price of the Company's common stock. During 1995, 1994 and 1993, no options were granted. At December 31, 1995, options for 35,000 shares were outstanding and no options were available for future grant.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nActivity in the Company's Incentive Stock Option Plan for 1995 and 1994 is summarized below:\nAt December 31, 1995 and 1994, outstanding options for 35,000 and 51,250 shares, respectively, were exercisable.\nNOTE 9 -- EMPLOYEE BENEFIT PLANS\nRETIREMENT AND SAVINGS PLAN\nThe Company maintains a Retirement and Savings Plan (the \"Plan\") pursuant to Section 401 of the Internal Revenue Code (i.e., a 401(k) plan). All employees of the Company are entitled to participate in the Plan after meeting the eligibility requirements. Generally, employees may contribute up to 15% of their annual compensation but not more than prescribed amounts as established by the United States Secretary of the Treasury. Employee contributions, up to a maximum of 6% of an employee's compensation, are matched 50% by the Company. During 1995, 1994 and 1993, provisions for Company matching contributions totaled approximately $372,000, $339,000 and $296,000, respectively. In addition, the Company has the option to make a profit sharing contribution to the Plan. The size of the profit sharing contribution is set annually at the end of each Plan year by the Company's Board of Directors. Provisions recorded for profit sharing contributions authorized by the Company's Board of Directors totaled $401,000, $370,000 and $334,000 during 1995, 1994 and 1993, respectively. Company contributions to the Plan vest for a participant at a rate of 20% per year commencing in the participant's third year of service until the participant becomes fully vested after seven years of service.\nINCENTIVE COMPENSATION PLAN\nThe Company has incentive compensation plans which provide for the payment of cash bonus awards to certain officers and key employees of the Company. The Compensation Committee of the Company's Board of Directors, which consists of two directors who are not employees of the Company, oversees the administration of the plans. Cash bonus awards, which are subject to the approval of the Compensation Committee, are based upon prescribed formulae relating to the attainment of predetermined divisional and consolidated operating profit\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ntargets and the achievement of other objectives. Accruals for bonuses totaled $560,000, $214,000 and $386,000 during 1995, 1994 and 1993, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company maintains programs to fund certain costs related to a prescription drug card program for retirees of one of its former divisions and to fund insurance premiums for certain retirees of one of its divisions. At December 31, 1995, the Company's accumulated postretirement benefit obligation totaled $564,000. The Company is amortizing its accumulated postretirement benefit obligation over the remaining life expectancy of the participants (i.e., an annual rate of $57,000).\nThe following table presents the funded status of the postretirement benefits at December 31, 1995, 1994 and 1993 (dollar amounts in thousands):\nThe weighted average annual assumed rate of increase in the per capita cost of covered benefits for the prescription drug card program is 10.2% for 1996 and is assumed to decrease gradually to 6.45% in 2005. Changing the assumed rate of increase in the prescription drug cost by one percentage point in each year would not have a significant effect on the accumulated postretirement benefit obligation. The Company's program to fund certain insurance premiums for retirees of one of its divisions has a defined dollar benefit and is therefore unaffected by increases in health care costs. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% and 8.25% at December 31, 1995 and 1994, respectively. The change in the discount rate at December 31, 1995 reflects lower prevailing interest rates.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10 -- INCOME TAXES\nThe following table reflects the deferred tax assets and the deferred tax liabilities of the Company at December 31, 1995 and 1994 (dollar amounts in thousands):\nAt December 31, 1995, the Company's valuation allowance was adjusted to recognize the change in the Company's deferred tax assets and deferred tax liabilities and the federal operating loss carryforwards which the Company expects to utilize in 1996. The Company's valuation allowance decreased by $703,000 in 1995. At December 31, 1994, the Company's valuation allowance equaled 100% of its net deferred tax assets.\nAt December 31, 1995, the Company had net operating loss carryforwards for federal income tax purposes of $7,381,000 that expire in the years 2004 through 2007. Capital loss carryforwards for federal income tax purposes totaled $6,402,000 at December 31, 1995 and expire in 1996. For purposes of the federal alternative minimum tax, the Company essentially utilized all of its alternative minimum tax operating loss carryforwards during 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe income tax provision consisted of the following for 1995, 1994 and 1993 (dollar amounts in thousands):\nReconciliations of the federal statutory income tax rate to the Company's effective income tax rate for 1995, 1994 and 1993 are summarized below:\nNOTE 11 -- INDUSTRY SEGMENTS\nThrough its two business segments, the Rubber Group and the Metals Group, the Company manufactures, to customer specifications, rubber and metal components. The Rubber Group manufactures silicone and organic rubber components used primarily by manufacturers of automobiles, automotive replacement parts and medical devices. The Metals Group manufactures metal components used primarily by manufacturers of automobiles, industrial equipment, computers, office equipment and home appliances.\nDuring 1995, 1994 and 1993, net sales to automotive industry customers totaled $68,083,000, $53,005,000 and $45,223,000, respectively, which represented 65.3%, 59.9% and 60.3%, respectively, of the Company's total net sales. The Company's three largest customers accounted for 37.4%, 39.7% and 39.2% of net sales during the same respective periods. One customer of the Company's Rubber Group accounted for 22.5%, 20.6% and 22.3% of the Company's total net sales during the same respective periods. In addition, one customer of the Metals Group accounted for 8.1%, 13.0% and 11.8% of the Company's total net sales during such respective periods. Loss of a significant amount of business from the Company's three largest customers, as a group, would have a material adverse effect on the Company's business.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nInformation relating to the Company's industry segments for 1995, 1994 and 1993 is summarized below (dollar amounts in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12 -- INCOME PER SHARE\nThe calculation of primary net income per share and fully diluted net income per share for 1995, 1994 and 1993 are set forth below (dollar amounts in thousands, except per share amounts):\nThe calculation of fully diluted net income per common share for 1993 is antidilutive, therefore, fully diluted net income per common share for 1993 is equal to the primary net income per share.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13 -- COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company is lessee under various leases relating to buildings and equipment. Total rent expense under operating leases aggregated $269,000, $177,000 and $89,000 for 1995, 1994 and 1993, respectively. At December 31, 1995, future minimum lease commitments under non-cancelable operating leases were not significant for any year or in the aggregate.\nLEGAL ACTIONS\nThe Company is subject to various claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities, including actions naming the Company as a potentially responsible party or a third-party defendant, along with other companies, for certain waste disposal sites. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be decided unfavorably to the Company. Management believes that any liability that may ultimately result from the resolution of these matters will not have a material adverse effect on the financial position of the Company.\nNOTE 14 -- RELATED PARTIES\nThe Chairman of the Board and the President of the Company are the two largest holders of the Company's common stock, are the holders of the 14% Notes and beneficially own $200,000 principal amount of the 12-3\/4% Notes. In addition, the Chairman of the Board and certain of his affiliates hold an aggregate of $1,300,000 principal amount of the 12-3\/4% Notes.\nThe Chairman of the Board and the President of the Company are partners of an investment banking firm which was retained by the Company to provide management and investment banking services through December 31, 1995, for an annual fee of $400,000. Additionally, the firm may receive incentive compensation tied to the Company's operating performance and other compensation for specific transactions completed by the Company with the assistance of the firm. The Company also has agreed to reimburse the firm for certain expenses. During 1995, the Company paid the firm aggregate fees of $600,000 and reimbursed it for direct and indirect expenses of $97,000. During 1994, the Company paid the firm aggregate fees of $678,000 and reimbursed it for direct and indirect expenses of $135,000. During 1993, the Company paid the firm aggregate fees of $300,000 and reimbursed it for indirect expenses of $50,000.\nThe Secretary of the Company, who is also a member of the Company's Board of Directors, is a stockholder of a professional corporation which is a partner in a law firm which serves as general counsel to the Company. During 1995, 1994 and 1993, the Company made payments to the law firm for legal services in the amounts of $371,000, $364,000 and $383,000, respectively.\nA member of the Board of Directors of the Company is a member of the board of directors of an insurance brokerage firm which specializes in brokering commercial, life and accident insurance coverage and providing third party administration of health claims. After competitive bidding, the Company has from time to time secured large portions of its insurance coverage through this firm and purchased third party administrative services from this firm. During 1995, 1994 and 1993, the Company made cash payments to the brokerage firm for insurance premiums, including commissions thereon, of $798,000, $1,319,000 and $1,518,000, respectively,\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nand for administrative fees for services performed in connection with the administration of the Company's hospital and medical plans of $88,000, $70,000 and $76,000, respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation required by Item 10 is incorporated by reference to the Company's proxy statement to be issued in connection with its 1996 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required by Item 11 is incorporated by reference to the Company's proxy statement to be issued in connection with its 1996 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by Item 12 is incorporated by reference to the Company's proxy statement to be issued in connection with its 1996 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by Item 13 is incorporated by reference to the Company's proxy statement to be issued in connection with its 1996 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 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\nThe consolidated financial statements of Lexington Precision Corporation (\"LPC\") and its wholly owned subsidiary, Lexington Components, Inc. (\"LCI\"), are included in Part II, Item 8.\n2. FINANCIAL STATEMENT SCHEDULES\nSchedule II, Valuation and Qualifying Accounts and Reserves, is included in this Part IV, Item 14, on page 53. All other schedules are omitted because the required information is not applicable, not material or included in the consolidated financial statements or notes thereto.\n3. EXHIBITS\n[FN] * Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(a)(3).\n** Not deemed filed for purposes of Section 11 of the Securities Act of 1933, Section 18 of the Securities Exchange Act of 1934 and Section 323 of the Trust Indenture Act of 1939, or otherwise subject to the liabilities of such sections and not deemed part of any regulation statement to which such exhibit relates.\nNote: Pursuant to section (b)(4)(iii) of item 601 of Regulation S-K, the Company agrees to furnish to the Securities and Exchange Commission upon request documents defining the rights of other holders of long-term debt.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the quarter ended December 31, 1996.\nLEXINGTON PRECISION CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (THOUSANDS OF DOLLARS)\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLEXINGTON PRECISION CORPORATION (Registrant)\nBy: \/s\/ Warren Delano ---------------------------------- Warren Delano, President\nMarch 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 indicated on March 28, 1996:\nPRINCIPAL EXECUTIVE OFFICERS:\n\/s\/ Michael A. Lubin - ----------------------------------------- Michael A. Lubin, Chairman of the Board\n\/s\/ Warren Delano - ----------------------------------------- Warren Delano, President and Director\nPRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:\n\/s\/ Dennis J. Welhouse - ----------------------------------------- Dennis J. Welhouse, Senior Vice President and Chief Financial Officer\nDIRECTORS:\n\/s\/ William B. Conner - ----------------------------------------- William B. Conner, Director\n\/s\/ Kenneth I. Greenstein - ----------------------------------------- Kenneth I. Greenstein, Secretary and Director\n\/s\/ Arnold W. MacAlonan - ----------------------------------------- Arnold W. MacAlonan, Director\n\/s\/ Phillips E. Patton - ----------------------------------------- Phillips E. Patton, Director EXHIBIT INDEX\n- 2 -\n- 3 -\n- 4 -\n- 5 -\n- 6 -\n- 7 -\n- 8 -\n- 9 -","section_15":""}